Saturday, January 5, 2008

Credit-Default Swaps Have Worst Week in More Than Two Months

By Kabir Chibber and Shannon D. Harrington


Jan. 4 (Bloomberg) -- The risk of companies defaulting rose the most in more than two months this week after U.S. reports showing a slowdown in jobs growth and manufacturing stoked concern that the economy will sink into a recession.

Credit-default swaps tied to the bonds of mortgage lender Countrywide Financial Corp., homebuilder Lennar Corp. and Citigroup Inc., the biggest U.S. bank by assets, increased. Defaults may rise almost seven-fold to 2.25 percent this year, analysts at New York-based JPMorgan Chase & Co., the biggest underwriter of high-yield, high-risk corporate bonds last year, said in a report yesterday.

The U.S. economy is ``very close'' to recession, ``if not there already,'' Bill Gross, who manages the world's largest bond fund as Pacific Investment Management Co.'s chief investment officer, said in an interview on Bloomberg Television.

Contracts on the Markit CDX North America Investment Grade Series 9 Index of 125 companies rose 5 basis points to 88.75 basis points today, according to Deutsche Bank AG. The index climbed 11 basis points this week, the biggest increase since the period ended Oct. 19. A basis point is 0.01 percentage point.

In Europe, contracts on the Markit iTraxx Crossover Series 8 Index of 50 companies with mostly high-risk, high-yield credit ratings jumped 20 basis points to 388, according to JPMorgan. The index rose 50 basis points this week, Bloomberg data show.

Jobs Report

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 indicates deterioration in the perception of credit quality; a decline, the opposite.

Payrolls rose by 18,000 last month, down from 115,000 in November, the Labor Department said today in Washington. Unemployment increased to 5 percent, the highest in two years. The rate is up from 4.4 percent in March. Never has the rate risen so fast without a recession, according to Christopher Low, chief economist at FTN Financial in New York.

``An increase in unemployment of this magnitude and the jobs number are certainly indicative of a very weak economy,'' said Gross, who is based in Newport Beach, California.

The jobs data came two days after the Institute of Supply Management said its index showed the biggest decline in U.S. manufacturing in five years.

Averting Recession?

Economic growth may accelerate in the second half of 2008 and the U.S. economy is likely to avoid a recession, Edward Lazear, chairman of the White House's Council of Economic Advisers, said in an interview on Bloomberg Television.

``I think we very narrowly avoid a recession, but it will feel like a recession for many people throughout the economy,'' said Scott MacDonald, head of research at Aladdin Capital Management LLC in Stamford, Connecticut, which manages $20 billion in assets. ``And it can be argued that parts of the U.S. economy are already in recession.''

Credit-default swaps on New York-based Citigroup climbed 8 basis points to 87 basis points, according to broker Phoenix Partners Group. A basis point on a contract protecting $10 million of debt for five years is equivalent to $1,000 a year.

Contracts tied to the debt of Calabasas, California-based Countrywide moved deeper into distressed levels on concern that the company will continue to lose money amid the housing slump. The lender lost $1.2 billion in the third quarter, its first quarterly loss in 25 years.

Risk of Default

Traders demanded 19.5 percent upfront and 5 percent a year to protect Countrywide bonds from default for five years, Phoenix prices show. The cost rose from 16.5 percent upfront and 5 percent a year yesterday. Investors demand upfront payments when they see a high risk of default.

Contracts on Miami-based Lennar, the biggest U.S. homebuilder, climbed 13 basis points to a record 666 basis points, according to CMA Datavision in New York.

Credit-default swaps on SLM Corp., the biggest U.S. educational lender known as Sallie Mae, rose 40 basis points to 405 today, according to Phoenix. The Reston, Virginia-based company said it plans to become more selective in the business it does and cut services to borrowers as it struggles to restore its financial standing.

The Markit iTraxx Europe index of credit-default swaps on 125 investment-grade companies rose 5 basis points to 61.25, JPMorgan prices show.

The Markit LCDX Series 9 index, a gauge of confidence in the U.S. high-yield, high-risk loan market that falls as sentiment worsens, dropped 0.65 point to 96.15, the lowest in more than a month, according to Goldman Sachs Group Inc. The index dropped 4.3 percent since Oct. 15.

High-yield, high-risk, or junk, bonds are rated below Baa3 by Moody's Investors Service and BBB- by Standard & Poor's.

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