Higher interest rates pounded the market value of banks' bond portfolios in the third quarter, bringing a major input for tangible equity to a new low for the cycle.

Accumulated other comprehensive income (AOCI), which captures changes in the value of banks' available-for-sale securities portfolios, fell $15.77 billion sequentially to negative $170.29 billion in the third quarter across the 15 largest publicly traded US banks, according to data from S&P Global Market Intelligence. The previous low was negative $165.86 billion in the third quarter of 2022.

Negative AOCI cuts into tangible equity and would slice into regulatory capital measures for all banks with more than $100 billion in assets under a proposed rule (AOCI is already included in regulatory capital measures for the eight largest and most complex US banks). Banks have been countering the pressure by holding back on repurchases and accumulating capital while shrinking risk-weighted assets, and tangible common equity (TCE) per share actually increased sequentially at about half of the 15 banks.

Still, after the sharp rise in rates since the beginning of 2022 — bond values move inversely with rates — AOCI appears likely to be a major drag on bank capital for years. Banks generally expect about 35% to 40% of their negative AOCI to wear off by the end of 2025 as bonds mature, analysts at Jefferies said in a note Nov. 1.

Offsetting AOCI

Wells Fargo & Co. reported a sequential increase of 30 basis points in its Tier 1 common equity ratio (CET1) to 11.0% in the third quarter despite an incremental drag of 16 basis points from worse AOCI. The increase reflected retained earnings, lower risk-weighted assets, a benefit of 14 basis points from the sale of some private equity investments and a slowdown in stock buyback activity.

The bank executed $1.5 billion of gross share repurchases during the period, down from $4.0 billion in the second quarter. It estimated that the Basel III endgame rule as proposed would increase its risk-weighted assets by about 20% but that its CET1 ratio is currently about 50 basis points higher than what would be required and said it planned to continue stock buybacks.

Wells Fargo's TCE per share increased 2.5% sequentially to $37.13, according to data from Market Intelligence. The data does not include fair value marks against the bank's portfolio of held-to-maturity securities or other elements of its balance sheet.

The percentage deterioration in Truist Financial Corp.'s AOCI was, like Wells Fargo's, among the biggest in the group.

Truist is building its CET1 ratio toward a target of 10% at the end of the year in view of the proposals for tougher capital requirements and reiterated that it could achieve a further boost of 2 percentage points if it sold the rest of its large insurance brokerage subsidiary.

Its TCE per share declined 5.9% sequentially to $18.67.

Q4 so far

Treasury rates across two-year to seven-year maturities, which encompass much of banks' bond holdings, had continued to increase early in the fourth quarter but tumbled after a Nov. 1 Federal Reserve policymaking meeting that markets interpreted as dovish and a Nov. 3 jobs report that showed a cooling labor market.

As of market close on Nov. 3, rates across those maturities were lower than at Sept. 30. The drop, if it persists or deepens, would help accelerate the winding down of banks' negative AOCI.