Bank debt trades at distressed levels

Bank debt trades at distressed levels

By Nicole Bullock and Aline van Duyn in New York

Published: February 20 2009 00:58

Citigroup and other large, troubled financial institutions came under pressure in credit markets on Thursday as investors considered the possibility of nationalisations.

Under such a scenario, equity investors are likely to be wiped out – concerns that were on Thursday reflected in sharp falls in bank shares.

Some bank debt traded at distressed levels and protection against default in the credit derivatives markets was in demand, as investors considered potential losses in the event of a government seizure of the banks.

“Investors seem to be pricing in more damage up the capital structure for Citi,” said Tim Backshall, chief strategist at Credit Derivatives Research.

Christopher Whalen, managing director at Institutional Risk Analytics, said he expected continued weak performance at Citi to result in losses for bondholders, which have been protected in other financial crises. “Washington will finally be forced to have an adult conversation with the global community as to how much we haircut the bondholders,” Mr Whalen said.

Some investors still expected bondholders would not have to take any losses, even in a nationalisation, because US officials would be too afraid of triggering a repeat of the collapse of the global credit markets that followed the bankruptcy of Lehman Brothers last year, when bondholders lost billions of dollars.

“If the debt is impaired and you see what constitutes default, it would be worse than Lehman because Citigroup and Bank of America are much larger institutions than Lehman, and they have their tentacles in more places,” said Jason Brady, a portfolio manager at Thormburg Investment Management, which owns bonds in both companies.

The cost of default protection on Citi debt rose to the highest level since last November, the second time the US government pumped cash into the bank. A rise in this cost is an indication of heightened default risk in the credit derivatives market. For BofA, credit default swaps hit a record high, according to CMA Datavision.

Citi’s five-year senior bonds were quoted at 680 basis points over Treasuries, while the subordinated debt was trading at close to a full percentage point over Treasuries, a level indicative of distress.