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F e d e r a l R e s e r v e New York, AREA CODE Ba n k o f N.Y. 10045 2 12 N e w Y o r k 7 3 2 -5 7 0 0 August 6 , 1968 IMPROPER RECORDING OF CERTAIN BOND TRANSACTIONS To the Chief Executive Officer of each State Member Bank in the Second Federal Reserve District: On May 16, 1967; a circular letter was sent to you concerning the practice of certain banks of deferring and amortizing profits and losses on sales of securities. In this connection we have recently learned that some banks, with the cooperation of brokers, are engaging in bond transactions the circum stances of which are not properly disclosed on the bank's books. Under this procedure, a bank owning bonds carried on its books at cost but having a current market value below cost sells such bonds at a price above the market, usually at a price equivalent to book value of the bonds. The bank then purchases from the same broker other bonds (often of longer maturity and with a higher yield) at a price sufficiently above market value to reim burse the broker for (l) loss sustained on the bonds sold to him by the bank and (2) a broker’s fee. (above market value). The bonds are then recorded at the new "cost" Such a transaction has the effect of (l) deferring the recognition of loss on bonds sold by the bank and (2 ) placing new bonds on the bank's books at a price above their true market value when purchased. EXAMPLE Bank A - holds $100,000 of City PHA 3 bonds due May 1, 1973 . Book value $100,000 Market value $ 90,000 Dealer purchases bonds at $100,000 (Over) Dealer sells Bank A $100,000 of County 4 l/2$ bonds due May 1, 1983* Market value - $100,000 Dealer sells @ 3 * 5 0 basis - $111,590 Resume Bank A - sells a 3$ yield and purchases a 3 •50$> > yield. Covers up a market loss; fails to book and take advantage of a portfolio tax loss. Sales Advantage - Improves current yield 50 basis points. Dealer - Loss on purchase - $10,000 Dealer - Profit on sale - $11,590 Dealer's net profit - $ 1,590 Deferring losses incurred on the sale of bonds by recording bonds purchased at inflated prices is not considered to be a sound banking practice. When selling bonds the bank should record any gain or loss real ized based on the actual market price prevailing at that time. Moreover, bonds purchased should be recorded on a bank's books at actual market value. ALFRED HAYES President
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