Bank Premises

Introduction

Bank premises and equipment includes land, buildings, furniture and fixtures and other equipment, either owned or leased, and any leasehold improvements. This section covers the fair valuation, general propriety, and legality of the bank’s investment in premises and equipment. Other real estate owned and insurance coverage on fixed assets are discussed in other sections.

There are three primary means by which banks obtain premises and equipment for their use:

• Direct investment of bank funds in the form of cash outlays and/or by incurring debt, such as a mortgage.

• Indirect investment in the corporation holding title to bank premises. That corporation may or may not be affiliated with the bank. Indirect investment of this type may be in the form of purchases of stocks, bonds, debentures, or similar obligations of the corporation, or of loans to, or upon, the security of that stock.

• Negotiation of lease agreements.

Federal regulations require that all bank fixed assets, acquired subsequent to June 30, 1967, be stated at cost, less accumulated depreciation or amortization. Depreciation or amortization of assets or leasehold improvements, acquired prior to June 30, 1967, may be computed by applying any generally accepted depreciation method. The book values of such assets should not exceed, but may be less than, the nonaccelerated depreciation value for income tax purposes.

Bank premises and equipment should be booked at cost. Cost is determined by the method of acquisition, for example:

• Cash purchase cost is invoice cost plus freight, installation, and other related costs less cash discounts.

• Credit purchase cost is the cash amount required to settle the obligation at the purchase date, plus any freight, installation costs, and the like.

• Construction cost is the cost of survey, materials, labor, overhead, capitalized interest, and such items as building permits.

• Issuance of securities cost is the fair market value of securities given on the date the asset is acquired.

• Exchange cost is the market value of assets given, cash transferred, and/or obligations assumed.

• Donation cost is the fair market value of the asset at the date of acquisition.

When newly acquired assets need a period of time to prepare them for use, the cost of the funds expended during that period should be included as part of the assets’ cost. A bank contracting the construction of its premises would capitalize the contractor’s construction costs, his profit, and the cost of the funds used during the construction period. If the bank borrows funds specifically to construct or acquire the asset, the cost of the borrowed funds is capitalized. However, if the acquisition costs are funded internally, the bank must use the weighted average rate for all interest-bearing liabilities in determining the amount to be capitalized. Interest is not to be capitalized for assets that are already in use or that are ready for their intended use when acquired.

The book and tax values of bank premises and equipment often will not be the same, particularly for newly acquired assets. For book purposes, banks should depreciate assets over their useful life, using a straight line or accepted accelerated method. For tax return purposes, the following methods of depreciation are allowable for assets acquired between June 30, 1967 and December 31,1980:

• The straight line method (non-accelerated).

• The declining balance method, using a rate not exceeding twice the rate applicable under the straight line method.

• The sum-of-the-years digits method.

• Any other consistent accelerated method which produces an annual allowance that, when added to all allowances for the period commencing with the taxpayer’s use of the property and including the taxable year, does not, during the first two- thirds of the property’s useful life, exceed the total of such allowances that would have been used under other accelerated methods.

For assets acquired after January 1, 1981, recovery (depreciation) deductions will normally be based on the Accelerated Cost Recovery System (ACRS). Recovery deductions are determined by reference to accelerated recovery tables. Thus, the recovery periods (lives) of the assets used for tax purposes may vary from the lives used for book purposes. Under 12 CFR 7.7505, once dual treatment (i.e., different treatment for book and tax) is used for a given asset, it must be continued until the asset is fully depreciated. If book and tax depreciation differences exist, 12 CFR 7.7505 requires recognition of deferred income taxes, if the amount is material.

Banks frequently lease their premises and equipment rather than owning them outright. These leases may represent significant commitments which could materially affect earnings. The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 13 in 1976, which established generally accepted accounting principles regarding lease transactions. That FASB statement requires, among other things, that the lessee capitalize certain leases. The instructions for preparation of consolidated reports of condition contain details for the capitalization of leases. The amount capitalized would be the present value of the minimum required payments over the noncancelable term, as defined, of the lease, plus the present value of the payment required under the bargain purchase option, if any, less any portion of the payments representing executory expenses such as insurance, maintenance and taxes to be paid by the lessor. The amortization period should be the life of the lease or a period established in a manner consistent with the lessee’s normal schedule of depreciation for owned assets. The requirements of FASB Statement No. 13 are somewhat complex, and examiners who have questions on capitalization of leases are referred to that statement for necessary details.

Banks will occasionally sell premises or fixed assets and lease such property back from the buyer. The accounting standards for such transactions are defined in FASB 28, “Accounting for Sales with Leasebacks.” Generally, gains on these sale-leaseback transactions are not recognized immediately but are deferred in accordance with the terms of the underlying lease. In the case of a capital lease, the gain is accreted in proportion to the depreciation of the leased asset. If the lease does not meet the criteria for a capital lease, then it is an operating lease, and the gain is amortized in proportion to the rental payments made over the lease term. In the event that a loss is realized on the sale, the losses are deferred and accreted in the same manner as the gain. An exception is when the fair value of the property is less than the book value. In this case, the loss is recognized immediately. Examiners should refer to FASB No. 28 when reviewing these types of transactions.

Title 12 USC 371(d) forbids national banks to invest an amount greater than its capital stock in their banking premises, directly or indirectly, without the approval of the Comptroller of the Currency. In addition to direct investments in premises presently used by the bank, computation of the legal limitation must include:

• Property acquired for future expansion.

• Any investment in stocks, bonds, debentures, or similar obligations, in a corporation holding title to bank premises, whether affiliated with the bank or not.

• Indebtedness incurred by any bank premises holding corporation affiliated with the bank through stock ownership, as defined by 12 USC 221(a).

• Indirect investments in the form of loans to, or upon, the security of the stock of any corporation holding title to bank premises, whether affiliated with the bank or not.

Investments in furniture and fixtures are not subject to the legal limitations; however, the amount of such investments will be considered by the District Deputy Comptroller if the bank requests permission to exceed the legal limitation on investment in bank premises. Capitalized leases of bank premises are subject to the limitations of 12 USC 371(d). Any excess investment resulting from capitalization of leases entered into on or after November 15,1977 must have OCC approval.

National banks are encouraged to plan for future needs, and examiners should not arbitrarily classify real estate acquired for future use. However, when a bank acquires such realty, it should be utilized within a reasonable time. Reasonable time, as defined in 12 CFR 7.3025, normally will not exceed 3 years; however, it is the examiner’s responsibility to determine the reasonable time and the feasibility of intended use in each individual case. After real estate acquired for future expansion has been held for 1 year, a board resolution detailing plans for its use must be available for inspection. Real estate acquired for future expansion is considered “other real estate owned” from the date when its use for banking is no longer contemplated. In addition, former banking premises are considered “other real estate owned” from the date of relocation to new banking quarters.

As indicated earlier, the examiner responsible for this area should assess the appropriateness of the bank’s investment in premises and equipment and the overall impact of occupancy expense on the bank. Even if a bank’s total investment in bank premises is within legal limits and all of its fixed assets are valued fairly for book purposes, its total expenditures for, or investment in, premises and equipment may be inappropriate relative to its earnings, its total capital structure, or the nature and volume of its operations.

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