why does OCI(HTM) = 0 always?
why does OCI(HTM) = 0 always? I know this is mentioned in the material, but would like to understand a bit more on why this is the case. Say in 2017 fall Q14, OCI(HTM) = 0 when there's unrealized G/L from HTM assets, how can I rationalize this?
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That's a good question because you're asking about the reasoning behind the stated facts.
It would be a perfectly reasonable accounting rule simply to dump all income into the NI (Net Income) account. But if we did that, we'd be missing some important information.
Realized gains are always included in NI. But unrealized gains are treated differently.
I found a couple of good websites with simple definitions of the 3 bond types:
Here is what I found:
HTM: debt securities which the enterprise has the intent and ability to hold to maturity.
** reported at amortized cost
** unrealized gains excluded from NI
HFT: debt and equity securities held principally for selling them in the near term
** reported at fair value
** unrealized gains included in NI
AFS: all other debt and equity securities
** reported at fair value
** unrealized gains excluded from NI and reported in a separate component of shareholders’ equity, namely OCI
So, this OCI account, which is used only for unrealized gains for AFS bonds, is just a way to keep more finely detailed information about your bond portfolio. The AFS bonds are intended to be kept for longer than HFT, and the longer they are kept, the more likely it is there will be changes in the fair value of AFS bonds (in other words, unrealized gains/losses.) Their value could go up and down many times but you don't want your NI to constantly be going up and down. You mainly care about the gain/loss when it's sold. Until then, you can keep track of the AFS bond value through the OCI account.
One final comment: The fact that unrealized gains/losses for HFT are included in NI is generally not a big deal since those bonds are intended to be sold in the near-term anyway. There could be volatiliy in HFT value, which would cause volatility in NI, but it shouldn't last long.
Thank for Graham for the detailed explanations. Following this logic, can I take this to say for HTM assets, there is impact to OCI, however for the purpose of accounting we don't record any of this impact down as we intend to hold HTMs till maturity and can ignore all the fluctuations in the interim. So even though there are unrealized gains/losses, we do not record them down for the purpose of accounting.
That's pretty much right!
One small point: I know what you mean when you say "HTM has an impact on OCI, but is not recorded", but I would be a little more careful. There really is no impact to OCI. If you were going to record unrealized HTM gains, you could put them into OCI, which is a more precise way of expressing your idea. But your final statement is completely correct - even if there are unrealized HTM gains/losses, you don't record them for accounting purposes.
Gotcha! thanks!