Large U.S. banks have unrealized securities gains on their balance sheets at near peak levels, which, Fitch Ratings warns, could quickly evaporate when interest rates rise.
The rating agency reports that, at the end of the first quarter, regulatory data shows that unrealized gains totaled $25 billion for the top 15 U.S. banks. These gains have now grown for over four years, it notes, “despite a period of protracted low interest rates, profit taking from bank investment portfolios and high prepayment rates on [mortgage-backed securities].”
“These trends provide further evidence that quantitative easing purchases continue to support elevated bond prices,” it says.
And, Fitch notes that this is different from the previous rate cycle, when unrealized gains peaked before rates bottomed out.
“Relative to that period, we believe banks face additional downside risk now given the significant price appreciation seen in fixed-income securities during a prolonged low rate environment,” Fitch says.
It estimates that if these unrealized gains reverse as rapidly as they did during the prior rate cycle, this could reduce capital levels by 100 basis points for four of the 15 largest U.S. banks under Basel III capital proposals.
“However, we recognize that the realized impact to capital will largely be driven by how the Fed will exit the quantitative easing program,” it adds.