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Last updated: August 7, 2011 11:10 pm
The slow death of the US triple A credit rating has given banks time to prepare, bankers claimed over the weekend, though some expected a potentially “messy” start to Monday trading.
One banker said there had been “no special meetings; no one returned from the weekend” to discuss Standard & Poor’s announcement on Friday evening. “It’s more the psychological effect on America,” he said.
Another said: “There are no emergency meetings but there is a lot of communication going on. We’re checking all the obvious things, like liquidity and customer sentiment, making sure we’re ready for whatever the markets may bring tomorrow.”
Washington’s protracted and unruly budget talks left banks planning for a possible US default throughout July. Even when a deal was hatched between Democrats and Republicans to avert that outcome, Wall Street was well aware that a downgrade might still follow.
For weeks, banks have been looking to improve their liquidity, hoarding cash and liquid securities to deal with turmoil in the markets. Bankers say the inability of European policymakers to solve their fiscal crisis remains more important than the US downgrade.
But there are still unknowns that are haunting bank treasurers and executives. What happens when, as expected on Monday, Fannie Mae and Freddie Mac, the quasi-governmental agencies that buy and securitise mortgages, are themselves downgraded?
“The question a little bit is whether [Fannie and Freddie are] impacted more than the core Treasury market,” said one. “That will be interesting to see. If they start to bifurcate a little bit, market participants start to think that there’s a preference in the US [to pay Treasuries], things get ugly.”
Ira Jersey, strategist at Credit Suisse, said there “may be some forced selling over a month or so” of mortgage-backed securities issued by Fannie and Freddie if buyers’ mandates force them to do so. But he added: “On the other side of it, I wouldn’t be completely surprised if some people changed their mandates,” he said. “If you’re a mortgage buyer and you want to own mortgages and those mortgages have to be triple A, where do you go? Your choice is don’t own any mortgages or change your mandate.”
The gyrations of the market last week had ancillary effects linked to government policy – such as the decision by Bank of New York Mellon to charge fees on some large deposits to try to reduce its own balance sheet because of the impact on capital ratios and government insurance premiums.
It raises questions as to whether the Obama administration or its regulators could intervene in the market or change the rules. “I think they’ve done enough,” said one senior Wall Street executive but at the same time he blamed “a lack of leadership in the White House” for a lot of the current malaise.
Banking regulators, whom the banks had criticised for refusing to engage in scenario planning for a default, moved quickly on Friday night to emphasise that they expected the downgrade to have no impact on their assessment of banks’ capital adequacy. Some had suggested that if Treasuries now had a risk premium attached, they should not be deemed risk-free for the purposes of calculating the strength of banks’ balance sheets.
Although senior executives might not have been rushing to the office in the weekend, most banks’ analysts were holding conference calls on Sunday with institutional clients, looking to anticipate the market reaction to the downgrade.
The $3,000bn repurchase market, which provides short-term financing to banks, is often cited as a vulnerability, given its widespread use of Treasuries as collateral. But Mr Jersey said: “This is a misunderstanding among some who do not know the details of how repo margins and haircuts are calculated. Ratings themselves are irrelevant.” Bankers agreed that because repo markets referenced Treasuries rather than a specific credit rating, the impact should be minimal.
S&P indicated there would be further related downgrades to follow on Monday – Fannie Mae and Freddie Mac, which buy and sell mortgages and issue securities as quasi-government agencies, are almost certain to face a downgrade.
Mr Jersey said there “may be some forced selling over a month or so” of mortgage-backed securities issued by Fannie and Freddie if buyers’ mandates force them to do so. But he said: “On the other side of it, I wouldn’t be completely surprised if some people changed their mandates,” he said. “If you’re a mortgage buyer and you want to own mortgages and those mortgages have to be AAA, where do you go?” he said. “Your choice is don’t own any mortgages or change your mandate.”
Some have questioned whether bank ratings, many of which are already on negative watch, might themselves be reduced.
However, one banker said: “Even if there are follow-on downgrades, everyone will stay in place relative to each other.” He added that the fact it was a split rating – with Moody’s and Fitch maintaining their triple A opinion – would help avoid turmoil in the markets.
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