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bloomberg news report.

--Portugal sounds more and more like the next domino now.

Bank Swaps Surge as Moody’s Raises Sovereign Contagion Alert

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By Abigail Moses

May 6 (Bloomberg) -- The cost of protecting European bank bonds from default surged to the highest level in 13 months as Moody’s Investors Service said lenders face “very real, common threats” from the region’s fiscal crisis.

Banking systems in Greece, Portugal, Italy, Spain, Ireland and the U.K. may come under pressure as the crisis worsens, Moody’s said in a report today. The ratings firm said yesterday it may downgrade the Portuguese government and its banks after Standard & Poor’s last week cut sovereign debt of Greece, Portugal and Spain.

“The risk is for the banking sector because they’re the ones that own most of the government bonds and in cases of extreme crisis banks rely on governments to bail them out,” said Juan Esteban Valencia, a London-based credit strategist at Societe Generale SA. “If governments can’t issue at relatively normal levels, it’s going to be very difficult to bail out banks and that means banks are getting hammered.”

The Markit iTraxx Financial Index of credit-default swaps on 25 banks and insurers soared as much as 19 basis points to 167, according to JPMorgan Chase & Co. prices, the highest level since April 3, 2009. An increase signals deterioration in the perception of credit quality.

‘Common Threat’

The risk to the banks is “more as a consequence of the pressures on the sovereign rather than due to their own inherent creditworthiness,” the Moody’s analysts wrote. “Market sentiment can be sufficiently strong, and longlasting, to create its own reality and expose all these countries to a common threat.”

The European Central Bank’s Governing Council is meeting today in Lisbon, with President Jean-Claude Trichet under pressure to do more to calm markets after the pledge of a 110 billion-euro ($142 billion) bailout for Greece from euro-area countries and the International Monetary Fund failed to assuage investors’ concerns.

Credit-default swaps on Spanish and Portuguese banks rose to records, according to CMA DataVision prices. Portugal’s Banco Comercial Portugues SA increased 37 basis points to 516 and Banco Espirito Santo SA climbed 26.5 to 537.5. Contracts on Spain’s Banco Santander SA rose 16.5 basis points to 223.5 and Banco Bilbao Vizcaya Argentaria SA jumped 17.5 to 239.

Greek Debt Swaps

Swaps on Greece, Portugal, Spain and Italy rose to or near all-time high levels. Swaps on Greece surged 15 basis points to 859, Portugal climbed 18.5 to 434, Spain increased 11 to 241 and Italy rose 10 to 197, CMA prices show.

Contracts on the U.K. rose 1.5 basis points to 87.5, CMA prices show. Britain votes today in an election that polls show may produce no parliamentary majority for the first time since 1974, stoking concern the new government will be too weak to rein in its record budget deficit.

The cost of default protection on corporate debt also increased, with the Markit iTraxx Europe index of swaps linked to 125 companies with investment-grade ratings up as much as 11.75 basis points to 117.5, JPMorgan prices show, the highest level since July. The Markit iTraxx Crossover Index of companies with mostly high-yield credit ratings climbed as much as 44 basis points to 525, the highest level since Nov. 30.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year.

Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Abigail Moses in London at [email protected]

Last Updated: May 6, 2010 07:23 EDT