Regulatory Capital: Common Stockholders' Equity

SUMMARY: The Office of Thrift Supervision (OTS), consistent with the

other Federal banking agencies (collectively, the Agencies), is

amending its capital rule to conform its definition of ``common

stockholders' equity'' with the terminology used in referring to

available-for-sale equity securities in Statement of Financial

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

Debt and Equity Securities'' (SFAS No. 115). Specifically, this rule

substitutes the term ``available-for-sale equity securities with

readily determinable fair values'' used in SFAS No. 115 for the current

reference to ``marketable equity securities'' in the OTS definition of

``common stockholders' equity.''

The OTS has decided not to adopt other provisions of its June 1994

proposal that would include net unrealized gains and losses on all

available-for-sale debt and equity securities in regulatory capital.

The OTS and the other Agencies had initially issued proposed rules

to change institutions' regulatory capital computations to be

consistent with generally accepted accounting principles (GAAP), as

amended by SFAS No. 115. Although the Agencies' regulatory capital

rules will not conform with SFAS No. 115, institutions will continue to

be required to comply with SFAS No. 115 for regulatory reporting

purposes, as required by statute.

The Agencies decided not to change their regulatory capital

standards to conform with SFAS No. 115 after extensive interagency

discussion and consideration of comments received, most of which

opposed the Agencies' proposals. Those comments included concerns about

capital volatility if institutions were required to compute regulatory

capital in accordance with SFAS No. 115, which would also have a prompt

corrective action effect.

As a result of not amending the Agencies' capital rules to

incorporate SFAS No. 115, available-for-sale debt securities will

continue to be valued at amortized cost in computing regulatory

capital. (This differs from their valuation at fair value under SFAS

No. 115.) Available-for-sale equity securities will continue to be

valued at the lower of fair value or amortized cost in computing

regulatory capital, as they have been under the Agencies' capital

rules.

EFFECTIVE DATE: October 1, 1995.

FOR FURTHER INFORMATION CONTACT: John F. Connolly, Senior Program

Manager for Capital Policy, Supervision, (202) 906-6465, or Ellen J.

Sazzman, Counsel, Regulations and Legislation Division, Chief Counsel's

Office, (202) 906-7133, Office of Thrift Supervision, 1700 G Street,

NW., Washington, D.C. 20552.

SUPPLEMENTARY INFORMATION:

I. Background of SFAS No. 115

Under the current OTS minimum regulatory capital requirements set

forth at 12 CFR Part 567, common stockholders' equity is the primary

component of core capital for most savings associations. It includes

items that are generally the same as the items that comprised GAAP

equity when the capital rule was adopted. Common stockholders' equity

currently includes: (1) Common stock, (2) common stock surplus, (3)

retained earnings, (4) adjustments for the cumulative effect of foreign

currency translation, and (5) adjustments for net unrealized losses on

non-current marketable equity securities. The net unrealized losses

were those recorded under SFAS No. 12, ``Accounting for Certain

Marketable Securities.''

In May 1993, the Financial Accounting Standards Board (FASB)

amended GAAP by adopting SFAS No. 115, which superseded SFAS No. 12.

SFAS No. 115 divides securities held by depository institutions into

three categories: (1) Securities held to maturity; (2) trading account

securities; and (3) securities available for sale.

Under SFAS No. 115, held-to-maturity securities generally are debt

securities that an institution has the positive intent and ability to

hold to maturity, as evidenced by standards established by SFAS No.

115. Held-to-maturity securities are to be recorded at amortized cost.

Under SFAS No. 115, trading securities are defined as those

securities that an institution buys and holds principally for the

purpose of selling in the near term. As under earlier accounting

standards, these securities are to be reported at fair value (i.e.,

generally at market value), with net unrealized changes in their value

reported directly in the income statement as part of an institution's

earnings.

Securities meeting the definition of the available-for-sale

category (i.e., all debt and equity securities not held for trading

that an institution does not have the requisite intent and ability to

hold to maturity) are to be reported at fair value. This category

generally encompasses: (1) nontrading debt securities (e.g., bonds,

debentures, collateralized mortgage obligations) that an institution

cannot show it will hold to maturity, and (2) nontrading equity

securities (e.g., Fannie Mae or Freddie Mac stock). Changes in the fair

value of available-for-sale securities are to be reported, net of tax

effects, directly in a separate component of common stockholders'

equity. Consequently, any unrealized appreciation or depreciation in

the value of securities in the available-for-sale category has no

impact on the reported earnings of an institution but does affect its

GAAP equity capital position.

In August 1993, the Federal Financial Institutions Examination

Council (FFIEC) announced the adoption of SFAS No. 115 for regulatory

reporting purposes, effective January 1, 1994. The OTS made a similar

decision for regulatory reporting by savings associations in an August

16, 1993

[[Page 42026]]

policy statement.1 Accordingly, all savings associations now

follow SFAS No. 115 for regulatory reporting purposes. Associations

reflect unrealized gains and losses on all available-for-sale

securities (debt as well as equity), rather than just the net

unrealized losses on marketable equity securities, as a separate

capital component for regulatory reporting purposes.

\1\ See letter of August 16, 1993, from Acting Director Fiechter

to the Chief Executive Officers of Savings Associations.

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II. OTS Proposed Rule and Interim Policy

The issuance of SFAS No. 115 raised the question of how net

unrealized gains and losses on available-for-sale securities should be

treated for purposes of calculating the amount of an association's

regulatory capital under part 567. In its August 16, 1993 policy

statement, the OTS permitted savings associations to adopt SFAS No. 115

for both financial reporting and capital purposes as early as June 30,

1993. This early adoption option was expressly permitted by SFAS No.

115, which did not become mandatory until the fiscal year beginning

after December 15, 1993.

On June 22, 1994, the OTS published its proposal to amend the OTS

capital rule to include the SFAS No. 115 capital component in core

capital, replacing the superseded SFAS No. 12 component.2 The

other Agencies, the Office of the Comptroller of the Currency (OCC),

the Federal Reserve Board (FRB), and the Federal Deposit Insurance

Corporation (FDIC), published similar proposals to adopt SFAS No. 115

for regulatory capital purposes.3 The stated rationale for these

proposals was to conform the Agencies' capital regulations to GAAP and

to include unrealized gains and losses on available-for-sale debt and

equity securities in regulatory capital.

\2\ 59 FR 32143 (June 22, 1994).

\3\ See 59 FR 18328 (April 18, 1994) (OCC); 58 FR 68563

(December 28, 1993) (FRB); 58 FR 68781 (December 29, 1993) (FDIC).

In its June 22, 1994 notice of proposed rulemaking, the OTS

requested comment on all aspects of the proposed rule, and specifically

solicited comment on whether unrealized gains and losses under SFAS No.

115 should be included in core capital for purposes of the leverage

ratio requirement, for purposes of the risk-based capital requirements

and for purposes of Prompt Corrective Action (PCA).4 The OTS also

specifically solicited comment on what changes, if any, in asset

liability management or risk management would likely result from the

inclusion of SFAS No. 115 unrealized gains and losses in capital and

whether such changes would increase or decrease risk to the Savings

Association Insurance Fund (SAIF).5

\4\ See 59 FR at 32144. The OTS's risk-based capital

requirements are located at 12 CFR Part 567 and its PCA requirements

are located at 12 CFR Part 565.

\5\ See 59 FR at 32144.

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The proposal's comment period closed on July 22, 1994. After

consideration of the comments received and in anticipation of its final

rule, the OTS issued a November 28, 1994 interim policy statement,

which provided that the SFAS No. 115 capital component could no longer

be included in regulatory capital.6

\6\ See letter dated November 28, 1994, from Acting Director

Fiechter to the Chief Executive Officers of Savings Associations,

which revised the August 16, 1993 interim policy statement

(permitting associations to adopt SFAS No. 115 for financial

reporting and capital purposes). The November 28 policy statement

gave associations the option either to follow the revised policy for

submission of their December 1994 Thrift Financial Reports (TFRs),

or to defer implementation as late as submission of their June 1995

TFRs. The OTS provided this optional transition period to give

associations sufficient time to plan for the effects of the revised

policy on their regulatory capital and to take any appropriate

business actions.

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III. Comment Summary

In response to its notice of proposed rulemaking, the OTS received

10 comments: five from savings associations, one from a commercial

bank, one from a state-chartered savings bank, two from financial

institution trade associations, and one from an investment banking

firm. Eight of the commenters generally opposed the OTS proposal, while

two commenters strongly supported the proposal. The OTS has also

considered the comments received by the other federal banking agencies

in working with the other agencies to develop a consistent interagency

position on SFAS No. 115.

A. Comments Opposing a SFAS No. 115 Component

Commenters opposing the proposal raised a number of common

concerns. Their primary concern was a belief that the proposal would

distort the true picture of savings associations' core capital. These

commenters reasoned that the SFAS No. 115 capital component has less

bearing on their institutions' financial strength than the

institutions' more permanent base of common stock, paid-in surplus and

retained earnings. Under SFAS 115, changes in interest rates could

dramatically affect institutions' capital positions without affecting

their amount of common stock and retained earnings and without them

suffering any losses through their income statements. Commenters

asserted that another distortion arises because SFAS No. 115 requires

that the change in fair value of securities subject to SFAS No. 115 be

included in GAAP capital, but does not require that any offsetting

changes in the value of associations' deposit bases and hedging

instruments be included in GAAP capital.

A second related concern of commenters objecting to the proposal

was that adopting the proposal would result in excessive volatility in

associations' regulatory capital levels and present an inaccurate

picture of associations' long-range viability. Commenters observed that

associations' capital levels would change with temporary movements in

interest rates, which in turn cause temporary changes in a security's

market value. Commenters argued that associations may have sufficient

capital and liquidity to give them the discretion to determine not to

sell those securities when the market is unfavorable. These commenters

submitted that because associations would not be forced to sell their

available-for-sale securities in a market trough, they should not be

required to include those unrealized losses on securities in their

regulatory capital calculations. Such inclusion could result in

volatile temporary fluctuations in the associations' regulatory capital

levels, which in turn could trigger more permanent regulatory

limitations and subject associations to increased deposit insurance

premiums or PCA sanctions. These commenters argued that in the worst

case, some associations with the ability to survive a temporary market

trough might be forced into receivership because of unrealized losses

in their SFAS No. 115 capital component.

A number of commenters stressed that associations might take steps

to avoid unrealized losses that could harm their long-term financial

viability. Some commenters said that associations would purchase

shorter duration securities to avoid the greater volatility in the

value of longer term securities. This action would lower the yield on

associations' securities and reduce the net income that they could add

to their retained earnings. Some commenters added that associations

would have the incentive to make up for this lower yield by increasing

the credit risk in their portfolios. This strategy would increase

associations' yield in a potentially dangerous way not captured by SFAS

No. 115 without necessarily affecting their reported capital levels.

Some commenters also contended that because SFAS No. 115 only

applies to securities, associations would avoid

[[Page 42027]]

SFAS No. 115's mark-to-market requirements by purchasing or retaining

whole loans instead of similar loans that had been securitized and

guaranteed by government sponsored enterprises or the private market.

This approach could harm associations because many loans have greater

credit risk than guaranteed, high-quality mortgage-related securities.

Other commenters submitted that the OTS interest-rate risk model

and capital component already capture and address associations'

interest rate risk exposure. They argued that adoption of SFAS No. 115

for capital purposes was unnecessary, could conflict with the interest-

rate risk model and component, and could result in a double hit to

capital for interest rate swings.

Commenters opposing the proposal also argued that its adoption

would lead to associations' focusing too much attention on the short-

term effects of investment decisions instead of long-term economic

viability. Commenters also raised the possibility that adoption of the

proposal would make an association reluctant to sell securities from

its held-to-maturity portfolio for fear of having its entire held-to-

maturity portfolio reclassified as available-for-sale, thereby limiting

an association's flexibility to manage its investments properly.

Several commenters were critical of the market value accounting

approach imposed by SFAS 115 because it includes in capital unrealized

gains and losses that might never be realized by an association and so

could present a misleading picture of an association's current

financial condition. Commenters also submitted that SFAS 115 is

inconsistent in its approach because it requires institutions to

account for certain assets at fair market value while liabilities are

valued at cost.

B. Comments Supporting a SFAS No. 115 Component

The two commenters supporting the OTS proposed rule believed that

the OTS's adoption of SFAS No. 115 for regulatory capital purposes was

consistent with GAAP and the Agencies' requirements that institutions

comply with SFAS No. 115 for regulatory reporting purposes. These

commenters reasoned that the proposal would minimize the reporting and

systems burden that would otherwise result if the SFAS No. 115 capital

component is treated differently in regulatory capital calculations

than in GAAP and regulatory reports. Second, these commenters stated

that the OTS's adoption of SFAS No. 115 for regulatory capital purposes

would be consistent with Congressional intent as manifested in section

121 of the Federal Deposit Insurance Corporation Improvement Act of

1991 (FDICIA),7 which provides that Federal banking agency

regulatory accounting policy applicable to reports or statements filed

with those agencies be no less stringent than GAAP. One commenter

contended that including the SFAS No. 115 equity component in

regulatory capital would protect associations and the deposit insurance

fund by causing associations to control their interest-rate risk

exposure. This commenter believed that SFAS No. 115 gives associations

the appropriate incentive to hold shorter duration securities and to

limit their interest-rate risk exposure to avoid drops in their capital

levels.

\7\ Pub. L. 102-242 (1991).

Finally, one commenter contended that not adopting SFAS No. 115 for

regulatory capital purposes would arguably allow institutions

temporarily to hide their losses and to defer appropriate supervisory

action. This would be inconsistent with prudent asset liability

management and ultimately with protecting the SAIF from losses not

otherwise included in regulatory capital. Furthermore, failure to

include unrealized losses in regulatory capital would give

associations, particularly undercapitalized ones, an incentive to

speculate on interest rates by holding unhedged long-term securities.

C. Comments Suggesting Alternative Ways of Incorporating a SFAS No. 115

Component

The majority of commenters opposing the proposal supported

excluding the SFAS No. 115 equity component from regulatory capital

altogether. Several commenters, however, suggested alternative methods

of incorporating SFAS 115 into the OTS's regulatory capital regulation.

One commenter recommended that, if SFAS No. 115 was going to affect

regulatory capital, that it only be included in supplementary capital

or in risk-based capital computations. Commenters also argued that,

even if the SFAS No. 115 equity component was included in regulatory

capital, it should be excluded from computations and determinations

relating to PCA, insurance premiums, lending limits, and other

differential regulations based on capital levels. Other commenters

recommended that the OTS propose a method for balancing the mark-to-

market adjustment for available-for-sale securities with offsetting

adjustments to associations' deposits, other liabilities, and hedging

instruments. Finally, several commenters recommended that OTS institute

a three-quarter lag similar to that used with the interest-rate risk

component to reduce the effects of temporary market fluctuations and to

give associations time to take action ameliorating the effects of their

unrealized losses.

IV. The Final Rule

After considering all the comments received, the OTS, in

consultation with the other Agencies, has decided not to adopt its

proposal to include the SFAS No. 115 equity component in computing

regulatory capital. Savings associations, however, must follow SFAS No.

115 for regulatory reporting purposes, as required by statute. This

decision leaves in effect the OTS's current requirement that nontrading

debt securities be valued at amortized cost and nontrading marketable

equity securities be valued at the lower of fair value or amortized

cost for computing regulatory capital.\8\ This decision is consistent

with the recommendation of the Task Force on Supervision of the FFIEC

and the policies of the other Agencies.\9\

\8\ See current 12 CFR 567.1(d) and the OTS's November 28, 1994

interim policy statement, which provided that the SFAS No. 115

capital component could no longer be included in regulatory capital.

\9\ See 59 FR 60552 (November 25, 1994) (OCC), 59 FR 63241

(December 8, 1994) (FRB), and 59 FR 66662 (December 28, 1994)

(FDIC).

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Based on the comment letters received, the OTS determined that

adoption of the proposal could potentially have an inappropriate impact

on associations' regulatory capital and result in an inaccurate picture

of their capital positions. For example, fluctuations in interest rates

could cause temporary changes in regulatory capital levels, which in

turn could trigger more permanent regulatory intervention and

inappropriately affect industry profitability. In addition, including

the SFAS No. 115 adjustment in capital could potentially distort an

association's capital position by giving the same weight to an

association's SFAS 115 component as is given to its common stock, paid-

in surplus, and retained earnings. Also, changes in the value of

institutions' assets from interest rate changes would not be properly

balanced by offsetting changes in the value of institutions'

liabilities and hedge positions.

The OTS is also concerned that adoption of the proposal would

encourage management to place excessive weight on the accounting

implications of their decisions, rather than on their long-term

economic impacts. Associations could potentially take actions or make

investment

[[Page 42028]]

decisions to avoid the effects of SFAS No. 115 that could give

associations more flexibility in the short run but might not enhance

the associations' long-term viability.

The OTS considered the comments received regarding FDICIA's

requirement that regulatory accounting policy be no less stringent than

GAAP. Section 121 of FDICIA \10\ requires that policies applicable to

reports and statements filed with the Federal banking agencies

generally conform to GAAP. The section, however, does not require the

calculation of an institution's regulatory capital or the components of

regulatory capital to conform to GAAP, and the legislative history of

the section indicates that was not necessarily the intent of

Congress.\11\ Furthermore, calculation of associations' risk-based

capital requirements under the OTS capital rule is based on principles

that are so fundamentally different from GAAP that comparing the

stringency of the OTS rule with GAAP is not meaningful. Accordingly, we

do not believe that Congress intended the OTS to make such a

comparison.

\10\ 12 U.S.C. 1831n(a).

\11\ See generally H.R. Rep. No. 102-330, 102d Cong., 2d Sess.

119 (1991).

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By adopting SFAS No. 115 for regulatory reporting purposes, the OTS

is complying with the requirements of section 121 and is utilizing a

uniform approach with the other Agencies. Adoption of such a uniform

approach also complies with FDICIA's requirement that each Federal

banking agency ``maintain uniform accounting standards to be used for

determining compliance with statutory or regulatory requirements of

depository institutions.'' \12\ Adoption of this uniform interagency

policy also is consistent with the general goal of regulatory

uniformity set forth in Section 303 of the Riegle Community Development

and Regulatory Improvement Act of 1994 (CDRIA).\13\

\12\ 12 U.S.C. 1831n(b).

\13\ Pub. L. 103-325, 108 Stat. 2160.

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The OTS did consider alternatives suggested by several commenters

including counting the net unrealized holding gains and losses on

available-for-sale securities in risk-based or supplementary capital

calculations, or including net unrealized holding gains and losses on

available-for-sale securities in regulatory capital but excluding the

adjustment from capital calculations tied to other regulations.

However, the OTS believes such approaches would be too complex and

burdensome and potentially could require a savings association to

maintain yet another set of capital calculations. Furthermore, because

SFAS No. 115 significantly increased the number of securities subject

to market valuation, including the unrealized gains and losses in risk-

based capital may contribute to volatility in regulatory capital

levels.

The OTS has decided, therefore, to retain its current requirements

that available-for-sale debt securities be valued at amortized cost and

that marketable equity securities be valued at the lower of amortized

cost or fair value. This is consistent with the current capital

treatment of these securities by the other Federal banking agencies.

To conform the capital rule's definition of ``common stockholders'

equity'' to the terminology and standards used in SFAS No. 115,

however, this rule substitutes the phrase ``net unrealized losses on

available-for-sale equity securities with readily determinable fair

values'' instead of ``net unrealized losses on non-current marketable

equity securities.'' \14\ The latter phrase was based on terminology

included in the SFAS No. 12 accounting standard, which was superseded

by SFAS No. 115. The new terminology of the revised regulation

encompasses the identical types of securities as the pre-existing

regulation.

\14\ See current version of 12 CFR 567.1(d).

Finally, the OTS will continue to consider unrealized gains and

losses on securities, regardless of their classification under SFAS No.

115 or this rule, as a factor in various supervisory determinations.

For example, an association's unrealized gain or loss on securities

would be an appropriate factor for an examiner to consider in

evaluating the adequacy of the association's level of regulatory

capital or in making discretionary supervisory determinations, such as

the reasonableness of associations' capital distributions.

Regulatory Flexibility Act

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

hereby certified that this final rule will not have a significant

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

a regulatory flexibility analysis is not required. This final rule is

not expected to increase the capital requirements of a substantial

number of small entities. This final rule is not expected to have a

disparate effect on the capital levels of small entities as opposed to

larger entities; rather the effect on capital will be minimal

regardless of savings association size.

Executive Order 12866

The OTS has determined that this final rule is not a significant

regulatory action under Executive Order 12866.

Unfunded Mandates Reform Act of 1995

The OTS has determined that this final rule will not result in the

expenditure by State, local, and tribal governments, in the aggregate,

or by the private sector, of $100,000,000 or more in any one year, and

therefore is not a significant regulatory action under Section 202 of

the Unfunded Mandates Reform Act of 1995, Pub. L. 104-4, 109 Stat. 64

(signed into law on March 22, 1995).

Paperwork Reduction Act

The OTS has determined that this final rule will not increase the

regulatory paperwork burden of savings associations pursuant to the

provisions of the Paperwork Reduction Act, 44 U.S.C. 3501 et seq.

List of Subjects in 12 CFR Part 567

Capital, Reporting and recordkeeping requirements, Savings

associations.

Authority and Issuance

For the reasons set forth in the preamble, the Office of Thrift

Supervision hereby amends part 567, chapter V, title 12, Code of

Federal Regulations, as set forth below:

Subchapter D--Regulations Applicable to All Savings Associations

PART 567--[AMENDED]

1. The authority for part 567 continues to read as follows:

Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828

(note).

2. Section 567.1 is amended by revising paragraph (d) to read as

follows:

Sec. 567.1 Definitions.

* * * * *

(d) Common stockholders' equity. The term common stockholders'

equity means common stock, common stock surplus, retained earnings, and

adjustments for the cumulative effect of foreign currency translation,

less net unrealized losses on available-for-sale equity securities with

readily determinable fair values.

* * * * *

Dated: August 3, 1995.

[[Page 42029]]

By the Office of Thrift Supervision.

Jonathan L. Fiechter,

Acting Director.

[FR Doc. 95-19854 Filed 8-14-95; 8:45 am]

BILLING CODE 6720-01-P