Since the Federal Open Market Committee began tightening monetary policy in March 2022, interest rates have risen, resulting in higher borrowing costs and reducing the value of commercial bank’s securities investments, said Blake Marsh and Brendan Laliberte, economists at the Federal Reserve Bank of Kansas City, in a release.
“After amassing securities during the pandemic, banks saw rising interest rates erode the value of their securities portfolios by nearly $600 billion, or about 30% of their capital holdings,” Marsh and Laliberte wrote.
“UNREALIZED LOSSES” MOUNT
Declines in the value of a bank’s securities portfolio—known as “unrealized losses” may pose consequences for banks and borrowers alike, the economists said. In some cases, declines in the value of securities holdings in response to interest rate changes mechanically reduce key regulatory capital and liquidity ratios.
Further, should banks need to sell the securities to generate income when their valuations are low, the unrealized losses will become realized losses, eroding capital buffers and possibly threatening the solvency of the bank, they said. Lower capital, or liquidity, can reduce the willingness of banks to lend, as solvency concerns increase debt and equity costs. Ultimately, lower securities valuations can increase loan prices and reduce loan growth.
FOUR WAY TO LOSE
That dampening of loan growth can come through any of four channels, the release said.
First, unrealized losses can increase equity costs as investors’ perceptions of financial health deteriorate, they said.
Second, deterioration of financial strength combined with increased liquidity needs can increase debt funding costs, the economists said. These increased equity and debt funding costs likely will be passed on to borrowers as higher interest rates, potentially reducing loan demand.
Third, unrealized losses also can make banks more reluctant to sell securities, creating liquidity demand that could limit future loan supply, they said. Lower loan demand because of higher prices and lower loan supply from higher funding costs could reduce total loan growth.
Fourth, unrealized losses can dampen Merger and Acquisition activity because potential buyers may be reluctant to purchase a bank holding securities in a deep loss position, the economists said. Reduced M&A activity can result in a less effective banking system to the extent that it allows inefficiently run banks to continue operating. In this way, a slowdown in M&A activity can result in poorly allocated, or reduced, aggregate lending.
So, unrealized losses can affect all types of banks irrespective of size, regulatory treatment, or funding access, the release said. Some channels, like public equity or debt costs, most obviously affect large banks.
However, smaller community and non-public banks also can be affected by unrealized losses from funding covenants, limited access to alternative liquidity sources and the ability to market themselves as acquisition targets.
CATTLE, BEEF RECAP
The USDA reported formula and contract base prices for live FOB steers and heifers this week ranged from $172.20 per cwt to $178.00, compared with last week’s range of $164.63 to $171.57 per cwt. FOB dressed steers, and heifers went for $261.33 per cwt to $268.47, compared with $256.76 to $269.59.
The USDA choice cutout Wednesday was up $3.38 per cwt at $298.48 while select was down $0.23 at $281.81. The choice/select spread widened to $16.67 from $13.06 with 90 loads of fabricated product and 14 loads of trimmings and grinds sold into the spot market.
The USDA said basis bids for corn from feeders in the Southern Plains were unchanged at $1.58 to $1.65 a bushel over the May corn contract, which settled at $6.56 a bushel, up $0.05.
No live cattle futures deliveries were tendered Wednesday.
The CME Feeder Cattle Index for the seven days ended Tuesday was $193.24 per cwt, down $0.32. This compares with Wednesday’s Apr contract settlement of $202.22 per cwt, up $0.12.