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U.S. Banks Face Contagion Risk From Europe Debt

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.

Photographer: Scott Eells/Bloomberg

A construction worker climbs down a ladder in front of Morgan Stanley headquarters in New York, U.S. 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. Close

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Photographer: Scott Eells/Bloomberg

A construction worker climbs down a ladder in front of Morgan Stanley headquarters in New York, U.S. 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.

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, including BNP 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 fell 1.9 percent. U.S. stock declines continued today, with the S&P benchmark dropping 1.8 percent at 12:41 p.m. in New York.

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

Ratings on the U.S. banking industry are stable and take into account lenders’ improved capital and liquidity position, Fitch said. The rating company’s assumption is that “euro zone sovereign debt concerns will be dealt with in an orderly fashion” and that a disorderly restructuring of sovereign debt or the “forced exit” of a nation from the euro will not occur, according to the report.

Relative Safety

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, the highest level since June 2009.

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.

TED Spread

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. The TED spread was as wide as 4.64 percentage points in October 2008 when credit markets froze and the U.S. economy was in a recession.

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.

U.S. banks that run money-market funds may face additional risk if the funds suffer losses on European debt and the lenders are forced to offer support, Fitch said.

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.

To contact the reporter on this story: Dakin Campbell in New York at dcampbell27@bloomberg.net

To contact the editor responsible for this story: Rick Green at rgreen18@bloomberg.net

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