**CDS** Lehman, WaMu Lead Increase in Bank Bond Risk to Six-Month High
By Shannon D. Harrington
Sept. 10 (Bloomberg) -- The cost to protect against a default by banks and securities firms rose to the highest in six months as Lehman Brothers Holdings Inc. reported the biggest quarterly loss in its 158-year history and concern mounted that banks including Washington Mutual Inc. won't find buyers.
Credit-default swaps on Seattle-based WaMu, the biggest U.S. savings and loan, rose further into distressed levels and traded at a record high. Contracts on Lehman also traded at a record, signaling that investor confidence is deteriorating, after it reported a $3.9 billion loss and said it wrote down the value of mortgage and commercial real-estate assets by $5.6 billion amid the worst U.S. housing crisis since the Great Depression.
``The market's still shaking out who's going to be able to survive if the economy continues slowing down and home values continue to decline,'' said Mirko Mikelic, senior portfolio manager at Fifth Third Asset Management in Grand Rapids, Michigan. ``Capital is precious, and if you have it you want to hold onto it because more writedowns are coming down the pike.''
Banks and securities firms worldwide have reported more than $511 billion in writedowns and credit-market losses since the beginning of last year as home loan foreclosures rose to the highest on record and housing prices plunged.
Gains in credit markets earlier this week after the U.S. Treasury seized control of mortgage-finance companies Fannie Mae and Freddie Mac were wiped out as investors refocused on the battered balance sheets of other financial institutions.
Washington Mutual
The upfront price that credit-default swap sellers demanded to protect Washington Mutual bonds from default for five years rose 8 percentage points to 40 percentage points, according to broker Phoenix Partners Group. That's in addition to an annual fee of 5 percent, meaning it costs $4 million upfront and $500,000 annually to protect $10 million of the bonds for five years. The contracts earlier traded at an upfront price of 43 percentage points.
WaMu, which this week replaced Chief Executive Officer Kerry Killinger with former Independence Community Bank CEO Alan Fishman, said in July that rising home loan delinquencies may lead to losses of as much as $19 billion over the next 2 1/2 years.
Potential acquirers of the company ended talks this year in part because an accounting rule change will force acquirers to compute a target's assets at market prices instead of deriving values from measures including the purchase price, according to two bankers involved in the talks.
Default Chances
WaMu's credit-default swaps are trading at a level that would imply a more than 80 percent chance the company will default in the next five years, assuming bondholders recover 30 cents on the dollar in the case of a default, according to a JPMorgan Chase & Co. valuation model used by Bloomberg.
Investors can use the contracts to hedge against risks other than default, though, such as the risk the company will be cut below investment grade.
Standard & Poor's yesterday lowered its outlook on WaMu to negative. Moody's Investors Service, S&P and Fitch Ratings all have cut the company's credit ratings to the lowest investment- grade level and Moody's in July said it may cut its rankings further. Fitch also has a negative outlook on the company.
Lehman Swaps
Credit-default swaps on Lehman jumped as much as 135 basis points to a record 610 basis points before falling back to 580 basis points, Phoenix prices show. That surpassed the previous peak of 580 basis points in March after a run on Bear Stearns Cos. prompted the Federal Reserve to back an emergency sale of the fifth-largest U.S. securities firm to JPMorgan Chase & Co.
Lehman moved up its third-quarter earnings announcement by a week after its shares plunged 45 percent yesterday and Standard & Poor's and Fitch Ratings both said they may cut the firms' ratings. New York-based Lehman said today it wrote down the value of mortgage and commercial real estate assets by $5.6 billion. It will sell a majority stake in its asset-management unit, spin off commercial real-estate holdings and cut its shareholder dividend to shore up capital.
Lehman has posted more than $13 billion in asset writedowns amid the worst housing crisis since the Great Depression. A ratings cut may force Lehman to increase the amount of collateral it's required to post on derivatives contracts, according to regulatory filings by the company.
Survival Mode
Lehman is ``obviously in survival mode,'' said Liam Dalton, Chief Executive Officer of Axiom Capital Management, in a Bloomberg Television interview today. ``The market's concern right now is that they haven't taken aggressive enough steps early on in this process.''
A benchmark gauge of credit risk in North America also climbed today. The Markit CDX North America Investment Grade index of 125 companies in the U.S. and Canada rose 1.75 basis points to 146.25 basis points as of 2:30 p.m. in New York, Phoenix prices show. An increase in the contracts, used to speculate on the ability of companies to repay their debt or to hedge against losses, signals deterioration in investor confidence.
An index created by New York-based Credit Derivatives Research LLC that tracks credit-default swaps on 15 banks and securities firms, known as the CDR Counterparty Risk Index, rose 11.1 basis points today to 183.3 basis points. That would be the highest closing level since March 17, CDR data show.
A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements.
AIG
Contracts on American International Group, the biggest U.S. insurer, also climbed to a record today, rising 50 basis points to 514 basis points, according to CMA Datavision.
Contracts on Citigroup Inc., the biggest U.S. bank by assets, rose 8 basis points to 177 basis points, CMA data show. Contracts on Bank of America Corp., the second-largest U.S. bank, rose 9 basis points to 138 and those on Wachovia Corp., the fourth-largest bank, climbed 18 basis points to 328.
Lehman debt plunged today, with its 7.875 percent notes due in 2010 down 8 cents to 87 cents on the dollar for a yield of 16 percent, or 13.8 percentage points more than Treasuries of similar maturity, according to Trace, the Financial Industry Regulatory Authority's bond-pricing service. The firm's 7 percent securities due in 2027 dropped 5.8 cents to 84.9 cents on the dollar, to yield 8.6 percent or a spread of 437 basis points. A basis point is 0.01 percentage point.
Problems to Come
The bid-ask spread, the yield gap between the bid and asking prices offered by dealers, on Lehman's 6.875 percent notes due in 2018 widened to 22.5 basis points today from 9.1 basis points on Sept. 8, according to data compiled by Bloomberg. A wide bid-ask spread shows a lack of buyers for the debt.
``Balance sheets of many of these financial institutions are still terribly impaired and there are more problems to come,'' investor Jim Rogers said in a Bloomberg Television interview today. ``We had the worst credit bubble in the history of the world. You don't clean that out in a year or two or three.''
To contact the reporters on this story: Shannon D. Harrington in New York at sharrington6@bloomberg.net;
Last Updated: September 10, 2008 14:59 EDT |
