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US bank shares decline as Fitch hints at possible credit downgrades

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2023-08-16

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Shares in US banks experienced a drop on Tuesday following indications that the Fitch ratings group might follow rival agency Moody's in downgrading the credit ratings of several American banks, including industry leader JP Morgan.

The news emerged from an interview with a Fitch bank analyst on CNBC, discussing a report released by the ratings group in June. This report had effectively issued a warning of potential downgrades for the US banking sector, but it went largely unnoticed.

Moody's had issued its own warning earlier in the month, placing the credit ratings of 27 banks on credit watch for potential downgrades and downgrading the ratings of 10 banks. This received more attention due to the immediate action taken.

Moody's report led to credit rating cuts for 10 US banks and warnings for 17 others, including major players like Truist, Capital One, and US Bancorp.

This came after Fitch had already lowered the US rating from AAA to AA+, a move that received criticism from brokers, politicians, analysts, and bankers. This overshadowed the bank report issued in June.

Fitch's bank warning came to light through comments from an analyst discussing a June report that included a revision of the group's outlook for US banking.

The analyst, Chris Wolfe, explained that Fitch's report had gone unnoticed because it didn't involve actual downgrades of bank credit ratings, unlike Moody's recent actions.

In the report dated June 27, Fitch Ratings announced that it was "lowering the operating environment (OE) score for U.S. banks to ‘aa-‘ from ‘aa', reflecting downward pressure on the U.S. sovereign rating, gaps in the regulatory framework, and uncertainty regarding the normalisation of monetary policy."

Fitch indicated that rising interest rates, ending a long decline since the 1980s, would lead to an environment of elevated rates for an extended period, affecting deposit levels and increasing funding costs. The lowered OE score wasn't expected to immediately impact bank ratings, but it did reduce ratings headroom.

The news led to a decline in bank share prices, with the KBW banking index losing over 2.7%. This also contributed to lower values in the S&P 500 and the Dow. Shares in JPMorgan Chase fell by 2.5% as the analyst suggested that the bank's credit rating might decrease if the OE rating is downgraded again.

Wolfe emphasised that another one-notch downgrade of the industry's score to A+ from AA- would prompt Fitch to reevaluate ratings for all the more than 70 US banks it covers.

Fitch's intention is to signal to the market that bank downgrades are a real risk, though not inevitable, according to Wolfe. Another downgrade to A+ could lead to lower ratings for top institutions like JPMorgan and Bank of America. In turn, this might force Fitch to consider downgrades for other banks, possibly pushing some weaker lenders closer to non-investment grade status.

Wolfe refrained from speculating on the timing of potential actions or their impact on lower-rated firms. The OE rating will be influenced by factors such as the Federal Reserve's monetary policy stance.

Fitch believes that if interest rates remain higher for longer than anticipated, the banking industry's profit margins could be under pressure. Additionally, rising loan defaults beyond historically normal levels could be a concern.

While Wolfe emphasised that a downgrade is not inevitable, he acknowledged potential consequences if it occurs.

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