Fallout from the derivatives debacle in Orange County, Calif., is raining everywhere you look -- and the bank bond market is no exception.
Since the news broke that Orange County's investment fund lost more than $1.5 billion in derivatives trading, bank bond spreads -- the difference between the 10-year Treasury note and banks' 10-year subordinated debt -- have widened by as much as 10 basis points.
"So far, the ripple effect of Orange County is more directly affecting securities firms than banks, but we believe the indirect effect on the bank sector is certainly chilling," said Ann L. Robinson, a fixed-income analyst with Bear, Stearns & Co.
"There is an atmosphere of uncertainty out there that just does not prompt interest in bank bonds -- a feeling of 'where will hits come from next?' compounded by the likelihood of further tightening" of interest rates by the Federal Reserve Board.
A recent BankAmerica Corp. issue suddenly widened to 97 basis points from 89 basis points after the banking company was listed among the unsecured creditors in Orange County's bankruptcy filing.
Some of that movement later reversed when investors realized the bank's role was as trustee and not as a major lender, she said.
Other new issues have also widened considerably. Bank of New York Co.'s recent 10-year issue was trading 10 basis points higher last week than the previous week.
The furor over the affluent county's bankruptcy is hardly the only problem to beset the bank bond market.
Indeed, analysts said the Orange County fiasco has merely magnified other forces. Some said the wave of third- and fourth-quarter restructuring charges by the likes of Mellon Bank Corp. PNC Bank Corp., and Banc One Corp has reinforced the adage that rising rates are bad for banks.
The derivatives nightmare at Bankers Trust New York Corp. -- which has faced lawsuits by dissatisfied clients and regulatory probes of its derivatives sales operation -- has added uncertainty to the market, said Ethan M. Heisler, a Salomon Brothers Inc. analyst. Largely as a result of these factors, spreads have increased by 25 basis points since September, Mr. Heisler said.
Lack of investor interest in bank bonds is likely to push spreads to 120 basis points, from the mid-90s today, before the issues become popular again, Mr. Heisler said. Problems in the mutual fund business will further roil the market for bank bonds, the Salomon analyst said.
Banks that have marketed funds are now at risk of regulatory action if they failed to inform customers that funds are not insured, he said, while some also risk having to compensate customers for losses on mutual funds.
