Bank of America's Profits Caught Between the Fed and 10-Year Treasury

Rising interest rates are good for banks. A flatter yield curve isn't.

That was the dilemma faced by banks as the Federal Reserve again raised interest rates Wednesday. The Fed is now targeting short-term rates of between 1% and 1.25%.

Yet longer-dated rates have fallen of late; the yield on the 10-year U.S. Treasury hit 2.11% at one point Wednesday. On Thursday it was at 2.16%.

The result is compression between short- and long-term rates. The spread between yields on 10- and two-year government debt has fallen in recent days to 0.81 percentage points. That is not far off levels experienced last summer, which were the lowest in five years. At its peak in this period, in late 2013, the spread was 2.61 percentage points.

A flatter yield curve threatens to pinch bank profits, even as the Fed's move to end nearly a decade of near-zero rates promises to help bolster them.

Bank of America, the second-largest U.S. bank by assets, illustrates the challenge. The bank is seen as the big bank that will benefit most from higher rates. Investors often buy and sell the lender's stock on rate expectations.

The Fed's increases, which began in December 2015, have helped lift the bank's profits broadly. Notably, it has helped to relieve pressure on the bank's net-interest margin, a measure of the profit the bank generates from borrowing money and then lending it out.

While the bank has been able to charge more for some loans, it has been able to hold steady the rates it pays for deposits. That bolsters its net-interest margin.

Last year, Bank of America paid an average of 0.08% for its interest-bearing deposits in the U.S. That rate has barely budged since then. Despite this, Bank of America kept raking in customers' money; such deposits increased $33 billion versus 2015.

"We are doing better than our models would have said" on how quickly the bank would have to increase deposit rates, Bank of America CEO Brian Moynihan said in late May.

In the first quarter, higher rates helped lift net interest income by more than $700 million.

Over time, though, the bank and others are likely to have to increase the amount it pays to depositors. That will lessen some of the benefit from rising short-term rates.

The bigger problem: The recent reversal in long-term rates means Bank of America, like other banks, earns less on its massive investment portfolio. When those rates fall, banks reinvest maturing securities at lower rates.

So, in late May, Bank of America cut its expectations for growth in net interest income for the second quarter, saying lower rates would reduce a previous forecast of about $150 million by at least $30 million.

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

(END) Dow Jones Newswires

June 15, 2017 11:13 ET (15:13 GMT)