Rating Banks' Bond Exposure

"The natural move to a 4% yield was probably priced into the market," said Reilly Tierney, a financial services analyst with Fox, Pitt-Kelton. "A 5% move isn't."

Tierney expects the big selloff in bonds to depress trading revenue on Wall Street, but added that few believed that was sustainable anyway. Tierney said it's hard predicting which Wall Street banks will be hardest hit, because industry analysts traditionally have "a difficult time modeling trading revenue."

"This is going to be a period when you have divergences in performance between the companies," said Tierney.

Solid Bond in Your Heart

Still, the sudden rise in rates will no doubt cause pain for those banks and brokers caught off-guard by the action -- anyone who didn't properly hedge their exposure to rising rates. Indeed, the bond market's travail was sparked by a dangerous combination of new supply via a three-day auction and banks and other big mortgage holders trying to unwind earlier interest-rate hedges. (Banks and other investors commonly use Treasuries to guard against changes in the value of their mortgage portfolios.)

Some on Wall Street believe one big seller of Treasuries was the giant mortgage finance firm Fannie Mae(FNM). A hedge fund manager said the government-sponsored company was calling investment banks last Thursday trying to strike a deal to sell Treasuries in bulk. But analysts who cover the government-sponsored firm dispute that, and the company contends it doesn't rely on Treasuries to manage its interest rate risk.

The banks likely to feel the greatest pinch from the jump in Treasury yields are regional lenders such as New Jersey's Commerce Bank(CBH), which have invested heavily in low-yielding mortgage-backed securities. Rising rates are bad for mortgage-backed securities because they extend the life of those investments and reduce the value of the portfolio.

Standard & Poor's has estimated that Commerce is second only to Roslyn Savings Bank(RSLN), a small New York thrift, in its exposure to mortgage-backed securities. Another bank owning a large proportion of mortgage-backed securities is Provident Bank(PBKS).