Banks’ Problems Aren’t Over, According to the Bond Market

livemint.com:

Regional bank stocks have been on a tear lately. But what is happening with their bonds should be a wake-up call. On Monday, ratings firm Moody’s Investors Service took action on 27 banks, including downgrading the credit ratings of 10 and putting others under review or giving their ratings a negative outlook.

Credit ratings are very important for banks, which fund themselves partly with deposits, but also by selling bonds. Many of the reasons for the actions will be familiar: Rising deposit costs and risks to commercial property and construction loans posed by the shift to remote work. They might even feel a bit tired, after second-quarter earnings reports showed that many regional lenders had reversed or slowed deposit outflows, and were projecting a bounceback in interest income later this year or next.

The KBW Nasdaq Bank index has rallied over 9% since the start of July, and the KBW Nasdaq Regional Banking index of smaller lenders is up more than 17%. But the ratings moves are a reminder that many of the core issues revealed by the crisis this year—such as the risks posed by higher interest rates—are only beginning to be addressed. And one risk that investors can’t afford to ignore is that longer-term interest rates could keep pushing higher, even as the Federal Reserve looks to be pausing its rate hikes.

Moody’s analysts acknowledged in their Monday report that the Fed’s tougher capital requirements for banks with over $100 billion in assets should be positive for their credit risk, as more equity capital better protects bondholders. However, Moody’s also wrote that it saw some key issues unaddressed by the Fed’s thousand-plus-page proposal. While the July proposal would include paper losses on some bonds in many