U.S. banks: The issue is far from resolved

Losses stemming from the most significant non-performing loans in three years
U.S. banks: The issue is far from resolved
U.S. banks (Photo Credit: Reuters)

Has the market incorporated the downgrading of 10 medium-sized U.S. banks by Moody’s and placed them under surveillance alongside the 6 major banks? What does this classification signify?

The report unequivocally indicates that the banking sector is still under strain following the Silicon Valley collapse.

Despite the sector’s diminishing concerns following the second-quarter results, which revealed that most banks have managed to stabilize their deposit levels after enduring significant losses during the regional banking crisis in March, the recent classification raises doubts about the standing of small and medium-sized banks, casting a shadow over their status.

“Banks kept their deposits, but they did so at a cost,” said Ana Arsov, global co-head of banking at Moody’s Investors Service and a co-author of the downgrade report, reported CNBC. “They’ve had to replace it with funding that’s more expensive. It’s a profitability concern as deposits continue to leave the system,” Arsov added.

“Bank profitability has peaked for the time being,” Arsov said. “One of the strongest factors for U.S. banks, which is above-average profitability to other systems, won’t be there because of weak loan growth and less of an ability to make the spread.”

Key factors

The key factors leading to Moody’s reassessment of bank ratings were shrinking profit margins, relatively lower capital levels compared to peers at certain regional banks, and concerns regarding defaults in commercial real estate. These factors prompted Moody’s to take further actions after previous evaluations.

In March, Moody’s initiated a review for downgrades on six banks, including First Republic, and revised its industry outlook from stable to negative.

The classification adjustments served as a reminder that several crucial concerns exposed during this year’s crisis, such as the risks associated with increasing interest rates, were still in the early stages of being tackled. One risk that investors cannot overlook is the potential for long-term interest rates to continue rising, despite the Federal Reserve’s intention to pause rate hikes.

Huge losses

Currently, data indicates that U.S. banks experienced losses of nearly $19 billion on non-performing loans during the second quarter, marking the highest level in over three years. Lenders are grappling with increasing defaults among credit card borrowers and in the commercial real estate sector.

Read more: Moody’s, Italy shake up banks… and fear of new disruptions

According to the report by the Financial Times, lenders disclosed losses amounting to $18.9 billion on loans classified as non-refundable during the second quarter. This figure represents an increase of nearly 17 percent compared to the previous three months and a significant surge of 75 percent compared to the same period last year.

The surge in loan losses coincides with borrowers facing increased repayment obligations on their interest rate loans, following a series of significant interest rate hikes implemented by the Federal Reserve to address elevated inflation.

In anticipation of a fresh wave of loan losses, U.S. banks are preparing themselves by collectively allocating an additional $21.5 billion to cover potential future loan losses.

This marked the highest amount of provisions for future losses allocated by U.S. banks within a three-month period since mid-2020, and it stands as the third-highest sum in the past decade. Numerous banks make provisions for loan losses based on the assumption that if unemployment increases to around 5 percent from its current level of 3.5 percent.

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