Iceland Bank Default Swaps Rise Amid `Unscrupulous' Speculating

The cost to protect the bonds of Iceland's three biggest lenders from default rose after central bank Governor David Oddsson said ``unscrupulous dealers'' are trying to break the country's financial system.

Credit-default swaps on Kaupthing Bank hf, the nation's largest lender, increased to a record 16.5 percent upfront and 5 percent a year to protect 10 million euros ($15.8 million) of bonds, CMA Datavision prices show. The cost rose from 15.8 percent in advance and implies a 59 percent risk of default within five years, according to a JPMorgan Chase & Co. valuation model.

Oddsson called for an international investigation into attempts to drive Iceland's economy ``to its knees,'' in a speech on March 28. The central bank was forced to raise its benchmark rate to a record 15 percent last week to defend the krona after a 30 percent slump against the euro this year.

``The longer this goes on, the worse it gets,'' said Olivia Frieser, a London-based bank analyst at BNP Paribas SA, France's biggest lender. ``It is a question of confidence.''

The nation of 300,000 has been among the hardest hit as the credit market freeze prompted investors to shun all but the safest assets. The financial sector's net $35.3 billion of debt represents 211 percent of the country's gross domestic product, according to Paul Rawkins, a senior director at Fitch Ratings in London.

``Iceland has been likened to a hedge fund because the banks borrowed to invest in equity assets,'' Rawkins said in an interview. ``It was a punt on getting higher returns to pay off the debt. They are exposed now, and sentiment has shifted against them.''

Default Cost

The cost to protect the country's lenders from default is the highest of 81 banks worldwide with credit-default swaps listed on Bloomberg.

Credit-default swaps on Glitnir Banki hf, Iceland's third- biggest bank, traded at 17 percent upfront and 5 percent a year, according to CMA, up from 16 percent in advance. The cost implies a 60 percent risk of default, according to the JPMorgan model. The contracts have soared from 2.02 percent, or 202 basis points, with no upfront payment at the start of the year.

Contracts on Landsbanki Islands hf, the second-largest lender, rose 25 basis points to 8.07 percent, CMA prices show. The credit-default swaps traded at 9.5 percent upfront and 5 percent a year before closing at 7.82 percent with no advance payment on March 28, according to CMA.

A basis point on a credit-default swap contract protecting 10 million euros of debt from default is equivalent to 1,000 euros a year.

`Unpleasant Odor'

Attacks on the country's Reykjavik-based banks ``give off an unpleasant odor of unscrupulous dealers who have decided to make a last stab at breaking down the Icelandic financial system,'' Oddsson said at the central bank's annual meeting in Reykjavik. ``They will not get away with it.''

Credit-default swaps are financial instruments based on bonds and loans that are used to speculate on a company's ability to repay debt. They 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 rise indicate deterioration in the perception of credit quality; a decline, the opposite.

``Its very important that the Icelandic financial supervisory authority, in cooperation with other countries, investigates the market and determines whether the allegations are true,'' Glitnir spokesman Bjoern Richard Johansen in Reykjavik said in a phone interview today.

Landsbanki spokesman Andrew Walton and Kaupthing spokesman Jonas Sigurgeirsson were not immediately available for comment.

Legal Action

Kaupthing may take legal action against Bear Stearns Cos., the collapsed U.S. broker, which arranged a trip to Iceland in January by three of its own executives and representatives of four hedge funds, the Financial Times reported today. If Kaupthing decides to file a lawsuit, it will be able to subpoena e-mails and records from Bear Stearns and possibly the hedge funds, the newspaper said.

Bear Stearns London-based spokeswoman Jessica Shepherd- Smith didn't provide an immediate comment.

Credit-default swaps on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 25 basis points to 580 today, according to JPMorgan.

The Markit iTraxx Europe index of 125 companies with investment-grade ratings rose 6 basis points to 123.5, JPMorgan prices show.

The CDX North America Investment Grade Index increased 1.5 basis points to 143 in New York, according to broker Phoenix Partners Group.