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Toughing Out the Rate Spike

New research argues that many banks are simply keeping quiet and hoping the problem goes away.

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.

Bank of America

(BAC) - Get Report

, for instance, began selling some of its more interest-rate sensitive mortgage-backed securities in early July. Long Island, N.Y.-based

North Fork Bank

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(NFB)

, where mortgage-backed securities had accounted for 82% of its investment portfolio, began doing it even earlier. The day before the Fed's last interest rate cut in June, North Fork said it was beginning to reposition its investment portfolio for a rising rate environment.

An earlier study by Standard & Poor's estimated that regional lenders such as New Jersey's

Commerce Bank

(CBH) - Get Report

, which invested heavily in low-yielding mortgage-backed securities, could be hardest hit by the rise in rates. 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)

.

The sudden closing earlier this month of

Capitol Commerce

, one of the West Coast's biggest privately owned mortgage bankers, also sowed jitters. Most on Wall Street believe Capitol Commerce's problems were due for a failure to anticipate a rise in rates and hedge its loan portfolio.

Of course, the nation's banks will get another chance to address the impact of soaring interest rates when they report third-quarter earnings in mid-October.