Bank of America Has Biggest Losses in Bond Portfolio Among Peers

Bank of America had $862 billion of debt securities on its balance sheet totaling roughly $3 trillion at the end of 2022. Of that, $632 billion of bonds, mostly federal agency mortgage securities, were classified as held to maturity for accounting purposes.

Banks don’t have to record losses on changes in those securities’ value, cutting into their capital, unless the debt is sold. Still, holdings in that bucket, which carry minimal or no credit risk, were nonetheless showing a loss of about $109 billion at the end of 2022 due to the rise in interest rates over the past year.

This compares with losses of $36 billion for a similarly classified bond portfolio at

JPMorgan Chase

(JPM), $41 billion for

Wells Fargo

(WFC), and $25 billion at

Citigroup

( C) and just $1 billion at

Goldman Sachs Group

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

Attention on banks’ bond losses has increased since regulators seized Silicon Valley Bank on Friday.

SVB Financial
,
the lender’s parent, had a $15 billion unrealized loss on its $91 billion held-to-maturity bond portfolio. That was equivalent to nearly all its $16 billion of tangible capital. 

 Banks also classify their holdings of debt and other securities under another accounting treatment called available-for-sale. Any losses on these securities must be reflected in capital levels and reduce capital even if the debt isn’t sold. Bank of America had $221 billion of bonds classified under this accounting treatment, and that bucket showed a loss of about $4 billion at the end of 2022.

Bank stocks were down again Monday after getting hit last week. In late afternoon, Bank of America was off  3.8% at $29.13 after trading under $28 early in the session. JPMorgan Chase fell 1.2% to $132 and Wells Fargo (WFC) dropped 5% to $39.29.

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

Bank of America, like other big banks, has an enormous amount of liquidity and faces no pressure to sell any of its held-to-maturity bond portfolio and realize losses. 

Bank of America ended 2022 with $1.9 trillion in deposits including about $1.4 trillion of retail deposits, which tend to remain at a given bank given the hassle involved in moving them. The Federal Reserve also is providing a backstop to banks in the form of loans if they need them.

But the size of banks’ bond portfolios and any losses as a result 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 this: how much duration risk did each bank take in its investment portfolio during the deposit surge [in recent years], and how much was invested at the lows in Treasury and Agency yields?” wrote Michael Cembalist, the chairman of investment strategy at JP Morgan Asset Management in a client note Friday.

Cembalist measured the theoretical hit to bank capital, in terms of a measure called Common Equity Tier One capital, that lenders would face from “an assumed immediate realization of unrealized securities losses.” SVB stood out with by far the biggest effect. Among the largest banks, the biggest impact was at Bank of America.

If held-to-maturity bonds are sold, any losses need to be realized and depress capital. The $109 billion of unrealized losses in the held-to-maturity bond portfolio at Bank of America compare with $175 billion of year-end tangible common equity.

 The bank’s $632 billion of held-to-maturity bonds yield just 2%. The bulk of them, roughly $500 billion, consist of agency mortgage securities maturing in 10 years or more. 

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

“The underlying gains on deposits offsets” any losses on the bond portfolio, he argues. This is a nuanced view since banks  don’t put any value on their deposit franchise. Mayo’s point is that the Bank of America deposit base, on which the bank is paying 1% or less for the bulk of its retail accounts, is hugely valuable and difficult if not impossible to replicate. The value of low-cost deposits goes up when interest rates rise, assuming the spread widens between what banks pay for deposits and the interest they receive on loans.

As for the federal agency debt and Treasuries held by the bank, “These are money-good securities and there is no reason to sell them,” Mayo says. 

One can question, however, the wisdom of Bank of America having such an outsize investment in longer-dated mortgage securities at historically low yields. While the bond market has rallied in recent days, current mortgage securities yields are closer to 4.5% or 5%. 

The bank’s net interest margins could contract if it needs to pay appreciably more for deposit money given the wide spread between deposit rates and market rates on money-market funds and high-yielding bank deposits.

Mortgage securities have an effective maturity, usually expressed as an average life, of less than their stated maturities. They usually mature before their stated maturities, often 30 years, as cusromers prepay their debt when they sell their homes to move, or refinance. 

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

Bank of America doesn’t disclose data on the effective or average maturity of the bond portfolio or its duration.

Write to Andrew Bary at [email protected]