How Banks Are Using Accounting Shifts to Prepare for an Interest Rate Rise

You are a large bank with a multibillion dollar portfolio of securities, ranging from municipal bonds to U.S. Treasuries and mortgage debt backed by the government.

For years, you were able to classify those securities as either available-for-sale (AFS) or held-to-maturity (HTM). If the market value of the securities moved, you didn't have to worry too much unless you crystallized your paper gains or losses by actually selling the securities. So-called unrealized gains and losses on AFS holdings were excluded from net income and counted only toward shareholder equity under generally accepted accounting principles. That began to change in 2013, thanks to new banking regulations. Any mark-to-market gains or losses on securities classified as AFS will now affect your capital levels. As a savvy bank person, you know that the Federal Reserve is thinking of raising interest rates soon(ish) and that such a move would traditionally spell bad news for bonds. Faced with upcoming interest rate volatility, you have two choices: a) reduce rate risk in your portfolio or b) figure out a way to avoid mark-to-market losses on the bonds.