Government initiatives such as TARP and Quantitative Easing were supposed to soften the blow of hard economic times and a monetary system that was all but dried up. The first two rounds didn't exactly do much, and the short-term economic outlook continues to be weak at best.
We're now on the verge of finding credit rating agencies reassessing an already delicate financial situation and big banks aren't doing too much to take cover. Are they implementing solutions to ease the wounds of investors? Some would agree to that. Are they doing enough to get this country, and its government back on the path to financial stability? Clearly they aren't. Bank of America (BAC), Goldman Sachs (GS) and Citigroup (C) are once again at the center of attention as far as Moody's, Standard & Poor's, and Fitch are concerned.
Bank of America has come to the realization that if its credit ratings were cut by two notches it could be liable for as much as $6.2 billion dollars in collateral. That equates to $5.1 billion dollars in long-term senior debt and $1.1 billion dollars in something called a net derivative liability. As of right now, BAC has Baa1/P-2 rating with Moody's, which is currently under review and has the possibility of being lowered in the coming weeks. This could be very detrimental to the existence of critical contracts and agreements Bank of America has in place with its customers and clients.
According to its recent 10-Q filing:
A further reduction of our credit ratings or the ratings of certain asset-backed securitizations may have a material adverse effect on our liquidity, potential loss of access to credit markets, the related cost of funds, our businesses and on certain trading revenue, particularly in those businesses where counterparty creditworthiness is critical. In addition, under the terms of certain OTC derivative contracts and other trading agreements, the counterparties to those agreements may require us to provide additional collateral, or to terminate these contracts or agreements, which could cause us to sustain losses and/or adversely impact our liquidity.
Investors haven't responded well to the news and BAC's stock has taken a 10% hit since its mid-week high on May 1. I'd be very cautious to pursue a position in the company in the coming weeks, as we wait and see what Moody's has to say. That being said, we should note the positions of both Citigroup (C) and Goldman Sachs (GS), as their blatant denial of Moody's credibility could drive their stocks downward.
As noted in its recent earnings conference calls, Citigroup and Goldman Sachs both believe that the individual investor doesn't consider the ratings agencies to carry much weight. According to Citigroup's CFO John Gerspach, "People are less and less solely relying on ratings of a single agency in making their decisions. Some might note changes in ratings from Moody's, but at this point in time, we don't think that the impact on us would be material." That's like saying no one pays attention to the Federal Reserve. It's a complete inaccuracy, since many investors cling to every bit of information that becomes available to them. If Moody's or S&P or Fitch downgrades a financial institution, you can bet your bottom dollar you will see a sell program initiated on that stock.
Investors should remain cautious on both Citigroup and Goldman Sachs as downgrades by the ratings agencies could send both stocks into a tailspin. Options may be a good strategy for the advanced traders, but unless some serious weakness occurs, I'd stay away from acquiring a long-term position in any of the three banks I've referenced.