The US banking sector is under pressure from multiple factors, including the withdrawal of deposits, the rise of interest rates, and the looming threat of a recession, according to a new report by Moody’s Investors Service.
Deposit Flight and Interest Rate Risk
The credit rating agency said that US banks are facing “significant risk” of deposit flight as the Federal Reserve’s quantitative tightening (QT) program reduces the amount of reserves in the banking system. QT is the process of shrinking the Fed’s balance sheet by allowing its holdings of Treasury securities and mortgage-backed securities to mature without reinvesting the proceeds.
Moody’s said that QT has drained about $1.5 trillion of deposits from the banking system since 2017, and that there is a possibility that deposits will continue to decline in the coming quarters. This could force banks to rely more on wholesale funding sources, which are more expensive and less stable than deposits.
Moreover, Moody’s said that US banks are exposed to interest rate risk, as higher interest rates lower the value of their fixed-rate assets, such as loans and securities. The Fed has raised its benchmark interest rate nine times since 2015, reaching a range of 2.25%-2.5% in December 2018. Moody’s expects the Fed to hike rates two more times in 2023, bringing the target range to 3%-3.25%.
Moody’s said that higher interest rates have also increased the cost of deposits for banks, as customers demand higher returns for their savings. This has eroded banks’ net interest income and net interest margins, which are key measures of profitability for banks.
Recession Risk and Asset Quality
Moody’s also warned that US banks are facing the risk of a mild recession in early 2024, which could lead to a deterioration of asset quality and an increase in loan losses. Moody’s said that some banks are particularly vulnerable to commercial real estate (CRE) portfolios, which have grown rapidly in recent years and may be subject to overvaluation and oversupply.
Moody’s said that CRE loans accounted for 22% of total loans for US banks as of September 30, 2022, up from 19% in 2015. Moody’s said that CRE loans have higher loss rates than other types of loans in a downturn, and that some banks have concentrations of CRE loans above regulatory guidelines.
Moody’s also said that consumer lending, especially credit cards and auto loans, could see higher delinquencies and charge-offs in a recession, as household debt levels remain high and wage growth remains modest.
Rating Actions and Outlook
As a result of these challenges, Moody’s took several rating actions on US banks on August 8, 2023. Moody’s downgraded the ratings of 10 regional banks by one notch, citing their exposure to deposit flight, interest rate risk, and CRE lending. The affected banks are:
- M&T Bank Corporation
- Pinnacle Financial Partners Inc.
- BOK Financial Corporation
- Webster Financial Corporation
- First Horizon National Corporation
- Hancock Whitney Corporation
- Bank OZK
- First Hawaiian Inc.
- BankUnited Inc.
- Texas Capital Bancshares Inc.
Moody’s also placed six large banks under review for downgrade, indicating that their ratings may be lowered in the near future. The affected banks are:
- Bank of New York Mellon Corporation
- U.S. Bancorp
- State Street Corporation
- Truist Financial Corporation
- Cullen/Frost Bankers Inc.
- Northern Trust Corporation
Moody’s said that these banks have relatively high levels of unrealized losses on their securities portfolios, which could impair their capital ratios and liquidity positions in a rising interest rate environment.
Moody’s also changed its outlook to negative for 11 banks, meaning that their ratings may be lowered in the medium term. The affected banks are:
- Capital One Financial Corporation
- Citizens Financial Group Inc.
- Fifth Third Bancorp
- Huntington Bancshares Incorporated
- KeyCorp
- Regions Financial Corporation
- Synovus Financial Corp.
- Comerica Incorporated
- Zions Bancorporation NA
- SVB Financial Group
- Signature Bank
Moody’s said that these banks face profitability pressures from rising deposit costs, lower net interest margins, and higher loan loss provisions.
On the other hand, Moody’s affirmed the ratings of eight large banks with stable outlooks, indicating that their ratings are unlikely to change in the near term. The affected banks are:
- JPMorgan Chase & Co.
- Bank of America Corporation
- Citigroup Inc.
- Wells Fargo & Company
- Goldman Sachs Group Inc.
- Morgan Stanley
- Ally Financial Inc.
- American Express Company
Moody’s said that these banks have diversified revenue streams, strong capital buffers, and resilient asset quality.
