An increased appetite for government debt helped KeyCorp post a higher-than-expected third-quarter profit.
The Cleveland-based lender was among a handful of deposit-rich regional banks that used excess liquidity for a buying spree of short-term mortgage bonds issued by Fannie Mae and Freddie Mac.
These types of bonds — which mature in two to three years — only offer a modest yield, particularly with interest rates so low. But in an environment where borrowers aren't borrowing, even a modest yield is better than no yield. Also, their short duration mitigates interest rate risks facing Key and other bond-hungry banks like Huntington Bancshares Inc. and PNC Financial Services Group Inc.
"They're keeping it short," said Terry McEvoy, a managing director and regional bank analyst with Oppenheimer & Co. Inc. "They don't want to make an interest rate bet. They want to protect themselves when rates go up. Taking very little credit risk and very little interest rate risk."
Higher interest from a swelling securities book boosted Key's income and net margins, making it one of the few banks to grow revenue, the company said Friday. A better top line — combined with a big release of credit reserves on lower business loan losses — helped Key earn $178 million, its second straight profitable quarter after a long spell of losses.
Key, like Huntington and PNC, is buying securities to replace declining loan and fee income. It's not a new strategy. But the rate of increases at these companies was notable, as was the amount of detail they disclosed about the exact types of assets they were buying. All three said they favored short-term, government-backed housing bonds. KeyCorp's securities book was up 17% from the prior quarter and 67% from a year earlier, to $20.2 billion. That was about 22% of all its assets. PNC's securities, meanwhile, were up 18% from the prior quarter to $63 billion. Huntington's rose 6%, $9.2 billion.
Interest rate changes are a risk for any bank with lots of securities, because a rate increase could force deposit rates to rise faster than rates on earning assets. That spread is the bread and butter of banking.
These companies are counting on rates staying low for the foreseeable future while counting on short maturities to protect them when they do.
"Staying short is clearly important. We've said frequently — we don't want to risk the capital of the company in a bond trade," PNC's chairman and chief executive, James E. Rohr, said Thursday in a call with analysts.
Key, for one, said it has so much extra cash from swelling deposits that it has plenty of liquidity for making loans should demand pick up. At that point it would likely let securities mature, using the proceeds for lending rather than purchasing more securities.
"We have that stored liquidity to meet future loan demand. We do expect future loan demand in the organization," Henry Meyer, Key's chairman and chief executive, said in a call with analysts Friday. "But the overall size have the investment portfolio may not change materially from where it is."
Securities are inferior to loans when it comes to income, and they've become less profitable rates decline. That's something bankers are mindful of.
"We're not trying to sort of lever up by growing investments," Huntington's chief executive, Stephen Steinour, said in an interview Thursday.
"We're growing loans as fast as we can," Steinour said. "We'd love to grow them faster so we don't have to invest [deposits] in securities. … If we could make more loans, we'd prefer to do that."
KeyCorp's $52.6 billion in loans yielded 4.95% last quarter, generating interest of $656 million. The yield on its $20.3 billion in securities was 3.43%, bringing in interest of $170 million. They yielded 3.63% in the prior quarter and 4% a year earlier.