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Moody’s Downgrades U.S. Banks: What Does This Mean for Investors?

Moody’s Downgrades U.S. Banks: What Does This Mean for Investors?

September 05, 2023

Moody’s Investors Service cut the credit ratings of 10 U.S. regional, midsized banks by one notch and put six large banks under review for possible downgrades including U.S. Bancorp, Truist Financial, and Bank of New York Mellon.

Moody’s also changed the outlook from stable to negative for 11 banks, which include Fifth Third Bancorp, Citizens Financial, and Capital One. To understand how this news may potentially impact finances and investments, investors must look at the whole picture. Here’s what investors need to know about the recent bank downgrades.

What is Moody’s?

Moody’s is a global risk assessment firm that delivers independent, well-researched, and transparent opinions on credit risk through credit ratings. Moody’s, Standard & Poor’s (S&P), and Fitch Group are the Big Three credit ratings agencies approved by the US Securities and Exchange Commission (SEC).

Why did this happen?

Moody’s cited the downgrade based on “several sources of strain on the U.S. banking sector,” which includes:

  • An increase in funding costs
    • How much do banks and financial institutions spend in order to acquire money to lend to their customers?
  • Profitability pressures
    • Deposits are either declining or growing at a slow rate.
  • Slowing loan growth
  • Low capital buffers
    • A capital buffer refers to extra capital required by regulators for financial institutions to ensure a more resilient global banking system.
  • Significant deposit outflows
    • When customers withdraw funds from their bank accounts at a faster rate than new deposits are being made.

What does this all mean?

Essentially Moody’s is concerned about the quality of the banks’ capital due to its macroeconomic outlook forecasting the potential for a recession at some point over the next year. “U.S. banks’ Q2 earnings showed material increases in funding costs as well as profitability pressures related to the significant and rapid tightening in monetary policy and inverted yield curve (long-term interest rates are less than short-term interest rates, a fairly reliable indicator of a recession), which will continue to lower profitability and implies a weaker ability to generate capital internally,” an analyst from Moody’s said. However, according to CNN Business, “some investors say the downgrade isn’t groundbreaking and is a reminder that the markets and the economy still have challenges ahead.”

What is a macroeconomic outlook?

A focus on the performance of economies, for example,

  • Changes in economic output
    • The total production of a country. Information used in measuring Gross Domestic Product (GDP).
  • Changes in inflation
    • If aggregate supply (total quantity of all goods and services produced in an economy at all possible price levels at a given time) falls but aggregate demand remains unchanged, you then have an upward pressure on prices and inflation.
  • Changes in the interest rate
    • The interest rate is affected by supply and demand, inflation, and government activity.
  • Changes in foreign exchange rates
    • Foreign exchange rates are constantly changing. The U.S. updates our rates at least once every business day.
  • Changes in the balance of payments
    • The Balance of Payments (BOP) is a statement of transactions (imports and exports) made between entities in one country and the rest of the world over a defined time frame.

How will this impact investors?

According to Reuters, chief fixed income strategist for LPL Financial, Lawrence Gillum said, “As long as U.S. government debt is the risk free asset, it’s unlikely a downgrade by Moody’s would elicit a much different response than what occurred (or didn’t occur) with Fitch.”

Are there any preventative measures that can be taken?

Consulting a financial professional to help you review your financial situation and current strategy to determine if any modifications are needed could be beneficial during these uncertain times of market volatility.




Important Disclosures:

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.

This article was prepared by LPL Marketing Solutions

LPL Tracking # 1-05377249


Sources:

Explainer: Moody's latest views on the US government: The last triple-A standing | Reuters

What Is a Capital Buffer? Definition, Requirements, and History (investopedia.com)

Moody's downgrades US banks, warns of possible cuts to others | Reuters

Funding pressure a theme for community banks across US | S&P Global Market Intelligence (spglobal.com)

Moody's Downgrades Credit Ratings For 10 Banks, Puts Six Others On Notice (investopedia.com)

Cost of Funds: What It Is, How It Works, Why It's Important (investopedia.com)

Macroeconomics (worldbank.org)

What does Moody's downgrade mean for markets? | CNN Business