Interest-rate risks could sneak up on some community banks; regulators may need a stricter approach

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Big banks aren't the only ones that stocked up on bonds only later to regret it. "Dozens of other banks — most of them quite small — are deeply underwater on their bond investments and could hit trouble if they were unexpectedly forced to liquidate the investments. That's according to an American Banker analysis of regulatory filings by the country's more than 4,700 banks," reports Polo Rocha of American Banker. "The losses, a result of banks' bonds losing their value when interest rates rose, remain 'unrealized' and only theoretical. They would only cause trouble if a bank needed cash and was forced to sell the bonds early for less than it bought them, thus making the losses real."

"Bert Ely, a bank consultant, said it 'boggles the mind' that banks took on the same type of interest rate risk that brought down hundreds of savings and loan companies starting in the 1980s," Rocha adds. "Ely, who predicted what became the savings-and-loan crisis, said American Banker's analysis shows a need for regulators to take a stricter approach on the issue. Commenting on the large degree of risk many banks took on, Ely told Rocha, "It just absolutely astounds me that they can be in compliance with the regulations."

"Several bankers contacted for this story pushed back on any concern that they'd ever need to get rid of the bonds to raise cash. Those bankers said they have plenty of cash available. . . . The Federal Reserve Board launched a new program this month aimed specifically at helping banks with underwater bonds," Rocha reports. Still, "The review of call report data reveals how some banks appear to have misplanned for a scenario in which interest rates rose sharply. . . They effectively took the same position as Silicon Valley Bank, where executives thought interest rates would stay ultralow for years and were caught by surprise when the Fed raised rates aggressively." Cliff Rossi, a University of Maryland professor and former chief risk officer of Citigroup's consumer lending division, told Rocha, "It was Risk Management 101. They need to be all over that."

"The Federal Deposit Insurance Corp., whose chairman has warned about unrealized bond losses across the industry since at least May 2022, declined to comment," Rocha adds. "Bank lobbying groups, as well as several of the banks in question, said American Banker's analysis is incomplete and paints an inaccurate picture of those banks' health. . . .Hugh Carney, a top executive at the American Bankers Association, said a single metric such as unrealized bond losses 'does not accurately capture the risks or health of an individual bank.'"