Managing Your ADRs: The Case of European Financials

Taking a look at the yield curve in the UK; the yield on the 10-year gilt recently rose above that of the 2-year gilt for the first time since Q2 of 2006 as the yield curve shows signs of normalizing. The spread between the 2-year gilt and the 2-year swap has, over the past week, risen to its highest level since the early 1990’s as market participants move away from corporate debt and into sovereign debt. Similarly, 5-year credit default swaps on UK financial companies such as HBOS (HBOS), HSBC (HBC), Lloyds (LYG), and Barclays (BCS) are currently trading at lifetime highs, breaking above previous highs set in late August/early September. Set in an atmosphere of sharp volatility, these developments, along with investor’s ‘jittery’ behavior suggest that the general market consensus is that the long arms of the sub-prime crisis are still bent at the elbows.

Over in Germany the spread between 2-year swaps and the 2-year bobl has also reached its highest level since the 1990s. While credit default swaps are only above their August levels in some cases, namely Allianz (AZ), Bayerische Hypo, and Deutsche Bank (DB), they are certainly on the rise. As one might expect, a flight to sovereign instruments away from corporate debt, as well as a rise in credit default swaps can be observed in most major European countries. The data paints a simple picture. Over the coming weeks and months volatility is likely to continue, especially within the financial sector, as market uncertainty seems to be on the rise. While everyone has their own approach, it may be best to throw a cautious eye at the European financials. Better safe than sorry.