Spreads on dollar-denominated bonds sold by financial institutions have hit their widest levels in nearly two years amid growing concerns about the impact on the sector of European sovereign risk and US economic weakness.
The benchmark Barclays Capital bond index showed that the average spread for the financials component of the index had risen to 282 basis points over risk-free rates on Monday night.
The last time spreads on dollar-denominated bonds sold by financial institutions traded at these levels was in October 2009.
At the beginning of August, the spread was under 200bp, highlighting the speed with which sentiment towards the financial sector has deteriorated.
“Much of the recent weakness in US bank credit spreads is clearly due to the fragile economy,” said analysts at Bank of America Merrill Lynch in a note to investors.
“Even without a recession, the sharp turn lower in interest rates has led to a significant flattening of the [US Treasury yield] curve, making it more difficult for banks to generate revenue.”
Concerns about the economic and credit outlook have also resulted in weaker performance in other parts of the bond markets with spreads on the broader investment grade corporate bond index and the high-yield or junk bond index also widening significantly.
Some individual banks have been particularly hard hit in the last few days amid investor concerns that the banks will have to raise significant amounts of new capital.
“There are a large number of people who feel we are already in the next recession and, as a result of that, there’s a belief that the loan losses at the banking institutions will grow,” said Richard Bove, banks analyst at Rochdale Securities.
Credit default swaps on senior Bank of America debt at one point traded at an all-time high of 438 basis points on Tuesday, more than double where they began the month and topping the previous peak in March 2009. The CDS price implies a cost $438,000 to insure $10m in debt.
“There seems to be a lot of concern about near-term risk, which corresponds with this concern about capital,” said Otis Casey, director of credit research at Markit. “The worry is that if there’s some kind of short-term event, the bank wouldn’t have adequate capital.”
CDS spreads on other banks also reached the highest levels for the year but are still not close to the all-time highs reached in the depths of the financial crisis.
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