Time For An ETN Checkup?
June 22, 2012
Downgrades of major global banks should give investors pause about what this means for the ETN holders. But how worried should they be?
Yesterday, Moody’s downgraded five of the six largest U.S. banks—Bank of America, Citigroup, Goldman Sachs, J.P. Morgan Chase, and Morgan Stanley—along with Deutsche Bank, Barclays, HSBC, Credit Suisse, Royal Bank of Scotland, BNP Paribas, Credit Agricole, Societe Generale, UBS and the Royal Bank of Canada.
Most people would probably worry about the state of the economy, which is fair.
The market tanked yesterday and Bank of America and Citi Group are now just two notches away from junk bond status.
I must admit, however, that my first thought was something far simpler—and probably less important in the grand scheme of things; namely, what does that mean for ETNs?
After all, the list of banks above reads a lot like a list of the biggest ETN credit counterparties.
When you buy an ETN, you’re buying senior, unsecured debt of the issuing company. The difference is that there’s no element of credit risk involved in an ETN’s price.
Generally, higher-risk counterparties have to offer higher yields to entice investors to take on their debt, and bonds will trade at a discount to par when their issuer’s credit risk increases.
That’s not the case with ETNs.
There are currently 217 ETNs listed in the U.S., and the vast majority of them—87 percent—are backed by Barclays, UBS, Deutsche Bank and Credit Suisse.
Barclays, UBS, Deutsche Bank and Credit Suisse currently all have CDS rates around 1%, while other, less ETN-friendly, banks are in much worse shape.
The good news is that yesterday’s ratings change didn’t have much of an effect on CDS rates: In fact, it had a marginally positive impact, since the downgrades weren’t as bad as people expected them to be.
The bad news is that spreads are still really, really high.
Morgan Stanley, Svenska Handelsbanken AB, and Citigroup all have CDS rates in the danger zone—particularly Morgan Stanley, at 3.1 percent.
With all that said, these spreads have been elevated since late 2011, and nothing catastrophic has happened to holders of these banks’ ETNs.