The cost of insuring against default on senior bank bonds rose after the European Central Bank was said to drop its opposition to holders of the securities taking losses in bailouts.
The Markit iTraxx Senior Financial Index of credit default swaps on 25 banks and insurers increased seven basis points to 280 at 1:44 p.m. in London, the highest since July 9, data compiled by Bloomberg show. The ECB backed imposing losses on senior bondholders of the most troubled Spanish banks at a July 9 meeting, a position rejected by euro-area finance ministers, said an official with knowledge of the ECB’s thinking.
When Ireland bailed out its banks after the country’s real estate boom turned to bust, the ECB insisted senior bondholders be spared losses to prevent them from pulling out of the market. Spain said it will impose losses on subordinated bonds and equity in exchange for a bank bailout of as much as 100 billion euros ($122 billion), though the draft of the agreement with the European Union doesn’t mention senior debt.
“It runs counter to everything the ECB’s said in the past,” said Roger Francis, an analyst at Mizuho International Plc in London. “I’m skeptical.”
A key condition for senior bondholders to share the burden of bank bailouts is if the institution in question is being wound down, according to another official familiar with the ECB’s thinking. Both people spoke on condition of anonymity because the talks are confidential.
An ECB spokeswoman wasn’t available for comment when contacted by Bloomberg News.
Credit-default swaps on Banco Santander SA (SAN), which isn’t calling for capital under Spain’s bank bailout, rose nine basis points to 434 basis points, Bloomberg data show. Swaps on Banco Bilbao Vizcaya Argentaria SA (BBVA), Spain’s second-biggest bank, climbed eight basis points to 456 basis points, the highest since July 12.
“The fact it was even considered is bad news for euro- region banks,” said Ramon Nieto, a fund manager at Geroa EPSV Fondos, which oversees 1.1 billion euros of assets in San Sebastian, Spain.
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. An increase in the contracts indicates deterioration in perceptions of credit quality.
While credit default swaps are increasing, bank bond prices are holding near 19-month highs. The Markit iBoxx Euro Financial bond index rose 0.04 percent to 91.57 after earlier reaching 91.6, the highest since November 2010. The gauge tracks 500 securities of banks and insurers from Barclays Plc to Swiss Re.
The Wall Street Journal reported today the central bank’s change of position and that ECB President Mario Draghi proposed the senior bondholder bail-in at the July 9 meeting.
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