Unrealized Losses (Securities Portfolios)

Unrealized losses on a securities portfolio are the amount by which the current market value of bonds or other securities still held falls below what the holder paid for them, or below their carrying value. The loss exists on paper only: it becomes a realized loss when the securities are sold, and it can disappear if prices recover or the bonds are held until they repay at face value. Banks, insurers and pension funds report these losses because they hold large portfolios of bonds.

Most unrealized losses in bank portfolios come from rising interest rates, not from borrowers failing to pay. A safe Treasury bond bought when yields were low loses market value when new bonds pay more. How the loss shows up in accounts and capital depends on the accounting label the holder chose when buying the security.

Imagine buying a house for a price that later falls because the whole street has become less fashionable. You have not lost money in your bank account, and if you never sell, the drop may never touch you. But if you suddenly need cash and must sell tomorrow, the lower price becomes very real.

Banks are in the same position with their bonds. When interest rates climb, older bonds paying low rates become less attractive, so their resale price drops. As long as the bank can wait until each bond matures, it gets its full money back. The danger comes when customers want their deposits back faster than expected and the bank has to sell bonds early, turning a paper loss into a real one.

Under US generally accepted accounting principles, debt securities fall into three categories, and the category decides where price changes appear:

• Trading. Securities held for short-term resale are carried at fair value, and gains and losses go straight through net income; see mark-to-market.
• Available for sale (AFS). Securities that may be sold before maturity are carried at fair value, but unrealized gains and losses go to accumulated other comprehensive income (AOCI), part of shareholders' equity, rather than profit.
• Held to maturity (HTM). Securities the holder intends and is able to keep to maturity are carried at amortized cost, so falls in market value are disclosed in the notes but do not reduce equity. Selling HTM securities early can taint the whole category.

International standards under IFRS 9 use a similar split between amortized cost, fair value through other comprehensive income and fair value through profit or loss. Neither framework treats a rate-driven price fall as a credit loss, which is assessed separately.

A common estimate of how much a bond portfolio loses when yields rise uses modified duration:

• $\Delta P$ is the change in the portfolio's market value.
• $D_{\text{mod}}$ is the portfolio's modified duration, in years.
• $\Delta y$ is the change in yield, as a decimal.
• $P$ is the portfolio's market value before the change.

A bank holding a portfolio worth 100 million dollars with a modified duration of 6 that sees yields rise by 3 percentage points loses about $6 \times 0.03 \times 100 = 18$ million dollars of market value. The approximation is close for small moves and less precise for large ones.

For regulatory capital, the 2013 US rules implementing Basel III let most banks opt out of counting AOCI, so unrealized losses on AFS securities did not reduce their capital ratios. Only the largest banks, Category I and II under the 2019 tailoring rules, had to include them. HTM losses do not count for any bank. In July 2023 US regulators proposed extending AOCI recognition to all banks with 100 billion dollars or more in assets.

As the Federal Reserve raised the federal funds rate through 2022, bond prices fell across the banking system. FDIC Chairman Martin Gruenberg said on 6 March 2023 that unrealized losses on banks' AFS and HTM securities totalled about 620 billion dollars at year-end 2022. Silicon Valley Bank had invested heavily in long-dated securities funded by uninsured deposits. On 8 March 2023 it announced it had sold about 21 billion dollars of AFS securities at an after-tax loss of about 1.8 billion dollars and sought new capital. Depositors withdrew money at record speed, and California regulators closed the bank on 10 March 2023, a modern bank run. On 12 March the Federal Reserve created the Bank Term Funding Program, lending against Treasury and agency securities posted as collateral at par value rather than market value, so banks would not need to sell at a loss. The episode showed that maturity transformation turns paper losses into solvency risk when funding runs.

• Federal Deposit Insurance Corporation: Quarterly Banking Profile
• Board of Governors of the Federal Reserve System: Review of the Federal Reserve's Supervision and Regulation of Silicon Valley Bank (April 2023)