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Big investors are increasingly concerned about the prospect of widespread defaults among U.S. companies with currently sound credit ratings. One glaring piece of evidence? The price of insuring corporate debt against default has soared, according to a new report from analysts at Walnut Creek (Calif.)-based Credit Derivatives Research.
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Merrill Adds to Concerns
Demand for corporate default insurance is rising. The surging cost reflects the sentiment of big investors such as pension funds and hedge funds, which can trade in such insurance contracts even if they don't hold the underlying debt tied to the insurance policy. Such investors use the insurance policies to bet that the number of defaults will rise as the credit crunch and the slowing housing market exact a toll on the economy, pushing a greater number of companies into default. They don't even need to bet on which specific companies will default, since the insurance is tied to the index, overseen by Dow Jones (NYSE:DJ - News).
Comments by Merrill Lynch (NYSE:MER - News) Chief Executive Stanley O'Neal on Oct. 24 may have stoked the general fears (BusinessWeek, 10/24/07). He said Merrill, which reported an $8 billion write-down that same day, sold off lower-rated assets during the first quarter as the credit crunch began. It held on to higher-rated tranches of debt, and hedged against their possible decline in value. "We hedged but not aggressively or fast enough," O'Neal said. The fact that Merrill's huge write-down was tied to higher-rated tranches of debt may have scared investors.
The concern is driven by several forces, according to Credit Derivatives. There's a fear that troubles in the housing market will depress consumer spending. There's also rising nervousness that huge, credit-related write-downs in the banking sector could force a major financial institution to go under, according to Backshall. Citigroup (NYSE:C - News) reported a $6 billion write-down (BusinessWeek, 10/15/07) earlier in October. Merrill Lynch reported $8 billion in write-downs on Oct. 24. The worry is that a combination of housing and credit-related problems will cause systemic trouble in the financial system and the economy, leading to widespread defaults.
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The systemic risk is that investors will be forced to sell off higher-rated assets to cover bad bets on assets with lower ratings -- indeed, in its bombshell news this week, Merrill Lynch warned it could not guarantee against such a risk. In such a climate, default insurance has become the hot new buy among large investors. More »
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The concern is driven by several forces, according to Credit Derivatives. There's a fear that troubles in the housing market will depress consumer spending. There's also rising nervousness that huge, credit-related write-downs in the banking sector could force a major financial institution to go under, according to Backshall. Citigroup (NYSE:C - News) reported a $6 billion write-down (BusinessWeek, 10/15/07) earlier in October. Merrill Lynch reported $8 billion in write-downs on Oct. 24. The worry is that a combination of housing and credit-related problems will cause systemic trouble in the financial system and the economy, leading to widespread defaults.
.. snip ..
The systemic risk is that investors will be forced to sell off higher-rated assets to cover bad bets on assets with lower ratings -- indeed, in its bombshell news this week, Merrill Lynch warned it could not guarantee against such a risk. In such a climate, default insurance has become the hot new buy among large investors.">
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