The government’s new plan for improving the financial markets will be positive for major banks’ depositors as well as debt holders, Moody’s Investors Service said in a new Special Comment.
“Despite the lack of specifics about the terms of the initiatives announced [on Tuesday], Moody’s positive view is based on its assessment that the FSP (Financial Stability Plan) reflects the U.S. Government’s commitment to providing bridge capital and liquidity support to major banks and to re-starting the flow of credit,” says Jean-Francois Tremblay, a vice president in Moody’s Financial Institutions Group.
Moody’s points out that under the FSP, the Public-Private Investment Fund component encourages the recognition of losses on distressed assets, which will reduce the common equity base of banks. However, it stresses that this will be compensated for by an infusion of convertible preferred stock provided under the Capital Assistance Program.
The rating agency explains that the two components provide the banks with a process to rid themselves of troubled assets while maintaining the appropriate level of regulatory capital, which is supportive of creditors. Further, this two-tiered approach is supposed to improve the chances of regaining confidence in the system, and therefore attracting private capital in the future.
Moody’s goes on to explain that the funds will be allocated following a comprehensive forward-looking stress test that will establish a form of contingent equity buffer to ensure that firms have the capital strength to preserve or increase lending during a more severe decline in the economy than projected. “The stress test proposed by the U.S. Government appears similar to a key component of Moody’s current methodology, which focuses on the ability of a bank to sustain a deterioration of its financial position,” commented Tremblay. “This is an important departure from [the Troubled Asset Relief Program], which allocated funds on the basis of a specified percentage of a bank’s risk-weighted assets.”
However, Moody’s asserts that the benefits of the FSP are less clear for creditors of smaller banks – those with less than $100 billion in assets. This is important, given that the FSP’s overall aim is to restart the flow of credit.
Moody’s says the FSP will have several rating implications for banks. For one thing, the FSP’s measures to address liquidity concerns and capital deficiency could support the banks’ intrinsic value over the long term. Moody’s also believes that the FSP clearly supports senior debt and deposit ratings.
The rating agency also noted that the FSP will support junior subordinated debt ratings, as additional capital injections further cushion this class of debt against losses. “Although these securities have interest deferral features, Moody’s does not believe that regulators will impose them,” it concludes.
“On balance, Moody’s believes the FSP is supportive of preferred securities,” added the report. “However, the rating agency is less confident that dividend payments would not be deferred by those institutions that require sizeable injections of public funds and where there is a higher likelihood that these stakes could be converted into common equity.”