NEW YORK, Dec 10 (Reuters) - U.S. municipal bonds were viewed as having more risk than U.S. high grade corporate bonds for the first time on Wednesday, based on contracts insuring their debt.
Credit default swaps (CDS) protecting the debt of California meanwhile, jumped to similar levels as that of contracts insuring Mexico's debt. Investors were fretting over the impact any financial bailout of California might have on its CDS.
"A confluence of events -- an economy in recession, decreasing home values and increasing unemployment -- has combined to reduce municipalities' sources of income," said Gavan Nolan, credit analyst at Markit, a data provider that owns a series of benchmark credit derivative indexes.
A CDS index based on muni debt, known as the MCDX, jumped to 330 basis points on Wednesday, compared with a spread of 269 basis points for the high grade corporate credit derivative index, according to Markit.
The muni index, which is based on 50 muni CDS, is less liquid than the corporate index, making its moves more exaggerated.
Nonetheless, the record spread still indicates increasing concern over the health of muni finances, analysts said.
"Several municipalities have announced recently that they are experiencing financial difficulties," said Markit's Nolan. "The likes of Michigan and New York City, exposed to the struggling auto and financial sectors respectively, demonstrate the importance of credit risk in the municipal market."
CALIFORNIA
The cost to insure California's debt remained elevated on Wednesday, after hitting a new high on Tuesday, on concerns that any government bailout of the state may take a similar form to the bailout proposed for the auto industry, which may trigger payments on the contracts.
California's credit default swaps have jumped to around 387 basis points, or $387,000 per year for five years to insure $10 million in debt, compared with 308 basis points a week ago and 187 basis points at the beginning of November, according to Markit data.
This level is comparable with contracts on Mexico, which trade around 370 basis points, Markit data shows.
"Concerns over the language in the auto bailout regarding super seniority gave rise to considerable concerns over California (and its potential bailout)," said Tim Backshall, chief strategist at Credit Derivatives Research.
Congressional Democrats offered bills to aid U.S. automakers in the House of Representatives and the Senate on Wednesday, including up to $15 billion of loans.
The bills specify that existing bonds of automakers that receive government loans will be subordinated to the new loans in so far as it is permitted by the terms of the debt.
Government intervention in the auto industry also may result in CDS insurance written on automaker debt needing to be paid out, though this will depend on the language in the final bailout bill.
If a bailout of California uses similar language, this also means that contracts protecting the state's debt may need to be paid out.
No data specifying outstanding CDS volumes on California's debt are available, though around $780 billion in net volumes are outstanding on muni CDS indexes, according to the Depository Trust & Clearing Corp, which confirms the majority of trades in the market.
The government of California, the world's eighth-largest economy, is struggling with a growing deficit.
General fund revenues in November came in below expectations at $1.3 billion, suggesting the government of the most populous U.S. state could run out of money as early as February, State Controller John Chiang said on Tuesday. For details, see [ID:nN09294034] (Reporting by Karen Brettell; Editing by Chris Reese)
