[Federal Register Volume 66, Number 230 (Thursday, November 29, 2001)]
[Rules and Regulations]
[Pages 59614-59667]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-29179]



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Part II

Department of the Treasury
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Office of the Comptroller of the Currency



Office of Thrift Supervision



12 CFR Parts 3 and 567



Federal Reserve System

12 CFR Parts 208 and 225



Federal Deposit Insurance Corporation

12 CFR Part 325



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

  Federal Register / Vol. 66, No. 230 / Thursday, November 29, 2001 / 
Rules and Regulations  

[[Page 59614]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 01-24]
RIN 1557-AB14

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1055]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AB31

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

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


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

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

ACTION: Final rule.

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

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

FOR FURTHER INFORMATION CONTACT: OCC: Amrit Sekhon, Risk Expert, 
Capital Policy Division, (202) 874-5211; Laura Goldman, Senior 
Attorney, Legislative and Regulatory Activities Division, (202) 874-
5090, Office of the Comptroller of the Currency, 250 E Street, SW, 
Washington, DC 20219.
    Board: Thomas R. Boemio, Senior Supervisory Financial Analyst, 
(202) 452-2982, Arleen Lustig, Supervisory Financial Analyst, (202) 
452-2987, or Barbara Bouchard, Assistant Director (202) 452-3072, 
Division of Banking Supervision and Regulation. For the hearing 
impaired only, Telecommunication Device for the Deaf (TDD), (202) 263-
4869, Board of Governors of the Federal Reserve System, 20th Street and 
Constitution Avenue, NW, Washington, DC 20551.
    FDIC: Robert F. Storch, Chief, Accounting Section, Division of 
Supervision, (202) 898-8906; Jason C. Cave, Senior Capital Markets 
Specialist, Division of Supervision, (202) 898-3548; Miguel D. Browne, 
Manager, Policy, Risk Management and Operations, Division of 
Supervision, (202) 898-6789; Marc J. Goldstrom, Counsel, (202) 898-8807 
or Michael B. Phillips, Counsel, (202) 898-3581, Supervision and 
Legislation Branch, Legal Division, Federal Deposit Insurance 
Corporation, 550 17th Street, NW, Washington, DC 20429.
    OTS: Michael D. Solomon, Senior Program Manager for Capital Policy, 
(202) 906-5654, David Riley, Project Manager, Supervision Policy, (202) 
906-6669; Teresa Scott, Counsel (Banking and Finance), (202) 906-6478, 
or Karen Osterloh, Assistant Chief Counsel, (202) 906-6639, Office of 
Thrift Supervision, 1700 G Street, NW, Washington, DC 20552.

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

I. Introduction

    The agencies are amending their regulatory capital standards to 
change

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

A. Asset Securitization

    This final rule builds on the agencies' earlier work with respect 
to the appropriate risk-based capital treatment for recourse 
obligations and direct credit substitutes. On May 25, 1994, the 
agencies published in the Federal Register a proposal to reduce the 
capital requirement for low-level recourse transactions, and to treat 
first-loss (but not second-loss) direct credit substitutes like 
recourse. 59 FR 27116, May 25, 1994 (the 1994 Notice). The 1994 Notice 
also contained, in an advance notice of proposed rulemaking, a proposal 
to use credit ratings from nationally recognized statistical rating 
organizations (rating agencies) to determine the capital treatment of 
certain recourse obligations and direct credit substitutes. The OCC, 
the Board, and the FDIC subsequently implemented the capital reduction 
for low-level recourse transactions, thereby satisfying the 
requirements of section 350 of the Riegle Community Development and 
Regulatory Improvement Act, Pub. L. 103-325, sec. 350, 108 Stat. 2160, 
2242 (1994) (CDRI Act).\1\ The OTS risk-based capital regulation 
already included the low-level recourse treatment required by the 
statute. The agencies did not issue a final regulation on the remaining 
elements of the 1994 Notice.
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    \1\ See 60 FR 17986, April 10, 1995 (OCC); 60 FR 8177, February 
13, 1995 (Board); 60 FR 15858, March 28, 1995 (FDIC).
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    On November 5, 1997, the agencies published another notice of 
proposed rulemaking. 62 FR 59943, November 5, 1997 (1997 Proposal). In 
the 1997 Proposal, the agencies proposed to use credit ratings from 
rating agencies to determine the capital requirements for recourse 
obligations, direct credit substitutes, and senior asset-backed 
securities in asset securitizations. Additionally, the 1997 Proposal 
requested comment on a series of options and alternatives to supplement 
or replace the proposed ratings-based approach.
    On March 8, 2000, the agencies published a third notice of proposed 
rulemaking on recourse and direct credit substitutes. 65 FR 12320, 
March 8, 2000 (2000 Recourse Proposal). The 2000 Recourse Proposal 
built on the ratings-based approach and eliminated several options from 
the 1997 Proposal, including the modified gross-up approach, the 
ratings benchmark approach, and the historical losses approach. The 
2000 Recourse Proposal also permitted the limited use of a banking 
organization's qualifying internal risk rating system, a rating 
agency's or other appropriate third party's review of the credit risk 
of positions in structured programs, or qualifying software to 
determine the capital requirement for certain unrated direct credit 
substitutes. Finally, the 2000 Recourse Proposal required a sponsor of 
a revolving credit securitization that contained an early amortization 
feature to hold capital against the amount of assets under management 
in that securitization.
    In the international arena, the Basel Committee on Banking 
Supervision (of which the OCC, the Board, and the FDIC are members) 
issued a consultative paper entitled, ``A New Capital Adequacy 
Framework'' in January 2001,\2\ on possible revisions to the 1988 Basel 
Accord.\3\ The Basel Consultative Paper discusses potential 
modifications to the current capital standards, including the capital 
treatment of securitizations. The standards established by this final 
rule are consistent in many respects with the Basel Consultative Paper. 
In particular, the use of external credit ratings issued by rating 
agencies as a basis for determining the credit quality and the 
resulting capital treatment of securitizations is consistent with the 
approach outlined by the Basel Committee. While the agencies believe 
that it is essential to address securitizations by rule at this time, 
they intend to consider additional changes to this rule when revisions 
to the Basel Accord are finalized.
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    \2\ The January 2001 Basel Consultative Paper amends and refines 
a Consultative Paper issued in June 1999.
    \3\ International Convergence of Capital Measurement and Capital 
Standards (July 1988).
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B. Residual Interests

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

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

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

II. Background

A. Asset Securitization

    Asset securitization is the process by which loans or other credit 
exposures are pooled and reconstituted into securities, with one or 
more classes or positions, that may then be sold. Securitization \7\ 
provides an efficient mechanism for banking organizations to buy and 
sell loan assets or credit exposures and thereby to increase the 
organization's liquidity.
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    \7\ For purposes of this discussion, references to 
``securitization'' also include structured finance transactions or 
programs and synthetic transactions that generally create stratified 
credit risk positions, which may or may not be in the form of a 
security, whose performance is dependent upon a pool of loans or 
other credit exposures. Synthetic transactions bundle credit risks 
associated with on-balance sheet assets and off-balance sheet items 
and resell them into the market. For examples of synthetic 
securitization structures, see Banking Bulletin 99-43, November 15, 
1999 (OCC); SR Letter 99-32, Capital Treatment for Synthetic CLOs, 
November 17, 1999 (Board).
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    Securitizations typically carve up the risk of credit losses from 
the underlying assets and distribute it to different parties. The 
``first dollar,'' or most subordinate, loss position is first to absorb 
credit losses; the most ``senior'' investor position is last to absorb 
losses; and there may be one or more loss positions in between 
(``second dollar'' loss positions). Each loss position functions as a 
credit enhancement for the more senior positions in the structure.
    For residential mortgages sold through certain Federally-sponsored 
mortgage programs, a Federal government agency or Federal government-
sponsored enterprise (GSE) guarantees the securities sold to investors 
and may assume the credit risk on the underlying mortgages. However, 
many of today's asset securitization programs involve assets that are 
not Federally supported in any way. Sellers of these privately 
securitized assets therefore often provide other forms of credit 
enhancement--that is, they take first or second dollar loss positions--
to reduce investors' credit risk.
    A seller may provide this credit enhancement itself through 
recourse arrangements. The agencies use the term ``recourse'' to refer 
to the credit risk that a banking organization retains in connection 
with the transfer of its assets. Banking organizations have long 
provided recourse in connection with sales of whole loans or loan 
participations; today, recourse arrangements frequently are also 
associated with asset securitization programs. Depending on the type of 
securitization transaction, the sponsor of a securitization may provide 
a portion of the total credit enhancement internally, as part of the 
securitization structure, through the use of excess spread accounts, 
overcollateralization, retained subordinated interests, or other 
similar on-balance sheet assets. When these or other on-balance sheet 
internal enhancements are provided, the enhancements are ``residual 
interests'' for regulatory capital purposes. Such residual interests 
are a form of recourse.
    A seller may also arrange for a third party to provide credit 
enhancement \8\ in an asset securitization. If the third-party 
enhancement is provided by another banking organization, that 
organization assumes some portion of the assets' credit risk. In this 
final rule, all forms of third-party enhancements, i.e., all 
arrangements in which a banking organization assumes credit risk from 
third-party assets or other claims that it has not transferred, are 
referred to as ``direct credit substitutes.'' \9\ The economic 
substance of a banking organization's credit risk from providing a 
direct credit substitute can be identical to its credit risk from 
retaining recourse on assets it has transferred.
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    \8\ As used in this final rule, the terms ``credit enhancement'' 
and ``enhancement'' refer to both recourse arrangements, including 
residual interests, and direct credit substitutes.
    \9\ For purposes of this rule, purchased credit-enhancing 
interest-only strips are also ``residual interests.''
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    Many asset securitizations use a combination of recourse and third-
party enhancements to protect investors from credit risk. When third-
party enhancements are not provided, the selling banking organization 
ordinarily retains virtually all of the credit risk on the assets 
transferred.

B. Risk Management of Exposures Arising From Securitization Activities

    While asset securitization can enhance both credit availability and 
a banking organization's profitability, managing the risks associated 
with this activity can pose significant challenges. The risks involved, 
while not new to banking organizations, may be less obvious and more 
complex than the risks of traditional lending. Specifically, 
securitization can involve credit, liquidity, operational, legal, and 
reputational risks in concentrations and forms that may not be fully 
recognized by management or adequately incorporated into a banking 
organization's risk management systems.
    The capital treatment required by the final rule provides one 
important way of addressing the credit risk presented by securitization 
activities. However, a banking organization's compliance with capital 
standards should be complemented by effective risk management 
strategies. The agencies expect that banking organizations will 
identify, measure, monitor and control the risks of their 
securitization activities (including synthetic securitizations using 
credit derivatives) and explicitly incorporate the full range of risks 
into their risk management systems. Management is responsible for 
having adequate policies and procedures in place to ensure that the 
economic substance of their risks is fully recognized and appropriately 
managed. Banking organizations should be able to measure and manage 
their risk exposure from risk positions in the securitizations, either 
retained or acquired, and should be able to assess the credit quality 
of any retained residual portfolio. The formality and sophistication 
with which the risks of these activities are incorporated into a 
banking organization's risk management system should be commensurate 
with the nature and volume of its securitization activities. Banking 
organizations with significant securitization activities, no matter 
what the size of their on-balance sheet assets, are expected to have 
more advanced and formal approaches to manage the risks.
    The Securitization Guidance addresses the fundamental risk 
management practices that should be in

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

    Currently, the agencies' risk-based capital standards apply 
different treatments to recourse obligations, including residual 
interests, and direct credit substitutes. As a result, capital 
requirements applicable to credit enhancements do not consistently 
reflect credit risk, even though the risk characteristics are similar. 
The current rules of the OCC, Board, and FDIC (the banking agencies) 
are also not entirely consistent with those of the OTS. One objective 
of the final rule is to remove or reduce these inconsistencies.
1. Recourse and Retained Residual Interests
    The agencies' risk-based capital guidelines prescribe a single 
treatment for assets transferred with recourse (including retained 
residual interests), regardless of whether the transaction is reported 
as a sale of assets or as a financing in a bank's Consolidated Report 
of Condition and Income (Call Report), a bank holding company's FR Y-9 
reports, or a thrift's Thrift Financial Report. For a transaction 
reported as a financing, the transferred assets remain on the balance 
sheet and are risk-weighted. For a transaction reported as a sale, the 
entire outstanding amount of the assets sold with recourse (not just 
the contractual amount of the recourse obligation) is converted into an 
on-balance sheet credit equivalent amount using a 100% credit 
conversion factor. This credit equivalent amount (less any applicable 
recourse liability account recorded on the balance sheet) is then risk-
weighted.\11\ If the seller's balance sheet includes as an asset (other 
than a servicing asset) any interest that acts as a credit enhancement 
to the assets sold, that interest is not risk-weighted a second time as 
an on-balance sheet item. Thus, regardless of the method used to 
account for the transfer, risk-based capital is held against the full, 
risk-weighted amount of the assets transferred with recourse, unless 
the transaction is subject to the low-level recourse rule.\12\
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    \11\ Consistent with statutory requirements, the agencies' 
current rules also provide for special treatment of sales of small 
business obligations with recourse. See 12 CFR part 3, appendix A, 
Section 3(c) (OCC); 12 CFR parts 208 and 225, appendix A, II.B.5 
(FRB); 12 CFR part 325, appendix A, II.B.6 (FDIC); 12 CFR 
567.6(a)(3) (OTS). See also discussion in section III.B.11 of this 
preamble.
    \12\ Section 350 of the CDRI Act required the agencies to 
prescribe regulations providing that the risk-based capital 
requirement for assets transferred with recourse could not exceed a 
banking organization's maximum contractual exposure. The agencies 
may require a higher amount if necessary for safety and soundness 
reasons. See 12 U.S.C. 4808.
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    The low-level recourse rule limits the maximum risk-based capital 
requirement to the lesser of the banking organization's maximum 
contractual exposure or the full capital charge against the outstanding 
amount of assets transferred with recourse. When the low-level recourse 
rule applies, a banking organization generally holds capital on a 
dollar-for-dollar basis against the amount of its maximum contractual 
exposure. In the absence of any other recourse provisions, the on-
balance sheet amount of a residual interest represents the maximum 
contractual exposure. For example, assume that a banking organization 
securitizes $100 million of credit card loans and records a residual 
interest on the balance sheet of $5 million that serves as a credit 
enhancement for the assets transferred. Before the low-level recourse 
rule was issued, the banking organization was required to hold $8 
million of risk-based capital against the $100 million in loans sold, 
as though the loans had not been sold. Under the low-level recourse 
rule, the banking organization is required to hold $5 million in 
capital, that is, ``dollar-for-dollar'' capital up to the banking 
organization's maximum contractual exposure. However, if the banking 
organization has recorded a residual interest of $10 million (rather 
than $5 million), the low-level recourse rule would not have applied. 
The banking organization would have been required to hold the full 
capital charge, i.e., $8 million in this example, even though its 
maximum contractual exposure was $10 million.
    For leverage capital ratio purposes, if a transfer with recourse is 
reported as a financing, the transferred assets remain on the 
transferring banking organization's balance sheet and the banking 
organization must hold leverage capital against these assets. If a 
transfer with recourse is reported as a sale, the assets sold do not 
remain on the selling banking organization's balance sheet and the 
banking organization need not hold leverage capital against these 
assets. However, because certain recourse obligations (e.g., retained 
residual interests) are recorded as an asset on the seller's balance 
sheet, leverage capital must be held against those obligations.
2. Direct Credit Substitutes
    Direct credit substitutes are treated differently from recourse 
obligations under the existing risk-based capital standards. Currently, 
off-balance sheet direct credit substitutes, such as financial standby 
letters of credit provided for third-party assets, carry a 100% credit 
conversion factor. However, only the face amount of the direct credit 
substitute is converted into an on-balance sheet credit equivalent 
amount. As a result, capital is held only against the face amount of 
the direct credit substitute. The capital requirement for a recourse 
arrangement, in contrast, generally is based on the full amount of the 
assets enhanced.
    If a direct credit substitute covers less than 100% of the 
potential losses on the assets enhanced, the current capital treatment 
results in a lower capital charge for a direct credit substitute than 
for a comparable recourse arrangement

[[Page 59618]]

even though the economic risk of loss is similar. For example, if a 
direct credit substitute covers losses up to the first 20% of $100 of 
enhanced assets, then the on-balance sheet credit equivalent amount 
equals $20, and risk-based capital is held against only the $20 amount. 
In contrast, required capital for a first-loss 20% recourse arrangement 
on $100 of transferred assets is higher because capital is held against 
the entire $100 of the assets enhanced.
    Currently, under the banking agencies' risk-based capital 
guidelines, purchased subordinated interests receive the same capital 
treatment as off-balance sheet direct credit substitutes; that is, only 
the dollar amount of the purchased subordinated interest is placed in 
the appropriate risk-weight category. In contrast, a banking 
organization that retains a subordinated interest in connection with 
the transfer of its own assets is considered to have transferred the 
assets with recourse, even though the economic and credit risks are 
similar. As a result, the banking organization must hold capital 
against the carrying amount of the retained subordinated interest as 
well as the outstanding dollar amount of all senior interests that it 
supports, subject to the low-level recourse rule.
    The OTS risk-based capital regulation treats some forms of direct 
credit substitutes (e.g., financial standby letters of credit) in the 
same manner as the banking agencies' guidelines. However, unlike the 
banking agencies, the OTS treats purchased subordinated interests 
(except for certain high quality subordinated mortgage-related 
securities) under its general recourse provisions. The risk-based 
capital requirement is based on the carrying amount of the subordinated 
interest plus all senior interests, as though the thrift owned the full 
outstanding amount of the assets enhanced.
3. Concerns Raised by Current Capital Treatment
    The agencies' current leverage and risk-based capital standards 
raise significant concerns with respect to the treatment of recourse 
and direct credit substitutes. First, banking organizations are often 
required to hold different amounts of capital for recourse arrangements 
and direct credit substitutes that expose the banking organization to 
similar credit risks. Banking organizations are taking advantage of 
this anomaly, for example, by taking first-loss positions through 
financial standby letters of credit, i.e., direct credit substitutes, 
in asset-backed commercial paper conduits that lend directly to 
corporate customers. These direct credit substitutes are accorded a 
significantly lower capital requirement than if a banking organization 
were to retain a subordinated position in a securitization comprised of 
loans that had originally been carried on its balance sheet, i.e. a 
recourse obligation, notwithstanding that the credit risks of both 
positions are virtually the same. Moreover, the current capital 
standards do not recognize differences in risk associated with 
different loss positions in asset securitizations, nor do they provide 
uniform definitions of recourse, residual interest, direct credit 
substitute, and associated terms.
    Residual interests, including retained or purchased credit-
enhancing interest-only strips (credit-enhancing I/Os), raise further 
supervisory concerns. Fair value is the basis for the initial 
measurement and, in most cases, the ongoing measurement of residual 
interests on banking organizations' balance sheets. In addition, 
declines in fair value trigger determinations as to whether other than 
temporary impairments of residual interests should be recognized. 
Banking organizations' fair value estimates for these instruments, 
however, are often based on unwarranted assumptions about expected 
future cash flows. No active market exists for many residual interests, 
including credit-enhancing I/Os. As a result, there is no marketplace 
from which an arm's length market price can readily be obtained to 
support the residual interest valuation. Recent examinations have 
highlighted the inherent uncertainty and volatility regarding the 
initial and ongoing valuation of credit-enhancing I/Os and other 
residual interests. A banking organization that securitizes assets may 
overvalue its residual interests, including its credit-enhancing I/Os, 
and thereby inappropriately generate ``paper profits'' (or mask actual 
losses) through incorrect cash flow modeling, flawed loss assumptions, 
inaccurate prepayment estimates, and inappropriate discount rates. This 
often leads to an inflation of capital, making the banking organization 
appear more financially sound than it is. Embedded within residual 
interests, including credit-enhancing I/Os, is a significant level of 
credit and prepayment risk that make their valuation extremely 
sensitive to changes in underlying assumptions. Market events can 
affect the discount rate, prepayment speed or performance of the 
underlying assets in a securitization transaction and can swiftly and 
dramatically alter their value. A banking organization that holds an 
excessive concentration of residual interests in relation to capital 
presents significant safety and soundness concerns.
    Existing regulatory capital rules do not adequately reflect the 
risks associated with residual interests. Often, banking organizations 
that securitize and sell higher risk assets are required to retain a 
large residual interest (often greater than the full capital charge of 
8 percent on 100 percent risk-weighted assets) to ensure that the more 
senior positions in the securitization or other asset sale can receive 
the desired investment ratings. The booking of a residual interest 
using gain-on-sale accounting can increase the selling banking 
organization's capital and thereby allow the banking organization to 
leverage the capital created from the securitization. This creation of 
capital is most commonly associated with credit-enhancing I/Os and 
other spread-related assets. Write-downs of the recorded value of the 
residual interest due to changes in assumptions concerning loss, 
prepayment or discount rates can subsequently result in losses. Any 
losses in excess of the full capital charge (8 percent in the example 
above) will negatively affect the capital adequacy of the banking 
organization and, thereby, its safety and soundness.
    Moreover, the current capital rules also do not subject either 
purchased or retained credit-enhancing I/Os to a concentration limit. 
In 1998, the agencies amended their capital rules to impose strict 
limits on the amount of nonmortgage servicing assets that may be 
included in Tier 1 capital.\13\ These strict limitations were imposed 
due to the lack of depth and maturity of the marketplace for such 
assets, and related concerns about their valuation, liquidity, and 
volatility.
---------------------------------------------------------------------------

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

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

[[Page 59619]]

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

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

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

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

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

A. The General Approach Taken in the Final Rule

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

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

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

[[Page 59620]]

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

[[Page 59621]]

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

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

B. Definitions and Scope of the Final Rule

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

[[Page 59622]]

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

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

5. Credit Derivatives
    The proposed definitions of ``recourse'' and ``direct credit 
substitute'' cover credit derivatives to the extent that a banking 
organization's credit risk exposure exceeds its pro rata interest in 
the underlying obligation. The ratings-based approach therefore applies 
to rated instruments such as credit-linked notes issued as part of a 
synthetic securitization. With the issuance of this final rule, the 
agencies reaffirm the validity of the structural and risk-management 
requirements of the December 1999 guidance on synthetic securitizations 
issued by the Board and the OCC,\19\ while modifying the risk-based 
capital treatment detailed therein with the treatment presented in this 
final rule.
---------------------------------------------------------------------------

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

6. Credit-Enhancing Representations and Warranties
    When a banking organization transfers assets, including servicing 
rights, it customarily makes representations and warranties concerning 
those assets. When a banking organization purchases

[[Page 59623]]

loan servicing rights, it may also assume representations and 
warranties made by the seller or a prior servicer. These 
representations and warranties give certain rights to other parties and 
impose obligations upon the seller or servicer of the assets. The 2000 
Recourse Proposal addressed those particular representations and 
warranties that function as credit enhancements, i.e., those where, 
typically, a banking organization agrees to protect purchasers or some 
other party from losses due to the default or non-performance of the 
obligor or insufficiency in the value of collateral. To the extent a 
banking organization's representations and warranties function as 
credit enhancements to protect asset purchasers or investors from 
credit risk, the final rule treats them as recourse or direct credit 
substitutes.
    The final rule is consistent with the agencies' longstanding 
recourse treatment of representations and warranties that effectively 
guaranty performance or credit quality of transferred loans. However, 
the agencies also recognize that banking organizations typically make a 
number of factual warranties unrelated to ongoing performance or credit 
quality. These warranties entail operational risk, as opposed to the 
open-ended credit risk inherent in a financial guaranty, and are 
excluded from the definitions of recourse and direct credit substitute. 
Warranties that create operational risk include: warranties that assets 
have been underwritten or collateral appraised in conformity with 
identified standards, and warranties that provide for the return of 
assets in instances of incomplete documentation, fraud or 
misrepresentation.
    Warranties can impose varying degrees of operational risk. For 
example, a warranty that asset collateral has not suffered damage from 
hazard entails risk that is offset to some extent by prudent 
underwriting practices requiring the borrower to provide hazard 
insurance to the banking organization. A warranty that asset collateral 
is free of environmental hazards may present acceptable operational 
risk for certain types of properties that have been subject to 
environmental assessment, depending on the circumstances. The agencies 
address appropriate limits for these operational risks through 
supervision of a banking organization's loan underwriting, sale, and 
servicing practices. Also, a banking organization that provides 
warranties to loan purchasers and investors must include associated 
operational risks in its risk management of exposures arising from loan 
sale or securitization-related activities. Banking organizations should 
be prepared to demonstrate to examiners that operational risks are 
effectively managed.
    The final rule requires recourse or direct credit substitute 
treatment for warranties providing assurances about the actual value of 
asset collateral, including that the market value corresponds to its 
appraised value or that the appraised value will be realized in the 
event of foreclosure and sale. Warranties such as these, which make 
representations about the future value of a loan or related collateral 
constitute an enhancement of the loan transferred and, thus, are 
recourse arrangements or direct credit substitutes. One commenter 
suggested that a representation that the seller ``has no knowledge'' of 
circumstances that could cause a loan to be other than investment 
quality is an operational warranty. The agencies agree that if a seller 
represents that it has no knowledge of the existence of such 
circumstances at the time that the loans are transferred the 
representation would not be recourse.
    Commenters sought clarification of the agencies' statement in the 
2000 Recourse Proposal that early-default clauses are recourse. Early-
default clauses typically give the purchaser of a loan the right to 
return the loan to the seller if the loan becomes 30 or more days 
delinquent within a stated period after the transfer--four months after 
transfer, for example. Once the stated period has expired, the early-
default clause will no longer trigger recourse treatment, provided that 
there is no other provision that constitutes recourse.
    Several commenters stated that early-default clauses are not 
recourse because they are designed to cover loans that, due to their 
non-payment within the first few months of origination, most likely 
contained underwriting deficiencies. Early-default clauses can allow 
for a reasonable but limited period of time for a purchaser to review 
loan file documentation. Therefore, the final rule specifically exempts 
from recourse treatment, for a limited period of time, these types of 
warranties on certain 1-4 family residential mortgage loans. The 
agencies have modified the definition of ``credit-enhancing 
representations and warranties'' to exclude warranties, such as early-
default clauses and similar warranties that permit the return of 
qualifying 1-4 family residential first mortgage loans for a maximum 
period of 120 days from the date of transfer. To be excluded from the 
definition, however, these warranties must cover only 1-4 family 
residential mortgage loans that are eligible for the 50% risk weight 
and that were originated within 1 year of the date of transfer. All 
other early-default clauses, including those for periods of greater 
than 120 days on qualifying 1-4 family residential first mortgages, are 
recourse or direct credit substitutes.
    The 2000 Recourse Proposal also sought comment on premium refund 
clauses. A premium refund clause is a warranty that obligates a seller 
who has sold a loan at a price in excess of par, i.e., at a premium, to 
refund the premium, either in whole or in part, if the loan defaults or 
is prepaid within a certain period of time. Commenters responded that 
premium refund clauses are not recourse because they reflect interest 
rate risk, not credit risk.
    Although premium refund clauses can be triggered as a result of 
prepayments, they can also be triggered by defaults. Accordingly, 
premium refund clauses are generally credit-enhancing representations 
and warranties under the final rule. However, the agencies have 
included an exception for premium refund clauses on U.S. government-
guaranteed loans and qualifying 1-4 family first mortgage loans that 
impose a refund obligation on a seller for a period not to exceed 120 
days from the date of transfer. These types of loans hold significantly 
reduced credit risk.
    For those warranties not exempt from recourse or direct credit 
substitute treatment under the final rule, industry concerns about 
assets that are delinquent at the time of transfer or unsound 
originations may be dealt with by warranties directly addressing the 
condition of the asset at the time of transfer (i.e., creation of an 
above described operational warranty) and compliance with stated 
underwriting standards. Alternatively, banking organizations might 
create warranties with exposure caps that would permit the banking 
organization to take advantage of the low-level recourse rule.
7. Clean-Up Calls
    The final rule clarifies the agencies' longstanding interpretations 
on the use of clean-up calls in a securitization. A clean-up call is an 
option that permits a servicer or its affiliate (which may be the 
originator) to take investors out of their positions in a 
securitization before all of the transferred loans have been repaid. 
The servicer accomplishes this by repurchasing the remaining loans in 
the pool once the pool balance has fallen below some specified level. 
This option in a securitization raises longstanding agency concerns 
that a banking organization may implicitly assume a credit-enhancing 
position by

[[Page 59624]]

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

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

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

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

10. Reservation of Authority
    Banking organizations are developing novel transactions that do not 
fit well into the risk-weight categories and credit conversion factors 
in the current standards. Banking organizations also are devising novel 
instruments that nominally fit into a particular risk-weight category 
or credit conversion factor, but that impose risks on the banking 
organization at levels that are not commensurate with the nominal risk-
weight or credit conversion factor for the asset, exposure or 
instrument. Accordingly, the agencies have clarified their authority, 
on a case-by-case basis, to determine the appropriate risk-weight for 
assets and credit equivalent amounts and the appropriate credit 
conversion factor for off-balance sheet items in these circumstances.
    Exercise of this authority by the agencies may result in a higher 
or lower risk weight for an asset or credit

[[Page 59625]]

equivalent amount or a higher or lower credit conversion factor for an 
off-balance sheet item. This reservation of authority explicitly 
recognizes the agencies' retention of sufficient discretion to ensure 
that banking organizations, as they develop novel financial assets, 
will be treated appropriately under the regulatory capital standards. 
Under this authority, the agencies reserve the right to assign risk 
positions in securitizations to appropriate risk categories on a case-
by-case basis if the credit rating of the risk position is determined 
to be inappropriate.
11. Alternative Capital Calculation for Small Business Obligations
    Certain commenters noted that the capital treatment in the 
Residuals Proposal would have a significant negative impact on banking 
organizations' small business lending. According to these commenters, 
the dollar-for-dollar capital requirement and concentration limits for 
residual interests arising from asset securitizations under the 
Residuals Proposal would apply to asset securitizations involving the 
transfer of small business obligations. These commenters concluded 
that, unless the Residuals Proposal is amended to exclude small 
business obligations from coverage, the capital treatment in the final 
rule would contravene section 208 of the CDRI Act. The final rule 
retains the alternative capital calculation for small business 
obligations that implements section 208 of the CDRI Act.

C. Ratings-Based Approach: Traded and Non-Traded Positions

    As described in section II.A., each loss position in an asset 
securitization structure functions as a credit enhancement for the more 
senior loss positions in the structure. Currently, the risk-based 
capital standards do not vary the capital requirement for different 
credit enhancements or loss positions to reflect differences in the 
relative credit risk represented by the positions.
    To address this issue, the agencies are implementing a multi-level, 
ratings-based approach to assess capital requirements on recourse 
obligations, residual interests (except credit-enhancing I/O strips), 
direct credit substitutes, and senior and subordinated securities in 
asset securitizations based on their relative exposure to credit risk. 
The approach uses credit ratings from the rating agencies to measure 
relative exposure to credit risk and determine the associated risk-
based capital requirement. The use of credit ratings provides a way for 
the agencies to use determinations of credit quality relied upon by 
investors and other market participants to differentiate the regulatory 
capital treatment for loss positions representing different gradations 
of risk. This use permits the agencies to give more equitable treatment 
to a wide variety of transactions and structures in administering the 
risk-based capital system.
    The use of credit ratings in the final rule is similar to the 2000 
Recourse Proposal. Although many commenters expressed concerns about 
specific aspects of the 2000 Recourse Proposal, commenters generally 
supported the goal of making the capital requirements for asset 
securitizations more rational and efficient, and viewed the 2000 
Recourse Proposal as a positive step toward this goal. The agencies 
have made several changes to the 2000 Recourse Proposal and Residual 
Proposal in response to commenters' concerns and based on further 
consideration of the issues.
    Several commenters on the 2000 Recourse Proposal expressed concern 
over reliance on external rating agency ratings for the purposes of 
assessing risk-based capital charges for banking organizations. They 
asserted that credit ratings are not intended to measure risks 
associated with regulatory capital and that, without market discipline 
imposed on them, the ratings may not be reliable for that purpose. They 
also noted an inherent conflict of interest between a rating agency's 
ability to objectively assign a rating upon which regulators can rely 
in imposing capital charges and one that measures the risks in a 
securitization for the banking organization who is paying for the 
rating.
    Investors rely on ratings to make investment decisions. This 
reliance exerts market discipline on the rating agencies and gives 
their ratings market credibility. The market's reliance on ratings, in 
turn, gives the agencies confidence that it is appropriate to consider 
ratings as a major factor in the risk weighting of assets for 
regulatory capital purposes. Further, the use of a single rating will 
only be adequate under the ratings-based approach for a position that 
is traded. The agencies, however, reserve the authority to override the 
use of certain ratings or the ratings on certain instruments, either on 
a case-by-case basis or through broader supervisory policy, if 
necessary or appropriate to address the risk that an instrument poses 
to banking organizations.
    Under the ratings-based approach, the capital requirement for a 
position is computed by multiplying the face amount of the position by 
the appropriate risk weight determined in accordance with the following 
tables.\23\ The first chart shown below maps long-term ratings to the 
appropriate risk-weights under the final rule. In response to requests 
from commenters, the agencies have also included another chart (the 
second chart shown below) that maps short-term ratings for asset-backed 
commercial paper to the appropriate risk-weights under this rule.
---------------------------------------------------------------------------

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

------------------------------------------------------------------------
                                                            Risk weight
     Long-term rating category            Examples         (In percent)
------------------------------------------------------------------------
Highest or second highest           AAA or AA...........              20
 investment grade.
Third highest investment grade....  A...................              50
Lowest investment grade...........  BBB.................             100
One category below investment       BB..................             200
 grade.
More than one category below        B or unrated........           (\1\)
 investment grade, or unrated.


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

[[Page 59626]]

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

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

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

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

    \25\ Similar to the banking agencies' current approach under 
which ``stripped'' mortgage-backed securities are not eligible for 
risk weighting at 50% on a ``pass-through'' basis, stripped 
mortgage-backed securities are ineligible for the 20% or 50% risk 
categories under the ratings-based approach. Currently, OTS also 
includes most interest-only and principal-only strips in the 100% 
risk-weight category. See 12 CFR 567.6(a)(1)(iv) (introductory 
statement) and (a)(1)(iv)(M). However, certain high-quality stripped 
mortgage-related securities are eligible for a 20% risk weight under 
the OTS' capital standards. OTS recently proposed to conform its 
capital treatment for high-quality stripped mortgage-related 
securities to that of other agencies, and received not comments in 
opposition to this change. See 66 FR 15049, March 15, 2001. 
Accordingly, OTS in conforming these aspects of its rule to those of 
the other agencies.
---------------------------------------------------------------------------

    While the ratings-based approach is available for both traded and 
untraded positions, the rule applies different requirement to these 
positions. A traded position, for example, is only required to be rated 
by one rating agency. A position is defined as ``traded'' if, at the 
time it is rated by an external rating agency, there is a reasonable 
expectation that in the near future: (1) The position may be sold to 
unaffiliated investors relying on the rating; or (2) an unaffiliated 
third party may enter into a transaction (e.g., a loan or repurchase 
agreement) involving the position in which the third party relies on 
the rating of the position.
    A few commenters expressed concern over the provision in the 2000 
Recourse Proposal that allowed a banking organization to use the single 
highest rating obtained on a traded position, stating that doing so 
encourages rating-shopping. The agencies agree and, therefore, the 
final rule requires a banking organization to use the lowest single 
rating assigned to a traded position. Moreover, if a rating changes, 
the banking organization must use the new rating.
    Rated, but untraded, asset-backed securities, recourse obligations, 
direct credit substitutes and residual interests may also be eligible 
for the ratings-based approach if they meet certain conditions. To 
qualify, the position must be rated by more than one rating agency, the 
ratings must be one category below investment grade or better for long-
term positions (or investment grade or better for short-term positions) 
by all rating agencies providing a rating, the ratings must be publicly 
available, and the ratings must be based on the same criteria used to 
rate securities that are traded. If the ratings are different, the 
lowest single rating will determine the risk-weight category.
    Recourse obligations and direct credit substitutes (other than 
residual interests) that do not qualify for the ratings-based approach 
(or the internal ratings, program ratings or computer program ratings 
approaches outlined below) receive ``gross-up'' treatment, that is, the 
banking organization holding the position must hold capital against the 
amount of the position plus all more senior positions, subject to the 
low-level exposure rule.\26\ This grossed-up amount is placed into a 
risk-weight category according to the obligor or, if relevant, the 
guarantor or the nature of the collateral. The grossed-up amount 
multiplied by both the risk-weight and 8 percent is never greater than 
the full capital charge that would otherwise be imposed on the assets 
if they were on the banking organization's balance sheet.\27\
---------------------------------------------------------------------------

    \26\ ``Gross-up'' treatment means that a position is combined 
with all more senior positions in the transaction. The result is 
then risk-weighted based on the obligor or, if relevant, the 
guarantor or the nature of the collateral. For example, if a banking 
organization retains a first-loss position (other than a residual 
interest) in a pool of mortgage loans that qualify for a 50% risk 
weight, the banking organization would include the full amount of 
the assets in the pool, risk-weighted at 50%, in its risk-weighted 
assets for purposes of determining its risk-based capital ratio. The 
low-level exposure rule provides that the dollar amount of risk-
based capital required for assets transferred with recourse should 
not exceed the maximum dollar amount for which a banking 
organization is contractually liable. See 12 CFR part 3, appendix A, 
Section 3(d) (OCC); 12 CFR 208 and 225, appendix A, III.D.1(g) 
(FRB); 12 CFR part 325, appendix A, II.D.1 (FDIC); 12 CFR 
567.6(a)(2)(i)(C) (OTS).
    \27\ For assets that are assigned to the 100 percent risk-weight 
category, the minimum capital charge is 8 percent of the amount of 
assets transferred, and banking organizations are required to hold 8 
cents of capital for every dollar of assets transferred with 
recourse. For assets that are assigned to the 50 percent risk-weight 
category, the minimum capital charge is 4 cents of capital for every 
dollar of assets transferred with recourse.
---------------------------------------------------------------------------

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

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

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

D. Unrated Positions

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

[[Page 59627]]

requirements for certain unrated direct credit substitutes and recourse 
obligations. Under each of these approaches, the banking organization 
must satisfy its supervisory agency that the use of the approach is 
appropriate for the particular banking organization and for the 
exposure being evaluated. The final rule limits, however, the risk 
weight that may be applied to an exposure under these alternative 
approaches to a minimum of 100%.
    Under the 2000 Recourse Proposal, only direct credit substitutes 
could qualify for beneficial risk-weighting using the three 
alternatives to external ratings (i.e., internal ratings, program 
ratings, and computer programs). Commenters questioned the agencies' 
limitation of the application of these alternative approaches to direct 
credit substitutes. After considering the arguments for extending the 
application of these approaches to recourse obligations, the agencies 
have decided not to permit the internal ratings-based approach to apply 
to any positions other than direct credit substitutes issued in 
connection with an asset-backed commercial paper program. Industry 
research and empirical evidence indicates that these positions are more 
likely than recourse positions to be of investment-grade credit 
quality, and that the banking organizations providing these direct 
credit substitutes are more likely to have internal risk rating systems 
for these credit enhancements that are sufficiently reliable for risk-
based capital calculations.
    However, the agencies have reconsidered their position with respect 
to qualifying program ratings and computer program ratings. The final 
rule extends beneficial risk-weighting treatment, through the use of 
qualifying program and computer ratings, to off-balance sheet recourse 
obligations to accommodate structured finance programs. By extending 
this treatment to off-balance sheet recourse obligations the final rule 
facilitates the structuring of these programs in a more efficient 
manner. The agencies believe this result is appropriate because of the 
similarity of economic risks between off-balance sheet direct credit 
substitutes and off-balance sheet recourse obligations.
    The final rule, however, does not extend the use of internal 
ratings, program ratings or computer program ratings to residual 
interests. Such a change would not facilitate existing asset-backed 
commercial paper programs and structured finance programs, which 
generally do not book any on-balance sheet residuals. Further, residual 
interests by their nature are generally illiquid, hard-to-value assets, 
often with limited performance history. These characteristics make 
determining internal capital requirements difficult. The agencies also 
believe that the economic risk differs between residual interests and 
off-balance sheet recourse and direct credit substitute exposures. 
Therefore, based on the risks associated with residual interests, the 
agencies have decided for the present not to allow banking 
organizations to use internal ratings, program ratings or computer 
programs to apply a risk-based capital treatment more favorable than a 
dollar-for-dollar capital requirement to these positions.
    The agencies will continue to evaluate the effectiveness and 
reliability of these alternative approaches for assessing regulatory 
capital at banking organizations and may revisit this issue if, over 
time, new information indicates that reconsideration is warranted.
1. Use of Banking Organizations' Internal Risk Ratings
    The final rule permits a banking organization with a qualifying 
internal risk rating system to use that system to apply the ratings-
based approach to the banking organization's unrated direct credit 
substitutes in asset-backed commercial paper programs. Internal risk 
ratings could be used to qualify such a credit enhancement for a risk 
weight of 100% or 200% under the ratings-based approach, but not for a 
risk weight of less than 100%. This relatively limited use of internal 
risk ratings for risk-based capital purposes is a step toward potential 
adoption of a broader use of internal risk ratings as discussed in the 
Basel Committee's June 1999 and January 2001 Consultative Papers on a 
new Basel Capital Accord.
    Most sophisticated banking organizations that participate 
extensively in the asset securitization business assign internal risk 
ratings to their credit exposures, regardless of the form of the 
exposure. Usually, internal risk ratings more finely differentiate the 
credit quality of a banking organization's exposures than the 
categories that the agencies use to evaluate credit risk during 
examinations of banking organizations (pass, substandard, doubtful, 
loss). Individual banking organizations' internal risk ratings may be 
associated with a certain probability of default, loss in the event of 
default, and loss volatility.
    The credit enhancements that sponsors obtain for their commercial 
paper conduits are rarely rated or traded. If an internal risk ratings 
approach were not available for these unrated credit enhancements, the 
provider of the enhancement would have to obtain two ratings solely to 
avoid the gross-up treatment that would otherwise apply to non-traded 
positions in asset securitizations for risk-based capital purposes. 
However, before a provider of an enhancement decides whether to provide 
a credit enhancement for a particular transaction (and at what price), 
the provider will generally perform its own analysis of the transaction 
to evaluate the amount of risk associated with the enhancement.
    Allowing banking organizations to use internal credit ratings 
harnesses information and analyses that they already generate rather 
than requiring them to obtain independent but potentially redundant 
ratings from outside rating agencies. An internal risk ratings approach 
therefore has the potential to be less costly than a ratings-based 
approach that relies exclusively on ratings by the rating agencies for 
the risk-weighting of these positions.
    Internal risk ratings that correspond to the rating categories of 
the rating agencies could be mapped to risk weights under the agencies' 
capital standards in a way that would make it possible to differentiate 
the riskiness of various unrated direct credit substitutes in asset-
backed commercial paper programs based on credit risk. However, the use 
of internal risk ratings raises concerns about the accuracy and 
consistency of the ratings, especially because the mapping of ratings 
to risk-weight categories will give banking organizations an incentive 
to rate their risk exposures in a way that minimizes the effective 
capital requirement. A banking organization engaged in asset-backed 
commercial paper securitization activities that wishes to use the 
internal risk ratings approach must be able to demonstrate to the 
satisfaction of its primary regulator, prior to relying upon its use, 
that the bank's internal credit risk rating system is adequate. 
Adequate internal risk rating systems usually:
    (1) Are an integral part of an effective risk management system 
that explicitly incorporates the full range of risks arising from an 
organization's participation in securitization activities. The system 
must also fully take into account the effect of such activities on the 
organization's risk profile and capital adequacy as discussed in 
Section II.B.
    (2) Link their ratings to measurable outcomes, such as the 
probability that a position will experience any losses, the expected 
losses on that position in the event of default, and the degree of 
variance in losses given default on that position.

[[Page 59628]]

    (3) Separately consider the risk associated with the underlying 
loans and borrowers and the risk associated with the specific positions 
in a securitization transaction.
    (4) Identify gradations of risk among ``pass'' assets, not just 
among assets that have deteriorated to the point that they fall into 
``watch'' grades. Although it is not necessary for a banking 
organization to use the same categories as the rating agencies, its 
internal ratings must correspond to the ratings of the rating agencies 
so that the agencies can determine which internal risk rating 
corresponds to each rating category of the rating agencies. A banking 
organization would have the responsibility to demonstrate to the 
satisfaction of its primary regulator how these ratings correspond with 
the rating agency standards used as the framework for this final rule. 
This is necessary so that the mapping of credit ratings to risk weight 
categories in the ratings-based approach can be applied to internal 
ratings.
    (5) Classify assets into each risk grade, using clear, explicit 
criteria, even for subjective factors.
    (6) Have independent credit risk management or loan review 
personnel assign or review credit risk ratings. These personnel should 
have adequate training and experience to ensure that they are fully 
qualified to perform this function.
    (7) Periodically verify, through an internal audit procedure, that 
internal risk ratings are assigned in accordance with the banking 
organization's established criteria.
    (8) Track the performance of its internal ratings over time to 
evaluate how well risk grades are being assigned, make adjustments to 
its rating system when the performance of its rated positions diverges 
from assigned ratings, and adjust individual ratings accordingly.
    (9) Make credit risk rating assumptions that are consistent with, 
or more conservative than, the credit risk rating assumptions and 
methodologies of the rating agencies.
    If a banking organization's rating system is no longer found to be 
adequate, the banking organization's primary regulator may preclude the 
banking organization from applying the internal risk ratings approach 
to new transactions for risk-based capital purposes until it has 
remedied the deficiencies. Additionally, depending on the severity of 
the problems identified, the primary regulator may also decline to rely 
on the internal risk ratings that the banking organization had applied 
to previous transactions for purposes of determining the banking 
organization's regulatory capital requirements.
2. Ratings of Specific Positions in Structured Financing Programs
    Under the final rule, a banking organization may use a rating 
obtained from a rating agency for unrated direct credit substitutes or 
recourse obligations (but not residual interests) in structured finance 
programs that satisfy specifications set by the rating agency. The 
banking organization would need to demonstrate that the rating meets 
the same rating standards generally used by the rating agency for 
rating traded positions. In addition, the banking organization must 
also demonstrate to its primary regulator's satisfaction that the 
criteria underlying the rating agency's assignment of ratings for the 
program are satisfied for the particular direct credit substitute or 
recourse exposure.
    To use this approach, a banking organization must demonstrate to 
its primary regulator that it is reasonable and consistent with the 
standards of this final rule to rely on the rating of positions in a 
securitization structure under a program in which the banking 
organization participates if the sponsor of that program has obtained a 
rating. This aspect of the final rule is most likely to be useful to 
banking organizations with limited involvement in securitization 
activities. In addition, some banking organizations extensively 
involved in securitization activities already rely on ratings of the 
credit risk positions under their securitization programs as part of 
their risk management practices. Such banking organizations also could 
rely on such ratings under this final rule if the ratings are part of a 
sound overall risk management process and the ratings reflect the risk 
of non-traded positions to the banking organizations.
    This approach can be used to qualify a direct credit substitute or 
recourse obligation (but not a residual interest) for a risk weight of 
100% or 200% of the face value of the position under the ratings-based 
approach, but not for a risk weight of less than 100%.
3. Use of Qualifying Rating Software Mapped to Public Rating Standards
    The agencies will also allow banking organizations, particularly 
those with limited involvement in securitization activities, to rely on 
qualifying credit assessment computer programs that the rating agencies 
have developed to rate otherwise unrated direct credit substitutes and 
recourse obligations (but not residual interests) in asset 
securitizations.
    To qualify for use by a banking organization for risk-based capital 
purposes, a computer program's credit assessments must correspond 
credibly and reliably to the rating standards of the rating agencies 
for traded positions in securitizations. A banking organization must 
demonstrate the credibility of the computer program in the financial 
markets, which would generally be shown by the significant use of the 
computer program by investors and other market participants for risk 
assessment purposes. A banking organization must also demonstrate the 
reliability of the program in assessing credit risk.
    A banking organization may use a computer program for purposes of 
applying the ratings-based approach under this final rule only if the 
banking organization satisfies its primary regulator that the program 
results in credit assessments that credibly and reliably correspond 
with the ratings of traded positions by the rating agencies. The 
banking organization should also demonstrate to its primary regulator's 
satisfaction that the program was designed to apply to its particular 
direct credit substitute or recourse exposure and that it has properly 
implemented the computer program. Sophisticated banking organizations 
with extensive securitization activities generally should use this 
approach only if it is an integral part of their risk management 
systems and their systems fully capture the risks from the banking 
organizations' securitization activities.
    This approach can be used to qualify a direct credit substitute or 
recourse obligation (but not a residual interest) for a risk weight of 
100% or 200% of the face value of the position under the ratings-based 
approach, but not for a risk weight of less than 100%.

IV. Effective Date of the Final Rule

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

[[Page 59629]]

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

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

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

V. Miscellaneous Changes

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

VI. Regulatory Analysis

A. Regulatory Flexibility Act

    OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act, 
the OCC certifies that this final rule will not have a significant 
impact on a substantial number of small entities. 5 U.S.C. 601 et seq. 
The provisions of this final rule that increase capital requirements 
are likely to affect large national banks almost exclusively. Small 
national banks rarely sponsor or provide direct credit substitutes in 
asset securitizations. Accordingly, a regulatory flexibility analysis 
is not required.
    Board: Pursuant to section 605(b) of the Regulatory Flexibility 
Act, the Board has determined that this final rule will not have a 
significant impact on a substantial number of small business entities 
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et 
seq.). The Board's comparison of the applicability section of this 
proposal with Call Report Data on all existing banks shows that 
application of the proposal to small entities will be the rare 
exception. Accordingly, a regulatory flexibility analysis is not 
required. In addition, because the risk-based capital standards 
generally do not apply to bank holding companies with consolidated 
assets of less than $150 million, this proposal will not affect such 
companies.
    FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act 
(5 U.S.C. 601 et seq.) the FDIC hereby certifies that the final rule 
will not have a significant economic impact on a substantial number of 
small entities. Comparison of Call Report data on FDIC-supervised banks 
to the items covered by the proposal that result in increased capital 
requirements shows that application of the proposal to small entities 
will be the infrequent exception.
    OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act, 
the OTS certifies that this final rule will not have a significant 
impact on a substantial number of small entities. The provisions of 
this final rule that increase capital requirements for thrifts--the 
provisions on residual interests and certain direct credit substitutes 
(e.g., financial standby letters of credit)--are unlikely to affect 
small savings associations. Current TFR data reveal that few small 
savings associations hold residual interests and that no small thrift 
holds residual interests in excess of 25 percent of core capital. 
Further, the application of the revised capital requirements to 
existing residual interests will not result in a change in the capital 
category of any small thrift. Few small savings associations issue 
standby letters of credit. In addition, virtually all of the standby 
letters of credit that are issued by small thrifts will not be subject 
to an increased capital requirement since these positions will continue 
to be eligible for lower risk weights under the alternative approaches 
outlines in the final rule. Accordingly, OTS concludes that a 
regulatory flexibility analysis is not required.

B. Paperwork Reduction Act

    The agencies have determined that this final rule does not involve 
a collection of information pursuant to the provisions of the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3501, et seq.).

C. Executive Order 12866

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

D. Unfunded Mandates Reform Act of 1995

    OCC: Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. 
L. 104-4, (Unfunded Mandates Act), requires that an agency prepare a 
budgetary impact statement before promulgating a rule that includes a 
Federal mandate that may result in the expenditure by state, local, and 
tribal governments, in the aggregate, or by the private sector, of $100 
million or more in any one year. If a budgetary impact

[[Page 59630]]

statement is required, section 205 of the Unfunded Mandates Act also 
requires an agency to identify and consider a reasonable number of 
regulatory alternatives before promulgating a rule. The OCC has 
determined that this final rule will not result in expenditures by 
state, local, and tribal governments, or by the private sector, of more 
than $100 million or more in any one year. Therefore, the OCC has not 
prepared a budgetary impact statement or specifically addressed the 
regulatory alternatives considered. As discussed in the preamble, this 
final rule will reduce inconsistencies in the agencies' risk-based 
capital standards and, in certain circumstances, will allow banking 
organizations to maintain lower amounts of capital against certain 
rated recourse obligations, residual interests and direct credit 
substitutes.
    OTS: Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. 
L. 104-4 (Unfunded Mandates Act), requires an agency to prepare a 
budgetary impact statement before promulgating a rule that includes a 
Federal mandate that may result in the expenditure by state, local, and 
tribal governments, in the aggregate, or by the private sector, of $100 
million or more in any one year. As discussed in the preamble, the 
final rule prescribes ratings-based and other alternative approaches 
that are likely to reduce the risk-based capital requirement for most 
recourse obligations and direct credit substitutes. The rule will, 
however, increase capital requirements for certain direct credit 
substitutes (e.g., standby letters of credit) and residual interests. 
OTS has reviewed current TFR data to determine whether current OTS-
regulated institutions hold these positions in significant amounts. 
These data indicate that, while these institutions hold some residual 
interests, most standby letters of credit issued by thrifts continue to 
be eligible for a lower risk weight under one of the alternative 
approaches outlined in the final rule. OTS has analyzed the additional 
cost of capital that will be incurred by thrift institutions that hold 
residual interests and direct credit substitutes that are subject to 
increased capital requirements. Based on this analysis, it has 
concluded that the likely increases to the industry's cost of capital 
will not result in the expenditure by state, local, and tribal 
governments, in the aggregate, or by the private sector, of $100 
million or more in any one year.

E. Plain Language

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

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Accounting, Agriculture, Banks, banking, Confidential business 
information, Crime, Currency, Federal Reserve System, Mortgages, 
Reporting and recordkeeping requirements, Securities.

12 CFR Part 225

    Administrative practice and procedure, Banks, banking, Federal 
Reserve System, Holding companies, Reporting and recordkeeping 
requirements, Securities.

12 CFR Part 325

    Administrative practice and procedure, Bank deposit insurance, 
Banks, banking, Capital adequacy, Reporting and recordkeeping 
requirements, Savings associations, State non-member banks.

12 CFR Part 567

    Capital, Reporting and recordkeeping requirements, Savings 
associations.

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons set out in the preamble, part 3 of chapter I of 
title 12 of the Code of Federal Regulations is amended as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

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

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n 
note, 1835, 3907, and 3909.


Sec. 3.4  [Amended]

    2. In Sec. 3.4:
    A. The undesignated paragraph is designated as paragraph (a);
    B. A heading is added to newly designated paragraph (a);
    C. The second and third sentences in the newly designated paragraph 
(a) are revised; and
    D. New paragraph (b) is added to read as follows:


Sec. 3.4  Reservation of authority.

    (a) Deductions from capital. * * * Similarly, the OCC may find that 
a particular intangible asset, deferred tax asset or credit-enhancing 
interest-only strip need not be deducted from Tier 1 or Tier 2 capital. 
Conversely, the OCC may find that a particular intangible asset, 
deferred tax asset, credit-enhancing interest-only strip or other Tier 
1 or Tier 2 capital component has characteristics or terms that 
diminish its contribution to a bank's ability to absorb losses, and may 
require the deduction from Tier 1 or Tier 2 capital of all of the 
component or of a greater portion of the component than is otherwise 
required.
    (b) Risk weight categories. Notwithstanding the risk categories in 
sections 3 and 4 of appendix A to this part, the OCC will look to the 
substance of the transaction and may find that the assigned risk weight 
for any asset or the credit equivalent amount or credit conversion 
factor for any off-balance sheet item does not appropriately reflect 
the risks imposed on a bank and may require another risk weight, credit 
equivalent amount, or credit conversion factor that the OCC deems 
appropriate. Similarly, if no risk weight, credit equivalent amount, or 
credit conversion factor is specifically assigned, the OCC may assign 
any risk weight, credit equivalent amount, or credit conversion factor 
that the OCC deems appropriate. In making its determination, the OCC 
considers risks associated with the asset or off-balance sheet item as 
well as other relevant factors.

Appendix A to Part 3--[Amended]

    3. In appendix A to Part 3, revise all references to ``financial 
guarantee-type standby letter of credit'' to read ``financial standby 
letter of credit''.

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

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

* * * * *

Section 2. Components of Capital

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

[[Page 59631]]

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

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

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

    4. In section 3 of appendix A:
    A. Footnote 11a in paragraph (a)(3)(v) is revised;
    B. Paragraph (b) introductory text is amended by adding a new 
sentence at its end;
    C. Paragraph (b)(1)(i) and footnote 13 are removed and reserved;
    D. Paragraph (b)(1)(ii) is revised;
    E. Paragraph (b)(1)(iii) and footnote 14 are removed and reserved;
    F. Footnote 16 in paragraph (b)(2)(i) is revised;
    G. Footnote 17 in paragraph (b)(2)(ii) is revised;
    H. Paragraph (c) is removed; and
    I. Paragraph (d) is removed.
* * * * *

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

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

    \11a\ The portion of multifamily residential property loans that 
is sold subject to a pro rata loss sharing arrangement may be 
treated by the selling bank as sold to the extent that the sales 
agreement provides for the purchaser of the loan to share in any 
loss incurred on the loan on a pro rata basis with the selling bank. 
The portion of multifamily residential property loans sold subject 
to any loss sharing arrangement other than pro rata sharing of the 
loss shall be accorded the same treatment as any other asset sold 
under an agreement to repurchase or sold with recourse under section 
4(b) of this appendix A.
    \16\ For purposes of this section 3(b)(2)(i), a ``performance-
based standby letter of credit'' is any letter of credit, or similar 
arrangement, however named or described, which represents an 
irrevocable obligation to the beneficiary on the part of the issuer 
to make payment on account of any default by the account party in 
the performance of a non-financial or commercial obligation. 
Participations in performance-based standby letters of credit are 
treated in accordance with section 4 of this appendix A.
    \17\ Participations in commitments are treated in accordance 
with section 4 of this appendix A.
---------------------------------------------------------------------------

* * * * *

    5. Section 4 is redesignated Section 5.

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

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

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

[[Page 59632]]

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

[[Page 59633]]

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

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

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


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


[[Page 59634]]

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

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

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

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

[[Page 59635]]

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

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

 

[[Page 59636]]

     Table 2--Credit Conversion Factors for Off-Balance Sheet Items
------------------------------------------------------------------------
 
-------------------------------------------------------------------------
                      100 Percent Conversion Factor
1. [Reserved]
 
 
------------------------------------------------------------------------

* * * * *

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

FEDERAL RESERVE SYSTEM

12 CFR Chapter II

Authority and Issuance

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

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

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

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

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

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

* * * * *

II. * * *

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

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

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

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

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

[[Page 59637]]

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

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

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

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

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

[[Page 59638]]

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

III. * * *

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

B. * * *

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

[[Page 59639]]

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

[[Page 59640]]

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

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


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

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

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


[[Page 59641]]

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

[[Page 59642]]

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

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

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

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

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

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

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

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

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

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

[[Page 59643]]



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

* * * * *

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

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

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

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

* * * * *

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

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

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


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

[[Page 59644]]

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

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

* * * * *

II. * * *

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

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

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

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

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

[[Page 59645]]

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

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

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

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

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

III. * * *

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

[[Page 59646]]

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

[[Page 59647]]

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

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


[[Page 59648]]


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

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

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

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

[[Page 59649]]

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

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

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

[[Page 59650]]

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

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

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

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

    e. In the case of direct credit substitutes in which a risk 
participation has been acquired, the acquiring banking organization's 
percentage share of the direct credit substitute is multiplied by the 
full amount of the assets that are supported, in whole or in part, by 
the credit enhancement and converted to a credit equivalent amount at 
100 percent. The credit equivalent amount of an acquisition of a risk 
participation in a direct credit substitute is assigned to the risk 
category appropriate to the account party obligor or, if relevant, the 
nature of the collateral or guarantees.
    f. In the case of direct credit substitutes that take the form of a 
syndication where each banking organization is obligated only for its 
pro rata share of the risk and there is no recourse to the originating 
banking organization, each banking organization will only include its 
pro rata share of the assets supported, in whole or in part, by the 
direct credit substitute in its risk-based capital calculation.\46\
---------------------------------------------------------------------------

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

* * * * *

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

[[Page 59651]]

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

* * * * *

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

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

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

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

* * * * *

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

    Dated: November 8, 2001.

Margaret McCloskey Shanks,
Assistant Secretary of the Board.

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Chapter III

Authority and Issuance

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

PART 325--CAPITAL MAINTENANCE

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

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

[[Page 59652]]

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


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


Sec. 325.2  Definitions.

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

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

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


Sec. 325.5  Miscellaneous.

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

[[Page 59653]]

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


Sec. 325.103  [Amended]

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

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

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

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

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

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

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

    Although nonvoting common stock, noncumulative perpetual preferred

[[Page 59654]]

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

[[Page 59655]]

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

[[Page 59656]]

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

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

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

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

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


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


[[Page 59657]]

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

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

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

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

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

[[Page 59658]]

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

[[Page 59659]]

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

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

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

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

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

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

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

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

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

[[Page 59660]]

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

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

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

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


[[Page 59661]]

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

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

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

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

    By order of the Board of Directors.

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

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

DEPARTMENT OF THE TREASURY 

Office of Thrift Supervision

12 CFR Chapter V

Authority and Issuance

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

PART 567--CAPITAL

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

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


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


Sec. 567.1  Definitions.

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

[[Page 59662]]

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

[[Page 59663]]

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

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


Sec. 567.2  Minimum regulatory capital requirement.

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

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


Sec. 567.5  Components of capital.

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

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


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

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

[[Page 59664]]

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

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


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


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

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

[[Page 59665]]

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

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

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

[[Page 59666]]

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

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


Sec. 567.9  Tangible capital.

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

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


Sec. 567.11  Reservation of authority.

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

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

[[Page 59667]]

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


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

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

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