August 9, 2023 | Premium Service | Moody’s (MCO) downgraded the credit rating of a number of banks this week and put more on watch for a future downgrade. These were institution-specific downgrades that were more attributable to the bank failures in Q1 2023 than to the downgrade of the US by Fitch Ratings earlier this month.
A couple of readers asked about the impact of the US ratings downgrade on the largest globally systemically important banks (GSIB). Here's what you need to know:
First, in the world of credit we always use the lowest rating. Now that S&P and Fitch are at AA+ for US risk, the whole credit market must go there in terms of using the lowest rating for asset allocation purposes. We could ignore S&P for a decade. Not now.
Second, GSIBs tend to have 1-2 ratings notches of "uplift" in the rating on the assumption of sovereign support. In the US, one notch. Japan, two notches for GSIBs. Most of the agencies have explicit sovereign support in their published criteria.
When the sovereign goes down, everything else in the world of credit ratings that depends upon it goes down, GSIBs, GSEs, agencies, etc. The sovereign credit of the US is now AA+. The rating on Ginnie Mae MBS is now AA+. And the sovereign rating may go lower before we are done. Large banks will definitely move lower as Moody and other agencies adjust their view of the industry’s prospects.
The Basel capital proposal, in this regards, is pretty much a guarantee of downgrades for the largest US banks, first because it hurts profitability. The increase in risk weights for high-LTV loans will basically push commercial banks out of lending to low-income households.
The Mortgage Bankers Association (MBA) has voiced strong opposition to the Basel capital rule changes, pointing out seven key areas that could affect major banks and regional banks, lenders, servicers, and borrowers within the housing finance ecosystem.
Western Alliance Bancorp