Annuities Migrate Offshore? Silicon Valley Syndrome and Bank of America

May 29, 2025 | Updated | Earlier this week, our friend Nom de Plumber send us a missive from the ongoing collapse of the world of private equity and related insurance markets. If you have been paying attention over the past several years, you know that banks have been sellers of risk and insurers have been buyers, especially in private credit.

Insurance companies led by Apollo Global (APO) insurance unit Athene (ATH) have been buyers of credit products to fund annuities. Credit products sold to insurers are in theory held to maturity and at historical cost, of note. This is why Wall Street loves using insurers as "balance sheet" to hide crap assets and also why American International Group (AIG) failed in September 2008.

“US life insurers have shifted more than $1tn of liabilities offshore,” reported the Financial Times, “offloading more risk to foreign jurisdictions despite regulators’ concerns about protections for retirement savings and broader financial stability.” Could the great migration of risk out of banks into insurers and nonbanks hold risk for investors and retirees? Yup.

“If the Private Credit, Private Equity, and other Alternative Assets which back these annuity liabilities become distressed, US annuity beneficiaries will need to petition offshore re-insurers and regulators (Bermuda, Cayman Islands, etc.) for protection against financial loss,” NDP offers with his usual optimism.

“The US-based managers of these annuities, which have collected asset origination and management fees, would point beneficiaries to them. State insurance regulators would have scant resources or jurisdiction to help. This systemic risk dwarfs the 2008 Mortgage Crisis. Thank you.”

Do millions of US retirees face total loss because their annuity underwriter invested their nest egg in private credit? And then transferred the liability offshore, with little or no protection in the event of default? You bet. Major banks continue to publish bullish notes about private credit, but the actions of insurers migrating liabilities offshore speak to another risk perspective. Yes, many Defined Benefit pension and Defined Contribution 401(k) recipients now rely upon these offshored annuities for payment.

Imagine the conflict-of-interest risks for the very large insurers which Apollo, Blackstone, KKR, Carlyle, Brookfield, and other Private Equity managers directly own, potentially impacting the retail and group-contract annuities which they sell. Fundamental question: What control is continually monitoring the actual cashflow performance of the credit assets versus underwritten projections, and appropriately re-valuing if material shortfalls?

"If neither the insurer nor its regulator imposes such control, breaching Fiduciary Duty," notes NDP, "then the un-monitored financial risks fall directly to the unwary annuity beneficiaries."

Is Bank of America Insolvent?

Leaving happy thoughts about private credit aside, a long-time reader named Alan returned us to a question we asked back in 2023, namely are Bank of America (BAC) and other institutions with large portfolios of underwater loans and securities insolvent (“Calculate the WAC of Bank of America”). The question arose again following a comment on the Jimmy Dore Show saying that BAC is on “the verge of collapse.”  

We do business with BAC and also Merrill Lynch, so naturally we keep tabs on the antics of CEO Brian Moynihan, who has made avoiding risk and revenue the hallmarks of his storied career. With the 10-year Treasury note yielding 4.5% and many analysts calling for higher Treasury yields in 2026, the M2M solvency of BAC and poorly managed other banks seems relevant. But Moynihan has certainly built himself a cool party pad on Sixth Avenue in Manhattan.

2 Bryant Park

“Looking at BAC balance sheet some interesting things pop out,” notes Alan, who worked at Countrywide, Bankers Trust and the Fed Board of Governors in Washington. “Since 12/31/20, total liabilities have risen by $500 billion or 20%. Interest bearing deposits are up $332 billion (30%), non-interest bearing deposits are down. Short term borrowings are up 83%, that is hot money. Investments securities are up 30%, but I am afraid that is filled with bonds that are trading at a significant discount to purchase price. Total equity is up 8.5% but would be down by 30% if the bond portfolio is trading at 90.”

Unfortunately, an average price of 90 for the assets of BAC is a tad optimistic. If we turn to Page 9 of the excellent BAC Earnings Supplement for Q1 2025, we can see that the average return on earning assets was just 4.67%, down from 5.12% in Q1 2024. Short duration sucks sometimes, especially with Donald Trump in the White House. The average cost of the bank’s liabilities was 3.47% or down 50 bp from Q1 2024, but BAC has the highest funding costs in the large bank group after Citigroup (C) as shown in the chart below.

Source: FFIEC

The net spread between BAC’s assets and liabilities was just 120 bp BEFORE we subtract 2% for BAC’s overhead costs (vs the average of 2.4% for Peer Group 1). You see, Brian and his team of cost-cutters have already sliced the bank's overhead expenses to the bone, yet BAC still has an efficiency ratio in the 60s or more than 10 points above JPMorgan (JPM). Why? Poor profitability.

In other words, the interest rate side of BAC’s $3.3 trillion balance sheet is underwater by several points. The bank is surviving with non-interest income and revenue from Merrill Lynch and other nonbank affiliates. If BAC’s forward estimate for yields on the 10-year Treasury next year are correct, then stress on BAC and other lenders with significant portfolios of low-coupon securities will grow. But the linear view of risk shown in the numbers for BAC's risk exposures above is only half of the story.

The most recent data from the FDIC shows that the industry is slowly reducing its negative carry by selling low coupon securities. That said, net losses on securities were only $1.9 billion for all US banks in Q1 2025. Even though US banks took $16 billion in realized losses on securities last year, there is still a huge problem hanging over the US banking industry.  This problem worsens as LT interest rates rise and spreads widen.

As of Q1 2025, BAC’s unrealized losses on its $942 billion in total debt securities was $99.8 billion or almost half of the bank’s $203 billion in tangible common equity. The yield on the bank’s huge securities portfolio was 2.9% at the end of Q1. Of course, if we mark-to-market the bank’s $228 billion portfolio of residential mortgage loans, which have a 3.36% average yield, BAC is arguably insolvent. Fannie Mae 3.5s for delivery in June traded at 88 yesterday.

The problem with the FDIC chart above is that is reflects a linear, two-dimensional snapshot of duration risk facing banks. Since the end of COVID and the increase in interest rates, the risks applicable to mortgage-backed securities have expanded dramatically. This is the primary reason why banks have not been increasing MBS exposures, of note, despite the constant drumbeat from Sell Side firms. Call bank reluctance to increase mortgage or duration risk the "Silicon Valley" syndrome.

Since 2022, prepayments, market volatility and bond maturity premia have “normalized” and now reflect heightened expectations for inflation and also market volatility. Or to put it another way, if the chart from the FDIC measured actual duration risk, the Q1 2025 figure for unrealized losses would run off the bottom of the page. 

Think about the dollar cost of decreased prepayments on the BAC mortgage book if the Treasury 10-year goes to say 5% yield. Even a small decrease in prepayments due to higher LT interest rates could significantly impact the fair value of the BAC mortgage portfolio, forcing unrealized losses higher. A half point rise in yields on the 10-year Treasury note could cost BAC points in unrealized losses.

Should the 10-year Treasury go to 4.75% or even 5% yield, how will that move impact the fair value of the BAC mortgage portfolio?  How will higher LT yields for Treasury collateral impact the profitability and capital of other US banks? These are the questions that the folks at the Fed and Treasury need to ponder as they fight publicly about reducing short-term interest rates. But if LT rates continue to rise, one veteran banker told The IRA yesterday, then BAC and several other large banks are going to start to literally shake apart from unrealized losses on COVID era assets.

Alan: "QE is a very powerful drug to which our financial system is addicted. All those low coupon, long duration MBS would trade even lower if the owners (Fed and big banks) tried to sell them."

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