Credit Markets Update: European spreads drift wider due to negative sentiment

Credit default swap spreads in Europe drifted gradually wider during the week, reacting to weakness in the equity markets and general economic pessimism. Five-year debt protection spreads were 30 to 40 basis points wider on European telecoms, 3-8bp wider on utilities and 3-5bp wider on industrials and autos. But trading volumes were relatively light as the Fifa World Cup continued to focus attention away from the trading floors, traders in London said.

“We have seen something of a rally in spreads over the past three or four weeks, and the market is now reacting against that,” said Stephen Mills, a credit derivatives trader at Bank of America in London. Negative market sentiment has pervaded due to concerns over flagging US markets, corruption charges in some major US names and whether the global economy will pick up, he added. “There is little good news to drive the markets tighter.”

Five-year credit protection on telecom firms KPN, Telefonica and Deutsche Telekom widened 30-40bp over the week, trading at 250bp-mid, 126bp-mid and 280bp-mid respectively today. Spreads on France Telecom also widened from 395/410bp on Wednesday to 440/460bp today.

“The [credit derivatives] markets are thin and volatile, and fragile credits such as France Telecom and Deutsche Telekom are suffering,” said another trader in London today.

News in the financial press yesterday regarding further cash burdens for France Telecom also contributed to the widening on its five-year protection, said the trader. It emerged that the telco will have to pay about €457 million ($424 million) in cash relating to a disposal of Crown Castle Entertainment, a communications business it sold in June 2000. The contingent liability requires France Telecom to reimburse the buyers the difference between the company’s share prices then and on June 30 2002. The Financial Times in London reported that France Telecom said the payment will be made in July.

Spreads on utilities Endesa, Vivendi and E.On widened out 3-8bp this week in light trading. Standard and Poor’s downgraded German-based multi-utility RWE one notch to A+ reflecting deterioration in the company’s financial profile. Credit default swaps on RWE traded today at 43/49bp, about 5bp wider on the week.

In the industrials sector, the cost of credit protection for UK-based metals group Corus rose. Analysts are predicting weak profits projections and a potential downgrade for Corus, said Mills at Bank of America. Spreads on Corus rose from 283/320bp to 315/360bp after the stock fell roughly 17%. Spreads also widened by 3-5bp on Lafarge and Siemens towards the end of the week.