‘Lack of Trust’ Pummels Bank Lending in Europe: Credit Markets

Monday, May 17, 2010
By Paul Martin

By Pierre Paulden and Shannon D. Harrington

May 17 (Bloomberg) — Money markets are showing rising levels of mistrust between Europe’s banks on concern an almost $1 trillion bailout package won’t prevent a sovereign debt default that might trigger a breakup of the euro.

Royal Bank of Scotland Group Plc and Barclays Plc led financial firms punished by rising borrowing costs, British Bankers’ Association data show. The cost to hedge against losses on European bank bonds is 62 percent higher than a month ago. Investment-grade corporate debt sales in the region plummeted 88 percent last week to $1.2 billion from the previous period, according to data compiled by Bloomberg.

The rate banks say they charge each other for three-month loans in dollars rose to a nine-month high, even after a government-led rescue designed to prevent Greece from defaulting, and a new financial crisis. The euro fell to its weakest against the dollar since 2006.

Bank lending “conveys a lack of trust in the system,” said Robert Baur, chief global economist at Des Moines, Iowa- based Principal Global Investors, which manages $222 billion. “Banks are a little reluctant to lend overnight as they don’t know the full extent of what is on the bank balance sheets.”

The three-month London interbank offered rate in dollars, or Libor, climbed to 0.46 percent today, the highest since Aug. 7, from 0.445 percent on May 14 and 0.252 at the end of February, according to the British Bankers’ Association.

The spread between the three-month Libor rate and the overnight indexed swap rate, a barometer of the reluctance of banks to lend that’s known as the Libor-OIS spread, increased to 24 basis points, the most since Aug. 17, from 22 basis points.

Spreads Widen

Elsewhere in credit markets, the extra yield investors demand to own corporate bonds instead of government securities climbed 3 basis points on May 14 to 171 basis points, or 1.71 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. The index fell from 177 basis points a week earlier, the first decline since the period ended April 16.

Investors seeking to protect themselves from losses on corporate bonds or speculate on creditworthiness drove credit- default swaps higher today. The Markit iTraxx Europe Index of contracts linked to the debt of 125 companies climbed 5.4 basis point to 115.2 basis points as of 11:25 a.m. in New York, after earlier advancing to the highest level in more than a week, according to Markit Group Ltd. The contracts rise as investor confidence deteriorates and fall as it improves.

Markit CDX Index

The Markit CDX North America Investment Grade Index, tied to 125 companies in the U.S. and Canada, rose 2.75 to 110.6. The index was at 118.7 on May 7.

The extra yield investors demand to own emerging-market bonds instead of Treasuries rose 15 basis points on May 14 to 295 basis points, according to JPMorgan Chase & Co.’s Emerging Market Bond index. Spreads rose as high as 328 a week earlier.

European policy makers’ plan to prevent a sovereign-debt collapse that threatened to tear apart the common currency was released May 10. The loan package offers as much as 750 billion euros ($923 billion), including International Monetary Fund backing, to countries facing instability, while the European Central Bank said it will buy government and private debt.

The euro dropped to $1.2235, the lowest level in more than four years, before erasing losses to trade little changed at $1.2349.

Deutsche Bank AG Chief Executive Officer Josef Ackermann said Greece may not be able to repay its debt in full, and former Federal Reserve Chairman Paul Volcker said he’s concerned the euro area may break up. Sony Corp., the world’s second- largest maker of consumer electronics, said it may suffer a “significant impact” if Europe’s deficit spreads, while Chinese Premier Wen Jiabao said the foundations for a worldwide recovery aren’t “solid” as the sovereign-debt crisis deepens.

Commercial Paper

Concerns have spilled into the market for commercial paper, debt used by companies and banks for their short-term operating needs. Rates on 90-day paper are more than double the upper band of the federal funds rate, about twice the average in the five years before credit markets seized up in mid-2007.

“The list of banks able to tap the three-month market remains extremely limited with access spotty and expensive,” Joseph Abate, a money-market strategist at Barclays in New York, wrote in a May 14 note to clients.

Rates on commercial paper for 90 days are 25 basis points above the upper band of the Fed’s zero to 25-basis point target rate for overnight loans among banks. While far below the 245- basis point gap reached in October 2008, the spread is more than double the 10-basis-point average in the five years before credit markets seized up in the middle of 2007. As recently as February, financial CP rates were below the federal funds rate.

‘Scarce Liquidity’

Except for banks with little exposure to European sovereign risk, lenders “have found liquidity to be scarce, securing funding only one month and shorter and mostly concentrated inside one week,” Abate from Barclays wrote in the report.

The rate at which Edinburgh-based Royal Bank of Scotland, the U.K.’s biggest state-controlled bank, told the BBA it could borrow for three months in dollars rose 3 basis points today to 49 basis points. The bank’s rate is up from 36 basis points since April 30 and is 3 basis points above three-month Libor.

RBS finance director Bruce Van Saun said last week the bank held 1.5 billion pounds ($2.2 billion) in Greek debt with about 400 million pounds of unrealized losses. Credit exposure to Greece was less than 1 billion pounds, he said. “Overall, our exposure to Greece is moderate, and any potential economic impact, I would say, is manageable,” Van Saun said on a May 7 conference call.

RBS spokesman Michael Strachan declined to comment further.

Barclays, Credit Suisse

The reported rate for London-based Barclays, the U.K.’s third-largest bank by market value, was unchanged today at 47 basis points, having climbed 2 basis points last week to the highest level since July 2009, Bloomberg data show. The bank’s rate is up from 34 basis points on April 30 and 1 basis point above three-month Libor. On average, Barclays reported a rate that was 1.3 basis points below Libor during the past year.

Barclays spokesman Mark Lane declined to comment.

Credit Suisse Group’s rate has jumped 12 basis points this month to 48, compared with an average 1.5 basis points higher during the past year, and is 2 basis point higher than Libor. The firm’s primary sources of funding are long-term debt, shareholders’ equity and deposits, said Marc Dosch, a spokesman for Switzerland’s biggest bank by market value.

Releasing its first-quarter results last month, the Zurich- based bank said its “exposure to Greece is not material” and its “exposure to the other southern European economies that have been subject to credit downgrades is relatively limited.”

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