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FDIC Chicago Region Regulatory TeleconferenceOctober 21, 2010

Accounting – Current IssuesPamela J. RichFDIC Chicago Regional Accountantprich@fdic.gov

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Topics

Troubled Debt Restructuring Deferred Tax Assets and Regulatory

Capital Limit Loan Participations

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Troubled Debt Restructuring

Applicable Accounting Standards ASC 310-40, Troubled Debt Restructurings by

Creditors (formerly FAS 15) ASC 310-10-35, Receivables, Subsequent

Measurement (formerly FAS 114) Center for Audit Quality White Paper, Application

of Statement 114 to Modifications of Residential Mortgage Loans that Qualify as Troubled Debt Restructurings Issued December 2008

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Troubled Debt Restructuring

A and B Note Structure A formal restructuring may involve a multiple

note structure in which a troubled loan is restructured into two notes

“A” note represents portion of original loan principal expected to be fully collected

“B” note represents portion of original loan that has been charged off

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Troubled Debt Restructuring

Can Note A be returned to accrual status?Yes, if all of the following conditions are met:

Charge-off of Note “B” is recorded at time of restructuring

Ultimate collectibility of all amounts contractually due on Note A is not in doubt

There is a period of satisfactory payment performance before Note A is returned to accrual status (generally six months)

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Troubled Debt Restructuring

Disclosures ASC 310-40-50-2 provides conditions relating

to when a loan need not be included in TDR disclosures in years after the restructuring

Loan has been reset to a market rate determined at modification

Loan is not impaired based on terms specified by restructuring agreement

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Troubled Debt Restructuring

Call Report InstructionsA restructured loan need not continue to be

reported as a TDR in calendar years after the year in which the restructuring took place if:

In compliance with its modified terms, and Yields a market rate

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Troubled Debt Restructuring

Call Report InstructionsMarket yield is an effective rate that at the

time of the restructuring is greater than or equal to the rate bank is willing to accept for a new extension of credit with comparable risk

TDR may result in recorded amount of loan bearing a market yield. This may arise as a result of a charge-off prior to the restructure.

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Troubled Debt Restructuring

Recent FASB Board Decisions At its August 25, 2010, Board Meeting the FASB

decided to issue potential clarifications to the guidance in Subtopic 310-40. FASB tentatively decided: Creditors should be explicitly precluded from using

borrower’s effective rate test in ASC 470-60, Troubled Debt Restructurings by Debtors (formerly EITF 02-4) in its evaluation of whether a modification was executed at a market rate

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Troubled Debt Restructuring

A situation in which a market rate is not readily available is a strong indication that the modification was executed at a rate that is below market

A modification that results in a temporary or permanent increase to the contractual interest rate cannot be presumed to be at a rate that is at or above market

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Troubled Debt Restructuring

A borrower not currently in default may still be considered to be experiencing financial difficulty

A creditor should not conclude that a modification is not a TDR simply because a delay in payment resulting from that modification is insignificant

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Deferred Tax Assets

Reporting of Income Taxes and Deferred Taxes for Call Report Each depository institution that is a subsidiary of a holding

company must report its income taxes as a separate legal and accounting entity

Amount and timing of payments to, and refunds from, holding company must be no less favorable to subsidiary than if the subsidiary were a separate taxpayer

Interagency Policy Statement on Income Tax Allocation In A Holding Company Structure

http://www.fdic.gov/regulations/laws/rules/5000-5000.html#fdic5000interagencypolicystate

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Deferred Tax Assets

Principal GAAP guidance is FASB Accounting Standards Codification (ASC) Topic 740, Income Taxes Formerly FASB Statement No. 109, Accounting for

Income Taxes

Call Report Glossary – Income Taxes

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Deferred Tax Assets

The realizability of all deferred tax assets must be evaluated each period Per ASC Topic 740, a valuation allowance must be

recorded, if needed, to reduce deferred tax assets to an amount that is more likely than not (greater than 50% likelihood) to be realized.

Consider all available evidence, both positive and negative, in assessing the need for a valuation allowance

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Deferred Tax Assets

Realization of deferred tax assets depends on the existence of sufficient taxable income of the appropriate character in either the carryback or carryforward period

On the balance sheet, report net amount of deferred tax assets (less any valuation allowance) and deferred tax liabilities separately for each tax jurisdiction (e.g., federal, state, and local)

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Deferred Tax Assets Part 325 regulatory capital standards limit

amount of deferred tax assets that can be included in Tier 1 capital Limit applies to deferred tax assets that are

dependent on future taxable income: Deferred tax assets arising from deductible temporary

differences that exceed taxes previously paid that could be recovered through loss carrybacks if all temporary differences (both deductible and taxable) fully reverse at the report date

Deferred tax assets arising from operating loss and tax credit carryforwards

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Deferred Tax Assets Determination of deferred tax assets “dependent on

future taxable income” Per Section 325.5(g)(4), banks may exclude deferred tax

effects of unrealized holding gains (losses) on available-for-sale debt securities reported in accumulated other comprehensive income (AOCI)

Banks may also exclude Deferred tax assets arising from other-than-temporary impairment

losses on debt securities reported, net of tax, in AOCI Deferred tax effects associated with amounts recorded in AOCI

resulting from application of ASC Topic 715, Compensation-Retirement Benefits (FAS 158) that are excluded from regulatory capital

In each case, if excluded, follow this treatment consistently

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Deferred Tax Assets Determination of deferred tax assets

“dependent on future taxable income” For a bank subsidiary of a holding company, if

parent lacks financial capability to reimburse bank for the tax benefit of bank’s carryback of its net operating losses or tax credits, bank should limit carryback potential available for realization of its deferred tax assets to amount it could reasonably expect to have refunded by its parent

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Deferred Tax Assets Regulatory capital limit (Section 325.5(g)(2))

Deduct from Tier 1 capital amount by which deferred tax assets dependent on future taxable income exceed lesser of

Amount of deferred tax assets the bank expects to realize within one year based on projected future taxable income or

10% of the bank's Tier 1 capital before deducting certain disallowed assets

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Deferred Tax Assets

Calculation of regulatory capital limit should be made on a separate entity basis Treat bank (plus its consolidated subsidiaries)

that is a subsidiary of a holding company as a separate taxpayer rather than as part of a consolidated group

Bank should calculate one overall regulatory capital limit on deferred tax assets that covers all tax jurisdictions rather than a separate limit for each tax jurisdiction

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Deferred Tax Assets For certain assets deducted from Tier 1 capital,

deduction may be made net of associated deferred tax liability Disallowed mortgage and nonmortgage servicing

assets Intangible assets acquired in nontaxable business

combinations Goodwill acquired in taxable business combinations Disallowed credit-enhancing interest-only strips Deducted nonfinancial equity investments

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Deferred Tax Assets Any deferred tax liability netted in this manner

cannot also be netted against deferred tax assets when determining the amount of deferred tax assets dependent upon future taxable income and the disallowed amount of deferred tax assets, if any, for regulatory capital purposes

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Deferred Tax Assets Projected future taxable income

Regulatory capital limit on deferred tax assets is based in part on projected future taxable income for one year from the calendar quarter-end report date

Per Section 325.5(g)(3), projected future taxable income does not include

Net operating loss carryforwards to be used within one year of calendar quarter-end report date

Amount of existing temporary differences expected to reverse within that year

These reversals are excluded because all existing temporary differences are assumed to fully reverse at quarter-end report date when determining amount of deferred tax assets dependent on future taxable income

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Deferred Tax Assets Projected future taxable income

May include estimated effect of tax planning strategies that are expected to be implemented to realize tax carryforwards that will otherwise expire during that year

Differs from tax planning strategies used under GAAP for purposes of determining need for and amount of any valuation allowance against deferred tax assets, i.e., prudent and feasible actions that management ordinarily might not take to realize deferred tax assets, but would do so to prevent an operating loss carryforward from expiring unused

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Deferred Tax AssetsCalculation of Disallowed Deferred Tax Assets (Schedule RC-R, item 9.b)(a) Enter the amount from Schedule RC-R, item 8 ________ (b) Enter 10% of the amount in (a) above ________ (c) Enter the amount of deferred tax assets reported in Schedule RC-F,

item 2 _______

(d) Enter the amount of taxes previously paid that the bank could recover through loss carrybacks if the bank's temporary differences (both deductible and taxable) fully reverse at the report date ________

(e) Amount of deferred tax assets that is dependent upon future taxable income: subtract (d) from (c); enter 0 if the result is a negative amount ________

(f) Enter the portion of (e) that the bank could realize within the next 12 months based on its projected future taxable income. (Future taxable income should not include net operating loss carryforwards to be used during the next12 months or existing temporary differences that are expected to reverse over the

next 12 months.)

________ (g) Enter the lesser of (b) and (f) ________ (h) Disallowed net deferred tax assets - subtract (g) from (e); enter 0

if the result is a negative amount ________

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Loan Participations FASB Statement No. 166, Accounting for

Transfers of Financial Assets, an amendment of FASB Statement No. 140 (FAS 166) Now codified in FASB ASC Topic 860, Transfers and

Servicing Effective as of beginning of an entity’s first annual

reporting period that begins after 11/15/09 1/1/10 for calendar year banks

Recognition and measurement provisions must be applied to transfers on or after the effective date

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Loan Participations

FAS 166 modifies the financial components approach in FAS 140 Limits the circumstances in which a portion of a

financial asset is eligible for derecognition Transfers of portions of financial assets are eligible

for derecognition only if the transferred portions mirror the characteristics of the original financial asset

Introduces concept of a “participating interest” for transfers of portions of an entire financial asset

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Loan Participations A participating interest has all of the following

characteristics Represents a proportionate (pro rata) ownership interest in

an entire financial asset All cash flows received from entire asset (except any

allocated as compensation for services performed provided certain conditions are met) must be divided among participating interest holders in proportion to their shares of ownership

No interest is subordinated to another interest and no participating interest holder has recourse to another

No party has right to pledge or exchange entire asset unless all participating interest holders agree

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Loan Participations Compensation for services performed

Must not be subordinated Must not significantly exceed amount that would fairly

compensate a substitute service provider should one be required

If transfer of a portion of an entire financial asset does not meet definition of a participating interest Both lead lender transferring the participation and the

party acquiring the participation must account for the transaction as a secured borrowing with a pledge of collateral

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Loan Participations If transfer of a portion of an entire financial asset

meets the definition of a participating interest Transferor (normally lead lender) must evaluate

whether the transfer meets all of the conditions for derecognition in FAS 166

Isolation of transferred assets from the transferor Transferee has right to pledge or exchange the

assets received Transferor does not maintain effective control over

the transferred assets If all conditions are met, account for transfer as a sale

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Loan Participations Participations in lines of credit and loans with

multiple advances (e.g., construction loans) Accounting under FAS 166 is based on the date that

a participation is transferred, not the date of loan agreement or participation agreement

For a calendar year bank, even if loan agreement or participation agreement was entered into before 2010, when all or a portion of an advance that has lost its identity is transferred in 2010, portion of entire loan transferred and other portion of entire loan must meet definition of a participating interest in order to evaluate whether transfer qualifies for sale accounting

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Loan Participations “Last-in, first out“ (LIFO) and “first-in, first out”

(FIFO) participations Do not meet definition of participating interest because

all principal cash flows collected on the loan are paid first to one of the parties, not proportionately

Transfers on or after effective date of FAS 166 (1/1/10 for calendar year banks) do not qualify as sales, must be reported as secured borrowings

Transfers before effective date of FAS 166 not affected

If transfer qualified as a sale, it continues to be reported as a sale

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Loan Participations

“Last-in, proportionate-out“ (LIPO) revolving participationsLead bank arranges a credit facility under

which it advances to its maximum exposureAdvances that exceed Lead bank’s maximum

exposure are transferred to a Participant bank

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Loan Participations

“Last-in, proportionate-out“ (LIPO) revolving participationsPercentage ownership will vary over the life of

the credit facility as partial draws and pay downs occur

Borrower payments (cash flows received) are allocated proportionately, although at varying percentages, depending on the relative ownership shares of the Lead and Participant

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Loan Participations Reporting in Call Report by lead lender for

participations that are secured borrowings Report transferred participation, as well as retained

portion, i.e., entire loan, as a loan asset Normally in Schedule RC, item 4.b, “Loans and leases,

net of unearned income,” and in appropriate loan category in Schedule RC-C, part I, Loans and Leases

Include interest income on both portions in Schedule RI, item 1.a

Include in risk-weighted assets in Schedule RC-R Include in loan and lease portfolio for purposes of

determining allowance for loan and lease losses

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Loan Participations Reporting in Call Report by lead lender for

participations that are secured borrowings Report transferred participation as a secured

borrowing (liability) Schedule RC, item 16, “Other borrowed money” Appropriate subitem(s) of Schedule RC‑M, item 5.b,

“Other borrowings” Schedule RC-M, item 10.b, “Amount of ‘Other

borrowings’ that are secured” Schedule RC-C, part I, Memorandum item 14,

“Pledged loans and leases” Include interest expense in Schedule RI, item 2.c

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Loan Participations Reporting in Call Report by participating bank

for participations that are secured borrowings Normally report acquired participation in

Schedule RC, item 4.b, “Loans and leases, net of unearned income”

Report in Schedule RC-C, part I, Loans and Leases, in the loan category appropriate to the underlying loan, not as a loan to the lead lender

Include in loan and lease portfolio for purposes of determining allowance for loan and lease losses

In Schedule RC-R, assign acquired participation to risk-weight category appropriate to underlying borrower or, if relevant, guarantor or nature of collateral

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Questions ???