The US banking system faces risks amid the fallout from the collapse of Silicon Valley Bank and two other lenders as the Federal Reserve hikes interest rates to curb inflation, Moody’s Investors Service warned.
The rating agency downgraded its outlook for the US banking system to negative from stable as the Fed tightens quickly and risk management is weak, compounding the underlying risks of banks’ asset-liability management.
Moody’s said its decision follows the winding-up of SVB, Signature Bank and Silvergate Capital, which prompted the US Treasury, the Fed and the Federal Deposit Insurance Corporation to step in and guarantee depositors could get all their money back.
“We have changed our outlook for the US banking system to negative from stable to reflect the rapid deterioration in the operating environment following deposit runs at SVB, Silvergate Bank and Signature Bank (SNY) and the collapses of SVB and SNY.” Agency in the outlook with.
In a separate note, Moody’s said that while the three banks were unique in their focus on cryptocurrency and venture capital, or private equity, areas of unbanked finance that have grown rapidly in the easy monetary policy era, “it is becoming increasingly clear that others US banks are also facing ALM charges.”
Lenders with significant unrealized securities losses and “with non-retail and uninsured U.S. depositors could still be more vulnerable to depositor competition or eventual flight, with adverse impacts on funding, liquidity, earnings and capital,” Moody’s said.
“Banks with lower unrealized securities losses, stronger capitalisation, diverse industry exposures and granular insured deposit bases will be better insulated or benefit from a flight to quality.”
Moody’s said it expects the Fed’s monetary tightening to continue, which could deepen challenges for some banks.
Speaking Tuesday at an Independent Community Bankers of America conference in Honolulu, Fed Governor Michelle Bowman said the US banking system remains resilient and “on solid foundations, with strong capital and liquidity throughout the system.”
“The Board of Directors continues to closely monitor developments in the financial markets and in the broader financial system.”
Markets echoed Ms Bowman’s view with stocks in the financial sector and banks rallied on Tuesday.
The S&P 500 was up 1.7 percent at the close, while the Nasdaq Composite and blue-chip Dow Jones Industrial Average were up 2.14 percent and 1.06 percent, respectively.
Pandemic-related fiscal stimulus and more than a decade of ultra-low interest rates and quantitative easing led to excess deposits in the US banking sector, Moody’s said.
“This has created challenges in asset-liability management, as some banks have invested excess deposits in longer-dated fixed income securities, which have depreciated during the rapid rise in US interest rates, resulting in significant unrealized losses in available funds assets of the banks. portfolios of securities held for sale and held to maturity,” it said.
“We expect the pressure to continue and be exacerbated by continued monetary tightening, with interest rates likely to remain elevated for longer until inflation returns to the Fed’s target range.”
While inflation in the world’s largest economy has eased after hitting a 40-year high last year, it remains high, with the annual consumer price index rising 6.4 percent for January and 6 percent in February and is well above the Fed’s 2 percent target interest rate.
The Fed faces a delicate balancing act when it meets to decide its monetary policy next week as it considers the fallout from further tightening to fight inflation amid the collapse of the SVB.
The Fed started raising interest rates this week last year. She was criticized by many on Wall Street for acting too slowly and catching up on what was originally thought to be temporary inflation.
However, when US inflation rose to over 9 percent last year, a 40-year high, and a similar scenario played out in Europe, the Fed became more aggressive, resorting to a series of hikes of 75 basis points and 50 basis points an attempt to restore price stability, fueling fears and criticism that tightening too harshly could increase the risk of a recession.
“US banks are also now facing soaring deposit costs after years of low funding costs, which will weigh on banks’ earnings, particularly those with a larger proportion of fixed income assets,” Moody’s said.
“Combined with this recent stress in the banking sector, further rate hikes could deepen some banks’ ALM and profitability problems.”
Rate hikes have reduced the economic value of securities on banks’ balance sheets, it said.
In 2005, government securities held by US banks totaled $1 trillion, or 13 percent of their combined balance sheet. Today, those holdings have grown to $4.4 trillion, or 19 percent of the assets of the US banking system, according to the rating agency.
Moody’s expects the US economy to slide into a mild recession towards the end of 2023, with real gross domestic product growth remaining below trend in 2024.
It also forecasts the US unemployment rate to rise below 5 percent from its low of 3.4 percent in January 2023.
While the real estate sector is already weakening, the real estate, construction and manufacturing sectors are likely to slow as rising interest rates, a strong dollar and weaker growth from the US’s trading partners weigh on domestic demand and exports, the rating agency said.
Asset risk metrics will increase from historical lows to 18 months over the next 12 months, with both non-performing loans and net charge-offs expected to rise, it said.
“Higher interest rates reduce debt affordability, excess consumer and corporate liquidity dwindles, and financial conditions, particularly bank lending, tighten,” Moody’s said.
“The deteriorating operating environment will be felt most strongly by banks exposed to deposit flight. Banks that are perceived as the most stable will benefit from drawing on deposits from other banks as liquidity improves.”
Moody’s expects headline and core inflation to decline over the period 2023-24, allowing the Fed to “move to a neutral policy stance in 2025.”
Updated Mar 15, 2023 8:06 am
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