Company Bond Risk Jumps to Record as Goldman Predicts Recession
By Hamish Risk and Shannon D. Harrington
Jan. 9 (Bloomberg) -- The risk of companies defaulting on their debt rose to a record after Goldman Sachs Group Inc. said the U.S. economy is probably slipping into recession.
Credit-default swaps tied to U.S. mortgage lender Countrywide Financial Corp. rose to a record, and those for U.K. retailer Marks & Spencer Plc increased to the widest in more than two years. The Markit CDX North America Investment Grade Index and Markit iTraxx Hi Vol index both jumped to the highest since they were created in 2004.
Goldman forecast today that the Federal Reserve will need to cut interest rates to 2.5 percent by the third quarter from 4.25 percent now. The global default rate on bonds will climb more than fivefold by the end of this year as the economy weakens, Moody's Investors Service said yesterday.
``Contagion jitters are spreading,'' said David Brown, chief European economist at Bear Stearns Cos. in London. ``Things could get a lot worse before they get better. In this environment, the overriding investor strategy should continue to be dominated by risk aversion, safe haven and flight to quality.''
Contracts on the CDX investment-grade index of 125 North America companies jumped 5.25 basis points to 101.5 as of 11:45 a.m. in New York, for a rise of 24 basis points in the first six trading days this year, according to Deutsche Bank AG. Contracts on the Markit iTraxx Hi Vol index of 30 European investment-grade companies rose 8 basis points to 100 basis points, according to JPMorgan Chase & Co.
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.
Contracts on New York-based Alcoa Inc., the world's third- largest aluminum company, rose 12 basis points to 77 today, according to CMA Datavision in London. The company is scheduled to report earnings after the close of trading today.
Credit-default swaps on Countrywide, the biggest U.S. mortgage lender, rose for a second day on concern that rising defaults on home loans and the collapse of the subprime market will force the Calabasas, California-based company into bankruptcy. The company faces bankruptcy.
Sellers of credit-default swaps were demanding 29.5 percent upfront and 5 percent a year for contracts protecting Countrywide bondholders from default for five years, according to broker Phoenix Partners Group in New York. That compares with 28 percent upfront and 5 percent a year at the close of trading yesterday. The price means it costs $2.95 million upfront and $500,000 a year to protect Countrywide bonds from default for five years.
Countrywide today said foreclosures doubled to 1.44 percent of unpaid principal in December from 0.7 percent a year earlier at the company's unit that handles billing and processing.
Contracts on Washington Mutual Inc., the largest U.S. thrift, climbed 75 basis points to a record 645 basis points, Phoenix prices show.
Concerns that the economy will enter a recession is growing after the Labor Department said last week unemployment is at the highest in two years amid the worst housing slump in 27 years.
Former U.S. Treasury Secretary Lawrence Summers said in Stockholm today there's a 60 percent or greater chance that the U.S. economy will go into recession this year because of declining home prices and a loss of consumer confidence.
Economic growth will average 1.5 percent in the first six months of 2008, matching the fourth quarter's pace and skirting a recession, a Bloomberg News survey of 62 economists shows.
Marks & Spencer
In Europe, credit-default swaps on retailers soared after London-based Marks & Spencer, the U.K.'s biggest clothing retailer, said sales unexpectedly declined.
Contracts on Marks & Spencer jumped 20.5 basis points to 110.5 and the company's shares dropped the most in 19 years after revenue fell 2.2 percent at stores open at least a year in the fiscal third quarter.
Credit-default swaps on Paris-based LVMH Moet Hennessy Louis Vuitton SA, the world's largest maker of luxury goods, rose 5 basis points to 61.5. U.K. clothing retailer Next Plc increased 16 basis points to 123.5. London airports operator BAA Ltd., which manages 65 duty free outlets, rose 30 basis points to 247.5.
Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-risk, high-yield credit ratings increased 9 basis points to 401 today, according to JPMorgan.
A basis point on a credit-default swap contract protecting 10 million euros ($14.7 million) of debt from default for five years is equivalent to 1,000 euros a year.
To contact the reporters on this story: Hamish Risk in London firstname.lastname@example.org ; Shannon D. Harrington in New York at email@example.com Last Updated: January 9, 2008 11:53 EST