Default swaps follow strange track
Are the risks attached to the probability of liabilities repayment by major Australian banks much worse at the end of September than at the end of June as pricing on credit default swap spreads suggest?Or are the risks attached to the probability of liabilities repayment by many banks, especially in Europe, so much worse now than three months ago as widely quoted indices of bank credit spreads (such as iTraxx) suggest?At face value, the risk, and costs, of bank debt are much worse now. Financial markets have reconsidered (and taken fright) at the thorny problems around the credit, liquidity and capitalisation of European banks. The credibility of public sector debt-management plans, intended to shore up those banks and the common currency for Europe, are also a concern.Using the iTraxx index for five-year credit default swaps for major Australian banks, spreads have widened by 90 basis points to 220 bps since the end of June. Credit default swaps are a form of insurance contract against a borrower defaulting. They are also tradeable securities.This widening, if sustained, and reflected in the cost of new wholesale debt, will flow through to banks' cost of funds. And, as the CBA's CEO, Ralph Norris, has pointed out, this will put pressure on interest rates paid by all borrowers.It's worth noting, however, that while wide CDS spreads are often referenced, credit default swaps are rarely traded and may lack short-term relevance.The data for this article was sourced from Depository Trust & Clearing Corporation, the largest of the US clearing houses.DTCC data for credit default swap spreads shows the Australian iTraxx index moving in lock-step with the European index since the end of the second quarter of 2011. The Australian iTraxx has even moved ahead of the European index. This could be due to the relative illiquidity of the Australian index. (However, recent DTCC data shows contract volumes being similar with only contract values being substantially different. This suggests more significant differences in scale between the two markets rather than liquidity issues.) CDS spreads for the sovereign risk of Australia virtually mirror those of Germany, whereas there is little correlation with the much more muted rise in the spreads for US sovereign debt.These conditions help explain the extremely limited actions by banks in selling wholesale debt in recent weeks, at least in deals visible in public markets.Commonwealth Bank last week topped up, by A$25 million, the $250 million, two-year floating rate note first sold two weeks ago, through Colonial Finance, to a largely domestic investor base. These notes were sold at 150bps over bank bills.National Australia Bank included a US$400 million tranche in its $1.5 billion sale of mortgage-backed securities.Two weeks ago, the Australian branch of Rabobank placed a A$300 million addition to its July 2016 FRN line, priced at 115 bps over bank bills - a level unchanged on the pricing achieved when the line was opened in July.Three weeks ago, NAB completed an Uridashi issue, raising A$103 million for three years at a yield of