Credit market risks lurk despite global thaw

By Dena Aubin and John Parry – Analysis

NEW YORK (BestGrowthStock) – The global credit crisis may have eased, but the hangover is still punishing some of the largest U.S. borrowers in the credit derivatives market.

Credit default swaps, contracts that insure against debt defaults, are treating debt-laden borrowers ranging from Citigroup (C.N: ) to MetLife Inc (MET.N: ) as though they were rated at junk status, a sign of lingering fears of the risks of heavy debt.

One key cause: in a post-credit crisis world, investors can no longer trust that companies can always refinance debt at affordable rates.

That fear is heightened by trillions of dollars of bank and corporate debt coming due over the next three years, threatening to push interest rates higher as borrowers scramble for funds.

“If you were to look at what the stock market is doing, you would assume we are in some sort of bull market,” said Gary Kelly, head of research at Tradition Asiel Securities in New York. “That’s not being echoed from the credit perspective.”

Credit insurance costs on major U.S. banks have risen by about 17 percent overall this week, according to data from Tradition Asiel Securities.

JPMorgan Chase’s (JPM.N: ) swaps are up nearly 20 percent, while swaps on the finance arm of General Electric Co (GE.N: ) are up 11 percent, according to Markit Intraday.

That contrasts with a more bullish view in stocks, where strong first-quarter earnings have lifted the KBW banks index (.BKX: ) by more than 6 percent this week.

$5 TRILLION DEBT WALL

The disparity is not limited to U.S. financial firms. Aggregate CDS spreads for companies across the board in both the United States and Europe remain elevated compared to historical levels, indicating latent concerns, Kelly said.

A debt crisis in Greece and the threat of stricter U.S. bank regulations are adding to worries about credit risk.

Among the chief concerns is that increased momentum in the U.S. Congress for financial reform will end bailouts of financial institutions with government funds.

Credit rating agencies have warned that financial firms’ could be downgraded if they can no longer count on government support.

Any banks downgraded to A-minus or below could lose their all-important Tier 1 short-term rating and access to financing in the short-term market, Bank of America Merrill Lynch warned in a recent report.

Banks that have to refinance debt will be competing with a huge wave of government debt. The International Monetary Fund warned this week that mounting government debt is a risk to global financial stability and could strain the funding markets as banks face nearly $5 trillion in debt coming due over the next three years.

Market concerns about Greece, if unchecked, could even ignite a full-blown sovereign debt crisis if they spill over to other euro zone members, the IMF warned.

“That’s something we have been predicting and talking about,” said Scott Mather, head of global portfolio management for Pacific Investment Management Co in Newport Beach, California, which oversees more than $1 trillion in assets. “The private sector cannot totally escape the sovereign issues.”

Greece on Friday appealed to its European partners and the IMF for emergency loans, yet global markets remained wary that the rescue would bring only short-term relief.

FROM AAA TO JUNK

One sign of the market’s caution is the extraordinary deterioration in credit default swaps of highly indebted euro zone countries since the global credit crisis erupted in the summer of 2007.

Swaps on Spain, Portugal and Greece have all traded down to junk-like levels from the top triple-A category just before the crisis, according to data from Moody’s Market Implied Ratings Service.

“The sovereign issuer is supposed to be the risk-free benchmark,” Mather said. “If you have a rising risk premium of the sovereign, (private sector debt) should be a multiple of that.”

While short-term speculators may be behind some of the swap moves, many investors still see them as a good barometer of credit risk.

“You would ignore a high CDS at your own peril,” said Howard Simons, strategist with Bianco Research in Chicago. “The one thing I have always pointed out to people about the CDS market is to remember what ‘D’ stands for. It stands for default.”

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Credit market risks lurk despite global thaw