Investors Still Wary Of Wall Street's Credit Risk

Investors are still on guard when it comes to the credit risk of Wall Street, seen by many to be at the epicenter of the collective storm created by faulty home loans and tepid demand for risky corporate debt.
Though the cost of credit protection for such banks as Bear Stearns Cos. (BSC), Lehman Brothers Holding Inc. (LEH), Merrill Lynch & Co. (MER) and Goldman Sachs Group Inc. (GS) has fallen from unprecedented heights last week, levels indicate that investors are still wary.
In fact, derivatives traders have been consistently viewing Bear Stearns as a junk-rated credit for over a week. Earlier this month, Bear told clients in two of its hedge funds that their investments are virtually worthless. The bank is still rated investment-grade by major rating companies.
News that mortgage lender American Home Investment Corp. (AMH) confirmed it is facing serious liquidity issues amid a flood of margin calls from lenders renewed jitters in credit markets Tuesday afternoon, causing some of the banks' implied credit risk to rise again.
The annual cost of protecting a notional amount of $10 million of Bear bonds against a possible default for five years was at $93,000 Tuesday afternoon, according to GFI Group, a New York-based inter-dealer broker, citing credit default swaps levels. At the end of last week, it went as high as $120,000.
Bear's current cost of credit protection is about 350% higher than the $21,000 it cost to buy the same protection at the beginning of the year, according to data from London-based data provider Markit Group.
The costs still imply a credit rating of six notches below the A1 rating that Bear enjoys from Moody's Investors Service, according to Moody's Market Implied Ratings. The trading levels are also indicative of a Ba1 rating, Moody's highest ranking for junk debt. Last week, Lehman Brothers' cost of credit protection also reflected a Ba1 junk rating even though it is rated A1 by Moody's.
Lehman's cost of five-year credit protection for $10 million of bonds was quoted Tuesday afternoon at $86,000 a year, according to GFI. It reached as high as $100,000 last week. The cost of protection for Merrill bonds was recently quoted at $77,000, lower than the $80,000 a year last week, according to GFI. Goldman Sachs Group Inc. (GS) saw its cost of credit protection decline to $73,000 Tuesday, from $80,000 last week.
The surge last week in the cost of credit protection for Wall Street banks was in part driven concerns of further losses due to subprime mortgages gone sour.
Wall Street's role as a debt underwriter is also a source of concern as there is an increasing likelihood that banks will be forced to step up to the plate with funding for debt-laden private buyouts as investors shy away from risky buys.
With over $300 billion in loans and bonds waiting in the wings to be sold in the junk debt market, banks may have to carry at least a portion of that debt on their books, potentially denting profits.