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Rising 10-Year Yields Come Back to Punish Regional Banks

Rising yields on Treasurys has pushed commercial real estate distress rates up and increased the difficulty of refinancing. That, in turn, is an albatross around the neck of regional banks, which were just getting out from under unrealized losses from holding bonds.

Federal Deposit Insurance Corporation Chairman Martin Gruenberg said in a speech last month about 2024 Q3 that the banking industry had been showing resilience. “The industry’s net interest income and net interest margin increased this quarter,” he said. “Asset quality metrics deteriorated modestly but remained generally favorable despite continued weakness in several loan portfolios, which we are monitoring closely.”

Part of the good news in that quarter was that “unrealized losses on available-for-sale and held-to-maturity securities declined $149 billion to $364 billion in the third quarter,” Gruenberg said.

The interaction between securities — typically Treasurys and mortgage-backed securities — and changing interest rates were the dynamics that caused federal regulators to close Silicon Valley Bank, First Republic Bank, and Signature Bank in 2023.

The general pattern was that during ultra-low interest rates, some banks stocked up on buying Treasurys and mortgage-backed securities in what they thought would be a safe way to maintain cash. These bonds were considered quite safe. However, the strategy only worked so long as interest rates didn’t suddenly jump, as they ultimately did in the Federal Reserve’s response to high inflation.

When rates jumped, bond prices shifted inversely, leaving banks with piles of assets that suddenly were worth much less. Worried depositors took their money elsewhere, leaving the institutions insolvent because of the sudden lack of cash.

The 2024 Q3 drop in unrealized losses was enormous. However, to remain, the 10-year and longer-term bonds needed to keep prices up and yields down. They did the reverse. Instead of the 10-year yield being 3.81% on September 30, 2024, they ended Q4 at 4.58%. On Tuesday, January 21, 2025, they were about the same.

According to Bloomberg, higher interest rates are again making it difficult for commercial real estate properties to refinance, sending default rates up.

The changes have already had their effect on bank stocks. Shares of smaller banks have fallen about 8.2% since late November as the 10-year yield moved upwards.

“Rising long-term yields certainly leave the banking system more fragile in the short run, if more profitable in a base case economic scenario,” Steven Kelly, associate director of research at the Yale Program on Financial Stability, told Bloomberg.

“Net loan charge-offs within the CRE office portfolio were $62 million, down from $95 million in the third quarter,” PNC Financial Service Group Chief Executive Officer Bill Demchak said on an earnings call last week. “Despite this decline, we continue to see stress in the office portfolio, given the challenges inherent in this book and the lack of demand for office properties. As a result, we expect additional charge-offs, the size of which will vary quarter-to-quarter, given the nature of the loans.”

Reprinted with permission from the Wednesday, 22 January 2025 07:06:56 EST online edition of GlobeSt © 2025 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or reprints@alm.com.