U.S. banks face credit rating cuts amid rising interest rates and funding risks

S&P Global, one of the world’s leading credit rating agencies, has downgraded and revised its outlook for several U.S. banks, citing the challenges posed by the rising interest rates and the declining deposits in the banking sector.

S&P lowers ratings and outlooks for multiple banks

On Monday, S&P Global announced that it had cut the credit ratings of five U.S. banks and revised the outlook of two others to negative from stable. The rating agency said that the banks were facing “tough” operating conditions due to the funding risks and the weaker profitability that would likely test their credit strength.

U.S. banks face credit rating cuts amid rising interest rates and funding risks
U.S. banks face credit rating cuts amid rising interest rates and funding risks

The banks that were downgraded by S&P were Associated Banc-Corp, Valley National Bancorp, UMB Financial Corp, Comerica Bank and Keycorp. S&P said that these banks had a higher reliance on brokered deposits, which are more costly and less stable than core deposits. The rating agency also said that these banks had experienced large deposit outflows and were exposed to the prevailing higher interest rates, which could erode their net interest margins and earnings.

The banks that had their outlooks revised to negative were S&T Bank and River City Bank. S&P said that these banks had high commercial real estate (CRE) exposure, which could pose asset quality risks in a downturn. The rating agency also cited other factors such as geographic concentration, competitive pressures and regulatory uncertainty as reasons for the negative outlook.

Rising interest rates weigh on bank funding and liquidity

S&P’s move followed a similar action by Moody’s, another major credit rating agency, earlier this month. Moody’s had cut the ratings of 10 banks by one notch and placed six banking giants, including Bank of New York Mellon, US Bancorp, State Street and Truist Financial on review for potential downgrades.

Both rating agencies pointed out that the sharp rise in interest rates was weighing on many U.S. banks’ funding and liquidity. They said that deposits held by Federal Deposit Insurance Corp (FDIC)-insured banks would continue to decline as long as the Federal Reserve was “quantitatively tightening”, or reducing its bond purchases and raising its policy rate.

The Fed has signaled that it would start tapering its monthly asset purchases later this year and possibly hike its benchmark rate next year, as inflation has surged above its 2% target amid the economic recovery from the pandemic. The 10-year Treasury yield, a key indicator of long-term borrowing costs, has risen to around 1.5% from 0.9% at the start of the year.

Bank stocks underperform amid sector headwinds

The credit rating downgrades and outlook revisions have added to the headwinds facing the U.S. banking sector, which has underperformed the broader market this year. The S&P 500 Banks Index, which tracks the performance of 24 major U.S. banks, has gained about 18% year-to-date, compared to a 25% rise in the S&P 500 Index.

The banking sector has also been hit by the crisis of confidence triggered by the collapse of Silicon Valley Bank and Signature Bank earlier this year, which led to a run on deposits at a host of regional banks, despite authorities launching emergency measures to shore up confidence.

The sector has also faced increased regulatory scrutiny and competition from fintech firms and non-bank lenders, which have been offering more attractive products and services to customers. Moreover, the sector has been challenged by the low loan demand and the high loan loss provisions amid the uncertain economic outlook.

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