High interest on bonds to hit bank, insurers’ earnings

Banks and insurance companies’ earnings are expected to take a hit from unrealised losses arising from the recent hike in interest rates for Treasury bills and bonds.

While some of the losses affect the profit and loss account, other unrealised losses have the potential of eroding capital, thereby requiring injection of new cash should certain capital thresholds be breached.

Interest rates of the bills have shot to 20.6 per cent at the end of September up from 8.6 per cent at the close of the last reporting period ending in June.

A rise in interest rates has an inverse relationship with the price of bills and bonds in the market such that losses are incurred once the yield rises because the price falls.

“We expect to see a surge in lines that account for government securities, that is, unrealised losses,” said Genghis Capital’s research analyst Mercyline Gatebi.

Insurers are also required to mark their portfolio to market prices. Insurance firms publish financial results half yearly indicating their impact of marking to market would be revealed by the year-end reports.

Besides government securities, insurance companies will also be adversely affected by the bear run in the equities market that has seen the indicative NSE 20 share index drop by nearly a quarter to hit four-year lows.

More than 14 counters at the securities market are trading at one-year lows with many others hovering just above the mark.

As at the end of September, insurers and bankers were holding two-thirds of all bonds and bills issued by the government securities. Banks were the largest holders with 56.5 per cent, which is estimated to be worth Sh740 billion.

READ: Banks lower growth forecasts on high interest rates

The companies have an option of classifying the securities as ‘held to maturity’, ‘available for sale’ and ‘open for dealing’. If they hold the bills and bonds as ‘available for sale’ or primarily for dealing, they have to consider the value of the securities at the time of reporting and declare the potential gains or losses to be made from a trade at that moment.

Unrealised losses associated with securities held for trading or dealing are booked directly into the profit and loss account while those arising from ‘available to sell’ affect shareholders’ funds in the bank. This means the losses may reduce the capital adequacy levels of banks.

“The unrealised losses affects equity position but where they sell it then becomes an actual loss,” said Vimal Parmar, head of research at Burbidge Capital.

Those ‘held to maturity’ are not marked as the lender does not intend to sell the securities in the open market.

Tight liquidity positions may, however, force some of the banks to sell their securities in order to avoid the punitive overnight borrowing window, which will result in realisation of the capital losses by end of financial year.

Ms Gatebi noted that banks had the option of increasing their securities holding during this period of high interest rates so as to ride on unrealised gains when the rates drop.

The interest hike mirrors events of 2011 that saw banks and insurance companies exposed to paper losses. At the time banks were accused of committing accounting malpractices of irregularly shifting securities to avoid reporting the losses.

The Central Bank of Kenya responded by changing the financial reporting format which now requires them to disclose how they have classified the securities.