Silicon Valley Bank’s collapse last week sent tingles of panic down investors’ spines as it highlighted a larger problem across the banking sector: The widening gap between the value large lenders place on the bonds they hold and what they’re actually worth on the market.
SVB’s downfall was tied, in part, to the plunge in the value of bonds it acquired during boom times, when it had a lot of customer deposits coming in and needed somewhere to park the cash.
But SVB isn’t the only institution with that issue. US banks were sitting on $620 billion in unrealized losses (assets that have decreased in price but haven’t been sold yet) at the end of 2022, according to the FDIC.
What’s happening: Back when interest rates were near zero, US banks scooped up lots of Treasuries and bonds. Now, as the Federal Reserve hikes rates to fight inflation, those bonds have declined in value.
When interest rates rise, newly issued bonds start paying higher rates to investors, which makes the older bonds with lower rates less attractive and less valuable.
The result is that most banks have some amount of unrealized losses on their books.
“The current interest rate environment has had dramatic effects on the profitability and risk profile of banks’ funding and investment strategies,” said FDIC Chairman Martin Gruenberg in prepared remarks at the Institute of International Bankers last week.
“Unrealized losses weaken a bank’s future ability to meet unexpected liquidity needs,” he added.
In other words, banks might find they have less cash on hand than they thought — especially when they need it — because their securities are worth less than they expected.
“Many institutions — from central banks, commercial banks and pension funds — sit on assets that are worth significantly less than reported in their financial statements,” said Jens Hagendorff, a finance professor at King’s College London. “The resulting losses will be large and need to be financed somehow. The scale of the problem is starting to cause concern.”
Still, there’s no need to panic yet, say analysts.
“[Falling bond prices are] only really a problem in a situation where your balance sheet is sinking quite quickly… [and you] have to sell assets that you wouldn’t ordinarily have to sell,” said Luc Plouvier, senior portfolio manager at Van Lanschot Kempen, a Dutch wealth management firm.
Most large US banks are in good financial condition and won’t find themselves in a situation where they’re forced to realize bond losses, said Gruenberg.
Shares of larger banks stabilized Friday after plunging to their worst day in nearly three years on Thursday, CNN reports.
