CDS spreads continue to tighten

Credit default swap (CDS) spreads on financial institutions had tightened further by close of play on September 19, as market confidence continued to rise after large injections of cash from central banks

The Credit Derivatives Research Counterparty Risk Index, which averages the five-year CDS spreads of the 15 largest credit derivatives dealers, dropped to 302.1 basis points on Friday, down from 389.8bp on September 18 and an all-time high of 419bp the day before.

Amid rumours of a government-led rescue for the financial industry, the cost of protection on Goldman Sachs tightened to 375bp on Friday, from 489.6bp the day before, according to Bloomberg. CDSs on American International Group (AIG), which received an $85 billion loan from the US Federal Reserve Board on September 16, were 991.1bp by close of play, from 1528.2bp on September 18.

Meanwhile, CDSs referencing Citi - which had reportedly been considering a bid for Washington Mutual- fell to 203.3bp from 298.3bp. The cost of protection on Washington Mutual fell to 1638.8bp on September 19 from 2159.1bp the day before, according to Bloomberg. CDSs on Bank of America, which bought Merrill Lynch in a $50 billion deal on September 15, tightened to 153.3bp from 182.9bp.

CDS spreads on Morgan Stanley widened, however, reaching 934bp on September 19 compared with a closing level of 865.8bp the day before.

In Europe, CDSs on Barclays tightened to 157bp on Friday from 212.9bp on September 18, while the cost of protection on the Royal Bank of Scotland fell to 187.9bp from 230bp.

CDSs on UK banking giant HBOS tightened to 254.2bp on Friday, from 294.2bp on September 18, following news of its takeover by rival Lloyds TSB. The cost of protection on Lloyds TSB also declined during the same period, from 195bp to 165bp.

On September 18, six major central banks announced a co-ordinated initiative to improve short-term US dollar liquidity. The Federal Open Market Committee authorised a $180 billion expansion of swap lines with the European Central Bank (ECB), the Bank of England (BOE), the Bank of Canada, the Bank of Japan (BOJ) and the Swiss National Bank. The announcement followed huge increases in liquidity lines earlier in the week, including $51.8 billion from the BOJ, $142.1 billion from the ECB, $70 billion from the US Federal Reserve and $44.6 billion from the BOE.

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