Banks

Banks May Face Rating Cuts, Analyst Says

Posted on Wednesday, December 8, 2010

One of Wall Street’s most influential securities analysts is telling investors to brace themselves: some of the nation’s biggest banks could be on the cusp of a credit rating downgrade.
In a new report, Glenn Schorr, who covers brokerage firms and banks at Nomura, says that while “it’s not a done deal, at present, Bank of America, Citigroup and Morgan Stanley appear most at risk of being downgraded to Tier 2 status.”
Credit ratings are very important to banks and affect them in a number of ways. For instance, lower credit ratings hurt a bank’s ability to issue commercial paper.
At the same time, however, Mr. Schorr plays down the impact of a downgrade. He sees the affect on commercial paper issuance as a minor challenge, noting that “most of the big firms have meaningfully reduced CP and built up large liquidity buffers.”
A lower debt rating would also affect a bank’s ability to engage in repo transactions, or repurchase agreements, with credit-sensitive counterparties. Again, Mr. Schorr thinks this is an insignificant issue because firms have been “scaling back less-liquid repo with money market funds.”
A downgrade in the banks’ debt ratings could require them to make contractual collateral or termination payments, but Mr. Schorr is sanguine that these “are very manageable.”
Morgan Stanley and Citigroup declined to comment.
A spokesman for Bank of America said: “We have made significant strides to strengthen our balance sheet, improve earnings, capital and liquidity and reduce our risk profile.” Among other things, the spokesman noted, since the first quarter of 2009, the bank has raised more than $57 billion of Tier 1 common equity and reduced risk-weighted assets by $290 billion.
The credit downgrade may strike some investors as coming at an odd time.
“While balance sheets are in better shape and fundamentals are improving, the pace of recovery is likely a bit slower than the agencies were expecting,” Mr. Schorr wrote in his report. Among other things, banks are facing new challenges like European sovereign risk and the negative impact of regulatory reforms on revenue.
The lower credit ratings could reflect changes in the assumed levels of government support that the rating agencies have assigned the banks.
Mr. Schorr says in his report that the rating agencies assume a certain level of government backing of banks, meaning the agencies don’t think the system or the government is going to let banks fail if they got into trouble. Some firms like Bank of America have four notches of government support in their Moody’s rating, he writes. Meanwhile, other banks, like JPMorgan Chase, have no assumed government support in its S.&P. rating, he says.
The bottom line: Downgrades would ultimately drive up financing costs and make it more difficult for the affected banks to compete in businesses like prime brokerage.
But “we don’t think it will cause a meaningful loss of funding capacity,” Mr. Schorr wrote.
. By ANITA RAGHAVAN


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