The recent downgrades and warnings from Moody’s ratings on multiple U.S. banks indicate that the industry is still facing challenges following the collapse of Silicon Valley Bank. Despite the stabilization of deposit levels during the second quarter after the regional banking crisis in March, small and midsized banks are now dealing with the issue of having to pay customers higher deposit rates, which exceeds the growth in their earnings from loans. Ana Arsov, global co-head of banking for Moody’s Investors Service, explains that while banks have managed to retain their deposits, it has come at a cost as they have had to seek more expensive funding to replace the lost deposits. This poses a profitability concern as deposits continue to leave the banking system.
Typically, banks are expected to thrive when interest rates rise, as they can charge higher rates for loans and other products. However, this time around, the boost in profitability from higher rates was short-lived. In the first quarter of this year, bank failures disrupted depositors’ complacency, and as a result, the net interest margin growth turned negative. Arsov states that bank profitability has currently peaked, as weak loan growth and a decreased ability to make a spread will hamper their above-average profitability compared to other systems.
Moody’s reassessed its ratings on banks due to shrinking profit margins, relatively lower capital levels compared to peers at some regional banks, and concerns about defaults in the commercial real estate sector. In March, Moody’s placed six banks, including First Republic, under review for downgrades and downgraded its outlook for the industry to negative from stable.
As a result, U.S. Bank and Fifth Third were both placed under review for downgrades by Moody’s. U.S. Bank was flagged for reasons such as rising deposit costs and increased use of wholesale funding, while Fifth Third’s outlook was lowered due to higher deposit costs. It is important to note that even though Moody’s made these adjustments, the U.S. banking system as a whole remains strong, and the banks that were downgraded still hold investment-grade ratings, indicating a low risk of default.
Arsov emphasizes that this does not suggest that the banking system is broken, but rather warns that profitability will be under pressure in the next 12 to 24 months due to rising regulation and credit costs.
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