Moody’s Downgrades Regional Banks

At cocktail parties for professional investment community, investors often joke that bond professionals are the “smart people in the room.”  While there are, in fact, many VERY smart investors in all asset classes, bond folks generally stick out because they speak a different language.  They talk about convexity and duration as if normal people understand these measures.  They somehow get a kick out of things like yield curve changes and refer to them as twists, bull steepeners, bear steepeners, flatteners, and any number of other gyrations.  To make it worse, they talk in yields which are, of course, inversely related to prices… if you’re confused already, we get it.  

The flip side of this of course, is that bond folks often rely heavily on ratings agencies to help with fundamental due diligence.  Moody’s is one of the big three ratings agencies and considering recent news of Fitch downgrading the US Government to AA+, it seems they were due to make some headlines. 

Moody’s, of course, holds the one remaining Aaa rating on the US Government, so they couldn’t change that without controversy, so instead, they decided to downgrade regional banks and warn some larger players.  Make no mistake, this is the right thing to do, but it was unnerving to those who weren’t paying attention.  That’s not to say that these are bad banks, most of them are not.  But the market has taken a cyclical downturn.  Interest rates have moved faster than the banks could adjust their balance sheets, and tightening credit conditions mean that they won’t generate the same fee revenue they’re used to.  Profitability will be negatively affected, and debt services will similarly be less attractive.  

What we find alarming about the downgrades over the last few weeks is that they did not come with new information.  We’ve known what was coming for a LONG time.  You’ve known what was happening for a long time.  In the investment business, we often refer to situations like this as “barn door” downgrades because the horses have clearly already left the stable.  As we mentioned above, bond people are supposed to be the smart ones, why should they be so beholden to what the ratings agencies have to say? 

Source: The Wall Street Journal