S&P Global, one of the world’s leading credit rating agencies, has recently downgraded the credit ratings and revised the outlooks for several US banks. These include Associated Banc-Corp, Valley National Bancorp, UMB Financial Corporation, Comerica Bank, KeyCorp, S&T Bank, and River City Bank. This action follows a similar move by Moody’s, which cited weaker profitability and funding risks as factors that will likely test the credit strength of the banking sector.
Why did S&P downgrade the US banks?
According to S&P, the main reason for the downgrades is the challenging operating environment that many US banks are facing due to the rise in interest rates and the decline in deposits. S&P anticipates that deposits held by Federal Deposit Insurance Corporation (FDIC)-insured banks will go down as long as the Federal Reserve pursues “quantitative tightening” to combat high inflation.
Quantitative tightening is the opposite of quantitative easing, which is a monetary policy tool that involves buying large amounts of bonds and other assets to inject liquidity into the economy and lower interest rates. Quantitative tightening, on the other hand, involves selling or letting these assets mature without reinvesting the proceeds, which reduces the money supply and raises interest rates.
Higher interest rates mean that banks have to pay more interest to depositors, while the value of some bond assets have slumped. These factors have also increased the likelihood of asset quality deterioration, as borrowers may face difficulties in repaying their loans.
How did the banking crisis start?
The banking crisis in the US started in March 2023, when Silicon Valley Bank, once the country’s 16th largest bank, collapsed just days after depositors grew fearful of its solvency and made a classic bank run. The bank had been heavily exposed to risky loans in the technology sector, which suffered a sharp downturn amid regulatory scrutiny and rising competition.
The collapse of Silicon Valley Bank triggered a crisis of confidence in the US banking sector as a whole, resulting in a significant decline in deposits held by FDIC-insured banks. The FDIC, which is responsible for insuring deposits up to $250,000 per account, had to intervene and take over several failing banks, including Signature Bank, which was ranked 17th in the country.
The FDIC also implemented emergency measures to restore trust in the banking system, such as increasing deposit insurance premiums, imposing stricter capital requirements, and providing liquidity support to solvent but illiquid banks. However, these measures were not enough to prevent further downgrades by credit rating agencies, which raised concerns about the banks’ funding costs and profitability.
Which banks are affected by the downgrades?
S&P said it is cutting the ratings of five banks, which together have a combined asset base of more than $400 billion:
- Associated Banc Corp: The Wisconsin-based bank was downgraded from BBB+ to BBB with a negative outlook. S&P said that the bank has a high reliance on brokered deposits, which are deposits obtained from third-party brokers rather than directly from customers. Brokered deposits are considered less stable and more expensive than core deposits.
- Comerica Inc: The Texas-based bank was downgraded from A- to BBB+ with a stable outlook. S&P said that the bank has a low deposit-to-loan ratio, which indicates that it has less funding available than its lending needs. The bank also has a high exposure to commercial real estate loans, which are vulnerable to market fluctuations.
- KeyCorp: The Ohio-based bank was downgraded from A- to BBB+ with a negative outlook. S&P said that the bank has a weak funding profile compared to its peers, as it relies more on wholesale funding sources such as federal funds and repurchase agreements. The bank also has a high concentration of loans in certain industries such as health care and energy.
- UMB Financial Corp: The Missouri-based bank was downgraded from A- to BBB+ with a stable outlook. S&P said that the bank has a low net interest margin, which measures the difference between the interest income generated by its assets and the interest expense paid on its liabilities. The bank also has a high exposure to municipal securities, which are subject to interest rate risk and credit risk.
- Valley National Bancorp: The New Jersey-based bank was downgraded from BBB+ to BBB with a stable outlook. S&P said that the bank has a high loan-to-deposit ratio, which indicates that it has more lending than funding available. The bank also has a high exposure to commercial and industrial loans, which are sensitive to economic conditions.
S&P also revised the outlook to negative on two banks:
- River City Bank: The California-based bank was affirmed at BBB+ with a negative outlook. S&P said that the bank has a high dependence on non-core deposits, such as internet deposits and brokered deposits. The bank also has a high exposure to construction and land development loans, which are risky and cyclical.
- S&T Bank: The Pennsylvania-based bank was affirmed at BBB+ with a negative outlook. S&P said that the bank has a low net interest margin and a high cost of funds. The bank also has a high exposure to commercial real estate loans, which are subject to market volatility and regulatory pressure.
S&P also reviewed three additional banks, but did not change their ratings or outlooks:
- Zions Bancorporation: The Utah-based bank was affirmed at BBB+ with a stable outlook. S&P said that the bank has a strong capital position and a diversified loan portfolio. The bank also has a moderate reliance on non-core deposits and a low exposure to commercial real estate loans.
- Synovus Financial: The Georgia-based bank was affirmed at BBB with a stable outlook. S&P said that the bank has a solid deposit base and a balanced loan mix. The bank also has a moderate exposure to commercial real estate loans and a low exposure to construction and land development loans.
- Truist Financial: The North Carolina-based bank was affirmed at A with a stable outlook. S&P said that the bank has a strong franchise and a diversified revenue stream. The bank also has a low exposure to commercial real estate loans and a high exposure to consumer loans, which are more resilient to economic shocks.
What are the implications of the downgrades?
The downgrades by S&P have several implications for the affected banks and the banking sector in general. Some of the possible consequences are:
- Higher funding costs: The downgrades may increase the cost of borrowing for the banks, as investors may demand higher interest rates to lend money to them. This may erode their profitability and limit their growth potential.
- Lower investor confidence: The downgrades may also reduce the confidence of investors in the banks, as they may perceive them as less creditworthy and more risky. This may affect their stock prices and market valuations.
- Regulatory scrutiny: The downgrades may also attract more regulatory attention from the FDIC and other authorities, who may impose more stringent rules and supervision on the banks. This may affect their operational flexibility and strategic choices.
