8182 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

48 In regulatory reports and under GAAP, bank

holding companies are permitted to treat some asset

sales with recourse as ‘‘true’’ sales. For risk-based

capital purposes, however, such assets sold with

recourse and reported as ‘‘true’’ sales by bank

holding companies are converted at 100 percent

and assigned to the risk category appropriate to the

underlying obligor or, if relevant, the guarantor or

nature of the collateral, provided that the

transactions meet the definition of assets sold with

recourse (including assets sold subject to pro rata

and other loss sharing arrangements), that is

contained in the instructions to the commercial

bank Consolidated Reports of Condition and

Income (Call Report). This treatment applies to any

assets, including the sale of 1- to 4-family and

multifamily residential mortgages, sold with

recourse. Accordingly, the entire amount of any

assets transferred with recourse that are not already

included on the balance sheet, including pools of

1- to 4-family residential mortgages, are to be

converted at 100 percent and assigned to the risk

category appropriate to the obligor, or if relevant,

the nature of any collateral or guarantees. The terms

of a transfer of assets with recourse may

contractually limit the amount of the institution’s

liability to an amount less than the effective riskbased capital requirement for the assets being

transferred with recourse. If such a transaction is

recognized as a sale under GAAP, the amount of

total capital required is equal to the maximum

amount of loss possible under the recourse

provision, less any amount held in an associated

non-capital liability account established pursuant to

GAAP to cover estimated probable losses under the

recourse provision.

49Forward forward deposits accepted are treated

as interest rate contracts.

obligation to make a payment to the customer

or to a third party in the event the customer

fails to repay an outstanding debt obligation

or fails to perform a contractual obligation is

treated, for risk-based capital purposes, as

respectively, a financial guarantee standby

letter of credit or a performance standby.

f. A loan commitment, on the other hand,

involves an obligation (with or without a

material adverse change or similar clause) of

the banking organization to fund its customer

in the normal course of business should the

customer seek to draw down the

commitment.

g. Sale and repurchase agreements and

asset sales with recourse (to the extent not

included on the balance sheet) and forward

agreements also are converted at 100

percent.48 So-called ‘‘loan strips’’ (that is,

short-term advances sold under long-term

commitments without direct recourse) are

treated for risk-based capital purposes as

assets sold with recourse and, accordingly,

are also converted at 100 percent.

h. Forward agreements are legally binding

contractual obligations to purchase assets

with certain drawdown at a specified future

date. Such obligations include forward

purchases, forward forward deposits

placed,49 and partly-paid shares and

securities; they do not include commitments

to make residential mortgage loans or

forward foreign exchange contracts.

i. Securities lent by a banking organization

are treated in one of two ways, depending

upon whether the lender is at risk of loss. If

a banking organization, as agent for a

customer, lends the customer’s securities and

does not indemnify the customer against loss,

then the transaction is excluded from the

risk-based capital calculation. If,

alternatively, a banking organization lends its

own securities or, acting as agent for a

customer, lends the customer’s securities and

indemnifies the customer against loss, the

transaction is converted at 100 percent and

assigned to the risk weight category

appropriate to the obligor, to any collateral

delivered to the lending banking

organization, or, if applicable, to the

independent custodian acting on the lender’s

behalf. Where a banking organization is

acting as agent for a customer in a transaction

involving the lending or sale of securities

that is collateralized by cash delivered to the

banking organization, the transaction is

deemed to be collateralized by cash on

deposit in a subsidiary lending institution for

purposes of determining the appropriate riskweight category, provided that any

indemnification is limited to no more than

the difference between the market value of

the securities and the cash collateral received

and any reinvestment risk associated with

that cash collateral is borne by the customer.

* * * * *

By order of the Board of Governors of the

Federal By Reserve System, February 7, 1995.

William W. Wiles,

Secretary of the Board.

[FR Doc. 95–3469 Filed 2–10–95; 8:45 am]

BILLING CODE 6210–01–P

FEDERAL DEPOSIT INSURANCE

CORPORATION

12 CFR Part 325

RIN 3064–AB20

Capital Maintenance

AGENCY: Federal Deposit Insurance

Corporation (FDIC).

ACTION: Final rule.

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
Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 8183

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.

2Prior 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.

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.

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.

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 quarterend 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
8184 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

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 twothirds 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 ‘‘wellcapitalized’’ 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
Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 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 quarterend 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
8186 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

allowance, in excess of the limitation

will be deducted from Tier 1 capital for

purposes of calculating both the riskbased and leverage capital ratios. Banks

should not include the amount of

disallowed deferred tax assets in riskweighted 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 oneyear 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-forsale 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
Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations 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).

§ 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 § 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:

§ 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.
8188 Federal Register / Vol. 60, No. 29 / Monday, February 13, 1995 / Rules and Regulations

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.

4An 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.

(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 quarterend 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 quarterend 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.

* * * * *

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 § 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]

Components

Minimum requirements and limitations

after transition period

Core Capital

(Tier 1) * * *

* * * * *

Less: Certain deferred tax assers.3

* * * * *

3 Deferred tax assets are subject to the capital limitations set forth in § 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

CONSUMER PRODUCT SAFETY

COMMISSION

16 CFR Part 1500

Statement of Policy or Interpretation;

Enforcement Policy for Art Materials

AGENCY: Consumer Product Safety

Commission.

ACTION: Final rule; statement of

enforcement policy.

SUMMARY: In 1988, Congress enacted the

Labeling of Hazardous Art Materials Act

which mandated a labeling standard

and certain other requirements for art

materials. Based on its experience

enforcing these requirements, the

Commission is issuing a statement of

enforcement policy to more clearly

apprise the public of its intended

enforcement focus.