INVESTMENT SECURITIES
1A. Investments in Debt and Equity Securities
Bank Accounting Advisory Series
5
August 2018
There is also a limited exclusion for certain unusual events.
Question 8
What are the ramifications of selling debt securities that have been classified as HTM and that do
not meet any of the safe harbor exemptions set forth in question 7?
Staff Response
A sale outside of the safe harbor exemptions would taint the HTM portfolio. Once a portfolio is
tainted, all remaining securities in the existing HTM portfolio must be transferred to the AFS
category. In addition, future purchases of securities may not be classified as HTM. After the
tainting, judgment is required in determining when circumstances have changed such that
management can assert with a greater degree of credibility that it now has the intent and ability
to hold debt securities to maturity. The SEC staff expressed the view in the past that the tainting
period for sales or transfers of HTM securities that do not meet any of the safe harbor
exemptions should be two years.
Because AFS securities are carried at fair value in the financial statements, the transfer of tainted
HTM securities would result in an unrealized holding gain or loss, net of applicable taxes, at the
date of transfer. Unrealized holding gains or losses should be included in AOCI, a component of
stockholders’ equity, as long as the losses do not represent OTTI.
In addition, ASC 320 requires certain disclosures for sales or transfers of securities out of the
HTM category. Specifically, the amortized cost, realized or unrealized gain or loss, and
circumstances leading to the sale or transfer of HTM securities must be disclosed in the bank’s
financial statements. For call report purposes, the amortized cost of securities sold or transferred
from the HTM category should be included on Schedule RC-B, Memoranda.
Facts
A bank sells a portion of its investment securities that were included in the HTM
portfolio. The securities were sold to gain additional liquidity.
Question 9
Would this sale of securities from the HTM portfolio taint the remaining securities in the
portfolio?
Staff Response
Yes. Except for the safe harbor exceptions stated in question 8, transfers out of the HTM
portfolio taint the portfolio. Sales for liquidity reasons are excluded from the ASC 320 safe
harbor exceptions. As a result, the HTM portfolio would be considered tainted as of the sale date.
INVESTMENT SECURITIES
1A. Investments in Debt and Equity Securities
Bank Accounting Advisory Series
6
August 2018
Facts
In anticipation of converting from a taxable corporation to Subchapter S status, a bank
sells some tax-exempt municipal securities that had been included in the HTM portion of the
investment portfolio. The bank sold the securities because it no longer benefits from the tax-free
status of the municipal securities, and the individual shareholders do not need the tax-exempt
income.
Question 10
Does the sale of these securities taint the entire HTM portfolio?
Staff Response
Yes. Selling securities from the HTM portfolio because of a change in tax status of the bank to
Subchapter S is not one of the safe harbor exceptions included in ASC 320. Although ASC 320
does provide an exception for changes in tax law that eliminate or reduce the tax-exempt status
of interest, this exception does not extend to changes in the tax status of the bank. Accordingly,
the HTM portfolio is tainted.
This change resembles a change in tax rates more than a change in tax law. Therefore, it is not
covered by the safe harbor exceptions in ASC 320.
Facts
A bank purchases trust preferred securities using its legal lending limit authority.
Question 11
Should these securities be reported as loans or securities on the bank’s financial statements?
Staff Response
The trust preferred securities should be classified and reported as securities on the bank’s
financial statements, including call reports. The legal means for acquiring the security is not
relevant for the accounting treatment. The financial statement classification is governed by
GAAP, not the legal authority under which the assets are purchased. The trust preferred
securities are debt securities subject to the accounting requirements of ASC 320.
Facts
In 20X1, Bank A purchased $10 million in 30-year trust preferred securities from the
Trust of Bank Holding Company B (BHC B). These securities have a fixed distribution (interest)
rate, quarterly payment dates, and a fixed maturity date. In accordance with ASC 320, Bank A
has classified these assets as AFS debt securities.
The Trust exists for the sole purpose of investing in junior subordinated deferrable interest
debentures of BHC B. Accordingly, the ability of the Trust to pay the quarterly distribution is
INVESTMENT SECURITIES
1A. Investments in Debt and Equity Securities
Bank Accounting Advisory Series
7
August 2018
based solely on BHC B’s ability to pay interest on the debentures. Interest on the debentures is
paid quarterly, unless deferred by BHC B. The agreements allow BHC B to defer interest
payments on the debentures for a period of up to 20 consecutive quarters without creating a legal
default. If the interest payments on the debentures are deferred, the distribution payments on the
trust preferred securities are also deferred, without creating a legal default. The payments,
however, are cumulative.
During 20X4, BHC B began experiencing financial difficulties. Consequently, in June 20X4,
BHC B announced that the interest payment on the debentures and the Trust’s distribution
payment on the trust preferred securities scheduled for July 31 would be deferred. These
payments will be deferred for the last two quarters of 20X4. Resumption of payments in 20X5 is
dependent upon BHC B returning to profitable operations. Further, the trust preferred securities
are publicly traded and selling at a discount in excess of 25 percent of par value.
Question 12
Should the accrual of interest income be discontinued on the trust preferred securities that are not
paying scheduled interest payments but are not in legal default according to the terms of the
instrument?
Staff Response
Bank A should discontinue the accrual of income on its investment in the trust preferred
securities and include the securities as a nonaccrual asset on Schedule RC-N of the call report.
Previously accrued interest should be reversed.
In this case, both the 20X4 third-quarter and fourth-quarter distribution (interest) payments will
not be made because of the financial condition and operating losses of BHC B. Payments may
resume in 20X5, but only if BHC B becomes profitable. Accordingly, there is no assurance that
Bank A will receive these or future payments. Therefore, it meets the criteria for nonaccrual
status set forth in the call report instructions.
While it is true that a legal default has not occurred, the staff believes that interest should not be
accrued on an asset that is impaired or when the financial condition of the borrower is troubled.
Although the nonaccrual policies of the banking agencies are not codified in GAAP, they are
followed by financial institutions in the preparation of their financial statements. This has
resulted in these policies being considered an element of GAAP even though they are not
specifically included in the accounting literature.
Further, the trust preferred securities are classified by Bank A as AFS and are currently trading at
a substantial discount from par. Therefore, in addition to the uncertainty about the collection of
the income, concern exists about recovery of the principal.
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