Looking at the prospect of lower interest rates, many banks increased their exposure to longer-dated bonds in the second quarter.
Long-term rates plunged during the first half amid growing fears of a recession emerging. Short-term rates held steady in the first half, leaving the yield curve inverted, but by June, the market expected the Federal Reserve to begin cutting short-term rates soon. The central bank delivered on rate cuts in the third quarter, and long-term rates have headed lower as well, leaving bank managers with fewer opportunities to put cash to work at attractive yields.
Banks that kept their powder dry or increased their exposure to shorter-dated assets in recent quarters now are faced with the prospect of investing at lower rates, including at the front of the yield curve. The Fed cut its target fed funds rate twice in the third quarter, and many economists see additional cuts on the horizon, suggesting that higher-yielding opportunities could be tougher to find.

Many banks prepared for that prospect by reaching further out the curve for yield and increasing their exposure to longer-dated bonds in the second quarter. Bonds expected to reprice or mature in more than 15 years represented 33.4% of bank-held securities at the end of the second quarter, up from 32.1% in the prior quarter and 31.7% in the year-ago period. The exposure is considerably higher than four years ago, when the securities equated to 24.4% at the end of the second quarter of 2015.
Long-term rates have fallen close to 150 basis points since the recent peak in November 2018. While much of the decline came in the first half of 2019, long-term rates have fallen further since the end of the second quarter, with the yield on the 10-year Treasury trading from the 2% level to as low as 1.47% against the backdrop of the trade war between the U.S. and China and slowing global economic growth. In September, the 10-year Treasury yield traded at a level not seen since summer 2016 in the aftermath of Britain's decision to leave the European Union.
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 September installment of that survey, economists expected the 10-year to hit 1.69% in December and average 1.83% in 2020.


The futures market expects short-term rates to move even lower in the near future, pegging more than a 60% probability of the Fed cutting rates at least once before year-end 2019. Lower rates would pile onto existing income pressures weighing on investment portfolios. Institutions that reached further out the curve in recent quarters might not face the same pressure as others, 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 second quarter were smaller institutions. Fifteen of the top 20 banks that reported the largest growth from year-ago levels had less than $10 billion in assets. However, a number of institutions with more than $25 billion in assets — Texas Capital Bancshares Inc. unit Texas Capital Bank NA, TCF Financial Corp. unit TCF National Bank, Barclays PLC unit Barclays Bank Delaware, and Synovus Financial Corp. unit Synovus Bank — were among the banks reporting the biggest year-over-year increase in longer-dated bonds.
Still, banks have not put all their funds to work on the long end of the curve. 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 29.3% of total securities held, up from 28.3% in the prior quarter, but up considerably from 26.1% in the year-ago period.

