STT State Street Corporation

Will the government protect big banks any more? Will the "too big to fail" presumption stick around anymore? The answers to these questions will determine rating agencies’ actions on major U.S. banks. 

These perceptions may no longer hold true. At least, that’s what the Dodd-Frank act clearly conveys. Ratings accorded by agencies that were inflated assuming that mega banks are entitled to government protection by default during a major financial crisis, can now be downgraded.

First among the rating agencies, Moody's Investors Service, a unit of Moody's Corp. (MCO), said on Thursday that it is reviewing the ratings of three mega banks,Bank of America Corp. (BAC), Citigroup Inc. (C) and Wells Fargo & Co. (WFC) for possible downgrades.

The agency had given strong investment-grade credit ratings to these banks on the presumption of obvious government shelter. However, now the agency is weighing the odds of government support to these banks after the rules of Dodd-Frank financial act are put into practice.

Currently, Bank of America, Citigroup and Wells Fargo respectively hold Aa3, A1 and Aa2 from Moody’s. Without the presupposition of government support, these ratings would have been about three to five notches lower.

The reviewing process would take maximum three months. According to the rating agency, the magnitude of downward rating revision will be inversely proportional to the improvement of asset quality and capital position of these banks by that time. As a result, there will be normal ratings cushion like other small and medium sized banks.

Then again, Moody’s does not entirely discount government support to these banks. While the agency will definitely not rule out government backing, it might tone down its stance to some extent.

What would be the implication for banks if their credit ratings are downgraded? Apart from losing out on investors’ confidence, these banks would face high cost of borrowing. The reason is that investors would invest in these low rated banks if they are compensated for taking higher risk.

Apart from these three, five more banks enjoy higher ratings from Moody's based on federal government support. These banks are JPMorgan Chase & Co. (JPM), Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), Bank of New York Mellon Corp. (BK) and State Street Corp. (STT). Moody’s would target these banks next for rating downgrades. The agency said that it has already started evaluating its assumption of government support on these banks.

To Conclude…

The unclear goals of the government bailout program strengthened the perception that some big institutions are “too big to fail.” Precisely, the lack of articulation ended up in a malformed impression that Federal Reserve will always protect these institutions from failing if they are in major financial trouble.

Quite obviously, if the big institutions get the idea that a bigger brother will be there to save them whenever they are in dire straits, they will never hesitate to take extravagant risks. Unfortunately, taxpayers will have to suffer by bearing the cost if these institutions lose the gamble.

However, the Dodd-Frank act clearly conveys that if big institutions dig their own holes by taking extravagant risks, they would not get taxpayers’ assistance in future. As a result, rating agencies are also keeping an eye on these banks. So, for these big banks, the only way to exist is to do business without jeopardizing the hard earned money of investors and taxpayers.

 
BANK OF AMER CP (BAC): Free Stock Analysis Report
 
BANK OF NY MELL (BK): Free Stock Analysis Report
 
CITIGROUP INC (C): Free Stock Analysis Report
 
GOLDMAN SACHS (GS): Free Stock Analysis Report
 
JPMORGAN CHASE (JPM): Free Stock Analysis Report
 
MOODYS CORP (MCO): Free Stock Analysis Report
 
MORGAN STANLEY (MS): Free Stock Analysis Report
 
STATE ST CORP (STT): Free Stock Analysis Report
 
WELLS FARGO-NEW (WFC): Free Stock Analysis Report
 
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