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Pros and Cons: Held to Maturity Securities on Companies’ Balance Sheets

Did you know that the majority of financial assets for most companies comprise of marketable securities? Did you also know that companies such as Microsoft, Amazon, Google, and Berkshire Hathaway hold upwards of 25% of their assets as marketable securities?

It’s true; you can look it up.

Or you can read the rest of this post and learn more about another segment concerning these marketable securities, held to maturity securities.

Like held to maturity, securities are not exciting, sexy ideas, but many companies use these securities to hedge against inflation or juice their returns on assets.

Not every investment idea a company dreams up is going to return 20% to the company. And in many cases, the company might produce so much cash flow that they struggle to deploy it in a way that returns lots of value to shareholders.

Instead of dumping all that cash in a savings account and earning pennies, many companies choose to utilize marketable securities to earn better returns.

In today’s post, we will learn:

  • What are Held to Maturity Securities?
  • Can You Sell Held to Maturity Securities?
  • Some Pros and Cons of Held to Maturity Securities
  • Examples of Held to Maturity Securities

Okay, let’s dive in and learn more about held to maturity securities.

What Are Held to Maturity Securities?

Held to maturity securities are investments purchased by a company meant to own until maturity. For example, Amazon might purchase a bond they intend to hold until maturity of that bond.

There are different accounting treatments for held to maturity investments compared to its cousins:

The most common forms of held to maturity securities are bonds, CDs, and other debt vehicles. Bonds and debt vehicles have stated or fixed payment schedules, fixed maturities and are typically purchased and held until maturity.

However, stocks do not have a stated maturity; they are bought and sold based on the investor’s decisions. There is no expiration date on your investment of Visa or Mastercard.

For accounting purposes, companies have a few different categories to align their investments. Depending on the companies’ goals and desires, they can define them as available for sale or held for trading.

These different classifications are treated differently on the company’s balance sheets. Also treated differently are the respective gains or losses of these investments.

Held to maturity securities are typically reported as a noncurrent asset and are not considered part of its working capital.

Companies amortize the held for maturity securities on the balance sheet. It is an accounting practice that allows for adjustments of the assets throughout the asset’s life (for those not familiar with amortization).

Earned interest income lists as a separate line item on the income statement. But changes in the stock price of the investment doesn’t change on the balance sheet.

Held to maturity securities only report as current assets if the security has a maturity of one year or less.

Securities with maturities of longer than a year will list on the balance sheet at an amortized cost. All of which means the initial acquisition cost along with any entailed additional costs to date.

Both available for sale and held for trading securities list on the balance sheet at fair value, while held to maturity securities list at amortized value.

Also, any temporary price changes in a held for maturity securities do not appear in financial documents.

Okay, now that we have a basic understanding of held to maturity securities, let’s look at some accounting guidelines.

Can You Sell Held to Maturity Securities?

Suppose a company decides to invest in bonds or other debt securities, then it has the choice of holding it until it matures or selling it at a premium when the interest rates decline.

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Many banks or insurance companies hold these securities to hedge against inflation and have a solid secured return over a set period.

With the return fixed on the balance sheet under the amortization rules, any fluctuations of prices don’t affect the balance sheet’s value, unlike available for sale or equity securities that will fluctuate with the market.

Any earned income from held to maturity securities flows from the balance sheet to the income statement via the net investment income line item.

A danger of selling the held to maturity securities for companies to consider is the potential that auditors might prohibit companies from using this category in the future.

There are one-time exceptions that allow these sales, but accountants look down on this arrangement. One of the advantages to companies using this accounting treatment is its stability, with price-fixing.

There is a one-time opportunity offered now that allows companies to reclassify their held to maturity securities.

But if a company chooses to liquidate its held to maturity securities, it runs the risk of “tainting” its marketable security portfolio.

Suppose FASB, the accounting council, determines the company is acting within the rules by declassifying its held to maturity securities. In that case, they may determine the portfolio must change to available for sale securities.

There are exemptions, such as nonrecurring events, for which the 2020 pandemic is a perfect example. In that case, the company can liquidate its held to maturity securities without any penalties.

Okay, let’s next look at some of the pros and cons of held to maturity securities.

Some Pros and Cons of Held to Maturity Securities

There are naturally, like any investment, advantages, and disadvantages to buying held to maturity securities.

In this section, we will cover some of those ups and downs.

Let’s discuss some of the pros involved in investing in held to maturity securities.

The first benefit for held to maturity securities is they are generally low-risk investments. Assuming that the bond issuer doesn’t default on the loan, then the returns are a lock.

The predictability of those returns allows the company to make plans for the future.

The second benefit is the low volatility associated with the market. Since the held to maturity securities list on the balance sheet at a fixed price, the market’s ups and downs will not affect those securities’ value.

Given that bonds have a fixed coupon rate and maturity date, fixing that bond’s price on the balance sheet smooths out those long-term returns. Remember that the interest earned from the coupons post on the income statement as a part of the net investment income.

The third pro for held to maturity securities is the diversification they offer companies. Investors can plan their portfolios around the returns generated by held to maturity securities.

Plus, the low-beta securities offer diversification away from some of the volatility associated with equities or other available for sale securities.

Most held to maturity securities are debt instruments, particularly bonds that offer lower beta or volatility investing in stocks. When a company holds a longer maturity Treasury bond or corporate bond, the return is known, allowing it to step out a little more and invest in riskier investments.

Some of these choices will depend on the nature of the business and its goals for the investment portfolio.

Some businesses such as property-casualty insurance firms use available for sale securities because the shorter-nature of those insurance premiums lends itself to turning over quicker.

Where a life insurer might hold longer-term securities to match the longer nature of life insurance premiums, life insurers are referred to as long-tail insurers and property-casualty insurers are short-term.

There are two main cons to holding to maturity securities:

  • Limited liquidity
  • Limited upside potential

When a company invests in a held to maturity security, they are tying up those funds in an investment that limits its ability to use those funds for another reason.

A few situations allow the company to liquidate or sell its held to maturity securities. But for the most part, those funds are there until maturity. And if a situation comes up that affords another better opportunity, these particular funds are not available.

If the company does a poor job of planning, it could limit itself by investing in these securities and accounting for them as a held to maturity security. Of course, they can and do invest in bonds, but many companies list them as available for sale securities, which gives them more flexibility.

The second con of holding securities to maturity is the risk of default. While Treasuries have never defaulted, there are occasions where corporate bonds default.

If a company invests in riskier bonds, they could set themselves up for the risk of default.

And one of the pros of holding securities to maturity is getting that secured stable income and decreased volatility.

The final con is the loss of higher gains in the case of better opportunities. When a company ties up its monies held to maturity securities, they are opening themselves to the cost of opportunities lost.

Remember that held to maturity securities returns are a done deal. And they don’t allow for the company to take advantage of any favorable market conditions.

Examples of Held to Maturity Securities

A great example is the Treasury 10-year note, which is backed by the U.S. government’s full faith and is one of the safest investments anyone can make.

The 10-year bond pays a fixed-rate return. For example, the current 10-year rate is 0.90%, and for the 30-year it is 1.63%.

Depending on what kind of maturity you are looking for, companies have different rates from which to choose. But along with those kinds of rates, we have corporate rates to choose from as well.

The credit rating of those individual bonds offers slightly better returns, with approximately the same risk level.

For example, Microsoft offered a recent bond for 3.30%, which will mature in 2029, and Microsoft is one of the few companies with a AAA rating, which is higher than the U.S. government.

Let’s say that Apple wants to invest in a bond offering listing at $1,000 for a 10-year bond and to hold it until maturity. If the bond pays a coupon of 3.30%, then each year, Apple will receive that 3.30%, and ten years later, Apple receives it’s $1,000 back from the bond’s face value.

Whether the interest rates rise or fall, Apple will receive 3.30% over the next ten years, or for each year of 3.30% in interest income.

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As we investigate the above screenshot, we see that Prudential uses foreign government bonds and other corporate securities, all of which are at amortized costs.

We can see that Prudential purchased those securities at a fixed cost of $1,920 million, and which they have grown to a fair value of $2,264 million.

And if we look next at the net investment income, which is a line item listing on the income statement, the net investment income is a combination of interest income, dividends, and other income.

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From the above screenshot, we can see that Prudential earned $59 million from its held to maturity securities, which is 1.3% of its net investment income.

Granted, that is not much in the grand scheme of things, but it does allow the company to risk a small portion of its investment portfolio to equity securities.

If we look at another insurer, Chubb (CB), we can see a different breakdown of the held to maturity securities.

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Looking at Chubb’s investment notes allows us to see the breakdown of its investment portfolio.

From the above screenshot from Chubb’s held to maturity section, we can see that the company holds many of its securities in a variety of different vehicles.

Included are U.S. treasuries, municipals, corporate bonds, and mortgage back securities.

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Another little nugget from the Investment note sections of Chubb’s latest 10-q noted above for our investigation.

It notates the breakdown of its held to maturity securities bond credit ratings. The great part of this little breakout is we can see the vast majority of the portfolio is in strong credit rated bonds. All of which lends itself to stable, albeit lower returns.

Investor Takeaways

Held to maturity securities are part of the bundle that includes all marketable securities. Each bucket has a part to play in the performance of the company.

Available for sale securities typically hold a larger portion of most companies’ investment portfolios, with equity positions a smaller portion, with the exceptions of large equity portfolios such as Berkshire Hathaway and Markel.

Most companies use their investment portfolios as a means of capturing returns while they wait for better opportunities. Therefore, most of their investments are short-term in nature.

But there are cases where a company might want to hedge against inflation or stabilize its equity portfolio with safer, long term investments.

That is where the held to maturity classification comes into play. Using this accounting definition to apply to its long-term investments, the company can avoid any market volatility and plan on fixed returns from a portion of its portfolio.

As investors, we need to understand this classification because it concerns the returns a company earns on its assets. But it also limits a company’s liquidity, and if management is not planning ahead, it could tie up funds at lower returns.

That lack of liquidity could hurt the company in the long run as it may miss out on better investment opportunities.

One of the reasons to have a complete understanding of each line item of a financial document and its ramifications is to help us understand what management is thinking and how it impacts the company.

With that, we will wrap up our discussion on held to maturity securities.

As always, thank you for taking the time to read today’s post, and I hope you find something of value on your investing journey.

If I can be of any further assistance, please don’t hesitate to reach out.

Until next time, take care and be safe out there,

Dave