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Why regional banks are now willing to take on billions in losses
More regional banks in the U.S. are taking a step that was unthinkable more than a year ago, following the failure of Silicon Valley Bank: selling underwater bonds at a loss.
When Silicon Valley Bank did this, caused panic among investors and depositors.
The difference this time is that regional banks aren’t selling lower-yielding bonds to pay depositors. Instead, they’re bracing for interest-rate cuts from 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 money from those sales is being used to buy new bonds that lenders hope will perform well as rates fall in the coming months or years. The Fed should start cutting rates as early as September.
“If they have extra cash, bank treasurers who think we’re at the top of the cycle may decide to go ahead and secure long-duration bonds so that when we get into a lower rate environment they still have a decent yield,” said Feddie Strickland, equity research analyst at Hovde Group.
Locking the ‘swoosh’
Regional banks that have announced bond sales in recent weeks include Pittsburgh-based PNC Financial Services Group and Charlotte-based Truist (TFC), two of the 10 largest U.S. lenders, along with Regions (RF) and Webster (AND AP). More people are expected to do the same.
PNC suffered losses of half a billion dollars on its bond sales and reinvested the proceeds in bonds with yields “approximately 400 basis points higher than the bonds sold,” according to the bank.
The logo of PNC Bank on the window of a branch in Washington, April 30, 2023. (REUTERS/Ashraf Fahim/File Photo) (REUTERS/Reuters)
That boosted the bank’s confidence that it would reap a record amount of net interest income next year. Net interest income measures the difference between what a bank earns on its assets and pays out on its deposits — a critical source of revenue for any regional bank.
An analyst on PNC’s second-quarter earnings call said the year-ahead increase looked like Nike’s “swoosh” logo.
“Basically what we did was block out part of the swoosh,” PNC CFO Robert Reilly told analysts.
PNC’s decision to take losses on bonds didn’t impact earnings thanks to a one-time stock gain booked on its Visa holdings.
Other banks are choosing to take those bond losses even when they can’t offset them with one-off quarterly gains.
Truist suffered a $5.1 billion after-tax loss when it sold bonds that yielded just 2.80%.
It used some of the proceeds — $29.3 billion — to buy new bonds yielding 5.27%. The bank now expects its net interest income to be 2% to 3% higher next quarter.
Truist is a Charlotte-based regional bank with a large presence in the southeastern U.S. (Jakub Porzycki/NurPhoto via Getty Images) (NurPhoto via Getty Images)
The regions also took a $50 million pre-tax loss to replace approximately $1 billion in bonds.
The story continues
The Birmingham, Alabama-based bank’s CFO, David Turner, called the “repositioning” move a “good use of capital” and said Regions may look for opportunities to make more bond sales.
Another bank that sold some underwater securities was Stamford, Conn.-based Webster. It posted an after-tax loss of $38.7 million in the quarter when it realized the losses.
Despite replacing more securities with higher-yielding ones, the bank cut its net interest income expectations for the year by $60 million to $80 million, anticipating higher deposit costs and lower yields on its loans.
“We missed the mark on guidance, obviously, and we’re not happy about that,” Webster CFO Glenn MacInnes 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 thorny challenge for many regional lenders still struggling with high deposit costs, troubled borrowers and weak profits.
A reminder of those challenges emerged again this week when commercial real estate lender New York Community Bancorp reported a second-quarter loss, the sale of a mortgage servicing business and revealed that it had added more to its reserves for future loan losses.
Its shares fell Thursday after reporting the loss but rebounded Friday. It remains one of the worst-performing stocks of the year, a sign that investors are still concerned about some regional banks’ exposure to weaknesses in the commercial real estate market.
The hope among many regional banks is that loans on banks’ balance sheets will regain their value as rates fall, and that deposit costs could also fall.
“When the rate cycle changes, that will have a big impact on the profitability story,” said Moody’s Ratings analyst Megan Fox.
How these dynamics play out will vary greatly across banks. So buying new bonds now is one of the safest bets lenders can make ahead of the cuts they expect to happen.
David Hollerith is a senior reporter at Yahoo Finance covering banking, cryptocurrencies, and other areas of finance.
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