By Mary Childs – Nov 9, 2011
Credit-default swaps on the biggest U.S. banks climbed as yields for Italy, the world’s third biggest sovereign borrower, rose to euro era records and stoked concern that Europe’s fiscal crisis is accelerating.
Contracts linked to the debt of Morgan Stanley (MS) jumped 21.1 basis points to 413.8 basis points and those tied to Goldman Sachs Group Inc. surged 17.7 basis points to 330.6 as of 8:52 a.m. in New York, according to data provider CMA. A benchmark gauge of U.S. corporate credit risk jumped by the most in a week.
Traders pushed the contracts higher on concern that Europe’s burgeoning debt crisis may infect bank balance sheets worldwide. Yields on Italy’s $2.2 trillion of debt surged as Italian Prime Minister Silvio Berlusconi agreed to step down after the approval of an austerity plan and a clearinghouse said it will demand more money to back trades in the bonds, further squeezing banks.
“There is a risk of contagion that sits there in the financial sector,” Scott MacDonald, head of credit and economic research at Aladdin Capital Management LLC in Stamford, Connecticut, said in a telephone interview. “If we have a big tumble here with Italy, it’s going to cause a very steep recession in Europe and it will have ripples through interbank markets.”
Yields on Italian five-year notes rose above 7 percent for the first time in the euro era. The yield on Italy’s 10-year bond rose to 7.33 percent, and credit-default swaps on Italy’s government bonds jumped to 562, CMA data show.
New York-based Morgan Stanley said last month it had $2.1 billion of net exposure in the peripheral European countries.
Goldman Sachs said today that it had $4.16 billion of gross funded exposure to governments, financial institutions and companies in Greece, Ireland, Italy, Portugal and Spain as of Sept. 30, with Italy accounting for more than half.
Concern over bets on European sovereign debt has already toppled one U.S. firm. New York-based MF Global Inc. filed for bankruptcy protection on Oct. 31 after a $6.3 billion bet on the bonds of some of Europe’s most indebted nations prompted regulator concerns and a credit rating downgrade.
MF Global’s bankruptcy triggered an 18 percent slide in New York-based Jefferies Group Inc. last week, as investors speculated that the firm could be hurt by its risk to European sovereign debt. This month, Jefferies has issued six statements detailing its investments in European sovereign debt and said it cut both its gross holdings in sovereign securities of Portugal, Italy, Ireland, Greece and Spain by almost 50 percent since last week’s close to demonstrate how easily it can reduce funds at risk.
Swaps on Bank of America Corp. increased 16.4 basis points to 363.4 basis points, and those on Citigroup Inc. added 15.5 basis points to 245.5, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.
Liquidity Drying Up
Credit-default swaps tied to JPMorgan Chase & Co.’s debt increased 8.5 basis points to 148.7, and those on Wells Fargo & Co. added 8.3 to 153.8, the data show. The average of contracts of the six biggest U.S. banks has eased to 275.9 basis points from 360 on Oct. 4, CMA data show.
LCH raising margin requirements “really is not a good sign,” according to MacDonald. “This is something that’s done when people feel that the country or the other party at the other end of the line cannot fund itself, so you’re beginning to raise issues of liquidity,” he said. The drying up of liquidity in international markets is “what gets dangerous,” MacDonald said. “That’s a real problem. That impacts Main Street, and that’s what you had in 2008.”
The Markit CDX North America Investment Grade Index, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, increased 4.8 basis points to a mid-price of 126.1 basis points as of 11:19 a.m. in New York, according to index administrator Markit Group Ltd.
The credit swaps index, which typically rises as investor confidence deteriorates and falls as it improves, has increased from 113.4 basis points on Oct. 27, the lowest level in more than two months, on concern that Europe’s debt crisis is spreading.
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.