U.S. Bank Capital at Risk When Bond Gains Evaporate, Fitch Says

U.S. Bank Capital at Risk When Bond Gains Evaporate, Fitch Says

About $25 billion in unrealized bond gains are at risk from rising interest rates that may erode capital levels at some of the largest banks by 1 percentage point or more, according to Fitch Ratings.

Four years of price appreciation and growth in the bond portfolios of the 15 largest banks have left them with unrealized gains approaching a two-decade high, Fitch said today in an e-mailed statement. The gains may be erased by rising interest rates in a manner that could be worse than the last cycle when gains topped out in 2002, according to the ratings firm.“Today’s pattern of investment portfolio price appreciation deviates from the prior rate cycle,” Fitch said, citing the 2002 peak. “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 is the latest to warn of an impending reversal of bond prices as Federal Reserve bond purchases drive down interest rates and lead investors searching for returns to push junk-bond yields to below 6 percent. Goldman Sachs Group Inc. Chief Executive Officer Lloyd C. Blankfein has warned that the interest-rate environment has parallels to 1994, when a sudden and sharp increase in rates caught many investors off-guard.

An “immediate reversal” of bond gains in bank portfolios as seen in the last cycle could trim 1 percentage point from the capital levels at four of the largest 15 lenders under Basel III rules, Fitch said. Fitch declined to identify the banks, or detail years included in the last cycle.

Yields on junk-rated bonds reached an unprecedented 5.984 percent on May 9 before rising to 6.043 percent yesterday, according to the Bank of America Merrill Lynch U.S. High Yield index. Junk, or high-yield bonds, are rated below Baa3 by Moody’s Investors Service and BBB- at Fitch and Standard & Poor’s.

To contact the reporter on this story: Dakin Campbell in San Francisco at dcampbell27@bloomberg.net

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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