JPMorgan, BofA, Citigroup Among Eight U.S. Banks Cut by S&P

  • Move is prompted by Fed rule aimed at avoiding future bailouts
  • Ratings firm signaled last month that downgrades were likely

JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. are among eight large U.S. banks that had their credit grades cut by one level by Standard & Poor’s on the prospect that the U.S. government is less likely to provide aid in a crisis.

After signaling the move last month, S&P lowered its long-term issuer credit, senior unsecured, and non-deferrable subordinated debt ratings, according to a statement Wednesday. Firms affected also include Wells Fargo & Co., Goldman Sachs Group Inc., Morgan Stanley, Bank of New York Mellon Corp. and State Street Corp.

“We now consider the likelihood that the U.S. government would provide extraordinary support to its banking system to be ‘uncertain’ and are removing the uplift based on government support from our ratings,” S&P said in the statement. It had put the companies on negative credit watch Nov. 2 as it reviewed regulatory changes.

The Federal Reserve approved a rule in October that will require large U.S. banks to hold a stockpile of debt that can be converted into equity if they falter -- a key part of regulators’ efforts to avoid another financial crisis. If U.S. companies were to fail, investors in their stock would lose everything, but the debt would be converted into equity in a new, reconstituted bank.

Wells Fargo, Bank of New York Mellon and State Street had their long-term issuer credit ratings cut to A from A+. JPMorgan’s was lowered to A- from A. Citigroup, Bank of America, Goldman Sachs and Morgan Stanley were reduced to BBB+ from A-.

Positive Effects

The concept of using banks’ debts to avoid collapse is known as a “bail-in,” as opposed to a taxpayer-funded bail-out. During the financial crisis, governments used hundreds of billions of dollars of public money to rescue lenders, often leaving the banks’ bondholders untouched.

The biggest U.S. lenders face a shortfall of $120 billion of long-term debt under the Fed proposal while CreditSights Inc., a debt research firm, estimates the gap could be anywhere from $69 billion to $550 billion, according to a Dec. 1 article.

The higher figure is a possibility because bonds of U.S. banks’ holding companies typically contain terms that may render them ineligible for a bail-in, CreditSights analyst Pri de Silva wrote. The Fed has to rule on how to proceed, according to de Silva.

Because creditors would end up providing support under the Fed’s plan, S&P has said it’s taking no negative actions on the eight banks’ operating businesses. In some cases, the rules may even have a positive impact on the companies’ “core and highly strategic operating subsidiaries,” S&P said. It has placed such units at Bank of America, Citigroup, Morgan Stanley, and Goldman Sachs under review for potential upgrades.

Representatives for the banks declined to comment.

Ratings cuts typically raise borrowing costs and force banks to increase collateral. Still, the effects aren’t always clear. When Moody’s Investors Service downgraded 15 of the largest banks in June 2012, the stocks and bonds of the firms rose on relief that the cuts weren’t more severe.

Borrowing costs may “creep up,” according to Christopher Wheeler, an analyst in London with Atlantic Equities LLP who covers the biggest U.S. banks. “A lot of long-term debt will be implicitly bail-inable, so investors are taking on more risk than they were before.”

Bonds of U.S. banks have returned 2.5 percent in 2015, compared with 5.1 percent in the same period a year earlier, Bank of America Merrill Lynch index data show. The debt has gained 1.6 percent since the end of August, compared with 1.2 percent for dollar-denominated investment-grade corporates.

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