Bank CDS spreads widen dramatically following Lehman collapse

The cost of protection on credit default swaps (CDSs) referenced to the world’s largest financial institutions has skyrocketed as Lehman Brother’s bankruptcy has heightened counterparty credit risk concerns.

The CDR Counterparty Risk Index (which averages the market CDS spreads of 15 major credit derivatives dealers) smashed through its previous widest levels of 250 basis points, set in the wake of the near-collapse of Bear Stearns in March, to reach a new all-time high of 389.33bp this morning.

“Counterparty risk is dramatically higher as the bankruptcy of Lehman Brothers ripples through the CDS markets. The market is in turmoil as massive unwinds of open CDS positions sweep across all desks and uncertainty surrounding the viability of the broker-dealer business model spreads contagiously across Europe and the US,” commented Tim Backshall, California-based chief strategist at independent credit research house and data provider Credit Derivatives Research, which compiles the index.

CDSs referencing US investment banks were among those experiencing the greatest spread widening, amid fears their business models expose them to the same weaknesses as Lehman Brothers.

Five-year CDSs on Morgan Stanley rose to 496.7bp on September 15, up from 215bp a week before, while CDSs referencing Goldman Sachs reached 344.6bp from 159.3bp over the same period. Wachovia’s hit 596.7bp from 291.8bp, and Citi’s climbed to 267.5bp from 165bp.

Spreads on CDSs referencing Bank of America, which bought Merrill Lynch in a $50 billion deal at the weekend, rose to 200.8bp on September 15 from 124bp on September 8. Meanwhile, Merrill Lynch’s CDS rose to 455bp on September 12 from 306bp at the start of that week. The bank’s CDS was trading at 334.6bp on September 15.

Concerns about other US financials also resulted in an increase in the cost of protection. CDSs referenced to New York-based insurance giant American International Group rose sharply to 1908.2bp on September 15 from 432.8bp the week before, while CDSs on Seattle-based savings and loan bank Washington Mutual reached 2747.2bp on September 12 from 1443.7bp on September 8.

Counterparty credit risk worries were also felt in Europe. Barclays Capital’s CDS was trading at 170bp on September 15 from 124.2bp a week earlier. Royal Bank of Scotland reached 160.3bp from 111.8bp over the same period, while UK banking and insurance firm HBOS climbed to 315.4bp from 213.5bp over the week.

See also: AIG secures £20 billion bridge loan, but still downgraded
Lehman Brothers bankruptcy to be largest in history