Andrew Bary
A sharp rise in rates since the end of the third quarter widened losses on bank securities portfolio and could become an investor issue again when banks start reporting their fourth-quarter results in the next week.
Bank of America has the largest unrealized losses in the banking industry and could be a focus of investor attention.
Barron’s estimates that Bank of America’s paper losses on a portfolio of $568 billion of bonds, mostly U.S. agency mortgage securities, could widen to $111 billion or more, compared with $86 billion at the end of September.
Industrywide, total unrealized losses could top $500 billion, up from $364 billion at the end of the third quarter. These losses involve all banks insured by the FDIC. The total potential losses would still be narrower than the nearly $700 billion at banks at the end of the third quarter of 2022. Why the wider losses recently? Bond prices move inversely with yields.
The yield on the Treasury 10-year note rose about 3/4 of a percentage point in the fourth quarter to end the year at 4.57% and the yield has risen further since then to 4.67%. Yields on mortgage securities also have risen sharply, depressing the value of bank portfolios that are heavy in mortgage issues.
Bank of America’s big paper losses are in a portfolio that is classified as held to maturity. Under accounting rules, paper losses on such portfolios don’t depress reported capital although the losses are real in an economic sense. The bank had about $200 billion of tangible equity at the end of the third quarter. Barron’s has written about the Bank of America unrealized bond losses periodically over the past few years.
Bank of America had $111 billion of paper losses on its held-to-maturity portfolio on June 30, 2024, and Treasury 10-year bond rates were higher at year-end 2024 than they were then. That suggests the losses could be equal to that amount or larger at year-end.
The Bank of America unrealized bond loss greatly exceeds the one at industry leader JPMorgan Chase, which had paper losses of about $20 billion on its held-to-maturity portfolio at the end of the third quarter.
Bank of America and other banks also hold bonds in portfolios designated as available for sales. Changes in values of those portfolios do affect capital.
Bank of America and most banks with large held-to-maturity portfolios plan to let the underlying securities mature steadily over time with the paper losses gradually melting away. There is minimal credit risk on the Bank of America portfolio since it consists almost entirely of Treasury securities and government agency mortgage securities.
Wall Street has been paying considerably less attention to this issue over the past year relative to 2022 when Silicon Valley Bank failed in part due to bond losses. The investor concerns ebbed further after a bond rally in the third quarter of 2024 narrowed the losses across the industry.
Analyst Mike Mayo of Wells Fargo wrote during the summer that nearly half of all bank unrealized bond losses had been recouped from the low point in 2022 and that banks would benefit from greater financial flexibility as a result.
He wrote that the “nightmare” scenario of a liquidation of bank bond portfolios “should be put to rest.”
Bank of America executives have said that the bank’s held-to-maturity portfolio continues to roll off, or steadily mature. That process is slow, however, at a recent rate of 6% to 7% annually. The bank declined to comment, citing its prior public statements.
Analysts have rarely asked much about the portfolio in recent quarterly conference calls and focused on the bank’s margins, profits, segment performance and credit outlook.
Some analysts have said the Bank of America bond portfolio needs to be looked at holistically along with other assets as well as its huge deposit franchise.
Bank of America’s stock, which gained 0.3% to $46.21 Wednesday, is up 35% in the past year, trailing a 41% advance for rival JPMorgan Chase. Bank of America stock is considerably behind JP Morgan over the past three years — an 0.6% annualized return against 16.5% a year for JP Morgan, Bloomberg data show. Bank of America stock is still below its 2022 high of almost $50.
The bulk of the Bank of America held-to-maturity portfolio consists of agency mortgage securities with a final maturity of more than 10 years, accordin g to its third quarter 10-Q.
Much of the Bank of America held-to-maturity portfolio was purchased near historic lows in rates during 2020 and 2021. The average yield on its held-to-maturity portfolio is just 2%, considerably below current market yields on government and mortgage securities of 4.5% to 6%. The low yield on the portfolio could be a drag on profits for some time.
JP Morgan Chase has smaller paper losses on its bond portfolio in part because CEO Jamie Dimon tempered the bank’s investments when rates were at historic lows. Dimon didn’t think the risk/reward of such investments was favorable and was willing to accept tighter profit margins at the time to mitigate risk.
Write to Andrew Bary at andrew.bary@barrons.com