Stocks slipped this morning in response to major downgrades from ratings agency Moody’s. The decision to do so led to a 1% fall in the Dow, which was heavily impacted by a decline in Goldman Sachs. The S&P also fell 1% while the Nasdaq Composite retracted by 1.5%.
Moody’s downgraded the credit ratings of several regional banks, such as M&T Bank and Pinnacle Financial, while warning that additional downgrades could come for other major banks. Concerns about deposit risks, the looming threat of a potential recession, and challenges facing commercial real estate portfolios threatened banks earlier this year.
Moody’s pointed to all three hazards as the primary reasons for the credit downgrades.
“Collectively, these three developments have lowered the credit profile of a number of US banks, though not all banks equally,” the ratings agency wrote.
Banking giants Goldman Sachs and JPMorgan Chase (who weren’t downgraded) weren’t immune to the repercussions of Moody’s decision. Both banks saw their stocks dip by 3% and 2% respectively. A clear reflection of the broader market’s concern was seen in the SPDR S&P Regional Banking ETF (KRE), which also plummeted by over 3%. Jay Hatfield, CEO of Infrastructure Capital Advisors, highlighted the importance of robust credit ratings for regional banks, emphasizing that any dwindling faith in the regional banking system spells trouble for market sentiment.
“It’s not optional to have good credit ratings, because they need faith,” remarked Jay Hatfield, CEO of Infrastructure Capital Advisors.
“Any sort of reduction of faith in the regional banking system is really terrible for market sentiment.”
Despite proactive measures from both Washington and Wall Street to rejuvenate confidence, Moody’s did not shy away from addressing the vulnerabilities of banks, especially those with unrealized losses not accounted for by their regulatory capital ratios. Such banks remain susceptible to abrupt losses, particularly in an environment with high interest rates.
“Rising funding costs and declining income metrics will erode profitability, the first buffer against losses,” Moody’s wrote, explaining the downgrades.
“Asset risk is rising, in particular for small and midsize banks with large CRE exposures.”
Further elaborating on the situation were Moody’s analysts Jill Cetina and Ana Arsov:
“U.S. banks continue to contend with interest rate and asset-liability management (ALM) risks with implications for liquidity and capital, as the wind-down of unconventional monetary policy drains system-wide deposits and higher interest rates depress the value of fixed-rate assets.”
The analysts continued, adding:
“Meanwhile, many banks’ Q2 results showed growing profitability pressures that will reduce their ability to generate internal capital. This comes as a mild U.S. recession is on the horizon for early 2024 and asset quality looks set to decline from solid but unsustainable levels, with particular risks in some banks’ commercial real estate (CRE) portfolios.”
As to what’s to come, Moody’s expects additional pain for banks:
“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.”
Most banks rallied off their daily lows, but Moody’s has likely killed any hopes for a yield curve-driven bank rally. The yield curve has steepened significantly over the last few sessions, lifting banking shares, as they benefit from a steep yield curve.
But with the threat of additional downgrades looming, investors should remain very “gunshy” about buying banking shares again, especially if this week’s inflation data comes in hotter-than-expected.
