What Moody's Downgrades Mean for Your Business

by Cesar Bacani, 25 June 2012

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topics:
Finance and Banking

tags:
Corporate finance cost of capital risk management

In the hierarchy of Moody’s Investors Service’s standalone credit assessments, a ‘baa’ rating comes with the expectation that about one in 25 organisations with this profile “may fail or need support over a 10-year time horizon.”

That’s why there were some headshaking among CFOs and treasurers last week when the credit rating agency announced downgrades of 15 major banks with global capital markets operations. The median standalone credit assessment of those financial groups, which include heavyweights such as HSBC, Citigroup, JP Morgan, Bank of America, Goldman Sachs and Morgan Stanley, now stands at ‘baa2.’

However, the median long-term rating, which takes into account government and shareholder/group support, is ‘A2’ – the sixth highest grade in Moody’s 13-category ratings.

“We’re still assessing,” the CFO of a manufacturing company headquartered in Hong Kong told CFO Innovation. Like the other executives and bankers interviewed for this article, he requested anonymity to protect banking relationships and forestall investor and regulatory concerns.

A source at one of the 15 banking groups does expect some fallout. Some treasury governance policies specify that a counterparty to derivatives, hedging, foreign exchange and other contracts should have an ‘a’ standalone credit assessment. This bank’s standalone credit assessment has fallen to ‘baa2,’ although its long-term rating is ‘A2.’

The treasury governance policy can be changed to take into account the lowered ratings of many counterparties. But that’s something that must be decided by the risk committee and possibly at the board-level. In the meantime, financial risks must continue to be mitigated. The banks whose standalone credit assessment remained at the ‘a’ range might benefit at the expense of the ‘baa” ones.

Some companies might even rethink their panel of cash management and credit banking partners. “We want a long-term relationship with our banks,” explained one treasurer. If a bank is seen as potentially failing within ten years, its status within the panel of banking partners might be downgraded in favour of those with higher ratings.

Higher Cost of Capital

There are concerns as well about the higher cost of capital if the downgraded banks pass on the higher cost of doing business to customers. “These downgrades will increase the cost of doing business for banks, either through reduced, or more costly, access to funding or the need to lodge extra collateral with creditors,” Daiwa Capital Markets analyst Michael Symonds told Reuters.

Before its long-term rating was downgraded two notches from A1 to A3, Morgan Stanley warned in its first-quarter report that a downgrade by major credit rating agencies to A3 could cost it US$6.7 billion, representing one-off collateral and termination payments to counterparties.

Goldman Sachs estimated the hit of a two-notch downgrade at US$2.2 billion (Moody’s cut its long-term rating two notches from Aa3 to A2). For its part, Bank of America said a one-notch cut – Moody’s downgraded its long-term rating one notch from A2 to A3 – would cost it US$2.7 billion.

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