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RMS Manual of Examination Policies 3.7-1 Other Assets and Other Liabilities (3/12)
- INTRODUCTION .............................................................
- OTHER ASSETS...............................................................
- Accrued Income .............................................................
- Tax Assets ......................................................................
- Interest-Only Strips ........................................................
- Equities without Readily Determinable Fair Values ......
- Bank-Owned Life Insurance Policies.............................
- Miscellaneous Assets .........................................................
- Prepaid Expenses ...........................................................
- Repossessed Personal Property ......................................
- Suspense Accounts.........................................................
- Cash Items Not In Process Of Collection.......................
- Other Accrued Interest Receivables...............................
- Indemnification Assets...................................................
- INTANGIBLE ASSETS ....................................................
- Goodwill and Other Intangible Assets ...........................
- Accounting for Goodwill ...............................................
- Servicing Assets.............................................................
- Accounting .....................................................................
- Valuation........................................................................
- Regulatory Capital .........................................................
- Servicing Risk ................................................................
- Examination Procedures.................................................
- OTHER LIABILITIES ......................................................
- Other Borrowed Money .................................................
- Accrued Expenses ..........................................................
- Servicing Liabilities .......................................................
- Deferred Tax Liabilities .................................................
- Allowance for Off-Balance Sheet Exposures.................
- All Other Miscellaneous Liabilities ...............................
INTRODUCTION
Assets and liabilities that are not reported in major balance sheet categories are generally reported in other asset or other liability categories. Although these items are listed in "other" categories, it does not mean the accounts are of less significance than items detailed in major categories. Intangible assets lack physical substance and are also reported separately on the balance sheet. The following pages include descriptions of common other assets, intangible assets, and other liabilities. Additional guidance and information is included in the Call Report Instructions and the Examination Documentation (ED) Module - Other Assets and Liabilities.
OTHER ASSETS
Accrued Income
All banks, regardless of size, shall prepare the Call Report on an accrual basis. Accrued income represents the amount of interest earned or accrued on earning assets and applicable to current or prior periods that has not yet been collected. Examples include accrued interest receivable on loans and investments. When income is accrued but not yet collected, a bank debits a receivable account and credits an applicable income account. When funds are collected, cash or an equivalent is debited, and the receivable account is credited.
The degree to which accrual accounts and practices are reviewed during an examination should be governed by the examination scope. When scoping examination procedures, examiners should consider the adequacy of a bank’s internal control structure and the extent to which accrual accounting procedures are analyzed during audits.
When reviewing accrual accounts and practices, examiners should assess the general accuracy of the accrual accounting system and determine if accruals relate to items in default or to items where collection is doubtful. If accrued income accounts are materially overstated, examiners should consider the impact to overall profitability levels, classify overstated amounts as Loss, and recommend management amend Call Reports.
Tax Assets
Banks must estimate the amount of the current income tax liability (or receivable) to be reported on its tax returns. Estimating this liability (or receivable) may involve consultation with the bank's tax advisers, a review of the previous year's tax returns, the identification of significant
expected differences between items of income and expense reflected on the Call Report and on the tax returns, and the identification of expected tax credits.
Deferred tax assets and liabilities represent the amount by which taxes receivable (or payable) are expected to increase or decrease in the future as a result of temporary differences and net operating losses or tax credit carryforwards that exist at the reporting date. When determining the current and deferred income tax assets and liabilities to be reported in any period, a bank’s income tax calculation will contain an inherent degree of uncertainty surrounding the realizability of the tax positions included in the calculation.
A net deferred tax asset is reported if a debit balance results after offsetting deferred tax assets (net of valuation allowance) and deferred tax liabilities measured at the report date for a particular tax jurisdiction. If the result for a particular tax jurisdiction is a net credit balance, then a net deferred tax liability is reported. A bank may report a net deferred tax debit, or asset, for one tax jurisdiction, such as for federal income tax purposes, and also report at the same time a net deferred tax credit, or liability, for another tax jurisdiction, such as for state or local income tax purposes.
Temporary differences arise when an institution recognizes income or expense items on the books during one period, but records them for tax purposes in another period. For example a deductible temporary difference is created when a provision for loan and lease losses is expensed in one period for financial reporting purposes, but deferred for tax purposes until the loans are charged off in a subsequent period.
A bank sustains an operating loss when deductions exceed income for federal income tax purposes. An operating loss in a year following periods when the bank had taxable income may be carried back to recover income taxes previously paid. Banks may carry back operating losses for two years. Generally, an operating loss that occurs when loss carrybacks are not available (e.g., when losses occur in a year following periods of losses) becomes an operating loss carryforward. Banks may carry operating losses forward 20 years.
Tax credit carryforwards are tax credits that cannot be used for tax purposes in the current year, but which can be carried forward to reduce taxes payable in a future period.
Deferred tax assets are recognized for operating loss and tax credit carryforwards just as they are for deductable temporary differences. However, a bank can only recognize the benefit of a net operating loss, or a tax credit
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Management should conduct a thorough pre-purchase analysis to help ensure that the institution understands the risks, rewards, and unique characteristics of BOLI. The nature and extent of this analysis should be commensurate with the size and complexity of the potential BOLI purchases and should take into account existing BOLI holdings.
A comprehensive assessment of BOLI risks on an ongoing basis is especially important for an institution whose aggregate BOLI holdings represent a capital concentration. Management should analyze the financial condition of BOLI insurance carriers, review the performance of BOLI products, and report their findings to the board at least annually. More frequent reviews may be necessary if management anticipates additional BOLI purchases, a decline in an insurance carrier's financial condition, policy surrenders, or changes in tax laws that could affect BOLI products or performance.
Examiners should review the Interagency Statement on the Purchase and Risk Management of Life Insurance (Interagency Statement) when assessing an institution’s BOLI program. Examiners should closely scrutinize risk management policies and controls associated with BOLI assets when an institution holds BOLI in an amount that approaches or exceeds 25 percent of Tier 1 capital. An institution holding life insurance in a manner inconsistent with safe and sound banking practices is subject to supervisory action. Where ineffective controls over BOLI risks exist, or the exposure poses a safety and soundness concern, supervisory action against the institution, may include requiring the institution to divest affected policies, irrespective of potential tax consequences.
ASC 325-30, Investments-Other – Investments in Insurance Contracts (formerly FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance, and Emerging Issues Task Force Issue No. 06-5, Accounting for Purchases of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4) addresses the accounting for BOLI. Only the amount that could be realized under an insurance contract as of the balance sheet date (that is, the CSV reported by the carrier, less any applicable surrender charges not reflected in the CSV) is reported as an asset. If a bank records amounts in excess of the net CSV of the policy, then the excess should be classified Loss.
For risk-based capital purposes, an institution that owns general account permanent insurance should apply a 100 percent risk weight to its claim on the insurance company. If an institution owns a separate account policy and can demonstrate that it meets certain requirements, it may choose to apply a look-through approach to the underlying
assets to determine the risk weight. Refer to Call Report Instructions, the ED Module - Bank-Owned Life Insurance (BOLI), and the Interagency Statement for further details.
MISCELLANEOUS ASSETS
Miscellaneous assets that are not reported in major Balance Sheet or Other Asset categories should be reported separately under all other assets in the Call Report. Examples include derivative instruments held for purposes other than trading that have a positive fair value, computer software, and bullion. Some of the more common miscellaneous assets are described below.
Prepaid Expenses
Prepaid expenses are the costs that are paid for goods and services prior to the periods in which the goods or services are consumed or received. When the cost is prepaid, the payment is recorded as an asset because it represents a future benefit to the bank. In subsequent periods the asset is reduced (expensed) as the goods or services are used or rendered. At the end of each accounting period, the bank makes adjusting entries to reflect the portion of the cost that has expired during that period. The prepayment is often for a service for which the benefit is spread evenly throughout the year. As the service is provided, the prepaid expense is amortized to match the cost to the period it benefits. Examples of prepaid expenses include premiums paid for insurance, advance payments for leases or asset rentals, payments for stationery or other supplies that will be used over several months, and retainer fees paid for legal services to be provided over a specified period.
Examiners should ensure management accurately adjusts prepaid expenses to reflect exhausted purchased goods or services. Prepaid expenses that are recorded and amortized in accordance with generally accepted accounting principles should not be adversely classified. However, any prepaid expense that is overstated should be classified Loss.
Repossessed Personal Property
Repossessed personal property such as automobiles, boats, equipment, and appliances, represents assets acquired for debts previously contracted. A bank that receives assets from a borrower in full satisfaction of a loan, such as a receivable from a third party, an equity interest in the borrower, or another type of asset (except a long-lived asset that will be sold), will account for the asset at its fair value. An asset received in partial satisfaction of a loan should be accounted for as described above and the
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recorded amount of the loan should be reduced by the asset’s fair value less the cost to sell. .Examiners should assess repossessed assets individually for possible adverse classification.
Suspense Accounts
Suspense accounts, also known as interoffice or clearing accounts, are temporary holding accounts in which items are carried until they can be identified and their disposition to the proper account is made. For example, items are included in suspense accounts when a transaction is coded incorrectly and cannot be processed immediately, when an account number is missing on a loan or deposit transaction, or when a check drawn on a deposit account at the bank is not properly endorsed. Most suspense items are researched and cleared the following day. The balances of suspense accounts as of the report date should not automatically be reported as Other Assets or Other Liabilities. Rather, the items included in these accounts should be reviewed and material amounts should be reported appropriately in the Call Report. Moreover, banks should regularly reconcile suspense accounts. Stale suspense items should be charged off when it is determined that they are uncollectible and should be classified Loss in the report of examination.
Cash Items Not In Process Of Collection
In contrast to those cash items that are in process of collection, cash items that are not paid when presented are referred to as cash items that are not in the process of collection. In general, cash items that are not in the process of collection occur when the paying bank has refused payment after being presented with the cash item. Once payment has been refused, the cash item immediately becomes not in process of collection and is reclassified as an Other Asset. Cash items not in the process of collection are frequently kept in a suspense account. Although collection efforts will continue, when it becomes clear that the cash item will not be paid, the bank should promptly charge off the cash item. It is common for the payee bank to refuse payment if the customer’s deposit account had insufficient funds, the check was improperly endorsed, the checking account on which the check is drawn has been closed, or for some other acceptable reason.
Other Accrued Interest Receivables
Accrued interest on securities purchased (if accounted for separately from accrued interest receivable in the bank’s records) and retained interests in accrued interest receivable related to securitized credit cards is reported in all other assets in the Call Report. Accrued interest
receivable amounts that are overstated should be classified Loss.
In a typical credit card securitization, an institution transfers a pool of receivables and the right to receive the future collections of principal (credit card purchases and cash advances), finance charges, and fees on the receivables to a trust. If a securitization transaction qualifies as a sale, then the selling institution removes the receivables that were sold from its reported assets and continues to carry any retained interests in the transferred receivables on its balance sheet. An institution should treat this accrued interest receivable asset as a retained (subordinated) beneficial interest. Accordingly, it should be reported in all other assets in the Call Report and not as a loan receivable.
For further guidance refer to the Interagency Advisory on the Accounting Treatment of Accrued Interest Receivable Related to Credit Card Securitizations and the Call Report Instructions.
Indemnification Assets
Indemnification assets represent the carrying amount of the right to receive payments from the FDIC for losses incurred on specified assets acquired from failed insured depository institutions or otherwise purchased from the FDIC that are covered by loss-sharing agreements. Despite the linkage between them, the acquired covered assets and the indemnification asset, are treated as separate units of account. Each covered asset is reported in the appropriate category on the balance sheet. The indemnification asset is recorded at its acquisition-date fair value and is reported in all other assets in the Call Report.
Examiners should ensure the acquiring institution’s financial and regulatory reporting is appropriate for the covered assets and the indemnification asset. Refer to the Call Report Instructions for further details.
INTANGIBLE ASSETS
Goodwill and Other Intangible Assets
Goodwill is an intangible asset that is commonly recognized as a result of a business combination. .Other intangible assets resulting from a business combination, such as core deposit intangibles, purchased credit card relationships, servicing assets, favorable leasehold rights, trademarks, trade names, internet domain names, and non- compete agreements, should be recognized as an asset
RMS Manual of Examination Policies 3.7-5 Other Assets and Other Liabilities (3/12)
assets for which the servicing benefits (revenues from contractually specified servicing fees, late charges, and other ancillary sources) are expected to more than adequately compensate the servicer. Contractually specified servicing fees are all amounts that, per contract, are due to a servicer in exchange for servicing the financial assets and which would no longer be received by a servicer if the contract for servicing were shifted to another servicer.
A bank must recognize and initially measure at fair value a servicing asset or a servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract in either of the following situations:
The bank’s transfer of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset that meets the requirements for sale accounting; or An acquisition or assumption of a servicing obligation that does not relate to financial assets of the bank or its consolidated affiliates included in the Call Report.
If a bank sells a participating interest in an entire financial asset, it only recognizes a servicing asset or servicing liability related to the participating interest sold.
A bank should subsequently measure each class of servicing assets and servicing liabilities using either the amortization method or the fair value measurement method. Once a bank elects the fair value measurement method for a class of servicing, that election must not be reversed.
Under the amortization method, all servicing assets or servicing liabilities in the class should be amortized in proportion to, and over the period of, estimated net servicing income for assets (servicing revenues in excess of servicing costs) or net servicing loss for liabilities (servicing costs in excess of servicing revenues). The servicing assets or servicing liabilities should be assessed for impairment or increased obligation based on fair value at each quarter-end Call Report date. The servicing assets within a class should be stratified into groups based on one or more of the predominant risk characteristics of the underlying financial assets. If the carrying amount of a stratum of servicing assets exceeds its fair value, the bank should separately recognize impairment for that stratum by reducing the carrying amount to fair value through a valuation allowance for that stratum. The valuation allowance should be adjusted to reflect changes in the measurement of impairment subsequent to the initial measurement of impairment. For the servicing liabilities within a class, if subsequent events have increased the fair
value of the liability above the carrying amount of the servicing liabilities, the bank should recognize the increased obligation as a loss in current earnings.
Under the fair value measurement method, all servicing assets or servicing liabilities in a class should be measured at fair value at each quarter-end report date. Changes in the fair value of these servicing assets and servicing liabilities should be reported in earnings in the period in which the changes occur.
Institutions that sell only a limited number of financial assets with servicing retained and do not otherwise actively purchase or sell servicing rights may determine that the servicing activity is immaterial. Typically, these institutions will have a relatively low volume of financial assets serviced for others and the value of any servicing assets and liabilities would likewise be immaterial. Management must provide a reasonable basis for not reporting servicing activity. Refer to the Servicing Liabilities section below and the Call Report Instructions for further details.
Valuation
The fair value of servicing assets and liabilities is determined in accordance with ASC 820, Fair Value Measurements and Disclosures (formerly FAS 157, Fair Value Measurements) that defines fair value and establishes a framework for measuring fair value. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the asset’s or liability’s principal (or most advantageous) market at the measurement date. This value is often referred to as an exit price. ASC 820 establishes a three level fair value hierarchy that prioritizes inputs used to measure fair value based on observability. The highest priority is given to Level 1 (observable, unadjusted) and the lowest priority to Level 3 (unobservable).
Valuation techniques consistent with the market approach, income approach, and/or cost approach should be used to measure fair value, as follows:
The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. Valuation techniques consistent with the market approach include matrix pricing and often use market multiples derived from a set of comparables.
The income approach uses valuation techniques to convert future amounts (for example, cash flows or earnings) to a single present amount (discounted). The measurement is
RMS Manual of Examination Policies 3.7-7 Other Assets and Other Liabilities (3/12)
based on the value indicated by current market expectations about those future amounts. Valuation techniques consistent with the income approach include present value techniques, option-pricing models, and the multi period excess earnings method.
The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (often referred to as current replacement cost). Fair value is determined based on the cost to a market participant (buyer) to acquire or construct a substitute asset of comparable utility, adjusted for obsolescence.
When the discounted cash flow approach is used to measure the fair value of servicing assets, a number of factors and assumptions are considered when projecting the potential income stream (net of servicing costs) generated by the servicing rights. This income stream is present valued using appropriate market discount rates to determine the estimated fair value of the servicing rights. These factors and assumptions, which should be adequately documented, include:
Average loan balance and coupon rate, Average portfolio age and remaining maturity, Contractual servicing fees, Estimated income from escrow balances, Expected late charges and other possible ancillary income, Anticipated loan balance repayment rate (including estimated prepayment speeds), Direct servicing costs and appropriate allocations of other costs, as well as the inflation rate effect, and Delinquency rate and estimated out-of-pocket foreclosure and collection costs that will not be recovered.
Regulatory Capital
Part 325 provides information on the regulatory capital treatment of mortgage servicing assets and nonmortgage servicing assets.
For purposes of calculating Tier 1 capital, the balance sheet assets for mortgage servicing assets and nonmortgage servicing assets will each be reduced to an amount equal to the lesser of:
90 percent of the fair value of these assets; or 100 percent of the remaining unamortized book value of these assets (net of any related valuation allowances).
The total amount of mortgage servicing assets, nonmortgage servicing assets, along with purchased credit card relationships recognized for regulatory purposes (i.e., not deducted from assets and capital) is limited to no more than 100 percent of Tier 1 capital. In addition to the aggregate limitation on such assets, the maximum allowable amount of purchased credit card relationships and nonmortgage servicing assets, when combined, is limited to 25 percent of Tier 1 capital. These limitations are calculated before the deduction of any disallowed servicing assets, disallowed purchased credit card relationships, disallowed credit-enhancing interest-only strips, disallowed deferred tax assets, and any nonfinancial equity investments. In addition, banks may elect to deduct disallowed servicing assets on a basis that is net of any associated deferred tax liability.
Servicing Risk
Examiners should be aware of the risks that can affect an institution from the failure to follow the servicing rules related to securitized assets. While credit risk may appear to be of little or no concern, the mishandling of procedures in these transactions can affect a holder's ability to collect. Financial institutions perform roles as sellers, buyers, servicers, trustees, etc., in these types of transactions. Examiners should evaluate the potential risks that might arise from one or more of these roles. In most cases, the government agency that provided the guarantee or insurance against ultimate default will also impose guidelines and regulations for the servicer to follow. If the servicer or others involved in the servicing function fail to follow these rules and guidelines, then the government agency that is providing the guarantee or insurance may refuse to honor its commitment to insure all parties against loss due to default. It is necessary for the financial institution to have adequate policies and procedures in place to control and limit the institution's liability and exposure in this regard.
Examination Procedures
When assessing asset quality during onsite examinations and when reviewing merger applications, examiners and supervisory personnel should review the valuation and accounting treatment of servicing assets. The ED Module
- Mortgage Banking contains various examination procedures and references for reviewing mortgage servicing assets.
OTHER LIABILITIES
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