Risk & Compliance

Moody’s: TARP Covers Well with Preferred Stock

But rating agency says that form of capital injection, because it isn't considered permanent, could lead to unfavorable treatment.
Stephen TaubNovember 21, 2008

Moody’s Investors Service takes a positive view of the government’s infusion of capital to ailing financial institutions in the form of preferred stock issued under the federal Troubled Assets Relief Program.

In a new report, the debt-rating company notes that capital injection comes at a time when banks have limited, if any, access to capital, and that it also immediately lifts regulatory capital ratios. “However, since we do not consider the TARP preferred stock to be permanent, we will not be treating the TARP investment as 100 percent equity and, consequently, we do not expect upgrades of our bank ratings following an infusion of TARP funds,” says Jean-Francois Tremblay, a Moody’s vice president and one of the report’s authors.

Of course, under TARP’s Capital Purchase Program, the U.S. Treasury will purchase senior preferred stock of eligible financial institutions by year-end 2008.

Moody’s explains that in addition to regulatory Tier 1 Capital ratios, an important component of its current methodology for assessing bank capital positions is the Tangible Common Equity over Risk Weighted Assets ratio, or TCE/RWA, which includes Moody’s opinion of the equity value of hybrid securities, including the government-owned preferred stock.

Under the Moody’s approach, TARP preferred stock will receive what it calls Basket B treatment, granting these securities 25 percent equity credit. This means that as the new capital is deployed, banks will likely experience a reduction in TCE/RWA, it explains. “We do not expect upgrades of our bank ratings in the near-term as a direct result of this capital program,” it adds.

In the intermediate term, Moody’s stresses it will monitor how prudently banks manage their TCE/RWA ratio positions in determining their risk and ratings profile. “Also, because we expect bank managements to redeem the TARP preferred stock in earnest as soon as the financial system stabilizes, banks will need to adopt capital management strategies that will provide for capital levels to be maintained after redemption of the TARP stock,” Moody’s adds. For banks that fail to do this, negative rating actions could occur, it warns.

Moody’s also says that as part of its rating analysis, it will closely monitor banks’ use of the TARP funds as well as the longer-term implications of banks’ capital-management philosophy and policies. “We expect that banks will maintain prudent capital levels even after they call the TARP preferred stock, but, if not, negative rating actions may result,” it adds.

It notes, too, that banks may replace the TARP capital through internal capital generation or the potential new issuance of equity or hybrid securities with a high equity component, as defined by Moody’s.

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