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F e d e r a l R e s e r v e Ba n k o f N e w Y o r k
New Y ork , N.Y. 10045-0001
AREA CODE 212-720-5000
August 23, 1 995
To:
The Chief Executive Officer of Each State Member Bank and Bank Holding
Company
Subject: Supervisory Guidance related to FASB Statement No. 114
The Federal Financial Institutions Examination Council ("FFIEC") recently
adopted Financial Accounting Standards Boards Statement No. 114, "Accounting
by Creditors for Impairment of a Loan" ("FAS 114"), as amended by Statement No.
118, "Accounting by Creditors for Impairment of a Loan -- Income Recognition and
Disclosures" ("FAS 118"), for purposes of bank reporting in Call Reports. The
FFIEC also determined that although banks must use FAS 114 to determine the
portion of the ALLL attributable to impaired loans, separate reporting of this portion
would not be required for Call Reports. The overall ALLL should continue to be
reported on existing Call Report line items.
The attached letter, SR 95-38, discusses how banks should determine and
report the ALLL in accordance with FAS 114. Additionally, SR 95 -38 reviews
supervisory issues related to the implementation of FAS 114 and FAS 118,
including the loan identification and classification process; the treatment of
collateral dependent loans, charge-offs, and additional allowances; income
recognition on impaired loans; and regulatory reporting, disclosure and capital.
Should you have any questions regarding these issues please contact
Sarah Dahlgren, Manager, at (212) 7 2 0 -7 5 3 7 or Michael Tursi, Senior Financial
Specialist, at (212) 7 2 0 -2 8 2 4 .
Sincerely,
Christine M. Cumming
Senior Vice President
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
W ASHINGTON. D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 95-38 (SUP)
June 26, 1995
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Supervisory Guidance related to FASB Statement No. 114
Financial Accounting Standards Board Statement No. 114, "Accounting by
Creditors for Impairment of a Loan" (FAS 114), as amended by Statement No. 118,
"Accounting by Creditors for Impairment of a Loan — Income Recognition and
Disclosures" (FAS 118), sets forth standards for estimating the impairment of a loan for
general financial reporting purposes. This letter provides guidance for use by examiners
in assessing the portion of the allowance for loan and lease losses (ALLL) established for
impaired loans under FAS 114 in conjunction w ith the evaluation of the overall
adequacy of a bank's loan loss allowance. Guidance is also provided herein on other
supervisory issues affected by FAS 114.1 In summary, w hile allowances established
under FAS 114 should be considered by examiners in performing an evaluation of the
adequacy of a bank's allowance, examiners should continue to focus primarily on the
assessment of the adequacy of the overall ALLL.
Summary of FAS 114
FAS 114, as amended by FAS 118 with regard to income recognition,
establishes generally accepted accounting principles (GAAP) for use by banking
organizations and other creditors when accounting for the impairment of certain loans.
According to FAS 114, a loan is "impaired" when, based on current information and
events, it is probable that a creditor w ill be unable to collect all amounts due (principal
1
This guidance applies to examinations of state member banks which file Reports of
Condition and Income (Call Reports) with the Federal Reserve. Except for the guidance
on the regulatory capital treatment of the portion of the ALLL established under FAS 114,
this guidance does not directly apply to bank holding companies; however, bank holding
companies are required to follow FAS 114 in FR Y-9C Reports. The guidance included
herein is generally not applicable ~to U.S. branches and agencies of foreign banks for
purposes of preparing FFIEC 002 reports. U. S. branches and agencies of foreign banks
should refer to SR 95-4 for further guidance on the ALLL.
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2
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and interest) according to the contractual terms of the loan agreement.2
When a creditor has determined that a loan is impaired, FAS 114 requires
that an allowance be established based on the present value of expected future cash
flows of the loan discounted at the loan's effective interest rate (i.e., contract rate, as
adjusted for any net deferred loan fees or costs, premium, or discount) or, as a practical
expedient, at the loan's observable market price, or the fair value of the collateral if the
loan is collateral dependent. Since allowances under FAS 114 apply only to a subset of
loans (i.e., those that are subject to the standard and that are deemed to be impaired),
FAS 114 does not address the adequacy of a creditor's overall ALLL or how the creditor
should assess the adequacy of its ALLL.
FA$ 114 is effective for fiscal years beginning after December 15, 1994,
and earlier application was permitted. FAS 118 is effective concurrently with FAS 114.
Supervisory Guidance
FAS 114, as amended by FAS 118, has been adopted by the Federal
Financial Institutions Examination Council (FFIEC) for purposes of reporting by banks in
Call Reports, subject to the additional regulatory reporting guidelines discussed below.3
Furthermore, the FFIEC concluded that FAS 114 sets forth methods for establishing only a
portion of an institution's ALLL. Accordingly, w hile the methods set forth in FAS 114
must be used by banks in determining the portion of the ALLL attributable to impaired
loans as defined by FAS 114 for purposes of reporting in Call Reports, no separate
reporting of the portion established under FAS 114 has been required in such reports.
The overall ALLL should continue to be reported on existing Call Report line items.
2 FAS 114’s guidance on impairment does not apply to "large groups of smallerbalance homogeneous loans that are collectively evaluated for impairment," loans that
are measured at fair value or at the lower of cost or fair value, leases, and debt
securities as defined in FAS 115, "Accounting for Certain Investments in Debt and Equity
Securities." FAS 114 also generally applies to loans that are restructured in a troubled
debt restructuring involving a modification of terms.
3 Guidance from the FFIEC that has been reiterated in this letter was previously
announced in the February 10, 1995 Federal Register.
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Examiners should continue to focus prim arily on the assessment of the
adequacy of the overall ALLL.4 W hile the allowances determined under FAS 114 should
be considered by examiners in performing an evaluation of the adequacy of a bank's
allowance, examiners should not focus unduly on the adequacy of this or any other
portion of the ALLL established for a subset of loans.
Several other supervisory issues related to the implementation of FAS 114
and FAS 118 by banks are discussed below:
Identifying loans to evaluate. FAS 114 does not specify how a bank should
identify loans that are to be evaluated for collectibility, but suggests that each
bank should apply its normal loan review procedures. Simply identifying a loan
as being Subject to evaluation for collectibility, for example, by placing a loan on
a "Watch List," does not necessarily mean that the loan is impaired.
As a GAAP standard, FAS 114 is generally intended to be applied on a
consolidated basis. Some banks may be subsidiaries of holding companies that
have chosen to identify loans for evaluation under FAS 114 on a consolidated
holding company basis. In that event, the size threshold used for determining
whether FAS 114 is applied to a loan may be so large that smaller subsidiary
banks w ill have few or no loans identified for evaluation under FAS 114.
Examiners should not take exception to this method of applying FAS 114 for Call
Report purposes, provided that the same approach is used for financial reporting
purposes and the bank continues to review credits that are large or significant to it
(whether or not subject to FAS 114) on an individual basis when analyzing the
adequacy of its ALLL.
Collateral dependent loans. A loan is considered "collateral dependent" when
the repayment of the debt w ill be provided solely by the underlying collateral,
and there are no other available and reliable sources of repayment. When
determining the amount of impairment on a collateral dependent loan for
purposes of reporting on Call Reports, the FFIEC decided that, consistent with the
Interagency Policy Statement on the Review and Classification of Commercial Real
Estate Loans (November 1991, SR 91-24), institutions must base their
determination on the fair value of the collateral. In addition, the FFIEC reiterated
that any portion of the loan balance on a collateral dependent loan that exceeds
4
Consistent with existing policy as set forth in the Interagency Policy Statement on
the Allowance for Loan and Lease Losses, the ALLL should be adequate to absorb
estimated credit losses associated with the loan and lease portfolio, including all binding
commitments to lend. To the extent not provided for in a separate liability account, the
ALLL should also be sufficient to absorb estimated credit losses associated with offbalance sheet credit instruments such as standby letters of credit.
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the fair value of the collateral and that can be identified as uncollectible should
generally be classified Loss and promptly charged off against the ALLL.
A collateralized loan that becomes impaired is not considered "collateral
dependent" if repayment is available from reliable sources other than the
collateral. Any impairment on such a loan may, at the bank's option, be
determined based on the present value of the expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient, on the
loan's observable market price.
Additional allowance on impaired loans. Consistent w ith guidance issued by the
FFIEC, the Federal Reserve w ill not automatically require an additional allowance
for credit Losses for impaired loans over and above what is required on these
loans under FAS 114. However, an additional allowance on impaired loans may
be necessary based on consideration of institution-specific factors, such as
historical loss experience compared with estimates of such losses and concerns
about the reliability of cash flow estimates, the quality of an institution's loan
review function, and controls over its process for estimating its FAS 114
allowance. O f course, when ah institution's reported ALLL does not meet the
objectives for an adequate ALLL set forth in the Interagency Policy Statement on
the Allowance for Loan and Lease Losses, the institution should be required to
restore the level of the ALLL to an adequate level as of the evaluation date.
Charge-offs. The FFIEC has recently reaffirmed existing supervisory policies that
require banks to promptly charge off identified losses. Thus, when available
information confirms that specific loans and leases (including any recorded
accrued interest, net deferred loan fees or costs, and unamortized premium or
discount), or portions thereof, are uncollectible, these amounts should be
promptly charged off against the ALLL, regardless of whether an allowance was
established to recognize impairment under FAS 114. Any recoveries on loans or
leases previously charged off should be credited to the A L L L /
Income recognition. FAS 118 amended FAS 114 to eliminate its income
recognition provisions, and, thus, no FASB standard exists for income recognition
on impaired loans. For supervisory purposes, and to ensure consistency in the
recognition of interest income, the FFIEC decided to retain existing nonaccrual
policies. As w ith all other loans, impaired loans should be reported as past due
or nonaccrual loans in Call Report Schedule RC-N when meeting the definitions
to these Call Report items. Since full collection of principal and interest is
generally not expected for impaired loans, income accrual should normally be
discontinued on such loans at the time that they first become impaired. Any cash
payments received on impaired loans should be reported in accordance.with the
criteria for the cash basis recognition of income in the Glossary entry for
"nonaccrual status" contained in the instructions to the Call Report.
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Classification. An institution's adoption or FAS 114 tor regulatory reporting
purposes generally should not affect the examiner's classification of troubled
loans. Examiners should continue to classify troubled loans, including any
troubled collateral dependent loans, based on the definitions of Loss, Doubtful,
and Substandard contained in the Federal Reserve's Commercial Bank
Examination Manual and other supervisory guidance. If any loan is determined to
be w holly or partially Loss, the amount of such Loss should be promptly charged'
off w ithout regard to whether the loan is subject to FAS 114 or whether an
allowance for estimated credit losses has been established in accordance with the
standard.
Regulatory reporting and disclosure. Consistent with the decisions that FAS 114
sets forth/methods for determining a portion of the overall ALLL and that
examiners should prim arily focus their attention on the adequacy of the overall
ALLL, the FFIEC decided not to collect anv new supervisory information in Call
Reports w ith respect to FAS 114. Nonetheless, if a banking organization prepares
GAAP financial statements, disclosures w ill be provided in the financial statements
or accompanying notes about impaired loans and the allowance related to such
loans. The examiner should consider reviewing these disclosures as part of the
assessment of the adequacy of an institution's ALLL.
Regulatory capital. Consistent with determinations made by the FFIEC, the ALLL,
including the part established in accordance with FAS 114, should continue to be
reported net of any identified losses and be includible in Tier 2 capital, subject to
current limits.5
As noted above, for additional examination guidance on the evaluation of
the adequacy of the overall ALLL, please refer to the Interagency Policy Statement on the
Allowance for Loan and Lease Losses (see SR 93-70) and to Section 2070.1 of the
Commercial Bank Examination Manual, "Allowance for Loan and Lease Losses."
Additional guidance w ith respect to commercial real estate loans is Contained in the
Interagency Policy Statement on the Review and Classification of Commercial Real Estate
Loans (SR 91-24). For further information on FAS 114 and its application for Call Report
purposes, refer directly to FAS 114 and the Call Report glossary "Loan Impairment."
5
Under current risk-based capital guidelines, the amount of the ALLL qualifying in
Tier 2 capital may not exceed 1.25 percent of risk-weighted assets.
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If you have any questions on FAS 114 or the guidance contained herein,
please call Charles Holm, Project Manager, Regulatory Reporting and Accounting Issues
Section, at (202) 452-3502, Arthur Lindo, Supervisory Financial Analyst, Regulatory
Reporting and Accounting Issues Section, at (202) 452-2695, or Kevin Bertsch,
Supervisory Financial Analyst, Policv Development Section, at (202) 452-5265.
Richard Spillenkothen
Director
Cross Reference: /
SR 93-70
SR 91-24
Commercial Bank Examination Manual, Section 2070.1
Bank H olding Company Manual, Sections 2010.7 and 2065.2
@FedFRASER