Banks learned some hard lessons from being burned by interest rate risks to their investment securities, and they've worked to reduce their exposure, analysts said. Banc One Corp., PNC Bank Corp., and a number of others suffered lower- than-expected earnings in 1994 because they had bet that interest rates would remain low.
Indeed, some analysts estimated that interest rate bets caused more than half of the bank group to underperform. "Banks got very complacent with interest rate risk in 1994," said Dennis Shea, a bank analyst at Morgan Stanley & Co.
"We had steady declines in interest rates for quite a period of time. The easiest thing to do was position yourself for a continued decline." Nonetheless, as a group, banks have reduced that kind of risk because they got "punched in the nose" and they still remember it well, Mr. Shea said.
Moshe A. Orenbuch, a bank analyst at Sanford C. Bernstein & Co. in New York, said banks have cut their average interest rate sensitivity about in half. They have reduced the gap between assets and liabilities that reprice in 12 months to 0.6% from 1.0% of earning assets, according to research by Bernstein.
Additionally, the standard deviation in interest rate sensitivity has fallen to 4.9% from 5.8%.
That means the riskiest banks "got their acts together," Mr. Orenbuch said.
To be sure, interest rate risk remains a fundamental issue that can affect a bank's balance sheet, causing periodic drops in earnings. "I don't think as a result of a few banks having problems that the issue is either larger or smaller," said Diane Glossman, a bank analyst at Salomon Brothers Inc.
"It's still an issue and has been so ever since there have been banks." Nonetheless, Ms. Glossman said, banks' balance sheets have become less tied to fixed rates.
"The more fixed-rate product, the more difficult to manage the interest rate risk," Mr. Shea said. Some analysts, however, said one of the largest fixed-rate investments remains a concern: mortgages.
"It's a product where the optionality sits with the customer," Mr. Shea said. "I'm not sure the banks get paid enough to hold that asset on their books."
Mortgages do not present a great risk right now, he said, but a sudden spike in rates could be damaging. Mr. Shea said holding a mortgage on a bank's books is more profitable in dollars but not from the perspective of return on equity.
In general, banks have been reducing the amount of their mortgage holdings, Mr. Shea said, but some still have a way to go. The analyst singled out Amsouth Bancorp., Barnett Banks Inc., and First Fidelity - recently acquired by First Union Corp. - as having large mortgage portfolios.
In general, however, bank analysts did not seem particularly concerned about interest rate bets. "These problems were like a kidney stone," said George Salem, a bank analyst at Gerard Klauer Mattison & Co. "It was painful for a while, but it's definitely passed."
