Fears about the creditworthiness of US and European banks have pushed sharply higher the interest rate premium on bank bonds over government debt, hitting other corporate bond markets and raising borrowing costs for many companies.
In the past month, the spreads over government debt for bank bonds in euros and dollars tracked by the Barclays Capital corporate bond index have widened by more than 70 basis points.
There have also been sharp moves in non-financial corporate bonds, even though many industrial companies face few specific credit pressures as cash balances have improved.
Debt sold by financial institutions accounts for a large proportion of all outstanding bonds. In Europe, it is more than 50 per cent of the total and in the US it is about 35 per cent.
Investors said concerns weighing on the outlook for the banking system included possible losses from banks’ exposure to the eurozone sovereign debt crisis.
In the US, a regulatory crackdown could lead to lower credit ratings for banks because lawmakers wanted bondholders to absorb more losses should a bank fail.
Another worry was the potential costs and reputational damage for big banks following the civil fraud charges filed by the Securities and Exchange Commission against Goldman Sachs.
“Much of the volatility in the corporate bond markets is driven by the spread moves in financials,” said Curtis Arledge, chief investment officer for fixed income at BlackRock.
“This uncertainty around the financial sector could persist for some time causing the entire investment grade corporate bond sector to be more volatile.”
This volatility is expected to persist. It could take months to determine banks’ sovereign risk exposure and the impact of new US financial regulation.Of the three main pressures on banks, the only one that could be resolved quickly is the case against Goldman Sachs if there is a settlement, which is far from certain. Exposures to eurozone sovereign risks, and the ratings and business impact of new legislation will take months to determine. In addition, there is also uncertainty about the effects on banks of new capital rules.
Derivatives prices indicate the cost to banks of borrowing money in the interbank lending market will also rise through the year.
“The forward swaps are telling you that tension should increase and things may get worse before we get any resolution about what banks hold on their balance sheets,” said Gerald Lucas, senior investment adviser at Deutsche Bank.
Banks and companies that use the bond markets may need to look for alternative funding should credit concerns intensify and investors demand much higher rates of interest from new bond issues.
Additional reporting by Michael Mackenzie in New York
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