America's banks have an unusual problem: They have more cash than ever but they are making much less from it.
With more deposits than loans, banks have been forced to buy securities. But persistently low interest rates have been squeezing the investment yields on these securities. Banks' earnings likely will continue to be hit by lower profit margins unless they can boost their lending business.
Bank customers made $7.5 trillion in deposits last year, 10.7% more than in 2010. But only $6.3 trillion of loans were made, up 0.8%. Banks invested the overflow mainly in bonds backed by mortgages or Treasury notes and bills because these investments won't add much risk to a bank's balance sheet.
By the end of 2011, banks held $1.2 trillion of mortgage-backed securities, almost 13% more than a year earlier.
As mortgage bonds mature or get sold, banks have to reinvest the cash at lower rates. The resulting decline in securities yield is putting pressure on net interest margins--the profit margin of anything banks earn interest on, including loans and investments. MBS yields have fallen to 2.88%, from 4.13% a year earlier, according to Keefe, Bruyette & Woods analyst Bose George.
BB&T Corp. (BBT) bought $9.4 billion of mortgage-backed securities in the fourth quarter, with a yield of 2.67%. The bank sold $3.5 billion of mainly 30-year maturity Government National Mortgage Association (GNMA) bonds with a yield of 3.75%. The Winston-Salem, N.C., bank expected more borrowers holding the mortgages backing those bonds would prepay early to refinance, which reduces the cash flow from the investments and lowers their value.
By selling them, "we basically reduced the risk of prepayment," Chief Financial Officer Daryl Bible said in an interview. "It's hard to know when rates will go up."
BB&T, one of the largest banks in the South, held $31 billion of bonds backed by mortgages of government-sponsored entities like Fannie Mae (FNMA) and Freddie Mac (FMCC) on its book. Bible told analysts during a conference call on Jan. 19 he expects the first-quarter net interest margin to be around 3.9%, compared with 4% a year earlier.
Last week, U.S. Bancorp (USB) reported its net interest margin shrank to $3.6% in the fourth quarter from 3.83% a year earlier. Yields on its securities portfolio fell 60 basis points, or hundredths of a percentage point. Yields on loans declined only 16 basis points. Chief Financial officer Andrew Cecere blamed an "increase in low-yielding investment securities" and "higher cash balances."
The more mortgage-backed securities, the harder the hit to margins. Among 15 banks that reported fourth-quarter earnings by Jan. 19, those with more than 10% of interest-earning assets in residential-mortgage-backed securities reported fourth-quarter net interest margins below analyst estimates, analysts at Sterne, Agee & Leach Inc. calculated.
With demand picking up, particularly from American businesses to borrow, the volume of new loans is making up for some of the lost revenue from falling interest rates.
"The differentiating factor is that banks that have loan growth have better-than-expected margins," said Sterne Agee analyst Peyton Green.
Further, banks have been able to lower the interest rates they pay for their customers' money, particularly on certificates of deposits they lured customers into when cash was short during the height of the financial crisis.
KeyCorp (KEY) Chief Executive Beth Mooney said in an interview the Cleveland bank has more than $6 billion of CDs maturing with interest rates "north of 4.5%." Interest on CDs is now below 2.5%, she said. Cutting those rates will improve profitability.
But over all, banks have little leverage to avoid the impact from falling interest rates. Bible, BB&T's CFO, said the bank held off the sale of its bonds until the very end of the quarter to protect its margin. BB&T also can lower CD rates, and might be able to call Trust Preferred Securities, he said. Those measures "would give some relief to falling net interest margin," he said. And the bank expects to increase loans between 5% and 7% in the first quarter, so the origination volume will offset the decline in profitability, Bible said.
Still, margins will decline, he predicted.
Sterne Agee's Green said the pressure on margins "is getting worse in the first quarter" because more home owners were approved for refinancing late last year but their new, lower interest-rate mortgages haven't closed yet. "Generally, refi volumes are up and it's going to be an issue for another quarter or two."
Attractive reinvestment opportunities for bonds running off banks' books are rare. Scott Buchta, head of mortgage strategy at Sandler O'Neill + Partners LP, said some banks already have started buying slightly more risky bonds, such as corporate bonds or commercial-mortgage-backed securities.
Ironically, yields of such commercial-mortgage bonds started to decline late last year as banks began to "stick their toe into the water," Buchta said.
The best way out: Making more loans. That means borrowers may be the winners, because low benchmark interest rates and increasing competition have lowered interest rates on loans too, bankers have said.
-By Matthias Rieker, Dow Jones Newswires; 212-416-2471; firstname.lastname@example.org