Moody’s Investors Service has lowered the debt ratings of Bank of America Corporation (senior debt to Aa3 from Aa2) and the ratings on its subsidiaries, including its lead bank, Bank of America, N.A. (long-term bank deposits to Aa1 from Aaa). Moody’s bank financial strength rating on the lead bank was lowered two notches to B from A-, which translates to a change in the baseline credit assessment to Aa3 from Aa1. The Prime-1 ratings on the short-term obligations of all Bank of America entities were affirmed. The rating outlook is negative.
The rating agency also raised the debt ratings of Merrill Lynch to match those of Bank of America Corporation, while the debt and deposit ratings of Merrill Lynch’s US bank subsidiaries were raised to equal those of Bank of America’s bank subsidiaries. The rating actions follow the January 1 closing of Bank of America’s acquisition of Merrill Lynch & Co., Inc., and complete Moody’s rating review that began on September 15, 2008.
The downgrade and negative outlook on Bank of America reflect Moody’s view of the greater challenges Bank of America and Merrill Lynch are likely to face over the next few years under a more difficult economic environment.
“Bank of America has taken a number of steps recently to bolster its capital position,” says Moody’s senior vice president, David Fanger, “But we believe that its pro forma tangible common equity position remains relatively weak, leaving a modest cushion to absorb unexpected losses.”
Additionally, Moody’s believes the combined company’s equity position is unlikely to improve substantially before 2010 because of reduced earnings from capital markets activities and the need to sustain high loan-loss provisions to absorb higher credit costs, most notably in credit cards and residential real estate loans. At September 30, Bank of America’s aggregate exposure to these loan types was roughly $660 billion. The combined company also remains exposed to potential further writedowns in legacy structured assets from both predecessors. Weak earnings, combined with Bank of America’s still sizable quarterly dividend payments of approximately $3.0 billion will substantially limit internal capital formation, constraining its ability to reduce its leverage.
The downgrade and negative outlook also reflect the challenges which Bank of America faces in integrating Merrill Lynch. While Bank of America has demonstrated a solid track record in integrating traditional commercial banks, Moody’s believes the challenges of integrating an investment banking and wealth management franchise are significantly greater than those involved in a traditional commercial bank acquisition. Bank of America typically imposes its own systems and practices upon an acquired firm, which, as noted, has worked effectively with commercial banks. However, in the case of Merrill Lynch, this approach carries a greater risk of employee defections.
“Investment banking and wealth management businesses are heavily reliant on their personnel and their client relationships,” says Fanger. “This increases the risk of customer defections and franchise impairment as a result of a poor integration.”
On the other hand, it remains important that Bank of America fully integrate Merrill Lynch’s risk management practices with its own; indeed Moody’s believes that Bank of America’s risk management practices may need to be enhanced to accommodate the increased size and complexity of its capital markets activities following the acquisition of Merrill Lynch.
For more detailed information please visit www.moodys.com.
D.C.