Track the companies that matter to you. It's FREE! Click one of these fan favorites to get started: Apple; Google; Ford.



Why You Shouldn't Care That Moody's Downgraded These 4 Banks

This past Thursday ratings agency Moody's (NYSE: MCO  ) downgraded the credit rating for four major U.S. banks: Morgan Stanley (NYSE: MS  ) , JPMorgan Chase (NYSE: JPM  ) , Goldman Sachs (NYSE: GS  ) , and the Bank of New York Mellon (NYSE: BK  )  after a review of both industry wide trends and considerations for each institution specifically.

If you're an investor in any of these institutions, you shouldn't care. Here's why.

Terrible track record
First of all, everything we learn from Moody's or any other ratings agency should always be taken with a sizable grain of salt. If the financial crisis taught us anything, its to do your own homework. And certainly don't put all your faith into the opinion of a ratings agency. 

That being said, Moody's is a reputable company with sophisticated models developed by very smart people. Sophisticated models that, well, haven't really worked all that well in recent years.

  April 2007 November 2013 Change
Morgan Stanley Aa3 Baa2 Down 5 ratings
JPMorgan Chase Aa2 A3 Down 4 ratings
Goldman Sachs Aa3 Baa1 Down 4 ratings
Bank of NY Mellon Aaa Aa2 Down 2 ratings


Based on this chart, we must assume these banks are today either considerably more risky than they were just before the financial crisis erupted in the spring of 2007, or that Moody's was so unequivocally bad in their ratings back in 2007 that the disparity is due to an improvement in their systems. Both options are a bit of a hard sell, if you ask me.

As a market participant, I am placing no confidence whatsoever in Moody's assessment of these banks. It simply does not have the track record to deserve the credit. 

Cost of funds
Moody's report indicates that today there is less of an implied guarantee from the U.S. government to support these institutions in the event of another crisis. Without this implied backing, Moody's claims that the cost of capital will increase, tightening margins and weakening the earnings ability for each institution.

Data from the FDIC's Q2 2013 Quarterly Banking Profile, charted below, does indicate that large institutions have enjoyed a lower cost of funding since the financial crisis. It also makes logical sense that some of that cost advantage could come from investor confidence based on an implied government backing.

Source: FDIC.

That being said, the gap between large institutions and small institutions has narrowed in recent quarters, driven not by an increase in costs for large institutions but by a decrease in costs at smaller institutions.

Institutions by Size 6/30/13 6/30/2012 % Change
> $10 billion 0.40% 0.51% (21.6)%
$1 to $10 billion 0.53% 0.71% (25.4)%
$100 million to $1 billion 0.59% 0.79% (25.3)%
< $100 million 0.56% 0.73% (23.2)%

Source: FDIC.

The chart and the data bear it out. Cost of funds are declining across the industry, but the decline is more rapid at smaller institutions than large ones. 

Bottom line: The megabanks today really don't enjoy much of an advantage in terms of costs of funds, at least not clearly attributed to an implied government backing.

An alternative theory
In my view, it's more likely that the cost advantage stems from having a disproportionate market share of low-cost demand deposits. Checking accounts, savings accounts, and even certificates of deposit are all paying laughably low interest rates in today's world. It follows the banks with the highest concentrations of these funds will have a lower cost of capital.

Fellow Fool John Maxfield highlights the nation's top 10 deposit holders here, and it should come as little surprise that both JPMorgan Chase and the Bank of New York Mellon on are the list.

A final point -- what Moody's is and what it is not
If you are an investor in one or all of these banks and are concerned about your equity position because of the downgrade, I encourage you not to worry based on this fact alone. In fact, Moody's is not actually assessing the equity portion of the balance sheet. 

In the event of a catastrophic event where one or all of these banks were to fall into bankruptcy, Moody's ratings pay no mind to the shareholder. The concern is only of the likelihood of repayment to the company's debtors.

That being said, there's nothing wrong with monitoring your investments for ratings changes; a ratings change could be a harbinger for a change in the industry or at the company. Moody's analysis could point you to a new fact you may not have considered.

And that is the crux of it. An investment should be made after reviewing the data -- company data, industry data, and economic data -- and making your own decision. It's your hard earned money. Don't buy or sell because someone or some company recommends it. The best investors do their own homework, have their own point of view, and most fundamentally, make their own decisions.

A Moody's downgrade (or upgrade) is simply another data point in your analysis. And in my view, its a data point of very little value.

Finding the winning stocks
Many investors are terrified about investing in big banking stocks after the crash, but the sector has one notable stand-out. In a sea of mismanaged and dangerous peers, it rises above as "The Only Big Bank Built to Last." You can uncover the top pick that Warren Buffett loves in The Motley Fool's new report. It's free, so click here to access it now.

Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Compare Brokers

Fool Disclosure

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2733035, ~/Articles/ArticleHandler.aspx, 5/31/2016 12:32:03 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

Today's Market

updated Moments ago Sponsored by:
DOW 17,780.46 -92.76 -0.52%
S&P 500 2,093.82 -5.24 -0.25%
NASD 4,933.63 0.12 0.00%

Create My Watchlist

Go to My Watchlist

You don't seem to be following any stocks yet!

Better investing starts with a watchlist. Now you can create a personalized watchlist and get immediate access to the personalized information you need to make successful investing decisions.

Data delayed up to 5 minutes

Related Tickers

5/31/2016 12:16 PM
BK $42.09 Down -0.18 -0.43%
The Bank of New Yo… CAPS Rating: ****
GS $159.51 Down -0.02 -0.01%
Goldman Sachs CAPS Rating: ****
JPM $65.35 Down -0.08 -0.12%
JPMorgan Chase & C… CAPS Rating: ****
MCO $98.48 Down -0.26 -0.26%
Moody's CAPS Rating: ****
MS $27.47 Down -0.06 -0.22%
Morgan Stanley CAPS Rating: ***