Bloomberg News

Default Swaps in U.S. Rise as Greece Prepares for a New Election

May 16, 2012

A gauge of U.S. corporate credit risk increased as a Greek caretaker government will prepare new elections probably on June 17 that may decide whether the country should remain a euro member.

The Markit CDX North America Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses on corporate debt or to speculate on creditworthiness, rose 1.6 basis points to a mid-price of 119 basis points at 5 p.m. in New York, according to prices compiled by Bloomberg. The gauge has been rising for 10 straight days, the longest streak since July 2007. Contracts linked to Pepsico Inc. (PEP:US) rose by the most since October 2008.

The swaps index gained as uncertainty surrounding Greece’s status on the single currency outweighed better-than-expected U.S. economic numbers. Builders in the U.S. broke ground on more homes than forecast as starts rose 2.6 percent to a 717,000 annual rate from March’s revised 699,000 pace, Commerce Department figures showed today in Washington. Industrial production climbed 1.1 percent, the most since December 2010, the Federal Reserve said.

“You are going to get these little reprieves,” said Jacob Oubina, a senior U.S. economist at RBC Capital Markets LLC in New York. “We have also had comments from European leaders suggesting they don’t want Greece to exit the euro.”

A Bloomberg survey of economists called for a 0.6 percent advance in industrial production and another one estimated 685,000 housing starts.

‘Fragile Recoveries’

The European Central Bank President Mario Draghi said that the governing council’s “strong preference” is that Greece stay in the Euro in a speech in Frankfurt today.

“That is a bit of relief for risk, but not enough to quell the bigger issue,” Oubina said. “We are in a recovery that is one of the most fragile recoveries in history and that leaves you unprepared for any sort of financial crisis.”

The ECB has no immediate plans to increase stimulus measures as it reviews its policy tools, two euro-area officials said, even as concern mounts that Greece won’t honor its bailout agreements.

“European authorities tend to respond to the rising financial market pressure and not ahead of it,” JPMorgan Chase & Co. analysts said in a research note. “There is little evidence that a credible plan is being agreed to ring-fence other European peripherals.”

Pepsi CDS

The swaps index typically increases as investor confidence deteriorates and falls as it improves. The contracts 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.

The cost to protect against losses on the debt of Pepsi rose by the most since Oct. 22 2008 as activist shareholder Ralph Whitworth’s Relational Investors LLC has built a stake worth about $600 million as of March 31, the company said yesterday in a regulatory filing.

Credit-default swaps on Pepsi increased by 6 basis points to a mid-price of 66 basis points at 5:02 p.m., Bloomberg prices show.

“Whenever activist investors garner ownership in a company, they agitate management to force change on the company,” Carla Norfleet Taylor, an analyst at Fitch Ratings, said in a telephone interview. “The CDS spreads are rising as bondholders are wondering if there is any imminent change.”

Whitworth has used his shareholdings in the past to push for changes at ITT Corp. and defense contractor L-3 Communications Holdings Inc., before they announced spinoffs in 2011.

“Over the past several months, there has been a debate on whether Pepsi should separate its beverage business from the food business,” Taylor said. “If that happens, bondholders are thinking about how such a move will affect their debt.”

Pepsi had $22.1 billion of long-term debt obligations as of March 24, according to an April 26 company filing.

To contact the reporter on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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Companies Mentioned

  • PEP
    (PepsiCo Inc)
    • $99.35 USD
    • 0.42
    • 0.42%
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