Richard Drew/Associated PressMorgan Stanley, along with Credit Suisse and UBS, could face a cut of up to three notches in its long-term credit rating from Moody’s Investors Service.Moody’s Investors Service has a message for Wall Street: the skies are still dark.
The ratings agency is reviewing 17 global banks, including Morgan Stanley, Citigroup, Goldman Sachs, Bank of America and Credit Suisse, for possible downgrades to their long-term credit ratings, dulling optimism caused by a monthlong rally in which major banks have recovered some of last year’s losses.
Moody’s said it was weighing the risks to the institutions’ investment banking models and exposures to its capital markets business, which include trading securities and underwriting stocks and bonds.
In a separate statement from London, Moody’s said it was reviewing its ratings for scores of banks based in European countries, including Italy, Spain and Britain. It cited the prolonged sovereign debt crisis and risks linked to large capital market businesses.
“The combination of changed operating conditions and increased regulatory requirements and restrictions has diminished these firms’ longer-term profitability and growth prospects,” Moody’s said in one of the statements, which was released on Wednesday after markets closed in New York.
Morgan Stanley, Credit Suisse and UBS could face cuts of up to three notches in their long-term credit ratings. Barclays, Goldman Sachs, JPMorgan Chase, Citigroup and Deutsche Bank are among the 10 firms that could have their ratings cut by two notches, while Bank of America and three others could be cut by a single notch, Moody’s said.
Credit downgrades could hamper Wall Street firms by making it more expensive for them to borrow money, as well as increasing the amount of collateral they are required to post for certain trades. In a regulatory filing last year, Morgan Stanley estimated that a credit downgrade of two notches — a more minor downgrade than the three notches being considered — would require it to post approximately $4.2 billion in additional collateral on derivatives contracts with its trading partners.
A Morgan Stanley spokesman, Mark Lake, declined to comment.
In the United States, the Moody’s review points to a sector that has been hobbled, perhaps permanently, by the introduction of new regulation designed to curb risky types of trading and require banks to hold more capital in reserve.
“The tone does seem to be secular rather than cyclical,” said Jeffery Harte, an analyst with Sandler O’Neill. “They’re looking at how the world is changed.”
Downgrades would be unlikely to surprise many investors, who have known for months about the constraints and dangers posed by regulation and the European debt crisis. On Thursday, the largest United States banks being reviewed for downgrade showed little movement in either their stock prices or their credit default swap levels, a measure of the cost of insuring against a firm’s default.
“It seems to be more of a historical rating than a prospective rating,” said Richard X. Bove, an analyst with Rochdale Securities, of the Moody’s review. “The reason they’ve provided is something they could have said 12 or 18 months ago.”
Although some firms were threatened with bigger downgrades than others, David Fanger, a senior vice president with Moody’s, said the problems that led to the wide-ranging review were common to most firms.
“With the most recent action, what we’re saying is that the whole sector’s relative positioning within our scale may be too high,” Mr. Fanger said in an interview on Thursday. “We don’t like to move ratings that quickly, but this is an industry that has demonstrated fairly significant transition risk.”
Last year was the worst since the financial crisis for Wall Street banks, which saw their revenues plunge as market activity dried up and a European debt crisis loomed. In November, Standard & Poor’s, a rival ratings agency, downgraded 15 banks, expressing concerns that new regulations and capital requirements could cut into their long-term profitability.
The Moody’s review, a project similar in scope to the review that led to the S.&P. downgrades, was sparked by concerns that the choppy waters of 2011 were caused by a seismic shift in the banking industry, rather than temporary problems that could lessen when the markets recover fully. Moody’s expects to make its final decisions on the downgrades within 90 days.
“Capital markets firms are confronting evolving challenges, such as more fragile funding conditions, wider credit spreads, increased regulatory burdens and more difficult operating conditions,” Moody’s said in its report.
In its review of European banks, Moody’s put under review 114 banks from 16 countries, including HSBC of Britain and Deutsche Bank of Germany. Among the reasons Moody’s cited were the deteriorating creditworthiness of the region’s countries and continued volatility in the Continent’s financial markets.
Italian banks were the most affected by Moody’s announcement, with 24 to be reviewed. Much of the ratings agency’s concern is targeted at the stagnant Italian economy. The International Monetary Fund expects the country’s gross domestic product to contract by 1.7 percent this year, while government debt currently stands at 120 percent of Italy’s gross domestic product.
“There’s a strong belief that the country’s public debt is not under control,” said Stefano Caselli, a banking professor at Bocconi University in Milan.
While downgrades could be bad news for banks, they may give investors a truer measure of the health of the financial sector. Firms are increasingly turning to businesses like wealth management that carry fewer risks, but lower returns, than once-lucrative proprietary trading desks that are now all but absent at large Wall Street banks.
The changes have already shown up in the bottom line. Goldman Sachs’s earnings dropped nearly 70 percent last year; Morgan Stanley’s were down 42 percent. And return on equity — a critical figure used to gauge a firm’s profitability — dipped into the single digits for many firms, a far cry from the 20 percent and 30 percent figures common in the precrisis era.
Those figures may recover as the market lifts, but Moody’s and other ratings agencies are still cautioning that Wall Street may be stuck with a less profitable, more constrained business model for the foreseeable future.
“On one hand, we think it will be more challenging for things to get back to the way they were,” Mr. Fanger said. “On the other hand, market participants may not want them to get back to the way they were.”