Moody’s Investors Service downgraded State Street Corporation (STT)’s senior unsecured rating to A1 from Aa3. State Street Bank & Trust Company’s financial strength rating was downgraded to B from B+ and its deposit rating to Aa2 from Aa1. Moody’s incorporates one notch of lift in State Street Bank & Trust Company ratings from systematic support. The outlook is negative.
The downgrade follows STT’s announcement that the unrealized after taxmark-to-market losses on its securities investment portfolio and the assets in its off balance sheet asset-back commercial paper conduits (conduits) increased to $6.3 billion and $3.6 billion, respectively, at December 31, 2008. On a combined basis this represents an approximately $4.5 billion increase from September 30, 2008.
“Although SST’s current regulatory capital levels are strong, they would be substantially reduced if the securities portfolio marks were realized and the conduits consolidated,” says Moody’s vice president and senior credit officer Craig Emrick. “Moody’s believes that these risks to the company’s capital base warrant the negative rating action.”
Moody’s primary concern regarding the investment portfolio is the potential for “other than temporary impairment” (OTTI) and the related impact on STT regulatory capital ratios. Although Moody’s considers the likely ultimate loss on this portfolio to be much lower than that signified by its current market value, even small credit losses could result in significant accounting impairment. In regards to the conduits, the risk remains that these off-balance sheet structures will be consolidated in the short term. If this would occur, the unrealized mark on the assets they contain would immediately be charged to the income statement and regulatory capital.
The negative outlook reflects that STT’s mark-to-market losses could increase further or that Moody’s assumptions regarding the expected loss could rise if economic conditions deteriorate beyond current expectations. As well, Moody’s will monitor the resilience of the firm’s customer franchise.
Positively, Moody’s considers the company’s operating performance in the fourth quarter to be strong considering the substantial market turmoil. Additionally, STT’s liquidity benefits from a high percent of liquid assets and funding focused on customer deposits.
STT’s outlook could be changed to stable if the risk of capital impairment is diminished through the bolstering of capital levels while maintaining current levels of profitability and liquidity. STT could be downgraded further should the mark-to-market on the securities portfolio and conduit assets increase at the same velocity as that experienced in the third quarter or if there is evidence of franchise erosion.
D.C.