In a move that was unthinkable just a year ago, US regional banks are now selling underwater bonds at a loss. This strategic decision comes in the aftermath of the Silicon Valley Bank failure, which had previously triggered panic among investors and depositors. However, the current landscape sees these banks not selling lower-yielding securities to pay depositors but rather preparing for anticipated interest rate cuts from the Federal Reserve.
Adjusting to the New Financial Landscape
Unlike the past, regional banks are now redirecting cash from these bond sales to buy new bonds that are expected to perform better as interest rates decline in the coming months or years. The Federal Reserve is anticipated to start cutting rates as early as September. As Feddie Strickland, an equity research analyst with Hovde Group, explains, “If they’ve got 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 still have a decent yield.”
Locking in ‘the Swoosh’
Several regional banks, including Pittsburgh-based PNC Financial Services Group and Charlotte-based Truist (NYSE:TFC), have announced bond sales in recent weeks. Other notable banks include Regions (NYSE:RF) and Webster (NYSE:WBS). These banks are expected to continue this trend.
PNC took a half-billion dollars in losses on its bond sales and reinvested the proceeds into securities with yields approximately 400 basis points higher than the securities sold. This strategic move increased the bank’s confidence in achieving a record amount of net interest income next year. Such income is critical for regional banks as it measures the difference between what a bank earns from its assets and pays out on its deposits.
An analyst on PNC’s second-quarter earnings call likened the anticipated income growth over the next year to Nike’s “swoosh” logo. PNC CFO Robert Reilly remarked, “Essentially, what we’ve done is locked in some of the swoosh.” Notably, PNC’s decision to realize bond losses did not impact earnings due to a one-time stock gain from its Visa (NYSE:V) holdings.
Strategic Moves Amidst Losses
Other banks, such as Truist, are taking bond losses without offsetting them with one-time quarterly gains. Truist incurred a $5.1 billion after-tax loss when it sold bonds that yielded a mere 2.80%. The proceeds, amounting to $29.3 billion, were used to purchase new bonds yielding 5.27%. This move is expected to boost the bank’s net interest income by 2% to 3% in the upcoming quarter.
Regions also took a $50 million pre-tax loss to replace approximately $1 billion of bonds. David Turner, CFO of the Birmingham, Ala.-based bank, described the “repositioning” as a “good use of capital” and indicated that Regions might pursue more bond sales in the future.
Webster, based in Stamford, Conn., realized a $38.7 million after-tax loss in the quarter from its bond sales. Despite replacing its bonds with higher-yielding ones, the bank lowered its net interest income expectations for the year by $60 million to $80 million, citing higher deposit costs and lower loan yields. Webster CFO Glenn MacInnes candidly admitted, “We missed the mark on the guidance, obviously, and we’re not pleased with it.”
Anticipating Rate Changes
Not all regional banks are taking these steps, and the future direction of interest rates remains a significant challenge for many. High deposit costs, troubled borrowers, and lackluster profits continue to affect regional lenders. This week, commercial real estate lender New York Community Bancorp (NYSE:NYCB) reported a second-quarter loss, the sale of a mortgage-servicing business, and increased reserves for future loan losses, reflecting ongoing challenges.
The hope for many regional banks is that as rates come down, the loans on their balance sheets will recover value and deposit costs will decrease. Moody’s Ratings analyst Megan Fox notes, “When the rate cycle changes is going to have a big impact on what the profitability story looks like.” As such, buying new bonds now is one of the most strategic moves regional banks can make in anticipation of the expected interest rate cuts.
Featured Image: Freepik
