January 10, 2011 / 7:18 PM / 8 years ago

MONEY MARKETS-U.S. investors wary of European bank debt

* U.S. funds concerned but have not shunned European debt

* Dollar interbank loan premiums hold steady

* Key measure of euro money market stress near 1-week high (Updates with US action, changes dateline, previous London)

By Richard Leong

NEW YORK, Jan 10 (Reuters) - U.S. investors are wary of buying debt issued by European banks on worries over the ability of the region’s weaker members to raise funds at sustainable levels from capital markets.

Concerns over those nations and their banks were compounded after a source told Reuters that Portugal was being pressured into accepting financial aid. This pushed Portuguese and Spanish sovereign bond yields to their highest levels since Dec. 1, analysts said on Monday.

The Reuters report came after a plan unveiled last week by the European Commission that calls for a withdrawal government support, which analysts say could result in the banks’ credit downgrades.

Still investors’ caution has not resulted in any safehaven stampede into cash and Treasury bills. Bank-to-bank costs for dollar funds have been edging up but remained far below the crisis peaks seen last spring, they said.

“They have been selective for some time,” Alex Roever, short-term fixed-income strategist at J.P. Morgan Securities in New York, said of U.S. money investors. “There is still buying from investors but the scale of dollar funding from banks in certain European countries has contracted.”

J.P. Morgan, in a report published late Friday, estimated U.S. money market investors own roughly $1.1 trillion in short-term securities, plus another $100 billion in long-term debt, issued by European banks.

If the regulatory proposal were enacted and government support were removed, the long-term debt ratings of 55 large European banks could decline by an average of 3 to 4 notches and short-term ratings to P-2 from P-1 on Moody’s rating scale, J.P. Morgan said in the report.

This magnitude of rating downgrades will “likely smother short-term investors demand for the afflicted credits,” they wrote.

Despite the dire fallout if such regulatory changes were implemented, U.S. money market funds, a key source of short-term cash for banks, have not shunned dollar-denominated debt from Europe, analysts said.

“Strangely, money funds have sailed passed (this),” said Lance Pan, director of investment research at Capital Advisors Group in Newton, Massachusetts.

In fact, some prime money funds have nibbled at short-term securities offered by Spanish and Italian banks, Pan said.

Still most U.S. funds prefer securities issued by banks in stronger European countries like Germany and France over those in weaker nations, analysts said.

This tiering has kept a lid on secured lending for Portuguese assets, while Irish and Greek repo markets were still all but shut, they said.

The premium that London interbank offered rates (Libor) for three-month euros trade over the three-month Overnight Index Swap rate — a gauge of market stress — rose to 35 basis points from 32 basis points on Friday.

This sign of increased strain in the European banking system has not spread to the dollar loan market. The spread between three-month dollar Libor over three-month OIS was steady at about 0.14 percent.

The spread on two-year dollar interest rate swaps over Treasuries narrowed to 26.00 basis points from 26.50 basis points late on Friday. (Reporting by Richard Leong, additional reporting by Emelia Sithole-Matarise in London; Editing by Diane Craft)

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