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[Federal Register: December 28, 1994]



 

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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325


 

RIN 3064-AB29


 

 

Capital Maintenance


 

AGENCY: Federal Deposit Insurance Corporation (FDIC).


 

ACTION: Final rule.


 

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SUMMARY: The FDIC has decided not to proceed with its proposal to

include net unrealized holding gains (losses) on available-for-sale

securities in Tier 1 capital. Instead, the FDIC is adopting only

technical wording changes to conform the language in its leverage and

risk-based capital standards with the terminology used in Statement of

Financial Accounting Standards No. 115, ``Accounting for Certain

Investments in Debt and Equity Securities'' (FASB 115). For regulatory

capital purposes, this FDIC final rule requires net unrealized holding

losses on available-for-sale equity securities with readily

determinable fair values to be deducted in determining the amount of

Tier 1 capital. All other net unrealized holding gains (losses) on

available-for-sale securities are excluded from the definition of Tier

1 capital. However, for purposes of the quarterly Reports of Condition

and Income (Call Reports) filed by FDIC-supervised institutions, the

Federal Financial Institutions Examination Council (FFIEC) requires net

unrealized gains (losses) on all available-for-sale securities to be

reported as a separate component of stockholders' equity, in accordance

with FASB 115.


 

EFFECTIVE DATE: January 27, 1995.


 

FOR FURTHER INFORMATION CONTACT: For supervisory purposes, Stephen G.

Pfeifer, Examination Specialist (202/898-8904), or Robert F. Storch,

Section Chief (202/898-8906), Accounting Section, Division of

Supervision; for legal issues, Cristeena G. Naser, Attorney, Legal

Division (202/898-3587).


 

SUPPLEMENTARY INFORMATION:


 

I. Background


 

The FDIC's leverage and risk-based capital standards (12 CFR part

325--subpart A and appendix A to part 325) set forth a definition of

Tier 1 capital that includes common stockholders' equity. The capital

definitions (12 CFR 325.2(d) and section 1.A.1. of appendix A) further

explain that common stockholders' equity includes common stock and any

related surplus, undivided profits, disclosed capital reserves that

represent a segregation of undivided profits, and foreign currency

translation adjustments, less net unrealized losses on marketable

equity securities.

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

FASB 115 which, in effect, changes the composition of stockholders'

equity in financial statements prepared in accordance with generally

accepted accounting principles (GAAP) by including as a separate

component of equity the amount of net unrealized holding gains and

losses on debt and equity securities that are deemed to be available-

for-sale. The FFIEC has notified all banks that they must adopt the new

FASB 115 accounting standard for purposes of their Call Reports as of

January 1, 1994, or the beginning of their first fiscal year

thereafter, if later. Early adoption of this standard was also

permitted in Call Reports to the extent allowable under FASB 115.

Prior to the adoption of FASB 115, Call Report instructions

required banks to report a separate capital component for the net

unrealized loss on marketable equity securities, consistent with the

provisions of Statement of Financial Accounting Standards No. 12,

``Accounting for Certain Marketable Securities'' (FASB 12). FASB 115,

which supersedes FASB 12, broadens the scope of this separate component

of stockholders' equity in that the FASB 115 capital component includes

unrealized gains and losses on all securities that are available-for-

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

losses on marketable equity securities.

This new GAAP accounting standard and the conforming Call Report

guidance raised the question of how the FASB 115 capital component for

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

securities should be treated for purposes of calculating the amount of

an institution's regulatory capital under part 325.


 

II. December 1993 Proposal


 

In view of this FASB 115 issue, the FDIC issued a proposal (58 FR

68781, December 29, 1993) to amend its leverage and risk-based capital

standards to explicitly recognize net unrealized holding gains and

losses on available-for-sale securities in determining the amount of an

institution's Tier 1 capital. Accordingly, the FDIC requested specific

comments on the following:

(1) Recognition of FASB 115 Capital Adjustments for Regulatory

Capital Purposes. Given the provisions of section 37 of the Federal

Deposit Insurance Act (FDI Act) and the other issues discussed in the

proposal's preamble, should the FASB 115 capital adjustments that

institutions are required to reflect for GAAP and Call Report purposes

also be taken into consideration for purposes of determining an

institution's Tier 1 capital under the FDIC's leverage and risk-based

capital standards? If not, what regulatory capital treatment should be

applied?

(2) Effect of FASB 115 Adjustments on Other Capital-Based

Regulations. If the FASB 115 capital adjustments are recognized for

purposes of calculating an institution's leverage and risk-based

capital ratios, these adjustments may also have an effect on certain

other laws and regulations that are based, in part, on regulatory

capital levels, including the prompt corrective action rules (12 CFR

part 325--subpart B), the risk-related insurance premium system (12 CFR

part 327), the brokered deposit restrictions (12 CFR 337.6), and the

restrictions on activities and investments of insured state banks (12

CFR part 362), such as the limitations in Sec. 362.3(d)(4) on the book

value of certain equity investments as a percent of Tier 1 capital. If

the FASB 115 capital adjustments are recognized in calculating an

institution's compliance with the minimum leverage and risk-based

capital standards, should these adjustments also be recognized for

purposes of the other rules noted above that are based, in part, on an

institution's regulatory capital levels? If not, what treatment should

be used for these other regulations?

(3) Appropriateness of Recognizing FASB 115 Net Appreciation for

Regulatory Capital Purposes. In determining the amount of any FASB 115

adjustment to stockholders' equity for changes in the fair value of

available-for-sale securities, FASB 115 as well as the conforming Call

Report guidance take into consideration all changes in the fair value

of these securities, regardless of whether these changes represent net

appreciation or net depreciation. Under the accounting rules that were

applicable prior to the adoption of FASB 115, an institution's capital

for GAAP and Call Report purposes could not be increased by the amount

of any net unrealized appreciation on securities held for sale. Should

the regulatory capital treatment for changes in the fair value of

securities held in the FASB 115 available-for-sale category differ,

depending upon whether the change represents net appreciation or net

depreciation? If so, what treatment is appropriate?


 

III. Summary and Analysis of Comment Letters Received


 

The FDIC received 61 responses to its request for comment,

including 41 from banks, 11 from multibank holding companies, four from

financial institution trade associations, three from state banking

regulators, and two from banking consultants. Nearly three-fourths of

the respondents were opposed to the proposal to include net unrealized

holding gains (losses) on available-for-sale securities in Tier 1

capital. Many of the 41 letters from banks were from community banks

and 37 of these respondents were against the proposal. The 11 responses

from multibank holding companies were generally mixed, with six

appearing to favor the proposed rule and the remaining five opposed to

it.

Three of the four financial institution trade associations that

responded to the proposal at least cautiously supported the proposal;

however, one of the associations in favor of the proposal did so

partially out of a concern that, if the proposal were not adopted, an

even more restrictive lower-of-cost-or-market (LOCOM) approach might be

required where only net depreciation (but not net appreciation) on

available-for-sale securities would be recognized for Tier 1 capital

purposes. The responses from the three state banking regulators and the

two banking consultants were mixed.

Common arguments raised by many of the respondents opposing the

proposal included: (1) The additional capital volatility arising from

marking-to-market the available-for-sale securities, which may cause

banks to shorten maturities, sacrifice yield and thus realize less net

income; (2) the distortive effect that the piecemeal application of

market value accounting may have on a bank's financial statements,

particularly when interest rates rise but offsetting changes in the

value of the bank's deposit base cannot be recognized; (3) the adverse

impact that these market fluctuations may have on other capital-based

rules, such as prompt corrective action and risk-related insurance

premiums; and (4) the potential for more banks to fail simply because

of market value changes in securities that may be temporary and that

may exist on available-for-sale securities which the bank does not have

the current intent to sell.

The most common alternative to the FDIC's proposed treatment of the

FASB 115 net unrealized gains (losses) on available-for-sale

securities, which was expressed by 37 of the commenters, was to exclude

the FASB 115 unrealized gains and losses from Tier 1 capital. However,

if the FASB 115 adjustments were to be included in regulatory capital,

12 commenters indicated that net appreciation and depreciation on

available-for-sale securities should be treated consistently (otherwise

a LOCOM approach could result for regulatory capital purposes).

Additionally, seven of the respondents specifically mentioned that FASB

115 net unrealized gains (losses) on available-for-sale securities

should only be included in Tier 2 (or total risk-based capital) rather

than in Tier 1 capital. Several respondents also indicated that, even

if these net unrealized gains (losses) are recognized for purposes of

calculating supervisory capital ratios, they should be ignored in

determining capital for purposes of prompt corrective action, risk-

related insurance premiums, applicable lending limits, Federal Reserve

Board Regulation O, and section 23A of the Federal Reserve Act.

Some of the reasons given by the minority of the commenters who

favored the proposal included the following: (1) The proposal to

recognize net unrealized holding gains (losses) on available-for-sale

securities in Tier 1 capital is consistent with the requirements under

GAAP and the Call Report instructions that these unrealized gains

(losses) be recognized as a component of stockholders' equity; (2) the

proposal is consistent with section 37 of the FDI Act, which generally

provides that accounting principles applicable to depository

institutions for regulatory reporting purposes should be no less

stringent than GAAP; and (3) the proposal would minimize the reporting

and systems burden that might otherwise exist if the FASB 115 capital

component is treated differently for regulatory capital purposes than

it is for regulatory reporting and GAAP purposes.

The FDIC has considered the comments raised by those responding to

the request for comment. After carefully evaluating the merits of the

proposed rule and consulting with the other federal banking agencies,

the FDIC has decided not to proceed with its proposal but rather to

retain the existing regulatory capital treatment. As a result, net

unrealized holding losses on available-for-sale equity securities with

readily determinable fair values should continue to be deducted in

determining the amount of Tier 1 capital. However, all other net

unrealized holding gains (losses) on available-for-sale securities will

be excluded from the definition of Tier 1 capital.

In addition, for regulatory reporting (as opposed to regulatory

capital) purposes, FDIC-supervised institutions will continue to

reflect FASB 115 net unrealized gains (losses) on available-for-sale

securities as a separate component of equity capital in the Call

Reports they file with the FDIC on a quarterly basis. This reporting

treatment is consistent with the provisions of section 37 of the FDI

Act.

Although section 37 generally requires that accounting principles

applicable to depository institutions for regulatory reporting purposes

must be consistent with or no less stringent than GAAP, the FDIC

believes that the requirements of section 37 do not extend to the

federal banking agencies' definitions of regulatory capital. It is well

established that the calculation of regulatory capital for supervisory

purposes can differ from the measurement of equity capital for

financial reporting purposes. For example, statutory restrictions

against the recognition of goodwill for regulatory capital purposes may

lead to differences between the reported amount of equity capital and

the regulatory capital calculation for Tier 1 capital. Other types of

intangible assets are also subject to limitations under the agencies'

regulatory capital rules. In addition, subordinated debt and the

allowance for loan and lease losses are examples of items where the

regulatory reporting and the regulatory capital treatments differ.

The FDIC acknowledges that unrealized gains and losses on all

securities, regardless of whether they are in the held-to-maturity,

available-for-sale, or trading accounts, should be taken into

consideration in the overall qualitative evaluation of an institution's

capital adequacy. Further, if an institution has established a

securities trading account in which it buys and holds securities

principally for the purpose of selling those assets in the near term,

it is appropriate for such an institution to reflect the amount of any

net unrealized gains (losses) on these trading account assets in both

net income and the calculation of Tier 1 capital. However, for debt

securities that are placed in the held-to-maturity or available-for-

sale categories, the FDIC does not believe that market value

fluctuations should automatically be factored into the quantitative

calculations for regulatory capital, but rather these unrealized gains

(losses) generally should be qualitatively considered in assessing

capital adequacy.

Under the final rule, FDIC-supervised institutions will continue to

reflect net unrealized holding gains (losses) on available-for-sale

securities as a separate capital component for regulatory reporting

purposes, consistent with the Call Report instructions issued by the

FFIEC. However, because unrealized holding gains (losses) on available-

for-sale securities will not be included in the determination of

regulatory capital (other than for net unrealized holding losses on

available-for-sale equity securities with readily determinable fair

values), institutions' capital levels under the FDIC's leverage and

risk-based capital standards will not be adversely affected by

temporary fluctuations in the fair value of these securities that may

give rise to net unrealized holding losses. Similarly, if banks have

net unrealized holding gains on available-for-sale securities, these

gains, which also may be temporary in nature, will be excluded from the

calculation of Tier 1 capital.

The FDIC is concerned that if unrealized losses on all available-

for-sale securities are deducted in the Tier 1 capital calculation, but

unrealized gains are not included, an inequitable treatment would exist

in that institutions would reflect the full impact of any net

unrealized losses in their regulatory capital calculations without

receiving the benefit of net unrealized gains.

The FDIC believes that both net appreciation and net depreciation

on available-for-sale debt securities should be treated consistently

for regulatory capital purposes and that it is more appropriate to

exclude these unrealized gains and losses from the calculation of

regulatory capital than it is to include both in Tier 1 capital,

particularly since Tier 1 capital generally is expected to be comprised

of the most permanent forms of capital. In this regard, the FDIC

considers it more appropriate to qualitatively evaluate the impact of

these FASB 115 net unrealized gains (losses) on a case-by-case basis

(e.g., in conjunction with the overall assessment of the institution's

interest rate risk exposure), rather than to automatically incorporate

these amounts into the quantitative calculation of Tier 1 capital.

This approach is deemed proper in view of the potential volatility

in the amount of net unrealized gains (losses) on available-for-sale

debt securities as interest rates change, particularly where these

changes may be temporary in nature, and the effect that these

unrealized gains and losses could otherwise have on an institution's

capital category for purposes of the FDIC's prompt corrective action,

risk-related insurance premiums, brokered deposit, and other capital-

based rules if these unrealized gains (losses) were included in Tier 1

capital. In addition, because of the piecemeal application of market

value accounting mandated by FASB 115, the FDIC believes it is

inappropriate to explicitly recognize in regulatory capital all

unrealized gains (losses) on available-for-sale securities when

offsetting gains (losses) in the value of an institution's other assets

and liabilities are not similarly recognized.

The FDIC, however, retains the authority to require institutions to

maintain more capital than the minimums set forth in part 325.1

This enables the FDIC to take appropriate action against an institution

where, for example, the institution is deemed to have an excessive

amount of net unrealized losses on available-for-sale securities in

relation to the institution's overall capital structure.

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\1\ For example, in discussing the minimum leverage ratio

requirement, Sec. 325.3(a) of the FDIC's regulations states, in

part, that

Banks must maintain at least the minimum leverage capital

requirement set forth in this section. The capital standards in this

part are the minimum acceptable for banks whose overall financial

condition is fundamentally sound, which are well-managed and which

have no material or significant financial weaknesses. Thus, the FDIC

is not precluded from requiring an institution to maintain a higher

capital level based on the institution's particular risk profile.

Also, in discussing the FDIC's minimum risk-based capital

guidelines, the fifth paragraph in the FDIC's Statement of Policy on

Risk-Based Capital (Appendix A to Part 325) states that

The risk-based capital ratio focuses principally on broad

categories of credit risk; however, the ratio does not take account

of many other factors that can affect a bank's financial condition.

These factors include overall interest rate risk exposure;

liquidity, funding and market risks; the quality and level of

earnings; investment or loan portfolio concentrations; the quality

of loans and investments; the effectiveness of loan and investment

policies; and management's overall ability to monitor and control

financial and operating risks. In addition to evaluating capital

ratios, an overall assessment of capital adequacy must take account

of each of these other factors, including, in particular, the level

and severity of problem and adversely classified assets. For this

reason, the final supervisory judgment on a bank's capital adequacy

may differ significantly from the conclusions that might be drawn

solely from the absolute level of the bank's risk-based capital

ratio.

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With respect to the impact that FASB 115 may have on how capital is

determined for purposes of legal lending limits, Federal Reserve Board

Regulation O and section 23A of the Federal Reserve Act, the FDIC notes

that many borrower lending limits for FDIC-supervised state-chartered

banks are established by the institutions' appropriate state regulatory

authorities and that the issuance of interpretive guidance pertaining

to Regulation O and section 23A is generally within the purview of the

Federal Reserve Board.


 

IV. Final Rule


 

After considering the comments received and consulting with the

other federal banking agencies, the FDIC has decided not to proceed

with its proposal to include net unrealized gains (losses) on

available-for-sale securities in Tier 1 capital. Instead, the FDIC is

adopting only technical wording changes to its existing capital rules.

The FDIC's consultations with the other agencies included participating

in the deliberations of the FFIEC's Task Force on Supervision. The

regulatory capital treatment of net unrealized gains (losses) in this

final rule is consistent with the treatment that the Task Force on

Supervision has recommended to the agencies.

The definitions under the FDIC's leverage and risk-based capital

standards indicate that Tier 1 capital includes, among other items,

``common stockholders' equity.'' In this regard, the FDIC is revising

Sec. 325.2(d) of its regulations and section I.A.1. of Appendix A to

Part 325 to indicate that, for regulatory capital purposes, common

stockholders' equity includes common stock and related surplus,

undivided profits, disclosed capital reserves that represent a

segregation of undivided profits, and foreign currency translation

adjustments, less net unrealized holding losses on available-for-sale

equity securities with readily determinable fair values.

Thus, although FASB 115 net unrealized losses on available-for-sale

equity securities are deducted in determining the amount of Tier 1

capital, all other net unrealized holding gains (losses) on available-

for-sale securities generally will be excluded (i.e., ignored) in these

regulatory capital calculations.

This final rule refers to deducting the ``net unrealized holding

losses'' on ``equity securities'' with ``readily determinable fair

values''. The captioned phrases are consistent with the terms defined

in FASB 115 and in the Call Report guidance issued by the FFIEC. This

language replaces the existing phrase in the FDIC's leverage and risk-

based capital rules, ``net unrealized losses on marketable equity

securities'', which was based on terminology included in the FASB 12

accounting standard that has now been superseded by FASB 115.

This final rule is also consistent with the interim regulatory

capital guidance that was jointly issued on December 21, 1993, by the

FDIC, the Federal Reserve Board, and the Office of the Comptroller of

the Currency after the issuance of FASB 115.2 Accordingly, the

amortized cost rather than fair value of available-for-sale debt

securities generally will continue to be used for purposes of

calculating both the numerator and the denominator for the leverage and

risk-based capital ratios. The amortized cost of available-for-sale

debt securities will also continue to be used in determining the amount

of average total assets reported on the Call Report schedule for

quarterly averages and the amount of risk-weighted assets reflected on

the Call Report's risk-based capital schedule.3

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\2\See FIL-91-93, which is available upon request from the

FDIC's Office of Corporate Communications (202/898-6996). This

interim guidance had provided that, until the federal banking

agencies can complete any necessary amendments to their respective

capital rules, net unrealized losses on marketable equity securities

should continue to be deducted when computing Tier 1 capital and

that other net unrealized gains or losses on available-for-sale

securities resulting from the adoption of FASB 115 should be

excluded from the computation of Tier 1 capital.

\3\For further information, refer to the Call Report

instructions issued by the FFIEC.

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V. Regulatory Flexibility Act Statement


 

The Board of Directors of the FDIC hereby certifies that these

amendments to part 325 will not have a significant economic impact on a

substantial number of small business entities within the meaning of the

Regulatory Flexibility Act (5 U.S.C. 601 et seq). These amendments will

not necessitate the development of sophisticated recordkeeping or

reporting systems by small institutions nor will small institutions

need to seek out the expertise of specialized accountants, lawyers or

managers to comply with the regulation. In light of this certification,

the Regulatory Flexibility Act requirements (at 5 U.S.C. 603, 604) to

prepare initial and final regulatory flexibility analyses do not apply.


 

VI. Paperwork Reduction Act and Regulatory Burden


 

No collections of information pursuant to section 3504(h) of the

Paperwork Reduction Act (44 U.S.C. 3501 et seq.) are contained in this

notice. Consequently, no information has been submitted to the Office

of Management and Budget for review.

Section 302 of the Riegle Community Development and Regulatory

Improvement Act of 1994 (Pub. Law 103-325, 108 Stat. 2160) provides

that the federal banking agencies must consider the administrative

burdens and benefits of any new regulations that impose additional

requirements on insured depository institutions. Section 302 also

requires such a rule to take effect on the first day of the calendar

quarter following final publication of the rule, unless the agency, for

good cause, determines an earlier effective date is appropriate. The

new capital rule does not impose any new requirements on depository

institutions for purposes of calculating their risk-based and leverage

capital ratios. The amended rule clarifies the regulatory capital

treatment of a new common equity component (i.e., net unrealized

holding gains (losses) on available-for-sale securities) created by

FASB 115, but does not change the current treatment. For these reasons,

the FDIC has determined that an effective date 30 days from the date of

this rule's publication in the Federal Register is appropriate.


 

List of Subjects in 12 CFR Part 325


 

Bank deposit insurance, Banks, Banking, Capital adequacy, Reporting

and recordkeeping requirements, State nonmember banks, Savings

associations.


 

For the reasons set forth in the preamble, the Board of Directors

of the Federal Deposit Insurance Corporation is amending part 325 of

title 12 of the Code of Federal Regulations as follows:


 

PART 325--CAPITAL MAINTENANCE


 

1. The authority citation for part 325 continues to read as

follows:


 

Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),

1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),

1828(o), 1831o, 3907, 3909; Pub. L. 102-233, 105 Stat. 1761, 1789,

1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 2236, 2355,

2386 (12 U.S.C. 1828 note).


 

2. Section 325.2(d) is revised to read as follows:



 

Sec. 325.2 Definitions.


 

* * * * *

(d) Common stockholders' equity means the sum of common stock and

related surplus, undivided profits, disclosed capital reserves that

represent a segregation of undivided profits, and foreign currency

translation adjustments, less net unrealized holding losses on

available-for-sale equity securities with readily determinable fair

values.

* * * * *

3. In appendix A to part 325, the definition of common

stockholders' equity in the first paragraph in section I.A.1. is

revised to read as follows:


 

Appendix A to Part 325--Statement of Policy on Risk-Based Capital


 

* * * * *

I. * * *

A. * * *

1. * * *


 

--Common stockholders' equity capital (includes common stock and

related surplus, undivided profits, disclosed capital reserves that

represent a segregation of undivided profits, and foreign currency

translation adjustments, less net unrealized holding losses on

available-for-sale equity securities with readily determinable fair

values);

* * * * *

By order of the Board of Directors.


 

Dated at Washington, D.C. this 20th day of December, 1994.


 

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Acting Executive Secretary.

[FR Doc. 94-31725 Filed 12-27-94; 8:45 am]

BILLING CODE 6714-01-P