U.S. banks are buying U.S. government securities at the fastest pace in nine months as lenders retreat to the safety of Treasuries with the economy expanding slower than forecast and loan demand dormant.
Commercial banks bought $65 billion of U.S. debt in the past seven weeks, as their total holdings reached $1.68 trillion, Federal Reserve data show. The purchases were the most since $79.1 billion in the period ended July 21, just before the recovery began to falter and Fed Chairman Ben S. Bernanke signaled policy makers would conduct a second round of bond purchases to spur growth.
Economists from JPMorgan Chase & Co., the second-largest U.S. bank by assets, to Credit Suisse Group AG, the No. 2 Swiss lender, are lowering growth forecasts as rising fuel prices cut disposable income and housing prices continue to fall. Bonds are helping bolster earnings as the Fed keeps its target interest-rate for overnight loans between banks at a record low.
“The idea that we’re going to see anything remotely approximating robust growth is quickly fading,” said Jeffrey Caughron, a partner at Baker Group LP in Oklahoma City who advises community banks on investments of more than $30 billion. “They simply don’t have the loan demand, or good loan demand. They have to keep their money working for them, so there’s no place else to go but the bond market.”
Drop in Loans
Debt analysts at New York-based JPMorgan said in an April 29 report that total loans at the 30 banks they cover, including Bank of America Corp. and Citigroup Inc., fell by 1.08 percent, or $46.7 billion, in the first quarter to $4.29 trillion. They increased 0.14 percent in the final three months of last year.
Loans fell even though assets increased by 1.47 percent, or $146.6 billion, to $10.1 trillion, according to the JPMorgan analysts. While Fed data show banks are carrying 3.5 percent more commercial and industrial loans on their books now than in September, or $1.25 trillion, that’s still 23 percent below the peak reached in October 2008 of $1.62 trillion.
Banks’ U.S. government debt purchases are helping to support demand for the record amount debt the Obama administration is selling to finance the $1.4 trillion budget deficit as the Fed winds down its $600 billion bond-purchase program known as quantitative easing in June.
Treasuries returned 1.15 percent on average in April, including reinvested interest, the most since they gained 2.05 percent in August, according to Bank of America Merrill Lynch’s U.S. Treasury Master index.
The yield on the benchmark 10-year note fell 10 basis points, or 0.1 percentage point, last week to 3.29 percent, and is down from the this year’s high of 3.77 percent on Feb. 9, according to Bloomberg Bond Trader data. The price of the 3.625 percent note maturing in February 2021 rose 29/32, or $9.06 per $1,000 face value, to 102 25/32 last week.
Treasuries today halted last week’s rally after President Barack Obama said Al Qaeda founder Osama bin Laden had been killed in a U.S. military operation, reducing demand for the safest assets. Ten-year bond yields rose one basis point to 3.30 percent at 10:07 a.m. in New York.
Credit Suisse, one of the 20 primary dealers of U.S. government securities obligated to bid at Treasury auctions, sees yields ranging from 3.25 percent to 3.75 percent through year-end. The weighted average of 76 forecasts in a Bloomberg survey that gives a greater emphasis to recent estimates is for the yield to end the year at 3.93 percent.
“Our base case for the looming end of QE is not a catastrophic sell-off,” strategists at Credit Suisse led by Carl Lantz in New York wrote in an April 29 report.
Bonds rallied last week as Bernanke signaled no plans to raise rates and the Commerce Department said April 28 that gross domestic product rose at a 1.8 percent annual rate in the first quarter, compared with 3.1 percent at the end of 2010. The median estimate of economists in a Bloomberg survey was for 2 percent growth.
GDP will likely expand 2.9 percent this year, based on a survey of 74 economists by Bloomberg, down from estimates of 3.2 percent in February. Forecasts dropped as the average price of a gallon of gasoline reached $3.89 on April 27, the highest in more than two years. Average hourly earnings adjusted for inflation shrank 1 percent in the 12 months ended in March.
Residential real-estate prices measured by the S&P/Case-Shiller index of properties in 20 cities fell 3.3 percent in February from a year earlier, the biggest drop since November 2009.
Banks are facing the biggest percentage drop in quarterly revenue in three years, led by lower lending and reduced fees, according to data compiled by Bloomberg. Revenue at Bank of America, JPMorgan, Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley fell 13.3 percent in the first quarter from a year earlier.
“Bank earnings are not good,” said Hideo Shimomura, who helps oversee the equivalent of $73.2 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., a unit of Japan’s biggest lender. “They cannot take much risk. It’s supportive for Treasuries.”
Banks can profit by borrowing money from the Fed at almost nothing and investing in Treasuries, profiting from the near record gap between short- and long-term rates.
Ten-year Treasuries have yielded an average of 2.89 percentage points more than the Fed’s target federal funds rate since Lehman Brothers Holdings Inc. collapsed in September 2008. In the decade before that, the difference averaged 1.15 percentage points.
Lenders have raised U.S. government bond holdings 4.3 percent since March 2, after keeping them unchanged in the first nine weeks of the year. Banks increased Treasuries by more than 12 percent annually in each of the past three years as they sought less risky assets following the collapse of global credit markets.
“Banks are getting some leading indicators from their own loan growth,” Amitabh Arora, an interest-rate strategist in New York at Citigroup. “There continues to be a decline in consumer loans” including mortgages and credit cards, he said.
Banks have few alternatives to Treasuries as sluggish home sales reduce the amount of AAA-rated mortgage-related debt sold by government-chartered agencies Fannie Mae and Freddie Mac.
Offerings of bonds backed by consumer loans have fallen to $35 billion this year from $127 billion in all of 2010 and $184 billion in 2009, according to Bloomberg data. The U.S. savings rate has risen to 5.5 percent from 1.2 percent in 2005, according to government data.
The Fed said last month that consumer borrowing totaled $7.62 billion in February, compared with the peak of $17.3 billion in August 2007. Total bank assets have grown about 17.6 percent over that time to $12.2 trillion.
Lenders have an added incentive to buy Treasuries after the Basel Committee on Banking Supervision proposed rules on Oct. 4 that banks increase available capital and improve their measurement and control lending risk.
Banks will have less than five years to comply with the so-called Basel III rules for minimum tier-1 capital ratios and until Jan. 1, 2019, to meet the capital buffer requirements. The Treasury Borrowing Advisory Committee forecast in February that banks may have as much as $1.6 trillion in demand for Treasuries in the next five years based on the evolving rules.
“You have an environment effectively where the private markets are in deleveraging mode and the governments are in re-leveraging mode,” said Jeffrey Rosenberg, head of global credit strategy research at Bank of America Merrill Lynch in New York.