Though others may feel no need for such drastic measures as Fifth Third Bancorp announced last week to prepare its balance sheet for rising rates, banking companies are clearly looking differently at their investment portfolios.
After the market close Thursday the Cincinnati company said it would reposition and take a $340 million charge this quarter to do so. The restructuring includes selling about $6.5 billion of its securities portfolio, about 20% of the third-quarter balance.
The plans would shave $6 billion from an asset base of $98.3 billion and dramatically reduce fourth-quarter earnings.
Observers say Fifth Third got into this game rather late. Since early last year many banks have repositioned their balance sheets to make sure assets reprice faster than liabilities as rates rise.
Fifth Third, on the other hand, has remained liability-sensitive - that is, its liabilities repriced faster than its assets - until now.
Matthew O'Connor, an analyst with UBS Investment Research, wrote in a report Thursday that it is unlikely more banks will restructure their balance sheets in the near-term.
However, he cautioned that the environment could become more difficult - with higher rates, slowing deposit growth, and higher credit costs. If that happens "we'd expect more charges," he said. More banks would restructure because deposits would have to be replaced with higher-cost short-term borrowings - and spreads on fixed-rate assets would probably drop.
Banks use their securities portfolios to fund loan growth and generate cash flow to reinvest in higher-yielding securities as short-term rates and Treasury yields rise and as loan demand picks up.
"The portfolio is there to provide liquidity," said Jeff Aberdeen, the controller of Commerce Bancshares Inc. of Kansas City, Mo. "As the economy expands, we see that being funded out of the bond portfolio," he said.
At the end of the third quarter 33.76% of the company's assets were securities. Mr. Aberdeen predicted in an interview that if its loan portfolio grows by 7% to 8%, half to three quarters of that growth will probably come out of the securities portfolio.
In a report earlier last week from Keefe, Bruyette & Woods Inc., analysts said that on balance the industry has had a long time to adjust for an upward trend in interest rates.
However, the report said, "We believe there will be mixed performances in the industry, and that companies with a high proportion of earning assets in securities and those that have funded that expansion with borrowings have a greater chance of experiencing margin challenges."
Denis Laplante, a Keefe Bruyette analyst, said that as short-term rates continue to rise and loan demand picks up, the industry is likely to migrate from fixed-rate to floating-rate securities. Banks might not sell their portfolios but would be more inclined to reinvest the cash they generate each month, he said.
Mr. Laplante also said that the trends in banks' securities portfolios will reflect the pace of loan growth. He expects good consumer loan growth again next year and a slight acceleration in commercial and industrial loan growth. "Loans as a percentage of earning assets will probably go up a little bit," Mr. Laplante said.
The Keefe Bruyette study, which looked at the 50 largest U.S.-based commercial banks by assets at the end of the third quarter, found that about 62% reported a decline from the second quarter in securities investments as a percent of assets.
On average, the top 50 banks had about 23.23% of assets in securities, down from 23.80% in the second quarter and 24.36% in the first.
Commerce Bancorp Inc. of Cherry Hill, N.J., continued to have the highest percentage (59%) in securities, though that was down from 59.48% in the second quarter. First Horizon National Corp. of Memphis had the lowest, 6.26%, down from 8.83%.
BB&T Corp. of Winston-Salem, N.C., is among those that sold securities on its balance sheet a year ago, when it thought rates were getting ready to bottom out. The company now has about 19% of its assets in securities, compared with an average of 23.23% for the top 50.
Morris Marley, the head of funds management at BB&T, said it deleveraged intending to reinvest later on.
Hal Johnson, the balance sheet manager at BB&T, said that with short-term rates expected to rise for the foreseeable future, the portfolio will generate more cash for reinvestment.
The company plans to invest in more collateralized mortgage obligations because by nature they "will generate cash flow and give us a little bit of a yield pickup," he said.
Mr. Marley said that the securities portfolio is an integral part of BB&T's balance sheet; if loan demand changes, the portfolio will be used to balance the mix, he said.
Among the top 50 commercial banks, BB&T has the highest percentage of its securities in U.S. government agency bonds, (83.5%) and the lowest in mortgage-backed securities (14.1%). Mr. Marley said it wanted to limit its exposure to the mortgage business, already high because of its mortgage banking activities.
Commerce of Kansas City, on the other hand, has spread its securities portfolio almost evenly among government, mortgage-backed, and asset-backed securities.
Banking companies that have already done much of the interest rate work seem to be better positioned. Mr. O'Connor from UBS picks Bank of America Corp., Wachovia Corp., and Wells Fargo & Co. as those least susceptible to an earnings hit from rising rates because they are already neutral or asset-sensitive.
Mr. O'Connor also singled out PNC Financial Services Group Inc. of Pittsburgh and TCB Financial Corp. of Minneapolis.
PNC is among the most asset-sensitive banks; its earnings could rise 1% to 2% for every one 1% rate increase, he said. TCB has reduced its securities and mortgage portfolios by nearly 40% since 2002, Mr. O'Connor; its earnings could rise 2% to 3% for every 1% increase in rates.
Gary Townsend, an analyst with Friedman, Billings, Ramsey & Co., said his favorite picks for a smooth ride in a rising rate environment are asset-sensitive banking companies including Comerica Inc. and North Fork Bancorp. Inc. Those with a good deposit strategy, such as UnionBanCal Corp. (mostly owned by Mitsubishi Tokyo Financial Group Inc.) and Commerce Bancorp of New Jersey, also at an advantage, Mr. Townsend said.
