Kevin Kabat, CEO at Fifth Third, Ohio’s largest bank, and BB&T’s Kelly King told a New York investor conference Tuesday they have a chance to reinvest fresh cash from lower-yielding investments as government debt pays the most since 2011. Unlike JPMorgan Chase & Co. or Bank of America Corp., the two biggest U.S. lenders, their firms hold fewer securities subject to markdowns as long-term rates rise.
Higher rates would help bring relief to bankers who’ve seen lending margins squeezed and expenses pushed up by new technology and regulations. The Federal Open Market Committee is debating whether the economy is strong enough to justify reducing the central bank’s monthly purchases of about $85 billion in bonds, a maneuver that was intended to stimulate growth by keeping borrowing costs low.
“If you’re a bank that takes in deposits and lends money out, you’re probably going to appreciate a steeper curve more than an institution that focuses more on trading,” Scott Warman, treasurer of Buffalo-based M&T Bank Corp., said in an interview last week.
A yield curve charts interest rates for loans of different lengths of time. A steeper curve creates more of a “spread” or profit margin for banks between what they pay for short-term deposits and the longer-term yields they earn on lending and investments.
“We’re clearly heading for a steeper yield curve that’s going to give reinvestment opportunities,” King said at Tuesday’s Barclays Global Financial Services Conference.
While some bigger banks may suffer in the short term from writedowns, they’re also expecting to gain like their smaller rivals from wider margins and more interest income as rates improve.
“We will benefit as we have lower-yielding assets burn off, and we replace them with higher-yielding assets,” Thomas P. Gibbons, finance chief at Bank of New York Mellon Corp., told the Barclays conference Tuesday.
Smaller banks have outperformed the largest lenders since midyear. The KBW Bank Index, comprised of the 24 biggest firms, gained 2.85% this quarter through last week. The 50-company KBW Regional Banking Index added 4.95% and the 391-company Nasdaq Bank Index, which includes smaller community lenders, rose 3.65%.
Fifth Third, based in Cincinnati, gained 22% this year. BB&T, based in Winston-Salem, N.C., added 16% and Birmingham-based Regions advanced 35%.
Regional bank profits have been bolstered by lenders taking back money from reserves that had been intended to cover future losses. Now that the economy has improved and overdue loans have dropped, the 11 biggest regional lenders have booked $1.36 billion in reserve releases in the first half of 2013, compared with $865 million in the year-earlier period, according to data compiled by Bloomberg. That helped their collective first-half earnings climb 21% from the year earlier.
Rising rates won’t necessarily mean higher profit growth, according to Chris Mutascio, an analyst at Stifel Financial Corp.’s KBW unit. With economic growth running at a modest pace, banks might struggle to increase lending in the coming quarters, and rising interest rates are already cutting into mortgage revenue as refinancing drops, he said.
The question for bankers is whether they can make the transition from growth that’s powered by tapping reserves to growth that reflects better lending and margins once the economy and short-term rates improve, he said. Investors may be reacting too soon by bidding up bank stocks now, he said.
“We’re pricing in this net interest margin expansion that may not be till two years from now,” he said.