Evening Brief – 08.08.23
Moody’s Investors Service downgraded the credit ratings of several small and mid-sized banks and placed six larger lenders on review for a possible downgrade in response to US banking stresses, including funding pressures, regulatory capital deficiencies and risks tied to commercial real estate loans.
M&T Bank, Pinnacle Financial Partners, and Old National Bancorp were downgraded by the ratings agency.
Bank of New York Mellon, U. Bancorp, State Street, Truist Financial, Cullen Frost, and Northern Trust are under review for a downgrade.
Additionally, Moody’s revised the outlook to negative for 11 institutions, including Capital One, PNC Financial Services and Fifth Third Bancorp.
“Many banks’ Q2 results showed growing profitability pressures that will reduce their ability to generate internal capital,” Moody’s said in a note. US banks’ Q2 earnings showed “material” increases in funding costs and profitability pressures related to the Federal Reserve’s aggressive tightening. “Higher interest rates continue to reduce the value of fixed rate securities and loans, and this risk is not captured well in bank regulation and can create liquidity risks.”
Despite Washington (and Wall St) going to great lengths to restore confidence, most U.S. banks are subject to lower capital requirements than the largest lenders, leaving some more susceptible to a loss of investor confidence, particularly those with substantial losses resulting from increased rates that are not reflected in their regulatory capital ratios.
Moody’s added that small and mid-sized banks with greater exposure to commercial real estate, particularly in construction and office lending, face greater risks because of the economic downturn and weak demand for office space resulting from the rise of work-from-home trends.
Finally, Moody’s warns of more pain to come: “This comes as a mild U.S. recession is on the horizon for early 2024 and asset quality looks set to decline.”
Since bottoming in early May, the regional bank sector, as measured by the S&P Regional Banking Sector ETF, has recovered a little more than half its losses that took the sector down 46%. But the regionals were already in a protracted downtrend dating back to when the Fed began raising rates in March 2022. Eleven rate hikes later, they are telegraphing that they are not done.
Despite the recent upswing, many of the issues that precipitated the regional banking crisis in March are still present. A further increase in interest rates exerts additional downward pressure on valuations, while continuing to encourage depositors to withdraw funds in search of higher yielding assets, namely money market funds or Treasury bills.