Most nonbank financial institutions (NBFIs) are in a good position to absorb or even benefit from long-term increases in interest rates, according to Fitch. The impact of a rising rate scenario will vary considerably across NBFI subsectors, but most institutions should benefit from expanding net interest margins (NIMs) and net investment income (NII), particularly if rates rise in connection with broader improvements in the economy.

Funding profiles for many NBFIs, including consumer finance companies, auto lenders and leasing companies, have some flexibility in a rising rate scenario, and higher borrowing costs can typically be passed on to customers, limiting margin pressure. As a result, Fitch expects the impact to be modest.

Retail brokers and mortgage servicers are expected to be among the largest beneficiaries of rising rates. As an example, retail brokers will likely report higher NIM and NII, and new asset inflows and portfolio appreciation could also generate increased fee and commission income. Mortgage companies are expected to experience higher valuations on mortgage servicing rights (MSRs) in a rising rate, lower default environment, offsetting the impact of reduced loan origination volumes.

The impact of higher rates will depend greatly on the quality and diversity of individual companies' asset portfolios, their business models, the relationship between the interest rate risks of the companies' assets relative to liabilities, and associated hedging strategies. The nature of the rising rate trend, particularly whether short-term rates rise in line with long-term rates, will also be a key factor influencing the ability of NBFIs to thrive in a higher rate environment.

If interest rate increases result from a general improvement in overall economic conditions and a recovery in the labor market -- a scenario similar to that outlined by the Fed in launching the tapering of quantitative easing -- rising rates would signal the arrival of a more normal macro environment consistent with strong NBFI performance. If, on the other hand, higher rates result from increasing inflationary expectations, NBFIs would face a much more difficult operating environment.

For a review of the impact of rising interest rates across various NBFI subsectors, see the Fitch special report 'Nonbank Financial Institution Interest Rate Sensitivity,' dated Jan. 30, 2014, at www.fitchratings.com.

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Applicable Criteria and Related Research: Nonbank Financial Institution Interest Rate Sensitivity

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