BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 95-42 (SUP.IB)
August 2, 1995
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Allowance for Loan and Lease Losses for U.S. Branches and Agencies of Foreign Banking Organizations
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.
William A. Ryback
Cross Reference: SR 95-4 (SUP.IB) January 17, 1995
Z-9061, March 28, 1995
SR letters | 1995