Monday, August 18, 2008

US banks scramble to refinance maturing debt

(FT) Battered US financial groups will have to refinance billions of dollars in maturing debt over the coming months, a move likely to push banks’ funding costs higher and curb their profitability, say bankers and analysts.

The banks’ need to raise capital to offset mounting credit-related losses is forcing them to pay higher interest rates to entice investors.

The rising funding costs are set to put pressure on earnings because, in many of their businesses, banks rely on the difference between borrowing and lending rates to make money.

“It is difficult to see how banks will continue to repeat the heady profit growth of the past few years if they borrow at these levels,” said a Wall Street banker.

Banks could also be forced to raise lending rates, exacerbating the credit crunch felt by many businesses and individuals and further depressing economic activity.

Mohamed El-Erian, co-chief executive of Pimco, the asset management group, said: “If banks keep borrowing at these levels, you will get a repricing of credit for the whole economy.”

Last week, financial groups including Citigroup, JPMorgan Chase and American International Group borrowed almost $20bn in new long-term debt, paying some of the highest interest rates ever in order to lock in funding. The wave of refinancing is set to continue for several months as billions of dollars in bank debt come due.

For example, Citigroup has more than $5bn of maturing bonds in August, but this climbs to $12.8bn in December, according to Dealogic data. Bank of America, with $7bn maturing in August, also faces higher refunding needs in December, with $9bn of maturing bonds.

Adding together 10 of the biggest bank borrowers, Dealogic said that maturing bonds total $27bn in August, $52bn in September, $23bn in October, $20bn in November and $86bn in December. The extent of the scramble for funds became clear last week when banks tapped central lending facilities, with strong demand for one- and three-month money lent by the Federal Reserve and the European Central Bank. US commercial banks borrowed a record daily average of $17.7bn from the Fed last week.

The lack of investor demand for structured finance products means that more short-term funding will need to come from traditional money market products, according to analysts.

Surge of bond deals lifts credit risk premiums

(FT) Multi-billion dollar debt sales from AIG and Citigroup led a sudden wave of US bond deals last week that lifted corporate credit risk premiums across the market - in contrast to an improving picture in Europe.

However, these market moves mask a rapidly worsening picture for European economies and credit markets versus the US, which some analysts see as a bigger trend that will gather pace.

The past couple of weeks have seen a tipping point for sentiment on Europe as the euro and sterling have changed direction against the US dollar and the news on economic growth for the eurozone and UK has turned sharply more bleak.

Stephen Dulake, European credit strategist at JPMorgan Chase, calls this change "macro risk reversal".

"Europe is becoming increasingly more risky than the US," he said. "Negative economic surprises in our in-house index are at a four-year high in Europe and we're seeing accelerating profit warnings across industrial sectors."

But such changes have yet to be reflected in credit markets, as can be seen from the main credit derivatives indices. Last week, these maintained the pattern seen for much of the past year in spite of confirmation that the eurozone economy shrank by 0.2 per cent in the three months to June.

The cost of protecting bonds against default in the US investment grade index, the CDX IG, has increased by more than the similar index in Europe, the iTraxx, consistently over the past year, apart from a short period in late March, when the US rallied after the Bear Stearns rescue.

The cost of protection, or spread, on the CDX leapt following the Citigroup and AIG bond deals last week because both were very large - $3bn (£1.6bn) and $3.25bn respectively - and both were sold at yields significantly more than their prevailing rates in the credit markets.

The deals were part of $18.5bn worth of North American bond sales, one of the largest weekly totals this summer in what is traditionally a very quiet week, according to data from Dealogic.

US credit sentiment improved sharply on Friday, but the CDX spread was still about 2.6 basis points higher at 134.4bp, according to data from Markit, which means it costs $134,400 annually to insure $10m worth of debt in the index over five years. The spread on the European iTraxx fell 4.3bp over the week to 92bp.

Analysts expect this pattern to reverse, but the worse outlook for Europe does not mean an entirely positive outlook for the US. "Many risks still hang over the credit markets, including a slow but deliberate deterioration in fundamentals," say analysts at Lehman Brothers.

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