In the U.S.: Banks Face Contagion Risk From Europe Debt

17 November 2011

Look out for U.S. banks’ ratings downgrades, reviews etc. Six biggest players hold an estimated $50bn in risk within the ‘PIIGS.’

U.S. banks face a “serious risk” that their creditworthiness will deteriorate if Europe’s debt crisis deepens and spreads beyond the five most-troubled nations, Fitch Ratings said.

“Unless the euro zone debt crisis is resolved in a timely and orderly manner, the broad credit outlook for the U.S. banking industry could worsen,” the New York-based rating company said yesterday in a statement. Even as U.S. banks have “manageable” exposure to stressed European markets, “further contagion poses a serious risk,” Fitch said, without explaining what it meant by contagion.

The “exposures” of U.S. lenders to major European banks and the stressed nations of Greece, Ireland, Italy, Portugal and Spain, known as the GIIPS, are smaller than those to some of the continent’s larger countries, Fitch said.

The six biggest U.S. banks — JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Citigroup Inc. (C), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. and Morgan Stanley (MS) — had $50 billion in risk tied to the GIIPS on Sept. 30, Fitch said. So-called cross-border outstandings to France for all except Wells Fargo were $188 billion, including $114 billion to French banks. Risk to Britain and its banks was $225 billion and $51 billion, respectively.

Europe’s debt crisis has toppled four elected governments, with the last two, in Greece and Italy, falling last week. Italian bond yields remained at about 7 percent — the threshold that led Greece, Portugal and Ireland to seek bailouts — and shares of French banks, includingBNP Paribas (BNP) SA and Societe Generale (GLE) SA, dropped amid concern they’ll need more capital.

Stocks Slump

U.S. stocks slumped yesterday after the Fitch report was released. The Standard & Poor’s 500 Index slid 1.7 percent and the 24-company KBW Bank Index declined 1.9 percent. U.S. index futures fell earlier today as Spanish and French borrowing costs rose.

The Fitch report is a worst-case scenario and is “oddly out of step” with the rating company’s previous reports, analysts at HSBC Holdings Plc said today. U.S. banks may even benefit as investors shift money to the U.S. from Europe, HSBC said.

Investor demand for the relative safety of Treasuries during the European debt crisis has sent the difference between U.S. short-term yields and bank rates surging to levels not seen in more than two years.

The gap between the London interbank offered rate and the overnight index swap, or what traders expect the Federal Reserve’s benchmark to be over the term of the contract, widened to 38 basis points today. It was the highest level since June 2009.

Swap Spreads

U.S. five-year swap spreads climbed to 45 basis points, the most since August 2009. Investors use swaps to exchange fixed and floating interest rates. The spread, the gap between the fixed component and the yield on similar-maturity Treasuries, is a measure of bank creditworthiness.

The TED spread, the difference between what lenders and the U.S. government pay to borrow for three months, widened to 47 basis points today, or 0.47 percentage point, the most since June 2010.

Yields have yet to reach the levels seen three years ago when credit markets froze and the U.S. economy was in a recession. The TED spread was as wide as 4.64 percentage points in October 2008.

Hedging Risk

While U.S. banks have hedged some of their risk with credit-default swaps, those may not be effective if voluntary debt forgiveness becomes “more prevalent” and the insurance provisions of the instruments aren’t triggered, Fitch said in the report. The top five U.S. banks had $22 billion in hedges tied to stressed markets, according to Fitch.

Disclosure practices also make it difficult to gauge U.S. banks’ risk, Fitch said. Firms including Goldman Sachs and JPMorgan don’t provide a full picture of potential losses and gains in the event of a European default, giving only net numbers or excluding some derivatives altogether.

Guarantees provided by U.S. lenders on government, bank and corporate debt in Greece, Italy, Ireland, Portugal and Spain rose by $80.7 billion to $518 billion in the first half of 2011, according to the Bank for International Settlements.

Also yesterday, Moody’s Investors Service downgraded the senior debt and deposit ratings of 10 German public-sector banks, citing its assumption that “there is now a lower likelihood” that the lenders would get external support.


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