Do Banks Deserve All of These Downgrades?
U.S. banks are getting a harsh reception from ratings firms like Fitch, regulators and even investors. Do they deserve the abuse?
Four years after the financial crisis started, banks are still having trouble shaking off their images as villains. The litany of banking sins has grown long: mortgage securitizations, aggressive lobbying against regulation, toxic cultures overly tolerant of jerks, a fitful commitment to lending, fees so high and so petty that they enter the realm of the absurd.Whether their alleged crimes happened on Wall Street, with zany derivatives, or Main Street, with usurious debit fees, there's no sympathy in America right now for anyone wearing a pinstriped suit.
So, if Fitch decided to downgrade all the major banks in a sweeping, "cut them all and let God sort 'em out" move today - following the months-old lead of Moody's and S&P - who will weep for the banks? That's right: no one.
It's still worthwhile to ask, however, if the banks are really as bad off as the tsunamis of downgrades and general unfocused scorn might suggest they are.
The short answer is: no, they're mostly okay, except for Bank of America and maybe Citigroup. The long answer is: no, they're mostly okay, except for Bank of America and maybe Citigroup, but all bets are off if Europe melts down.
Here's the explanation in a handy Q&A form.
Wait, what exactly did Fitch do? The details of Fitch's move aren't riveting, but just so you can drop the knowledge at dinner parties this weekend, here it is: Fitch cut its long-term ratings for all the biggies. It kicked Bank of America, Goldman and Citigroup down one notch, to A from A+. It knocked the European banks a bit harder, taking Credit Suisse and Barclays to A from AA-, and followed that up by marking down Deutsche Bank and BNP Paribas to A+ from their previous grade of AA-. (If you need a quick primer on what all these letters mean, check it out here; if you're really committed to winning the Internet on this , check out Fitch's long explainer on what "ratings" are here. )
Why would Fitch do this? Fitch's primary concern was that banks would be hit by regulation ("oh, boo hoo," replies an embittered populace). The firm was also concerned that banks would suffer from all the volatility that's been sweeping the market. Think of volatility in the markets as a choppy ocean; when stock and bond prices move up and down in crazy ways during the day, like brutal waves hitting the shore, that causes companies and pension funds to be reluctant to raise money, trade stocks, or otherwise take their boats out. The job of investment banks is to rent the boats - to be the middlemen who help these companies set sail. When there's volatility, the boats stay tethered and the investment banks don't make any money.
Were any banks spared? Yes. Fitch did not change its 'A' ratings on JPMorgan, Morgan Stanley and UBS, and kept its A+ rating on Societe Generale. Morgan Stanley pronounced itself "gratified" by this.
Are these the same complaints that Moody's and S&P had with banks? No, they had different concerns. (Banks are so big now that there are lots of reasons to worry.) Moody's downgraded BNP Paribas and two other French banks, for instance, because it feared the French government would be unlikely to save them if they need a bailout. Moody's cut its ratings on Bank of America, Citigroup and Wells Fargo for the same "too big to fail" reason in September. S&P downgraded the banks because it decided to use a new method of valuing them.
What's the effect of a downgrade, anyway? Is it just to talk smack? No. (Even though one of Easy Street's friends appealingly compares the process to the fake enmities in pro wrestling.) It's true that that downgrades can have a political purpose - as, for instance, when countries are downgraded when they refuse to pass perfectly sane laws making sure they don't default and take down the world financial system- but downgrades of banks largely serve as a real warning on the weakness of their businesses. A downgrade of credit will have a noticeable effect on most banks, in the same way that a lower credit score would have an effect on anyone: it makes it more expensive for them to borrow, and they have to fork up more collateral. Citigroup, for instance, estimated that just a one-notch cut in its ratings would cost the bank a whopping extra $4 billion in collateral payments, according to Bloomberg.
Are the U.S. banks running low on cash? Definitely not. They've been hoarding money since the financial crisis ended, and they continue to do that. KBW predicts that the main problem banks will have this year is how to spend all their loot - dividends, share buybacks, buying other banks?
Okay, but are banks going to be hurting for profits this upcoming year? KBW thinks most of them will do okay, mainly because they expect the economy to improve. But some banks will, inevitably, be worried about profits taking a downward slope in 2012, mainly because of issues like the European crisis and dodgy information about the regulatory future. Banks have been facing an identity crisis as they decide what businesses they should stay in, what will make them money, and how best to use their time and resources. They've been openly bitter about the Volcker Rule, an as-yet-undefined regulation in the Dodd-Frank act that will force banks to take fewer risks with their own money. Trading, a major source of fees, is suffering from that volatility we mentioned. Much of the investment-banking business, including the business of underwriting bonds, has slowed down in the wake of the European crisis. Confidence in banks is still low, too. (Although it's not as bad as September 2008, when Morgan Stanley had to remind its employees, "we still play a constructive role.") One method of figuring out how much a bank is worth is called "tangible book value." (It measures the worth of all their assets). KBW analysts pointed out that this week that for the group of big U.S. banks, they are now trading at 1.1 times tangible book value - the same value they had back in the dark days of early 2009, just after the bailouts.
Which ones? Bank of America, for one, according to analysts at KBW. It has been determined to stay focused the U.S., and the consumer. and real estate - three struggling groups - so the economic slowdown, the continuining mortgage crisis and the high national unemployment rate are likely to continue to hit the bank's profits, according to analysts at Keefe Bruyette & Woods. KBW also suggests that "if the Fed requires the banks to raise new capital, we believe Bank of America could be a likely candidate." (KBW said much of that would hinge on how Bank of America's mortgage settlements go this year.)
Are any of the downgraded banks in denial? Yes. Bank of America. It was downgraded by all three agencies but stubbornly refuses to take that personally. The bank's spokesman told Reuters, "This decision is driven more by concerns about the global economy than the specific credit quality of Bank of America. We continue to maintain strong liquidity levels and to build capital."
Is there a way to tell how badly the banks would be hurt if Europe hit a recession, or if the eurozone broke up? Nope, and not even the professionals don't know how U.S. banks would react to a true destabilization of the European banking system, or a breakup of the Eurozone. Barclays Capital analyst Jeff Meli told Easy Street, "trying to understand the interlinkages between banks is virtually impossible." Even the Federal Reserve, which supervises banks, is none too clear on the issue; analysts at KBW noted this week in their banking outlook that part of the purpose of the Fed's upcoming stress tests, called CCAR, is to judge how U.S. banks would fare in "a meaningful shock to the economic system." KBW concluded, "the Fed may be raising the bar to keep more capital in the system."