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This year’s failures of Silicon Valley Bank, Signature Bank and First Republic Bank put regional banks under scrutiny, but Fitch Ratings is warning that dozens of banks it covers — including leading lenders like JPMorgan Chase and Bank of America — could soon face rating downgrades.
That’s according to Fitch Ratings analyst Chris Wolke, who told CNBC Tuesday that the rating agency wants investors to know that bank downgrades, which would likely raise the cost of borrowing for businesses and individuals, are a real risk.
Fitch analysts put investors on notice in June that with interest rates on the rise, they had concerns about the banking industry as a whole, lowering their “operating environment” (OE) score for the U.S. banking industry from “aa” to “aa-.”
“Interest rates have begun to reverse a long-run decline since the early 1980s and banks will be operating in an environment of higher rates for an extended period, pressuring deposit levels and increasing funding costs,” Fitch analysts said at the time.
Fitch left the ratings of more than 70 U.S. banks it covers untouched but warned that the reduced OE score for the industry “reduces ratings headroom” for individual banks. In the event of another reduction of the OE score for the banking industry as a whole, individual banks would face revised performance benchmarks that might hurt their ratings.
“If we were to move it [the OE score for the banking industry] to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions” for individual banks, Wolfe told CNBC Tuesday.
Analysts at Moody’s last week downgraded the ratings of 10 small and midsized banks, including M&T Bank, Pinnacle Financial, BOK Financial and Webster Financial. For now, nearly all banks are still considered “investment grade,” but Moody’s analysts also warned that the ratings of another 17 lenders were under review for downgrades, including big names like Bank of New York Mellon, U.S. Bancorp and Truist Financial.
The failures of Silicon Valley Bank, Signature Bank and First Republic Bank “brought into focus several vulnerabilities and gaps in the regulatory framework” and prompted a shift to higher-cost wholesale funding, tightened underwriting standards and the potential for new regulations, Fitch analysts said in June.
That’s already translated into higher rates for jumbo mortgages too big for purchase by Fannie Mae and Freddie Mac, as regional banks are forced to cut back.
Fitch’s lower OE score for the banking industry as a whole “reflects an increasingly uncertain macroeconomic environment and the potential for sustained structural challenges to the U.S. banking system should interest rates stay higher for longer,” analysts at the rating agency said. “These include the residual effects from unprecedented government stimulus during the pandemic, including high and persistent inflation, interest rate shocks and the Fed’s quantitative tightening aimed at reducing systemwide liquidity.”
During the pandemic, the Federal Reserve helped bring mortgage rates to historic lows — not only by bringing the short-term federal funds rate to near-zero percent but by relaunching a “quantitative easing” program that helped the U.S. economy weather the 2007-09 Great Recession.
‘Quantitative tightening’ shrinks Fed’s balance sheet
Source: Board of Governors of the Federal Reserve System, Federal Reserve Bank of St. Louis
At the height of the pandemic, the Fed was buying $80 billion in Treasurys and $40 billion in mortgage-backed securities each month, growing its balance sheet to nearly $9 trillion.
After it began raising short-term interest rates in March 2022, last year the Fed embarked on a “quantitative tightening” program to trim its balance sheet. Having ramped up the pace of tightening over several months, the Fed is now letting $60 billion in Treasurys and $35 billion in mortgage-backed securities roll off its books each month, putting more upward pressure on interest rates.
As of Aug. 9, the Fed had trimmed $946 billion from its balance sheet in less than 18 months: $723 billion from the central bank’s June 2022 peak Treasury holdings of $5.77 trillion and $223 billion from April 2022 peak holdings of $2.74 trillion in mortgage-backed securities.
Also factoring into Fitch’s decision to lower the operating environment (OE) score for the banking industry were doubts about the federal government’s ability to tackle rising budget deficits.
Fitch analysts placed the U.S. government’s AAA rating on rating watch negative in May, citing “debt ceiling brinkmanship” as the U.S. reached its $31.4 trillion debt limit. Although a crisis was ultimately averted with a deal that suspended the debt limit until Jan. 1, 2025, Fitch analysts on Aug. 1 downgraded the United States’ long-term ratings from “AAA” to “AA+.”
“The repeated debt-limit political standoffs and last-minute resolutions have eroded confidence in fiscal management,” Fitch analysts said, while also lamenting “limited progress” in tackling medium-term challenges, such as Social Security and Medicare costs.
With the government bringing in less revenue as the economy cools — and also paying higher interest rates on its growing debt — Fitch analysts said they expected the federal deficit to rise from 3.7 percent of gross domestic product (GDP) in 2022 to 6.3 percent this year.
Fitch said it was prepared to issue further downgrades to U.S. long-term ratings in the event of “a marked increase in general government debt,” or “a decline in the coherence and credibility of policymaking that undermines the reserve currency status of the U.S. dollar, thus diminishing the government’s financing flexibility.”
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