Friday, November 18, 2011

Wall St can't escape risks from Europe's crisis

NEW YORK (Nov 17): No matter how much Wall Street cuts its ties to Europe, it can't seem to eliminate the risk that the euro-zone crisis could engulf the U.S. financial system.

U.S. banks and money funds have been slashing their direct exposure to Italy, Greece, and other debt-laden nations in the last six months. But U.S. institutions are still vulnerable to Europe's debt turmoil.

The last few days have been particularly disconcerting. The crisis has grown more serious, with bond yields spiking in even top-rated nations like Austria, France and the Netherlands.

Bond traders are pricing in a greater possibility of a replay of the days after Lehman Brothers' collapse more than three years ago as European leaders have been unable to get ahead of the spreading debt crisis.

Renewed fears of contagion could again send stock prices tumbling, spark new rating downgrades and drive up the cost of accessing the debt markets to unsustainable levels.

"You get to a point of no return," said Jim Swanson, chief investment strategist at MFS Investment Management at a press briefing in New York this week.

EXPOSURE TO THE EXPOSED

Compared with France and other nations, U.S. exposure to Italy and Greece is relatively small. But they hold debt in those institutions that have been big buyers of Italian or Greek debt.

U.S. banks' and money funds' holdings of French, German and British debt, while smaller than earlier this year, are roughly the same size as those three countries' combined exposure to peripheral Europe.

German, French and British banks combined had $1.5 trillion in exposure in Italy, Greece, Spain, Portugal and Ireland as of June 2011, according to the Bank for International Settlements.

American banks, on the other hand, had $1.3 trillion in exposure to that trio of European Union members.

"You can see why you could make the case that there could be a potential ripple effect into the French banks and ultimately to the U.S. banks," said Doug Penn, U.S. financials sector head at RCM Capital Management in San Francisco.

At the end of October, U.S. money market funds invested $287 billion in German, French and British bank securities, down $248 billion since the flare-up of the euro zone's debt crisis in May, according to J.P. Morgan Securities.

Analysts reckon this indirect exposure to peripheral Europe would be unlikely to cause the repurchasing and other short-term lending markets to seize up as seen in the days after Lehman's collapse in September 2008.

The funds are major lenders in these markets. After Lehman failed, a big money market fund's share value "broke the buck," a watershed that intensified the global credit crisis.

Banks' balance sheets are also holding more cash and similar instruments now. They are less reliant on unsecured short-term funding and they benefit from Fed support. However, in a systemic crisis, all bets are off.

"The majority of counterparty exposure tends to be overnight type of risk, which needs to be collateralized. What you do worry about, though, is an overall systemic problem and what that means to access to funding and repo and other things," said Ashish Shah, head of credit at AllianceBernstein in New York.

U.S. Federal Reserve data shows that U.S. banks are sitting on $1 trillion in excess reserves.

MUDDY DISCLOSURE

Giant U.S. commercial and investment banks - J.P. Morgan,Bank of America, Citigroup, Goldman Sachs and Morgan Stanley - remain the vulnerable from their remaining exposure to Europe, analysts say.

Potential losses from lending to the region would be another blight for banks still struggling with bad mortgages, thinning interest margins and an increasingly stringent regulatory environment.

It's unclear if credit default swap hedges would be effective in mitigating risks, and there is little clarity over gross exposures to the region, including credit protection sold there.

If any ring-fence program to contain the euro-zone debt problem fails, analysts reckon French banks have the most to lose, and their trouble would most certainly be felt by U.S. banks that are exposed to them.

Fitch Ratings warned in a report on Wednesday that if the crisis gets worse, that could cause the agency to reduce its outlook on U.S. banks.

Ratings downgrades can spark collateral calls on derivatives, reduce access to some funding markets and add to market fears over bank heath.

Any stress over one bank's strength can quickly extend to others due to the complex web of derivatives and lending agreements, such as repos, between large institutions.

After a review of their quarterly statements with the Securities and Exchange Commission, U.S. banks gave a glimpse but far from full disclosure on their exposures to Europe.

Goldman Sachs said it has $23.8 billion in cross-border exposure to France, including $15.12 billion to French banks.

This number doesn't include derivatives or the effect of risk-mitigation techniques, which includes collecting collateral from counterparties. The bank exposure is also largely collateral posted to a French clearinghouse, which is deemed very low risk.

Goldman further said its gross "funded" credit exposure to Europe is $35.26 billion, of which $31.10 billion is to Germany, the U.K. or other non-peripheral nations.

Bank of America said its cross-border French exposure was $17.1 billion, but did not offer any details.

Citigroup said it had gross funded exposure to Belgium and France of $14.4 billion, and that this nets down to $2 billion after accounting for $6.8 billion in margin and collateral postings and $5.5 billion in purchased credit protection.

JPMorgan said its net exposure to peripheral Europe, including Spain, Italy, Ireland, Portugal and Greece, is $15.2 billion, but it did not break out its exposure to France.

Banks are not required to break out this figure if the exposure as a percentage of assets falls below reporting requirements of 0.75 percent, as set by the Federal Financial Institutions Examination Council.

Morgan Stanley said it had a net short in "funded" exposure to France, after offsetting with $1.53 billion in exposure with $1.82 billion in hedges.

"Everybody had some level of European exposure because of the level of business they've done in Europe. It's inevitable. It's a big continent," Morgan Stanley spokesman Mark Lake said.

Goldman Sachs declined to comment further on their European exposure.

J.P. Morgan, Bank of America and Citigroup could not immediately reached for comment. ' Reuters

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