Cyprus Deposit Raid Stokes Senior Bond Concerns: Credit Markets

Europe’s unprecedented tax on Cyprus bank deposits is raising concern among holders of senior bank bonds that they’ll be made to take losses should another country need rescuing.

The Markit iTraxx Financial Index of credit-default swaps insuring senior debt of 25 banks and insurers rose as much as 19 basis points to 162 basis points yesterday, according to prices compiled by Bloomberg. That’s the biggest jump since Aug. 2, before the European Central Bank steadied markets by announcing its bond-buying program, and the gauge is now at the highest in almost three weeks.

European authorities pushed President Nicos Anastasiades to raid bank accounts to help fund Cyprus’s 10-billion euro ($13 billion) bailout, potentially providing a blueprint for imposing losses on senior investors, who rank alongside depositors as the last to be hurt when bonds are impaired.

“This sets a precedent,” said Robert Kendrick, an analyst in London at Legal & General Investment Management, which oversees about $585 billion. “If the authorities are prepared to impose losses on depositors, then presumably they wouldn’t think twice about impairing senior bondholders.”

Moody’s Investors Service said the move is bad for bank debt across Europe and shows policy makers are willing to disrupt markets to avoid sovereign defaults and a euro break-up.

Bonds ‘Hit’

Banks in the south of Europe, whose governments are most in need of international cash to meet their debt obligations, bore the brunt of the increase in swap prices. Contracts on Milan-based UniCredit SpA climbed as much as 23 basis points yesterday and were up 13 basis points today at 353, the highest since March 4, prices compiled by Bloomberg show. Banco Santander SA, Spain’s biggest lender, surged as much as 21 basis points yesterday and today rose 13 to 279.

If countries such as Spain or Italy needed to produce money to help fund their own bailouts, “it’s quite clear that senior bonds would be hit before” depositors protected by government deposit-guarantee programs, said Steve Hussey, a credit analyst in London at AllianceBernstein Ltd., which manages $430 billion.

U.S. Risk

Elsewhere in credit markets, the cost of protecting corporate debt from default in the U.S. rose. The Markit CDX North American Investment Grade Index, which investors use to hedge against losses or to speculate on creditworthiness, climbed 2.1 basis points to a mid-price of 81.6 basis points as of 12:40 p.m. in New York, according to prices compiled by Bloomberg.

The index typically falls as investor confidence improves and rises as it deteriorates. Credit-default swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

The U.S. two-year interest-rate swap spread, a measure of debt market stress, rose 2.8 basis points to 17.89 basis points, the highest since August 2012. The gauge widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures.

Bonds of Morgan Stanley were the most actively traded dollar-denominated corporate securities by dealers today, accounting for 6.1 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Richest Pickings

By taxing bank accounts, European Union policy makers are targeting Cyprus’s richest pickings. The island’s banks had 40.1 billion euros of deposits as of Jan. 31, equivalent to 208 percent of the economy, data compiled by Bloomberg show.

That’s higher than for other countries in the euro region’s weaker peripheral countries, stoking speculation policy makers would target Spanish or Italian lenders’ debt piles to fund bailouts. Spanish bank deposits are equivalent to 82 percent of the nation’s gross domestic product and in Italy the figure is 64 percent, data compiled by Bloomberg show.

“There just wasn’t a significant layer of subordinated or senior unsecured debt in the capital structure to take the hit” in Cyprus, though elsewhere “that’s not necessarily the case,” said Steve Hooker, the managing director of foreign research in Hartford, Connecticut, at Newfleet Asset Management LLC, which oversees about $10.7 billion. “It just calls into question the sanctity of the senior unsecured bondholder in the banks.”


Senior bank bondholders have avoided losses in the financial crisis, apart from in Denmark in 2011. Policy makers are aiming to give member states powers to impair senior bondholders by 2018.

“The EU and ECB don’t want to lose money and will do what it takes to make somebody else pay, and if it’s convenient to make bondholders pay they’ll do it,” said Peter Tchir, the founder of TF Market Advisors in New York. “They’ve gone too far. This will impact people’s long-term decision making. The only rational decision seems to be to reduce exposure to European banks.”

Bank default swaps extended their increase today on speculation Cypriot lawmakers will shoot down the deposit levy when they vote in Nicosia, risking the Mediterranean island’s euro membership. The Markit iTraxx Financial gauge rose a further 10 basis points to 162 basis points, the highest since March 1, prices compiled by Bloomberg show.

Bearing Brunt

Bonds sold by lenders with the lowest credit ratings were hurt the most by the downturn in sentiment toward European lenders after Cyprus’s announcement. The market disruption has sent the euro down 1.5 percent to its weakest level this year versus the dollar.

“It’s opening a bunch of potential outcomes going forward,” said Dorian Garay, a New York-based money manager of investment-grade debt at ING Investment Management, which oversees about $240 billion. “Everything will be included” to pay for future bailouts, and senior debt may “be affected in the same way that depositors have been affected in this case,” Garay said.

The extra yield that investors demand to hold speculative-grade bank bonds instead of government debt rose 14 basis points to a two-week high of 377 since the Cyprus tax announcement, according to the Bloomberg High-Yield Financials Spread Index. Yesterday’s 16 basis-point jump was the biggest since Feb. 26, after Italy’s inconclusive elections.

“The situation in Cyprus is dramatically different than it’s been in Italy or Spain, for example, but this does show the extent to which the ECB and EU countries are prepared to go,” said Mark Pibl, the head of credit strategy at Pierpont Securities LLC in New York. “That’s what a lot of people are nervous about. Today there’s more uncertainty out there.”