Standard & Poor's has placed five top banks on CreditWatch, with positive implications, reflecting overall improvement within the industry
From Standard & Poor's RatingsDirectOn Nov. 1, Standard & Poor's Ratings Services placed the credit ratings assigned to large U.S. financial institutions Bank of America (BAC), Citigroup (C), J.P. Morgan Chase (JPM), U.S. Bancorp (USB), and Wells Fargo (WFC), on CreditWatch with positive implications (see list below). Wachovia (WB) remains on CreditWatch positive as well, where it was placed last month, on Oct. 2. These placements will not necessarily result in ratings upgrades.
The five banks placed on CreditWatch are the leaders in the U.S. industry in terms of diversification and risk controls. In some cases (e.g., U.S. Bancorp and Bank of America), they lead in terms of profitability as well.
The CreditWatch placement reflects S&P's view that the U.S. banking industry has become sounder on a variety of fronts over the years, so that the potential for higher ratings—including the highest AAA level—now exists. This revised assessment has already had a positive ratings effect on several of the stronger U.S. regional banks and some of the largest U.S. brokers, which have been upgraded throughout 2006.
Here are some of the main positive developments we have taken into account in this reassessment:
Profitability is higher on a number of measures and more consistent now than it was a decade ago. It provides a substantial cushion for any potential credit-related or other losses. This reflects greater efficiency, as well as a decade-long process of weeding out underperforming businesses. The absolute level of earnings is larger as well, which means that more things have to go wrong at once for the bottom line to be negative.
Diversification by product, by customer, and by geography has improved with consolidation and globalization in the industry. It has resulted in an improved franchise value, with a better mix of corporate business, which we view as riskier, and consumer business, which is more predictable.
Risk management has improved substantially and afforded banks a great deal more financial flexibility in the face of potential problems. Greater liquidity in capital markets permits sale of a greater variety of asset classes either outright or through securitization or hedging. By the same token, capital markets are an increasing source of funding. Internal risk controls are also more sophisticated, so that risk information flows more widely through the organization and ensures that risk is at least taken consciously.
Taken together, the earnings profiles and risk-management capabilities should further soften the cyclical nature of bank performance. While we expect some general deterioration in bank earnings in the coming year, we would be comfortable with moderate declines even at higher rating levels.
S&P will resolve the CreditWatch status of each company individually after yearend results are reported. We will evaluate the ability of each company to withstand a significant cyclical downturn relative to other financial institutions. We will also examine risk governance and growth potential as well.
The circumstances that would result in a one-notch rating upgrade will be particular to each situation. Companies whose superior financial performance is deemed to be cyclical and not structural in nature will be affirmed.