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A Boost for Big U.S. Banks

S&P hikes credit ratings on six big banking players including Citi, JPMorgan Chase, and Bank of America

From Standard & Poor's RatingsDirectOn Feb. 14, Standard & Poor's Ratings Services raised its counterparty credit ratings on six major U.S. banking institutions and their subsidiaries. The companies—and S&P's views on each—are listed below:

Bank of America Corp. (BAC)

Rating raised to AA from AA–

"The ratings are based on BofA's success in creating the first true nationwide banking franchise and in converting this competitive advantage into improved financial performance," says Standard & Poor's credit analyst John K. Bartko. A key strength for BofA resides in its retail branch network of approximately 5,800 branches, an unrivaled distribution network from which it gathers stable and inexpensive core deposit funding.

Profitability measures have moved in line with those of other large complex banks, as BofA succeeded in meeting its cost savings targets from the FleetBoston and MBNA mergers. Furthermore, only Citigroup's earnings level rivals that of BofA's at just over $21 billion annually.

Nevertheless, we expect profitability and asset quality to be modestly pressured, but to remain acceptable for the current rating. We anticipate this pressure as a result of several factors including cyclical trends, primarily in the mortgage business, narrowing net interest margins resulting from the continuing flat/inverted yield curve environment, and possibly higher credit card costs as charge-offs for bad debt revert to a normalized level following the surge of bankruptcy filings in October, 2005, as a result of changes to the bankruptcy legislation.

Citigroup (C)

Rating raised to AA from AA–

Strong earnings generation from an extraordinarily diverse set of businesses allows Citi to cover some of the high risks that it incurs. Citi has also achieved a substantial change in its control environment in the aftermath of a wave of heavy litigation expenses and criticism of its business practices from regulators around the world. The period of adjustment is over, and Citi has been investing heavily to stimulate organic growth. These investments should begin to bear fruit in 2007 to reverse the negative operating leverage trend.

Together with some modestly sized acquisitions in emerging markets and cost cuts, earnings should grow more dynamically. They should be sufficient to offset mounting provision expenses that can be expected, as losses return to more normal levels from the very low rates of today. The need to boost reserves should accelerate the trend. "Despite the slow growth, the basic retail and corporate banking franchises are very impressive, with an infrastructure that is best in class in many areas," says Standard & Poor's credit analyst Tanya Azarchs.

JPMorgan Chase & Co. (JPM)

Rating raised to AA– from A+

"JPMorgan's recent performance appears to be improving and is nearing its potential," says Azarchs. Merger-related savings are producing positive operating leverage, and credit costs remain at historic lows. Trading income, which has been a source of unusual volatility, is stabilizing as risk levels have been curtailed. Revenue growth has been very difficult in the face of a flat yield curve and a slowdown in the credit card and mortgage environments. Underlying volume growth, however, is benefiting from a strong economy and should help boost revenues in the future. This should help offset an expected increase in credit costs, which have been abnormally low.

The ratings should remain at this level until JPMorgan establishes a record of consistently higher profitability over a longer period of time. Its earnings strength is such that, even in a less benign economic environment, the firm should remain profitable. The current ratings discount a moderate downturn in the credit cycle some time in the next few years.

U.S. Bancorp (USB)

Rating raised to AA from AA–

"The upgrade reflects USB's continuing generation of well-above-average profitability among its peer group of large regional and large complex banks, even while it has maintained a relatively low-risk business mix and growth strategy," says Standard & Poor's credit analyst Scott Sprinzen. USB's results are significantly less volatile than those of many of its competitors, and profitability measures have remained strong despite the current challenging interest rate environment.

USB's excellent business position, well-above-average profit-generating ability, strong capitalization, and excellent liquidity and funding flexibility, should enable the company to sustain performance commensurate with the revised rating even in less favorable business and funding environments. On the other hand, we now believe it is unlikely the company could sufficiently improve profitability to warrant a further upgrade within the next two years.

Wachovia Corp. (WB)

Rating raised to AA– from A+

"The ratings on Wachovia reflect the strengths of its retail banking franchise, strong diversification of earnings, and the expansion of its consumer lending franchise that has resulted from key acquisitions," says Standard & Poor's credit analyst Victoria Wagner. The merger of Wachovia and Golden West, which closed on Oct. 1, 2006, created a financial services holding company with total assets of $707 billion and a deposit base of $407 billion at yearend 2006.

The unique combination of the merged companies increased the geographic diversification of Wachovia's banking franchise, and increased its market position in the highly competitive residential mortgage business. Golden West brings a unique, prime-quality option adjustable-rate mortgage (ARM) lending franchise that originates loans across the nation and has a long history of negligible credit losses.

The ratings on Wachovia also reflect its strong liquidity profile and improved deposit funding profile. Wachovia has raised its level of earnings performance while maintaining good asset quality and successfully integrating several key acquisitions during the past few years. Its retail banking franchise currently operates with a strong market position in several of its major Southeastern and Mid-Atlantic states, which also house the markets with the strongest growth.

Wells Fargo & Co. (WFC)

Rating raised to AA+ from AA

"The upgrade for Wells Fargo & Co. and its primary banking subsidiaries reflects the company's leading market positions in several of its core regional banking business lines, consistency of core profitability, and strong capital measures that are leading among the large bank peer group," says Wagner. A strong commitment to capital to support risk and growth opportunities is a key factor in the credit ratings. The strength of Wells Fargo's capital position is a key distinguishing factor from the other large, complex bank peers.

While we expect asset quality measures to experience modest deterioration in the coming year, overall credit quality measures should remain quite good and aligned with the diversity of risk in Wells Fargo's loan portfolio. The credit risk profile of the loan portfolio is very balanced with no significant exposures as Wells Fargo carries a higher retail loan concentration in its loan mix than the other large U.S. banks.

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