A Tale of Two CDS
2What the Dickens is going on? Five year credit default swaps in Royal Bank of Scotland reached an all time high of 407 basis points last week; that is to say someone is willing to pay over 4% a year to insure bonds or deposits in the bank for a five year period. That seems more than a little excessive for a bank with a middle “A” credit rating from the three big rating agencies.
By comparison, Skipton Building Society has the much more acceptable five year CDS of 208, despite having credit ratings between 3 and 5 notches lower than RBS. Moody’s even rates it as speculative grade, a polite term for what some would refer to as junk status. Which is the safer home for your cash though? Should you believe the rating agencies, with their thorough but rather slow analysis of credit risk; or do you place your faith in the ups and downs of the financial markets?
Royal Bank of Scotland, of course, has fallen on Hard Times recently. It had Great Expectations for its acquisition of the Dutch bank ABN Amro, which proved disastrous for both RBS and its new owner the UK taxpayer. The RBS Group operates around the world, and has subsidiaries throughout Europe as well as the 8th largest bank in the US, Citizens. There is no surprise, then, that global economic events are reflected in the CDS and share prices of Royal Bank of Scotland. Its credit ratings, though, seem to reflect higher levels of potential government support than the market thinks likely.
Our Mutual Friend in Skipton, on the other hand, operates almost exclusively in the UK. It might be reliant on earning interest income from the mortgages it has lent on a few Bleak Houses and an Old Curiosity Shop, but at least is has no direct Eurozone exposure. Credit rating agencies believe that building societies have little chance of external support – they have no shareholders to tap for rights issues, and might be too small for the government to bother rescuing. However, Skipton’s recent acquisitions of Scarborough and Chesham Building Societies, alongside many other mergers in the sector, suggest that
mutual support remains strong.
Treasury managers making investment decisions this month and hoping to avoid the Ghost of Christmas Past will no doubt take both credit ratings and CDS into account and treat all banks and building societies accordingly.
David Green is the Head of Sterling Consultancy Services, a provider of treasury management advice to local authorities and other not for profit organisations. This is the writer’s personal opinion and does not constitute investment advice. It should not be relied upon when making investment decisions.
I would agree strongly that counterparty assessment should go beyond simple reference to credit ratings.
Noting the rather flat profile of Skipton’s CDS would you agree that it is not frequently traded? In fact when did it last trade and can you confirm the source of the pricing for Skipton’s CDS?
Yes, Skipton’s CDS is traded quite infrequently, which reduces its usefulness as a measure of credit risk, although I would argue that its better than nothing. The spreads charted are Reuters end-of-day five year senior unsecured “modified-modified restructuring” CDS, displayed in basis points.