Standard & Poor’s Bank Credit Ratings — June 17, 2009

Standard & Poor’s (S&P) and Moody’s are the giant financial rating agencies. On June 17, 2009, S&P analysts downgraded the credit ratings or outlooks on 22 banks. Eight within this group are bank holding companies (BHCs) that underwent the stress test. The remaider are regional banks. Both of these groups received a one- or two-notch rating cut. They were also put on a negative watch which means that their ratings could be cut even further.  Five of the regional banks were downgraded to “junk” status. The one exception is PNC Financial that was upgraded one notch.

S&P said that its rating modifications reflect “our belief that operating conditions for the industry will become less favorable than they were in the past, characterized by greater volatility in financial markets during credit cycles, and tighter regulatory supervision.”

By way of contrast, Moody’s did not release any bank credit ratings alongside S&P. In fact, Moody’s does not expect to downgrade ratings for any of the BHCs that made TARP fund repayments. Should the economic picture change, Moody’s may cut their ratings.

Also on June 17, the Obama administration proposed an overhaul of financial regulation. For the credit-rating establishment, the administration is only proposing modest changes. Considering that credit-raters at S&P, Moody’s and Fitch gave out high ratings on many subprime securities during the real estate boom, it is unclear why there is no proposal to overhaul the credit-rating industry. To the outrage of detractors, the credit rating establishment will continue to be compensated by investment banks selling the securities. So much for managing conflicts of interest and rating independence.

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Rating Definitions:

AAA: Extremely strong capacity to meet its financial commitments.

AA: Very strong capacity to meet its financial commitments.

A: Strong capacity to meet its financial commitments

BBB: Adequate capacity to meet its financial commitments.

BB, B, CCC, and CC: regarded as having significant speculative

characteristics

BB: Adverse business, financial, or economic conditions could

lead to the bank’s inadequate capacity to meet its financial commitments.

B: Adverse business, financial, or economic conditions will likely impair

the bank’s capacity or willingness to meet its financial commitments.

CCC: Currently vulnerable, and is dependent upon favorable business,

financial, and economic conditions to meet its financial commitments.

CC: Highly vulnerable to meet its financial commitments.

R: Under regulatory supervision owing to its financial condition.

Bankroll: Credit Rating Agencies

The giant financial rating agencies are Standard & Poor’s (S&P) and Moody’s.

Standard & Poor’s (S&P) is a financial services company that rates stocks and corporate and municipal bonds according to risk profiles. It’s parent company is McGraw-Hill, a publishing company.

Moody’s Investors Service is an independent, unaffiliated research company that assigns ratings on the basis of risk and the borrower’s ability to make interest payments. Moody’s backs its ratings with exhaustive financial research and unbiased commentary and analysis.

Both of these rating services have dedicated followers. There are, of course, smaller credit-rating services with modest staff that are dwarfed by Moody’s and S&P. The ratings are generally released during industry cycle changes and not at specified intervals like quarterly and annual reports.

However, any discussion of these services would not be complete without reference to a 10-month review conducted by the Securities and Exchange Commission (SEC). The review, “Summary Report of Issues Identified in the Commission Staff’s Examinations of Select Credit Rating Agencies,” was released in July 2008.

The SEC report found that some analysts at Moody’s, S&P and Fitch Ratings gave unjustified high ratings to mortgage and related securities. These phoney “high” ratings turned out to be much riskier and lower than their ratings would have actually implied. In many cases, credit raters were paid by investment banks selling the securities. This in turn prompted the SEC review to question improperly managed conflicts of interest and their rating independence.

The SEC report concluded by saying that “Each credit rating agency was cooperative in the course of these examinations and has committed to taking remedial measures to address the issues identified.”

Having said this, you will often see media references to S&P or Moody’s. For an understanding of the ratings, listed below are the rating profiles and definitions for each service.

S&P – Long-Term Rating Definitions

AAA: Extremely strong capacity to meet its financial commitments.

AA: Very strong capacity to meet its financial commitments.

A: Strong capacity to meet its financial commitments

BBB: Adequate capacity to meet its financial commitments.

BB, B, CCC, and CC: regarded as having significant speculative

characteristics

BB: Adverse business, financial, or economic conditions could lead to the bank’s inadequate capacity to meet its financial commitments.

B: Adverse business, financial, or economic conditions will likely impair the bank’s capacity or willingness to meet its financial commitments.

CCC: Currently vulnerable, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments.

CC: Highly vulnerable to meet its financial commitments.

R: Under regulatory supervision owing to its financial condition.

Moody’s Long-Term Rating Definitions

Aaa: Highest quality, with minimal credit risk.

Aa: High quality and are subject to very low credit risk.

A: Upper-medium grade and are subject to low credit risk.

Baa: Moderate credit risk and may possess certain speculative characteristics.

Ba: With speculative elements and are subject to substantial credit risk.

B: Speculative and are subject to high credit risk.

Caa: Poor standing and are subject to very high credit risk.

Ca: Highly speculative and are likely in, or very near, default, with some prospect of recovery of principal and interest.

C: Lowest rated class and are typically in default, with little prospect for recovery of principal or interest.

Note: Moody’s adds numerical modifiers 1, 2, and 3 to each rating classification from Aa through Caa.

Modifier 1: higher end of its generic rating category.

Modifier 2: mid-range ranking.

Modifier 3: lower end of that generic rating category.

When S&P and Moody’s release ratings for the bank holding companies that underwent stress testing, they will be posted under “Bankroll.”

Bankroll: June 17, 2009

Starting this week, FindSafeBank will regularly post newsworthy items about the 19 bank holding companies that underwent the stress test. We need to ferret out information on everyday things in addition to U.S. Treasury press releases, bank financial reporting and related matters.

Stay tuned for upcoming posts.