J.P. Morgan & Co. lost its coveted triple-A ratings this week when Moody's Investors Service Inc. finally reacted to the bank's shift in business focus with a downgrade.
As far as Morgan's business is concerned, however, the action - which affected about $5.4 billion of securities of the holding company and various units - was a nonevent. Markets had already penalized the bank for its business strategy.
"The downgrade had more psychological than financial implications," said Katy Rossow, vice president of corporate bond research at Salomon Brothers Inc.
"What drove the rating change was not any one negative event or a series of negative events," said Moody's senior analyst Michael Foley. Morgan's shift away from commercial banking and toward more volatile trading-based investment banking prompted the action, he said.
"Moody's is sending a message that this business that banks are moving into in a bolder fashion is not supportive of a triple-A rating," said Joseph Labriola, director of bond research at Deutsche Bank Securities Corp.
The two Morgan banks, Morgan Guaranty Trust Co., and J.P. Morgan Delaware, were the last U.S. banks with a triple-A counterparty rating from both Moody's and Standard & Poor's Corp. Long-term deposits and senior obligations also carried the highest rating.
Morgan's banks still have AAA ratings from Standard & Poor's, though the agency has placed them on a negative outlook.
The two banks will now share the distinction of having the highest rating of any U.S. banks, Aa1, with Republic National Bank of New York.
Analysts said the change in Morgan's business mix was reflected in bond spreads even before the downgrade.
Moody's had placed Morgan's debt on negative credit watch on Nov. 10. In late January and early February, as the bank debt market weakened, Morgan's debt climbed to 69 basis points over comparable Treasuries.
The day before Moody's announcement, on Feb. 13, the debt spread had narrowed to close at 61 basis points over Treasuries. The downgrade raised the debt spread by 3 basis points. The next day, however, the debt fell a basis point and was trading down another basis point on Thursday.
"The market activity suggests that there was overkill," said Ms. Rossow of Salomon Brothers.
Some suggested that the downgrade in counterparty rating to Aa1 from AAA might affect Morgan's derivatives business, but Ms. Rossow said it would have little impact.
"The first real ratings hurdle for derivatives is between AA and A," she said. "There is also a massive cut from A to BBB, although Morgan is a long way from that." Any loss in Morgan's derivatives business will not only be on the margin, she said, but would be negligible relative to the daily vacillations of the balance sheet.
Indeed, Morgan's weakening balance sheet during 1994 tipped off the fixed-income and equity markets to an impending downgrade. Along with several others, Lawrence W. Cohn, a bank analyst at PaineWebber Inc., predicted a downgrade last year.
"We viewed the volatility in trading results and sharp reductions in earnings as the key that would drive a downgrade," said Mr. Cohn.
Mr. Cohn thinks the mild effect on Morgan's stock shows that the equity markets had anticipated this.
Morgan disputed the downgrade. "By traditional measures of creditworthiness - capitalization, asset quality, liquidity, and long-term profitability - Morgan remains an exceptionally sound institution," the bank said.
"Morgan is correct about their capitalization and asset quality. However, they certainly are no longer in a traditional business," Mr. Labriola said.
Several analysts suggested that they wouldn't be surprised if Standard & Poor's followed suit in changing its rating. S&P, however, said that its negative ratings outlook bespeaks a longer-term perspective. It would not speculate on a rating change.