By Christopher Whittall
For banks, credit derivatives are back in the spotlight--and
flashing warning signals.
The market for credit-default swaps has shrunk to a fraction of
the size it was before the financial crisis. But these securities,
created to insure against default, still can send shivers through
markets as a closely watched measure of banks'
creditworthiness.
This week, that happened.
On Thursday, the average cost of insuring senior European bank
debt against default increased to its highest level since October
2013, according to data provider Markit. In the U.S., the cost of
insuring against default on banks from Goldman Sachs Group Inc. to
Wells Fargo & Co. also has shot up.
Credit-default swaps have become another negative marker in a
market swoon that is pummeling shares, debt and commodities around
the world amid concerns over global growth.
Those worries on growth, coupled with fears about persistently
low or negative interest rates, are pressuring banks now,
triggering the sudden rise in the cost of insuring against their
default.
Now, the CDS market itself is adding to the turmoil, as it feeds
into the signals that have sent bank shares plummeting this
week.
"CDS drives market sentiment," said Antoine Cornut, head of
investment manager Camares Capital. "In a bull market, people don't
really use CDS. Now that things are bad, it's become very
fashionable again."
Credit derivatives gained notoriety for their contribution to
the 2008 credit crisis. Then, credit-default swaps were used to
insure against everything from subprime mortgages to corporate
credit and were packaged into complex products that helped spread
and amplify risks throughout the financial system.
After the crisis, these products all but disappeared along with
investor appetite for such complexity. The more standardized market
for buying and selling protection against corporate debt defaults
also shrank. Postcrisis regulations forced banks to lay aside more
capital against riskier trading businesses, making it expensive for
banks to hold large amounts of credit-default swaps on their
books.
At the end of June, the global CDS market was $14.6 trillion, as
measured by the total amount of default protection outstanding,
according to the Bank for International Settlements. It was $57.9
trillion at the end of 2007, ahead of the crisis.
But while the market's size shrank, its role as a barometer of
credit risk did not. Some traders buy the securities not as a hedge
against default, but to bet that corporate fundamentals and market
sentiment will decline, causing the credit-default swaps to rise in
value.
"Bank CDS is a pretty important gauge of overall financial risk
sentiment," said Aritra Banerjee, a credit-derivatives strategist
at Citigroup.
Now that risk is seen as rising, these instruments are reacting
and investors one again are taking note.
In the U.S., the cost of insuring against a default on $10
million worth of Goldman Sachs debt for five years rose $20,000 to
$159,000 a year on Thursday, according to Markit. The cost of
insuring against a default from other major lenders such as J.P.
Morgan Chase & Co. and Wells Fargo also rose.
Among the biggest movers in this market has been embattled
German lender Deutsche Bank AG.
On Thursday, the cost of insuring against a default on $10
million worth of Deutsche Bank debt for five years rose $36,000 to
$268,000 a year, according to Markit, its highest level since
November 2011. That compares with $95,000 at the start of the
year.
Deutsche has been among the worst-hit banks in the recent
tumult, amid long-standing worries that the bank is too thinly
capitalized and, more recently, weak financial results.
This week, credit concerns also pushed the German bank's shares
down. Investors were worried it wouldn't be able to pay a coupon
due in April on a type of new risky debt.
Deutsche Bank now is considering buying back billions of euros
worth of its own bonds, a move that would be aimed in part at
lowering the price of its credit-default swaps to send a signal of
confidence to investors and reduce its funding costs.
"Now you have the CDS driving the equity on the bank side," said
Pierre Lagrange, who heads up global equities at hedge-fund firm
Man Group's GLG unit.
As concerns mount, trading in these securities has risen,
analysts say. Two of the three most traded investment-grade
credit-default swaps last week were Barclays PLC and Deutsche Bank,
according to Mr. Banerjee, citing data from the Depository Trust
& Clearing Corporation.
Still, nobody is predicting a full resurgence in this market.
Prices are volatile, and some investors don't see the securities as
a completely reliable hedge against default risk. In the past, the
contracts haven't always paid out following a debt default.
"There's a fundamental issue about whether CDS is attractive or
not as a product," said Chris Telfer, a portfolio manager at ECM
Asset Management.
Mike Bird and Laurence Fletcher contributed to this article.
(END) Dow Jones Newswires
February 11, 2016 16:43 ET (21:43 GMT)
Copyright (c) 2016 Dow Jones & Company, Inc.
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