U.S. Banks Dangerously Exposed to European Markets - Fitch

Even though U.S. banks have been cutting their direct exposure to the continent's stressed markets like Spain and Italy for more than a year, Fitch's warning underscores how European contagion increasingly threatens U.S. banks holding the debt of France and other large European countries.

Fitch believes that, unless the Eurozone debt crisis is resolved in a timely and orderly manner, the broad outlook for U.S. banks will darken, it said Wednesday in a report. The risks of a negative shock are rising and could alter Fitch's stable rating outlook for U.S. banks.

The agency said although much of U.S. banks' exposure to Eurozone contagion is secured, the exposure data show the susceptibility of banks to contagion risk and the interconnectivity of large global banks.

Among U.S. banks most heavily exposed to European markets are Goldman Sachs with $38.5 billion in exposure, Morgan Stanley with $28.1 billion in exposure and JP Morgan Chase with $22.8 billion in exposure, Fitch said.

Several other factors heighten risks to U.S. banks, the agency said. The risk has grown since Eurozone authorities negotiated a 50 percent default on Greek debt being called voluntary so as not to trigger the credit default swaps that supposedly guaranteed that debt.

While U.S. banks have hedged part of their European exposures through the credit default swap (CDS) market, this tactic could prove problematic if 'voluntary' debt forgiveness becomes more prevalent and CDS contracts are not triggered, Fitch said.

In addition to the possibility that CDS contract may not protect U.S. banks from European debt, the agency also cited the difficulty in gathering complete U.S. bank exposure data for all countries.

Finally, three of the 10 largest money market funds, which have a total of $89 billion in exposure to European banks, are affiliated with U.S. banks, Fitch said.

While not contractually required, banks often times offer support to affiliated (money market funds) in the event of need for business/reputation reasons, the agency said. Any prolonged turmoil could negatively affect capital market-related revenues well into the future, not to mention the possible effects on loan portfolios and other revenue opportunities.

A worst-case scenario would have consequences far beyond the banking industry, the agency warned.

The risks of a negative shock are rising and could alter this view (that the outlook for U.S. banks is stable), even for banks with little or no exposure to Europe. While it would appear that the Eurozone debt crisis is largely a big bank issue, Fitch is of the view that the consequences could affect global economic growth and further weigh down the U.S. economy.