bank signals

FINANCIAL INSTITUTIONS

SECTOR IN-DEPTH3 JUNE 2015

TABLE OF CONTENTS

US financial institutions 1Non-US financial institutions 5Market-implied ratings tables for globalbanking regions and companies

8

Monthly Bank Risk Report: key creditmetrics: CDS, bonds

9

Appendix : Moodys Capital MarketsResearch recent publications on thefinance sector

23

ANALYST CONTACTS

Allerton G. Smith 212-553-4058Sr Dir-Sr Research Analyst250 Greenwich [email protected]

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Bank Risk Report

Bank Market Signals Reflect ContinuedStressesUS Financial Institutions: Challenges to Profitability Underlie CreditSpread MovementsBy Allerton (Tony) Smith

Over the last year the market-implied ratings for US banks slightly underperformed the broadmarket. The average CDS-implied rating for the 12 banking companies which we cover inthis report has slipped from A3 to Baa1. The average bond-implied rating for the 39 bankingcompanies which we cover in this publication also worsened by one notch from A3 to Baa1.

Investor concerns about bank profitability and the continuing market shocks from sizeableregulatory fines and settlements have likely been the main impediments to the banks creditmarket signals. Profitability metrics within the US banking system are returning toward pre-crisis levels but only slowly, and net income actually declined in 2014 for the largest USbanks. This trend reflects numerous challenges for all of the banks.

We do expect profitability to benefit from a slowly rising interest rates, continued loangrowth, and the finalization of regulatory fines and settlements. The improving balancesheets of the US banks are likely to support consistency in US banks credit spreads, keepingthem relatively stable and range bound for the near future.

The average CDS five-year mid-spread for our 12-bank peer group widened from 55 bp ayear ago to 59 bp, and this modest 6% widening slightly underperformed the broad market.CDS spreads widened for nine of the 12 banks over the last year; just three banks enjoyed atightening. The average senior debt ratings for our CDS and bond bank peer groups are bothA3, thus the average CDS- and bond-implied ratings gaps deteriorated by one notch to -1notch over the year. As recovery in profitability levels and consistency returns, the market-implied ratings and the Moodys ratings for our bank peer groups could converge.

Moodys Investors Service recently noted: The outlook for US banks is stable. GDP growth,low oil prices, and rising employment will bolster already strong asset quality. However, lowinterest rates and competition among banks and from the shadow banking sector will keep

MOODY'S ANALYTICS FINANCIAL INSTITUTIONS

2 3 JUNE 2015 BANK RISK REPORT: BANK MARKET SIGNALS REFLECT CONTINUED STRESSES

banks margins and profitability low over the next 12-18 months. Intense competition also raises the risk that banks will relaxunderwriting standards, leaving them with higher-risk loans on their balance sheets. 1

Challenges from the regulatory and operating environment were evident in 2014Net income fell on average by 8.5% for the 10 largest US banking companies in FY 2014 (Figure 1). The largest banks profitabilitygrowth underperformed their larger peer group of 65 banks shown in the expanded tables below. Six of the 10 largest US banksreported a rise in profitability in FY 2014, but trends for revenues remained lackluster. Weighing on profitability were higher legal andregulatory settlements, regulatory compliance costs, sluggish trading revenues, intensifying competition, and net interest marginspressured by the persistent low interest-rate environment. A positive offset in 2014 was a continuing decline in the provisions for loanlosses, although this benefit is waning.

FIGURE 1. TEN LARGEST US BANKING COMPANIES, RANKED BY NET INCOME BEFORE EXTRAORDINARY ITEMS, AT 12/31/14

2104 earnings improved at the 65 largest US banking companiesThe aggregate net income for the 65 largest US banks declined by 4.5% at FY 2014 versus FY 2013. However 2014 it rose by 6.4%from the aggregate level reported in 2012.

More US banks are profitableMore banks are reporting profitable operations. Of the top 65 US banks, 63 reported positive net income in 2014 and 2013, versus just61 in 2012. This constructive trend is likely to continue and even improve in FY 2015.

Problem loans drop further at US banks2.

The ratio of problem loans to gross loans strengthened significantly over the last several years for the largest US banking companies.The ratio fell by 19% from year-end 2013 to year-end 2014, strengthening from 2.41% to 2.02%. The ratio fell by 10.5% between 2012and 3013, from 3.02% to 2.41% (Figure 2).



FIGURE 2. TEN LARGEST US BANKS RANKED BY THE RATIO OF PROBLEM LOANS TO GROSS LOANS3

Among the largest US banking companies, the best drop in the ratio of problem loans to gross loans in 2014 was 24%, at both Bank ofAmerica Corp. and JP Morgan Chase & Co.

The ratio of problem loans to gross loans has recovered by 15% since the end of 2012 for the 65 largest US banking companies.

Sixty of the 65 largest US banking companies experienced an improvement in the problem loan to gross loan ratio in FY 2014. Fiftynine of the banks demonstrated an improvement in the ratio in FY 2013. No bank reported a worsening of the ratio in both 2014 and2013.

Total assets are rising at US BanksTotal assets grew by 9.4% at the 65 largest US banking companies in FY2014. The rate of growth accelerated from a rise of 2.9% in the2012-2013 period. Sixty of the top banks showed an expanded asset base in 2014 versus only 43 banks in 2013. Nominal GDP grew at3.9% in 2014. We attribute the spurt of bank assets to rapid deposit inflows, deployed into more robust commercial loan growth (up10% in 2014) and to the banks additions to investment portfolios of low risk weighted securities.

Top 10 US banks remain an elite groupThe ten largest (by total assets) US banking companies at year-end 2014 are the same as the ten largest at year-end 2013 (Figure 3).The group grew more slowly in 2014 (3.0%) and 2013 (1.6%) than the larger peer group of 65 rated US banking companies (whereasset growth was 9.4%).

FIGURE 3. TEN LARGEST US BANKING COMPANIES RANKED BY TOTAL ASSETS FY 2014



Four largest banks maintain their asset size positionsJP Morgan Chase, Bank of America, Citigroup, and Wells Fargo & Company were the four largest US banking companies (in that order,by total assets) in 2014, 2013, and 2012. Reflecting pressures from Dodd-Frank regulations, total assets shrank in 2014 at the brokerdealers, with a drop of 6% in total assets at Goldman Sachs and 4% at Morgan Stanley.

Shareholders equity is rising at US banking companiesShareholders equity continued its growth trend at the largest US banking companies, rising on average by 8.4% in FY 2014 and 5.1% inFY 2013 (Figure 4).

FIGURE 4. TEN LARGEST US BANKING COMPANIES RANKED BY SHAREHOLDERS EQUITY

Top 10 US banks continue to top all peers for shareholders equityThe same ten US banking companies, as ranked by shareholders equity, were at the head of their peers in 2014, 2013, and 2012.

Most banks are growing their capital positionsFifteen of the largest US banks had a drop in shareholders equity in 2013, but only five experienced a decline in 2014. Only one bank,Fulton Financial, had a dip in shareholders equity in both 2013 and 2014.

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Non-US Financial Institutions: Market Signals Reflect Local Operating EnvironmentsBy Allerton (Tony) Smith

Credit spreads for banks outside the US did not perform as well, in general, as for the US banks over the last 12 months. In Europe, theaverage CDS spread widened by 28% from 132 bp to 170 bp over the last year. In the EMA region, the average CDS spread widenedfrom 466 bp to 1,055 bp, in Africa average CDS spreads widened by 23% from 128 to 158 bp, and in South America average CDSspreads widened by 29% from 201 to 258 bp. The best performing region was Asia-Pacific where CDS spreads tightened by 6% from134 a year ago to 125 bp.

Bond-implied ratings gap movements for banks outside the US were mixed. The gap for the EMA (including Hungary, Poland andUkraine) banks worsened by -4 notches, with the bond-implied rating changing from Ba2 to B3. The gap for Asia-Pacific banks slippedby two notches, with the bond-implied rating changing from A3 to Baa2. For African and Middle Eastern banks the bond-implied ratingwas unchanged from a year ago at Ba1. As a region South American banks and European banks each enjoyed a +1 notch improvementin its average bond-implied ratings gaps, with South America changing from Ba3 to Ba2, and Europe from Baa1 to A3.

The highest and lowest rated banking companies globallyThe four tabulations (Figures 5-8) below show the 10 best and 10 worst banking companies rated by Moodys, as ranked by theirCDS- and bond-implied ratings. The lowest ratings come mostly from well-known troubled regions and countries, such as Ukraine,Kazakhstan, and Greece. These are rounded out by some special situations in Russia, Italy, Argentina, and Portugal, plus Ally Financialand CIT in the US. The best bond-implied ratings come from banks in Europe and Canada.

The CDS- and bond-implied ratings gaps for the 10 lowest ranked banking companies show relatively close agreement between theirmarket-implied ratings and their Moodys ratings, as do the bond-implied ratings gaps for the 10 highest ranked companies. Howeverthe CDS-implied ratings gaps for the 10 best ranked banks range from -4 notches to -6 notches. In large part this reflects the extremecompression between the CDS five-year mid-spreads at the top of the credit spectrum, but also likely reflects some investor cautionabout the highest-rated banks versus similarly rated corporate bond issuers.

FIGURE 5. TEN LOWEST MOODYS-RATED BANKS WITH BOND-IMPLIED RATINGS



FIGURE 6. TEN HIGHEST MOODYS-RATED BANKS WITH BOND-IMPLIED RATINGS

FIGURE 7. TEN LOWEST MOODYS-RATED BANKS WITH CDS-IMPLIED RATINGS

FIGURE 8. TEN HIGHEST MOODYS-RATED BANKS WITH CDS-IMPLIED RATINGS



End Notes:1. Excerpted from Banking System Outlook, June 1, 2014. https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1004697

2. The compilation includes the 65 largest US banking companies with credit ratings from Moodys Investors Service at 12/31/14.

3. Data as reported from Moodys Credit View Bank Financials and Analytics. Figures in green indicate improvement or growth, figures in red indicate worsening or declines.



Market-implied ratings tables for global banking regions and companies

FIGURE 1. AVERAGE CDS-IMPLIED RATINGS FOR GLOBAL BANKING COMPANIES BY REGION.

FIGURE 2. AVERAGE BOND-IMPLIED RATINGS FOR GLOBAL BANKING COMPANIES BY REGION.

FIGURE 3. MAJOR GLOBAL BANKS CDS- AND BOND-IMPLIED MARKET SIGNALS AND MOODYS RATINGS

Figures 1,2, and 3: Moodys Senior or Moodys Sra. (Moodys senior rating algorithm)

Source:: Markit; Moodys Analytics



Monthly Bank Risk Report: key CDS credit metrics



Monthly Bank Risk Report: key bond credit metrics



Appendix: Moodys Capital Markets Research - recent publications on finance sector

https://www.moodys.com/research/Market-Signals-Review-GECCs-CDS-and-Bond-Implied-Ratings-Converge--PBM_1005628

https://www.moodys.com/research/Market-Signals-Review-Genworth-All-Three-Market-Implied-Ratings-Remain--PBC_1005175

https://www.moodys.com/research/Bank-Risk-Report-Globally-Bank-Market-Signals-Reflect-Operating-Environments--PBC_1004989

https://www.moodys.com/research/Market-Signals-Review-Ally-Financials-Market-Signals-Were-Idiosyncratic-Over--PBC_1005152

https://www.moodys.com/research/Market-Signals-Review-AXA-SA-Implied-Ratings-Move-in-Narrow--PBC_1005108

https://www.moodys.com/research/Market-Signals-Review-Ocwens-Market-Implied-Ratings-Slip-Lower--PBC_1005050

https://www.moodys.com/research/Market-Signals-Review-Health-Net-Inc-Market-Signals-Mostly-Steady--PBC_1004941

https://www.moodys.com/research/Market-Signals-Review-BBT-Corporation-EDF-Implied-Rating-Advances--PBC_1004878

https://www.moodys.com/research/Market-Signals-Review-Morgan-Stanleys-EDF-Implied-Rating-Rises-to--PBM_1004866

https://www.moodys.com/research/Market-Signals-Review-Citigroup-Inc-Two-Market-Implied-Ratings-Rise--PBM_1004804

https://www.moodys.com/research/Market-Signals-Review-Bank-of-America-All-Market-Signals-Retreat--PBC_1004735

https://www.moodys.com/research/Market-Signals-Review-Goldman-Sachs-EDF-Implied-Rating-Rises-CDS--PBC_1004696

https://www.moodys.com/research/Market-Signals-Review-JPM-All-Three-Market-Signals-Rally--PBM_1004592



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AUTHORS

Allerton (Tony) Smith 1.212.553.4058Senior [email protected]

Lisa Hintz, CFA 1.212.553.7151Associate [email protected]

Irina Baron 1.212.553.4307Asst. Dir-Research [email protected]

Xian (Peter) Li 1.212.553.1404Research [email protected]

EDITOR

Dana Gordon 1.212.553.0398Assc Dir-Senior [email protected]

CLIENT SERVICES

Americas 1.212.553.4399Europe +44 (0) 20.7772.5588Asia 813.5408.4131

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