Full text of Federal Reserve Bank of New York Circulars : Federal Reserve Confirmations of Charge-Offs Declared for Tax Purposes

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

■‘

AT CIRCULAR h tn f f ) S 9 /

•

Federal Reserve Bank

of

N

ew

Yo r k

N E W Y O R K , N. Y. 1 0 0 4 5 - 0 0 0 1
AREA C O DE

212

7 20-6375

C h e s t e r B. F e l d b e r g
E x e c u t iv e V ice Pr e s i d e n t

N o v e m b e r 18,

1992

TO T H E C H I E F E X E C U T I V E O F F I C E R S OF A L L S T A T E M E M B E R
B A N K S IN T H E SECOND F E D E R A L R E S E R V E D I S T R I C T

SUBJECT:

F E D E R A L R E S E R V E C O N F I R M A T I O N S OF C H A R G E - O F F S D E C L A R E D
F O R T A X PU R P O S E S

U n d e r l o n g s t a n d i n g r e g u l a t i o n s of t he I n t e r n a l R e v e n u e
S e r v i c e (IRS) (i.e., s e c t i o n 1 . 1 6 6 - 2 ( d ) (1) of the I n c o m e T ax
R e g u l a t i o n s ) , a c o m m e r c i a l ban k can s u p p o r t its loan c h a r g e - o f f s
by o b t a i n i n g w r i t t e n c o n f i r m a t i o n from its p r i m a r y federal
r e g u l a t o r t h a t s uch c h a r g e - o f f s w o u l d h a v e b e e n r e q u i r e d for
r e g u l a t o r y purposes.
In particular, such c o n f i r m a t i o n s indicate
t h a t loans c h a r g e d off by the ban k b e t w e e n e x a m i n a t i o n s w o u l d have
b e e n o r d e r e d by an e x a m i n e r h a d the ban k b e e n u n d e r e x a m i n a t i o n at
t he t i m e of t h e charge-off.
Since S e p t e m b e r 1973, th e Federal
R e s e r v e h as a s s i s t e d state m e m b e r banks by issuing, u p o n r e q u e s t
and in a p p r o p r i a t e circumstances, " c o n f i r m a t i o n letters" t h a t are
a c c e p t a b l e to t he IRS.
Recently, the IRS a d d e d s e c t i o n 1 . 1 6 6 - 2 ( d ) (3) to the
Income T a x R e g u l a t i o n s in order to p r o v i d e c o m m e r c i a l b a nks w i t h
an a l t e r n a t i v e a p p r o a c h to su p p o r t bad d e b t d e d u c t i o n s . 1 U n d e r
this approach, a bank, as an a l t e r n a t i v e to o b t a i n i n g w r i t t e n
c o n f i r m a t i o n of its charge-offs, can o b t a i n fro m its p r i m a r y
f e d e r a l r e g u l a t o r an "express d e t e r m i n a t i o n letter" c e r t i f y i n g
t h a t t h e b a n k ' s loss c l a s s i f i c a t i o n s t a n d a r d s for loan c h a r g e - o f f s
are c o n s i s t e n t w i t h r e g u l a t o r y requirements.
A f t e r du e consideration, and in c o o p e r a t i o n w i t h the
U.S. D e p a r t m e n t of the T r e a s u r y and the o t h e r f e d eral b a n k and
t h r i f t s u p e r v i s o r y agencies, the Federal R e s e r v e has d e t e r m i n e d
t h a t it w i l l p r o v i d e a state m e m b e r bank, u p o n its r e q u e s t and in
a p p r o p r i a t e c i r c u mstances, e i ther of the a b o v e letters.
The




(Over)

T h e n e w IRS r e g u l a t i o n w as p u b l i s h e d in the Federal
R e g i s t e r on F e b r u a r y 24, 1992, and an a m e n d m e n t to the
r e g u l a t i o n w as p u b l i s h e d on O c t o b e r 2, 1992.

,OV1 * A J U O * * D TA

4

FEDERAL RESERVE BANK OF NEW YORK____ 2

Fe d e r a l R e s e r v e ' s g u i d a n c e to exa m i n e r s on t h e s e letters is
a t t a c h e d an d sets forth the p r o c e d u r e s and c i r c u m s t a n c e s in w h i c h
the F e d eral R e s e r v e w ill issue them.
A n y q u e s t i o n s on this g u i d a n c e s h o u l d be d i r e c t e d to
B a r b a r a A. Klein, Manager, D o m e s t i c B a n k i n g Department, at (212)
720-8324.
Y o urs sincerely,

Attachment




EXAMINER GUIDANCE ON REVIEWING
LOAN LOSSES FOR TAX PURPOSES

A c o m m e r c i a l b a n k can o b t a i n c o n c l u s i v e s u p p o r t for the
loan c h a r g e - o f f s it d e c l a r e s for f e d eral income t ax p u r p o s e s by
obtaining, f r o m its p r i m a r y federal regulator, e i t h e r (1)
a
" c o n f i r m a t i o n letter" i n d i c a t i n g tha t the bank's c h a r g e - o f f s
w o u l d h a v e b e e n r e q u i r e d for r e g u l a t o r y purposes, or (2) an
"expr e s s d e t e r m i n a t i o n letter" c e r t i f y i n g t h a t the bank's loan
loss c l a s s i f i c a t i o n s t a n d a r d s are c o n s i s t e n t w i t h r e g u l a t o r y
requirements.
T h e s e letters are a u t h o r i z e d by the Internal'
R e v e n u e S e r v i c e (IRS) in s e c t i o n 1 . 1 6 6 - 2 (d) of the Income T a x
R egulations.
T he Federal R e s e r v e ha s d e t e r m i n e d tha t it w i l l
p r o v i d e a s t ate m e m b e r bank, u p o n its r e q u e s t and in a p p r o p r i a t e
c i r c u m stances, eith e r of the a b ove letters.
Ex a m i n e r g u i d a n c e on
i s s u i n g t h ese letters is set forth below.

E x p r e s s D e t e r m i n a t i o n L e t ters
U n d e r the IRS r e g u l a t i o n s r e l a t i n g to express
d e t e r m i n a t i o n letters, a c o m m e r c i a l bank m a y elect to c o n f o r m its
t ax t r e a t m e n t of bad debts w i t h its r e g u l a t o r y reporting.
I n s t i t u t i o n s m a k i n g this e l e c t i o n and m e e t i n g the IRS's
r e q u i r e m e n t s w i l l a u t o m a t i c a l l y be a l l o w e d to d e c l a r e c h a r g e - o f f s
for federal income tax p u r p o s e s in the same year it takes c h a r g e offs for r e g u l a t o r y purposes.
To be eligible, a b ank m u s t file a c o n f o r m i t y e l e c t i o n
w i t h its f e d eral tax return.
The r e g u l a t i o n s also r e q u i r e the
b a n k ' s p r i m a r y federal s u p e r v i s o r y a g e n c y to d e t e r m i n e e x p r e s s l y
t h a t the b ank m a i n t a i n s and ap p l i e s c l a s s i f i c a t i o n sta n d a r d s for
loan c h a r g e - o f f s that are c o n s i s t e n t w i t h r e g u l a t o r y
r e q u i rements.
To co n t i n u e u s i n g the n e w method, the bank m u s t
r e q u e s t a n e w letter at each s u b s e q u e n t e x a m i n a t i o n that covers
the loan r e v i e w process.
A c c o r d i n g to the IRS regulations,
e x p r e s s d e t e r m i n a t i o n letters m a y be issued to s u p port c h a r g e offs of c o m m e r c i a l banks, b ut not b a n k h o l d i n g c o m p a n i e s and n o n ­
b a n k s u b s i d i a r i e s of the b a n k or h o l d i n g company.

Procedures
T h e b a n k is r e s p o n s i b l e for r e q u e s t i n g an e x p r e s s
d e t e r m i n a t i o n letter.
The r e q u e s t s h o u l d be m a d e i m m e d i a t e l y
p r i o r to or at the start of an e x a m i n a t i o n to the e x a m i n e r - i n
charge.
T he e x a m i n e r - i n - c h a r g e w i l l issue the letter o n l y at
t he c o m p l e t i o n of an e x a m i n a t i o n tha t covers the bank's loan
r e v i e w p r o c e s s and only w h e n the e x a m i n e r c o n c ludes t hat its
i s s uance is appropriate.
The letter will be signed and d a t e d by
t he e x a m i n e r - i n - c h a r g e and p r o v i d e d to the bank for its files.




' 2

AT CIRCULAR K O .J U

The letter is not p a r t of the e x a m i n a t i o n report, but a copy of
it s h ould be m a i n t a i n e d in the e x a m i n a t i o n w o r k p a p e r s and
s u p p o r t e d by a d e q u a t e d o c u m e n t a t i o n .
Federal R e s e r v e sta n d a r d s
for loan c h a r g e - o f f s and c l a s s i f i c a t i o n s t a n d a r d s are set forth
in S e c t i o n 211 ( I nstallment L o a n s ) , S e c tion 214 (Credit Car d
P l a n s ) , and in S e c t i o n 217 (C l a s s i f i c a t i o n of Credits) of the
C o m m e r c i a l Bank E x a m i n a t i o n M a n u a l , as well as in s u p p l e m e n t a r y
p o l i c y guidance.
T he l e t t e r will be issued onl y if:
o

o

T he

T h e e x a m i n a t i o n i n d i c a t e s that the b a n k m a i n t a i n s and
a p p l i e s loan loss c l a s s i f i c a t i o n s t a n d a r d s that are
c o n s i s t e n t w i t h F e d e r a l R e s e r v e s t a n d a r d s r e g a r d i n g the
i d e n t i f i c a t i o n of losses and c h a r g e - o f f of loans.
T h e r e are no m a t e r i a l d e v i a t i o n s from r e g u l a t o r y
standards.
M i n o r c r i t i c i s m of the b a nk's loan r e v i e w
p r o c e s s or i m m a t e r i a l d e v i a t i o n s f rom r e g u l a t o r y
s t a n d a r d s s h o u l d not p r e c l u d e issua n c e of the letter;
however, any c r i t i c i s m s or d e v i a t i o n s s h o u l d be
d i s c u s s e d by the e x a m i n e r w ith s e n i o r s t aff of the
R e s e r v e Ban k b e f o r e an e x p ress d e t e r m i n a t i o n letter is
provided.

l e t t e r s h o u l d not be issu e d if any of the f o l l o w i n g occur:
o

T h e bank's loan r e v i e w p r o c e s s r e l a t i n g to c h a r g e - o f f s
is s u b ject to s i g n i f i c a n t criticism.

o

L o a n c h a r g e - o f f s for call r e port p u r p o s e s
m a t e r i a l l y misstated.

o

T h e r e are
ins t a n c e s of m a t e r i a l loan c h a r g e - o f f s not
b e i n g r e c o g n i z e d in the a p p r o p r i a t e year.

o

M a n y loan c h a r g e - o f f s are not r e c o g n i z e d
a p p r o p r i a t e year.

are

in the

Revoking the Election
T h e bank's e l e c t i o n of t h e new m e t h o d is to be r e v o k e d
a u t o m a t i c a l l y if the e x a m i n e r does not issue an e x p r e s s
d e t e r m i n a t i o n letter at the end of an e x a m i n a t i o n c o v e r i n g the
loan r e v i e w process.
T he Federal R e s e r v e is not r e q u i r e d to
r e s c i n d any p r e v i o u s l y i s s u e d d e t e r m i n a t i o n letters.
F a i l u r e by the b ank to o b t a i n a d e t e r m i n a t i o n l e t t e r
g e n e r a l l y r e v o k e s the b a n k ' s e l e c t i o n for the c u r r e n t year.
However, it g e n e r a l l y does not i n v a l i d a t e a bank ' s e l e c t i o n for
p r i o r y e a r ( s ) . F a i l u r e to o b t a i n a d e t e r m i n a t i o n l e t t e r p l a c e s
the b u r d e n of p r oof on t he ban k to su p p o r t its loan c h a r g e - o f f s
for t a x purposes.
In c e r t a i n instances, the b ank m a y q u a l i f y for
a l e tter c o n f i r m i n g the a p p r o p r i a t e n e s s of its c h a r g e - o f f s (as
d i s c u s s e d in the next m a j o r s e c t i o n b e l o w ) .




AT CIRCULAR NO.
3

L a n g u a g e for Ex p r e s s D e t e r m i n a t i o n L e t t e r s
TO W H O M IT M A Y CONCERN:
In c o n n e c t i o n w i t h the m o s t r e c e n t e x a m i n a t i o n of [NAME
OF BANK], by the F e d e r a l R e s e r v e B a n k of [DISTRICT] as of
[ EXAMINATION DATE], we r e v i e w e d the i n s t i t u t i o n ' s loan r e v i e w
p r o c e s s as it re l a t e s to loan charge-offs.
B a s e d on our review,
we c o n c l u d e d t h a t the bank, as of t h a t date, m a i n t a i n e d and
a p p l i e d loan loss c l a s s i f i c a t i o n s t a n d a r d s t h a t w e r e c o n s i s t e n t
w i t h r e g u l a t o r y s t a n d a r d s r e g a r d i n g loan charge-offs.
This s t a t e m e n t is m a d e on t he basis of a r e v i e w t h a t
was c o n d u c t e d in a c c o r d a n c e w i t h our normal e x a m i n a t i o n
p r o c e d u r e s and criteria, i n c l u d i n g s a m p l i n g of loans in
a c c o r d a n c e w i t h t h ose p r o c e d u r e s and criteria.
It does not in
a ny w a y limit or p r e c l u d e any formal or infor m a l s u p e r v i s o r y
a c t i o n (including e n f o r c e m e n t actions) by this s u p e r v i s o r y
a u t h o r i t y r e l a t i n g to the i n s t i t u t i o n ' s loan r e v i e w pr o c e s s or
t he level at w h i c h it m a i n t a i n s its a l l o w a n c e for loan and lease
losses.

Examiner-in-charge

C o n f i r m a t i o n L e t ters
Th e l o n g s t a n d i n g Federal R e s e r v e p o l i c i e s and
p r o c e d u r e s for c o n f i r m i n g c h a r g e - o f f s are set forth in the
a t t a c h e d l e tter d a ted S e p t e m b e r 7, 1973 sent to the o f f i c e r in
c h a r g e of e x a m i n a t i o n s at eac h Fe d e r a l R e s e r v e Bank (excluding
a t t a c h m e n t s w h i c h r e i t e r a t e d the g u i d a n c e i n c luded in the
l e t t e r ) . T h e s e p o l i c i e s and p r o c e d u r e s r e m a i n in effect.
C o n f i r m a t i o n letters g e n e r a l l y wil l be p r o v i d e d only for a ban k
and its subsidiaries.
To a s s i s t the e x a m i n e r in i s s u i n g c o n f i r m a t i o n letters,
it will be n e c e s s a r y for the bank to p r o v i d e the e x a m i n e r a list
of c h a r g e-offs, i n c l u d i n g th e name of the borrower, the a m o u n t
c h a r g e d off, the dat e c h a r g e d off, the u n p a i d balance, and the
l e n g t h of t i m e each loan was d e l i n q u e n t w h e n c h a r g e d off.
Furth e r m o r e , the b a n k s h o u l d m a i n t a i n c o m p l e t e r e c o r d s s u p p o r t i n g
t he c h a r g e - o f f s , i n c l u d i n g f i n a n c i a l statements, o t h e r s u p p o r t i n g
d ocuments, a nd t he r e a s o n s for m a k i n g the charge-offs.
Examiners
s h o u l d f u r n i s h the c o n f i r m a t i o n l e t t e r to the b ank a l ong w i t h the
b a n k ' s list of c h a r g e - o f f s (adjusted as n e c e s s a r y b a s e d on the
e x a m i n e r ' s review) b a s e d on a r e v i e w of c h a r g e d - o f f loans t h a t
are s i g n i f i c a n t in a m o u n t in r e l a t i o n to the size of the b a n k
and, for o t h e r loans, a r e v i e w of t he c h a r g e - o f f p o l i c i e s of the
ban k for s u c h loans and a r e v i e w of an a d e q u a t e s a m p l e of the
loan c h a r g e-offs.




AT CIRCULAR NO.

lD~fPQ/ _

4
L a n g u a g e for C o n f i r m a t i o n L e t t e r s
TO W H O M IT M A Y CONCERN:
In c o n n e c t i o n w i t h the s a f e t y and s o u n d n e s s e x a m i n a t i o n
of [NAME'OF BANK] by t he F e d e r a l R e s e r v e S y s t e m as of
[EXAMINATION D A T E ] , we r e v i e w e d the i n s t i t u t i o n ' s loan ch a r g e offs.
B a sed on our review, h ad the i n s t i t u t i o n bee n e x a m i n e d as
of the dates of the c h a r g e - o f f s on th e a t t a c h e d list, the loans
w o u l d have been r e q u i r e d to be c h a r g e d - o f f on t h ose dates.
Thi s s t a t e m e n t is m a d e on the basis of a r e v i e w of the
i n s t i t u t i o n ' s loan charge-offs, i n c l u d i n g s a m p l i n g of loan .
c h a r g e - o f f s in a c c o r d a n c e w i t h our p o l i c i e s and proc e d u r e s .
This
s t a t e m e n t does not a t t e s t to the a d e q u a c y or s u f f i c i e n c y of the
i n s t i t u t i o n ' s charge-offs.
F urthermore, it does not in an y wa y
limit or p r e c l u d e any formal or i n f o r m a l s u p e r v i s o r y a c t ions
(including e n f o r c e m e n t actions) by thi s s u p e r v i s o r y a g e n c y
r e l a t i n g to the i n s t i t u t i o n ' s loan r e v i e w p r o c e s s or the level at
w h i c h it m a i n t a i n s its a l l o w a n c e for loan and lease losses.




Examiner-in-charge

at

c ir c u l a r

no

.J D S

5
BO AR D -O F

GOVERNORS

or
FEDERAL

thc

RESERVE

W ASH IN G TO N,

O.

C.

SYSTEM

2CSSI

OIVISION

QF

A N O

SUPERVISION

R EG U LA TIO N

S e p te m b e r 7,

TO T H E O F F I C E R

IN CHARGE OF EXAMINATIONS

AT EACH FEDERAL

RESERVE

On January
Section
obtain
loans

1.166-2(d)
a written

1973,

its

off w o uld have been c l a s s i f i e d

individually during

voluntarily made

by

have

been

time

of

would

conducted

at
a

been

writing

the

"loss"

and

at

given

charged

the

siz e

of

or l a c k
where

bank prior

time o f

off,

when

should

unpaid

to

the e x a m i n a t i o n
"loss"

if a n

"loss"

had

by State member

the

such

loans

given
time

if

had

been

determined
be

to

listed
the

borrower,

length o f

charge-offs

to d e t e r m i n e

should

th e n a m e o f th e
and

to

that

examination

All s u c h

of their worthlessness

balance,

charged

when requested

the c h a r g e - o f f s

include

as

the e x a m i n a t i o n a n y

the c h a r g e - o f f s .

the

amended
banks

o f the c h a r g e - o f f s .

classified

a confirmation

confirmation
delinquent

the

Service

to r e q u i r e

f r o m the s u p e r v i s o r y a u t h o r i t i e s

on the d a t e s

such
have

Internal R e v e n u e

i nstruct your examiners,

to r e v i e w

loans

the

Income Tax Regulations

charged

been made

Please
ban k s ,

24,

of

BANK

confirmation

voluntarily

an e x a m i n a t i o n

19 7 3

th e

each

to

in

bank.

Th e

date

loan was

off.

A l l c h a r g e d - o f f loans s i g n i f i c a n t in a m o u n t in r e l a t i o n to the
t h e b a n k s h o u l d be r e v i e w e d i n d i v i d u a l l y to d e t e r m i n e t h e i r v a l u e
of value

banks

at

have

the

ti m e o f

charged

the c h a r g e - o f f .

off small

loa ns

However,

or b l o c k s

of

in

those

installment

instances
l o ans ,

it

is n o t n e c e s s a r y to r e v i e w e a c h s u c h loan.
T he e x a m i n e r s h o u l d n e v e r t h e l e s s
s a t i s f y h i m s e l f t h a t c h a r g e - o f f p o l i c i e s on s u c h l o a n s a r e r e a s o n a b l e
and

that

a review

such p o l i c i e s

are

There
State m e m b e r
which

the

is

bank

examiner
Attached

Service

(wi th o u t




containing

of an

adequate

being

followed.

attached
to a s s u r e
can
also

a c opy of a

of

the c h a r g e - o f f s

l e t t er w h i c h

that a d e q u a t e

substantiates

should

records w i l l

be

be

sent

available

is a c o p y o f a
of

l e t t er

the p r o c e d u r e s

from

the

outlined

Internal
above.

th at

to ea c h
on

base a determination.

approval

attachments)

sample

Revenue