Are bank balance sheets really as prepared for interest rate increases as bankers claim? Some recent analysis says no, implying that profit margins may continue to be squeezed.
Peter Winter and Lana Chan of Mony Group Inc.’s Advest Inc. said in a research report issued Wednesday that though many banking companies have made a show of shifting assets, most will not generate profits from a rate rise.
The view earlier this year was that rising rates would help widen net interest margins, which have been squeezed painfully over the past two years. But analysts and investors say that widening is becoming less likely this year.
“While a lot of banks say they’re asset-sensitive, we haven’t seen it yet from the second quarter,” said David Hendler, an analyst with CreditSights Inc., in a recent American Banker roundtable discussion.
“It may filter over the next couple of quarters,” he said, but for most of this year bankers have taken advantage of spreads from a steep yield curve and did too little, too late to accommodate rising rates.
“I’d agree that they are not as asset-sensitive as they think they are,” said Nancy A. Bush, who runs her own research firm, NAB Research LLC, in Annandale, N.J. “Most of the big banks are closer to neutral or actually slightly more liability-sensitive than they would have us believe. But I must also say: The ability of these companies to move these balance sheets around in a pretty short time and at a relatively immaterial cost is pretty remarkable, and I don’t think we’re looking at a replay of the 1993-1994 interest rate debacle.”
Most banking companies are naturally liability-sensitive; when interest rates rise, the rates bankers pay for deposits change faster than those they charge on loans. When long-term rates started climbing earlier this year, many banks began hedging their balance sheets in an effort to at least get to neutral or be more asset-sensitive.
But some companies actually became less asset-sensitive in the second quarter, according to Advest’s report. They include San Francisco’s UnionBanCal Corp. (mostly owned by Mitsubishi Tokyo Financial Group Inc.), Houston’s Sterling Bancshares Inc. and Southwest Bancorp of Texas Inc.; and East West Bancorp Inc. in San Marino, Calif., which is among the most asset-sensitive banks Advest follows, it said.
Of course, interest rates themselves have been in flux. Long-term rates rose strongly earlier this year only to fall back, and short-term rates have risen a total of 50 basis points, to 1.5%. The yield curve flattened as a result.
Fed Chairman Alan Greenspan told Congress last week that the economy “hit a soft patch” in the late spring but has shown improvement.
Bank projections of rising rates’ effects include assumptions about loan demand that may have been too optimistic.
Hilary Hayes a portfolio manager with KeyCorp’s Victory SBSF Capital Management, said in an interview that her hopes for stronger loan demand have faded. She expressed doubt that bank customers would continue to add deposits instead of putting their money in the stock market or other investments.
In addition, most analysts and bankers say that lending competition is stiff and that bankers have to lure borrowers with low interest rates, putting more pressure on net interest margins. Ms. Hayes said she expects margins to fall in the third quarter and possibly rise in the fourth — but not by much.
Analysts at Swiss Reinsurance Co.’s Fox-Pitt, Kelton Inc. said in a research report released Thursday that Wall Street’s expectations for interest margins “could prove to be too aggressive.” And, it said, “banks have little flexibility to lower their funding costs from current levels.”
Advest’s Ms. Chan and Mr. Winter wrote that they expected net interest margins to remain flat for the rest of the year, “with a few basis points of expansion in 2005.”
Trying to figure out how banks arrive at their projections for margin expansion or contraction is tricky because they all use different criteria, which many do not fully explain.
“There are only a couple of banks that really tell you what their assumptions are,” and even those do not say what loan and deposit growth they factored into their calculations, said Ms. Hayes at Victory SBSF.
To the surprise of some on Wall Street, a few companies, including Fifth Third Bancorp of Cincinnati, remain stubbornly liability-sensitive. After the company’s second-quarter earnings report July 15, Mark Graf, its chief financial officer, said in an interview that its balance-sheet positioning “really is a function of our business model and our business mix.”
Fifth Third, despite strong commercial loan growth, is mainly a retail banking company, and its assets reprice more slowly than other banks’.
“We have taken some continuous actions to reposition that a little bit and make ourselves less liability-sensitive. … It is fair to say that we haven’t finished that process yet,” Mr. Graf said. On Friday, Fifth Third disclosed in its midquarter update that it had terminated $2.2 billion of swaps and was focusing more on attracting deposits, reducing wholesale funding, and selling securities. (See story on page 19.)
Though that will put pressure on spreads, it prepares the company for rising rates. Mr. Winter at Advest said he still considers Fifth Third liability-sensitive.
Wachovia Corp. said in its second-quarter 2003 10-Q filing that earnings would suffer when the Federal Reserve increased interest rates. But in its filing in this year’s second-quarter, the Charlotte company said profits would rise 1.8% if the Fed funds rate climbed to 3%.
Wachovia’s analysis of its asset and liability sensitivity consists of three pages of tight text, which Mr. Hendler at CreditSights called “esoteric.” One sentence read: “As economic conditions improve and loan demand increases, we expect to rely to a large extent on our large base of low-cost core deposits to fund lending activities.”
Such generalizations are the rule among banks, and analysts say that is part of the problem in assessing companies’ sensitivity. How much loan and deposit growth bankers expect is a crucial gauge of how profit margins might change when rates rise. Their models include assumptions that short- and long-term rates rise simultaneously, which analysts say rarely happens.
“A lot of that’s based on asset assumptions that are not clear will pan out, such as more robust commercial loan growth,” Mr. Hendler said. “It’s a tricky area.”
