CDS report: The flight from risk continues

European credit derivatives markets gave up early gains on Thursday amid signs the US subprime mortgage turmoil could be spreading to other parts of the financial world.

The iTraxx Crossover index, a closely-watched indicator of sentiment in the European credit market, widened about 1bp to 295bp after trading as low as 279bp following a rally on Wall Street overnight. On Wednesday the Crossover traded as high as 310bp, its widest level in over a year.

But emerging markets have proved surprisingly resilient despite the global turbulence. The CDX EM 7 index has performed relatively well compared to its developed world counterparts, despite the increase in risk aversion, data provider Markit said in a note. The CDX EM index is composed of sovereign issuers from Latin America, Eastern Europe, the Middle East, Africa and Asia.

In single name news, Rio Tinto‘s five-year credit default swaps widened to as much as 28 basis points from 16 basis points in Asian trading before heading back to 22 basis points, analysts at RBS said in a note. The mining heavyweight has agreed a $38.1bn friendly takeover of Canadian Alcan, a deal that would create the world’s biggest aluminium company.

Rio Tinto’s CDS do not trade much in either euro or sterling. “There remains some speculation that other bidders are drawn in, though we would expect CDS to settle in the low 20s in the event this deal goes through,” RBS said.

SLM Corp, better known as Sallie Mae, tightened yesterday on news that a proposed LBO of the student loan company could collapse. Sallie Mae agreed in April to be bought out by two private equity firms backed by JP Morgan and Bank of America. Late last night, the buyout houses appeared to pull back, saying legislative proposals going through Congress and Senate “could result in a failure of the conditions to the closing of the merger to be satisfied”.

But analysts at RBS said the move appeared to be a cynical ploy to “force down the offer price of $60 per share and so make the deal more palatable in the face of fast-rising acquisition financing costs”:

in our view deal certainty has reduced from 90% likely to maybe 75%. At the end of the day, the chances are that SLM, who are vigorously contesting the consortium’s assertion, will accept a lower price to close the deal, say $55 per share.

Sallie Mae’s CDS tightened as much as 90bp tighter when the news broke, but by the US close had widened out to 230bp, or 45bp tighter on the day.

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