Right before Silicon Valley Bank failed in March 2023, analysts noticed something unusual: A large portion of its total assets consisted of “held-to-maturity” securities.

A bank can categorize a debt security – such as a bond – as “held to maturity” or “HTM” when it intends to hold the security until its repayment date. But in some cases, like SVB’s, HTM accounting can obscure major losses.

That’s because banks aren’t required to factor the “fair value,” or market value, of HTM securities into their total capital calculations. A bank could have significant holdings of securities that are plummeting in value. But the HTM designation shields others from seeing that reflected in their total capital.

In SVB’s case, a sign of trouble came when it sold all its “available for sale” – meaning non-HTM investments – at a near $2 billion loss to boost liquidity. That sell-off raised concerns: Banks aren’t supposed to sell HTM investments for quick cash, but would SVB be forced to “taint” its portfolio by doing so? If that happened, any losses in the fair value of those securities would come to light. 

Hard look at SVB finances reveals major problems

After taking a closer look at SVB’s finances, analysts found that those losses would top $15 billion – enough to wipe out nearly all SVB’s capital.

Panic among investors and depositors ensued, triggering a social-media-fueled bank run and ultimately leading to the bank’s failure, said Michael Walker, a senior risk specialist at the Federal Reserve Bank of Boston.

In a new note called “Accounting for Debt Securities in the Age of Silicon Valley Bank,” Walker explores a longtime debate renewed by SVB’s collapse: What can be done to make sure HTM accounting isn’t used by banks to “hide” losses?

Walker said this question is especially relevant as financial institutions are actively increasing their HTM portfolios.

Walker: Accounting is critical to bank supervision, regulation

Regulators require banks and other financial institutions to maintain a certain amount of capital to protect against investment losses.

The main measures of this “regulatory capital” are based on accounting, so changes in accounting rules can have significant impacts on how banks comply with regulations, said Walker, who works in the Boston Fed’s Supervisory Research and Analysis Unit.

In the note, Walker examines three potential options for addressing concerns related to HTM usage:

• Eliminate the HTM classification
• Further restrict use of the HTM classification
• Require banks to include unrealized gains and losses on HTM debt securities when calculating certain regulatory capital

What if “held to maturity” accounting was eliminated or restricted?

Eliminating HTM accounting could increase transparency around a firm’s investment strategy, Walker said. All changes in the market values of a bank’s securities would be immediately reflected on its balance sheet, including the gains and losses of unsold securities. It could also provide a better measurement for a bank’s regulatory capital.

But some argue that doing so could lead to more volatility because a bank's overall capital would be impacted by the fluctuating market prices of securities they aren’t planning to sell any time soon. This volatility can hurt a bank’s safety and soundness as investors might be discouraged from buying the bank’s stock, and depositors may be encouraged to pull their funds, Walker said. And the long-term “buy-and-hold” strategies often used by small community banks wouldn’t be accurately reflected on their balance sheets, he said.

Restricting, rather than eliminating, HTM accounting is another possible solution. Walker noted that more than 40% of SVB’s total assets were classified as HTM – roughly double the typical amount.

So, limiting HTM securities to a particular percentage of a bank’s overall portfolio could be one way to prevent other firms from experiencing the same liquidity issues that led to SVB’s failure, he said.

Firms could also be obligated to provide evidence that they are actually able to hold their investments to maturity, something that’s currently not required under the U.S. Securities and Exchange Commission’s Generally Accepted Accounting Principles.

Still, Walker said restricting the use of held to maturity accounting could result in many of the same challenges as eliminating it.

Can changing bank regulations instead of accounting rules impact HTM use?

Instead of eliminating HTM accounting, Walker said regulators could require banks to include changes in the market value of these securities when calculating a measure called “Common Equity Tier 1 capital,” or CET1 capital.

A bank’s CET1 capital is important in determining whether it has sufficient capital to meet regulatory requirements. The change would mean gains or losses in the value of HTM securities would also affect a bank’s CET1 capital. However, Walker noted that even with that change, banks would still have incentives to classify securities as HTM to reduce volatility in other capital measures.

Read the full note on bostonfed.org.