US Banks Facing ‘Significant Risk’ of Deposit Flight As Profit Margins Narrow, Warns Top Ratings Agency

The credit ratings agency Moody’s just issued a fresh warning on the US banking system.

In new research note, Moody’s says it’s cutting the ratings of 10 regional banks, and is considering whether to downgrade a number of big lenders including Bank of New York Mellon, US Bancorp, State Street, Truist Financial, Cullen/Frost Bankers and Northern Trust.

After a quarter of relative calm, Moody’s says American banks are now facing the prospect of further deposit flight amid “eroding” profitability and continued rate hikes from the Fed.

US banks continue to contend with interest rate and asset-liability management (ALM) risks with implications for liquidity and capital, as the wind-down of unconventional monetary policy drains systemwide deposits and higher interest rates depress the value of fixed-rate assets…

Although the general drain on deposit funding caused by quantitative tightening (QT) moderated in Q2, there remains a significant risk that systemwide deposits will resume their decline in coming quarters. Most banks’ deposits were flat or down only modestly, but the mix worsened, with 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.”

Moody’s analysts also say that the US economy will likely contract in the coming months.

“Meanwhile, many banks’ Q2 results showed growing profitability pressures that will reduce their ability to generate internal capital. This comes as a mild US recession is on the horizon for early 2024 and asset quality looks set to decline from solid but unsustainable levels, with particular risks in some banks’ commercial real estate (CRE) portfolios.” 

The rating agency says that the Federal Reserve will likely keep interest rates high until the central bank sees inflation coming down to its target of 2%. The company also says that US banks’ lending losses are likely to surge if the economy witnesses a recession.

“We continue to expect a mild recession in early 2024, and given the funding strains on the US banking sector, there will likely be a tightening of credit conditions and rising loan losses for US banks.”

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