The Big Idea
Market value and the bank AFS-to-HTM split
This material is a Marketing Communication and does not constitute Independent Investment Research.
Available-for-sale securities portfolios add important liquidity to a bank balance sheet. But the value of these portfolios fluctuates with market rates, spreads and other factors. An increase in rates or widening of spreads hits portfolio value and reduces a bank’s liquid asset pool by lowering potential proceeds from a securities sale. These value changes should weigh in a bank’s decision about accounting for incremental investment as AFS or held-to-maturity. A sell-off should push more securities toward AFS and a rally should push more securities toward HTM.
Cash and AFS securities comprise liquid assets
For the entire U.S. banking universe, liquid assets over the past year have amounted to about 22% of total assets, with cash and AFS securities each comprising roughly half of the liquid asset pool (Exhibit 1).
Exhibit 1: Cash and AFS securities comprise liquid assets
Source: S&P Global / Capital IQ,, Santander U.S. Capital Markets
Much of the variability of this liquid asset pool comes from changes in AFS portfolio value, largely due to changes in interest rates (Exhibit 2). Changes in the percentage of AFS portfolio value to total assets clearly inversely tracks the level of interest rates.
Exhibit 2: AFS liquidation value changes with market factors
Note: bank regulatory filings do not distinguish between portfolio changes driven by trading activity and those driven by market-based valuation changes. While this analysis assumes that all changes are driven by valuation changes, some percentage will have been due to trading activity.
Source: S&P Global / Capital IQ, Santander U.S. Capital Markets
AFS portfolio allocation naturally increases in a rally
Fluctuations in AFS securities market value, largely driven by changes in interest rates, will affect the mix of AFS and HTM since banks carry HTM securities at amortized cost and do not mark-to-market (Exhibit 3). This pattern is evident when looking at the change from the first quarter of 2023 to the second quarter, when the market sold off and AFS allocation declined. Similarly, much of the increase in AFS allocation from the third quarter to the fourth quarter can be explained by the market rally. It is interesting that with a large market sell-off in the third quarter of 2023, the AFS allocation remained constant from the end of the second quarter, where it could have been expected to decline. This could be explained by banks over-allocating new purchases to AFS in the third quarter following the bank failures in the first half of the year, which highlighted the priority for liquidity.
Exhibit 3: AFS portfolio allocation naturally increases in a rally
Source: S&P Global / Capital IQ, Santander U.S. Capital Markets
Assuming banks want to maintain their liquid assets pool at 22% of total assets, banks should be allocating more new purchase bonds to AFS when rates rise and values fall, and more new purchase bonds to HTM when the market rallies.
There has been much market speculation around the Basel III Endgame proposal being significantly watered down, and possibly even scrapped altogether and re-proposed. But one key provision expected to survive is that banks with assets between $100 billion and $700 billion will need to reflect valuation changes from their AFS portfolios into regulatory capital ratios. This will introduce additional capital ratio volatility to many regional and super-regional banks. While liquidity is a top priority following last year’s bank failures, HTM classification will be an important tool to help minimize this capital volatility and banks will need to continue to strike the right AFS-to-HTM balance. Note also that the market has been expecting new liquidity-related proposals for several months, and it is possible that these include new rules on HTM classification—stay tuned.
First quarter 2024 estimate
With interest rates higher year-to-date as of this writing in late March, based on average industry implied AFS portfolio durations for much of last year of about 3.5, AFS allocation could be expected to decline from 55% to 54%. All things equal, for upcoming portfolio purchases, banks should be over-allocating to AFS.
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