Moody’s Downgrades Credit Ratings of Three Large Banks

The downgrades were driven by Moody’s conclusion that the federal government was less likely to step in and provide support for a faltering big bank the way it did after the 2008 collapse of Lehman Brothers, when Washington executed a series of actions including capital infusions and credit guarantees to halt the spreading panic.

Moody’s had put the banks on notice for a possible downgrade on June 2.

While Moody’s said it “believes that the government is likely to continue to provide some level of support to systemically important financial institutions,” the agency added that the government “is also more likely now than during the financial crisis to allow a large bank to fail should it become financially troubled.”

Under the Dodd-Frank financial regulatory reform passed by Congress in 2010, financial institutions must file a so-called living will that lays out steps for an orderly liquidation in the event of a financial collapse. The goal is to avoid future government bailouts, as well as the kind of turmoil unleashed by Lehman’s unexpected bankruptcy.

“Now, having moved beyond the depths of the crisis, Moody’s believes there is an increased possibility that the government might allow a large financial institution to fail, taking the view that the contagion could be limited,” the firm said in a statement. Even so, Moody’s said it doubted whether a global financial institution could be liquidated “without a disruption of the marketplace and the broader economy.”

The ratings agency cut Bank of America’s long-term senior debt to Baa1, three levels above junk. For Citigroup, Moody’s cut its ratings on short-term debt to Prime 2 from Prime 1, while affirming its A3 long-term rating. Moody’s lowered its rating on Wells Fargo’s senior debt to A2 from A1. Its Prime-1 short-term rating was affirmed. Of the three institutions, Bank of America has the lowest credit rating.

Shares of all three big banks fell sharply after the downgrade, but Bank of America dropped the most, falling 7.5 percent to $6.38 a share.

Although big banks enjoyed higher credit ratings before the financial crisis, Wednesday’s move was not unexpected, and analysts played down its significance. Although it could slightly raise borrowing costs over the long term, banks are not expected to have to pay significantly more to finance their operations in the near term.

“It’s not a good headline, but it shouldn’t have much impact,” said Jason Goldberg, an analyst with Barclays Capital, adding that even the federal government’s loss of its AAA rating this summer had not raised its borrowing costs.

In addition to seeing the government as less likely to support Bank of America, if needed, Moody’s said that the company “remains exposed to potentially significant risks related to both the residential mortgage and home equity loans on its balance sheet, as well as to mortgages previously sold to investors.”

Investors are seeking to force Bank of America to pay billions of dollars for its alleged misdeeds during the height of the housing boom, especially the bubble-related excesses at Countrywide Financial, the subprime giant Bank of America acquired in 2008. Bank of America has reached settlements with some investors, but other holders of mortgage-backed securities assembled by Bank of America, Countrywide and Merrill Lynch, another subsidiary, are suing to recover multibillion-dollar losses.

Moody’s was careful to note that its action did not reflect a weakening of Bank of America’s “intrinsic credit quality.”

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