Feb 12 (Reuters) - Credit derivatives indexes in Europe have set repeated new record highs in recent days due to fears over the unravelling of complex credit instruments.
The Markit iTraxx Europe index ITRAC5EA=GFI has been at the centre of attention, displacing the previous focus on the iTraxx Crossover index ITCRS5EA=GFI. Here are five facts about the Europe index.
*125 COMPANIES The index, run by derivatives pricing group Markit, is made up of 125 investment-grade companies — those rated at or above Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s and Fitch Ratings.
The index contains financial companies such as Barclays (BARC.L) and Deutsche Bank (DBKGn.DE), and also non-financial companies such as retailer Marks & Spencer (MKS.L) and carmaker Peugeot (PEUP.PA). For a full list of members, click on <0#2I666VAH85E>.
A standard contract on the index is for 10 million euros of credit protection on the debt of the underlying companies for five years. Each company accounts for 0.8 percent of the exposure.
The index on Tuesday hit a record high just above 110 basis points, according to data from Markit. That means it costs 110,000 euros a year to insure 10 million euros of debt against default.
At that level, the index is 60 basis points wider than at the start of the year, and some 90 basis points wider than its all-time lows, reached ahead of the credit crisis. The widening in the index spread has been particularly pronounced in the past few days. In the past week it has widened some 25 basis points, according to data from Markit.
*STRUCTURED PRODUCT UNWINDING
Analysts and traders say the sharp move has been driven by the unravelling of complex structured credit products built from derivatives, such as collateralised debt obligations (CDOs).
The creation of these products, which essentially involve investors selling credit protection on a group of companies, was one of the factors that helped to drive spreads tighter during the credit bull market between 2004 and the first half of 2007.
Now that the products are being unwound, spreads are being forced wider as investment banks and others use the indexes to hedge the resulting exposures, analysts say.
This has hit the iTraxx Europe index hardest as the underlying pools are made up mainly of investment-grade companies.
*PERFORMANCE VERSUS CROSSOVER The Europe index has sharply underperformed the Crossover index, which is made up of 50 mostly “junk”-rated companies, even though the underlying companies are seen as less risky from a credit perspective.
According to Deutsche Bank, in the first half of 2007 the ratio between spreads on Europe and Crossover was 1:12; it is now around 1:5.
The spread on the Europe index has more than doubled since January 1, while the move on Crossover is more restrained, at 66 percent wider than the start of the year.
*ROLLING CONTRACT The current index contract is series 8; a new series of the index is launched every six months, with series 9 due to begin in March.
This allows the index to be rebalanced to include companies with the most traded underlying default swaps as well as to remove companies that fall below investment-grade status.
For more details and data, please visit Markit’s index website at www.indexco.com or click on ITRAXXCDS. (Reporting by Richard Barley; Editing by Quentin Bryar)