A shift by U.S. banks to increase the proportion of securities classified as held-to-maturity (HTM) likely signals an attempt to reduce capital volatility, especially during periods of rising interest rates, according to Fitch Ratings. Banks will have to balance these benefits with the reduced liquidity of HTM securities.
HTM securities increased to 16.4% of banks' total securities holdings at end-2013 from 9.1% two years previously, when the changes were first proposed, according to FDIC data. The majority of this rise has occurred since mid-2013, when long-term rates started rising. Some banks achieved this change largely by reinvesting cash flows or maturing available-for-sale (AFS) securities into HTM. However, some banks are making one-time reclassifications given flexibility under US GAAP.
The greatest shift has been at U.S.banks subject to the advanced approach (those with over $250bn of assets or $10bn of foreign exposure) as new Basel III rules on unrealized gains and losses on AFS flowing through regulatory capital only apply to them. They are likely transferring securities from AFS to HTM to avoid a build-up of unrealized losses in accumulated other comprehensive income (AOCI), which will be included in the common equity tier 1 calculation starting in 2015.
HTM securities at advanced approach banks increased on average to 20% of securities from 8% two years ago, although there was significant variance among individual banks. U.S. Bancorp made the greatest shift to HTM securities, increasing them by 22 percentage points since end-2011 to a substantial 48.7% of securities.
Even banks that are not subject to the advanced approach and are allowed to opt out of including AOCI in their CET1 calculation are making this shift. BB&T, UnionBanCal and M&T Bank are examples of large regional banks that are increasing their HTM securities. Fitch notes the rating agency has also observed some community banks taking part in portfolio shifts, such as Trustmark, which moved about a third of its securities to HTM in 4Q13. These banks are likely protecting tangible common equity to support their credit profiles and equity valuations.
Changes made to protect bank capital from interest rate volatility may reduce available liquidity. HTM securities cannot be sold prior to maturity without a punitive impact from an accounting standpoint, so banks will balance the capital benefits with liquidity needs. However, HTM securities can be used for pledging or repo purposes, so an outsized portion of them in bank portfolios may not raise liquidity risks provided the investments are high credit quality.