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Bond Risk Falls in Europe Before Second Round of ECB Lending

The cost of insuring against default on European sovereign and corporate bonds fell before the European Central Bank provides a second round of unlimited funds to banks tomorrow to help ease the region’s crisis.

The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments fell two basis points to 344 at 10 a.m. in London. A decline signals improvement in perceptions of credit quality.

European banks will probably borrow 470 billion euros ($632 billion) in three-year funds from the ECB, according to a Bloomberg News survey. Investors shrugged off a suspension of the use of Greek bonds as collateral after Standard & Poor’s downgraded the nation to “selective default” and a request for a ruling on whether swaps should pay out.

“Everybody is waiting for the outcome” of the ECB’s financing operation, said Maureen Schuller, an analyst at ING Groep NV in Amsterdam. “If it falls significantly short of expectations, it may be perceived as not doing enough to ease refinancing concerns for banks. If it’s too big it may signal a too-heavy reliance on the ECB.”

The International Swaps & Derivatives Association said late yesterday it has been asked to rule on whether credit-default swaps on Greece should trigger after the ECB exchanged about 50 billion euros of the nation’s bonds for new securities to sidestep losses being imposed on private investors. The switch makes the ECB effectively, though not legally, senior to other bondholders, according to JPMorgan Chase & Co.

Legal Change

There must be a legal change in the ranking or priority of bondholders for credit-default swaps to be triggered, according to ISDA rules. The group’s determinations committee decides whether contracts can be paid out.

A similar request on Irish swaps was rejected last year when the committee ruled subordination hadn’t occurred because of the International Monetary Fund’s preferential creditor status in that nation’s rescue.

The cost of insuring corporate debt also fell with the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings dropping eight basis points to 572.5, according to JPMorgan. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings fell two basis points to 130 basis points.

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers decreased 5.5 basis points to 210 and the subordinated index dropped 8.5 to 356.5.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. 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.

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