Jun 15, 2012, 09.27 AM | Source: Reuters
Credit rating downgrades of the world's biggest banks expected this month could widen the gulf in prospects between the strongest banks and their weaker rivals.
Once Moody's Investors Service cuts the ratings, funding costs for the banks are likely to rise, and their trading partners may ask for more collateral. Clients and counterparties will also tend to steer business away from those whose credit profiles have sunk furthest.
To be sure, the effects of Moody's action are probably already priced into stock and bond prices because of months of forewarning.
Banks generally say that even with ratings cuts, they are strong enough to fund massive trading operations and retain the business of credit-sensitive clients. But Morgan Stanley
Pushing weaker banks such as Morgan Stanley to a lower rung of the ratings ladder would make them "vulnerable to lose market share to higher-rated companies such as JPMorgan Chase and Goldman Sachs Group," said Credit Suisse Group equities analyst Howard Chen.
"We don't believe the impact would be material," Citigroup spokesman Jon Diat said. "Our clients tend to be more sophisticated in their analysis than to rely solely on ratings from a single agency."
Bank of America and Morgan Stanley declined to comment.
When it began its review in February, Moody's said it had grown so concerned about large banks' ability to control the risks, costs and regulatory burdens of their capital markets businesses - and to retain client confidence in their business models - that it had to examine the outlook for their long-term profitability and growth. It said it would announce the new ratings by the end of June.
The review goes beyond standard attempts by ratings agencies to gauge the creditworthiness of banks. Standard & Poor's and Fitch Ratings late last year each downgraded more than a dozen banks around the world, but not to the levels that Moody's outlined four months ago.
Most of the banks left on Moody's review list are expected to be cut between two and three notches - but it could be much worse for those already low on the ratings scale.
For example, the ratings agency has said three banks - Credit Suisse Group
Morgan Stanley, Citigroup and Bank of America are expected to be reduced to Baa2, which would be three notches below the expected new rating for JPMorgan
Goldman estimated in May that a two-notch downgrade from Moody's would require it to post another USD 2.2 billion in collateral and penalties for early termination. To put that into context, it had USD 951 billion of assets on March 31.
Morgan Stanley, with about USD 781 billion of assets, said a cut of one to three notches by a major rating agency could lead trading counterparties to demand USD 1.03 billion to USD 9.6 billion in such payments. Bank of America said a one-notch cut would require it to post USD 2.7 billion in derivatives collateral on positions held as of March 31, while Citi estimates a two-notch downgrade could leave it facing calls for an additional USD 1.1 billion in cash obligations and collateral requirements.
Moody's has targeted some of the banks that were hit hardest during the financial crisis, such as Bank of America, for only one-notch downgrades since their ratings are already relatively low.
Other European banks under review include Germany's Deutsche Bank
RIVALS TO POUNCE
Downgrades will give smaller rivals another potential lever as they compete with the big banks in trading and other areas.
"It's a jittery market, and people are very uncertain about the big banks," said Scott Bok, chief executive officer of Greenhill & Co
Bond markets began treating Morgan Stanley like a junk-rated company after Moody's warning.
At a conference Tuesday, Morgan Stanley CEO James Gorman reiterated that while he did not agree with Moody's downgrade rationale, the threatened two- or three-notch ratings cuts would have a "manageable outcome."
"We're not panicked over this, but we're prepared for it, and we'll make whatever business adjustments are necessary once we get there," Gorman said. "It's been a long process to be hanging out there in the wind waiting for this."
Goldman CEO Lloyd Blankfein said Wednesday that Moody's warning of a potential two-notch cut was "concerning" and at odds with the company's own view of its creditworthiness. But Blankfein said the rating agency had "done a good job of communicating their contention and letting the market adjust to it."
JPMorgan, the biggest US bank by assets, appears confident, even if its long-term rating is slapped with the two-notch drop Moody's is considering.
Funding costs would not rise "materially," JPMorgan said in a regulatory filing, and unsecured debt agreements with investors would not require accelerated payments if ratings are reduced.
Several large investors in big bank debt and equity said they were more confident today about banks' capital strength because they had been shedding billions of dollars of assets and raising a similar boatload of equity.
"We're very positive on the fundamentals of big US banks' debt," said Michael Lillard, chief investment officer of fixed income at Prudential, who oversees about USD 332 billion of assets. "The upcoming Moody's downgrades are more than priced into the market. Banks have large amounts of liquidity, and the additional collateral requirements they might have to put up is easily manageable."
Traders in swaps and other derivatives have had time to reduce their exposure to banks likely to fall below A-rating levels, according to market sources. Some banks expecting the hits have been working with some corporate customers to rewrite corporate policies to allow them to continue trading with lower-rated banks, said corporate treasurers and bank analysts.