Three of the nation's top banks are likely to start paying more to borrow money.
Moody's Investors Service on Wednesday lowered its debt ratings for Bank of America, Wells Fargo and Citigroup. The ratings agency said it has become less likely that the U.S. government would step in and prevent the three lenders from failing in a crisis.
"The probability of government support for the banks is less now than during the financial crisis," said David Fanger, senior vice president at Moody's.
The downgrades were widely expected after the ratings agency placed the three banks on review in June. The cuts also stem partly from new laws taking effect under the Dodd-Frank Wall Street Reform Act. The new law ended the possibility of the government bailing out a large financial firm and created a process that would allow a financially troubled bank to fail and liquidate its assets.
Bank of America Corp. was hit worst. Moody's downgraded its key long-term debt ratings two notches, to Baa1 from A2. Wells Fargo & Co.'s long-term debt rating fell one notch to A2 from A1, while Citigroup Inc.'s rating remained the same at A3. Moody's did downgrade Citi's short-term debt.
Bank of America's ratings are the lowest among the three. All three of the banks' debt is still rated investment grade.
A downgrade is a warning to buyers of debt that the chance that they won't get their money back has increased, however slightly. Downgrades usually lead to higher borrowing costs for the issuer because investors want more interest if they're taking a bigger risk. Long-term debt includes bonds that come due in more than one year.
The downgrades couldn't have come at a worse time for the banks, whose stocks have been pounded this year on uncertainty over how the European debt crisis will affect them. The KBW bank index, which serves as a benchmark of the banking sector and tracks the stock prices of 24 bank stocks, is down 30 percent this year.
Bank of America's stock tumbled most, 7.5 percent, to close at $6.38. The bank is already dealing with investors' concerns over whether it has enough capital to deal with its financial losses and over lawsuits related to poorly written mortgages of the past. In the first half of the year the bank paid out $12.7 billion to settle claims from investors that BofA sold them securities backed by faulty mortgages.
Moody's said although the nation's largest bank has ample resources to absorb additional losses, it was concerned that any deterioration in the economy or negative court rulings on the mortgage litigation could have a "significant impact on (the bank's) capital position."
In a statement, Bank of America said: "While we disagree with their conclusions and we believe our ratings should be higher, to minimize any potential impact of this decision on our business, we have been managing our liquidity carefully and we have prefunded our planned borrowing needs for the year."
Moody's also downgraded Bank of America's long-term deposit ratings to A2 from Aa3. The deposit ratings reflect the level of risk faced by customers whose deposits are not insured and the bank's ability to make them whole in the event of a crisis. Currently, the Federal Deposit Insurance Corporation insures deposits up to $250,000. So the rating downgrade affects deposits larger than that.
Citigroup's stock fell more than 5 percent to close Wednesday at $25.52. Moody's said Citigroup's ratings stability reflects its improved performance. That's quite a reversal of fortune for Citi, which was viewed as one of the weakest financial institutions immediately after the financial crisis and was partially owned by the government until last December.
"Citi has reduced the size of its problematic assets and improved its risk profile," said Sean Jones, senior vice president at Moody's.
Still, Citi was not happy at having its short-term ratings downgraded. The bank said in a statement that it disagreed with the Moody's decision.
"It does not accurately reflect the significant progress Citi has made since Moody's last rated Citi more than two-and-a-half years ago," the bank said.
Moody's downgraded the short-term rating of Citigroup to Prime-2 from Prime-1.
Moody's said its downgrade of Wells Fargo was driven solely by the reduced government support. Its stock fell 3.9 percent to close at $23.71. Besides its long-term debt, Moody's also downgraded Wells Fargo's bank deposit ratings to Aa3 from Aa2.
Alex Veiga contributed to this report from Los Angeles.