Last month, the employment situation looked to be improving as private job growth was the highest in 5 years. But this morning’s May employment report is disappointing and did not maintain the upward momentum from April. The 54,000 new jobs created in May was the smallest number in eight months and the unemployment rate rose to 9.1%, the highest rate so far this year. Also worrying: manufacturing jobs actually declined for the first time in 7 months, and last month’s good employment numbers were revised downward.
Moody's Will Likely Downgrade Three U.S. Banks Soon
Less optimistic Moody’s & Standard & Poor’s constitute the “big two” credit-rating agencies that control 80% of the U.S. market. Yesterday (June 2nd), Moody’s placed the debt ratings of Wells Fargo, Bank of America (NYSE: BAC), and Citigroup (NYSE: C) on review for possible downgrade. Although the impending May employment report was not the catalyst, it certainly didn’t help! The real catalyst was Title II of the Dodd-Frank financial reform legislation which President Obama signed into law in July 2010. Under Title II of Dodd-Frank, the Federal Deposit Insurance Corporation (FDIC) is responsible for liquidating “covered financial companies” that pose a threat to the financial stability of the U.S.
According to Moody’s Senior V.P. Sean Jones, this legislation means that the U.S. govt wants to eliminate the “too big to fail” policy that bails out big banks in times of financial distress:
The US govt'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.
Most at danger of a debt downgrade is Bank of America, which currently receives 5 notches of credit upgrade based on the govt’s “too big to fail” bailout policy during the 2008-09 financial crisis, whereas before the crisis it would have received only 3 notches (i.e., 2 notches of “extraordinary” upgrade). In other words, Bank of America’s current credit rating of Aa3 (4th best) would be only A2 (6th best) under pre-financial crisis bailout assumptions and only Baa2 (9th best) if the “too big to fail” bailout assumption was eliminated entirely.
Citigroup currently receives 4 notches of credit upgrade, which is one notch of “extraordinary” upgrade. This means that its current credit rating of A1 (5th best) would be only A2 (6th best) under pre-financial crisis bailout assumptions and only Baa2 (9th best) if the “too big to fail” bailout assumption was eliminated entirely.
Lastly, Wells Fargo currently receives 3 notches of credit upgrade, whereas before the crisis it would have received only two notches (i.e., one notch of “extraordinary” upgrade). In other words, its current credit rating of Aa2 (3rd best) would be only Aa3 (4th best) under pre-financial crisis bailout assumptions and only A2 (6th best) if the “too big to fail” bailout assumption was eliminated entirely.
"Reviews for Possible Downgrade" are Worse Than "Negative Outlooks"
Moody’s has also assigned a “negative outlook” on the credit ratings of five other big financial institutions: JPMorgan, Goldman Sachs, Morgan Stanley, State Street Corp. and Bank of New York Mellon. None of these banks have the “extraordinary” credit upgrades that the other 3 banks have, but Moody’s is also considering whether to downgrade any banks that have even pre-crisis “too big to fail” credit upgrades.
What’s the difference between a “review for possible downgrade” and a “negative outlook?” Long story short, a “review for possible downgrade” designation is worse. It means that Moody’s is likely to downgrade a credit rating in the short term (e.g., 3 months) whereas a negative outlook is a medium-term designation and less imminent.
Bottom line: get ready for credit downgrades of Bank of America, Citigroup, and Wells Fargo within 3 months. Although a single-notch credit downgrade would increase these banks’ financing costs by anywhere between $500 million and $1.2 billion, I don’t think it automatically means that you should sell these stocks. Keep in mind, though, what Sean Jones of Moody's had to say about Bank of America and Citigroup:
These 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, Wells Fargo remains one of Warren Buffett’s largest holdings and Wells Fargo CFO Timothy Sloan purchased 10,000 shares of the company’s stock on April 21st.
The turnaround at U.S. banks remains very uncertain and their balance sheets remain chock full of toxic mortgage assets.
No comments:
Post a Comment