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On Aug 7, credit ratings of several small to mid-sized U.S. banks were slashed by Moody’s due to prevailing funding risks and profitability struggles faced by banks. The rating agency indicated potential downgrades in the credit strength for some of the nation's largest lenders.
According to Reuters, the credit ratings of 10 banks were cut by a notch and six other banking giants including — Bank of New York Mellon (BK - Free Report) , US Bancorp (USB - Free Report) and Truist Financial (TFC - Free Report) — were placed on review for potential downgrade by the credit rating agency.
Reasons for the Changed Outlook
Moody’s stated that the underlying profitability pressures faced by banks and its impact on their recent quarter earnings along with tight credit conditions are the main reasons behind the downgrade. Mounting profitability strains could limit the ability of the banks to generate internal capital and this coincides with the possibility of the U.S. economy entering a mild recession in early 2024.
Additionally, Moody's mentioned that holding too much commercial real estate (CRE) could be risky because of higher interest rates, less demand for office space due to remote work, and less available credit for CRE.
The Federal Reserve’s recent survey data revealed that American banks tightened their credit requirements and experienced reduced borrowing requests from both companies and individuals in the second quarter. According to Morgan Stanley analysts, as quoted by Reuters, this trend of reduced loan demand is expected to persist, with the pace of decline slowing down.
Along similar lines, Fitch, another rating agency, lowered the U.S. credit rating by a notch to AA+ from AAA, due to projected fiscal challenges over the next three years and recurrent last-minute negotiations regarding the debt ceiling.
What Does the Downgrade Imply?
In an interview with Reuters, Ana Arsov, Moody's Managing Director for Financial Institutions, shared that the main motive of the downgrades is to put the spotlight on the persistent difficulties in the banking system, without implying that the system is completely broken. The primary factor for the lowered credit ratings is the potential for bank's profits to decline in the upcoming quarters due to worsening economic conditions. Despite the downgrade, Moody's maintained that the U.S. banking sector remains strong.
Banks will face tougher times making money due to rising interest rates, increased funding expenses, and an approaching economic downturn that will impact profits, explained Arsov. Even with the downgrades, the U.S. banking system maintains a top global rating, she noted.
ETFs in Focus
The S&P Banks Select Industry Index slipped around 3.86% after Moody’s downgrade. However, the index later recovered about 2.73% after the downfall (as of Aug 8). Investors seeking to navigate the uncertain landscape of the banking sector can keep a close watch on the following financial ETFs in the upcoming weeks.
SPDR S&P Regional Banking ETF tracks the performance of the S&P Regional Banks Select Industry Index with a basket of 139 securities. The fund has amassed an asset base of $3.24 billion and charges an annual fee of 0.35%.
SPDR S&P Regional Banking ETF has a Zacks ETF Rank #4 (Sell) and a High risk outlook. The fund lost about 4.27% after the downgrade but has recovered around 1.65% since then (as of Aug 9).
iShares U.S. Regional Banks ETF tracks the performance of the Dow Jones U.S. Select Regional Banks Index with a basket of 35 securities. The fund has amassed an asset base of $787.16 million and charges an annual fee of 0.39%.
iShares U.S. Regional Banks ETF has a Zacks ETF Rank #4 and a High risk outlook. The fund lost about 4.52% after the downgrade. However, it has recovered around 1.55% since then (as of Aug 9).
Invesco KBW Regional Banking ETF tracks the performance of the KBW Nasdaq Regional Banking Index with a basket of 51 securities. The fund has an asset base of $65.75 million and charges an annual fee of 0.35%.
Invesco KBW Regional Banking ETF has a Zacks ETF Rank #2 (Buy) and a High risk outlook. The fund lost about 4.31% after the downgrade but has recovered around 1.52% since then (as of Aug 9).
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Banking Woes Still Linger? ETFs in Focus
On Aug 7, credit ratings of several small to mid-sized U.S. banks were slashed by Moody’s due to prevailing funding risks and profitability struggles faced by banks. The rating agency indicated potential downgrades in the credit strength for some of the nation's largest lenders.
According to Reuters, the credit ratings of 10 banks were cut by a notch and six other banking giants including — Bank of New York Mellon (BK - Free Report) , US Bancorp (USB - Free Report) and Truist Financial (TFC - Free Report) — were placed on review for potential downgrade by the credit rating agency.
Reasons for the Changed Outlook
Moody’s stated that the underlying profitability pressures faced by banks and its impact on their recent quarter earnings along with tight credit conditions are the main reasons behind the downgrade. Mounting profitability strains could limit the ability of the banks to generate internal capital and this coincides with the possibility of the U.S. economy entering a mild recession in early 2024.
Additionally, Moody's mentioned that holding too much commercial real estate (CRE) could be risky because of higher interest rates, less demand for office space due to remote work, and less available credit for CRE.
The Federal Reserve’s recent survey data revealed that American banks tightened their credit requirements and experienced reduced borrowing requests from both companies and individuals in the second quarter. According to Morgan Stanley analysts, as quoted by Reuters, this trend of reduced loan demand is expected to persist, with the pace of decline slowing down.
Along similar lines, Fitch, another rating agency, lowered the U.S. credit rating by a notch to AA+ from AAA, due to projected fiscal challenges over the next three years and recurrent last-minute negotiations regarding the debt ceiling.
What Does the Downgrade Imply?
In an interview with Reuters, Ana Arsov, Moody's Managing Director for Financial Institutions, shared that the main motive of the downgrades is to put the spotlight on the persistent difficulties in the banking system, without implying that the system is completely broken. The primary factor for the lowered credit ratings is the potential for bank's profits to decline in the upcoming quarters due to worsening economic conditions. Despite the downgrade, Moody's maintained that the U.S. banking sector remains strong.
Banks will face tougher times making money due to rising interest rates, increased funding expenses, and an approaching economic downturn that will impact profits, explained Arsov. Even with the downgrades, the U.S. banking system maintains a top global rating, she noted.
ETFs in Focus
The S&P Banks Select Industry Index slipped around 3.86% after Moody’s downgrade. However, the index later recovered about 2.73% after the downfall (as of Aug 8). Investors seeking to navigate the uncertain landscape of the banking sector can keep a close watch on the following financial ETFs in the upcoming weeks.
SPDR S&P Regional Banking ETF (KRE - Free Report)
SPDR S&P Regional Banking ETF tracks the performance of the S&P Regional Banks Select Industry Index with a basket of 139 securities. The fund has amassed an asset base of $3.24 billion and charges an annual fee of 0.35%.
SPDR S&P Regional Banking ETF has a Zacks ETF Rank #4 (Sell) and a High risk outlook. The fund lost about 4.27% after the downgrade but has recovered around 1.65% since then (as of Aug 9).
iShares U.S. Regional Banks ETF (IAT - Free Report)
iShares U.S. Regional Banks ETF tracks the performance of the Dow Jones U.S. Select Regional Banks Index with a basket of 35 securities. The fund has amassed an asset base of $787.16 million and charges an annual fee of 0.39%.
iShares U.S. Regional Banks ETF has a Zacks ETF Rank #4 and a High risk outlook. The fund lost about 4.52% after the downgrade. However, it has recovered around 1.55% since then (as of Aug 9).
Invesco KBW Regional Banking ETF (KBWR - Free Report)
Invesco KBW Regional Banking ETF tracks the performance of the KBW Nasdaq Regional Banking Index with a basket of 51 securities. The fund has an asset base of $65.75 million and charges an annual fee of 0.35%.
Invesco KBW Regional Banking ETF has a Zacks ETF Rank #2 (Buy) and a High risk outlook. The fund lost about 4.31% after the downgrade but has recovered around 1.52% since then (as of Aug 9).