Compass Investments

– Uncovered losses are not always an immediate precursor to insolvency, but they weaken balance sheets in a number of significant ways:

They constrain working capital as financial institutions are reluctant to dispose of assets whose market value is below book value.

They make borrowing conditions more difficult as capital reserves become more vulnerable.

They increase overall volatility, especially when deposit conditions deteriorate or when rapid withdrawals force urgent asset sales.

Such tensions were a factor in last year’s turmoil, when Silicon Valley Bank and other institutions were unable to meet the immediate demand for withdrawals while incurring significant costs on their debt securities.

The continued decline in the value of bank securities portfolios comes as high key rates continue to transform the U.S. financial environment. Even if rate cuts begin by 2026, the return to par value could take years, especially for long-term bonds purchased at very low yields.

Supervisors are keeping the sector under scrutiny. The FDIC warns that unrealized write-downs throughout 2024 and 2025 will continue to be a critical vulnerability, especially for community banks that rely heavily on their securities portfolios rather than diverse sources of revenue.

According to FDIC statistics for the second quarter, the U.S. banking sector has yet to fully recover from the rapid rate hikes of the past three years. With nearly $400 billion in hidden losses, any new destabilization – be it deposit outflows, economic downturns or deteriorating credit quality – could expose the system’s weaknesses once again.