Monday 5 September 2011

Markets update - Credit - Crossing An Event Horizon

Following Andrew P's comment on my post "Credit Terminal Velocity?", this post title refers to credit crossing an event horizon and indeed it has.
"Once an object crosses an event horizon of a black hole, its fate is sealed. No matter what path it takes, it is destined to be crushed at the center. There is no way out", Andrew P.

The markets were not pretty to say the least.
Itraxx Crossover (High Yield) index 5 year CDS morning snap:
and ended up the day much wider, 61.5 bps wider to 755.5 bps.

All credit indices broke new records today.

Itraxx SOVx Western Europe, representing 15 countries rose 18 bps to 328 bps.
Here was the morning picture for SOVx:

Itraxx Financial Senior Index 5 year linked to senior debt of 25 banks and insurance rose 24 bps to 270 bps. A new record.
Here was the picture in the morning and it got worse in the afternoon:

In relation to German 10 year Government Bond, we have reached a new record today as well in terms of yield, we flew through the 2% barrier we touched Friday to close at 1.84% level.
Here is a graph displaying German 10 year Goverment bond yield and German 5 year CDS level:

And German 10 year Bund today's price action viewed differently:
Massive flight to quality movement today as risk-off is even more apparent.

An update on my previous graph from my post - "Macro and Markets update - It's the liquidity stupid...and why it matters again..." on Eurostoxx 50 (SX5E), Itraxx Financial Senior 5 year CDS index, German Bund (10 year Governement bond, GDBR10), and at the bottom Eurostoxx 6 month Implied volatility:
You can notice the correlation between the sell-off in the Eurostoxx index and the flight to quality with the drop in the 10 year German Bund yield.

And in relation to Greek yields, I give you Bloomberg chart of the day:
Default looms. The yield on two year Greek bonds rose above its price for the first time. Even after the July 21st meeting pledging 159 billion euros of support with 50 billion expected from the PSI (Private Sector Involvement), based on a 90% participation rate, the yield managed to climb 15%. Markets are expecting a default when you have 49.85% yield, jumping 265 bps on a day (face value 49.82 cents to 100 euros).

In terms of liquidity indicators, the situation is worsening as clearly indicated by the FRA-OIS spread:

Here is the picture compared to 2008:
Top panel: Swap Spread 4 year / Eur FRA-OIS spread / Spread 10 year Italy/Germany
Bottom Panel: Itraxx Financial Senior 5 year / Crossover and SOVx
Only FRA-OIS and Crossover are below the highest level reached following Lehman's collapse in 2008. All of the others are above.
The yield on 10 year Italian government bonds has risen for 11 days in a row, the longest streak since the euro started in 1999. It’s now at 5.28%, less than one percentage point away from its level before the ECB started buying the country’s securities as of the 8th of August.

Today's full liquidity picture:
"The difference between the three-month euro interbank
offered rate, or Euribor, and the overnight indexed swap rate, a
measure of banks’ reluctance to lend to each other, rose to 71.3
basis points today, the widest gap since April 2009" - Source Bloomberg.

As I previously commented on liquidity issues and the consequences of lack of issuance, in August the cost of insuring European debt reached a record level while bond issuance was extremely light:

Although banks recently came furiously to issue covered bonds (bonds backed by pools of loans) during the small tightening period we witnessed on the 31st of August("Markets update - Credit Ripcord? Update on markets move and review of the CDS market and more"), the largest market being the unsecured market has been effectively closed since early July.
Truth is banks have had to pay higher prices to issue their bonds, triggering in effect a repricing of previous secondary issues:
ING sold AAA bonds at 80 basis points over midswaps but Unicredit paid 215 bps the following day, reflecting sovereign concerns.

Lenders, by using prime assets are willing to do whatever is necessary to get funding, as other sources, such as unsecured issuance have dried up, clearly reflected by the very high level reached by the Itraxx Financial Subordinate 5 year index:

As indicated by Morgan Stanley, referenced in my previous post regarding liquidity and why it mattered again, "Europe's leading banks are on average issued around 90% of their term funding needs for 2011 with significant liquidity pools, better solvency and resolute ECB commitment to support the system".
The big concern depends on how long the current issuance "shutdown" will go on.

In relation to weaker issuers from the peripheral countries "unlimited loans from the ECB are keeping them alive".

According to Bloomberg, banks have 152 billion euros of deposits parked at the ECB:

In terms of the deflation scenario playing out (and paying out), according to Bloomberg, Deflation floor contracts, instruments that pay investors when consumer prices fall have risen by more than 50% since the end of June.

In relation to the risk of a double dip, it is nearly guaranteed, zero freight rates fuel default risk for the third-largest container line CGM CMA, according to Bloomberg. The probability of default for CGM CMA on 5 year is around 90%.
About CGM CMA (rated B+) from the same Bloomberg article:
"The company posted an 8 percent increase in first-half sales to $7.3 billion and had $675 million of cash at the end of July, according to a statement on its website. CMA CGM said it had $5.3 billion of net debt at the end of June and recorded $685 million of earnings before interest, tax, depreciation and amortization in the first half of the year.
That means debt is more than three times Ebitda, compared with a ratio of about less than one time at Maersk, according to that company’s earnings report on Aug. 17.
CMA CGM also issued 325 million euros ($461 million) of 8.875 percent bonds maturing in 2019 in April, which were quoted at 51 percent of face value on Sept. 2, Bloomberg Bond Trader prices show."

Facts on current freight charges - source Bloomberg:
"Freight charges collapsed on the Asia-to-Europe lines, the world’s second busiest route, as a capacity glut combines with the slowest growth in trade since 2009. Rates excluding fuel surcharges were “practically” zero in July and little changed last month, the worst run ever, according to Menno Sanderse, an analyst at Morgan Stanley in London."

Industry losses:
"The industry may lose $2.5 billion to $3 billion this year, said Philip Damas, director of liner shipping and supply chains at Drewry Shipping Consultants Ltd. in London. Owners and operators lost $20 billion in 2009, when the global container trade contracted for the first time ever, he said." - Source Bloomberg.

And if you think about the decoupling story between Emerging Markets and Developed countries, well, so far Chinese banks are trading tighter CDS wise than their European peers, the big question is how long is it going to last?
Daily Focus Graph

Stay tuned!

1 comment:

  1. Once again an excellent roundup of the funding crisis hitting European banks.
    Your offer to title the next post was too kind as I certainly don't own the rights to your previous title. Please take these under advisement but do not feel compelled to use:

    7 deadly sins - greed, sloth, gluttony, etc. Could make a nice series of posts on the various actors in Europe

    Dante's Inferno - The various levels of hell could also provide inspiration

    As I thought about it, I don't think meeting Godot is the best idea. I'd rather not meet my maker during a banking crisis :)


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