European credit spreads pushed to fresh record wide levels on Tuesday after Credit Suisse shocked investors with a surprise $2.85 billion writedown a week after announcing full-year results. Five-year credit default swaps on Credit Suisse widened sharply, pulling the market in their wake as fears rose of more hits to banks' balance sheets.
The sharp widening in spreads also generated further concerns that some structured credit products might be forced to unwind, producing more losses. By 1630 GMT, the investment-grade Markit iTraxx Europe index was at 119 basis points, according to data from Markit, 11 basis points wider on the day. The iTraxx Crossover index was at 588 basis points, 24 basis points wider. Both indexes are at all-time wide levels.
The move was in sharp contrast to European equity indexes, which ended little changed, although they had shed earlier gains of 1.5 percent or more. Mehernosh Engineer, a credit strategist at BNP Paribas, said equity markets had failed to understand the problems that the credit market is concerned about.
"Equities are very much lagging. Credit has been the leading indicator. Equities are still not understanding what this counterparty risk means, what the writedowns will mean," he said. "We're being driven by pure credit momentum about technicals, real (protection) buyers," said one trader. "We're not really tied to equities at the moment. They're doing their own thing."
Engineer said that there was also technical pressure from the risk of structured credit investments being unwound. "The market is very skewed in terms of the demand-supply imbalance... Whoever needs to buy protection will have to pay up. There's no natural seller of protection," he said.
The situation now is the flipside of the cycle of "crazy" spread tightening in the two years running up to summer 2007, he said. "We are trying to unwind all of that in two months now."
Credit Suisse CDS widened 13 basis points to 114 basis points, and the bank faced calls to reprice a $2 billion 10-year subordinated bond issue priced just last week, after it announced its shock writedown on the value of asset-backed securities. "We consider the news as another blow for the banking sector and for investment banks in particular," analysts at Dresdner Kleinwort said in a note to clients.
"It is difficult to envisage how investor confidence can return in the short to medium term when even the banks that we perceived performing relatively well have to potentially revise downward previous statements and outlooks."
The news overshadowed relief that earnings at Britain's Barclays were in line with expectations. CDS on Barclays were pushed wider too, up 7 basis points at 110 basis points.
In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 121.5 basis points more than similarly dated government bonds at 1642 GMT, 1.2 basis points more on the day.