Time for another bath. This time metaphorical. And based on Moody's downgrade methodology, a Citi downgrade is imminent.
New York, September 21, 2011 -- Moody's Investors Service has downgraded the ratings of Bank of America Corporation's (BAC) holding company to Baa1 from A2 for long-term senior debt and to Prime-2 from Prime-1 for short-term debt. The long-term deposit ratings of Bank of America N.A.
(BANA) were downgraded to A2 from Aa3, while BANA's short-term rating was affirmed at Prime-1. The actions conclude a review for downgrade announced on June 2, 2011. The outlook on the long-term senior ratings remains negative.
The downgrades result from a decrease in the probability that the US government would support the bank, if needed. Moody's believes that the government is likely to continue to provide some level of support to systemically important financial institutions. However, it is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled, as the risks of contagion become less acute. Moody's is therefore lowering the amount of support it incorporates into Bank of America's ratings to levels reflected prior to the crisis.
The downgrades do not reflect a weakening of the intrinsic credit quality of BAC. BAC has made significant progress in improving in its capital and liquidity positions, in shedding legacy and noncore assets, in measuring and monitoring risk, and in managing its risk appetite. These improvements have not, however, resulted in an upgrade of its stand-alone financial strength rating or in an offset to the declining assumption of systemic support in the long-term ratings. This is due in large part to the risks that continue to be presented by the bank's exposures in its mortgage business.
The ratings affected are as follows:
Bank of America Corporation (BAC), Merrill Lynch & Co., Inc., and all rated debt guaranteed or assumed by BAC or Merrill Lynch (including the rated debt of Countrywide Financial Corporation): Moody's downgraded the long-term senior debt rating to Baa1 from A2 and the short-term rating to
Prime-2 from Prime-1. The holding company senior debt ratings now incorporate two notches of uplift due to systemic support, down from four notches previously. BAC's senior subordinated debt rating was downgraded to Baa2 from A3, and its cumulative junior subordinated-backed trust preferred securities were lowered to Ba1 (hyb) from Baa3 (hyb),
Bank of America, N.A. (BANA): Moody's downgraded the long-term bank deposit and senior bank debt ratings to A2 from Aa3 and the short-term
Prime-1 rating was affirmed. The bank financial strength rating (BFSR) of
C- was also affirmed, and the bank's corresponding baseline credit assessment (BCA), or unsupported rating, remains unchanged at Baa2. The outlook on the BFSR is stable. The bank deposit and senior debt ratings now incorporate three notches of uplift due to systemic support, down from five notches previously. BANA's subordinated debt was downgraded to
A3 from A1.
Please see the link for a full list of rating actions.
Moody's will publish separate press releases on other institutions covered by the review announced on June 2, 2011.
Moody's continues to see the probability of support for highly interconnected, systemically important institutions as very high, although that probability is lower than it was during the financial crisis. During the crisis, the risk of contagion to the US and global financial system from a major bank failure was viewed as too great to allow such a failure to occur -- a view borne out in the aftermath of the Lehman failure. This led the government to extend an unusual level of support to weakened financial institutions and Moody's to incorporate the expectations of such support in its ratings. Now, having moved beyond the depths of the crisis, Moody's believes there is an increased possibility that the government might allow a large financial institution to fail, taking the view that contagion could be limited.
Moody's decision to assign a negative rating outlook reflects the possibility it may further reduce its systemic support assumptions in the future as a consequence of the process set in motion by the enactment of the Dodd-Frank Act. Under the rules recently finalized by the FDIC, the orderly liquidation authority included in Dodd-Frank demonstrates a clear intent to impose losses on bondholders in the event that a systemically important bank such as BAC was nearing failure. If fully implemented, the provisions of Dodd-Frank could further lower systemic risk by reducing interconnectedness among large institutions and could further strengthen regulators' abilities to resolve such firms.
However, the final form of several critical components of Dodd-Frank intended to reduce such interconnectedness, such as resolution plans or changes to the over-the-counter derivatives market, are still pending.
There is also no global process yet in place whereby regulators could resolve a global financial company such as Bank of America in an orderly fashion. As a result, Moody's believes that it would be very difficult for the US government to utilize the orderly liquidation authority to resolve a systemically important bank without a disruption of the marketplace and the broader economy.
The affirmation with a stable outlook of the stand-alone bank financial strength rating at C-, which continues to map to a baseline credit assessment of Baa2, reflects the challenges posed by the significant contingent risks BAC continues to face in its mortgage business. BAC has made significant improvements to its capital and liquidity positions, continues to focus on shedding legacy and noncore assets, has improved its ability to measure and monitor risk, and has adopted a lower risk appetite. Nonetheless, the bank remains exposed to potentially significant risks related to both the residential mortgage and home equity loans on its balance sheet, as well as to mortgages previously sold to investors.
Moody's believes BAC has ample resources to absorb the additional losses it is likely to experience on these exposures. However, if the economic environment were to deteriorate and the bank were to receive adverse legal rulings on the claims pending against it related to its mortgage business, it could have a significant impact on BAC's capital position.
Moody's also believes the variability around potential negative outcomes is substantial, and their resolution is not entirely within the direct control of management.
The resulting uncertainty is a constraining factor on BAC's baseline credit assessment, especially in light of the bank's still relatively modest capital position compared to its major peers.
The ratings for BAC's cumulative junior subordinated-backed trust preferred securities were lowered by one notch to Ba1 (hyb) from Baa3 (hyb), reflecting a reduction in the rating agency's support assumption for those securities. Those ratings are now consistent with Moody's guidelines for rating bank hybrid securities whereas previously they had included an additional notch of uplift for systemic support. The ratings for BAC's noncumulative preferred stock and the HITS issued by BAC Capital Trust XIII and BAC Capital Trust XIV, which do not incorporate any government support, were confirmed at Ba3 (hyb). (The HITS, or Hybrid Income Trust Securities ultimately have a non-cumulative preferred stock claim on BAC under the terms of a forward contract.)
The methodologies used in this rating were "Bank Financial Strength Ratings: Global Methodology" published in February 2007, "Incorporation of Joint-Default Analysis into Moody's Bank Ratings: A Refined Methodology" published in March 2007, and "Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt" published in November 2009.