Rising bond yields are putting fresh pain on some banks’ bond portfolios, but that doesn’t mean acquisitions of those lenders are off the table.
One recent M&A deal shows even the most upside-down of banks can make the math work, observers say. Few banks had
Unrealized losses — which got widespread scrutiny after Silicon Valley Bank’s failure in March 2023 — are not yet a problem of the past. At banks that kept their exposure to interest-rate swings relatively short, time is healing those wounds.
But even at banks facing longer-term pain, unrealized losses are a known issue that dealmakers can easily price, though that price is not as high as potential sellers once hoped.
“Every day it gets better, but it is still an issue, unequivocally,” said Bill Burgess, co-head of financial services investment banking at Piper Sandler, adding that banks’ bond portfolios are far easier to value than a “$250 million condo loan in Miami in 2009 — that could be worth zero.”
The discounts nonetheless remain painful for over-exposed banks. For those depositories that plowed money into the bond market in 2020 and 2021, a subsequent series of aggressive rate hikes by the Federal Reserve, which was battling inflation, took a toll. Bonds lose their value when rates rise, since newer bonds pay more interest.
Some bankers had hoped that rates would have fallen by now, fixing the problem and wiping out their unrealized losses. But “they haven’t seen the recovery that they thought they were going to,” said Kirk Hovde, head of investment banking at Hovde Group.
Instead, unrealized losses on banks’ bond portfolios grew last quarter to $482.4 billion, up by $118.4 billion from a quarter earlier but below their peak in 2022, according to the Federal Deposit Insurance Corp.
The losses could “increase banks’ vulnerability if other developments, such as a large surge in commercial real estate loan losses, make depositors question a bank’s viability,” two researchers at the Treasury Department’s Office of Financial Research wrote in a blog post
Rates on a roller coaster
The recent rise in bond yields has renewed some of the pressure. The yield on the benchmark 10-year U.S. Treasury security fell to as low as 3.63% in mid-September, but then traders started pricing in the possibility that President Donald Trump’s election victory and a potential economic boom would drive up inflation.
The optimism pushed up yields to nearly 4.8% just before Trump’s inauguration, but then they settled back down.
Yields spiked again in the aftermath of Trump’s April 2 tariff announcement — then came back down again as he paused many of the levies. This week, yields rose sharply again, partly over worries about rising U.S. fiscal deficits.
Some experts say the recent volatility underlines lingering risks for the banking industry.
“It’s not a sector-wide problem … but there are institutions where it’s still a meaningful overhang,” said Jill Cetina, a Texas A&M University professor who was previously a bank supervisor at the Federal Reserve and a top bank analyst at the ratings agency Moody’s.
The overhang gives banks less room to absorb loan losses if a recession hits and their borrowers start facing defaults, Cetina said.
With rates still stubbornly high, some previously hesitant bankers are starting to consider whether it’s finally time to sell their institutions.
“You are starting to see some thawing of people’s views, saying, ‘Maybe we should start thinking about this,'” Hovde said.
And as more time passes, more bankers may accept they can’t fetch the prices they would have been able to get before.
“It slowly feeds in, even to [privately held banks]: ‘OK, we’re really worth less money now,'” said Robert Klinger, a lawyer at Nelson Mullins who advises community banks on mergers. “It’s arguably less of a shock.”
Between January and April, banks announced some 44 M&A deals totaling $4.5 billion in value, according to
End of an era
Industry Bancshares’ pending acquisition by Mississippi-based Cadence Bank would close a tough chapter for a bank that dates back to 1911.
The Texas company’s lopsided bond portfolio landed it in the pages of
Industry has $4.4 billion of assets, most of it in high-quality bonds issued by Texas municipal issuers. The problem isn’t that the issuers aren’t expected to repay the bonds, 98% of which are deemed investment-grade, according to
Rather, it’s that Industry bought its bonds when the interest they paid was very little. The yield paid on the company’s bond portfolio was just 2.6% at the end of the first quarter — far less than the more than 4.5% investors can fetch on a 10-year Treasury today. Without a buyer, the bank would be stuck getting paid very little for a very long time. The weighted average maturity of its portfolio is 18 years.
“They got smoked — they got way beyond smoked,” said Jeff Davis, a former bank analyst who’s now managing director of the advisory firm Mercer Capital’s financial institutions group.
But Industry’s deposit franchise still has value, Davis said. The bank’s rural markets are located within the fast-growing “Texas Triangle,” which refers to the areas between Austin, Dallas, Houston and San Antonio.
“They’re right smack in the middle of our footprint,” Cadence Bank CEO Dan Rollins told analysts last month. “We drive through and by these markets every day.”
The acquisition would vault Cadence above a few competitors to become a top-five regional bank in Texas, according to the deal presentation. And with many of Industry’s relationships spanning more than a decade, the deal is “deposit-rich,” said Valerie Toalson, Cadence’s chief financial officer.
Cadence, meanwhile, plans to sell some of the bonds in question — making fresh cash available that can be put into higher-yielding loans.
Making the math work
Cadence’s stock price has moved higher since the deal was announced, suggesting investors are onboard.
It helps that Cadence isn’t spending all that much on the acquisition. Cadence agreed to pay between $20 million and $60 million in cash, depending on whether a drop in rates helps Industry dig out of its hole before the deal closes.
The sale, which the companies hope to close this year, also gives Cadence the right to walk away if rates go up, and Industry’s equity falls below a certain threshold.
Industry’s troubles are unique, even among the dozens of banks that took a massive hit from their bond portfolios tanking. But many banks still have bigger exposures than they might like, and Cadence’s acquisition of Industry shows “there’s an avenue to a potential partnership,” said Hovde, whose firm advised the selling bank.
So the case for buying a bank with certain attractive attributes remains, even if rising interest rates have left it a little bruised.
Washington-based Columbia Banking System, for example, has become a powerhouse in the West and has long sought to expand in Southern California.
Last month, Columbia announced a deal to buy Irvine, California-based Pacific Premier Bancorp, agreeing to absorb the latter bank’s underwater bonds. But Columbia is also gaining the bank’s attractive deposit base, including a niche business that serves homeowners associations, and accelerating its plans to expand in Southern California by at least a decade.
“I’ve been honestly salivating over the Southern California market for a decade,” Tory Nixon, a top executive at Columbia, told analysts last month. “Just the sheer number of companies of all sizes, the density of it, it’s just such a wonderful market to be able to be a part of and to be able to grow into.”
Unlike other deals involving banks with underwater bonds, Columbia did not need to raise extra capital to absorb those hits, partly because Pacific Premier had amassed a large capital buffer of its own.
Such capital raises dilute existing banks’ shareholders, offering a potential pain point. But in other transactions, investors have encouragingly proven receptive to capital raises and other “creative means to fill the holes,” said Burgess, the Piper Sandler investment banker.
The trade-offs may make sense if a deal is strategically compelling for the acquiring bank, Burgess said, particularly when the selling bank has been able to skillfully manage its operations despite interest rate dings.
“This is the house you want. It’s the neighborhood you’re dying to move into. But it’s a fixer-upper,” Burgess said.