Understanding Investment Securities

Banks often purchase marketable securities to hold in their portfolios; these are usually one of two main sources of revenue, along with loans. Investment securities can be found on the balance sheet assets of many banks, carried at amortized book value (defined as the original cost less amortization until the present date).

The main difference between loans and investment securities is that loans are generally acquired through a process of direct negotiation between the borrower and lender, while the acquisition of investment securities is typically through a third-party broker or dealer. Investment securities at banks are subject to capital restrictions. For example, the number of Type II securities or securities issued by a state government is restricted to 10% of the bank's overall capital and surplus.

Investment securities provide banks with the advantage of liquidity, in addition to the profits from realized capital gains when these are sold. If they are investment-grade, these investment securities are often able to help banks meet their pledge requirements for government deposits. In this instance, investment securities can be viewed as collateral.

Types of Investment Securities

Equity Stakes

As with all securities, investment securities held by banks as collateral can take the form of equity (ownership stakes) in corporations or debt securities. Equity stakes can be in the form of preferred or common shares—although it is critical that they provide a measure of safety in this case. High-risk, high-reward securities, such as initial public offering (IPO) allocations or small gap growth companies. Might not be appropriate for investment securities. Some companies offer dual-class stock, which provide distinct voting rights and dividend payments.

Debt Securities

Debt securities can take the common forms of secured or unsecured corporate debentures. (Secured corporate debentures can be backed by company assets, such as a mortgage or company equipment). In this scenario, secured debt (also called investment-grade) would be preferred. Treasury bonds or Treasury bills and municipal bonds (state, county, municipal issues) are also options for a bank’s investment securities portfolio. Again, these bonds should be investment-grade.

While securities, in general, include derivative securities—such as mortgage-backed securities, whose value is derived from the asset(s) underlying the financial instrument—these are higher risk and not often encouraged to be part of a bank’s investment securities portfolio.

Money Market Securities

Other types of investment securities can include money-market securities for quick conversion to cash. These generally take the form of commercial paper (unsecured, short-term corporate debt that matures in 270 days or less), repurchase agreements, negotiable certificates of deposit (CDs), bankers' acceptances, and/or federal funds.

How to Buy and Sell Securities