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IPFS News Link • Central Banks/Banking

How the rating agencies missed the mark: Reassessing recent analyses of the banking sector

• By Dan Brown, Jeff Huther and J.P. Rothenberg

In light of the August 2023 downgrade by Moody's of several US banks, as well as commentary by Fitch Ratings on the banking sector, ABA's Office of the Chief Economist is providing a brief assessment of the rating agency comments and highlighting critical flaws in some of the assumptions impacting their analyses. In their assessments, the rating agencies focused on three key headwinds for banks: rising funding costs eroding profitability, low regulatory capital of regional banks, and asset risk of commercial real estateWe will explore each in more detail in this analysis and show that banks' earnings remain robust (once you factor in rising lending rates), they continue to hold high capital ratios, and have highly diversified CRE portfolios. 

The analyses made key incorrect assumptions regarding bank profits. The text and title of Exhibit 3 from the Moody's report claim deposits are repricing more rapidly than loans, implying that banks' net interest margins for new loans are falling.?The Fitch report also voiced concerns about net interest margin, saying, "Net interest margin compression will continue, but at a slower pace for the rest of the year." However, the chart shows deposit rates rising 1.5% since liftoff while loan rates are up 2.3%.?Also, the combination of floating rate loans and loan maturities (coupled with higher rates relative to deposits) has actually been buffering deposit cost increases.   

Another assumption regarding profitability was that loan growth of banks has slowed considerably. However, as the charts below display, loan growth for banks of all sizes is still quite healthy. This resilience is remarkable considering the large increase in the federal funds rate.