What it means
In everyday use, investment securities means any tradable financial asset bought to be held as an investment: government bonds, corporate bonds, mortgage-backed securities (bonds backed by pools of home loans) and shares. In banking the phrase has a more specific meaning.
It describes the pool of securities a bank buys with spare deposits, to earn a return and to hold a reserve of assets that can be sold quickly if cash is needed. The accounting depends on the intent behind the purchase.
Under US-style rules, debt securities are usually sorted into held to maturity, available for sale and trading. Under international standards the sorting is instead based on the business model and the cash flow features of the instrument, with outcomes such as amortised cost, fair value through other comprehensive income and fair value through profit or loss.
The practical effect is on reported profit. Securities held at amortised cost (the original price adjusted for the gradual write-off of any premium or discount) are not marked to market, so a price fall does not reduce profit unless the security is sold or impaired.
Securities carried at fair value through other comprehensive income show their price swings in equity, which is the section of the balance sheet owned by shareholders, and not in the income statement. Investment securities matter to analysts because they show how a bank is taking risk.
A large portfolio of long-dated bonds earns steady interest but loses value when interest rates rise, and this unrealised loss can shrink a bank's capital without any sale taking place. Careful readers therefore look at the footnotes, which disclose fair values, maturities and credit quality.
For non-financial companies, the same term appears on the balance sheet for surplus cash placed in bonds or shares. These holdings are often split between current assets, if the company expects to sell within a year, and non-current assets.
The classification affects ratios such as the current ratio, so it is worth understanding.
In practice
Real-world examples.
Example
A regional bank invests $50,000,000 of surplus deposits in government bonds that mature in five to ten years. The bonds earn a steady coupon, and the bank treats them as available for sale so that it can sell some if customers withdraw cash.
Example
A manufacturing company has $4,000,000 of cash it will not need for a year. The treasurer buys short-dated corporate bonds and records them as current investment securities, because she intends to sell or redeem them within twelve months.
Example
An insurance company holds a large portfolio of bonds to match the long-term claims it expects to pay. It classifies most of them at amortised cost because it plans to collect the interest and principal over the full term, and it discloses the fair values in the notes.
Formula
Calculation
Unrealised gain or loss = fair value of the securities - amortised cost of the securities
A bank holds government bonds with an amortised cost of $10,000,000. After a rise in interest rates their fair value falls to $9,600,000. The unrealised loss is 9,600,000 - 10,000,000 = -$400,000. If the bonds are classed as available for sale, the $400,000 reduces equity through other comprehensive income and profit is unchanged. If they are classed as held to maturity, the loss is disclosed in the notes but not recorded on the balance sheet unless the bank has to sell.Case study
Seen in the real world.
Calderbank Savings is an illustrative, fictional lender with $2,000,000,000 in deposits and a securities portfolio of $600,000,000 made up of long-dated bonds. When market interest rates rose sharply, the fair value of the portfolio fell by 6%, or $36,000,000.
Because $400,000,000 of the bonds was classed as held to maturity, only the $200,000,000 available-for-sale portion, a loss of $12,000,000, passed through equity. Analysts noticed the disclosed but unrecorded loss on the rest, which was $24,000,000.
The illustrative lesson is that the classification decides what shows up in the accounts, but not the economic loss. When depositors later withdrew funds and the bank had to sell bonds, the hidden loss became real.
Watch out
Common mistakes.
- Assuming that holding securities to maturity means the price fall does not matter, when the bank may still be forced to sell before maturity if it needs cash.
- Treating all investment securities as risk-free because many are government bonds, when interest rate risk and credit risk can both be significant.
- Confusing investment securities with trading securities, which are held to profit from short-term price changes and are marked to market through profit.
Questions
People also ask.
What is the difference between available for sale and held to maturity?
Available for sale securities are carried at fair value with changes shown in equity, while held to maturity securities are carried at amortised cost because the owner intends and is able to keep them until they mature.
Where do I find a company's investment securities?
Look at the balance sheet for the line item and at the notes, which give the types, maturities, fair values and any unrealised gains or losses.
Why do rising interest rates reduce the value of bonds?
New bonds pay higher interest, so older bonds with lower interest must fall in price to give buyers a comparable return.
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