By David Henry

NEW YORK, (Reuters) – Wall Street bankers often talk about the potential for higher interest rates to generate additional income from securities and loans.

The downside to rising interest rates is that bankers need to confront it: As yields increase, the bonds they have lose value. This can affect their capital.

The biggest U.S. bank have more capital for share buybacks, which is good news. Stock prices are under more pressure because there is less buybacks.

The S&P Banks Index has declined by 11% since the start of the year, almost double the 6% decline of the benchmark over the same period.

Charles Peabody, a bank analyst at Portales Partners said that buybacks will be lower than they were last year.

Analysts believe that Bank of America Corp (NYSE) will show the largest capital loss from declining bond prices next week. This is because it invested more cash last year in securities than other banks.

Peabody stated, “I am pretty certain you will notice that they have slowed down their buybacks significantly in the first quarter. This is primarily because of this issue.”

Bank of America declined comment.

DOUBLE-EDGED SWORD

Higher rates and higher net interest income should compensate for the loss of capital. Analysts stated that this timing makes it difficult to buy back shares.

In a report, Ken Usdin from Jefferies wrote that rising interest rates were a double-edged weapon for banks.

The yields on increased 0.83 percentage points to 2.34% in the quarter’s first quarter. Usdin estimates that a full 1 point increase in yields on Bank of America would have reduced its Common Equity Tier 1 capital ratio (which is a crucial regulatory measure) to 10.2%, from 10.6%.

This would bring the bank within the 10 to 10% range that Bank of America executive have stated the bank will keep to protect its regulatory requirements of 9.5%.

Citigroup Inc (NYSE:) would have had its CET1 ratio reduced by 0.22 of a point while JPMorgan Chase & Co (NYSE:) would have seen a 0.15-point cut, Usdin.

Peabody said that JPMorgan as well as Citigroup are likely to decrease buybacks. Citigroup will likely have to make losses on Russian assets, and the company has stated that they could reach nearly $5Billion in “severe” scenarios.

Jamie Dimon, JPMorgan’s CEO, stated Monday in a letter addressed to shareholders that buybacks by his bank “will be lower over the next year” due to its higher capital requirements. Also, it must invest in new businesses.

Analysts will review the bank’s results to see how they have changed their cash-securities mix in order to generate more interest income or manage unrealized loss on securities.

Banks are taking measures to minimize the damage caused by unrealized losses. Banks can also hedge their holdings, as Bank of America has.

The bank can make an accounting decision that reduces risk. Banks can designate some bonds “held-to maturity” and they won’t be required to track changes in value.

Or, banks can keep the bonds as “available-for-sale,” (AFS) which means having to count unrealized losses against capital but being free to sell the securities, such as to raise money to make more loans.

According to Usdin, bank securities portfolios are now 47% held to maturity from 28% just two years ago.

Because most banks are not large enough, regulators do not require that they count AFS changes towards their capital requirements.

The unrealized loss does not affect earnings, no matter if AFS is used or HTM.

Peabody predicts that investors will pay more attention to changes in capital over the next quarters as bond prices fall. This is because book value (also called capital) can give a better indication than earnings whether companies have created value or are making losses.

Usdin predicted that the average book value per share of 20 banks that he represents would fall by 4%, with an increase of 1 percentage point in 10-year yields.