Moody’s lowered ratings for 10 small and midsize US lenders, considering potential weaknesses and higher funding costs. Major banks, including US Bancorp and Bank of New York Mellon, face possible downgrades.
Commercial real estate risks, regulatory capital concerns, and funding costs prompted the review. Due to recent developments, Moody noted varying credit profile impacts on different US banks.
Stocks of downgraded firms, such as M&T Bank Corp., declined by 4.6%. Webster Financial Corp. shares lost 3.4% after its ratings were cut by Moody’s.
The “negative” outlook was adopted by Moody’s for 11 lenders, including PNC Financial Services Group. PNC’s stock fell by 4.6% in response to the impact. Capital One Financial Corp.’s shares decreased by 3% following the outlook shift by Moody’s. Citizens Financial Group Inc. also faced a “negative” outlook, impacting its market value.
How Investors Are Navigating
Concerned by bank collapses in California and New York, investors monitor signs of industry strain. Rising interest rates increase deposit and funding costs, impacting banks. Higher rates diminish asset value and hinder commercial real estate debt refinancing, weakening lenders.
Investors are attentive due to bank failures; elevated rates affect funding and asset values. Lenders’ balance sheets may weaken due to difficulties in refinancing and eroding asset values caused by higher rates.
The upcoming US consumer price index release will guide investors about the Fed’s policy stance. John Williams of the Fed Bank of New York suggested maintaining restrictive policy for a while. Williams indicated potential rate cuts in the following year if inflation decelerates. Investor demand will face a substantial test with the surge in Treasury sales.
The bond market is preparing for the largest series of refunding auctions since the previous year. This week, a combined $103 billion of 3-, 10-, and 30-year auctions must be absorbed. This amount is $7 billion higher compared to the auctions in May. The auction outcomes will determine if the market selloff can continue.
Moody’s downgrades and outlook alerts on US banks highlight ongoing industry pressure post-Silicon Valley Bank collapse. Concern had eased after Q2 results showed banks stabilizing deposits post-March crisis. But a new issue arises as small and midsize banks pay more for deposits than loan earnings grow. Ana Arsov of Moody’s notes banks retained deposits at a cost, needing pricier funding sources.
Replacing deposits with costlier funding poses profitability worries as deposits leave the system. The industry’s stability was questioned after the Silicon Valley Bank collapse and amid higher deposit costs.
Ana Arsov, Moody’s global banking co-head, explained the deposit costs and funding situation.
How US Banks are Navigating the Change
As interest rates rise, banks usually flourish by charging more for loans and maintaining slower deposit rate growth. Higher rates enhance lending margins, boosting their core activity’s profitability. However, this time the benefits of increased rates were brief, vanishing in Q1.
Bank failures shook depositors’ complacency, leading to negative net interest margin growth. The current peak in bank profitability is temporary due to weak loan growth and narrower spreads. Ana Arsov noted that a strong factor for US banks—above-average profitability—won’t persist. Weak loan expansion and reduced spread capabilities contribute to the absence of this factor.
Bank profitability temporarily declined as higher rates’ benefits waned and challenges arose.
Reasons Behind Moody’s Re-evaluation
Moody’s re-evaluated bank ratings due to reduced profit margins, lower capital levels compared to peers, and real estate worries. Shrinking margins, capital disparities, and commercial real estate concerns led Moody’s to reassess bank ratings. Moody’s revised bank ratings due to declining profit margins, lower capital levels than peers, and real estate anxieties.
Declining margins influenced credit assessments for multiple banks, Moody’s indicated in individual reports this week. US Bank is under review for a downgrade due to increased deposit costs and higher wholesale funding usage. Fifth Third’s outlook was downgraded to negative for similar reasons – elevated deposit costs. Banks, however, didn’t promptly respond to comment requests.
The analyst emphasized overall strength. First Republic was among six banks Moody’s reviewed for downgrades in March. Moody’s shifted the industry outlook to negative from stable during that period. Overall strength in the US banking system and maintained investment-grade ratings for downgraded banks. The message isn’t about a broken system but profitability, regulation, and credit challenges in the coming years.
Moody’s highlights that even downgraded banks are investment-grade, implying low default risk. The next 1 to 2 years will witness pressure on profitability, rising regulations, and increasing credit costs. Ana Arsov clarified that the banking system isn’t failing but anticipates challenges in the near future.