Bloomberg News

Banks Buy Treasuries at Seven Times Pace in 2011

March 12, 2012

The administration of President Barack Obama has called for $1.5 trillion in tax increases. Photographer: Andrew Harrer/Bloomberg

The administration of President Barack Obama has called for $1.5 trillion in tax increases. Photographer: Andrew Harrer/Bloomberg

U.S. banks bought more government and related debt in the first two months of 2012 than they did in all of last year, an endorsement of Federal Reserve Chairman Ben S. Bernanke’s assessment of the economy that’s boosting demand for bonds even with yields near the lowest on record.

Commercial lenders purchased $78.2 billion of Treasuries and securities of agencies in January and February, compared with $62.6 billion in all of 2011, bringing their holdings to $1.78 trillion, Fed data show. Deposits exceeded loans by a record $1.63 trillion last month, up from $1.17 trillion in January 2011, providing scope to buy more bonds.

While the economy has expanded for eight straight quarters, unemployment at 8.3 percent, the scheduled end of the Bush-era tax cuts, a mandatory $1 trillion in federal budget cuts over 10 years and the presidential election campaign have made banks hesitant to accelerate lending. Instead of providing credit, they are exploiting the gap between the Fed’s target interest rate for overnight loans and Treasury yields to make profits.

“Bank managers are still very cautious, and that’s appropriate,” Jeffrey Caughron, a partner at Baker Group LP in Oklahoma City who advises community banks on investments of more than $30 billion, said in a March 6 telephone interview. “We don’t expect negative growth or a recession, but we expect sluggish growth. There’s not the kind of loan demand that banks are used to having, so banks have excess liquidity and the place to go is the bond market.”

Caughron advises clients to invest in government and municipal bonds.

Yields Rise

Banks are buying more Treasuries even with yields on benchmark 10-year notes about 35 basis points above the record low of 1.67 percent on Sept. 23 because Bernanke has pledged to keep rates around zero through 2014. The difference between the federal funds rate and the yield on the 10-year Treasury was at 177 basis points, or 1.77 percentage points, today. In 2006 and 2007, yields were below the Fed’s key rate.

The benchmark 10-year yield was little changed at 2.02 percent at 2:42 p.m. New York time, according to Bloomberg Bond Trader prices. The yield advanced five basis points last week, the most since the period ended Feb. 10.

‘Frustratingly Low’

Low yields will allow the U.S. to finance a fourth straight annual budget deficit of more than $1 trillion at a cost of 3.1 percent of gross domestic product, compared with 3.8 percent in 2000 and 4.1 percent in 1999, when the nation had budget surpluses, according to Office of Management and Budget and International Monetary Fund data compiled by Bloomberg.

Bond strategists forecast that yields will rise by the end of 2012, with the median estimate for the 10-year note at 2.47 percent. The benchmark government issue yielded an average of 4.9 percent for the past two decades.

“Treasury yields are going to remain lower than people think, frustratingly low for a while,” Eric Pellicciaro, head of global rates investment at New York-based BlackRock Inc., which manages $1.14 trillion in fixed-income assets, said in a March 7 telephone interview. “That’s a very good backdrop for fixed income.”

Pellicciaro said he is buying mortgage securities and recommends Treasuries when yields rise to between 2.25 percent to 2.5 percent. “Under two percent is not a lot of value.”

Buying Time

Banks have increased holdings of government debt since 2008 to protect their capital after the credit crisis caused more than $2 trillion in writedowns and losses at global financial institutions, according to data compiled by Bloomberg.

The Fed’s low-rate policy “has been a plan to buy time for the banks to take free money and invest it, and make some kind of spread, and work their way out of the hole they were in,” said Mark MacQueen, a partner and money manager in Austin, Texas, at Sage Advisory Services Ltd., which oversees $10 billion, in a telephone interview on March 6. “Banks are trying to clean up and improve the appearance of their balance sheets and buying Treasuries accomplishes this.”

They have just as much reason to own Treasuries now after falling profits led banks and brokers to announce more than 50,000 job cuts in the past year, Bloomberg data show.

The average net interest margin at the four largest U.S. banks -- JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc. and Wells Fargo & Co. -- shrank to 2.99 percent in the fourth quarter from 3.17 percent a year earlier. Net interest margin is a gauge of bank profitability based on the difference between the cost of funds and what they earn on assets.

New Rules

Lenders have added Treasuries to meet new reserve rules from the Dodd-Frank financial-overhaul law and Basel III regulations set by the Bank for International Settlements in Basel, Switzerland.

In 2011 banks bought $30.6 billion in government securities in the first half and $32 billion in the second half. Purchases in 2011 fell from $190 billion the year before. Bank of America, the second-biggest U.S. lender, cut its $49 billion holdings of Treasuries to about $43 billion at the end of last year, Jerome F. Dubrowski, a company spokesman, wrote in a March 8 e-mail.

While the unemployment rate remained steady for a second month at the lowest since February 2009, and the index of U.S. leading indicators rose 0.4 percent in January, its fourth straight increase, Bernanke said in testimony before Congress March 1 that economic conditions may warrant low interest rates at least through late 2014. The central bank has kept its benchmark rate about zero since December 2008.

Bernanke’s Caution

Bernanke told the House Financial Services Committee on Feb. 29 that, while there have been “positive developments” in the labor market, it “remains far from normal.”

A month earlier, Bernanke said the Fed was considering another set of asset purchases to boost economic growth even after the central bank bought $2.3 trillion in bonds in two stages of so-called quantitative easing ending in June.

The central bank lowered its projected range for growth this year to a range of 2.2 percent to 2.7 percent, from 2.5 percent to 2.9 percent in November. The range for next year is 2.8 percent to 3.2 percent, down from a previous forecast of 3 percent to 3.5 percent. The median estimate of economists surveyed by Bloomberg News is for growth of 2.2 percent.

While those rates would be up from 1.7 percent in 2011, they’re below the average of 3.1 percent in 2004 through 2006, before the start of the biggest financial crisis since the Great Depression. In the past 60 years, the U.S. economy grew at an average annual rate of 3.2 percent.

Spending Cuts

A deficit reduction law passed last year that requires $1 trillion in discretionary spending cuts spread over 10 years would take effect in January 2013 if Congress and the administration can’t agree on an alternative plan.

The administration of President Barack Obama has called for $1.5 trillion in tax increases, in part by allowing tax cuts from the era of President George W. Bush to expire for families earning more than $250,000, as well as spending to boost jobs as part of his 2013 budget request. The four major Republican candidates said they would lower taxes and cut federal spending if elected.

“In the next eight or nine months, we face some headwinds,” David Ader, head of U.S. government-bond strategy at CRT Capital Group LLC in Stamford, Connecticut, said in a telephone interview March 6. “The real issue here is that there’s just not that much creation of credit.”

Loans Below Peak

Ader forecasts a 2.75 percent yield on the 10-year at year- end and a 1.5 percent GDP for this year.

While commercial and industrial loans at U.S. banks have risen to $1.38 trillion from $1.2 trillion in October 2010, they’re below the peak of $1.62 trillion reached in October 2008. Credit losses for U.S. lenders fell to $25.4 billion, the lowest in 15 quarters, the FDIC said Feb. 28.

Banks had $1.58 trillion in cash as of Feb. 29, according to data compiled by Bloomberg. While down from a record $1.9 trillion in July, the amount was $287 billion in 2007.

“With the elections coming up, loan demand will stay weak and banks will continue to buy the securities and keep rates low,” Priya Misra, head of U.S. rates strategy in New York at Bank of America, one of the 21 primary dealers of U.S. government securities that trade with the Fed, said in a March 5 telephone interview. “Banks are not voluntarily buying these Treasuries. They just don’t have enough loan demand.”

To contact the reporter on this story: Susanne Walker in New York at swalker33@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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