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> why is it that we allow a bank to not mark-to-market a security for which there is a liquid market? Because at maturity, the bank gets back its money. So it

• SilasX 4y ago
  The problem, though, is that it's not necessarily 100% up to them whether they'll hold it to maturity, since withdrawals can force them to liquidate it. It seems like they should have a ruling forcing the use of some formula that factors in this possibility.
• tnel77 4y ago
  Maybe both metrics would be useful. “If we had to sell today, this is our situation. If these bonds are held to maturity, this will be our situation.” Seems like that would allow an investor to see the state of the bank more clearly.
  • echion 4y ago
    Definitely. And SVB's financial reporting / balance sheet showed this problem beforehand, AIUI.
• hn_throwaway_99 4y ago
  > The "I intend to hold it" is the relevant part of the valuation, though. Yup, and definitely anticipate there will be major new regulations in this area. A huge part of SVB's book of bonds were categorized as "Hold to Maturity". And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. The fact that SVB had such a huge book of bonds at paltry rates with no/minimal hedging is just awful risk management.
  • dragonwriter 4y ago
    > Yup, and definitely anticipate there will be major new regulations in this area. It already happened. The new regulation is that the Fed now has a liquidity backstop for banks holding this asset class, using cash loans with a set maximum term against the par value. Apparently the Fed decided “if we treat it this way for capital adequacy, and we provide liquidity backstops for banks for other asset classes based on how they are valued for capital adequacy, maybe we should do the same thing here, since otherwise adequate capital can easily and suddenly become inadequate.”
    • bryananderson 4y ago
      This backstop only applies to existing holdings. Banks can't go out today and load up on hold-to-maturity assets and expect the Fed to backstop them tomorrow with loans at par value. Presumably the next step is to regulate HTM holdings so that this won't be necessary again, or else you're creating a moral hazard.
  • daydream 4y ago
    > And, legally, if you mark bonds as HTM, you are not allowed to hedge against their interest rate risk. Basically, the regulations say that if you're hedging against interest rate risk, you don't really intend to hold to maturity, so you need to put them in the "Available for Sale" category. This seems like an important point that I haven’t seen mentioned elsewhere. Lots of folks have been like “these people are morons they didn’t hedge their crappy bonds.” Can you write more about this?
    • hn_throwaway_99 4y ago
      Well, "these people are morons they didn’t hedge their crappy bonds" is pretty much correct. Here's a good explainer on the topic: https://corporatefinanceinstitute.com/resources/accounting/held-to-maturity-securities https://corporatefinanceinstitute.com/resources/accounting/h... . But it's not just that they didn't hedge their interest rate risk, it's also that they assumed that their deposit base would continue to stay the same or grow. The problem is that their highly correlated deposit base of tech startups actually all needed to take their money out at the same time when they couldn't get additional funding. Thus, it's important to understand that banks themselves make the choice of whether a bond goes into the "held to maturity" or "available for sale" bucket. I'm not a bank compliance officer so I don't know the rules about how much they're allowed to put in each bucket, but one problem was that SVB incorrectly estimated how much liquidity they would need because they didn't plan for the risk of their deposits all needing to be drawn down simultaneously.
• UncleMeat 4y ago
  But the entire point of computing current assets is to understand the effects of rapid withdrawals from the bank. If you are trying to predict the future value of the bank or how much money they will make then looking at the value at maturity makes sense. But the regulatory system doesn't (or shouldn't) care about that. The regulatory system should be concerned with estimating and mitigating the risk of sudden bank failure.
  • stanleydrew 4y ago
    I believe this is what various "stress tests" are for. If your bank is a certain size you have to basically do scenario planning for situations like ”what if 25% of your deposits leave overnight and you have to sell securities that you didn't plan to sell?” As I understand the situation, SVB was just under the required size to submit to those stress tests.
    • fifticon 4y ago
      to my understanding, they themselves lobbied legislators to put them under that size (by increasing the ceiling).
    • fwlr 4y ago
      There are smaller tests for liquidity, but the specific major stress test that SVB lobbied themselves out of is the DFAST (the Dodd Frank Act Stress Test) and it does not test liquidity. It takes the scenario of an adverse economic situation and comes up with a bunch of hypothetical numbers you might see for major economic variables - “the unemployment rate will be this, the default rate will be that, etc,” - and then banks have to run their books according to those hypothetical numbers and report back what their capital would look like in that situation. If it looks bad, they have to take action to make their capital more secure. Nowhere does it simulate a situation where depositors leave en masse. There are liquidity tests and SVB was probably failing them (which is probably why the FDIC was paying close attention to them), but that specific test you’ve heard about is not related.
      • insonable 4y ago
• deleted 4y ago
  [deleted]
• shapefrog 4y ago
  Except the treasury desk is paying 5% to the person who gave you the $100m to buy the bond that is paying you and interest rate of 1%.
• codeflo 4y ago
  > The "I intend to hold it" is the relevant part of the valuation, though. It’s really not, at least not mathematically. That intentions play a role is purely an artifact of regulations.
  • echion 4y ago
    > > relevant > not mathematically Agreed. I don't think the GP was asking a mathematical question, so "relevant" meant "to explain why MTM accounting is not the only way".
• jasode 4y ago
  >So it is perfectly valid to say "in ten years, this $100m bond is worth $100m...and I intend to hold it for ten years, so it's worth $100m [equivalent] today". But that valuation model is not perfectly valid. It's only partially valid under limited scenarios. As many comments have already pointed out, the issue is the bank has customers with demand deposits. The customers can demand withdrawal of their money anytime -- without advanced notice. In other words, SVB is not a hedge fund that has the customers' deposits contractually locked up for 10 years. Therefore, the "10 year bond held to maturity" assumption becomes invalid if the bank has to sell them prematurely at distressed discount prices -- to meet liquidity requirements of demand deposits. You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations.
  • dragonwriter 4y ago
    > But that valuation model is not perfectly valid. It’s only partially valid under limited scenarios. Its valid under the applicable regulations. However, it is one case where having adequate capital under those rules was not backstopped by available liquidity measures from the Fed. One thing that seems to be generating less commentary is that, in the wake of the SVB collapse, and virtually simultaneously to the announcement of the systemic risk exception for SVB by the FDIC/Treasury/Fed, the Federal Reserve also announced a generally-available liquidity backstop program for this kind of hold-to-maturity assets. > You can’t use value securities as “mark-to-intended-optimal-future” as an alternative to “mark-to-market” for purposes of insolvency risk calculations. To the extent that refers to valuing the class of assets at issue at their par value, and to the extent that that was true last week, its not now.
  • s1artibartfast 4y ago
    >You can't use value securities as "mark-to-intended-optimal-future" as an alternative to "mark-to-market" for purposes of insolvency risk calculations. I think this is exactly correct, but I dont think that is the purpose and scenario reported on their financial statements. I think it is fine to report valuation in terms of "mark-to-solvent future", as long as the appropriate data is provided to enable insolvency risk calculations, and the "mark-to-solvent future" model is not presented or confused with a insolvency risk model. If an investor does not understand how HTM assets are accounted per regulation, but they are accurately reported, confusing the models is an investor error, not a bank reporting error. My understanding is that banks provide clear reporting, and are transparent with their HTM portfolio. HTM securities are typically reported as separate noncurrent assets; they have an amortized cost on a company's financial statements.
• kmod 4y ago
  Welcome to a non-zero interest rate environment. "$100m equivalent today" is not $100m -- the term to search for is "net present value". These considerations are precisely what marking to market captures
  • s1artibartfast 4y ago
    If those assets are in your hold to maturity portfolio, they are still worth $100m. This return is guaranteed unless the Federal Bank defaults on those treasuries.
    • kmod 4y ago
      $100m future dollars, which are less valuable than present dollars.
      • daveguy 4y ago
        That's hedging against inflation (which is definitely something they should have been doing for long term bonds). Interest rates directly affect the sale price of a bond, and it could have been hedged against, but it wasn't required. They won't do it unless it's required. Banks over 50 billion need to be regulated again (and they should lower it to 10 billion too).
      • s1artibartfast 4y ago
        $100m future dollars are still still $100m dollars. It is the value of the dollar that is changing, not the number of them that you hold. The day you are paid, you will still get handed exactly $100m million. Every day between now and then you will still have exactly $100m in bond holdings. How many cheeseburgers you can buy with that number of dollars may change from day to day, but the number of dollars will not.
        • morelisp 4y ago
          You don't need to appeal to cheeseburgers to not want to value 100 future dollars at 100 current dollars, if you can buy 100 future dollars for 80 current dollars, which is essentially what happened when rates rose. (Someone else is offering 100 future for 80 current because they have a forecast about cheeseburgers, sure. But you don't have to agree with that forecast to take their deal; the deal looks even better for you if you don't agree.)
• OJFord 4y ago
  But why is that valid, if it's trading below par? In the extreme - obviously you can't buy a call option and say 'I intend to hold this until it's $10 in the money, so it's actually worth (time-adjusted) $10'. What's the difference, besides probabilities of outcomes?
• ars 4y ago
  Let's extend your example - I have a bond that costs $1 today, but is worth $1,000 at maturity - except that maturity is in 1,000 years. So, can the bank claim it has $1,000 now?