The jump in interest rates in May and June pummeled the value of banks’ bond portfolios, but investors have mostly shrugged off the losses.
Second-quarter marks against securities have cost several banks billions of dollars each, and have run as high as 5% or more of tangible equity at the start of the period. Nonetheless, investors have been bidding up the shares of these companies, many of which beat earnings estimates. (The following graphic shows data on unrealized gains and losses on securities. Interactive controls are described in the caption. Text continues below.)
Drops in the market value of banks’ bond investments — prices move inversely with yields — have been nearly universal. The vast majority of banks’ holdings of securities are classified as available for sale, meaning that most changes in market value do not flow through to net income. Instead, they are accounted for under “accumulated other comprehensive income,” through which unrealized gains boost equity and unrealized losses reduce equity. (Currently, unrealized gains and losses are excluded from regulatory capital ratios, and all but the largest banks will have the option to continue the treatment under the proposal to implement Basel III.)
Among a group of 138 publicly listed banks for which second-quarter figures are available, AOCI fell in amounts equal to more than 1% of March 31 tangible equity at 114.
Yet the SNL U.S. Bank and Thrift Index has outperformed the S&P 500 index since the beginning of May, and since earnings season began about two weeks ago. Investors appear to have focused on other trends, including earnings that have outweighed the diminished market value of bonds at many. About 40% of the companies considered here posted increases in tangible book value per share in the second quarter.
Bank of America’s (BAC) tangible book value was about flat at $20.18 in the second quarter despite a $4.2 billion drop in its AOCI. The company’s estimate for its Tier 1 common capital ratio under Basel III, which is influenced by unrealized gains and losses, increased by 8 basis points from the first quarter to 9.6%. Factors like rising home prices helped reduce Bank of America’s risk-weighted assets under the new regime.
JPMorgan Chase’s (JPM) tangible book value increased by about 1.3% despite a $3.1 billion drop in AOCI. AOCI “is not that big a deal,” said Chief Executive Jamie Dimon, with higher rates generally poised to help earnings over time.
Pacific Continental (PCBK), a $1.4 billion-asset bank in Eugene, Ore., posted a 2.5% decline in tangible book value per share as its AOCI fell in an amount equal to 3.1% of its March 31 tangible equity. The company projected that its net interest margin would be about stable in the third quarter after falling 9 basis points to 4.2% in the second quarter.
Pacific Continental said it continues to be “liability sensitive,” meaning higher rates would generally tend to hurt it because yields on liabilities are poised to move quicker than yields on assets, in part because floors on loan rates remain higher than market rates. It said it has done things like issuing five-year and 10-year brokered time deposits and swapping into a fixed rate for its trust-preferred securities to reduce its liability sensitivity.
In a note this week, analysts with KBW said they expect investors to continue to weigh earnings growth more heavily than moves in tangible book value, but that banks posting equity declines without offsets are likely to underperform.