Moody's Has Big U.S. Banks in Its Sights

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Moody's Investors Service has been traipsing around the globe the past few weeks, wielding its sword to trim banks' credit ratings to reflect their actual status in the financial world. Recently bailed-out Spain had 16 banks downgraded last month, preceded by cuts in Italy, where 26 banks were also hit. This year, banks in Denmark, Austria, and even Germany have felt the pain, as new economic crises keep cropping up in the European arena and banks have their ratings adjusted to reflect the risk. Next in line? U.S. banks, perhaps as early as this week, will come under Moody's scrutiny -- causing jitters throughout the financial sector.

Plenty of warning
Moody's sent out warning flares in February, when it announced its plans to examine 17 global banks, including Bank of America (NYS: BAC) , JPMorgan Chase (NYS: JPM) , Morgan Stanley (NYS: MS) , Citigroup (NYS: C) , and Goldman Sachs (NYS: GS) . Although a blurb on Moody's website a few days ago indicated that the ratings agency acknowledges the strides U.S. banks have made so far this year, the outlook is being dampened by economic problems at home. Of course, the European situation is not helping, either.

Big banks have been using the grace period to lobby the agency in an attempt to blunt the effects downgrades would have on their businesses. Meanwhile, investment groups have been reducing their exposure to the banks' investment products, and municipalities have been moving their debt around to avoid repercussions in case of a ratings cut. Good for some banks, perhaps, but not for the big five undergoing the review.


Fool's take
How much of a cut is Moody's considering for each of the big boys? The ratings agency indicated that Morgan Stanley could suffer a downgrade of up to three levels, but the bank seems to doubt that it will be more than two, considering its robust Tier 1 common ratio, which surpasses those of its closest competitors. Goldman Sachs, Citigroup, and JPMorgan are in line for a cut of two notches, while B of A may escape with a slight trim, at only one. Citi and B of A may have their short-term debt rating knocked down, however, from Prime-1 to Prime-2, possibly taking them off the table as an investment vehicle by money market funds.

Justified or not, one result of these downgrades could be rising borrowing costs and smaller trading revenue for the big banks. Cities and towns that issue debt backed by the banks could need to find other backers or see their borrowing costs rise.

Investors are holding their collective breath at the moment, waiting to see where the chips fall. Right now, that's the best course of action to take. Despite some brighter economic news recently, actions like this one bring home the reality of just how far we have to go before the Great Recession is behind us.

There's a lot of uneasiness right now in the financial sector, but there are still some bright spots for investors looking for well-managed, profitable banks. Find out why our banking analysts call these investments "The Stocks Only the Smartest Investors Are Buying." This special report is free.

At the time this article was published Fool contributorAmanda Alixowns no shares in the companies mentioned above. The Motley Fool owns shares of Bank of America, JP Morgan Chase, and Citigroup.Motley Fool newsletter serviceshave recommended buying shares of Moody's and Goldman Sachs. The Motley Fool has adisclosure policy. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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