Risk Management Manual of Examination Policies - FDIC

LOANS Section 3.2
opinions and ideas should not have to be emphasized; if a
classification is well-founded, the facts will speak for
themselves. If well-written, there is little need for long
summary comments reemphasizing major points of the
loan write-up.
When the volume of loan classifications reaches the point
of causing supervisory concern, analysis of present and
previous classifications from the standpoint of source and
disposition becomes very important. For this reason, the
Analysis of Loans Subject to Adverse Classification page
should be completed in banks possessing characteristics
which present special supervisory problems; when the
volume or composition of adversely classified loans has
changed significantly since the previous examination,
including both upward and downward movements; and, in
such other special or unusual situations as examiners deem
appropriate. Generally, the page should not include
consumer loans and overdrafts and it should be footnoted
to indicate that these assets are not included.
Issuance of "Express Determination" Letters
to Banks for Federal Income Tax Purposes
Tax Rules - The Internal Revenue Code and tax
regulations allow a deduction for a loan that becomes
wholly or partially worthless. All pertinent evidence is
taken into account in determining worthlessness. Special
tax rules permit a federally supervised depository
institution to elect a method of accounting under which it
conforms its tax accounting for bad debts to its regulatory
accounting for loan charge-offs, provided certain
conditions are satisfied. Under these rules, loans that are
charged-off pursuant to specific orders of the institution's
supervisory authority or that are classified by the institution
as Loss assets under applicable regulatory standards are
conclusively presumed to have become worthless in the
taxable year of the charge-offs. These special tax rules are
effective for taxable years ending on or after December 31,
1991.
To be eligible for this accounting method for tax purposes,
an institution must file a conformity election with its
Federal income tax return. The tax regulations also require
the institution's primary Federal supervisory authority to
expressly determine that the institution maintains and
applies loan loss classification standards that are consistent
with the regulatory standards of its supervisory authority.
For taxable years ending before the completion of the first
examination of an institution's loan review process that is
after October 1, 1992, transition rules allow an institution
to make the conformity election without the determination
letter from its primary supervisory authority. However, the
letter must be obtained at the first examination involving
the loan review process after October 1, 1992. If the letter
is not issued by the supervisory authority at the
examination, the election is revoked retroactively.
Once the first examination of the loan review process after
October 1, 1992, has been performed by an institution's
primary Federal supervisory authority, the transition rules
no longer apply and the institution must have the "express
determination" letter before making the election. To
continue using the tax-book conformity method, the
institution must request a new letter at each subsequent
examination that covers the loan review process. If the
examiner does not issue an "express determination" letter
at the end of such an examination, the institution's election
of the tax-book conformity method is revoked
automatically as of the beginning of the taxable year that
includes the date of examination. However, that
examiner's decision not to issue an "express determination"
letter does not invalidate an institution's election for any
prior years. The supervisory authority is not required to
rescind any previously issued "express determination"
letters.
When an examiner does not issue an "express
determination" letter, the institution is still allowed tax
deductions for loans that are wholly or partially worthless.
However, the burden of proof is placed on the institution to
support its tax deductions for loan charge-offs.
Examination Guidelines - Banks are responsible for
requesting "express determination" letters during
examinations that cover their loan review process, i.e.,
during safety and soundness examinations. Examiners
should not alter the scope or frequency of examinations
merely to permit banks to use the tax-book conformity
method.
When requested by a bank that has made or intends to
make the election under Section 1.166-2(d)(3) of the tax
regulations, the examiner-in-charge should issue an
"express determination" letter, provided the bank does
maintain and apply loan loss classification standards that
are consistent with the FDIC's regulatory standards. The
letter should only be issued at the completion of a safety
and soundness examination at which the examiner-incharge
has concluded that the issuance of the letter is
appropriate.
An "express determination" letter should be issued to a
bank only if:
• The examination indicates that the bank maintains and
applies loan loss classification standards that are
Loans (12-04) 3.2-50 DSC Risk Management Manual of Examination Policies
Federal Deposit Insurance Corporation