Many banks have been hesitant to invest excess cash before the Federal Reserve raises short-term interest rates, but they are likely leaving money on the table given the strong move in immediate rates that has already occurred, according to Piper Sandler's Scott Hildenbrand.
Hildenbrand, chief balance sheet strategist and head of the financial strategies group at Piper Sandler, discussed in the latest "Street Talk" podcast how banks should view their excess liquidity, investment opportunities in the current market and whether the outlook for interest rates and loan growth should change investment strategy.
Hildenbrand said the Fed likely will begin widely expected rate hikes this week but noted that bank managers have already been presented with opportunities to put cash to work at higher rates in the "belly" of the yield curve. Hildenbrand said banks "obsess" over the Fed as the driver of interest rate risk. Meanwhile, as bankers wait for Fed action, the yield on the 5-year Treasury through March 11 had risen more than 30 basis points in a week and nearly 120 basis points from year-ago levels.
"We've seen a massive rate move in the belly of the curve — parts of the curve where it actually matters to a lot of the community banks I talk to — and yet we're also waiting for the Fed to move interest rates," Hildenbrand said in the episode.
Hildenbrand said he is almost agnostic to interest rate moves and focuses more on the liquidity position of the institution. He said banks can use interest rate and economic data to drive pricing but should base their strategy on their balance sheet needs.
When putting money to work in their securities portfolios, banks should look for assets where their balance sheet is not as exposed, Hildenbrand said. For instance, he noted that many banks have exposure to the short-term assets whose yields would move higher with Fed hikes. However, recent market movements would allow banks to pick up considerable yield by investing along the 5-year part of the yield curve.
"This is a wonderful opportunity to get more of your assets out on that part of the curve and less of your assets relying on and waiting for the Fed," Hildenbrand said.
Some banks are fearful that if they put cash to work today, those investments would move underwater if interest rates rise further. And there is some evidence that it might have already occurred at some institutions. BOK Financial Corp. recently disclosed that it logged about $50 million in pretax losses as it decreased the carrying value of its trading securities based on sales of securities and market observations.
Hildenbrand said banks should consider what would hurt them more — the 5-year Treasury rising another 100 basis points or possibly falling 100 basis points from current levels. Fifth Third Bancorp seems to have recognized this possibility. The company said at a recent investor conference that it has ramped up bond purchases because it expects interest rates to top out at a lower peak as geopolitical tensions have increased the risk of a recession.
Other institutions seem hopeful that loan growth will be strong enough to put excess cash to work by making new loans, as opposed to having to deploy the funds in the bond market. The fourth quarter of 2021 offered signs of stronger loan growth, with loans increasing 3.0% from the prior quarter, while deposits rose 2.8%. With the move, the industry's loan-to-deposit ratio inched higher to 57.09% from 56.98% in the third quarter, but the ratio remained well below 72.36% recorded at year-end 2019.
Hildenbrand said some banks have put cash to work to build a bridge until they see stronger loan growth, but most are "trying to hit that home run" and have left funds sitting in cash as they wait on higher rates and stronger loan growth.
New loans might not carry yields that reflect the increase in immediate rates, either, because competition remains too strong, Hildenbrand noted. With loan-to-deposit ratios at historic lows, all banks are trying to allocate more cash to loans and fewer funds in securities and cash. Hildenbrand said that could prove very difficult "when we're all chasing each other."
"Street Talk" is a podcast hosted by S&P Global Market Intelligence.
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