Bank Debt Already Reflects Lower Rates
The happy prospect of refinancing long-term debt at much lower rates will not produce a sharp drop in banks' interest expense, experts warn.
Most banks used interest rate swaps to convert a large portion of their fixed-rate interest payments on old debt to floating-rate obligations, so they have already reaped savings as interest rates have fallen over the past year.
Banks "won't have any real savings because they swapped into floating rate interest payments," said Matthew J. Grayson, a vice president at Salomon Brothers. "They are already paying low rates. These are the times they were hoping for" when they entered into the swap contracts in the expectation that interest rates would fall.
Yield Premium Rises
Moreover, as banks' asset quality has deteriorated, the yield premium they would have to pay for new debt has increased. Investors perceive many large banks as riskier credits, so they demand interest payments at a greater premium to Treasury rates.
In effect, while Treasury rates have fallen sharply, the decline in rates on many banks' debt has been more moderate.
For example, Citicorp's 9.75% subordinated capital notes due in 1999 were trading at rates 150 basis points over Treasuries in May 1990. These days, they change hands at rates closer to 310 basis points over Treasuries.
"There may be one or two banks that have difficulty [rolling over their debt] cheaply," said Mara Hilderman, an analyst at Moody's Investors Service.
$10.6 Billion in Debt
At midyear, the 10 banks with the most debt maturing had $10.6 billion in long-term funding coming due, according to regulatory filings.
The good news: replacing that debt with new issues will cost relatively little at today's low rates. Ten-year Treasuries now yield 7.38%, compared with 8.6% in May 1990.
But many banks' maturing issues already cost the banks little, because banks have converted their fixed-rate interest payments into floating-rate payments. As a result, the banks' interest costs have dropped as overall market rates have fallen.
"To the extent they've swapped into floating, they've benefited a great deal," said Steven Schwimmer, a managing director at Fuji Capital Markets.
Move to the Floating Rate
Experts estimate that banks were swapping interest payments on about half their fixed-rate debt during the late 1980s, when interest rates were higher.
Bankers Trust New York Corp. is a case in point. It had $2.6 billion in long-term debt outstanding at midyear. Roughly 10% of that was issued with floating-rate interest payments, and nearly $1 billion of the remainder was converted into floating-rate debt through swaps.
As a result, it is already paying low rates on a large proportion of its debt.
At Republic New York Corp., "in the last year, we've swapped a fair amount," said treasurer Thomas Robards. The swaps were initiated because Republic believed interest rates would fall, and because it wanted to use floating-rate liabilities to fund its many floating-rate assets.
Due for Redemption
Long-term debt of selected bank holding companies and their subsidiaries, as of June 30 Maturing within Total a year (in billions) (in billions)Citicorp $22.4 $3.99J.P. Morgan 6.1 1.51
Pacific 10.0 1.46
ChaseManhattan 6.9 0.75Wells Fargo 3.7 0.73First Chicago 3.3 0.63
Interstate 3.2 0.50
ManufacturersHanover 2.7 0.37Bankers Trust 2.6 0.36
Banking 3.4 0.33
Source: Automatic Data Processing