Banks in the US are sitting on a record cumulative loss of $620 billion on their bond portfolio. But what is worse is that the number is as of end-2022, the year when the US Fed increased rates by 450 bps. The losses would have increased in the current calendar year as the central bank had further raised the rate by 25 bps in February to 4.50-4.75% range, the highest level since 2007.
According to the Federal Deposit Insurance Corporation (FDIC), the losses on the available-for-sale portfolio of banks was $279.53 billion, and $340.87 billion on the held-to-maturity basket of securities, as of 2022. The unrealised losses, which are up from $8 billion a year earlier before the Fed's rate push began, are the highest facing US banks since the 2008 credit crisis, when the unrealised losses were 1/10th ($63 billion) of the current number.
Following the rapid rate increases in the US, the benchmark US 10-year treasury yield is flirting 4% levels, even as the mortgage backed securities (MBS) yields spiked to 5.67%. A large part of Silicon Valley Bank's (SVB) woes is tied to its exposure to MBS where prices fell as yields spiked. Since SVB held a chunk of its bond portfolio in longer dated securities of more than 10 years, its $91 billion held-to-maturity portfolio lost value, falling to $76 billion.
Though banks will not incur a loss if they hold on to the debt securities until maturity, the Silicon Valley Bank (SVB) crisis just goes to show that if a bank indulges in a fire sale of bonds to raise cash to meet liquidity requirements, it will have to take a hit on the P&L, which, in turn, could impact its capital buffers. SVB reportedly offloaded $21 billion worth of bonds, incurring a loss of $1.8 billion. The sudden loss set the alarm bells ringing, thwarting the bank's planned raise of $2.3 billion in fresh capital to stay solvent. A subsequent downgrade by rating agencies only accentuated the crisis with the stock tumbling more than 60%.
FDIC chairman Martin Gruenberg had cautioned that the combination of a high level of longer–term asset maturities and a moderate decline in total deposits underscores the risk that these unrealised losses could become actual losses should banks need to sell securities to meet liquidity needs. Gruenberg had remarked that the banking industry continues to face significant downside risks from the effects of inflation, rising market interest rates, and continued geopolitical uncertainty. Credit quality and profitability may weaken owing to these risks and may result in tighter loan underwriting, slower loan growth, higher provision expenses, and liquidity constraints, the chairman had stated at a press meet in February to mark the release of the agency's quarterly banking update.
What's worrying is that in 2022 banks in the US notched up a cumulative net income of $263 billion, a decline of $16.1 billion led by an increase in provision expense of $82.6 billion. Gruenberg had warned that economic uncertainty may affect future credit quality even as provision expenses increase the amount set aside by institutions to protect against future credit losses. With the return–on–assets ratio for the industry declining from 1.23% in 2021 to 1.12% in 2022, the nervousness on Wall Street is palpable.
With inflation still over 6%, the market believes that the Fed Funds rate could reach 5.25% to 5.50% in the current year, with the likelihood of the benchmark hitting 6%. Investor and hedge fund manager Stanley Freeman Druckenmiller had commented that once inflation goes above 5%, it has never come back down without the Fed Rate exceeding the CPI.
