Sep 24, 2013
New York, September 18th 2013 - Low absolute interest rates, particularly short-term rates near zero, combined with a rise in long-term rates, continue to dampen US banks' earnings prospects, says Moody's Investors Service in its new report "Interest Rates Throw Earnings Curve at US Banks."
"Despite an increase in US long-term interest rates during the second quarter, low absolute interest rates, particularly short-term rates near zero, continue to challenge US banks' earnings prospects," said Moody's Senior Vice President Allen Tischler. "Although we expect little impact on asset quality from the jump in long-term rates, a sharper increase in the yield curve could be more problematic."
Low short-term rates limit net-interest income, which makes up the majority of revenue for most US banks, typically from 50%-75%, says Moody's. The asset yields of US banks continue to re-price downward, as they have over the past five years of low rates, while banks have offset some of this decline through lower funding costs. But with funding costs closer to zero, banks are struggling to further reduce them, added the rating agency.
The recent long-term interest rate rise - the 10-year Treasury yield has climbed about 100 basis points since the end of the first quarter - is initially negative since rising rates have slowed mortgage originations and hit security values.
Moody's said that in general, for core-funded banks declining securities values are not a direct credit concern. Growing unrealized losses on available-for-sale (AFS) securities, or shrinking unrealized gains, are economically hedged to the extent banks' non-interest-bearing deposits remain sizable when compared to their securities portfolios. Moody's added that the increased value of these deposits is not captured in US GAAP accounting.
In addition, for major US banks, whose unrealized securities losses affect their Basel III capital, Moody's expects them to hold a capital buffer against AFS portfolio unrealized losses.
Still, long-term rates remain low in historic terms, even with the recent rise, and should not derail the improvement in net charge-offs and non-performing assets that began to gain steam in 2010, says Moody's. However, a more appreciable rise in long-term rates would significantly increase the cost of mortgage loans and slow the US housing recovery, undermining further improvements in banks' asset quality, particularly related to residential real estate.
Re-disseminated by The Asian Banker