A Fitch Ratings analyst has issued a warning regarding the U.S. banking industry, stating that it is inching closer to another potential source of turbulence. This risk involves possible sweeping rating downgrades for numerous U.S. banks, including even major institutions like JPMorgan Chase.

In June, Fitch Ratings lowered its assessment of the industry’s health. However, this action went largely unnoticed as it didn’t lead to downgrades on individual banks.

If the industry’s score were to be downgraded from AA- to A+, Fitch would be compelled to reassess the ratings of all the more than 70 U.S. banks it covers. This could result in negative rating actions across the banking sector.

The credit rating agencies, whose ratings are relied upon by bond investors, have recently caused market turmoil with their actions. Just last week, Moody’s downgraded several small and mid-sized banks and warned of possible cuts for larger institutions like Truist and U.S. Bank. Fitch also downgraded the U.S. long-term credit rating due to political dysfunction and escalating debt levels, a move that drew criticism from business leaders.

Fitch is emphasizing that while bank downgrades are not inevitable, they are a real risk. The initial rating cut in June was a result of pressure on the country’s credit rating, regulatory gaps exposed by regional bank failures, and uncertainty surrounding interest rates.

The problem with another downgrade to A+ is that the industry’s rating would then be lower than some of the top-rated lenders. For example, banks like JPMorgan and Bank of America, which currently hold AA- ratings, would likely be downgraded. This scenario could force Fitch to consider downgrades for other banks as well, potentially pushing weaker lenders toward non-investment grade status.

Lower-rated banks, such as BankUnited, which is already at the lower bounds of investment grade at BBB, could face additional risks. A further downgrade for such banks could result in a non-investment grade rating.

Fitch analyst Chris Wolfe refrained from speculating on the timing or impact of this potential move on lower-rated firms. However, he suggested that some banks could hold on to their rating given their existing discounted valuation.

The path of interest rates set by the Federal Reserve is a significant factor that could prompt Fitch to downgrade the industry. Higher rates than anticipated would put pressure on the industry’s profit margins.

Loan defaults beyond what Fitch considers normal could also lead to downgrades. Rising defaults are typically associated with an environment of increasing interest rates, and Fitch has expressed concerns about the impact of office loan defaults on smaller banks.

The broad downgrades could have unpredictable consequences. Following the recent downgrades by Moody’s, there were concerns that downgraded banks would have to offer higher yields to attract bond investors, further squeezing profit margins. There were also worries that some banks could be entirely excluded from debt markets. Additionally, downgrades may trigger unfavorable provisions in lending agreements and other complex contracts.

Although a downgrade is not inevitable, Fitch warns that there will be consequences if it does occur.