Trillion-euro cash injection vanishes into growing Greek crisis

Athens: The record rally in bank debt fuelled by the European Central Bank injection of $1.3 trillion (Dh4.8 trillion) into the region's financial system has evaporated as the worsening Greek crisis triggers deposit withdrawals and ratings downgrades.

The Markit iTraxx Financial Index of credit-default swaps on the senior debt of 25 European banks and insurers including Spain's Banco Santander SA and Italy's UniCredit SpA reached 308.398 on May 18, up from this year's low of 181.472 on March 20 and the highest since December 19.

That was two days before the ECB's first offering of unlimited funds under its Long Term Refinancing Operation to fend off a liquidity crisis among lenders in the 27 member states of the European Union.

"The real risk is not so much the departure of Greece, but contagion," said Roger Francis, an analyst at Mizuho International Plc in London. "There's not the same imminent fear of banks running out of cash, but big systemic fears about what a Greek exit would mean."

Greece's banking system lost an average of €622 million (Dh2.9 billion) a week in deposits in the two years through March 31, and speculation customers were withdrawing money in Spain caused an almost 30 per cent drop on May 17 in shares of Bankia SA, created to help clean up the nation's financial system.

‘Expensive and Messy'

Deutsche Bank AG said Ireland may be forced into rescuing its banks for a second time by mounting loan losses. Yields on Italian five-year notes rose above 5 per cent this month for the first time since January.

Encouraged by their governments to take the ECB's money and buy bonds, banks borrowed €489 billion on December 21 and €530 billion on February 29. That helped drive yields on Spain's benchmark 10-year bonds as low as 4.85 per cent on February 1 from more than 6.75 per cent in November.

They rose to 6.28 per cent yesterday, while Italy's were at 5.79 per cent, up from this year's low of 4.68 per cent on May 9.

"A Greek exit will be expensive and messy, but it's probably inevitable and therefore we should plan for it," Mohammad Al Erian, chief executive officer of Pacific Investment Management Co., said in an interview yesterday on Bloomberg Radio's "Bloomberg Surveillance" with Tom Keene and Ken Prewitt. The firm manages the world's largest bond fund.

Elsewhere in credit markets, a benchmark gauge of US corporate debt risk fell from the highest level this year. Insurer American International Group Inc., sold debentures as the Federal Reserve resumed a $1.7 billion auction of assets acquired in the company's rescue. Royal Bank of Canada won permission from the US Securities and Exchange Commission to issue covered bonds as publicly registered securities.

Debt market measure

The US two-year interest-rate swap spread, a measure of debt market stress, decreased 1.9 basis points to 35.1 basis points. The gauge, which reached 39.13 on May 15, the highest since January 10, narrows when investors favour assets such as corporate bonds and widens when they seek the perceived safety of government securities.

The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, dropped 5.5 basis points to a mid-price of 117.9 basis points, according to prices compiled by Bloomberg. The index closed at 123.4 on May 18, the highest since December 21.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 2.4 to 180.4.

Both indexes typically fall as investor confidence improves and rise as it deteriorates. Credit 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.

AIG, the insurer majority-owned by the US government after a 2008 bailout, issued $750 million of 4.875 per cent 10- year bonds to yield 325 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. Proceeds will be used to repay debt coming due in 2013, said a person with knowledge of the transaction, who declined to be identified because terms aren't public.

AIG last issued 10-year notes at the parent level in November 2010, selling $1.5 billion of 6.4 per cent bonds at a spread of 362.5 basis points, Bloomberg data show.