fitch ratings fi ratings methodology

Fitch Ratings FI Ratings Methodology

Joo-Yung Lee, Managing Director

Presentation to Capital Markets Credit Analysts

Society

28 March 2012

Agenda

Fitch’s Approach to Rating Banks

US Banks

Bank Support

Viability Ratings Definition

Overview of Fitch’s Bank Rating Methodology• Notching

Rating Banks in a Changing World

Global Trading and Universal Bank Review

04/21/23

3

www.fitchratings.com

Fitch’s Approach to Rating Banks

Five key elements to FI ratings analysis

• Ownership, support and group factors

• Industry profile and operating environment

• Company profile and risk management

• Financial profile

• Profitability, funding, liquidity and capitalization

• Management strategy and corporate governance

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US Bank Ratings Stabilized at Lower Levels Than Pre Crisis (2007); Outlooks Mostly Stable

Bank Rating Outlooks

0

5

10

15

20

25

30

35

40

Ratingoutlookstable

Ratingwatch

negative

Ratingoutlookpositive

Ratingoutlooknegative

Bank Rating Distribution

02468

101214161820

AA

A

AA

A+ A-

BB

B

BB

+

BB

- B

CC

C C

2007 2011

Source: Fitch

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Support Meaningful for Banks

Comparative Failure/Default Rates 1990-2009

Source: Fitch, not dollar weighted

Support is meaningful for banks as history has proven they ‘fail’ far more often than they

‘default’ – with the difference being support.

0

2

4

6

8

1yr 2yr 3yr 4yr 5yr

Failed banks Defaulted corporate finance Defaulted banks(%)

The value of support

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Fitch Considers Bank Stand-Alone Financial Strength Coupled with View of Support

Changed from Individual Rating in July 2011

• ‘aa’ – very high fundamental credit quality

• ‘a’ – high fundamental credit quality

• ‘bbb’ – good fundamental credit quality

• ‘bb’ – speculative fundamental credit quality

• ‘b’ – highly speculative fundamental credit

quality

Support scale from ‘1’ to ‘5’

• ‘1’ – Minimum long-term rating floor of ‘A-’

• ‘2’ – Minimum long-term rating floor of ‘BBB-’

• ‘3’ – Minimum long-term rating floor of ‘BB-’

• ‘4’ – Minimum long-term rating floor of ‘B’

• ‘5’ – Support possible but not relied upon

Support RatingViability Rating

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Viability Ratings Defined

• Viability ratings (VRs) are designed to be internationally comparable and represent

Fitch’s view of the intrinsic creditworthiness of an issuer

• Together with the agency’s support ratings framework, the VR is a key component of a

bank’s Issuer Default Rating (IDR) and considers various fundamental factors

• VRs represent not only the capacity of a rated entity to meet its obligations in the

absence of extraordinary sources of financial strength but also in the absence of

extraordinary constraints (eg transfer and convertability risk)

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Overview of Fitch’s Bank Rating Methodology

A Bank’s Issuer Default Rating (IDR) is the Higher of the VR or SRF

Viability Rating (VR) – Intrinsic

Creditworthiness ‘aaa’ Scale Support Unlikely

Support Rating = 5

Support Likely – Support Rating on Scale of 1-4

Support Rating Floor (SRF)

IDR = VRIDR on ‘AAA’

Scale

SRF > VR,IDR = SRF

SRF < VRIDR = VR

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National Depositor Preference Results in Deposit Ratings Notched Above IDR in US

• With national depositor preference, Fitch rates uninsured deposit obligations one notch

above the IDR reflecting the superior recovery in receivership

• Deposits often assumed by acquiring bank due to value of relationship

• Even liquidated banks recover 77% from FDIC

• Policymakers reluctant to impose losses on depositors

• Retroactive features to increase deposit insurance in the US (Indymac)

• UK and Dutch bailout of domestic customers of Icelandic banks

• Depositor preference puts pressure on recovery for other unsecured creditors

• Expect to see other jurisdictions implement similar type of depositor preference

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Hybrid Notching From Stand-Alone (VR) Wider for Bank Capital Securities of Investment Grade Issuers

• Implemented changes to bank regulatory capital instruments (hybrids)

• 1 notch down from VR for traditional subordinated debt

• Generally 4 notches down from VR for trust preferred securities (US issuers)

• Generally 5 notches down from VR for straight preferred stock

Before Hybrid Criteria Change After Hybrid Criteria Change

LT IDR ‘A’ ‘A’

VR ‘A-’ ‘A-’

Subordinated debt ‘A-’ ‘BBB+’

TruPs ‘BBB’ ‘BB+’

Preferred stock ‘BBB’ ‘BB’

Example Bank, Hybrid Ratings

Source: Fitch

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Holding Company vs. Bank Ratings

• Fitch typically equalizes bank and holding company IDRs

• May notch holding company down when double leverage considered high (>1.25x) or liquidity

profile of holding company considered relatively weak vs. bank

• Typically notch if there are dividend or other financial restrictions between bank and holding

company

• IDR measures default risk

• Holding companies often default at the same time with receivership of bank thus default

probability assumed to be the same

• Sometimes holding company default occurs AFTER bank receivership

• Could be more of a loss severity issue for holding company creditors

• FDIC Orderly Liquidation Authority could alter this view over time

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Bank Holding Company (Holdco) and Bank Operating Company (Bank) Ratings Examples

Example A Holdco Bank

LT IDR ‘AA-’ ‘AA-’

ST IDR ‘F1+’ ‘F1+’

VR ‘AA-’ ‘AA-’

Support Rating 1 1

Support Rating Floor ‘A’ ‘A’

LT Deposits ─ ‘AA’

ST Deposits ─ ‘F1+’

Sr Unsecured Debt ‘AA-’ ‘AA-’

Sub Debt ‘A+’ ‘A+’

TruPs ‘BBB+’ ─

Preferred ‘BBB’ ‘BBB’

Source: Fitch

Example B Holdco Bank

LT IDR ‘A’ ‘A’

ST IDR ‘F1’ ‘F1’

VR ‘A-’ ‘A-’

Support Rating 1 1

Support Rating Floor ‘A’ ‘A’

LT Deposits ─ ‘A+’

ST Deposits ─ ‘F1+’

Sr Unsecured Debt ‘A’ ‘A’

Sub Debt ‘BBB+’ ‘BBB+’

TruPs ‘BB+’ ─

Preferred ‘BB’ ‘BB’

Without Support With Support

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Rating Banks in a Changing World

Ratings framework consistent – formal review of largest global banks announced Oct

2011

• Stressed economic environment persists

• Confidence sensitive business

• Enhanced but uncertain regulatory regimes

• Propensity for support diminishing in US and scope of support Fitch believes is

narrower

• Downgraded support rating floors to ‘A’ in US (Dec 2011)

• 2 US banks had IDRs lowered, Bank of America (VR downgraded to ‘bbb+’ and Citigroup (VR

maintained at ‘a-’ – support rating floors still higher than VRs))

• 1 US bank, Morgan Stanley kept at its support floor, VR downgraded to ‘a-’

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Global Trading and Universal Bank Review

Downgrades across the Global Trading and Universal Banks

• Reflected sector challenges

• Challenges remain

• Structural aspects of their funding, earnings and leverage make them vulnerable to market

sentiment and confidence, particularly during periods of stress

• Complex business models and exposure to potential bulky losses from various sources make it

difficult to assess the size of loss that could emerge from unexpected events

• Regulation and profitability dynamics

• Business environment still difficult

• But GTUBs defensively positioned

• Better liquidity and capitalization

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Trading Revenues Likely to Remain Volatile with Global Capital Markets Slowdown

Securities Business Pre-Tax Profit/Total

Pre-Tax Profit

Trading Revenues

-4,000

-2,000

0

2,000

4,000

6,000

8,000

10,000

Q1

09

Q2

09

Q3

09

Q4

09

Q1

10

Q2

10

Q3

10

Q4

10

Q1

11

Q2

11

Q3

11

(USDm)

J.P. Morgan Chase & Co.Bank of America CorpCitigroup, IncWells Fargo & CompanyGoldman Sachs Group, IncMorgan Stanley

Source: FR Y 9-C

9M11 H111 Q111 2010

JPMorgan 40.4 42.6 45.6 41.5

Citigroup 39.7 45.1 58 66.5

Bank of

America -55.8 -57.2 99.9 190.8

Goldman Sachs 96.5 58.5 59.5 67.8

Morgan Stanley 188.5 67.1 37.4 61.2

Source: Fitch Ratings, includes FV of debt adjustments

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Global Trading Universal Bank Ratings – Many at Support Floors and Therefore Outlooks are Stable

Bank Viability Rating Support Rating Floor Long-Term IDR Outlook

Bank of America bbb+ A A Stable

Barclays a A A Stable

BNP Paribas a+ A+ A+ Stable

Citigroup a- A A Stable

Credit Suisse a A A Stable

Deutsche Bank a A+ A+ Stable

HSBC aa A AA Stable

JP Morgan aa- A AA- Stable

Goldman Sachs a A A Stable

Morgan Stanley a- A A Stable

Bank of Royal bbb A A Stable

Société Générale a- A+ A+ Stable

UBS a- A A Stable

Source: Fitch

Ratings

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Disclaimer

Fitch Ratings’ credit ratings rely on factual information received from issuers and other sources.Fitch Ratings cannot ensure that all such information will be accurate and complete. Further, ratings are inherently forward-looking, embody assumptions and predictions that by their nature cannot be verified as facts, and can be affected by future events or conditions that were not anticipated at thetime a rating was issued or affirmed.

The information in this presentation is provided “as is” without any representation or warranty.A Fitch Ratings credit rating is an opinion as to the creditworthiness of a security and does notaddress the risk of loss due to risks other than credit risk, unless such risk is specifically mentioned.A Fitch Ratings report is not a substitute for information provided to investors by the issuer and its agents in connection with a sale of securities.

Ratings may be changed or withdrawn at any time for any reason in the sole discretion ofFitch Ratings. The agency does not provide investment advice of any sort. Ratings are nota recommendation to buy, sell, or hold any security.

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS AND THE TERMS OF USE OF SUCH RATINGS AT WWW.FITCHRATINGS.COM.

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