By Davide Barbuscia and Shankar Ramakrishnan
NEW YORK (Reuters) -Credit risk indicators flashed red on Monday, as investors worried about contagion risks across corporate debt markets after the collapse of Silicon Valley Bank (SVB) and New York's Signature Bank (NASDAQ:SBNY) in the space of 72 hours.
An index of credit default swaps (CDS) on U.S. investment-grade companies rose to 90.2 basis points, its highest since November, after U.S. action to guarantee deposits at tech-focused lender SVB failed to reassure investors that other banks remain financially sound.
The equivalent index for CDS on junk-rated companies fell in price to 98.8 on Monday, its lowest since November. In Europe, the cost of insuring exposure to European junk bonds on Monday posted its biggest jump in three months.
Rising CDS spreads signal investors are hedging bets on a deterioration in credit quality.
"Unfortunately these things tend to rarely be isolated," said Jordan Kahn, president and chief investment officer at ACM Funds in Los Angeles.
"This is a really ugly credit event that's happening and the Fed and the Treasury have come out to backstop it, but even if there is some relief period after this, (my concern is) that it will spread to other things," he said. "There are other types of credit events that are likely to unfold."
Investment grade credit spreads, which indicate the premium investors demand to hold corporate bonds over safer government debt securities, have also been widening. This indicates that SVB's collapse last week, the second largest bank failure in U.S. history, has sparked broader concerns over whether companies can still fund themselves in a higher interest-rate environment.
Spreads for investment grade bonds widened about 15 basis points last week "in the worst week for credit spreads since the peak of pandemic stress," Daniel Krieter, director of fixed income strategy, BMO Capital Markets, said in a report.
The BlackRock (NYSE:BLK) Investment Institute said that after recently trimming its 'overweight' recommendation for investment grade credit, it was reassessing its view due to tighter financial conditions. "We prefer short-term government bonds for income," it said in a note on Monday.
In money markets, a closely watched indicator of credit risk in the U.S. banking system edged up on Monday.
With investors worried about possible bank runs, the Federal Reserve on Sunday unveiled a new program to ensure banks can meet the needs of all their depositors.
The Bank Term Funding Program should alleviate funding concerns, but it "will not likely stop deposit migration into the largest U.S. depository institutions," said BMO's Krieter.
Some bonds issued by Silicon Valley Bank were trading at around 40 cents on the dollar on Monday, down from nearly 90 cents early last week.
"Hedge funds are probably the ones that are buyers in this case," said Dan Bruzzo, a strategist at Santander (BME:SAN) US Capital Markets. Other banks with California exposure were taking the brunt of the sell-off in the debt capital markets, he added.