Moody’s Investors Service has lowered the debt ratings of Bank of America Corporation and Merrill Lynch & Co. (senior debt to A1 from Aa3) and the debt and deposit ratings on its subsidiaries, including its lead bank, Bank of America, N.A., and Merrill Lynch’s U.S. bank subsidiaries (long-term bank deposits to Aa2 from Aa1). Moody’s bank financial strength rating on the lead bank was also lowered to B- from B, which translates to a change in the baseline credit assessment to A1 from Aa3. The Prime-1 ratings on the short-term obligations of all Bank of America entities and the bank financial strength ratings of all other U.S. bank subsidiaries were affirmed. The rating outlook is negative. These actions had no impact on the FDIC-guaranteed debt issued by Bank of America Corporation and Bank of America, N.A. That debt remains rated at Aaa with a stable outlook.
The rating action follows the disclosure of substantial losses at Merrill Lynch for the fourth quarter of 2008, and more modest losses at Bank of America. At the same time, the U.S. government has agreed to limit Bank of America’s exposure to additional losses in a specified pool of capital markets assets, and to purchase additional Bank of America preferred stock. In connection with this, Bank of America has reduced its common stock dividend to one cent per share.
“Moody’s views positively the actions taken by Bank of America to limit further losses in the asset pool, to bolster its Tier 1 capital, and to cut its common dividend,” says David Fanger, Moody’s senior vice president. “However, in light of the magnitude of losses at Merrill Lynch, Moody’s has concerns that the risk management challenges at Merrill Lynch extend beyond the pool of assets on which Bank of America is receiving government protection.”
This includes concerns about the strength of Merrill Lynch’s risk management as well as the potential for the disruption of risk management processes during the integration. This concern is heightened by Moody’s view that Bank of America’s own 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.
Furthermore, the rating agency added, although Bank of America’s regulatory capital position has been strengthened with the additional preferred stock, Bank of America’s tangible common equity position has been weakened following the reported fourth quarter losses. Moody’s estimates that adjusted tangible common equity was approximately 3.9% of risk-weighted assets on a pro forma basis at year-end, down from 5.0% at mid-year.
“While the reduced common dividend increases Bank of America’s ability to generate capital internally, we believe the bank is unlikely to generate much capital over the next year and a half due to the need to sustain high loan-loss provisions to absorb higher credit costs, most notably in credit cards and residential real estate loans,” says Fanger.
Bank of America’s ratings continue to be supported by its strong franchise. The bank has market leading positions in U.S. deposits, credit cards, and mortgages. With a nationwide franchise in each of these businesses, the bank has limited regional geographic concentrations. These businesses generate a relatively stable pre-provision earnings base with which to absorb an anticipated sharp rise in credit costs. The addition of Merrill Lynch’s wealth and asset management businesses further diversify Bank of America’s business mix. The bank has also been prudent in managing its borrower and counterparty concentrations. Solid liquidity profiles at both the bank and the parent holding company provide further creditor protection.
Bank of America’s debt ratings benefit from Moody’s view that Bank of America enjoys very high systemic support, owing to its position as the largest deposit-taking institution in the U.S. with a pro forma market share of nearly 12%. As a result, the deposits and senior debt of the U.S. bank subsidiaries of Bank of America Corporation get a two-notch lift to Aa2 from their baseline credit assessment of A1. The holding company also benefits from systemic support, but not to the same degree as the bank — it receives a one-notch lift. The holding company’s senior debt is rated A1 and its subordinated debt is rated A2.
Moody’s also lowered its rating for Bank of America Corporation’s preferred stock and other instruments with an equivalent claim to Baa1 from A2. The preferred stock rating was lowered by two notches in response to Moody’s observation that with Bank of America’s weak earnings prospects, the quarterly preferred dividend payment of $1.4 billion is a meaningful barrier to capital generation. Given the company’s relatively low level of tangible common equity, this increases the possibility that preferred dividends could be deferred.
The most likely reasons for any further downgrade would be evidence of credit weaknesses resulting from the integration of Merrill Lynch, such as additional losses due to risk management failures, significant employee defections, or lost earnings due to customer attrition. A downgrade could also result if the bank were to suffer a significant deterioration in tangible common equity, most likely due to higher than anticipated losses in the bank’s loan portfolio.
Moody’s said that for Bank of America’s B- bank financial strength rating to be upgraded, Bank of America would need to significantly improve its tangible common equity ratios, enhance its profitability, and demonstrate success in integrating Merrill Lynch without increasing its risk profile or suffering customer attrition..
D.C.