[Federal Register Volume 60, Number 29 (Monday, February 13, 1995)]
[Rules and Regulations]
[Pages 8182-8188]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-3179]



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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                                              
 assers.\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