Moody’s Surprises the Market With Bank Downgrades

Post-SVB, most thought all was well with the banking system, but the rating agency sees worrisome weaknesses.


It’s ba-a-a-a-ack. The market recoiled Tuesday after Moody’s Investors Service downgraded 10 regional U.S. lenders and placed six major banks under review for a possible downgrade.

This came after investors had assumed the banking crisis from the spring was over. Their dismay was reminiscent of the shock from hockey-mask-wearing fiend Jason’s resurrection in the “Friday the 13th” movies. On Tuesday, the S&P 500 lost 0.4%, the KBW Bank Index was off 1.2% and the KBW Nasdaq Regional Bank Index fell 1.4%.

Investors were jolted when Moody’s downgraded the 10 smaller lenders (which included M&T Bank Corp. and Pinnacle Financial Partners Inc.), put the six large banks under review (among them State Street Corp. and U.S. Bancorp) and gave 11 more regionals negative outlooks, meaning they could be on a future downgrade list (notably PNC Financial Services Group Inc. and Fifth Third Bancorp).

The 10 downgrades were not harsh: The affected banks are still investment grade, each knocked down a single notch. M&T, for instance, was demoted to A3 from A2. Anything below Baa3 is in junk territory.

“We continue to expect a mild recession in early 2024, and given the funding strains on the U.S. banking sector, there will likely be a tightening of credit conditions and rising loan losses for U.S. banks,” Moody’s wrote in its report, explaining the actions.

The rating agency’s report pointed at how banks’ net interest margins have contracted this year, to 2.0 percentage points lately from 3.25 in January. A measure of profitability, the margin is the difference between what a bank earns in interest and the (lower) amount it pays out for deposits.

Moody’s noted that, as the Fed has raised interest rates, many banks are paying more to attract and keep deposits, which are the lifeblood of their finances. Further, the agency stated, many banks, mostly the smaller ones, are saddled with an onerous expense: suffering from deposit flight, these institutions have turned to costly brokered deposits, which third parties sell to them for a fee.

In the spring, the collapse of Silicon Valley Bank and two other small banking companies shocked the stock market. But as large banks and regulators moved in to shore up the small fries, no 2008-style system failure ensued. Since May, the two KBW bank indexes have partially recovered, regaining about half of their losses from the crisis.

Although the SVB-related woes appeared to be resolved, credit weaknesses remain a persistent presence on the financial scene. Moody’s move comes a week after Fitch Ratings dropped the rating of the U.S. government—and by extension U.S. Treasurys and the debt of Fannie Mae and Freddie Mac—one notch to AA+ from its top rank, AAA. In May, the nation barely escaped a U.S. default when Congress and the White House struck a last-minute deal to raise the federal debt ceiling.

In Moody’s eyes, banking may be getting riskier than is prudent. Given Americans’ penchant for debt, however, there’s an argument that this situation is to be expected from time to time.

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