A warning has been raised by an analyst at Fitch Ratings regarding the U.S. banking industry, indicating a heightened risk of approaching instability. The focal point of worry revolves around the potential for notable declines in the credit ratings of various American banks, including prominent entities like JPMorgan Chase.
Back in June, Fitch Ratings revised its evaluation of the industry’s general well-being, a change that garnered little attention as it did not prompt reductions in ratings for specific banks. Nonetheless, should the industry’s rating encounter an additional single-notch decline, transitioning from AA- to A+, Fitch would be obligated to reevaluate the ratings of more than 70 U.S. banks within its purview. Chris Wolfe, the analyst, shared in an exclusive conversation with CNBC at Fitch’s New York headquarters that such a downgrade might result in adverse rating measures across all sectors.
Recent moves made by credit rating agencies have ignited upheaval in the market. Moody’s has lowered the ratings of several smaller and medium-sized banks and raised concerns about the possibility of reducing ratings for more lenders, including those of larger stature. In a parallel vein, Fitch has decreased the U.S. long-term credit rating due to political inefficiencies and growing debt responsibilities. On this occasion, Fitch aims to communicate to the market that potential bank downgrades, while not assured, pose a real and tangible risk.
In June, Fitch undertook a revision in the industry’s “operating environment” rating, downshifting it from AA to AA-, prompted by factors such as the weight of credit rating strains, regulatory deficiencies brought to light by regional bank collapses, and uncertainties revolving around interest rates. The apprehension tied to a potential descent to A+ arises from the possibility of the industry’s rating slipping beneath that of certain highest-rated lenders. Of particular note, JPMorgan and Bank of America, the largest banks in terms of assets, would probably feel the impact of such a shift.
Should significant establishments such as JPMorgan encounter rating reductions, Fitch might find itself in a position where it must contemplate lowering the ratings of other banks as well. This could have ramifications for less robust lenders, potentially nudging them closer to a classification of non-investment grade. As part of a larger market decline, the stock values of JPMorgan, Bank of America, and Citigroup all saw declines, mirroring the performance of the KBW Bank Index.
Regarding factors that could initiate potential rating downgrades, the decisions made by the Federal Reserve regarding interest rates assume a critical importance. Should interest rates surpass market anticipations, there exists the potential for added strain on the profit margins of the banking sector. An additional concern pertains to the chance of loan defaults surpassing levels historically considered normal, with a particular focus on defaults involving office loans that could impact smaller banks.
The ramifications of broad-based downgrades are intricate and unpredictable. In the wake of recent downgrades carried out by Moody’s, experts at Morgan Stanley emphasized potential outcomes. These include the likelihood of banks needing to provide elevated yields in order to attract bond investors, potentially exerting additional pressure on profits. Furthermore, there are apprehensions that downgrades might activate unfavorable clauses within lending agreements or other complex contractual arrangements.
Wolfe highlighted that although a downgrade is not certain, its realization would bring about significant repercussions for the banking industry.
