17Equity and Disclosures Regarding Capital Matters – Audit and Accounting Guide – Depository and Lending Institutions

Chapter 17
Equity and Disclosures Regarding Capital Matters

Introduction

17.01 Chapters 1, “Industry Overview — Banks and Savings Institutions,” and 2, “Industry Overview — Credit Unions,” of this guide discuss the regulatory capital requirements for banks and savings institutions and credit unions, respectively. Chapter 4, “Industry Overview — Mortgage Companies,” of this guide discusses similar capital requirements for mortgage companies. This chapter discusses the related financial statement disclosures and auditing guidance. Chapter 3, “Regulatory Considerations,” of the AICPA Accounting Guide Brokers and Dealers in Securities, discusses similar capital requirements for broker-dealers. Finance companies unaffiliated with banking organizations are not subject to regulatory capital requirements. Finance companies affiliated with banking organizations are subject to consolidated regulatory capital requirements and prudential supervision by the Board of Governors of the Federal Reserve System (Federal Reserve).

Banks and Savings Institutions

Introduction

17.02 Banks are organized with capital stock and shareholders. Savings institutions operate under a capital stock structure, like banks, or a cooperative form of ownership, similar to credit unions. Savings institutions operating under the cooperative form are referred to as “mutual institutions.” Although mutual institutions may be incorporated, they issue no capital stock and have no stockholders. The equity section of a mutual institution's statement of financial condition generally consists only of retained earnings and the accumulated other comprehensive income under FASB Accounting Standards Codification (ASC) 220, Comprehensive Income. The equity section for banks and stock savings institutions additionally include common stock and additional paid-in capital.

Equity

17.03 Common stock. Common stock consists of stock certificates issued to investors (stockholders) as evidence of their ownership interest. As defined in the FASB ASC glossary, common stock is stock that is subordinate to all other stock of the issuer.

17.04 Preferred stock. Preferred stock has certain privileges over common stock, such as a first claim on dividends. Typically, preferred stock conveys no voting rights, or only limited voting rights, to the holders. The rights of preferred stockholders are described in the articles of incorporation. As defined in the FASB ASC glossary, preferred stock is a security that has preferential rights compared to common stock.

17.05 Preferred stock may have certain characteristics or features that qualify it for different components of regulatory capital consistent with the applicable functional regulations and guidelines, for example, cumulative versus noncumulative dividends and perpetual versus limited life.

17.06 Additional paid-in capital. Amounts paid in the excess of par are additional paid-in capital. Absent such a stated par value, the bank or savings institution will assign a nominal par value to capital stock. Adjustments for treasury stock transactions, stock-based compensation and capital contributions may also be included in additional paid-in capital.

17.07 Retained earnings. Retained earnings include undivided earnings and other appropriations as designated by management or regulatory authorities. Undivided earnings include the transfer of net income, declaration of dividends and transfers to additional paid-in capital.

17.08 Accumulated other comprehensive income. In accordance with FASB ASC 220-10-45-14, the total of other comprehensive income for a period should be transferred to a component of equity that is presented separately from retained earnings and additional paid-in capital in a statement of financial position at the end of each accounting period.

17.09 In accordance with FASB ASC 220-10-45-10A, other comprehensive income includes, but is not limited to, the following:

     Unrealized holding gains and losses on available-for-sale securities (see FASB ASC 320-10-45-1).

     Unrealized holding gains and losses on available-for-sale debt securities (see FASB ASC 320-10-45-1).1

     Amounts recognized in other comprehensive income for debt securities classified as available-for-sale and held-to-maturity related to an other-than-temporary impairment recognized in accordance with FASB ASC 320-10-35 if a portion of the impairment was not recognized in earnings.

     Gains and losses (effective portion) on derivative instruments that are designated as, and qualify as, cash flow hedges (see item (c) in FASB ASC 815-20-35-1). As stated in FASB ASC 815-30-35-3, the ineffective portion of the gain or loss on a derivative instrument designated as a cash flow hedge is reported in earnings.

17.10 Minority interest in consolidated subsidiaries. A minority interest is the portion of equity in a bank's subsidiary not attributable, directly or indirectly, to the parent bank. For regulatory capital purposes, generally, banks may include such minority interests in equity capital accounts (both common and noncumulative perpetual preferred stocks) of consolidated subsidiaries if the subsidiary is a depository institution or a foreign bank, unless such accounts would not otherwise qualify for inclusion in common equity tier 1 or tier 1 capital. For example, a bank may not include minority interests representing cumulative preferred stock in consolidated subsidiaries because such preferred stock, if issued directly by the bank, would not be eligible for inclusion in tier 1 capital. The amount of minority interest includable is limited if the subsidiary has equity in excess of the subsidiary’s minimum capital requirements and the applicable capital conservation buffer. Minority interests in consolidated asset-backed commercial paper conduits are excluded for regulatory capital purposes if the consolidated program assets are excluded from risk-weighted assets. Although a minority interest in a consolidated subsidiary is generally includable in common equity tier 1 or tier 1 capital, a bank’s primary federal regulator may determine that it is not includable if it fails to provide meaningful capital support, fails to contribute to the subsidiary’s ability to absorb losses, or presents other safety and soundness concerns.

Holding Company Equity and Regulatory Capital2

17.11 Trust preferred securities. In accordance with FASB ASC 942-810-55-1, trust preferred securities (TPSs) have been issued by banks for a number of years due to favorable regulatory capital treatment. However, under current regulatory capital rules, TPSs no longer receive as favorable a capital treatment. See further discussion beginning in paragraph 17.20. FASB ASC 942-810-55-1 goes on to explain that various trust preferred structures have been developed involving minor differences in terms. Under the typical structure, a bank holding company first organizes a business trust or other special purpose entity. This trust issues two classes of securities: common securities, all of which are purchased and held by the bank holding company, and TPSs, which are sold to investors. The trust's only assets are deeply subordinated debentures of the corporate issuer, which the trust purchases with the proceeds from the sale of its common and preferred securities. The bank holding company makes periodic interest payments on the subordinated debentures to the business trust, which uses these payments to pay periodic dividends on the TPSs to the investors. The subordinated debentures have a stated maturity and may include an embedded call option. Most TPSs are subject to a mandatory redemption upon the repayment of the debentures.

17.12 Under the provisions of FASB ASC 810, Consolidation, a bank or a holding company that sponsored a structure described in the preceding paragraph should not consolidate the trust because the trust is a variable interest entity (VIE) and the bank or holding company is not the primary beneficiary of that VIE, as provided by FASB ASC 942-810-55-2.

17.13 The trust's dividend is financed by the trust through the purchase of the debentures.

17.14 In accordance with FASB ASC 942-810-45-1, in the typical trust preferred arrangement, the bank holds no variable interest in the trust, and therefore, cannot be the trust’s primary beneficiary. If the bank does not consolidate the trust, the bank or holding company should report its debt issued to the trust and an equity-method investment in the common stock of the trust.

17.15 FASB ASC 810-10-55-31 states that some assets and liabilities of a VIE have embedded derivatives. For the purpose of identifying variable interests, an embedded derivative that is clearly and closely related economically to its asset or liability host is not to be evaluated separately.

17.16 Under this guidance, an embedded call option is not a variable interest in the trust.

17.17 Regulatory capital treatment of TPSs. On October 21, 1996, the Federal Reserve approved the use of certain cumulative preferred stock instruments in tier 1 capital for bank holding companies. Similar interpretive guidance and approvals for qualification as tier 1 capital for national banks and state chartered nonmember banks and thrifts also have been provided, on an institution-specific preapproval basis, by the Office of the Comptroller of the Currency (OCC), the FDIC, and the Office of Thrift Supervision (prior to its transfer of powers to the OCC, the FDIC, and the Federal Reserve).3 The Capital and Dividends Booklet of the Comptroller’s Licensing Manual provides additional information regarding the guidance issued by the OCC.

17.18 On March 1, 2005, the Federal Reserve issued Risk-Based Capital Standards: Trust Preferred Securities and the Definition of Capital (Title 12 U.S. Code of Federal Regulations [CFR] Parts 208 and 225 [Regulations H and Y]). This rule allows the continued limited inclusion of TPSs in the tier 1 capital of bank holding companies. Under this rule, TPSs and other restricted core capital elements are subject to stricter quantitative limits. Prior to the rule, the amount of TPSs, together with other cumulative preferred stock that a bank holding company could include in tier 1 capital was limited to 25 percent of tier 1 capital. This rule limits restricted core capital elements to 25 percent of all core capital elements, net of goodwill less any associated deferred tax liability. Internationally active bank holding companies, defined as those with consolidated assets greater than or equal to $250 billion or on a consolidated basis reports on-balance sheet foreign exposure greater than or equal to $10 billion, will be subject to a 15 percent limit (excluding mandatory convertible preferred securities). They may include qualifying mandatory convertible preferred securities up to the generally applicable 25 percent limit. Amounts of restricted core capital elements in excess of these limits generally may be included in tier 2 capital.

17.19 The requirement for TPSs to include a call option was eliminated and standards for the junior subordinated debt underlying TPSs eligible for tier 1 capital treatment were clarified. The rule also addressed supervisory concerns, competitive equity considerations, and the accounting for TPSs. The rule also strengthened the definition of regulatory capital by incorporating long standing board policies regarding the acceptable terms of capital instruments included in banking organizations' tier 1 or tier 2 capitals.

17.20 Section 171 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) addresses deductions from regulatory capital and includes the following provisions:

     Trust-preferred securities issued by banks and thrift holding companies after May 19, 2010, will no longer count as tier 1 capital. Trust-preferred securities may otherwise qualify to be treated as tier 2 capital.

     Trust-preferred securities issued before May 19, 2010, by bank and thrift holding companies with $15 billion or more in assets were treated as tier 1 capital (subject to existing limitations, see paragraphs 17.17–.18) until January 2013. The tier 1 capital treatment was phased out over a 3-year period (see paragraph 17.21) ending December 2016.

     Bank and thrift holding companies with assets of less than $15 billion as of December 31, 2009, may continue to include trust-preferred securities that were issued before May 19, 2010, as tier 1 capital (subject to existing limitations, see paragraphs 17.17–.18).

     These provisions of the Dodd-Frank Act do not apply to small bank and savings and loan holding companies (holding companies with less than $1 billion in assets). See further discussion of small banking and savings and loan holding companies in paragraph 17.26.

17.21 In July 2013, the OCC, the Federal Reserve, and the FDIC issued the new regulatory capital rules. Among other provisions, the new rule improves the quality of capital by phasing out of tier 1 capital by 2016 instruments such as TPSs and cumulative preferred securities.4 However, the new rule grandfathers the inclusion of these instruments in tier 1 capital, subject to limitations, for banking organizations that have consolidated assets of less than $15 billion as of December 31, 2009. Although new issuances from these institutions will have to meet new stricter criteria, these banking organizations may continue to include instruments issued prior to May 19, 2010, in tier 1 capital subject to current limitations.

17.22 Mandatory redeemable preferred stock. Banks may issue mandatorily redeemable preferred stock as part of their capital structure.

17.23 FASB ASC 480-10-25-4 states that a mandatorily redeemable financial instrument should be classified as a liability unless the redemption is required to occur only upon the liquidation or termination of the reporting entity. FASB ASC 480-10-45-1 states that items within the scope of FASB ASC 480-10 should be presented as liabilities (or assets in some circumstances). Those items should not be presented between the liabilities section and the equity section of the statement of financial position. See further discussion on distinguishing liabilities from equity in paragraph 15.41 of this guide.5

17.24 FASB ASC 480, Distinguishing Liabilities from Equity, does not address redeemable preferred stock that is conditionally redeemable (for example, stock that is putable by the holder at a specified date.) Mezzanine presentation would continue to apply for conditionally redeemable stock that is not in the scope of FASB ASC 480. If mandatorily redeemable shares are not within scope of certain classification, measurement, and disclosure provisions of FASB ASC 480-10, the guidance in the SEC Regulation S-X, Section No. 210.5–02.28, is applicable. This regulation states that mandatory redeemable preferred stock is not to be included in amounts reported as stockholders' equity. Although nonpublic companies are not required to follow Regulation S-X, it would be appropriate for them to do so in most cases.

17.25 Perpetual preferred stock issued to the U.S. Treasury. On June 1, 2009, the Federal Reserve adopted a final rule (Federal Register Vol. 74, No. 103 [1 June 2009], pp. 26081–26084) to allow bank holding companies that have issued senior perpetual preferred stock to the U.S. Department of the Treasury under the capital purchase and other programs established by the Secretary of the Treasury under the Emergency Economic Stabilization Act of 2008, to include such capital instruments in tier 1 capital for purposes of the Federal Reserve's risk-based and leverage capital guidelines for bank holding companies. The final rule became effective on July 1, 2009.

17.26 Bank and savings and loan holding companies under $1 billion in assets. The Federal Reserve adopted a Small Bank Holding Company Policy that provides flexibility for qualifying bank and savings and loan holding companies to be exempt from the minimum regulatory capital requirements and a surveillance program to assist in the assessment of the capital adequacy of small bank and savings and loan holding companies regulated by the Federal Reserve. The bank and savings and loan holding company capital adequacy guidelines apply on a consolidated basis to bank and savings and loan holding companies with consolidated assets of $1 billion or more. For bank and savings and loan holding companies with less than $1 billion in consolidated assets, the guidelines will be applied on a bank only basis unless the parent is engaged in a nonbank activity involving significant leverage, conduct significant off-balance sheet activities, or the parent company has a significant amount of outstanding debt that is held by the general public.

17.27 Foreign banking organizations with U.S. non-branch assets of $50 billion or more. On February 17, 2014, the Federal Reserve adopted a final rule, which establishes a number of enhanced prudential standards for large U.S. bank holding companies and foreign banking organizations. These standards include liquidity, risk management, and capital. The final rule was required by section 165 of the Dodd-Frank Act. Foreign banking organizations with U.S. non-branch assets of $50 billion or more will be required to establish a U.S. intermediate holding company over their U.S. subsidiaries. The foreign-owned U.S. intermediate holding company generally will be subject to the same risk-based and leverage capital standards applicable to U.S. bank holding companies. The intermediate holding companies also will be subject to the Federal Reserve's rules requiring regular capital plans and stress tests. Although the final rule became effective June 1, 2014, the initial compliance date for foreign banking organizations is July 1, 2016 and generally defers application of the leverage ratio to foreign-owned U.S. intermediate holding companies until 2018.

Disclosures for Banks and Savings Institutions

17.28 Noncompliance with regulatory capital requirements could materially affect the economic resources of a bank or savings institution and claims to those resources, as stated in FASB ASC 942-505-50-1. Accordingly, at a minimum, the entity should disclose the following in the footnotes to the financial statements:

a.     A description of regulatory capital requirements for both of the following:

i.     Those for capital adequacy purposes

ii.     Those established by the prompt corrective action (PCA) provisions of Section 38 of the Federal Deposit Insurance Act (FDI Act)

b.     The actual or possible material effects of noncompliance with such requirements

c.     Whether the entity is in compliance with the regulatory capital requirements, including, as of each balance sheet date presented, the following with respect to quantitative measures:

i.     The entity's required and actual ratios and amounts of tier 1 leverage, tier 1 risk-based, and total risk-based capital, (for savings institutions) tangible capital, and (for certain banks and bank holding companies) tier 3 capital for market risk

ii.     Factors that may significantly affect capital adequacy such as potentially volatile components of capital, qualitative factors, and regulatory mandates

d.     As of each balance sheet date presented, the PCA category in which the entity was classified as of its most recent notification

e.     As of the most recent balance sheet date, whether management believes any conditions or events since notification have changed the institution's category

Noncompliance with regulatory capital requirements may, when considered with other factors, raise substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.

17.29 As stated in FASB ASC 942-505-50-1C, a bank or savings institution is (under federal regulations) deemed to be within a given capital category as of the most recent date of any of the following:

a.     The date the institution filed a regulatory financial report

b.     The date a final regulatory examination report is delivered to the institution

c.     The date the institution's primary regulator provides written notice of the entity's capital category or that the institution's capital category has changed

17.30 In accordance with FASB ASC 942-505-50-1A, disclosures should also be presented for any state-imposed capital requirements that are more stringent than or significantly different from federal requirements.

17.31 For “adequately capitalized” or “undercapitalized” institutions, the disclosure in item c in paragraph 17.28 should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the PCA framework and should include the effect of any supervisory action that has been imposed, as stated in FASB ASC 942-505-50-1B. The amounts disclosed under that paragraph may be presented in either narrative or tabular form. The percentages disclosed should be those applicable to the entity. Also, if the institution has been advised that it must meet capital adequacy levels that exceed the statutory minimums, those higher levels should be disclosed. Such institution-specific requirements also should be the basis for management's assertion in FASB ASC 942-505-50-1(c) (see item c in paragraph 17.28) about whether the institution is in compliance.

17.32 Paragraphs 1D–1E of FASB ASC 942-505-50 state that if, as of the most recent balance sheet date presented, the entity is (a) not in compliance with capital adequacy requirements, (b) considered less than adequately capitalized under the PCA provisions, or (c) both, the possible material effects of such conditions and events on amounts and disclosures in the financial statements should be disclosed.

17.33 The institution should consider also making such disclosures when one or more of the institution's actual ratios is nearing noncompliance or when capital adequacy restrictions are imposed by regulation. Capital ratios higher than those in the PCA provisions may be required by the federal banking agencies, either informally through a board resolution or memorandum of understanding or formally though a consent order or formal agreement. Elevated capital levels may be considered for disclosure based on the nature of the agreement and the potential impact on operations.

17.34 If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is alleviated as a result of consideration of management’s plans, FASB ASC 205-40-50-12 states that an entity should disclose in the footnotes information that enables users of the financial statements to understand all of the following (or refer to similar information disclosed elsewhere in the footnotes):

     Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern (before consideration of management’s plans)

     Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

     Management’s plans that alleviated substantial doubt about the entity’s ability to continue as a going concern

17.35 If, after considering management’s plans, substantial doubt about an entity’s ability to continue as a going concern is not alleviated, FASB ASC 205-40-50-13 states that an entity should include a statement in the footnotes indicating that there is substantial doubt about the entity’s ability to continue as a going concern within one year after the date that the financial statements are issued. Additionally, the entity should disclose information that enables users of the financial statements to understand all of the following:

     Principal conditions or events that raised substantial doubt about the entity’s ability to continue as a going concern

     Management’s evaluation of the significance of those conditions or events in relation to the entity’s ability to meet its obligations

     Management’s plans that are intended to mitigate the conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern

17.36 Additional information that might be disclosed in situations where there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time may include the following:

     Possible effects of such conditions and events giving rise to the assessment of substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time;

     Possible discontinuance of operations; and

     Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

17.37 FASB ASC 942-505-50-1F states that other regulatory limitations may exist despite compliance with minimum regulatory capital requirements. To the extent such limitations could materially affect the economic resources of the institution and claims to those resources, they should similarly be disclosed in the notes to the financial statements.

Disclosure for Holding Companies

17.38 FASB ASC 942-505-50-1G states that the disclosures required by paragraphs 1–1F of FASB ASC 942-505-50 should be presented for all significant subsidiaries of a holding company. Bank holding companies should also present the disclosures required by paragraphs 1–1F of FASB ASC 942-505-50 as they apply to the holding company, except for the PCA disclosure required by item (d) in FASB ASC 942-505-50-1. Savings institution holding companies are not subject to regulatory capital requirements separate from those of their subsidiaries. Bank holding companies are not subject to the PCA provisions of the FDI Act.

17.39 A bank holding company that is a financial holding company (FHC) should disclose the applicable regulatory requirements for maintaining its status as a FHC, including that each of its insured deposit taking subsidiaries must be well capitalized, well managed, and have at least a satisfactory Community Reinvestment Act rating. If the Federal Reserve were to find that any depository institution subsidiary owned or controlled by the bank holding company ceases to be well capitalized or well managed and such noncompliance is not subsequently corrected, the Federal Reserve could require the banking organization to cease its FHC related activities or divest its banking subsidiaries. Paragraph 1.19 of this guide and Section 3901.0.2, “Holding Company Fails to Continue Meeting Financial Holding Company Capital and Management Requirements,” of the Federal Reserve’s Bank Holding Company Supervision Manual provide additional guidance.

17.40 If a bank holding company is an FHC, the significant subsidiaries include all U.S. insured deposit taking subsidiaries.

Illustrative Disclosures for Banks and Savings Institutions

(The example disclosures that follow are for illustrative purposes only.)

17.41 Well capitalized. Following is an illustrative disclosure for an institution that is in compliance with capital adequacy requirements and considers itself well capitalized under the PCA framework. Comparative disclosures should be included for each balance sheet presented.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct material effect on the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table) of total, Tier 1 and common equity Tier 1 capital (as defined) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined).6 Management believes, as of December 31, 200X, that the Bank meets all capital adequacy requirements to which it is subject.

As of December 31, 200X, and December 31, 200W, the most recent notification from [institution's primary regulator] categorized the Bank as [well capitalized] under the regulatory framework for prompt corrective action. To be categorized as [well capitalized] the Bank must maintain minimum total risk-based, Tier 1 risk-based, common equity Tier 1 risk-based capital, and Tier 1 leverage ratios as set forth in the table.7 There are no conditions or events since that notification that management believes have changed the institution's category.

17.42 Adequately capitalized. Following is an illustrative paragraph to be added to the disclosures illustrated in paragraph 17.41 when an institution considers itself adequately capitalized:

Under the framework, the Bank's capital levels do not allow the Bank to accept brokered deposits without prior approval from regulators [describe the possible effects of this restriction].

17.43 Undercapitalized. Following are illustrative paragraphs to be added to the disclosures illustrated in paragraphs 17.41–.42 when an institution considers itself undercapitalized, significantly undercapitalized, or critically undercapitalized. For a discussion about the auditor's consideration of noncompliance, see discussion beginning in paragraph 5.222 of this guide.

The Bank may not issue dividends or make other capital distributions, and may not accept brokered or high rate deposits, as defined, due to the level of its risk-based capital. [Describe the possible effects of these restrictions.]

Under the regulatory framework for prompt corrective action, the Bank's capital status may preclude the Bank from access to borrowings from the Federal Reserve System through the discount window. [Describe the possible effects of these restrictions.] Also, as required by the framework, the Bank has a capital plan that has been filed with and accepted by the FDIC. The plan outlines the Bank's steps for attaining the required levels of regulatory capital. Management believes, at this time, that the Bank will meet all the provisions of the capital plan and all the regulatory capital requirements by December 31, 200Y (or earlier if stated in the capital plan). [The disclosure should continue with discussion of management plans such as reducing the size of the institution by converting noncash assets and reducing liabilities, issuing additional equity securities, or other plans for financial restructuring.]

17.44 Advanced approaches banks and savings institutions. Following is an illustrative table for presentation in financial statements for an advanced approaches bank or savings institution’s actual capital amounts and ratios as of the balance sheet date. All disclosures required by paragraphs 1–1F of FASB ASC 942-505-50 should be presented.

Actual For Capital Adequacy Purposes1, 2 To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 8.0% $X,XXX,XXX 10.0%
Tier 1 Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 6.0% $X,XXX,XXX 8.0%
Common Equity Tier 1 Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.5% $X,XXX,XXX 6.5%
Tier 1 Capital (to Average Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.0% $X,XXX,XXX 5.0%
Tier 1 Capital (to Total Leverage Exposure) $X,XXX,XXX X.X% $X,XXX,XXX 3.0% $X,XXX,XXX 6.0%
                                   

1 See paragraph 17.31.

2 For adequately capitalized or undercapitalized institutions, this column should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the prompt corrective action framework and should include the effect of any prompt corrective action capital directive.

17.45 Banks and savings institutions not subject to advanced approaches regulations. Following is an illustrative table for presentation in financial statements for a bank or saving institution’s actual capital amounts and ratios as of the balance sheet date. All disclosures required by paragraphs 1–1F of FASB ASC 942-505-50 should be presented.

Actual For Capital Adequacy Purposes1, 2 To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 8.0% $X,XXX,XXX 10.0%
Tier 1 Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 6.0% $X,XXX,XXX 8.0%
Common Equity Tier 1 Capital (to Risk Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.5% $X,XXX,XXX 6.5%
Tier 1 Capital (to Average Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.0% $X,XXX,XXX 5.0%
                                   

1 See paragraph 17.31.

2 For adequately capitalized or undercapitalized institutions, this column should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the prompt corrective action framework and should include the effect of any prompt corrective action capital directive.

17.46 Holding companies. Following is an illustrative table for presentation in consolidated financial statements for a bank (or savings and loan association) holding company and each significant subsidiary as of the balance sheet date.8 Tier 3 capital market risk requirements are required to be disclosed only for certain banks and bank holding companies. All disclosures required by paragraphs 1–1F of FASB ASC 942-505-50 should be presented except item (d) disclosures in FASB ASC 942-505-50-1 related to PCA.

Actual For Capital Adequacy Purposes 1, 2 To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Risk Weighted Assets):
Consolidated $X,XXX,XXX X.X% $X,XXX,XXX X.X% N/A
Subsidiary Bank A $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank B $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank C $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Tier 1 Capital (to Risk Weighted Assets):
Consolidated $X,XXX,XXX X.X% $X,XXX,XXX X.X% N/A
Subsidiary Bank A $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank B $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank C $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Common Equity Tier 1 Capital (to Risk Weighted Assets):
Consolidated $X,XXX,XXX X.X% $X,XXX,XXX X.X% N/A
Subsidiary Bank A $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank B $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank C $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Tier 1 Capital (to Average Assets):
Consolidated $X,XXX,XXX X.X% $X,XXX,XXX X.X% N/A
Subsidiary Bank A $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank B $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
Subsidiary Bank C $X,XXX,XXX X.X% $X,XXX,XXX X.X% $X,XXX,XXX X.X%
                                   

1 See paragraph 17.31.

2 For adequately capitalized or undercapitalized institutions, this column should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the prompt corrective action framework and should include the effect of any prompt corrective action capital directive.

Credit Unions

Introduction

17.47 Credit unions operate under a cooperative form of ownership. Members, in effect, “own” the credit union, although their interests in the credit union (that is, their shares) have the characteristics of deposits. Although the equity section of a credit union's statement of financial condition generally consists of retained earnings and accumulated other comprehensive income, GAAP requires other items to be classified as equity. As GAAP evolves, other items may also be included in members' equity. Retained earnings includes statutory reserves, undivided earnings, and other appropriations as designated by management or regulatory authorities. Although credit unions may be incorporated, no stock is issued. Retained earnings is generally shown as a single line item in the statement of financial condition. The components of retained earnings may be presented in the body of the statement of financial condition, the notes to the financial statements, or the statement of retained earnings. All appropriations and other restrictions of retained earnings should be disclosed.

Members’ Equity

17.48 Regular reserve (statutory reserve). The Federal Credit Union Act and certain states require that a regular (or statutory) reserve be established and maintained to provide a restriction on undivided earnings. At one time, the regular (or statutory) reserve was used to record charged-off loans and its funding was based on a periodic (typically quarterly) charge to undivided earnings and a credit to the reserve account. For federal credit unions, the amount currently required to be transferred, if any, is defined in Sections 702.201 and 702.303 of the National Credit Union Administration (NCUA) regulations. The PCA rules describe the mandatory and discretionary PCAs that a credit union is subject to in cases where the credit union’s capital level is below the well capitalized level, or the credit union fails to meet its required risk-based net worth requirement (RBNWR), or the credit union is subject to regulatory restrictions because of activities that are judged by the NCUA to be unsafe and unsound. In cases relating to inadequate capital with respect to the net worth requirement or the RBNWR, a credit union is generally required to increase its net worth by the equivalent of at least 0.1 percent of assets each quarter until the credit union is classified as well capitalized.

17.49 Certain states may have adopted similar regulations that apply to state chartered credit unions. The statutes for each state should be consulted for applicable requirements.

17.50 Undivided earnings. Undivided earnings represent unappropriated accumulated earnings or losses of the credit union since its inception. The undivided earnings may also be increased or decreased as a result of transfers to or from appropriated accounts such as the regular reserve or appropriated undivided earnings.

17.51 Appropriated undivided earnings. The board of directors of a credit union may restrict or appropriate portions of undivided earnings for specific purposes in accordance with paragraphs 3–4 of FASB ASC 505-10-45. Examples may include appropriations for loss contingencies and for major expenditures. The amount of such appropriations is normally transferred from undivided earnings, pending resolution of its purpose. Amounts appropriated may be returned to undivided earnings when they are no longer deemed necessary.

17.52 Federally insured state chartered credit unions are required under terms of the insurance agreement to establish an investment valuation reserve, displayed as an equity classification, for held-to-maturity nonconforming investments. Nonconforming investments are those investments permissible under state law for a state chartered credit union, but which are impermissible for federally chartered credit unions.

17.53 Other components of equity. GAAP provides guidance for other items that should be classified as equity (for example, equity acquired in a combination arising from a mutual to mutual acquisition in which no purchase price is paid).

17.54 In accordance with FASB ASC 220-10-45-14, the total of other comprehensive income for a period should be transferred to a component of equity that is presented separately from retained earnings and additional paid-in capital in a statement of financial position at the end of an accounting period. See FASB ASC 220-10-45-10A and paragraph 17.09 for examples of items required to be reported as other comprehensive income.

New Credit Unions and Low Income Designated Credit Unions

17.55 The PCA regulations for credit unions designated as new are different than for other natural person credit unions. According to regulations, to be designated as new a credit union must have been in existence for less than 10 years and have $10 million or less in total assets. For credit unions designated as low income by the NCUA, the net worth calculation includes certain uninsured, secondary capital accounts (as defined in the regulations).10

Disclosures for Natural Person Credit Unions

17.56 FASB ASC 942-505-50-1H states noncompliance with regulatory capital requirements could materially affect the economic resources of a credit union and claims to those resources. Accordingly, at a minimum, a credit union within the scope of FASB ASC 942-10-15-2 should disclose all of the following in notes to financial statements:

a.     A description of regulatory capital requirements (a) for capital adequacy purposes and (b) for PCA

b.     The actual or possible material effects of noncompliance with such requirements

c.     Whether the entity is in compliance with the regulatory capital requirements, including, as of each balance sheet date presented, the following with respect to quantitative measures:

i.     Whether the institution meets the definition of a complex credit union as defined by the NCUA

ii.     The institution's required and actual capital ratios and required and actual capital amounts

iii.     Factors that may significantly affect capital adequacy such as potentially volatile components of capital, qualitative factors, and regulatory mandates

d.     As of each balance sheet date presented, the PCA category in which the institution was classified

e.     If, as of the most recent balance sheet date or date financial statements are issued or are available to be issued (as discussed in FASB ASC 855-10-25), the institution is not in compliance with capital adequacy requirements, the possible material effects of such conditions on amounts and disclosures in the financial statements

f.     Whether subsequent to the balance sheet date and before the financial statements are issued or are available to be issued (as discussed in FASB ASC 855-10-25), management believes any events or changes have occurred to change the institution’s PCA category

Noncompliance with regulatory capital requirements may, when considered with other factors, raise substantial doubt about a credit union’s ability to continue as a going concern for a reasonable period of time.

17.57 The institution should consider also making such disclosures, as discussed in the preceding paragraph, when the institution's actual ratio is nearing noncompliance.

17.58 See paragraphs 17.34–.35 for required going concern disclosure guidance. Additional information that might be disclosed in situations where there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time may include the following:

     Possible effects of such conditions and events giving rise to the assessment of substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time

     Possible discontinuance of operations

     Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

17.59 Disclosures should also be presented for any state-imposed capital requirements that are more stringent than or significantly different from federal requirements, in accordance with FASB ASC 942-505-50-2.

17.60 The NCUA board adopted PCA rules in response to the Credit Union Membership Access Act requirement that the NCUA adopt a system to restore the net worth of inadequately capitalized federally insured credit unions. In conjunction with the adopted PCA rule, the NCUA board also issued a rule, which defines a complex credit union and establishes RBNWRs. Readers should refer to the NCUA regulations for the risk-based net worth and PCA requirements.

Illustrative Disclosures for Natural Person Credit Unions

17.61 Well capitalized. The example disclosures that follow are for illustrative purposes only. Following is an illustrative disclosure for an institution that is in compliance with capital adequacy requirements and considers itself well capitalized under the PCA framework. Comparative disclosures should be included for each balance sheet presented.

The Credit Union is subject to various regulatory capital requirements administered by the NCUA. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct material effect on the Credit Union's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Credit Union must meet specific capital guidelines that involve quantitative measures of the Credit Union's assets, liabilities, and certain off-balance-sheet items as calculated under U.S. GAAP, regulatory reporting requirements, and regulatory capital standards. The Credit Union's capital amounts and net worth classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Credit Union to maintain minimum amounts and ratios (set forth in the following table) of net worth (as defined) to total assets (as defined). Credit unions are also required to calculate a RBNWR which establishes whether or not the Credit Union will be considered “complex” under the regulatory framework. The Credit Union’s RBNW ratio as of December 31, 200X was ___ percent. The minimum ratio to be considered complex under the regulatory framework is 6 percent. Management believes, as of December 31, 200X, that the Credit Union meets all capital adequacy requirements to which it is subject.

As of December 31, 200X, the most recent call reporting period, the NCUA categorized the Credit Union as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized the Credit Union must maintain a minimum net worth ratio of 7 percent of assets.11 There are no conditions or events since that notification that management believes have changed the institution's category.

The Credit Union’s actual capital amounts and ratios are also presented in the table.

Actual To Be Adequately Capitalized Under Prompt Corrective Action Provisions1 To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Net worth $2,000,000 7.5% $1,600,000 6.0% $1,800,000 7.0%
Risk-Based Net Worth Requirement $1,700,000 6.5% N/A N/A N/A N/A
                                   

1 For adequately capitalized or undercapitalized institutions, this column should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the prompt corrective action framework and should include the effect of any mandatory or discretionary supervisory actions.

Because the RBNWR, 6.5 percent, is less than the net worth ratio, 7.5 percent, the Credit Union retains its original category. Further, in performing its calculation of total assets, the Credit Union used the [select one: average of the quarter-end balances of the four most recent quarters, monthly average over the quarter, daily average over the quarter, or quarter-end balance] option, as permitted by regulation.

17.62 Adequately capitalized. Following is an illustrative paragraph to be added in place of the third illustrative paragraph in paragraph 17.61 for an institution that is in compliance with capital adequacy requirements and considers itself adequately capitalized under the PCA framework:

As of December 31, 200X, and December 31, 200W, the most recent call reporting period, the NCUA categorized the Credit Union as adequately capitalized under the regulatory framework for prompt corrective action. To be categorized as adequately capitalized the Credit Union must maintain a minimum net worth ratio of 6 percent of assets and, if applicable, must maintain adequate net worth to meet the Credit Union’s RBNWR of X percent as set forth in the table.12 As an adequately capitalized credit union, the NCUA’s prompt corrective action regulations require that the Credit Union increase its net worth quarterly by an amount equivalent to at least 0.1 percent of its total assets for the current quarter, and must transfer that amount (or more by choice) from undivided earnings to its regular reserve account until it is well capitalized, while continuing to meet its RBNWR. There are no conditions or events since that filing date that management believes have changed the institution's category.

17.63 Undercapitalized. Following are illustrative paragraphs to be added to the disclosures illustrated in paragraph 17.61 when a credit union considers itself undercapitalized, significantly undercapitalized, or critically undercapitalized [for existing credit unions].

The Credit Union may not increase assets and must restrict member business loans due to its net worth. [Describe the possible effects of these restrictions.] Under the regulatory framework for prompt corrective action, the Credit Union has a net worth restoration plan that has been filed with and accepted by the NCUA. The plan outlines the Credit Union's steps for attaining the required levels of net worth. Management believes, at this time, that the Credit Union will implement the steps and meet all the provisions of the plan and all the regulatory net worth requirements by December 31, 200Y (or earlier if stated in the restoration plan). [The disclosure should continue with discussion of any discretionary actions required by the NCUA.]

17.64 New credit unions. Following are illustrative paragraphs to be added to the disclosures illustrated in paragraph 17.61 when a new credit union considers itself moderately capitalized, marginally capitalized, minimally capitalized, or uncapitalized.

The Credit Union must restrict member business loans due to its net worth. [Describe the possible effects of these restrictions.] Under the regulatory framework for prompt corrective action, a revised business plan has been filed, as required, with and accepted by the NCUA. The plan outlines the Credit Union's steps for attaining the required levels of net worth. Management believes, at this time, that the Credit Union will implement the steps and meet all the provisions of the plan and all the regulatory net worth requirements by December 31, 200Y (or earlier if stated in the revised business plan). [The disclosure should continue with discussion of any discretionary actions required by the NCUA.]

Corporate Credit Unions

Introduction

17.65 Corporate credit unions operate under a cooperative form of ownership similar to natural person credit unions. Corporate credit unions are established to serve the financial needs of natural person credit unions that join the corporate. Although, the equity section of a corporate credit union's statement of financial condition generally consists of paid-in capital, retained earnings and accumulated other comprehensive income, GAAP requires other items to be classified as equity.13 As GAAP evolves, other items may also be included in members' equity. Retained earnings include all forms of retained earnings such as regular or statutory reserves and undivided earnings. Although some corporate credit unions may be incorporated under state laws, no stock is issued.

Equity

17.66 Nonperpetual capital.14 Corporate credit unions are different from natural person credit unions in that they have specific nonperpetual capital accounts (NCAs). NCAs, as defined in 12 CFR 704.2, are funds contributed by members or nonmembers that (a) are term certificates with an original minimum term of five years or that have an indefinite term (that is, no maturity) with a minimum withdrawal notice of five years, (b) are available to cover losses that exceed retained earnings and perpetual contributed capital (PCC), (c) are not insured by the National Credit Union Share Insurance Fund (NCUSIF) or other share or deposit insurers, and (d) cannot be pledged against borrowings. In the event the corporate credit union is liquidated, the holders of NCAs will claim equally. These claims will be subordinate to all other claims (including NCUSIF claims), except that any claims by the holders of PCC will be subordinate to the claims of holders of NCAs.

17.67 PCC. PCC, as defined in 12 CFR 704.2, means accounts or other interests of a corporate credit union that are perpetual, noncumulative dividend accounts; are available to cover losses that exceed retained earnings; are not insured by the NCUSIF or other share or deposit insurers; and cannot be pledged against borrowings. In the event the corporate is liquidated, any claims made by the holders of PCC will be subordinate to all other claims (including NCUSIF claims). These funds are callable only if the corporate credit union meets its minimum required capital and net economic value ratios after the funds are called and only with the prior approval of the NCUA and, for state chartered corporate credit unions, the applicable state regulator. They are callable on a pro-rata basis across an issuance class.15 A corporate credit union may issue PCC to both members and nonmembers.16,17

17.68 Reserves and undivided earnings. Reserves and undivided earnings represent unappropriated accumulated earnings or losses of the corporate credit union since its inception. The accounting treatment of transactions in undivided earnings of a credit union is similar to that of transactions in retained earnings of corporate entities. Corporate credit unions must maintain at all times (a) a leverage ratio18 of 4.0 percent or greater; (b) a tier 1 risk-based capital ratio19 of 4.0 percent or greater; and (c) a total risk-based capital ratio20 of 8.0 percent or greater. To ensure it meets its capital requirements, a corporate credit union must develop and ensure implementation of written short and long term capital goals, objectives, and strategies that provide for the building of capital consistent with regulatory requirements, the maintenance of sufficient capital to support the risk exposures that may arise from current and projected activities, and the periodic review and reassessment of the capital position of the corporate credit union.21

17.69 When significant circumstances or events warrant, 12 CFR 704.3(d) notes that the NCUA may establish increased minimum capital requirements, including modification of the minimum capital requirements related to being either significantly and critically undercapitalized for purposes of 12 CFR 704.4, upon a determination that the corporate credit union’s capital is or may become inadequate in view of the credit union’s circumstances. Examples of when higher capital levels may be appropriate can be found in 12 CFR 704.3(d)(2).

17.70 Other components of equity. GAAP provides guidance for other items that should be classified as equity.

17.71 In accordance with FASB ASC 220 10-45-14, the total of other comprehensive income for a period should be transferred to a component of equity that is presented separately from retained earnings and additional paid-in capital in a statement of financial position at the end of an accounting period. See FASB ASC 220-10-45-10A and paragraph 17.09 for examples of items required to be reported as other comprehensive income.

Disclosures for Corporate Credit Unions

17.72 FASB ASC 942-505-50-1H states that noncompliance with regulatory capital requirements could materially affect the economic resources of a credit union and claims to those resources. Accordingly, at a minimum, a corporate credit union within the scope of FASB ASC 942-10-15-2 should disclose all of the following in the notes to the financial statements:

a.     A description of regulatory capital requirements (a) for capital adequacy purposes and (b) for PCA

b.     The actual or possible material effects of noncompliance with such requirements

c.     Whether the entity is in compliance with the regulatory capital requirements, including, as of each balance sheet date presented, all of the following with respect to quantitative measures:

i.     Whether the institution meets the definition of a complex credit union as defined by the NCUA

ii.     The institution's required and actual capital ratios and required and actual capital amounts

iii.     Factors that may significantly affect capital adequacy such as potentially volatile components of capital, qualitative factors, and regulatory mandates

d.     As of each balance sheet date presented, the PCA category in which the institution was classified

e.     If, as of the most recent balance sheet date or date financial statements are issued or are available to be issued (as discussed in FASB ASC 855-10-25), the institution is not in compliance with capital adequacy requirements, the possible material effects of such conditions on amounts and disclosures in the financial statements

f.     Whether subsequent to the balance sheet date and prior financial statements are issued or are available to be issued (as discussed in FASB ASC 855-10-25), management believes any events or changes have occurred to change the institution’s PCA category

17.73 FASB ASC 942-505-50-1H also states that noncompliance with regulatory capital requirements may, when considered with other factors, raise substantial doubt about the credit union’s ability to continue as a going concern for a reasonable period of time. See paragraphs 17.34–.35 for required going concern disclosure guidance.

17.74 Disclosures should also be presented for any state-imposed capital requirements that are more stringent than or significantly differ from federal requirements, in accordance with FASB ASC 942-505-50-2.

17.75 Additional information that might be disclosed in situations where there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time may include the following:

     Possible effects of such conditions and events giving rise to the assessment of substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time

     Possible discontinuance of operations

     Information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities

17.76 Effective October 20, 2011, the NCUA adopted PCA requirements for corporate credit unions. The purpose of 12 CFR 704.4 is to define, for corporate credit unions that are not adequately capitalized, the capital measures and capital levels that are used for determining appropriate supervisory actions. It also establishes procedures for the submission and review of capital restoration plans and the issuance and review of capital directives, orders, and other supervisory directives.

Illustrative Disclosures for Corporate Credit Unions

17.77 Well capitalized. The example disclosures that follow are for illustrative purposes only. Following is an illustrative disclosure for a corporate credit union that is in compliance with capital adequacy requirements and is considered well capitalized under the PCA framework. Comparative disclosures should be included for each balance sheet presented.

The Corporate Credit Union is subject to various regulatory capital requirements administered by the NCUA. Failure to meet minimum capital requirements can initiate certain mandatory — and possibly additional discretionary — actions by regulators that, if undertaken, could have a direct material effect on the Corporate Credit Union’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporate Credit Union must meet specific capital guidelines that involve quantitative measures of the Corporate Credit Union's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory reporting requirements. The Credit Union's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulatory capital standards to ensure capital adequacy require the Corporate Credit Union to maintain minimum amounts and ratios (set forth in the following table) of total and Tier 1 capital (as defined) to moving monthly average net risk-weighted assets (as defined) and total capital to moving daily average net assets (as defined). Management believes, as of December 31, 200X, that the Corporate Credit Union meets all capital adequacy requirements to which it is subject.

As of December 31, 200X, the most recent call reporting period, the NCUA categorized the Corporate Credit Union as [well capitalized] under the regulatory framework for prompt corrective action. To be categorized as [well capitalized] the Corporate Credit Union must maintain a minimum total risk-based, Tier 1 risk-based, and leverage ratios as set forth in the table.22 There are no conditions or events since that notification that management believes have changed the Corporate Credit Union’s category.

The Corporate Credit Union’s actual capital amounts and ratios are also presented in the table.

Actual To Be Adequately Capitalized Under Prompt Corrective Action Provisions1 To Be Well Capitalized Under Prompt Corrective Action Provisions
Amount Ratio Amount Ratio Amount Ratio
Total Capital (to Moving Monthly Average Net Risk-Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 8.0% $X,XXX,XXX 10.0%
Tier 1 Risk-Based Capital (to Moving Monthly Average Net Risk-Weighted Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.0% $X,XXX,XXX 6.0%
Total Capital (to Moving Daily Average Net Assets) $X,XXX,XXX X.X% $X,XXX,XXX 4.0% $X,XXX,XXX 5.0%
                                   

1 For adequately capitalized or undercapitalized institutions, this column should present the minimum amounts and ratios the institution must have to be categorized as adequately capitalized under the prompt corrective action framework and should include the effect of any mandatory or discretionary supervisory actions.

17.78 Adequately capitalized. The following is an illustrative paragraph to be added in place of the third illustrative paragraph in paragraph 17.77 for a corporate credit union that is in compliance with capital adequacy requirements and is considered adequately capitalized under the PCA framework.

As of December 31, 200X, the most recent call reporting period, the NCUA categorized the Corporate Credit Union as [adequately capitalized] under the regulatory framework for prompt corrective action. To be categorized as [adequately capitalized] the Corporate Credit Union must maintain a minimum total risk-based, Tier 1 risk-based, and leverage ratios as set forth in the table.23 There are no conditions or events since that notification that management believes have changed the Corporate Credit Union’s category.

17.79 Undercapitalized. The following is an illustrative paragraph to be added to the disclosures illustrated in paragraph 17.77 when a corporate credit union is considered undercapitalized, significantly undercapitalized, or critically undercapitalized.

The Corporate Credit Union may not increase its daily average net assets during any calendar month to exceed its moving daily average net assets.24 In addition, the Corporate Credit Union is prohibited from making any capital distribution, including payment of dividends on perpetual and nonperpetual capital accounts while the Corporate Credit Union is undercapitalized. [Describe the possible effects of these restrictions.] Also, as required by the framework, the Corporate Credit Union has a capital restoration plan that has been filed and accepted by the NCUA. The plan outlines the Corporate Credit Union’s steps for attaining the required levels of regulatory capital. Management believes, at this time, that the Corporate Credit Union will meet all the provisions of the capital plan and all the regulatory capital requirements by December 31, 200Y (or earlier if stated in the capital plan) [The disclosure should continue with discussion of any discretionary actions required by the NCUA.]

Mortgage Companies and Mortgage Banking Activities

Introduction

17.80 Mortgage companies are organized with capital stock and shareholders. Mortgage banking activities primarily consist of two separate but interrelated activities: (1) the origination or acquisition of mortgage loans for the purpose of selling those loans to permanent investors in the secondary market, and (2) the subsequent long term servicing of those loans. Mortgage loans are acquired for sale to permanent investors from a variety of sources, including in-house origination and purchases from third party correspondents. Certain common requirements are discussed in chapter 4 of this guide. For example, to participate in the Federal Housing Administration mortgage insurance program, a mortgage lender must obtain, U.S. Department of Housing and Urban Development (HUD) approval by meeting various requirements prescribed by HUD, including maintaining minimum net worth requirements. Net worth requirements vary depending on the program. To obtain approval to sell and service mortgage loans for Federal National Mortgage Association (Fannie Mae) or Federal Home Loan Mortgage Corporation (Freddie Mac), a mortgage lender must meet various federal requirements including maintaining an acceptable net worth.

Disclosure for Mortgage Companies and Mortgage Banking Activities

17.81 FASB ASC 948-10-50-3 states that noncompliance with minimum net worth (capital) requirements imposed by secondary market investors or state imposed regulatory mandates could materially affect the economic resources of a mortgage banking entity and claims to those resources. To the extent an entity is subject to such requirements, the entity should disclose all of the following in the notes to the financial statements:

a.     A description of the minimum net worth requirements related to the following:

i.     Secondary market investors

ii.     State imposed regulatory mandates

b.     The actual or possible material effects of noncompliance with those requirements

c.     Whether the entity is in compliance with the regulatory capital requirements, including, as of each balance sheet date presented, the following with respect to quantitative measures:

i.     The entity’s required and actual net worth amounts

ii.     Factors that may significantly affect adequacy of net worth such as potentially volatile components of capital, qualitative factors, or regulatory mandates

d.     If, as of the most recent balance sheet date, the entity is not in compliance with capital adequacy requirements, the possible material effects of such conditions on amounts and disclosures in the notes to the financial statements

17.82 Further, FASB ASC 948-10-50-4 states that noncompliance with minimum net worth requirements may, when considered with other factors, raise substantial doubt about an entity’s ability to continue as a going concern for a reasonable period of time. See paragraphs 17.34–.35 for required going concern disclosure guidance. Additional information that might be disclosed in situations where there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time may include

     possible effects of such conditions and events giving rise to the assessment of substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.

     possible discontinuance of operations.

     information about the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities.

17.83 FASB ASC 948-10-50-5 states that servicers with net worth requirements from multiple sources should disclose, in the notes to the financial statements, the net worth requirement of the following:

a.     Significant servicing covenants with secondary market investors with commonly defined servicing requirements (common secondary market investors include the HUD, Fannie Mae, Government National Mortgage Association, and Freddie Mac)

b.     Any other secondary market investor where violation of the requirement would have a significant adverse effect on the business

c.     The most restrictive third-party agreement if not previously included

Illustrative Disclosures for Mortgage Companies and Mortgage Banking Activities

17.84 The disclosures that follow are for illustrative purposes only, and represent a mortgage company that is in compliance with capital adequacy requirements. Comparative disclosures should be included for each balance sheet presented.

The Company is subject to various capital requirements in connection with seller-servicer agreements that the Company has entered into with secondary market investors. Failure to maintain minimum capital requirements could result in the Company’s inability to originate and service loans for the respective investor and, therefore, could have a direct material effect on the Company’s financial statements. Management believes, as of December 31, 200X and 200W, that the Company met all capital requirements to which it is subject.

The Company’s actual capital amounts and the minimum amounts required for capital adequacy purposes, by investor, are as follows:

Actual Capital Minimum Capital Requirement
As of December 31, 200X:
HUD $X,XXX,XXX $XXX,XXX
FHLMC $X,XXX,XXX $ XX,XXX
FNMA $X,XXX,XXX $ XX,XXX

Regulatory Capital Matters for All Entities

Regulatory Capital Disclosures for Branches of Foreign Institutions

17.85 The disclosure requirements related to capital adequacy and PCA do not apply to branches of foreign organizations because such branches do not have capital. See discussion of enhanced prudential standards for foreign banking organizations discussed in paragraph 17.27.

17.86 Paragraphs 3–4 of FASB ASC 942-505-50 state that branches of foreign financial institutions, although they do not have regulatory capital requirements, may be required to maintain capital-equivalent deposits and, depending on facts and circumstances, supervisory mandated reserves. These requirements carry regulatory uncertainty of a nature similar to that posed by the regulatory capital rules in that failure to meet such mandates can result in supervisory action and ultimately going-concern questions. Accordingly, branches should disclose such requirements. Quantitative disclosure should be made, highlighting mandated deposit or reserve requirements and actual balances in those reserve or deposit accounts at the balance sheet date(s) reported. Further, if an uncertainty exists related to a parent that creates a higher than normal risk as to the viability of a branch or subsidiary, then that matter should be adequately disclosed in the notes to the financial statements of the branch or subsidiary. If factors do not exist that indicate a higher than normal amount of risk or uncertainty regarding parent capital and other regulatory matters, then disclosures of capital and supervisory issues of the parent would not be required.

Regulatory Capital Disclosures for Trust Operations

17.87 Trust banks are required by certain federal regulators to hold capital as a percentage of discretionary and nondiscretionary assets under management. The percentages vary for each category. The percentages are not standardized as with other capital requirements and are communicated on an entity by entity basis in the application to obtain a trust charter or by other supervisory processes. Depending on the type of charter, these entities may be subject to risk-based standards as well. Because these are not published requirements, these guidelines are applied on a discretionary basis by the agencies and may not be uniformly applied to all entities.

17.88 FASB ASC 942-505-50-5 states that if an institution is subject to capital requirements based on trust assets under management, a discussion of the existence of these requirements, ramifications of failure to meet them, and a measurement of the entity’s position relative to imposed requirements should be disclosed in the notes to the financial statements.

Auditing25

Banks, Savings Institutions, and Credit Unions

Objectives

17.89 In addition to testing of disclosures, as discussed subsequently, the auditor should consider the implications of capital noncompliance, as discussed in chapter 5, “Audit Considerations and Certain Financial Reporting Matters,” and chapter 23, “Reporting Considerations,” of this guide.

17.90 In addition to the normal objectives sought in auditing equity (for example balances are presented in accordance with GAAP), the auditor's objective in this area is to obtain reasonable assurance that the financial statements include proper and understandable description and disclosure of regulatory matters (as discussed earlier in this chapter) in the context of the financial statements taken as a whole. Similarly, the audit objective for regulatory capital matters relates primarily to disclosure.26 Capital amounts are determined under GAAP, regulatory reporting requirements, and regulatory capital standards.

17.91 An auditor’s report on financial statements containing the required regulatory capital disclosures does not constitute an opinion on the fair presentation of the institution’s regulatory reports (in part or taken as a whole) in accordance with underlying instructions for such reports. Nor does the opinion indicate that the auditor has confirmed with any regulatory agency that the agency has examined or otherwise evaluated or opined on the fair presentation of such reports.

Planning

17.92 In accordance with AU-C section 315, Understanding the Entity and Its Environment and Assessing the Risks of Material Misstatement,27 the objective of the auditor is to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels through understanding the entity and its environment, including the entity’s internal control, thereby providing a basis for designing and implementing responses to the assessed risks of material misstatement (see chapter 5 of this guide for additional information). In complying with the requirements of AU-C section 315, auditors should obtain an understanding of capital regulations sufficient to understand application and classification decisions made by management. In addition, the auditor should obtain audit evidence about the changes in regulatory reporting instructions and related capital requirements since the preceding audit. AU-C section 500, Audit Evidence, explains what constitutes audit evidence in an audit of financial statements and addresses the auditor’s responsibility to design and perform audit procedures to obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion (further discussion on AU-C section 500 can be found in chapter 5 of this guide).

17.93 Paragraphs 5.233–.238 of this guide discuss the auditor's responsibility relative to review of supervisory reports and coordination with examiners.

17.94 While planning and carrying out procedures in other audit areas, the auditor should consider the regulatory reporting requirements and regulatory capital standards that affect the risk weighting of assets resulting from the institution's transactions. This information will help the auditor assess (a) the regulatory interpretations and reporting requirements that provide guidance consistent with GAAP in greater detail, (b) GAAP equity amounts adjusted in calculating regulatory capital amounts (for example, tier 1 capital and tier 2 capital), and (c) GAAP asset amounts and off-balance-sheet amounts risk weighted for regulatory capital purposes. The information will also be useful for performing any procedures applied to such adjustments (including consideration of the relative risk weightings assigned to certain amounts or transactions).

17.95 As a part of understanding the entity and its environment, paragraph .12 of AU-C section 315 states that the auditor should obtain an understanding of relevant industry, regulatory, and other external factors, including the applicable financial reporting framework. In this regard, some components of regulatory capital ratios, including related amounts, asset measures, and risk weightings, may be difficult to determine due to (a) the complexity and subjectivity of capital standards and related regulatory reporting requirements or (b) the complexity of the institution's transactions. The number and variety of adjustments between GAAP and regulatory capital amounts affecting the institution also will affect inherent risk in this area.

17.96 Management's regulatory financial reporting classification and risk weighting decisions involve a high degree of subjective analysis by management and might be challenged by examiners. Accordingly, such decisions that could have a material impact on regulatory disclosures should be carefully considered by the auditor.

17.97 The following are examples of factors related to regulatory matters that may indicate higher risks of material misstatement:

     A high volume or high degree of complexity of off-balance-sheet transactions

     Actual or borderline noncompliance with minimum capital requirements

     A poor regulatory rating

     Past disagreements between management and regulators about classifications, risk weightings, other regulatory reporting requirements, or application of regulatory capital standards in general

     Frequent corrections to filed regulatory reports

     Regulatory restrictions or other regulatory actions taken related to capital compliance (for example, the federal banking agencies may issue informal enforcement actions such as a memorandum of understanding or commitment letter)

     Unusual, material, or frequent related party transactions

     Capital calculations, including management's classification or risk weighting decisions, that are not well documented

Internal Control Over Financial Reporting

17.98 AU-C section 315 addresses the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements through understanding the entity and its environment, including the entity’s internal control. Paragraphs .13–.14 of AU-C section 315 state that the auditor should obtain an understanding of internal control relevant to the audit and, in doing so, should evaluate the design of those controls and determine whether they have been implemented by performing procedures in addition to inquiry of the entity’s personnel. (See chapter 5 of this guide for further discussion of the components of internal control.) To provide a basis for designing and performing further audit procedures, paragraph .26 of AU-C section 315 states that the auditor should identify and assess the risks of material misstatement at the financial statement level and the relevant assertion level for classes of transactions, account balances, and disclosures.

17.99 Effective internal control over financial reporting in this area should provide reasonable assurance that errors or fraud in financial statement disclosures about regulatory matters are prevented or detected. In part, these controls may overlap with controls the institution has established for compliance with capital requirements. Institutions' systems for gathering the necessary information and preparing regulatory financial reports vary in sophistication. Examples of factors that may contribute to effective internal control in this area include the following:

     Responsibilities for capital planning, monitoring compliance with capital laws and regulations, and preparation of Call Reports have been assigned to competent individuals in the institution.

     Regulatory financial reporting is subject to risk assessment and supervisory control procedures and is overseen by officers of the institution who review the details supporting classifications and risk weightings.

     Capital amounts reported to regulators are reconciled to underlying detailed schedules and subsidiary ledgers with reconciling items supported by appropriate computations and documentation and with appropriate supervisory review and oversight.

     Procedures are in place for collection and reporting by branches, divisions, and subsidiaries of amounts necessary for regulatory capital calculations.

     Management obtains competent outside advice, as warranted, on significant classification or risk weighting questions before and after major transactions are executed.

     Regulatory capital analyses, calculations, and supporting documentation are well prepared and readily accessible.

     The regulatory financial reporting process (including classifications and risk weightings) is reviewed periodically by the internal audit function.

Substantive Procedures

17.100 Irrespective of the assessed risks of material misstatement, paragraph .18 of AU-C section 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained, states that the auditor should design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure. In accordance with paragraph .A45 of AU-C section 330, this requirement reflects the facts that (a) the auditor’s assessment of risk is judgmental and may not identify all risks of material misstatement and (b) inherent limitations to internal control exist, including management override.

17.101 The extent to which the auditor applies tests to specific transactions or amounts will depend on the auditor's assessment of the risks of material misstatement and the materiality of the accounts. Where the risks of material misstatement are assessed at lower levels, the auditor may consider testing a reconciliation of differences between GAAP as applied in the financial statements versus GAAP as applied in regulatory reports (if management chose to use an option available under GAAP for financial statement purposes that is different than the regulatory interpretation of GAAP for regulatory reporting purposes) before year-end, reviewing classifications made for risk weighting purposes, reviewing examination findings, and testing material differences, risk weighting classifications, and ratio calculations in preparation for any substantive tests to be applied to disclosures of year-end amounts and ratios.

17.102 Satisfaction that regular reserve transfers are in compliance with regulatory requirements is necessary when conducting a credit union engagement. To gain such satisfaction, the auditor should obtain an understanding of the applicable federal and state laws and regulations. Other entries, including direct charges and credits in accordance with regulatory requirements, should be tested for propriety. Other appropriations of net “retained earnings” should be traced to authorization by the board of directors. Certain changes to the regular reserve are subject to regulatory approval and the auditor should be familiar with these requirements.

17.103 Paragraphs 5.233–.238 of this guide discuss the auditor's responsibility relative to review of supervisory reports and coordination with examiners. Such review and coordination should involve consideration of the adequacy of the financial statement disclosures in this area.

17.104 Paragraphs .A46–.A50 of AU-C section 330 provide additional guidance on the nature and extent of substantive procedures. Depending on the circumstances, the auditor may determine that performing only substantive analytical procedures will be sufficient to reduce audit risk to an acceptably low level (for example, when the auditor’s assessment of risk is supported by audit evidence from tests of controls), only tests of details are appropriate, or a combination of substantive analytical procedures and tests of details are most responsible to the assessed risks. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The nature of the risk and assertion is relevant to the design of tests of details.

17.105 Substantive audit procedures might include the following:

     Obtain and test management's schedules supporting calculation of the institution's actual and required regulatory capital ratios, including regulatory capital amounts (ratio numerators) and related asset bases (ratio denominators).

     Review and evaluate management's analyses of significant nonrecurring transactions and their impact on regulatory capital.

     Inquire about, and discuss with officers having responsibility for regulatory financial reporting, the existence and nature of any differences between GAAP as applied in the financial statements versus GAAP as applied in regulatory reports (if management chose to use an option available under GAAP for financial statement purposes that is different than the regulatory interpretation of GAAP for regulatory reporting purposes). Review copies of prior year regulatory reports (and, as necessary, client's supporting working papers), and obtain management's analysis of classification issues concerning preparation of Call Reports, including risk weighting classifications assigned. In assessing the completeness of any reconciliation, consider the potential for GAAP to have been applied differently for any other of the institution's transactions in the financial statements versus regulatory reports.

     Obtain any reconciliation of amounts supporting the institution's regulatory capital ratio calculations to amounts in the institution's financial statements prepared in conformity with GAAP:

     Test management's supporting schedules and reconciliations for completeness and mathematical accuracy.

     Agree GAAP amounts to general or subsidiary ledgers, or both, and obtain supporting schedules for non-GAAP amounts.

     Review the nature and amount of material non-GAAP amounts for propriety and consistency with prior years.

     Consider current treatment of items that resulted in past corrections or changes to regulatory financial reports.

     Consider whether significant changes in instructions for preparation of Call Reports have been applied to material transactions.

     Inquire about, and discuss with officers having responsibility for call reporting, any significant reclassification of transactions since the last filed regulatory report.

Mortgage Companies and Activities

Objectives

17.106 The auditor’s objective in this area includes the normal objectives sought in auditing equity (for example, balances are presented in accordance with GAAP), including obtaining reasonable assurance that the financial statements include proper description and disclosure of capital matters in the context of the financial statements taken as a whole. Capital noncompliance is an important consideration for auditors when conducting a mortgage company engagement.

Planning

17.107 In accordance with paragraph .A1 of AU-C section 300, Planning an Audit, the nature and extent of planning activities will vary according to the size and complexity of the entity, the key engagement team members’ previous experience with the entity, and changes in circumstances that occur during the audit engagement. Paragraphs .09–.10 of AU-C section 210, Terms of Engagement, state that the auditor should agree upon the terms of the audit engagement with management or those charged with governance, as appropriate. The agreed-upon terms of the audit engagement should be documented in an audit engagement letter or other suitable form of written agreement (see paragraph .10 of AU-C section 210 for a listing of agreed-upon terms that should be included). Both management and the auditor have an interest in documenting the agreed-upon terms of the audit engagement before the commencement of the audit to help avoid misunderstandings with respect to the audit as stated in paragraph .A22 of AU-C section 210. For example, it might be necessary for an auditor to obtain an understanding about the capital requirements that the entity is subject to as a result of seller-servicer agreements entered into with investors, as well as capital requirements that may be imposed as a result of other business transactions such as borrowing arrangements. In connection with these requirements, it is important that the auditors understand the elements that constitute capital, as defined in the various agreements.

17.108 In accordance with paragraph .12 of AU-C section 315, the auditor should obtain an understanding of the entity’s objectives and strategies and those related business risks that may result in risks of material misstatement. For purposes of generally accepted auditing standards, business risks are defined as risks resulting from significant conditions, events, circumstances, actions, or inactions that could adversely affect the entity’s ability to achieve its objectives and execute its strategies or from the setting of inappropriate objectives and strategies.

17.109 The following are examples of factors related to capital matters that may indicate higher risks of material misstatement:

     Actual or borderline noncompliance with minimum capital requirements

     Communications or restrictions from investors regarding capital compliance issues

     Capital requirements and calculations that are not well documented

Internal Control Over Financial Reporting

17.110 In accordance with paragraph .08 of AU-C section 330, the auditor should design and perform tests of controls to obtain sufficient appropriate audit evidence about the operating effectiveness of relevant controls if (a) the auditor’s assessment of risks of material misstatement at the relevant assertion level includes an expectation that the controls are operating effectively or (b) substantive procedures alone cannot provide sufficient appropriate audit evidence at the relevant assertion level.

17.111 Examples of factors that may contribute to effective internal control in this area follow:

     Responsibilities for capital planning and monitoring compliance with capital requirements have been assigned to competent officials in the company.

     Capital analyses, calculations, and supporting documentation are well prepared and readily accessible.

Substantive Procedures

17.112 Irrespective of the assessed risks of material misstatement, paragraph .18 of AU-C section 330 states that the auditor should design and perform substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure.

17.113 The extent to which the auditor applies tests to specific transactions or amounts will depend on the auditor’s assessment of inherent and control risks and the materiality of the accounts.

17.114 Paragraphs .A46–.A50 of AU-C section 330 provide additional guidance on the nature and extent of substantive procedures. Depending on the circumstances, the auditor may determine that performing only substantive analytical procedures will be sufficient to reduce audit risk to an acceptably low level (for example, when the auditor’s assessment of risk is supported by audit evidence from tests of controls), only tests of details are appropriate, or a combination of substantive analytical procedures and tests of details are most responsible to the assessed risks. Substantive analytical procedures are generally more applicable to large volumes of transactions that tend to be predictable over time. The nature of the risk and assertion is relevant to the design of tests of details.

17.115 Such procedures might include the following:

     Obtain and read new seller-servicer agreements entered into during the period, or amendments to existing agreements, for capital requirements in effect

     Obtain and test management’s schedules supporting calculation of the entity’s actual and required capital amounts

     Review and evaluate management’s analyses of significant nonrecurring transactions and their impact on capital

     Obtain any reconciliation of amounts supporting the entity’s capital calculations to amounts in the entity’s financial statements prepared in accordance with GAAP

     Test management’s supporting schedules and reconciliations for completeness and mathematical accuracy

     Agree GAAP amounts to general or subsidiary ledgers, or both

Notes

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