High-Grade Credit-Derivatives Index Set To Roll On Sept 21
September 02 2009 - 12:35PM
Dow Jones News
Who's in, who's out? That's the question faced twice a year by
investors and dealers in the credit-derivatives arena, when the
existing indexes are replaced with new versions.
It's known as the "roll" and refreshes the names in the indexes,
establishing a more accurate representation of the markets they
represent. Downgrades to some companies contained in the high-grade
index, for example, causes distortions as their credit costs go up,
meaning that index is no longer a reliable gauge for credit market
participants.
The indexes are the most liquid products in the derivatives
world. They are a handy way for investors to take a position on the
general direction of the corporate world or protect their debt
holdings against default. The existing indexes won't stop trading,
however, meaning the credit protection continues to exist.
The next roll in the investment grade derivatives index, the
Markit CDX North America Investment Grade index, takes place on
Sept. 21, and credit strategists have begun the game of analyzing
which issuers will be replaced. Replacements are decided by the
dealer banks, which include the biggest names on Wall Street.
Liquidity and ratings changes are the key determinants.
For the high-grade index, which groups the credit default swaps
of 125 North American companies, the question centers on the status
of the beleaguered retailers, and, not surprisingly, embattled
small business lender CIT.
Bank of America Merrill Lynch thinks CIT Group Inc. (CIT), which
is struggling to restructure outside of bankruptcy, will not be
part of the new high-grade index, the IG13. Also on the drop list:
retailers JC Penney (JCP) and Macy's (M), as well as furniture
group Masco Corp. (MAS). Textron Financial is another
candidate.
The concentration on retailers is not a surprise but a reminder
that the U.S. consumer isn't readily contributing to an economic
recovery.
The analysts recommend replacing the retailers with CDS from
cyclical sectors that aren't adequately represented.
"The addition of Kinder Morgan Energy (KMP) would add a
benchmark name to the pipelines sector which has only one member in
the index (Sempra Energy)." It also recommends adding Reynolds
American (RAI), which would "add to Altria in the tobacco
sector."
Other suggestions include Genworth Financial (GNW), Commercial
Metals (CMC) and auto supplier Johnson Controls (JCI).
Eric Beinstein, head of Investment Grade Strategy and CDS
Research at JPMorgan in New York, says dealers are more likely to
focus on liquidity versus sectors when considering new credits to
include in IG Series 13. He adds that the new IG13 series will
likely trade at a lower risk premium, or spread, than IG12 simply
because the new credits are replacing ones with higher credit
protection costs. "It happens with every roll. The new index will
trade at a premium because the replacement names are higher rated
credits."
According to rules posted on index administrator Markit's Web
site, 10 business days prior to the "roll date" of a new IG Index,
each voting member is requested to submit a list of entities
currently included in the index that they think should be ousted
for the next six-month period. Members are then required to back up
their submissions in writing. Majority rules, and the companies
with the most votes are replaced with a new set, also chosen by
voters.
At last check, the current IG index was quoted at 118.5 basis
points. That means it costs $118,500 a year to protect a basket of
bonds sold by the companies in the index for five years.
-By Kellie Geressy-Nilsen, Dow Jones Newswires; 212-416-2225;
kellie.geressy@dowjones.com