Wednesday, 31 August 2011

Markets update - Credit Ripcord? Update on markets move and review of the CDS market and more.

Today brought some welcome respite in the credit space, which was also the case in the equity space, with most indices in positive territory.

The tightening of some Itraxx credit indices has been important but, although I do not want to sound like a perma bear, it is too early to say if this rally will be short lived or not given: the economic data being on the weak side and the ongoing European sovereign debt crisis not yet being resolved.
The iTraxx Crossover Index (40 companies mostly high-yield credit ratings) dropped by around 23 basis points to 658 bps in the morning, as a follow up to the minutes of the FOMC meeting suggesting markets might get an addtional of QE down their veins.

In relation to corporate credit, the Itraxx Main Europe 5 year index (investment grade corporate debt) also retreated to around 155 bps.
Truth is corporate debt is still perceived as safer than financial debt as per the below graph displaying Itraxx Financial 5 year Index versus Itraxx Main Europe 5 year:

The rally in credit was pretty much all accross the board, even in the sovereign space where Portugal 5 year sovereign CDS tightened by around 36 bps and Ireland was 21 bps lower to around 783 bps:

The Itraxx SOVx representing 15 countries of Western Europe was as well tighter on the day by around 11 bps to 289 bps on the 5 year point:
The interesting point is that the SOVx Western Europe index on the 5 year is still wider than its Central Europe and Middle East counterpart, namely SOVx CE as per the above graph.

In conjunction with the Fed's minute for the FOMC meeting, we had some noise from Germany relating to the EFSF, as the German cabinet ratified an expansion plan of the facility.

While the rally was significant, we are still on elevated levels for Financial Senior Itraxx indices and Subordinate:
Itraxx Financial Senior 5 year index:

and Itraxx Financial Sub 5 year index:
At the same time liquidity as indicated partly by OIS Libor spread, has not improved significantly yet:

So yes, there was a feeling of a "credit ripcord effect" today, in relation to our previous post relating to terminal velocity and parachuting, looks like there is a welcome pause in the unabating widening process with have been witnessing throughout the month of August.

In relation to the issue surrounding Greek debt, I found some interesting data in the latest issue from Creditflux magazine:
Greek Sovereign write-downs up to 25th of August - Source Creditflux
According to Creditflux, banks and insurance companies have written down their Greek goverment debt holdings in recent weeks by 5.3 billion euros, representing a 21% haircut that will result to their "voluntary" participation to the debt exchange proposed on the 21st of July. What is interesting from the information extracted from the September 2011 Creditflux issue is that smaller German player Dekabank has been much more agressive in the write-down process, a 50 million euros bond in its held-to-maturity book (banking book) was cut to its market value of 47 cents to the dollar.

In relation to the review of current CDS market, here are some more information on the players:
Leading CDS counterparties - Source Creditflux - As of 1st of July 2011:
The most actively traded CDS remains Credit Indices. In Europe, Itraxx Main Europe and Itraxx Crossover are actively traded.

Top CDS counterparties according to Creditflux are:
Single name trade size is in the 5 million USD notional amount to 20 million, 5 year being the most liquid part of the curve and most quoted. Indices such as Itraxx Main Europe can trade in clips of 100 million euros in notional amount.
Creditflux Top index families:
But given current volatility and depending on the level of spread of a specific single name CDS, sometimes 5 million USD trade can move the market.
In recent weeks the most actively traded names have been in the financial space, given they are the most frequent issuers in the market and the debt they issue may vary in complexity from Tier 1 subordinated debt, with callable features and step-up features to plain vanilla senior fixed bonds.
Source Creditflux:

Source Creditflux - Corporate Top sectors traded and top names:

Although the market in Europe has been virtually shut down in the corporate space in August, last couple of days have seen some banks tapping the market via covered bonds only. In Europe, risk appetite so far hasn't yet come back and we have not seen in Europe some new issues from the corporate space.

So we know who are the dealers, but who are the active clients in the CDS space?
While real money accounts are becoming more active, major buyers and sellers remain so far hedge funds and trading desks. The new players which have developed in recent years are CVA desks (Credit Valuation Adjustment).
What are CVA desks?
CVA desks within banks are managing counterparty credit risk using CDS.
As per Creditflux:
"For a given portfolio of trades facing the same investor or institution, the credit valuation adjustment (CVA) aims to capture the expected loss associated with the counterparty defaulting in a situation in which the position, netted for any collateral agreement, has a positive mark-to-market for the dealer."

In relation to volumes trade and net exposure relating to the CDS market, information is available using the following link to the DTCC website:

DTCC Further Expands Public Release Of CDS Data

That's all folks for now!

To be continued shortly!

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