Few Banks Are Hedging Interest-Rate Risk
Summary
- A recent paper focuses on how banks handle rising rates
Few U.S. banks protected themselves against rising interest rates during the Federal Reserve’s monetary-tightening campaign last year, according to a research paper that says unhedged securities holdings are more widespread than investors might realize.
The paper—“Limited Hedging and Gambling for Resurrection by U.S. Banks During the 2022 Monetary Tightening?"—contends that hundreds of other banks share that risk, which played a role in the collapse last month of Silicon Valley Bank. The paper didn’t single out individual institutions, instead presenting an analysis of aggregate data.
Investors this week are taking a fresh look at the health of U.S. banks such as Bank of America Corp., Zions Bancorp of Utah and Comerica Inc. of Texas as they report first-quarter results.
The authors—professors Erica Jiang of the University of Southern California’s Marshall School of Business, Gregor Matvos of Northwestern University’s Kellogg School of Management, Tomasz Piskorski of Columbia Business School and Amit Seru of Stanford Graduate School of Business—say Silicon Valley Bank and parent SVB Financial weren’t alone in declining to shield assets against rising rates. Across the banking sector, only about 6% of bank assets were protected by interest-rate swaps, contracts a bank can purchase to ease the pain of rising rates, the professors found, drawing on public financial filings.
Even as rates continued to climb throughout 2022, about a quarter of publicly traded banks reduced their protective hedging last year, the researchers found. For instance, SVB had hedged about 12% of its securities portfolio at the end of 2021, but only 0.4% by the end of 2022. The professors described this as akin to a gamble.
“These banks have taken a large risk, which is profitable for bank shareholders on the upside, but the losses are borne by the FDIC on the downside," they wrote, referring to losses incurred in the SVB failure by the Federal Deposit Insurance Corp.
Their paper, posted this month on Social Science Research Network, a repository for new research work that isn’t yet peer reviewed, follows a separate article by the group in March that said nearly 200 banks had exposure to unrealized losses and uninsured depositors that was similar to SVB’s.
“You could think of SVB as the canary in the coal mine," Mr. Piskorski said.
The March market mayhem reminded Wall Street that higher interest rates set by the Fed inevitably hurt the market value of stocks, bonds, loans and other financial assets held by banks—and in some cases can impair a bank’s reputation for soundness, spurring flight on the part of depositors whose holdings exceed the $250,000 FDIC limit.
In the case of Silicon Valley Bank, the firm came under intense pressure because of cash burn on the part of its technology-startup clients, which led to deposit outflows—even before fears about its health flared following an attempt last month to raise cash by selling stock. A catastrophic run on uninsured deposits followed. The FDIC took over SVB on March 10.
Analysts, investors and bank executives say it makes sense that many banks don’t insure themselves against rising rates. All else equal, banks’ profits often benefit from higher rates because they allow banks to charge higher interest on loans.
For M&T Bank Corp., which on Monday was one of the first regional banks to post first-quarter results, net income from interest more than doubled to $1.82 billion over the past three months, helped in part by an acquisition. Its shares on Monday had their biggest percentage gain in the past year.
Rising income provides a natural hedge against losses on banks’ securities portfolios when rates rise and explain why many don’t hedge, said Stephen Biggar, director of financial-services research at Argus Research, which analyzes stocks.
“Banks are interest-rate-sensitive vehicles by design," Mr. Biggar said.
Suhail Shaikh, chief investment officer at London-based fund manager Fulcrum Asset Management, said that his team’s funds are positioned to benefit from a rise in British and Japanese bond yields that he believes will follow from dissipating concern about U.S. regionals.
“In the last month, the crisis has died down quite significantly," he said.