[Federal Register Volume 64, Number 40 (Tuesday, March 2, 1999)]
[Rules and Regulations]
[Pages 10201-10204]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-5013]
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FEDERAL RESERVE SYSTEM
12 CFR Part 225
[Regulation Y; Docket No. R-0948]
Risk-Based Capital Standards: Construction Loans on Presold
Residential Properties; Junior Liens on 1- to 4-Family Residential
Properties; and Investments in Mutual Funds
AGENCY: Board of Governors of the Federal Reserve System.
ACTION: Final rule.
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SUMMARY: The Board of Governors of the Federal Reserve System (Board)
is amending its risk-based capital standards for bank holding
companies. The intended effect of this final rule is to keep the
Board's bank holding company risk-based capital standards for
construction loans on presold residential properties, real estate loans
secured by junior liens on 1- to 4-family residential properties, and
investments in mutual funds consistent with the risk-based capital
standards for banks and thrifts.
EFFECTIVE DATE: This final rule is effective April 1, 1999. The Federal
Reserve will not object if an institution wishes to apply the
provisions of this final rule beginning with the date it is published
in the Federal Register.
FOR FURTHER INFORMATION CONTACT: Norah Barger, Assistant Director (202/
452-2402), Barbara Bouchard, Manager (202/452-3072), T. Kirk Odegard,
Financial Analyst (202/530-6225), Division of Banking Supervision and
Regulation; or Mark E. Van Der Weide, Attorney (202/452-2263), Legal
Division. For the hearing impaired only, Telecommunication Device for
the Deaf (TDD), Diane Jenkins (202/452-3544), Board of Governors of the
Federal Reserve System, 20th and C Streets, NW., Washington, DC 20551.
SUPPLEMENTARY INFORMATION:
I. Background
The bank and thrift regulatory agencies have recently engaged in an
interagency effort to make uniform capital standards pursuant to
section 303 of the Riegle Community Development and Regulatory
[[Page 10202]]
Improvement Act of 1994 (CDRI Act).1 Section 303 of the CDRI
Act requires the agencies to review their own regulations and written
policies and to streamline those regulations where possible, and also
requires the agencies to work jointly to make uniform all regulations
and guidelines implementing common statutory or supervisory policies.
To fulfill the CDRI Act section 303 mandate, the agencies reviewed
their capital standards for banks and thrifts to identify areas where
they had substantively different capital treatments or where
streamlining was appropriate.
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\1\ The Board has worked with the Office of the Comptroller of
the Currency (OCC), the Federal Deposit Insurance Corporation
(FDIC), and the Office of Thrift Supervision (OTS) (collectively,
the agencies) to fulfill the CDRI Act section 303 mandate.
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As a result of these reviews, on October 27, 1997, the agencies
proposed conforming amendments to their risk-based and leverage capital
standards for banks and thrifts (62 FR 55686), while the Board
concurrently proposed similar amendments to the capital standards for
bank holding companies (62 FR 55692). Specifically, the agencies
proposed to amend the risk-based capital treatments for construction
loans on presold residential properties, loans secured by junior liens
on 1- to 4-family residential properties, and investments in mutual
funds. In addition, the agencies proposed a streamlining revision to
their leverage capital rules. While not technically mandated under
section 303 of the CDRI Act, the Board decided to amend the risk-based
and leverage capital standards for bank holding companies to maintain
consistency with the capital standards for banks and thrifts. The
interagency and Board proposals were identical with respect to risk-
based capital standards, but differed with respect to leverage capital
standards.
This Board final rule applies to the bank holding company risk-
based capital standards the same changes that are being concurrently
implemented in the risk-based capital standards for banks and
thrifts.2 The Board amended its leverage capital standard
for bank holding companies effective June 30, 1998 (63 FR 30369); the
leverage capital standard is not discussed further in this notice.
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\2\ Amended risk-based and leverage capital standards for banks
and thrifts are included in a separate interagency notice published
elsewhere in today's Federal Register.
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II. The Board's Proposal
The Board proposed to amend its risk-based capital standards for
bank holding companies in three areas. First, with regard to
construction loans on presold residential property, the Board proposed
to conform its regulatory language to that of the FDIC. This revision
would provide guidance on the characteristics of loans to builders that
would be considered prudently underwritten, but would not substantively
change the Board's capital treatment for such loans.3
Second, the Board proposed to adopt the OCC's capital treatment for
first and junior liens on 1- to 4-family residential properties where
no institution holds an intervening lien. This would entail treating
first and junior liens separately, with qualifying first liens risk-
weighted at 50 percent, and nonqualifying first liens and all junior
liens risk-weighted at 100 percent.4 Finally, the Board
proposed to modify its capital treatment for investments in mutual
funds 5 by allowing an institution to allocate its
investment in a mutual fund on a pro rata basis to various risk weight
categories based on the investment limits set forth in the fund's
prospectus.
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\3\ Qualifying construction loans on presold residential
property are accorded a risk weight of 50 percent when the property
is sold, regardless of when the institution makes the loan to the
builder.
\4\ Generally, qualifying liens are liens where the underlying
loan meets prudent underwriting criteria, including an appropriate
loan-to-value ratio, and is considered to be performing adequately.
A lien where the underlying loan is 90 days or more past due, or is
in nonaccrual status, is not considered to be performing adequately.
\5\ An institution's investment in a mutual fund is generally
assigned entirely to the risk category that is applicable to the
highest-risk asset allowed under the fund's prospectus.
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III. Comments Received
The Board received 4 public comments on the risk-based capital
components of the proposal (one each from a bank holding company and an
industry trade group, and two from concerned individuals).6
No commenters specifically addressed the proposed risk-based capital
treatment for construction loans on presold residential property or
investments in mutual funds, while three commenters opposed the
proposed treatment for junior liens on 1- to 4-family residential
properties. One commenter supported the entire proposal without
elaboration.
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\6\ For more information about public opinion with respect to
this final rule, see the comment summaries in the concurrent
interagency final rule regarding capital standards for banks and
thrifts.
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Of the three commenters opposing the junior lien proposal, two
opposed what they perceived to be lower capital requirements for first
and junior liens to the same borrower. Both commenters indicated that
lowering capital requirements would increase credit risk for
institutions with high loan-to-value (LTV) loans, and one of these
commenters expressed the opinion that this increased risk would
negatively impact lending to low- and moderate-income borrowers. The
third commenter opposed the proposal for different reasons. This
commenter indicated that the proposed 100 percent risk weight for all
junior liens was unreasonable because the credit risk inherent in such
liens varies widely. This commenter further suggested that first and
junior liens by the same lender should be treated separately because of
the complexity of tracking such loans, and that junior liens
individually should be eligible for either a 50 percent or 100 percent
risk weight.
IV. Final Rule
After consideration of the comments received and further
deliberation of the issues involved, the Board has determined to adopt
a final rule that is largely consistent with the original proposal. The
Board is adopting the proposed capital treatments for construction
loans on presold residential property and investments in mutual funds.
The Board has decided, however, to adopt a capital treatment for junior
liens on 1- to 4-family residential properties that differs from the
proposed treatment.
Construction Loans on Presold Residential Property
As proposed, the Board will continue to permit a qualifying
residential construction loan to become eligible for the 50 percent
risk category at the time the property is sold, regardless of when the
institution made the loan to the builder. The Board is revising its
regulatory language to conform its discussion of qualifying
construction loans to that of the FDIC.
Junior Liens on 1- to 4-Family Residential Properties
Rather than implementing the proposed treatment of junior liens on
1- to 4-family residential properties, the Board is maintaining its
current treatment of such liens. Where a bank holding company holds the
first lien and junior lien(s) on a residential property and no other
party holds an intervening lien, the loans will be viewed as a single
extension of credit secured by a first lien on the underlying property
for the purpose of determining the LTV ratio, as well as for risk
weighting. The combined loan amount will be assigned to either the 50
percent or 100 percent risk category, depending on whether the credit
satisfies the criteria for a 50 percent risk weighting. To qualify for
the 50 percent risk
[[Page 10203]]
category, the combined loan must be made in accordance with prudent
underwriting standards, including an appropriate LTV ratio.7
In addition, none of the combined loan may be 90 days or more past due,
or be in nonaccrual status. Loans that do not meet all of these
criteria must be assigned in their entirety to the 100 percent risk
category.
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\7\ In this regard, bank holding companies are encouraged to
adhere to the criteria established in the interagency guidelines for
real estate lending. See 12 CFR part 208, subpart C.
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Investments in Mutual Funds
As proposed, a bank holding company's total investment in a mutual
fund should be assigned to the risk category appropriate to the highest
risk-weighted asset the fund may hold in accordance with the stated
investment limits set forth in its prospectus. Bank holding companies
will also have the option of assigning the investment on a pro rata
basis to different risk categories according to the investment limits
in the fund's prospectus. Regardless of the risk-weighting method used,
the total risk weight of a mutual fund must be no less than 20 percent.
If the bank chooses to assign investments on a pro rata basis, and the
sum of the investment limits of assets in the fund exceeds 100 percent,
the bank must assign investments in descending order, beginning with
the highest-risk assets.8
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\8\ For example, assume that a fund's prospectus permits 100
percent risk-weighted assets up to 30 percent of the fund, 50
percent risk-weighted assets up to 40 percent of the fund, and 20
percent risk-weighted assets up to 60 percent of the fund. In such a
case, the institution must assign 30 percent of the total investment
to the 100 percent risk category, 40 percent to the 50 percent risk
category, and 30 percent to the 20 percent risk category. The
institution may not minimize its capital requirement by assigning 60
percent of the total investment to the 20 percent risk category and
40 percent of the total investment to the 50 percent risk category.
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In addition, if a mutual fund can hold an insignificant amount of
highly liquid, high-quality securities that do not qualify for a
preferential risk weight, then these securities may be disregarded in
determining the fund's risk weight. The prudent use of hedging
instruments by a mutual fund to reduce its risk exposure will not
increase the mutual fund's risk weighting. The Board also emphasizes
that any activities which are speculative in nature or otherwise
inconsistent with the preferential risk weighting assigned to the
fund's assets could result in the fund being assigned to the 100
percent risk category.
V. Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, the
Board has determined that this final rule will not have a significant
economic impact on a substantial number of small entities within the
meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et seq.). The
effect of the final rule will be to reduce regulatory burden on bank
holding companies by unifying the agencies' risk-based capital
treatment for presold construction loans, junior liens, and investments
in mutual funds. Moreover, because the risk-based capital guidelines
generally do not apply to bank holding companies with consolidated
assets of less than $150 million, the final rule will not affect such
companies. Accordingly, a regulatory flexibility analysis is not
required.
VI. Paperwork Reduction Act
The Board has determined that the final rule does not involve a
collection of information pursuant to the provisions of the Paperwork
Reduction Act of 1995 (44 U.S.C. 3501 et seq.).
VII. Small Business Regulatory Enforcement Fairness Act
The Small Business Regulatory Enforcement Fairness Act of 1996
(SBREFA) (Title II, Pub. L. 104-121) provides generally for agencies to
report rules to Congress for review. The reporting requirement is
triggered when a federal agency issues a final rule. Accordingly, the
agencies filed the appropriate reports with Congress as required by
SBREFA.
The Office of Management and Budget has determined that this final
rule does not constitute a ``major rule'' as defined by SBREFA.
List of Subjects in 12 CFR Part 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
For the reasons set forth in the preamble, part 225 of chapter II
of title 12 of the Code of Federal Regulations is amended as set forth
below.
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, section III.A., footnote 24 is
revised to read as follows:
Appendix A to Part 225--Capital Adequacy Guidelines for Bank
Holding Companies: Risk-Based Measure
* * * * *
III. * * *
A. * * * \24\
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\24\ An investment in shares of a fund whose portfolio consists
primarily of various securities or money market instruments that, if
held separately, would be assigned to different risk categories,
generally is assigned to the risk category appropriate to the
highest risk-weighted asset that the fund is permitted to hold in
accordance with the stated investment objectives set forth in the
prospectus. An organization may, at its option, assign a fund
investment on a pro rata basis to different risk categories
according to the investment limits in the fund's prospectus. In no
case will an investment in shares in any fund be assigned to a total
risk weight of less than 20 percent. If an organization chooses to
assign a fund investment on a pro rata basis, and the sum of the
investment limits of assets in the fund's prospectus exceeds 100
percent, the organization must assign risk weights in descending
order. If, in order to maintain a necessary degree of short-term
liquidity, a fund is permitted to hold an insignificant amount of
its assets in short-term, highly liquid securities of superior
credit quality that do not qualify for a preferential risk weight,
such securities generally will be disregarded when determining the
risk category into which the organization's holding in the overall
fund should be assigned. The prudent use of hedging instruments by a
fund to reduce the risk of its assets will not increase the risk
weighting of the fund investment. For example, the use of hedging
instruments by a fund to reduce the interest rate risk of its
government bond portfolio will not increase the risk weight of that
fund above the 20 percent category. Nonetheless, if a fund engages
in any activities that appear speculative in nature or has any other
characteristics that are inconsistent with the preferential risk
weighting assigned to the fund's assets, holdings in the fund will
be assigned to the 100 percent risk category.
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* * * * *
3. In appendix A to part 225, section III.C.3. footnote 37 is
revised to read as follows:
* * * * *
III. * * *
C. * * *
3. * * * 37
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\37\ If a banking organization holds the first and junior
lien(s) on a residential property and no other party holds an
intervening lien, the transaction is treated as a single loan
secured by a first lien for the purposes of determining the loan-to-
value ratio and assigning a risk weight.
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* * * * *
4. In appendix A to part 225, section III.C.3. is amended by adding
a new sentence to the end of footnote 38 to read as follows:
* * * * *
III. * * *
C. * * *
3. * * * 38
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\38\ * * * Such loans to builders will be considered prudently
underwritten only if the bank holding company has obtained
sufficient documentation that the buyer of the home intends to
purchase the home (i.e., has a legally binding written sales
contract) and has the ability to obtain a mortgage loan sufficient
to purchase the home (i.e., has a firm written commitment for
permanent financing of the home upon completion).
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* * * * *
[[Page 10204]]
By order of the Board of Governors of the Federal Reserve
System, February 24, 1999.
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 99-5013 Filed 3-1-99; 8:45 am]
BILLING CODE 6210-01-U