Moody's Analytics Report Finds Market Reacts to Ratings Downgrade

A recent report from Moody's Analytics suggests that credit default swap (CDS) spreads widened on the debt of Bank of America, Citigroup, and Wells Fargo following a ratings downgrade by Moody's Investors Service on September 21. The report, which notes the arm's length relationship between Moody's Analytics and Moody's Investors Service, concludes that the market priced in a greater risk of default by these banks. Specifically, Bank of America, which received a two-notch downgrade, showed the most negative reaction from CDS investors.

Key Takeaways:

• The market reacted to Moody's Investors Service's September 21 ratings downgrade of Bank of America, Citigroup, and Wells Fargo by pricing in a greater risk of default by these banks.
• Credit default swap (CDS) spreads widened on the debt of Bank of America, Citigroup, and Wells Fargo following the ratings downgrade.
• Bank of America, which received a two-notch downgrade, showed the most negative reaction from CDS investors.
• Moody's Analytics' report highlights the increased likelihood of these banks being bailed out as a result of the Dodd-Frank law passed in 2010.
• Tony Smith, author of the Moody's report, argues that Moody's Investors Service's ratings downgrade was a market-moving event that introduced a new input not previously discounted into prices.
• Moody's Analytics' report appears to be an attempt to provide objective analysis of the impact of ratings decisions made by Moody's Investors Service.

Statistics:

• 2-notch downgrade of Bank of America by Moody's Investors Service on September 21.
• 1-notch downgrade of Citigroup and Wells Fargo by Moody's Investors Service on September 21.
• CDS spreads widened by 10-15 basis points on the debt of Bank of America, Citigroup, and Wells Fargo following the ratings downgrade.
• The Dodd-Frank law passed in 2010 reduced the likelihood of bank bailouts.

Sources:

• "Bank of America, Citigroup, Wells Fargo cut by Moody's" by Dan Freed, TheStreet, September 21.
• "Moody's Analytics: Market appears to have reacted to Moody's ratings downgrade" by TheStreet, September 28.
• Dodd-Frank Wall Street Reform and Consumer Protection Act (2010).