People walk past a Capital One banking center in New York's financial district
Major U.S. banks, including Capital One, received a downgrade, a negative outlook or are being placed under review by Moody's. Reuters

KEY POINTS

  • The credit ratings of seven of the top 20 U.S. banks are getting downgraded, placed under review or receiving a negative outlook
  • Moody's is forecasting a U.S. recession in 2024
  • Federal Reserve policy was partially blamed for a worsening outlook in the banking sector

Moody's Investor Service Inc. is putting the U.S. banking system on notice.

In a Monday note, provided to International Business Times by Moody's Corp. (NYSE: MCO), the risk assessment firm downgraded the credit ratings of the following banking companies:

Additionally, it placed the following companies "under review:"

Moody's assigned a negative outlook to the following companies:

According to financial data released by the Federal Reserve in March, seven of the 20 largest U.S. commercial banks — ranked in terms of total consolidated assets — were included on the list either receiving a downgrade, being placed under review or receiving a negative outlook.

Collectively, U.S. Bank, Truist, PNC, Capital One, BNY Mellon, State Street and Fifth Third hold more than $3 trillion in assets, according to Fed figures.

The market reaction was swift after news of the downgrade circulated on Monday evening. All of the downgraded banks saw their stock prices drop sharply from Monday's closing bell price.

At the close of trading on Wednesday, none of the shares had returned to their Monday price. The same was true for all of the banks placed under review and those that received a negative outlook.

Representatives of U.S. Bank, Truist, PNC, Capital One, NY Mellon, State Street and Fifth Third did not immediately respond to a request for comment from IBT.

In an email to IBT, Jill Cetina, associate managing director at Moody's Investor Service, said the six banks placed on review will have their ratings review completed within 90 days. Those banks on review "have a higher likelihood than not of a ratings transition."

However, she told IBT, the downgrade should not be a reason for investors or consumers to lose confidence in the U.S. banking system.

"The US banking sector remains strong and very highly rated as compared to global peers," Cetina told IBT. "That said, the U.S. banking sector is facing some structural headwinds, most notably related to funding, higher interest rates, and, in some cases, adapting to higher regulatory expectations.

"Funding is generally a sector-wide challenge due to tighter monetary policy. The quality of a bank's deposits has become clearer in this environment and lower-quality deposits have implications for banks' profitability and ability to generate capital."

In the Monday note, Cetina and Ana Arsov, managing director for financial institutions at Moody's Investors Service, said its rating actions on the banks mentioned in the note were influenced by lower deposits, higher interest rates and a reduced ability to generate internal capital.

"This comes as a mild U.S. 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 portfolios," the Cetina and Arsov said in the note.

Cetina told IBT banks tightened their credit standards significantly over the past few quarters which historically is associated with a "material decline in banks' lending" to corporations."

The Moody's note also said a proposed increase in regulatory capital requirements for banks holding assets greater than $100 billion could potentially "strain some banks' profitability."

"Further, regulatory tailoring that sets lower capital and liquidity requirements for banks with less than $100 billion in assets is credit negative, and weaker regulations can promote excessive risk-taking at some banks," the note said.

Additionally, Cetina told IBT, the Fed's interest actions over the past 12 months are exacerbating asset-liability challenges at U.S. banks. She said she expects interest rates to remain elevated until inflation returns to the Fed's 2% year-over-year target range.

"We expect banks' asset-liability management risks to be exacerbated by the significant increase in the Federal Reserve's policy rate and the ongoing reduction in bank reserves and, relatedly, deposits because of the unwind of unconventional monetary policy through quantitative tightening," Cetina said in an email.

As for a recession, Cetina pointed to an April report authored by Madhavi Bokil, senior vice president of strategy and research at Moody's, Elena Duggar, managing director for credit strategy at Moody's, Atsi Sheth, also a managing director for Credit Strategy at Moody's and Radhika Ramalingam, an associate analyst at Moody's, which forecasted U.S. real GDP growth to weaken to 0.9% in 2023 from 2.1% in 2022 "followed by slightly better but still below-trend 1.1% growth in 2024."

"Our baseline 2023 growth projections incorporate decelerating economic growth resulting in a shallow recession in the second half of the year with the unemployment rate rising to just under 5% by year-end."

If a recession does come to pass, the Moody's analysts said in the Monday note they expect "rising loan losses for U.S. banks."

"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," the Monday note said.

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