[Federal Register Volume 59, Number 245 (Thursday, December 22, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-31441]
[[Page Unknown]]
[Federal Register: December 22, 1994]
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FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-0795]
Capital; Capital Adequacy Guidelines
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board or
Federal Reserve) is revising its capital adequacy guidelines for state
member banks and bank holding companies 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. The capital rule was developed in response to the
Financial Accounting Standards Board's (FASB) issuance of Statement No.
109, ``Accounting for Income Taxes'' (FAS 109). Under the final rule,
deferred tax assets that can only be realized if an institution earns
taxable income in the future are limited for regulatory capital
purposes to the amount that the institution expects to realize within
one year of the quarter-end report date--based on its projection of
taxable income--or 10 percent of Tier 1 capital, whichever is less.
EFFECTIVE DATE: April 1, 1995.
FOR FURTHER INFORMATION CONTACT: Charles H. Holm, Project Manager,
(202) 452-3502; Nancy J. Rawlings, Senior Financial Analyst, (202) 452-
3059, Regulatory Reporting and Accounting Issues Section; Barbara J.
Bouchard, Supervisory Financial Analyst, (202) 452-3072, Policy
Development Section, Division of Banking Supervision and Regulation,
Board of Governors of the Federal Reserve System. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Dorothea
Thompson (202) 452-3544.
SUPPLEMENTARY INFORMATION:
I. Background
A. Characteristics of Deferred Tax Assets
Deferred tax assets are assets that reflect, for financial
reporting purposes, benefits of certain aspects of tax laws and rules.
Deferred tax assets may arise because of specific limitations under tax
laws of different tax jurisdictions that require that certain net
operating losses (e.g., when, for tax purposes, expenses exceed
revenues) or tax credits be carried forward if they cannot be used to
recover taxes previously paid. These ``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 and bank
holding companies may report higher income to taxing authorities than
they reflect in their regulatory reports1 because their loan loss
provisions are expensed for reporting purposes but are not deducted for
tax purposes until the loans are charged off.
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\1\State member banks are required to file quarterly
Consolidated Reports of Condition and Income (Call Reports) with the
Federal Reserve. Bank holding companies with total consolidated
assets of $150 million or more file quarterly Consolidated Financial
Statements for Bank Holding Companies (FR Y-9C reports) with the
Federal Reserve.
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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
organization's 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
net operating loss and tax credit carryforwards, are hereafter referred
to as ``deferred tax assets that are dependent upon future taxable
income.''
B. Summary of FAS 109
In February 1992, the FASB issued Statement No. 109, ``Accounting
for Income Taxes'' which supersedes Accounting Principles Board Opinion
No. 11 and FASB Statement No. 96. FAS 109 provides guidance on many
aspects of accounting for income taxes, including the accounting for
deferred tax assets. FAS 109 potentially allows some state member banks
and bank holding companies to record significantly higher deferred tax
assets than previously permitted under generally accepted accounting
principles (GAAP) and the federal banking agencies' prior reporting
policies.2 Unlike the general practice under previous standards,
FAS 109 permits the reporting of deferred tax assets that are dependent
upon future taxable income. However, FAS 109 requires the establishment
of a valuation allowance to reduce the net deferred tax asset to an
amount that is more likely than not (i.e., a greater than 50 percent
likelihood) to be realized.
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\2\The federal banking agencies consist of the Federal Reserve
Board (Board), the Federal Deposit Insurance Corporation (FDIC), the
Office of the Comptroller of the Currency (OCC), and the Office of
Thrift Supervision (OTS) (hereafter, the ``agencies''.)
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FAS 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 FR Y-9C
reports that directly increase institutions' undivided profits
(retained earnings) and Tier 1 capital.
C. Concerns Regarding Deferred Tax Assets That Are Dependent Upon
Future Taxable Income
The Federal Reserve 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 banking organization
has sufficient future taxable income during the carryforward period.
Since a banking organization 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 an
organization may be sound and well-managed. Thus, for many
organizations such deferred tax assets may not be realized, and for
other organizations there is a high degree of subjectivity in
determining the realizability of this asset. Furthermore, while many
organizations may be able to make reasonable projections of taxable
income for relatively short periods and actually realize this income,
beyond a short time period, the reliability of the projections tends to
decrease significantly. In addition, unlike many other assets, banking
organizations generally cannot obtain the value of deferred tax assets
by selling them.
Moreover, as an organization's condition deteriorates, it is less
likely that deferred tax assets that are dependent upon future taxable
income will be realized. Therefore, the organization is required under
FAS 109 to reduce its deferred tax assets through increases to the
asset's valuation allowance. Additions to this allowance would reduce
the organization's regulatory capital at precisely the time it needs
capital support the most. Thus, the inclusion in 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
whether it would be appropriate to adopt FAS 109 for regulatory
reporting purposes. On August 3, 1992, the FFIEC requested public
comment on this matter, and on December 23, 1992, after consideration
of the comments received, the FFIEC decided that banks and savings
associations should adopt FAS 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). Furthermore, the Board decided that bank holding
companies should adopt FAS 109 in FR Y-9C Reports at the same time.
D. Proposal for the Treatment of Deferred Tax Assets
The FFIEC, in reaching its decision on regulatory reporting, also
recommended that each of the agencies 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 February 11, 1993, the Board issued for public
comment a proposal to adopt the recommendation of the FFIEC in full, as
summarized below (54 FR 8007, February 11, 1993). The FFIEC recommended
that the agencies limit the amount of deferred tax assets that are
dependent upon future taxable income that can be included in regulatory
capital to the lesser of:
i. 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 taxable income (exclusive of net operating
loss or tax credit carryforwards and reversals of existing temporary
differences), or
ii. 10 percent of Tier 1 capital, net of goodwill and all
identifiable intangible assets other than purchased mortgage servicing
rights and purchased credit card relationships (and before any
disallowed deferred tax assets are deducted). Deferred tax assets that
can be realized from taxes paid in prior carryback years and from
future reversals of existing taxable temporary differences would
generally not be limited under the proposal.
II. Public Comments on the Proposal
The comment period for the Board's proposal ended on March 15,
1993. The Board received nineteen comment letters including ten from
multinational and large regional banking organizations, and three
community banks. In addition, the Board received four comment letters
from bank trade associations and two from finance companies. Sixteen
commenters offered support for the Board's proposal to require banking
organizations to report, for regulatory purposes, deferred tax assets
in accordance with FAS 109. In addition, fifteen commenters indicated
that it would be preferable for the Board to place no limit on the
amount of deferred tax assets allowable in capital. These commenters
indicated that, in their view, embracing FAS 109 in its entirety would
achieve consistency between regulatory standards and GAAP as well as
maintain consistency with the intent of Section 121 of the Federal
Deposit Insurance Corporation Improvement Act (FDICIA) of 1991.
Commenters asserted that the criteria set forth in FAS 109 to recognize
and value deferred tax assets is sufficiently conservative to limit any
exposure to the bank insurance fund and that an arbitrary or mechanical
formula, such as the ones proposed, would not provide a more accurate
or reliable result.
While preferring no capital limit on deferred tax assets, some
commenters noted that the proposal represented a compromise and a step
forward from prior regulatory policies that permitted little or no
inclusion in regulatory reports or capital of deferred tax assets that
are dependent upon future taxable income. Two commenters generally
supported the proposal or expressed their understanding of the
regulator's concern regarding the realizability of deferred tax assets
and one commenter indicated the capital treatment should be consistent
with the capital treatment for identifiable intangible assets.
A. Responses to the Board's Questions
Question 1: (Gross-up of Intangible Assets) Nine commenters
responded to the Board's first question regarding whether certain
identifiable intangible 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 FAS 109, this tax effect is recorded
separately in a deferred tax liability account, whereas under
preexisting GAAP, this tax effect reduced the amount of the intangible
asset. This change in treatment could cause a large increase (i.e.,
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.
Seven commenters indicated that banking organizations 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 FAS 109 will create artificially high values for
intangible assets and the related deferred tax liability when a banking
organization acquires the assets with a carryover basis for tax
purposes but revalues the asset for financial reporting purposes. The
commenters generally indicated that, under FAS 109, the balance sheet
will not accurately reflect the value paid for the intangibles.
Furthermore, commenters indicated that the increased value of the
intangible posed no risk to institutions, because a reduction in the
value of the asset would effectively extinguish the related deferred
tax liability.
On the other hand, two commenters indicated that the pretax (gross)
value of intangible assets should be deducted for regulatory capital
purposes in this situation. This organization contended that intangible
assets should be treated similarly to other assets, which are not
reduced by any related liability.
Question 2: The Board's second question inquired about (i) the
potential burden associated with the proposal and whether a limitation
based on projections of taxable income would be difficult to implement,
and (ii) the appropriateness of the separate entity method for deferred
tax assets and tax sharing agreements in general.
i. Methodology Based on Income Projections. The Board received
eleven letters from commenters who responded directly to this aspect of
the question. Four commenters supported using income projections and
stated that calculating deferred tax asset limitations for capital
purposes based on projected taxable income would not be difficult to
implement and would not impose an additional burden because many
banking organizations already forecast taxable income in order to
recognize their deferred tax assets. One commenter added that these
calculations should not pose any problems, provided they are done on a
consolidated basis. In addition, one commenter suggested that the Board
clarify the term ``realized within one year'' so that readers
understand that the phrase means the amount of deferred tax assets that
could be used to offset income taxes generated in the next 12 months,
and not the amount of deferred tax assets that actually will be used.
Four commenters specifically opposed an income approach, citing the
additional burden that would be created by the detailed calculations.
One commenter specifically favored implementing the percentage of
capital method since it is certain and exact and does not involve as
many estimations or fluctuations as the income approach.
Five commenters supported an approach based on the financial
condition of the institution, some of whom also offered support or
opposition to the income or percentage of capital approach. One
commenter suggested that ``healthy'' institutions be permitted to
include deferred tax assets in regulatory capital in an amount based on
a specified percentage of Tier 1 capital. Another commenter supported
an approach that excluded ``well capitalized'' banks from the
limitation. On the other hand, one commenter did not support using an
approach for calculating the capital limitation based upon the
perceived ``health'' of the institution, stating that this method could
lead to arbitrary and inconsistent measures of capital adequacy.
ii. Separate Entity Approach. Twelve commenters specifically
addressed this part of the question. Under the Board's proposal, the
capital limit for deferred tax assets would be determined on a separate
entity basis for each state member bank so that a bank that is a
subsidiary of a holding company would be treated as a separate taxpayer
rather than as part of the consolidated entity. All of the commenters
opposed the separate entity approach. They 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 that any
systematic and rational method should be permitted for the calculation
of the limitation for each bank.
One commenter based its opposition for the separate entity approach
on the view that the limitation is not consistent with the Board's 1987
``Policy Statement on the Responsibility of Bank Holding Companies to
Act as Sources of Strength to Their Subsidiary Banks'' which, in some
respects, treats 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 which would be
inconsistent with the March 10, 1993, ``Interagency Policy Statement on
Credit Availability''. The same commenter also noted that the
regulatory burden and cost of calculating the deferred tax asset on a
separate entity basis would be substantial for both bankers and
regulators.
Question 3: The Board's third question addressed three specific
provisions of the proposal. These provisions included (i) requiring tax
planning strategies to be part of an institution's projection of
taxable income for the next year, (ii) requiring organizations to
assume that all temporary differences fully reverse at the report date,
and (iii) permitting the grandfathering of amounts previously reported
if they were in excess of the proposed limitation.
i. Inclusion of Tax Planning Strategies. Two commenters addressed
this issue. Both commenters stated that they support including tax
planning strategies in an institution's projection of taxable income.
One commenter stated 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. The proposal
provided that organizations should consider tax planning strategies
that would realize tax carryforwards or net operating losses that would
otherwise expire during that time frame.
ii. Temporary Differences. Four commenters specifically addressed
this aspect of the question, and all agreed that it is appropriate to
require the assumption that all temporary differences fully reverse as
of the report date. One commenter noted that this assumption would
eliminate the burden of scheduling the ``turnaround'' of temporary
differences.
iii. Grandfathering. Five commenters discussed the proposal's
provision on grandfathering which would allow the amount of any
deferred tax assets reported as of September 1992 in excess of the
limit to be phased out over a two year period ending in 1994. Four
commenters offered support for grandfathering but argued that excess
deferred tax assets should be grandfathered until the underlying
temporary differences reversed, rather than be phased out over two
years. The other commenter disagreed with the grandfathering proposal
and stated that such provisions would be inconsistent with the
proposal's capital adequacy objectives.
III. Final Amendment to the Capital Adequacy Guidelines
A. Limitation on Deferred Tax Assets
Consistent with the FFIEC's recommendation and the Board's
proposal, the Board is limiting in regulatory capital deferred tax
assets that are dependent on future taxable income to the lesser of:
i. 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 taxable income (exclusive of net operating
loss or tax credit carryforwards and reversals of existing temporary
differences), or
ii. 10 percent of Tier 1 capital, net of goodwill and all
identifiable intangible assets other than purchased mortgage servicing
rights and purchased credit card relationships (and before any
disallowed deferred tax assets are deducted).
Deferred tax assets that can be realized from taxes paid in prior
carryback years and from future reversals of existing taxable temporary
differences are generally not limited under the final rule. The
reported amount of deferred tax assets, net of its valuation allowance,
in excess of the limitation would be deducted from Tier 1 capital for
purposes of calculating both the risk-based and leverage capital
ratios. Banking organizations should not include the amount of
disallowed deferred tax assets in weighted-risk 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 banking organization should assume that
all existing temporary differences fully reverse as of the report date.
Also, estimates of taxable income for the next year should include the
effect of tax planning strategies the organization is planning to
implement to realize net operating losses or tax credit carryforwards
that will otherwise expire during the year. Consistent with FAS 109,
the Board believes tax planning strategies are carried out to prevent
the expiration of such carryforwards. Both of these requirements are
consistent with the proposal.
The capital limitation is intended to balance the Board'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. This approach generally permits full inclusion of deferred
tax assets potentially recoverable from carrybacks, since these amounts
will generally be realized. This approach also includes those deferred
tax assets that are dependent upon future taxable income, if they can
be recovered from projected taxable income during the next year. The
Board is limiting projections of future taxable income to one year
because, in general, the Board believes that organizations are
generally capable of making projections of taxable income 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 further limited to 10
percent of Tier 1 capital, since the Board believes such assets should
not comprise a large portion of an organization's capital base given
the uncertainty of realization associated with these assets and the
difficulty in selling these assets apart from the organization.
Furthermore, a 10% capital limit also reduces the risk that an overly
optimistic estimate of future taxable income will cause the bank to
significantly overstate the value of deferred tax assets.
Banking organizations already follow FAS 109 for regulatory reports
and accordingly, are making projections of taxable income. Banking
organizations already report in regulatory reports the amount of
deferred tax assets that would be disallowed under the proposal. In
addition, the 10 percent calculation of Tier 1 capital is
straightforward. Therefore, the Board believes that banking
organizations will have little difficulty implementing this final rule.
B. Guidance on Specific Implementation Issues
In response to the comments received and after discussions with the
other agencies, the Board is providing the following guidance.
Originating Temporary Differences--Consistent with the Board's
proposal, the final rule does not specify how the provision for loan
and lease losses and other originating temporary differences should be
treated for purposes of projecting taxable income for the next year.
Banking organizations routinely prepare income forecasts for future
periods and, in theory, income forecasts for book income should be
adjusted for originating temporary differences in arriving at a
projection of taxable income. On the other hand, requiring such
adjustments adds complexity to the final rule. Furthermore, deductible
originating temporary differences, such as the provision for loan and
lease losses, generally would lead to additional deferred tax assets.
Thus, arguably, such temporary differences should not be added back to
book income in determining the amount of deferred tax assets that will
be realized. Accordingly, the Board is permitting each institution to
decide whether or not to adjust projected book income for originating
temporary differences. While the Board is not specifying a single
treatment on originating temporary differences in the final rule,
institutions should follow a reasonable and consistent approach.
Gross-up of Intangibles--As noted above, FAS 109 could 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 value of an intangible posed no risk to institutions,
because a reduction in the value of the asset would effectively
extinguish the related deferred tax liability. The Board concurs with
this position and, consequently, will permit, for capital adequacy
purposes, netting of deferred tax liabilities arising from this gross-
up effect against related intangible assets. To ensure this benefit is
not double counted, a deferred tax liability netted in this manner
could 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 (PMSRs) and purchased credit card
relationships (PCCRs), since only the portion of these assets that
exceed specified capital limits are deducted for capital adequacy
purposes.
Leveraged Leases--While not expected to significantly affect many
banking organizations, one commenter stated that future net tax
liabilities related to leveraged leases acquired in a purchase business
combination are included in the valuation of the leveraged lease and
are not shown on the balance sheet as deferred tax liabilities. This
artificially increases the amount of deferred tax assets for those
institutions that acquire a leveraged lease portfolio. 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 Board agrees with this commenter and, therefore, banking
organizations 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.
Tax Jurisdictions--Unlike the proposal, the final rule does not
require an institution to determine its limitation on deferred tax
assets on a jurisdiction-by-jurisdiction basis. While such an approach
may theoretically be more accurate, the Board 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. Thus, banking organizations may make projections of their
taxable income on an organization-wide basis and use a combined tax
rate for purposes of calculating the one-year limitation.
Timing--Institutions may 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 projection
each quarter. Several commenters requested this treatment because it
reduces the frequency with which banking organizations are required to
revise their estimate of future taxable income.
Available for Sale Securities--Under FASB Statement No. 115,
``Accounting for Certain Investments in Debt and Equity Securities''
(FAS 115), ``available-for-sale'' securities are reported in regulatory
reports at market value, and unrealized gains and losses on such
securities are included, net of tax effects, in a separate component of
stockholders equity. These tax effects may increase or decrease the
amount of deferred tax assets an institution reports.
The Board has recently decided to exclude from regulatory capital
the amount of net unrealized gains and losses on available for sale
securities (except net unrealized losses of available-for-sale equity
securities with readily determinable fair values) (59 FR 63241,
December 8, 1994). Thus, excluding for capital adequacy purposes
deferred tax effects arising from reporting unrealized holding gains
and losses on available-for-sale securities is consistent with the
regulatory capital treatment for such gains and losses. On the other
hand, requiring the exclusion of such deferred tax effects would add
significant complexity to the capital guidelines 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 Board 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--The proposed capital limit was to be
determined on a separate entity basis for each state member bank. Use
of a separate entity approach on income tax sharing agreements
(including intercompany tax payments and current and deferred taxes) is
generally required by the Board's 1978 Policy Statement on
Intercorporate Income Tax Accounting Transactions of Bank Holding
Companies and State Member Banks, and similar policies are followed by
the other 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 Board notes that regulatory reports of banks are generally required
to be filed using a separate entity approach and consistency between
the reports would be reduced if the Board permitted institutions 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 Board consider permitting other approaches, the
Board will generally require the separate entity approach.\3\
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\3\State member banks should project taxable income for the
bank, generally on a consolidated basis including subsidiaries of
the bank. Bank holding companies should project taxable income for
the holding company, generally on a consolidated basis including
bank and non-bank subsidiaries of the holding company.
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As proposed, the final rule contains an exception to the separate
entity approach when a state member bank's parent holding company 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. In these cases, the amount of carryback potential the bank
may consider in calculating the capital limit on deferred tax assets is
limited to the lesser amount which it could reasonably expect to have
refunded by its parent.
Grandfathering--The proposal would grandfather any deferred tax
assets reported as of September 1992 in excess of the proposed limit,
but would require that such excess amounts be phased out over a two
year period ending in 1994. Since all grandfathered amounts are now
fully amortized, the Board's final rule does not include any
grandfathering provision.
IV. Regulatory Flexibility Act Analysis
The Board 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 banking organizations), 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
banking organizations currently have very limited amounts of net
deferred tax assets, which are the subject of this proposal, as a
component of their capital structures. In addition, this final rule, in
combination with the adoption by the Board of FAS 109 for regulatory
reporting purposes, allows many organizations to increase the amount of
deferred tax assets they include in regulatory capital. Moreover,
because the risk-based and leverage capital guidelines generally do not
apply to bank holding companies with consolidated assets of less than
$150 million, this proposal will not affect such companies. The Board
did not receive any comment letters specifically addressing regulatory
flexibility concerns, and therefore, no alternatives to the proposal
were considered to address regulatory flexibility.
V. Paperwork Reduction Act and Regulatory Burden
The Board has determined that this final rule will not increase the
regulatory paperwork burden of banking organizations pursuant to the
provisions of the Paperwork Reduction Act (44 U.S.C. 3501 et seq.).
Section 302 of the Riegle Community Development and Regulatory
Improvement Act of 1994 (Pub. L. 103-325, 108 Stat. 2160) provides that
the federal banking agencies must consider the administrative burdens
and benefits of any new regulation that impose additional requirements
on insured depository institutions. Section 302 also requires such a
rule to take effect on the first day of the calendar quarter following
final publication of the rule, unless the agency, for good cause,
determines an earlier effective date is appropriate.
List of Subjects
12 CFR Part 208
Accounting, Agriculture, Banks, banking, Confidential business
information, Crime, Currency, Federal Reserve System, Mortgages,
Reporting and recordkeeping requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the preamble, the Board is amending 12
CFR parts 208 and 225 as set forth below:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues to read as
follows:
Authority: 12 U.S.C. 36, 248(a), 248(c), 321-338, 371d, 461,
481-486, 601, 611, 1814, 1823(j), 1828(o), 1831o, 1831p-1, 3105,
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c) (5), 78q, 78q-l, and 78w; 31 U.S.C. 5318.
2. Appendix A to part 208 is amended by adding a new paragraph (iv)
to the introductory text of Section II.B. to read as follows:
Appendix A to Part 208--Capital Adequacy Guidelines for State Member
Banks: Risk-Based Measure
* * * * *
II. * * *
B. * * *
(iv) Deferred tax assets--portions are deducted from the sum of
core capital elements in accordance with section II.B.4. of this
Appendix A.
* * * * *
3. Appendix A to Part 208 is amended by:
a. Revising footnote 19 in section II.B.3.;
b. Removing footnote 20 from the end of section II.B.3.; and
c. Adding section II.B.4.
The additions and revisions read as follows:
* * * * *
II. * * *
B. * * *
3. * * *\19\* * *
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\1\9Deductions of holdings of capital securities also would not
be made in the case of interstate ``stake out'' investments that
comply with the Board's Policy Statement on Nonvoting Equity
Investments, 12 CFR 225.143 (Federal Reserve Regulatory Service 4-
172.1; 68 Federal Reserve Bulletin 413 (1982)). In addition,
holdings of capital instruments issued by other banking
organizations but taken in satisfaction of debts previously
contracted would be exempt from any deduction from capital. The
Board intends to monitor nonreciprocal holdings of other banking
organizations' capital instruments and to provide information on
such holdings to the Basle Supervisors' Committee as called for
under the Basle capital framework.
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4. Deferred tax assets. The amount of deferred tax assets that
are dependent upon future taxable income, net of the valuation
allowance for deferred tax assets, that may be included in, that is,
not deducted from, a bank's capital may not exceed the lesser of:
(i) the amount of these deferred tax assets that the bank is
expected to realize within one year of the calendar quarter-end
date, based on its projections of future taxable income for that
year,\20\ or (ii) 10 percent of tier 1 capital. For purposes of
calculating this limitation, Tier 1 capital is defined as the sum of
core capital elements, net of goodwill and all identifiable
intangible assets other than purchased mortgage servicing rights and
purchased credit card relationships (and before any disallowed
deferred tax assets are deducted). The amount of deferred tax assets
that can be realized from taxes paid in prior carryback years and
from future reversals of existing taxable temporary differences and
that do not exceed the amount which the bank could reasonably expect
to have refunded by its parent (if applicable) generally are not
limited. The reported amount of deferred tax assets, net of any
valuation allowance for deferred tax assets, in excess of these
amounts is to be deducted from a bank's core capital elements in
determining tier 1 capital.
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\20\Projected future taxable income should not include net
operating loss carryforwards to be used during that year or the
amount of existing temporary differences a bank expects to reverse
within the year. Such projections should include the estimated
effect of tax planning strategies that the organization expects to
implement to realize net operating losses or tax credit
carryforwards that would otherwise expire during the year.
Institutions may 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 projection
each quarter. To determine the limit, an institution should assume
that all existing temporary differences fully reverse as of the
report date.
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* * * * *
4. Appendix B to part 208 is revised to read as follows:
Appendix B to Part 208--Capital Adequacy Guidelines for State Member
Banks: Tier 1 Leverage Measure
I. Overview
a. The Board of Governors of the Federal Reserve System has
adopted a minimum ratio of tier 1 capital to total assets to assist
in the assessment of the capital adequacy of state member banks.\1\
The principal objective of this measure is to place a constraint on
the maximum degree to which a state member bank can leverage its
equity capital base. It is intended to be used as a supplement to
the risk-based capital measure.
---------------------------------------------------------------------------
\1\Supervisory risk-based capital ratios that related capital to
weighted-risk assets for state member banks are outlined in Appendix
A to this part.
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b. The guidelines apply to all state member banks on a
consolidated basis and are to be used in the examination and
supervisory process as well as in the analysis of applications acted
upon by the Federal Reserve. The Board will review the guidelines
from time to time and will consider the need for possible
adjustments in light of any significant changes in the economy,
financial markets, and banking practices.
II. The Tier 1 Leverage Ratio
a. The Board has established a minimum level of tier 1 capital
to total assets of 3 percent. An institution operating at or near
these levels is expected to have well-diversified risk, including no
undue interest-rate risk exposure; excellent asset quality; high
liquidity; and good earnings; and in general be considered a strong
banking organization, rated composite 1 under CAMEL rating system of
banks. Institutions not meeting these characteristics, as well as
institutions with supervisory, financial, or operational weaknesses,
are expected to operate well above minimum capital standards.
Institutions experiencing or anticipating significant growth also
are expected to maintain capital ratios, including tangible capital
positions, well above the minimum levels. For example, most such
banks generally have operated at capital levels ranging from 100 to
200 basis points above the stated minimums. Higher capital ratios
could be required if warranted by the particular circumstances or
risk profiles of individual banks. Thus for all but the most highly
rated banks meeting the conditions set forth above, the minimum tier
1 leverage ratio is to be 3 percent plus an additional cushion of a
least 100 to 200 basis points. In all cases, banking institutions
should hold capital commensurate with the level and nature of all
risks, including the volume and severity of problem loans, to which
they are exposed.
b. A bank's tier 1 leverage ratio is calculated by dividing its
tier 1 capital (the numerator of the ratio) by its average total
consolidated assets (the denominator of the ratio). The ratio will
also be calculated using period-end assets whenever necessary, on a
case-by-case basis. For the purpose of this leverage ratio, the
definition of tier 1 capital for year-end 1992 as set forth in the
risk-based capital guidelines contained in Appendix A of this part
will be used.\2\ As a general matter, average total consolidated
assets are defined as the quarterly average total assets (defined
net of the allowance for loan and lease losses) reported on the
bank's Reports of Condition and Income (Call Report), less goodwill;
amounts of purchased mortgage servicing rights and purchased credit
card relationships that, in the aggregate, are in excess of 50
percent of tier 1 capital; amounts of purchased credit card
relationships in excess of 25 percent of tier 1 capital; all other
intangible assets; any investments in subsidiaries or associated
companies that the Federal Reserve determines should be deducted
from tier 1 capital; and deferred tax assets that are dependent upon
future taxable income, net of their valuation allowance, in excess
of the limitation set forth in section II.B.4 of this Appendix A.\3\
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\2\At the end of 1992, Tier 1 capital for state member banks
includes common equity, minority interest in the equity accounts of
consolidated subsidiaries, and qualifying noncumulative perpetual
preferred stock. In addition, as a general matter, Tier 1 capital
excludes goodwill; amounts of purchased mortgage servicing rights
and purchased credit card relationships that, in the aggregate,
exceed 50 percent of Tier 1 capital; amounts of purchased credit
card relationships that exceed 25 percent of Tier 1 capital; all
other intangible assets; and deferred tax assets that are dependent
upon future taxable income, net of their valuation allowance, in
excess of certain limitations. The Federal Reserve may exclude
certain investments in subsidiaries or associated companies as
appropriate.
\3\Deductions from Tier 1 capital and other adjustments are
discussed more fully in section II.B. in Appendix A of this part.
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c. Whenever appropriate, including when a bank is undertaking
expansion, seeking to engage in new activities or otherwise facing
unusual or abnormal risks, the Board will continue to consider the
level of an individual bank's tangible tier 1 leverage ratio (after
deducting all intangibles) in making an overall assessment of
capital adequacy. This is consistent with the Federal Reserve's
risk-based capital guidelines an long-standing Board policy and
practice with regard to leverage guidelines. Banks experiencing
growth, whether internally or by acquisition, are expected to
maintain strong capital position substantially above minimum
supervisory levels, without significant reliance on intangible
assets.
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(i), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. Appendix A to part 225 is amended by adding a new paragraph (iv)
to the introductory text of section II.B. to read as follows:
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
* * * * *
II. * * *
B. * * *
(iv) Deferred tax assets--portions are deducted from the sum of
core capital elements in accordance with section II.B.4. of this
Appendix A.
* * * * *
3. Appendix A to part 225 is amended by:
a. Revising footnote 22 in section II.B.3.;
b. Removing footnote 23 from the end of section II.B.3. and;
c. Adding section II.B.4.
The revisions and additions read as follows:
* * * * *
II. * * *
B. * * *
3. * * *\22\* * *
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\22\Deductions of holdings of capital securities also would not
be made in the case of interstate ``stake out'' investments that
comply with the Board's Policy Statement on Nonvoting Equity
Investments, 12 CFR 225.143 (Federal Reserve Regulatory Service 4-
172.1; 68 Federal Reserve Bulletin 413 (1982)). In addition,
holdings of capital instruments issued by other banking
organizations but taken in satisfaction of debts previously
contracted would be exempt from any deduction from capital. The
Board intends to monitor nonreciprocal holdings of other banking
organizations' capital instruments and to provide information on
such holdings to the Basle Supervisors' Committee as called for
under the Basle capital framework.
---------------------------------------------------------------------------
4. Deferred tax assets. The amount of deferred tax assets that
are dependent upon future taxable income, net of the valuation
allowance for deferred tax assets, that may be included in, that is,
not deducted from, a banking organization's capital may not exceed
the lesser of: (i) the amount of these deferred tax assets that the
banking organization is expected to realize within one year of the
calendar quarter-end date, based on its projections of future
taxable income for that year,\23\ or (ii) 10 percent of tier 1
capital. For purposes of calculating this limitation, tier 1 capital
is defined as the sum of core capital elements, net of goodwill and
all identifiable intangible assets other than purchased mortgage
servicing rights and purchased credit card relationships (and before
any disallowed deferred tax assets are deducted). The amount of
deferred tax assets that can be realized from taxes paid in prior
carryback years and from future reversals of existing taxable
temporary differences generally are not limited. The reported amount
of deferred tax assets, net of any valuation allowance for deferred
tax assets, in excess of these amounts is to be deducted from a
banking organization's core capital elements in determining tier 1
capital.
---------------------------------------------------------------------------
\23\Projected future taxable income should not include net
operating loss carryforwards to be used during that year or the
amount of existing temporary differences a bank holding company
expects to reverse within the year. Such projections should include
the estimated effect of tax planning strategies that the
organization expects to implement to realize net operating loss or
tax credit carryforwards that will otherwise expire during the year.
Banking organizations may 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
projection each quarter. To determine the limit, a banking
organization should assume that all existing temporary differences
fully reverse as of the report date.
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* * * * *
4. Appendix D to part 225 is revised to read as follows:
Appendix D to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
I. Overview
a. The Board of Governors of the Federal Reserve System has
adopted a minimum ratio of tier 1 capital to total assets to assist
in the assessment of the capital adequacy of bank holding companies
(banking organizations).\1\ The principal objectives of this measure
is to place a constraint on the maximum degree to which a banking
organization can leverage its equity capital base. It is intended to
be used as a supplement to the risk-based capital measure.
---------------------------------------------------------------------------
\1\Supervisory ratios that related capital to total assets for
state member banks are outlined in Appendix B of this part.
---------------------------------------------------------------------------
b. The guidelines apply to consolidated basis to banking holding
companies with consolidated assets of $150 million or more. For bank
holding companies with less that $150 million in consolidated
assets, the guidelines will be applied on a bank-only basis unless
(i) the parent bank holding company is engaged in nonbank activity
involving significant leverage\2\ or (ii) the parent company has a
significant amount of outstanding debt that is held by the general
public.
---------------------------------------------------------------------------
\2\A parent company that is engaged is significant off balance
sheet activities would generally be deemed to be engaged in
activities that involve significant leverage.
---------------------------------------------------------------------------
c. The tier 1 leverage guidelines are to be used in the
inspection and supervisory process as well as in the analysis of
applications acted upon by the Federal Reserve. The Board will
review the guidelines from time to time and will consider the need
for possible adjustments in light of any significant changes in the
economy, financial markets, and banking practices.
II. The Tier 1 Leverage Ratio
a. The Board has established a minimum level of tier 1 capital
to total assets of 3 percent. A banking organization operating at or
near these levels is expected to have well-diversified risk,
including no undue interest-rate risk exposure; excellent asset
quality; high liquidity; and good earnings; and in general be
considered a strong banking organization, rated composite 1 under
BOPEC rating system of bank holding companies. Organizations not
meeting these characteristics, as well as institutions with
supervisory, financial, or operational weaknesses, are expected to
operate well above minimum capital standards. Organizations
experiencing or anticipating significant growth also are expected to
maintain capital ratios, including tangible capital positions, well
above the minimum levels. For example, most such banks generally
have operated at capital levels ranging from 100 to 200 basis points
above the stated minimums. Higher capital ratios could be required
if warranted by the particular circumstances or risk profiles of
individual banking organizations. Thus for all but the most highly
rated banks meeting the conditions set forth above, the minimum tier
1 leverage ratio is to be 3 percent plus an additional cushion of a
least 100 to 200 basis points. In all cases, banking organizations
should hold capital commensurate with the level and nature of all
risks, including the volume and severity of problem loans, to which
they are exposed.
b. A banking organization's tier 1 leverage ratio is calculated
by dividing its tier 1 capital (the numerator of the ratio) by its
average total consolidated assets (the denominator of the ratio).
The ratio will also be calculated using period-end assets whenever
necessary, on a case-by-case basis. For the purpose of this leverage
ratio, the definition of tier 1 capital for year-end 1992 as set
forth in the risk-based capital guidelines contained in Appendix A
of this part will be used.\3\ As a general matter, average total
consolidated assets are defined as the quarterly average total
assets (defined net of the allowance for loan and lease losses)
reported on the organization's Consolidated Financial Statements (FR
Y-9C Report), less goodwill; amounts of purchased mortgage servicing
rights and purchased credit card relationships that, in the
aggregate, are in excess of 50 percent of tier 1 capital; amounts of
purchased credit card relationships in excess of 25 percent of tier
1 capital; all other intangible assets; any investments in
subsidiaries or associated companies that the Federal Reserve
determines should be deducted from tier 1 capital; and deferred tax
assets that are dependent upon future taxable income, net of their
valuation allowance, in excess of the limitation set forth in
section II.B.4 of this Appendix A.\4\
---------------------------------------------------------------------------
\3\At the end of 1992, Tier 1 capital for state member banks
includes common equity, minority interest in the equity accounts of
consolidated subsidiaries, and qualifying noncumulative perpetual
preferred stock. In addition, as a general matter, Tier 1 capital
excludes goodwill; amounts of purchased mortgage servicing rights
and purchased credit card relationships that, in the aggregate,
exceed 50 percent of Tier 1 capital; amounts of purchased credit
card relationships that exceed 25 percent of Tier 1 capital; all
other intangible assets; and deferred tax assets that are dependent
upon future taxable income, net of their valuation allowance, in
excess of certain limitations. The Federal Reserve may exclude
certain investments in subsidiaries or associated companies as
appropriate.
\4\Deductions from Tier 1 capital and other adjustments are
discussed more fully in section II.B. in Appendix A of this part.
---------------------------------------------------------------------------
c. Whenever appropriate, including when an organization is
undertaking expansion, seeking to engage in new activities or
otherwise facing unusual or abnormal risks, the Board will continue
to consider the level of an individual organization's tangible tier
1 leverage ratio (after deducting all intangibles) in making an
overall assessment of capital adequacy. This is consistent with the
Federal Reserve's risk-based capital guidelines an long-standing
Board policy and practice with regard to leverage guidelines.
Organizations experiencing growth, whether internally or by
acquisition, are expected to maintain strong capital position
substantially above minimum supervisory levels, without significant
reliance on intangible assets.
By order of the Board of Governors of the Federal Reserve
System, December 16, 1994.
William W. Wiles,
Secretary of the Board
[FR Doc. 94-31441 Filed 12-21-94; 8:45 am]
BILLING CODE 6210-01-P
