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Massive deficit in Greece and Portugal threatens banks
CLANCY YEATES
February 5, 2010

Markets gripped by default fear

Fear is once more ruling global markets over the possibility of a sovereign default by Greece and Portugal.

GROWING fears over ballooning public debt in Greece and Portugal have sparked a fresh round of global credit markets jitters, which threaten to increase funding costs for Australian banks.

The market for credit default swaps - which gauge the risk of default by a company or government - suggest that investors are increasingly anxious about lending on global markets.

A wave of pessimism this week has driven CDS spreads on debt issued by the federal government and the big banks to their highest levels in more than six months, even though Australia's finances are widely seen as sound.

The once-obscure CDS market registers on many investors' radar because it was an early pointer to the credit woes that triggered the market meltdown of 2008.

The head of credit trading for UBS, Luke Fay, said the spread on Australia's sovereign debt had widened from about 30 basis points this year to 56 basis points yesterday, its highest level in six months.

CDS spreads of the big banks - Commonwealth, Westpac, ANZ and National Australia Bank - have widened to more than 90 basis points, their highest levels since August.

''The world's obviously a bit concerned about Greece, and the emphasis has shifted to some of the other peripheral European nations,'' Mr Fay said. ''We've deteriorated on the back of that, but we've performed in line with the other high-quality sovereigns of western Europe.''

Despite the increase, the spread on Australian sovereign debt remains well below the 190-basis-point peak reached in March last year. But analysts fear that any default by a government could cut investors' appetite for government or corporate bonds, threatening the health of credit markets.

The latest bout of market fears has been sparked by the massive deficits of several European countries. Greece led the way, posting the region's biggest deficit of 12.7 per cent of gross domestic product last year.

For Australia, the trend threatens to push up borrowing costs of banks, which obtain about 40 per cent of their funds on wholesale markets. The Reserve Bank governor, Glenn Stevens, drew attention to the rising concern over sovereign risk when explaining his decision to leave interest rates on hold this week.

The principal of fixed interest consulting firm ADCM Services, Philip Bayley, said the rising market jitters flowed into the price at which investors were prepared to lend to Australian banks.

''This [CDS] is how the market is judging the credit risk of the banks. It does start to feed into the cost of debt for Australian corporates and also for Australian banks,'' he said.

Other sources pointed out that CDS spreads of big banks had widened more than other companies, because markets were sceptical about the value of implicit government guarantees given to lenders.

In response to market fears, Greece has been forced to take swift action. This week it promised to cut this deficit-to-GDP ratio to 2.8 per cent by 2012, from 12.17 per cent, and it will have to report to the European Commission every quarter on its progress.

On Wednesday night the market's attention turned to Portugal. After a poorly received bond auction, Portugal's CDS sovereign spread blew out to a record high of 196 basis points.

Mr Bayley said a default from Greece, Portugal or Ireland would unleash the most severe turmoil since last year's recovery. ''If any of those were to default on their debt or if they were to remove themselves from the European monetary union, that would be a very significant event for financial markets,'' he said. ''At that stage you would see the cost of debt for all Australian borrowers moving sharply higher.''