Moody’s: U.S. banking system outlook changed to stable as economy improves

Editor’s Note: Moody’s Investors Service issued the following press released earlier today.

Moody’s has changed its outlook on the U.S. banking system to stable from negative, reflecting continued improvement in the operating environment and reduced downside risks to the banks from a faltering economy, says Moody’s Investors Service in its latest “Banking System Outlook: United States of America.” The outlook had been negative since 2008.

Moody’s expects U.S. GDP growth to be in the 1.5% to 2.5% range in 2013-14, accompanied by a continuing decline in unemployment 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 and co-author of the report. “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,” added Jones.

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, such low interest rates also harm U.S. banks’ pre-provision earnings in both the near- and medium-term. Most immediately, low rates reduce a key source of profitability – banks’ net interest margins. In addition, low rates encourage looser loan underwriting standards as banks seek out higher return, and consequently higher risk, assets. This will result in greater credit costs, reducing pre-provision earnings, in the future. Moody’s said the most likely scenario that could result in a reversion to a negative outlook on the U.S. banking system would be related to a protracted slackening of underwriting standards.

Moody’s banking system outlook expresses the rating agency’s expectation of how bank creditworthiness will evolve in this system over the next 12-18 months.