Credit Buckles in `Whiff of 2008′ as ECB Lets Athens Burn: Credit Markets

Friday, May 7, 2010
By Paul Martin

By Shannon D. Harrington

May 7 (Bloomberg) — The 13-month rally in credit markets is unraveling as Europe fails to contain its debt crisis.

Money markets showed banks may be the most reluctant to lend to each other in six months and a derivatives index used to protect against European bank failures soared to a record. U.S. company bond sales are poised for the slowest week this year, while in Europe they all but disappeared, according to data compiled by Bloomberg. Emerging-market and mortgage bonds also tumbled.

Investors are increasingly concerned that a 110-billion euro ($140 billion) rescue package for Greece won’t work, escalating into a sovereign crisis reminiscent of the subprime mortgage meltdown that pushed Lehman Brothers Holdings Inc. into bankruptcy. Stocks in Europe and Asia plunged after a decline in U.S. equities in New York yesterday, which at one point was the biggest since 1987.

“I don’t think we’re in panic mode but there’s a little bit of a whiff of 2008 here,” said Scott MacDonald, head of credit and economics research at Aladdin Capital Holdings LLC in Stamford, Connecticut, which oversees $12.5 billion.

“We had the subprime debacle in the U.S.,” he said. “Does Europe relive that in terms of the massive leveraging they’ve done to keep the social model running? Because then it’s a worry of not 110 billion euros for Greece, but it’s potentially a project that could go up over 1 trillion euros or more.”

Trichet Pressure

European Central Bank President Jean-Claude Trichet is under mounting pressure from investors to take new steps to contain government fiscal strains that led to credit-rating downgrades in Greece, Portugal and Spain and triggered riots in Athens.

As euro-region leaders prepare to meet in Brussels today to discuss the Greek bailout, bond yields are surging across the southern European nations, threatening to undermine the euro. Benchmark German bunds are ralling as investors seek a haven from the global turmoil.

The yield premium on Greek 10-year bonds versus German bunds rose to 964 basis points, from 852 yesterday and 595 a week ago, according to Bloomberg generic data. The region’s common currency snapped four days of losses to strengthen 1.2 percent against the dollar, though it’s still worth 18 percent less than on Dec. 1.

“Right now it doesn’t seem like anyone is concerned about anything other than the sovereigns,” said Jeffrey Burch, head of European credit at Investec Asset Management in London. “There is so much risk aversion in the market.”

Subprime Response

After the subprime market collapsed, the U.S. government agreed to spend, lend or commit as much as $12.8 trillion to stabilize the financial system. The Bank of Japan said today that it will pump 2 trillion yen ($21.7 billion) into the financial system after the Greek debt crisis caused instability.

The credit-market rally began as the extra yield investors demand to own corporate bonds instead of government securities started falling from the record 511 basis points reached on March 30, 2009, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. It fell to as low as 142 basis points on April 21.

The spread widened 10 basis points to 168 yesterday, the biggest increase since it rose by the same amount on Nov. 20, 2008. The index has returned 23 percent since the peak in spreads last year.

Libor-OIS Spread

The spread between the three-month dollar London interbank offered rate and the overnight indexed swap rate, a barometer of the reluctance of banks to lend that’s known as the Libor-OIS spread, is at 18.4 basis points, more than three times the 6 basis-point spread on March 15 and the highest level since August 2009. It’s still far from the record 364 basis points in October 2008, almost a month after Lehman’s bankruptcy. A basis point is 0.01 percentage point.

Three-month dollar Libor also rose to the highest since August, climbing to 0.428 percent from 0.374 percent yesterday, according to the British Bankers Association.

“After morphing into a regional dislocation, the Greek crisis is now going global,” Mohamed El-Erian, chief executive officer of Newport Beach, California-based Pacific Investment Management Co., said yesterday in an e-mail. El-Erian shares the title of co-chief investment officer of Pimco with Bill Gross, who runs the world’s biggest bond fund.

The Markit iTraxx Financial Index of credit-default swaps linked to the senior debt of 25 European banks and insurers soared as much as 40 basis points to an all-time high of 223, according to JPMorgan Chase & Co. prices.

The cost of default protection on corporate debt in Europe rose to the highest since April 2009. The Markit iTraxx Europe index of swaps linked to investment-grade companies, which investors use to hedge against losses or to speculate on creditworthiness, climbed as much as 29.5 basis points to 152.5 before paring its advance to 137, JPMorgan prices show.

Junk Bond Risk

The Markit iTraxx Crossover Index linked to 50 mostly high- yield companies increased as much as 74 basis points to 625, JPMorgan prices show, the highest since September. Non- investment grade, or junk, bonds are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s. The Markit CDX North America Investment Grade Index jumped 24 basis points to 128.8 yesterday, according to Markit Group Ltd.

Credit-default swaps on Greece, Portugal, Spain and Italy rose to or near all-time highs. Swaps on Greece surged 75 basis points to a record 1,008 basis points, according to CMA. Portugal climbed 42 to 502, Spain increased 14 to 288 and Italy rose 24 to 255.5, CMA prices show.

Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bond Sales Fall

U.S. corporate bond sales fell 86 percent this week to the lowest this year, Bloomberg data show. Beazer Homes USA Inc., the Atlanta-based homebuilder, and Lennox International Inc., the Richardson, Texas-based maker of heating and air- conditioning systems, led $2.55 billion of debt issuance, compared with a 2010 weekly average of $23.9 billion.

In Europe, corporate bond sales have mostly evaporated as investors retreated from riskier assets, with issuance this week of 1.3 billion euros. Those borrowers that were able to sell debt paid more. French retailer Casino Guichard-Perrachon SA sold 508 million euros of 4.48 percent notes due in 2018 by offering investors a spread of 160 basis points over the benchmark swap rate, 20 basis points more than the supermarket owner marketed to investors before delaying the sale a week ago.

Renhe Pulls

Renhe Commercial Holdings Co., a developer of underground shopping malls in China, delayed pricing of a sale of five-year dollar bonds today amid the market rout, according to a person familiar with the matter.

Spreads on emerging-market bonds rose 32 basis points, the biggest increase since October 2008, to 323 basis points, according to JPMorgan’s EMBI+ Index. Argentina’s bonds fell for a third day. The extra yield investors demand to own Argentine bonds instead of Treasuries swelled 25 basis points to 749 as of 12 p.m. yesterday in New York.

Relative yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates jumped as investors sought the safety of U.S. government notes. Spreads on Fannie Mae’s current-coupon 30-year fixed-rate mortgage bonds widened about 6 basis points to 85 basis points more than 10-year Treasuries, the highest since Nov. 3, Bloomberg data show.

The gap touched a record low of 59 basis points on March 29 as the Federal Reserve that month completed its purchases of $1.25 trillion of agency mortgage bonds.

Commercial Mortgage Bonds

The spread on a top-rated commercial mortgage-backed security commonly cited as a market barometer widened as much as 85 basis points to 4.2 percentage points more than the benchmark swap rate, according to RBS Securities Inc. It then narrowed to about 3.8 percentage points over the benchmark, RBS data show.

“It’s a spillover effect,” said Brian Lancaster, a strategist at RBS in Stamford, Connecticut. “All the spread markets are feeling the pressure of Greece.”

European stocks sank for a fourth day, with the Stoxx Europe 600 Index tumbling as much as 3.1 percent to the lowest intraday level in almost three months. The gauge has retreated 12 percent from this year’s high on April 15.

U.S. stocks tumbled the most in a year yesterday, briefly erasing more than $1 trillion in market value as the Dow Jones Industrial Average fell almost 1,000 points before paring the drop.

Almost 77 percent of companies in the S&P 500 Index have topped the average analyst profit forecast for the first quarter.

Consumer spending in the U.S. rose in March by the most in five months, with purchases increasing 0.6 percent, Commerce Department figures showed this week. Incomes climbed for the first time this year.

‘Chips Off Table’

“We have taken some chips off the table,” said Frank Koster, chief investment officer at Dwight Asset Management Co. in Burlington, Vermont, where he helps oversee $70 billion of fixed-income assets. “There’s just too much bad news.”

“How long it lasts will depend on equities’ resilience or lack thereof in the next couple of weeks,” he said. “The wealthier consumers have been leading the growth in consumer spending, and those are the same people who will pull in their horns if they see their equities portfolio cut by 25 percent, just as they were starting to regain confidence and come back to retail.”

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