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Rankings & dataApril 30 2015

US banks and rising interest rates: a balancing act

As the US's economic recovery picks up steam, the Federal Reserve has tapered purchases of debt securities and expects to raise interest rates later this year. First quarter results of the largest US commercial banks show that they are more than prepared for the challenges that will follow.
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The US Federal Reserve's quantitative easing (QE) programme has left banks starved for higher interest rates. The five largest commercial US banks by Tier 1 capital – JPMorgan, Bank of America (BoA), Citigroup, Wells Fargo and PNC – estimate that a 1 percentage point increase in interest rates would result in higher interest income, with the figure being as high as $3.69bn for BoA. However, the end of QE will also send down the value of banks’ securities portfolios, which increased under the programme.

Top five US commercial banks by deposits

But, while banks will see the value of their debt portfolios fall, lenders with investment divisions may also gain from the return of interest rate differentials, creating more volatility and hedging opportunities, which should boost profits in fixed-income, currency and commodities divisions (FICC).

At the core

Wells Fargo has been more sensitive to interest rate movements than some other large banks. In 2008, at the onset of QE, it had the largest net interest margin of the five banks, by nearly 150 basis points (bps). In the first quarter of 2015, this lead was reduced to 3bps, as the margin shrunk to 2.95%.

As chart one shows, deposits have increased across the board for all five banks since 2008, but Wells Fargo outperformed its competitors by growing 53.14%. JPMorgan, which, behind Wells Fargo, suffered the second largest drop in margins – saw its margin narrow 0.8 percentage points between 2008 and the first quarter of 2015, while its deposits grew by 35.53%.

Top five US commercial banks - loan to deposits

Stagnant loans may have been one of the causes for declining margins –  in chart two it can be seen that all five banks saw their loan-to-deposit ratio drop as the funding they were receiving had nowhere to go. This could mean that once demand for loans picks up, Wells Fargo and JPMorgan will be well positioned to benefit, as they have the greatest capability to lend.

Portfolios on the verge

QE has seen banks’ securities portfolios soar to unprecedented heights. Its end might lead to markdowns in their values. The securities that will be most sensitive to curtailing of the programme will be the ones that the Federal Reserve purchased – Federal agency insured mortgage-backed securities (MBS) and treasuries.

As can be seen in chart three, of the top five commercial US banks, BoA holds the largest portfolio of Fed-targeted assets in both relative and absolute terms – the bank now has $255.3bn-worth of these among its available-for-sale securities, making up 88.36% of the portfolio. Citigroup, Wells Fargo and Citi, on the other hand, all have similarly composed portfolios, with Fed targets comprising between 51% and 55% of the total.

Top 5 US commercial banks

JPMorgan, however, stands out in the group as being least dependent on MBS and treasuries. The bank’s annual report for 2014 shows that they amount to only 26.43% of all securities, with other holdings including foreign government debt and non-US MBS among others.

Back in favour?

It appears that FICC is staged to make a comeback, as volatility returns to the markets with negative interest rates in Switzerland, Denmark and Sweden, and the onset of QE in the eurozone.

While PNC and Wells Fargo do not compete in this line of business, BoA, Citibank and JPMorgan do. Of these three, only JP Morgan has been able to increase its FICC trading revenue in the first quarter of 2015, as it grew by 5% from last year.

At BoA and Citigroup, the revenue from FICC dropped by 7% and 11%, respectively. Despite these figures, BoA and Citigroup may nonetheless see their trading divisions profit from the interest rate hike, as both banks blamed the decrease on low revenues from spread products. 

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