Planning Critical Capital Infusions By: David J. Bayens, CPA Date: 11/19/09 Among other problems, capital adequacy is keeping many bankers awake at night.  Losses have whittled down capital to the point where meeting regulatory capital standards is in jeopardy.  A magnifying glass is on each bank organization, as it is required to publicly report its financial results at least quarterly. The problem that a growing number of banks face is that events often take place near the end of a quarter (or even after the end of the quarter) that can significantly affect capital.  Examples of these include adjustments for ALLL provisions, OTTI losses or fair values, the amounts of which might not be quantified until after the end of the quarter.  When the amount of these adjustments impacts capital adequacy, banks may be unable to record a capital infusion to restore capital to an adequate level in the same period that the losses are required to be recognized. The OTS has provided guidance in this area with its issuance of CEO Memo #293 in which it applies GAAP rules to situations faced by financial institutions.  The memo addresses the recognition of capital contributions in the form of cash or notes.  Quite simply, capital contributions in the form of cash are always recognized as capital at the time the cash is received.  If the bank receives notes, the issue becomes more complicated.  Issuing notes receivable to a bank does not create equity in the bank.  To recognize the notes as an asset and the corresponding amount as equity, the notes be originated prior to the end of the quarter and the cash must be received no later than the date of the filing of the Call Report or TFR (or earlier than that if public financial statements are issued sooner). The note must meet the following criteria: There must be written documentation that the note was contributed prior to quarter-end. The note is legally binding and enforceable and is executed before quarter-end. The note identifies a specific amount and payment date. Some Examples, as Provided by the OTS #1 On 12/31/09, the HC Board executes a $20 million note payable to its subsidiary bank in anticipation of an undetermined capital shortfall. On 1/12/10, the Bank determines that it needs $12 million to remain well capitalized. On 1/13/10, the HC pays the Bank the $12 million and the bank forgives the remaining $8 million due under the note. Question:  How much of the note may be included in capital at 12/31/09? Answer:  Zero- the note is deemed to non-substantive. #2 On 12/31/09, a HC commits to make a capital contribution that is sufficient “to ensure well-capitalized status” for its subsidiary bank, payable no later than 1/15/10. On 1/15/10, the HC contributes $10 million in cash to the bank as capital. Question:  May the bank include the $10 million in capital at 12/31/09? Answer:  No- the amount of the obligation was not quantified at the time the obligation was created. #3 On 12/31/09, the HC Board authorizes a $10 million capital injection into its bank subsidiary and immediately wires $10 million to the deposit account at the bank. On 12/31/09, a bank employee erroneously processes the contribution as a $10,000 withdrawal from the HC’s deposit account. On 1/3/10, the error is identified and the correcting entry of $9,990,000 is made. Question:  How much of the capital injection may be recognized at 12/31/09? Answer:  The entire $10 million.  Management had taken all the appropriate actions within the proper timeframe.  The concept of substance over form would dictate that the transaction would be recognized as it was originally approved.   Moral of the Story Ideally, we are informed of events in plenty of time to take appropriate action.  Also, ideally, our organizations have plenty of capital resources so that the prospect of falling below capital guidelines is not an issue.  When situations become tight, the ability to plan and marshal available resources is critical.