Pub. 6 2016 Issue 3

Interest Rate Risk: How an Increase in Rates May Hurt Your Institution—and the Economy E V ERYONE IS WAITING WITH BATED BREATH FOR INTEREST RATES TO RISE. WHEN WILL THEY RISE? HOW MUCH WILL THEY RISE? Bankers are out doing a net interest rate margin dance, praying the gods that make these changes (the Federal Reserve) will increase rates so they can have improved net income. The assumption is that net interest rate margins will improve with an increase in interest rates since many financial institutions are currently asset sensitive. But what if rises in interest rates mean deposits reprice more quickly than ex- pected and more quickly than your loan portfolio? What if a rise in interest rates will actually harm borrowers, which in turn hurts credit quality? I am talking of course about variable rate loans. Many financial institutions still have a large portion of their portfo- lio tied to an index, and many of those loans are sitting on interest rate floors. You still may not be able to change rates on your loan portfolio as rates begin to rise—and this could be compounded if rates rise slowly. Even if rates do rise at a slow pace, financial institutions at some point will feel the pressure to increase deposit interest rates, which will have a nega- tive impact on already compressed net interest margins. If rates rise more quickly, this negative impact may be alleviated by moving loans off their inter- est rate floors. However, there are other risks associated with variable rate loans in this economic environment. Loans will begin to reprice, be it quickly or slowly, as interest rates rise. As loans reprice, borrowers may have debt service coverage ratios in excess of the amount needed to service the debt. However, how many of those borrow- ers can sustain an increase of 100 basis points? And will you still being able to meet your underwriting criteria with a 200 basis point increase? By KATHERINE HART, CPA, SENIOR MANAGER, MOSS ADAMS LLP 8 www.azbankers.org