Bond yields are up, but banks' rotation into securities appears to be slowing down as deposit stockpiles become less stable.

Large U.S. banks, including Fifth Third Bancorp, accelerated their bond purchases in the first quarter as interest rates spiked and yields became more attractive, according to data from S&P Global Market Intelligence. The median sequential increase in securities portfolios was 5.4% for publicly traded banks with more than $50 billion of assets, compared with 3.3% in the fourth quarter.

Medium-term interest rates rose further still through mid-May, though not as sharply as in March, but banks appear less willing to deploy their cash into bonds, with industrywide holdings of securities down 0.7% through the first five weeks of the second quarter, according to data from the Federal Reserve. Banks must contend with the potential for deposit outflows as the Fed tightens policy, which could cut into balance sheet capacity, and continued growth in lending is providing an outlet for excess liquidity.

How much excess liquidity

The gusher of deposits throughout the pandemic fueled a median increase in cash and equivalents across the big banks of 196.1% from the end of 2019 through the end of the first quarter this year, and a median 52.6% increase in securities.

The banks have tilted toward securities growth in recent periods, with cash dropping by a median 9.0% sequentially in the first quarter.

Industrywide cash levels continued to drop during the first five weeks of the second quarter, according to the Fed data. The shift over the past few months reflects a drop in bank reserves held with the central bank as the federal government has increased its own cash holdings after the debt ceiling was increased late last year.

More broadly, banks have to decide to what extent they want to lock themselves into bonds, with loan growth consuming more of their balance sheets, and deposits leveling off as rates increase and the Fed gets ready to withdraw money it has directly injected into the system.

After using close to half of its estimate of its excess liquidity in the first quarter, Fifth Third said in early May that it has continued to deploy some of the remaining $15 billion into securities in the second quarter, and that it still expected about $5 billion to leave because of deposit runoff.

Deployment strategies

Cash and securities trajectories have varied widely across the banks since the onset of the pandemic, with companies like Bank of America Corp. showing relatively strong shifts toward securities.

BofA executives have said securities growth is largely a function of deposit growth, with the bank putting money to work in bonds when loans weren't increasing. Now, "if we keep seeing the same kind of loans growth we're seeing right now, the securities may decline over time, they may stay flat," CFO Alastair Borthwick said on the company's earnings call in April. "We'll see, depends on deposits."

At JPMorgan Chase & Co., by contrast, growth in cash since the end of 2019 has exceeded growth in securities, and executives have said they have no plans to significantly bulk up on bonds.

Yields on short-term cash are rising in lockstep with Fed hikes, CFO Jeremy Barnum noted on the bank's earnings call. "Given the timing and expected speed of the rate hikes, increasingly, it just kind of doesn't matter that much."