Fitch Ratings has upgraded State Street’s long-term credit rating from A+ to AA-, while the agency affirmed the rating of BNY Mellon and Northern Trust at AA- and Brown Brothers Harriman at A+.
The ratings came as part of Fitch’s U.S. trust and processing bank peer review, with the rating outlook for all four custodians now at Stable (State Street was previously Positive, the others were Stable).
Fitch says that State Street’s “reflects the company’s improved and more seasoned risk management practices and procedures, continued relatively conservative overall balance sheet posture, and continued efforts in streamlining its business, which Fitch believes will lead to more significant positive operating leverage in a higher short-term interest rate environment.”
The four trust banks all received high ratings due to their business models, which have “high barriers to and sticky customer relationships,” says Fitch. Moreover, the banks “are further supported by a sound funding profile, consisting mainly of core custody deposits, strong capital ratios supporting comparatively low risk balance sheets, and good asset quality metrics.”
BBH’s rating remains one level lower due to its smaller scale and less financial flexibility compared to the other three banks, which are publicly traded. While the bank’s rating outlook remains stable, “over a very long-term time horizon there is some potential upside to Brown Brother’s ratings,” says Fitch, as the bank could benefit from increased asset management revenue.
For all four banks, Fitch notes that while their business models have kept them afloat during the difficult, each firm has had a “laser focus on managing its expense base over the last few years,” which can allow the banks to achieve greater scale, leading to more aggressive pricing against one another. Through a combination of controlling headcount and streamlining operations through significant technology investments, but much of the expenses have been offset by regulatory costs. Still, Fitch says that the banks have laid “the groundwork for good positive operating leverage.”
Plus, once short-term interest rates rise and when volatility increases, along with regulatory costs leveling off, these banks are in a position to benefit, which should increase earnings and “boost ROEs (return on equities) back to historical levels and in line with Fitch’s cost of equity assumptions and is embedded with Fitch’s Stable Rating Outlook on the trust banks.”
However, the high level of operational risk inherent in trust banks’ business models limits some of the upwards rating momentum, the agency says. Fitch thinks that the banks’ main threat is a large technological mishap or operational loss unique to one firm, and although these risks are well controlled, they are difficult to predict. Yet an industry wide event that causes a significant operational loss affecting each firm equally might not have an impact on ratings, as it would allow each firm to better maintain its client base, says Fitch.
BNY Mellon and State Street also face the challenge of complying with the supplementary leverage ratio (Northern Trust and BBH are not subject to the rule, due to their smaller size.). Fitch says it believes both banks will be in compliance when the ratio when it comes into effect, but because some deposit flows are countercyclical during periods of market stress, the banks risk falling below the requirements in this scenario, says Fitch.
Generally, though, Fitch rates the trust banks higher than most other than banks in the U.S., aside from the AAA rating of Farm Credit System, the U.S. system of lending institutions for rural areas. BMO Harris, HSBC, TD Bank, U.S. Bancorp and Wells Fargo, all have AA- ratings, but other major banks such as J.P. Morgan and Deutsche Banks have an A+ rating, and others such as Goldman Sachs, Citi, Bank of America have A ratings. Lower down the list, BBVA and Santander have BBB+ ratings in the U.S.
Last fall, however, another ratings agency, Moody’s, downgraded the baseline credit assessments of BNY Mellon and State Street, citing profitability pressures, despite their overall health.
State Street Gets Credit Rating Boost, Other Custodians Remain Stable
Fitch Ratings has upgraded State Street’s long-term credit rating from A+ to AA-, while the agency affirmed the rating of BNY Mellon and Northern Trust at AA- and Brown Brothers Harriman at A+.