Moody’s Downgrades Credit Ratings For 10 Banks, Puts Six Others On Notice

Ratings agency Moody’s cut the credit ratings of 10 small and midsized banks late Monday, while placing six big lenders on notice for a future downgrade, citing profitability challenges and funding risks.

The agency downgraded the credit ratings of 10 midsized banks by one notch. They were M&T Bank (MTB), Webster Bank (WBS), Pinnacle Financial Partners (PNFP), BOK Financial Corp. (BOKF), Associated Banc-Corp. (ASB), Old National Bancorp (ONB), Amarillo National Bank, Commerce Bancshares (CBSH), Prosperity Bank (PB), and Fulton Financial Corp. (FULT).

It also assigned a negative outlook to six top-tier lenders—Bank of New York Mellon (BK), U.S. Bancorp (USB), State Street Corp. (STT), Truist Financial Corp. (TFC), Northern Trust Corp. (NTRS), and Cullen/Frost Bankers Inc. (CFR)—placing them on review for a potential future downgrade.

The decision reflects a challenging backdrop for the banking industry, amid intense competition for attracting deposits in the aftermath of this year’s banking crisis. Moody’s cited increased funding costs, profitability pressures, and slowing loan growth as a common theme in banks’ second-quarter earnings.

“U.S. banks’ Q2 earnings showed material increases in funding costs as well as profitability pressures related to the significant and rapid tightening in monetary policy and inverted yield curve, which will continue to lower profitability and implies a weaker ability to generate capital internally,” Moody’s analysts said.

Among the bigger banks, reasons for assigning a negative outlook varied by lender. Some, including U.S. Bancorp and Truist Financial, have low capital buffers that could make them vulnerable in a time of renewed crisis. Others, including State Street and BNY Mellon, have experienced significant outflows in non-interest bearing deposits, which could lead to higher funding pressure.

Regional Banks Not Out of the Woods Yet

Meanwhile, analysts at Wedbush Securities noted that although deposit outflows have stabilized at most regional banks, lenders are seeking to trim their balance sheets and reduce borrowing in the coming quarters, which could eat away at any excess liquidity banks may have amassed.

Banks’ net interest margins—a key profitability metric that measures the difference between interest earned on loans and interest paid out to depositors—have been pressured amid an outflow of non-interest bearing deposits stemming from this year’s crisis, as a greater share of banks’ deposits bear interest, leading to higher funding costs.

Lending also has come under pressure as higher interest rates, driven by the Fed’s rate hikes, dented consumer demand for new loans. However, most banks already face high loan-to-deposit ratios. This means a greater proportion of their deposits were used to make loans, and a sign that banks may not have sufficient liquidity should the need arise. Banks may have to become more conservative in managing their balance sheets, which could reduce loan growth in the quarters ahead.

On a positive note, Wedbush analysts highlighted excellent credit quality amid improving capital ratios, and said they haven’t observed any systemic risks in this area. At the same time, many regional banks reduced their exposure to uninsured deposits in the aftermath of the banking crisis, which could prevent the kind of massive deposit outflows that occurred earlier this year at now-defunct Silicon Valley Bank, Signature Bank, or First Republic Bank.

Shares of many top-tier lenders, including Truist Financial, State Street, and U.S. Bancorp, have rebounded from recent lows hit in the spring, but are still down year-to-date. The broader S&P 500 banking sector is up just under 1% so far this year, as shares of the biggest banks like JPMorgan Chase (JPM) and Wells Fargo (WFC) have outperformed their smaller counterparts.