Moody’s Investors Service downgraded 28 Spanish banks on Monday and 15 global ones last week. Many of these companies’ managers are still struggling to improve their governance, which contributes to doubts about the strength of their businesses.
The New York ratings agency cut its long-term debt and deposit ratings on Spanish banks by one to four notches, noting factors such as the weakening European government’s decreasing ability to bail them out and that their exposures to commercial real estate will likely cause them higher losses. On Thursday Moody’s had also lowered its evaluations of global firms by one to three notches, citing problems ranging from poor track records on risk management to the risk of having “outsized losses inherent to capital markets activities.”
Some protested. Citigroup, for example, called Moody’s analysis “arbitrary,” “completely unwarranted” and “backward-looking” in a statement Thursday. The New York financial services firm said Moody’s failed to recognize indications of the company’s transformation over the past several years, such as its making “substantial improvements” in risk management, selling off assets to become one quarter of the size it had been in 2008 and building up more cash-on-the-ready than yet required by international law.
Moody’s did say in its report that Citigroup has made “visible progress” in rebuilding its corporate governance and risk management. But the agency also noted the challenges of instilling a culture that results in low earnings volatility, especially considering that Citigroup has a high commitment to capital markets business.
A company’s culture doesn’t change overnight. We continue giving D or F corporate governance ratings to firms that Moody’s recently downgraded including Citigroup, Morgan Stanley, Goldman Sachs Group, and Bank of America. All four of these companies’ financial statements result in AGR scores that indicate more accounting and governance risk than at least three quarters of their peers.
Of course most banking firms have taken steps to improve their practices since the financial crisis, and some that Moody’s downgraded do have better governance than others. For example the Royal Bank of Canada, which has a C rating and financial statements reflecting an AGR score of 48, took steps in 2011 such as holding a shareholder vote on executive compensation and adding an extra person to its now 16 member board. Meanwhile it’s obvious that the Spanish banks aren’t entirely to blame for their government’s decreasing capacity to provide future support amid the European debt crisis.
Nonetheless, many global firms that Moody’s downgraded clearly continue having regulatory issues. To name just a couple recent examples, Morgan Stanley is being probed over whether its analysts gave privileged information to clients ahead of Facebook’s initial public offering in May, according to news reports. in July 2011 JPMorgan agreed to pay around $228 million to settle allegations by the Securities and Exchange Commission and others that it fraudulently rigged municipal bond reinvestment deals, generating millions in ill-gotten gains.
Meanwhile, uncertainty continues to linger over bank profits in the wake of their consolidation and overhaul during the financial crisis. Whenever a company makes an acquisition or major change to its business structure, the upheaval forces its managers to guess about the value of their assets and the extent of their earnings. Having to guess doesn’t mean that you’re a liar, but it does make your earnings statements less reliable. Until global financial services firms complete the chaotic transitions and massive cultural shifts they began in 2008, investors should be taking these companies’ earnings statements with a grain of salt.
Region: North America
Sector: Investment Services