The gap between U.S. bank deposits and loans is growing at the fastest pace in two years, providing lenders with more funds to buy bonds and temper the biggest sell-off in Treasuries since 2010.
As deposits increased 3.3 percent to $8.88 trillion in the two months ended July 31, business lending rose 0.7 percent to $7.11 trillion, Federal Reserve data show. The record gap of $1.77 trillion has expanded 15 percent since May, the biggest similar-period gain since July, 2010. Banks have already bought $136.4 billion in Treasury and government agency debt this year, more than double the $62.6 billion in all of 2011, pushing their holdings to an all-time high of $1.84 trillion.
Faced with a slowing U.S. economy, unemployment above 8 percent for more than three years and regulations forcing them to hold more and higher-quality assets, banks are lending at below pre-recession levels. The bond purchases help explain why even after rising this month, Treasury 10-year note rates are about half the 3.5 percent median forecast of 43 economists in a Bloomberg survey a year ago.
“Bank deposits continue to explode and in turn they continue to buy Treasuries as the economy loses momentum, inflation is trending down, Europe continues to hang over our heads and political uncertainty reigns” said Michael Mata, a money manager in Atlanta at ING Investment Management Americas, which oversees about $160 billion. “There is no reason for interest rates to climb in any meaningful way any time soon.”
While the gap has narrowed to $1.75 trillion as of Aug. 8 as lending of $7.12 trillion trailed $8.87 trillion in deposits, the gap is more than 17 times the $100 billion average in the decade before credit markets seized up, Fed data show.
Commercial and industrial lending reached a peak of $1.61 trillion in October 2008, a month after the bankruptcy of Lehman Brothers Holdings Inc. As the credit crisis deepened, loans tumbled to $1.2 trillion two years later, before recovering to $1.46 trillion Aug. 1.
The recent rise isn’t keeping up with record bank deposits as savings of U.S. households have risen to 4.4 percent of incomes as of June from 1.7 percent in 2007, the data show.
“Every bank is looking for a way to increase their yield,” said Mike Pearce, president of Bank of The West in Grapevine, Texas, whose company has been purchasing government securities after deposits grew faster than loans in 2010 and 2011. Instead of earning the Federal Funds rate of zero to 0.25 percent on the deposits, its bond holdings are yielding about 3.25 percent, he said.
Bank Treasury holdings reached $500 billion, the highest since June 2011, even with interest rates minus inflation for benchmark 10-year notes of 0.38 percent, compared to the average of 1.26 percent over the past decade.
Yields on 10-year Treasury notes rose 15 basis points, or 0.15 percentage point, last week to 1.81 percent. The price of the 1.625 percent security maturing in August 2022 declined 1 12/32, or $13.75 per $1,000 face value, or 98 9/32. The yield was little changed to 1.81 percent today.
They increased from a record low 1.379 percent on July 25 as investors became more optimistic about the economy. The U.S. added 163,000 jobs last month, a government report showed Aug. 3, more than the 100,000 projected by analysts. Sales at U.S. retailers increased 0.8 percent, more than the 0.3 percent forecast and following a 0.5 percent slide in June, Commerce Department data released Aug. 14 showed.
The benchmark notes will yield 1.60 percent by the end of September, below June’s projection of 1.90 percent, median estimates in separate Bloomberg surveys show. The year-end forecast fell to 1.65 percent from 2.1 percent.
Banks may be forced into more risky assets and lending practices if yields continue to hover about record low levels, said David Hendler, an analyst at financial research firm CreditSights Inc. in New York. Their net interest margin, a measure of lending profitability, has declined to 3.52 percent, the lowest since 2009, according to FDIC data.
“It doesn’t pay to be aggressive right now if you are a bank, but continuing to buy bonds near these levels is not sustainable in the long run,” Hendler said in an Aug. 14 telephone interview.
The Federal Reserve said in its quarterly survey of senior loan officers, released Aug. 6, that “domestic banks, on balance, continued to report having eased their lending standards across most loan types over the past three months.” Lending standards for large and medium-sized firms loosened, while those for small business were little changed for the fourth consecutive period.
Wall Street’s five biggest banks are off to their worst start in four years. JPMorgan Chase & Co. (JPM:US), Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley had combined first-half revenue of $161 billion, down 4.5 percent from 2011 and the lowest since $135 billion in 2008. The firms blamed the decline on low interest rates and a drop in trading and deal-making.
Low government bond yields are a legacy of the credit crisis that caused more than $2 trillion in write downs and losses at global financial institutions, according to data compiled by Bloomberg.
After cutting its target rate for overnight loans between banks in 2008 to a range of zero to 0.25 percent, the Fed under Chairman Ben S. Bernanke bought $2.3 trillion of Treasury and mortgage-related debt to reduce market interest rates and stimulate the economy.
The central bank owned $1.66 trillion of Treasuries as of August, ahead of China’s $1.16 trillion.
Investors are more willing to accept low yields “when you have large demand from the Fed as well as natural demand from banks,” said Matthew Duch, a fixed-income money manager at Calvert Investments, which oversees more than $12 billion in assets. “Are bonds where banks want to be right now? No, but given the uncertainty over regulation, the economy and still weak loan demand in the market it’s the best of lots of bad options,” he said.
Banks have “very conservative” balance sheets, JPMorgan Chief Executive Officer Jamie Dimon said in a July 13 conference call with analysts. The bank lent out $700 billion of its $1.1 trillion in deposits in the second quarter. “That would generally be considered totally conservative,” Dimon said.
JPMorgan increased the Treasury and government agencies portion of their available-for-sale credit portfolio to $11.743 billion as of June 30, from $8.351 billion at the start of the year, according to a filing with the Securities and Exchange Commission on Aug. 9.
“We get a lot of deposits in,” he said. “The extra deposits of $423 billion, plus equity, plus some other net liabilities, give us $522 billion that’s not being lent out that we have to invest.”
The global supply of the highest-quality securities, as measured by ratings companies, is poised to fall by as much as $4 trillion. Reforms such as the Dodd-Frank financial-overhaul law and global regulations set by the Bank for International Settlements require institutions to hold more top-graded debt.
Lenders have an added incentive to buy Treasuries after the Basel Committee on Banking Supervision proposed rules in 2011 that banks increase available capital to bolster the cushion against potential losses and better measure and control their risk. Treasuries’ safety and liquidity makes them suitable capital under regulations designed to prevent a repeat of the global financial crisis.
Loans are being damped by the slow recovery. Gross domestic product expanded at a 1.5 percent annual rate in the second quarter after a revised 2 percent gain in the prior three months, below the average of 2.6 percent since 1982, the Commerce Department said on July 27.
The share of U.S. households viewing the economy as heading in the wrong direction rose to 45 percent in August, the highest since November, from 36 percent in July, the Bloomberg Consumer Comfort survey showed today. The monthly expectations gauge dropped to minus 22 from minus 11. The weekly Bloomberg Consumer Comfort Index fell to minus 44.4 in the period ended Aug. 12, the lowest since January, from minus 41.9.
Household purchases, which account for about 70 percent of GDP, grew at the slowest pace in a year, according to the commerce department’s report on GDP.
Fed policy makers said Aug 1 they would provide more monetary stimulus “as needed.”
“There’s all sorts of good long-term developments that are occurring on household balance sheets, but you sense the Fed would like them to be not quite as thrifty and instead put a little more money to work,” said Jim Vogel, head of agency-debt research at FTN Financial in Memphis, Tennessee. “But that’s not going to happen without salary incomes rising.”
That explains the gap between deposits and lending, said Jeffrey Caughron, a partner at Baker Group LP in Oklahoma City who advises community banks on more than $30 billion of investments.
“It’s a function of inherently weak demand for loans and that relates to inherently weak demand in the economy,” he said. “Consumers, households, businesses: they’re paying down debt, they’re saving money, they’re not borrowing. They don’t have an appetite.”
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