Credit Markets Update: Xerox scandal spooks market

Reports of another major accounting blunder, this time at Xerox, have spooked the credit derivatives market and sent bids for credit protection on European names escalating again. Credit default swaps spreads on European credits had been tightening after widening across the board on Wednesday following WorldCom’s accounting scandal, said traders.

The Wall Street Journal reported today that a new Xerox audit found the company had improperly accelerated far more revenue during the past five years than the Securities and Exchange Commission (SEC) estimated in an April settlement. The total amount of improperly recorded revenue from 1997 through 2001 could be more than $6 billion, it said.

“The market has been a complete roller-coaster. It has felt like the week following September 11th,” said Semi Adewale, a credit derivatives trader at Bank of America in London. On Wednesday, following the news of WorldCom’s multi-billion-dollar accounting fraud, credit protection spreads in Europe, especially for telcos, ballooned in a contagion effect as bidders attempted to get short credit protection. Bids were made up to 200 basis points wider than previous levels, but few offers were made, traders said.

Spreads began to recover yesterday, with most European telecoms back in 10-30bp to levels consistent with trading earlier in the week, said another credit derivatives trader in London today.

Five-year credit default spreads on France Telecom narrowed another 20bp today with the credit trading back at 640bp-mid, while Deutsche Telekoms spreads were at 370bp-mid, in 30bp. Spreads on European utilities Endesa, RWE, EdF and E.On also narrowed 1-4bp on Thursday. And autos, including Ford Credit, Volkswagon and General Motors had all returned to levels this morning where they traded earlier in the week.

Spreads on troubled European telecommunication equipment makers Alcatel and Ericsson remained high. Alcatel’s short-term credit rating was put on negative watch on Wednesday by Standard and Poor’s. The rating agency’s decision was triggered by a trading statement released earlier that day that revealed Alcatel was heading for an operating loss this year.

“Alcatel is trading like a sub-investment-grade credit. There’s just no confidence in the telco equipment market,” said one trader. Credit default swaps on Alcatel traded at 950/1,100bp today, with protection on Ericsson trading roughly 50bp below that.

“But the breaking news on Xerox has totally spooked the market and reversed the trend,” added Adewale. “No-one is selling, and the bids on European credits are now unchanged from a few days ago,” he said.

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