U.S. stocks tumbled on the news that credit rating agency Moody’s Investors Service downgraded 10 small to mid-sized U.S. banks by one notch on Monday and placed six of the nation’s biggest lenders on review for potential downgrades.
The Dow ended Tuesday’s session 159 points, or 0.5 percent lower. The S&P 500 declined 0.4 percent, and the Nasdaq lost 0.8 percent.
Moody’s also changed its outlook to negative for 11 major lenders, including Capital One, Citizens Financial and Fifth Third Bancorp, warning that the banking sector’s credit strength will likely be tested by funding risks and weaker profitability.
“U.S. banks continue to contend with interest rate and asset-liability management 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,” Moody’s wrote in a note.
“Meanwhile, many banks’ second-quarter results showed growing profitability pressures that will reduce their ability to generate internal capital,” the agency added.
Only one week ago, another major credit rating agency Fitch Ratings downgraded the U.S. government’s credit rating from the stellar AAA to AA+.
As for the reasons behind it, Diao Daming, a research fellow at the National Academy of Development and Strategy, Renmin University of China, said that recent credit rating cuts reflect the worrisome situation of the U.S. economy.
“It seems the U.S. went through recent economic problems such as bank failures, debt default and inflation pressure with positive indicators,” said Diao. “But fundamental problems affecting the current situation and prospects of its economy and the credit of the banking industry have not been resolved.”
“Under the pressure of the coming election, U.S. fiscal policymakers still maintain the trend of interest rate hikes, which brings systemic risks to its financial industry, especially regional banks,” Diao added.
A lower credit rating could push banks’ funding costs higher. Moody’s said regional banks are at greater risk since they have comparatively low regulatory capital, and institutions with a higher share of fixed-rate assets on the balance sheet are more constrained in terms of profitability and ability to grow capital and continue lending.
“Risks may be more pronounced if the U.S. enters a recession, which we expect will happen in early 2024, because asset quality will worsen and increase the potential for capital erosion,” the agency said.
Analysts believe the credit rating cut was another blow to the U.S. banking industry, which has been shaken by the collapse of Silicon Valley Bank, Signature Bank and First Republic in quick succession since March.
The collapses sparked a crisis of confidence in the U.S. banking sector, leading to a run on deposits at a host of regional banks despite authorities launching emergency measures to shore up confidence. In mid-March, Moody’s slashed its outlook on the entire U.S. banking system to negative in the wake of the bank turmoil.
Diao pointed out that major rating agencies made their decisions based on the realities of U.S. political and economic landscapes, such as the growing debt burden and the erosion of governance.
“Two major U.S. political parties only postponed the debt problem by raising the debt ceiling, and the country may come across a fiscal or even political crisis in fiscal year 2024 as the political polarization of the two parties intensifies,” he said.
Diao added that these downgrades are reasonable and that the whole world should be alert to the economic risks caused by the country’s chaos in governance.