• Moody’s just issued a warning on the US banking system, cutting ratings of 10 regional banks and considering downgrading some big lenders.
• US banks are now facing the prospect of further deposit flight amid “eroding” profitability and continued rate hikes from the Fed.
• There is a significant risk that systemwide deposits will resume their decline in coming quarters, leading to reduced profitability and capital depletion.
Moody’s Warning on US Banking System
Moody’s credit ratings agency recently issued a fresh warning on the US banking system, cutting the ratings of 10 regional banks and also considering whether to downgrade a number of big lenders including Bank of New York Mellon, US Bancorp, State Street, Truist Financial, Cullen/Frost Bankers and Northern Trust.
Deposit Flight Risk
The agency has indicated that American banks are now facing a significant risk of deposit flight as profit margins narrow due to rising interest rates from the Federal Reserve. This could result in further decline in system-wide deposits which would lead to reduced profitability and capital depletion. Additionally, there is concern that if the economy enters into recession early next year then this could cause asset quality problems for commercial real estate portfolios held by certain banks.
Interest Rates & Quantitative Tightening
In order to combat inflationary pressures, it is expected that the Federal Reserve will keep interest rates high until inflation comes back down towards its target level of 2%. This means that quantitative tightening (QT) measures will continue to drain away deposits from across the banking industry with negative implications for liquidity and capital.
Rising Loan Losses
Furthermore, if the economy indeed enters into recession then loan losses across all US banks could surge due to tighter credit conditions being imposed upon borrowers. This would compound existing revenue issues caused by lower net interest margins as well as increased costs associated with paying more for deposits.
To conclude then, despite having enjoyed relative calm over recent months it appears that US banks are heading towards uncertain times ahead with risks related both to eroding profitability and potential asset quality issues should economic conditions deteriorate further down the line.