Moody’s says may downgrade ratings on big banks if reform removes “too big to fail” assumption

Moody’s may cut bank ratings if overhaul passes

DES MOINES, Iowa — Moody’s Investors Service said Tuesday that if financial overhaul legislation passes, it may cut debt ratings on a number of big U.S. banks because the reform would make it less likely that the government would step in to rescue troubled firms.

Moody’s analysts said the bill proposed by Senate Banking Committee Chairman Chris Dodd, D-Conn., would make no bank “too big to fail” and allow regulators to unwind large financial institutions along lines similar to how the FDIC shuts down failed banks. Eliminating the assumption that the government will bail out large banks would demand that some banks’ ratings be downgraded.

“The Dodd bill contains provisions that, if passed into law, could weaken our assumptions regarding the probability that the U.S. government would support the largest, most systemically important financial institutions,” said Robert Young, managing director for Moody’s North American Bank Ratings.

Bills under consideration in the House and Senate would create a mechanism for liquidating large firms that get into trouble, set up a council to detect systemwide financial threats and establish a consumer protection agency to police lending. The legislation also would require investment derivatives, blamed for helping precipitate the market meltdown, to be traded in open exchanges.

Congressional Democrats and the Obama administration say their proposals are aimed at heading off any recurrence of the near collapse of the financial system in 2008.

Moody’s said 17 of the 70 banks it rates have higher ratings because analysts assume a government safety net exists. The ratings agency said it likely will reduce its support assumptions for some banks if reform passes.

The banks that currently get a ratings lift from the “too big to fail” assumption are: Bank Of America Corp., Citigroup Inc., Wells Fargo & Co., Bank of New York Mellon Corp., JPMorgan Chase & Co., Morgan Stanley, Regions Financial Corp., SunTrust Banks Inc., BB&T Corp., Capital One Financial Corp., Fifth Third Bancorp, Goldman Sachs Group Inc., KeyCorp, PNC Financial Services Group Inc., State Street Corp., US Bancorp, and Zions Bancorp.

All but SunTrust were trading lower Tuesday as the broader markets also tumbled on fears that Europe’s debt problems are spreading.

Moody’s analysts said the level of support that the ratings agency would continue to model would be determined by whether the law gives regulators flexibility in dealing with troubled institutions and systemic problems. Hard mandates would more likely result in ratings downgrades.

Provisions that require higher capital and liquidity buffers at banks would improve those firms’ credit standings, partially offsetting some of the negative pressure from the potential reform. However, proposed limits on bank activities, such as proprietary trading or over-the-counter trading in derivatives, might weaken the earnings power of some banks.

Moody’s said it is unlikely to take ratings actions on banks that may be affected until it is clear what the government’s proposal includes and its implications if passed into law. The agency said its first step would likely be to place affected banks on review before cutting ratings.