Moody’s downgrades outlook for US banking system to negative, citing ‘rapidly deteriorating operating environment’

People walk past the New York Stock Exchange (NYSE) on Wall Street on July 12, 2022 in New York City.

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In a blow to an already reeling sector, Moody’s Investors Service downgraded its outlook for the broader banking system from negative to stable on Monday.

The firm, which is one of the Big Three rating services, said it was making the decision in light of key bank failures that prompted regulators to step in on Sunday with a dramatic bailout package for depositors and other institutions hit by crisis.

“We have changed our outlook on the U.S. banking system from stable to reflect the rapidly deteriorating operating environment following deposit runs at Silicon Valley Bank (SVB), Silvergate Bank and Signature Bank (SNY) and failures of SVB and SNY,” Moody’s said in a statement.

The move followed action Monday night when Moody’s warned it had been demoted or indicted for downgrading seven individual institutions.

These measures are important because they could have an impact on credit ratings and therefore on the sector’s borrowing costs.

In its downgrading of the entire sector, rating agencies noted the extraordinary actions taken to support the sector. But he said other banks with unrealized losses or uninsured depositors could still be at risk.

The Federal Reserve has set up a facility to ensure that institutions facing liquidity problems have access to liquidity. The Treasury backed the program with $25 billion in funds and promised that depositors with more than $250,000 at SVB and Signature would have full access to their funds.

But Moody’s said concerns remained.

“Banks with large unrealized securities losses and with non-retail, uninsured U.S. depositors may still be more susceptible to depositor competition or ultimate flight, with adverse effects on funding, liquidity, profits and capital,” the report said.

Bank stocks rallied strongly despite the downgrade. The SPDR Bank exchange-traded fund was up nearly 6.5% in morning trading. Major indexes were also higher, with the Dow Jones Industrial Average up nearly 450 points, or 1.4%.

Moody’s downgraded Signature Bank’s signature on Monday and said it would remove all ratings. He placed the following institutions under review for possible downgrades: First Republic, INTRUST Financial, UMB, Zions Bancorp, Western Alliance and Comerica.

The company noted that a prolonged period of low rates combined with pandemic-related fiscal and monetary stimulus has complicated banking.

SVB, for example, ended up with some $16 billion in unrealized losses on the long-term treasury bills it held. As yields rose, it eroded the principal value of those bonds and created liquidity problems for the bank, long a favorite of high-flying tech investors who couldn’t get funding from traditional institutions. SVB had to sell these bonds at a loss to meet its obligations.

Rates rose as the Federal Reserve battled a surge in inflation that took prices to their highest levels in more than 40 years. Moody’s said it expects the Fed to continue raising rates.

“We expect the pressures to persist and be exacerbated by the continued tightening of monetary policy, with interest rates expected to stay higher for longer until inflation returns to the Fed’s target range.” , said Moody’s. “US banks are also facing a sharp increase in deposit costs after years of low funding costs, which will reduce bank profits, especially those with a higher proportion of fixed-rate assets.”

The company said it expects the U.S. economy to slide into recession later this year, which will put further pressure on the industry.

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