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Caution Still Reigns When It Comes To Corporate Credit Risk

Feb 27, 2008 Market Outlook

Caution Still Reigns When It Comes To Corporate Credit Risk

Last Update: 2/27/2008 2:03:36 PM

By Kate Haywood
  Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)–The rebound didn’t last very long.

Credit markets came under pressure again Wednesday, damping the brief bout of
optimism that hit its peak when leading ratings firms said bond insurer MBIA Inc.
(MBI) could hold on to its top-notch triple-A ratings.

Bigger issues such as the plummeting value of the U.S. dollar and concerns about
hidden problems in structured financial products, however, continue to prevail,
meaning that the record weakness in closely watched derivatives indexes is here
to stay for a while.

Risk premiums on the corporate credit derivatives indexes such as Markit’s
investment-grade IG9 are still reeling from the the sharpest widening recorded
since trading in credit defaults swaps kicked off earlier this decade. The
indexes widen when investors grow cautious and buy credit protection in
anticipation of a downturn in the market.

“The moves have been extremely violent,” said Jeff Rosenberg, managing director,
head of credit strategy at Banc of America Securities in New York.

Risk premiums, or spreads, on the benchmark high-grade derivatives index, the
Markit IG9, which measures the cost of insuring a basket of U.S. investment-grade
corporate debt against defaults, jumped to 165.5 basis points last week. It
marked the weakest intraday point ever, according to administrator Markit.

Spreads have since moved back in and were quoted around the 140 basis points
level early Wednesday. However, this is still significantly weaker than levels of
around the 83 basis points seen in January. It also is more than 100 basis points
wider than the 33 basis points seen at the beginning of 2007 in a previous
incarnation of the index. New derivative indexes are launched every six months.

Monoline Muddle

Concerns about monoline bond insurers had driven the weakness in credit markets,
but it became more pronounced over the last few weeks as fears relating to the
unwinding of billions of dollars of structured products mushroomed.

The uncertainty about the breadth and depth of problems in the complex world of
collateralized debt obligations and other structured products has made it
exceedingly difficult for investors to feel confident about fair value.

“Calling the bottom is an impossible task,” Rosenberg said.

For a brief moment earlier this week, however, investors breathed a sigh of
relief, leading some to believe that markets would finally stabilize.

The IG9 index closed at 135 basis points Tuesday, buoyed as the threat of a
downgrade to the top credit ratings of the bond insurers receded after Standard &
Poor’s said Monday that MBIA and Ambac Financial Group (ABK) would keep their
triple-A ratings, after making progress in securing new financing.

Tuesday, Moody’s Investors Service followed suit announcing it would maintain
MBIA’s rating.

But investors are still wary, arguing that the monolines remain the big trump
card for credit spreads. Moody’s changed MBIA’s outlook to negative and said it
will have to better its capital position further if it is to retain its rating.
And Ambac, unlike MBIA, which recently raised $2.6 billion, hasn’t yet raised new
capital to support its rating, but it is reportedly in negotiations to raise $3
billion.

“We still don’t have a sign, sealed and delivered deal for Ambac. Once that is in
front of people and is real, then that will be a definite positive,” said Scott
MacDonald, director of research at Stamford, Conn.-based Aladdin Capital
Holdings.

On top of this, the broader key issues for the market - the plunging value of the
dollar, expected imminent interest rate cuts to prop up the faltering U.S.
economy and an increase in bank write-downs - remain.

There will be an increasing focus on corporate fundamentals as the real economic
backdrop deteriorates, which should see companies that are sensitive to the
broader economy struggle, Rosenberg said.

“This year started carrying over the issues from 2007. 2008 will end in a global
economic slowdown and more traditional credit cycle discussions and corporates
will be the next big discussion,” Rosenberg said.

On a positive note, investors are buying new issue corporate bonds. This shows
that the money markets are functioning, although liquidity is still very low,
Scott Amero, global chief investment officer for fixed income at BlackRock, said
earlier this week, speaking to reporters at the money management firm’s
investment outlook conference.

But although investors have cash to put to work, portfolio managers certainly
aren’t diving back into the market.

“For people to really get back in to the market, they have to have much more of
an indicator of which way things are going for a while and at the moment, the
market doesn’t have this,” MacDonald said.

And even if spreads do eventually stabilize, they are unlikely to re-visit the
tight levels seen in early 2007 - at least not in the short to medium term, Banc
Of America’s Rosenberg said.

“To get back there, we need to get to the other side of the credit cycle. We have
to go through a full default cycle and enter a new financial world,” Rosenberg
said.

-By Kate Haywood, Dow Jones Newswires; 201-938-2348; kate.haywood@dowjones.com

(END) Dow Jones Newswires

February 27, 2008 14:03 ET (19:03 GMT)

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