BC - 260
BANKING ISSUANCE
Comptroller of the Currency
Administrator of National Banks
Type:  Banking Circular
Subject:  EDP Service Contracts

TO:  Chief Executive Officers of all National Banks, Deputy Comptrollers,
     District Administrators, Department and Division Heads, and All
     Examining Personnel

BACKGROUND

This issuance replaces BB 90-4 dated February 16, 1990. The FFIEC
statement is unchanged.

SUMMARY

Attached is an "Interagency Statement on EDP Service Contracts" issued by
the Federal Financial Institutions Examinations Council (FFIEC). This
statement alerts financial institutions to potential risks in contracting
for EDP services and failing to properly account for certain contract
provisions.

Management of national banks is cautioned against contracting for services
that include excessive fees or "inducement" provisions similar to those
described in this statement. Furthermore, accounting for transactions
under the contracts must conform to generally accepted accounting
principles and call report instructions. This office considers contracting
for excessive servicing fees, or failing to properly account for such
transactions, an unsafe and unsound banking practice.

ORIGINATING OFFICE


Office of the Chief National Bank Examiner
(202) 874-5350

Donald G. Coonley
Chief National Bank Examiner

Attachment

Date:  July 14, 1992
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Federal Financial Institutions Examination Council
1776 G Street, NW, Suite 701 * Washington, DC 20006

Interagency Statement on EDP Service Contracts

To: Chief Executive Officers of all Federally Supervised Financial
    Institutions, Senior Management of each FFIEC Agency, and all
    Examining Personnel

PURPOSE:

This interagency statement alerts financial institutions to potential
risks in contracting for EDP services and/or failing to properly account
for certain contract provisions.

ISSUE:

Some financial institutions are entering into EDP servicing contracts that
contain provisions which may adversely affect the institution. Contract
provisions may include extended terms (up to ten years), significant
increases in costs after the first few years, and/or substantial
cancellation penalties.

In addition, some service contracts improperly offer inducements that
allow an institution to retain or increase capital by deferring losses on
the disposition of assets or avoiding expense recognition for current
charges. Institutions experiencing earnings and capital problems are
particularly attracted to these inducements.

Examples of inducements include:

o The servicer purchasing assets (e.g., computer equipment or foreclosed
  real estate) at book value, which exceeds current market value;

o The servicer providing capital by purchasing stock from the institution;

o The servicer providing cash bonuses to the institution once the
  conversion process is complete; and

o The institution deferring expenses for conversion costs or processing
  fees under the terms of a lease or licensing contract.

These inducements offer a short-term benefit to the institution. However,
the servicer usually recoups its costs by charging a premium for the data
processing services it provides. These excessive data processing fees
adversely affect an institution's financial condition over the long-term.
Furthermore, the institution's accounting for such inducements typically
is inconsistent with generally accepted accounting principles (GAAP) and
regulatory reporting requirements.

Title II, Section 225 of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 states:

An (FDIC) insured depository institution may not enter into a written or
oral contract with any person to provide goods, products or services to or
for the benefit of such depository institution if the performance of such
contract would adversely affect the safety or soundness of the
institution.

Accordingly, when negotiating contracts, an institution must ensure that
the servicer can provide a level of service that meets the needs of the
institution over the life of the contract. It is also the responsibility
of the institution to ensure that contracts are accounted for in
accordance with GAAP.

In summary, contracting for excessive servicing fees and/or failing to
properly account for such transactions is considered an unsafe and unsound
practice. Servicing agreements that include contract provisions or
inducements similar to those discussed above should be closely reviewed by
the institution. Institutions must ensure that accounting under such
agreements reflects the "substance" of the transaction, not merely the
"form."

Although this statement focuses on contracting for EDP services, these
same issues may exist in contracts for other vital services.


Board of Governors of the Federal Reserve System, Federal Deposit
Insurance Corporation, National Credit Union Administration, Office of the
Comptroller of the Currency, Office of Thrift Supervision