[Federal Register Volume 60, Number 28 (Friday, February 10, 1995)]
[Notices]
[Pages 7966-7969]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3392]



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FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL


Implementation Issues Arising from FASB Statement No. 114, 
``Accounting by Creditors for Impairment of a Loan''

AGENCY: Federal Financial Institutions Examination Council.

ACTION: Final action.

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SUMMARY: The Federal Financial Institutions Examination Council 
(FFIEC)\1\ has decided that the portion of an institution's allowance 
established pursuant to Statement of Financial Accounting Standards No. 
114, ``Accounting by Creditors for Impairment of a Loan'' (FAS 114), 
[[Page 7967]] should be reported as part of the general allowance, 
which is includible in Tier 2 capital subject to current limitations. 
In concluding that the FAS 114 allowance is general in nature, the 
FFIEC has also reaffirmed existing regulatory reporting policies that 
require banks to promptly charge-off identified losses. Similarly, 
savings associations are required to promptly charge-off identified 
losses, or create specific allowances which are reported separately 
from general allowances. With respect to impaired collateral-dependent 
loans, any portion of the loan balance that exceeds the amount that is 
adequately secured by the fair value of the collateral is generally 
classified as loss by examiners. Consequently, such losses on 
collateral-dependent loans are excluded from the general allowance and 
Tier 2 capital. Because of the conclusions on the treatment of FAS 114 
allowances, no changes are required in the federal banking agencies' 
regulatory capital rules. In addition, the FFIEC has decided to 
maintain its existing regulatory nonaccrual standards.

    \1\The FFIEC consists of representatives from the Board of 
Governors of the Federal Reserve System (FRB), the Federal Deposit 
Insurance Corporation (FDIC), the Office of the Comptroller of the 
Currency (OCC), the Office of Thrift Supervision (OTS) (referred to 
as the ``agencies''), and the National Credit Union Administration. 
However, this guidance is not directed to credit unions. Section 
1006(c) of the Federal Financial Institutions Examination Council 
Act requires the FFIEC to develop uniform reporting standards for 
federally-supervised financial institutions.

EFFECTIVE DATE: For regulatory reports prepared as of March 31, 1995, 
unless an institution has elected to adopt FAS 114 and the guidance in 
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this notice as of an earlier date.

FOR FURTHER INFORMATION CONTACT:
At the FRB: Gerald A. Edwards, Jr., Assistant Director (202) 452-2741 
or Charles H. Holm, Project Manager (202) 452-3502. For questions 
pertaining to regulatory capital issues, Rhoger H. Pugh, Assistant 
Director (202) 728-5883, or Kevin M. Bertsch, Supervisory Financial 
Analyst (202) 452-5265.

At the FDIC: Doris L. Marsh, Examination Specialist, Accounting 
Section, Division of Supervision (202) 898-8905, or Robert F. Storch, 
Chief, Accounting Section, Division of Supervision (202) 898-8906.
At the OCC: Eugene W. Green, Deputy Chief Accountant, (202) 874-4933, 
or Frank Carbone, National Bank Examiner (202) 874-5170.
At the OTS: Timothy Stier, Deputy Chief Accountant (202) 906-5699.

SUPPLEMENTARY INFORMATION:

I. Background

A. Summary of FAS 114

    FAS 114 was adopted in May 1993 by the Financial Accounting 
Standards Board (FASB). The statement applies to all creditors and to 
all loans that are identified for evaluation of collectibility, except: 
(1) large groups of smaller-balance homogeneous loans that are 
collectively evaluated for impairment (such as credit card, residential 
mortgage, and consumer installment loans), (2) loans that are measured 
at fair value or at the lower of cost or fair value (such as loans held 
for sale), (3) leases, and (4) debt securities. FAS 114 does not 
specify how an institution should identify loans that are to be 
evaluated for collectibility. An institution should apply its normal 
loan review procedures in making that judgment.
    Under FAS 114, a loan is impaired when it is probable that a 
creditor will be unable to collect all amounts due (including interest 
and principal) according to the contractual terms of the loan 
agreement. When a loan is impaired, a creditor must measure the extent 
of that impairment by determining the present value of expected future 
cash flows discounted at the loan's effective interest rate. However, 
as practical expedients, the creditor may measure impairment based on 
either the loan's observable market price, or the fair value of the 
collateral for the loan if the loan is collateral dependent. Although 
under FAS 114 a creditor is generally allowed to use any of these three 
measurement methods to determine the amount of impairment, a creditor 
must measure impairment based on the fair value of collateral when the 
creditor determines that foreclosure is probable.
    FAS 114 does not address when a creditor should record a charge-off 
of an impaired loan. Furthermore, FAS 114, as amended by Statement of 
Financial Accounting Standards No. 118, ``Accounting by Creditors for 
Impairment of a Loan--Income Recognition and Disclosures'' (FAS 118), 
in October 1994, does not address how a creditor should recognize 
interest income on an impaired loan.

B. FFIEC Guidance on FAS 114 Announced in May 1994

    The May 17, 1994, Federal Register (59 FR 25656) stated that ``the 
FFIEC and the agencies are requiring institutions to adopt FAS 114 as 
of its effective date for purposes of reporting on the Call Report and 
TFR. Furthermore, the agencies will permit early adoption.'' This 
regulatory reporting treatment is consistent with the requirements of 
Section 37 of the Federal Deposit Insurance Act (12 U.S.C. 1831n).
    While institutions are required to adopt FAS 114 for regulatory 
reporting purposes, the ``Interagency Policy Statement on the Review 
and Classification of Commercial Real Estate Loans,'' issued on 
November 7, 1991, will remain in effect. Therefore, impaired, 
collateral-dependent loans must be reported at the fair value of 
collateral in regulatory reports. This treatment is to be applied to 
all collateral-dependent loans, regardless of the type of collateral.
    The FFIEC and the agencies also announced that they do not plan to 
automatically require additional allowances for credit losses on 
impaired loans over and above what is required on these loans under FAS 
114.\2\ However, an additional allowance on impaired loans may be 
necessary based on consideration of institution-specific factors, such 
as historical loss experience compared with estimates of such losses, 
concerns about the reliability of cash flow estimates, or the quality 
of an institution's loan review function and controls over its process 
for estimating its FAS 114 allowance.

    \2\FAS 114 does not address the overall adequacy of the ALLL. 
However, in addition to requiring an allowance for credit losses on 
impaired loans, FAS 114 requires each institution to continue to 
maintain an overall allowance that complies with Statement of 
Financial Accounting Standards No. 5, ``Accounting for 
Contingencies.'' Thus, consistent with existing regulatory policy, 
the ALLL should be adequate to cover all estimated credit losses 
arising from the loan and lease portfolio, including losses on loans 
that do not meet FAS 114's impairment criterion.
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C. Issues on Which the FFIEC Sought Public Comment

    In the May 17, 1994, Federal Register, the FFIEC sought public 
comment on two primary reporting issues and certain other matters 
related to FAS 114.

1. The Character of the FAS 114 Allowance

    Should that portion of an institution's allowance established 
pursuant to FAS 114 be reported and considered as a specific allowance 
and, thus, not be eligible for inclusion in Tier 2 capital under the 
agencies' current capital rules? Alternatively, should the FAS 114 
allowance be regarded as a general allowance which would be eligible 
for inclusion in Tier 2 capital subject to existing limits?\3\

    \3\Under the agencies' risk-based capital rules, general 
allowances includible in Tier 2 capital are limited to 1.25 percent 
of gross risk-weighted assets and an institution's Tier 2 capital 
cannot exceed its Tier 1 capital.
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2. Maintenance of Nonaccrual Reporting Requirements

    Should regulatory nonaccrual standards be maintained for loans 
subject to FAS 114?

3. Other Issues

    a. Comment was sought on (i) how much the adoption of FAS 114 is 
expected to change overall allowance [[Page 7968]] levels, and (ii) 
what portion of total overall allowances are expected to be related to 
impaired loans evaluated pursuant to FAS 114.
    b. Comment was sought on implementation issues arising from FAS 114 
to the extent they relate to U.S. branches and agencies of foreign 
banks. These entities are required to file quarterly the Report of 
Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks 
(002 Report), which in many respects is similar to the bank Call 
Report. The 002 Report requires U.S. branches and agencies of foreign 
banks to report the amount of nonaccrual loans (see issue 2, 
``Maintenance of Nonaccrual Reporting Requirements'').
    c. Comment was sought on how FAS 114 might affect an institution's 
internal loan review process and its internal loan classification 
system for loans subject to FAS 114. In this regard, the FFIEC noted 
that, according to the December 21, 1993, Interagency Policy Statement 
on the Allowance for Loan and Lease Losses, each institution should 
ensure that it has a formal credit grading system that can be 
reconciled with the classification framework used by the agencies.

II. Public Comments

    The FFIEC received 85 comment letters concerning the regulatory 
implementation issues arising from FAS 114. Seventy letters came from 
banking and thrift institutions. Eight financial institution trade 
associations, one professional association for accountants, three state 
banking departments, a state banking supervisors' conference, and two 
accounting firms also offered comments.

A. The Character of the FAS 114 Allowance

    58 of the 70 commenters who addressed this issue indicated that an 
institution's allowance established pursuant to FAS 114 should be 
reported as a general allowance and be eligible for inclusion in Tier 2 
capital. Many commenters stated that they believe that the FAS 114 
allowance is a general allowance because of its availability to absorb 
any losses in the loan portfolio. Others noted that the banking 
agencies' current policy of requiring prompt charge-offs supports the 
idea that an institution's allowance for loan and lease losses (ALLL) 
does not contain identified losses and that any FAS 114 allowances 
included in the ALLL would be general. Respondents also indicated that 
the methodology required by FAS 114 is similar to that recommended in 
the agencies' current policies for determining an adequate ALLL and 
that other allocations of the ALLL for analytical purposes are 
currently disclosed in documents filed with the Securities and Exchange 
Commission without implying that they are specific allowances.
    12 of the commenters recommended that the FAS 114 allowance be 
considered a ``specific allowance'' and not be eligible for inclusion 
in Tier 2 capital. These commenters indicated that they believe that 
FAS 114 relates to identified losses of particular loans and groups of 
loans. One commenter stated that, because of the current limit on the 
amount of the ALLL that may be included in Tier 2 capital (i.e., 1.25 
percent of gross risk-weighted assets), the current impact on 
institutions of a decision to treat the FAS 114 allowance as a specific 
allowance would be minimal. At the same time, this commenter noted that 
considering the FAS 114 allowance to be specific would promote 
consistency in the application and analysis of financial accounting, 
regulatory reporting, and capital standards. In addition, the commenter 
suggested that viewing the FAS 114 allowance as specific would add 
discipline to the loan review process.

B. Maintenance of Nonaccrual Reporting Requirements

    51 of the 60 commenters addressing this reporting issue agreed that 
the agencies should maintain existing nonaccrual policies for 
regulatory reporting purposes. Many respondents stated that, since 
nonaccrual policies are widely recognized, used, and understood, no 
change in these policies was needed. Some respondents indicated that 
institutions should not be required to modify their accounting systems 
until a change in income recognition methods for loans, if any, is made 
by FASB.
    9 of the commenters did not believe the agencies should retain 
existing nonaccrual policies. One respondent stated that the agencies' 
nonaccrual policies did not improve the safety and soundness of 
institutions, but rather forced the cost recovery method of accounting 
for all funds collected on these loans. Some commenters suggested 
modifications to the current nonaccrual policies.

C. Specific Questions Raised by the Agencies

1. Allowance Levels
    Commenters were asked how much the adoption of FAS 114 was expected 
to change overall allowance levels. Of the 41 commenters who responded, 
almost all stated that there would be little change in their allowance 
level. Other respondents indicated that they had not yet studied the 
impact of FAS 114.
    Thirteen respondents answered the question about what portion of 
the overall ALLL is expected to be related to impaired loans evaluated 
pursuant to FAS 114. Several commenters simply indicated that they 
expected the FAS 114 portion of their ALLL to be small, while three 
provided separate specific estimates of less than 25 percent, 10 
percent, and 5 percent. One stated that the FAS 114 allowance would be 
less than its existing ALLL and another indicated that its size would 
depend on the types of loans in portfolio. One commenter suggested that 
the FAS 114 allowance would be larger if assessed during an economic 
downturn.
2. U.S. Branches and Agencies of Foreign Banks
    Four of nine commenters on this subject suggested that nonaccrual 
standards should be maintained for these branches and agencies. Three 
suggested that the same rules should apply to all institutions 
operating in the U.S. so that institutions chartered in the U.S. are 
not placed at a competitive disadvantage. Two commenters stated that 
branches and agencies of foreign banks should not have to record an 
ALLL at the branch. One commenter also requested that the agencies make 
no changes to the 002 Report.
3. Internal Review Systems
    About half of the 55 institutions commenting on how FAS 114 might 
affect an institution's internal loan review process and its internal 
loan classification system said that FAS 114 will have little or no 
effect. Another third indicated that it will cause some operating and 
reporting changes with accompanying cost, but little or no perceived 
benefit. Changes that may be needed include more analysis and 
monitoring of loans, more time estimating cash flows and reviewing cash 
flow estimates, and more time estimating cash flows and reviewing cash 
flow estimates, and more documentation of the work performed.

III. Decisions on FAS 114 Implementation Issues

    After review of the comments received and further consideration of 
the issues involved, the FFIEC has made the following decision on 
implementation issues arising from FAS 114.
[[Page 7969]]

A. The Character of the FAS 114 Allowance

    The FFIEC has concluded that FAS 114 sets forth a method for 
estimating a portion of an institution's allowance for loan and lease 
losses. Therefore, the regulatory capital treatment of the ALLL for 
institutions will not be affected by the adoption of FAS 114 for 
regulatory reporting purposes. Consistent with this determination, the 
ALLL of institutions will continue to be reported net of any identified 
losses and will be includible in Tier 2 capital, subject to current 
limits.
    In concluding that the portion of the allowance established 
pursuant to FAS 114 is general in nature, the FFIEC notes that FAS 114 
in no way affects regulatory charge-off policies and is reiterating 
that these policies require banks to promptly charge-off all identified 
losses and require thrifts to either promptly charge-off identified 
losses or provide for them using separate, specific allowances that may 
not be included in regulatory capital. With respect to impaired 
collateral-dependent loans, any portion of the loan balance that 
exceeds the amount that is adequately secured by the fair value of the 
collateral is generally classified as loss by examiners. Consequently, 
the FFIEC notes that such losses on collateral-dependent loans are 
excluded from the general allowance and Tier 2 capital. Because of the 
conclusions on the treatment of FAS 114 allowances, no changes are 
required in the agencies' regulatory capital rules. The FFIEC further 
notes that the portion of the allowance established pursuant to FAS 114 
is available to meet losses in any part of the loan and lease portfolio 
and that institutions currently use a number of techniques in 
estimating the overall adequacy of their ALLL.

B. Nonaccrual Policies

    The FFIEC has also decided to retain its existing nonaccrual 
policies governing the recognition of interest income. As noted above, 
FASB has amended FAS 114 by issuing FAS 118 to remove the provisions 
describing how income on an impaired loan should be reported. Thus, the 
agencies' nonaccrual standards are not inconsistent with GAAP. 
Furthermore, as noted in the request for comment included in the 
Federal Register of May 17, 1994, the agencies' nonaccrual policies 
also provide many supervisory benefits, and retention of nonaccrual 
policies reduces regulatory burden by permitting institutions to 
continue their current reporting systems.
    Consistent with its determinations with respect to the Call Report, 
the FFIEC is not recommending any changes to regulatory nonaccrual 
standards in the 002 Report as a result of FAS 114. Accordingly, 
current regulatory nonaccrual standards will continue to apply to U.S. 
branches and agencies of foreign banks.

    Dated: February 7, 1995.
Keith J. Todd,
Assistant Executive Secretary, Federal Financial Institutions 
Examination Council.
[FR Doc. 95-3392 Filed 2-9-95; 8:45 am]
BILLING CODE 6210-01-M