Wednesday, February 10, 2010

S&P Warns (Again) About Political Risk for Bondholders

US Banks

•Move to Negative Outlook on BAC — Standard & Poor’s changed BAC’s outlook
from stable, citing “increased uncertainty” about the US Govt’s willingness to
provide extraordinary support to systematically important financial institutions.
S&P referred to the House bill on bank regulatory reform, which would mandate
losses for bondholders, and the recently proposed special tax on banks.

•A reminder — S&P was essentially reminding bond investors about the possible
repercussions if the US Govt abolished the “too big to fail” doctrine. S&P (and
Moody’s) have previously expressed their concerns about the potential impact on
senior bondholders if that policy changes. BAC’s ratings currently receive three
notches of “uplift” to single A because of Govt support. (See Figure 1).

•GS and MS at some risk — Goldman Sachs and Morgan Stanley receive two and
three notches of uplift from S&P. JPMorgan and Wells Fargo receive none and
would not be affected. (Moody’s has a somewhat different approach).

•Curious timing — The timing of S&P’s move was somewhat curious, we thought,
because the negotiations in the Senate on bank regulatory reform recently hit an
“impasse”, according to Sen. Dodd, the chairman of the Sen. Banking Committee.

•No imminent action...unless Senate moves — S&P said that the negative outlook
was signaling a 1-in-3 chance of a downgrade over the next two years. S&P left
open some (but not much) possibility that BAC’s stand-alone credit fundamentals
might improve over the next two years and offset or mitigate rating pressure from
a change in Govt policy. The real risk scenario, we think, is that the Senate passes
a bill with House-type language this year (which remains possible). In that event
S&P would most likely feel obligated to downgrade BAC, in our opinion.

• S-T ratings could fall to A-2 — We confirmed with S&P that if BAC were
downgraded one notch, to A-,
its short-term rating would fall to A-2. If that were
to happen, we think that BAC would most likely not be able to access the
commercial paper market. BAC could also face collateral calls related to
derivative transactions and repo financing transactions, we believe.

•BAC "well positioned" on liquidity — The rating agency said that BAC could
handle the impact of a downgrade (while emphasizing that a downgrade was not
imminent). S&P said that BAC’s liquidity planning took into account the potential
effects of a downgrade.

• Buy on BAC 7.625s of 2019 (T+215bp) — In our view, BAC’s asset
quality is stabilizing and the bank could earn $8.8 bil this yr. The company has
also increased its capital base significantly. So we think that its stand-along
credit profile is likely to improve materially this yr and that a need for further Govt
support is not a high probability event.

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