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Banks step up purchases of US Treasuries

Record gap of $1.77tr between deposits and loans has expanded 15% since May

Gulf News

New York: The gap between US 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 per cent to $8.88 trillion in the two months ended July 31, business lending rose 0.7 per cent to $7.11 trillion, Federal Reserve data show. The record gap of $1.77 trillion has expanded 15 per cent 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 US economy, unemployment above 8 per cent 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 per cent 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.”

Borrowing Rises

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 US households have risen to 4.4 per cent of incomes as of June from 1.7 per cent 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 per cent on the deposits, its bond holdings are yielding about 3.25 per cent, he said.

Seeking Safety

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 per cent, compared to the average of 1.26 per cent over the past decade.

Yields on 10-year Treasury notes rose 15 basis points, or 0.15 per centage point, last week to 1.81 per cent. The price of the 1.625 per cent security maturing in August 2022 declined 1 12/32, or $13.75 per $1,000 face value, or 98 9/32. The rate was little changed today as of 11:34 a.m. in Tokyo.

They increased from a record low 1.379 per cent on July 25 as investors became more optimistic about the economy. The US added 163,000 jobs last month, a government report showed Aug. 3, more than the 100,000 projected by analysts. Sales at US retailers increased 0.8 per cent, more than the 0.3 per cent forecast and following a 0.5 per cent slide in June, Commerce Department data released Aug. 14 showed.

Rate Forecast

The benchmark notes will yield 1.60 per cent by the end of September, below June’s projection of 1.90 per cent, median estimates in separate Bloomberg surveys show. The year-end forecast fell to 1.65 per cent from 2.1 per cent.

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 per cent, 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.

Recession Legacy

Wall Street’s five biggest banks are off to their worst start in four years. JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc. and Morgan Stanley had combined first-half revenue of $161 billion, down 4.5 per cent 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 per cent, 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.