Banks continued to slowly put more cash to work in the bond market in the second quarter, but many institutions remain hesitant to invest at low yields, fearing higher interest rates lie around the corner.
Bank securities portfolios maintained strong growth in the second quarter, increasing 27.5% from year-ago levels. Even as banks put more cash to work, excess liquidity continued to build on balance sheets as deposit growth remained far stronger than loan growth. That pushed securities books in the second quarter to 25.1% of assets for the banking industry in aggregate, compared to 21.4% in the year-ago period. Banks have winnowed their reliance on short-dated securities and modestly increased their holdings of longer-dated bonds in an effort to gain more yield.
While banks have generally increased securities investments, many institutions are still proceeding with caution. Donald Kimble, CFO of KeyCorp, said during the bank's second-quarter earnings call that the company is maintaining around $20 billion in excess cash but is still looking for opportunities to invest. Kimble said the excess liquidity represents a significant drag on the company's net interest margin and noted that applying yields available in the market at the time would result in nearly $250 million of additional revenue.
"We've been more holding water as far as replacing some of the runoff with new purchases. But we do expect rates over the next several quarters to start picking up again and giving us some opportunities to buy," Kimble said.
James Herzog, CFO of Comerica Inc., told a similar story at a recent investor conference. While the bank will look to reduce its asset sensitivity, Herzog said the company will not be making any big bets.
"We think being very measured makes sense, being consistent makes sense," Herzog said, adding that the company increased its securities portfolio by $500 million in the second quarter. "I feel like that's what we've been doing in recent quarters, and that's what I would expect going forward before those rates potentially start rising."
Long-term rates have moved higher this year, with the yield on the benchmark 10-year Treasury more than doubling since the lows witnessed in the summer of 2020. Still, the yield on the 10-year Treasury remains more than 100 basis points below the three-year average recorded between 2017 and 2019. The excess liquidity in the system has depressed security yields even further as cash has flocked to limited yield opportunities in the market.
Bank managers could pick up some yield by extending the duration of assets, but many are hesitant to do so at this point in the interest rate cycle. Many banks expect higher rates due to heightened inflation and the Federal Reserve's eventual tapering of asset purchases in the bond markets.
Other institutions have said they might need to recognize that excess liquidity could persist for longer than anticipated. Synovus Financial Corp. CFO Andrew Gregory Jr. said on a second-quarter earnings call that the company typically looks at its securities portfolio as part of traditional balance sheet management, but historic levels of excess liquidity have changed the approach.
"We do believe that this liquidity environment will remain for the foreseeable future, and we're managing our balance sheet accordingly where we are growing the securities portfolio in a prudent manner at 17% of assets," Gregory said. The executive also said the company has acquired third-party loans, adding that it would prefer to purchase prime auto loans with a two-year duration versus extending out on the yield curve in its securities book.
While some bankers were hesitant to extend duration, the banking industry in aggregate increased its exposure to the long end of the yield curve in the second quarter. In the period, securities portfolios grew 4.7% from the prior quarter, in part due to continued investments in longer-dated instruments. Bonds expected to reprice or mature in more than 15 years increased 4.8% from the prior period. The growth pushed longer-term bonds to 36.3% of bank-held securities at the second quarter.
Meanwhile, banks trimmed their exposure to shorter-term securities in the second quarter. Securities expected to mature or reprice in less than three years dipped 3.7% in the second quarter from the prior period. With the decreases in positions, shorter-term securities declined to 20.8% of total securities from 22.7% in the prior quarter.
