The cost to protect corporate bonds from default soared to a record as hedge fund failures and rising bank funding costs stoked concern that a financial institution may collapse.
Credit-default swaps tied to Citigroup Inc., Bank of America Corp., JPMorgan Chase & Co. and Wachovia Corp., the nation's four biggest banks, climbed to the highest on record. Benchmark gauges of credit risk in the U.S., Europe and Asia also set records. Contracts on CIT Group Inc., the largest independent commercial finance company in the U.S., approached distressed levels.
``There's so much concern about a market failure,'' said Gregory Peters, head of credit strategy at Morgan Stanley in New York. ``It's a situation where there's just a general lack of trust, and there's a heightened fear of the unknown.''
The perceived risk rose as Carlyle Group's publicly traded mortgage bond fund failed to meet margin calls and investors speculated that Ambac Financial Group Inc., the world's second- biggest bond insurer, won't be able to raise enough capital to keep the AAA rating that it stamped on $556 billion of securities.
Washington Mutual Inc., the largest U.S. savings and loan, had its credit ratings lowered to two steps above junk by Standard & Poor's as a report showed mortgage foreclosures rose to an all-time high at the end of 2007. Speculation also increased that New Mexico mortgage lender Thornburg Mortgage Inc. will be forced into bankruptcy after the company said it received a default notice from its bankers.
`Never, Ever'
Credit-default swaps on the benchmark CDX North America Investment-Grade Index climbed as much as 21.5 basis points to a record 186 basis points, according to Deutsche Bank AG. The index, which ended the day at 185, has surged more than 107 basis points this year.
``I've been in this market for 30 years, I'm one of the senior citizens of the bond market, and I have never, ever seen such a confluence of negative events,'' said Marilyn Cohen, who manages $215 million in fixed income investments as president of Envision Capital Management in Los Angeles. ``Clearly the Fed has been rendered impotent on doing anything to end this credit crisis.''
Credit-default swaps on New York-based Citigroup, the biggest U.S. bank by assets, climbed 17 basis points to 207 basis points, according to broker Phoenix Partners Group. Contracts on Bank of America and JPMorgan, the second- and third-biggest banks, rose 15 basis points to 135, Phoenix prices show. Charlotte, North Carolina-based Wachovia jumped 55 basis points to 305 basis points.
Risk of Default
Sellers of contracts on CIT demanded 16 percent upfront and 5 percent a year to protect the New York-based company's bonds from default for five years, according to Phoenix. That means it costs $1.6 million initially and $500,000 a year to protect $10 million in CIT bonds. The cost is up from $740,000 a year yesterday. Upfront payments are demanded when investors see a heightened risk of imminent default.
Contracts on Seattle-based Washington Mutual increased 158 basis points to a record 700 basis points, according to CMA Datavision.
Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. A rise indicates deterioration in the perception of credit quality; a decline, the opposite.
The extra yield investors demand to own investment-grade bonds rather than Treasuries widened 8 basis points to 272 basis points, matching a record high set in 2002, according to Merrill Lynch & Co. Spreads last reached that level on Oct. 10, 2002, according to Merrill Lynch index data, three months after WorldCom Inc. filed for the largest bankruptcy in history.
Raise Capital
Ambac, which needs to raise capital to preserve its AAA rating because of potential losses on mortgage-linked securities it guaranteed, said yesterday it will seek to raise $1.5 billion through equity offerings. That disappointed investors who were expecting as much as $3 billion in capital that would be backed by banks. It also fueled concern that bank balance sheets are being squeezed, said Chuck Moon, head of investment-grade credit at Hartford Investment Management Co. in Hartford, Connecticut.
``It put a lot of fear in the marketplace as to whether or not that meant any concerns by the banks themselves about their capital or liquidity situations,'' Moon, who manages about $30 billion in investment-grade credit, said in an interview.
The world's banks and securities firms have reported $181 billion in asset writedowns and credit losses since the beginning of 2007.
Bear Stearns
Credit-default swaps on Bear Stearns Cos., the securities firm that had its first-ever loss last quarter because of mortgage-asset writedowns, rose 60 basis points to 405, Phoenix prices show.
The widening on the banks and securities firms contracts has been exacerbated by growing concerns that clients on the other side of trades will lose money if companies can't meet their obligations.
A hedge fund, for example, that has $200 million in trades with a bank may seek to limit some of that risk by buying credit- default swap protection on the bank itself.
``Everybody is keyed on risk management in this environment,'' said John Tierney, a strategist at Deutsche Bank in New York. ``I would suspect a fair amount of institutions are basically just hedging more as standard operating procedures.''
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Contracts on the Markit iTraxx Europe index of 125 companies with investment-grade ratings rose 14.5 basis points to 142, JPMorgan Chase & Co. prices show. The Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 35 basis points to 617.
In Asia, the Markit iTraxx Japan index rose 10 basis points to a record 134.5 in Tokyo, Morgan Stanley prices show.
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