Financial Sector: Bank Bonds In Trouble...UBS Losses...

Citigroup and Bank of America's bond prices are sliding on concern that should the government inject more cash in the troubled banks, they will force bondholders to swap bonds for new debt that offers reduced interest rates or lower face values. U.S. bank debt has lost 7.8% and yields have jumped to record levels compared with benchmark rates in the past month.

The four largest U.S. bank currently have about $1 trillion in debt outstanding.

Since any reduction in debt at a bank helps boost capital ratios, members of Congress including U.S. Representative Brad Sherman say it’s time for bondholders to share the pain.

“These banks can go into receivership, shed their shareholders, shed or reduce the amount they owe to their bondholders and come back out much stronger institutions,” said Sherman, who sits on the House Financial Services Committee.

Citigroup’s $789 million outstanding in 7.25% notes due in October 2010 fell 6.5 cents today to 70.5 cents on the dollar and have lost 23.2 cents in the past three weeks. That puts the spread over Treasuries of similar maturity at 32.2 percentage points (3220 basis points).

Contracts on the Markit iTraxx financial index of credit default swaps linked to the senior debt of 25 banks and insurers were more expensive today than the Markit iTraxx Europe corporate index. That hasn’t happened since Lehman Brothers Holdings Inc. went bankrupt in September and, before that, JPMorgan’s takeover of Bear Stearns. The numbers suggest systemic stress in the financial system.

UBS, Switzerland’s biggest bank, posted a $18 billion loss for 2008, more than initially reported, and said it remains “extremely cautious” about the outlook for this year. The 2008 loss is the biggest in Swiss history.

The full-year net loss widened from the figure reported on Feb. 10 because of costs to settle a U.S. tax investigation and additional write downs on securities, the bank said in its annual report.

“Our near-term outlook remains extremely cautious,” Chairman Peter Kurer said in a letter to shareholders. “Even after substantial risk reduction, our balance sheet remains exposed to illiquid and volatile markets and our earnings will therefore remain at risk for some time to come.”

The firm was forced to raise more than $32 billion from investors, including the Swiss government. UBS has also cut its workforce by 11,000.

Citigroup and Deutsche Bank have recently provided better outlooks for 2009. Citigroup CEO Vikram Pandit said in an internal memo (published by Bloomberg yesterday) that his bank was having the best quarter since 2007, when it last posted a profit. Banking shares, including UBS, rallied the past two days. Deutsche Bank, which said revenue in January rose “significantly,” saw the trend continuing in February, CEO Josef Ackermann said last week.