US Banks: Realignment of Securities Investments to Optimize Returns

The recent interest rate cuts and declining bond yields have prompted US banks to reduce potential losses on low-yield securities and shift funds into higher-yielding papers. This trend could intensify by 2025, as the Federal Reserve is expected to make additional interest rate cuts. The decrease in interest rates is helping to reduce banks' book losses, which significantly increased two years ago and contributed to instability in the regional banking sector. Banks traditionally invest in bonds such as government and mortgage-backed securities to enhance returns and secure liquidity, being aware of the interest rate risk. The Fed's interest rate increase in 2022 caused US banks' unrealized losses to rise to a peak of $690 billion but fell to $513 billion in the second quarter, according to the Federal Deposit Insurance Corporation. Following the September key interest rate cut, large banks like Wells Fargo, together with regional banks like KeyCorp, started moving to sell low-yield investments and invest in higher-yielding securities. The Federal Reserve reduced the key interest rate by half a percentage point to a new range of 4.75% to 5.0%, with some policymakers openly supporting further cuts. Wes West, chief analyst at Nomis Solutions, stated that banks are willing to accept short-term losses from the sale of investments to benefit from new, higher-yielding securities in the long term. In recent years, banks refrained from such sales to avoid jeopardizing regulatory capital ratios. Many of these investments were classified as “available-for-sale securities,” since banks had the option to sell them before maturity. Recently, Wells Fargo took a step in this paradigm in the third quarter, selling securities worth $16 billion at a one-time loss of $447 million to invest in papers with yields 130 basis points higher. Wells offered no comment on this. The strategic move by banks aims to secure the currently high yields and improve profitability, especially as further interest rate cuts are expected in the coming quarters, explained Megan Fox, vice president at Moody’s Ratings. Smaller banks are also seizing this opportunity to realign. For instance, the Banc of California, which acquired PacWest last year, announced on Tuesday that it restructured securities worth $742 million at an average yield of 2.94%. This restructuring led to a pre-tax loss of $60 million, while now acquiring securities with an average yield of 5.65%.