February 01, 2010, 12:42 AM EST
By Dakin Campbell
Feb. 1 (Bloomberg) -- Wells Fargo & Co., unlike its three biggest competitors, is so convinced interest rates will rise that it sacrificed as much as $1 billion last year cutting back on fixed-income investments.
The nation’s fourth-largest bank, whose biggest shareholder is Warren Buffett’s Berkshire Hathaway Inc., reduced investments in mostly fixed-income securities by $34 billion in 2009’s second half, company filings show. JPMorgan Chase & Co., Bank of America Corp. and Citigroup Inc. boosted their holdings by an average of $35.5 billion.
By scaling back on the so-called carry trade, in which banks borrow in overnight lending markets at rates near zero and invest in higher-yielding securities, San Francisco-based Wells Fargo aims to protect against losses when rates rise. The three other lenders increased investments on the theory that profit will outpace any future losses.
“The bias is for higher rates,” Chief Executive Officer John Stumpf, 56, said on the company’s fourth-quarter earnings call. “We’re willing to wait for that to happen. We think that’s the better trade.”
Stumpf’s stance may put him at odds with the Fed, which said Jan. 27 that it would keep rates low for an “extended period.” The majority of traders see no increase before the September policy meeting, according to futures traded on the Chicago Board of Trade.Wells Isn’t ‘Speculating’
“I applaud Wells,” said Chris Whalen, managing director of Institutional Risk Analytics in Torrance, California. “The other three are speculating, taking a position on risk, and Wells is not.”
JPMorgan CEO Jamie Dimon told analysts on the fourth- quarter earnings call that the bank’s exposure to rising rates was “way down” after having been high.
“I wouldn’t worry about it that much,” Dimon, 53, said on the call. JPMorgan spokesman Joseph Evangelisti declined to comment beyond Dimon’s remarks.
Wells Fargo had an investment portfolio of $172.7 billion at the end of 2009 after the reductions. Citigroup led increases at the three largest U.S. banks, adding $47.5 billion of investments in securities to bring it to $254.6 billion. Citigroup spokesman Jon Diat declined to comment.
Bank of America’s investment portfolio grew to $301.6 billion at the end of the year from $257.5 billion in June, according to company filings. In the company’s fourth-quarter earnings call, Chief Financial Officer Joe Price said the bank would benefit from rising rates because it would receive more income from loans and other interest-bearing assets. Spokesman Scott Silvestri declined to elaborate.Bankers’ ‘Complacency’
Some banks may not be taking the danger of rising rates seriously enough, says Nancy Bush, an independent bank analyst at NAB Research LLC in Annandale, New Jersey.
“There is a great deal of complacency right now that rates are going to stay low for a long time,” she said. “When that happens you always run the risk of a shock.”
Wells Fargo is paying a price for playing it safe.
If the bank had left its investments unchanged at the end of June, it would have earned about $1.15 billion of pretax income from the carry trade during the next six months, assuming an average yield of 6.78 percent on its debt securities and a top funding cost of 3.40 percent. The yield and funding costs are based on company filings.Loan Demand Lags
Chief Financial Officer Howard Atkins said Wells Fargo is willing to forgo short-term income to avoid the risks of bigger losses down the road. “We don’t believe in the carry trade,” he said on the conference call. As one of the nation’s two biggest mortgage lenders with Bank of America, Wells Fargo could suffer if higher rates damp demand for home loans.
Banks have turned to investments in securities in part because of a lack of loan demand from consumers and businesses. The recession led households to reduce debt and increase savings, leaving banks with a larger pool of deposits and fewer options to deploy them.
“Banks are experiencing strong deposit growth and weak loan demand and they have nothing else to do but to buy bonds,” said Jeffrey Caughron, an associate partner in Oklahoma City at Baker Group Ltd., which advises community banks investing $25 billion.
Some banks bought bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae, taking advantage of a Fed program to purchase $1.25 trillion of the securities that pushed up prices. The program is now slated to end in March, and the Fed reiterated its intention to do so in its Jan. 27 statement. Without government purchases, the bonds may fall in value.Interest-Rate Risk
“The composition of available-for-sale securities portfolios has stayed mostly in agency MBS,” CreditSights Inc. analysts led by David Hendler wrote in Jan. 19 report. Those bonds “can be extremely tricky to manage in a rising rate environment,” they wrote.
Federal Deposit Insurance Corp. Chairman Sheila Bair urged U.S. banks to prepare for losses driven by an end to low interest rates, saying rapid rate changes are “worrisome” because they may harm lending and earnings.
“If there is evidence that this risk is building, I think we need to know more about it and how we can defuse it before the pressure causes problems for insured banks and thrifts,” Bair said Jan. 29 at an FDIC conference in Arlington, Virginia.
--With assistance from Jody Shenn in New York. Editors: Eric Gelman, Alec McCabe.
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