European credit derivative spreads widened on Monday, tracking a drop in stock markets, as analysts said last week's rally had overshot and as big US banks announced share sales. Cash bond spreads kept their tighter spread levels, analysts said, as more new issues came to market.
By 1546 GMT, the investment-grade Markit iTraxx Europe index was at 128.5 basis points, according to data from Markit, 4.5 basis points wider than late Friday. "CDS spreads are getting too rich, especially the heavily shorted credits, some of which have moved to unreasonably tight levels," Citigroup credit strategists said in a note to investors on Friday.
Three US banks said they would sell $5.55 billion of common stock and repay funds from the government's bailout programme after stress tests showed they were unlikely to need more capital. Several other banks said they would sell stock to help make up for capital shortfalls.
The Markit iTraxx Crossover index, made up of 45 mostly "junk"-rated credits, was at 777.50 basis points, 42.5 basis points wider. Credit strategists at Morgan Stanley looked at the Crossover relative to default forecasts, noting that Series 11, which went on the run in March, is five names smaller and of significantly higher quality than the previous index.
They ran the new index against a base case scenario of a five-year cumulative default rate of around 23 percent with recovery at 25 percent and against a worst-case rate of 29 percent with recovery at 20 percent. They calculated fair value for the Crossover, or a risk-adjusted return similar to equities, at 640 basis points for the base case and 848 basis points for the worst case.
The wide range of estimates "reflects our reluctance to wed ourselves too closely to one number for fair value in the current market", the strategists said. Meanwhile, the cash bond market remained buoyant with new issues in the works from UBS, RSA Insurance Group, and Swiss Re, among others.
"No change, then, as far as cash credit is concerned: spreads tighter when the whole market is up and stable/tighter when the rest of the market is down," SG CIB credit strategist Suki Mann said. Banco Santander unveiled the first big Spanish mortgage-backed covered bond deal since last June at 1.5 billion euros ($2.1 billion), taking advantage of tighter spreads after the European central bank said last week it had decided to buy around 60 billion euros of covered bonds to support the market.