By Rick Rothacker and Steve Slater
LONDON/CHARLOTTE, North Carolina (Reuters) - Ratings agency Moody's is set to announce downgrades of many of the world's biggest banks later on Thursday, banking industry sources said.
Moody's Investors Service has said it will release the ratings reviews on 15 major banks, including significant downgrades for many, by the end of June.
According to a source familiar with the matter the downgrades will be announced on Thursday after the market closes at 4 pm EDT.
The ratings cuts could increase funding costs for Morgan Stanley
A spokeswoman for Moody's declined to comment on the exact timing.
Bank stocks were down Thursday in afternoon trading. Bank of America shares fell more than 3 percent to $7.87, while Morgan Stanley shares slumped 1.9 percent. The KBW Banks Index <.BKX> was down about 1.9 percent.
There has been speculation the downgrades were imminent for several days.
"The rating agencies are doing their best to point out that government support may not be what it used to be," said Peter Hahn from Cass Business School.
"The rating agencies' high ratings were overly generous and largely correct on the level of government support for banks pre-crisis and it seems likely they will overshoot the other way in the current turmoil," he said.
In February Moody's said U.S. bank Morgan Stanley and Swiss banks UBS
There could be cuts of two notches for Barclays
Moody's has said there could be one notch downgrades for Bank of America
Nomura <8604.T> and Macquarie
In a May securities filing, Morgan Stanley estimated that the impending downgrade would cost the bank $1.03 billion to $9.6 billion in additional collateral postings and termination payments to derivatives counterparties and clearing houses.
Moody's said in February that it might cut Morgan Stanley by either two or three notches from its previous A2 rating. The worst-case scenario would leave the bank at a Baa2 rating, which is just two steps shy of junk.
Investors, rattled by the European debt crisis, have already been trading Morgan Stanley bonds at essentially junk levels.
The effects of the Moody's action are probably already factored into stock and bond prices, but they could widen the division between the strongest banks and their weaker competitors. With their ratings hovering not far above junk status, Morgan Stanley, Citigroup
Morgan Stanley, like other big banks, has previously disagreed with Moody's review, with executives arguing publicly that a downgrade made little sense given that the bank was far less risky, and had far more money on hand, than it was before the financial crisis erupted.
The stocks of banks being reviewed have been under pressure since Moody's announced its plans on February 15. Morgan Stanley's shares, for example, are down about 25 percent since the day before the announcement.
"This has been a painfully slow process and damaging because it allowed speculation to continue as long as it has," said Gary Townsend, chief executive of Hill-Townsend Capital, in Chevy Chase, Maryland.
In a report on Wednesday, CLSA analyst Mike Mayo said the downgrades are likely priced into the stocks of banks such as Morgan Stanley and Bank of America, but the firms could face a loss of business from the actions.
"Lower ratings will likely reduce the degree of trading activities over time at a particular institution," Mayo wrote.
JPMORGAN LOSS DEMONSTRATES RISK
JPMorgan said in a public filing in May that while downgrades of one or two notches in its ratings would increase its costs of funds, the company's ability to fund itself would not be "materially" affected. The company said there are no provisions in its unsecured debt that would require early repayments if its ratings were reduced.
JPMorgan's loss of $2 billion or more trading credit derivatives highlighted the risks of global investment banks and was a negative mark for the company's creditworthiness, Moody's analysts said in a May 14 report.
It also underscored the rationale Moody's described in February for updating its ratings across global investment banks, the May report said. Moody's called the JPMorgan loss "a nasty surprise from one of the better-managed banks" that demonstrated the hidden risks in global investment banks.
Moody's said the loss was also a reminder of the difficulty banks are having earning enough profits at a time of low interest rates.
Citigroup said in a public filing on May 4 that a two-notch downgrade of the holding company and the bank by Moody's could result in an additional $1.1 billion of cash obligations and collateral requirements on derivatives and exchange margin requirements.
To deal with that outcome, Citigroup said that as of March 31 it had $421 billion of "aggregate liquidity resources." The bank said it could sell liquid securities, shrink trading books, scale back new lending, raise additional deposits and borrow from central banks to cover the additional requirements triggered by a downgrade.
In a securities filing on May 3, Bank of America said a one-notch downgrade would require the bank to post $2.7 billion in collateral. It faced a less severe downgrade than other banks because its ratings were already relatively low.
Credit Suisse, which Moody's said it might cut by three notches, maintains that it would remain one of the highest-rated banks with a single-A grade and would likely pick up market share. The downgrade may require the bank to post more collateral with trading counterparties, but that is not a big issue because the Swiss bank has so much liquidity.
British banks should be relatively well placed to deal with the increased funding costs triggered by the downgrades, having shrunk their balance sheets aggressively.
However, there is a danger that the turnaround efforts of Royal Bank of Scotland, which is 82 percent owned by the state, could be derailed and the knock-on effect is that it will become even harder for the UK government to dispose of its stake and for the bank to achieve its ultimate goal of privatization.
(Reporting by Steve Slater, Matt Scuffham and Rick Rothacker; additional reporting by Lauren Tara LaCapra and David Henry; Editing by Elaine Hardcastle and Carol Bishopric)