SRC Insights: Fourth Quarter 2003

Importance of Accurate Call Report Data

by Avi Peled, Senior Financial Specialist

Commercial banks submit income and balance sheet data to federal bank regulators in their quarterly Consolidated Reports of Condition and Income, referred to as Call Reports. Bank holding companies with consolidated assets of $150 million or more submit the Consolidated Financial Statements for Bank Holding Companies (FR Y-9C) report to the Federal Reserve System. To ensure accountability, an authorized officer must sign the Call Report and, by doing so, declare that the Call Report was prepared in accordance with the instructions issued by the institution's federal regulatory authority and contains accurate data. In addition, directors (two for state nonmember banks and three for state member and national banks) must attest to the correctness of the Call Report.

Federal bank regulators use Call Report and BHC report data to analyze the risks to bank and holding company balance sheets and income streams. Regulators also use the data to monitor the health of the banking industry by different bank segments and geographical areas, and in the aggregate. Much of the data in financial regulatory reports is publicly available, providing information for investment analysts and other members of the public. Incorrect data provides a false view of the reporting institution and can distort aggregate statistics, while also reflecting poorly on management and internal controls. With corporate governance and financial transparency issues so prominent among the investing public's concerns, it is critical that public regulatory reports accurately reflect a financial institution's condition.

While inaccurate reporting can result from management's attempt to conceal information from regulators and the public, most cases of inaccurate reporting probably arise from lack of proper controls or from misunderstanding the reporting requirements for specific line items on regulatory reports. Incorrect data that makes a bank look less risky may have significant safety and soundness implications. However, it is still serious when incorrectly reported data makes the bank look riskier and it gives us an inaccurate understanding of the institution's financial position.

The remainder of this article will highlight some areas where inaccurate reporting in Call Reports and BHC reports is a concern for Capital Markets examiners.

Maturity and Repricing Buckets
Capital Markets examiners focus on an institution's Market Risks, particularly an institution's sensitivity to interest rate risk. To analyze an institution's interest rate risk, it is important for examiners to have a clear understanding of the maturity structure of the balance sheet. For off-site surveillance, examiners rely on the maturity and repricing data reported on Schedule RC-B—Securities, Schedule RC-C— Loans and Lease Financing Receivables, and Schedule RC-E—Deposit Liabilities.

At the Federal Reserve, Capital Markets examiners use an internal model to monitor interest rate risk. This model relies upon maturity and repricing data for assets and liabilities, among other data, to produce a rough estimate of a bank's Economic Value of Equity. Examiners also use this information to compute various ratios to improve their understanding of the financial institution's liquidity position and sensitivity to interest rate movements.

Specific instructions for reporting assets and liabilities in different maturity and repricing buckets are in the Call Report instructions. One area that may require clarification or additional explanation is the difference between fixed and floating assets and liabilities for reporting purposes. In general, a fixed interest rate for reporting purposes is a rate that is known at origination, or a rate that changes on a predetermined basis according to terms agreed upon at origination, such as a step-up bond. A floating rate is a rate that cannot be known at origination for the life of the asset or liability. Floating rates usually vary in relation to another rate or index, such as a Treasury rate, LIBOR, or the prime rate. Generally, fixed rate assets and liabilities are reported according to the instruments' remaining maturity without regard to repayment schedules. Floating rate instruments are reported according to the next repricing date when the rate can change, or the contractual maturity date, whichever is earlier. Examiners have found instances where financial institutions' systems were reporting some floating rate instruments according to their maturity, instead of the much earlier repricing dates.

Special provisions exist for reporting loans for delivery in the secondary market. Fixed rate loans that a bank is holding for delivery to the secondary market under a binding commitment must be reported according to the amount of time until the delivery date specified in the commitment. Floating rate loans for sale to the secondary market under a binding commitment are to be reported according to the earlier of the next repricing date or the scheduled delivery date.

Structured Notes
Structured notes are defined in the Call Report instructions as those debt securities, including all asset-backed securities except mortgage-backed securities and inflation-indexed treasuries, "whose cash flow characteristics (coupon rate, redemption amount, or stated maturity) depend upon one or more indices and/or that have embedded forwards or options or are otherwise commonly known as 'structured notes.'" Some examples of structured notes include floating rate debt, where the interest rate is based on a Constant Maturity Treasury rate or a Cost of Funds Index; step-up bonds; index-amortizing notes; dual index notes; de-leveraged bonds; range bonds; and inverse floaters. Securities with adjusting caps or floors are also considered structured notes. The Call Report instructions provide a more detailed description of what is and is not a structured note.

Structured notes have to be reported on both an amortized cost and fair value basis. Information is collected on the structured notes in a financial institution's portfolio because their complex structures often make it difficult to quantify market risk and examiners monitor the amount of structured notes in bank portfolios to gauge possible market risks.

Despite the lengthy description and examples of structured notes in the reporting form instructions, uncertainty whether to report certain securities as structured notes may exist. State member banks and holding companies should call their central point of contact at the Federal Reserve for clarification when uncertain whether to classify a security as a structured note.

Mortgage Servicing Assets
Banks that report mortgage servicing assets on schedule RC-M—Memoranda normally should also report data in one of the line items for "outstanding principal balance of assets serviced for others" in the memoranda section of Schedule RC-S—Servicing, Securitization, and Asset Sale Activities. Banks should review the valuation of mortgage servicing assets periodically to determine their fair market value and to recognize any impairment charges, especially during periods of high prepayment and declining mortgage rates. Examiners expect that the ratio of the book value of mortgage servicing assets to total mortgages serviced for others would be a reasonable number.

A FAS 149 Reminder on
Mortgage Loan Origination Commitments
According to FASB's Financial Accounting Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities, mortgage loan origination commitments issued after June 30, 2003 and being held for sale are to be considered derivatives. These commitments must be reported at fair value on the balance sheet. In addition, the par value of the future loans must be reported on Schedule RC-L—Derivatives and Off-Balance Sheet Items as interest rate "over-the-counter option contracts, written options" and as part of the "total gross notional amount of derivative contracts held for purposes other than trading." The gross positive or negative fair value of these commitments must also be reported in Schedule RC-L as part of "contracts held for purposes other than trading."

Conclusion
Banks and bank holding companies have the responsibility to report accurately all items on their Call Report and BHC reports. Aside from their regulatory obligations, these institutions have corporate governance reasons to report accurately the condition of their institutions to federal regulators and the public. A financial institution should also be interested in mistake-free reporting from an operational risk perspective.

Perhaps the easiest check of report accuracy is periodic review of regulatory reports by line officers and executives to verify that the reports reflect their understanding of the financial institution's condition and policies. For example, if the institution has a policy of not making loans with a maturity or repricing period longer than three years, a substantial balance of loans in the over-three-year buckets should raise a warning flag.

While financial institutions generally do a good job of financial reporting, they should review the reporting process periodically to verify that no inaccuracies have entered either the accounting process or the data or programs in computer systems. Review is particularly important after mergers and acquisitions, any time changes are made to the reporting process, or when new instructions are received from federal regulators.

Management should consider having internal auditors review the accuracy of its regulatory reports as well as its data collection and accounting process. Early identification and tracking of mistakes can help the institution reduce operational risk and implement strategies for improved efficiency.

State member banks and bank holding companies that have any questions on the proper reporting for balance sheet or income statement items in the Call Report or BHC reports should contact Charles Kirkland at (215) 574-6605 or Vince Poppa at (215) 574-6492.

The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.

SRC Insights: Fourth Quarter 2003

Importance of Accurate Call Report Data

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