Spreads on three-year credit default protection on Verizon Communications widened last week after the telecommunications giant sold USD3 billion in convertible bonds. Before the zero-coupon, 20-year issue Wednesday, default swap levels on New York-based Verizon were at around 65/75 basis points, according to a credit derivatives trader in New York. As DW went to press on Friday, those levels had widened by about 20 bps, to around 85/95 bps. He added that convertible bond issues tend to push spreads out.
John Tierney, director, head of credit derivatives research at Deutsche Bank in New York, said credit default swap levels sometimes widen after convertible bond issuances because hedge funds and other convertible arbitrage players will buy protection on the name after they purchase the converts. He added that these players want the equity arbitrage opportunity, but not the credit risk. This may cause a sharp increase in the demand for the protection, which will widen the spreads, because it takes some time for the market to find sellers. Tierney added that the widening of Verizon's default swap levels is a reflection of the equity arbitrage opportunity, rather than a negative statement about the company's credit.
Another credit derivatives trader in New York noted that there had been fairly heavy trading of three-year protection on Verizon in the days after the convertible bond issuance. He said there had been at least 25 trades at around 80-90 bps, with typical notional sizes of USD5-10 million. He added that hedge funds were the most active players. The trader expects protection levels on Verizon to narrow in the next few weeks after the demand for protection caused by the convertible bond issuance eases.
