Credit Spreads Widen On Bank Fears, RBS Wider

European credit spreads widened on Tuesday, with subordinated bonds of Royal Bank of Scotland
falling further on concerns the bank will not pay coupons on some of its Tier 1 debt.

By 0920 GMT, the investment-grade Markit iTraxx Europe index was at 165 basis points, according to data from Markit, 2 basis points wider versus late on Monday.

The Markit iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was at 995.75 basis points, 5.75 basis points wider.

The UK government announced a second bank rescue plan and raised its stake in Royal Bank of Scotland to almost 70 percent on Monday after the bank revealed the biggest loss in British corporate history.

BNP Paribas credit strategists said the bailout was neutral to positive for senior and Lower Tier 2 RBS bondholders, but particularly negative for the lowest ranking Tier 1 bondholders.

UK Tier 1 bank debt fell between 5 and 10 points on Monday, in what Deutsche Bank credit strategist Jim Reid called panic selling.

The worst performer was a 2017 RBS Tier 1, non-step bond which closed 7 points lower at 30 percent of face value on Monday, BNP Paribas said. One trader said the bonds fell further to around 20 percent on Tuesday, while five-year credit default swaps on RBS were about 15 basis points wider at 135 basis points.

On a call on Monday, "the management answer as to what their policy would be regarding hybrid coupons was not very reassuring," said BNP Paribas in a note, adding that RBS said the decision on whether to pay coupons on its hybrid bonds would be made at the time of its full-year results.

Later in the session, the focus is likely to be centred on the inauguration of Barack Obama as U.S. President and his administration's plans to pull the U.S. economy out of recession.

"We do think that the U.S. will be keener to demonstrate the desire to keep the banks in the private sector for longer," said Reid.

Despite the more negative backdrop, the new issues market continued to see new deals with Spain's Telefonica and Iberdrola bringing deals on Tuesday.

Telefonica plans to issue a five-year euro-denominated benchmark bond, with guidance set at mid-swaps plus 250 to 260 basis points, IFR reported on Tuesday.

Iberdrola, meanwhile, plans to sell a 15-year benchmark sterling bond, with guidance set at gilts plus 290 to 300 basis points, IFR said.

In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 286.2 basis points more than similarly dated government bonds, 1.0 basis point up on the day.

In underlying government bond markets, the yield on the interest rate sensitive two-year Schatz was 1.515 percent, 1.7 basis points down on the day. The 10-year Bund yielded 3.010 percent, 1.8 basis points higher.

The 10-year euro swap rate was 3.5650 percent.