t consideration is the nature and timing of the settlement. Regulators can impose civil penalties that reduce earnings immediately. But we expect a portion of the settlement to lead to enhanced modification programs. In this case, the charge amount could translate into principal reduction for a number of mortgages. To the extent that a portion of any such writedowns can be absorbed through existing loan-loss reserves, rather than requiring additional provisioning, this would limit the effect on the bottom line. However, we expect that a significant portion of such writedowns would occur on loans serviced for third-parties, against which servicers generally hold little or no reserves. We anticipate that the settlement will require the servicers, not the third-party investors, to bear the costs of such modifications, adding to their servicing costs. As for timing, should the settlement take the form of monetary penalties, these would likely be recognized in earnings immediately, net of any existing litigation reserves already set aside. If the settlement results in mortgage modifications or principal reductions, then this would likely be spread over time, easing the financial burden for the firms. It would be in the best interest of both parties to agree to terms that would not only provide closure to this issue, but more importantly, reduce uncertainties in a confidence sensitive market.
13
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Allen Tischler Vice President - Senior Credit Officer +1.212.553.4541 allen.tischler@moodys.com
SEC Investigation of Fifth Third Is Credit Negative
Last Tuesday, Fifth Third Bancorp (A3 stable; C/A3 stable)6 released its 10-K and noted that the US Securities and Exchange Commission (SEC) is investigating accounting and reporting matters related to some of the bank¡¯s commercial loans. The scope of the SEC¡¯s investigation is unclear at this stage, but Fifth Third noted that it might result in fines, restatements of financials, or other penalties that are credit negative. Fifth Third¡¯s disclosures regarding the SEC¡¯s investigation have escalated since it was initially revealed last November in the following ways:
» »
November 2010: In its third-quarter 2010 10-Q, Fifth Third stated that the SEC had requested information relating to its commercial loan accounting and reporting January 2011: In the registration statements related to both Fifth Third¡¯s successful $1.7 billion common equity raise and $1.0 billion senior debt issuance that facilitated the repayment of its TARP preferred shares, the company repeated its November statement, but added that the SEC had commenced the process of seeking a formal investigation March 2011: In its 2010 10-K, Fifth Third repeated its earlier disclosures, but also noted that the SEC had issued a subpoena as part of its information requests. That contributed to a more than 4% decline in Fifth Third¡¯s stock on 1 March
»
Neither Fifth Third nor the SEC has indicated the range of issues related to commercial loan accounting that are being explored. However, although the SEC¡¯s purview is focused on the content and presentation of an issuer¡¯s financial statements, as opposed to its business plans or strategy, we cannot dismiss the possibility that the SEC findings result in a subsequent investigation of Fifth Third by its primary banking regulators. That would be a significant negative development. Nonetheless, we are not aware of any current bank regulatory issues facing Fifth Third. Moreover, we note that Fifth Third¡¯s auditors, Deloitte & Touche, have signed off on its financial statements and issued unqualified opinions for 2010 and prior years, which gives us some comfort that any issues with its commercial loan accounting and reporting may not be widespread. Therefore, although the SEC¡¯s investigation of Fifth Third is credit negative and will be time consuming and potentially costly for its management team, at this stage it is not a rating issue. Nonetheless, the SEC investigation is an unwelcome development for a company that has been increasingly focused on the future of its franchise after returning to profitability in mid-2010 after multiple quarters of losses.
6
The bank ratings shown in this article are the bank¡¯s deposit rating, its standalone bank financial strength rating mapped to the long-term scale, and the corresponding rating outlooks.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Curt Beaudouin, CFA Vice President - Senior Analyst +1.212.553.1474 john.beaudouin@moodys.com Allen Tischler Vice President - Senior Credit Officer +1.212.553.4541 allen.tischler@moodys.com
PNC¡¯s Plan to Stick with Free Checking Is Credit Positive
Last Tuesday, PNC Bank (A2 positive; C+/A2 positive)7 announced that it will continue to offer its base-level free checking account. PNC¡¯s decision to stick with this retail banking product is credit positive, as we think the bank will seize the opportunity to gain market share from rivals and steer customers to new product offerings. Many banks are backing away from free checking as they look for ways to recoup lost revenue attributable to the Durbin Amendment to the Dodd Frank financial reform bill. Starting on 21 July, the amendment will cut debit interchange fees for banks by approximately 73%. Although PNC has stated that for 2011 the negative revenue impact from Durbin and Reg E8 will be approximately $400 million, it is taking a different tack than other banks. The company will continue to offer the free checking product, although certain related features9 will be cut. Approximately 70% of the bank¡¯s retail customers have free checking and maintaining the product (though in a somewhat diluted form) avoids the risk of alienating this large core customer base. Moreover, given its strong core direct retail banking franchise is located in the Mid-Atlantic and Midwest regions, PNC stands to gain new customers via fallout from other banks eliminating the product (though gains may be lessened depending on the degree that some competitors copy PNC¡¯s approach). PNC may also further enhance revenues by steering both existing and new customers to an enhanced suite of product offerings, such as a new fee-based checking account with a lower balance threshold, relationship pricing on deposit and loan rates, and enhanced credit card rewards.
Felipe Carvallo Assistant Vice President - Analyst +52.55.1253.5738 felipe.carvallo@moodys.com David Olivares Vice President - Senior Credit Officer +52.55.1253.5705 david.olivares@moodys.com Busy Juárez Associate Analyst +52.55.1253.5735 busy.juarez@moodys.com
Mexico¡¯s New Mortgage and Consumer Loan Reserves Are Credit Positive for Banks
Last Tuesday, the Mexican banking regulator (known as the CNBV) enacted new methods for calculating reserves for mortgage and non-revolving consumer loans. The methods include detailed formulas that more precisely calculate expected losses, which is credit positive for banks since it allows them to rationalize provisioning and ultimately reduce credit costs by acknowledging differences among consumer loan types. Because of Mexican banks¡¯ high existing levels of reserves, we expect the new calculations to lower reserves or require a negligible amount of additional reserves. The new norms also foster a strong datagathering culture and will allow updates on the main variables every three years, thus ensuring a continuous loop of improvement on which variables best predict expected losses. Unfortunately, it is still unclear if these rules will apply to the government¡¯s large mortgage financing trusts or to nonbank mortgage lenders (known as SOFOLes). The new mortgage-reserve formulas are not limited to observed performance (e.g., days past due), but incorporate the variables statistically proven to best predict expected losses: coupon payment, sum of prior payments, asset value, remaining balance, currency, and the involvement of a third-party loan
7 8 9
The ratings shown are PNC¡¯s deposit rating, its standalone bank financial strength rating mapped to the long-term scale, and the corresponding rating outlooks. Federal Reserve regulation stipulating overdraft fee policy changes, effective 1 July 2010; disallows overdraft charges unless a customer explicitly opts-in. Debit card rewards points and rebates for use of non-PNC ATMs by Free Checking customers.
15
MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
originator. The new formulas for non-revolving consumer lending include additional variables, including number of payments, remaining number of payments, and original amount of loan. The regulator had previously announced that it would differentiate loss-given defaults for mortgages between Mexican states, using our Contract Enforceability Indicator (EC),10 which classifies each state on enforceability of legal proceedings. In the final calculation methodology published last Tuesday, the regulator incorporated a further loss-given default variable, acknowledging best practices already functioning well among the banks. It includes the existence of judicial lender/borrower arrangements aimed at bypassing sometimes snail-paced court proceedings and the existence of trusts that only transfer ownership to the borrower once the loan has been paid off. Both of these greatly speed up repossessions in Mexico. The new non-revolving consumer reserves differentiate between asset-backed, auto, payroll-linked, personal, and group micro lending. In the past, niche banks found themselves complying with a general consumer-lending norm. Now, banks focused on asset-backed lending, such as Banco Azteca S.A. (unrated), will utilize specialized formulas that incorporate differences in payment behavior/culture among its clients. Also benefitting are Banco Autofin México S.A. (B1 stable; E+/B2 stable)11 and Volkswagen Bank S.A. (unrated), which are focused on auto lending; Banco Compartamos S.A. (unrated), which is focused on group micro lending; and Banco Ahorro Famsa S.A. (unrated), which is focused on personal loans. Missed payments will nevertheless continue to be a major trigger for reserve creation. As a general rule, four missed payments for mortgages will prompt 100% reserve requirements. The 100% reserve requirements for non-revolving consumer credits will vary between seven weeks and four months after non-payment, in line with the different characteristics of these loan types. As seen in the exhibit below, the banking system is well reserved against expected losses. No individual bank maintains reserves that are lower than our stress-case losses. Mexican Banking System: Adjusted Reserves Against Expected and Stressed Losses
Year-end 2010
Expected 25 20 15 10 5 Total Portfolio Consumer Mortgages Commercial Financial Institutions Government Stressed Reserves Pre WO
Source: CNBV and Moody¡¯s estimates.
10 11
Please see Special Comment entitled ¡°Indicadores de Ejecutabilidad Contractual,¡± published November 2009. The bank ratings shown in this article are the bank¡¯s deposit rating, its standalone bank financial strength rating mapped to the long-term scale, and the corresponding rating outlooks.
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MOODY¡¯S WEEKLY CREDIT OUTLOOK
7 MARCH 2011
NEWS & ANALYSIS
Credit Implications of recent worldwide news events
Marjan Riggi Vice President - Senior Credit Officer +44.20.7772.1603 marjan.riggi@moodys.com
LSE¡¯s Trading Outages: Bad for Them and Bad for Their Customers
On 25 February, the London Stock Exchange Group (LSE, Baa2 review for upgrade), halted cash equities trading for nearly four hours because of a trading system fault that prevented orderly dissemination of equity prices. This was the third outage in the four months since the LSE rolled-out its new MilleniumIT electronic trading system late last year. We believe that these technological setbacks are credit negative for the LSE. The 25 February outage occurred early in the day, disrupted the ¡°daily auction¡± (when price references are set for trades for later that day), coincided with the day of some company earnings results, and left many brokers frustrated and scrambling to find alternative platforms. Overhauling its trading technology is one of the most important strategic initiatives for the LSE, which has lost significant cash equity market share (see exhibit below) to faster and more efficient platforms like Chi-X Trading (unrated) and BATS Europe (unrated). We believe that the persistent problems with its migration to a more competitive trading system is resulting in increasingly downbeat customer feedback and is negative for LSE¡¯s market share and pricing power. FTSE Listed Cash Equity Market Share %
90% 80% 70% 60% 50% 40% 30% 20% 10% 0% LSE Group Turquoise Chi-X BATS NYSE Euronext
Source: BATS Europe
In October 2009, the LSE acquired MilleniumIT, a Sri Lankan-based technology services company specialising in trading platforms and financial markets software. The rationale was to reduce the latency of trade executions and give the LSE a more agile and scalable i