KBRA Financial Intelligence

Analyzing the Surprise Surge in Long-Term Yields and How It Could Bolster Net Interest Margins

Traders Revamp Rate Cut Expectations

Market expectations for Fed rate cuts may be evolving toward a more moderate path than previously anticipated by policymakers and bond traders. In our August Insights report, KFI observed that the U.S. Treasury market had started to price in significant easing in monetary policy, months before the Federal Open Market Committee (FOMC) initiated its first rate cut in four years this September. This shift was marked by a notable decline in long-term yields, while shorter-term yields, particularly those on one-year maturities or less, remained relatively stable.

Since the Fed initiated its anticipated rate cut regime, those stubborn short-term rates have finally begun to ease as well. Conversely, longer-term yields are now experiencing upward pressure, with the 10-year yield reaching 4.3% at the end of October, its highest level since July. This has led to a narrowing of the spread between the 10-year and three-month (T10Y3M) Treasury yields, bringing the yield curve’s inversion to its smallest margin in nearly a year by late October.

This shift in long-term yields carries significant implications for banks, whose profitability, as measured by net interest margin (NIM), depends largely on their ability to fund long-term lending through deposits acquired at short-term rates. In five of the last six quarters to 2Q 2024, FDIC data shows that the costs banks accrued to acquire and maintain deposits grew at a greater rate than their loan yields. This contributed to a third consecutive quarterly decline in the industrywide NIM. By contrast, a fading of the inversion in the T10Y3M, which has now persisted for almost two years, signals a steepening of the yield curve. If that trend continues, it could contribute to a re-expansion of NIMs in the coming months, reversing the trajectory KFI highlighted in September when NIMs were facing continued compression from rising deposit costs and a slide in long-term yields.

One likely factor behind the increase in the 10-year yield is shifting sentiment among market participants. As FOMC members voted to cut the benchmark fed funds rate by 50 basis points (bps) on September 17, it also laid out a path toward 50 bps of further cuts through the end of the year as a median expectation in its dot plot. By the start of October, market participants were largely expecting even more dovishness from policymakers. At that time, CME’s Fedwatch indicated that positioning in 30-day fed funds futures contracts implied a two-thirds probability of at least 75 bps of cuts through 2024’s final two FOMC meetings. As of October 31, the probability of 75 bps collapsed to 0%, while the estimated probability of a more moderate path toward 50 bps of cuts by the end of the year skyrocketed to 75%.

Macro Data and Deficit Financing Drive up Yields

Recent data releases related to employment and inflation have eroded the dovish expectations that market participants had been pricing in. Core consumer price growth has largely held steady since July. The Consumer Price Index (CPI), excluding food and energy, has ranged between 3.2%-3.3% year-over-year (YoY) throughout that span. This signals that price pressures among core constituents in the CPI may be getting sticky, keeping inflation well above the central bank’s 2% target. Though the latest nonfarm payrolls report showed job growth slowing to a nearly four-year low in October, part of the weakness could be chalked up to temporary factors like ongoing labor union strikes and the impact of Hurricanes Helene and Milton. The response rate for the business survey that informs the payrolls figure was just 47.4%, the lowest collection rate recorded since 1991. Additionally, the national unemployment rate came in at just 4.1%, remaining below a 2024 high of 4.3% reported in July, and partly counterbalancing concerns about the slowing rate of job creation.

If the fed funds rate remains elevated longer than expected, it could sustain higher long-term rates across the yield curve, raising the interest costs tied to all new debt issued by the U.S. government. This is an increasingly significant concern, considering the U.S. fiscal 2024 deficit ballooned to more than $1.8 trillion, the third-largest annual deficit ever and up 8.1% YoY. The deficit is being supercharged by mounting interest payments that the federal government owes on its outstanding debt. Annual federal expenditures on interest payments recently surged to a record high north of $1.1 trillion, ramped up by aggressive monetary tightening between 2022-23. The expansion of the deficit signals that the U.S. is far outspending the revenue it is taking in, increasing the risk associated with holding its long-term Treasury bonds. In turn, that could be generating demand for higher yields to compensate U.S. creditors.

Mortgage Rate Reversal

Macro trends like these also impact downstream financial products, such as mortgage rates. Following a steep decline through September, mortgage rates have since reversed course. After reaching a two-year low under 6.1%, the average rate on a 30-year fixed rate mortgage rebounded by 64 bps throughout October. That was its largest monthly increase in more than two years. Data from the Philadelphia Fed’s latest FR Y-14M release indicates that although both the number of new originations and the dollar value of new mortgage accounts among large U.S. banks did rebound from series lows in 2Q 2024, each gauge continued to drop on an annual basis for a tenth consecutive quarter. The good news for many banks in the mortgage business is that the outstanding body of residential mortgages are in historically good standing.

KFI last analyzed the state of the residential mortgage market in September, highlighting 2Q 2024 data. All U.S. banks (excluding those with foreign offices) were required to complete the filing their 3Q 2024 Call Reports by October 30. All quarterly data is now available to KFI clients via our web application and Excel add-in. Among nearly 4,400 reporting commercial and savings banks, the average rate of delinquency impacting residential mortgage loans was just 1.43%, up slightly from 1.39% in the previous quarter but still 23 bps below the five-year moving average. Among the 198 banks with more than $1 billion in mortgage loans, delinquency rates are only slightly higher at 1.51%.

Recent M&A and Bank Failures

Fitchburg, Massachusetts-based Rollstone Bancorp, as well as its $917 million commercial bank Rollstone Bank & Trust (KFI Score: B), announced it will merge into Newburyport, Massachusetts’ River Run Bancorp for an undisclosed price in an October 1 press release. Rollstone will become the third banking subsidiary of River Run, alongside $1.6 billion Newburyport Bank (KFI Score: B) and $1.1 billion Pentucket Bank (KFI Score: B). The transaction is expected to close in 1H 2025.

Yuma, Arizona-based Western Arizona Bancorp Inc. and Phoenix’s $3.4 billion OneAZ Credit Union (KFI Score: B+) announced in an October 3 press release that OneAZ would acquire the former’s $578 million subsidiary bank, 1st Bank Yuma (KFI Score: B+), in an all-cash transaction. The price of the deal was not disclosed, but it is expected to close by 2026.

Richland, Washington’s HAPO Community Credit Union (KFI Score: B+) announced in an October 8 press release that the $2.4 billion credit union would acquire $653 million lender Community First Bank (KFI Score: B+) for an undisclosed price. The transaction is expected to close in 3Q 2025.

Grasshopper Bank, N.A. (KFI Score: B), an $870 million subsidiary of Grasshopper Bancorp, Inc. in New York, announced an agreement to acquire $495 million savings bank Auto Club Trust (KFI Score: B-), headquartered in Dearborn, Michigan, in a cash and stock transaction of undisclosed value, according to an October 8 press release. The deal is expected to close in 1H 2025.

Georgia Banking Company, Inc., the parent company of $2 billion Georgia Banking Company (KFI Score: C+) and Primary Bancshares Corporation, the parent company of $353 million Georgia Primary Bank (KFI Score: B), jointly announced in an October 9 press release that the two Atlanta-based firms will merge in a cash and stock transaction with an aggregate value of approximately $27 million. The deal is expected to close in 1H 2025.

Family Savings Credit Union (KFI Score: B+), a $1 billion credit union in Gadsden, Alabama, announced an agreement to acquire the Valley Head and Ider, Alabama, branches of Merit Bank (KFI Score: B), a $434 million lender in Huntsville, Alabama, for an undisclosed price in an October 10 press release. The acquisition is expected to close in 1H 2025.

Bravera Holdings Corp. (KFI Score: B), parent of $3.2 billion Dickson, North Dakota, lender Bravera Bank (KFI Score: B), announced in an October 11 press release that it has agreed to acquire $265 million VISIONBank (KFI Score: B), which operates three branches in Fargo, North Dakota, for an undisclosed price. The acquisition is anticipated to be completed in late 2024.

Austin Bancorp, Inc., the parent company of $2.9 billion lender Austin Bank, Texas National Association (KFI Score: B+), announced an agreement to acquire Houston’s The Chasewood Bank (KFI Score: B-) for an undisclosed price in an October 16 press release. Chasewood serves northern Harris County in Texas, with two locations and assets of approximately $83 million. The merger is expected to close in December 2024.

First Liberty National Bancshares, Inc., parent company of $475 million First Liberty Bank (KFI Score: B) announced in an October 17 press release that it has agreed to acquire $190 million Pearland State Bank (KFI Score: A-) and $151 million First National Bank of Alvin (KFI Score: A) for an undisclosed price. Both of those banks are currently owned by Pearland, Texas-based Coastal Bancshares, Inc. The acquisition is expected to close in 1Q 2025.

Jewel Box Financial Services, Inc. of Columbus, Wisconsin, parent company of $521 million lender Farmers & Merchants Union Bank (KFI Score: A-), and River Holding Company, the parent company of $178 million Sauk City, Wisconsin-based lender Wisconsin River Bank (KFI Score: B+), jointly announced the signing of an all-stock deal to merge the two subsidiaries, according to an October 17 press release. The surviving bank will operate under the Farmers & Merchants Union Bank name. The deal is expected to close in 1Q 2025.

First Commerce Bancorp, Inc., the parent company of $665 million First Commerce Bank (KFI Score: B+), announced in an October 17 press release that the Lewisburg, Tennessee, lender would acquire the $187 million Peoples Bank of Middle Tennessee (KFI Score: B+), headquartered in Shelbyville, Tennessee, for an undisclosed price. The acquisition is expected to close in 1Q 2025.

On October 18, The First National Bank of Lindsay was closed by the Office of the Comptroller of the Currency (OCC), marking the second U.S. bank failure of 2024. The First National Bank of Lindsay held total assets of $114 million and was most recently scored as a C in 2Q 2024 by KFI, down from B- in the prior quarter. The OCC cited “false and deceptive bank records and other information suggesting fraud” in its closure announcement, implying management may have been misreporting its financials. The FDIC said it would take six months to complete an investigation regarding the failure ahead of making its findings public.

Clara City, Minnesota’s Citizens Alliance Bank (KFI Score: B), a $1.5 billion subsidiary of Forstrom Bancorporation, announced in an October 19 press release that it has agreed to acquire Cascade, Montana-based Stockmens Bank (KFI Score: B-), a $42 million lender, for an undisclosed price. The acquisition is expected to close in early 2025.

Atlantic Union Bankshares Corporation (NYSE: AUB) (KFI Score: B), a $24.8 billion bank holding company based in Glen Allen, Virginia, and Sandy Spring Bancorp (NASDAQ: SASR) (KFI Score: B), a $14 billion lender in Olney, Maryland, jointly announced in an October 21 press release that Atlantic Union Bankshares will acquire Sandy Spring Bancorp in an all-stock transaction valued at approximately $1.6 billion. The deal is expected to close by 3Q 2025.

Y-12 Federal Credit Union (KFI Score: B+), a $2 billion credit union based in Oak Ridge, Tennessee, announced in an October 23 press release that it has agreed to buy $413 million lender First State Bank of the Southeast, Inc. (KFI Score: C+), based in Middlesboro, Kentucky, for an undisclosed price. The deal is expected to close in early 2025.

Griggsville, Illinois-based Griggsville Bancshares, the parent company of $148 million lender Farmers National Bank of Griggsville (KFI Score: B), announced in an October 23 press release that it will acquire Bluffs, Illinois’ Scott Morgan Bancorp, the parent company of $60 million Bank of Bluffs (KFI Score: B-), merging the two subsidiaries. The terms of the deal were undisclosed, but it is expected to close in 2Q 2025.

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