France's Rating Downgrade a Warning for Banks

French banks were reminded of risks to their own growth and credit ratings when Moody's stripped France of its triple-A badge because of an uncertain fiscal and economic outlook.

Lenders such as BNP Paribas, Societe Generale and Credit Agricole have spent the past year trying to contain their exposure to peripheral troublespots in the euro area like Greece by dumping assets and cutting costs.

But the sector was singled out as an economic risk by Moody's and analysts said cuts to the ratings of individual banks most exposed to the French economy could follow.

"It is likely that Moody's will cut its outlook on SocGen and Credit Agricole in coming weeks," said Yannick Naud, fund manager at Glendevon King Asset Management.

Larger BNP is seen as more financially robust, with regulatory capital levels above most big global banks under "Basel III" accounting methods.

Moody's warned in its overnight announcement of the downgrade that French banks remain vulnerable to a further deepening of the eurozone debt crisis, both via their cross-border exposures and their reliance on wholesale markets, rather than deposits, to fund operations.

The French government said the criticism of the banking sector was unjustified since it has already taken steps to reduce exposure to the southern European economies that are worst affected by the crisis.

"I don't think that it is fair by Moody's to flag an increased weakness in the French banking sector, I think that it's the contrary," Finance Minister Pierre Moscovici said.

French banks have strengthened their balance sheets over the past year by cutting staff, costs and dividends. They have also sold assets including peripheral euro sovereign bonds and entire business lines to help meet tougher capital requirements under Basel III banking rules.

BAD NEWS

Monday's Moody's downgrade was not a huge surprise because it followed Standard and Poor's decision to cut France's AAA rating in January.

French debt hardly reacted and there was also little impact on banking stocks which have soared some 30 to 50 percent year-to-date on the back of support from the European Central Bank.

Shares of BNP, SocGen and Credit Agricole, France's biggest banks, were up 0.1 to 1.2 percent at 1530 GMT, outperforming a 0.7 percent drop for the STOXX 600 bank index.

But a stagnating domestic economy, rising unemployment and consumer belt-tightening have started to hit revenues and analysts expect more problems ahead.

SocGen said that the French economy had "slowed to a crawl" when it announced an 86-percent drop in third-quarter net profit on Nov. 8, while Credit Agricole took $4.6 billion in writedowns for the same quarter on investments in Greece, Italy and Spain.

"It's not good news, it will lead to other downgrades and it is bad for both the French banks and other holders of French sovereign debt," said Hugues Le Maire, head of asset manager Diamant Bleu.

BNP's rating was recently cut to A+ by Standard & Poor's, citing economic headwinds. France accounted for nearly a third of BNP's loan exposure at end-2011, while at SocGen it was nearly half.

French banks are also important holders of sovereign debt: BNP had about 10 billion euros ($12.8 billion) in French government bonds in its banking book at end-June, while SocGen had around 16 billion. Relative to their balance sheets, however, the figures are low - in the low single-digit percent.

BNP did not respond to requests for comment about the downgrade, while SocGen, Credit Agricole and Natixis' parent declined to comment.

Analysts said smaller banks may feel the biggest pressure from the Moody's decision.

"It's a non-event for sovereign debt ... But it means further downward pressure on the weakest entities in the French banking system," said Naud.

Credit-rating downgrades have already caused problems for smaller bank entities that rely on securitization vehicles to raise funds on the market. Property lender Credit Immobilier and auto-loans provider Banque PSA Finance, part of Peugeot , both got state guarantees after ratings downgrades.