Pub. 5 2010-2011 Issue 2

www.nebankers.org 16 Extraordinary Service for Extraordinary Members. Among other things, FAS 166 amends and clarifies the accounting de-recognition criteria to be applied to transfers of participating interests in an entire financial asset. In order to obtain the traditional sale treatment for the sale of a portion of a loan, the sale must meet the new test for a “participating interest.” A participating interest possesses all of the following characteristics: • It must be nonrecourse; • It must represent a proportionate or pro rata ownership interest in the entire loan through maturity; • From the date of the transfer, all cash flows (after payment of a reasonable servicing fee) received must be divided proportionately among the participating interest holders in an amount equal to their share of ownership; • Each participating interest holder must have the same priority with no participating interest holder subordinate to another (i.e., LIFO participations are no longer treated as true participations); and • No partymay have the right to pledge or exchange the entire financial asset unless all participating interest holders agree to the pledge or exchange. Impact of Changes If a participation does not qualify for sale accounting treat- ment, adverse consequences may occur for both the trans- ferring lender and the participant. Among other things, the balance sheet of the transferring lender will show the entire loan as an asset with capital and loan loss reserve require- ments and the participation amount will be a secured liability. With respect to the participant, the participant must maintain capital on its loan to the transferring lender, thereby causing both to have capital maintenance requirements. In addition, lending limits will apply not to the underlying loan obligor but to the transferring lender as the “borrower.” Furthermore, if the transferring lender and participant are affiliated, the par- ticipant has a “covered loan,” which is subject to Regulation W quantitative and collateral requirements unless the two banks are “sister banks” for RegulationWpurposes. Finally, upon the entry into receivership of the transferring lender, the FDIC may treat the transaction as a secured loan to the transferring lender, and exercise its authority to disaffirm or repudiate the participation agreements to reclaim, recover, or recharacterize the transferred assets. Aaron Johnson is a partner in Husch Blackwell Sanders LLP’s Banking & Finance Department, where he concentrates his practice in the areas of commercial lending, structured finance, and regulatory compliance. He regularly represents both borrowers and lenders in a variety of financing transactions, including asset-based loans, letter of credit facilities, syndicated loans, and loan participations. He can be reached at (402) 964-5023 or aaron.johnson@huschblackwell.com . Q Accounting Standards Regulators have granted some relief in this area. The FDIC has adopted a transitional safe harbor which pro- vides that it will not, as conservator or receiver, exercise its authority to disaffirm or repudiate contracts or reclaim as- sets transferred prior to Sept. 30, 2010, if the participation satisfied all conditions for sale accounting treatment under generally accepted accounting principles in effect prior to the enactment of FAS 166. This safe harbor, however, does not delay the lending limit or capital ramifications of a failure to meet the new “participating interest” test. In addition, regarding regulatory capital requirements, there is: a) an optional two-quarter implementation delay followed by an optional two-quarter partial implementation of the effect on risk-weighted assets that will result from the accounting changes, and b) an optional two-quarter delay, followed by an optional two-quarter phase-in, of the application of the regulatory limit on the inclusion of the allowance of loan and lease losses (ALLL) in Tier 2 capital for the portion of the ALLL associated with the assets which are consolidated as a result of accounting changes. Compliance Community banks should prepare new participation agreement forms that are FAS 166 compliant for all new participations. In addition, existing participations cover- ing revolving and construction loan facilities for which new advances will be required should be amended to meet the requirements of FAS 166, as FAS 166 applies to any advance or draw on a loan commitment, even if the underlying par- ticipation agreement was outstanding prior to the effective date of FAS 166. The changes should be communicated to all lending personnel and participation policies should be modified in consultation with the institution’s accountants and other advisors. Among other things, a participant in a non-compliant transaction should file a UCC financing state- ment showing the transferring bank as “debtor.” Finally, regulatory developments should be closely monitored, as regulators and other interested parties continue to react to these accounting changes. Z Community banks should prepare new participation agreement forms that are FAS 166 compliant for all new participations.