[Federal Register: February 13, 1995 (Volume 60, Number 29)]
[Rules and Regulations]
[Page 8182-8188]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
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FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB20
Capital Maintenance
AGENCY: Federal Deposit Insurance Corporation (FDIC).
ACTION: Final rule.
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SUMMARY: The FDIC is amending its capital standards for insured state
nonmember banks to establish a limitation on the amount of certain
deferred tax assets that may be included in (that is, not deducted
from) Tier 1 capital for risk-based and leverage capital purposes.
Under the final rule, deferred tax assets that can be realized through
carrybacks to taxes paid on income earned in prior periods generally
will not be subject to limitation for regulatory capital purposes. On
the other hand, deferred tax assets that can only be realized if an
institution earns sufficient taxable income in the future will be
limited for regulatory capital purposes to the amount that the
institution is expected to realize within one year of the most recent
calendar quarter-end date, based on the institution's projection of
taxable income for that year, or ten percent of Tier 1 capital,
whichever is less. Deferred tax assets in excess of these limitations
will be deducted from Tier 1 capital and from assets for purposes of
calculating both the risk-based and leverage capital ratios.
This regulatory capital limit was developed on a consistent basis
by the FDIC, the Board of Governors of the Federal Reserve System
(FRB), the Office of the Comptroller of the Currency (OCC), and the
Office of Thrift Supervision (OTS) (hereafter, the federal banking
agencies or the agencies) in response to the issuance by the Financial
Accounting Standards Board (FASB) of Statement No. 109, ``Accounting
for Income Taxes'' (FASB 109), in February 1992.
The capital limitation is intended to balance the FDIC's continued
concerns about deferred tax assets that are dependent upon future
taxable income against the fact that such assets will, in many cases,
be realized. The limitation also ensures that state nonmember banks do
not place excessive reliance on deferred tax assets to satisfy the
minimum capital standards.
EFFECTIVE DATE: April 1, 1995.
FOR FURTHER INFORMATION CONTACT: Robert F. Storch, Chief, Accounting
Section, Division of Supervision, (202) 898-8906, or Joseph A. DiNuzzo,
Counsel, Legal Division, (202) 898-7349, Federal Deposit Insurance
Corporation, 550 17th Street NW., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
Characteristics of Deferred Tax Assets
Deferred tax assets are assets that reflect, for financial
reporting purposes, amounts that will be realized as reductions of
future taxes or as future receivables from a taxing authority. Deferred
tax assets may arise because of specific limitations under tax laws of
different tax jurisdictions that require that certain net operating
losses (i.e., when, for tax purposes, expenses exceed revenues) or tax
credits be carried forward if they cannot be used to recover taxes
previously paid. These ``tax carryforwards'' are realized only if the
institution generates sufficient future taxable income during the
carryforward period.
Deferred tax assets may also arise from the tax effects of certain
events that have been recognized in one period for financial statement
purposes but will result in deductible amounts in a future period for
tax purposes, i.e., the tax effects of ``deductible temporary
differences.'' For example, many depository institutions may report
higher income to taxing authorities than [[Page 8183]] they reflect in
their regulatory reports\1\ because their loan loss provisions are
expensed for reporting purposes but are not deducted for tax purposes
until the loans are charged off.
\1\Insured commercial banks and FDIC-supervised savings banks
are required to file quarterly Consolidated Reports of Condition and
Income (Call Reports) with their primary federal regulatory agency
(the FDIC, the FRB, or the OCC, as appropriate). Insured savings
associations file quarterly Thrift Financial Reports (TFRs) with the
OTS.
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Deferred tax assets arising from an organization's deductible
temporary differences may or may not exceed the amount of taxes
previously paid that the organization could recover if the temporary
differences fully reversed at the report date. Some of these deferred
tax assets may theoretically be ``carried back'' and recovered from
taxes previously paid. On the other hand, when deferred tax assets
arising from deductible temporary differences exceed such previously
paid tax amounts, they will be realized only if there is sufficient
future taxable income during the carryforward period. Such deferred tax
assets, and deferred tax assets arising from tax carryforwards, are
hereafter referred to as ``deferred tax assets that are dependent upon
future taxable income.''
FASB 109
In February 1992, the FASB issued Statement No. 109, which
superseded Accounting Principles Board Opinion No. 11 (APB 11) and FASB
Statement No. 96 (FASB 96), the previous standards governing accounting
for income taxes. FASB 109 provides guidance on many aspects of
accounting for income taxes, including the accounting for deferred tax
assets. FASB 109 generally allows institutions to report certain
deferred tax assets on their balance sheets that they could not
recognize as assets under previous generally accepted accounting
principles (GAAP) and the federal banking agencies' prior reporting
policies.\2\ Unlike the general practice under previous standards, FASB
109 permits the reporting of deferred tax assets that are dependent
upon future taxable income. However, FASB 109 requires the
establishment of a valuation allowance to reduce deferred tax assets to
an amount that is more likely than not (i.e., a greater than 50 percent
likelihood) to be realized.
\2\Prior reporting policies of the OCC and FDIC, as set forth in
Banking Circular 202 dated July 2, 1985, and Bank Letter BL-36-85
dated October 4, 1985, respectively, limited the reporting of
deferred tax assets in the regulatory reports filed by national
banks and insured state nonmember banks to the amount of taxes
previously paid which are potentially available through carryback of
net operating losses. As such, the OCC and FDIC did not permit the
reporting of deferred tax assets that are dependent upon future
taxable income in the Call Reports filed by national and insured
state nonmember banks. The FRB and OTS did not issue policies
explicitly addressing the recognition of deferred tax assets.
Consequently, state member banks and savings associations were able
to report deferred tax assets in accordance with GAAP. Prior to FASB
109, GAAP, as set forth in APB 11 and FASB 96, also for the most
part did not permit the reporting of deferred tax assets that are
dependent upon future taxable income.
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FASB 109 became effective for fiscal years beginning on or after
December 15, 1992. The adoption of this standard has resulted in the
reporting of additional deferred tax assets in Call Reports and TFRs
that have directly increased institutions' undivided profits and Tier 1
capital.
Concerns Regarding Deferred Tax Assets That Are Dependent Upon Future
Taxable Income
The FDIC has certain concerns about including in capital deferred
tax assets that are dependent upon future taxable income. Realization
of such assets depends on whether a bank has sufficient future taxable
income during the carryforward period. Since a bank that is in a net
operating loss carryforward position is often experiencing financial
difficulties, its prospects for generating sufficient taxable income in
the future are uncertain. In addition, the condition of and future
prospects for an organization often can and do change very rapidly in
the banking environment. This raises concerns about the realizability
of deferred tax assets that are dependent upon future taxable income,
even when a bank ostensibly appears to be sound and well-managed. Thus,
for many banks, such deferred tax assets may not be realized and, for
other banks, there is a high degree of subjectivity in determining the
realizability of this asset. In this regard, many banks may be able to
make reasonable projections of future taxable income for relatively
short periods of time and actually realize the projected income, but
beyond these short time periods, the reliability of the projections
tends to decrease significantly. Furthermore, unlike many other assets,
banks generally cannot realize the value of deferred tax assets by
selling them.
In addition, as a bank's condition deteriorates, it is less likely
that deferred tax assets that are dependent upon future taxable income
will be realized. Therefore, the bank is required under FASB 109 to
reduce its deferred tax assets through increases to the asset's
valuation allowance. Additions to this allowance would reduce the
bank's regulatory capital at precisely the time it needs capital
support the most. Thus, the inclusion in a bank's reported capital of
deferred tax assets that are dependent upon future taxable income
raises supervisory concerns.
Because of these concerns, the agencies, under the auspices of the
Federal Financial Institutions Examination Council (FFIEC), considered
how the deferred tax assets of depository institutions should be
treated for regulatory reporting and capital purposes. In August 1992,
the FFIEC requested public comment on this matter (57 FR 34135, Aug. 3,
1992). After considering the comments received, the FFIEC decided in
December 1992, that banks and savings associations should adopt FASB
109 for reporting purposes in Call Reports and Thrift Financial Reports
(TFRs) beginning in the first quarter of 1993 (or the beginning of
their first fiscal year thereafter, if later). Insured banks were
notified by the FFIEC that they should report deferred tax assets in
their Call Reports in accordance with FASB 109 in Financial
Institutions Letter FIL-97-92 dated December 31, 1992. For insured
state nonmember banks, this GAAP reporting standard has superseded the
regulatory reporting limitation on deferred tax assets established by
the FDIC in Bank Letter BL-36-85 dated October 4, 1985. As a
consequence, this 1985 Bank Letter has been withdrawn.
II. Proposed Regulatory Capital Treatment of Deferred Tax Assets
The FFIEC, in reaching its decision on regulatory reporting, also
recommended that each of the federal banking agencies should amend its
regulatory capital standards to limit the amount of deferred tax assets
that can be included in regulatory capital. In response to the FFIEC's
recommendation, on May 5, 1993, the FDIC issued for public comment a
proposal to adopt the recommendation of the FFIEC in full, as
summarized below (58 FR 26701). The FFIEC recommended that the agencies
limit the amount of deferred tax asset that are dependent upon future
taxable income that an institution can include in regulatory capital to
the lesser of:
(1) the amount of such deferred tax assets that the institution
expects to realize within one year of the quarter-end report date,
based on its projection of future taxable income (exclusive of tax
carryforwards and reversals of existing temporary differences) for that
year, or
(2) ten percent of Tier 1 capital before deducting any disallowed
purchased mortgage servicing rights, any disallowed purchased credit
card [[Page 8184]] relationships, and any disallowed deferred tax
assets.
When the recorded amount of deferred tax assets that are dependent
upon future taxable income, net of any valuation allowance for deferred
tax assets, exceeds this limitation, the excess amount would be
deducted from Tier 1 capital and from assets in regulatory capital
calculations. Deferred tax assets that can be realized from taxes paid
in prior carryback years and from future reversals of existing taxable
temporary differences generally would not be limited under the
proposal.
III. Public Comments on the Proposal
The comment period for the FDIC's proposal closed on June 4, 1993.
The FDIC received comment letters from 23 entities, 18 of which were
banks or bank holding companies, four of which were bank trade
associations, and one of which was an accounting firm (which submitted
two comment letters). Only two commenters expressed support for or
nonobjection to the proposed regulatory capital limitation, although
each raised an implementation question about the limit. Two others
favored the concept of a regulatory capital limitation on deferred
taxes, but recommended that the limit be set in a different manner than
was proposed. Three commenters seemed to suggest that deferred tax
assets should not be included in regulatory capital at all. The
remaining 16 commenters, including all of the larger banking
organizations that commented, expressed a preference for placing no
limit on the amount of deferred tax assets that can be included in
regulatory capital. These commenters generally indicated that a
regulatory capital limitation on deferred tax assets is unnecessary
because FASB 109 contains sufficient safeguards to ensure that the
amount of deferred tax assets carried on an institution's balance sheet
is realizable. Instead, they supported the full adoption of FASB 109
for both regulatory reporting and regulatory capital purposes,
indicating that such an approach would limit regulatory burden.
Nevertheless, while preferring no capital limit on deferred tax assets,
two commenters considered the agencies' decision to include some
deferred tax assets that are dependent upon future taxable income in
regulatory capital as a positive step compared to prior regulatory
policies and proposals permitting little or no inclusion of such
deferred tax assets in regulatory reports and regulatory capital.
Responses to the FDIC's Questions
The proposed rule requested specific comment on a number of
questions.
Question (1): The FDIC's first question asked about the
appropriateness of the proposed capital limit, particularly the ten
percent of Tier 1 capital limitation. Eight commenters specifically
responded to this question, while the views expressed by most of the
remaining commenters could also be regarded as responsive to this
question. In other words, because more than two-thirds of the
commenters favored relying on the proper application of GAAP to the
reporting of deferred tax assets over establishing a separate
regulatory capital limit on such assets, these commenters generally
considered the proposed limits to be inappropriate and unnecessary.
Some of those who commented on this issue noted that any percentage of
capital limit would be inappropriate because realizability is a
function of an institution's ability to generate future taxable income.
Thus, several letters described the proposed ten percent limit as
arbitrary and too conservative.
One commenter noted that healthy banks typically earn in excess of
ten percent of Tier 1 capital each year, thereby ensuring that this
percentage limit will be the operative limit for such banks. This
commenter suggested setting the percentage limitation for institutions
that are deemed to be ``well-capitalized'' for prompt corrective action
purposes at 20 percent of Tier 1 capital.
Another commenter likened deferred tax assets to the two
identifiable intangible assets, purchased mortgage servicing rights
(PMSRs) and purchased credit card relationships (PCCRs), that are
included in Tier 1 capital. This commenter's recommendation was to
apply the existing percentage limits for these two intangibles to
deferred tax assets, i.e., a 50 percent of Tier 1 capital limit for the
total of PMSRs, PCCRs, and deferred tax assets along with 25 percent of
Tier 1 capital sublimits for both PCCRs and deferred tax assets.
Question (2): The second question dealt with whether certain
identifiable assets acquired in a nontaxable business combination
accounted for as a purchase should be adjusted for the tax effect of
the difference between the market or appraised value of the asset and
its tax basis. Under FASB 109, this tax effect is recorded separately
in a deferred tax liability account, whereas under previous GAAP, this
tax effect reduced the amount of the intangible asset. This change in
treatment could cause a large increase, i.e., a ``gross-up,'' in the
reported amount of certain identifiable intangible assets, such as core
deposit intangibles, which are deducted for purposes of computing
regulatory capital.
Six commenters indicated that institutions should be permitted to
deduct the net after-tax amount of the intangible asset from capital,
not the gross amount of the intangible asset. These commenters argued
that FASB 109 will create artificially high carrying values for
intangible assets and a related deferred tax liability when an
institution acquires assets with a carryover basis for tax purposes but
revalues the assets for financial reporting purposes. The commenters
generally indicated that, under FASB 109, the balance sheet will not
accurately reflect the value paid for the intangibles. Furthermore,
commenters indicated that the increased carrying value of the
intangible asset posed no risk to an institution, because a reduction
in the value of the asset would effectively extinguish the related
deferred tax liability.
On the other hand, one commenter indicated that deferred tax assets
resulting from the gross-up effect in certain business combinations
should not be treated differently from other deferred tax assets.
Question (3): The FDIC's third question inquired about (a) the
potential burden associated with the proposal and whether a limitation
based on projections of future taxable income would be difficult to
implement and (b) the appropriateness of the separate entity method for
determining the proposed limit on deferred tax assets and for tax
sharing agreements in general.
Question (3)(a): The FDIC received seven comment letters
specifically addressing the issue of potential burden and a limitation
based on income projections.
Two commenters supported the use of income projections. The first
one stated that capital limitations on deferred tax assets based on
projected future taxable income should not be difficult to implement
and should not impose an additional burden. This commenter noted that
many institutions already forecast future taxable income in order to
support the recognition of deferred tax assets on their balance sheets.
The second commenter similarly observed that these taxable income
projections must be evaluated by institutions' independent auditors and
that the subjectivity and complexity involved in such projections are
no greater than for the process of determining loan loss reserves.
Another commenter added that [[Page 8185]] these calculations should
not pose any problems, provided they are done on a consolidated basis.
One other commenter, who did not appear to oppose the concept of income
projections, nevertheless reported that requiring banks to project
their taxable income for the next year at the end of each interim
quarter presents a potentially difficult burden to smaller banks.
In addition, one commenter who did not directly address the burden
of income projections recommended that the FDIC clarify the term
``expected to be realized within one year.'' This commenter suggested
that the term should mean the amount of deferred tax assets that could
be absorbed by the expected amount of income taxes that would result
from an institution's projected future taxable income for the next 12
months, and not the amount of deferred tax assets that actually will be
used.
In contrast, three commenters specifically opposed an income
approach, preferring that a limit be determined by other means. These
commenters opposed the income approach because they believe that
projecting future earnings involves either too much subjectivity or
complexity. Instead, the three commenters expressed a preference for
setting the regulatory capital limit for deferred tax assets solely as
a percentage of capital. Two of these commenters suggested that the
deferred tax asset limit should be a function of an institution's
capital level for prompt corrective action purposes, with the highest
limit for ``well capitalized'' banks. The other commenter recommended
that the FDIC adopt percentage of capital limits consistent with those
applicable to purchased mortgage servicing rights and purchased credit
card receivables. On the other hand, one commenter specifically opposed
the establishment of a capital limitation based upon the perceived
``health'' of an institution, stating that this method could lead to
arbitrary and inconsistent measures of capital adequacy.
Question (3)(b): Seven commenters expressed opinions concerning the
separate entity method. The FDIC's proposal stated that the capital
limit for deferred tax assets would be determined on a separate entity
basis for each insured state nonmember bank. Under this method, a bank
(together with its consolidated subsidiaries) that is a subsidiary of a
holding company is treated as a separate taxpayer rather than as part
of a consolidated group.
All of these commenters opposed the separate entity approach,
although one commenter appeared to support this approach for banks that
do not have a ``strong'' holding company. Commenters argued that the
separate entity approach is artificial and that tax-sharing agreements
between financially capable bank holding companies and bank
subsidiaries should be considered when evaluating the recognition of
deferred tax assets for regulatory capital purposes. Commenters also
stated that the separate entity method is unnecessarily restrictive and
is contrary to bank tax management practices. It was suggested that any
systematic and rational method that is in accordance with GAAP should
be permitted for the calculation of the limitation for each bank.
One commenter's opposition to the separate entity approach was
based on the view that the limitation is not consistent with the
Federal Reserve Board's 1987 ``Policy Statement on the Responsibility
of Bank Holding Companies to Act as Sources of Strength to Their
Subsidiary Banks'' and the FDIC's 1990 ``Statement of Policy Regarding
Liability of Commonly Controlled Depository Institutions,'' which, in
some respects, treat a controlled group as one entity. Another
commenter contended that the effect of a separate entity calculation
would be to reduce bank capital which is needed for future lending, an
outcome that would be inconsistent with the objectives of the March 10,
1993, ``Interagency Policy Statement on Credit Availability.'' This
same commenter as well as one other further noted that the required use
of the separate entity method creates significant regulatory burden and
adds to the cost and complexity of calculating deferred tax assets for
both bankers and regulators.
Question (4): The FDIC's fourth question requested comment on the
appropriateness of the provisions of the proposal that would (a)
consider tax planning strategies as part of an institution's
projections of taxable income for the next year and (b) assume that all
temporary differences fully reverse at the report date.
Question (4)(a): The FDIC's proposal stated that the effect of tax
planning strategies that are expected to be implemented to realize tax
carryforwards that will otherwise expire during the next year should be
included in taxable income projections. Five commenters addressed this
issue. All of these commenters expressed support for including tax
planning strategies in an institution's projection of taxable income.
However, one commenter went on to state that the proposal should be
modified to permit institutions to consider strategies that would
ensure realization of deferred tax assets within the one-year time
frame.
Question (4)(b): Six commenters specifically addressed the full
reversal of temporary differences assumption and all but one agreed
that this assumption is appropriate. One commenter observed that this
assumption would eliminate the burden of scheduling the ``turnaround''
of temporary differences. In contrast, one commenter felt that this
assumption was not realistic.
Question (5): The FDIC's final question asked whether the
definition for the term ``deferred tax assets that are dependent upon
future taxable income'' should appear in the rule, as proposed, or in
the Call Report instructions. The only commenter who responded to this
question indicated that the Call Report instructions should reference
definitions in the tax rules and FASB 109.
IV. Final Rule
Limitation on Deferred Tax Assets
After considering the comments received on the proposed rule and
consulting with the other federal banking agencies, the FDIC is
limiting the amount of deferred tax assets that are dependent on future
taxable income that can be included in Tier 1 capital for risk-based
and leverage capital purposes. The limitation is consistent with both
the FDIC's proposal and the recommendation of the FFIEC's Task Force on
Supervision to the agencies as announced by the FFIEC on November 18,
1994. Under the final rule, for regulatory capital purposes, deferred
tax assets that are dependent upon future taxable income are limited to
the lesser of:
(1) the amount of such deferred tax assets that the institution
expects to realize within one year of the quarter-end report date,
based on its projection of future taxable income (exclusive of tax
carryforwards and reversals of existing temporary differences), or
(2) ten percent of Tier 1 capital before deducting any disallowed
purchased mortgage servicing rights, any disallowed purchased credit
card relationships, and any disallowed deferred tax assets.
Deferred tax assets that can be realized from taxes paid in prior
carryback years and from the reversal of existing taxable temporary
differences generally are not limited under the final rule. The
reported amount of deferred tax assets, net of its valuation
[[Page 8186]] allowance, in excess of the limitation will be deducted
from Tier 1 capital for purposes of calculating both the risk-based and
leverage capital ratios. Banks should not include the amount of
disallowed deferred tax assets in risk-weighted assets in the risk-
based capital ratio and should deduct the amount of disallowed deferred
tax assets from average total assets in the leverage capital ratio.
Deferred tax assets included in capital continue to be assigned a risk
weight of 100 percent.
To determine the limit, a bank should assume that all temporary
differences fully reverse as of the report date. The amount of deferred
tax assets that are dependent upon future taxable income that is
expected to be realized within one year means the amount of such
deferred tax assets that could be absorbed by the amount of income
taxes that are expected to be payable based upon the bank's projected
future taxable income for the next 12 months. Estimates of taxable
income for the next year should include the effect of tax planning
strategies that the bank is planning to implement to realize tax
carryforwards that will otherwise expire during the year. Consistent
with FASB 109, the FDIC believes tax planning strategies are carried
out to prevent the expiration of such carryforwards. These provisions
of the final rule are consistent with the proposed rule.
The capital limitation is intended to balance the FDIC's continued
concerns about deferred tax assets that are dependent upon future
taxable income against the fact that such assets will, in many cases,
be realized. The limitation also ensures that state nonmember banks do
not place excessive reliance on deferred tax assets to satisfy the
minimum capital standards.
The final rule generally permits full inclusion of deferred tax
assets potentially recoverable from carrybacks, since these amounts
normally will be realized. The final rule also includes in Tier 1
capital those deferred tax assets that are dependent upon future
taxable income, if they can be recovered from projected taxable income
during the next year, provided this amount does not exceed ten percent
of Tier 1 capital. The FDIC is limiting projections of future taxable
income to one year because the FDIC believes that banks generally are
capable of making taxable income projections for the following twelve
month period that have a reasonably good probability of being achieved.
However, the reliability of projections tends to decrease significantly
beyond that time period. Deferred tax assets that are dependent upon
future taxable income are also limited to ten percent of Tier 1
capital, since the FDIC believes such assets should not comprise a
large portion of a bank's capital base given the uncertainty of
realization associated with these assets and the difficulty in selling
these assets apart from the bank. Furthermore, a ten percent of capital
limit also reduces the risk that an overly optimistic estimate of
future taxable income will cause a bank to significantly overstate the
allowable amount of deferred tax assets.
Banks are required to follow FASB 109 for regulatory reporting
purposes and, accordingly, are already making projections of taxable
income. The ten percent of Tier 1 capital calculation also is
straightforward. In addition, banks have been reporting the amount of
deferred tax assets that would be disallowed under the proposal in
their Call Reports since the March 31, 1993, report date. Therefore,
the FDIC believes that banks will not have significant difficulty in
implementing this final rule. In this regard, as of the September 30,
1994, report date, more than one third of the 7,000 state nonmember
banks carried no net deferred tax assets on their balance sheets. Fewer
than 300 state nonmember banks with net deferred tax assets reported
that any portion of this asset would have been disallowed under the
proposal.
Guidance on Specific Implementation Issues
In response to the comments received and after discussions with the
other federal banking agencies, the FDIC is providing the following
additional guidance concerning the implementation of the limit.
Projecting Future Taxable Income: Banks may choose to use the
future taxable income projections for their current fiscal year
(adjusted for any significant changes that have occurred or are
expected to occur) when applying the capital limit at an interim report
date rather than preparing a new one-year projection each quarter. One
commenter expressed concern about the potential burden and difficulty
of preparing revised projections each quarter, particularly for smaller
banks.
In addition, the final rule does not specify how originating
temporary differences should be treated for purposes of projecting
future taxable income for the next year. Each institution should decide
whether to adjust its income projections for originating temporary
differences and should follow a reasonable and consistent approach.
Tax Jurisdictions: Unlike the proposed rule, the final rule does
not require an institution to determine its limitation on deferred tax
assets on a jurisdiction-by-jurisdiction basis. While an approach that
looks at each jurisdiction separately theoretically may be more
accurate, the FDIC does not believe the greater precision that would be
achieved in mandating such an approach outweighs the complexities
involved and its inherent cost to institutions. Therefore, to limit
regulatory burden, a bank may calculate one overall limit on deferred
tax assets that covers all tax jurisdictions in which the bank
operates.
Available-for-sale Securities: Under FASB Statement No. 115,
``Accounting for Certain Investments in Debt and Equity Securities''
(FASB 115), ``available-for-sale'' securities are reported in
regulatory reports at fair value, with unrealized holding gains and
losses on such securities, net of tax effects, included in a separate
component of stockholders equity. These tax effects may increase or
decrease the reported amount of a bank's net deferred tax assets.
The FDIC has recently decided to exclude from regulatory capital
the amount of net unrealized holding gains and losses on available-for-
sale securities (except net unrealized holding losses of available-for-
sale equity securities with readily determinable fair values) (59 FR
66662, Dec. 28, 1994). Therefore, it would be consistent to exclude the
deferred tax effects relating to unrealized holding gains and losses on
these available-for-sale securities from the calculation of the
allowable amount of deferred tax assets for regulatory capital
purposes. On the other hand, requiring the exclusion of such deferred
tax effects would add significant complexity to the regulatory capital
standards and in most cases would not have a significant impact on
regulatory capital ratios.
Therefore, when determining the capital limit for deferred tax
assets, the FDIC has decided to permit, but not require, institutions
to adjust the reported amount of deferred tax assets for any deferred
tax assets and liabilities arising from marking-to-market available-
for-sale debt securities for regulatory reporting purposes. This choice
will reduce implementation burden for institutions not wanting to
contend with the complexity arising from such adjustments, while
permitting those institutions that want to achieve greater precision to
make such adjustments. Institutions must follow a consistent approach
with respect to such adjustments.
Separate Entity Method: Under the proposed rule, the capital limit
would [[Page 8187]] be determined on a separate entity basis by each
bank that was a subsidiary of a holding company. The use of a separate
entity approach for income tax sharing agreements (including
intercompany tax payments and current and deferred taxes) is generally
required by the FDIC's 1978 Statement of Policy on Income Tax
Remittance by Banks to Holding Company Affiliates, and similar policies
are followed by the other federal banking agencies. Thus, any change to
the separate entity approach for deferred tax assets would also need to
consider changes to this policy statement, which is outside the scope
of this rulemaking. The FDIC also notes that income tax data in bank
regulatory reports generally are required to be prepared using a
separate entity approach and consistency between these reports would be
reduced if institutions were permitted to use other methods for
calculating deferred tax assets in addition to a separate entity
approach. Thus, while a number of the commenters suggested that the
FDIC consider permitting other approaches, the FDIC has decided that
the final rule should retain the separate entity approach.
The final rule departs from the separate entity approach in one
situation. This situation arises when a bank's parent holding company,
if any, does not have the financial capability to reimburse the bank
for tax benefits derived from the bank's carryback of net operating
losses or tax credits. If this occurs, the amount of carryback
potential the bank may consider in calculating the amount of deferred
tax assets that may be included in Tier 1 capital may not exceed the
amount which the bank could reasonably expect to have refunded by its
parent. This provision of the final rule is consistent with the
proposed rule.
Gross-up of Intangibles: As noted above, the manner in which FASB
109 must be applied when accounting for purchase business combinations
can lead to a large increase (i.e., ``gross-up'') in the reported
amount of certain intangible assets, such as core deposit intangibles,
which are deducted for purposes of computing regulatory capital.
Commenters stated that the increased carrying value of such an
intangible posed no risk to an institution, because a reduction in the
value of the asset would effectively extinguish the related deferred
tax liability. The FDIC agrees with these commenters and, consequently,
will permit, for capital adequacy purposes, the netting of deferred tax
liabilities arising from this gross-up effect against related
intangible assets. This will result in the same treatment for
intangibles acquired in purchase business combinations as under the
accounting standards in effect prior to FASB 109. However, a deferred
tax liability netted in this manner may not also be netted against
deferred tax assets when determining the amount of deferred tax assets
that are dependent upon future taxable income. Netting will not be
permitted against purchased mortgage servicing rights and purchased
credit card relationships, since these intangible assets are deducted
for capital adequacy purposes only if they exceed specified capital
limits.
Leveraged Leases: While not expected to significantly affect many
banks, one commenter stated that future net tax liabilities related to
leveraged leases acquired in a purchase business combination are
included in the value assigned to the leveraged leases and are not
shown on the balance sheet as part of an institution's deferred taxes.
This artificially increases the amount of deferred tax assets for those
institutions that acquire leveraged leases. Thus, this commenter
continued, the future taxes payable included in the valuation of a
leveraged lease portfolio in a purchase business combination should be
treated as a taxable temporary difference whose reversal would support
the recognition of deferred tax assets, if applicable. The FDIC agrees
with this commenter and, therefore, banks may use the deferred tax
liabilities that are embedded in the carrying value of a leveraged
lease to reduce the amount of deferred tax assets subject to the
capital limit.
V. Regulatory Flexibility Act Analysis
The FDIC does not believe that the adoption of this final rule will
have a significant economic impact on a substantial number of small
business entities (in this case, small banks), in accordance with the
spirit and purposes of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). In this regard, the vast majority of small banks currently have
very limited amounts of net deferred tax assets, which are the subject
of this proposal, as a component of their capital structures.
Furthermore, adoption of this final rule, in combination with the
adoption of FASB 109 for regulatory reporting purposes, will allow many
banks to increase the amount of deferred tax assets they include in
regulatory capital.
VI. Paperwork Reduction Act
The FDIC has previously received approval from the Office of
Management and Budget (OMB) to collect in the Reports of Condition and
Income (Call Reports) information on the amount of deferred tax assets
disallowed for regulatory capital purposes. (OMB Control Number 3064-
0052.) Therefore, this final rule will not increase banks' existing
regulatory paperwork burden.
List of Subjects in 12 CFR Part 325
Bank deposit insurance, Banks, banking, Capital adequacy, Reporting
and recordkeeping requirements, Savings associations, State nonmember
banks.
For the reasons set forth in the preamble, the Board of Directors
of the Federal Deposit Insurance Corporation hereby amends 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).
Sec. 325.2 [Amended]
2. Section 325.2 is amended in paragraphs (t) and (v) by adding
``minus deferred tax assets in excess of the limit set forth in
Sec. 325.5(g),'' after ``12 CFR part 567),''.
3. Section 325.5 is amended:
a. In paragraphs (f)(3)(i) and (f)(4)(i), by removing the word
``and'', by adding a comma after ``rights'', and by adding ``, and any
disallowed deferred tax assets'' after ``relationships''; and
b. By adding a new paragraph (g) to read as follows:
Sec. 325.5 Miscellaneous.
* * * * *
(g) Treatment of deferred tax assets. For purposes of calculating
Tier 1 capital under this part (but not for financial statement
purposes), deferred tax assets are subject to the conditions,
limitations, and restrictions described in this section.
(1) Deferred tax assets that are dependent upon future taxable
income. These assets are:
(i) Deferred tax assets arising from deductible temporary
differences that exceed the amount of taxes previously paid that could
be recovered through loss carrybacks if existing temporary differences
(both deductible and taxable and regardless of where the related
deferred tax effects are reported on the balance sheet) fully reverse
at the calendar quarter-end date; and
(ii) Deferred tax assets arising from operating loss and tax credit
carryforwards. [[Page 8188]]
(2) Tier 1 capital limitations. (i) The maximum allowable amount of
deferred tax assets that are dependent upon future taxable income, net
of any valuation allowance for deferred tax assets, will be limited to
the lesser of:
(A) The amount of deferred tax assets that are dependent upon
future taxable income that is expected to be realized within one year
of the calendar quarter-end date, based on projected future taxable
income for that year; or
(B) Ten percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed purchased mortgage servicing rights,
any disallowed purchased credit card relationships, and any disallowed
deferred tax assets.
(ii) For purposes of this limitation, all existing temporary
differences should be assumed to fully reverse at the calendar quarter-
end date. The recorded amount of deferred tax assets that are dependent
upon future taxable income, net of any valuation allowance for deferred
tax assets, in excess of this limitation will be deducted from assets
and from equity capital for purposes of determining Tier 1 capital
under this part. The amount of deferred tax assets that can be realized
from taxes paid in prior carryback years and from the reversal of
existing taxable temporary differences generally would not be deducted
from assets and from equity capital. However, notwithstanding the
above, the amount of carryback potential that may be considered in
calculating the amount of deferred tax assets that a member of a
consolidated group (for tax purposes) may include in Tier 1 capital may
not exceed the amount which the member could reasonably expect to have
refunded by its parent.
(3) Projected future taxable income. Projected future taxable
income should not include net operating loss carryforwards to be used
within one year of the most recent calendar quarter-end date or the
amount of existing temporary differences expected to reverse within
that year. Projected future taxable income should include the estimated
effect of tax planning strategies that are expected to be implemented
to realize tax carryforwards that will otherwise expire during that
year. Future taxable income projections for the current fiscal year
(adjusted for any significant changes that have occurred or are
expected to occur) may be used when applying the capital limit at an
interim calendar quarter-end date rather then preparing a new
projection each quarter.
(4) Unrealized holding gains and losses on available-for-sale debt
securities. The deferred tax effects of any unrealized holding gains
and losses on available-for-sale debt securities may be excluded from
the determination of the amount of deferred tax assets that are
dependent upon future taxable income and the calculation of the maximum
allowable amount of such assets. If these deferred tax effects are
excluded, this treatment must be followed consistently over time.
(5) Intangible assets acquired in nontaxable purchase business
combinations. A deferred tax liability that is specifically related to
an intangible asset (other than purchased mortgage servicing rights and
purchased credit card relationships) acquired in a nontaxable purchase
business combination may be netted against this intangible asset. Only
the net amount of the intangible asset must be deducted from Tier 1
capital. When a deferred tax liability is netted in this manner, the
taxable temporary difference that gives rise to this deferred tax
liability must be excluded from existing taxable temporary differences
when determining the amount of deferred tax assets that are dependent
upon future taxable income and calculating the maximum allowable amount
of such assets.
4. Section I.A.1. of appendix A to part 325 is amended by revising
the first paragraph following the definitions of Core capital elements
to read as follows:
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
I. * * *
A. * * *
1. * * *
At least 50 percent of the qualifying total capital base should
consist of Tier 1 capital. Core (Tier 1) capital is defined as the
sum of core capital elements\3\ minus all intangible assets other
than mortgage servicing rights and purchased credit card
relationships\4\ and minus any disallowed deferred tax assets.
\3\In addition to the core capital elements, Tier 1 may also
include certain supplementary capital elements during the transition
period subject to certain limitations set forth in section III of
this statement of policy.
\4\An exception is allowed for intangible assets that are
explicitly approved by the FDIC as part of the bank's regulatory
capital on a specific case basis. These intangibles will be included
in capital for risk-based capital purposes under the terms and
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------
* * * * *
5. Section I.B. of Appendix A to part 325 is amended by adding a
new paragraph (5) immediately after paragraph (4) and preceding the
final undesignated paragraph of Section I.B. to read as follows:
* * * * *
I. * * *
B. * * *
(5) Deferred tax assets in excess of the limit set forth in
Sec. 325.5(g). These disallowed deferred tax assets are deducted
from the core capital (Tier 1) elements.
* * * * *
Appendix A to Part 325 [Amended]
6. Table I in Appendix A to part 325 is amended by redesignating
footnote 3 as footnote 4, by adding a new entry at the end under ``Core
Capital (Tier 1)'' and by adding a new footnote 3 to read as follows:
Table I.--Definition of Qualifying Capital
[Note: See footnotes at end of table]
------------------------------------------------------------------------
Minimum requirements and
Components limitations after transition period
------------------------------------------------------------------------
Core Capital P(Tier 1) * * *
* * * * *
Less: Certain deferred tax
assets.\3\
* * * * *
------------------------------------------------------------------------
\3\Deferred tax assets are subject to the capital limitations set forth
in Sec. 325.5(g).
* * * * *
By order of the Board of Directors.
Dated at Washington, D.C., this 31st day of January 1995.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary.
[FR Doc. 95-3179 Filed 2-10-95; 8:45 am]
BILLING CODE 6714-01-P
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