Regional banks sell underwater bonds, betting on Fed rate cuts
Regional banks are taking a calculated risk by selling underwater bonds at a loss, preparing for anticipated interest rate cuts from the Fed.
PNC Financial Services Group, Truist, and others are using the proceeds to purchase higher-yielding securities, aiming to boost their income as rates potentially decline in the coming months.
"If they've got extra cash, bank treasurers who think we're at the top of the cycle may decide to go ahead and lock in long-duration bonds so that once we're in a lower-rate environment they still have a decent yield," said Feddie Strickland, an equity research analyst with Hovde Group.
This kind of activity raised eyebrows just a year ago. Selling off bonds at a loss triggered a crisis when Silicon Valley Bank did it in 2023. But this time, it's different.
These bond sales are part of a calculated gamble.
Banks are betting on the Federal Reserve cutting interest rates, possibly as soon as September. By selling low-yield bonds now and buying higher-yield ones, they're aiming to boost their future profits.
It's a bit like trading in a low-interest savings account for a high-yield one, just before interest rates are expected to drop.
Betting big on the "swoosh"
PNC took a $500 million hit on bond sales but reinvested in securities yielding 400 basis points more.
This bold move aims to boost the bank's net interest income—the difference between what it earns on loans and pays on deposits—to record levels next year.
According to one analyst who sat in on PNC’s second-quarter earnings call, the bank’s projected earnings look a lot like Nike’s trademark “swoosh.”
CFO Robert Reilly told analysts that this move to sell off bonds “locked in some of the swoosh.”
Other banks are following suit. Truist accepted a $5.1 billion after-tax loss to swap bonds yielding 2.80% for new ones yielding 5.27%, projecting a 2-3% increase in net interest income.
Regions Financial took a $50 million pre-tax loss to replace about $1 billion of bonds, with CFO David Turner calling it a "good use of capital."
Webster Bank also joined in, taking a $38.7 million after-tax loss on bond sales, though it subsequently lowered its income expectations.
Timing is everything
Not all regional banks are jumping on this bandwagon.
Many are still wrestling with high deposit costs, troubled borrowers, and dwindling profits. New York Community Bancorp, for example, recently reported a quarterly loss and sold off its mortgage-servicing business.
If rates fall as expected, banks could see a significant boost in profitability. But if rates remain elevated or the economy takes a downturn, this gamble could backfire.
Moody's Ratings analyst Megan Fox said it all comes down to timing. "When the rate cycle changes, it is going to have a big impact on what the profitability story looks like,” she said.
Investors seem to think it’s a pretty good bet. T
The CME FedWatch Tool, which tracks market expectations for interest rates, shows that traders are pricing in an almost 90% probability of a quarter-point rate reduction at the Fed's September meeting.