The armed conflict in Ukraine has roiled financial markets and created new risk dynamics across the globe. Although the direct impact for U.S. financial institutions is limited, the situation has created uncertainty, with many secondary effects from the conflict looming. Notably, our economists recently lowered the U.S. GDP growth forecast for 2022 by 0.7 percentage points to 3.2%, with only a small impact from slower Russian growth. Policy developments and energy prices will push growth lower, raising our 2022 consumer price inflation projection to 6% from 3.9% (see "Global Macro Update: Preliminary Forecasts Reflecting The Russia-Ukraine Conflict," March 8, 2022).

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets--notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks.

We do not expect the direct or indirect consequences of the armed conflict, on their own, to lead to immediate rating actions, but there could be ratings pressure down the road. Below, we lay out the possible risks for U.S. financial institutions from the Russia-Ukraine conflict in more detail

Banks

Regarding direct exposure to Russia and Ukraine, according to the Bank for International Settlements, U.S. claims on an immediate counterparty basis to Russia total $14.7 billion, with $7 billion in local currency. Per data from the Federal Financial Institutions Examination Council, no U.S. bank has exposure to Russia or Ukraine that exceeds 0.75% of assets or greater than 15% of capital.

We believe Citigroup Inc. has the largest absolute exposure to Russia of any bank in the U.S., and the conflict could complicate Citigroup's plans to exit consumer banking in Russia, which it announced last year. The bank now says it will exit other lines of business as well. Citigroup's reported $8.2 billion exposure to Russia equated to only about 0.3% of its assets and about 5% of its S&P Global Ratings total adjusted capital (the numerator of our risk-adjusted capital ratio, which was 8.6% at June 2021). Its exposure includes corporate and consumer loans, local government securities, and deposits with the Russian Central Bank and other financial institutions. Citibank also said it had $1.6 billion of exposure to Russian counterparties not held at its Russian subsidiary. The company has estimated that under a severe stress scenario related to the conflict, its losses would equate to less than half of those exposures, or around 2%-3% of its S&P Global Ratings total adjusted capital.

Only two of the other seven U.S. global systemically important banks--Goldman Sachs and Bank of New York Mellon Corp.--disclosed exposure to Russia in their 2021 annual reports. Both showed minimal exposure. None of the others, including JPMorgan Chase & Co.--the most global of the U.S. banks after Citi--listed Russia or Ukraine among their largest country exposures (usually top 20). Both Goldman and JPMorgan have indicated they will cease their operations in Russia.

Still, we believe U.S. banks could experience some indirect impacts from heightened geopolitical risk. Specifically, there is potential for elevated counterparty risk to institutions with more direct exposure to these countries. In addition, counterparty risk could also develop around margin requirements and for banks clearing trades for clients, particularly for counterparties trading in commodities, given the recent high volatility and price movement. This has already been the case with Chinese nickel producer Tsingshan Holdings, which had attempted to hedge its nickel production and eventually could not meet its liquidity needs subsequent to margin calls by its clearing banks. These banks are working out a secured lending agreement with Tsingshan so that its positions don't need to be closed out. Separately, higher-than-normal volatility in financial markets could generate trading losses.

Other risks include heightened cyber/operational risk given the placement of sanctions and fallout regarding interbank lending from a spike in lending rates, mitigated by most banks having ample liquidity and likely less need to borrow. Higher energy and commodity prices, combined with protracted supply side constraints, could exacerbate already-concerning inflation trends. This in turn could weigh on credit costs for U.S. banks, particularly for banks exposed to lower income consumers. Other risks include more complicated operational procedures amid a complex array of sanctions. In addition, we believe banks and possibly the Society for Worldwide Interbank Financial Telecommunications (SWIFT), an international financial messaging system, could be subject to elevated cyber attacks.

At the start of the year, U.S. banks seemed well positioned to benefit from higher interest rates as the Federal Reserve looked to keep inflation in check. The ongoing conflict will likely exacerbate inflation, with supply chain disruptions likely continuing for longer amid elevated gasoline prices. Although the Fed still seems intent on raising rates, the impact to the economy from the armed conflict could result in lower interest rates than expected, particularly at the long end of the yield curve, which would reduce the significant rise in net interest income that higher rates are likely to drive for banks. In addition, if the recent turmoil pushes the U.S. into a recession, which is not our base case, muted loan growth would likely limit the benefit of higher interest rates, and credit costs would likely rise more quickly than we currently expect.

Authors: Stuart Plesser, Brendan Browne, and Devi Aurora

Securities Firms

We believe rated U.S. securities firms are exposed to secondary impacts, particularly financial market value declines and increased volatility. Retail firms' exposure is mostly to declining market values of securities causing a reduction in asset-based fee revenue, and, to a lesser extent, potential losses on margin loans, neither of which is expected to be a material ratings issue for any rated firm. Institutional firms that hold securities are more exposed to potential write-downs from declining market prices, as well as increased trading book value-at-risk from increased volatility, which could lower their risk-adjusted capitalization. There is also potential for counterparty exposure to other institutions that are more directly exposed. Given securities firms' overall capitalization, we do not expect this to be material, unless market stress is more severe or prolonged than currently expected.

For firms that self-clear, higher market volatility also increases counterparty risk on trades, and the amount of margin they must post to their trading counterparties, including clearinghouses, to cover settlement risk on their and their clients' trades. This risk, as well as higher market volatility, has already been fairly acute in commodities markets but has so far been weathered well by the few rated U.S. brokers that participate in these markets.

If funding market conditions erode more than expected, it could force brokers to sell off positions--crystalizing market losses--and reduce liquidity.

Authors: Robert Hoban and Thierry Grunspan

Finance Companies

We believe the direct exposure for U.S. finance companies to Russia and Ukraine is limited, as these finance companies mainly lend to U.S. businesses and consumers, with little or no international exposure in most cases. Nevertheless, ripple effects from the armed conflict may create headwinds for U.S. finance companies. Finance companies rely on wholesale financing and, in general, took advantage of favorable funding conditions over the past two years to refinance near-term maturities and extend their funding profiles while taking advantage of low-cost funding. These companies now face more volatile debt capital markets.

Higher commodity prices and supply chain disruptions could boost inflation, potentially affecting asset quality for commercial and consumer finance companies. This is most likely to be felt by consumer finance companies focused on lower income borrowers, who likely are experiencing the most financial stress from elevated inflation. Overall, performance in the consumer finance segment was surprisingly resilient during the pandemic-related shutdowns, although higher inflation may accelerate the normalization of asset quality we expect this year. Higher inflation may also affect the profitability of those businesses that cannot pass on higher costs to their customers, which could affect some loans held by commercial finance companies and business development corporations (BDCs).

For BDCs, as well as commercial real estate (CRE) finance companies, higher interest rates may also pressure debt service coverage for their borrowers. However, the effect is not likely to be immediate because most of these loans have floating rates with floors that are typically above current benchmark rates and will take a few interest rate hikes to reach. Positively, if rates rise 100 basis points or more, many BDCs and CRE finance lenders will benefit from higher net interest margins because a portion of their funding is typically at fixed rates.

Authors: Matthew Carroll and Sebnem Caglayan

Asset Managers

While market conditions have weakened recently due to the armed conflict in Ukraine, we believe the traditional, wealth, and alternative asset managers we rate continue to benefit from a strong post-pandemic economic recovery which has supported assets under management (AUM) and margins. This accounts for the preponderance of stable outlooks in our rated portfolio.

Notwithstanding some negative headlines, the direct exposure to Russia and Ukraine is not elevated (as a proportion of total AUM) for the larger asset managers we cover. Therefore, the losses from declining valuations of assets in Russia and Ukraine do not translate into an immediate impact on the ratings. However, we will monitor for any indirect effects on valuations, declining AUM due to volatile markets, AUM flows, earnings, profitability, and the impact of rising rates and inflation. A more prolonged or sharper downturn in market conditions than we currently expect could translate into negative rating pressure, but is not currently factored into our base case.

Authors: Elizabeth Campbell and Sebnem Caglayan

Payment Companies

Among the payment companies, Mastercard Inc., Visa Inc., and PayPal Holdings Inc. have all suspended operations in Russia. Revenue from Russia and Ukraine accounted for only about 0.5% of PayPal's revenue in 2021, but a more meaningful 6% and 5% for Mastercard and Visa, respectively, in their latest fiscal years.

Mastercard and Visa likely also have some outstanding settlement exposure to financial institutions in Russia. Both companies guarantee settlement among their clients for payment volumes they authorize, clear, and settle through their respective networks. This creates settlement risk given the difference in timing between the date of a payment transaction and the date of settlement. If a card issuer fails settlement, Mastercard or Visa typically has to cover the payment to the merchant acquirers that accepted the transactions.

We believe Mastercard and Visa are likely to more than offset the Russia-Ukraine revenue pressure with growth in the rest of the world, and they have a history of managing settlement risks well. Economic growth and a continued shift to electronic payments have been driving net revenue growth well into the double digits for both companies, meaning they are still likely to have fairly robust revenue growth this year. Also, they have various ways to manage settlement exposure to higher-risk institutions, including by limiting and reducing exposures and sometimes requiring collateral. The shorter-term nature of settlement exposures usually allows them to limit problems.

Authors: Brendan Browne and Thierry Grunspan

Related Research

• Asia-Pacific Banks And The Ukraine Crisis: Small Exposures But Secondary Impacts Could Bite, March 15, 2022
• How The Conflict In Ukraine Is Affecting Financial Institutions Ratings, March 4, 2022
• Credit FAQ: How The Russia-Ukraine Conflict Could Affect Middle East And African Banks, March 4, 2022
• The Failure Of Sberbank Europe: International In Life, National In Death, March 4, 2022
• Cryptos Won't Blunt The Sting Of Sanctions On Russia, March 4, 2022
• Credit FAQ: The Significance Of Some Russian Banks Being Excluded From The SWIFT System, March 4, 2022