When there is a problem, the bond analysts typically spot it and call it out before the stock analysts. It makes sense. People buy stocks for the upside opportunity. People buy investment-grade bonds for income and safety. Investment-grade bonds have limited upside opportunity if the company's financials improve, but significant downside risk if the company's financials worsen. That gets bond analysts to focus on downside risk much more than stock analysts.
One of the best-known credit raters, Moody's, is getting more worried about downside risk at Bank of America (NYSE: BAC), Bank of NY Mellon (NYSE: BK), Citigroup (NYSE: C), and Wells Fargo (NYSE: WFC). Moody's has put its credit ratings on those four companies on watch for a potential downgrade. They join four other banks that were already on a negative credit watch: Goldman Sachs (NYSE: GS), JPMorgan Chase (NYSE: JPM), Morgan Stanley (NYSE: MS), and State Street.
Moody's deepening concerns center on an expected reduction in government support of "too big to fail" banks. Here's what Moody's had to say about B of A, Citigroup, and Wells Fargo:
Each of these ratings currently incorporates an unusual amount of "uplift" from Moody's systemic support assumptions that were increased during the financial crisis. ... The US government's intent under Dodd-Frank is very clear. Going forward, it does not want to bail out even large, systemically important banking groups. ... The support assumptions built into these three banks' ratings are unusually high, which may no longer be appropriate in the evolving post-crisis environment. ... [T]hese banks still have sizable residential mortgage exposures; their credit costs could therefore spike if the US economy were to contract again. Further, they continue to face litigation costs related to faulty foreclosure practices.
In contrast, Moody's went on to describe its government support assumptions for Bank of NY Mellon, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and State Street as in line with pre-crisis levels.
Foolish takeaway
Moody's has fired a warning shot on that front by putting eight big banks under review. News of a credit downgrade would likely increase borrowing costs and cause the stock price to decline.
The Motley Fool recently introduced a free My Watchlist feature to help watch your investments. You can get up-to-date news and analysis by adding companies to your Watchlist now:
