Bank of America Benefits from Bond Market Rally

Bank of America’s CEO, Brian Moynihan, is undoubtedly pleased with the recent rally in the bond market. As of the end of the third quarter, the bank held the largest unrealized bond losses in the industry. However, since the fixed-income rally began in late October, these losses have significantly narrowed.

Estimates suggest that Bank of America’s losses in a $603 billion portfolio of Treasuries and mortgage securities, classified as held to maturity for accounting purposes, could now be around $100 billion, compared to $131 billion at the end of September. In contrast, JPMorgan Chase’s unrealized bond losses may now be in the range of $30 billion to $35 billion, down from approximately $40 billion at the end of the third quarter.

Although these paper losses do not impact Bank of America’s capital ratios based on accounting rules, many investors still pay close attention to them. Warren Buffett, CEO of Berkshire Hathaway and Bank of America’s largest shareholder, has criticized banks for purchasing mortgage securities at historically low rates in 2020 and 2021. He specifically highlighted the negative behavior of mortgage securities in a rising rate environment, as they lengthen in effective maturity, contrary to holders’ desires.

Berkshire Hathaway, which owns roughly one billion shares (equivalent to 13% of the bank’s stock), has not increased its holding this year. Nevertheless, the narrower losses have benefited Bank of America stock. It has experienced a 33% increase from its late October low, around the same time the Treasury 10-year note yielded 5%. Currently, the yield stands at 3.95%.

Furthermore, the price of mortgage securities has risen by approximately 5% since September 30th, which aligns with a reduction of about $30 billion in the bank’s losses.

Despite these positive developments, Bank of America’s shares fell by 0.5% on Monday, reaching $33.42. While the stock has gained 1% this year, it lags behind its industry peers, with JPMorgan leading the way with a 24% increase.

Over the past five years, Bank of America has also significantly underperformed JPMorgan, with an annualized total return of 9% compared to JPMorgan’s superior 14%.

In conclusion, Bank of America has reaped significant benefits from the bond market rally, reducing its unrealized bond losses and boosting its stock performance. However, it still faces some challenges in catching up to its industry rivals.

Bank of America’s Capital and Paper Bond Losses

Bank of America has experienced significant paper losses, although they do not affect the bank’s capital ratios according to accounting rules. However, these losses are still substantial relative to its capital base.

If the paper bond losses were to flow through Bank of America’s capital position, its tangible common equity capital of $188 billion at the end of the third quarter would be halved. On the other hand, another group of bonds, classified as available for sale for accounting purposes, do impact bank capital.

During the company’s third-quarter conference call, UBS analyst Erika Najarian expressed concerns about the held-to-maturity portfolio, which has been a persistent issue affecting the bank’s stock.

Bank of America executives have defended the portfolio, which primarily consists of federal agency mortgage securities, claiming it carries no credit risk and will mature over time, allowing the bank to reinvest at higher rates. This portfolio is gradually decreasing by approximately $10 billion per quarter as the mortgage securities are paid down.

CEO Brian Moynihan stated in an interview with CNBC in October that the bank’s net interest margin is expected to expand by mid-2024.

However, the portfolio, with an average interest rate of about 2.5%, could weigh on the bank’s returns for several years. Additionally, if interest rates rise, the paper losses may further increase.

Bank of America accumulated most of this portfolio during 2020 and 2021 when interest rates were at historic lows.

During that period, JPMorgan, under the leadership of CEO Jamie Dimon, outperformed Bank of America by avoiding investments in long-term securities. Dimon prioritized avoiding long-term bonds with yields of 1% to 2% due to poor risk-reward prospects. This decision had a temporary negative impact on JPMorgan’s earnings in 2020 and 2021.

Bank of America has declined to comment on the matter but is expected to provide more information when it reports its fourth-quarter earnings in January.