| NEW YORK, Sept 10
NEW YORK, Sept 10 U.S. banks are increasingly
giving up the right to sell tens of billions of securities in
their investment portfolios, a shift that helps them avoid the
pain of weaker bond markets but will cut into future profits as
interest rates rise.
Lenders ranging from large banks like U.S. Bancorp
to smaller banks like Cullen/Frost Bankers Inc have been
changing the way they account for investment securities,
adopting a treatment that essentially forces them to hold onto
bonds through thick and thin, instead of being able to sell them
when markets tank. The accounting switch gives them near-term
relief that helps them meet new international capital and
But analysts fear that as bond markets keep weakening, banks
will be stuck with more turkeys in their portfolios, giving them
less cash to invest or lend at higher rates.
The willingness of lenders to surrender future profits shows
the pressures they face in an era of restrictive regulations,
soft loan demand and historically low rates that are now poised
to rise. The exposure of banks to rising interest rates
threatens to undo much of the progress that lenders had made in
building capital since the financial crisis, said David Hendler,
an analyst at New York research firm CreditSights.
"You've got all these hurdles that banks have to jump over,
and they get higher and higher," Hendler said, adding that the
challenges are testing the acumen of bank treasury and finance
departments. "A lot of these guys didn't train for this."
The accounting shift is known as moving assets from
"available-for-sale" treatment to "held-to-maturity," a change
that has been underway for several years. U.S. commercial banks'
held-to-maturity books increased 62 percent to $347.4 billion in
the second quarter from $215.0 billion in the fourth quarter of
2010, according to SNL Financial.
As bond markets weakened in the second quarter, the switch
accelerated, with held-to-maturity accounts rising 8.7 percent
from the first quarter, the biggest increase in nearly two
One of the first big banks to make the shift was U.S.
Bancorp of Minneapolis, Minnesota, the sixth-largest U.S. bank,
with $353.4 billion in assets. The bank is a favorite of Warren
Buffett, whose Berkshire Hathaway Inc is one of its
U.S. Bancorp's held-to-maturity securities book ballooned to
$34.7 billion at the end of the second quarter, or 46 percent of
its investment portfolio, from just $1.5 billion at the end of
2010, with most of the change coming in 2011. In January 2012,
U.S. Bancorp finance chief Andrew Cecere told analysts and
investors the bank used the held-to-maturity book to help manage
new regulatory requirements for liquidity and capital.
But the bank is now saddled with tens of billions of dollars
in low-yielding assets. The weighted average yield on U.S.
Bancorp's held-to-maturity portfolio was 1.89 percent in the
second quarter of 2013, compared with 2.72 percent for the
available-for-sale portfolio. As rates start to rise, the bank
could earn less on some assets than it has to pay to fund
itself, cutting into its income.
To be sure, banks have some ways to mitigate that pain. For
example, they can borrow against the held-to-maturity assets and
invest the proceeds. And many bank loans carry floating rates,
so rising rates will boost interest income.
But banks that go too far with a held-to-maturity strategy
will not be able to free up as much of their balance sheet to
make new loans if the economy improve in the coming months, said
Johannes Palsson, managing director at Angel Oak Advisory, a
risk management consulting firm.
Those banks are "kind of stuck. There's not much you can do"
to take advantage of future loan growth, Palsson said in an
For available-for-sale assets, banks must record paper
losses each quarter when the securities' values fall. The paper
losses do not hit earnings but reduce net worth, as measured by
the book value of assets minus liabilities. That happened to
banks in the second quarter, when bond markets weakened amid
talk of the Federal Reserve cutting back on its bond buying
The $38 billion of unrealized investment gains they had
reported at the start of the year swung to $13.1 billion of
paper losses by the end of August, according to Federal Reserve
For a long time, regulators ignored changes in the value of
available-for-sale books when assessing a bank's capital
strength. But under the framework known as Basel III that
international regulators finalized in December 2010, losses from
available-for-sale assets will hit regulatory capital, and a
bond market selloff could force U.S. banks to boost their
Paper losses on held-to-maturity securities, however, would
not subtract from banks' capital levels. This, along with new
liquidity rules that pressured banks to increase their
securities holdings, encouraged banks to park assets in their
held-to-maturity bucket of their investment portfolios.
Bank officials have argued that regulators are pulling them
in too many directions without much consideration about how the
new rules interact with each other. Hearing those complaints,
earlier this year U.S. regulators exempted banks with less than
$250 billion in assets from capital rules linked to
But for some that ruling came too late. For instance,
Cullen/Frost, a San Antonio, Texas bank with $22.6 billion in
assets, classified $2.6 billion of its municipal bond portfolio
as held-to-maturity in last year's fourth quarter. It made the
move because regulators seemed "incapable" of stripping out the
requirement to subtract paper losses on securities from capital
ratios, finance chief Phillip Green said on an earnings call
with analysts at the time.
"That was absolutely ridiculous for a bank like ours" which
is flush with liquidity and has never had a problem funding its
securities portfolio, Cullen/Frost Chief Investment Officer Bill
Sirakos said in an interview about the Fed's initial proposal.
But that transfer proved unnecessary when the bank was later
exempted. Sirakos said the bank didn't have any big regrets
about its use of the held-to-maturity account. "We gave up some
flexibility, but we generally hold the stuff to maturity
anyway," he said.
Though regulators can easily reverse course, under
accounting rules banks cannot. If they chose to sell some
securities out of the held-to-maturity portfolio, outside of few
extreme circumstances ,the entire portfolio becomes "tainted."
Once that happens, all held-to-maturity securities - not
just the ones the bank planned to sell - are transferred to
banks' available-for-sale books where any unrealized loss
immediately detracts from their net worth. Additionally, the
bank would be prohibited from using hold-to-maturity portfolios
for two years.
With that inflexibility, some banks, including JPMorgan
Chase & Co have opted to accept the risk of rising rates
clobbering their investment portfolios, and use held-to-maturity
accounting for little-to-none of their investment securities.