Will Bank Profits Get Clipped From Credit Rating Downgrades?

Bank Profits Could Be Squeezed by Credit Rating DowngradesProfits at some of the nation's leading regional banks could suffer as the result of a potential credit rating downgrades stemming from the adoption of the Dodd-Frank financial regulation overhaul legislation.

Moody's Investors Service (MCO) has disclosed that it's reviewing 10 large regional banks for possible downgrades because it believes "the potential for government support for these banks will be reduced" following adoption of the Dodd-Frank legislation, which was signed into law by President Obama on July 21.

Moody's also said it was changing its credit outlook from stable to negative for Bank of America (BAC), Citigroup (C) and Wells Fargo (WFC), also because of Dodd-Frank, though it said it was affirming both the short-term and long-term ratings of those banks.

The ratings agency said it had previously taken into consideration the government's statements that it would provide extraordinary support for regional banks when it issued its ratings for those firms in 2009. "Now that the U.S. banking system has moved beyond the depths of the financial crisis, the probability of government support for these banks could be lower, in Moody's view," it said in a release.

Still "Too Big to Fail"?

The 10 banks under review are subsidiaries of BB&T (BBT), Capital One Financial (COF), Fifth Third Bancorp (FITB), KeyCorp (KEY), PNC Financial Services (PNC), Popular (BPOP), Regions Financial (RF), SunTrust Banks (STI), U.S. Bancorp (USB) and Zions Bancorp (ZION). The U.S. government has a stake in six of the banks because of capital it injected at the height of the financial crisis under the TARP program, which those banks have not yet paid back.

Brian Kelly, president of Kanundrum Capital in Darien, Conn., says he thinks it's likely that the ratings agencies will downgrade those regional banks because the main point of the Dodd-Frank legislation was to remove taxpayer support for too-big-to-fail financial institutions. "There's a lot of unintended consequences coming down the line from Dodd-Frank," Kelly says.

Albert Savastano, banking analyst at Macquarie Capital (USA), notes that if Moody's does downgrade the regional banks, "it could cost them more to borrow." Borrowers with lower credit ratings generally have to pay more for loans. Higher credit costs would be an "incremental negative" for profits, Savastano says, but the banks might have other avenues to boost earnings.

But Savastano says he doesn't agree with the underlying Moody's analysis because there's nothing in the Dodd-Frank bill that leads him to believe the government will really end its support for those institutions. "When push comes to shove, when one of these too-big-to-fail banks is going to fail, do you really think they are going to wind it down?" he asks. "I don't think so."

Bullish View on International Banks

Kelly believes profits at the regional banks could suffer for a number of reasons. If a ratings downgrade causes credit costs to rise, at this point, the banks might have a hard time trying to pass those costs on to customers.

"We saw in all the banks' earnings reports over the last week that there's not much demand for credit," Kelly says. "If there's no demand, you can't really raise your price to lend. If the banks' costs of borrowing go up, obviously their margins get squeezed."

Kelly added that he thinks the regionals are suffering because small business is hurting at the moment. While U.S. economic indicators are turning downward, companies like Caterpillar (CAT) and IBM (IBM) are doing fairly well because of the strength of their overseas business. That suggests to him that U.S. weakness is primarily due to smaller businesses that don't have access to overseas markets.

For the same reason he's more bullish on the big money-center banks like Bank of America and Citi because they have exposure to Asia and other developing markets that are doing reasonably well.

Savastano disagrees, however, saying that the big banks may suffer more because that's where the bulk of derivatives trading and hedge fund and private-equity investing take place. Both of those activities have been curbed by the financial reform law, but the full impact of the law on earnings won't be known until regulators draft the rules under which it will be implemented.

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Several factors come in to play when determining which bank may be right for you. There are countless choices and options that factor in where you bank and there are many issues you may want to consider prior to establishing a relationship.


August 02 2010 at 8:30 AM Report abuse rate up rate down Reply

Oh Yes--I must have been watching FOX NEWS--that's an ORIGINAL ONE...Didn't you want to add, IT'S ALL BUSH'S FAULT TOO? That's another one people probably haven't heard before! LMAO!!

July 29 2010 at 3:02 PM Report abuse +1 rate up rate down Reply

I saw the president on The View today, teachanne......he answered questions about the war in Afghanistan, talked about Iraq, answered questions about jobs and the stimulus, talked about al-qaeda in the Pakistan/Afghanistan region......called it "Chaosistan"......lol......talked about healthcare reform, talked about small businesses, talked about education and a particular letter he received from a 10 year old student......it was a great discussion. You must have been watching Fox, and just thought it was The View.

July 29 2010 at 2:46 PM Report abuse -1 rate up rate down Reply

Did anyone notice the headline - "Citigroup paying $75M to settle fraud charges"? This is how large corporations avoid jail time for their misdeeds.......they pay off governments across the globe.

July 29 2010 at 2:41 PM Report abuse +3 rate up rate down Reply

I CANNOT BELIEVE The President of the United States was taking his time to be on The View answering those oh so important questions about Lindsay Lohan and Snooki! THIS PRESIDENT IS A JOKE!! He has absolutely NO RESPECT for his position and his country--What an embarrassment!!

Let's spend time on a useless talk show, not worrying about the economy or oil spill!

July 29 2010 at 2:39 PM Report abuse +1 rate up rate down Reply
1 reply to teachanne's comment

Look, America is failing, in large part because Americans are encouraged to gamble and not to save money. Just the opposite of a strong economy. To build a strong economy, savings accounts need to pay between 5% and 7% interest. The national average today, is 1/2%.

July 29 2010 at 2:20 PM Report abuse +2 rate up rate down Reply

Who are you kidding. Banks will never be happy with less. Make them keep more in reserve and it becomes an expense that needs to be paid for with higher fee's or interest rates. In fact anything the Government madates to any business becomes an operational expense that will be paid for with higher income or a cut in expenses like payroll. And in the end you and I will end up paying the bill with higher prices for any and all of the goods and services we buy.

July 29 2010 at 2:17 PM Report abuse rate up rate down Reply

When asked on "The View" today " Do you think Snooki should run for mayor of Wasala, Alaska"? He admitted he didn't know who Snooki was. AHA!

July 29 2010 at 2:02 PM Report abuse +2 rate up rate down Reply

Welcome to the Brave New World, folks. LOL

July 29 2010 at 1:50 PM Report abuse -3 rate up rate down Reply

Banks profits will be down if this regulation is to do any good at all. They were rigging the risk with leverage and little ovcersight. They would tell customers to buy the same thing they were selling.

July 29 2010 at 12:52 PM Report abuse +2 rate up rate down Reply