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

FEDERAL RESERVE SYSTEM

Report to Congressional Committees Regarding Differences in

Capital and Accounting Standards Among the Federal Banking and Thrift

Agencies

AGENCY: Board of Governors of the Federal Reserve System.

ACTION: Notice of report to the Committee on Banking, Housing, and

Urban Affairs of the United States Senate and to the Committee on

Banking, Finance and Urban Affairs of the United States House of

Representatives.

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SUMMARY: This report has been prepared by the Federal Reserve Board

pursuant to section 121 of the Federal Deposit Insurance Corporation

Improvement Act of 1991. Section 121 requires each Federal banking and

thrift agency to report annually to the above specified Congressional

Committees regarding any differences between the accounting or capital

standards used by such agency and the accounting or capital standards

used by other banking and thrift agencies. The report must also contain

an explanation of the reasons for any discrepancy in such accounting or

capital standards. The report must be published in the Federal

Register.

FOR FURTHER INFORMATION CONTACT: Rhoger H Pugh, Assistant Director

(202/728-5883), Norah M. Barger, Manager (202/452-2402), Gerald A.

Edwards, Jr., Assistant Director (202/452-2741), Robert E. Motyka,

Supervisory Financial Analyst (202/452-3621), or Nancy J. Rawlings,

Senior Financial Analyst (202/452-3059), Division of Banking

Supervision and Regulation, Board of Governors of the Federal Reserve

System. For the hearing impaired only, Telecommunication Device for the

Deaf (TDD), Dorothea Thompson (202/452-3544), Board of Governors of the

Federal Reserve System, 20th & C Street, NW., Washington, DC 20551.

Introduction and Overview

This is the fourth annual report\1\ on the differences in capital

standards and accounting practices that currently exist among the three

banking agencies (the Board of Governors of the Federal Reserve System

(FRB), the Office of the Comptroller of the Currency (OCC), and the

Federal Deposit Insurance Corporation (FDIC)) and the Office of Thrift

Supervision (OTS).\2\ Section One of the report focuses on differences

in the agencies' capital standards; Section Two discusses differences

in accounting standards. The remainder of this introduction provides an

overview of the discussion contained in these sections.

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\1\ The first two reports prepared by the Federal Reserve Board

were made pursuant to section 1215 of the Financial Institutions

Reform, Recovery, and Enforcement Act of 1989 (FIRREA). The third

report was made pursuant to section 121 of the Federal Deposit

Insurance Corporation Improvement Act of 1991 (FDICIA), which

superseded section 1215 of FIRREA.

\2\ At the federal level, the Federal Reserve System has primary

supervisory responsibility for state-chartered banks that are

members of the Federal Reserve System as well as all bank holding

companies. The FDIC has primary responsibility for state nonmember

banks and FDIC-supervised savings banks. National banks are

supervised by the OCC. The OTS has primary responsibility for

savings and loan associations.

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Capital Standards

As stated in the previous reports to the Congress, the three bank

regulatory agencies have, for a number of years, employed a common

regulatory framework that establishes minimum capital adequacy ratios

for commercial banking organizations. In 1989, all three banking

agencies as well as the OTS, adopted a risk-based capital framework

that was based upon the international capital accord developed by the

Basle Committee on Banking Regulations and Supervisory Practices (Basle

Accord) and endorsed by the central bank governors of the G-10

countries.

The risk-based capital framework establishes minimum ratios of

total and Tier 1 (core) capital to risk-weighted assets. The Basle

Accord requires banking organizations to have total capital equal to at

least 8 percent, and Tier 1 capital equal to at least 4 percent, of

risk-weighted assets after a phase-in period which ended on December

31, 1992. Tier 1 capital is principally comprised of common

shareholders' equity and qualifying perpetual preferred stock, less

disallowed intangibles such as goodwill. The other component of total

capital, Tier 2, may include certain supplementary capital items, such

as general loan loss reserves and subordinated debt. The risk-based

capital requirements are viewed by the three banking agencies and the

OTS as minimum standards, and most institutions are expected to, and

generally do, maintain capital levels well above the minimums.

In addition to specifying identical ratios, the risk-based capital

framework implemented by the three banking agencies includes a common

definition of regulatory capital and a uniform system of risk weights

and categories. While the minimum standards and risk weighting

framework are common to all the banking agencies, there are some

technical differences in language and interpretation among the

agencies. The OTS employs a similar risk-based capital framework

although it differs in some respects from that adopted by the three

banking agencies. These differences, as well as other technical

differences in the agencies' capital standards, are discussed in

Section One of this report.

In addition to the risk-based capital requirements, the agencies

also have established leverage standards setting forth minimum ratios

of capital to total assets. As discussed in Section One, the three

banking agencies employ uniform leverage standards, while the OTS has

established, pursuant to FIRREA, somewhat different standards.

The staffs of the agencies meet regularly to identify and address

differences and inconsistencies in their capital standards. The

agencies are committed to continuing this process in an effort to

achieve full uniformity in their capital standards. In this regard,

Section One contains discussions of the banking agencies' efforts

during the past year to achieve uniformity with respect to the risk

categories of certain assets, specifically, identifiable intangible

assets, loans to finance construction of 1- to 4-family residential

homes that have been pre-sold, and multifamily housing loans. In

addition, the agencies have worked together to revise the risk-based

capital requirements as required by provisions of section 305 of FDICIA

to take account of interest rate risk and risks arising from

concentrations of credit and nontraditional activities. Finally, staffs

of the agencies have been meeting in 1993 to discuss a uniform draft

proposal that would amend their risk-based capital guidelines to

provide for recognition of bilateral netting arrangements associated

with rate contracts that genuinely reduce credit risk.

Accounting Standards

Over the years, the three banking agencies, under the auspices of

the Federal Financial Institutions Examination Council (FFIEC), have

developed Uniform Reports of Condition and Income (Call Reports) for

all commercial banks and FDIC-supervised savings banks. The reporting

standards followed by the three banking agencies are substantially

consistent, aside from a few limited exceptions, with generally

accepted accounting principles (GAAP) as they are applied by commercial

banks.\3\ The uniform bank Call Report serves as the basis for

calculating risk-based capital and leverage ratios, as well as for

other regulatory purposes. Thus, material differences in regulatory

accounting and reporting standards among commercial banks and FDIC-

supervised savings banks do not exist.

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\3\ In those cases where bank Call Report standards are

different from GAAP, the regulatory reporting requirements are

intended to be more conservative than GAAP.

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The OTS requires each thrift institution to file the Thrift

Financial Report (TFR), which is consistent with GAAP as it is applied

by thrifts. The TFR differs in some respects from the bank Call Report.

One reason is that thrift GAAP is different in a few limited areas from

GAAP as it is applied by banks; another, as previously mentioned, is

that there are a few minor areas in which the bank Call Report departs

from bank GAAP. A summary of the differences between the bank Call

Report and the TFR is presented in Section Two.

Over the past year, the three banking agencies and the OTS have

continued to undertake projects that seek to simplify and reduce

differences in reporting standards between commercial banks and thrift

institutions. On June 10, 1993, the four agencies announced six

initiatives to implement the President's March 10 program to improve

the availability of credit to businesses and individuals. These

initiatives included changes to regulatory reporting requirements, all

of which are consistent with GAAP. In this respect, the agencies

separately issued guidance to banks and thrifts that generally conforms

regulatory reporting requirements for sales of Other Real Estate Owned

(OREO) with GAAP, as set forth in FASB Statement No. 66. These changes

generally eliminated a 10 percent minimum down payment requirement

needed by the borrower/purchaser to record a sale of OREO for

regulatory reporting purposes. In addition, as part of these

initiatives, the agencies issued joint policies on restoring nonaccrual

loans to performing status and improving the reporting guidance on

insubstance foreclosures.

Although these actions end the first phase of the President's

credit availability program, the agencies are continuing efforts to

reduce paperwork and regulatory burdens. These efforts include

considering the remaining few differences between GAAP and regulatory

accounting principles. In this regard, the agencies now have projects

under way that are to refine and improve policies and addresses a few

differences that currently exist among the agencies, including projects

on recourse, netting, and hedging.

Section One

Differences In Capital Standards Among Federal Banking and Thrift

Supervisory Agencies

Leverage capital ratios

The three banking agencies employ a leverage standard based upon

the common definition of Tier 1 capital contained in their risk-based

capital guidelines. These standards, established in the second half of

1990 and in early 1991, require the most highly-rated institutions to

meet a minimum Tier 1 capital ratio of 3 percent. For all other

institutions, these standards generally require an additional cushion

of at least 100 to 200 basis points, i.e., a minimum leverage ratio of

at least 4 to 5 percent, depending upon an organization's financial

condition.

As required by FIRREA, the OTS has established a 3 percent core

capital ratio and a 1.5 percent tangible capital leverage requirement

for thrift institutions. However, the OTS is in the process of

finalizing a new leverage rule that will generally conform to the rules

of the three banking agencies. The differences that will exist after

the OTS has adopted its new standard pertain to the definition of core

capital. While this definition generally conforms to Tier 1 bank

capital, certainadjustments discussed below apply to the core capital

definition used by savings associations. In addition, core capital as

currently defined by the OTS includes qualifying supervisory goodwill.

Such goodwill is to be phased out of thrift core capital by the end of

1994, after which time the treatment of goodwill for thrift

institutions will be consistent with that of the banking agencies.

Risk-based capital ratios

The three banking agencies have adopted risk-based capital

standards consistent with the Basle Accord. These standards, which were

fully phased in at the end of 1992, require all commercial banking

organizations to maintain a minimum ratio of total capital (Tier 1 plus

Tier 2) to risk-weighted assets of 8 percent. Tier 1 capital comprises

common stockholders' equity, qualifying perpetual preferred stock, and

minority interests in consolidated subsidiaries, less goodwill. Tier 1

capital must comprise at least 50 percent of the total risk-based

capital requirement. Tier 2 capital includes such components as general

loan loss reserves, subordinated term debt, and certain other preferred

stock and convertible debt capital instruments, subject to appropriate

limitations and conditions. Risk-weighted assets are calculated by

assigning risk weights of 0, 20, 50, and 100 percent to broad

categories of assets and off-balance sheet items based upon their

relative credit risks. The OTS has adopted a risk-based capital

standard that in most respects is similar to the framework adopted by

the banking agencies. Beginning with year-end 1992, the OTS standard

requires a minimum risk-based capital ratio equal to 8 percent.

All the banking agencies view the risk-based capital standard as a

minimum supervisory benchmark. In part, this is because the risk-based

capital standard focuses primarily on credit risk; it does not take

full or explicit account of certain other banking risks, such as

exposure to changes in interest rates. The full range of risks to which

depository institutions are exposed are reviewed and evaluated

carefully during on-site examinations. In view of these risks, most

banking organizations are expected to operate with capital levels well

above the minimum risk-based and leverage capital requirements.

The Federal Reserve has for some time been working with the other

U.S. banking agencies and the regulatory authorities on the Basle

Supervisors' Committee to develop possible methods to measure and

address certain market and price risks. In April, 1993, the Basle

Supervisors' Committee issued a consultative paper that addresses,

among other items, proposals to include certain risks into the

framework of the Basle Accord. These risks include exposures resulting

from imbalances between the maturity of debt instruments held as assets

and issued as liabilities and holdings of traded debt and equity

securities. One important reason for addressing these risks on an

international level is to develop supervisory approaches that do not

undermine the competitiveness of U.S. banking organizations.

Notwithstanding this initial effort, the OTS capital standards for

some time have taken into account interest rate risk and the FRB, OCC

and FDIC sought public comment on a proposed framework for

incorporating into their capital standards interest rate risk in

August, 1992, as required under section 305 of FDICIA. In response to

concerns raised and recommendations made by commenters, on September

14, 1993, the three banking agencies issued for public comment a

substantially modified proposal on interest rate risk. The approach

ultimately adopted by the banking agencies could differ from that

already taken by the OTS.

Section 305 of FDICIA also requires the banking agencies to amend

their risk-based capital rules to take account of concentrations of

credit risk and nontraditional activities. During 1993 the staffs of

the four agencies met regularly to draft proposals for public

consideration. Final proposals are expected to be issued in the first

part of 1994.

In addition to coordinating their efforts to implement section 305,

the agencies also worked together to eliminate differences in their

capital standards, as well as to revise their standards in response to

legislative mandates, accounting changes, and industry concerns. In

this regard, during 1993, the three banking agencies eliminated the

principal difference in their capital standards when they issued final

rules revising those standards with regard to the types of intangible

assets that may be included in the Tier 1 capital calculation for risk-

based and leverage capital purposes. Specifically, under these final

rules, banking organizations may include in capital purchased mortgage

servicing rights (PMSRs) and purchased credit card relationships

(PCCRs), but are required to deduct from capital core deposit

intangibles (CDIs) and other identifiable intangible assets. The final

rule also included limits and discounts that are applicable to PMSRs

and PCCRs in capital. The OTS draft final rule, which is consistent

with the final rule issued by the other agencies, is currently under

review.

Another difference the federal banking agencies worked to eliminate

during 1993 was the risk-based capital treatment of multifamily housing

loans. While the three banking agencies assign multifamily housing

loans (5 units or more) to the 100 percent risk category, the OTS

allows certain multifamily mortgage loans to qualify for the 50 percent

risk category. This would apply, for example, to loans secured by

buildings with 5-36 units (as described below). This effort was

undertaken pursuant to section 618 of the Resolution Trust Corporation

Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRIA),

which requires the agencies to lower the risk weight for multifamily

housing loans meeting certain criteria from 100 to 50 percent. At the

time of this report, final rules have not been issued by the agencies,

although it is anticipated that they will be uniform and will be issued

in the very near future.

Section 618 of the RTCRRIA also required the agencies to revise

their risk-based capital guidelines to lower from 100 percent to 50

percent the risk category for certain construction loans for presold 1-

to 4-family residential properties. During 1993, the four agencies

issued similar final rules implementing this provision of section 618.

The staffs of the four agencies also have been coordinating the

issuance of uniform proposals to include in Tier 1 capital the net

unrealized changes in value of securities available for sale for

purposes of calculating the risk-based and leverage capital ratios of

banking organizations. This proposal effectively would result in the

adoption, for regulatory capital purposes, of the Financial Accounting

Standards Board (FASB) Statement of Financial Accountant Standards No.

115 (FASB 115), ``Accounting for Certain Investments in Debt and Equity

Securities.'' It is expected that the agencies will issue proposals for

public comment in the very near term.

In response to industry recommendations, and in conjunction with

the Basle Supervisors' Committee consultative paper issued in April,

1993, the staffs of the four agencies have been meeting to draft

uniform rules which would amend their risk-based capital standards with

regard to bilateral netting arrangements. Specifically, the proposals

would seek public comment on whether to recognize for risk-based

capital purposes bilateral netting arrangements associated with

interest and foreign exchange rate contracts. Such netting arrangements

would have to genuinely reduce credit risk and be enforceable in all

relevant jurisdictions as evidenced by well-founded and reasoned legal

opinions. It is anticipated that the agencies will issue proposals on

this matter early in 1994.

Differences among the risk-based capital standards of the OTS and

the three banking agencies are discussed below.

Certain collateralized transactions

On December 23, 1992, the Federal Reserve Board issued, after an

appropriate public comment period, an amendment to its risk-based and

leverage capital guidelines for state member banks and bank holding

companies that lowers from 20 to 0 percent the risk category for

collateralized transactions meeting certain criteria. This preferential

treatment is only available for claims collateralized by cash on

deposit in the bank or by securities issued or guaranteed by OECD

central governments or U.S. government agencies. In addition, a

positive margin of collateral must be maintained on a daily basis fully

taking into account any change in the banking organization's exposure

to the obligor or counterparty under a claim in relation to the market

value of the collateral held in support of that claim.

The OCC, on August 18, 1993, issued a proposal for public comment

that would also lower the risk weight for certain collateralized

transactions. The FDIC and OTS are considering similar proposals.

Equity investments

In general, commercial banks that are members of the Federal

Reserve System are not permitted to invest in equity securities, nor

are they generally permitted to engage in real estate investment or

development activities. To the extent that commercial banks are

permitted to hold equity securities (for example, in connection with

debts previously contracted), the three banking agencies generally

assign such investments to the 100 percent risk category for risk-based

capital purposes.

Under the three banking agencies' rules, the agencies may, on a

case-by-case basis, deduct equity investments from the parent bank's

capital or make other adjustments, if necessary, to assess an

appropriate capital charge above the minimum requirement. The banking

agencies' treatment of investments in subsidiaries is discussed below.

The OTS risk-based capital standards require that thrift

institutions deduct certain equity investments from capital over a

phase-in period, which ends on July 1, 1994, as explained more fully

below in the section on subsidiaries.

FSLIC/FDIC - covered assets (assets subject to guarantee arrangements

by the FSLIC or FDIC)

The three banking agencies generally place these assets in the 20

percent risk category, the same category to which claims on depository

institutions and government-sponsored agencies are assigned.

The OTS places these assets in the zero percent risk category.

Limitation on subordinated debt and limited-life preferred stock

Consistent with the Basle Accord, the three banking agencies limit

the amount of subordinated debt and limited-life preferred stock that

may be included in Tier 2 capital. This limit, in effect, states that

these components together may not exceed 50 percent of Tier 1 capital.

In addition, maturing capital instruments must be discounted by 20

percent in each of the last five years prior to maturity.

Neither of these capital components is a permanent source of funds,

and subordinate debt cannot absorb losses while the bank continues to

operate as a going-concern. On the other hand, both components can

provide a cushion of protection to the FDIC insurance fund. Thus, this

limitation permits the inclusion of some subordinated debt in capital,

while assuring that permanent stockholders' equity capital remains the

predominant element in bank regulatory capital.

The OTS has no limitation on the total amount of limited-life

preferred stock or maturing capital instruments that may be included

within Tier 2 capital. In addition, the OTS allows thrifts the option

of: (1) discounting maturing capital instruments, issued on or after

November 7, 1989, by 20 percent a year over the last 5 years of their

term -- the approach required by the banking agencies; or (2) including

the full amount of such instruments provided that the amount maturing

in any of the next seven years does not exceed 20 percent of the

thrift's total capital.

Subsidiaries

Consistent with the Basle Accord and long-standing supervisory

practices, the three banking agencies generally consolidate all

significant majority-owned subsidiaries of the parent organization for

capital purposes. This consolidation assures that the capital

requirements are related to all of the risks to which the banking

organization is exposed.

As with most other bank subsidiaries, banking and finance

subsidiaries generally are consolidated for regulatory capital

purposes. However, in cases where banking and finance subsidiaries are

not consolidated, the Federal Reserve, consistent with the Basle

Accord, generally deducts investments in such subsidiaries in

determining the adequacy of the parent bank's capital.

The Federal Reserve's risk-based capital guidelines provide a

degree of flexibility in the capital treatment of unconsolidated

subsidiaries (other than banking and finance subsidiaries) and

investments in joint ventures and associated companies. For example,

the Federal Reserve may deduct investments in such subsidiaries from an

organization's capital, may apply an appropriate risk-weighted capital

charge against the proportionate share of the assets of the entity, may

require a line-by-line consolidation of the entity, or otherwise may

require that the parent organization maintain a level of capital above

the minimum standard that is sufficient to compensate for any risks

associated with the investment.

The guidelines also permit the deduction of investments in

subsidiaries that, while consolidated for accounting purposes, are not

consolidated for certain specified supervisory or regulatory purposes.

For example, the Federal Reserve deducts investments in, and unsecured

advances to, Section 20 securities subsidiaries from the parent bank

holding company's capital. The FDIC accords similar treatment to

securities subsidiaries of state nonmember banks established pursuant

to Section 337.4 of the FDIC regulations.

Similarly, in accordance with Section 325.5(f) of the FDIC

regulations, a state nonmember bank must deduct investments in, and

extensions of credit to, certain mortgage banking subsidiaries in

computing the parent bank's capital. (The Federal Reserve does not have

a similar requirement with regard to mortgage banking subsidiaries. The

OCC does not have requirements dealing specifically with the capital

treatment of either mortgage banking or securities subsidiaries. The

OCC, however, does reserve the right to require a national bank, on a

case-by-case basis, to deduct from capital investments in, and

extensions of credit to, any nonbanking subsidiary.)

The deduction of investments in subsidiaries from the parent's

capital is designed to ensure that the capital supporting the

subsidiary is not also used as the basis of further leveraging and

risk-taking by the parent banking organization. In deducting

investments in, and advances to, certain subsidiaries from the parent's

capital, the Federal Reserve expects the parent banking organization to

meet or exceed minimum regulatory capital standards without reliance on

the capital invested in the particular subsidiary. In assessing the

overall capital adequacy of banking organizations, the Federal Reserve

may also consider the organization's fully consolidated capital

position.

Under the OTS capital guidelines, a distinction, mandated by

FIRREA, is drawn between subsidiaries that are engaged in activities

that are permissible for national banks and subsidiaries that are

engaged in ``impermissible'' activities for national banks.

Subsidiaries of thrift institutions that engage only in permissible

activities are consolidated on a line-by-line basis if majority-owned

and on a pro rata basis if ownership is between 5 percent and 50

percent. As a general rule, investments, including loans, in

subsidiaries that engage in impermissible activities are deducted in

determining the capital adequacy of the parent. However, investments,

including loans, outstanding as of April 12, 1989, to subsidiaries that

were engaged in impermissible activities prior to that date are

grandfathered and will be phased-out of capital over a transition

period that expires on July 1, 1994. During this transition period,

investments in subsidiaries engaged in impermissible activities that

have not been phased-out of capital are to be consolidated on a pro

rata basis.

Qualifying multifamily mortgage loans

The three banking agencies currently place multifamily mortgage

loans (five units or more) in the 100 percent risk weight category.

Historically, when compared to loans secured by mortgages on 1- to 4-

family residences, which generally are assigned to the 50 percent risk

category, the credit risk associated with multifamily mortgage loans,

unless conservatively underwritten and seasoned, is more akin to that

experienced on commercial property loans, which are assigned to the 100

percent risk category. The OTS allows certain multifamily mortgage

loans to qualify for the 50 percent risk category. This would apply,

for example, to loans secured by buildings with 5-36 units, provided

these loans have a maximum 80 percent loan-to-value ratio and an 80

percent occupancy rate.

Pursuant to Section 618(b) of the RTCRRIA, the three banking

agencies and the OTS were directed to amend their risk-based capital

guidelines to lower the risk weight of certain multifamily housing

loans, and securities backed by such loans, from 100 percent to 50

percent. The section specifies several criteria that a multifamily

housing loan must satisfy in order to qualify for a 50 percent risk

weight. These criteria are:

(1) The loan is secured by a first lien;

(2) The ratio of the principal obligation to the appraised value of

the property, that is, the loan-to-value ratio, does not exceed 80

percent (75 percent if the loan is based on a floating interest rate);

(3) The annual net operating income generated by the property

(before debt service) is not less than 120 percent of the annual debt

service on the loan (115 percent if the loan is based on a floating

interest rate);

(4) The amortization of principal and interest occurs over a period

of not more than 30 years and the minimum maturity for repayment of

principal is not less than seven years; and

(5) All principal and interest payments have been made on time for

a period of not less than one year.

In addition, Section 618(b) also provides that multifamily housing

loans accorded a 50 percent risk weight must meet any underwriting

characteristics that the appropriate Federal banking agency may

establish, consistent with the purposes of the minimum acceptable

capital requirements to maintain the safety and soundness of financial

institutions.

The agencies have proposed revisions to their capital standards to

meet the requirement of section 618(b). It is anticipated that final

rules implementing section 618(b) will be issued by the respective

agencies in the very near future.

Nonresidential construction and land loans

The three banking agencies assign loans for real estate development

and construction purposes to the 100 percent risk category. Reserves or

charge-offs are required, in accordance with examiner judgment, when

weaknesses or losses develop in such loans. The banking agencies have

no requirement for an automatic charge-off when the amount of a loan

exceeds the fair value of the property pledged as collateral for the

loan.

The OTS generally assigns these loans to the 100 percent risk

category. However, if the amount of the loan exceeds 80 percent of the

fair value of the property, that excess portion must be deducted from

capital in accordance with a phase-in arrangement, which ends on July

1, 1994.

Mortgage-backed securities (MBS)

The three banking agencies, in general, place privately-issued MBSs

in a risk category appropriate to the underlying assets but in no case

to the zero percent risk category. In the case of privately-issued MBSs

where the direct underlying assets are mortgages, this treatment

generally results in a risk weight of 50 percent or 100 percent.

Privately-issued MBSs that have government agency or government-

sponsored agency securities as their direct underlying assets are

generally assigned to the 20 percent risk category.

The OTS assigns privately-issued high quality mortgage-related

securities to the 20 percent risk category. These are, generally,

privately-issued MBSs with AA or better investment ratings.

At the same time, both the banking and thrift agencies

automatically assign to the 100 percent risk weight category certain

MBSs, including interest-only strips, residuals, and similar

instruments that can absorb more than their pro rata share of loss. The

Federal Reserve, in conjunction with the other banking agencies and the

OTS, issued, on January 10, 1992, more specific guidance as to the

types of ``high risk'' MBSs that will qualify for a 100 percent risk

weight.

Assets sold with recourse

In general, recourse arrangements allow the purchaser of an asset

to ``put'' the asset back to the originating institution under certain

circumstances, for example if the asset ceases to perform

satisfactorily. This, in turn, can expose the originating institution

to any loss associated with the asset. As a general rule, the three

banking agencies require that sales of assets involving any recourse to

be reported as financings and that the assets be retained on the

balance sheet. This effectively requires a full leverage and risk-based

capital charge whenever assets are sold with recourse, including

limited recourse. The Federal Reserve generally applies a capital

charge to any off-balance sheet recourse arrangement that is the

equivalent of a guarantee, regardless of the nature of the transaction

that gives rise to the recourse obligation.

An exception to this general rule involves pools of 1- to 4-family

residential mortgages and to certain farm mortgage loans. Certain

recourse transactions involving these assets are reported in the bank

Call Report as sales, thereby removing these transactions from leverage

ratio calculations. These transactions, which are the equivalent of

off-balance sheet guarantees, involve the type of credit risk that is

addressed by bank risk-based capital requirements, although some

questions in this regard have been raised because of the treatment

afforded these transactions for leverage purposes. The Federal Reserve

has clarified its risk-based capital guidelines to ensure that recourse

sales involving residential mortgages are to be taken into account for

determining compliance with risk-based capital requirements. The FDIC

clarified its guidelines on this matter in 1993.

In general, the OTS also requires a full capital charge against

assets sold with recourse. However, in the case of limited recourse,

the OTS limits the capital charge to the lesser of the amount of

recourse or the actual amount of capital that would otherwise be

required against that asset, that is, the normal full capital charge.

Some securitized asset arrangements involve the issuance of senior

and subordinated classes of securities against pools of assets. When a

bank originates such a transaction by placing loans that it owns in a

trust and retaining any portion of the subordinated securities, the

banking agencies require that capital be maintained against the entire

amount of the asset pool. When a bank acquires a subordinated security

in a pool of assets that it did not originate, the banking agencies

assign the investment in the subordinated piece to the 100 percent

risk-weight category. The Federal Reserve carefully reviews these

instruments to determine if additional reserves, asset write-downs, or

capital are necessary to protect the bank.

The OTS requires that capital be maintained against the entire

amount of the asset pool in both of the situations described in the

preceding paragraph. Additionally, the OTS applies a capital charge to

the full amount of assets being serviced when the servicer is required

to absorb credit losses on the assets being serviced.

In 1990, the three banking agencies and the OTS, under the FFIEC,

issued for public comment a fact finding paper pertaining to the wide

range of issues relating to recourse arrangements. These issues include

the definition of ``recourse'' and the appropriate reporting and

capital treatments to be applied to recourse arrangements, as well as

so-called recourse servicing arrangements and limited recourse. The

objective of this effort was to develop a comprehensive and uniform

approach to recourse arrangements for capital adequacy, reporting, and

other regulatory purposes. The comments received were very extensive

and generally illustrated the extreme complexity of the subject. In

view of the project's significance and complexity, the FFIEC in

December 1990 decided to narrow the scope of the initial phase of the

recourse project to credit-related risks, including the appropriate

treatment of credit-related recourse arrangements that involve limited

recourse or that support a third party's assets.

A recourse working group, composed of representatives from the

member agencies of the FFIEC, presented a report and recommendations to

the FFIEC in August 1992 and were directed to carry out a study of the

impact of their recommendations on depository institutions, financial

markets, and other affected parties. The interagency group carried out

this study in early 1993. As a result of that study, the working group

has revised several of their recommendations to reflect market

practice. Proposals for public comment are expected to be issued

shortly.

Agricultural loan loss amortization

In the computation of regulatory capital, those banks accepted into

the agricultural loan loss amortization program pursuant to Title VIII

of the Competitive Equality Banking Act of 1987 are permitted to defer

and amortize losses incurred on agricultural loans between January 1,

1984 and December 31, 1991. The program also applies to losses incurred

between January 1, 1983 and December 31, 1991, as a result of

reappraisals and sales of agricultural Other Real Estate Owned (OREO)

and agricultural personal property. These loans must be fully amortized

over a period not to exceed seven years and, in any case, must be fully

amortized by year-end 1998. Thrifts are not eligible to participate in

the agricultural loan loss amortization program established by this

statute.

Treatment of junior liens on 1- to 4-family properties

In some cases, a banking organization may make two loans on a

single residential property, one loan secured by a first lien, the

other by a second lien. In such a situation, the Federal Reserve views

these two transactions as a single loan, provided there are no

intervening liens. This could result in assigning the total amount of

these transactions to the 100 percent risk weight category, if, in the

aggregate, the two loans exceeded a prudent loan-to-value ratio and,

therefore, did not qualify for the 50 percent risk weight. This

approach is intended to avoid possible circumvention of the capital

requirements and capture the risks associated with the combined

transactions.

The FDIC, OCC, and the OTS generally assign the loan secured by the

first lien to the 50 percent risk-weight category and the loan secured

by the second lien to the 100 percent risk-weight category.

Pledged deposits and nonwithdrawable accounts

The capital guidelines of OTS permit thrift institutions to include

in capital certain pledged deposits and nonwithdrawable accounts that

meet the criteria of the OTS. Income Capital Certificates and Mutual

Capital Certificates held by the OTS may also be included in capital by

thrift institutions. These instruments are not relevant to commercial

banks, and, therefore, they are not addressed in the three banking

agencies' capital guidelines.

Mutual Funds

The three banking agencies assign all of a bank's holdings in a

mutual fund to the risk category appropriate to the highest risk asset

that a particular mutual fund is permitted to hold under its operating

rules. The purpose of this is to take into account the maximum degree

of risk to which a bank may be exposed when investing in a mutual fund

in view of the fact that the future composition and risk

characteristics of the fund's holding cannot be known in advance.

The OTS applies a capital charge appropriate to the riskiest asset

that a mutual fund is actually holding at a particular time. In

addition, the OTS guidelines also permit, on a case-by-case basis,

investments in mutual funds to be allocated on a pro rata basis in a

manner consistent with the actual composition of the mutual fund.

Section Two

Differences In Accounting Standards Among Federal Banking and

Thrift Supervisory Agencies

Under the auspices of the FFIEC, the three banking agencies have

developed uniform reporting standards for commercial banks which are

used in the preparation of the Call Report. The FDIC has also applied

these uniform Call Report standards to savings banks under its

supervision. The income statement and balance sheet accounts presented

in the Call Report are used by the bank supervisory agencies for

determining the capital adequacy of banks and for other regulatory,

supervisory, surveillance, analytical, and general statistical

purposes.

Section 121 of FDICIA requires accounting principles applicable to

financial reports (including the Call Report) filed by federally

insured depository institutions with a federal banking agency to be

uniform and consistent with generally accepted accounting principles

(GAAP). However, under Section 121, a federal banking agency may

require institutions to use accounting principles ``no less stringent

than GAAP'' when the agency determines that a specific accounting

standard under GAAP does not meet these new accounting objectives. The

banking agencies believe that GAAP generally satisfies the three

accounting objectives included in FDICIA Section 121. The three

accounting objectives in FDICIA Section 121 mandate that accounting

principles should:

1. Result in financial statements and reports of condition that

accurately reflect the institution's capital;

2. Facilitate effective supervision of depository institutions; and

3. Facilitate prompt corrective action at least cost to the

insurance funds.

As indicated above, Section 121 of FDICIA requires the Federal

Reserve and the other federal banking agencies to utilize accounting

principles for regulatory reports that are consistent with GAAP or are

no less stringent than GAAP. The reporting instructions for Call

Reports that are required by the three banking agencies are

substantially consistent, aside from a few limited exceptions, with

GAAP as applied by commercial banks. As a matter of policy, the

regulatory reporting instructions for Call Reports deviate from GAAP

only in those instances where statutory requirements or overriding

supervisory concerns warrant a departure from GAAP. Furthermore, in

those cases where accounting principles applicable to bank Call Reports

are different from GAAP, the regulatory accounting principles are

intended to be more conservative than GAAP. Thus, the accounting

principles that are followed for regulatory reporting purposes are

consistent with the objectives and mandate of FDICIA Section 121.

The agencies have been working to limit the number of differences

between regulatory accounting principles and GAAP, however, in some

circumstances differences will exist when there is a need to address

supervisory concerns. In addition, the agencies have been working

closely to coordinate any new accounting policies, to ensure

consistency among the agencies and to reduce or eliminate differences

with GAAP.

The OTS has developed and maintains a separate reporting system for

the thrift institutions under its supervision. The TFR is based on GAAP

as applied by thrifts, which differs in some respects from GAAP for

banks.

A summary of the primary differences in accounting principles by

the federal banking and thrift agencies for regulatory reporting

purposes are set forth below, based on a study developed on an

interagency basis:

Futures and forward contracts

The banking agencies, as a general rule, do not permit the deferral

of gains or losses by banks on futures and forwards whether or not they

are used for hedging purposes. All changes in market value of futures

and forward contracts are reported in current period income. The

banking agencies adopted this reporting standard as a supervisory

policy prior to the adoption of FASB Statement No. 80, which allows

hedge or deferral accounting, under certain circumstances. Contrary to

this general rule, hedge accounting in accordance with FASB Statement

No. 80 is permitted by the three banking agencies only for futures and

forward contracts used in mortgage banking operations.

The OTS practice is to follow FASB Statement No. 80 for futures

contracts. In accordance with this statement, when hedging criteria are

satisfied, the accounting for the futures contract is related to the

accounting for the hedged item. Changes in the market value of the

futures contract are recognized in income when the effects of related

changes in the price or interest rate of the hedged item are

recognized. Such reporting can result in deferred gains or losses which

would be reflected on the thrift's balance sheet in accordance with

GAAP.

Excess servicing fees

As a general rule, the three banking agencies do not follow GAAP

for excess servicing fees, but require a more conservative treatment.

Excess servicing results when loans are sold with servicing retained

and the stated servicing fee rate is greater than the normal servicing

fee rate. With the exception of sales of pools of first lien one-to-

four family residential mortgages for which the banking agencies'

approach is consistent with FASB Statement No. 65, excess servicing fee

income in banks must be reported as realized over the life of the

transferred asset, not recognized up front as required by FASB

Statement No. 65.

The OTS allows the present value of the future excess servicing fee

to be treated as an adjustment to the sales price for purposes of

recognizing gain or loss on the sale. This approach is consistent with

FASB Statement No. 65.

In-substance defeasance of debt

The banking agencies do not permit banks to report defeasance of

their debt obligations in accordance with FASB Statement No. 76.

Defeasance involves a debtor irrevocably placing risk-free monetary

assets in a trust solely for satisfying the debt. Under FASB Statement

No. 76, the assets in the trust and the defeased debt are removed from

the balance sheet and a gain or loss for the current period can be

recognized. However, for Call Report purposes, banks may not remove

assets or defeased liabilities from their balance sheets or recognize

resulting gains or losses. The banking agencies have not adopted FASB

Statement No. 76 because of uncertainty regarding the irrevocable

trusts established for defeasance purposes. Furthermore, defeasance

would not relieve the bank of its contractual obligation to pay

depositors or other creditors.

OTS practice is to follow FASB Statement No. 76.

Sales of assets with recourse

In accordance with FASB Statement No. 77, a transfer of receivables

with recourse is recognized as a sale if:

(1) The transferor surrenders control of the future economic

benefits,

(2) The transferor's obligation under the recourse provisions can

be reasonably estimated, and

(3) The transferee cannot require repurchase of the receivables

except pursuant to the recourse provisions.

The practice of the three banking agencies is generally to permit

commercial banks to report transfers of receivables with recourse as

sales only when the transferring institution

(1) Retains no risk of loss from the assets transferred and

(2) Has no obligation for the payment of principal or interest on

the assets transferred.

As a result, virtually no transfers of assets with recourse can be

reported as sales. However, this rule does not apply to the transfer of

first lien 1- to 4-family residential or agricultural mortgage loans

under certain government-sponsored programs (including the Federal

National Mortgage Association and the Federal Home Loan Mortgage

Corporation). Transfers of mortgages under these programs are generally

treated as sales for Call Report purposes.

Furthermore, private transfers of first lien 1- to four- family

residential mortgages are also reported as sales if the transferring

institution retains only an insignificant risk of loss on the assets

transferred. However, the seller's obligation under recourse provisions

related to sales of mortgage loans under the government programs is

viewed as an off-balance sheet exposure. Thus, for risk-based capital

purposes, capital is generally expected to be held for recourse

obligations associated with such transactions.

The OTS policy is to follow FASB Statement No. 77. However, in the

calculation of risk-based capital under the OTS guidelines, off-balance

sheet recourse obligations generally are converted at 100 percent. This

effectively negates the sale treatment recognized on a GAAP basis for

risk-based capital purposes, but not for leverage capital purposes.

Thus, by making this adjustment in the risk-based capital calculation,

the differences between the OTS and the banking agencies for capital

adequacy measurement purposes, are substantially reduced.

The FFIEC has a study under way involving the topic of transfers of

assets with recourse (often referred to as the ``recourse study''). As

part of this study, the staff of the Federal Reserve is reviewing the

reporting treatment for sales of assets with recourse and is exploring

with the staffs of the other agencies the possibility of reducing or

eliminating the differences between regulatory reporting requirements

and GAAP in this area. A proposal addressing this issue is being

finalized for issuance for public comment in the near future.

Push-Down Accounting

When a depository institution is acquired in a purchase

transaction, but retains its separate corporate existence, the

institution is required to revalue all of the assets and liabilities at

fair value at the time of acquisition. When push-down accounting is

applied, the same revaluation made by the parent holding company is

made at the depository institution level.

The three banking agencies require push-down accounting when there

is at least a 95 percent change in ownership. This approach is

generally consistent with interpretations of the Securities and

Exchange Commission.

The OTS requires push-down accounting when there is at least a 90

percent change in ownership.

Negative Goodwill

The three banking agencies require that negative goodwill be

reported as a liability, and not be netted against goodwill assets.

Such a policy ensures that all goodwill assets are deducted in

regulatory capital calculations, consistent with the Basle Accord.

The OTS permits negative goodwill to offset goodwill assets

reported in the financial statements.

Offsetting of Amounts Related to Certain Contracts

The three banking agencies are planning to adopt FASB

Interpretation No. 39 (FIN 39) solely for on-balance sheet items

arising from off-balance sheet derivative instruments, when FIN 39

becomes effective in 1994. FIN 39 allows institutions to offset assets

and liabilities arising from traditional balance sheet items (e.g.,

loans, deposits, etc.) as well as netting assets and liabilities

arising from off-balance sheet derivative instruments only when four

conditions are met. The Call Report's existing guidance generally

prohibits netting of assets and liabilities.

The OTS policy on netting of assets and liabilities is consistent

with GAAP.

The Board staff intends to join the other agencies in a study of

the possibility of adopting FIN 39 for traditional balance sheet items

in the next year.

William W. Wiles,

Secretary of the Board.

[FR Doc. 94-648 Filed 1-10-94; 8:45 am]

BILLING CODE 6210-01-F