Fresh pessimism sweeps over credit sector
By Michael Mackenzie and Aline van Duyn in New York
Published: March 9 2009 19:46 | Last updated: March 9 2009 19:46
http://www.ft.com/cms/s/0/bbaa8a16-0cda-11de-a555-0000779fd2ac.html
Credit market indicators – barometers of stress since the financial crisis began 18 months ago – are once more flashing red.
Heightened concern over the fate of US carmakers and worries about escalating losses at banks and financial institutions and at General Electric, the largest debt issuer in capital markets, are creating a grim mood.
“There has been a strong repricing of credit risk as there is a panic almost about the financial sector,” Brian Yelvington, strategist at Creditsights, says.
“So far, most of the pain of the problems at financial institutions is being taken by shareholders and taxpayers, but there are real concerns that the problems will be so large that the pain will shift to holders of bonds and other securities.”
Debt from financial institutions – including some of the biggest banks such as Citigroup and Bank of America – is widely held by investors ranging from pension funds to insurance companies.
Concerns about the value of these holdings have pushed risk premiums higher across the board.
“We are in another round of the credit crunch where the intensity is spreading,” Mary Miller, director of fixed income at T. Rowe Price, says.
“There is a lot of government support still to come, but the details are uncertain.
“This uncertainty is worrying investors, because they do not know if they will or will not be included in the government support.”
In the credit sphere, high yield debt has been hit hardest as companies at risk of bankruptcy are punished.
Delicate balance of bonds, equities and derivatives:
The rise in the cost of default protection for General Electric Capital highlights how tightly credit derivatives are linked to equities and bonds, writes Nicole Bullock in New York.
Credit default swaps on the financing arm of General Electric last week jumped to distressed levels. GECC CDS implies a rating 14 notches below its triple A, says Moody’s Capital Markets Research.
General Electric stock collapsed on fears that the top rating was in jeopardy. That raises the threat of collateral calls on GECC’s financial contracts – a scenario that crushed AIG.
“The basic idea is that as the equity price falls, then the asset value of the firm drops below the value of the liabilities and boom: bankruptcy,” says Tim Backshall, chief strategist at Credit Derivatives Research.
Mr Backshall says it is unclear which market led the moves.
“Over the past six months, equity has actually been the leader of weakness in the capital structure,” he says.
Adding to the pressure, ratings concerns led to hedging of collateralised debt obligations, whose top tranches are full of GECC bonds.
At higher prices, CDS become an uneconomical hedge, forcing dealers to sell equity or buy puts, closing the negative feedback loop.
Fund data for the week ending last Wednesday show that US investors pulled $911m from high yield bond funds, making it their worst week since early in the fourth quarter of 2008, according to EPFR Global.
The high yield credit derivative index for US companies set a series of record wides last week, driven by worries over carmakers and a forecast by Moody’s Investors Service of a 14 per cent default rate by the fourth quarter.
The Markit iTraxx Crossover index of mostly sub-investment grade European credits hit a record wide of 1,170 basis points.
US high yield debt has slipped 3.3 per cent so far this month, reversing early gains for the year, according to Barclays Capital.
High yield in Europe has fallen 5.1 per cent in March, reducing its gain for the year to 3.5 per cent.
Not even investment grade is escaping the selling pressure. The US CDX index – which tracks 125 investment grade credits – is trading at a risk premium of 250 basis points over US Treasuries, its widest level since last December.
This comes at a time when some investors have shunned equities and plumped for high grade credit exposure. The moves in credit come, however, as equity values continue to tumble.
The deteriorating mood follows the Federal Reserve’s unveiling of a credit facility designed to restore securitised borrowing for credit cards, car and student loans.
The inability of the Fed’s term asset-backed securities loan facility to boost confidence in banks and for asset-backed securities is adding to pressure on financials and credit markets.
“The Fed’s delayed but still quite welcome debut of the initial version of the Talf programme to try to restart consumer ABS markets elicited almost no reaction from investors, a seemingly unduly pessimistic attitude about the potential for this programme to help unclog bank balance sheets,” Ted Wieseman, economist at Morgan Stanley, says.
In spite of the Fed’s various liquidity programmnes, the money market’s benchmark rate, the three-month dollar London Interbank Offered Rate, has been rising.
Libor set a low of 1.08 per cent in mid-January and has been creeping up. The move gathered pace last week, when Libor rose 5 basis points to 1.31 per cent.
The upward pressure comes amid uncertainty about the banking system, with government “stress tests” looming in April and banks having to contribute more money to the Federal Deposit Insurance Corporation.
The end of March also marks the conclusion of the first quarter, with banks facing further writedowns from deteriorating credit and mortgage exposure.
Forward measures of Libor show the market expects no alleviation in stresses in 2009.
“This key gauge of bank balance sheet pressures is thus showing that investors see no prospect for improvement this year, a very pessimistic outlook for any medium-term easing in the credit crunch,” Mr Wieseman says.
The renewed pressure in Libor is weighing on interest rate swap spreads, which reflect the credit quality of banks in the inter-dealer derivatives market.
The two-year swap spread is back above 80 basis points, its widest level over the two-year Treasury yield since mid-December.
