(MCO) Moody’s Downgrades Three U.S. Mega Banks

On Wednesday, Moody’s Investors Service, a credit rating arm of Moody’s Corp. (MCO) downgraded its credit ratings on Bank of America Corporation (BAC), Citigroup Inc. (C) and Wells Fargo & Company (WFC). The rating cut followed the agency’s belief that the federal government will not save them whenever they are in dire straits.

The credit agency downgraded the long-term senior debt ratings of BofA to Baa1 from A2 and short-term debt to Prime-2 from Prime-1. The agency affirmed its negative outlook. Further, Citigroup’s short-term debt was reduced to Prime 2 from Prime 1, and long-term rating of A3 was maintained with a negative outlook.

For Wells Fargo’s, the rating on deposits was downgraded to Aa3 from Aa2. Also, the rating agency moved the long-term senior debt ratings to A2 from A1, affirming a negative outlook.

The U.S. banks that were sheltered by government bailout during the height of financial crisis, took more credit risk afterward, according to a University of Michigan study released last week. About 700 financial institutions received approximately $205 billion in bailout money as part of their participation in the Troubled Assets Relief Program (TARP) initiated by the government in 2008. Citigroup, BofA, Wells Fargo and JPMorgan Chase (JPM) were among the banks that received the largest bailouts from the government.

According to the study, after gaining ground with the bailout money, these banks aggravated their investments in risky securities than the less privileged banks that were deprived of government aid.

These repeated risks will ultimately result in further threats to the system. This has happened just because they did not pay for their previous mistakes. Moreover, risky assets have aggravated chances of collapse these days with the bailed out banks acting smart.

Therefore, Moody’s concludes that the federal government will allow the financially troubled banks to collapse, though might provide some support to systemically important financial institutions.

Further, Moody’s decision of downgrading BofA’s credit rating is based on the factors that are external to the company and do not reflect fading of its intrinsic credit quality. We believe that the negative outlook for the banks would lower investors’ confidence in their respective stocks. Moreover, debt ratings downgrade would lead to higher borrowing costs for the banks.

Meanwhile, The Federal Deposit Insurance Corp. (FDIC) entails the nation’s largest banks to outline ways to liquidate by breaking up and selling off assets if these are on the verge of collapsing. The resolution plans or so-called ‘living wills’ are required in a bid to reduce risks of further bailouts, if these banks sink in the event of another financial crisis.

Last week, the FDIC board voted in favor of living wills, which were mandated under the Dodd-Frank Act passed by Congress last year to revive the country’s financial system.

Actually, a systemic resolution would make it easy for the regulator to address bank failures efficiently, maximizing the sale value of a failed bank while minimizing their creditor losses. Moreover, the FDIC will carry the power to liquidate a bank if its collapse shakes the country’s financial stability.

Systemically important banks with at least $50 billion in assets will be required to file these wills to the FDIC, the Federal Reserve and the Financial Stability Oversight Council, effective January 1, 2012.

In June, the Federal Reserve needed 35 systemically important U.S. banks to submit their capital plans annually to prove their financial ability to confront another recession. The Federal Reserve also holds the right to ban capital deployment activities of unsuccessful banks. This is part of Federal Reserve’s effort to closely monitor capital ratios of banks and identify systemic risk in advance in order to avoid recurrence of the latest federal bailout program.

After learning a lesson from the latest recession, Americans will never wish to go back to those dreadful days only to earn higher capital rewards from their banks. Hopefully, living wills and disciplined reruns of stress tests will prevent big banks from experimenting with risky activities that can jeopardize general economic health. Most importantly, these advance precautions could ultimately translate to less involvement of taxpayers’ money for bailing out troubled financial institutions.

Currently, Wells Fargo retains a Zacks #3 Rank, which translates into a short-term Hold rating, BofA retains a Zacks #4 Rank, which translates into a short-term Sell rating, while Citi retains a Zacks #5 Rank, which implies a short-term Strong Sell rating.

BANK OF AMER CP (BAC): Free Stock Analysis Report

CITIGROUP INC (C): Free Stock Analysis Report

JPMORGAN CHASE (JPM): Free Stock Analysis Report

MOODYS CORP (MCO): Free Stock Analysis Report

WELLS FARGO-NEW (WFC): Free Stock Analysis Report

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