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| | Standard & Poor's Ratings Services' bank ratings are based upon three pillars: financial condition and performance of the bank, the regulatory environment, and extraordinary support factors. The latter factors include sovereign guarantees, government ownership, and the likelihood that a government would intervene in a failing bank in a timely way to prevent it from defaulting. Generally speaking, the regulated nature of banking serves as a positive rating factor, one that helps to offset concerns about the extraordinary leverage and high liquidity risk that characterize the industry. Indeed, without the benefits provided by regulation, examination, and liquidity support, bank ratings would not be as high as they are. In a sense, then, virtually all bank ratings benefit from the government's interest in keeping its banking system in good shape, although some bank ratings benefit from this more than others. Standard & Poor's carries out an assessment of the regulatory regime in every country where it has rated banks, and this assessment is part of the industry risk evaluation that it does for every banking system. This industry risk evaluation, in turn, feeds into the rating process for individual banks. The third pillar of analysis goes beyond the financial analysis and generalized kind of regulatory system support. This type of analysis determines whether the relationship of the bank to its government calls for additional ratings uplift beyond what the financial and regulatory assessment would indicate, and further, what this uplift should be. This analysis for banks is consistent with that for all government-supported entities, which include industrial and service companies as well as various kinds of financial institutions, not all of which are banks.
Three Categories of Institutions with Associated Ratings Methodology | Under Standard & Poor's general criteria for rating government-supported entities, there are three categories of entities with associated ratings methodology. The first of these is for entities that are deemed to be sovereign equivalent, that is, so bound up with the government and with such a strong claim upon the government that it is appropriate to rate them the same as the sovereign. Many of these Category One institutions have government guarantees of some kind and are otherwise closely associated with the government. While Standard & Poor's typically performs a financial assessment for these companies, their rating is the same as that of the government, regardless of the companies' financial condition. Moreover, the rating for these entities would only change with that of the government, provided that they remained a Category One entity in Standard & Poor's judgment. Some examples of this first category are export/import banks and some government-development banks. The second category of banks, so-called policy banks, are not as closely integrated into their governments but still have a claim upon sovereign support. For these financial institutions, Standard & Poor's does a financial assessment of the company but then notches down from the sovereign rating up to two rating categories to determine the final rating. Given privatization trends around the world and the transition of banking systems from an explicit policy role to a more commercial orientation, Standard & Poor's deems that very few financial institutions are in this category for ratings purposes. The third category is for banks and other financial institutions in which the government has a strong interest, which is usually (although not always) evidenced by ownership. Here the analysis begins with a financial assessment of the bank. Standard & Poor's then adds ratings uplift where appropriate to reflect the degree of governmental interest and the level of Standard & Poor's confidence that this interest would lead to timely intervention that would support creditors. The uplift can be up to one ratings category, although in special circumstances, and with highly rated sovereigns, it may be even more. This category of bank or financial institution is rare in the U.S., Europe, and Australia, although some of the issuers in this category are major presences in the credit markets. The U.S. Housing government-sponsored enterprises, for example, are in this category, and the German Landesbanks will soon be in this catergory once their government guarantees are eliminated. On a regional basis, the emerging markets have slightly more banks in this category, but the highest percentage of uplifted ratings is in Japan and Korea, reflecting the fact that almost every financial institution in Japan has some degree of enhancement due to the strong governmental interest in maintaining the creditworthiness of its major financial institutions. The analysis of how much, if any, uplift to give banks or other financial institutions in Category Three is a function of the nature of the bank as well as of government policy. Banks that account for a large part of the market for deposits and loans are more likely to receive extraordinary support than smaller, less important institutions. Similarly, institutions that specialize in an area like housing, which is considered important in most systems, may expect support that may be unavailable for companies that specialize in activities like car finance. The government's track record in supporting financial institutions in the past would be relevant, as well as any policy pronouncements made by government officials with relevant authority. The rating of the sovereign itself is usually not a major consideration, since even very low-rated sovereigns have demonstrated support for some banks. However, in cases where the sovereign is very highly rated and has a good track record of meeting even its implied obligations in a timely way, it may be appropriate to give more than the three-notch uplift, which is the customary upper limit for government support for Category Three institutions. |
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Application of the Criteria Guidelines | Standard & Poor's application of these criteria guidelines endeavors to be dynamic, so that a given financial institution may transition from one category to another. Moreover, the evidence leading to greater or lesser confidence in government support may vary over time, leading to appropriate ratings adjustments. In particular, the evidence for governmental support may increase as the financial condition of a financial institution (or of an entire financial system) deteriorates. Ratings may accordingly incorporate additional support as the financials deteriorate, breaking a slide in ratings that may otherwise occur. The case of Japan illustrates how this rating policy works in practice. As the fundamental strength of the Japanese financial system deteriorated, Standard & Poor's monitored the reaction of the government. Since the government evidenced support, in particular by enhancing the capital bases of some of the banks through the purchase of preferred stock in the banks, Standard & Poor's incorporated additional governmental support credit in the ratings of the most important Japanese banks. While the ratings did come down, they did not reach levels commensurate with the banks' financial condition. It is important to add that when governmental support is factored into counterparty and senior debt ratings, this support may not be factored into ratings on junior securities to the same extent, if at all. Ratings on instruments like preferred stock and hybrid equity on which payment may be deferred, for example, may be substantially below the bank's company or senior debt ratings, if in Standard & Poor's judgment the government's support would not preclude payment default on the junior instruments. |
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