Regional Banks Face Headache From Rising Treasury Yields

As the Federal Reserve continues its monetary tightening cycle, regional banks are grappling with the consequences of rising Treasury yields. The recent increase in interest rates has put pressure on regional banks' net interest margins (NIMs), as the cost of funding has risen while loan yields have not yet fully repriced. This article explores the impact of rising Treasury yields on regional banks and the strategies they can employ to mitigate the effects on their balance sheets.



Rising Treasury yields can impact regional banks' NIMs in several ways. First, as interest rates rise, the cost of funding for banks increases, which can lead to a decrease in NIM if banks are unable to pass on these higher costs to their customers. However, banks can also benefit from higher interest rates if they have a significant portion of their assets in floating-rate loans or securities, as these will reprice higher with rising rates. This can lead to an increase in interest income, offsetting the higher funding costs and potentially increasing NIM.

For example, in the United States, regional banks have seen their NIMs improve as the Federal Reserve has raised interest rates. According to a report by the Federal Reserve Bank of St. Louis, the average NIM for regional banks increased from 3.1% in the fourth quarter of 2021 to 3.4% in the fourth quarter of 2022, as interest rates rose (Source: Federal Reserve Bank of St. Louis, "Net Interest Margin for Regional Banks," January 2023).

However, regional banks may face challenges in passing on higher interest rates to their customers, particularly if they are facing intense competition or if their customers are sensitive to price increases. Additionally, regional banks may be more exposed to the risks associated with rising interest rates if they have a significant portion of their assets in long-term, fixed-rate loans or securities, as these will not reprice higher with rising rates. This can lead to a decrease in NIM if the yield curve steepens and long-term interest rates rise faster than short-term rates.

Regional banks can employ several strategies to mitigate the effects of rising yields on their balance sheets. Here are some key strategies, supported by specific examples and data from the provided materials:

1. Improve Operational Efficiency and Expense Control:
- *Regions Financial Corporation* reported a 6% improvement in their adjusted quarterly efficiency ratio to 60.1%, reflecting improvements in operating efficiency and expense control (Source: Earnings call, 2024).
- *Truist Financial Corporation* reported progress on their organization simplification plan, which included reducing headcount and realigning significant elements of their organizational structure, aiming to manage their expense growth in 2024 to flat to up 1% (Source: Earnings call, 2024).
- *Synovus* took prudent expense rationalization actions, with adjusted employment expense down 4% sequentially and year-over-year, driven by headcount reductions during the fourth quarter (Source: Earnings call, 2024).
- *Zions Bank* reported that their adjusted expenses increased by less than 1%, linked quarter, and decreased by 4% on a year-over-year basis, committing to delivering their expense objectives in 2024 (Source: Earnings call, 2024).

2. Rationalize Exposure and Optimize Loan Portfolios:
- *Banc of California* sold approximately $6 billion of assets and paid down approximately $9 billion of wholesale funding, retaining a portion of their multifamily portfolio rather than selling the entire portfolio as originally planned (Source: Earnings call, 2024).
- *Cadence Bank* reported a significant loss on securities restructure, implying some form of asset sale or portfolio adjustment (Source: Earnings call, 2024).
- *Truist Financial Corporation* announced the sale of their remaining stake in Truist Insurance Holdings, expected to close in the second quarter (Source: Earnings call, 2024).
- *Trustmark* sold their insurance agency, Fisher Brown Bottrell Insurance, to Marsh McLennan Agency in a cash transaction valued at $345 million (Source: Earnings call, 2024).
- *Webster Financial Corp* transferred $240 million of payroll finance and factoring loans to held for sale to exit that business, and will pursue "proactive, selective and opportunistic loan sales" (Source: Earnings call, 2024).
- *New York Community Bancorp* is considering a sale or runoff of nonstrategic assets (Source: Earnings call, 2024).

3. Diversify Funding Sources:
- Banks can diversify their funding sources to reduce dependence on wholesale funding and large time deposits, which may become more expensive as yields rise. This can be achieved by fostering stable deposit growth and attracting new depositors (Source: H.8 data, 2024).

4. Strengthen Capital Buffers:
- Maintaining adequate capital buffers can help regional banks absorb potential losses from rising yields and interest rate risk in the banking book (IRRBB). This can be achieved by retaining earnings, issuing new equity, or reducing dividends (Source: Basel Committee on Banking Supervision, 2023).

5. Enhance Interest Rate Risk Management:
- Banks can enhance their interest rate risk management by extending the time series used in model calibration for IRRBB, bringing more volatile rate distributions into the equation (Source: Basel Committee on Banking Supervision, 2023).
- Banks can also improve their pricing strategies on loans and deposits, beef up ALM governance and monitoring capabilities, and engage business units more closely to define pricing strategies and product innovation (Source: McKinsey roundtable, 2023).

By implementing these strategies, regional banks can better navigate the challenges posed by rising yields and improve their balance sheets' resilience. However, it is essential for regional banks to maintain adequate capital buffers and diversify their investment portfolios to minimize the impact of interest rate fluctuations on their financial health.

In conclusion, rising Treasury yields present both opportunities and challenges for regional banks. While higher interest rates can lead to improved NIMs, regional banks must also be prepared to manage the potential risks associated with rising yields. By employing strategic responses such as expense discipline, loan portfolio rationalization, and enhanced interest rate risk management, regional banks can better position themselves to withstand the effects of rising yields on their balance sheets.