Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM) are among banks whose debt ratings may be cut by Moody’s Investors Service as it examines whether the U.S. would be less likely to ensure creditors are repaid in a crisis.
Morgan Stanley and Wells Fargo & Co. (WFC) also may be downgraded, Moody’s said yesterday in a report. Citigroup Inc. (C) and Bank of America Corp. (BAC) are under review, with the direction of any rating change uncertain, Moody’s said. Bank of New York Mellon Corp. and State Street Corp. (STT) already were under review.
Moody’s and Standard & Poor’s have said downgrades may be needed because the federal government has new tools to wind down banks instead of rescuing them with taxpayer money. Those plans can include forcing debtholders to incur losses or convert stakes to equity. The policies also may have an impact on ratings of the companies’ deposit-taking subsidiaries.
“In the past year, we have seen progress towards establishing a framework to credibly resolve these large systemically important banks,” Robert Young, a Moody’s managing director, said in the report.
The reviews may lead to a one- or two-step downgrade at the banks depending on the level of government support built in to the ratings, David Fanger, a senior banking analyst at Moody’s, said in a phone interview. Bank of America and New York-based Citigroup may avoid cuts or be upgraded because of their improving financial performance, Fanger said.
The debt of JPMorgan and Wells Fargo is rated A2, the sixth-highest of Moody’s 10 investment-grade levels. Goldman Sachs is one step below that at A3, followed by Morgan Stanley at Baa1. Citigroup and Charlotte, North Carolina-based Bank of America are rated Baa2, two rungs above junk.
JPMorgan may have to post $1 billion in extra collateral in the event of a one-step cut and $3.4 billion after a two-level reduction, the New York-based lender said in its latest quarterly filing. The bank said it may not need to put up the collateral if a downgrade by one firm doesn’t go below that of an existing grade provided by another major ratings company.
Goldman Sachs may have to post $1.26 billion extra collateral or termination payments if its credit ratings are cut one level and $2.17 billion for a two-step drop, the New York-based firm said in a filing for the quarter ended June 30. A one-level cut by Moody’s along with a two-level downgrade by S&P could force New York-based Morgan Stanley (MS) to post $1.85 billion, according to its second-quarter filing.
The Federal Deposit Insurance Corp.’s favored approach for winding down banks in a crisis, known as single-point-of-entry, may lead to higher recoveries for bondholders by keeping operating units open, Fanger said. Firms may be required to hold a minimum amount of debt, which also could help recoveries because losses would be spread among more investors, he said.
There would be “more bondholders to share the burden,” Fanger said.
Moody’s said March 27 it would reconsider its assumptions of government support for the largest lenders, and outlined four areas where more work needed to be done. Since then, global regulators have made progress in all areas and are “starting to speak more from the same playbook,” Fanger said.
Relative yields on bank bonds have narrowed 8 basis points this year to 159 basis points, or 1.59 percentage points more than Treasuries, as of yesterday, according to the Bank of America Merrill Lynch U.S. Banking Index. That compares with an increase of 9 basis points for industrial bonds that had an average spread of 153.
Credit-default swaps linked to the six biggest U.S. banks also signal improved credit quality. The contracts, which pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt, cost an average 112 basis points at 5:44 p.m. yesterday in New York from 129 at year-end, according to prices compiled by Bloomberg.