Hold to maturity: Meaning, Criticisms & Real-World Uses

What Is Hold to Maturity?

Hold to maturity (HTM) is an accounting classification within the broader field of financial accounting that applies to certain debt securities that an entity has both the positive intent and ability to retain until their maturity date. When debt securities are classified as hold to maturity, they are reported on the balance sheet at their amortized cost, rather than their fair value. This contrasts with other classifications, such as trading securities or available-for-sale securities, where fair value fluctuations are reflected differently in the financial statements. The primary characteristic of hold to maturity securities is the commitment by the holder to collect the contractual cash flows through the security's full term.

History and Origin

The classification of investments, including those designated as hold to maturity, was formally addressed in U.S. Generally Accepted Accounting Principles (GAAP) with the issuance of Financial Accounting Standards Board (FASB) Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in May 1993. This standard was developed in response to concerns, particularly intensified after the savings and loan (S&L) crisis of the late 1980s, about how financial institutions recognized and measured investments in debt securities. Regulators questioned the appropriateness of using historical cost for certain investments when trading and sales practices suggested a different intent, a practice sometimes referred to as "gains trading," where appreciated securities were sold to realize gains while those with unrealized losses were held at cost.¹², ¹³

FASB 115 aimed to introduce more fair value into financial reporting but retained the amortized cost method for debt securities that an entity genuinely intended and had the ability to hold until maturity.¹⁰, ¹¹ This approach provided a compromise, allowing entities to account for long-term, fixed-income investments differently from those intended for active trading or potential sale before maturity.

Key Takeaways

Hold to maturity (HTM) is an accounting classification for debt securities an entity intends and is able to hold until their maturity.
HTM securities are reported on the balance sheet at amortized cost, not fair value.
Unrealized gains and losses on HTM securities are generally not recognized in earnings or other comprehensive income.
The classification requires a positive intent and ability to hold the security to maturity, and this intent is reassessed periodically.
This accounting treatment can reduce volatility in reported earnings compared to fair value accounting.

Interpreting the Hold to Maturity

When a debt security is classified as hold to maturity, its accounting treatment focuses on the collection of contractual cash flows over its life. This means that the security is initially recorded at its cost, and then adjusted over time for any premium or discount paid at acquisition. This adjustment process, known as amortized cost, systematically allocates the premium or discount to interest income over the life of the bond, using methods like the effective interest method.

A key implication of the hold to maturity classification is that unrealized gains and losses resulting from changes in interest rates or market conditions are generally not recognized in the income statement or accumulated other comprehensive income. Instead, these fluctuations are typically only disclosed in the footnotes to the financial statements.⁹ This approach reflects the assumption that if the security is held to maturity, interim market fluctuations are irrelevant because the issuer will ultimately pay the stated face value plus scheduled coupon payments. For an entity, particularly financial institutions, this can lead to less volatility in reported earnings compared to accounting methods that require securities to be marked to fair value.

Hypothetical Example

Consider XYZ Corp., a manufacturing company, that purchases a five-year U.S. Treasury bond with a face value of $100,000 and a 3% annual coupon rate. XYZ Corp. intends to hold this bond until its maturity date to fund a future capital expenditure.

Purchase: On January 1, Year 1, XYZ Corp. purchases the bond for $98,000. It pays a discount of $2,000 because the market interest rate at the time of purchase is slightly higher than the bond's coupon rate. XYZ Corp. classifies this as a hold to maturity security.
Initial Balance Sheet Entry:
- Debt Securities (HTM) $98,000
- Cash $98,000
Annual Interest and Amortization: Each year, XYZ Corp. receives $3,000 in coupon payments. Additionally, the $2,000 discount is amortized over the five-year life of the bond. Using a simple straight-line method for this example, $400 ($2,000 / 5 years) of the discount is amortized each year, increasing the carrying value of the bond and recognized interest income.
Year-End 1 Balance Sheet: The bond's carrying value increases to $98,400 ($98,000 + $400).
Market Fluctuations: Suppose market interest rates rise significantly in Year 2, causing the fair value of the bond to drop to $95,000. Because the bond is classified as hold to maturity, XYZ Corp. does not report this unrealized loss on its income statement or adjust the balance sheet carrying amount (except for ongoing amortization). The bond continues to be reported at its amortized cost, which would be $98,800 at the end of Year 2 (assuming another $400 amortization).

This example illustrates how the hold to maturity classification allows the company to insulate its reported financial performance from temporary market value fluctuations, aligning the accounting with the company's long-term investment strategy.

Practical Applications

Hold to maturity classification is primarily used by financial institutions, such as banks and insurance companies, as part of their risk management strategies. These entities often acquire large portfolios of corporate bonds, mortgage-backed securities, and government bonds with the explicit intent of holding them to collect regular interest income and the principal at maturity.⁸ This approach helps to stabilize their reported earnings by preventing volatility that would arise if these long-term investments were marked to fair value through profit and loss.

For example, a bank might invest in long-term Treasury bonds and classify them as hold to maturity to match the duration of its long-term liabilities, such as certificates of deposit. This strategy aims to ensure predictable cash flows to meet future obligations, regardless of short-term movements in market interest rates. The Securities and Exchange Commission (SEC) provides guidance through its Accounting Standards Codification (ASC) Topic 320, which outlines the rules for classifying and measuring debt securities, including those held to maturity.⁷

Limitations and Criticisms

While hold to maturity accounting provides stability in reported earnings, it has faced criticism, particularly following recent financial crises. A significant drawback is that it can obscure significant unrealized gains and losses that exist in the fair value of the securities, as these are typically only disclosed in footnotes to the financial statements. This can potentially paint an incomplete picture of an entity's financial health, especially when market conditions change rapidly.⁶

The collapse of Silicon Valley Bank (SVB) in March 2023 highlighted these concerns. SVB held a substantial portion of its assets, specifically U.S. government and agency securities, in its hold to maturity portfolio. As interest rates rose sharply, the fair value of these HTM securities declined significantly, leading to massive unrealized losses that were not reflected in the bank's primary balance sheet figures.⁴, ⁵ When SVB faced large deposit outflows and a liquidity crisis, it was forced to sell some of these securities at a substantial loss, which ultimately contributed to its failure.³ This event renewed the debate over whether the HTM classification should be eliminated or modified to require fair value accounting for all debt securities, thus providing more transparent and timely information to investors and regulators.¹, ²

Hold to Maturity vs. Available-for-Sale Securities

The distinction between hold to maturity (HTM) and available-for-sale securities (AFS) is crucial in financial accounting due to differing reporting requirements. Both classifications apply to debt securities, but they are determined by management's intent and ability regarding the investment.

Hold to Maturity (HTM): An entity classifies a debt security as HTM if it has the positive intent and ability to hold the security until its maturity date. These securities are reported at amortized cost on the balance sheet. Changes in the fair value of HTM securities are not recognized in earnings or other comprehensive income; they are typically only disclosed in the footnotes to the financial statements. This means that price volatility due to interest rates does not impact reported net income or equity directly.
Available-for-Sale (AFS): Debt securities are classified as AFS if they are not intended to be held to maturity or for active trading. The entity might sell them before maturity, but there is no specific intent for near-term sale as with trading securities. AFS securities are reported at fair value on the balance sheet. Unlike HTM, unrealized gains and losses on AFS securities are recognized in other comprehensive income (OCI), a component of equity, rather than directly impacting net income. This still reflects market value fluctuations but bypasses the income statement, reducing direct earnings volatility compared to trading securities.

The primary point of confusion often arises because both HTM and AFS securities are typically held for longer periods than trading securities. However, the critical differentiating factor is the firm's documented intent and capacity to hold the security until maturity, which dictates the accounting treatment and the impact (or lack thereof) of fair value changes on the income statement.

FAQs

What types of investments are typically classified as hold to maturity?

Hold to maturity classification primarily applies to debt securities, such as Treasury bonds, municipal bonds, and corporate bonds. These are financial instruments with a fixed maturity date and contractual principal and coupon payments.

Why do companies classify securities as hold to maturity?

Companies, particularly financial institutions, classify securities as hold to maturity to align their accounting with their investment strategy of holding these assets for the long term to collect contractual cash flows. This classification allows them to report these securities at amortized cost, which helps to reduce volatility in their reported earnings and financial statements from fluctuations in market fair value.

Are hold to maturity securities impacted by changes in interest rates?

Yes, hold to maturity securities are impacted by changes in interest rates in terms of their market fair value. However, under the hold to maturity accounting classification, these market value fluctuations (unrealized gains or losses) are generally not recognized in the company's income statement or balance sheet (except for disclosure in footnotes), as the intent is to hold the security until its maturity date.

Can a company change the classification of a hold to maturity security?

Generally, changing the classification of a hold to maturity security to another category, like available-for-sale securities or trading, is restricted and can have significant accounting implications, potentially "tainting" the remaining HTM portfolio. Such reclassifications are typically allowed only under specific, infrequent circumstances that are outside the entity's control.

What is the primary difference between hold to maturity and trading securities?

The main difference lies in the intent of holding the security and the accounting treatment. Hold to maturity securities are intended to be held until their maturity date and are reported at amortized cost, with unrealized gains and losses not affecting the income statement. Trading securities, in contrast, are bought with the intent to sell them in the near term (for profit from short-term price movements) and are reported at fair value, with all unrealized gains and losses recognized directly in current earnings.