Bank of America is posting the largest losses in its bond portfolio among its peers

Bank of America had $862 billion in debt at the end of 2022.

Banks do not have to book losses on changes in the value of these securities, which deplete their capital, unless the debt is sold. Still, holdings in this category, which carry minimal or no credit risk, posted a loss of about $109 billion at the end of 2022 due to the rise in interest rates over the past year.

That compares to losses of $36 billion for a similarly classified bond portfolio at JPMorgan Chase (JPM), $41 billion at Wells Fargo (WFC) and $25 billion at Citigroup (C) and just $1 billion at Goldman Sachs Group (GS) on each company’s 10-K filings with the Securities and Exchange Commission.

Since regulators seized Silicon Valley Bank on Friday, attention has grown on banks’ bond losses. SVB Finance
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The lender’s parent company had an unrealized loss of $15 billion. That was almost the entirety of its $16 billion 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 the capital level and reduce capital even if the debt securities are not sold. Bank of America had $221 billion worth of bonds classified under this accounting method, and that bucket reported a loss of about $4 billion at the end of 2022.

Bank stocks fell back on Monday after being hit last week. By late afternoon, Bank of America was down 3.8% at $29.13 after trading below $28 at the start of the session. JPMorgan Chase was down 1.2% to $132 and Wells Fargo (WFC) was down 5% to $39.29.

The idea behind the held-to-maturity accounting rule is that banks invest long-term in Treasury and federal agency mortgage securities that carry minimal or no credit risk and intend to hold them to the maturity of the bonds. Assuming this happens, the losses due to changes in bond prices will melt away when the bonds mature and result in full principal repayment.

Bank of America, like other large banks, has tremendous liquidity and is not under pressure to sell its held-to-maturity bond portfolio and take losses.

Bank of America ended 2022 with $1.9 trillion in deposits, including about $1.4 trillion in retail customer deposits, which given the expense involved in the transfer, typically at a specific bank. The Federal Reserve also provides backing to banks in the form of loans when needed.

But the size of banks’ bond portfolios and the resulting losses are an indicator of the interest rate risk, or duration risk, that lenders face. In this sense, Bank of America stands out among its peers.

The company had no comment.

“So the big question for investors and depositors is: How much duration risk has each bank taken on in its investment portfolio during the deposit surge? [in recent years]and how much was invested at the bottoms in Treasury and agency yields?” wrote Michael Cembalist, the chairman of investment strategy at JP Morgan Asset Management, in a note to clients on Friday.

Cembalist measured the theoretical damage to bank capital in terms of a metric called hard tier one capital that lenders would suffer assuming “an assumed immediate realization of unrealized securities losses”. The SVB stood out the most by far. Among the largest banks, Bank of America was hardest hit.

When held-to-maturity bonds are sold, any losses must be realized and drain capital. The unrealized losses on Bank of America’s held-to-maturity debt portfolio were $109 billion compared to $175 billion in tangible common equity at year-end.

The bank’s $632 billion of held-to-maturity bonds are yielding just 2%. The majority of them, about $500 billion, are agency mortgage securities with maturities of 10 years or more.

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

“The underlying gains on deposits offset” any losses on the bond portfolio, he argues. This is a nuanced view as banks do not value their deposit taking business. Mayo’s argument is that Bank of America’s deposit base, on which the bank pays 1% or less for the majority of its retail accounts, is tremendously valuable and difficult, if not impossible, to replicate. The value of low-cost deposits increases when interest rates rise, provided the spread between what banks pay for deposits and the interest they receive on loans widens.

As for the federal agency debt and government bonds held by the bank, “These are securities of monetary value and there is no reason to sell them,” Mayo says.

However, one can question Bank of America’s prudence in making such an outsized investment in longer-dated mortgage securities at historically low yields. While the bond market has rallied over the past few days, current mortgage rates are closer to 4.5% or 5%.

The bank’s net interest margin could fall if it pays significantly more for deposit money due to the wide spread between deposit rates and market rates for money market funds and high-yield bank deposits.

Mortgage securities have an effective life, usually expressed as an average life, which is less than the stated life. They typically mature before their stated maturity, often 30 years, as clients prepay their debt when they sell, move, or refinance their homes.

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

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

Write to Andrew Bary at andrew.bary@barrons.com