Fitch hints at further bank downgrades

An analyst from Fitch Ratings has issued a cautionary statement regarding the potential for significant rating downgrades across numerous U.S. banks, including prominent institutions such as JPMorgan Chase. The banking industry in the United States has moved closer to facing another form of upheaval due to this risk.

In June, Fitch Ratings reduced its assessment of the industry’s overall health. This action, although not causing downgrades at that time, has been overlooked by many. According to analyst Chris Wolfe, another one-notch downgrade to the industry’s score – from AA- to A+ – would compel Fitch to reevaluate the ratings of over 70 U.S. banks under its coverage.

In an exclusive interview with CNBC at the company’s New York headquarters, Wolfe stated, “If we were to move it to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions.”

Recent actions by credit rating firms have disrupted financial markets. Moody’s, for instance, downgraded ten smaller and mid-sized banks and signalled possible cuts for an additional 17 banks, including larger institutions like Truist and U.S. Bank. Fitch, earlier in the same month, downgraded the U.S. long-term credit rating due to political dysfunction and increasing debt levels.

This time, Fitch is aiming to communicate to the market that bank downgrades, while not guaranteed, pose a genuine risk. The June assessment reduction was attributed to pressures on the country’s credit rating, regulatory vulnerabilities highlighted by regional bank failures in March, and uncertainties surrounding interest rates.

A crucial issue stemming from a downgrade to A+ is that it would position the industry’s score lower than that of certain top-rated banks. This would likely lead to the downgrade of JPMorgan and Bank of America, the two largest banks by assets, from AA- to A+. This is because banks cannot hold a higher rating than the operating environment they function within.

Should major institutions like JPMorgan experience downgrades, Fitch would be compelled to consider similar actions for other banks. Weaker banks could consequently approach the threshold of non-investment-grade status.

Shares of banks such as JPMorgan, Bank of America, and Citigroup dipped in response to this news amid broader market declines. The KBW Bank Index also experienced a decline.

Factors that could trigger an industry downgrade for Fitch include the Federal Reserve’s trajectory of interest rates. An environment of prolonged higher rates would squeeze profit margins within the banking sector. Another consideration is the potential for loan defaults to exceed historically typical levels, particularly for smaller banks.

The consequences of such widespread downgrades remain uncertain. Previous downgrades by Moody’s led to concerns that affected banks might need to offer higher yields to attract bond investors, which could further compress profit margins. There were also worries that certain banks might struggle to access debt markets or face undesirable provisions in lending agreements.

Wolfe acknowledged that while a downgrade is not certain, there would be ramifications if it were to occur. “It’s not inevitable that it goes down. We could be at AA- for the next 10 years. But if it goes down, there will be consequences,” Wolfe stated.

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