Toughing Out the Rate Spike

Banks have been conspicuously quiet about the impact of spiking interest rates on their balance sheets this month. A new research report argues managements are simply keeping quiet in the hope the problem doesn't worsen.

To date, most financial firms have said little about how they are coping with the 150-basis-point spike, which seems to have finally leveled off in the 10-year note. Speculation continues to be rife that someone is licking his wounds after guessing wrong on rates.

The nation's banks have been especially quiet, even though many invested heavily in mortgage-backed securities and regularly use the 10-year Treasury note as a hedge against interest rate fluctuations.

Bank analysts at Fox-Pitt Kelton, which just completed a review of second-quarter 10-Qs filed by the nation's major banks, found "surprisingly little commentary'' about the spike in Treasury yields -- which began around June 13 when the 10-year note stood at 3.10%.

The Fox-Pitt Kelton crew concluded the banking industry might be keeping mum in hopes that the yield on the 10-year note doesn't rise much above 4.5%, a level that many banks probably had factored into their hedging strategy.

On Friday, the yield on the 10-year Treasury was hovering around 4.46%.

A swift rise in rates can be bad news for holders of mortgage-backed securities because it reduces the value of low-yielding investments and can increase the life of a portfolio because borrowers are less likely to prepay mortgages when rates are rising.

"We get the sense that many banks are crossing their fingers, hoping that long rates will stabilize or come in slightly from the 4.5% level,'' said the bank analysts in 98-page report. "This level still seems comfortable for many institutions, but a further increase in rates will cause banks to consider restructuring their portfolios.''

Some banks have already started. The most recent information compiled by the Federal Reserve shows that since June, the nation's big commercial banks have shed some $68 billion in mortgage-backed securities, a 17% decline.