In the dynamic landscape of wealth management and investment, Bank of America has recently seen a significant shift in its financial position, primarily due to the recent bond market rally. Under the leadership of CEO Brian Moynihan, the bank has experienced a notable reduction in its unrealized bond losses. Initially recorded as the largest in the industry at the end of the third quarter, these losses have since contracted considerably.
As per Barron’s analysis, the estimated losses in Bank of America's extensive portfolio, valued at $603 billion and comprising Treasuries and mortgage securities held to maturity, have decreased from $131 billion to approximately $100 billion. This change is attributed to the positive trend in the fixed-income market that began in late October.
Comparatively, JPMorgan Chase, another key player in the sector, has also seen a reduction in its unrealized bond losses. Currently, these losses are estimated to be between $30 billion and $35 billion, down from the $40 billion reported at the end of the third quarter.
It's important to note that these paper losses do not impact Bank of America’s capital ratios due to specific accounting rules. However, they remain a point of interest for investors. Warren Buffett, CEO of Berkshire Hathaway and the largest shareholder in Bank of America, has previously criticized banks for their investment strategies in mortgage securities during the low-rate periods of 2020 and 2021. He highlighted that mortgage securities typically underperform in rising rate environments due to their increasing effective maturity.
Berkshire Hathaway maintains a significant stake in Bank of America, owning about 13% of the bank's stock, totaling approximately one billion shares. However, it has not increased its holding in the current year.
The diminishing losses have positively influenced Bank of America's stock, which has risen by about a third since its low in late October. This uptick coincided with the peak yield of 5% on the Treasury 10-year note. The yield has since adjusted to 3.95%.
Furthermore, the value of mortgage securities has appreciated by roughly 5% since September 30, aligning with the $30 billion reduction in the bank's losses. Despite these gains, Bank of America's stock performance still trails its peers this year, with an increase of only 1%, compared to the 24% rise experienced by industry leader JPMorgan.
Over the past five years, Bank of America has also lagged behind JPMorgan, with an annualized total return of 9% against JPMorgan’s 14%. The substantial paper losses, though not affecting the bank's capital ratios, still represent a significant portion of its capital base. Bank of America's tangible common equity capital stood at $188 billion at the end of the third quarter. If the paper bond losses were to affect its capital position, it could halve this equity capital.
During the third-quarter conference call, UBS analyst Erika Najarian referred to the held-to-maturity portfolio as a persistent concern for the stock. Bank of America executives, however, have defended this portfolio, emphasizing its low credit risk and the potential for reinvestment at higher rates as the securities mature. The portfolio is reducing at a rate of about $10 billion per quarter due to the paydown of mortgage securities.
CEO Moynihan expressed optimism about the bank’s future prospects, forecasting an expansion in net interest margin by mid-2024. However, the current average rate of the portfolio, at about 2.5%, might continue to impact the bank’s returns for several years, and there is a possibility that the paper losses could increase if interest rates rise again.
Bank of America's strategy during 2020 and 2021, which involved substantial investments in long-term securities at historically low rates, contrasts sharply with the approach taken by JPMorgan under CEO Jamie Dimon. Dimon opted not to invest heavily in long-term bonds with yields between 1% and 2% during this period, prioritizing long-term risk-reward balance over immediate earnings.
Bank of America, which has not publicly commented on these developments, is expected to provide further insights during its fourth-quarter earnings report in January. This forthcoming disclosure is anticipated to shed more light on the bank's strategic decisions and financial trajectory in the context of the evolving economic landscape.
