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U.S. Downgrade Will Hurt Bank Margins: KBW

NEW YORK. (TheStreet) - While a downgrade of U.S. debt by Standard & Poor's, and possibly Moody's and Fitch wouldn't necessarily mean the government would default on any payments, it would hurt large banks' margins, which have already declined over the past year.

KBW analyst Fred Cannon said in a Friday report that the "direct impact of a one-agency downgrade would be limited," but would include "somewhat higher collateral posting requirements for repurchase and [Federal Home Loan Bank Borrowings], resulting in modest earnings pressure" for banks that use the FHLB has a wholesale funding source.

Of course, the likelihood of a "one-agency downgrade" seems rather small, as Moody's and Fitch wouldn't want to be left out of the party of S&P were to downgrade the U.S.

Cannon believes a downgrade could also hurt banks' earnings and could possibly "weigh on equity," because of "because of negative fair value marks in other comprehensive income." The analyst also said that "cost of debt issue would go up as well given yields of Treasuries would go up."

While the "big four" U.S. banks -- including Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C) and Wells Fargo (WFC) -- have all seen their bottom lines boosted from the release of loan loss reserves over the past year, the additional collateral burdens for repo and FHLB borrowings would be a very big deal.

As of June 30, Bank of America had $239.5 billion in federal funds purchased and securities sold under agreements to repurchase, along with $426.7 billion in long-term debt, including FHLB advances. The nation's largest bank's net interest margin -- the difference between its average yield on loans and investment securities and its average cost of funds -- was 2.48% during the second quarter according to SNL Financial, declining from 2.64% in the first quarter and 2.74% in the second quarter of 2010.

JPMorgan Chase had $254.1 billion in FFP and repo borrowings, and $279.3 billion in long-term debt, including FHLB advances, as of June 30. The company's second-quarter net interest margin was 2.71%, declining from 2.85% the previous quarter and 3.05% a year earlier.

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