Long-term rates have plunged this year and should offer a considerable boost to banks' tangible book values during third-quarter earnings season.
Long-term rates have fallen more than 150 basis points since the recent peak in early November 2018 amid concerns about slowing global growth and the brewing trade war between the U.S. and China. The Federal Reserve has responded with a pair of rate cuts in July and September, and economists are entertaining the possibility of an another rate cut before year-end.

Most economists expect rates to remain low throughout the remainder of the year, and the decline this year has already pushed bond values considerably higher since prices move inverse to yields.
Most banks' available-for-sale, or AFS, securities portfolios, which hold the vast majority of bonds owned by banks, should move deeper into the black after closing in positive territory in the second quarter for the first time since the third quarter of 2017. Value changes in AFS portfolios impact tangible common equity, and the continued positive shift should offer a notable lift to tangible book value in a number of banks' third-quarter reports.
Bank investors look for steady growth in tangible book value over time, but the sector has come under pressure in the markets over the last few months as the challenging interest rate environment has prompted a series of reductions in earnings estimates. More investors are also considering the prospect of a recession on the horizon due to extended length of the credit cycle and concerns about slowing economic growth.
Bank stock multiples remain considerably lower than they were a year ago, with the SNL U.S. Bank and Thrift index falling to 165% of tangible book value from just shy of 200% a year ago.


That multiple erosion might even seem more pronounced in the face of continued growth in tangible book values. If tangible book values are growing, a bank's price-to-tangible book value would decline, assuming no change in stock price.
The Federal Reserve's H.8 release, which tracks all commercial bank balances, shows that the group of institutions reported $16.0 billion in unrealized gains in their AFS securities portfolios through the week ended Sept. 18. Portfolios have swung significantly in a positive direction in the last three months compared with the $9.1 billion in unrealized losses reported in the week ending June 26, a few days before the second quarter closed.
In the second quarter, institutions including U.S. commercial banks, savings banks, and savings and loan associations that file GAAP financials reported $9.21 billion of unrealized gains in their AFS portfolios, compared with $4.43 billion in unrealized losses in the first quarter.
Some banks have shielded their investment portfolios from large valuation swings 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.
U.S. banks have grown their HTM portfolios considerably in the last five years, but some advisers have questioned the move, arguing that any acquirer or investor valuing the institution would still assume the market value of bonds in HTM portfolios. Increased reliance on HTM portfolios could also bring additional interest rate risk since banks are essentially locking in the yields on securities held in that bucket. That likely poses less of a risk in the near term given the recent decline in interest rates.
However, banks appear to have heeded to past warnings in recent quarters, reducing their allocation to HTM portfolios this year. Those portfolios fell to 29.09% of securities from 29.97% in the prior quarter and 29.55% a year ago. Still, the balances remained higher than two years ago when HTM securities equated to 27.66% of securities.
Some of the HTM portfolio movement came in response 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 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 nearly tripled since the liquidity coverage ratio surfaced in its 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 grown modestly since the latter half of 2013.
