TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
SR 95-4, issued January 17, 1995, clarified the System's policy with
respect to the treatment of loan loss reserves in uninsured U.S. branches and
agencies of foreign banking organizations.1 The statement emphasized that U.S.
branches must have adequate procedures for identifying problem credits in their loan
portfolios. Further, the statement noted that the outstanding balance of a loan should
only be written down for regulatory reporting purposes when management has
identified a specific loss amount. Accordingly, the amount to be reported on the
Report of Assets and Liabilities of U.S. Branches and Agencies of Foreign Banks
(FFIEC 002), consistent with the instructions to that report, is the outstanding balance
less any specified loss amount.
Discussion of this matter at meetings of Board and Reserve Bank staff
have suggested that further clarification of selected issues would be helpful.
Loan Valuation and Regulatory Reporting Issues
For regulatory reporting purposes, the outstanding reportable balance
of a loan should be reduced only when a specific loss amount has been identified for
an individual credit. In each such case, the amount of loss identified would be
deducted from the outstanding loan balance through a charge-off or specific reserve.
Such charge-offs or specific reserves would be appropriate for an amount identified as
loss by examiners or where management has estimated a likely specific loss amount
on a particular loan. (Such loss estimates should be supported by documentation in
the credit files.) This would include a loan where the entire balance has been charged
off or specifically reserved against, as well as a loan where, because of collateral or
for other reasons, only a portion of the loan is viewed as loss (e.g., loans subject to a
split classification).
Where no specific loss has been identified for a loan, the loan balance
should be reported gross on the FFIEC 002, even if reserves have been established
based on the expectation that a certain loss rate is likely to be incurred over time on
portfolios of loans with various degrees of credit weaknesses (e.g., for substandard
loans.) If management elects to establish reserves for such credits, these reserves
are defined as general reserves for regulatory reporting purposes and should be
reported on Schedule M of the FFIEC 002 report.
The "asset quality" component of the ROCA rating assigned during an
examination should be based on loan balances computed on a regulatory reporting
basis.
Documentation and Examination Procedures
Bank management should be able to substantiate specific reserves
established by the U.S. branch with supporting analyses and documentation. Credit
files at the U.S. branch should indicate that a specific loss has been identified. SR
95-4 emphasized that U.S. branches must have adequate procedures in place to
identify problem credits. If the U.S. branch's overall system for identifying losses is
deemed adequate, the examiner should accept management's determinations, even if
an identified loss amount is greater than the examiner's determination.
If specific reserves established for a particular loss remain on the books
of the U.S. branch for successive examinations, bank management should provide an
explanation as to why the credit has not been charged off.
Assets Classified for Transfer Risk
A U.S. branch of a foreign banking organization is not required to
maintain allocated transfer risk reserves (ATRR) or the equivalent; however, a value-impaired classification indicates severe debt servicing problems that are likely to lead
to some loss. In such circumstances, a U.S. branch would be expected to have some
methodology for estimating a likely loss amount that would be specifically reserved
against or charged off. This adjusted book value should be reported on the FFIEC
002 report. The ICERC valuation would suffice as one well-defined methodology the
U.S. branch might use in order to net the reserve against the outstanding balance of
the loans, but other methodologies, such as reliance on market value, that arrive at
supportable conclusions also are acceptable, even if the valuation is somewhat higher
or lower than the ICERC results.
Internal Reporting Systems
A U.S. branch must maintain a well-defined methodology for identifying
problem credits (including loss amounts) and for reporting asset quality information to
its head office. Policies should document the accounting procedures for head office
reporting, which should be applied on a consistent basis. Any significant deficiencies
in the above should be considered in determining the risk management component of
the ROCA rating system and should be described in the examination report.
Branches are expected to inform head office of all amounts that have
been charged off or specifically reserved against for U.S. regulatory purposes. If
adjustments have been made between the FFIEC 002 report and internal reports filed
with head office, these adjustments must be documented and explained to the head
office.
Adjustment of Existing Specific Reserves
The letter that transmitted the March FFIEC 002 Report to the Reserve
Banks (Z-9061, March 28, 1995) reiterated the correct reporting of loans and reserves
as described in SR 95-4. Branches that have been inappropriately netting what
amounted to general loan loss reserves against loans on the FFIEC 002 report were
advised to report correctly as of March 1995; however, no revisions to previous
reports were required. Where a change to the correct reporting basis resulted in
increasing reportable loan balances by an amount greater than $5 million or 0.5
percent of a reporting institution's total loans and leases, the U.S. branch was
instructed to provide a letter to the Reserve Bank detailing the effects of the change.
A copy of this letter was to be forwarded by the Reserve Bank to the Board. The
information provided was to be used by the regulatory agencies to adjust the reported
information for purposes such as trend analysis.
No letters detailing the effects of reporting changes have been received
by the Board; however, the March data shows increases in nonperforming loans that
would be consistent with U.S. branches revising their reporting procedures. U.S.
branches that reported a significant increase in nonperforming loans for March should
be contacted to ascertain whether the increase was due to a change in reporting
procedures and, where applicable, the information detailing the effect of the change
should be obtained and sent to the Board.
Any U.S. branch that continues to inappropriately net reserves against
loans (or charge off) on the FFIEC 002 report in 1995 should be required to file
amended reports for any 1995 reporting dates for which inappropriate reports were
filed.
If you have any questions, please contact Elizabeth H. Roberts,
Manager, International Regulatory and Examination Policy Section at 202-452-3354, or Michael G. Martinson, Assistant Director, at 202-452-3640.
Associate Director
Footnotes 1. "U.S. branch" or collectively referred to as "U.S. branches." Return to text |
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