Hold or sell? High Treasury yields spur US banks to rethink bond portfolios

By Manya Saini, Arasu Kannagi Basil and Niket Nishant

Oct 27 (Reuters) - A spike in Treasury yields is forcing US banks to confront an uncomfortable question: sell bonds worth billions of dollars they own at a loss, or hold on to paper losses?

Both carry costs. Selling involves taking an immediate financial hit, while waiting would pile on losses on the balance sheet that can weaken some measures of financial strength and limit payouts to shareholders.

"Persistent higher rates or a steepening long end would prolong the drag and keep pressure on tangible equity, and for some banks, regulatory capital," said Brian Mulberry, chief market strategist at Zacks Investment Management, which holds several bank stocks.

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Banks record changes in the value of bonds they might sell before maturity under an accounting measure known as accumulated other comprehensive income (AOCI). It reflects gains or losses that have not yet been realized through a sale.

The industry's AOCI balance remained deeply negative at $156.64 billion in the second quarter, despite improving substantially from 2023 levels, according to S&P Global Market Intelligence data.

That was before the 10-year US Treasury yield, a benchmark for global borrowing costs, posted its sharpest rise since 1994 in the third quarter, potentially deepening the losses.

Bank of America's BAC.N accumulated other comprehensive loss swelled by over $3 billion in the three months ended September 30, compared with the end of June.

The bank had unrealized ​losses on its bond portfolio of $109 billion at the end of September, up from $85 billion at June-end. The bulk of these securities were in the held-to-maturity segment, which the bank does not intend to sell.

SELL NOW OR WAIT?

Treasury yields and bond prices move inversely. As yields rise, prices of existing bonds fall, deepening unrealized losses reflected in AOCI.

"Given the movement in rates, it may be worth it to take a loss and then redeploy that capital at higher yields, which would benefit cash flow and capital generation in the future," said Macrae Sykes, portfolio manager at Gabelli Funds.

The risks associated with bond portfolios are not entirely hypothetical. Deep losses on bond investments, combined with customers rapidly withdrawing deposits, contributed to the collapse of Silicon Valley Bank in 2023.

Although banks have since trimmed their exposure, the latest jump in yields shows how decisions made years ago can continue to be a drag.

"A bank should be willing to realize a loss if the higher yield on replacement assets earns the loss back over a reasonable horizon," said Brian Jacobsen, chief economic strategist at Annex Wealth Management.

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SHARE REPURCHASES COULD STALL

The impact is already showing on plans to return money to shareholders.

Fifth Third FITB.N said it delayed a planned share repurchase in September after a sharp rise in interest rates affected its AOCI.

Wells Fargo WFC.N also said future buybacks may depend partly on how rates impact its investments.

"Looking ahead, we will continue to consider the interest rate environment and the impact on accumulated other comprehensive income in determining how much stock we repurchase," Chief Financial Officer Mike Santomassimo told analysts.

Meanwhile, Truist TFC.N has been repositioning its securities portfolio, with Chief Financial Officer Mike Maguire saying the bank sees scope for further sales but that the pool of actionable bonds is finite.

"With Basel III really coming into focus and in sight, we do feel like it's sensible to take action around the securities portfolio."

Basel III refers to an international framework which could influence how banks manage their investments and how much money they can return to shareholders. The rules could add another layer of complexity to banks' decisions on how to manage their bond portfolios.

PNC executives also said the bank is factoring in Basel III capital rules, which are "just around the corner," as it evaluates its AOCI holdings.