Unrealized Losses Have Piled Up at Regional Banks Facing Credit Downgrades: Report

In wake of failures, Moody's warned six U.S. banks they could face downgrades

First Republic Bank Storefront

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  • Unrealized losses have piled up on the balance sheets of many regional, mid-sized banks.
  • Book values based on accounting regulations don't reflect current market conditions.
  • Rising interest rates have reduced the value of banks loan, securities portfolios, attracting the attention of credit rating agencies.

Regional and mid-sized banks facing possible credit downgrades in the wake of two U.S. bank failures have unrealized losses placing their fair market values vastly lower than book values based on required U.S. accounting standards.

A research report from Wedbush Securities delineates the difference between the tangible book values of Silicon Valley Bank (SIVB), which collapsed Friday, and several other regional banks and the values of their assets based on the actual market prices of the securities and loans in their portfolio.

Wedbush's calculations show that First Republic Bank (FRC), placed on review Monday by Moody's Analytics for possible downgrade, has "negative tangible equity" when accounting for the unrealized market losses in its loan and securities portfolios.

In addition, the firm's report found that another other bank downgraded by Moody's, Western Alliance Bancorp (WAL), had a fair market value 92% below its book value based on generally accepted accounting principles (GAAP) for publicly traded U.S. companies.

Two other banks, Zion Bancorp (ZION) and Comerica Inc. (CMA), have respective fair market equity values 49% and 44% below their GAAP book values, Wedbush found.

Wedbush's report didn't include calculations for two other banks, UMB Financial and Intrust, that Moody's placed on review. The fair market values present only a snapshot in time based on current conditions. A surge in the loan and securities values in banks portfolios' would reduce their unrealized losses and thereby increase their fair market assessment.

Assessing Market Values

The report outlines the difference between the book values that GAAP accounting standards reflect and those based on current markets.

Analysts have cited deepening unrealized losses, based on declining market values in their portfolios caused by rising interest rates, as a primary reason that Silicon Valley Bank and New York's Signature Bank (SBNY) failed. The U.S. government and the Federal Reserve late Sunday announced they would guarantee deposits at both institutions.

"The common thread that led to the failures was the significant level of unrealized losses in their securities portfolios which, if realized, would take their regulatory capital ratios below well-capitalized levels," Wedbush's report stated.

U.S. accounting rules allow banks to report the value of certain assets, such as loans and securities they intend to own until they mature, at their historical cost of purchase.

The resulting book values, however, can mask the losses or gains those loans and securities have encountered based on market conditions since their purchase.

Wedbush's report calculated the impact of market conditions to adjust each company's GAAP book value to a "fair market" book value based on the present worth of its loan and securities portfolios.

Snapshot in Time

The median fair book values of 28 mid-capitalization and nine regional bank stocks that Wedbush assessed fell 41% and 44%, respectively, below their GAAP book values. The median stock prices of those same groupings were 54% and 63% below their GAAP respective book values.

Potential gains in securities held by those banks, however, largely explains why Wedbush still has "outperform" stock ratings on First Republic and Comerica and "neutral" ratings on Western Alliance and Zion.

"We expect bank stocks to rally following the government's actions," Wedbush's report said, noting that those actions have mitigated the risk of bank runs. "But we remain cautious on the trajectory of the economy and bank stocks given our expectation of a coming recession."

The Invesco KBW Regional Banking ETF (KBWR), reflecting a broad swath of regional and mid-size banks, rose 2% today after sliding 11% last week and another 7% Monday.

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  1. Moody's Analytics. "Moody's places First Republic Bank's ratings under review for downgrade."

  2. Moody's Analytics. "Moody's places Western Alliance's ratings on review for downgrade."

  3. Board of Governors of the Federal Reserve System. "Federal Reserve Board announces it will make available additional funding to eligible depository institutions to help assure banks have the ability to meet the needs of all their depositors."

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