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?