UPDATE 3-Bank CDS spreads retrace losses on Bernanke

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NEW YORK Feb 24 (Reuters) - Credit default swap spreads on U.S. banks reversed earlier weakness on Tuesday after U.S. Federal Reserve Chairman Ben Bernanke said bank stress tests would be used to determine how much capital they need and signaled nationalization was not at hand.

Bank debt spreads had weakened earlier on concerns over the amount of risky assets left on bank balance sheets and that efforts to sure up financial institutions may not support bondholders.

"The outcome of the stress test is not going to be fail or pass," Bernanke said in testimony to the Senate Banking Committee on Tuesday.

"The outcome of the stress test is how much capital does this bank need in order to meet the credit needs of borrowers in our economy," he added.

Credit default swaps insuring Citigroup's (C.N) debt tightened after Bernanke's testimony to 460 basis points, or $460,000 per year for five years to insure $10 million in debt, said a trader. The swaps had earlier risen to 510 basis points, after closing on Monday at 470 basis points.

Bank of America's (BAC.N) CDS also retraced to 270 basis points, from 315 basis points on Tuesday morning and 280 basis points at Monday's close.

Bank credit spreads have deteriorated to their widest level in several months on concerns over banks continuing to take losses on risky assets including mortgage loans.

Sellers of CDS protection were asking to be paid on an upfront basis to insure Citigroup's (C.N) subordinated debt earlier on Tuesday, a sign of greater perceived risks at the third-largest U.S. bank.

"Uncertainty about financials is about asset quality, reserve adequacy more than nationalization in my opinion," said Ricardo Kleinbaum, trading sector specialist at BNP Paribas in New York.

CDS on Wells Fargo & Co's (WFC.N) debt also improved to 235 basis points, from 280 basis points earlier on Tuesday.

(Reporting by Dena Aubin and Karen Brettell; )