Verizon bond demand causes CDS-bond distortion
* CDS in Verizon undergoes decisive re-pricing
* Verizon 5-year CDS spikes to 99.5bp intraday
* Z-spread on 8.75% Nov 2018s increases to 192.5bp
By Melissa Mott
NEW YORK, Sept 11 (IFR) - The massive US$101bn demand for Verizon Communications' US$49bn bond that priced on Wednesday caused an optical distortion in the company's underlying CDS versus its cash bonds.
The five-year CDS spiked to 99.5bp intraday from 71.5bp on August 28 - when chatter first evolved about Verizon Communications' 45% stake purchase in Verizon Wireless.
The Z-spread on its 8.75% November 2018s increased to 192.5bp today from 98bp on August 28. The CDS-cash basis between the five-year CDS and the 2018s touched its most negative point since December 2011 at minus-92.99bp, according to Thomson Reuters data.
The Z-spread is commonly used to calculate the relationship between a credit's CDS levels and its cash bonds - otherwise known as the basis.
Riskier bonds usually have a large negative basis since there usually is an underlying concern about rapid credit deterioration. If this concern is coupled with significant widening, funding is perceived as more expensive. A larger negative basis is seen as compensation for an investor as it can generate the same returns as a more creditworthy name.
"The magnitude of Verizon's debt issuance leads us to believe that the distortion between the bond and CDS markets is likely to be due to technical factors," said Fitch Solutions' Diana Allmendinger.
Prior to the buyout speculation, the CDS-cash basis was minus-26.55bp and was minus-57.64bp before chatter of the new bond deal appeared. Since the Verizon bonds priced on Wednesday, the CDS-cash basis has eased back to minus-87.28bp, the Z-spread is now 174.53bp and the 5-year CDS tightened to 87.25bp.
CDS in Verizon underwent a decisive re-pricing to incorporate a growing fear of rating downgrade risk after it announced plans to issue a huge bond to fund the acquisition of the Verizon Wireless stake from Vodafone.
Allmendinger said the recent move wider in its CDS is indicative of where the market prices Verizon, at BBB+. And, the widening has combined with an increase in liquidity in Fitch's CDS Pricing universe, which "indicates more uncertainty within the marketplace over future pricing."
Fitch's implied rating, which reflects the historical CDS trading pattern, is steady at A.
Meanwhile, Markit's implied rating pegs the CDS a bit lower, at BBB. This CDS implied level is lower than where Moody's or S&P rating agencies grade Verizon's long term debt rating - at Baa1 and BBB+.
Moody's, S&P and Fitch all downgraded Verizon one notch on September 2 and 3, collectively. All the rating agencies cited the uptick in leverage and debt levels. Fitch cut the telecom to A-.
This risk aversion and protection buying, was evidenced not only in the increasing spread, but also by net notional.
DTCC data for the week ending September 2 shows a 6.58% spike in Verizon net positions to US$1.5bn and placing it among the top 20 biggest increases in net notional for the weekly period.