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Financial Institution Letters
The ABCP rule bases the risk-based capital treatment of an ABCP liquidity facility, in part, on whether the facility is "eligible" or "ineligible." Eligibility is determined based on whether a liquidity facility contains contractual provisions that preclude the purchase of certain low credit quality assets. Prior to September 30, 2005, the ABCP rule prescribes the same two-step capital calculation for eligible and ineligible liquidity facilities, i.e., the amount of the unused portion of the facility is multiplied by a credit conversion factor (CCF) that depends on the facility's maturity, which is then multiplied by the risk weight of the obligor, taking into account the underlying assets and any external ratings. For maturities of one year or less, the CCF is 10 percent; for maturities greater than one year, the CCF is 50 percent.
As of September 30, 2005, the ABCP rule requires that eligible and ineligible facilities be treated differently. To be an eligible liquidity facility and qualify for the 10 or 50 percent CCF, the liquidity provider may not fund against assets that are 90 days or more past due3, in default, or below investment grade. If a liquidity facility is ineligible, it is treated as a recourse exposure or direct credit substitute for risk-based capital purposes.4
Risk-Based Capital Treatment
Accordingly, the agencies will deem an ABCP liquidity facility to be in compliance with the requirement for an asset quality test if (i) the liquidity provider has access to certain types of acceptable credit enhancements and (ii) the notional amount of such credit enhancements available to the liquidity facility provider exceeds the amount of underlying assets that are 90 days or more past due, defaulted, or below investment grade that the liquidity provider may be obligated to fund under the facility. In this circumstance, the liquidity facility may be considered "eligible" for purposes of the agencies' risk-based capital standards because the provider of the credit enhancement generally bears the credit risk of the assets that are 90 days or more past due, in default, or below investment grade rather than the banking organization providing liquidity.
The agencies have determined that the following forms of credit enhancements are generally acceptable for purposes of satisfying the asset quality test:
Recourse directly to the seller, other than the funded credit enhancements enumerated above, regardless of the seller's external credit rating, is not an acceptable form of credit enhancement for purposes of satisfying the asset quality test. Seller recourse—for example, a seller's agreement to buy back nonperforming or defaulted loans or downgraded securities—may expose the liquidity provider to an increased level of credit risk. A decline in the performance of assets sold to an ABCP conduit may signal impending difficulties at the seller itself.
If the amount of acceptable credit enhancement associated with the pool of assets is less than the current amount of assets that are 90 days or more past due, in default, or below investment grade that the liquidity facility provider may be obligated to fund against, the liquidity facility should be treated as recourse or a direct credit substitute. The full amount of assets supported by the liquidity facility would be subject to a 100 percent CCF.5 The agencies reserve the right to deem an otherwise eligible liquidity facility to be, in substance, a direct credit substitute if a banking organization uses the liquidity facility to provide credit support.
A banking organization will be responsible for demonstrating to the relevant agency whether acceptable credit enhancements cover the 90 days or more past due, defaulted, or below investment grade assets that the organization may be obligated to fund against in each seller's asset pool. If a banking organization cannot adequately demonstrate satisfaction of the conditions in this interagency guidance, the agencies further reserve the right to determine that a credit enhancement is unacceptable for purposes of the requirement for an asset quality test and, therefore, deem the liquidity facility ineligible.
1 See 12 C.F.R. part 3, appendix A, § 3(a)(6)(ii)(A) (OCC); 12 C.F.R. parts 208 and 205, appendix A, § III.B.3.a.iv. (FRB); 12 C.F.R. part 325, appendix A, § II.B.5(a)(5) (FDIC); 12 C.F.R. 567.1 (OTS).
3 In the preamble to the ABCP rule, the agencies determined that the past due limitation is not a relevant asset quality test in the case of certain credit enhancements, such as a guarantee issued by the United States government, its agencies, or an OECD country. The preamble did not specifically address other types of credit enhancements discussed in this guidance. 69 FR 44908, 44912 (July 28, 2004).
4 For the capital treatment for recourse exposures and direct credit substitutes, see, 12 C.F.R. part 3, appendix A § 4 (OCC); 12 C.F.R. parts 208 and 225, appendix A, § III.B.3.b (FRB); 12 C.F.R. part 325, appendix A, § II.B.5 (FDIC); and 12 C.F.R. 567.6 (b) (OTS).
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