US Bank crisis: Moody's downgrades 10 small to mid-sized US banks, warns of more cuts

Credit rating agency Moody’s downgraded the credit ratings of 10 small to mid-sized US banks and placed some banks on review for potential downgrades. The agency also changed its outlook to ‘negative’ for 11 banks. 

The main reasons for this downgrade were the possibility of a mild recession in the US in early 2024, followed by high-interest rate risks, asset-liability management issues, the tightening of monetary policies by the Federal Reserve and finally changes in regulatory capital requirements for US banks.  

Investor confidence in the otherwise robust US banking sector shook in March 2023 with the sudden collapse of Silicon Valley Bank, followed by Signature Bank and First Republic Bank. 

Here, customers frantically pulled their money from these lenders before US regulators (the US government’s Federal Deposit Insurance Corporation) intervened to take control. The collapse in the banking sector got triggered because banks were chasing high growth, ignoring basic principles which resulted in major asset-liability mismatch.

Furthermore, the frantic rise in interest rates by the US Fed further added pressure on banks with weak asset-liability control. These interest rate hikes to slow down persistently high inflation can also raise recession risks making investors more prudent with their investments. 

Moody’s Downgrade: The 10 Banks and their Ratings

Moody’s Bank Downgrades: Reasons 

• Higher interest rates resulted in decreased value of fixed-rate assets
• Asset-liability management risks with implications for liquidity and capital in US banks. Banks are still at risk for depositors to withdraw their funds due to increased uncertainty of banks’ liquidity.
• Unconventional tightening of monetary policies by the Federal Reserve and a rapid rise in banks’ cost of funding led to a drop in system-wide deposits. Non-interest-bearing deposits declining and banks paying more for deposits. The resulting drop in net interest income and net interest margins eroded profitability and, thus, the ability to replenish capital internally. 
• A proposed increase in regulatory capital requirements for all banks with assets above $100 billion is credit positive, but in the near term will come with increased regulatory costs and may entail business model changes that strain some banks' profitability. Regulatory tailoring that sets lower capital and liquidity requirements for banks with less than $100 billion in assets is credit-negative, and weaker regulations can promote excessive risk-taking at some banks.
• A mild US recession in early 2024 will worsen banks’ asset quality and increase the potential for capital erosion and strain profitability. There are unrealized economic losses as well that are not reflected in banks’ regulatory capital ratios. This may lead to a loss in investor confidence. 
• Particular risks in some banks’ commercial real estate (CRE) portfolios. Elevated CRE exposures are a key risk given sustained high-interest rates, structural declines in office demand due to remote work, and a reduction in the availability of CRE credit.

Effect on Share Price: The S&P 500 Banks index has slipped 2.5% year to date