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Fitch: Market Moves Bring Bank Interest Rate Risks to Forefront
June 18, 2013 / 3:18 PM / 4 years ago

Fitch: Market Moves Bring Bank Interest Rate Risks to Forefront

(The following statement was released by the rating agency) CHICAGO, June 18 (Fitch) The recent rise in U.S. Treasury yields and speculation surrounding possible changes in the Fed's bond buying program have highlighted the potential risks faced by U.S. banks in a rising rate environment, according to Fitch Ratings. A sustained increase in interest rates, potentially signaling an end to the prolonged low rate environment that has hampered bank margins, could have a meaningful impact on capital and bank earnings. We remain primarily focused on the adverse impact that rising rates could have on bank capital under the current proposed Basel III framework for U.S. banks. Unrealized gains on securities held on U.S. bank balance sheets have risen to historically high levels, potentially setting the stage for a reversal of gains and an ensuing erosion of capital levels should rate increases hit bond prices hard. This is especially relevant given banks' increased exposure to mortgage bonds in investment portfolios on both an absolute and proportional basis. We recognize that the realized impact to capital will largely be driven by how the Fed may exit the quantitative easing program. If the Fed were to exit its bond buying strategy in a gradual and transparent fashion, the impact on bond prices could be less significant. However, to the extent that this does not occur, we see the potential for further declines in bond prices, with losses potentially larger on a percentage basis than those reported during the credit crisis. The vast majority of Fitch-rated banks have disclosed that they are asset-sensitive, meaning net interest income (NII) rises along with interest rates, as assets reprice faster than liabilities. While we believe that most income simulation models are likely directionally sound, the magnitude of NII changes could be vastly different than modeled outcomes, depending on how depositors and borrowers actually behave as rates rise. This is particularly relevant given the unprecedented length of time during which rates have remained at historically low levels. Even as the Fed raises short-term rates, margins could remain depressed if long-term rates do not follow suit. This would result in a flattened yield curve, potentially leading to an outcome similar to that experienced during 2004-2006. In addition, rising rates may put additional pressure on banks with longer-duration balance sheets to pursue mergers with shorter-duration banks that will be better positioned to maintain earnings in a rising rate scenario. We believe that asset quality could deteriorate as rates rise, causing cap rates to increase, leading to lower commercial real estate values. Moreover, borrowers that were unable to lock in long-term, fixed rate funding will be burdened with greater debt costs, potentially leading to higher default rates. We note that U.S. banks have experienced prolonged periods of low rates before, such as in the early 1990s, when the U.S. economy was exiting recession. The Fed's unexpected 1994 rate hike caused bond values to drop, hurting bank earnings and capital in the process. However, we note that there were no bank failures resulting directly from the steep increases in interest rates seen in 1994. In general, Fitch expects most banks' margins to expand along with rising rates. This view is incorporated in our ratings and outlook for the banking industry. Fitch does not believe the impact of rising rates will create solvency issues at U.S. banks. However, negative rating actions could emerge if we identify an absence of risk management practices commensurate with balance sheet strategies that could result in adverse impacts to capital and earnings as rates rise. For more detail, see the special report titled "U.S. Banks: Interest Rate Risk -- What Happens When Rates Rise," published today at www.fitchratings.com. Contact: Bain Rumohr, CFA Associate Director Financial Institutions +1-312-368-3153 Julie Solar Senior Director Financial Institutions +1-312-368-5472 Bill Warlick Senior Director Fitch Wire +1-312-368-3141 Fitch, Inc. 70 W. Madison Chicago, IL 60602 Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549, Email: brian.bertsch@fitchratings.com. The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings. Applicable Criteria and Related Research: U.S. Banks: Interest Rate Risks (What Happens When Rates Rise) here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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