Friday, June 22, 2012

Rating agencies will become less relevant for bank risk

The bank downgrades last night were met with enthusiasm by the markets. Morgan Stanley stock jumped after hours when the downgrade was less severe than expected.
SFGate/Bloomberg: - "If anything, the market is reacting with relief," said Strickland, who helps oversee $14 billion of fixed-income assets as a managing director at Santa Fe, New Mexico-based Thornburg. Morgan Stanley bonds likely will rally, said Strickland, whose firm owns the bank's debt. "The market is shrugging it off."

None of the financial firms was cut more than Moody's had forecast. Morgan Stanley's long-term senior unsecured debt rating was reduced two grades to Baa1, and nine other firms received two-level cuts, Moody's said yesterday in a statement. Credit Suisse's rating was cut three levels to A2 and Zurich- based UBS AG, the other firm singled out for a potential three- level cut, was lowered two instead.
Now that the well telegraphed downgrades are over, bank CDS are tightening this morning (MS and JPM CDS shown below).


At this point Moody's might as well downgrade major banks to below investment grade level and be done with it. Over time rating agencies will become less relevant for large bank credits as all major banks involved in capital markets will converge to roughly the same rating.
SFGate/Bloomberg: - "To downgrade a BofA or Citigroup or companies that are sitting on hundreds of billions of dollars of cash in government-backed securities makes no sense," Richard Bove, an analyst at Rochdale Securities LLC, said in an interview on Bloomberg Radio and Television's "Bloomberg Surveillance."

"You can forget Moody's," Bove said. "You should have forgotten them a long time ago."
Credit ratings may not even matter when government policy will dictate the outcomes. Bail-in provisions may drive the payout on unsecured bank bonds, particularly in Europe. Spain just announced that it plans to haircut some unsecured bank bonds (discussed here), setting precedent for this approach going forward.
Bloomberg (June 22): - Spanish policy makers are considering forcing investors who hold equity and junior debt in banks to absorb losses in a restructuring, according to a person with knowledge of the plan.

Such burden sharing is among conditions being negotiated with the European Union in a 100 billion-euro ($126 billion) rescue for Spain’s financial industry, said the person, who asked not to be named as the conversations are private. Depositors who bought subordinated instruments such as preferred stock may be partially shielded from losses through a compensation plan being considered, the person said.
There is very little that a rating agency can do to assess the risks of such policy decisions and whether or not a bank bondholder will receive par.
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