Since the close of second quarter this year, data shows that large banks have reduced their holdings of securities by $66.7 billion and MBS by $27.5 billion late last month, said a recent report by Merrill Lynch.

Passthrough holdings, in particular, dipped by $23.5 billion over that period. While this drop in MBS holdings may be partly because of rapid paydowns of holdings that were not quickly re-invested into MBS or securities, the dip in overall securities (which is the net of MBS reductions) was probably due to sales. These reductions in securities and MBS holdings happened at the initial 50 basis points of the eventual 80 basis points backup that happened from June 30 to July 23.

The decreases in large bank securities and MBS holdings were partly reversed as passthrough holdings posted a $23.6 billion upward trend from July 16 to July 23. Merrill believes that the quick reduction and increase in passthrough holdings was due partly to portfolio duration and convexity management efforts. With the rising interest rates, figures for unrealized gains reported by banks have dropped in the last few weeks.

Initially, the amounts do not seem to be very significant. However, because the data provided is the net of tax effects, the gross change in unrealized gains for the available for sale portfolios would need to be considerably large. Changes to unrealized gains or losses are potentially due to a combination of declines in market value because of the rise in interest rate and the realization of the gains as securities are sold.

Merrill said that the reported unrealized gains or loss figures are net of hedges normally used by banks. The five-year swap rate had risen by 100 basis points from June 11 to July 23 and the total securities holdings by these institutions as of June 11, 2003 was $873 billion. If it is assumed that 100% of the decline in unrealized gains was because of the rate rise, then the recent effective portfolio duration of the large banks was 1.49 years. However, Merrill said that the changes of unrealized gains or losses over a longer period would imply that the portfolio duration is roughly 2.0 years.

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