Rising interest rates have taken another bite out of the value of banks' bond holdings just as large banks face rule changes that will force them to recognize paper losses in measurements of their regulatory capital.

Accumulated other comprehensive income (AOCI), which includes changes in the market value of available-for-sale securities, dropped by $18.31 billion sequentially in the second quarter to negative $301.63 billion for the industry as a whole, according to data from S&P Global Market Intelligence. The decline helped drive an aggregate decline in tangible common equity of $11.00 billion.

Under the Basel III endgame proposal, AOCI will feed into regulatory capital for all banks with more than $100 billion of assets, in addition to the global systemically important banks for which that is already the case.

The impacted banks have been providing estimates for how long it will take their bonds to "pull to par" based on maturities and market expectations for interest rates, and some have outlined plans to rapidly build capital, including through suspensions of share buybacks.

Broad impact

Average Treasury rates across two-year to seven-year maturities, which encompass much of banks' bond portfolios, increased 61 basis points in the second quarter. Since rates move in the opposite direction as bond values, the increase helped drive down the value of banks' holdings.

Average rates across those maturities had fallen by 38 basis points in the first quarter and held about flat in the fourth quarter of 2022. AOCI had been improving during those periods, though it remained deeply negative. The impact of higher rates on the fair value of balance sheets was a key ingredient of the turmoil this year, in some cases triggering depositors to yank their money and leaving some banks with few options after the outflows.

While most of the industry has weathered the pressure well, the impact of lower bond values has been broad: 3,833 banks posted worse AOCI sequentially in the second quarter, while just 360 showed improvement. Earnings can provide an offset to deterioration in bond values, however. For adjusted tangible common equity, which includes loss reserves less nonperforming and some overdue loans, 2,537 banks showed sequential improvement, while 1,992 showed sequential deterioration.

In the third quarter, average Treasury rates across two-year to seven-year maturities increased by another 28 basis points through Aug. 25.

Long unwind

It could take years for AOCI to recover from negative amounts at many banks.

KeyCorp, for instance, projected that 44% of its negative AOCI would "burn down" by the end of 2024 and 55% by the end of 2025, assuming market expectations for interest rates.

Truist Financial Corp. projected a 36% reduction in its negative AOCI, from $13.4 billion to $8.6 billion, by the end of 2026. In its second-quarter earnings report, however, the bank's CFO said it should generate capital through earnings sufficient to "offset the estimated remaining impact of [the accumulated other comprehensive loss] on CET1 over this time period."

Fifth Third Bancorp projected a 50% reduction in its negative AOCI by the end of 2025. The bank suspended share repurchases in the second quarter.

At a conference in June, CFO James Leonard said Fifth Third would likely shorten the duration of its bond portfolio but that it might seek more duration in its loans to protect against the potential for falling interest rates.