AOCI and Opting-Out – Explained
The FDIC on March 23, 2015 reminded institutions in FIL-12-2015 that most banks must make a one-time, permanent election and may opt-out of including unrealized gains and losses on available for sale securities in common equity tier 1 capital. Unrealized gains and losses for banks is a common component of accumulated other comprehensive income (AOCI), a GAAP equity account. The one-time election allows banks to exclude most AOCI items from regulatory capital.
Here’s the plain English version: If you want to exclude from regulatory capital, changes in investment fair values that are caused by market interest rate changes, then you need to opt-out of including such changes. This one-time election is permanent (or until someone changes the rules again).
Since market interest rates are at historic lows and can go nowhere but up, most banks are choosing to opt-out. That’s because when the Federal Reserve increases rates, many banks expect the fair values of their debt securities could decrease resulting in an unrealized loss (or decrease in unrealized gain). Opting-out will exclude this decrease from regulatory capital. Note that increases in the fair value of securities due to market interest rates would also be excluded from regulatory capital if you opt-out.
The election whether to opt-out or not opt-out is required in the March 31, 2015 call report. The instructions and form can be confusing, so it is critical that you do not mistakenly make the wrong election. In Schedule RC-R, select “1” for Yes, meaning “yes, I want to opt-out”.
The following is a snapshot of the section that includes the AOCI election, and an illustration of how to “opt out”:
See also the Schedule RC-R instructions that describe this.
If you select “1”, then the form and instructions will guide you to adjust out of AOCI (line 3 above), unrealized gains and losses and other AOCI items that you may now exclude from regulatory capital (because you opted-out).