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Rising Rates Pressuring Bond-Heavy Bank Stocks

Several large banks have shown growing paper losses in their fixed-income securities portfolios.

Severe weakness in the bond market is torturing bank stocks, as investors wager that rising interest rates will pressure financial institutions.

As bonds have tanked -- the 30-year Treasury bond recently hit levels it hadn't seen since September 1997, yielding around 6.60% -- several large banks have shown growing paper losses in their fixed-income securities portfolios. If banks realize these losses -- as some analysts and investors contend they may -- earnings would get clobbered, almost certainly causing the banks to fall far short of their projected profits targets.

Three's a Crowd

Of the nation's 15 largest banks, three institutions had paper losses at the third quarter's end that exceeded 3% of the size of their so-called available-for-sale debt securities portfolios (available-for-sale is the balance-sheet label given to securities that aren't held for trading or until maturity). They are

Bank of America

(BAC) - Get Bank of America Corporation Report






(PNC) - Get PNC Financial Services Group Inc. (The) Report

. (See table below.)

On Monday, Bank of America, Chase and PNC slid 3.5%, 6% and 5.2%, respectively, as the

KBW Bank Index

posted a 4.6% decline.

Charles Peabody, banks analyst at New York-based

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Mitchell Securities

, says banks with paper losses will be more likely to realize them to stem the losses rather than letting them get worse. This could take place soon, he adds. "We're going to see much more prolific restructuring of balance sheets in the first half of 2000," he says.

"You have a lot of large-cap banks praying for a bond-market rally in the new year," says one New York-based bank-stock hedge fund manager who requested anonymity.

What They Don't Realize

A Bank of America spokesman says his firm has no plans to realize any of the $2.9 billion unrealized loss in its debt securities portfolio at the third quarter's end. And he adds that the loss is more or less made up for by a rise in the value of assets and liabilities that benefit from increases in interest rates. Unfortunately for the bank, the spokesman notes, this offsetting appreciation isn't included in reported financial statements, due to accounting rules. Also, Bank of America and others may decide to hold the bonds to maturity, thereby getting the original investment back at no loss.

Says PNC's Treasurer Randall King: "To the best of my knowledge, we have no plans to realize these losses." King, too, explains that the losses are almost wholly covered by an increase in the value of the bank's mortgage business. Chase didn't comment.

"The focus now is where the

available-for-sale hits are going to come," says David Harvey, a manager of

Everest Partners

, the Gardnerville, Nev.-based financial-services hedge fund. In the thrift sector, Harvey identifies



as having heavy debt securities losses. The thrift, in which Harvey has no position, had a $391 million loss in its debt securities portfolio at the third quarter's end, equivalent to 3.9% of its debt portfolio.

An Astoria spokesman says the thrift isn't going to realize its losses. "Our strategy has always been to hold to maturity," he says.

No Pain, No Gain

While banks have good reasons not to realize bond losses, it may actually be beneficial for them after the pain and embarrassment of announcing a hit to earnings have worn off. For example,

State Street

(STT) - Get State Street Corporation Report

recently sold out of some underwater bond positions, but said in a release that it expects the move to increase the yield of its portfolio, even though it's going to cause the bank to take a pretax $57 million charge on fourth-quarter earnings. State Street sold bonds and invested the proceeds in higher-yielding securities.

In addition,


(STI) - Get SunTrust Banks, Inc. Report

in the fourth quarter sold bonds at a loss and invested in more attractive bonds.

Wells Fargo

(WFC) - Get Wells Fargo & Company Report

announced that it was going to book some debt securities losses in the fourth quarter, but didn't respond to calls Monday seeking to determine whether it did.

These three banks had one convenient luxury going for them that may not exist at most other banks: State Street and SunTrust used, and Wells said it intended to use, large one-time gains from selling assets to soften, or fully absorb, the bond losses' impact on fourth-quarter earnings.

This suggests banks want to take bond losses now to protect themselves against even steeper declines in the future, but only those with a cash cushion have been able to do so.

But Mitchell's Peabody thinks even banks without cushions will eventually be forced to realize these losses, as they did in 1994, when the


raised interest rates six times. And Peabody notes that bonds performed worse in 1999 than they did in 1994. "Look at past cycles: Banks have always restructured their balance sheets when they think interest rates have reached a peak," he says.