Analysis: Small and mid-sized banks face interest-rate struggles

Wed Mar 20, 2013 7:22am EDT
 
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By Tim McLaughlin

BOSTON (Reuters) - Some banks have been buying longer-term bonds to boost profits in a low-interest rate environment, sparking fears their profits will be squeezed when the Federal Reserve eventually starts to hike rates.

Banks are drawn to bonds maturing years in the future because the securities pay more interest than shorter-term debt. But rising rates will give banks higher funding costs, without necessarily giving the same lift to the income from all their assets, squeezing profits.

The lenders that could get hit hardest by higher rates are smaller community banks and mid-size regional lenders, analysts say. These banks generally have low income from fees and no real earnings from investment banking, relying mostly on income from lending and their growing bond portfolios.

Jeremy Stein, a member of the Federal Reserve's powerful board of governors, recently warned in a speech that low interest rates may have quietly contributed to banks taking more risk "below-the-radar."

"The added interest rate exposure may itself be a meaningful source of risk for the banking sector and should be monitored carefully, especially since existing capital regulation does not explicitly address interest rate risk," Stein said.

Bankers say they have few good choices when it comes to investing now, and are buying bonds because they need the income.

"Running a bond shop is not my favorite way to deploy assets," Commerce Bancshares Inc Chief Financial Officer Charles Kim said.

Since 2008, the Kansas City, Missouri-based bank's investment portfolio has surged by $5.9 billion, or 156 percent, to more than $9 billion, and the bank has been buying longer-dated bonds. Investment securities account for 44 percent of the bank's $22.2 billion in assets, compared with 22 percent in 2008.   Continued...

 
The Federal Reserve building in Washington is pictured in this August 22, 2012 file photo. REUTERS/Larry Downing/Files