Analysts from Moody’s said that the credit strength of the banking industry was shown as the beginning of the coronavirus shock to the industry hit, but as the pandemic continues, the shock could increase vulnerabilities to banks’ credit.
Moody’s said that its baseline economic scenario assumes disruption of economic activity through the second quarter, followed by a modest recovery in the second half of 2020. But the potential for a prolonged downturn is increasing, analysts said.
“The shock has not led to immediate or wholesale changes in the underlying credit strength of banks, as represented by their baseline credit assessments,” Moody’s said.
However, analysts said that the credit strength of many banks would become increasingly vulnerable if the economic shock broadened and lengthened.
“The current deterioration in profitability, coupled with further weakening of asset quality, will likely lead to weakening capital for at least some banks,” the analysts said. “Thus, when comparing a bank to its peers, the level of capital with which the bank entered this recession and its ability to retain capital throughout the next several years take on particular importance.”
Since the crisis began, Moody’s said it changed deposit ratings for only 5 percent of the banks in its coverage area, and only 12 percent have been assigned a negative outlook or have been placed on review for a downgrade.
“As we have previously commented, for most banks where we expect the impact to be less severe or more short-lived, reviews for downgrade or negative outlooks are more likely than immediate downgrades,” Moody’s stated.
Moody’s said that capital levels, during and after the pandemic, will be a key differentiator of credit profiles among banks.
“Generally, banks are facing a sharp deterioration in asset quality and reductions in profitability from already low levels, while central banks are providing extraordinary levels of liquidity and governments have strong incentives to support banking systems to foster an eventual recovery,” the analysts stated. “Thus, when comparing a bank to its peers, the level of capital with which it entered this recession and its ability to retain capital throughout the next several years take on particular importance.”
Moody’s did caution that because of the unknown situation regarding the pandemic’s continuing effect on the economy, credit profiles could change, based on a determination of the institution’s capital strength in the future.
“Changes in ratings would most likely be triggered at the point where our forward view is that capital will materially deteriorate without a return to pre-crisis levels within two to three years,” the analysts stated. “Conversely, we would not expect to take any negative rating actions when we are highly confident that capital levels will broadly return to pre-crisis levels within two to three years.
“As mentioned, banks’ pre-crisis liquidity has been inherently strong, and it has remained so in recent weeks. Because of this strong starting point, as well as substantial external liquidity support, we do not anticipate broad confidence issues in banking systems.”