As interest rates rose from record lows, more banks sought to protect their capital from changes in the value of their securities portfolios.

As 2020 came to a close, bank investment portfolios remained firmly in the black, but increases in long-term interest rates late in the year appear to have prompted many institutions to become increasingly suspect of potential for bond prices to move in the other direction. Many banks placed even greater amounts of their securities in their held-to-maturity, or HTM, portfolios to shield the books from swings in market valuation. Unlike available-for-sale, or AFS portfolios, banks do not have to mark HTM portfolios to market on a quarterly basis.

Changes in the value of AFS portfolios flow through accumulated other comprehensive income and impact tangible common equity. For banks over $700 billion in assets, changes in AOCI impact regulatory capital as well.

After declining in recent quarters, banks grew their HTM portfolios to 26.3% of total securities in the fourth quarter of 2020 and 23.7% in the third quarter of 2020 as long-term rates rose notably in the last three months of the year.

Some institutions, particularly among the nation's largest banks, reported sizable increases in their HTM portfolios in the last half of 2020. JPMorgan Chase & Co. and Bank of America Corp. built their HTM portfolio substantially in the fourth quarter, growing the books by 325% and 103%, respectively, year over year.

JPMorgan has said that it transferred more securities to held to maturity in recent quarters to protect capital. CFO Jennifer Piepszak noted at an investor conference in February that some of those moves came in response to preparing for the stress capital buffer associated with the annual stress tests.

At the same investor conference, BofA CFO Paul Donofrio noted that his company deployed a little over $100 billion of cash into securities, predominantly mortgage-backed securities. He said much of the company's purchases with any duration risk were classified as held to maturity to protect capital against future increases in interest rates.

Some banks have suggested that they could look to increase duration in their securities portfolios as they seek to deploy excess liquidity that has built on bank balance sheets. Comerica Inc. CFO James Herzog, for instance, said at an investor conference in March that some of the securities the company purchased recently were "a little bit longer in duration."

Still, while HTM portfolios have grown over the last six months, banks' AFS securities portfolios still hold the majority of bonds owned by the industry. In the fourth quarter, institutions including U.S. commercial banks, savings banks, and savings and loan associations that file GAAP financials reported $39.7 billion in unrealized gains in their AFS portfolios, compared with $41.2 billion in unrealized gains in the third quarter.

Portfolios remain firmly in the black but gains in banks' securities portfolios have decreased notably since the end of the year. The Federal Reserve's H.8 data, which tracks all commercial bank balances, shows that the group reported $45.2 billion in unrealized gains through the week ended Feb. 24. Values in portfolios have declined since Dec. 30, 2020, when institutions reported $61.1 billion in unrealized gains.

Those gains have declined as the yield on the 10-year Treasury has risen back above 1.5% for the first time since the pandemic began as expectations for stronger economic growth and potential concerns over inflation have pushed rates higher. The yield on the 10-year Treasury averaged 0.86% in the fourth quarter, up significantly from 0.65% in the third quarter. In the first few months of 2021, the yield on the 10-year Treasury has risen substantially, averaging 1.23% through March 11. Economists now expect the benchmark yield to rise further and reach 1.78% by December 2021 — 50 basis points higher than the consensus estimate just a few months ago.

The use of HTM portfolios to protect from swings in market valuations was more common between 2013 and 2018 due to capital and liquidity rules. Those portfolios peaked at 30.4% of securities in the third quarter of 2018 but shrank as portions of bank balance sheets in subsequent quarters, and they dropped notably during the first half of 2020.

HTM portfolios became smaller portions of banks' investment portfolios after the passage of regulatory relief measures that had required many large institutions to hold higher concentrations of market-sensitive securities. The Economic Growth, Regulatory Relief and Consumer Protection Act passed in May 2018 gave institutions with assets between $50 billion and $100 billion immediate relief from enhanced prudential standards. The Fed subsequently proposed plans to provide a further off-ramp for certain regulations applied to some banks with assets between $100 billion and $250 billion, including the liquidity coverage ratio, which required them to hold higher concentrations of government securities.

HTM portfolios remain considerably higher than before the passage of the liquidity coverage ratio and the Basel III capital rules, particularly with their growth over the last two quarters. The Basel III rules proposed in 2012 required accumulated other comprehensive income to flow through regulatory capital at all banks. A year later, the final Basel III rules allowed institutions that fell under the nonadvanced approach capital framework — generally those with less than $250 billion in assets — to opt out of that provision.

HTM portfolios have more than doubled since the liquidity coverage ratio surfaced in its proposed form in the fall of 2013 and have increased even more since the Basel III rules were proposed.