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FEDERAL RESERVE B A *
OF MEW YORK
[
Circular No. 10271 1
November 23, 1988
J
INTEREST RATE SWAP REPORTING STANDARDS
Comment on FFIEC Proposal Invited by January 9, 1989
To A ll Depository Institutions, and Others Concerned,
in the Second Federal Reserve District:
T h e F e d e r a l F in a n c ia l I n s titu t io n s E x a m in a ti o n C o u n c il ( F F I E C ) h a s r e q u e s te d p u b lic c o m
m e n t o n a p r o p o s a l to in c lu d e in th e in s t r u c tio n s to th e R e p o r t s o f C o n d i tio n a n d I n c o m e ( C a ll R e
p o r ts ) s u b m i tte d b y b a n k i n g in s t itu ti o n s to t h e ir r e g u la to r y a g e n c i e s a r e q u i r e m e n t to r e p o r t in c o m e
f r o m in te r e s t r a te s w a p s o v e r th e lif e o f th e s w a p c o n t r a c t. T h e p r o p o s e d C a ll R e p o r t r e q u ir e m e n t
w o u ld b e c o m e e f f e c tiv e f o r a ll in te r e s t r a te s w a p c o n t r a c ts e n t e r e d in to a f te r D e c e m b e r 3 1 , 1 9 8 8 .
T h e f o llo w in g s ta te m e n t w a s is s u e d b y th e F F I E C :
The Examination Council has announced its approval of the issuance for public comment of a Call
Report instruction relating to the reporting of income from interest rate swaps.
The proposed instruction would require that income from interest rate swaps be recognized over
the life of the swap contract, rather than at the swap’s inception. Also, changes in the market value
of swaps subsequent to their inception (except for most swaps accounted for as hedges) would have
to be reflected in the bank’s income in the period in which the changes occur.
Interest rate swaps, in their simplest form, are contractual agreements between two parties to ex
change interest payments periodically over the life of the swaps. One party typically agrees to make
fixed-rate interest payments while the other party agrees to make variable-rate payments on an amount
specified in the contract. Swaps are used by banks to help meet their customers’ needs relating to assetliability management or by the banks themselves for their own requirements.
In approving the proposed instruction, the Council determined that the recognition of income at
the date of the swap’s inception is not appropriate from a regulatory standpoint because such a practice
overstates income and capital. Substantial risk continues to be incurred by a bank over the life of a
swap, and income may never be realized if unfavorable events occur.
The proposed instruction would be a Glossary entry that would be included in the Instructions for
the Preparation of Reports of Condition and Income (Call Reports) for FDIC-insured commercial and
State-chartered savings banks. It is being issued for public comment for 60 days and would become
effective for all interest rate swaps entered into after December 31, 1988.
P r in t e d o n th e f o llo w in g p a g e s is th e te x t o f th e F F I E C ’s p r o p o s a l, w h ic h h a s b e e n r e p r in te d
f r o m th e F ederal Register o f N o v e m b e r 9 , 1 9 8 8 . C o m m e n t s s h o u ld b e s u b m i tte d b y J a n u a r y 9 ,
1 9 8 9 , a n d m a y b e s e n t d ir e c tly to R o b e r t J . L a w r e n c e , E x e c u tiv e S e c r e ta r y , F e d e r a l F in a n c ia l I n
s titu tio n s E x a m in a ti o n C o u n c il, 1 7 7 6 G S tr e e t , N W . , S u ite 7 0 1 , W a s h in g t o n , D .C . 2 0 0 0 6 . Q u e s
tio n s r e g a r d in g th e p r o p o s a l m a y b e d ir e c te d to o u r S u p e r v is io n S u p p o r t D e p a r t m e n t ( T e l. N o .
2 1 2 -7 2 0 -6 3 5 7 ).
E. G erald C o rr ig a n ,
President.
FEDERAL FINANCIAL INSTITUTIONS
EXAMINATION COUNCIL
Interest Rate Swap Reporting
Standards
a g e n c y : Federal Financial Institutions
Examination Council
ACTION: Request for comment.
SUMMARY: This proposal, which
pertains to interest rate swap contracts
("swaps”), would preclude al FDICinsured U.S. commercial banks and
FDIC-insured state-chartered savings
banks, for purposes of the Reports of
Condition and Income (Call Reports),
from recognizing arrangement fees and
spread income at the inception of a
swap. Instead, this income would be
recognized over the life of the swap. It
also would require that subsequent
changes in the market value of swaps,
except for most swaps accounted for as
hedges, be reflected in income during
the period in which the changes occur.
This proposed Call Report instruction
has been developed jointly by the Office
of the Comptroller of the Currency
("OCC”), the Federal Reserve Board
(“FRB”), and the Federal Deposit
Insurance Corporation (“FDIC”), under
the auspices of the Council. The
instruction will be effective for swap
contracts entered into after December
31, 1988, and the first Call Report
affected will be the Call Report for
March 31,1989.
d a t e : Comments must be received on or
before January 9,1989.
a d d r e s s : All comments should be
mailed to Robert J. Lawrence, Executive
S ecretary , Federal Financial Institutions
Examination Council, 1776 G St., NYV.,
Suite 701, Washington, DC 20006, or
delivered to the same address between
the hours of 9:00 a.m. and 5:00 p.m. on
business days.
FOR FURTHER INFORMATION CONTACT:
OCC: David C. Motter, Special Assistant
to the Chief National Bank Examiner,
(202/447-1587), Office of the
Comptroller of the Currency, 490
L’Enfant Plaza East SW., Washington,
DC 20219.
Board: Rhoger H. Pugh, Manager,
Division of Banking Supervision and
Regulation, (202/728-5883), Board of
Governors of the Federal Reserve
System, 20th & Constitution Avenue
NW„ Washington, DC 20551.
FDIC: Robert F. Storch, Chief, Securities
and Accounting Section, Division of
Bank Supervision, (202/898-8906),
Federal Deposit Insurance
Corporation, 550 17th Street NW„
Washington, DC 20429.
SUPPLEMENTARY INFORMATION: This
proposed Call Report instruction was
developed on a joint interagency basis
by the OCC, FRB, and the FDIC due to
concerns over the lack of a consistent
authoritative standard regarding the
recognition of swap income. The
agencies are not relying upon generally
accepted accounting principles as the
reporting standard for these
transactions because there is an overall
lack of authoritative accounting
guidance pertaining to swap income and
such guidance is not likely to be
forthcoming from accounting rulemaking
authorities for some time. When and if
accounting rulemaking authorities adopt
authoritative guidance for the
recognition of swap income, the banking
agencies will reconsider the
appropriateness of any reporting
standard for swaps that becomes
inconsistent with generally accepted
accounting principles.
Proscription on the Immediate
Recognition of Fees and Spreads
In the absence of specific
authoritative accounting
pronouncements in this area, banks
have generally followed two basic
approaches in accounting for swap
income. One method recognizes the
arrangement fee and the discounted
present value of the spread on a
portfolio of swaps, net of a provision for
related credit risk and administrative
costs, as profit at the inception of the
swap. The second method amortizes the
arrangement fees and takes the spread
into income over the life of the swap,
i.e., income is recognized as the swap
payments are accrued each period.
The Council believes the second
method of income recognition is the
more appropriate method for Call Report
purposes. Swap income should not be
recognized at inception, since that
practice is not in accordance with the
fundamental accounting principle that
income earned as a result of a
contractual obligation should be
recognized over the life of the contract.
The logic that the income is earned over
that time period rather than at the
inception of the swap is supported by
the fact that, in the case of a bank acting
as a principal in a swap contract, credit
risk, interest rate risk, and
administrative costs are incurred over
the life of the contract. Therefore, since
costs and risks are incurred by the bank
over the swap’s life, it is appropriate
that the income from the swap be
recognized over the life of the swap.
The immediate recognition of income
leads to higher reported income and
capital at the time a swap is booked.
However, substantial risks remain over
the life of the contract and the recorded
income may not be ultimately realized
due to credit losses or adverse interest
rate changes. Consequently, the Council
believes that income recognition at the
swap’s inception is an unsafe or
unsound banking practice.
Recording Changes In Market Value
After Inception
The second aspect of the proposed
Call Report instruction deals with
whether changes in the market values of
swaps after their inception should be
recorded in income in the period in
which they occur. The value of an
imperfectly matched swap portfolio can
change markedly with changes in
interest rates, and the value of an
individual swap contract is also subject
to change if the creditworthiness of the
counterparty changes. Therefore, it is
important to set a reporting standard
that currently records such changes in
value. The proposed Call Report
instruction would require that changes
in the market value of swaps (except
most swaps accounted for as hedges) be
recorded in the period in which they
occur, with the cumulative change in
market value being reported in the
Report of Condition. Therefore, any
losses in value in a bank's swap
portfolio would be reflected in current
period income rather than being
deferred, thus providing more discipline
to banks engaging in the swap market.
Issues for Specific Public Comment
The Council is aware of the current
diversity in practice in accounting for
swaps. The proposed Call Report
instruction would promulgate the
accounting considered appropriate for
supervisory purposes commensurate
with the federal banking agencies’
safety and soundness responsibilities.
The Council intends to seek general
public comment concerning the
proposed Call Report instruction and
encourages specific comments on the
following additional issues:
PRINTED IN NEW YORK, FROM FEDERAL REGISTER, VOL. 53, NO. 217, pp. 45386-45388
2
1 . The proposal would require that
arrangement fees and spread income be
recognized as income over the life of the
swap contract. The Council requests
comment on whether certain costs
directly related to originating a swap
contract should be deferred and
amortized over the life of the swap,
similar to the method prescribed for
loan origination costs under FASB
Statement No. 91, “Accounting for
Nonrefundable Fees and Costs
Associated with Originating or
Acquiring Loans and Initial Direct Costs
of Leases”. The Council also seeks
comment on an alternative to deferring
the costs. This alternative is to allow the
arrangement fee (but not the spread) to
be recorded as income at inception, to
the extent it does not exceed the direct
costs of originating the related swap
contract
2. The proposed Call Report
instruction would require that changes
in the market value of swaps subsequent
to inception (except most swaps
accounted for as hedges) be recognized
in income during the period they occur.
Market valuation methods that have
been used by banks isaclude the
following:
a. The present value of the known
cash flows from the swap is calculated
using as a discount rate the current rate
on a Treasury security of equal
remaining maturity plus the excess at
inception of the swap rate (defined as
the mid-point of the fixed rate side’s bid
and ask rate) over the rate on a
Treasury security of equal maturity.
b. The present value of the known
cash flows from the swap is calculated
using as a discount rate the current
swap rate (defined as the mid-point of
the fixed rate side’s bid and ask rate) on
a swap with equal remaining maturity.
c. The present value of the known
cash flows from the swap is calculated
using as discount rates the zero coupon
rates derived from the current swap
yield curve. Swap yields for each
maturity are defined as the midpoint of
the fixed rate side’s bid and ask rates.
The Council requests'comment on
which of these valuation methods is
most appropriate. The Council also
requests details on alternatives to the
above methodologies that may be more
appropriate in all or certain
circumstances.
Proposed Instruction
The text of the proposed instruction
follows:
Proposed Call Report Glossary Entry for
Interest Rate Swaps
An interest rate swap, in its simplest
form, entails an agreement between two
parties (“counterparties”) to exchange
interest payments for a specified period
of time. These interest payments are
calculated on a specified principal
value, called the notional amount.
Ordinarily, counterparties are only
obligated to pay to each other the
interest due on this amount and are not
obligated to repay the underlying or
related principal.
Interest rate swaps are often used to,
in effect, transform the interest rates
associated with assets or liabilities from
fixed-rate to floating-rate or vice versa,
or from one floating rate index to
another. Banks generally engage in
interest rate swaps either to hedge their
exposures to interest rate risk or to
generate fee income by acting as
intermediaries between other swap
participants or by trading in swaps.
Since notional principal amounts are
not counterparty obligations for singlecurrency interest rate swaps, these
amounts should not be reported on
Schedule RC, Balance Sheet. These
amounts should be reported on Schedule
RC-L, “Commitments and
Contingencies," in Memoranda Item 3,
"Notional Value of All Outstanding
Interest Rate Swaps," as discussed in
the instructions for that schedule.
Some cross-currency interest rate
swaps—those involving obligations of
the respective parties denominated in
different currencies—also obligate the
counterparties to exchange principal
amounts at maturity. Such principal
amounts shall be reported cm the FFTEC
031, 032, and 033 as “Commitments to
Purchase Foreign Currencies and U.S.
Dollar Exchange,” in Item 5 of Schedule
RC-L (not reported on the FFIEC 034).
Such transactions can alter a bank’s
foreign exchange risk position.
Bank management should evaluate the
credit risk associated with interest rate
swap activities. An allowance for credit
losses should be maintained that is
sufficient to cover any estimated credit
losses associated with swap activities.
3
Under interest rate swaps, the
amounts of interest receivable and
payable should be accrued as of the end
of each calendar quarter (or more
frequently). The receivable and payable
balances relating to a particular swap
may be reported net only if a
contractual right of offset exists and the
swap payments are exchanged on a net
basis. The aggreate amounts of
receivables and payables should be
reported as “Other Assets” and “Other
Liabilities,” respectively, on Schedule
RC-Balance Sheet (Items 11 and 20 ,
respectively) and on Schedule RC-F
(“Other Assets,” Item 3) and Schedule
RC-G (“Other Liabilities,” Item 4). For
purposes of these reports, receivables
and payables shall not be accrued for
amounts applicable to periods beyond
the report date.
In no case shall income be recognized
at the inception of a swap. Arrangement
fees must be recognized as income over
the life of the swap contract. Spread
income, i.e., the difference between
future cash receipts and payments for a
portfolio of swaps, must be recognized
only as accrued for the current period,
i.e., not beyond the report date.
A bank’s activities using interest rate
swaps, both as hedges and non-hedges,
are subject to review by examiners.
Accordingly, banks must fully document
their swap hedging policies and
transactions. A pattern of excessive and
unsatisfactorily documented hedge
swap terminations may lead examiners
to conclude that an institution has in
effect been trading in swaps and require
that the results of such swap activities
be restated and reported as swaps not
used for hedging purposes.
FASB Statement No. 80, Accounting
for Futures Contracts, for swaps
denomMaated in one currency, and
Statement No. 52, Foreign Currency
Translation, for swaps denominated in
more than one currency, should be
consulted for additional information
regarding a c c o u n t^ standards to be
applied by analogy to interest rate
swaps.
Reporting for Hedge Swaps
Swaps that are used to reduce a
bank’s interest rate risk exposure may
be reported as hedges of such risk if, in
principle, ail of tfee hedging criteria set
forth in PASS Statemasat No. 80 have
been fnifiiied. Therefore, for example,
the specific itesa to be hedged sraasi
expsae f a enterprise to price {m
interest rate} risk, asid f a swap most
reduce f a t exposure and be designated
as a hedge of that item. Swats
d en o m in a te d in m ore th a n one cu rren cy
th a t are u sed to red u c e a b a n k ’s in te rest
ra te or foreign ex c h an g e risk m ay be
rep o rted as h edges of such risk s if, in
principle, all of the hedging crite ria set
forth in FASB S ta te m e n t No. 52 h av e
b een met. H o w ev er, in no ca se m ay
sw a p s used to h edge o th e r sw a p s be
rep o rted as h ed g es. For ex am ple,
offsetting sw a p s for w h ich a b a n k is
acting as an in te rm e d ia ry a re n o t sw ap s
th at red u ce its in te re st ra te risk
exposure.
If the hedge c riteria a re m et, the
acco u n tin g for the sw a p sh a ll be re la te d
to the acco u n tin g for the h ed g e d item so
th a t ch an g es in the m a rk e t v alu e of the
sw a p are reco g n ized in incom e w h e n the
effects of re la te d ch a n g es in the p rice or
in te re st ra te of the hed g ed item are
recognized. T h erefo re, the incom e or
ex p e n se from the sw a p sh o u ld be
rep o rte d in S ch ed u le RI, Incom e
S tatem en t, in the sam e line item as the
incom e or e x p e n se from the underlying
hed g ed item . In m o st ca se s, the s w a p ’s
ac cru ed in te re st incom e or e x p e n se for
the perio d sh a ll a d ju st the un d erly in g
in te re st incom e or e x p e n se of the
hed g ed item . In a d d itio n , th e ch an g e in
the m ark e t v alu e of the sw a p sh a ll be
d efe rred an d a c c o u n te d for as p a rt of
the carry in g v alu e of the item being
hedged, an d re fle c te d as an a d ju stm e n t
of the re la te d in te re st incom e or ex p e n se
o v er the life of the h ed g ed item .
H o w ever, if the sw a p h ed g es an
u n d erly in g item w h ich is c a rrie d a t
m a rk e t v alu e (m ark to m a rk e t
accounting), a ch an g e in the m a rk e t
v alu e of the re la te d sw a p sh a ll n o t b e
d efe rred b u t ra th e r sh o u ld b e reco g n ized
in incom e in the p erio d the ch an g e in
v alu e occurs.
If a sw a p is ac c o u n te d for a s a hedge
(of an un d erly in g item n o t c a rrie d a t
m a rk e t value), th e n th e g ain or lo ss on
an ea rly te rm in atio n of th e sw a p sh a ll
be d efferred , reco g n ized a s p a rt of the
ca rry in g v alu e of th e h ed g ed item , a n d
am o rtize d o v er the rem ain in g life of the
h ed g ed item or the sw ap , w h ic h e v e r is
sh o rter. G en erally , te rm in a tio n s o f
sw a p s th a t a re u se d for hedging
p u rp o se s sh o u ld n o t b e sig n ific an t in
re la tio n to the to ta l n u m b e r or n o tio n a l
am o u n t of sw a p s th a t a re h ed g es.
Reporting for Non-Hedge Swaps
For all interest rate swaps that are not
reportable as hedges as set forth in the
preceding section, the income or
expense associated with the accrual of
swap receivables and payables shall be
reported as “Other Noninterest Income,"
in Schedule RI (Income Statement), Item
5.f. (item 5.b. on the FFIEC 034), or as
"Other Noninterest Expense," in
Schedule RI, Item 7.c., as appropriate.
At the first Call Report date following
the inception of an interest rate swap,
any change in the market value of that
swap since its inception shall be
recognized in current period income or
expense. At each successive Call Report
date, any change in the market value of
that swap since the previous Call Report
date must be recognized in current
period income or expense, using a
consistent methodology.
These changes in the market value of
swaps shall be reflected in Scheduled
RI, Item 5.f. (item 5.b. on the FFIEC 034),
"Other Noninterest Income,” or Item
7.c., “Other Noninterest Expense,” as
appropriate. The cumulative valuation
exposure (asset or liability) on the
balance sheet shall be reported as
“Other assets,” in Schedule RC, Item 11 ,
or as “Other liabilities,” in Schedule RC,
Item 20 .
If a non-hedge swap is terminated
early, any amounts the reporting bank
receives from or pays to the
counterparty on early termination shall
be reported net as “Other Noninterest
Income," in Schedule RI, Item 5.f. (item
5.b. on the FFIEC 034), or as “Other
Noninterest Expense,” in Schedule RI,
Item 7.c., as appropriate.
November 4,1988.
Robert J. Lawrence,
Executive Secretary, Federal Financial
Institutions Examination Council.
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[FR Doc. 88-25845 Filed 11-8-88; 8:45 am]
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