The unrealized losses are getting realized at some banks.
More banks sold parts of their underwater bond portfolios at a loss last quarter — or said they were considering doing so. Those that pulled the trigger took a temporary hit from the sales, but they plan on making their money back by reinvesting the cash into higher-paying options.
Until now, the losses from banks’ bond portfolios have mostly been “unrealized,” because banks have hung onto their bonds rather than selling them. But now more banks are getting rid of low-yielding bonds, which pay them interest of maybe 2%, and replacing them with others that pay double that rate or more.
“More and more banks are doing it,” said Brandon King, who covers regional and community banks at Truist Securities. He added that the higher-yielding bonds give banks a “decent pick-up” in their earnings.
Unrealized losses on bond portfolios became a hot-button issue in March following the collapse of Silicon Valley Bank, whose surprise sale of underwater bonds woke depositors up to the bank’s shaky financial condition.
Over the ensuing months, concerns about the ability of particular banks to survive have mostly gone away, and banks have been able to sell their bond portfolios with little fanfare. The challenge now facing many banks is that sitting on a big pool of low-yielding bonds means making less money.
Bond sales come with some pain, but they are helping banks refocus on their “original game plan” of pursuing growth and looking ahead, rather than regretting their past purchases, said Brett Rabatin, head of research at the Hovde Group.
“If you’re stuck with this albatross of low-yielding assets on your balance sheet, it’s probably making you more defensive because you know that your revenue outlook is not good,” Rabatin said.
Banks bought many of the bonds after the Federal Reserve slashed interest rates during the pandemic, but the rapid increase in rates since 2022 has eroded their value, since newly issued bonds pay much more.
By crystallizing their losses and repositioning their portfolios, rather than waiting around for rates to drop, banks are taking their lumps upfront.
That reality is deterring some banks from taking the leap. Over time, banks that sell their bonds will earn the money back, as higher interest payments roll in from the new securities they’re buying, or from new loans they’re making.
But in the meantime, the losses they’re absorbing are leaving a hole on banks’ balance sheets. Their capital — the cushion that guards against losses from loans going sour — is taking a hit and leaving them less prepared to handle an economic downturn.
“Ultimately, it’s a judgment call, because who knows what the future holds?” said Bert Ely, a bank consultant.
The opportunity to sell low-yielding bonds is only available to banks that have ample capital, as they have a larger cushion available to absorb losses from the sales, Ely said. Other banks have thinner capital or larger exposures to low-paying bonds. Selling bonds would put them at capital levels that regulators deem concerning.
“The banks that are in a tougher spot are the ones with less wiggle room, that their capital cushion is not as thick as they would like it to be,” Ely said.
The restructuring of bond portfolios has occurred at banks of all sizes. In September, the global custody bank State Street said it sold $4 billion in bonds to reinvest in higher-yielding options.
Cadence Bank, a midsize bank based in Tupelo, Mississippi, said last month that it planned to sell $1.5 billion in low-yielding securities. While the bank’s capital is taking a hit, it is separately adding to its capital by selling an insurance brokerage subsidiary. The downside is that selling the high-performing insurance business will deprive Cadence of a solid earnings stream.
Truist Financial, the North Carolina-based regional bank, is facing a similar trade-off as it weighs selling its stake in an insurance unit and repositioning its bond portfolio.
“There’s not one perfect path. There are trade-offs to all of them,” Truist CEO Bill Rogers told analysts last month.
Other banks that have unloaded chunks of their bond portfolios recently include Atlantic Union Bankshares Corporation in Richmond, Virginia, which sold $228 million in low-yielding securities and recorded a $27.7 million loss. The sale ended up being “capital-neutral,” executives said, since it was paired with a sale-leaseback arrangement of 27 properties.
Rather than sitting on securities that pay 2.3%, Atlantic Union has reinvested the proceeds from the sale into securities that yield about 6%.
Other banks said they’re evaluating the trade-offs and running the numbers to figure out whether bond sales make sense.
“We are constantly thinking about the logic of restructuring the securities portfolio,” said David Rosato, chief financial officer of Berkshire Hills Bancorp in Boston. “We’re very similar to a lot of banks where the whole portfolio is underwater.”
Reinvesting into higher-yielding options would “create a much better run rate going forward,” but the capital hit would be significant, Rosato said.
Still other bankers were more explicit in ruling out bond sales.
“We run the math on it. We see the numbers. We have not seriously considered this right now,” said Jefferson Harralson, chief financial officer of United Community Banks in Blairsville, Georgia. He did note, however, that the bank’s higher capital means that United Community has the “ability to do this.”
At Independent Bank Group in McKinney, Texas, executives are eyeing the uncertain macroeconomic outlook and preferring to hang onto their capital, rather than selling bonds at a loss.
“I don’t think that’s something that we would consider,” Paul Langdale, the company’s chief financial officer, told analysts last month. “We’re in a mode to really preserve and accrete capital at the moment. We think that’s the right place to be at this point in the cycle.”