S&P downgrades show some regional banks still face rising pressures

S&P Global downgraded its bond ratings for several US regional banks, another reminder of the many challenges facing an industry roiled by high interest rates, rising funding costs, and eroding profitability.

The agency lowered ratings for Associated Bank (ASB), Comerica (CMA), Key Bank (KEY), UMB Financial Corp (UMBF), and Valley National Bancorp (VLY). It also revised outlooks for River City Bank and S&T Bank (STBA) to negative while maintaining a negative outlook for Zions Bancorporation (ZION).

Those stocks fell in Tuesday trading. The KBW Nasdaq regional bank index (^KRX) dropped 4% so far this week and is poised for its weakest month since turmoil roiled the entire industry in March.

The downgrades from S&P Global announced on Monday night came two weeks after Moody’s Investors Service downgraded 10 mid-sized institutions by a single notch, warned about a review of six additional lenders, and assigned a negative outlook to 11 others.

A Fitch Ratings analyst has also warned that the entire industry could be downgraded to A+ from AA-, which could trigger cuts for some of the country's largest banks and sweeping downward adjustments for smaller rivals.

The pressure on the industry comes from the Federal Reserve's aggressive campaign to cool inflation with higher interest rates, which has in turn lowered the value of bonds held by many institutions and forced many institutions to pay more to attract or keep deposits.

Read more: What the Fed rate hike means for bank accounts

That, in turn, has lowered profits and heightened the risk of liquidity problems. Three sizable banks, including Silicon Valley Bank and First Republic, failed in the spring after depositors pulled their funds in a mass exit.

Many depositors have "shifted their funds into higher-interest-bearing accounts, increasing banks’ funding costs," S&P said. "The decline in deposits has squeezed liquidity for many banks while the value of their securities — which make up a large part of their liquidity — has fallen."

Deposits held by FDIC-insured banks have fallen 6% since the beginning of 2022, according to S&P Global.

The danger to banks affected by downgrades is that their efforts to raise money with bond sales could get more expensive, thus placing even more pressure on their profits. And if the value of the Treasury bonds they own as investments continues to fall, that will put pressure on balance sheets by increasing unrealized losses.

All of this has the potential to create a "doom loop" for some regional banks, NewEdge Wealth senior portfolio manager Ben Emons told Yahoo Finance earlier this month.

"If Treasury yields go up and the value of Treasuries declines, it pressures the stock price of regional banks, who then have to sell those Treasury bonds to make up for those losses and also build up reserves," he said. "And that can further affect their stock price."

Despite S&P’s expectation for profitability to "likely worsen further in 2024," the agency said the outlook for most US banks remains stable thanks in part to an emergency bank funding program initiated by US regulators and the "greater-than-anticipated resilience" of the US economy.

But profitability for the select banks is "likely to continue declining as long as the Federal Reserve is quantitatively tightening," the ratings agency added.

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