Investors are buying more credit- default swaps on Wall Street banks than any other companies as they seek insurance against the prospects for diminished revenue amid tighter regulations, downgrades and Europe’s debt crisis.
Contracts tied to the debt of Goldman Sachs (GS:US) Group Inc., JPMorgan Chase & Co., Morgan Stanley and Bank of America Corp. were the most traded among companies last week, with a combined gross notional amount of $7.45 billion, according to the latest data from the Depository Trust & Clearing Corp., which runs a central registry for the market. Swaps on New York-based Goldman Sachs were the most active, up from 13th the previous week.
Calls for tighter regulation are intensifying as JPMorgan grapples with $2 billion of losses on derivative bets and Morgan Stanley faces an inquiry by the U.S. Securities and Exchange Commission over Facebook Inc.’s initial public offering. Global investment bank revenue will fall 24 percent in the second quarter, JPMorgan (JPM:US) analysts wrote in a May 18 note.
“People are worried about the regulatory scrutiny these banks will face,” said Peter Tchir, founder of New York-based hedge fund TF Market Advisors. “People now fully believe regulators are in charge and will get to push things through, and there’s a real risk they overregulate.”
Swaps insuring an average $470 million of Goldman Sachs’s debt were traded each day last week, double the past month’s average of $230 million. They were the seventh most traded of 1,000 entities tracked by the DTCC, following Italy, France, Brazil, Spain, Turkey and Portugal.
Contracts on JPMorgan were the second-most traded, up from ninth and the eighth highest overall, followed by Russia and Mexico. Morgan Stanley jumped three levels to third among companies and Bank of America advanced to fourth from 19th.
Moody’s Investors Service is in the process of reviewing its credit ratings for banks, and may downgrade 26 lenders, according to a May 22 report from JPMorgan.
“Moody’s remains the largest overhang for the sector,” strategist at the New York-based bank wrote in the report.
Elsewhere in credit markets, United Technologies Corp. (UTX:US) raised $9.8 billion in the largest U.S. corporate bond sale in more than three years to help finance its $16.5 billion acquisition of Goodrich Corp. (GR:US) Vanguard Group Inc., the world’s biggest mutual-fund provider, closed its $16.9 billion High Yield Corporate Fund (VWEHX:US) to most new investors. Cheniere Energy Partners LP is seeking $2.05 billion of loans.
Swap Spreads Fall
The U.S. two-year interest-rate swap spread, a measure of debt market stress, declined 0.4 basis point to 34.4 basis points. The gauge, which has dropped from a four-month high of 39.13 on May 15, narrows when investors favor assets such as corporate bonds and widens when they seek the perceived safety of government securities.
The cost of protecting corporate debt from default in the U.S. declined for a second day, with the Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, falling 1.03 basis point to a mid-price of 117.24 basis points, according to prices compiled by Bloomberg. The index has dropped from a five-month high of 123.4 on May 18.
The Markit iTraxx Europe Index of 125 companies with investment-grade ratings was unchanged at 175 basis points at 10:40 a.m. in London. The Markit iTraxx Asia index of 40 investment-grade borrowers outside Japan declined 2 to 196, Royal Bank of Scotland Group Plc prices show.
United Technologies Bonds
The indexes typically fall as investor confidence improves and rise as it deteriorates. 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.
Bonds of Hartford, Connecticut-based United Technologies were the most actively traded dollar-denominated corporate securities by dealers, with 304 trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
United Technologies bond sale was the largest in dollars since March 2009, when Pfizer Inc. (PFE:US) sold $13.5 billion of bonds in a five-part offering, according to data compiled by Bloomberg.
The maker of Sikorsky helicopters and Pratt & Whitney engines, with investment-grade ratings (UTX:US) from Moody’s Investors Service and Standard & Poor’s, is seeking to lure bond buyers as turmoil in Europe sends them to safer assets. While speculative- grade bonds in the U.S. have declined 1.3 percent this month, investment grade is unchanged, according to Bank of America Merrill Lynch index data.
In its previous sale in February 2010, the Hartford, Connecticut-based company sold $2.25 billion of debt split between 10- and 30-year maturities, Bloomberg-compiled data show.
Vanguard restricted access to its fund after clients poured $2 billion into it over the past six months. The fund, managed by Boston-based Wellington Management Co. since 1978, remains open to existing shareholders and some Vanguard clients, the Valley Forge, Pennsylvania-based company said yesterday in a statement. The fund has gained 4.2 percent this year, trailing 61 percent of rivals, Bloomberg data show.
“We are taking these proactive steps to preserve the ability of the advisor to manage the fund effectively and protect the interests of existing shareholders,” William McNabb, Vanguard’s chief executive officer, said in the statement.
Investors have poured money into funds that invest in higher-yielding securities as the Federal Reserve has kept rates near zero since December 2008. U.S. high-yield mutual funds attracted $16.6 billion in deposits this year through April, second-highest among all categories tracked by Morningstar Inc.
Loan Prices Fall
The S&P/LSTA U.S. Leveraged Loan 100 index fell for a second day by 0.05 cent to 92.79 cents on the dollar. The measure, which tracks the 100 largest dollar-denominated first- lien leveraged loans, has declined from 94.56 cents on May 14, the highest since July 28.
Leveraged loans and high-yield bonds are rated below Baa3 by Moody’s and lower than BBB- by S&P.
Cheniere Energy’s debt is intended to help fund the expansion of a liquefied natural gas facility in Louisiana. The energy company is seeking a 6.5 year $750 million term loan with proceeds being used to finance the acquisition of the Creole Trail Pipeline, said a person familiar with the transaction, who declined to be identified because the terms are private.
Credit Suisse Group AG is arranging the financing and will host a lender meeting May 29 at 2 p.m. in New York, said the person.
In emerging markets, relative yields fell 4 basis points to 404 basis points or 4.04 percentage points, according to JPMorgan Chase & Co.’s EMBI Global index. The measure has averaged 372.5 this year.
Banks are under pressure as Europe’s debt crisis causes lenders to retrench and fire thousands. In the U.S., the so- called Volcker rule, the provision in the 2010 Dodd-Frank Act named for former Federal Reserve Chairman Paul Volcker, will set limits on risk-taking by depositories with government backing.
JPMorgan’s losses (JPM:US), which Chief Executive Officer Jamie Dimon called “egregious,” self-inflicted mistakes that he said could increase by $1 billion, came at a key point in the almost two-year-old debate over Wall Street regulation. The 2010 Dodd- Frank Act, which includes a ban on proprietary trading by banks, is being decided by the Commodity Futures Trading Commission and the Securities and Exchange Commission.
Bank Revenue Falls
“Lessons will have to be learned and heads may have to roll,” said Georg Grodzki, who helps manage $515 billion as head of credit research at Legal & General Investment Management in London. “I hope it stops there and regulators resist the habitual urge to throw more regulation at banks.”
While global investment bank revenue will fall 24 percent this quarter, fixed income, currencies and commodities will be the worst hit, dropping 32 percent from the previous quarter, JPMorgan analysts led by Kian Abouhossein wrote in a May 18 note.
JPMorgan ‘s announcement May 10 that the biggest U.S. bank by assets had lost $2 billion on corporate credit indexes fueled a surge in the cost of insuring debt across Wall Street. Default swaps on the bank jumped as high as 154 basis points this week from 90 in March.
Swaps on Goldman Sachs soared to a 5 1/2-month high of 348 basis points May 21 from 200 in March. Morgan Stanley climbed to 453 this week from 278 in March and Bank of America rose to 306 from 200 in March. Swaps on Citigroup Inc. rose as high as 271 this week, from 183 in March while Wells Fargo & Co. got as high as 126 from 80 in March.
Their bonds have also suffered. The extra yield investors demand to hold the debt of banks worldwide instead of benchmark government securities increased 47 basis points to 294 basis points as of March 23 from the low this year of 247 on March 21, according to Bank of America Merrill Lynch’s Global Corporates, Banking index. Investors in the bonds have lost 0.45 percent this month, heading for the first monthly decline since November.
The combination of deteriorating market conditions and “increased regulatory requirements and restrictions has diminished longer-term profitability and growth prospects,” according to Tony Smith, a senior banking analyst at Moody’s Analytics in New York.
Default swaps on Goldman Sachs and Morgan Stanley imply credit ratings that are six levels lower than their actual grades, according to Moody’s Analytics, while JPMorgan’s signal the bank should be rated five levels lower.
Further deterioration in the perceived credit quality of banks may spark the Federal Reserve to provide more assistance to the financial system, according to TF’s Tchir.
Wall Street Reputation
With bank swaps rising “I’ve got to believe the Fed is watching that as much as any other economic data,” Tchir said. “Their biggest fear is getting back to where people don’t trust the banks and stop trading with each other.”
The reputation of Wall Street banks took a hit as the IPO of Facebook (FB:US) turned into a quagmire of blame as the company’s shares tumbled. Buyers of the stock sued the company, Nasdaq OMX Group Inc. and the underwriters, claiming they were misled. The SEC and the brokerage industry’s watchdog both said they may review the offering, and the scrutiny prompted Morgan Stanley, the lead underwriter, to defend its handling of the IPO in a statement.
Bank risk is also rising as Europe’s sovereign debt crisis deepens, with investors concerned that a Greek exit from the euro area may trigger a banking crisis. Loan and currency losses in the event of a euro breakup may reach $1.1 trillion across German, French, U.K., U.S., Swedish, Swiss, Dutch, Austrian and Belgian banking systems, analysts at Paris-based Societe Generale SA estimated in a note last week.
“The market is more correlated now than it was two to three weeks ago,” said Graham Neilson, who helps manage about $20 billion as chief investment strategist at Cairn Capital Ltd. in London. “The losses have clearly impacted JPMorgan’s bottom line and there’s stuff going on in Greece and Europe that impacts everyone.”
To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net
To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net