The U.S. banking sector faces a new wave of challenges as Moody’s recently lowered credit ratings for several small to mid-sized banks and indicated the potential downgrade of larger financial institutions. These actions were driven by concerns over funding risks and weakening profitability amidst an anticipated mild U.S. recession in early 2024 and uncertainties in asset quality, according to a report in Thomson Reuters.
Moody’s noted in its report that the second-quarter results of many banks revealed growing profitability pressures. This looming threat may restrict their capacity to generate internal capital, making them more reliant on external sources to meet regulatory requirements and sustain operations. The confluence of these challenges with the imminent recessionary headwinds is adding to the urgency for banks to recalibrate their strategies.
One of the focal points of Moody’s concerns is the commercial real estate (CRE) portfolios of various banks. Elevated CRE exposures are considered a key risk due to multiple factors, including high interest rates, changes in office demand stemming from remote work practices, and reduced availability of CRE credit. These circumstances could lead to an increase in delinquencies and defaults in CRE loans, impacting the overall asset quality of banks.
Moody’s lowered the credit ratings of ten banks by a single notch and initiated a review process for potential downgrades involving six prominent banking giants, which include Bank of New York Mellon (BK.N), US Bancorp (USB.N), State Street (STT.N), and Truist Financial (TFC.N). In addition, it changed its outlook to negative for eleven banks, including Capital One (COF.N), Citizens Financial (CFG.N) and Fifth Third Bancorp (FITB.O). The banks that received downgrades by Moody’s include M&T Bank (MTB.N), Pinnacle Financial Partners (PNFP.O), Prosperity Bank, and BOK Financial Corp (BOKF.O).
Moody’s underscored banks’ vulnerability with substantial unrealized losses yet to be reflected in their regulatory capital ratios. As market dynamics evolve in the current high-rate environment, banks risk losing confidence among investors and depositors. This threat is magnified if market participants become apprehensive about the capital adequacy of banks, potentially triggering a chain reaction of withdrawals and instability.
The context of Moody’s actions is set against the backdrop of the Federal Reserve’s steady and steep interest rate increases in recent times, resulting in tighter monetary conditions. As borrowing costs rise, consumer and business demand for loans has weakened, which has implications for the revenue streams of banks. The challenges associated with these evolving economic conditions are prompting banks to adjust their strategies to remain resilient.
Moody’s downgrades and review actions signal a period of uncertainty and transformation for the U.S. banking sector. Institutions under review for potential downgrades will need to proactively address the risks in their CRE portfolios to safeguard their asset quality, according to the report.
The U.S. banking sector finds itself at a crossroads, where the challenges of funding risks, weakening profitability, and changing economic dynamics are converging. In an environment of tightening monetary conditions and impending economic headwinds, the banking sector will likely see additional challenges associated with its CRE portfolios while the real estate industry finds its footing.