We Have Unrealized Losses – What Should We Do?

Impact of inflation on unrealized losses in a bank's investment portfolio

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With rising interest rates, we’ve received an influx of questions about the impact on the unrealized losses in the bank’s investment portfolio.

Most banks classify their securities as available for sale (AFS), which requires them to record the asset at fair value, with an unrealized gain or loss (URGL) in capital through accumulated other comprehensive income (AOCI).  While the URGL impacts balance sheet capital, it does not have any impact on regulatory capital, as the AOCI adjustment is eliminated when calculating regulatory capital ratios.

However, in some instances, balance sheet capital is being reviewed. For example, the Federal Home Loan Bank (FHLB), cannot make a new advance to an institution whose tangible capital (which includes AOCI) is not positive.  We’ve also heard from some banks that their regulators are questioning their unrealized losses, and asking about their liquidity plans. One question we’ve been receiving is if banks should transfer their securities from AFS to Held to Maturity (HTM). 

Things to consider if transferring from AFS to HTM:

  • You can only classify your securities as HTM if your bank has the positive intent and ability to hold until maturity. This could potentially limit your liquidity options.  Once a security is classified as HTM, it should not be sold prior to maturity.
  • Beginning in 2023, HTM securities must be evaluated for impairment using a current expected credit loss (CECL) model similar to loans. This is different than the current process of evaluating securities for impairment than the current OTTI model.
  • If you do decide to convert to HTM, the AOCI as of the transfer date does not go away. Instead, the unrealized losses will be “locked in”.  You will accrete the unrealized loss remaining in AOCI over the life of the security.  While transferring securities will not eliminate existing AOCI, it will limit any additional accumulation of unrealized losses.  Because the unrealized losses are “locked in”, the bank will not be able reverse the losses or even recognize unrealized gains through AOCI if the market improves.
  • You do not have to transfer all securities to HTM. In fact, it probably would be difficult to support your bank’s intent and ability to hold all securities to HTM. However, you may choose to transfer some securities to HTM and leave other securities classified as AFS.

As you’re discussing your liquidity plans, as it relates to the unrealized losses in your portfolio, these are some things you should consider. 

Connect with a Pinion advisor for any questions you may have. 

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