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Moody's reminds investors that regional banks aren't out of the woods yet

The banking industry got another reminder Tuesday that the problems that roiled the financial world in the spring are not yet in the past.

Regional bank stocks fell Tuesday after Moody’s Investors Service downgraded 10 mid-sized institutions by a single notch, including M&T Bank (MTB), Webster Financial (WBS), BOK Financial (BOKF), Old National Bancorp (ONB), and Fulton Financial Corp (FULT).

Moody's also warned about a review of six other banks for possible downgrades, including US Bancorp (USB), Truist (TFC), State Street (STT), and Bank of New York Mellon (BK), while assigning a negative outlook to PNC (PNC), Citizens Financial (CFG), Fifth Third (FITB), and eight other banks.

FILE- This May 3, 2017, file photo shows a U.S. Bank branch in Omaha, Neb. U.S. Bancorp said Thursday, Feb. 15, 2018, that it will pay $613 million in fines and penalties to settle allegations that the bank had poor anti-money laundering controls. (AP Photo/Nati Harnik, File)
US Bancorp is among the banks on review for a possible downgrade by Moody's. (AP Photo/Nati Harnik, File) (ASSOCIATED PRESS)

Stocks of many of these banks closed down by more than 1%. The KBW Nasdaq Bank Index (^BKX) and the SPDR S&P Regional Banking ETF (KRE) both dropped more than 1% as well.

Moody’s attributed its decisions to a series of pressures making life more difficult for mid-sized financial institutions across the country, from higher deposit costs and eroding profitability to new capital requirements and a commercial real estate slump.

The trigger for many of these issues is an aggressive campaign by the Federal Reserve to cool inflation with higher interest rates. Moody's said that campaign "continues to have a material impact on the US banking system’s funding and its economic capital."

"I don't think that the ratings downgrades suggest that there's more weakness coming that we didn't already see," JPMorgan US equity strategist Abby Yoder told Yahoo Finance Live, describing what happened as a "rearview mirror" look at the sector.

The move downward in many regional bank stocks, she added, had more to do with the fact that many of these stocks had rallied in recent weeks.

In fact, many investors pushed stocks higher following a series of second quarter earnings that appeared to ease any lingering fears that mid-sized financial institutions faced the sort of existential threat that surfaced in the spring when the failures of three sizable banks triggered outflows across the banking system.

Deposits were up at most smaller banks, even those that suffered outflows during the first quarter.

But there was one troublesome trend that emerged from those second quarter results. Namely, most regional banks attracted more deposits during the quarter by paying a lot more for them, thus cutting into a key measure of profitability.

Many, as a result, revised down their estimates of revenue or lending profits for the rest of the year, including PNC and Truist.

Fifth Third also trimmed its full-year forecast range for net interest income, which measures the difference between what banks earn on their loans and what they pay for their deposits.

"We're going to always plan around a more conservative outcome because if we're wrong, everybody does well, and if we're right, we're better positioned to deliver stable earnings," Fifth Third chief executive Tim Spence said last month.

The fresh volatility introduced by Moody's may come in handy for regulators as the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency try to sell a complex overhaul of new capital standards for banks.

They argue the changes are needed to make lenders stronger, more resilient, and better prepared for shocks like the crisis of this spring.

The new capital proposals are expected to face pushback from the banking industry, which argues that lenders are much more resilient than they were during the 2008-09 financial crisis and that higher requirements could restrict lending.

Many midsize banks that could be part of these new rules are already making adjustments by holding back on any increases in dividends or share buybacks. Several also are selling assets to reduce the risks on their balance sheets or examining a pullback in certain types of lending.

Banks are "doing the right things," Yoder, the JPMorgan equity strategist, told Yahoo Finance Live, citing the restructuring of balance sheets ahead of new regulatory requirements.

Banks will probably be less profitable, but in the long term, she added, "they will be in better shape."

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