Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
subject to the isolation test in FAS 125, but are otherwise
accounted for based on FAS 140. Based upon the FASB's
initial understanding of the nature of the FDIC's
receivership power to reclaim certain assets sold by
institutions that subsequently failed when it was drafting
FAS 125, the FASB deemed assets sold by FDIC-insured
institutions to be beyond the reach of creditors in an FDIC
receivership. Therefore in FAS 125, the FASB concluded
that assets transferred by an FDIC-insured institution,
including participations, generally met the isolation test for
sales accounting treatment with respect to receiverships.
(Depending on the terms of the transfer, the transferred
assets might not meet the isolation test for other reasons.)
As a result, the mere existence of formal (written,
contractual) recourse provisions would not, in and of
themselves, preclude loan participations transferred prior
to January 1, 2002, from being accounted for as sales
provided all other criteria necessary for sales accounting
treatment are met. However, participations transferred
prior to January 1, 2002, which are subject to formal
recourse provisions, as well as those subject to implicit
(unwritten, noncontractual) recourse provisions in which
the seller demonstrates intent to repurchase participations
in the event of default even in the absence of a formal
obligation to do so, would be considered assets sold with
recourse when calculating the seller's risk-based capital
ratios.
After the issuance of FAS 125, the FASB further clarified
its understanding of the FDIC's ability to reclaim certain
assets in a receivership, and the FDIC clarified when it
would not seek to reclaim loan participations sold in Part
360 of the FDIC Rules and Regulations. Section 360.6
limits the FDIC's ability to reclaim certain loan
participations sold without recourse, but does not limit the
FDIC's ability to reclaim loan participations sold with
recourse. For purposes of Section 360.6, the phrase
"without recourse" means that the participation is not
subject to any agreement which requires the lead bank
(seller) to repurchase the participant's (purchaser's) interest
in the loan or to otherwise compensate the participant due
to a default on the underlying loan. The FASB's new
understanding of the FDIC's receivership powers, including
Part 360, is addressed in FAS 140.
Loan participations transferred after December 31, 2001,
must be accounted for pursuant to all of the provisions of
FAS 140, including its isolation test. In accordance with
FAS 140, loan participations sold by FDIC-insured
institutions with recourse generally will not be considered
isolated from creditors in the event of receivership due to
the FDIC's power to reclaim the participated assets. As a
result, loan participations transferred after December 31,
2001, which are subject to formal (written, contractual)
recourse provisions should be accounted for as secured
borrowings by both the seller and the purchaser for
financial reporting purposes. This means that the seller
must not reduce the loan assets on its balance sheet for the
participation, and that the entire amount of the loan must
be included in the seller's assets for both leverage and riskbased
capital purposes. Participations transferred after
December 31, 2001, which are subject to implicit
(unwritten, noncontractual) recourse provisions may be
accounted for as sales by both the seller and the purchaser
for financial reporting purposes, provided the other sales
criteria addressed above are met. However, if the seller
demonstrates intent to repurchase participations sold in the
event of default even in the absence of a formal obligation
to do so, then these participations will be treated as assets
sold with recourse when calculating the seller's risk-based
capital ratios. Consistent with an AICPA auditing
interpretation, FDIC-insured institutions which account for
loan participations transferred after December 31, 2001, as
sales rather than as secured borrowings for financial
reporting purposes should generally do so only if the
participation agreement is supported by a legal opinion
explaining how the isolation test for sales accounting
treatment is met given the FDIC's receivership powers.
Call Report Treatment - When a loan participation is
accounted for as a sale, the seller removes the participated
interest in the loan from its books. The purchaser reports
its interest in the loan as Loans in the Report of Condition,
and in Call Report Schedule RC-C - Loans and Lease
Financing Receivables, based upon collateral, borrower, or
purpose. If a loan participation is accounted for as a
secured borrowing, the seller does not remove the loan
from its books. The participated portion of the loan is
reported as both Loans and Other Borrowed Money in the
Report of Condition. The purchaser would report its
interest in the loan as Loans in the Report of Condition,
and as Loans to depository institutions and acceptances of
other banks in Schedule RC-C. More detailed guidance on
accounting for transfers of financial assets, including loan
participations, is contained in the Transfers of Financial
Assets entry in the Glossary of the Call Report Instructions.
Independent Credit Analysis - A bank purchasing a
participation loan is expected to perform the same degree
of independent credit analysis on the loan as if it were the
originator. To determine if a participation loan meets its
credit standards, a participating bank must obtain all
relevant credit information and details on collateral values,
lien status, loan agreements and participation agreements
before a commitment is made to purchase. The absence of
such information may be evidence that the participating
bank has not been prudent in its credit decision.
During the life of the participation, the participant should
monitor the servicing and the status of the loan. In order to
Loans (12-04) 3.2-34 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation