Moody’s Cuts Bank Ratings, Recession Risk Looms
• The credit ratings agency Moody’s just issued a warning on the US banking system, cutting the ratings of 10 regional banks and considering whether to downgrade several big lenders.
• Banks are facing deposit flight due to “eroding” profitability and rate hikes from the Fed. There is a significant risk that deposits will continue to decline in coming quarters.
• A mild US recession is expected in early 2024, with rising loan losses for US banks and tightened credit conditions. The Federal Reserve will likely keep interest rates high until inflation comes down to its target of 2%.
Moody’s Warns of ‘Significant Risk’ for US Banks
The credit ratings agency Moody’s has released a warning on the US banking system, cutting ratings for 10 regional banks and considering downgrading several large lenders. This comes as profitability margins are narrowing and rate hikes from the Federal Reserve (Fed) have caused increased deposit flight.
Deposit Flight Threatens Bank Profitability
While there was some moderation in quantitative tightening (QT)-related deposit funding during Q2, there remains a significant risk that systemwide deposits will decline further in coming quarters. Most banks reported flat or modestly decreased deposits, but non-interest bearing deposits declined while banks paid more for their remaining deposits—reducing net interest income and net interest margins, which has eroded bank ability to internally generate capital.
Recession Could Lead To Increased Loan Losses
Moody’s also expects a mild recession in early 2024, with declining asset quality—particularly in commercial real estate portfolios—and an increase in loan losses for US banks if such an economic downturn occurs. Credit conditions may also tighten as a result of this recessionary period.
High Interest Rates Until Inflation Drops
To counter these issues, Moody’s notes that the Fed will likely keep interest rates high until inflation drops to its target level of 2%, which could help stabilize markets during any recessionary periods.
Overall, Moody’s warns that US banks face increasing pressure due to dwindling profits from deposit flight and higher borrowing costs brought about by rate hikes from the Fed. This situation could be exacerbated by the expected mild recession in early 2024 leading to increased loan losses and tighter credit conditions.