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Shortly after downgrading its credit rating for the US earlier this month, the renowned ratings agency Fitch has once again issued a warning that it might be compelled to downgrade the ratings of dozens of US banks if loan defaults continue their upward trajectory.
At present, the banking industry’s rating in the US – as per Fitch’s assessment – stands at A+. If this rating were to be downgraded to the next level, it would reflect a rating of AA-, representing a step down in ranking.
Should this scenario unfold, Fitch would find itself obligated to reassess the ratings of numerous US banks. Fitch analyst Chris Wolfe has commented that such a situation “would probably translate into negative rating actions.”
The ratings agency has articulated its expectation that the persisting challenges within the banking sector will endure throughout the second half of 2023.
As in the US, so in Australia
Fitch has pointed out that sluggish growth, elevated funding costs, and increased credit expenses are detrimental factors impacting bank performance considerably.
Similar to the Australian context, the US banking landscape is also grappling with persistent pressure on the Net Interest Margin (NIM).
Australia’s largest bank, Commonwealth Bank, recently underscored a parallel scenario in its latest report. The report highlighted that intensified competition and escalated operational costs are taking a toll on its NIMs.
While the attention was drawn to the headline profit of $10 billion upon Commonwealth’s release, the report was replete with cautionary signals. These included, among other things, a rise in loan repayments that were three months overdue, amplified operational expenses driven partly by a consumer shift towards term deposit accounts, and a loan impairment cost of $1.5 billion.
Analysts at Citigroup anticipate that this status quo will endure for the Australian banking sector as a whole, illustrating how macroeconomic outcomes in the US resonate in Australia – and vice versa.
Of noteworthy importance for Australian readers is that the vast majority of stock analysts have consistently rated Commonwealth as a “sell” for the past twelve months or more. Nonetheless, the household name status of Commonwealth seems to have been sufficient to maintain its share price buoyancy above lower levels.
Fitch is expecting a recession
In essence, Fitch is preparing for a recession to hit in the fourth quarter of this year, a perspective it conveyed in its recent note that downgraded the United States.
If the decision to downgrade numerous US banks is executed, this would undoubtedly cast a pall over market sentiment, potentially reinforcing the cyclical pattern of reluctance to expend and invest that often characterizes recessions.
However, it’s worth noting that Fitch’s projection only points towards a “moderate” recession expected to persist for two quarters. Yet, even this duration is substantial enough to substantially challenge the prevailing ‘soft landing’ narrative that a substantial portion of the market has embraced as a belief.
While Fitch is characterising this as a technical recession, an argument can be made that beyond the confines of conventional economic jargon, we might already find ourselves within a recession. Factors like historically low business sentiment, consumer sentiment, and overall life satisfaction all contribute to this perspective.
Adding to this, Fitch’s calculations, released on Friday, August 11, reveal that the net income for the top 20 largest banks in the US has declined by 7.9 per cent on a quarter-on-quarter basis.
The projection is that the downward pressure on Net Interest Margins (NIMs) will moderate through the latter half of 2023, with the assumed recession in the fourth quarter being the catalyst for suspending NIM compression.
One certainty remains – if the US plunges into a recession, it’s highly probable that Australia will follow suit. As the adage goes: when the US sneezes, the rest of the world catches a cold.
