The credit ratings of 15 major banks were slashed on Thursday, the latest setback for an industry that is already grappling with global economic turmoil and weak profits.
The decision by Moody’s Investors Service to cut banks’credit scores to new lows could further damage their bottom lines and unsettle markets even more.
Citigroup and Bank of America, which have struggled to fully recover from the financial crisis, were among the hardest hit. After two-notch downgrades, their credit ratings now stand just two levels above junk, a sign of the difficult business conditions they face.
The cuts reflect the changing nature of the banking industry. Banks have struggled to improve their profits against the backdrop of the European sovereign debt crisis, a weak American economy and new regulations.”The risks of this industry became apparent in the financial crisis,” said Robert Young, a managing director at Moody’s. “These new ratings capture those risks.”
The downgrades may only amplify their problems. With lower ratings, creditors could charge the banks more on their loans. Big clients may also move their business to less-risky companies, further crimping earnings.
As bank profits falter, consumers could feel the pain. Companies often try to make up for lost revenue by passing costs on to customers. In the face of new regulations, banks have raised fees and other expenses to bolster their business.
Moody’s downgrades are part of a broad effort to make its analysis more rigorous. During the financial crisis, Moody’s and rivals like Standard & Poor’s got a black eye for slapping high ratings on mortgage bonds that later imploded.
Moody’s approach reflects its belief that large banks have fundamental weaknesses that could still hurt their creditors. Along with Citigroup and Bank of America, the credit rating agency took action on 13 other banks, Morgan Stanley, JPMorgan Chase, Goldman Sachs, Credit Suisse, Deutsche Bank, UBS, HSBC, Barclays, BNP Paribas, Credit Agricole, Societe Generale, Royal Bank of Canada, and Royal Bank of Scotland.
But some analysts feel that Moody’s is playing a game of catch-up. The latest actions, say critics, are backward-looking and do not take into account the measures that banks have taken to strengthen themselves, including raising capital and getting out of certain risky businesses like proprietary trading.
“I feel that Moody’s action is five years too late,” said Gerard Cassidy, an analyst with RBC Capital Markets.
The threat of a downgrade has rippled through the markets since February, when Moody’s warned that it could cut the banks’ ratings. It held out the prospect of a severe, three-notch downgrade for Morgan Stanley, whose shares have dropped more than 25 percent since February. Moody’s ended up cutting the bank’s rating by two levels.
Now, bank executives will now try to convince their creditors and large customers that Moody’s has overreacted. The executives will probably highlight moves they have made since the crisis.
On Thursday, Citi said in a statement that Moody’s approach “fails to recognize Citi’s transformation over the past several years,” adding that “Citi strongly disagrees with Moody’s analysis of the banking industry and firmly believes its downgrade of Citi is arbitrary and completely unwarranted.”
Bank of America echoed such sentiments: “In addition to strengthening our governance and risk management, Bank of America ended the first quarter of 2012 with record capital ratios.”
Those capital positions, which are banks’ main buffer against losses, could be a point of strength across the industry. The lack of capital in the crisis left the financial system vulnerable, prompting the government to bail out many of the industry’s largest banks. Since then, they have significantly increased their cushions. Today, Morgan Stanley’s capital is twice what it was in 2007.
“The banking system is safer today than any time in the last 30 years,” said Mr. Cassidy. “We have not seen capital levels like this since the 1930s.”
Even so, Moody’s remains concerned. In its report Thursday, the credit rating agency said it saw several weaknesses in the banks’ Wall Street operations, including their complexity and opacity. Moody’s highlighted a history of volatile profits and problems with risk management.
In its review, Moody’s mentioned the recent trading debacle at JPMorgan Chase. In May, the bank disclosed that a bet on financial instruments tied to corporate bonds had soured, prompting multibillion dollar losses; those losses could eventually reach $5 billion.
The credit rating agency also noted the industry’s continued dependence on short-term loans to finance their Wall Street operations. This type of credit dried up quickly in the crisis, forcing them to borrow from the government.
Some banking experts welcomed the downgrades, saying the credit rating agencies were finally beginning to reflect the risks within large banks.
“These downgrades are good news,” said Anat R. Admati, a professor of finance and economics at Stanford University. “Right now, their balance sheets are very fragile.”
The downgrades could widen the divide in the banking system.
Some customers may simply choose to transfer their business from the lowest-rated banks to higher-rated ones. One beneficiary may be JPMorgan Chase, despite its large trading loss. It was downgraded two notches but still has a higher rating than Goldman Sachs.
Moody’s may cut some of its ratings still further once a critical part of the financial overhaul comes into place. The Dodd-Frank legislation aims to give regulators the power to wind down large banks and inflict losses on banks’ creditors in the process. Once these powers take effect, Moody’s may downgrade the banks to reflect the fact that the government is less likely to bail out large banks.
Some analysts see the downgrades as important, but only one step toward making the financial system safer. For one, the country does not have a coherent solution for dealing with large banks when they run into trouble, said Mike Mayo, an analyst with Crédit Agricole Securities.
“Will actions like this make the banking system safer? The jury’s still out on that,” said Mr. Mayo. “That’s unfortunate four years after the crisis.”