Fitch: Yield Curve Flattening Remains a Risk to US Bank Margins
The uncertainty over the rate trajectory and terminal rate, coupled with the unprecedented length of this low rate period, remain key challenges and sources of uncertainty for the US banking sector. That said, Fitch believes that rate risks alone are unlikely to pose major risks to bank credit profiles or ratings.
The Fed highlighted that economic conditions had strengthened the case for a rate increase at the FOMC meeting held on 21 September, underscoring Fitch's view that an additional 25bps hike by the end of this year is likely. However the broader messaging remained consistent with a very slow and gradual process of interest rate normalization, while the Fed's weighted average median projection for the target rate through to 2019 fell by 25-50bps. This follows a steady and continuous decline in the target rate projections over the past year.
The economic uncertainty and declining long-term rate expectations have contributed to a steadily flattening yield curve since early 2014, which has continued this year. Without a sustained reversal in this trend, bank net interest margins (NIM) are unlikely to see a material increase as margin pressures are likely to remain. Even a rise in short-term rates would have limited effect on bank earnings without a corresponding increase in medium and long-term rates. Fitch maintains that a sustained and consistently steep yield curve will be the key factor for improving NIMs over a meaningful period with the shape of the curve being more important for bank earnings than the level of short-term rates.
Continued low rates could contribute to higher mortgage refinancing and improved non-interest income, but on aggregate, this has not been sufficient to offset the earnings effects from falling NIMs.
Banks will continue to focus on expenses and operational efficiencies to address margin compression. Longer duration balance sheets will also be a consequence as expectations for the low rate environment extend further into the future. Fitch expects growth in the proportion of long-term loans and securities - maturities greater than 5 years - in recent years to continue.
On aggregate, the longer duration balance sheet could pose a risk to banks in the event of a sudden and unexpected increase in rates, but for now are unlikely to pose a substantive risk to bank ratings. However, should individual banks react to longer-than-expected margin compression with significant changes to their balance sheet or business strategies, this may sufficiently alter credit profiles to warrant a rating action.