Bank CDS blowout

A credit default swaps (CDS) is a derivative that enables market players to insure holdings of bonds (as well as gamble on their price movements). CDS prices of Australia’s big four banks are on the move – the wrong way. Here is a chart of recent market action:

On a longer term time time frame we can see that the blowout is very rapidly approaching the risk aversion pricing that struck during the first European debt crisis in May 2010:

For what it’s worth, that looks like a cup and handle formation on the chart, which suggests a further move upwards.

For some context, here are the CDS prices of other assorted American banks:

We can conclude several things. First, Australian bank CDS prices are suggesting a much higher risk profile to their debt than credit ratings suggest. The volatility also shows that the banks’s debt is considered relatively risky next to many major US banks. Finally, the congruence of the move in big four’s debt, I would argue, shows how global markets pretty much perceive them as a single block, protected more or less by the same government guarantee.

The good news is that the underlying bond spreads have not moved as much as the CDS prices suggest.

Houses and Holes
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  1. “The underlying bond spreads have not moved as much as the CDS prices suggest.”

    Why don’t they move the same way ? Should be correlated isnt it ?


    • Also bonds could be held by “slow moving” organisations like banks and traditional bond managers.

      Bond Manager: Errrr, should I hold more gov’t bonds or more corporate bonds?

      CDS Market: Sell out you fool!

  2. Interesting indeed. This is the very ‘indicator’ Pater Tenebrarum (Acting Man) has been anticipating for some time.

    He regularly covers a number of areas but always the Big 4 despite his site being US/Euro focussed. He has long held concern re the Big 4 (property portfolio risk factors) and kept watch – felt that when the spreads moved like this it obviously told two stories, one the Aussie property bubble was over (likely to implode) and the other that the markets knew this. Will have to wait and see where it goes from here.

    Bill Evans’ position is looking like a plea.

  3. Hey, Glenn Stevens, the CDS Band are playing your song-shake your moneymaker!

    Chuck said to keep dancing whilst the music’s playing.

    And no, that is NOT coffee percolating.

    • It’s largely an account of the major banks’ derivative portfolios, dominated by interest rate and foreign currency swaps, which are why we don’t have a LAtin American style debt crisis problem because we’re swapping foreign borrowings into Australian dollars…

      • Hi H&H is that statement in reply to Adrian’s question given in isolation or does it factor the mortgage re-hypothication as per DT contributions?

        I.e. foreign debt nominated in AUD to reduce currency risk. Is that it for the $15Trillion in mainly the two classes mentioned. Or better put, are they genuine hedges or speculative bets? They may reduce risk of an “explosion” but what risk heightening properties do they have for the opposite- an “implosion”.

  4. “The good news is that the underlying bond spreads have not moved as much as the CDS prices suggest.”
    Just a matter for the naked CDS holders to “persuade” the rating agencies to give it a lil nudge to help move things along 🙂

  5. Good info, H&H. Thanks.
    Is there by any chance a central – peripheral bias in the CDS numbers? You compared our numbers to US Banks (similar to Capital One’s??? God help us!) but what about Canada, Brazil for example?