The risk of owning bank bonds plunged from a record after the European Central Bank was said to be snapping up Italian and Spanish government debt, helping lenders already nursing Greek writedowns. “The perceived support from the ECB for Italian and Spanish bonds is leading to a reduction in systemic risk which helps banks as they’re large holders of European peripheral debt,” said Andreas Fischer, a Zurich-based fund manager at Clariden Leu AG. A benchmark index of credit-default swaps on European banks and insurers dropped as much as 9 percent after reaching a record 218.5 basis points on Aug. 5, according to JPMorgan Chase & Co. The extra yield investors demand to buy bank bonds instead of benchmark German debt surged to 242 basis points, or 2.42 percentage points, at the end of last week, the highest since July 2010, Bank of America Merrill Lynch data show. Bondholders are assigning a lower perceived risk to bank debt as five people familiar with the matter said the ECB stepped in to buy Italy and Spain’s debt, whose 10-year yields had surged to euro-area records and approached the 7 percent level that presaged the rescues of Greece, Ireland and Portugal. Policy makers, who last week broke an 18-week hiatus by buying Irish and Portuguese securities, wouldn’t comment on today’s news, though announced yesterday they would “actively implement” purchases while saying they welcomed pledges from Italy and Spain to cut their deficits. ‘Volatility’ “There’s a lot of volatility around sovereigns, which leads to uncertainty for banks,” said Hans Stoter, head of credit investments at ING Investment Management in the Hague, Netherlands, which manages 218 billion euros ($313 billion) of fixed-income assets. Societe Generale (GLE) SA said last week it may miss its 2012 earnings target after discounting the value of its Greek notes, following similar writedowns by institutions including Deutsche Bank AG and BNP Paribas SA. Analysts have cited concern that banks don’t have sufficient capital to endure further writedowns as a motivation for EU leaders to bolster sovereign debt values in the region. Greece’s second bailout, agreed on last month, proposed that banks accept a 21 percent writedown on the value of their Greek debt. Europe’s 90 biggest lenders hold about 98 billion euros of the country’s notes, the European Banking Authority said July 15. Investors judged the plan wouldn’t prevent the sovereign crisis from engulfing Spain and Italy and bank bond risk jumped last week. Bond Sales Slow Bank bond sales slowed to about 7.7 billion euros since the beginning of July, the lowest this year and less than half the 27 billion-euro monthly average for 2011, according to data compiled by Bloomberg. In a statement issued in the name of President Jean-Claude Trichet after an emergency teleconference meeting of policy makers yesterday, the Frankfurt-based ECB said “a decisive and swift” implementation of reforms by both Spain and Italy’s governments is “essential.” It also called on all euro-area governments to follow through on the measures agreed at a July 21 summit, including allowing the European Financial Stability Facility to purchase bonds on the secondary market. Greece’s bailout terms may set a “precedent” for future restructurings, according to Fitch Ratings and Moody’s Investors Service. Last week, Standard & Poor’s removed its AAA rating for U.S. Treasuries, citing a political impasse that can’t reduce the deficit of the world’s biggest economy. SocGen Losses SocGen, France’s second-largest bank, reported a 31 percent drop in second-quarter profit because of a 395 million-euro writedown on Greek government debt. Deutsche Bank took a 155 million-euro hit and BNP Paribas (BNP) marked down 534 million euros of Greek IOUs. Royal Bank of Scotland Group Plc said Aug. 5 that it lost money in the first half after writing down Greek holdings by 733 million pounds ($1.2 billion). Speculation that other countries will succumb to the crisis had pushed up bond yields for the euro region’s most indebted nations. “If Italy is sucked into the peripheral crisis then it starts to become a systemic issue for European banks because Italian government debt is quite widely held,” said Roger Doig, a London-based analyst at Schroders Plc, which manages 36.5 billion pounds of fixed-income assets. EU agencies may have to purchase as much as 850 billion euros of Italian and Spanish debt, or about half of the amount actively traded, according to a note by RBS strategists. Europe Banks European banks outside Italy held $233.5 billion of the country’s public-sector debt at the end of March, while foreign lenders held $90.3 billion of Spanish state obligations, according to the Bank for International Settlements in Basel, Switzerland. The Markit iTraxx Financial index of credit-default swaps on the senior debt of 25 banks and insurers fell 14 basis points to 198 today, JPMorgan prices show. The Markit iTraxx SovX Western Europe Index of swaps linked to the debt of 15 governments dropped 26 basis points to 259.5. That’s the lowest since July 26 and down from a record last week. European governments’ deteriorating finances contrast with the relatively robust balance sheets of the region’s non- financial companies, which have been “hoarding liquidity,” according to Dagmar Kent Kershaw, head of credit fund management at Intermediate Capital Group Plc in London, which manages 12 billion euros of assets. The ECB restarted its bond-purchase program to prop up sovereign debt markets last week, though it had limited itself to buying the debt of Ireland and Portugal. World stock markets lost more than $4.4 trillion since July 26 as speculation mounts that the global economy faces a recession that would send more countries begging for international bailouts. UniCredit, Popolare Italian lenders UniCredit SpA (UCG) and Banco Popolare SC (BP) led Bank of America’s Euro Banking index of bond spreads wider since the start of July. Relative yields on the debt of UniCredit, Italy’s biggest bank, surged 189 basis points to 444 on Aug. 4 and Banco Popolare bond spreads widened 179 basis points to 463, the index data show. After Greece, for banks “what comes next?” said Alexander Plenk, an analyst at UniCredit SpA in Munich. “That’s the big question.” To contact the reporter on this story: Ben Martin in London at bmartin38@bloomberg.net To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net

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