The Shadow of Elevated Interest Rates Continues to Loom over US Banks

More than a year has elapsed since the collapse of Silicon Valley Bank, yet the shadow of elevated interest rates continues to loom over the US banking landscape.

The Federal Deposit Insurance Corporation's report for the first quarter indicates that the US banking sector is grappling with a substantial $517 billion in unrealized losses, with 63 institutions now classified as "problem banks."

These losses have been primarily ignited by a significant rise in interest rates over the last two years, causing a depreciation in the value of fixed-income securities held by these banks.

In a striking revelation, unrealized losses within banks escalated by $39 billion in the first quarter compared to the final quarter of 2023.

The FDIC attributed this increase mainly to the heightened losses on residential mortgage-backed securities, a consequence of rising mortgage rates during the quarter.

Mortgage rates have been consistently climbing since the year's inception, with the 30-year fixed mortgage rate advancing from approximately 6.6% in early January to just above 7% currently, based on Freddie Mac's data.

This marks the ninth consecutive quarter of abnormally high unrealized losses since the Federal Reserve initiated interest rate hikes in the first quarter of 2022.

From 2008 to 2021, the US banking system's unrealized losses and gains on investment securities oscillated between a high of $75 billion in losses to nearly $150 billion in gains.

The increase to 63 problem banks in the first quarter marks an uptick of 11 banks since the last quarter of the previous year. The FDIC defines problem banks as those with a CAMELS composite rating of four or five.

The CAMELS rating, a measure of a bank's financial health, evaluates six critical areas: capital adequacy, assets, management capability, earnings, liquidity, and sensitivity to market conditions.

This rating scale ranges from one to five, with one indicating a bank of high quality and minimal concern, and five signaling weak performance and a need for extensive regulatory oversight.

The total assets managed by these 63 problem banks reached $82 billion in the first quarter, pointing to the predominance of smaller-scale institutions among the troubled banks.

Despite the rise in problem banks driven by higher interest rates, the FDIC suggests that the situation is not yet alarming.

"Problem banks constitute 1.4% of the total banking entities, which falls within the typical one to two percent range observed during non-crisis periods," the FDIC explains.


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