Standard & Poor's ("S&P") Ratings Services, part of McGraw Hill Financial MHFI has downgraded the senior unsecured and non-deferrable subordinated debt ratings of eight major U.S. banks by one level, which were kept under review for a downgrade last month. These banks include The Goldman Sachs Group, Inc. GS, Wells Fargo & Company WFC, JPMorgan Chase & Co. JPM, Citigroup Inc. C, Bank of America Corporation BAC, The Bank of New York Mellon Corporation BK, State Street Corporation STT and Morgan Stanley MS.
Notably, in October, the Federal Reserve Board, led by Chairperson Janet Yellen, proposed a new long-term debt and capital requirement level for the “too big to fail” banks. Under the proposed rule, the selected banks will be required to include the long-term debt in their respective holding companies’ balance sheets. Notably, such debt can be converted into equity in the event of a failure, as this would help infuse the capital required to support critical operations during a crisis.
According to Yellen, the proposed rule "would substantially reduce the risk for taxpayers and the threat to financial stability stemming from the failure of these banks. This is an important step toward ending the market perception that any banking firm is ‘too big to fail.” (Read more: Fed Proposes New Rules: Big Banks to Raise $120B in Debt?)
Regulators are planning to build liquidation plans for U.S. banks to combat another financial crisis. Change in federal policies to support troubled banks is the rationale behind the S&P downgrade.
“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. Therefore, S&P believes the level of government support might be lower compared with the bailout of banks owing to the financial crisis in 2008.
For Wells Fargo, BNY Mellon and State Street, S&P’s long-term issuer rating was cut from A+ to A, while JPMorgan was downgraded one notch below to A- from A. Further, the remaining four banks were lowered to BBB+ from A-.
Bottom Line
Downgrade in the ratings by S&P of major global banks will lower investors’ confidence in the stocks, though it might prepare the firms to better tackle another economic crisis. Moreover, it might increase funding costs, thereby leading to higher expenses impacting the banks’ financials further.
We believe that reduced government support for banks, in case of failure, will make these financial institutions more responsible with their business conducts.
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