Saturday, 5 January 2008

Rising Credit Default Risks Sound Alarm Bells

Australia Bond Risk Rises to Record as Banks Lift Mortgage Rate

The risk of Australian companies defaulting rose to a record as two of the nation's biggest banks increased mortgage rates after the collapse of the U.S. subprime market drove up funding costs.

National Australia Bank Ltd. and Australia & New Zealand Banking Group Ltd. lifted home-loan charges without the central bank changing benchmark rates, the first time that's happened in a decade. Losses in the U.S. caused Centro Properties Group in Melbourne to put itself up for sale, triggered the collapse of Sydney-based hedge fund Basis Capital Fund Management Ltd. and contributed to the highest bank borrowing costs in 11 years.

Credit-default swaps on the Markit iTraxx Australia Series 8 Index of 25 companies, including the nation's five largest lenders, jumped 2 basis points to 70.5 today, according to Citigroup Inc. The index, a benchmark for the cost of protecting bonds against default, rises when perceptions of credit quality deteriorate.

"Risk sentiment will remain high,'' said Annisa Lee, a credit analyst at Lehman Brothers Holdings Inc. in Hong Kong. "The woes of the housing sector in the U.S. may be starting to spread into the broader economy.''

Oh Really Annisa? Thanks for the tip.

National Australia, the country's second-biggest provider of mortgages, raised the interest it charges for floating-rate home loans by 12 basis points to 8.69 percent. Credit-default swaps on the Melbourne-based bank rose 10 basis points to 42.8 this week, according to prices on Bloomberg.

ANZ, which funds 40 percent of its assets in the wholesale debt market, raised borrowing charges by 25 basis points to as much as 8.54 percent. Credit-default swaps on the Melbourne- based lender increased 10 basis points to 42.83 this week.

The fact this article focuses on Australian corporates is not the main point. Credit markets are clearly spooked and despite the smoke and mirrors liquidity magic tricks played by the Fed and the ECB that have bought LIBOR rates down credit default swap rates continue to rise. The credit markets are telling us something important here. The problem is not one of liquidity but insolvency.

Above is the the North American High Yield Credit Default swap index. Note the spread (red line) has climbed back to the highs of November. This in an environment of relative calm in credit markets over recent weeks.