Citi’s Ryan O’Connell worries that if the U.S. were to abolish the ‘Too-Big-To-Fail’ doctrine this year, it could slam the credit ratings of Too Big To Fail banks such as Bank of America, Goldman Sachs, and Morgan Stanley.
Citi is probably included in the list, but being a Citi analyst, Mr. O’Connell doesn’t cover Citi.
Ryan O’Connell @ Citi: (The prospects for passage of such a bill by the Senate remain uncertain but such a development should not be ruled out). In the short-term, passage of such legislation could lead to multiple- notch downgrades for several institutions including Bank of America, Goldman Sachs and Morgan Stanley.
If the legislation passes and downgrades result, the potential consequences include reduced access to the short-term funding markets and increased collateral requirements related to derivative transactions and repo financing transactions, we believe.
At this point, we think that the incremental impact on funding costs is not likely to be severe, and it might not last long. Market conditions have stabilised and, in our opinion, Bank of America, Goldman and Morgan Stanley are not likely to require additional government support in the current environment.
Still, especially when it comes to funding costs for these banks, the market reaction would all depend on whether or not markets believed that these banks were truly no longer Too Big To Fail. Even if some kind of legislation were passed to make the banks ‘Able To Fail’ in word, markets might still suspect that if push came to shove, the U.S. would be willing to support the banks once again. In fact, it is hard to believe that markets could expect Too Big To Fail to end any time soon given the fragile state of the U.S. recovery. Thus even if the government pretends like the doctrine is dead in word, markets might not penalise the banks too much since they simply wouldn’t believe what they were hearing.
Still, major banks appear to have been preparing for the worst regardless.
One of the largest threats from a loss of Too Big To Fail status would be an inability to tap the commercial paper marker for funding due to credit downgrades, according to Mr. O’Connell. Yet he points out that the three banks mentioned above should be fine in such an event since they have already reduced their reliance on this market for funding.
On the positive side, large firms have aggressively reduced their reliance on CP [commercial paper] over the last year. CP is now a de minimis component of overall funding for Bank of America, Goldman Sachs and Morgan Stanley, according to our calculations. Bank of America and Morgan Stanley, for example, reduced their CP by almost 70% and 90% from Q4 08 to Q3 09. (See Figure 1 for CP balances outstanding as of Q3 09). It is possible that the firms have reduced their CP outstanding since Q3 2009.
All in all, credit ratings could be slammed but deep down major banks should be OK, according to Mr. O’Connell. He recommends buying the senior bonds of Bank of America, Goldman Sachs, and Morgan Stanley.
(See the full report for details — Citi, Too Big To Fail — From Ratings Uplift to Downdraft?, Ryan O’Connell, CFA, 16 Feb 2010)