Late last week, the credit rating agency Moody’s announced its decision to review the long-term debt ratings of four of the country’s largest banks for a possible downgrade.  Moody’s move is based on its belief that senior and subordinated debt issued by Goldman Sachs (NYSE:GS), JPMorgan Chase (NYSE:JPM), Morgan Stanley (NYSE:MS) and Wells Fargo (NYSE:WFC) could be riskier than what their current credit ratings reflect given the U.S. government’s focus on policies that aim at reducing support for the banking giants in the event of financial distress. These banks join the custody banks Bank of New York Mellon (NYSE:BK) and State Street (NYSE:STT) which are being reviewed for a rating downgrade since early July.
Moody’s is also reviewing the credit ratings for Bank of America (NYSE:BAC) and Citigroup (NYSE:C) for a possible upgrade or downgrade, as the improvement in underlying operating conditions for these banks over recent quarters could offset the negative impact of reduced government support on them.
The announcement by Moody’s comes roughly a year after it downgraded the credit ratings for 17 global banks last June in the wake of deteriorating economic conditions in Europe (see Moody’s Issues Rating Downgrade Warning For 17 Banks). The banks may very well have to contend with yet another cut to their ratings over the coming months – something that does not bode well for the ones that have plans to raise more cash through debt issuances as they will end up paying more to creditors.
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The U.S. banks have seen a series of downgrades since the economic downturn with some of them like Bank of America and Citigroup being downgraded by as much as 7 notches from their peak ratings in late 2008. The table below summarizes the current long-term credit rating as adjudged by Moody’s for each of these banks:
|Bank of America||Baa2|
A downgrade by credit rating agencies normally makes it more difficult for a company to arrange for more cash – with the sources proving more costly due to the higher perceived risk associated with a company having a lower rating. As we have seen in the past, Moody’s almost always follows-up an announcement placing a company on its watchlist for an upgrade or a downgrade with the actual upgrade/downgrade within a few months. So the actual credit ratings downgrade should not come as a surprise and the market will no doubt price this fact into the share prices for these banks over trading early this week.
Incidentally, Moody’s had already downgraded the credit ratings for some of these banks in September 2011, stating the same reason: the growing unwillingness of the U.S. government to bail out large banks in trouble. (see Moody’s Sizes up Gov’t Support in Downgrades: BofA, Wells Fargo & Citi Slump) The banks – Bank of America, Citigroup and Wells Fargo – were unsurprisingly not happy with the downgrades as they reflected a change in Moody’s view of government support to banks rather than a change in the health of these banks. And the situation is no different this time around too.
But the real source of concern for the banks is that if the other rating agencies Standard & Poor’s and Fitch take a cue from this downgrade and go ahead with making similar downgrades to the banks, then they may end up pledging more collateral to existing loans and may also have to close out various derivatives contracts by shelling out termination penalties. To put things in perspective, JPMorgan stated in its latest quarterly filing that it may have to post $1 billion as extra collateral if its credit rating falls one notch, and $3.4 billion for a two-notch fall. Similarly, Goldman Sachs estimates that it would need $1.26 billion and $2.17 billion, respectively, for a one-notch and two-notch downgrade. Notes:
- Moody’s reviews US bank holding company ratings to consider reduced government support, Moody’s Press Releases, Aug 26 2013 [↩]
- Biggest Banks Face Moody’s Cuts as U.S. Support Ebbs, Bloomberg, Aug 23 2013 [↩]