As many financial firms prepare to release earnings reports this week, investors will learn whether they were right to start thinking about a recovery in financials. Nevertheless, in wary credit markets, others believe that stock investors might have gotten ahead of themselves.
One yardstick of the amount of “worry” present is via the credit-default swap market, insurance contracts that pay off when a company defaults on its debt. The price tag of default insurance on a wide range of financial firms has risen sharply in the past few months in the face of the spreading mortgage crisis. Coverage became less expensive on Countrywide debt following Bank of America’s purchase announcement last week, but costs for the coverage continue to rise for other companies, a sign of the dangers investors still see as plaguing the industry.
Case in point: municipal bond insurers MBIA, which has significant exposure to floundering mortgage debt. Friday, it cost $898,000 annually to buy default insurance on $10 million of MBIA’s own debt over five years, says Credit Derivatives Research LLC, a 7 percent increase from just two days earlier, before the Countrywide bailout prompted investors to start talking about bottoms.
Those who already poured money into MBIA – for example, Warburg Pincus, Third Avenue funds, and others -- have seen their investments decline quickly. MBIA was able to secure another $1 billion in capital last week by selling new debt securities, but it had to agree to pay a hefty 14% interest rate on them.
“Are there other time bombs? Absolutely,” believes Kevin Murphy, a bond portfolio manager at Putnam Investments in Boston. According to Murphy, “The financial sector will continue to take some significant losses, and the system still has risk. Some capital has been destroyed and it needs to be replenished.”