Moody's tilts playing field towards safe haven banks

By Matt Scuffham and Sarah White

LONDON | Fri Jun 22, 2012 8:29am EDT

Credit: Reuters/Mike Segar/Files

 (Reuters) - Downgrades by ratings agency Moody's will make funding more expensive for banks that rely the most on capital markets, while reinforcing the competitive advantage of "safe haven" banks that can fund themselves from stable customer deposits.

Stock markets took Moody's announcement that it had downgraded 15 of the world's biggest banks in their stride, as the rating agency's lowering by up to three notches had been widely anticipated.
European bank shares rose just under 1 percent. But longer-term, the downgrades could have a lasting impact.
But over the medium term, the downgrades will reinforce a trend that has seen weaker banks punished for their risk taking, while stronger banks are rewarded for conservative funding models, ensuring lower costs and higher margins.
 
Not only will funding costs rise for the worst-rated banks, but trading partners are bound to ask for more collateral - and steer business to those perceived to be financially stronger.
"The new ratings landscape could provide a competitive edge for higher-rated firms," said analysts at Citigroup.
Moody's gave the highest ratings to HSBC, Royal Bank of Canada and JP Morgan, which it said had stronger buffers than peers.
All three are regarded as safe haven banks, funded by deposits from millions of retail customers and relying less than riskier banks on capital markets for short term financing.
Moody's gave the lowest credit ratings to banks that have been affected by problems with their risk management or whose capital buffers are not as strong as rivals.
Those include banks like Morgan Stanley with few retail deposits, as well as banks like Bank of America, Citigroup and Royal Bank of Scotland, which despite having big deposit bases have gotten into trouble by combining their retail business with riskier investment banking.
Moody's placed Barclays, BNP Paribas, Credit Agricole, Credit Suisse, Deutsche Bank, Goldman Sachs, Societe Generale and UBS in a middle group of banks, which it said include firms that rely on unpredictable capital markets revenues to meet shareholder expectations.
For banks which rely heavily on markets for funding, the lower ratings make difficult conditions even worse, at a time when they are suffering because of the euro zone crisis and a global slowdown in growth.
"Markets tend to discriminate more between issuers at lower ratings - in terms of funding costs - particularly during times of stress," said Citigroup analysts.
The downgrades reflected a view on capital markets that was "something more structural and fundamental rather than what is just cyclical noise", Johannes Wassenberg, Moody's managing director of European banks, told Reuters.

"We tried to assess risk from capital markets... and the shock absorbers banks have," Wassenberg said.
Regulators have told investment banks to keep far higher capital buffers, making their business less profitable, while also taking a knife to some of their most lucrative businesses, such as trading for their own account.
The sector has been left with significant overcapacity, reports from consultancy firms have said, meaning the battle for the favors of clients can only intensify.


RISK MANAGEMENT
The ratings agency looked at the banks where exposures to capital markets were the most pronounced, picking firms by the share of revenue generated by fees from debt and equity advisory, trading revenues and trading inventories.
Analysts say banks that will be most affected by funding costs rising as a result of the downgrades are those that were most likely to have to put more collateral on the table.
"Most directly, there are contractual provisions in agreements that would require a firm to post additional collateral, or to replace itself as the counterparty to transactions," said analysts at Execution Noble.
Moody's said some of the lowest rated banks had undertaken considerable changes to their risk management models and were implementing business strategy changes intended to increase earnings from more stable activities such as retail banking. However, it said these transformations are ongoing and their success has yet to be tested.
Moody's said it had taken into account management action at firms like UBS, where it listed the bank's reduced ambition in investment banking as a positive factor.
The downgrades had been widely anticipated having been flagged by Moody's in February and the initial market reaction across Europe was muted.
Daiwa Capital Markets analyst Michael Symonds said the cuts could have been worse and the conclusion of the review removed an uncertainty from the market. However, he warned there could be more downgrades to come.

"The next round of downgrades may be just around the corner given the myriad challenges still weighing on the sector, including the far-from-resolved euro area crisis and imminent legislation on bail ins and resolution regimes," he said.

(Editing by Peter Graff)