CDS markets fear European sovereign debt crisis

george-papandreou

The continuing budget crises in several eurozone countries, led by Greece, are being reflected in spiking credit default swap (CDS) prices on the countries' sovereign debt – and on the debt of their major banks. Even some domestically focused corporates are being caught out.

A general strike in Greece began today, and with the prospect of a bailout for the deficit-laden country still uncertain, the market's perception of the risk of default was still high at close of trading yesterday. Five-year CDSs on Greek sovereign debt were priced at 375.38 basis points according to Bloomberg, down slightly from 389.445bp at the start of the month, but up considerably from 280.45bp on January 4, the first trading day of the year. On December 1, before the sovereign debt crisis intensified, Greek CDS were at 175.42 bp.

The other troubled eurozone countries – Portugal, Italy, Greece and Spain – have also seen their CDSs rise. Italian sovereign CDSs now trade at 139.135bp, up from 119.515bp on February 1 and 89.025 on December 1. Spanish CDSs have gone from 84.985bp in December to 145.28bp yesterday. Portugal has seen its CDSs climb from 71.99bp in December to 209.535bp today.

Even the more stable eurozone economies have seen rises, reflecting growing pressure on the single currency area: German CDSs have more than doubled since December 1 from 23.005bp to 46.245bp, and French CDSs have jumped from 26.875bp to 67.925bp. Since the Markit iTraxx SovX Western Europe index started in September 28, CDS five-year spreads have widened from 48.75bp to 93bp as of February 9.

Fitch Solutions noted yesterday that the stress is also being reflected in rising CDS liquidity for many eurozone financial institutions. Since the start of the month, BBVA, BNP Paribas, Banco Comercial Portugues, Commerzbank, Société Générale and Banco Santander have all seen significant increases in CDS prices on their senior debt, which has been coupled with increased liquidity, Fitch observes.

"In general, the liquidity of a credit derivatives asset increases when it is showing signs of financial stress in combination with a significant amount of debt outstanding and/or changes in its capital structure," the ratings agency wrote yesterday. "The fact that market-perceived stalwarts such as Banco Santander are being scrutinised by the CDS market is reflective of the degree to which markets consider government support in assessing a bank's risk of potential default."

Nor is government support for the financial sector considered reliable. Thomas Aubrey, a London-based director at Fitch Solutions, says: "There are market concerns as to whether governments would step in if the banking sector were to come under pressure again, given the significantly wider sovereign spreads than in 2009." Consequently, he adds, spreads have widened most on banks that were already performing poorly in the CDS market, as these are perceived to be the ones most likely to require future government assistance.

And the link between sovereign and corporate risk is not limited to the financial sector. Spreads in industries such as telecoms and utilities, which wholly or predominately cater for their home market, are imitating the movement of the relevant sovereigns. Therefore CDS spreads for southern European corporates are rising quickly, while German and French corporates show only a gentle increase.

In the telecoms sector, for example, the spread for Portugal Telecom almost doubled between the end of 2009 and February 9, widening from 70bp to 135bp. On the other hand, Deutsche Telecom rose by only 8bp from 66bp to 74bp, while France Telecom fell from 52bp to 51bp.

In the utilities sector, Iberdrola, the Spanish provider of electricity and natural gas, widened from 68bp to 102bp, while Ener de Portugal widened from 69bp to 134bp.

A corporate's spread would typically move in line with its industry rather than its sovereign, as a country's fiscal or structural difficulties should not affect corporate credit metrics in the short term. According to Unicredit Research, this new correlation suggests investors believe sovereign default will remain an ongoing risk for long enough – the next few years – to affect domestic corporates.

Rating agency Standard & Poor's comments that, even if deficit reduction plans go ahead in the troubled nations, it will still take decades to bring government debt down to pre-crisis levels – 33 years in the case of Greece. "Spanish policymakers were prudently creating fiscal space against a downturn by running sustained fiscal surpluses averaging 1.6% of GDP during 2005 and 2007. This stands in pronounced contrast to the 3% to 4% deficits run by Italy, Greece, and Portugal during the same period," says Standard & Poor's credit analyst Moritz Kraemer. He adds that further sovereign downgrades are likely this year.

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