The U.S. banking sector saw stock prices sink on 7 August after Fitch Ratings lowered its credit ratings on 10 small and midsize lenders and put 17 other institutions under review.
Fitch also warned that it might cut its ratings for some major banks, including Bank of New York Mellon, State Street Corp., Truist Financial, and U.S. Bancorp.
Fitch cited the banks’ higher borrowing costs, possible capital shortages, and outstanding loans in commercial real estate, a sector currently in a nosedive.
“Collectively, these three developments have lowered the credit profile of a number of U.S. banks, though not all banks equally,” Fitch said in a statement announcing the reductions.
Moody’s signaled its own “negative” outlook for 11 banks, including Capital One Financial, Citizens Financial Group, and PNC Financial Services Group.
Moody’s cited problems such as the diminished value of mortgage loans with fixed low-interest rates. The research firm lopped 15 percent from the book value of banks’ residential mortgage holdings.
The banking industry has been under scrutiny since three prominent U.S. banks collapsed last spring.
Second-quarter earnings reports showed many banks bouncing back, having slowed the outflow of deposits and projecting higher income from interest for the rest of this year.
Still, the factors that concern investors, regulators, and rating agencies remain:
● banks must pay higher interest rates on deposits to keep accounts from going elsewhere, as we reported in “Cash Flight to Money Market Funds Worsens Banks’ Plight” (4 Apr 2023);
● banks purchased low-yield bonds as a safety measure during the COVID War; those bonds are now near worthless as more recent issues pay much higher returns. Banks are sitting as much as $500 billion of bonds they find no market for;
● regulators are urging banks to set aside more cash reserves against the possibility that more loans will go bad (see “Value of Commercial Real Estate Loans Shrinks” 1 Aug 2023);
● commercial real estate is collapsing, with more than $300 billion in loans to be repaid or refinanced before 2027. Major landlords already are defaulting, a trend we noted in “Office Tower Owner Defaults on $1.7 Billion in Mortgages” (28 Feb 2023). Banks not only might be risk-averse to lending on commercial real estate but also might not have the cash to do so
“Rising funding costs and declining income metrics will erode profitability, the first buffer against losses,” Moody’s wrote in a note explaining its decision. “Asset risk is rising, in particular for small and midsize banks with large commercial real estate exposures.”
TREND FORECAST: The “Office Building Bust,” one of our Top Trends 2023, is only beginning to impact small and regional banks, which hold more than 60 percent of U.S. commercial real estate loans.
As more office landlords default, more banks will weaken at a faster pace and become one of the key factors propelling the country’s economy into a sharp economic downturn.