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June 15, 2021
Michelle BrennanAlexandre BirryHow Our Proposed Methodology
Changes Would Apply To Financial Institutions Ratings
ContentsKey Takeaways Proposed Changes That May Be Most Meaningful Analytically Potential Rating Impact Of The FI And BICRA RFC Proposals Criteria Summary Potential Impact Of A BICRA Change Under The Framework A Hypothetical Bank Under The Framework | FI-Specific Factors A Hypothetical Bank Under The Framework | CRA AdjustmentA Hypothetical Bank Under The Framework | ALAC ALAC Proposals ICR Adjustment NBFI Proposals Related Research Analytical Contacts
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Key Takeaways
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– No significant changes to our analytical frameworks or a recalibration of our rating approach; many proposed changes are to presentation.
– Rating changes will be limited. The rating impact statements in the requests for comments (RFCs) highlight where ratings may potentially (rather than automatically) change if the proposals are adopted.
– We have not provided a breakdown of potential rating changes by country or subsector since we expect a limited number of them. We are flagging analytical areas that we think are most likely to lead to rating changes, however.
– This slide deck walks through hypothetical examples of a bank and nonbank financial institution (NBFI) to show where we expect the proposals to be most meaningful analytically.
For details on the proposed changes, please see “Request For Comment: Financial Institutions Rating Methodology,” June 8, 2021; “Request For Comment: Banking Industry Country Risk Assessment Methodology And Assumptions,", June 8, 2021; and “Credit FAQ: What's Behind The Proposals To Update Our Financial Institutions And BICRA Methodologies,” June 8, 2021.
Proposed Changes That May Be Most Meaningful Analytically
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– The proposed changes to the financial institutions (FI) framework that we expect to have the most impact on how we analyze FIs:
– A potential one-notch adjustment of the stand-alone credit profile (SACP) for banks,– The increased ability to make a qualitative adjustment to the capital and earnings score,– Some adjustments to our additional loss-absorbing capacity (ALAC) calculations, and– Alignment of rating on a foreign branch of a bank with that on a core subsidiary in the same country.
– Proposed changes to the Banking Industry Country Risk Assessment (BICRA) methodology could lead to a change in a small number of BICRAs due to the removal of more mechanistic scoring of subfactors and the ability for a wider range of metrics and economic indicators to be used to reflect the specifics of different economic structures.
Potential Rating Impact Of The FI And BICRA RFC Proposals (1/2)
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– We believe that, based on our testing, and assuming that entities maintain their current credit characteristics, less than 10% of issuer credit ratings (ICRs) within the scope of the RFCs will be affected.
– This reflects where ratings could potentially – not automatically would – change if the proposals are adopted.
– We estimate that the majority of ICR rating changes would be by one notch, with more upgrades than downgrades.
– We expect that about one-third of these potential ICR changes will be driven by a potential change in BICRA scores –but that fewer than 2% of our BICRAs to change.
– We don’t see a geographic or thematic factor dominating which BICRAs might change. But the single biggest impact on ICRs would be from where a BICRA change occurs.
Potential Rating Impact Of The FI And BICRA RFC Proposals (2/2)
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– We expect that, potentially, 50 ratings on hybrid instruments (less than 3% of FI hybrid ratings) may change because of changes in SACPs on the issuers due to the proposal to factor in an adjustment to the SACP based on a comparable ratings analysis (CRA).
– This potential impact relates only to banks because for NBFIs the CRA adjustment is already part of the SACP assessment.
– If these SACPs change, we would expect to lower approximately two-thirds of the 50 hybrid ratings by one notch and raise approximately one-third of the ratings by one notch.
– Our definition of hybrids includes Additional Tier 1 securities, Tier 2 instruments that can potentially absorb losses before a bank's bankruptcy (for example during a resolution), and other instruments included in loss-absorbing measures such as TLAC/MREL (such as senior nonpreferred securities and similar instruments).
– The count of 50 potential ratings is based on individual hybrid instruments assigned an issue credit rating. For example, if, for a hypothetical bank with an SACP change, the affected issues comprise two rated Tier 1 securities, five rated Tier 2 instruments, and five rated MREL-qualifying instruments, then these would count as 12 ratings.
Criteria Summary
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Note: Issue credit ratings on hybrids typically reference the SACP, while issue ratings on senior unsecured instruments typically reference the ICR unless they are guaranteed by a higher-rated entity or are RCR liabilities (see “Hybrid Capital Methodology And Assumptions,” published July 1, 2019 for more details on hybrids). *Subject to jurisdictional assessment and expected resolution strategy. §In some cases, an FI may also qualify for an additional support adjustment. BICRA--Banking industry country risk assessment. NBFI--Nonbank financial institution. FI--Financial institution. CRA--Comparable ratings analysis. GRE--Government-related entity. ALAC--Additional loss-absorbing capacity.
The Fundamental FI And BICRA Framework Will Not Change
Potential Impact Of A BICRA Change Under The Framework
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– If a BICRA changes, then this may affect the anchor for a bank or NBFI operating in that country.
– If the anchor improves, then often the SACP and then the ICR improves (and the SACP and ICR often weakens if the anchor weakens).
– A BICRA change could potentially affect the anchor of an FI based in another country if it has significant exposure in the country with the BICRA change.
– We think that the impact of BICRA changes on ICRs will be the largest single potential driver of ICR changes –accounting for about one-third of the potential 10% of ICRs that could change.
– These ICR changes would be for FIs located in – or with significant exposures to – the countries where the BICRAs change. We expect only about 2% of our BICRAs to potentially change, however.
Where The BICRA Feeds Into The Framework How A BICRA Change Can Change Ratings
FI--Financial institution. NBFI--Nonbank financial institution.
A Hypothetical Bank Under The Framework | FI-Specific Factors
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– A change in one of the four scores will change the SACP (and therefore probably the ICR) unless it is offset by a change in another score.
– We think the aspect of the RFC most likely to change these scores for a bank is the proposal for the capital and earnings (C&E) score, which gives more capacity than currently to incorporate a qualitative adjustment. We expect the resulting impact on bank ICRs to be limited, however.
– A change in the C&E score could be offset by a change in the risk position score, because the risk position score will no longer have to capture some of the limitations associated with the risk adjusted capital (RAC) model.
– The qualitative adjustment could also be used to give more weight to earnings in our C&E assessment; any positive impact would be based on sustainable earnings and not on headline earnings only.
– In general, we do not expect the proposals to lead to meaningful changes in bank SACPs due to business position or funding and liquidity.
How The FI-Specific Factors Feed Into The Framework How These Factors Could Change Ratings
CRA--Comparable rating analysis. FI--Financial institution. NBFI--Nonbank financial institution.
A Hypothetical Bank Under The Framework | CRA Adjustment
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– This proposed change affects banks only – NBFIs already have a CRA adjustment at the SACP level.
– Currently we make this adjustment at the ICR level for banks, even if the reason for it is based on our view of the bank's stand-alone creditworthiness.
– The proposed change is to take into account factors that affect a bank's stand-alone creditworthiness, such as its relative earnings performance, at the SACP level instead of the ICR.
– The proposed change makes the approach consistent with that for NBFIs, as well as corporate and insurance issuers.
– We propose to still have an ICR-level adjustment if needed to take factors related to government support into account.
– The CRA proposal could change the SACPs of a small number of banks, and therefore potentially also 50 ratings on hybrids issued by those banks.
How The CRA Adjustment Feeds Into The Framework How The CRA Adjustment Could Change Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
A Hypothetical Bank Under The Framework | ALAC
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– The RFCs do not change how we look at group or guarantee support.
– We do not expect any changes in ratings due to the proposed language for government support.
– The only proposed change to our approach for government support is that we will consider the potential support uplift for a GRE bank due to systemic importance, as well as due to its GRE status. But we don’t expect this to change any existing ratings.
– Our ALAC proposals could potentially lead to changes in a very limited number of ICRs.
How External Support Feeds Into The Framework ALAC Support Could Change For Some
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
ALAC Proposals
Proposed Changes To ALAC Thresholds
No general recalibration of our approach to ALAC.– The key proposed change is to no longer include excess TAC in ALAC. This is because the C&E proposals allow more
capacity to represent the benefit of this ‘excess TAC’ in the bank’s C&E score.
– The C&E proposals also allow us to more clearly distinguish between capital resources that can support a bank on a going-concern basis (thus helping the SACP) and those that kick in only when a resolution occurs.
– We have lowered our ALAC thresholds to reflect that excess TAC would no longer be included. The amount by which we have lowered the thresholds reflects the typical contribution of excess TAC to ALAC today.
– Note that we use a forward-looking basis to assess the level of ALAC/S&P Global Ratings Risk Weighted Assets (RWAs) that a bank has, and that threshold adjustments are possible.
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ALAC--Additional loss-absorbing capacity. GRE--Government-related entity.
Proposed Changes To ALAC Thresholds | Ratings Impact
In a very limited number of cases, these proposals could lead to a bank’s ICR falling by a notch. – This will happen only if the SACP does not improve under the proposals, and the remaining ALAC (using the new lower
thresholds) is not sufficient for us to provide as much ALAC uplift as we do today.
– We don’t expect the other ALAC changes to lead to particular ICR changes.
– For example, we don’t expect rating changes from the proposal to no longer apply a limit of 0.5% on the amount of ALAC that we will include if it matures within the next year. This is because we are scoring on a forward-looking basis (not just the next 12 months) and can adjust the ALAC threshold if we are concerned about maturity concentrations.
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ALAC--Additional loss-absorbing capacity. GRE--Government-related entity.
ALAC Proposals | Hypothetical Case ACurrent Approach Proposed Approach Current Approach
– C&E is adequate on the basis of a RAC ratio of 9%, which is 2% above the lower threshold for the adequate category. Excess TAC is therefore 2%.
– The bank’s ALAC ratio includes the 2% excess TAC. The ALAC ratio is 6%.
– The bank’s anchor is 'bbb', so the threshold for one notch of ALAC uplift is an ALAC/RWA* ratio of 5% or more (unless we make an adjustment).
– We give one notch of ALAC uplift – raising the ICR by one notch.
Proposed Approach– The ALAC ratio no longer includes excess TAC so is now 4% (6% minus
2%). – This is still enough for a notch of ALAC uplift under the new lower
threshold of 3%.– This means no change to the ICR.– The bank could potentially qualify for a higher C&E score, which could
raise the SACP by a notch – in which case the ICR would probably also go up by a notch (subject to constraints).
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9%Excess TAC
RAC
ALAC ALAC
10% Strong C&E threshold
7% Adequate C&E threshold
ALAC thresholds:+1 notch: 5%
+2 notches: 8%
ALAC typical thresholds:
+1 notch: 3%+2 notches: 6%
Anchor: bbb
10% Strong C&E threshold
7% Adequate C&E threshold
ALAC--Additional loss-absorbing capacity. C&E--Capital and earnings. RAC--Risk-adjusted capital. TAC--Total adjusted capital.
ALAC Proposals: Hypothetical Case BCurrent Approach– C&E is adequate on the basis of a RAC ratio of 9.5%, which is 2.5%
above the lower threshold of the adequate category. Excess TAC is therefore 2.5%.
– The bank’s ALAC ratio includes the 2.5% excess TAC. The ALAC ratio is 5%.
– The bank’s anchor is 'bbb', so the threshold for one notch of ALAC uplift is an ALAC/RWA ratio of 5% or more (unless we make an adjustment).
– We give one notch of ALAC uplift – raising the ICR by one notch.Proposed Approach– The ALAC ratio no longer includes excess TAC so is now 2.5% (5%
minus 2.5%).– This is just below the typical 3% threshold for a one-notch uplift.– We could in certain cases lower the threshold to below 3% and include
one notch of ALAC uplift (e.g. if we consider that our RWAs overstate the ALAC requirement for this bank).
– Another possible scenario is a one-notch positive adjustment to the C&E score to reflect the proximity to the 10% C&E threshold; this would depend on the bank's situation and our view of whether C&E is neutral or positive to the SACP.
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9.5%Excess TAC
RAC
ALAC ALAC
10% Strong C&E threshold
7% Adequate C&E threshold
ALAC Thresholds:
+1: 5%+2: 8%
ALAC Typical Thresholds:
+1: 3%+2: 6%
Anchor: bbb
10% Strong C&E threshold
7% Adequate C&E threshold
Current Approach Proposed Approach
ALAC--Additional loss-absorbing capacity. C&E--Capital and earnings. RAC--Risk-adjusted capital. TAC--Total adjusted capital.
ICR Adjustment
A Hypothetical Bank Under The Framework | ICR Adjustment
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– We expect this adjustment to change a very limited number of current ICRs.
– This adjustment can be used for transitional or more fixed situations where we consider the ICR over- or under-represents the level of potential extraordinary external government support.
– We don’t propose to use this for group support or GRE support because the RFCs don’t change the Group Rating Methodology or GRE criteria.
– For a bank, we could in theory use both a CRA adjustment at the SACP level and an adjustment at the ICR level. This is because they are used for mutually exclusive things: the CRA for factors that affect stand-alone creditworthiness and the ICR adjustment for factors relating to the potential for extraordinary government support. We don’t expect either of these adjustments to be used on a typical basis, however.
How The ICR Adjustment Feeds Into The Framework How The ICR Adjustment Could Change Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
A Hypothetical Bank Under The Framework | Foreign Branches
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– The ICR assigned to a bank’s foreign branches can be capped by risks relating to the jurisdiction in which the branch operates.
– We are proposing a change to our approach to assigning ratings to non-EU branches.
– This won’t lead to any changes on existing branch ICRs but addresses a situation whereby a bank could potentially have a core subsidiary in a foreign country that is rated higher than a branch of the bank in that country. Under the proposals, the branch and subsidiary could be rated the same.
Ratings On Foreign Branches How Our Proposals Could Change Branch Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
NBFI Proposals
A Hypothetical NBFI Under The Framework | FI-Specific Factors
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– A change in one of the four scores will change the SACP (and therefore probably the ICR) unless it is cancelled out by a change in another score.
– We expect a very limited impact on these scores for an NBFI under the proposals.
– In a limited number of cases, a score could change because we are proposing to remove the mechanistic roll-ups of subfactor scores.
– The proposals do not ‘shoe-horn’ NBFIs into a framework where they are scored on the same metrics as banks. Finance companies, securities firms, and BDCs retain their own specific scoring approaches under the RFC proposals.
– We do not expect material changes because of the proposal to use a debt/EBITDA approach to assess C&E for certain securities firms.
– We don’t expect material changes to funding and liquidity scores, except for a limited number of securities firms, due to the move from the current 5 x 5 matrix for those entities to the 4 x 4 matrix for all FIs.
How The FI-specific Factors Feed Into The Framework How These Factors Could Change Ratings
CRA--Comparable rating analysis. FI--Financial institution. NBFI--Nonbank financial institution.
A Hypothetical NBFI Under The Framework | CRA Adjustment
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– This will not lead to any changes in ratings because for NBFIs, already have a CRA adjustment at the SACP level.
How The CRA Adjustment Feeds Into The Framework How The CRA Adjustment Could Change Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
A Hypothetical NBFI Under The Framework | Government Support
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– The RFCs do not change how we look at group or guarantee support.
– We do not expect any changes in NBFI ratings due to the proposed language for external support.
– NBFIs are not currently subject to resolutions like banks, so the ALAC proposals do not affect NBFI ratings.
– The proposals allow for an NBFI to theoretically be considered systemically important and therefore benefit from extraordinary government support.
– We do not expect this to change any NBFI ratings, however, because we do not expect this to apply under current circumstances.
How External Support Feeds Into The Framework Government Support And NBFI Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
A Hypothetical NBFI Under The Proposed Framework | ICR Impact
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– We don’t expect this adjustment to change ICRs on NBFIs. This is because we don’t anticipate extraordinary government support for non-GRE NBFIs under current circumstances.
– This adjustment can be used for transitional or more fixed situations where we consider the ICR over- or under-represents the level of potential extraordinary external government support.
– We don’t propose to use this for group support or GRE support – this is because these RFCs don’t change the GRM or GRE criteria.
How The ICR Adjustment Feeds Into The Framework How The ICR Adjustment Could Change Ratings
ALAC--Additional loss absorbing capacity. CRA--Comparable rating analysis. FI--Financial institution. GRE--Government-related entity.
Related Research
– Request For Comment: Financial Institutions Rating Methodology, June 8, 2021
– Request For Comment: Banking Industry Country Risk Assessment Methodology And Assumptions, June 8, 2021
– Credit FAQ: What's Behind The Proposals To Update Our Financial Institutions And BICRA Methodologies, June 8, 2021
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FI Contacts
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Alexandre Birry
London
+ 44 20 7176 7108
Richard Barnes
London
+ 44 20 7176 7227
Brendan Browne, CFA
New York
+ 1 (212) 438 7399
Ivana Recalde
Buenos Aires
+ 54 11 4891 2127
Sharad Jain
Melbourne
+ 61 3 9631 2077
Emmanuel Volland
Paris
+ 33 14 420 6696
Matthew T. Carroll, CFA
New York
+ 1 (212) 438 3112
Methodologies Contacts
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Matthew B. Albrecht, CFA
Centennial
+ 1 (303) 721 4670
Steven Ader
New York
+ 1 (212) 428 1447
Russell Bryce
Charlottesville
+ 1 (214) 871 1419
Michelle M. Brennan
London
+ 44 20 7176 7105
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