Yield Curve Bites TD Banknorth

It warns on earnings and will sell off some investments.
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TD Banknorth

(BNK)

has become the latest financial institution to sell off investments whose value was hurt by a tricky interest rate environment.

The Portland, Maine-based lender said it would take a $45 million pretax charge in the fourth quarter in conjunction with the sale of $2.6 billion in mortgage-backed securities. The sale will results in an after-tax charge of $29.3 million.

The bank says the proceeds from the sale will be reinvested into "shorter-duration assets.''

"In the current interest rate environment, these actions mitigate our interest rate risk going forward," said William Ryan, the bank's chairman and CEO.

Excluding the charge, TD North said warned that fourth-quarter earnings will come in 2 cents shy of the current consensus estimate of 64 cents a share. The bank blamed the earnings shortfall on the squeeze in its net interest margin, one measure of the profitability of a bank's lending and deposit operation.

In recent months, a number of banks and institutions that are heavily invested in mortgage-backed securities have been restructuring their portfolios because of the flattening of the spread between short- and long-term interest rates. Some that announced similar restructuring charges are

Commerce Bancorp

(CBH) - Get Report

and

Friedman Billings Ramsey

(FBR)

.

The so-called flattening of the yield curve has reduced the value of many longer-term mortgage-backed securities that bear a low interest rate. Indeed, earlier this month, the yield curve briefly inverted, with the yield on the 10-year Treasury dropping below the yield on the two-year government bond.

An inverted yield curve is often seen as a precursor to a recession. But many economists say other factors may be influencing the bond market this time around.

Either way, a flat or inverted yield curve makes it difficult for banks to make money.

For the past few years, many banks feasted on the wide gap between short-term and long-term interest rates, by borrowing on the cheap and reinvesting the money in higher-yielding mortgage-backed securities. On Wall Street, this type of investing is called the carry trade, and it was a big source of income for many banks.

But the flattening yield has been the death knell for this kind of quick profit, and it poses a problem for banks that are heavily invested in interest-rate-sensitive securities.