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Moody's Downgrades and Outlook Warnings Highlight Pressure on U.S. Banks
Concerns Over the Banking Sector
The recent downgrades and outlook warnings issued by Moody's Investors Service indicate ongoing pressure on the U.S. banking industry, even after the collapse of Silicon Valley Bank. Although concerns had subsided following the stabilization of deposit levels in most banks after the regional banking crisis in March, a new issue has emerged. Small and mid-sized banks have been compelled to pay customers more for their deposits, a rate that exceeds the growth of their earnings from loans.
Ana Arsov, the global co-head of banking for Moody's Investors Service, and co-author of the downgrade report, stated that while banks have managed to retain their deposits, it has come at a significant cost. The need to replace these deposits with more expensive funding has led to concerns over profitability as deposits continue to exit the system.
The Impact of Rising Interest Rates
Banks are typically expected to flourish when interest rates rise. They can immediately charge higher rates for credit card loans and other products, while gradually increasing the amount they pay to depositors. This strategy enhances their lending margins, thereby making their core activities more profitable.
However, the benefits of higher rates were short-lived this time around. The boost evaporated in the first quarter of this year, when bank failures shocked depositors and the growth in net interest margin turned negative. Arsov noted that bank profitability has reached its peak for now. The above-average profitability of U.S. banks, compared to other systems, is threatened by weak loan growth and a reduced ability to maintain the spread.
Moody's Reassessment of Bank Ratings
Moody's reassessed its ratings on banks due to shrinking profit margins, relatively lower capital levels compared to peers at some regional banks, and concerns about commercial real estate defaults. In March, Moody's put six banks, including First Republic, under review for downgrades and downgraded its industry outlook from stable to negative.
This week, Moody's announced that it had placed U.S. Bank under review for a downgrade due to "rising deposit costs and increased use of wholesale funding." It also downgraded its outlook on Fifth Third from stable to negative, citing similar reasons.
The Future of the U.S. Banking System
Despite these concerns, Arsov emphasized that the U.S. banking system remains robust overall. Even the banks that were downgraded are still rated investment grade, indicating a low risk of default. However, she warned that in the next 12 to 24 months, profitability will be under pressure, regulations will increase, and credit costs will rise.
Implications for New Businesses: Navigating the Banking Sector's Challenges
The recent downgrades and outlook warnings issued by Moody's Investors Service highlight significant pressure on the U.S. banking industry, which could have substantial implications for new businesses. These businesses often rely heavily on banks for funding, and changes in the banking sector could affect their access to capital.
The fact that small and mid-sized banks are being compelled to pay more for deposits could potentially lead to tighter lending conditions for businesses. Additionally, the erosion of banks' profitability due to rising deposit costs and increased use of wholesale funding could further constrain their lending capacity.
Moreover, the anticipated increase in regulations and credit costs over the next 12 to 24 months could make it more challenging for new businesses to secure loans. This underscores the importance of businesses having robust financial strategies and contingency plans in place.
In conclusion, while the U.S. banking system remains robust overall, the challenges it faces could impact new businesses. It's crucial for these businesses to stay informed about developments in the banking sector and to plan their financing strategies accordingly.
Article First Published at: https://www.cnbc.com/2023/08/09/moodys-bank-downgrade-in-charts-us-bank-fifth-third-others-under-review-.html
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