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What the Moody's U.S. Bank Downgrades Mean for Investors

Moody's ratings agency issued five U.S. bank downgrades Thursday and a total of 15 cuts for global institutions, but markets shook off the news.

The ratings agency cited concerns about the stability of the global systems. Moody's said the banks are not as sound now as they were before the recent global financial woes and contagion.

"All of the banks affected by today's actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities," Greg Bauer, Moody's Global Managing Director, said in a statement Thursday.

Included in the ratings cuts were Citigroup (NYSE: C), Morgan Stanley (NYSE: MS), Goldman Sachs (NYSE: GS), Bank of America (NYSE: BAC) and JPMorgan Chase (NYSE: JPM).

Bank of America and Citi are now rated just two notches above junk status, while Morgan Stanley sits a hair higher at three notches above junk.

Moody's announcement came after the close Thursday, a rocky day for markets with the Dow Jones ending down 250 points and the Nasdaq lower by 71.

The cuts appeared to be a non-event in trading Friday. Shortly after the open, all three major indexes were modestly higher, with affected banks all in the green.

But Moody's U.S. bank downgrades could be a precursor to aggressive trading activity.

"It is a trading indicator that speaks to more volatility in the future for the banks as traders will be jumping all over earnings, derivatives moves, counterparty fears, correlation concerns, "negative watch" implications and regulatory impacts," said Money Morning Capital Waves Strategist Shah Gilani. "I expect the volume in financials to go higher as traders play them more and more."

U.S. Bank Downgrades Long Overdue

According to Money Morning Chief Investment Strategist Keith Fitz-Gerald, Moody's is late to the party.

"These downgrades are years too late and several trillion dollars short," said Fitz-Gerald. "What a joke by a bunch of clowns who missed the entire crisis in formation and who are now playing catch up in a pathetic attempt to appear as if they are on top of things."

Moody's first announced it was examining the banks in February. The review was driven by a "reassessment of the volatility and risks that creditors of firms with global capital markets operations face."

Now that the ratings cuts actually have been issued, the downgrades might have little effect on the market – but could limit the banks' profitability.

"It will affect cost of capital and collateral requirements for those with poor ratings and affect counterparty risk of those who don't," said Fitz-Gerald. "I expect this to also create an uneven playing field in terms of how these costs potentially affect profitability in regards to the ratings driven margin requirements, etc."

The downgrades could raise costs for the banks, making it more expensive for them to borrow money. The cuts may also make it more difficult for the banks to sell their commercial paper (a form of borrowing banks and other companies use to meet their short-term needs) to money market funds.

"Strategically the big universal banks may want to re-examine their business model," said Money Morning Global Investing Strategist Martin Hutchinson.

Investing on the U.S. Bank Downgrades

Banks stocks rallied Friday as investors viewed the downgrades less severe than anticipated.

"Ironically, markets will probably like this because "now the ratings are getting serious,'" said Fitz-Gerald.

While the cuts had little effect on the downgraded banks, the ones that maintained their credit ratings should fare even better.

"The downgrades should provide a great advantage to banks like Wells Fargo (NYSE: WFC) which haven't been downgraded because they are still primarily real banks, not fooling around in international capital markets," said Hutchinson. "Even if it gives them a funding cost advantage of only 0.0% to 0.1%, that's a huge income statement benefit on a $2 trillion balance sheet."

If nothing else, the U.S. bank downgrades give investors some clarity to things the public doesn't always see.

"It's a wake-up call that there's more to banks' balance sheets than meets the eye," said Money Morning's Gilani. "If S&P come out on the heels of Moody's and does downgrades that will be significant in terms of corroboration. It will have an impact if they don't announce in advance that they're doing it…if they do."

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