Bank of America Swaps Soar to Record

By Mary Childs - Nov 24, 2011 5:09 AM GMT+0700

The cost to protect Bank of America Corp. (BAC) debt surged to a record and a benchmark gauge of U.S. corporate credit risk climbed to a seven-week high as Europe’s sovereign fiscal crisis intensified.

The Markit CDX North America Investment Grade Index of credit default swaps, which investors use to hedge against losses on company debt or to speculate on creditworthiness, added 5.9 basis points to a mid-price of 146.4 at 4:57 p.m. in New York, the highest since Oct. 4, according to Markit Group Ltd.

Investors pushed the gauge higher on concern that Europe’s bond market turmoil, which began more than two years ago in Greece, now risks engulfing the region’s biggest economy. Germany failed to get bids for 35 percent of 10-year bonds offered for sale today, sending its borrowing costs higher and the euro lower. French and Belgian bonds fell as the cost to protect European government debt (PMI) against default rose to a record.

“If ‘the least’ riskiest of the EU has a difficult time selling its debt, that’s not a particularly encouraging sign for the rest,” Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York, said in an e-mail today.

The U.S. index, which typically rises as investor confidence deteriorates and falls as it improves, has increased from a two-month low of 113.4 basis points on Oct. 27 as traders have wagered that Europe’s escalating fiscal crisis will taint bank balance sheets worldwide.

Fed Tests

Five-year credit-default swaps tied to Bank of America Corp.’s senior debt added 37.1 basis points to 479.9, according to data provider CMA, the highest closing price on record. Swaps on unit Merrill Lynch & Co. rose 35.7 to 530.8, and contracts on Goldman Sachs Group Inc. (GS) added 35.5 to 432, the data show. Contracts tied to Morgan Stanley debt climbed 22.1 to 525.

The Federal Reserve released criteria yesterday for capital tests measuring the strength of the largest 31 U.S. banks. The standards measure their wherewithal if the U.S. economy sours and major trading partners default on their debt. Lenders need to prove they have the capital to withstand a “severe” U.S. recession with 13 percent unemployment and an 8 percent decline in gross domestic product before they can increase dividends or repurchase shares.

The two-year U.S. swap spread widened 3.06 basis points to 54.5 basis points, the most since May 2009, as investors sought the relative safety of government debt. In a swap, investors exchange fixed for floating interest rates.

Europe Swaps

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings jumped 9.4 basis points to 208.8 basis points, the highest level since December 2008.

Credit-default swaps tied to PMI Group Inc.’s bonds rose after the mortgage insurer filed for bankruptcy, potentially triggering contracts totaling more than double the company’s debt. The Walnut Creek, California-based company listed assets of $225 million and debt of $736 million as of Aug. 4 in a Chapter 11 petition filed today in U.S. Bankruptcy Court in Wilmington, Delaware.

The cost to protect the company’s debt climbed 0.7 percentage point to 75.2 percentage points upfront, according to data provider CMA. That’s about twice the level in June and means investors would pay $7.52 million initially and $500,000 annually to protect $10 million of the insurer’s obligations.

Banks, hedge funds and other money managers had bought and sold credit swaps on a net $1.8 billion of PMI’s debt as of Nov. 18, according to the Depository Trust & Clearing Corp., which runs a central repository for the market. A gross total of $37.9 billion is outstanding, when counting offsetting trades between dealers, the data show.

The New York-based International Swaps & Derivatives Association is an industry group that sets standards in the credit swaps market and acts as a secretary to a committee of banks and other firms that decide if the contracts pay out.

Credit swaps pay 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.

To contact the reporter on this story: Mary Childs in New York at mchilds5@bloomberg.net;

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net