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Rating Agencies See Mixed Prospects for Financial Institutions

US banks and life insurance companies are generally healthy but face meaningful challenges to their business prospects, according to executives from two of the nation's leading credit-rating agencies.

Speaking at the SVIA's 2003 National Forum, David Fanger, a Senior Vice President and Credit Analyst with Moody's Investors Services, said his firm had upgraded its credit ratings on 19 US banks since the start of 2002, while downgrading only six. The backbone of that improved ratings scenario, he said, is the strong earnings coverage banks are generating; the gap between their provision for losses and their pre-provision income has been rising steadily since 1991, reaching approximately $108 billion in 2002.

Despite this generally healthy environment, Fanger said, some negative factors are working against banks' interest, particularly on the consumer side of the business. These include stagnant employment growth in the US, high rates of personal bankruptcy filings, elevated credit card chargeoffs, elevated levels of 30-day-plus delinquencies in the credit card market, and higher levels of household debt. On the other hand, a low interest rate environment has meant that household interest payments as a percentage of disposable personal income are actually down since 2001.

The biggest threat to bank credit ratings right now, Fanger said, would be sustained low interest rates. Most US banks earn important sums of money by lending against their customer deposits, and the risk-free arbitrage on that core deposit base is weaker when rates are low.

James Moss, Managing Director and Co-Head of Fitch Ratings' North American Financial Institutions Group, offered a slightly more conservative view of the banking industry globally. He told attendees at the SVIA forum that weak economic growth around the world is pressuring the quality and growth of banks' loan portfolios, while low interest rates continue to exert margin pressure. In 2002, he noted, Fitch downgraded 11 banks and upgraded only eight. He said he anticipates that upgrades and downgrades this year will end up being approximately equal in number. On a more positive note, he reported that of Europe's top 40 banking groups, Fitch has assigned a stable credit rating outlook to 35 and positive prospects to three. Of the top 31 US banks, 19 have a stable outlook and seven have a positive outlook.

Life insurers are also facing significant challenges, according to credit analysts from Fitch and Moody's. Fitch Managing Director Julie Burke said Fitch assigned the sector a stable outlook in September 2002, revising a long-standing negative outlook it had assigned in August 1998. However, she said, the industry continues to face intense competitive pressures and has been battling volatile earnings patterns, stressed risk-adjusted margins, and declining sustainable earnings and capital growth rates.

Robert Reigel, a Managing Director at Moody's, observed that at his firm, downgrades of credit ratings for life insurers have outpaced upgrades by a three-to-one or better margin in 2002 and the first nine months of 2003, sharply reversing the trend in the late 1990s, when upgrades outpaced downgrades. His firm continues to hold a negative ratings outlook on the industry, but nonetheless said the industry is likely to remain highly rated (single A) overall. He said Moody's would want to see "a couple more quarters of a positive environment and capital growth among some of the negatively rated companies" before considering a reassessment of the industry's outlook.

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