Capital Adequacy; Net Unrealized Holding Gains and Losses on Available-for-Sale Securities

SUMMARY: The Office of the Comptroller of the Currency (OCC) is

proposing to amend its capital adequacy rules to revise the definition

of common stockholders' equity to include unrealized holding gains and

losses on available-for-sale securities, net of applicable tax effects.

Inclusion of such unrealized gains and losses as a separate component

of stockholders' equity is consistent with Statement of Financial

Accounting Standards No. 115, ``Accounting for Certain Investments in

Debt and Equity Securities,'' and would keep the OCC's definition of

common stockholders' equity consistent with generally accepted

accounting principles (GAAP). As Tier 1 capital under the OCC's capital

adequacy rules is defined to include common stockholders' equity, this

proposal, if adopted, would require these net unrealized holding gains

and losses to be considered in determining the amount of an

institution's Tier 1 capital.

DATES: Comments should be submitted on or before May 18, 1994.

ADDRESSES: Comments on the OCC's proposal may be submitted to Docket

No. 94-05, Communications Division, Ninth floor, Office of the

Comptroller of the Currency, 250 E Street, SW., Washington, DC 20219.

Comments will be available for inspection and photocopying at that

address.

FOR FURTHER INFORMATION CONTACT: Zane D. Blackburn, Chief Accountant,

(202) 874-5180; Roger Tufts, Senior Economic Advisor, Office of the

Chief National Bank Examiner, (202) 874-5070; Ronald Shimabukuro,

Senior Attorney, Bank Operations and Assets Division, (202) 874-4460,

Office of the Comptroller of the Currency.

SUPPLEMENTARY INFORMATION:

Background

Under the current OCC minimum capital requirements (leverage ratio)

and the risk-based capital guidelines set forth at 12 CFR part 3, a

major component of Tier 1 capital is common stockholders' equity.

Common stockholders' equity is defined to include (1) common stock, (2)

common stock surplus, (3) undivided profits, (4) capital reserves, (5)

adjustments for the cumulative effect of foreign currency translation,

and (6) net unrealized losses on non-current marketable equity

securities. The net unrealized losses are those recorded under

Statement of Financial Accounting Standards No. 12, ``Accounting for

Certain Marketable Securities'' (SFAS 12).

In May 1993, the Financial Accounting Standards Board issued

Statement of Financial Accounting Standards No. 115, ``Accounting for

Certain Investments in Debt and Equity Securities,'' (SFAS 115). This

statement supersedes SFAS 12 and establishes a new component of common

stockholders' equity consisting of net unrealized holding gains and

losses on available-for-sale securities. Under SFAS 115, available-for-

sale securities are those securities which a bank does not have the

positive intent and ability to hold to maturity, but does not intend to

trade actively as part of its trading account.

In August 1993, the OCC, the Federal Reserve Board, The Federal

Deposit Insurance Corporation, and the Office of Thrift Supervision,

announced the adoption of SFAS 115 for regulatory reporting purposes.

The OCC now proposes to adopt SFAS 115 for regulatory capital purposes

as well.

SFAS 115

SFAS 115 applies for all debt securities and certain equity

securities that have readily determinable fair values. The statement

establishes new accounting and reporting requirements for such

securities effective for fiscal years beginning after December 15,

1993, but banks have the option of adopting the statement as of the end

of an earlier fiscal year. For most banks, that would be as of December

31, 1993.

SFAS 115 requires banks to divide their securities holdings among

three categories: securities held-to-maturity, trading securities, and

available-for-sale securities. Each category of security is accounted

for differently.

Held-to-Maturity

The held-to-maturity category replaces the existing held for

investment category. Presently, securities held for investment are

recorded at amortized cost. Under SFAS 115, securities in the held-to-

maturity category will be recorded at amortized cost. However, only

those securities that a bank has both the positive intent and ability

to hold to maturity may be included in this account.

This change will restrict a bank's ability to carry securities at

amortized cost. For example, if a bank has the intent to hold a

security for only an indefinite period, the security cannot be

classified as held-to-maturity. Consequently, if a security would be

sold in response to (1) changes in market interest rates and related

changes in the security's prepayment risk, (2) liquidity needs, (3)

changes in the availability of and yield on alternative investments,

(4) changes in funding sources and terms, or (5) changes in foreign

currency risk, then it must be assigned to either the available-for-

sale or trading categories.

Nonetheless, changes in circumstances may occur that cause a bank

to change its intent to hold a security to maturity. SFAS 115 notes

that a sale or transfer of a security from the held-to-maturity account

in response to events that are isolated, nonrecurring, and unusual and

that could not have been anticipated, would not necessarily call into

question the bank's intent to hold other securities to maturity.

Trading Securities

The accounting for trading securities has not changed. Trading

securities are those debt and equity securities that a bank buys and

holds principally for the purpose of selling in the near term. Trading

securities will continue to be recorded at fair value with unrealized

changes in fair value reported directly in the income statement as part

of the bank's earnings.

Available-for-Sale

All securities that are not classified as either held-to-maturity

or trading will be considered available-for-sale securities. The

available-for-sale category replaces the existing held-for-sale

category. However, it is likely to include some securities previously

considered held for investment. The accounting treatment also has

changed. Under existing accounting requirements, held-for-sale

securities are carried at the lower of cost or fair value, with the

offsetting entry reported directly in the income statement. Under SFAS

115, available-for-sale securities will be recorded at fair value and

any unrealized appreciation or depreciation will be excluded from

earnings and reported, net of applicable tax effects, as a separate

component of common stockholders' equity.

Impact of SFAS 115 on Regulatory Capital

This proposed rule would amend the OCC's capital adequacy rules by

revising the definition of common stockholders' equity. Specifically,

the proposed rule would remove the adjustment for net unrealized losses

on non-current marketable equity securities and replace it with the net

unrealized holding gains and losses on available-for-sale securities

under SFAS 115. Since common stockholders' equity is a component of

Tier 1 capital, the proposed rule would affect the calculation of an

institution's Tier 1 capital under the OCC's capital adequacy rules.

This amendment is intended to adopt SFAS 115 for regulatory capital

purposes and to ensure greater consistency with GAAP.

As discussed earlier, SFAS 115 restricts the circumstances in which

securities may be reported at amortized cost. Thus, a greater

proportion of a national bank's securities will be carried at fair

value. While this proposed rule to adopt SFAS 115 for regulatory

capital purposes will not affect reported earnings, it could result in

an increase in the volatility of regulatory capital. Under the current

interest rate environment, the precise impact of this proposed rule is

difficult to predict. Until recently, interest rates were declining.

Consequently, the fair value for most banks' securities portfolios

generally exceeded their book value. Therefore, the impact of this

proposal likely would have resulted in an increase in the regulatory

capital of national banks. However, with the recent upturn in interest

rates, it is not possible to generalize the impact of this proposed

rule on regulatory capital. Over time, as the interest rate environment

changes, the proposed rule could result in periods of lower regulatory

capital for some national banks and possibly subject a bank to

regulatory action under the OCC's prompt corrective action rules. See

12 CFR part 6. Nonetheless, while the amount of regulatory capital may

vary with changes in interest rates, banks can exercise some control

over the volatility through effective interest rate risk management

techniques.

Issues for Comment

The OCC invites comments on all aspects of this proposal regarding

the regulatory capital treatment of net unrealized holding gains and

losses on available-for-sale securities. However, the OCC specifically

seeks comment on (1) the costs and benefits of adopting SFAS 115 for

regulatory capital purposes, and (2) the extent to which banks will

adjust their behavior to manage the potential volatility in regulatory

capital if the OCC adopts the proposed rule.

Regulatory Flexibility Act

Pursuant to section 605(b) of the Regulatory Flexibility Act, it is

hereby certified that this regulation will not have a significant

economic impact on a substantial number of small entities. Accordingly,

a regulatory flexibility analysis is not required.

This rule may increase the volatility of small banks' regulatory

capital. However, it should not lead to a significant increase in the

number of small banks that do not meet regulatory capital standards

because most small banks operate with capital levels well above

regulatory capital standards. Even if there were a significant decline

in the market value of banks' available-for-sale securities, most banks

would still meet regulatory standards.

Executive Order 12866

It has been determined that this document is not a significant

regulatory action under Executive Order 12866. This proposed rule

affects the method of calculating regulatory capital. This proposed

rule is intended to amend the capital adequacy rules to make the

definition of common stockholders' equity for regulatory capital

consistent with GAAP. This proposed rule should not have a material

impact upon national banks.

List of Subjects in 12 CFR Part 3

Administrative practice and procedure, National banks, Reporting

and recordkeeping requirements.

Authority and Issuance

For the reasons set out in the preamble, title 12, chapter I, part

3 of the Code of Federal Regulations is proposed to be amended as set

forth below.

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

1. The authority citation for part 3 is revised to read as follows:

Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n

note, 3907, and 3909.

2. In appendix A, section 1, paragraph (c)(7) is revised to read as

follows:

Appendix A to Part 3--Risk-Based Capital Guidelines

Section 1. Purpose, Applicability of Guidelines, and Definitions.

* * * * *

(c) * * *

(7) Common stockholders' equity means common stock, common stock

surplus, undivided profits, capital reserves, adjustments for the

cumulative effect of foreign currency translation and net of

unrealized holding gains or losses on available-for-sale securities.

* * * * *

Editorial Note: This document was received by the Office of the

Federal Register on April 13, 1994.

Dated: October 25, 1993.

Eugene A. Ludwig,

Comptroller of the Currency.

[FR Doc. 94-9271 Filed 4-15-94; 8:45 am]

BILLING CODE 4810-33-P