Moody's Downgrades Banks

As was long foreshadowed, Moody’s rating service has cut the ratings of just about every large U.S. banking firm last Thursday. Although the banks opened lower to start off the week, the share prices were relatively stable during the days of the Moody’s announcement. Primarily because the ratings cut have been priced in as it was public knowledge for some time now that Moody’s was going to go through with a downgrade.

What issues does a rate cut present? Well, it primarily affects institutional investors; most pension funds, endowments, etc. require that their capital is allocated to bonds and equity of investment grade entities. However, when a downgrade of this magnitude occurs, the pensions and endowments are no longer able to hold assets that are not investment grade due to the legal requirements of the funds and are forced to sell any of their holdings that do not meet the criteria.

The problem for the banks is that after a downgrade their cost of capital goes up, so it costs more money to run day to day operations, therefore, firms have to tighten up their policies on how to deploy their capital as it becomes more scarce. Another factor is that banks will have to post higher collateral when entering into new contracts.

Moody’s is saying that these downgrades are primarily based on capital requirements and the results of stress testing the banks for potential systemic shocks. However, if you think about it, most banks that have been working over the last few years to become compliant with the tiered Basel liquidity standards are now for the most part much better capitalized than they were before 2008 when their ratings were high. Part of me thinks that this is an aggressive move by Moody’s to ensure that they don’t get burned like they did by the AAA rated sub-prime mortgage CDOs back in 2007 more than any structural fault that they see in the banks.

Finally Business Week reports that Moody’ is planning to cut the ratings on several Spanish banks, for the second time in less than six weeks. There is a ton of chatter on the various finance forums and media outlets regarding these downgrades and many experts have different consequences that are a result of bank downgrades. Do you all think that the downgrades are a bunch of fluff? Or are there other negative issues that they will possibly cause other than what I have mentioned?

Primary Sources:
Reuters
Business Week

Comments (34)

 
Jun 26, 2012 - 7:42am

One for the finance boffins - JP Morgan holds more debt than MS, but they were able to "hide" their debt by transferring it to another legal entity (their commercial banking division). Everyone knows this happened, knows they have more exposure than MS, yet they weren't downgraded.

This seems like fraud to me, like a scam to fool the markets. Can anyone comment on whether this apparently selective downgrade makes any sense from a financial perspective?

But Rhaegar fought valiantly, Rhaegar fought nobly, Rhaegar fought bravely. And Rhaegar died.
 
Jun 26, 2012 - 10:19am

Anomanderis:
One for the finance boffins - JP Morgan holds more debt than MS, but they were able to "hide" their debt by transferring it to another legal entity (their commercial banking division). Everyone knows this happened, knows they have more exposure than MS, yet they weren't downgraded.

This seems like fraud to me, like a scam to fool the markets. Can anyone comment on whether this apparently selective downgrade makes any sense from a financial perspective?

I don't think you or most people on street have read the press release. JPM has a retail funding base that despite the higher leverage provides significantly more cushion. In stupid words, yes JPM may have more debt but has more assets earnings to cushion hence a lower leverage ratio than MS. MS has no retail base but relies primarily on wholesale funding ie short term paper, bonds, discount window etc. It is already clear from the prior crises that when shit hits the fan these markets dry up and serve an unreliable source of liquidity. The fact is that all banks are insolvent as those even with a retail base continue to rely strongly on back stop funding from central banks and it is a model that can not continue indefinitely.

 
Jun 26, 2012 - 11:07am

monaco1:
Anomanderis:
One for the finance boffins - JP Morgan holds more debt than MS, but they were able to "hide" their debt by transferring it to another legal entity (their commercial banking division). Everyone knows this happened, knows they have more exposure than MS, yet they weren't downgraded.

This seems like fraud to me, like a scam to fool the markets. Can anyone comment on whether this apparently selective downgrade makes any sense from a financial perspective?

I don't think you or most people on street have read the press release. JPM has a retail funding base that despite the higher leverage provides significantly more cushion. In stupid words, yes JPM may have more debt but has more assets earnings to cushion hence a lower leverage ratio than MS. MS has no retail base but relies primarily on wholesale funding ie short term paper, bonds, discount window etc. It is already clear from the prior crises that when shit hits the fan these markets dry up and serve an unreliable source of liquidity. The fact is that all banks are insolvent as those even with a retail base continue to rely strongly on back stop funding from central banks and it is a model that can not continue indefinitely.

I feel the line "I don't think you or most people on street have read the press release" was unecessary and smug, but thanks for the explanation.

But Rhaegar fought valiantly, Rhaegar fought nobly, Rhaegar fought bravely. And Rhaegar died.
 
Jun 26, 2012 - 1:09pm

+1. No worries.

But Rhaegar fought valiantly, Rhaegar fought nobly, Rhaegar fought bravely. And Rhaegar died.
 
Jun 26, 2012 - 6:21pm

A to A-: Bank of America, Goldman Sachs and Morgan Stanley.
A+ to A: Barclays and J.P. Morgan.
AA- to A+: Wells Fargo, BNY Mellon and HSBC.

With the compliments of our trusted S&P, get ready to post your collateral boys

Rien à prouver.. neuf quatre
 
Jun 26, 2012 - 6:24pm

Three Major Banks Prepare for Possible Credit Downgrades (Originally Posted: 03/30/2012)

This ones an interesting one as a similar downgrade happened last year.

Morgan Stanley, which was hit hard in the financial crisis, appears to be the most vulnerable.

Bank of America and Citigroup may also fall to the same level as Morgan Stanley, but those two are helped by having higher-rated subsidiaries.

Questions:
1. JPM seems to be quite strong compared to all of the other investment banks. Why?
2. Do you think these downgrades will happen? To all three investment banks above?

Check Out This Article Here

 
Jun 26, 2012 - 6:25pm

J.P. Morgan had a "fortress balance sheet" going into the 2008 crisis, so they handled it extremely well compared to their peers. They were able to buy Bear Stearns, which greatly expanded their IB presence. JPM also benefits by having diversified lines of business (instead of just being a pure-play investment bank like Goldman Sachs). I believe that JPM and BarCap were the only BB banks to post a RoE of over 10% last year.

 
Best Response
Jun 26, 2012 - 6:28pm

Bank Downgrades Today - Would You Trust Them? (Originally Posted: 06/21/2012)

Since the financial crisis, the inherent flaws of ratings agency have become much more apparent. Downgrades are dangerous self-fulling prophecies in my opinion. As many as 17 banks and securities lender that are exposed to the European debt crisis may be downgraded today by Moody's.

UBS, Credit Suisse and Morgan Stanley (MS)’s credit ratings may be cut by as many as three levels, Moody’s said in February. Barclays, BNP Paribas SA (BNP), Credit Agricole SA (ACA), HSBC Holdings Plc (HSBA), Goldman Sachs Group Inc. (GS), Deutsche Bank AG (DBK), JPMorgan Chase & Co. (JPM), Citigroup Inc. (C), Macquarie Group Ltd. and Royal Bank of Canada (RY) may be lowered by two, Moody’s said.

Bank of America Corp., Nomura Holdings Inc. (8604), Royal Bank of Scotland Group Plc (RBS) and Societe Generale SA (GLE) may be lowered by one grade, it said.

Thoughts? How much does this affect the sentiment on Wall Street? And how much credibility do you give ratings institutions?

 
Jun 26, 2012 - 6:35pm

jesus of nazareth:
Huh, RBC. Canadian banks are usually quite robust..

RBC is rated the highest out of all the banks in that list at Aa1/P1. However, they are one of the banks that could be downgraded by 2 notches to Aa3.

I think the worst outcome would be for MS, with a potential 3 notch downgrade from their A2 rating to a Baa2.

Who gives a shit what these rating agencies think right now anyway?

Under my tutelage, you will grow from boys to men. From men into gladiators. And from gladiators into SWANSONS.
 
Jun 26, 2012 - 6:32pm

I am tired of the pseudo-monopoly that these ratings agencies enjoy. How can they have any real credibility after failing to protect their investors from many of the toxic MBSs and their associated structured products leading up to the crisis? Are these not the same people who seem to think that the US is not a AAA country while the bond markets emphatically cry otherwise (what's the latest yield on the 10-year treasury?).

I think I said this before on another WSO post, but why not remove power of determining capital quality from ratings agencies and just let market forces determine what is Tier 1,2,3,etc. For example, bank regulators would say that certain institutions most hold a pre-determined percentage of Tier 1 capital and then they define Tier 1 as those with yields that trade within a certain band (i.e. the corresponding LIBOR plus a certain amount).

 
Jun 26, 2012 - 6:37pm

FormerHornetDriver:
I am tired of the pseudo-monopoly that these ratings agencies enjoy. How can they have any real credibility after failing to protect their investors from many of the toxic MBSs and their associated structured products leading up to the crisis? Are these not the same people who seem to think that the US is not a AAA country while the bond markets emphatically cry otherwise (what's the latest yield on the 10-year treasury?).

I think I said this before on another WSO post, but why not remove power of determining capital quality from ratings agencies and just let market forces determine what is Tier 1,2,3,etc. For example, bank regulators would say that certain institutions most hold a pre-determined percentage of Tier 1 capital and then they define Tier 1 as those with yields that trade within a certain band (i.e. the corresponding LIBOR plus a certain amount).

Yes.

I was taught that the human brain was the crowning glory of evolution so far, but I think it's a very poor scheme for survival.
 
Jun 26, 2012 - 6:33pm

From my viewpoint, our competition are taking themselves out of the equation. Competition is all fine and well, but being just good while others are sucking....well, that's a cool deal, I'll take it.

They'll bounce back though, I think they're framing these assessments in terms of the generally depressed economic climate, so as soon as things pick up the ratings will climb.

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