Federal Reserve Rules on Banks Good for Bondholders Despite S&P Ratings Action

The Federal Reserve recently released rules for U.S. banks as it relates to the amount of balance sheet cushion that must be held to protect against potential losses. The Fed’s guidance for TLAC (Total Loss Absorbing Capacity), which is the ratio of capital plus long-term debt as a percent of risk weighted assets, came in at 18%. While that number is difficult to conceptualize, the market was anticipating a higher number, which would have meant banks needed to issue billions of dollars of additional debt in the coming years to comply. Less issuance means more favorable supply/demand dynamics, which should support credit spreads in the sector. In a related note, the rules from the Fed prompted the ratings agency S&P to drop their assumption for government support of U.S. banks, which may mean lower ratings in the future. S&P placed the eight U.S. globally systemic important banks on credit watch negative. The market has paid little attention to the NSRO’s opinion on banks since the financial crisis (when Lehman was rated “A” up to their bankruptcy filing) and we advise our clients to do the same. As we’ve highlighted in recent notes, the banks are doing well from a credit perspective, and our comfort level with our bank holdings in portfolios has rarely been higher.

Source: Federal Reserve, JPM, S&P