The recent spike in interest rates has put a dent in the paper gains banks have accumulated on their securities investments, but it is not expected to dampen earnings this quarter.
The reason: The long decline in rates enabled banks to build up huge unrealized gains on their securities holdings.
Huge Paper Gains
Commercial banks had $19 billion in paper gains at mid-year, according to the Federal Deposit Insurance Corp. NationsBank Corp. alone had $750 million of unrealized gains at Sept. 30; First Union Corp. had $298 million.
"You're talking about huge amounts of gains here," said Tony Davis, banking analyst at Wheat First Securities. "With the recent increases in rates, we're not talking about the re-emergence of losses on securities, we're talking about winding down of huge securities gains."
Gains from the sale of securities have been a key factor in a sharp rise in bank profits this year. From January 1991 to June 1992, FDIC-insured banks earned $4.9 billion from such sales.
An unrealized gain occurs when the market value of a security in the investment portfolio is higher than the original cost.
Unrealized gains do not affect the bottom line but represent potential profits.
Values Still Above Cost
The Securities and Exchange Commission is pushing banks to report more of their investment securities at the lower of cost or market value.
This means that, if the market prices of bank investment securities fell below their original cost, bank earnings would be reduced.
But analysts said the recent uptick in rates has not pushed any major bank to that point.
The value of fixed-rate bonds declines when interest rates rise. Rates have risen sharply above their low points of the year. Since early this month, 10-year U.S. Treasury notes have grown in yield from 6.22% to 6.78% in Friday trading.
The price of two-year Treasuries has fallen as yields shot up to 4.32% Friday, compared with 4.00% a week earlier and a low for the year of 3.67%.
Banks typically do not hold many securities with maturities of more than five years. The average maturity of NationsBank's investment portfolio, for instance, was about two years at Sept. 30.
Bond market observers are predicting that interest rates will not continue their surge.
Fears of Clinton Moves
Rates have risen mostly because of fears that, as president, Bill Clinton would overstimulate the economy with government spending and reignite inflation, said Sally Kleinman, domestic economist at Chemical Banking Corp.
She said she believes such fears are exaggerate and therefore does not expect further rate increases.
European interest rates are likely to trend down within the next three to six months, leaving the way open for cuts in U.S. rates, as long as inflation remains subdued, said John Lonski, senior economist at Moody's Investor Service.
"The likelihood of any kind of monetary tightening in the near term is very remote," he added.
BayBanks Inc. this month sold roughly $1 million in investment securities as it repositioned its portfolio in expectation of a rising rate environment. The Boston-based banking company will take a $41 million gain on the sale.