What potential effect could a cut in financial strength ratings of regional banks have on an already ailing industry and their exchange traded funds (ETFs)?

On Thursday, Moody’s said that it might cut the financial strength ratings of 23 regional banks because of higher credit losses, caused by the housing and economic crisis, than previously expected.  Additionally, Moody’s put the deposit and debt ratings of 17 of the 23 banks on review for downgrade and changed the outlook of 19 of the 23 to negative from stable, states Reuters.

A combination of a sharp decline in commercial real estate, rising corporate defaults and the deterioration in residential loans are the main causes for these raised expectations of losses and negative future outlook of these banks.

These losses will most likely put a damper on the capital position of most banks, which will give the industry yet a further blow.  The banks that will most likely be downgraded are the ones that have significant exposure to commercial real estate, especially construction and land development.

Some of these banks include U.S. Bancorp (USB), PNC Financial Services Group (PNC), Sun Trust Banks (STI)and KeyCorp (KEY).  This downgrade could have a negative impact on regional bank ETFs, such as the SPDR KBW Regional Banking ETF (KRE), which is down 37.6% year to date. Despite the warnings, KRE is up 22.5% in the last week.

Tags: Financial, KRE, Regional Banks, Sector ETFs