Sovereign Bond Risk Plunges as Leaders Ease Euro Bailout Rules

The cost of insuring European sovereign debt plunged to the lowest in almost two months after leaders of the 17 euro nations eased repayment rules for emergency loans to Spanish banks and relaxed conditions on help for Italy.

The Markit iTraxx SovX Western Europe Index of credit-default swaps on 15 governments fell 15 basis points to 282 at 4:15 p.m. in London, the lowest since May 8. The measure posted a fourth weekly drop and the first monthly decline since March, signalling an improvement in perceptions of credit quality.

The deal at the Brussels summit alleviates concern about bank failures and a collapse of the currency union that fueled a surge in borrowing costs for Spain and Italy. Financial debt risk tumbled the most this year after euro chiefs said they’re determined to “break the vicious circle between banks and sovereigns” to contain the crisis that began in Greece in 2009.

“This is an important development as it potentially breaks the sovereign-banking death spiral that has dogged the crisis,” said Harpreet Parhar, a strategist at Credit Agricole SA in London. “For today, and possibly a bit longer, this sets us up for an outperformance of financials and peripheral credits, but we would still urge caution.”

Preferred Status

After talks ended at 4:30 a.m. local time, the leaders dropped requirements that taxpayers get preferred-creditor status on aid to Spain’s banks and opened the way to recapitalize lenders directly.

Default swaps on Spain tumbled 56 basis points to a one-month low of 533. The contracts, which jumped to a record 633 on June 18, had their biggest monthly decline since January 2011. Ireland fell 50 basis points to 562 adding to a 21 percent rally this month, while Italy dropped 51 basis points to 488.

A basis point on a credit-default swap protecting 10 million euros ($12.7 million) 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.

The news from the summit also pushed government bonds higher. Spain’s 10-year bond yield fell 53 basis points to 6.41 percent, its first decline in a week after surging to 7.29 percent on June 18, data compiled by Bloomberg show. Italian rates dropped 39 basis points to 5.81 percent.

Bank Risk

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers fell 28 basis points to 261, its biggest daily decline since Nov. 30, while the subordinated index dropped 34 to 438. Both measures posted fourth weekly declines and the biggest monthly rally since January.

Contracts on the Markit iTraxx Crossover Index of 50 companies with mostly high-yield credit ratings fell 36 basis points to 664. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings decreased 11 basis points to 166. Both gauges had the biggest monthly rallies since January.

Default swaps on Banco Santander SA, Spain’s biggest bank, dropped 50 basis points to 425, after climbing to a record yesterday, Bloomberg data show. Contracts on Banco Bilbao Vizcaya Argentaria SA fell 50 to 449.

“The potential for the Spanish bailout to go directly to the banks rather than through the sovereign improves Spain’s creditworthiness,” said Elisabeth Afseth, a fixed-income analyst at Investec Bank Plc in London. “Expectations were very low ahead of the summit.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE