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 and Financial Services 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 (12 U.S.C 1831n(c)). Section

37(c) requires each federal banking agency to report to the Committee

on Banking and Financial Services 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, D.C. 20429, telephone (202) 898-8906.

SUPPLEMENTARY INFORMATION: The text of the report follows: Report to

the Committee on Banking and Financial Services 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.

A. Introduction

This report has been prepared by the Federal Deposit Insurance

Corporation (FDIC) pursuant to Section 37(c) of the Federal Deposit

Insurance Act, which requires the agency to submit a report to

specified Congressional Committee describing any differences in

regulatory capital and accounting standards among the federal banking

and thrift agencies, including an explanation of the reasons for these

differences. Section 37(c) also requires the FDIC to publish this

report in the Federal Register. This report covers differences existing

during 1995 and 1996 and developments affecting these differences.

The FDIC, the Board of Governors of the Federal Reserve System

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

(hereafter, the banking agencies) have substantially similar leverage

and risk-based capital standards. While the Office of Thrift

Supervision (OTS) employs a regulatory capital framework that also

includes leverage and risk-based capital requirements, it differs in

several respects from that of the banking agencies. Nevertheless, the

agencies view the leverage and risk-based capital requirements as

minimum standards and most institutions 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.

The 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 banking agencies through December 31, 1996, have been substantially

consistent with generally accepted accounting principles (GAAP). In the

limited number of cases where the bank Call Report standards differed

from (GAAP), the regulatory reporting requirements were intended to be

more conservative than GAAP. The OTS requires each savings association

to file the Thrift Financial Report (TFR), the reporting standards for

which are consistent with GAAP. Thus, the reporting standards

applicable to the bank Call Report have differed in some respect from

the reporting standards applicable to the TFR.

On November 3, 1995, the FFIEC announced that it had approved the

adoption of GAAP as the reporting basis for the balance sheet, income

statement, and related schedules in the Call Report, effective with the

March 31, 1997, report date. On December 31, 1996, the FFIEC notified

banks about the Call Report revisions for 1997, including the

previously announced move to GAAP. Adopting GAAP as the reporting basis

for recognition and measurement purposes in the basic schedules of the

Call Report was designed to eliminate existing differences between bank

regulatory reporting standards and GAAP, thereby producing greater

consistency in the information collected in bank Call Reports and

general purpose financial statements and reducing regulatory burden. In

addition, the move to GAAP for Call Report purposes in 1997 should for

the most part eliminate the differences in accounting standards among

the agencies.

Section 303 of the Riegle Community Development and Regulatory

Improvement Act (RCDRIA) of 1994 (12 U.S.C. 4803) requires the banking

agencies and the OTS to conduct a systematic review of the regulations

and written policies in order to improve efficiency, reduce unnecessary

costs, and eliminate inconsistencies. It also directs the four agencies

to work jointly to make uniform all regulations and guidelines

implementing common statutory or supervisory policies. The results of

these efforts must be ``consistent with the principles of safety and

soundness, statutory law and policy, and the public interest.'' The

four agencies' efforts to eliminate existing differences among their

regulatory capital standards as part of the Section 303 review are

discussed in the following section.

B. Differences in Capital Standards Among the Federal Banking and

Thrift Agencies

B.1. Minimum Leverage Capital

The banking agencies have established leverage capital standards

based upon the definition of tier 1 (or core) capital contained in

their risk-based capital standards. These standards require the most

highly-rated banks (i.e., those with a composite rating of ``1'' under

the Uniform Financial Institutions Rating System) to maintain a minimum

leverage capital ratio of at least 3 percent if they are not

anticipating or experiencing any significant growth and meet certain

[[Page 62311]]

other conditions. All other 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 ration of not less than 4

percent).

The OTS has a 3 percent core capital and a 1.5 percent tangible

capital leverage requirement for savings associations. Consistent with

the requirements of the Financial Institutions Reform, Recovery, and

Enforcement Act of 1989 (FIRREA), the OTS has proposed revisions to its

leverage standards 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. However, from a

practical standpoint, the 4 percent leverage requirement to be

``adequately capitalized'' under the OTS' Prompt Correction Action rule

is the controlling standard for savings associations.

As a result of the Section 303 review of the four agencies'

regulatory capital standards, the agencies are considering adopting a

uniform leverage requirement that would subject institutions rated a

composite 1 under the Uniform Financial Institutions Rating System to a

minimum 3 percent leverage ratio and all other institutions to a

minimum 4 percent leverage ratio. This change would simplify and

streamline the banking agencies' leverage rules and would make all four

agencies' rules in this area uniform. On February 4, 1997, the FDIC

Board of Directors approved the publication for public comment of a

proposed amendment to the FDIC's leverage capital standards that would

implement this change. This proposal is to be published jointly with

the other agencies.

B.2. Interest Rate Risk

Section 305 of the Federal Deposit Insurance Corporation

Improvement Act of 1991 (FDICIA) mandates that the agencies' risk-based

capital standards take adequate account of interest rate risk. The

banking agencies requested comment in August 1992 and September 1993 on

proposals to incorporate interest rate risk into their risk-based

capital standards. In August 1995, each of the banking agencies amended

its capital standards to specifically include an assessment of a bank's

interest rate risk, as measured by its exposure to declines in the

economic value of its capital due to changes in interest rates, in the

evaluation of bank capital adequacy. At the same time, the banking

agencies issued a proposed joint policy statement describing the

process the agencies would use to measure and assess the exposer of the

economic value of a bank's capital. After considering the comments on

the proposed policy statement, the banking agencies issued a Joint

Agency Policy Statement on Interest Rate Risk in June 1996 which

provides guidance on sound practices for managing interest rate risk.

This policy statement does not establish a standardized measure of

interest rate risk nor does it create an explicit capital charge for

interest create risk. Instead, the policy statement identifies the

standards upon which the agencies will evaluate the adequacy and

effectiveness of a bank's interest rate risk management.

In 1993, the OTS adopted a final rule which adds an interest rate

risk component to its risk-based capital standards. Under this rule,

savings associations with a greater than normal interest rate exposure

must take a deduction from the total capital available to meet their

risk-based capital requirement. The deduction is equal to one half of

the difference between the institution's actual measured exposure and

the normal level of exposure. The OTS has partially implemented this

rule by formalizing the review of interest rate risk; however, no

deductions from capital are being made. As described above, the

approach adopted by the banking agencies differs from that of the OTS.

B.3. Subsidiaries

The banking agencies generally consolidate all significant

majority-owned subsidiaries of the parent organization for regulatory

capital purposes. The purpose of this practice is to assure that

capital requirements are related to all of the risks to which the bank

ins 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

form capital, or the investments may be risk-weighted at 100 percent,

depending upon the circumstances. These options for handling

subsidiaries for purposes of determining the capital adequacy of the

parent organization provide the banking agencies with the flexibility

necessary to ensure that institutions maintain capital levels that are

commensurate with the actual risks involved.

Under OTS capital guidelines, a distinction, mandated by FIRREA, is

drawn between subsidiaries engaged in activities that are permissible

for national banks and subsidiaries engaged in ``impermissible''

activies for national banks. For regulatory capital purposes,

subsidiaries of savings associations 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, and loans to,

subsidiaries that engage in impermissible activities are deducted when

determing the capital adequacy of the parent. However, for subsidiaries

which were engaged in impermissible activities prior to April 12, 1989,

investments in, and loans to, such subsidiaries that were outstanding

as of that date were grandfathered and were phased out of capital over

a five-year transition period that expired on July 1, 1994. During this

transition period, investments in subsidiaries engaged in impermissible

activities which had not been phased out of capital were consolidated

on a pro rata basis. The phase-out provisions were amended by the

Housing and Community Development Act of 1992 with respect to

impermissible and activities. The OTS was permitted to extend the

transition period until July 1, 1996, on a case-by-case basis if

certain conditions were met.

B.4. Intangible Assets

The banking agencies' rules permit purchased credit card

relationships and 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 Tier 1 capital. In

addition, purchased credit card relationships alone are restricted to

no more than 25 percent of an institution's Tier 1 capital. Any

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 Tier 1 capital.

In February 1994, the OTS issued a final rule making its capital

treatment of intangible assets generally consistent with the banking

agencies' rules. However, the OTS rule grandfathers preexisting core

deposit intangibles up to 25 percent of core capital and all purchased

mortgage servicing rights acquired before February 1990.

B.5. Capital Requirements for Recourse Arrangements

B.5.a. Leverage Capital Requirements--Through December 31, 1996,

the banking agencies required full leverage capital charges on most

assets sold with recourse, even when the recourse is limited. This

included transactions where the recourse arises

[[Page 62312]]

because the seller, as servicer, must absorb credit losses on the

assets being serviced. Two exceptions to this general rule pertained to

certain pools of first lien one-to-four family residential mortgages

and to certain agricultural mortgage loans. As required by Section 208

of the RCDRIA, an additional exception took effect in 1995 for small

business loans and leases sold with recourse by ``qualified insured

depository institutions.'' Banks had to maintain leverage capital

against most assets sold with recourse because the banking agencies'

regulatory reporting rules that were in effect through December 31,

1996, generally did not permit assets sold with recourse to be removed

from a bank's balance sheet (see ``Sales of Assets With Recourse'' in

Section C.1. below for further details). As a result, such assets

continued to be included in the asset base which was used to calculate

a bank's leverage capital ratio.

Because the regulatory reporting rules for thrifts enable them to

remove assets sold with recourse from their balance sheets when such

transactions qualify as sales under GAAP, the OTS capital rules do not

require thrifts to hold leverage capital against such assets.

As a result of the adoption of GAAP as the reporting basis for bank

Call Reports in 1997, banks will no longer be precluded from removing

assets transferred with recourse from their balance sheets if the

transfers qualify for sale treatment under GAAP. Thus, this capital

difference disappears in 1997.

B.5.b. Low Level Recourse Transactions--The banking agencies and

the OTS generally require a full risk-based capital charge against

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

limited recourse, the OTS has limited the capital charge 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 full

effective risk-based capital charge. This is known as the ``low level

recourse'' rule.

The banking agencies proposed in May 1994 to adopt the low level

recourse rule that the OTS already had in place. Such action was

mandated four months later by Section 350 of the RCDRIA. The FDIC

adopted the low level recourse rule in March 1995, and the other

banking agencies have taken similar action. Hence, this difference in

capital standards has been eliminated.

B.5.c. Senior-Subordinated Structures--Some securitized asset

arrangements involve the creation of senior and subordinated classes of

securities. When a bank originates such a transaction and retains the

subordinated interest, the banking agencies require that capital be

maintained against the entire amount of the asset pool. However, when a

bank acquires a subordinated interest in a pool of assets that it did

not own, the banking agencies assign the investment in the subordinated

security to the 100 percent risk weight category.

In general, the OTS requires a thrift that holds the subordinated

interest in a senior-subordinated structure to maintain capital against

the entire amount of the underlying asset pool regardless of whether

the subordinated interest has been retained or has been purchased.

In May 1994, the banking agencies proposed to 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. This

proposal was part of a larger proposal issued jointly by the four

agencies to address the risk-based capital treatment of recourse and

direct credit substitutes (i.e., guarantees on a third party's assets).

The four agencies have considered the comments on the entire proposal

and have been developing a revised proposal on recourse and direct

credit substitutes that will also encompass the risk-based capital

treatment of asset securitization transactions.

B.5.d. Recourse Servicing--The right to service loans and other

assets may be retained when the assets are sold. This right also may be

acquired from another entity. Regardless of whether servicing rights

are retained or acquired, recourse is present whenever the servicer

must absorb credit losses on the assets being serviced. The banking

agencies and the OTS require risk-based capital to be maintained

against the full amount of assets upon which a selling institution, as

servicer, must absorb credit losses. Additionally, the OTS applies a

capital charge to the full amount of assets being serviced by a thrift

that has purchased the servicing from another party and is required to

absorb credit losses on the assets being serviced.

The agencies' aforementioned May 1994 proposal also would require

banking organizations that purchase certain loan servicing rights which

provide loss protection to the owners of the loans serviced to hold

capital against those loans. The treatment of purchased recourse

servicing is also being addressed in the revised proposal on recourse

and direct credit substitutes that the agencies are developing.

B.6. Collateralized Transactions

The FRB and the OCC have lowered from 20 percent to zero percent

the risk weight accorded collaterialized claims for which a positive

margin of protection is maintained on a daily basis by cash on deposit

in the institution or by securities issued or guaranteed by the U.S.

Government or the central governments of countries that are members of

the Organization of Economic Cooperation and Development (OECD).

The FDIC and the OTS still assign a 20 percent risk weight to

claims collateralized by cash on deposit in the institution or by

securities issued or guaranteed by the U.S. Government or OECD central

governments.

As part of their Section 303 review of capital standards, the

banking and thrift agencies issued a joint proposal in August 1996 that

would permit collateralized claims that meet criteria that are uniform

among all four agencies to be eligible for a zero percent risk weight.

In general, this proposal would allow less capital to be held by

institutions supervised by the FDIC and the OTS for transactions

collateralized by cash or U.S. or OECD government securities. The

proposal would eliminate the differences among the agencies regarding

the capital treatment of collateralized transactions.

B.7. Limitation on Subordinated Debt and Limited-Life Preferred

Stock

Consistent with the Basle Accord, the banking agencies limit the

amount of 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 in each of the last 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 capital. 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.

[[Page 62313]]

B.8. Presold Residential Construction Loans

The four agencies assign a 50 percent risk weight to loans that a

builder has obtained to finance the construction of one-to-four family

residential properties. These properties must be presold, and the

lending relationships must meet certain other criteria. The OTS and OCC

rules indicate that the property must be presold before the

construction loan is made in order for the loan to qualify for the 50

percent risk weight. 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.

As a result of the Section 303 review of the four agencies'

regulatory capital standards, the OTS and OCC are considering adopting

the treatment of presold residential construction loans followed by the

FDIC and the FRB, thereby making the agencies' rules in this area

uniform. This would not require an amendment of the FDIC's risk-based

capital standards.

B.9. Nonresidential Construction and Land Loans

The banking agencies assign loans for nonresidential real estate

development and construction purposes to the 100 percent risk weight

category. The 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.

B.10. Privately-Issued Mortgage-Backed Securities

The banking agencies, in general, place privately-issued mortgage-

backed securities in either the 50 percent or 100 percent risk-weight

category, depending upon the appropriate risk category of the

underlying assets. However, privately-issued mortgage-backed

securities, if 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 to the 20 percent risk weight category. These are,

generally, privately-issued mortgage-backed securities with AA or

better investment ratings.

B.11. Other Mortgage-Backed Securities

The banking agencies and the OTS automatically assign to the 100

percent risk weight category certain mortgage-backed securities,

including interest-only strips, principal-only strips, and residuals.

However, once the OTS' interest rate risk amendments to its risk-based

capital standards take effect, stripped mortgage-backed securities will

be reassigned to the 20 percent or 50 percent risk weight category,

depending upon these securities' characteristics. Residuals will remain

in the 100 percent risk weight category.

B.12. Junior Liens on One-to-Four Family Residential Properties

In some cases, a bank may make two loans on a single residential

property, one secured by a first lien, the other by a second lien. In

this situation, the FRB and the OTS view both loans as a single

extension of credit secured by a first lien and assign the combined

loan amount a 50 percent risk weight if this amount represents a

prudent loan-to-value ratio. If the combined amount exceeds a prudent

loan-to-value ratio, the loans are assigned to the 100 percent risk

weight category. The FDIC also combines the first and second liens to

determine the appropriateness of the loan-to-value ratio, but it

applies the risk weights differently than the FRB and the OTS. If the

combined loan amount represents a prudent loan-to-value ratio, the FDIC

risk weights the first lien at 50 percent and the second lien at 100

percent; otherwise, both liens are risk-weighted at 100 percent. This

combining of first and second liens is intended to avoid possible

circumvention of the capital requirement and to capture the risks

associated with the combined loans.

The OCC treats all first and second liens separately. It assigns

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.

As a result of the Section 303 review of the four agencies'

regulatory capital standards, the agencies are considering adopting the

OCC's treatment of junior liens on one-to-four family residential

properties in order to eliminate this difference among the agencies'

risk-based capital guidelines. On February 4, 1997, the FDIC Board of

Directors approved the publication for public comment of a proposed

amendment to the FDIC'S guidelines that would treat first and junior

liens separately with qualifying first liens risk-weighted at 50

percent and all junior liens risk-weighted at 100 percent. This

amendment, which is to be published jointly with the other agencies,

will simplify the risk-based capital standards and treat all junior

liens consistently.

B.13. 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. In no case, however, may a risk-weight of less than 20 percent

be assigned to an investment in a mutual fund.

The OTS applies a capital charge appropriate to the riskiest asset

that a mutual fund is actually holding at a particular time, but not

less than 20 percent. In addition, both the OTS and the OCC guidelines

also permit, on a case-by-case basis, investments in mutual funds to be

allocated on a pro rata basis. However, the OTS and the OCC apply the

pro rata allocation differently. While the OTS applies the allocation

based on the actual holdings of the mutual fund, the OCC applies it

based on the highest amount of holdings the fund is permitted to hold

as set forth in its prospectus.

The four agencies' Section 303 review of their regulatory capital

standards has led them to consider adopting the OCC's pro rata

allocation alternative for risk weighting investments in mutual funds,

thereby making their risk-based capital rules in this area uniform. On

February 4, 1997, the FDIC Board of Directors approved the publication

for public comment of a proposed amendment to the FDIC's risk-based

capital standards that would allow banks to apply a pro rata allocation

of risk weights to a mutual fund based on the limits set forth in the

prospectus. This proposal is to be published jointly with the other

agencies.

B.14. ``Covered Assets''

The banking agencies generally place assets subject to guarantee

arrangements by the FDIC or the former Federal Savings and Loan

Insurance Corporation in the 20 percent risk weight category. The OTS

places these ``covered assets'' in the zero percent risk-weight

category.

B.15. Pledged Deposits and Nonwithdrawable Accounts

Instruments such as pledged deposits, nonwithdrawable accounts,

Income Capital Certificates, and Mutal Capital Certificates do not

exist in the banking industry and are not addressed in the capital

guidelines of the three banking agencies.

[[Page 62314]]

The capital guidelines of the OTS permit savings associations to

include pledged deposits and nonwithdrawable accounts that meet OTS

criteria, Income Capital Certificates, and Mutal Capital Certificates

in capital.

B.16. 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

certain losses related to agricultural lending that were incurred on or

before December 31, 1991. These losses must be amortized over seven

years. The unamortized portion of these losses is included as an

element of Tier 2 capital under the banking agencies' risk-based

capital standards.

Thrifts were not eligible to participate in the agricultural loan

loss amortization program established by this statute.

C. Differences in Reporting Standards Among the Federal Banking and

Thrift Agencies

C.1. Sales of Assets with Recourse

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

with recourse before January 1, 1997, 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.

Through December 31, 1996, the practice of the banking agencies

generally has been 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, except for the types of transfers noted below, transfers of

assets with recourse could not normally be reported as sales on the

Call Report. However, this general rule did not apply to the transfer

of first lien one-to-four family residential mortgage loans and

agricultural mortgage loans under one of the government programs

(Government National Mortgage Association, Federal National Mortgage

Association, Federal Home Loan Mortgage Corporation, and Federal

Agricultural Mortgage Corporation). Transfers of mortgages under these

programs were treated as sales for Call Report purposes, provided the

transfers would be reported as sales under GAAP. Furthermore, private

transfers of first lien one-to-four family residential mortgages also

were reported as sales if the transferring institution retained only an

insignificant risk of loss on the assets transferred. However, under

the risk-based capital framework, transfers of mortgage loans with

recourse under the government programs or in private transfers that

qualify as sales for Call Report purposes are viewed as off-balance

sheet items that are assigned a 100 percent credit conversion factor.

Thus, for risk-based capital purposes, capital is generally required to

be held for the full amount outstanding of mortgages sold with recourse

in such transactions, subject to the low-level recourse rule discussed

earlier in this report.

Through year-end 1996, the OTS accounting policy has been to follow

FASB Statement No. 77. However, in the calculation of risk-based

capital under the OTS guidelines, assets sold with recourse that have

been removed from the balance sheet in accordance with Statement No. 77

are converted at 100 percent and also are subject to the low-level

recourse rule. This effectively negates that sale treatment recognized

on a GAAP basis for risk-based capital purposes, but not for leverage

capital purposes.

Another exception to the banking agencies' general rule for

reporting transfers with recourse applies to sales of small business

loans and leases with recourse by ``qualified insured depository

institutions.'' Section 208 of the RCDRIA specifies that the regulatory

reporting requirements applicable to these recourse transactions must

be consistent with GAAP. Section 208 also requires the banking agencies

and the OTS to adopt more favorable risk-based capital requirements for

these recourse exposures than those described above. During August and

September 1995, the FRB published a final rule and the FDIC, the OCC,

and the OTS published interim rules (with requests for comment) which

implemented Section 208 in a uniform manner.

C.2. Futures and Forward Contracts

Through December 31, 1996, the banking agencies have not, as a

general rule, permitted the deferral of losses on futures and forward

contracts 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 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.

The OTS practice is to follow GAAP for futures and forward

contracts. In accordance with FASB Statement No. 80, when hedging

criteria are satisfied, the accounting for a contract is related to the

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

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 the deferral of losses which are reflected as

basis adjustments to assets and liabilities on the balance sheet.

C.3. Excess Servicing Fees

As a general rule, through December 31, 1996, the banking agencies

did not follow GAAP for excess servicing fees, but required a more

conservative treatment. For loan sales that occurred prior to 1997,

excess servicing arose when loans were sold with servicing retained and

the stated servicing fee rate exceeded a normal servicing fee rate.

Except for sales of pools of first lien one-to-four family residential

mortgages for which the banking agencies' approach was consistent with

the provisions of FASB Statement No. 65 that were in effect through

year-end 1996, excess servicing fee income in banks was to be reported

as realized over the life of the transferred asset.

In contrast, for loan sales that occurred prior to 1997, the OTS

allowed 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 was consistent with the then

applicable provisions of FASB Statement No. 65.

C.4. Offsetting of Assets and Liabilities

FASB Interpretation No. 39, ``Offsetting of Amounts Related to

Certain Contracts,'' became effective in 1994. Interpretation No. 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 Interpretation No. 39, four

conditions must be met in order to demonstrate that a right of setoff

exists. Then, a debtor with ``a valid right of setoff may offset the

related asset and liability and report the net amount.'' The banking

agencies allow banks to apply Interpretation No. 39 for Call Report

purposes solely as it relates to on-balance sheet amounts associated

with off-balance sheet conditional and

[[Page 62315]]

exchange contracts (e.g., forwards, interest rate swaps, and options).

Under the Call Report instructions in effect through December 31, 1996,

the netting of other assets and liabilities is not permitted unless

specifically required by the instructions.

The OTS practice has been to follow GAAP as it relates to

offsetting in the balance sheet.

C.5. 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 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.

C.6. 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 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 Accord.

The OTS permits negative goodwill to offset goodwill assets on the

balance sheet.

C.7. In-Substance Defeasance of Debt

In-substance defeasance involves a debtor irrevocably placing risk-

free monetary assets in a trust established solely for satisfying the

debt. According to FASB Statement No. 76, the liability is considered

extinguished for financial reporting purposes if the possibility that

the debtor would be required to make further payments on the debt,

beyond the funds placed in the trust, is 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.

For Call Report purposes through December 31, 1996, the banking

agencies did not permit banks to report the defeasance of their

liabilities in accordance with Statement No. 76. Instead, banks were to

continue reporting any defeased debt as a liability and the securities

contributed to the trust as assets. No netting was permitted, nor was

any recognition of gains or losses on the transaction allowed. The

banking agencies did not adopt 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. In June

1996, the FASB issued a new accounting standard (FASB Statement No.

125) that supersedes Statement No. 76 for defeasance transactions

occurring after 1996, thereby bringing GAAP in line with the Call

Report treatment for these transactions.

The OTS practice has been to follow GAAP for defeasance

transactions.

Dated at Washington, D.C., this 17th day of November, 1997.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. 97-30560 Filed 11-20-97; 8:45 am]

BILLING CODE 6714-01-M