FINANCIAL INSTITUTIONS RESEARCH

The Evolution Of Government Support In U.S. Bank Ratings

Primary Credit Analyst: Rodrigo Quintanilla, New York (1) 212-438-3090; rodrigo.quintanilla@standardandpoors.com Secondary Contact: Carmen Y Manoyan, New York (1) 212-438-6162; carmen.manoyan@standardandpoors.com Contributor: Raphaele Hunter, New York

Table Of Contents
How We Factor Government Support In U.S. Bank Ratings Government Support May Be Waning, Especially For Bank Holding Companies Related Criteria And Research

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The Evolution Of Government Support In U.S. Bank Ratings

When credit markets all but shut down and confidence in financial institutions globally deteriorated during the financial crisis in the fall of 2008, in our view, the concerted actions of governments worldwide were instrumental in pulling the entire system from the brink of a massive collapse. In fact, governments demonstrated a willingness to provide extraordinary support in the face of the market crisis to a degree that we had not previously anticipated. As a result, at the end of 2008, Standard & Poor's Ratings Services for the first time introduced explicit uplift in ratings for extraordinary government support for certain U.S. banks (see "External Support Key In Rating Private Sector Banks Worldwide," published Feb. 27, 2007, on RatingsDirect). We later revised the criteria in 2011 (see "Banks: Rating Methodology And Assumptions," published on Nov. 9, 2011). Now, however, U.S. government officials, regulators, and legislators have clearly stated an unwillingness to provide extraordinary financial support in the future to institutions deemed "too big to fail." In fact, the Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA) that Congress enacted on July 21, 2010, expressly prohibits it (see "U.S. Financial Regulations: Positive Change Amid Uncertainty And Missed Opportunities," published on Aug. 5, 2010). Overview We first explicitly included an uplift in our ratings from a U.S. bank's stand-alone credit profile based on government support in December 2008, but we revised the criteria for determining the ratings and potential government rating uplift in November 2011. Increasing public statements and regulatory proposals on how to resolve banks that are too big to fail suggest that government support may not be as forthcoming in the future. We may reduce the degree to which we include extraordinary government support into the ratings, and we have reflected that possibility in the negative outlooks on the holding company ratings of the eight institutions that we deem as highly systemically important.

Regulators and banks are formulating resolution plans for systemically important financial institutions to create a strategy should these institutions fail or fall under significant financial distress. We are watching the development of a resolution mechanism in the U.S. that aims to ensure market confidence will not erode with the failure of a large bank, and we may reduce the degree to which we include extraordinary government support into the ratings as a result of such regulatory developments. Under Title II of the DFA, the orderly liquidation authority (OLA) provision provides an alternative to bankruptcy, where the Federal Deposit Insurance Corp. (FDIC) acts as a receiver to restructure and unwind large, complex financial companies with a view to prevent systemic impact. Indeed, the FDIC's proposed single-point-of entry resolution plan under DFA's Title II and the Federal Reserve Board's new and proposed higher minimum capital and liquidity requirements for systemically important financial institutions further attempt to eliminate future government involvement in the rescue of failing large institutions (see "An Update Of The Dodd-Frank Act's Building Blocks Three Years Later," published on July 16, 2013). The intent behind these rules and regulations are clear. Whether large banks can be managed in such a way without affecting financial stability is yet to be tested.

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The Evolution Of Government Support In U.S. Bank Ratings

Many of the same issues that the U.S. is facing in the evolution of government support are also relevant for banks in other countries, particularly in Western Europe. For example, the European Union is developing its own proposals for bank resolution.

How We Factor Government Support In U.S. Bank Ratings

We have long viewed ongoing support from government authorities as an essential part of bank creditworthiness in good times and bad (see "External Support Key In Rating Private Sector Banks Worldwide"). This support principally comes through macroprudential regulation and access to central bank liquidity, which mitigate the high leverage and funding mismatches inherent in bank business models. Our approach to reflecting external extraordinary government support in the ratings on private-sector financial institutions depends on an analysis of the policy and track record in governing the banking sector. A bank's stand-alone credit profile (SACP) reflects its strategies, performance, and prospects, including any ongoing government support or intervention that the bank typically receives in the normal course of business. However, the SACP does not incorporate potential future extraordinary government assistance or influence that might be expected in a crisis. In developing the SACP and issuer credit rating (ICR) for a bank under our revised bank rating criteria, we consider the potential for additional direct support from the bank's parent group or from the sovereign government (see "Banks: Rating Methodology And Assumptions"). Accordingly, for a private-sector commercial bank (which does not qualify to be characterized as a government-related entity), the criteria assess the likelihood of government support by drawing on both the bank's "systemic importance"--that is, its role in maintaining overall confidence in the financial system--and the government's tendency to support private-sector commercial banks (see section B. Factoring Government Support Into The Indicative ICR in "Banks: Rating Methodology And Assumptions"). Systemic importance is the degree to which a bank's failure affects all or parts of the financial system and the real economy of the country where the bank operates. We classify a bank as being of high, moderate, or low systemic importance. It is possible that a bank classified as having high or moderate systemic importance might not receive support in a time of stress because no one can predict with certainty whether a sovereign will provide it. On the other hand, in the event of a crisis, the government may decide to support a bank even though we may have classified it as having low systemic importance. Moreover, we do not automatically classify a bank as having high, moderate, or low systemic importance just because the government or local market participants refer to it that way. In our view, a bank has high systemic importance if a default of its senior unsecured obligations is likely to weaken the country's financial system, limit the availability of credit for the private sector, and trigger a significant financial stress at several other financial institutions. The combination of a government's tendency to provide support and a bank's systemic importance indicates our view on the likelihood the institution will receive direct government extraordinary support when under stress. We may rate the aided institution higher than the institution's stand-alone creditworthiness when we anticipate direct and material extraordinary government support for that specific institution when under stress.

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The Evolution Of Government Support In U.S. Bank Ratings

We first explicitly considered government support in our U.S. bank ratings in late 2008
Before we revised our bank rating criteria in November 2011, we incorporated notches of uplift into bank ratings for extraordinary government support only during times of financial stress in developed markets. Extraordinary support became most evident in the U.S. on Oct. 14, 2008, when the government, through a joint statement by the Federal Reserve Board, the U.S. Treasury, and the FDIC, announced three actions following the enactment of the Emergency Economic Stabilization Act of 2008. These included a voluntary capital purchase program (CPP) whereby U.S. financial institutions would sell preferred shares to the government; the Temporary Liquidity Guarantee Program, which allowed the FDIC temporarily to guarantee the newly issued senior unsecured debt of all FDIC-insured institutions and certain holding companies, as well as all non-interest-bearing deposit accounts; and the Fed's Commercial Paper Funding Facility program to fund purchases of high-quality issuers' three-month commercial paper. Initially, nine large financial institutions signed up for the CPP in an aggregate amount of $125 billion and to have the FDIC guarantee their new senior unsecured debt issuances. In our view, these actions helped stabilize the financial system and rebuild market confidence. On Dec. 19, 2008, we announced downgrades and outlook changes for 12 major U.S. and European financial institutions. We lowered our ratings on 11 institutions by one or two notches, and we revised the outlook and affirmed the ratings on one. The rating actions reflected our view of the significant pressure on these large complex and interconnected financial institutions' future performance because of increasing bank industry risk and the deepening global economic slowdown. We also recognized the mitigating impact of significant government intervention aimed at stabilizing the sector and restoring public confidence. This was the first time that we explicitly recognized this extraordinary support in the ratings of U.S. banks that, in our opinion, were highly systemically important. (See "Twelve Major U.S. And European Financial Institutions Have Ratings Lowered, Outlooks Revised," published on Dec. 19, 2008.) At that time, we were unlikely to rate any of these highly systemically important financial institutions at the group or operating company level lower than 'A+' based on our expectation that the government would provide extraordinary support if needed. At the same time, we didn't rate any higher than 'A+' on the basis of extraordinary government support because we believed that this extraordinary support would be only temporary, creating some uncertainties about the future long-term creditworthiness of these banks. As a consequence, the amount of extraordinary support we explicitly factored into issuer credit ratings varied from zero to four notches, depending on our view of stand-alone creditworthiness. Initially, we assigned notches of uplift for this expected extraordinary government support from the SACP to only three of the eight identified large financial institutions: Citigroup, Goldman Sachs, and Morgan Stanley. Over time, we also added notches of uplift to Bank of America (see table 1). We further clarified our approach to reviewing the components of ratings when other entities, including governments and parents, influence credit quality (see "Stand-Alone Credit Profiles: One Component Of A Rating," published Oct. 1, 2010).

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The Evolution Of Government Support In U.S. Bank Ratings

Table 1

Notches Of Rating Uplift For Government Support In U.S. Bank ICRs Under Previous Rating Criteria
2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 2010Q4 2011Q1 2011Q2 2011Q3 Issuer credit rating Bank of America Wells Fargo & Co. JP Morgan Chase Citigroup Bank of New York Mellon Corp. State Street Morgan Stanley Goldman Sachs & Co. AAAA+ AAA+ AA A+ AA+ AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA A+ AA AAA+ AA

AA A+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A*

AAA+ A+

AAA+ A+

Notches of uplift Bank of America Wells Fargo & Co. JP Morgan Chase Citigroup Bank of New York Mellon Corp. State Street Morgan Stanley Goldman Sachs & Co. 0 0 0 3 0 1 0 0 4 0 3 0 0 4 0 3 0 0 4 0 3 0 0 4 0 3 0 0 3 0 3 0 0 3 0 3 0 0 3 0 2 0 0 2 0 2 0 0 2 0 2 0 0 2 0 2 0 0 2 0

0 3 2

0 3 2

0 3 2

0 3 2

0 3 2

0 3 2

0 3 2

0 3 2

0 2 1

0 2 1

0 2 1

0 2 1

*Holding company ratings. Otherwise, bank or broker dealer subsidiary rating. ICR--Issuer credit rating. Source: Standard & Poor's Global Fixed Income Research.

Our criteria included ratings uplift for extraordinary government support after 2011
Ongoing government support is one factor we use in assessing the Banking Industry Country Risk Assessment (see "Banking Industry Country Risk Assessment Methodology And Assumptions," published Nov. 9, 2011). We build this type of ongoing support in to our SACP of banks. The criteria also assess the capacity and willingness of sovereigns to support failing banks during a crisis and classify sovereigns into three groups: "highly supportive," "supportive," and "support uncertain." We classified the U.S. as "supportive" and the original nine banks (later eight banks after Bank of America acquired Merrill Lynch) that participated in the government's CPP as being of high systemic importance. According to our revised methodology, all eight banks received one or two notches of uplift from their SACP starting in November 2011

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The Evolution Of Government Support In U.S. Bank Ratings

(see table 2). Specifically, if a bank is likely to receive "future extraordinary support" in a crisis from a sovereign government, the criteria may allow adding one or more notches to the SACP ("support uplift") to determine the ICR on a bank. On the other hand, the government may not offer such support, in which case the ICR would be the same as the SACP. The criteria for determining notch uplift in the rating resulting from the expectation of extraordinary government support includes five steps: First, determine the degree of a bank's systemic importance; Second, determine a government's tendency to support private-sector banks; Third, establish the likelihood that the government will provide support to a particular bank; Fourth, determine whether additional short-term support is available; and Fifth, link government-supported bank ratings to sovereign ratings.

Table 2

Evolution Of Bank Level SACP , ICR, And Notches Of Uplift For Government Support For Banks Of High Systemic Importance Under Current Criteria
2011Q4 Stand-alone credit profile (SACP) Bank of America Wells Fargo & Co. JP Morgan Chase Citigroup Bank of New York Mellon Corp. State Street Morgan Stanley Goldman Sachs & Co. bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ bbb+ a+ a bbb a a+ bbb+ bbb+ 2012Q1 2012Q2 2012Q3 2012Q4 2013Q1 2013Q2

Issuer credit rating (ICR) Bank of America Wells Fargo & Co. JP Morgan Chase Citigroup Bank of New York Mellon Corp. State Street Morgan Stanley Goldman Sachs & Co. A AAA+ A AAAAA A A AAA+ A AAAAA A A AAA+ A AAAAA A A AAA+ A AAAAA A A AAA+ A AAAAA A A AAA+ A AAAAA A A AAA+ A AAAAA A

Notches of uplift for government support Bank of America Wells Fargo & Co. JP Morgan Chase Citigroup 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2

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Table 2

Evolution Of Bank Level SACP , ICR, And Notches Of Uplift For Government Support For Banks Of High Systemic Importance Under Current Criteria (cont.)
Bank of New York Mellon Corp. State Street Morgan Stanley Goldman Sachs & Co. 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2 1 1 2 2

Note: Citigroup and Bank of New York Mellon also benefit from a "transition notch of uplift" in the final ICR. See section VI. Methodology: Setting The Issuer Credit Rating of Banks: Rating Methodology And Assumptions. Source: Standard & Poor's Global Fixed Income Research.

Government Support May Be Waning, Especially For Bank Holding Companies

We currently continue to reflect the potential for extraordinary government support in the ratings of banks that we view as having high systemic importance because we believe that the orderly resolution of a large systemic bank is unlikely to be feasible today. To minimize contagion risk, reduce uncertainties, and ensure continuity of essential banking services, an orderly resolution would need to be operated through a weekend. While orderly resolution is possible for a midsize bank that is not highly interconnected, the complexity and international ramifications of large banking groups make it much more difficult to achieve, in our opinion. Depending on the final plans for how to resolve a too-big-to-fail bank in different nations, we could change our thinking about sovereign support in times of financial stress. In addition, we could lower our ratings on certain bank bonds depending on the scope of the proposed resolution regime, the degree of policy flexibility that the government retains, and the level of sovereign support that we may already include in the ratings on such instruments. We might also change our views on the classification of the financial institution. The availability of group support for subsidiaries or foreign branches could also influence the ratings on those subsidiaries or foreign branches. While we assess the progress concerning OLA that U.S. regulators still need to make, we reflected in our outlooks on the eight bank holding companies (the nonoperating holding companies) that we deem as having high systemic importance (Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo) the possibility that we may not continue to factor support into the ratings. (See "Various Outlook Actions Taken On Highly Systemically Important U.S. Banks; Ratings Affirmed," published June 11, 2013.) Our negative outlooks reflect the current progress and the political willingness to achieve effective resolution regimes for large complex groups, and that while the U.S. is one of the countries that is most advanced in resolution, work remains to be done. The challenge to put in place effective resolution regimes for large complex groups is one of the elements that is leading G-20 countries and policymakers around the world to increase capital requirements for large systemically important banks to increase their resilience and attempt to reduce the likelihood that they will require support. We believe clarity in rulemaking related to minimum levels of holding company debt, bail-ins (when bondholders forfeit part of their investments to aid a bank under financial stress), and globally consistent resolution mechanisms would be important milestones in building a credible resolution regime in the U.S. Should we see progress toward

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some or all of these factors, which we believe would make an effective resolution under OLA more likely, we could remove the extraordinary government support that we include in the ratings, which would lead us to lower the ratings on the eight bank holding companies. We rate investment-grade bank holding companies (those rated 'BBB-' or higher) one notch lower than their operating companies to reflect structural subordination--that is, their reliance on dividends and other distributions from operating companies to meet obligations (see section G. Financial Institution Nonoperating Holding Companies in "Group Rating Methodology," published on May 7, 2013). Beyond potentially removing the government support that we factor into our ratings, we are not currently considering wider notching. However, we could reconsider it if the creditworthiness of bank holding companies deteriorates broadly relative to operating companies because of final regulatory requirements. As resolution under the OLA becomes clear, we believe that under an extreme scenario the market may move toward not accepting debt at the holding company and, instead, the operating subsidiary may issue all future debt. This would increase risk for senior bondholders of the original holding company, and at best, bond investors would have to weigh the benefits of yield relative to potential haircuts in the resolution. In this situation, it is unclear what path the resolution would take. Furthermore, the mandates of many institutions that currently invest in unsecured debt may limit their type of investments, making these entities unable to hold the converted equity of a new holding company. This could dampen the market for unsecured holding company debt that is currently outstanding for systemically important financial institutions. We further believe that implementing an OLA could increase uncertainty in the market at a time when confidence is already low. For instance, dismantling a large financial firm might spur creditors to pull out of other similar financial firms in times of stress. Creditors may react by cutting off funding and accelerating other bank failures. One lesson from the recent crisis is that capital providers' loss of confidence can quickly trigger liquidity events, which can lead to a firm's failure. So, although the DFA constrains the type and form of support that the government is permitted to give (requiring that the financial firm be in liquidation), we believe that amendments to the current legislation might prove necessary in future crises. This may especially be the case in circumstances that could depress the real economy and threaten the well being of the population. As resolution becomes clearer, we will continue to consider how much we factor government support into our U.S. bank ratings and how we might differentiate between operating company and holding company rating uplift.

Related Criteria And Research

An Update Of The Dodd-Frank Act's Building Blocks Three Years Later, July 16, 2013 Various Outlook Actions Taken On Highly Systemically Important U.S. Banks; Ratings Affirmed, June 11, 2013 Group Rating Methodology, May 7, 2013 Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010 U.S. Financial Regulations: Positive Change Amid Uncertainty And Missed Opportunities, Aug. 5, 2010 Twelve Major U.S. And European Financial Institutions Have Ratings Lowered, Outlooks Revised, Dec. 19, 2008

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The Evolution Of Government Support In U.S. Bank Ratings External Support Key In Rating Private Sector Banks Worldwide, Feb. 27, 2007

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