Several banks have announced balance sheet restructurings this year in a bid to shore up their margin and position their institutions for better and stronger future earnings.
While there were a handful of restructurings in the first half of the year, repositioning activity has remained popular in third-quarter earnings announcements as bankers prepare for a high-interest rate environment. The earnings strategy that worked in 2020 and 2021 hasn’t worked for many banks in 2023 — and may be increasingly painful in 2024. On the other hand, restructurings force most banks to recognize a one-time loss, which can be a difficult pill to swallow.
A balance sheet restructuring entails “abandoning lower-yielding assets and placing the funds into higher-yielding assets,” says Dan Flaherty, Janney Montgomery Scott’s FIG Group managing director. “The problem, and why many banks are hesitant to do it, is that when you sell those lower-yielding securities [after] rates have gone up, you’re going to be booking a loss.”
Accounting rules mean that these transactions involve securities in the bank’s available-for-sale portfolio. The resale value of these bonds has fallen as rates have risen, and banks must report this quarterly loss in value in their accumulated other comprehensive income. In addition to the paper loss, the securities have contributed to lackluster earnings and compression in the net interest margin.
If a bank’s securities portfolio is underwater, margin expansion in 2024 is going to be almost impossible, says Scott Hildenbrand, Piper Sandler Cos.’ chief balance sheet strategist and head of the financial strategies group.
In contrast, the proceeds from selling these securities — after realizing the loss — allow executives to do several things: pay off expensive wholesale fundings, buy newer bonds at a higher rate or make new, more profitable loans. Depending on how the bank uses the funds, these transactions can offset margin compression, decrease interest rate risk, improve capital ratios, increase future earnings and give the bank additional flexibility for future growth, Hildenbrand and Flaherty say.
One aspect of a restructuring is the calculable certainty around the earnings hit and how long it will take the bank to recover from the loss, Hildenbrand points out. Indeed, Hovde analysts in an October research note encouraged management teams at banks with “plentiful” capital to consider transactions that have a payback period of two years or less to offset the “sizable NIM drag for years” that low-yielding assets have on the balance sheet.
However, banks may be spooked at the possible investor or depositor reaction to a restructuring, given what happened to Silicon Valley Bank. Hovde analysts note that there’s no consensus among investors on whether restructuring is a good thing, and some view it as not adding value or risky, for example, should the bank use the funds to purchase mortgage-backed securities and interest rates decline.
Still, some banks have tried it anyway. One of them is Richmond, Virginia-based Atlantic Union Bankshares Corp., which announced two balance sheet restructurings in 2023: one at the end of the first quarter and one at the end of the third. While the bank is always thinking opportunistically about its balance sheet, SVP Director of Strategic Finance and Treasurer John Tull says an increase in deposit costs and pressure on the margin at the start of 2023 led the $20.7 billion bank to explore various transactions during the first quarter. (For more details on Atlantic Union’s restructurings, see the end of this article.)
Tull says the feedback from investors on the transactions has been positive; they appreciate that the bank is “always looking for opportunities to improve go-forward earnings from a risk-adjusted mindset.”
Hildenbrand recommends that banks considering a restructuring ensure they have excess capital to absorb the loss or find an offsetting transaction that would carry a gain. When announcing the transaction, he says bank management should make sure it is easy to understand, its purpose is clear and concise and the announcement itself is transparent.
Some investment bankers say 2023 may be the ideal time for banks to announce a restructuring and take a loss, given that most banks’ stock values are down in light of the spring banking stress and runup in funding costs. A restructuring is a chance for executives to show that they’re taking bold and tangible steps to improve liquidity and capital ratios, along with the future earnings outlook.
“Good banks take advantage of what the market gives them,” Flaherty says. “In down markets or rising rate markets, the opportunity is to restructure. [These banks are] taking what’s there so that when the next thing comes around, they’re ready to go.”
Overview of Atlantic Union Bankshares Corp.’s 2023 Restructurings
Source: Public filings and earnings calls
First quarter: The bank sold about $500 million in AFS securities yielding 3.4% for a pre-tax loss of $13.4 million. The sale brought the securities book back to historical levels; the bank used the proceeds to reduce Federal Home Loan Bank borrowings that cost 4.75%.
The transaction carried a two-year earn-back period; executives said it would be 1.8% accretive to EPS, add 13 basis points to the margin, accrete 6 basis points to the bank’s return on assets, boost the return on tangible common equity ratio by 36 basis points and add 20 basis points to the tangible common equity ratio.
Third quarter: The bank sold 27 properties it owned for a pre-tax gain of $27.9 million and used the proceeds to offset a pre-tax loss of about $27.7 million it would take in selling $228.3 million of available-for-sale securities.
The two transactions were capital neutral; the bank reinvested the proceeds into AFS securities yielding about 6%. The trade increased earnings per share by 2%, expanded net interest margin by 5 basis points and reduced the efficiency ratio by 24 basis points.
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