US CREDIT-Basis trades offer opportunity as bond sales hit

By Karen Brettell

NEW YORK, Nov 30 (Reuters) - New corporate debt sales are pricing at wider spreads as credit concerns weigh on the bond market, while credit default swaps are rallying.

This makes it an ideal time to profit from divergence between the spreads of both securities.

"Following a substantial rally in equities on Tuesday and Wednesday, a flood of investment grade credits seized the better tone to tap the market," Morgan Stanley analysts said in a report on Friday.

"These deals have come considerably wide to credit default swaps," they said.

As the new debt is sold the basis, or difference between the spreads of corporate bonds and credit default swaps, has turned more sharply negative. Negative basis occurs when default swap spreads are tighter than those of comparable corporate bonds.

Credit default swap spreads on average are trading 28 basis points tighter than comparable bond spreads, compared with 13 basis points a week ago, JPMorgan analysts said.

The negative basis of some companies is 60 basis points or more, with Washington Mutual Inc (WM.N: Quote, Profile, Research, Stock Buzz) among the most negative at minus-167 basis points, they said.

When the basis turns negative, investors can buy a company's bonds and also buy protection with its credit default swaps to pocket the difference between the two spreads, while also taking on very little risk.