Thursday, January 29, 2009

New Issuance Negative Basis Trades at All Time Wides

In another take on the previously discussed basis trade topic, a curious statistic that few have paid attention to is the significant premia new issues have offered to existing comparable CDS spreads on the same issuer. The definition of the new issue premium is the spread of the new issue versus the matched maturity CDS spread. Whether it is a function of the basis spread aberrations in the secondary market, or just a method to incite existing CDS holders, or any other potential purchasers to purchase new issues (with a free hedge) is not sure, but seems to be the norm over the past several months.

Empirically, new issue premia have increased over the past 6 months, and even as spreads have tightened overall, some of the most recent market new comes have come at record wides to their corporate CDS: John Deere priced 333 bps wide to its comparable CDS on January 19, and Casino Guichard priced 326 bps wide on January 22.
As Felix Salmon of, pointed out it might make sense to entice the government to purchase these kinds of low- to mid-grade securities and not only in the secondary market via negative basis trades but in the primary market itself, especially as they can be completely hedged thru maturity, and on top of that make regulators happy by purchasing a non-naked CDS-cash bond pair trade.
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David Murphy said...

It's only hedged if the CDS counterparty performs to term...

What we are seeing here, I would conjecture, is the non-default components of the spread. The CDS are wide because of counterparty risk (and regulatory risk, and liquidity risk on margin, and ...), while the cash bonds are also wide (given any rational assessment of probability of default) because of funding risk. Central Banks can most easily manipulate those non default components of the spread by their collateral policy. If you can repo a corporate bond to term with the FED at a fixed haircut, then you can monetise the non-default related component of the spread.