With the 10-year treasury yield rising 86bps since the start of May, investors have been asking several questions on the group. Still, Jason M. Goldberg, CFA of Barclays notes that the 10-year is relatively low compared to historical standards. Of note, the current 10-year remains in the bottom decile when examining data back to 1800. Additionally, this recent back-up in the long end of the curve has not resulted in a move in shorter-end rates like Fed Funds or 3- month Libor. This report examines the implications for the increase in the long end of the curve, though we highlight that higher short-term rates, coupled with a steep yield curve and greater economic expansion, would be a more beneficial backdrop.

Treasury Yield: Impact Of The 10-year Jump on Banks [ANALYSIS]

As detailed herein, historically, a back-up in the 10-year yield has resulted in:

  • Mixed stock price performance, though better performance when accompanied by yield curve steepening.
  • A decline in unrealized AFS gains/increase in unrealized AFS losses, which matters more under Basel III. In 1Q13, unrealized AFS gains contributed the most to the TCE ratio at The Bank of New York Mellon Corporation (NYSE:BK), Fifth Third Bancorp (NASDAQ:FITB), Signature Bank (NASDAQ:SBNY), Wells Fargo & Co (NYSE:WFC), State Street Corporation (NYSE:STT), Regions Financial Corporation (NYSE:RF) and PNC Financial Services (NYSE:PNC); all in excess of 30bps.
  • Some benefit to net interest margins as securities portfolio reinvestment rates improve, though other pressures due to low short-end. Zions Bancorporation (NASDAQ:ZION), Fifth Third Bancorp (NASDAQ:FITB), Citigroup Inc (NYSE:C), East West Bancorp, Inc. (NASDAQ:EWBC), Synovus Financial Corp. (NYSE:SNV) and Wells Fargo & Co (NYSE:WFC) saw the most pressure on securities yields in 1Q13.
  • Lower mortgage refi activity and reduced gain on sale margin, though increased MSR values, expectations of an improved purchase environment, and expense saving opportunities. In our coverage, Fifth Third Bancorp (NASDAQ:FITB), Wells Fargo & Co (NYSE:WFC), SunTrust Banks, Inc. (NYSE:STI), M&T Bank Corporation (NYSE:MTB), U.S. Bancorp (NYSE:USB), BB&T Corporation (NYSE:BBT) and Huntington Bancshares Incorporated (NASDAQ:HBAN) all had 7%-plus of their 1Q13 revenues tied to mortgage fee income.
  • Rapid changes in interest rates can impact trading results, though recent commentary has been constructive. FICC trading/debt underwriting is largest at Bank of America Corp (NYSE:BAC), Citigroup Inc (NYSE:C) and JPMorgan Chase & Co. (NYSE:JPM).
  • We expect asset quality to be benign for the intermediate term, though refinancing risk could increase, particularly for CRE. CRE as percent of average earning assets is highest at Synovus Financial Corp. (NYSE:SNV), Zions Bancorporation (NASDAQ:ZION), M&T Bank Corporation (NYSE:MTB), Wells Fargo & Co (NYSE:WFC), BB&T Corporation (NYSE:BBT) and Signature Bank (NASDAQ:SBNY).
  • Higher rates can lead to increased bank M&A activity. Mid-cap banks with a CEO over age 62 include Comerica Incorporated (NYSE:CMA), City National Corp (NYSE:CYN) and TCF Financial Corporation (NYSE:TCB).

Examining several current income statement and balance sheet factors, all else equal, we believe Bank of America Corp (NYSE:BAC), CMA, East West Bancorp, Inc. (NASDAQ:EWBC), First Horizon National Corporation (NYSE:FHN), JPMorgan Chase & Co. (NYSE:JPM), M&T Bank Corporation (NYSE:MTB), Northern Trust Corporation (NASDAQ:NTRS), Synovus Financial Corp. (NYSE:SNV) and Zions Bancorporation (NASDAQ:ZION) could be relatively larger beneficiaries of a rising interest rate environment while COF, Fifth Third Bancorp (NASDAQ:FITB), KeyCorp (NYSE:KEY), Signature Bank (NASDAQ:SBNY), State Street Corporation (NYSE:STT), U.S. Bancorp (NYSE:USB) and Wells Fargo & Co (NYSE:WFC) stand out on the other end. Still, we expect the better management teams to adapt to dynamic environments.

Impact of the 10-year Jump

With the 10-year treasury yield rising 86bps since the start of May, investors have been asking several questions on the group. Still, we note the 10-year is relatively low compared to historical standards. Of note, the current 10-year remains in the bottom decile when examining data back to 1800. Additionally, this recent back-up in the long end of the curve has not resulted in shorter-end rates like Fed Funds or 3-month Libor moving. This report examines the implications for the increase in the long-end of the curve, though we highlight that higher short-term rates, coupled with a steep yield curve and greater economic expansion, would be a more beneficial backdrop.

10 year treasury yield chart

As detailed herein, historically, a back-up in the 10-year yield has resulted in:

  • Mixed stock price performance, though better performance when accompanied by yield curve steepening.
  • A decline in unrealized AFS gains/increase in unrealized AFS losses, which matters more under Basel III. In 1Q13, unrealized AFS gains contributed the most to the TCE ratio at The Bank of New York Mellon Corporation (NYSE:BK), Fifth Third Bancorp (NASDAQ:FITB), Signature Bank (NASDAQ:SBNY), Wells Fargo & Co (NYSE:WFC), State Street Corporation (NYSE:STT), RF and PNC; all in excess of 30bps.
  • Some benefit to net interest margins as securities portfolio reinvestment rates improve, though other pressures due to low short-end. Zions Bancorporation (NASDAQ:ZION), Fifth Third Bancorp (NASDAQ:FITB), C, East West Bancorp, Inc. (NASDAQ:EWBC), Synovus Financial Corp. (NYSE:SNV) and Wells Fargo & Co (NYSE:WFC) saw the most pressure on securities yields in 1Q13.
  • Lower mortgage refi activity and reduced gain on sale margin, though increased MSR values, expectations of an improved purchase environment and expense saving opportunities. In our coverage, Fifth Third Bancorp (NASDAQ:FITB), Wells Fargo & Co (NYSE:WFC), SunTrust Banks, Inc. (NYSE:STI), M&T Bank Corporation (NYSE:MTB), U.S. Bancorp (NYSE:USB), BB&T Corporation (NYSE:BBT) and Huntington Bancshares Incorporated (NASDAQ:HBAN) all had 7%- plus of their 1Q13 revenues tied to mortgage fee income.
  • Rapid changes in interest rates can impact trading results, though recent commentary has been constructive. FICC trading/debt underwriting is largest at Bank of America Corp (NYSE:BAC), Citigroup Inc (NYSE:C) and JPMorgan Chase & Co. (NYSE:JPM).
  • We expect asset quality to be benign for the intermediate term, though refinancing risk could increase, particularly for CRE. CRE as percent of average earning assets is highest at Synovus Financial Corp. (NYSE:SNV), Zions Bancorporation (NASDAQ:ZION), M&T Bank Corporation (NYSE:MTB), Wells Fargo & Co (NYSE:WFC), BB&T Corporation (NYSE:BBT) and Signature Bank (NASDAQ:SBNY).
  • Higher rates can lead to increased bank M&A activity. Mid-cap banks with a CEO over age 62 include Comerica Incorporated (NYSE:CMA), City National Corp (NYSE:CYN) and TCB.

Stock Price Impact By Yields

Higher rates yield mixed bank stock performance. The curve matters more. The Figure below examines 15 instances over the past 20 years when the 10-year yield moved sharply higher. It also tracks the effective Fed Funds and the spread between the two. In the periods where the 10-year treasury yield rose by a relatively large amount, the BKX rose 9 times and declined 6 times. Still, it outperformed 7 times and underperformed 8 times. However, the yield curve seems to matter more. When the spread between the 10- year treasury yield and the effective Fed Funds increased more than 150bps, the BKX has increased in 5 of the 6 instances and in the 8 instances it rose less than 150bps, it has risen only 3 times (excluding the current period).

Bank Stocks And Interest rates

Unrealized Gains/Losses on Yield

AFS securities gains have dropped, which impacts Basel III tier 1 common and tangible book, but not net income.

One of the first things you learn in a basic fixed income class, is “if interest rates go up, bond prices go down.” Since May 1 through June 12 unrealized available for sale securities gains for the large domestic banks have been cut by more than half, dropping from $32bn to $15bn, its lowest level since May 2011, as the 10-year treasury yield jumped 59bps. Still, it’s up another 27bps since, likely further reducing this figure. While we believe this is manageable near-term, we believe this could be more of an issue looking out as/if interest rates continue to back-up. We believe some banks could be poorly positioned for this phenomenon.

While this impact has always been felt in book value, it was historically excluded from regulatory capital ratios. However, at the moment, it is captured in Basel III tier 1 common ratios, which investors seem to be focused on. Still, CCAR 2013 focused on Basel I tier 1 common. While its ‘severely adverse’ scenario had the 10-year declining from 1.4% to 1.2% during 2013 and to 1.9% at the end of 2014, its undisclosed ‘adverse’ scenario looked at the 10-year rising from 2.5% at the end of 2012 to 3.6% at 2013 to 4.6% by 2014. Wonder if they will ever release this.

10-year treasury yield vs unrealized AFS Gains

In 1Q13, unrealized AFS gains contributed the most to the TCE ratio at The Bank of New York Mellon Corporation (NYSE:BK), Fifth Third Bancorp (NASDAQ:FITB), Signature Bank (NASDAQ:SBNY), Wells Fargo & Co (NYSE:WFC), State Street Corporation (NYSE:STT), RF and PNC; all in excess of 30bps. There has also been a lot focus around MBS exposure in the current interest rate environment given it sensitivity to interest rates. MBS as percent of average earning assets is highest at SBNY, City National Corp (NYSE:CYN), KeyCorp (NYSE:KEY), RF, BK and STT.

Unrealized Gains chartsecurities portfolio mix chart

Net Interest Income/Margin Impact By Yield

With respect to NIMs, spreads matter more than absolute levels. The following Figure shows net interest margins have historically had a negative correlation with interest rates, though a positive correlation with the yield curves.

Net Interest margin chart

Scenario Analysis

A balance sheet is considered asset-sensitive when its assets (loans & securities) reprice faster or to a greater extent than its liabilities (deposits & borrowings). Generally speaking, an asset-sensitive balance sheet will produce more net interest income when interest rates rise and less net interest income when interest rates fall. However, the shape of the yield curve is sometimes not fully captured in this analysis. All else equal, a steeper yield curve is usually better for banks’ profits than a flat or an inverted yield curve.

Figure 9 shows interest rate sensitivity for the banks in our universe from the Form 10-Q filings. Based on the assumptions the banks used in their simulation models, there is a more uniform trend toward asset sensitivity. All 25 banks under coverage appear assetsensitive, a feat we have not seen before in our 36-quarter (9-year) data set (see Figure 8).

asset and liability chart

1. It should be noted that in addition to various methodologies, each company uses different assumptions in their analysis with respect to deposits levels, extension and repricing schedules, among other factors. Moreover, the majority of companies model off a parallel shift, which rarely occurs. Citigroup Inc (NYSE:C) and M&T Bank Corporation (NYSE:MTB) use the forward curve. City National Corp (NYSE:CYN) models 400bp gradually over 24 months with impact at the end of year one and year two – for our tables we use impact at the end of year one. Last quarter, COF switched from measuring earnings sensitivity assuming a gradual plus or minus 200 basis point change in forward rates to one based on an instantaneous plus or minus 200 basis point shock, with the lower rate scenario limited to zero. First Horizon National Corporation (NYSE:FHN), unlike prior quarters, offered an update to its interest rate sensitivity this quarter, while Northern Trust Corporation (NASDAQ:NTRS) provides an update to interest rate sensitivity disclosure only in its 10-K filings, with a note in 10-Q that rate sensitivity has not changed. And Wells Fargo & Co (NYSE:WFC) changed its analysis to measuring earnings at risk over 24 months in different rate scenarios. At end of 1Q13, earnings would most likely increase 0% to 5% if Fed Funds went to 1.25% and 10year Treasury rate went to 3.98%, compared with at year-end 2012 less than 1% of earnings are at risk if fed funds went to 0.50% and 10year Treasury rates went to 3.50%.

interest rate chart

In Figure 10, we group our universe into three categories based on the companies’ own simulation models’ results and several adjustments made by us in an attempt to normalize for different methodologies. Bank of America Corp (NYSE:BAC), The Bank of New York Mellon Corporation (NYSE:BK), Comerica Incorporated (NYSE:CMA), City National Corp (NYSE:CYN), East West Bancorp, Inc. (NASDAQ:EWBC), M&T Bank Corporation (NYSE:MTB), Northern Trust Corporation (NASDAQ:NTRS), RF and Zions Bancorporation (NASDAQ:ZION) appear to be the most asset-sensitive names under coverage. Citigroup Inc (NYSE:C), COF, Fifth Third Bancorp (NASDAQ:FITB), Huntington Bancshares Incorporated (NASDAQ:HBAN), KeyCorp (NYSE:KEY), Synovus Financial Corp. (NYSE:SNV), State Street Corporation (NYSE:STT), U.S. Bancorp (NYSE:USB) and Wells Fargo & Co (NYSE:WFC) stand out on the other end as relatively less asset-sensitive.

Relative interest rate chart

Yield – One-Year Gap

The one-year gap ratio is defined as assets with maturities of one year or less, minus liabilities with maturities of one year or less as a percentage of total assets. Generally the further the bank’s gap is from zero, the greater the bank’s interest rate risk. For most banks under coverage this figure is positive, implying it would benefit from rising interest rates.

one year gap ratio chart

One year gap ratio is negative at 1Q13, where short-term rate sensitive liabilities are greater than rate sensitive assets, for Signature Bank (NASDAQ:SBNY) (66% of assets) and Citigroup Inc (NYSE:C) (6%). The rest of the universe is positioned asset-sensitive, led by Comerica Incorporated (NYSE:CMA), Zions Bancorporation (NASDAQ:ZION), Northern Trust Corporation (NASDAQ:NTRS), First Horizon National Corporation (NYSE:FHN), M&T Bank Corporation (NYSE:MTB), Synovus Financial Corp. (NYSE:SNV) and RF (all with 40% or greater), compared with the median bank at 23%.

Figure 12 shows short-term asset-sensitive assets vs. short-term liability-sensitive assets all as percent of assets on a scatter diagram for a different view of 1-year gap at 1Q13. If rates were to rise, one would want to be in the upper right-hand corner as they would want more of their assets to reprice, but less of their liabilities.

asset sensitive vs liability chartNIM, Yields and Cost Chart

Loan & Deposits Impact

Higher long-term interest rates have typically not had a major impact on loan or deposit growth, though it could hurt loan pricing. Figure 14 shows there is not much correlation with the long-end of the curve and loan growth. We continue to believe loan growth will follow GDP growth overtime and the overall economy plays a bigger role. Still, some bank execs have commented to us that they felt if borrowers anticipate a rise in interest rates is approaching, they would be more apt to borrow beforehand. Still, rising interest rates have weighed on C&I loan pricing (Figure 15).

loan growth chart

Higher interest rates have also lead to increased liability costs and a slow down in core deposit growth, though overall growth tends to stay positive. We believe demand deposits would be least exposed. DDA as a percent of average earning assets is highest at Comerica Incorporated (NYSE:CMA), M&T Bank Corporation (NYSE:MTB), The Bank of New York Mellon Corporation (NYSE:BK), State Street Corporation (NYSE:STT) and U.S. Bancorp (NYSE:USB).