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US banks reaching further out yield curve in the face of lower rates

As the interest rate cycle shifted once again, many banks continued to increase their exposure to longer-dated bonds in the third quarter.

Long-term rates fell notably throughout 2019 amid fears of slowing economic growth. The Federal Reserve has changed its posture as well, moving from a tightening to an easing cycle, with a trio of rate cuts in the second half of the year.

The lower-rate environment has left bank managers with fewer opportunities to put cash to work at attractive yields, and institutions have responded in kind, adding exposure to the long end of the yield curve.

Bonds expected to reprice or mature in more than 15 years represented 34.40% of bank-held securities at the end of the third quarter, up from 33.43% in the prior quarter and 31.73% in the year-ago period.

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Over the last few years, banks have steadily increased their exposure to the long end of the yield curve. Four years ago, securities expected to reprice or mature in more than 15 years equated to 25.09% of bank-held securities at the end of the third quarter of 2015.

Banks that reached further out the curve more recently mitigated some pressure from having to reinvest maturing bonds at lower rates. Long-term rates have fallen more than 125 basis points since the recent peak in November 2018. While much of the decline came in the first half of 2019, the yield on the 10-year Treasury has traded below 2% for much of the second half of 2019, breaching a level not seen since 2016.

Throughout 2019, economists have consistently lowered their outlook for long-term rates, but forecasts heading into the third quarter still failed to predict the sharp decline in rates. Economists surveyed by The Wall Street Journal in June expected the 10-year Treasury to trade at 2.34% in December and to average 2.42% in 2020. By the December installment of that survey, economists expected the 10-year to hit 1.84% in December and average 1.83% in 2020.

Economists do not expect much of an increase in long-term rates for the foreseeable future, and the future markets expect the Fed to remain on hold at least through the first half of 2020. A return of persistently low rates would add to existing pressures on net interest margins as many earning-asset yields began to decline in the third quarter, while deposit costs continued to inch higher.

Increased exposure to longer-dated bonds could help combat that risk, at least in the short term.

Most of the banks reporting the greatest year-over-year increase in exposure to longer-dated bonds in the third quarter were smaller institutions. Fifteen of the top 20 banks that reported the largest growth from year-ago levels had less than $5 billion in assets. However, two institutions with more than $45 billion in assets — United Services Automobile Association's USAA Federal Savings Bank and Synovus Financial Corp. unit Synovus Bank— were among the banks reporting the biggest year-over-year increase in longer-dated bonds.

Still, many institutions seem to be taking a barbell approach, adding exposure to shorter-term securities as well. The banking industry as a whole continued to increase its exposure to securities expected to mature or reprice in less than three years. Such bonds represented 29.94% of total securities held, up modestly from 29.27% in the prior quarter, but up considerably from 26.74% in the year-ago period.

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