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New Fed Rule Sparks Cut in Banks’ Debt Ratings

Requirements to increase convertible debt as a hedge against fiscal crises may be undermining a paring of bank credit ratings.
Matthew HellerDecember 3, 2015

Standard & Poor’s has cut the credit ratings of eight large U.S. banks by one notch, citing the possible effects of new Federal Reserve regulations aimed at preventing another “too big to fail” scenario.

The globally and systemically important banks had been on negative credit watch as S&P reviewed the regulatory changes, which require them to hold big buffers of debt that could be converted into equity in a crisis.

“We now consider the likelihood that the U.S. government would provide extraordinary support to its banking system to be ‘uncertain’ and are removing the uplift based on government support from our ratings,” S&P said Wednesday in a news release.

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The ratings agency cut the long-term issuer credit ratings of Wells Fargo, Bank of New York Mellon, and State Street to A from A+. JPMorgan’s was lowered to A- from A and those of Citigroup, Bank of America, Goldman Sachs, and Morgan Stanley were reduced to BBB+ from A-.

Cuts in bank credit ratings cuts typically raise borrowing costs and force banks to increase collateral, but according to Bloomberg, “the impacts aren’t always clear. When Moody’s Investors Service downgraded 15 of the largest banks in June 2012, the stocks and bonds of the firms rose on relief that the cuts weren’t more severe.”

In October, the Federal Reserve projected that the six largest banks faced a $120 billion capital shortfall under the new rules. Banks are expected to hold total loss-absorbing capacity (TLAC) of at least 18% of their risk-weighted assets.

The TLAC rule is part of a global regime established by the Financial Stability Board, a group of regulators appointed by the G20 countries.

S&P noted that it remained unsure which debt instruments would ultimately count as TLAC-eligible, but said it was satisfied that the effect of the changes would be to reduce the chances of another round of government-led bailouts.