After putting banks on watch four months ago, Moody’s Investors Service on Thursday slashed the credit ratings of 15 large financial firms, in a move that could do lasting damage to their bottom lines and unsettle the markets.
Two U.S. banks that were hit hard in the financial crisis emerged with the lowest ratings. Citigroup and Bank of America are now rated only two notches above junk-bond rating. While Morgan Stanley avoided a worst-case scenario of a three-notch downgrade, its rating slipped by two levels.
The downgrades are a blow for the banking industry, which is already dealing with the European sovereign debt crisis, a weak U.S. economy and new regulations.
“All of the banks affected by today’s actions have significant exposure to the volatility and risk of outsized losses inherent to capital markets activities,” Moody’s global banking managing director, Greg Bauer, said in a statement.
Executives from big banks will try to convince creditors and large customers that Moody’s has overreacted.
“While Moody’s revised ratings are better than its initial guidance of up to three notches, we believe the ratings still do not fully reflect the key strategic actions we have taken in recent years,” Morgan Stanley said in a news release.
Moody’s downgrades are part of a broad effort to make the company’s analysis more rigorous. The financial crisis stained the reputation of credit rating agencies.
Banks are particularly sensitive to downgrades because they rely on the confidence of creditors and big customers. A lower rating could push up their borrowing costs.
A downgrade also could crimp core business, such as derivatives. In the face of a downgrade, some customers might choose to transfer their business from the lowest-rated banks to higher-rated ones.
The threat of the downgrade has rippled through the markets for months. Morgan Stanley’s shares are down 25 percent since Feb. 15, when Moody’s first held out the possibility of large downgrades. The cost of insuring against a Morgan Stanley default has risen by 16 percent since then, according to Markit, a firm that provides the prices of default swaps.
Before the announcement Thursday, bank shares continued to fall. Goldman Sachs, Citigroup, Bank of America and Morgan Stanley were all down for the day.
The downgrades come at a time of great uncertainty in the global economy. Europe’s currency union is under threat from bad bank loans. The U.S. economy is slowing and the fast-growing emerging economies of India, Brazil and China are also cooling. Financial markets also have been volatile.
On Thursday the Dow Jones industrial average plunged 251 points, its second-worst loss of the year, as new reports indicating slower manufacturing in the U.S. and China made investors fearful that the global economy could be heading for another slump.
Moody’s has been on a downgrading spree lately. In June Moody’s downgraded Spain by three notches, after downgrading 16 Spanish lenders in May. It also has cut the ratings on seven German and three Austrian lenders.The Associated Press contributed to this report.