Big US banks have seen billions of dollars of losses on their vast portfolios of securities reversed following the recent rally in the price of Treasuries and other assets.
Data released by the Federal Reserve on Friday showed unrealised gains in these portfolios had recovered to $8bn after plummeting into negative territory from June to September, when worries that the central bank might taper its bond-buying programme caused investors to sell securities including US government debt.
The recovery will come as a relief to bank executives who had worried that the paper losses, which reached more than $10bn in early September, would translate into lower regulatory capital ratios under new Basel III proposals.
In spite of the recent gains, regulators and some analysts remain concerned about how banks will cope with rising interest rates when the Fed eventually decides to wind down its emergency economic programmes.
The central bank revealed last week that it would include a sharp rise in interest rates when it next “stress tests” the largest US banks, suggesting it is concerned about rate risk in the financial system.
Other regulators have already been warning that banks are assuming more risk to boost their flatlining profits. Some banks have been snapping up higher-yielding assets, such as structured products, or investing in securities with longer durations, to make up for lower returns on more plain-vanilla investments.
“The way banks have been trying to generate incremental income is through interest rate risk,” said David Hendler, the former CreditSights banking analyst, who is now setting up his own consulting firm. “The question is how are they going to get out of that without disappointing earnings and capital hits?”
Profits on big banks’ securities portfolios plummeted from almost $40bn at the beginning of the year as the yield on the benchmark 10-year Treasury spiked to 3 per cent. The yield on the Treasury note has fallen back to 2.6 per cent in recent weeks, helping to push banks’ securities portfolios back into black.
Fed data showed that the securities portfolios of smaller US banks had yet to return to profit. Their losses stand at $1.77bn, down from $4.35bn in September.
“The big banks probably have a little more flexibility in terms of managing their interest rate risk. They’re just able to hedge and use more tools,” said Joo-Yung Lee, head of the North American financial institutions group at Fitch Ratings.
The amount of structured products, such as asset-backed securities, held by all US banks jumped to $65.8bn at the end of June, according to the latest data from the Federal Deposit Insurance Corporation (FDIC).
That is the highest amount since at least 2009, when the FDIC began breaking the figure out in its statistics.
The Fed’s bond-buying programme “is a little bit of a narcotic,” said Mr Hendler, whose new consulting firm is David Hendler Consulting, LLC. “It really hurts [the banks’] ability to do conservative asset management.”
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