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Staff Updates Guidance On Segment Reporting, Allowance for Loan Losses

The Division of Corporation Finance recently updated its guidance on changes in segment disclosure and the financial statement presentation for loan losses. With respect to changes in segments, the staff advised that changes in the structure of a registrant's internal organization after the fiscal year-end, or plans to make a change, should not be presented in the financial statements until the operating results that are managed on the basis of that structure are reported. Registrants should present disclosure based on the historical reportable segments until the financial statements for the periods managed on the basis of the new organizational structure are presented. The staff added that it may be useful to supplement the registrant's disclosure with the future effects of the changes.

Registrants should include a revised segment footnote to the annual audited financial statements when the financial statements are required in a registration statement, including Form S-8, or a proxy statement that includes subsequent periods managed on the basis of the new organizational structure. The description of the business and the MD &A should also be revised to include the newly reportable segments. The staff advised that previous filings that contain the old organizational structure should not be amended.

The revised annual financial statements may be included in the registration or the proxy statement, or in a Form 8-K incorporated by reference, according to the guidance. If a registrant files a Form S-3 or S-8 that incorporates its most recent Form 10-K and 10-Q before the new organizational structure is required to be presented in the financial statements, the staff advised that management and its advisers should consider whether the change in reportable segments is a material change under Form S-3 Item 11 or Form S-8 General Instruction G.2. If the change is material, the registrant should report revised segment information before the effective date of either Form S-3 or Form S-8.

With respect to allowances for loan losses, the staff noted that allowances for credit losses are valuation accounts that should be presented as a reduction of the carrying value of the related balance sheet item. The allowance for loan losses should not include amounts for losses on financial instruments that are not classified on the balance sheet as loans.

Financial Accounting Standards Board Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, does not provide specific guidance on geography, but the staff stated that certain classifications may not make sense. The guidance noted, for example, that a financial institution that classified in the provision for loan losses all changes in credit derivatives used as economic hedges did not seem appropriate given the importance of that line item for certain credit quality analyses.

Financial institutions must present the provision for loan losses as a deduction in the determination of net interest income. Credit loss provisions on other types of balance sheet and off-balance sheet items that do not affect net interest income should not be included in the provision for loan losses, according to the staff. Loss provisions that are not related to interest income should be recorded in other appropriate categories of income or expense.

The staff noted that direct transfers of amounts between the allowance for loan losses and other credit loss allowances are not appropriate except when an off-balance sheet loan commitment becomes an outstanding loan. The staff advised registrants to reflect changes in the amount of the allowance for loan losses in the provision for loan losses. Changes in other allowances should appear in other appropriate categories of income or expense.