Bank Stress Declining From Highest Since June: Credit Markets

Thursday, 02 Dec 2010 02:07 PM

 

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Dec. 2 (Bloomberg) -- Derivatives traders pared bets that European leaders will fail to contain the crisis engulfing the region’s single currency as the European Central Bank delayed a withdrawal of emergency liquidity measures.

Contracts used to bet on the future premium banks will charge each other for dollar loans in London over the federal funds rate dropped for a second day after almost doubling in November. The so-called FRA/OIS spread eased to 34.25 basis points today after soaring to 42.75 basis points on Nov. 30, UBS AG data show.

The falling spread signals declining stress in bank funding markets after borrowing costs soared in countries from Spain to Belgium and the cost to protect against losses on their debt reached records. While markets rebounded as the ECB bought more government bonds and central bank President Jean-Claude Trichet pledged to fight “acute” financial market tensions, the calm may be temporary, said Brian Yelvington of Knight Libertas LLC.

“The problem is much bigger and is going to ultimately require a systematic solution to a potentially systemic problem,” said Yelvington, head of the broker-dealer’s fixed- income strategy in Greenwich, Connecticut. “Until that is resolved, we’re going to move from mini crisis to mini crisis of varying degrees.”

The gains in the FRA/OIS spread in recent weeks signaled the market’s expectation that the London interbank offered rate, or Libor, will increase in coming months, Bank of America Merrill Lynch strategists led by Jeffrey Rosenberg in New York wrote in a Nov. 30 note to clients.

Relative Yield

The premium European banks pay in the currency swaps market to borrow in dollars also doubled in November, reaching the highest level since May 30, before narrowing the past two days. The cost to protect against losses on their bonds jumped to a 20-month high before paring the increase.

Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar-maturity government debt fell 1 basis point from a 12-week high to 176 basis points, or 1.76 percentage points, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.821 percent, the highest since July 27.

The cost of protecting company bonds in the U.S. from default fell, with credit-default swaps on the Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, declining 2.8 basis points to 92.9 basis points as of 1:26 p.m. in New York. That’s the lowest since Nov. 22.

European iTraxx

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 6.6 to 106.2.

The indexes typically fall as investor confidence improves and rise as it deteriorates. 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.

American International Group Inc.’s aircraft-leasing unit plans to sell $1 billion of 10-year notes, according to a person familiar with the transaction. International Lease Finance Corp. may issue the debt at a yield of 8.375 percent, said the person, who declined to be identified because terms aren’t set.

The FRA/OIS spread reflects trading in the forward market on the premium of the three-month dollar Libor over what investors expect the overnight federal funds rate to average, the Libor-OIS spread. The gauge has climbed from 23 basis points on Oct. 29 and was at the highest level Nov. 30 since reaching 44.25 on June 28, UBS data show.

Libor-OIS Spread

The spread reached a record 128.25 basis points in November 2008, as the collapse of Lehman Brothers Holdings Inc. two months earlier caused credit markets to seize up.

The Libor-OIS spread, a gauge of banks’ reluctance to lend, declined to 10.59 basis points after reaching 11.13 basis points Nov. 30.

The cost to protect against a default on bank debt also fell for a second day. The Markit iTraxx Financial Index of swaps on junior debt of banks and insurers fell 11.5 basis points to 284 after reaching a 20-month high of 311.5 on Nov. 30, JPMorgan Chase & Co. prices show.

Currency Swaps

Europe’s sovereign crisis also has caused a jump in the premium the region’s banks pay to borrow in dollars in the swaps market. The price of two-year cross-currency basis swaps between euros and dollars reached minus 50.6 basis points on Nov. 30, the largest effective premium for dollar borrowing in swaps since May, Bloomberg data show. The gap narrowed to minus 41.9 basis points today. It was minus 30.3 basis points on Nov. 22.

Two-year cross-currency basis swaps between euros and dollars widened to as much as a record minus 92.5 basis points in October 2008.

The tensions in bank funding markets haven’t reached the levels that roiled the markets in May, when European leaders took measures to stem the sovereign debt crisis and bail out Greece, the Bank of America analysts wrote. Swap lines created by the Federal Reserve in 2008 and reinstated in May have relieved European banks’ dollar funding needs, the analysts wrote.

SEC Rules

The strains in May also were exacerbated by new SEC rules that forced money-market funds to shift more of their holdings into shorter maturity debt, causing a decline in demand for longer debt sold by banks.

“This recent increase in measures of funding pressures pales in comparison to what we saw earlier this year as the first round of sovereign crisis played out,” the Bank of America analysts wrote.

“With financial contagion gathering pace across countries and sectors, we reiterate our view that it is urgent for the ECB to intervene in the market to send a powerful message to global investors that the central bank stands ready to provide an unlimited line of defense for the euro area,” Jacques Cailloux, chief European economist at Royal Bank of Scotland in London, said yesterday in a note to clients.

--With assistance from Liz McCormick, John Detrixhe, Tim Catts and Kristen Haunss in New York, Ed Johnson in Sydney and Abigail Moses and Bryan Keogh in London. Editors: Alan Goldstein, Pierre Paulden

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; John Glover in London at johnglover@bloomberg.net

To contact the editors responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net; Paul Armstrong at Parmstrong10@bloomberg.net

© Copyright 2014 Bloomberg News. All rights reserved.

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