Nothing gets people interested in accounting rules like a failed bank, and when Silicon Valley Bank (SVB) failed in March, rules governing how banks value government bonds and mortgage-backed securities (MBS) were suddenly of intense interest. Why? It turns out that SVB accounted for a large portion of its securities portfolio using held-to-maturity (HTM) accounting, which allows banks to avoid recognizing unrealized losses in the securities that they are holding in their portfolios. HTM means that a bank carries a security on its balance sheet at the purchase price rather than current market price. Also, banks can only use HTM if they plan to hold the securities until they come due.
This works fine when a bank has enough assets to cover declines in bond values in the short- term. However, this was not the case for SVB, which had an inordinately large number of long-term securities in its portfolio, and which had purchased many of them with uninsured deposits. When the Federal Reserve started raising rates and SVB’s bonds fell in value, the jig was up for SVB. The bank was initially able to avoid recognizing unrealized losses, but a massive run by its uninsured depositors forced its hand. At that point, SVB had to liquidate its long-term securities at a steep discount to meet depositors’ demands, exposing enormous “hidden” losses. Insolvency loomed, and the FDIC was forced to put SVB into receivership.
Of course, SVB was not the only bank to feel such pressure. The entire industry felt the pain of rising interest rates: The market value of long-term fixed income securities declined between 10% and 30% during 2022, and unless banks valued these securities using HTM accounting, their balance sheets and statements of income would have to reflect these losses (this is known as available for sale, or AFS, accounting). The accompanying figure reveals that in early 2022, only about one-third of the $6 trillion of securities held by commercial banks were valued using HTM accounting. By the end of 2022, the banking system still held approximately $6 trillion in securities, but 45% were now valued using HTM accounting, suggesting that banks actively sought to insulate their balance sheets and statements of income from declining market prices.
How many of those banks are similar to SVB in that they attempted to “hide” AFS losses by switching to HTM accounting? In this paper, João Granja reveals that banks reclassified $0.45 trillion of their existing securities from AFS to HTM during 2022, thus avoiding recognizing losses on these assets simply by renaming them. (Of note: In a forthcoming update to this paper, Granja hand-collected more data revealing that this number doubles to $0.90 trillion.) SVB itself reclassified $8.8 billion or about a third of its AFS portfolio during 2021. However, were many of those banks weak, like SVB, and did they intentionally hope to hide losses by making the accounting switch?
For Granja, the answer is clear:
- Less stable banks with lower capital ratios, higher share of run-prone uninsured depositors, and with longer duration securities portfolios that were more exposed to interest rate risk were more likely to reclassify securities from AFS to HTM during 2021 and 2022.
- Only one percent of banks reclassify securities from AFS to HTM if they depend on uninsured deposits for less than 20% of their total deposit funding.
- By contrast, more than six percent of the banks that depend on uninsured deposits for more than half of their deposit funding reclassify securities from AFS to HTM. These effects are particularly strong for the group of banks that finance longer duration securities portfolios with a large fraction of run-prone uninsured deposits.
Bottom line: Accounting rules matter. That fragile banks are significantly more likely to transfer securities from AFS to HTM accounting just as the value of these securities start to decline, is a clarion call for auditors and bank supervisors. Those responsible for monitoring accounting rules must assess whether auditors failed to properly evaluate what was happening, or whether the rules themselves are effective, or some combination thereof. Either way, they should not delay in this appraisal, as monetary policy continues to tighten during 2023 and the quality of banks’ underlying lending portfolios shows signs of further deterioration.
FAQs
Move Securities to Held to Maturity and Realize Losses
In accordance with ASC 320-10-35-10B, an institution is permitted to reclassify and transfer a security to the HTM category at its amortized cost basis, if the entity has positive intent and ability to hold these securities until maturity.
Can banks sell HTM securities? ›
Banks have to carry HTM instruments at amortized cost, or an adjusted version of the original price they paid. Bonds the banks plan to sell need to be classified as available-for-sale securities and accounted for at fair market value.
What is the difference between HTM and AFS banks? ›
HTM securities are held until they mature. AFS securities are sold before they mature. The former is recorded at cost minus impairment, the latter is recorded at fair value.
What is htm in banking? ›
Held-to-maturity (HTM) securities are purchased to be owned until maturity. Bonds and other debt vehicles—such as certificates of deposit (CDs)—are the most common form of held-to-maturity (HTM) investments.
Can you reclassify held to maturity securities? ›
A reporting entity may make a one-time election prior to December 31, 2024 to sell or reclassify (or both sell and reclassify) debt securities classified as held-to-maturity (HTM) to either available-for-sale (AFS) or trading pursuant to ASC 848-10-35-1.
Is shifting securities from AFS to HFT generally permitted? ›
the beginning of the accounting year; investments from AFS to HFT may be done with the approval of the Board/ALCO/Investment Committee; shifting from HFT to AFS is generally not allowed.
What is the HTM limit for banks? ›
The HTM limits would be restored from 23 per cent to 19.5 per cent in a phased manner starting from the quarter ending June 30, 2024. Unified Payments Interface (UPI) has emerged as a popular retail payments system for Person to Person (P2P) and Person to Merchant (P2M) transactions.
Can banks hedge HTM securities? ›
The notion of hedging the interest rate risk in a security classified as held to maturity is inconsistent with the held-to-maturity classification under ASC 320, which requires the reporting entity to hold the security until maturity regardless of changes in market interest rates.
What are unrealized losses on HTM? ›
Note: For HTM securities, unrealized losses are proxied as the difference between amortized value and fair value. Unrealized gains and losses on HTM securities are excluded from regulatory capital under the proposal, however, as they are never likely to be realized (because banks do not intend to sell them).
Did SVB sell HTM securities? ›
To meet the withdrawals, SVB had to sell bonds. Consequently, the bonds could no longer be considered HTM. Instead, they had to be categorized as “available for sale” (AFS), meaning (a) the bonds were marked down on SVB's financial statements and (b) actual sales caused the losses to be crystalized.
Held to maturity securities bite into the company's liquidity. Since companies make the commitment to hold these securities until maturity, they cannot really count on these securities to be sold if cash is needed in the short term.
Are held to maturity securities marked to market? ›
Held-to-maturity securities are debt securities that will be held by the company until the debt matures. Therefore, unrealized gains and losses will not be recognized in the financial statements because they do not mark to market at the end of the period.
Why do banks buy HTM securities? ›
HTM means that a bank carries a security on its balance sheet at the purchase price rather than current market price. Also, banks can only use HTM if they plan to hold the securities until they come due. This works fine when a bank has enough assets to cover declines in bond values in the short- term.
What is the HTM investment strategy? ›
Investors in HTM securities typically adopt a buy-and-hold strategy. This approach means they intend to hold the security until it matures, reaping the benefits of stable interest income over the life of the investment.
What requires a reclassification of an investment in debt securities? ›
Debt securities may be reclassified if there is a change in management's intent and ability to hold the investment, as outlined by ASC 320. Transfers into or from the trading category should be rare.
Does HTM hit AOCI? ›
HTM securities, which management has the intent and ability to hold until maturity, are carried at amortized cost. AFS securities are carried at fair value and unrealized gains and losses are reported as net increases or decreases to accumulated other comprehensive income (“AOCI”).
What is HTM vs AFS vs HFT? ›
The investment portfolio of banks is classified under three categories, viz., 'Held to Maturity (HTM)', 'Available for Sale (AFS)' and 'Held for Trading (HFT)'. Banks normally hold securities acquired by them with the intention to hold them up to maturity under HTM category.
Can held to maturity securities be sold? ›
Held to maturity securities bite into the company's liquidity. Since companies make the commitment to hold these securities until maturity, they cannot really count on these securities to be sold if cash is needed in the short term.
Is a HELOC unconditionally cancellable? ›
Yes. A HELOC may be considered unconditionally cancellable to the extent it meets certain requirements.
