Credit rating agency Moody’ Investors Service has raised its outlook on the U.S. banking system to stable from negative, citing continued economic recovery.
Moody’s, which has had a negative outlook on the U.S. banking business since 2008, said today that it is altering its long-term view due to improvements in the operating environment, and reduced downside risks to the banks as the recovery takes hold.
It says it expects U.S. GDP growth to be in the 1.5% to 2.5% range in 2013-2014,with unemployment continuing to decline toward 7%. “Sustained GDP growth and improving employment conditions will help banks protect their now-stronger balance sheets,” said Sean Jones, a Moody’s associate managing director.
“In addition, after another year of reducing credit-related costs and restoring capital, U.S. banks are now even better positioned to face any future economic downturn,” he added.
Moody’s says that the low interest rate environment is the single most important issue that will drive U.S. banks’ performance in the next 12-18 months. “Low rates help to promote private-sector employment growth that more than offsets government job losses; low interest rates also have supported the recent improvements in the banks’ asset quality metrics, with net charge-offs now approaching pre-crisis levels,” says Moody’s.
However, it also notes that these very low rates also harm U.S. banks’ pre-provision earnings in both the near- and medium-term. For one, low rates reduce banks’ net interest margins, which is a key source of profits. Low rates also encourage looser loan underwriting standards as banks seek out riskier, higher return assets, it says; which results in higher credit costs, reducing future earnings.
If underwriting standards get too loose again, for too long, this is the scenario Moody’s says is most likely to cause it to revert to a negative outlook on the banking system.