Moody's Investors Service said it may downgrade the debt ratings of Bank of America Corp, Citigroup Inc and Wells Fargo & Co, citing concerns about waning U.S. political willingness to offer support for the largest banks.
The sweeping Dodd-Frank financial reform law is eliminating the certainty of U.S. governmental support that some too big to fail banks needed to survive the financial crisis, Moody's said on Thursday.
Lower ratings can translate into higher borrowing costs, which can have a big impact on a bank's bottom line. They can also force banks to post more collateral in derivative trades.
But the ratings agency acknowledged an overall improvement in the operations of Bank of America and Citigroup since the crisis. That recovery could compensate for the changing political environment and lessen the severity of any downgrade, Moody's said on Thursday.
The banks' shares fell initially after Moody's made its announcement, but turned positive by midday.
If you factor in the credit improvement, basically it could be a wash. ... The headline was scary but if you read further, it's not that bad, said Alan Villalon, a senior bank analyst at Chicago-based Nuveen Investments, which owns bank shares.
Debt markets reacted more negatively, with costs for credit-default swaps on the banks rising. Bank of America CDS were most affected, with the price to protect $10 million of bonds over five years rising to $157,000 a year from $147,000 the day before, according to Markit.
But some of the banks' debt holders were unconcerned.
It's old news and reactive to events that are very obvious ... it doesn't dissuade us from owning the debt of those banks, said Marshall Front, chairman of money manager Front Barnett Associates, which owns bonds of banks including Citigroup, Bank of America and Wells Fargo.
LOSING GOVERNMENT 'UPLIFT'
Moody's said on Thursday it placed the deposit, senior debt and senior subordinated debt ratings of the three banks under review for possible downgrades.
The banks' ratings are currently buoyed by uplift from government support of the banking system during the financial crisis, Moody's said.
But the Dodd-Frank financial oversight law of last year has reduced the level of government support that large U.S. banks can count on. The banks' ratings may need to be downgraded to reflect the loss of that uplift, Moody's said.
Dodd-Frank aims to remove the market perception that some banks enjoy an implicit government backstop by giving the Federal Deposit Insurance Corp the power to dismantle financial firms if they start to topple.
The FDIC is working to sketch out how this orderly liquidation authority will work. It hopes the fleshed-out plan will convince markets that policymakers are serious about not bailing out financial giants in the future.
Moody's on Thursday also changed the deposit, senior debt and senior subordinated debt rating outlook on Bank of New York Mellon to negative from stable. The change will bring the bank's outlook into line with the seven other U.S. banks whose ratings currently benefit from an expectation of governmental support, the agency said.
The ratings agency also will reassess the financial strength of Citigroup and Bank of America on their own, without considering possible government support. Moody's said it could raise the banks' baseline credit assessments, which would temper the size of the potential downgrades to the banks' debt and deposit ratings.
But the banks still face other outstanding risks. Moody's cited their large exposure to residential mortgages and their potential legal costs related to faulty foreclosure practices.
Bank of America is currently rated A2 by Moody's, while Citigroup is rated A3 and Wells Fargo is rated A1.
Bank of America said in its quarterly filing with regulators that it had long-term debt of $434.4 billion as of March 31. Citigroup said it had $376.5 billion, while Wells Fargo said it has $148.6 billion.
Citigroup Chief Financial Officer John Gerspach said in an e-mailed statement, We welcome the reassessment of our stand-alone financial strength by Moody's.
Bank of America spokesman Jerry Dubrowski said, We believe that our stand-alone rating should be higher, given the progress we've made in recovering from the financial crisis and strengthening the bank's balance sheet.
Wells Fargo spokeswoman Mary Eshet said in a statement that the bank's unsupported ratings were not placed under review and remain among the strongest in the industry.
A Bank of New York Mellon spokesman declined to comment.
(Reporting by Maria Aspan; additional reporting by Stephen Carter of IFR Markets; Editing by Derek Caney, John Wallace, Tim Dobbyn and Gunna Dickson)