Moody’s Downgrades Ratings of 10 U.S. Banks; Flags Major Names for Potential Downgrade

Moody’s downgraded the credit ratings of numerous small and medium-sized U.S. banks on Monday night, and it placed several prominent Wall Street banks under review with a negative outlook.

The firm lowered the ratings of 10 banks by one level. Additionally, major lenders like Bank of New York Mellon, U.S. Bancorp, State Street, Truist Financial, Cullen/Frost Bankers, and Northern Trust are now being evaluated for a potential downgrade.

Moody’s also changed its outlook to negative for 11 banks, including Capital One, Citizens Financial, and Fifth Third Bancorp.

Among the smaller banks that experienced an official downgrade in ratings were M&T Bank, Pinnacle Financial, BOK Financial, and Webster Financial.

According to Moody’s analysts Jill Cetina and Ana Arsov, “U.S. banks continue to face interest rate and asset-liability management (ALM) risks, which have implications for liquidity and capital. The winding down of unconventional monetary policy is leading to a decrease in systemwide deposits, and higher interest rates are reducing the value of fixed-rate assets. Furthermore, many banks’ second-quarter results indicate increasing profitability pressures, which will limit their ability to generate internal capital. Additionally, a mild U.S. recession is anticipated in early 2024, and asset quality is projected to decline from its current strong but unsustainable levels, with potential risks in certain banks’ commercial real estate portfolios.”

Earlier this year, regional U.S. banks gained attention following the collapse of Silicon Valley Bank and Signature Bank, which triggered a wave of deposit withdrawals across the sector. This panic eventually spread to Europe and resulted in the emergency rescue of Credit Suisse by its domestic rival UBS.

Although authorities made significant efforts to restore confidence, Moody’s cautioned that banks with substantial unrealized losses, not reflected in their regulatory capital ratios, might still be vulnerable to sudden market or consumer confidence losses in a high-interest-rate environment.

In July, the Federal Reserve increased its benchmark borrowing rate to a range of 5.25%-5.5% after implementing aggressive monetary policy tightening for the past year and a half to combat high inflation.

“We anticipate that ALM risks for banks will be further compounded by the significant rise in the Federal Reserve’s policy rate, as well as the ongoing reduction in reserves at the Fed and deposits due to quantitative tightening,” stated Moody’s in its report.

The report also mentioned, “Interest rates are likely to remain elevated until inflation returns to the Fed’s target range. Moreover, long-term U.S. interest rates are also increasing due to various factors, which will put additional pressure on banks’ fixed-rate assets.”

Moody’s highlighted that regional banks are at a higher risk due to their relatively low regulatory capital. The agency noted that institutions with a larger share of fixed-rate assets on their balance sheets will face constraints in terms of profitability, capital growth, and lending capacity.

The analysts added, “Risks may become more pronounced if the U.S. enters a recession, as we anticipate will happen in early 2024, as it will worsen asset quality and increase the potential for capital erosion.”

While the stress on U.S. banks has mainly been centered around funding and interest rate risks stemming from monetary policy tightening, Moody’s warned of an impending deterioration in asset quality.

The agency stated, “We continue to expect a mild recession in early 2024, and with the funding strains facing the U.S. banking sector, a tightening of credit conditions and rising loan losses for U.S. banks is highly likely.”