Investors dumped bank bonds Thursday, reacting to Citigroup's disclosure of additional losses from exposure to foreign markets and rumors that a hedge fund was liquidating its holdings.
Citigroup-the merged Citicorp and Travelers Group-announced that its exposure to foreign markets had driven down third-quarter earnings. The losses came from Citigroup's brokerage, Salomon Smith Barney, and its global banking arm.
At the same time rumors tore through trading rooms that Eagle Global Value Fund, a fixed-income hedge fund with a significant position in bank bonds, was in trouble. No comment was available from Eagle.
Bank bond spreads-the basis-point difference between the yields of Treasuries and of corporate bank bonds-widened by as much as 30 basis points as investors panicked to sell the securities.
The trading came with bank bond spreads already wider than they have been for years. With many worried about the possibility of a recession on the horizon that could put pressure on bank capital ratios, the wider spreads indicate that investor sentiment has turned negative on banks. That would make it more expensive to raise capital.
Some of the biggest movements were in the bonds of money-centers, such as Bankers Trust Corp., Citicorp and J.P. Morgan & Co. Though regional banks' bonds held up better than money-centers', they were also caught in the downturn.
"Certainly this is the widest that bank spreads have been in about four years," said one trader, who asked not to be named. "This does not feel good. There are no buyers. None."
Market experts pointed out that investors are already skittish about the slowing economy, the possibility of recession, and the credit crunch that would result.
They are also concerned about deteriorating asset quality and dropping interest rates-an environment that makes it difficult for banks to make money.
But most market experts said that investors were especially spooked about rumors that another hedge fund might go under. Two weeks ago the Federal Reserve of New York and several banks stepped in to save the $3.2 billion hedge fund Long-Term Capital Management, which had suffered severe losses from emerging markets.
Long-Term Capital, which ranked among the top hedge funds, was a severely leveraged fund, which poses problems for banks that have made loans to them.
Market analysts said since the Long-Term bailout, rumors about other hedge funds going under have run fast and furious.
Sources said that the troubled hedge fund was the Eagle, a fixed-income hedge fund in Bloomington, Minn., with an estimated $2 billion of assets.
The Eagle fund reportedly got into trouble because it was leveraged against Treasuries, which have rallied in recent weeks.
A person who answered the phone at Eagle hung up when the caller identified herself as a reporter.
Investors fear that the assets of a so large a hedge fund, if dumped into the market, would put significant pressure on the already deteriorating spreads of corporate bonds.
Market analysts said investors' reaction was far too severe.
"The situation right now just defies rational analytical process," said bank bond analyst Eric Grubelich of Keefe, Bruyette & Woods. "There has been a mini-panic with the pricing of bonds."
Bank bond analyst Stanley T. August of First Union Capital Markets also said that the wide spreads in bank bonds are overdone.
"The last time banks were at these spreads there were serious concerns about the banking sector," Mr. August said. "Banks, however, are generally healthy. So it seems that the risk premium is out of sync with the condition of the industry."
