The upcoming second-quarter earnings report from Bank of America is expected to reveal a significant loss in its bond portfolio. However, this important detail might not be prominently featured in the main press release, but rather tucked away in the financial supplement.

The bank's held-to-maturity securities portfolio, valued at $625 billion as of March, suffered a loss of $99 billion on that date. This substantial loss can be attributed to the decline in the bond market since the purchase of these securities, primarily mortgage-backed securities, in 2020 and 2021 when interest rates were at an all-time low of around 2%.

When interest rates rise, fixed-income securities, like bonds, decrease in value. Consequently, the Federal Reserve's implementation of a five-percentage-point short-term rate increase since March 2022 has severely impacted the bond holdings of various financial institutions. However, Bank of America's portfolio loss significantly surpasses that of its competitors such as JPMorgan Chase and Wells Fargo.

This substantial loss has had a negative impact on Bank of America's stock performance relative to its rivals. While Bank of America's stock experienced a slight increase of 1.2% on Monday, reaching $29.47, it has fallen by 11% this year. In contrast, JPMorgan's shares have increased by 13% to $152.69 in 2023, including a 2% gain on Monday. In the past year, Bank of America's stock has returned a negative 6% compared to JPMorgan's positive 39%, according to Bloomberg data.

JPMorgan's market value now nearly doubles that of Bank of America, further widening the gap between the two major banks. JPMorgan currently boasts a market value of approximately $440 billion, while Bank of America's market value stands at $232 billion.

Analyzing JPMorgan's second-quarter profit report from last Friday, it appears that Bank of America's bond portfolio losses may have increased slightly in the second quarter, reflecting a modest decline in mortgage-backed securities prices. The loss reported by JPMorgan reached approximately $33 billion on June 30, compared to $30 billion on March 31.

Though accounting rules allow banks to exclude losses on held-to-maturity securities from their capital positions, the economic losses suffered by Bank of America due to its portfolio are undeniably real. These losses would significantly impact the bank's tangible equity, which stood at $182 billion on March 31, even after adjusting for taxes.

Bank of America's Bond Portfolios and Their Impact on Capital Ratios

Bank of America and other banks hold separate bond portfolios that are classified as available for sale for accounting purposes. These portfolios can have a significant impact on capital ratios, as any losses incurred must be reflected, thereby reducing the banks' equity.

Bank of America asserts that its held-to-maturity portfolio, primarily consisting of agency mortgage securities with minimal credit risk, will ultimately mature, rendering the losses negligible over time. Currently, principal payments are being made at a rate of approximately $10 billion per quarter.

During Bank of America's first-quarter earnings conference call in April, Evercore ISI Analyst Glenn Schorr raised a question concerning the bank's ability to weather the storm and gradually diminish the losses. Alastair Borthwick, the bank's chief financial officer, responded by confirming that the bank has indeed been following this strategy. He emphasized that they have communicated this approach clearly and have every intention of persisting with it. Borthwick went on to state, "It just keeps getting smaller and shorter."

While the size of the portfolio has decreased from its peak of $683 billion in 2021, it remains substantial. The challenge with mortgage securities lies in the fact that effective maturities tend to lengthen during periods of rising interest rates. This phenomenon leads to increased losses as homeowners are encouraged to retain their below-market loans.

Another concern for Bank of America pertains to the average yield on its held-to-maturity bond portfolio, which currently sits at 2.6%. This figure is roughly half of the prevailing market rate. As deposit costs for the bank continue to rise, there is a risk of squeezing Bank of America's net interest margins. During the first quarter, average deposit costs for the bank stood at approximately 1%.

Looking ahead, analysts are anticipating that Bank of America's second-quarter earnings will exhibit growth, rising to 84 cents a share from 73 cents in the year-earlier period. However, CEO Brian Moynihan's upcoming conference call to discuss the numbers is likely to elicit questions regarding the outlook for loan demand, credit quality, interest margins, investment banking trends, and retail brokerage. Additionally, it is expected that some analysts will inquire about the impact of the substantial bond losses on the bank's overall performance.

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