U.S.-listed exchange-traded funds (ETFs) that invest in bank stocks experienced a sharp decline on Tuesday following an announcement by Moody's Investors Service. Moody's revealed that it is reviewing several major U.S. banks for potential downgrades and has already lowered debt ratings for a number of smaller banks.

The SPDR S&P Regional Banking ETF (KRE), which tracks an equal-weighted index of U.S. regional bank stocks, recorded a 3.2% drop on Tuesday, marking its largest one-day percentage decrease since May 4. Similarly, the Invesco KBW Regional Banking ETF (KBWR) fell 3.8%, reaching its worst daily performance since May 2 according to Dow Jones Market Data.

The SPDR S&P Bank ETF (KBE) and the Invesco KBW Bank ETF (KBWB) also experienced significant declines, with a 3.3% and 3% drop respectively. This put both funds on track for their poorest performance in over three months as reported by FactSet data.

Moody's issued a statement on Monday evening highlighting that the U.S. banking industry continues to face challenges related to interest rates, asset and liability management risks, which have implications for liquidity and capital. These challenges have persisted since the shock collapse of Silicon Valley Bank and other regional lenders in March.

Given this recent announcement by Moody's, investors are cautious about the future performance of U.S. bank stocks, especially those that focus on regional banking. It remains to be seen how these possible downgrades will impact the overall banking sector in the coming months.

Growing Profitability Pressures for Banks Amid Looming Recession

Moody’s, a credit-ratings firm, has warned that many banks are facing increasing profitability pressures in their Q2 results. These pressures will ultimately reduce the banks' ability to generate internal capital. In addition, the firm suggests that a mild recession is on the horizon, which will likely lead to a decline in asset quality, particularly in some banks' commercial real estate portfolios.

As a result of these concerns, several small- to midsize U.S. banks downgraded by Moody's experienced a significant drop in their stock prices. Shares of M&T Bank Corp., BOK Financial Corp., and Commerce Bancshares Inc. were all down nearly 3% in Tuesday's trading.

Moody's has also placed several major U.S. banks on review for potential downgrades. U.S. Bancorp, State Street, Bank of New York Mellon, Northern Trust Corp., Cullen/Frost Bankers Inc., and Truist Financial Corp. are being closely monitored by the credit-ratings firm.

The impact of these developments was not limited to the downgraded banks alone. Other bank shares also underperformed on Tuesday in comparison to the three major stock averages. Bank of America Corp. experienced a 3.3% decrease in its stock value, while Goldman Sachs dropped by 3.1%. U.S. Bancorp fell 2%, State Street Corp. declined 2.6%, and Bank of New York Mellon Corp. experienced a 2.4% decrease.

The overall outlook for the banking industry appears challenging due to growing profitability pressures and the looming recession. Investors and market participants should closely monitor these developments as they unfold.

See: Moody’s places credit ratings of 6 major U.S. banks on review for downgrade

U.S. Stocks Experience Broad Decline

The U.S. stock market witnessed a significant downtrend on Tuesday, reflecting a downward movement across various sectors. The S&P 500 index (SPX) was down by 1.1%, which follows a temporary recovery observed on Monday post last week's selloff. FactSet data reveals that the Dow Jones Industrial Average (DJIA) endured a drop of 357 points, equivalent to a 1% decline, settling at 35,113. Similarly, the Nasdaq Composite (COMP) experienced a fall of 1.3%.

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