Finance

Households across China have been thrown into panic over the past week. The company building their flats, Country Garden, missed $22.5m in coupon payments on August 6th. Now the firm, one of the world’s largest homebuilders, has until early September to make the payments or follow hundreds of other developers into default and restructuring. Trading in its bonds, which are worth just pennies on the dollar, was halted on August 14th.Officials across the country are watching closely. Country Garden is renowned for its huge projects in China’s second- and third-tier cities. The firm’s debts are smaller than those of Evergrande, a big, heavily indebted company that defaulted in 2021. But at the start of the year Country Garden was building four times more homes than Evergrande was before it defaulted. At the rate Country Garden was delivering them in the first half of 2022, at least 144,000 buyers will not receive homes they were promised by the end of this year. A sudden debt meltdown at the firm would leave even more families out in the cold.China’s housing crisis turns three this month, if measured by the introduction of the government’s “three red lines” policy, which sought to limit leverage. Throughout, officials have struggled to manage confidence and expectations. At the start, few observers believed Evergrande could collapse, and that the government might fail to put a stop to the pain. Until recently, most thought that Country Garden was immune to default. Since late last year officials have sought to calm the market by drawing up an informal list of healthy developers, including Country Garden, which investors could feel comfortable funding and Chinese citizens could trust. The calculation has changed in recent days. Country Garden’s issue is not one of over-leverage in the style of Evergrande. Instead, it is a victim of a loss of confidence among regular folk—a sign the government is losing control. After a short rebound following the lifting of covid-19 controls, the property crisis has intensified. Prices are dropping. Sales among the 100 biggest developers fell by 33% in July compared with a year earlier. Country Garden’s tumbled by 60%. The firm’s decline is forcing market-watchers to confront their deepest fears about the property sector.One is that property supply chains collapse. Over the past three years suppliers of materials, along with the engineering and construction firms that build homes, have often not been paid on time by developers. But so far this backbone of the sector has withstood the pressure. That could change as developers grow shorter on funds. The decline in payments to suppliers is already noticeable. Between 2021 and 2022, Country Garden’s transfers to such firms fell from 285bn yuan ($44bn) to 192bn yuan, according to s&p Global, a rating agency. They are all but certain to fall further this year. Although the biggest contracting firms will probably survive with help from the government, it is not hard to imagine widespread collapses among the myriad smaller engineering and materials companies that do the work on the ground. Another concern is that the crisis spreads to state firms. Since 2021 Chinese developers have been almost entirely shut out of international bond markets. But the onshore debt market has remained open to state-backed firms. The large Chinese investors that dominate the market have so far provided a degree of stability; they have not dumped developers’ credit as have asset managers in Hong Kong. Any change would spell trouble. And in recent weeks investors have noted pressure in the domestic bond market. Sino-Ocean, a state-owned developer, has shown signs that it may struggle to repay debts. Homebuyers have chosen state developers because they are seen as safer. If the crisis hits state firms, that notion would be shattered.The fear that the collapse of a developer will bring down a large Chinese bank has mostly been dismissed. Banks’ exposure to developers, analysts say, is reasonable. They would survive even the fall of a firm like Country Garden. But other types of contagion cannot be ignored. If property continues to weaken, the government may ask banks to offer more loans to the industry, says Michael Chang of cgs-cimb Securities, a broker. This would lower returns and also be a poor allocation of credit at a time when China’s economy is suffering. No worry will loom larger in the minds of officials, however, than threats to social stability. Country Garden may have to cut prices to generate sales. This could create competition and lead to swifter price falls across the industry, pushing people to delay home purchases in the hope that prices will fall still further. During past downturns, those who bought homes too early, missing a discount, have protested and demanded a matching reduction in price.Indeed, Country Garden’s biggest creditors are not banks or bond holders, but folk who have paid for homes upfront. Some 668bn yuan, or about half the firm’s liabilities, were put up by homebuyers. Last year thousands stopped paying their mortgages in protest at years-long delays in delivering homes. There is now the threat of much broader protests across the 300 cities in which Country Garden builds.So far officials in Beijing have decided against direct intervention in the property market. Country Garden almost certainly has the $22.5m it needed to cover payments this month. By not paying up, its bosses are signalling a desire to eventually restructure its debts—perhaps betting that the firm is too big to fail. This puts the central government in an excruciating position. Letting Country Garden fail could lead to wider panic, more economic pain and potentially more defaults, risking contagion and social unrest. Yet stepping in with a rescue package would put officials on the hook for many more bail-outs, and prop up an unsustainable industry. ■For more expert analysis of the biggest stories in economics, finance and markets, sign up to Money Talks, our weekly subscriber-only newsletter. More

A new U.K. investment fund with up to £1 billion ($1.27 billion) in capital raised has been launched to back growth-stage financial technology companies.
The fund, which is backed by Mastercard, Barclays and the London Stock Exchange Group, aims to address the issue of fintech companies struggling to reach scale and pursue public listings.
The U.K. has faced criticisms from some in the industry that it is posing barriers to its fintech entrepreneurs and forcing them to consider listings overseas.

The U.K. has faced criticisms from some in the industry that it is posing barriers to its fintech entrepreneurs and forcing them to consider listings overseas.
Justin Tallis | AFP via Getty Images

The U.K. has created an investment vehicle to back growth-stage financial technology companies until they can go public, in a bid to bolster Britain’s global image as a fintech investment hub.
Backed by the likes of Mastercard, Barclays and the London Stock Exchange Group, the Fintech Growth Fund aims to invest between £10 million to £100 million into fintech companies, ranging from consumer-focused challenger banks and payments tech groups to financial infrastructure and regulatory technology.

The fund, which is being advised by U.K. investment bank Peel Hunt, looks to support companies at the growth stage of their funding cycle, as they seek Series C rounds and above.
The venture was created in response to a 2021 government-commissioned review helmed by former Worldpay Vice Chairman Ron Kalifa and examined whether the U.K.’s listings environment is unattractive for tech firms.
“It’s definitely a start,” Gautam Pillai, an equity analyst at Peel Hunt covering fintech, told CNBC in an interview Wednesday.
It marks a rare commitment to a specialized fund focused on fintech backed by mega-industry players. While fintech-focused funds like Augmentum Fintech and Anthemis Group exist, the U.K. has yet to see a fintech-oriented fund that came about from a government-led strategy.
Britain has faced some industry criticisms that it poses barriers to fintech entrepreneurs and forces them to consider listings overseas — particularly after the country’s exit from the European Union, which has cast some shadow over the U.K.’s status as a global financial center.

The London Stock Exchange has committed to a number of reforms to encourage fintech firms to float in the U.K. rather than in the U.S. — a particularly pressing step, following British chip design firm Arm’s decision to ditch a London listing for New York.
“It’s about finding the next Stripe, the next Worldpay, the next Adyen,” Pillai said.
The fund also counts Philip Hammond, the former U.K. finance minister, as an advisor.

The move could also be an opportunity for financial heavyweights to access to expertise in the development of new technologies. Big banks and financial institutions are trying to advance their own digital ambitions, as they face competition from younger tech upstarts.
The aim is for the Fintech Growth Fund to make its first investment by the end of the year, Pillai said.
While £1 billion pales in comparison to some of the huge sums being deployed in fintech and tech more broadly, Pillai said it’s “definitely a start.”
The U.K. is a hotbed of fintech innovation, only behind the U.S. when it comes to the scale of its fintech industry, he added. The U.K. is home to 16 of the world’s top 200 fintech companies, according to an analysis from independent research firm Statista conducted for CNBC.
The fintech industry is facing a period of turbulence, as rising inflation and macroeconomic weakness soften consumer spending. The valuations of companies such as Checkout.com, Revolut and Freetrade have dropped sharply in recent months.
Last year, the internal valuation of Checkout.com plunged by 73% to $11 billion in a stock options transfer deal.
Revolut, the British foreign exchange services giant, suffered a 46% valuation cut — implying a $15 billion markdown — by shareholder Schroders Capital, according to a filing. Atom Bank, a U.K. challenger bank, meanwhile had its valuation marked down 31% by Schroders.
U.K. fintech investment plummeted by 57% in the first half of 2023, according to KPMG.
Pillai said now is the right time to start a new fintech fund, as the entry level for investors to take positions in privately-held mature companies has been reduced heavily.
“From a pure investment standpoint, you couldn’t find a better time in fintech history to start a fintech fund.”
While 2020 and 2021 experienced a “bubble” of sky-high valuations in the tech sector, Pillai believes this correction “killed some very weak business models butt the stronger business models will survive and thrive.”
“There’s still an active investment market in the U.K., we still have one of the world’s leading financial centers — no matter what was assumed would happen in the last 10 years or so,” Phil Vidler, managing director at Fintech Growth Fund, told CNBC in an interview.
“A center for business — time, location and law, etc. — those fundamentals are still here, and similarly we’re now getting to a point where second-time founders are starting companies, and large, global venture firms touted as the best in the world are setting up here in the U.K.” More

In this photo illustration, a Target logo is displayed on the screen of a smartphone.
Sheldon Cooper | SOPA Images | Lightrocket | Getty Images

Check out the companies making headlines before the bell
Target – Target shares popped nearly 8% before the market opened even as the retailer slashed its full-year forecast and posted revenue for the recent quarter that fell short of Wall Street’s expectations. The company posted earnings of $1.80 a share, versus the $1.39 expected by analysts polled by Refinitiv. Revenue came in at $24.77 billion, lighter than the $25.16 billion that was estimated.

Tesla – The electric vehicle stock lost more than 2% premarket on news that it cut prices on existing Model S and Model X inventories in China.  
Cava – Shares of the Mediterranean fast-casual chain jumped more than 9% after posting a profit in its first quarterly report following its initial public offering. Revenue surged 62% in the latest quarter to nearly $173 million as Cava opened new stores.
Coinbase – Shares of the U.S. cryptocurrency exchange rose about 4% before the bell after the National Futures Association, a CFTC-designated self-regulatory organization, cleared the company to operate a futures trading service alongside its existing spot crypto trading offering.
TJX Companies – The off-price retailer’s stock rose 3% on stronger-than-expected quarterly results. TJX posted adjusted earnings of 85 cents per share on $12.76 billion in revenue. That came in ahead of the 77 cents and $12.45 billion expected by analysts, per Refinitiv.
Coherent – Coherent plunged more than 23% before the bell after posting weaker-than-expected guidance for the fiscal first quarter and full year. The company attributed the disappointing outlook to expectations for “no meaningful improvement” in the macroeconomic environment, including China.

VinFast Auto – The Vietnamese electric vehicle stock shed more than 12% in the premarket, one day after its debut on the Nasdaq via a SPAC merger. Shares more than doubled in Tuesday’s session.
JD.com – U.S.-listed shares of JD.com dropped 5% even after the China-based e-commerce company surpassed expectations for the recent quarter on the top and bottom lines.
Keurig Dr Pepper – The beverage stock rose about 1.4% after UBS upgraded Keurig Dr Pepper to a buy from a neutral rating, citing its cheap valuation relative to peers and its historical average.
H&R Block – The tax preparer’s stock jumped more than 4% after topping fiscal fourth-quarter earnings expectations and hiking its dividend by 10%. H&R Block earned $2.05 adjusted per share on revenues of $1.03 billion. Analysts polled by Refinitiv had estimated $1.88 in earnings and $1.01 billion in revenue.
Agilent Technologies – Shares lost 2.5% in the premarket after the laboratory technology company cut its full-year guidance, citing a softer macroenvironment. Agilent topped its third-quarter revenue and EPS expectations, posting adjusted earnings of $1.43 a share on $1.67 billion in revenue.
Jack Henry & Associates — Jack Henry & Associates dropped 6.3% in the premarket. The financial tech company issued full-year earnings guidance for June 2024 that was weaker than expected; it forecast per-share earnings in the range of $4.92 to $4.99, while analysts polled by FactSet expected $5.35. Otherwise, it beat analysts’ expectations in its most recent quarter. Jack Henry reported fiscal fourth-quarter earnings of $1.34 per share, better than the consensus estimate of $1.19 per share, while revenue of $534.6 million topped analysts’ $512.8 million estimate.
Mercury Systems — The aerospace technology stock fell about 11% in premarket trading after fiscal fourth-quarter results came in short of analyst expectations. Mercury reported 11 cents of adjusted earnings per share on $253.2 million of revenue. Analysts surveyed by FactSet’s StreetAccount were expecting 52 cents per share on $278.8 million of revenue. Guidance for the 2024 fiscal year also missed estimates on several metrics, as the company said it was entering a “transition year.”
— CNBC’s Sarah Min, Jesse Pound and Tanaya Macheel contributed reporting More

In a report on China, Nomura says it’s “increasingly possible that annual GDP growth this year will miss the 5.0% mark.”
But “the current weakness of localities’ finances prevents Beijing from utilizing fiscal policy to support the economy,” Rhodium Group analysts wrote in June.
“A tepid response to the cratering housing market would indicate that the top leadership’s reduced emphasis on economic growth — in favor of priorities like national security and technological self-sufficiency — is more far-reaching than we anticipated,” Gabriel Wildau, managing director at consulting firm Teneo, said in a report Tuesday.

A man looks at his smartphone inside a mall in Beijing on August 15, 2023.
Greg Baker | Afp | Getty Images

BEIJING — Without more stimulus, China is increasingly likely to miss its growth target of around 5% this year, economists said.
The country on Tuesday suspended releases of data on youth unemployment, which had recently soared to records. Other data for July showed a broad slowdown, worsened by the property market slump.

“Prolonged weakness in property construction will add to destocking pressures in the industrial space and depress consumption demand as well,” Tao Wang, head of Asia economics and chief China economist at UBS Investment Bank, said in a note.
“In such a case, economic momentum may stay subdued in the rest of the year and China may miss this year’s growth target of around 5%,” she said. “Deflation pressures could persist longer in such a scenario. The economy would then warrant much stronger or unconventional policies to revive.”
China is the world’s second-largest economy, and accounted for nearly 18% of global GDP in 2022, according to World Bank data.

Beijing should play the role of lender of last resort to support some major developers and financial institutions in trouble, and should play the role of spender of last resort to boost aggregate demand.

Ting Lu and team

“In our view, Beijing should play the role of lender of last resort to support some major developers and financial institutions in trouble, and should play the role of spender of last resort to boost aggregate demand,” Nomura’s Chief China Economist Ting Lu and a team said in a report Tuesday.
“We also see bigger downside risk to our 4.9% y-o-y growth forecast for both Q3 and Q4, and it is increasingly possible that annual GDP growth this year will miss the 5.0% mark,” the report said.

Headline risk

Beijing has acknowledged economic challenges and signaled more policy support. The People’s Bank of China unexpectedly cut key rates on Tuesday.
But the moves need time to take effect and haven’t been enough to bolster market confidence so far, especially as worrisome headlines pick up.
“In August, contagion fears around property developers and default risk in the trust industry have also pushed sentiment lower, setting a higher bar for stimulus to be effective,” said Louise Loo, lead economist at Oxford Economics.

A firmer policy shift could come in the fourth quarter, when a top-level meeting known as the “Third Plenum” is expected to be held, Loo said.
Once-healthy giant developer Country Garden is now on the brink of default. In other news this month, Zhongrong International Trust missed payments to three mainland China-listed companies, according to disclosures accessed via Wind Information.

The current weakness of localities’ finances prevents Beijing from utilizing fiscal policy to support the economy.

Rhodium Group

Zhongrong did not immediately respond to a CNBC request for comment. Its website warned in a notice dated Aug. 13 of fraudulent claims that it was no longer able to operate.
Even if all of Zhongrong’s 630 billion yuan ($86.5 billion) in assets — plus leverage — were in trouble, that’s “not a systemically threatening number” for China’s 21 trillion yuan trust industry and 315 trillion yuan banking system, Xiangrong Yu, Citi’s chief China economist said in a note.
He added the trust firm and its parent company are “much less connected in the financial system compared with previous cases such as Baoshang Bank and Anbang Group.”

Growth vs. national security

Chinese authorities’ initial crackdown on real estate developers in 2020 was an attempt to curb their high reliance on growth. Beijing emphasized this year that defusing financial risks is one of its priorities. This year, the country is also in the process of reorganizing its financial regulatory bodies.
As local government debt remained high, cash levels have fallen, according to a Rhodium report in June. It noted regional authorities have spent money to buy land, to fill demand that once came from developers.
“The current weakness of localities’ finances prevents Beijing from utilizing fiscal policy to support the economy,” Rhodium analysts said.

For many, especially overseas investors, prolonged apparent inaction can affirm the Chinese government has firmly shifted its priorities as well.
“A tepid response to the cratering housing market would indicate that the top leadership’s reduced emphasis on economic growth — in favor of priorities like national security and technological self-sufficiency — is more far-reaching than we anticipated,” Gabriel Wildau, managing director at consulting firm Teneo, said in a report Tuesday.
“Our base case is that policymakers will significantly escalate housing stimulus in coming months, leading to improving sales and construction volumes by year end,” Wildau said.

Read more about China from CNBC Pro

Many of China’s recent troubles are not necessarily new. China has been in a multi-year process to try to improve the long-term sustainability of its economy, and shift away from reliance on investment into sectors such as infrastructure and real estate, and toward consumption.
“The challenge for policymakers is to calibrate stimulus that avoids an economic hard-landing on one hand, but that also smoothly transitions property and investments to their nascent downtrend on the other,” said Loo from Oxford Economics.
“In the years to come, China’s emerging strategic sectors — including green economy sectors, digital economy, advanced and semiconductor manufacturing — will continue to be the ones to watch as China transitions to new growth drivers,” Loo said.
She pointed out that high-tech manufacturing’s year-to-date average year-on-year growth of 7.4% has outpaced industrial production’s roughly 3.8% pace. More

The New York Stock Exchange welcomes executives and guests of Cava in celebration of its initial public offering, June 15, 2023.

Check out the companies making headlines in extended trading.
H&R Block — The tax preparer rose nearly 5.9% after posting quarterly earnings per share of $2.05 that beat Wall Street’s expectations of $1.88, according to Refinitiv. H&R Block reported $1.03 billion in revenue, while analysts expected $1.01 billion. The company also increased its quarterly dividend 10.3% to $0.32 from $0.29 and raised its full-year guidance.

Cava — Shares of the Mediterranean restaurant chain advanced 4.3% after hours following a second-quarter earnings report that topped consensus estimates. The fast-casual chain posted $172.9 million in revenue, exceeding analysts’ expectations of $163.2 million, according to FactSet. Earnings per share came to $0.21, while analysts surveyed by FactSet had forecast a loss of $0.02.
AgEagle Aerial Systems — Shares climbed 3% after the bell following the company reporting a smaller loss per share in the second quarter than it did in the same quarter a year ago. AgEagle reported a loss of 5 cents per share, 2 cents less than in 2022. But the company reported a smaller quarterly revenue than a year ago at $3.3 million.
Mercury Systems — The defense stock dropped 10.4% after missing Wall Street expectations for the fiscal fourth quarter. Mercury reported profit of 11 cents per share, excluding items, on revenue of $263.2 million. Analysts surveyed by FactSet estimated 52 cents earned per share and revenue of $278.8 million for the quarter. The company’s full-year guidance similarly missed FactSet consensus forecasts.
Stride — Shares popped 8.9% after the educational technology stock delivered a better-than-expected report in its fiscal fourth quarter. GAAP earnings per share of $1.01 topped the consensus estimate from analysts polled by FactSet by 14 cents, while revenue of $483.5 million also exceeded the forecast $460.7 million. More

Neel Kashkari, President and CEO of the Federal Reserve Bank of Minneapolis, speaks during an interview with Reuters in New York City, New York, May 22, 2023.
Mike Segar | Reuters

Minneapolis Federal Reserve President Neel Kashkari favors getting tougher on regional banks, following a crisis earlier this year that he said may not be over.
Asked during a town hall whether he agrees with proposals setting higher capital requirements for banks with more than $100 billion in assets, the central bank official said, “My own personal opinion is it doesn’t go far enough. I think it’s a step in the right direction, but I would like to go significantly further.”

Regional bank shares fell as Kashkari spoke. The SPDR S&P Regional Banking ETF (KRE) was off 2.4% around midday.
The architect of the Troubled Asset Relief Program that helped bail out banks during the 2008 financial crisis, Kashkari said that if the Fed has to keep raising interest rates, it could cause more problems for smaller banks.
At the root of the crisis was duration risk. A crisis of confidence forced some banks to liquidate assets to meet withdrawal demand. Those banks holding longer-dated Treasurys faced capital losses as rates went up and bond prices fell.
Should the Fed have to keep raising rates, that could affect banks in the same situation. Kashkari did not indicate if he thought the Fed was positioned for more rate hikes, but he noted that “we’re a long way away from cutting rates.”
“Right now it seems like things are quite stable, that banks have gotten through this reasonably well,” he said. “Now, the risk is that if inflation is not completely under control, and that we have to raise rates further from here, to bring it down, that they might face more losses than they currently face today. And these pressures could flare up again in the future.”
Referring to the issues in March that took down Silicon Valley Bank and others, Kashkari replied “all of the above” when asked whether it was higher interest rates or bank mismanagement that caused the failures. More

A man wearing a mask walks past a Nvidia logo in Taipei, Taiwan.
Sopa Images | Lightrocket | Getty Images

Check out the companies making headlines in midday trading.
Banks — Major Wall Street banks slid during midday trading after CNBC reported Tuesday that Fitch Ratings may once again downgrade the health of the banking sector. Shares of Bank of America and JPMorgan Chase slid 2%, while Citigroup and Morgan Stanley each fell more than 1%. Regional banks also slid, with Citizens Financial Group falling more than 3%.

Cleveland-Cliffs — Shares of the steel company shed 2.7% as investors weighed the latest developments in potential consolidation in the industry. Cleveland-Cliffs’ stock jumped more than 8% on Monday after U.S. Steel announced that it was rejecting a takeover offer from its rival. Industrial conglomerate Esmark announced its own offer for U.S. Steel on Monday.
Discover Financial Services — Shares of the credit card issuer dropped 9% after the company announced late Monday that president and CEO Roger Hochschild will step down and John Owen will take over in the interim. The changes take effect immediately.
Hannon Armstrong Sustainable Infrastructure Capital — Hannon Armstrong Sustainable Infrastructure Capital rose 2.3% after Bank of America upgraded the renewable energy investment firm to buy. The Wall Street firm said Hannon Armstrong will likely get a boost from the Inflation Reduction Act.
Paramount Global — Paramount Global shares climbed 2% in midday trading. The Alliance of Motion Pictures & Television Producers, which represents companies including Paramount Global, reportedly offered screenwriters on strike a new deal that includes crediting humans as screenwriters, rather than artificial intelligence, according to a Bloomberg report citing people familiar with the discussions.
Homebuilders — A slew of homebuilding stocks gained Tuesday after regulatory filings revealed fresh positions from Warren Buffett’s Berkshire Hathaway during the second quarter. That included D.R. Horton and Lennar, last up about 2% and 1.5%, respectively. NVR shares added about 0.5%.

Nvidia — The artificial intelligence stock advanced 1.7% after UBS, Wells Fargo and Baird all raised their estimates for where they believe share prices will go in the next year. The stock climbed 7.1% Monday, regaining ground after dropping 8.6% last week.
Turnstone Biologics — The biotechnology stock added 1.96% in midday trading. Investment firm Piper Sandler initiated coverage of the stock earlier Tuesday with an overweight rating, while Bank of America began coverage of Turnstone, also on Tuesday, with a buy rating.
— CNBC’s Alex Harring, Jesse Pound, Tanaya Macheel, Pia Singh and Samantha Subin contributed reporting More

Fitch Ratings cut its assessment of the banking industry’s health in June, a move that analyst Chris Wolfe said went largely unnoticed because it didn’t trigger downgrades on banks.
But another one-notch downgrade of the industry’s score from AA- to A+ would force Fitch to reevaluate ratings on each of the more than 70 U.S. banks it covers, Wolfe told CNBC.
“If we were to move it to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions,” Wolfe said.

A Fitch Ratings analyst warned that the U.S. banking industry has inched closer to another source of turbulence — the risk of sweeping rating downgrades on dozens of U.S. banks that could even include the likes of JPMorgan Chase.
The ratings agency cut its assessment of the industry’s health in June, a move that analyst Chris Wolfe said went largely unnoticed because it didn’t trigger downgrades on banks.

But another one-notch downgrade of the industry’s score, to A+ from AA-, would force Fitch to reevaluate ratings on each of the more than 70 U.S. banks it covers, Wolfe told CNBC in an exclusive interview at the firm’s New York headquarters.
“If we were to move it to A+, then that would recalibrate all our financial measures and would probably translate into negative rating actions,” Wolfe said.
The credit rating firms relied upon by bond investors have roiled markets lately with their actions. Last week, Moody’s downgraded 10 small and midsized banks and warned that cuts could come for another 17 lenders, including larger institutions like Truist and U.S. Bank. Earlier this month, Fitch downgraded the U.S. long-term credit rating because of political dysfunction and growing debt loads, a move that was derided by business leaders including JPMorgan CEO Jamie Dimon.

This time, Fitch is intent on signaling to the market that bank downgrades, while not a foregone conclusion, are a real risk, said Wolfe.
The firm’s June action took the industry’s “operating environment” score to AA- from AA because of pressure on the country’s credit rating, regulatory gaps exposed by the March regional bank failures and uncertainty around interest rates.

The problem created by another downgrade to A+ is that the industry’s score would then be lower than some of its top-rated lenders. The country’s two largest banks by assets, JPMorgan and Bank of America, would likely be cut to A+ from AA- in this scenario, since banks can’t be rated higher than the environment in which they operate.
And if top institutions like JPMorgan are cut, then Fitch would be forced to at least consider downgrades on all their peers’ ratings, according to Wolfe. That could potentially push some weaker lenders closer to non-investment-grade status.
Shares of lenders including JPMorgan, Bank of America and Citigroup dipped in premarket trading Tuesday.

Hard decisions

For instance, Miami Lakes, Florida-based BankUnited, at BBB, is already at the lower bounds of what investors consider investment grade. If the firm, which has a negative outlook, falls another notch, it would be perilously close to a non-investment-grade rating.
Wolfe said he didn’t want to speculate on the timing of this potential move or its impact on lower-rated firms.
“We’d have some decisions to make, both on an absolute and relative basis,” Wolfe said. “On an absolute basis, there might be some BBB- banks where we’ve already discounted a lot of things and maybe they could hold onto their rating.”
JPMorgan declined to comment for this article, while Bank of America and BankUnited didn’t immediately respond to messages seeking comment.

Rates, defaults

In terms of what could push Fitch to downgrade the industry, the biggest factor is the path of interest rates determined by the Federal Reserve. Some market forecasters have said the Fed may already be done raising rates and could cut them next year, but that isn’t a foregone conclusion. Higher rates for longer than expected would pressure the industry’s profit margins.
“What we don’t know is, where does the Fed stop? Because that is going to be a very important input into what it means for the banking system,” he said.
A related issue is if the industry’s loan defaults rise beyond what Fitch considers a historically normal level of losses, said Wolfe. Defaults tend to rise in a rate-hiking environment, and Fitch has expressed concern on the impact of office loan defaults on smaller banks.
“That shouldn’t be shocking or alarming,” he said. “But if we’re exceeding [normalized losses], that’s what maybe tips us over.”
The impact of such broad downgrades is hard to predict.
In the wake of the recent Moody’s cuts, Morgan Stanley analysts said that downgraded banks would have to pay investors more to buy their bonds, which further compresses profit margins. They even expressed concerns some banks could get locked out of debt markets entirely. Downgrades could also trigger unwelcome provisions in lending agreements or other complex contracts.
“It’s not inevitable that it goes down,” Wolfe said. “We could be at AA- for the next 10 years. But if it goes down, there will be consequences.” More