Utilities, tech and media most affected by CDS roll, says JP Morgan

In its ‘Credit Strategy Weekly’ research, published on Friday, JP Morgan examines the roll of credit default swaps into new on-the run five-year contracts. Beginning today (Monday), the new five-year tenor will have a maturity date of 20 September 2015, replacing the current contract.

As most curves are upward sloping, the new CDS should be wider than the current one, on average by about 1bp. However, the curve has a limited impact on “roll cost” compared to the bid/ask spread, says JP Morgan. One way to analyse the spread change associated with a single name CDS roll is to look at the level of the new 5.25 year CDS as a percent of the current five-year. Analysts illustrate that the largest spread changes are in the utilities, technology, and media/entertainment sectors. The least are in the insurance, financial services, and banks sectors.

In general, one would expect costs to change with spreads since curves tend to steepen when spreads tighten. The five-10 year part of the curve is inverted for most of the contracts that fall within the 600- 800bp five-year spread range. As a buyer of protection, you get the benefit of both the roll and the slide in this case, says JP Morgan.

The cost of rolling single name contracts for high grade versus the high yield names differs. On average, to roll the names in the high grade space will cost the buyer of protection about 1bp. For the high yield names, on average, the buyer of protection will actually gain 1bp from rolling contracts. The 1bp gain from the roll is negligible compared to the bid/ask spread.