U.S. banks are currently facing a significant crunch on their bond holdings as Treasury yields surge, forcing a difficult choice between immediate, realized losses and long-term balance sheet erosion. Mainstream reports highlight how this situation threatens banks' financial strength and their ability to return capital to shareholders through buybacks. What the numbers reveal, however, is a direct, multi-billion-dollar hit to capital measures, limiting shareholder payouts and reviving concerns from past banking crises.
Banks find themselves in a bind: either sell bonds worth billions of dollars at a loss or continue to hold them, carrying those losses on their balance sheets. Both options present considerable financial risks. Selling would force banks to immediately accept the losses, impacting current financial strength. Holding the bonds would keep the losses as unrealized, weakening some measures of financial strength and potentially limiting the money they can return to shareholders, as reported by Reuters.
The industry reported $156.64 billion in combined accumulated other comprehensive income (AOCI) losses in the second quarter, according to data from S&P Global Market Intelligence cited by Reuters. AOCI is an accounting measure that tracks changes in the value of certain investments not yet sold, indicating unrealized gains or losses. While this figure showed an improvement from levels seen earlier in 2023, the balance remained deeply negative.
The situation likely worsened after the third quarter saw a sharp increase in U.S. Treasury yields. The 10-year Treasury yield, a key global borrowing benchmark, recorded its biggest quarterly rise since 1994. Since bond prices and yields move inversely, rising yields mean existing bonds decline in value, increasing the losses banks face on their current holdings.
Bank of America, for example, reported a substantial increase in its unrealized bond losses. Its accumulated losses on some investments grew by more than $3 billion in the three months ending September 30, compared to the end of June, Reuters reported. By the end of September, the bank's losses on bonds it had not sold reached $109 billion, up from $85 billion at the end of June. Most of these bonds were marked as “held to maturity,” meaning the bank had originally planned to keep them until maturity rather than selling them early.
Higher interest rates could further pressure banks' financial strength. Brian Mulberry, chief market strategist at Zacks Investment Management, stated that if interest rates remain high or long-term Treasury yields continue to climb, banks could face ongoing pressure on their tangible equity and, in some instances, their regulatory capital. The dangers of these bond losses became starkly clear during the 2023 banking crisis, where Silicon Valley Bank collapsed after realizing large losses on bond investments amid rapid customer withdrawals. While banks have since reduced some of their exposure, the recent yield surge demonstrates the persistent impact of past investment decisions when interest rates shift.
Some investors suggest banks should consider selling their existing bonds to reinvest at higher returns. Macrae Sykes, a portfolio manager at Gabelli Funds, indicated banks could accept current losses to buy new, higher-yielding investments, potentially improving cash flow and generating more capital over time. Brian Jacobsen, chief economic strategist at Annex Wealth Management, concurred, advising banks to accept bond losses if new investments could sufficiently recover those losses within a “reasonable time.”
The impact extends directly to shareholders. Higher interest rates are also affecting banks' plans for share buybacks, a method companies use to return money to shareholders. Bond losses and capital rules could make banks more cautious about funding these repurchases.
Fifth Third, for instance, delayed a planned share buyback in September, attributing the decision to a sharp increase in interest rates affecting its AOCI. Wells Fargo's Chief Financial Officer, Mike Santomassimo, informed analysts that the bank would continue to consider interest rate conditions and their impact on AOCI when determining future share repurchases, Reuters reported.
Regulatory changes add another layer of complexity. Truist is actively adjusting its bond portfolio to manage the impact of interest rates and capital rules. Chief Financial Officer Mike Maguire noted that the bank might sell more securities, although the realistic volume for such sales is limited. Maguire also stated it made sense for the bank to take action on its securities portfolio as the international banking rules, Basel III, gained focus. PNC executives are similarly reviewing their AOCI holdings with the upcoming Basel III capital rules in mind.
Basel III, an international framework setting standards for banks' financial strength, including capital requirements, could further influence how banks manage their investments and the capital they can return to shareholders. The key challenge for U.S. banks remains balancing immediate bond losses, future returns, and shareholder payouts. The choices made by bank executives now will ultimately determine who bears the cost of the Treasury market's volatility and who benefits from its shifting landscape.
