Fed cuts set to unwind damage to US banks' bond holdings

US banks are poised to slash unrealized losses on bond portfolios as the Federal Reserve appears ready to initiate a steep rate-cutting cycle.

The industry posted an $8.26 billion sequential improvement in accumulated other comprehensive income (AOCI) to a loss of $254.58 billion in the second quarter, according to data from S&P Global Market Intelligence. AOCI includes unrealized losses on available-for-sale securities, and banks notched the advance even though interest rates, which move inversely with bond prices, increased modestly across most of the Treasury yield curve during the period. Adjusted tangible common equity (TCE), which also includes unrealized losses on held-to-maturity securities, increased $39.01 billion to $1.802 trillion.

Ahead of the Fed cuts, Treasury yields have tumbled, with the average across two- to five-year maturities — which encompass much of banks' holdings — falling 99 basis points from the end of the second quarter through Sept. 12. That is a bigger drop than in any quarter since 2022, when the Fed started raising rates. Banks eliminated about a quarter of their AOCI deficit in the fourth quarter of 2023 when the average across two- to five-year maturities fell 78 basis points.

Regions Financial Corp. finished the second quarter with a common equity Tier 1 ratio of 8.2% after adjusting for AOCI. "Today, it's probably 9% or better," Treasurer M. Deron Smithy said at a Sept. 11 industry conference. "That movement in rates has been pretty dramatic in terms of the impact of AOCI."

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Restructuring gains

Most of the 20 biggest banks by assets posted sequential improvement in AOCI, and 15 had gains in adjusted TCE.

The shifts reflect bond maturities and changes in portfolio composition in addition to fluctuations in interest rates.

Truist Financial Corp. led the way on AOCI with a 35.7% improvement to a loss of $8.50 billion after selling its insurance brokerage and executing a bond repositioning. Its adjusted TCE improved 48.3% to $30.63 billion.

PNC Financial Services Group Inc. posted a 7.4% improvement in its AOCI to a loss of $7.45 billion. The bank also executed a repositioning, using the sale of Visa Inc. shares to absorb the realized losses. Its adjusted TCE improved 1.9% to $29.95 billion.

AOCI recapture

Individual banks posting sequential improvement in AOCI and adjusted TCE outnumbered those posting sequential deterioration by more than 2-to-1. Year over year, the balance was even more favorable, with 3,833 posting improvement in adjusted TCE and 578 posting deterioration.

With markets anticipating sharp cuts by the Fed, analysts at Raymond James looked at the prospect for full "AOCI recapture" in a Sept. 3 industry brief.

Along with projected tangible book value (TBV) growth through the end of 2025, complete AOCI recapture would deliver an average TBV increase of 17.8% across the analysts' coverage universe. The 20 banks with the biggest potential boosts from AOCI would post TBV growth of 20.0% to 65.6%.