NEW YORK, Nov 20 (Reuters) - Credit default swaps on U.S. bank debt have erased all of the gains made in the last month from government attempts to shore up their liquidity, and are likely to remain weak as concerns over their asset exposures and future earnings ability remain.
The CDR Counterparty Risk Index, which averages credit default swap spreads of the 14 largest credit derivative dealers, jumped on Wednesday to its highest level since Oct. 10.
Swaps on individual banks are also trading at their weakest levels since before October 14, when the Federal Deposit Insurance Corp (FDIC) sparked a rally by expanding its guarantee program to new, senior bank debt.
"There are significant concerns about the value of bank assets and the earning power of the various banks with the downturn in the economy," said Sean Egan, principal of Egan-Jones Ratings Co in Haverford, Pennsylvania.
"Even though the Fed has done everything it possibly could to support the banks it seems like they are rolling a rock up a hill," he added.
The U.S. Treasury Department has pumped $250 billion in equity to support banks as part of its Troubled Asset Relief Program (TARP), while the FDIC's implicit government guarantee of new bank debt is designed to ease concerns over their debt values and aid sales of new bonds.
"We're basically right back where we were before the government intervention and TARP was announced," said Carlos Mendez, senior managing director at investment firm ICP Capital. "People still don't understand what banks have on their balance sheets."
One issue is confusion over the role of TARP and whether the $700 billion committed to the program will be enough to restore stability in the financial sector.
"Neither Treasury nor the banks ever explained why the TARP injections were adequate to fund writedowns or cover future losses," said Ricardo Kleinbaum, analyst at BNP Paribas in New York.
"We still don't know what's on the balance sheet of the banks, and we don't have an unlimited guarantee," he added. "The Treasury has the authority to guarantee credits, but they haven't put any program in place that specifically addresses these troubled assets."
Debt protection costs on Citigroup Inc (C.N) have jumped to record highs, based on end of day levels, a day after the bank said it agreed to buy $17.4 billion of assets remaining in a series of funds known as structured investment vehicles.
The cost to insure Citigroup's debt for five years rose to around 390 basis points on Thursday, or $390,000 per year to insure $10 million in debt. The swap had traded at 240 basis points on Tuesday.
Adding to concerns is the impact that any failure by General Motors Corp (GM.N) could have on bank balance sheets, in addition to banks' ability to generate earnings amid a global downturn.
"We no longer have the short term illiquidity problems, but these are big institutions that are facing difficulties, General Electric, Citigroup, GM," said Kleinbaum.
"The banks do have some exposure to the auto industry, but the issue there is we don't know what the banks' indirect exposures to suppliers and everybody else who falls are, if that unravels," he said.
Meanwhile the transition to a new U.S. government is likely to delay any improvement in credit markets as investors wait to hear solutions from the new government to tame the financial crisis.
"We're between rulers and so it's going to be difficult, even though the market is in turmoil we're not going to have the ability to react," said Egan. "We're in flux until the middle of January."