"Black Swan" Reappears? Moody's Downgrades Ratings of 10 US Banks, More Prominent Banks Placed on Downgrade Watchlist

Moody's, one of the world's three most influential rating agencies, released a report on the evening of August 7, downgrading the credit ratings of 10 small and medium-sized banks in the United States. It also placed 6 larger banks on the potential downgrade watchlist and changed the outlook for 11 mainstream banks from stable to negative. This news, along with the announcement of Italy's proposed "windfall tax" on banks, severely dampened market risk sentiment on Tuesday.

Moody's Downgrades Ratings of 10 Small and Medium-Sized Banks, Places 6 Larger Banks on Downgrade Watchlist, and Changes Outlook for 11 Banks to Negative

The list of 10 small and medium-sized banks in the United States that were downgraded by Moody's includes: 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.

The downgraded banks are mostly regional banks, with M&T Bank, headquartered in Buffalo, New York, being the largest in terms of assets among the mentioned batch. However, Moody's stated that all ratings were downgraded by one notch but still maintained investment grade. "Overall, we believe that the U.S. banking industry remains very robust."

Six larger U.S. banks have been placed on the potential downgrade watchlist, including some of the largest banking institutions in the country.

Among them, The Bank of New York Mellon, with assets exceeding $430 billion as of the end of June this year, is classified as a systemically important bank by regulatory authorities. State Street, with assets under management of $35 trillion as of the end of last year, is also a major global asset management institution. Others include: Northern Trust Corporation, Cullen/Frost Bankers, Truist Financial Corporation, and U.S. Bancorp, which had assets exceeding $450 billion as of the end of the second quarter.

In addition, the outlook for 11 banks has been changed from stable to negative, including PNC Financial Services Group, the seventh-largest commercial bank in the United States, Capital One Financial Corporation, the sixth-largest retail bank and tenth-largest bank, as well as Citizens Financial Group, Fifth Third Bancorp, Huntington Bancshares, Regions Financial Corporation, Cadence Bank, and Synovus Financial Corp. F.N.B. Corporation, Simmons First National Corporation, Ally Financial, and Bank OZK.

Moody's warns of deposit outflow risk under high interest rates, potential recession, squeezed bank profits, and commercial real estate distress

Moody's stated that the reasons for the downgrade are deposit risk, potential economic recession, and distress in commercial real estate loans:

"The U.S. banking industry continues to face rising interest rates and asset-liability management (ALM) risks, which impact liquidity and capital as the gradual end of unconventional monetary easing policies (i.e., tapering) depletes deposits within the system and rising rates depress the value of fixed-rate assets.

Meanwhile, the second-quarter performance of many banks has shown increasing profit pressure, which will reduce their ability to generate internal capital. Against this backdrop, we expect a mild recession in the U.S. to occur in early 2024, and asset quality appears poised to deteriorate from its current stable but unsustainable level, particularly as risks facing some banks' commercial real estate (CRE) portfolios worsen."

Moody's also warned that small and medium-sized banks' regulatory capital ratios fail to reflect significant unrealized losses on their balance sheets, making them more susceptible to sudden market or consumer confidence loss in a high-interest-rate environment:

"We expect that the Federal Reserve's policy rate hikes (over the past year and a half) and ongoing balance sheet reduction will lead to a continued decline in reserves held at Federal Reserve Banks and subsequent deposit contraction, worsening banks' asset-liability management risks.

Rates may remain elevated for a longer period until inflation returns to the Federal Reserve's target range. Under the influence of various factors, long-term U.S. bond yields are also rising, which will further pressure banks' fixed-rate assets.

Given the signs of funding stress in the current U.S. banking system, if the U.S. economy experiences a mild recession early next year, credit conditions in the banking industry may tighten further, asset quality will deteriorate, increasing the possibility of capital erosion, and loan losses will rise.

This puts U.S. regional banks with relatively lower regulatory capital ratios at greater risk. Institutions with a higher proportion of fixed-rate assets on their balance sheets will face more constraints on profitability, capital growth, and continued lending."

Moody's specifically pointed out that some of the issues that triggered the banking crisis earlier this year have not disappeared. Banks still face the risk of deposit outflows and runs, and the current high-interest-rate environment is also reducing the investment value of borrowers made during ultra-low interest rates:

"Depositors have been transferring cash to accounts that offer higher interest rates, increasing the cost for lenders and eroding profitability. There remains significant risk of a decline in total system deposits over the next few quarters."

Asset risks for small and medium-sized banks are rising, especially those with large commercial real estate investment portfolios.

Given the persistently high interest rates, structural decline in office space demand due to remote work, and reduced supply of commercial real estate credit, the increase in exposure to commercial real estate risks is a key concern. "

US Bank Index Falls 4% but Decline Significantly Narrows, Moody's Soothes Saying US Banking Industry Still Strong

Moody's warning and the corresponding negative actions taken against 27 banks initially caused major US bank stocks to drop 4%, further distancing themselves from the high levels seen since the crisis on March 8. Not only did the aforementioned "named" bank stocks decline, but the four major US banks were also affected by the risk aversion sentiment, with all of them falling about 2%. Goldman Sachs experienced the deepest decline of 3.8% and led the Dow Jones Industrial Average.

However, by the closing bell, the decline in bank stocks had generally narrowed. The Philadelphia Stock Exchange KBW Bank Index (BKX) and the KBW Nasdaq Regional Bank Index (KRX) both fell more than 1% to a one-week low. Among the key regional bank stocks, Zions Bancorporation initially dropped nearly 6% but then slightly rebounded. This was mainly due to Moody's accepting interviews with multiple media outlets and stating that "the US banking industry is still strong."

Moody's executives stated that the reason for the rating downgrades and negative watchlist placements was mainly due to the outlook for future profit compression:

"What we are doing here is pointing out some unfavorable factors—we are not saying that the US banking system has already collapsed."

Moody's pointed out that the pressure from rising interest rates and overall monetary policy tightening has not diminished. The rating changes are due to the potential contraction of bank profits in the coming quarters.

On one hand, as the economy worsens, more borrowers will default on loans, and banks will have to pay higher interest rates to retain deposit customers, thereby eroding their profit margins:

"The financing pressure and deposit pressure faced by the US banking system are unprecedented for us in the long term, but the US banking industry has not adequately prepared for interest rate risks, so certain banks are facing some challenges.

Banks will find it more difficult to make money as they deal with rising interest rates, rising financing costs, and the imminent economic recession's pressure on profits.

Despite the rating downgrades, the US banking system is still one of the highest-rated banking systems in the world. This is largely a profit anxiety—we do not have significant concerns about the system's capital or funding deficiencies."

Analysis: Market Tension Indicates Lingering Issues for the Banking Industry's Spring Crisis, Moody's Sounds the Alarm

Some analysts point out that the market's reaction indicates that the US banking industry is still susceptible to the issues triggered by the collapse of several medium-sized lending institutions this spring: bond depreciation, investor nervousness, deposit withdrawals, and rising costs. The KBW Nasdaq Bank Index has fallen 13% this year, while the S&P 500 Index has risen 17% over the same period.

Other analysts are trying to reassure investors. Mike Mayo, an analyst at Wells Fargo, stated that investors had already lowered their expectations for future bank profits before Moody's downgraded the ratings, and the market had already digested some of the negative factors mentioned by Moody's earlier this week:

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"Unlike the situation during the crisis in March, the current situation is more about interest rates, recession, and risk."

Christopher Marinac, the research director at consulting firm Janney Montgomery Scott, has a more optimistic view, stating that there have been no changes in the US banking industry, and Tuesday's stock price fluctuations were more like an immediate knee-jerk reaction to the downgrade:

"The second-quarter earnings report proves that banks can withstand weak revenues while still maintaining improved capital ratios and stable tangible book values. Profitability may not be outstanding, but they can still make money. Moody's is just sounding the alarm, which is nothing new."

It is worth noting that Moody's is the only one of the three major rating agencies to maintain the top sovereign credit rating of AAA for the United States. Standard & Poor's and Fitch have respectively downgraded the US rating in August 2011 and last week.