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Does Moody's Slap at Banks Really Matter?

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Now that the smoke has cleared a bit following Moody's recent mass bank rating downgrade, there is somewhat of a hush as analysts, investors, consumers, and the banks themselves wait to see what effect the ratings agency's hatchet job will have on the banking industry.

Big banks get some serious trimming
Bank of America
(NYSE: BAC  ) was knocked down one notch, and Citigroup (NYSE: C  ) was cut by two -- leaving both two steps above junk status. Morgan Stanley (NYSE: MS  ) suffered a two-notch cut, as did Goldman Sachs (NYSE: GS  ) and JPMorgan Chase (NYSE: JPM  ) , which places Morgan Stanley three levels above junk, Goldman four levels above junk, and JPMorgan five levels above. Moody's blamed the reductions on the banks' "exposure to ... risk of outsized losses."

Will these cuts have an effect on the industry? There are many schools of thought on this, but the consensus seems to be: not much. The markets didn't show much interest, and many seemed to feel that the downgrades were long overdue. Banks had been on notice since February that Moody's was planning ratings adjustments, and in some cases, there was relief that the damage wasn't worse.

Some effects will be felt
Moody's actions will not be without consequences, however. According to some sources, banks' short-term borrowing costs will probably rise, cutting into profits. Derivatives may not be such an easy sell anymore, as investors nervous about taking on more risk demand better terms. The downgrades will also have a psychological effect, as Main Street sees its concerns about the banking sector corroborated by this action.

For consumers, tighter profit margins at banks always seem to express themselves as more fees for bank customers. Some analysts note that banks have plenty of cash on hand in the form of deposits, and will be able to absorb the added costs. This may be true, but those who think that banks will pass these increases in the cost of doing business on to their customers seem to have past practice on their side.

For investors, the effect of the downgrades on mutual funds will be felt most acutely. Thirty-eight closed-end funds, which are traded like stocks, were affected -- possibly increasing their costs to issue preferred shares to raise capital for other investments. Because public entities invest in these funds, federal law requires the securities they contain to be high-quality. The securities are backed by banks, but if their value falls, fund managers may sell.

Fool's take
While there seems to be some annoyance in store for everyone, especially investors, the damage doesn't appear to be earth-shattering. Time will tell, of course, but right now it seems as if everyone, including investors, is taking the news in stride. Banks will have to pay a little more to conduct their business, and the rest of us will wind up making up the difference. You know -- just like before the downgrade.

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Fool contributor Amanda Alix owns no shares in the companies mentioned above.

The Motley Fool owns shares of Citigroup, Bank of America, and JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Goldman Sachs Group. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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  • Report this Comment On June 28, 2012, at 8:43 PM, JacksonInVA wrote:

    I was way ahead of Moody's. I took my money out of my former bank and put it in a credit union. I have not invested in financials. Their business model is not sustainable.

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