By Pam Martens and Russ Martens: April 24, 2023

All of those pundits who have written over the past two weeks that the banking crisis is over, have failed to persuade the big credit ratings agency, Moody’s. Last Friday, Moody’s downgraded the credit ratings of 11 banks and put another five banks on negative watch – all in one day. And, for good measure, it downgraded the entire U.S. banking system from “Very Strong –” to “Strong +.”

While not mentioning the Federal Reserve directly, the Moody’s downgrade of the U.S. banking system seemed to point directly at the Fed’s unrelenting interest rate hikes. Moody’s wrote:

“Moody’s has lowered the macro profile of the US banking system to ‘Strong +’ from ‘Very Strong –.’ The change in funding conditions reflects rising asset liability management challenges at US banks. Specifically, the banking system faces rising funding and profitability pressures related to the significant and rapid tightening in monetary policy, which has led to a reduction in US banking system deposits and higher funding costs. Higher interest rates have also reduced the value of US banks’ fixed rate securities and loans which increases their liquidity and capital risks.”

In simple terms, banks are actually going to have to start competing for deposits by paying bank customers a decent yield, instead of bragging about their great franchise and offering a fraction of one percent on deposits while big mutual fund companies are offering close to 5 percent on government money market funds. (See our report: The Banking Crisis Knock-On Effect Has Been a Stampede into Government Money Market Funds – Foiling the Fed’s Effort to Raise Market Interest Rates.)

This raises the dilemma the Fed now faces after too many unprecedented years of ZIRP (Zero Interest Rate Policy): kill inflation or kill the banks.

First Republic Bank, which is set to report earnings and the extent of its deposit shrinkage after the market closes today, was one of the 11 banks impacted by Moody’s downgrades on Friday. Moody’s downgraded its preferred shares deeper into junk territory, to CA from Caa1.

First Republic Bank is the west coast bank that U.S. Treasury Secretary, Janet Yellen, and Jamie Dimon, Chairman and CEO of JPMorgan Chase, set out to “rescue” in mid-March with the dumb idea of putting $30 billion more of uninsured deposits from the mega banks on Wall Street into the sinking bank. (One of its key problems at the time was that First Republic Bank already had too many billions of uninsured deposits. The FDIC caps federal deposit insurance at $250,000 per depositor per bank.)

After that “rescue” mission occurred on March 16, S&P Global downgraded the bank deeper into junk territory and the share price of First Republic Bank continued to collapse. First Republic’s stock has lost 90 percent of its value over the past year.

To conserve cash, First Republic had suspended its common stock dividend on March 16 and suspended dividends on its preferred on April 7.

As for the feasibility of the “rescue” plan actually working, Moody’s had this to say:

“…while the news of the banking consortium’s deposits is positive in the short-run, the longer-run path for the bank back to sustained profitability remains uncertain.

“The rating action also takes into consideration Moody’s assessment that the likelihood of government support for the bank’s preferred stockholders is low. The low level of government support for preferred shares reflects Moody’s expectation that, in the event of a continued deterioration in the bank’s financial profile, those preferred shareholders would not be protected.

Moody’s also listed its outlook for First Republic at “RUR,” meaning “Ratings Under Review.” It wrote:

“The review for downgrade reflects the continuing challenges to the bank’s medium-term credit profile in light of its significantly eroded deposit base, increased reliance on expensive / costly short-term wholesale funding and sizeable volume of unrealized losses on its investment securities. The review will focus on the likelihood of the bank’s preferred stocks being partly or wholly wound down, which would trigger a further downgrade to C(hyb), the lowest rating on Moody’s scale.”

And just who was it that did all that due diligence (or lack thereof) in underwriting $3.6 billion of those preferred shares for First Republic Bank? See our report: First Republic Bank’s “Rescuers” Had Underwritten $3.6 Billion of its Preferred Shares, Which Have Lost 65 to 70 Percent of their Value Year-to-Date.

Among the curious aspects of the First Republic Bank situation is the fact that its CEO, Michael Roffler, had been a CPA at the big accounting firm, KPMG LLP, for 16 years prior to joining First Republic in 2009. Five of his years at KPMG were as an audit partner.

The other 10 banks downgraded by Moody’s were the following: Associated Banc-Corp; Bank of Hawaii Corporation; Comerica Incorporated; First Hawaiian, Inc.; INTRUST Financial Corporation; Washington Federal, Inc.; Western Alliance Bancorporation; UMB Financial Corporation; U.S. Bancorp; and Zions Bancorporation, National Association. The ratings outlook for Comerica and Washington Federal were listed as “Negative,” while the other 8 banks’ outlooks were listed as “Stable” by Moody’s.

Five other banks, which did not receive a credit ratings downgrade by Moody’s on Friday, did have their ratings outlook placed on negative watch. Those banks were: BankUnited Inc.; First Merchants Corporation; Fulton Financial Corporation; KeyCorp; and Old National Bancorp.

The largest bank receiving a downgrade by Moody’s on Friday was U.S. Bank, the federally-insured commercial bank of U.S. Bancorp. According to U.S. Bank’s regulatory filings, as of December 31, 2022 it had $453 billion in deposits in domestic offices and $11.5 billion in foreign offices. Its assets were listed at $585 billion. That asset figure puts U.S. Bank in the number five place in terms of the 25 largest banks in the U.S., according to the December 31, 2022 data released by the Federal Reserve.

According to the FDIC, U.S. Bank has 2,208 domestic branches in 28 states, stretching more than 2,000 miles from Ohio to Oregon. That doesn’t sound to us like a “regional” bank. Nonetheless, mainstream media continues to present this as a regional bank problem.

Moody’s cut to the chase on the seriousness of what is ailing U.S. Bank, whose shares plunged by 30 percent in March and have recovered only a small amount of that lost ground. Moody’s wrote:

“…the downgrade of U.S. Bancorp’s ratings reflects its relatively low capitalization, which decreased following the December 2022 acquisition of MUFG Union Bank, N.A.. The downgrade also reflects Moody’s view that governance no longer has a positive impact on U.S. Bancorp’s ratings, but is instead a neutral component in its currently assigned ratings…

“The rating action also reflects U.S. Bancorp’s asset liability management challenges. Specifically, based on regulatory filings at year-end 2022, about half of its total deposits were uninsured, which is above the median rated US bank, and its unrealized securities losses, both AFS [Available for Sale] and held-to-maturity (HTM), were 62% of TCE [Tangible Common Equity], an elevated level for a highly-rated bank. Adding in an estimated 15% loss on the firm’s residential real estate loans brings unrealized losses to 109% of TCE at year-end. This limits its balance sheet flexibility in the event of unexpected deposit outflow.”

On the plus side, Moody’s offered this:

“However, U.S. Bancorp’s deposit base is strong and highly diversified and management classifies more than half of its uninsured deposits as operational, including the sizable component sourced from its trust business. Moreover, at 31 December, prior to funding strains in the sector, U.S. Bancorp had a sound level of cash on its balance sheet relative to its large regional bank peers, at more than 7% of total assets. At 31 March 2023, the level of cash on its balance sheet had grown to roughly 10% of total assets. U.S. Bancorp also benefits from multiple sources of contingent liquidity.”