By Brett Philbin and Patrick McGee Many financial stocks moved higher, while bonds rallied early Friday as investors expressed relief that the long awaited downgrades of more than a dozen global banks are complete, ending a four month overhang that threatened a sector already rife with economic and regulatory concerns. In recent trading, financials were the best-performing sector in the Standard & Poor's 500 Index, rising 0.9%, while the KBW Bank Index, a collection of large capitalization financial stocks, rose 1%. Among individual banks, Morgan Stanley (MS) rose 1.1% to $14.11. Late Thursday, Moody's Investors Service cut the firm's long-term debt rating by two notches to Baa1 from A2, in a move that will likely raise its funding costs and could mean a collateral call of roughly $6.7 billion. But Moody's spared the firm from a three-level downgrade, allowing it avoid a worst-case scenario. Other banks trading higher Friday include Bank of America Corp. (BAC), which gained 1.7% to $7.95; J.P. Morgan Chase & Co. (JPM), which rose 1.9% to $36.19; UBS AG (UBS, USBN.VX), which rose 3% to $12.05; and Credit Suisse Group AG (CS, CSGN.VX), which climbed 2.3% to $19.00. Overall, Moody's lowered the credit ratings of 15 global banks on Thursday, moves which reflected its concerns over exposure to the volatility and potential losses related to their capital markets activities. In a note to clients Friday, Keefe, Bruyette & Woods analyst David Konrad wrote that the Moody's review, "coupled with the European financial crisis, has been the primary reason for the underperformance of the universal banks," adding that "although a downgrade is not a positive, we are encouraged that the downgrades were in line or better than expectations and it appears that a headwind has been removed." For months, investors have fretted about the affect ratings downgrades would have on major banks that are in the midst of coping with Europe's debt woes and a slowing U.S. economy. The downgrades could force those firms to put up billions of dollars in additional collateral to back their trading activities. Bank bonds are also rallying in early trading, led by Morgan Stanley. The risk premium, or spread, on the firm's 5.75% coupon, 10-year bonds has improved 0.33 percentage points to 4.03%, extending the month-to-date improvement to 0.96 points, according to MarketAxess. "Everyone thought they would be downgraded three notches," said Dan Hannis, who runs corporate bond trading at William Blair & Co. He characterized the positive moves as a "relief rally," adding that Morgan Stanley bonds could improve another 0.50 percentage points. Hannis said the long-awaited downgrades removes the threat of the unknown and allows investors to trade bank bonds on their individual merits rather than on speculation of what a ratings firm might do. The 5.75% coupon, 10-year bond from Goldman Sachs Group Inc. (GS), which also got hit with a two-notch downgrade, improved 0.10 percentage points in early trading to a spread of 3.31 over Treasurys. Citigroup Inc.'s (C) 10-year bonds improved 0.11 points after being slashed two notches, while Bank of America (BAC), which suffered a one-notch hit, is seeing its 10-year bond spread strengthen by 0.17 percentage points. Ed Marrinan, strategist at RBS Securities, said before the downgrades took place that the bond market wouldn't see a selloff. "This has been telegraphed--it's the financial market's worst-kept secret," he said. "The market has had literally months to plan different scenarios." The bank bond rally has led the entire corporate bond market higher. According to Markit's CDX North America Investment Grade Index, the market strengthened 1.4% in early trading. Write to Brett Philbin at brett.philbin@dowjones.com
