Think Rates Are Going Up? Banks Don't

By Rachel Louise Ensign Features Dow Jones Newswires

After years of waiting for interest rates to rise, some banks have started to lend as if they never will, loading up on a record amount of loans and securities that carry low rates for years.

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The percentage of bank assets that won't mature or change rates for more than five years reached a new high in the second quarter, according to Federal Deposit Insurance Corp data released Tuesday. That means banks are allowing more borrowers to lock in low rates for long periods of time, a potential risk should rates move sharply higher.

"The interest-rate environment and competitive lending conditions continue to pose challenges for many institutions. Some banks have responded to this environment by 'reaching for yield' through higher-risk and longer-term assets," FDIC chairman Martin Gruenberg said in remarks accompanying the release of the quarterly data.

An added worry: Much of this lending for longer is in the booming area of commercial real estate, where borrowers finance offices and apartment buildings typically with loans that have fixed-rate periods from three to 10 years.

The rise in bank assets with longer maturities is a side effect of nearly a decade of historically low interest rates. Those have pinched bank profits and led more firms to lend for longer to try to capture more yield.

So far, that hasn't proven a problem as long-term rates have remained low, despite the Federal Reserve increasing short-term rates, and credit quality has stayed strong. Regulators have warned, though, that the growing share of longer-term and commercial-real estate loans at some banks could be risky.

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Across all banks, the percentage of total assets that are at a fixed rate for more than five years was 27.5% in the second quarter of 2017, its highest since the FDIC started tracking it in 1984. The metric reached 33.7% in the second quarter at smaller banks with $1 billion to $10 billion in assets.

Commercial real-estate loans made up 31.5% of assets at those midsize banks in the quarter, up from 25.7% in the second quarter of 2012. The figure is far lower at bigger banks, at 6.4%, and has remained steady in recent years.

Banks largely make money in two ways: from lending and fees. Smaller lenders tend to rely more on lending profits than bigger banks that have fee businesses like wealth management. Lending profits typically come from the difference between what banks pay out on deposits and what they earn on loans and securities.

But rock-bottom interest rates following the financial crisis eroded these margins across the industry, leading some banks to make longer-term loans to try to get similar yields. Growing their volume of loans also helped them compensate.

The firms that were often hungriest for bank debt in recent years were commercial-real estate borrowers. Between 2015 and early 2017, commercial-real-estate loans generally grew at a pace above a 10% annual rate at smaller lenders, according to Federal Reserve data.

That rate, now around 9%, has helped banks compensate for a slowdown in general business lending. Much of that lending is floating rate, meaning banks face less risk from rising rates.

As banks chased commercial-real-estate borrowers, competition led to more favorable lending terms. "Every meeting I went to, bankers said, 'We're not going to go past five years" on commercial real-estate, said Scott Hildenbrand, chief balance sheet strategist at Sandler O'Neill & Partners. Within a year or so, the bankers were saying, 'We're not going to go past 10 years."

Write to Rachel Louise Ensign at rachel.ensign@wsj.com

(END) Dow Jones Newswires

August 22, 2017 12:40 ET (16:40 GMT)