The Pitfalls of “Hide-to-Maturity” Accounting

The Pitfalls of “Hide-to-Maturity” Accounting

By Jaime Krug, CPA, and Rikki Williams, CPA

All it took was a social media fueled bank run on Silicon Valley Bank (SVB) – the likes of which was reminiscent of the panic that beset George Bailey’s Bedford Falls Building and Loan – to kickstart the March 2023 banking crisis, the second significant financial crisis in 15 years. The SVB collapse reignited the debate about whether financial instruments should be carried at amortized cost (held-to-maturity or HTM) or at fair value (available-for-sale or AFS), otherwise known as the “mixed measurement” model.

Bank implosions may not be predictable, but there are usually warning signs that can help regulators and investors plan for stress situations. With fair value information for HTM securities usually found only in the footnotes, the relevancy of fair value measures is reduced due to the reporting lag of preliminary earnings releases, which typically reflect the financial statements and not the footnotes. This forces users to take additional steps to find the necessary information for understanding interest-rate risk and its effect on financial instruments held. Further, since earnings calls are held shortly after an earnings release and before the filing of financial statements with the Securities and Exchange Commission (SEC), users are precluded from posing questions related to information they simply do not have: they “don’t know what they don’t know.”

Sophisticated investors will adjust amounts reported on the balance sheet for fair value to paint a clearer picture of the financial health of a company. HTM accounting, sometimes jokingly referred to as "hide-to-maturity," only serves to delay the recognition of stressed realities because of the inability to discern the real economics and financial health of a company. Fair value, as evidenced by its widespread usage by analysts in valuation and market pricing, should be reflected in financial statements.

Measuring all financial instruments at fair value – for both balance sheet and performance reporting purposes – would serve to improve the transparency and understandability of financial statements. Following the global financial crisis in 2008, both the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) contemplated applying a “full fair value” model for financial instruments. Accounting for such instruments under full fair value would simplify financial reporting because there would be no need for many of the existing complex and/or judgmental areas of the guidance, such as classification and impairment testing.

A switch to a full fair value model for financial instruments (or even an increased use of fair value in a mixed measurement model) seems highly unlikely. The FASB previously stated it is always open to engaging with stakeholders on accounting issues to continue efforts to improve accounting and financial reporting, but if the FASB were to address the issue it would be like disturbing the proverbial hornet’s nest. The same arguments would arise, just as they had when the FASB issued its 2010 proposal on fair value accounting.

With that being said, the FASB should heavily consider eliminating HTM accounting and require all financial instruments to be reported at fair value in the financial statements. Additionally, the FASB and the SEC should enact new or enhance current reporting standards to provide greater transparency into bank business models and the cash flow characteristics of financial instruments.

One idea, proposed by Brent Beardall, chief executive of the Seattle-based bank Washington Federal Inc., provides for the FASB to consider requiring financial institutions to present two balance sheets, one at amortized cost and the other at fair value, so that information is comparable across all classes of assets and liabilities. “Fair value is a useful piece of information, but it’s only useful if you get all of the information. Picking and choosing is a disaster,” Beardall said. “I think it’s time that the FASB look at it and provide information to investors the way they want it.”

We couldn’t agree more. At Centri, we take pride in assisting our clients in the preparation of transparent financial statements and disclosures which enable financial statement users to make informed investment decisions.

Jaime Krug, CPA, is the chief quality officer and partner at Centri Business Consulting, overseeing Centri’s national office and the strategic development, processes, and initiatives related to training and development. She can be reached at jkrug@centriconsulting.com.

Rikki Williams, CPA, is the director of quality at Centri Business Consulting. He leads Centri’s quality and concurrence review program and serves as the firm’s subject matter expert for complex financial instruments. He can be reached at rwilliams@centriconsulting.com.

Statements of fact and opinion are the authors’ responsibility alone and do not imply an opinion on the part of the PICPA's officers or members. The information contained herein does not constitute accounting, legal, or professional advice. For actionable advice, you must engage or consult with a qualified professional.