'Lack of Trust' Pummels Europe Bank Lending as Libor Rises: Credit Markets

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'Lack of Trust' Pummels Europe Bank Lending as Libor Rises: Credit Markets
By Pierre Paulden and Shannon D. Harrington - May 16, 2010


The Royal Bank of Scotland Group, company logo hangs outside a bank in London. Photographer: Chris Ratcliffe/Bloomberg
The Barclays bank logo hangs on a branch in central London. Photographer: Jason Alden/Bloomberg

Money markets are showing rising levels of mistrust between Europe's banks on concern an almost $1 trillion bailout package won't prevent a sovereign debt default that might trigger a breakup of the euro.

Royal Bank of Scotland Group Plc and Barclays Plc led financial firms punished by rising borrowing costs, British Bankers' Association data show. The cost to hedge against losses on European bank bonds is 63 percent higher than a month earlier. Investment-grade corporate debt sales in the region plummeted 88 percent last week to $1.2 billion from the prior period, according to data compiled by Bloomberg.

The rate banks say they charge each other for three-month loans in dollars is the highest in nine months, even after a government-led rescue designed to prevent Greece from defaulting on its debt and a new financial crisis. The euro is trading at its weakest level versus the dollar since the aftermath of Lehman Brothers Holdings Inc.'s collapse, and stocks tumbled.

Bank lending "conveys a lack of trust in the system," said Robert Baur, chief global economist at Des Moines, Iowa- based Principal Global Investors, which manages $222 billion. "Banks are a little reluctant to lend overnight as they don't know the full extent of what is on the bank balance sheets."

The three-month London interbank offered rate in dollars, or Libor, rose to 0.445 percent last week, the highest level since August, from 0.428 percent on May 7 and 0.252 at the end of February, according to the British Bankers' Association.

'Access Spotty'

Concerns have spilled into the market for commercial paper, debt used by companies and banks for their short-term operating needs. Rates on 90-day paper are more than double the upper band of the federal funds rate, about twice the average in the five years before credit markets seized up in mid-2007.

"The list of banks able to tap the three-month market remains extremely limited with access spotty and expensive," Joseph Abate, a money-market strategist at Barclays in New York, wrote in a May 14 note to clients.

Elsewhere in credit markets, the extra yield investors demand to own corporate bonds instead of government securities climbed 3 basis points on May 14 to 171 basis points, or 1.71 percentage points, according to Bank of America Merrill Lynch's Global Broad Market Corporate Index. The index fell from 177 basis points a week earlier, the first decline since the period ended April 16.

Investors seeking to protect themselves from losses on bonds or speculate on creditworthiness by buying credit-default swaps drove benchmark indexes in Europe and the U.S. higher at the end of the week, according to prices from Markit Group Ltd.

Default Swaps

The Markit iTraxx Europe Index, linked to the bonds of 125 companies, rose 11.5 basis points to 109.75 basis points on May 14, down from 133 a week earlier, Markit prices show. The Markit CDX North America Investment Grade Index, tied to 125 companies in the U.S. and Canada, rose 6.8 to 107.9. The index was at 118.7 on May 7.

Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt. The contracts typically rise as investor confidence deteriorates and fall as it improves.

Yields on Fannie Mae and Freddie Mac mortgage securities that guide home-loan rates dropped to the lowest in five months on concern the sovereign debt crisis will stunt economic growth.

Yields of Fannie Mae's current-coupon 30-year fixed-rate mortgage bonds tumbled 0.07 percentage point to 4.2 percent, the lowest since Dec. 17, according to data compiled by Bloomberg.

Global corporate bond sales rose to $20.2 billion last week from $11.9 billion in the previous five-day period, which was the lowest this year, Bloomberg data show. Issuance compares with a weekly average for 2010 of $53 billion.

Leveraged Loans

Prices on the Standard & Poor's/LSTA U.S. Leveraged Loan 100 Index, which tracks the 100 largest dollar-denominated first-lien leveraged loans, rose 0.09 cent on the dollar last week to 90.98 cents.

About $111.4 billion in U.S. speculative-grade loans have been arranged this year, according to Bloomberg data, up from $34.4 billion in the comparable period in 2009. More than $373.1 billion of the loans were arranged during the period in 2007.

Cincinnati Bell Inc., a telephone company serving Ohio, is seeking a $760 million term loan to finance its acquisition of CyrusOne and to refinance existing bank debt. The loan is part of a $970 million senior secured credit facility, which also includes a $210 million revolving credit line, the Cincinnati- based company said in a May 13 filing.

EMI Lifeline

In Europe's loan market, EMI Group Plc was given a lifeline after investors agreed to inject enough cash to maintain the banking agreements of the 79-year-old record company of The Beatles. Guy Hands's Terra Firma Capital Partners Ltd. will put more cash into the label, EMI said in a May 14 statement. The investment will be made by June 14. Citigroup Inc. is the principal lender. No further details were disclosed.

The extra yield investors demand to own emerging-market bonds instead of Treasuries rose 15 basis points on May 14 to 295 basis points, according to JPMorgan Chase & Co.'s Emerging Market Bond index. Spreads rose as high as 328 a week earlier.

Brazil central bank President Henrique Meirelles said May 14 that market volatility stems from "natural" doubts over the measures taken by Europe. Meirelles, speaking to reporters in Rio de Janeiro, said Brazil is well prepared to face any international crisis because of its high currency reserves, floating exchange rate and inflation near target.

European Bailout

European policy makers' plan to prevent a sovereign-debt collapse that threatened to slow the global economic recovery and tear apart the 11-year-old common currency was released on May 10. The loan package offers as much as 750 billion euros ($927 billion), including International Monetary Fund backing, to countries facing instability, while the European Central Bank said it will buy government and private debt.

On May 14, the euro slid below $1.24 to the lowest level since October 2008 and stocks trimmed a weekly rally. The Standard & Poor's 500 Index declined 1.9 percent, paring gain for the week to 2.3 percent. The Stoxx Europe 600 Index slumped 3.4 percent to finish a 4.8 percent weekly advance.

Deutsche Bank AG Chief Executive Officer Josef Ackermann said Greece may not be able to repay its debt in full, and former Federal Reserve Chairman Paul Volcker said he's concerned the euro area may break up. Sony Corp., the world's second- largest maker of consumer electronics, said it may suffer a "significant impact" if Europe's deficit spreads, while Chinese Premier Wen Jiabao said the foundations for a worldwide recovery aren't "solid" as the sovereign-debt crisis deepens.

Commercial Paper

Rates on commercial paper for 90 days are 24 basis points above the upper band of the Fed's zero to 25-basis point target rate for overnight loans among banks. While far below the 245- basis point gap reached in October 2008, the spread is more than double the 10-basis-point average in the five years before credit markets seized up in the middle of 2007. As recently as February, financial CP rates were below the federal funds rate.

Except for banks with little exposure to European sovereign risk, banks "have found liquidity to be scarce, securing funding only one month and shorter and mostly concentrated inside one week," Abate from Barclays wrote in the report.

The rate at which London-based Barclays, the U.K.'s third- largest bank by market value, told the British Bankers' Association it could borrow for three months in dollars climbed 2 basis points last week to 47 basis points, the highest since July 2009, and is up from 34 basis points on April 30, Bloomberg data show. The bank's rate is 2.5 basis points above the three- month Libor. On average, Barclays reported a rate that was 1.3 basis points below Libor during the past year.

Barclays spokesman Mark Lane declined to comment.

Credit Suisse Rate

Credit Suisse Group's rate has jumped 11 basis points to 47 this month and was 2.5 basis points higher than the benchmark on May 14, compared with an average 1.5 basis points higher during the past year. The firm's primary sources of funding are long- term debt, shareholders' equity and deposits, said Marc Dosch, a spokesman for Switzerland's biggest bank by market value.

Releasing its first-quarter results last month, the Zurich- based bank said its "exposure to Greece is not material" and its "exposure to the other southern European economies that have been subject to credit downgrades is relatively limited."

The reported rate for Edinburgh-based Royal Bank of Scotland, the U.K.'s biggest state-controlled bank, climbed 10 basis points to 46 this month, 1.5 basis points higher than the benchmark.

RBS finance director Bruce Van Saun said last week the bank held 1.5 billion pounds ($2.2 billion) in Greek debt with about 400 million pounds of unrealized losses. Credit exposure to Greece was less than 1 billion pounds, he said. "Overall, our exposure to Greece is moderate, and any potential economic impact, I would say, is manageable," Van Saun said on a May 7 conference call.

RBS spokesman Michael Strachan declined to comment further.

To contact the reporters on this story: Pierre Paulden in New York at sharrington6@bloomberg.net

http://preview.bloomberg.com/news/2010- ... rkets.html
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