Earlier this week, rating agency Moody’s slashed the credit ratings of 10 smaller regional and midsized U.S. banks while placing six of the mega lenders, including Bank of New York Mellon and Truist Financial Corp., under review for a possible downgrade. The credit ratings agency’s decision made stocks tumble as investors are now more worried about the country’s economic situation.
Analysts at Moody’s cited that, in their second-quarter earnings report, U.S. banks showed “material increases” in funding costs, profitability pressures due to “significant and rapid tightening” of monetary policy by the Federal Reserve to combat inflation, and a slowed-down loan growth that continued to lower their revenues and weaken the amount of capital that lenders can hold.
A lower credit rating would punish the banks by increasing their funding costs.
This was another major blow to the head of the U.S. economy after Fitch Ratings downgraded the federal government’s credit rating from the top-tier AAA to AA+. Fitch explained that rising national debt and deteriorating governance standards at all levels of government over the last two decades have cost the country dearly.
Moody’s downgraded the credit ratings of M&T Bank (MTB), Webster Bank (WBS), Pinnacle Financial Partners (PNFP), BOK Financial Corporation (BOKE), Associated Banc-Crop. (ASB), Old National Bancorp (ONB), Amarillo National Bank, Commerce Bancshares (CBSH), Prosperity Bank (PB), and Fulton Financial Corporation (FULT).
Record-High Interest Rates are Pushing Banks Towards a Liquidity Crisis
In its warning, the credit rating agency stated that higher interest rates on the dollar continue to reduce the value of fixed-rate securities and loans in U.S. banks. Moody’s also noted that since interest rate risk is not observed well by the country’s banking regulations, there is a higher chance for the banks to suffer a liquidity crisis.
USD interest rates are at their highest level in 22 years at 5.50%, and this has negatively affected a majority of American banks, placing them on a thin line.
Moody’s also assigned a negative outlook to six of the largest banks in the country – Bank of New York Mellon, U.S. Bancorp, State Street Corp., Truist Financial Corp., Northern Trust Corp., and Cullen/Frost Bankers Inc.
BNY Mellon, State Street, and Northern Trust were warned by the rating agency of the “ongoing strain” in the U.S. banking sector caused by increased funding pressures that could dent their ability to generate “capital internally”.
The banks have been experiencing significant fund outflows in non-interest-bearing deposits. Meanwhile, U.S. Bancorp, Truist, and Cullen/Frost Bankers were warned of the rising risks of exposure to commercial real estate. The agency says the banks have low capital buffers that could put them at risk of collapse during a time of crisis.
Drop in Commercial Real Estate Value Affecting Majority of U.S. Banks
Since the onset of the pandemic, many companies in the country reverted to a work-from-home culture that has left office buildings half or fully empty. Now, the value of U.S. offices is falling rapidly, which is causing severe damage to the $20 trillion commercial real estate market.
This has instilled fear in the nation’s banks, especially regional and community banks, which finance many commercial real estate deals and hold assets in real estate.
Following the collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank earlier this year, Investors and regulators are on full alert and always looking out for any signs of trouble in the financial system. The banks suffered a major deposit run after reporting heavy financial losses.
Analysts at Wedbush Securities say most regional banks have now stabilized their deposit outflows. But it seems like lenders are focused on reducing borrowing in the coming quarters to trim down their balance sheet so as to protect any excess liquidity they may have amassed over the period from being drained.
Wedbush analysts highlighted that the banks have an “excellent” credit quality. Improving capital ratios have led the agency to report that they haven’t observed any systemic risks to lenders in that area.
Meanwhile, net interest margins – a key metric that calculates the difference between interest earned on loans and interest paid out to depositors – of banks are under pressure due to the heavy outflow of non-interest-bearing deposits, which was fueled by this year’s crisis. Since a large number of bank deposits are interest-bearing, there is a risk that their funding costs will rise.
Demand for New Loans is at an All-Time Low
The higher interest rates are also affecting lending programs, resulting in less demand for new loans. Here the problem is that most banks already have a high loan-to-deposit ratio, meaning a large proportion of their customer deposits are used to issue loans. Loans are the single biggest source of income for banks, and without it, lenders face a liquidity risk.
Wedbush analysts also stated that in the aftermath of April’s banking collapse, many regional banks reduced their exposure to uninsured deposits.
They believe it could help prevent the sort of massive bank run that occurred at the now-defunct Silicon Valley Bank, Signature Bank, or First Republic Bank, which together held assets worth $532 billion.
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U.S. Stocks Tumbled After Moody’s Decision
U.S. stocks markets tanked on Monday, with the Dow closing Tuesday’s session 0.5% lower at 159 points, while the S&P 500 dropped by 0.4%, and Nasdaq declined 0.8%.
Banking stocks were the most affected with Wells Fargo losing 1.3%, JPMorgan Chase dropping 0.6%, and Bank of America falling by 1.9% in value. The KBW Nasdaq Bank Index fell 1.2% on Tuesday.
