[Federal Register: March 8, 2000 (Volume 65, Number 46)]
[Proposed Rules]
[Page 12319-12352]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr08mr00-37]
[[Page 12319]]
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Part II
Department of the Treasury
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Office of the Comptroller of the Currency
Office of Thrift Supervision
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Federal Reserve System
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Federal Deposit Insurance Corporation
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12 CFR Parts 3, 208, 225, 325 and 567
Risk-Based Capital Standards; Recourse and Direct Credit Substitutes;
Proposed Rule
[[Page 12320]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 00-06]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1055]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB31
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[Docket No. 2000-15]
RIN 1550-AB11
Risk-Based Capital Standards; Recourse and Direct Credit
Substitutes
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance
Corporation; and Office of Thrift Supervision, Treasury.
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board
of Governors of the Federal Reserve System (Board), the Federal Deposit
Insurance Corporation (FDIC), and the Office of Thrift Supervision
(OTS) (collectively, the agencies) are proposing changes to their risk-
based capital standards to address the regulatory capital treatment of
recourse obligations and direct credit substitutes that expose banks,
bank holding companies, and thrifts (collectively, banking
organizations) to credit risk. The proposal treats recourse obligations
and direct credit substitutes more consistently than under the
agencies' current risk-based capital standards. In addition, the
agencies would use credit ratings and certain alternative approaches to
match the risk-based capital requirement more closely to a banking
organization's relative risk of loss in asset securitizations. The
proposal also requires the sponsor of a revolving credit securitization
that involves an early amortization feature to hold capital against the
amount of assets under management, i.e. the off-balance sheet
securitized receivables.
This proposal is intended to result in more consistent treatment of
recourse obligations and similar transactions among the agencies, more
consistent risk-based capital treatment for certain types of
transactions involving similar risk, and capital requirements that more
closely reflect a banking organization's relative exposure to credit
risk.
DATES: Your comments must be received by June 7, 2000.
ADDRESSES: Comments should be directed to:
OCC: You may send comments electronically to regs.comments@
occ.treas.gov or by mail to Docket No. 00-06, Communications Division,
Third Floor, Office of the Comptroller of the Currency, 250 E Street,
SW, Washington, DC 20219. In addition, you may send comments by
facsimile transmission to (202) 874-5274. You can inspect and photocopy
comments at that address.
Board: Comments, which should refer to Docket No. R-1055, may be
mailed to Jennifer J. Johnson, Secretary, Board of Governors of the
Federal Reserve System, 20th Street and Constitution Avenue, NW,
Washington, DC 20551. Comments may also be delivered to Room B-2222 of
the Eccles Building between 8:45 a.m. and 5:15 p.m. weekdays, or to the
guard station in the Eccles Building courtyard on 20th Street between
Constitution Avenue and C Street, NW, at any time. Comments may be
inspected in Room MP-500 of the Martin Building between 9 a.m. and 5
p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's Rules
Regarding Availability of Information.
FDIC: Written comments should be addressed to Robert E. Feldman,
Executive Secretary, Attention: Comments/OES, Federal Deposit Insurance
Corporation, 550 17th Street, NW, Washington, DC 20429. Comments may be
hand delivered to the guard station at the rear of the 550 17th Street
Building (located on F Street), on business days between 7 a.m. and 5
p.m. (Fax number: (202) 898-3838; Internet address: comments@fdic.gov).
Comments may be inspected and photocopied in the FDIC Public
Information Center, Room 100, 801 17th Street, NW, Washington, DC,
between 9 a.m. and 4:30 p.m. on business days.
OTS: Send comments to Manager, Dissemination Branch, Records
Management and Information Policy, Office of Thrift Supervision, 1700 G
Street, NW, Washington, DC 20552, Attention Docket No. 2000-15. These
submissions may be hand-delivered to 1700 G Street, NW, from 9 a.m. to
5 p.m. on business days or may be sent by facsimile transmission to FAX
number (202) 906-7755; or by e-mail: public.info@ots.treas.gov. Those
commenting by e-mail should include their name and telephone number.
Comments will be available for inspection at 1700 G Street, NW, from 9
to 4 p.m. on business days.
FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic
Advisor or Amrit Sekhon, Risk Specialist, Capital Policy Division,
(202) 874-5070; Laura Goldman, Senior Attorney, Legislative and
Regulatory Activities Division, (202) 874-5090, Office of the
Comptroller of the Currency, 250 E Street, SW, Washington, DC 20219.
Board: Thomas R. Boemio, Senior Supervisory Financial Analyst,
(202) 452-2982, or Norah Barger, Assistant Director (202) 452-2402,
Division of Banking Supervision and Regulation. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Diane
Jenkins, (202) 452-3544, Board of Governors of the Federal Reserve
System, 20th Street and Constitution Avenue, NW, Washington, DC 20551.
FDIC: Robert F. Storch, Chief, Accounting Section, Division of
Supervision, (202) 898-8906; or Jamey Basham, Counsel, Legal Division,
(202) 898-7265, Federal Deposit Insurance Corporation, 550 17th Street,
NW, Washington, DC 20429.
OTS: Michael D. Solomon, Senior Program Manager for Capital Policy,
Supervision Policy, (202) 906-5654; or Karen Osterloh, Assistant Chief
Counsel (202) 906-6639, Office of Thrift Supervision, 1700 G Street,
NW, Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
I. Introduction
The agencies are proposing to amend their risk-based capital
standards to change the treatment of certain recourse obligations,
direct credit substitutes, and securitized transactions that expose
banking organizations to credit risk. This proposal amends the
agencies' risk-based capital standards to align more closely the risk-
based capital treatment of recourse obligations and direct credit
substitutes and to vary the capital requirements for positions in
securitized transactions (and certain other credit exposures) according
to their relative risk. The proposal also requires the sponsor of a
revolving credit securitization that involves an early amortization
feature to hold capital
[[Page 12321]]
against the amount of assets under management in that securitization.
This proposal builds on the agencies' earlier work with respect to
the appropriate risk-based capital treatment for recourse obligations
and direct credit substitutes. On May 25, 1994, the agencies published
in the Federal Register a proposal to reduce the capital requirement
for banks for low-level recourse transactions, to treat first-loss (but
not second-loss) direct credit substitutes like recourse, and to
implement definitions of ``recourse,'' ``direct credit substitute,''
and related terms. 59 FR 27116 (May 25, 1994) (the 1994 Notice). The
1994 Notice also contained, in an advance notice of proposed
rulemaking, a proposal to use credit ratings to determine the capital
treatment of certain recourse obligations and direct credit
substitutes. The OCC, the Board, and the FDIC subsequently implemented
the capital reduction for low-level recourse transactions, thereby
satisfying the requirements of section 350 of the Riegle Community
Development and Regulatory Improvement Act, Public Law 103-325, sec.
350, 108 Stat. 2160, 2242 (1994) (CDRI Act).\1\ The OTS risk-based
capital regulation already included the low-level recourse treatment
required by the statute.\2\ The agencies did not issue a final
regulation on the remaining elements of the 1994 Notice.
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\1\ See 60 FR 17986 (April 10, 1995) (OCC); 60 FR 8177 (February
13, 1995) (Board); 60 FR 15858 (March 28, 1995) (FDIC).
\2\ See 60 FR 45618 (August 31, 1995.)
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On November 5, 1997, the agencies published another notice of
proposed rulemaking. 62 FR 59943 (1997 Proposal). In the 1997 Proposal,
the agencies proposed to use credit ratings from nationally recognized
statistical rating organizations to determine the capital requirement
for recourse obligations, direct credit substitutes, and senior asset-
backed securities. Additionally, the 1997 Proposal requested comment on
a series of options and alternatives to supplement or replace the
ratings-based approach.
In June 1999, the Basel Committee on Banking Supervision issued a
consultative paper, ``A New Capital Adequacy Framework, that sets forth
possible revisions to the 1988 Basel Accord.\3\ The Basel consultative
paper discusses potential modifications to the current capital
standards, including the capital treatment of securitizations. The
suggested changes in the Basel consultative paper move in the same
direction as this proposal by looking to external credit ratings issued
by qualifying external credit assessment institutions as a basis for
determining the credit quality and the resulting capital treatment of
securitizations.
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\3\ International Convergence of Capital Measurement and Capital
Standards (July 1988).
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II. Background
A. Asset Securitization
Asset securitization is the process by which loans or other credit
exposures are pooled and reconstituted into securities, with one or
more classes or positions, that may then be sold. Securitization \4\
provides an efficient mechanism for banking organizations to buy and
sell loan assets or credit exposures and thereby to make them more
liquid.
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\4\ For purposes of this discussion, references to
``securitization'' also include structured finance transactions or
programs that generally create stratified credit risk positions,
which may or may not be in the form of a security, whose performance
is dependent upon a pool of loans or other credit exposures.
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Securitizations typically carve up the risk of credit losses from
the underlying assets and distribute it to different parties. The
``first dollar,'' or subordinate, loss position is first to absorb
credit losses; the most ``senior'' investor position is last; and there
may be one or more loss positions in between (``second dollar'' loss
positions). Each loss position functions as a credit enhancement for
the more senior loss positions in the structure.
For residential mortgages sold through certain Federally-sponsored
mortgage programs, a Federal government agency or Federal government
sponsored enterprise (GSE) guarantees the securities sold to investors.
However, many of today's asset securitization programs involve
nonmortgage assets or are not Federally supported in any way. Sellers
of these privately securitized assets therefore often provide other
forms of credit enhancement--first and second dollar loss positions--to
reduce investors' risk of credit loss.
A seller may provide this credit enhancement itself through
recourse arrangements. As defined in this proposal, ``recourse'' refers
to the risk of credit loss that a banking organization retains in
connection with the transfer of its assets. Banking organizations have
long provided recourse in connection with sales of whole loans or loan
participations; today, recourse arrangements frequently are associated
with asset securitization programs.
A seller may also arrange for a third party to provide credit
enhancement \5\ in an asset securitization. If the third-party
enhancement is provided by another banking organization, that
organization assumes some portion of the assets' credit risk. In this
proposal, all forms of third-party enhancements, i.e., all arrangements
in which a banking organization assumes risk of credit loss from third-
party assets or other claims that it has not transferred, are referred
to as ``direct credit substitutes.'' The economic substance of a
banking organization's risk of credit loss from providing a direct
credit substitute can be identical to its risk of credit loss from
transferring an asset with recourse.
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\5\ As used in this proposal, the terms ``credit enhancement''
and ``enhancement'' refer to both recourse arrangements and direct
credit substitutes.
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Depending on the type of securitization transaction, the sponsor of
a securitization may provide a portion of the total credit enhancement
internally, as part of the securitization structure, through the use of
spread accounts, overcollateralization, retained subordinated
interests, or other similar forms of on-balance sheet assets. When
these or other types of internal enhancements are provided, the
enhancements are considered a form of recourse for risk-based capital
purposes. Many asset securitizations use a combination of internal
enhancement, recourse, and third-party enhancement to protect investors
from risk of credit loss.
B. Risk Management of Exposures Arising From Securitization Activities
While asset securitization can enhance both credit availability and
a banking organization's profitability, managing the risks associated
with this activity can pose significant challenges. This is because the
risks involved, while not new to banking organizations, may be less
obvious and more complex than the risks of traditional lending.
Specifically, securitization can involve credit, liquidity,
operational, legal, and reputational risks in concentrations and forms
that may not be fully recognized by management or adequately
incorporated into a banking organization's risk management systems.
The risk-based capital treatment described in this proposal
provides one important way of addressing the credit risk presented by
securitization activities, but a banking organization's compliance with
capital standards should be complemented by effective risk management
strategies. The agencies expect that banking organizations will
identify, measure, monitor and control the risks of their
securitization activities (including
[[Page 12322]]
synthetic securitizations \6\ using credit derivatives) and explicitly
incorporate the full range of risks into their risk management systems.
Management is responsible for having adequate policies and procedures
in place to ensure that the economic substance of their risks is fully
recognized and appropriately managed. Banking organizations should be
able to measure and manage their risk exposure from risk positions in
the securitizations, either retained or acquired, and should be able to
assess the credit quality of the retained residual portfolio after the
transfer of assets in a securitization transaction. The formality and
sophistication with which the risks of these activities are
incorporated into a banking organization's risk management system
should be commensurate with the nature and volume of its securitization
activities. Banking organizations with significant securitization
activities, no matter what the size of their on-balance sheet assets,
are expected to have more elaborate and formal approaches to manage the
risks. Failure to understand the risks inherent in securitization
activities and to incorporate them into risk management systems and
internal capital allocations may constitute an unsafe or unsound
banking practice.
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\6\ ``Synthetic securitization'' refers to the bundling of
credit risk associated with on-balance sheet assets and off-balance
sheet items for subsequent sale into the market.
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Banking organizations must have adequate systems that evaluate the
effect of securitization transactions on the banking organization's
risk profile and capital adequacy. Based on the complexity of
transactions, these systems should be capable of differentiating
between the nature and quality of the risk exposures transferred versus
those that the banking organization retains. Adequate management
systems usually:
Have an internal system for grading credit risk exposures,
including: (1) Adequate differentiation of risk among risk grades; (2)
adequate controls to ensure the objectivity and consistency of the
rating process; and (3) analysis or evidence supporting the accuracy or
appropriateness of the risk-grading system.\7\
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\7\ In this regard, the agencies note that one increasingly
important component of the systems for controlling credit risk at
larger banking organizations is the identification of the gradations
in credit risk among their business loans and the assignment of
internal credit risk ratings to loans that correspond to these
gradations. The agencies believe that the use of such an internal
rating process is appropriate--indeed, necessary--for sound risk
management at large banking organizations. In particular, those
banking organizations with significant involvement in securitization
activities should have relatively elaborate and formal approaches
for assessing and managing the associated credit risk.
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Evaluate the effect of the transaction on the nature and
distribution of the banking book exposures that have not been
transferred in connection with securitization. This analysis should
include a comparison of the banking book's risk profile before and
after the transaction, including the mix of exposures by risk grade and
by business or economic sector. The analysis should also include
identification of any concentrations of credit risk.
Perform rigorous, forward-looking stress testing \8\ on
exposures that have not been transferred (that is, loans and
commitments remaining in the banking book), transferred exposures, and
exposures retained to facilitate transfers (that is, credit
enhancements).
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\8\ Stress testing usually involves identifying possible events
or changes in market behavior that could have unfavorable effects on
an banking organization and assessing the organization's ability to
withstand them. Stress testing should not only consider the
probability of adverse events, but also potential ``worst case''
scenarios. Such an analysis should be done on a consolidated basis
and consider, for example, the effect of higher than expected levels
of delinquencies and defaults. The analysis should also consider the
consequences of early amortization events that could raise concerns
regarding a banking organization's capital adequacy and its
liquidity and funding capabilities. Stress test analyses should also
include contingency plans regarding the actions management might
take given certain situations.
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Have an internal economic capital allocation methodology
that provides the banking organization will have adequate
capitalization to meet a specific probability that it will not become
insolvent if unexpected credit losses occur and that readjusts, as
necessary, the sponsoring bank's internal economic capital requirements
to take into account the effect of the securitization transactions.
Banking organizations should ensure that their capital positions
are sufficiently strong to support all of the risks associated with
these activities on a fully consolidated basis and should maintain
adequate capital in all affiliated entities engaged in these
activities.
C. Current Risk-Based Capital Treatment of Recourse and Direct Credit
Substitutes
Currently, the agencies' risk-based capital standards apply
different treatments to recourse arrangements and direct credit
substitutes. As a result, capital requirements applicable to credit
enhancements do not consistently reflect credit risk. The current rules
of the OCC, Board, and FDIC (the banking agencies) are also not
entirely consistent with those of the OTS.
1. Recourse
The agencies' risk-based capital guidelines prescribe a single
treatment for assets transferred with recourse, regardless of whether
the transaction is reported as a financing or a sale of assets in a
bank's Consolidated Reports of Condition and Income (Call Report), a
bank holding company's FR Y-9 reports, or a thrift's Thrift Financial
Report.\9\ For a transaction reported as a financing, the transferred
assets remain on the balance sheet and are risk-weighted. For a
transaction reported as a sale, the entire outstanding amount of the
assets sold (not just the contractual amount of the recourse
obligation) is converted into an on-balance sheet credit equivalent
amount using a 100% credit conversion factor. This credit equivalent
amount (less any applicable recourse liability account recorded on the
balance sheet) is then risk-weighted.\10\ If the seller's balance sheet
includes as an asset any retained interest in the assets sold, the
retained interest is not risk-weighted separately. Thus, regardless of
the method used to account for the transfer, risk-based capital is held
against the full, risk-weighted amount of the transferred assets,
although the transaction is subject to the low-level recourse rule,
which limits the maximum risk-based capital requirement to the banking
organization's maximum contractual exposure. \11\
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\9\ Assets transferred with any amount of recourse in a
transaction reported as a financing in accordance with generally
accepted accounting principles (GAAP) remain on the balance sheet
and are risk-weighted in the same manner as any other on-balance
sheet asset. Assets transferred with recourse in a transaction that
is reported as a sale under GAAP are removed from the balance sheet
and are treated as off-balance sheet exposures for risk-based
capital purposes.
\10\ Consistent with statutory requirements, the agencies'
current rules also provide for special treatment of sales of small
business loan obligations with recourse. See 12 CFR Part 3, appendix
A, Section 3(c) (OCC); 12 CFR parts 208 and 225, appendix A, II.B.5
(FRB); 12 CFR part 325, appendix A, II.B.6 (FDIC); 12 CFR
567.6(E)(3) (OTS).
\11\ Section 350 of the CDRI Act required the agencies to
prescribe regulations providing that the risk-based capital
requirement for assets transferred with recourse could not exceed a
banking organization's maximum contractual exposure. The agencies
may require a higher amount if necessary for safety and soundness
reasons. See 12 U.S.C. 4808.
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For leverage capital ratio purposes, if a transfer with recourse is
reported as a financing, the transferred assets remain on the
transferring banking organization's balance sheet and the banking
organization must hold leverage capital against these assets. If a
transfer with recourse is reported as a sale, the assets sold do not
remain on the selling
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banking organization's balance sheet and the banking organization need
not hold leverage capital against these assets. However, if the
seller's balance sheet includes as an asset any retained interest in
the assets sold, leverage capital must be held against the retained
interest.
2. Direct Credit Substitutes
Direct credit substitutes are treated differently from recourse
under the current risk-based capital standards. Under the banking
agencies' current standards, off-balance sheet direct credit
substitutes, such as financial standby letters of credit provided for
third-party assets, carry a 100% credit conversion factor. However,
only the dollar amount of the direct credit substitute is converted
into an on-balance sheet credit equivalent amount, so that capital is
held only against the face amount of the direct credit substitute. The
capital requirement for a recourse arrangement, in contrast, generally
is based on the full amount of the assets enhanced.
If a direct credit substitute covers less than 100% of the
potential losses on the assets enhanced, the current capital treatment
results in a lower capital charge for a direct credit substitute than
for a comparable recourse arrangement. For example, if a direct credit
substitute covers losses up to the first 20% of the assets enhanced,
then the on-balance sheet credit equivalent amount equals that 20%
amount, and risk-based capital is held against only the 20% amount. In
contrast, required capital for a first-loss 20% recourse arrangement is
higher because capital is held against the full outstanding amount of
the assets enhanced, subject to the low-level recourse rule.
Currently, under the banking agencies' guidelines, purchased
subordinated interests receive the same capital treatment as off-
balance sheet direct credit substitutes. That is, the amount of the
purchased subordinated interest is placed in the appropriate risk-
weight category. In contrast, a banking organization that retains a
subordinated interest in connection with the transfer of its own assets
is considered to have transferred the assets with recourse. As a
result, the banking organization must hold capital against the carrying
amount of the retained subordinated interest as well as the outstanding
amount of all senior interests that it supports, subject to the low-
level recourse rule.
The OTS risk-based capital regulation treats some forms of direct
credit substitutes (e.g., financial standby letters of credit) in the
same manner as the banking agencies' guidelines. However, unlike the
banking agencies, the OTS treats purchased subordinated interests
(except for certain high quality subordinated mortgage-related
securities) under its general recourse provisions. The risk-based
capital requirement is based on the carrying amount of the subordinated
interest plus all senior interests, as though the thrift owned the full
outstanding amount of the assets enhanced.
3. Concerns Raised by Current Risk-Based Capital Treatment
The agencies' current risk-based capital standards raise
significant concerns with respect to the treatment of recourse and
direct credit substitutes. First, banking organizations are often
required to hold different amounts of capital for recourse arrangements
and direct credit substitutes that expose the banking organization to
equivalent risk of credit loss. Banking organizations are taking
advantage of this anomaly, for example, by providing first-loss letters
of credit to asset-backed commercial paper conduits that lend directly
to corporate customers. This results in a significantly lower capital
requirement than if the loans had originally been carried on the
banking organizations' balance sheets and then were sold. Moreover, the
current capital standards do not recognize differences in risk
associated with different loss positions in asset securitizations, nor
do they provide uniform definitions of recourse, direct credit
substitute, and associated terms.
III. Description of the Proposal
This proposal would amend the agencies' risk-based capital
standards as follows:
The proposal defines ``recourse'' and revises the
definition of ``direct credit substitute''; \12\
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\12\ The OTS, which already defines the term ``recourse'' in its
rules, would revise its definition so that it is consistent with the
definition adopted by the other agencies. The OTS is also adding a
definition of ``financial guarantee-type letter of credit'' to be
consistent with the OCC and the Board.
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It provides more consistent risk-based capital treatment
for recourse obligations and direct credit substitutes;
It varies the capital requirements for positions in
securitized transactions according to their relative risk exposure,
using credit ratings from nationally recognized statistical rating
organizations \13\ (rating agencies) to measure the level of risk;
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\13\ ``Nationally recognized statistical rating organization''
means an entity recognized by the Division of Market Regulation of
the Securities and Exchange Commission as a nationally recognized
statistical rating organization for various purposes, including the
capital rules for broker-dealers. See SEC Rule 15c3-1(c)(2)(vi)(E),
(F) and (H), 17 CFR 240.15c3-091(c)(2)(vi)(E), (F), and (H).
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It permits the limited use of a banking organization's
qualifying internal risk rating system, a rating agency's or other
appropriate third party's review of the credit risk of positions in
structured programs, and qualifying software to determine the capital
requirement for certain unrated direct credit substitutes; and
It requires the sponsor of a revolving credit
securitization that involves an early amortization feature to hold
capital against the amount of assets under management in that
securitization.
The use of credit ratings in this proposal is similar to the 1997
Proposal. Although many commenters expressed concerns about specific
details in the 1997 Proposal, commenters generally supported the goal
of making the capital requirements associated with asset
securitizations more rational and efficient, and viewed the 1997
Proposal as a positive step toward achieving a more consistent,
rational, and efficient regulatory capital framework. The agencies have
made several changes to the 1997 Proposal in response to commenters'
concerns and based on further agency consideration of the issues
presented.
Several options and alternatives in the 1997 Proposal have been
eliminated: the modified gross-up approach, the ratings benchmark
approach, and the historical losses approach.\14\ Commenters expressed
numerous concerns about these approaches and the agencies agree that
better alternatives exist.
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\14\ For a description of these approaches, see 62 FR 59944,
59952-59961 (November 5, 1997).
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Commenters responding to the 1997 Proposal expressed a number of
concerns about the use of ratings from rating agencies to determine
capital requirements, especially in the case of unrated direct credit
substitutes. Commenters noted that banking organizations actively
involved in the securitization business have their own internal risk
rating systems, that banking organizations know their assets better
than third parties, and that a requirement that a banking organization
obtain a rating from a rating agency solely for regulatory capital
purposes is burdensome. Some commenters also expressed skepticism about
the suitability of rating agency credit ratings for regulatory capital
purposes.
In the opinion of the agencies, ratings have the advantages of
being relatively objective, widely used, and relied upon by investors
and other participants in
[[Page 12324]]
the financial markets. Ratings provide a flexible, efficient, market-
oriented way to measure credit risk. The agencies recognize, however,
that there are drawbacks to using credit ratings from rating agencies
to set capital requirements. Moreover, the agencies agree with some
commenters' observation that credit ratings are most useful with
respect to publicly-traded positions that would be rated regardless of
the agencies' risk-based capital requirements.
To minimize the need for banking organizations to obtain ratings on
otherwise unrated enhancements that are provided in asset-backed
commercial paper securitizations, the proposal permits banking
organizations to use their own qualifying internal risk rating systems
in place of ratings from rating agencies for risk weighting certain
direct credit substitutes. The use of internal risk ratings to assign
direct credit substitutes in asset-backed commercial paper programs to
rating categories under the ratings-based approach is dependent upon
the existence of adequate internal risk rating systems. The adequacy of
any internal risk rating system will depend upon a banking
organization's incorporation of the prudential standards outlined in
this proposal, as well as other factors recommended through supervisory
guidance or on a case-by-case basis.
Finally, the agencies are proposing an additional measure to
address the risk associated with early amortization features in certain
asset securitizations. The managed assets approach, described in
Section III.D., would apply a 20% risk weight to the amount of off-
balance sheet securitized assets under management in such transactions.
A. Definitions and Scope of the Proposal
1. Recourse
The proposal defines the term ``recourse'' to mean an arrangement
in which a banking organization retains risk of credit loss in
connection with an asset transfer, if the risk of credit loss exceeds a
pro rata share of the banking organization's claim on the assets. The
proposed definition of recourse is consistent with the banking
agencies' longstanding use of this term, and incorporates existing
agency practices regarding retention of risk in asset transfers into
the risk-based capital standards.\15\
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\15\ The OTS currently defines the term ``recourse'' more
broadly than the proposal to include arrangements involving credit
risk that a thrift assumes or accepts from third-party assets as
well as risk that it retains in an asset transfer. Under the
proposal, credit risk that a banking organization assumes from
third-party assets falls under the definition of ``direct credit
substitute'' rather than ``recourse.''
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Currently, the term ``recourse'' is not defined explicitly in the
banking agencies' risk-based capital guidelines. Instead, the
guidelines use the term ``sale of assets with recourse,'' which is
defined by reference to the Call Report Instructions. See Call Report
Instructions, Glossary (entry for ``Sales of Assets for Risk-Based
Capital Purposes''). Once a definition of recourse is adopted in the
risk-based capital guidelines, the banking agencies would remove the
cross-reference to the Call Report instructions from the guidelines.
The OTS capital regulation currently provides a definition of the term
``recourse,'' which would also be replaced once a final definition of
recourse is adopted.
2. Direct Credit Substitute
The proposed definition of ``direct credit substitute'' complements
the definition of recourse. The term ``direct credit substitute'' would
refer to any arrangement in which a banking organization assumes risk
of credit-related losses from assets or other claims it has not
transferred, if the risk of credit loss exceeds the banking
organization's pro rata share of the assets or other claims. Currently,
under the banking agencies' guidelines, this term covers guarantee-type
arrangements. As revised, it would also include explicitly items such
as purchased subordinated interests, agreements to cover credit losses
that arise from purchased loan servicing rights, credit derivatives and
lines of credit that provide credit enhancement.
Some commenters responding to the 1997 Proposal suggested that the
definition of ``direct credit substitute'' should exclude risk
positions that are not part of an asset securitization. Although direct
credit substitutes commonly are used in asset securitizations,
enhancements involving similar credit risk exposure can arise in other
contexts and should receive the same capital treatment as enhancements
associated with securitizations.
Several commenters objected to the 1997 Proposal's treatment of
direct credit substitutes as recourse. Commenters asserted that the
business of providing third-party credit enhancements has historically
been safe and profitable for banks and objected that the proposed
capital treatment would impair the competitive position of U.S. banks
and thrifts. As has been previously described, however, the current
treatment of direct credit substitutes is not consistent with the
treatment of recourse obligations. The agencies have concluded that the
difference in treatment between the two forms of credit enhancement
invites banking organizations to obtain direct credit substitutes in
place of recourse obligations in order to avoid the capital requirement
applicable to recourse obligations and on-balance-sheet assets. For
this reason, the agencies are again proposing, as a general rule, to
extend the current risk-based capital treatment of asset transfers with
recourse, including the low-level recourse rule, to direct credit
substitutes.
In an effort to address competitive inequities at the international
level, however, the agencies have raised this issue with the bank
supervisory authorities from the other countries represented on the
Basel Committee on Banking Supervision. The Basel Committee's
consultative paper, ``A New Capital Adequacy Framework,'' acknowledges
that the current Basel Capital Accord, upon which the agencies' risk-
based capital standards are based, lacks consistency in its treatment
of credit enhancements.
3. Lines of Credit
One commenter requested clarification that a line of credit that
provides credit enhancement for the financial obligations of an account
party could be a direct credit substitute only if it represented an
irrevocable obligation to the beneficiary. A revocable line of credit
would not be a direct credit substitute because the issuer could
protect itself against credit losses at any time prior to a draw on the
line of credit. However, an irrevocable line of credit could expose the
issuer to credit losses and would constitute a direct credit
substitute, if it met the criteria in the definitions. Also, any
conditions attached to the issuer's ability to revoke the undrawn
portion of a line of credit, or that interfere with the issuer's
ability to protect itself against credit loss prior to a draw, will
cause the line of credit to constitute a direct credit substitute.
4. Credit Derivatives
The proposed definitions of ``recourse'' and ``direct credit
substitute'' cover credit derivatives to the extent that a banking
organization's credit risk exposure exceeds its pro rata interest in
the underlying obligation. The ratings-based approach therefore applies
to rated instruments such as credit-linked notes issued as part of a
[[Page 12325]]
synthetic securitization. \16\ The agencies request comment on the
inclusion of credit derivatives in the definitions of ``recourse'' and
``direct credit substitute,'' as well as on the definition of ``credit
derivative'' contained in the proposal.
---------------------------------------------------------------------------
\16\ ``Synthetic securitization'' refers to the bundling of
credit risk associated with on-balance sheet assets and off-balance
sheet items for subsequent sale into the market. Credit derivatives,
and in particular credit-linked notes, are used to structure a
synthetic securitization. For more information on synthetic
securitizations see, Joint OCC and Federal Reserve Board Issuance on
Credit Derivatives, ``Capital Interpretations--Synthetic
Collateralized Loan Obligations,'' dated November 15, 1999.
---------------------------------------------------------------------------
5. Risks Other Than Credit Risks
A capital charge would be assessed only against arrangements that
create exposure to credit or credit-related risks. This continues the
agencies' current practice and is consistent with the risk-based
capital standards' traditional focus on credit risk. The agencies have
undertaken other initiatives to ensure that the risk-based capital
standards take interest rate risk and other non-credit related market
risks into account.
6. Implicit Recourse
The definitions cover all arrangements that are recourse or direct
credit substitutes in form or in substance. Recourse may also exist
when a banking organization assumes risk of loss without an explicit
contractual agreement or, if there is a contractual limit, when the
banking organization assumes risk of loss in an amount exceeding the
limit. The existence of implicit recourse is often a complex and fact-
specific issue, usually demonstrated by a banking organization's
actions to support a securitization beyond any contractual obligation.
Actions that may constitute implicit recourse include: providing
voluntary support for a securitization by selling assets to a trust at
a discount from book value; exchanging performing for non-performing
assets; or other actions that result in a significant transfer of value
in response to deterioration in the credit quality of a securitized
asset pool.
To date, the agencies have taken the position that when a banking
organization provides implicit recourse, it generally should hold
capital in the same amount as for assets sold with recourse. However,
the complexity of many implicit recourse arrangements and the variety
of circumstances under which implicit recourse may be provided raise
issues about whether recourse treatment is always the most appropriate
way to address the level of risk that a banking organization has
effectively retained or whether a different capital requirement would
be warranted in some circumstances. Accordingly, the 1997 Proposal
requested comment on the types of actions that should be considered
implicit recourse and how the agencies should treat those actions for
regulatory capital purposes.
Commenters responding to the 1997 Proposal generally supported the
view that implicit recourse is best handled on a case-by-case basis,
guided by the general rule that actions that demonstrate retention of
risk will trigger recourse treatment of affected transactions. The
agencies intend to continue to address implicit recourse case-by-case,
but may issue additional guidance if needed to clarify further the
circumstances in which a banking organization will be considered to
have provided implicit recourse.
7. Subordinated Interests in Loans or Pools of Loans
The definitions of recourse and direct credit substitute explicitly
cover a banking organization's ownership of subordinated interests in
loans or pools of loans. This continues the banking agencies'
longstanding treatment of retained subordinated interests as recourse
and recognizes that purchased subordinated interests can also function
as credit enhancements. (The OTS currently treats both retained and
purchased subordinated securities as recourse obligations.)
Subordinated interests generally absorb more than their pro rata share
of losses (principal and interest) from the underlying assets in the
event of default. For example, a multi-class asset securitization may
have several classes of subordinated securities, each of which provides
credit enhancement for the more senior classes. Generally, the holder
of any class that absorbs more than its pro rata share of losses from
the total underlying assets is providing credit protection for all of
the more senior classes. \17\
---------------------------------------------------------------------------
\17\ Current OTS risk-based capital guidelines exclude certain
high-quality subordinated mortgage-related securities from treatment
as recourse arrangements due to their credit quality.
---------------------------------------------------------------------------
Some commenters questioned the treatment of purchased subordinated
interests as recourse. Subordinated interests expose holders to
comparable risk regardless of whether the interests are retained or
purchased. If purchased subordinated interests were not treated as
recourse, banking organizations could avoid recourse treatment by
swapping retained subordinated interests with other banking
organizations or by purchasing subordinated interests in assets
originated by a conduit. The proposal would mitigate the effect of
treating purchased subordinated interests as recourse by reducing the
capital requirement on interests that qualify under the multi-level
approach described in section III.B.
8. Representations and Warranties
When a banking organization transfers assets, including servicing
rights, it customarily makes representations and warranties concerning
those assets. When a banking organization purchases loan servicing
rights, it may also assume representations and warranties made by the
seller or a prior servicer. These representations and warranties give
certain rights to other parties and impose obligations upon the seller
or servicer of the assets. The proposal addresses those particular
representations and warranties that function as credit enhancements,
i.e. those where, typically, a banking organization agrees to protect
purchasers or some other party from losses due to the default or non-
performance of the obligor or insufficiency in the value of collateral.
Therefore, to the extent a banking organization's representations and
warranties function as credit enhancements to protect asset purchasers
or investors from credit risk by obligating the banking organization to
protect another party from losses due to credit risk in the transferred
assets, the proposal treats them as recourse or direct credit
substitutes.
The 1997 Proposal treated as recourse or a direct credit substitute
any representation or warranty other than a standard representation or
warranty. Standard representations and warranties were those referring
to facts verified by the seller or servicer with reasonable due
diligence or conditions within the control of the seller or servicer
and those providing for the return of assets in the event of fraud or
documentation deficiencies. Some commenters objected that the 1997
Proposal would treat as recourse many industry-standard warranties that
impose only minor operational risk instead of true credit risk. Other
commenters objected that the due diligence requirement was burdensome,
and that it would impose compliance costs on banking organizations
disproportionate to the risk assumed.
The current proposal focuses on whether a warranty allocates credit
risk to the banking organization, rather than whether the warranty is
somehow standard or customary within the industry. Several commenters
suggested
[[Page 12326]]
that the agencies expressly take accepted mortgage banking industry
practice into account in determining whether a warranty should receive
recourse treatment. However, the agencies are aware of warranties
sometimes characterized as ``standard'' that effectively function as
credit enhancements. These include warranties that transferred loans
will remain of investment quality, or that no circumstances exist
involving the loan collateral or borrower's credit standing that could
cause the loan to become delinquent. They may also include warranties
that, for seasoned mortgages, the value of the loan collateral still
equals the original appraised value and the borrower's ability to pay
has not changed adversely.
The proposal is consistent with the agencies' longstanding recourse
treatment of representations and warranties that effectively guaranty
performance or credit quality of transferred loans. However, the
proposal and the agencies' longstanding practice also recognize that
banking organizations typically make a number of factual warranties
unrelated to ongoing performance or credit quality. These warranties
entail operational risk, as opposed to the open-ended credit risk
inherent in a financial guaranty. Warranties that create operational
risk include: warranties that assets have been underwritten or
collateral appraised in conformity with identified standards, and
warranties that provide for the return of assets in instances of
incomplete documentation or fraud.
Warranties can impose varying degrees of operational risk. For
example, a warranty that asset collateral has not suffered damage from
hazard entails risk that is offset to some extent by prudent
underwriting practices requiring the borrower to provide hazard
insurance to the banking organization. A warranty that asset collateral
is free of environmental hazards may present acceptable operational
risk for certain types of properties that have been subject to
environmental assessment, depending on the circumstances. The agencies
address appropriate limits for these operational risks through
supervision of a banking organization's loan underwriting, sale, and
servicing practices. Also, a banking organization that provides
warranties to loan purchasers and investors must include associated
operational risks in its risk management of exposures arising from loan
sale or securitization-related activities. Banking organizations should
be prepared to demonstrate to examiners that the operational risks are
effectively managed.
The proposal continues the agencies' current practice of imposing
recourse treatment on ``early-default'' clauses. Early-default clauses
typically warrant that transferred loans will not become more than 30
days delinquent within a stated period, such as four months. Once the
stated period has run, the early-default clause will no longer trigger
recourse treatment, provided that there is no other provision that
constitutes recourse. One commenter to the 1997 Proposal stated that
early-default clauses carry minimal risk, and are intended to deal with
inadvertent transfers of loans that are already 30-day delinquencies,
or to guard against unsound originations by the loan seller. Another
commenter found recourse treatment of early-default clauses to be an
appropriate response to the transfer of credit risk that takes place
under these clauses.
The agencies find that early-default clauses are often drafted so
broadly that they are indistinguishable from a guaranty of financial
assets. The agencies have even found recent examples in which early-
default clauses have been expanded to cover the first year after loan
transfer. Industry concerns about assets delinquent at the time of
transfer or unsound originations could be dealt with by warranties
directly addressing the condition of the asset at the time of transfer
and compliance with stated underwriting standards or, failing that,
exposure caps permitting the banking organization to take advantage of
the low-level recourse rule. The proposal also requires recourse
treatment for warranties providing assurances about the actual value of
asset collateral, including that the market value corresponds to its
appraised value or that the appraised value will be realized in the
event of foreclosure and sale.
The agencies invite further comment on these issues. The agencies
also invite comment on whether ``premium refund'' clauses should
receive recourse treatment under any final rule. These clauses require
the seller to refund the premium paid by the investor for any loan that
prepays within a stated period after the loan is transferred. The
agencies are aware of premium refund clauses with terms ranging from 90
days to 36 months.
9. Loan Servicing Arrangements
The proposed definitions of ``recourse'' and ``direct credit
substitute'' cover loan servicing arrangements if the servicer is
responsible for credit losses associated with the loans being serviced.
However, cash advances made by residential mortgage servicers to ensure
an uninterrupted flow of payments to investors or the timely collection
of the mortgage loans are specifically excluded from the definitions of
recourse and direct credit substitute, provided that the residential
mortgage servicer is entitled to reimbursement for any significant
advances.\18\ This type of advance is assessed risk-based capital only
against the amount of the cash advance, and is assigned to the risk-
weight category appropriate to the party obligated to reimburse the
servicer.
---------------------------------------------------------------------------
\18\ Servicer cash advances include disbursements made to cover
foreclosure costs or other expenses arising from a loan in order to
facilitate its timely collection (but not to protect investors from
incurring these expenses).
---------------------------------------------------------------------------
If a residential mortgage servicer is not entitled to full
reimbursement, then the maximum possible amount of any nonreimbursed
advances on any one loan must be contractually limited to an
insignificant amount of the outstanding principal on that loan in order
for the servicer's obligation to make cash advances to be excluded from
the definitions of recourse and direct credit substitute. This
treatment reflects the agencies' traditional view that servicer cash
advances meeting these criteria are part of the normal mortgage
servicing function and do not constitute credit enhancements.
Commenters responding to the 1997 Proposal generally supported the
proposed definition of servicer cash advances. Some commenters asked
for clarification of the term ``insignificant'' and whether
``reimbursement'' includes reimbursement payable out of subsequent
collections or reimbursement in the form of a general claim on the
party obligated to reimburse the servicer. Nonreimbursed advances on
any one loan that are generally contractually limited to no more than
one percent of the amount of the outstanding principal on that loan
would be considered insignificant. Reimbursement includes reimbursement
payable from subsequent collections and reimbursement in the form of a
general claim on the party obligated to reimburse the servicer,
provided that the claim is not subordinated to other claims on the cash
flows from the underlying asset pool.
Some commenters responding to the 1997 Proposal suggested that the
agencies treat servicer cash advances as any advances that the servicer
reasonably expects will be repaid. The agencies believe that a clear,
specific standard is needed to prevent the use of servicer cash
advances to circumvent the proposed risk-based capital
[[Page 12327]]
treatment of recourse obligations and direct credit substitutes.
10. Spread Accounts and Overcollateralization
Several commenters requested that the agencies state in their rules
that spread accounts and overcollateralization do not impose a risk of
loss on a banking organization and are, therefore, not recourse. By its
terms, the definition of recourse covers only the retention of risk in
a sale of assets. Overcollateralization does not ordinarily impose a
risk of loss on a banking organization, so it normally would not fall
within the proposed definition of recourse. However, a retained
interest in a spread account that is reflected as an asset on a selling
banking organization's balance sheet (directly as an asset or
indirectly as a receivable) is a form of recourse and is treated
accordingly for risk-based capital purposes.
11. Interaction With Market Risk Rule
Some commenters responding to the 1997 Proposal asked for
clarification of the treatment of a transaction covered by both the
market risk rule and the recourse rule. Under the market risk rule,\19\
a position properly located in the trading account is excluded from
risk-weighted assets. The banking agencies are not proposing to modify
this treatment, so a position that is properly held in the trading
account would not be included in risk-weighted assets, even if the
position otherwise met the criteria for a recourse obligation or a
direct credit substitute.
---------------------------------------------------------------------------
\19\ The OTS does not have a market risk rule.
---------------------------------------------------------------------------
12. Participations in Direct Credit Substitutes
If a direct credit substitute is originated by a banking
organization which then sells a participation in that direct credit
substitute to another entity, the originating banking organization must
apply a 100% conversion factor to the full amount of the assets
supported by the direct credit substitute. The originating banking
organization would then risk weight the credit equivalent amount of the
participant's pro rata share of the direct credit substitute at the
lower of the risk category appropriate to the obligor in the underlying
transaction, after considering any relevant guaranties or collateral,
or the risk category appropriate to the participant entity. The
remaining pro rata share of the credit equivalent amount is assigned to
the risk-weight category appropriate to the obligor in the underlying
transaction, guarantor or collateral.
A banking organization that acquires a risk participation in a
direct credit substitute must apply a 100% conversion factor to its
percentage share of the direct credit substitute multiplied by the full
amount of the assets supported by the credit enhancement. The credit
equivalent amount is then assigned to the risk category appropriate to
the obligor or, if relevant, the nature of the collateral or guaranty.
Finally, in the case of the syndication of a direct credit
substitute where each banking organization is obligated only for its
pro rata share of the risk and there is no recourse to the originating
banking organization, each banking organization must hold risk-based
capital against its pro rata share of the assets supported by the
direct credit substitute.
13. Reservation of Authority
The agencies are proposing to add language to the risk-based
capital standards that will provide greater flexibility in
administering the standards. Banking organizations are developing novel
transactions that do not fit well into the risk-weight categories and
credit conversion factors set forth in the standards. Banking
organizations also are devising novel instruments that nominally fit
into a particular risk-weight category or credit conversion factor, but
that impose risks on the banking organization at levels that are not
commensurate with the nominal risk-weight or credit conversion factor
for the asset, exposure or instrument. Accordingly, the agencies are
proposing to add language to the standards to clarify their authority,
on a case-by-case basis, to determine the appropriate risk-weight for
assets and credit equivalent amounts and the appropriate credit
conversion factor for off-balance sheet items in these circumstances.
Exercise of this authority by the agencies may result in a higher or
lower risk weight for an asset or credit equivalent amount or a higher
or lower credit conversion factor for an off-balance sheet item. This
reservation of authority explicitly recognizes the agencies retention
of sufficient discretion to ensure that banking organizations, as they
develop novel financial assets, will be treated appropriately under the
risk-based capital standards.\20\ In addition, the agencies reserve the
right to assign risk positions in securitizations to appropriate risk
categories if the credit rating of the risk position is deemed to be
inappropriate.
---------------------------------------------------------------------------
\20\ The Board is also proposing to add language to its risk-
based capital standards that would permit the Board to adjust the
treatment of a capital instrument that does not fit into the
existing capital categories or that provides capital to a banking
organization at levels that are not commensurate with the nominal
capital treatment of the instrument. The other agencies already have
this flexibility under their existing rules.
---------------------------------------------------------------------------
14. Privately-Issued Mortgage-Backed Securities
Currently, the agencies assign privately-issued mortgage-backed
securities to the 20% risk-weight category if the underlying pool is
composed entirely of mortgage-related securities issued by the Federal
National Mortgage Association (Fannie Mae), Federal Loan Mortgage
Corporation (Freddie Mac), or Government National Mortgage Association
(Ginnie Mae). Privately-issued mortgage-backed securities backed by
whole residential mortgages are now assigned to the 50% risk-weight
category. The agencies propose to eliminate this ``pass-through''
treatment in favor of a ratings based approach. Because most mortgage-
backed securities usually also receive the highest or second highest
credit rating, the agencies believe that ``pass-through'' treatment
will be redundant once the ratings-based approach is implemented and,
therefore, propose to eliminate it.
B. Proposed Treatment for Rated Positions
As described in section II.A., each loss position in an asset
securitization structure functions as a credit enhancement for the more
senior loss positions in the structure. Currently, the risk-based
capital standards do not vary the rate of capital requirement for
different credit enhancements or loss positions to reflect differences
in the relative risk of credit loss represented by the positions.
To address this issue, the agencies are proposing a multi-level,
ratings-based approach to assess capital requirements on recourse
obligations, direct credit substitutes, and senior and subordinated
securities in asset securitizations based on their relative exposure to
credit risk. The approach uses credit ratings from the rating agencies
and, to a limited extent, banking organization's internal risk ratings
and other alternatives, to measure relative exposure to credit risk and
to determine the associated risk-based capital requirement. The use of
credit ratings provides a way for the agencies to use determinations of
credit quality relied upon by investors and other market participants
to differentiate the regulatory capital treatment for loss
[[Page 12328]]
positions representing different gradations of risk. This use permits
the agencies to give more equitable treatment to a wide variety of
transactions and structures in administering the risk-based capital
system.
The fact that investors rely on these ratings to make investment
decisions exerts market discipline on the rating agencies and gives
their ratings market credibility. The market's reliance on ratings, in
turn, gives the agencies confidence that it is appropriate to consider
ratings as a major factor in the risk weighting of assets for
regulatory capital purposes. The agencies, however, would retain their
authority to override the use of certain ratings or the ratings on
certain instruments, either on a case-by-case basis or through broader
supervisory policy, if necessary or appropriate to address the risk to
banking organizations.
Under the ratings-based approach, the capital requirement for a
recourse obligation, direct credit substitute, or traded asset-backed
security would be determined as follows: \21\
---------------------------------------------------------------------------
\21\ The example rating designations (``AAA,'' ``BBB,'' etc.)
are illustrative and do not indicate any preference for, or
endorsement of, any particular rating agency designation system.
------------------------------------------------------------------------
Rating category Examples Risk weight
------------------------------------------------------------------------
Highest or second highest AAA or AA......... 20%.
investment grade.
Third highest investment grade.. A................. 50%.
Lowest investment grade......... BBB............... 100%.
One category below investment BB................ 200%.
grade.
More than one category below B or unrated...... ''Gross-up''
investment grade, or unrated. treatment.
------------------------------------------------------------------------
Many commenters expressed concerns about the so-called ``cliff
effect'' that would arise because of the small number of rating
categories--three--contained in the 1997 Proposal. To reduce the cliff
effect, which causes relatively small differences in risk to result in
disproportionately large differences in the capital requirement for a
risk position, the agencies are proposing to add two additional rating
categories, for a total of five.
Under the proposal, the ratings-based approach is available for
traded asset-backed securities \22\ and for traded and non-traded
recourse obligations and direct credit substitutes. A position is
considered ``traded'' if, at the time it is rated by an external rating
agency, there is a reasonable expectation that in the near future: (1)
The position may be sold to investors relying on the rating; or (2) a
third party may enter into a transaction (e.g., a loan or repurchase
agreement) involving the position in which the third party relies on
the rating of the position. If external rating agencies rate a traded
position differently, the single highest rating applies.
---------------------------------------------------------------------------
\22\ Similar to the current approach under which ``stripped''
mortgage-backed securities are not eligible for risk weighting at
50% on a ``pass-through'' basis, stripped mortgage-backed securities
are ineligible for the 20% or 50% risk categories under the ratings
based approach.
---------------------------------------------------------------------------
An unrated position that is senior (in all respects, including
access to collateral) to a rated position that is traded is treated as
if it had the rating given the rated position, subject to the banking
organization satisfying its supervisory agency that such treatment is
appropriate.
Recourse obligations and direct credit substitutes not qualifying
for a reduced capital charge and positions rated more than one category
below investment grade receive ``gross-up'' treatment, that is, the
banking organization holding the position would hold capital against
the amount of the position plus all more senior positions, subject to
the low-level recourse rule.\23\ This grossed-up amount is placed into
risk-weight categories according to the obligor and collateral.
---------------------------------------------------------------------------
\23\ ``Gross-up'' treatment means that a position is combined
with all more senior positions in the transaction. The result is
then risk-weighted based on the nature of the underlying assets. For
example, if a banking organization retains a first-loss position in
a pool of mortgage loans that qualify for a 50% risk weight, the
banking organization would include the full amount of the assets in
the pool, risk-weighted at 50% in its risk-weighted assets for
purposes of determining its risk-based capital ratio. The low level
recourse rule provides that the dollar amount of risk-based capital
required for assets transferred with recourse should not exceed the
maximum dollar amount for which a banking organization is
contractually liable. See, 12 CFR part 3, appendix A, Section 3(d)
(OCC); 12 CFR 208 and 225, appendix A, III.D.1(g) (FRB); 12 CFR part
325, appendix A, II.D.1 (FDIC); 12 CFR 567.6(a)(2)(i)(C) (OTS).
---------------------------------------------------------------------------
The ratings-based approach is based on current ratings, so that a
rating downgrade or withdrawal of a rating could change the treatment
of a position under the proposal. However, a downgrade of a position by
a single rating agency would not affect the capital treatment of a
position if the position still qualified for the previous capital
treatment under one or more ratings from a different rating agency.
C. Proposed Treatment for Non-Traded and Unrated Positions
1. Ratings on Non-Traded Positions
In the 1994 Notice, the agencies proposed to permit a banking
organization to obtain a rating for a non-traded recourse obligation or
direct credit substitute in order to permit that position to qualify
for a favorable risk-weight. In response to the 1994 Notice, one rating
agency expressed concern that use of ratings by the agencies for
regulatory purposes could undermine the integrity of the rating
process. Ordinarily, according to the commenter, there is a tension
between the interests of the investors who rely on ratings and the
interests of the issuers who pay rating agencies to generate ratings.
Under the ratings-based approach in the 1994 Notice, however, the
holder of a recourse obligation or direct credit substitute that was
not traded or sold could, in some cases, seek a rating for the sole
purposes of permitting the credit enhancement to qualify for a
favorable risk weight. The rating agency expressed a strong concern
that, without the counterbalancing interest of investors to rely on
ratings, rating agencies may have an incentive to issue inflated
ratings.
In response to this concern, the 1997 Proposal included criteria to
reduce the possibility of inflated ratings and inappropriate risk
weights if ratings are used for a position that is not traded. A non-
traded position could qualify for the ratings-based approach only if:
(1) It qualified under ratings obtained from two different rating
agencies; (2) the ratings were publicly available; (3) the ratings were
based on the same criteria used to rate securities sold to the public;
and (4) at least one position in the securitization was traded. In
comments responding to the 1997 Proposal, banking organizations
expressed concern about the cost and delay associated with obtaining
ratings, particularly for direct credit substitutes, that they would
not need absent the agencies' adoption of a ratings-based approach for
risk-based capital purposes.
In this proposal, the agencies continue to permit a non-traded
[[Page 12329]]
recourse obligation or direct credit substitute to qualify for the
ratings-based approach if the banking organization obtains ratings for
the position. The agencies have retained the first three of the 1997
Proposal's four criteria for non-traded positions, but have eliminated
the fourth criterion, i.e., the requirement that one position in the
securitization be traded.
To address concerns expressed by commenters on the 1997 Proposal,
however, the agencies have developed, and are also proposing,
alternative approaches for determining the capital requirements for
unrated direct credit substitutes, which are discussed in the following
sections. Under each of these approaches, the banking organization must
satisfy its supervisory agency that use of the approach is appropriate
for the particular banking organization.
2. Use of Banking Organizations' Internal Risk Ratings
The proposal would permit a banking organization with a qualifying
internal risk rating system to use that system to apply the ratings-
based approach to the banking organization's unrated direct credit
substitutes in asset-backed commercial paper programs. Internal risk
ratings could be used to qualify a credit enhancement (other than a
retained recourse position) for a risk weight of 100% or 200% under the
ratings-based approach, but not for a risk weight of less than 100%.
This relatively limited use of internal risk ratings for risk-based
capital purposes is a step towards potential adoption of broader use of
internal risk ratings as discussed in the Basel Committee's June 1999
Consultative Paper. Limiting the approach to these types of credit
enhancements reflects the agencies' view, based on industry research
and empirical evidence, that these positions are more likely than
recourse positions to be of investment-grade credit quality, and that
the banking organizations providing them are more likely to have
internal risk rating systems for these credit enhancements that are
sufficiently accurate to be relied on for risk-based capital
calculations.
Most sophisticated banking organizations that participate
extensively in the asset securitization business assign internal risk
ratings to their credit exposures, regardless of the form of the
exposure. Usually, internal risk ratings more finely differentiate the
credit quality of a banking organization's exposures than the
categories that the agencies use to evaluate credit risk during
examinations of banking organizations (pass, substandard, doubtful,
loss). Individual banking organizations' internal risk ratings may be
associated with a certain probability of default, loss in the event of
default, and loss volatility.
The credit enhancements that sponsors obtain for their commercial
paper conduits are rarely rated. If an internal risk ratings approach
were not available for these unrated credit enhancements, the provider
of the enhancement would have to obtain two ratings solely to avoid the
gross-up treatment that would otherwise apply to unrated positions in
asset securitizations for risk-based capital purposes. However, before
a provider of an enhancement decides whether to provide a credit
enhancement for a particular transaction (and at what price), the
provider will generally perform its own analysis of the transaction to
evaluate the amount of risk associated with the enhancement.
Allowing banking organizations to use internal credit ratings
harnesses information and analyses that they already generate rather
than requiring them to obtain independent but redundant ratings from
outside rating agencies. An internal risk ratings approach therefore
has the potential to be less costly than a ratings-based approach that
relies exclusively on ratings by the rating agencies for the risk-
weighting of these positions.
Internal risk ratings that correspond to the rating categories of
the rating agencies could be mapped to risk weights under the agencies'
capital standards in a way that would make it possible to differentiate
the riskiness of various unrated direct credit substitutes based on
credit risk. However, the use of internal risk ratings raises concerns
about the accuracy and consistency of the ratings, especially because
the mapping of ratings to risk-weight categories will give banking
organizations an incentive to rate their risk exposures in a way that
minimizes the effective capital requirement. Banking organizations
engaged in securitization activities that wish to use the internal risk
ratings approach must ensure that their internal risk rating systems
are adequate. Adequate internal risk rating systems usually:
(1) Are an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from an
organization's participation in securitization activities. The system
must also fully take into account the effect of such activities on the
organization's risk profile and capital adequacy as discussed in
Section II.B.
(2) Link their ratings to measurable outcomes, such as the
probability that a position will experience any losses, the expected
losses on that position in the event of default, and the degree of
variance in losses given default on that position.
(3) Separately consider the risk associated with the underlying
loans and borrowers and the risk associated with the specific positions
in a securitization transaction.
(4) Identify gradations of risk among ``pass'' assets, not just
among assets that have deteriorated to the point that they fall into
``watch'' grades. Although it is not necessary for a banking
organization to use the same categories as the rating agencies, its
internal ratings must correspond to the ratings of the rating agencies
so that agencies can determine which internal risk rating corresponds
to each rating category of the rating agencies. A banking organization
would have the responsibility to demonstrate to the satisfaction of its
primary regulator how these ratings correspond with the rating agency
standards used as the framework for this proposal. This is necessary so
that the mapping of credit ratings to risk weight categories in the
ratings-based approach can be applied to internal ratings.
(5) Classify assets into each risk grade, using clear, explicit
criteria, even for subjective factors.
(6) Have independent credit risk management or loan review
personnel assign or review credit risk ratings. These personnel should
have adequate training and experience to ensure that they are fully
qualified to perform this function.
(7) Periodically verify, through an internal audit procedure, that
internal risk ratings are assigned in accordance with the banking
organization's established criteria.
(8) Track the performance of its internal ratings over time to
evaluate how well risk grades are being assigned, make adjustments to
its rating system when the performance of its rated positions diverges
from assigned ratings, and adjust individual ratings accordingly.
(9) Make credit risk rating assumptions that are consistent with,
or more conservative than, the credit risk rating assumptions and
methodologies of the rating agencies.
The agencies also are considering whether to develop review and
approval procedures governing their respective determinations of
whether a particular banking organization may use the internal risk
rating process. The agencies request comment on the appropriate scope
and nature of that process.
[[Page 12330]]
If a banking organization's rating system is found to no longer be
adequate, the banking organization's primary regulator may preclude it
from applying the internal risk ratings approach to new transactions
for risk-based capital purposes until it has remedied the deficiencies.
Additionally, depending on the severity of the problems identified, the
primary regulator may also decline to rely on the internal risk ratings
that the banking organization has applied to previous transactions that
remain outstanding for purposes of determining the banking
organization's regulatory capital requirements.
3. Ratings of Specific Positions in Structured Financing Programs
The agencies also propose to authorize a banking organization to
use a rating obtained from a rating agency or other appropriate third
party of unrated direct credit substitutes in securitizations that
satisfy specifications set by the rating agency. The banking
organization would need to demonstrate that the rating meets the same
rating standards generally used by the rating agency for rating
publicly-issued securities. In addition, the banking organization must
also demonstrate to its primary regulator's satisfaction that the
criteria underlying the rating agency's assignment of ratings for the
program are satisfied for the particular direct credit substitute
issued by the banking organization.
The proposal would also allow banking organizations to demonstrate
to the agencies that it is reasonable and consistent with the standards
of this proposal to rely on the rating of positions in a securitization
structure under a program in which the banking organization
participates if the sponsor of that program has obtained a rating. This
aspect of the proposal is most likely to be useful to banking
organizations with limited involvement in securitization activities. In
addition, some banking organizations extensively involved in
securitization activities already rely on ratings of the credit risk
positions under their securitization programs as part of their risk
management practices. Such banking organizations also could rely on
such ratings under this proposal if the ratings are part of a sound
overall risk management process and the ratings reflect the risk of
non-traded positions to the banking organizations.
This approach could be used to qualify a direct credit substitute
(but not a retained recourse position) for a risk weight of 100% or
200% of the face value of the position under the ratings-based
approach, but not for a risk weight of less than 100%.
4. Use of Qualifying Rating Software Mapped to Public Rating Standards
The agencies are also proposing to allow banking organizations,
particularly those with limited involvement in securitization
activities, to rely on qualifying credit assessment computer programs
that the rating agencies or other appropriate third parties have
developed for rating otherwise unrated direct credit substitutes in
asset securitizations. To qualify for use by banking organizations for
risk-based capital purposes, the computer programs must be tracked to
the rating standards of the rating agencies. Banking organizations must
demonstrate the credibility of these programs in the financial markets,
which would generally be shown by the significant use of the computer
program by investors and market participants for risk assessment
purposes. Banking organizations also would need to demonstrate the
reliability of the programs in assessing credit risk. Banking
organizations may use these programs for purposes of applying the
ratings-based approach under this proposal only if the banking
organization satisfies its primary regulator that the programs result
in credit assessments that credibly and reliably correspond with the
rating of publicly issued securities by the rating agencies.
Sophisticated banking organizations with extensive securitization
activities generally should use this approach only if it is an integral
part of their risk management systems and their systems fully capture
the risks from the banking organizations' securitization activities.
This approach could be used to qualify a direct credit substitute
(but not a retained recourse position) for a risk weight of 100% or
200% of the face value of the position under the ratings-based
approach, but not for a risk weight of less than 100%.
D. Managed Assets Approach
When assets are securitized, the extent to which the selling or
sponsoring entity transfers the risks associated with the assets
depends on the structure of the securitization and the revolving nature
of the assets involved. To the extent the sponsoring institution is
dependent on future securitizations as a funding source, as a practical
matter, the amount of risk transferred often will be limited. Revolving
credits include credit card and home equity line securitizations as
well as commercial loans drawn down under long-term commitments that
are securitized as collateralized loan obligations (CLOs).
The early amortization feature present in some revolving credit
securitizations ensures that investors will be repaid before being
subject to any risk of significant credit losses. For example, if a
securitized asset pool begins to experience credit deterioration to the
point where the early amortization feature is triggered, then the
asset-backed securities held by investors begin to rapidly pay down.
This occurs because, after an early amortization feature is triggered,
new receivables that are generated from the accounts designated to the
securitization trust are no longer sold to investors, but are instead
retained on the sponsoring banking organization's balance sheet.
Early amortization features raise several distinct concerns about
risks to the seller. First, the seller's interest in the securitized
assets is effectively subordinated to the interests of the investors by
the payment allocation formula applied during early amortization.
Investors effectively get paid first, and the seller's residual
interest will therefore absorb a disproportionate share of credit
losses.
Second, early amortization can create liquidity problems for the
seller. For example, a credit card issuer must fund a steady stream of
new credit card receivables. When a securitization trust is no longer
able to purchase new receivables due to early amortization, the seller
must either find an alternative buyer for the receivables or else the
receivables will accumulate on the seller's balance sheet, creating the
need for another source of funding.
Third, the first two risks to the seller can create an incentive
for the seller to provide implicit recourse--credit enhancement beyond
any pre-existing contractual obligation--to prevent early amortization.
Incentives to provide implicit recourse are to some extent present in
other securitizations, because of concerns about damage to the seller's
reputation and its ability to securitize assets going forward if one of
its securitizations performs poorly. However, the early amortization
feature creates additional and more direct financial incentives to
prevent early amortization through implicit recourse.
Because of their concerns about these risks, the agencies are
proposing to apply a managed assets approach to securitization
transactions that incorporate early amortization provisions. The
approach would require a sponsoring banking organization's securitized
(off-balance sheet) receivables to be included in risk-
[[Page 12331]]
weighted assets when determining its risk-based capital requirements.
The securitized, off-balance sheet assets would be assigned to the 20
percent risk category, thereby effectively applying a 1.6% risk-based
capital charge to those assets.
The 1.6% capital charge against securitized assets could be limited
in certain cases. If the sponsoring banking organization in a revolving
credit securitization provides credit protection to investors, either
in the form of retained recourse or a direct credit substitute, the sum
of the regulatory capital requirements for the credit protection and
the 1.6% charge on the off-balance sheet securitized assets may not
exceed 8% of securitized assets for that particular securitization
transaction.
A managed assets approach would require a banking organization to
hold additional capital against the potential credit and liquidity
risks stemming from the early amortization provisions of revolving
credit securitization structures. This proposed capital charge would
ensure that a banking organization maintain at least a minimum level of
capital against the risks that arise when early amortization provisions
are present in securitizations of revolving credits.
The agencies request comment on the purpose of early amortization
provisions, the proposed managed assets approach, and on any potential
effects that the approach will have on current industry practices
involving revolving credit securitizations. The agencies also recognize
that there may be concerns that the managed assets approach may not
produce safety and soundness benefits commensurate with the additional
regulatory burden that would result from a 20% risk weight on managed
assets, and they request comment on possible alternative measures that
would address more effectively the risks arising from early
amortization provisions in revolving securitizations. For example, one
alternative to the managed assets approach described here would be to
require greater public disclosure of securitization performance. This
additional information could allow market participants and regulators
to better assess the risks inherent in revolving securitizations with
early amortization provisions and the capital level appropriate for
those risks. The agencies also request comment on whether the benefits
of greater public disclosure outweigh the costs associated with
increased reporting.
IV. Effective Date of a Final Rule Resulting From This Proposal
The agencies intend that any final rules adopted as a result of
this proposal that result in increased risk-based capital requirements
for banking organizations will apply only to securitization activities
(as defined in the proposal) entered into or acquired after the
effective date of those final rules. Conversely, any final rules that
result in reduced risk-based capital requirements for banking
organizations may be applied to all transactions outstanding as of the
effective date of those final rules and to all subsequent transactions.
Because some ongoing securitization conduits may need additional time
to adapt to any new capital treatments, the agencies intend to permit
banking organizations to apply the existing capital rules to asset
securitizations with no fixed term, e.g., asset-backed commercial paper
conduits, for up to two years after the effective date of any final
rule.
V. Request for Comment
The agencies request comment on all aspects of this proposal, as
well as on the specific issues described in the preamble.
VI. Regulatory Flexibility Act
OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OCC certifies that this proposal will not have a significant impact
on a substantial number of small entities. 5 U.S.C. 601 et seq. The
provisions of this proposal that increase capital requirements are
likely to affect large national banks almost exclusively. Small
national banks rarely sponsor or provide direct credit substitutes in
asset securitizations. Accordingly, a regulatory flexibility analysis
is not required.
Board: Pursuant to section 605(b) of the Regulatory Flexibility
Act, the Board has determined that this proposal will not have a
significant impact on a substantial number of small business entities
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). The Board's comparison of the applicability section of this
proposal with Call Report Data on all existing banks shows that
application of the proposal to small entities will be the rare
exception. Accordingly, a regulatory flexibility analysis is not
required. In addition, because the risk-based capital standards
generally do not apply to bank holding companies with consolidated
assets of less than $150 million, this proposal will not affect such
companies.
FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act
(Public Law 96-354, 5 U.S.C. 601 et seq.), the FDIC certifies that the
proposed rule will not have a significant impact on a substantial
number of small entities. Comparison of Call Report data on FDIC-
supervised banks to the items covered by the proposal that result in
increased capital requirements shows that application of the proposal
to small entities will be the infrequent exception.
OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act,
the OTS certifies that this proposal will not have a significant impact
on a substantial number of small entities. A comparison of TFR data on
OTS-supervised thrifts shows that the proposed rule would have little
impact on the overall level of capital required at small thrifts, since
capital requirements (other than the risk-based capital standards) are
typically more binding on smaller thrifts. Moreover, the provisions of
this proposal that may increase capital requirements are unlikely to
affect small savings associations. Small thrifts rarely provide direct
credit substitutes in asset securitizations and do not serve as
sponsors of revolving securitizations. Accordingly, a regulatory
flexibility analysis is not required.
VII. Paperwork Reduction Act
The Agencies have determined that this proposal does not involve a
collection of information pursuant to the provisions of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501, et seq.).
VIII. Executive Order 12866
OCC: The OCC has determined that this proposal is not a significant
regulatory action for purposes of Executive Order 12866. The OCC
expects that any increase in national banks' risk-based capital
requirement, resulting from the proposed treatment of direct credit
substitutes largely will be offset by the ability of those banks to
reduce their capital requirement in accordance with the ratings-based
approach. The managed assets position of the proposal may require a
limited number of national banks to raise additional capital in order
to remain in the category to which they are assigned currently under
the OCC's prompt corrective action framework. The OCC believes that the
costs associated with raising this new capital are below the thresholds
prescribed in the Executive Order. Nonetheless, the impact of any final
rule resulting from this proposal will depend on factors for which the
agencies do not currently collect industry-wide information, such as
the
[[Page 12332]]
proportion of bank-provided direct credit substitutes that would be
rated below investment grade. The OCC, therefore, welcomes any
quantitative information national banks wish to provide about the
impact they expect the various portions of this proposal to have if
issued in final form.
OTS: The Director of the OTS has determined that this proposal does
not constitute a ``significant regulatory action'' under Executive
Order 12866. Since OTS already applies a ``gross up'' treatment for
recourse obligations and for most direct credit substitutes, the
proposal generally is likely to reduce the risk-based capital
requirements for thrifts. The proposed rule would increase capital
requirements only for certain direct credit substitutes issued in
connection with asset securitizations or for thrifts that may serve as
sponsors of revolving securitization programs. Currently, thrifts
rarely participate in such activities. As a result, OTS has concluded
that the proposal will have only minor effects on the thrift industry.
IX. OCC and OTS--Unfunded Mandates Reform Act of 1995
Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
104-4, (Unfunded Mandates Act), requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
Federal mandate that may result in the expenditure by state, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year. If a budgetary impact statement is
required, section 205 of the Unfunded Mandates Act also requires an
agency to identify and consider a reasonable number of regulatory
alternatives before promulgating a rule. The OCC and OTS have
determined that this proposed rule will not result in expenditures by
state, local, and tribal governments, or by the private sector, of more
than $100 million or more in any one year. Therefore, the OCC and OTS
have not prepared a budgetary impact statement or specifically
addressed the regulatory alternatives considered. As discussed in the
preamble, this proposal will reduce inconsistencies in the agencies'
risk-based capital standards and, in certain circumstances, will allow
banking organizations to maintain lower amounts of capital against
certain rated recourse obligations and direct credit substitutes.
X. Plain Language Requirement
Section 722 of the Gramm-Leach-Bliley Act of 1999 requires the
federal banking agencies to use ``plain language'' in all proposed and
final rules published after January 1, 2000. We invite your comments on
how to make this proposal easier to understand. For example:
(1) Have we organized the material to suit your needs?
(2) Are the requirements in the rule clearly stated?
(3) Does the rule contain technical language or jargon that isn't
clear?
(4) Would a different format (grouping and order of sections, use
of headings, paragraphing) make the rule easier to understand?
(5) Would more (but shorter) sections be better?
(6) What else could we do to make the rule easier to understand?
XI. FDIC Assessment of Impact of Federal Regulation on Families
The FDIC has determined that this proposed rule will not affect
family well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act of 1999 (Pub. Law 105-277).
List of Subjects
12 CFR Part 3
Administrative practice and procedure, Capital, National banks,
Reporting and recordkeeping requirements, Risk.
12 CFR Part 208
Accounting, Agriculture, Banks, Banking, Confidential business
information, Crime, Currency, Federal Reserve System, Mortgages,
Reporting and recordkeeping requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, Banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Bank deposit insurance,
Banks, Banking, Capital adequacy, Reporting and recordkeeping
requirements, Savings associations, State non-member banks.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set out in the preamble, part 3 of chapter I of
title 12 of the Code of Federal Regulations is proposed to be amended
as follows:
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 1835, 3907, and 3909.
Sec. 3.4 [Amended]
2. In Sec. 3.4:
A. The undesignated paragraph is designated as paragraph (a);
B. The second sentence in the newly designated paragraph (a) is
revised; and
C. New paragraph (b) is added to read as follows:
Sec. 3.4 Reservation of authority.
(a) * * * Similarly, the OCC may find that a particular intangible
asset need not be deducted from Tier 1 or Tier 2 capital. * * *
(b) Notwithstanding the risk categories in section 3 of appendix A
to this part, the OCC may find that the assigned risk weight for any
asset or the credit equivalent amount or credit conversion factor for
any off-balance sheet item does not appropriately reflect the risks
imposed on a bank and may require another risk weight, credit
equivalent amount, or credit conversion factor that the OCC deems
appropriate. Similarly, if no risk weight, credit equivalent amount, or
credit conversion factor is specifically assigned, the OCC may assign
any risk weight, credit equivalent amount, or credit conversion factor
that the OCC deems appropriate. In making its determination, the OCC
considers risks associated with the asset or off-balance sheet item as
well as other relevant factors.
Appendix A to Part 3--[Amended]
3. In section 3 of appendix A:
A. Footnote 11a in paragraph (a)(3)(v) is revised;
B. Paragraph (b) introductory text is amended by adding a new
sentence at its end;
C. Paragraph (b)(1)(i) and footnote 13 are removed and reserved;
D. Paragraph (b)(1)(ii) is revised;
E. Paragraph (b)(1)(iii) and footnote 14 are removed and
reserved;
[[Page 12333]]
F. Footnotes 16 and 17 in paragraphs (b)(2)(i) and (ii),
respectively, are revised; and
G. Paragraph (d) is revised to read as follows:
Appendix A to Part 3--Risk-Based Capital Guidelines
* * * * *
Sec. 3 Risk Categories/Weights for On-Balance Sheet Assets and Off-
Balance Sheet Items
* * * * *
(a) * * *
(3) * * *
(v) * * * \11a\
---------------------------------------------------------------------------
\11a\ The portion of multifamily residential property loans that
is sold subject to a pro rata loss sharing arrangement may be
treated by the selling bank as sold to the extent that the sales
agreement provides for the purchaser of the loan to share in any
loss incurred on the loan on a pro rata basis with the selling bank.
The portion of multifamily residential property loans sold subject
to any loss sharing arrangement other than pro rata sharing of the
loss shall be accorded the same treatment as any other asset sold
under an agreement to repurchase or sold with recourse under section
3(d)(2) of this appendix A.
---------------------------------------------------------------------------
* * * * *
(b) * * * However, direct credit substitutes, recourse
obligations, and securities issued in connection with asset
securitizations are treated as described in section 3(d) of this
appendix A.
(1) * * *
(ii) Risk participations purchased in bankers' acceptances.
* * * * *
(2) * * *
(i) * * * \16\ * * *
---------------------------------------------------------------------------
\16\ Participations in performance-based standby letters of
credit are treated in accordance with section 3(d) of this appendix
A.
---------------------------------------------------------------------------
(ii) * * * \17\ * * *
---------------------------------------------------------------------------
\17\ Participations in commitments are treated in accordance
with section 3(d) of this appendix A.
---------------------------------------------------------------------------
* * * * *
(d) Recourse obligations, direct credit substitutes, and asset-
backed securities--(1) Definitions. For purposes of this section 3
of this appendix A:
(i) Covered 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 absorb losses arising from credit risk in the
assets transferred or the loans serviced. Covered 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.
(ii) Credit derivative means a contract that allows one party
(the beneficiary) to transfer the credit risk of an asset or off-
balance sheet credit exposure to another party (the guarantor). The
value of a credit derivative is dependent, at least in part, on the
credit performance of a ``reference asset.''
(iii) Direct credit substitute means an arrangement in which a
bank assumes credit risk associated with an on-or off-balance sheet
asset 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 risk of
credit loss is a direct credit substitute. Direct credit substitutes
include:
(A) Financial guarantee-type standby letters of credit that
support financial claims on a third party that exceed a bank's pro
rata share in the financial claim;
(B) Guarantees, surety arrangements, credit derivatives and
similar instruments backing financial claims that exceed a bank's
pro rata share in the financial claim;
(C) Purchased subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(D) 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;
(E) Loans or lines of credit that provide credit enhancement for
the securitization activities of a third party; and
(F) Purchased loan servicing assets if the servicer is
responsible for credit losses or if the servicer makes or assumes
covered representations and warranties with respect to the loans
serviced. Cash advances described in section 4(d)(1)(vii) of this
appendix A are not direct credit substitutes.
(iv) Externally rated means that an instrument or obligation has
received a credit rating from at least one 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 guarantee-type standby letter of credit means a
letter of credit or similar arrangement that represents an
irrevocable obligation to a third-party beneficiary:
(A) To repay money borrowed by, or advanced to, or for the
account of, a second party (the account party); or
(B) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(vii) Mortgage servicer cash advance means funds that a 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:
(A) 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
(B) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an
insignificant amount.
(viii) 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.
(ix) Recourse means the retention, by a bank, of any risk of
credit loss directly or indirectly associated with a transferred
asset that exceeds a pro rata share of that 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 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:
(A) Making covered representations and warranties on transferred
assets;
(B) Retaining loan servicing assets pursuant to an agreement
under which the bank will be responsible for losses associated with
the loans serviced. Mortgage servicer cash advances, as defined in
section 4(d)(1)(vii) of this appendix A, are not recourse
arrangements;
(C) Retaining a subordinated interest that absorbs more than its
pro rata share of losses from the underlying assets;
(D) Selling assets under an agreement to repurchase, if the
assets are not already included on the balance sheet; and
(E) Selling loan strips without contractual recourse where the
maturity
[[Page 12334]]
of the transferred portion of the loan is shorter than the maturity
of the whole loan.
(x) 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.
(xi) Securitization means the pooling and repackaging of assets
or other credit exposures into securities that can be sold to
investors, including transactions that create stratified credit risk
positions.
(xii) Traded position means a recourse obligation, direct credit
substitute or asset-backed security retained, assumed or issued in
connection with a securitization that is externally rated, where
there is an expectation that, in the near future, the rating will be
relied upon by:
(A) Investors to purchase the position; or
(B) A third party to enter into a transaction involving the
position, such as a purchase, loan or repurchase agreement.
(2) Credit equivalent amounts and risk weights of recourse
obligations and direct credit substitutes--(i) Credit-equivalent
amount. Except as provided in sections 3(d)(3) and (4) of this
appendix A, 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.
(ii) 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.
(3) 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:
(i) 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 institution 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.
(ii) In the case of a direct credit substitute in which the bank
has acquired a risk participation, the acquiring bank's percentage
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.
(iii) In the case of a direct credit substitute that takes 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'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.
(4) Externally rated positions: Credit-equivalent amounts and
risk weights.--(i) Traded positions. With respect to a recourse
obligation, direct credit substitute, or asset-backed security that
is a ``traded position'' and that has received an external rating
that is one grade below investment grade or better, the bank shall
multiply the face amount of the position by the appropriate risk
weight, determined in accordance with Table B. \24\
---------------------------------------------------------------------------
\24\ Stripped mortgage-backed securities, such as interest-only
or principal-only strips, may be assigned only, at a minimum, to the
100% risk category.
Table B
------------------------------------------------------------------------
Risk weight
Rating category Examples (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 grade BB.................... 200
------------------------------------------------------------------------
(ii) Non-traded positions. A recourse obligation or direct
credit substitute extended in connection with a securitization that
is not a ``traded position'' is assigned a risk weight in accordance
with section 3(d)(4)(i) of this appendix A if:
(A) It has been externally rated one category below investment
grade or better by two NRSROs;
(B) The ratings are publicly available; and
(C) The ratings are based on the same criteria used to rate
securities sold to the public. If the two ratings are different, the
lower rating will determine the risk category to which the recourse
obligation or direct credit substitute will be assigned.
(5) Senior positions not externally rated. For a recourse
obligation, direct credit substitute, or asset-backed security that
is not externally rated but is senior in all credit-risk related
features to a traded position (including collateralization), a bank
may apply a risk weight to the face amount of the senior position in
accordance with section 3(d)(4)(i) of this appendix A, based upon
the traded position, subject to the bank satisfying the OCC that
this treatment is appropriate.
(6) Direct credit substitutes that are not externally rated. A
direct credit substitute extended in connection with a
securitization that is not externally rated may risk weight the face
amount of the direct credit substitute based on the bank's
determination of the credit rating of the position, as specified in
Table C. In order to qualify for this treatment, the bank's system
for determining the credit rating of the direct credit substitute
must meet one of the three alternative standards set out in section
3(d)(6)(i) through (iii) of this appendix A.
[[Page 12335]]
Table C
------------------------------------------------------------------------
Risk weight
Rating category Examples (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 grade BB.................... 200
------------------------------------------------------------------------
(i) Internal risk rating used for asset-backed programs. The
direct credit substitute is issued in connection with an asset-
backed commercial paper program sponsored by the bank and the bank's
internal credit risk rating system is adequate. Adequate internal
credit risk rating systems usually contain the following criteria:
\25\
---------------------------------------------------------------------------
\25\ The adequacy of a bank's use of its internal credit risk
rating system must be demonstrated to the OCC considering the
criteria listed in this section and the size and complexity of the
credit exposures assumed by the bank.
---------------------------------------------------------------------------
(A) 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;
(B) 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;
(C) 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;
(D) The bank's internal credit risk system must identify
gradations of risk among ``pass'' assets and other risk positions;
(E) The bank must have clear, explicit criteria that are used to
classify assets into each internal risk grade, including subjective
factors;
(F) The bank must have independent credit risk management or
loan review personnel assigning or reviewing the credit risk
ratings;
(G) An internal audit procedure should periodically verify that
internal risk ratings are assigned in accordance with the banking
organization's established criteria.
(H) 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
(I) 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. The direct credit substitute is issued in
connection with a securitization program and a NRSRO (or other
entity satisfactory to the OCC) has reviewed the terms of the
securitization 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 or other entity 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.
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. In addition,
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 direct credit substitute
issued by the bank. 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.
(iii) Computer program. The bank is using an acceptable credit
assessment computer program to determine the rating of a direct
credit substitute extended in connection with a securitization. A
NRSRO (or another entity approved by the OCC) 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.
(7) Off-balance sheet securitized assets subject to early
amortization. An asset that is sold by a bank into a revolving
securitization sponsored by the bank, notwithstanding such sale,
shall be converted to an on-balance sheet credit equivalent using a
100% conversion factor, and assigned to the 20 percent risk-weight
category, if the securitization has an early amortization
feature.\26\ The total capital requirement for these assets,
including capital charges arising from any retained recourse or
direct credit substitute, may not exceed 8% of the amount of the
assets in the securitization.
---------------------------------------------------------------------------
\26\ This requirement does not apply to interests that the
seller has retained.
---------------------------------------------------------------------------
(8) Limitations on risk-based capital requirements--(i) Low-
level exposure rule. If the maximum contractual liability or
exposure to loss retained or assumed by a bank is less than the
effective risk-based capital requirement 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 liability, less any
recourse liability account established in accordance with generally
accepted accounting principles.
(ii) Related on-balance sheet assets. If an asset is included in
the calculation of the risk-based capital requirement under this
section 3(d) 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 3(d) 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 are incorporated into the risk-based
capital calculation.
* * * * *
4. In appendix A, Table 2, ``100 Percent Conversion Factor,''
Item 1 is revised to read as follows:
* * * * *
Table 2--Credit Conversion Factors for Off-Balance Sheet Items
100 Percent Conversion Factor
1. [Reserved]
* * * * *
Dated: February 9, 2000.
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
proposed to be 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, 36, 92(a), 93(a), 248(a), 248(c), 321-
338a, 371d, 461, 481-486,
[[Page 12336]]
601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j), 1828(o), 1831,
1831o, 1831p-1, 1831r-1, 1835(a), 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 to section II. are revised;
B. A new undesignated fifth paragraph is added at the end of
section III.A;
C. In section III.B., paragraph 3 is revised and footnote 23 is
removed, and in paragraph 4, footnote 24 is removed;
D. In section III.C., paragraphs 1 through 3, footnotes 25 through
37 are redesignated as footnotes 23 through 35, and paragraph 4 is
revised;
E. In section III.D., the introductory paragraph and paragraph 1
are revised;
F. In sections III.D. and III.E., footnote 46 is removed and
footnotes 47 through 51 are redesignated as footnotes 44 through 48;
and
G. In section IV.B., footnote 52 is removed.
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 liability 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 liability to liabilities explicitly treated in the guidelines,
the ability of the liability to absorb losses while the bank
operates as a going concern, the maturity and redemption features of
the liability, 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.
---------------------------------------------------------------------------
* * * * *
III. * * *
A. * * *
The Federal Reserve will, on a case-by-case basis, determine the
appropriate risk weight for any asset or the 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 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 the terms of
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, 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. Use of the term ``asset securitizations'' or
``securitizations'' in this rule includes structured financings, as
well as asset securitization transactions.
a. Definitions--(i) Credit derivatives are on-or off-balance
sheet notes or contracts that allow one party (the ``beneficiary'')
to transfer the credit risk of a ``reference asset,'' which it often
owns, to another party (the ``guarantor''). The value of a credit
derivative is dependent, at least in part, on the credit performance
of the reference asset, which typically is a publicly traded loan or
corporate bond.
(ii) Credit-enhancing representations and warranties means
representations and warranties extended by a bank when it transfers
assets (including loan servicing assets) or assumed by the bank when
it purchases loan servicing assets that obligate the bank to absorb
credit losses on transferred assets or serviced loans. These
representations and warranties typically arise when the bank agrees
to protect purchasers or some other party from losses due to the
default or nonperformance of the obligor on the transferred assets
or serviced loans, or insufficiency in the value of collateral
supporting the transferred assets or serviced loans.
(iii) Direct credit substitute means an arrangement in which a
bank assumes, in form or in substance, any risk of credit loss
directly or indirectly associated with a third-party asset or other
financial claim, that exceeds the bank's pro rata share of the asset
or claim. If the bank has no claim on the asset, then the assumption
of any risk of loss is a direct credit substitute. Direct credit
substitutes include, but are not limited to:
(1) Financial guarantee-type standby letters of credit that
support financial claims on the account party;
(2) Guarantees, surety arrangements, credit derivatives, and
irrevocable guarantee-type instruments backing financial claims such
as outstanding securities, loans, or other financial liabilities, or
that back off-balance sheet items against which risk-based capital
must be maintained;
(3) Purchased subordinated interests or securities that absorb
more than their pro rata share of losses from the underlying assets;
(4) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party; and
(5) Purchased loan servicing assets if the servicer is
responsible for credit losses associated with the loans being
serviced (other than mortgage servicer cash advances as defined in
paragraph III.B.3.a.(vi) of this section), or if the servicer makes
or assumes credit-enhancing representations and warranties with
respect to the serviced loans.
(iv) Externally rated means, with respect to an instrument or
obligation, that the instrument or obligation has received a credit
rating from a nationally-recognized statistical rating organization.
(v) Financial guarantee-type standby letter of credit means any
letter of credit or similar arrangement, however named or described,
that represents an irrevocable obligation to the beneficiary on the
part of the issuer:
(1) To repay money borrowed by, advanced to, or for the account
of, the account party; or
(2) To make payment on account of any indebtedness undertaken by
the account party in the event that the account party fails to
fulfill its obligation to the beneficiary.
(vi) Mortgage servicer cash advance means funds that a
residential mortgage loan 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 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.
(vii) Nationally recognized statistical rating organization
means an entity recognized by the Division of Market Regulation of
the Securities and Exchange Commission as a nationally recognized
statistical rating organization for various purposes, including the
Commission's uniform net capital requirements for brokers and
dealers (17 CFR 240.15c3-1(c)(2)(vi)(E), (F), and (H)).
(viii) Recourse means an arrangement in which a bank retains, in
form or in
[[Page 12337]]
substance, any risk of credit loss directly or indirectly associated
with a transferred asset 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 loss is recourse. A recourse
obligation typically arises when an institution transfers assets 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. Recourse
obligations include, but are not limited to:
(1) Credit-enhancing representations and warranties on the
transferred assets that obligate the servicer to absorb credit
losses, including early-default clauses;
(2) Retained loan servicing assets if the servicer is
responsible for losses associated with the loans being serviced
other than mortgage servicer cash advances as defined in paragraph
III.B.3.a.(vi) of this section.
(3) Retained subordinated interests or securities or credit
derivatives 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; and
(5) Loan strips sold without direct recourse where the maturity
of the transferred loan that is drawn is shorter than the maturity
of the commitment.
(ix) Securitization means the pooling and repackaging of loans
or other credit exposures into securities that can be sold to
investors. For purposes of this appendix A, securitization also
includes structured finance transactions or programs that generally
create stratified credit risk positions whose performance is
dependent upon an underlying pool of credit exposures, including
loans and commitments.
(x) Traded position means a recourse obligation, direct credit
substitute, or asset-or mortgage-backed security that is retained,
assumed, or issued in connection with an asset securitization and
that is rated with a reasonable expectation that, in the near
future:
(1) The position would be sold to investors relying on the
rating; or
(2) A third party would, in reliance on the rating, enter into a
transaction such as a purchase, loan, or repurchase agreement
involving the position.
b. Amount of position to be included in risk-weighted assets.
Other types of recourse obligations or direct credit substitutes,
other than those listed in section III.B.3.b.(i)(1) through (7) of
this appendix A, should be treated in accordance with the principles
contained in section III.B.3. of this appendix A. 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 A.
(i) General rule for determining the credit equivalent amount
and risk weight of recourse obligations and direct credit
substitutes. Except as otherwise provided in section III of this
appendix A, the risk weighted asset amount or the credit equivalent
amount for a recourse obligation or direct credit substitute is the
full amount of the credit enhanced assets from which risk of credit
loss is directly or indirectly retained or assumed. This credit
equivalent amount is assigned to the risk weight category
appropriate to the obligor or, if relevant, the guarantor or nature
of any collateral. Thus, a bank that extends a partial direct credit
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. Furthermore,
for direct credit substitutes that are on-balance sheet assets,
e.g., purchased subordinated securities, banks must maintain capital
against the amount of the direct credit substitutes and the full
amount of the assets being supported, i.e., all more senior
positions. This treatment is subject to the low-level capital rule
discussed in section III.B.3.c.i. of this appendix A. For purposes
of this appendix A, the full amount of the credit enhanced assets
from which risk of credit loss is directly or indirectly retained or
assumed means for:
(1) A financial guarantee-type standby letter of credit, surety
arrangement, credit derivative, guarantee, or irrevocable guarantee-
type instruments, the full amount of the assets that the direct
credit substitute fully or partially supports;
(2) A subordinated interest or security, the amount of the
subordinated interest or security plus all more senior interests or
securities;
(3) Mortgage servicing assets that are recourse obligations or
direct credit substitutes, the outstanding amount of the loans
serviced;
(4) Credit-enhancing representations and warranties, the amount
of the assets subject to the representations or warranties;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party, the full amount of
the enhanced financial obligations;
(6) Loans strips, the amount of the loans; and
(7) For assets sold with recourse, the amount of assets for
which risk of loss is directly or indirectly retained, less any
applicable recourse liability account established in accordance with
generally accepted accounting principles.
(ii) Determining the credit risk weight of recourse obligations,
direct credit substitutes, and asset- and mortgage-backed securities
that are rated within one of the five highest rating categories. (1)
A traded position is eligible for the risk-based capital treatment
described in this paragraph if its external rating is within one of
the five highest rating categories, e.g., AAA through BB, used by a
nationally-recognized statistical rating organization. A recourse
obligation, direct credit substitute, or asset- or mortgage-backed
security which is not externally rated but is senior in all respects
to a traded position that is externally rated, including access to
any collateral, is also eligible for the risk-based capital
treatment described in this paragraph III.B.3.b.(ii) as if it had
the same rating as the traded position. This treatment for the
unrated senior position is subject to current and prospective
supervisory guidance on a case-by-case basis.
(A) Two highest investment grades. Except as otherwise provided
in section III. of this appendix A, the face amount of a recourse
obligation, direct credit substitute, or an asset- or mortgage-
backed security that is rated in either of the two highest
investment grade categories, e.g., AAA or AA, is assigned to the 20
percent risk category.
(B) Third highest investment grade. Except as otherwise provided
in this section III. of this appendix A, the face amount of a
recourse obligation, direct credit substitute, or an asset-or
mortgage-backed security that is rated in the third highest
investment grade category, e.g., A, is assigned to the 50 percent
risk category.
(C) Lowest investment grade. Except as otherwise provided in
this section III. of this appendix A, the face amount of a recourse
obligation, direct credit substitute, or an asset-or mortgage-backed
security that is rated in the lowest investment grade category,
e.g., BBB, is assigned to the 100 percent risk category.
(D) One category below investment grade. Except as otherwise
provided in this section III. of this appendix A, the face amount of
a recourse obligation, direct credit substitute, or an asset-or
mortgage-backed security that is rated in the next lower category
below the lowest investment grade category, e.g., BB, is assigned a
200 percent risk weight.
(2) Nontraded recourse obligations, direct credit substitutes,
or asset-or mortgage-backed securities that are retained, assumed or
issued in connection with an asset securitization also are eligible
for the treatment described in this paragraph III.B.3.b.(ii) if they
are externally rated within one of the five highest rating
categories by two nationally-recognized statistical rating
organizations, the ratings are publicly available, and the ratings
are based on the same criteria used to rate securities sold to the
public.
(3) A direct credit substitute extended in connection with an
asset securitization that is not a traded position and is not
externally rated by a nationally-recognized statistical rating
organization (such as a letter of credit) may be eligible for the
treatment described in section III.B.3.b.(ii)(1)(C) and (D) of this
appendix A, i.e., a minimum risk weight of 100 percent, if it
satisfies the criteria of one of the following approaches deemed
appropriate for the institution by the Federal Reserve:
(A) A bank, under its qualifying internal risk rating system,
assigns an internal rating to a direct credit substitute extended to
an asset-backed commercial paper program that is equivalent to an
external credit rating one category below investment grade or higher
provided by a nationally recognized statistical rating organization.
A qualifying internal risk rating system must be reviewed and deemed
appropriate by the Federal Reserve and must satisfy the following
criteria and any other prudential standards that the Federal Reserve
determines are necessary. Qualifying internal risk rating systems at
a minimum must:
[[Page 12338]]
(i) Be an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from a
bank's participation in securitization activities;
(ii) Link the internal ratings 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) Separately consider the risk associated with the
underlying loans or borrowers, and the risk associated with the
structure of a particular securitization transaction;
(iv) Identify gradations of risk among ``pass'' assets and other
risk positions;
(v) Have clear, explicit criteria that are used to classify
assets into each internal risk grade, including subjective factors;
(vi) Have independent credit risk management or loan review
personnel assigning or reviewing the credit risk ratings;
(vii) Have an internal audit procedure that periodically
verifies that the internal credit risk ratings are assigned in
accordance with the established criteria;
(viii) Monitor the performance of the internal ratings assigned
to nonrated nontraded direct credit substitutes over time to
determine the appropriateness of the initial rating assignment and
adjust individual ratings accordingly; and
(ix) Be consistent with, or more conservative than, the rating
assumptions and methodologies of nationally recognized statistical
rating organizations.
(B) A bank's direct credit substitute extended to a
securitization or structured finance program is reviewed by a
nationally recognized statistical rating organization, in
conjunction with a review of the overall program, and is assigned a
rating or its equivalent. If the program has options for different
combinations of assets, standards, internal credit enhancements, and
other relevant factors, the rating organization may specify ranges
of rating categories that may apply premised on which options are
utilized by the bank's risk position. The bank must demonstrate to
the Federal Reserve that the nationally recognized statistical
rating organization's programmatic rating for its risk position
generally meets the same standards used by the rating organization
for rating traded positions, and that the rating organization's
underlying premises are satisfied for particular direct credit
substitutes issued by the bank. If a bank participates in a
securitization or structured finance program 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.
(C) A bank may rate its credit risk exposure to direct credit
substitutes by relying on a qualifying credit assessment computer
program. A nationally recognized statistical rating agency or other
acceptable third party must have developed such a credit assessment
system for determining the credit risk of direct credit substitutes
and other stratified credit positions. Banks must demonstrate to the
Federal Reserve that ratings under such a credit assessment computer
program correspond credibly and reliably with the ratings assigned
by the rating agencies to publicly traded securities.
(iii) Determining the credit risk weight for off-balance sheet
securitized assets that are subject to early amortization
provisions. If a bank securitizes revolving assets, such as credit
cards, home equity lines, or commercial loans issued under lines of
credit, in a securitization transaction that it has sponsored and
which includes early amortization provisions, then the sponsoring
bank must maintain risk-based capital against the off-balance sheet
securitized assets from the inception of the transaction. An early
amortization feature is a provision that, under specified
conditions, returns principal to investors prior to the expected
payment dates and generally is a result of a deteriorating
portfolio. The securitized, off-balance sheet assets are to be
converted to an on-balance sheet credit equivalent amount using the
100 percent conversion factor and assigned to the 20 percent risk
category. However, this capital requirement, when combined with the
capital requirements for any retained recourse or direct credit
substitute associated with the securitized assets, is limited to a
total of 8 percent of the off-balance sheet securitized assets.
c. Limitations on risk-based capital requirements. (i) Low-level
exposure. If the maximum contractual liability or 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
liability or exposure to loss, less any liability account
established in accordance with generally accepted accounting
principles. This limitation does not apply to assets sold with
implicit recourse.
(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 an on-balance sheet asset.
(iii) Related on-balance sheet assets. If a recourse obligation
or direct credit substitute subject to section III.B.3. of this
appendix A 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 the latter cases, 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.\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, 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).
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\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 subsidiary depository institutions.
\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.
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c. Also included in this category are industrial-development
bonds and similar obligations issued under the auspices of state 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
[[Page 12339]]
conversion factor, except for direct credit substitutes and recourse
obligations as discussed in section III.D.1. of this appendix A. 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 A sets forth the conversion factors for various types of
off-balance sheet items.
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\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.
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1. Items with a 100 percent conversion factor. a. Except as
otherwise provided in section III.B.3. 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 III.B.3.
of this appendix A.
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.
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\39\ Forward forward deposits accepted are treated as interest
rate contracts.
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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\
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\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.
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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\
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\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.
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* * * * *
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), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
2. In appendix A to part 225:
A. The three introductory paragraphs to section II. are revised;
B. A new fifth undesignated paragraph is added to section III.A.;
C. In section III.B., paragraph 3 is revised and footnote 26 is
removed, and in paragraph 4 footnote 27 is removed;
D. In section III.C., paragraphs 1 through 3, footnotes 28 through
40 are redesignated as footnotes 26 through 38, and paragraph 4 is
revised;
E. In section III.D., the introductory paragraph and paragraph 1
are revised; and
F. In section III.D. and III.E., footnote 50 is removed and
footnotes 51 through 57 are redesignated as footnotes 47 through 53.
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 liability 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 liability to liabilities explicitly treated in the guidelines,
the ability of the liability to absorb losses while the institution
operates as a going concern, the maturity and redemption features of
the liability, 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
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\
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\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.
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* * * * *
III. * * *
A. * * *
[[Page 12340]]
The Federal Reserve will, on a case-by-case basis, determine the
appropriate risk weight for any asset or the 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 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 the terms of
one of the credit conversion factors set forth below or that imposes
risks on an institution 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, 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. Use of the term ``asset securitizations'' or
``securitizations'' in this rule includes structured financings, as
well as asset securitization transactions.
a. Definitions. (i) Credit derivatives are on-or off-balance
sheet notes or contracts that allow one party (the ``beneficiary'')
to transfer the credit risk of a ``reference asset,'' which it often
owns, to another party (the ``guarantor''). The value of a credit
derivative is dependent, at least in part, on the credit performance
of the reference asset, which typically is a publicly traded loan or
corporate bond.
(ii) Credit-enhancing representations and warranties means
representations and warranties extended by a bank when it transfers
assets (including loan servicing assets) or assumed by the bank when
it purchases loan servicing assets that obligate the bank to absorb
credit losses on transferred assets or serviced loans. These
representations and warranties typically arise when the bank agrees
to protect purchasers or some other party from losses due to the
default or nonperformance of the obligor on the transferred assets
or serviced loans, or insufficiency in the value of collateral
supporting the transferred assets or serviced loans.
(iii) Direct credit substitute means an arrangement in which a
banking organization assumes, in form or in substance, any risk of
credit loss directly or indirectly associated with a third-party
asset or other financial claim, that exceeds the banking
organization's pro rata share of the asset or claim. If the banking
organization has no claim on the asset, then the assumption of any
risk of loss is a direct credit substitute. Direct credit
substitutes include, but are not limited to:
(1) Financial guarantee-type standby letters of credit that
support financial claims on the account party;
(2) Guarantees, surety arrangements, credit derivatives, and
irrevocable guarantee-type instruments backing financial claims such
as outstanding securities, loans, or other financial liabilities, or
that back off-balance sheet items against which risk-based capital
must be maintained;
(3) Purchased subordinated interests or securities that absorb
more than their pro rata share of losses from the underlying assets;
(4) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party; and
(5) Purchased loan servicing assets if the servicer is
responsible for credit losses associated with the loans being
serviced (other than mortgage servicer cash advances as defined in
paragraph III.B.3.a.(vi) of this appendix A), or if the servicer
makes or assumes credit-enhancing representations and warranties
with respect to the serviced loans.
(iv) Externally rated means, with respect to an instrument or
obligation, that the instrument or obligation has received a credit
rating from a nationally-recognized statistical rating organization.
(v) Financial guarantee-type standby letter of credit means any
letter of credit or similar arrangement, however named or described,
that represents an irrevocable obligation to the beneficiary on the
part of the issuer:
(1) To repay money borrowed by, advanced to, or for the account
of, the account party; or
(2) To make payment on account of any indebtedness undertaken by
the account party in the event that the account party fails to
fulfill its obligation to the beneficiary.
(vi) Mortgage servicer cash advance means funds that a
residential mortgage loan 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 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.
(vii) Nationally recognized statistical rating organization
means an entity recognized by the Division of Market Regulation of
the Securities and Exchange Commission as a nationally recognized
statistical rating organization for various purposes, including the
Commission's uniform net capital requirements for brokers and
dealers (17 CFR 240.15c3-1(c)(2)(vi)(E), (F), and (H)).
(viii) Recourse means an arrangement in which a banking
organization retains, in form or in substance, any risk of credit
loss directly or indirectly associated with a transferred asset 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 loss is recourse. A
recourse obligation typically arises when an institution transfers
assets 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 banking
organization provides credit enhancement beyond any contractual
obligation to support assets it has sold. Recourse obligations
include, but are not limited to:
(1) Credit-enhancing representations and warranties on the
transferred assets that obligate the servicer to absorb credit
losses, including early-default clauses;
(2) Retained loan servicing assets if the servicer is
responsible for losses associated with the loans being serviced
other than mortgage servicer cash advances as defined in paragraph
III.B.3.a.(v) of this appendix A.
(3) Retained subordinated interests or securities or credit
derivatives 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; and
(5) Loan strips sold without direct recourse where the maturity
of the transferred loan that is drawn is shorter than the maturity
of the commitment.
(ix) Securitization means the pooling and repackaging of loans
or other credit exposures into securities that can be sold to
investors. For purposes of this appendix A, securitization also
includes structured finance transactions or programs that generally
create stratified credit risk positions, whether in the form of a
security or not, whose performance is dependent upon an underlying
pool of credit exposures, including loans and commitments.
(x) Traded position means a recourse obligation, direct credit
substitute, or asset- or mortgage-backed security that is retained,
assumed, or issued in connection with an asset securitization and
that is rated with a reasonable expectation that, in the near
future:
(1) The position would be sold to investors relying on the
rating; or
(2) A third party would, in reliance on the rating, enter into a
transaction such as a purchase, loan, or repurchase agreement
involving the position.
b. Amount of position to be included in risk-weighted assets.
Types of recourse obligations or direct credit substitutes, other
than those listed in section III.B.3.b.(i)(1) through (7) of this
appendix A, should be treated in accordance with the principles
contained in section III.B.3 of this appendix A. 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 A.
(i) General rule for determining the credit equivalent amount
and risk weight of recourse obligations and direct credit
substitutes. Except as otherwise provided in section III of this
appendix A, the risk weighted asset amount or the credit equivalent
amount for a recourse obligation or direct credit substitute is the
full amount of the credit enhanced assets from which risk of credit
loss is directly or indirectly retained or assumed. This credit
equivalent amount is
[[Page 12341]]
assigned to the risk weight category appropriate to the obligor or,
if relevant, the guarantor or nature of any collateral. Thus, a
banking organization that extends a partial direct credit
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. Furthermore,
for direct credit substitutes that are on-balance sheet assets,
e.g., purchased subordinated securities, banking organizations must
maintain capital against the amount of the direct credit substitutes
and the full amount of the assets being supported, i.e., all more
senior positions. This treatment is subject to the low-level capital
rule discussed in section III.B.3.c.(i) of this appendix A. For
purposes of this appendix A, the full amount of the credit enhanced
assets from which risk of credit loss is directly or indirectly
retained or assumed means for:
(1) A financial guarantee-type standby letter of credit, surety
arrangement, credit derivative, guarantee, or irrevocable guarantee-
type instruments, the full amount of the assets that the direct
credit substitute fully or partially supports;
(2) A subordinated interest or security, the amount of the
subordinated interest or security plus all more senior interests or
securities;
(3) Mortgage servicing assets that are recourse obligations or
direct credit substitutes, the outstanding amount of the loans
serviced;
(4) Credit-enhancing representations and warranties, the amount
of the assets subject to the representations or warranties;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party, the full amount of
the enhanced financial obligations;
(6) Loans strips, the amount of the loans; and
(7) For assets sold with recourse, the amount of assets for
which risk of loss is directly or indirectly retained, less any
applicable recourse liability account established in accordance with
generally accepted accounting principles.
(ii) Determining the credit risk weight of recourse obligations,
direct credit substitutes, and asset- and mortgage-backed securities
that are rated within one of the five highest rating categories. (1)
A traded position is eligible for the risk-based capital treatment
described in this paragraph if its external rating is within one of
the five highest rating categories, e.g. AAA through BB, used by a
nationally-recognized statistical rating organization. A recourse
obligation, direct credit substitute, or asset- or mortgage-backed
security which is not externally rated but is senior in all respects
to a traded position that is externally rated, including access to
any collateral, is also eligible for the risk-based capital
treatment described in this paragraph III.B.3.b.(ii) as if it had
the same rating as the traded position. This treatment for the
unrated senior position is subject to current and prospective
supervisory guidance on a case-by-case basis.
(A) Two highest investment grades. Except as otherwise provided
in this section III. of this appendix A, the face amount of a
recourse obligation, direct credit substitute, or an asset- or
mortgage-backed security that is rated in either of two highest
investment grade categories, e.g., AAA or AA, is assigned to the 20
percent risk category.
(B) Third highest investment grade. Except as otherwise provided
in this section III. of this appendix A, the face amount of a
recourse obligation, direct credit substitute, or an asset- or
mortgage-backed security that is rated in the third highest
investment grade category, e.g., A, is assigned to the 50 percent
risk category.
(C) Lowest investment grade. Except as otherwise provided in
this section III. of this appendix A, the face amount of a recourse
obligation, direct credit substitute, or an asset- or mortgage-
backed security that is rated in the lowest investment grade
category, e.g., BBB, is assigned to the 100 percent risk category.
(D) One category below investment grade. Except as otherwise
provided in this section III. of this appendix A, the face amount of
a recourse obligation, direct credit substitute, or an asset- or
mortgage-backed security that is rated in the next lower category
below the lowest investment grade category, e.g., BB, is assigned to
the 200 percent risk category.
(2) Nontraded recourse obligations, direct credit substitutes,
or asset- or mortgage-backed securities that are retained, assumed,
or issued in connection with an asset securitization are also
eligible for the treatment described in this paragraph
III.B.3.b.(ii) if they are externally rated within one of the five
highest rating categories by two nationally-recognized statistical
rating organizations, the ratings are publicly available, and the
ratings are based on the same criteria used to rate securities sold
to the public.
(3) A direct credit substitute extended in connection with an
asset securitization that is not a traded position and is not
externally rated by a nationally-recognized statistical rating
organization (such as a letter of credit) may be eligible for the
treatment described in paragraph III.B.3.b.ii(1)(C) and (D), i.e., a
minimum risk weight of 100 percent, if it satisfies the criteria of
one of the following approaches deemed appropriate for the
organization by the Federal Reserve:
(A) A banking organization, under its qualifying internal risk
rating system, assigns an internal rating to a direct credit
substitute extended to an asset-backed commercial paper program that
is equivalent to an external credit rating one category below
investment grade or higher provided by a nationally recognized
statistical rating organization. A qualifying internal risk rating
system must be reviewed and deemed appropriate by the Federal
Reserve and must satisfy the following criteria and any other
prudential standards that the Federal Reserve determines are
necessary. Qualifying internal risk rating systems at a minimum
must:
(i) Be an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from a
banking organization's participation in securitization activities;
(ii) Link the internal ratings 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) Separately consider the risk associated with the
underlying loans or borrowers, and the risk associated with the
structure of a particular securitization transaction;
(iv) Identify gradations of risk among ``pass'' assets and other
risk positions;
(v) Have clear, explicit criteria that are used to classify
assets into each internal risk grade, including subjective factors;
(vi) Have independent credit risk management or loan review
personnel assigning or reviewing the credit risk ratings;
(vii) Have an internal audit procedure that periodically
verifies that the internal credit risk ratings are assigned in
accordance with the established criteria;
(viii) Monitor the performance of the internal ratings assigned
to nonrated nontraded direct credit substitutes over time to
determine the appropriateness of the initial rating assignment and
adjust individual ratings accordingly; and,
(ix) Be consistent with, or more conservative than, the rating
assumptions and methodologies of nationally recognized statistical
rating organizations.
(B) A banking organization's direct credit substitute extended
to a securitization or structured finance program is reviewed by a
nationally recognized statistical rating organization, in
conjunction with a review of the overall program, and is assigned a
rating or its equivalent. If the program has options for different
combinations of assets, standards, internal credit enhancements, and
other relevant factors, the rating organization may specify ranges
of rating categories that may apply premised on which options are
utilized by the bank's risk position. The banking organization must
demonstrate to the Federal Reserve that the nationally recognized
statistical rating organization's programmatic rating for its risk
position generally meets the same standards used by the rating
organization for rating traded positions, and that the rating
organization's underlying premises are satisfied for particular
direct credit substitutes issued by the institution. If a banking
organization participates in a securitization or structured finance
program sponsored by another party, the Federal Reserve may
authorize the institution to use this approach based on a
programmatic rating obtained by the sponsor of the program.
(C) An institution may rate its credit risk exposure to direct
credit substitutes by relying on a qualifying credit assessment
computer program. A nationally recognized statistical rating agency
or other acceptable third party must have developed such a credit
assessment system for determining the credit risk of direct credit
substitutes and other stratified credit positions. Institutions must
demonstrate to the Federal Reserve that ratings under such a credit
assessment computer program correspond credibly and reliably with
the ratings assigned by the rating agencies to publicly traded
securities.
(iii) Determining the credit risk weight for off-balance sheet
securitized assets that are subject to early amortization
provisions. If a
[[Page 12342]]
bank securitizes revolving assets, such as credit cards, home equity
lines, or commercial loans issued under lines of credit, in a
securitization transaction that it has sponsored and which includes
early amortization provisions, then the sponsoring bank must
maintain risk-based capital against the off-balance sheet
securitized assets from the inception of the transaction. An early
amortization feature is a provision that, under specified
conditions, returns principal to investors prior to the expected
payment dates and generally is a result of a deteriorating
portfolio. The securitized, off-balance sheet assets are to be
converted to an on-balance sheet credit equivalent amount using the
100 percent conversion factor and assigned to the 20 percent risk
category. However, this capital requirement, when combined with the
capital requirements for any retained recourse or direct credit
substitute associated with the securitized assets, is limited to a
total of 8 percent of the off-balance sheet securitized assets.
c. Limitations on risk-based capital requirements. (i) Low-level
exposure. If the maximum contractual liability or exposure to loss
retained or assumed by a banking organization 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 liability or exposure to loss, less any recourse
liability account established in accordance with generally accepted
accounting principles. This limitation does not apply to assets sold
with implicit recourse.
(ii) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a banking organization 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 banking organization continued to hold these
loans as an on-balance sheet asset.
(iii) Related on-balance sheet assets. If a recourse obligation
or direct credit substitute subject to section III.B.3. of this
appendix A also appears as a balance sheet asset, the balance sheet
asset is not included in a banking 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 the latter
cases, 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 bank 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).
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\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.
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c. Also included in this category are industrial-development
bonds and similar obligations issued under the auspices of state 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 A. 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.
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\41\ The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the
collateral of 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.
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1. Items with a 100 percent conversion factor. a. Except as
otherwise provided in section III.B.3. 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 III.B.3.
of this appendix A. 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 deposits placed,\42\ and partly-paid shares and securities;
they do not include commitments to make residential mortgage loans
or forward foreign exchange contracts.
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\42\ Forward deposits accepted are treated as interest
rate contracts.
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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 bank, or, the independent
custodian acting on the lending banking 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 the
banking organization 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
[[Page 12343]]
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\
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\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.
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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\
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\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.
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* * * * *
By order of the Board of Governors of the Federal Reserve
System, February 10, 2000.
Jennifer J. Johnson,
Secretary of the Board.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons set forth in the joint preamble, part 325 of
chapter III of title 12 of the Code of Federal Regulations is proposed
to be amended as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat.
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).
2. In appendix A to part 325, section II:
A. In paragraph A., the first two undesignated paragraphs are
designated 1. and 2. respectively;
B. A new paragraph A.3. is added;
C. Paragraph B. is amended by revising paragraph B.5.;
D. In paragraph C., Category 1--Zero Percent Risk Weight through
Category 3--50 Percent Risk Weight, footnotes 15 through 31 are
redesignated as footnotes 19 through 34;
E. In paragraph C., Category 2--20 Percent Risk Weight, the three
undesignated paragraphs are designated as paragraphs a. through c.,
respectively, and a new paragraph d. is added;
F. In paragraph C., Category 3--50 Percent Risk Weight, the third
undesignated paragraph is removed and the remaining three undesignated
paragraphs are designated as paragraphs a. through c., respectively;
G. In paragraph C., Category 3--50 Percent Risk Weight, newly
designated footnote 32 is revised;
H. In paragraph C., Category 4--100 Percent Risk Weight is revised;
I. In paragraph C., following the paragraph titled Category 4--100
Percent Risk Weight, a new paragraph titled Category 5--200 Percent
Risk Weight is added;
J. In paragraph D., the undesignated introductory paragraph is
revised;
K. Paragraph D.1. is revised;
L. In paragraph D.2., footnote 38 is removed; and
M. In paragraphs D.2. and E., footnotes 39 through 42 are
redesignated as footnotes 38 through 41.
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
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 below or that imposes risks on a bank
that are not commensurate with the risk weight otherwise specified
below 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 below or that imposes risks on a
bank that are not commensurate with the credit conversion factor
otherwise specified below 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 the
guidelines, as well as other relevant factors.
B. * * *
5. Recourse obligations, direct credit substitutes, and asset-
and mortgage-backed securities. Direct credit substitutes, assets
sold with recourse, and securities issued in connection with asset
securitizations are treated as described below.
(a) Definitions. (i) Credit derivative means an on-or off-
balance sheet note or contract that allows one party (the
``beneficiary'') to transfer the credit risk of a ``reference
asset,'' which the beneficiary often owns, to another party (the
``guarantor''). The value of a credit derivative is dependent, at
least in part, on the credit performance of the reference asset,
which typically is a publicly traded loan or corporate bond.
(ii) Credit-enhancing representations and warranties means
representations and warranties, extended by a bank when it transfers
assets (including loan servicing assets) or assumed by the bank when
it purchases loan servicing assets, that obligate the bank to
protect another party from losses due to credit risk in the
transferred assets or serviced loans. These representations and
warranties typically arise when the bank agrees to protect
purchasers or some other party from losses due to:
(1) The default or nonperformance of the obligor on the
transferred assets or serviced loans; or
(2) Insufficiency in the value of collateral supporting the
transferred assets or serviced loans.
(iii) Direct credit substitute means an arrangement in which a
bank assumes, in form or in substance, any risk of credit loss
directly or indirectly associated with a third-party asset or other
financial claim, that exceeds the bank's pro rata share of the asset
or claim. If the bank has no claim on the asset, then the assumption
of any risk of loss is a direct credit substitute. Direct credit
substitutes include, but are not limited to:
(1) Financial standby letters of credit, which includes any
letter of credit or similar arrangement, however named or described,
that represents an irrevocable obligation to the beneficiary on the
part of the issuer:
(a) To repay money borrowed by, advanced to, or for the account
of, the account party, or
(b) To make payment on account of any indebtedness undertaken by
the account party in the event that the account party fails to
fulfill its obligation to the beneficiary.
(2) Guarantees, surety arrangements, credit derivatives, and
irrevocable guarantee-type
[[Page 12344]]
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;
(3) Purchased subordinated interests or securities that absorb
more than their pro rata share of credit losses from the underlying
assets;
(4) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party; and
(5) Purchased loan servicing assets if the servicer is
responsible for credit losses associated with the loans being
serviced (other than mortgage servicer cash advances as defined in
paragraph B.5(a)(vi) of this section), or if the servicer makes or
assumes credit-enhancing representations and warranties on the
serviced loans.
(iv) Externally rated means, with respect to an instrument or
obligation, that the 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) Mortgage servicer cash advance means funds that a
residential mortgage loan 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, so long as the mortgage servicer
is entitled to full reimbursement or nonreimbursable advances are
contractually limited to an insignificant amount of the outstanding
principal for any one residential mortgage loan, and the servicer's
entitlement to reimbursement is not subordinated.
(vii) Nationally recognized statistical rating organization
means an entity recognized by the Division of Market Regulation of
the Securities and Exchange Commission as a nationally recognized
statistical rating organization for various purposes, including the
Commission's uniform net capital requirements for brokers and
dealers (17 CFR 240.15c3-1(c)(2)(vi)(E), (F), and (H)).
(viii) Recourse means an arrangement in which a bank retains, in
form or in substance, any risk of credit loss 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 an asset it has transferred and sold, then the retention of
any risk of credit loss 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. Recourse
obligations include, but are not limited to:
(1) Credit-enhancing representations and warranties on the
transferred assets;
(2) Retained loan servicing assets if the servicer is
responsible for credit losses associated with the loans being
serviced (including credit-enhancing representations and
warranties), other than mortgage servicer cash advances as defined
in paragraph B.5(a)(vi) of this section;
(3) Retained subordinated interests or securities, or credit
derivatives that absorb more than their pro rata share of credit
losses from the underlying assets;
(4) Assets sold under an agreement to repurchase, if the assets
are not already included on the balance sheet; and
(5) Loan strips sold without direct recourse where the maturity
of the transferred loan that is drawn is shorter than the maturity
of the commitment.
(ix) Securitization means the pooling and repackaging of loans
or other credit exposures into securities that can be sold to
investors. For purposes of this section II.B.5, securitization also
includes transactions or programs that generally create stratified
credit risk positions, whether in the form of a security or not,
whose performance is dependent upon an underlying pool of loans or
other credit exposures.
(x) Traded position means a recourse obligation, direct credit
substitute, or asset-or mortgage-backed security that is retained,
assumed, or issued in connection with an asset securitization and
that is externally rated with a reasonable expectation that, in the
near future:
(1) The position would be sold to investors relying on the
external rating; or
(2) A third party would, in reliance on the external rating,
enter into a transaction such as a purchase, loan, or repurchase
agreement involving the position.
(b) Amount of position to be included in risk-weighted assets--
(i) General rule for determining the credit equivalent amount and
risk weight of recourse obligations and direct credit substitutes.
Except as otherwise provided in this section II.B. of this appendix
A, the credit equivalent amount for a recourse obligation or direct
credit substitute is the full amount of the credit enhanced assets
from which risk of credit loss is directly or indirectly retained or
assumed by the bank. This credit equivalent amount is assigned to
the risk category appropriate to the obligor, or if relevant, the
guarantor or nature of any collateral. Thus, a bank that extends a
partial direct credit 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. Furthermore, for a direct credit substitute
that is an on-balance sheet asset, e.g., a purchased subordinated
security, a bank must maintain capital against the amount of the
direct credit substitute and the full amount of the assets being
supported, i.e., all more senior positions. This treatment is
subject to the low-level exposure rule discussed in section
II.B.5(c)(i) of this appendix A. For purposes of this appendix A,
the full amount of the credit enhanced assets from which risk of
credit loss is directly or indirectly retained or assumed means for:
(1) A financial standby letter of credit, surety arrangement,
credit derivative, guarantee, or irrevocable guarantee-type
instrument, the full amount of the assets that the direct credit
substitute fully or partially supports;
(2) A subordinated interest or security, the amount of the
subordinated interest or security plus all more senior interests or
securities;
(3) Loan servicing assets that are recourse obligations or
direct credit substitutes, the outstanding amount of the loans
serviced;
(4) Credit-enhancing representations and warranties, the amount
of the assets subject to the representations or warranties;
(5) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party, the full amount of
the enhanced financial obligations;
(6) Loans strips, the amount of the loans sold; and
(7) Assets sold with recourse, the full amount of the assets
from which risk of credit loss is directly or indirectly retained,
less any applicable recourse liability account established in
accordance with generally accepted accounting principles.
(ii) Participations in and syndications of direct credit
substitutes. Subject to the low-level exposure rule discussed in
section II.B.5(c)(i) of this appendix A:
(1) In the case of a direct credit substitute in which the bank
has conveyed a risk participation,\14\ the full amount of the assets
that are supported, in whole or in part, by the direct credit
substitute 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.\15\ 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 an OECD bank is assigned to the 20 percent risk
category.\16\
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\14\ 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.
\15\ A risk participation in a bankers acceptance conveyed to
another institution is also assigned to the risk category
appropriate to the institution acquiring the participation or, if
relevant, the guarantor or nature of the collateral.
\16\ 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.
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(2) In the case of a direct credit substitute in which the bank
has acquired a risk participation, 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
direct credit substitute and converted to a credit equivalent amount
at 100 percent. The resulting credit equivalent amount is
[[Page 12345]]
assigned to the risk category appropriate to the account party
obligor, guarantor, or collateral.
(3) In the case of a direct credit substitute that takes 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's credit equivalent amount will be only its pro rata
share of the assets supported, in whole or in part, by the direct
credit substitute. The resulting credit equivalent amount is
assigned to the risk category appropriate to the obligor, guarantor,
or collateral. \17\
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\17\ 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 to a private obligor, then the bank's $1 pro rata share
in the enhancement means that a $10 pro rata share of the loan is
included in the bank's risk weighted assets.
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(iii) Face-amount treatment for externally rated recourse
obligations, direct credit substitutes, and asset-and mortgage-
backed securities. (1) A traded position is eligible for the risk-
based capital treatment described in this paragraph II.B.5(b)(iii)
if its external rating is within one of the five highest rating
categories, e.g., AAA through BB, used by a nationally-recognized
statistical rating organization.
(a) Two highest investment grades. The face amount of a recourse
obligation, direct credit substitute, or an asset-or mortgage-backed
security that is rated in either of the two highest investment grade
categories, e.g., AAA or AA, is assigned to the 20 percent risk
category.
(b) Third highest investment grade. The face amount of a
recourse obligation, direct credit substitute, or an asset-or
mortgage-backed security that is rated in the third highest
investment grade category, e.g., A, is assigned to the 50 percent
risk category.
(c) Lowest investment grade. The face amount of a recourse
obligation, direct credit substitute, or an asset-or mortgage-backed
security that is rated in the lowest investment grade category,
e.g., BBB, is assigned to the 100 percent risk category.
(d) One category below investment grade. The face amount of a
recourse obligation, direct credit substitute, or an asset- or
mortgage-backed security that is rated in the next lower category
below the lowest investment grade category, e.g., BB, is assigned to
the 200 percent risk category.
(2) Other recourse obligations and direct credit substitutes
that are retained, assumed, or issued in connection with an asset
securitization are also eligible for the risk-based capital
treatment described in this paragraph II.B.5(b)(iii) if they are
externally rated by two nationally-rated statistical rating
organizations as falling within one of the five highest rating
categories used by the organizations, the ratings are publicly
available, and the ratings are based on the same criteria used to
rate traded positions.\18\ If the two ratings differ, the lower
rating will determine the risk category to which the recourse
obligation or direct credit substitute will be assigned.
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\18\ The bank must demonstrate to the FDIC's satisfaction that
the ratings are based on the same criteria that the ratings
organizations use to rate traded positions.
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(3) Stripped mortgage-backed securities (such as interest-only
or principal-only strips) may not be assigned to the 20 percent or
50 percent risk category under section II.B.5(b)(iii)(1)(a)-(b) of
this appendix A.
(4) A position which is not externally rated but is senior in
all respects to a traded position eligible for the risk-based
capital treatment described in section II.B.5(b)(iii)(1) of this
appendix A, including access to any collateral, will be eligible for
the risk-based capital treatment described in this paragraph
II.B.5(b)(iii) as if it had the same rating as the traded position,
if the bank can demonstrate to the FDIC's satisfaction that such
treatment is appropriate.
(iv) Face-amount treatment for direct credit substitutes which
are not externally rated. A direct credit substitute assumed or
issued in connection with an asset securitization which does not
qualify for face amount treatment under section II.B.5(b)(iii) of
this appendix A because it is not externally rated may still qualify
for face amount treatment, if the bank determines that the credit
risk of the direct credit substitute is equivalent to or better than
the external rating category set out at section II.B.5(b)(iii)(1)(d)
of this appendix A (e.g., BB). The face amount of a position which
the bank determines is equivalent to or better than the external
rating category set out at section II.B.5(b)(iii)(1)(c) of this
appendix A (e.g., BBB) must be assigned to the 100 percent risk
category, and a position equivalent to the external rating category
set out in section II.B.5(b)(iii)(1)(d) of this appendix A (e.g.,
BB) must be assigned to the 200 percent risk category. The bank's
determination may only be made pursuant to the following three
approaches, the use of which must be satisfactory to the FDIC:
(1) Internal risk ratings for asset-backed commercial paper
programs. A bank, under its internal risk rating system, assigns an
internal rating to a direct credit substitute the bank extends to
the asset-backed commercial paper program it sponsors, and the
rating is equivalent to or better than the rating category set out
at section B.5(b)(iii)(1)(d) of this appendix A (e.g., BB). The
internal risk rating system must be satisfactory to the FDIC and
must be prudent and appropriate for the size and complexity of the
bank's program. Adequate internal risk rating systems typically:
(a) are an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from a
bank's participation in securitization activities;
(b) link the internal ratings 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;
(c) separately consider the risk associated with the underlying
loans or borrowers and the risk associated with the structure of a
particular securitization transaction;
(d) identify gradations of risk among ``pass'' assets and other
risk positions;
(e) have clear, explicit criteria that are used to classify
assets into each internal risk grade, including criteria for
subjective factors;
(f) have independent credit risk management or loan review
personnel with adequate training assigning or reviewing the credit
risk ratings, subject to internal audit review to verify that
ratings are assigned in accordance with the bank's criteria;
(g) track the performance of the internal ratings over time and
make adjustments to the ratings system when the performance of rated
positions has a tendency to diverge from assigned ratings, and
adjust individual ratings accordingly; and,
(h) are consistent with, or more conservative than, the rating
assumptions and methodologies of nationally recognized statistical
rating organizations.
(2) Program ratings. If a nationally recognized statistical
rating organization or other entity satisfactory to the FDIC has
reviewed the terms of a securitization program and stated a rating
for direct credit substitutes to be issued under the program
equivalent to or better than the external rating category set out at
section II.B.5(b)(iii)(1)(d) of this appendix A (e.g., BB), a bank
may use such a rating for a direct credit substitute the bank issues
under the program. If the program has options for different
combinations of assets, standards, internal credit enhancements, and
other relevant factors, the rating organization or other entity may
specify ranges of rating categories that will apply premised on
which options correspond to the bank's position. The bank must
demonstrate to the FDIC's satisfaction that the program rating meets
the same standards generally used by nationally recognized
statistical rating organizations for rating traded positions, and
that the rating organization's or other entity's underlying premises
are satisfied for the particular direct credit substitute issued by
the bank.
(3) Credit assessment computer program. A bank may use an
acceptable credit assessment computer program to determine that a
direct credit substitute is equivalent to or better than the
external rating category set out at section II.B.5(b)(iii)(1)(d) of
this appendix A (e.g., BB). A nationally recognized statistical
rating organization or other party satisfactory to the FDIC must
have developed the credit assessment system for determining the
credit risk of direct credit substitutes and other stratified credit
positions. The bank must demonstrate to the FDIC's satisfaction that
ratings under such a credit assessment computer program correspond
credibly and reliably with the rating of traded positions.
(v) Determining the credit risk weight for off-balance sheet
securitized assets that are subject to early amortization
provisions. If a bank securitizes revolving assets, such as credit
cards, home equity lines, or commercial lines of credit, in a
transaction that it has sponsored and which includes early
amortization provisions, then the bank must maintain risk-based
capital against the off-balance sheet securitized assets from the
inception of the transaction. An early amortization feature is a
provision that, under specified conditions, returns principal to
investors prior to the expected payment
[[Page 12346]]
dates, generally as a result of a deterioration in the portfolio of
securitized revolving assets. The securitized, off-balance sheet
assets are to be converted to an on-balance sheet credit equivalent
amount using the 100 percent conversion factor and the resulting
amount is to be assigned to the 20 percent risk category. However,
this capital requirement, when combined with the capital
requirements for any retained recourse or direct credit substitute
associated with the securitized assets, is limited to a total of 8
percent of the managed assets.
(c) Limitations on risk-based capital requirements--(i) Low-
level exposure. If the maximum contractual liability or 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
liability or exposure to loss, less any recourse liability account
established in accordance with generally accepted accounting
principles. This limitation does not apply to assets sold with
implicit recourse.
(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 an on-balance sheet asset.
(iii) Related on-balance sheet assets. If a recourse obligation
or direct credit substitute subject to paragraph B.5. of this
section 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
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 such a case, both the on-balance sheet
servicing assets and the related recourse obligations or direct
credit substitutes are incorporated into the risk-based capital
calculation.
* * * * *
C. * * *
Category 2--20 Percent Risk Weight.
* * * * *
d. This category also includes the credit equivalent amount of
off-balance sheet securitized revolving assets in transactions which
include early amortization provisions that were sponsored by the
bank.
Category 3--50 Percent Risk Weight.
* * * * *
b. * * * \32\ * * *
---------------------------------------------------------------------------
\32\ 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
institution 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.
---------------------------------------------------------------------------
* * * * *
Category 4--100 Percent Risk Weight. (a) All assets not included
in the categories above, except the assets specifically included in
the 200 percent category below, 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; \35\
---------------------------------------------------------------------------
\35\ 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.
---------------------------------------------------------------------------
(2) 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);
(3) Claims on commercial firms owned by the public sector;
(4) Customer liabilities to the bank on acceptances outstanding
involving standard risk claims; \36\
---------------------------------------------------------------------------
\36\ 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) Mortgage- and asset-backed securities that do not meet the
criteria for assignment to a lower risk category;
(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; and
(10) All obligations of states or political subdivisions of
countries that do not belong to the OECD-based group.
(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 other allowed intangibles.
Category 5--200 Percent Risk Weight. This category includes:
(a) The face amount of externally rated recourse obligations,
direct credit substitutes, and asset- and mortgage-backed securities
that are rated in the next lower category below the lowest
investment grade category, e.g., BB, to the extent permitted in
section II.B.5(b)(iii) of this appendix A; and
(b) The face amount of direct credit substitutes 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.(b)(iii) 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 for
direct credit substitutes and recourse obligations as discussed in
section II.B.5. of this appendix A. 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.\37\ Table III to this appendix A sets forth the
conversion factors for various types of off-balance-sheet items.
---------------------------------------------------------------------------
\37\ 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.
(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 deposits
placed,\38\ and partly-paid shares and securities; they do not
include commitments to make residential mortgage loans or forward
foreign exchange contracts.
---------------------------------------------------------------------------
\38\ 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
[[Page 12347]]
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.
* * * * *
3. In the tables at the end of appendix A to part 325, Table II.--
Summary of Risk Weights and Risk Categories:
A. In Category 2--20 Percent Risk Weight, paragraph (11) is
removed, paragraph (12) is redesignated as paragraph (11), and new
paragraphs (12) and (13) are added;
B. In Category 3--50 Percent Risk Weight, paragraph (3) is revised;
C. In Category 4--100 Percent Risk Weight, paragraph (9) is revised
and a new paragraph (10) is added; and
D. Following the paragraph titled Category 4--100 Percent Risk
Weight, a new paragraph titled, Category 5--200 Percent Risk Weight, is
added to read as follows:
* * * * *
Table II.--Summary of Risk Weights and Risk Categories.
* * * * *
Category 2--20 Percent Risk Weight.
* * * * *
(12) Asset- or mortgage-backed securities (or recourse
obligations or direct credit substitutes issued in connection with
such securitizations) rated in either of the two highest investment
grade categories, e.g., AAA or AA.
(13) The credit equivalent amount of off-balance sheet revolving
assets in securitization transactions featuring early amortization
provisions sponsored by the bank.
Category 3--50 Percent Risk Weight.
* * * * *
(3) Asset- or mortgage-backed securities (or recourse
obligations or direct credit substitutes issued in connection with
such securitizations) rated in the third-highest investment grade
category, e.g., A.
* * * * *
Category 4--100 Percent Risk Weight.
* * * * *
(9) Asset- or mortgage-backed securities (or recourse
obligations or direct credit substitutes issued in connection with
such securitizations) rated in the lowest investment grade category,
e.g., BBB, as well as certain direct credit substitutes which the
bank rates as the equivalent of the lowest investment grade
category, e.g., BBB, or above through an internal assessment
satisfactory to the FDIC.
(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\ 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 time to a risk
weight category.
---------------------------------------------------------------------------
Category 5--200 Percent Risk Weight.
Asset- or mortgage-backed securities (or recourse obligations or
direct credit substitutes issued in connection with such
securitizations) rated one category below investment grade, e.g.,
BB, as well as certain direct credit substitutes which the bank
rates as the equivalent of one category below investment grade,
e.g., BB, through an internal assessment satisfactory to the FDIC.
4. In the tables at the end of appendix A to part 325, Table III.--
Credit Conversion Factors for Off-Balance Sheet Items:
A. In this table, references to footnote 1 are removed each time
they appear and footnote 1 is removed.
B. In 100 Percent Conversion Factor, paragraphs (1) through (3) are
revised, and a new paragraph (6) is added, to read as follows:
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 or recourse obligations (unless a different treatment is
otherwise specified). For risk participations in such arrangements
and 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.
* * * * *
(6) Off-balance sheet revolving assets in securitization
transactions featuring early amortization provisions sponsored by
the bank.
* * * * *
By Order of the Board of Directors.
Dated at Washington, DC this 9th day of February, 2000.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
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 proposed to be 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 revising the definitions of direct
credit substitute and recourse and adding definitions of covered
representations and warranties, credit derivative, financial guarantee-
type standby letter of credit, nationally recognized statistical rating
organization, performance-based standby letter of credit, rated,
securitization, servicer cash advance, standby letter of credit and
traded position, to read as follows:
Sec. 567.1 Definitions.
* * * * *
Covered representations and warranties. The term covered
representations and warranties means representations and warranties
extended by a savings association when it transfers assets (including
loan servicing assets) or assumed by a savings association when it
purchases loan servicing assets, that obligate the savings association
to protect another party from losses due to credit risk in the
transferred assets or serviced loans.
Credit derivative. The term credit derivative means on- or off-
balance sheet notes or contracts that allow one party to transfer the
credit risk of a referenced asset, that it may own, to another party.
The value of a credit derivative is dependent, at least in part, on the
credit performance of the referenced asset.
* * * * *
Direct credit substitute. The term direct credit substitute means
an arrangement in which a savings association assumes, in form or in
substance, any risk of credit loss directly or indirectly associated
with an asset or other financial claim owned in whole or in part by
another party, that exceeds the association's pro rata share of the
asset or claim. If the savings association has no claim on the asset,
then the assumption of any risk of loss is a direct credit substitute.
Direct credit substitutes include:
(1) Financial guarantee-type standby letters of credit that support
financial claims on the account party;
(2) Guarantees, surety arrangements, credit derivatives, and
irrevocable guarantee-type instruments backing financial claims;
(3) Purchased subordinated interests or securities that absorb more
than their pro rata share of losses from the underlying assets;
[[Page 12348]]
(4) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party; and
(5) Purchased loan servicing assets if the servicer is responsible
for credit losses associated with the loans being serviced (other than
a servicer cash advance), or if the servicer makes or assumes covered
representations and warranties with respect to such loans.
* * * * *
Financial guarantee-type standby letter of credit. The term
financial guarantee-type standby letter of credit means any letter of
credit or similar arrangement, however named or described, that
represents an irrevocable obligation to the beneficiary on the part of
the issuer:
(1) To repay money borrowed by, advanced to, or for the account of,
the account party; or
(2) To make payment on account of any indebtedness undertaken by
the account party in the event that the account party fails to fulfill
its obligation to the beneficiary.
* * * * *
Nationally recognized statistical rating organization. The term
nationally recognized statistical rating organization means an entity
recognized by the Division of Market Regulation of the Securities and
Exchange Commission as a nationally recognized statistical rating
organization for various purposes, including the uniform net capital
regulations for broker-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.
* * * * *
Rated. The term rated means, with respect to an instrument or
obligation, that the instrument or obligation has received a credit
rating from a nationally recognized statistical rating organization. An
instrument or obligation is rated investment grade if it has received a
credit rating that falls within one of the four highest rating
categories used by the organization. An instrument or obligation is
rated in the highest investment grade if it has received a credit
rating that falls within the highest rating category used by the
organization.
* * * * *
Recourse. The term recourse means an arrangement in which a savings
association retains, in form or in substance, any risk of credit loss
directly or indirectly associated with a transferred asset that exceeds
the pro rata share of the association's claim on the asset. If a
savings association has no claim on a transferred asset, then the
retention of any risk of loss is recourse. A recourse obligation
typically arises when an institution transfers assets and retains an
obligation to repurchase the assets or to 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 savings association provides credit
enhancement beyond any contractual obligation to support assets it has
sold. Recourse obligations include:
(1) Covered representations and warranties on transferred assets;
(2) Retained loan servicing assets if the servicer is responsible
for losses associated with the loans being serviced (other than a
servicer cash advance);
(3) Retained subordinated interests or securities, or credit
derivatives that absorb more than their pro rata share of losses from
the underlying assets;
(4) Assets sold under an agreement to repurchase; and
(5) Loan strips sold without direct recourse where the maturity of
the transferred loan is shorter than the maturity of the commitment.
* * * * *
Securitization. The term securitization means the pooling and
repackaging of loans or other credit exposures into securities that can
be sold to investors. For purposes of Sec. 567.6(b) of this part, the
term securitization also includes transactions or programs that
generally create stratified credit risk positions, whether in the form
of a security or not, whose performance is dependent upon an underlying
pool of loans or other credit exposures.
Servicer cash advance. The term servicer cash advance means funds
that a residential mortgage loan 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 servicer cash advance is not a recourse obligation or a
direct credit substitute if the servicer is entitled to full
reimbursement or, for any single residential mortgage loan,
nonreimbursable advances are contractually limited to an insignificant
amount of the outstanding principal on that loan.
Standby letter of credit. The term standby letter of credit means
any financial guarantee-type standby letter of credit or performance-
based standby letter of credit.
* * * * *
Traded position. The term traded position means a recourse
obligation, direct credit substitute, or asset- or mortgage-backed
security that is retained, assumed, or issued in connection with an
asset securitization and that is rated with a reasonable expectation
that, in the near future:
(1) The position would be sold to investors relying on the rating;
or
(2) A third party would, in reliance on the rating, enter into a
transaction such as a purchase, loan, or repurchase agreement involving
the position.
* * * * *
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 associations'
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. Section 567.6 is amended by:
A. Revising paragraph (a) introductory text;
B. Revising paragraph (a)(1) introductory text;
C. Revising paragraph (a)(2) introductory text;
D. Removing and reserving paragraphs (a)(2)(i)(A) and (C);
E. Revising paragraph (a)(2)(i)(B);
F. Revising paragraph (a)(2)(ii)(A);
G. Removing paragraph (a)(3); and
H. 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 (as computed under paragraph (a)(1) of this
section), plus risk-weighted off-balance-sheet activities (as computed
under paragraph (a)(2) of this section), plus risk-weighted recourse
obligations, direct credit substitutes and asset- and mortgage-backed
securities (as computed under
[[Page 12349]]
paragraph (b) of this section). Assets not included 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 for on-balance-sheet
assets are:
* * * * *
(2) Off-balance-sheet activities. 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-
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 bank 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 asset-and
mortgage-backed securities--(1) In general. Except as otherwise
provided in this paragraph (b), to calculate the risk-weighted asset
amount for a recourse obligation, direct credit substitute, or asset-
or mortgage-backed security, multiply the amount of assets from which
risk of credit loss is directly or indirectly retained or assumed, by
the appropriate risk weight using the criteria regarding obligors,
guarantors, and collateral listed in paragraph (a)(1) of this section.
For purposes of this paragraph (b), the amount of assets from which
risk of credit loss is directly or indirectly retained or assumed
means:
(i) For a financial guarantee-type standby letter of credit, surety
arrangement, credit derivative, guarantee, or irrevocable guarantee-
type instruments, the amount of the assets that the direct credit
substitute fully or partially supports;
(ii) For a subordinated interest or security, the amount of the
subordinated interest or security plus all more senior interests or
securities;
(iii) For mortgage servicing assets that are recourse obligations
or direct credit substitutes, the outstanding amount of unpaid
principal of the loans serviced;
(iv) For covered representations and warranties, the amount of the
assets subject to the representations or warranties;
(v) For loans or lines of credit that provide credit enhancement
for the financial obligations of an account party, the amount of the
enhanced financial obligations;
(vi) For loans strips, the amount of the loans;
(vii) For assets sold with recourse, the amount of assets from
which risk of loss is directly or indirectly retained, less any
applicable recourse liability account established in accordance with
generally accepted accounting principles; and
(viii) Other types of recourse obligations and direct credit
substitutes should be treated in accordance with the principles
contained in this paragraph (b).
(2) Ratings-based approach--(i) Calculation. As an alternative to
the calculation described in paragraph (b)(1) of this section, a
savings association may calculate the risk-weighted asset amount for
eligible recourse obligations, direct credit substitutes, or asset- or
mortgage-backed securities described in paragraph (b)(2)(ii) of this
section by multiplying the face amount of the position by the risk-
weight associated with the applicable rating under the following chart.
------------------------------------------------------------------------
Rating category Risk weight
------------------------------------------------------------------------
Highest or second highest investment grade... 20%.
Third highest investment grade............... 50%.
Fourth highest investment grade.............. 100%.
One grade below investment grade............. 200%.
More than one grade below investment grade or Risk weight the asset
not rated. under paragraph (b)(1)
of this section.
------------------------------------------------------------------------
(ii) Eligibility. To be eligible for the treatment described in
this paragraph (b)(2), a recourse obligation, direct credit substitute,
or asset- or mortgage-backed security must meet one of the following
criteria:
(A) Traded position rated by a rating organization. (1) A traded
position is eligible for the risk-based capital treatment described in
this paragraph (b)(2), if a nationally recognized statistical rating
organization rates the position in one of its five highest grades. If
two or more nationally recognized statistical rating organizations
assign different ratings to a position, the savings association may use
the highest rating as the rating of the position for the purposes of
this paragraph (b)(2). If a rating changes, the savings association
must use the new rating.
(2) If a recourse obligation, direct credit substitute, or asset-
or mortgage-backed security or other credit risk position is not rated
but is senior in all credit risk related features (including access to
any collateral) to a rated, traded position, the savings association
may risk weight the position under this paragraph (b)(2) using the
rating of the traded position. The savings association must satisfy OTS
that this treatment is appropriate.
(B) Non-traded position rated by two rating organizations. (1) A
recourse obligation or direct credit substitute that is not a traded
position is eligible for the treatment described in this paragraph
(b)(2), if two nationally recognized statistical rating organizations
rate the recourse obligation or direct credit substitute in one of
their five highest grades. The organizations must apply the same
criteria that they use to rate securities that are traded positions and
must make the rating publicly available.
(2) If two or more national recognized statistical rating
organizations assign different ratings to the recourse obligation or
direct credit substitute, the savings association must use the second
highest rating as the rating of the position for the purposes of this
paragraph (b)(2). If a rating changes, the
[[Page 12350]]
savings association must use the new rating.
(3) Internal ratings, qualified structured transactions, and credit
assessment computer programs--(i) Calculation. As an alternative to the
calculation described in paragraph (b)(1) of this section, a savings
association may calculate the risk-weighted asset amount for eligible
direct credit substitutes described in paragraph (b)(3)(ii) of this
section by multiplying the face amount of the position by the risk-
weight associated with the applicable rating under the following chart:
------------------------------------------------------------------------
Rating category Risk weight
------------------------------------------------------------------------
Investment grade............................. 100%.
One grade below investment grade............. 200%.
More than one grade below investment grade or Risk weight the asset
not rated. under paragraph (b)(1)
of this section.
------------------------------------------------------------------------
(ii) Eligibility. To be eligible for the treatment described in
this paragraph (b)(3), a direct credit substitute must meet one of the
following criteria.
(A) Non-traded position rated internally. A direct credit
substitute assumed or issued in connection with an asset-backed
commercial paper program and that is not a traded position is eligible
for the treatment described in this paragraph (b)(3), if a savings
association that is the sponsor of the program rates the direct credit
substitute as investment grade or one category immediately below
investment grade. The savings association must use an internal risk
weighting system that is satisfactory to OTS. Adequate internal risk
rating systems typically:
(1) Are an integral part of an effective risk management system
that explicitly incorporates the full range of risks arising from the
institution's securitization activities.
(2) Link ratings to measurable outcomes, such as the probability
that the position will experience loss, the expected loss on the
position in the event of default, and variance of 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 even among those assets where no
loss is likely as well as other risk positions;
(5) Use clear, explicit criteria to classify assets into each
internal rating category;
(6) Employ independent credit risk management or loan review
personnel to assign or review the internal 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 ratings to
determine if the system correctly identified individual ratings and, if
appropriate, adjust the rating system and individual ratings; and
(9) Use assumptions and methodologies that are consistent with, or
more conservative than, the rating assumptions and methodologies used
by nationally recognized statistical rating organizations.
(B) Non-traded positions in approved securitization or structured
financing programs. A direct credit substitute that is not a traded
position is eligible for the treatment described in this paragraph
(b)(3), if the position is generated through a securitization or
structured financing program that is approved by OTS. OTS will not
approve the use of a securitization or structured financing program
unless the program meets the following minimum criteria and other
appropriate prudential standards:
(1) A nationally recognized statistical rating organization (or
other entity approved by OTS) must review the terms of the program, and
state a rating for the direct credit substitutes to be issued under the
program. If the program has options for different combinations of
assets, standards, internal or external credit enhancements and other
relevant factors, the rating organization or other approved entity may
specify ranges of rating categories that will be applied based on the
options that are utilized in the position.
(2) The savings association must demonstrate to OTS' satisfaction
that the rating corresponds credibly and reliably with the ratings
issued by nationally recognized statistical rating organizations for
traded positions, and that the rating organization's or other entity's
underlying premises are satisfied by the direct credit substitute.
(3) If a savings association participates in a securitization or
structured financing program sponsored by another party, OTS may
authorize the savings association to use this approach based on the
program rating obtained by the sponsor of the program.
(C) Non-traded position in a structured financing program rated by
using qualifying credit assessment computer software. A direct credit
substitute that is not a traded position is eligible for the treatment
described in this paragraph (b)(3), if the position is generated
through a structured financing program and the position is rated using
credit assessment computer software that has been approved by OTS. OTS
will not approve the use of credit assessment computer software unless
the software meets the following minimum criteria and other appropriate
prudential standards:
(1) A nationally recognized statistical rating organization (or
other entity approved by OTS) developed the computer software for
determining the credit ratings of direct credit substitutes and other
stratified positions; and
(2) The savings association must demonstrate that the ratings
generated using the computer software correspond credibly and reliably
with the ratings issued by nationally recognized statistical rating
organizations for traded positions.
(4) Alternative capital computation for small business
obligations--(i) Definitions. For the purposes of this paragraph
(b)(4):
(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 paragraph
(b)(4)(ii) of this section; or
(2) Is adequately capitalized as defined in Sec. 565.4 of this
chapter without applying the capital treatment described in paragraph
(b)(4)(ii) of this section and has received written permission from the
OTS to apply that capital calculation.
(B) 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.
(ii) Capital requirement. 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
[[Page 12351]]
only the amount of its retained recourse in its risk-weighted assets
for the purposes of paragraph (b)(1) of this section. 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)(4)(ii) of this section, may not exceed 15
percent of the association's total capital computed under
Sec. 567.5(c)(4).
(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)(4)(iii) of this section, the savings
association may continue to apply the capital treatment described in
paragraph (b)(4)(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)(4) 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)(4) 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)(4) for the purposes of applying 12
U.S.C. 1381o(g), regardless of the association's capital level.
(5) Risk participations and syndications of direct credit
substitutes. Except as otherwise provided in this paragraph (b) and
subject to the low level recourse rule, a savings association must
calculate the risk-weighted asset amount for a risk participation in,
or syndication of, a direct credit substitute as described below. For
the purposes of this paragraph (b)(5), in a risk participation the
originator of the participation remains liable to the beneficiary for
the full amount of the direct credit substitute, even though another
party may have acquired a participation in the obligation:
(i) Where a savings association conveys a risk participation, the
savings association must risk weight the full amount the assets
supported, in whole or in part, by the direct credit substitute. The
savings association must assign a percentage share (i.e., the
percentage of the direct credit substitute that is conveyed) of these
assets 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 entity acquiring the participation. The remainder of the assets
supported, in whole or in part, by the direct credit substitute, must
be assigned to the risk-weight category appropriate to the obligor,
guarantor or collateral.
(ii) If a savings association acquires a risk participation in a
direct credit substitute, the savings association must multiply a
percentage share (i.e. the percentage of the direct credit substitute
that is acquired) by the full amount the assets supported, in whole or
in part, by the direct credit substitute. The savings association must
assign this amount to the risk-weight category appropriate to the
account party obligor, guarantor or collateral.
(iii) If the savings association holds a direct credit substitute
as a part of a syndication and it is obligated only for its pro rata
share of the risk of loss on the direct credit substitute and there is
no recourse to the originating entity, the savings association must
assign its share of the assets supported, in whole or in part, by the
direct credit substitute to the risk-weight category appropriate to the
obligor, guarantor or collateral.
(6) Limitations on risk-based capital requirements--(i) Low-level
recourse. If the maximum contractual liability or exposure to credit
loss retained or assumed by a savings association in connection with a
recourse obligation or a direct credit substitute calculated under
paragraphs (b)(1) through (5) of this section is less than the
effective risk-based capital requirement for the enhanced assets, the
risk-based capital requirement is limited to the maximum contractual
liability or exposure to loss, less any recourse liability account
established in accordance with generally accepted accounting
principles. This limitation does not apply to assets sold with implicit
recourse.
(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, 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
savings association continued to hold these loans as an on-balance-
sheet asset.
(iii) Related on-balance-sheet assets. To the extent that an asset
may be included in the calculation of risk-weighted on-balance-sheet
assets under paragraph (a)(1) of this section and may also be included
in the calculation of risk-weighted assets under this paragraph (b),
the savings association should risk-weight the asset only under this
paragraph (b), except mortgage servicing assets and similar
arrangements with embedded recourse obligations or direct credit
substitutes. In such cases, the mortgage servicing asset is risk
weighted as an on-balance-sheet asset under paragraph (a)(1) of this
section and the related recourse obligations and direct credit
substitutes are risk-weighted under this paragraph (b).
(7) 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).
(8) Addition to risk-weighted assets--managed assets. (i) A savings
association must include an additional amount in the risk-weighted
asset amount calculated under this paragraph (b), if:
(A) The savings association sells assets to a revolving
securitization (e.g., credit card receivables or home equity line
securitizations) with an early amortization feature. An early
amortization feature is a provision that, under specified conditions,
terminates the ability of the savings association to add new
receivables or debt to the securitization, and requires the savings
[[Page 12352]]
association to use any payments received from the debtors to pay down
the receivables or debts previously included in the securitization; and
(B) The savings association is the sponsor of the revolving
securitization.
(ii) The additional amount is equal to the face amount of the
assets that the savings association sells to the revolving
securitization less the face amount of any recourse obligation or
direct credit substitute that the savings association retains or
assumes in connection with the sale of the asset, multiplied by a 20
percent risk weight.
5. Section 567.11 is amended by redesignating paragraph (c) as
paragraph (c)(1) and adding a new paragraph (c)(2) to read as follows:
Sec. 567.11 Reservations of authority.
* * * * *
(c) * * *
(2) If a savings association has calculated the risk-weighted asset
amount for a recourse obligation, a direct credit substitute or an
asset under Sec. 567.6(b), OTS may determine that risk-weighted asset
amount does not adequately reflect the credit risk that the savings
association assumed or retained in the transaction and require the
institution to revise the risk-weighted asset amount to reflect the
risk of, and other relevant factors associated with, the recourse
obligation, direct credit substitute or asset.
Dated: February 9, 2000.
By the Office of Thrift Supervision.
Ellen Seidman,
Director.
[FR Doc. 00-4211 Filed 3-7-00; 8:45 am]
BILLING CODE 4810-33-P, 6210-01-P, 6714-01-P, 6720-01-P