FINANCIAL INSTITUTIONS

SECTOR IN-DEPTH Banks – US

7 August 2023
Funding risks, weaker profitability and turn
in asset quality will test bank credit strength
US banks continue to contend with interest rate and asset-liability management (ALM) risks
with implications for liquidity and capital, as the wind-down of unconventional monetary
policy drains systemwide deposits and higher interest rates depress the value of fixed-rate
Contacts
assets. Meanwhile, many banks’ Q2 results showed growing profitability pressures that will
reduce their ability to generate internal capital. This comes as a mild US recession is on the
Jill Cetina, CFA +1.212.335.7000
Associate Managing Director horizon for early 2024 and asset quality looks set to decline from solid but unsustainable
[email protected] levels, with particular risks in some banks’ commercial real estate (CRE) portfolios. Combined,
Ana Arsov +1.212.553.3763 these factors underpinned our 7 August rating actions on 27 US banks.
MD-Financial Institutions
[email protected] Rising funding costs and declining income metrics will erode profitability, the first
buffer against losses. US banks’ Q2 results broadly show a rapid rise in the cost of funding.
CLIENT SERVICES Although the general drain on deposit funding caused by quantitative tightening (QT)
Americas 1-212-553-1653 moderated in Q2, there remains a significant risk that systemwide deposits will resume
their decline in coming quarters. Most banks' deposits were flat or down only modestly,
Asia Pacific 852-3551-3077
but the mix worsened, with non-interest-bearing deposits declining and banks paying more
Japan 81-3-5408-4100 for deposits. The resulting drop in net interest income and net interest margins eroded
EMEA 44-20-7772-5454 profitability and, thus, the ability to replenish capital internally. Banks have reduced loan
growth to preserve capital, but this will slow the shift of balance sheets toward higher
yielding assets, even as funding costs rise and banks deal with a yield curve inversion.

Most regional banks have comparatively low regulatory capital versus the largest
US banks and global peers. In the current high-rate environment, this leaves some banks
with sizable unrealized economic losses that are not reflected in their regulatory capital ratios
vulnerable to a loss of investor confidence. Further, we expect a US recession in early 2024
will worsen banks’ asset quality and increase the potential for capital erosion. A proposed
increase in regulatory capital requirements for all banks with assets above $100 billion is
credit positive, but in the near term will come with increased regulatory costs and may entail
business model changes that strain some banks' profitability. Further, regulatory tailoring that
sets lower capital and liquidity requirements for banks with less than $100 billion in assets is
credit negative, and weaker regulations can promote excessive risk-taking at some banks.

Asset risk is rising, in particular for small and mid-size banks with large CRE
exposures. Asset quality metrics remain solid across most consumer and commercial
lending segments, but have begun to deteriorate and have been unsustainably strong
compared with historical pre-pandemic levels. Elevated CRE exposures are a key risk given
sustained high interest rates, structural declines in office demand due to remote work, and a
reduction in the availability of CRE credit.
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

US banks’ interest rate and ALM risks continue to have wide-ranging credit implications
The Federal Reserve's rapid tightening of monetary policy – which we identified as a key risk to the sector in November 2022 –
continues to have a material impact on the US banking system's funding and its economic capital, which informs our credit analysis
and the 7 August rating actions on 27 US banks. The current environment also reminds us that issues beyond Federal Reserve actions
can put upward pressure on interest rates, with negative implications for some US banks. For example, in Q3 2022 challenges in the
UK gilt market resulted in higher long-dated US Treasury yields that hurt some US banks' performance. Other non-Fed factors such as
heavy Treasury bond issuance and spillovers from monetary policy developments in Japan are also pushing US interest rates higher. The
10-year Treasury yield has risen both Q3 to date and sequentially in Q2 from Q1, even as the yield curve remains inverted, deepening
some banks' ALM risk and profitability pressures.

The 7 August rating actions follow previous actions on 13 March and 21 April in response to US banks' rising interest rate risk and
deposit volatility stemming from QT. The growing risks to US banks were also reflected in the change of the US Banking System
Outlook to negative in March and the lowering of the Macro Profile for the US banking system to ‘Strong +’ from ‘Very Strong –’ in
April.

The revised Macro Profile, in particular, reflects a deterioration in the US operating environment and banking sector funding conditions.
Funding and profitability pressures will be more pronounced for banks that have allowed capital to decline, have extensive holdings of
fixed-rate assets and lack a strong deposit franchise.

Rising funding costs and declining income will erode profitability, banks' first buffer against losses
US banks’ Q2 results broadly show a rise in the cost of a number of banks' funding, even as there has been a pause in the general drain
on deposit funding caused by ongoing QT. This pause in pressure on the quantity of deposits was the result of Treasury drawing down
its cash balances at the Fed during debt limit negotiations and then rapidly increasing T-bill issuance after the debt limit resolution,
both of which supported US banking sector reserve balances at the Fed and, relatedly, deposits. Looking ahead, we expect significant
downward pressure to remain on systemwide deposits in coming quarters.

Most banks' deposit levels were flat or down only modestly in the quarter, but the deposit mix worsened, with non-interest-bearing
deposits declining and banks paying higher rates to retain deposits. The resulting drop in banks' net interest income and net interest
margin has begun to erode profitability, essentially banks' first buffer against losses because it allows them to replenish capital
internally. In response to growing profitability pressures, some banks have proactively reduced loan growth to preserve capital.
However, this will impede banks' effort to shift balance sheets toward higher yielding assets, even as funding costs continue to rise and
they must also contend with an inverted yield curve. We have also observed some banks significantly increasing their use of brokered
deposits. Brokered deposits are costly and can also become credit sensitive when a bank's credit weakens.

In this context, Exhibit 1 summarizes the 7 August rating actions on 27 banks, which resulted in the downgrades of 10 banks, the placing
of six banks on review for possible downgrade, and changes in the outlooks of 11 banks to negative from stable.

Exhibit 2 shows selected publicly available balance sheet and income statement metrics as of Q1 2023 that informed the rating
actions. We considered Q2 2023 earnings releases as part of this action.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the issuer/deal page on https://ratings.moodys.com for the
most updated credit rating action information and rating history.

2 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Exhibit 1
Ratings summary
US bank rating actions taken on 7 August 2023
Baseline Credit Baseline Credit
Outlook Outlook
Assessment Assessment
Post-rating action Pre-rating action
Post-rating action Pre-rating action
Downgrades
Commerce Bancshares, Inc. a2 STA a1 STA
BOK Financial Corporation a3 STA a2 STA
M&T Bank Corporation a3 STA a2 STA
Old National Bancorp a3 NEG a2 NEG
Prosperity Bancshares, Inc. a3 STA a2 STA
Amarillo National Bancorp, Incorporated baa1 STA a3 STA
Webster Financial Corporation baa1 STA a3 NEG
Fulton Financial Corporation baa1 NEG a3 NEG
Pinnacle Financial Partners, Inc. baa1 NEG a3 STA
Associated Banc-Corp baa2 STA baa1 STA
Ratings under review
Bank of New York Mellon Corporation (The) a1 RUR DOWN a1 STA
Northern Trust Corporation a1 RUR DOWN a1 STA
State Street Corporation a1 RUR DOWN a1 STA
Cullen/Frost Bankers, Inc. a2 RUR DOWN a2 STA
Truist Financial Corporation a2 RUR DOWN a2 STA
U.S. Bancorp a2 RUR DOWN a2 STA
Negative outlooks
PNC Financial Services Group, Inc. a2 NEG a2 STA
Capital One Financial Corporation a3 NEG a3 STA
Citizens Financial Group, Inc. a3 NEG a3 STA
Fifth Third Bancorp a3 NEG a3 STA
Huntington Bancshares Incorporated a3 NEG a3 STA
Regions Financial Corporation a3 NEG a3 STA
Cadence Bank baa1 NEG baa1 STA
F.N.B. Corporation baa1 NEG baa1 STA
Simmons First National Corporation baa1 NEG baa1 STA
Ally Financial Inc. baa2 NEG baa2 STA
Bank OZK baa2 NEG baa2 STA

1) The Baseline Credit Assessments shown in the above table refer to the operating lead banks. 2) Outlooks shown in the table refer to the Senior Unsecured/Issuer Rating outlook of the
operating lead banks. Please see individual bank press releases for additional details.
Source: Moody's Investors Service

3 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

Exhibit 2
Interest rate risk, funding/ALM challenges, weaker capital and CRE exposures weaken credit of some rated US banks
Selected indicators as of Q1 2023 that informed recent rating actions
Unrealized AFS+HTM Estimated
TCE as % of Total CRE as a % Construction loans
losses +15% residential uninsured Deposit beta
RWA of TCE as a % of TCE
mortgages as a % of TCE deposit share Q4 22 - Q1 23
Q1 23 Q1 23 Q1 23
Q1 23 Q1 23
Downgrades
Commerce Bancshares, Inc. 14.4% -51% 39% 40% 109% 42%
BOK Financial Corporation 12.2% -29% 57% 104% 146% 46%
M&T Bank Corporation 9.9% -33% 45% 90% 229% 52%
Old National Bancorp 9.8% -67% 43% 76% 287% 73%
Prosperity Bancshares, Inc. 15.5% -69% 41% 36% 194% 83%
Amarillo National Bancorp, Incorporated 10.6% -8% 46% 121% 110% 40%
Webster Financial Corporation 10.3% -48% 37% 99% 320% 30%
Fulton Financial Corporation 9.6% -61% 32% 77% 271% 59%
Pinnacle Financial Partners, Inc. 9.8% -27% 39% 118% 289% 104%
Associated Banc-Corp 9.2% -68% 49% 127% 242% 72%
Ratings under review
Bank of New York Mellon Corporation (The) 12.7% -57% 99% 104% 25% 5%
Northern Trust Corporation 13.2% -32% 92% 115% 46% 7%
State Street Corporation 14.7% -43% 94% 102% 18% 0%
Cullen/Frost Bankers, Inc. 13.0% -42% 52% 43% 159% 54%
Truist Financial Corporation 8.4% -85% 42% 88% 97% 25%
U.S. Bancorp 7.9% -98% 52% 56% 111% 28%
Negative outlooks
PNC Financial Services Group, Inc. 9.1% -48% 44% 87% 92% 18%
Capital One Financial Corporation 11.2% -22% 29% 110% 71% 7%
Citizens Financial Group, Inc. 9.7% -46% 45% 75% 156% 37%
Fifth Third Bancorp 9.1% -52% 50% 89% 66% 35%
Huntington Bancshares Incorporated 9.2% -65% 32% 93% 112% 17%
Regions Financial Corporation 9.4% -52% 36% 42% 86% 29%
Cadence Bank 9.9% -65% 45% 98% 249% 97%
F.N.B. Corporation 9.8% -53% 43% 68% 243% 66%
Simmons First National Corporation 11.6% -59% 26% 106% 346% 115%
Ally Financial Inc. 8.8% -57% 10% 128% 11% 2%
Bank OZK 11.2% -8% 33% 137% 385% 222%
TCE = tangible common equity, RWA = risk-weighted assets, AFS = available-for-sale securities, HTM = held-to-maturity securities.
We present Q1 2023 data above but considered Q2 earning releases as part of this rating action. Unrealized HTM losses include net of unrealized gain/loss of HTM included in accumulated
other comprehensive income; tangible common equity and net income/tangible assets are Moody’s-adjusted ratios and are calculated per Moody’s global banking methodology. Unrealized
losses are shown on a pretax basis. A 15% haircut is applied to outstanding mortgage loans to reflect the estimated decline in their market value given higher interest rates. Some
banks also use interest rate derivatives to hedge interest rate risk, which are not reported here. Total CRE includes loans secured by other (non-owner-occupied) nonfarm nonresidential
properties, multifamily (five or more) residential properties, and construction, land development and other land loans. Loans secured by owner-occupied nonfarm nonresidential properties
are not included in total CRE.
Source: Y-9C reports, Call reports, Moody's Investors Service

We evaluate banks' interest rate and funding risks through a number of factors, including the size of a bank's unrealized securities
losses and estimated potential losses on fixed-rate residential mortgages1; deposit growth; deposit granularity; uninsured deposit share;
quality of the liquidity buffer; deposit beta; capitalization; and profitability, the first buffer against loss and also a possible indicator of
ALM challenges.

In Q2 the pressure point of bank funding shifted from quantity of deposits to cost of deposits, with negative implications
for bank profitability
We expect banks' ALM risks to be exacerbated by the significant increase in the Federal Reserve's policy rate as well as the ongoing
reduction in banking system reserves at the Fed and, relatedly, deposits because of ongoing QT.2 Interest rates are likely to remain
higher for longer until inflation returns to within the Fed's target range and, as noted earlier, longer-term US interest rates also are
moving higher because of multiple factors, which will put further pressure on banks' fixed-rate assets.

In Q1 banks' funding strains reflected a reduced quantity of funding, influenced by factors we write about in our weekly Fed H.4.1
report. Post the March bank failures, deposit flight also became a factor.

In Q2 funding strains eased a bit on expectations of an end to Fed tightening, and instead banks faced rising deposit costs and a
worsening mix of deposit funding. For example, in the May Senior Financial Officer Survey (SFOS), responding banks said they expect
to increase their use of noncore funding, particularly brokered deposits, as 2023 progresses, and have raised deposit rates since the
banking system stress in March. Survey responses indicate that more than a quarter of the reporting banks expect deposits to grow

4 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

more than 2% during the second half of 2023. We think this may be challenging as long as the Fed continues to shrink its balance
sheet.

Because deposits are now repricing higher more quickly than loans (Exhibit 3), the median US bank's net interest margin has declined in
recent periods (Exhibit 4). If inflation proves sticky and more rate hikes are needed, funding strains could reemerge.

Exhibit 3
Deposits repricing more rapidly than loans, raising pressure on margins
Median deposit cost and loan yield vs. the fed funds rate, Q4 2015 - Q2 2023
US recession Federal funds rate (upper bound) Median cost of deposits Median loan yield
7.00%
5.94%
6.00% 5.63%
5.25%
5.05%
4.78% 4.85% 4.83% 4.75% 5.00%
5.00% 4.57% 4.68% 4.49% 4.50%
4.38% 4.40% 4.28%
4.08% 4.17% 4.25% 4.27%
3.84% 3.80% 3.84% 3.94%
4.00% 3.73% 3.74% 3.64%
3.64% 3.70% 3.73% 3.66% 3.64%3.50% 3.41%
3.25%

3.00% 2.50%2.50%
2.25% 2.25%
2.00%
1.75% 1.75% 1.75%
2.00% 1.50%
1.25% 1.25% 1.25%
1.00%
1.00% 0.25% 0.50% 0.75% 0.75% 0.50% 1.49%
0.50% 0.50% 1.11%
0.25% 0.25% 0.25% 0.25%0.25% 0.25% 0.25%
0.62% 0.68% 0.67% 0.59% 0.64%
0.00% 0.46% 0.54% 0.52% 0.25%
0.31% 0.38%
0.14% 0.15% 0.14% 0.15% 0.15% 0.17% 0.20% 0.25% 0.28% 0.17% 0.11% 0.07% 0.05% 0.04% 0.04% 0.03% 0.03% 0.07%

-1.00%
Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 2019 2019 2020 2020 2020 2020 2021 2021 2021 2021 2022 2022 2022 2022 2023 2023

The dark green and light blue lines represent the median cost of deposits and the median loan yield, respectively, for the following banks: BAC, C, CFG, CMA, FITB, FRC, HBAN, JPM, KEY,
MTB, PNC, RF, TFC, USB, WFC and ZION. From Q4 2015 - Q4 2019 the medians did not include TFC.
Source: FDIC, company reports, Moody’s Investors Service

Exhibit 4
Median US bank's net interest margin has peaked
Quarterly change in banks’ median net interest margin, Q1 2015 – Q2 2023
Median change in NIM (LHS) Average NIM for the median US commercial banks from 2010-2022 (RHS) Median NIM (RHS) Periods with rate increases 3.19%
0.40% 3.50%

3.06% 3.15% 3.10% 3.17% 3.20% 3.21% 3.25% 3.25% 3.21% 3.12% 3.25% 3.20% 3.00%
3.04% 3.06%3.06% 3.12%
0.30% 2.90% 2.93% 2.94% 2.92% 2.92% 2.87% 2.87% 2.94% 2.75% 2.74% 2.92%
2.62% 2.58% 2.61% 2.46%
2.50%
2.53% 2.53% 2.44%
2.00%
0.20%
1.50%

1.00%
0.10%
225 bps Fed 0.50%
Funds rate cuts
0.00% 0.00%

-0.50%
-0.10%
-1.00%
500 bps Fed Funds rate
hikes -1.50%
-0.20%
-2.00%

-2.50%
-0.30%
-3.00%

-0.40% -3.50%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
2015 2015 2015 2015 2016 2016 2016 2016 2017 2017 2017 2017 2018 2018 2018 2018 2019 2019 2019 2019 2020 2020 2020 2020 2021 2021 2021 2021 2022 2022 2022 2022 2023 2023

The blue dashed line represents the median net interest margin of the following banks: BAC, C, CMA, CFG, FITB, HBAN, JPM, KEY, MTB, PNC, TFC, USB, WFC and ZION. From Q1 2015 – Q3
2019, the peer group included BBT and STI, but not TFC. The orange dotted line represents the median net interest margin of aggregate US commercial banks from 2010-22.
Source: Company reports, US Federal Reserve, Moody’s Investors Service

Regional banks have comparatively low regulatory capital versus the largest US banks and global peers
In the current high-rate environment, banks with sizable unrealized losses that are not reflected in their regulatory capital ratios are
vulnerable to a loss of confidence. Additionally, a higher share of fixed-rate assets on the balance constrains a bank's profitability and,
thus, its ability to grow capital and continue lending. Risks may be more pronounced if the US enters a recession – which we expect will
happen in early 2024 – because asset quality will worsen and increase the potential for capital erosion.

Recently proposed changes that would increase regulatory capital requirements for banks with assets above $100 billion or over $5
billion in trading activity are credit positive for these firms (Exhibit 5), though in the near term they will come with increased regulatory

5 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

costs and may entail business model changes that strain some banks' profitability. However, banks with less than $100 billion in assets
would still be subject to lower capital and liquidity requirements, a credit negative for investors. For example, the opt-out for including
accumulated other comprehensive income, including unrealized AFS losses, in regulatory capital would still be available to banks
with assets less than $100 billion. As US banking developments in 2023 have shown, weaker prudential standards with less stringent
expectations on parts of the industry can promote excessive risk-taking.

We also expect there will be a proposal to harmonize prudential regulatory standards for liquidity for banks with assets greater
than $100 billion; in addition, there will likely be a requirement that these banks issue long-term debt, which would reduce costs in
resolution. For banks below this asset size threshold, we view weaker prudential requirements as credit negative for investors, which
may require some ratings differentiation compared with banks subject to higher regulatory standards.

Exhibit 5
Proposed tailoring-related changes to large US bank regulatory capital; red in table indicates area of proposed change
Column1 Category I Category II Category III Category IV
US G-SIBs => $700 billion in total =>$250 billion total assets Other firms with $100
assets or => $75 billion or => $75 billion in nonbank billion to $250 billion in
cross jurisdictional activity assets, weighted short-term total assets
wholsale funding (wSTWF)
or off-balance sheet
exposure

G-SIB surcharge ✔
Risk-based capital

Expanded risk-based ✔ ✔ ✔ ✔
approach
Countercyclical capital buffer ✔ ✔ ✔ ✔
No opt-out of AOCI capital ✔ ✔ ✔ ✔
impact
Standard supplementary ✔ ✔ ✔
Leverage
capital

leverage ratio
Enhanced supplementary ✔
leverage ratio

The expanded risk-based approach replaces the advanced approach for Category I and Category II banks. See Appendix for a table of the Moody's-rated US banks that fall under each of the
four bank regulatory categories.
Source: Federal Reserve, Moody's Investors Service

Proposed rules, if adopted, are positive for large banks in medium term, but still do not fully address interest rate risk and
leave smaller banks out
Federal banking regulators indicated that the aggregate impact from the proposed joint rule on US banks' risk-weighted assets (RWAs)
would be a 25% increase of RWAs for Category I and Category II bank holding companies and a 6% increase of RWAs for Category III
and Category IV domestic bank holding companies. FDIC Chair Gruenberg said all but five banks covered by the proposed rule currently
have enough capital to meet the proposed requirements based on year-end 2021 data, with agency staff estimating those five banks'
shortfalls to be below one year of average earnings over the last seven years. It is unclear how banks' so-called management buffers to
regulatory capital minimums were considered in the agencies' analysis.

Events in the spring of 2023 exposed a material gap between banks' regulatory capital and economic capital, which the proposed
rule would partially address by requiring banks with assets greater than $100 billion to include the unrealized gains and losses on AFS
securities in their regulatory capital requirements. This is helpful, but interest rate risk at banks is significantly more complicated than
unrealized AFS gains and losses, which were not the main source of excess interest rate risk at some of the failed banks. For example,
First Republic Bank's interest rate risk challenges derived from its high fixed-rate residential mortgage exposures and less stable deposit
funding.

Because banks face significant regulatory compliance pressures on multiple types of risks, the absence of even a small quantitative
expectation for interest rate risk metrics on net income and economic capital remains a key prudential regulatory gap and is credit
negative for US banks. Though the proposed interagency rule does consider expanding large banks' required disclosures in other areas,

6 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
 MOODY'S INVESTORS SERVICE FINANCIAL INSTITUTIONS

it does not enhance public disclosure requirements related to banks' modeling and management of interest rate risk in the banking
book.

Finally, the timeline for public comment and finalization of the proposed rules could prove to be extended, given the length, complexity
and scope of the interagency capital proposal. Large banks would begin transitioning to the new framework on 1 July 2025, with
regulators not expecting a bank to be fully compliant until 1 July 2028. However, experience suggests that once draft rules are issued,
some banks will begin transitioning to the new standards, and in our view some rated US banks already have begun to undertake
actions to transition to higher regulatory expectations for capital, liquidity and loss-absorbing capacity.

Asset risk is rising, with recession on horizon and commercial real estate exposures vulnerable
To date, stress on US banks has been reflected almost exclusively in funding and interest rate risk related to monetary policy tightening,
but a worsening in asset quality will likely come. We continue to expect a mild recession in early 2024, and given the funding strains on
the US banking sector, there will likely be a tightening of credit conditions and rising loan losses for US banks.

The Q2 2023 Senior Loan Officer Opinion Survey (SLOOS) shows how the recent tightening in banks' commercial and industrial (C&I)
lending standards (Exhibit 6, dark blue line) point toward a deceleration in US banks' intermediation to corporates, starting in early
2024 (light blue line), that could be at least as deep as in the 2000-01 recession. History suggests that recessions associated with
banking strains are both deeper and more protracted, and a sharper downturn is possible if bank lending standards continue to tighten.

Further, a rise in unemployment (orange line) historically is the single biggest macroeconomic driver of banks' credit losses, though
it is a lagging indicator. SLOOS, on the other hand, is a leading indicator. Smaller US banks are important providers of credit to small
businesses that employ about half of the US workforce.

Exhibit 6
Tighter lending standards (dark blue) point toward recessionary levels of C&I lending (light blue) and weaker employment conditions
(orange) in 2024
Recession
Fed SLOOS Net Percentage of Domestic Banks Tightening C&I Loan Standards (1 year lead) (LHS)
C&I Loan growth all domestic banks NSA (y/y) (RHS)
Change in US nonfarm payrolls y/y (RHS)
Tighter lending standards Looser lending standards

-100 25%
-80 20%
-60 15%
-40 10%
-20 5%
0 0%
20 -5%
40 -10%
60 -15%
80 -20%
100 -25%
Dec-93

Dec-97

Dec-01

Dec-05

Dec-09

Dec-13

Dec-17

Dec-21
Apr-91

Aug-92

Apr-95

Aug-96

Apr-99

Aug-00

Apr-03

Aug-04

Apr-07

Aug-08

Apr-11

Aug-12

Apr-15

Aug-16

Apr-19

Aug-20

Apr-23

Aug-24

Source: Federal Reserve, BLS, Moody's Investors Service

In the second quarter, US banks' underwriting standards tightened across all commercial and consumer loan segments, most
prominently in C&I and CRE portfolios. About half of C&I lenders reported tightening underwriting standards, as did an even larger
majority of CRE lenders. About a third of credit card lenders report tightening underwriting standards for cards, the most for the three
consumer asset classes.

A significant portion of bank lenders also reported that underwriting standards in Q2 were on the tighter end of the range of
underwriting standards from 2005 to today for all major loan categories, most notably for all three CRE loan types.

7 7 August 2023 Banks – US: Funding risks, weaker profitability and turn in asset quality will test bank credit strength
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CRE risks are material for small and mid-size banks with high CRE concentrations
Banks’ CRE exposures are another key credit consideration, in particular if banks with significant CRE holdings have had material growth
in CRE, or if they have significant concentrations in construction, office or land development loans. US banks hold about half of the
total US CRE debt outstanding, and smaller banks are both more CRE-concentrated as a percentage of TCE (Exhibit 7) and have been
doing significantly more late-cycle CRE lending than the largest banks, which have been more disciplined in their CRE lending since
the start of the COVID-19 pandemic. One notable feature of US banks' Q2 earnings was that several larger banks' earnings releases
included the impact of higher CRE provisions while those of smaller banks with higher CRE concentrations did not. We think that higher
CRE provisions for the industry are simply a matter of time. Additionally, CRE lending does not consistently bring with it good core
deposit funding, which can also leave some banks with higher CRE concentrations exposed to profitability challenges from net interest
margin compression even as credit costs rise.

Exhibit 7
Small banks are more CRE-concentrated than large banks
CRE loan concentrations by bank asset size for all US banks, 31 March 2023
Non owner-occupied non-farm non-res % TCE Multifamily % TCE
Commercial construction and land % TCE 1-4 family residential construction % TCE
Farmland % TCE
300%
279%

250%

200% 181%

150%
126%

100%

51%
50%

0%
All Banks Bank Assets < $10 BN Bank Assets $10 - $250 BN Bank Assets > $250 BN

TCE = Moody’s-adjusted tangible common equity for all US Banks

Source: FDIC Statistics on Depository Institutions; Moody’s Investors Service

Finally, if smaller US banks seek to shrink their balance sheets, and pull back on lending, CRE would be a particularly vulnerable asset
class in this scenario. Some regional and community banks face ALM/funding pressures and are more concentrated in CRE, which will
complicate the roll-over of maturing CRE loans. Additionally, CRE credit fundamentals could erode materially in an atypical recession in
which US interest rates stay high even as the unemployment rate rises, especially since the office sector faces structural challenges post
the pandemic.

Exhibit 8 shows one piece of data from a survey we completed in July 2023 of 55 rated banks to assess developments and risks in US
banks' CRE portfolios. For the median US bank, about 46% of its Moody's-adjusted tangible common equity is exposed to CRE loans
coming due in the next 18 months. Some of the top takeaways from our CRE survey of rated US banks include: meaningful differences
in the maturity profile of banks' CRE exposures; a greater share of fixed-rate CRE loans at some banks than we anticipated; a clearer
horizontal view of banks' office exposures; and greater ease/difficulty at some banks with providing relevant portfolio-wide risk metrics
on their CRE exposures, such as loan-to-value and debt service coverage ratios.

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Exhibit 8
Some banks' CRE maturities through 2024 are material relative to capital
Median of 46% of TCE exposed to CRE loans maturing in the next 18 months
20

18

16

14
Number of Banks

12

10

0
0 - 25% 25 - 46% 46 - 75% 75 - 100% 100 - 125% > 125%
2023 & 2024 CRE Maturities as a % Capital

Source: Company responses to Moody's July 2023 CRE survey

Meanwhile, the Federal Reserve's H.8 data3 indicate that large banks (banks with assets greater than $150 billion) historically have
tended to grow their CRE loan balances annually only in the $40 to $80 billion range. Thus, if funding strains cause smaller banks to
pull back on CRE lending, large banks as a group may not step up CRE lending sufficiently to prevent a material contraction in CRE
credit from the US banking sector. Additionally, non-bank CRE lenders generally make larger loans and may be less likely to step in to
fund the comparatively small CRE deals traditionally funded by these banks. Even though private credit funds are actively raising capital
to acquire distressed assets, their lending capacity is unlikely to completely fulfill borrowing needs in times of distress, since their
market share is significantly smaller than that of banks. Given post-pandemic concerns with some office properties, these significant
loan roll-over needs, combined with small bank funding strains, suggest rising risks for certain types of CRE and, in turn, some CRE-
concentrated banks.

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Appendix
Exhibit 9
US regulatory categorizations of banks and Moody's rated US bank universe
Category I Category II Category III Category IV Other US banks in rated universe

US G-SIBs => $700 billion in total =>$250 billion total assets or Other firms with $100 billion to $250 <$100 billion total assets
assets or => $75 billion => $75 billion in nonbank billion in total assets
cross jurisdictional assets, weighted short-term
activity wholsale funding (wSTWF) or
off-balance sheet exposure

Bank of America Northern Trust Capital One Ally Financial Amarillo National Bancorp, Incorporated
Bank of New York Mellon Charles Schwab American Express Associated Banc-Corp
Citigroup PNC Financial Citizens Financial Axos Financial, Inc.
Goldman Sachs Truist Financial Discover Bank of Hawaii Corporation
JPMorgan Chase U.S. Bancorp Fifth Third Bank OZK
Morgan Stanley First Citizens BankUnited, Inc.
State Street Huntington Berkshire Hills Bancorp, Inc.
Wells Fargo KeyCorp BOK Financial Corporation
M&T Bank Cadence Bank
New York Community Bancorp, Inc. CIBC Bank USA
Regions Financial City National Bank
Comerica Incorporated
Commerce Bancshares, Inc.
Cullen/Frost Bankers, Inc.
Dime Community Bancshares, Inc.
F.N.B. Corporation
First BanCorp
US domestic banking organization

First Hawaiian, Inc.

First Horizon Corporation
First Merchants Corporation
Domestic firms

First National of Nebraska, Inc.

Fulton Financial Corporation
Hancock Whitney Corporation
Hilltop Holdings Inc.
Merchants Bancorp
Old National Bancorp
Peapack-Gladstone Financial Corporation
Pinnacle Financial Partners, Inc.
Popular, Inc.
Prosperity Bancshares, Inc.
Simmons First National Corporation
SouthState Corporation
Synovus Financial Corp.
Texas Capital Bancshares, Inc.
UMB Financial Corporation
United Bankshares, Inc.
Washington Federal, Inc.
Webster Financial Corporation
Western Alliance Bancorporation
WSFS Financial Corporation
Zions Bancorporation, National Association

Credit Suisse USA BMO Financial

Intermediate
Foreign firms (standards vary by legal entity)

company
holding

Deutsche Bank USA HSBC USA

TD Group US Santander Holdings USA

Barclays US Bank of Montreal Banco Santander

Combined US operations

MUFG BNP Paribas Bank of Nova Scotia

Sumitomo Mitsui Credit Suisse Canadian Imperial
Deutsche Bank USA Société Générale
Mizuho
Royal Bank of Canada
Toronto-Dominion
UBS Americas

As of Q2 2023
Source: Federal Reserve, Moody's Investors Service

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Endnotes
1 Under our capital definition, deferred tax assets (DTAs) do not contribute more than 10% of a bank's tangible common equity. Thus, this key capital metric
in our analysis is conservative and declines more than the reported regulatory Common Equity Tier 1 ratios of banks with assets less than $700 billion
when there are large unrealized losses on available-for-sale securities and other types of DTAs.
2 The Bank of International Settlement's (BIS) 2023 annual economic report argued that more policy tightening may be needed in advanced economies
because inflation has become entrenched, increasing the risk of further banking stress. According to the BIS, since the 1970s, about 15% of monetary
policy tightening episodes globally were followed by severe banking stress, but the incidence of severe banking stress rose to 25% if the tightening episode
was also accompanied by high inflation, and rose to nearly 40% if it was accompanied by elevated levels of private debt-to-GDP. In other words, the
current environment points to elevated risks of severe banking stress from multiple angles before even considering the effects of the rapid and ongoing
withdrawal of unconventional monetary policy on the US banking system's cash and funding.
3 The Federal Reserve's H.8 data present an estimate of developments in the weekly aggregate balance sheet for the US banking system.

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