The recurring factors of increased funding expenses and challenges to profitability were evident across these banks’ second-quarter earnings reports.

Moody’s has downgraded the credit ratings of ten midsized banks by one notch. These include 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).

Additionally, the agency has 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). These institutions are under review for potential future downgrades.

This decision underscores the challenging environment within the banking industry, marked by intense competition for deposit acquisition following this year’s banking crisis. Moody’s identified prevalent factors of heightened funding costs, pressures on profitability, and a slowdown in loan growth as recurring themes in banks’ second-quarter earnings.

Moody’s analysts highlighted, “U.S. banks’ Q2 earnings revealed significant rises in funding costs, alongside profitability pressures stemming from the substantial and swift tightening of monetary policy and an inverted yield curve. This trajectory is expected to persist, impacting profitability and potentially weakening internal capital generation.”

Among larger banks, the rationale for assigning a negative outlook varied by institution. Some, like U.S. Bancorp and Truist Financial, exhibit low capital buffers that could render them susceptible during periods of renewed crisis. Others, such as State Street and BNY Mellon, have experienced notable declines in non-interest bearing deposits, potentially leading to heightened funding stress.

Regional banks are not yet free from challenges.
Wedbush Securities analysts highlighted that while most regional banks have stabilized deposit outflows, they are actively looking to streamline their balance sheets and reduce borrowing in upcoming quarters. This strategic move might erode any excess liquidity these banks have accumulated.

The net interest margins of banks, a crucial measure of profitability indicating the difference between interest earned on loans and paid out to depositors, have been squeezed due to a decrease in non-interest bearing deposits, resulting from the crisis earlier this year. With a larger portion of banks’ deposits now attracting interest, funding costs have risen.

Lending has also faced pressure as increased interest rates, influenced by the Federal Reserve’s rate hikes, dampened consumer demand for new loans. However, many banks already operate with high loan-to-deposit ratios. This indicates that a substantial portion of their deposits has been utilized for loans, potentially leaving them with inadequate liquidity in times of need. As a result, banks might adopt a more cautious approach to balance sheet management, which could potentially slow down loan growth in the forthcoming quarters.

On a positive note, Wedbush analysts emphasized strong credit quality alongside improving capital ratios. They mentioned the absence of any systemic risks in this domain. Concurrently, numerous regional banks have reduced their exposure to uninsured deposits post the banking crisis, potentially averting the magnitude of deposit outflows seen earlier this year at now-defunct institutions like Silicon Valley Bank, Signature Bank, or First Republic Bank.

While shares of several prominent lenders like Truist Financial, State Street, and U.S. Bancorp have rebounded from recent lows experienced in spring, their performance year-to-date remains lackluster. The broader S&P 500 banking sector has registered a modest gain of just under 1% this year, with larger banks such as JPMorgan Chase (JPM) and Wells Fargo (WFC) outperforming their smaller counterparts.

Source: Adapted from original text – Source: Moody’s. “Ratings and Assessments News.” (Registration required.)