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The cost to insure Australian bank debt is rising

NPhoto by Spencer Platt/Getty Images

On the back of a slowing housing market, uptick in home loan arrears, commodity price rout and persistent concerns surrounding its largest trading partner, China, the perceived riskiness of Australian banks is on the rise, according to the credit default swap (CDS) market.

A CDS is a contract that transfers the credit risk of a fixed income product from one counterparty to another. The buyer pays the seller up until the contract expires. In return, the seller agrees to pay the buyer the maturing face value of the investment, as well all interest payments, in the event of the issuer of the underlying security defaulting on its obligations.

In essence, it’s taking out insurance on a fixed income product.

According to analysis from Bloomberg, the average cost of protecting bonds issued by the four largest lenders in Australia – CBA, Westpac, ANZ and the NAB – climbed to 29 basis points more than the average for the four biggest American banks last week, the widest gap in perceived riskiness seen going back to 2004.

Here’s Bloomberg:

The rout in global credit drove the cost of protecting Australian bank bonds to a more than three-year high of 139 basis points on February 11, CDS data show. It was at 126 on Friday. In the meantime, the average CDS cost on the biggest American lenders has retreated from its Feb. 11 high of 122 basis points to 104 at the end of last week.

The rise in credit default swap pricing follows a similar widening in the spread demanded by investors to buy bonds issued by Australian lenders.

According to Bloomberg, the NAB sold $2.25 billion in three-year bonds at a spread of 98 basis points to underlying swaps pricing last week. That compares to a spread of 88 basis points for bonds of a similar tenor issued by the ANZ last month and just 78 basis points for three-year debt issued by the CBA, Australia’s largest bank by market capitalisation, in October last year.

Like the CDS and bond market, the share prices for Australia’s largest lenders have copped a pummeling over recent months. As the chart below shows, with the exception of Westpac, from June 30 last year all have fallen by more than 10%.

You can read more here.

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