[Federal Register Volume 60, Number 59 (Tuesday, March 28, 1995)]
[Rules and Regulations]
[Pages 15858-15861]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-7535]



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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AB60


Capital Maintenance

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Final rule.

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SUMMARY: The FDIC is amending its risk-based capital standards for 
insured state nonmember banks to implement section 350 of the Riegle 
Community Development and Regulatory Improvement Act of 1994 (Riegle 
Act). Section 350 states that the amount of risk-based capital required 
to be maintained by any insured depository institution, with respect to 
assets transferred with recourse, may not exceed the maximum amount of 
recourse for which the institution is contractually liable under the 
recourse agreement. This rule will have the effect of correcting the 
anomaly that currently exists in the risk-based capital treatment of 
recourse transactions under which an institution could be required to 
hold capital in excess of the maximum amount of loss possible under the 
contractual terms of the recourse obligation.

EFFECTIVE DATE: April 27, 1995.

FOR FURTHER INFORMATION CONTACT: Robert F. Storch, Chief, Accounting 
Section, Division of Supervision, (202) 898-8906, or Cristeena G. 
Naser, Attorney, Legal Division, (202) 898-3587, Federal Deposit 
Insurance Corporation, 550 17th Street, NW., Washington, D.C. 20429.

SUPPLEMENTARY INFORMATION:

I. Background

    The FDIC's current regulatory capital standards are intended to 
ensure that FDIC-supervised banks that transfer assets and retain the 
credit risk inherent in the assets maintain adequate capital to support 
that risk. This is generally accomplished by requiring that bank assets 
transferred with recourse continue to be reported on the balance sheet 
in the Reports of Condition and Income (Call Reports). These amounts 
are thus included in the calculation of banks' risk-based and leverage 
capital ratios. The regulatory reporting treatment for most asset 
transfers with recourse differs from the treatment of such transactions 
under generally accepted accounting principles (GAAP).\1\

    \1\The GAAP treatment focuses on the transfer of benefits rather 
than the retention of risk and, thus, allows a transfer of 
receivables with recourse to be accounted for as a sale if the 
transferor: (1) Surrenders control of the future economic benefits 
of the assets; (2) is able to reasonably estimate its obligations 
under the recourse provision; and (3) is not obligated to repurchase 
the assets except pursuant to the recourse provision. In addition, 
the transferor must establish a separate liability account equal to 
the estimated probable losses under the recourse provision (GAAP 
recourse liability account). [[Page 15859]] 
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    In cases where an institution retains a low level of recourse, the 
amount of capital required under the FDIC's risk-based capital 
standards could exceed the institution's maximum contractual liability 
under the recourse agreement. This can occur in transactions in which a 
bank contractually limits its recourse exposure to less than the full 
effective risk-based capital requirement for the assets transferred--
generally, four percent for residential mortgage loans and eight 
percent for most other assets.
    The FDIC and the other federal banking agencies have long 
recognized this anomaly in the risk-based capital standards. On May 25, 
1994, the banking agencies, acting upon a recommendation by the Federal 
Financial Institutions Examination Council, issued a Notice of Proposed 
Rulemaking (NPR) (59 FR 27116) addressing the risk-based capital 
treatment of recourse and direct credit substitutes. One of the 
principal features of the NPR was a proposal to amend the banking 
agencies' risk-based capital standards to limit the capital charge in 
low level recourse transactions to an institution's maximum contractual 
recourse liability. The proposal for these types of transactions would 
effectively result in a one dollar capital charge for each dollar of 
low level recourse exposure, up to the full effective risk-based 
capital requirement on the underlying assets.
    The proposal requested specific comment on whether an institution 
should be able to use the balance of the GAAP recourse liability 
account to reduce the dollar-for-dollar capital charge for the recourse 
exposure on assets transferred with low level recourse in a transaction 
reported as a sale for Call Report purposes. In addition, the proposal 
indicated that the capital requirement for an exposure to low level 
recourse retained in a transaction associated with a swap of mortgage 
loans for mortgage-related securities would be the lower of the capital 
charge for the swapped mortgages or the combined capital charge for the 
low level recourse exposure and the mortgage-related securities, 
adjusted for any double counting.
    The NPR also addressed other issues related to recourse 
transactions, including equivalent capital treatment of recourse 
arrangements and direct credit substitutes that provide first dollar 
loss protection and definitions for ``recourse'' and associated terms 
such as ``standard representations and warranties.'' The NPR was issued 
in conjunction with an Advance Notice of Proposed Rulemaking (ANPR) 
that outlined a possible alternative approach to deal comprehensively 
with the risk-based capital treatment of asset securitizations and any 
associated recourse arrangements and direct credit substitutes. The 
comment period for the NPR and ANPR ended on July 25, 1994.
    During the agencies' review of the comments received, the Riegle 
Act was signed into law on September 23, 1994. Section 350 of the Act 
requires the federal banking agencies to issue regulations not later 
than March 22, 1995, limiting the amount of risk-based capital an 
insured depository institution is required to hold for assets 
transferred with recourse to the maximum amount of recourse for which 
the institution is contractually liable. In order to meet the statutory 
requirements of section 350, the FDIC is now issuing a rule that puts 
into final form only those portions of the NPR dealing with low level 
recourse transactions.

II. Comments Received

    In response to the NPR and ANPR, the FDIC received comment letters 
from 37 entities. Of these respondents, 25 addressed issues related to 
the NPR's proposed low level recourse capital treatment. These 
commenters included 12 banking organizations, nine trade associations, 
one government-sponsored agency, and three other commenters. Of these 
25 respondents, 22 provided a favorable overall assessment of the low 
level recourse proposal. In general, these respondents viewed the low 
level proposal as a way of correcting an anomaly in the existing risk-
based capital standards so that institutions would not be required to 
hold capital in excess of their contractual liability.
    Nevertheless, seven of the commenters further indicated that, while 
the proposed low level recourse capital treatment was a positive step, 
it still would result in too high of a capital requirement for assets 
sold with limited recourse. These respondents, which included five of 
the 12 banking organizations and two of the nine trade associations, 
expressed the view that the banking agencies should adopt the GAAP 
treatment of assets sold with recourse for purposes of calculating the 
regulatory capital ratios. These commenters maintained that the GAAP 
recourse liability account provides adequate protection against the 
risk of loss on assets sold with recourse, obviating the need for 
additional capital.
    The NPR specifically sought comment on five issues related to the 
proposed capital treatment of low level recourse transactions. Twelve 
of the 25 respondents commented on the first issue, which concerned the 
treatment of the GAAP recourse liability account established for assets 
sold with recourse reported as sales in the Call Report. These 12 
commenters favored reducing the capital requirement for low level 
recourse transactions by the balance of the related GAAP recourse 
liability account, which would continue to be excluded from an 
institution's regulatory capital. In their view, not taking the GAAP 
recourse liability account into consideration would result in double 
coverage of the portion of the risk provided for in that account.
    Twelve commenters, including five banking organizations and five 
trade associations, responded to the second issue, which sought comment 
on whether a dollar-for-dollar capital requirement would be too high 
for low level recourse transactions. Ten commenters indicated that such 
a capital charge would be too high since it was unlikely that an 
institution would incur losses up to its maximum contractual liability. 
Two others responded that whether the capital treatment was too high 
depended upon the credit quality of the underlying asset pool and the 
structure of the securitization.
    The third issue dealt with ways of demonstrating that the dollar-
for-dollar capital requirement might be too high and possible methods 
for reducing this requirement without jeopardizing safety and 
soundness. The nine commenters on this issue indicated that historical 
analysis, examiner review, and ``depression scenario'' stress testing 
would show whether the capital requirement would be too high relative 
to historical losses.
    The fourth issue concerned ways the banking agencies could handle 
the increased probability of loss to the insurance funds administered 
by the FDIC if less than dollar-for-dollar capital is maintained 
against low level recourse transactions. The eight commenters on this 
issue stated that as long as the amount of required capital held 
against the low level recourse transactions was prudently assessed 
based upon expected losses, actual losses would seldom, if ever, exceed 
the capital requirement. [[Page 15860]] Thus, the insurance funds would 
not likely experience losses.
    The fifth issue sought comment on whether the proposed low level 
recourse capital treatment would reduce transaction costs or otherwise 
help to facilitate the sale or securitization of banks' assets. The 
eight commenters that responded to this issue were all of the opinion 
that the low level capital treatment generally would help lower 
transaction costs and help facilitate securitization.

III. Final Rule

    After considering the comments received, further deliberating on 
the issues involved, particularly the requirements of section 350 of 
the Riegle Act, and consulting with the other banking agencies, the 
FDIC is adopting a final rule amending its risk-based capital standards 
with respect to the treatment of low level recourse transactions. 
Specifically, the final amendment implements section 350 by reducing 
the risk-based capital requirements for all recourse transactions in 
which an FDIC-supervised bank contractually limits its recourse 
exposure to less than the full, effective risk-based capital 
requirement for the assets transferred.
    This rule applies to low level recourse transactions involving all 
types of assets, including small business loans, commercial loans, 
multifamily housing loans, and residential mortgages. In this regard, 
the FDIC notes that previously under the risk-based capital standards 
certain residential mortgage loans transferred with recourse were 
excluded from risk-weighted assets if the institution did not retain 
significant risk of loss.\2\ As proposed, this treatment would be 
superseded by the broader low level recourse rule that the FDIC is 
adopting.

    \2\Under this treatment, a pool of residential mortgages that 
had been transferred with recourse was excluded from risk-weighted 
assets if the transferring institution did not retain significant 
risk of loss, i.e., the institution's maximum contractual recourse 
exposure did not exceed its reasonably estimated probable losses on 
the transferred mortgages, and the institution established and 
maintained a recourse liability account equal to the maximum amount 
of its recourse obligation. Under the low level recourse rule, this 
type of sale transaction would effectively continue to be excluded 
from risk-weighted assets because of the size of the recourse 
liability account that must be maintained.
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    Under the final low level recourse rule, an FDIC-supervised bank 
that contractually limits its maximum recourse obligation to less than 
the full effective risk-based capital requirement for the transferred 
assets would be required to hold risk-based capital equal to the 
contractual maximum amount of its recourse obligation. This requirement 
limits to one dollar the capital charge for each dollar of low-level 
recourse exposure. Under this dollar-for-dollar capital requirement, 
the capital charge for a 100 percent risk-weighted asset transferred 
with three percent recourse would be three percent of the amount of the 
transferred assets, rather than the eight percent previously required. 
Thus, a bank's risk-based capital requirement on a low level recourse 
transaction would not exceed the contractual maximum amount it could 
lose under the recourse obligation.
    Under the final rule, an institution may reduce the dollar-for-
dollar capital charge held against the recourse exposure on assets 
transferred with low level recourse for a transaction reported as a 
sale for Call Report purposes by the balance of any associated 
noncapital GAAP recourse liability account. In adopting this aspect of 
the final rule, the FDIC concurs with commenters that indicated that 
nonrecognition of the liability account would result in double coverage 
of the portion of the credit risk provided for in that account.
    In applying the final rule, the FDIC will, as proposed, limit the 
risk-based capital requirement for an exposure to low level recourse 
retained in a transaction associated with a swap of mortgage loans for 
mortgage-related securities to the lower of the capital charge for the 
swapped mortgages or the combined capital charge for the low level 
recourse exposure and the mortgage-related securities, adjusted for any 
double counting.
    In setting forth this final rule, the FDIC has considered the 
arguments that several commenters made for adopting for regulatory 
capital purposes the GAAP treatment for all assets sold with recourse, 
including those sold with low levels of recourse. Under such a 
treatment, assets sold with recourse in accordance with GAAP would have 
no capital requirement, but the GAAP recourse liability account would 
provide some level of protection against losses. Nevertheless, the FDIC 
continues to believe it would not be appropriate to adopt for 
regulatory capital purposes the GAAP treatment of recourse 
transactions, even if the transferring bank retains only a low level of 
recourse.
    In the FDIC's view, the GAAP recourse liability account would be an 
inadequate substitute for maintaining capital at a level commensurate 
with the risks. One of the principal purposes of regulatory capital is 
to provide a cushion against unexpected losses. In contrast, the GAAP 
recourse liability account is, in effect, a specific reserve that is 
intended to cover only an institution's probable expected losses under 
the recourse provision. In this regard, the FDIC notes that the risk-
based capital standards explicitly state that specific reserves created 
against identified losses may not be included in regulatory capital.
    In addition, the amount of credit risk that is typically retained 
in a recourse transaction greatly exceeds the normal expected losses 
associated with the transferred assets. Thus, even though a 
transferring institution may reduce its exposure to potential 
catastrophic losses by limiting the amount of recourse it provides, it 
may still retain, in many cases, the bulk of the risk inherent in the 
assets. For example, an institution transferring high quality assets 
with a reasonably estimated expected loss rate of one percent that 
retains ten percent recourse in the normal course of business will 
sustain the same amount of losses it would have had the assets not been 
transferred. This occurs because the amount of exposure under the 
recourse provision is very high relative to the amount of expected 
losses. The FDIC believes that in such transactions the transferor has 
not significantly reduced its risk for purposes of assessing regulatory 
capital and should continue to be assessed regulatory capital as though 
the assets had not been transferred.
    The FDIC is issuing this final rule now in order to implement 
section 350 of the Riegle Act in accordance with the statutory 
deadline. Consequently, the rule deals with only those portions of the 
NPR concerned with low level recourse transactions. The FDIC will 
continue to consider, on an interagency basis, other aspects of the 
NPR, as well as all aspects of the ANPR that was issued in conjunction 
with the NPR.
    This final rule is effective April 27, 1995. However, FDIC-
supervised banks may choose to apply the low level recourse rule when 
completing the risk-based capital schedule (Schedule RC-R) in their 
Reports of Condition and Income (Call Reports) for March 31, 1995.

IV. Regulatory Flexibility Act Analysis

    The purpose of this final rule is to reduce the risk-based capital 
requirement on transfers of assets with low levels of recourse. 
Therefore, pursuant to section 605(b) of the Regulatory Flexibility 
Act, the FDIC hereby certifies that this rule will have a beneficial 
economic impact on small business entities (in this case, small banks) 
that sell assets with low levels of recourse. [[Page 15861]] 

V. Paperwork Reduction Act

    The FDIC has determined that, in comparison to the existing risk-
based capital treatment of low level recourse transactions, this final 
rule will not increase the regulatory paperwork burden of FDIC-
supervised banks pursuant to the provisions of the Paperwork Reduction 
Act (44 U.S.C. 3501 et seq.).

List of Subjects in 12 CFR Part 325

    Bank deposit insurance, Banks, banking, Capital adequacy, Reporting 
and recordkeeping requirements, Savings associations, State nonmember 
banks.
    For the reasons set forth in the preamble, the Board of Directors 
of the Federal Deposit Insurance Corporation hereby amends part 325 of 
title 12 of the Code of Federal Regulations as follows:

PART 325--CAPITAL MAINTENANCE

    1. The authority citation for Part 325 is revised 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, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 1761, 
1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 2236, 
2355, 2386 (12 U.S.C. 1828 note).

    2. Section II.D.1. of appendix A to part 325 is amended by removing 
the sixth paragraph and adding in its place two new paragraphs to read 
as follows:

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

* * * * *
    II. * * *
    D. * * *
    1. * * *
    Sale and repurchase agreements and asset sales with recourse, if 
not already included on the balance sheet, are also converted at 100 
percent. For risk-based capital purposes, the definition of sales of 
assets with recourse, including the sale of one-to-four family 
residential mortgages, is consistent with the definition contained in 
the instructions for the preparation of the Consolidated Reports of 
Condition and Income. Accordingly, except as noted below, the entire 
amount of any assets transferred with recourse that are not already 
included on the balance sheet, including pools of one-to-four family 
residential mortgages, is to be converted at 100 percent and assigned 
to the risk weight category appropriate to the obligor or, if relevant, 
the guarantor or the nature of the collateral. The terms of a transfer 
of assets with recourse may contractually limit the amount of the 
bank's liability to an amount less than the effective risk-based 
capital requirement for the assets being transferred with recourse. If 
such a transaction (including one that, in accordance with the 
instructions for the preparation of the Consolidated Reports of 
Condition and Income, is reported as a financing, i.e., the assets are 
not removed from the balance sheet) meets the criteria for sale 
treatment under generally accepted accounting principles, the amount of 
total capital required is equal to the maximum amount of loss possible 
under the recourse provision. If the transaction is also treated as a 
sale in accordance with the instructions for the preparation of the 
Consolidated Reports of Condition and Income, then the required amount 
of capital may be reduced by the balance of any associated noncapital 
liability account established pursuant to generally accepted accounting 
principles to cover estimated probable losses under the recourse 
provision. So-called ``loan strips'' (that is, short-term advances sold 
under long-term commitments without direct recourse) are defined in the 
instructions for the preparation of the Consolidated Reports of 
Condition and Income and for risk-based capital purposes as assets sold 
with recourse.
    In addition, a 100 percent conversion factor applies to forward 
agreements. Forward agreements are legally binding contractual 
obligations to purchase assets with drawdown which is certain at a 
specified future date. These obligations include forward purchases, 
forward deposits placed, and partly paid shares and securities, but do 
not include forward foreign exchange rate contracts or commitments to 
make residential mortgage loans.
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    By order of the Board of Directors.

    Dated at Washington, D.C., this 21st day of March, 1995.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary.
[FR Doc. 95-7535 Filed 3-27-95; 8:45 am]
BILLING CODE 6714-01-P