March 4, 2008 / 7:57 PM / 10 years ago

UPDATE 3-Financial swaps weaken on credit exposures

(Adds analyst comments, background, updates prices)

NEW YORK, March 4 (Reuters) - Debt protection costs on banks and brokers jumped on Tuesday on concerns banks will face additional losses from exposure to risky mortgage-backed debt, as policy-makers called for proposals to forgive borrowers some loan principal to avoid foreclosures.

A warning by a prominent Middle East investor that Citigroup (C.N) will need to raise more capital added to negative sentiment, as the markets also grappled with the large exposures of financial companies to a plethora of credit products viewed as increasingly risky.

Federal Reserve Chairman Ben Bernanke said on Tuesday that banks may have to swallow reductions in the principal of some troubled home loans to ward off greater losses that could result from outright default. For details, see [ID:nN04237897].

“There is more uncertainty over the mortgage situation and a public policy stance on helping people out, as Bernanke is encouraging banks to forgive more people so they can avoid foreclosure,” said John Tierney, head of U.S. investment grade corporate strategy and credit derivatives research at Deutsche Bank in New York.

Also, “we are seeing more analysts revising earnings outlooks down for financials in the first quarter and longer-term, and it’s weighing on the sector,” Tierney said.

Credit default swap spreads on Washington Mutual Inc (WM.N) widened 17 percent to 550 basis points, or $550,000 per year for five years to insure $10 million in debt, from 468 basis points at Monday’s close, according to Markit Intraday. The swap is the widest level since Jan. 9.

Wells Fargo & Co’s (WFC.N) credit default swap spreads also widened 18 percent to 125 basis points from 106 basis points at Monday’s close.

“The market coming to terms with large problem credit exposures,” said Ricardo Kleinbaum, analyst at BNP Paribas in New York.

Banks and brokers have around $167 billion in exposure to leveraged loans, $64 billion to Collateralized Debt Obligations (CDOs), $25 billion in exposure to risky subprime residential mortgage backed securities and $11.3 billion in exposure to bond insurers, he said.

As banks write down the value of bad investments they are also increasingly capital constrained, which is feeding the negative market sentiment.

Speaking at a private equity conference, Sameer al-Ansari, the head of Gulf investment agency Dubai International Capital, said Citigroup may need “a lot more money” from investors, after billions of dollars of write-downs tied to subprime mortgages had depleted the bank’s capital. [ID:nN04453041]

New York-based Citigroup in January slashed its dividend 41 percent, and since November has raised some $30 billion of capital from investors including Abu Dhabi, Kuwait, Singapore and Saudi Prince Alwaleed bin Talal.

Credit default swaps on large broker dealers weakened on Tuesday, according to data from CMA DataVision.

Bear Stearns Cos BSC.N credit default swaps widened to 345 basis points from around 312 basis points on Monday, CMA said.

Merrill Lynch’s MER.N spreads widened 32 basis points to 250 basis points, Morgan Stanley (MS.N) widened 20 basis points to 240 basis points and Goldman Sachs (GS.N) widened 18 basis points to 188 basis points, CMA said. (Reporting by Karen Brettell;)

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