More and more regional banks in the United States are taking a step that was unthinkable more than a year ago after the bankruptcy of Silicon Valley Bank: selling bonds underwater at a loss.
When Silicon Valley Bank did it, it caused panic among investors and depositors.
The difference this time is that regional banks aren’t selling lower-yielding securities to pay depositors, but are instead preparing for interest rate cuts by the Federal Reserve.
Some of the cash raised from these sales is being used to buy new bonds that lenders expect will perform well as rates fall in the coming months or years. The Federal Reserve is expected to begin cutting rates in early September.
“If they have extra cash, bank treasurers who think we’re at the top of the cycle may decide to go ahead and lock in long-duration bonds so that once we’re in a lower rate environment they’ll still have a decent yield,” said Feddie Strickland, an equity research analyst at Hovde Group.
Blocking on ‘the swoosh’
Regional banks announcing bond sales in recent weeks include Pittsburgh-based PNC Financial Services Group and Charlotte-based Truist (TFC), two of the top 10 U.S. lenders, along with Regions (RF) and Webster (WBS). Others are expected to follow suit.
PNC took $500 million in losses on its bond sales and re-priced the gains into securities with yields “approximately 400 basis points higher than the securities sold,” according to the bank.
The PNC Bank logo is seen on the window of a branch in Washington, April 30, 2023. (REUTERS/Ashraf Fahim/File Photo) (REUTERS/JOBsNews)
That boosted the bank’s confidence that it would earn a record amount of net interest income next year. Such income measures the difference between what a bank earns on its assets and what it pays on its deposits, a key source of revenue for any regional bank.
An analyst on PNC’s second-quarter earnings conference call said the rally over the next year resembled Nike’s swoosh logo.
“Basically what we’ve done is ironed out some of the details,” PNC Chief Financial Officer Robert Reilly told analysts.
PNC’s decision to take losses on bonds did not hurt earnings, thanks to a one-time stock gain it recorded on its Visa (V) holdings.
Other banks are choosing to take these bond losses even when they can’t offset them with one-time quarterly earnings.
Truist suffered a $5.1 billion after-tax loss when it sold bonds that yielded a paltry 2.80%.
The bank used part of the proceeds ($29.3 billion) to buy new bonds with a yield of 5.27%. It now expects its net interest income to be 2% to 3% higher next quarter.
Regions also took a $50 million pretax loss to replace about $1 billion in bonds.
The Birmingham, Alabama-based bank’s chief financial officer, David Turner, called the “repositioning” move a “good use of capital” and said Regions may look for opportunities to make further bond sales.
Another bank that sold some bonds underwater was Stamford, Connecticut-based Webster. In the quarter, it suffered an after-tax loss of $38.7 million from the realization of those losses.
Despite replacing more of its bonds with higher-yielding ones, the bank cut its net interest income expectations for the year by $60 million to $80 million, predicting higher deposit costs and lower returns on its loans.
“Obviously we didn’t meet expectations and we’re not satisfied with them,” Webster Chief Financial Officer Glenn MacInnes told analysts on Tuesday.
When the rate cycle changes
Not all regional banks are taking similar steps, and the direction of interest rates remains a thorny challenge for many regional lenders still struggling with high deposit costs, troubled borrowers and lackluster profits.
A reminder of those challenges came again this week when commercial real estate lender New York Community Bancorp (NYCB) reported a second-quarter loss, the sale of a mortgage servicing business and revealed it had added more to its reserves for future loan losses.
Its shares fell on Thursday after reporting the loss but recovered on Friday. It remains one of the worst-performing stocks of the year, a sign that investors remain concerned about the exposure of some regional banks to weaknesses in the commercial real estate sector.
The hope for many regional banks is that loans on their balance sheets will regain their value as rates come back down, and that deposit costs may fall as well.
“The change in the rate cycle will have a big impact on what the profitability story looks like,” said Moody’s Ratings analyst Megan Fox.
How that dynamic plays out will continue to vary widely across banks, so buying new bonds now is one of the safest bets lenders can make ahead of the cuts they expect to come.
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