Bank of America has biggest losses in bond portfolio among peers

Bank of America had $862 billion in debt securities at the end of 2022 totaling nearly $3 trillion in debt securities. Of that, $632 billion of bonds, mostly federal agency mortgage securities, were classified as near maturity for accounting purposes.

Banks are not required to record a loss on the change in value of those securities unless the loan is sold. Nevertheless, holdings in that bucket, which carry minimal or no credit risk, were still showing a loss of about $109 billion at the end of 2022 due to increased interest rates over the past year.

This compares with a loss of $36 billion for similarly classified bond portfolios.

JPMorgan Chase

(JPM), for $41 billion

Wells Fargo

(WFC), and $25 billion in

City Group

(c) and only at $1 billion

goldman sachs group

(GS), based on each company’s 10-K filing with the Securities and Exchange Commission.

The attention on the banks’ bond losses has increased since regulators seized on the Silicon Valley bank on Friday.

SVB Financial
,

The lender’s parent had unrealized losses of $15 billion on its $91 billion held-to-maturity bond portfolio. This was equivalent to almost all of $16 billion in tangible capital.

Banks classify their loans and other securities under another accounting treatment called available for sale. Any loss on these securities should be reflected in the capital level and reduce capital, even if the debt is not sold. Bank of America had $221 billion in bonds classified under this accounting treatment, and that bucket showed losses of about $4 billion at the end of 2022.

Bank stocks fell again on Monday after last week’s beating. In late afternoon, Bank of America closed down 3.8% at $29.13 after trading below $28 early in the session. JPMorgan Chase fell 1.2% to $132 and Wells Fargo (WFC) fell 5% to $39.29.

The idea behind the held-to-maturity accounting rule is that banks invest in Treasury and federal agency mortgage securities that carry minimal or zero credit risk for the long term and intend to hold them until the bonds mature. Assuming this occurs, losses from changes in bond prices melt away as the bond matures, bringing about full repayment of the principal.

Like other large banks, Bank of America has plenty of liquidity and is under no pressure to sell any of its held-to-maturity bond portfolios and realize losses.

Bank of America ends 2022 with $1.9 trillion in deposits, including the roughly $1.4 trillion in retail deposits that remain at a given bank because of trouble moving them. The Federal Reserve is also providing a backstop in the form of loans to banks when they need them.

But the size of banks’ bond portfolios and any resulting losses are indicative of the interest-rate risk, or duration risk, that lenders face. In that sense, Bank of America is a standout among its peers.

The company had no comment.

“So, the big question for investors and depositors is: How much duration risk did each bank take on in their investment portfolios during deposit growth? [in recent years], and how much was invested in Treasuries and agency yields? Michael Cembalist, president of investment strategy at JPMorgan Asset Management, wrote in a client note Friday.

Semblist measured the theoretical hit on bank capital that lenders would face from the “immediate realization of unrealized securities losses,” in terms of a measure called Common Equity Tier One Capital. SVB stood out with the biggest impact ever. Bank of America was the most affected among the biggest banks.

If the held-to-maturity bonds are sold, any loss is required to be realized and capital reduced. Unrealized losses of $109 billion in the held-to-maturity bond portfolio at Bank of America compare with year-end tangible common equity of $175 billion.

The bank’s $632 billion held-to-maturity bonds yield just 2%. Most of that, about $500 billion, consists of agency mortgage securities maturing in 10 years or more.

Wells Fargo analyst Mike Mayo says that focusing on mark-to-market losses on Bank of America’s bond portfolio neglects the value of the vast deposit base that essentially finances those holdings.

They argue, “the underlying gain on the deposit offsets” any loss on the bond portfolio. It’s a subtle idea because banks don’t charge a price on their deposit franchise. Mayo says that the Bank of America deposit base, on which the bank is paying 1% or less for the bulk of its retail accounts, is extremely valuable and difficult if not impossible to replicate. Low-cost deposits increase when interest rates rise, assuming that the spread between what banks pay for deposits and the interest they receive on loans increases.

As for federal agency loans and Treasuries held by the bank, “these are money-good securities and there’s no reason to sell them,” Mayo says.

However, the wisdom of Bank of America investing so heavily in long-term mortgage securities at historically low yields can be questioned. While the bond market has rallied in recent times, yields on current mortgage securities are closer to 4.5% or 5%.

A bank’s net interest margin may be lower if it is required to pay significantly more for deposits, given the wider spread between deposit rates and market rates between money-market funds and high-yielding bank deposits. Due to this.

Mortgage securities have an effective maturity, usually expressed as the average life minus their stated maturity. They typically mature earlier than their stated maturity, often 30 years, because customers pay off their loans when they sell their homes to move or refinance.

An unfortunate aspect of mortgage securities for investors is that their average life lengthens as rates rise, a factor known as negative convexity in the bond market. This makes sense because rising rates give people less reason to repay low-cost loans or refinance.

Bank of America does not disclose data on the effective or average maturity of the bond portfolio or its duration.

Write to Andrew Barry at [email protected]