Prior to two of the largest banking catastrophes in American history, credit-rating agencies held regional banks in high regard.
Fast failures at Silicon Valley Bank and Signature Bank raise the possibility that bondholders won’t ever receive their money back. Before regulators intervened to guarantee those accounts, uninsured depositors feared they would lose their money.
Both banks had excellent ratings before they fell. The collapses were the latest blot on the corporations’ records for forewarning of financial turmoil, even though Wall Street and regulators have frequently unable to forecast meltdowns.
The possibility of a Moody’s downgrading spurred Silicon Valley Bank to launch an emergency fundraising campaign last week. These occurrences alarmed depositors and contributed to a run on the lender. On March 8, Moody’s lowered some of Silicon Valley Bank’s and its parent company’s ratings, although not below investment grade. The rating agency also reiterated its favourable evaluation of the bank’s short-term deposits.
Wall Street and regulators routinely criticise the ratings sector, especially after it was found to have missed the risks that contributed to the financial crisis of 2008. The business model of the firms, according to critics, presents a conflict of interest because the institutions they score pay the firms. Veteran members of the ratings profession claim that bank meltdowns in particular can occur swiftly and that ratings organisations find it difficult to respond in time.
The rating agencies need to adapt, but they can’t because they are too bureaucratic, “Christopher Whalen, the head of Whalen Global Advisers and a former bank ratings leader at Kroll Bond Rating Agency, made this statement. “A downgrade is too difficult a process.”
Rating agencies like S&P Global Ratings and Moody’s Investors Service are used by depositors and investors to assess a company’s capacity to repay debts. The businesses’ ratings of financial institutions are intended to assist bondholders and customers in evaluating banks by determining the creditworthiness of debt and deposits.
Investors and debt issuers have occasionally argued that rating agencies are unfairly harsh in their assessments of some debt. For instance, a bank’s early warning of crisis can scare depositors and cause a collapse. But, waiting too long to take action can blindside customers and investors to possible losses.
The S&P rating agency stated that the U.S. banking industry was in good form and that risk was decreasing in its global bank outlook for 2023, which was released in November. A slowing economy could present challenges for North American banks, according to Moody’s annual forecast, which was released in early December.
“Moody’s frequently emphasised new dangers for regional banks in the United States starting in June 2022 as interest rates started to rise, “a representative for Moody’s stated. We continuously evaluate our credit ratings, and where necessary, we quickly changed the ratings for a few particular regional banks in the United States.”
A S&P spokeswoman cited business documents that said that ratings can occasionally change due to uncontrollably unforeseen occurrences and are only one factor in investors’ decisions.
When it folded, Signature Bank had received investment-grade ratings from three rating agencies.
“It’s just not going to happen that ratings organisations provide struggling banks a lot of advance notice, “Mark Adelson, who served as S&P’s chief credit officer from 2008 to 2011, said.
After the failure of the banks, Moody’s changed the outlook for the U.S. banking system to negative on Monday. Six institutions were also put under consideration for possible downgrades. Moreover, the company removed its coverage of Signature Bank and downgraded it to trash. S&P downgraded First Republic Bank to junk status on Wednesday, citing the possibility of client withdrawals.
A new Federal Reserve emergency loan facility, according to Moody’s analyst Ana Arsov on Thursday, helped stabilise the system and should reduce the amount of ratings actions the company takes in the future.
Ratings that were too positive for some mortgage securities contributed to the start of the world financial crisis 15 years ago. Even Lehman Brothers itself had excellent ratings up until a few days before it declared bankruptcy. Afterwards, S&P claimed that it would have been challenging to predict Wall Street’s abrupt loss of confidence in Lehman.
After the 2008 financial crisis, regulators tightened their control over the ratings sector. Nonetheless, agencies persisted in their battle for market dominance by giving clients of their rivals higher ratings. After downgrading an issuer, they occasionally lost out on subsequent negotiations.
Other precautions failed in the present banking crisis as well. After advocating for banks of its size to be exempted from the regulations, Silicon Valley Bank avoided the authorities’ assessment of the strength of its funding source. Also, independent auditors granted the bank a perfect score.
While experiencing their first yearly net losses since 1948, banks were already scrambling to close the gap left by emigrating deposits. Data from the St. Louis Federal Reserve show that total borrowings by U.S. banks have surpassed $2 trillion this year for the first time since early 2020.
Wall Street stock analysts move more quickly than ratings companies, yet prior to Silicon Valley Bank’s collapse, they held an average price objective of $261.85 per share, which was close to the stock’s current market value.
According to John Kim, CEO of credit-investment firm Panagram Structured Asset Management, analysts may have been falsely reassured by banks’ relative soundness.
Positive biases towards institutions that have historically been safe may occasionally lead rating agencies to ignore possible issues with those institutions, “said he.
Before reducing exposure last week, Aptus Capital Advisors, which manages around $4.3 billion in assets, owned shares in First Republic and Western Alliance Corp., according to David Wagner, an Aptus portfolio manager.
Currently, it appears evident that problems with bank balance sheets and deposit withdrawals will get worse, “said Mr. Wagner. We had money on the line, but we didn’t see it either.”
