Moody's recent credit rating downgrade has sent ripples through the U.S. banking sector, raising concerns about the stability and resilience of both major Wall Street names and smaller regional banks. The downgrade comes as these financial institutions grapple with a complex mix of challenges, from interest rate volatility to asset-liability management risks.
In any case, failure of three banks in early 2023 has put U.S. regional banks in tight spot this year. Invesco KBW Regional Banking ETF KBWR lost 1.6% on Aug 8, post the rating downgrade. The Fed's aggressive tightening of monetary policy over the past year and a half, including lifting the benchmark borrowing rate to a 5.25%-5.5% range, has implications for U.S. banks.
Moody's predicts that the ALM risks faced by banks will intensify as if the policy rate increases further. Regional U.S. banks are particularly vulnerable due to their comparatively low regulatory capital. Institutions with a higher proportion of fixed-rate assets on their balance sheets may face constraints, as quoted on CNBC.
Rating Downgrades and Negative Reviews
Moody's decision to cut the credit ratings of 10 small and mid-sized U.S. banks has cast a spotlight on the vulnerabilities present in the financial sector. Additionally, major players like Bank of New York Mellon, U.S. Bancorp, State Street, Truist Financial, Cullen/Frost Bankers, and Northern Trust are now under review for potential downgrades (read: Regional Bank ETFs: Value Play or Value Trap?).
Changing Outlook and Growing Profitability Pressures
Notably, Moody's also shifted its outlook to negative for 11 banks, including Capital One, Citizens Financial, and Fifth Third Bancorp. This shift in outlook reflects concerns about the ability of these institutions to weather the storm of economic uncertainty and market volatility. Growing profitability pressures were evident in many banks' Q2 results, raising questions about their ability to generate internal capital in the face of ongoing challenges.
Interest Rate and Asset-Liability Management Risks
Basically, the erosion in the value of fixed-rate assets due to higher interest rates adds to the challenges. In particular, commercial real estate (CRE) portfolios pose risks for some banks. This could further weaken banks' stability if there is a recession, which Moody's anticipates in early 2024.
How to Navigate the Uncertainty?
While Moody's downgrade highlights the challenges faced by U.S. banks,there are ways to navigate the challenge through ETF investing.
Short Financial Sector
Direxion Daily Financial Bear 3X Shares FAZ
The Direxion Daily Financial Bear 3x Shares seek daily investment results, before fees and expenses, of 300% of the inverse of the performance of the Financial Select Sector Index. The expense ratio of the fund 1.09%.
Big Banks Better Bets?
While regional banks appear to be stressed, big banks look way to more proofed if we look at the latest earnings. So, one can bet on big bank ETFs like Financial Select Sector SPDR Fund XLF.
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