published Friday, June 22nd, 2012

Moody's sees big banks' risks of 'outsized losses'

In this May 11, 2012 file photo, people stand in the lobby of JPMorgan Chase headquarters in New York. Moody's Investors Service on Thursday, June 21, 2012 lowered the credit ratings of 15 the world's largest banks late Thursday, including JPMorgan Chase, Bank of America, and Goldman Sachs, saying their long-term prospects for profitability and growth are shrinking. (AP Photo/Mark Lennihan, File)
In this May 11, 2012 file photo, people stand in the lobby of JPMorgan Chase headquarters in New York. Moody's Investors Service on Thursday, June 21, 2012 lowered the credit ratings of 15 the world's largest banks late Thursday, including JPMorgan Chase, Bank of America, and Goldman Sachs, saying their long-term prospects for profitability and growth are shrinking. (AP Photo/Mark Lennihan, File)
Photo by Associated Press /Chattanooga Times Free Press.

PALLAVI GOGOI

NEW YORK (AP) — Moody's Investors Service has lowered the credit ratings on some of the world's biggest banks, including Bank of America, JPMorgan Chase and Goldman Sachs, reflecting concern over their exposure to the violent swings in global financial markets.

The downgrades late Thursday ultimately are a measure of Moody's view on the ability of the banks to repay their debts. The ratings agency also cut its ratings on Barclays, Deutsche Bank and HSBC, some of the largest banks in Europe, a region fighting to contain a government debt crisis.

The banks "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 in a statement outlining the rationale for the downgrades.

The behemoth banks are all major players in the global stock and bond markets, which have become extremely volatile. Critics such as former U.S. Federal Reserve Chairman Paul Volcker argue that the stability of the financial system is threatened when banks' profits rely on proprietary trading desks that make high-risk bets on derivatives and other opaque financial instruments. Rich profits can be made from such trades but the losses can also be huge.

JPMorgan said last month it suffered a $2 billion trading loss related to a hedging strategy.

Analysts said the lure of larger profits from riskier, highly leveraged trading may prove too tempting compared with traditional banking such as loans for housing or small businesses, which require high volume and a network of branches to boost returns.

"The trade-offs for Western banks, purely from a profitability perspective, may favor the prop desk and trading and hedging," said Anand Pathmakanthan, who analyzes Singapore-based banks for Nomura Equity Research.

"The banks here in Asia are much more fundamentally sound and much easier to understand than say, Citigroup or JPMorgan, which events have shown, nobody really knows what's going on there."

Bauer, of Moody's, said that some of the banks, including JPMorgan and HSBC, do have reliable buffers in more stable businesses that could act as "shock absorbers" during a crisis. Moody's had said in February that it was considering downgrading the ratings of major banks in the U.S. and in Europe.

A downgrade usually means banks will have to pay more for its debt. Investors demand higher interest for riskier debt, which is what the downgrades represent. However, with interest rates already at rock-bottom levels, the lower ratings may not significantly affect the cost of funding for the banks.

The stock market has also factored in any negative impact from the ratings downgrades, according to Bert Ely, a banking consultant in the Washington, D.C. area. "They've been telegraphing this thing for months," he said.

In a sign that investors were taking the news in stride, stocks of major U.S. banks rose in afterhours trading. Moody's made its announcement after regular stock trading had closed.

Morgan Stanley rose the most, 3.2 percent, gaining 45 cents to $14.41. JPMorgan Chase & Co. rose 38 cents to $35.89 and Bank of America Corp. rose 6 cents to $7.88.

Citigroup Inc. said it "strongly disagrees" with Moody's assessment. Citi said it doesn't believe the downgrade will impact its funding costs because the ratings actions have already been expected by the market and its business partners have included them in their analyses.

Morgan Stanley also disagreed with Moody's, saying it did not think the ratings agency had fully considered the actions the bank has taken to shore up its finances.

The downgrades come at a time of great uncertainty in the global economy. Europe's currency union is under threat, the U.S. economy is slowing and the red-hot economies of India, Brazil and China are cooling.

On Thursday the Dow Jones industrial average plunged 251 points, its second-worst loss of the year, as new reports indicating slower manufacturing in the U.S. and China made investors fearful that the global economy could be heading for another slump.

Moody's has been on a downgrading spree lately. In June, it downgraded Spain by three notches, after downgrading 16 Spanish lenders in May. It also cut the ratings on seven German and three Austrian lenders in this month.

In its latest report, Moody's didn't treat all large banks alike. It sorted the banks it was downgrading into three categories, with JPMorgan, HSBC Holdings PLC, and Royal Bank of Canada in the top one.

Moody's said those banks have stable businesses that can offset market losses. JPMorgan, for example, has a large base of consumer deposits and major lending, credit card and asset management businesses.

These banks have also managed to contain their exposure to risky European government debt, Moody's said. While all three were downgraded, their debt had the highest ratings among the 15 banks affected.

The second group included Goldman Sachs Group Inc., Deutsche Bank AG and Credit Suisse Group AG. Moody's said those banks rely heavily on their markets businesses to satisfy their shareholders, although some of them have managed their risk effectively.

In its last group were the weakest banks — Bank of America, Citigroup, Morgan Stanley, and Royal Bank of Scotland Group PLC. Moody's said these banks have either had "problems in risk management or have a history of high volatility," and some of them have implemented business strategy changes.

"These transformations are ongoing and their success has yet to be tested," Moody's said.

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