Credit Suisse Group AG’s credit rating was cut three levels by Moody’s Investors Service, Morgan Stanley was reduced two levels and 13 other banks were downgraded in moves that may shake up competition among Wall Street’s biggest firms.
Credit Suisse, the second-largest Swiss bank, received the maximum reduction that Moody’s said in February it may make during a review of global banks with capital markets operations. Morgan Stanley and UBS AG, the other firms singled out for such a steep cut, were lowered two steps instead.
“All of the banks affected by today’s actions 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 Thursday in a statement.
The downgrades may force banks to post additional collateral to trading partners in derivatives deals while boosting the companies’ borrowing costs. Moody’s said when it announced the review that it was seeking to reflect the banks’ reliance on fragile confidence in funding markets and increased pressures from regulation and a difficult market environment.
The ratings firm said Feb. 15 it was reviewing grades for 17 banks. Moody’s cut Macquarie Group Ltd. and Nomura Holdings Inc. one level each in March. It also started a review of lenders in more than a dozen European nations and already has reduced grades in Spain, Germany, Italy, Sweden, Austria and Denmark.
The downgrades may affect the competitive landscape in derivatives that aren’t centrally cleared, a business that provides about 15 percent of the industry’s trading revenue, Kinner Lakhani, a Citigroup Inc. analyst, wrote in an April 30 note. Banks with the largest cuts may lose revenue from such long-term derivatives, Charles Peabody, an analyst with Portales Partners LLC, said in a June 4 interview on the “Bloomberg Surveillance” radio program.
“Right now there are a lot of internal bank policies that if you’re doing a longer-term structured derivative, you want the counterparty to be A-rated or above,” said David Konrad, an analyst at KBW Inc. in New York. Because Moody’s is downgrading the entire banking industry rather than one or two firms, “a lot of those policies may be rewritten over time.”
A three-level cut for Morgan Stanley could cost it $400 million in annual trading revenue from those types of derivative deals, estimated Brad Hintz, an analyst at Sanford C. Bernstein & Co., before Moody’s released its decisions.
The downgrades also may hasten obligations to post additional collateral and termination payments. New York-based Morgan Stanley said last month it may face payments of $9.61 billion in the event of a three-level cut from Moody’s and two grades by Standard & Poor’s, according to a filing based on March 31 data. The total included $7.21 billion in collateral.
Credit Suisse said in its annual report that a three-level downgrade in the bank’s long-term debt ratings would result in additional collateral requirements or termination payments under certain derivative instruments of 4.5 billion Swiss francs ($4.7 billion), as of Dec. 31. UBS said it would face 2.1 billion francs of collateral calls from a two-level cut.
Banks’ large liquidity buffers will make collateral requirements “manageable,” Amit Goel, a Credit Suisse analyst, wrote in a May report.
“Pre-crisis bank ratings used to be clustered together,” Lakhani wrote. “In the new world, dispersion has increased. Markets tend to discriminate more between issuers at lower ratings -- in terms of funding costs. Over time, this could provide a competitive edge for higher-rated firms,” including HSBC Holdings Plc. and JPMorgan Chase & Co.
Morgan Stanley’s stock fell on June 4 to what was then its lowest close since December 2008 as investors weighed a potential credit-rating cut. The shares have rallied 15 percent since then through Wednesday.
Moody’s wrote on Jan. 19 that credit profiles of global lenders are weakening as governments struggle with their finances, and economic uncertainty and higher funding costs persist. When Moody’s places a company’s ratings on review for a downgrade, it typically decides whether to cut them within three months.
The ratings firm said Feb. 15 it was reviewing grades for 17 banks and securities firms with what it called “global capital-markets operations.” That’s when it put Morgan Stanley, Bank of America Corp., Citigroup, Goldman Sachs Group Inc., JPMorgan and Royal Bank of Canada on review for downgrades.
Moody’s has said all the reviews will be wrapped up by the end of this month, after it delayed its rating actions on the largest banks, which had previously been scheduled for mid-May.
“Moody’s is taking an appropriately deliberate approach during this review process and will conclude when it is confident that all relevant information has been received and analyzed,” the firm said in an April 13 statement.
Events that have occurred since the review was announced, including developments in the European debt crisis and JPMorgan’s $2 billion trading loss, have forced Moody’s to take longer with its decisions, said David Hendler, an analyst at CreditSights Inc. in New York. Morgan Stanley Chief Executive Officer James Gorman said this week that the review has been “a long process to be hanging out there in the wind.”
Companies have spoken out against the Moody’s review, citing the firm’s methodology and approach. UBS Chief Financial Officer Tom Naratil said his firm’s financial position is “completely inconsistent” with one that would have its short- term rating cut from P-1.
Gorman said it would be “somewhat stunning” if his firm was cut three levels given the bank’s increased capital and liquidity. Goldman Sachs CFO David Viniar has said that he and other executives “strongly disagree” with Moody’s approach.
“If you look at every single credit metric there is for Goldman Sachs and frankly for many of our competitors, none of the actions they’ve talked about are warranted,” Viniar said during an April 17 conference call with analysts and investors after the company reported first-quarter results. “We are, as you know, we’re quite analytical. And when we do all of the analysis, we cannot figure out why they are where they are."
David Knutson, a Chicago-based credit analyst with Legal & General Investment Management, said Moody’s is in a difficult business because it collects fees from the banks.
“When you upgrade someone, I imagine they’re happy to sign the check because they earn it back in lower rates,” Knutson said. “When you downgrade them, signing that check is a much harder thing to do.”
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