At first glance, a recent shift in how some large banking companies are managing their balance sheets indicates bankers are optimistic that interest rates will not go any higher.
But observers disagree on whether the shift is a true rate play or simply an indication that bankers face fewer options when the yield curve is flat.
Recent filings show that both Bank of America Corp. and JPMorgan Chase & Co. appeared to have switched their balance sheets in the first quarter from being asset-sensitive — a position commonly seen in a rising rate environment — to being more liability-sensitive, analysts said. That means that liabilities, such as deposits, reprice faster than loans and could hurt earnings in a rising rate environment.
During its first-quarter earnings presentation in April, BB&T Corp. said that it is becoming less asset-sensitive.
However, some analysts said these companies likely are not betting that the Federal Reserve Board will lower rates or stop raising them soon. Last week the Fed said it had considered raising rates by 50 basis points at its May meeting, though instead it opted for a 25-basis-point hike. The increase was the Fed’s 16th since June 2004.
Some say it’s much more likely that the companies have simply run out of wiggle room on their balance sheets to deal with rising short-term rates and stubbornly low long-term rates.
David Hendler, an analyst with CreditSights Inc., has long argued that asset-liability management has been one of the most significant challenges for bank executives in recent quarters.
“You can’t get a boost from your mortgage-backed securities portfolio. You can’t get a boost from your interest rate swap position. You are not getting much yield there,” he said. “It’s just a bummer. There is nothing really to help you much.”
Bradley S. Adams, the head of investor relations at Fifth Third Bancorp, said in an interview May 26 that bank balance sheets reflect slower growth in home equity lines of credit, along with “rapidly decelerating deposit growth trends.” When bankers “plug those slower growth assumptions in their models, what is spit out is a more liability-sensitive position.”
His $105 billion-asset Cincinnati company struggled for several quarters with its sensitivity to rising rates, and some analysts said that it became even more liability-sensitive in the first quarter.
For now, Mr. Adams said, Fifth Third will continue to focus on raising core deposits and reduce its wholesale borrowings to deal with the current rate environment. “That is the only way” it can affect its rate sensitivity. “There is no trade that makes this an easy environment.”
But some bankers and analysts said the recent trend toward making balance sheets more liability-sensitive is a preparation for when the Fed is done raising rates.
“The largest U.S. banks have positioned their balance sheets to benefit from a pause in the Federal Reserve Board’s two-year-long series of increases in short-term interest rates,” David B. Hilder, a Bear, Stearns & Co. Inc. analyst, wrote in a report issued Thursday.
Andrew B. Collins of Piper Jaffray & Co. said companies that “have been asset-sensitive are taking some chips off the table.” After all, how much room does the Fed have left to raise rates, he asked.
JPMorgan Chase might be one of the companies slowly preparing for a change in Fed policy, Mr. Collins said.
During a May 15 dinner hosted by UBS AG, Michael J. Cavanagh, JPMorgan Chase’s chief financial officer, told investors that the $1.3 trillion-asset New York company had “a little bit more exposure to rising rates at the end of the first quarter than we had at the end of last year.”
Its balance sheet remains neutral to interest rate changes, though “a little less neutral than we were,” he said.
BB&T has been more explicit about its management style. “We’ve continued to reduce our asset sensitivity and move to a more neutral position in anticipation of the Fed nearing the end of the tightening cycle,” Christopher L. Henson, the $110 billion-asset Winston-Salem, N.C., company’s CFO, told investors during its first quarter earnings conference call April 20.
Keith Horowitz, a Citigroup Inc. analyst, wrote in a report issued May 12 that Securities and Exchange Commission filings showed the balance sheets at most large banking companies became more liability-sensitive and less asset-sensitive in the first quarter compared with the fourth quarter.
But analysts do not always agree on their interpretation of a company’s balance-sheet position.
Mr. Collins wrote in a note issued May 4 that Wachovia Corp. is neutral to rate changes, but Lori Appelbaum of Goldman, Sachs & Co. wrote in a note issued a day later that the $542 billion-asset Charlotte company “remains slightly liability-sensitive as Wachovia is positioning for the end of the rate cycle.”
Wachovia, like many other banking companies, said in its quarterly filing issued May 4 that it is naturally asset-sensitive and uses derivatives to hedge its balance sheet.
A Wachovia spokeswomen would not comment on the analyst reports.
However, Mr. Hendler said the company’s deal, announced May 7, to buy the Oakland thrift company Golden West Financial Corp. would give it a substantial portfolio of adjustable-rate mortgages — exactly the kind of assets a banking company would want when rates rise.
Those mortgages, whose yields will keep increasing long after the Fed has stopped raising rates, would boost Wachovia’s interest-earning assets, he said.
However, B of A and M&T Bank Corp. of Buffalo, are among the most liability-sensitive companies in his coverage, Mr. Horowitz wrote in his report.
As of March 31 a 100-basis-point increase in long- and short-term interest rates would shave $924 million off B of A’s net interest income, almost three times as much as it would have on Dec. 31, according to the Charlotte company’s 10-Q filing, filed May 9.
A yield curve flattening, through a 100-basis-point rise in short-term rates and a 100 basis point drop in long-term rates, would cost B of A $1.1 billion of net interest income, more than double the loss on Dec. 31. If rates moved the other way, the amounts would roughly reverse in both scenarios.
The increased vulnerability is partly the result of the Jan. 1 acquisition of MBNA Corp. The credit card lender brought consumer loans with attractive yields, but it had a liability-sensitive balance sheet, B of A said in its 10-Q filing issued May 9.
A spokesman for the $1.4 trillion-asset company would not discuss the matter further.
Several analysts consider B of A one of the most skilled banking companies in using derivatives and securities to hedge its balance sheet against rising interest rates. But it said in its filing that certificates of deposit and wholesale borrowings hurt its net interest margin when rates go up.
Edward Najarian, a Merrill Lynch & Co. analyst, wrote in a report issued May 26 that wholesale funds “should stop repricing upward when the Fed stops tightening, and B of A should be able to offset some of its extra deposit repricing pressure with solid growth in high-yielding credit card loans.”
Mr. Collins said JPMorgan Chase also might not suffer too much, despite a more liability-sensitive balance sheet. The position is unlikely to cause much damage to the company’s second-quarter earnings, he said. In fact, he expects its net interest margin to expand.
In a 10-Q filing issued May 8, JPMorgan Chase disclosed that a 100-basis-point rise in short- and long-term rates would reduce its net interest income by $272 million, compared with a $172 million gain on Dec. 31. Falling rates would have hurt JPMorgan Chase at yearend, but the company would now benefit.
Asked during the dinner whether it would shift its balance sheet to take advantage of a Fed change in rate policy, Mr. Cavanagh said that would depend on the reason the Fed stops raising rates.
“I think we’ll be cautious until we feel a greater degree of conviction” about the reason, he said.
Mr. Adams was skeptical about whether a shift in balance sheet management to reflect a change in Fed policy is in order. Fifth Third’s assessment of the forward yield curve, a measure used to model rate sensitivity, “is indicating a flat [yield] curve for the remainder of the year.”
According to Mr. Hendler, to make a fully liability-sensitive position worthwhile, the Fed would have to reduce rates rather than stopping its increases.
And a drop in rates might still be far off, he said. “It is not going to turn the ship by the right angle in one month.”
