Revisiting the Banking Industry

August 16, 2023 | Jessica Noviskis, CFA, Portfolio Strategist, OCIO Services

Though the regional banking turmoil that surfaced in March has largely faded into the background, Moody’s brought focus back to the sector last week when the rating agency downgraded 10 regional banks one notch (all remain investment grade). Moody’s also placed six larger lenders under review for a potential downgrade and cut the outlook for another 11 banks from stable to negative, indicating their ratings could be downgraded in the future. The rating agency cited interest rate and asset-liability management risks, as well as growing profitability pressures and expectations for a mild U.S. recession in early 2024 as reasons for these changes. Similar to Fitch’s downgrade of U.S. credit the week prior, the timing of these moves is being critiqued as deposit flows have generally stabilized since March, the Federal Reserve is likely at or near peak rates, and a soft landing appears increasingly likely.

Bank stocks pulled back modestly on the news, after notably outperforming the broader market in July. From here, a number of moving pieces remain at play. These include sensitivity of the banking industry to commercial real estate issues, tighter lending standards, and potentially higher-for-longer rates, though it is important to note that overall credit quality remains strong and the banking system remains well capitalized. Though the Moody’s downgrades may have little practical impact, they do serve as a reminder — especially after the strong performance of equities since the start of the year — that a number of uncertainties remain and, therefore, market volatility along with elevated dispersion could likely continue for the remainder of 2023.

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