The era of extraordinarily low interest rates may be coming to an end. For investors who have thrown big wads of cash toward the “safety” of long-term bonds, this end will not be a welcome one. For banks, however, rising interest rates may prove more satisfying.
The Good News
The low-rate, flat yield curve environment has squeezed banks’ net interest margins considerably over the last few years. The return of a steeper yield curve will allow for some slack in the net interest margins going forward.
On May 1, the yield on the six month T-bill was about eight basis points and the yield on the 10-year Treasury bond was 1.63%. Since then, the yield on the six month is up three basis points while the yield on the 10-year is up almost 100 basis points. That big exhale you just heard was the collective sigh of relief of countless community bankers across the country.
Smaller banks will have the most to gain from the steeper yield curve. Banks with less than $1 billion in assets have far fewer sources of non-interest income, so those banks will find even greater salvation in a steeper curve environment.
The Bad News
Conceivably, short-term interest rates could climb faster than long-term rates, although this does not appear to be an immediate risk. If that were to come to fruition, the banking sector would have more issues that it would know what to do with.
The steeper yield curve comes with some risks of its own. Higher long-term Treasury rates could put a damper on the US economy and in particular, a segment of commercial lending that has been critical for many U.S. commercial real estate backed loans. For banks to benefit from deploying funds at higher margins, they need loan demand to endure. When it comes to CRE loans, continued demand is not necessarily a slam dunk.
Using the CMBS market as a proxy, issuance levels for 2013 are predicted to be about 100% higher in 2013 than in 2012 (from about $46 billion to $90 or $100 billion). This recovery has been driven by skimpy U.S. Treasury yields and the tightest lending spreads since 2008. This combination has allowed many otherwise unrefinancable properties to obtain new financing. The fact that the 10-year Treasury yield is up 100 basis points and lending spreads are off 50 or more basis points certainly could put a lot of deals in jeopardy in the near future.
