Moody's May Massacre Hybrid Ratings

A Bloomberg story just appeared Moody’s May Downgrade Up to $450 Billion of Bank Debt:

Moody’s Investors Service is reviewing about $450 billion of bank hybrid and subordinated notes for possible downgrade after changing the assumptions underlying its ratings of the debt.

Some 775 securities issued by 170 “bank families” in 36 countries are affected, the New York-based risk assessor said in an e-mailed statement. Half the hybrids may have their ratings lowered by three to four grades, 40 percent may be cut by one or two grades and the remainder may be lowered by five steps or more, it said.

Moody’s reviews come after it stopped assuming holders of hybrids, which mingle characteristics of debt and equity, would benefit from government support for troubled lenders after the global financial crisis proved that wasn’t the case. The new system expects regulators to treat them more like equity, and takes into account the risk that banks might be forced to suspend coupon payments on their lower-ranked debt.

There does not appear to be a press release or notice on the Moody’s website yet … all I found was a July 28 press release saying that they expected to finalized the methodology in September, which was part of the same story reported on PrefBlog in June.

But then I had a look at their ratings list for Bank of Montreal and hey, looky-looky! All the prefs have “Possible Downgrade, 18 NOV 2009” under “Watch Status”. It the same thing for BNS, by the way, so the notation is not related to the extant Moody’s Watch on BMO.

Stay tuned.

3 Responses to “Moody's May Massacre Hybrid Ratings”

  1. prefhound says:

    I don’t get it. Why does Moody’s say “… new system expects regulators to treat [debentures, prefs and hybrid instruments] more like equity … [reflecting] the risk that banks might be forced to suspend coupon payments on their lower ranked debt”?

    As far as I can tell, the opposite is true — regulators expect all bonds to be repaid and have not demanded [as they could have] that sub debt suspend coupon payments prior to government bailouts (if any).

    Considering the ladder of cash flow cutbacks:
    1. common dividend reduction
    2. common and pref dividend elimination
    3. sub debt coupon suspension
    4. default on senior bonds

    it seems to me the regulators hardly got past step 1 with most banks (and I would guess most dividend cuts may have been voluntary despite the involuntary nature of most government investment). After government investment, did Bank of America get to stage 2 before “forcing” conversion into common on the prefs? — in retrospect a wonderful outcome for pref holders who hung on to the common.

    Regulators, it seems, have so far been reluctant to go to level 3 for fear it will seize up the entire bond market. How does Moody’s think reglatory behaviour will change in the future?

    My feeling is that fear of going to level 3 for the first time is a fear of the unknown. What we really need is to go there to underline the real difference between levels 3 and 4. After some experience, investors will adapt. The more regluators protect, the more investors (mistakenly) think their protections extend to riskier investments (money market funds, sub debt, ABCP, ….).

    Why should Moody’s think bank prefs are any risker than they were six months ago? — we already knew level 2 meant pref dividends get the chop.

    Why should Moody’s think bank sub debt is any more likely (due to forthcoming regulatory changes) to have coupons suspended? The regulatory noise you report seems to be more about new and different forms of capital (contingent, for example), rather than turning the screws on already outstanding sub debt.

    Am I just thick?

  2. jiHymas says:

    As far as I can tell, the opposite is true — regulators expect all bonds to be repaid and have not demanded [as they could have] that sub debt suspend coupon payments prior to government bailouts (if any).

    Not much of this has happened in North America – other than a few coercive exchange offers, such as Citigroup’s – but it’s happening big-time in Europe.

    See, for example the EU Restucturing Paper, Clause 26:

    The banks should be able to remunerate capital, also in the form of dividends and coupons on outstanding subordinated debt, out of profits generated by their activities. However, banks should not use State aid to remunerate own funds (equity and subordinated debt) when those activities do not generate sufficient profits. Therefore, in a restructuring context, the discretionary offset of losses (for example by releasing reserves or reducing equity) by beneficiary banks in order to guarantee the payment of dividends and coupons on outstanding subordinated debt, is in principle not compatible with the objective of burden sharing. This may need to be balanced with ensuring the refinancing capability of the bank and the exit incentives. In the interests of promoting refinancing by the beneficiary bank, the Commission may favourably regard the payment of coupons on newly issued hybrid capital instruments with greater seniority over existing subordinated debt. In any case, banks’ should not normally be allowed to purchase their own shares during the restructuring phase.

    Banks in Europe have been bailed out without sub-debt, IT1C or pref holders suffering in the least and the regulators are PISSED. It was the EU’s refusal to approve the Lloyd’s bail-out unless all discretionary coupons were suspended that led to the recent Contingent Capital issue.

  3. […] There have been rumours of something like this, as I posted on Moody’s May Massacre Hybrid Ratings. […]

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