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US bank bond portfolios stay in the red, weighing on tangible book value

Negative values in banks' bond portfolios could limit tangible book value growth.

Rising long-term rates pushed banks' securities portfolios deep into negative territory in the first quarter and those positions likely remained underwater in the second quarter.

While changes in bond portfolios' values do not affect banks' earnings, they do flow through accumulated other comprehensive income and impact tangible common equity. With additional rate increases expected, banks' portfolios could move further into the red, limiting future growth in tangible book value much to the dismay of investors.

As long-term rates rose in the first quarter of 2018, institutions, including U.S. commercial banks, savings banks and savings and loan associations, reported $17.2 billion in unrealized losses in their available-for-sale, or AFS, securities portfolios.

Values in those portfolios did not appear to have materially improved in the second quarter.

The Federal Reserve's H.8 release, which tracks all commercial bank balances, shows that the group of institutions reported $32.6 billion in unrealized losses in the AFS portfolio through the week ended June 20. That is down modestly from the level of unrealized losses reported in March even though the average yield on the 10-year Treasury has risen 16 basis points since then.

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In recent years, banks have increased their reliance on their held-to-maturity, or HTM, portfolios to shield their balance sheets from the mark-to-market accounting adjustments they must take on their AFS portfolios.

Banks have more than doubled their HTM portfolios in the last five years as they have increased their exposure to longer-dated bonds. Securities expected to reprice or mature in excess of 15 years equated to more than 30% of banks' total securities at the end of the first quarter, up considerably from approximately 26% in 2015 and 23% in 2013.

While HTM portfolios are not subject to quarterly adjustments, advisers note that any acquirer or investor valuing the institution would still assume the market value of those bonds. 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 of time, while their funding costs move higher.

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Banks did report a modest decline in their HTM portfolio concentration in the first quarter, marking the first decrease in five years. But with HTM portfolios equating to 27.94% of all securities, the positions still remain elevated when compared to past levels. HTM securities equated to 26.32% of all securities a year earlier, 23.59% two years ago and just 10.64% in the first quarter of 2013.

The increase in banks' HTM portfolios comes as banks also react to new capital and liquidity standards. Banks with more than $50 billion in assets arguably face a greater threat from rising rates since they must comply with the liquidity coverage ratio. That provision requires them to hold higher concentrations of market-sensitive securities such as Treasurys and Ginnie Maes.

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Other regulations have caused 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 nonadvanced approach institutions, generally those with less than $250 billion in assets, to opt out of that provision.

HTM portfolios have grown by 143.6% 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 risen 2.1% since the fall of 2013.

AFS portfolios remain exposed to higher rates and more increases are expected to come, with economists' projecting that the yield on the 10-year Treasury could rise another 40 basis points by December 2018. If that occurs, tangible book value growth could slow during the remainder of the 2018.

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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.