In the wake of the Silicon Valley bank failure, a growing number of regional U.S. banks are taking steps that would have been unthinkable more than a year ago. The idea is to sell underwater bonds at a loss.
When Silicon Valley Bank did this, it caused panic among investors and depositors.
The difference this time is that local banks aren’t selling low-yield securities to pay depositors. Instead, they are bracing for interest rate cuts by the Federal Reserve.
Silicon Valley Bank’s headquarters in Santa Clara, California, after the lender was seized by regulators in March 2023. (Reuters/Brittany Hosea-Small) (Reuters/Reuters)
Some of the cash from those sales is being used to buy new bonds that lenders hope will perform well as interest rates fall in the coming months and years. The Fed is expected to start cutting interest rates as early as September.
“If they have extra cash, bank tellers who believe we are at the top of the economic cycle will be able to secure long-term debt even after we enter a low interest rate environment. It’s a decent yield,” said Fedi Strickland, equity research analyst at Hovde Group.
Fixing the “Swoosh”
Regional banks that have announced bond sales in recent weeks include Pittsburgh-based PNC Financial Services Group and Charlotte-based Trust (TFC), which are leading the charge for Regions (RF) and Webb. Along with Star (WBS), it ranks among the top 10 major financial institutions in the United States. We expect more people to do the same.
The bank said PNC lost $500 million on the bond sale and reinvested the proceeds in securities yielding “approximately 400 basis points higher than the securities sold.”
PNC Bank logo on a branch window in Washington, April 30, 2023. (Reuters/Ashraf Fahim/File Photo) (Reuters/Reuters)
This increased confidence that the bank would earn record net interest income next year. Such income measures the difference between the income a bank earns from its assets and the amount it pays out on deposits, and is an important source of income for local banks.
One analyst who attended PNC’s second-quarter earnings call said the rate of increase over the next 12 months is similar to Nike’s “swoosh” logo.
“Essentially, what we’ve done is lock in some Swoosh,” PNC Chief Financial Officer Robert Riley told analysts.
PNC’s decision to recognize a bond loss did not impact its earnings as it recorded a temporary equity gain from its Visa (V) holdings.
Other banks choose to accept these bond losses, even if they cannot be offset by one-off quarterly gains.
The trust sold bonds yielding just 2.80%, resulting in an after-tax loss of $5.1 billion.
A portion of the proceeds ($29.3 billion) was used to purchase new bonds with a yield of 5.27%. The bank now expects net interest income to increase 2-3% in the next quarter.
Truist is a Charlotte-based regional bank with a large presence in the southeastern United States. (Jakub Porzycki/NurPhoto via Getty Images) (NurPhoto via Getty Images)
The region also incurred a pre-tax loss of $50 million to replace approximately $1 billion in bonds.
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David Turner, the Birmingham, Alabama-based bank’s chief financial officer, called the “repositioning” move “a good use of capital,” and Regions will explore additional bond sales opportunities. He said it was possible.
Another bank that sold some underwater bonds is Stamford, Conn.-based Webster Bank. The bank incurred an after-tax loss of $38.7 million in the quarter due to the realization of these losses.
The bank lowered its annual net interest income forecast by $60 million to $80 million, anticipating higher deposit costs and lower loan yields, even as it replaced more bonds with higher-yield bonds.
“Obviously we’ve strayed from our guidance and we’re not satisfied,” Webster CEO John Ciulla told analysts on Tuesday.
When the rate cycle changes
Not all regional banks are making such moves. And the direction of interest rates remains a thorn in the side of many regional lenders, which continue to struggle with high deposit costs, borrower problems and weak profits.
This week, commercial real estate lender New York Community Bancorp (NYCB) reported a second-quarter loss and the sale of its mortgage servicing business, and said it had increased reserves for future loan losses. This reminded me of these issues again. .
The company’s stock fell on Thursday after reporting a loss, but recovered on Friday. The stock remains one of the year’s worst performers, showing investors remain concerned about the exposure of some regional banks to weaknesses in commercial real estate.
The hope for many local banks is that as interest rates return, the value of loans on banks’ balance sheets will recover, potentially lowering the cost of deposits.
“When the interest rate cycle changes will have a significant impact on the outlook for profitability,” said Moody’s Ratings analyst Megan Fox.
How these dynamics play out remains very different from bank to bank. So buying new bonds now is one of the surest bets financial institutions can make ahead of an expected rate cut.
Correction: A previous version of this article attributed Webster CFO Glenn MacInnes to Webster CEO John Ciulla. We apologize for the error.
David Hollerith is a senior reporter at Yahoo Finance, covering banking, cryptocurrencies, and other financial areas.
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