The Final Step to End Too-Big-To-Fail?

Abstract

As Federal banking authorities work to implement rules to allow for the quick and efficient dissolution of too-big-to-fail banks, ratings once again are under assault, and most large U.S. banks could lose their access to the short-term markets toward the end of 2013. The anticipated negative rating moves will be the direct result of reduced government support for holding company debt, not deteriorating operating or financial results at the respective banks. Corporate treasurers should review their investment policies and existing exposure to the affected bank names. The FDIC initiative may be a precursor to similar events in other countries, as well. Increased risk and reduced supply again argue for flexible portfolio strategies through separately managed accounts.

Introduction

Just a few months ago, we wrote about the trend of deteriorating creditworthiness of large banks. A major cause behind this credit deterioration has been a reduced assumption of government support for “too-big-to-fail” banks. A recent report from Moody’s rating service suggests that a new initiative at the Federal Reserve and FDIC may trigger another round of bank ratings downgrades toward the end of 2013. If this occurs, even the highest rated bank credits no longer may qualify as approved investments for most corporate liquidity accounts. Institutional cash investors need to be aware of this latest development and prepare their game plan now.

The Slippery Slope of Bank Credit Quality

In the decade leading up to the 2008 financial crisis, financial institutions in the U.S. consistently received higher credit ratings than their non-financial peers. But the revelation of many financial firms’ exposure to sub-prime assets and derivatives and a dramatic decline in investor confidence eventually resulted in a number of bank failures, forced mergers, substantial charge-offs, regulatory and litigation penalties and, of course, ratings downgrades.
As we wrote in March 2012 and again in March 2013, many previous “marquee” bank names no longer qualify as worthy investments for corporate cash portfolios, primarily due to lower credit ratings. However, some practitioners continue to conclude that, given their size and importance to the overall economy, large financial institutions are safe because they will receive government backing in times of distress. This flawed assumption was addressed with a stern reminder in a special commentary from Moody’s on March 27, 2013.
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