[Federal Register Volume 60, Number 28 (Friday, February 10, 1995)]
[Notices]
[Pages 7966-7969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3392]
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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
Implementation Issues Arising from FASB Statement No. 114,
``Accounting by Creditors for Impairment of a Loan''
AGENCY: Federal Financial Institutions Examination Council.
ACTION: Final action.
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SUMMARY: The Federal Financial Institutions Examination Council
(FFIEC)\1\ has decided that the portion of an institution's allowance
established pursuant to Statement of Financial Accounting Standards No.
114, ``Accounting by Creditors for Impairment of a Loan'' (FAS 114),
[[Page 7967]] should be reported as part of the general allowance,
which is includible in Tier 2 capital subject to current limitations.
In concluding that the FAS 114 allowance is general in nature, the
FFIEC has also reaffirmed existing regulatory reporting policies that
require banks to promptly charge-off identified losses. Similarly,
savings associations are required to promptly charge-off identified
losses, or create specific allowances which are reported separately
from general allowances. With respect to impaired collateral-dependent
loans, any portion of the loan balance that exceeds the amount that is
adequately secured by the fair value of the collateral is generally
classified as loss by examiners. Consequently, such losses on
collateral-dependent loans are excluded from the general allowance and
Tier 2 capital. Because of the conclusions on the treatment of FAS 114
allowances, no changes are required in the federal banking agencies'
regulatory capital rules. In addition, the FFIEC has decided to
maintain its existing regulatory nonaccrual standards.
\1\The FFIEC consists of representatives from the Board of
Governors of the Federal Reserve System (FRB), the Federal Deposit
Insurance Corporation (FDIC), the Office of the Comptroller of the
Currency (OCC), the Office of Thrift Supervision (OTS) (referred to
as the ``agencies''), and the National Credit Union Administration.
However, this guidance is not directed to credit unions. Section
1006(c) of the Federal Financial Institutions Examination Council
Act requires the FFIEC to develop uniform reporting standards for
federally-supervised financial institutions.
EFFECTIVE DATE: For regulatory reports prepared as of March 31, 1995,
unless an institution has elected to adopt FAS 114 and the guidance in
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this notice as of an earlier date.
FOR FURTHER INFORMATION CONTACT:
At the FRB: Gerald A. Edwards, Jr., Assistant Director (202) 452-2741
or Charles H. Holm, Project Manager (202) 452-3502. For questions
pertaining to regulatory capital issues, Rhoger H. Pugh, Assistant
Director (202) 728-5883, or Kevin M. Bertsch, Supervisory Financial
Analyst (202) 452-5265.
At the FDIC: Doris L. Marsh, Examination Specialist, Accounting
Section, Division of Supervision (202) 898-8905, or Robert F. Storch,
Chief, Accounting Section, Division of Supervision (202) 898-8906.
At the OCC: Eugene W. Green, Deputy Chief Accountant, (202) 874-4933,
or Frank Carbone, National Bank Examiner (202) 874-5170.
At the OTS: Timothy Stier, Deputy Chief Accountant (202) 906-5699.
SUPPLEMENTARY INFORMATION:
I. Background
A. Summary of FAS 114
FAS 114 was adopted in May 1993 by the Financial Accounting
Standards Board (FASB). The statement applies to all creditors and to
all loans that are identified for evaluation of collectibility, except:
(1) large groups of smaller-balance homogeneous loans that are
collectively evaluated for impairment (such as credit card, residential
mortgage, and consumer installment loans), (2) loans that are measured
at fair value or at the lower of cost or fair value (such as loans held
for sale), (3) leases, and (4) debt securities. FAS 114 does not
specify how an institution should identify loans that are to be
evaluated for collectibility. An institution should apply its normal
loan review procedures in making that judgment.
Under FAS 114, a loan is impaired when it is probable that a
creditor will be unable to collect all amounts due (including interest
and principal) according to the contractual terms of the loan
agreement. When a loan is impaired, a creditor must measure the extent
of that impairment by determining the present value of expected future
cash flows discounted at the loan's effective interest rate. However,
as practical expedients, the creditor may measure impairment based on
either the loan's observable market price, or the fair value of the
collateral for the loan if the loan is collateral dependent. Although
under FAS 114 a creditor is generally allowed to use any of these three
measurement methods to determine the amount of impairment, a creditor
must measure impairment based on the fair value of collateral when the
creditor determines that foreclosure is probable.
FAS 114 does not address when a creditor should record a charge-off
of an impaired loan. Furthermore, FAS 114, as amended by Statement of
Financial Accounting Standards No. 118, ``Accounting by Creditors for
Impairment of a Loan--Income Recognition and Disclosures'' (FAS 118),
in October 1994, does not address how a creditor should recognize
interest income on an impaired loan.
B. FFIEC Guidance on FAS 114 Announced in May 1994
The May 17, 1994, Federal Register (59 FR 25656) stated that ``the
FFIEC and the agencies are requiring institutions to adopt FAS 114 as
of its effective date for purposes of reporting on the Call Report and
TFR. Furthermore, the agencies will permit early adoption.'' This
regulatory reporting treatment is consistent with the requirements of
Section 37 of the Federal Deposit Insurance Act (12 U.S.C. 1831n).
While institutions are required to adopt FAS 114 for regulatory
reporting purposes, the ``Interagency Policy Statement on the Review
and Classification of Commercial Real Estate Loans,'' issued on
November 7, 1991, will remain in effect. Therefore, impaired,
collateral-dependent loans must be reported at the fair value of
collateral in regulatory reports. This treatment is to be applied to
all collateral-dependent loans, regardless of the type of collateral.
The FFIEC and the agencies also announced that they do not plan to
automatically require additional allowances for credit losses on
impaired loans over and above what is required on these loans under FAS
114.\2\ However, an additional allowance on impaired loans may be
necessary based on consideration of institution-specific factors, such
as historical loss experience compared with estimates of such losses,
concerns about the reliability of cash flow estimates, or the quality
of an institution's loan review function and controls over its process
for estimating its FAS 114 allowance.
\2\FAS 114 does not address the overall adequacy of the ALLL.
However, in addition to requiring an allowance for credit losses on
impaired loans, FAS 114 requires each institution to continue to
maintain an overall allowance that complies with Statement of
Financial Accounting Standards No. 5, ``Accounting for
Contingencies.'' Thus, consistent with existing regulatory policy,
the ALLL should be adequate to cover all estimated credit losses
arising from the loan and lease portfolio, including losses on loans
that do not meet FAS 114's impairment criterion.
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C. Issues on Which the FFIEC Sought Public Comment
In the May 17, 1994, Federal Register, the FFIEC sought public
comment on two primary reporting issues and certain other matters
related to FAS 114.
1. The Character of the FAS 114 Allowance
Should that portion of an institution's allowance established
pursuant to FAS 114 be reported and considered as a specific allowance
and, thus, not be eligible for inclusion in Tier 2 capital under the
agencies' current capital rules? Alternatively, should the FAS 114
allowance be regarded as a general allowance which would be eligible
for inclusion in Tier 2 capital subject to existing limits?\3\
\3\Under the agencies' risk-based capital rules, general
allowances includible in Tier 2 capital are limited to 1.25 percent
of gross risk-weighted assets and an institution's Tier 2 capital
cannot exceed its Tier 1 capital.
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2. Maintenance of Nonaccrual Reporting Requirements
Should regulatory nonaccrual standards be maintained for loans
subject to FAS 114?
3. Other Issues
a. Comment was sought on (i) how much the adoption of FAS 114 is
expected to change overall allowance [[Page 7968]] levels, and (ii)
what portion of total overall allowances are expected to be related to
impaired loans evaluated pursuant to FAS 114.
b. Comment was sought on implementation issues arising from FAS 114
to the extent they relate to U.S. branches and agencies of foreign
banks. These entities are required to file quarterly the Report of
Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks
(002 Report), which in many respects is similar to the bank Call
Report. The 002 Report requires U.S. branches and agencies of foreign
banks to report the amount of nonaccrual loans (see issue 2,
``Maintenance of Nonaccrual Reporting Requirements'').
c. Comment was sought on how FAS 114 might affect an institution's
internal loan review process and its internal loan classification
system for loans subject to FAS 114. In this regard, the FFIEC noted
that, according to the December 21, 1993, Interagency Policy Statement
on the Allowance for Loan and Lease Losses, each institution should
ensure that it has a formal credit grading system that can be
reconciled with the classification framework used by the agencies.
II. Public Comments
The FFIEC received 85 comment letters concerning the regulatory
implementation issues arising from FAS 114. Seventy letters came from
banking and thrift institutions. Eight financial institution trade
associations, one professional association for accountants, three state
banking departments, a state banking supervisors' conference, and two
accounting firms also offered comments.
A. The Character of the FAS 114 Allowance
58 of the 70 commenters who addressed this issue indicated that an
institution's allowance established pursuant to FAS 114 should be
reported as a general allowance and be eligible for inclusion in Tier 2
capital. Many commenters stated that they believe that the FAS 114
allowance is a general allowance because of its availability to absorb
any losses in the loan portfolio. Others noted that the banking
agencies' current policy of requiring prompt charge-offs supports the
idea that an institution's allowance for loan and lease losses (ALLL)
does not contain identified losses and that any FAS 114 allowances
included in the ALLL would be general. Respondents also indicated that
the methodology required by FAS 114 is similar to that recommended in
the agencies' current policies for determining an adequate ALLL and
that other allocations of the ALLL for analytical purposes are
currently disclosed in documents filed with the Securities and Exchange
Commission without implying that they are specific allowances.
12 of the commenters recommended that the FAS 114 allowance be
considered a ``specific allowance'' and not be eligible for inclusion
in Tier 2 capital. These commenters indicated that they believe that
FAS 114 relates to identified losses of particular loans and groups of
loans. One commenter stated that, because of the current limit on the
amount of the ALLL that may be included in Tier 2 capital (i.e., 1.25
percent of gross risk-weighted assets), the current impact on
institutions of a decision to treat the FAS 114 allowance as a specific
allowance would be minimal. At the same time, this commenter noted that
considering the FAS 114 allowance to be specific would promote
consistency in the application and analysis of financial accounting,
regulatory reporting, and capital standards. In addition, the commenter
suggested that viewing the FAS 114 allowance as specific would add
discipline to the loan review process.
B. Maintenance of Nonaccrual Reporting Requirements
51 of the 60 commenters addressing this reporting issue agreed that
the agencies should maintain existing nonaccrual policies for
regulatory reporting purposes. Many respondents stated that, since
nonaccrual policies are widely recognized, used, and understood, no
change in these policies was needed. Some respondents indicated that
institutions should not be required to modify their accounting systems
until a change in income recognition methods for loans, if any, is made
by FASB.
9 of the commenters did not believe the agencies should retain
existing nonaccrual policies. One respondent stated that the agencies'
nonaccrual policies did not improve the safety and soundness of
institutions, but rather forced the cost recovery method of accounting
for all funds collected on these loans. Some commenters suggested
modifications to the current nonaccrual policies.
C. Specific Questions Raised by the Agencies
1. Allowance Levels
Commenters were asked how much the adoption of FAS 114 was expected
to change overall allowance levels. Of the 41 commenters who responded,
almost all stated that there would be little change in their allowance
level. Other respondents indicated that they had not yet studied the
impact of FAS 114.
Thirteen respondents answered the question about what portion of
the overall ALLL is expected to be related to impaired loans evaluated
pursuant to FAS 114. Several commenters simply indicated that they
expected the FAS 114 portion of their ALLL to be small, while three
provided separate specific estimates of less than 25 percent, 10
percent, and 5 percent. One stated that the FAS 114 allowance would be
less than its existing ALLL and another indicated that its size would
depend on the types of loans in portfolio. One commenter suggested that
the FAS 114 allowance would be larger if assessed during an economic
downturn.
2. U.S. Branches and Agencies of Foreign Banks
Four of nine commenters on this subject suggested that nonaccrual
standards should be maintained for these branches and agencies. Three
suggested that the same rules should apply to all institutions
operating in the U.S. so that institutions chartered in the U.S. are
not placed at a competitive disadvantage. Two commenters stated that
branches and agencies of foreign banks should not have to record an
ALLL at the branch. One commenter also requested that the agencies make
no changes to the 002 Report.
3. Internal Review Systems
About half of the 55 institutions commenting on how FAS 114 might
affect an institution's internal loan review process and its internal
loan classification system said that FAS 114 will have little or no
effect. Another third indicated that it will cause some operating and
reporting changes with accompanying cost, but little or no perceived
benefit. Changes that may be needed include more analysis and
monitoring of loans, more time estimating cash flows and reviewing cash
flow estimates, and more time estimating cash flows and reviewing cash
flow estimates, and more documentation of the work performed.
III. Decisions on FAS 114 Implementation Issues
After review of the comments received and further consideration of
the issues involved, the FFIEC has made the following decision on
implementation issues arising from FAS 114.
[[Page 7969]]
A. The Character of the FAS 114 Allowance
The FFIEC has concluded that FAS 114 sets forth a method for
estimating a portion of an institution's allowance for loan and lease
losses. Therefore, the regulatory capital treatment of the ALLL for
institutions will not be affected by the adoption of FAS 114 for
regulatory reporting purposes. Consistent with this determination, the
ALLL of institutions will continue to be reported net of any identified
losses and will be includible in Tier 2 capital, subject to current
limits.
In concluding that the portion of the allowance established
pursuant to FAS 114 is general in nature, the FFIEC notes that FAS 114
in no way affects regulatory charge-off policies and is reiterating
that these policies require banks to promptly charge-off all identified
losses and require thrifts to either promptly charge-off identified
losses or provide for them using separate, specific allowances that may
not be included in regulatory capital. With respect to impaired
collateral-dependent loans, any portion of the loan balance that
exceeds the amount that is adequately secured by the fair value of the
collateral is generally classified as loss by examiners. Consequently,
the FFIEC notes that such losses on collateral-dependent loans are
excluded from the general allowance and Tier 2 capital. Because of the
conclusions on the treatment of FAS 114 allowances, no changes are
required in the agencies' regulatory capital rules. The FFIEC further
notes that the portion of the allowance established pursuant to FAS 114
is available to meet losses in any part of the loan and lease portfolio
and that institutions currently use a number of techniques in
estimating the overall adequacy of their ALLL.
B. Nonaccrual Policies
The FFIEC has also decided to retain its existing nonaccrual
policies governing the recognition of interest income. As noted above,
FASB has amended FAS 114 by issuing FAS 118 to remove the provisions
describing how income on an impaired loan should be reported. Thus, the
agencies' nonaccrual standards are not inconsistent with GAAP.
Furthermore, as noted in the request for comment included in the
Federal Register of May 17, 1994, the agencies' nonaccrual policies
also provide many supervisory benefits, and retention of nonaccrual
policies reduces regulatory burden by permitting institutions to
continue their current reporting systems.
Consistent with its determinations with respect to the Call Report,
the FFIEC is not recommending any changes to regulatory nonaccrual
standards in the 002 Report as a result of FAS 114. Accordingly,
current regulatory nonaccrual standards will continue to apply to U.S.
branches and agencies of foreign banks.
Dated: February 7, 1995.
Keith J. Todd,
Assistant Executive Secretary, Federal Financial Institutions
Examination Council.
[FR Doc. 95-3392 Filed 2-9-95; 8:45 am]
BILLING CODE 6210-01-M