Default Swaps Soar on `Sacrosanct' Senior Europe Bank Debt: Credit Markets
December 17 2010
The cost of protecting against defaults on senior notes of European banks is soaring on speculation bondholders will be forced to take losses as governments try to share the burden of taxpayer-funded bailouts.
The Markit iTraxx Financial Index of credit-default swaps on senior debt rose 6.5 basis points, or 0.065 percentage point, to 157.5. basis points. Contracts on Portugal’s Banco Espirito Santo SA are at a record, and Spain’s Banco Santander SA are at the highest level in five months.
Contracts on Spain’s Banco Santander SA are at the highest level in five months. Photographer: Denis Doyle/Bloomberg
Europe’s debt crisis has spread to Ireland from Greece, and bond investors bet that Portugal and Spain will be next in line for a bailout from the European Union and International Monetary Fund. The EU estimates a rescue for Ireland, downgraded yesterday by Standard & Poor’s, may total 85 billion euros ($113 billion).
“Under a ‘bail-in’ regime, senior bondholders will most likely find themselves as potential burden-sharers, which is in stark contrast with the rules of engagement of the market hitherto,” Roberto Henriques, an analyst at JPMorgan Chase & Co. in London, said in a research report. “Even at the worst point of the current crisis, it was generally a given that senior debt was sacrosanct.”
Subordinated bonds have largely borne the brunt of losses because they stop paying before senior securities in case of a default or debt restructuring. Should banks be unable to pay senior bondholders, they may find it more difficult and expensive to raise money. Anglo Irish Bank Corp. investors were forced to take 20 cents on the euro for subordinated debt this week.
Elsewhere in credit markets, the extra yield investors demand to own company bonds instead of similar maturity government debt rose 3 basis points to 169 basis points, the highest since Oct. 20, according to Bank of America Merrill Lynch’s Global Broad Market Corporate Index. Yields averaged 3.61 percent.
Performance Food Group Co. withdrew a planned $550 million note sale citing “adverse market conditions.” National Amusements Inc., the movie-theater chain and holding company controlled by billionaire Sumner Redstone, planned to issue $390 million of bonds. Loan prices fell yesterday and relative yields on emerging market debt soared.
“There’s a risk-off trade right now because there’s a lot of fear in the marketplace,” said Kingman Penniman, chief executive officer of KDP Investment Advisors in Montpelier, Vermont. “With the combination of everything that’s happening in Europe and Asia and the aggressive amount of new issuance that’s come recently, we’re definitely seeing a correction.”
Performance Food, owned by Blackstone Group LP and Wellspring Capital Management LLC, pulled its offering even after sweetening terms for the debt on Nov. 22 in an effort to attract investors, said a person familiar with the transaction who declined to be identified because the marketing was private.
Bain Capital LLC’s Burlington Coat Factory Warehouse Corp. decided to cancel a $1.5 billion debt financing on Nov. 18. In Asia, Hongkong Electric Holdings Ltd., delayed its sale of as much as $500 million of 10-year dollar bonds due to tensions on the Korean peninsula, two people familiar with the matter said today.
Yuzhou Properties Co., a developer in southern China, and Vietnam National Coal-Mineral Industries Group postponed dollar- denominated bond offerings as investor appetite for risk diminished, people with knowledge of the sales said yesterday.
In Europe, Vienna Insurance Group, the east of the region’s biggest insurer, postponed its 500 million-euro ($666 million) sale of 30-year subordinated bonds, according to a banker involved in the transaction.
Caterpillar Inc., the world’s biggest maker of construction equipment, hired Goldman Sachs Group Inc. to help it sell yuan- denominated bonds in Hong Kong, according to a person familiar with the matter.
The Peoria, Illinois-based company plans to raise as much as 1 billion yuan ($150 million) from two-year bonds, said the person, who asked not to be identified as the matter is private.
National Amusements may sell its seven-year senior secured notes as soon as next week, said a person familiar with the transaction. The notes will have a provision allowing up to 10 percent of the debt to be redeemed at 103 percent annually during the first three years, after which time all of it can be called, said the person, who declined to be identified because terms aren’t set.
In the asset-backed securities market, the Securities and Exchange Commission indefinitely extended the timeframe for bond issuers to omit credit ratings from marketing materials, effectively exempting companies from part of the U.S. Dodd-Frank financial reform act.
Fears of burden sharing are also being seen in senior bank bonds. The 1 billion euros of senior unsecured floating-rate notes due 2012 issued by Banco Espirito Santo were at 90.8 cents, down from 93.4 on Nov. 4, according to Bloomberg composite prices. Its 500 million euros of senior notes due 2013 were at 83 cents, down from 88.38 on Nov. 4.
Banco Bilbao Vizcaya Argentaria SA’s 1.25 billion euros of 3.875 percent senior notes due 2015 were at 98.8 cents to yield 4.14 percent, down from 101.7 cents and a yield of 3.47 percent on Nov. 1, according to Bloomberg composite prices.
While Irish Finance Minister Brian Lenihan has pledged only to impose losses on holders of subordinated bonds of nationalized lenders, investors are concerned his promise won’t be honored as EU and IMF officials gain authority in Dublin.
Outlook for Bondholders
“There will be private-sector burden-sharing,” said Willem Buiter, chief economist at Citigroup Inc. in London. “Ireland may be the first example, with haircutting of senior unsecured bank debt and possible sovereign debt restructuring as well in due course.”
The Markit iTraxx SovX Western Europe Index of contracts on 15 governments reached a record high 181.5 basis points.
Credit-default swaps typically rise as investor confidence deteriorates and fall as it improves, paying 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.
Dublin-based Anglo Irish was taken over by the government in January 2009 as loan losses spiraled after a real-estate bubble burst. The government has also taken a 36 percent stake in Bank of Ireland, the country’s biggest lender, and is preparing to take a majority share of Allied Irish.
Credit-default swaps on Anglo Irish’s bonds may be triggered following a subordinated debt exchange, with investors asking the International Swaps & Derivatives Association whether the transaction constitutes a so-called restructuring credit event.
If ISDA rules that Anglo Irish swaps can be triggered, buyers of insurance on the bank’s senior bonds should hold off demanding payment because they may recover more as the risk of holding the debt increases, according to Tim Brunne, a credit strategist at UniCredit SpA in Munich.
Forcing holders of senior bonds sold by some European banks to take losses may be necessary given the amount of debt involved, according to Brunne.
“You don’t have the possibility to solve the situation without cutting the link between the financial sector and the sovereign, and that’s a problem you see everywhere,” he said.
The 750-billion-euro European Financial Stability Facility, created in May to support the region’s most indebted governments, won’t be big enough to rescue Spain, Citigroup’s Buiter said. A rise in Spanish bank risk could be the “tipping point” for the financial credit swaps gauge, according to JPMorgan.
Credit-default swaps on Lisbon-based Banco Espirito Santo have climbed to a record 722, according to CMA. Contracts on Banco Santander are at a five-month high of 236.
German Chancellor Angela Merkel wants buyers of new euro- region bonds to accept liability clauses starting in 2011, two years before a revamped crisis-management system kicks in, according to a government document obtained by Bloomberg News.
“The problem areas are there for all to see -- haircuts for subordinated bank debt holders and fear that senior holders could get dragged in,” said Suki Mann, a credit strategist at Societe Generale SA in London. “The market has moved on from Greece, is beating up on Ireland and is looking closely at Portugal.”