[Federal Register Volume 59, Number 7 (Tuesday, January 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-648]
[[Page Unknown]]
[Federal Register: January 11, 1994]
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FEDERAL RESERVE SYSTEM
Report to Congressional Committees Regarding Differences in
Capital and Accounting Standards Among the Federal Banking and Thrift
Agencies
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Notice of report to the Committee on Banking, Housing, and
Urban Affairs of the United States Senate and to the Committee on
Banking, Finance and Urban Affairs of the United States House of
Representatives.
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SUMMARY: This report has been prepared by the Federal Reserve Board
pursuant to section 121 of the Federal Deposit Insurance Corporation
Improvement Act of 1991. Section 121 requires each Federal banking and
thrift agency to report annually to the above specified Congressional
Committees regarding any differences between the accounting or capital
standards used by such agency and the accounting or capital standards
used by other banking and thrift agencies. The report must also contain
an explanation of the reasons for any discrepancy in such accounting or
capital standards. The report must be published in the Federal
Register.
FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director
(202/728-5883), Norah M. Barger, Manager (202/452-2402), Gerald A.
Edwards, Jr., Assistant Director (202/452-2741), Robert E. Motyka,
Supervisory Financial Analyst (202/452-3621), or Nancy J. Rawlings,
Senior Financial Analyst (202/452-3059), Division of Banking
Supervision and Regulation, Board of Governors of the Federal Reserve
System. For the hearing impaired only, Telecommunication Device for the
Deaf (TDD), Dorothea Thompson (202/452-3544), Board of Governors of the
Federal Reserve System, 20th & C Street, NW., Washington, DC 20551.
Introduction and Overview
This is the fourth annual report\1\ on the differences in capital
standards and accounting practices that currently exist among the three
banking agencies (the Board of Governors of the Federal Reserve System
(FRB), the Office of the Comptroller of the Currency (OCC), and the
Federal Deposit Insurance Corporation (FDIC)) and the Office of Thrift
Supervision (OTS).\2\ Section One of the report focuses on differences
in the agencies' capital standards; Section Two discusses differences
in accounting standards. The remainder of this introduction provides an
overview of the discussion contained in these sections.
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\1\ The first two reports prepared by the Federal Reserve Board
were made pursuant to section 1215 of the Financial Institutions
Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The third
report was made pursuant to section 121 of the Federal Deposit
Insurance Corporation Improvement Act of 1991 (FDICIA), which
superseded section 1215 of FIRREA.
\2\ At the federal level, the Federal Reserve System has primary
supervisory responsibility for state-chartered banks that are
members of the Federal Reserve System as well as all bank holding
companies. The FDIC has primary responsibility for state nonmember
banks and FDIC-supervised savings banks. National banks are
supervised by the OCC. The OTS has primary responsibility for
savings and loan associations.
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Capital Standards
As stated in the previous reports to the Congress, the three bank
regulatory agencies have, for a number of years, employed a common
regulatory framework that establishes minimum capital adequacy ratios
for commercial banking organizations. In 1989, all three banking
agencies as well as the OTS, adopted a risk-based capital framework
that was based upon the international capital accord developed by the
Basle Committee on Banking Regulations and Supervisory Practices (Basle
Accord) and endorsed by the central bank governors of the G-10
countries.
The risk-based capital framework establishes minimum ratios of
total and Tier 1 (core) capital to risk-weighted assets. The Basle
Accord requires banking organizations to have total capital equal to at
least 8 percent, and Tier 1 capital equal to at least 4 percent, of
risk-weighted assets after a phase-in period which ended on December
31, 1992. Tier 1 capital is principally comprised of common
shareholders' equity and qualifying perpetual preferred stock, less
disallowed intangibles such as goodwill. The other component of total
capital, Tier 2, may include certain supplementary capital items, such
as general loan loss reserves and subordinated debt. The risk-based
capital requirements are viewed by the three banking agencies and the
OTS as minimum standards, and most institutions are expected to, and
generally do, maintain capital levels well above the minimums.
In addition to specifying identical ratios, the risk-based capital
framework implemented by the three banking agencies includes a common
definition of regulatory capital and a uniform system of risk weights
and categories. While the minimum standards and risk weighting
framework are common to all the banking agencies, there are some
technical differences in language and interpretation among the
agencies. The OTS employs a similar risk-based capital framework
although it differs in some respects from that adopted by the three
banking agencies. These differences, as well as other technical
differences in the agencies' capital standards, are discussed in
Section One of this report.
In addition to the risk-based capital requirements, the agencies
also have established leverage standards setting forth minimum ratios
of capital to total assets. As discussed in Section One, the three
banking agencies employ uniform leverage standards, while the OTS has
established, pursuant to FIRREA, somewhat different standards.
The staffs of the agencies meet regularly to identify and address
differences and inconsistencies in their capital standards. The
agencies are committed to continuing this process in an effort to
achieve full uniformity in their capital standards. In this regard,
Section One contains discussions of the banking agencies' efforts
during the past year to achieve uniformity with respect to the risk
categories of certain assets, specifically, identifiable intangible
assets, loans to finance construction of 1- to 4-family residential
homes that have been pre-sold, and multifamily housing loans. In
addition, the agencies have worked together to revise the risk-based
capital requirements as required by provisions of section 305 of FDICIA
to take account of interest rate risk and risks arising from
concentrations of credit and nontraditional activities. Finally, staffs
of the agencies have been meeting in 1993 to discuss a uniform draft
proposal that would amend their risk-based capital guidelines to
provide for recognition of bilateral netting arrangements associated
with rate contracts that genuinely reduce credit risk.
Accounting Standards
Over the years, the three banking agencies, under the auspices of
the Federal Financial Institutions Examination Council (FFIEC), have
developed Uniform Reports of Condition and Income (Call Reports) for
all commercial banks and FDIC-supervised savings banks. The reporting
standards followed by the three banking agencies are substantially
consistent, aside from a few limited exceptions, with generally
accepted accounting principles (GAAP) as they are applied by commercial
banks.\3\ The uniform bank Call Report serves as the basis for
calculating risk-based capital and leverage ratios, as well as for
other regulatory purposes. Thus, material differences in regulatory
accounting and reporting standards among commercial banks and FDIC-
supervised savings banks do not exist.
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\3\ In those cases where bank Call Report standards are
different from GAAP, the regulatory reporting requirements are
intended to be more conservative than GAAP.
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The OTS requires each thrift institution to file the Thrift
Financial Report (TFR), which is consistent with GAAP as it is applied
by thrifts. The TFR differs in some respects from the bank Call Report.
One reason is that thrift GAAP is different in a few limited areas from
GAAP as it is applied by banks; another, as previously mentioned, is
that there are a few minor areas in which the bank Call Report departs
from bank GAAP. A summary of the differences between the bank Call
Report and the TFR is presented in Section Two.
Over the past year, the three banking agencies and the OTS have
continued to undertake projects that seek to simplify and reduce
differences in reporting standards between commercial banks and thrift
institutions. On June 10, 1993, the four agencies announced six
initiatives to implement the President's March 10 program to improve
the availability of credit to businesses and individuals. These
initiatives included changes to regulatory reporting requirements, all
of which are consistent with GAAP. In this respect, the agencies
separately issued guidance to banks and thrifts that generally conforms
regulatory reporting requirements for sales of Other Real Estate Owned
(OREO) with GAAP, as set forth in FASB Statement No. 66. These changes
generally eliminated a 10 percent minimum down payment requirement
needed by the borrower/purchaser to record a sale of OREO for
regulatory reporting purposes. In addition, as part of these
initiatives, the agencies issued joint policies on restoring nonaccrual
loans to performing status and improving the reporting guidance on
insubstance foreclosures.
Although these actions end the first phase of the President's
credit availability program, the agencies are continuing efforts to
reduce paperwork and regulatory burdens. These efforts include
considering the remaining few differences between GAAP and regulatory
accounting principles. In this regard, the agencies now have projects
under way that are to refine and improve policies and addresses a few
differences that currently exist among the agencies, including projects
on recourse, netting, and hedging.
Section One
Differences In Capital Standards Among Federal Banking and Thrift
Supervisory Agencies
Leverage capital ratios
The three banking agencies employ a leverage standard based upon
the common definition of Tier 1 capital contained in their risk-based
capital guidelines. These standards, established in the second half of
1990 and in early 1991, require the most highly-rated institutions to
meet a minimum Tier 1 capital ratio of 3 percent. For all other
institutions, these standards generally require an additional cushion
of at least 100 to 200 basis points, i.e., a minimum leverage ratio of
at least 4 to 5 percent, depending upon an organization's financial
condition.
As required by FIRREA, the OTS has established a 3 percent core
capital ratio and a 1.5 percent tangible capital leverage requirement
for thrift institutions. However, the OTS is in the process of
finalizing a new leverage rule that will generally conform to the rules
of the three banking agencies. The differences that will exist after
the OTS has adopted its new standard pertain to the definition of core
capital. While this definition generally conforms to Tier 1 bank
capital, certainadjustments discussed below apply to the core capital
definition used by savings associations. In addition, core capital as
currently defined by the OTS includes qualifying supervisory goodwill.
Such goodwill is to be phased out of thrift core capital by the end of
1994, after which time the treatment of goodwill for thrift
institutions will be consistent with that of the banking agencies.
Risk-based capital ratios
The three banking agencies have adopted risk-based capital
standards consistent with the Basle Accord. These standards, which were
fully phased in at the end of 1992, require all commercial banking
organizations to maintain a minimum ratio of total capital (Tier 1 plus
Tier 2) to risk-weighted assets of 8 percent. Tier 1 capital comprises
common stockholders' equity, qualifying perpetual preferred stock, and
minority interests in consolidated subsidiaries, less goodwill. Tier 1
capital must comprise at least 50 percent of the total risk-based
capital requirement. Tier 2 capital includes such components as general
loan loss reserves, subordinated term debt, and certain other preferred
stock and convertible debt capital instruments, subject to appropriate
limitations and conditions. Risk-weighted assets are calculated by
assigning risk weights of 0, 20, 50, and 100 percent to broad
categories of assets and off-balance sheet items based upon their
relative credit risks. The OTS has adopted a risk-based capital
standard that in most respects is similar to the framework adopted by
the banking agencies. Beginning with year-end 1992, the OTS standard
requires a minimum risk-based capital ratio equal to 8 percent.
All the banking agencies view the risk-based capital standard as a
minimum supervisory benchmark. In part, this is because the risk-based
capital standard focuses primarily on credit risk; it does not take
full or explicit account of certain other banking risks, such as
exposure to changes in interest rates. The full range of risks to which
depository institutions are exposed are reviewed and evaluated
carefully during on-site examinations. In view of these risks, most
banking organizations are expected to operate with capital levels well
above the minimum risk-based and leverage capital requirements.
The Federal Reserve has for some time been working with the other
U.S. banking agencies and the regulatory authorities on the Basle
Supervisors' Committee to develop possible methods to measure and
address certain market and price risks. In April, 1993, the Basle
Supervisors' Committee issued a consultative paper that addresses,
among other items, proposals to include certain risks into the
framework of the Basle Accord. These risks include exposures resulting
from imbalances between the maturity of debt instruments held as assets
and issued as liabilities and holdings of traded debt and equity
securities. One important reason for addressing these risks on an
international level is to develop supervisory approaches that do not
undermine the competitiveness of U.S. banking organizations.
Notwithstanding this initial effort, the OTS capital standards for
some time have taken into account interest rate risk and the FRB, OCC
and FDIC sought public comment on a proposed framework for
incorporating into their capital standards interest rate risk in
August, 1992, as required under section 305 of FDICIA. In response to
concerns raised and recommendations made by commenters, on September
14, 1993, the three banking agencies issued for public comment a
substantially modified proposal on interest rate risk. The approach
ultimately adopted by the banking agencies could differ from that
already taken by the OTS.
Section 305 of FDICIA also requires the banking agencies to amend
their risk-based capital rules to take account of concentrations of
credit risk and nontraditional activities. During 1993 the staffs of
the four agencies met regularly to draft proposals for public
consideration. Final proposals are expected to be issued in the first
part of 1994.
In addition to coordinating their efforts to implement section 305,
the agencies also worked together to eliminate differences in their
capital standards, as well as to revise their standards in response to
legislative mandates, accounting changes, and industry concerns. In
this regard, during 1993, the three banking agencies eliminated the
principal difference in their capital standards when they issued final
rules revising those standards with regard to the types of intangible
assets that may be included in the Tier 1 capital calculation for risk-
based and leverage capital purposes. Specifically, under these final
rules, banking organizations may include in capital purchased mortgage
servicing rights (PMSRs) and purchased credit card relationships
(PCCRs), but are required to deduct from capital core deposit
intangibles (CDIs) and other identifiable intangible assets. The final
rule also included limits and discounts that are applicable to PMSRs
and PCCRs in capital. The OTS draft final rule, which is consistent
with the final rule issued by the other agencies, is currently under
review.
Another difference the federal banking agencies worked to eliminate
during 1993 was the risk-based capital treatment of multifamily housing
loans. While the three banking agencies assign multifamily housing
loans (5 units or more) to the 100 percent risk category, the OTS
allows certain multifamily mortgage loans to qualify for the 50 percent
risk category. This would apply, for example, to loans secured by
buildings with 5-36 units (as described below). This effort was
undertaken pursuant to section 618 of the Resolution Trust Corporation
Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRIA),
which requires the agencies to lower the risk weight for multifamily
housing loans meeting certain criteria from 100 to 50 percent. At the
time of this report, final rules have not been issued by the agencies,
although it is anticipated that they will be uniform and will be issued
in the very near future.
Section 618 of the RTCRRIA also required the agencies to revise
their risk-based capital guidelines to lower from 100 percent to 50
percent the risk category for certain construction loans for presold 1-
to 4-family residential properties. During 1993, the four agencies
issued similar final rules implementing this provision of section 618.
The staffs of the four agencies also have been coordinating the
issuance of uniform proposals to include in Tier 1 capital the net
unrealized changes in value of securities available for sale for
purposes of calculating the risk-based and leverage capital ratios of
banking organizations. This proposal effectively would result in the
adoption, for regulatory capital purposes, of the Financial Accounting
Standards Board (FASB) Statement of Financial Accountant Standards No.
115 (FASB 115), ``Accounting for Certain Investments in Debt and Equity
Securities.'' It is expected that the agencies will issue proposals for
public comment in the very near term.
In response to industry recommendations, and in conjunction with
the Basle Supervisors' Committee consultative paper issued in April,
1993, the staffs of the four agencies have been meeting to draft
uniform rules which would amend their risk-based capital standards with
regard to bilateral netting arrangements. Specifically, the proposals
would seek public comment on whether to recognize for risk-based
capital purposes bilateral netting arrangements associated with
interest and foreign exchange rate contracts. Such netting arrangements
would have to genuinely reduce credit risk and be enforceable in all
relevant jurisdictions as evidenced by well-founded and reasoned legal
opinions. It is anticipated that the agencies will issue proposals on
this matter early in 1994.
Differences among the risk-based capital standards of the OTS and
the three banking agencies are discussed below.
Certain collateralized transactions
On December 23, 1992, the Federal Reserve Board issued, after an
appropriate public comment period, an amendment to its risk-based and
leverage capital guidelines for state member banks and bank holding
companies that lowers from 20 to 0 percent the risk category for
collateralized transactions meeting certain criteria. This preferential
treatment is only available for claims collateralized by cash on
deposit in the bank or by securities issued or guaranteed by OECD
central governments or U.S. government agencies. In addition, a
positive margin of collateral must be maintained on a daily basis fully
taking into account any change in the banking organization's exposure
to the obligor or counterparty under a claim in relation to the market
value of the collateral held in support of that claim.
The OCC, on August 18, 1993, issued a proposal for public comment
that would also lower the risk weight for certain collateralized
transactions. The FDIC and OTS are considering similar proposals.
Equity investments
In general, commercial banks that are members of the Federal
Reserve System are not permitted to invest in equity securities, nor
are they generally permitted to engage in real estate investment or
development activities. To the extent that commercial banks are
permitted to hold equity securities (for example, in connection with
debts previously contracted), the three banking agencies generally
assign such investments to the 100 percent risk category for risk-based
capital purposes.
Under the three banking agencies' rules, the agencies may, on a
case-by-case basis, deduct equity investments from the parent bank's
capital or make other adjustments, if necessary, to assess an
appropriate capital charge above the minimum requirement. The banking
agencies' treatment of investments in subsidiaries is discussed below.
The OTS risk-based capital standards require that thrift
institutions deduct certain equity investments from capital over a
phase-in period, which ends on July 1, 1994, as explained more fully
below in the section on subsidiaries.
FSLIC/FDIC - covered assets (assets subject to guarantee arrangements
by the FSLIC or FDIC)
The three banking agencies generally place these assets in the 20
percent risk category, the same category to which claims on depository
institutions and government-sponsored agencies are assigned.
The OTS places these assets in the zero percent risk category.
Limitation on subordinated debt and limited-life preferred stock
Consistent with the Basle Accord, the three banking agencies limit
the amount of subordinated debt and limited-life preferred stock that
may be included in Tier 2 capital. This limit, in effect, states that
these components together may not exceed 50 percent of Tier 1 capital.
In addition, maturing capital instruments must be discounted by 20
percent in each of the last five years prior to maturity.
Neither of these capital components is a permanent source of funds,
and subordinate debt cannot absorb losses while the bank continues to
operate as a going-concern. On the other hand, both components can
provide a cushion of protection to the FDIC insurance fund. Thus, this
limitation permits the inclusion of some subordinated debt in capital,
while assuring that permanent stockholders' equity capital remains the
predominant element in bank regulatory capital.
The OTS has no limitation on the total amount of limited-life
preferred stock or maturing capital instruments that may be included
within Tier 2 capital. In addition, the OTS allows thrifts the option
of: (1) discounting maturing capital instruments, issued on or after
November 7, 1989, by 20 percent a year over the last 5 years of their
term -- the approach required by the banking agencies; or (2) including
the full amount of such instruments provided that the amount maturing
in any of the next seven years does not exceed 20 percent of the
thrift's total capital.
Subsidiaries
Consistent with the Basle Accord and long-standing supervisory
practices, the three banking agencies generally consolidate all
significant majority-owned subsidiaries of the parent organization for
capital purposes. This consolidation assures that the capital
requirements are related to all of the risks to which the banking
organization is exposed.
As with most other bank subsidiaries, banking and finance
subsidiaries generally are consolidated for regulatory capital
purposes. However, in cases where banking and finance subsidiaries are
not consolidated, the Federal Reserve, consistent with the Basle
Accord, generally deducts investments in such subsidiaries in
determining the adequacy of the parent bank's capital.
The Federal Reserve's risk-based capital guidelines provide a
degree of flexibility in the capital treatment of unconsolidated
subsidiaries (other than banking and finance subsidiaries) and
investments in joint ventures and associated companies. For example,
the Federal Reserve may deduct investments in such subsidiaries from an
organization's capital, may apply an appropriate risk-weighted capital
charge against the proportionate share of the assets of the entity, may
require a line-by-line consolidation of the entity, or otherwise may
require that the parent organization maintain a level of capital above
the minimum standard that is sufficient to compensate for any risks
associated with the investment.
The guidelines also permit the deduction of investments in
subsidiaries that, while consolidated for accounting purposes, are not
consolidated for certain specified supervisory or regulatory purposes.
For example, the Federal Reserve deducts investments in, and unsecured
advances to, Section 20 securities subsidiaries from the parent bank
holding company's capital. The FDIC accords similar treatment to
securities subsidiaries of state nonmember banks established pursuant
to Section 337.4 of the FDIC regulations.
Similarly, in accordance with Section 325.5(f) of the FDIC
regulations, a state nonmember bank must deduct investments in, and
extensions of credit to, certain mortgage banking subsidiaries in
computing the parent bank's capital. (The Federal Reserve does not have
a similar requirement with regard to mortgage banking subsidiaries. The
OCC does not have requirements dealing specifically with the capital
treatment of either mortgage banking or securities subsidiaries. The
OCC, however, does reserve the right to require a national bank, on a
case-by-case basis, to deduct from capital investments in, and
extensions of credit to, any nonbanking subsidiary.)
The deduction of investments in subsidiaries from the parent's
capital is designed to ensure that the capital supporting the
subsidiary is not also used as the basis of further leveraging and
risk-taking by the parent banking organization. In deducting
investments in, and advances to, certain subsidiaries from the parent's
capital, the Federal Reserve expects the parent banking organization to
meet or exceed minimum regulatory capital standards without reliance on
the capital invested in the particular subsidiary. In assessing the
overall capital adequacy of banking organizations, the Federal Reserve
may also consider the organization's fully consolidated capital
position.
Under the OTS capital guidelines, a distinction, mandated by
FIRREA, is drawn between subsidiaries that are engaged in activities
that are permissible for national banks and subsidiaries that are
engaged in ``impermissible'' activities for national banks.
Subsidiaries of thrift institutions that engage only in permissible
activities are consolidated on a line-by-line basis if majority-owned
and on a pro rata basis if ownership is between 5 percent and 50
percent. As a general rule, investments, including loans, in
subsidiaries that engage in impermissible activities are deducted in
determining the capital adequacy of the parent. However, investments,
including loans, outstanding as of April 12, 1989, to subsidiaries that
were engaged in impermissible activities prior to that date are
grandfathered and will be phased-out of capital over a transition
period that expires on July 1, 1994. During this transition period,
investments in subsidiaries engaged in impermissible activities that
have not been phased-out of capital are to be consolidated on a pro
rata basis.
Qualifying multifamily mortgage loans
The three banking agencies currently place multifamily mortgage
loans (five units or more) in the 100 percent risk weight category.
Historically, when compared to loans secured by mortgages on 1- to 4-
family residences, which generally are assigned to the 50 percent risk
category, the credit risk associated with multifamily mortgage loans,
unless conservatively underwritten and seasoned, is more akin to that
experienced on commercial property loans, which are assigned to the 100
percent risk category. The OTS allows certain multifamily mortgage
loans to qualify for the 50 percent risk category. This would apply,
for example, to loans secured by buildings with 5-36 units, provided
these loans have a maximum 80 percent loan-to-value ratio and an 80
percent occupancy rate.
Pursuant to Section 618(b) of the RTCRRIA, the three banking
agencies and the OTS were directed to amend their risk-based capital
guidelines to lower the risk weight of certain multifamily housing
loans, and securities backed by such loans, from 100 percent to 50
percent. The section specifies several criteria that a multifamily
housing loan must satisfy in order to qualify for a 50 percent risk
weight. These criteria are:
(1) The loan is secured by a first lien;
(2) The ratio of the principal obligation to the appraised value of
the property, that is, the loan-to-value ratio, does not exceed 80
percent (75 percent if the loan is based on a floating interest rate);
(3) The annual net operating income generated by the property
(before debt service) is not less than 120 percent of the annual debt
service on the loan (115 percent if the loan is based on a floating
interest rate);
(4) The amortization of principal and interest occurs over a period
of not more than 30 years and the minimum maturity for repayment of
principal is not less than seven years; and
(5) All principal and interest payments have been made on time for
a period of not less than one year.
In addition, Section 618(b) also provides that multifamily housing
loans accorded a 50 percent risk weight must meet any underwriting
characteristics that the appropriate Federal banking agency may
establish, consistent with the purposes of the minimum acceptable
capital requirements to maintain the safety and soundness of financial
institutions.
The agencies have proposed revisions to their capital standards to
meet the requirement of section 618(b). It is anticipated that final
rules implementing section 618(b) will be issued by the respective
agencies in the very near future.
Nonresidential construction and land loans
The three banking agencies assign loans for real estate development
and construction purposes to the 100 percent risk category. Reserves or
charge-offs are required, in accordance with examiner judgment, when
weaknesses or losses develop in such loans. The banking agencies have
no requirement for an automatic charge-off when the amount of a loan
exceeds the fair value of the property pledged as collateral for the
loan.
The OTS generally assigns these loans to the 100 percent risk
category. However, if the amount of the loan exceeds 80 percent of the
fair value of the property, that excess portion must be deducted from
capital in accordance with a phase-in arrangement, which ends on July
1, 1994.
Mortgage-backed securities (MBS)
The three banking agencies, in general, place privately-issued MBSs
in a risk category appropriate to the underlying assets but in no case
to the zero percent risk category. In the case of privately-issued MBSs
where the direct underlying assets are mortgages, this treatment
generally results in a risk weight of 50 percent or 100 percent.
Privately-issued MBSs that have government agency or government-
sponsored agency securities as their direct underlying assets are
generally assigned to the 20 percent risk category.
The OTS assigns privately-issued high quality mortgage-related
securities to the 20 percent risk category. These are, generally,
privately-issued MBSs with AA or better investment ratings.
At the same time, both the banking and thrift agencies
automatically assign to the 100 percent risk weight category certain
MBSs, including interest-only strips, residuals, and similar
instruments that can absorb more than their pro rata share of loss. The
Federal Reserve, in conjunction with the other banking agencies and the
OTS, issued, on January 10, 1992, more specific guidance as to the
types of ``high risk'' MBSs that will qualify for a 100 percent risk
weight.
Assets sold with recourse
In general, recourse arrangements allow the purchaser of an asset
to ``put'' the asset back to the originating institution under certain
circumstances, for example if the asset ceases to perform
satisfactorily. This, in turn, can expose the originating institution
to any loss associated with the asset. As a general rule, the three
banking agencies require that sales of assets involving any recourse to
be reported as financings and that the assets be retained on the
balance sheet. This effectively requires a full leverage and risk-based
capital charge whenever assets are sold with recourse, including
limited recourse. The Federal Reserve generally applies a capital
charge to any off-balance sheet recourse arrangement that is the
equivalent of a guarantee, regardless of the nature of the transaction
that gives rise to the recourse obligation.
An exception to this general rule involves pools of 1- to 4-family
residential mortgages and to certain farm mortgage loans. Certain
recourse transactions involving these assets are reported in the bank
Call Report as sales, thereby removing these transactions from leverage
ratio calculations. These transactions, which are the equivalent of
off-balance sheet guarantees, involve the type of credit risk that is
addressed by bank risk-based capital requirements, although some
questions in this regard have been raised because of the treatment
afforded these transactions for leverage purposes. The Federal Reserve
has clarified its risk-based capital guidelines to ensure that recourse
sales involving residential mortgages are to be taken into account for
determining compliance with risk-based capital requirements. The FDIC
clarified its guidelines on this matter in 1993.
In general, the OTS also requires a full capital charge against
assets sold with recourse. However, in the case of limited recourse,
the OTS limits the capital charge to the lesser of the amount of
recourse or the actual amount of capital that would otherwise be
required against that asset, that is, the normal full capital charge.
Some securitized asset arrangements involve the issuance of senior
and subordinated classes of securities against pools of assets. When a
bank originates such a transaction by placing loans that it owns in a
trust and retaining any portion of the subordinated securities, the
banking agencies require that capital be maintained against the entire
amount of the asset pool. When a bank acquires a subordinated security
in a pool of assets that it did not originate, the banking agencies
assign the investment in the subordinated piece to the 100 percent
risk-weight category. The Federal Reserve carefully reviews these
instruments to determine if additional reserves, asset write-downs, or
capital are necessary to protect the bank.
The OTS requires that capital be maintained against the entire
amount of the asset pool in both of the situations described in the
preceding paragraph. Additionally, the OTS applies a capital charge to
the full amount of assets being serviced when the servicer is required
to absorb credit losses on the assets being serviced.
In 1990, the three banking agencies and the OTS, under the FFIEC,
issued for public comment a fact finding paper pertaining to the wide
range of issues relating to recourse arrangements. These issues include
the definition of ``recourse'' and the appropriate reporting and
capital treatments to be applied to recourse arrangements, as well as
so-called recourse servicing arrangements and limited recourse. The
objective of this effort was to develop a comprehensive and uniform
approach to recourse arrangements for capital adequacy, reporting, and
other regulatory purposes. The comments received were very extensive
and generally illustrated the extreme complexity of the subject. In
view of the project's significance and complexity, the FFIEC in
December 1990 decided to narrow the scope of the initial phase of the
recourse project to credit-related risks, including the appropriate
treatment of credit-related recourse arrangements that involve limited
recourse or that support a third party's assets.
A recourse working group, composed of representatives from the
member agencies of the FFIEC, presented a report and recommendations to
the FFIEC in August 1992 and were directed to carry out a study of the
impact of their recommendations on depository institutions, financial
markets, and other affected parties. The interagency group carried out
this study in early 1993. As a result of that study, the working group
has revised several of their recommendations to reflect market
practice. Proposals for public comment are expected to be issued
shortly.
Agricultural loan loss amortization
In the computation of regulatory capital, those banks accepted into
the agricultural loan loss amortization program pursuant to Title VIII
of the Competitive Equality Banking Act of 1987 are permitted to defer
and amortize losses incurred on agricultural loans between January 1,
1984 and December 31, 1991. The program also applies to losses incurred
between January 1, 1983 and December 31, 1991, as a result of
reappraisals and sales of agricultural Other Real Estate Owned (OREO)
and agricultural personal property. These loans must be fully amortized
over a period not to exceed seven years and, in any case, must be fully
amortized by year-end 1998. Thrifts are not eligible to participate in
the agricultural loan loss amortization program established by this
statute.
Treatment of junior liens on 1- to 4-family properties
In some cases, a banking organization may make two loans on a
single residential property, one loan secured by a first lien, the
other by a second lien. In such a situation, the Federal Reserve views
these two transactions as a single loan, provided there are no
intervening liens. This could result in assigning the total amount of
these transactions to the 100 percent risk weight category, if, in the
aggregate, the two loans exceeded a prudent loan-to-value ratio and,
therefore, did not qualify for the 50 percent risk weight. This
approach is intended to avoid possible circumvention of the capital
requirements and capture the risks associated with the combined
transactions.
The FDIC, OCC, and the OTS generally assign the loan secured by the
first lien to the 50 percent risk-weight category and the loan secured
by the second lien to the 100 percent risk-weight category.
Pledged deposits and nonwithdrawable accounts
The capital guidelines of OTS permit thrift institutions to include
in capital certain pledged deposits and nonwithdrawable accounts that
meet the criteria of the OTS. Income Capital Certificates and Mutual
Capital Certificates held by the OTS may also be included in capital by
thrift institutions. These instruments are not relevant to commercial
banks, and, therefore, they are not addressed in the three banking
agencies' capital guidelines.
Mutual Funds
The three banking agencies assign all of a bank's holdings in a
mutual fund to the risk category appropriate to the highest risk asset
that a particular mutual fund is permitted to hold under its operating
rules. The purpose of this is to take into account the maximum degree
of risk to which a bank may be exposed when investing in a mutual fund
in view of the fact that the future composition and risk
characteristics of the fund's holding cannot be known in advance.
The OTS applies a capital charge appropriate to the riskiest asset
that a mutual fund is actually holding at a particular time. In
addition, the OTS guidelines also permit, on a case-by-case basis,
investments in mutual funds to be allocated on a pro rata basis in a
manner consistent with the actual composition of the mutual fund.
Section Two
Differences In Accounting Standards Among Federal Banking and
Thrift Supervisory Agencies
Under the auspices of the FFIEC, the three banking agencies have
developed uniform reporting standards for commercial banks which are
used in the preparation of the Call Report. The FDIC has also applied
these uniform Call Report standards to savings banks under its
supervision. The income statement and balance sheet accounts presented
in the Call Report are used by the bank supervisory agencies for
determining the capital adequacy of banks and for other regulatory,
supervisory, surveillance, analytical, and general statistical
purposes.
Section 121 of FDICIA requires accounting principles applicable to
financial reports (including the Call Report) filed by federally
insured depository institutions with a federal banking agency to be
uniform and consistent with generally accepted accounting principles
(GAAP). However, under Section 121, a federal banking agency may
require institutions to use accounting principles ``no less stringent
than GAAP'' when the agency determines that a specific accounting
standard under GAAP does not meet these new accounting objectives. The
banking agencies believe that GAAP generally satisfies the three
accounting objectives included in FDICIA Section 121. The three
accounting objectives in FDICIA Section 121 mandate that accounting
principles should:
1. Result in financial statements and reports of condition that
accurately reflect the institution's capital;
2. Facilitate effective supervision of depository institutions; and
3. Facilitate prompt corrective action at least cost to the
insurance funds.
As indicated above, Section 121 of FDICIA requires the Federal
Reserve and the other federal banking agencies to utilize accounting
principles for regulatory reports that are consistent with GAAP or are
no less stringent than GAAP. The reporting instructions for Call
Reports that are required by the three banking agencies are
substantially consistent, aside from a few limited exceptions, with
GAAP as applied by commercial banks. As a matter of policy, the
regulatory reporting instructions for Call Reports deviate from GAAP
only in those instances where statutory requirements or overriding
supervisory concerns warrant a departure from GAAP. Furthermore, in
those cases where accounting principles applicable to bank Call Reports
are different from GAAP, the regulatory accounting principles are
intended to be more conservative than GAAP. Thus, the accounting
principles that are followed for regulatory reporting purposes are
consistent with the objectives and mandate of FDICIA Section 121.
The agencies have been working to limit the number of differences
between regulatory accounting principles and GAAP, however, in some
circumstances differences will exist when there is a need to address
supervisory concerns. In addition, the agencies have been working
closely to coordinate any new accounting policies, to ensure
consistency among the agencies and to reduce or eliminate differences
with GAAP.
The OTS has developed and maintains a separate reporting system for
the thrift institutions under its supervision. The TFR is based on GAAP
as applied by thrifts, which differs in some respects from GAAP for
banks.
A summary of the primary differences in accounting principles by
the federal banking and thrift agencies for regulatory reporting
purposes are set forth below, based on a study developed on an
interagency basis:
Futures and forward contracts
The banking agencies, as a general rule, do not permit the deferral
of gains or losses by banks on futures and forwards whether or not they
are used for hedging purposes. All changes in market value of futures
and forward contracts are reported in current period income. The
banking agencies adopted this reporting standard as a supervisory
policy prior to the adoption of FASB Statement No. 80, which allows
hedge or deferral accounting, under certain circumstances. Contrary to
this general rule, hedge accounting in accordance with FASB Statement
No. 80 is permitted by the three banking agencies only for futures and
forward contracts used in mortgage banking operations.
The OTS practice is to follow FASB Statement No. 80 for futures
contracts. In accordance with this statement, when hedging criteria are
satisfied, the accounting for the futures contract is related to the
accounting for the hedged item. Changes in the market value of the
futures contract are recognized in income when the effects of related
changes in the price or interest rate of the hedged item are
recognized. Such reporting can result in deferred gains or losses which
would be reflected on the thrift's balance sheet in accordance with
GAAP.
Excess servicing fees
As a general rule, the three banking agencies do not follow GAAP
for excess servicing fees, but require a more conservative treatment.
Excess servicing results when loans are sold with servicing retained
and the stated servicing fee rate is greater than the normal servicing
fee rate. With the exception of sales of pools of first lien one-to-
four family residential mortgages for which the banking agencies'
approach is consistent with FASB Statement No. 65, excess servicing fee
income in banks must be reported as realized over the life of the
transferred asset, not recognized up front as required by FASB
Statement No. 65.
The OTS allows the present value of the future excess servicing fee
to be treated as an adjustment to the sales price for purposes of
recognizing gain or loss on the sale. This approach is consistent with
FASB Statement No. 65.
In-substance defeasance of debt
The banking agencies do not permit banks to report defeasance of
their debt obligations in accordance with FASB Statement No. 76.
Defeasance involves a debtor irrevocably placing risk-free monetary
assets in a trust solely for satisfying the debt. Under FASB Statement
No. 76, the assets in the trust and the defeased debt are removed from
the balance sheet and a gain or loss for the current period can be
recognized. However, for Call Report purposes, banks may not remove
assets or defeased liabilities from their balance sheets or recognize
resulting gains or losses. The banking agencies have not adopted FASB
Statement No. 76 because of uncertainty regarding the irrevocable
trusts established for defeasance purposes. Furthermore, defeasance
would not relieve the bank of its contractual obligation to pay
depositors or other creditors.
OTS practice is to follow FASB Statement No. 76.
Sales of assets with recourse
In accordance with FASB Statement No. 77, a transfer of receivables
with recourse is recognized as a sale if:
(1) The transferor surrenders control of the future economic
benefits,
(2) The transferor's obligation under the recourse provisions can
be reasonably estimated, and
(3) The transferee cannot require repurchase of the receivables
except pursuant to the recourse provisions.
The practice of the three banking agencies is generally to permit
commercial banks to report transfers of receivables with recourse as
sales only when the transferring institution
(1) Retains no risk of loss from the assets transferred and
(2) Has no obligation for the payment of principal or interest on
the assets transferred.
As a result, virtually no transfers of assets with recourse can be
reported as sales. However, this rule does not apply to the transfer of
first lien 1- to 4-family residential or agricultural mortgage loans
under certain government-sponsored programs (including the Federal
National Mortgage Association and the Federal Home Loan Mortgage
Corporation). Transfers of mortgages under these programs are generally
treated as sales for Call Report purposes.
Furthermore, private transfers of first lien 1- to four- family
residential mortgages are also reported as sales if the transferring
institution retains only an insignificant risk of loss on the assets
transferred. However, the seller's obligation under recourse provisions
related to sales of mortgage loans under the government programs is
viewed as an off-balance sheet exposure. Thus, for risk-based capital
purposes, capital is generally expected to be held for recourse
obligations associated with such transactions.
The OTS policy is to follow FASB Statement No. 77. However, in the
calculation of risk-based capital under the OTS guidelines, off-balance
sheet recourse obligations generally are converted at 100 percent. This
effectively negates the sale treatment recognized on a GAAP basis for
risk-based capital purposes, but not for leverage capital purposes.
Thus, by making this adjustment in the risk-based capital calculation,
the differences between the OTS and the banking agencies for capital
adequacy measurement purposes, are substantially reduced.
The FFIEC has a study under way involving the topic of transfers of
assets with recourse (often referred to as the ``recourse study''). As
part of this study, the staff of the Federal Reserve is reviewing the
reporting treatment for sales of assets with recourse and is exploring
with the staffs of the other agencies the possibility of reducing or
eliminating the differences between regulatory reporting requirements
and GAAP in this area. A proposal addressing this issue is being
finalized for issuance for public comment in the near future.
Push-Down Accounting
When a depository institution is acquired in a purchase
transaction, but retains its separate corporate existence, the
institution is required to revalue all of the assets and liabilities at
fair value at the time of acquisition. When push-down accounting is
applied, the same revaluation made by the parent holding company is
made at the depository institution level.
The three banking agencies require push-down accounting when there
is at least a 95 percent change in ownership. This approach is
generally consistent with interpretations of the Securities and
Exchange Commission.
The OTS requires push-down accounting when there is at least a 90
percent change in ownership.
Negative Goodwill
The three banking agencies require that negative goodwill be
reported as a liability, and not be netted against goodwill assets.
Such a policy ensures that all goodwill assets are deducted in
regulatory capital calculations, consistent with the Basle Accord.
The OTS permits negative goodwill to offset goodwill assets
reported in the financial statements.
Offsetting of Amounts Related to Certain Contracts
The three banking agencies are planning to adopt FASB
Interpretation No. 39 (FIN 39) solely for on-balance sheet items
arising from off-balance sheet derivative instruments, when FIN 39
becomes effective in 1994. FIN 39 allows institutions to offset assets
and liabilities arising from traditional balance sheet items (e.g.,
loans, deposits, etc.) as well as netting assets and liabilities
arising from off-balance sheet derivative instruments only when four
conditions are met. The Call Report's existing guidance generally
prohibits netting of assets and liabilities.
The OTS policy on netting of assets and liabilities is consistent
with GAAP.
The Board staff intends to join the other agencies in a study of
the possibility of adopting FIN 39 for traditional balance sheet items
in the next year.
William W. Wiles,
Secretary of the Board.
[FR Doc. 94-648 Filed 1-10-94; 8:45 am]
BILLING CODE 6210-01-F