Downgrades Put Added Pressure on Big Banks to Sell Assets

Expect less lending and more divestitures at some of the largest U.S. banks in reaction to the downgrades by Moody's Investors Service.

The short-term damage from Thursday's downgrades should be minimal at Bank of America (BAC), JPMorgan Chase (JPM) and Citigroup (C). The three are awash in liquidity, and they have counterparties and investors that have priced the ratings changes into their cost of funds, experts say.

But higher borrowing costs and the need to post more collateral with lenders over time puts more pressure on the banks to stockpile more reserves.

"At the margin it makes them more anxious and willing to divest," says David Deitze, the chief investment officer of Point View Wealth management in Summit, N.J. "There are various ways that you can build up the reserves. You can decrease lending. But if you feel like you can get a good price for a piece of a non-core business, you can take the cash and use that to pad the reserve."

Though Bank of America and Citigroup in particular have already been looking to divest non-core operations such as overseas wealth management arms, "this makes those types of transactions even more likely," Deitze says.

Overall, analysts described the downgrades of the three biggest U.S. banks and 12 other major players as unsurprising but important.

The "downgrades could impact funding costs and reduce liquidity, albeit modestly," Andrew Marquardt, a banking analyst with Evercore Partners (EVR), wrote in a research note Thursday.

The need to post additional collateral could increase their borrowing costs, he wrote, adding that big stores of excess liquidity should mitigate the near-term impact to funding costs.

He also noted that Citigroup has already indicated that its counterparties have already factored in a Moody's downgrade in determining funding rates.

Brad Hintz, a bank analyst with Sanford C. Bernstein, was for the most part similarly unfazed by what he described in a note Friday as "Moody's well-telegraphed action" that banks had already "provided guidance on."

These institutions' credit default swaps have long traded at a discount to the market rates appropriate for their pre-downgrade credit ratings, he wrote.

He concurred that pricier funding could hamper lending and capital markets activity.

"Funding availability will be more constrained," Hintz wrote. "This will make the bank's management more cautious in managing its trading books and approving new, less liquid commitments."

David Konrad of Keefe Bruyette & Woods (KBW) said the actual downgrades remove a market "headwind" in that there was considerable uncertainty over the expected downgrades.

The actual size of the downgrades came in as expected at JPMorgan, Bank of America and Citigroup, he wrote. The additional collateral they now need to post should be immaterial given their "large amounts of unencumbered assets," he wrote.

Moody's made the following long-term debt downgrades: Bank of America fell one notch from Baa1 to Baa2; Citigroup declined two notches from A3 to Baa2; and JPMorgan Chase declined two notches from Aa3 to A2.