BC-200
Type:  Banking Circular       
Subject:  Accounting for Loan Swaps
Date: May 22, 1985

TO:  Chief Executive Officers of All National Banks, Deputy
     Comptrollers, Regional Administrators and All Examining
     Personnel

PURPOSE

The purpose of this Banking Circular is to provide guidance in accounting
for loan swaps, principally of foreign borrowers.

BACKGROUND

With increased frequency, banks are exchanging public and/or private
sector loans of borrowers in financially troubled countries. While these
"swaps" are recordable events for accounting purposes, valuing the
elements of an individual exchange has been difficult because there does
not currently exist any established secondary market for these loans. This
Circular addresses the problem of exchange valuation and discusses related
accounting issues.

ACCOUNTING

General Principles

A swap of loans to different debtors represents an exchange of monetary
assets which should be accounted for at current fair value. Normally, when
monetary assets are exchanged, with or without additional cash payments,
and the parties have no remaining obligations to each other, the earnings
process is complete. The transaction may result in recognition of a gain
or loss for either or both parties. The gain or loss is measured on the
date of agreement to the exchange as the difference between (1) the amount
of the recorded investment in the loan plus any cash or other
consideration paid and (2) the current fair value of the loan plus any
cash or other consideration received.

Application of General Principles to Foreign Loan Swaps

The estimated fair value of the consideration given and received in a loan
swap must be determined. Certain foreign countries are currently
experiencing financial difficulties. These difficulties are a significant
factor in determining estimated fair values of consideration given and
received. For exchanges involving loans to debtors of such countries, it
is presumed the estimated fair values will be less than the respective
face values of the loans and other consideration. Assuming the general
presumption is not overcome, this would result in a loss on the swap.

Establishing fair values usually will be difficult and subjective because
of significant uncertainties in the timing and amount of cash flows.
Further, there is presently no established market for such loans. These
problems, however, do not preclude a bank from making reasonable estimates
and judgments. Indeed, it must be assumed that any swap decision is
predicated on the ability of a bank to estimate reasonably the value of
the consideration to be received from the exchange.

The determination of fair value should, among other things, consider the
following:
 
- similar transactions for cash;

- secondary market values, if any, of similar financial instruments;

- the credit standing of the debtor and/or guarantor (including prospects
  for re-entry into the voluntary lending markets in the foreseeable
  future);

- prevailing interest rates;

- pricing options available (e.g., prime-based vs. LIBOR-based loans);

- anticipated delays in receipt of payment; and

- tax consequences, including the effect of foreign withholding taxes on
  after-tax yields.

Because of the highly judgmental nature of the valuation process in swap
transactions, it would not be uncommon for two banks involved in a swap to
reach a different conclusion on the value of the consideration (foreign
loans) paid and received.

Classification of Losses and Valuation of Remaining Loans to a Troubled
Debtor

If the current fair value of the proceeds of the swap is less than the
recorded investment in the loan and other consideration paid, a loss
should be recognized and recorded at the date the transaction is agreed to
by both parties. The following guidelines should be followed in
determining whether the swap loss should be recorded as a direct charge to
income or as a loan write- off:

- A loss resulting from a change in the interest rate environment for
  similar loans (e.g., sovereign loans) during the period of time the loan
  was held in the bank's loan portfolio should be recorded as a direct
  charge to income.

- A loss resulting from a major concern as to collectibility of the loan
  should be charged to the allowance for loan losses (whether or not
  specifically reflected in an allocation of such allowance).

- A loss which is not identified solely with either of the aforementioned
  factors should be recorded as a direct charge to income.

If a loss from a swap transaction is attributable to a major concern as to
collectibility, then there should generally be a presumption that a
reserve for losses on other loans to that debtor is warranted.

Gains and Loss Recoveries

In rare cases, gains or loss recoveries might be indicated as a result of
the valuation process. However, due to the subjective nature of the
valuation process and the troubled financial condition of certain of the
foreign debtors, gains or loss recoveries should not be recognized until
the acquired loan is repaid in cash by the borrower.

Discounts on Loans Received

Unless timely collection in accordance with current terms is assured, any
difference between the carrying value and face value of the loan received
in the swap should not be accreted to income over the remaining life of
the loan but rather should be reported as income when the loan is
collected or when collection has become assured.

Fees and Transaction Costs

All fees and transaction costs involved in a loan swap should be expensed
when the loan transaction is complete. The new loan received in the
exchange is initially recorded at its current fair value. Deferring
recognition in income of any fees paid or transaction costs incurred would
cause the new loan to be carried at an amount greater than its current
fair value.

Domestic Loan Swaps

The principles set forth in this policy are equally applicable to swaps of
domestic loans in which the borrower is financially troubled.

ORIGINATING OFFICE

Questions regarding this Banking Circular may be directed to the Chief
National Bank Examiner's Office, Bank Accounting Division (202) 874-5180.
 
Michael Patriarca
Deputy Comptroller of the Currency