In the most sweeping credit downgrades since 2007, Moody’s Investor Service lowered the credit ratings of fifteen global banks, including the five largest banks in the United States. The scope of the credit downgrades left many wondering if we are entering a new phase of the global financial meltdown that started in 2008. Despite trillions of dollars in government bailouts, the banking industry remains beset by a host of problems including slow loan growth, persistent loan defaults, costly financial regulations and a slowing economy.
The latest credit downgrades will reinforce the impression by investors that the too big to fail banks are simply too complex and risky to accurately evaluate their true financial health. Given the precarious condition of the world financial system, especially in Europe, many investors doubt that the big banks have the financial ability to weather the European banking crisis or some other economic shock.
The credit downgrades of Bank of America and Citigroup put both banks only two notches above the “junk level” investment grade. The other three U.S. megabanks downgraded by Moody’s were Goldman Sachs, JP Morgan Chase and Morgan Stanley. Despite vows by federal banking regulators that too big to fail banks will not be bailed out again, Moody’s noted that many of the bank credit ratings would have been cut even further absent the implicit backing of U.S. taxpayers. According to Bloomberg,
JPMorgan was among 15 global banks downgraded yesterday and one of the three strongest evaluated by Moody’s, the ratings firm said in a statement. The New York-based bank’s standalone assessment fell to a3 from aa3 and would have been even lower without implicit support from the federal government, Moody’s said.
“It illustrates the challenges of monitoring and managing risk in a complex global organization and highlights the opacity of such risks,” Moody’s said. JPMorgan’s capital markets business, which accounted for 26 percent of the firm’s revenue in 2011, and high levels of wholesale funding also hurt its standalone rating, according to the statement.
JPMorgan benefited from the assumption that there’s a “very high likelihood” the U.S. government would back the bank’s bondholders and creditors if it defaulted on its debt, according to the statement. Without the implied federal backing, JPMorgan’s long-term deposit rating would have been three levels lower and its senior debt would have dropped two more steps, Moody’s said.
JPMorgan is seeking to stem at least $2 billion in trading losses from it U.K. CIO operation, where Bruno Iksil, known as the London Whale, managed a portfolio of credit derivatives so large it distorted the market. Trading in the index that contributed to the bank’s losses soared to a record June 19 as the lender worked to unwind its position.
Indirectly addressing the huge amount of speculative derivatives held by the largest banks, a Moody’s spokesman said that “All of the bank’s affected by today’s actions have significant exposure to volatility and risk of out sized losses inherent to capital market activities.”
The credit ratings of Citigroup, Goldman Sachs, JP Morgan Chase and Morgan Stanley were all lowered by two notches while Bank of America saw its credit rating drop by one notch. The lowered credit ratings are expected to raise funding costs for the banks which will wind up being passed on in the form of higher credit costs to both consumers and businesses.
Adding further to the concern about the health of the global banking industry, the Wall Street Journal reports that some European banks are artificially inflating capital ratios reported to regulators.
Regulators and investors are concerned that some European banks are artificially boosting a key measure of their financial health, a worry that is further eroding market confidence in the Continent’s banks.
Such concerns have been building up for more than a year. But they have intensified lately, with a parade of banks announcing that they intend to increase their capital ratios—a key gauge of their abilities to absorb future losses—partly by tinkering with the way they assess the riskiness of their assets. Spanish banks, including Banco Santander SA, are among those that have announced plans to boost their capital ratios by “optimizing” their risk weightings.
If banks underestimate the riskiness of their assets, their cushions to absorb losses could prove in a crisis to be perilously thin.
The current “approach undermines confidence in the system, and this forces investors to require that banks hold more capital,” said Richard Black, a fund manager at Legal & General Investment Management in London.
While the FDIC and other bank regulatory agencies try to paint a picture of a recovering banking industry, today’s actions make it clear that the banking industry has a long ways to go before recovering from the banking crisis that started in 2008.
In response to the credit downgrades, Citigroup dismissed Moody’s downgrades as unwarranted, backward-looking and failing to take into account improvements in risk management over the past several years. Ahem – what would you expect the bank’s reply to be?