DBRS Removes U.S. Rating Floor

DBRS, Inc. (DBRS) has today removed the A (high) rating floor that has been in place for critically important banking organizations (CIBs) in the U.S. since February 2009. This action follows the July 8, 2013 announcement that DBRS is reviewing the applicability of its floor ratings (“DBRS Assesses Applicability of Rating Floors for Critically Important Banks in 9 Countries”). The removal of the U.S. floor ratings reflects DBRS’s view that the probability, timeliness, and extent of support for the largest, critically important banks in the U.S. has become insufficiently reliable and predictable to provide uplift to the final ratings above their intrinsic strength.

Previously, DBRS had assigned an A (high) rating floor to CIBs in the U.S. in February 2009; a time when DBRS also implemented floors for CIBs in other countries. CIBs are determined to be banking organizations that have extensive involvement in a country’s financial markets and perform critical roles in the flow of financial transactions and whose ability to perform as long-term counterpartys are essential for the functioning of a country’s capital markets and the robustness of its financial system as a whole. The application of the rating floor reflected DBRS’s expectation that the US government would provide support, if necessary, to prevent any CIB from weakening below this rating level during a period of heightened stress in the U.S. banking system. The implementation of a floor in the U.S. reflected government actions and statements during the crisis that indicated the much increased willingness of the U.S. authorities to act to support U.S. CIBs and the financial system generally.

The removal of the floor in the U.S. reflects DBRS’s assessment that the likelihood of support in the U.S. is no longer sufficiently predictable to underpin the floor. This reflects changes in the legislative and regulatory environment, as well as the improving economy and strengthening financial sector.

As the recent financial crisis progressed, the provision of support to the banking sector became a key regulatory and political concern in the U.S.. The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act expanded and clarified aspects of regulatory authority. Specifically, Title II, the Orderly Liquidation Authority (OLA) section of the legislation grants expanded powers to regulators to liquidate financial companies and legally codified that taxpayers will not bear losses or fund the prevention of a bank liquidation. Regulators have also added living wills to regulatory requirements in order to assist financial institutions in winding down complex financial businesses. The goal is that banks should be allowed to fail with the risk being borne by shareholders and creditors.

The U.S. Government and Bank Regulatory authorities are currently formulating new rules for bank holding company (BHC) debt and equity levels in order to reduce the need for government assistance during a period of stress. In particular, implementation of OLA may require BHC’s to carry significantly higher long-term debt loads to facilitate loss absorption and recapitalization (bail-in) of a bank operating subsidiary during a period of stress. Depending upon the details of implementation, DBRS believes a potential rating outcome is for downward pressure on BHC ratings resulting in the widening of notching between the BHC and operating subsidiary bank. DBRS is closely monitoring policy implementation and will announce any potential changes as new rules are clarified and implemented.

While it is clear that the U.S. regulators have an invigorated willingness and framework to resolve troubled financial institutions, DBRS and the regulators themselves also recognize that they are still at an early stage of the complex process of enabling the biggest and most complex banks to be wound down without putting financial stability at risk. Accordingly, this brings DBRS’s U.S. bank ratings universe back to its pre-crisis standard where the U.S. robust regulatory and legal framework are already built into intrinsic ratings and no lift in the ratings is provided from support considerations which are now much less timely and predictable in DBRS’ opinion. In DBRS’s view, support for individual institutions is now less likely and predictable, but there remains the potential for support in a systemic crisis. Should another financial crisis occur, systemic support could again be put in place to preserve the functioning of the U.S. financial system.

A separate announcement will be made on the ratings of the Bank of America Corporation and Citigroup Inc. which are the only U.S. banking organizations whose ratings are potentially affected by the removal of the rating floor.

Notes:

All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other applicable methodologies include the DBRS Criteria – Intrinsic and Support Assessments, DBRS Criteria: Bank and Bank Holding Company Trust Preferred Securities, DBRS Criteria: Rating Bank Subordinated Debt & Hybrid Instruments with Discretionary Payments and DBRS Criteria: Rating Bank Preferred Shares & Equivalent Hybrids. These can be found at: http://www.dbrs.com/about/methodologies

[Amended on January 6, 2015 to reflect actual methodologies used.]

The sources of information used include company documents, FDIC, the Federal Reserve, and the US Treasury. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The removal of the U.S. Rating Floor is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: William Schwartz
Rating Committee Chair: Alan G. Reid

For additional information on this rating, please refer to the linking document under Related Research.