Rating agencies to keep an eye on the banking sector

The world’s three key rating agencies have released statements about the possible repercussions on the banking sector of last week’s tragic attacks in New York. Moody’s said it is not contemplating any immediate rating downgrades for European banks solely as a consequence of the September 11 tragedy and Fitch said that no single firm will experience untoward difficulties due to the successful implementation of disaster recovery plans. Standard and Poor’s (S&P), meanwhile, paints a more negative picture, saying that firms already on a negative review will be closely examined in the wake of recent events.

"The September 11 calamity - aside from its considerable human-tragedy dimension - will accelerate the ongoing US economic slowdown and create a more unpredictable global environment for financial transactions," according to Moody’s. However, Moody’s also said that most European banks will be protected by their widely diversified operations and the central banks’ focus on keeping short-term rates at low levels, aiding the banking sector’s performance and liquidity.

Moody’s also emphasised that banks with strong and profitable home retail market positions will probably be better able to preserve stable earnings for the longer term than banks, which rely primarily on more volatile sources of revenue such as trading and investment banking. Moody’s has said in recent years that warnings about impending banking crises have failed to materialise, with only very minor and limited downgrades during the Asian and Russian turmoil, and none due to the Y2K threat.

But Moody’s underlined the framework of its credit concerns for the forthcoming, more unstable, near to medium term. These credit concerns relate to both the likelihood of lower pre-provision profits and possible downward adjustments in asset values - loans, investments, equity participations - and other risks.

Like Fitch, Moody’s said it would assess the involvement of banks in sectors such as airlines, aircraft financing, other transportation such as shipping, technology, tourism-related hotel and travel companies, and insurance. Revenue drops could make it more difficult for several firms in these sectors to service their debt. For example, there are several European banks, including some less profitable institutions owned by the German government, that are very active participants in aircraft financing, a sector likely to face stress in the aftermath of the terrorist attack.

Exposure to hedge funds, currently at very high levels according to Moody’s, represents another risk, especially when it is not properly collateralised. Moody's said that it is assessing the degree to which individual banks are exposed to these risks in a market downturn, although detailed knowledge about such activities and risk exposures is often not transparent even within the organisation itself.

S&P said that firms such as Bear Stearns, Merrill Lynch, Goldman Sachs, Morgan Stanley and Charles Schwab, which were all on a negative outlook before September 11, are likely to experience an exacerbation of a poor operating environment. S&P also includes Credit Suisse, Lehman Brothers and Deutsche Bank among other institutions that will be closely examined.

Fitch, meanwhile, points to possible future settlement difficulties in securities and credit derivatives that may have resulted in as yet unrealised mark-to-market losses or already realised losses resulting from increased market volatility. Fitch added that it will be closely monitoring any downward slump in US and international banks. Japanese banks, many of which faced Fitch downgradings last month, may also be adversely affected, as they are particularly sensitive to movements in the stock markets. "And if this does not recover, it will present the Japanese authorities with a major challenge," said Fitch.

Presenting a more positive outlook for general financial recovery, New York-based RiskMetrics, the JP Morgan spin-off risk software firm, found that US equities historically bounce back after significant security threats. RiskMetrics tracked the price movement of the Dow Jones Industrial Average, New York's benchmark equities index, in response to the bombing of Pearl Harbor on December 7, 1941; the first Soviet nuclear detonation, on August 29, 1949; the televised coverage at the beginning of the Cuban missile crisis, on October 22, 1962; the assassination of John F Kennedy on November 22, 1963; and the beginning of the Gulf War on January 16, 1991. Historical price response was tracked over one-month, three-month, six-month and one-year time periods from the first full day of trading following each event.