Niche Info Online Business

Simon Watkins, Financial Mail
16 March 2008, 12:36pm

Is your bank about to go bust? Before anyone gets too panicked by this aggressive opening gambit, I should say that despite Northern Rock and now Bear Stearns in the US, the likelihood of any High Street bank going bust is slim indeed.

But not impossible. And as with everything that is theoretically possible, the markets have a way to put a price on that risk and that is the price of a credit default swap.

CDSs are quite simple. They are contracts that allow someone who owns bonds issued by a company to insure themselves against it defaulting. The price of CDSs is measured in percentage points and is essentially a price for insuring debt.

For example, CDSs on Lloyds TSB are priced at about 1.33%, or 133 basis points. That means anyone with £10m of Lloyds TSB bonds could insure against it defaulting for £133,000 a year.

These prices move constantly because there is a market in CDS contracts, so watching the figures gives an idea of just how risky the market thinks a bank or any other company is. The higher the figure, the higher the risk.

Lloyds TSB has low exposure to US mortgage market toxicity and its 133-point figure is one of the lowest among banks. Most are in the same ballpark. Barclays, for example, is at about 170 basis points and HSBC 145.

To get a sense of what is a bad figure, let us take Bear Stearns, the bank that needed an emergency bailout last week. In the days and hours before the crisis hit Bear Stearns, its CDS price hit 720 points.

The message being sent out by the credit markets was clear - the bank's debt is very high risk.

So what are the other interesting figures? In the UK it is worth noting HBOS (Halifax Bank of Scotland). Its CDS price was about 235 points last week, a long way from seriously worrying but markedly higher than most other British banks.

This reflects its high mortgage exposure in the UK, its relatively high exposure to certain types of near-prime mortgages in the US and its slightly higher dependence on financial markets to fund lending.

More risky is Alliance & Leicester, whose price was about 342 points last week, again reflecting its high dependence on wholesale financial markets, which have become frozen in recent months. But the real horrors are in Iceland.

Credit insurance for debts at Iceland's biggest bank, Landsbanki, is priced at 610 points while that for Kaupthing is priced at a hair-raising 856. Given that these two have taken billions in UK retail deposits, it may be a sobering thought for savers to consider where they are putting their cash. These banks are now seen as the most unsafe in the developed world.

Of course, no one can be sure that disaster looms for anyone, but the figures on credit default swaps show clearly where investment professionals think the big risks are.

You have been warned.