US banks taper securities buys in Q3 as some wait for higher rates

Another slump in interest rates in the third quarter restrained bond buying by U.S. banks, but an improving rate picture and a pickup in lending has improved the outlook for deployment of excess deposits.

Banks over $50 billion in assets, in aggregate, reported a $157.32 billion increase in cash and equivalents in the third quarter, more than double the $70.38 billion increase in their securities holdings. Cash increases outpaced bond holdings growth at 15 of the 27 institutions. That is a switch from the second quarter, when most of the big banks added more securities than cash.

Long-term interest rates hit another trough during the third quarter, with 10-year Treasurys yielding 1.19% to 1.36% from the middle of July to the middle of August. But banks said the rise in rates late in the quarter — Treasury yields exited the period at about 1.5% — started to create more attractive opportunities, and the Federal Reserve's decision to taper its asset purchases at its early November meeting helped reinforce optimism for higher asset yields.

During earnings calls, banks expressed a range of views on securities investments, with some looking to put excess cash to work immediately and others saying they want to wait for rates to rise. There was a similar split on derivatives strategies, with some banks positioning for higher rates in the future and others locking in yields now. Some analysts argue the industry is not moving fast enough to deploy idle cash into higher-yielding assets.

"We came to the conclusion that banks should steadily be investing in their securities portfolio," said Michael Rose, an analyst at Raymond James. He pointed to an analysis his firm published in June that compared potential additional revenue from trading cash for bonds now against the upside implied by banks' interest rate model disclosures if they chose to preserve their asset sensitivity until rates rise. Some banks would take years to earn back the forgone bond earnings, the comparison found.

"In some cases, the math is super compelling for them, given the view that excess liquidity is probably going to stick around here for, I would say, the foreseeable future," Rose said.

Scott Hildenbrand, head of the financial strategies group at Piper Sandler, also said that banks have tended to be too conservative in buying securities. Most banks "will do better as rates rise," he said. The concern is that rates could stay range bound for some time. Adding bonds can generate revenue "while I wait for loan growth and mitigate waiting for the Fed to move [short-term] rates."

"Sitting in cash or buying a bond are not terribly different from a liquidity perspective," Hildenbrand said. "In many cases, we are buying liquid, pledge-able assets that are cash flowing, that we could sell and that we could pledge to raise money, if and when the pendulum swings on the deposit growth side and loan demand starts to outpace deposits again."

Call commentary

At the Big Four, period-end securities ranged from a sequential decline of 1.7% at Citigroup Inc. to 1.9% increases at Bank of America Corp. and Wells Fargo & Co. The behemoths continued to sound different messages on the risk-reward picture in bond markets.

BofA has executed the largest rotation into securities among the megabanks since the pandemic began, with its ratio of securities to assets jumping 11.6 percentage points from the end of 2019 to 42.1% at Sept. 30. Deposit inflows that have outpaced loan growth nevertheless left it with a ratio of cash to assets of 17.8%, only modestly down from 18.2% at the end of 2019 but still ahead of the big bank median of 13.6%.

"We have a lot of excess liquidity right now," said CFO Paul Donofrio on the company's earnings call, emphasizing that its low-cost deposits still mean the bank is asset-sensitive, particularly to rate increases at the short end of the curve.

Wells Fargo CFO Michael Santomassimo and JPMorgan Chase & Co. CFO Jeremy Barnum both said they were staying patient, citing upward pressure on rates from the outlooks for economic growth and inflation. At the same time, Santomassimo said Wells Fargo will take advantage of opportunities that present themselves, and Barnum said that yields have come closer to the bank's fundamental view on where they should be.

Some banks were categorical that rates have not yet increased enough to induce them to build their portfolios. Securities at Fifth Third Bancorp ticked down 0.5% sequentially to $38.89 billion and were just 5.4% higher than at the end of 2019. CFO James Leonard said the bank would continue to reinvest cash flows from the portfolio but that it would wait for yields to exceed 2% before deploying its cash.

Leonard also reiterated Fifth Third's guidance that it ultimately expects about one-third of its $30 billion of excess liquidity to fund loan growth, another third to move out of the bank into alternatives such as money market funds and the final third to move into the securities portfolio, which would raise its securities-to-assets ratio from about 18.7% to 23% to 25%.

Derivative dealing

Some banks looked to derivatives to prepare for the changing rate environment. Citizens Financial Group Inc.'s securities-to-assets ratio is near the same level as year-end 2019, and its cash-to-assets ratio has jumped from 2.2% to 7.5% over the same time. But the bank reported that it added about $3.75 billion of derivatives in the third quarter and the beginning of the fourth quarter under which it will receive fixed interest rate payments in exchange for floating rates.

It said the swaps were a more efficient way to "monetize" its asset sensitivity than adding bonds. It is also seeking to reduce its exposure to a fall in rates, especially with its acquisitions Investors Bancorp Inc. and a large chunk of HSBC Holdings PLC's retail operations in the U.S., which will increase its asset sensitivity further.

"Rates can go up, and we hope they do continue to go up, but they can go down as well," Vice Chairman and CFO John Woods said.

Huntington Bancshares Inc. and Regions Financial Corp. went in the opposite direction, with repositioned derivatives designed to gear them for higher rates.

Huntington said it added $6 billion of swaps under which it will be able to trade fixed interest rates in the future for floating ones. It also reduced its cash by $3.74 billion sequentially in the third quarter and boosted its securities portfolio by $3.72 billion, focusing on short-duration bonds.

"We're currently at about 22% securities as a percentage of assets, and we'd be comfortable if that rose modestly over time here given the acceptable returns we're seeing and the fact that it's accretive to [the net interest margin] versus holding that cash," said CFO Zachary Wasserman.

Regions said it terminated $5 billion of swaps under which it receives fixed interest rates and replaced them with shorter-term contracts.

"There's a little bit more probability of rates starting to rise towards the end of 2022. And we want to participate in that rate environment," CFO David Turner Jr. said.

The bank cut its securities by $352 million sequentially in the third quarter as its cash increased $1.91 billion.

"We acknowledge we have a lot of cash," Turner said. "We just right now want to be patient because we think if we're patient enough, there's going to be a better opportunity to put that cash to work."