Moody’s downgrades 10 regional banks, warns bigger Wall Street names

Credit rating agency Moody’s Investors Service downgraded 10 regional banks and put six other lenders on notice that they are under review, the latest blow to an industry still reverberating from the March banking crisis that led three firms to collapse.

The targeted banks remain vulnerable to nervous depositors and investors, risks from higher interest rates, and a weakening commercial real estate market, Moody’s said. Some of those conditions helped spark the panic this spring that brought down Silicon Valley Bank and Signature Bank, respectively the second- and third-largest bank failures in U.S. history.

The KBW Nasdaq Regional Banking Index closed the day down more than 1 percent, underperforming the broader market. The Dow Jones Industrial Average and the S&P 500 were both down less than 1 percent.

The biggest bank to receive a downgrade was Buffalo-based M&T Bank, the 19th largest in the nation by assets, according to the Federal Reserve. Others included Old National Bank, Associated Bank and Prosperity Bank.

A number of larger banks are under review, indicating the agency could downgrade them soon. They include Bank of New York Mellon, U.S. Bancorp, State Street and Truist Financial.

The banks declined to comment or did not respond to requests for comment.

And Moody’s assigned a negative outlook to 11 more banks, meaning their ratings could be downgraded in the medium to long term. That group also included some of the nation’s biggest lenders, including PNC Financial Services Group, Capital One and Citizens Financial.

“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,” Moody’s analysts Jill Cetina and Ana Arsov wrote in a note accompanying the announcement.

Moody’s maintained all of the banks’ investment-grade ratings, meaning they are unlikely to default on their debt. By contrast, Silicon Valley Bank experienced a head-spinning unraveling this spring after it failed to adjust for rising interest rates.

The bank, a darling of tech-focused venture capitalists, had plowed too much of its deposits into long-term government bonds, a seemingly safe bet before the Federal Reserve started hiking interest rates to combat inflation. But higher borrowing costs made those investments worth less than new government debt, saddling the bank with billions of dollars in unrealized losses. When the bank’s customers started pulling their own funds amid a tech industry slump, the bank had to sell off its holdings at a loss, precipitating a bank run that destroyed it.

The broader banking sector has shown more resilience. In the second quarter of this year, regional banks generally reported stable or growing deposits since the banking crisis in the spring prompted some customers to pull their funds. The results encouraged investors, and the KBW Nasdaq Regional Banking Index, which tracks the sector, has recovered to its pre-crisis levels.

Still, many Main Street banks reported steep drop-offs in profits as they paid out higher interest on deposits to keep customers happy and also padded their reserves of capital in anticipation of tougher requirements from federal regulators.

“There’s a realization that we’re not completely out of the woods,” said Scott Siefers, a senior research analyst at Piper Sandler. “We’ve passed the acute phase, but there’s a chronic phase that will take a long time to play out.”

Banking regulators have proposed requiring lenders to add to their capital cushions so they can better withstand future crises — a rule they want to apply to more regional banks. Moody’s said the plan will benefit the creditworthiness of banks in the long run, but in the near term, it could come with “increased regulatory costs and may entail business model changes that strain some banks’ profitability.”

Moody’s said banks could face more pressure if the economy enters a recession, which the rating agency expects to happen early next year. Such a downturn would force banks to restrict lending as they weather losses from existing loans, Moody’s said — a response that would exacerbate the economic skid. “History suggests that recessions associated with banking strains are both deeper and more protracted, and a sharper downturn is possible if bank lending standards continue to tighten,” Moody’s said.

Eric Compton, a Morningstar Research Services analyst who focuses on both Wall Street and regional banks, took a brighter view. He said that while bank earnings will continue to face pressure, the sector should “easily remain profitable.” Even in the event of an economic downturn, he said, “banks are already holding excess reserves and are at least partially reserved for any potential recession.”

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