[Federal Register: March 8, 2000 (Volume 65,
Number 46)]
[Proposed Rules]
[Page 12319-12352]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08mr00-37]
[[Page 12319]]
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Part II
Department of the Treasury
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Office of the Comptroller of the Currency
Office of Thrift Supervision
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Federal Reserve System
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Federal Deposit Insurance Corporation
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12 CFR Parts 3, 208, 225, 325 and 567
Risk-Based Capital Standards; Recourse and Direct Credit Substitutes;
Proposed Rule
[[Page 12320]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 00-06]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1055]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB31
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[Docket No. 2000-15]
RIN 1550-AB11
Risk-Based Capital Standards; Recourse and Direct Credit
Substitutes
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: Joint notice of proposed rulemaking.
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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 proposing changes to their risk-
based capital standards to address the regulatory capital treatment of
recourse obligations and direct credit substitutes that expose banks,
bank holding companies, and thrifts (collectively, banking
organizations) to credit risk. The proposal treats recourse obligations
and direct credit substitutes more consistently than under the
agencies' current risk-based capital standards. In addition, the
agencies would use credit ratings and certain alternative approaches to
match the risk-based capital requirement more closely to a banking
organization's relative risk of loss in asset securitizations. The
proposal also requires the sponsor of a revolving credit securitization
that involves an early amortization feature to hold capital against the
amount of assets under management, i.e. the off-balance sheet
securitized receivables.
This proposal is intended to result in more consistent treatment of
recourse obligations and similar transactions among the agencies, more
consistent risk-based capital treatment for certain types of
transactions involving similar risk, and capital requirements that more
closely reflect a banking organization's relative exposure to credit
risk.
DATES: Your comments must be received by June 7, 2000.
ADDRESSES: Comments should be directed to:
OCC: You may send comments electronically to regs.comments@
occ.treas.gov or by mail to Docket No. 00-06, Communications Division,
Third Floor, Office of the Comptroller of the Currency, 250 E Street,
SW, Washington, DC 20219. In addition, you may send comments by
facsimile transmission to (202) 874-5274. You can inspect and photocopy
comments at that address.
Board: Comments, which should refer to Docket No. R-1055, may be
mailed to Jennifer J. Johnson, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW,
Washington, DC 20551. Comments may also be delivered to Room B-2222 of
the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the
guard station in the Eccles Building courtyard on 20th Street between
Constitution Avenue and C Street, NW, at any time. Comments may be
inspected in Room MP-500 of the Martin Building between 9 a.m. and 5
p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's Rules
Regarding Availability of Information.
FDIC: Written comments should be addressed to Robert E. Feldman,
Executive Secretary, Attention: Comments/OES, Federal Deposit Insurance
Corporation, 550 17th Street, NW, Washington, DC 20429. Comments may be
hand delivered to the guard station at the rear of the 550 17th Street
Building (located on F Street), on business days between 7 a.m. and 5
p.m. (Fax number: (202) 898-3838; Internet address: comments@fdic.gov).
Comments may be inspected and photocopied in the FDIC Public
Information Center, Room 100, 801 17th Street, NW, Washington, DC,
between 9 a.m. and 4:30 p.m. on business days.
OTS: Send comments to Manager, Dissemination Branch, Records
Management and Information Policy, Office of Thrift Supervision, 1700 G
Street, NW, Washington, DC 20552, Attention Docket No. 2000-15. These
submissions may be hand-delivered to 1700 G Street, NW, from 9 a.m. to
5 p.m. on business days or may be sent by facsimile transmission to FAX
number (202) 906-7755; or by e-mail: public.info@ots.treas.gov. Those
commenting by e-mail should include their name and telephone number.
Comments will be available for inspection at 1700 G Street, NW, from 9
to 4 p.m. on business days.
FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic
Advisor or Amrit Sekhon, Risk Specialist, Capital Policy Division,
(202) 874-5070; Laura Goldman, Senior Attorney, Legislative and
Regulatory Activities Division, (202) 874-5090, Office of the
Comptroller of the Currency, 250 E Street, SW, Washington, DC 20219.
Board: Thomas R. Boemio, Senior Supervisory Financial Analyst,
(202) 452-2982, or Norah Barger, Assistant Director (202) 452-2402,
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 Street and Constitution Avenue, NW, Washington, DC 20551.
FDIC: Robert F. Storch, Chief, Accounting Section, Division of
Supervision, (202) 898-8906; or Jamey Basham, Counsel, Legal Division,
(202) 898-7265, Federal Deposit Insurance Corporation, 550 17th Street,
NW, Washington, DC 20429.
OTS: Michael D. Solomon, Senior Program Manager for Capital Policy,
Supervision Policy, (202) 906-5654; or Karen Osterloh, Assistant Chief
Counsel (202) 906-6639, Office of Thrift Supervision, 1700 G Street,
NW, Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
I. Introduction
The agencies are proposing to amend their risk-based capital
standards to change the treatment of certain recourse obligations,
direct credit substitutes, and securitized transactions that expose
banking organizations to credit risk. This proposal amends the
agencies' risk-based capital standards to align more closely the risk-
based capital treatment of recourse obligations and direct credit
substitutes and to vary the capital requirements for positions in
securitized transactions (and certain other credit exposures) according
to their relative risk. The proposal also requires the sponsor of a
revolving credit securitization that involves an early amortization
feature to hold capital
[[Page 12321]]
against the amount of assets under management in that securitization.
This proposal builds on the agencies' earlier work with respect to
the appropriate risk-based capital treatment for recourse obligations
and direct credit substitutes. On May 25, 1994, the agencies published
in the Federal Register a proposal to reduce the capital requirement
for banks for low-level recourse transactions, to treat first-loss (but
not second-loss) direct credit substitutes like recourse, and to
implement definitions of ``recourse,'' ``direct credit substitute,''
and related terms. 59 FR 27116 (May 25, 1994) (the 1994 Notice). The
1994 Notice also contained, in an advance notice of proposed
rulemaking, a proposal to use credit ratings to determine the capital
treatment of certain recourse obligations and direct credit
substitutes. The OCC, the Board, and the FDIC subsequently implemented
the capital reduction for low-level recourse transactions, thereby
satisfying the requirements of section 350 of the Riegle Community
Development and Regulatory Improvement Act, Public Law 103-325, sec.
350, 108 Stat. 2160, 2242 (1994) (CDRI Act).\1\ The OTS risk-based
capital regulation already included the low-level recourse treatment
required by the statute.\2\ The agencies did not issue a final
regulation on the remaining elements of the 1994 Notice.
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\1\ See 60 FR 17986 (April 10, 1995) (OCC); 60 FR 8177 (February
13, 1995) (Board); 60 FR 15858 (March 28, 1995) (FDIC).
\2\ See 60 FR 45618 (August 31, 1995.)
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On November 5, 1997, the agencies published another notice of
proposed rulemaking. 62 FR 59943 (1997 Proposal). In the 1997 Proposal,
the agencies proposed to use credit ratings from nationally recognized
statistical rating organizations to determine the capital requirement
for recourse obligations, direct credit substitutes, and senior asset-
backed securities. Additionally, the 1997 Proposal requested comment on
a series of options and alternatives to supplement or replace the
ratings-based approach.
In June 1999, the Basel Committee on Banking Supervision issued a
consultative paper, ``A New Capital Adequacy Framework, that sets forth
possible revisions to the 1988 Basel Accord.\3\ The Basel consultative
paper discusses potential modifications to the current capital
standards, including the capital treatment of securitizations. The
suggested changes in the Basel consultative paper move in the same
direction as this proposal by looking to external credit ratings issued
by qualifying external credit assessment institutions as a basis for
determining the credit quality and the resulting capital treatment of
securitizations.
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\3\ International Convergence of Capital Measurement and Capital
Standards (July 1988).
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II. Background
A. Asset Securitization
Asset securitization is the process by which loans or other credit
exposures are pooled and reconstituted into securities, with one or
more classes or positions, that may then be sold. Securitization \4\
provides an efficient mechanism for banking organizations to buy and
sell loan assets or credit exposures and thereby to make them more
liquid.
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\4\ For purposes of this discussion, references to
``securitization'' also include structured finance transactions or
programs that generally create stratified credit risk positions,
which may or may not be in the form of a security, whose performance
is dependent upon a pool of loans or other credit exposures.
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Securitizations typically carve up the risk of credit losses from
the underlying assets and distribute it to different parties. The
``first dollar,'' or subordinate, loss position is first to absorb
credit losses; the most ``senior'' investor position is last; and there
may be one or more loss positions in between (``second dollar'' loss
positions). Each loss position functions as a credit enhancement for
the more senior loss positions in the structure.
For residential mortgages sold through certain Federally-sponsored
mortgage programs, a Federal government agency or Federal government
sponsored enterprise (GSE) guarantees the securities sold to investors.
However, many of today's asset securitization programs involve
nonmortgage assets or are not Federally supported in any way. Sellers
of these privately securitized assets therefore often provide other
forms of credit enhancement--first and second dollar loss positions--to
reduce investors' risk of credit loss.
A seller may provide this credit enhancement itself through
recourse arrangements. As defined in this proposal, ``recourse'' refers
to the risk of credit loss that a banking organization retains in
connection with the transfer of its assets. Banking organizations have
long provided recourse in connection with sales of whole loans or loan
participations; today, recourse arrangements frequently are associated
with asset securitization programs.
A seller may also arrange for a third party to provide credit
enhancement \5\ in an asset securitization. If the third-party
enhancement is provided by another banking organization, that
organization assumes some portion of the assets' credit risk. In this
proposal, all forms of third-party enhancements, i.e., all arrangements
in which a banking organization assumes risk of credit loss from third-
party assets or other claims that it has not transferred, are referred
to as ``direct credit substitutes.'' The economic substance of a
banking organization's risk of credit loss from providing a direct
credit substitute can be identical to its risk of credit loss from
transferring an asset with recourse.
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\5\ As used in this proposal, the terms ``credit enhancement''
and ``enhancement'' refer to both recourse arrangements and direct
credit substitutes.
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Depending on the type of securitization transaction, the sponsor of
a securitization may provide a portion of the total credit enhancement
internally, as part of the securitization structure, through the use of
spread accounts, overcollateralization, retained subordinated
interests, or other similar forms of on-balance sheet assets. When
these or other types of internal enhancements are provided, the
enhancements are considered a form of recourse for risk-based capital
purposes. Many asset securitizations use a combination of internal
enhancement, recourse, and third-party enhancement to protect investors
from risk of credit loss.
B. Risk Management of Exposures Arising From Securitization Activities
While asset securitization can enhance both credit availability and
a banking organization's profitability, managing the risks associated
with this activity can pose significant challenges. This is because the
risks involved, while not new to banking organizations, may be less
obvious and more complex than the risks of traditional lending.
Specifically, securitization can involve credit, liquidity,
operational, legal, and reputational risks in concentrations and forms
that may not be fully recognized by management or adequately
incorporated into a banking organization's risk management systems.
The risk-based capital treatment described in this proposal
provides one important way of addressing the credit risk presented by
securitization activities, but a banking organization's compliance with
capital standards should be complemented by effective risk management
strategies. The agencies expect that banking organizations will
identify, measure, monitor and control the risks of their
securitization activities (including
[[Page 12322]]
synthetic securitizations \6\ using credit derivatives) and explicitly
incorporate the full range of risks into their risk management systems.
Management is responsible for having adequate policies and procedures
in place to ensure that the economic substance of their risks is fully
recognized and appropriately managed. Banking organizations should be
able to measure and manage their risk exposure from risk positions in
the securitizations, either retained or acquired, and should be able to
assess the credit quality of the retained residual portfolio after the
transfer of assets in a securitization transaction. The formality and
sophistication with which the risks of these activities are
incorporated into a banking organization's risk management system
should be commensurate with the nature and volume of its securitization
activities. Banking organizations with significant securitization
activities, no matter what the size of their on-balance sheet assets,
are expected to have more elaborate and formal approaches to manage the
risks. Failure to understand the risks inherent in securitization
activities and to incorporate them into risk management systems and
internal capital allocations may constitute an unsafe or unsound
banking practice.
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\6\ ``Synthetic securitization'' refers to the bundling of
credit risk associated with on-balance sheet assets and off-balance
sheet items for subsequent sale into the market.
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Banking organizations must have adequate systems that evaluate the
effect of securitization transactions on the banking organization's
risk profile and capital adequacy. Based on the complexity of
transactions, these systems should be capable of differentiating
between the nature and quality of the risk exposures transferred versus
those that the banking organization retains. Adequate management
systems usually:
<bullet> Have an internal system for grading credit risk exposures,
including: (1) Adequate differentiation of risk among risk grades; (2)
adequate controls to ensure the objectivity and consistency of the
rating process; and (3) analysis or evidence supporting the accuracy or
appropriateness of the risk-grading system.\7\
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\7\ In this regard, the agencies note that one increasingly
important component of the systems for controlling credit risk at
larger banking organizations is the identification of the gradations
in credit risk among their business loans and the assignment of
internal credit risk ratings to loans that correspond to these
gradations. The agencies believe that the use of such an internal
rating process is appropriate--indeed, necessary--for sound risk
management at large banking organizations. In particular, those
banking organizations with significant involvement in securitization
activities should have relatively elaborate and formal approaches
for assessing and managing the associated credit risk.
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<bullet> Evaluate the effect of the transaction on the nature and
distribution of the banking book exposures that have not been
transferred in connection with securitization. This analysis should
include a comparison of the banking book's risk profile before and
after the transaction, including the mix of exposures by risk grade and
by business or economic sector. The analysis should also include
identification of any concentrations of credit risk.
<bullet> Perform rigorous, forward-looking stress testing \8\ on
exposures that have not been transferred (that is, loans and
commitments remaining in the banking book), transferred exposures, and
exposures retained to facilitate transfers (that is, credit
enhancements).
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\8\ Stress testing usually involves identifying possible events
or changes in market behavior that could have unfavorable effects on
an banking organization and assessing the organization's ability to
withstand them. Stress testing should not only consider the
probability of adverse events, but also potential ``worst case''
scenarios. Such an analysis should be done on a consolidated basis
and consider, for example, the effect of higher than expected levels
of delinquencies and defaults. The analysis should also consider the
consequences of early amortization events that could raise concerns
regarding a banking organization's capital adequacy and its
liquidity and funding capabilities. Stress test analyses should also
include contingency plans regarding the actions management might
take given certain situations.
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<bullet> Have an internal economic capital allocation methodology
that provides the banking organization will have adequate
capitalization to meet a specific probability that it will not become
insolvent if unexpected credit losses occur and that readjusts, as
necessary, the sponsoring bank's internal economic capital requirements
to take into account the effect of the securitization transactions.
Banking organizations should ensure that their capital positions
are sufficiently strong to support all of the risks associated with
these activities on a fully consolidated basis and should maintain
adequate capital in all affiliated entities engaged in these
activities.
C. Current Risk-Based Capital Treatment of Recourse and Direct Credit
Substitutes
Currently, the agencies' risk-based capital standards apply
different treatments to recourse arrangements and direct credit
substitutes. As a result, capital requirements applicable to credit
enhancements do not consistently reflect credit risk. The current rules
of the OCC, Board, and FDIC (the banking agencies) are also not
entirely consistent with those of the OTS.
1. Recourse
The agencies' risk-based capital guidelines prescribe a single
treatment for assets transferred with recourse, regardless of whether
the transaction is reported as a financing or a sale of assets in a
bank's Consolidated Reports of Condition and Income (Call Report), a
bank holding company's FR Y-9 reports, or a thrift's Thrift Financial
Report.\9\ For a transaction reported as a financing, the transferred
assets remain on the balance sheet and are risk-weighted. For a
transaction reported as a sale, the entire outstanding amount of the
assets sold (not just the contractual amount of the recourse
obligation) is converted into an on-balance sheet credit equivalent
amount using a 100% credit conversion factor. This credit equivalent
amount (less any applicable recourse liability account recorded on the
balance sheet) is then risk-weighted.\10\ If the seller's balance sheet
includes as an asset any retained interest in the assets sold, the
retained interest is not risk-weighted separately. Thus, regardless of
the method used to account for the transfer, risk-based capital is held
against the full, risk-weighted amount of the transferred assets,
although the transaction is subject to the low-level recourse rule,
which limits the maximum risk-based capital requirement to the banking
organization's maximum contractual exposure. \11\
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\9\ Assets transferred with any amount of recourse in a
transaction reported as a financing in accordance with generally
accepted accounting principles (GAAP) remain on the balance sheet
and are risk-weighted in the same manner as any other on-balance
sheet asset. Assets transferred with recourse in a transaction that
is reported as a sale under GAAP are removed from the balance sheet
and are treated as off-balance sheet exposures for risk-based
capital purposes.
\10\ Consistent with statutory requirements, the agencies'
current rules also provide for special treatment of sales of small
business loan obligations with recourse. See 12 CFR Part 3, appendix
A, Section 3(c) (OCC); 12 CFR parts 208 and 225, appendix A, II.B.5
(FRB); 12 CFR part 325, appendix A, II.B.6 (FDIC); 12 CFR
567.6(E)(3) (OTS).
\11\ Section 350 of the CDRI Act required the agencies to
prescribe regulations providing that the risk-based capital
requirement for assets transferred with recourse could not exceed a
banking organization's maximum contractual exposure. The agencies
may require a higher amount if necessary for safety and soundness
reasons. See 12 U.S.C. 4808.
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For leverage capital ratio purposes, if a transfer with recourse is
reported as a financing, the transferred assets remain on the
transferring banking organization's balance sheet and the banking
organization must hold leverage capital against these assets. If a
transfer with recourse is reported as a sale, the assets sold do not
remain on the selling
[[Page 12323]]
banking organization's balance sheet and the banking organization need
not hold leverage capital against these assets. However, if the
seller's balance sheet includes as an asset any retained interest in
the assets sold, leverage capital must be held against the retained
interest.
2. Direct Credit Substitutes
Direct credit substitutes are treated differently from recourse
under the current risk-based capital standards. Under the banking
agencies' current standards, off-balance sheet direct credit
substitutes, such as financial standby letters of credit provided for
third-party assets, carry a 100% credit conversion factor. However,
only the dollar amount of the direct credit substitute is converted
into an on-balance sheet credit equivalent amount, so that capital is
held only against the face amount of the direct credit substitute. The
capital requirement for a recourse arrangement, in contrast, generally
is based on the full amount of the assets enhanced.
If a direct credit substitute covers less than 100% of the
potential losses on the assets enhanced, the current capital treatment
results in a lower capital charge for a direct credit substitute than
for a comparable recourse arrangement. For example, if a direct credit
substitute covers losses up to the first 20% of the assets enhanced,
then the on-balance sheet credit equivalent amount equals that 20%
amount, and risk-based capital is held against only the 20% amount. In
contrast, required capital for a first-loss 20% recourse arrangement is
higher because capital is held against the full outstanding amount of
the assets enhanced, subject to the low-level recourse rule.
Currently, under the banking agencies' guidelines, purchased
subordinated interests receive the same capital treatment as off-
balance sheet direct credit substitutes. That is, the amount of the
purchased subordinated interest is placed in the appropriate risk-
weight category. In contrast, a banking organization that retains a
subordinated interest in connection with the transfer of its own assets
is considered to have transferred the assets with recourse. As a
result, the banking organization must hold capital against the carrying
amount of the retained subordinated interest as well as the outstanding
amount of all senior interests that it supports, subject to the low-
level recourse rule.
The OTS risk-based capital regulation treats some forms of direct
credit substitutes (e.g., financial standby letters of credit) in the
same manner as the banking agencies' guidelines. However, unlike the
banking agencies, the OTS treats purchased subordinated interests
(except for certain high quality subordinated mortgage-related
securities) under its general recourse provisions. The risk-based
capital requirement is based on the carrying amount of the subordinated
interest plus all senior interests, as though the thrift owned the full
outstanding amount of the assets enhanced.
3. Concerns Raised by Current Risk-Based Capital Treatment
The agencies' current risk-based capital standards raise
significant concerns with respect to the treatment of recourse and
direct credit substitutes. First, banking organizations are often
required to hold different amounts of capital for recourse arrangements
and direct credit substitutes that expose the banking organization to
equivalent risk of credit loss. Banking organizations are taking
advantage of this anomaly, for example, by providing first-loss letters
of credit to asset-backed commercial paper conduits that lend directly
to corporate customers. This results in a significantly lower capital
requirement than if the loans had originally been carried on the
banking organizations' balance sheets and then were sold. Moreover, the
current capital standards do not recognize differences in risk
associated with different loss positions in asset securitizations, nor
do they provide uniform definitions of recourse, direct credit
substitute, and associated terms.
III. Description of the Proposal
This proposal would amend the agencies' risk-based capital
standards as follows:
<bullet> The proposal defines ``recourse'' and revises the
definition of ``direct credit substitute''; \12\
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\12\ The OTS, which already defines the term ``recourse'' in its
rules, would revise its definition so that it is consistent with the
definition adopted by the other agencies. The OTS is also adding a
definition of ``financial guarantee-type letter of credit'' to be
consistent with the OCC and the Board.
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<bullet> It provides more consistent risk-based capital treatment
for recourse obligations and direct credit substitutes;
<bullet> It varies the capital requirements for positions in
securitized transactions according to their relative risk exposure,
using credit ratings from nationally recognized statistical rating
organizations \13\ (rating agencies) to measure the level of risk;
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\13\ ``Nationally recognized statistical rating organization''
means an entity recognized by the Division of Market Regulation of
the Securities and Exchange Commission as a nationally recognized
statistical rating organization for various purposes, including the
capital rules for broker-dealers. See SEC Rule 15c3-1(c)(2)(vi)(E),
(F) and (H), 17 CFR 240.15c3-091(c)(2)(vi)(E), (F), and (H).
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<bullet> It permits the limited use of a banking organization's
qualifying internal risk rating system, a rating agency's or other
appropriate third party's review of the credit risk of positions in
structured programs, and qualifying software to determine the capital
requirement for certain unrated direct credit substitutes; and
<bullet> It requires the sponsor of a revolving credit
securitization that involves an early amortization feature to hold
capital against the amount of assets under management in that
securitization.
The use of credit ratings in this proposal is similar to the 1997
Proposal. Although many commenters expressed concerns about specific
details in the 1997 Proposal, commenters generally supported the goal
of making the capital requirements associated with asset
securitizations more rational and efficient, and viewed the 1997
Proposal as a positive step toward achieving a more consistent,
rational, and efficient regulatory capital framework. The agencies have
made several changes to the 1997 Proposal in response to commenters'
concerns and based on further agency consideration of the issues
presented.
Several options and alternatives in the 1997 Proposal have been
eliminated: the modified gross-up approach, the ratings benchmark
approach, and the historical losses approach.\14\ Commenters expressed
numerous concerns about these approaches and the agencies agree that
better alternatives exist.
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\14\ For a description of these approaches, see 62 FR 59944,
59952-59961 (November 5, 1997).
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Commenters responding to the 1997 Proposal expressed a number of
concerns about the use of ratings from rating agencies to determine
capital requirements, especially in the case of unrated direct credit
substitutes. Commenters noted that banking organizations actively
involved in the securitization business have their own internal risk
rating systems, that banking organizations know their assets better
than third parties, and that a requirement that a banking organization
obtain a rating from a rating agency solely for regulatory capital
purposes is burdensome. Some commenters also expressed skepticism about
the suitability of rating agency credit ratings for regulatory capital
purposes.
In the opinion of the agencies, ratings have the advantages of
being relatively objective, widely used, and relied upon by investors
and other participants in
[[Page 12324]]
the financial markets. Ratings provide a flexible, efficient, market-
oriented way to measure credit risk. The agencies recognize, however,
that there are drawbacks to using credit ratings from rating agencies
to set capital requirements. Moreover, the agencies agree with some
commenters' observation that credit ratings are most useful with
respect to publicly-traded positions that would be rated regardless of
the agencies' risk-based capital requirements.
To minimize the need for banking organizations to obtain ratings on
otherwise unrated enhancements that are provided in asset-backed
commercial paper securitizations, the proposal permits banking
organizations to use their own qualifying internal risk rating systems
in place of ratings from rating agencies for risk weighting certain
direct credit substitutes. The use of internal risk ratings to assign
direct credit substitutes in asset-backed commercial paper programs to
rating categories under the ratings-based approach is dependent upon
the existence of adequate internal risk rating systems. The adequacy of
any internal risk rating system will depend upon a banking
organization's incorporation of the prudential standards outlined in
this proposal, as well as other factors recommended through supervisory
guidance or on a case-by-case basis.
Finally, the agencies are proposing an additional measure to
address the risk associated with early amortization features in certain
asset securitizations. The managed assets approach, described in
Section III.D., would apply a 20% risk weight to the amount of off-
balance sheet securitized assets under management in such transactions.
A. Definitions and Scope of the Proposal
1. Recourse
The proposal defines the term ``recourse'' to mean an arrangement
in which a banking organization retains risk of credit loss in
connection with an asset transfer, if the risk of credit loss exceeds a
pro rata share of the banking organization's claim on the assets. The
proposed definition of recourse is consistent with the banking
agencies' longstanding use of this term, and incorporates existing
agency practices regarding retention of risk in asset transfers into
the risk-based capital standards.\15\
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\15\ The OTS currently defines the term ``recourse'' more
broadly than the proposal to include arrangements involving credit
risk that a thrift assumes or accepts from third-party assets as
well as risk that it retains in an asset transfer. Under the
proposal, credit risk that a banking organization assumes from
third-party assets falls under the definition of ``direct credit
substitute'' rather than ``recourse.''
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Currently, the term ``recourse'' is not defined explicitly in the
banking agencies' risk-based capital guidelines. Instead, the
guidelines use the term ``sale of assets with recourse,'' which is
defined by reference to the Call Report Instructions. See Call Report
Instructions, Glossary (entry for ``Sales of Assets for Risk-Based
Capital Purposes''). Once a definition of recourse is adopted in the
risk-based capital guidelines, the banking agencies would remove the
cross-reference to the Call Report instructions from the guidelines.
The OTS capital regulation currently provides a definition of the term
``recourse,'' which would also be replaced once a final definition of
recourse is adopted.
2. Direct Credit Substitute
The proposed definition of ``direct credit substitute'' complements
the definition of recourse. The term ``direct credit substitute'' would
refer to any arrangement in which a banking organization assumes risk
of credit-related losses from assets or other claims it has not
transferred, if the risk of credit loss exceeds the banking
organization's pro rata share of the assets or other claims. Currently,
under the banking agencies' guidelines, this term covers guarantee-type
arrangements. As revised, it would also include explicitly items such
as purchased subordinated interests, agreements to cover credit losses
that arise from purchased loan servicing rights, credit derivatives and
lines of credit that provide credit enhancement.
Some commenters responding to the 1997 Proposal suggested that the
definition of ``direct credit substitute'' should exclude risk
positions that are not part of an asset securitization. Although direct
credit substitutes commonly are used in asset securitizations,
enhancements involving similar credit risk exposure can arise in other
contexts and should receive the same capital treatment as enhancements
associated with securitizations.
Several commenters objected to the 1997 Proposal's treatment of
direct credit substitutes as recourse. Commenters asserted that the
business of providing third-party credit enhancements has historically
been safe and profitable for banks and objected that the proposed
capital treatment would impair the competitive position of U.S. banks
and thrifts. As has been previously described, however, the current
treatment of direct credit substitutes is not consistent with the
treatment of recourse obligations. The agencies have concluded that the
difference in treatment between the two forms of credit enhancement
invites banking organizations to obtain direct credit substitutes in
place of recourse obligations in order to avoid the capital requirement
applicable to recourse obligations and on-balance-sheet assets. For
this reason, the agencies are again proposing, as a general rule, to
extend the current risk-based capital treatment of asset transfers with
recourse, including the low-level recourse rule, to direct credit
substitutes.
In an effort to address competitive inequities at the international
level, however, the agencies have raised this issue with the bank
supervisory authorities from the other countries represented on the
Basel Committee on Banking Supervision. The Basel Committee's
consultative paper, ``A New Capital Adequacy Framework,'' acknowledges
that the current Basel Capital Accord, upon which the agencies' risk-
based capital standards are based, lacks consistency in its treatment
of credit enhancements.
3. Lines of Credit
One commenter requested clarification that a line of credit that
provides credit enhancement for the financial obligations of an account
party could be a direct credit substitute only if it represented an
irrevocable obligation to the beneficiary. A revocable line of credit
would not be a direct credit substitute because the issuer could
protect itself against credit losses at any time prior to a draw on the
line of credit. However, an irrevocable line of credit could expose the
issuer to credit losses and would constitute a direct credit
substitute, if it met the criteria in the definitions. Also, any
conditions attached to the issuer's ability to revoke the undrawn
portion of a line of credit, or that interfere with the issuer's
ability to protect itself against credit loss prior to a draw, will
cause the line of credit to constitute a direct credit substitute.
4. Credit Derivatives
The proposed definitions of ``recourse'' and ``direct credit
substitute'' cover credit derivatives to the extent that a banking
organization's credit risk exposure exceeds its pro rata interest in
the underlying obligation. The ratings-based approach therefore applies
to rated instruments such as credit-linked notes issued as part of a
[[Page 12325]]
synthetic securitization. \16\ The agencies request comment on the
inclusion of credit derivatives in the definitions of ``recourse'' and
``direct credit substitute,'' as well as on the definition of ``credit
derivative'' contained in the proposal.
---------------------------------------------------------------------------
\16\ ``Synthetic securitization'' refers to the bundling of
credit risk associated with on-balance sheet assets and off-balance
sheet items for subsequent sale into the market. Credit derivatives,
and in particular credit-linked notes, are used to structure a
synthetic securitization. For more information on synthetic
securitizations see, Joint OCC and Federal Reserve Board Issuance on
Credit Derivatives, ``Capital Interpretations--Synthetic
Collateralized Loan Obligations,'' dated November 15, 1999.
---------------------------------------------------------------------------
5. Risks Other Than Credit Risks
A capital charge would be assessed only against arrangements that
create exposure to credit or credit-related risks. This continues the
agencies' current practice and is consistent with the risk-based
capital standards' traditional focus on credit risk. The agencies have
undertaken other initiatives to ensure that the risk-based capital
standards take interest rate risk and other non-credit related market
risks into account.
6. Implicit Recourse
The definitions cover all arrangements that are recourse or direct
credit substitutes in form or in substance. Recourse may also exist
when a banking organization assumes risk of loss without an explicit
contractual agreement or, if there is a contractual limit, when the
banking organization assumes risk of loss in an amount exceeding the
limit. The existence of implicit recourse is often a complex and fact-
specific issue, usually demonstrated by a banking organization's
actions to support a securitization beyond any contractual obligation.
Actions that may constitute implicit recourse include: providing
voluntary support for a securitization by selling assets to a trust at
a discount from book value; exchanging performing for non-performing
assets; or other actions that result in a significant transfer of value
in response to deterioration in the credit quality of a securitized
asset pool.
To date, the agencies have taken the position that when a banking
organization provides implicit recourse, it generally should hold
capital in the same amount as for assets sold with recourse. However,
the complexity of many implicit recourse arrangements and the variety
of circumstances under which implicit recourse may be provided raise
issues about whether recourse treatment is always the most appropriate
way to address the level of risk that a banking organization has
effectively retained or whether a different capital requirement would
be warranted in some circumstances. Accordingly, the 1997 Proposal
requested comment on the types of actions that should be considered
implicit recourse and how the agencies should treat those actions for
regulatory capital purposes.
Commenters responding to the 1997 Proposal generally supported the
view that implicit recourse is best handled on a case-by-case basis,
guided by the general rule that actions that demonstrate retention of
risk will trigger recourse treatment of affected transactions. The
agencies intend to continue to address implicit recourse case-by-case,
but may issue additional guidance if needed to clarify further the
circumstances in which a banking organization will be considered to
have provided implicit recourse.
7. Subordinated Interests in Loans or Pools of Loans
The definitions of recourse and direct credit substitute explicitly
cover a banking organization's ownership of subordinated interests in
loans or pools of loans. This continues the banking agencies'
longstanding treatment of retained subordinated interests as recourse
and recognizes that purchased subordinated interests can also function
as credit enhancements. (The OTS currently treats both retained and
purchased subordinated securities as recourse obligations.)
Subordinated interests generally absorb more than their pro rata share
of losses (principal and interest) from the underlying assets in the
event of default. For example, a multi-class asset securitization may
have several classes of subordinated securities, each of which provides
credit enhancement for the more senior classes. Generally, the holder
of any class that absorbs more than its pro rata share of losses from
the total underlying assets is providing credit protection for all of
the more senior classes. \17\
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\17\ Current OTS risk-based capital guidelines exclude certain
high-quality subordinated mortgage-related securities from treatment
as recourse arrangements due to their credit quality.
---------------------------------------------------------------------------
Some commenters questioned the treatment of purchased subordinated
interests as recourse. Subordinated interests expose holders to
comparable risk regardless of whether the interests are retained or
purchased. If purchased subordinated interests were not treated as
recourse, banking organizations could avoid recourse treatment by
swapping retained subordinated interests with other banking
organizations or by purchasing subordinated interests in assets
originated by a conduit. The proposal would mitigate the effect of
treating purchased subordinated interests as recourse by reducing the
capital requirement on interests that qualify under the multi-level
approach described in section III.B.
8. Representations and Warranties
When a banking organization transfers assets, including servicing
rights, it customarily makes representations and warranties concerning
those assets. When a banking organization purchases loan servicing
rights, it may also assume representations and warranties made by the
seller or a prior servicer. These representations and warranties give
certain rights to other parties and impose obligations upon the seller
or servicer of the assets. The proposal addresses those particular
representations and warranties that function as credit enhancements,
i.e. those where, typically, a banking organization agrees to protect
purchasers or some other party from losses due to the default or non-
performance of the obligor or insufficiency in the value of collateral.
Therefore, to the extent a banking organization's representations and
warranties function as credit enhancements to protect asset purchasers
or investors from credit risk by obligating the banking organization to
protect another party from losses due to credit risk in the transferred
assets, the proposal treats them as recourse or direct credit
substitutes.
The 1997 Proposal treated as recourse or a direct credit substitute
any representation or warranty other than a standard representation or
warranty. Standard representations and warranties were those referring
to facts verified by the seller or servicer with reasonable due
diligence or conditions within the control of the seller or servicer
and those providing for the return of assets in the event of fraud or
documentation deficiencies. Some commenters objected that the 1997
Proposal would treat as recourse many industry-standard warranties that
impose only minor operational risk instead of true credit risk. Other
commenters objected that the due diligence requirement was burdensome,
and that it would impose compliance costs on banking organizations
disproportionate to the risk assumed.
The current proposal focuses on whether a warranty allocates credit
risk to the banking organization, rather than whether the warranty is
somehow standard or customary within the industry. Several commenters
suggested
[[Page 12326]]
that the agencies expressly take accepted mortgage banking industry
practice into account in determining whether a warranty should receive
recourse treatment. However, the agencies are aware of warranties
sometimes characterized as ``standard'' that effectively function as
credit enhancements. These include warranties that transferred loans
will remain of investment quality, or that no circumstances exist
involving the loan collateral or borrower's credit standing that could
cause the loan to become delinquent. They may also include warranties
that, for seasoned mortgages, the value of the loan collateral still
equals the original appraised value and the borrower's ability to pay
has not changed adversely.
The proposal is consistent with the agencies' longstanding recourse
treatment of representations and warranties that effectively guaranty
performance or credit quality of transferred loans. However, the
proposal and the agencies' longstanding practice also recognize that
banking organizations typically make a number of factual warranties
unrelated to ongoing performance or credit quality. These warranties
entail operational risk, as opposed to the open-ended credit risk
inherent in a financial guaranty. Warranties that create operational
risk include: warranties that assets have been underwritten or
collateral appraised in conformity with identified standards, and
warranties that provide for the return of assets in instances of
incomplete documentation or fraud.
Warranties can impose varying degrees of operational risk. For
example, a warranty that asset collateral has not suffered damage from
hazard entails risk that is offset to some extent by prudent
underwriting practices requiring the borrower to provide hazard
insurance to the banking organization. A warranty that asset collateral
is free of environmental hazards may present acceptable operational
risk for certain types of properties that have been subject to
environmental assessment, depending on the circumstances. The agencies
address appropriate limits for these operational risks through
supervision of a banking organization's loan underwriting, sale, and
servicing practices. Also, a banking organization that provides
warranties to loan purchasers and investors must include associated
operational risks in its risk management of exposures arising from loan
sale or securitization-related activities. Banking organizations should
be prepared to demonstrate to examiners that the operational risks are
effectively managed.
The proposal continues the agencies' current practice of imposing
recourse treatment on ``early-default'' clauses. Early-default clauses
typically warrant that transferred loans will not become more than 30
days delinquent within a stated period, such as four months. Once the
stated period has run, the early-default clause will no longer trigger
recourse treatment, provided that there is no other provision that
constitutes recourse. One commenter to the 1997 Proposal stated that
early-default clauses carry minimal risk, and are intended to deal with
inadvertent transfers of loans that are already 30-day delinquencies,
or to guard against unsound originations by the loan seller. Another
commenter found recourse treatment of early-default clauses to be an
appropriate response to the transfer of credit risk that takes place
under these clauses.
The agencies find that early-default clauses are often drafted so
broadly that they are indistinguishable from a guaranty of financial
assets. The agencies have even found recent examples in which early-
default clauses have been expanded to cover the first year after loan
transfer. Industry concerns about assets delinquent at the time of
transfer or unsound originations could be dealt with by warranties
directly addressing the condition of the asset at the time of transfer
and compliance with stated underwriting standards or, failing that,
exposure caps permitting the banking organization to take advantage of
the low-level recourse rule. The proposal also requires recourse
treatment for warranties providing assurances about the actual value of
asset collateral, including that the market value corresponds to its
appraised value or that the appraised value will be realized in the
event of foreclosure and sale.
The agencies invite further comment on these issues. The agencies
also invite comment on whether ``premium refund'' clauses should
receive recourse treatment under any final rule. These clauses require
the seller to refund the premium paid by the investor for any loan that
prepays within a stated period after the loan is transferred. The
agencies are aware of premium refund clauses with terms ranging from 90
days to 36 months.
9. Loan Servicing Arrangements
The proposed definitions of ``recourse'' and ``direct credit
substitute'' cover loan servicing arrangements if the servicer is
responsible for credit losses associated with the loans being serviced.
However, cash advances made by residential mortgage servicers to ensure
an uninterrupted flow of payments to investors or the timely collection
of the mortgage loans are specifically excluded from the definitions of
recourse and direct credit substitute, provided that the residential
mortgage servicer is entitled to reimbursement for any significant
advances.\18\ This type of advance is assessed risk-based capital only
against the amount of the cash advance, and is assigned to the risk-
weight category appropriate to the party obligated to reimburse the
servicer.
---------------------------------------------------------------------------
\18\ Servicer cash advances include disbursements made to cover
foreclosure costs or other expenses arising from a loan in order to
facilitate its timely collection (but not to protect investors from
incurring these expenses).
---------------------------------------------------------------------------
If a residential mortgage servicer is not entitled to full
reimbursement, then the maximum possible amount of any nonreimbursed
advances on any one loan must be contractually limited to an
insignificant amount of the outstanding principal on that loan in order
for the servicer's obligation to make cash advances to be excluded from
the definitions of recourse and direct credit substitute. This
treatment reflects the agencies' traditional view that servicer cash
advances meeting these criteria are part of the normal mortgage
servicing function and do not constitute credit enhancements.
Commenters responding to the 1997 Proposal generally supported the
proposed definition of servicer cash advances. Some commenters asked
for clarification of the term ``insignificant'' and whether
``reimbursement'' includes reimbursement payable out of subsequent
collections or reimbursement in the form of a general claim on the
party obligated to reimburse the servicer. Nonreimbursed advances on
any one loan that are generally contractually limited to no more than
one percent of the amount of the outstanding principal on that loan
would be considered insignificant. Reimbursement includes reimbursement
payable from subsequent collections and reimbursement in the form of a
general claim on the party obligated to reimburse the servicer,
provided that the claim is not subordinated to other claims on the cash
flows from the underlying asset pool.
Some commenters responding to the 1997 Proposal suggested that the
agencies treat servicer cash advances as any advances that the servicer
reasonably expects will be repaid. The agencies believe that a clear,
specific standard is needed to prevent the use of servicer cash
advances to circumvent the proposed risk-based capital
[[Page 12327]]
treatment of recourse obligations and direct credit substitutes.
10. Spread Accounts and Overcollateralization
Several commenters requested that the agencies state in their rules
that spread accounts and overcollateralization do not impose a risk of
loss on a banking organization and are, therefore, not recourse. By its
terms, the definition of recourse covers only the retention of risk in
a sale of assets. Overcollateralization does not ordinarily impose a
risk of loss on a banking organization, so it normally would not fall
within the proposed definition of recourse. However, a retained
interest in a spread account that is reflected as an asset on a selling
banking organization's balance sheet (directly as an asset or
indirectly as a receivable) is a form of recourse and is treated
accordingly for risk-based capital purposes.
11. Interaction With Market Risk Rule
Some commenters responding to the 1997 Proposal asked for
clarification of the treatment of a transaction covered by both the
market risk rule and the recourse rule. Under the market risk rule,\19\
a position properly located in the trading account is excluded from
risk-weighted assets. The banking agencies are not proposing to modify
this treatment, so a position that is properly held in the trading
account would not be included in risk-weighted assets, even if the
position otherwise met the criteria for a recourse obligation or a
direct credit substitute.
---------------------------------------------------------------------------
\19\ The OTS does not have a market risk rule.
---------------------------------------------------------------------------
12. Participations in Direct Credit Substitutes
If a direct credit substitute is originated by a banking
organization which then sells a participation in that direct credit
substitute to another entity, the originating banking organization must
apply a 100% conversion factor to the full amount of the assets
supported by the direct credit substitute. The originating banking
organization would then risk weight the credit equivalent amount of the
participant's pro rata share of the direct credit substitute at the
lower of the risk category appropriate to the obligor in the underlying
transaction, after considering any relevant guaranties or collateral,
or the risk category appropriate to the participant entity. The
remaining pro rata share of the credit equivalent amount is assigned to
the risk-weight category appropriate to the obligor in the underlying
transaction, guarantor or collateral.
A banking organization that acquires a risk participation in a
direct credit substitute must apply a 100% conversion factor to its
percentage share of the direct credit substitute multiplied by the full
amount of the assets supported by the credit enhancement. The credit
equivalent amount is then assigned to the risk category appropriate to
the obligor or, if relevant, the nature of the collateral or guaranty.
Finally, in the case of the syndication of a direct credit
substitute where each banking organization is obligated only for its
pro rata share of the risk and there is no recourse to the originating
banking organization, each banking organization must hold risk-based
capital against its pro rata share of the assets supported by the
direct credit substitute.
13. Reservation of Authority
The agencies are proposing to add language to the risk-based
capital standards that will provide greater flexibility in
administering the standards. Banking organizations are developing novel
transactions that do not fit well into the risk-weight categories and
credit conversion factors set forth in the standards. Banking
organizations also are devising novel instruments that nominally fit
into a particular risk-weight category or credit conversion factor, but
that impose risks on the banking organization at levels that are not
commensurate with the nominal risk-weight or credit conversion factor
for the asset, exposure or instrument. Accordingly, the agencies are
proposing to add language to the standards to clarify their authority,
on a case-by-case basis, to determine the appropriate risk-weight for
assets and credit equivalent amounts and the appropriate credit
conversion factor for off-balance sheet items in these circumstances.
Exercise of this authority by the agencies may result in a higher or
lower risk weight for an asset or credit equivalent amount or a higher
or lower credit conversion factor for an off-balance sheet item. This
reservation of authority explicitly recognizes the agencies retention
of sufficient discretion to ensure that banking organizations, as they
develop novel financial assets, will be treated appropriately under the
risk-based capital standards.\20\ In addition, the agencies reserve the
right to assign risk positions in securitizations to appropriate risk
categories if the credit rating of the risk position is deemed to be
inappropriate.
---------------------------------------------------------------------------
\20\ The Board is also proposing to add language to its risk-
based capital standards that would permit the Board to adjust the
treatment of a capital instrument that does not fit into the
existing capital categories or that provides capital to a banking
organization at levels that are not commensurate with the nominal
capital treatment of the instrument. The other agencies already have
this flexibility under their existing rules.
---------------------------------------------------------------------------
14. Privately-Issued Mortgage-Backed Securities
Currently, the agencies assign privately-issued mortgage-backed
securities to the 20% risk-weight category if the underlying pool is
composed entirely of mortgage-related securities issued by the Federal
National Mortgage Association (Fannie Mae), Federal Loan Mortgage
Corporation (Freddie Mac), or Government National Mortgage Association
(Ginnie Mae). Privately-issued mortgage-backed securities backed by
whole residential mortgages are now assigned to the 50% risk-weight
category. The agencies propose to eliminate this ``pass-through''
treatment in favor of a ratings based approach. Because most mortgage-
backed securities usually also receive the highest or second highest
credit rating, the agencies believe that ``pass-through'' treatment
will be redundant once the ratings-based approach is implemented and,
therefore, propose to eliminate it.
B. Proposed Treatment for Rated Positions
As described in section II.A., each loss position in an asset
securitization structure functions as a credit enhancement for the more
senior loss positions in the structure. Currently, the risk-based
capital standards do not vary the rate of capital requirement for
different credit enhancements or loss positions to reflect differences
in the relative risk of credit loss represented by the positions.
To address this issue, the agencies are proposing a multi-level,
ratings-based approach to assess capital requirements on recourse
obligations, direct credit substitutes, and senior and subordinated
securities in asset securitizations based on their relative exposure to
credit risk. The approach uses credit ratings from the rating agencies
and, to a limited extent, banking organization's internal risk ratings
and other alternatives, to measure relative exposure to credit risk and
to determine the associated risk-based capital requirement. The use of
credit ratings provides a way for the agencies to use determinations of
credit quality relied upon by investors and other market participants
to differentiate the regulatory capital treatment for loss
[[Page 12328]]
positions representing different gradations of risk. This use permits
the agencies to give more equitable treatment to a wide variety of
transactions and structures in administering the risk-based capital
system.
The fact that investors rely on these ratings to make investment
decisions exerts market discipline on the rating agencies and gives
their ratings market credibility. The market's reliance on ratings, in
turn, gives the agencies confidence that it is appropriate to consider
ratings as a major factor in the risk weighting of assets for
regulatory capital purposes. The agencies, however, would retain their
authority to override the use of certain ratings or the ratings on
certain instruments, either on a case-by-case basis or through broader
supervisory policy, if necessary or appropriate to address the risk to
banking organizations.
Under the ratings-based approach, the capital requirement for a
recourse obligation, direct credit substitute, or traded asset-backed
security would be determined as follows: \21\
---------------------------------------------------------------------------
\21\ The example rating designations (``AAA,'' ``BBB,'' etc.)
are illustrative and do not indicate any preference for, or
endorsement of, any particular rating agency designation system.
------------------------------------------------------------------------
Rating category Examples Risk weight
------------------------------------------------------------------------
Highest or second highest AAA or AA......... 20%.
investment grade.
Third highest investment grade.. A................. 50%.
Lowest investment grade......... BBB............... 100%.
One category below investment BB................ 200%.
grade.
More than one category below B or unrated...... ''Gross-up''
investment grade, or unrated. treatment.
------------------------------------------------------------------------
Many commenters expressed concerns about the so-called ``cliff
effect'' that would arise because of the small number of rating
categories--three--contained in the 1997 Proposal. To reduce the cliff
effect, which causes relatively small differences in risk to result in
disproportionately large differences in the capital requirement for a
risk position, the agencies are proposing to add two additional rating
categories, for a total of five.
Under the proposal, the ratings-based approach is available for
traded asset-backed securities \22\ and for traded and non-traded
recourse obligations and direct credit substitutes. A position is
considered ``traded'' if, at the time it is rated by an external rating
agency, there is a reasonable expectation that in the near future: (1)
The position may be sold to investors relying on the rating; or (2) a
third party may enter into a transaction (e.g., a loan or repurchase
agreement) involving the position in which the third party relies on
the rating of the position. If external rating agencies rate a traded
position differently, the single highest rating applies.
---------------------------------------------------------------------------
\22\ Similar to the current approach under which ``stripped''
mortgage-backed securities are not eligible for risk weighting at
50% on a ``pass-through'' basis, stripped mortgage-backed securities
are ineligible for the 20% or 50% risk categories under the ratings
based approach.
---------------------------------------------------------------------------
An unrated position that is senior (in all respects, including
access to collateral) to a rated position that is traded is treated as
if it had the rating given the rated position, subject to the banking
organization satisfying its supervisory agency that such treatment is
appropriate.
Recourse obligations and direct credit substitutes not qualifying
for a reduced capital charge and positions rated more than one category
below investment grade receive ``gross-up'' treatment, that is, the
banking organization holding the position would hold capital against
the amount of the position plus all more senior positions, subject to
the low-level recourse rule.\23\ This grossed-up amount is placed into
risk-weight categories according to the obligor and collateral.
---------------------------------------------------------------------------
\23\ ``Gross-up'' treatment means that a position is combined
with all more senior positions in the transaction. The result is
then risk-weighted based on the nature of the underlying assets. For
example, if a banking organization retains a first-loss position in
a pool of mortgage loans that qualify for a 50% risk weight, the
banking organization would include the full amount of the assets in
the pool, risk-weighted at 50% in its risk-weighted assets for
purposes of determining its risk-based capital ratio. The low level
recourse rule provides that the dollar amount of risk-based capital
required for assets transferred with recourse should not exceed the
maximum dollar amount for which a banking organization is
contractually liable. See, 12 CFR part 3, appendix A, Section 3(d)
(OCC); 12 CFR 208 and 225, appendix A, III.D.1(g) (FRB); 12 CFR part
325, appendix A, II.D.1 (FDIC); 12 CFR 567.6(a)(2)(i)(C) (OTS).
---------------------------------------------------------------------------
The ratings-based approach is based on current ratings, so that a
rating downgrade or withdrawal of a rating could change the treatment
of a position under the proposal. However, a downgrade of a position by
a single rating agency would not affect the capital treatment of a
position if the position still qualified for the previous capital
treatment under one or more ratings from a different rating agency.
C. Proposed Treatment for Non-Traded and Unrated Positions
1. Ratings on Non-Traded Positions
In the 1994 Notice, the agencies proposed to permit a banking
organization to obtain a rating for a non-traded recourse obligation or
direct credit substitute in order to permit that position to qualify
for a favorable risk-weight. In response to the 1994 Notice, one rating
agency expressed concern that use of ratings by the agencies for
regulatory purposes could undermine the integrity of the rating
process. Ordinarily, according to the commenter, there is a tension
between the interests of the investors who rely on ratings and the
interests of the issuers who pay rating agencies to generate ratings.
Under the ratings-based approach in the 1994 Notice, however, the
holder of a recourse obligation or direct credit substitute that was
not traded or sold could, in some cases, seek a rating for the sole
purposes of permitting the credit enhancement to qualify for a
favorable risk weight. The rating agency expressed a strong concern
that, without the counterbalancing interest of investors to rely on
ratings, rating agencies may have an incentive to issue inflated
ratings.
In response to this concern, the 1997 Proposal included criteria to
reduce the possibility of inflated ratings and inappropriate risk
weights if ratings are used for a position that is not traded. A non-
traded position could qualify for the ratings-based approach only if:
(1) It qualified under ratings obtained from two different rating
agencies; (2) the ratings were publicly available; (3) the ratings were
based on the same criteria used to rate securities sold to the public;
and (4) at least one position in the securitization was traded. In
comments responding to the 1997 Proposal, banking organizations
expressed concern about the cost and delay associated with obtaining
ratings, particularly for direct credit substitutes, that they would
not need absent the agencies' adoption of a ratings-based approach for
risk-based capital purposes.
In this proposal, the agencies continue to permit a non-traded
[[Page 12329]]
recourse obligation or direct credit substitute to qualify for the
ratings-based approach if the banking organization obtains ratings for
the position. The agencies have retained the first three of the 1997
Proposal's four criteria for non-traded positions, but have eliminated
the fourth criterion, i.e., the requirement that one position in the
securitization be traded.
To address concerns expressed by commenters on the 1997 Proposal,
however, the agencies have developed, and are also proposing,
alternative approaches for determining the capital requirements for
unrated direct credit substitutes, which are discussed in the following
sections. Under each of these approaches, the banking organization must
satisfy its supervisory agency that use of the approach is appropriate
for the particular banking organization.
2. Use of Banking Organizations' Internal Risk Ratings
The proposal would permit a banking organization with a qualifying
internal risk rating system to use that system to apply the ratings-
based approach to the banking organization's unrated direct credit
substitutes in asset-backed commercial paper programs. Internal risk
ratings could be used to qualify a credit enhancement (other than a
retained recourse position) for a risk weight of 100% or 200% under the
ratings-based approach, but not for a risk weight of less than 100%.
This relatively limited use of internal risk ratings for risk-based
capital purposes is a step towards potential adoption of broader use of
internal risk ratings as discussed in the Basel Committee's June 1999
Consultative Paper. Limiting the approach to these types of credit
enhancements reflects the agencies' view, based on industry research
and empirical evidence, that these positions are more likely than
recourse positions to be of investment-grade credit quality, and that
the banking organizations providing them are more likely to have
internal risk rating systems for these credit enhancements that are
sufficiently accurate to be relied on for risk-based capital
calculations.
Most sophisticated banking organizations that participate
extensively in the asset securitization business assign internal risk
ratings to their credit exposures, regardless of the form of the
exposure. Usually, internal risk ratings more finely differentiate the
credit quality of a banking organization's exposures than the
categories that the agencies use to evaluate credit risk during
examinations of banking organizations (pass, substandard, doubtful,
loss). Individual banking organizations' internal risk ratings may be
associated with a certain probability of default, loss in the event of
default, and loss volatility.
The credit enhancements that sponsors obtain for their commercial
paper conduits are rarely rated. If an internal risk ratings approach
were not available for these unrated credit enhancements, the provider
of the enhancement would have to obtain two ratings solely to avoid the
gross-up treatment that would otherwise apply to unrated positions in
asset securitizations for risk-based capital purposes. However, before
a provider of an enhancement decides whether to provide a credit
enhancement for a particular transaction (and at what price), the
provider will generally perform its own analysis of the transaction to
evaluate the amount of risk associated with the enhancement.
Allowing banking organizations to use internal credit ratings
harnesses information and analyses that they already generate rather
than requiring them to obtain independent but redundant ratings from
outside rating agencies. An internal risk ratings approach therefore
has the potential to be less costly than a ratings-based approach that
relies exclusively on ratings by the rating agencies for the risk-
weighting of these positions.
Internal risk ratings that correspond to the rating categories of
the rating agencies could be mapped to risk weights under the agencies'
capital standards in a way that would make it possible to differentiate
the riskiness of various unrated direct credit substitutes based on
credit risk. However, the use of internal risk ratings raises concerns
about the accuracy and consistency of the ratings, especially because
the mapping of ratings to risk-weight categories will give banking
organizations an incentive to rate their risk exposures in a way that
minimizes the effective capital requirement. Banking organizations
engaged in securitization activities that wish to use the internal risk
ratings approach must ensure that their internal risk rating systems
are adequate. Adequate internal risk rating systems usually:
(1) Are an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from an
organization's participation in securitization activities. The system
must also fully take into account the effect of such activities on the
organization's risk profile and capital adequacy as discussed in
Section II.B.
(2) Link their ratings to measurable outcomes, such as the
probability that a position will experience any losses, the expected
losses on that position in the event of default, and the degree of
variance in losses given default on that position.
(3) Separately consider the risk associated with the underlying
loans and borrowers and the risk associated with the specific positions
in a securitization transaction.
(4) Identify gradations of risk among ``pass'' assets, not just
among assets that have deteriorated to the point that they fall into
``watch'' grades. Although it is not necessary for a banking
organization to use the same categories as the rating agencies, its
internal ratings must correspond to the ratings of the rating agencies
so that agencies can determine which internal risk rating corresponds
to each rating category of the rating agencies. A banking organization
would have the responsibility to demonstrate to the satisfaction of its
primary regulator how these ratings correspond with the rating agency
standards used as the framework for this proposal. This is necessary so
that the mapping of credit ratings to risk weight categories in the
ratings-based approach can be applied to internal ratings.
(5) Classify assets into each risk grade, using clear, explicit
criteria, even for subjective factors.
(6) Have independent credit risk management or loan review
personnel assign or review credit risk ratings. These personnel should
have adequate training and experience to ensure that they are fully
qualified to perform this function.
(7) Periodically verify, through an internal audit procedure, that
internal risk ratings are assigned in accordance with the banking
organization's established criteria.
(8) Track the performance of its internal ratings over time to
evaluate how well risk grades are being assigned, make adjustments to
its rating system when the performance of its rated positions diverges
from assigned ratings, and adjust individual ratings accordingly.
(9) Make credit risk rating assumptions that are consistent with,
or more conservative than, the credit risk rating assumptions and
methodologies of the rating agencies.
The agencies also are considering whether to develop review and
approval procedures governing their respective determinations of
whether a particular banking organization may use the internal risk
rating process. The agencies request comment on the appropriate scope
and nature of that process.
[[Page 12330]]
If a banking organization's rating system is found to no longer be
adequate, the banking organization's primary regulator may preclude it
from applying the internal risk ratings approach to new transactions
for risk-based capital purposes until it has remedied the deficiencies.
Additionally, depending on the severity of the problems identified, the
primary regulator may also decline to rely on the internal risk ratings
that the banking organization has applied to previous transactions that
remain outstanding for purposes of determining the banking
organization's regulatory capital requirements.
3. Ratings of Specific Positions in Structured Financing Programs
The agencies also propose to authorize a banking organization to
use a rating obtained from a rating agency or other appropriate third
party of unrated direct credit substitutes in securitizations that
satisfy specifications set by the rating agency. The banking
organization would need to demonstrate that the rating meets the same
rating standards generally used by the rating agency for rating
publicly-issued securities. In addition, the banking organization must
also demonstrate to its primary regulator's satisfaction that the
criteria underlying the rating agency's assignment of ratings for the
program are satisfied for the particular direct credit substitute
issued by the banking organization.
The proposal would also allow banking organizations to demonstrate
to the agencies that it is reasonable and consistent with the standards
of this proposal to rely on the rating of positions in a securitization
structure under a program in which the banking organization
participates if the sponsor of that program has obtained a rating. This
aspect of the proposal is most likely to be useful to banking
organizations with limited involvement in securitization activities. In
addition, some banking organizations extensively involved in
securitization activities already rely on ratings of the credit risk
positions under their securitization programs as part of their risk
management practices. Such banking organizations also could rely on
such ratings under this proposal if the ratings are part of a sound
overall risk management process and the ratings reflect the risk of
non-traded positions to the banking organizations.
This approach could be used to qualify a direct credit substitute
(but not a retained recourse position) for a risk weight of 100% or
200% of the face value of the position under the ratings-based
approach, but not for a risk weight of less than 100%.
4. Use of Qualifying Rating Software Mapped to Public Rating Standards
The agencies are also proposing to allow banking organizations,
particularly those with limited involvement in securitization
activities, to rely on qualifying credit assessment computer programs
that the rating agencies or other appropriate third parties have
developed for rating otherwise unrated direct credit substitutes in
asset securitizations. To qualify for use by banking organizations for
risk-based capital purposes, the computer programs must be tracked to
the rating standards of the rating agencies. Banking organizations must
demonstrate the credibility of these programs in the financial markets,
which would generally be shown by the significant use of the computer
program by investors and market participants for risk assessment
purposes. Banking organizations also would need to demonstrate the
reliability of the programs in assessing credit risk. Banking
organizations may use these programs for purposes of applying the
ratings-based approach under this proposal only if the banking
organization satisfies its primary regulator that the programs result
in credit assessments that credibly and reliably correspond with the
rating of publicly issued securities by the rating agencies.
Sophisticated banking organizations with extensive securitization
activities generally should use this approach only if it is an integral
part of their risk management systems and their systems fully capture
the risks from the banking organizations' securitization activities.
This approach could be used to qualify a direct credit substitute
(but not a retained recourse position) for a risk weight of 100% or
200% of the face value of the position under the ratings-based
approach, but not for a risk weight of less than 100%.
D. Managed Assets Approach
When assets are securitized, the extent to which the selling or
sponsoring entity transfers the risks associated with the assets
depends on the structure of the securitization and the revolving nature
of the assets involved. To the extent the sponsoring institution is
dependent on future securitizations as a funding source, as a practical
matter, the amount of risk transferred often will be limited. Revolving
credits include credit card and home equity line securitizations as
well as commercial loans drawn down under long-term commitments that
are securitized as collateralized loan obligations (CLOs).
The early amortization feature present in some revolving credit
securitizations ensures that investors will be repaid before being
subject to any risk of significant credit losses. For example, if a
securitized asset pool begins to experience credit deterioration to the
point where the early amortization feature is triggered, then the
asset-backed securities held by investors begin to rapidly pay down.
This occurs because, after an early amortization feature is triggered,
new receivables that are generated from the accounts designated to the
securitization trust are no longer sold to investors, but are instead
retained on the sponsoring banking organization's balance sheet.
Early amortization features raise several distinct concerns about
risks to the seller. First, the seller's interest in the securitized
assets is effectively subordinated to the interests of the investors by
the payment allocation formula applied during early amortization.
Investors effectively get paid first, and the seller's residual
interest will therefore absorb a disproportionate share of credit
losses.
Second, early amortization can create liquidity problems for the
seller. For example, a credit card issuer must fund a steady stream of
new credit card receivables. When a securitization trust is no longer
able to purchase new receivables due to early amortization, the seller
must either find an alternative buyer for the receivables or else the
receivables will accumulate on the seller's balance sheet, creating the
need for another source of funding.
Third, the first two risks to the seller can create an incentive
for the seller to provide implicit recourse--credit enhancement beyond
any pre-existing contractual obligation--to prevent early amortization.
Incentives to provide implicit recourse are to some extent present in
other securitizations, because of concerns about damage to the seller's
reputation and its ability to securitize assets going forward if one of
its securitizations performs poorly. However, the early amortization
feature creates additional and more direct financial incentives to
prevent early amortization through implicit recourse.
Because of their concerns about these risks, the agencies are
proposing to apply a managed assets approach to securitization
transactions that incorporate early amortization provisions. The
approach would require a sponsoring banking organization's securitized
(off-balance sheet) receivables to be included in risk-
[[Page 12331]]
weighted assets when determining its risk-based capital requirements.
The securitized, off-balance sheet assets would be assigned to the 20
percent risk category, thereby effectively applying a 1.6% risk-based
capital charge to those assets.
The 1.6% capital charge against securitized assets could be limited
in certain cases. If the sponsoring banking organization in a revolving
credit securitization provides credit protection to investors, either
in the form of retained recourse or a direct credit substitute, the sum
of the regulatory capital requirements for the credit protection and
the 1.6% charge on the off-balance sheet securitized assets may not
exceed 8% of securitized assets for that particular securitization
transaction.
A managed assets approach would require a banking organization to
hold additional capital against the potential credit and liquidity
risks stemming from the early amortization provisions of revolving
credit securitization structures. This proposed capital charge would
ensure that a banking organization maintain at least a minimum level of
capital against the risks that arise when early amortization provisions
are present in securitizations of revolving credits.
The agencies request comment on the purpose of early amortization
provisions, the proposed managed assets approach, and on any potential
effects that the approach will have on current industry practices
involving revolving credit securitizations. The agencies also recognize
that there may be concerns that the managed assets approach may not
produce safety and soundness benefits commensurate with the additional
regulatory burden that would result from a 20% risk weight on managed
assets, and they request comment on possible alternative measures that
would address more effectively the risks arising from early
amortization provisions in revolving securitizations. For example, one
alternative to the managed assets approach described here would be to
require greater public disclosure of securitization performance. This
additional information could allow market participants and regulators
to better assess the risks inherent in revolving securitizations with
early amortization provisions and the capital level appropriate for
those risks. The agencies also request comment on whether the benefits
of greater public disclosure outweigh the costs associated with
increased reporting.
IV. Effective Date of a Final Rule Resulting From This Proposal
The agencies intend that any final rules adopted as a result of
this proposal that result in increased risk-based capital requirements
for banking organizations will apply only to securitization activities
(as defined in the proposal) entered into or acquired after the
effective date of those final rules. Conversely, any final rules that
result in reduced risk-based capital requirements for banking
organizations may be applied to all transactions outstanding as of the
effective date of those final rules and to all subsequent transactions.
Because some ongoing securitization conduits may need additional time
to adapt to any new capital treatments, the agencies intend to permit
banking organizations to apply the existing capital rules to asset
securitizations with no fixed term, e.g., asset-backed commercial paper
conduits, for up to two years after the effective date of any final
rule.
V. Request for Comment
The agencies request comment on all aspects of this proposal, as
well as on the specific issues described in the preamble.
VI. Regulatory Flexibility Act
OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OCC certifies that this proposal will not have a significant impact
on a substantial number of small entities. 5 U.S.C. 601 et seq. The
provisions of this proposal that increase capital requirements are
likely to affect large national banks almost exclusively. Small
national banks rarely sponsor or provide direct credit substitutes in
asset securitizations. Accordingly, a regulatory flexibility analysis
is not required.
Board: Pursuant to section 605(b) of the Regulatory Flexibility
Act, the Board has determined that this proposal will not have a
significant impact on a substantial number of small business entities
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). The Board's comparison of the applicability section of this
proposal with Call Report Data on all existing banks shows that
application of the proposal to small entities will be the rare
exception. Accordingly, a regulatory flexibility analysis is not
required. In addition, because the risk-based capital standards
generally do not apply to bank holding companies with consolidated
assets of less than $150 million, this proposal will not affect such
companies.
FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act
(Public Law 96-354, 5 U.S.C. 601 et seq.), the FDIC certifies that the
proposed rule will not have a significant impact on a substantial
number of small entities. Comparison of Call Report data on FDIC-
supervised banks to the items covered by the proposal that result in
increased capital requirements shows that application of the proposal
to small entities will be the infrequent exception.
OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OTS certifies that this proposal will not have a significant impact
on a substantial number of small entities. A comparison of TFR data on
OTS-supervised thrifts shows that the proposed rule would have little
impact on the overall level of capital required at small thrifts, since
capital requirements (other than the risk-based capital standards) are
typically more binding on smaller thrifts. Moreover, the provisions of
this proposal that may increase capital requirements are unlikely to
affect small savings associations. Small thrifts rarely provide direct
credit substitutes in asset securitizations and do not serve as
sponsors of revolving securitizations. Accordingly, a regulatory
flexibility analysis is not required.
VII. Paperwork Reduction Act
The Agencies have determined that this proposal does not involve a
collection of information pursuant to the provisions of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501, et seq.).
VIII. Executive Order 12866
OCC: The OCC has determined that this proposal is not a significant
regulatory action for purposes of Executive Order 12866. The OCC
expects that any increase in national banks' risk-based capital
requirement, resulting from the proposed treatment of direct credit
substitutes largely will be offset by the ability of those banks to
reduce their capital requirement in accordance with the ratings-based
approach. The managed assets position of the proposal may require a
limited number of national banks to raise additional capital in order
to remain in the category to which they are assigned currently under
the OCC's prompt corrective action framework. The OCC believes that the
costs associated with raising this new capital are below the thresholds
prescribed in the Executive Order. Nonetheless, the impact of any final
rule resulting from this proposal will depend on factors for which the
agencies do not currently collect industry-wide information, such as
the
[[Page 12332]]
proportion of bank-provided direct credit substitutes that would be
rated below investment grade. The OCC, therefore, welcomes any
quantitative information national banks wish to provide about the
impact they expect the various portions of this proposal to have if
issued in final form.
OTS: The Director of the OTS has determined that this proposal does
not constitute a ``significant regulatory action'' under Executive
Order 12866. Since OTS already applies a ``gross up'' treatment for
recourse obligations and for most direct credit substitutes, the
proposal generally is likely to reduce the risk-based capital
requirements for thrifts. The proposed rule would increase capital
requirements only for certain direct credit substitutes issued in
connection with asset securitizations or for thrifts that may serve as
sponsors of revolving securitization programs. Currently, thrifts
rarely participate in such activities. As a result, OTS has concluded
that the proposal will have only minor effects on the thrift industry.
IX. OCC and OTS--Unfunded Mandates Reform Act of 1995
Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
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 the 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. The OCC and OTS have
determined that this proposed rule will not result in expenditures by
state, local, and tribal governments, or by the private sector, of more
than $100 million or more in any one year. Therefore, the OCC and OTS
have not prepared a budgetary impact statement or specifically
addressed the regulatory alternatives considered. As discussed in the
preamble, this proposal will reduce inconsistencies in the agencies'
risk-based capital standards and, in certain circumstances, will allow
banking organizations to maintain lower amounts of capital against
certain rated recourse obligations and direct credit substitutes.
X. Plain Language Requirement
Section 722 of the Gramm-Leach-Bliley Act of 1999 requires the
federal banking agencies to use ``plain language'' in all proposed and
final rules published after January 1, 2000. We invite your comments on
how to make this proposal easier to understand. For example:
(1) Have we organized the material to suit your needs?
(2) Are the requirements in the rule clearly stated?
(3) Does the rule contain technical language or jargon that isn't
clear?
(4) Would a different format (grouping and order of sections, use
of headings, paragraphing) make the rule easier to understand?
(5) Would more (but shorter) sections be better?
(6) What else could we do to make the rule easier to understand?
XI. FDIC Assessment of Impact of Federal Regulation on Families
The FDIC has determined that this proposed rule will not affect
family well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act of 1999 (Pub. Law 105-277).
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 225
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Bank deposit insurance,
Banks, Banking, Capital adequacy, Reporting and recordkeeping
requirements, Savings associations, State non-member banks.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set out in the preamble, part 3 of chapter I of
title 12 of the Code of Federal Regulations is proposed to be 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.
Sec. 3.4 [Amended]
2. In Sec. 3.4:
A. The undesignated paragraph is designated as paragraph (a);
B. The second sentence in the newly designated paragraph (a) is
revised; and
C. New paragraph (b) is added to read as follows:
Sec. 3.4 Reservation of authority.
(a) * * * Similarly, the OCC may find that a particular intangible
asset need not be deducted from Tier 1 or Tier 2 capital. * * *
(b) Notwithstanding the risk categories in section 3 of appendix A
to this part, the OCC may find that the assigned risk weight for any
asset or the credit equivalent amount or credit conversion factor for
any off-balance sheet item does not appropriately reflect the risks
imposed on a bank and may require another risk weight, credit
equivalent amount, or credit conversion factor that the OCC deems
appropriate. Similarly, if no risk weight, credit equivalent amount, or
credit conversion factor is specifically assigned, the OCC may assign
any risk weight, credit equivalent amount, or credit conversion factor
that the OCC deems appropriate. In making its determination, the OCC
considers risks associated with the asset or off-balance sheet item as
well as other relevant factors.
Appendix A to Part 3--[Amended]
3. In section 3 of appendix A:
A. Footnote 11a in paragraph (a)(3)(v) is revised;
B. Paragraph (b) introductory text is amended by adding a new
sentence at its end;
C. Paragraph (b)(1)(i) and footnote 13 are removed and reserved;
D. Paragraph (b)(1)(ii) is revised;
E. Paragraph (b)(1)(iii) and footnote 14 are removed and
reserved;
[[Page 12333]]
F. Footnotes 16 and 17 in paragraphs (b)(2)(i) and (ii),
respectively, are revised; and
G. Paragraph (d) is revised to read as follows:
Appendix A to Part 3--Risk-Based Capital Guidelines
* * * * *
Sec. 3 Risk Categories/Weights for On-Balance Sheet Assets and Off-
Balance Sheet Items
* * * * *
(a) * * *
(3) * * *
(v) * * * \11a\
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\11a\ The portion of multifamily residential property loans that
is sold subject to a pro rata loss sharing arrangement may be
treated by the selling bank as sold to the extent that the sales
agreement provides for the purchaser of the loan to share in any
loss incurred on the loan on a pro rata basis with the selling bank.
The portion of multifamily residential property loans sold subject
to any loss sharing arrangement other than pro rata sharing of the
loss shall be accorded the same treatment as any other asset sold
under an agreement to repurchase or sold with recourse under section
3(d)(2) of this appendix A.
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* * * * *
(b) * * * However, direct credit substitutes, recourse
obligations, and securities issued in connection with asset
securitizations are treated as described in section 3(d) of this
appendix A.
(1) * * *
(ii) Risk participations purchased in bankers' acceptances.
* * * * *
(2) * * *
(i) * * * \16\ * * *
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\16\ Participations in performance-based standby letters of
credit are treated in accordance with section 3(d) of this appendix
A.
---------------------------------------------------------------------------
(ii) * * * \17\ * * *
---------------------------------------------------------------------------
\17\ Participations in commitments are treated in accordance
with section 3(d) of this appendix A.
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