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[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