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12/11/2016 Rising Interest Rates Trigger Losses on Banks’ Massive Bond Holdings WSJ
http://www.wsj.com/articles/risinginterestratestriggerlossesonbanksmassivebondholdings1481132298?tesla=y 1/2
Rising interest rates have sent bank stocks soaring. But there is a dark side to this kind of market move—banks in the fourth quarter are likely to report losses on their massive bond portfolios.
U.S. banks suffered a $6.5 billion unrealized loss on the value of securities they hold as investments as of Nov. 23, according to the most recent data from the Federal Reserve. This was the first time since 2014 that the Fed data for the banking system as a whole showed a loss on these securities. As recently as early July, banks had total unrealized gains on these portfolios of $33.8 billion.
They key is that these losses, or gains, are unrealized and don’t hit earnings. While they do affect a bank’s book value, or net worth, the losses over time will be offset by increasing net interest income. That is a trade-off banks and their investors will take in stride, and even welcome.
Speaking at a financial industry conference Tuesday, Wells Fargo & Co. chief Timothy Sloan said that while there was likely to be short-term unrealized losses in the bank’s securities portfolio, higher interest rates were an overall “positive” for the bank.
When rates rise, the value of debt securities tends to fall because the relatively low rates on existing bonds will look unattractive compared with the higher rates of new bonds. The decline in bond prices brings the yields of similar bonds in line with each other.
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http://www.wsj.com/articles/risinginterestratestriggerlossesonbanksmassivebondholdings1481132298
MARKETS
Rising Interest Rates Trigger Losses on Banks’ Massive Bond Holdings These losses are unrealized, however, and over time they will be offset by higher net interest income
Wells Fargo bank teller machines in San Francisco, Calif. PHOTO: ROBERT GALBRAITH/REUTERS
Dec. 7, 2016 12:38 p.m. ET By JOHN CARNEY
12/11/2016 Rising Interest Rates Trigger Losses on Banks’ Massive Bond Holdings WSJ
http://www.wsj.com/articles/risinginterestratestriggerlossesonbanksmassivebondholdings1481132298?tesla=y 2/2
Banks classify a big portion of their bond holdings as investment holdings, or “available for sale,” distinguishing them from those held for trading purposes. These investment holdings were $2.66 trillion for U.S. banks at the end of the third quarter, or about 16% of total assets, according to data from the Federal Deposit Insurance Corp. As well, there is a smaller group of bonds banks classify as being held to maturity.
When investment securities lose value, the losses are described as “unrealized” and don’t immediately diminish a bank’s profits. Instead, the losses go into a special bucket in shareholders’ equity called “accumulated other comprehensive income.”
This cuts into banks’ book value as well some measures of regulatory capital. That can be a problem for banks with thin capital cushions. But with many banks comfortably above required minimum capital levels, this isn’t likely to be a cause for concern today.
“I don’t hear many investors concerned about [investment-security] losses and the impact on capital because the stocks seem to be trading much more on price to earnings than price to book value and capital ratios are so strong,” said Sanford C. Bernstein analyst John McDonald.
The losses will only cut into a bank’s profits if they are realized through a sale, meaning a bank sells bonds for a price lower than what it paid. Or a hit to profit could result if a bank determines a bond has become permanently impaired—typically because it is unlikely to pay the promised cash flow.
During the financial crisis, some investors believed banks were hiding losses on permanently impaired securities in their investment portfolios. That is unlikely to be the case now. Mostly, bonds are losing value simply because of interest rate moves.
Any knock to bank balance sheets will also be cushioned by the fact that many large banks have substantially increased the portion of their securities portfolios they classify as “held to maturity.” Those bonds don’t get marked to market prices unless there is a permanent impairment.
Such holdings were once a tiny portion of bank balance sheets but have grown in recent years. The holdings were equal to 24% of banks’ total securities portfolios at the end of the third quarter, FDIC data show. At the end of 2011, they were just 9%.
Write to John Carney at [email protected]
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