US Market: Rising Treasury yields put US banks under pressure over bond losses

Selling bonds would crystallise losses immediately, while holding them could prolong the pressure on balance sheets and constrain banks' ability to return capital to shareholders through dividends and share repurchases.

According to Reuters, the industry's accumulated other comprehensive income (AOCI), an accounting measure that captures unrealised gains and losses on certain securities, remained deeply negative at $156.64 billion in the second quarter, according to S&P Global Market Intelligence data. Although the figure had improved significantly from 2023 levels, the subsequent rise in Treasury yields threatens to deepen the losses.

The 10-year US Treasury yield, a key benchmark for global borrowing costs, recorded its sharpest quarterly rise since 1994 in the third quarter, potentially increasing losses across banks' investment portfolios.

Bank of America Sees Bond Losses Increase

Bank of America reported a significant increase in unrealised losses on its bond holdings during the third quarter, Reuters reported. The bank's unrealised bond portfolio losses reached $109 billion at the end of September, up from $85 billion at the end of June.

Its accumulated other comprehensive loss also increased by more than $3 billion during the three months ended September 30.

Most of the securities were classified as held-to-maturity investments, indicating that the bank does not intend to sell them before maturity. Such holdings allow banks to avoid recognising certain market-value fluctuations in earnings, provided they meet the relevant accounting requirements. However, the underlying economic losses remain a consideration for capital management and liquidity planning.

Treasury yields and bond prices move in opposite directions. When yields rise, the market value of existing bonds falls because newly issued securities offer higher returns, making older bonds less attractive by comparison.

Banks Weigh Selling Bonds Against Holding Losses

The latest increase in yields has renewed debate over whether banks should sell some of their existing securities and reinvest the proceeds in higher-yielding assets, Reuters reported.

Selling at a loss could let lenders buy replacement securities that offer better returns, potentially improving future earnings and cash generation. However, the strategy would require banks to absorb immediate losses and assess how long it would take for the additional income to compensate for the initial financial hit.

The risks of substantial bond losses became evident in 2023, when Silicon Valley Bank collapsed after a combination of losses on bond investments and rapid customer deposit withdrawals. The episode exposed the vulnerability of banks holding long-duration securities when interest rates rise sharply and depositors demand access to their funds.

Although banks have reduced some of their exposure since then, the latest rise in Treasury yields highlights how investment decisions made when interest rates were lower can continue to affect financial performance years later.

According to Reuters, the central consideration for banks is whether the additional income generated by higher-yielding replacement assets can offset realised losses within a reasonable period.

Share Buybacks Face Fresh Pressure

Rising interest rates are also influencing banks' plans to return capital to shareholders, Reuters reported.

Fifth Third Bancorp delayed a planned share repurchase in September after a sharp increase in interest rates affected its accumulated other comprehensive income.

Wells Fargo has also indicated that the interest-rate environment and its impact on investment holdings will influence future share buybacks.

The developments suggest that banks may need to balance shareholder returns against the need to preserve financial flexibility as bond valuations fluctuate and regulatory requirements evolve.

Truist Financial has been repositioning its securities portfolio and sees scope for additional sales, although the pool of bonds it can sell strategically is limited, Reuters reported.

The bank is also preparing for the potential implications of Basel III capital requirements, which could influence how lenders manage securities portfolios and determine the amount of capital available for distribution to shareholders.

PNC Financial Services Group has similarly been considering the implications of upcoming Basel III rules as it evaluates its AOCI holdings.

Basel III Adds to Banks' Capital Challenges

Basel III is an international regulatory framework designed to strengthen banks' capital and risk-management standards. Changes in how capital requirements apply could affect banks' decisions to hold securities with substantial unrealised losses.

Reuters reported that lenders are factoring these potential regulatory implications into their decisions on managing bond portfolios and determining shareholder payouts.

For banks, the challenge extends beyond whether bond prices eventually recover. Lenders must also consider the interaction between market valuations, accounting treatment, regulatory capital and shareholder distributions when deciding whether to retain or sell securities.

The latest rise in Treasury yields has therefore renewed attention on the trade-off between preserving capital in the near term and improving earnings potential over time.

As banks navigate an uncertain interest-rate environment, their decisions on bond portfolios could influence future profitability, capital positions and the pace of share repurchases. The extent of the impact will depend partly on how long yields remain elevated and how effectively lenders can offset existing portfolio losses with income from higher-yielding investments.