OREANDA-NEWS. US banks will continue to have their short and long-term business strategies affected by a "lower-for-longer" interest rate environment, concludes Fitch Ratings in a new report. Fitch believes banks will place additional focus on cost controls to improve operating efficiencies and extend balance sheet duration to stave off further margin compression while waiting for the Fed to increase short-term rates. Even when short-term rates do rise, there are important variables that could significantly affect the ultimate earnings and capital positions of US banks in a higher rate environment.

Given the protracted, unprecedented period of low interest rates, industry margins continue to compress. While funding costs have leveled off, higher yielding assets are running off balance sheets and being replaced by lower yielding assets. Bank margins fell to 3.02% at first-quarter 2015, the lowest average net interest margin (NIM) since 1984, according to the FDIC. Bank NIMs bounced up slightly in second-quarter 2015, but still remain significantly depressed compared with the industry's long-term average.

With the Fed's decision last month to maintain a target range of 0% to 0.25%, and the possibility that it might leave rates unchanged again next week, Fitch believes the banking industry will seek to find even greater operating efficiencies. While many banks have already laid out and executed cost-cutting initiatives, Fitch anticipates further efforts to reduce operating costs and improve operating leverage. These decisions come at time when many banks have been significantly investing in operational infrastructure to bolster regulatory compliance as well as technology in order to defend against ongoing cyber security threats but also to improve customer experience.

In general, banks have extended balance sheet duration in this protracted low rate environment. Loans and securities maturing or repricing in greater than five years relative to total loan and securities portfolios have increased to nearly 30% from 25%. This shows a fairly clear strategy by some management teams to extend duration to augment asset yields as expectations turn to a lower rate environment well into 2016.

The vast majority of the banks within Fitch's rating universe continue to disclose that they are asset-sensitive, meaning when rates rise, so does net interest income, as assets reprice faster than liabilities. However, many asset-sensitivity disclosures assume a 100-bps or 200-bps parallel increase in rates. Thus, a very gradual rate rise coupled with longer term rates remaining stable would make it unlikely for many US banks to see any meaningful NIM improvement over the near to immediate term.
Fitch continues to believe that predictions of what will happen following a rate increase by the Fed are complicated by how banks retain core deposits under the new liquidity coverage ratio rules as well as the current level of excess deposits in the banking system. Other factors that may prove influential include a potentially faster velocity of money given the rise of Internet banking, which could be mitigated with the impact of money market reform.

On balance, Fitch does not expect significant ratings movements due to rate risks. However, should some banks not be as asset-sensitive as assumed, or should some liquidity or capital be relatively and adversely affected more than others, there could be select negative pressure on ratings.

The report, "U.S. Banks: Interest Rate Risks - Lower for Longer", is available on www.fitchratings.com.