European credit derivative markets opened in great turmoil once more on Tuesday following the biggest single-day correction ever witnessed for the investment grade indices in both the US and Europe on Monday.
The investment grade indices were again hardest hit because they contain the financial names, the banks and insurers, that are being battered in the wake of the collapse of Lehman Brothers and the desperate efforts to keep a struggling AIG, the world’s biggest insurer, on its feet.
The Main US CDX investment grade index opened early, with Markit Group seeing enough trades to provide intra-day prices from about 6.30am New York time. The spread on the index leapt to 217.5 basis points, up more than 23bp from Monday’s close, easily surpassing the record levels hit during the crisis that lead up to the bail out of Bear Stearns in March.
AIG’s cost of protection leapt by almost 1,000bp on Monday, to 1857.10bp, according to Markit, meaning it costs $1.86m annually to insure $10m of companies debt over five years. This is a theoretical spread, which in fact would be broken up into a very large upfront payment for protection plus a smaller running premium.
In Europe, banks and insurers were both hit hard. HBoS saw the biggest move in the index, mimicking the drop in its share price. Its cost of protection rose 57.8bp to 369.2bp. Deutsche Bank was next among banks, rising 23.75bp to 140bp, followed by RBS, up 19.4bp to 178.3bp, and UBS, up 18.1bp at 192.5bp.
The biggest insurance company move was Aegon, up 25.3bp to 217.5bp, followed by Axa, plus 20.25bp to 148.3bp, and Aviva, plus 19bp also to 148.3bp.
The main iTraxx Europe index of investment-grade corporate debt was a 27.4bp wider before at 152.9bp, after jumping 22.8bp on Monday. The iTraxx Croxssover list of junk-rated names was 31.2bp wider at 631.5bp, inside Monday’s intra-day high of about 640bp.
The extent of the volatility and and trading chaos in the markets was illustrated late Monday evening when Markit Group, which runs the indices, announced that dealers had voted to delay the upcoming 6-monthly index changes by one week.
The index “rolls”, which refresh the lists of companies to be included via a dealer poll of the most liquid qualifying names, are traditionally among the busiest periods for trading in credit default swaps, which provide a kind of insurance against non-payment of corporate debt.
But the huge uncertainty over the mark-to-market value of contracts taken out with Lehman Brothers in the indices and in single company names is causing a huge amount of stress in the CDS markets, according to traders.
One trader on Tuesday morning said that people were finding it hard to keep up having already to cope with the technical defaults of fannie and freddie and trying to sort out their risk related to those names they have now been hit with the unprecedented failure of a major counterparty in the market.
Volumes were said to be heavy as banks scrambled to cover their exposures and realign their books.
“Needless to say that the Lehman bankruptcy is unprecedented in terms of size and complexity and, as we write, there are numerous questions and very few answers (the market has truly found itself in unchartered territory),” wrote analysts at one UK bank.
“There are (understandably) more unknowns than knowns in terms of how the mark-to-market of trades with Lehman as a counterparty will be resolved. The reset of cash and CDS hedges done with Lehman is bound to continue putting pressure on CDS spreads.”