Capital Markets

S&P Downgrades 12 Financial Giants

Government intervention likely will save the banks, the ratings agency says, but in the meantime they face higher capital costs.
Stephen TaubDecember 19, 2008

Standard & Poor’s has cut its ratings or outlooks on 12 of the biggest U.S. and European financial institutions, increasing bank industry risk and the deepening global economic slowdown.

The 12 banks are Bank of America, Barclays, Citibank, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorgan Chase, Morgan Stanley, Royal Bank of Scotland, UBS, and Wells Fargo.

However, the ratings agency said government intervention to stabilize the sector and restore public confidence may balance these pressures to a large extent.

Even so, a reduction in the banks’ credit ratings potentially increases their cost of capital. In this week’s issue of The Economist, former Federal Reserve chairman Alan Greenspan said investors today may want banks to boost their capital-to-asset ratio to 14 percent capital, rather than the 10 percent level seen in mid-2006.

S&P predicted there will be more volatility in funding markets. “We expect higher levels of stress than those experienced during a typical business-cycle trough,” it said.

The agency said it is placing more emphasis on risk-adjusted capital (RAC) measures. It is developing a proprietary framework for assessing RAC that it claims is more risk-sensitive than Basel I and more conservative in most cases than Basel II, particularly with regard to market risk and private-equity risk.

S&P also factored into its ratings two types of government support: “ongoing system support” and “extraordinary support.” It explained that it views ongoing system support from government authorities as an essential part of bank creditworthiness in good times and bad. Prudent regulation and access to central bank liquidity can mitigate the high leverage and funding mismatches inherent in bank business models, S&P said. “Without these benefits, we believe bank balance sheets would be very different,” it added.

S&P noted that the prospect of future government intervention for financial institutions under stress has not in the past been a part of its stand-alone credit analysis in the United States. It is doing so now, it said, because recently many governments have intervened as a result of, or in anticipation of, deeper solvency pressures at specific institutions.

The upshot is that none of these systemically crucial financial institutions at the group or operating company level is likely to have an Issuer Credit Rating (ICR) lower than “A+” based on S&P’s expectation that government support will likely be provided if needed. At the same time, none would be assigned an ICR higher than “A+” on the basis of extraordinary government support.

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