The Bond Selloff Adds To The Pressure On Regional Banks

Investors are exerting pressure on regional banks by demanding higher yields to own their bonds, which could worsen the impact of rising deposit costs already affecting lenders. The spread on regional-bank bonds over US Treasuries has risen by about 2 percentage points or more since early March, following the failures of Silicon Valley Bank and Signature Bank. 

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This spread widening affects actively traded bonds of lenders with $150 billion to $220 billion in assets, such as Huntington Bancshares and M&T Bank. 

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While the spread on 10-year JPMorgan Chase bonds increased by only about 0.1 percentage point over the same period, the spread on smaller banks' bonds has grown due to concerns about their health.

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Federal regulators have signaled that banks with as little as $100 billion in assets could be forced to issue more long-term bonds to create a buffer of debt that can be converted into equity if a bank becomes insolvent, reducing the need for taxpayer-funded bailouts. 

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However, the impact for regional banks could be selling bonds into a market that is not eager to purchase them, as higher funding costs will require them to issue more bonds. 

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The prospect of higher funding costs is one reason why many equity analysts are negative on regional banks, as they will not be able to produce returns as they did in the past.

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Higher yields on regional-bank bonds will not immediately translate to higher borrowing costs for regional lenders, as they would still be overwhelmingly funded by deposits even after new regulations are applied. 

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However, higher borrowing costs could be a drag on midsize banks, especially when many are already having to increase deposit rates to retain customers.

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 Huntington, for example, could reduce its annual net interest income by about $130 million if it replaced all of its bonds with new bonds that paid 1.5 percentage points more in interest over time. 

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Huntington could also need to issue as much as $6 billion in new bonds to satisfy expected regulations, which could result in some margin erosion depending on how the proceeds are invested.

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