Torrent of commercial loan paydowns pressures net interest income

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Surging commercial loan paydowns threaten to further weaken net interest income — already under pressure from low interest rates — at Bank of America and other large banks, as business borrowers repay lines of credit that were drawn upon at the onset of the coronavirus pandemic.

Brian Moynihan, the chairman and CEO of the $2.7 trillion-asset BofA, said the bank saw “a massive amount of commercial line draws in mid-March to mid-April … out of panic and the need to create instant liquidity.”

BofA said commercial loans grew by $67 billion in the first quarter — driven by draws on credit lines — but $62 billion of that was repaid in the second quarter, primarily in May and June, when states lifted restrictions intended to slow spread of the coronavirus and business activity began to stabilize, Moynihan said on the company’s second-quarter earnings call Thursday.

Those loans, initially and into the second quarter, propped up interest income. But after the paydowns, that interest income is shrinking — at a time when new loan growth could prove difficult to come by as the virus surges anew, swaths of the economy sputter, and bankers struggle to discern borrowers’ creditworthiness.

BofA said its second-quarter net interest income declined 11% from the prior quarter to $10.8 billion, driven by lower interest rates the Federal Reserve imposed to combat the recessionary conditions caused by the pandemic. The Fed’s benchmark rate hovers near zero.

The second-largest U.S. bank by assets said its interest yields dropped 46 basis points during the second quarter from just three months earlier.

The low net interest income “will not be well received by the market and puts pressure on forward estimates” unless BofA “redeploys cash balances into higher-yielding assets soon,” Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods, said Thursday in a note to clients.

Bank of America’s shares were down 3% in late trading Tuesday.

To be sure, the company’s challenges are not unique.

The $2.2 trillion-asset Citigroup in New York saw significant commercial line repayments during the second quarter that led to a sequential decline in end-of-period loans in its corporate lending division. The $2 trillion-asset Wells Fargo in San Francisco said almost all of the $80 billion of loan draws made by its business clients in March were paid down during the second quarter. And the $459 billion-asset PNC Financial in Pittsburgh said about 75% of the commercial lines that were drawn in late March and early April were subsequently paid down. By the end of the second quarter, PNC’s utilization rates were essentially flat with pre-pandemic levels.

BofA Chief Financial Officer Paul Donofrio said net interest income in the third quarter could drop by $200 million from the business line paydowns alone. “NII stability, absent material changes from the economic conditions, will be dependent on asset growth and/or redeployment of deposits into higher-yielding securities rather than cash,” he said.

Like most banks, BofA has packed on deposits this year, as clients are spending less and saving more amid the highly uncertain duration of a pandemic and economic malaise. The Charlotte, N.C., company added $284 billion in deposits in the first six months of 2020. All of that has gone into cash, Donofrio said, earning a modest 10 basis points.

With no clarity on the ultimate containment of the virus, it is difficult to tell how much of that deposit growth is sustainable. If the economy improves, the bank’s clients could withdraw savings and start to spend more, making reinvestment levels in securities difficult to determine. If conditions worsen, asset growth — namely new loans — could prove exceptionally difficult to generate.

“The place we're uncertain is in the large cash inflows from corporate customers — you're not sure when they're going to start using the money,” Moynihan said.

He noted that consumer spending started to recover in June and that the trend has continued into July. But the pace of recovery and the potential for more disruptions remain unclear.

"Customers and businesses have adapted to a new environment. Some have reopened, and yes, some have also been reclosed or limited again," Moynihan said. "We expect this start-stop to be the base case as we look ahead."

Scott Brown, chief economist at Raymond James, said that the U.S. economy rebounded markedly in June and early July, and that the recovery could continue if most states do not lock down again. But even in that scenario, with cases of the virus hitting national daily records this month, economic activity is bound to be light relative to pre-pandemic conditions. Brown said he expects most increases in business spending to be offset by job cuts in the near term.

“A lot of the economy won’t be coming back anytime soon,” Brown said. “In a lot of sectors, including the services sector that drives 70% of consumer spending, weakness is actually spreading.”

BofA’s own defensive posture on credit quality amplifies the cloudy economic outlook and the potential for continued sluggishness.

The bank put aside $5.12 billion in the second quarter to cover loan losses — in addition to $4.76 billion in the first last quarter. The latest addition to the provision included $3.97 billion to cover future potential losses.

The higher provision cut into profits. B of A earned $3.53 billion in the second quarter, or 37 cents per share. That was above the 28 cents that analysts polled by FactSet forecasted, but down from the 74 cents it earned a year earlier.

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Commercial lending Bank of America Brian Moynihan Earnings PNC Financial Services Group Wells Fargo Citigroup Coronavirus