Wells Fargo & Co. (WFC) and JPMorgan Chase & Co. (JPM), the most-profitable U.S. banks, lost $6.5 billion in combined equity as rising interest rates and falling bond prices threaten capital levels across the industry.
JPMorgan suffered a $3.1 billion decline in accumulated other comprehensive income, a measure of shareholder equity, in the second quarter while Wells Fargo reported a $3.35 billion hit, according to results released yesterday. The equity figure includes unrealized security gains, which fell to $5.1 billion at Wells Fargo from $11.2 billion at the end of March.
Bond losses sparked by rising interest rates may force banks to hoard more profits as they build capital to meet stricter regulatory requirements. Pending rules let lenders count unrealized bond gains as core equity in regulatory capital calculations, reducing the need to sell shares or retain earnings.
“The banks want that in their capital levels,” said Todd Hagerman, a Sterne Agee & Leach Inc. analyst and former Federal Reserve bank examiner. “If they lose that they have to raise that much more equity.”
Accounting rules require banks to record unrealized gains and losses from securities characterized as “available-for-sale” under accumulated other comprehensive income, or AOCI. Those are excluded from net income and instead counted in balance sheet equity. Under rules proposed by the Basel Committee on Banking Supervision, known as Basel III, Tier 1 common equity will include AOCI.
Bond losses were sparked by rising interest rates after Federal Reserve Chairman Ben S. Bernanke indicated May 22 the central bank could slow bond purchases as employment improves. Ten-year Treasury yields rose from this year’s low of 1.63 percent on May 2 to 2.74 percent on July 5, the highest since August 2011.
At JPMorgan, AOCI dropped to $389 million in the second quarter from $3.49 billion in the first quarter, according to figures on the New York-based bank’s website. Wells Fargo’s tally fell to $1.8 billion from $5.15 billion.
Even with the slide in bond values, second-quarter earnings at the two banks were strong enough to boost the firms’ total capital levels. JPMorgan, the largest U.S. bank by assets, boosted net income 31 percent to $6.5 billion from the year-earlier period. Wells Fargo, the largest U.S. home lender, said profit climbed 19 percent to a record $5.52 billion.
JPMorgan’s Basel III Tier 1 common ratio rose to 9.3 percent at the end of June even with a 0.2 percentage point hit tied to security losses, Chief Financial Officer Marianne Lake said on the company’s conference call.
“Higher long-term rates and wider spreads drove a significant reduction in the unrealized gains in our securities portfolio,” Lake said. That affected the bank’s Basel III ratio “negatively,” she said.
Wells Fargo’s ratio rose to 8.54 percent, even with a 0.24 percentage point decline tied to the drop in other comprehensive income. The San Francisco-based bank bought $21.1 billion in securities during the second quarter to take advantage of higher yields and the increased income. The lender bought $6 billion in July, CFO Timothy Sloan said on an earnings conference call.
“When you have a large security portfolio like we do, and most of the portfolio is at a fixed rate, it’s worth less on paper” when interest rates rise, Sloan said in a phone interview. “It’s not as if rising rates make the income coming off those securities any lower. It’s the same income, it’s just the value that’s different.”