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Most, But Not All U.S. Banks to See Earnings Benefit from Rising Rates, Fitch

April 14, 2017, 07:08 AM
Filed Under: Banking News

Most U.S. banks should see an earnings boost from a rising interest rate environment over the next several years, according to Fitch Ratings. However, not all banks will be beneficiaries, and the potential impact will depend on individual bank's balance sheet positioning and the extent to which a potential flattening yield curve pressures margins and offsets earning asset or fee income growth. Fitch does not expect that the overall impact of rising rates from a flattening curve will create solvency issues for U.S. banks or lead to broad-based negative ratings actions in the sector.

Fitch's U.S. bank ratings reflect a base case for a total of seven 25-bps hikes to the Fed Funds rate in 2017-2018, bringing it to 2.50%, while the 10-year U.S. treasury yield is expected to rise to 3.1% by year-end 2018. Rising rates should be positive for earnings, particularly if they are reflective of an improving macroeconomic environment. Fitch expects US real GDP growth to accelerate this year and next to 2.3% and 2.6%, respectively.

Rising rates have not always resulted in increased bank net interest margins (NIM), especially under a flattening yield curve. U.S. bank NIMs compressed during the last major U.S. rate hiking cycle - from 1Q04 to 4Q06 - when short end rates rose, while the long end remained roughly stable.

Over time, asset quality should normalize under a rising rate environment. The extended period of ultra-low interest rates has been a factor in the present strong asset quality metrics. Higher rates and increased debt service costs could contribute to the expected reversion. Loan segments that are typically floating rate such as credit cards, commercial and industrial, construction and commercial real estate will be more sensitive to higher rates. However, Fitch believes that the deterioration should be manageable for the banking sector.

The effect on margins and asset quality will likely play out over the medium and long term, but rising rates could also have a more immediate effect on bank capital. A rise in U.S. treasury yields alongside increasing long-term inflation and rate expectations will lead to unrealized losses on tangible common equity and on regulatory capital for the largest banks.

This analysis is part of a series of special reports related to Fitch's updated view that recent U.S. rate hikes could mark the beginning of a significant shift in the global interest rate environment, with the potential for the Fed Funds rate to normalize far more quickly and at a higher terminal rate than current market expectations.

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