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Inactive Financial Institution Letters 



[Federal Register: March 2, 1999 (Volume 64, Number 40)]
[Rules and Regulations]
[Page 10193-10201]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02mr99-8]

[[Page 10193]]

_______________________________________________________________________

Part III

Department of the Treasury
Office of the Comptroller of the Currency

12 CFR Part 3

Federal Reserve System

12 CFR Part 208, 225

Federal Deposit Insurance Corporation

12 CFR Part 325

Department of the Treasury
Office of Thrift Supervision

12 CFR Part 567

Risk-Based Capital Standards: Construction Loans on Presold Residential
Properties; Junior Liens on 1- to 4-Family Residential Properties; and
Investments in Mutual Funds; Leverage Capital Standards: Tier 1
Leverage Ratio; Final Rules

[[Page 10194]]

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

Office of Thrift Supervision

12 CFR Part 567

[Docket No. 99-01]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM

12 CFR Part 208

[Regulation H; Docket No. R-0947]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AB 96

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

[Docket No. 98-125]
RIN 1550-AB11


Risk-Based Capital Standards: Construction Loans on Presold
Residential Properties; Junior Liens on 1-to 4-Family Residential
Properties; and Investments in Mutual Funds; Leverage Capital
Standards: Tier 1 Leverage Ratio

AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance
Corporation; and Office of Thrift Supervision, Treasury.

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board
of Governors of the Federal Reserve System (Board), the Federal Deposit
Insurance Corporation (FDIC), and the Office of Thrift Supervision
(OTS) (collectively, the agencies) are amending their respective risk-
based and leverage capital standards for banks and thrifts
(institutions).1 This final rule represents a significant
step in implementing section 303 of the Riegle Community Development
and Regulatory Improvement Act of 1994, which requires the agencies to
work jointly to make uniform their regulations and guidelines
implementing common statutory or supervisory policies. The intended
effect of this final rule is to make the risk-based capital treatments
for construction loans on presold residential properties, real estate
loans secured by junior liens on 1-to 4-family residential properties,
and investments in mutual funds consistent among the agencies. It is
also intended to simplify and make uniform the agencies' Tier 1
leverage capital standards.
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    \1\ An amended risk-based capital standard for bank holding
companies is included in a separate Board notice published elsewhere
in today's Federal Register; references to ``institutions'' in this
final rule generally do not apply to bank holding companies.

EFFECTIVE DATE: This final rule is effective April 1, 1999. The
agencies will not object if an institution wishes to apply the
provisions of this final rule beginning with the date it is published
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in the Federal Register.

FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic
Advisor (202/874-5070), Capital Policy Division; or Ronald Shimabukuro,
Senior Attorney (202/874-5090), Legislative and Regulatory Activities
Division, Office of the Comptroller of the Currency, 250 E Street,
S.W., Washington, DC 20219.
    Board: Norah Barger, Assistant Director (202/452-2402), Barbara
Bouchard, Manager (202/452-3072), T. Kirk Odegard, Financial Analyst
(202/530-6225), Division of Banking Supervision and Regulation. For the
hearing impaired only, Telecommunication Device for the Deaf (TDD),
Diane Jenkins (202/452-3544), Board of Governors of the Federal Reserve
System, 20th and C Streets, N.W., Washington, DC 20551.
    FDIC: For supervisory issues, Stephen G. Pfeifer, Examination
Specialist (202/898-8904), or Carol L. Liquori, Examination Specialist
(202/898-7289), Accounting Section, Division of Supervision; for legal
issues, Jamey Basham, Counsel, Legal Division (202/898-7265), Federal
Deposit Insurance Corporation, 550 17th Street, N.W., Washington, DC
20429.
    OTS: Michael D. Solomon, Senior Program Manager for Capital Policy
(202/906-5654), Supervision Policy; or Vern McKinley, Senior Attorney
(202/906-6241), Regulations and Legislation Division, Office of the
Chief Counsel, Office of Thrift Supervision, 1700 G Street, N.W.,
Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

    Section 303(a)(1) of the Riegle Community Development and
Regulatory Improvement Act of 1994 (12 U.S.C. 4803(a)) (CDRI Act)
requires the agencies to review their regulations and policies and to
streamline those regulations where possible. Section 303(a)(3) of the
CDRI Act directs the agencies, consistent with the principles of safety
and soundness, statutory law and policy, and the public interest, to
work jointly to make uniform all regulations and guidelines
implementing common statutory or supervisory policies. Although the
agencies' risk-based and leverage capital standards are already very
similar, the agencies have nevertheless reviewed these standards,
internally and on an interagency basis, to fulfill the CDRI Act section
303 mandate and identify areas where they have different capital
treatments or where streamlining is appropriate.
    As a result of this review, the agencies identified inconsistencies
in their respective risk-based capital treatments for certain types of
transactions and determined that their minimum Tier 1 leverage capital
standards could be streamlined and made uniform. Accordingly, on
October 27, 1997, the agencies issued a joint proposal (62 FR 55686) to
amend their respective risk-based and leverage capital standards to
address the following: (1) construction loans on presold residential
properties; (2) junior liens on 1-to 4-family residential properties;
(3) investments in mutual funds; and (4) the Tier 1 leverage ratio.
    The agencies received 15 public comments on the proposal (six from
industry trade groups, two each from thrifts, bank holding companies,
and national banks, and one each from a savings bank, a state nonmember
bank, and a concerned individual). These comments are discussed in
greater detail in the material that follows.
    After consideration of these comments and further deliberation of
the issues involved, the agencies are adopting this final rule to make
their risk-based and leverage capital standards uniform with respect to
the aforementioned items. The capital treatments for construction loans
on presold residential properties, investments in mutual funds, and the
Tier 1 leverage ratio are adopted essentially as proposed. The capital
treatment for junior liens on 1- to 4-family residential properties,
however, differs from the proposed treatment.

II. Proposal, Comments Received, and Final Rule

A. Construction Loans on Presold Residential Properties

Proposal
    Certain qualifying construction loans on presold residential
properties currently are eligible for the 50 percent

[[Page 10195]]

risk weight.\2\ Under OCC and OTS rules, a qualifying construction loan
on presold residential property is eligible for a 50 percent risk
weight if, prior to the extension of credit to the builder, the
property is sold to an individual who will occupy the residence upon
completion of construction. In contrast, the Board and FDIC consider
such a loan to be eligible for a 50 percent risk weight once the
property is sold, regardless of whether the institution made the loan
to the builder before or after the individual purchased the residence
from the builder. Consistent with the capital treatment accorded such
loans by the Board and FDIC, the agencies proposed that qualifying
construction loans on presold residential property would be eligible
for a 50 percent risk weight at the time the property was sold,
regardless of when the institution made the loan to the builder.
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    \2\ Qualifying construction loans on presold residential
property generally are those in which the borrower has substantial
equity in the project, the property has been presold under a binding
contract, the purchaser has a firm commitment for a permanent
qualifying mortgage loan, and the purchaser has made a substantial
earnest money deposit.
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Comments Received
    The nine commenters who addressed this issue expressed unanimous
support for the proposal. Four commenters noted that presold
residential loans were equally safe whether the property was sold
before or after the initial extension of credit to the builder. One of
these commenters added that the quality of the loan was of greater
importance than the timing of the property sale. Five commenters did
not provide reasons for supporting the proposal.\3\
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    \3\ One commenter noted that the OTS, through guidance in the
Thrift Financial Report, interprets the earnest money deposit
requirement more stringently than guidance in the Call Report. On an
ongoing basis, the agencies review their reporting instructions to
move toward greater consistency among the agencies.
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Final Rule
    The agencies concur with commenters and believe that qualifying
construction loans on presold residential property have the same credit
risk regardless of the timing of the property sale. Consequently, as
proposed, the agencies will permit a qualifying residential
construction loan to be eligible for the 50 percent risk category at
the time the property is sold, regardless of when the institution made
the loan to the builder. The OCC and OTS are revising their risk-based
capital standards to permit this treatment. The Board is revising its
regulatory language to conform its discussion of qualifying
construction loans to that of the FDIC.

B. Junior Liens on 1- to 4-Family Residential Properties

Proposal
    The current agency rules are not uniform with respect to the risk
based capital treatment for junior liens on 1- to 4-family residential
properties. Under Board and FDIC rules, first and junior liens on 1- to
4-family residential properties are combined to determine loan-to-value
(LTV) ratios.\4\ The Board treats these liens as a single extension of
credit and assigns the combined loan to either the 50 percent or 100
percent risk category, depending on whether or not the loan is
``qualifying'' under other criteria in the capital standards.\5\ The
FDIC risk-weights the first lien at 50 percent, unless the combined
loan amount is not qualifying, in which case the first lien is risk-
weighted at 100 percent. All junior liens are risk-weighted at 100
percent. The OCC also risk-weights all junior liens at 100 percent,
qualifying first liens at 50 percent, and nonqualifying first liens at
100 percent, but does not combine liens when calculating LTV ratios.
The OTS definition of qualifying loans parallels that of the OCC, but
in response to specific inquiries, the OTS has interpreted this
provision to treat first and second mortgage loans to a single borrower
with no intervening liens as a single extension of credit secured by a
first lien.
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    \4\ As the LTV ratio increases, the risk profile of a loan is
generally considered to increase as well. In the event of a loan
default, a high LTV may indicate that the value of the underlying
collateral will not be sufficient to cover the amount of the loan.
In addition, borrowers who have a greater equity stake in their
property are generally less willing to default on their loans. Since
high-LTV loans are considered to carry greater risk, institutions
are expected to hold more capital against these loans.
    \5\ Generally, a loan is qualifying when it meets prudent
underwriting criteria, including appropriate LTV ratios, and is
considered to be performing adequately. A loan that is 90 days or
more past due, or is in nonaccrual status, is not considered to be
performing adequately.
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    Under the proposal, when an institution holds a first lien and
junior lien(s) on a 1- to 4-family residential property, and no other
party holds an intervening lien, the liens would be treated separately
for LTV and risk-weighting purposes. Liens would not be combined for
LTV purposes. Qualifying first liens would be risk-weighted at 50
percent and nonqualifying first liens and all junior liens would be
risk-weighted at 100 percent. This is the capital treatment currently
accorded by the OCC. The agencies note that this rulemaking does not
affect the risk-based capital treatment of junior liens where an
institution does not hold the first lien, or where there are
intervening liens; such junior liens remain subject to the 100 percent
risk weight.
Comments Received
    The agencies received ten comments on the junior lien component of
the proposal. Three commenters supported the proposed capital treatment
for junior liens, six commenters were opposed, and one commenter
expressed neither support nor opposition.
    Of the three commenters that supported the proposal, one offered
support without explanation. The other two agreed with the proposal's
simplicity and ease of understanding and implementation, but disagreed
about whether first and junior liens should be combined for LTV
purposes. One supported the separate treatment for first and junior
liens for the purposes of calculating LTV ratios, while the other
suggested that the liens should be combined.
    Of the six commenters opposing the junior lien proposal, two
opposed the separate treatment of loans for LTV purposes, stating that
all liens should be combined when calculating the LTV ratio for a
single borrower. According to these commenters, failure to combine
liens when calculating LTV ratios would increase the incentive for
lenders to utilize creative lending arrangements to reduce capital
charges without a corresponding reduction of risk. One further
suggested that the presence of any form of junior financing should
result in the entire loan receiving a 100 percent risk weight.
    The other four commenters opposing the junior lien proposal
indicated that the degree of risk associated with junior liens varies
widely and that a 100 percent risk weight for all junior liens could be
too high in some instances. Two of these commenters essentially
endorsed the current approach taken by the Board, suggesting that first
and junior liens held by the same lender should be treated as a single
extension of credit that would be risk-weighted in its entirety at
either 50 percent or 100 percent, depending on LTV ratios and loan
performance. Another commenter suggested that the definition of
``qualifying mortgage loans'' should include junior liens that meet the
same performance criteria as first liens, and that qualifying junior
liens with a combined LTV of 80 percent or less--regardless of who
holds the first lien--should receive a 50 percent risk weight. A fourth
commenter suggested that first and junior liens by the same lender be
combined and placed in the 50 percent

[[Page 10196]]

risk category if the combined LTV ratio at loan inception is below 75
percent.
    Finally, one commenter neither supported nor opposed the proposal,
but indicated that it was inappropriate because a 100 percent risk
weight was too high for a single-family first mortgage loan. This
commenter suggested that limitations, such as a $200 thousand maximum,
could be placed on certain nonqualifying first liens that would allow
them to be risk-weighted at 50 percent.
Final Rule
    The agencies are adopting a capital treatment for junior liens on
1-to 4-family residential properties that differs from the proposal.
Although the proposed treatment is the simplest of the agencies'
current approaches to apply, the agencies believe that the goal of
simplicity is outweighed by other concerns. The agencies believe that,
when an institution holds first and junior liens to a single borrower
with no intervening liens, placing all of these junior liens in the 100
percent risk category--regardless of the quality of the individual
loans--places an unfair capital burden on institutions. Where junior
liens held by the first lienholder (with no intervening liens) do not
pose an undue risk, the agencies agree with the commenters that the 100
percent risk weight may be excessive.
    The agencies also agree with the commenters who believe that it is
appropriate to combine first and junior liens when calculating the LTV
ratio. The agencies are concerned that institutions could use creative
lending arrangements to reduce capital charges without reducing risk.
Moreover, where an institution holds first and junior liens to a single
borrower with no intervening liens, it is the economic equivalent of a
single extension of credit that is secured by the same collateral and
should be treated accordingly. The agencies believe that it is
therefore appropriate that first and junior liens be combined when
calculating the LTV ratio.
    Consequently, the agencies are adopting the current Board treatment
for such loans. When a lending institution holds the first lien and
junior liens on a 1-to 4-family residential property and no other party
holds an intervening lien, the loans will be viewed as a single
extension of credit secured by a first lien on the underlying property
for the purpose of determining the LTV ratio, as well as for risk
weighting. The institution's combined loan amount will be assigned to
either the 50 percent or 100 percent risk category, depending on
whether the credit satisfies the criteria for a 50 percent risk
weighting.
    To qualify for the 50 percent risk category, the combined loan must
be made in accordance with prudent underwriting standards, including an
appropriate LTV ratio.\6\ In addition, none of the combined loans may
be 90 days or more past due, or be in nonaccrual status. Loans that do
not meet all of these criteria must be assigned in their entirety to
the 100 percent risk category. The OCC, FDIC, and OTS are revising
their respective risk-based capital standards to conform with this
capital treatment.
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    \6\ Prudent underwriting standards include an appropriate ratio
of the loan balance to the value of the property. A loan secured by
a 1-to 4-family residential property has such a ratio if the loan
complies with the Interagency Guidelines for Real Estate Lending
(guidelines). See 12 CFR part 34, subpart D (OCC); 12 CFR part 208,
subpart C (Board); 12 CFR part 365 (FDIC); and 12 CFR 560.100-101
(OTS). A loan may comply with these guidelines despite having a
ratio above the supervisory limit if, for example, the loan is
supported by other credit factors, is an excluded transaction, or is
a prudently underwritten exception to the lender's policies. The
aggregate amount of (1) all loans in excess of the supervisory loan-
to-value limits, and (2) all loans made via exceptions to the
general lending policy is limited to 100 percent of total capital.
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C. Investments in Mutual Funds

Proposal
    The current agency rules are not uniform with respect to the risk-
based capital treatment for investments in mutual funds. The Board,
FDIC, and OCC generally assign a risk weight to an institution's mutual
fund investment according to the highest risk-weighted asset allowable
under the fund's prospectus. The OCC also permits institutions, on a
case-by-case basis, to allocate mutual fund investments among the
various risk weight categories based on a pro rata distribution of
allowable investments under the fund's prospectus. The OTS assigns a
risk weight to a mutual fund investment based on the highest risk-
weighted asset actually held by the fund, but also allows, on a case-
by-case basis, an institution's investment in a mutual fund to be
allocated among risk weight categories based on a pro rata distribution
of actual fund holdings. All four agencies apply a 20 percent minimum
risk weight to such investments.
    Mirroring the OCC's treatment for investments in mutual funds, the
agencies proposed that an institution's investment in a mutual fund
generally would be assigned a risk weight according to the highest
risk-weighted asset allowable in the fund's prospectus. The proposal
also would permit institutions the option of assigning mutual fund
investments on a pro rata basis to different risk weight categories
according to the limits set forth in the fund's prospectus. In no case
could the risk weight of a mutual fund investment be less than 20
percent. If, for purposes of liquidity, a fund holds an insignificant
amount of its assets in short-term, highly liquid securities, the
institution could disregard these securities in determining the proper
risk weight.
Comments Received
    The agencies received eight comments on this component of the
proposal. Six commenters supported the proposal--with two suggesting
further modifications--while two commenters opposed the proposal.
    Commenters supporting the proposal noted that it would provide
flexibility and would encourage investment in lower-risk mutual funds.
One of these commenters suggested that, to reflect the volatility of
mutual fund values, the minimum risk weight on mutual fund investments
should be raised from 20 percent to 50 percent. Another commenter
stated that the 20 percent risk weight floor was too high, and that up
to half of a mutual fund's authorized investment in U.S. Government
securities should be accorded a zero percent risk weight. One commenter
requested that the risk-based capital standards clarify precisely what
constitutes an ``insignificant quantity of highly liquid securities of
superior quality,'' suggesting a cap of 5 percent on such investments.
    The two commenters that opposed the proposal stated that instead of
assigning risk weights based on the maximum investment limits permitted
under the fund's prospectus, institutions should have the option of
assigning risk weights based on pro rata calculations of actual fund
holdings. Both commenters asserted that this approach would assign risk
weights based on the actual risk of the underlying fund assets instead
of their potential risk. One commenter added that the proposal would
disproportionately affect smaller institutions, which are more likely
to invest in mutual funds than are large institutions.
Final Rule
    After consideration of these comments, the agencies are adopting
the final rule as proposed. The final rule assigns an institution's
total investment in a mutual fund to the risk category appropriate to
the highest risk-weighted asset the fund may hold in accordance with
its stated investment limits set

[[Page 10197]]

forth in the prospectus. The agencies concur with commenters that
permitting the option of assigning risk weights for mutual fund
investments on a pro rata basis provides greater flexibility.
Consequently, under the final rule, institutions also have the option
of assigning the investment on a pro rata basis to different risk
categories according to the investment limits in the fund's prospectus.
Because actual fund holdings can change significantly from day-to-day,
the agencies believe that it is more prudent to base risk weight
distributions on investment limits than on a fund's actual underlying
assets. The agencies note that this should not impose an additional
burden on small institutions because all institutions will have a
choice between the two risk weight calculation methods for investments
in mutual funds.
    Regardless of the risk-weighting method used, the total risk weight
of a mutual fund must be no less than 20 percent. While the agencies
are sensitive to the concern that the 20 percent minimum risk weight
may be higher than the standard risk weight of some of the assets held
by a mutual fund, the agencies nevertheless believe that a mutual fund
has certain credit, operational, and legal risks that necessitate a
risk weight greater than zero percent. The agencies are also aware that
the sum of investment limits in a mutual fund prospectus may exceed 100
percent. If this is the case, then institutions may not reduce their
capital requirements by assigning the highest proportion of the total
fund investment to the lowest risk weight categories. Instead,
institutions must assign risk weights in descending order, beginning
with the highest risk-weighted assets.7
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    \7\ For example, assume that a fund's prospectus permits 100
percent risk-weighted assets up to 30 percent of the fund, 50
percent risk-weighted assets up to 40 percent of the fund, and 20
percent risk-weighted assets up to 60 percent of the fund. In such a
case, the institution must assign 30 percent of the total investment
to the 100 percent risk category, 40 percent to the 50 percent risk
category, and 30 percent to the 20 percent risk category. The
institution may not minimize its capital requirement by assigning 60
percent of the total investment to the 20 percent risk category and
40 percent to the 50 percent risk category.
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    In addition, if a mutual fund can hold an immaterial amount of
highly liquid, high quality securities that do not qualify for a
preferential risk weight, then those securities may be disregarded in
determining the fund's risk weight. The agencies are not designating a
specific level below which an amount of such securities is immaterial,
as this may vary on a case-by-base basis depending on the particular
mutual fund. As a general matter, however, this amount is immaterial if
it is reasonably necessary to ensure the short-term liquidity of the
fund, and the securities do not materially affect the risk profile of
the fund.
    The prudent use of hedging instruments by a mutual fund to reduce
its risk exposure will not increase the mutual fund's risk weighting.
Mutual fund investments are assigned to the 100 percent risk category
if they are speculative in nature or otherwise inconsistent with the
preferential risk weighting assigned to the fund's assets.
    The Board, FDIC, and OTS are revising their risk-based capital
standards to reflect the capital treatment accorded investments in
mutual funds by the OCC.

D. Tier 1 Leverage Ratio

Proposal
    The Tier 1 leverage ratio--that is, the ratio of Tier 1 capital to
total assets--is an indicator of an institution's capital adequacy and
places a constraint on the degree to which an institution can leverage
its capital base. The Board, FDIC, and OCC currently require
institutions with a composite rating of ``1'' under the Uniform
Financial Institutions Rating System to have a minimum leverage ratio
of 3.0 percent. Institutions that are not ``1''-rated must have a
minimum leverage ratio of 3.0 percent, plus an additional cushion of at
least 100 to 200 basis points. The OTS currently requires all
institutions to maintain core capital in an amount equal to 3.0 percent
of adjusted total assets.\8\
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    \8\ The OTS core capital ratio is the equivalent of the other
agencies' Tier 1 leverage ratio. This final rule will add
definitions of Tier 1 and Tier 2 capital to the OTS capital rule to
clarify that these are the equivalents of core and supplemental
capital, respectively.
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    In order to streamline and clarify the leverage ratio requirement,
the agencies proposed to revise the leverage ratio requirement to make
clear that ``1''-rated institutions would be required to maintain a
minimum Tier 1 leverage ratio of 3.0 percent, while all other
institutions would be required to maintain a minimum leverage ratio of
4.0 percent. These thresholds are the same as required to be
``adequately capitalized'' under the agencies' prompt corrective action
(PCA) guidelines.
Comments Received
    The agencies received nine comments with regard to this component
of the proposal, seven of which supported the more consistent leverage
capital treatment among the agencies. Two commenters neither supported
nor opposed the proposal. One of these commenters stated that the
proposal was essentially meaningless because an institution with a
leverage ratio of 3.0 percent would be unlikely to receive a composite
rating of ``1'', while the other commenter encouraged the agencies to
continue working together to make the capital standards more simple and
consistent.
    Four of the commenters that supported the proposal nevertheless
expressed concerns about the use of the leverage ratio as a supervisory
tool. All four questioned the appropriateness of leverage requirements
in light of comprehensive risk-based capital requirements, noting that
banks were at a competitive disadvantage relative to securities firms,
foreign banking organizations, and secondary market agencies. One of
these commenters proposed that PCA guidelines be modified so that
institutions that have either adopted a risk-based capital market risk
measure or are ``1''-rated be subject to a 3.0 percent minimum leverage
ratio to be considered ``adequately capitalized,'' and a 4.0 percent
minimum leverage ratio to be considered ``well capitalized.'' Three
commenters recommended that the agencies consider discontinuing
entirely the use of the leverage ratio, noting that risk-based capital
requirements now incorporate credit and market risks.
Final Rule
    The agencies are adopting the final rule as proposed. Consequently,
under this final rule the most highly-rated institutions must maintain
a minimum Tier 1 leverage ratio of 3.0 percent, with all other
institutions required to maintain a minimum leverage ratio of 4.0
percent. In addition, as proposed, the OTS is amending its leverage
capital standard to be consistent with the other three agencies by
stating that higher-than-minimum capital levels may be required if
warranted, and that institutions should maintain capital levels
consistent with their risk exposures.
    The agencies acknowledge commenter concerns about the usefulness of
the leverage ratio as a supervisory tool for those institutions that
have adopted market risk capital measures. Nevertheless, the agencies
note that a leverage requirement for PCA purposes is mandated under the
provisions of the Federal Deposit Insurance Corporation Improvement Act
of 1991. Moreover, the agencies believe that the Tier 1 leverage ratio,
when used in conjunction with risk-based capital ratios, is a useful
supervisory tool in assessing an institution's capital adequacy. While
a

[[Page 10198]]

change to the PCA leverage ratio guidelines is beyond the scope of this
final rule, the agencies may consider whether the leverage requirements
under PCA should be further modified in the future.

III. Regulatory Flexibility Act Analysis

    OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OCC certifies that this final rule will not have a significant
impact on a substantial number of small entities. This final rule makes
no changes with respect to the capital treatment of mutual funds or
with respect to the minimum leverage ratio for national banks. However,
with respect to the capital treatment of construction loans the final
rule eases the regulatory burden on national banks by providing a more
favorable risk-based capital treatment. As to the capital treatment of
junior liens on 1- to 4-family residences, the OCC believes that while
certain loans may be subject to an increased capital requirement, other
loans may be subject to a lower capital charge. However, the OCC does
not believe that the impact of this provision will be significant.
Therefore, the OCC believes that the net economic impact of these
changes on national banks, regardless of size, is expected to be
minimal and a regulatory flexibility analysis is not required.
    Board: Pursuant to section 605(b) of the Regulatory Flexibility
Act, the Board has determined that this final rule will not have a
significant economic impact on a substantial number of small entities
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). The treatment of construction loans, junior liens, and the
leverage ratio does not differ from the Board's current treatment. The
treatment of mutual fund risk weights differs from current treatment,
but affected institutions are not required to adopt the new treatment.
Accordingly, a regulatory flexibility analysis is not required, because
the economic impact of the final rule on institutions, regardless of
size, is expected to be minimal.
    FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the FDIC has determined that this final rule will not have a
significant economic impact on a substantial number of small entities
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). The treatment of construction loans and the leverage ratio does
not differ from the FDIC's current treatment. The treatment of junior
liens under the final rule is the same as current treatment to the
extent affected institutions must combine the loans in evaluating the
prudence of the loan-to-value ratio, and the change in treatment (lower
risk weighting of the junior lien) is optional. The treatment of mutual
fund risk weights differs from current treatment, but this change is
also optional. Accordingly, a regulatory flexibility analysis is not
required, because the economic impact of the final rule on
institutions, regardless of size, is expected to be minimal.
    OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OTS certifies that this final rule will not have a significant
impact on a substantial number of small entities. The final rule
relaxes regulatory burdens on all savings associations by providing a
more favorable risk-based capital treatment for construction loans. The
changed treatment of mutual funds should have minimal impact on small
savings associations, as the new treatment is consistent with most
thrifts' current actual practice. The increased monitoring and
recordkeeping necessary to use OTS' current regulatory treatment was
not cost-effective for small thrifts. While the rule also increases the
leverage ratio requirement, this change should have little impact since
it is consistent with requirements for an ``adequately capitalized''
institution under the prompt corrective action rules. The current
treatment of junior liens on 1-to 4-family residences is unchanged.
Accordingly, the economic impact of these changes on savings
associations, regardless of size, is expected to be minimal and a
regulatory flexibility analysis is not required.

IV. Paperwork Reduction Act

    The agencies have determined that the final rule will not involve a
collection of information pursuant to the provisions of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501 et seq.).

V. Small Business Regulatory Enforcement Fairness Act

    The Small Business Regulatory Enforcement Fairness Act of 1996
(SBREFA) (Title II, Pub. L. 104-121) provides generally for agencies to
report rules to Congress for review. The reporting requirement is
triggered when a federal agency issues a final rule. Accordingly, the
agencies filed the appropriate reports with Congress as required by
SBREFA.
    The Office of Management and Budget has determined that this final
rule does not constitute a ``major rule'' as defined by SBREFA.

VI. OCC and OTS Executive Order 12866 Determination

    The OCC and the OTS have determined that this final rule does not
constitute a ``significant regulatory action'' for the purposes of
Executive Order 12866.

VII. OCC and OTS Unfunded Mandates Reform Act of 1995
Determinations

    Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L.
104-4 (Unfunded Mandates Act) requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
Federal mandate that may result in expenditure by State, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year. If a budgetary impact statement is
required, section 205 of the Unfunded Mandates Act also requires an
agency to identify and consider a reasonable number of regulatory
alternatives before promulgating a rule. As discussed in the preamble,
this final rule is limited to making the risk weighting of presold
residential construction loans, second liens, and mutual fund
investments consistent under the agencies' risk-based capital rules. It
also establishes a uniform, simplified leverage requirement for all
institutions. In addition, with respect to the OCC, this final rule
clarifies and makes uniform existing regulatory requirements for
national banks. The OCC and OTS, therefore, have determined that the
final rule will not result in expenditures by State, local, or tribal
governments or by the private sector of $100 million or more.
Accordingly, the OCC and OTS have not prepared a budgetary impact
statement or specifically addressed the regulatory alternatives
considered.

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Accounting, Agriculture, Banks, banking, Confidential business
information, Crime, Currency, Federal Reserve System, Mortgages,
Reporting and recordkeeping requirements, Securities.

12 CFR Part 325

    Bank deposit insurance, Banks, banking, Capital adequacy, Reporting
and recordkeeping requirements,

[[Page 10199]]

Savings associations, State non-member banks.

12 CFR Part 567

    Capital, Reporting and recordkeeping requirements, Savings
associations.

Authority and Issuance

Office of the Comptroller of the Currency

12 CFR CHAPTER I

    For the reasons set out in the joint preamble, part 3 of chapter I
of title 12 of the Code of Federal Regulations is amended as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 continues to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 1835, 3907 and 3909.

    2. In Sec. 3.6, paragraph (c) is revised to read as follows:

Sec. 3.6  Minimum capital ratios.

* * * * *
    (c) Additional leverage ratio requirement. An institution operating
at or near the level in paragraph (b) of this section should have well-
diversified risks, including no undue interest rate risk exposure;
excellent control systems; good earnings; high asset quality; high
liquidity; and well managed on-and off-balance sheet activities; and in
general be considered a strong banking organization, rated composite 1
under the Uniform Financial Institutions Rating System (CAMELS) rating
system of banks. For all but the most highly-rated banks meeting the
conditions set forth in this paragraph (c), the minimum Tier 1 leverage
ratio is 4 percent. In all cases, banking institutions should hold
capital commensurate with the level and nature of all risks.
    3. In appendix A to part 3, section 3, the second undesignated
paragraph and paragraphs (a)(3)(iii) and (a)(3)(iv) introductory text
are revised to read as follows:

Appendix A To Part 3--Risk-Based Capital Guidelines

* * * * *

Section 3. Risk Categories/Weights for On-Balance Sheet Assets and
Off-Balance Sheet Items

* * * * *
    Some of the assets on a bank's balance sheet may represent an
indirect holding of a pool of assets, e.g., mutual funds, that
encompasses more than one risk weight within the pool. In those
situations, the bank may assign the asset to the risk category
applicable to the highest risk-weighted asset that pool is permitted
to hold pursuant to its stated investment objectives in the fund's
prospectus. Alternatively, the bank may assign the asset on a pro
rata basis to different risk categories according to the investment
limits in the fund's prospectus. In either case, the minimum risk
weight that may be assigned to such a pool is 20%. If a bank assigns
the asset on a pro rata basis, and the sum of the investment limits
in the fund's prospectus exceeds 100%, the bank must assign the
highest pro rata amounts of its total investment to the higher risk
category. If, in order to maintain a necessary degree of liquidity,
the fund is permitted to hold an insignificant amount of its assets
in short-term, highly-liquid securities of superior credit quality
(that do not qualify for a preferential risk weight), such
securities generally will not be taken into account in determining
the risk category into which the bank's holding in the overall pool
should be assigned. The prudent use of hedging instruments by a fund
to reduce the risk of its assets will not increase the risk
weighting of the investment in that fund above the 20% category.
However, if a fund engages in any activities that are deemed to be
speculative in nature or has any other characteristics that are
inconsistent with the preferential risk weighting assigned to the
fund's assets, the bank's investment in the fund will be assigned to
the 100% risk category. More detail on the treatment of mortgage-
backed securities is provided in section 3(a)(3)(vi) of this
appendix A.
    (a) * * *
    (3) * * *
    (iii) Loans secured by first mortgages on one-to-four family
residential properties, either owner-occupied or rented, provided
that such loans are not otherwise 90 days or more past due, or on
nonaccrual or restructured. It is presumed that such loans will meet
prudent underwriting standards. If a bank holds a first lien and
junior lien on a one-to-four family residential property and no
other party holds an intervening lien, the transaction is treated as
a single loan secured by a first lien for the purposes of both
determining the loan-to-value ratio and assigning a risk weight to
the transaction. Furthermore, residential property loans made for
the purpose of construction financing are assigned to the 100% risk
category of section 3(a)(4) of this appendix A; however, these loans
may be included in the 50% risk category of this section 3(a)(3) of
this appendix A if they are subject to a legally binding sales
contract and satisfy the requirements of section 3(a)(3)(iv) of this
appendix A.
    (iv) Loans to residential real estate builders for one-to-four
family residential property construction, if the bank obtains
sufficient documentation demonstrating that the buyer of the home
intends to purchase the home (i.e., a legally binding written sales
contract) and has the ability to obtain a mortgage loan sufficient
to purchase the home (i.e., a firm written commitment for permanent
financing of the home upon completion), subject to the following
additional criteria:
* * * * *
    Dated: February 23, 1999.
John D. Hawke, Jr.,
Comptroller of the Currency.

Federal Reserve System

12 CFR CHAPTER II

    For the reasons set forth in the joint preamble, part 208 of
chapter II of title 12 of the Code of Federal Regulations is amended as
set forth below:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 is revised to read as
follows:

    Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d), 1823(j),
1828(o), 1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 3105,
3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),
78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318; 42 U.S.C.
4012a, 4104a, 4104b, 4106, and 4128.

    2. In appendix A to part 208, section III. A., footnote 21 is
revised to read as follows:

Appendix A to Part 208--Capital Adequacy Guidelines for State
Member Banks: Risk-Based Measure

* * * * *
    III. * * *
    A. * * * 21
---------------------------------------------------------------------------

    \21\ An investment in shares of a fund whose portfolio consists
primarily of various securities or money market instruments that, if
held separately, would be assigned to different risk categories,
generally is assigned to the risk category appropriate to the
highest risk-weighted asset that the fund is permitted to hold in
accordance with the stated investment objectives set forth in its
prospectus. A bank may, at its option, assign a fund investment on a
pro rata basis to different risk categories according to the
investment limits in the fund's prospectus. In no case will an
investment in shares in any fund be assigned to a total risk weight
less than 20 percent. If a bank chooses to assign a fund investment
on a pro rata basis, and the sum of the investment limits of assets
in the fund's prospectus exceeds 100 percent, the bank must assign
risk weights in descending order. If, in order to maintain a
necessary degree of short-term liquidity, a fund is permitted to
hold an insignificant amount of its assets in short-term, highly
liquid securities of superior credit quality that do not qualify for
a preferential risk weight, such securities generally will be
disregarded when determining the risk category into which the bank's
holding in the overall fund should be assigned. The prudent use of
hedging instruments by a fund to reduce the risk of its assets also
will not increase the risk weighting of the fund investment. For
example, the use of hedging instruments by a fund to reduce the
interest rate risk of its government bond portfolio will not
increase the risk weight of that fund above the 20 percent category.
Nonetheless, if a fund engages in any activities that appear
speculative in nature or has any other characteristics that are
inconsistent with the preferential risk weighting assigned to the
fund's assets, holdings in the fund will be assigned to the 100
percent risk category.
---------------------------------------------------------------------------

* * * * *

[[Page 10200]]

    3. In appendix A to part 208, section III.C.3., footnote 34 is
revised to read as follows:
* * * * *
    III. * * *
    C. * * *
    3. * * *34
---------------------------------------------------------------------------

    \34\ If a bank holds the first and junior lien(s) on a
residential property and no other party holds an intervening lien,
the transaction is treated as a single loan secured by a first lien
for the purposes of determining the loan-to-value ratio and
assigning a risk weight.
---------------------------------------------------------------------------

* * * * *
    4. In appendix A to part 208, section III.C.3. is amended by adding
a new sentence to the end of the first paragraph of footnote 35 to read
as follows:
* * * * *
    III. * * *
    C. * * *
    3. * * *35
---------------------------------------------------------------------------

    \35\ * * * Such loans to builders will be considered prudently
underwritten only if the bank has obtained sufficient documentation
that the buyer of the home intends to purchase the home (i.e., has a
legally binding written sales contract) and has the ability to
obtain a mortgage loan sufficient to purchase the home (i.e., has a
firm written commitment for permanent financing of the home upon
completion). * * *
---------------------------------------------------------------------------

* * * * *
    4. In appendix B to part 208, section II.a. is revised to read as
follows:

Appendix B to Part 208--Capital Adequacy Guidelines for State
Member Banks: Tier 1 Leverage Measure

* * * * *
    II. * * *
    a. The minimum ratio of Tier 1 capital to total assets for
strong banking institutions (rated composite ``1'' under the UFIRS
rating system of banks) is 3.0 percent. For all other institutions,
the minimum ratio of Tier 1 capital to total assets is 4.0 percent.
Banking institutions with supervisory, financial, operational, or
managerial weaknesses, as well as institutions that are anticipating
or experiencing significant growth, are expected to maintain capital
ratios well above the minimum levels. Moreover, higher capital
ratios may be required for any banking institution if warranted by
its particular circumstances or risk profile. In all cases,
institutions should hold capital commensurate with the level and
nature of the risks, including the volume and severity of problem
loans, to which they are exposed.
* * * * *
    By order of the Board of Governors of the Federal Reserve
System, February 24, 1999.
Jennifer J. Johnson,
Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR CHAPTER III

    For the reasons set forth in the preamble, part 325 of chapter III
of title 12 of the Code of Federal Regulations is proposed to be
amended as follows:

PART 325--CAPITAL MAINTENANCE

    1. The authority citation for part 325 continues to read as
follows:

    Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat.
2236, 2355, 2386 (12 U.S.C. 1828 note).

    2. Paragraph (b)(2) in Sec. 325.3 is revised to read as follows:

Sec. 325.3  Minimum leverage capital requirement.

* * * * *
    (b) * * *
    (2) For all but the most highly-rated institutions meeting the
conditions set forth in paragraph (b)(1) of this section, the minimum
leverage capital requirement for a bank (or for an insured depository
institution making an application to the FDIC) shall consist of a ratio
of Tier 1 capital to total assets of not less than 4 percent.
* * * * *
    3. In appendix A to part 325, section II.B., paragraph 1. is
revised to read as follows:

Appendix A To Part 325--Statement of Policy on Risk-Based Capital

* * * * *
    II. * * *
    B. * * *

    1. Indirect Holdings of Assets. Some of the assets on a bank's
balance sheet may represent an indirect holding of a pool of assets;
for example, mutual funds. An investment in shares of a mutual fund
whose portfolio consists solely of various securities or money
market instruments that, if held separately, would be assigned to
different risk categories, generally is assigned to the risk
category appropriate to the highest risk-weighted asset that the
fund is permitted to hold in accordance with the stated investment
objectives set forth in its prospectus. The bank may, at its option,
assign the investment on a pro rata basis to different risk
categories according to the investment limits in the fund's
prospectus, but in no case will indirect holdings through shares in
any mutual fund be assigned to a risk weight less than 20 percent.
If the bank chooses to assign its investment on a pro rata basis,
and the sum of the investment limits in the fund's prospectus
exceeds 100 percent, the bank must assign risk weights in descending
order. If, in order to maintain a necessary degree of short-term
liquidity, a fund is permitted to hold an insignificant amount of
its assets in short-term, highly liquid securities of superior
credit quality that do not qualify for a preferential risk weight,
such securities will generally be disregarded in determining the
risk category to which the bank's holdings in the overall fund
should be assigned. The prudent use of hedging instruments by a
mutual fund to reduce the risk of its assets will not increase the
risk weighting of the mutual fund investment. For example, the use
of hedging instruments by a mutual fund to reduce the interest rate
risk of its government bond portfolio will not increase the risk
weight of that fund above the 20 percent category. Nonetheless, if
the fund engages in any activities that appear speculative in nature
or has any other characteristics that are inconsistent with the
preferential risk weighting assigned to the fund's assets, holdings
in the fund will be assigned to the 100 percent risk category.

    4. In appendix A to part 325, section II.C., footnote number 26 is
revised to read as follows:
* * * * *
    II. * * *
    C. * * * 26

    \26\ If a bank holds the first and junior lien(s) on a
residential property and no other party holds an intervening lien,
the transactions are treated as a single loan secured by a first
lien for purposes of determining the loan-to-value ratio and
assigning a risk weight.
---------------------------------------------------------------------------

    By order of the Board of Directors.

    Dated at Washington, DC, this 18th day of December, 1998.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.

Office of Thrift Supervision

12 CFR CHAPTER V

    Accordingly, the Office of Thrift Supervision hereby amends title
12, chapter V, of the Code of Federal Regulations, as set forth below:

PART 567--CAPITAL

    1. The authority citation for part 567 continues to read as
follows:

    Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828
(note).

    2. Section 567.1 is amended by adding a new sentence following the
third sentence in the definition of qualifying mortgage loan, revising
paragraphs (1)(ii) and (1)(iii) introductory text in the definition of
qualifying residential construction loan and adding the definitions of
Tier 1 capital and Tier 2 capital as follows:

Sec. 567.1  Definitions.

* * * * *
    Qualifying mortgage loan. * * * If a savings association holds the
first and junior lien(s) on a residential property and no other party
holds an intervening lien, the transaction is treated as a single loan
secured by a first lien for the purposes of determining the loan-to-

[[Page 10201]]

value ratio and the appropriate risk weight under Sec. 567.6(a).
* * * * *
    Qualifying residential construction loan. (1) * * *
    (ii) The residence being constructed must be a 1-4 family residence
sold to a home purchaser;
    (iii) The lending savings association must obtain sufficient
documentation from a permanent lender (which may be the construction
lender) demonstrating that:
* * * * *
    Tier 1 capital. The term Tier 1 capital means core capital as
computed in accordance with Sec. 567.5(a) of this part.
    Tier 2 capital. The term Tier 2 capital means supplementary capital
as computed in accordance with Sec. 567.5 of this part.
* * * * *
    3. Section 567.2(a)(2)(ii) is revised to read as follows:

Sec. 567.2  Minimum regulatory capital requirement.

    (a) * * *
    (2) Leverage ratio requirement. * * *
    (ii) A savings association must satisfy this requirement with core
capital as defined in Sec. 567.5(a) of this part.
* * * * *
    4. Section 567.6(a)(1)(vi) is revised to read as follows:

Sec. 567.6  Risk-based capital credit risk-weight categories.

    (a) * * *
    (1) * * *
    (vi) Indirect ownership interests in pools of assets. Assets
representing an indirect holding of a pool of assets, e.g., mutual
funds, are assigned to risk-weight categories under this section based
upon the risk weight that would be assigned to the assets in the
portfolio of the pool. An investment in shares of a mutual fund whose
portfolio consists primarily of various securities or money market
instruments that, if held separately, would be assigned to different
risk-weight categories, generally is assigned to the risk-weight
category appropriate to the highest risk-weighted asset that the fund
is permitted to hold in accordance with the investment objectives set
forth in its prospectus. The savings association may, at its option,
assign the investment on a pro rata basis to different risk-weight
categories according to the investment limits in its prospectus. In no
case will an investment in shares in any such fund be assigned to a
total risk weight less than 20 percent. If the savings association
chooses to assign investments on a pro rata basis, and the sum of the
investment limits of assets in the fund's prospectus exceeds 100
percent, the savings association must assign the highest pro rata
amounts of its total investment to the higher risk categories. If, in
order to maintain a necessary degree of short-term liquidity, a fund is
permitted to hold an insignificant amount of its assets in short-term,
highly liquid securities of superior credit quality that do not qualify
for a preferential risk weight, such securities will generally be
disregarded in determining the risk-weight category into which the
savings association's holding in the overall fund should be assigned.
The prudent use of hedging instruments by a mutual fund to reduce the
risk of its assets will not increase the risk weighting of the mutual
fund investment. For example, the use of hedging instruments by a
mutual fund to reduce the interest rate risk of its government bond
portfolio will not increase the risk weight of that fund above the 20
percent category. Nonetheless, if the fund engages in any activities
that appear speculative in nature or has any other characteristics that
are inconsistent with the preferential risk-weighting assigned to the
fund's assets, holdings in the fund will be assigned to the 100 percent
risk-weight category.
* * * * *
    5. Section 567.8 is revised to read as follows:

Sec. 567.8  Leverage ratio.

    (a) The minimum leverage capital requirement for a savings
association assigned a composite rating of 1, as defined in Sec. 516.3
of this chapter, shall consist of a ratio of core capital to adjusted
total assets of 3 percent. These generally are strong associations that
are not anticipating or experiencing significant growth and have well-
diversified risks, including no undue interest rate risk exposure,
excellent asset quality, high liquidity, and good earnings.
    (b) For all savings associations not meeting the conditions set
forth in paragraph (a) of this section, the minimum leverage capital
requirement shall consist of a ratio of core capital to adjusted total
assets of 4 percent. Higher capital ratios may be required if warranted
by the particular circumstances or risk profiles of an individual
savings association. In all cases, savings associations should hold
capital commensurate with the level and nature of all risks, including
the volume and severity of problem loans, to which they are exposed.

    Dated: December 15, 1998.

    By the Office of Thrift Supervision.
Ellen Seidman,
Director.
[FR Doc. 99-5012 Filed 3-1-99; 8:45 am]
BILLING CODE OCC: 4810-33-P (25%); Board: 6210-01-P (25%); FDIC: 6714-
01-P (25%); OTS: 6720-01-P (25%)

Last Updated 07/17/1999 communications@fdic.gov