Are rising interest rates good for banks? Executives at some of the world’s largest lenders are trying to reassure investors that the answer is yes. Higher returns on new investments, increased profit margins on loans, and improved earnings from bond trading, they say, will offset any losses they suffer on existing bond holdings. (The value of bonds falls as rates rise.) Rising bond yields are “very healthy,” said Anshu Jain, Deutsche Bank’s (DB) co-chief executive officer, at a June 4 investor conference in New York.
It may not work out that way. Rates are rising in part because investors are speculating that the Federal Reserve will slow its $85 billion-a-month bond-buying program—not because the economy is about to take off. Banks could face losses on the bonds they own without gaining opportunities to make more money on loans and investments. “Higher rates without meaningful economic growth are bad for banks,” says Paul Miller, an analyst at FBR Capital Markets (FBRC). “A lot of these banks have put on big securities portfolios at very low rates, trying to put their money to work. If rates move up materially, those things will be marked down.”
Another concern for banks is that short-term rates are not rising as much as longer-term rates, and short-term rates have a bigger impact on bank profitability. The rate on the 10-year Treasury note climbed to 2.13 percent on June 14, from 1.63 percent in May. The central bank has said it won’t raise its target for the federal funds rate (currently a range of 0 percentage points to 0.25 percentage points) until the U.S. jobless rate falls to 6.5 percent—as long as inflation remains low.
Home-equity loans, credit-card rates, and working capital lines of credit to businesses are among bank assets pegged to short-term borrowing benchmarks such as the prime rate, fed funds rate, or the London interbank offered rate, known as Libor, according to Chris Mutascio, an analyst at Keefe, Bruyette & Woods (SF). “There’s kind of a general view that the 10-year Treasury yield rising is significantly beneficial for the banks,” he says. “That’s not nearly as beneficial as if short-term rates were rising.”
There’s also a danger that higher rates without robust economic growth will squelch already weak demand from borrowers, according to Miller and other analysts. Increased borrowing costs could crimp mortgage lending and refinancings.
The prospect that rising interest rates may boost bank profits has led some investors to buy bank stocks, says Ralph Cole, a senior vice president of research at money manager Ferguson Wellman. The KBW Bank Index of 24 companies rose 9 percent from May 1 through June 18, more than double the 4 percent gain for the Standard & Poor’s 500-stock index.
William Fitzpatrick, an analyst at Manulife Asset Management, warns investors to be cautious. “There are pockets of business that I’m sure are going to benefit,” says Fitzpatrick, whose firm owns shares of Deutsche Bank. “But the punch line is that in traditional banking land, a rise in long-term bond yields that’s not accompanied by a rise in short-term rates is going to be painful.”