U.S. Bank Franchises Could Be Damaged

Includes: MER, XLF
by: Research Recap

Moody’s is paying increasing attention to the potential damage to US banks’ long-term franchises caused by persistent negative headlines about losses and writedowns.

In its Commentary on US Banks’ First Quarter Earnings, Managing Director Robert Young writes that a bank may have substantial capacity to handle even severely stressed asset quality and high credit costs over a four- to six-quarter period.

However, this level of credit costs can lead to a bank’s management reporting an additional four to six quarters of operating losses — and likely creating negative headlines and incurring damage to its reputation in the process.

We are focused on the implications for this with regard to the long-term health of a bank’s franchise. We’ll be studying management actions (such as business-line divestitures), as well as customer behavior and market share, as we consider lasting franchise deterioration in our ratings.

Young writes that “liquidity continues to be a keen focus for us, but we don’t expect it to drive widespread ratings changes. Earnings and capital, as a result of asset quality deterioration, are key concerns, and franchise risk has increased – particularly for those banks that are most exposed to headline risk or persistently negative news flow. “

Other key points from other Moody’s contributors to the Commentary:

  • Under the most likely scenario of an extended period of sizeable credit costs, banks have less ability to generate capital internally. Low price-to-book values suggest constraints on capital-raising. Banks now find themselves with limited financial flexibility.
  • Merrill Lynch’s (MER) settlement with monoline insurer XL was for about 20 cents on the dollar of the current value of the insured protection. This may also set a new precedent for any monoline that would consider agreeing to any form of recouponing or collateral posting.
  • If stock prices and asset valuations continue to remain pressured, we would expect more banks to take goodwill write-downs in the coming quarters.