Credit-default swaps on Rolls-Royce tightened briefly last week after it released its annual results, before widening as investors recognized the company's GBP1.1 pension shortfall could be a long-term problem and could lead to a ratings downgrade. On Tuesday spreads tightened to 265 basis points/280bps from 295bps/305bps, after the results, but almost immediately widened back out to 300bps/315bps. Traders said this initial tightening happened because the net debt position of the company had not grown as much as anticipated. One trader said after the results were released, volumes quadrupled. He saw about a dozen trades in one day.
There is a chance Standard & Poor's will downgrade Rolls-Royce two notches, said James Ravine, senior credit analyst at Barclays Capital in London, which would give the manufacturer a BBB rating and widen spreads. Ravine said he remains negative on the credit because the company may have to boost its contributions to its pension fund. In addition, half of the business remains civilian, so it has exposure to a drop in airline demand if there is a war in Iraq.
Technical factors may compress spreads on Rolls-Royce in the near-term, but in the long-term levels should continue to widen because of the pension shortfall, traders noted. One trader explained that recently credit-default swaps spreads have tightened as firms structure collateralized debt obligations.
Five-Year Credit Protection On Rolls-Royce
