Bank of America May See Bond Hit; Citi Looks Safe: Analyst
Bank of America is one of three large-capitalization banks that could face earnings pressure from the recent rally in five-year and 10-year U.S. Treasurys, while Citigroup and Huntington Bancshares “seem least exposed near term” to negative impacts from the rally, according to a recent report from Deutsche Bank.
Yields on 10-year U.S. government bonds had fallen from 2.18 percent at the start of the second quarter to record lows of 1.50 percent as of Friday morning. Five-year Treasury yields fell from 1.01 percent to 0.61 percent over the same period.
The decline in interest rates threatens to pressure banks’ net interest margins (NIM) — the difference between what it costs them to borrow and what they can earn on their loans, according to the report from analyst Matt O’Connor.
Banks holding high-yielding securities face a risk to their NIMs because as those securities mature, the banks are forced to reinvest at lower yields. Also at risk of lower NIMs are banks with a high concentration of bonds backed by pools of residential mortgages that are guaranteed by U.S. government agencies, such as Fannie Mae or Freddie Mac. Those bonds, known as agency RMBS, tend to mature earlier than anticipated as borrowers take advantage of lower interest rates to refinance their mortgages.
According to O’Connor’s research, however, all the banks that stand out as holding high yielding securities do not have a high concentration of agency RMBS. And the ones with a high concentration of agency RMBS don’t own lots of high-yielding bonds. The translation, then is that (at least by these measures) no large-cap banks face a high near-term threat to their NIMs. However, O’Connor singles out Citigroup and Huntington as being in particularly good shape by both of these measures relative to their peers.
Still, O’Connor singles out Bank of America , Regions Financial, and SunTrust Banks as institutions he covers that could see a hit to their NIMs. That’s because he believes they more than others have paid a premium for mortgage bonds, taking the extra cost out of their net interest income over time. However, if the bonds pay off more quickly than anticipated (due to refinancing at lower rates) that causes a hit to net interest income, as the premium must be amortized over a shorter period.
O’Connor isn’t 100 percent sure which banks fall into this last category, however.
“Most [banks] don’t disclose how much (if any) bonds were purchased at a premium — so it’s difficult to know for sure,” he writes.
—By TheStreet.com’s Dan Freed
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