-226-
position in the swap given that the counterparty has a worse
credit rating than FNBC. Whereas petitioner is correct that
credit risk is normally negligible at the inception of a swap,
and that interest rate movements after inception may produce an
incremental credit risk warranting a downward adjustment at a
revaluation date, petitioner ignores the reality of the converse
of this principle; i.e., that an upward credit adjustment might
be justified when changes in interest rates have caused the
market value of the swap to become negative.
2. One-Month Lag in Recording Swaps
Whereas FNBC calculated its credit adjustments quarterly,
those quarterly periods did not coincide with the calendar
quarters in which its swaps actually arose. FNBC treated each of
its swaps as arising 1 month after the date that the swap
actually arose. FNBC’s 1-month lag for determining the swaps
which it included in its credit adjustment for a quarter was
inconsistent with the section 475 mark-to-market requirement that
value be determined as of the last business day in the taxable
year. FNBC’s 1-month lag resulted inappropriately in FNBC’s
postponing the recognition of some of its credit adjustments for
1 whole year; e.g., the credit adjustments for 32 swaps which
FNBC initiated in December 1993 were actually claimed in 1994.
Page: Previous 216 217 218 219 220 221 222 223 224 225 226 227 228 229 230 231 232 233 234 235 NextLast modified: May 25, 2011