Moody's downgrades 15 global banks
Moody's Investors Service has lowered the credit ratings on some of the world's biggest banks, including Bank of America, JPMorgan Chase and Goldman Sachs, reflecting concern over their exposure to the violent swings in global financial markets.
The downgrades late Thursday ultimately are a measure of Moody's view on the ability of the banks to repay their debts. The ratings agency also cut its ratings on Barclays, Deutsche Bank and HSBC, some of the largest banks in Europe, a region fighting to contain a government debt crisis.
The banks "have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," Moody's global banking managing director Greg Bauer said in a statement outlining the rational for the downgrades.
The behemoth banks are all major players in the global stock and bond markets, which have become extremely volatile. However, Bauer noted that some of the banks, including JPMorgan Chase and HSBC, have reliable buffers in more stable businesses that could act as "shock absorbers" during a crisis.
Moody's had said in February that it was considering downgrading the ratings of major banks in the US and in Europe.
A downgrade usually means banks will have to pay more for its debt. Investors demand higher interest for riskier debt, which is what the downgrades represent. However, with interest rates already at rock-bottom levels, the lower ratings may not significantly affect the cost of funding for the banks.
The stock market has also priced in any negative impact from the ratings downgrades, according to Bert Ely, a banking consultant in the Washington, D.C. area. "They've been telegraphing this thing for months," he said.
In a sign that investors were taking the news in stride, stocks of major U.S. banks rose in afterhours trading. Moody's made its announcement after regular stock trading had closed.
Morgan Stanley rose the most, 3.2 per cent, gaining 45 cents to $14.41. JPMorgan Chase & Co. rose 38 cents to $35.89 and Bank of America Corp. rose 6 cents to $7.88.
Citigroup Inc. said it "strongly disagrees" with Moody's assessment. Citi said it doesn't believe the downgrade will impact its funding costs because the ratings actions have already been expected by the market and its business partners have included them in their analyses.
Morgan Stanley also disagreed with Moody's, saying it did not think the ratings agency had fully considered the actions the bank has taken to shore up its finances.
The downgrades come at a time of great uncertainty in the global economy. Europe's currency union is under threat, the U.S. economy is slowing and the red-hot economies of India, Brazil and China are cooling.
On Thursday the Dow Jones industrial average plunged 251 points, its second-worst loss of the year, as new reports indicating slower manufacturing in the U.S. and China made investors fearful that the global economy could be heading for another slump.
Moody's has been on a downgrading spree lately. In June, it downgraded Spain by three notches, after downgrading 16 Spanish lenders in May. It also cut the ratings on seven German and three Austrian lenders in this month.
In its latest report, Moody's didn't treat all large banks alike. It sorted the banks it was downgrading into three categories, with JPMorgan, HSBC Holdings PLC, and Royal Bank of Canada in the top one.
Moody's said those banks have stable businesses that can offset market losses. JPMorgan, for example, has a large base of consumer deposits and major lending, credit card and asset management businesses.
These banks have also managed to contain their exposure to risky European government debt, Moody's said. While all three were downgraded, their debt had the highest ratings among the 15 banks affected.
The second group included Goldman Sachs Group Inc., Deutsche Bank AG and Credit Suisse Group AG. Moody's said those banks rely heavily on their markets businesses to satisfy their shareholders, although some of them have managed their risk effectively.
In its last group were the weakest banks — Bank of America, Citigroup, Morgan Stanley, and Royal Bank of Scotland Group PLC. Moody's said these banks have either had "problems in risk management or have a history of high volatility," and some of them have implemented business strategy changes.
"These transformations are ongoing and their success has yet to be tested," Moody's said.
Moody's tilts playing field towards safe haven banks
Downgrades by ratings agency Moody's will make funding more expensive for banks that rely the most on capital markets, while reinforcing the competitive advantage of "safe haven" banks that can fund themselves from stable customer deposits.
Stock markets took Moody's announcement that it had downgraded 15 of the world's biggest banks in their stride, as the rating agency's lowering by up to three notches had been widely anticipated.
European bank shares rose just under 1 percent. But longer-term, the downgrades could have a lasting impact.
But over the medium term, the downgrades will reinforce a trend that has seen weaker banks punished for their risk taking, while stronger banks are rewarded for conservative funding models, ensuring lower costs and higher margins.
Not only will funding costs rise for the worst-rated banks, but trading partners are bound to ask for more collateral - and steer business to those perceived to be financially stronger.
"The new ratings landscape could provide a competitive edge for higher-rated firms," said analysts at Citigroup.
Moody's gave the highest ratings to HSBC, Royal Bank of Canada and JP Morgan, which it said had stronger buffers than peers.
All three are regarded as safe haven banks, funded by deposits from millions of retail customers and relying less than riskier banks on capital markets for short term financing.
Moody's gave the lowest credit ratings to banks that have been affected by problems with their risk management or whose capital buffers are not as strong as rivals.
Those include banks like Morgan Stanley with few retail deposits, as well as banks like Bank of America, Citigroup and Royal Bank of Scotland, which despite having big deposit bases have gotten into trouble by combining their retail business with riskier investment banking.
Moody's placed Barclays, BNP Paribas, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, Societe Generale and UBS in a middle group of banks, which it said include firms that rely on unpredictable capital markets revenues to meet shareholder expectations.
For banks which rely heavily on markets for funding, the lower ratings make difficult conditions even worse, at a time when they are suffering because of the euro zone crisis and a global slowdown in growth.
"Markets tend to discriminate more between issuers at lower ratings - in terms of funding costs - particularly during times of stress," said Citigroup analysts.
The downgrades reflected a view on capital markets that was "something more structural and fundamental rather than what is just cyclical noise", Johannes Wassenberg, Moody's managing director of European banks, told Reuters.
"We tried to assess risk from capital markets... and the shock absorbers banks have," Wassenberg said.
Regulators have told investment banks to keep far higher capital buffers, making their business less profitable, while also taking a knife to some of their most lucrative businesses, such as trading for their own account.
The sector has been left with significant overcapacity, reports from consultancy firms have said, meaning the battle for the favours of clients can only intensify.
RISK MANAGEMENT
The ratings agency looked at the banks where exposures to capital markets were the most pronounced, picking firms by the share of revenue generated by fees from debt and equity advisory, trading revenues and trading inventories.
Analysts say banks that will be most affected by funding costs rising as a result of the downgrades are those that were most likely to have to put more collateral on the table.
"Most directly, there are contractual provisions in agreements that would require a firm to post additional collateral, or to replace itself as the counterparty to transactions," said analysts at Execution Noble.
Moody's said some of the lowest rated banks had undertaken considerable changes to their risk management models and were implementing business strategy changes intended to increase earnings from more stable activities such as retail banking. However, it said these transformations are ongoing and their success has yet to be tested.
Moody's said it had taken into account management action at firms like UBS, where it listed the bank's reduced ambition in investment banking as a positive factor.
The downgrades had been widely anticipated having been flagged by Moody's in February and the initial market reaction across Europe was muted.
Daiwa Capital Markets analyst Michael Symonds said the cuts could have been worse and the conclusion of the review removed an uncertainty from the market. However, he warned there could be more downgrades to come.
"The next round of downgrades may be just around the corner given the myriad challenges still weighing on the sector, including the far-from-resolved euro area crisis and imminent legislation on bail ins and resolution regimes," he said.