Are These Banks About to be Downgraded?

On Friday, analyst Dick Bove said that investors should keep buying equities despite all the uncertainties facing the markets.  More specifically, he is still a big cheerleader for bank stocks.

“If we look at what’s happening now in the world today for banks, everything is moving in a positive direction,” the Rochdale Securities analyst said in a CNBC interview. “I think you should be buying these stocks hand over fist. But I believed that when they were substantially higher than they are right now.”  Although Bove can not buy the stocks he covers, he says he would buy Bank of America (NYSE:BAC), Morgan Stanley (NYSE:MS), State Street (NYSE:STT), and US Bancorp (NYSE:USB).

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Investors have a good reason to be gun shy of banking recommendations.  Dick Bove infamously upgraded Lehman Brothers to a buy just days for its collapse.  More recently, he speculated that Goldman Sachs (NYSE:GS) may purchase MF Global, right before the broker-dealer collapsed and the markets found out the company stole its clients’ money.  Currently, the Financial Select Sector SPDR (NYSEARCA:XLF) is down 21% year-to-date, while the KBW Bank Index (NYSE:BKX) is down 28%.  The coming weeks may also prove to be a trying time for banking stocks.

Standard & Poor’s announced it plans to update its credit ratings for the world’s 30 biggest banks within three weeks, which could very well lead to downgrades.  The updates in the ratings is part of a major overhaul for scoring creditworthiness, as the credit rating agency received heavy criticism after failing to properly rate mortgage-backed securities in the housing bubble.  Among the institutions that could be impacted are Bank of America (NYSE:BAC), Citigroup (NYSE:C), Morgan Stanley (NYSE:MS), Deutsche Bank (NYSE:DB), Barclays (NYSE:BCS), Wells Fargo (NYSE:WFC), UBS (NYSE:UBS), and JP Morgan (NYSE:JPM).

Reuters reports S&P has taken pains to prepare the markets for the changes, but when it actually releases results for individual banks some downgrades could surprise.  “One reason there could be surprises is that the new ratings method is very complex and it has been very difficult to simulate results,” said Beate Muenstermann, a London-based research analyst for the money management arm of JPMorgan Chase & Co.  One area for potential surprise lies in differences between actions the agency may take on bank holding companies compared with grades for their operating units. Another is variations between long-term and short-term ratings.

Earlier this month, S&P announced it expects 60% of all bank ratings to stay the same, 20% to increase one notch, 15% to fall by one notch, and less than 5% to drop by two or more notches.

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