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Are Securities Crowding Out Bank Lending?

bmoreland's picture





 

We hear a lot of angst about bank lending and the continued trends regarding a reduction in outstanding bank loans. I tend to think it's a healthy step in our collective recovery, but I do worry that we are seeing a fundamental shift in the bank model regarding asset makeup.

As many long time readers know I run a small firm (BankRegData.com) focused on building tools to analyze bank data from the quarterly Call Reports. The data for the charts and tables below is from the 2nd Quarter and is therefore somewhat stale. The FDIC will relase the 3rd quarter update in a couple of weeks.

I have selected Bank of Hawaii (BOH) for the review. I chose BOH primarily because I think they are good example of a well run bank that has clearly made a change. I have no financial position nor have any relationships with the institution.

First up is a review of BOH's Assets:

Yep, $5.2 Billion in Net Loans and $6.6 Billion in Securities. U.S. Treasury securities make up $1.1 Billion (16.80%) while U.S. Government Agency Obligations are another $5.3 Billion (80.57%). Mortgage-backed Securities are $5.2 of the $5.3 Billion.

In an interesting aside, for the entire U.S., Net Loans and Leases have dropped $719 Billion in the past 12 quarters from $7.84 Trillion to $7.12 Trillion. Coincidently, Securities have risen $697 Billion in the past 12 quarters ($2.027 Trillion to $2.724 Trillion).

 

The table below details 12 quarters of BOH activity highlighting Assets Per FTE:

In the past 12 quarters, Total Assets at BOH have grown from $10.31 to $13.19 Billion - a $2.88 Billion increase. The number of FTEs (Full Time Equivalent employees) has dropped from 2,573 to 2,405. From an efficiency perspective, they have grown from $4.0 Million in Assets Per FTE to $5.4 Million.

On the surface, this ability to grow assets and shrink employees is commendable. Let's now take a look at Total Securities to Total Assets for BOH relative to 99 similar sized national peers:

Three years ago 27.36% of their assets were Securities. That ratio is now up to over half at 50.23%.

Securities as a % of Assets for BOH and 9 similarly sized National banks:

Very clearly, Bank of Hawaii has shifted their focus to growing their Securities portfolio. This is not an indictment of the strategy. One could argue they are smartly responding to the environment and taking the best interest of their shareholders into account.

 

Let's now take a look at growth across various Asset classes along with Deposit growth:

 

Total Assets have grown by 27.93% - very similar to the 30.27% growth in Deposits. Net Loans & Leases have shrunk by $1.2 Billion while U.S. Treasuries have increased by a remarkably identical $1.1 Billion. Now, why can't we get these banks to lend? Why can't we get them to hire?

Look, I'm pretty much a simpleton (and this is by no means my bailiwick), but is this really what we want from our banking system? I understand that banks will have excess cash and will want places to park it to earn some return while they figure out future lending strategies. That said, when banks would prefer to buy and sell securities rather than lend money that can't possibly be healthy for the communities banks are supposed to serve.

When banks (prudently) lend that loan creates opportunities for the borrower as well as the ripple effects of capital being put to use - local contractors for the home equity loan, equipment manufacturers for the commercial loan, new employees for a loan to expand retail footprint, etc... Lending activity also creates opportunities for the bank and their employees. They need lenders, back office personnel to service the loan, and yes, profit opportunity for the shareholders.

When a bank purchases a security most of the above benefits disappear - the profit opportunitiy pretty much being the only one left.

The U.S. Government loves having these banks pick up Treasuries and with ZIRP distorting lending rate levels they are encouraging this behavior. From a bank's perspective, is the marginal Commerical Real Estate Loan, Construction & Development Loan or 1-4 Family Mortgage riskier than the U.S. Treasury?

 

The strategy, however, is not without risk to Bank of Hawaii. The following table details Pre-Tax Net Operating Income and Non Interest Income gains from Securities:

Note the increasing reliance upon gains from Securities to pad an already impressive Pre-Tax NOI. The recent performance, however, begs the dual questions of whether it can continue and are they sitting on losses? Operation Twist anyone?

 

 


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Fri, 11/11/2011 - 15:02 | Link to Comment Ura Bonehead
Ura Bonehead's picture

Thanks for the article, bmorland.

Of course, thanks to a zero rate bank borrowing environment, there's very little risk-reward incentive for a bank to make a single loan.  With zero rates, the Fed has each bank eating out of their hand, absorbing excess supply of their paper.

To further the problem....  If $5.2B of $5.3B in 'Net Loans and Leases' has been 'invested' in MBS, then is BH, anyone, making ANY loans??

Are securities crowding out bank lending?  Instead of dealing with the symptom let's deal with the cancer:  an accommodative Fed.

Fri, 11/11/2011 - 15:51 | Link to Comment RiverRoad
RiverRoad's picture

You nailed that one.

Absurdly low interest rates with very little lending going on is just the way the Fed wants it:  no money out there in people's hands = no inflation to worry about.  People with no jobs = same thing.  The oligarghy's pocketing everybody's (former) salaries and keeping the "little" guy right where he wants him.  Best of all, Obummer gets to blame the Republicans for everything.

Fri, 11/11/2011 - 14:54 | Link to Comment TheArmageddonTrader
TheArmageddonTrader's picture

Excellent points.

The big drivers here are the more solid government guarantee of GSE MBS since the GSEs were nationalized, and the Fed downward manipulation of interest rates. This drives banks to load up on GSE MBS instead of taking the mortgage risk of direct mortgage lending. It's something of a myth that banks are "borrowing at zero and buying Treasurys". They are, a bit. But much more so they are loading up on GSE MBS.

You've hit the first problem that this causes on the head: the GSE MBS are so profitable and seemingly so secure that banks have less incentive to make other kinds of loans. This is exactly what any sensible person would expect: when the government intervenes to subsidize (in this case through loan guarantees) a particular sector, that inevitably pulls real resources away from other sectors.

You've also hit the second problem, but I think you could put it more clearly: the combination of Fed-manipulated falling long interest rates and accounting rules give banks an additional short-term incentive to load up on GSE MBS, to their own detriment later. Banks have been marking gains on their GSE MBS holdings as their market value has risen in line with falling interest rates. (By contrast, banks don't get to mark any gains on direct mortgage loans when rates fall.)

However, when interest rates rises, as they eventually must, those gains on GSE MBS will reverse to losses. Given that banks have been loading up on GSE MBS at or near the trough of the interest-rate cycle, the eventual losses from rising interest rates will far outweigh the gains they've been recording.

Even banks that are not marking their GSE MBS to market, and thus not claiming any gains on them, would eventually suffer losses when short interest rates rose to the point (~4%) that their GSE MBS purchases from the ZIRP era would generate negative net interest margins.

Fri, 11/11/2011 - 14:13 | Link to Comment SwingForce
SwingForce's picture

When will they start buying stocks?

Fri, 11/11/2011 - 14:27 | Link to Comment Freddie
Freddie's picture

Obam's CIA cut out grandmother worked at BOH.  A real slimeball outfit too.

Fri, 11/11/2011 - 14:02 | Link to Comment ItsDanger
ItsDanger's picture

Banks are quasi hedge funds these days. 

Fri, 11/11/2011 - 14:54 | Link to Comment Clowns on Acid
Clowns on Acid's picture

hedge funds backed by the FDIC to added to your description.

Fri, 11/11/2011 - 13:17 | Link to Comment MrBoompi
MrBoompi's picture

I agree, this doesn't seem like a good model for US banking.  Instead of providing a much-needed service they seem to be becoming more parasitic every day.

Fri, 11/11/2011 - 12:57 | Link to Comment csmith
csmith's picture

From a bank's perspective, is the marginal Commerical Real Estate Loan, Construction & Development Loan or 1-4 Family Mortgage riskier than the U.S. Treasury?

 

Quite obviously it is, because such a large proportion of the assets created in the last cycle (mostly real estate loans) are no longer supported by collateral values. Only when house and CRE prices reach a level which balances supply and demand will this change. There is still a huge glut of properties - some intentionally hidden and some not. Accounting rules have not only permitted banks to hide bad assets, but encouraged it in order to boost confidence in the system. Extend and pretend, pray and delay, call it what you want.

Fri, 11/11/2011 - 12:32 | Link to Comment swani
swani's picture

This is why everyone should move into credit unions. I want a retail bank that is a retail bank and nothing else, if not, one will never know the true exposure of the banks that hold your money. There is pressure for these banks to perform for shareholders and too many idiots, fraudsters and incompetents making, or influencing investment decisions. 

Fri, 11/11/2011 - 12:07 | Link to Comment mikeymac510-38
mikeymac510-38's picture

You ask why don't banks lend more and the answer is that there must be demand for loans, which there is not as consumers delever. BOH has two options to either buy securities from their increasing deposits or to discourage additional deposits by lowering deposit rates even further. Given that banks enjoy the ability to use lots of leverage from deposits, and the steep yield curve, they can generate nice yields with low yielding securities to replenish their capital for those banks that need to (BAC) oy pay dividends and buy back shares (BOH).

Fri, 11/11/2011 - 13:30 | Link to Comment eatthebanksters
eatthebanksters's picture

No demand for loans...hmmm...how about people like me who had a good business going (small business) and an 800+ average credit score...financing sources dried up - that's right I couldn't get a loan let alone at rates the big boys are getting.  I shut down my business and just gave my house back to the bank. I have lost 80% of my net worth.  Yup, there is no demand for loans from people who know what they are doing and could continue to make money even in a down economy.  The real problem for the big boys is that they have to do everything in a cookie cutter process or its not profitable enough for them. There is so much fat at the top that the days of personal banking with little guys like me are over. When you think about historically how much of the US economy has been the small businessman, it is a worrisome trend.  But, in Obama's world, union's, big business and oligarchs will make everything right! If you are a self actualized and responsible small businessman, you're fucked. Send me what you are smoking, please!

Fri, 11/11/2011 - 13:50 | Link to Comment mikeymac510-38
mikeymac510-38's picture

There are people like you have not been able to get loans for one reason or another, but when I say there is no demand, I mean in the aggregate as loan balances are lower today than a year ago and two years ago etc...  Consumers and companies in the aggregate are paying down debt after 20+ years of borrowing. this is happening not only in the US but worldwide. The company I work for has paid off all its short term debt and its only remaining debt matures in 20 years. Cash on corporate balance sheets has never been higher. they do not want to invest it new plant and equipment because they are not confident that the goods that will be produced will have demand, so in general, they are not investing. Companies park their cash at banks, and banks are now sitting with $1.5 trillion in excess deposits with the Fed (see the Fed's H.3 report) and are using some of the excess cash to buy treasuries and agency MBS.  There are exceptions like you who need to borrow, but you are part of a minority group. 

 

Fri, 11/11/2011 - 12:06 | Link to Comment daxtonbrown
daxtonbrown's picture

Wouldn't this make the banks even more susceptible to systemic failure? It would certainly boost the stock market, but at what point is everyone just holding worthless paper?

Fri, 11/11/2011 - 12:08 | Link to Comment mikeymac510-38
mikeymac510-38's picture

Banks do not buy equities for their securities portfolio, this has no affect on the stock market.

Fri, 11/11/2011 - 13:33 | Link to Comment mind_imminst
mind_imminst's picture

But by the FED policies "encouraging" securities purchases (by banks) during a time of cosumer deleveraging in order to turn a profit, helps the bank stocks, and the financial sector has grown to an out-sized percentage of the S&P 500, so at least indirectly, this does have a bearing on equity prices.

Fri, 11/11/2011 - 12:14 | Link to Comment narnia
narnia's picture

You have to make some pretty implausible assumptions of who the banks are purchasing MBS from & what they are paying for it to conclude this has no effect on the stock market.

Fri, 11/11/2011 - 11:56 | Link to Comment Corn1945
Corn1945's picture

Is it accurate to say that these banks are turning into investment banks? Isn't this the behavior Glass-Steagal was supposed to prevent?

Fri, 11/11/2011 - 12:27 | Link to Comment narnia
narnia's picture

Glass-Steagall is a red herring.  The parts of G-S that have survived have contributed more to TBTF than anything repealed.  The problems with the financial system are systemic- so much so that regulation is an exercise in futility. 

The BOH has $2B of lending capacity right now.  They are not lending because of the overhang of the massive $ bubble.

It would be nice to see the underyling property on the MBS they are purchasing and what they paid for it.  If it's in real estate in the markets they know at haircut prices, they are actually evolving closer to the standard operations of a regional bank.  The proceeds used to pay for the MBS are now in the hands of investment banks (directly or through pension funds) who are undoubtedly doing high leverage speculating with them. 

Fri, 11/11/2011 - 12:10 | Link to Comment mikeymac510-38
mikeymac510-38's picture

That is funny about becoming an "investment bank" because they buy securities. Should I take that comment seriously?

Fri, 11/11/2011 - 12:36 | Link to Comment PeterLemonJello
PeterLemonJello's picture

Ahhhhhh yes, you should.  I would define an investment bank as holding more "investments" that benefit the banks bottom line, rather than "loans" that benefit the banks bottom line.  The basic tenet of being a "bank" is collecting deposits and making loans. 

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