Banks In The United States Have Unrealized Losses Of $620 Billion

Silicon Valley Bank's investment losses in low-yielding bonds were a part of a trend that can be seen across the US financial system to one degree or another. In total, the sector ended the year with $620 billion in unrealized losses on its books due to investments in low-yielding bonds.

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Fortunately, most banks are able to handle this issue in a reasonable amount of time.

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There were only a quarter of $23.6 trillion of bank assets held in investment books in December, and lenders have usually a large number of depositors who are unlikely to all need funds at the same time, unlike SVB, which typically has a wide range of depositors. It is even less likely for the biggest banks to fail. In fact, they are regarded as too big to fail due to the size of their deposits. The recent rally in the Treasury bond market is also leading to a reduction in the $620 billion of paper losses, which, ironically, is sparked by the jitters about the health of the banking industry. In the coming weeks, banks are expected to start reporting first-quarter earnings.

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When paper losses have to be repaid, the bank's equity could be affected

Unlike investors and depositors, which are jittery about the prospects of banks churning out money-losing bonds, some lenders are managing unrealized losses with the help of financial experts.

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Despite this, banks are facing a squeeze as depositors keep withdrawing their money and putting it into money market funds and other investments, despite the fact that depositors have been gradually withdrawing their money for many years. The bank must pay more for funding, while their revenues are limited due to their investments in bonds with low yields during the pandemic, which may hinder their ability to provide loans to consumers and businesses, thereby slowing down the economy.

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A retired bank examiner for the Richmond Federal Reserve Bank and a former bond analyst at Bank of America, Stan August, discusses the situation in this interview. “They are paying a higher interest rate for deposits and their earnings on bonds remain fixed,” August said.

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A large number of banks piled up on long-term government and mortgage-backed bonds when the pandemic hit, when the Federal Reserve pumped unprecedented amounts of money into the economy, pushing down rates yet another time. It is said that some Treasury notes over the period of ten years would pay a annual interest rate of just 0.6%.

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When inflation surged, the Fed began to push interest rates up urgently and the value of those bonds plunged as new bonds were suddenly paying more than 3% off, which made it impossible for people to purchase old bonds that were paying 0.6%.

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Whenever rates go up, banks’ holdings of bonds can lose money, but their holdings in 2022 were larger than usual. Almost all that cash that the Fed and the government put into the economy made its way into the banking system, giving lenders trillions of dollars to invest in the economy. As a result of the increased deposits at SVB between March 2020 and March 2022, SVB's domestic deposits, for example, increased by more than 150%.

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A rise in the amount of deposits at banks alone does not necessarily pose a problem to them. For SVB Bank, however, it spelled trouble not only because the bank required its clients to keep large balances at the bank in order to receive services like lines of credit, but also because of the prominence of its customers.

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As a result, US deposit insurance limits are often higher than one's customers' deposits, which has the effect of causing customers with high accounts to have skepticism about the safety of their funds, and are more likely to withdraw money as soon as signs of trouble arise.

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A perfect storm of factors led to depositors becoming concerned with SVB as each of the three data points concerned them: the rapid growth of SVB's deposits, the high percentage of uninsured deposits the bank had in future, and the magnitude of the losses compared to equity.

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Nevertheless, bond losses are still an issue for banks that avoided the storm. The banks' investment portfolios are heavily populated with bonds that are held to maturity, an accounting method that prevents them from having to record losses, or hits on their balance sheets, when their bond values decline. However, the bonds need to be kept until they mature as well.

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The banks initially started to increase their deposits during the pandemic. To take advantage of the growth, they plowed more money into bonds that were available for sale using an accounting method called "available for sale." When the value of the bonds changed, the balance sheets of these securities were affected, but their income statements were not affected. It is true that banks can have to increase their capital levels as a result of that accounting method, if their losses become too high.

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There was a growing group of banks that, by 2021, believed the Federal Reserve would start raising interest rates. As a result, they began to count more of their bonds held until maturity in 2021. During the two years that ended in December, the biggest banks added about $1.7 trillion worth of bonds to the books. In some cases, the banks switched from one accounting treatment to another for the bonds. Other times, they stopped buying new securities that were available for sale, but only increased the value of their bonds held to maturity.

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Initially, it seemed to work remarkably well. Profits exploded. In 2021, the run rate of return on equity, or the measurement of profitability in the US banking system, reached its highest level since 2006, averaging 12.2%.

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The banks have suddenly found themselves under pressure from both sides as inflation and rate hikes have arrived. In the spring of 2022, banks had to pay more money to win deposits, with the average one-year CD rate rising from 0.35% to 2.7%, according to DepositAccounts. Companies and consumers are increasingly investing their money in government bonds instead of banks. For the first time since 1948, deposits in commercial banks fell last year. The most painful impact was felt by the smaller banks, which lost $109 billion in the week ended March 15, while the biggest banks continued to gain deposits.

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In the meantime, bond investors were also suffering financial losses due to the unrealized losses on their holdings on paper. At the end of 2022, there were $620 billion of unrealized losses on available-for-sale and held-to-maturity securities in the system.

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As it stands, the combination of soaring interest rates, high investment losses, and heavy outflows of deposits from the banking industry is entirely new to most investors and executives in the industry. Again, it appears as if this is an unfamiliar territory.

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The investment principal at Cambiar Investors, Ania Aldrich, said she not only covered this industry for between 20 and 30 years, but she has never seen anything like this. “In all the stress tests we have conducted for a few of the biggest banks, we have not faced anything like this.