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It's all too easy to skim through a bank's quarterly and annual reports. They're big, loaded with jargon, and about as easy to read as a phone book.
But they detail everything you need to know about a bank. Today, I want to focus on just one piece of a bank's balance sheet, because I think this one small accounting quirk will really show its importance in the coming quarters.
Will you marry me?
Big banks have commitment issues -- they aren't committed to low rates, but they're coming around slowly. We're seeing banks hold fewer of their loans as "available for sale," an accounting treatment that limits the impact of rising and falling rates to their income statement. These losses only show on the balance sheet.
Accounting for investments as available-for-sale securities also allows banks to sell their holdings – anything from mortgages to U.S. Treasuries -- at a moment's notice. Many banks like this flexibility. JPMorgan Chase (NYSE: JPM ) holds almost all of its investment portfolio as available-for-sale. Just $6 million of assets are held to maturity compared to $354.7 billion in available-for-sale assets. By contrast, similarly sized Bank of America (NYSE: BAC ) has more than $55 billion in held-to-maturity investments.
Other banks are doing it differently. U.S. Bancorp (NYSE: USB ) stuffed more into its held-to-maturity accounts as of the last quarter. It now holds some $34.7 billion in held-to-maturity accounts, nearly 10% of its total assets.
Moving assets to held-to-maturity removes some limits on capital requirements. Losses on held-to-maturity accounts aren't part of Basel III rules. Thus, these accounts are a great place to stuff low-yielding assets that move the most -- up and down -- when rates fluctuate.
The big risk
There are a multitude of reasons large banks like Wells Fargo (NYSE: WFC ) and JPMorgan don't use held-to-maturity accounts all that often. The first of which is that they don't want to commit to low-yielding assets. If banks put an investment in a held-to-maturity account, it has to stay there forever, otherwise the whole account immediately flips to available-for-sale, which could ruffle a bank's balance sheet.
Held-to-maturity accounts are best used for low-yield assets. But if they hold low-yield assets they can't sell, they run the risk of earning less on their investments than they pay on deposits in a rising rate environment.
Most banks are very well capitalized, so we probably won't see banks move assets to investment accounting just to eke past regulatory codes. But it is possible we'll see banks finally start making some commitments to assets on their balance sheet by slowly moving investments over from available-for-sale securities.
If your favorite bank starts making use of its held-to-maturity account, it may be time to start worrying about the future impact to its net interest margin. Placing assets in a held-to-maturity basket is a huge commitment, one that requires them to hold assets for years and years.
If rates rise further, banks with a big basket of held-to-maturity assets could see their net interest margin fall precipitously as their earnings are fixed at today's level and their short-term funding costs push higher.
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