Held to maturity security

What Is Held-to-Maturity Security?

A held-to-maturity (HTM) security is a type of debt investment that an entity has the positive intent and ability to hold until its maturity date. These securities are a key component of financial accounting and are treated distinctly from other investment classifications due to this specific intent. Unlike securities bought for short-term trading or those available for sale, held-to-maturity securities are not subject to fair value fluctuations on the balance sheet and are instead reported at amortized cost. This accounting treatment reflects the investor's commitment to collecting the contractual cash flows rather than benefiting from or being exposed to market price changes. Held-to-maturity securities primarily include fixed-income instruments such as bonds, notes, and debentures.

History and Origin

The concept of held-to-maturity securities as a distinct accounting classification gained prominence with the issuance of Financial Accounting Standards Board (FASB) Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in May 1993. Prior to this, accounting for marketable securities was less nuanced, primarily focusing on the lower of cost or market value. SFAS 115, later codified under Accounting Standards Codification (ASC) 320, introduced a "mixed measurement" approach for financial assets, allowing different accounting treatments based on management's intent and ability to hold or sell an investment.¹⁹,¹⁸

This standard emerged from decades of debate, particularly in the aftermath of the savings and loan crisis in the 1980s, about whether financial instruments should be carried at amortized cost or fair value.¹⁷ Banks and other financial institutions often advocated for amortized cost for assets intended to be held long-term, arguing it better reflected the long-term earning effects and ultimate recoverable value. Conversely, proponents of fair value accounting emphasized its utility in providing more relevant information about a firm's investment strategies.¹⁶ SFAS 115 represented a compromise, allowing HTM classification for debt securities where management could demonstrate clear intent and ability to hold them to maturity, thereby retaining the amortized cost method for these specific holdings.¹⁵

Key Takeaways

• Held-to-maturity (HTM) securities are debt investments an entity intends and is able to hold until their maturity date.
• They are reported on the balance sheet at amortized cost, rather than at fair value.
• Changes in market value for held-to-maturity securities do not impact reported earnings or accumulated other comprehensive income unless an impairment is recognized.
• The classification of a held-to-maturity security requires a positive intent and demonstrable ability to hold it until maturity; significant sales before maturity can lead to "tainting" the entire HTM portfolio.
• While offering predictable returns, HTM securities can mask significant unrealized gains and losses in a volatile interest rate environment.

Interpreting the Held-to-Maturity Security

When analyzing a company's financial statements, the presence and size of its held-to-maturity (HTM) portfolio offer insights into its investment strategy and exposure. Because HTM securities are carried at amortized cost rather than fair value, their reported value on the balance sheet does not fluctuate with market interest rate risk changes. This can provide a stable asset base for entities, particularly financial institutions, that aim to match the duration of their assets and liabilities.

However, interpreting HTM holdings requires careful consideration. While the recorded value remains constant (save for amortization and impairment), the actual market value of these securities can diverge significantly, especially in periods of rapid interest rate changes. This divergence is typically disclosed in the footnotes to the financial statements, which is crucial for a complete understanding of the entity's true economic position and exposure to market risk.¹⁴ For example, a bank might hold long-term government bonds classified as HTM. If interest rates rise, the market value of these bonds would fall, but this decline would not be reflected in the bank's reported assets on the balance sheet for the HTM portfolio. This can lead to a less transparent view of the bank's actual asset value and potential liquidity challenges if forced to sell these assets.

Hypothetical Example

Consider XYZ Bank, which on January 1, 2024, purchases a U.S. Treasury bond with a face value of $1,000,000, a 5-year maturity date, and a 3% annual coupon payment. The bank intends and has the ability to hold this bond until its maturity. Since the bank classifies it as a held-to-maturity security, it records the bond at its original purchase price, or amortized cost, on its balance sheet.

Initial Recognition (January 1, 2024):

XYZ Bank records the HTM security at its cost.

Subsequent Accounting (December 31, 2024):

Throughout 2024, market interest rates fluctuate. Despite these changes, the recorded value of the held-to-maturity security on XYZ Bank's balance sheet remains at $1,000,000 (assuming no premium or discount at acquisition, or after amortization of any such premium/discount). XYZ Bank recognizes the annual interest income.

If, at the end of 2024, the market value of this bond has fallen to $950,000 due to rising interest rates, this $50,000 unrealized loss is not reflected on XYZ Bank's primary financial statements, although it would be disclosed in the footnotes.

Practical Applications

Held-to-maturity (HTM) securities appear prominently in the portfolios of financial institutions, such as commercial banks and insurance companies, due to their specific accounting treatment and strategic implications.

• Balance Sheet Management: Banks often classify a portion of their debt securities as HTM to stabilize their balance sheet by locking in yields and minimizing the impact of short-term market fluctuations on their reported earnings. This allows them to manage their exposure to interest rate risk from an accounting perspective.
• Asset-Liability Matching: Financial institutions use HTM securities to match the duration of their assets with their liabilities, particularly long-term deposits or policy obligations. By holding investments until maturity date, they ensure a predictable stream of cash flows to meet future obligations, regardless of interim market price changes.
• Regulatory Capital Calculation: For some financial institutions, the accounting treatment of HTM securities can influence regulatory capital requirements. Since unrealized gains and losses on HTM securities are not recognized in equity (unlike available-for-sale securities), they do not directly impact regulatory capital ratios. This aspect became a focal point during recent banking stresses.¹³

For instance, the collapse of Silicon Valley Bank (SVB) in March 2023 highlighted the critical role of HTM securities. SVB held a substantial portfolio of long-dated U.S. Treasury and mortgage-backed securities classified as HTM. As the Federal Reserve rapidly increased interest rates, the fair value of these bonds significantly declined, creating large unrealized losses that were not reflected on the face of SVB's balance sheet but were disclosed in footnotes.¹²,¹¹ When deposit outflows forced SVB to sell a portion of its available-for-sale securities at a loss, it raised concerns about the underlying value of its HTM portfolio, contributing to a bank run.¹⁰

Limitations and Criticisms

Despite their intended benefits, held-to-maturity (HTM) securities and their accounting treatment have faced significant criticism, particularly in times of volatile interest rates.

One major limitation is that HTM accounting can obscure a company's true economic exposure to interest rate risk. Because these securities are reported at amortized cost rather than fair value, significant unrealized losses may accumulate without being directly reflected in the primary financial statements, though they are disclosed in footnotes.⁹,⁸ This can mislead investors and analysts about the underlying value of a firm's assets and its overall financial health, particularly its sensitivity to market changes and its liquidity risk.⁷

A notable criticism revolves around the "intent and ability" criterion for HTM classification. Critics argue that management's intent can be fluid and may be influenced more by desired financial accounting and regulatory capital treatments than by a genuine economic commitment to hold securities to maturity date.⁶ The classification can be seen as a tool to manage reported earnings and capital ratios, especially when interest rates rise and the market value of fixed-rate debt securities declines.⁵

Furthermore, the "tainting" rule is a significant constraint: if an entity sells a "significant" amount of HTM securities before maturity for reasons other than isolated, nonrecurring, and unanticipated events (such as major credit deterioration or regulatory changes), it can be prohibited from classifying any financial assets as HTM for the current and two subsequent fiscal years.⁴,³ This strict rule can limit a firm's flexibility to sell assets if unexpected liquidity needs arise, as demonstrated by bank failures in 2023.² Investor advocates have voiced disappointment with the FASB's decision not to eliminate HTM classification, arguing that it hinders transparency and does not adequately convey risks such as interest rate sensitivity and asset-liability duration mismatches.¹

Held-to-Maturity Security vs. Available-for-Sale Security

Held-to-maturity (HTM) securities and available-for-sale (AFS) securities are two distinct classifications for debt securities on an entity's balance sheet, differing primarily in management's intent and their accounting treatment.

The key source of confusion often stems from the fact that both classifications involve debt securities and appear on the balance sheet as investments. However, their distinct accounting treatments mean that their reported values can vary significantly. AFS securities reflect their current market value, providing a more up-to-date picture of their worth, whereas HTM securities remain at their cost basis, regardless of market fluctuations, unless an impairment is recognized.

FAQs

Q: Can a company sell a held-to-maturity security before its maturity date?
A: Generally, no. Selling a held-to-maturity (HTM) security before its maturity is highly restricted. Such a sale can "taint" the entire HTM portfolio, meaning the company might be prohibited from classifying any new debt securities as HTM for the current and subsequent two fiscal years. Sales are permitted only under very specific, non-recurring circumstances, such as a major deterioration in the issuer's credit quality or a significant change in tax law.

Q: How does a held-to-maturity security affect a company's earnings?
A: For a held-to-maturity security, only the periodic interest income (e.g., coupon payments on a bond) is recognized in the company's income statement. Any changes in the security's market value due to fluctuating interest rates are not reported as gains or losses on the income statement, distinguishing it from trading securities.

Q: Are held-to-maturity securities considered risky?
A: Held-to-maturity (HTM) securities are generally considered to have lower credit risk if they are issued by a creditworthy entity, as the intent is to collect predictable cash flows until maturity. However, they are still exposed to interest rate risk and liquidity risk. While market value fluctuations aren't reflected in reported earnings, a significant rise in interest rates can lead to substantial unrealized losses that could become real if the company is forced to sell the securities.