June 2 (Bloomberg) -- Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. may be downgraded by Moody’s Investors Service as the rating firm reviews whether the government will limit its support of the largest financial firms.
Ever since the financial crisis, ratings for the banks have been boosted by an assumption that the U.S. would provide extra support if the lenders got into trouble again, the ratings firm said in a statement today. A review by Moody’s will “focus on whether these ratings should be adjusted to remove this unusual uplift and include only pre-crisis levels of government support.”
Investors have regarded the banks as too big to fail after they received government aid in 2008 to keep the financial system from collapsing. Lawmakers have since overhauled regulations and passed the Dodd-Frank legislation to avoid a repeat of bailouts that aided firms including Charlotte, North Carolina-based Bank of America, which received $45 billion.
“Everyone is cognizant of the fact that the banks will end up back in the lap of the government should there be a problem,” said Daniel Alpert, managing partner at Westwood Capital LLC, a New York-based investment bank. “What the ratings agency is saying here is that if we had another problem in the next six to 12 months, it’s unlikely the government will once again unilaterally protect bondholders. It’s politically untenable.” Alpert said he holds a small stake in Citigroup.
Building a Cushion
Bank of America, Citigroup and San Francisco-based Wells Fargo have raised funds from private investors to repay U.S. aid and have been building capital to guard against further declines in housing prices. Moody’s rates Citigroup’s senior unsecured debt at A3, and assigns a rating of A2 to Bank of America and A1 to Wells Fargo. A1 is the fifth-highest of 10 investment-grade ratings and A2 is sixth.
Citigroup welcomes the reassessment of its rating, Chief Financial Officer John Gerspach said in an e-mailed statement, calling his bank one of the best-capitalized financial institutions in the industry. At Bank of America, “our stand-alone rating should be higher given the progress that we’ve made to strengthen our balance sheet, improve our capital and liquidity and reduce our risk profile,” said Jerry Dubrowski, a spokesman for the lender.
Mary Eshet, a spokeswoman for Wells Fargo, said Moody’s review is consistent with its statements from as far back as a year ago and that the bank’s unsupported ratings remain among the strongest in the industry.
Credit-default swaps on Citigroup rose 7 basis points to 135.4 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Bank of America’s swaps increased 6.7 basis points to 155.5 basis points.
Wells Fargo’s swaps rose 4.3 basis points to 89 basis points, according to CMA. A rising price indicates more doubt on the part of investors about whether a debtor will meet its obligations.
Moody’s will assess improvements in Bank of America’s and Citigroup’s financial strength, and “this may temper the extent of any ratings downgrades that could result from its review of these firms’ unusual level of systemic support,” the ratings firm said.
In March, under expanded powers granted by Dodd-Frank, the Federal Deposit Insurance Corp. laid out a framework for priority payment of creditors and procedures for filing claims in liquidations of large, complex firms. Congress sought the liquidation authority after the September 2008 bankruptcy of Lehman Brothers Holdings Inc. deepened the credit crisis and highlighted the ties among the largest financial firms.
The move to establish an orderly process for winding down firms was “key” to Moody’s review, Robert Young, managing director with the ratings firm, said in a phone interview.
“Post-Dodd Frank, you evaluate willingness and ability to reduce support or impose losses on creditors,” Young said. “Clearly the intent of the government is to not provide support.” The government’s liquidation authority wouldn’t work as of right now, so Moody’s isn’t prepared to discount government support entirely, he said.
Bank of America and Citigroup “have sizable residential mortgage exposures,” Moody’s said. “Their credit costs could therefore spike if the U.S. economy were to contract again. Further, they continue to face litigation costs related to faulty foreclosure practices.”
Downgrades could weaken the banks’ liquidity, limit access to credit markets and pressure businesses that rely on trading revenue, according to regulatory filings. A downgrade by one level at all rating firms could cost Bank of America $1.2 billion for collateral posting and termination payments tied to derivatives and trading agreements, the bank said.
Citigroup said a one-grade reduction of senior and short-term ratings could result in the loss of $8.7 billion in commercial paper funding and $500 million in derivative triggers and margin requirements, and Wells Fargo said it would have been required to post collateral of $1.1 billion as of March 31 had downgrades below investment grade triggered provisions in derivative contracts.
“We would not be surprised to see a one-notch downgrade in Citi and possibly a two notch downgrade in Bank of America’s published senior ratings,” said David Havens, managing director of credit trading at Nomura Holdings Inc., in an e-mail. “This is because Citi has a notch less support, and seems to have less current issues (read: mortgages) than Bank of America.”
Bank of America advanced 5 cents to $11.29 at 4 p.m. in New York Stock Exchange composite trading, leaving it down 15 percent this year. Citigroup gained 36 cents to $40.01, also with a 15 percent drop year to date. Wells Fargo rose 22 cents to $27.16; it’s down 12 percent since Dec. 31.
Bank of New York Mellon Corp. had the outlook on its debt lowered to “negative” from “stable,” Moody’s said. That brings it in line with other financial firms benefiting from the assumption of government support, including JPMorgan Chase & Co., Goldman Sachs Group Inc. and Morgan Stanley, all based in New York.
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