Analysis: Moody's bank review may mark new era of lower ratings

Fri Mar 30, 2012 7:24pm EDT
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By Karen Brettell and Lauren Tara LaCapra

NEW YORK (Reuters) - The largest U.S. banks including Morgan Stanley, Bank of America and Citigroup are facing what could be a historic shift to lower credit ratings which could increase their cost of funding and reduce competitiveness in their capital markets businesses.

Moody's Investors Service is reviewing 15 of the world's largest banks for possible credit ratings downgrades in mid-May, and broad cuts could send banks on average to their lowest historical levels.

In the U.S. Morgan Stanley could see the largest cut after being warned of a possible three-level downgrade to the Baa category, a rating that has traditionally been associated with more speculative risk than some investors and trading partners have been comfortable with.

Bank of America and Citigroup, which are currently lower rated than Morgan Stanley, are also under review for downgrades to the same Baa2 level, and all three-banks are under review to lose their top tier short-term debt rating which would effectively cut their access to some short-dated funding markets.

Moody's action is unlikely to spark funding stress at the banks. Many banks have been dramatically scaling back their reliance on short-term and ratings-sensitive funding since 2008, when fears over exposure to risky mortgage-backed debt caused short-term debt investors to pull back from lending to the firms.

The banks have also increased deposits and capital cushions, making them less vulnerable to the type of client runs that felled banks including Bear Stearns and Lehman Brothers.

Nevertheless, new downgrades may disrupt some short-dated debt markets and have knock-on effects for municipal issuers, who sell debt that is backed by the strong bank ratings.

Downgrades may also hurt the lowest-rated banks relative to competitors including JPMorgan and Goldman Sachs which are expected to maintain ratings in the more solid single-A category.   Continued...

A Moody's sign on the 7 World Trade Center tower is photographed in New York August 2, 2011. REUTERS/Mike Segar