The recent decline in long-term rates should offer support to U.S. banks' tangible book values in the upcoming fourth-quarter earnings season.
Rising long-term rates pushed banks' securities portfolios deep into negative territory in the third quarter, but the trend reversed course as 2018 came to a close. After hitting a peak in early October, the yield on 10-year U.S. Treasury bonds fell more than 50 basis points in the final few months of the year. That in turn likely allowed those positions to recover some in the fourth quarter.
Changes in bond portfolios' values do not affect banks' earnings, but they do flow through accumulated other comprehensive income and impact tangible common equity. As long-term rates declined late in 2018, unrealized losses in banks' portfolios likely fell as well, supporting growth in tangible book values.
Compass Point Research & Trading analyst Laurie Hunsicker noted in a Jan. 9 report that banks with large available-for-sale securities portfolios could see a jump in tangible book values due to the recent decline in long-term rates. Within the analyst's coverage universe, Bank of Hawaii Corp., Columbia Financial Inc. (MHC), Central Pacific Financial Corp., Entegra Financial Corp., First Hawaiian Inc., Franklin Financial Network Inc., PDL Community Bancorp, Washington Trust Bancorp Inc., and Western New England Bancorp are among the largest beneficiaries from the swing in tangible book values, Hunsicker said.
Those institutions are unlikely to be alone in receiving a boost to tangible book values from the decline in unrealized losses. The Federal Reserve's H.8 release, which tracks all commercial bank balances, shows that the group of institutions reported $27.9 billion in unrealized losses in their available-for-sale, or AFS, securities portfolios through the week ended Jan. 2, 2019. That is down modestly from the $46.7 billion in unrealized losses reported in the week ending Oct. 3, 2018, a few days after the third quarter closed.
In the third quarter, institutions, including U.S. commercial banks, savings banks and savings and loan associations, reported $32.93 billion of unrealized losses in their AFS portfolios.
Many banks, however, have opted to shield their investment portfolios from swings in market valuations by placing significant amounts of securities in their held-to-maturity, or HTM, portfolios. Unlike AFS portfolios, banks do not have to mark those portfolios to market on a quarterly basis.
Banks have more than doubled their HTM portfolios in the last five years as they have increased their exposure to longer-dated bonds. Bonds expected to reprice or mature in excess of 15 years equated to 31.72% of bank-held securities at the end of the 2018 third quarter, up slightly from 31.70% in the prior quarter but considerably higher than the 26.31% reported at year-end 2015.
Some advisers question the practice, noting that any acquirer or investor valuing the institution would still assume the market value of bonds in HTM portfolios, even though the securities are not subject to mark-to-market adjustments. Placing bonds in HTM portfolios could also bring additional interest rate risk since banks are essentially locking in relatively low-yielding securities. If rates rise significantly, banks would hold on to below-market-rate securities for longer periods, while their funding costs move higher.
Still, banks increased their allocation to HTM portfolios in the third quarter of 2018, building their positions to 30.48% of all securities from 29.55% in the second quarter and 28.04% a year ago. HTM securities equated to 24.25% of all securities two years ago.
Banks started to increase their HTM portfolios well before then as they reacted to new capital and liquidity rules. Over much of the last five years, banks with more than $50 billion in assets had to comply with the liquidity coverage ratio, which required them to hold higher concentrations of market-sensitive securities.
Other regulations forced banks to consider how changes in security valuations would impact their balance sheets. The originally proposed Basel III rules in the summer of 2012 required accumulated other comprehensive income to flow through regulatory capital at all banks. A year later, the final Basel III rules allowed institutions that fall under the nonadvanced approach capital framework — generally those with less than $250 billion in assets — to opt out of that provision.
HTM portfolios have more than doubled since the liquidity coverage ratio surfaced in proposed form in the fall of 2013 and have increased even more since the Basel III rules were first proposed. Conversely, banks' AFS portfolios have declined modestly since the fall of 2013.
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Bank holding companies report information about held-to-maturity and available-for-sale securities on FR Y-9C Schedule HC-B, which can be accessed under the Regulatory Financials section of a company's Briefing Book page on the Market Intelligence website or in MI Office.