A Boost for Big U.S. Banks

S&P hikes credit ratings on six big banking players including Citi, JPMorgan Chase, and Bank of America

From Standard & Poor's RatingsDirect

On Feb. 14, Standard & Poor's Ratings Services raised its counterparty credit ratings on six major U.S. banking institutions and their subsidiaries. The companies—and S&P's views on each—are listed below:

Bank of America Corp. (BAC)

Rating raised to AA from AA–

"The ratings are based on BofA's success in creating the first true nationwide banking franchise and in converting this competitive advantage into improved financial performance," says Standard & Poor's credit analyst John K. Bartko. A key strength for BofA resides in its retail branch network of approximately 5,800 branches, an unrivaled distribution network from which it gathers stable and inexpensive core deposit funding.

Profitability measures have moved in line with those of other large complex banks, as BofA succeeded in meeting its cost savings targets from the FleetBoston and MBNA mergers. Furthermore, only Citigroup's earnings level rivals that of BofA's at just over $21 billion annually.

Nevertheless, we expect profitability and asset quality to be modestly pressured, but to remain acceptable for the current rating. We anticipate this pressure as a result of several factors including cyclical trends, primarily in the mortgage business, narrowing net interest margins resulting from the continuing flat/inverted yield curve environment, and possibly higher credit card costs as charge-offs for bad debt revert to a normalized level following the surge of bankruptcy filings in October, 2005, as a result of changes to the bankruptcy legislation.

Citigroup (C)

Rating raised to AA from AA–

Strong earnings generation from an extraordinarily diverse set of businesses allows Citi to cover some of the high risks that it incurs. Citi has also achieved a substantial change in its control environment in the aftermath of a wave of heavy litigation expenses and criticism of its business practices from regulators around the world. The period of adjustment is over, and Citi has been investing heavily to stimulate organic growth. These investments should begin to bear fruit in 2007 to reverse the negative operating leverage trend.

Together with some modestly sized acquisitions in emerging markets and cost cuts, earnings should grow more dynamically. They should be sufficient to offset mounting provision expenses that can be expected, as losses return to more normal levels from the very low rates of today. The need to boost reserves should accelerate the trend. "Despite the slow growth, the basic retail and corporate banking franchises are very impressive, with an infrastructure that is best in class in many areas," says Standard & Poor's credit analyst Tanya Azarchs.

JPMorgan Chase & Co. (JPM)

Rating raised to AA– from A+

"JPMorgan's recent performance appears to be improving and is nearing its potential," says Azarchs. Merger-related savings are producing positive operating leverage, and credit costs remain at historic lows. Trading income, which has been a source of unusual volatility, is stabilizing as risk levels have been curtailed. Revenue growth has been very difficult in the face of a flat yield curve and a slowdown in the credit card and mortgage environments. Underlying volume growth, however, is benefiting from a strong economy and should help boost revenues in the future. This should help offset an expected increase in credit costs, which have been abnormally low.

The ratings should remain at this level until JPMorgan establishes a record of consistently higher profitability over a longer period of time. Its earnings strength is such that, even in a less benign economic environment, the firm should remain profitable. The current ratings discount a moderate downturn in the credit cycle some time in the next few years.