At acquisition, an investor shall document the classification of debt securities.
Amortized cost is relevant only if a security is actually held to maturity. Use of the held-to-maturity category is restrictive because the use of amortized cost must be justified for each investment in a debt security. At acquisition, an entity shall determine if it has the positive intent and ability to hold a security to maturity, which is distinct from the mere absence of an intent to sell. If management's intention to hold a debt security to maturity is uncertain, it is not appropriate to carry that investment at amortized cost. In establishing intent, an entity shall consider pertinent historical experience, such as sales and transfers of debt securities classified as held-to-maturity. A pattern of sales or transfers of those securities is inconsistent with an expressed current intent to hold similar debt securities to maturity.
Specific scenarios in which a debt security shall not be classified as held-to-maturity (or where sale or transfer of a held-to-maturity security will call into question an investor's stated intent to hold other debt securities to maturity in the future) are as follows:
- a
A security shall not be classified as held-to-maturity if that security can contractually be prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment. The justification for using historical-cost-based measurement for debt securities classified as held-to-maturity is that no matter how market interest rates fluctuate, the holder will recover its recorded investment and thus realize no gains or losses when the issuer pays the amount promised at maturity. However, that justification does not extend to receivables purchased at a substantial premium over the amount at which they can be prepaid, and it does not apply to instruments whose payments derive from prepayable receivables but have no principal balance. Therefore, a callable debt security purchased at a significant premium might be precluded from held-to-maturity classification under paragraph 860-20-35-2 if it can be prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment. In addition, a mortgage-backed interest-only certificate shall not be classified as held-to-maturity. Paragraphs
provide further guidance on application of this paragraph.
Note that a debt security that is purchased late enough in its life such that, even if it was prepaid, the holder would recover substantially all of its recorded investment, could be initially classified as held-to-maturity if the conditions of this paragraph and paragraph 320-10-25-1 are met. (A debt security that can contractually be prepaid or otherwise settled in such a way that the holder of the security would not recover substantially all of its recorded investment may contain an embedded derivative. Therefore, such a security should be evaluated in accordance with Subtopic 815-15 to determine whether it contains an embedded derivative that needs to be accounted for separately.) - b
A debt security that is available to be sold in response to changes in market interest rates, changes in the security's prepayment risk, the entity's need for liquidity, changes in foreign exchange risk, or other similar factors shall not be included in the held-to-maturity category because the possibility of a sale is indicative that the entity does not have a positive intent and ability to hold the security to maturity. A debt security that is considered available to be sold as part of an entity's asset-liability management activities shall not be classified as held-to-maturity. Similarly, an entity that maintains a dynamic hedging program in which changes in external factors require that certain securities be sold to maintain an effective hedge would not have the intent and ability to hold those securities to maturity.
- c
Securities that may need to be sold to implement tax-planning strategies (for example, to generate taxable gains to offset existing taxable losses—or vice versa—or in response to changes in the entity's anticipated future profitability—for example, if taxable losses were expected for the next several years) should be classified as available-for-sale, not held-to-maturity.
- d
The sale of a held-to-maturity security in advance of any deterioration in the creditworthiness of the issuer, perhaps based solely on industry statistics, will call into question an investor's stated intent to hold other debt securities to maturity in the future. The sale of a held-to-maturity security must be in response to an actual deterioration, not mere speculation. That deterioration shall be supported by evidence about the issuer's creditworthiness; however, the entity need not await an actual downgrading in the issuer's published credit rating or inclusion on a credit watch list.
- e
The sale of held-to-maturity securities to meet regulatory capital requirements will call into question an investor's stated intent to hold other debt securities to maturity in the future. An entity's ability and intent to hold securities to maturity would be called into question by the sale of held-to-maturity securities to realize gains to replenish regulatory capital that had been reduced by a provision for loan losses. Gains trading with held-to-maturity securities to meet an entity's capital requirements is inconsistent with the held-to-maturity notion.
- f
The exercise of a put option on a security classified as held-to-maturity will call into question an investor's stated intent to hold other debt securities to maturity in the future. Furthermore, a puttable debt security might be precluded from held-to-maturity classification pursuant to paragraph 860-20-35-2. - g
Convertible debt securities shall not be classified as held-to-maturity. Classifying a security as held-to-maturity means that the entity is indifferent to future opportunities to profit from changes in the security's fair value and intends to accept the debt security's stipulated contractual cash flows, including the repayment of principal at maturity. Convertible debt securities generally bear a lower interest rate because the investor hopes to benefit from appreciation in value of the option embedded in the debt security. Given the unique opportunities for profit embedded in a convertible security, it generally would be contradictory to assert the positive intent and ability to hold a convertible debt security to maturity and forego the opportunity to exercise the conversion feature. The exercise of a conversion feature on a security classified as held-to-maturity will call into question an investor's stated intent to hold other debt securities to maturity in the future. (See Section 815-15-25 for additional guidance. If convertible debt is bifurcated into an equity option and a host debt instrument under the requirements of Subtopic 815-15, it generally still would be contradictory to assert the positive intent and ability to hold the debt host contract to maturity and forego the opportunity to exercise the conversion feature.) - h
A documented policy to initially classify all debt securities as held-to-maturity but then automatically transfer every security to available-for-sale when it reaches a predetermined point before maturity (for example, every held-to-maturity security will be transferred to available-for-sale 24 months prior to its stated maturity) so that an entity has the flexibility to sell securities is not consistent with the held-to-maturity classification. Under the policy described, the entity does not intend to hold any security to maturity.
- i
An insurance entity or other regulated entity shall not classify securities as held-to-maturity and also indicate to regulators that those securities could be sold to meet liquidity needs in a defined interest rate scenario whose likelihood of occurrence is reasonably possible but not probable.
It is not appropriate to analogize to the exceptions specified in (a) through (f) in the preceding paragraph.
In addition to the changes in circumstances listed in paragraph 320-10-25-6(a) through (f), certain other events may cause the entity to sell or transfer a held-to-maturity security without necessarily calling into question (tainting) its intent to hold other debt securities to maturity. Such events must meet all of the following four conditions to avoid tainting its intent to hold other debt securities to maturity in the future:
- a
The event is isolated.
- b
The event is nonrecurring.
- c
The event is unusual for the reporting entity.
- d
The event could not have been reasonably anticipated.
Other than extremely remote disaster scenarios (such as a run on a bank or an insurance entity), very few events would meet all four of those conditions.
Extremely remote disaster scenarios shall not be anticipated by an entity in deciding whether it has the positive intent and ability to hold a debt security to maturity.
With respect to the discussion in paragraph 320-10-25-6(c) about a major business combination or a major disposition, this Subtopic does not specify a quantitative threshold for a major business combination or disposition. Examples of transactions that would qualify for the exception in paragraph
320-10-25-6(c) are as follows:
- a
Sales of held-to-maturity securities only when the combination or disposition necessitates the sale or transfer of held-to-maturity securities to maintain the entity's existing interest rate risk position or credit risk policy. Necessary transfers or sales shall occur concurrent with or shortly after the business combination or disposition. This Subtopic does not define shortly. As time passes, however, it is increasingly difficult to demonstrate that the business combination, and not other events or circumstances, necessitated the transfer or sale of held-to-maturity securities.
- b
A sale of a component of an entity is an example of a major disposition.
Examples of transactions that would not qualify for the exception in paragraph
320-10-25-6(c) are as follows:
- a
A purchase or sale of a large pool of financial assets (for example, conforming mortgages) or liabilities (for example, deposit liabilities) (which would not be considered a major business combination or disposition)
- b
Sales of held-to-maturity securities to fund an acquisition (or a disposition, for example, if deposit liabilities are being assumed by the other party)
- c
Sales of held-to-maturity securities in anticipation of or otherwise before a major business combination or disposition
- d
A sale of held-to-maturity securities in response to an unsolicited tender offer from the issuer (which also is not an event that is isolated, nonrecurring, and unusual that could not have been reasonably anticipated).
Selling a debt security after a substantial portion of the principal has been collected shall be considered equivalent to holding the security to maturity. The collection of 85 percent of the principal outstanding at acquisition (not the principal outstanding at issuance for securities purchased in the secondary market) constitutes a reasonable threshold of what represents a substantial portion of the principal.
Specific scenarios in which a debt security may be classified as held to maturity (or where sale or transfer of a held-to-maturity security will not call into question an investor's stated intent to hold other debt securities to maturity in the future) are as follows:
- a
Although its asset-liability management may encompass consideration of the maturity and repricing characteristics of all investments in debt securities, an entity may decide that it can accomplish the necessary adjustments under its asset-liability management without having all of its debt securities available for disposition. In that case, the entity may choose to designate certain debt securities as unavailable to be sold to accomplish those ongoing adjustments deemed necessary under its asset-liability management, thereby enabling those debt securities to be accounted for at amortized cost on the basis of a positive intent and ability to hold them to maturity.
- b
The sale of one or more held-to-maturity securities if an entity chooses to downsize to comply with a significant increase in the industry's capital requirements would not call into question the classification of other held-to-maturity securities.
- c
In some circumstances it may not be possible to hold a security to its original stated maturity, such as when the security is called by the issuer before maturity. The issuer's exercise of the call option effectively accelerates the security's maturity and shall not be viewed as inconsistent with classification in the held-to-maturity category.
- d
A puttable debt security shall be classified as held-to-maturity only if the entity has the positive intent and ability to hold it to maturity.
- e
If a transfer of a held-to-maturity debt security is accounted for as a sale under Subtopic 860-20 and it is transferred for a reason other than those specified in paragraphs 320-10-25-6, 320-10-25-9, and 320-10-25-14, then the transfer would taint the held-to-maturity portfolio. However, if the transfer is accounted for as a secured borrowing, then the transfer would not taint the held-to-maturity portfolio. Transactions involving held-to-maturity securities that are not accounted for as sales under Subtopic 860-20 would not contradict an entity's stated intent to hold a security to maturity and, therefore, do not call into question the entity's intent to hold other debt securities to maturity. Examples of such transactions are as follows:
- 1
Held-to-maturity securities pledged as collateral, provided that the transaction is not accounted for as a sale under Subtopic 860-20 and the entity intends and expects to be able to satisfy the obligation and recover access to its collateral - 2
Held-to-maturity securities subject to a repurchase agreement or a securities lending agreement, provided that the transaction is accounted for as a secured borrowing under Subtopic 860-20 and the entity intends and expects to be able to repay the borrowing - 3
Beneficial interests classified as held-to-maturity that are desecuritized in a transaction that is not accounted for as a sale if the financial assets received in or that continue to be held after the desecuritization are held to maturity. Unless the debt instrument received or retained as a result of the transaction is held to maturity, the transaction would call into question the entity's intent to hold other debt securities to maturity. Desecuritizations are not specifically included within the scope of this paragraph. Nevertheless, that guidance is also appropriate for desecuritizations that are not accounted for as sales.