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The 2008 financial crisis exposed many flaws in the U.S. financial system, including the inherent danger that America’s largest banks would become overleveraged. Despite a series of reforms aimed at ensuring that banks remain on a sound financial footing, significant risks remain. A recent article in Cryptopolitan magazine revealed that U.S. banks’ potential loss exposure on real estate-related securities soared to $750 billion in the third quarter of 2024.
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This raises concerns for a variety of reasons. First, the estimated $750 billion is about seven times the amount held by banks in 2008. Second, many unrealized losses are concentrated in portfolios that are critical to banks’ profits. The riskiest portfolios are:
· AFS – Available for sale
· HTM – hold until maturity
One very worrying aspect of the potential $750 billion loss is that much of it involves residential mortgage-backed securities (RMBS). Banks put these aside when interest rates were low. Easier credit has made it easier for banks to acquire larger debt tranches and easier to sell the underlying assets. Investing so much money in RMBS could come back as a huge boomerang for banks and investors.
Many of these HTM portfolio loans are nearing maturity, and high interest rates are slowing AFS portfolio sales. This is why the potential losses start to add up. Investors are wary of buying RMBS in the current environment, as increased funding costs have wiped out huge sums of previously profitable stocks.
This reduces the value of RMBS held by banks while increasing potential losses on the underlying assets. Banks went out of business because large AFS or HTM portfolios were turned upside down. In 2023, unrealized losses on First Republic Bank’s commercial loan portfolio were the primary cause of the bank’s eventual failure and acquisition by JPMorgan Chase.
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Banks may have been able to store these balances in years past, but one of the major reforms introduced since 2008 has made it much more difficult. U.S. banks must undergo periodic “stress tests” to weigh their liquidity against their outstanding debt. If these numbers diverge, banks could be forced to close or drastically cut prices.
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If that is not enough, banks are even more likely to incur large losses in other areas, especially government and corporate bonds. Cryptopolitan cited Bank of America’s recent admission that it lost $85 billion in its bond portfolio this year. To make matters worse, Bank of America has taken a $116 billion hit to its HTM portfolio over the past three years. they are not alone.
According to Cryptopolitan research and public documents, 47 of the 1,027 U.S. banks with more than $1 billion in assets have potential liabilities and losses on their books that exceed 50% of the bank’s capital. At this point, it is important to emphasize that these are unrealized losses. This means that the bank holding the paper won’t necessarily lose it, but it’s possible.
If the worst-case scenario materializes, the banking industry and economy will be plunged into crisis. That said, the future is difficult to predict, and what happens next will depend on what the Fed does with interest rates going forward. Some analysts believe banks could reduce unrealized losses by up to 25% if interest rates remain flat or decline.
That would take billions of dollars of unrealized losses off the books. On the other hand, if interest rates rise again, the long-term outlook could deteriorate rapidly. Either way, those investing in RMBS and big bank stocks should keep a close eye on the sector over the next 18 months. They may lead a very turbulent life.
The current interest rate environment creates an excellent opportunity for income-seeking investors to earn huge yields, but not through publicly traded REITs.
Alived Homes, the investment platform backed by Jeff Bezos, has launched a private credit fund. It provides investors with access to a pool of short-term loans backed by residential real estate with a target net annual yield of 7% to 9% paid monthly. In August, it was 8.1%. The best part? Due to high demand, the current maximum investment is $5,000 and the minimum investment is only $100.
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The article U.S. Banks Suffer $750 Billion in Losses on Real Estate Debt-Related Securities – Which Sectors Are Most Affected? originally appeared on Benzinga.com
