Moody’s (NYSE:MCO) downgraded the credit ratings of many small to mid-sized US banks on Monday and said it may downgrade some of the country’s largest lenders, warning that funding risks and lower profitability will likely put the sector’s financial strength to the test.

Ratings Cuts and Reviews

Moody’s cut the ratings of 10 banks, including M&T Bank (NYSE:MTB), Pinnacle Financial Partners (NASDAQ:PNFP), Prosperity Bank (NYSE:PB), and BOK Financial Corp. (NASDAQ:BOKF) by one notch. Additionally, it placed six banking giants, such as Bank of New York Mellon (NYSE:BK), US Bancorp (NYSE:USB), State Street (NYSE:STT), and Truist Financial (NYSE:TFC) on review for potential downgrades.

“Many banks’ second-quarter results showed growing profitability pressures that will reduce their ability to generate internal capital,” Moody’s stated in a recent note. “This comes as a mild US recession is on the horizon for early 2024, and asset quality looks set to decline, with particular risks in some banks’ commercial real estate portfolios.”

Elevated Risks and a Negative Outlook

According to Moody’s, rising CRE exposures are a major concern due to high interest rates, decreases in office demand due to remote work, and a drop in the availability of CRE credit.

The agency downgraded the outlook for eleven large lenders, including Capital One (NYSE:COF), Citizens Financial (NYSE:CFG), and Fifth Third Bancorp (NASDAQ:FITB).

The collapse of Silicon Valley Bank (NASDAQ:SIVB) and Signature Bank (NASDAQ:SBNY) earlier this year sparked a crisis of confidence in the U.S. banking sector, leading to a run on deposits at various regional banks despite authorities launching emergency measures to boost confidence.

Vulnerabilities and Challenges Ahead

Moody’s warned that banks with significant unrealized losses that are not reflected in their regulatory capital ratios are vulnerable to a loss of confidence in the present high-rate environment.

This comprehensive report arrives against the backdrop of tightening monetary conditions. The Federal Reserve’s unprecedented pace of interest rate increases slows demand and borrowing, raising the specter of recession and pressuring sectors like real estate to adapt to post-pandemic realities.

According to statistics from a Federal Reserve poll released last week, US banks reported tighter credit criteria and weaker loan demand from businesses and consumers during the second quarter. Analysts at Morgan Stanley (NYSE:MS) predict that loan demand will continue to deteriorate, with the rate of change slowing even further.

International Impact

Rating agency peer Fitch has downgraded the United States to AA+ due to fiscal deterioration over the next three years and repeated down-to-the-wire debt ceiling negotiations, reflecting global concerns over the U.S. financial landscape.

Conclusion

The sweeping actions and warnings from Moody’s serve as a grim reminder of the challenges and risks faced by the US banking sector. While economic recovery continues, uncertainties around interest rates, remote work impacts on commercial real estate, and looming recession fears present significant obstacles for financial institutions navigating the complex post-pandemic economic environment.

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