Lehman Brothers' announcement Tuesday that it plans to use Fitch Ratings credit ratings as one of the factors in determining which securities to include in its index had an immediate impact for one company: five-year credit default swaps on TXU Corp. tightened to around 80 basis points from 93bps a week before.
Lehman will factor in ratings in its U.S. Credit Index by calculating the middle rating from Fitch, Moody's Investors Service and Standard & Poor's. TXU got an immediate boost because the market priced in the fact both Fitch and S&P rate the Dallas-based energy player's five-year credit a BBB negative, while Moody's puts it one notch lower at a Ba1.
A few weeks ago, TXU's spread ranged between 80-85 bps before widening out to the 90-95bps area. One trader said a mixed bag of investors used the widening as an entry point to get long on risk. "The Street was short on risk, so they started buying protection," he said, adding technical factors could also be behind TXU tightening. Market players were caught long CDS which drove the spread tighter. "I think the Street is still a bit short," he said, adding TXU's spread can narrow another five to eight bps.
Other energy companies which now qualify for the Lehman index include FirstEnergy Corp., Amerada Hess Corp. and CenterPoint Energy. The change in index inclusion rules resulted in the addition of 59 securities worth approximately USD33.4 billion. Lehman will include them in the index come July, when it will begin factoring in Fitch's rating.