Stubborn Credit Crunch
Co-written with other RGE Lead Analysts.
The situation in the money market is improving on the wake of central bank easing, on the other hand the credit crunch is still holding up well. Spread decomposition shows that whereas unsecured LIBOR versus secured OIS rate was mainly driven by liquidity premium in 2007, it is now clearly driven by credit premium in line with signals from corporate credit markets.
The cost of protecting bonds against default keeps increasing as the perceptions of credit quality deteriorate. The iTraxx Crossover Index of 50 European companies with mostly high-risk, high-yield credit ratings jumped 18bps to 571 yesterday. The Markit iTraxx Europe index of 125 companies with investment-grade ratings soared 7.25 basis points to 109.
The CDX North America Investment Grade Index rose 5bps to 129.5 at the close of trading in New York on Monday. Check out: “Credit Squeeze Won’t Go Away: What Are Central Banks’ Alternative Tools?”
The credit crunch is getting worse and the alphabet soup of structured finance is getting richer and new acronyms are popping up and quickly becoming everyday’s financial talk. Tender Option Bonds (TOBs) and Variable Rate Demand Obligations (VRDOs) are the municipal cousins of ABCP conduits and SIVs which together represent more than $400bn of muni debt outstanding. TOBs vehicles issue securities with long-term maturities backed by long-term municipal bond assets. The buyers of such notes have the right to tender them back to the issuer for repayment, usually on a weekly basis. Now that the bond insurers, also known as monolines, might lose their crucial AAA ratings on the wake of the subprime crisis, money market investors seek protections by selling TOB paper. Read our spotlight on“The SIVs of the Muni Bond Market: Tender Option Bonds (TOB), Variable Rate Demand Obligations (VRDO), and Auction-Rate Securities” and Elisa Parisi-Capone’s RGE Structured Finance Glossary – Making Sense of the Alphabet Soup
Wall Street cheered up on the news that Warren Buffett offered to assume responsibility for $800 billion of municipal bonds guaranteed by MBIA, Ambac Financial and FGIC. However, according to some analysts the plan cherry picks only the worthwhile parts of the portfolio leaving the three companies – on the verge of losing their AAA credit rating – with bad mix of troubled assets. Take a look at: “Buffett Offers To Assume Muni Liabilities of Bond Insurers: Who Will Take the Bad Assets?”
And the so-called non-traditional muni-land buyers, included European banks.
Q4 European banks cluster…
And the subprime crisis is rapidly spreading to the non-financial companies like American International Group. AIG sparked fears in the markets in the beginning of the week by making public their estimated $5bn losses coming from exposure to mortgage-related instruments in October and November. Moreover, AIG’s $63bn of exposure to subprime CDOs might very well have taken additional hits since last November. See: “Subprime Woes Spreading to AIG and Futher to Non-Financial Companies”
G7 Debates Financial Stability: Towards a New Regulatory Paradigm?
Finally take a look at Nouriel Roubini’s latest Global EconoMonitors pieces: “The Rising Risk of a Systemic Financial Meltdown: The Twelve Steps to Financial Disaster” and “Can the Fed and Policy Makers Avoid a Systemic Financial Meltdown? Most Likely Not.”
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