Bloomberg News

Company Credit Risk Drops as Europe Agrees to Rescue Fund Boost

October 27, 2011

Oct. 27 (Bloomberg) -- Benchmark gauges of credit risk plunged globally after European leaders agreed to a rescue package for debt-laden nations and investors unloaded protection against a deal failing to materialize.

The Markit CDX North America Investment Grade Index, a credit-default swaps index that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, dropped 12.2 basis points to a mid-price of 113.6 at 4:59 p.m. in New York, according to index administrator Markit Group Ltd. That’s the biggest daily decline since May 2010. An index protecting against losses on the bonds of European banks and other financial companies fell to the lowest since Aug. 3.

Europe’s deal to boost its rescue fund’s capacity to 1 trillion euros ($1.4 trillion) and bolster the capital of banks facing losses on sovereign debt is helping to ease global risk aversion that earlier this month had sent the Markit CDX index to the highest since May 2009. For the rally to hold, investors will need more details, including how banks will raise capital, said Scott MacDonald, head of credit and economic research at Aladdin Capital Management LLC.

“There is something happening here and that’s all very positive,” said MacDonald, who’s based in Stamford, Connecticut. “What’s not positive is you still have an awful lot of haziness, not a lot of details.” The writedowns for holders of Greek bonds only reduce the country’s debt to 120 percent of gross domestic product, “which doesn’t really get you into the zip code where you can return to some kind of sustainable growth,” he said.

Banks and Insurers

The Markit iTraxx Financial Index of credit-default swaps linked to the senior debt of 25 banks and insurers including Credit Suisse Group AG and BNP Paribas SA fell 37.5 basis points to 204, according to JPMorgan Chase & Co. prices. The gauge, which falls as perceptions of credit quality improve, rose to a record 314 on Sept. 12.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings dropped 25 to 150, JPMorgan prices show.

Credit swaps indexes, which typically fall as investor confidence improves and rise as it deteriorates, 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.

Persuading Bondholders

Europe’s leaders also persuaded bondholders to accept 50 percent writedowns on Greek debt at a summit in Brussels. Last- ditch talks with bank representatives led to the debt-relief accord, in an effort to quarantine Greece and prevent speculation against Italy and France from ravaging the euro zone and wreaking global economic havoc.

Europe’s banks will need to raise 106 billion euros in fresh capital under tougher rules introduced in response to the crisis, the European Banking Authority said yesterday. The lenders have until Dec. 25 to submit their plans for raising the money to national supervisors.

“Some details are still missing but the market seems to like the wide set of measures that tackle all the main short- term risks,” said Annalisa Piazza, a fixed-income strategist at Newedge Group in London.

Credit-default swaps on Credit Suisse, Switzerland’s second-largest bank, narrowed 22 basis points to 129, and BNP Paribas fell 34 to 203, according to London-based data provider CMA.

U.S. Bank Swaps

Contracts on Morgan Stanley dropped 49 to 303, CMA prices show. The contracts have plunged from 650 on Oct. 4 on speculation the bank faced losses from French banks if the crisis escalates.

Swaps on Bank of America Corp. fell 44 to 301, and contracts tied to Goldman Sachs Group Inc. fell 49 to 253. Credit-default swaps on Citigroup Inc. eased 29 to 199, and those on JPMorgan Chase & Co. fell 17 to 124.

“A lot of the European crisis relates back to bank funding,” David Withrow, the head of taxable fixed income at Fifth Third Asset Management Inc., said in a telephone interview.

“The real solution is not necessarily saving the debt of Greece, it’s funding the debt of banks exposed to Greece,” Withrow said. “As long as there’s a resolution that makes it at least a manageable process to look at the capital of these banks, the banks should perform well because they were exposed to the most uncertainty in the marketplace.”

Europe’s crisis-fighting package also eased the perceived risk of holding sovereign debt, with the Markit iTraxx SovX Western Europe Index dropping to the lowest since Sept. 1. The gauge of credit-default swaps on 15 governments dropped 43 basis points to 291.

Credit-default swaps on France fell 28 basis points to 160, the lowest since Aug. 31, CMA prices at the close of trading in London show. Contracts on Italy fell 48 basis points to 407, Spain dropped 50 to 328 and Portugal fell 112 to 999.

The upfront price to insure $10 million of Greek bonds for five years dropped to $5.4 million from $6 million yesterday, CMA data show.

--With assistance from David Goodman in London. Editor: Pierre Paulden

To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net; Mary Childs in Washington at mchilds5@bloomberg.net;

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


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