CDO Loss Speculation Raises Corporate Bond Risk to Record (Bloomberg) (20-02-2008)

Feb. 20 (Bloomberg) -- The cost of protecting corporate bonds from default has surged to a record as investors have been buying credit-default swaps to hedge against mounting losses in the $2 trillion market for collateralized debt obligations.

Because of the falling value of Securities known as constant proportion debt obligations that package indexes of credit-default swaps about $44 billion of assets may have to be sold. The value of the so-called CPDOs has fallen to as low as 40 percent of face value, according to Morgan Stanley.

Credit-default swaps on the Markit CDX North America Investment-Grade Index of 125 companies with investment-grade ratings jumped 9 basis points to 163 at 7:44 a.m. in New York, according to Deutsche Bank AG.

The CDX index of credit-default swaps doubled this year as bank losses and writedowns on debt investments soared above $145 billion worldwide. The equivalent iTraxx index in Europe rose 14.5 basis points today to a record 132.5, according to JPMorgan Chase & Co., up from 51 basis points on Jan. 2.

Moody's Investors Service downgraded 1.1 billion euros ($1.62 billion) of CPDOs arranged by ABN Amro Holding NV, Lehman Brothers Holdings Inc. and BNP Paribas SA last week as asset values fell. CPDOs arranged in 2006 by banks including Amsterdam-based ABN Amro may be forced to unwind if the iTraxx Europe index rises to 140, according to UniCredit's Brunne and BNP's Cicione.

Banks would seek to unwind CPDOs by buying credit-default swap indexes to offset their bets.

Contracts on U.K. mortgage lender Alliance & Leicester Plc jumped 40 basis points to 245 after the bank slashed its profit target for this year and next, citing rising borrowing costs and declining valuations on asset-backed securities because of the U.S. subprime mortgage slump.

Contracts on Standard Chartered Plc rose 3 basis points to 112 after the London-based bank abandoned a plan to refinance its $7.15 billion Whistlejacket Capital Ltd. structured investment vehicle, the largest SIV run by a bank to collapse.

The risk of defaults on European LBO loans is the highest recorded by the benchmark Markit iTraxx LevX Senior Index of loan credit-default swaps. The index fell to 90, according to Bank of America Corp. prices, the lowest since it started in October 2006. A level below 100 indicates loans are valued below par.

Source: Bloomberg