US banks hold an estimated $650 billion in unrealized losses on their bond holdings, a result of the surge in interest rates over the past 18 months. The outcome was a string of bank failures earlier this year. While this might seem like a massive ticking time bomb, the banking sector has the flexibility to defuse the situation.
Consumers, flush with cash from stimulus checks and spending less during lockdowns, poured their excess savings into US bank deposits. The banks then invested those deposits in low-yielding government debt. This led to US banks holding over $4 trillion in government debt yielding less than 2% by the end of 2021.
However, when interest rates started to surge, the sudden shock sent bond prices plunging, leading to a spate of bank failures and a market crash. This resulted in an estimated $650 billion in unrealized losses held by the banks.
To avoid realizing these losses, banks are considering holding onto their low-yielding debt until it matures, selling some or all of their low-yielding debt and reinvesting the proceeds in higher yielding bonds, or hoping that the value of their bond assets increases and unrealized losses decrease if interest rates move lower.
Furthermore, the Federal Reserve may offer emergency funding arrangements to prevent another banking crisis.
While banks are managing their multi-trillion dollar pile of low-yielding debt, they should be able to escape this period without realizing any losses. Nonetheless, it’s the money they could have made if they hadn’t invested in low-yielding debt that will weigh on investor sentiment in the sector.
As a result, the stock performance of the banking sector has been poor, with no signs of recovering anytime soon. The SPDR S&P Bank ETF is down about 20% year-to-date, while the SPDR S&P Regional Bank ETF is down 30% over the same time period.
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