An accounting change, which has long been controversial, has allowed some of our nation’s largest banks to hide the actual value of their bond portfolios. In doing so, they’ve stopped billions of dollars in losses from accumulating on their books.
Please remember that there’s an inverse relationship between the value of a bond and its interest rate. If the interest rate goes up, then the value of the bond decreases.
A few years ago, when interest rates were well under 1%, banks bought billions of dollars of bonds. As interest rates increased, the value of those bonds decreased significantly.
The accounting change in question is a simple classification. If the bonds are held “available for sale”, then they must be valued at their actual market price.
But some consider that to be the incorrect way to value a bond for balance sheet purposes given the daily fluctuations of the market. If the bonds are recharacterized as “held to maturity”, then the bank is able to value the bond at its initial cost in the interim until it is redeemed.
Six of our nation’s largest banks have made this change. In doing so, they were valued at $681B in 2021. Once they completed this accounting change, they were valued at $1.14T by the end of last year.
This hid $118B in bond losses in the valuation of their balance sheets. The banks making this change included Charles Schwab and PNC.
Please remember that the devaluation of bonds is one of the issues that led to the most recent failure of SVB and Signature. The question becomes how many more banks will share their fate.
Let me leave you with this.
One interesting note is the fact that KPMG Intl had just completed audits on both SVB and Signature a couple of weeks before they failed. Neither of the audits revealed any of the systemic problems that led to the banks collapsing.
KPMG had signed off on both as being healthy.
Leadership at KPMG has begun the usual sound bites of how audits are limited and how market events change financial conditions over time. All this is certainly ture.
But the fact that these huge banks failed a couple of weeks after getting a clean bill of health from KPMG has again begun the debate about the questionable valuation of bond portfolios. It is possible that major changes are in the works.
I’ll continue to write about this when additional facts come to light.
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