So turns the post-subprime bizarro world of credit-rating companies: Moody’s Investors Service (MCO) downgraded Morgan Stanley (MS), Credit Suisse Group (CS), and 13 other banks. Today the banks respond by … rallying? Has the sector no shame? Or do credit ratings perhaps not mean what they used to?
“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,” Greg Bauer, Moody’s global banking managing director, said in a June 21 statement.
That sounded dour enough, especially with everyone so worried about the systemic reverberations that could emanate from a full-blown euro crisis. Moody’s reduced Morgan Stanley’s long-term senior unsecured debt rating two grades to Baa1, while nine other banks, including Switzerland’s UBS (UBS), got two-level cuts; Credit Suisse was taken down three levels to A2. Meanwhile, in a Scarlet Letter-like rebuke, Goldman Sachs (GS) now must endure the ignominy of an A3 rating on its senior debt—the lowest in the storied investment bank’s history.
This all comes after Moody’s in February said it was reviewing the health of 17 banks. So investors have had four months—which included JPMorgan Chase’s (JPM) bombshell trading-loss revelation, as well as fresh fear and loathing out of Athens and Madrid—to price in new concerns.
Shares of all the firms affected by the downgrade were up Friday in early trading, several by more than 2 percent, with financials leading gains in the Standard & Poor’s 500-stock index. Notably, the cost to protect Morgan Stanley debt against losses dropped to the lowest in more than seven weeks, while credit-default swaps linked to Bank of America (BAC) and Citigroup (C) also improved.
The banks themselves were defiant. Citigroup, which took a cut from Moody’s to its lowest rating since it was formed 14 years ago, said in a statement: “Moody’s approach is backward-looking and fails to recognize Citi’s transformation over the past several years. Citi believes that investors and clients have become much more sophisticated in their credit analysis over the past few years, and that few rely on ratings alone—particularly from a single agency—to make their credit decisions.” The bank said it was “especially surprised” at the ”disproportionately adverse treatment” it says Moody’s has given U.S. banks compared with their European counterparts. Moody’s included Citi among a list of four banks, including Morgan Stanley, Bank of America, and Royal Bank of Scotland Group (RBS), that have a history of “high volatility” and problems with risk management.
Edinburgh-based RBS, the majority U.K. taxpayer-owned lender that took the biggest bailout in the global financial crisis, said the Moody’s action “is backward-looking and does not give adequate credit for the substantial improvements the group has made to its balance sheet, funding, and risk profile.” For its part, Morgan Stanley said that while the new ratings “are better than its initial guidance of up to three notches, we believe the ratings still do not fully reflect the key strategic actions we have taken in recent years.”
Citi further used the Moody’s downgrade to lend its bailed-out moral suasion to the anti-ratings companies movement. ”Investors and clients should make their own decisions,” the bank said. “Citi is aware that analytical alternatives to the ratings agencies exist today from several providers that would further enhance the ability of investors and clients to arrive at their own conclusions without being captive to the judgments of rating agencies.”
The ghost of subprime lingers for the ratings companies. As housing and financials led the economy into its deepest dive in a generation, Moody’s, Standard & Poor’s (MHP), and Fitch Ratings were all late to recognize the error of their overly optimistic credit ratings on everything from mortgage-backed securities to bank debt. They have since been trying to win back the reputational clout they enjoyed before the crisis. The cuts by Moody’s are “a mea culpa from 2007 and 2008,” says James Leonard, a credit analyst with Morningstar (MORN). “The banks have gotten so much better in the last few years in terms of capital, yet their ratings keep going down. What does that tell you? That the ratings were so wrong before.”
“To downgrade a BofA or Citigroup or companies that are sitting on hundreds of billions of dollars of cash in government-backed securities makes no sense,” added Dick Bove, the oft-quoted banks analyst, in an interview on Bloomberg Radio. “You can forget Moody’s,” he said. “You should have forgotten them a long time ago.”