[Federal Register Volume 65, Number 188 (Wednesday, September 27, 2000)]
[Proposed Rules]
[Pages 57993-58011]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-24203]


 ========================================================================
 Proposed Rules
                                                 Federal Register
 ________________________________________________________________________
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
 
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 

  Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / 
Proposed Rules  

[[Page 57993]]



DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 00-17]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1080]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AC34

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 565 and 567

[Docket No. 2000-70]
RIN 1550-AB11


Capital; Leverage and Risk-Based Capital Guidelines; Capital 
Adequacy Guidelines; Capital Maintenance: Residual Interests in Asset 
Securitizations or Other Transfers of Financial Assets

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

ACTION: 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) propose to amend their capital 
adequacy standards for banks, bank holding companies and thrifts 
(collectively, banking organizations) concerning the treatment of 
certain residual interests in asset securitizations or other transfers 
of financial assets. Residual interests are defined as those on-balance 
sheet assets that represent interests (including beneficial interests) 
in the transferred financial assets retained by a seller (or 
transferor) after a securitization or other transfer of financial 
assets; and are structured to absorb more than a pro rata share of 
credit loss related to the transferred assets through subordination 
provisions or other credit enhancement techniques (credit enhancement). 
Examples of residual interests include, but are not limited to, 
interest only strips receivable (I/O strips), spread accounts, cash 
collateral accounts, retained subordinated interests, and other similar 
forms of on-balance sheet assets that function as a credit enhancement. 
Residual interests as defined in the proposed rule do not include 
interests purchased from a third party.
    Generally, these residual interests are non-investment grade or 
unrated assets retained by the issuing institution in order to provide 
``first-loss'' credit support for the senior positions in a 
securitization or other financial asset transfer. They generally lack 
an active market through which a readily available market price can be 
obtained. In addition, many of these residual interests are exposed, on 
a leveraged basis, to a significant level of credit and interest rate 
risk that make their valuation extremely sensitive to changes in the 
underlying credit and prepayment assumptions. As a result, such 
residual interests present valuation and liquidity concerns. High 
concentrations of such illiquid and volatile assets in relation to 
capital can threaten the safety and soundness of banking organizations.
    This proposed rule is intended to better align regulatory capital 
requirements with the risk exposure of these types of residual 
interests, encourage conservative valuation methods, and restrict 
excessive concentrations in these assets. The proposed rule would 
require that risk-based capital be held in an amount equal to the 
amount of the residual interest that is retained on the balance sheet 
by a banking organization in a securitization or other transfer of 
financial assets, even if the capital charge exceeds the full risk-
based capital charge typically held against the transferred assets. The 
proposed rule also would restrict excessive concentrations in residual 
interests by limiting the amount that may be included in Tier 1 capital 
for both leverage and risk-based capital purposes. When aggregated with 
nonmortgage servicing assets and purchased credit card relationships 
(PCCRs), the balance sheet amount of residual interests would be 
limited to 25 percent of Tier 1 capital, with any amount in excess of 
this limitation deducted in determining the amount of a banking 
organization's Tier 1 capital.

DATES: Comments must be received by December 26, 2000.

ADDRESSES: Comments should be directed to:
    OCC: Comments may be submitted to Docket No. 00-17, Communications 
Division, Third Floor, Office of the Comptroller of the Currency, 250 E 
Street, SW., Washington, DC 20219. Comments will be available for 
inspection and photocopying at that address. In addition, comments may 
be sent by facsimile transmission to FAX number (202/874-5274), or by 
electronic mail to [email protected].
    Board: Comments directed to the Board should refer to Docket No. R-
1080 and may be mailed to Ms. Jennifer J. Johnson, Secretary, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue, NW., Washington DC 20551 or mailed electronically to 
[email protected]. Comments addressed to the attention 
of Ms. Johnson may also be delivered to Room B-2222 of the Eccles 
Building between 8:45 a.m. and 5:15 p.m. weekdays, or the security 
control room in the Eccles Building courtyard on 20th Street, N.W. 
(between Constitution Avenue and C Street) 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: Send written comments to Robert E. Feldman, Executive 
Secretary, Attention: Comments/OES, Federal Deposit Insurance 
Corporation, 550 17th

[[Page 57994]]

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. Send facsimile 
transmissions to FAX number (202/898-3838); Internet address: 
[email protected].) Comments may be inspected and photocopied in the 
FDIC Public Information Center, Room 100, 801 17th Street, NW., 
Washington, DC 20429, between 9 a.m. and 4:30 p.m. on business days.
    OTS: Send comments to Manager, Dissemination Branch, Information 
Management and Services Division, Office of Thrift Supervision, 1700 G 
Street, NW, Washington, DC 20552, Attention Docket No. 2000-70. Hand 
deliver comments to the Guard's Desk, East Lobby Entrance, 1700 G 
Street, NW., from 9 a.m. to 4 p.m. on business days. Send facsimile 
transmissions to FAX Number (202) 906-7755; or (202) 906-6956 (if 
comments are over 25 pages). Send e-mails to public.info@ots.treas.gov">public.info@ots.treas.gov, 
and include your name and telephone number. Interested persons may 
inspect comments at the Public Reference Room, 1700 G Street, NW., from 
10 a.m. until 4 p.m. on Tuesdays and Thursdays.

FOR FURTHER INFORMATION CONTACT:   
    OCC: Amrit Sekhon, Risk Specialist (202/874-5211), Capital Policy; 
Ron Shimabukuro, Senior Attorney, or Laura Goldman, Senior Attorney, 
Legislative and Regulatory Activities Division (202/874-5090).
    Board: Thomas R. Boemio, Senior Supervisory Financial Analyst (202/
452-2982); Arleen Lustig, Supervisory Financial Analyst (202/452-2987), 
Division of Banking Supervision and Regulation; and Mark E. Van Der 
Weide, Counsel, (202/452-2263), Legal Division. For the hearing 
impaired only, Telecommunication Device for the Deaf (TDD), Janice 
Simms (202/872-4984), Board of Governors of the Federal Reserve System, 
20th and C Streets, NW., Washington, DC 20551.
    FDIC: William A. Stark, Assistant Director, Division of Supervision 
(202/898-6972); Stephen G. Pfeifer, Senior Examination Specialist, 
Division of Supervision (202/898-8904); Keith A. Ligon, Chief, Policy 
Unit, Division of Supervision (202/898-3618); and Marc J. Goldstrom, 
Counsel, Legal Division (202/898-8807).
    OTS: Michael D. Solomon, Senior Program Manager for Capital Policy 
(202/906-5654), and Teresa A. Scott, Counsel, Banking and Finance (202/
906-6478), Regulation and Legislation Division, Office of the Chief 
Counsel, Office of Thrift Supervision, 1700 G Street, NW., Washington, 
DC 20552.

SUPPLEMENTARY INFORMATION: This preamble consists of the following 
sections:

I. Introduction
II. Nature of Supervisory Concerns
III. Current Capital Treatment for Residual Interests
IV. Residual Interests Subject to the Proposal
V. Proposed Amendments to the Capital Standards
VI. Request for Public Comment
VII. Plain Language
VIII. Regulatory Analysis

I. Introduction

    The proposed rule addresses the supervisory concerns arising from 
the illiquid and volatile nature of residual interests that are 
retained by the securitizer or other seller of financial assets, when 
those residual interests are used as a credit enhancement to support 
the financial assets transferred. The proposal also reduces the risk 
from excessive concentrations in these residual interests, including 
those situations where large residual interests are retained in 
connection with the sale or securitization of low quality, higher risk 
loans. As discussed in more detail in section V, the proposed rule 
would (1) require capital to be maintained in an amount equal to the 
amount of the residual interest that is retained on the balance sheet 
for risk-based capital purposes, and (2) require the amount of any such 
residual interests to be included in the 25 percent of Tier 1 capital 
sublimit that currently applies to nonmortgage servicing assets and 
purchased credit card relationships (PCCRs), with any amounts in excess 
of this limit deducted from Tier 1 capital for both leverage and risk-
based capital purposes.

II. Nature of Supervisory Concerns

    Securitizations and other financial asset transfers provide an 
efficient mechanism for banking organizations to sell loan assets or 
credit exposures. The benefits of these transactions must be balanced 
against the significant risks that such activities can pose to banking 
organizations and to the deposit insurance funds. Recent examinations 
have disclosed significant weaknesses in the risk management processes 
related to securitization activities at certain institutions. The most 
frequently encountered problems stem from: (1) The failure to recognize 
recourse obligations that frequently accompany securitizations and to 
hold sufficient capital against such obligations; (2) the excessive or 
inadequately supported valuation of residual interests; (3) the 
liquidity risk associated with over reliance on asset securitization as 
a funding source; and (4) the absence of adequate independent risk 
management and audit functions.
    The Agencies addressed these concerns in the Interagency Guidance 
on Asset Securitization (Securitization Guidance) issued in December 
1999.\1\ The Securitization Guidance highlighted some of the risks 
associated with asset securitization and emphasized the Agencies' 
concerns with certain residual interests generated from the 
securitization and sale of assets.
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    \1\ See OCC Bulletin 99-46 (December 14, 1999) (OCC); FDIC FIL 
109-99 (December 13, 1999) (FCIC); SR 99-37(SUP) (December 13, 1999) 
(FRB); and CEO LTR 99-119 (December 14, 1999) (OTS). See this 
guidance for a more detailed discussion of the risk management 
processes applicable to securitization activities.
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    The Securitization Guidance addressed the fundamental risk 
management practices that should be in place at institutions that 
engage in securitization activities and stressed the need for bank 
management to implement policies and procedures that include limits on 
the amount of residual interests that may be carried as a percentage of 
capital. In particular, the Securitization Guidance set forth the 
supervisory expectation that the value of a residual interest in a 
securitization must be supported by objectively verifiable 
documentation of the asset's fair market value utilizing reasonable, 
conservative valuation assumptions. Under this guidance, residual 
interests that do not meet this expectation, or that fail to meet the 
supervisory standards set forth in the Securitization Guidance, should 
be classified as ``loss'' and disallowed as assets of the banking 
organization for regulatory capital purposes.
    Moreover, the Agencies indicated in this guidance that institutions 
found lacking effective risk management programs or engaging in 
practices that present safety and soundness concerns would be subject 
to more frequent supervisory review, limitations on residual interest 
holdings, more stringent capital requirements, or other supervisory 
response. The Securitization Guidance further advised the industry that 
given the risks presented by securitization activities, and the 
illiquidity and potential volatility of residual interests, the 
Agencies were actively considering the establishment of regulatory 
restrictions that would limit or eliminate the amount of certain 
residual interests that

[[Page 57995]]

may be recognized in determining the adequacy of regulatory capital.
    The Agencies have identified three areas of continuing supervisory 
concern:
    (1) Inappropriate or aggressive valuations of residual interests;
    (2) Inadequate capital in relation to the risk exposure of the 
organization retaining residual interests; and
    (3) Excessive concentrations of residual interests in relation to 
capital.
    The Statement of Financial Accounting Standards No. 125, 
``Accounting for Transfers and Servicing of Financial Assets and 
Extinguishment of Liabilities'' (FAS 125) \2\ governs the recognition 
of a residual interest in a securitization as an asset of the 
sponsoring institution. Under these generally accepted accounting 
principles (GAAP), when a transfer of assets is treated as a sale, the 
securitizing or selling institution carries any residual interests as 
an asset on its books at an estimate of fair value.\3\ Retaining this 
residual interest on the balance sheet in connection with a sale 
generally has the effect of increasing the amount of current earnings 
generated by the gains from the sale.
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    \2\ FAS 125 establishes certain transfer of control, accounting, 
and valuation criteria surrounding the transfer of financial assets 
as a benchmark for determining whether a transfer is recorded as a 
``sale'' and, if so, at what value it is recorded. Under FAS 125, 
the transferring financial institution generally will immediately 
recognize gains from the sale of the transferred assets and record 
retained interests in a manner that captures all of the financial 
components of, including the residual interests that arise in 
connection with, the securitization or other asset transfer.
    \3\ The fair value reflects the expected future cash flows 
discounted in an appropriate market interest rate, and is calculated 
using assumptions regarding estimated credit loss rates and 
prepayment speeds.
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    The Agencies have become increasingly concerned with fair value 
estimates that are based on unwarranted assumptions of expected cash 
flows. No active market exists for many residual interests. As a 
result, there is no marketplace from which an arm's length market price 
can readily be obtained to support the residual interest valuation. 
Recent examinations have highlighted the inherent uncertainty and 
volatility regarding the initial and ongoing valuation of residual 
interests. A banking organization that securitizes assets may overvalue 
its residual interests and thereby inappropriately generate ``paper 
profits'' (or mask actual losses) through incorrect cash flow modeling, 
flawed loss assumptions, inaccurate prepayment estimates, and 
inappropriate discount rates. Residual interests are exposed to a 
significant level of credit and interest rate risk that make their 
valuation extremely sensitive to changes in the underlying assumptions. 
Market events can affect the discount rate or performance of assets 
supporting residual interests and can swiftly and dramatically alter 
their value. Should the institution hold an excessive concentration of 
such assets in relation to capital, the safety and soundness of the 
institution may be threatened.
    The Agencies believe that the current regulatory capital 
requirements do not adequately reflect the risk of unexpected losses 
associated with these transactions. The booking of a residual interest 
using gain-on-sale accounting can increase the selling institution's 
capital and thereby allow the bank to leverage the capital created from 
the securitization. This increased leverage resulting from the current 
recognition of uncertain future cash flows is a supervisory concern. 
Accordingly, the proposed rule focuses on those transfers of financial 
assets treated as sales under GAAP.\4\
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    \4\ When the securitization or other transfer of financial 
assets is treated as a financing, under GAAP and for regulatory 
capital purposes, rather than a sale, the assets continue to be 
reflected on the balance sheet of the transferring institution. In 
these circumstances, the assets continue to be subject to the 
minimum capital requirement (generally 8 percent). The level of 
supervisory concern is diminished in these circumstances because 
there is no residual interest created to pose valuation or liquidity 
concerns. Importantly, a financing transaction does not generate 
earnings leading to the creation of capital. For this reason, the 
proposal only changes the regulatory capital requirements for 
banking organizations when they securitize or otherwise transfer 
financial assets and treat the transactions as sales under GAAP.
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    A related concern is the adequacy of capital held by institutions 
that securitize or sell assets and retain residual interests. First, 
the lack of liquidity of residual interests and the potential 
volatility of residual interests arising from their leveraged credit 
and interest rate risk limits their ability to support the institution, 
especially in times of stress. Second, any weaknesses in the valuation 
of the residual interest can translate into weaknesses in the quality 
of capital available to support the institution. Liberal or 
unsubstantiated assumptions can result in material inaccuracies in 
financial statements. Even when such residual interests have been 
appropriately valued, relatively small changes in the underlying 
assumptions can lead to material changes in the residual interest's 
fair value. Inaccuracies in the initial valuation of residual 
interests, as well as changes in the underlying assumptions over time, 
can result in substantial write-downs of residual interests. If these 
generally illiquid and volatile residual interests represent an 
excessive concentration of the sponsoring institution's capital, they 
can contribute to the ultimate failure of the institution.
    The concerns regarding excessive concentration and adequacy of 
capital are heightened where the residual interests are generated from 
the securitization of certain assets, such as low-quality or high loan-
to-value loans. Recent examinations have shown that in order to provide 
adequate credit enhancement to the senior positions in securitizations 
involving low quality assets, institutions generally must retain 
relatively greater credit risk exposure. In such transactions, the 
sponsoring institutions may retain residual interests in amounts that 
exceed the risk-based capital that would have been associated with the 
loans had they not been transferred.
    Because of these continuing supervisory concerns, the Agencies 
believe it is appropriate to propose these revisions to their 
respective capital adequacy rules in order to limit the amount of 
residual interests that are retained by banking organizations and 
require adequate capital for the risk exposure created.

III. Current Capital Treatment for Residual Interests

Assets Sold ``With Recourse'' \5\
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    \5\ Consolidated Reports of Condition and Income (Call Report) 
instructions issued by the Federal Financial Institutions 
Examination Council provide examples of transfers of assets that 
involve recourse arrangements. See the Call Report Glossary entry 
for ``Sales of Assets for Risk-Based Capital Purposes.'' These 
examples address the risk of loss retained in connection with 
transfers of assets. OTS currently defines the term ``recourse'' 
more broadly in its capital rules at 12 CFR 567.1 to include the 
``acceptance, assumption or retention'' of the risk of loss. The 
Agencies have issued a separate proposal that, among other things, 
would provide a uniform definition of ``recourse.'' See 65 FR 12319 
(March 8, 2000).
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    Under current risk-based capital guidelines, banking organizations 
that retain ``recourse'' on assets sold generally are required to hold 
capital as though the loans remained on the institution's books,\6\ up 
to the ``full capital charge''.\7\ For regulatory capital

[[Page 57996]]

purposes, recourse is generally defined as an arrangement in which a 
banking organization retains the risk of credit loss in connection with 
an asset transfer, if the risk of credit loss exceeds a pro rata share 
of the institution's claim on the assets.\8\
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    \6\ Under the Agencies' current capital rules, assets 
transferred with recourse in a transaction that is reported as a 
sale under generally accepted accounting principles (GAAP) are 
removed from the balance sheet and are treated as off-balance sheet 
exposures for risk-based capital purposes. For transactions reported 
as a sale, the entire amount of the assets sold (not just the 
contractual amount of the recourse obligation) is normally converted 
into an on-balance sheet credit equivalent amount using a 100 
percent conversion factor. This credit equivalent amount is then 
risk weighted for risk-based capital calculation purposes.
    \7\ For assets that are assigned to the 100 percent risk-weight 
category, the full capital charge is 8 percent of the amount of 
assets transferred, and institutions are required to hold 8 cents of 
capital for every dollar of assets transferred with recourse. For 
assets that are assigned to the 50 percent risk-weight category, the 
full capital charge is 4 cents of capital for every dollar of assets 
transferred with recourse.
    \8\ The risk-based capital treatment for sales with recourse can 
be found at 12 CFR 3, appendix A, section (3)(b)(1)(iii) (OCC); 12 
CFR 208, appendix A, section III.D.1 and 12 CFR 225, appendix A, 
section III.D.1 (FRB); 12 CFR 325, appendix A, section II.D.1 
(FDIC); and 12 CFR 567.6(a)(2)(i)(C) (OTS).
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    As required by statute,\9\ the Agencies have adopted rules that 
provide ``low-level recourse'' treatment for those institutions that 
securitize or sell assets and retain recourse in dollar amounts less 
than the full capital charge.\10\ Before the issuance of the low-level 
recourse rules, these institutions could have been required to hold a 
greater level of capital than their maximum contractual exposure to 
loss on the transferred assets. The low-level recourse treatment 
applies to transactions accounted for as sales under FAS 125 in which a 
banking organization contractually limits its recourse exposure to less 
than the full capital charge for the assets transferred.
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    \9\ Low-level recourse treatment is mandated by section 350 of 
the Riegle Community Development and Regulatory Improvement Act, 12 
U.S.C. 4808, which generally provides that: ``the amount of risk-
based capital required to be maintained * * * by any insured 
depository institution with respect to assets transferred with 
recourse by such institution may not exceed the maximum amount of 
recourse for which such institution is contractually liable under 
the recourse agreement.''
    \10\ The Agencies' low-level resourse rules appear at: 12 CFR 3, 
appendix A, section 3(d) (OCC); 12 CFR 208, appendix A, section 
III.D.1.g and 225, appendix A, section III.D.1.g (FRB); 12 CFR 325, 
appendix A, section II.D.1 (FDIC); and 12 CFR 567.6(a)(2)(i)(C) 
(OTS). A brief explanation is also contained in the instructions for 
regulatory reporting in section RC-R for the Call Report or schedule 
CCR for the Thrift Financial Report.
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    Under the low-level recourse rule, a banking organization generally 
holds capital on a dollar-for-dollar basis up to the amount of the 
maximum contractual exposure. In the absence of any other recourse 
provisions, the on-balance sheet amount of the residual interests 
represents the maximum contractual exposure. For example, assume that a 
banking organization securitizes $100 million of credit card loans and 
records a residual interest on the balance sheet of $5 million that 
serves as a credit enhancement for the assets transferred. Before the 
low-level recourse rule was issued, the institution would be required 
to hold $8 million of risk-based capital against the $100 million in 
loans sold, as though the loans had not been sold. Under the low-level 
recourse rule, the institution would be required to hold $5 million in 
capital, that is, ``dollar-for-dollar'' capital up to the institution's 
maximum contractual exposure.
    Existing regulatory capital rules, however, do not require 
institutions to hold ``dollar-for-dollar'' capital against residual 
interests that exceed the full capital charge ($8 million in the above 
example). Typically, institutions that securitize and sell higher risk 
assets are required to retain a large residual interest (often greater 
than the full capital charge of 8 percent on 100 percent risk-weighted 
assets) in order to ensure that the more senior positions in the 
securitization or other asset sale can receive the desired investment 
ratings. Write-downs of the recorded value of the residual interest, 
due to unrealistic (or changing) loss or prepayment assumptions, can 
result in residual losses that exceed the amount of capital held 
against these assets, thereby impairing the safety and soundness of the 
institution.
    For example, assume that a banking organization securitizes $100 
million of subprime credit card loans and records a residual interest 
on the balance sheet of $15 million that serves as a credit enhancement 
for the securitization. Under the current risk-based capital rules, the 
transferred loans would be treated as sold with recourse, and an 8 
percent risk-based capital charge for these 100 percent risk-weighted 
loans would be required; that is, $8 million in risk-based capital 
would be required to be held against the $100 million of transferred 
loans. In this hypothetical example, however, the amount of residual 
interests retained on the balance sheet ($15 million) exceeds the full 
equivalent risk-based capital charge held against the assets 
transferred ($8 million). Accordingly, the amount of the residual 
interest is not fully covered by dollar-for-dollar risk-based capital; 
only $8 million in capital is required to be held by the institution 
against the $15 million residual interest exposure.
    This example demonstrates that, for residual interests that exceed 
the dollar amount of the full capital charge on the assets transferred, 
current capital standards do not require dollar-for-dollar capital 
protection for the full contractual exposure to loss retained by the 
selling institution. Any losses in excess of the full capital charge (8 
percent in the example above) could negatively affect the capital 
adequacy of the institution. Should the asset be written down from $15 
million to $5 million, the $8 million of required capital would be 
insufficient to absorb the full loss of $10 million.

B. Prior Consideration of Concentration Limits on Residual Interests

    In 1998, the Agencies amended their capital rules to change the 
regulatory capital treatment of servicing assets.\11\ This rulemaking 
increased from 50 percent to 100 percent the amount of mortgage 
servicing assets that could be included in Tier 1 capital. The Agencies 
imposed more restrictive limits on the amount of nonmortgage servicing 
assets and PCCRs that could be included in Tier 1 capital. These 
stricter limitations were imposed due to the lack of depth and maturity 
of the marketplace for such assets, and related concerns about their 
valuation, liquidity, and volatility.
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    \11\ See 63 FR 42668 (August 10, 1998).
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    At the time the Agencies issued the final rule on servicing assets, 
the Agencies declined to adopt similar capital limits for I/O strips, a 
form of residual interest, notwithstanding that certain I/O strips 
possessed cash flow characteristics similar to servicing assets and 
presented similar valuation, liquidity, and volatility concerns. At 
that time, the Agencies chose not to impose such limitations in 
recognition of the ``prudential effects of banking organizations 
relying on their own risk assessment and valuation tools, particularly 
their interest rate risk, market risk, and other analytical models.'' 
\12\ The Agencies expressly indicated that they would continue to 
review banking organizations' valuation of I/O strips and the 
concentrations of these assets relative to capital. Moreover, the 
Agencies noted that they ``may, on a case-by-case basis, require 
banking organizations that the Agencies determine have high 
concentrations of these assets relative to their capital, or are 
otherwise at risk from these assets, to hold additional capital 
commensurate with their risk exposures''.\13\ In addition, most of the 
residual interests at that time that were used as credit enhancements 
did not exceed the full capital charge on the transferred assets and 
thus were subject to ``dollar-for-dollar'' capital requirements under 
the Agencies'' existing low-level recourse rules. However, a trend 
toward the securitization of higher risk loans has now resulted in 
residual interests that exceed the full capital charge and for which 
``dollar-for-dollar'' capital is not required under the current risk-
based capital rules. This trend has also resulted in certain banking 
organizations engaged in such

[[Page 57997]]

securitization transactions having large concentrations in residual 
interests as a percentage of capital.
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    \12\ Id. at 42672.
    \13\ Id.
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IV. Residual Interests Subject to the Proposal

    Included in this proposal are residual interests that are 
structured to absorb more than a pro rata share of credit loss related 
to the securitized or sold assets through subordination provisions or 
other credit enhancement techniques. Such residual interests can take 
many forms. Generally, these residual interests are non-investment 
grade or unrated ``first-loss'' positions that provide credit support 
for the senior positions of the securitization or other asset sale. A 
key aspect of such residual interests is that they reflect an 
arrangement in which the institution retains risk of credit loss in 
connection with an asset transfer. In addition to recourse provisions 
that may require the selling institution to support a securitization, 
residual interests can take the form of spread accounts, over-
collateralization, subordinated securities, cash collateral accounts, 
or other similar forms of on-balance sheet assets that function as a 
credit enhancement. Servicing assets that function as credit 
enhancements would be subject to the proposed rule.
    The definition of residual interests excludes those interests that 
do not serve as credit enhancements. In this regard, highly rated, 
liquid, marketable residual interests where the institution assumes 
only the interest rate risk associated with the assets transferred in 
the securitization (e.g., Fannie Mae or Freddie Mac I/O strips) do not 
serve as a credit enhancement for the transferred assets and thus do 
not expose the institution to a concentrated level of credit risk. 
Further, such instruments are traded in a currently active marketplace 
and thus do not present the same degree of liquidity and valuation 
concerns.
    The residual interests covered by the proposed rule are generally 
retained by the securitizing institution rather than sold because they 
are generally illiquid and volatile in nature and thus present 
liquidity and valuation concerns. The proposed rule extends only to 
residual interests that have been retained by a banking organization as 
a result of a securitization or other sale transaction and does not 
cover residual interests that a banking organization has purchased from 
another party.\14\
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    \14\ The proposed rule would extend to all residual interests as 
defined, whether included in the banking book or included in the 
trading book and subject to the market risk rules.
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    Purchased residual interests can present the same degree of 
concentrated credit risk associated with retained residual interests. 
The exclusion of purchased residual interests from the proposed rule 
could establish a different capital treatment for the same asset, 
depending on whether the interest is purchased from a third party or 
retained in connection with the transfer of financial assets to a third 
party. The Agencies are particularly concerned about the possible 
``swapping'' of residual interests, where there is otherwise limited 
breadth and depth of the market for these residual interests, and both 
parties stand to gain from accommodation valuations of each asset.
    However, residual interests purchased in an arm's length 
transaction may not pose the same degree of liquidity risk as interests 
that are retained. In addition, purchased interests do not present the 
same opportunity to create capital as do interests that are originated 
and retained by a securitizing institution. Further, unlike retained 
residual interests where an overvaluation of the residual interest can 
lead to a higher gain on sale and the creation of additional capital, 
there is a marketplace discipline on the initial amount at which a 
purchased residual interest is recorded (that is, it is limited to the 
purchase price), and there is no incentive on the part of the purchaser 
to pay a price above market because such a purchase does not create any 
capital for the purchaser.
    The Agencies are considering including such purchased interests 
within the scope of the rule and are requesting comment on this issue.

V. Proposed Amendments to the Capital Standards

A. Proposed Treatment of Residual Interests

    The Agencies propose to amend the regulatory risk-based capital 
standards by eliminating the distinction between the treatment of low-
level recourse obligations and the treatment of assets securitized or 
sold with recourse in those cases where the amount of the residual 
interest retained on balance sheet exceeds the full capital charge for 
the assets transferred. The current rules essentially place a ceiling 
on the ``dollar-for-dollar'' capital requirement for recourse 
obligations. Removal of this ``cap'' will ensure that all residual 
interests are subject to the same ``dollar-for-dollar'' capital 
standard that is applied to residual interests in low-level recourse 
transactions and that capital is held for the organization's total 
contractual exposure to loss.
    In addition to modifying the risk-based capital treatment for 
residual interests, the Agencies propose limiting the amount of 
residual interests that can be recognized in determining Tier 1 capital 
under the Agencies' leverage and risk-based capital standards. The 
purpose of the limit is to prevent excessive concentrations in holdings 
of residual interests. The Agencies propose including residual 
interests within the 25 percent of Tier 1 capital sublimit already 
placed upon nonmortgage servicing assets and PCCRs. Under this 
restriction, any amounts of residual interests, when aggregated with 
nonmortgage servicing assets and PCCRs, that exceed of 25 percent of 
Tier 1 capital, would be deducted from Tier 1 capital for purposes of 
calculating both the risk-based and leverage capital ratios.\15\
---------------------------------------------------------------------------

    \15\ The unrealized gains that may be recorded by an institution 
with respect to residual interests that are accounted for as 
available-for-sale securities are presently not included in Tier 1 
capital and would not be subject to further deduction under this 
rule.
---------------------------------------------------------------------------

    In addition to including residual interests in the sublimit 
currently applied to PCCRs and nonmortgage servicing assets, residual 
interests would also be included in the calculation of the overall 100 
percent limit on servicing assets. Under this proposal, the maximum 
allowable amount of mortgage servicing assets, PCCRs, nonmortgage 
servicing assets, and residual interests, in the aggregate, would be 
limited to 100 percent of the amount of Tier 1 capital that exists 
before the deduction of any disallowed mortgage servicing assets, any 
disallowed PCCRs, any disallowed nonmortgage servicing assets, any 
disallowed residual interests, and any disallowed deferred tax assets. 
The residual interests, however, would not be subject to the 90 percent 
of fair value limitation that applies to servicing assets and PCCRs. 
Under the proposed rule, residual interests would already be subject to 
a ``dollar-for-dollar'' capital requirement. Any residual interests 
deducted in determining the Tier 1 capital numerator for the leverage 
and risk-based capital ratios also would be excluded from the 
denominators of these ratios.
    In summary, under the proposed rule, institutions generally would 
be required to hold ``dollar-for-dollar'' capital for residual 
interests and additionally would be required to deduct from Tier 1 
capital the amount of any residual interests (when aggregated with 
nonmortgage servicing assets and PCCRs) that exceed the established 25 
percent sublimit. In combination, the proposal is intended to ensure 
that all

[[Page 57998]]

residual interests are supported by ``dollar-for-dollar'' capital and 
that excessive concentrations (over 25 percent) in residual interests 
relative to capital are avoided.\16\
---------------------------------------------------------------------------

    \16\ The Agencies are also proposing minor technical changes. 
For example, this proposal does not effect the calculation of 
tangible equity the under prompt corrective action regulations. 
However, because the Agencies define tangible equity using different 
core capital concepts (i.e., ``core capital'' vs. ``core capital 
elements''), the OTS is proposing a technical revision to its 
definition of tangible equity (12 CFR 565.2(f)) to ensure that this 
calculation is not effected by the proposal.
    In addition, the FDIC is also amending its regulations to remove 
an obsolete provision concerning the transitional 7.25 percent risk-
based capital standard that was only effective until December 31, 
1992. This provision currently appears in section III.B of appendix 
A to part 325. Similarly, OTS is making technical revisions to 
related regulatory provisions at 12 CFR 565.2(f).
---------------------------------------------------------------------------

B. Net-of-Tax Treatment

    The Agencies propose to extend the current net-of-tax treatment 
permitted in their existing capital standards to residual 
interests.\17\ Thus, the proposed rule would permit: (1) Disallowed 
amounts of residual interests (that is, those amounts in excess of the 
25 percent of Tier 1 capital sublimit) to be determined on a basis that 
is net of any associated deferred tax liability, and (2) any amounts of 
residual interests that are subject to the ``dollar-for-dollar'' 
capital requirement (that is, those amounts included in the 25 percent 
of Tier 1 capital sublimit) to be determined on a basis that is net of 
any associated deferred tax liability. In instances where there is no 
difference between the book basis and the tax basis of the residual 
interest, no deferred tax liability would be created. Any deferred tax 
liability used to reduce the capital requirement for a residual 
interest would not be available for the organization to use in 
determining the amount of net deferred tax assets that may be included 
in the calculation of Tier 1 capital.\18\
---------------------------------------------------------------------------

    \17\ The proposed treatment is consistent with that permitted 
for low-level recourse exposures, disallowed servicing assets, and 
disallowed intangible assets in non-taxable business combinations.
    \18\ For example, see Sec. 325.5(g) of the FDIC's capital 
regulations (12 CFR 325.5(g)), which sets forth the limitations on 
the amount of deferred tax assets that state nonmember banks can 
recognize for purposes of calculating Tier 1 capital under the 
leverage and risk-based capital rules.
---------------------------------------------------------------------------

    The following example helps illustrate the proposed tax treatment. 
Assume residual interests of $100 with an associated deferred tax 
liability of $35 and Tier 1 capital (before the deduction of any 
disallowed residual interests) of $200. In this example, the 25 percent 
concentration limit on residual interests (when combined with 
nonmortgage servicing assets and PCCRs) would be $50 (i.e., 25 percent 
times $200). The amount of disallowed residual interests (before 
considering the associated deferred tax liability) would have been $50. 
The deferred tax liability associated with the otherwise disallowed 
residual interests of $50 would be $17.50 (a $35 associated deferred 
tax liability against $100 in residual interests drives a 35 percent 
tax effect against the $50 disallowed residual interest). Thus, the 
amount of disallowed residual interests to be deducted in determining 
Tier 1 capital under the leverage and risk-based capital standards net 
of the associated deferred tax liability would be $32.50 (i.e., the $50 
in disallowed residual interests minus the $17.50 tax effect associated 
with the disallowed residual interests).
    In determining risk-weighted assets, the remaining $50 amount of 
residual interests allowable in Tier 1 would be subject to a ``dollar-
for-dollar'' capital on a basis that is also net of the deferred tax 
liability associated with the $50 residual interest. The deferred tax 
liability associated with the $50 not deducted from Tier 1 capital 
would be $17.50 (i.e., the 35 percent tax effect as calculated above 
times $50). Thus, the amount of residual interests that would be 
subjected to ``dollar-for-dollar'' treatment would be $32.50 ($50 less 
the $17.50 in deferred tax liabilities). Calculation of this ``dollar-
for-dollar'' capital charge is consistent with the ``dollar-for-
dollar'' capital requirements that are currently required for low-level 
recourse transactions.
    Other alternative calculations are possible and will be considered 
by the Agencies.\19\ The Agencies seek comment on whether the 
complexity of a ``net-of-tax'' approach is necessary and justified, and 
if so, what, if any, alternative calculations should be allowed.
---------------------------------------------------------------------------

    \19\ Two additional treatments are possible. Under the first 
approach, the amount of residual interests subject to a ``dollar-
for-dollar'' deduction for risk-based capital purposes, and a 
concentration limit for leverage capital purposes, would be the 
``at-risk'' amount; that is, the residual interests reduced by any 
associated deferred tax liability. For example, assume residual 
interests of $100 with an associated deferred tax liability of $35. 
Under this approach, the amount of residual interests subject to a 
``dollar-for-dollar'' capital charge and a concentration limit is 
$65 ($100-$35). In a worst-case scenario, if the value of the 
residual interests drops to zero, then the corresponding deferred 
tax liability would also drop to zero, and therefore capital would 
decline by $65--the net-of-tax amount. If the 25% of Tier 1 
concentration limitation is $50, then the deduction would be $15 
($65-$50). Under the second approach, the amount of residual 
interests subject to the ``dollar-for-dollar'' capital requirement 
and 25% of Tier 1 capital concentration limit would be determined on 
a gross basis, that is, without netting the associated deferred tax 
liability.
---------------------------------------------------------------------------

C. Reservation of Authority

    While this proposal should help remedy some of the major concerns 
associated with the generally illiquid and volatile nature of residual 
interests, the Agencies are also proposing to add language to the risk-
based capital standards that will provide greater flexibility in 
administering the standards. Institutions are developing novel 
transactions that do not fit well into the risk-weight categories set 
forth in the standards. Institutions are also devising novel 
instruments that nominally fit into a particular risk-weight category, 
but that impose risks on the banking organization at levels that are 
not commensurate with the nominal risk-weight for the asset, exposure, 
or instrument. Accordingly, the Agencies are proposing to add language 
to the standards to clarify the Agencies' authority, on a case-by-case 
basis, to determine the appropriate risk-weight asset amount in these 
circumstances. Exercise of this authority by the Agencies may result in 
a higher or lower risk weight for an asset. This reservation of 
authority explicitly recognizes the Agencies' retention of sufficient 
discretion to ensure that institutions, as they develop novel financial 
assets, will be treated appropriately under the risk-based capital 
standards.

D. Relationship of This Residual Interest Proposal to the March 2000 
Securitization Proposal

    This proposed rule regarding residual interests (residual interest 
proposal) and the March 2000 notice of proposed rulemaking on the risk-
based capital treatment of recourse arrangements, direct credit 
substitutes, and asset securitizations (the securitization proposal) 
are interrelated in that both proposals would address the regulatory 
capital treatment for residual interests that are retained in 
connection with securitizations and other transfers of financial 
assets.\20\ The capital treatment of residual interests under the 
securitization proposal differs in certain respects from the treatment 
proposed in this residual interest proposal. In any final rule that 
addresses the regulatory capital treatment of residual interests, the 
Agencies will ensure that any regulatory capital treatment of residual

[[Page 57999]]

interests resulting from these two proposals will be consistent.
---------------------------------------------------------------------------

    \20\ See 65 FR 12320 (March 8, 2000) for the text of the 
proposed revisions to the risk-based capital treatment of recourse 
arrangements, direct credit substitutes, and asset securitizations.
---------------------------------------------------------------------------

    In the securitization proposal, the Agencies propose using external 
credit ratings to match the risk-based capital requirement more closely 
to the relative risk of loss in asset securitizations. Highly rated 
investment-grade positions in securitizations would receive a favorable 
(less than 100 percent) risk-weight. Below-investment grade or unrated 
positions in securitizations would receive a less favorable risk-weight 
(greater than 100 percent risk-weight or gross-up treatment). A 
residual interest retained by an institution in an asset securitization 
(as well as residual interests that are purchased) would be subject to 
this capital framework under the securitization proposal.
    The residual interest proposal differs from the securitization 
proposal in several respects. For example, under the residual interest 
proposal, all residual interests that are retained by the institution 
and that fall within the 25 percent of Tier 1 capital limit would be 
subject to ``dollar-for-dollar'' capital treatment regardless of rating 
(and comment is sought on whether purchased interests should be treated 
similarly). To date, the Agencies believe that residual interests in 
asset securitizations generally are unrated and illiquid interests; 
however, as the market evolves, residual interests may in the future 
take the form of rated, liquid, certificated securities. If the rating 
provided to such a residual interest were investment grade (or no more 
than one category below investment grade) the securitization proposal 
would afford that residual interest more favorable capital treatment 
than the dollar-for-dollar capital requirement set forth in this 
residual interest proposal. In addition, the risk-based capital 
requirement for unrated residual interests that are subject to gross-up 
treatment under the securitization proposal would not exceed the full 
risk-based capital charge for the underlying assets that are being 
supported by the residual interest. Under this residual interest 
proposal, however, ``dollar-for-dollar'' capital would be required for 
the amount of the residual interest that is retained and falls within 
the 25 percent of Tier 1 capital limit, even if this amount exceeds the 
full capital charge typically held against the underlying assets that 
have been transferred with recourse. Also, unlike the residual interest 
proposal, the securitization proposal does not establish any 
concentration limit for residual interests as a percentage of capital.
    These differences between the residual interest proposal and the 
securitization proposal will be taken into account in any final rule 
published under either proposal. In developing a final rule on residual 
interests, the Agencies specifically invite comment on how the capital 
treatment for residual interests under this residual interest proposal 
should be reconciled with the capital treatment set forth in the 
securitization proposal.

E. Effective Date

    The Agencies intend to apply this proposal to existing as well as 
future transactions. Because banking organizations may need additional 
time to adapt to any new capital treatment, the Agencies may delay the 
effective date for a specific period of time (transition period). The 
Agencies view this transition period as an opportunity for institutions 
to consider the proposal's impact on their balance sheet structure and 
capital position. The Agencies invite comment on the need for and 
duration of a transition period.

VI. Request for Public Comment

    The Agencies invite public comment on all aspects of the proposed 
rule. In particular, the Agencies request comment on the definition of 
residual interest, the treatment of residual interests in determining 
compliance with minimum capital requirements, the conditions 
established in the proposal, and the implementation of the proposal. 
The Agencies also specifically request comment on the ``dollar-for-
dollar'' risk-based capital charge for residual interests, the 25 
percent of Tier 1 capital concentration limit on the amount of residual 
interests that can be recognized for leverage and risk-based capital 
purposes, and the issue of whether a ``net-of-associated deferred tax 
liability'' approach is appropriate in determining the capital 
requirements for residual interests.

VII. Plain Language

    Section 722 of the Gramm-Leach-Bliley (GLB) Act (12 U.S.C. 4809) 
requires 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 proposed rule 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?

VIII. Regulatory Analysis

A. Regulatory Flexibility Act Analysis

    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 rare. 
Accordingly, a regulatory flexibility analysis is not required. In 
addition, because the risk-based capital standards generally do not 
apply to bank holding companies with consolidated assets of less than 
$150 million, this proposal will not affect such companies''.
    FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act 
(5 U.S.C. 601 et seq.) the FDIC hereby certifies that the final rule 
will not have a significant economic impact on a substantial number of 
small entities. Comparison of Call Report data on FDIC-supervised banks 
to the items covered by the proposal that result in increased capital 
requirements shows that application of the proposal to small entities 
will be the infrequent exception.
    OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act 
(5 U.S.C. 601 et seq.) the OTS certifies that the proposed rule will 
not have a significant economic impact on a substantial number of small 
entities. Comparison of TFR data on OTS supervised savings associations 
regarding the items that would result in increased capital requirements 
indicate that the application of the proposal to small entities will be 
the infrequent exception.
    OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act 
(5 U.S.C. 601 et seq.) the OCC certifies that the proposed rule will 
not have a significant economic impact on a substantial number of small 
entities. Call Report data indicate that generally small banks do not 
have large residual interests that exceed the full risk-based capital 
charge required for transferred assets, and typically do not hold 
residual interests in amounts that would exceed the 25 percent of Tier 
1 capital limitation. For these reasons, the OCC believes that 
application of the proposed rule to small entities will be rare.

[[Page 58000]]

Consequently, a regulatory flexibility analysis is not required.

B. 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 (44 U.S.C. 3501 et seq.).

C. OCC and OTS Executive Order 12866 Statement

    The Comptroller of the Currency and the Director of the OTS have 
determined that the proposal described in this notice is not a 
significant regulatory action under Executive Order 12866. Accordingly, 
a regulatory impact analysis is not required. Nonetheless the OCC 
specifically invites comment on the dollar impact of the proposed rule.

D. OCC and OTS Unfunded Mandates Act Statement

    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 government, or by the private sector, of more 
than $100 million or more in any one year. Based on the Call Report, 
TFR and other data, OTS and OCC estimate that those banks and savings 
associations that would be required to increase capital under the 
proposed rule will not incur additional expenses in this amount in any 
one year. Therefore, the OCC and OTS have not prepared a budgetary 
impact statement or specifically addressed the regulatory alternatives 
considered. Nonetheless the OCC specifically invites comment on the 
dollar impact of the proposed rule.

E. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families

    The Agencies have determined that this proposed rule will not 
affect family well-being within the meaning of section 654 of the 
Treasury and Government Appropriations Act, 1999, Pub. L. 105-277, 112 
Stat. 2681 (1998).

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, Banks, banking, Capital 
adequacy, Reporting and recordkeeping requirements, Savings 
associations, State non-member banks.

12 CFR Part 565

    Administrative practice and procedures, Capital, Savings 
associations.

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 joint preamble, the Office of the 
Comptroller of the Currency proposes to amend part 3 of chapter I of 
title 12 of the Code of Federal Regulations 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 existing text 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 does not appropriately reflect the risks imposed on a bank and 
may require another risk weight that the OCC deems appropriate. 
Similarly, if no risk weight is specifically assigned, the OCC may 
assign any risk weight that the OCC deems appropriate. In making its 
determination, the OCC considers risks associated with the asset as 
well as other relevant factors.
    3. In appendix A to part 3:
    A. In section 1:
    i. Redesignate paragraphs (c)(25) through (c)(31) as paragraphs 
(c)(28) through (c)(34), paragraph (c)(24) as paragraph (c)(26), and 
paragraphs (c)(13) through (c)(23) as paragraphs (c)(14) through 
(c)(24);
    ii. Add new paragraphs (c)(13), (c)(25), and (c)(27);
    B. In section 2, revise paragraphs (c)(1)(ii), (c)(2) introductory 
text, (c)(2)(i), (c)(2)(ii) introductory text, (c)(2)(iii), and 
(c)(2)(iv);
    C. In section 3, add new paragraph (e) to read as follows:

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

Section 1. Purpose, Applicability of Guidelines, and Definitions

* * * * *
    (c) * * *
    (13) Financial asset means cash, evidence of an ownership 
interest in an entity, or a contract that conveys to a second entity 
a contractual right to receive cash or another financial instrument 
from a first entity or to exchange other financial instruments on 
potentially favorable terms with the first entity.
* * * * *
    (25) Residual interest means any on-balance sheet asset that 
represents an interest (including a beneficial interest) created by 
the transfer of financial assets, whether through a securitization 
or otherwise, and structured to absorb more than a pro rata share of 
credit loss related to the transferred assets through subordination 
provisions or other credit enhancement techniques. Residual 
interests generally include interest only strips receivable, spread 
accounts, cash collateral accounts, retained subordinated interests 
and other similar forms of on-balance sheet assets that function as 
a credit enhancement. Residual interests do not include residual 
interests purchased from a third party.
* * * * *
    (27) Securitization. Securitization means the pooling and 
repackaging of loans or other

[[Page 58001]]

credit exposures into securities that can be sold to investors.
* * * * *

Section 2. Components of Capital

* * * * *
    (c) * * *
    (1) * * *
* * * * *
    (ii) Other intangible assets and residual interests, except as 
provided in section 2(c)(2) of this appendix A; and * * *
    (2) Qualifying intangible assets and residual interests. Subject 
to the following conditions, mortgage servicing assets, nonmortgage 
servicing assets,\6\ purchased credit card relationships and 
residual interests need not be deducted from Tier 1 capital:
---------------------------------------------------------------------------

    \6\ Intangible assets are defined to exclude any IO strips 
receivable related to these mortgage and non-mortgage servicing 
assets. See section 1(c)(14) of this appendix A. Consequently, IO 
strips receivable related to mortgage and non-mortgage servicing 
assets are not required to be deducted under section 2(2)(2) of this 
appendix A. However, these IO strips receivable are subject to a 100 
percent risk weight under section 3(a)(4) of this appendix A.
---------------------------------------------------------------------------

    (i) The total of all intangible assets and residual interests 
that are included in Tier 1 capital is limited to 100 percent of 
Tier 1 capital, of which no more than 25 percent of Tier 1 capital 
can consist of purchased credit card relationships, nonmortgage 
servicing assets and residual interests in the aggregate. 
Calculation of these limitations must be based on Tier 1 capital net 
of goodwill, and all identifiable intangible assets, other than 
mortgage servicing assets, nonmortgage servicing assets, purchased 
credit card relationships and residual interests.
    (ii) Banks must value each intangible asset and residual 
interest included in Tier 1 capital at least quarterly. In addition, 
intangible assets included in Tier 1 capital must also be valued at 
the lesser of:
* * * * *
    (iii) The quarterly determination of the current fair value of 
the intangible asset or residual interest must include adjustments 
for any significant changes in original valuation assumptions, 
including changes in prepayment estimates.
    (iv) Banks may elect to deduct disallowed servicing assets and 
residual interests on a basis that is net of any associated deferred 
tax liability. Deferred tax liabilities netted in this manner cannot 
also be netted against deferred tax assets when determining the 
amount of deferred tax assets that are dependent upon future taxable 
income.
* * * * *

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

* * * * *
    (e) Residual interests. (1) General capital requirement. All 
residual interests are subject to both a capital concentration limit 
and a residual interest capital requirement in accordance with 
sections 3(e)(2) and 3(e)(3) of this appendix A. In determining the 
general capital requirement for a residual interest, the amount of 
all residual interests in excess of the capital concentration limit 
must be deducted from Tier 1 capital, in accordance with section 
3(e)(2) of this appendix A, before the residual interest capital 
requirement in section 3(e)(3) of this appendix A is applied.
    (2) Capital concentration limit. In addition to the residual 
interest capital requirement provided by section 3(e)(3) of this 
appendix A, a bank must deduct from Tier 1 capital all residual 
interest in excess of the 25 percent sublimit on qualifying 
intangible assets and residual interests in accordance with section 
2(c)(2)(i) of this appendix A.
    (3) Residual interests capital requirement. A bank must maintain 
risk-based capital for a residual interest equal to the amount of 
the residual interest that is retained on the balance sheet (less 
any amount disallowed in accordance with section 3(e)(2) of this 
appendix A and net of any associated deferred tax liability), even 
if the amount of risk-based capital required to be maintained 
exceeds the full risk-based capital requirement for the assets 
transferred.
    (4) Residual interests and other recourse obligations. Where a 
bank holds a residual interest and another recourse obligation (such 
as a standby letter of credit) in connection with the same asset 
transfer, the bank must maintain risk-based capital equal to the 
greater of the risk-based capital requirement for the residual 
interest as calculated under section 3(e)(3) of this appendix A or 
the full risk-based capital requirement for the assets transferred, 
subject to the low-level recourse rules under section 3(d) of this 
appendix A.
* * * * *

    Dated: August 16, 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, the Board of 
Governors of the Federal Reserve System proposes to amend parts 208 and 
225 of chapter II of title 12 of the Code of Federal Regulations 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, 92a, 93a, 248(a), 248(c), 321-338a, 
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j), 
1828(o), 1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 3105, 
3310, 3331-3351 and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g), 
78l(i), 78o-4(c)(5), 78q, 78q-l, 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. Section II.A.1. and the first seven paragraphs of section 
II.A.2. are revised, and footnote 5 is removed and reserved;
    B. In sections II, III and IV, footnotes 13 through 52 are 
redesignated as footnotes 14 through 53.
    C. In section II.B., a new paragraph (i)(c) and new footnote 14 are 
added, section II.B.1.b. and newly designated footnote 15 are revised, 
new sections II.B.1.c. through II.B.1.g. are added, and section II.B.4. 
is revised;
    D. In section III.A, the four undesignated paragraphs are 
designated as sections III.A.1. through III.A.4., and a new section 
III.A.5. is added.
    E. Section III.B.6. is added.
    F. Attachment II is revised.

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

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

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

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

[[Page 58002]]

    (i) * * *
    (c) Certain on-balance sheet residual interests--deducted from 
the sum of core capital elements in accordance with sections 
II.B.1.c. through e. of this appendix A.\14\
---------------------------------------------------------------------------

    \14\ Residual interests consist of balance sheet assets that: 
(a) Represent interests (including beneficial interests) in 
transferred financial assets retained by a seller (or transferor) 
after a securitization or other transfer of financial assets; and 
(b) are structured to absorb more than a pro rata share of credit 
loss related to the transferred assets through subordination 
provisions or other credit enhancement techniques. Residual 
interests do not include interests purchased from a third party. 
Residual interests generally include interest-only strips 
receivable, spread accounts, cash collateral accounts, retained 
subordinated interests, and other similar forms of on-balance sheet 
assets that function as a credit enhancement.
---------------------------------------------------------------------------

* * * * *
    1. Goodwill, other intangible assets, and residual interests. * 
* *
    b. Other intangible assets. i. All servicing assets, including 
servicing assets on assets other than mortgages (i.e., nonmortgage 
servicing assets), are included in this appendix as identifiable 
intangible assets. The only types of identifiable intangible assets 
that may be included in, that is, not deducted from, a bank's 
capital are readily marketable mortgage servicing assets, 
nonmortgage servicing assets, and purchased credit card 
relationships. The total amount of these assets that may be included 
in capital is subject to the limitations described below in sections 
II.B.1.d. and e. of this appendix A.
    ii. The treatment of identifiable intangible assets set forth in 
this section generally will be used in the calculation of a bank's 
capital ratios for supervisory and applications purposes. However, 
in making an overall assessment of a bank's capital adequacy for 
applications purposes, the Board may, if it deems appropriate, take 
into account the quality and composition of a bank's capital, 
together with the quality and value of its tangible and intangible 
assets.
    c. Residual interests. Residual interests may be included in, 
that is, not deducted from, a bank's capital subject to the 
limitations described below in sections II.B.1.d. and e. of this 
appendix A.
    d. Fair value limitation. The amount of mortgage servicing 
assets, nonmortgage servicing assets, and purchased credit card 
relationships that a bank may include in capital shall be the lesser 
of 90 percent of their fair value, as determined in accordance with 
section II.B.1.f. of this appendix A, or 100 percent of their book 
value, as adjusted for capital purposes in accordance with the 
instructions in the commercial bank Consolidated Reports of 
Condition and Income (Call Reports). The amount of residual 
interests a bank may include in capital shall be 100 percent of its 
book value. If both the application of the limits on mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and residual interests and the adjustment of the 
balance sheet amount for these assets would result in an amount 
being deducted from capital, the bank would deduct only the greater 
of the two amounts from its core capital elements in determining 
tier 1 capital.
    e. Tier 1 capital limitation. i. The total amount of mortgage 
and nonmortgage servicing assets, purchased credit card 
relationships, and residual interests that may be included in 
capital, in the aggregate, cannot exceed 100 percent of tier 1 
capital. Nonmortgage servicing assets, purchased credit card 
relationships, and residual interests, in the aggregate, are subject 
to a separate sublimit of 25 percent of tier 1 capital.\15\
---------------------------------------------------------------------------

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

    ii. For purposes of calculating these limitations on mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and residual interests, tier 1 capital is 
defined as the sum of core capital elements, net of goodwill, and 
net of all identifiable intangible assets other than mortgage 
servicing assets, nonmortgage servicing assets, and purchased credit 
card relationships, prior to the deduction of any disallowed 
mortgage servicing assets, any disallowed nonmortgage servicing 
assets, any disallowed purchased credit card relationships, any 
disallowed residual interests, and any disallowed deferred-tax 
assets, regardless of the date acquired.
    iii. Banks may elect to deduct disallowed mortgage servicing 
assets, disallowed nonmortgage servicing assets, and disallowed 
residual interests on a basis that is net of any associated deferred 
tax liability. Deferred tax liabilities netted in this manner cannot 
also be netted against deferred-tax assets when determining the 
amount of deferred-tax assets that are dependent upon future taxable 
income.
    f. Valuation. Banks must review the book value of all intangible 
assets and residual interests at least quarterly and make 
adjustments to these values as necessary. The fair value of mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and residual interests also must be determined 
at least quarterly. This determination shall include adjustments for 
any significant changes in original valuation assumptions, including 
changes in prepayment estimates or account attrition rates. 
Examiners will review both the book value and the fair value 
assigned to these assets, together with supporting documentation, 
during the examination process. In addition, the Federal Reserve may 
require, on a case-by-case basis, an independent valuation of a 
bank's intangible assets or residual interests.
    g. Growing organizations. Consistent with long-standing Board 
policy, banks experiencing substantial growth, whether internally or 
by acquisition, are expected to maintain strong capital positions 
substantially above minimum supervisory levels, without significant 
reliance on intangible assets or residual interests.
* * * * *
    4. Deferred-tax assets. The amount of deferred-tax assets that 
is dependent upon future taxable income, net of the valuation 
allowance for deferred-tax assets, that may be included in, that is, 
not deducted from, a bank's capital may not exceed the lesser of:
    (i) The amount of these deferred-tax assets that the bank is 
expected to realize within one year of the calendar quarter-end 
date, based on its projections of future taxable income for that 
year,\21\ or
---------------------------------------------------------------------------

    \21\ To determine the amount of expected deferred-tax assets 
realizable in the next 12 months, an institution should assume that 
all existing temporary differences fully reverse as of the report 
date. Projected future taxable income should not include net 
operating loss carry-forwards to be used during that year or the 
amount of existing temporary differences a bank expects to reverse 
within the year. Such projections should include the estimated 
effect of tax-planning strategies that the organization expects to 
implement to realize net operating losses or tax-credit carry-
forwards that would otherwise expire during the year. Institutions 
do not have to prepare a new 12-month projection each quarter. 
Rather, on interim report dates, institutions may use the future-
taxable income projections for their current fiscal year, adjusted 
for any significant changes that have occurred or are expected to 
occur.
---------------------------------------------------------------------------

    (ii) 10 percent of tier 1 capital. The reported amount of 
deferred-tax assets, net of any valuation allowance for deferred-tax 
assets, in excess of the lesser of these two amounts is to be 
deducted from a bank's core capital elements in determining tier 1 
capital. For purposes of calculating the 10 percent limitation, tier 
1 capital is defined as the sum of core capital elements, net of 
goodwill and net of all identifiable intangible assets other than 
mortgage and nonmortgage servicing assets, purchased credit card 
relationships, prior to the deduction of any disallowed mortgage 
servicing assets, any disallowed nonmortgage servicing assets, any 
disallowed purchased credit card relationships, any disallowed 
residual interests, and any disallowed deferred-tax assets. There 
generally is no limit in tier 1 capital on the amount of deferred-
tax assets that can be realized from taxes paid in prior carry-back 
years or from future reversals of existing taxable temporary 
differences, but, for banks that have a parent, this may not exceed 
the amount the bank could reasonably expect its parent to refund.
    III. * * *
    A. * * *
    5. The Federal Reserve will, on a case-by-case basis, determine 
the appropriate risk-weight for any asset 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.
    B. * * *
    6. Residual interests--a. General capital requirement. All 
residual interests are subject to both a residual interest capital 
requirement and a capital concentration limitation in accordance 
with sections II.B.1.e. and III.B.6.b. of this appendix A. In 
determining

[[Page 58003]]

the capital requirement for a residual interest, the amount of all 
residual interests in excess of the capital concentration limit must 
be deducted from tier 1 capital, in accordance with section 
II.B.1.e. of this appendix A, before the residual interest capital 
requirement in this section is applied.
    b. Residual interest capital requirement. Notwithstanding 
section III.D.1.g. of this appendix A, a bank must maintain capital 
for a residual interest equal to the amount of the residual interest 
that is retained on the balance sheet (less any amount disallowed in 
accordance with section II.B.1.e. of this appendix A and net of any 
associated deferred tax liability), even if the amount of capital 
required to be maintained exceeds the standard capital charge that 
would be required under section IV.A. of this appendix A for assets 
transferred.
    c. Multiple recourse obligations. Where a bank holds a residual 
interest and another recourse obligation (such as a standby letter 
of credit) in connection with the same asset transfer, the bank must 
maintain risk-based capital equal to the greater of:
    (i) The risk-based capital requirement for the residual interest 
as calculated under section III.B.6.b. of this appendix A; or
    (ii) The full risk-based capital requirement for the assets 
transferred, subject to the low-level recourse rules (section 
III.D.1.g. of this appendix A).
* * * * *

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

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

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

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

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

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

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

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


[[Page 58004]]


    2. In appendix A to part 225:
    A. Section II.A.1. and the first seven paragraphs of section 
II.A.2. are revised, and footnote 6 is removed and reserved;
    B. In sections II, III and IV, footnotes 13 through 57 are 
redesignated as footnotes 14 through 58.
    C. In section II.B., a new paragraph (i)(c) and new footnote 15 are 
added, section II.B.1.b and newly designated footnote 16 are revised, 
new sections II.B.1.c. through II.B.1.g. are added, and section II.B.4. 
is revised.
    D. In section III.A, the four undesignated paragraphs are 
designated as sections III.A.1. through III.A.4. and a new section 
III.A.5, is added.
    E. Section III.B.6. is added.
    F. Attachment II is revised.

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

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

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

* * * * *
    2. Supplementary capital elements (tier 2 capital). The tier 2 
component of an institution's qualifying capital may consist of the 
following items that are defined as supplementary capital elements:
    (i) Allowance for loan and lease losses (subject to limitations 
discussed below);
    (ii) Perpetual preferred stock and related surplus (subject to 
conditions discussed below);
    (iii) Hybrid capital instruments (as defined below), perpetual 
debt, and mandatory convertible debt securities;
    (iv) Term subordinated debt and intermediate-term preferred 
stock, including related surplus (subject to limitations discussed 
below);
    (v) Unrealized holding gains on equity securities (subject to 
limitations discussed in section II.A.2.e. of this appendix A).
    The maximum amount of tier 2 capital that may be included in an 
organization's qualifying total capital is limited to 100 percent of 
tier 1 capital (net of goodwill, other intangible assets, and 
residual interests required to be deducted in accordance with 
section II.B.1. of this appendix A).
* * * * *
    B. * * *
    (i) * * *
    (c) Certain on-balance sheet residual interests deducted from 
the sum of core capital elements in accordance with sections 
II.B.1.c. through e. of this appendix A.\15\
---------------------------------------------------------------------------

    \15\ Residual interests consist of balance sheet assets that: 
(a) Represent interests (including beneficial interests) in 
transferred financial assets retained by a seller (or transferor) 
after a securitization or other transfer of financial assets; and 
(b) are structured to absorb more than a pro rata share of credit 
loss related to the transferred assets through subordination 
provisions or other credit enhancement techniques. Residual 
interests do not include interests purchased from a third party. 
Residual interest include interest-only strips receivable, spread 
accounts, cash collateral accounts, retained subordinated interests, 
and similar on-balance sheet assets that function as a credit 
enhancement.
---------------------------------------------------------------------------

* * * * *
    1. Goodwill, other intangible assets, and residual interests. * 
* *
    b. Other intangible assets. i. All servicing assets, including 
servicing assets on assets other than mortgages (i.e., nonmortgage 
servicing assets), are included in this appendix as identifiable 
intangible assets. The only types of identifiable intangible assets 
that may be included in, that is, not deducted from, an 
organization's capital are readily marketable mortgage servicing 
assets, nonmortgage servicing assets, and purchased credit card 
relationships. The total amount of these assets that may be included 
in capital is subject to the limitations described below in sections 
II.B.1.d. and e. of this appendix A.
    ii. The treatment of identifiable intangible assets set forth in 
this section generally will be used in the calculation of a bank 
holding company's capital ratios for supervisory and applications 
purposes. However, in making an overall assessment of an 
organization's capital adequacy for applications purposes, the Board 
may, if it deems appropriate, take into account the quality and 
composition of an organization's capital, together with the quality 
and value of its tangible and intangible assets.
    c. Residual interests. Residual interests may be included in, 
that is, not deducted from, an organization's capital subject to the 
limitations described below in sections II.B.1.d. and e. of this 
appendix A.
    d. Fair value limitation. The amount of mortgage servicing 
assets, nonmortgage servicing assets, and purchased credit card 
relationships that a bank holding company may include in capital 
shall be the lesser of 90 percent of their fair value, as determined 
in accordance with section II.B.1.f. of this appendix A, or 100 
percent of their book value, as adjusted for capital purposes in 
accordance with the instructions to the Consolidated Financial 
Statements for Bank Holding Companies (FR Y-9C Report). The amount 
of residual interests a bank holding company may include in capital 
shall be 100 percent of its book value. If both the application of 
the limits on mortgage servicing assets, nonmortgage servicing 
assets, purchased credit card relationships, and residual interests 
and the adjustment of the balance sheet amount for these assets 
would result in an amount being deducted from capital, the bank 
holding company would deduct only the greater of the two amounts 
from its core capital elements in determining tier 1 capital.
    e. Tier 1 capital limitation. i. The total amount of mortgage 
and nonmortgage servicing assets, purchased credit card 
relationships, and residual interests that may be included in 
capital, in the aggregate, cannot exceed 100 percent of tier 1 
capital. Nonmortgage servicing assets, purchased credit card 
relationships, and residual interests, in the aggregate, are subject 
to a separate sublimit of 25 percent of tier 1 capital.\16\
---------------------------------------------------------------------------

    \16\ Amounts of servicing assets, purchased credit card 
relationships, and residual interests in excess of these 
limitations, as well as all other identifiable intangible assets, 
including core deposit intangibles and favorable leaseholds, are to 
be deducted from an organization's core capital elements in 
determining tier 1 capital. However, identifiable intangible assets 
(other than mortgage servicing assets and purchased credit card 
relationships) acquired on or before February 19, 1992, generally 
will not be deducted from capital for supervisory purposes, although 
they will continue to be deducted for applications purposes.
---------------------------------------------------------------------------

    ii. For purposes of calculating these limitations on mortgage 
servicing assets, nonmortgage servicing assets, purchased credit 
card relationships, and residual interests, tier 1 capital is 
defined as the sum of core capital elements, net of goodwill, and 
net of all identifiable intangible assets other than mortgage 
servicing assets, nonmortgage servicing assets, and purchased credit 
card relationships, prior to the deduction of any disallowed 
mortgage servicing assets, any disallowed nonmortgage servicing 
assets, any disallowed purchased credit card relationships, any 
disallowed residual interests, and any disallowed deferred-tax 
assets, regardless of the date acquired.
    iii. Bank holding companies may elect to deduct disallowed 
mortgage servicing assets, disallowed nonmortgage servicing assets, 
and disallowed residual interests on a basis that is net of any 
associated deferred tax liability. Deferred tax liabilities netted 
in this manner cannot also be netted against deferred tax assets 
when determining the amount of deferred tax assets that are 
dependent upon future taxable income.
    f. Valuation. Bank holding companies must review the book value 
of all intangible assets and residual interests at least quarterly 
and make adjustments to these values as necessary. The fair value of 
mortgage servicing assets, nonmortgage servicing assets, purchased 
credit card relationships, and residual interests also must be 
determined at least quarterly. This determination shall include 
adjustments for any significant changes in original valuation 
assumptions, including changes in prepayment estimates or account 
attrition rates. Examiners will review both the book value and the 
fair value assigned to these assets, together with supporting 
documentation, during the inspection

[[Page 58005]]

process. In addition, the Federal Reserve may require, on a case-by-
case basis, an independent valuation of an organization's intangible 
assets or residual interests.
    g. Growing organizations. Consistent with long-standing Board 
policy, banking organizations experiencing substantial growth, 
whether internally or by acquisition, are expected to maintain 
strong capital positions substantially above minimum supervisory 
levels, without significant reliance on intangible assets or 
residual interests.
* * * * *
    4. Deferred-tax assets. The amount of deferred-tax assets that 
is dependent upon future taxable income, net of the valuation 
allowance for deferred-tax assets, that may be included in, that is, 
not deducted from, a banking organization's capital may not exceed 
the lesser of:
    (i) The amount of these deferred-tax assets that the banking 
organization is expected to realize within one year of the calendar 
quarter-end date, based on its projections of future taxable income 
for that year,\24\ or
---------------------------------------------------------------------------

    \24\ To determine the amount of expected deferred-tax assets 
realizable in the next 12 months, an institution should assume that 
all existing temporary differences fully reverse as of the report 
date. Projected future taxable income should not include net 
operating loss carry-forwards to be used during that year or the 
amount of existing temporary differences a bank holding company 
expects to reverse within the year. Such projections should include 
the estimated effect of tax-planning strategies that the 
organization expects to implement to realize net operating losses or 
tax-credit carry-forwards that would otherwise expire during the 
year. Institutions do not have to prepare a new 12-month projection 
each quarter. Rather, on interim report dates, institutions may use 
the future-taxable income projections for their current fiscal year, 
adjusted for any significant changes that have occurred or are 
expected to occur.
---------------------------------------------------------------------------

    (ii) 10 percent of tier 1 capital. The reported amount of 
deferred-tax assets, net of any valuation allowance for deferred-tax 
assets, in excess of the lesser of these two amounts is to be 
deducted from a banking organization's core capital elements in 
determining tier 1 capital. For purposes of calculating the 10 
percent limitation, tier 1 capital is defined as the sum of core 
capital elements, net of goodwill and net of all identifiable 
intangible assets other than mortgage and nonmortgage servicing 
assets, purchased credit card relationships, prior to the deduction 
of any disallowed mortgage servicing assets, any disallowed 
nonmortgage servicing assets, any disallowed purchased credit card 
relationships, any disallowed residual interests, and any disallowed 
deferred-tax assets. There generally is no limit in tier 1 capital 
on the amount of deferred-tax assets that can be realized from taxes 
paid in prior carry-back years or from future reversals of existing 
taxable temporary differences.
    III. * * *
    A. * * *
    5. The Federal Reserve will, on a case-by-case basis, determine 
the appropriate risk weight for any asset that does not fit wholly 
within one of the risk categories set forth below or that imposes 
risks on a bank holding company that are not commensurate with the 
risk weight otherwise specified below for the asset.
    B. * * *
    6. Residual interests--a. General capital requirement. All 
residual interests are subject to both a residual interest capital 
requirement and a capital concentration limitation in accordance 
with sections II.B.1.e. and III.B.6.b. of this appendix A. In 
determining the capital requirement for a residual interest, the 
amount of all residual interests in excess of the capital 
concentration limit must be deducted from tier 1 capital, in 
accordance with section II.B.1.e. of this appendix A, before the 
residual interest capital requirement in this section is applied.
    b. Residual interest capital requirement. Notwithstanding 
section III.D.1.g. of this appendix A, organizations must maintain 
capital for a residual interest equal to the amount of the residual 
interest (less any amount disallowed in accordance with section 
II.B.1.e. of this appendix A and net of any associated deferred tax 
liability), even if the amount of capital required to be maintained 
exceeds the standard capital charge under section IV.A. of this 
appendix A for the assets transferred.
    c. Multiple recourse obligations. Where an organization holds a 
residual interest and another recourse obligation (such as a standby 
letter of credit) in connection with the same asset transfer, the 
organization must maintain risk-based capital equal to the greater 
of:
    (i) The risk-based capital requirement for the residual interest 
as calculated under section III.B.6.b of this appendix A; or
    (ii) The full risk-based capital requirement for the assets 
transferred, subject to the low-level recourse rules (section 
III.D.1.g. of this appendix A).
* * * * *

Attachment II--Summary Definition of Qualifying Capital for Bank Holding
                               Companies*
                   [Using the year-end 1992 standards]
------------------------------------------------------------------------
                                            Minimum requirements after
               Components                       transition period
------------------------------------------------------------------------
Core Capital (tier 1)..................  Must equal or exceed 4% of
                                          weighted-risk assets.
    Common stockholders' equity........  No limit.
    Qualifying noncumulative perpetual   No limit.
     preferred stock.
    Qualifying cumulative perpetual      Limited to 25% of the sum of
     preferred stock.                     common stock, qualifying
                                          perpetual preferred stock, and
                                          minority interests.
    Minority interest in equity          Organizations should avoid
     accounts of consolidated             using minority interests to
     subsidiaries.                        introduce elements not
                                          otherwise qualifying for tier
                                          1 capital.
    Less: Goodwill, other intangible
     assets, and residual interests
     required to be deducted from
     capital \1\
Supplementary Capital (tier 2).........  Total of tier 2 is limited to
                                          100% of tier 1.\2\
    Allowance for loan and lease losses  Limited to 1.25% of weighted-
                                          risk assets.\2\
    Perpetual preferred stock..........  No limit within tier 2.
    Hybrid capital instruments,          No limit within tier 2.
     perpetual debt, and mandatory
     convertible securities.
    Subordinated debt and intermediate-  Subordinated debt and
     term preferred stock (original       intermediate-term preferred
     weighted average maturity of 5       stock are limited to 50% of
     years or more).                      tier 1; \2\ amortized for
                                          capital purposes as they
                                          approach maturity.
    Revaluation reserves (equity and     Not included; organization
     building).                           encouraged to disclose; may be
                                          evaluated on a case-by-case
                                          basis for international
                                          comparisons; and taken into
                                          account in making and overall
                                          assessment of capital.
Deductions (from sum of tier 1 and tier
 2):
    Investments in unconsolidated        As a general rule, one-half of
     subsidiaries.                        the aggregate investments will
                                          be deducted from tier 1
                                          capital and one-half from tier
                                          2 capital.\3\

[[Page 58006]]

 
    Reciprocal holdings of banking
     organizations' capital securities
    Other deductions (such as other
     subsidiaries or joint ventures) as
     determined by supervisory
     authority
Total Capital (tier 1 + tier 2-          Must equal or exceed 8% of
 deductions).                             weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets and
  residual interests are set forth in section II.B.1.e. of this
  appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\3\ A proportionally greater amount may be deducted from tier 1 capital.
 
\*\ See discussion in section II of this appendix for a complete
  description of the requirements for, and the limitations on, the
  components of qualifying capital.

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

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

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

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

* * * * *

    By order of the Board of Governors of the Federal Reserve 
System, September 13, 2000.
Jennifer J. Johnson,
Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR Chapter III

Authority and Issuance
    For the reasons set out in the joint preamble, the Board of 
Directors of the Federal Deposit Insurance Corporation proposes to 
amend part 325 of chapter III 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, 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).


Sec. 325.2  [Amended]

    2. In Sec. 325.2:
    A. Redesignate paragraphs (s) through (x) as paragraphs (v) through 
(aa), paragraphs (q) through (r) as paragraphs (s) through (t), and 
paragraphs (g) through(p) as pragraphs (h) through (q);
    B. Add new paragraphs (g), (r), and (u);
    C. Revise newly designated paragraphs (w) and (y) to read as 
follows:


Sec. 325.2  Definitions.

* * * * *
    (g) Financial assets means cash, evidence of an ownership interest 
in an entity, or a contract that conveys to a second entity a 
contractual right:
    (1) To receive cash or another financial instrument from a first 
entity; or
    (2) To exchange other financial instruments on potentially 
favorable terms with the first entity.
* * * * *
    (r) Residual interests means:
    (1) Balance sheet assets that:
    (i) Represent interests (including beneficial interests) in 
transferred financial assets retained by a seller (or transferor) after 
a securitization or other transfer of financial assets; and
    (ii) Are structured to absorb more than a pro rata share of credit 
loss related to the transferred assets through subordination provisions 
or other credit enhancement techniques.
    (2) Exclusion. Residual interests do not include interests 
purchased from a third party.
    (3) Examples. Residual interests include interest only strips 
receivable, spread accounts, cash collateral accounts, retained 
subordinated interests, and other similar forms of on-balance sheet 
assets that function as a credit enhancement.
* * * * *
    (u) Securitization means the pooling and repackaging of loans or 
other credit exposures into securities that can be sold to investors.
* * * * *
    (w) Tier 1 capital or core capital means the sum of common 
stockholders' equity, noncumulative perpetual preferred stock 
(including any related surplus), and minority interests in consolidated 
subsidiaries, minus all intangible assets (other than mortgage 
servicing assets, nonmortgage servicing assets, and purchased credit 
card relationships eligible for inclusion in core capital pursuant to 
Sec. 325.5(f) and qualifying supervisory goodwill eligible for 
inclusion in core capital pursuant to 12 CFR part 567), minus residual

[[Page 58007]]

interests (other than residual interests eligible for inclusion in core 
capital pursuant to Sec. 325.5(f)), minus deferred tax assets in excess 
of the limit set forth in Sec. 325.5(g), minus identified losses (to 
the extent that Tier 1 capital would have been reduced if the 
appropriate accounting entries to reflect the identified losses had 
been recorded on the insured depository institution's books), and minus 
investments in securities subsidiaries subject to 12 CFR 337.4.
* * * * *
    (y) Total assets means the average of total assets required to be 
included in a banking institution's ``Reports of Condition and Income'' 
(Call Report) or, for savings associations, the consolidated total 
assets required to be included in the ``Thrift Financial Report,'' as 
these reports may from time to time be revised, as of the most recent 
report date (and after making any necessary subsidiary adjustments for 
state nonmember banks as described in Secs. 325.5(c) and 325.5(d) of 
this part), minus intangible assets (other than mortgage servicing 
assets, nonmortgage servicing assets, and purchased credit card 
relationships eligible for inclusion in core capital pursuant to 
Sec. 325.5(f) and qualifying supervisory goodwill eligible for 
inclusion in core capital pursuant to 12 CFR part 567), minus residual 
interests (other than residual interests eligible for inclusion in core 
capital pursuant to Sec. 325.5(f)), minus deferred tax assets in excess 
of the limit set forth in Sec. 325.5(g), and minus assets classified 
loss and any other assets that are deducted in determining Tier 1 
capital. For banking institutions, the average of total assets is found 
in the Call Report schedule of quarterly averages. For savings 
associations, the consolidated total assets figure is found in Schedule 
CSC of the Thrift Financial Report.
    3. In Sec. 325.5, revise paragraphs (f) and (g)(2) to read as 
follows:


Sec. 325.5  Miscellaneous.

* * * * *
    (f) Treatment of mortgage servicing assets, purchased credit card 
relationships, nonmortgage servicing assets, and residual interests. 
For purposes of determining Tier 1 capital under this part, mortgage 
servicing assets, purchased credit card relationships, nonmortgage 
servicing assets, and residual interests will be deducted from assets 
and from common stockholders' equity to the extent that these items do 
not meet the conditions, limitations, and restrictions described in 
this section. Banks may elect to deduct disallowed servicing assets and 
disallowed residual interests on a basis that is net of any associated 
deferred tax liability. Any deferred tax liability netted in this 
manner cannot also be netted against deferred tax assets when 
determining the amount of deferred tax assets that are dependent upon 
future taxable income and calculating the maximum allowable amount of 
these assets under paragraph (g) of this section.
    (1) Valuation. The fair value of mortgage servicing assets, 
purchased credit card relationships, nonmortgage servicing assets, and 
residual interests shall be estimated at least quarterly. The quarterly 
fair value estimate shall include adjustments for any significant 
changes in the original valuation assumptions, including changes in 
prepayment estimates or attrition rates. The FDIC in its discretion may 
require independent fair value estimates on a case-by-case basis where 
it is deemed appropriate for safety and soundness purposes.
    (2) Fair value limitation. For purposes of calculating Tier 1 
capital under this part (but not for financial statement purposes), the 
balance sheet assets for mortgage servicing assets, purchased credit 
card relationships, and nonmortgage servicing assets will each be 
reduced to an amount equal to the lesser of:
    (i) 90 percent of the fair value of these assets, determined in 
accordance with paragraph (f)(1) of this section; or
    (ii) 100 percent of the remaining unamortized book value of these 
assets (net of any related valuation allowances), determined in 
accordance with the instructions for the preparation of the 
Consolidated Reports of Income and Condition (Call Reports).
    (3) Tier 1 capital limitation. The maximum allowable amount of 
mortgage servicing assets, purchased credit card relationships, 
nonmortgage servicing assets, and residual interests in the aggregate, 
will be limited to the lesser of:
    (i) 100 percent of the amount of Tier 1 capital that exists before 
the deduction of any disallowed mortgage servicing assets, any 
disallowed purchased credit card relationships, any disallowed 
nonmortgage servicing assets, any disallowed residual interests, and 
any disallowed deferred tax assets; or
    (ii) The sum of the amounts of mortgage servicing assets, purchased 
credit card relationships, and nonmortgage servicing assets, determined 
in accordance with paragraph (f)(2) of this section, plus the amount of 
residual interests determined in accordance with paragraph
    (f)(1) of the section.
    (4) Tier 1 capital sublimit. In addition to the aggregate 
limitation on mortgage servicing assets, purchased credit card 
relationships, nonmortgage servicing assets, and residual interests set 
forth in paragraph (f)(3) of this section, a sublimit will apply to 
purchased credit card relationships, nonmortgage servicing assets, and 
residual interests. The maximum allowable amount of the aggregate of 
purchased credit card relationships, nonmortgage servicing assets, and 
residual interests, will be limited to the lesser of:
    (i) Twenty-five percent of the amount of Tier 1 capital that exists 
before the deduction of any disallowed mortgage servicing assets, any 
disallowed purchased credit card relationships, any disallowed 
nonmortgage servicing assets, any disallowed residual interests, and 
any disallowed deferred tax assets; or
    (ii) The sum of the amounts of purchased credit card relationships 
and nonmortgage servicing assets determined in accordance with 
paragraph (f)(2) of this section, plus the amount of residual interests 
determined in accordance with paragraph (f)(1) of the section.
    (g)(2) * * *
    (2) Tier 1 capital limitations. (i) The maximum allowable amount of 
deferred tax assets that are dependent upon future taxable income, net 
of any valuation allowance for deferred tax assets, will be limited to 
the lesser of:
    (A) The amount of deferred tax assets that are dependent upon 
future taxable income that is expected to be realized within one year 
of the calendar quarter-end date, based on projected future taxable 
income for that year; or
    (B) Ten percent of the amount of Tier 1 capital that exists before 
the deduction of any disallowed mortgage servicing assets, any 
disallowed nonmortgage servicing assets, any disallowed purchased 
credit card relationships, any disallowed residual interests and any 
disallowed deferred tax assets.
    (iii) For purposes of this limitation, all existing temporary 
differences should be assumed to fully reverse at the calendar quarter-
end date. The recorded amount of deferred tax assets that are dependent 
upon future taxable income, net of any valuation allowance for deferred 
tax assets, in excess of this limitation will be deducted from assets 
and from equity capital for purposes of determining Tier 1 capital 
under this part. The amount of deferred tax assets that can be realized 
from taxes paid in prior carryback years and from the reversal of 
existing taxable temporary differences generally would not be deducted 
from assets and from equity

[[Page 58008]]

capital. However, notwithstanding the above, the amount of carryback 
potential that may be considered in calculating the amount of deferred 
tax assets that a member of a consolidated group (for tax purposes) may 
include in Tier 1 capital may not exceed the amount which the member 
could reasonably expect to have refunded by its parent.
* * * * *
    4. In appendix A to part 325:
    A. Revise section I.A.l.;
    B. In section II:
    i. Designate the first two undesignated paragraphs as sections 
II.A.l. and II.A.2., respectively, and add a new section II.A.3.;
    ii. Revise section II.B.5., and add new section II.B.7.;
    iii. Amend paragraph II.C. by revising the second paragraph under 
``Category 4--100 Percent Risk Weight'';
    C. Revise section III; and
    D. Revise Table I to read as follows:

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

* * * * *
    I. * * *
    A. * * *
    1. Core capital elements (Tier 1) consists of:
    i. Common stockholders' equity capital (includes common stock 
and related surplus, undivided profits, disclosed capital reserves 
that represent a segregation of undivided profits, and foreign 
currency translation adjustments, less net unrealized holding losses 
on available-for-sale equity securities with readily determinable 
fair values);
    ii. Noncumulative perpetual preferred stock,\2\ including any 
related surplus; and
---------------------------------------------------------------------------

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

    iii. Minority interests in the equity capital accounts of 
consolidated subsidiaries.
    At least 50 percent of the qualifying total capital base should 
consist of Tier 1 capital. Core (Tier 1) capital is defined as the 
sum of core capital elements\3\ minus all intangible assets (other 
than mortgage servicing assets, nonmortgage servicing assets and 
purchased credit card relationships eligible for inclusion in core 
capital pursuant to Sec. 325.5(f)) \4\ minus residual interests 
(other than residual interests eligible for inclusion in core 
capital pursuant to Sec. 325.5(f)) and minus any disallowed deferred 
tax assets.
---------------------------------------------------------------------------

    \3\ In addition to the core capital elements, Tier 1 may also 
include certain supplementary capital elements during the transition 
period subject to certain limitations set forth in section III of 
this statement of policy.
    \4\ An exception is allowed for intangible assets that are 
explicitly approved by the FDIC as part of the bank's regulatory 
capital on a specific case basis. These intangibles will be included 
in capital for risk-based capital purposes under the terms and 
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------

    Although nonvoting common stock, noncumulative perpetual 
preferred stock, and minority interests in the equity capital 
accounts of consolidated subsidiaries are normally included in Tier 
1 capital, voting common stockholders' equity generally will be 
expected to be the dominant form of Tier 1 capital. Thus, banks 
should avoid undue reliance on nonvoting equity, preferred stock and 
minority interests.
    Although minority interests in consolidated subsidiaries are 
generally included in regulatory capital, exceptions to this general 
rule will be made if the minority interests fail to provide 
meaningful capital support to the consolidated bank. Such a 
situation could arise if the minority interests are entitled to a 
preferred claim on essentially low risk assets of the subsidiary. 
Similarly, although residual interests and intangible assets in the 
form of mortgage servicing assets, nonmortgage servicing assets and 
purchased credit card relationships are generally recognized for 
risk-based capital purposes, the deduction of part or all of the 
residual interests, mortgage servicing assets, nonmortgage servicing 
assets and purchased credit card relationships may be required if 
the carrying amounts of these rights are excessive in relation to 
their market value or the level of the bank's capital accounts. 
Residual interests, mortgage servicing assets, nonmortgage servicing 
assets and purchased credit card relationships that do not meet the 
conditions, limitations and restrictions described in Sec. 325.5(g) 
of this part will not be recognized for risk-based capital purposes.
* * * * *
    II. * * *
    A. * * *
    3. The Director of the Division of Supervision may, on a case-
by-case basis, determine the appropriate risk weight for any asset 
that does not fit wholly within one of the risk categories set forth 
in sections II.B. and II.C. of this appendix A or that imposes risks 
on a bank that are not commensurate with the risk weight otherwise 
specified in sections II.B. and II.C. of this appendix A for the 
asset.
* * * * *
    B. * * *
    5. Mortgage-Backed Securities. Mortgage-backed securities, 
including pass-throughs and collateralized mortgage obligations (but 
not stripped mortgage-backed securities) that are issued or 
guaranteed by a U.S. Government agency or a U.S. Government-
sponsored agency, normally are assigned to the risk weight category 
appropriate to the issuer or guarantor. Generally, a privately-
issued mortgage-backed security is treated as essentially an 
indirect holding of the underlying assets, and assigned to the same 
risk category as the underlying assets, in accordance with the 
provisions and criteria spelled out in detail in the accompanying 
footnote;\14\ however, such privately-issued mortgage-backed 
securities may not be assigned to the zero percent risk category. 
Privately-issued mortgage-backed securities whose structures do not 
comply with the specified provisions set forth in the footnote are 
assigned to the 100 percent risk category. In addition, any class of 
a mortgage-backed security, other than a residual interest, that can 
absorb more than its pro rata share of loss without the whole issue 
being in default (for example, a subordinated class) will also be 
assigned to the 100 percent risk weight category. All stripped 
mortgage-backed securities, including interest-only strips (IOs) 
(unless covered under section II.B.7. of this appendix A), 
principal-only strips (POs), and similar instruments, are assigned 
to the 100 percent risk weight category, regardless of the issuer or 
guarantor.
* * * * *
---------------------------------------------------------------------------

    \14\ A privately-issued mortgage-backed security may be treated 
as an indirect holding of the underlying assets provided that (1) 
the underlying assets are held by an independent trustee and the 
trustee has a first priority, perfected security interest in the 
underlying assets on behalf of the holders of the security, (2) 
either the holder of the security has an undivided pro rata 
ownership interest in the underlying mortgage assets or the trust or 
single purpose entity (or conduit) that issues the security has no 
liabilities unrelated to the issued securities (3) the security is 
structured such that the cash flow from the underlying assets in all 
cases fully meets the cash flow requirements of the security without 
undue reliance on any reinvestment income, and (4) there is no 
material reinvestment risk associated with any funds awaiting 
distribution to the holders of the security. In addition, if the 
underlying assets of a mortgage-backed security are composed of more 
than one type of asset, the entire mortgage-backed security is 
generally assigned to the category appropriate to the highest risk-
weighted asset underlying the issue.
---------------------------------------------------------------------------

    7. Residual interests--a. General capital requirement. All 
residual interests are subject to both a residual interest capital 
requirement and a capital concentration limitation in accordance 
with Sec. 325.5 of this part. In determining the general capital 
requirement for a residual interest, the amount of all residual 
interest in excess of the capital concentration limit must be 
deducted from Tier 1 capital, in accordance with Sec. 325.5 of this 
part, before the residual interest capital requirement in this 
section is applied.
    b. Residual interest capital requirement. Notwithstanding 
section III. of this appendix A, a bank must maintain risk-based 
capital for a residual interest equal to the amount of the residual 
interest that is retained on the balance sheet (less any amount 
disallowed in accordance with Sec. 325.5 and net of any associated 
deferred tax liability), even if the amount of risk-based capital 
required to be maintained exceeds the full risk-based capital 
requirement for the assets transferred.
    c. Recourse Obligation. Where a bank holds a residual interest 
and another recourse obligation (such as a standby letter of credit) 
in connection with the same asset transfer, the bank must maintain 
risk-based capital equal to the greater of: The risk-based capital 
requirement for the residual interest as calculated under section 
II.B.7.b. of this appendix A; or the full risk-based capital 
requirement for the assets transferred, subject to the low-level 
recourse rules (section II.D.1.of this appendix A).
* * * * *
    C. * * *

[[Page 58009]]

Category 4--100 Percent Risk Weight

* * * * *
    This category also includes all claims on foreign and domestic 
private sector obligors that are not assigned to lower risk weight 
categories, including: loans to nondepository financial institutions 
and bank holding companies; claims on commercial firms owned by the 
bank on acceptances outstanding involving standard risk claims; \34\ 
fixed assets, premises and other real estate owned; common and 
preferred stock of corporations, including stock acquired for debt 
previously contracted; commercial and consumer loans (except those 
loans assigned to lower risk categories due to recognized guarantees 
or collateral); real estate loans and mortgage-backed securities 
that do not meet the criteria for assignment to a lower risk weight 
(including any classes of mortgage-backed securities that can absorb 
more than their pro rata share of loss without the whole issue being 
in-default, such as subordinated classes, but not including residual 
interests); and all stripped mortgage-backed securities, including 
interest-only (IOs) (unless covered under section II.B.7. of this 
appendix A) and the principal-only (POs) strips.
---------------------------------------------------------------------------

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

* * * * *

III. Minimum Risk-Based Capital Ratio

    Subject to section II.B.7. of this appendix A, banks generally 
will be expected to meet a minimum ratio of qualifying total capital 
to risk-weighted assets of 8 percent, of which at least 4 percentage 
points should be in the form of core capital (Tier 1). Any bank that 
does not meet the minimum risk-based capital ratio, or whose capital 
is otherwise considered inadequate, generally will be expected to 
develop and implement a capital plan for achieving an adequate level 
of capital, consistent with the provisions of this risk-based 
capital framework, the specific circumstances affecting the 
individual bank, and the requirements of any related agreements 
between the bank and the FDIC.

* * * * *

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


[[Page 58010]]

* * * * *

    By order of the Board of Directors.

    Dated at Washington, DC, this 14th day of August, 2000.

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

Office of Thrift Supervision

12 CFR Chapter V

Authority and Issuance
    For the reasons set out in the joint preamble, The Office of Thrift 
Supervision proposes to amend parts 565 and 567 of chapter V of title 
12 of the Code of Federal Regulations as follows:

PART 565--PROMPT CORRECTIVE ACTION

    1. The authority citation for part 565 continues to read as 
follows:

    Authority: 12 U.S.C. 1831o.

    2. Amend Sec. 565.2 by revising paragraph (f) to read as follows:


Sec. 565.2  Definitions.

* * * * *
    (f) Tangible equity means the amount of a savings association's 
core capital as computed in part 567 of this chapter plus the amount of 
its outstanding cumulative perpetual preferred stock (including related 
surplus) and disallowed residual interests minus intangible assets as 
defined in Sec. 567.1 of this chapter and nonmortgage servicing assets 
that have not been previously deducted in calculating core capital.
* * * * *

PART 567--CAPITAL

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

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

    4. Amend Sec. 567.1 by adding definitions of ``financial asset'', 
``residual interests,'' and ``securitization'' to read as follows:


Sec. 567.1  Definitions.

* * * * *
    Financial asset. The term financial asset means cash, evidence of 
an ownership interest in an entity, or a contract that conveys to a 
second entity a contractual right:
    (1) To receive cash or another financial instrument from a first 
entity; or
    (2) To exchange other financial instruments on potentially 
favorable terms with the first entity.
* * * * *
    Residual interests. (1) The term residual interests means balance 
sheet assets that:
    (i) Represent interests (including beneficial interests) in 
transferred financial assets retained by a seller (or transferor) after 
a securitization or other transfer of financial assets; and
    (ii) Are structured to absorb more than a pro rata share of credit 
loss related to the transferred assets through subordination provisions 
or other credit enhancement techniques.
    (2) Residual interests do not include interests purchased from a 
third party.
    (3) Residual interests include interest only on strips receivable, 
spread accounts, cash collateral accounts, retained subordinated 
interests, and similar on-balance sheet assets that function as a 
credit enhancement.
* * * * *
    Securitization. The term securitization means the pooling and 
repackaging of loans or other credit exposures into securities that can 
be sold to investors.
* * * * *
    5. Amend Sec. 567.5 by adding new paragraph (a)(2)(iii) to read as 
follows:


Sec. 567.5  Components of capital.

    (a) * * *
    (2) * * *
    (iii) Residual interests that are not includable in core capital 
under Sec. 567.12 of this part are deducted from assets and capital in 
computing core capital.
* * * * *
    6. Amend Sec. 567.6 by revising paragraph (a) introductory text and 
paragraph (a)(1) introductory text, and 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). 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. Risk-weighted on-balance-sheet assets 
are computed by multiplying the on-balance-sheet asset amounts times 
the appropriate risk weight categories, except for residual interests, 
which are discussed in paragraph (b) of this section. The risk weight 
categories for on-balance-sheet assets are:
* * * * *
    (b) Residual interests. (1) In general. A savings association must 
maintain risk-based capital for a residual interest equal to the amount 
of the residual interest that is retained on the balance sheet (less 
any amount disallowed under Sec. 567.12(e) and net of any associated 
deferred tax liability), even though this risk-based capital 
requirement may exceed the full equivalent risk-based capital 
requirement for the assets transferred.
    (2) Recourse obligation. Where a savings association holds a 
residual interest and another recourse obligation (such as a standby 
letter of credit) in connection with the same asset transfer, the 
savings association must maintain risk-based capital equal to the 
greater of:
    (i) The risk-based capital requirement for the residual interest as 
calculated under paragraph (b)(1) of this section; or
    (ii) The full risk-based capital requirement for the assets 
transferred, subject to the low-level recourse rules (paragraph 
6(a)(2)(i)(C) of this section).
    7. Amend Sec. 567.9 by revising paragraph (c)(1) to read as 
follows:


Sec. 567.9  Tangible capital requirement.

* * * * *
    (c) * * *
    (1) Intangible assets as defined in Sec. 567.1 of this part, and 
servicing assets and residual interests not includable in tangible 
capital under Sec. 567.12 of this part.
* * * * *
    8. Amend Sec. 567.11 by redesignating paragraph (c) as paragraph 
(c)(1) and adding a new paragraph (c)(2) to read as follows:


Sec. 567.11  Reservation of authority.

* * * * *
    (c) * * *
    (2) If a savings association has calculated the risk-weighted asset 
amount under Sec. 567.6, OTS may determine that risk-weighted asset 
amount does not adequately reflect the credit risk that the savings 
association 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 residual interest.
    9. Amend Sec. 567.12 by revising the section heading and paragraphs 
(a), (b), and (e) and by removing and reserving paragraph (f) to read 
as follows:


Sec. 567.12  Intangible assets, servicing assets, and residual 
interests.

    (a) Scope. This section prescribes the maximum amount of intangible 
assets, servicing assets, and residual interests that savings 
associations may include in calculating tangible and core capital.
    (b) Computation of core and tangible capital. (1) Intangible 
assets, as defined

[[Page 58011]]

in Sec. 567.1 of this part (other than purchased credit card 
relationships described under paragraph (b)(2) of this section and core 
deposit intangibles described at paragraph (g)(3) of this section), are 
deducted in computing tangible and core capital.
    (2) Purchase card relationships may be included (that is not 
deducted) in computing core capital subject to the restrictions of this 
section, but must be deducted in computing tangible capital.
    (3) Mortgage servicing assets may be included (that is not 
deducted) in computing core capital subject to the restrictions in this 
section, and may be included in tangible capital in the same amount.
    (4) Nonmortgage servicing assets may be included (that is not 
deducted) in computing core capital subject to the restrictions in this 
section. All nonmortgage servicing assets must be deducted in computing 
tangible capital.
    (5) Residual interests may be included (that is not deducted) in 
computing core capital subject to the restrictions of this section, and 
may be included in tangible capital in the same amount.
* * * * *
    (e) Core capital limitation. (1) Aggregate limit. The maximum 
aggregate amount of servicing assets, purchased credit card 
relationships, and residual interests that may be included in core 
capital shall be limited to the lesser of:
    (i) 100 percent of the amount of core capital computed before the 
deduction of any disallowed servicing assets, disallowed purchased 
credit card relationships, and disallowed residual interests; or
    (ii) The amount of servicing assets and purchased credit card 
relationships determined in accordance with paragraph (d) of this 
section plus the amount of residual interests.
    (2) Reduction by deferred tax liability. Associations may elect to 
deduct disallowed servicing assets and residual interests on a basis 
that is net of any associated deferred tax liability.
    (3) Sublimit for purchased credit card relationships, non mortgage-
related servicing assets, and residual interests. In addition to the 
aggregate limitation in paragraph (e)(1) of this section, a sublimit 
shall apply to purchased credit card relationships, non mortgage-
related servicing assets, and residual interests. The maximum allowable 
amount of these three types of assets combined shall be limited to the 
lesser of:
    (i) 25 percent of the amount of core capital computed before the 
deduction of any disallowed servicing assets, purchased credit card 
relationships, and residual interests; or
    (ii) The amount of purchased credit card relationships and non 
mortgage-related servicing assets determined in accordance with 
paragraph (d) of this section plus the amount of residual interests.
    (f) [Reserved]
* * * * *

    Dated: August 4, 2000.

    By the Office of Thrift Supervision.
Ellen Seidman,
Director.
[FR Doc. 00-24203 Filed 9-26-00; 8:45 am]
BILLING CODES 4810-33-P, 6210-01-P, 6714-01-P, 6720-01-P