US banks are facing growing losses on their bond investments as Treasury yields rise. Banks must decide whether to sell bonds worth billions of dollars at a loss or continue holding them and carry the losses on their balance sheets.
Both options come with financial risks for banks. Selling bonds would force banks to accept losses immediately. Holding the bonds could keep the losses on their balance sheets, weaken some measures of financial strength and limit the money they can return to shareholders, Reuters reported.
US banks face rising bond losses
Higher interest rates could put further pressure on banks’ financial strength. Brian Mulberry, chief market strategist at Zacks Investment Management, said that if interest rates remain high or long-term Treasury yields rise further, banks could continue facing pressure on their tangible equity and, in some cases, regulatory capital.
Banks track some bond losses through an accounting measure called accumulated other comprehensive income (AOCI). This measure records changes in the value of certain investments that banks have not yet sold. It helps show the unrealized gains or losses on bonds that banks may sell before they mature.
US banks had $156.64 billion in combined AOCI losses in the second quarter. The industry's balance remained deeply negative, although it had improved significantly from levels seen in 2023, according to data from S&P Global Market Intelligence cited by Reuters.
{{/usCountry}}US banks had $156.64 billion in combined AOCI losses in the second quarter. The industry's balance remained deeply negative, although it had improved significantly from levels seen in 2023, according to data from S&P Global Market Intelligence cited by Reuters.
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The situation could have worsened after US Treasury yields recorded a sharp increase in the third quarter. The 10-year Treasury yield, which is an important benchmark for borrowing costs around the world, recorded its biggest quarterly rise since 1994.
Bank of America reported a sharp increase in its unrealized bond losses. Bank of America's accumulated losses on some investments increased by more than $3 billion in the three months ending September 30, compared with the end of June, Reuters reported.
The bank's losses on bonds that it had not sold reached $109 billion at the end of September, up from $85 billion at the end of June. Most of these bonds were marked as “held to maturity.” This means the bank planned to keep them until they reached their maturity date instead of selling them early.
Rising Treasury yields hurt bond prices
Treasury yields and bond prices move in opposite directions. When bond yields rise, the prices of existing bonds usually fall. This is because new bonds may offer higher returns, making older bonds with lower returns less attractive. This can increase the losses banks face on their existing bonds if they do not sell them.
Some investors believe banks could sell some of their existing bonds and use the money to buy new bonds that offer higher returns. Macrae Sykes, a portfolio manager at Gabelli Funds, said banks could consider accepting losses now and using the money to buy investments that offer higher returns. Over time, these investments could improve cash flow and help banks generate more capital, according to Reuters.
The dangers of bond losses became clear during the 2023 banking crisis. Silicon Valley Bank collapsed in 2023 after suffering large losses on its bond investments while many customers quickly withdrew their money. Banks have reduced some of their exposure to these risks since the 2023 crisis. However, the latest increase in Treasury yields shows that investment decisions made years ago can continue to hurt banks when interest rates change.
Some financial experts say banks should consider selling bonds if new investments can make up for the losses. Brian Jacobsen, chief economic strategist at Annex Wealth Management, said banks should accept losses on their bonds if they can earn enough money from new investments to recover those losses within a reasonable time, Reuters reported.
Banks delay share buybacks
Higher interest rates are also affecting banks’ plans to buy back their own shares. A share buyback is when a company buys its own shares to return money to its shareholders. However, losses on bonds and rules about how much money banks must keep could make them more careful about spending money on buybacks.
Fifth Third delayed its planned share buyback in September. The bank said a sharp increase in interest rates had affected its accumulated other comprehensive income, leading it to postpone the planned repurchase.
Wells Fargo said interest rates could influence its future share buybacks. Chief Financial Officer Mike Santomassimo told analysts that the bank would continue to consider interest rate conditions and their impact on AOCI when deciding how many shares to repurchase, Reuters reported.
Basel III rules add pressure on banks
Truist is changing its bond portfolio to manage the impact of interest rates and capital rules. Chief Financial Officer Mike Maguire said the bank could sell more securities, but the number of bonds it could realistically sell was limited.
Truist believes it makes sense to review its bond holdings as Basel III rules come closer to implementation. Maguire said the bank considered it sensible to take action on its securities portfolio as the international banking rules came into focus, Reuters reported.
Basel III could add another challenge for banks deciding whether to sell bonds or hold them. The international framework sets standards for banks' financial strength, including capital requirements. These rules could influence how banks manage their investments and how much money they can return to shareholders.
PNC is also considering the impact of Basel III when reviewing its bond losses. Bank executives said they were taking the upcoming capital rules into account while evaluating the bank's AOCI holdings, according to Reuters.
The key challenge for US banks is balancing bond losses, future returns and shareholder payouts. Selling bonds could allow banks to reinvest at higher yields, but it would mean accepting losses immediately. Holding them could avoid an immediate sale but leave banks exposed to continued pressure on their balance sheets and potentially limit future share buybacks.