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FDIC Federal Register Citations

[Federal Register: November 29, 2001 (Volume 66, Number 230)]
[Rules and Regulations]
[Page 59613-59667]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr29no01-5]

[[Page 59613]]




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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


12 CFR Parts 3 and 567


Federal Reserve System

12 CFR Parts 208 and 225


Federal Deposit Insurance Corporation

12 CFR Part 325


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Risk-Based Capital Guidelines; Capital Adequacy Guidelines; Capital
Maintenance: Capital Treatment of Recourse, Direct Credit Substitutes
and Residual Interests in Asset Securitizations; Final Rules

[[Page 59614]]

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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 01-24]
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. 2001-68]
RIN 1550-AB11


Risk-Based Capital Guidelines; Capital Adequacy Guidelines;
Capital Maintenance: Capital Treatment of Recourse, Direct Credit
Substitutes and Residual Interests in Asset Securitizations

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

ACTION: Final rule.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board
of Governors of the Federal Reserve System (Board), the Federal Deposit
Insurance Corporation (FDIC), and the Office of Thrift Supervision
(OTS) (collectively, the agencies) are changing their regulatory
capital standards to address the treatment of recourse obligations,
residual interests and direct credit substitutes that expose banks,
bank holding companies, and thrifts (collectively, banking
organizations) primarily to credit risk. The final rule treats recourse
obligations and direct credit substitutes more consistently than the
agencies' current risk-based capital standards and adds new standards
for the treatment of residual interests, including a concentration
limit for credit-enhancing interest-only strips. In addition, the
agencies 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 for certain positions in asset
securitizations. The final rule does not include the proposed
requirement that the sponsor of a revolving credit securitization that
involves an early amortization feature hold capital against the amount
of assets under management.
This rule is intended to result in a more consistent treatment for
similar transactions among the agencies, more consistent regulatory
capital treatment for certain transactions involving similar risk, and
capital requirements that more closely reflect a banking organization's
relative exposure to credit risk.

DATES: This rule is effective January 1, 2002. Any transactions settled
on or after January 1, 2002, are subject to this final rule. Banking
organizations that enter into transactions before January 1, 2002, may
elect early adoption, as of November 29, 2001, of any provision of the
final rule that results in a reduced capital requirement. Conversely,
banking organizations that enter into transactions before January 1,
2002, that result in increased capital requirements under the final
rule may delay the application of this rule to those transactions until
December 31, 2002.

FOR FURTHER INFORMATION CONTACT: OCC: Amrit Sekhon, Risk Expert,
Capital Policy Division, (202) 874-5211; 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, Arleen Lustig, Supervisory Financial Analyst, (202)
452-2987, or Barbara Bouchard, Assistant Director (202) 452-3072,
Division of Banking Supervision and Regulation. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-
4869, 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; Jason C. Cave, Senior Capital Markets
Specialist, Division of Supervision, (202) 898-3548; Miguel D. Browne,
Manager, Policy, Risk Management and Operations, Division of
Supervision, (202) 898-6789; Marc J. Goldstrom, Counsel, (202) 898-8807
or Michael B. Phillips, Counsel, (202) 898-3581, Supervision and
Legislation Branch, Legal Division, Federal Deposit Insurance
Corporation, 550 17th Street, NW, Washington, DC 20429.
OTS: Michael D. Solomon, Senior Program Manager for Capital Policy,
(202) 906-5654, David Riley, Project Manager, Supervision Policy, (202)
906-6669; Teresa Scott, Counsel (Banking and Finance), (202) 906-6478,
or Karen Osterloh, Assistant Chief Counsel, (202) 906-6639, Office of
Thrift Supervision, 1700 G Street, NW, Washington, DC 20552.

SUPPLEMENTARY INFORMATION:
I. Introduction
A. Asset Securitization
B. Residual Interests
C. The Combined Final Rule
II. Background
A. Asset Securitization
B. Risk Management of Exposures Arising from Securitization
Activities
C. Current Risk-Based Capital Treatment of Recourse, Residual
Interests and Direct Credit Substitutes
1. Recourse and Retained Residual Interests
2. Direct Credit Substitutes
3. Concerns Raised by Current Capital Treatment
III. Description of the Final Rule: Treatment of Recourse, Residual
Interests and Direct Credit Substitutes
A. The General Approach Taken in the Final Rule
1. Combined Final Rule
2. Managed Assets Capital Charge
3. Capital Charge for Residual Interests
a. Concentration Limit Capital Charge
b. Dollar-for-Dollar Capital Charge
B. Definitions and Scope of the Final Rule
1. Recourse
2. Direct Credit Substitute
3. Residual Interests
4. Credit-Enhancing Interest-Only Strips
5. Credit Derivatives
6. Credit-Enhancing Representations and Warranties
7. Clean-up Calls
8. Loan Servicing Arrangements
9. Interaction with Market Risk Rule
10. Reservation of Authority
11. Alternative Capital Calculation for Small Business
Obligations
C. Ratings-based Approach: Traded and Non-traded Positions
D. Unrated Positions
1. Use of Banking Organizations' Internal Risk Ratings
2. Ratings of Specific Positions in Structured Financing
Programs
3. Use of Qualifying Rating Software Mapped to Public Rating
Standards
IV. Effective Date of the Final Rule
V. Miscellaneous Changes
VI. Regulatory Analysis
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
C. Executive Order 12866
D. Unfunded Mandates Reform Act of 1995
E. Plain Language

I. Introduction

The agencies are amending their regulatory capital standards to
change

[[Page 59615]]

the treatment of certain recourse obligations, direct credit
substitutes, residual interests and other positions in securitized
transactions that expose banking organizations to credit risk. This
final rule amends the agencies' regulatory capital standards to align
more closely the risk-based capital treatment of recourse obligations
and direct credit substitutes, to vary the capital requirements for
positions in securitized transactions (and certain other credit
exposures) according to their relative risk, and to require capital
commensurate with the risks associated with residual interests.

A. Asset Securitization

This final rule 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 low-level recourse transactions, and to treat
first-loss (but not second-loss) direct credit substitutes like
recourse. 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 from nationally recognized statistical rating
organizations (rating agencies) 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, Pub. L. 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. 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).
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On November 5, 1997, the agencies published another notice of
proposed rulemaking. 62 FR 59943, November 5, 1997 (1997 Proposal). In
the 1997 Proposal, the agencies proposed to use credit ratings from
rating agencies to determine the capital requirements for recourse
obligations, direct credit substitutes, and senior asset-backed
securities in asset securitizations. Additionally, the 1997 Proposal
requested comment on a series of options and alternatives to supplement
or replace the proposed ratings-based approach.
On March 8, 2000, the agencies published a third notice of proposed
rulemaking on recourse and direct credit substitutes. 65 FR 12320,
March 8, 2000 (2000 Recourse Proposal). The 2000 Recourse Proposal
built on the ratings-based approach and eliminated several options from
the 1997 Proposal, including the modified gross-up approach, the
ratings benchmark approach, and the historical losses approach. The
2000 Recourse Proposal also permitted 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, or qualifying software to
determine the capital requirement for certain unrated direct credit
substitutes. Finally, the 2000 Recourse Proposal required a sponsor of
a revolving credit securitization that contained an early amortization
feature to hold capital against the amount of assets under management
in that securitization.
In the international arena, the Basel Committee on Banking
Supervision (of which the OCC, the Board, and the FDIC are members)
issued a consultative paper entitled, ``A New Capital Adequacy
Framework'' in January 2001,\2\ on 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 standards established by this final
rule are consistent in many respects with the Basel Consultative Paper.
In particular, the use of external credit ratings issued by rating
agencies as a basis for determining the credit quality and the
resulting capital treatment of securitizations is consistent with the
approach outlined by the Basel Committee. While the agencies believe
that it is essential to address securitizations by rule at this time,
they intend to consider additional changes to this rule when revisions
to the Basel Accord are finalized.
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\2\ The January 2001 Basel Consultative Paper amends and refines
a Consultative Paper issued in June 1999.
\3\ International Convergence of Capital Measurement and Capital
Standards (July 1988).
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B. Residual Interests

In response to the increased use of securitizations by
instititutions, the agencies published Interagency Guidance on Asset
Securitization Activities \4\ in December 1999 (Securitization
Guidance), which addresses the supervisory concerns with the risk
management and oversight of securitization programs.\5\ The
Securitization Guidance highlighted the most significant risks
associated with asset securitization, emphasized the agencies' concerns
with certain residual interests generated from the securitization and
sale of assets, and set forth fundamental risk management practices for
banking organizations that engage in securitization activities. In
addition, the Securitization Guidance stressed the need for management
to implement policies and procedures that include limits on the amount
of residual interests that may be carried as a percentage of capital.
Furthermore, the Guidance stated that, given the risks presented by
these activities, the agencies would actively consider the
establishment of regulatory restrictions that would limit or eliminate
the amount of certain residual interests that could be recognized in
determining the adequacy of regulatory capital.
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\4\ See OCC Bulletin 99-46 (December 14, 1999) (OCC); FDIC
Financial Institution Letter 109-99 (December 13, 1999) (FDIC); SR
Letter 99-37(SUP) (December 13, 1999) (Board); and CEO LTR 99-119
(December 14, 1999) (OTS).
\5\ The agencies previously considered, but declined to adopt,
capital rules imposing concentration limits on certain residual
assets, i.e., interest-only strips. See 63 FR 42668 (August 10,
1998). This 1998 rulemaking is discussed more fully at section
II.C.3. of this preamble.
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In September 2000, the agencies published a notice of proposed
rulemaking on residual interests in asset securitizations and other
transfers of financial assets. 65 FR 57993, September 27, 2000
(Residuals Proposal). The proposal more directly addressed the
agencies' concerns with residual interests, which were highlighted in
the Securitization Guidance. The Residuals Proposal defined residual
interests and proposed a deduction from Tier 1 capital \6\ for the
amount of residual interests held by a banking organization that exceed
25% of Tier 1 capital (concentration limit). The agencies further
proposed that risk-based capital be held dollar-for-dollar against the
remaining residuals (dollar-for-dollar capital charge) even if the
resulting capital charge exceeded the full risk-based capital charge
(e.g., 8%) typically held against the transferred assets that are
supported by the residual. The Residuals Proposal also permitted
banking organizations to calculate the amount of a residual ``net-of-
associated deferred tax liability'' in determining the appropriate
amount of

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capital required. In no event would the amount of capital have exceeded
the residual interest balance.
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\6\ The OTS also uses the term ``core capital'' to describe Tier
1 capital.
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C. The Combined Final Rule

The agencies collectively received 32 comments on the 2000 Recourse
Proposal and 34 comments on the Residuals Proposal. Comments were
received from banks and thrifts, law and accounting firms, trade
associations, and government-sponsored enterprises. Commenters
generally favored the ratings-based approach proposed in the 2000
Recourse Proposal, but were concerned about the increased capital
requirements outlined for residuals in the Residuals Proposal.
The two proposals overlap in scope in that both address leveraged
credit risk. As many commenters noted, for certain positions the
Residuals Proposal required capital treatment that differed from that
required under the 2000 Recourse Proposal. Recognizing the overlap and
interaction between the two proposals, the agencies have developed a
single final rule that combines aspects of the Residuals Proposal and
the 2000 Recourse Proposal.

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 \7\
provides an efficient mechanism for banking organizations to buy and
sell loan assets or credit exposures and thereby to increase the
organization's liquidity.
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\7\ For purposes of this discussion, references to
``securitization'' also include structured finance transactions or
programs and synthetic transactions 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. Synthetic transactions bundle credit risks
associated with on-balance sheet assets and off-balance sheet items
and resell them into the market. For examples of synthetic
securitization structures, see Banking Bulletin 99-43, November 15,
1999 (OCC); SR Letter 99-32, Capital Treatment for Synthetic CLOs,
November 17, 1999 (Board).
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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 most subordinate, loss position is first to absorb
credit losses; the most ``senior'' investor position is last to absorb
losses; 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 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
and may assume the credit risk on the underlying mortgages. However,
many of today's asset securitization programs involve assets that are
not Federally supported in any way. Sellers of these privately
securitized assets therefore often provide other forms of credit
enhancement--that is, they take first or second dollar loss positions--
to reduce investors' credit risk.
A seller may provide this credit enhancement itself through
recourse arrangements. The agencies use the term ``recourse'' to refer
to the credit risk 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 also
associated with asset securitization programs. 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 excess spread accounts,
overcollateralization, retained subordinated interests, or other
similar on-balance sheet assets. When these or other on-balance sheet
internal enhancements are provided, the enhancements are ``residual
interests'' for regulatory capital purposes. Such residual interests
are a form of recourse.
A seller may also arrange for a third party to provide credit
enhancement \8\ 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
final rule, all forms of third-party enhancements, i.e., all
arrangements in which a banking organization assumes credit risk from
third-party assets or other claims that it has not transferred, are
referred to as ``direct credit substitutes.'' \9\ The economic
substance of a banking organization's credit risk from providing a
direct credit substitute can be identical to its credit risk from
retaining recourse on assets it has transferred.
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\8\ As used in this final rule, the terms ``credit enhancement''
and ``enhancement'' refer to both recourse arrangements, including
residual interests, and direct credit substitutes.
\9\ For purposes of this rule, purchased credit-enhancing
interest-only strips are also ``residual interests.''
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Many asset securitizations use a combination of recourse and third-
party enhancements to protect investors from credit risk. When third-
party enhancements are not provided, the selling banking organization
ordinarily retains virtually all of the credit risk on the assets
transferred.

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. 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 capital treatment required by the final rule provides one
important way of addressing the credit risk presented by securitization
activities. However, 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 synthetic securitizations 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 any retained residual portfolio. 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 advanced and formal approaches to manage the risks.
The Securitization Guidance addresses the fundamental risk
management practices that should be in

[[Page 59617]]

place at banking organizations that engage in securitization
activities. The Guidance stresses the need for management to implement
policies and procedures that include limits on the amount of residual
interests that may be carried as a percentage of capital. Moreover, the
Securitization Guidance sets forth the supervisory expectation that the
value of a residual interest in a securitization must be supported by
objectively verifiable documentation of the asset's fair market value
using reasonable, conservative valuation assumptions. Residual
interests that do not meet this expectation, or that fail to meet the
supervisory standards set forth in the Securitization Guidance, should
be classified as ``loss'' and disallowed as assets of the banking
organization for regulatory capital purposes.
Moreover, the agencies indicated in the Securitization Guidance
that banking organizations found to be lacking effective risk
management programs or engaging in practices that present safety and
soundness concerns will be subject to more frequent supervisory review,
limitations on residual interest holdings, more stringent capital
requirements, or other supervisory response. Thus, 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 and
may result in a downgrading of a banking organization's CAMELS or BOPEC
\10\ rating.
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\10\ CAMELS is the acronym for the supervisory rating assigned
to banks and thrifts. It measures Capital, Asset quality,
Management, Earnings, Liquidity and Sensitivity to market risk.
BOPEC is the acronym for the supervisory rating assigned to bank
holding companies. It measures performance of Banking subsidiaries,
Other subsidiaries, the Parent holding company, Earnings and
Capital.
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C. Current Risk-Based Capital Treatment of Recourse, Residual Interests
and Direct Credit Substitutes

Currently, the agencies' risk-based capital standards apply
different treatments to recourse obligations, including residual
interests, and direct credit substitutes. As a result, capital
requirements applicable to credit enhancements do not consistently
reflect credit risk, even though the risk characteristics are similar.
The current rules of the OCC, Board, and FDIC (the banking agencies)
are also not entirely consistent with those of the OTS. One objective
of the final rule is to remove or reduce these inconsistencies.
1. Recourse and Retained Residual Interests
The agencies' risk-based capital guidelines prescribe a single
treatment for assets transferred with recourse (including retained
residual interests), regardless of whether the transaction is reported
as a sale of assets or as a financing in a bank's Consolidated Report
of Condition and Income (Call Report), a bank holding company's FR Y-9
reports, or a thrift's Thrift Financial Report. 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 with recourse (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.\11\ If the seller's balance sheet includes as an asset (other
than a servicing asset) any interest that acts as a credit enhancement
to the assets sold, that interest is not risk-weighted a second time as
an on-balance sheet item. Thus, regardless of the method used to
account for the transfer, risk-based capital is held against the full,
risk-weighted amount of the assets transferred with recourse, unless
the transaction is subject to the low-level recourse rule.\12\
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\11\ Consistent with statutory requirements, the agencies'
current rules also provide for special treatment of sales of small
business 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(a)(3) (OTS). See also discussion in section III.B.11 of this
preamble.
\12\ 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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The low-level recourse rule limits the maximum risk-based capital
requirement to the lesser of the banking organization's maximum
contractual exposure or the full capital charge against the outstanding
amount of assets transferred with recourse. When the low-level recourse
rule applies, a banking organization generally holds capital on a
dollar-for-dollar basis against the amount of its maximum contractual
exposure. In the absence of any other recourse provisions, the on-
balance sheet amount of a residual interest represents the maximum
contractual exposure. For example, assume that a banking organization
securitizes $100 million of credit card loans and records a residual
interest on the balance sheet of $5 million that serves as a credit
enhancement for the assets transferred. Before the low-level recourse
rule was issued, the banking organization was required to hold $8
million of risk-based capital against the $100 million in loans sold,
as though the loans had not been sold. Under the low-level recourse
rule, the banking organization is required to hold $5 million in
capital, that is, ``dollar-for-dollar'' capital up to the banking
organization's maximum contractual exposure. However, if the banking
organization has recorded a residual interest of $10 million (rather
than $5 million), the low-level recourse rule would not have applied.
The banking organization would have been required to hold the full
capital charge, i.e., $8 million in this example, even though its
maximum contractual exposure was $10 million.
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 banking organization's balance sheet and the
banking organization need not hold leverage capital against these
assets. However, because certain recourse obligations (e.g., retained
residual interests) are recorded as an asset on the seller's balance
sheet, leverage capital must be held against those obligations.
2. Direct Credit Substitutes
Direct credit substitutes are treated differently from recourse
obligations under the existing risk-based capital standards. Currently,
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 face amount of the direct credit
substitute is converted into an on-balance sheet credit equivalent
amount. As a result, 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

[[Page 59618]]

even though the economic risk of loss is similar. For example, if a
direct credit substitute covers losses up to the first 20% of $100 of
enhanced assets, then the on-balance sheet credit equivalent amount
equals $20, and risk-based capital is held against only the $20 amount.
In contrast, required capital for a first-loss 20% recourse arrangement
on $100 of transferred assets is higher because capital is held against
the entire $100 of the assets enhanced.
Currently, under the banking agencies' risk-based capital
guidelines, purchased subordinated interests receive the same capital
treatment as off-balance sheet direct credit substitutes; that is, only
the dollar 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, even though the economic and credit risks are
similar. As a result, the banking organization must hold capital
against the carrying amount of the retained subordinated interest as
well as the outstanding dollar 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 Capital Treatment
The agencies' current leverage and 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
similar credit risks. Banking organizations are taking advantage of
this anomaly, for example, by taking first-loss positions through
financial standby letters of credit, i.e., direct credit substitutes,
in asset-backed commercial paper conduits that lend directly to
corporate customers. These direct credit substitutes are accorded a
significantly lower capital requirement than if a banking organization
were to retain a subordinated position in a securitization comprised of
loans that had originally been carried on its balance sheet, i.e. a
recourse obligation, notwithstanding that the credit risks of both
positions are virtually the same. 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, residual interest, direct credit
substitute, and associated terms.
Residual interests, including retained or purchased credit-
enhancing interest-only strips (credit-enhancing I/Os), raise further
supervisory concerns. Fair value is the basis for the initial
measurement and, in most cases, the ongoing measurement of residual
interests on banking organizations' balance sheets. In addition,
declines in fair value trigger determinations as to whether other than
temporary impairments of residual interests should be recognized.
Banking organizations' fair value estimates for these instruments,
however, are often based on unwarranted assumptions about expected
future cash flows. No active market exists for many residual interests,
including credit-enhancing I/Os. As a result, there is no marketplace
from which an arm's length market price can readily be obtained to
support the residual interest valuation. Recent examinations have
highlighted the inherent uncertainty and volatility regarding the
initial and ongoing valuation of credit-enhancing I/Os and other
residual interests. A banking organization that securitizes assets may
overvalue its residual interests, including its credit-enhancing I/Os,
and thereby inappropriately generate ``paper profits'' (or mask actual
losses) through incorrect cash flow modeling, flawed loss assumptions,
inaccurate prepayment estimates, and inappropriate discount rates. This
often leads to an inflation of capital, making the banking organization
appear more financially sound than it is. Embedded within residual
interests, including credit-enhancing I/Os, is a significant level of
credit and prepayment risk that make their valuation extremely
sensitive to changes in underlying assumptions. Market events can
affect the discount rate, prepayment speed or performance of the
underlying assets in a securitization transaction and can swiftly and
dramatically alter their value. A banking organization that holds an
excessive concentration of residual interests in relation to capital
presents significant safety and soundness concerns.
Existing regulatory capital rules do not adequately reflect the
risks associated with residual interests. Often, banking organizations
that securitize and sell higher risk assets are required to retain a
large residual interest (often greater than the full capital charge of
8 percent on 100 percent risk-weighted assets) to ensure that the more
senior positions in the securitization or other asset sale can receive
the desired investment ratings. The booking of a residual interest
using gain-on-sale accounting can increase the selling banking
organization's capital and thereby allow the banking organization to
leverage the capital created from the securitization. This creation of
capital is most commonly associated with credit-enhancing I/Os and
other spread-related assets. Write-downs of the recorded value of the
residual interest due to changes in assumptions concerning loss,
prepayment or discount rates can subsequently result in losses. Any
losses in excess of the full capital charge (8 percent in the example
above) will negatively affect the capital adequacy of the banking
organization and, thereby, its safety and soundness.
Moreover, the current capital rules also do not subject either
purchased or retained credit-enhancing I/Os to a concentration limit.
In 1998, the agencies amended their capital rules to impose strict
limits on the amount of nonmortgage servicing assets that may be
included in Tier 1 capital.\13\ These strict limitations were imposed
due to the lack of depth and maturity of the marketplace for such
assets, and related concerns about their valuation, liquidity, and
volatility.
---------------------------------------------------------------------------

\13\ See 63 FR 42688 August 10, 1998.
---------------------------------------------------------------------------

The agencies, however, considered but declined to adopt similar
concentration limits for I/O strips in that 1998 rulemaking,
notwithstanding that certain I/O strips possessed cash flow
characteristics similar to servicing assets and presented similar
valuation, liquidity, and volatility concerns. The agencies chose not
to impose such a limitation in recognition of the ``prudential effects
of banking organizations relying on their own risk assessment and
valuation tools, particularly their interest rate risk, market risk,
and other analytical models.'' \14\ The agencies expressly indicated
that they would continue to review banking organizations' valuation of
I/O strips and the concentrations of these assets relative to capital.

[[Page 59619]]

Moreover, the agencies noted that they ``may, on a case-by-case basis,
require banking organizations that the agencies determine have high
concentrations of these assets relative to their capital, or are
otherwise at risk from these assets, to hold additional capital
commensurate with their risk exposures.'' \15\
---------------------------------------------------------------------------

\14\ Id. at 42672.
\15\ Id.
---------------------------------------------------------------------------

When the servicing assets final rule was issued in 1998, most I/O
strips used as credit enhancements did not exceed the full-capital
charge on the transferred assets. However, the securitization of higher
risk loans has resulted in residual interests, such as credit-enhancing
I/O strips, that exceed the full-capital charge. In addition, certain
banking organizations engaged in such securitization transactions have
significant concentrations in highly volatile credit-enhancing I/Os as
a percentage of capital.

III. Description of the Final Rule: Treatment of Recourse, Residual
Interests and Direct Credit Substitutes

This final rule amends the agencies' regulatory capital standards
as follows:
It defines the terms ``recourse,'' ``residual interest''
and related terms and revises the definition of ``direct credit
substitute'';
It provides more consistent risk-based capital treatment
for recourse obligations and direct credit substitutes;
It varies the capital requirements for positions in
securitization transactions according to their relative risk exposure,
using credit ratings from rating agencies to measure the level of risk;
It permits the limited use of a banking organization's
qualifying internal risk rating system to determine the capital
requirement for certain unrated direct credit substitutes;
It permits the limited use of a rating agency'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 recourse exposures (but not residual
interests);
It requires a banking organization to deduct credit-
enhancing interest-only strips, whether retained or purchased, that are
in excess of 25% of Tier 1 capital from Tier 1 capital and from assets
(concentration limit);
It requires a banking organization to maintain risk-based
capital in an amount equal to the face amount of a residual interest
that does not qualify for the ratings-based approach (including credit-
enhancing interest-only strips that have not been deducted from Tier 1
capital) (dollar-for-dollar capital); and
It permits each agency to modify a stated risk-weight,
credit conversion factor or credit equivalent amount, if warranted, on
a case-by-case basis.
The agencies intend to apply this final rule to the substance,
rather than the form, of a securitization transaction. Regulatory
capital will be assessed based on the risks inherent in a position
within a securitization, regardless of its characterization.

A. The General Approach Taken in the Final Rule

1. Combined Final Rule
As noted above, this final rule harmonizes the proposed capital
treatment for residuals with the broader capital treatment for recourse
and direct credit substitutes. It also permits the use of ratings to
match the risk-based capital requirement more closely to the relative
risk of loss in asset securitizations (see discussion below at section
III.C.). Highly rated investment-grade positions in securitizations
receive a favorable (less than 100 percent) risk-weight. Below-
investment grade or unrated positions in securitizations would receive
a less favorable risk-weight (generally greater than 100 percent risk-
weight). A residual interest retained by a banking organization in an
asset securitization (other than a credit-enhancing I/O strip) would be
subject to this capital framework. Therefore, if the external rating
provided to such a residual interest is investment grade or no more
than one category below investment grade, the final rule affords that
residual interest more favorable capital treatment than the dollar-for-
dollar capital requirement otherwise required for residuals (see
discussion below in section III.C.).
2. Managed Assets Capital Charge
The 2000 Recourse Proposal proposed to assess a risk-based capital
charge on sponsors of revolving credit securitizations that contain an
early amortization feature (managed assets capital charge). All
commenters that addressed the managed assets issue opposed the adoption
of such a capital charge. Commenters noted that the risks the managed
assets capital charge is meant to address (e.g., liquidity risk and
credit risk) are not unique to securitizations with early amortization
features. Several commenters observed that liquidity risk exists in
varying degrees in every banking organization, and implicit recourse
arises any time that a banking organization securitizes assets.
Commenters also noted that a banking organization faces the credit risk
associated with future receivables resulting from revolving loan
commitments even if the banking organization is not involved in
securitization.
For these reasons, the agencies have agreed at this time not to
assess risk-based capital against securitized off-balance sheet assets
in revolving securitizations incorporating early amortization
provisions. The agencies strongly believe, however, that the risks
associated with securitization, including those posed by an early
amortization feature, are not fully captured in current regulatory
capital rules and need to be addressed. Therefore, the agencies plan to
make a more comprehensive assessment of the risks to a selling banking
organization posed by the securitization process, including the risks
arising from early-amortization features, implicit recourse
arrangements and non-credit risks. The agencies have not, as yet,
determined whether they will issue a proposed capital rule or
supervisory guidance on this matter.
3. Capital Charge for Residual Interests
The final rule imposes a ``dollar-for-dollar'' capital charge on
residual interests and a concentration limit on a subset of residual
interests--credit-enhancing I/O strips.\16\ Under the combined
approach, credit-enhancing I/O strips are limited to 25% of Tier 1
capital. Everything above that amount will be deducted from Tier 1
capital. Generally, all other residual interests that do not qualify
for the ratings-based approach (including any credit-enhancing I/O
strips that were not deducted from Tier 1 capital) are subject to a
dollar-for-dollar capital charge. In no event will this combined
capital charge exceed the face amount of a banking organization's
residual interests.
---------------------------------------------------------------------------

\16\ The definitions of residual interests and credit-enhancing
I/Os are discussed in Sections III.B.3 and 4, below.
---------------------------------------------------------------------------

a. Concentration Limit Capital Charge. The final rule imposes a
concentration limit on a subset of residual interests. It limits the
inclusion of interest-only strips that serve in a credit-enhancing
capacity (credit-enhancing I/O strips), whether retained or purchased,
to 25% of Tier 1 capital for regulatory capital purposes (see
discussion below at III.B.4).
For regulatory capital purposes only, any amount of credit-
enhancing I/O strips that exceeds the 25% limit will be deducted from
Tier 1 capital and from assets. Credit-enhancing I/O strips that are
not deducted from Tier 1 capital, along with all other residual
interests not subject to the concentration limit are

[[Page 59620]]

subject to the dollar-for-dollar capital requirement (as described
below). In calculating the capital requirement in this manner, banking
organizations will not be required to hold capital for more than 100%
of the amount of the residual interest. The following example
illustrates the concentration calculation required for banking
organizations that hold credit-enhancing I/O strips:
A banking organization has purchased and retained credit-enhancing
I/O strips with a face amount of $100 on its balance sheet and Tier 1
capital of $320 (before any disallowed servicing assets, disallowed
purchased credit card relationships, disallowed credit-enhancing I/O
strips and disallowed deferred tax assets). To determine the amount of
credit-enhancing I/O strips that fall within the concentration limit,
the banking organization would multiply the Tier 1 capital of $320 by
25%, which is $80. The amount of credit-enhancing I/O strips that
exceed the concentration limit, in this case $20, is deducted from Tier
1 capital and from assets. For risk-based capital purposes (but not for
leverage capital purposes), the remaining $80 is then subject to the
dollar-for-dollar capital charge, which is discussed below.
Of those organizations commenting on the proposed concentration
limit, most believed that a concentration limit should not be included
in the final rule. However, the narrower concentration limit is
consistent with commenters' suggestions that only interest-only strips
be included in this limit. Moreover, credit-enhancing I/O strips are
not aggregated with any servicing assets or purchased credit card
relationships for purposes of calculating the 25% concentration limit.
In that respect, the concentration limit in the final rule is a less
binding constraint than the proposed limit.
The agencies narrowed the scope of assets subject to the
concentration limit to credit-enhancing interest-only strips in
recognition of the fact that these assets generally serve in a first
loss capacity and are typically the most vulnerable to significant
write-downs due to changes in valuation assumptions. In addition,
interest-only strips are the asset type most often associated with the
creation of capital as a result of gain-on-sale accounting, which
allows a banking organization to leverage the capital created based on
the current recognition of uncertain future cash flows.
b. Dollar-for-Dollar Capital Charge. For risk-based capital
purposes (but not for leverage capital purposes), all residual
interests that do not qualify for the ratings-based approach (including
retained and purchased credit-enhancing I/O strips that have not been
deducted from Tier 1 capital) are assessed a dollar-for-dollar capital
charge. This charge requires that banking organizations hold a dollar
in capital for every dollar in residual interests, even if this capital
requirement exceeds the full risk-based capital charge on the assets
transferred. The agencies believe that the current limited capital
requirement could, in certain instances, be insufficient given the risk
inherent in large residual interest positions. Because these assets are
a subordinated interest in the future cash flows of the securitized
assets, they have a concentration of credit and prepayment risk that,
depending upon the life of the underlying asset, makes them vulnerable
to sudden and sizeable impairment. In addition, when given accounting
recognition, certain residuals, such as retained credit-enhancing I/O
strips, have the effect of creating capital, which may not be available
to support these assets if write-downs become necessary. Recent
experience has shown that residual interests can be among the riskiest
assets on the balance sheet and, therefore, most deserving of a higher
capital charge.
Continuing the above illustration for credit-enhancing I/O strips,
once a banking organization deducts the $20 in disallowed credit-
enhancing I/O strips, it must hold $80 in total capital for the $80
that represents the credit-enhancing I/O strips not deducted from Tier
1 capital. The $20 deducted from Tier 1 capital, plus the $80 in total
risk-based capital required under the dollar-for-dollar treatment,
equals $100, the face amount of the credit-enhancing I/O strips.
Banking organizations may apply a net-of-tax approach to any credit-
enhancing I/O strips that have been deducted from Tier 1 capital, as
well as to the remaining residual interests subject to the dollar-for-
dollar treatment. This calculation is illustrated in the preamble of
the Residuals Proposal at 65 FR 57998. Under this method, a banking
organization is permitted, but not required, to net the deferred tax
liabilities recorded on its balance sheet, if any, that are associated
with the residual interests. This may result in a banking organization
holding less than 100% capital against residual interests.
Several commenters on the Residuals Proposal opposed the proposed
capital treatment, believing that concerns associated with residual
interests should be handled on a case-by-case basis under the agencies'
existing supervisory authority. These commenters often referred to the
Securitization Guidance, which highlights the supervisory concerns
associated with residual interests.
The agencies believe that a minimum capital standard that more
closely aligns capital with risk, along with supervisory review, is the
appropriate course of action in dealing with residual interests. The
agencies remain concerned with the credit risk exposure associated with
these deeply subordinated assets, particularly subinvestment grade and
unrated residual interests. The lack of an active market makes these
assets difficult to value and relatively illiquid.
Most commenters considered the dollar-for-dollar risk-based capital
treatment to be overly broad and too harsh, particularly when applied
to higher quality residual interests. Commenters also were concerned
that the proposed treatment could increase the capital requirement for
a residual interest above the capital requirement for the transferred
assets when they were held on the banking organization's balance sheet.
The agencies have revised the Residuals Proposal in response to
some of the industry's concerns. The agencies understand that the
dollar-for-dollar capital requirement could result in a banking
organization holding more capital on residual interests than on the
underlying assets had they not been sold. However, in many cases the
relative size of the retained exposure by the originating banking
organization reveals additional market information about the quality of
the securitized asset pool. To facilitate a transaction in a manner
that meets with market acceptance, the securitization sponsor will
often increase the size of the residual. This practice is often
indicative of the quality of the underlying assets in the pool. In
other words, large residual positions often signal the lower credit
quality of the sold assets. Further, a banking organization's use of
gain-on-sale accounting affords it the opportunity to create capital,
the amount of which is related to a residual interest that may not be
worth its reported carrying value. Thus, to mitigate the effects of
these gains, the final rule requires banks to hold dollar-for-dollar
capital against the related assets.
Commenters suggested several alternative capital treatments such as
using the ratings based approach presented in the 2000 Recourse
Proposal to set capital requirements for residual interests, excluding
certain types of assets from the dollar-for-dollar treatment, and
revising the existing capital treatment by requiring additional

[[Page 59621]]

capital only against the gain-on-sale ``asset.'' Other commenters
proposed to limit the maximum capital requirement to the full capital
charge plus any gain-on-sale amount.
The agencies have decided not to alter the dollar-for-dollar
capital charge for residual interests that are unrated or rated B or
below, although certain residual interests rated BB or better will be
eligible for the ratings-based approach.\17\ Certain types of assets
were not excluded from the definition of ``residual interest'' because
every residual reflects a concentration of credit risk and is,
therefore, subject to valuation concerns associated with estimating
future losses. Further, gain-on-sale accounting, while a concern, was
not the only criterion in the agencies' determination of a suitable
method for calculating the capital charge for residual interests.
Basing the capital charge on the gain-on-sale amount would have made
the rule more complex, and would not necessarily result in the
maintenance of adequate capital for a residual interest since the gain-
on-sale amount can be significantly less than the carrying value of the
residual.
---------------------------------------------------------------------------

\17\ Credit-enhancing I/Os are not eligible for the ratings-
based approach.
---------------------------------------------------------------------------

B. Definitions and Scope of the Final Rule

1. Recourse
The final rule defines the term ``recourse'' to mean an arrangement
in which a banking organization retains, in form or in substance, the
credit risk in connection with an asset sale in accordance with
generally accepted accounting principles, if the credit risk exceeds a
pro rata share of the banking organization's claim on the assets. The
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 sales.
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''). With the adoption of a definition for recourse in
the final rule, the cross-reference to the Call Report instructions in
the guidelines is no longer necessary and has been removed. The OTS
capital regulation currently provides a definition of the term
``recourse,'' which has also been revised.
Several commenters sought clarification as to whether second lien
positions constitute recourse. While second liens are subordinate to
first liens, the agencies believe that second liens will not, in most
instances, constitute recourse. Second mortgages or home equity loans
generally will not be considered recourse arrangements unless they
actually function as credit enhancements.
Commenters also requested clarification that third-party
enhancements, e.g. insurance protection, purchased by the originator of
a securitization for the benefit of investors do not constitute
recourse. The agencies generally agree. The purchase of enhancements
for a securitization, where the banking organization is completely
removed from any credit risk will not, in most instances, constitute
recourse. However, if the purchase or premium price is paid over time
and the size of the payment is a function of the third-party's loss
experience on the portfolio, such an arrangement indicates an
assumption of credit risk and would be considered recourse.
2. Direct Credit Substitute
The definition of ``direct credit substitute'' complements the
definition of recourse. The term ``direct credit substitute'' refers to
an arrangement in which a banking organization assumes, in form or in
substance, credit risk associated with an on- or off-balance sheet
asset or exposure that was not previously owned by the banking
organization (third-party asset) and the risk assumed by the banking
organization exceeds the pro rata share of the banking organization's
interest in the third-party asset. As revised, it also explicitly
includes 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 purchased subordinated interests, such as credit-enhancing I/O
strips, are also residual interests for regulatory capital purposes
(see discussion in section III.B.4).
3. Residual Interests
The agencies define residual interests in the final rule as any on-
balance sheet asset that represents an interest (including a beneficial
interest) created by a transfer that qualifies as a sale (in accordance
with generally accepted accounting principles) of financial assets,
whether through a securitization or otherwise, and that exposes a
banking organization to any credit risk directly or indirectly
associated with the transferred asset that exceeds a pro rata share of
that banking organization's claim on the asset, whether through
subordination provisions or other credit enhancement techniques.
Residual interests do not include interests purchased from a third
party, except for credit-enhancing interest-only strips. Examples of
these types of assets include credit-enhancing interest-only strips
receivable; spread accounts; cash collateral accounts; retained
subordinated interests; accrued but uncollected interest on transferred
assets that, when collected, will be available to serve in a credit-
enhancing capacity; and similar on-balance sheet assets that function
as a credit enhancement. The functional-based definition reflects the
fact that securitization structures vary in the way they use certain
assets as credit enhancements. Therefore, residual interests include
any retained on-balance sheet asset that functions as a credit
enhancement in a securitization, regardless of how a banking
organization refers to the asset in its financial or regulatory
reports. In addition, due to their similar risk profile, purchased
credit-enhancing I/O strips are residual interests for regulatory
capital purposes.
Some commenters thought that the definition of residual interest
was too broad and captured assets that are not subject to valuation
concerns. The agencies have considered these comments and, as a result,
have refined the definition of residual interest in the final rule. In
general, the definition of residual interests includes only an on-
balance sheet asset that represents an interest created by a transfer
of financial assets treated as a sale under GAAP. Interests retained in
a securitization or transfer of assets accounted for as a financing
under GAAP are generally excluded from the residual interest definition
and capital treatment. In the case of GAAP financings, the transferred
assets remain on the transferring banking organization's balance sheet
and are, therefore, directly included in both the leverage and risk-
based capital calculations. Further, when a transaction is treated as a
financing, no gain is recognized from an accounting standpoint, which
serves to mitigate some of the agencies' concerns. The agencies,
however, will monitor securitization transactions that are accounted
for as financings under GAAP and will factor into the banking
organization's capital adequacy

[[Page 59622]]

determination the risk exposures being assumed or retained in
connection with a securitization transaction.
Some commenters stated that sellers' interests should not
constitute residual interests because they do not involve a
subordinated interest in a stream of cash flows, but rather a pro-rata
interest. The agencies agree that sellers' interests generally do not
function as a credit enhancement and should not be captured by the
rule. Thus, if a seller's interest shares losses on a pro rata basis
with investors, such an interest would not be a residual interest for
purposes of the rule. However, banking organizations should recognize
that sellers' interests that are structured to absorb a
disproportionate share of losses will be residual interests and subject
to the capital treatment described in the final rule.
Other commenters suggested that overcollateralization accounts are
not residual interests because the banking organization does not suffer
a potential loss from the assets transferred. They argue that certain
residual interests, such as interest-only strips, are subject to
valuation concerns that might lead to losses. However, other assets,
such as overcollateralization or spread accounts, do not present the
same level of valuation concerns and, therefore, should not be included
in the definition of residual interest.
Overcollateralization and spread accounts are susceptible to the
potential future credit losses within the loan pools that they support
and, thus, are subject to valuation inaccuracies. Further, the agencies
do not want to encourage arbitrage of the final rule by affording
banking organizations the opportunity to retain a subordinated position
in an asset labeled ``overcollateralization'' when that asset
represents the same level of credit risk as another residual interest,
just otherwise named. As a result, the definition of residual interest
continues to include overcollateralization. The agencies agree that
spread accounts and overcollateralization that do not meet the
definition of credit-enhancing interest-only strips generally do not
expose a banking organization to the same level of risk as credit-
enhancing interest-only strips, and thus, have excluded them from the
concentration limit. The agencies also believe that where a banking
organization provides additional loans to a securitization at
inception, but does not book as an asset a beneficial interest for the
present value of the future cash flows from these loans, the mere
contribution of excess assets, although it constitutes a credit
enhancement, will not constitute a residual interest under the final
rule because the banking organization has no on-balance sheet asset
that is susceptible to a write-down.
The capital treatment designated for a residual interest will apply
when a banking organization effectively retains the risk associated
with that residual interest, even if the residual is sold. The agencies
intend to look to the economic substance of the transaction to
determine whether the banking organization has transferred the risk
associated with the residual interest exposure. Banking organizations
that transfer the risk on residual interests, either directly through a
sale, or indirectly through guarantees or other credit risk mitigation
techniques, and then reassume this risk in any form will be required to
hold risk-based capital as though the residual interest remained on the
banking organization's books. For example, if a banking organization
sells an asset that is an on-balance sheet credit enhancement to a
third party and then writes a credit derivative to cover the credit
risk associated with that asset, the selling banking organization must
continue to risk weight, and hold capital against, that asset as a
residual as if the asset had not been sold.
4. Credit-Enhancing Interest-Only Strips
A credit-enhancing I/O strip is defined in the final rule as ``an
on-balance sheet asset that, in form or in substance, (i) represents
the contractual right to receive some or all of the interest due on
transferred assets; and (ii) exposes the banking organization to credit
risk that exceeds its pro rata claim on the underlying assets whether
through subordination provisions or other credit enhancing
techniques.'' Thus, credit-enhancing I/O strips include any balance
sheet asset that represents the contractual right to receive some or
all of the remaining interest cash flow generated from assets that have
been transferred into a trust (or other special purpose entity), after
taking into account trustee and other administrative expenses, interest
payments to investors, servicing fees, and reimbursements to investors
for losses attributable to the beneficial interests they hold, as well
as reinvestment income and ancillary revenues \18\ on the transferred
assets. Credit-enhancing I/O strips are generally carried on the
balance sheet at the present value of the expected net cash flow that
the banking organization reasonably expects to receive in future
periods on the assets it has securitized, adjusted for some level of
prepayments if relevant to that asset class, and discounted at an
appropriate market interest rate. Typically, when assets are
transferred in a securitization transaction that is accounted for as a
sale under GAAP, the accounting recognition given to the credit-
enhancing I/O strip on the seller's balance sheet results in the
recording of a gain on the portion of the transferred assets that has
been sold. This gain is recognized as income, thus increasing the
banking organization's capital position. In determining whether a
particular interest cash flow functions as a credit-enhancing I/O
strip, the agencies will look to the economic substance of the
transaction, and will reserve the right to identify other cash flows or
spread-related assets as credit-enhancing I/O strips on a case-by-case
basis. For example, including some principal payments with interest and
fee cash flows will not otherwise negate the regulatory capital
treatment of that asset as a credit-enhancing I/O strip. Credit-
enhancing I/O strips include both purchased and retained interest-only
strips that serve in a credit-enhancing capacity, even though purchased
I/O strips generally do not result in the creation of capital on
purchaser's balance sheet.
---------------------------------------------------------------------------

\18\ According to FASB Statement No. 140, ``Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities,'' ancillary revenues include such revenues as late
charges on the transferred assets.
---------------------------------------------------------------------------

5. 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
synthetic securitization. With the issuance of this final rule, the
agencies reaffirm the validity of the structural and risk-management
requirements of the December 1999 guidance on synthetic securitizations
issued by the Board and the OCC,\19\ while modifying the risk-based
capital treatment detailed therein with the treatment presented in this
final rule.
---------------------------------------------------------------------------

\19\ See, Banking Bulletin 99-43, December, 1999 (OCC); SR
Letter 99-32, Capital Treatment for Synthetic CLOs, November 17,
1999 (Board).
---------------------------------------------------------------------------

6. Credit-Enhancing 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

[[Page 59623]]

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 2000
Recourse Proposal addressed 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. To the extent a
banking organization's representations and warranties function as
credit enhancements to protect asset purchasers or investors from
credit risk, the final rule treats them as recourse or direct credit
substitutes.
The final rule is consistent with the agencies' longstanding
recourse treatment of representations and warranties that effectively
guaranty performance or credit quality of transferred loans. However,
the agencies 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, and are
excluded from the definitions of recourse and direct credit substitute.
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, fraud or
misrepresentation.
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 operational risks are
effectively managed.
The final rule requires recourse or direct credit substitute
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. Warranties such as these, which make
representations about the future value of a loan or related collateral
constitute an enhancement of the loan transferred and, thus, are
recourse arrangements or direct credit substitutes. One commenter
suggested that a representation that the seller ``has no knowledge'' of
circumstances that could cause a loan to be other than investment
quality is an operational warranty. The agencies agree that if a seller
represents that it has no knowledge of the existence of such
circumstances at the time that the loans are transferred the
representation would not be recourse.
Commenters sought clarification of the agencies' statement in the
2000 Recourse Proposal that early-default clauses are recourse. Early-
default clauses typically give the purchaser of a loan the right to
return the loan to the seller if the loan becomes 30 or more days
delinquent within a stated period after the transfer--four months after
transfer, for example. Once the stated period has expired, the early-
default clause will no longer trigger recourse treatment, provided that
there is no other provision that constitutes recourse.
Several commenters stated that early-default clauses are not
recourse because they are designed to cover loans that, due to their
non-payment within the first few months of origination, most likely
contained underwriting deficiencies. Early-default clauses can allow
for a reasonable but limited period of time for a purchaser to review
loan file documentation. Therefore, the final rule specifically exempts
from recourse treatment, for a limited period of time, these types of
warranties on certain 1-4 family residential mortgage loans. The
agencies have modified the definition of ``credit-enhancing
representations and warranties'' to exclude warranties, such as early-
default clauses and similar warranties that permit the return of
qualifying 1-4 family residential first mortgage loans for a maximum
period of 120 days from the date of transfer. To be excluded from the
definition, however, these warranties must cover only 1-4 family
residential mortgage loans that are eligible for the 50% risk weight
and that were originated within 1 year of the date of transfer. All
other early-default clauses, including those for periods of greater
than 120 days on qualifying 1-4 family residential first mortgages, are
recourse or direct credit substitutes.
The 2000 Recourse Proposal also sought comment on premium refund
clauses. A premium refund clause is a warranty that obligates a seller
who has sold a loan at a price in excess of par, i.e., at a premium, to
refund the premium, either in whole or in part, if the loan defaults or
is prepaid within a certain period of time. Commenters responded that
premium refund clauses are not recourse because they reflect interest
rate risk, not credit risk.
Although premium refund clauses can be triggered as a result of
prepayments, they can also be triggered by defaults. Accordingly,
premium refund clauses are generally credit-enhancing representations
and warranties under the final rule. However, the agencies have
included an exception for premium refund clauses on U.S. government-
guaranteed loans and qualifying 1-4 family first mortgage loans that
impose a refund obligation on a seller for a period not to exceed 120
days from the date of transfer. These types of loans hold significantly
reduced credit risk.
For those warranties not exempt from recourse or direct credit
substitute treatment under the final rule, industry concerns about
assets that are delinquent at the time of transfer or unsound
originations may be dealt with by warranties directly addressing the
condition of the asset at the time of transfer (i.e., creation of an
above described operational warranty) and compliance with stated
underwriting standards. Alternatively, banking organizations might
create warranties with exposure caps that would permit the banking
organization to take advantage of the low-level recourse rule.
7. Clean-Up Calls
The final rule clarifies the agencies' longstanding interpretations
on the use of clean-up calls in a securitization. A clean-up call is an
option that permits a servicer or its affiliate (which may be the
originator) to take investors out of their positions in a
securitization before all of the transferred loans have been repaid.
The servicer accomplishes this by repurchasing the remaining loans in
the pool once the pool balance has fallen below some specified level.
This option in a securitization raises longstanding agency concerns
that a banking organization may implicitly assume a credit-enhancing
position by

[[Page 59624]]

exercising the option when the credit quality of the securitized loans
is deteriorating. An excessively large clean-up call facilitates a
securitization servicer's ability to take investors out of a pool to
protect them from absorbing credit losses and, thus, may indicate that
the servicer has retained or assumed the credit risk on the underlying
pool of loans.
As a result, clean-up calls are treated generally as recourse and
direct credit substitutes. However, because clean-up calls can also
serve an administrative function in the operation of a securitization,
the agencies have included a limited exemption for these options. Under
the final rule, an agreement that permits a banking organization that
is a servicer or an affiliate of the servicer to elect to purchase
loans in a pool is not recourse or a direct credit substitute if the
agreement permits the banking organization to purchase the remaining
loans in a pool when the balance of those loans is equal to or less
than 10 percent of the original pool balance. However, an agreement
that permits the remaining loans to be repurchased when their balance
is greater than 10 percent of the original pool balance is considered
to be recourse or a direct credit substitute. The exemption from
recourse or direct credit substitute treatment for a clean-up call of
10 percent or less recognizes the real market need to be able to call a
transaction when the costs of keeping it outstanding are burdensome.
However, to minimize the potential for using such a feature as a means
of providing support for a troubled portfolio, a banking organization
that exercises a clean-up call should not repurchase any loans in the
pool that are 30 days or more past due. Alternatively, the banking
organization should repurchase the loans at the lower of their
estimated fair value or their par value plus accrued interest.
Regardless of the size of the clean-up call, the agencies will closely
scrutinize any transaction where the banking organization repurchases
deteriorating assets for an amount greater than a reasonable estimate
of their fair value and will take action accordingly.
8. Loan Servicing Arrangements
The definitions of ``recourse'' and ``direct credit substitute''
cover loan servicing arrangements if the banking organization, as
servicer, is responsible for credit losses associated with the serviced
loans. 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 and this reimbursement is not subordinate to other
claims. To be excluded from recourse and direct credit substitute
treatment, the banking organization, as servicer, should make an
independent credit assessment of the likelihood of repayment of the
servicer advance prior to advancing funds and should only make such an
advance if prudent lending standards are met. Risk-based capital is
assessed only against the amount of the cash advance, and the advance
is assigned to the risk-weight category appropriate to the party
obligated to reimburse the servicer.\20\
---------------------------------------------------------------------------

\20\ The Board has issued a notice of proposed rulemaking that
considers whether a special purpose entity should be characterized
as a bank affiliate and whether asset securitizations should be
classified as covered transactions pursuant to section 23A of the
Federal Reserve Act, 12 U.S.C. 371c. See ``Transactions between
Banks and Their Affiliates'', 66 FR 24186, May 11, 2001 and 66 FR
33649, June 25, 2001. Any final rule resulting from this Proposal
could affect the regulatory capital treatment of servicer cash
advances.
---------------------------------------------------------------------------

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.
Otherwise, the servicer's obligation to make cash advances will not 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 enhancement.
Commenters responding to the 2000 Recourse Proposal generally
supported the proposed definition of servicer cash advances. Some
commenters, however, expressed concern over the description of
``insignificant'' nonreimbursed advances as advances on any one loan
that are contractually limited to no more than 1% of the outstanding
principal amount on that loan. They argued that this 1% limit would
unfairly penalize smaller loans and was unnecessary.
The agencies suggested the 1% limit in the 2000 Recourse Proposal
in response to commenters' requests for guidance from commenters on the
1997 Proposal. However, upon reconsideration, the agencies agree that
the 1% limit is unnecessarily restrictive for smaller loans.
Accordingly, the final rule does not contain this benchmark.
Banking organizations that act as servicers, however, should
establish policies on servicer advances and use discretion in
determining what constitutes an ``insignificant'' servicer advance. The
agencies will monitor industry practice and may revisit the issue if
this exemption from recourse treatment is used inappropriately.
Further, the agencies will exercise their supervisory authority to
apply recourse or direct credit substitute treatment to servicer cash
advances that expose a banking organization acting as servicer to
excessive levels of credit risk.
9. Interaction With Market Risk Rule
Some commenters responding to the 2000 Recourse Proposal and the
Residuals Proposal asked for clarification of the treatment of a
transaction covered by both the market risk rule and the recourse rule.
This final rule generally applies to positions held in the banking
book.\21\ For banking organizations that comply with the market risk
rules,\22\ positions in the trading book arising from asset
securitizations, including recourse obligations, residual interests,
and direct credit substitutes, should be treated for risk-based capital
purposes in accordance with those rules. However, these banking
organizations remain subject to the 25 percent concentration limit for
credit-enhancing I/O strips.
---------------------------------------------------------------------------

\21\ This rule applies also to banking organizations that hold
positions in their trading book, but are not otherwise subject to
the market risk rules.
\22\ The OTS did not participate in the market risk rulemaking.
As a result, certain OTS definitions--for example, the OTS's
definition of ``face amount'';--differ from those of the other
agencies.
---------------------------------------------------------------------------

10. Reservation of Authority
Banking organizations are developing novel transactions that do not
fit well into the risk-weight categories and credit conversion factors
in the current 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 have clarified 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

[[Page 59625]]

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 regulatory capital standards.
Under this authority, the agencies reserve the right to assign risk
positions in securitizations to appropriate risk categories on a case-
by-case basis if the credit rating of the risk position is determined
to be inappropriate.
11. Alternative Capital Calculation for Small Business Obligations
Certain commenters noted that the capital treatment in the
Residuals Proposal would have a significant negative impact on banking
organizations' small business lending. According to these commenters,
the dollar-for-dollar capital requirement and concentration limits for
residual interests arising from asset securitizations under the
Residuals Proposal would apply to asset securitizations involving the
transfer of small business obligations. These commenters concluded
that, unless the Residuals Proposal is amended to exclude small
business obligations from coverage, the capital treatment in the final
rule would contravene section 208 of the CDRI Act. The final rule
retains the alternative capital calculation for small business
obligations that implements section 208 of the CDRI Act.

C. Ratings-Based Approach: Traded and Non-Traded 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 capital requirement for different
credit enhancements or loss positions to reflect differences in the
relative credit risk represented by the positions.
To address this issue, the agencies are implementing a multi-level,
ratings-based approach to assess capital requirements on recourse
obligations, residual interests (except credit-enhancing I/O strips),
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 to measure
relative exposure to credit risk and 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 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 use of credit ratings in the final rule is similar to the 2000
Recourse Proposal. Although many commenters expressed concerns about
specific aspects of the 2000 Recourse Proposal, commenters generally
supported the goal of making the capital requirements for asset
securitizations more rational and efficient, and viewed the 2000
Recourse Proposal as a positive step toward this goal. The agencies
have made several changes to the 2000 Recourse Proposal and Residual
Proposal in response to commenters' concerns and based on further
consideration of the issues.
Several commenters on the 2000 Recourse Proposal expressed concern
over reliance on external rating agency ratings for the purposes of
assessing risk-based capital charges for banking organizations. They
asserted that credit ratings are not intended to measure risks
associated with regulatory capital and that, without market discipline
imposed on them, the ratings may not be reliable for that purpose. They
also noted an inherent conflict of interest between a rating agency's
ability to objectively assign a rating upon which regulators can rely
in imposing capital charges and one that measures the risks in a
securitization for the banking organization who is paying for the
rating.
Investors rely on ratings to make investment decisions. This
reliance 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. Further, the use of a single rating will
only be adequate under the ratings-based approach for a position that
is traded. The agencies, however, reserve the 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 that an instrument poses
to banking organizations.
Under the ratings-based approach, the capital requirement for a
position is computed by multiplying the face amount of the position by
the appropriate risk weight determined in accordance with the following
tables.\23\ The first chart shown below maps long-term ratings to the
appropriate risk-weights under the final rule. In response to requests
from commenters, the agencies have also included another chart (the
second chart shown below) that maps short-term ratings for asset-backed
commercial paper to the appropriate risk-weights under this rule.
---------------------------------------------------------------------------

\23\ The rating designations (e.g., ``AAA,'' ``BBB,'' ``A-1,''
and ``P-1'') used in the charts are illustrative only and do not
indicate any preference for, or endorsement of, any particular
rating agency designation system.

------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
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........ (\1\)
investment grade, or unrated.

------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100

[[Page 59626]]

Below investment grade............ Not Prime........... (\1\)
------------------------------------------------------------------------
\1\ Not eligible for ratings-based approach.

The chart for short-term ratings is not identical to the long-term
ratings table because the rating agencies do not assign short-term
ratings using the same methodology as long-term ratings. Each short-
term rating category covers a range of longer-term rating
categories.\24\ For example, a P-1 rating could map to a long-term
rating as high as Aaa or as low as A3.
---------------------------------------------------------------------------

\24\ See, for example, Moody's Global Ratings Guide, June 2001,
p.3.
---------------------------------------------------------------------------

Under the final rule, the ratings-based approach is available for
asset-backed securities,\25\ recourse obligations, direct credit
substitutes and residual interests (other than credit-enhancing I/O
strips). The agencies have excluded credit-enhancing I/O strips from
the ratings-based approach based on their high risk profile, discussed
above at section III.B.4.
---------------------------------------------------------------------------

\25\ Similar to the banking agencies' 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. Currently, OTS also
includes most interest-only and principal-only strips in the 100%
risk-weight category. See 12 CFR 567.6(a)(1)(iv) (introductory
statement) and (a)(1)(iv)(M). However, certain high-quality stripped
mortgage-related securities are eligible for a 20% risk weight under
the OTS' capital standards. OTS recently proposed to conform its
capital treatment for high-quality stripped mortgage-related
securities to that of other agencies, and received not comments in
opposition to this change. See 66 FR 15049, March 15, 2001.
Accordingly, OTS in conforming these aspects of its rule to those of
the other agencies.
---------------------------------------------------------------------------

While the ratings-based approach is available for both traded and
untraded positions, the rule applies different requirement to these
positions. A traded position, for example, is only required to be rated
by one rating agency. A position is defined as ``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
unaffiliated investors relying on the rating; or (2) an unaffiliated
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.
A few commenters expressed concern over the provision in the 2000
Recourse Proposal that allowed a banking organization to use the single
highest rating obtained on a traded position, stating that doing so
encourages rating-shopping. The agencies agree and, therefore, the
final rule requires a banking organization to use the lowest single
rating assigned to a traded position. Moreover, if a rating changes,
the banking organization must use the new rating.
Rated, but untraded, asset-backed securities, recourse obligations,
direct credit substitutes and residual interests may also be eligible
for the ratings-based approach if they meet certain conditions. To
qualify, the position must be rated by more than one rating agency, the
ratings must be one category below investment grade or better for long-
term positions (or investment grade or better for short-term positions)
by all rating agencies providing a rating, the ratings must be publicly
available, and the ratings must be based on the same criteria used to
rate securities that are traded. If the ratings are different, the
lowest single rating will determine the risk-weight category.
Recourse obligations and direct credit substitutes (other than
residual interests) that do not qualify for the ratings-based approach
(or the internal ratings, program ratings or computer program ratings
approaches outlined below) receive ``gross-up'' treatment, that is, the
banking organization holding the position must hold capital against the
amount of the position plus all more senior positions, subject to the
low-level exposure rule.\26\ This grossed-up amount is placed into a
risk-weight category according to the obligor or, if relevant, the
guarantor or the nature of the collateral. The grossed-up amount
multiplied by both the risk-weight and 8 percent is never greater than
the full capital charge that would otherwise be imposed on the assets
if they were on the banking organization's balance sheet.\27\
---------------------------------------------------------------------------

\26\ ``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 obligor or, if relevant, the
guarantor or the nature of the collateral. For example, if a banking
organization retains a first-loss position (other than a residual
interest) 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 exposure 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).
\27\ For assets that are assigned to the 100 percent risk-weight
category, the minimum capital charge is 8 percent of the amount of
assets transferred, and banking organizations are required to hold 8
cents of capital for every dollar of assets transferred with
recourse. For assets that are assigned to the 50 percent risk-weight
category, the minimum capital charge is 4 cents of capital for every
dollar of assets transferred with recourse.
---------------------------------------------------------------------------

Residual interests that are not eligible for the ratings-based
approach receive dollar-for-dollar treatment. Dollar-for-dollar
treatment means, effectively, that one dollar in total risk-based
capital must be held against every dollar of a residual interest,
except for credit-enhancing I/Os that have already been deducted from
Tier 1 capital under the concentration limit.\28\ Thus, the capital
requirement for residual interests is not limited by the 8 percent cap
in place under the current risk-based capital system.
---------------------------------------------------------------------------

\28\ Residual interests that are retained or purchased credit-
enhancing I/O strips are first subject to a capital concentration
limit of 25 percent of Tier 1 capital. For risk-based capital
purposes (but not for leverage capital purposes), once this
concentration limit is applied, a banking organization must then
hold dollar-for-dollar capital against the face amount of credit-
enhancing I/O strips remaining.
---------------------------------------------------------------------------

Finally, an unrated position that is senior or preferred in all
respects (including collateralization and maturity) to a rated position
that is traded is treated as if it had the rating assigned to the rated
position. The banking organization, however, must satisfy its
supervisory agency that such treatment is appropriate. Senior unrated
positions qualify for the risk weighting of the subordinated rated
positions in the same securitization transaction as long as the
subordinated rated position (1) is traded and (2) remains outstanding
for the entire life of the unrated position, thus providing full credit
support for the term of the unrated position.

D. Unrated Positions

In response to the 2000 Recourse Proposal and earlier proposals,
commenters expressed concern over the expense and inefficiency of
requiring the purchase of ratings to qualify for the ratings-based
approach and advocated alternative approaches. In response to these
concerns, the final rule incorporates three alternative approaches for
determining the capital

[[Page 59627]]

requirements for certain unrated direct credit substitutes and recourse
obligations. Under each of these approaches, the banking organization
must satisfy its supervisory agency that the use of the approach is
appropriate for the particular banking organization and for the
exposure being evaluated. The final rule limits, however, the risk
weight that may be applied to an exposure under these alternative
approaches to a minimum of 100%.
Under the 2000 Recourse Proposal, only direct credit substitutes
could qualify for beneficial risk-weighting using the three
alternatives to external ratings (i.e., internal ratings, program
ratings, and computer programs). Commenters questioned the agencies'
limitation of the application of these alternative approaches to direct
credit substitutes. After considering the arguments for extending the
application of these approaches to recourse obligations, the agencies
have decided not to permit the internal ratings-based approach to apply
to any positions other than direct credit substitutes issued in
connection with an asset-backed commercial paper program. Industry
research and empirical evidence indicates that these positions are more
likely than recourse positions to be of investment-grade credit
quality, and that the banking organizations providing these direct
credit substitutes are more likely to have internal risk rating systems
for these credit enhancements that are sufficiently reliable for risk-
based capital calculations.
However, the agencies have reconsidered their position with respect
to qualifying program ratings and computer program ratings. The final
rule extends beneficial risk-weighting treatment, through the use of
qualifying program and computer ratings, to off-balance sheet recourse
obligations to accommodate structured finance programs. By extending
this treatment to off-balance sheet recourse obligations the final rule
facilitates the structuring of these programs in a more efficient
manner. The agencies believe this result is appropriate because of the
similarity of economic risks between off-balance sheet direct credit
substitutes and off-balance sheet recourse obligations.
The final rule, however, does not extend the use of internal
ratings, program ratings or computer program ratings to residual
interests. Such a change would not facilitate existing asset-backed
commercial paper programs and structured finance programs, which
generally do not book any on-balance sheet residuals. Further, residual
interests by their nature are generally illiquid, hard-to-value assets,
often with limited performance history. These characteristics make
determining internal capital requirements difficult. The agencies also
believe that the economic risk differs between residual interests and
off-balance sheet recourse and direct credit substitute exposures.
Therefore, based on the risks associated with residual interests, the
agencies have decided for the present not to allow banking
organizations to use internal ratings, program ratings or computer
programs to apply a risk-based capital treatment more favorable than a
dollar-for-dollar capital requirement to these positions.
The agencies will continue to evaluate the effectiveness and
reliability of these alternative approaches for assessing regulatory
capital at banking organizations and may revisit this issue if, over
time, new information indicates that reconsideration is warranted.
1. Use of Banking Organizations' Internal Risk Ratings
The final rule permits 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 such a credit enhancement 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 toward potential
adoption of a broader use of internal risk ratings as discussed in the
Basel Committee's June 1999 and January 2001 Consultative Papers on a
new Basel Capital Accord.
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 or traded. 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 non-traded
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 potentially 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 in asset-
backed commercial paper programs 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. A banking organization engaged in asset-backed
commercial paper securitization activities that wishes to use the
internal risk ratings approach must be able to demonstrate to the
satisfaction of its primary regulator, prior to relying upon its use,
that the bank's internal credit risk rating system is 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.

[[Page 59628]]

(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 the 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 final rule.
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.
If a banking organization's rating system is no longer found to be
adequate, the banking organization's primary regulator may preclude the
banking organization 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 had applied
to previous transactions for purposes of determining the banking
organization's regulatory capital requirements.
2. Ratings of Specific Positions in Structured Financing Programs
Under the final rule, a banking organization may use a rating
obtained from a rating agency for unrated direct credit substitutes or
recourse obligations (but not residual interests) in structured finance
programs 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 traded positions. 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 or
recourse exposure.
To use this approach, a banking organization must demonstrate to
its primary regulator that it is reasonable and consistent with the
standards of this final rule 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 final rule 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 final rule 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 can be used to qualify a direct credit substitute or
recourse obligation (but not a residual interest) 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%.
3. Use of Qualifying Rating Software Mapped to Public Rating Standards
The agencies will also allow banking organizations, particularly
those with limited involvement in securitization activities, to rely on
qualifying credit assessment computer programs that the rating agencies
have developed to rate otherwise unrated direct credit substitutes and
recourse obligations (but not residual interests) in asset
securitizations.
To qualify for use by a banking organization for risk-based capital
purposes, a computer program's credit assessments must correspond
credibly and reliably to the rating standards of the rating agencies
for traded positions in securitizations. A banking organization must
demonstrate the credibility of the computer program in the financial
markets, which would generally be shown by the significant use of the
computer program by investors and other market participants for risk
assessment purposes. A banking organization must also demonstrate the
reliability of the program in assessing credit risk.
A banking organization may use a computer program for purposes of
applying the ratings-based approach under this final rule only if the
banking organization satisfies its primary regulator that the program
results in credit assessments that credibly and reliably correspond
with the ratings of traded positions by the rating agencies. The
banking organization should also demonstrate to its primary regulator's
satisfaction that the program was designed to apply to its particular
direct credit substitute or recourse exposure and that it has properly
implemented the computer program. 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 can be used to qualify a direct credit substitute or
recourse obligation (but not a residual interest) 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%.

IV. Effective Date of the Final Rule

This final rule is effective January 1, 2002, a date that comports
with the delayed effective date requirements of both the Administrative
Procedure Act (APA) and the CDRI Act.\29\ Any transaction covered by
this final rule that is settled on or after that date is subject to the
capital requirements established by the rule. Banking organizations
that have entered into transactions prior to the effective date of

[[Page 59629]]

the final rule may elect early adoption, as of November 29, 2001, of
any provision of the final rule that results in a reduced risk-based
capital requirement. Conversely, banking organizations that enter into
transactions prior to the effective date of this final rule that result
in increased regulatory capital requirements may delay the application
of this rule to those transactions until December 31, 2002.
---------------------------------------------------------------------------

\29\ See 5 U.S.C. 553(d) (APA provision prescribing 30-day
delayed effective date); 12 U.S.C. 4802(b) (CDRI provision requiring
that a regulation take effect on the first day of the calendar
quarter following publication in final form if the regulation
imposes ``reporting, disclosures or other new requirements'' on
insured depository institutions.)
---------------------------------------------------------------------------

Although the Residual Proposal indicated that the agencies intended
to permit banking organizations to continue to apply existing capital
rules to certain asset securitizations for up to two years after the
effective date of the final rule, the agencies believe that the one
year effective date should give banking organizations ample time to
bring their capital requirements in line with the economic risks that
they have already assumed through their securitization activities. The
agencies have, through the issuance of supervisory guidance and four
separate notices of proposed rulemaking, identified the risks to
banking organizations from securitizations and demonstrated the
agencies' concern over the management of these risks by banking
organizations. These rulemakings and guidance have placed the industry
on notice that, among other things, the agencies have concluded that
the securitization activities of banking organizations often expose
them to greater economic risk than their capital levels reflect.
Therefore, this final rule requires that all transactions, whether
entered into before its effective date or not, be subject to the
capital requirements stated in the rule, but allows for flexibility in
the time by which that must occur.

V. Miscellaneous Changes

Each of the agencies has made miscellaneous changes to its proposed
regulatory text to conform its rule to the texts of the other agencies.
In addition, the agencies have made revisions to existing rules to
appropriately accommodate the revised treatment of recourse, direct
credit substitutes and residual interests.

VI. Regulatory Analysis

A. Regulatory Flexibility Act

OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OCC certifies that this final rule will not have a significant
impact on a substantial number of small entities. 5 U.S.C. 601 et seq.
The provisions of this final rule 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 final rule 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
(5 U.S.C. 601 et seq.) the FDIC hereby certifies that the final rule
will not have a significant economic 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 final rule will not have a significant
impact on a substantial number of small entities. The provisions of
this final rule that increase capital requirements for thrifts--the
provisions on residual interests and certain direct credit substitutes
(e.g., financial standby letters of credit)--are unlikely to affect
small savings associations. Current TFR data reveal that few small
savings associations hold residual interests and that no small thrift
holds residual interests in excess of 25 percent of core capital.
Further, the application of the revised capital requirements to
existing residual interests will not result in a change in the capital
category of any small thrift. Few small savings associations issue
standby letters of credit. In addition, virtually all of the standby
letters of credit that are issued by small thrifts will not be subject
to an increased capital requirement since these positions will continue
to be eligible for lower risk weights under the alternative approaches
outlines in the final rule. Accordingly, OTS concludes that a
regulatory flexibility analysis is not required.

B. Paperwork Reduction Act

The agencies have determined that this final rule 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.).

C. Executive Order 12866

OCC: The OCC has determined that this final rule 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 treatment of residual interests largely
will be offset by the ability of those banks to reduce their capital
requirement in accordance with the ratings-based approach.
OTS: The Director of the OTS has determined that this final rule
does not constitute a ``significant regulatory action'' under Executive
Order 12866. The final rule prescribes ratings-based and other
alternative approaches that are likely to reduce the risk-based capital
requirement for most recourse obligations and direct credit
substitutes. The rule will, however, increase capital requirements for
certain direct credit substitutes (e.g., standby letters of credit) and
residual interests. OTS has reviewed current TFR data to determine
whether current OTS-regulated institutions hold these positions in
significant amounts. These data indicate that, while these institutions
hold some residual interests, most standby letters of credit issued by
thrifts continue to be eligible for a lower risk weight under one of
the alternative approaches outlined in the final rule. OTS has analyzed
the additional cost of capital that will be incurred by thrift
institutions that hold residual interests and direct credit substitutes
that are subject to increased capital requirements. Based on this
analysis, it has concluded that the likely increases to the industry's
cost of capital will not have a significant impact on the economy, as
described in the Executive Order.

D. Unfunded Mandates Reform Act of 1995

OCC: Section 202 of the Unfunded Mandates Reform Act of 1995, Pub.
L. 104-4, (Unfunded Mandates Act), requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
Federal mandate that may result in 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

[[Page 59630]]

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 has
determined that this final 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 has not
prepared a budgetary impact statement or specifically addressed the
regulatory alternatives considered. As discussed in the preamble, this
final rule 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, residual interests and direct credit
substitutes.
OTS: Section 202 of the Unfunded Mandates Reform Act of 1995, Pub.
L. 104-4 (Unfunded Mandates Act), requires an agency to 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. As discussed in the preamble, the
final rule prescribes ratings-based and other alternative approaches
that are likely to reduce the risk-based capital requirement for most
recourse obligations and direct credit substitutes. The rule will,
however, increase capital requirements for certain direct credit
substitutes (e.g., standby letters of credit) and residual interests.
OTS has reviewed current TFR data to determine whether current OTS-
regulated institutions hold these positions in significant amounts.
These data indicate that, while these institutions hold some residual
interests, most standby letters of credit issued by thrifts continue to
be eligible for a lower risk weight under one of the alternative
approaches outlined in the final rule. OTS has analyzed the additional
cost of capital that will be incurred by thrift institutions that hold
residual interests and direct credit substitutes that are subject to
increased capital requirements. Based on this analysis, it has
concluded that the likely increases to the industry's cost of capital
will not 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.

E. Plain Language

The 2000 Recourse Proposal and the Residuals Proposal sought
comment on the agencies' compliance with the ``plain language''
requirement of section 722 of the Gramm-Leach-Bliley Act (12 U.S.C.
4809). No comments were received.

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 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. A heading is added to newly designated paragraph (a);
C. The second and third sentences in the newly designated paragraph
(a) are revised; and
D. New paragraph (b) is added to read as follows:

Sec. 3.4 Reservation of authority.

(a) Deductions from capital. * * * Similarly, the OCC may find that
a particular intangible asset, deferred tax asset or credit-enhancing
interest-only strip need not be deducted from Tier 1 or Tier 2 capital.
Conversely, the OCC may find that a particular intangible asset,
deferred tax asset, credit-enhancing interest-only strip or other Tier
1 or Tier 2 capital component has characteristics or terms that
diminish its contribution to a bank's ability to absorb losses, and may
require the deduction from Tier 1 or Tier 2 capital of all of the
component or of a greater portion of the component than is otherwise
required.
(b) Risk weight categories. Notwithstanding the risk categories in
sections 3 and 4 of appendix A to this part, the OCC will look to the
substance of the transaction and 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 appendix A to Part 3, revise all references to ``financial
guarantee-type standby letter of credit'' to read ``financial standby
letter of credit''.

4. In section 2 of appendix A,
A. Remove the word ``and'' at the end of paragraph (c)(1)(ii);
B. Revise paragraph (c)(1)(iii)(B);
C. Add a new paragraph (c)(1)(iv);
D. Footnote 6 is revised;
E. The second sentence of paragraph (c)(2)(i) is revised;
F. Paragraph (c)(4) is redesignated as paragraph (c)(5);
G. A new paragraph (c)(4) is added.

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

* * * * *

Section 2. Components of Capital

* * * * *
(c) * * *
(1) * * *

[[Page 59631]]

(iii) * * *
(B) 10% of Tier 1 capital, net of goodwill and all intangible
assets other than purchased credit card relationships, mortgage
servicing assets and non-mortgage servicing assets; and
(iv) Credit-enhancing interest-only strips (as defined in section
4(a)(3) of this appendix A), as provided in section 2(c)(4).
* * * * *
(2) * * *\6\ * * *
---------------------------------------------------------------------------

\6\ Intangible assets are defined to exclude IO strips
receivable related to these mortgage and non-mortgage servicing
assets. See section 1(c)(14) of this appendix A. Consequently, IO
strips receivable related to mortgage and non-mortgage servicing
assets are not required to be deducted under section 2(c)(2) of this
appendix A. However, credit-enhancing interest-only strips as
defined in section 4(a)(3) are deducted from Tier 1 capital in
accordance with section 2(c)(4) of this appendix A. Any non credit-
enhancing IO strips receivable are subject to a 100% risk weight
under section 3(a)(4) of this appendix A.
---------------------------------------------------------------------------

(i) * * * Calculation of these limitations must be based on Tier 1
capital net of goodwill and all other identifiable intangibles, other
than purchased credit card relationships, mortgage servicing assets and
non-mortgage servicing assets.
* * * * *
(4) Credit-enhancing interest-only strips. Credit-enhancing
interest-only strips, whether purchased or retained, that exceed 25% of
Tier 1 capital must be deducted from Tier 1 capital. Purchased and
retained credit-enhancing interest-only strips, on a non-tax adjusted
basis, are included in the total amount that is used for purposes of
determining whether a bank exceeds its Tier 1 capital.
(i) The 25% limitation on credit-enhancing interest-only strips
will be based on Tier 1 capital net of goodwill and all identifiable
intangibles, other than purchased credit card relationships, mortgage
servicing assets and non-mortgage servicing assets.
(ii) Banks must value each credit-enhancing interest-only strip
included in Tier 1 capital at least quarterly. The quarterly
determination of the current fair value of the credit-enhancing
interest-only strip must include adjustments for any significant
changes in original valuation assumptions, including changes in
prepayment estimates.
(iii) Banks may elect to deduct disallowed credit-enhancing
interest-only strips on a basis that is net of any associated deferred
tax liability. Deferred tax liabilities netted in this manner cannot
also be netted against deferred tax assets when determining the amount
of deferred tax assets that are dependent upon future taxable income.
* * * * *

4. 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;
F. Footnote 16 in paragraph (b)(2)(i) is revised;
G. Footnote 17 in paragraph (b)(2)(ii) is revised;
H. Paragraph (c) is removed; and
I. Paragraph (d) is removed.
* * * * *

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

* * * * *
(a) * * *
(3) * * *
(v) * * * \11a\
* * * * *
(b) * * * However, direct credit substitutes, recourse obligations,
and securities issued in connection with asset securitizations are
treated as described in section 4 of this appendix A.
(1) * * *
(ii) Risk participations purchased in bankers' acceptances;
* * * * *
(2) * * *
(i) * * * \16\ * * *
(ii) * * * \17\ * * *
---------------------------------------------------------------------------

\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
4(b) of this appendix A.
\16\ For purposes of this section 3(b)(2)(i), a ``performance-
based standby letter of credit'' is any letter of credit, or similar
arrangement, however named or described, which represents an
irrevocable obligation to the beneficiary on the part of the issuer
to make payment on account of any default by the account party in
the performance of a non-financial or commercial obligation.
Participations in performance-based standby letters of credit are
treated in accordance with section 4 of this appendix A.
\17\ Participations in commitments are treated in accordance
with section 4 of this appendix A.
---------------------------------------------------------------------------

* * * * *

5. Section 4 is redesignated Section 5.

6. A new Section 4 is added to read as follows:
* * * * *

Section 4. Recourse, Direct Credit Substitutes and Positions in
Securitizations

(a) Definitions. For purposes of this section 4 of this appendix A,
the following definitions apply:
(1) Credit derivative means a contract that allows one party (the
protection purchaser) to transfer the credit risk of an asset or off-
balance sheet credit exposure to another party (the protection
provider). The value of a credit derivative is dependent, at least in
part, on the credit performance of a ``reference asset.''
(2) Credit-enhancing interest-only strip means an on-balance sheet
asset that, in form or in substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the bank to credit risk directly or indirectly
associated with the transferred assets that exceeds its pro rata claim
on the assets whether through subordination provisions or other credit
enhancing techniques.
(3) Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate a bank to protect investors from losses arising from credit
risk in the assets transferred or the loans serviced. Credit-enhancing
representations and warranties include promises to protect a party from
losses resulting from the default or nonperformance of another party or
from an insufficiency in the value of the collateral. Credit-enhancing
representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans (as described in section 3(a)(3)(iii) of this
appendix A) for a period not to exceed 120 days from the date of
transfer. These warranties may cover only those loans that were
originated within 1 year of the date of transfer;
(ii) Premium refund clauses that cover assets guaranteed, in whole
or in part, by the U.S. Government, a U.S. Government agency, or a U.S.
Government-sponsored enterprise, provided the premium refund clauses
are for a period not to exceed 120 days from the date of transfer; or
(iii) Warranties that permit the return of assets in instances of
fraud,

[[Page 59632]]

misrepresentation or incomplete documentation.
(4) Direct credit substitute means an arrangement in which a bank
assumes, in form or in substance, credit risk associated with an on- or
off-balance sheet asset or exposure that was not previously owned by
the bank (third-party asset) and the risk assumed by the bank exceeds
the pro rata share of the bank's interest in the third-party asset. If
a bank has no claim on the third-party asset, then the bank's
assumption of any credit risk is a direct credit substitute. Direct
credit substitutes include:
(i) Financial standby letters of credit that support financial
claims on a third party that exceed a bank's pro rata share in the
financial claim;
(ii) Guarantees, surety arrangements, credit derivatives and
similar instruments backing financial claims that exceed a bank's pro
rata share in the financial claim;
(iii) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Credit derivative contracts under which the bank assumes more
than its pro rata share of credit risk on a third-party asset or
exposure;
(v) Loans or lines of credit that provide credit enhancement for
the financial obligations of a third party;
(vi) Purchased loan servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Mortgage servicer cash advances that meet the conditions of section
4(a)(8)(i) and (ii) of this appendix A, are not direct credit
substitutes; and
(vii) Clean-up calls on third-party assets. Clean-up calls that are
10% or less of the original pool balance and that are exercisable at
the option of the bank are not direct credit substitutes.
(5) Externally rated means that an instrument or obligation has
received a credit rating from at least one nationally recognized
statistical rating organization.
(6) Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
(7) Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or a
contract that conveys a right to receive or exchange cash or another
financial instrument from another party.
(8) Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(i) To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party); or
(ii) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(9) Mortgage servicer cash advance means funds that a residential
mortgage servicer advances to ensure an uninterrupted flow of payments,
including advances made to cover foreclosure costs or other expenses to
facilitate the timely collection of the loan. A mortgage servicer cash
advance is not a recourse obligation or a direct credit substitute if:
(i) The servicer is entitled to full reimbursement and this right
is not subordinated to other claims on the cash flows from the
underlying asset pool; or
(ii) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal amount of that loan.
(10) Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers.
(11) Recourse means a bank's retention, in form or in substance, of
any credit risk directly or indirectly associated with an asset it has
sold that exceeds a pro rata share of that bank's claim on the asset.
If a bank has no claim on a sold asset, then the retention of any
credit risk is recourse. A recourse obligation typically arises when a
bank transfers assets and retains an explicit obligation to repurchase
assets or to absorb losses due to a default on the payment of principal
or interest or any other deficiency in the performance of the
underlying obligor or some other party. Recourse may also exist
implicitly if a bank provides credit enhancement beyond any contractual
obligation to support assets it has sold. The following are examples of
recourse arrangements:
(i) Credit-enhancing representations and warranties made on
transferred assets;
(ii) Loan servicing assets retained pursuant to an agreement under
which the bank will be responsible for losses associated with the loans
serviced. Mortgage servicer cash advances that meet the conditions of
section 4(a)(8)(i) and (ii) of this appendix A, are not recourse
arrangements;
(iii) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Assets sold under an agreement to repurchase, if the assets
are not already included on the balance sheet;
(v) Loan strips sold without contractual recourse where the
maturity of the transferred portion of the loan is shorter than the
maturity of the commitment under which the loan is drawn;
(vi) Credit derivatives issued that absorb more than the bank's pro
rata share of losses from the transferred assets; and
(vii) Clean-up calls. Clean-up calls that are 10% or less of the
original pool balance and that are exercisable at the option of the
bank are not recourse arrangements.
(12) Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally
accepted accounting principles) of financial assets, whether through a
securitization or otherwise, and that exposes a bank to any credit risk
directly or indirectly associated with the transferred asset that
exceeds a pro rata share of that bank's claim on the asset, whether
through subordination provisions or other credit enhancement
techniques. Residual interests generally include credit-enhancing
interest-only strips, spread accounts, cash collateral accounts,
retained subordinated interests (and other forms of
overcollateralization) and similar assets that function as a credit
enhancement. Residual interests further include those exposures that,
in substance, cause the bank to retain the credit risk of an asset or
exposure that had qualified as a residual interest before it was sold.
Residual interests generally do not include interests purchased from a
third party.
(13) Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full amount
of an obligation (e.g. a direct credit substitute) notwithstanding that
another party has acquired a participation in that obligation.
(14) Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures that can be sold to
investors. Securitization includes transactions that create stratified
credit risk positions

[[Page 59633]]

whose performance is dependent upon an underlying pool of credit
exposures, including loans and commitments.
(15) Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and credit enhancement provided to the program.
(16) Traded position means a position retained, assumed or issued
in connection with a securitization that is externally rated, where
there is a reasonable expectation that, in the near future, the rating
will be relied upon by:
(i) Unaffiliated investors to purchase the position; or
(ii) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan or repurchase
agreement.
(b) Credit equivalent amounts and risk weights of recourse
obligations and direct credit substitutes--(1) Credit-equivalent
amount. Except as otherwise provided, the credit-equivalent amount for
a recourse obligation or direct credit substitute is the full amount of
the credit-enhanced assets for which the bank directly or indirectly
retains or assumes credit risk multiplied by a 100% conversion factor.
(2) Risk-weight factor. To determine the bank's risk-weighted
assets for off-balance sheet recourse obligations and direct credit
substitutes, the credit equivalent amount is assigned to the risk
category appropriate to the obligor in the underlying transaction,
after considering any associated guarantees or collateral. For a direct
credit substitute that is an on-balance sheet asset (e.g., a purchased
subordinated security), a bank must calculate risk-weighted assets
using the amount of the direct credit substitute and the full amount of
the assets it supports, i.e., all the more senior positions in the
structure.
(c) Credit equivalent amount and risk weight of participations in,
and syndications of, direct credit substitutes. The credit equivalent
amount for a participation interest in, or syndication of, a direct
credit substitute is calculated and risk weighted as follows:
(1) In the case of a direct credit substitute in which a bank has
conveyed a risk participation, the full amount of the assets that are
supported by the direct credit substitute is converted to a credit
equivalent amount using a 100% conversion factor. The pro rata share of
the credit equivalent amount that has been conveyed through a risk
participation is then assigned to whichever risk-weight category is
lower: the risk-weight category appropriate to the obligor in the
underlying transaction, after considering any associated guarantees or
collateral, or the risk-weight category appropriate to the party
acquiring the participation. The pro rata share of the credit
equivalent amount that has not been participated out is assigned to the
risk-weight category appropriate to the obligor after considering any
associated guarantees or collateral.
(2) In the case of a direct credit substitute in which the bank has
acquired a risk participation, the acquiring bank's pro rata share of
the direct credit substitute is multiplied by the full amount of the
assets that are supported by the direct credit substitute and converted
using a 100% credit conversion factor. The resulting credit equivalent
amount is then assigned to the risk-weight category appropriate to the
obligor in the underlying transaction, after considering any associated
guarantees or collateral.
(3) In the case of a direct credit substitute that takes the form
of a syndication where each bank or participating entity is obligated
only for its pro rata share of the risk and there is no recourse to the
originating entity, each bank's credit equivalent amount will be
calculated by multiplying only its pro rata share of the assets
supported by the direct credit substitute by a 100% conversion factor.
The resulting credit equivalent amount is then assigned to the risk-
weight category appropriate to the obligor in the underlying
transaction, after considering any associated guarantees or collateral.
(d) Externally rated positions: credit-equivalent amounts and risk
weights.--(1) Traded positions. With respect to a recourse obligation,
direct credit substitute, residual interest (other than a credit-
enhancing interest-only strip) or asset- or mortgage-backed security
that is a ``traded position'' and that has received an external rating
on a long-term position that is one grade below investment grade or
better or a short-term position that is investment grade, the bank may
multiply the face amount of the position by the appropriate risk
weight, determined in accordance with Tables B or C of this Appendix
A.\24\ If a traded position receives more than one external rating, the
lowest single rating will apply.
---------------------------------------------------------------------------

\24\ Stripped mortgage-backed securities or other similar
instruments, such as interest-only or principal-only strips, that
are not credit enhancing must be assigned to the 100% risk category.

Table B
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

Table C
------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------

[[Page 59634]]

(2) Non-traded positions. A recourse obligation, direct credit
substitute, residual interest (but not a credit-enhancing interest-only
strip) or asset- or mortgage-backed security extended in connection
with a securitization that is not a ``traded position'' may be assigned
a risk weight in accordance with section 4(d)(1) of this appendix A if:
(i) It has been externally rated by more than one NRSRO;
(ii) It has received an external rating on a long-term position
that is one category below investment grade or better or a short-term
position that is investment grade by all NRSROs providing a rating;
(iii) The ratings are publicly available; and
(iv) The ratings are based on the same criteria used to rate traded
positions.

If the ratings are different, the lowest rating will determine the risk
category to which the recourse obligation, residual interest or direct
credit substitute will be assigned.
(e) Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest or asset- or
mortgage-backed security that is not externally rated but is senior or
preferred in all features to a traded position (including
collateralization and maturity), a bank may apply a risk weight to the
face amount of the senior position in accordance with section 4(d)(1)
of this appendix A, based upon the traded position, subject to any
current or prospective supervisory guidance and the bank satisfying the
OCC that this treatment is appropriate. This section will apply only if
the traded position provides substantive credit support to the unrated
position until the unrated position matures.
(f) Residual Interests--(1) Concentration limit on credit-enhancing
interest-only strips. In addition to the capital requirement provided
by section 4(f)(2) of this appendix A, a bank must deduct from Tier 1
capital all credit-enhancing interest-only strips in excess of 25
percent of Tier 1 capital in accordance with section 2(c)(2)(iv) of
this appendix A.
(2) Credit-enhancing interest-only strip capital requirement. After
applying the concentration limit to credit-enhancing interest-only
strips in accordance with section (f)(1), a bank must maintain risk-
based capital for a credit-enhancing interest-only strip equal to the
remaining amount of the credit-enhancing interest-only strip (net of
any existing associated deferred tax liability), even if the amount of
risk-based capital required to be maintained exceeds the full risk-
based capital requirement for the assets transferred. Transactions
that, in substance, result in the retention of credit risk associated
with a transferred credit-enhancing interest-only strip will be treated
as if the credit-enhancing interest-only strip was retained by the bank
and not transferred.
(3) Other residual interests capital requirement. Except as
provided in sections (d) or (e) of this section, a bank must maintain
risk-based capital for a residual interest (excluding a credit-
enhancing interest-only strip) equal to the face amount of the residual
interest that is retained on the balance sheet (net of any existing
associated deferred tax liability), even if the amount of risk-based
capital required to be maintained exceeds the full risk-based capital
requirement for the assets transferred. Transactions that, in
substance, result in the retention of credit risk associated with a
transferred residual interest will be treated as if the residual
interest was retained by the bank and not transferred.
(4) Residual interests and other recourse obligations. Where the
aggregate capital requirement for residual interests (including credit-
enhancing interest-only strips) and recourse obligations arising from
the same transfer of assets exceed the full risk-based capital
requirement for those assets, a bank must maintain risk-based capital
equal to the greater of the risk-based capital requirement for the
residual interest as calculated under sections 4(f)(1) through (3) of
this appendix A or the full risk-based capital requirement for the
assets transferred.
(g) Positions that are not rated by an NRSRO. A position (but not a
residual interest) extended in connection with a securitization and
that is not rated by an NRSRO may be risk-weighted based on the bank's
determination of the credit rating of the position, as specified in
Table D of this appendix A, multiplied by the face amount of the
position. In order to qualify for this treatment, the bank's system for
determining the credit rating of the position must meet one of the
three alternative standards set out in section 4(g)(1)through (3) of
this appendix A.

Table D
------------------------------------------------------------------------
Risk weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Investment grade.................. BBB, or better...... 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

(1) Internal risk rating used for asset-backed programs. A direct
credit substitute (but not a purchased credit-enhancing interest-only
strip) is assumed by a bank in connection with an asset-backed
commercial paper program sponsored by the bank and the bank is able to
demonstrate to the satisfaction of the OCC, prior to relying upon its
use, that the bank's internal credit risk rating system is adequate.
Adequate internal credit risk rating systems usually contain the
following criteria:
(i) The internal credit risk system is an integral part of the
bank's risk management system that explicitly incorporates the full
range of risks arising from a bank's participation in securitization
activities;
(ii) Internal credit ratings are linked to measurable outcomes,
such as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
(iii) The bank's internal credit risk system must separately
consider the risk associated with the underlying loans or borrowers,
and the risk associated with the structure of a particular
securitization transaction;
(iv) The bank's internal credit risk system must identify
gradations of risk among ``pass'' assets and other risk positions;
(v) The bank must have clear, explicit criteria that are used to
classify assets into each internal risk grade, including subjective
factors;
(vi) The bank must have independent credit risk management or loan
review personnel assigning or reviewing the credit risk ratings;
(vii) An internal audit procedure should periodically verify that
internal risk ratings are assigned in accordance with the bank's
established criteria.

[[Page 59635]]

(viii) The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit substitutes
over time to determine the appropriateness of the initial credit risk
rating assignment and adjust individual credit risk ratings, or the
overall internal credit risk ratings system, as needed; and
(ix) The internal credit risk system must make credit risk rating
assumptions that are consistent with, or more conservative than, the
credit risk rating assumptions and methodologies of NRSROs.
(2) Program Ratings. A direct credit substitute or recourse
obligation (but not a residual interest) is assumed or retained by a
bank in connection with a structured finance program and a NRSRO has
reviewed the terms of the program and stated a rating for positions
associated with the program. If the program has options for different
combinations of assets, standards, internal credit enhancements and
other relevant factors, and the NRSRO specifies ranges of rating
categories to them, the bank may apply the rating category applicable
to the option that corresponds to the bank's position. In order to rely
on a program rating, the bank must demonstrate to the OCC's
satisfaction that the credit risk rating assigned to the program meets
the same standards generally used by NRSROs for rating traded
positions. The bank must also demonstrate to the OCC's satisfaction
that the criteria underlying the NRSRO's assignment of ratings for the
program are satisfied for the particular position. If a bank
participates in a securitization sponsored by another party, the OCC
may authorize the bank to use this approach based on a program rating
obtained by the sponsor of the program.
(3) Computer Program. The bank is using an acceptable credit
assessment computer program to determine the rating of a direct credit
substitute or recourse obligation (but not a residual interest)
extended in connection with a structured finance program. A NRSRO must
have developed the computer program and the bank must demonstrate to
the OCC's satisfaction that ratings under the program correspond
credibly and reliably with the rating of traded positions.
(h) Limitations on risk-based capital requirements--(1) Low-level
exposure rule. If the maximum contractual exposure to loss retained or
assumed by a bank is less than the effective risk-based capital
requirement, as determined in accordance with section 4(b) of this
appendix A, for the asset supported by the bank's position, the risk
based capital required under this appendix A is limited to the bank's
contractual exposure, less any recourse liability account established
in accordance with generally accepted accounting principles. This
limitation does not apply when a bank provides credit enhancement
beyond any contractual obligation to support assets that it has sold.
(2) Related on-balance sheet assets. If an asset is included in the
calculation of the risk-based capital requirement under this section 4
of this appendix A and also appears as an asset on a bank's balance
sheet, the asset is risk-weighted only under this section 4 of this
appendix A, except in the case of loan servicing assets and similar
arrangements with embedded recourse obligations or direct credit
substitutes. In that case, both the on-balance sheet servicing assets
and the related recourse obligations or direct credit substitutes must
both be separately risk weighted and incorporated into the risk-based
capital calculation.
(i) Alternative Capital Calculation for Small Business Obligations.
(1) Definitions. For purposes of this section 4(i):
(i) Qualified bank means a bank that:
(A) Is well capitalized as defined in 12 CFR 6.4 without applying
the capital treatment described in this section 4(i), or
(B) Is adequately capitalized as defined in 12 CFR 6.4 without
applying the capital treatment described in this section 4(i) and has
received written permission from the appropriate district office of the
OCC to apply the capital treatment described in this section 4(i).
(ii) Recourse has the meaning given to such term under generally
accepted accounting principles.
(iii) Small business means a business that meets the criteria for a
small business concern established by the Small Business Administration
in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(2) Capital and reserve requirements. Notwithstanding the risk-
based capital treatment outlined in section 2(c)(4) and any other
subsection (other than subsection (i)) of this section 4, with respect
to a transfer of a small business loan or a lease of personal property
with recourse that is a sale under generally accepted accounting
principles, a qualified bank may elect to apply the following
treatment:
(i) The bank establishes and maintains a non-capital reserve under
generally accepted accounting principles sufficient to meet the
reasonable estimated liability of the bank under the recourse
arrangement; and
(ii) For purposes of calculating the bank's risk-based capital
ratio, the bank includes only the face amount of its recourse in its
risk-weighted assets.
(3) Limit on aggregate amount of recourse. The total outstanding
amount of recourse retained by a qualified bank with respect to
transfers of small business loans and leases of personal property and
included in the risk-weighted assets of the bank as described in
section 4(i)(2) of this appendix A may not exceed 15 percent of the
bank's total capital after adjustments and deductions, unless the OCC
specifies a greater amount by order.
(4) Bank that ceases to be qualified or that exceeds aggregate
limit. If a bank ceases to be a qualified bank or exceeds the aggregate
limit in section 4(i)(3) of this appendix A, the bank may continue to
apply the capital treatment described in section 4(i)(2) of this
appendix A to transfers of small business loans and leases of personal
property that occurred when the bank was qualified and did not exceed
the limit.
(5) Prompt Corrective Action not affected. (i) A bank shall compute
its capital without regard to this section 4(i) for purposes of prompt
corrective action (12 U.S.C. 1831o and 12 CFR part 6) unless the bank
is an adequately or well capitalized bank (without applying the capital
treatment described in this section 4(i)) and, after applying the
capital treatment described in this section 4(i), the bank would be
well capitalized.
(ii) A bank shall compute its capital without regard to this
section 4(i) for purposes of 12 U.S.C. 1831o(g) regardless of the
bank's capital level.
* * * * *

4. In appendix A, Table 2, ``100 Percent Conversion Factor,'' Item
1 is revised to read as follows:
* * * * *


[[Page 59636]]

Table 2--Credit Conversion Factors for Off-Balance Sheet Items
------------------------------------------------------------------------

-------------------------------------------------------------------------
100 Percent Conversion Factor
1. [Reserved]

------------------------------------------------------------------------

* * * * *

Dated: October 23, 2001.
John D. Hawke, Jr.,
Comptroller of the Currency

FEDERAL RESERVE SYSTEM

12 CFR Chapter II

Authority and Issuance

For the reasons set forth in the joint preamble, parts 208 and 225
of chapter II of title 12 of the Code of Federal Regulations are
amended as follows:

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

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

Authority: 12 U.S.C. 24, 24a, 36, 92a, 93a, 248(a), 248(c), 321-
338a, 371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9),
1823(j), 1828(o), 1831o, 1831p-1, 1831r-1, 1831w, 1835a, 1882, 2901-
2907, 3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b),
78l(g), 78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318; 42
U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.

2. In appendix A to part 208:
A. The three introductory paragraphs of section II, the first five
paragraphs of section II.A.1, and the first seven paragraphs of section
II.A.2. are revised and footnote 5 is removed and reserved;
B. In section II.B., a new paragraph (i)(c) is added, section
II.B.1.b. and footnote 14 are revised, new sections II.B.1.c. through
II.B.1.g. are added, and section II.B.4. is revised;
C. In section III.A., a new undesignated fifth paragraph is added
at the end of the section;
D. In section III.B., paragraph 3 is revised and footnote 23 is
removed, and in paragraph 4, footnote 24 is removed;
E. In section III.C., paragraphs 1 through 3, footnotes 25 through
39 are redesignated as footnotes 23 through 37, and paragraph 4 is
revised;
F. In section III.D., the introductory paragraph and paragraph 1
are revised;
G. In sections III.D. and III.E., footnote 46 is removed and
footnotes 47 through 51 are redesignated as footnotes 44 through 48;
H. In section IV.B., footnote 52 is removed; and
I. Attachment II is revised.

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

* * * * *

II. * * *

A bank's qualifying total capital consists of two types of capital
components: ``core capital elements'' (comprising tier 1 capital) and
``supplementary capital elements'' (comprising tier 2 capital). These
capital elements and the various limits, restrictions, and deductions
to which they are subject, are discussed below and are set forth in
Attachment II.
The Federal Reserve will, on a case-by-case basis, determine
whether and, if so, how much of any instrument that does not fit wholly
within the terms of one of the capital categories set forth below or
that does not have an ability to absorb losses commensurate with the
capital treatment otherwise specified below will be counted as an
element of tier 1 or tier 2 capital. In making such a determination,
the Federal Reserve will consider the similarity of the instrument to
instruments explicitly treated in the guidelines, the ability of the
instrument to absorb losses while the bank operates as a going concern,
the maturity and redemption features of the instrument, and other
relevant terms and factors. To qualify as an element of tier 1 or tier
2 capital, a capital instrument may not contain or be covered by any
covenants, terms, or restrictions that are inconsistent with safe and
sound banking practices.
Redemptions of permanent equity or other capital instruments before
stated maturity could have a significant impact on a bank's overall
capital structure. Consequently, a bank considering such a step should
consult with the Federal Reserve before redeeming any equity or debt
capital instrument (prior to maturity) if such redemption could have a
material effect on the level or composition of the institution's
capital base.\4\
---------------------------------------------------------------------------

\4\ Consultation would not ordinarily be necessary if an
instrument were redeemed with the proceeds of, or replaced by, a
like amount of a similar or higher quality capital instrument and
the organization's capital position is considered fully adequate by
the Federal Reserve.
---------------------------------------------------------------------------

A. * * *
1. Core capital elements (tier 1 capital). The tier 1 component of
a bank's qualifying capital must represent at least 50 percent of
qualifying total capital and may consist of the following items that
are defined as core capital elements:
(i) Common stockholders' equity;
(ii) Qualifying noncumulative perpetual preferred stock (including
related surplus); and
(iii) Minority interest in the equity accounts of consolidated
subsidiaries.
Tier 1 capital is generally defined as the sum of core capital
elements \5\ less goodwill, other intangible assets, and interest-only
strips receivables that are required to be deducted in accordance with
section II.B.1. of this appendix.
---------------------------------------------------------------------------

\5\ [Reserved]
---------------------------------------------------------------------------

* * * * *
2. Supplementary capital elements (tier 2 capital). The tier 2
component of a bank's qualifying capital may consist of the following
items that are defined as supplementary capital elements:
(i) Allowance for loan and lease losses (subject to limitations
discussed below);
(ii) Perpetual preferred stock and related surplus (subject to
conditions discussed below);
(iii) Hybrid capital instruments (as defined below), and mandatory
convertible debt securities;
(iv) Term subordinated debt and intermediate-term preferred stock,
including related surplus (subject to limitations discussed below);
(v) Unrealized holding gains on equity securities (subject to
limitations discussed in section II.A.2.e. of this appendix).
The maximum amount of tier 2 capital that may be included in a
bank's qualifying total capital is limited to 100 percent of tier 1
capital (net of goodwill, other intangible assets, and interest-only
strips receivables that are required to be deducted in accordance with
section II.B.1. of this appendix).
* * * * *
B. * * *
(i) * * *
(c) Certain credit-enhancing interest-only strips receivables--
deducted from the sum of core capital elements in

[[Page 59637]]

accordance with sections II.B.1.c. through e. of this appendix.
* * * * *
1. Goodwill, other intangible assets, and residual interests. * * *
b. Other intangible assets. i. All servicing assets, including
servicing assets on assets other than mortgages (i.e., nonmortgage
servicing assets), are included in this appendix as identifiable
intangible assets. The only types of identifiable intangible assets
that may be included in, that is, not deducted from, a bank's capital
are readily marketable mortgage servicing assets, nonmortgage servicing
assets, and purchased credit card relationships. The total amount of
these assets that may be included in capital is subject to the
limitations described below in sections II.B.1.d. and e. of this
appendix.
ii. The treatment of identifiable intangible assets set forth in
this section generally will be used in the calculation of a bank's
capital ratios for supervisory and applications purposes. However, in
making an overall assessment of a bank's capital adequacy for
applications purposes, the Board may, if it deems appropriate, take
into account the quality and composition of a bank's capital, together
with the quality and value of its tangible and intangible assets.
c. Credit-enhancing interest-only strips receivables (I/Os). i.
Credit-enhancing I/Os are on-balance sheet assets that, in form or in
substance, represent the contractual right to receive some or all of
the interest due on transferred assets and expose the bank to credit
risk directly or indirectly associated with transferred assets that
exceeds a pro rata share of the bank's claim on the assets, whether
through subordination provisions or other credit enhancement
techniques. Such I/Os, whether purchased or retained, including other
similar ``spread'' assets, may be included in, that is, not deducted
from, a bank's capital subject to the limitations described below in
sections II.B.1.d. and e. of this appendix.
ii. Both purchased and retained credit-enhancing I/Os, on a non-tax
adjusted basis, are included in the total amount that is used for
purposes of determining whether a bank exceeds the tier 1 limitation
described below in this section. In determining whether an I/O or other
types of spread assets serve as a credit enhancement, the Federal
Reserve will look to the economic substance of the transaction.
d. Fair value limitation. The amount of mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships
that a bank may include in capital shall be the lesser of 90 percent of
their fair value, as determined in accordance with section II.B.1.f. of
this appendix, or 100 percent of their book value, as adjusted for
capital purposes in accordance with the instructions in the commercial
bank Consolidated Reports of Condition and Income (Call Reports). The
amount of I/Os that a bank may include in capital shall be its fair
value. If both the application of the limits on mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships and the adjustment of the balance sheet amount for these
assets would result in an amount being deducted from capital, the bank
would deduct only the greater of the two amounts from its core capital
elements in determining tier 1 capital.
e. Tier 1 capital limitation. i. The total amount of mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships that may be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital. The aggregate of
nonmortgage servicing assets and purchased credit card relationships
are subject to a separate sublimit of 25 percent of tier 1 capital. In
addition, the total amount of credit-enhancing I/Os (both purchased and
retained) that may be included in capital cannot exceed 25 percent of
tier 1 capital.\14\
---------------------------------------------------------------------------

\14\ Amounts of servicing assets, purchased credit card
relationships, and credit-enhancing I/Os (both retained and
purchased) in excess of these limitations, as well as all other
identifiable intangible assets, including core deposit intangibles
and favorable leaseholds, are to be deducted from a bank's core
capital elements in determining tier 1 capital. However,
identifiable intangible assets (other than mortgage servicing assets
and purchased credit card relationships) acquired on or before
February 19, 1992, generally will not be deducted from capital for
supervisory purposes, although they will continue to be deducted for
applications purposes.
---------------------------------------------------------------------------

ii. For purposes of calculating these limitations on mortgage
servicing assets, nonmortgage servicing assets, purchased credit card
relationships, and credit-enhancing I/Os, tier 1 capital is defined as
the sum of core capital elements, net of goodwill, and net of all
identifiable intangible assets other than mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships,
prior to the deduction of any disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any disallowed purchased
credit card relationships, any disallowed credit-enhancing I/Os (both
purchased and retained), and any disallowed deferred-tax assets,
regardless of the date acquired.
iii. Banks may elect to deduct disallowed mortgage servicing
assets, disallowed nonmortgage servicing assets, and disallowed credit-
enhancing I/Os (both purchased and retained) on a basis that is net of
any associated deferred tax liability. Deferred tax liabilities netted
in this manner cannot also be netted against deferred-tax assets when
determining the amount of deferred-tax assets that are dependent upon
future taxable income.
f. Valuation. Banks must review the book value of all intangible
assets at least quarterly and make adjustments to these values as
necessary. The fair value of mortgage servicing assets, nonmortgage
servicing assets, purchased credit card relationships, and credit-
enhancing I/Os also must be determined at least quarterly. This
determination shall include adjustments for any significant changes in
original valuation assumptions, including changes in prepayment
estimates or account attrition rates. Examiners will review both the
book value and the fair value assigned to these assets, together with
supporting documentation, during the examination process. In addition,
the Federal Reserve may require, on a case-by-case basis, an
independent valuation of a bank's intangible assets or credit-enhancing
I/Os.
g. Growing organizations. Consistent with long-standing Board
policy, banks experiencing substantial growth, whether internally or by
acquisition, are expected to maintain strong capital positions
substantially above minimum supervisory levels, without significant
reliance on intangible assets or credit-enhancing I/Os.
* * * * *
4. Deferred-tax assets. a. The amount of deferred-tax assets that
is dependent upon future taxable income, net of the valuation allowance
for deferred-tax assets, that may be included in, that is, not deducted
from, a bank's capital may not exceed the lesser of:
i. The amount of these deferred-tax assets that the bank is
expected to realize within one year of the calendar quarter-end date,
based on its projections of future taxable income for that year,\20\ or
---------------------------------------------------------------------------

\20\ To determine the amount of expected deferred-tax assets
realizable in the next 12 months, an institution should assume that
all existing temporary differences fully reverse as of the report
date. Projected future taxable income should not include net
operating loss carry-forwards to be used during that year or the
amount of existing temporary differences a bank expects to reverse
within the year. Such projections should include the estimated
effect of tax-planning strategies that the organization expects to
implement to realize net operating losses or tax-credit carry-
forwards that would otherwise expire during the year. Institutions
do not have to prepare a new 12-month projection each quarter.
Rather, on interim report dates, institutions may use the future-
taxable income projections for their current fiscal year, adjusted
for any significant changes that have occurred or are expected to
occur.

---------------------------------------------------------------------------

[[Page 59638]]

ii. 10 percent of tier 1 capital.
b. The reported amount of deferred-tax assets, net of any valuation
allowance for deferred-tax assets, in excess of the lesser of these two
amounts is to be deducted from a bank's core capital elements in
determining tier 1 capital. For purposes of calculating the 10 percent
limitation, tier 1 capital is defined as the sum of core capital
elements, net of goodwill and net of all identifiable intangible assets
other than mortgage servicing assets, nonmortgage servicing assets,
purchased credit card relationships, prior to the deduction of any
disallowed mortgage servicing assets, any disallowed nonmortgage
servicing assets, any disallowed purchased credit card relationships,
any disallowed credit-enhancing I/Os, and any disallowed deferred-tax
assets. There generally is no limit in tier 1 capital on the amount of
deferred-tax assets that can be realized from taxes paid in prior
carry-back years or from future reversals of existing taxable temporary
differences, but, for banks that have a parent, this may not exceed the
amount the bank could reasonably expect its parent to refund.
* * * * *

III. * * *

A. * * *
The Federal Reserve will, on a case-by-case basis, determine the
appropriate risk weight for any asset or credit equivalent amount of an
off-balance sheet item that does not fit wholly within one of the risk
weight categories set forth below or that imposes risks on a bank that
are incommensurate with the risk weight otherwise specified below for
the asset or off-balance sheet item. In addition, the Federal Reserve
will, on a case-by-case basis, determine the appropriate credit
conversion factor for any off-balance sheet item that does not fit
wholly within one of the credit conversion factors set forth below or
that imposes risks on a bank that are incommensurate with the credit
conversion factors otherwise specified below for the off-balance sheet
item. In making such a determination, the Federal Reserve will consider
the similarity of the asset or off-balance sheet item to assets or off-
balance sheet items explicitly treated in the guidelines, as well as
other relevant factors.
* * * * *

B. * * *

3. Recourse obligations, direct credit substitutes, residual
interests, and asset- and mortgage-backed securities. Direct credit
substitutes, assets transferred with recourse, and securities issued in
connection with asset securitizations and structured financings are
treated as described below. The term ``asset securitizations'' or
``securitizations'' in this rule includes structured financings, as
well as asset securitization transactions.
a. Definitions--i. Credit derivative means a contract that allows
one party (the ``protection purchaser'') to transfer the credit risk of
an asset or off-balance sheet credit exposure to another party (the
``protection provider'') The value of a credit derivative is dependent,
at least in part, on the credit performance of the ``reference asset.''
ii. Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate the bank to protect investors from losses arising from credit
risk in the assets transferred or the loans serviced. Credit-enhancing
representations and warranties include promises to protect a party from
losses resulting from the default or nonperformance of another party or
from an insufficiency in the value of the collateral. Credit-enhancing
representations and warranties do not include:
1. Early default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans that qualify for a 50 percent risk weight for a
period not to exceed 120 days from the date of transfer. These
warranties may cover only those loans that were originated within 1
year of the date of transfer;
2. Premium refund clauses that cover assets guaranteed, in whole or
in part, by the U.S. Government, a U.S. Government agency or a
government-sponsored enterprise, provided the premium refund clauses
are for a period not to exceed 120 days from the date of transfer; or
3. Warranties that permit the return of assets in instances of
misrepresentation, fraud or incomplete documentation.
iii. Direct credit substitute means an arrangement in which a bank
assumes, in form or in substance, credit risk associated with an on-or
off-balance sheet credit exposure that was not previously owned by the
bank (third-party asset) and the risk assumed by the bank exceeds the
pro rata share of the bank's interest in the third-party asset. If the
bank has no claim on the third-party asset, then the bank's assumption
of any credit risk with respect to the third party asset is a direct
credit substitute. Direct credit substitutes include, but are not
limited to:
1. Financial standby letters of credit that support financial
claims on a third party that exceed a bank's pro rata share of losses
in the financial claim;
2. Guarantees, surety arrangements, credit derivatives, and similar
instruments backing financial claims that exceed a bank's pro rata
share in the financial claim;
3. Purchased subordinated interests or securities that absorb more
than their pro rata share of losses from the underlying assets;
4. Credit derivative contracts under which the bank assumes more
than its pro rata share of credit risk on a third party exposure;
5. Loans or lines of credit that provide credit enhancement for the
financial obligations of an account party;
6. Purchased loan servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Mortgage servicer cash advances that meet the conditions of section
III.B.3.a.viii. of this appendix are not direct credit substitutes; and
7. Clean-up calls on third party assets are direct credit
substittues. Clean-up calls that are 10 percent or less of the original
pool balance that are exercisable at the option of the bank are not
direct credit substitutes.
iv. Externally rated means that an instrument or obligation has
received a credit rating from a nationally-recognized statistical
rating organization.
v. Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
vi. Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or a
contract that conveys a right to receive or exchange cash or another
financial instrument from another party.
vii. Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:

[[Page 59639]]

1. To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party), or
2. To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
viii. Mortgage servicer cash advance means funds that a residential
mortgage loan servicer advances to ensure an uninterrupted flow of
payments, including advances made to cover foreclosure costs or other
expenses to facilitate the timely collection of the loan. A mortgage
servicer cash advance is not a recourse obligation or a direct credit
substitute if:
1. The servicer is entitled to full reimbursement and this right is
not subordinated to other claims on the cash flows from the underlying
asset pool; or
2. For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal balance of that loan.
ix. Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers.
x. Recourse means the retention, by a bank, in form or in
substance, of any credit risk directly or indirectly associated with an
asset it has transferred and sold that exceeds a pro rata share of the
bank's claim on the asset. If a bank has no claim on a transferred
asset, then the retention of any risk of credit loss is recourse. A
recourse obligation typically arises when a bank transfers assets and
retains an explicit obligation to repurchase the assets or absorb
losses due to a default on the payment of principal or interest or any
other deficiency in the performance of the underlying obligor or some
other party. Recourse may also exist implicitly if a bank provides
credit enhancement beyond any contractual obligation to support assets
it has sold. The following are examples of recourse arrangements:
1. Credit-enhancing representations and warranties made on the
transferred assets;
2. Loan servicing assets retained pursuant to an agreement under
which the bank will be responsible for credit losses associated with
the loans being serviced. Mortgage servicer cash advances that meet the
conditions of section III.B.3.a.viii. of this appendix are not recourse
arrangements;
3. Retained subordinated interests that absorb more than their pro
rata share of losses from the underlying assets;
4. Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
5. Loan strips sold without contractual recourse where the maturity
of the transferred loan is shorter than the maturity of the commitment
under which the loan is drawn;
6. Credit derivatives issued that absorb more than the bank's pro
rata share of losses from the transferred assets; and
7. Clean-up calls at inception that are greater than 10 percent of
the balance of the original pool of transferred loans. Clean-up calls
that are 10 percent or less of the original pool balance that are
exercisable at the option of the bank are not recourse arrangements.
xi. Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally
accepted accounting principles) of financial assets, whether through a
securitization or otherwise, and that exposes the bank to credit risk
directly or indirectly associated with the transferred assets that
exceeds a pro rata share of the bank's claim on the assets, whether
through subordination provisions or other credit enhancement
techniques. Residual interests generally include credit-enhancing I/Os,
spread accounts, cash collateral accounts, retained subordinated
interests, other forms of over-collateralization, and similar assets
that function as a credit enhancement. Residual interests further
include those exposures that, in substance, cause the bank to retain
the credit risk of an asset or exposure that had qualified as a
residual interest before it was sold. Residual interests generally do
not include interests purchased from a third party, except that
purchased credit-enhancing I/Os are residual interests for purposes of
this appendix.
xii. Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full amount
of an obligation (e.g., a direct credit substitute) notwithstanding
that another party has acquired a participation in that obligation.
xiii. Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures into securities that
can be sold to investors. Securitization includes transactions that
create stratified credit risk positions whose performance is dependent
upon an underlying pool of credit exposures, including loans and
commitments.
xiv. Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and credit enhancement provided to the program.
xv. Traded position means a position that is externally rated and
is retained, assumed, or issued in connection with an asset
securitization, where there is a reasonable expectation that, in the
near future, the rating will be relied upon by unaffiliated investors
to purchase the position; or an unaffiliated third party to enter into
a transaction involving the position, such as a purchase, loan, or
repurchase agreement.
b. Credit equivalent amounts and risk weight of recourse
obligations and direct credit substitutes. i. Credit equivalent amount.
Except as otherwise provided in sections III.B.3.c. through f. and
III.B.5. of this appendix, the credit equivalent amount for a recourse
obligation or direct credit substitute is the full amount of the
credit-enhanced assets for which the bank directly or indirectly
retains or assumes credit risk multiplied by a 100 percent conversion
factor.
ii. Risk-weight factor. To determine the bank's risk-weight factor
for off-balance sheet recourse obligations and direct credit
substitutes, the credit equivalent amount is assigned to the risk
category appropriate to the obligor in the underlying transaction,
after considering any associated guarantees or collateral. For a direct
credit substitute that is an on-balance sheet asset (e.g., a purchased
subordinated security), a bank must calculate risk-weighted assets
using the amount of the direct credit substitute and the full amount of
the assets it supports, i.e., all the more senior positions in the
structure. The treatment of direct credit substitutes that have been
syndicated or in which risk participations have been conveyed or
acquired is set forth in section III.D.1 of this appendix.
c. Externally-rated positions: credit equivalent amounts and risk
weights of recourse obligations, direct credit substitutes, residual
interests, and asset- and mortgage-backed securities (including asset-
backed commercial paper). i. Traded positions. With respect to a
recourse obligation, direct credit substitute, residual interest (other
than a credit-enhancing I/O strip) or asset-

[[Page 59640]]

and mortgage-backed security (including asset-backed commercial paper)
that is a traded position and that has received an external rating on a
long-term position that is one grade below investment grade or better
or a short-term rating that is investment grade, the bank may multiply
the face amount of the position by the appropriate risk weight,
determined in accordance with the tables below. Stripped mortgage-
backed securities and other similar instruments, such as interest-only
or principal-only strips that are not credit enhancements, must be
assigned to the 100 percent risk category. If a traded position has
received more than one external rating, the lowest single rating will
apply.

------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.

------------------------------------------------------------------------
Risk weight
Short-term rating Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------

ii. Non-traded positions. A recourse obligation, direct credit
substitute, or residual interest (but not a credit-enhancing I/O strip)
extended in connection with a securitization that is not a traded
position may be assigned a risk weight in accordance with section
III.B.3.c.i. of this appendix if:
1. It has been externally rated by more than one NRSRO;
2. It has received an external rating on a long-term position that
is one grade below investment grade or better or on a short-term
position that is investment grade by all NRSROs providing a rating;
3. The ratings are publicly available; and
4. The ratings are based on the same criteria used to rate traded
positions.
If the ratings are different, the lowest rating will determine the
risk category to which the recourse obligation, direct credit
substitute, or residual interest will be assigned.
d. Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest, or asset- or
mortgage-backed security that is not externally rated but is senior or
preferred in all features to a traded position (including
collateralization and maturity), a bank may apply a risk weight to the
face amount of the senior position in accordance with section
III.B.3.c.i. of this appendix, based on the traded position, subject to
any current or prospective supervisory guidance and the bank satisfying
the Federal Reserve that this treatment is appropriate. This section
will apply only if the traded subordinated position provides
substantive credit support to the unrated position until the unrated
position matures.
e. Capital requirement for residual interests--i. Capital
requirement for credit-enhancing I/O strips. After applying the
concentration limit to credit-enhancing I/O strips (both purchased and
retained) in accordance with sections II.B.2.c. through e. of this
appendix, a bank must maintain risk-based capital for a credit-
enhancing I/O strip (both purchased and retained), regardless of the
external rating on that position, equal to the remaining amount of the
credit-enhancing I/O strip (net of any existing associated deferred tax
liability), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the
assets transferred. Transactions that, in substance, result in the
retention of credit risk associated with a transferred credit-enhancing
I/O strip will be treated as if the credit-enhancing I/O strip was
retained by the bank and not transferred.
ii. Capital requirement for other residual interests. 1. If a
residual interest does not meet the requirements of sections III.B.3.c.
or d. of this appendix, a bank must maintain risk-based capital equal
to the remaining amount of the residual interest that is retained on
the balance sheet (net of any existing associated deferred tax
liability), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the
assets transferred. Transactions that, in substance, result in the
retention of credit risk associated with a transferred residual
interest will be treated as if the residual interest was retained by
the bank and not transferred.
2. Where the aggregate capital requirement for residual interests
and other recourse obligation in connection with the same transfer of
assets exceed the full risk-based capital requirement for those assets,
a bank must maintain risk-based capital equal to the greater of the
risk-based capital requirement for the residual interest as calculated
under section III.B.3.e.ii.1 of this appendix or the full risk-based
capital requirement for the assets transferred.
f. Positions that are not rated by an NRSRO. A position (but not a
residual interest) maintained in connection with a securitization and
that is not rated by a NRSRO may be risk-weighted based on the bank's
determination of the credit rating of the position, as specified in the
table below, multiplied by the face amount of the position. In order to
obtain this treatment, the bank's system for determining the credit
rating of the position must meet one of the three alternative standards
set out in sections III.B.3.f.i. through III.B.3.f.iii. of this
appendix.

------------------------------------------------------------------------
Risk weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA,AA.............. 100
investment grade.
Third highet investment grade..... A................... 100
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

[[Page 59641]]

i. Internal risk rating used for asset-backed programs. A direct
credit substitute (other than a purchased credit-enhancing I/O) is
assumed in connection with an asset-backed commercial paper program
sponsored by the bank and the bank is able to demonstrate to the
satisfaction of the Federal Reserve, prior to relying upon its use,
that the bank's internal credit risk rating system is adequate.
Adequate internal credit risk rating systems usually contain the
following criteria:
1. The internal credit risk system is an integral part of the
bank's risk management system, which explicitly incorporates the full
range of risks arising from a bank's participation in securitization
activities;
2. Internal credit ratings are linked to measurable outcomes, such
as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
3. The bank's internal credit risk system must separately consider
the risk associated with the underlying loans or borrowers, and the
risk associated with the structure of a particular securitization
transaction;
4. The bank's internal credit risk system must identify gradations
of risk among ``pass'' assets and other risk positions;
5. The bank must have clear, explicit criteria that are used to
classify assets into each internal risk grade, including subjective
factors;
6. The bank must have independent credit risk management or loan
review personnel assigning or reviewing the credit risk ratings;
7. The bank must have an internal audit procedure that periodically
verifies that the internal credit risk ratings are assigned in
accordance with the established criteria;
8. The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit substitutes
over time to determine the appropriateness of the initial credit risk
rating assignment and adjust individual credit risk ratings, or the
overall internal credit risk ratings system, as needed; and
9. The internal credit risk system must make credit risk rating
assumptions that are consistent with, or more conservative than, the
credit risk rating assumptions and methodologies of NRSROs.
ii. Program Ratings. A direct credit substitute or recourse
obligation (other than a residual interest) is assumed or retained in
connection with a structured finance program and a NRSRO has reviewed
the terms of the program and stated a rating for positions associated
with the program. If the program has options for different combinations
of assets, standards, internal credit enhancements and other relevant
factors, and the NRSRO specifies ranges of rating categories to them,
the bank may apply the rating category that corresponds to the bank's
position. In order to rely on a program rating, the bank must
demonstrate to the Federal Reserve's satisfaction that the credit risk
rating assigned to the program meets the same standards generally used
by NRSROs for rating traded positions. The bank must also demonstrate
to the Federal Reserve's satisfaction that the criteria underlying the
NRSRO's assignment of ratings for the program are satisfied for the
particular position. If a bank participates in a securitization
sponsored by another party, the Federal Reserve may authorize the bank
to use this approach based on a programmatic rating obtained by the
sponsor of the program.
iii. Computer Program. The bank is using an acceptable credit
assessment computer program to determine the rating of a direct credit
substitute or recourse obligation (but not residual interest) issued in
connection with a structured finance program. A NRSRO must have
developed the computer program, and the bank must demonstrate to the
Federal Reserve's satisfaction that ratings under the program
correspond credibly and reliably with the rating of traded positions.
g. Limitations on risk-based capital requirements--i. Low-level
exposure. If the maximum contractual exposure to loss retained or
assumed by a bank in connection with a recourse obligation or a direct
credit substitute is less than the effective risk-based capital
requirement for the enhanced assets, the risk-based capital requirement
is limited to the maximum contractual exposure, less any recourse
liability account established in accordance with generally accepted
accounting principles. This limitation does not apply when a bank
provides credit enhancement beyond any contractual obligation to
support assets it has sold.
ii. Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a bank holds a mortgage-related
security or a participation certificate as a result of a mortgage loan
swap with recourse, capital is required to support the recourse
obligation plus the percentage of the mortgage-related security or
participation certificate that is not covered by the recourse
obligation. The total amount of capital required for the on-balance
sheet asset and the recourse obligation, however, is limited to the
capital requirement for the underlying loans, calculated as if the bank
continued to hold these loans as on-balance sheet assets.
iii. Related on-balance sheet assets. If a recourse obligation or
direct credit substitute subject to section III.B.3. of this appendix
also appears as a balance sheet asset, the balance sheet asset is not
included in a bank's risk-weighted assets to the extent the value of
the balance sheet asset is already included in the off-balance sheet
credit equivalent amount for the recourse obligation or direct credit
substitute, except in the case of loan servicing assets and similar
arrangements with embedded recourse obligations or direct credit
substitutes. In that case, both the on-balance sheet assets and the
related recourse obligations and direct credit substitutes must be
separately risk-weighted and incorporated into the risk-based capital
calculation.
* * * * *
C. * * *
4. Category 4: 100 percent. a. All assets not included in the
categories above are assigned to this category, which comprises
standard risk assets. The bulk of the assets typically found in a loan
portfolio would be assigned to the 100 percent category.
b. This category includes long-term claims on, and the portions of
long-term claims that are guaranteed by, non-OECD banks, and all claims
on non-OECD central governments that entail some degree of transfer
risk.\36\ This category includes all claims on foreign and domestic
private-sector obligors not included in the categories above (including
loans to nondepository financial institutions and bank holding
companies); claims on commercial firms owned by the public sector;
customer liabilities to the bank on acceptances outstanding involving
standard risk claims;\37\ investments in fixed assets,

[[Page 59642]]

premises, and other real estate owned; common and preferred stock of
corporations, including stock acquired for debts previously contracted;
all stripped mortgage-backed securities and similar instruments; and
commercial and consumer loans (except those assigned to lower risk
categories due to recognized guarantees or collateral and loans secured
by residential property that qualify for a lower risk weight).
---------------------------------------------------------------------------

\36\ Such assets include all nonlocal currency claims on, and
the portions of claims that are guaranteed by, non-OECD central
governments and those portions of local currency claims on, or
guaranteed by, non-OECD central governments that exceed the local
currency liabilities held by the bank.
\37\ Customer liabilities on acceptances outstanding involving
nonstandard risk claims, such as claims on U.S. depository
institutions, are assigned to the risk category appropriate to the
identity of the obligor or, if relevant, the nature of the
collateral or guarantees backing the claims. Portions of acceptances
conveyed as risk participations to U.S. depository institutions or
foreign banks are assigned to the 20 percent risk category
appropriate to short-term claims guaranteed by U.S. depository
institutions and foreign banks.
---------------------------------------------------------------------------

c. Also included in this category are industrial-development bonds
and similar obligations issued under the auspices of states or
political subdivisions of the OECD-based group of countries for the
benefit of a private party or enterprise where that party or
enterprise, not the government entity, is obligated to pay the
principal and interest, and all obligations of states or political
subdivisions of countries that do not belong to the OECD-based group.
d. The following assets also are assigned a risk weight of 100
percent if they have not been deducted from capital: investments in
unconsolidated companies, joint ventures, or associated companies;
instruments that qualify as capital issued by other banking
organizations; and any intangibles, including those that may have been
grandfathered into capital.
* * * * *
D. * * *
The face amount of an off-balance sheet item is generally
incorporated into risk-weighted assets in two steps. The face amount is
first multiplied by a credit conversion factor, except for direct
credit substitutes and recourse obligations as discussed in section
III.D.1. of this appendix. The resultant credit equivalent amount is
assigned to the appropriate risk category according to the obligor or,
if relevant, the guarantor or the nature of the collateral.\38\
Attachment IV to this appendix sets forth the conversion factors for
various types of off-balance sheet items.
---------------------------------------------------------------------------

\38\ The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section III.B. of this appendix A.
---------------------------------------------------------------------------

1. Items with a 100-percent conversion factor. a. Except as
otherwise provided in section III.B.3. of this appendix, the full
amount of an asset or transaction supported, in whole or in part, by a
direct credit substitute or a recourse obligation. Direct credit
substitutes and recourse obligations are defined in section III.B.3. of
this appendix.
b. Sale and repurchase agreements and forward agreements. Forward
agreements are legally binding contractual obligations to purchase
assets with certain drawdown at a specified future date. Such
obligations include forward purchases, forward forward deposits
placed,\39\ and partly-paid shares and securities; they do not include
commitments to make residential mortgage loans or forward foreign
exchange contracts.
---------------------------------------------------------------------------

\39\ Forward forward deposits accepted are treated as interest
rate contracts.
---------------------------------------------------------------------------

c. Securities lent by a bank are treated in one of two ways,
depending upon whether the lender is at risk of loss. If a bank, as
agent for a customer, lends the customer's securities and does not
indemnify the customer against loss, then the transaction is excluded
from the risk-based capital calculation. If, alternatively, a bank
lends its own securities or, acting as agent for a customer, lends the
customer's securities and indemnifies the customer against loss, the
transaction is converted at 100 percent and assigned to the risk weight
category appropriate to the obligor, or, if applicable, to any
collateral delivered to the lending bank, or the independent custodian
acting on the lending bank's behalf. Where a bank is acting as agent
for a customer in a transaction involving the lending or sale of
securities that is collateralized by cash delivered to the bank, the
transaction is deemed to be collateralized by cash on deposit in the
bank for purposes of determining the appropriate risk-weight category,
provided that any indemnification is limited to no more than the
difference between the market value of the securities and the cash
collateral received and any reinvestment risk associated with that cash
collateral is borne by the customer.
d. In the case of direct credit substitutes in which a risk
participation \40\ has been conveyed, the full amount of the assets
that are supported, in whole or in part, by the credit enhancement are
converted to a credit equivalent amount at 100 percent. However, the
pro rata share of the credit equivalent amount that has been conveyed
through a risk participation is assigned to whichever risk category is
lower: the risk category appropriate to the obligor, after considering
any relevant guarantees or collateral, or the risk category appropriate
to the institution acquiring the participation.\41\ Any remainder is
assigned to the risk category appropriate to the obligor, guarantor, or
collateral. For example, the pro rata share of the full amount of the
assets supported, in whole or in part, by a direct credit substitute
conveyed as a risk participation to a U.S. domestic depository
institution or foreign bank is assigned to the 20 percent risk
category.\42\
---------------------------------------------------------------------------

\40\ That is, a participation in which the originating bank
remains liable to the beneficiary for the full amount of the direct
credit substitute if the party that has acquired the participation
fails to pay when the instrument is drawn.
\41\ A risk participation in bankers acceptances conveyed to
other institutions is also assigned to the risk category appropriate
to the institution acquiring the participation or, if relevant, the
guarantor or nature of the collateral.
\42\ Risk participations with a remaining maturity of over one
year that are conveyed to non-OECD banks are to be assigned to the
100 percent risk category, unless a lower risk category is
appropriate to the obligor, guarantor, or collateral.
---------------------------------------------------------------------------

e. In the case of direct credit substitutes in which a risk
participation has been acquired, the acquiring bank's percentage share
of the direct credit substitute is multiplied by the full amount of the
assets that are supported, in whole or in part, by the credit
enhancement and converted to a credit equivalent amount at 100 percent.
The credit equivalent amount of an acquisition of a risk participation
in a direct credit substitute is assigned to the risk category
appropriate to the account party obligor or, if relevant, the nature of
the collateral or guarantees.
f. In the case of direct credit substitutes that take the form of a
syndication where each bank is obligated only for its pro rata share of
the risk and there is no recourse to the originating bank, each bank
will only include its pro rata share of the assets supported, in whole
or in part, by the direct credit substitute in its risk-based capital
calculation.\43\
* * * * *
---------------------------------------------------------------------------

\43\ For example, if a bank has a 10 percent share of a $10
syndicated direct credit substitute that provides credit support to
a $100 loan, then the bank's $1 pro rata share in the enhancement
means that a $10 pro rata share of the loan is included in risk
weighted assets.

[[Page 59643]]


Attachment II.--Summary of Definition of Qualifying Capital for State
Member Banks*
[Using the year-end 1992 standard]
------------------------------------------------------------------------
Components Minimum requirements
------------------------------------------------------------------------
Core Capital (Tier 1).................. Must equal or exceed 4% of
weighted-risk assets.
Common stockholders' equity........ No limit.
Qualifying noncumulative perpetual No limit; banks should avoid
preferred stock. undue reliance on preferred
stock in tier 1.
Minority interest in equity Banks should avoid using
accounts of consolidated minority interests to
subsidiaries. subsidiaries introduce
elements not otherwise
qualifying for tier 1 capital.
Less: Goodwill, other intangible
assets, and credit-enhancing interest-
only strips required to be deducted
from capital \1\
Supplementary Capital (Tier 2)......... Total of tier 2 is limited to
100% of tier 1.\2\
Allowance for loan and lease losses Limited to 1.25% of weighted-
risk assets.\2\
Perpetual preferred stock.......... No limit within tier 2.
Hybrid capital instruments and No limit within tier 2.
equity contract notes.
Subordinated debt and intermediate- Subordinated debt and
term preferred stocks (original intermediate-term preferred
weighted average maturity of 5 stock are limited to 50% of
years or more). tier 1,\2\ amortized for
capital purposes as they
approach maturity.
Revaluation reserves (equity and Not included; banks encouraged
building). to disclose; may be evaluated
on a case-by-case basis for
international comparisons; and
taken into account in making
an overall assessment of
capital.
Deductions (from sum of tier 1 and tier
2):
Investment in unconsolidated As a general rule, one-half of
subsidiaries. the aggregate investments will
be deducted from tier 1
capital and one-half from tier
2 capital.\3\
Reciprocal holdings of banking
organizations' capital securities
Other deductions (such as other On a case-by-case basis or as a
subsidiaries or joint ventures) as matter of policy after a
determined by supervisory formal rulemaking.
authority.
Total Capital (tier 1 + tier 2-- Must equal or exceed 8% or
deductions). weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets and
residual interests are set forth in section II.B.1. of this appendix.
\2\ Amount in excess of limitations are permitted but do not qualify as
capital.
\3\ A proportionately greater amount may be deducted from tier 1
capital, if the risks associated with the subsidiary so warrant.
* See discussion in section II of the guidelines for a complete
description of the requirements for, and the limitations on, the
components of qualifying capital.

* * * * *

3. In Appendix B to part 208, section II.b is revised to read as
follows:

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

* * * * *
II. * * *
b. A bank's tier 1 leverage ratio is calculated by dividing its
tier 1 capital (the numerator of the ratio) by its average total
consolidated assets (the denominator of the ratio). The ratio will also
be calculated using period-end assets whenever necessary, on a case-by-
case basis. For the purpose of this leverage ratio, the definition of
tier 1 capital as set forth in the risk-based capital guidelines
contained in appendix A of this part will be used.\2\ As a general
matter, average total consolidated assets are defined as the quarterly
average total assets (defined net of the allowance for loan and lease
losses) reported on the bank's Reports of Condition and Income (Call
Reports), less goodwill; amounts of mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships
that, in the aggregate, are in excess of 100 percent of tier 1 capital;
amounts of nonmortgage servicing assets, purchased credit card
relationships that, in the aggregate, are in excess of 25 percent of
tier 1 capital; amounts of credit-enhancing interest-only strips that
are in excess of 25 percent of tier 1 capital; all other identifiable
intangible assets; any investments in subsidiaries or associated
companies that the Federal Reserve determines should be deducted from
tier 1 capital; and deferred tax assets that are dependent upon future
taxable income, net of their valuation allowance, in excess of the
limitation set forth in section II.B.4 of appendix A of this part.\3\
---------------------------------------------------------------------------

\2\ Tier 1 capital for state member banks includes common
equity, minority interest in the equity accounts of consolidated
subsidiaries, and qualifying noncumulative perpetual preferred
stock. In addition, as a general matter, tier 1 capital excludes
goodwill; amounts of mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships that, in
the aggregate, exceed 100 percent of tier 1 capital; amounts of
nonmortgage servicing assets and purchased credit card relationships
that, in the aggregate, exceed 25 percent of tier 1 capital; amounts
of credit-enhancing interest-only strips in excess of 25 percent of
tier 1 capital; all other identifiable intangible assets; and
deferred tax assets that are dependent upon future taxable income,
net of their valuation allowance, in excess of certain limitations.
The Federal Reserve may exclude certain investments in subsidiaries
or associated companies as appropriate.
\3\ Deductions from tier 1 capital and other adjustments are
discussed more fully in section II.B. of appendix A of this part.
---------------------------------------------------------------------------

* * * * *

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)

1. The authority citation for part 225 continues to read as
follows:

Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843(c)(8), 1843(k), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351,
3907, and 3909.

2. In appendix A to part 225:
A. The three introductory paragraphs of section II, the first six
paragraphs of section II.A.1, and the first seven paragraphs of section
II.A.2. are revised and footnote 6 is removed and reserved;
B. In section II.B., a new paragraph (i)(c) is added, section
II.B.1.b. and footnote 15 are revised, new sections II.B.1.c. through
II.B.1.g. are added, and section II.B.4. is revised;
C. In section III.A., a new undesignated fourth paragraph is added
at the end of the section;
D. In section III.B., paragraph 3 is revised and footnote 26 is
removed, and in paragraph 4, footnote 27 is removed;

[[Page 59644]]

E. In section III.C., paragraphs 1 through 4, footnotes 28 through
42 are redesignated as footnotes 26 through 40, and paragraph 4 is
revised;
F. In section III.D., the introductory paragraph and paragraph 1
are revised;
G. In sections III.D. and III.E., footnotes 50 and 52 are removed,
footnote 51 is redesignated as footnote 47, footnotes 53 through 55 are
redesignated as footnotes 48 through 50;
H. In sections IV.A. and IV.B., footnote 57 is removed and footnote
56 is redesignated as footnote 51; and
I. Attachment II is revised.

Appendix A To Part 225--Capital Adequacy Guidelines For Bank
Holding Companies: Risk-Based Measure

* * * * *

II. * * *

An institution's qualifying total capital consists of two types of
capital components: ``core capital elements'' (comprising tier 1
capital) and ``supplementary capital elements'' (comprising tier 2
capital). These capital elements and the various limits, restrictions,
and deductions to which they are subject, are discussed below and are
set forth in Attachment II.
The Federal Reserve will, on a case-by-case basis, determine
whether, and if so how much of, any instrument that does not fit wholly
within the terms of one of the capital categories set forth below or
that does not have an ability to absorb losses commensurate with the
capital treatment otherwise specified below will be counted as an
element of tier 1 or tier 2 capital. In making such a determination,
the Federal Reserve will consider the similarity of the instrument to
instruments explicitly treated in the guidelines, the ability of the
instrument to absorb losses while the institution operates as a going
concern, the maturity and redemption features of the instrument, and
other relevant terms and factors. To qualify as an element of tier 1 or
tier 2 capital, a capital instrument may not contain or be covered by
any covenants, terms, or restrictions that are inconsistent with safe
and sound banking practices.
Redemptions of permanent equity or other capital instruments before
stated maturity could have a significant impact on an organization's
overall capital structure. Consequently, an organization considering
such a step should consult with the Federal Reserve before redeeming
any equity or debt capital instrument (prior to maturity) if such
redemption could have a material effect on the level or composition of
the organization's capital base.\5\
---------------------------------------------------------------------------

\5\ Consultation would not ordinarily be necessary if an
instrument were redeemed with the proceeds of, or replaced by, a
like amount of a similar or higher quality capital instrument and
the organization's capital position is considered fully adequate by
the Federal Reserve. In the case of limited-life tier 2 instruments,
consultation would generally be obviated if the new security is of
equal or greater maturity than the one it replaces.
---------------------------------------------------------------------------

* * * * *
A. * * *
1. Core capital elements (tier 1 capital). The tier 1 component of
an institution's qualifying capital must represent at least 50 percent
of qualifying total capital and may consist of the following items that
are defined as core capital elements:
(i) Common stockholders' equity;
(ii) Qualifying noncumulative perpetual preferred stock (including
related surplus);
(iii) Qualifying cumulative perpetual preferred stock (including
related surplus), subject to certain limitations described below; and
(iv) Minority interest in the equity accounts of consolidated
subsidiaries.
Tier 1 capital is generally defined as the sum of core capital
elements \6\ less goodwill, other intangible assets, and interest-only
strips receivables that are required to be deducted in accordance with
section II.B.1. of this appendix.
---------------------------------------------------------------------------

\6\ [Reserved]
---------------------------------------------------------------------------

* * * * *
2. Supplementary capital elements (tier 2 capital). The tier 2
component of an institution's qualifying capital may consist of the
following items that are defined as supplementary capital elements:
(i) Allowance for loan and lease losses (subject to limitations
discussed below);
(ii) Perpetual preferred stock and related surplus (subject to
conditions discussed below);
(iii) Hybrid capital instruments (as defined below), perpetual
debt, and mandatory convertible debt securities;
(iv) Term subordinated debt and intermediate-term preferred stock,
including related surplus (subject to limitations discussed below);
(v) Unrealized holding gains on equity securities (subject to
limitations discussed in section II.A.2.e. of this appendix).
The maximum amount of tier 2 capital that may be included in an
institution's qualifying total capital is limited to 100 percent of
tier 1 capital (net of goodwill, other intangible assets, and interest-
only strips receivables that are required to be deducted in accordance
with section II.B.1. of this appendix).
* * * * *
B. * * *
(i) * * *
(c) Certain credit-enhancing interest-only strips receivables--
deducted from the sum of core capital elements in accordance with
sections II.B.1.c. through e. of this appendix.
* * * * *
1. Goodwill, other intangible assets, and residual interests. * * *
b. Other intangible assets. i. All servicing assets, including
servicing assets on assets other than mortgages (i.e., nonmortgage
servicing assets), are included in this appendix as identifiable
intangible assets. The only types of identifiable intangible assets
that may be included in, that is, not deducted from, an organization's
capital are readily marketable mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships. The total
amount of these assets that may be included in capital is subject to
the limitations described below in sections II.B.1.d. and e. of this
appendix.
ii. The treatment of identifiable intangible assets set forth in
this section generally will be used in the calculation of a bank
holding company's capital ratios for supervisory and applications
purposes. However, in making an overall assessment of a bank holding
company's capital adequacy for applications purposes, the Board may, if
it deems appropriate, take into account the quality and composition of
an organization's capital, together with the quality and value of its
tangible and intangible assets.
c. Credit-enhancing interest-only strips receivables (I/Os) i.
Credit-enhancing I/Os are on-balance sheet assets that, in form or in
substance, represent a contractual right to receive some or all of the
interest due on transferred assets and expose the bank holding company
to credit risk directly or indirectly associated with transferred
assets that exceeds a pro rata share of the bank holding company's
claim on the assets, whether through subordination provisions or other
credit enhancement techniques. Such I/Os, whether purchased or
retained, including other similar ``spread'' assets, may be included
in, that is, not deducted from, a bank holding company's capital
subject to the limitations described below in sections II.B.1.d. and e.
of this appendix.
ii. Both purchased and retained credit-enhancing I/Os, on a non-tax
adjusted basis, are included in the total

[[Page 59645]]

amount that is used for purposes of determining whether a bank holding
company exceeds the tier 1 limitation described below in this section.
In determining whether an I/O or other types of spread assets serve as
a credit enhancement, the Federal Reserve will look to the economic
substance of the transaction.
d. Fair value limitation. The amount of mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships
that a bank holding company may include in capital shall be the lesser
of 90 percent of their fair value, as determined in accordance with
section II.B.1.f. of this appendix, or 100 percent of their book value,
as adjusted for capital purposes in accordance with the instructions to
the Consolidated Financial Statements for Bank Holding Companies (FR Y-
9C Report). The amount of credit-enhancing I/Os that a bank holding
company may include in capital shall be its fair value. If both the
application of the limits on mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships and the
adjustment of the balance sheet amount for these assets would result in
an amount being deducted from capital, the bank holding company would
deduct only the greater of the two amounts from its core capital
elements in determining tier 1 capital.
e. Tier 1 capital limitation. i. The total amount of mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships that may be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital. Nonmortgage servicing
assets and purchased credit card relationships are subject, in the
aggregate, to a separate sublimit of 25 percent of tier 1 capital. In
addition, the total amount of credit-enhancing I/Os (both purchased and
retained) that may be included in capital cannot exceed 25 percent of
tier 1 capital.\15\
---------------------------------------------------------------------------

\15\ Amounts of servicing assets, purchased credit card
relationships, and credit-enhancing I/Os (both retained and
purchased) in excess of these limitations, as well as all other
identifiable intangible assets, including core deposit intangibles
and favorable leaseholds, are to be deducted from a bank holding
company's core capital elements in determining tier 1 capital.
However, identifiable intangible assets (other than mortgage
servicing assets and purchased credit card relationships) acquired
on or before February 19, 1992, generally will not be deducted from
capital for supervisory purposes, although they will continue to be
deducted for applications purposes.
---------------------------------------------------------------------------

ii. For purposes of calculating these limitations on mortgage
servicing assets, nonmortgage servicing assets, purchased credit card
relationships, and credit-enhancing I/Os, tier 1 capital is defined as
the sum of core capital elements, net of goodwill, and net of all
identifiable intangible assets other than mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card relationships,
prior to the deduction of any disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any disallowed purchased
credit card relationships, any disallowed credit-enhancing I/Os (both
purchased and retained), and any disallowed deferred-tax assets,
regardless of the date acquired.
iii. Bank holding companies may elect to deduct disallowed mortgage
servicing assets, disallowed nonmortgage servicing assets, and
disallowed credit-enhancing I/Os (both purchased and retained) on a
basis that is net of any associated deferred tax liability. Deferred
tax liabilities netted in this manner cannot also be netted against
deferred-tax assets when determining the amount of deferred-tax assets
that are dependent upon future taxable income.
f. Valuation. Bank holding companies must review the book value of
all intangible assets at least quarterly and make adjustments to these
values as necessary. The fair value of mortgage servicing assets,
nonmortgage servicing assets, purchased credit card relationships, and
credit-enhancing I/Os also must be determined at least quarterly. This
determination shall include adjustments for any significant changes in
original valuation assumptions, including changes in prepayment
estimates or account attrition rates. Examiners will review both the
book value and the fair value assigned to these assets, together with
supporting documentation, during the inspection process. In addition,
the Federal Reserve may require, on a case-by-case basis, an
independent valuation of a bank holding company's intangible assets or
credit-enhancing I/Os.
g. Growing organizations. Consistent with long-standing Board
policy, banking organizations experiencing substantial growth, whether
internally or by acquisition, are expected to maintain strong capital
positions substantially above minimum supervisory levels, without
significant reliance on intangible assets or credit-enhancing I/Os.
4. Deferred-tax assets. a. The amount of deferred-tax assets that
is dependent upon future taxable income, net of the valuation allowance
for deferred-tax assets, that may be included in, that is, not deducted
from, a bank holding company's capital may not exceed the lesser of:
i. The amount of these deferred-tax assets that the bank holding
company is expected to realize within one year of the calendar quarter-
end date, based on its projections of future taxable income for that
year,\23\ or
---------------------------------------------------------------------------

\23\ To determine the amount of expected deferred-tax assets
realizable in the next 12 months, an institution should assume that
all existing temporary differences fully reverse as of the report
date. Projected future taxable income should not include net
operating loss carry-forwards to be used during that year or the
amount of existing temporary differences a bank holding company
expects to reverse within the year. Such projections should include
the estimated effect of tax-planning strategies that the
organization expects to implement to realize net operating losses or
tax-credit carry-forwards that would otherwise expire during the
year. Institutions do not have to prepare a new 12-month projection
each quarter. Rather, on interim report dates, institutions may use
the future-taxable income projections for their current fiscal year,
adjusted for any significant changes that have occurred or are
expected to occur.
---------------------------------------------------------------------------

ii. 10 percent of tier 1 capital.
b. The reported amount of deferred-tax assets, net of any valuation
allowance for deferred-tax assets, in excess of the lesser of these two
amounts is to be deducted from a banking organization's core capital
elements in determining tier 1 capital. For purposes of calculating the
10 percent limitation, tier 1 capital is defined as the sum of core
capital elements, net of goodwill and net of all identifiable
intangible assets other than mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships, prior to the
deduction of any disallowed mortgage servicing assets, any disallowed
nonmortgage servicing assets, any disallowed purchased credit card
relationships, any disallowed credit-enhancing I/Os, and any disallowed
deferred-tax assets. There generally is no limit in tier 1 capital on
the amount of deferred-tax assets that can be realized from taxes paid
in prior carry-back years or from future reversals of existing taxable
temporary differences.
* * * * *

III. * * *

A. * * *
The Federal Reserve will, on a case-by-case basis, determine the
appropriate risk weight for any asset or credit equivalent amount of an
off-balance sheet item that does not fit wholly within the terms of one
of the risk weight categories set forth below or that imposes risks on
a bank holding company that are incommensurate with the risk weight
otherwise specified below for the asset or off-balance sheet item. In
addition, the Federal Reserve will, on a case-by-case basis, determine
the appropriate credit conversion factor

[[Page 59646]]

for any off-balance sheet item that does not fit wholly within the
terms of one of the credit conversion factors set forth below or that
imposes risks on a banking organization that are incommensurate with
the credit conversion factors otherwise specified below for the off-
balance sheet item. In making such a determination, the Federal Reserve
will consider the similarity of the asset or off-balance sheet item to
assets or off-balance sheet items explicitly treated in the guidelines,
as well as other relevant factors.
* * * * *
B. * * *
3. Recourse obligations, direct credit substitutes, residual
interests, and asset- and mortgage-backed securities. Direct credit
substitutes, assets transferred with recourse, and securities issued in
connection with asset securitizations and structured financings are
treated as described below. The term ``asset securitizations'' or
``securitizations'' in this rule includes structured financings, as
well as asset securitization transactions.
a. Definitions--i. Credit derivative means a contract that allows
one party (the ``protection purchaser'') to transfer the credit risk of
an asset or off-balance sheet credit exposure to another party (the
``protection provider''). The value of a credit derivative is
dependent, at least in part, on the credit performance of the
``reference asset.''
ii. Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate the bank holding company to protect investors from losses
arising from credit risk in the assets transferred or the loans
serviced. Credit-enhancing representations and warranties include
promises to protect a party from losses resulting from the default or
nonperformance of another party or from an insufficiency in the value
of the collateral. Credit-enhancing representations and warranties do
not include:
1. Early default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans that qualify for a 50 percent risk weight for a
period not to exceed 120 days from the date of transfer. These
warranties may cover only those loans that were originated within 1
year of the date of transfer;
2. Premium refund clauses that cover assets guaranteed, in whole or
in part, by the U.S. Government, a U.S. Government agency or a
government-sponsored enterprise, provided the premium refund clauses
are for a period not to exceed 120 days from the date of transfer; or
3. Warranties that permit the return of assets in instances of
misrepresentation, fraud or incomplete documentation.
iii. Direct credit substitute means an arrangement in which a bank
holding company assumes, in form or in substance, credit risk
associated with an on- or off-balance sheet credit exposure that was
not previously owned by the bank holding company (third-party asset)
and the risk assumed by the bank holding company exceeds the pro rata
share of the bank holding company's interest in the third-party asset.
If the bank holding company has no claim on the third-party asset, then
the bank holding company's assumption of any credit risk with respect
to the third-party asset is a direct credit substitute. Direct credit
substitutes include, but are not limited to:
1. Financial standby letters of credit that support financial
claims on a third party that exceed a bank holding company's pro rata
share of losses in the financial claim;
2. Guarantees, surety arrangements, credit derivatives, and similar
instruments backing financial claims that exceed a bank holding
company's pro rata share in the financial claim;
3. Purchased subordinated interests or securities that absorb more
than their pro rata share of losses from the underlying assets;
4. Credit derivative contracts under which the bank holding company
assumes more than its pro rata share of credit risk on a third party
exposure;
5. Loans or lines of credit that provide credit enhancement for the
financial obligations of an account party;
6. Purchased loan servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Mortgage servicer cash advances that meet the conditions of section
III.B.3.a.viii. of this appendix are not direct credit substitutes; and
7. Clean-up calls on third party assets are direct credit
substitutes. Clean-up calls that are 10 percent or less of the original
pool balance that are exercisable at the option of the bank holding
company are not direct credit substitutes.
iv. Externally rated means that an instrument or obligation has
received a credit rating from a nationally-recognized statistical
rating organization.
v. Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
vi. Financial asset means cash or other monetary instrument,
evidence of debt, evidence of an ownership interest in an entity, or a
contract that conveys a right to receive or exchange cash or another
financial instrument from another party.
vii. Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
1. To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party), or
2. To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
viii. Mortgage servicer cash advance means funds that a residential
mortgage loan servicer advances to ensure an uninterrupted flow of
payments, including advances made to cover foreclosure costs or other
expenses to facilitate the timely collection of the loan. A mortgage
servicer cash advance is not a recourse obligation or a direct credit
substitute if:
1. The servicer is entitled to full reimbursement and this right is
not subordinated to other claims on the cash flows from the underlying
asset pool; or
2. For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal balance of that loan.
ix. Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers.
x. Recourse means the retention, by a bank holding company, in form
or in substance, of any credit risk directly or indirectly associated
with an asset it has transferred and sold that exceeds a pro rata share
of the banking organization's claim on the asset. If a banking
organization has no claim on a transferred asset, then the retention of
any risk of credit loss is recourse. A recourse obligation typically
arises when a bank holding company transfers assets and retains an
explicit obligation

[[Page 59647]]

to repurchase the assets or absorb losses due to a default on the
payment of principal or interest or any other deficiency in the
performance of the underlying obligor or some other party. Recourse may
also exist implicitly if a bank holding company provides credit
enhancement beyond any contractual obligation to support assets it has
sold. The following are examples of recourse arrangements:
1. Credit-enhancing representations and warranties made on the
transferred assets;
2. Loan servicing assets retained pursuant to an agreement under
which the bank holding company will be responsible for credit losses
associated with the loans being serviced. Mortgage servicer cash
advances that meet the conditions of section III.B.3.a.viii. of this
appendix are not recourse arrangements;
3. Retained subordinated interests that absorb more than their pro
rata share of losses from the underlying assets;
4. Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
5. Loan strips sold without contractual recourse where the maturity
of the transferred loan is shorter than the maturity of the commitment
under which the loan is drawn;
6. Credit derivatives issued that absorb more than the bank holding
company's pro rata share of losses from the transferred assets; and
7. Clean-up calls at inception that are greater than 10 percent of
the balance of the original pool of transferred loans. Clean-up calls
that are 10 percent or less of the original pool balance that are
exercisable at the option of the bank holding company are not recourse
arrangements.
xi. Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally
accepted accounting principles) of financial assets, whether through a
securitization or otherwise, and that exposes the bank holding company
to credit risk directly or indirectly associated with the transferred
assets that exceeds a pro rata share of the bank holding company's
claim on the assets, whether through subordination provisions or other
credit enhancement techniques. Residual interests generally include
credit-enhancing I/Os, spread accounts, cash collateral accounts,
retained subordinated interests, other forms of over-collateralization,
and similar assets that function as a credit enhancement. Residual
interests further include those exposures that, in substance, cause the
bank holding company to retain the credit risk of an asset or exposure
that had qualified as a residual interest before it was sold. Residual
interests generally do not include interests purchased from a third
party, except that purchased credit-enhancing I/Os are residual
interests for purposes of this appendix.
xii. Risk participation means a participation in which the
originating party remains liable to the beneficiary for the full amount
of an obligation (e.g., a direct credit substitute) notwithstanding
that another party has acquired a participation in that obligation.
xiii. Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures into securities that
can be sold to investors. Securitization includes transactions that
create stratified credit risk positions whose performance is dependent
upon an underlying pool of credit exposures, including loans and
commitments.
xiv. Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and credit enhancement provided to the program.
xv. Traded position means a position that is externally rated, and
is retained, assumed, or issued in connection with an asset
securitization, where there is a reasonable expectation that, in the
near future, the rating will be relied upon by unaffiliated investors
to purchase the position; or an unaffiliated third party to enter into
a transaction involving the position, such as a purchase, loan, or
repurchase agreement.
b. Credit equivalent amounts and risk weight of recourse
obligations and direct credit substitutes. i. Credit equivalent amount.
Except as otherwise provided in sections III.B.3.c. through f. and
III.B.5. of this appendix, the credit-equivalent amount for a recourse
obligation or direct credit substitute is the full amount of the
credit-enhanced assets for which the bank holding company directly or
indirectly retains or assumes credit risk multiplied by a 100 percent
conversion factor.
ii. Risk-weight factor. To determine the bank holding company's
risk-weight factor for off-balance sheet recourse obligations and
direct credit substitutes, the credit equivalent amount is assigned to
the risk category appropriate to the obligor in the underlying
transaction, after considering any associated guarantees or collateral.
For a direct credit substitute that is an on-balance sheet asset (e.g.,
a purchased subordinated security), a bank holding company must
calculate risk-weighted assets using the amount of the direct credit
substitute and the full amount of the assets it supports, i.e., all the
more senior positions in the structure. The treatment of direct credit
substitutes that have been syndicated or in which risk participations
have been conveyed or acquired is set forth in section III.D.1 of this
appendix.
c. Externally-rated positions: credit-equivalent amounts and risk
weights of recourse obligations, direct credit substitutes, residual
interests, and asset- and mortgage-backed securities (including asset-
backed commercial paper)--i. Traded positions. With respect to a
recourse obligation, direct credit substitute, residual interest (other
than a credit-enhancing I/Ostrip) or asset- and mortgage-backed
security (including asset-backed commercial paper) that is a traded
position and that has received an external rating on a long-term
position that is one grade below investment grade or better or a short-
term rating that is investment grade, the bank holding company may
multiply the face amount of the position by the appropriate risk
weight, determined in accordance with the tables below. Stripped
mortgage-backed securities and other similar instruments, such as
interest-only or principal-only strips that are not credit
enhancements, must be assigned to the 100 percent risk category. If a
traded position has received more than one external rating, the lowest
single rating will apply.

------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.

[[Page 59648]]

------------------------------------------------------------------------
Risk weight
Short-term rating Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------

ii. Non-traded positions. A recourse obligation, direct credit
substitute, or residual interest (but not a credit-enhancing I/O strip)
extended in connection with a securitization that is not a traded
position may be assigned a risk weight in accordance with section
III.B.3.c.i. of this appendix if:
1. It has been externally rated by more than one NRSRO;
2. It has received an external rating on a long-term position that
is one grade below investment grade or better or on a short-term
position that is investment grade by all NRSROs providing a rating;
3. The ratings are publicly available; and
4. The ratings are based on the same criteria used to rate traded
positions.
If the ratings are different, the lowest rating will determine the
risk category to which the recourse obligation, direct credit
substitute, or residual interest will be assigned.
d. Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest, or asset-or
mortgage-backed security that is not externally rated but is senior or
preferred in all features to a traded position (including
collateralization and maturity), a bank holding company may apply a
risk weight to the face amount of the senior position in accordance
with section III.B.3.c.i. of this appendix, based on the traded
position, subject to any current or prospective supervisory guidance
and the bank holding company satisfying the Federal Reserve that this
treatment is appropriate. This section will apply only if the traded
subordinated position provides substantive credit support to the
unrated position until the unrated position matures.
e. Capital requirement for residual interests--i. Capital
requirement for credit-enhancing I/O strips. After applying the
concentration limit to credit-enhancing I/O strips (both purchased and
retained) in accordance with sections II.B.2.c. through e. of this
appendix, a bank holding company must maintain risk-based capital for a
credit-enhancing I/O strip (both purchased and retained), regardless of
the external rating on that position, equal to the remaining amount of
the credit-enhancing I/O (net of any existing associated deferred tax
liability), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the
assets transferred. Transactions that, in substance, result in the
retention of credit risk associated with a transferred credit-enhancing
I/O strip will be treated as if the credit-enhancing I/O strip was
retained by the bank holding company and not transferred.
ii. Capital requirement for other residual interests. 1. If a
residual interest does not meet the requirements of sections III.B.3.c.
or d. of this appendix, a bank holding must maintain risk-based capital
equal to the remaining amount of the residual interest that is retained
on the balance sheet (net of any existing associated deferred tax
liability), even if the amount of risk-based capital required to be
maintained exceeds the full risk-based capital requirement for the
assets transferred. Transactions that, in substance, result in the
retention of credit risk associated with a transferred residual
interest will be treated as if the residual interest was retained by
the bank holding company and not transferred.
2. Where the aggregate capital requirement for residual interests
and other recourse obligations in connection with the same transfer of
assets exceed the full risk-based capital requirement for those assets,
a bank holding company must maintain risk-based capital equal to the
greater of the risk-based capital requirement for the residual interest
as calculated under section III.B.3.e.ii.1. of this appendix or the
full risk-based capital requirement for the assets transferred.
f. Positions that are not rated by an NRSRO. A position (but not a
residual interest) maintained in connection with a securitization and
that is not rated by a NRSRO may be risk-weighted based on the bank
holding company's determination of the credit rating of the position,
as specified in the table below, multiplied by the face amount of the
position. In order to obtain this treatment, the bank holding company's
system for determining the credit rating of the position must meet one
of the three alternative standards set out in sections III.B.3.f.i.
through III.B.3.f.iii. of this appendix.

------------------------------------------------------------------------
Risk weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 100
investment grade.
Third highest investment grade.... A................... 100
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

i. Internal risk rating used for asset-backed programs. A direct
credit substitute (other than a purchased credit-enhancing I/O) is
assumed in connection with an asset-backed commercial paper program
sponsored by the bank holding company and the bank holding company is
able to demonstrate to the satisfaction of the Federal Reserve, prior
to relying upon its use, that the bank holding company's internal
credit risk rating system is adequate. Adequate internal credit risk
rating systems usually contain the following criteria:
1. The internal credit risk system is an integral part of the bank
holding company's risk management system, which explicitly incorporates
the full range of risks arising from a bank holding company's
participation in securitization activities;
2. Internal credit ratings are linked to measurable outcomes, such
as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
3. The bank holding company's internal credit risk system must
separately consider the risk associated with the underlying loans or
borrowers,

[[Page 59649]]

and the risk associated with the structure of a particular
securitization transaction;
4. The bank holding company's internal credit risk system must
identify gradations of risk among ``pass'' assets and other risk
positions;
5. The bank holding company must have clear, explicit criteria that
are used to classify assets into each internal risk grade, including
subjective factors;
6. The bank holding company must have independent credit risk
management or loan review personnel assigning or reviewing the credit
risk ratings;
7. The bank holding company must have an internal audit procedure
that periodically verifies that the internal credit risk ratings are
assigned in accordance with the established criteria;
8. The bank holding company must monitor the performance of the
internal credit risk ratings assigned to nonrated, nontraded direct
credit substitutes over time to determine the appropriateness of the
initial credit risk rating assignment and adjust individual credit risk
ratings, or the overall internal credit risk ratings system, as needed;
and
9. The internal credit risk system must make credit risk rating
assumptions that are consistent with, or more conservative than, the
credit risk rating assumptions and methodologies of NRSROs.
ii. Program Ratings. A direct credit substitute or recourse
obligation (other than a residual interest) is assumed or retained in
connection with a structured finance program and a NRSRO has reviewed
the terms of the program and stated a rating for positions associated
with the program. If the program has options for different combinations
of assets, standards, internal credit enhancements and other relevant
factors, and the NRSRO specifies ranges of rating categories to them,
the bank holding company may apply the rating category that corresponds
to the bank holding company's position. In order to rely on a program
rating, the bank holding company must demonstrate to the Federal
Reserve's satisfaction that the credit risk rating assigned to the
program meets the same standards generally used by NRSROs for rating
traded positions. The bank holding company must also demonstrate to the
Federal Reserve's satisfaction that the criteria underlying the NRSRO's
assignment of ratings for the program are satisfied for the particular
position. If a bank holding company participates in a securitization
sponsored by another party, the Federal Reserve may authorize the bank
holding company to use this approach based on a programmatic rating
obtained by the sponsor of the program.
iii. Computer Program. The bank holding company is using an
acceptable credit assessment computer program to determine the rating
of a direct credit substitute or recourse obligation (but not residual
interest) issued in connection with a structured finance program. A
NRSRO must have developed the computer program, and the bank holding
company must demonstrate to the Federal Reserve's satisfaction that
ratings under the program correspond credibly and reliably with the
rating of traded positions.
g. Limitations on risk-based capital requirements--i. Low-level
exposure. If the maximum contractual exposure to loss retained or
assumed by a bank holding company in connection with a recourse
obligation or a direct credit substitute is less than the effective
risk-based capital requirement for the enhanced assets, the risk-based
capital requirement is limited to the maximum contractual exposure,
less any liability account established in accordance with generally
accepted accounting principles. This limitation does not apply when a
bank holding company provides credit enhancement beyond any contractual
obligation to support assets it has sold.
ii. Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a bank holding company holds a
mortgage-related security or a participation certificate as a result of
a mortgage loan swap with recourse, capital is required to support the
recourse obligation plus the percentage of the mortgage-related
security or participation certificate that is not covered by the
recourse obligation. The total amount of capital required for the on-
balance sheet asset and the recourse obligation, however, is limited to
the capital requirement for the underlying loans, calculated as if the
organization continued to hold these loans as on-balance sheet assets.
iii. Related on-balance sheet assets. If a recourse obligation or
direct credit substitute subject to section III.B.3. of this appendix
also appears as a balance sheet asset, the balance sheet asset is not
included in an organization's risk-weighted assets to the extent the
value of the balance sheet asset is already included in the off-balance
sheet credit equivalent amount for the recourse obligation or direct
credit substitute, except in the case of loan servicing assets and
similar arrangements with embedded recourse obligations or direct
credit substitutes. In that case, both the on-balance sheet assets and
the related recourse obligations and direct credit substitutes are
incorporated into the risk-based capital calculation.
* * * * *
C. * * *
4. Category 4: 100 percent. a. All assets not included in the
categories above are assigned to this category, which comprises
standard risk assets. The bulk of the assets typically found in a loan
portfolio would be assigned to the 100 percent category.
b. This category includes long-term claims on, and the portions of
long-term claims that are guaranteed by, non-OECD banks, and all claims
on non-OECD central governments that entail some degree of transfer
risk.\39\ This category includes all claims on foreign and domestic
private-sector obligors not included in the categories above (including
loans to nondepository financial institutions and bank holding
companies); claims on commercial firms owned by the public sector;
customer liabilities to the organization on acceptances outstanding
involving standard risk claims;\40\ investments in fixed assets,
premises, and other real estate owned; common and preferred stock of
corporations, including stock acquired for debts previously contracted;
all stripped mortgage-backed securities and similar instruments; and
commercial and consumer loans (except those assigned to lower risk
categories due to recognized guarantees or collateral and loans secured
by residential property that qualify for a lower risk weight).
---------------------------------------------------------------------------

\39\ Such assets include all nonlocal currency claims on, and
the portions of claims that are guaranteed by, non-OECD central
governments and those portions of local currency claims on, or
guaranteed by, non-OECD central governments that exceed the local
currency liabilities held by subsidiary depository institutions.
\40\ Customer liabilities on acceptances outstanding involving
nonstandard risk claims, such as claims on U.S. depository
institutions, are assigned to the risk category appropriate to the
identity of the obligor or, if relevant, the nature of the
collateral or guarantees backing the claims. Portions of acceptances
conveyed as risk participations to U.S. depository institutions or
foreign banks are assigned to the 20 percent risk category
appropriate to short-term claims guaranteed by U.S. depository
institutions and foreign banks.
---------------------------------------------------------------------------

c. Also included in this category are industrial-development bonds
and similar obligations issued under the auspices of states or
political subdivisions of the OECD-based group of countries for the
benefit of a private party or enterprise where that party or
enterprise, not the government entity, is obligated to pay the
principal and interest, and all obligations of states or political
subdivisions of countries that do not belong to the OECD-based group.

[[Page 59650]]

d. The following assets also are assigned a risk weight of 100
percent if they have not been deducted from capital: investments in
unconsolidated companies, joint ventures, or associated companies;
instruments that qualify as capital issued by other banking
organizations; and any intangibles, including those that may have been
grandfathered into capital.
* * * * *
D. * * *
The face amount of an off-balance sheet item is generally
incorporated into risk-weighted assets in two steps. The face amount is
first multiplied by a credit conversion factor, except for direct
credit substitutes and recourse obligations as discussed in section
III.D.1. of this appendix. The resultant credit equivalent amount is
assigned to the appropriate risk category according to the obligor or,
if relevant, the guarantor or the nature of the collateral.\41\
Attachment IV to this appendix A sets forth the conversion factors for
various types of off-balance sheet items.
---------------------------------------------------------------------------

\41\ The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section III.B. of this appendix A.
\42\ Forward forward deposits accepted are treated as interest
rate contracts.
---------------------------------------------------------------------------

1. Items with a 100 percent conversion factor. a. Except as
otherwise provided in section III.B.3. of this appendix, the full
amount of an asset or transaction supported, in whole or in part, by a
direct credit substitute or a recourse obligation. Direct credit
substitutes and recourse obligations are defined in section III.B.3. of
this appendix.
b. Sale and repurchase agreements and forward agreements. Forward
agreements are legally binding contractual obligations to purchase
assets with certain drawdown at a specified future date. Such
obligations include forward purchases, forward forward deposits
placed,\42\ and partly-paid shares and securities; they do not include
commitments to make residential mortgage loans or forward foreign
exchange contracts.
c. Securities lent by a banking organization are treated in one of
two ways, depending upon whether the lender is at risk of loss. If a
banking organization, as agent for a customer, lends the customer's
securities and does not indemnify the customer against loss, then the
transaction is excluded from the risk-based capital calculation. If,
alternatively, a banking organization lends its own securities or,
acting as agent for a customer, lends the customer's securities and
indemnifies the customer against loss, the transaction is converted at
100 percent and assigned to the risk weight category appropriate to the
obligor, or, if applicable, to any collateral delivered to the lending
organization, or the independent custodian acting on the lending
organization's behalf. Where a banking organization is acting as agent
for a customer in a transaction involving the lending or sale of
securities that is collateralized by cash delivered to the banking
organization, the transaction is deemed to be collateralized by cash on
deposit in a subsidiary depository institution for purposes of
determining the appropriate risk-weight category, provided that any
indemnification is limited to no more than the difference between the
market value of the securities and the cash collateral received and any
reinvestment risk associated with that cash collateral is borne by the
customer.
d. In the case of direct credit substitutes in which a risk
participation \43\ has been conveyed, the full amount of the assets
that are supported, in whole or in part, by the credit enhancement are
converted to a credit equivalent amount at 100 percent. However, the
pro rata share of the credit equivalent amount that has been conveyed
through a risk participation is assigned to whichever risk category is
lower: the risk category appropriate to the obligor, after considering
any relevant guarantees or collateral, or the risk category appropriate
to the institution acquiring the participation.\44\ Any remainder is
assigned to the risk category appropriate to the obligor, guarantor, or
collateral. For example, the pro rata share of the full amount of the
assets supported, in whole or in part, by a direct credit substitute
conveyed as a risk participation to a U.S. domestic depository
institution or foreign bank is assigned to the 20 percent risk
category.\45\
---------------------------------------------------------------------------

\43\ That is, a participation in which the originating banking
organization remains liable to the beneficiary for the full amount
of the direct credit substitute if the party that has acquired the
participation fails to pay when the instrument is drawn.
\44\ A risk participation in bankers acceptances conveyed to
other institutions is also assigned to the risk category appropriate
to the institution acquiring the participation or, if relevant, the
guarantor or nature of the collateral.
\45\ Risk participations with a remaining maturity of over one
year that are conveyed to non-OECD banks are to be assigned to the
100 percent risk category, unless a lower risk category is
appropriate to the obligor, guarantor, or collateral.
---------------------------------------------------------------------------

e. In the case of direct credit substitutes in which a risk
participation has been acquired, the acquiring banking organization's
percentage share of the direct credit substitute is multiplied by the
full amount of the assets that are supported, in whole or in part, by
the credit enhancement and converted to a credit equivalent amount at
100 percent. The credit equivalent amount of an acquisition of a risk
participation in a direct credit substitute is assigned to the risk
category appropriate to the account party obligor or, if relevant, the
nature of the collateral or guarantees.
f. In the case of direct credit substitutes that take the form of a
syndication 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 will only include its
pro rata share of the assets supported, in whole or in part, by the
direct credit substitute in its risk-based capital calculation.\46\
---------------------------------------------------------------------------

\46\ For example, if a banking organization has a 10 percent
share of a $10 syndicated direct credit substitute that provides
credit support to a $100 loan, then the banking organization's $1
pro rata share in the enhancement means that a $10 pro rata share of
the loan is included in risk weighted assets.
---------------------------------------------------------------------------

* * * * *

Attachment II.--Summary of Definition of Qualifying Capital for Bank
Holding Companies*
[Using the year-end 1992 standard]
------------------------------------------------------------------------
Components Minimum requirements
------------------------------------------------------------------------
Core Capital (Tier 1).................. Must equal or exceed 4% of
weighted-risk assets.
Common stockholders' equity........ No limit.
Qualifying noncumulative perpetual No limit; banks should avoid
preferred stock. undue reliance on preferred
stock in tier 1.

[[Page 59651]]

Qualifying cumulative preferred Limited to 25% of the sum of
stock. common stock, qualifying
perpetual preferred stock, and
minority interests.
Minority interest in equity Banks should avoid using
accounts of consolidated minority interests to
subsidiaries.. subsidiaries introduce
elements not otherwise
qualifying for tier 1 capital.
Less: Goodwill, other intangible
assets, and credit-enhancing
interest-only strips required to
be deducted from capital1
Supplementary Capital (Tier 2)......... Total of tier 2 is limited to
100% of tier 1.2
Allowance for loan and lease losses Limited to 1.25% of weighted-
risk assets. 2
Perpetual preferred stock.......... No limit within tier 2.
Hybrid instruments, perpetual debt No limit within tier 2.
and mandatory convertible
securities..
Subordinated debt and intermediate- Subordinated debt and
term preferred stock (original intermediate-term preferred
weighted average maturity of 5 stock are limited to 50% of
years or more). tier 1, 2 amortized for
capital purposes as they
approach maturity.
Revaluation reserves (equity and Not included; banks encouraged
building). to disclose; may be evaluated
on a case-by-case basis for
international comparisons; and
taken into account in making
an overall assessment of
capital.
Deductions (from sum of tier 1 and tier
2):
Investment in unconsolidated As a general rule, one-half of
subsidiaries. the aggregate investments will
be deducted from tier 1
capital and one-half from tier
2 capital.3
Reciprocal holdings of banking
organizations' capital securities.
Other deductions (such as other On a case-by-case basis or as a
subsidiaries or joint ventures) as matter of policy after a
determined by supervisory formal rulemaking.
authority.
Total Capital (tier 1 + tier 2 - Must equal or exceed 8% or
deductions). weighted-risk assets.
------------------------------------------------------------------------
1 Requirements for the deduction of other intangible assets and residual
interests are set forth in section II.B.1. of this appendix.
2 Amount in excess of limitations are permitted but do not qualify as
capital.
3 A proportionately greater amount may be deducted from tier 1 capital,
if the risks associated with the subsidiary so warrant.
* See discussion in section II of the guidelines for a complete
description of the requirements for, and the limitations on, the
components for qualifying capital.

* * * * *

3. In Appendix D to part 225, section II.b. is revised to read as
follows:

Appendix D to Part 225--Capital Adequacy Guidelines for Bank
Holding Companies: Tier 1 Leverage Measure

* * * * *
II. * * *
b. A banking organization's tier 1 leverage ratio is calculated by
dividing its tier 1 capital (the numerator of the ratio) by its average
total consolidated assets (the denominator of the ratio). The ratio
will also be calculated using period-end assets whenever necessary, on
a case-by-case basis. For the purpose of this leverage ratio, the
definition of tier 1 capital as set forth in the risk-based capital
guidelines contained in appendix A of this part will be used.\3\ As a
general matter, average total consolidated assets are defined as the
quarterly average total assets (defined net of the allowance for loan
and lease losses) reported on the organization's Consolidated Financial
Statements (FR Y-9C Report), less goodwill; amounts of mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships, that, in the aggregate, are in excess of 100
percent of tier 1 capital; amounts of nonmortgage servicing assets, and
purchased credit card relationships that, in the aggregate, are in
excess of 25 percent of tier 1 capital; the amounts of credit-enhancing
interest-only strips that are in excess of 25 percent of tier 1
capital; all other identifiable intangible assets; any investments in
subsidiaries or associated companies that the Federal Reserve
determines should be deducted from tier 1 capital; and deferred tax
assets that are dependent upon future taxable income, net of their
valuation allowance, in excess of the limitation set forth in section
II.B.4. of appendix A of this part.\4\
---------------------------------------------------------------------------

\3\ Tier 1 capital for banking organizations includes common
equity, minority interest in the equity accounts of consolidated
subsidiaries, qualifying noncumulative perpetual preferred stock,
and qualifying cumulative perpetual preferred stock. (Cumulative
perpetual preferred stock is limited to 25 percent of tier 1
capital.) In addition, as a general matter, tier 1 capital excludes
goodwill; amounts of mortage servicing assets, nonmortgage servicing
assets, and purchased credit card relationships that, in the
aggregate, exceed 100 percent of tier 1 capital; amounts of
nonmortgage servicing assets and purchased credit card relationships
that, in the aggregate, exceed 25 percent of tier 1 capital; amounts
of credit-enhancing interest-only strips that are in excess of 25
percent of tier 1capital; all other identifiable intangible assets;
and deferred tax assets that are dependent upon future taxable
income, net of their valuation allowance, in excess of certain
limitations. The Federal Reserve may exclude certain investments in
subsidiaries or associated companies as appropriate.
\4\ Deductions from tier 1 capital and other adjustments are
discussed more fully in section II.B. of appendix A of this part.
---------------------------------------------------------------------------

* * * * *

By order of the Board of Governors of the Federal Reserve
System.

Dated: November 8, 2001.

Margaret McCloskey Shanks,
Assistant Secretary of the Board.

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Chapter III

Authority and Issuance

For the reasons set out in the joint preamble, part 325 of chapter
III of title 12 of the Code of Federal Regulations is amended as
follows:

PART 325--CAPITAL MAINTENANCE

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

Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat.
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat.

[[Page 59652]]

2236, 2386, as amended by Pub. L. 102-550, 106 Stat. 3672, 4089 (12
U.S.C. 1828 note).

2. In Sec. 325.2:
A. Redesignate paragraphs (g) through (x) as paragraphs (i) through
(z);
B. Add new paragraphs (g) and (h);
C. Amend newly designated paragraphs (v) and (x) to read as
follows:

Sec. 325.2 Definitions.

* * * * *
(g)(1) Credit-enhancing interest-only strip means an on-balance
sheet asset that, in form or in substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the bank to credit risk directly or indirectly
associated with the transferred assets that exceeds a pro rata share of
the bank's claim on the assets, whether through subordination
provisions or other credit enhancement techniques.
(2) Reservation of authority. In determining whether a particular
interest cash flow functions, directly or indirectly, as a credit-
enhancing interest-only strip, the FDIC will consider the economic
substance of the transaction. The FDIC, through the Director of
Supervision, or other designated FDIC official reserves the right to
identify other interest cash flows or related assets as credit-
enhancing interest-only strips.
(h) Face amount means the notional principal, or face value, amount
of an off-balance sheet item; the amortized cost of an asset not held
for trading purposes; and the fair value of a trading asset.
* * * * *
(v) Tier 1 capital or core capital means the sum of common
stockholders' equity, noncumulative perpetual preferred stock
(including any related surplus), and minority interests in consolidated
subsidiaries, minus all intangible assets (other than mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships eligible for inclusion in core capital pursuant to
Sec. 325.5(f)), minus credit-enhancing interest-only strips that are
not eligible for inclusion in core capital pursuant to Sec. 325.5(f),
minus deferred tax assets in excess of the limit set forth in
Sec. 325.5(g), minus identified losses (to the extent that Tier 1
capital would have been reduced if the appropriate accounting entries
to reflect the identified losses had been recorded on the insured
depository institution's books), and minus investments in financial
subsidiaries subject to 12 CFR part 362, subpart E.
* * * * *
(x) Total assets means the average of total assets required to be
included in a banking institution's ``Reports of Condition and Income''
(Call Report) or, for savings associations, the consolidated total
assets required to be included in the ``Thrift Financial Report,'' as
these reports may from time to time be revised, as of the most recent
report date (and after making any necessary subsidiary adjustments for
state nonmember banks as described in Secs. 325.5(c) and 325.5(d) of
this part), minus intangible assets (other than mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships eligible for inclusion in core capital pursuant to
Sec. 325.5(f)), minus credit-enhancing interest-only strips that are
not eligible for inclusion in core capital pursuant to Sec. 325.5(f)),
minus deferred tax assets in excess of the limit set forth in
Sec. 325.5(g), and minus assets classified loss and any other assets
that are deducted in determining Tier 1 capital. For banking
institutions, the average of total assets is found in the Call Report
schedule of quarterly averages. For savings associations, the
consolidated total assets figure is found in Schedule CSC of the Thrift
Financial Report.

3. In Sec. 325.3, amend paragraph (b)(1) by changing ``CAMEL'' to
``CAMELS.''

4. In Sec. 325.5, revise paragraphs (f) and (g)(2) to read as
follows:

Sec. 325.5 Miscellaneous.

* * * * *
(f) Treatment of mortgage servicing assets, purchased credit card
relationships, nonmortgage servicing assets, and credit-enhancing
interest-only strips. For purposes of determining Tier 1 capital under
this part, mortgage servicing assets, purchased credit card
relationships, nonmortgage servicing assets, and credit-enhancing
interest-only strips will be deducted from assets and from common
stockholders' equity to the extent that these items do not meet the
conditions, limitations, and restrictions described in this section.
Banks may elect to deduct disallowed servicing assets and disallowed
credit-enhancing interest-only strips on a basis that is net of a
proportional amount of any associated deferred tax liability recorded
on the balance sheet. Any deferred tax liability netted in this manner
cannot also be netted against deferred tax assets when determining the
amount of deferred tax assets that are dependent upon future taxable
income and calculating the maximum allowable amount of these assets
under paragraph (g) of this section.
(1) Valuation. The fair value of mortgage servicing assets,
purchased credit card relationships, nonmortgage servicing assets, and
credit-enhancing interest-only strips shall be estimated at least
quarterly. The quarterly fair value estimate shall include adjustments
for any significant changes in the original valuation assumptions,
including changes in prepayment estimates or attrition rates. The FDIC
in its discretion may require independent fair value estimates on a
case-by-case basis where it is deemed appropriate for safety and
soundness purposes.
(2) Fair value limitation. For purposes of calculating Tier 1
capital under this part (but not for financial statement purposes), the
balance sheet assets for mortgage servicing assets, purchased credit
card relationships, and nonmortgage servicing assets will each be
reduced to an amount equal to the lesser of:
(i) 90 percent of the fair value of these assets, determined in
accordance with paragraph (f)(1) of this section; or
(ii) 100 percent of the remaining unamortized book value of these
assets (net of any related valuation allowances), determined in
accordance with the instructions for the preparation of the ``Reports
of Income and Condition'' (Call Reports).
(3) Tier 1 capital limitations. (i)The maximum allowable amount of
mortgage servicing assets, purchased credit card relationships, and
nonmortgage servicing assets in the aggregate, will be limited to the
lesser of:
(A) 100 percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
nonmortgage servicing assets, any disallowed credit-enhancing interest-
only strips, and any disallowed deferred tax assets; or
(B) The sum of the amounts of mortgage servicing assets, purchased
credit card relationships, and nonmortgage servicing assets, determined
in accordance with paragraph (f)(2) of this section.
(ii) The maximum allowable amount of credit-enhancing interest-only
strips, whether purchased or retained, will be limited to the lesser
of:
(A) 25 percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
nonmortgage servicing assets, any disallowed credit-enhancing interest-
only strips, and any disallowed deferred tax assets; or

[[Page 59653]]

(B) The sum of the face amounts of all credit-enhancing interest-
only strips.
(4) Tier 1 capital sublimit. In addition to the aggregate
limitation on mortgage servicing assets, purchased credit card
relationships, and nonmortgage servicing assets set forth in paragraph
(f)(3) of this section, a sublimit will apply to purchased credit card
relationships and nonmortgage servicing assets. The maximum allowable
amount of the aggregate of purchased credit card relationships and
nonmortgage servicing assets will be limited to the lesser of:
(i) 25 percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
nonmortgage servicing assets, any disallowed credit-enhancing interest-
only strips, and any disallowed deferred tax assets; or
(ii) The sum of the amounts of purchased credit card relationships
and nonmortgage servicing assets determined in accordance with
paragraph (f)(2) of this section.
(g) * * *
(2) Tier 1 capital limitations. (i) The maximum allowable amount of
deferred tax assets that are dependent upon future taxable income, net
of any valuation allowance for deferred tax assets, will be limited to
the lesser of:
(A) The amount of deferred tax assets that are dependent upon
future taxable income that is expected to be realized within one year
of the calendar quarter-end date, based on projected future taxable
income for that year; or
(B) 10 percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any disallowed purchased
credit card relationships, any disallowed credit-enhancing interest-
only strips and any disallowed deferred tax assets.
(ii) For purposes of this limitation, all existing temporary
differences should be assumed to fully reverse at the calendar quarter-
end date. The recorded amount of deferred tax assets that are dependent
upon future taxable income, net of any valuation allowance for deferred
tax assets, in excess of this limitation will be deducted from assets
and from equity capital for purposes of determining Tier 1 capital
under this part. The amount of deferred tax assets that can be realized
from taxes paid in prior carryback years and from the reversal of
existing taxable temporary differences generally would not be deducted
from assets and from equity capital. However, notwithstanding the first
three sentences in this paragraph, the amount of carryback potential
that may be considered in calculating the amount of deferred tax assets
that a member of a consolidated group (for tax purposes) may include in
Tier 1 capital may not exceed the amount which the member could
reasonably expect to have refunded by its parent.
* * * * *

Sec. 325.103 [Amended]

5. In Sec. 325.103, amend paragraph (b) by revising all references
to ``CAMEL'' to read ``CAMELS'.

6. In appendix A to part 325:
A. In the introductory section, second undesignated paragraph
remove the last sentence and in the third undesignated paragraph revise
the first sentence;
B. In section I, revise paragraph I.A.l. and redesignate footnotes
5 through 10 as footnotes 4 through 9;
C. In section II:
i. Amend paragraph II.A. by designating the first two undesignated
paragraphs as l. and 2., respectively, adding a new paragraph 3., and
redesignating footnote 11 as footnote 10;
ii. Amend paragraph II.B. by redesignating footnotes 12 through 13
as footnotes 11 through 12, revising paragraph 5, and removing
paragraph 6;
iii. Amend paragraph II.C. by redesignating footnotes 15 through 31
as footnotes 16 through 32; under ``Category 2-20 Percent Risk Weight''
designating the three undesignated paragraphs as paragraphs a. through
c., respectively, and adding a new paragraph d.; under ``Category 3--50
Percent Risk Weight'' removing the third undesignated paragraph,
designating the three remaining paragraphs as a. through c.,
respectively, revising newly designated footnote 30, and adding a new
paragraph d; revising ``Category 4--100 Percent Risk Weight''; and
adding a new paragraph entitled ``Category 5--200 Percent Risk
Weight'';
iv. Amend paragraph II.D. by revising the undesignated introductory
paragraph and paragraph II.D.1.; removing footnote 38 and redesignating
footnotes 39 through 42 as footnotes 37 through 40.
D. Revise section III;
E. Revise Table I;
F. In Table II:
i. Amend Category 2--20 Percent Risk Weight, by removing paragraph
(11), redesignating paragraph (12) as paragraph (11), and adding new
paragraph (12);
ii. Amend Category 3--50 Percent Risk Weight, by revising paragraph
(3);
iii. Amend Category 4--100 Percent Risk Weight, by revising
paragraph (9) and adding a new paragraph (10); and
iv. Following the paragraph titled Category 4--100 Percent Risk
Weight, add a new paragraph titled Category 5--200 Percent Risk Weight;
G. Amend Table III by removing references to footnote 1 each time
they appear and revising paragraphs (1) through (3) under ``100 Percent
Conversion Factor''.

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

* * * * *
The framework set forth in this statement of policy consists of (1)
a definition of capital for risk-based capital purposes, and (2) a
system for calculating risk-weighted assets by assigning assets and off
balance sheet items to broad risk categories. * * *
I. * * *
A. * * *
1. Core capital elements (Tier 1) consists of:
i. Common stockholders' equity capital (includes common stock and
related surplus, undivided profits, disclosed capital reserves that
represent a segregation of undivided profits, and foreign currency
translation adjustments, less net unrealized holding losses on
available-for-sale equity securities with readily determinable fair
values);
ii. Noncumulative perpetual preferred stock,\2\ including any
related surplus; and
---------------------------------------------------------------------------

\2\ Preferred stock issues where the dividend is reset
periodically based, in whole or in part, upon the bank's current
credit standing, including but not limited to, auction rate, money
market or remarketable preferred stock, are assigned to Tier 2
capital, regardless of whether the dividends are cumulative or
noncumulative.
---------------------------------------------------------------------------

iii. Minority interests in the equity capital accounts of
consolidated subsidiaries.
At least 50 percent of the qualifying total capital base should
consist of Tier 1 capital. Core (Tier 1) capital is defined as the sum
of core capital elements minus all intangible assets (other than
mortgage servicing assets, nonmortgage servicing assets and purchased
credit card relationships eligible for inclusion in core capital
pursuant to Sec. 325.5(f)),\3\ minus credit-enhancing interest-only
strips that are not eligible for inclusion in core capital pursuant to
Sec. 325.5(f)), and minus any disallowed deferred tax assets.
---------------------------------------------------------------------------

\3\ An exception is allowed for intangible assets that are
explicitly approved by the FDIC as part of the bank's regulatory
capital on a specific case basis. These intangibles will be included
in capital for risk-based capital purposes under the terms and
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------

Although nonvoting common stock, noncumulative perpetual preferred

[[Page 59654]]

stock, and minority interests in the equity capital accounts of
consolidated subsidiaries are normally included in Tier 1 capital,
voting common stockholders' equity generally will be expected to be the
dominant form of Tier 1 capital. Thus, banks should avoid undue
reliance on nonvoting equity, preferred stock and minority interests.
Although minority interests in consolidated subsidiaries are
generally included in regulatory capital, exceptions to this general
rule will be made if the minority interests fail to provide meaningful
capital support to the consolidated bank. Such a situation could arise
if the minority interests are entitled to a preferred claim on
essentially low risk assets of the subsidiary. Similarly, although
credit-enhancing interest-only strips and intangible assets in the form
of mortgage servicing assets, nonmortgage servicing assets and
purchased credit card relationships are generally recognized for risk-
based capital purposes, the deduction of part or all of the credit-
enhancing interest-only strips, mortgage servicing assets, nonmortgage
servicing assets and purchased credit card relationships may be
required if the carrying amounts of these assets are excessive in
relation to their market value or the level of the bank's capital
accounts. Credit-enhancing interest-only strips, mortgage servicing
assets, nonmortgage servicing assets, purchased credit card
relationships and deferred tax assets that do not meet the conditions,
limitations and restrictions described in Sec. 325.5(f) and (g) of this
part will not be recognized for risk-based capital purposes.
* * * * *
II. * * *
A. * * *
3. The Director of the Division of Supervision may, on a case-by-
case basis, determine the appropriate risk weight for any asset or
credit equivalent amount that does not fit wholly within one of the
risk categories set forth in this Appendix A or that imposes risks on a
bank that are not commensurate with the risk weight otherwise specified
in this Appendix A for the asset or credit equivalent amount. In
addition, the Director of the Division of Supervision may, on a case-
by-case basis, determine the appropriate credit conversion factor for
any off-balance sheet item that does not fit wholly within one of the
credit conversion factors set forth in this Appendix A or that imposes
risks on a bank that are not commensurate with the credit conversion
factor otherwise specified in this Appendix A for the off-balance sheet
item. In making such a determination, the Director of the Division of
Supervision will consider the similarity of the asset or off-balance
sheet item to assets or off-balance sheet items explicitly treated in
sections II.B and II.C of this appendix A, as well as other relevant
factors.
B. * * *
5. Recourse, Direct Credit Substitutes, Residual Interests and
Mortgage- and Asset-Backed Securities. For purposes of this section
II.B.5 of this appendix A, the following definitions will apply.
(a) Definitions. (1) Credit derivative means a contract that allows
one party (the protection purchaser) to transfer the credit risk of an
asset or off-balance sheet credit exposure to another party (the
protection provider). The value of a credit derivative is dependent, at
least in part, on the credit performance of a ``reference asset.''
(2) Credit-enhancing interest-only strip is defined in
Sec. 325.2(g).
(3) Credit-enhancing representations and warranties means
representations and warranties that are made or assumed in connection
with a transfer of assets (including loan servicing assets) and that
obligate a bank to protect investors from losses arising from credit
risk in the assets transferred or the loans serviced. Credit-enhancing
representations and warranties include promises to protect a party from
losses resulting from the default or nonperformance of another party or
from an insufficiency in the value of the collateral. Credit-enhancing
representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the
return of, or premium refund clauses covering, 1-4 family residential
first mortgage loans (as described in section II.C, Category 3-50
Percent Risk Weight, of this appendix A) for a period of 120 days from
the date of transfer. These warranties may cover only those loans that
were originated within 1 year of the date of transfer;
(ii) Premium refund clauses covering assets guaranteed, in whole or
in part, by the U.S. Government, a U.S. Government agency, or a U.S.
Government-sponsored agency, provided the premium refund clauses are
for a period not to exceed 120 days from the date of transfer; or
(iii) Warranties that permit the return of assets in instances of
fraud, misrepresentation, or incomplete documentation.
(4) Direct credit substitute means an arrangement in which a bank
assumes, in form or in substance, credit risk directly or indirectly
associated with an on-or off-balance sheet asset or exposure that was
not previously owned by the bank (third-party asset) and the risk
assumed by the bank exceeds the pro rata share of the bank's interest
in the third-party asset. If the bank has no claim on the asset, then
the bank's assumption of any credit risk is a direct credit substitute.
Direct credit substitutes include, but are not limited to:
(i) Financial standby letters of credit, which includes any letter
of credit or similar arrangement, however named or described, that
support financial claims on a third party that exceed a bank's pro rata
share in the financial claim;
(ii) Guarantees, surety arrangements, credit derivatives, and
irrevocable guarantee-type instruments backing financial claims such as
outstanding securities, loans, or other financial claims, or that back
off-balance-sheet items against which risk-based capital must be
maintained;
(iii) Purchased subordinated interests or securities that absorb
more than their pro rata share of credit losses from the underlying
assets. Purchased subordinated interests that are credit-enhancing
interest-only strips are subject to the higher capital charge specified
in section II.B.5.(f) of this Appendix A;
(iv) Entering into a credit derivative contract under which the
bank assumes more than its pro rata share of credit risk on a third-
party asset or exposure;
(v) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party;
(vi) Purchased loan servicing assets if the servicer:
(A) Is responsible for credit losses associated with the loans
being serviced,
(B) Is responsible for making mortgage servicer cash advances
(unless the advances are not direct credit substitutes because they
meet the conditions specified in paragraph B.5(a)(9) of this appendix
A), or
(C) Makes or assumes credit-enhancing representations and
warranties on the serviced loans; and
(vii) Clean-up calls on third party assets. Clean-up calls that are
exercisable at the option of the bank (as servicer or as an affiliate
of the servicer) when the pool balance is 10 percent or less of the
original pool balance are not direct credit substitutes.
(5) Externally rated means, with respect to an instrument or
obligation, that an instrument or obligation has received a credit
rating from at least one

[[Page 59655]]

nationally recognized statistical rating organization.
(6) Face amount is defined in Sec. 325.2(h).
(7) Financial asset means cash, evidence of an ownership interest
in an entity, or a contract that conveys to a second entity a
contractual right:
(i) To receive cash or another financial instrument from a first
entity; or
(ii) To exchange other financial instruments on potentially
favorable terms with the first entity.
(8) Financial standby letter of credit means a letter of credit or
similar arrangement that represents an irrevocable obligation to a
third-party beneficiary:
(i) To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party); or
(ii) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(9) Mortgage servicer cash advance means funds that a residential
mortgage servicer advances to ensure an uninterrupted flow of payments
or the timely collection of residential mortgage loans, including
disbursements made to cover foreclosure costs or other expenses arising
from a mortgage loan to facilitate its timely collection. A mortgage
servicer cash advance is not a recourse obligation or a direct credit
substitute if:
(i) The mortgage servicer is entitled to full reimbursement or, for
any one residential mortgage loan, nonreimbursable advances are
contractually limited to an insignificant amount of the outstanding
principal on that loan, and
(ii) The servicer's entitlement to reimbursement is not
subordinated.
(10) Nationally recognized statistical rating organization (NRSRO)
means an entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (or any successor Division)
(Commission) as a nationally recognized statistical rating organization
for various purposes, including the Commission's uniform net capital
requirements for brokers and dealers (17 CFR 240.15c3-1).
(11) Recourse means an arrangement in which a bank retains, in form
or in substance, any credit risk directly or indirectly associated with
an asset it has sold (in accordance with generally accepted accounting
principles) that exceeds a pro rata share of the bank's claim on the
asset. If a bank has no claim on an asset it has sold, then the
retention of any credit risk is recourse. A recourse obligation
typically arises when an institution transfers assets in a sale and
retains an obligation to repurchase the assets or absorb losses due to
a default of principal or interest or any other deficiency in the
performance of the underlying obligor or some other party. Recourse may
exist implicitly where a bank provides credit enhancement beyond any
contractual obligation to support assets it has sold. The following are
examples of recourse arrangements:
(i) Credit-enhancing representations and warranties made on the
transferred assets;
(ii) Loan servicing assets retained pursuant to an agreement under
which the bank:
(A) Is responsible for losses associated with the loans serviced,
(B) Is responsible for making mortgage servicer cash advances
(unless the advances are not a recourse obligation because they meet
the conditions of paragraph B.5(a)(9) of this appendix A), or
(C) Makes credit-enhancing representations and warranties on the
serviced loans;
(iii) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(iv) Assets sold under an agreement to repurchase, if the assets
are not already included on the balance sheet;
(v) Loan strips sold without contractual recourse where the
maturity of the transferred portion of the loan is shorter than the
maturity of the commitment under which the loan is drawn;
(vi) Credit derivative contracts under which the bank retains more
than its pro rata share of credit risk on transferred assets; and
(vii) Clean-up calls. Clean-up calls that are exercisable at the
option of the bank (as servicer or as an affiliate of the servicer)
when the pool balance is 10 percent or less of the original pool
balance, are not recourse.
(12) Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by a
transfer that qualifies as a sale (in accordance with generally
accepted accounting principles) of financial assets, whether through a
securitization or otherwise, and that exposes a bank to credit risk
directly or indirectly associated with the transferred asset that
exceeds a pro rata share of that bank's claim on the asset, whether
through subordination provisions or other credit enhancement
techniques. Residual interests generally include credit-enhancing
interest-only strips, spread accounts, cash collateral accounts,
retained subordinated interests and other forms of over-
collateralization, and similar assets that function as a credit
enhancement. Residual interests further include those exposures that,
in substance, cause the bank to retain the credit risk of an asset or
exposure that had qualified as a residual interest before it was sold.
Residual interests generally do not include interests purchased from a
third party, except that purchased credit-enhancing interest-only
strips are residual interests.
(13) Risk participation means a participation in which the
originating bank remains liable to the beneficiary for the full amount
of an obligation (e.g. a direct credit substitute) notwithstanding that
another party has acquired a participation in that obligation.
(14) Securitization means the pooling and repackaging by a special
purpose entity of assets or other credit exposures into securities that
can be sold to investors. Securitization includes transactions that
generally create stratified credit risk positions whose performance is
dependent upon an underlying pool of credit exposures, including loans
and commitments.
(15) Structured finance program means a program where receivable
interests and asset-backed securities issued by multiple participants
are purchased by a special purpose entity that repackages those
exposures into securities that can be sold to investors. Structured
finance programs allocate credit risks, generally, between the
participants and the credit enhancement provided to the program.
(16) Traded position means a position or asset-backed security
retained, assumed or issued in connection with a securitization that is
externally rated, where there is a reasonable expectation that, in the
near future, the rating will be relied upon by:
(i) Unaffiliated investors to purchase the position; or
(ii) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan or repurchase
agreement.
(b) Credit equivalent amounts and risk weights of recourse
obligations and direct credit substitutes--(1) General rule for
determining the credit-equivalent amount. Except as otherwise provided,
the credit-equivalent amount for a recourse obligation or direct credit
substitute is the full amount of the credit-enhanced assets for which
the bank directly or indirectly retains or assumes credit risk
multiplied by a 100% conversion factor. Thus, a bank that extends a
partial direct credit

[[Page 59656]]

substitute, e.g., a financial standby letter of credit that absorbs the
first 10 percent of loss on a transaction, must maintain capital
against the full amount of the assets being supported.
(2) Risk-weight factor. To determine the bank's risk-weighted
assets for an off-balance sheet recourse obligation or a direct credit
substitute, the credit equivalent amount is assigned to the risk
category appropriate to the obligor in the underlying transaction,
after considering any associated guarantees or collateral. For a direct
credit substitute that is an on-balance sheet asset, e.g., a purchased
subordinated security, a bank must calculate risk-weighted assets using
the amount of the direct credit substitute and the full amount of the
assets it supports, i.e., all the more senior positions in the
structure. The treatment covered in this paragraph (b) is subject to
the low-level exposure rule provided in section II.B.5(h)(1) of this
appendix A.
(c) Credit equivalent amount and risk weight of participations in,
and syndications of, direct credit substitutes. Subject to the low-
level exposure rule provided in section II.B.5(h)(1) of this appendix
A, the credit equivalent amount for a participation interest in, or
syndication of, a direct credit substitute (excluding purchased credit-
enhancing interest-only strips) is calculated and risk weighted as
follows:
(1) Treatment for direct credit substitutes for which a bank has
conveyed a risk participation. In the case of a direct credit
substitute in which a bank has conveyed a risk participation, the full
amount of the assets that are supported by the direct credit substitute
is converted to a credit equivalent amount using a 100% conversion
factor. However, the pro rata share of the credit equivalent amount
that has been conveyed through a risk participation is then assigned to
whichever risk-weight category is lower: the risk-weight category
appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral, or the risk-weight
category appropriate to the party acquiring the participation. The pro
rata share of the credit equivalent amount that has not been
participated out is assigned to the risk-weight category appropriate to
the obligor, guarantor, or collateral. For example, the pro rata share
of the full amount of the assets supported, in whole or in part, by a
direct credit substitute conveyed as a risk participation to a U.S.
domestic depository institution or an OECD bank is assigned to the 20
percent risk category.\13\
---------------------------------------------------------------------------

\13\ A risk participation with a remaining maturity of one year
or less that is conveyed to a non-OECD bank is also assigned to the
20 percent risk category.
---------------------------------------------------------------------------

(2) Treatment for direct credit substitutes in which the bank has
acquired a risk participation. In the case of a direct credit
substitute in which the bank has acquired a risk participation, the
acquiring bank's pro rata share of the direct credit substitute is
multiplied by the full amount of the assets that are supported by the
direct credit substitute and converted using a 100% credit conversion
factor. The resulting credit equivalent amount is then assigned to the
risk-weight category appropriate to the obligor in the underlying
transaction, after considering any associated guarantees or collateral.
(3) Treatment for direct credit substitutes related to
syndications. In the case of a direct credit substitute that takes the
form of a syndication where each party is obligated only for its pro
rata share of the risk and there is no recourse to the originating
entity, each bank's credit equivalent amount will be calculated by
multiplying only its pro rata share of the assets supported by the
direct credit substitute by a 100% conversion factor. The resulting
credit equivalent amount is then assigned to the risk-weight category
appropriate to the obligor in the underlying transaction, after
considering any associated guarantees or collateral.
(d) Externally rated positions: credit-equivalent amounts and risk
weights.--(1) Traded positions. With respect to a recourse obligation,
direct credit substitute, residual interest (other than a credit-
enhancing interest-only strip) or mortgage- or asset-backed security
that is a ``traded position'' and that has received an external rating
on a long-term position that is one grade below investment grade or
better or a short-term position that is investment grade, the bank may
multiply the face amount of the position by the appropriate risk
weight, determined in accordance with Table A or B of this appendix A,
as appropriate.\14\ If a traded position receives more than one
external rating, the lowest rating will apply.
---------------------------------------------------------------------------

\14\ Stripped mortgage-backed securities and similar
instruments, such as interest-only strips that are not credit-
enhancing and principal-only strips, must be assigned to the 100%
risk category.

Table A
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest or second highest AAA, AA............. 20
investment grade.
Third highest investment grade.... A................... 50
Lowest investment grade........... BBB................. 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

Table B
------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (In percent)
------------------------------------------------------------------------
Highest investment grade.......... A-1, P-1............ 20
Second highest investment grade... A-2, P-2............ 50
Lowest investment grade........... A-3, P-3............ 100
------------------------------------------------------------------------

[[Page 59657]]

(2) Non-traded positions. A recourse obligation, direct credit
substitute, residual interest (but not a credit-enhancing interest-only
strip) or mortgage- or asset-backed security extended in connection
with a securitization that is not a ``traded position'' may be assigned
a risk weight in accordance with section II.B.5(d)(1) of this appendix
A if:
(i) It has been externally rated by more than one NRSRO;
(ii) It has received an external rating on a long-term position
that is one category below investment grade or better or a short-term
position that is investment grade by all NRSROs providing a rating;
(iii) The ratings are publicly available; and
(iv) The ratings are based on the same criteria used to rate traded
positions. If the ratings are different, the lowest rating will
determine the risk category to which the recourse obligation, direct
credit substitute, residual interest, or mortgage- or asset-backed
security will be assigned.
(e) Senior positions not externally rated. For a recourse
obligation, direct credit substitute, residual interest or mortgage- or
asset-backed security that is not externally rated but is senior in all
features to a traded position (including collateralization and
maturity), a bank may apply a risk weight to the face amount of the
senior position in accordance with section II.B.5(d)(1) of this
appendix A, based upon the risk weight of the traded position, subject
to any current or prospective supervisory guidance and the bank
satisfying the FDIC that this treatment is appropriate. This section
will apply only if the traded position provides substantial credit
support for the entire life of the unrated position.
(f) Residual interests--(1) Concentration limit on credit-enhancing
interest-only strips. In addition to the capital requirement provided
by section II.B.5(f)(2) of this appendix A, a bank must deduct from
Tier 1 capital the face amount of all credit-enhancing interest-only
strips in excess of 25 percent of Tier 1 capital in accordance with
Sec. 325.5(f)(3).
(2) Credit-enhancing interest-only strip capital requirement. After
applying the concentration limit to credit-enhancing interest-only
strips in accordance with Sec. 325.5(f)(3), a bank must maintain risk-
based capital for a credit-enhancing interest-only strip, equal to the
remaining face amount of the credit-enhancing interest-only strip (net
of the remaining proportional amount of any existing associated
deferred tax liability recorded on the balance sheet), even if the
amount of risk-based capital required to be maintained exceeds the full
risk-based capital requirement for the assets transferred. Transactions
that, in substance, result in the retention of credit risk associated
with a transferred credit-enhancing interest-only strip will be treated
as if the credit-enhancing interest-only strip was retained by the bank
and not transferred.
(3) Other residual interests capital requirement. Except as
otherwise provided in section II.B.5(d) or (e) of this appendix A, a
bank must maintain risk-based capital for a residual interest
(excluding a credit-enhancing interest-only strip) equal to the face
amount of the residual interest (net of any existing associated
deferred tax liability recorded on the balance sheet), even if the
amount of risk-based capital required to be maintained exceeds the full
risk-based capital requirement for the assets transferred. Transactions
that, in substance, result in the retention of credit risk associated
with a transferred residual interest will be treated as if the residual
interest was retained by the bank and not transferred.
(4) Residual interests and other recourse obligations. Where the
aggregate capital requirement for residual interests (including credit-
enhancing interest-only strips) and recourse obligations arising from
the same transfer of assets exceed the full risk-based capital
requirement for assets transferred, a bank must maintain risk-based
capital equal to the greater of the risk-based capital requirement for
the residual interest as calculated under sections II.B.5(f)(2) through
(3) of this appendix A or the full risk-based capital requirement for
the assets transferred.
(g) Positions that are not rated by an NRSRO. A bank's position
(other than a residual interest) in a securitization or structured
finance program that is not rated by an NRSRO may be risk-weighted
based on the bank's determination of the credit rating of the position,
as specified in Table C of this appendix A, multiplied by the face
amount of the position. In order to qualify for this treatment, the
bank's system for determining the credit rating of the position must
meet one of the three alternative standards set out in section
II.B.5(g)(1) through (3) of this appendix A.

Table C
------------------------------------------------------------------------
Risk Weight
Rating category Examples (In percent)
------------------------------------------------------------------------
Investment grade.................. BBB or better....... 100
One category below investment BB.................. 200
grade.
------------------------------------------------------------------------

(1) Internal risk rating used for asset-backed programs. A bank
extends a direct credit substitute (but not a purchased credit-
enhancing interest-only strip) to an asset-backed commercial paper
program sponsored by the bank and the bank is able to demonstrate to
the satisfaction of the FDIC, prior to relying upon its use, that the
bank's internal credit risk rating system is adequate. Adequate
internal credit risk rating systems usually contain the following
criteria:\15\
---------------------------------------------------------------------------

\15\ The adequacy of a bank's use of its internal credit risk
rating system must be demonstrated to the FDIC considering the
criteria listed in this section and the size and complexity of the
credit exposures assumed by the bank.
---------------------------------------------------------------------------

(i) The internal credit risk rating system is an integral part of
the bank's risk management system that explicitly incorporates the full
range of risks arising from a bank's participation in securitization
activities;
(ii) Internal credit ratings are linked to measurable outcomes,
such as the probability that the position will experience any loss, the
position's expected loss given default, and the degree of variance in
losses given default on that position;
(iii) The internal credit risk rating system must separately
consider the risk associated with the underlying loans or borrowers,
and the risk associated with the structure of a particular
securitization transaction;
(iv) The internal credit risk rating system identifies gradations
of risk among ``pass'' assets and other risk positions;

[[Page 59658]]

(v) The internal credit risk rating system must have clear,
explicit criteria (including for subjective factors), that are used to
classify assets into each internal risk grade;
(vi) The bank must have independent credit risk management or loan
review personnel assigning or reviewing the credit risk ratings;
(vii) An internal audit procedure should periodically verify that
internal risk ratings are assigned in accordance with the bank's
established criteria;
(viii) The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit substitutes
over time to determine the appropriateness of the initial credit risk
rating assignment and adjust individual credit risk ratings, or the
overall internal credit risk ratings system, as needed; and
(ix) The internal credit risk rating system must make credit risk
rating assumptions that are consistent with, or more conservative than,
the credit risk rating assumptions and methodologies of NRSROs.
(2) Program Ratings. A bank extends a direct credit substitute or
retains a recourse obligation (but not a residual interest) in
connection with a structured finance program and an NRSRO has reviewed
the terms of the program and stated a rating for positions associated
with the program. If the program has options for different combinations
of assets, standards, internal credit enhancements and other relevant
factors, and the NRSRO specifies ranges of rating categories to them,
the bank may apply the rating category applicable to the option that
corresponds to the bank's position. In order to rely on a program
rating, the bank must demonstrate to the FDIC's satisfaction that the
credit risk rating assigned to the program meets the same standards
generally used by NRSROs for rating traded positions. The bank must
also demonstrate to the FDIC's satisfaction that the criteria
underlying the NRSRO's assignment of ratings for the program are
satisfied for the particular position issued by the bank. If a bank
participates in a securitization sponsored by another party, the FDIC
may authorize the bank to use this approach based on a program rating
obtained by the sponsor of the program.
(3) Computer Program. A bank is using an acceptable credit
assessment computer program that has been developed by an NRSRO to
determine the rating of a direct credit substitute or recourse
obligation (but not a residual interest) extended in connection with a
structured finance program. In order to rely on the rating determined
by the computer program, the bank must demonstrate to the FDIC's
satisfaction that ratings under the program correspond credibly and
reliably with the ratings of traded positions. The bank must also
demonstrate to the FDIC's satisfaction the credibility of the program
in financial markets, the reliability of the program in assessing
credit risk, the applicability of the program to the bank's position,
and the proper implementation of the program.
(h) Limitations on risk-based capital requirements--(1) Low-level
exposure rule. If the maximum exposure to loss retained or assumed by a
bank in connection with a recourse obligation, a direct credit
substitute, or a residual interest is less than the effective risk-
based capital requirement for the credit-enhanced assets, the risk-
based capital required under this appendix A is limited to the bank's
maximum contractual exposure, less any recourse liability account
established in accordance with generally accepted accounting
principles. This limitation does not apply when a bank provides credit
enhancement beyond any contractual obligation to support assets it has
sold.
(2) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a bank holds a mortgage-related
security or a participation certificate as a result of a mortgage loan
swap with recourse, capital is required to support the recourse
obligation plus the percentage of the mortgage-related security or
participation certificate that is not covered by the recourse
obligation. The total amount of capital required for the on-balance
sheet asset and the recourse obligation, however, is limited to the
capital requirement for the underlying loans, calculated as if the bank
continued to hold these loans as an on-balance sheet asset.
(3) Related on-balance sheet assets. If a recourse obligation or
direct credit substitute also appears as a balance sheet asset, the
asset is risk-weighted only under this section II.B.5 of this appendix
A, except in the case of loan servicing assets and similar arrangements
with embedded recourse obligations or direct credit substitutes. In
that case, the on-balance sheet servicing assets and the related
recourse obligations or direct credit substitutes must both be
separately risk weighted and incorporated into the risk-based capital
calculation.
(i) Alternative Capital Calculation for Small Business Obligations.
(1) Definitions. For purposes of this section II.B. 5(i):
(i) Qualified bank means a bank that:
(A) Is well capitalized as defined in Sec. 325.103(b)(1) without
applying the capital treatment described in this section II.B.5(i), or
(B) Is adequately capitalized as defined in Sec. 325.103(b)(2)
without applying the capital treatment described in this section
II.B.5(i) and has received written permission by order of the FDIC to
apply the capital treatment described in this section II.B.5(i).
(iii) Small business means a business that meets the criteria for a
small business concern established by the Small Business Administration
in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(2) Capital and reserve requirements. Notwithstanding the risk-
based capital treatment outlined in any other paragraph (other than
paragraph (i) of this section II.B.5), with respect to a transfer with
recourse of a small business loan or a lease to a small business of
personal property that is a sale under generally accepted accounting
principles, and for which the bank establishes and maintains a non-
capital reserve under generally accepted accounting principles
sufficient to meet the reasonable estimated liability of the bank under
the recourse arrangement; a qualified bank may elect to include only
the face amount of its recourse in its risk-weighted assets for
purposes of calculating the bank's risk-based capital ratio.
(3) Limit on aggregate amount of recourse. The total outstanding
amount of recourse retained by a qualified bank with respect to
transfers of small business loans and leases to small businesses of
personal property and included in the risk-weighted assets of the bank
as described in section II.B.5(i)(2) of this appendix A may not exceed
15 percent of the bank's total risk-based capital, unless the FDIC
specifies a greater amount by order.
(4) Bank that ceases to be qualified or that exceeds aggregate
limit. If a bank ceases to be a qualified bank or exceeds the aggregate
limit in section II.B.5(i)(3) of this appendix A, the bank may continue
to apply the capital treatment described in section II.B.5(i)(2) of
this appendix A to transfers of small business loans and leases to
small businesses of personal property that occurred when the bank was
qualified and did not exceed the limit.
(5) Prompt correction action not affected. (i) A bank shall compute
its capital without regard to this section II.B.5(i) for purposes of
prompt corrective action (12 U.S.C. 1831o) unless the bank is a well
capitalized bank (without applying the capital treatment described in
this section

[[Page 59659]]

II.B.5(i)) and, after applying the capital treatment described in this
section II.B.5(i), the bank would be well capitalized.
(ii) A bank shall compute its capital without regard to this
section II.B.5(i) for purposes of 12 U.S.C. 1831o(g) regardless of the
bank's capital level.
* * * * *
C. * * *
Category 2-20 Percent Risk Weight.
* * * * *
d. This category also includes recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing
interest-only strip) and asset- or mortgage-backed securities rated in
the highest or second highest investment grade category, e.g., AAA, AA,
in the case of long-term ratings, or the highest rating category, e.g.,
A-1, P-1, in the case of short-term ratings.
Category 3--50 Percent Risk Weight.
* * * * *
b. * * *\30\ * * *
---------------------------------------------------------------------------

\30\ The types of loans that qualify as loans secured by
multifamily residential properties are listed in the instructions
for preparation of the Consolidated Reports of Condition and Income.
In addition, from the standpoint of the selling bank, when a
multifamily residential property loan is sold subject to a pro rata
loss sharing arrangement which 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, that portion of the loan is not subject to
the risk-based capital standards. In connection with sales of
multifamily residential property loans in which the purchaser of the
loan shares in any loss incurred on the loan with the selling bank
on other than a pro rata basis, the selling bank must treat these
other loss sharing arrangements in accordance with section II.B.5 of
this appendix A.
---------------------------------------------------------------------------

* * * * *
d. This category also includes recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing
interest-only strip) and asset- or mortgage-backed securities rated in
the third highest investment grade category, e.g., A, in the case of
long-term ratings, or the second highest rating category, e.g., A-2, P-
2, in the case of short-term ratings.
Category 4--100 Percent Risk Weight. (a) All assets not included in
the categories above in section II.C of this appendix A, except the
assets specifically included in the 200 percent category below in
section II.C of this appendix A and assets that are otherwise risk
weighted in accordance with section II.B.5 of this appendix A, are
assigned to this category, which comprises standard risk assets. The
bulk of the assets typically found in a loan portfolio would be
assigned to the 100 percent category.
(b) This category includes:
(1) Long-term claims on, and the portions of long-term claims that
are guaranteed by, non-OECD banks, and all claims on non-OECD central
governments that entail some degree of transfer risk; \33\
---------------------------------------------------------------------------

\33\ Such assets include all non-local currency claims on, and
the portions of claims that are guaranteed by, non-OECD central
governments and those portions of local currency claims on, or
guaranteed by, non-OECD central governments that exceed the local
currency liabilities held by the bank.
---------------------------------------------------------------------------

(2) All claims on foreign and domestic private-sector obligors not
included in the categories above in section II.C of this appendix A
(including loans to nondepository financial institutions and bank
holding companies);
(3) Claims on commercial firms owned by the public sector;
(4) Customer liabilities to the bank on acceptances outstanding
involving standard risk claims; \34\
---------------------------------------------------------------------------

\34\ Customer liabilities on acceptances outstanding involving
nonstandard risk claims, such as claims on U.S. depository
institutions, are assigned to the risk category appropriate to the
identity of the obligor or, if relevant, the nature of the
collateral or guarantees backing the claims. Portions of acceptances
conveyed as risk participations to U.S. depository institutions or
foreign banks are assigned to the 20 percent risk category
appropriate to short-term claims guaranteed by U.S. depository
institutions and foreign banks.
---------------------------------------------------------------------------

(5) Investments in fixed assets, premises, and other real estate
owned;
(6) Common and preferred stock of corporations, including stock
acquired for debts previously contracted;
(7) Commercial and consumer loans (except those assigned to lower
risk categories due to recognized guarantees or collateral and loans
secured by residential property that qualify for a lower risk weight);
(8) Recourse obligations, direct credit substitutes, residual
interests (other than a credit-enhancing interest-only strip) and
asset-or mortgage-backed securities rated in the lowest investment
grade category, e.g., BBB, as well as certain positions (but not
residual interests) which the bank rates pursuant to section section
II.B.5(g) of this appendix A.;
(9) Industrial-development bonds and similar obligations issued
under the auspices of states or political subdivisions of the OECD-
based group of countries for the benefit of a private party or
enterprise where that party or enterprise, not the government entity,
is obligated to pay the principal and interest;
(10) All obligations of states or political subdivisions of
countries that do not belong to the OECD-based group; and
(11) Stripped mortgage-backed securities and similar instruments,
such as interest-only strips that are not credit-enhancing and
principal-only strips.
(c) The following assets also are assigned a risk weight of 100
percent if they have not already been deducted from capital:
investments in unconsolidated companies, joint ventures, or associated
companies; instruments that qualify as capital issued by other banks;
deferred tax assets; and mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card relationships.
Category 5--200 Percent Risk Weight. This category includes:
(a) Externally rated recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing
interest-only strip), and asset- and mortgage-backed securities that
are rated one category below the lowest investment grade category,
e.g., BB, to the extent permitted in section II.B.5(d) of this appendix
A; and
(b) A position (but not a residual interest) in a securitization or
structured finance program that is not rated by an NRSRO for which the
bank determines that the credit risk is equivalent to one category
below investment grade, e.g., BB, to the extent permitted in section
II.B.5.(g) of this appendix A.
* * * * *
D. * * *
The face amount of an off-balance sheet item is generally
incorporated into the risk-weighted assets in two steps. The face
amount is first multiplied by a credit conversion factor, except as
otherwise specified in section II.B.5 of this appendix A for direct
credit substitutes and recourse obligations. The resultant credit
equivalent amount is assigned to the appropriate risk category
according to the obligor or, if relevant, the guarantor or the nature
of the collateral.\35\ Table III to this appendix A sets forth the
conversion factors for various types of off-balance-sheet items.
---------------------------------------------------------------------------

\35\ The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral or the amount of the guarantee in relation to the face
amount of the item, except for derivative contracts, for which this
determination is generally made in relation to the credit equivalent
amount. Collateral and guarantees are subject to the same provisions
noted under section II.B. of this appendix A.
---------------------------------------------------------------------------

1. Items With a 100 Percent Conversion Factor. (a) Except as
otherwise provided in section II.B.5. of this appendix A, the full
amount of an asset or transaction supported, in whole or in part, by a
direct credit substitute or a recourse obligation. Direct credit
substitutes and recourse obligations are defined in section II.B.5. of
this appendix A.

[[Page 59660]]

(b) Sale and repurchase agreements, if not already included on the
balance sheet, and forward agreements. Forward agreements are legally
binding contractual obligations to purchase assets with drawdown which
is certain at a specified future date. Such obligations include forward
purchases, forward forward deposits placed,\36\ and partly-paid shares
and securities; they do not include commitments to make residential
mortgage loans or forward foreign exchange contracts.
---------------------------------------------------------------------------

\36\ Forward forward deposits accepted are treated as interest
rate contracts.
---------------------------------------------------------------------------

(c) Securities lent by a bank are treated in one of two ways,
depending upon whether the lender is exposed to risk of loss. If a
bank, as agent for a customer, lends the customer's securities and does
not indemnify the customer against loss, then the securities
transaction is excluded from the risk-based capital calculation. On the
other hand, if a bank lends its own securities or, acting as agent for
a customer, lends the customer's securities and indemnifies the
customer against loss, the transaction is converted at 100 percent and
assigned to the risk weight category appropriate to the obligor or, if
applicable, to the collateral delivered to the lending bank or the
independent custodian acting on the lending bank's behalf.
* * * * *
III. Minimum Risk-Based Capital Ratio
Subject to section II.B.5. of this appendix A, banks generally will
be expected to meet a minimum ratio of qualifying total capital to
risk-weighted assets of 8 percent, of which at least 4 percentage
points should be in the form of core capital (Tier 1). Any bank that
does not meet the minimum risk-based capital ratio, or whose capital is
otherwise considered inadequate, generally will be expected to develop
and implement a capital plan for achieving an adequate level of
capital, consistent with the provisions of this risk-based capital
framework and Sec. 325.104, the specific circumstances affecting the
individual bank, and the requirements of any related agreements between
the bank and the FDIC.

Table I.--Definition of Qualifying Capital
------------------------------------------------------------------------
Components Minimum requirements
------------------------------------------------------------------------
(1) Core Capital (Tier 1).............. Must equal or exceed 4% of
weighted-risk assets.
(a) Common stockholders' equity.... No limit.\1\
(b)Noncumulative perpetual No limit.\1\
preferred stock and any related
surplus.
(c) Minority interest in equity No limit.\1\
accounts of consolidated.
(d) Less: All intangible assets (\2\).
other than certain mortgage
servicing assets, nonmortgage
servicing assets and purchased
credit card relationships.
(e) Less: Certain credit-enhancing (\3\).
interest-only strips.
(f) Less: Certain deferred tax (\4\).
assets.
(2) Supplementary Capital (Tier 2)..... Total of tier 2 is limited to
100% of tier 1.\5\
(a) Allowance for loan and lease Limited to 1.25% of weighted-
losses. risk assets.\5\
(b) Unrealized gains on certain
equity securities.\6\
Limited to 45% of pretax net unrealized
gains.\6\.
(c) Cumulative perpetual and long- No limit within tier 2; long-
term preferred stock (original term preferred is amortized
maturity of 20 years or more) and for capital purposes as it
any related surplus. approaches maturity.
(d) Auction rate and similar No limit within Tier 2.
preferred stock (both cumulative
and non-cumulative).
(e) Hybrid capital instruments No limit within Tier 2.
(including mandatory convertible
debt securities).
(f) Term subordinated debt and Term subordinated debt and
intermediate-term preferred stock intermediate-term preferred
(original weighted average stock are limited to 50% of
maturity of five years or more). Tier 1 \5\ and amortized for
capital purposes as they
approach maturity.
(3) Deductions (from sum of tier 1 and
tier 2):
(a) Investments in banking and
finance subsidiaries that are not
consolidated for regulatory
capital purposes.
(b) Intentional, reciprocal cross-
holdings of capital securities
issued by banks.
(c) Other deductions (such as On a case-by-case basis or as a
investment in other subsidiaries matter of policy after formal
or joint ventures) as determined consideration of relevant
by supervisory authority. issues.
(4) Total Capital...................... Must equal or exceed 8% or
weighted-risk assets.
------------------------------------------------------------------------
\1\ No express limits are placed on the amounts of nonvoting common,
noncumulative perpetual preferred stock, and minority interests that
may be recognized as part of Tier 1 capital. However, voting common
stockholders' equity capital generally will be expected to be the
dominant form of Tier 1 capital and banks should avoid undue reliance
on other Tier 1 capital elements.
\2\ The amounts of mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships that can be recognized
for purposes of calculating Tier 1 capital are subject to the
limitations set forth in Sec. 325.5(f). All deductions are for
capital purposes only; deductions would not affect accounting
treatment.
\3\ The amounts of credit-enhancing interest-only strips that can be
recognized for purposes of calculating Tier 1 capital are subject to
the limitations set forth in Sec. 325.5(f).
\4\ Deferred tax assets are subject to the capital limitations set forth
in Sec. 325.5(g).
\5\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\6\ Unrealized gains on equity securities are subject to the capital
limitations set forth in paragraph I.A2.(f) of appendix A to part 325.

[[Page 59661]]

* * * * *
Table II.--Summary of Risk Weights and Risk Categories.
* * * * *
Category 2--20 Percent Risk Weight.
* * * * *
(12) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in either of the two highest
investment grade categories, e.g., AAA or AA, in the case of long-term
ratings, or the highest rating category, e.g., A-1, P-1, in the case of
short-term ratings.
Category 3--50 Percent Risk Weight.
* * * * *
(3) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in the third-highest investment
grade category, e.g., A, in the case of long-term ratings, or the
second highest rating category, e.g., A-2, P-2, in the case of short-
term ratings.
* * * * *
Category 4--100 Percent Risk Weight.
* * * * *
(9) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and asset-
or mortgage-backed securities rated in the lowest investment grade
category, e.g., BBB, as well as certain positions (but not residual
interests) which the bank rates pursuant to section II.B.5(g) of this
appendix A.
(10) All other assets, including any intangible assets that are not
deducted from capital, and the credit equivalent amounts \4\ of off-
balance sheet items not assigned to a different risk category.
---------------------------------------------------------------------------

\4\ In general, for each off-balance sheet item, a conversion
factor (see Table III) must be applied to determine the ``credit
equivalent amount'' prior to assigning the off-balance sheet item to
a risk weight category.
---------------------------------------------------------------------------

Category 5--200 Percent Risk Weight.
(1) Externally rated recourse obligations, direct credit
substitutes, residual interests (other than credit-enhancing interest-
only strips), and asset- and mortgage-backed securities that are rated
one category below the lowest investment grade category, e.g., BB, to
the extent permitted in section II.B.5(d) of this appendix A; and
(2) A position (but not a residual interest) extended in connection
with a securitization or structured financing program that is not rated
by an NRSRO for which the bank determines that the credit risk is
equivalent to one category below investment grade, e.g., BB, to the
extent permitted in section II.B.5.(g) of this appendix A.
* * * * *
Table III.--Credit Conversion Factors for Off-Balance Sheet Items.
100 Percent Conversion Factor.
(1) The full amount of assets supported by direct credit
substitutes and recourse obligations (unless a different treatment is
otherwise specified). For risk participations in such arrangements
acquired by the bank, the full amount of assets supported by the main
obligation multiplied by the acquiring bank's percentage share of the
risk participation.
(2) Acquisitions of risk participations in bankers acceptances.
(3) Sale and repurchase agreements, if not already included on the
balance sheet.
* * * * *

7. In appendix B to part 325:
A. Amend section I by changing ``CAMEL'' to ``CAMELS'' in the first
undesignated paragraph and in the second undesignated paragraph by
removing ``by December 31, 1992 (and at least 7.25 percent by December
31, 1990).''
B. Amend section III by removing the second undesignated paragraph.
C. In section IV. paragraph A:
i. Amend the first undesignated paragraph by removing ``in
accordance with Accounting Principles Board Opinion No. 16, as
amended,';
ii. Remove the second undesignated paragraph; and
iii. Amend the new second undesignated paragraph by changing
``Sec. 325(t)'' to ``Sec. 325.2(v).''

By order of the Board of Directors.

Dated at Washington, DC, this 23rd day of October, 2001.

Federal Deposit Insurance Corporation.
James D. LaPierre,
Deputy Executive Secretary.

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Chapter V

Authority and Issuance

For the reasons set out in the preamble, part 567 of chapter V of
title 12 of the Code of Federal Regulations is amended as follows:

PART 567--CAPITAL

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

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

2. Section 567.1 is amended by:
A. Revising the definitions of direct credit substitute and
recourse;
B. Adding definitions of credit derivative, credit-enhancing
interest-only strips, credit-enhancing representations and warranties,
face amount, financial asset, financial standby letter of credit,
nationally recognized statistical rating organization, performance-
based standby letter of credit, residual interest, risk participation,
securitization, servicer cash advance, structured financing program,
and traded position; and
C. Removing the definition of high quality mortgage related
securities to read as follows:

Sec. 567.1 Definitions.

* * * * *
Credit derivative. The term credit derivative means a contract that
allows one party (the protection purchaser) to transfer the credit risk
of an asset or off-balance sheet credit exposure to another party (the
protection provider). The value of a credit derivative is dependent, at
least in part, on the credit performance of a ``referenced asset.''
Credit-enhancing interest-only strip. (1) The term credit-enhancing
interest-only strip means an on-balance sheet asset that, in form or in
substance:
(i) Represents the contractual right to receive some or all of the
interest due on transferred assets; and
(ii) Exposes the savings association to credit risk directly or
indirectly associated with the transferred assets that exceeds its pro
rata share of the savings association's claim on the assets whether
through subordination provisions or other credit enhancement
techniques.
(2) OTS reserves the right to identify other cash flows or related
interests as a credit-enhancing interest-only strip. In determining
whether a particular interest cash flow functions as a credit-enhancing
interest-only strip, OTS will consider the economic substance of the
transaction.
Credit-enhancing representations and warranties. (1) The term
credit-enhancing representations and warranties means representations
and warranties that are made or assumed in connection with a transfer
of assets (including loan servicing assets) and that obligate a savings
association to protect investors from losses arising from credit risk
in the assets transferred or loans serviced.
(2) Credit-enhancing representations and warranties include
promises to protect a party from losses resulting from the default or
nonperformance of

[[Page 59662]]

another party or from an insufficiency in the value of the collateral.
(3) Credit-enhancing representations and warranties do not include:
(i) Early-default clauses and similar warranties that permit the
return of, or premium refund clauses covering, qualifying mortgage
loans for a period not to exceed 120 days from the date of transfer.
These warranties may cover only those loans that were originated within
one year of the date of the transfer;
(ii) Premium refund clauses covering assets guaranteed, in whole or
in part, by the United States government, a United States government
agency, or a United States government-sponsored enterprise, provided
the premium refund clause is for a period not to exceed 120 days from
the date of transfer; or
(iii) Warranties that permit the return of assets in instances of
fraud, misrepresentation or incomplete documentation.
* * * * *
Direct credit substitute. The term direct credit substitute means
an arrangement in which a savings association assumes, in form or in
substance, credit risk associated with an on-or off-balance sheet asset
or exposure that was not previously owned by the savings association
(third-party asset) and the risk assumed by the savings association
exceeds the pro rata share of the savings association's interest in the
third-party asset. If a savings association has no claim on the third-
party asset, then the savings association's assumption of any credit
risk is a direct credit substitute. Direct credit substitutes include:
(1) Financial standby letters of credit that support financial
claims on a third party that exceed a savings association's pro rata
share in the financial claim;
(2) Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims that exceed a savings
association's pro rata share in the financial claim;
(3) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(4) Credit derivative contracts under which the savings association
assumes more than its pro rata share of credit risk on a third-party
asset or exposure;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of a third party;
(6) Purchased loan servicing assets if the servicer is responsible
for credit losses or if the servicer makes or assumes credit-enhancing
representations and warranties with respect to the loans serviced.
Servicer cash advances as defined in this section are not direct credit
substitutes; and
(7) Clean-up calls on third party assets. However, clean-up calls
that are 10 percent or less of the original pool balance and that are
exercisable at the option of the savings association are not direct
credit substitutes.
* * * * *
Face amount. The term face amount means the notational principal,
or face value, amount of an off-balance sheet item or the amortized
cost of an on-balance sheet asset.
Financial asset. The term financial asset means cash or other
monetary instrument, evidence of debt, evidence of an ownership
interest in an entity, or a contract that conveys a right to receive or
exchange cash or another financial instrument from another party.
Financial standby letter of credit. The term financial standby
letter of credit means a letter of credit or similar arrangement that
represents an irrevocable obligation to a third-party beneficiary:
(1) To repay money borrowed by, or advanced to, or for the account
of, a second party (the account party); or
(2) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
* * * * *
Nationally recognized statistical rating organization (NRSRO). The
term nationally recognized statistical rating organization means an
entity recognized by the Division of Market Regulation of the
Securities and Exchange Commission (Commission) as a nationally
recognized statistical rating organization for various purposes,
including the Commission's uniform net capital requirements for brokers
and dealers.
* * * * *
Performance-based standby letter of credit. The term performance-
based standby letter of credit means any letter of credit, or similar
arrangement, however named or described, which represents an
irrevocable obligation to the beneficiary on the part of the issuer to
make payment on account of any default by a third party in the
performance of a nonfinancial or commercial obligation. Such letters of
credit include arrangements backing subcontractors' and suppliers'
performance, labor and materials contracts, and construction bids.
* * * * *
Recourse. The term recourse means a savings association's
retention, in form or in substance, of any credit risk directly or
indirectly associated with an asset it has sold (in accordance with
generally accepted accounting principles) that exceeds a pro rata share
of that savings association's claim on the asset. If a savings
association has no claim on a asset it has sold, then the retention of
any credit risk is recourse. A recourse obligation typically arises
when a savings association transfers assets in a sale and retains an
explicit obligation to repurchase assets or to absorb losses due to a
default on the payment of principal or interest or any other deficiency
in the performance of the underlying obligor or some other party.
Recourse may also exist implicitly if a savings association provides
credit enhancement beyond any contractual obligation to support assets
it has sold. Recourse obligations include:
(1) Credit-enhancing representations and warranties made on
transferred assets;
(2) Loan servicing assets retained pursuant to an agreement under
which the savings association will be responsible for losses associated
with the loans serviced. Servicer cash advances as defined in this
section are not recourse obligations;
(3) Retained subordinated interests that absorb more than their pro
rata share of losses from the underlying assets;
(4) Assets sold under an agreement to repurchase, if the assets are
not already included on the balance sheet;
(5) Loan strips sold without contractual recourse where the
maturity of the transferred portion of the loan is shorter than the
maturity of the commitment under which the loan is drawn;
(6) Credit derivatives issued that absorb more than the savings
association's pro rata share of losses from the transferred assets; and
(7) Clean-up calls on assets the savings association has sold.
However, clean-up calls that are 10 percent or less of the original
pool balance and that are exercisable at the option of the savings
association are not recourse arrangements.
* * * * *
Residual interest. (1) The term residual interest means any on-
balance sheet asset that:
(i) Represents an interest (including a beneficial interest)
created by a transfer that qualifies as a sale (in accordance with
generally accepted accounting principles) of financial assets, whether
through a securitization or otherwise; and

[[Page 59663]]

(ii) Exposes a savings association to credit risk directly or
indirectly associated with the transferred asset that exceeds a pro
rata share of that savings association's claim on the asset, whether
through subordination provisions or other credit enhancement
techniques.
(2) Residual interests generally include credit-enhancing interest-
only strips, spread accounts, cash collateral accounts, retained
subordinated interests (and other forms of overcollateralization), and
similar assets that function as a credit enhancement.
(3) Residual interests further include those exposures that, in
substance, cause the savings association to retain the credit risk of
an asset or exposure that had qualified as a residual interest before
it was sold.
(4) Residual interests generally do not include assets purchased
from a third party. However, a credit-enhancing interest-only strip
that is acquired in any asset transfer is a residual interest.
* * * * *
Risk participation. The term risk participation means a
participation in which the originating party remains liable to the
beneficiary for the full amount of an obligation (e.g., a direct credit
substitute), notwithstanding that another party has acquired a
participation in that obligation.
* * * * *
Securitization. The term securitization means the pooling and
repackaging by a special purpose entity of assets or other credit
exposures that can be sold to investors. Securitization includes
transactions that create stratified credit risk positions whose
performance is dependent upon an underlying pool of credit exposures,
including loans and commitments.
Servicer cash advance. The term servicer cash advance means funds
that a residential mortgage servicer advances to ensure an
uninterrupted flow of payments, including advances made to cover
foreclosure costs or other expenses to facilitate the timely collection
of the loan. A servicer cash advance is not a recourse obligation or a
direct credit substitute if:
(1) The servicer is entitled to full reimbursement and this right
is not subordinated to other claims on the cash flows from the
underlying asset pool; or
(2) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an insignificant
amount of the outstanding principal amount on that loan.
* * * * *
Structured financing program. The term structured financing program
means a program where receivable interests and asset-or mortgage-backed
securities issued by multiple participants are purchased by a special
purpose entity that repackages those exposures into securities that can
be sold to investors. Structured financing programs allocate credit
risk, generally, between the participants and credit enhancement
provided to the program.
* * * * *
Traded position. The term traded position means a position
retained, assumed, or issued in connection with a securitization that
is rated by a NRSRO, where there is a reasonable expectation that, in
the near future, the rating will be relied upon by:
(1) Unaffiliated investors to purchase the security; or
(2) An unaffiliated third party to enter into a transaction
involving the position, such as a purchase, loan, or repurchase
agreement.
* * * * *

3. Section 567.2 is amended by revising paragraph (a)(1)(i) to read
as follows:

Sec. 567.2 Minimum regulatory capital requirement.

(a) * * *
(1) Risk-based capital requirement. (i) A savings association's
minimum risk-based capital requirement shall be an amount equal to 8%
of its risk-weighted assets as measured under Sec. 567.6 of this part.
* * * * *

4. Amend Sec. 567.5 by adding a new paragraph (a)(2)(iii) to read
as follows:

Sec. 567.5 Components of capital.

(a) * * *
(2) * * *
(iii) Credit-enhancing interest-only strips that are not includable
in core capital under Sec. 567.12 of this part are deducted from assets
and capital in computing core capital.
* * * * *

5. Section 567.6 is amended by:
A. Revising paragraph (a) introductory text;
B. Revising paragraph (a)(1) introductory text and paragraphs
(a)(1)(ii)(R), (a)(1)(iii)(C), (a)(1)(iv)(J), and (a)(1)(iv)(M);
C. Removing and reserving paragraphs (a)(1)(ii)(H) and
(a)(1)(iv)(N);
D. Revising paragraph (a)(2) introductory text;
E. Removing and reserving paragraphs (a)(2)(i)(A) and (C);
F. Revising paragraph (a)(2)(i)(B);
G. Revising paragraph (a)(2)(ii)(A);
H. Removing paragraph (a)(3); and
I. Adding paragraph (b) to read as follows:

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

(a) Risk-weighted assets. Risk-weighted assets equal risk-weighted
on-balance sheet assets (computed under paragraph (a)(1) of this
section), plus risk-weighted off-balance sheet activities (computed
under paragraph (a)(2) of this section), plus risk-weighted recourse
obligations, direct credit substitutes, and certain other positions
(computed under paragraph (b) of this section). Assets not included
(i.e., deducted from capital) for purposes of calculating capital under
Sec. 567.5 are not included in calculating risk-weighted assets.
(1) On-balance sheet assets. Except as provided in paragraph (b) of
this section, risk-weighted on-balance sheet assets are computed by
multiplying the on-balance sheet asset amounts times the appropriate
risk-weight categories. The risk-weight categories are:
* * * * *
(ii) * * *
(R) Claims on, or guaranteed by depository institutions other than
the central bank, incorporated in a non-OECD country, with a remaining
maturity of one year or less;
* * * * *
(iii) * * *
(C) Privately-issued mortgage-backed securities (i.e., those that
do not carry the guarantee of a government or government sponsored
entity) representing an interest in qualifying mortgage loans or
qualifying multifamily mortgage loans. If the security is backed by
qualifying multifamily mortgage loans, the savings association must
receive timely payments of principal and interest in accordance with
the terms of the security. Payments will generally be considered timely
if they are not 30 days past due;
* * * * *
(iv) * * *
(J) Debt securities not otherwise described in this section;
* * * * *
(M) Interest-only strips receivable, other than credit-enhancing
interest-only strips;
* * * * *
(2) Off-balance sheet items. Except as provided in paragraph (b) of
this section, risk-weighted off-balance sheet items are determined by
the following two-step process. First, the face amount of the off-
balance sheet item must be multiplied by the appropriate credit
conversion factor listed in this paragraph (a)(2). This calculation
translates the face amount of an off-balance sheet exposure into an on-

[[Page 59664]]

balance sheet credit-equivalent amount. Second, the credit-equivalent
amount must be assigned to the appropriate risk-weight category using
the criteria regarding obligors, guarantors, and collateral listed in
paragraph (a)(1) of this section, provided that the maximum risk weight
assigned to the credit-equivalent amount of an interest-rate or
exchange-rate contract is 50 percent. The following are the credit
conversion factors and the off-balance sheet items to which they apply.
(i) * * *
(B) Risk participations purchased in bankers' acceptances;
* * * * *
(ii) * * *
(A) Transaction-related contingencies, including, among other
things, performance bonds and performance-based standby letters of
credit related to a particular transaction;
* * * * *
(b) Recourse obligations, direct credit substitutes, and certain
other positions. (1) In general. Except as otherwise permitted in this
paragraph (b), to determine the risk-weighted asset amount for a
recourse obligation or a direct credit substitute (but not a residual
interest):
(i) Multiply the full amount of the credit-enhanced assets for
which the savings association directly or indirectly retains or assumes
credit risk by a 100 percent conversion factor. (For a direct credit
substitute that is an on-balance sheet asset (e.g., a purchased
subordinated security), a savings association must use the amount of
the direct credit substitute and the full amount of the asset its
supports, i.e., all the more senior positions in the structure); and
(ii) Assign this credit equivalent amount to the risk-weight
category appropriate to the obligor in the underlying transaction,
after considering any associated guarantees or collateral. Paragraph
(a)(1) of this section lists the risk-weight categories.
(2) Residual interests. Except as otherwise permitted under this
paragraph (b), a savings association must maintain risk-based capital
for residual interests as follows:
(i) Credit-enhancing interest-only strips. After applying the
concentration limit under Sec. 567.12(e)(2) of this part, a saving
association must maintain risk-based capital for a credit-enhancing
interest-only strip equal to the remaining amount of the strip (net of
any existing associated deferred tax liability), even if the amount of
risk-based capital that must be maintained exceeds the full risk-based
capital requirement for the assets transferred. Transactions that, in
substance, result in the retention of credit risk associated with a
transferred credit-enhancing interest-only strip are treated as if the
strip was retained by the savings association and was not transferred.
(ii) Other residual interests. A saving association must maintain
risk-based capital for a residual interest (excluding a credit-
enhancing interest-only strip) equal to the face amount of the residual
interest (net of any existing associated deferred tax liability), even
if the amount of risk-based capital that must be maintained exceeds the
full risk-based capital requirement for the assets transferred.
Transactions that, in substance, result in the retention of credit risk
associated with a transferred residual interest are treated as if the
residual interest was retained by the savings association and was not
transferred.
(iii) Residual interests and other recourse obligations. Where a
savings association holds a residual interest (including a credit-
enhancing interest-only strip) and another recourse obligation in
connection with the same transfer of assets, the savings association
must maintain risk-based capital equal to the greater of:
(A) The risk-based capital requirement for the residual interest as
calculated under paragraph (b)(2)(i) through (ii) of this section; or
(B) The full risk-based capital requirement for the assets
transferred, subject to the low-level recourse rules under paragraph
(b)(7) of this section.
(3) Ratings-based approach--(i) Calculation. A savings association
may calculate the risk-weighted asset amount for an eligible position
described in paragraph (b)(3)(ii) of this section by multiplying the
face amount of the position by the appropriate risk weight determined
in accordance with Table A or B of this section.

Note: Stripped mortgage-backed securities or other similar
instruments, such as interest-only and principal-only strips, that
are not credit enhancing must be assigned to the 100% risk-weight
category.

Table A
------------------------------------------------------------------------
Risk weight
Long term rating category (In
percent)
------------------------------------------------------------------------
Highest or second highest investment grade................. 20
Third highest investment grade............................. 50
Lowest investment grade.................................... 100
One category below investment grade........................ 200
------------------------------------------------------------------------

Table B
------------------------------------------------------------------------
Risk weight
Short term rating category (In
percent)
------------------------------------------------------------------------
Highest investment grade................................... 20
Second highest investment grade............................ 50
Lowest investment grade.................................... 100
------------------------------------------------------------------------

(ii) Eligibility. (A) Traded positions. A position is eligible for
the treatment described in paragraph (b)(3)(i) of this section, if:
(1) The position is a recourse obligation, direct credit
substitute, residual interest, or asset- or mortgage-backed security
and is not a credit-enhancing interest-only strip;
(2) The position is a traded position; and
(3) The NRSRO has rated a long term position as one grade below
investment grade or better or a short term position as investment
grade. If two or more NRSROs assign ratings to a traded position, the
savings association must use the lowest rating to determine the
appropriate risk-weight category under paragraph (b)(3)(i) of this
section.
(B) Non-traded positions. A position that is not traded is eligible
for the treatment described in paragraph (b)(3)(i) of this section if:
(1) The position is a recourse obligation, direct credit
substitute, residual interest, or asset- or mortgage-backed security
extended in connection with a securitization and is not a credit-
enhancing interest-only strip;
(2) More than one NRSRO rate the position;
(3) All of the NRSROs that provide a rating rate a long term
position as one grade below investment grade or better or a short term
position as investment grade. If the NRSROs assign different ratings to
the position, the savings association must use the lowest rating to
determine the appropriate risk-weight category under paragraph
(b)(3)(i) of this section;
(4) The NRSROs base their ratings on the same criteria that they
use to rate securities that are traded positions; and
(5) The ratings are publicly available.
(C) Unrated senior positions. If a recourse obligation, direct
credit substitute, residual interest, or asset- or mortgage-backed
security is not rated by an NRSRO, but is senior or preferred in all
features to a traded position (including collateralization and
maturity), the savings association may risk-weight the face amount of
the senior position under paragraph (b)(3)(i) of this section, based on
the rating of the traded position, subject to supervisory guidance. The
savings association must

[[Page 59665]]

satisfy OTS that this treatment is appropriate. This paragraph
(b)(3)(i)(C) applies only if the traded position provides substantive
credit support to the unrated position until the unrated position
matures.
(4) Certain positions that are not rated by NRSROs. (i)
Calculation. A savings association may calculate the risk-weighted
asset amount for eligible position described in paragraph (b)(4)(ii) of
this section based on the savings association's determination of the
credit rating of the position. To risk-weight the asset, the savings
association must multiply the face amount of the position by the
appropriate risk weight determined in accordance with Table C of this
section.

Table C
------------------------------------------------------------------------
Risk weight
Rating category (In
percent)
------------------------------------------------------------------------
Investment grade........................................... 100
One category below investment grade........................ 200
------------------------------------------------------------------------

(ii) Eligibility. A position extended in connection with a
securitization is eligible for the treatment described in paragraph
(b)(4)(i) of this section if it is not rated by an NRSRO, is not a
residual interest, and meets the one of the three alternative standards
described in paragraph (b)(4)(ii)(A), (B), or (C) below of this
section:
(A) Position rated internally. A direct credit substitute, but not
a purchased credit-enhancing interest-only strip, is eligible for the
treatment described under paragraph (b)(4)(i) of this section, if the
position is assumed in connection with an asset-backed commercial paper
program sponsored by the savings association. Before it may rely on an
internal credit risk rating system, the saving association must
demonstrate to OTS's satisfaction that the system is adequate. Adequate
internal credit risk rating systems typically:
(1) Are an integral part of the savings association's risk
management system that explicitly incorporates the full range of risks
arising from the savings association's participation in securitization
activities;
(2) Link internal credit ratings to measurable outcomes, such as
the probability that the position will experience any loss, the
expected loss on the position in the event of default, and the degree
of variance in losses in the event of default on that position;
(3) Separately consider the risk associated with the underlying
loans or borrowers, and the risk associated with the structure of the
particular securitization transaction;
(4) Identify gradations of risk among ``pass'' assets and other
risk positions;
(5) Use clear, explicit criteria to classify assets into each
internal rating grade, including subjective factors;
(6) Employ independent credit risk management or loan review
personnel to assign or review the credit risk ratings;
(7) Include an internal audit procedure to periodically verify that
internal risk ratings are assigned in accordance with the savings
association's established criteria;
(8) Monitor the performance of the assigned internal credit risk
ratings over time to determine the appropriateness of the initial
credit risk rating assignment, and adjust individual credit risk
ratings or the overall internal credit risk rating system, as needed;
and
(9) Make credit risk rating assumptions that are consistent with,
or more conservative than, the credit risk rating assumptions and
methodologies of NRSROs.
(B) Program ratings. (1) A recourse obligation or direct credit
substitute, but not a residual interest, is eligible for the treatment
described in paragraph (b)(4)(i) of this section, if the position is
retained or assumed in connection with a structured finance program and
an NRSRO has reviewed the terms of the program and stated a rating for
positions associated with the program. If the program has options for
different combinations of assets, standards, internal or external
credit enhancements and other relevant factors, and the NRSRO specifies
ranges of rating categories to them, the savings association may apply
the rating category applicable to the option that corresponds to the
savings association's position.
(2) To rely on a program rating, the savings association must
demonstrate to OTS's satisfaction that that the credit risk rating
assigned to the program meets the same standards generally used by
NRSROs for rating traded positions. The savings association must also
demonstrate to OTS's satisfaction that the criteria underlying the
assignments for the program are satisfied by the particular position.
(3) If a savings association participates in a securitization
sponsored by another party, OTS may authorize the savings association
to use this approach based on a program rating obtained by the sponsor
of the program.
(C) Computer program. A recourse obligation or direct credit
substitute, but not a residual interest, is eligible for the treatment
described in paragraph (b)(4)(i) of this section, if the position is
extended in connection with a structured financing program and the
savings association uses an acceptable credit assessment computer
program to determine the rating of the position. An NRSRO must have
developed the computer program and the savings association must
demonstrate to OTS's satisfaction that the ratings under the program
correspond credibly and reliably with the rating of traded positions.
(5) Alternative capital computation for small business
obligations--(i) Definitions. For the purposes of this paragraph
(b)(5):
(A) Qualified savings association means a savings association that:
(1) Is well capitalized as defined in Sec. 565.4 of this chapter
without applying the capital treatment described in this paragraph
(b)(5); or
(2) Is adequately capitalized as defined in Sec. 565.4 of this
chapter without applying the capital treatment described in this
paragraph (b)(5) and has received written permission from the OTS to
apply that capital treatment.
(B) Small business means a business that meets the criteria for a
small business concern established by the Small Business Administration
in 13 CFR 121 pursuant to 15 U.S.C. 632.
(ii) Capital requirement. Notwithstanding any other provision of
this paragraph (b), with respect to a transfer of a small business loan
or lease of personal property with recourse that is a sale under
generally accepted accounting principles, a qualified savings
association may elect to include only the amount of its recourse in its
risk-weighted assets. To qualify for this election, the savings
association must establish and maintain a reserve under generally
accepted accounting principles sufficient to meet the reasonable
estimated liability of the savings association under the recourse
obligation.
(iii) Aggregate amount of recourse. The total outstanding amount of
recourse retained by a qualified savings association with respect to
transfers of small business loans and leases of personal property and
included in the risk-weighted assets of the savings association as
described in paragraph (b)(5)(ii) of this section, may not exceed 15
percent of the association's total capital computed under
Sec. 567.5(c).
(iv) Savings association that ceases to be a qualified savings
association or that exceeds aggregate limits. If a savings association
ceases to be a qualified savings association or exceeds the aggregate
limit described in paragraph (b)(5)(iii) of this section, the savings
association may continue to apply the capital treatment described in

[[Page 59666]]

paragraph (b)(5)(ii) of this section to transfers of small business
loans and leases of personal property that occurred when the
association was a qualified savings association and did not exceed the
limit.
(v) Prompt corrective action not affected. (A) A savings
association shall compute its capital without regard to this paragraph
(b)(5) of this section for purposes of prompt corrective action (12
U.S.C. 1831o), unless the savings association is adequately or well
capitalized without applying the capital treatment described in this
paragraph (b)(5) and would be well capitalized after applying that
capital treatment.
(B) A savings association shall compute its capital requirement
without regard to this paragraph (b)(5) for the purposes of applying 12
U.S.C. 1381o(g), regardless of the association's capital level.
(6) Risk participations and syndications of direct credit
substitutes. A savings association must calculate the risk-weighted
asset amount for a risk participation in, or syndication of, a direct
credit substitute as follows:
(i) If a savings association conveys a risk participation in a
direct credit substitute, the savings association must convert the full
amount of the assets that are supported by the direct credit substitute
to a credit equivalent amount using a 100 percent conversion factor.
The savings association must assign the pro rata share of the credit
equivalent amount that was conveyed through the risk participation to
the lower of: The risk-weight category appropriate to the obligor in
the underlying transaction, after considering any associated guarantees
or collateral; or the risk-weight category appropriate to the party
acquiring the participation. The savings association must assign the
pro rata share of the credit equivalent amount that was not
participated out to the risk-weight category appropriate to the
obligor, after considering any associated guarantees or collateral.
(ii) If a savings association acquires a risk participation in a
direct credit substitute, the savings association must multiply its pro
rata share of the direct credit substitute by the full amount of the
assets that are supported by the direct credit substitute, and convert
this amount to a credit equivalent amount using a 100 percent
conversion factor. The savings association must assign the resulting
credit equivalent amount to the risk-weight category appropriate to the
obligor in the underlying transaction, after considering any associated
guarantees or collateral.
(iii) If the savings association holds a direct credit substitute
in the form of a syndication where each savings association or other
participant is obligated only for its pro rata share of the risk and
there is no recourse to the originating party, the savings association
must calculate the credit equivalent amount by multiplying only its pro
rata share of the assets supported by the direct credit substitute by a
100 percent conversion factor. The savings association must assign the
resulting credit equivalent amount to the risk-weight category
appropriate to the obligor in the underlying transaction after
considering any associated guarantees or collateral.
(7) Limitations on risk-based capital requirements--(i) Low-level
exposure rule. If the maximum contractual exposure to loss retained or
assumed by a savings association is less than the effective risk-based
capital requirement, as determined in accordance with this paragraph
(b), for the assets supported by the savings association's position,
the risk-based capital requirement is limited to the savings
association's contractual exposure less any recourse liability account
established in accordance with generally accepted accounting
principles. This limitation does not apply when a savings association
provides credit enhancement beyond any contractual obligation to
support assets it has sold.
(ii) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a savings association holds a
mortgage-related security or a participation certificate as a result of
a mortgage loan swap with recourse, it must hold risk-based capital to
support the recourse obligation and that percentage of the mortgage-
related security or participation certificate that is not covered by
the recourse obligation. The total amount of risk-based capital
required for the security (or certificate) and the recourse obligation
is limited to the risk-based capital requirement for the underlying
loans, calculated as if the savings association continued to hold these
loans as an on-balance sheet asset.
(iii) Related on-balance sheet assets. If an asset is included in
the calculation of the risk-based capital requirement under this
paragraph (b) and also appears as an asset on the savings association's
balance sheet, the savings association must risk-weight the asset only
under this paragraph (b), except in the case of loan servicing assets
and similar arrangements with embedded recourse obligations or direct
credit substitutes. In that case, the savings association must
separately risk-weight the on-balance sheet servicing asset and the
related recourse obligations and direct credit substitutes under this
section, and incorporate these amounts into the risk-based capital
calculation.
(8) Obligations of subsidiaries. If a savings association retains a
recourse obligation or assumes a direct credit substitute on the
obligation of a subsidiary that is not an includable subsidiary, and
the recourse obligation or direct credit substitute is an equity or
debt investment in that subsidiary under generally accepted accounting
principles, the face amount of the recourse obligation or direct credit
substitute is deducted for capital under Secs. 567.5(a)(2) and
567.9(c). All other recourse obligations and direct credit substitutes
retained or assumed by a savings association on the obligations of an
entity in which the savings association has an equity investment are
risk-weighted in accordance with this paragraph (b).

6. Amend Sec. 567.9 by revising paragraph (c)(1) to read as
follows:

Sec. 567.9 Tangible capital.

* * * * *
(c) * * *
(1) Intangible assets (as defined in Sec. 567.1), servicing assets,
and credit-enhancing interest-only strips not includable in tangible
capital under Sec. 567.12.
* * * * *

7. Section 567.11 is amended by redesignating paragraph (c) as
paragraph (c)(1) and adding new paragraphs (c)(2) and (3) to read as
follows:

Sec. 567.11 Reservation of authority.

* * * * *
(c) * * *
(2) Notwithstanding Sec. 567.6 of this part, OTS will look to the
substance of a transaction and may find that the assigned risk weight
for any asset, or credit equivalent amount or credit conversion factor
for any off-balance sheet item does not appropriately reflect the risks
imposed on the savings association. OTS may require the savings
association to apply another risk-weight, credit equivalent amount, or
credit conversion factor that OTS deems appropriate.
(3) If this part does not specifically assign a risk weight, credit
equivalent amount, or credit conversion factor, OTS may assign any risk
weight, credit equivalent amount, or credit conversion factor that it
deems appropriate. In making this determination, OTS will consider the
risks associated with the asset or off-balance sheet item as well as
other relevant factors.

8. Section 567.12 is amended by:
A. Revising the section heading;

[[Page 59667]]

B. Revising paragraph (a);
C. Adding a new paragraph (b)(4), and
D. Revising paragraph (e) to read as follows:

Sec. 567.12 Intangible assets, servicing assets, and credit-enhancing
interest-only strips.

(a) Scope. This section prescribes the maximum amount of intangible
assets, servicing assets, and credit-enhancing interest-only strips
that savings associations may include in calculating tangible and core
capital.
(b) * * *
(4) Credit-enhancing interest-only strips may be included (that is
not deducted) in computing core capital subject to the restrictions of
this section, and may be included in tangible capital in the same
amount.
* * * * *
(e) Core capital limitations. (1) Servicing assets and purchased
credit card relationships. (i) The maximum aggregate amount of
servicing assets and purchased credit card relationships that may be
included in core capital is limited to the lesser of:
(A) 100 percent of the amount of core capital; or
(B) The amount of servicing assets and purchased credit card
relationships determined in accordance with paragraph (d) of this
section.
(ii) In addition to the aggregate limitation in paragraph (e)(1)(i)
of this section, a sublimit applies to purchased credit card
relationships and non mortgage-related serving assets. The maximum
allowable amount of these two types of assets combined is limited to
the lesser of:
(A) 25 percent the amount of core capital; and
(B) The amount of purchased credit card relationships and non
mortgage-related servicing assets determined in accordance with
paragraph (d) of this section.
(2) Credit-enhancing interest-only strips. The maximum aggregate
amount of credit-enhancing interest-only strips that may be included in
core capital is limited to 25 percent of the amount of core capital.
Purchased and retained credit-enhancing interest-only strips, on a non-
tax adjusted basis, are included in the total amount that is used for
purposes of determining whether a savings association exceeds the core
capital limit.
(3) Computation. (i) For purposes of computing the limits and
sublimit in this paragraph (e), core capital is computed before the
deduction of disallowed servicing assets, disallowed credit card
relationships, and disallowed credit-enhancing interest-only strips.
(ii) A savings association may elect to deduct disallowed servicing
assets and credit-enhancing interest-only strips on a basis that is net
of any associated deferred tax liability.

Dated: October 25, 2001.
Ellen Seidman,
Director, Office of Thrift Supervision.
[FR Doc. 01-29179 Filed 11-28-01; 8:45 am]
BILLING CODES 4810-33-P, 6210-01-P, 6714-01-P 6720-01-P

Last Updated 11/29/2001 regs@fdic.gov