S&P Report Says U.S. Banks Face Credit Quality Decline in '09

Although government support has buoyed U.S. banks, the industry will likely experience overall credit quality deterioration at least through this year, according to a report published Tuesday by Standard & Poor's Ratings Services.

S&P credit analyst Barbara Duberstein said the number of bank failures will likely rise in 2009 "from an already high number in 2008," as in other credit cycle downturns.

The ratings agency said its outlook on the U.S. banking industry through this year is negative, reflecting deteriorating economic conditions and mounting asset-quality problems. It said it expects negative rating actions will continue to "sharply exceed" positive actions this year, but that ratings would reflect the further divergence it expects in the performance of individual banks.

S&P said the industry will continue to be subject to concerns about systemic shocks from liquidity and confidence risks through at least early this year. But its outlook assumes that those concerns won't revert to the peak September-October "crisis levels" that followed the bankruptcy of Lehman Brothers Holdings Inc.

The U.S. government's involvement in the banking industry has become a theme in the credit analysis of banks, S&P said. The government's reaction has become "critical to the stability of the global financial system," it said, adding it includes the government's support as a credit factor for banks that were identified as systemically important.

"Although we expect government programs to largely support the banking system as a whole, they will not serve as a panacea for all U.S. banks, particularly midsize and smaller institutions that the government does not recognize as systemically important," S&P said.

It said it views the government's measures, such as the Troubled Asset Relief Program, as a "major positive" for the U.S. banking industry's credit quality as a whole. The bailout was put in place after Lehman's bankruptcy caused the credit markets to seize up in September.

The ratings agency also expects nonperforming loans and loan net charge-offs to continue rising through this year and next, and said asset-quality weakness will spread to a wider range of loan types.

Banks' earnings will continue to suffer from high loan-loss provisions, as banks need to further build their reserves, S&P said. The rating agency believes banks will take more "significant investment write-downs," realizing a portion of the losses on their balance sheets, but that those write-downs will be less than last year's levels.

S&P said competition in the industry is a wild card now, since the landscape has changed so much amid high-profile failures like Washington Mutual Inc. and the conversion of Morgan Stanley and Goldman Sachs Group Inc. to bank holding companies. The agency said it expects the pace of acquisitions to rise as healthy banks consolidate with weaker banks by the latter part of this year.

S&P cut its ratings on 12 U.S. and European banks and put a 13th bank on watch for possible downgrade last month amid what it called significant pressure on the large, complex financial institutions' future performance because of increasing risk and the deepening recession.

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