Moody’s may downgrade debt sold by three giants

Debt sold by Citigroup, Goldman Sachs Group and JPMorgan Chase & Co. is among the $450 billion of securities that Moody’s Investors Service said it may downgrade.

Some 775 hybrid and subordinated notes issued by 170 “bank families” in 36 countries are on review after Moody’s altered the assumptions it uses to rate the debt, according to an e-mailed statement from the New York-based risk assessor. Half the hybrids may have their ratings lowered by three to four grades, 40 percent may be cut by one or two grades and the rest may be lowered five steps or more, Moody’s said.

“The key concern is whether the ratings downgrades trigger investment mandate breaches which could force investors to sell,” said Ben Byrne, a credit analyst at Nomura Australia in Sydney. “We think the majority of the selling has already occurred, given that hybrids have been trading at prices significantly lower than their current ratings suggest are appropriate.”

The reviews come after financial institutions lost more than $1.6 trillion amid the worst global recession since World War II. Moody’s, Standard & Poor’s and Fitch Ratings were criticized by investors and lawmakers including U.S. Senate Banking Committee Chairman Christopher Dodd. The senator said the companies wrongly assigned top rankings to U.S. subprime-mortgage bonds that sparked a global credit crisis when their

value collapsed.

Susceptible to losses:

Moody’s has stopped assuming holders of hybrids, which mingle characteristics of debt and equity, would benefit from government support for troubled lenders after the global financial crisis proved that wasn’t the case, the ratings company said. The new system expects regulators to treat them more like equity, and takes into account the risk that banks might be forced to suspend coupon payments on their lower-ranked debt.

“In some cases government bank interventions throughout the crisis have not benefited, and have even hurt, the holders of those instruments,” Barbara Havlicek, a senior vice-president at Moody’s, said Nov. 17. “It is clear that hybrids are highly susceptible to losses due to their unique equity-like features.”

The debt being reviewed includes Goldman Sachs Capital I stock and Morgan Stanley Capital Trust III securities, according to a list of issues e-mailed by Moody’s. Goldman Sachs Capital I preferred stock was cut one level to A2, the fifth-lowest investment grade, by Moody’s in December.

Costly downgrades:

Any downgrades would be costly for banks, by increasing the amount they must pay to sell new notes, according to Nana Otsuki, a Tokyo-based analyst at UBS.

Preferred shares rated slightly above the lowest rung of investment grade are likely to be affected the most by the changes, Otsuki added.

Mizuho Financial Group sold $600 million of preferred shares in 2006 that are currently rated Baa1 by Moody’s, three grades higher than junk status, according to data compiled by Bloomberg. Some investors may have to sell securities like these if they were cut below investment grade, said Otsuki.

Shinsei Bank has $579 million of preferred shares outstanding sold in March 2006 and $675 million of securities outstanding sold the month prior, which are both rated as the lowest investment grade by Moody’s, the data show.

Wells Fargo’s Hybrid & Preferred Securities Financial Index has declined 17 percent since it peaked in May 2007, just before the onset of the global credit squeeze.

Securities ranked from Aaa, Moody’s highest grade, to Baa3 are considered investment grade by the ratings firm. Debt with a rating of Ba1 and below ranks as non-investment grade, also known as junk.

The reviews will take into account differences between countries and the relationships of individual banks with governments, Moody’s said. They are due to be completed within three months, it said.