Corporate CDS Indices

Because of the rapidly widening crisis in real estate, there has been a lot of attention in the ABX and CMBX indices tracking credit default swaps (CDS) for sub-prime and commercial mortgage-backed securities. They started showing signs of weakness as early as a year ago, well before the real estate situation became critical (see post from January 9, 2007 - "Some Rather Unpleasant Charts"). Thus, the CDS market was acting as an early warning signal, a canary in the mine.

Likewise, corporate bond and leveraged loan CDSs (CDX and LCDX respectively) are weakening significantly again, after their initial swoon and bounce in August.

LCDX spreads have jumped from 210 to 340 basis points in just one month; buyouts and other leveraged M&A transactions are facing strong headwinds. Banks will also have to further mark down their inventory of approx. $300 billion in such loans still sitting in their books, as they are unable to securitize and sell them to investors as CDOs. The golden age of LBOs is over and this has obvious consequences for share valuations in all stock markets.

The spread for investment grade corporate bonds (CDX IG, click to enlarge) has also rapidly moved towards its all time high, going from 45 to 78 bp in a manner of days.


Both of the indices are warning us that there is trouble ahead for the corporate sector. The canary may not be dead yet, but it has certainly stopped chirping happily and is looking rather distraught.