Seal of the Board of Governors of the Federal Reserve System

WASHINGTON, D. C.  20551


SR 93-72 (FIS)
December 30, 1993


SUBJECT: Guidance on the Capital Treatment and Other Issues Relating to the Financial Accounting Standards Board Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities"

                        The Federal Reserve and the other federal banking agencies have adopted Financial Accounting Standards Board (FASB) Statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (FASB 115), for regulatory financial reporting, effective as of January 1, 1994.  Early adoption is permitted to the extent allowable under FASB 115.

                        FASB 115 applies to all debt securities and to equity securities that have readily determinable fair values.  Under the new standard, banking institutions should include these securities in one of three categories: held-to-maturity, available-for-sale, or trading securities.  The held-to-maturity category replaces the current held-for-investment category.  However, only those debt securities for which the banking organization has the positive intent and ability to hold to maturity may be placed in the held-to-maturity category and carried at amortized cost.  The accounting treatment for trading securities remains unchanged under FASB 115. Securities not designated as either held-to-maturity or trading will be considered available for sale and carried at fair value. Net unrealized holding gains and losses on these securities will be reported directly in equity and not in earnings.  Those banking institutions adopting FASB 115 early should report such unrealized gains and losses in accordance with the instructions to the Reports of Condition and Income (call report) and the bank holding company financial statements (FR Y reports).

Capital Treatment

                        The Federal Reserve is requesting public comment on a proposal to amend its risk-based capital guidelines to include in Tier 1 capital net holding gains and losses on available-for-sale securities.  This proposal was issued on December 20, 1993.  The other federal banking agencies are requesting comment on similar proposals.  Until the Federal Reserve and other federal banking agencies can evaluate comments received on the proposals and issue any final amendments to their respective capital rules, banking organizations should continue to calculate their regulatory capital in accordance with their current procedures.  Accordingly, net unrealized gains or losses on debt securities categorized as available for sale should be excluded from the computation of regulatory capital.  Net unrealized losses on marketable equity securities should continue to be deducted when computing Tier 1 capital, while net unrealized gains on such securities should continue to be excluded from capital.

                        Notwithstanding the recent and proposed changes in reporting and regulatory capital standards, the Federal Reserve will continue to take into account net unrealized gains and losses on any securities carried at amortized cost in determining the overall capital adequacy of a banking organization.

Implications for Managing Securities Holdings

                        FASB 115 has important implications for how banking organizations manage their securities holdings.  Under the statement, an institution may not place a security in the held-to-maturity category unless it has the positive intent and ability to hold the security to maturity.  This criterion could limit the securities that an organization can carry at amortized cost and may result in more securities being carried at market value.  In addition, FASB 115 states that transfers and sales from the held-to-maturity category should be rare.  Furthermore, a decision to designate a security as held-to-maturity may affect a banking institution's ability to transfer or sell a security without sacrificing the ability to continue to carry the remainder of its held-to-maturity portfolio at amortized cost.  As a result, a banking institution's initial designation of its securities may adversely affect the degree of flexibility it has to manage its securities portfolio as a secondary source of liquidity. Therefore, banking organizations should carefully consider all relevant factors, including their liquidity position and their interest rate risk exposure, in assessing their intent and ability to hold their securities.

The Supervisory Policy Statement on Securities Activities

                        The federal banking agencies are currently studying the effects that FASB 115 may have on the FFIEC supervisory policy statement on securities activities, which was issued by the Board on January 10, 1992.  Any necessary amendments will be incorporated into the policy statement.

Income Tax Considerations

                        Under the Omnibus Budget Reconciliation Act, which was signed in August 1993, dealers in securities are required to mark certain securities to market for income tax purposes.  The law does provide exceptions to the mark-to-market requirements for some securities, including "any securities held for investment." However, this category as defined in the tax law is not the same as the held-to-maturity definition in FASB 115.  Accordingly, the manner in which a security is categorized on a banking organization's books or regulatory financial statements (i.e., the bank call report or the FR Y reports) will not necessarily indicate how the same security will be categorized under the new tax rules, and vice versa.  Banking institutions should consult their tax advisers concerning compliance with the specific provisions of the tax law.

                        This letter should be distributed to state member banks and bank holding companies as well as to examiners and analysts at Reserve Banks.  If you have any questions regarding the interim capital treatment or other issues related to FASB 115, please call Arleen Lustig (202/452-2987) or John Frech (202/452-2275).

Stephen C. Schemering
Deputy Director

SR letters | 1993