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Banks’ Junior Bond Risk Set for Record Quarterly Decline on LTRO

The cost of insuring against default on subordinated bank debt in Europe is heading for a record quarterly drop, while corporate and senior financial risk is set for the biggest declines since June 2009.

The Markit iTraxx Financial Index linked to junior debt of 25 banks and insurers fell as low as 350 basis points today from 512 at the start of the year, according to JPMorgan Chase & Co. A decline signals improvement in perceptions of credit quality.

The European Central Bank’s unprecedented 1 trillion euros ($1.3 trillion) of loans to financial firms under its longer-term refinancing operations headed off a credit crunch. Policy makers are near an agreement to bolster rescue funds to shield Spain and Italy after swaps on Greece were triggered this month by the largest-ever debt restructuring.

“The tightening is to do with the impact of LTRO on bank funding and general systemic risk falling out of the equation,” said Roger Francis, a financials analyst at Mizuho International Plc in London. “There’s some end-of-quarter profit taking and renewed concerns about Spain and Italy.”

The credit market rally is tapering off and the subordinated index was unchanged at 359 basis points at 11 a.m. in London and is up on the week and month.

The Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings dropped as much as 18 basis points to 601, before trading at 609, JPMorgan prices show. That’s down from 755 at the start of the year.

Europe Index

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings fell as much as 3 basis points to 123, compared with 172.5 at the start of the year, and was trading at 125.

The Markit iTraxx Financial Index linked to senior debt fell as much as 4.5 basis points to 213.5, before trading at 219. It started the year at 277.

The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments fell three basis points to 270. The measure fell this quarter when Greece was removed after a payout on its default swaps.

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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