Moody's Cut Ratings Of 10 US Banks; 6 Big Lenders On Downgrade Watch, Here's Why

Moody's Investors Service has trimmed the ratings of ten US banks by one rung while putting six big lenders on downgrade watch. The leading credit rating agency has also given a negative outlook on a total of 11 lenders. The US banking system is under pressure owing to funding risks, weaker profitability and a turn in asset quality. Moody believes this comes as a mild US recession is on the horizon for early 2024.

The ten banks to receive downgrade in rating are --- Commerce Bancshares, BOK Financial Corporation, M&T Bank Corporation, Old National Bancorp, Prosperity Bancshares, Amarillo National Bancorp, Webster Financial Corporation, Fulton Financial Corporation, Pinnacle Financial Partners, and Associated Banc-Corp.

Further, the six big lenders under review to downgrade are -- Bank of New York Mellon Corporation, Northern Trust Corporation, State Street Corporation, Cullen/Frost Bankers, Truist Financial Corporation, and U.S. Bancorp. These banks' share prices have tumbled by 0.5% to 3%, however, US Bankcorp shares ended on a flat note on Tuesday.

In a research report by Moody's Jill Cetina, Associate Managing Director and Ana Arsov, MD-Financial Institutions, said, "US banks continue to contend with interest rate and asset-liability management (ALM) risks with implications for liquidity and capital, as the wind-down of unconventional monetary policy drains systemwide deposits and higher interest rates depress the value of fixed-rate
assets. Meanwhile, many banks' Q2 results showed growing profitability pressures that will reduce their ability to generate internal capital."

The report added that "this comes as a mild US recession is on the horizon for early 2024 and asset quality looks set to decline from solid but unsustainable levels, with particular risks in some banks' commercial real estate (CRE) portfolios. Combined, these factors underpinned our 7 August rating actions on 27 US banks."

Among the banks to receive negative outlooks are --- PNC Financial Services Group, Capital One Financial Corporation, Citizens Financial Group, Fifth Third Bancorp, Huntington Bancshares Incorporated, Regions Financial Corporation, Cadence Bank, F.N.B. Corporation, Simmons First National Corporation, Ally Financial, and Bank OZK.

Explaining Q2 performance, Moody's pointed out that US banks' second quarter results broadly show a rapid rise in the cost of funding.

It added, "Although the general drain on deposit funding caused by quantitative tightening (QT) moderated in Q2, there remains a significant risk that systemwide deposits will resume their decline in coming quarters. Most banks' deposits were flat or down only modestly, but the mix worsened, with non-interest-bearing deposits declining and banks paying more for deposits. The resulting drop in net interest income and net interest margins eroded profitability and, thus, the ability to replenish capital internally.

Further, banks have reduced loan growth to preserve capital, but Moody's note said, "This will slow the shift of balance sheets toward higher-yielding assets, even as funding costs rise and banks deal with a yield curve inversion."

In the case of asset quality rising, Moody's pointed out that the asset quality metrics remain solid across most consumer and commercial lending segments, but have begun to deteriorate and have been unsustainably strong compared with historical pre-pandemic levels. Elevated CRE exposures are a key risk given sustained high-interest rates, structural declines in office demand due to remote work, and a reduction in the availability of CRE credit.

Moreover, according to Moody's, most regional banks have comparatively low regulatory capital versus the largest US banks and global peers.

In the current high-rate environment, Moody's believes that this leaves some banks with sizable unrealized economic losses that are not reflected in their regulatory capital ratios vulnerable to a loss of investor confidence.

Further, Moody's expects the US recession in early 2024 will worsen banks' asset quality and increase the potential for capital erosion.

As per Moody's, a proposed increase in regulatory capital requirements for all banks with assets above $100 billion is credit positive, but in the near term will come with increased regulatory costs and may entail business model changes that strain some banks' profitability.

Meanwhile, it said, regulatory tailoring that sets lower capital and liquidity requirements for banks with less than $100 billion in assets is credit negative, and weaker regulations can promote excessive risk-taking at some banks.