BofA: when plentiful deposits are not a nice problem to have

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Early on during the coronavirus pandemic, cash was king. Later it became more of an unwelcome guest. Bank of America initially found itself with hundreds of billions of deposited cash flooding in from customers, themselves flush with savings and stimulus payments. BofA bet that interest rates would stay low, parking these funds in low-risk bonds such as Treasuries. 

That gambit looks less clever now. Rapid monetary tightening has sent the base interest rate above 5 per cent. On BofA’s balance sheet, its portfolio of low coupon debt securities, recorded at a cost of $801bn, now has a fair value of $698bn. That lower net present value reflects a higher discount rate.

Most of those bonds are classified as hold to maturity, meaning accounting losses will not affect its income statement or capital ratios. The portfolio will throw off modest interest payments for years.

But with those deposits tied up in long-term securities, it curtails BofA’s ability to take advantage of new opportunities to make higher rate loans or buy new, more attractively priced securities. BofA’s shares are down 15 per cent this year while JPMorgan’s are slightly up. Their once similar net interest margins have started to diverge after years of running together.

Things might get worse. Late on Wednesday, the Federal Reserve released its annual stress test results. It noted that in its “severely adverse” scenario, unrealised losses on securities would actually decline given that interest rates should drop under such conditions. However, banks holding lots of securities backed by mortgages, credit cards and loans for commercial real estate would get hit hard.

Unrealised losses in bond portfolios are today linked with this year’s bank run and failure at Silicon Valley Bank. SVB was forced into selling securities and crystallising previous paper losses, not a risk for BofA. Accounting rules for banks are quirky, abstract and sometimes counterintuitive. But how cash ultimately gets allocated remains very real.