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This loss is due to US interest rate hikes, which have wiped out the value of $1 billion of Treasury bills, mortgage-backed debt instruments and other asset holdings held by the banking sector alongside their loan portfolio. Financial reporting requirements allow bankers to exclude loss carryforwards from net profit and help managers to show higher earnings on a quarter-on-quarter base.
However, the loss must be subtracted from the equity - the additional cash that regulatory authorities demand from banking institutions to cope with a major financial downswing. Lost bonds show how increasing interest rates, which many speculators were speculating would result in big bank fats, can be a double-edged saber.
Largest US companies are holding tens of billion US dollar of bonds, which could be vulnerable to even greater loss as the Fed drives interest rates up amid an expanding economic environment. "When you take a cool, harsh look at it, the increase in interest rates has given them huge problems," said Richard Bove, a financial executive at Garden City, New York Hilton Capital Management.
It is a new phenomena as it was only at the beginning of this century, when regulatory authorities introduced new regulations in the course of the 2008 global economic downturn, that banking institutions had to subtract security loss from equity. Recognized in an accounting relationship known as "other comprehensive income/OCI ", operating loss accumulates until the Group sells the security, thereby actually recognizing the effect of the loss in its fair value, or until it matures.
Security-related loss detail is deeply rooted in the quarterly news release that bankers publish on their financials. Charlotte, North Carolina-based Bank of America incurred OCI charges of approximately $4 billion in the first three months. Excluding these net loss items, the net loss would have been almost two-thirds lower at $6.49 billion.
"As Bank of America CFO Paul Donofrio said at a teleconference with early this week shareholders, the cut you see is just a feature of long-term interest rates rising. "It'?s just an accountancy construction all banking has to do with. "A Bank of America spokesperson refused to make any further comments.
Wells Fargo San Francisco-based Wells posted a $2. 66 billion deficit in its OCI accounts, while New York-based Citigroup posted $1. 9 billion deficits on capital spending papers. JPM (Get Report), the largest US financial institution, said its cumulative OCI had risen $944 million quarter-on-quarter. Looking at a 17-year low in employment and increasing headline rates, most analysts anticipate that the Fed will raise interest rates further for the near term - which means that stock market falls could soar.
This gives the bank two choices, none of which is good. Investors can keep the bonds until they mature, when they get their investment back and the loss is cancelled. However, this would slow their capacity to re-invest the cash in new higher yielding stocks.
They could also be selling the stocks, swallowing loss and starting immediately with higher returns on new stocks. A former banking chief financial officer who now works as an executive researcher for broker age company in Memphis, Tennessee, Marty Mosby says they should opt for the latter one. "There are several possible causes why bankers might oppose such a move.
It will probably cost associated with grading through the hundred of billion of securities on banking books to trade and then out of them, Mosby said. A further option is that when interest rates are rising, bankers are so keen to make higher returns that they are hesitant to emphasise the loss of value by taking it into account in carefully researched per stock results hit.
"Since we had these new regulations, we haven't had higher rates, and it's really not something they thought about in the past, or thought about in this way," Mosby said. Said David Hendler, a banking analyst at Viola Risk Advisors in Montebello, New York, that today every banking institution should be able to offset the loss on assets with new lending at higher interest rates.
However, the loss serves as a reminder that it will not be "easy and painless" for bankers as the Fed is reversing its policy after the economic downturn to keep interest rates at historic low rates, Hendler said.