Treasuries: high yields leave banks twice bitten, investors thrice shy

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The upward march of Treasury yields has largely wiped out US bond market returns for the year. Now they threaten to crimp US bank earnings.

The US banking sector was finally starting to enjoy some semblance of stability after turmoil following the collapse of Silicon Valley Bank in March. Deposit outflows have subsided at large banks and reversed at smaller ones, according to Federal Reserve data.

But the sharp rise in bond yields threatens to heap fresh pressure on the sector. Investors have been selling bank shares since the Federal Reserve signalled it may keep rates higher for longer. The yield on 30-year US Treasuries, which ended the third quarter with the biggest quarterly jump in more than a decade, hit a 16-year high this week.

Both the KBW regional banking index and the broader KBW bank index have fallen about 10 per cent over the past month. They are down 26 per cent since new year.

Higher yields on newly issued Treasury bonds will further erode the value of bonds and loans acquired or issued when rates were lower. US banks were sitting on $558bn of unrealised losses in their securities portfolio at the end of June, according to the Federal Deposit Insurance Corporation.

A resurgence of unrealised losses in the third quarter could put fresh strain on banks’ balance sheets, forcing lenders to tap the Fed for expensive emergency funding or pay more to keep depositors. The latter have poured vast sums into money market funds.

Higher funding costs, combined with slowing loan growth, would in turn put downward pressure on banks’ net interest margins.

Analysts are busy cutting their bank earnings forecasts. Wells Fargo has lowered its earnings per share estimates for the sector by 2 per cent this year and 5 per cent next year. Morgan Stanley has cut its forecasts by 3 per cent next year.

Investors had imagined successful resolutions of failed lenders marked the end of the sector’s painful adjustment to higher rates. Think again.