French Banks Downgrade Revives Euro Debt Fears

German two-year note yields reached a one-week high as the nation prepared to sell an additional 5 billion euros ($6.8 billion) of the securities.
Ten-year German bunds pared gains as European stocks rose for a second day. Yields on two- and 10-year securities fell to records this week as speculation Greece may default underscored demand for the safest assets. Italian 10-year bonds rose for the first time in five days before lawmakers hold a confidence vote on Prime Minister Silvio Berlusconi’s austerity plan.
“The two-year German yield has reached very low levels,” said Luca Cazzulani, a senior fixed-income strategist at UniCredit SpA in Milan. “The strength of demand at the auction will be an indicator of how powerful risk aversion is.”
Two-year German yields rose one basis point to 0.51 percent as of 9:25 a.m. in London after reaching 0.54 percent, the most since Sept. 5. They fell to an all-time low 0.359 percent on Sept. 12. The 0.75 percent security due in September 2013 declined 0.015, or 15 euro cents per 1,000-euro face amount, to 100.475.


Hill said the rating review also takes into account the likelihood of French government intervention to support French banks, but he declined to estimate the probability of such an intervention.


In the case of SocGen, Moody's concluded that its "capital base currently provides an adequate cushion to support its Greek, Portuguese, and Irish exposures," though the bank's dependency on wholesale funding is a problem. The outlook on Societe Generale's rating is negative.


Bank of France Governor Christian Noyer said on French radio RTL early Wednesday that French banks already have enough capital for them to face the debt crisis in Europe. But he also said they should keep building capital equity to remain among the top banks of the continent.


French bank shares have plummeted in the past weeks, with SocGen losing more than 50% since early August.


Minutes after the downgrade, Credit Agricole announced it will set up a general guarantee to its Credit Agricole Corporate and Investment Bank unit or its affiliation. The mechanism will be ready in December, Credit Agricole said.


BNP Paribas said Wednesday it has launched a plan to refocus its business on strategic activities, slashing its dollar liquidity needs and reducing assets in order to comply with the tougher Basel III capital adequacy rules by 2013.


BNP Paribas also said it said that potential losses from its EUR4 billion Greek sovereign debt portfolio are manageable. The bank, which has taken a 21% hit on its bonds so far, said that even if losses were to rise to 55% its impairments would be a pretax EUR1.7 billion.


Moody's said BNP Paribas's profitability and capital base currently provide an adequate cushion to support its Greek, Portuguese and Irish exposure. The ratings firm, however, kept BNP Paribas under review for a possible downgrade not to exceed one notch. Such a review would happen within the next three months.


Although widely expected after Moody's put French banks on credit watch in June, confirmation of the downgrades sent new concerns rippling through European financial markets.


The euro fell after the news, giving up some of its overnight gains and settling to $1.3632 from a high of $1.3706.


Societe Generale shares opened 6.4% lower before shaving its loss to 1.7%. Credit Agricole initially fell but recovered to post a 2.4% rise. BNP Paribas shares were 2.5% after the opening.


The cost of insuring European corporate and government debt against default rose early Wednesday after the French bank downgrades reminded of possible contagion in the financial system.


"Next up for Moody's will be Italy," said Gary Jenkins, credit rating strategist at Evolution Securities. "We would expect a downgrade by the end of this week although again note that [Standard and Poor's Corp.] is already two notches lower than Moody's."


German Chancellor Angela Merkel calmed markets Tuesday by playing down recent talk of an inevitable default by the Greek government, an event that many investors fear could put similar pressure on other countries along Europe's periphery.


Conflicting statements by German politicians about Greece have added to market fears that Greece will default on its debt and might be forced out of the euro.


Merkel will hold a teleconference later Wednesday with Greek Prime Minister George Papandreou and French President Nicolas Sarkozy on the Greek crisis. The inability of Athens to plug budget gaps during a recession is seen as the biggest threat to the future of the euro.