Moody’s Bank Downgrades Risk Choking European Recovery
Moody’s Investors Service will this month start cutting the credit ratings of more than 100 banks, a move that risks pushing up their funding costs and forcing them to curb lending in a threat to economic growth.
BNP Paribas SA (BNP), France’s biggest lender, Deutsche Bank AG, Germany’s largest, and New York-based Morgan Stanley are among firms that face having their short- and long-term debt downgraded to their lowest-ever levels by Moody’s, the ratings company said in February.
The cuts, which would follow downgrades by Standard & Poor’s and Fitch Ratings last year, could erode profits, trigger margin calls and leave some firms unable to borrow from money- market funds that have strict rules on who they can lend to. Without access to funding from private sources, banks have had to sell assets and reduce lending.
“I’d like to say the views of the rating agencies don’t matter anymore but, unfortunately, they do,” said Philippe Bodereau, London-based head of European credit research at Pacific Investment Management Co., the world’s largest bond investor. “This is a setback for the banks, particularly when you consider how much progress they have made in making themselves safer and more transparent.”
Even after the European Central Bank provided an unprecedented 1 trillion euros ($1.3 trillion) of three-year loans to bolster the region’s banks, loans to non-financial companies in the euro area fell 0.17 percent in April, according to ECB data. Europe’s economy probably slipped into recession in the first quarter as the debt crisis forced governments to step up spending cuts, according to 16 out of 19 economists surveyed by Bloomberg.
“The more the cost of wholesale funding goes up, the more likely it is that banks will want to retreat closer to a loan- to-deposit ratio of one,” said Huw van Steenis, a banking analyst at Morgan Stanley (MS) in London. “That adds to the intense pressure to deleverage, which will be a drag anchor on European economic recovery.”
Moody’s said in January it would overhaul how it rates European banks and firms with global securities operations to reflect the adverse effects of the sovereign-debt crisis, dwindling economic growth and the latest round of capital rules set by the Basel Committee on Banking Supervision.
The ratings company said in an April 13 note that it will start the downgrades in early May with a review of Italian lenders, before moving on to countries including Spain, Austria, Sweden, Norway, the U.K. and Germany. Global capital-markets firms, including the U.S. investment banks, are unlikely to have their ratings changed until June, according to analysts.
“The combination of current challenges and inherent risk factors has introduced speculative elements into the obligations of these firms that we believe are not fully reflected in their current ratings,” Moody’s said in a note published Jan. 19. Jessica Eddens, a spokeswoman for the firm, declined to comment on the review.
UBS AG (UBSN) and Credit Suisse Group AG (CSGN), Switzerland’s biggest lenders, Spain’s Banco Bilbao Vizcaya Argentaria SA (BBVA) and Morgan Stanley, owner of the world’s largest brokerage, are facing three-step downgrades on their long-term debt, Moody’s said. JPMorgan Chase & Co. (JPM), the largest and most profitable U.S. bank, Goldman Sachs Group Inc. (GS), the fifth-biggest in the U.S., and HSBC Holdings Plc (HSBA), the U.K.’s biggest, could be cut two levels.
Moody’s may apply less severe downgrades after a stronger- than-expected first quarter, Pimco’s Bodereau said. Officials at the banks declined to comment.
Any ratings cuts would heap further misery on the industry as the boost that followed the ECB’s cash injections in December and February wears off and policy makers struggle to extinguish the sovereign-debt crisis.
The 43-member Bloomberg Europe Banks and Financial Services Index (BEBANKS) has fallen 19 percent from its March 19 high. The Markit iTraxx Financial Index of credit-default swaps, which measures the cost of insuring the debt of 25 European banks against default, has jumped 47 percent over the same period. Bank stocks led the Stoxx Europe 600 index almost 1 percent lower as of noon in London trading today.
Bank of America Corp. (BAC), the U.K.’s Barclays Plc (BARC) and Royal Bank of Scotland Group Plc (RBS), and UBS are among firms whose short- term debt ratings, for loans of less than a year’s duration, could be cut. A reduction to P-2 from P-1 would bar some money funds from providing them with loans. The banks declined to comment about the ratings reviews.
U.S. money-market funds cut their exposure to lenders at risk of being downgraded to P-2 by $21 billion in the two months ended in March, according to an April 11 report by Alex Roever, an analyst at JPMorgan in New York. The funds increased their exposure to banks not under review by Moody’s by $4 billion.
Narrowing Funding Sources
Downgrades also threaten to reduce banks’ access to longer- term funding. European banks’ earnings could be reduced by 2 percent to 6 percent, Lakhani wrote, because investors demand a higher yield to lend to lower-rated banks. That will hit the weakest banks hardest, while giving lenders with the highest ratings, such as HSBC and JPMorgan, a competitive advantage in securing funding, the analyst said.
Banks in southern Europe may be unable to fund themselves privately at all. More than 800 lenders borrowed from the ECB in December and February to cover maturing debt and boost liquidity buffers. After a flurry of senior unsecured bond sales in January and February, the market froze again with Lloyds Banking Group Plc (LLOY), 40 percent owned by the government, being the only publicly traded lender to sell unsecured bonds in April.
Under pressure from regulators, banks are already shifting to longer-term, more stable and more expensive sources of funding, eroding profit. RBS cut its reliance on commercial paper and certificates of deposit by more than half to 22 billion pounds ($35.6 billion) at the end of 2011, the Citigroup note said.
“The big question is how will banks fund themselves going forward at a rate that is in keeping with providing credit to the economy,” said Guy Mandy, a fixed-income analyst at Nomura Holdings Inc. in London. “At this stage there is very limited appetite for private funding into banks.”
Downgrades would also trigger margin calls and force lenders to post additional collateral to counterparties at a time when balance sheets are encumbered to record levels.
Morgan Stanley would need to post an additional $9.61 billion were it to suffer the maximum three-step downgrade, as well as a two-level reduction by S&P, the New York-based lender said in a filing last week. Citigroup would require $4.7 billion if cut by two steps, it said.
BlackRock Inc. (BLK), the world’s biggest asset manager, said on April 18 it may be forced to reduce business with some banks if their ratings are lowered to comply with clients’ mandates.
“Many banks will have agreements in place that say if your ratings drop you need to post more collateral because you are deemed to be a higher risk,” said Nomura’s Mandy. “The general squeeze of collateral, whether it is from downgrades, assets pledged to the ECB or the general trend toward collateralizing everything, is likely keeping pressure on banks.”
The more a bank’s balance sheet is pledged as collateral, the further unsecured creditors are pushed down the queue for repayment. The process is accelerated by the increasing use of ECB funding and covered bonds.
Moody’s may stop short of imposing the steepest downgrades following better-than-estimated first-quarter earnings and evidence of rising capital and liquidity buffers. JPMorgan, Goldman Sachs, Deutsche Bank (DBK), RBS and BNP Paribas were among banks that beat analysts’ estimates in the first quarter after a resurgence in trading income.
Conditions in the interbank markets have also improved since the ECB announced its plan to offer banks unlimited three- year loans on Dec. 8. The Euribor-OIS spread, a measure of banks’ reluctance to lend to one another based on the difference between the borrowing benchmark and overnight indexed swaps, is at 0.38 percent, a nine-month low.
Moody’s had planned to start publishing details of any downgrades in April. On April 13, it issued a statement saying it was delaying publication until early May, a move some are taking to suggest banks’ lobbying efforts may be paying off.
“It’s important to note that when Moody’s first came out to render an opinion” it was before the stress-test results and the first-quarter earnings of the large institutions, Morgan Stanley Chief Executive Officer James Gorman, 53, said on an April 19 call to discuss the bank’s results for the first three months. “It’s important and constructive to note they’re delaying their readout on this.”
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