Banks have mostly been tight-lipped about what rising interest rates would mean for their bottom lines. They will soon have to open up a little more to regulators and investors.
For the first time this year, the Federal Reserve is requiring nation's 18 largest banks to submit mid-year stress tests showing how they would perform if they were hit with a negative economic shock, like a spike in unemployment or interest rates. The results are due to the Fed on July 5. Unlike the bank stress tests conducted at the beginning of the year, though, the Fed won't run its own test, or publicly critique the results. Still, banks will be required to make the results public at the end of September.
On the eve of the submission, bankers are meeting with Fed officials next week in Boston at a closed-door symposium to discuss the stress tests. There has been some contention over the process in the past. Bank executives have expressed frustration that the Fed won't say how it gets its results. At a similar conference last year, Wells Fargo's (WFC) treasurer Paul Ackerman reportedly drew applause from bankers when he said he still didn't get how the Fed's loss estimates could be so different than his bank's.
On the list of topics for this year's meeting are residential loans, corporate loans and so-called counterparty credit risk, which is how much money one bank could lose if one of its trading partners goes bust. Putting a figure on that is one of the fuzziest parts of stress testing. In the past few months, regulators have stepped up scrutiny of corporate lending, questioning whether banks have made too many "covenant-light" and leverage loans.
But rising interest rates are sure to come up at the conference and in the mid-year stress tests. The yield on the 10-year Treasury bond has been rising recently, after being stuck near historic lows ever since the recession. The Fed included a sharp rise in interest rates as one of the shocks banks could face when it calculated potential trading losses in the stress test that were released in March. That was the first time the Fed had done that.
What's more, bankers say the Office of the Comptroller of the Currency has recently been questioning banks about interest rate risk. Last year, the OCC included rising interest rates in its report of top risks for banks.
It's hard to know how much banks would lose. Generally, banks have stuck to positives. Higher interest rates would allow the banks to charge more for loans. That could boost lending revenue and profits. But at the same time higher interest rates, and falling debt prices, have in the past caused big losses for the banks in their bond and loan portfolios. Banks have been less outspoken about that part of the rising interest rate story. But that might be changing.
Last week, at an investor conference, Bank of America's CFO Bruce Thompson indicated that the bank could lose as much as $11 billion in its bond and loan portfolio if interest rates were to rise 1 percent. He said that was as much as three times what Bank of America (BAC) would gain from higher rates in its lending business. But the bank might not have to realize those losses immediately, or ever if it holds the debt and borrowers end up paying. Still, the bank's capital could fall, which is something both investors and regulators have watched closely since the financial crisis, and something that would show up on the bank's stress test.
The best of times, worst of times story banks are telling about rising interest rates could end up being the other way around.
As Interest Rates Rise, Banks Face New Stress Tests
Risk level: High
What do success stories like Henry Ford, Steve Jobs and Mark Zuckerberg have in common? They all made their mark (and their millions) by coming up with a better idea and running with it. Starting a business is a proven path to wealth, and the best way to get there is to start small and scale up -- which usually means being bought out by a larger company, selling franchises or licensing your product.
An ambitious goal is critical if you want to expand your business, says Barbara Findlay Schenck, a small-business strategist and author of Selling Your Business for Dummies.
Before you apply for loans or sign up investors, polish your business plan. And don't overlook sources of free help. For example, you could tap your alma mater's alumni network for potential mentors. You can also get advice from more than 13,000 small-business volunteers through Score, a nonprofit organization supported by the Small Business Administration. (For more, see Six Steps to Starting Your Own Business.)
Risk level: Medium
Creating a product and licensing it or selling it through retailers is another route to making money from your good idea.
One of the biggest mistakes that aspiring inventors make is to create a product before they've determined whether there's a demand for it, says Sidnee Peck, who teaches classes in entrepreneurship at Arizona State University's W.P. Carey School of Business. She encourages her students to talk to potential customers in person before they develop their products.
Nancy Tedeschi came up with the idea for SnapIt, an eyeglass-repair device, after her mother used an earring to jerry rig her broken glasses. Convinced that she could improve on the tiny tools contained in most eyeglass-repair kits, Tedeschi invented a small screw with a snap-off extension. Tedeschi got the attention of Walmart (WMT), the nation's largest retailer, by entering its "Get on the Shelf" contest, an "American Idol"-like competition for aspiring entrepreneurs. She was one of two runners-up, and her product is now available on Walmart.com.
Online surveys and social media provide an easy way to reach a lot of people, Peck says, "but you don't get to see people's eyes light up." Tedeschi also attended housewares and hardware trade shows, where she introduced her product to representatives of other big retailers. Those contacts helped her get SnapIt on the shelves at Walgreens (WAG) and Ace Hardware.
Risk level: High
You can make a lot of money fixing up run-down houses and selling them for a quick profit, but you need cash to venture into this business. It's tough to get a mortgage for a property you plan to flip, but a home-equity line of credit against your primary home is a good source of funds for first-time flippers. Short-term bridge loans from private lenders, known as hard-money loans, are a higher-risk way to get the cash -- and charge higher interest rates.
Look for ugly ducklings in upscale neighborhoods where the market has picked up. Before buying a property, research recent sale prices for nearby homes to get an idea of what you can make, and find out how long the homes were on the market. Successful flippers usually sell their properties in 30 to 60 days, says Letitia Patterson, a real estate agent who has invested in properties in the Detroit area.
Don't forget to factor in the expenses you'll incur while you're holding the property, along with closing costs. Justin Pierce, a real estate investor who flips properties in the Washington, D.C., suburbs, says he starts by estimating the sale price of a fixed-up home. Once he comes up with that number, he subtracts buying and selling costs (typically 10% to 15%), a profit margin of 15% to 20%, and the cost of repairs. With those numbers in hand, he can determine how much he will offer.
Risk level: Medium
The average interest rate for a 30-year, fixed-rate mortgage on a rental property is only about 4%, according to mortgage Web site LendingTree. That means your monthly rental income should cover the mortgage, which wasn't possible when rates were 7% or higher, says Michael Corbett, an adviser to the real estate Web site Trulia and author of Before You Buy! Plus, the National Association of Realtors projects that average apartment rents will increase 4.6% this year, following a 4.1% increase in 2012.
Once you've purchased your first property, you can use the equity to buy additional properties, typically through a cash-out refinancing, says Doug Lebda, chief executive officer of LendingTree. Most lenders won't let you take out more than 80% of the equity you have in the property.
Fayz Khan, a former auto engineer, ventured into the rental market in 2008 because he believed he could earn better returns in real estate than he could get from the stock market (see "What It Takes to Be a Landlord,"). He now owns eight rental properties in the Baltimore area, and the return on his investment has far exceeded his initial expectations. Khan and his business partners are exploring opportunities in North Dakota, where the oil boom has led to an acute housing shortage.
Risk level: Low
You don't need talent or money to cash in on YouTube. In fact, all you need is a camera, something unique to share and plenty of luck. "A lot of people make over six figures a year on YouTube," says Ross Ching, a commercial and music video director.
A good one-off viral video is under three minutes and it gets you hooked within the first ten seconds. But it's tough to be a one-hit wonder. A more reasonable goal for amateur filmmakers is to score viral fame with a YouTube channel. That means making a series of videos, each of which can run a little longer than three minutes. Try highlighting a specific skill or theme -- say, cooking or standup comedy. Your videos will drive traffic to one another while you perfect your craft and earn "subscribers."
Reach out to media outlets and bloggers with a link to your video. Don't expect your audience to find your video without some direction. A link-back on a popular site can skyrocket views.
You can earn cash with YouTube advertisements, which can run about $2 per 1,000 views. But the real money is in endorsements and product sales. Industry experts estimate that Korean pop star Psy earned about $8 million in 2012 from his addictive YouTube music video "Gangnam Style." As his video accumulates views, his single racks up iTunes downloads and he picks up lucrative contracts, such as his pistachio-promoting Super Bowl commercial.
Risk level: High
If you can withstand 12-hour workdays on an oil rig in the North Sea or maintain your composure during military coups, you may be rewarded with free housing, a six-figure salary and the chance to see the world.
According to Rigzone, an oil and gas industry data provider, entry-level workers on a rig earn more than $68,000, on average; the pay ratchets up dramatically as you gain experience, which is easy to do in an industry that believes heavily in on-the-job training, says Rigzone president Paul Caplan. Drilling positions are most lucrative, with an average salary of $126,471.
If physical labor isn't your thing, you could get a gig with the State Department. The harsher the environment, the better the incentives: Foreign Service jobs add up to 70% of base salary for certain field positions in Iraq and Afghanistan.
A bonus: Hardship posts in a remote locale afford few opportunities to spend -- so there's not much to do with your money but watch it grow.