[Federal Register Volume 59, Number 14 (Friday, January 21, 1994)] [Unknown Section] [Page 0] From the Federal Register Online via the Government Publishing Office [www.gpo.gov] [FR Doc No: 94-1455] [[Page Unknown]] [Federal Register: January 21, 1994] ======================================================================= ----------------------------------------------------------------------- FEDERAL DEPOSIT INSURANCE CORPORATION Differences in Capital and Accounting Standards Among the Federal Banking and Thrift Agencies; Report to Congressional Committees AGENCY: Federal Deposit Insurance Corporation (FDIC). ACTION: Report to the Committee on Banking, Finance and Urban Affairs of the U.S. House of Representatives and to the Committee on Banking, Housing, and Urban Affairs of the United States Senate Regarding Differences in Capital and Accounting Standards Among the Federal Banking and Thrift Agencies. ----------------------------------------------------------------------- SUMMARY: This report has been prepared by the FDIC pursuant to Section 37(c) of the Federal Deposit Insurance Act, as added by Section 121 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA). Section 37(c) requires each Federal banking agency to report annually to the Committee on Banking, Finance and Urban Affairs of the House of Representatives and to the Committee on Banking, Housing, and Urban Affairs of the Senate any differences between any accounting or capital standard used by such agency and any accounting or capital standard used by any other such agency. The report must also contain an explanation of the reasons for any discrepancy in such accounting and capital standards and must be published in the Federal Register. FOR FURTHER INFORMATION CONTACT: Robert F. Storch, Chief, Accounting Section, Division of Supervision, Federal Deposit Insurance Corporation, 550 17th Street, NW., Washington, DC 20429, telephone (202) 898-8906. SUPPLEMENTARY INFORMATION: The text of the report follows: Report to the Committee on Banking, Finance and Urban Affairs of the U.S. House of Representatives and to the Committee on Banking, Housing, and Urban Affairs of the United States Senate, Regarding Differences in Capital and Accounting Standards Among the Federal Banking and Thrift Agencies Introduction This report has been prepared by the Federal Deposit Insurance Corporation (FDIC) pursuant to Section 37(c) of the Federal Deposit Insurance Act, as added by Section 121 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which reads as follows: (1) ANNUAL REPORTS REQUIRED.--Each appropriate Federal banking agency shall annually submit a report to the Committee on Banking, Finance and Urban Affairs of the House of Representatives and the Committee on Banking, Housing, and Urban Affairs of the Senate containing a description of any difference between any accounting or capital standard used by such agency and any accounting or capital standard used by any other agency. (2) EXPLANATION OF REASONS FOR DISCREPANCY.--Each report * * * shall contain an explanation of the reasons for any discrepancy between any accounting or capital standard used by such agency and any accounting or capital standard used by any other agency. (3) PUBLICATION.--Each report * * * shall be published in the Federal Register. This introduction is followed by a discussion of the capital and underlying accounting and reporting standards employed by the FDIC as well as the two other federal banking agencies, the Board of Governors of the Federal Reserve System (FRB) and the Office of the Comptroller of the Currency (OCC), and the federal thrift supervisor, the Office of Thrift Supervision (OTS). Appendix One lists the differences in the capital standards among the FDIC, FRB, OCC and OTS as well as the reasons for these discrepancies. Appendix Two contains the differences in accounting and reporting standards among the banking and thrift agencies. Capital Standards The three banking agencies have implemented a common regulatory framework that sets forth two minimum capital standards--a minimum leverage capital requirement and a minimum risk-based capital requirement. In addition to common minimum standards, the definitions of capital used by the banking agencies have generally been consistent with the exception of certain differences in the treatment of intangible assets. However, during late 1992 and 1993, the banking agencies amended their capital definitions to incorporate a uniform approach to the regulatory capital treatment of identifiable intangible assets. While the OTS participated in the development of this uniform approach, that agency has not yet adopted comparable amendments to its capital standards. The leverage and risk-based capital requirements only represent minimum standards and the FDIC generally expects the banks that it supervises to maintain capital levels well above these minimums, particularly banks that are expanding or experiencing unusual or high levels of risk. Several sections of FDICIA require the banking agencies and the OTS to more specifically incorporate capital standards into the supervision and regulation of insured depository institutions. During 1993, the FDIC has continued to work with the other agencies toward the completion of the capital-related rules mandated by FDICIA, including the requirement under Section 305 that the risk-based capital standards take account of interest rate risk as well as concentration of credit risk and the risks of nontraditional activities. In June 1993, the FDIC approved revisions to its ``transitional'' risk-related insurance assessment system, thereby creating the ``final'' system required by Section 302. Both the ``transitional'' and ``final'' risk-related insurance systems use capital categories to differentiate among institutions. In December 1992, the Federal Financial Institutions Examination Council (FFIEC) concluded that, for regulatory reporting purposes, banks and thrifts should report applicable income taxes in accordance with Financial Accounting Standards Board Statement No. 109, ``Accounting for Income Taxes'' (FASB 109). The FFIEC also recommended to the banking agencies and to the OTS that they amend their capital standards to limit the amount of deferred tax assets recorded under FASB 109 that can be used to meet leverage and risk-based capital requirements. More specifically, the FFIEC recommended that deferred tax assets whose realization is dependent on an institution's future taxable income should be limited for regulatory capital purposes to the amount that can be realized within one year or ten percent of Tier 1 capital, whichever is less. The FDIC and FRB issued proposed amendments to their leverage and risk-based capital standards that would incorporate the recommended limitation on deferred tax assets during the first half of 1993. The OCC's proposed amendment is expected to be published shortly. Adoption of final rules by the banking agencies is anticipated during 1994. The OTS has already imposed this deferred tax asset limitation on thrift institutions. Another recently issued accounting standard, Financial Accounting Standards Board Statement No. 115, ``Accounting for Certain Investments in Debt and Equity Securities'' (FASB 115), which generally takes effect in 1994 (unless an institution elects to adopt this standard in 1993), has created the need for the agencies to revise their definitions of capital for leverage and risk-based capital purposes. Under FASB 115, debt and equity securities which are deemed to be ``available-for-sale'' must be carried at fair value (generally, market value) for balance sheet purposes. Net unrealized holding gains and losses on available-for-sale securities are reported as a separate component of stockholders' equity. The FFIEC announced in August 1993 that insured banks and thrifts must adopt FASB 115 for regulatory reporting purposes and indicated that the banking agencies and the OTS would be requesting comment on whether the new FASB 115 stockholders' equity component for net unrealized holding gains and losses on available-for-sale securities should be included in Tier 1 capital for leverage and risk-based capital purposes. The Board of Directors of the FDIC approved the publication of this proposal for a 30-day public comment period in December 1993. Similar proposals by the other agencies are also nearing publication. Leverage Capital Requirement The banking agencies have since 1985 employed a capital requirement that establishes a minimum ratio of capital as a percent of total assets (leverage ratio). The FDIC substantially revised its minimum leverage capital requirement for state nonmember banks in February 1991. This revised leverage requirement relies on a single narrow definition of capital that is based solely on Tier 1 (or core) capital. In most instances, a bank's Tier 1 capital is equal to the amount of its common equity capital minus certain intangible assets such as goodwill. Under the leverage capital rule, the most highly-rated banks in terms of safe and sound operation (i.e., those rated a composite ``1'' under the CAMEL system used by the three federal banking agencies) that are not anticipating or experiencing significant growth are required to meet a minimum Tier 1 leverage capital ratio of at least 3 percent. All other state nonmember banks are required to meet a minimum Tier 1 leverage capital ratio of at least 100 to 200 basis points above the 3 percent level--that is, an absolute minimum leverage ratio of at least 4 percent. Similar leverage capital requirements have been adopted by the OCC for national banks and by the FRB for state member banks and bank holding companies. As initially required by the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), the OTS that year adopted a 1.5 percent tangible and a 3 percent core capital to total assets leverage standard. However, also consistent with FIRREA, the OTS is continuing its efforts to revise this 3 percent core leverage capital requirement for savings associations so that its minimum leverage capital standard will be at least as stringent as the leverage capital requirement that the OCC currently applies to national banks. In addition, although goodwill is generally deducted in calculating a savings association's tangible and core capital levels, the OTS allows limited amounts of grandfathered ``qualifying supervisory goodwill'' to be included in the calculation of core capital during a five-year phase-out period that expires on January 1, 1995. Risk-Based Capital Requirement In 1989, the banking agencies adopted a risk-based capital framework based upon the July 1988 Capital Accord developed by the Basle Supervisors' Committee and endorsed by the central bank governors of the G-10 countries. A transition period ended on December 31, 1992. Under the risk-based capital framework, banks are currently expected to meet a minimum ratio of total qualifying capital to risk-weighted assets of 8 percent, of which at least one-half (or four percentage points) must be comprised of Tier 1 capital. In addition to identical ratios, the risk-based framework implemented by the banking agencies generally includes a common definition of capital and a uniform system of risk weights and categories. Nevertheless, some technical differences in language and interpretation exist among the agencies' risk-based capital guidelines. As required by FIRREA, the OTS also adopted in 1989 a risk-based capital standard for savings associations that generally parallels the risk-based standards of the banking agencies but which is different in some respects. The banking agencies are continuing their efforts to revise their risk-based capital standards to ensure that this framework adequately considers an institution's interest rate risk. This action is required by Section 305 of FDICIA. The three banking agencies requested comment in August 1992 on a proposed approach for incorporating interest rate risk into the risk-based capital standards. In response to the recommendations made by commenters and after further banking agency staff deliberations, the three banking agencies published on September 14, 1993, a substantially modified proposal on interest rate risk. The proposal would ensure that banks measure and monitor their interest rate risk and maintain adequate capital for that risk. During 1993, the OTS adopted a final rule which adds an interest rate risk component to its risk-based capital rule and requires thrift institutions with a greater than normal interest rate exposure to take a deduction from the total capital available to meet their risk-based capital requirement. The method the OTS has adopted for measuring the interest rate risk exposures of thrift institutions differs from that proposed by the banking agencies. Section 305 of FDICIA also mandates that the agencies' risk-based capital standards address concentration of credit risk and the risks of nontraditional activities. The banking agencies' August 1992 proposal also solicited comment in these two areas. During 1993, the agencies have developed proposed risk-based capital amendments for concentrations and nontraditional activities. The agencies' joint notice of proposed rulemaking covering these two areas should be published in 1994. In December 1993, the FFIEC recommended to the banking agencies and the OTS that they issue for public comment certain proposed changes to their risk-based capital standards pertaining to the treatment of recourse arrangements and direct credit substitutes. These proposed changes would bring the risk-based capital requirements of the banking agencies and the OTS into greater conformity. Among other features of the proposal, equivalent risk-based capital treatment would be required for recourse arrangements and certain direct credit substitutes that present equivalent risk of loss. Finally, the staffs of the agencies have been discussing during 1993 a proposal to amend the risk-based capital standards to provide for the recognition of the reduced credit risk associated with bilateral netting arrangements covering outstanding interest rate and foreign exchange rate contracts. Such netting arrangements would have to be enforceable in all relevant jurisdictions as evidenced by well- founded and reasoned legal opinions. The agencies anticipate issuing proposals on this matter early in 1994. The differences in the capital standards among the banking agencies and between the banking agencies and the OTS are set forth in Appendix One. In addition to the leverage capital ratio difference mentioned above, the major differences between the capital standards of the banking agencies on the one hand and the OTS on the other include the capital treatment for subsidiaries, intangible assets, and assets sold with recourse. The staffs of the banking agencies and the OTS meet regularly to achieve uniformity in targeted areas of their respective capital standards and to address differences and inconsistencies among these standards. Accounting and Reporting Standards Over the years, the banking agencies, under the auspices of the 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 banking agencies are substantially consistent with generally accepted accounting principles (GAAP) as they are applied by commercial banks. The uniform Call Report serves as the basis for calculating risk-based capital and leverage ratios and is also used extensively for other regulatory purposes. Thus, material differences in accounting and reporting standards do not exist among commercial banks and FDIC-supervised savings banks. OTS requires each thrift institution to file the Thrift Financial Report (TFR), which is consistent with GAAP as it is applied by thrifts. However, the TFR differs in material respects from the bank Call Report. Certain of these differences arise from differences in GAAP as applied by banks and thrifts and the few areas in which the banking agencies have adopted regulatory reporting standards at variance with GAAP, as it is applied by banks. However, there are also significant differences in the required information and its form of presentation on the two reports so that the required reports are significantly different. Nevertheless, more uniform reporting by all institutions is a long- term goal of the FDIC. The federal banking agencies and OTS continue to study ways to reduce differences in accounting and reporting standards between the banking agencies and OTS and between GAAP for banks and thrifts. In the latter regard, after the enactment of FIRREA, the FDIC requested the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA) to consider eliminating the differences in GAAP as applied by thrifts and by banks. Both of these organizations have since undertaken projects that move in this direction. For example, since the FDIC's last report on capital and accounting differences, the FASB has issued a Statement of Financial Accounting Standards on loan impairment that applies equally to banks and thrifts. An interagency staff working group has identified a series of implementation issues raised by this new accounting standard and is preparing its recommendations on how the banking agencies and the OTS should proceed on these issues in a uniform manner. At the same time, the agencies continue working toward the goal of eliminating differences in reporting by banks and thrifts. The banking agencies and OTS have cooperated on several projects relating to accounting and reporting since the FDIC's last report on capital and accounting differences, including interagency guidance on restoring certain nonaccrual loans to accrual status and on the reporting of in- substance foreclosures. This guidance was issued on June 10, 1993, as part of a package of six initiatives to implement President Clinton's March 10, 1993, program to improve the availability of credit to businesses and individuals. Under the auspices of the FFIEC's Task Force on Supervision, an interagency working group including staff members from the banking agencies and the OTS recently completed an interagency policy statement on the allowance for loan and lease losses which should promote consistency in supervisory policies among the agencies and the institutions they supervise. The policy statement provides comprehensive guidance on the maintenance of an adequate allowance and an effective loan review system. The guidance explains that the allowance is designed to absorb estimated credit losses associated with the loan and lease portfolio, including binding commitments to lend, and discusses the analysis of the portfolio and factors to consider in estimating credit losses. In addition, the banking agencies continue to look for ways in which the differences between the Call Report standards and GAAP can be eliminated, consistent with the agencies' supervisory responsibilities. As one of the June 10, 1993, credit availability initiatives, the banking agencies issued guidance to banks that generally conforms bank regulatory reporting (Call Report) requirements for sales of other real estate owned (OREO) with GAAP, as set forth in FASB Statement No. 66, ``Accounting for Sales of Real Estate.'' Thrift institutions were already following GAAP in this area. Appendix One Summary of Differences in Capital Standards Among Federal Banking and Thrift Supervisory Agencies The three federal banking agencies have substantially similar leverage and risk-based capital standards. Nevertheless, the banking agencies view the leverage and risk-based capital requirements as minimum standards and most banking organizations are expected to operate with capital levels well above the minimums, particularly those institutions that are expanding or experiencing unusual or high levels of risk. Most of the differences described below represent inconsistencies between the capital standards used by the banking agencies and those employed by the OTS. Leverage Capital Requirement In 1985, the three federal banking agencies established a minimum 5.5 percent primary capital and 6 percent total capital leverage (capital-to-total assets) standard. In February 1991, the FDIC substantially revised its leverage capital rule which is contained in Part 325 of its regulations. The revised rule replaced the primary and total capital definitions with a single, narrower definition for leverage capital that is based solely on Tier 1 (or core) capital. It also established a minimum Tier 1 leverage capital requirement of at least 3 percent for the most highly-rated banks (i.e., those with a composite CAMEL rating of 1) that are not anticipating or experiencing any significant growth and that meet certain other conditions. All other state nonmember banks must maintain a minimum leverage capital ratio that is at least 100 to 200 basis points above this minimum (i.e., an absolute minimum leverage ratio of not less than 4 percent). These revised minimum leverage requirements are similar to the revised minimum leverage standards that were adopted by the OCC and the FRB in the second half of 1990. The OTS has a three percent core capital and a 1.5 percent tangible capital leverage requirement for savings associations. Goodwill is generally deducted in calculating a savings association's tangible and core capital levels. However, limited amounts of ``qualifying supervisory goodwill'' acquired on or before April 12, 1989, can be included in the calculation of core capital during a five-year phase- out period. During 1993, the amount of qualifying supervisory goodwill included in the calculation of core capital cannot exceed 0.75 percentage point (i.e., one quarter of the minimum 3 percent leverage ratio requirement). This allowable level phases down to zero, effective January 1, 1995. Consistent with the requirements of FIRREA, the OTS has proposed revisions to its leverage standard for savings associations so that its minimum leverage standard will be at least as stringent as the revised leverage standard that the OCC applies to national banks. Risk-Based Capital Requirement In 1989, the three federal banking agencies adopted risk-based capital standards consistent with the July 1988 Basle Accord. A transition period ended on December 31, 1992. The risk-based capital standards currently require a minimum total risk-based capital (Tier 1 plus Tier 2) ratio for all banking organizations equal to 8 percent. Risk-adjusted 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. As is the case with leverage ratios, the banking agencies view the risk-based requirement as a minimum ratio. Under the auspices of the Basle Supervisors' Committee, and domestically among themselves, U.S. bank regulatory authorities have been attempting to develop ways of quantifying the risks associated with changes in interest rates, equity investments, traded debt securities, and foreign exchange activities to supplement the basic risk-based capital framework. Furthermore, Section 305 of FDICIA mandates that the risk-based capital standards of the banking agencies and of OTS take account of interest rate risk. The three banking agencies requested comment in September 1993 on a proposed rule that would incorporate interest rate risk into their risk-based capital standards. OTS has adopted a risk-based capital standard which, in many respects, is similar to the framework adopted by the banking agencies. The OTS standard also requires a minimum risk-based capital ratio equal to 8 percent of risk-adjusted assets. During 1993, the OTS adopted a final rule which adds an interest rate risk component to its risk-based capital rule. Under this rule, thrift institutions with a greater than normal interest rate exposure must take a deduction from the total capital available to meet their risk-based capital requirement. That deduction is equal to one half of the difference between the institution's actual measured exposure and the normal level of exposure. In addition, the OTS amended its capital regulation in 1993 to conform its risk weight for repossessed assets and assets more than 90 days past due to the risk weight used by the banking agencies for these items. Subsidiaries The federal banking agencies consolidate all significant majority- owned subsidiaries of the parent organization. The purpose of this practice is to assure that capital requirements are related to all of the risks to which the bank is exposed. For subsidiaries which are not consolidated on a line-for-line basis, their balance sheets may be consolidated on a pro-rata basis, bank investments in such subsidiaries may be deducted entirely from capital, or the investments may be risk- weighted at 100 percent, depending upon the circumstances. For example, the FDIC deducts investments in, and unsecured advances to, securities subsidiaries of state nonmember banks established pursuant to Section 337.4 of the FDIC regulations. These options, with respect to the consolidation or ``separate capitalization'' of subsidiaries for the purpose of determining the capital adequacy of the parent organization, provide the banking agencies with the flexibility necessary to ensure that adequate capital is being provided commensurate with the actual risks involved. Such flexibility is essential to ensure a realistic assessment of an institution's capital adequacy. Under OTS capital guidelines, a distinction, mandated by FIRREA, is drawn between subsidiaries engaged in those activities that are permissible for national banks and subsidiaries engaged in ``impermissible'' activities for national banks. Subsidiaries of thrift institutions that engage only in permissible activities are consolidated on a line-for-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 in, including loans to, subsidiaries that engage in impermissible activities are deducted in determining the capital adequacy of the parent. However, for subsidiaries which were engaged in impermissible activities prior to April 12, 1989, investments in, including loans to, such subsidiaries that were outstanding as of that date are grandfathered and will be phased out of capital over a five-year transition period that expires on July 1, 1994. During this transition period, investments in subsidiaries engaged in impermissible activities which have not been phased out of capital are to be consolidated on a pro rata basis. The phase-out provisions of FIRREA were amended in October 1992 by the Housing and Community Development Act of 1992 with respect to impermissible subsidiaries that are subject to this requirement solely by reasons of their real estate investments and activities. Under this legislation, the OTS is authorized to grant extensions of the transition period for the capital deduction on a case-by-case basis if certain conditions are met. If an extension is granted, the transition period will expire on July 1, 1996, instead of July 1, 1994. Intangible Assets The banking agencies do not allow goodwill to be included in capital for commercial banks and FDIC-supervised savings banks. Pursuant to FIRREA, the OTS allows ``qualifying supervisory goodwill'' acquired on or before April 12, 1989, to be included as part of core capital through year-end 1994. Supervisory goodwill is goodwill acquired in an acquisition where the fair value of the assets was less than the fair value of the liabilities at the acquisition date or goodwill acquired in the acquisition of a problem institution. However, in accordance with FIRREA and Section 18(n) of the Federal Deposit Insurance Act, goodwill acquired after April 12, 1989, cannot be included in calculating regulatory capital under the OTS capital rules. This explicit prohibition against recognizing goodwill also applies to the three federal banking agencies and the capital rules they have adopted for banking organizations. Starting in late 1991, the banking agencies and the OTS began working to eliminate their then existing differences in the regulatory capital treatments of identifiable intangible assets. After agreeing upon a uniform capital approach to these assets, each of the agencies issued proposed amendments to its capital standards during the second quarter of 1992. During late 1992 and 1993, the banking agencies adopted final rules permitting purchased credit card relationships and purchased mortgage servicing rights to count toward capital requirements, subject to certain limits. Both forms of intangible assets are in the aggregate limited to 50 percent of core capital. In addition, purchased credit card relationships alone are restricted to no more than 25 percent of an institution's core capital. Any purchased mortgage servicing rights and purchased credit card relationships that exceed these limits, as well as all other intangible assets such as goodwill and core deposit intangibles, are deducted from capital and assets in calculating an institution's core capital. The banking agencies' final rules also address the valuation of identifiable intangible assets that count toward capital requirements in a manner that is consistent with Section 475 of FDICIA. Section 475 provides that the value of purchased mortgage servicing rights included in an institution's capital may not exceed 90 percent of their fair market value and that this value be determined at least quarterly. Furthermore, the final rules also state that, for purposes of calculating regulatory capital (but not for financial statement purposes), the value of purchased mortgage servicing rights and purchased credit card relationships would be limited to the lesser of 90 percent of fair market value or 100 percent of remaining unamortized book value. The book value of these intangible assets must be determined at least quarterly using a discounted approach which looks to the discounted amount of the estimated future net cash flows from the asset. The OTS has developed but has not yet issued its final rule on the regulatory capital treatment of identifiable intangible assets which is comparable to the rules already in effect for banks. Until its final rule takes effect, the existing OTS treatment of identifiable intangible assets continues to apply to savings associations. Under these rules, the OTS limits the amount of purchased mortgage servicing rights that may be included in capital to the lower of 90 percent of fair market value, 90 percent of the original purchase price, or 100 percent of the remaining unamortized book value. In addition, purchased mortgage servicing rights equal to no more than 50 percent of a savings association's core capital may be included in calculating core and tangible capital. However, purchased mortgage servicing rights purchased, or under contract to be purchased, on or before February 9, 1990, are exempt from this concentration limit. The amount of any identifiable intangible assets (other than purchased mortgage servicing rights) that meet a qualifying three-part test can only be included in core capital for leverage and risk-based capital purposes up to a limit of 25 percent of core capital. Assets Sold with Recourse As a general rule, the banking agencies require full leverage and risk-based capital charges on assets sold with recourse, even when the recourse is limited. This includes transactions where the recourse arises because the seller, as servicer, must absorb credit losses on the assets being serviced. The exceptions to this rule (for leverage capital purposes only) pertain to certain pools of one-to-four family residential mortgages and to certain farm mortgage loans (see Appendix 2, ``Sales of Assets With Recourse'' for further details). For risk-based capital purposes, the OTS limits the capital required on assets sold with limited recourse to the lesser of the amount of the recourse or the actual amount of capital that would otherwise be required against that asset, i.e., the normal capital charge. This is known as the ``low-level recourse'' rule. Some securitized asset arrangements involve the issuance of senior and subordinated classes of securities. When a bank originates such a transaction and retains a subordinated piece, 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 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, regardless of whether the servicer was the seller of the assets or purchased the servicing from another party. In December 1993, the FFIEC recommended to the banking agencies and the OTS that they issue for public comment certain proposed changes to their risk-based capital standards pertaining to the treatment of recourse arrangements and direct credit substitutes. As recommended by the FFIEC, the banking agencies and the OTS would amend their risk- based capital standards to define ``recourse'' and certain related terms and would expand the existing definition of ``direct credit substitute.'' The banking agencies would adopt the ``low-level recourse'' rule, would require banking organizations that purchase loan servicing rights to hold capital against the outstanding amount of the loans being serviced, and would require banking organizations that purchase subordinated interests which absorb the first dollars of losses from the underlying assets to hold capital against the subordinated interest plus all more senior interests. In addition, the banking agencies and the OTS would amend their risk-based capital standards to require the provider of a financial standby letter of credit or other guarantee-like arrangement that absorbs the first dollars of losses on third-party assets to hold capital against the outstanding amount of assets enhanced. The banking agencies and the OTS expect to jointly publish these proposed risk-based capital changes in early 1994. Limitation on Subordinated Debt and Limited Life Preferred Stock The federal banking agencies limit subordinated debt and intermediate-term preferred stock that may be treated as part of Tier 2 capital to an amount not to exceed 50 percent of Tier 1 capital. In addition, all maturing capital instruments must be discounted by 20 percent each year of the five years before maturity. The banking agencies adopted this approach in order to emphasize equity versus debt in the assessment of capital adequacy. The OTS has no limitation on the ratio of maturing capital instruments as part of Tier 2. Also, for all maturing instruments issued on or after November 7, 1989 (those issued before are grandfathered with respect to the discounting requirement), thrifts have the option of using either (a) the discounting approach used by the banking regulators, or (b) an approach which allows for the full inclusion of all such instruments provided that the amount maturing in any one year does not exceed 20 percent of the thrift's total capital. Presold Residential Construction Loans As required by Section 618(a) of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRIA), the banking agencies and the OTS have amended their risk-based capital guidelines to lower from 100 percent to 50 percent the risk weight for loans to builders to finance the construction of one-to-four family residential properties that have been presold and meet certain other criteria. However, the criteria adopted by the FDIC and the FRB differ in one respect from those of the OTS and OCC. Under the OTS and OCC rules, the property must be presold before the construction loan is made in order for the loan to qualify for the 50 percent risk weight. In contrast, the FDIC and FRB permit loans to builders for residential construction to qualify for the 50 percent risk weight once the property is presold, even if that event occurs after the construction loan has been made. Qualifying Multifamily Mortgage Loans The banking agencies have generally placed multifamily (five units or more) residential mortgage loans in the 100 percent risk-weight category along with most other commercial loans since the risks in both assets are similar. The OTS allows certain multifamily residential mortgage loans (e.g., those secured by buildings with 5-36 units, a maximum 80 percent loan to value ratio, and 80 percent occupancy rate) to qualify for the 50 percent risk-weight category. However, Section 618(b) of RTCRRIA requires the banking agencies and the OTS to amend their risk-based capital guidelines to lower the risk weight of multifamily housing loans that meet certain criteria, and securities collateralized by such loans, from 100 percent to 50 percent. In December 1993, the FDIC and FRB adopted amendments to their risk-based capital standards to implement the Section 618(b) requirement. The OCC and OTS are in the process of finalizing their risk-based capital amendments for multifamily housing loans. Equity Investments To the extent that commercial banks and FDIC-supervised savings banks are allowed to invest in equity securities under applicable federal or state law, such investments are assigned to the 100 percent risk-weight category, for risk-based capital purposes, by all three of the federal banking agencies. The OTS risk-based capital standards require that thrift institutions deduct certain equity investments from capital over a five-year phase-in period, which ends on July 1, 1994. Nonresidential Construction and Land Loans The banking agencies assign loans for real estate development and construction purposes to the 100 percent risk weight category. OTS generally assigns these loans to the same 100 percent risk category. However, if the amount of the loan exceeds 80 percent of the fair value of the property, the excess portion is deducted from capital in accordance with the same five-year phase-in arrangement as described above for ``Equity Investments.'' Mortgage-Backed Securities (MBS) The federal banking agencies, in general, place privately-issued MBS in either the 50 percent or 100 percent risk-weight category, depending upon the appropriate risk category of the underlying assets. However, privately-issued MBS, collateralized by government agency or government-sponsored agency securities, are generally assigned to the 20 percent risk weight category. The OTS assigns privately-issued high-quality mortgage-related securities (also known as ``SMMEA'' securities) to the 20 percent risk weight category. These are, generally, privately-issued MBS with AA or better investment ratings. At the same time, the banking agencies and the OTS automatically assign to the 100 percent risk weight category certain mortgagebacked securities, including interest-only strips, residuals, and similar instruments that can absorb more than their pro rata share of loss. The FDIC, in conjunction with the other banking agencies and the OTS, continues to discuss the development of more specific guidance as to the types of ``high risk'' mortgagebacked securities that meet this definition. Treatment of Junior Liens on One to Four Family Properties In some cases, a bank may make two loans on a single residential property, one loan secured by a first lien, the other by a second lien. The FDIC and FRB view these two transactions as a single loan for purposes of determining whether the loan secured by the first lien has been prudently underwritten. The loan secured by the first lien could be assigned to the 100 percent risk weight category, if, in the aggregate, the two loans exceed a prudent loan-to-value ratio. In such a situation, the loan secured by the first lien would not qualify for the 50 percent risk weight (but, in all cases, the FDIC would assign the loan secured by the second lien to the 100 percent risk weight category regardless of the aggregate loan-to-value ratio). This approach for first liens is intended to avoid possible circumvention of the capital requirement and capture the risks associated with the combined transactions. The OCC and 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. Mutual Funds Rather than looking to a mutual fund's actual holdings, the 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. Thus, the banking agencies take into account the maximum degree of risk to which a bank may be exposed when investing in a mutual fund because the composition and risk characteristics of its future holdings cannot be known in advance. OTS applies a capital charge appropriate to the riskiest asset that a mutual fund is actually holding at a particular time. In addition, OTS guidelines also permit investments in mutual funds to be allocated on a pro-rata basis in a manner consistent with the actual composition of the mutual fund. FSLIC/FDIC-Covered Assets The federal banking agencies generally place FSLIC/FDIC-covered assets (assets subject to guarantee arrangements by the FSLIC or FDIC) in the 20 percent risk-weight category. However, the banking agencies have permitted limited exceptions on a case-by-case basis in several large bank assistance transactions. The OTS places these assets in the zero percent risk-weight category. Pledged Deposits and Nonwithdrawable Accounts Instruments such as pledged deposits, nonwithdrawable accounts, income capital certificates (ICCs), and mutual capital certificates (MCCs) do not exist in the banking industry and are not included in the capital guidelines of the banking agencies. The capital guidelines of OTS permit thrift institutions to include pledged deposits and nonwithdrawable accounts that meet OTS criteria as well as ICCs and MCCs as capital. 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 may defer and amortize losses incurred on agricultural loans between January 1, 1984, and December 31, 1991. The unamortized portion of any losses is included as an element of Tier 2 capital under the FDIC's risk-based capital framework. 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 and agricultural personal property. Thrifts are not eligible to participate in the agricultural loan loss amortization program established by this statute. Appendix Two Summary of Differences in Reporting Standards Among Federal Banking and Thrift Supervisory Agencies Under the auspices of the Federal Financial Institutions Examination Council, the three federal banking agencies have developed uniform reporting standards which must be followed by insured commercial banks and FDIC-supervised savings banks in the preparation of the Reports of Condition and Income (Call Report). The income statement, balance sheet, and supporting schedules presented in the Call Report are used by the federal bank supervisory agencies for off- site monitoring of the capital adequacy of banks and for other regulatory, supervisory, surveillance, analytical, insurance assessment, and general statistical purposes. The reporting standards set forth for the Call Report are based almost entirely on generally accepted accounting principles for banks, and, as a matter of policy, deviate only in those instances where statutory requirements or overriding supervisory concerns have warranted a departure from GAAP. In those areas where the Call Report instructions depart from GAAP, the GAAP requirements appear to be inconsistent with the objectives and standards for regulatory reporting that are set forth in section 121 of FDICIA. Accordingly, the Call Report standards in these areas are no less stringent than, i.e., are more conservative than, GAAP. Thus, insofar as the federal banking agencies are concerned, uniform accounting standards for regulatory and supervisory purposes have been established. The OTS has developed and maintains its own separate reporting scheme for the thrift institutions under its supervision. The reporting form used by savings institutions, known as the Thrift Financial Report, is based on GAAP as applied by thrifts, which differs in some respects from GAAP for banks. Specific Valuation Allowances for, and Charge-offs of, Troubled Real Estate Loans not in Foreclosure The banking agencies generally consider real estate loans which lack acceptable cash flow or other ready sources of repayment, other than the collateral, as ``collateral dependent.'' When a real estate loan is considered to be collateral dependent and the fair value of the collateral has declined below the book value of the loan, charge-off or the establishment of a specific valuation allowance is made to reduce the value of the loan to the fair value of the collateral. Fair value is generally determined by a current appraisal. The banking agencies believe that this approach accurately reflects the amount of recovery a financial institution is likely to receive if it is forced to foreclose on the underlying collateral. This banking agency approach is basically consistent with GAAP as it has been applied by banks. Effective September 30, 1993, OTS revised its policy for the valuation of troubled, collateral-dependent loans. When it is probable, based on current information and events, that a thrift will be unable to collect all amounts due (both principal and interest) on a troubled, collateral-dependent loan, OTS requires a specific valuation allowance against (or a partial charge-off of) the loan for the amount by which the recorded investment in the loan (generally, its book value) exceeds its ``value,'' as defined. The ``value'' is either the present value of the expected future cash flows on the loan discounted at the loan's effective interest rate, the loan's observable market price, or the fair value of the collateral. Previously, OTS generally required specific valuation allowances for troubled real estate loans based on the estimated net realizable value of the collateral, an amount that normally exceeds fair value. The revised OTS policy narrows this difference between banks and thrifts and is somewhat similar to the requirements of FASB Statement No. 114 on loan impairment, which was issued in May 1993. However, FASB Statement No. 114, which will apply to financial statements prepared in accordance with GAAP by both banks and thrifts, is not required to be adopted until 1995. Futures and Forward Contracts The banking agencies, as a general rule, do not permit the deferral of losses on futures and forward contracts 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 issuance of FASB Statement No. 80, which permits hedge or deferral accounting under certain circumstances. Hedge accounting in accordance with FASB Statement No. 80 is permitted by the banking agencies only for futures and forward contracts used in mortgage banking operations. 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 losses which would be reflected as assets on the thrift's balance sheet in accordance with GAAP. Excess Servicing Fees As a general rule, the banking agencies do not follow GAAP for excess servicing fees, but require a more conservative treatment. Excess servicing arises when loans are sold with servicing retained and the stated servicing fee rate is greater than a 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. In contrast, 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 the institution's defeasance of their liabilities in accordance with FASB Statement No. 76. Defeasance involves a debtor irrevocably placing risk-free monetary assets in a trust established solely for satisfying the debt. In order to qualify for this treatment, the possibility that the debtor will be required to make further payments on the debt, beyond the funds placed in the trust, must be remote. With defeasance, the debt is netted against the assets placed in the trust, a gain or loss results in the current period, and both the assets placed in the trust and the liability are removed from the balance sheet. However, for Call Report purposes, banks must continue to report defeased debt as a liability and the securities contributed to the trust must continue to be reported as assets. No netting is permitted, nor is any recognition of gains or losses on the transaction allowed. The banking agencies have not adopted FASB Statement No. 76 because of uncertainty regarding the irrevocability of 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 banking agencies is generally to allow banks to report transfers of receivables 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 one-to-four family residential mortgage loans and agricultural mortgage loans under any one of the government programs (GNMA, FNMA, FHLMC, and Farmer Mac). Transfers of mortgages under these programs are treated as sales for Call Report purposes, provided the transfers would be reported as sales under GAAP. Furthermore, private transfers of one-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, under the risk-based capital framework, the seller's obligation under any recourse provision resulting from transfers of mortgage loans under the government programs or in private transfers that qualify as sales is viewed as an off-balance sheet exposure that will be assigned a 100 percent credit conversion factor. Thus, for risk-based capital purposes, capital is generally required to be held for any recourse obligation associated with such transactions. OTS policy is to follow FASB Statement No. 77. However, in the calculation of risk-based capital under OTS guidelines, off-balance sheet recourse obligations 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. Push Down Accounting Push down accounting is the establishment of a new accounting basis for a depository institution in its separate financial statements as a result of a substantive change in control. Under push down accounting, when a depository institution is acquired, yet retains its separate corporate existence, the assets and liabilities of the acquired institution are restated to their fair values as of the acquisition date. These values, including any goodwill, are reflected in the separate financial statements of the acquired institution as well as in any consolidated financial statements of the institution's parent. 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 accounting interpretations issued by the staff 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 Under Accounting Principles Board Opinion No. 16, ``Business Combinations,'' negative goodwill arises when the fair value of the net assets acquired in a purchase business combination exceeds the cost of the acquisition and a portion of this excess remains after the values otherwise assignable to the acquired noncurrent assets have been reduced to a zero value. The three banking agencies require negative goodwill to be reported as a liability on the balance sheet and do not permit it to be netted against goodwill that is included as an asset. This ensures that all goodwill assets are deducted in regulatory capital calculations consistent with the internationally agreed-upon Basle Capital Accord. The OTS permits negative goodwill to offset goodwill assets on the balance sheet. Offsetting of Assets and Liabilities FASB Interpretation No. 39, ``Offsetting of Amounts Related to Certain Contracts'' (FIN 39), becomes effective in 1994. FIN 39 interprets the longstanding accounting principle that ``the offsetting of assets and liabilities in the balance sheet is improper except where a right of setoff exists.'' Under FIN 39, four conditions must be met in order to demonstrate that a right of setoff exists. A debtor with ``a valid right of setoff may offset the related asset and liability and report the net amount.'' Although an interpretive issue concerning one of the four conditions remains to be clarified, the banking agencies plan to allow banks to adopt FIN 39 for Call Report purposes solely as it relates to on-balance sheet amounts for conditional and exchange contracts (e.g., forwards, interest rate swaps, and options). However, consistent with the existing Call Report instructions, netting of other assets and liabilities will continue to not be permitted unless specifically required by the instructions. OTS practice is to follow GAAP as it relates to offsetting in the balance sheet. Dated at Washington, DC, this 14th day of January, 1994. Federal Deposit Insurance Corporation Robert E. Feldman, Acting Executive Secretary . [FR Doc. 94-1455 Filed 1-19-94; 4:15 pm] BILLING CODE 6174-01-P