Moody’s Investors Service has downgraded the baseline credit assessments of BNY Mellon and State Street by one notch due to profitability pressures on these custodians, but the ratings agency noted that these banks remain strong overall.
The baseline credit assessments reflect the fundamental business structure of a bank aside from shareholder and systemic support. The downgrade comes as a result of BNY Mellon and State Street facing several challenges such as operating in a low interest rate environment. Plus, “competition amongst the custody banks has undermined their pricing power for core custody products and services, particularly for large customer relationships,” Moody’s said in its ratings rationale for State Street. Additionally, these custodians face future earnings risk from foreign exchange and securities lending lawsuits, though Moody’s noted that many of these cases have been settled already.
For the senior debt ratings for the banks’ holding companies, BNY Mellon received a one notch downgrade due to Moody’s belief that the U.S. government is less likely to bailout banks. BNY Mellon would have been downgraded two notches due to the drop in baseline credit assessment, but both banks received a one notch upgrade due to the belief that in the event of a default, losses would be lower than they would have been in the past because of regulations that improve recapitalization measures and provide for orderly liquidation if necessary.
State Street’s holding company maintained the same overall rating because this recapitalization issue negated the drop in the baseline credit assessment. And unlike BNY Mellon, State Street’s previous rating did not include U.S. government support, so this removal of systemic support did not affect their rating.
“We believe that U.S. bank regulators have made substantive progress in establishing a credible framework to resolve a large, failing bank,” says Robert Young, managing director at Moody’s. “Rather than relying on public funds to bail-out one of these institutions, we expect that bank holding company creditors will be bailed-in and thereby shoulder much of the burden to help recapitalize a failing bank.”
Moody’s also noted that operational efficiency measures by these custodians do not overcome the profit challenges they face.
“Although both banks are engaged in broad efficiency initiatives that will somewhat offset their profitability pressures by leveraging technology, transforming core processes and generally reducing expenses, the rating agency does not expect an enduring competitive advantage to emerge for either of them. This reflects the fact that much of the industry is engaged in similar efficiency initiatives as well as the difficulty associated with re-pricing the banks’ largest custody relationships,” Moody’s said in its ratings rationale.
Still, the overall health of BNY Mellon and State Street remain strong.
“Notwithstanding the downgrade, both banks enjoy comparatively high baseline credit assessments based on their huge global custody and investment-servicing franchises, where the barriers to entry are high and the secular trends are favorable. They also have large, though less dominant, asset-management businesses,” the agency said.
Moody's Cuts Credit Ratings for Custodians
Moody's Investors Service has downgraded the baseline credit assessments of BNY Mellon and State Street by one notch due to profitability pressures on these custodians, but the ratings agency noted that these banks remain strong overall.