Here’s Why Higher Interest Rates Are Not Positive for Regional Banks

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Higher interest rates are not positive for regional banks. Yet Wall Street analysts and economists are recommending investments in regional banks, such as BB&T (BBT - Get Report) , Fifth Third Bancorp (FITB - Get Report) , PNC Financial (PNC - Get Report) , Regionals Financial (RF - Get Report) , SunTrust (STI - Get Report) , U.S. Bancorp (USB) and Zions Bancorp (ZION) , on the theory that higher rates are positive to the bottom line.

The FDIC Quarterly Banking Profile for the second quarter of 2015, however, supports the notion that higher interest may not be bullish for bank stocks. Here's why.

Let's start with a quote from a news release by the Federal Deposit Insurance Corporation covering the Quarterly Banking Profile for the second quarter: "The average net interest margin (the difference between the average yield on banks' interest-earning investments and the average interest expense of funding those investments) rose to 3.06% in the second quarter from 3.02 percent in the first quarter, but remained below the 3.15 percent average in second-quarter 2014. Average margins at community banks of 3.57 percent in the second quarter were up from 3.54 percent in the first quarter, but down from 3.61 percent in second-quarter 2014."

FDIC Chairman Martin J. Gruenberg indicated that "the low interest-rate environment remains a challenge. Many institutions have responded by acquiring higher-yielding, longer-term assets, but this has left banks more vulnerable to rising interest rates and that is a matter of ongoing supervisory attention."

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What this means is, in a rising-rate environment, a longer-maturity bond will decline in price by a larger dollar amount for the same rise in yield of a shorter-maturity bond. In addition, if an investment is in a non-U.S. bond the yield spread will likely widen vs. the corresponding U.S. Treasury equivalent.

Then there is the accounting component. Securities can be held in three accounting categories that determine how realized, unrealized gains and losses are recognized.

Securities in trading accounts are marked-to-market and any net price changes unrealized or realized are recognized in current income. This may include...