Differences in Capital and Accounting Standards Among the Federal Banking and Thrift Agencies; Report to Congressional Committees

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.

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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