Sunday, June 8, 2008

Derivatives Traders Signal Bank Woes Likely to Worsen

Interest-rate derivatives traders are betting banks' difficulties obtaining cash to fund holdings and shore up balance sheets will worsen.

The difference, or spread, between the three-month dollar London interbank offered rate, or Libor, and the overnight index swap rate, traded forward three months, is greater than similar spreads expiring this month, according to data tracked by Credit Suisse Holdings Inc.

``The movement in the forward Libor-OIS spreads is telling you that the market is concerned that things can get even worse before they get better,'' said Carl Lantz, an interest-rate strategist in New York at Credit Suisse. ``Until all banks' balance sheets are cleaned up and they've re-capitalized, there is going to be funding pressure.''

Derivatives trades are showing that while global markets have rebounded since March, the worst may not be over for banks after racking up $387 billion of losses and writedowns from mortgage-related securities since the start of last year. Lehman Brothers Holdings Inc. has tumbled 18 percent in the past 2 days on concern it will require outside funding to shore up its balance sheet.

The three-month Libor-OIS spread traded forward to June 16, the date the June Eurodollar futures contract expires, was 67 basis points yesterday, while the forward spread corresponding to the September Eurodollar expiration was 72 basis points.

The spot three-month dollar Libor-OIS spread was 68 basis points today, after ranging from 24 basis points to 90 basis points this year and peaking last year at 106 basis points in December. The spread averaged 11 basis points for the 10 years prior to August, when the global credit crunch began.

Concern institutions are having difficulty accessing financing increased this week after Standard & Poor's lowered credit ratings for Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers June 2, citing the possibility that the investment banks will have further writedowns on devalued assets.

Lehman Options

Lehman Brothers, the fourth-biggest U.S. securities firm, may report this month its first quarterly loss since going public in 1994, increasing pressure on the company to raise capital, according to analysts at Oppenheimer & Co. and Bank of America Corp. Lehman may be forced either to sell all or part of itself to a bigger financial firm or sell a large quantity of new shares to bolster its finances, the Wall Street Journal reported today.

Options trading shows bearish positions on Lehman exceeded bullish ones by 1.6-to-1 yesterday, a two-month high. The cost of protecting debt sold by Lehman from default rose to 240 basis points from 150 basis points in the credit-default swaps market during the past week, data compiled by UniCredit SpA show.

``Instead of being an immediate bank-liquidity problem, Libor is now being affected by a longer-term capital problem,'' Chowdhury said. The market ``had previously expected the liquidity problems that had boosted the Libor-OIS spread to dissipate relatively quickly.''