SR 96-40 (SUP)

December 30, 1996

TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK

SUBJECT: Interim Guidance for Purposes of Applying FAS 125 for
Regulatory Reporting in 1997 and for the Treatment of Servicing Assets
for Regulatory Capital

Overview

This letter and the attached press release provide guidance to state member banks and consolidated bank holding companies on: (1) the regulatory reporting requirements for servicing assets; and (2) the interim capital treatment of servicing assets, beginning January 1, 1997, the same date on which the Financial Accounting Standards Board (FASB) Statement No.125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS 125), becomes effective. The press release providing interim guidance for banks and thrift institutions was distributed under the auspices of the Federal Financial Institutions Examination Council on December 18, 1996.

Applicability of Statement No. 125 for Regulatory Reporting Purposes.

Effective January 1, 1997, insured commercial banks and bank holding companies must adopt the provisions of FAS 125, with the exception of those provisions for which FASB has deferred implementation, for purposes of reporting the commercial bank Reports of Condition and Income (Call Report) and the Consolidated Financial Statements for Bank Holding Companies (FR Y-9C). In addition, banking organizations must apply the provisions of FAS 125 governing the accounting and reporting for servicing contracts in existence before January 1, 1997, and certain other financial assets held on January 1, 1997, that are subject to substantial prepayment risk.

Regulatory Reporting Treatment for 1997

In the Call Report, banks should report the carrying value of all mortgage servicing assets (MSAs) in Schedule RC-M, item 6.a, which will be renamed "Mortgage servicing assets," and on the balance sheet in Schedule RC, item 10, "Intangible assets." The fair value of mortgage servicing assets would be reported in a proposed new item in Schedule RC-M, item 6.a (1), "Fair value of mortgage servicing assets." In addition, banks should report the carrying value of servicing assets related to financial assets other than mortgages in Schedule RC-M, item 6.b.(2), "All other identifiable intangible assets." 2/ Any interest-only strips receivable not in security form that arise out of transfers of financial assets will be reported on the balance sheet in Schedule RC, item 11, "Other assets." In Schedule RC-F -- Other Assets, further information on interest-only strips receivable in nonsecurity form recognized pursuant to FAS 125 would be provided by two proposed new items and an existing item in this schedule on "Excess residential mortgage servicing fees receivable" would be eliminated.

In the FR Y-9C, bank holding companies should report the carrying value of all mortgage servicing assets (MSAs) on the balance sheet in Schedule HC, item 10.a, which will be renamed "Mortgage servicing assets." The fair value of mortgage servicing assets will be reported in Schedule HC-I, item 6, which will be renamed, "Fair value of mortgage servicing assets." In addition, bank holding companies should report the carrying value of servicing assets related to financial assets other than mortgages on the balance sheet in Schedule HC, item 10.b.(2), "All other identifiable intangible assets." Any interest-only strips receivable not in security form that arise out of transfers of financial assets will be reported on the balance sheet in Schedule HC, item 11, "Other assets." In Schedule HC-G -- Memoranda, two proposed new items, items 18.a and 18.b would provide further information on interest-only strips receivable in nonsecurity form recognized pursuant to FAS 125 and existing item 18 in this schedule on "Excess residential mortgage servicing fees receivable" would be eliminated.

Interim Guidance on the Regulatory Capital Treatment

Under the interim guidance, the aggregate amount of MSAs and Purchased Credit Card Relationships (PCCRs) that may be recognized for regulatory capital purposes (i.e., not deducted from assets and capital) by banks and bank holding companies would be limited to no more than 50 percent of Tier 1 (core) capital. Institutions will continue to be subject to the restriction limiting the amount of MSAs and PCCRs that may be recognized for Tier 1 capital purposes to the lesser of 90 percent of fair value or 100 percent of book value (net of any valuation allowance), commonly referred to as the 10 percent haircut.

Purchased servicing assets related to financial assets other than mortgages that were previously capitalized under generally accepted accounting principles (GAAP) should continue to be treated as "all other identifiable intangible assets" and deducted when calculating banking organizations' Tier 1 capital.

Prior to implementation of FAS No. 125, the rights to future interest income from serviced assets in excess of the contractually specified fees (i.e., interest-only strips receivable arising out of servicing activities) were a component of either servicing rights of ESFRs under GAAP, but were not categorized as a separate financial asset. In the interim and until a final rule amending the Board's capital guidelines is issued, such interest-only strips receivable -- which will be reported as "other assets" in the bank Call Report and in the FR Y9-C -- generally will not be deducted in computing Tier 1 capital. At this time, however, no assurance regarding the capital treatment of such assets under any final capital rule on servicing assets can be provided.

If you have any questions on the supervisory or capital issues related to servicing assets, please contact Arleen Lustig, Supervisory Financial Analyst (202/452-2987), Tom Boemio, Supervisory Financial Analyst (202/452-2982). Questions concerning the accounting treatment for servicing assets may be addressed to Arthur Lindo, Supervisory Financial Analyst (202/452-2695).

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1/ The characterization of servicing assets as intangible assets for regulatory reporting purposes for both banks and bank holding companies will remain in effect until any change occurs in their characterization for regulatory capital purposes.

2/ For purposes of determining the amount of MSAs (or non-mortgage servicing assets) that would be deducted (or disallowed) in computing Tier 1 capital, institutions may choose to reduce the otherwise disallowed MSAs (or non-mortgage servicing assets) by the amount of any associated deferred tax liability.

Stephen C. Schemering
Deputy Director

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