How the rating agencies missed the mark: Reassessing recent analyses of the banking sector

By Dan Brown, Jeff Huther and J.P. Rothenberg

In light of the August 2023 downgrade by Moody’s of several US banks, as well as commentary by Fitch Ratings on the banking sector, ABA’s Office of the Chief Economist is providing a brief assessment of the rating agency comments and highlighting critical flaws in some of the assumptions impacting their analyses. In their assessments, the rating agencies focused on three key headwinds for banks: rising funding costs eroding profitability, low regulatory capital of regional banks, and asset risk of commercial real estate. We will explore each in more detail in this analysis and show that banks’ earnings remain robust (once you factor in rising lending rates), they continue to hold high capital ratios, and have highly diversified CRE portfolios. 

Lower profitability 

The analyses made key incorrect assumptions regarding bank profits. The text and title of Exhibit 3 from the Moody’s report claim deposits are repricing more rapidly than loans, implying that banks’ net interest margins for new loans are falling. The Fitch report also voiced concerns about net interest margin, saying, Net interest margin compression will continue, but at a slower pace for the rest of the year.” However, the chart shows deposit rates rising 1.5% since liftoff while loan rates are up 2.3%. Also, the combination of floating rate loans and loan maturities (coupled with higher rates relative to deposits) has actually been buffering deposit cost increases.   

Another assumption regarding profitability was that loan growth of banks has slowed considerably. However, as the charts below display, loan growth for banks of all sizes is still quite healthy. This resilience is remarkable considering the large increase in the federal funds rate.  

Regulatory capital 

The Moody’s analysis made the claim that regional banks have relatively low capital levels that will leave them vulnerable to large credit losses. While the tier 1 capital ratios of regional banks in 2023 Q2 were lower than other size cohorts, these regional banks’ capital levels are significantly above their advised capital level requirements. According to the OCC new capital rule quick reference guide, banks are considered adequately capitalized with a Tier 1 Capital Ratio of 6% and are considered well capitalized if their Tier 1 capital ratio is 8%. Notably, all size categories of banks are significantly above these recommendations by the OCC, as shown in the chart below, meaning that banks are wellprepared for adverse outcomes from the perspective of government regulators. 


With respect to Commercial Real Estate (CRE), the analysis in Exhibit 7 from Moody’s combines all nonfarm, nonresidential CRE holdings. This analysis makes the incorrect assumption that all of these CRE assets are of poor quality that would disproportionately underperform in a potential mild recession early next year. 

This analysis fails to look more granularly at CRE subsectors. As the figure below illustrates from a recent ABA staff analysis, office buildings make up about 17 percent of all CRE holdings of banks. The ABA staff analysis provides several additional data points that emphasize the resilience of the non-office non-residential component of CRE. Although regional banks proportionately have more assets in CRE, many regional banks have expressed confidence that even their office holdings are proportionately in more resilient subcomponents of office such as medical space, suburban office buildings, and newer Class A properties. 

To be sure, the industry faces challenges right now as Moody’s and Fitch note, including the prospect of further interest rate hikes and most significantly the threat of proposed regulatory changes that will affect their ability to lend and support their customers and communities. But the rating agency assessments, which generated significant media coverage, failed to include key data undermining some of their conclusions. Our data, which is readily available to the rating agencies and other outside analysts, should be included in any future review of the banking sector if the public and investors want a clear picture into the real health of America’s banks.  

Jeff Huther and J.P. Rothenberg are VPs for banking and economic policy research and Dan Brown is senior director at the American Bankers Association.