Trades by JPMorgan Chase & Co. (JPM:US)’s London-based chief investment office have raised the cost of hedging debt of companies from AT&T Inc. (T:US) to CenturyLink Inc. (CTL:US) and Dell Inc. (DELL:US)
After JPMorgan Chief Executive Officer Jamie Dimon said during a May 10 conference call with analysts and investors that the bank had a $2 billion trading loss in credit derivatives, the 10-year Markit CDX North America Investment Grade Index Series 9, created in 2007 and speculated to be one of the biggest positions contributing to the loss, has surged 21 basis points relative to the current most-active index, the five-year Series 18.
The technical effect of the so-called IG9 index’s surge has pushed credit-default swaps on the index’s constituents wider, including AT&T, CenturyLink and Dell’s five-year contracts, according to Hale Holden, a Barclays Plc strategist.
While “further normalization in IG9 positioning could take these credits even wider in the near term, they stand to benefit when technicals abate and fundamental relative value reasserts itself,” Barclays strategists Shobhit Gupta and Eric Gross wrote in a note dated today.
Bloomberg News reported in April that JPMorgan trader Bruno Iksil had amassed positions linked to the financial health of corporations that were so large he was driving price moves in the $10 trillion swap-index market, earning him the nickname the London Whale among some counterparties, according to market participants who asked not to be identified because they aren’t authorized to discuss the trades.
The jump in the index, fueled by the size of the JPMorgan trades relative to the market’s liquidity, has been exacerbated by traders anticipating an unwinding of the positions.
The distortion in the indexes and the individual-company swaps is caused by JPMorgan or “people trading against Bruno,” Bonnie Baha, head of global developed credit at DoubleLine Capital LP in Los Angeles, which oversees $35 billion, said in a telephone interview.
Dimon declined on the conference call to discuss specific transactions or people involved. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. JPMorgan used the instruments to hedge exposure on loans and other credit risks tied to corporations, banks and sovereign governments. The losses emerged after the firm tried to reduce that position, Dimon said.
Swaps tied to AT&T have climbed 8.4 basis points since May 10 to 98.1 basis points as of 1:38 p.m. in New York, Bloomberg prices show. Contracts on CenturyLink’s debt rose 62.4 basis points to 297.8 and those on Dell have added 60.9 basis points to 211.6, the data show. A basis point equals $1,000 annually on a contract protecting $10 million of debt. The current index has climbed 20.1 basis points to 123.
While the relationship between 10-year contracts of the IG9 and the current five-year index now looks “in line with historical levels,” the spread may continue to widen because dealers have sold a net $46 billion of protection on the IG9 index, while they’ve bought a net $7 billion on the current series, Gupta and Gross wrote. Investors should buy the 10-year IG9 contract and sell the on-the-run Series 18 five-year, they wrote.
Since the Depository Trust & Clearing Corp., which runs a central repository for the market, began publishing data in 2008, dealers typically haven’t been net buyers or sellers of more than $20 billion, and the median aggregate client position in investment-grade index swaps was $12 billion until a year ago, the strategists wrote. It’s almost $41 billion now, and reached $61 billion in April, with dealers bullish on the underlying credit by more than five times that historical median, according to the strategists. The changes were driven largely by trades in 2007’s Series 9 index at $46 billion, the Barclays strategists wrote.
As the five-year contract of the series nears maturity in December 2012, volumes typically would decline, and as it ticks down, the change in the remaining duration will “meaningfully” alter the balance with other parts of IG9-related trades, they wrote.
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