[Federal Register Volume 71, Number 247 (Tuesday, December 26, 2006)]
[Proposed Rules]
[Pages 77446-77518]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-9738]
[[Page 77445]]
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Part II
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Part 3
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Federal Reserve System
12 CFR Parts 208 and 225
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Federal Deposit Insurance Corporation
12 CFR Part 325
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Department of the Treasury
Office of Thrift Supervision
12 CFR Parts 566 and 567
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Risk-Based Capital Guidelines; Capital Adequacy Guidelines; Capital
Maintenance: Domestic Capital Modifications; Proposed Rules and Notice
Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 /
Proposed Rules
[[Page 77446]]
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DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 06-15]
RIN 1557-AC95
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1238]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AC96
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 567
[No. 2006-49]
RIN 1550-AB98
Risk-Based Capital Guidelines; Capital Adequacy Guidelines;
Capital Maintenance: Domestic Capital Modifications
AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of
Governors of the Federal Reserve System; Federal Deposit Insurance
Corporation; and Office of Thrift Supervision, Treasury.
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of
Governors of the Federal Reserve System (Board), Federal Deposit
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS)
(collectively, the Agencies) are proposing revisions to the existing
risk-based capital framework that would enhance its risk sensitivity
without unduly increasing regulatory burden. These changes would apply
to banks, bank holding companies, and savings associations (banking
organizations). A banking organization would be able to elect to adopt
these proposed revisions or remain subject to the Agencies' existing
risk-based capital rules, unless it uses the Advanced Capital Adequacy
Framework proposed in the notice of proposed rulemaking published on
September 25, 2006 (Basel II NPR).
In this notice of proposed rulemaking (NPR or Basel IA), the
Agencies are proposing to expand the number of risk weight categories,
allow the use of external credit ratings to risk weight certain
exposures, expand the range of recognized collateral and eligible
guarantors, use loan-to-value ratios to risk weight most residential
mortgages, increase the credit conversion factor for certain
commitments with an original maturity of one year or less, assess a
charge for early amortizations in securitizations of revolving
exposures, and remove the 50 percent limit on the risk weight for
certain derivative transactions. A banking organization would have to
apply all the proposed changes if it chose to use these revisions.
Finally, in Section III of this NPR, the Agencies seek further
comment on possible alternatives for implementing the ``International
Convergence of Capital Measurement and Capital Standards: A Revised
Framework'' (Basel II) in the United States as proposed in the Basel II
NPR.
DATES: Comments on this joint notice of proposed rulemaking must be
received by March 26, 2007.
ADDRESSES: Comments should be directed to:
OCC: You should include OCC and Docket Number 06-15 in your
comment. You may submit comments by any of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
OCC Web Site: http://www.occ.treas.gov. Click on ``Contact
the OCC,'' scroll down and click on ``Comments on Proposed
Regulations.''
E-mail address: [email protected].
Fax: (202) 874-4448.
Mail: Office of the Comptroller of the Currency, 250 E
Street, SW., Mail Stop 1-5, Washington, DC 20219.
Hand Delivery/Courier: 250 E Street, SW., Attn: Public
Information Room, Mail Stop 1-5, Washington, DC 20219.
Instructions: All submissions received must include the Agency name
(OCC) and docket number or Regulatory Information Number (RIN) for this
notice of proposed rulemaking. In general, OCC will enter all comments
received into the docket without change, including any business or
personal information that you provide. You may review comments and
other related materials by any of the following methods:
Viewing Comments Personally: You may personally inspect
and photocopy comments at the OCC's Public Information Room, 250 E
Street, SW., Washington, DC. You can make an appointment to inspect
comments by calling (202) 874-5043.
Viewing Comments Electronically: You may request e-mail or
CD-ROM copies of comments that the OCC has received by contacting the
OCC's Public Information Room at [email protected].
Docket: You may also request available background
documents and project summaries using the methods described above.
Board: You may submit comments, identified by Docket No. R-1238, by
any of the following methods:
Agency Web Site: http://www.federalreserve.gov. Follow the
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail: [email protected]. Include docket
number in the subject line of the message.
FAX: (202) 452-3819 or (202) 452-3102.
Mail: Jennifer J. Johnson, Secretary, Board of Governors
of the Federal Reserve System, 20th Street and Constitution Avenue,
NW., Washington, DC 20551.
All public comments are available from the Board's Web site at
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as
submitted, unless modified for technical reasons. Accordingly, your
comments will not be edited to remove any identifying or contact
information. Public comments may also be viewed electronically or in
paper form in Room MP-500 of the Board's Martin Building (20th and C
Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
FDIC: You may submit by any of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html
Mail: Robert E. Feldman, Executive Secretary, Attention:
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th
Street, NW., Washington, DC 20429.
Hand Delivered/Courier: The guard station at the rear of
the 550 17th Street Building (located on F Street), on business days
between 7 a.m. and 5 p.m.
E-mail: [email protected].
Public Inspection: Comments may be inspected and
photocopied in the FDIC Public Information Center, Room
[[Page 77447]]
E-1002, 3502 Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5
p.m. on business days.
Instructions: Submissions received must include the Agency name and
title for this notice. Comments received will be posted without change
to http://www.FDIC.gov/regulations/laws/federal/propose.html,
including any personal information provided.
OTS: You may submit comments, identified by No. 2006-49, by any of
the following methods:
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
E-mail address: [email protected]. Please
include No. 2006-49 in the subject line of the message and include your
name and telephone number in the message.
Fax: (202) 906-6518.
Mail: Regulation Comments, Chief Counsel's Office, Office
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552,
Attention: No. 2006-49.
Hand Delivery/Courier: Guard's Desk, East Lobby Entrance,
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention:
Regulation Comments, Chief Counsel's Office, Attention: No. 2006-49.
Instructions: All submissions received must include the Agency name
and docket number or Regulatory Information Number (RIN) for this
rulemaking. All comments received will be posted without change to the
OTS Internet Site at http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1, including any personal
information provided.
Docket: For access to the docket to read background documents or
comments received, go to http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1. In addition, you may inspect
comments at the Public Reading Room, 1700 G Street, NW., by
appointment. To make an appointment for access, call (202) 906-5922,
send an e-mail to public.info@ots.treas.gov">public.info@ots.treas.gov, or send a facsimile
transmission to (202) 906-7755. (Prior notice identifying the materials
you will be requesting will assist us in serving you.) We schedule
appointments on business days between 10 a.m. and 4 p.m. In most cases,
appointments will be available the next business day following the date
we receive a request.
FOR FURTHER INFORMATION CONTACT: OCC: Nancy Hunt, Risk Expert, (202)
874-4923; or Kristin Bogue, Risk Expert, (202) 874-5411, Capital Policy
Division; Ron Shimabukuro, Special Counsel, or Carl Kaminski, 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 Project Manager, Policy, (202) 452-
2982; Barbara Bouchard, Deputy Associate Director, (202) 452-3072;
William Tiernay, Supervisory Financial Analyst (202) 872-7579; or Juan
C. Climent, Supervisory Financial Analyst, (202) 872-7526, Division of
Banking Supervision and Regulation; or Mark E. Van Der Weide, Senior
Counsel, (202) 452-2263, Legal Division. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
FDIC: Karl R. Reitz, Capital Markets Specialist, (202) 898-3857, or
Bobby R. Bean, Chief, Policy Section Capital Markets Branch, (202) 898-
3575, Division of Supervision and Consumer Protection; or Benjamin W.
McDonough, Attorney, (202) 898-7411, 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: Teresa Scott, Senior Project Manager, Supervision Policy (202)
906-6478; or Karen Osterloh, Special Counsel, Regulation and
Legislation Division, Chief Counsel's Office, (202) 906-6639; Office of
Thrift Supervision, 1700 G Street, NW., Washington, DC 20552.
SUPPLEMENTARY INFORMATION:
I. Background
In 1989, the Office of the Comptroller of the Currency (OCC), Board
of Governors of the Federal Reserve System (Board), Federal Deposit
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS)
(collectively, the Agencies) implemented a risk-based capital framework
for U.S. banking organizations.\1\ The Agencies based the framework on
the ``International Convergence of Capital Measurement and Capital
Standards'' (Basel I), published by the Basel Committee on Banking
Supervision (Basel Committee) in 1988.\2\ Basel I addressed certain
weaknesses in the various regulatory capital regimes that were in force
in most of the world's major banking jurisdictions. In the United
States, the Basel I-based framework established a uniform regulatory
capital system that captured some of the risks not otherwise captured
by the regulatory capital to total assets ratio, provided some modest
differentiation of regulatory capital based on broadly defined risk-
weight categories, and encouraged banking organizations to strengthen
their capital positions.
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\1\ 12 CFR part 3, appendix A (OCC); 12 CFR parts 208 and 225,
appendix A (Board); 12 CFR part 325, appendix A (FDIC); and 12 CFR
part 567 (OTS). The risk-based capital rules generally do not apply
to bank holding companies with less than $500 million in assets. 71
FR 9897 (Februray 28, 2006).
\2\ The Basel Committee on Banking Supervision was established
in 1974 by central banks and governmental authorities with bank
supervisory responsibilities. Current member countries are Belgium,
Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands,
Spain, Sweden, Switzerland, the United Kingdom, and the United
States.
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Consistent with Basel I, the Agencies' existing risk-based capital
rules generally assign each credit exposure to one of five broad
categories of credit risk, which allows for only limited
differentiation in the assessment of credit risk for most exposures.
Since the implementation of Basel I-based capital rules, the Agencies
have made numerous revisions to these rules in response to changes in
financial market practices and accounting standards as well as to
implement legislative mandates and address safety and soundness issues.
Over time, these revisions have modestly increased the degree of risk
sensitivity of the Agencies' risk-based capital rules. The Agencies and
the industry generally agree that the existing risk-based capital rules
could be modified to better reflect the risks present in many banking
organizations' portfolios without imposing undue regulatory burden. In
recent years, however, the Agencies have limited modifications to the
existing risk-based capital rules while international efforts to create
a new risk-based capital framework were in process.
In June 2004, the Basel Committee introduced a new, more risk-
sensitive capital adequacy framework, ``International Convergence of
Capital Measurement and Capital Standards: A Revised Framework'' (Basel
II).\3\ Basel II is designed to promote improved risk measurement and
management processes and better align minimum capital requirements with
risk. For credit risk, Basel II includes three approaches for
regulatory capital: Standardized, foundation internal ratings-based,
and advanced internal ratings-based. For operational risk, Basel II
also includes three methodologies:
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Basic indicator, standardized, and advanced measurement.
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\3\ The complete text for Basel II as amended in November 2005
is available on the Bank for International Settlements Web site at
http://www.bis.org/publ/bcbs118.htm.
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In August 2003, the Agencies issued an advance notice of proposed
rulemaking (Basel II ANPR), which explained how the Agencies might
implement Basel II in the United States.\4\ On September 25, 2006, the
Agencies issued a notice of proposed rulemaking that provides the
industry with a more definitive proposal for implementing Basel II in
the United States (Basel II NPR).\5\
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\4\ As stated in its preamble, the Base II ANPR was based on the
consultative document ``The New Basel Capital Accord'' that was
published by the Basel Committee on April 29, 2003. The Basel II
ANPR anticipated the issuance of a final revised accord. See 68 FR
45900 (August 4, 2003).
\5\ 71 FR 55380 (September 25, 2006). The Basel II NPR would add
new appendices to the Agencies' existing capital regulations. These
new appendices would be found at 12 CFR Part 3, Appendix C (OCC); 12
CFR Part 208, Appendix F and 12 CFR Part 225, Appendix F (FRB); 12
CFR Part 325, Appendix D (FDIC); and 12 CFR part 566, subpart A
(OTS).
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The Basel II NPR identifies two types of U.S. banking organizations
that would use the Basel II rules: Those for which application of the
rules would be mandatory (core banks), and those that might voluntarily
apply the rules (opt-in banks) (collectively referred to as Basel II
banking organizations). In general, the Basel II NPR defines a core
bank as a banking organization that has consolidated total assets of
$250 billion or more, has consolidated on-balance sheet foreign
exposure of $10 billion or more, or is a subsidiary of a Basel II
banking organization. The Basel II NPR presents the advanced internal
ratings-based approach for credit risk and the advanced measurement
approach for operational risk. However, the Agencies did seek comment
in the Basel II NPR on whether U.S. banking organizations subject to
the advanced approaches in the proposed rule (that is, core banks and
opt-in banks) should be permitted to use other credit and operational
risk approaches provided for in Basel II. The Agencies are seeking
further comment on possible alternatives for Basel II banking
organizations in Section III of this NPR.
The complexity and cost associated with implementing Basel II in
the United States effectively limit its application to those banking
organizations that are able to take advantage of economies of scale and
absorb the costs associated with the enhanced risk management practices
required of Basel II banking organizations. Thus, the implementation of
Basel II would create a bifurcated regulatory capital framework in the
United States: One set of rules for Basel II banking organizations, and
another for banking organizations that do not use the proposed Basel II
capital rules (non-Basel II banking organizations).
In comments responding to the Basel II ANPR, Congressional
testimony, and other industry communications, several banking
organizations, trade associations, and others raised concerns about the
competitive effects of a bifurcated regulatory framework on community
and regional banking organizations. Among other broad concerns, these
commenters asserted that implementing the Basel II capital regime in
the United States could result in lower minimum regulatory capital
requirements for Basel II banking organizations with respect to certain
types of credit exposures. As a result, regulatory capital requirements
for similar products could differ depending on the capital regime under
which a banking organization operates. Community and regional banking
organizations asserted that this would put them at a competitive
disadvantage.
To assist in quantifying the potential effects of implementing
Basel II in the United States, the Agencies conducted a quantitative
impact study during late 2004 and early 2005 (QIS 4).\6\ QIS 4 was a
comprehensive survey completed on a best efforts basis by 26 of the
largest U.S. banking organizations using their own internal estimates
of the key risk parameters driving the capital requirements under the
Basel II framework. The results of the study suggested that the
aggregate minimum risk-based capital requirements for the 26 banking
organizations could drop approximately 15.5 percent relative to the
existing Basel I-based framework. The QIS 4 results also indicated
dispersion in capital requirements across banking organizations and
portfolios, which was attributed in part to differences in the
underlying data and methodologies used by banking organizations to
quantify risk and their overall readiness to implement a Basel II
framework. The Basel II NPR contains several provisions designed to
limit potential reductions in minimum regulatory capital, such as an
extended transition period during which the Agencies can thoroughly
review those Basel II systems that are subject to supervisory
oversight.
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\6\ ``Summary Findings of the Fourth Quantitative Impact
Study,'' Joint Agency press release, February 24, 2006.
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On October 20, 2005, the Agencies issued an advanced notice of
proposed rulemaking soliciting public comment on possible revisions to
U.S. risk-based capital rules that would apply to non-Basel II banking
organizations (Basel IA ANPR).\7\ The proposals in this NPR are based
on those initial conceptual approaches and take into consideration the
public comments that the Agencies received.
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\7\ 70 FR 61068 (October 20, 2005).
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Together, the Agencies received 73 public comments from banking,
trade, and other organizations and individuals. Generally, most
commenters supported the Agencies' goal to make the risk-based capital
rules more risk-sensitive. Several larger banking organizations and
industry groups favored increased risk sensitivity, but argued that
many of the proposed revisions should be optional so that banking
organizations may weigh the costs and benefits of using the revisions.
Several non-Basel II banking organizations and industry groups argued
that the U.S. risk-based capital rules should allow banking
organizations to use internal assessments of risk to determine their
capital requirements. A few commenters endorsed a proposal for a four-
tier capital framework that would apply different approaches to banking
organizations based on the size and complexity, and the robustness of a
banking organization's internal ratings systems. The commenters'
proposal included an approach that would permit some non-Basel II
banking organizations to use internal rating-based systems.
One commenter suggested tying Basel IA capital requirements
directly to the aggregate results for Basel II calculations. This
commenter suggested that Basel IA capital charges should link by loan
category to the average risk-based capital requirements of the Basel II
banking organizations for that loan category, plus a small premium to
recognize the substantial costs of implementing Basel II.
Most smaller and midsize banking organizations generally requested
that any changes to the existing capital rules be simple and not
require large data gathering and monitoring expenses. A number of the
smallest banking organizations said that they do not wish to have any
changes in the capital rules that apply to them. They noted that they
already hold significantly more regulatory capital than the Agencies'
risk-based capital rules require and, therefore, amending the rules
would have little or no effect.
This NPR makes a number of proposals that should improve the risk
sensitivity of the existing risk-based capital rules. The Agencies,
however, are not proposing to allow a non-Basel II banking organization
to use internal risk ratings or to use its internal risk
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measurement processes to calculate risk-based capital requirements for
any new categories of exposures.\8\ The Agencies believe that the use
of these internal ratings and measurement processes should require the
systems controls, supervisory oversight, and other qualification
requirements that are proposed in the Basel II NPR.
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\8\ The Agencies' existing capital rules, however, would
continue to permit the use of internal ratings for a direct credit
substitute (but not a purchased credit-enhancing interest-only
strip) assumed in connection with an asset-backed commercial paper
program sponsored by a banking organization. 12 CFR part 3, appendix
A section 4(g) (OCC); 12 CFR parts 208 and 225, appendix A, section
III.B.3.F (Board); 12 CFR part 325, appendix A, section II.B.5(g)(1)
(FDIC); and 12 CFR 567.6(b)(4) (OTS).
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The Agencies also believe that any proposal to tie capital
requirements under Basel IA to the capital charges that would result
under the proposed Basel II rules is premature. The Agencies anticipate
that the Basel II transition phase would not be completed until 2011 at
the earliest. The Agencies also have other concerns about the
commenter's proposal including the absence of a capital charge for
operational risk; the method by which any premium over the Basel II
charges would be determined; difficulties in defining comparable
portfolios; and the need to periodically update capital requirements,
which would significantly increase complexity and burden.
II. Proposed Changes
In considering revisions to the existing risk-based capital rules,
the Agencies were guided by five broad principles. A revised framework
must: (1) Promote safe and sound banking practices and a prudent level
of regulatory capital; (2) maintain a balance between risk sensitivity
and operational feasibility; (3) avoid undue regulatory burden; (4)
create appropriate incentives for banking organizations; and (5)
mitigate material distortions in the risk-based capital requirements
for large and small banking organizations.
The Agencies are concerned about potential competitive
disadvantages that could result from capital requirements that differ
depending on the capital regime under which a banking organization
operates. By allowing non-Basel II banking organizations the choice of
adopting all of the provisions in this proposal or continuing to use
the existing risk-based capital rules, the proposed regulation is
intended to help maintain the competitive position of these banks
relative to Basel II banking organizations. Moreover, the proposed rule
strives for better alignment of capital and risk, with capital
requirements potentially higher for organizations with riskier
exposures and lower for those with safer exposures. The Agencies seek
to achieve these objectives while balancing operational feasibility and
regulatory burden considerations.
In this NPR, the Agencies are proposing to:
Allow non-Basel II banking organizations the choice of
adopting all of the revisions in this proposal or continuing to use the
existing risk-based capital rules. The voluntary nature of this
proposed rule gives banking organizations the opportunity to weigh the
various costs and benefits to them of adopting the new system.
Increase the number of risk weight categories to which
credit exposures may be assigned.
Use external credit ratings to risk weight certain
exposures.
Expand the range of recognized collateral and eligible
guarantors.
Use loan-to-value ratios to risk weight most residential
mortgages.
Increase the credit conversion factor for various
commitments with an original maturity of one year or less.
Assess a risk-based capital charge for early amortizations
in securitizations of revolving exposures.
Remove the 50 percent limit on the risk weight for certain
derivative transactions.
The existing risk-based capital requirements focus primarily on
credit risk and do not impose explicit capital charges for interest
rate, operational, or other risks. These risks, however, are implicitly
covered by the existing risk-based capital rules. The risk-based
capital charges proposed in this NPR continue the implicit coverage of
risks other than credit risk. Moreover, the Agencies are not proposing
revisions to the existing leverage ratio requirement (that is, the
ratio of Tier 1 capital to total assets).\9\
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\9\ 12 CFR 3.6(b) and (c) (OCC); 12 CFR part 208, appendix B and
12 CFR part 225, appendix D (Board); 12 CFR part 325.3 (FDIC); and
12 CFR 567.8 (OTS).
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To ensure safety and soundness, the Agencies intend to closely
monitor the level of risk-based capital at those banking organizations
that choose to opt in to Basel IA. Any significant decline in the
aggregate level of risk-based capital for these banking organizations
may warrant modifications to the proposed risk-based capital rules.
Question 1: The Agencies welcome comments on all aspects of these
proposals, especially suggestions for reducing the burden that may be
associated with these proposals. The Agencies believe that a banking
organization that chooses to adopt these proposals will generally be
able to do so with data it currently uses as part of its credit
approval and portfolio management processes. Commenters are
particularly requested to address whether any of the proposed changes
would require data that are not currently available as part of the
organization's existing credit approval and portfolio management
systems.
A. Opt-In Proposal
In the Basel IA ANPR, the Agencies recognized that certain banking
organizations might not want to assume the additional burden that might
accompany a more risk-sensitive approach and might prefer to continue
to apply the existing risk-based capital rules. Additionally, many
commenters, particularly community bank respondents, favored an
approach that would allow well-capitalized banking organizations to
remain under the existing risk-based capital rules. For these
commenters, limiting regulatory burden was a higher priority than
increasing the risk sensitivity of their risk-based capital charges.
One group of midsize banking organizations recommended applying the
proposed rules only to banking organizations with assets of $500
million or greater. Some commenters noted the risk of ``cherry
picking'' in permitting a choice between the framework discussed in the
Basel IA ANPR and the existing risk-based capital rules, or adoption of
parts of each.
The Agencies are proposing that a non-Basel II banking organization
may, if it chooses, adopt the revisions in this proposed rule. If a
banking organization chooses to use these proposed capital rules,
however, it would be required to implement them in their entirety. The
Agencies are proposing to permit a banking organization to adopt these
proposals by notifying its primary Federal supervisor. Before a banking
organization decides to opt in to these proposals, the Agencies expect
that the organization would review its ability to collect and utilize
the information required and evaluate the potential impact on its
regulatory capital. A banking organization that chooses to adopt these
proposals (that is, opts in) would also be able to request returning to
the existing capital rules by first notifying its primary Federal
supervisor. In its review of such a request, the primary Federal
supervisor would ensure that the risk-based capital requirements
appropriately reflect the risk profile of the banking organization and
the change is not for purposes of
[[Page 77450]]
capital arbitrage. Further, the Agencies expect that a banking
organization would not alternate between the existing and proposed
risk-based capital rules. The Agencies would reserve the authority to
require a banking organization to calculate its minimum risk-based
capital requirements in accordance with this proposal or the existing
risk-based capital rules.
Under this proposal, a non-Basel II banking organization could
continue to calculate its risk-based capital requirements using the
existing risk-based capital rules. In this case, the banking
organization would not need to notify its primary Federal supervisor or
take any other action. As noted, above, however, the Agencies would
retain the authority to require a non-Basel II banking organization to
use either the existing or the proposed risk-based capital rules if the
banking organization's primary Federal supervisor determines that a
particular capital rule is more appropriate for the risk profile of the
banking organization.
Question 2: The Agencies seek comment on all aspects of the
proposal to allow banks to opt in to and out of the proposed rules.
Specifically, the Agencies seek comment on any operational challenges
presented by the proposed rules. How far in advance should a banking
organization be required to notify its primary Federal supervisor that
it intends to implement the proposed rule? If a banking organization
wishes to ``opt out'' of the proposed rule, what criteria should guide
the review of a request to opt out? When should a banking
organization's election to opt in or opt out be effective? In addition,
the Agencies seek comment on the appropriateness of requiring a banking
organization to apply the proposed Basel IA capital rules based on a
banking organization's asset size, level of complexity, risk profile,
or scope of operations.
B. Increase the Number of Risk Weight Categories
The Agencies' existing risk-based capital rules contain five risk-
weight categories: Zero, 20, 50, 100, and 200 percent. Differentiation
of credit quality among individual exposures is generally limited to
these few risk-weight categories. In the Basel IA ANPR, the Agencies
suggested adding four new risk-weight categories (35, 75, 150, and 350
percent) and invited comment on whether: (1) Increasing the number of
risk-weight categories would allow supervisors to more closely align
capital requirements with risk; (2) the suggested additional risk-
weight categories would be appropriate; (3) the risk-based capital
framework should include more risk-weight categories than the four
suggested; and (4) increasing the number of risk-weight categories
would impose unnecessary burden on banking organizations.
Commenters generally supported increasing the number of risk-weight
categories to enhance the overall risk-sensitivity of the risk-based
capital rules. However, many commenters noted that adding too many
categories could make the rules too complex. Several commenters argued
that the 350 percent risk weight is too high and suggested that any new
risk-weight categories should be lower than 100 percent to reflect the
lower risks associated with certain mortgages and other high-quality
assets. A few commenters suggested that the Agencies create a new 10
percent risk weight category to account for very low-risk assets.
The Agencies agree with the commenters that increasing the number
of risk-weight categories would allow for greater risk sensitivity than
the existing risk-based capital rules. Accordingly, the Agencies
propose to add 35, 75, and 150 percent risk-weight categories. The
Agencies believe that adding a 150 percent risk weight category and
expanding the use of the existing 200 percent risk weight category
would allow for somewhat greater differentiation of credit risk among
more risky exposures than is permitted by the existing capital rules.
At the same time, for certain types of relatively low-risk exposures,
the existing risk-based capital charge may be higher than warranted.
Therefore, the 35 and 75 percent risk weight categories provide an
opportunity to increase the risk sensitivity of the regulatory capital
charges for these exposures.
The Agencies agree that the credit risks covered by this NPR
generally do not warrant a 350 percent category, and are not proposing
to add this risk weight. Question 3: The Agencies seek comment on
whether these or any other new risk weight categories would be
appropriate. More specifically, the Agencies are interested in any
comments regarding whether any categories of assets might warrant a
risk weight higher than 200 percent and what risk weight might be
appropriate for such assets. The Agencies also solicit comment on
whether a 10 percent risk weight category would be appropriate and what
exposures should be included in this risk weight category.
C. Use of External Credit Ratings to Risk Weight Exposures
The Agencies' existing risk-based capital rules permit the use of
external credit ratings issued by a nationally recognized statistical
rating organization (NRSRO) \10\ to assign risk weights to recourse
obligations, direct credit substitutes (DCS), residual interests (other
than a credit-enhancing interest-only strip), and asset- and mortgage-
backed securities.\11\ For example, AAA- and AA-rated mortgage-backed
securities \12\ are assigned to the 20 percent risk weight category
while BB-rated mortgage-backed securities are assigned to the 200
percent risk weight category. When the Agencies revised the risk-based
capital rules to allow for the use of external credit ratings issued by
an NRSRO for the types of exposures listed above, the Agencies
acknowledged that such ratings could be used to determine the risk-
based capital requirements for other types of debt instruments, such as
rated corporate debt.
---------------------------------------------------------------------------
\10\ An NRSRO is an entity recognized by the Division of Market
Regulation of the Securities and Exchange Commission (SEC) as a
nationally recognized statistical rating organization for various
purposes, including the SEC's uniform net capital requirements for
brokers and dealers 17 CFR 240.15c3-1). On September 29, 2006, the
President signed the Credit Rating Agency Reform Act of 2006 (Reform
Act) (Pub. L. 109-291) into law. The Reform Act requires a credit
rating agency that wants to represent itself as an NRSRO to register
with the SEC. The Agencies may review their risk-based capital
rules, guidance and proposals from time to time in order to
determine whether any modification of the Agencies' definition of an
NRSRO is appropriate.
\11\ Some synthetic structures may also be subject to the
external rating approach. For example, certain credit-linked notes
issued from a synthetic securitization are risk weighted according
to the rating given to the notes. 66 FR 59614, 59622 (November 29,
2001).
\12\ The ratings designations (for example, ``AAA,'' ``BBB,''
``A-1,'' and ``P-1''), are illustrative and do not indicate any
preference for, or endorsement of, any particular rating agency
description system.
---------------------------------------------------------------------------
In the Basel IA ANPR, the Agencies suggested expanding the use of
NRSRO ratings to determine the risk-based capital charge for most
categories of NRSRO-rated exposures, including sovereign and corporate
debt securities and rated loans. The Agencies indicated, however, that
they were considering retaining the existing risk-based capital
treatment for U.S. government and agency exposures, U.S. government-
sponsored entity exposures, and municipal obligations. Tables 1 and 2
in the Basel IA ANPR matched ratings and possible corresponding risk
weights for long- and short-term exposures. The Agencies requested
comment on the use of other methodologies to assign risk weights to
unrated exposures.
[[Page 77451]]
Many commenters supported the use of external ratings in principle
but noted that non-Basel II banking organizations' holdings of
securities and loans generally are not rated. Thus, they suggested that
the expansion of the use of NRSRO ratings would have little impact on
these banking organizations. A few commenters also asserted that using
NRSRO ratings might discourage lending to non-rated entities.
Many commenters argued that the risk weights suggested in the Basel
IA ANPR were too high. In particular, many commenters said that the 350
percent and 200 percent risk weights for exposures rated BB+ and lower
would be unnecessarily punitive. A few commenters also expressed
concerns about NRSRO ratings generally. These commenters said that
there are too few NRSROs to ensure adequate market discipline, NRSROs
are inadequately supervised, and NRSRO ratings often react too slowly
to crises.
A number of commenters suggested alternative methods for
differentiating risk among commercial exposures and making the capital
requirements for these exposures more risk sensitive. Many larger
banking organizations suggested allowing an internal risk measurement
approach to determine risk-based capital requirements. Some smaller
banking organizations sought increased recognition of a variety of risk
mitigation techniques, such as personal guarantees and collateral.
The Agencies acknowledge that expanding the use of external ratings
may have little effect on the risk-based capital requirements for
existing loan portfolios at most banking organizations. To the extent
that assets in a banking organization's investment portfolio are rated,
however, the Agencies believe that using external ratings will improve
risk sensitivity of the capital charges for these assets. Furthermore,
implementing broader use of external ratings would also provide a basis
for expanding recognition of eligible guarantees and recognized
collateral. Accordingly, the Agencies are proposing to expand the use
of external ratings for purposes of determining the risk-based capital
charge for certain externally rated exposures as described below in the
sections on direct exposures, recognized collateral, and eligible
guarantees.
An external rating would be defined as a credit rating that is
assigned by an NRSRO, provided that the credit rating (1) fully
reflects the entire amount of credit risk with regard to all payments
owed to the holder and the credit risk associated with timely repayment
of principal and interest; (2) is published in an accessible public
form, for example, on the NRSRO's Web site and in financial media; (3)
is monitored by the NRSRO; and (4) is, or will be, included in the
issuing NRSRO's publicly available transition matrix.\13\ If an
exposure has two or more external ratings, the banking organization
must use the lowest assigned external rating to risk weight the
exposure. If an exposure has components that are assigned different
external ratings, a banking organization would be required to assign
the lowest rating to the entire exposure. If a component is not
externally rated, the entire exposure would be treated as unrated.
---------------------------------------------------------------------------
\13\ A transition matrix tracks the performance and stability
(or ratings migration) of an NRSRO's issued external ratings.
---------------------------------------------------------------------------
i. Direct Exposures
The Agencies are proposing to use external ratings to risk weight
(1) sovereign \14\ debt and debt securities, and (2) debt securities
issued by and rated loans to non-sovereign entities including
securities firms, insurance companies, bank holding companies, savings
and loan holding companies, multilateral lending and regional
development institutions, partnerships, limited liability companies,
business trusts, special purpose entities, associations and other
similar organizations. External ratings for direct exposures to
sovereigns would be based on the external rating of the exposure or, if
the exposure is unrated, on the sovereign's issuer rating. Direct
exposures to non-sovereigns would be risk weighted based on the
external rating of the exposure. For example, a banking organization
would assign any AAA-rated debt security issued by a corporation,
insurance company, or securities firm to the 20 percent risk weight
category. The Agencies are, however, not proposing to permit the use of
issuer ratings for non-sovereigns.
---------------------------------------------------------------------------
\14\ A sovereign is defined as a central government, including
its agencies, departments, ministries, and the central bank. A
soverign does not include state, provincial, or local governments,
or commercial enterprises owned by a central government.
---------------------------------------------------------------------------
The risk weights for direct exposures are detailed in Table 1
(long-term exposures) and Table 2 (short-term exposures) below. The
Agencies are also proposing to replace the existing risk-weight tables
for externally rated recourse obligations, DCS, residual interests
(other than a credit-enhancing interest-only strip), and asset- and
mortgage-backed securities \15\ with the risk weights in Tables 1 and
2.\16\ This proposed treatment would apply to all externally rated
exposures unless the banking organization uses a market risk rule.\17\
For a banking organization that uses a market risk rule, this treatment
applies only to externally rated exposures held in the banking book.
---------------------------------------------------------------------------
\15\ 12 CFR part 3, appendix A, section 4, Tables B and C (OCC);
12 CFR parts 208 and 225, appendix A, section III.B.3.c.i. (Board);
12 CFR part 325, appendix A, section II.B.5.(d) (FDIC); and 12 CFR
567.6(b) (OTS) (the Recourse Rule).
\16\ With the exception of the clarification of the definition
of an external rating and the proposed risk-based capital charge for
securitizations with early amortization features described in
section F of this NPR, the Agencies are not proposing to make other
changes to the existing risk-based capital rules for recourse
obligations, DCS, and residual interests. See 12 CFR part 3,
appendix A, section 4 (OCC); 12 CFR parts 208 and 225, appendix A,
section III.B.3 (Board); 12 CFR part 325, appendix A, section II.B.5
(FDIC); and 12 CFR 567.6(b) (OTS) (Recourse Rule).
\17\ See 12 CFR part 3, appendix B (OCC); 12 CFR parts 208 and
225, appendix E (Board); and 12 CFR part 325 appendix C (FDIC). The
Agencies issued an NPR that proposes revisions to the Market Risk
rules. OTS does not currently have a market risk rule, but has
proposed to add a new rule on this topic in the Market Risk NPR. See
71 FR 55958 (September 25, 2006).
---------------------------------------------------------------------------
The Agencies intend to retain the existing risk-based capital
treatment for direct exposures to public-sector entities,\18\ the U.S.
government and its agencies, U.S. government-sponsored agencies, and
depository institutions (U.S. and foreign) and for unrated loans made
to non-sovereign entities. Exposures issued by these entities are not
subject to Table 1 or 2.
---------------------------------------------------------------------------
\18\ Public-sector entities include states, local authorities
and governmental subdivisions below the central government level in
an Organization for Economic Cooperation and Development (OECD)
country. In the United States, this definition encompasses a state,
county, city, town, or other municipal corporation, a public
authority, and generally any publicly-owned entity that is an
instrument of a state or municipal corporation. This definition does
not include commercial companies owned by the public sector. The
OECD-based group of countries comprises all full members of the
OECD, as well as countries that have concluded special lending
arrangements with the International Monetary Fund (IMF) associated
with the Fund's General Arrangements to Borrow.
[[Page 77452]]
Table 1.--Proposed Risk Weights Based on External Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
Securitization
Sovereign risk Non-sovereign exposure \1\
Long-term rating category Example weight (in risk weight risk weight
percent) (in percent) (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating........ AAA.................... 0 20 20
Second-highest investment grade rating. AA..................... 20 20 20
Third-highest investment grade rating.. A...................... 20 35 35
Lowest-investment grade rating--plus... BBB+................... 35 50 50
Lowest-investment grade rating......... BBB.................... 50 75 75
Lowest-investment grade rating--minus.. BBB-................... 75 100 100
One category below investment grade.... BB+, BB................ 75 150 200
One category below investment grade-- BB-.................... 100 200 200
minus.
Two or more categories below investment B, CCC................. 150 200 \1\
grade.
Unrated \2\............................ n/a.................... 200 200 \1\
----------------------------------------------------------------------------------------------------------------
\1\ A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and
residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are
externally rated more than one category below investment grade, short-term exposures that are rated below
investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as
described in the Agencies' Recourse Rule would be used.
\2\ Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
would continue to be risk weighted under the existing risk-based capital rules.
Table 2.--Proposed Risk Weights Based on External Ratings for Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
Securitization
Sovereign risk Non-sovereign exposure \1\
Short-term rating category Example weight (in risk weight risk weight
percent) (in percent) (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating........ A-1, P-1............... 0 20 20
Second-highest investment grade rating. A-2, P-2............... 20 35 3
Lowest investment grade................ A-3, P-3............... 50 75 75
Unrated \2\............................ n/a.................... 100 100 (\1\)
----------------------------------------------------------------------------------------------------------------
\1\ A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and
residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are
externally rated more than one category below investment grade, short-term exposures that are rated below
investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as
described in the Agencies' Recourse Rule would be used.
\2\ Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
would continue to be risk weighted under the existing risk-based capital rules.
The proposed risk weights in Tables 1 and 2 are generally
consistent with the historical default rates reported in the default
studies published by NRSROs. The Agencies believe that the additional
application of external ratings to the exposures specified above would
improve the risk sensitivity of the capital treatment for those
exposures. Furthermore, the Agencies believe that the revised risk-
weight tables for externally rated recourse obligations, DCS, residual
interests (other than credit-enhancing interest only-strips), and
asset- and mortgage-backed securities would also better reflect risk
than the Agencies' existing risk-based capital rules.
Under the proposal, the Agencies would retain their authority to
reassign an exposure to a different risk weight on a case-by-case basis
to address the risk of a particular exposure.
ii. Recognized Financial Collateral
The Agencies' existing risk-based capital rules recognize limited
types of collateral: (1) Cash on deposit; (2) securities issued or
guaranteed by central governments of the OECD countries; (3) securities
issued or guaranteed by the U.S. government or its agencies; (4)
securities issued or guaranteed by U.S. government-sponsored agencies;
and (5) securities issued by certain multilateral lending institutions
or regional development banks.\19\ In the past, the banking industry
has commented that the Agencies should recognize a wider array of
collateral types for purposes of reducing risk-based capital
requirements.
---------------------------------------------------------------------------
\19\ The Agencies' rules for collateral transactions, however,
differ somewhat as described in the Agencies' joint report to
Congress. ``Joint Report: Differences in Accounting and Capital
Standards among the Federal Banking Agences,'' 70 FR 15379 (March
25, 2005).
---------------------------------------------------------------------------
In the Basel IA ANPR, the Agencies noted that they were considering
expanding the list of recognized collateral to include short-or long-
term debt securities (for example, corporate and asset- and mortgage-
backed securities) that are externally rated at least investment grade
by an NRSRO, or issued or guaranteed by a sovereign central government
that is externally rated at least investment grade by an NRSRO.
Consistent with the proposed treatment for direct exposures, the Basel
IA ANPR suggested assigning exposures or portions of exposures
collateralized by financial collateral to risk-weight categories based
on the external rating of that collateral. To use this expanded list of
collateral, the Basel IA ANPR considered requiring a banking
organization to have collateral management systems to track collateral
and readily determine its realizable value. The Agencies sought comment
on whether this approach for expanding the scope of recognized
collateral would improve risk sensitivity without being overly
burdensome.
Many commenters supported expanding the list of recognized
collateral, but several also noted that using NRSRO ratings would have
little effect on most community banks. Some commenters suggested
reducing the risk weights applied to exposures secured by
[[Page 77453]]
any collateral that is legally perfected and has objective methods of
valuation or can be readily marked-to-market. Many commenters also
stated that any collateral valuation and monitoring requirements likely
would be too costly to benefit smaller community banks.
To increase the risk sensitivity of the existing risk-based capital
rules, the Agencies are proposing to revise the list of recognized
collateral to include a broader array of externally rated, liquid, and
readily marketable financial instruments. The revised list would
incorporate long- and short-term debt securities and securitization
exposures that are:
a. Issued or guaranteed by a sovereign where such securities are
externally rated at least investment grade by an NRSRO; or an exposure
issued or guaranteed by a sovereign with an issuer rating that is at
least investment grade; or
b. Issued by non-sovereigns where such securities are externally
rated at least investment grade by an NRSRO.
Consistent with the Agencies' existing risk-based capital rules, the
Agencies propose to continue to recognize collateral that is either
issued or guaranteed by certain sovereigns. For non-sovereign
exposures, however, the Agencies propose that the collateral itself
must be externally rated investment grade or better to qualify as
recognized collateral. The Agencies believe that this more conservative
approach for recognizing non-sovereign collateral is appropriate and
expect that any guarantee provided by a non-sovereign would be
reflected in the external rating of the collateral.
A banking organization would assign exposures collateralized by
financial collateral externally rated at least investment grade to the
appropriate risk weight in Table 1 or 2 above. If an exposure is
partially collateralized, a banking organization could assign the
portions of exposures collateralized by the market value of the
externally rated collateral to the appropriate risk weight category in
Tables 1 and 2 of this NPR. For example, the portion of an exposure
collateralized by the market value of a AAA-rated corporate debt
security would be assigned to the 20 percent risk weight category. The
Agencies are proposing a minimum risk weight of 20 percent for
collateralized exposures except as noted below.
The Agencies have decided to retain their respective risk-based
capital rules that govern the following collateral: Cash, securities
issued or guaranteed by the U.S. government or its agencies, and
securities issued or guaranteed by U.S. government-sponsored agencies.
The Agencies are also retaining the existing risk-based capital rules
for exposures collateralized by securities issued or guaranteed by
other OECD central governments that meet certain criteria.\20\
---------------------------------------------------------------------------
\20\ 12 CFR part 3, appendix A, section 3(a)(1)(viii) (OCC); and
12 CFR parts 208 and 225, appendix A, section III.C.1 (Board).
---------------------------------------------------------------------------
iii. Eligible Guarantors
Under the Agencies' existing risk-based capital rules, the
recognition of third party guarantees is limited to guarantees provided
by central governments of OECD countries, U.S. government and
government-sponsored entities, public-sector entities in OECD
countries, multilateral lending institutions and regional development
banks, depository institutions and qualifying securities firms in OECD
countries, depository institutions in non-OECD countries (short-term
claims), and central governments of non-OECD countries (local currency
exposures only).
In the Basel IA ANPR, the Agencies suggested expanding the scope of
eligible guarantors to include any entity whose long-term senior debt
has been assigned an external credit rating of at least investment
grade by an NRSRO. The applicable risk weight for guaranteed exposures
would be based on the risk weights corresponding to the rating of the
long-term debt of the guarantor.
Most commenters supported, in principle, expanding the list of
eligible guarantors. However, many commenters noted that very few
community and midsize banking organizations have exposures that are
guaranteed by externally rated entities. Thus, many commenters
suggested that this provision would have little impact unless the
proposed revisions recognized more types of guarantees.
The Agencies believe that the range of eligible third-party
guarantors under the existing risk-based capital rules is restrictive
and ignores market practice. As a result, the Agencies are proposing to
expand the list of eligible guarantors by recognizing entities that
have long-term senior debt (without credit enhancement) rated at least
investment grade by an NRSRO or, in the case of a sovereign, an issuer
rating that is at least investment grade. Under this NPR, a recognized
third-party guarantee would have to:
(1) Be written and unconditional, and, for a sovereign guarantee,
be backed by the full faith and credit of the sovereign;
(2) Cover all or a pro rata portion of contractual payments of the
obligor on the reference exposure; \21\
---------------------------------------------------------------------------
\21\ If an exposure is partially guaranteed, the pro rata
portion not covered by the guarantee would be assigned to the risk
weight category appropriate to the obligor, after consideration of
collateral and external ratings.
---------------------------------------------------------------------------
(3) Give the beneficiary a direct claim against the protection
provider;
(4) Be non-cancelable by the protection provider for reasons other
than the breach of the contract by the beneficiary;
(5) Be legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced; and
(6) Require the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligor on the reference exposure without first
requiring the beneficiary to demand payment from the obligor.
To be considered an eligible guarantor, a sovereign or its senior
long-term debt (without credit enhancement) must be externally rated at
least investment grade. Non-sovereigns must have long-term senior debt
(without credit enhancement) that is externally rated at least
investment grade. Under this proposal, a banking organization could
assign the portions of exposures guaranteed by eligible guarantors to
the proposed risk weight category corresponding to the external rating
of the eligible guarantors' long-term senior debt in accordance with
Table 1 above.
The Agencies would retain the existing risk-weight treatment of
exposures guaranteed by the U.S. government and its agencies, U.S.
government-sponsored agencies, public-sector entities, depository
institutions in OECD countries, and depository institutions in non-OECD
countries (short-term exposures only).
Question 4: The Agencies solicit comment on all aspects of the
proposed use of external ratings including the appropriateness of the
risk weights, expanded collateral, and additional eligible guarantors.
The Agencies also seek comment on whether to exclude certain externally
rated exposures from the ratings treatment as proposed or to use
external ratings as a measure for all externally rated exposures,
collateral, and guarantees. Alternatively, should the Agencies retain
the existing risk-based capital treatment for certain types of
exposures, for example, qualifying securities firms? The Agencies are
also interested in comments on all aspects of the scope of the terms
sovereign, non-
[[Page 77454]]
sovereign, and securitization exposures. Specifically, the Agencies
seek comment on the scope of these terms, whether they should be
expanded to cover other entities, or whether any entities included in
these definitions should be excluded.
iv. Government-Sponsored Agencies
One area of particular interest to the Agencies is the risk
weighting of exposures to U.S. government-sponsored agencies, also
commonly referred to as government-sponsored entities (GSEs). The
Agencies' existing risk-based capital regulations assign a 20 percent
risk weight to exposures issued or guaranteed by GSEs. The Basel IA NPR
proposes to retain this risk-based capital treatment. The Agencies are
aware that there are various types of ratings that might increase the
risk sensitivity of risk weights assigned to GSE exposures. For
example, NRSROs rate the creditworthiness of short-term senior debt,
senior unsecured debt, subordinated debt and preferred stock of some
GSEs. These ratings on individual exposures, however, are often based
in part on the NRSROs' assessment of the extent to which the U.S.
government might come to the financial aid of a GSE if necessary. In
this context, and as indicated in the preamble to the Basel II NPR, the
Agencies do not believe that risk weight determinations should be based
on the possibility of U.S. government financial assistance, except for
the financial assistance the U.S. government has legally committed to
provide. The Agencies believe the existing approach has thus far met
this objective. However, the Agencies also note that as part of the
October 19, 2000 agreement with their regulator,\22\ both Fannie Mae
and Freddie Mac agreed to obtain and disclose annually ratings that
would ``assess the risk to the government, or the independent financial
strength, of each of the companies.'' \23\
---------------------------------------------------------------------------
\22\ ``Freddie Mac and Fannie Mae Enhancements to Capital
Strength, Disclosure and Market Discipline'', October 19, 2000
(agreement between the GSEs and the Office of Federal Housing
Enterprise Oversight).
\23\ Ibid, p. 2.
---------------------------------------------------------------------------
In accordance with the agreement, Fannie Mae and Freddie Mac
currently obtain and disclose separate ratings from two NRSROs--
``Standard & Poor's (S&P) and Moody's Investors Service (Moody's). The
S&P ``risk to the government rating'' uses the same scale as its
standard corporate credit ratings. Currently, Fannie Mae and Freddie
Mac both have a risk to the government issuer rating of AA- from S&P,
which is unchanged from the initial AA- issuer rating that S&P
initially provided in 2001. Moody's ``bank financial strength rating''
(BFSR) uses a scale of A-E. In 2002, Moody's provided a BFSR of A- to
both GSEs. On March 28, 2005, Moody's downgraded Fannie Mae's BFSR to
B+. Based on Moody's mapping of BFSRs to Moody's basic credit
assessment ratings, A− is the equivalent of an Aa1 and B+ maps to
an Aa2.
Both the risk to government rating and the BFSR (collectively,
financial strength ratings) are issuer ratings that evaluate the
financial strength of each GSE without respect to any implied financial
assistance from the U.S. government. These financial strength ratings
are published and monitored by the issuing NRSRO but they are not
included in the NRSROs' transition matrices. These ratings are an
indicator of each GSE's overall financial condition and safety and
soundness and, thus, do not apply to any specific financial obligation
or the probability of timely payment thereof.\24\ If the Agencies were
to use these S&P and Moody's financial strength ratings to risk weight
exposures to Fannie Mae and Freddie Mac in a manner similar to the use
of external ratings for rated exposures as proposed in the Basel IA
NPR, the current ratings would map to a 20 percent risk weight.
---------------------------------------------------------------------------
\24\ Moody's and S&P's financial strength ratings would not meet
the definition of an ``external rating'' as proposed in this NPR.
Furthermore, the difficulty of defining an event of default and the
lack of default data suggest that it would not be feasible to
incorporate this type of rating into a transition matrix.
---------------------------------------------------------------------------
Question 5: The Agencies are considering whether to use financial
strength ratings to determine risk weights for exposures to GSEs, where
this type of rating is available, and are seeking comment on how a
financial strength rating might be applied. For example, should the
financial strength rating be mapped to the non-sovereign risk weights
in Tables 1 and 2? Should these ratings apply to all GSE exposures
including short- and long-term debt, mortgage-backed securities,
collateral, and guarantees? How should exposures to a GSE that lacks a
financial strength rating be risk weighted? Are there any requirements
in addition to publication and on-going monitoring that should be
incorporated into the definition of an acceptable financial strength
rating?
Question 6: The Agencies also seek comment on whether to exclude
certain other externally rated exposures from the ratings treatment as
proposed or to use external ratings as a measure for additional
externally rated exposures, collateral, and guarantees. Should the
proposed ratings treatment be applicable for direct exposures to public
sector entities or depository institutions? Likewise, should the
proposed ratings treatment be applicable to exposures guaranteed by
public sector entities or depository institutions, and to exposures
collateralized by debt securities issued by those entities?
D. Mortgage Loans Secured by a Lien on a One-to-Four Family Residential
Property
i. First Lien Risk Weights
The Agencies' existing risk-based capital rules assign first-lien,
one-to-four family residential mortgages to either the 50 percent or
100 percent risk weight category. Most mortgage loans secured by a
first lien on a one-to-four family residential property (first lien
mortgages) meet the criteria to receive a 50 percent risk weight.\25\
The broad assignment of most first lien mortgages to the 50 percent
risk weight category has been criticized for not being sufficiently
risk sensitive.
---------------------------------------------------------------------------
\25\ 12 CFR part 3 appendix A section 3(c)(iii) (OCC); 12 CFR
parts 208 and 225 appendix A section III.C.3 (Board); 12 CFR part
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50
percent risk weight) (OTS).
---------------------------------------------------------------------------
In the Basel IA ANPR, the Agencies stated they were considering
options to make the risk-based capital requirement for residential
mortgages more risk sensitive while not unnecessarily increasing
regulatory burden. One option was to base the capital requirement on
loan-to-value ratios (LTV), determined after consideration of private
mortgage insurance (PMI). This option was illustrated by an LTV risk
weight table that suggested risk weights of 20, 35, 50, and 100
percent.
Another option discussed in the Basel IA ANPR was to assign risk
weights based on LTV in combination with an evaluation of borrower
creditworthiness. Under this scenario, different ranges of LTV could be
paired with specified credit assessments, such as credit scores. A
first lien mortgage with a lower LTV made to a borrower with higher
creditworthiness would receive a lower risk weight than a loan with
higher LTV made to a borrower with lower creditworthiness.
The Agencies received many comments about how to risk weight first
lien mortgages. Many commenters cautioned against rules that would be
burdensome and costly to implement. Commenters generally supported the
use of LTV and stated that use of LTV in assigning risk weights would
not be overly burdensome because LTV
[[Page 77455]]
information is collected when lenders originate mortgage loans.
Some commenters supported the use of a matrix based on LTV and a
measure of creditworthiness, to further improve the risk sensitivity of
the risk weights assigned to residential mortgage loans. They stated
that this approach would address both collateral and borrower risk and
would mirror current practices among mortgage lenders. Other commenters
expressed concern about the potential burden of this approach,
particularly for smaller banking organizations. Some commenters noted
that certain credit assessment measures such as credit-scoring models
vary by region or credit reporting agency, and may harm lower income
borrowers, borrowers without credit histories, and borrowers who have
experienced unusual financial difficulties. Many of these commenters
suggested that the use of credit scores as a measure of borrower
creditworthiness be optional to alleviate the burden for some smaller
banking organizations.
To increase the risk sensitivity of the existing risk-based capital
rules while minimizing the overall burden to banking organizations, the
Agencies are proposing to risk weight first lien mortgages based on
LTV. LTV is a meaningful indicator of potential loss and the likelihood
of borrower default. Consequently, under this proposal a banking
organization would assign a risk weight for a first lien mortgage,
including mortgages held for sale and mortgages held in portfolio as
outlined in Table 3.
Table 3.--Proposed LTV and Risk Weights for 1-4 Family First Liens
------------------------------------------------------------------------
Risk weight
Loan-to-Value ratios (in percent) (in
percent)
------------------------------------------------------------------------
60 or less................................................. 20
Greater than 60 and less than or equal to 80............... 35
Greater than 80 and less than or equal to 85............... 50
Greater than 85 and less than or equal to 90............... 75
Greater than 90 and less than or equal to 95............... 100
Greater than 95............................................ 150
------------------------------------------------------------------------
The Agencies believe the implementation of this proposed approach
would not impose a significant burden on banking organizations because
LTV information is readily available and is commonly used in the
underwriting process.
The Agencies believe that the use of LTV would enhance the risk
sensitivity of regulatory capital but it remains a fairly simple
measurement of risk. Use of LTV in risk weighting first lien mortgages
does not substitute for, or otherwise release a banking organization
from, its obligation to have prudent loan underwriting and risk
management practices that are consistent with the size, type, and risk
of a mortgage product. Through the supervisory process, the Agencies
would continue to ensure that banking organizations engage in prudent
underwriting and risk management practices consistent with existing
rules, supervisory guidance, and safety and soundness. The Agencies
would continue to reserve the authority to require banking
organizations to hold additional capital where appropriate.
In general, Table 3 would apply to first lien mortgages. The
Agencies would maintain their respective risk-based capital criteria
for a first lien mortgage (for example, prudent underwriting) to
receive a risk weight less than 100 percent.\26\ Table 3 would not
apply to loans to builders secured by certain pre-sold properties,
which are subject to a statutory 50 percent risk weight.\27\ Other
loans to builders for the construction of residential property would
continue to be subject to a 100 percent risk weight. The Agencies would
maintain their respective capital treatment for a one-to-four family
residential mortgage loan to a borrower for the construction of the
borrower's own home.\28\ Question 7: The Agencies seek comment on all
aspects of using LTV to determine the risk weights for first lien
mortgages.
---------------------------------------------------------------------------
\26\ 12 CFR part 3 appendix A, section 3(3)(iii) (OCC); 12 CFR
Parts 208 and 225, appendix A, section III.C.3 (Board); 12 CFR part
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50
percent risk weight) (OTS).
\27\ This statutory risk weight applies to loans to builders
secured by one-to-four family residential properties with
substantial project equity for the construction of one-to-four
family residences that have been pre-sold under firm contracts to
purchasers who have obtained firm commitments for permanent
qualifying mortgage loans and have made substantial earnest money
deposits. See Resolution Trust Corporation Refinancing,
Restructuring, and Improvement Act of 1991, Pub. L. 102-233, Sec.
618(a), 105 Stat. 1761, 1789-91 (codified at 12 U.S.C. 1831n note
(1991)).
\28\ 12 CFR part 3 appendix A, section 3(3)(iv) (OCC); 12 CFR
parts 208 and 225, appendix A, section III.C.3. (Board); 12 CFR part
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition
of ``qualifying mortgage loan'') (OTS).
---------------------------------------------------------------------------
The Agencies' existing risk-based capital rules place certain
privately-issued mortgage-backed securities that do not carry the
guarantee of a government or a government-sponsored entity (for
example, unrated senior positions) in the 50 percent risk weight
category, provided the underlying mortgages would qualify for a 50
percent risk weight. The Agencies intend to continue to risk weight
these privately-issued mortgage-backed securities using the risk
weights assigned to underlying mortgages under the Agencies' existing
capital rules. Question 8: The Agencies seek comment on this treatment
and other methods for risk-weighting these privately-issued mortgage-
backed securities, including the appropriateness of assigning risk
weights to these securities based on the risk weights of the underlying
mortgages as determined under Table 3.
While the Agencies are not proposing to use LTV and borrower
creditworthiness to risk weight mortgages, the Agencies continue to
evaluate approaches that would consider borrower creditworthiness in
risk weighting first lien mortgages. One such approach could use LTV
and a measure of borrower creditworthiness to assign risk weights in a
manner similar to that shown in Table 3A below. Table 3A would assign a
lower risk weight to mortgages with a lower LTV that are underwritten
to borrowers with a stronger credit history and a higher risk weight to
mortgages with a higher LTV that are underwritten to borrowers with a
weaker credit history.
[[Page 77456]]
Table 3A.--Illustrative Risk-Weight Ranges for LTV and Credit History for 1-4 Family
[First liens]
----------------------------------------------------------------------------------------------------------------
First lien mortgages Illustrative risk weight ranges
----------------------------------------------------------------------------------------------------------------
Credit history Credit history Credit history
Loan-to-Value ratios (in percent) group 1 (in group 2 (in group 3 (in
percent) percent) percent)
----------------------------------------------------------------------------------------------------------------
60 or less...................................................... 20-35 20-35 20-35
Greater than 60 and less than or equal to 80.................... 20-35 20-35 35-75
Greater than 80 and less than or equal to 90.................... 20-50 35-75 75-150
Greater than 90 and less than or equal to 95.................... 20-50 50-100 100-200
Greater than 95................................................. 35-75 50-100 150-200
----------------------------------------------------------------------------------------------------------------
Table 3A presents three broad categories of relative credit
performance (credit history groups). The Agencies would determine the
credit history groups using default odds. The default odds would be
based upon credit reporting agencies' validation charts (also known as
odds tables). A banking organization would determine a borrower's
default odds by mapping the borrower's credit score, as obtained from a
credit reporting agency,\29\ to the credit reporting agency's
validation chart. In order for a validation chart to qualify, it would
be based on: (1) The same vendor and model as the credit scores used by
the banking organization, (2) a nationally diverse group of credits,
and (3) relevant default odds measured over no less than 18 months
following the scoring date used in the validation chart. If the
Agencies decide in the final rule to risk weight first lien mortgages
based on LTV and borrower creditworthiness, the Agencies would
generally determine a specific risk weight based on the ranges provided
in Table 3A.
---------------------------------------------------------------------------
\29\ See 15 U.S.C. 1681a(f), which defines a credit reporting
agency.
---------------------------------------------------------------------------
Question 9: While the Agencies are not proposing to use LTV and
borrower creditworthiness to risk weight mortgages, the Agencies may
decide to risk weight first lien mortgages based on LTV and borrower
creditworthiness in the final rule. Accordingly, the Agencies continue
to seek comment on an approach using LTV combined with credit scores
for determining risk-based capital. More specifically, the Agencies
seek comment on: operational aspects for assessing the use of default
odds to determine creditworthiness qualifications to determine
acceptable models for calculating the default odds; the negative
performance criteria against which the default odds are determined
(that is, 60-days past due, 90-days past due, etc.); regional
disparity, especially for a banking organization whose borrowers are
not geographically diverse; and how often credit scores should be
updated. In addition, the Agencies seek comment on determining the
proper credit history group for: an individual with multiple credit
scores, a loan with multiple borrowers with different probabilities of
default, an individual whose credit history was analyzed using
inaccurate data, and individuals with insufficient credit history to
calculate a probability of default.
ii. Calculation of LTV
The Agencies sought comment on whether LTV should be based on LTV
at origination or should be periodically updated. Some commenters
supported using LTV at origination only. These commenters stated that
regularly updating and monitoring LTV would be unduly burdensome and
costly. Other commenters said the Agencies should require periodic
updates, especially during significant declines in housing values in a
banking organization's service area. Some commenters said that banking
organizations should be able to update LTV at their discretion. Certain
commenters suggested that updates be based on periodic property
appraisals and loan balance updates. However, a number of commenters
expressed concern about the reliability of appraisals, especially in
over-heated markets.
Commenters had varying opinions about how the Agencies should
factor PMI into the LTV calculations. Most of the commenters that
addressed the issue supported calculating LTV net of loan-level PMI
coverage. However, some commenters suggested that the Agencies should
also consider the risk mitigation benefits of pool-level PMI. A few
commenters suggested considering PMI issued only by highly rated
insurers. One commenter endorsed a Basel IA ANPR suggestion to create
risk-weight floors for mortgages supported by loan-level PMI from
highly rated insurers. Another commenter suggested considering PMI
issued by non-affiliate insurers only.
In proposing the LTV calculation method, the Agencies aim to
balance burden and costs against the benefits of a more risk sensitive
risk-weighting system. The Agencies propose to calculate LTV at
origination of the first mortgage as follows. First, the value of the
property would be equal to the lower of the purchase price for the
property or the value at origination. The value at origination must be
based on an appraisal or evaluation of the property in conformance with
the Agencies' appraisal regulations \30\ and real estate lending
guidelines.\31\ The value of the property could only be updated for
risk-weight purposes when the borrower refinances its mortgage and the
banking organization extends additional funds. Second, for loans that
are positively amortizing, banking organizations may adjust the LTV
quarterly to reflect any decrease in the principal balance. For loans
that negatively amortize, banking organizations would be required to
adjust the LTV quarterly to reflect the increase in principal balance
and risk weight the loan based on the updated LTV. However, where
property values in a banking organization's market subsequently
experience a general decline in value, the Agencies continue to reserve
their authority to require additional capital when warranted for
supervisory reasons. The Agencies emphasize that the updating of LTV
for regulatory capital purposes is not intended to replace good risk
management practices at banking organizations for situations where more
frequent updates of loan or property values might be appropriate.
---------------------------------------------------------------------------
\30\ 12 CFR part 34 (OCC); 12 CFR part 208, subpart E and part
225, subpart G (Board); 12 CFR part 323, 12 CFR part 365 (FDIC); and
12 CFR part 564 (OTS).
\31\ 12 CFR part 34 Subpart C.43 (OCC); 12 CFR part 208, subpart
E and part 225, subpart G (Board); 12 CFR part 325, appendix A,
section II.C.3 (FDIC);12 CFR 560.100--560.101 (OTS).
---------------------------------------------------------------------------
Question 10: The Agencies seek comment on whether there are other
circumstances under which LTV should be adjusted for risk-weight
purposes.
[[Page 77457]]
The Agencies believe that the risk mitigating impact of loan-level
PMI should be reflected in calculating the LTV. Loan-level PMI is
insurance that protects a mortgage lender in the event of borrower
default up to a predetermined portion of the value of a one-to-four
family residential property provided that there is no pool-level cap. A
pool-level cap would effectively reduce coverage to any amount less
than the predetermined portion. PMI would be recognized only if the
loan-level insurer is not affiliated with the banking organization and
has long-term senior debt (without credit enhancement) externally rated
at least the third highest investment grade by an NRSRO. The Agencies
believe that pool-level PMI should not generally reduce the LTV,
because pool-level PMI absorbs losses based on a portfolio basis and is
not attributable to a given loan.
Question 11: The Agencies request comment on all aspects of PMI
including, whether PMI providers must be non-affiliated companies of
the banking organization. The Agencies also seek comment on the
treatment of PMI in the calculation of LTV when the PMI provider is not
an affiliate, but a portion of the mortgage insurance is reinsured by
an affiliate of the banking organization.
iii. Non-Traditional Mortgage Products
The Basel IA ANPR sought comment on whether mortgages with non-
traditional features pose unique risks that warrant higher risk-based
capital requirements. Non-traditional loan features include the
possibility of negative amortization of the loan balance, a borrower's
option to make interest-only payments, and interest rate reset
provisions that may result in significant payment shock to the
borrower.
Commenters generally supported risk weighting mortgage loans with
non-traditional features consistently with the risk weighting for
traditional first lien mortgages. These commenters suggested that any
additional risks posed by these mortgage products were the result of
imprudent underwriting practices or the combining of risks, not risks
inherent in the products. One commenter, however, supported higher
capital requirements for all non-traditional mortgage loans. Other
commenters supported additional capital for specific products, such as
negative amortization loans.
The Agencies recognize the difficultly in providing a clear and
consistent definition of higher-risk mortgage loans with non-
traditional features. Thus, the Agencies generally propose to risk
weight first lien mortgages with non-traditional features in the manner
described above. Notwithstanding this proposed treatment, the Agencies
recognize that certain underwriting practices may increase the risk
associated with a particular mortgage product. These practices may
include underwriting of loans with less stringent income and asset
verification requirements without offsetting mitigating factors;
offering loans with very low introductory rates and short adjustment
periods that may result in significant payment shock; and combining
first lien loans with simultaneous junior lien loans that could result
in an aggregate loan obligation with little borrower equity and the
potential for a sizeable payment increase. The Agencies will continue
to review banking organizations' lending practices on a case-by-case
basis and may require additional capital or reserves in appropriate
circumstances.
Loans with a negative amortization feature pose additional risks to
a banking organization in the form of an unfunded commitment.
Therefore, the Agencies propose to risk weight mortgage loans with
negative amortization features consistent with the risk-based capital
treatment for other unfunded commitments (for example, lines of
credit). Under the proposed approach, the unfunded portion of the
maximum negative amortization amount would be risk weighted separately
from the funded portion of the loan. The funded portion of the loan
would be risk weighted according to the risk weights for first-lien
mortgages, and the unfunded portion of the maximum negative
amortization amount would be risk weighted as a commitment based on the
LTV for the maximum contractual loan amount.
Therefore, banking organizations would need to calculate two LTVs
for a loan with a negative amortization feature for risk-based capital
purposes: the LTV for the funded commitment and the LTV for the
unfunded commitment. To demonstrate how loans with negative
amortization features would be risk weighted, assume that a property is
valued at $100,000 and the banking organization grants a first-lien
loan for $81,000 that includes a negative amortization feature with a
10 percent cap. The funded amount of $81,000 results in an 81 percent
LTV, which is risk weighted at 50 percent based on Table 3. In
addition, the off-balance sheet unfunded commitment of $8,100 would
receive a 50 percent credit conversion factor (CCF) resulting in an on-
balance sheet credit equivalent amount of $4,050. The combined LTV of
the funded and unfunded commitment would be 89.1 percent, hence $4,050
would receive a 75 percent risk weight based on Table 3. The total
risk-weighted assets for the first-lien mortgage with negative
amortization feature would equal the risk-weighted assets for the
funded amount plus the risk-weighted assets for the unfunded amount.
That loan would be risk weighted at origination as follows:
BILLING CODE 6720-01-P
[[Page 77458]]
[GRAPHIC] [TIFF OMITTED] TP26DE06.000
BILLING CODE 6720-01-C
The Agencies believe that this approach would result in a risk-
based capital charge that more accurately reflects the risk of mortgage
loans with negative amortization features.
Question 12: The Agencies seek comment on the proposed risk-based
capital treatment for all mortgage loans with non-traditional features
and, in particular the proposed approach for mortgage loans with
negative amortization features. The Agencies also seek comment on
whether the maximum contractual amount is the appropriate measure of
the unfunded exposure to loans with negative amortization features. The
Agencies seek comment on whether the unfunded commitment for a reverse
mortgage should be subject to a similar risk-based capital charge.
iv. Junior Lien One-to-Four Family Residential Mortgages
The Basel IA ANPR discussed the existing treatment for home equity
lines of credit (HELOCs) and other junior lien mortgages.\32\ If a
banking organization
[[Page 77459]]
holds both a first and a junior lien, and no other party holds an
intervening lien, the Agencies' existing capital rules require these
loans to be combined to determine the LTV and then risk weighted as a
first lien mortgage. The Basel IA ANPR indicated that the Agencies
intended to continue this approach.
---------------------------------------------------------------------------
\32\ The unfunded portion of a HELOC that is a commitment for
more than one year and that is not unconditionally cancelable is
converted to an on-balance sheet asset using a 50 percent CCF. That
amount plus the funded portion of the HELOC are added together to
determine the amount of the HELOC that is combined with the first
lien position and then risk weighted at either 50 percent or 100
percent. See generally, 12 CFR part 3 appendix A, section (b)(2) and
(a)(3)(iii) (OCC); 12 CFR parts 208 and 225, appendix A, section
III.C.3 and 12 CFR parts 208 and 225, appendix A, section III.D.2
(Board); 12 CFR part 325, appendix A, section II.D.2.b. (FDIC); and
12 CFR 567.6(a)(2)(ii)(B) (OTS).
---------------------------------------------------------------------------
Currently, stand-alone junior lien mortgages (a stand-alone junior
lien mortgage is one where an institution holds a second or more junior
lien without holding all of the more senior liens) receive a 100
percent risk weight. The Basel IA ANPR indicated that the Agencies were
considering retaining this risk weight for stand-alone junior lien
mortgages where the LTV (computed by combining the loan amounts for the
junior lien and all senior liens) does not exceed 90 percent. However,
for stand-alone junior lien mortgages where the LTV of the combined
liens exceeds 90 percent, the Agencies suggested that a risk weight
higher than 100 percent might be appropriate in recognition of the
elevated credit risk associated with these exposures.
Many commenters opposed this approach and suggested that a more
risk-sensitive approach, similar to that proposed for first lien
mortgages, would be more appropriate because not all stand-alone junior
lien mortgages are riskier than first lien mortgages. Other commenters
stated that the risk-based capital treatment of first and junior lien
mortgages, regardless of whether the same banking organization holds
both, should be consistent. In addition, many commented that it would
be illogical and unjustifiable to impose higher risk weights (for
example, 150 percent) for secured mortgage loans than for unsecured
retail loans (for example, 100 percent).
Consistent with the existing risk-based capital rules, the Agencies
propose that a banking organization that holds both the first and
junior lien mortgages on a one-to-four family residential property,
where there is no intervening lien, would assign the combined loans to
the appropriate risk-weight category in Table 3 above, based on the
loans' combined LTV. A banking organization that holds both the first
and any subsequent liens may update the property value for calculation
of the combined LTV of the senior loans and the junior lien if the
organization obtains an appraisal or evaluation of the collateral in
conformance with the Agencies' appraisal regulations and related
guidelines at the origination of the junior lien mortgage.
For a stand-alone junior lien mortgage, the Agencies propose that a
banking organization use the combined LTV of that loan and all senior
loans to determine the appropriate risk weight for the junior lien.
Using the combined LTV, a banking organization would risk weight the
stand-alone junior lien based on Table 5.
Table 5.--Proposed LTV and Risk Weights for 1-4 Family Junior Liens
------------------------------------------------------------------------
Risk weight
Combined loan-to-value ratios (in percent) (in
percent)
------------------------------------------------------------------------
60 or less................................................. 75
Greater than 60 and less than or equal to 90............... 100
Greater than 90............................................ 150
------------------------------------------------------------------------
The combined LTV for the funded portion of stand-alone junior liens
where the first lien can negatively amortize would be calculated using
the maximum contractual loan amount under the terms of the first lien
mortgage plus the funded portion of the junior lien. The combined LTV
for the unfunded portion of all junior liens where the first lien can
negatively amortize would be calculated using the maximum contractual
loan amount under the terms of the first lien mortgage plus the funded
unfunded portions of the junior lien.
The Agencies propose that banking organizations will be required to
hold capital for both the funded and unfunded portion of a HELOC.
Banking organizations that hold a HELOC where there is no intervening
lien would assign the first lien and funded portion of the HELOC to the
appropriate risk weight category in Table 3 above, based on the loans'
combined LTV using the senior loans and the funded portion of the
HELOC. The unfunded portion of the HELOC would be subject to the
appropriate CCF \33\ and risk weighted, using Table 3, based on the
combined LTV, (senior loans plus the funded and unfunded portions of
the HELOC).
---------------------------------------------------------------------------
\33\ The unfunded portion of a HELOC that is a commitment for
more than one year and that is not unconditionally cancelable is
converted to an on-balance sheet asset using a 50 percent CCF. If
the unfunded portion of the HELOC is a commitment for less than a
year or is unconditionally cancelable it is converted to an on-
balance sheet credit equivalent using a 0 percent CCF.
---------------------------------------------------------------------------
For stand-alone HELOCs, the funded and unfunded portion of the
stand-alone HELOC would be risk weighted based on Table 5. The funded
portion of a HELOC would receive a risk weight based on the combined
LTV of all senior loans and funded portion of the HELOC. The unfunded
portion of the HELOC would be subject to the appropriate CCF and risk
weighted, using Table 5, based on the combined LTV of all senior loans
and the funded portion of the HELOC and the unfunded portion of the
HELOC.
Question 13: The Agencies request comment on the appropriateness of
the proposed risk-based capital treatment for HELOCs including the
burden of adjusting LTV as the borrower utilizes the HELOC.
While the Agencies are not proposing in this NPR to use LTV and
borrower creditworthiness, they also continue to evaluate approaches
that would consider borrower creditworthiness in risk weighting junior
lien mortgages. The Agencies believe that greater risk sensitivity can
be achieved by evaluating not only LTV but also borrower
creditworthiness. If the Agencies decide in the final rule to risk
weight junior lien mortgages based on LTV and a measure of borrower
creditworthiness, the Agencies would generally determine a specific
risk weight based on the ranges provided in Table 5A.
Question 14: Accordingly, the Agencies seek further comment on all
aspects of the use of LTV and borrower creditworthiness to determine
the risk weight for a junior lien mortgage.
[[Page 77460]]
Table 5A.--Illustrative Risk-Weight Ranges for LTV and Credit History for Junior Lien 1-4 Family Mortgages
----------------------------------------------------------------------------------------------------------------
Junior liens/HELOCs Illustrative risk weight ranges
----------------------------------------------------------------------------------------------------------------
Credit history Credit history Credit history
Loan-to-Value Ratios Group 1 (in Group 2 (in Group 3 (in
percent) percent) percent)
----------------------------------------------------------------------------------------------------------------
60 or less...................................................... 20-50 75-150 150-200
Greater than 60 and less than or equal to 80.................... 35-50 75-150 150-200
Greater than 80 and less than or equal to 95.................... 35-75 75-200 200
Greater than 90 and less than or equal to 95.................... 35-75 75-200 200
Greater than 95................................................. 35-75 75-200 200
----------------------------------------------------------------------------------------------------------------
v. Transitional Rule
Some commenters raised concerns about the cost and burden
associated with recoding existing loans to conform to a new system. To
minimize burden while moving toward a more risk-sensitive approach, the
Agencies propose to allow banking organizations that choose to apply
the proposed rule an option to continue to risk weight existing
mortgage loans using the existing risk-based capital rules. The option
would apply only to those loans that the banking organization owned at
the time it chose to apply the proposed rules. The banking organization
would be required to apply the transitional provision to all of its
existing mortgage loans. A banking organization may not use this
transitional treatment if it previously used Tables 3 or 5 to risk
weight these existing loans.
E. Short-Term Commitments
Under the Agencies' existing risk-based capital rules, commitments
with an original maturity of one year or less (short-term commitments)
and commitments that are unconditionally cancelable \34\ are generally
converted to an on-balance sheet credit equivalent amount using a zero
percent CCF. Accordingly, banking organizations extending short-term
commitments or unconditionally cancelable commitments are not required
to maintain risk-based capital against the credit risk inherent in
these exposures. Short-term commitments that are eligible liquidity
facilities that support asset-backed commercial paper (ABCP), however,
are converted to on-balance sheet assets using a 10 percent CCF.
Commitments with an original maturity of more than one year (long-term
commitments), including eligible long-term liquidity facilities that
support ABCP, are converted to on-balance sheet credit equivalent
amounts using a 50 percent CCF.
---------------------------------------------------------------------------
\34\ An unconditionally cancelable commitment is one that can be
canceled for any reason at any time without prior notice. In the
case of a home equity line of credit, the banking organization is
deemed able to unconditionally cancel the commitment if it can, at
its option, prohibit additional extensions of credit, reduce the
line, and terminate the commitment to the full extent permitted by
relevant Federal law.
---------------------------------------------------------------------------
In the Basel IA ANPR, the Agencies noted that they were considering
amending the risk-based capital requirements for short-term
commitments. Even though commitments with an original maturity of one
year or less expose banking organizations to a lower degree of credit
risk than longer-term commitments, some credit risk exists. Thus, the
Agencies suggested applying a 10 percent CCF to short-term commitments.
The resulting credit equivalent amount would be risk-weighted according
to the rating of the facility or the underlying asset(s) or the
obligor, after considering any collateral and guarantees. The Agencies
noted that they planned to retain the zero percent CCF for commitments
that are unconditionally cancelable. The Agencies also sought comment
on an alternative approach that would apply a single CCF (for example,
20 percent) to all commitments, both short- and long-term.
Almost universally, commenters agreed that unconditionally
cancelable commitments should not receive a capital charge. However,
commenters' recommendations varied about how to approach other short-
and long-term commitments. Some commenters suggested that all
commitments, except unconditionally cancelable commitments, should
receive a 20 percent CCF, regardless of maturity. These commenters
argued that this simple approach would ease burden and counterbalance
new complexities within the Basel IA ANPR.
Conversely, several commenters suggested that the capital treatment
should reflect the fact that short-term commitments are less risky than
long-term commitments. Of these commenters, a few argued that short-
term commitments should not receive any capital charge. A few others
supported the Basel IA ANPR suggestion to apply a 10 percent CCF to
short-term commitments and 50 percent CCF to long-term commitments. One
commenter suggested using a 20 percent CCF for short-term commitments
and a 50 percent CCF for long-term commitments.
In the Agencies' view, banking organizations that provide short-
term commitments that are not unconditionally cancelable are exposed to
credit risk that the existing risk-based capital rules do not
adequately address. The Agencies also recognize that short-term
commitments generally expose banking organizations to a lower degree of
credit risk than long-term commitments, thereby justifying a CCF that
is lower than the 50 percent CCF currently assigned to long-term
commitments. Thus, the Agencies are proposing to assign a 10 percent
CCF to short-term commitments. The resulting credit equivalent amount
would then be risk-weighted according to the rating of the facility,
the underlying assets, or the obligor, after considering any applicable
collateral and guarantees. Commitments that are unconditionally
cancelable would retain a zero percent CCF.
Finally, the Agencies are not proposing to apply a CCF to
commitments to originate one-to-four family residential mortgage loans
that are provided in the ordinary course of business. The Agencies
believe these types of commitments present only minimal credit risk
because of their short durations, the significant number that expire
before being funded, and the large percentage of originations that are
held for resale. In addition, commitments on held-for-sale mortgages
are treated as derivatives and are accounted for at fair value on the
balance sheet of the issuer, and therefore already receive a capital
charge. Given these mitigating factors, the Agencies do not wish to
impose the burden of determining risk weights by LTV during the short
commitment period.
[[Page 77461]]
Question 15: The Agencies continue to seek comments on an
alternative approach that would apply a single CCF of 20 percent to all
commitments, both short- and long-term (that are not unconditionally
cancelable), and the advantages and disadvantages of such an approach.
F. Assess a Risk-Based Capital Charge for Early Amortization
The Agencies' existing risk-based capital rules do not assess a
capital charge for risks associated with early amortization of
securitizations of revolving credits (for example, credit card
receivables). When assets are securitized, the extent to which the
selling or sponsoring entity transfers the risks associated with the
assets depends on the structure of the securitization and the nature of
the underlying assets. Early amortization provisions \35\ in
securitizations of revolving retail credit facilities increase the
likelihood that investors will be repaid before being subject to any
risk of significant credit losses. These provisions raise two concerns
about the risks to banking organizations that sponsor securitizations
with early amortization provisions: (1) The payment allocation formula
can result in the subordination of the seller's interest in the
securitized assets during early amortization, and (2) an early
amortization event can increase a banking organization's capital and
liquidity needs in order to finance new draws on the revolving credit
facilities.
---------------------------------------------------------------------------
\35\ An early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision is solely triggered by events not directly related to
the performance of the underlying exposures or the originating
banking organization (such as material changes in tax laws or
regulations).
---------------------------------------------------------------------------
In recognition of the risks associated with these structures, the
Agencies have proposed a capital charge on securitizations of revolving
credit exposures with early amortization provisions in prior
rulemakings. On March 8, 2000, the Agencies published a proposed rule
on recourse and direct credit substitutes.\36\ In that proposal, the
Agencies proposed to apply a fixed CCF of 20 percent to the amount of
assets under management in all revolving securitizations that contained
early amortization features.\37\ The preamble to the final Recourse
Rule \38\ reiterated the concerns with early amortization, indicating
that the risks associated with securitization, including those posed by
an early amortization feature, are not fully captured in the Agencies'
capital rules. While the Agencies did not impose a risk-based capital
charge for early amortization provisions in the final Recourse Rule,
they indicated that they would revisit the issue at some point in the
future.\39\
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\36\ 65 FR 12320 (March 8, 2000).
\37\ Id. at 12330-12331.
\38\ 66 FR 59614, 59619 (November 29, 2001).
\39\ In October 2003, the Agencies issued another proposed rule
that included a risk-based capital charge for early amortization.
See 68 FR 56568, 56571-56573 (October 1, 2003). This proposal was
based upon the Basel Committee's third consultative paper issued
April 2003. When the Agencies finalized other unrelated aspects of
this proposed rule in July 2004, they did not implement the early
amortization proposal. The Agencies determined that the change was
inappropriate because the capital treatment of retail credit,
including securitizations of revolving credit, was subject to change
as the Basel framework proceeded through the U.S. rulemaking
process. 69 FR 44908, 44912-44913 (July 28, 2004).
---------------------------------------------------------------------------
In the Basel IA ANPR, the Agencies suggested two approaches to
address these risks. One option was to apply a flat CCF to off-balance
sheet receivables in revolving securitizations with early amortization
provisions. Alternatively, the Agencies suggested using a risk-
sensitive methodology based on excess spread \40\ compression. Under
this methodology, the risk-based capital charge would increase as
excess spread decreased and approached the early amortization trigger
point.
---------------------------------------------------------------------------
\40\ Excess spread means gross finance charge collections
(including market interchange fees) and other income received by a
trust or the special purpose entity (SPE) minus interest paid to
investors in the securitization exposures, servicing fees, charge-
offs, and other similar trust or SPE expenses.
---------------------------------------------------------------------------
Most commenters that addressed this issue opposed the application
of any capital charge on the investors' interest in credit card
securitizations. Of the few that supported such a charge, one
recommended that the rules apply a flat CCF to securitizations with
early amortization provisions, and four supported the approach based on
excess spread.
The Agencies are proposing to apply an approach based on excess
spread to all revolving securitizations of credits with early-
amortization features. This capital charge would be assessed against
the investors' interest (that is, the total amount of securities issued
by a trust or special purpose entity to investors, which is the portion
of the securitization that is not on the banking organization's balance
sheet) and would be imposed only in the event that the excess spread
has declined to a predetermined percentage of the trapping point. The
capital required would increase as the level of excess spread
approaches the early amortization trigger. The Agencies are proposing
to compare the three-month average excess spread against the point at
which the securitization trust would be required to trap excess spread
in a spread or reserve account as a basis for the capital charge. To
determine the excess spread trapping point and the appropriate CCF, a
banking organization would divide the level of excess spread by the
spread trapping point as described below. In securitizations that do
not require excess spread to be trapped, or that specify a trapping
point based primarily on performance measures other than the three-
month average excess spread, the excess spread trapping point would be
set for purposes of this proposed rule at 4.5 percent.
To calculate the securitization's excess spread trapping point
ratio, a banking organization must first calculate the annualized three
month ratio for excess spread as follows:
a. For each of the three months, divide the month's excess spread
by the outstanding principal balance of the underlying pool of
exposures at the end of each month.
b. Calculate the average ratio for the three months and convert the
resulting ratio to a compound annual rate.
Then a banking organization must divide the annualized three month
ratio for excess spread by the excess spread trapping point that is
specified in the documentation for the securitization. Finally, a
banking organization must apply the appropriate CCF from Table 6 to the
amount of investors' interest. The resulting on-balance sheet credit
equivalent amount would be assigned to the risk weight category
appropriate to the securitized assets.
Table 6.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
CCF (in
Excess spread trapping point ratio percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more................... 0
Less than 133.33 percent to 100 percent of trapping point.. 5
Less than 100 percent to 75 percent of trapping point...... 15
Less than 75 percent to 50 percent of trapping point....... 50
Less than 50 percent of trapping point..................... 100
------------------------------------------------------------------------
Question 16: The Agencies solicit comment on the appropriateness of
the 4.5 percent excess spread trapping point and on other types and
levels of early amortization triggers used in securitizations of
revolving exposures that should be considered, especially for HELOC
securitizations. The Agencies also seek comment on whether a flat 10
[[Page 77462]]
percent CCF is a more appropriate capital charge for revolving
securitizations with early amortization features.
G. Remove the 50 Percent Limit on the Risk Weight for Derivatives
Currently, the Agencies' risk-based capital rules permit banks to
apply a maximum 50 percent risk weight to the credit equivalent amount
of certain derivative contracts. The risk weight assigned to
derivatives contracts was limited to 50 percent when the derivatives
counterparty credit risk rule was finalized in 1995 because most
derivative counterparties were highly rated and were generally
financial institutions.\41\ At the time, the Agencies noted that they
intended to monitor the quality of credits in the interest rate and
exchange rate markets to determine whether some transactions might
merit a 100 percent risk weight.
---------------------------------------------------------------------------
\41\ 60 FR 46169-46185 (September 5, 1995).
---------------------------------------------------------------------------
As the market for derivatives has developed, the types of
counterparties acceptable to participants have expanded to include
counterparties that the Agencies believe should receive a risk weight
greater than 50 percent. Although the Basel IA ANPR did not discuss the
limit on the risk weight for derivatives contracts, the Agencies have
determined that it is appropriate to propose removing the 50 percent
risk weight limit that applies to certain derivative contracts. In this
proposed rule, the risk weight assigned to the credit equivalent amount
of a derivative contract would be the risk weight assigned to the
counterparty after consideration of any collateral or guarantees.
H. Small Loans to Businesses
The Agencies' existing risk-based capital rules generally assign
business loans to the 100 percent risk weight category unless the
credit risk is mitigated by an acceptable guarantee or collateral.
Banking organizations and other industry participants have criticized
the lack of sensitivity in the measurement of credit risk associated
with these exposures and maintained that the current risk-based capital
charge is greater than warranted for high quality loans to businesses.
In the Basel IA ANPR, the Agencies noted that they were considering
a lower risk weight for certain business loans under $1 million on a
consolidated basis to a single borrower (small loans to businesses).
One alternative discussed in the Basel IA ANPR would allow small loans
to businesses to be eligible for a lower risk weight if certain
requirements were satisfied. These requirements would include, for
example, full amortization over a period of seven years or less,
performance according to the contractual provisions of the loan
agreement, and full protection by collateral. The banking organization
would also have to originate the loans according to its underwriting
policies (or purchase loans that have been underwritten in a manner
consistent with the banking organization's underwriting policies),
which would have to include an acceptable assessment of the collateral
and the borrower's financial condition and ability to repay the debt.
The Agencies sought comment on whether this potential change would
improve the risk sensitivity of the risk-based capital rules without
unduly increasing complexity and burden.
The Agencies also suggested an alternative approach that would
assess risk-based capital requirements for small loans to businesses
based on a credit assessment of the principals of the business and
their ability to service the debt. This alternative could be applied in
those cases where the principals personally guarantee the loan. The
Agencies sought comment on any alternative approaches for improving the
risk sensitivity of the risk-based capital treatment for small loans to
businesses, including the use of credit assessments, LTV, collateral,
guarantees, or other methods for stratifying credit risk.
Most commenters supported a lower risk weight for small loans to
businesses. However, it was apparent from the comments that there is no
universal set of risk drivers used to measure credit risk for these
loans. In addition, there was little agreement among commenters about
how credit risk for these loans should be measured without generating
undue burden.
One commenter asked the Agencies to create a small-business risk-
based capital model that takes into account various risk drivers,
including financing leverage, use of funds, loss modeling, and lending
shelf and securitization. Another commenter recommended measuring
credit risk based on results obtained by the Fair Isaac Small Business
Scoring Service, which the commenter claimed allows businesses to
assess the creditworthiness of the principals of a small business and
of the ability of the small business to make repayment on credit
obligations up to $750,000.
Another commenter suggested that small loans to businesses that are
collateralized should be risk weighted according to the LTV using the
ratio of the amount of the loan to the value of eligible collateral.
This commenter suggested that non-collateralized loans should be risk-
weighted according to several factors, including credit assessments of
personal guarantors, loan terms, size of the loan, amortization
schedule, and past history of the borrower. Other commenters offered
similar suggestions that would use risk measures such as credit
assessments and debt-to-income ratios.
Several commenters suggested that the dollar threshold for
receiving a lower risk weight was too low. A few commenters suggested
increasing the threshold to $2 million. One commenter suggested setting
the threshold at $5 million and indexing it to inflation.
Although the Agencies are not making a specific proposal in this
NPR, they are exploring options for permitting certain small loans to
businesses that meet certain criteria to qualify for a 75 percent risk
weight. The Agencies believe that the application of the 75 percent
risk weight to loans to businesses should be limited to situations
where the banking organization's consolidated business credit exposure
to the individual or company is $1 million or less.
Second, the Agencies believe that to qualify for the lower risk
weight, these loans should be personally guaranteed by the owner or
owners of the business and that the loans should be fully
collateralized by the assets of the business. The Agencies believe that
these requirements provide prudential safeguards to ensure that the
banking organization is in the position to minimize losses in the event
of default.
Third, the Agencies are considering requiring that qualifying loans
fully amortize over a period of no more than seven years. The full
amortization requirement encourages conservative cash management
practices by the borrower and ensures that the banking organization can
monitor the continued ability of the business to service the debt. The
Agencies have chosen a seven-year limitation to coincide with the
maturity structure of many loans used to finance equipment purchases.
The Agencies are also considering criteria for short-term loans
that do not amortize, such as working capital loans and other revolving
lines of credit. Under one alternative, the Agencies would allow loans
or draws from a revolving line of credit that matures within 18 months
to forgo the amortization requirement to the extent that the loan is to
be repaid from the anticipated proceeds of a previously established
financial transaction and
[[Page 77463]]
such proceeds are pledged for the repayment of the loan.
Fourth, the Agencies are considering requiring that the loans be
(1) prudently underwritten in a manner that justifies the assessment of
a lower-than-100 percent risk weight and (2) performing, that is, the
loan payments must be current. Thus, consistent with prudential
standards required for the underwriting of any small loans to
businesses, the Agencies would require that a banking organization
establish standards for assessing the quality and sufficiency of
pledged collateral, the financial condition of the borrower, the
financial condition of any guarantors to the loan, and the ability of
the business to meet certain debt service coverage criteria. The
Agencies would also set requirements for an acceptable debt service
coverage ratio, that is, the ratio of net operating income divided by
total loan payments or net operating cash flow divided by debt service
cost. The Agencies are considering a minimum debt service coverage
ratio of 1.3.
Finally, the Agencies are analyzing the need for additional
qualifying criteria. Among other criteria, the Agencies might require
that the loans have not been restructured to prevent a past due
occurrence and that none of the proceeds of the loans are used to
service any other outstanding loan obligation.
Question 17: The Agencies seek comment on this or other approaches
that might improve the risk sensitivity of the existing risk-based
capital rules for small loans to businesses.
I. Multifamily Residential Mortgages, Other Retail Exposures, Loans 90
Days or More Past Due or In Nonaccrual, and Commercial Real Estate
(CRE) Exposures
In the Basel IA ANPR, the Agencies sought comment on the risk-based
capital treatment for multifamily residential mortgages, other retail
exposures, loans 90 days or more past due or in nonaccrual, and
commercial real estate exposures. After considering the comments that
addressed the Agencies' approaches to the risk-based capital treatment
for these exposures, the Agencies have decided that any increase in
risk sensitivity is outweighed by the additional burden that would
result from the suggested approaches. Consequently, the Agencies are
not proposing any changes in this NPR with respect to these exposures.
The Agencies will continue to examine these issues and may address the
risk-based capital treatment for these exposures at some future time.
Question 18: The Agencies remain interested in industry comments on
any methods that would increase the risk sensitivity of the risk-based
capital requirements for other retail exposures, particularly through
the use of credit assessments, such as the borrower's credit score or
ability to service debt. The Agencies are particularly interested in
whether and how credit assessments might be applied consistently and
uniformly in the determination of risk weights without creating undue
burden.
J. Other Issues Raised by Commenters
Although the issue was not addressed in the Basel IA ANPR, several
commenters suggested that the Agencies should conduct a study of the
potential effects of any proposed revisions to the Agencies' existing
risk-based capital rules. They asserted that such a study would help
the Agencies better understand the potential costs and benefits of the
potential revisions, and help compare the revisions to the Basel II
framework.
The Agencies intend to analyze the potential impact of these
proposed changes, as well as any changes to the proposals that may
result from the public comment process. The Agencies may make changes
to these proposals if warranted based on this impact analysis.
III. Possible Alternatives for Basel II Banking Organizations
As noted in the ``Background'' section, on September 25, 2006, the
Agencies issued the Basel II NPR. The Basel II advanced capital
adequacy framework proposed in the Basel II NPR is highly complex and
is directed primarily at banking organizations with total consolidated
assets of $250 billion or more, or total consolidated on-balance sheet
foreign exposure of $10 billion or more, and other banks that opt in to
the Basel II framework--referred to as ``Basel II banking
organizations.'' In the Basel II NPR, the Agencies requested comment on
whether Basel II banking organizations should be permitted to use other
credit and operational risk approaches similar to those provided under
Basel II.
The Agencies seek comment on all aspects of the following questions
and seek the perspectives of banking organizations of different sizes
and complexity.
Question 19: To what extent should the Agencies consider allowing
Basel II banking organizations the option to calculate their risk based
capital requirements using approaches other than the Advanced Internal
Ratings Based (A-IRB) approach for credit risk and the Advanced
Measurement Approach (AMA) for operational risk? What would be the
appropriate length of time for such an option?
Question 20: If Basel II banking organizations are provided the
option to use alternatives to the advanced approaches, would either
this Basel IA proposal or the standardized approach in Basel II be a
suitable basis for a regulatory capital framework for credit risk for
those organizations? What modifications would make either of these
proposals more appropriate for use by large complex banking
organizations? For example, what approaches should be considered for
derivatives and other capital markets transactions, unsettled trades,
equity exposures, and other significant risks and exposures typical of
Basel II banking organizations?
Question 21: The risk weights in this Basel IA proposal were
designed with the assumption that there would be no accompanying
capital charge for operational risk. Basel II, however, requires
banking organizations to calculate capital requirements for exposure to
both credit risk and operational risk. If the Agencies were to proceed
with a rulemaking for a U.S. version of a standardized approach for
credit risk, should operational risk be addressed using one of the
three methods set forth in Basel II?
Question 22: What additional requirements should the Agencies
consider to encourage Basel II banking organizations to enhance their
risk management practices or their financial disclosures, if they are
provided the option to use alternatives to the advanced approaches of
the Basel II NPR?
IV. Regulatory Analysis
Regulatory Flexibility Act Analysis
Pursuant to section 605(b) of the Regulatory Flexibility Act, 5
U.S.C. 605(b) (RFA), the regulatory flexibility analysis otherwise
required under section 604 of the RFA is not required if an agency
certifies that the rule will not have a significant economic impact on
a substantial number of small entities (defined for purposes of the RFA
to include banking organizations with assets less than or equal to $165
million) and publishes its certification and a short, explanatory
statement in the Federal Register along with its rule. Pursuant to
section 605(b) of the RFA, the Agencies certify that this proposed rule
will not have a significant economic impact on a substantial number of
small entities. Accordingly, a regulatory flexibility analysis is not
[[Page 77464]]
needed. The amendments to the Agencies' regulations described above are
elective. They will apply only to banking organizations that opt to
take advantage of the proposed revisions to the existing domestic risk-
based capital framework and that will not be required to use the
advanced approaches contained in the Basel II proposal.\42\ The
Agencies believe that banking organizations that elect to adopt these
proposals will generally be able to do so with data they currently use
as part of their credit approval and portfolio management processes.
Banking organizations not exercising this option would remain subject
to the current capital framework. The proposal does not impose any new
mandatory requirements or burdens. Moreover, industry groups
representing small banking organizations that commented on the Basel IA
ANPR noted that small banking organizations typically hold more capital
than is required by the capital rules and would prefer to remain under
the existing risk-based capital framework. For these reasons, the
proposal will not result in a significant economic impact on a
substantial number of small entities.
---------------------------------------------------------------------------
\42\ 71 FR 55830 (September 25, 2006).
---------------------------------------------------------------------------
OCC Executive Order 12866 Determination
Executive Order 12866 requires Federal agencies to prepare a
regulatory impact analysis for agency actions that are found to be
``significant regulatory actions.'' ``Significant regulatory actions''
include, among other things, rulemakings that ``have an annual effect
on the economy of $100 million or more or adversely affect in a
material way the economy, a sector of the economy, productivity,
competition, jobs, the environment, public health or safety, or State,
local, or tribal governments or communities.'' \43\ Regulatory actions
that satisfy one or more of these criteria are referred to as
``economically significant regulatory actions.''
---------------------------------------------------------------------------
\43\ Executive Order 12866 (September 30, 1993), 58 FR 51735
(October 4, 1993), as amended by Executive Order 13258, 67 FR 9385
(February 28, 2002). For the complete text of the definition of
``significant regulatory action,'' see E.O. 12866 at section 3(f). A
``regulatory action'' is ``any substantive action by an agency
(normally published in the Federal Register) that promulgates or is
expected to lead to the promulgation of a final rule or regulation,
including notices of inquiry, advance notices of proposed
rulemaking, and notices of proposed rulemaking.'' E.O. 12866 at
section 3(e).
---------------------------------------------------------------------------
The OCC anticipates that the proposed rule will meet the $100
million criterion and therefore is an economically significant
regulatory action. In conducting the regulatory analysis for an
economically significant regulatory action, Executive Order 12866
requires each Federal agency to provide to the Administrator of the
Office of Management and Budget's (OMB) Office of Information and
Regulatory Affairs (OIRA):
The text of the draft regulatory action, together with a
reasonably detailed description of the need for the regulatory action
and an explanation of how the regulatory action will meet that need;
An assessment of the potential costs and benefits of the
regulatory action, including an explanation of the manner in which the
regulatory action is consistent with a statutory mandate and, to the
extent permitted by law, promotes the President's priorities and avoids
undue interference with State, local, and tribal governments in the
exercise of their governmental functions;
An assessment, including the underlying analysis, of
benefits anticipated from the regulatory action (such as, but not
limited to, the promotion of the efficient functioning of the economy
and private markets, the enhancement of health and safety, the
protection of the natural environment, and the elimination or reduction
of discrimination or bias) together with, to the extent feasible, a
quantification of those benefits;
An assessment, including the underlying analysis, of costs
anticipated from the regulatory action (such as, but not limited to,
the direct cost both to the government in administering the regulation
and to businesses and others in complying with the regulation, and any
adverse effects on the efficient functioning of the economy, private
markets (including productivity, employment, and competitiveness),
health, safety, and the natural environment), together with, to the
extent feasible, a quantification of those costs; and
An assessment, including the underlying analysis, of costs
and benefits of potentially effective and reasonably feasible
alternatives to the planned regulation, identified by the agencies or
the public (including improving the current regulation and reasonably
viable nonregulatory actions), and an explanation why the planned
regulatory action is preferable to the identified potential
alternatives.
Set forth below is a summary of the OCC's regulatory impact
analysis, which can be found in its entirety at http://www.occ.treas.gov/law/basel.htm.
i. The Need for Regulatory Action
Federal banking law directs federal banking agencies including the
Office of the Comptroller of the Currency (OCC) to require banking
organizations to hold adequate capital. The law authorizes federal
banking agencies to set minimum capital levels to ensure that banking
organizations maintain adequate capital. The law also gives banking
agencies broad discretion with respect to capital regulation by
authorizing them to also use any other methods that they deem
appropriate to ensure capital adequacy.
Capital regulation seeks to address market failures that stem from
several sources. Asymmetric information about the risk in a bank's
portfolio creates a market failure by hindering the ability of
creditors and outside monitors to discern a bank's actual risk and
capital adequacy. Moral hazard creates market failure in which the
bank's creditors fail to restrain the bank from taking excessive risks
because deposit insurance either fully or partially protects them from
losses. Public policy addresses these market failures because
individual banks fail to adequately consider the positive externality
or public benefit that adequate capital brings to financial markets and
the economy as a whole.
Capital regulations cannot be static. Innovation in and
transformation of financial markets require periodic reassessments of
what may count as capital and what amount of capital is adequate.
Continuing changes in financial markets create both a need and an
opportunity to refine capital standards in banking. The proposed
revisions to U.S. risk-based capital rules, ``Risk-Based Capital
Guidelines; Capital Adequacy Guidelines; Capital Maintenance: Domestic
Capital Modifications'' (``Basel IA NPR''), which we address in this
impact analysis, provide a new option for determining risk-based
capital for banking organizations that would not be required to operate
under the other risk-based capital adequacy proposal, ``Risk-Based
Capital Standards: Advanced Capital Adequacy Framework'' (``Basel
II'').
ii. Regulatory Background
The proposed capital regulation examined in this analysis would
apply to commercial banks and thrifts. Three banking agencies, the OCC,
the Board of Governors of the Federal Reserve System (Board), and the
FDIC regulate commercial banks, while the Office of Thrift Supervision
(OTS) regulates all federally chartered and many state-chartered
thrifts. Throughout this document, the four are jointly referred to as
the federal banking agencies.
[[Page 77465]]
The Basel IA proposal seeks to improve the risk sensitivity of the
existing risk-based capital rules. This framework would be optional and
would be available to banking organizations not covered by the Basel II
proposal. Any institution that is not a Basel II bank would be able to
remain under the existing risk-based capital rules or elect to adopt
Basel IA. The proposed changes in Basel IA would:
1. Increase the number of risk weight categories from five to
eight.
2. Allow the greater use of external credit ratings.
3. Expand the range of recognized collateral and eligible
guarantors.
4. Use loan-to-value ratios to risk-weight residential mortgages.
5. Increase the credit conversion factor for certain commitments
with an original maturity of one year or less.
6. Assess a capital charge for early amortizations in
securitizations of revolving retail exposures.
7. Remove the 50 percent limit on the risk weight for certain
derivative transactions.
The Agencies would continue to reserve the authority to require
banking organizations to hold additional capital where appropriate.
iii. Benefit-Cost Analysis of the Proposed Rule
A cost-benefit analysis considers the costs and benefits of a
proposal as they relate to society as a whole. The social benefits of a
proposal are benefits that accrue directly to those subject to a
proposal plus benefits that might accrue indirectly to the rest of
society. Similarly, the overall social costs of a proposal are costs
incurred directly by those subject to the rule and costs incurred
indirectly by others. In the case of Basel IA, direct costs and
benefits are those that apply to the banking organizations that are
subject to the proposal. Indirect costs and benefits then stem from
banks and other financial institutions that are not subject to the
proposal, bank customers, and, through the safety and soundness
externality, society as a whole.
The enormous social and economic benefit that derives from a safe
and sound banking system supported by vigorous and comprehensive
supervision, including ensuring adequate capital clearly dwarfs any
direct benefits that might accrue to institutions adopting Basel IA.
Similarly, the social and economic cost of any reduction in the safety
and soundness of the banking system would dramatically overshadow any
cost borne by banking organizations subject to the rule. The banking
agencies are confident that the enhanced risk sensitivity of the
proposed rule could allow banking organizations to more effectively
achieve objectives that are consistent with a safe and sound banking
system.
Beyond the relatively minor societal benefit from the relatively
minor enhancement to bank safety and soundness, we do not anticipate
any benefits accruing other than directly to the banking organizations
that elect to adopt Basel IA. Because many factors besides regulatory
capital requirements affect pricing and lending decisions, we do not
expect the adoption or non-adoption of Basel IA to affect pricing or
lending. Hence, we do not anticipate any costs or benefits affecting
the customers or competitors of Basel IA institutions. For these
reasons, the cost and benefit analysis of Basel IA reduces to an
analysis of the costs and benefits directly attributable to
institutions that might elect to adopt Basel IA capital rules.
A. Organizations Affected by the Proposed Rule \44\
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\44\ Unless otherwise noted, the population of banks and thrifts
used in this analysis consists of all FDIC-insured institutions.
Banking organizations are aggregated to the top holding company
level.
---------------------------------------------------------------------------
As of June 30, 2006, eleven banking organizations meet the criteria
that would require them to adopt the U.S. implementation of Basel II.
Removing those 11 mandatory Basel II institutions from the 7,606 FDIC-
insured banking organizations active in June 2006 leaves 7,595
organizations that would be eligible to adopt Basel IA. Among national
banks, six of the eleven mandatory Basel II institutions are national
banks. Out of 1,545 banking organizations with national banks, 1,539
national banking organizations would thus be eligible to adopt Basel
IA.
B. Benefits of the Proposed Rule
The proposed rule aims to improve the risk sensitivity of
regulatory capital requirements. The five benefits of the proposed rule
are:
1. Enhances the risk sensitivity of capital charges.
2. More efficient use of required bank capital.
3. Recognizes new developments in financial markets.
4. Mitigates potential distortions in minimum regulatory capital
requirements between large and small banking organizations.
5. Ability to opt in offers long-term flexibility to banking
organizations.
C. Costs of the Proposed Rule
As with any rule, the costs of the proposal include expenditures by
banks and thrifts necessary to comply with the new regulation and costs
to the federal banking agencies of implementing the new rules. Because
of a lack of cost estimates from banking organizations, the OCC found
it necessary to use a scope-of-work comparison with Basel II in order
to arrive at a cost estimate for Basel IA. Based on this rough
assessment, we estimate that implementation costs for Basel IA could
range from $100,000 at smaller institutions to $3 million at larger
institutions.
1. Costs to Banking Organizations
Explicit costs of implementing the proposed rule at banking
organizations fall into two categories: setup costs and ongoing costs.
Setup costs are typically one-time expenses associated with introducing
the new programs and procedures necessary to achieve initial compliance
with the proposed rule. Setup costs may also involve expenses related
to tracking and retrieving data needed to implement the proposed rule.
Ongoing costs are also likely to reflect data costs associated with
retrieving and preserving data.
The total cost to national banks of adopting Basel IA depends
entirely on the number of institutions that elect to adopt the
voluntary rule and the size of those institutions. Obviously, if no
institutions adopt Basel IA, the cost will be zero. Based on comment
letters and discussions with bank supervision staff, we sought to
identify national banks that would be more likely to adopt Basel IA. We
selected national banks with significant mortgage holdings (over $500
million in 1-4 family first-lien mortgages and mortgages comprise at
least 10 percent of their portfolio) as well as national banks that do
not currently meet the well-capitalized threshold for their risk based
capital-to-assets ratio. Using those criteria, we identified 46
national banks. We estimate that the total cost of the rule for
national banks will be approximately $78 million. Over time, Basel IA
may become more appealing to a larger number of banks. The total cost
of the proposed rule would consequently increase to the extent that
more institutions opt into Basel IA over time. At present, it is
unclear how many national banks will ultimately elect to adopt Basel
IA.
2. Government Administrative Costs
Like the banking organizations subject to new requirements, the
costs to government agencies of implementing the proposed rule also
involve both startup and ongoing costs. Startup costs include expenses
related to the
[[Page 77466]]
development of the regulatory proposals, costs of establishing new
programs and procedures, and costs of initial training of bank
examiners in the new programs and procedures. Ongoing costs include
maintenance expenses for any additional examiners and analysts needed
to regularly apply the new supervisory processes. In the case of Basel
IA, because modest changes to Call Reports will capture most of the
rule changes, these ongoing costs are likely to be minor.
OCC expenditures fall into three broad categories: training,
guidance, and supervision. Training includes expenses for workshops and
other training courses and seminars for examiners. Guidance expenses
reflect expenditures on the development of Basel IA guidance.
Supervision expenses reflect organization-specific supervisory
activities. We estimate that OCC expenses for Basel IA will be
approximately $2.4 million through 2006. We also expect expenditures of
$1 million per year between 2007 and 2010. Applying a five percent
discount rate to future expenditures, past expenses ($2.4 million) plus
the present value of future expenditures ($3.6 million) equals total
OCC expenditures of $6 million on Basel IA.
3. Total Cost Estimate of Proposed Rule
The OCC's estimate of the total cost of the proposed rule includes
expenditures by banking organizations and the OCC from the present
through 2010. Based on our estimate that approximately 46 national
banks will adopt Basel IA at a cost to each institution of between
$100,000 and $3 million depending on the size of the institution, we
estimate that national banks will spend approximately $78 million on
Basel IA. Combining expenditures provides an estimate of $84 million
for the total cost of the proposed rule for the OCC and national banks.
iv. Analysis of Baseline and Alternatives
In order to place the costs and benefits of the proposed rule in
context, Executive Order 12866 requires a comparison between the
proposed rule, a baseline of what the world would look like without the
proposed rule, and a reasonable alternative to the proposed rule. In
this regulatory impact analysis, we analyze one baseline and one
alternative to the proposed rule. The baseline considers the
possibility that the proposed Basel IA rule is not adopted and current
capital standards continue to apply.
The baseline scenario appears in this analysis in order to estimate
the effects of adopting the proposed rule relative to a hypothetical
regulatory regime that might exist without Basel IA. Because the
baseline scenario considers costs and benefits as if the proposed rule
never existed, we set the costs and benefits of the baseline scenario
to zero. Obviously, banking organizations face compliance costs and
reap the benefits of a well-capitalized banking system even under the
baseline. However, because we cannot quantify these costs and benefits,
we normalize the baseline costs and benefits to zero and estimate the
costs and benefits of the proposed rule and alternative as deviations
from this zero baseline.
1. Baseline Scenario: Current capital standards based on the 1988
Basel Accord continue to apply.
Description of Baseline Scenario
Under the Baseline Scenario, current capital rules would continue
to apply to all banking organizations in the United States that are not
subject to the U.S. implementation of Basel II. Under this scenario,
the United States would not adopt the proposed Basel IA rule but the
implementation of the Basel II framework would continue.
Change in Benefits: Baseline Scenario
Staying with current capital rules instead of adopting the Basel IA
proposal would eliminate essentially all of the benefits of the
proposed rule listed above. Under the baseline, banking organizations
not subject to Basel II would not be given the option of voluntarily
selecting Basel IA. Institutions that would have adopted the proposed
rule would not be able to take advantage of the enhanced risk
sensitivity of Basel IA capital charges and the more efficient use of
bank capital that implies.
One benefit that would remain under the baseline is that there
would be no rule changes instead of just simple and voluntary rule
changes. Without Basel IA as an available option, an institution would
have to choose between the advanced approaches of Basel II and the
status quo. The baseline without Basel IA would leave a level playing
field for all the non-Basel II banks. However, the absence of an
opportunity to mitigate potential distortions in minimum required
capital would likely diminish this benefit in the eyes of an
institution concerned about potential distortions created by Basel II.
Changes in Costs: Baseline Scenario
Continuing to use current capital rules eliminates the benefits and
the costs of adopting the proposed rule. As discussed above, under the
proposed rule we estimate that organizations would spend up to $78
million on implementation-related expenditures. Retaining current
capital rules would eliminate any costs associated with the proposed
rule, even though banking organizations would only incur those costs if
they elected to do so.
2. Alternative: Require all U.S. banking organizations not subject
to Basel II to adopt Basel IA.
Description of Alternative
The only change under the alternative is that adoption of the
proposed rule would be mandatory rather than voluntary. Under this
alternative, the provisions of the proposed rule would remain intact
and apply to all national banks that are not subject to Basel II.
Institutions subject to Basel II would include mandatory Basel II
institutions and those institutions that elect to adopt the U.S.
implementation of the Basel II framework.
Change in Benefits: Alternative
Because there are no changes to the elements of the proposed rule
under the alternative, the list of benefits remains the same. Among
these benefits, only one benefit is lost by making the proposed rule
mandatory: the benefit derived from the fact that the proposed rule is
voluntary. As for the benefits relating to the enhanced risk
sensitivity of capital charges, because adoption of Basel IA is
mandatory under the alternative, more banks will be subject to Basel IA
provisions and the aggregate level of benefits will be higher. Because
we anticipate that only 46 national banks would adopt Basel IA
voluntarily, the difference in the aggregate benefit level could be
considerable.
Changes in Costs: Alternative
Clearly the most significant drawback to the alternative is the
dramatically increased cost of applying a new set of capital rules to
all U.S. banking organizations. Under the alternative, direct costs
would increase for every U.S. banking organization that would have
elected to continue to use current capital rules under the proposed
rule. The cost estimate for the alternative is the total cost estimate
for a 100 percent adoption rate of Basel IA. With 1,545 national
banking organizations eligible for Basel IA, we estimate that the cost
to national banking organizations of the alternative is approximately
$662 million. The actual cost may be somewhat less depending on the
number of national banks that elect to adopt Basel II capital rules,
but it is much greater than our cost estimate of $78 million for the
proposed rule.
[[Page 77467]]
3. Overall Comparison of Proposed Rule with Baseline and
Alternative.
The objective of the proposed rule is to enhance the risk
sensitivity of capital charges for institutions not subject to Basel II
capital regulations. The proposal also seeks to mitigate any potential
distortions in minimum regulatory capital requirements that the U.S.
implementation of Basel II might create between large and small banking
organizations. Like Basel II, the anticipated benefits of the Basel IA
proposal are difficult to quantify in dollar terms. Nevertheless, the
OCC believes that the proposed rule provides benefits without posing
any threat to the safety and soundness of the banking industry or the
security of the Federal Deposit Insurance system. To offset the costs
of the proposed rule, its voluntary nature offers regulatory
flexibility that will allow institutions to adopt Basel IA on a bank-
by-bank basis when an institution's anticipated benefits exceed the
anticipated costs of adopting this regulation.
The banking agencies are confident that the proposed rule could
serve to strengthen institutions electing to adopt Basel IA while the
safety and soundness of institutions electing to forgo Basel IA and
Basel II will not diminish. On the basis of our analysis, we believe
that the benefits of the proposed rule are sufficient to offset the
costs of implementing the proposed rule. However, because there is no
social cost to allowing institutions to remain subject to current
capital rules, we believe it is best to make the proposed rule
voluntary in order to let each national bank decide whether it is in
that institution's best interest to adopt Basel IA. Because adoption is
voluntary, the proposed rule offers an improvement over the baseline
scenario and the alternative. The proposed rule offers an important
degree of flexibility unavailable with either the baseline or the
alternative. The baseline does not give banking organizations a way
into Basel IA and the alternative does not offer them a way out. The
alternative would compel most banking organizations to follow a new set
of capital rules and require them to undertake the time and expense of
adjusting to these new rules. The proposed rule offers a better balance
between costs and benefits than either the baseline or the alternative.
Overall, the OCC believes that the benefits of the proposed rule
justify its costs.
OTS Executive Order 12866 Determination
OTS concurs with OCC's RIA. Rather than replicate that analysis,
OTS drafted an RIA incorporating OCC's analysis by reference and adding
appropriate material reflecting the unique aspects of the thrift
industry. The full text of OTS's RIA is available at the locations for
viewing the OTS docket indicated in the ADDRESSES section above. OTS
believes that its analysis meets the requirements of Executive Order
12866. The following discussion supplements OCC's summary of its RIA.
OTS is the primary federal regulator for 854 federal and state-
chartered savings associations with assets of $1.5 trillion as of June
30, 2006. OTS-regulated savings associations assets are highly
concentrated in residential mortgage-related assets. Approximately 68
percent of total thrift assets are residential mortgage-related assets.
As a result, the most important change made by the proposed rule for
OTS-regulated savings associations involves the proposed changes to the
risk weighting of residential mortgages. Other aspects of the Basel IA
NPR should not have a significant effect on saving associations.\45\
Accordingly, OTS's analysis focuses on the proposed risk-weighting of
residential mortgages.
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\45\ Savings associations, for example, do not have significant
holdings that would be affected by the ratings-based approaches for
exposures, collateral, or guarantors. Rather, savings associations'
assets are more heavily concentrated in mortgage-backed securities
issued or guaranteed by the government sponsored enterprises, whose
risk weightings would not change under the Basel IA NPR.
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Benefit-Cost Analysis
Overall OTS believes that the benefits of the proposed rule justify
its costs. Under OTS's analysis, direct costs and benefits include
costs and benefits to savings associations that opt-in to the proposed
rule. OTS estimates that approximately 115 savings associations will
opt-in to the proposed rule.\46\ Direct costs and benefits also include
OTS's costs of implementing the proposed rule. Indirect costs and
benefits are those that may affect the economy as a whole. These
indirect and direct costs arise from how the primary business of
banking (i.e., credit availability) is impacted by requirements for
risk-based capital adequacy.
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\46\ This is the number of well-capitalized thrifts that hold
total assets of $500 million or more, and that have a total risk-
based capital ratio of 15 percent or less.
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A. Direct Benefits
In general, the proposed rule seeks to improve the risk sensitivity
of minimum regulatory capital requirements and, by doing so, to address
some of the shortcomings of the current regulatory minimum capital
requirements.\47\ For OTS-regulated savings associations, the most
important change involves the risk weighting of residential mortgages.
Well-underwritten residential mortgages with LTV ratios at origination
of less than 90 percent are all currently risk weighed for regulatory
capital purposes at 50 percent. Data from a variety of sources,
including the security markets, indicate that this risk weight may be
too high for the credit risk of low LTV mortgages and insufficient for
the credit risk of higher LTV mortgages. As a result, to the extent
that minimum regulatory capital requirements affect savings
associations' investment decisions, the current rules may discourage
saving associations from retaining higher quality low LTV mortgages in
their portfolios or encourage them to retain lower quality high LTV
mortgages.
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\47\ The other benefits of the Basel IA NPR are more fully
discussed in the OCC analysis.
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In addition, for the largest banking organizations, the recently
published Basel II NPR addresses the credit risks of exposures more
directly than under the current capital requirement regime by relating
their probability of default and loss given default to minimum
regulatory capital requirements. Preliminary survey results suggest
that, on average, residential mortgages are likely to receive a lower
credit risk weight under the Basel II NPR than under the current
regime. The Basel IA NPR is intended to offer savings associations not
covered under the Basel II NPR a more risk sensitive weighting scheme
for residential mortgages, and, if adopted, may offer saving
associations a more level playing field on which to compete against
Basel II banking organizations in offering residential mortgage related
products.
B. Direct Costs
OTS estimates that the total direct costs of the proposed rule for
the six-year period from design through implementation will be $72
million. This includes direct costs of $67 million for the 115 savings
associations that may opt-in to the proposed rule, and direct costs of
$5 million for OTS implementation expenses.
C. Indirect Benefits and Costs
The primary business of banking is making credit available to
borrowers. A myriad of considerations affect credit decisions by
individual institutions. Among these considerations are the regulatory
cost of capital and how closely the regulatory cost matches an
institution's internal assessment of its
[[Page 77468]]
capital needs. To the extent that regulatory risk-based capital
requirements for capital adequacy may overstate (or understate) the
amount of capital that an institution must otherwise hold to support
its credit decisions, the regulatory requirements add costs of
compliance and, thus, introduce inefficiencies to the extent that a
savings association is unable to price its credit products consistent
with the underlying credit risk.
The Basel II NPR attempted to develop a models-based system that
more closely harmonized risk-based capital at the largest
internationally active banks with their internal capital allocation
models. For residential mortgages, the underwriting, risk
differentiation, and system tracking processes described in the Basel
II NPR are much closer to industry practice than the simple risk weight
bucket system based on Basel I. The centerpiece of the Basel IA NPR is
the expansion of the number of risk buckets and the establishment of
new risk-based capital criteria that should, for residential mortgages,
more closely mirror the underwriting, risk differentiation, and system
tracking at likely opt-in institutions.
To the extent that the Basel IA NPR achieves its goal of more
closely aligning risk-based capital requirements to real credit risk,
it should reduce the inefficiency inherent in the simpler Basel I-based
framework. This should enable adopters to price their mortgage credits
more closely to their internal assessment of credit risk. Competitive
equity would be easier to maintain, particularly vis-a-vis the largest
institutions. Moreover, there may be fewer forced consolidations, which
could also help maintain a more competitive mortgage credit
environment. Credit decisions could be made more rationally, and could
be based more exclusively on sound underwriting since capital adequacy
requirements would more closely match internal risk assessments.
Smaller institutions that choose to hold risk-based capital in
excess of the well-capitalized level could continue to operate under
their distinct business model. These institutions hold those capital
levels primarily due to concentration risk, their localized needs for
liquidity, and other factors. Because their capital levels already
exceed the regulatory minimums, these institutions have already
harmonized their own assessment of risk with a Basel I-based system,
and can presumably price their mortgage credits efficiently and
competitively in the current environment.
It would be nearly impossible to estimate a dollar amount of the
potential indirect cost or benefit to the economy derived from
introduction of an optional risk-based capital framework that more
closely aligns capital requirements with credit risk for residential
mortgages. However, since the decision to opt in or not would be made
by thousands of banks, even partial success at harmonizing risk-based
capital with internal risk assessment should improve the efficiency of
the mortgage credit decision and therefore reduce the cost to the
economy.
Analysis of Baseline and Alternatives
The OCC analysis includes a comparison between the Basel IA NPR, a
baseline scenario of what the world would look like without the Basel
IA NPR, and an alternative to the Basel IA NPR. The alternative would
require all banking organizations that are not subject to the Basel II
NPR to apply the Basel IA NPR. Except for the discussions focusing on
the benefit derived from the recognition of new developments in
financial markets, which is only a minor benefit for savings
associations, OTS believes that the OCC analysis is reasonable and
equally applicable to savings associations. OTS supports the OCC's
conclusion that the Basel IA NPR offers a better balance between costs
and benefits than the alternative. OTS has the following additional
comments:
A. Baseline Scenario
In its analysis of the baseline scenario, which would leave the
current risk-based capital rules unchanged, OCC determines that
national banks could avoid $78 million of implementation-related
expenditures that would otherwise be required by the Basel IA NPR. As
noted above, OTS estimates that 115 savings associations would spend up
to $67 million to implement the Basel IA NPR. Retaining the current
capital rules without adopting Basel IA would permit these savings
associations to avoid these new expenditures.
As an indirect cost to the economy, the baseline scenario of
maintaining a less risk-sensitive capital framework would continue to
pose some cost of inefficiency and compliance for some institutions.
This may lead to less competitive equity for those institutions, and
less efficiently and mis-priced mortgage credits for borrowers
generally.
B. Alternative Scenario
In its analysis of the alternative scenario, OCC concludes that the
aggregate benefits would considerably increase because 1,539, rather
than 46, national banks would implement the alternative. Under the
alternative scenario, OTS estimates that the aggregate costs to savings
associations would also increase considerably. Specifically, OTS
estimates that these costs would increase from $67 million (for 115
savings associations) to $164 million (for 850 savings associations).
The alternative scenario would impose direct costs on institutions
and indirect costs on the economy generally. Many savings associations
elect to hold capital in excess of the well-capitalized levels to
address other risks. This is a prudent decision regulators should
encourage and not discourage. For these institutions, the mandatory
imposition of the Basel IA NPR would only increase capital compliance
costs. These institutions would not obtain an offsetting benefit in the
form of lower capital requirements for mortgage credit risk. In such a
scenario, some of these institutions could choose to pass on the
increased costs, which would render them less competitive and could
lead to inefficiently and mis-priced mortgage credits for borrowers,
and hence, the economy generally. Alternatively, some of these
institutions might choose to absorb the costs in the form of weaker
earnings, which would make them more vulnerable targets for
consolidation, and reduce the competitive environment in that manner.
OCC Executive Order 13132 Determination
The OCC has determined that this proposed rule does not have any
Federalism implications, as required by Executive Order 13132.
Paperwork Reduction Act
Implementation of these proposed rules would require revisions to
the Agencies' quarterly regulatory reports \48\ to reflect the program
and system changes required for a banking organization that adopts
Basel IA. The Agencies project issuing a Federal Register notice for
certain upcoming changes to the quarterly regulatory reports in early
2007. This notice will separately present a detailed discussion of the
program and system changes and associated burden estimates for the
potential future changes to the quarterly regulatory reports for
banking organizations that decide to adopt Basel IA. This will afford
the public ample
[[Page 77469]]
opportunity to consider potential future reporting changes associated
with the Basel IA proposed rule before the comment period for this
proposed rulemaking closes. Prior to the publication of the upcoming
notice, public commenters may submit comments on aspects of this notice
that may affect reporting requirements at the addresses listed in the
ADDRESSES section of this NPR. The Agencies will submit such required
revisions to the quarterly regulatory reports to the Office of
Management and Budget (OMB) for review and approval under the Paperwork
Reduction Act.
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\48\ Consolidated Reports of Condition and Income (Call Report)
(OMB Nos. 7100-0036, 3064-0052, 1557-0081), Thrift Financial Report
(TFR) (OMB No. 1550-0023), Consolidated Financial Statemetns for
Bank Holding Companies (FR Y-9C) (OMB No. 7100-0128).
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OCC and OTS Unfunded Mandates Reform Act of 1995 Determination
Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
104-4 (Unfunded Mandates Act) requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
Federal mandate that may result in expenditure by State, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year. If a budgetary impact statement is
required, section 205 of the Unfunded Mandates Act also requires an
agency to identify and consider a reasonable number of regulatory
alternatives before promulgating a rule. The OCC and OTS each has
determined that this proposed rule will not result in expenditures by
State, local, and tribal governments, or by the private sector, of $100
million or more. Accordingly, neither the OCC nor the OTS has prepared
a budgetary impact statement or specifically addressed the regulatory
alternatives considered.
Solicitation of Comments on Use of Plain Language
Section 722 of the GLBA requires the Federal banking agencies to
use plain language in all proposed and final rules published after
January 1, 2000. The Federal banking agencies invite comment on how to
make this proposed rule easier to understand. For example:
Have we organized the material to suit your needs? If not,
how could this material be better organized?
Are the requirements in the rule clearly stated? If not,
how could the rule be more clearly stated?
Do the regulations contain technical language or jargon
that is not clear? If so, which language requires clarification?
Would a different format (grouping and order of sections,
use of headings, paragraphing) make the regulation easier to
understand? If so, what changes to the format would make the regulation
easier to understand?
Would more, but shorter, sections be better? If so, which
sections should be changed?
What else could we do to make the regulation easier to
understand?
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, Mortgages, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 225
Administrative practice and procedure, Banks, Banking, Holding
companies, Reporting and recordkeeping requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Bank deposit insurance,
Banks, banking, Capital adequacy, Reporting and recordkeeping
requirements, Savings associations, State non-member banks.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set out in the preamble, part 3 of chapter I of
title 12 of the Code of Federal Regulations is proposed to be amended
as follows:
PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES
1. The authority citation for part 3 continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n
note, 1835, 3907, and 3909.
2. Amend Sec. 3.4 by revising paragraph (b) and adding paragraphs
(c) and (d) to read as follows:
Sec. 3.4 Reservation of Authority.
* * * * *
(b) Risk-weight categories. Notwithstanding the risk categories in
appendices A and D of this part, the OCC will look to the substance of
the transaction and may find that the assigned risk weight for any
asset, the credit equivalent amount or credit conversion factor for any
off-balance sheet item, or the use of an external rating or the
external rating on any instrument does not appropriately reflect the
risks imposed on a bank and may require another risk weight, credit
equivalent amount, credit conversion factor or external rating that the
OCC deems appropriate. Similarly, if no risk weight, credit equivalent
amount, credit conversion factor, or external rating is specifically
assigned, the OCC may assign any risk weight, credit equivalent amount,
credit conversion factor, or external rating 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.
(c) In addition to the reservations of authority described in
paragraph (b) of this section, the OCC reserves the authority to assign
different risk weights to exposures as set forth in sections
1(c)(2)(i), and (ii) of appendix C and section 6 of appendix B of this
part.
(d) Applicability. The OCC reserves the authority to require a bank
calculate its minimum risk-based capital ratio according to either
appendix A, appendix C, or appendix D of this part. In making this
determination, the OCC will consider the bank's information systems and
risk profile and apply notice and response procedures in the same
manner and to the same extent as the notice and response procedures in
Sec. 3.12. Additionally, the OCC reserves the authority to require any
bank to apply the market risk capital adjustment set forth in appendix
B of this part.
3. Revise Sec. 3.6 to read as follows:
Sec. 3.6 Minimum capital ratios.
(a) General. A national bank must maintain a capital to total
assets leverage ratio and a risk-based capital ratio. The risk-based
capital ratio may be subject to a market risk adjustment.
(b) Total assets leverage ratio. All national banks must have and
maintain Tier 1 capital in an amount equal to at least 3.0 percent of
adjusted total assets.
(c) Additional leverage ratio requirement. An institution operating
at or near the level in paragraph (a) of this section should have well-
diversified risks, including no undue interest rate risk exposure;
excellent control systems; good earnings; high asset quality; high
liquidity; and well managed on- and off-balance sheet activities; and
in general be considered a strong banking organization, rated composite
1 under the Uniform Financial Institutions
[[Page 77470]]
Rating System (CAMELS) rating system of banks. For all but the most
highly-rated banks meeting the conditions set forth in this paragraph
(c), the minimum Tier 1 leverage ratio is 4 percent. In all cases,
banking institutions should hold capital commensurate with the level
and nature of all risks.
(d) Risk-based capital ratio. A national bank must have and
maintain the minimum risk-based capital ratio in either appendix A
(risk-based capital ratio), appendix C (internal ratings-based and
advanced measurement approaches), or appendix D (alternative risk-based
capital ratio), and, for certain banks, in appendix B of this part
(market risk capital adjustment).
(1) Risk-based capital ratio requirement. Except as provided by
paragraph (d)(2) (alternative risk-based capital ratio) and paragraph
(f) of this section (internal ratings-based and advanced measurement
approaches), a bank must maintain a minimum risk-based capital ratio as
calculated in accordance with appendix A of this part.
(2) Alternative risk-based capital ratio requirement. A bank that
is not subject (either mandatorily or by election) to the internal
ratings-based and advanced measurement approaches under Appendix C, may
adopt the alternative risk-based capital ratio requirements pursuant to
section 1(c) of appendix D of this part. A bank subject to appendix D
must maintain a minimum alternative risk-based capital ratio as
calculated in accordance with appendix D of this part.
(3) Internal ratings-based and advanced measurement approaches
requirement. (i) Applicability. A bank that meets any of the following
internal ratings-based and advanced measurement approaches
applicability requirements must apply appendix C of this part in
determining its minimum risk-based capital ratio:
(A) The bank's consolidated total assets, as reported on its most
recent year-end Call Report, equal to $250 billion or more;
(B) The bank's most recent year-end consolidated total on-balance
sheet foreign exposure equals to $10 billion or more (where total on-
balance sheet foreign exposure equals total cross-border claims less
claims with head office or guarantor located in another country plus
redistributed guaranteed amounts to the country of head office or
guarantor plus local country claims on local residents plus revaluation
gains on foreign exchange and derivative products, calculated in
accordance with the Federal Financial Institutions Examination Council
(FFIEC) 009 Country Exposure Report);
(C) The bank is a subsidiary of a depository institution that is
subject to 12 CFR Part 3, Appendix C, 12 CFR Part 208, Appendix F, 12
CFR Part 325, Appendix D, or 12 CFR Part 566, subpart A; or
(D) The bank is a subsidiary of a bank holding company (as defined
in 12 U.S.C. 1841) that is subject to 12 CFR Part 225, Appendix F.
(ii) Mandatory banks. A bank that meets the applicability
requirements under paragraph (d)(3)(i) of this section must maintain a
minimum risk-based capital ratio as calculated in accordance with
appendix C of this part.
(iii) Opt-in banks. A bank not otherwise required to use appendix
C, may elect to use the internal ratings-based and advanced measurement
approaches to calculate its minimum risk-based capital ratio, subject
to prior OCC approval as provided by section 21 of appendix C of this
part. A bank approved to use the internal ratings-based and advanced
measurement approaches, must maintain a minimum risk-based capital
ratio as calculated in accordance with appendix C of this part [Basel
II].
(4) Market risk capital adjustment requirement. (i) Market risk
capital adjustment applicability requirement. A bank that meets any of
the following applicability requirements, as determined by the bank's
most recent year-end Call Report, must apply the additional market risk
capital adjustment as provided by appendix B of this part:
(A) The bank has trading activities (on a worldwide consolidated
basis) equals to, or greater than, 10 percent of its total assets; or
(B) The bank has trading activities (on a worldwide consolidated
basis) equal to $1 billion or more.
(ii) Mandatory market risk bank. A bank that meets the market risk
applicability requirements under paragraph (d)(4) of this section must
apply the additional market risk capital adjustment in determining its
minimum risk-based capital ratio (or alternative risk-based capital
ratio, if applicable), as calculated in accordance with appendix B of
this part.
(iii) Opt-in market risk bank. A bank not otherwise required to use
appendix B, may elect to use the market risk capital adjustment,
subject to prior OCC approval as provided by section 3(c) of appendix B
of this part. A bank approved to use the market risk capital
adjustment, must apply the additional market risk capital adjustment in
determining its minimum risk-based capital ratio (or alternative risk-
based capital ratio, if applicable), as calculated in accordance with
appendix B of this part.
4. Appendix C to Part 3 is added and reserved.
5. Add Appendix D to Part 3 to read as follows:
Appendix D To Part 3--Alternative Risk-Based Capital Guidelines
Section 1. Purpose, Applicability of Guidelines, and Definitions
(a) Scope. This Appendix applies to all banks that have opted-in
in accordance with section 1(b) of this appendix D.
(b) Opt-in procedures. (1) Initial opt-in. Unless otherwise
subject to appendix C of this part, any bank may adopt the capital
requirements set forth in this appendix D by notifying the OCC of
its intent to do so.
(2) Opt-Out. Any bank that has opted into the capital
requirements of this appendix D subsequently may elect to adopt the
capital requirements set forth in appendix A by filing a notice with
the appropriate supervisory office.
(c) Reservation of authority. (1) The OCC may apply this
appendix D to any bank if the OCC deems it necessary or appropriate
for safe and sound banking practices or if the OCC determines that
this appendix D would produce risk-based capital requirements that
more accurately reflect the risk profile of the bank. In making a
determination under this paragraph, the OCC will apply notice and
response procedures in the same manner and to the same extent as the
notice and response procedures in Sec. 3.12.
(2) The OCC may exclude a bank that has otherwise opted-in
according to section 1(b)(1) of this appendix from applying the
capital requirements of this appendix D, if the OCC determines such
action is consistent with safe and sound banking practices. In
making a determination under this paragraph, the OCC will apply
notice and response procedures in the same manner and to the same
extent as the notice and response procedures in Sec. 3.12.
(d) Definitions. (1) Except where noted, the definitions listed
in sections 1 and 4 of appendix A to this part 3 shall apply to this
appendix D to this part 3. For the purposes of this appendix D,
where the definitions in appendix A include cross references to
other sections in appendix A, the OCC will construe them to refer to
the appropriate sections in this appendix D.
(2) For the purposes of this appendix D, the following
additional definitions apply:
Affiliate means, with respect to a company, any company that
controls, is controlled by, or is under common control with, the
company. For the purposes of this definition, a person or company
controls a company if it:
(A) Owns, controls, or holds with power to vote 25 percent or
more of a class of voting securities of the company; or
(B) Consolidates the company for financial reporting purposes.
Company means a corporation, partnership, limited liability
company,
[[Page 77471]]
business trust, special purpose entity, association, or similar
organization.
Early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision is solely triggered by events not directly related to
the performance of the underlying exposures or the originating
banking organization (such as material changes in tax laws or
regulations).
Eligible guarantee means a guarantee provided by a third party
eligible guarantor that is:
(A) Written and unconditional; and if extended by a central
government, is backed by the full faith and credit of the central
government;
(B) Covers all or a pro rata portion of the contractual payments
of the obligor on the reference exposure;
(C) Gives the beneficiary a direct claim against the protection
provider;
(D) Is non-cancelable by the protection provider for reasons
other than the breach of the contract by the beneficiary;
(E) Is legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced;
(F) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligor on the reference exposure without first
requiring the beneficiary to demand payment from the obligor.
Eligible guarantor means:
(A) A foreign central government with senior long-term debt
externally rated at least investment grade by a NRSRO; or
(B) An entity, other than a central government, (for example,
securities firms, insurance companies, bank holding companies,
savings and loan holding companies, multilateral lending and
regional development institutions, partnerships, limited liability
companies, business trusts, special purpose entities, associations
and other similar organizations) with senior long-term debt
externally rated at least investment grade by a NRSRO.
Excess spread means gross finance charge collections (including
market interchange fees) and other income received by a trust or the
special purpose entity (SPE) minus interest paid to investors in the
securitization exposures, servicing fees, charge-offs, and other
similar trust or SPE expenses.
Excess spread trapping point means the point at which the bank
is required by the documentation governing a securitization to
divert and hold excess spread in a spread or reserve account,
expressed as a percentage.
External rating means:
(A) A credit rating that is assigned by an NRSRO to a claim,
provided that the credit rating:
(1) Fully reflects the entire amount of credit risk with regard
to all payments owed on the claim (that is, the rating must fully
reflect the credit risk associated with timely repayment of
principal and interest);
(2) Is monitored by the issuing NRSRO;
(3) Is published in an accessible public form; and
(4) Is, or will be, included in the issuing NRSRO's publicly
available transition matrix, which tracks the performance and
stability (or ratings migrations) of an NRSRO's issued external
ratings for the specific type of claim (for example, corporate
debt); or
(B) An unrated claim on a foreign central government shall be
deemed to have an external rating equal to the foreign central
government's issuer rating assigned by an NRSRO.
Investor's interest means the total amount of securitization
exposures represented by securities issued by a trust or special
purpose entity to investors.
Loan-level private mortgage insurance means insurance provided
by a regulated mortgage insurance company that protects the mortgage
lender in the event of a default of a mortgage borrower up to a
predetermined portion of the value of a single one-to-four
residential property, provided there is no pool-level cap that would
effectively reduce coverage.
Non-central government entity means an entity that is not a
central government as that term is defined in this section. This
term includes securities firms, insurance companies, bank holding
companies, savings and loan holding companies, multilateral lending
and regional development institutions, partnerships, limited
liability companies, business trusts, special purpose entities,
associations and other similar organizations.
Revolving credit means a line of credit where the borrower is
permitted to vary both the drawn amount and the amount of repayment.
Section 2. Components of Capital
(a) A national bank's qualifying capital base is comprised as
set forth in section 2 of appendix A to this part 3.
(b) For the purposes of this appendix D, the OCC will construe
cross references in appendix A of this part to other sections in
appendix A as cross references to the appropriate sections in this
appendix D.
Section 3. Risk Categories/Weights for On-Balance Sheet Assets and
Off-Balance Sheet Items.
(a) General. (1) Calculations. The denominator of the risk-based
capital ratio, i.e., a national bank's risk-weighted assets, is
derived by assigning that bank's assets and off-balance sheet items
to one of the risk categories set out in this appendix D. Each
category has a specific risk weight. Off-balance sheet items are
converted to on-balance sheet equivalent amounts according to
section 3(c) of this appendix D and then assigned a risk category.
The risk weight assigned to a particular asset or on-balance sheet
credit equivalent amount determines the percentage of that asset/
credit equivalent that is included in the denominator of the bank's
risk-based capital ratio. Any asset deducted from a bank's capital
in computing the numerator of the risk-based capital ratio is not
included as part of the bank's risk-weighted assets. The OCC
reserves the right to require a bank to compute its risk-based
capital ratio on the basis of average, rather than period-end, risk-
weighted assets when necessary to carry out the purposes of these
guidelines.
(2) Indirect Holdings. Some of the assets on a bank's balance
sheet may represent an indirect holding of a pool of assets, e.g.,
mutual funds, that encompasses more than one risk weight within the
pool. In those situations, the bank may assign the asset to the
risk-weight category applicable to the highest risk-weighted asset
that pool is permitted to hold pursuant to its stated investment
objectives in the fund's prospectus. Alternatively, the bank may
assign the asset on a pro rata basis to different risk categories
according to the investment limits in the fund's prospectus. In
either case, the minimum risk weight that may be assigned to such a
pool is 20 percent. If a bank assigns the asset on a pro rata basis,
and the sum of the investment limits in the fund's prospectus
exceeds 100 percent, the bank must assign the highest pro rata
amounts of its total investment to the higher risk-weight category.
If, in order to maintain a necessary degree of liquidity, the fund
is permitted to hold an insignificant amount of its assets in short-
term, highly-liquid securities of superior credit quality (that do
not qualify for a preferential risk weight), such securities
generally will not be taken into account in determining the risk
category into which the bank's holding in the overall pool should be
assigned. The prudent use of hedging instruments by a fund to reduce
the risk of its assets will not increase the risk weighting of the
investment in that fund above the 20 percent category. However, if a
fund engages in any activities that are deemed to be speculative in
nature or has any other characteristics that are inconsistent with
the preferential risk weighting assigned to the fund's assets, the
bank's investment in the fund will be assigned to the 100 percent
risk-weight category. More detail on the treatment of mortgage-
backed securities is provided in sections 3(b)(1)(ii)(F) and (G),
3(b)(1)(iv)(D), and 4(c) and (d) of this appendix D.
(b) On-Balance Sheet Assets. (1) Risk-Weight Categories. Unless
otherwise provided by sections 3(b)(2) or 3(b)(3) of this appendix,
a bank must assign a risk weight to an on-balance sheet asset
according to the following risk-weight categories.
(i) Zero percent risk weight. (A) Cash, including domestic and
foreign currency owned and held in all offices of a national bank or
in transit. Any foreign currency held by a national bank should be
converted into U.S. dollar equivalents.
(B) Deposit reserves and other balances at Federal Reserve
Banks.
(C) Gold bullion held in the bank's own vaults or in another
bank's vaults on an allocated basis, to the extent it is backed by
gold bullion liabilities.
(D) The book value of paid-in Federal Reserve Bank stock.
(E) Securities issued by, and other direct claims on, the United
States Government or its agencies.
(F) That portion of assets directly and unconditionally
guaranteed by the United States Government or its agencies.
[[Page 77472]]
(G) That portion of assets and off-balance sheet transactions
\1\ collateralized by cash or securities issued or directly and
unconditionally guaranteed by the United States Government or its
agencies, or the central government of an OECD country, provided
that: \2\
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\1\ See footnote 18 in section 3(c)(1)(vii)(C) of this appendix
D (collateral held against derivative contracts).
\2\ Assets and off-balance sheet transactions collateralized by
securities issued or guaranteed by the United States Government or
its agencies include, but are not limited to, securities lending
transactions, repurchase agreements, collateralized letters of
credit, such as reinsurance letters of credit, and other similar
financial guarantees. Swaps, forwards, futures, and options
transactions are also eligible, if they meet the collateral
requirements. However, the OCC may at its discretion require that
certain collateralized transactions be risk weighted at 20 percent
if they involve more than a minimal risk.
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(1) The bank maintains control over the collateral:
(i) If the collateral consists of cash, the cash must be held on
deposit by the bank or by a third-party for the account of the bank;
(ii) If the collateral consists of OECD government securities,
then the securities must be held by the bank or by a third-party
acting on behalf of the bank;
(2) The bank maintains a daily positive margin of collateral
fully taking into account any change in the market value of the
collateral held as security;
(3) Where the bank is acting as a customer's agent in a
transaction involving the loan or sale of securities that is
collateralized by cash or OECD government securities delivered to
the bank, any obligation by the bank to indemnify the customer is
limited to no more than the difference between the market value of
the securities lent and the market value of the collateral received,
and any reinvestment risk associated with the collateral is borne by
the customer; and
(4) The transaction involves no more than minimal risk.
(H) Externally rated debt securities issued by, certain other
externally rated claims on, and that portion of assets supported by
an eligible guarantee of, a foreign central government that receive
a zero percent risk weight, as provided in section 3(b)(3) of this
appendix D.
(ii) Twenty Percent Risk Weight. (A) All claims on depository
institutions incorporated in an OECD country, and all assets backed
by the full faith and credit of depository institutions incorporated
in an OECD country. This includes the credit equivalent amount of
participations in commitments and standby letters of credit sold to
other depository institutions incorporated in an OECD country, but
only if the originating bank remains liable to the customer or
beneficiary for the full amount of the commitment or standby letter
of credit. Also included in this category are the credit equivalent
amounts of risk participations in bankers' acceptances conveyed to
other depository institutions incorporated in an OECD country.
However, bank-issued securities that qualify as capital of the
issuing bank are not included in this risk category, but are
assigned to the 100 percent risk category.
(B) Claims on, or guaranteed by depository institutions, other
than the central bank, incorporated in a non-OECD country, with a
residual maturity of one year or less.
(C) Cash items in the process of collection.
(D) That portion of assets collateralized by cash or by
securities issued or directly and unconditionally guaranteed by the
United States Government or its agencies that does not qualify for
the zero percent risk-weight category.
(E) That portion of assets conditionally guaranteed by the
United States government or its agencies.
(F) Securities issued by, or other direct claims on, United
States Government-sponsored agencies.
(G) That portion of assets guaranteed by United States
Government-sponsored agencies.\3\
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\3\ Privately issued mortgage-backed securities, e.g., CMOs and
REMICs, where the underlying pool is comprised solely of mortgage-
related securities issued by GNMA, FNMA and FHLMC, will be treated
as an indirect holding of the underlying assets and assigned to the
20 percent risk category. If the underlying pool is comprised of
assets which attract different risk weights, e.g., FNMA securities
and conventional mortgages, the bank should generally assign the
security to the highest risk category appropriate for any asset in
the pool. However, on a case-by-case basis, the OCC may allow the
bank to assign the security proportionately to the various risk
categories based on the proportion in which the risk categories are
represented by the composition cash flows of the underlying pool of
assets. Before the OCC will consider a request to proportionately
risk-weight such a security, the bank must have current information
for the reporting date that details the composition and cash flows
of the underlying pool of assets.
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(H) That portion of assets collateralized by the current market
value of securities issued or guaranteed by United States
Government-sponsored agencies.
(I) Claims representing general obligations of any public-sector
entity in an OECD country, and that portion of any claims guaranteed
by any such public-sector entity. In the United States, these
obligations must meet the requirements of 12 CFR 1.2(b).
(J) Unrated loans to official multilateral lending institutions
or regional development institutions in which the United States
Government is a shareholder or contributing member.\4\ Rated loans
to, debt securities issued by, claims guaranteed by, and claims
collateralized by debt securities issued by, official multilateral
lending institutions or regional development institutions shall be
risk weighted according to section 3(b)(3) of this appendix D.
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\4\ These institutions include, but are not limited to, the
International Bank for Reconstruction and Development (World Bank),
the Inter-American Development Bank, the Asian Development Bank, the
European Investments Bank, the International Monetary Fund, and the
Bank for International Settlements.
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(K) An unrated loan to a securities firm incorporated in an OECD
country, that satisfies the following conditions:
(1) If the securities firm is incorporated in the United States,
then the firm must be a broker-dealer that is registered with the
SEC and must be in compliance with the SEC's net capital regulation
(17 CFR 240.15c3(1)).
(2) If the securities firm is incorporated in any other OECD
country, then the bank must be able to demonstrate that the firm is
subject to consolidated supervision and regulation, including its
subsidiaries, comparable to that imposed on depository institutions
in OECD countries; such regulation must include risk-based capital
standards comparable to those applied to depository institutions
under the Basel Capital Accord.
(3) The securities firm, whether incorporated in the United
States or another OECD country, must also have a long-term credit
rating in accordance with section 3(b)(1)(ii)(K)(3)(i) of this
appendix D; a parent company guarantee in accordance with section
3(b)(1)(ii)(K)(3)(ii) of this appendix D; or a collateralized claim
in accordance with section 3(b)(1)(ii)(K)(3)(iii) of this appendix
D. Claims representing capital of a securities firm must be risk
weighted at 100 percent.
(i) Credit rating. The securities firm must have either a long-
term issuer credit rating or a credit rating on at least one issue
of long-term unsecured debt, from a NRSRO that is in one of the
three highest investment-grade categories used by the NRSRO. If the
securities firm has a credit rating from more than one NRSRO, the
lowest credit rating must be used to determine the credit rating
under this paragraph.
(ii) Parent company guarantee. The claim on the securities firm
must be guaranteed by the firm's parent company, and the parent
company must have either a long-term issuer credit rating or a
credit rating on at least one issue of long-term unsecured debt,
from a NRSRO that is in one of the three highest investment-grade
categories used by the NRSRO.
(iii) Collateralized claim. The claim on the securities firm
must be collateralized subject to all of the following requirements:
(A) The claim must arise from a reverse repurchase/repurchase
agreement or securities lending/borrowing contract executed using
standard industry documentation.
(B) The collateral must consist of debt or equity securities
that are liquid and readily marketable.
(C) The claim and collateral must be marked-to-market daily.
(D) The claim must be subject to daily margin maintenance
requirements under standard industry documentation.
(E) The contract from which the claim arises can be liquidated,
terminated, or accelerated immediately in bankruptcy or similar
proceedings, and the security or collateral agreement will not be
stayed or avoided under the applicable law of the relevant
jurisdiction. To be exempt from the automatic stay in bankruptcy in
the United States, the claim must arise from a securities contract
or a repurchase agreement under section 555 or 559, respectively, of
the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial
contract under section 11(e)(8) of the Federal Deposit Insurance Act
(12 U.S.C. 1821(e)(8)), or a netting contract between or among
financial institutions under sections 401-407 of the Federal Deposit
Insurance Corporation Improvement
[[Page 77473]]
Act of 1991 (12 U.S.C. 4407), or Regulation EE (12 CFR part 231).
Externally rated loans to, externally rated debt securities issued
by, claims guaranteed by, and claims collateralized by externally
rated debt securities issued by, securities firms shall be risk
weighted according to section 3(b)(3) of this appendix.
(L) Externally rated debt securities issued by, certain other
externally rated claims on, and that portion of assets supported by
an eligible guarantee from, a foreign central government that
receive a 20 percent risk weight as provided in section 3(b)(3) of
this appendix D.
(M) Externally rated debt securities issued by, certain other
rated claims on, and that portion of assets supported by an eligible
guarantee of, a non-central government entity, that receive a 20
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(N) Assets collateralized by liquid and readily marketable
externally rated debt securities that receive a 20 percent risk
weight as provided in section 3(b)(3) of this appendix D, and
recourse obligations, direct credit substitutes, residual interests,
and asset- and mortgage-backed securities that receive a 20 percent
risk weight as provided in section 4(c)(1) of this appendix D.
(O) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 20 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(iii) Thirty Five Percent Risk Weight. (A) Externally rated debt
securities issued by, certain other externally rated claims on, and
that portion of assets supported by an eligible guarantee of, a
foreign central government, that receive a 35 percent risk weight as
provided in section 3(b)(3) of this appendix D.
(B) Externally rated debt securities issued by, certain other
rated claims on, and that portion of assets supported by an eligible
guarantee of, a non-central government entity, that receive a 35
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(C) Assets collateralized by liquid and readily marketable
externally rated debt securities that receive a 35 percent risk
weight as provided in section 3(b)(3) of this appendix D, and
recourse obligations, direct credit substitutes, residual interests,
and asset- and mortgage-backed securities that receive a 35 percent
risk weight as provided in section 4(c)(1) of this appendix D.
(D) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 35 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(iv) Fifty Percent Risk Weight. (A) Revenue obligations of any
public-sector entity in an OECD country for which the underlying
obligor is the public-sector entity, but which are repayable solely
from the revenues generated by the project financed through the
issuance of the obligations.
(B) Loans to residential real estate builders for one-to-four
family residential property construction, if the bank obtains
sufficient documentation demonstrating that the buyer of the home
intends to purchase the home (i.e., a legally binding written sales
contract) and has the ability to obtain a mortgage loan sufficient
to purchase the home (i.e., a firm written commitment for permanent
financing of the home upon completion), subject to the following
additional criteria:
(1) The builder must incur at least the first 10 percent of the
direct costs (i.e., actual costs of the land, labor, and material)
before any drawdown is made under the construction loan and the
construction loan may not exceed 80 percent of the sales price of
the resold home;
(2) The individual purchaser has made a substantial earnest
money deposit of no less than 3 percent of the sales price of the
home that must be subject to forfeiture by the individual purchaser
if the sales contract is terminated by the individual purchaser;
however, the earnest money deposit shall not be subject to
forfeiture by reason of breach or termination of the sales contract
on the part of the builder;
(3) The earnest money deposit must be held in escrow by the bank
financing the builder or by an independent party in a fiduciary
capacity; the escrow agreement must provide that in the event of
default the escrow funds must be used to defray any cost incurred
relating to any cancellation of the sales contract by the buyer;
(4) If the individual purchaser terminates the contract or if
the loan fails to satisfy any other criterion under this section,
then the bank must immediately recategorize the loan at a 100
percent risk weight and must accurately report the loan in the
bank's next quarterly Consolidated Reports of Condition and Income
(Call Report);
(5) The individual purchaser must intend that the home will be
owner-occupied;
(6) The loan is made by the bank in accordance with prudent
underwriting standards;
(7) The loan is not more than 90 days past due, or on
nonaccrual; and
(8) The purchaser is an individual(s) and not a partnership,
joint venture, trust, corporation, or any other entity (including an
entity acting as a sole proprietorship) that is purchasing one or
more of the homes for speculative purposes.
(C) Loans secured by a first mortgage on multifamily residential
properties: \5\
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\5\ 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 appendix D.
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(1) The amortization of principal and interest occurs in not
more than 30 years;
(2) The minimum original maturity for repayment of principal is
not less than 7 years;
(3) All principal and interest payments have been made on a
timely basis in accordance with the terms of the loan for at least
one year immediately preceding the risk weighting of the loan in the
50 percent risk-weight category, and the loan is not otherwise 90
days or more past due, or on nonaccrual status;
(4) The loan is made in accordance with all applicable
requirements and prudent underwriting standards;
(5) If the rate of interest does not change over the term of the
loan:
(i) The current loan amount outstanding does not exceed 80
percent of the current value of the property, as measured by either
the value of the property at origination of the loan (which is the
lower of the purchase price or the value as determined by the
initial appraisal, or if appropriate, the initial evaluation) or the
most current appraisal, or if appropriate, the most current
evaluation; and
(ii) In the most recent fiscal year, the ratio of annual net
operating income generated by the property (before payment of any
debt service on the loan) to annual debt service on the loan is not
less than 120 percent; \6\
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\6\ For the purposes of the debt service requirements in
sections 3(b)(1)(iv)(C)(5)(ii) and 3(b)(1)(iv)(C)(6)(ii) of this
Appendix D, other forms of debt service coverage that generate
sufficient cash flows to provide comparable protection to the
institution may be considered for (a) a loan secured by cooperative
housing or (b) a multifamily residential property loan if the
purpose of the loan is for the development or purchase of
multifamily residential property primarily intended to provide low-
to moderate-income housing, including special operating reserve
accounts or special operating subsidies provided by federal, state,
local or private sources. However, the OCC reserves the right, on a
case-by-case basis, to review the adequacy of any other forms of
comparable debt service coverage relied on by the bank.
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(6) If the rate of interest changes over the term of the loan:
(i) The current loan amount outstanding does not exceed 75
percent of the current value of the property, as measured by either
the value of the property at origination of the loan (which is the
lower of the purchase price or the value as determined by the
initial appraisal, or if appropriate, the initial evaluation) or the
most current appraisal, or if appropriate, the most current
evaluation; and
(ii) In the most recent fiscal year, the ratio of annual net
operating income generated by the property (before payment of any
debt service on the loan) to annual debt service on the loan is not
less than 115 percent; and
(7) If the loan was refinanced by the borrower:
(i) All principal and interest payments on the loan being
refinanced which were made in the preceding year prior to
refinancing shall apply in determining the one-year timely payment
requirement under section 3(b)(1)(iv)(C)(3) of this appendix D; and
(ii) The net operating income generated by the property in the
preceding year prior to refinancing shall apply in determining the
applicable debt service requirements under sections
3(b)(1)(iv)(C)(5) and (a)(2)(iv)(C)(6) of this appendix D.
(D) Unrated privately-issued mortgage-backed securities, i.e.
those that do not carry the guarantee of a government or government-
sponsored agency, if the unrated privately-issued mortgage-backed
securities are at the time the mortgage-backed securities are
originated fully secured by or otherwise
[[Page 77474]]
represent a sufficiently secure interest in mortgages secured by
multifamily residential properties that qualify for the 50 percent
risk weight under section 3(b)(1)(iv)(C) of this appendix D; loans
to residential real estate builders for one-to-four family
residential property construction that qualify for the fifty percent
risk weight under section 3(b)(1)(iv)(B) of this appendix D; and
mortgages secured by residential properties that are either owner-
occupied or rented, meet prudent underwriting standards in
accordance with 12 CFR Part 34, and are not 90 days or more past
due, have not been placed in nonaccrual status, and have not been
restructured, provided that they meet the following criteria: \7\
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\7\ If all of the underlying mortgages in the pool do not
qualify, the bank should generally assign the entire value of the
unrated security to the 200 percent risk category of this appendix
D; however, on a case-by-case basis, the OCC may allow the bank to
assign only the portion of the security which represents an interest
in, and the cash flows of, nonqualifying mortgages to the 200
percent risk category, with the remainder being assigned a risk
weight of 50 percent. Before the OCC will consider a request to risk
weight a mortgage-backed security on a proportionate basis, the bank
must have current information for the reporting date that details
the composition and cash flows of the underlying pool of mortgages.
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(1) The underlying assets must be held by an independent trustee
that has a first priority, perfected security interest in the
underlying assets for the benefit of the holders of the security;
(2) The holder of the security must have an undivided pro rata
ownership interest in the underlying assets or the trust that issues
the security must have no liabilities unrelated to the issued
securities;
(3) The trust that issues the security must be structured such
that the cash flows from the underlying assets fully meet the cash
flows requirements of the security without undue reliance on any
reinvestment income; and
(4) There must not be any material reinvestment risk associated
with any funds awaiting distribution to the holder of the security.
(E) Externally rated debt securities issued by, certain other
externally rated claims on, and that portion of assets supported by
an eligible guarantee of, a foreign central government, that receive
a 50 percent risk weight as provided in section 3(b)(3) of this
appendix D.
(F) Externally rated debt securities issued by, certain other
rated claims on, and that portion of assets supported by an eligible
guarantee of, a non-central government entity, that receive a 50
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(G) Assets collateralized by liquid and readily marketable
externally rated debt securities that receive a 50 percent risk
weight as provided in section 3(b)(3) of this appendix D, and
recourse obligations, direct credit substitutes, residual interests,
and asset- and mortgage-backed securities that receive a 50 percent
risk weight as provided in section 4(c)(1) of this appendix D.
(H) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 50 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(v) Seventy Five Percent Risk Weight. (A) Externally rated debt
securities issued by, certain other externally rated claims on, and
that portion of assets supported by an eligible guarantee of, a
foreign central government, that receive a 75 percent risk weight as
provided in section 3(b)(3) of this appendix D.
(B) Externally rated debt securities issued by, certain other
rated claims on, and that portion of assets supported by an eligible
guarantee of non-central government entity, that receive a 75
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(C) Assets collateralized by liquid and readily marketable
externally rated debt securities that receive a 75 percent risk
weight as provided in section 3(b)(3) of this appendix D, and
recourse obligations, direct credit substitutes, residual interests,
and asset- and mortgage-backed securities that receive a 75 percent
risk weight as provided in section 4(c)(1) of this appendix D.
(D) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 75 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(vi) One Hundred Percent Risk Weight. All other assets not
specified in this appendix D,\8\ including:
---------------------------------------------------------------------------
\8\ A bank subject to the market risk capital requirements
pursuant to Appendix B of this part 3 may calculate the capital
requirement for qualifying securities borrowing transactions
pursuant to section 3(a)(1)(ii) of appendix B of this part 3.
---------------------------------------------------------------------------
(A) Asset- or mortgage-backed securities that are externally
rated are risk weighted in accordance with section 4 of this
appendix D.
(B) All stripped mortgage-backed securities, including interest
only portions (IOs), principal only portions (POs) and other similar
instruments, regardless of the issuer or guarantor.
(C) Obligations issued by any state or any political subdivision
thereof for the benefit of a private party or enterprise where that
party or enterprise, rather than the issuing state or political
subdivision, is responsible for the timely payment of principal and
interest on the obligation, e.g., industrial development bonds.
(D) Claims on commercial enterprises owned by foreign central
governments.
(E) Any investment in an unconsolidated subsidiary that is not
required to be deducted from total capital pursuant to section 2(c)
of this appendix D.
(F) Instruments issued by depository institutions incorporated
in OECD and non-OECD countries that qualify as capital of the
issuer.
(G) Investments in fixed assets, premises, and other real estate
owned.
(H) Claims representing capital of a securities firm.
(I) Bank-issued securities that qualify as capital of the
issuing bank.
(J) Externally rated debt securities issued by, certain other
externally rated claims on, and that portion of assets supported by
an eligible guarantee of, a foreign central government, that receive
a 100 percent risk weight as provided in section 3(b)(3) of this
appendix D.
(K) Externally rated marketable debt securities issued by,
certain other rated claims on, and that portion of assets supported
by an eligible guarantee of, a non-central government entity, that
receive a 100 percent risk weight as provided in section 3(b)(3) of
this appendix D.
(L) Assets collateralized by liquid and readily marketable
externally rated debt securities that receive a 100 percent risk
weight as provided in section 3(b)(3) of this appendix D, and
recourse obligations, direct credit substitutes, residual interests,
and asset- and mortgage-backed securities that receive a 100 percent
risk weight as provided in section 4(c)(1) of this appendix D.
(M) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 100 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(vii) One Hundred and Fifty Percent Risk Weight. (A) Externally
rated debt securities issued by, certain other externally rated
claims on, and that portion of assets supported by an eligible
guarantee of, a foreign central government, that receive a 150
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(B) Externally rated debt securities issued by, certain other
rated claims on, and that portion of assets supported by an eligible
guarantee of, a non-central government entity, that receive a 150
percent risk weight as provided in section 3(b)(3) of this appendix
D.
(C) Mortgage loans secured by liens on one-to-four family
residential properties that receive a 150 percent risk weight as
provided in section 3(b)(2) of this appendix D.
(viii) Two Hundred Percent Risk Weight. (A) Unrated debt
securities issued by, certain other unrated and rated claims on, and
that portion of assets supported by an eligible guarantee of, a
foreign central government, that receive a 200 percent risk weight
as provided in section 3(b)(3) of this appendix D.
(B) Externally rated and unrated debt securities issued by,
certain other externally rated and unrated claims on, and that
portion of assets supported by an eligible guarantee of, a non-
central government entity, that receive a 200 percent risk weight as
provided in section 3(b)(3) of this appendix D.
(2) Mortgage Loans Secured by Liens on One-to-Four Family
Residential Properties. (i) First Lien Mortgages. (A) Risk-Weight
Table. Unless otherwise provided in section 3(b)(2)(iii) (mortgage
loans with negative amortization features) of this appendix D, a
bank shall assign a mortgage loan secured by a first lien on a one-
to-four family residential property to a risk weight based on its
loan-to-value ratio, in accordance with Table 1 of this appendix D.
(B) Minimum Risk Weight for Certain Mortgage Loans Secured by
Liens on One-to-Four Family Residential Properties. Notwithstanding
section 3(b)(2)(i)(A) of this appendix D, a loan secured by a one-
to-four family residential property that is not either owner-
occupied or rented, that is 90 days or more past due, that has been
placed in
[[Page 77475]]
nonaccrual status, has been restructured, or that does not meet
prudent underwriting standards, shall receive a risk weight of 100
percent, or higher if warranted by the loan-to-value ratio,
according to Table 1 of this appendix D.
(C) First and Junior Liens. If a bank holds a first lien and
junior lien on a one-to-four family residential property and no
other party holds an intervening lien, the combined exposure is
treated as a single loan secured by a first lien for the purposes of
both determining the loan-to-value ratio and assigning a risk weight
to the combined exposure.
(D) Loan-to-value ratio. (1) Initial loan-to-value ratio
calculation. (i) Generally. For the purpose of determining the
appropriate risk weight in accordance with Table 1 of this appendix
D, a bank shall determine the loan-to-value ratio for a mortgage
loan secured by first lien mortgage on a one-to-four family
residential property using the lower of the purchase price or the
appraisal or evaluation at origination.
(ii) Loan level private mortgage insurance. In determining the
loan-to-value ratio, a bank may take in to account loan-level
private mortgage insurance, provided the insurer is not affiliated
with the bank and has long-term debt rated at least third highest
investment grade (without credit enhancements) by an NRSRO.
(iii) Appraisal or Evaluation. Any appraisal or evaluation used
by a bank for the purposes of this appendix D must satisfy the real
estate lending and appraisal requirements set forth in subpart C of
12 CFR part 34.
(2) Adjustments to the loan-to-value ratio. After origination of
a mortgage loan, a bank may update the value of a one-to-four family
residential property based on an appraisal or evaluation only if the
borrower refinances the mortgage loan and the bank extends
additional funds. On a quarterly basis, a bank may adjust the amount
of the loan to reflect any decrease in the principal balance. In the
case of a home equity line of credit, the bank shall adjust the
amount of the loan quarterly to reflect any increase in the balance
of the loan.
Table 1.--Risk Weights Applicable to Mortgage Loans Secured by First
Liens on One-to-Four Family Residential Properties
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (in
percent)
------------------------------------------------------------------------
Less than or equal to 60 percent........................... 20
Greater than 60 percent but less than or equal to 80 35
percent...................................................
Greater than 80 percent but less than or equal to 85 50
percent...................................................
Greater than 85 percent but less than or equal to 90 75
percent...................................................
Greater than 90 percent but less than or equal to 95 100
percent...................................................
Greater than 95 percent.................................... 150
------------------------------------------------------------------------
(ii) Junior lien mortgages. (A) Risk-weight table. Unless
otherwise provided in section 3(b)(2)(i) (when a junior lien
mortgages and all senior lien mortgages are held by same bank, the
transaction is treated as a single loan), or section 3(b)(2)(iii)
(mortgage loans with negative amortization features) of this
appendix D, a bank shall assign a mortgage loan secured by a junior
lien on a one-to-four family residential property to a risk weight
based on its loan-to-value ratio, in accordance with Table 2 of this
appendix D.
(B) Minimum Risk Weight for Certain Mortgage Loans Secured by
Junior Liens on One-to-Four Family Residential Properties.
Notwithstanding paragraph (b)(2)(ii)(A) of this section, a loan
secured by a one-to-four family residential property that is not
either owner-occupied or rented, that is 90 days or more past due,
that has been placed in nonaccrual status, has been restructured, or
that does not meet prudent underwriting standards, shall receive a
risk weight of 100 percent or higher, if warranted by the loan-to-
value ratio, according to Table 2 of this appendix D.
(C) Loan-to-value ratio calculation. (1) Initial loan-to-value
ratio calculation. (i) Generally. For the purpose of determining the
appropriate risk weight in accordance with Table 2 of this appendix
D, a bank shall determine the loan-to-value ratio for a mortgage
loan secured by junior lien a one-to-four family residential
property, including a structured mortgage or a home equity line of
credit, by dividing the aggregate principal outstanding on the
junior lien mortgage and all senior lien mortgages by the appraisal
or evaluation at the origination of the junior lien. For the
purposes of this calculation, if a third party holds a senior or
intervening lien mortgage with a negative amortization feature, the
bank must adjust the principal amount of the senior or intervening
lien mortgage to reflect the amount of that loan if it were to fully
negatively amortize under the applicable contract.
(ii) Loan level private mortgage insurance. In determining the
loan-to-value ratio, a bank may take into account loan-level private
mortgage insurance, provided the insurer is not affiliated with the
bank and has long term debt rated at least third highest investment
grade (without credit enhancements) by an NRSRO.
(iii) Appraisal or evaluation. Any appraisal or evaluation used
by a bank for the purposes of this section must satisfy the real
estate lending and appraisal requirements set forth in subpart C of
12 CFR part 34.
(2) Adjustments to the loan-to-value ratio. After origination of
a mortgage loan, a bank may update the value of a one-to-four family
residential property based on an appraisal or evaluation only if the
borrower refinances the mortgage loan and the bank extends
additional funds. On a quarterly basis, a bank may adjust the amount
of the loan to reflect any decrease in the principal balance. In the
case of a home equity line of credit, the bank shall adjust the
amount of the loan quarterly to reflect any increase in the balance
of the loan.
Table 2.--Risk Weights Applicable to Mortgage Loans Secured by Stand-
Alone Junior Liens on One-to-Four Family Residential Properties
------------------------------------------------------------------------
Risk weight
Combined loan-to-value ratio (in
percent)
------------------------------------------------------------------------
Less than 60 percent....................................... 75
Greater than 60 percent but less than or equal to 90 100
percent...................................................
Greater than 90 percent.................................... 150
------------------------------------------------------------------------
(iii) Mortgage loans with negative amortization features. (A)
Risk weight table. The funded portion of a mortgage loan secured by
a lien on a one-to-four family residential property that includes a
negative amortization feature shall be assigned to a risk-weight
category based on that portion's loan-to-value ratio, in accordance
with Table 1 or Table 2. The amount equal to the maximum unfunded
amount of the loan if it were to negatively amortize to the fullest
extent allowed under the applicable loan contract shall be treated
as a commitment, as set forth in section 3(c) of this appendix D.
The risk weight applicable to the unfunded amount is the risk weight
that would be assigned to a loan with a LTV ratio computed using a
loan amount that is equal to the funded amount of the loan plus the
maximum unfunded amount of the loan if it were to negatively
amortize to the fullest extent allowed under the applicable
contract.
(B) Loan-to-value ratio calculation. (1) Initial LTV ratio
calculation. (i) Generally. For the purpose of determining the
appropriate risk weight for a mortgage loan secured by lien on a
one-to-four family residential property in accordance with Table 1
or Table 2 of this appendix D, a bank initially shall determine the
loan-to-value ratio using the lower of the purchase price or the
appraisal or evaluation at origination.
(ii) Loan level private mortgage insurance. In determining the
loan-to-value ratio, a bank may take into account loan-level private
mortgage insurance, provided the insurer is not affiliated with the
bank and has long-term debt rated at least third highest investment
grade (without credit enhancements) by an NRSRO.
(iii) Appraisal or evaluation. Any appraisal or evaluation used
by a bank for the purposes of this appendix D must satisfy the real
estate lending and appraisal requirements set forth in subpart C of
part 34 of this title 12.
(2) Adjustments to the loan-to-value ratio. After origination of
a mortgage loan, a bank may update the value of a one-to-four family
residential property based on an appraisal or evaluation only if the
borrower refinances the mortgage loan and the bank extends
additional funds. As the loan balance increases, banks must
recalculate the LTV ratio on a quarterly basis.
(iv) Grandfathered loans. (A) If a bank owns mortgage loans
secured by liens on one-to-four-family residential properties prior
to electing to apply the requirements set forth in this appendix D
of this Part 3, the bank may elect to determine the risk weights
[[Page 77476]]
applicable to all such mortgage loans according to the requirements
set forth in appendix A of this part 3.
(B) If a bank has previously applied the requirements set forth
in this appendix D to determine the risk weight applicable to a
mortgage loan secured by a lien on a one-to-four family residential
property, the bank may not thereafter elect to determine the risk
weight applicable the mortgage loan according to the requirements
set forth in section 3(b)(2)(iv)(A) of this appendix D.
(3) Externally rated exposures. (i) Claims on foreign central
governments. A bank shall determine the risk weight applicable to an
externally rated short-or long-term foreign central government
security or claim based on the external rating of the issued
security or claim in accordance with Table 3 or Table 4 of this
appendix D. The lowest single rating shall apply if there are two or
more relevant external ratings. If the security or loan is not
rated, a bank shall determine the risk weight based on the external
rating of the issuing central government in accordance with Table 3
of this appendix D. The lowest single rating shall apply if the
central government receives two or more external ratings.
(ii) Claims collateralized by foreign central government debt
securities. A bank may determine the risk weight applicable to the
portion of a claim collateralized by a liquid and readily marketable
short-or long-term foreign central government security based on the
external rating of the issued security, provided that either the
central government or the security is externally rated at least
investment grade by an NRSRO, in accordance with Table 3 or Table 4
of this Appendix D. The lowest single rating shall apply if the
collateral receives more than one external rating. If the collateral
is not rated, a bank may determine the risk weight applicable to the
collateralized portion of the claim based on the risk weight of the
central government that issued the security, in accordance with
Table 3 or Table 4 of this appendix D. The lowest single rating
shall apply if the central government receives two or more external
ratings.
(iii) Claims guaranteed by foreign central governments. A bank
may determine the risk weight applicable to the portion of a claim
supported by an eligible guarantee from a foreign central government
based on the long-term external rating of the central government or
the external rating of the foreign central government's senior long-
term debt (without credit enhancement), provided that it is rated at
least investment grade by an NRSRO, in accordance with Table 3 of
this appendix D. The lowest single rating shall apply if there are
two or more relevant external ratings.
(iv) Other externally rated claims. Unless otherwise provided in
section 3(b)(1) in this Appendix D (risk-weight categories), a bank
shall determine the risk weight applicable to a claim on non-central
government entity \9\ based on the external rating of the claim, in
accordance with Table 3 or Table 4 of this appendix D. The lowest
single rating shall apply if the claim receives more than one
external rating. This section does not apply to asset- and mortgage-
backed securities, direct credit substitutes, and residual
interests. Asset- and mortgage-backed securities, direct credit
substitutes and residual interests are risk-weighted according to
section 4 of this appendix D.
---------------------------------------------------------------------------
\9\ Non-central government entities include securities firms,
insurance companies, bank holding companies, savings and loan
holding companies, multilateral lending and regional development
institutions, partnerships, limited liability companies, business
trusts, special purpose entities, associations and other similar
organizations.
---------------------------------------------------------------------------
(v) Other collateralized claims. Unless otherwise provided in
section 3(b)(1) in this appendix D (risk-weight categories), a bank
may determine the risk weight applicable to the portion of a claim
collateralized by a liquid and readily marketable externally rated
debt security based on the external rating of the security, provided
that the security is externally rated at least investment grade by
an NRSRO, in accordance with Table 3 or Table 4 of this appendix D.
A bank may determine the risk weight applicable to a claim
collateralized by an externally rated recourse obligation, direct
credit substitute, residual interest, or asset-or mortgage-backed
security, provided the collateral is rated at least investment grade
by an NRSRO, in accordance with section 4(c)(1) and Table 6 of this
appendix D. The lowest single rating shall apply if the collateral
receives more than one external rating.
(vi) Other guaranteed claims. Unless otherwise provided in
section 3(b)(1) in this appendix D (risk-weight categories), a bank
may determine the risk weight applicable to the portion of a claim
supported by an eligible guarantee based on the external rating of
the guarantor's senior long-term debt (without credit enhancement),
provided that it is rated at least investment grade by an NRSRO, in
accordance with Table 3 of this appendix D. The lowest single rating
shall apply if the guarantor's externally rated senior long-term
debt receives more than one external rating.
Table 3.--Risk Weights Based on External Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
Central Non-central
government government
Long-term rating category Examples risk weight risk weight
(in percent) (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating.............. AAA.............................. 0 20
Second-highest investment grade rating....... AA............................... 20 20
Third-highest investment grade rating........ A................................ 20 35
Lowest-investment grade rating--plus......... BBB+............................. 35 50
Lowest-investment grade rating............... BBB.............................. 50 75
Lowest-investment grade rating--minus........ BBB-............................. 75 100
One category below investment grade.......... BB+,BB........................... 75 150
One category below investment grade--minus... BB-.............................. 100 200
Two or more categories below investment grade B, CCC........................... 150 200
Unrated (excludes unrated loans to non- n/a.............................. 200 200
central government \1\.
----------------------------------------------------------------------------------------------------------------
\1\ Unrated claims on foreign central governments and unrated debt securities issued by non-central governments
would receive the risk weight indicated in Table 3. Other unrated claims, for example, unrated loans to non-
central governments, would continue to be risk weighted under the existing risk-based capital rules.
Table 4.--Risk Weights Based on External Ratings for Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
Central Non-central
government government
Short-term rating category Examples risk weight risk weight
(in percent) (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating................ A-1, P-1....................... 0 20
Second-highest investment grade rating......... A-2, P-2....................... 20 35
Lowest investment grade rating................. A-3, P-3....................... 50 75
[[Page 77477]]
Unrated (excludes unrated loans to non- n/a............................ 100 100
sovereigns) \1\.
----------------------------------------------------------------------------------------------------------------
\1\ Unrated claims on foreign central governments and unrated debt securities issued by non-central governments
would receive the risk weight indicated in Table 4. Other unrated claims, for example, unrated loans to non-
central governments, would continue to be risk weighted under the existing risk-based capital rules.
(c) Off-Balance Sheet Activities. (1) The risk weights assigned
to off-balance sheet activities are determined by a two-step
process. First, the face amount of the off-balance sheet item is
multiplied by the appropriate credit conversion factor specified in
this section. This calculation translates the face amount of an off-
balance sheet item into an on-balance sheet credit equivalent
amount. Second, the resulting credit equivalent amount is then
assigned to the proper risk-weight category using the criteria
regarding obligors, guarantors, and collateral listed in sections
3(b)(1) and 3(b)(3) of this appendix D. Collateral and guarantees
are applied to the face amount of an off-balance sheet item;
however, with respect to derivative contracts, collateral and
guarantees are applied to the credit equivalent amounts of such
derivative contracts. The following are the off-balance sheet items
subject to this appendix D, and their respective credit conversion
factors.
(i) 100 percent credit conversion factor. (A) Risk
participations purchased in bankers' acceptances.
(B) Contingent obligations with a certain draw down, e.g.,
legally binding agreements to purchase assets at a specified future
date.
(C) Indemnification of customers whose securities the bank has
lent as agent. If the customer is not indemnified against loss by
the bank, the transaction is excluded from the risk-based capital
calculation.\10\
---------------------------------------------------------------------------
\10\ When a bank lends its own securities, the transaction is
treated as a loan. When a bank lends its own securities or, acting
as agent, agrees to indemnify a customer, the transaction is
assigned to the risk weight appropriate to the obligor or collateral
that is delivered to the lending or indemnifying institution or to
an indepdent custodian acting on their behalf.
---------------------------------------------------------------------------
(ii) 50 percent credit conversion factor. (A) Transaction-
related contingencies including, among other things, performance
bonds and performance-based standby letters of credit related to a
particular transaction.\11\ To the extent permitted by law or
regulation, performance-based standby letters of credit include such
things as arrangements backing subcontractors' and suppliers'
performance, labor and materials contracts, and construction bids;
---------------------------------------------------------------------------
\11\ For purposes of this section, 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 standy letters of credit are
treated in accordance with 4 of this appendix D.
---------------------------------------------------------------------------
(B) Unused portions of commitments with an original maturity
exceeding one-year that are not unconditionally cancelable; \12\
however, commitments that are asset-backed commercial paper
liquidity facilities must satisfy the eligibility requirements under
section 3(c)(1)(vi)(B) of this appendix D.
---------------------------------------------------------------------------
\12\ Participations in commitments are treated in accordance
with section 4 of appendix D.
---------------------------------------------------------------------------
(C) Unused portions of negatively amortizing mortgage loans with
an original maturity exceeding one-year that are secured by liens on
one-to-four family residential properties and are not
unconditionally cancelable. If a mortgage loan secured by a lien on
a one-to-four family residential property may negatively amortize,
the bank shall calculate the risk-weighted asset amount for the
unfunded portion of the loan by multiplying the amount of the off-
balance sheet exposure by the applicable credit conversion factor.
(1) The amount of the off-balance sheet exposure is the maximum
unfunded amount of the loan if it were to negatively amortize to the
fullest extent allowed under the applicable contract; and
(2) The applicable risk weight is the risk weight that would be
assigned under section 3(b)(2) of this appendix D to a loan with an
LTV computed using a loan amount that is equal to the funded amount
of the loan plus the maximum unfunded amount of the loan if it were
to negatively amortize to the fullest extent allowed under the
applicable contract.
(D) Revolving underwriting facilities, note issuance facilities,
and similar arrangements pursuant to which the bank's customer can
issue short-term debt obligations in its own name, but for which the
bank has a legally binding commitment to either:
(1) Purchase the obligations the customer is unable to sell by a
stated date; or
(2) Advance funds to its customer if the obligations cannot be
sold.
(iii) 20 percent credit conversion factor. (A) Trade-related
contingencies. These are short-term self-liquidating instruments
used to finance the movement of goods and are collateralized by the
underlying shipment. A commercial letter of credit is an example of
such an instrument.
(B) [Reserved].
(iv) 10 percent credit conversion factor. (A) Unused portion of
asset-backed commercial paper liquidity facilities with an original
maturity of one year or less that satisfy the eligibility
requirements under section 3(c)(1)(vi)(B) of this appendix.
(B) Unused portions of commitments with maturities of one year
or less that are not unconditionally cancelable,\13\ except for
commitments to originate mortgage loans secured by one-to-four
family residential properties provided in the ordinary course of
business.
---------------------------------------------------------------------------
\13\ Participations in commitments are treated in accordance
with section of appendix D.
---------------------------------------------------------------------------
(C) Unused portions of negatively amortizing mortgage loans with
an original maturity of one-year or less that are secured by liens
on one-to-four family residential properties and that are not
unconditionally cancelable. If a mortgage loan secured by a lien on
a one-to-four family residential property may negatively amortize,
the bank shall calculate the risk-weighted asset amount for the
unfunded portion of the loan by multiplying the amount of the off-
balance sheet exposure by the applicable credit conversion factor.
(1) The amount of the off-balance sheet exposure is the maximum
unfunded amount of the loan if it were to negatively amortize to the
fullest extent allowed under the applicable contract; and
(2) The applicable risk weight is the risk weight that would be
assigned under section 3(b)(2) of this appendix D to a loan with a
loan-to-value ratio computed using a loan amount that is equal to
the funded amount of the loan plus the maximum unfunded amount of
the loan if it were to negatively amortize to the fullest extent
allowed under the applicable contract.
(v) Zero percent credit conversion factor. (A) Unused portion of
commitments, regardless of maturity, if they are unconditionally
cancelable \14\ at any time at the option of the bank and the bank
has the contractual right to make, and in fact does make, either--
---------------------------------------------------------------------------
\14\ See section 1(c)(35) of appendix A to this part 3.
---------------------------------------------------------------------------
(1) A separate credit decision based upon the borrower's current
financial condition, before each drawing under the lending facility;
or
(2) An annual (or more frequent) credit review based upon the
borrower's current financial condition to determine whether or not
the lending facility should be continued.
(B) The unused portion of retail credit card lines or other
related plans that are unconditionally cancelable by the bank in
accordance with applicable law.
(vi) Liquidity facility provided to asset-backed commercial
paper. (A) Noneligible asset-backed commercial paper liquidity
facilities treated as recourse or direct credit substitute. Unused
portion of asset-backed commercial paper liquidity facilities that
do not meet the criteria for an eligible liquidity
[[Page 77478]]
facility provided to asset-backed commercial paper in accordance
with section 3(c)(1)(vi)(B) of this appendix must be treated as
recourse or as a direct credit substitute, and assessed the
appropriate risk-based capital charge in accordance with section 4
of this appendix.
(B) Eligible asset-backed commercial paper liquidity facility.
Except as provided in section 3(c)(1)(vi)(C) of this appendix D, in
order for the unused portion of an asset-backed commercial paper
liquidity facility to be eligible for either the 50 percent or 10
percent credit conversion factors under sections 3(c)(1)(ii)(B) or
3(c)(1)(iv)(A) of this appendix D, the asset-backed commercial paper
liquidity facility must satisfy the following criteria:
(1) At the time of draw, the asset-backed commercial paper
liquidity facility must be subject to an asset quality test that:
(i) Precludes funding of assets that are 90 days or more past
due or in default; and
(ii) If the assets that an asset-backed commercial paper
liquidity facility is required to fund are externally rated
securities at the time they are transferred into the program, the
asset-backed commercial paper liquidity facility must be used to
fund only securities that are externally rated investment grade at
the time of funding. If the assets are not externally rated at the
time they are transferred into the program, then they are not
subject to this investment grade requirement.
(2) The asset-backed commercial paper liquidity facility must
provide that, prior to any draws, the bank's funding obligation is
reduced to cover only those assets that satisfy the funding criteria
under the asset quality test as provided in section
3(c)(1)(vi)(B)(1) of this appendix D.
(C) Exception to eligibility requirements for assets guaranteed
by the United States Government or its agencies, or the central
government of an OECD country. Notwithstanding the eligibility
requirements for asset-backed commercial paper program liquidity
facilities in section 3(c)(1)(vi)(B), the unused portion of an
asset-backed commercial paper liquidity facility may still qualify
for either the 50 percent or 10 percent credit conversion factors
under sections 3(c)(1)(ii)(B) or 3(c)(1)(iv)(A) of this appendix D,
if the assets required to be funded by the asset-backed commercial
paper liquidity facility are guaranteed, either conditionally or
unconditionally, by the United States Government or its agencies, or
the central government of an OECD country.
(vii) Derivative contracts. (A) Calculation of credit equivalent
amounts. The credit equivalent amount of a derivative contract
equals the sum of the current credit exposure and the potential
future credit exposure of the derivative contract. The calculation
of credit equivalent amounts must be measured in U.S. dollars,
regardless of the currency or currencies specified in the derivative
contract.
(1) Current credit exposure. The current credit exposure for a
single derivative contract is determined by the mark-to-market value
of the derivative contract. If the mark-to-market value is positive,
then the current credit exposure equals that mark-to-market value.
If the mark-to-market is zero or negative, then the current credit
exposure is zero. The current credit exposure for multiple
derivative contracts executed with a single counterparty and subject
to a qualifying bilateral netting contract is determined as provided
by section 3(c)(1)(vii)(B) of this appendix D.
(2) Potential future credit exposure. The potential future
credit exposure for a single derivative contract, including a
derivative contract with negative mark-to-market value, is
calculated by multiplying the notional principal \15\ of the
derivative contract by one of the credit conversion factors in Table
5 of this appendix D, for the appropriate category.\16\ The
potential future credit exposure for gold contracts shall be
calculated using the foreign exchange rate conversion factors. For
any derivative contract that does not fall within one of the
specified categories in Table 5 of this appendix D, the potential
future credit exposure shall be calculated using the other commodity
conversion factors. Subject to examiner review, banks should use the
effective rather than the apparent or stated notional amount in
calculating the potential future credit exposure. The potential
future credit exposure for multiple derivatives contracts executed
with a single counterparty and subject to a qualifying bilateral
netting contract is determined as provided by section
3(c)(1)(vii)(B)(1) of this appendix D.
---------------------------------------------------------------------------
\15\ For purposes of calculating either the potential future
credit exposure under section 3(c)(1)(vii)(A)(2) of this appendix D
or the gross potential future credit exposure under section
3(c)(1)(vii)(B)(1)(ii) of this appendix D for foreign exchange
contracts and other similar contracts in which the notional
principal is equivalent to the cash flows, total notional principal
is the net receipts to each party falling due on each value date in
each currency.
\16\ No potential future credit exposure is calculated for
single currency interest rate swaps in which payments are made based
upon two floating indices, so-called floating/floating or basis
swaps; the credit equivalent amount is measured solely on the basis
of the current credit exposure.
Table 5.--Conversion Factor Matrix \1\
----------------------------------------------------------------------------------------------------------------
Foreign
Interest rate exchange rate Equity (in Precious Other
Remaining maturity \2\ (in percent) and gold (in percent) metals (in commodity (in
percent) percent) percent)
----------------------------------------------------------------------------------------------------------------
One year or less................ 0.0 1.0 6.0 7.0 10.0
Over one year to five........... 0.5 5.0 8.0 7.0 12.0
Over five years................. 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
\1\ For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
number of remaining payments in the derivative contract.
\2\ For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
than one year shall be subject to a minimum conversion factor of 0.5 percent.
(B) Derivative contracts subject to a qualifying bilateral
netting contract. (1) Netting calculation. The credit equivalent
amount for multiple derivative contracts executed with a single
counterparty and subject to a qualifying bilateral netting contract
as provided by section (3)(c)(1)(vii)(B)(2) of this appendix D is
calculated by adding the net current credit exposure and the
adjusted sum of the potential future credit exposure for all
derivative contracts subject to the qualifying bilateral netting
contract.
(i) Net current credit exposure. The net current credit exposure
is the net sum of all positive and negative mark-to-market values of
the individual derivative contracts subject to a qualifying
bilateral netting contract. If the net sum of the mark-to-market
value is positive, then the net current credit exposure equals that
net sum of the mark-to-market value. If the net sum of the mark-to-
market value is zero or negative, then the net current credit
exposure is zero.
(ii) Adjusted sum of the potential future credit exposure. The
adjusted sum of the potential future credit exposure is calculated
as:
Anet=0.4xAgross+(0.6xNGRxAgross)
Anet is the adjusted sum of the potential future
credit exposure, Agross is the gross potential future
credit exposure, and NGR is the net to gross ratio.
Agross is the sum of the potential future credit exposure
(as determined under section 3(c)(1)(vii)(A)(2) of this appendix D)
for each individual derivative contract subject to the qualifying
bilateral netting contract. The NGR is the ratio of the net current
credit exposure to the gross current credit exposure. In calculating
[[Page 77479]]
the NGR, the gross current credit exposure equals the sum of the
positive current credit exposures (as determined under section
3(c)(1)(vii)(A)(1) of this appendix D) of all individual derivative
contracts subject to the qualifying bilateral netting contract.
(2) Qualifying bilateral netting contract. In determining the
current credit exposure for multiple derivative contracts executed
with a single counterparty, a bank may net derivative contracts
subject to a qualifying bilateral netting contract by offsetting
positive and negative mark-to-market values, provided that:
(i) The qualifying bilateral netting contract is in writing.
(ii) The qualifying bilateral netting contract is not subject to
a walkaway clause.
(iii) The qualifying bilateral netting contract creates a single
legal obligation for all individual derivative contracts covered by
the qualifying bilateral netting contract. In effect, the qualifying
bilateral netting contract must provide that the bank would have a
single claim or obligation either to receive or to pay only the net
amount of the sum of the positive and negative mark-to-market values
on the individual derivative contracts covered by the qualifying
bilateral netting contract. The single legal obligation for the net
amount is operative in the event that a counterparty, or a
counterparty to whom the qualifying bilateral netting contract has
been assigned, fails to perform due to any of the following events:
default, insolvency, bankruptcy, or other similar circumstances.
(iv) The bank obtains a written and reasoned legal opinion(s)
that represents, with a high degree of certainty, that in the event
of a legal challenge, including one resulting from default,
insolvency, bankruptcy, or similar circumstances, the relevant court
and administrative authorities would find the bank's exposure to be
the net amount under:
(A) The law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities, and if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(B) The law of the jurisdiction that governs the individual
derivative contracts covered by the bilateral netting contract; and
(C) The law of the jurisdiction that governs the qualifying
bilateral netting contract.
(v) The bank establishes and maintains procedures to monitor
possible changes in relevant law and to ensure that the qualifying
bilateral netting contract continues to satisfy the requirement of
this section.
(vi) The bank maintains in its files documentation adequate to
support the netting of a derivative contract.\17\
---------------------------------------------------------------------------
\17\ By netting individual derivative contracts for the purpose
of calculating its credit equivalent amount, a bank represents that
documentation adequate to support the netting of a set of derivative
contract is in the bank's files and available for inspection by the
OCC. Upon determination by the OCC that a bank's files are
inadequate or that a qualifying bilateral netting contract may not
be legally enforceable in any one of the bodies of law described in
sections 3(c)(1)(vii)(B)(2)(i) through (iii) of this appendix D, the
underlying derivative contracts may not be netted for the purposes
of this section.
---------------------------------------------------------------------------
(C) Risk weighting. Once the bank determines the credit
equivalent amount for a derivative contract or a set of derivative
contracts subject to a qualifying bilateral netting contract, the
bank assigns that amount to the risk weight category appropriate to
the counterparty, or, if relevant, the nature of any collateral or
guarantee.\18\
---------------------------------------------------------------------------
\18\ Derivative contracts are an exception to the general rule
of applying collateral and guarantees to the face value of off-
balance sheet items. The sufficiency of collateral and guarantees is
determined on the basis of the credit equivalent amount of
derivative contracts. However, collateral and guarantees held
against a qualifying bilateral netting contract is not recognized
for capital purposes unless it is legally available for all
contracts included in the qualifying bilateral netting contract.
---------------------------------------------------------------------------
(D) Exceptions. The following derivative contracts are not
subject to the above calculation, and therefore, are not part of the
denominator of a national bank's risk-based capital ratio:
(1) An exchange rate contract with an original maturity of 14
calendar days or less; \19\ and
---------------------------------------------------------------------------
\19\ Notwithstanding section 3(c)(1)(v)(A) of this appendix D,
gold contracts do not qualify for this exception.
---------------------------------------------------------------------------
(2) A derivative contract that is traded on an exchange
requiring the daily payment of any variations in the market value of
the contract.
Section 4. Securitizations.
(a) 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
percent 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.
(b) 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 percent 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 percent 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
percent 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.
(c) 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 Table 6 or Table 7 of this appendix D.\20\ If a traded position
receives more than one external rating, the lowest single rating
will apply.
---------------------------------------------------------------------------
\20\ 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 percent risk
category.
[[Page 77480]]
Table 6.--Risk Weights Based on External Ratings for Long-Term Exposures
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (in percent)
------------------------------------------------------------------------
Highest investment grade.... AAA....................... 20
Second highest investment AA........................ 20
grade.
Third highest investment A......................... 35
grade.
Lowest investment grade-- BBB+...................... 50
plus.
Lowest investment grade..... BBB....................... 75
Lowest-investment grade-- BBB-...................... 100
minus.
One category below BB+, BB................... 200
investment grade.
One category below BB-....................... 200
investment grade--minus.
------------------------------------------------------------------------
Table 7.--Risk Weights Based on External Ratings for Short-Term
Exposures
------------------------------------------------------------------------
Risk Weight
Short-term rating category Examples (in percent)
------------------------------------------------------------------------
Highest investment grade.... A-1, P-1.................. 20
Second highest investment A-2, P-2.................. 35
grade.
Lowest investment grade..... A-3, P-3.................. 75
------------------------------------------------------------------------
(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(c)(1) of
this appendix D 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.
(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
4(c)(1) of this appendix D, 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.
(e) Residual Interests--(1) Concentration limit on credit-
enhancing interest-only strips. In addition to the capital
requirement provided by section 4(e)(2) of this appendix D, 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 appendix A of this part.
(2) Credit-enhancing interest-only strip capital requirement.
After applying the concentration limit to credit-enhancing interest-
only strips in accordance with section 4(e)(1) of this appendix D, 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 3(d) or (e) of this appendix D, 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 section
4(e)(1)-(3) of this appendix D 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) 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 8 of this appendix D, 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(f)(1)through (3) of this appendix D.
Table 8.--Risk Weights Based on Internal Ratings
------------------------------------------------------------------------
Risk weight
Rating category Examples (in percent)
------------------------------------------------------------------------
Investment grade............ BBB or better............. 100
One category below BB........................ 200
investment grade.
------------------------------------------------------------------------
[[Page 77481]]
(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;
(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.
(g) 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(a)
of this appendix D, for the asset supported by the bank's position,
the risk based capital required under this appendix D 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 D 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 D, 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.
(h) Alternative Capital Calculation for Small Business
Obligations. (1) Definitions. For purposes of this section 4(h):
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(h), or
(B) Is adequately capitalized as defined in 12 CFR 6.4 without
applying the capital treatment described in this section 4(h) and
has received written permission from the appropriate district office
of the OCC to apply the capital treatment described in this section
4(h).
Recourse has the meaning given to such term under generally
accepted accounting principles.
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
paragraph (other than paragraph (h)) 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(h)(2) of this appendix D 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(h)(3) of this appendix D, the bank may
continue to apply the capital treatment described in section 4(h)(2)
of this appendix D 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(h) 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(h)) and,
after applying the capital treatment described in this section 4(h),
the bank would be well capitalized.
(ii) A bank shall compute its capital without regard to this
section 4(h) for purposes of 12 U.S.C. 1831o(g) regardless of the
bank's capital level.
(i) Additional capital charge for revolving securitizations with
an early amortization trigger. A bank that securitizes revolving
credits where the securitization structure contains an early
amortization provision must maintain risk-based capital against the
investors' interest as required under this section.
(1) Capital for securitizations of revolving credit exposures
that incorporate early-amortization provisions will be assessed
based on a comparison of the securitization's annualized three-month
average excess spread against the excess spread trapping point.
(2) To calculate the securitization's excess spread trapping
point ratio:
(i) A bank must first calculate the annualized three month ratio
for excess spread as follows:
(A) For each of the three months, divide the month's excess
spread by the outstanding principal balance of the underlying pool
of exposures at the end of each month.
[[Page 77482]]
(B) Calculate the average ratio for the three months, then
convert the result to a compound annual rate.
(ii) Then the bank must divide the annualized three month ratio
for excess spread by the excess spread trapping point that is
specified in the documentation for the securitization.
(3) Banks shall compare the excess spread trapping point ratio
to the ratios contained in Table 9 in appendix D to determine the
appropriate conversion factor to apply to the investor's interest.
The amount of investor's interest after conversion is then assigned
to a risk-weight category in accordance with that appropriate to the
underlying obligor, collateral, or guarantor. For securitizations
that do not require excess spread to be trapped, or that specify
trapping points based primarily on performance measures other than
the three-month average excess spread, the excess spread trapping
point is 4.5 percent.
Table 9.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
CCF (in
3-month average excess spread percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more................ 0
Less than 133.33 percent to 100 percent of trapping 5
point..................................................
Less than 100 percent to 75 percent of trapping point... 15
Less than 75 percent to 50 percent of trapping point.... 50
Less than 50 percent of trapping point.................. 100
------------------------------------------------------------------------
(4) Limitations on risk-based capital requirements. For a bank
subject to the early amortization requirements in this section, the
total risk-based capital requirement for all of the bank's exposures
to a securitization of revolving retail credits is limited to the
greater of the risk-based capital requirement for residual interests
plus any early amortization charges as described in this section
4(i), or the risk-based capital requirement for the underlying
securitized assets calculated as if the bank continued to hold the
assets on its balance sheet.
Section 5. Target Ratios
(a) All national banks are expected to maintain a minimum ratio
of total capital (after deductions) to risk-weighted assets of 8.0
percent.
(b) Tier 2 capital elements qualify as part of a national bank's
total capital base up to a maximum of 100 percent of that bank's
Tier 1 capital.
(c) In addition to the standards established by these risk-based
capital guidelines, all national banks must maintain a minimum
capital-to-total assets ratio in accordance with the provisions of
12 CFR part 3.
Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the joint preamble, the Board of
Governors of the Federal Reserve System proposes to amend parts 208 and
225 of chapter II of title 12 of the Code of Federal Regulations as
follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues to read as
follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j),
1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x, 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, the following amendments are
proposed:
a. Section I, Overview, is revised.
b. In section II, Definition of Qualifying Capital for the Risk-
Based Capital Ratio, the first paragraph is revised.
c. In section III.A, Procedures, the first paragraph is revised,
the fifth paragraph is redesignated as the sixth paragraph, and a new
fifth paragraph is added.
d. In section III.C, the first paragraph is revised.
e. Section IV is removed and a new section IV, Alternative Approach
for Computing Weighted Risk Assets and Off-Balance-Sheet Items, is
added.
f. Attachment I is removed.
Appendix A To Part 208--Capital Adequacy Guidelines For State Member
Banks: Risk-Based Measure
I. Overview
The Board of Governors of the Federal Reserve System has adopted
a risk-based capital measure to assist in the assessment of the
capital adequacy of state member banks.\1\ The principal objectives
of this measure are to: (i) Make regulatory capital requirements
more sensitive to differences in risk profiles among banks; (ii)
factor off-balance sheet exposures into the assessment of capital
adequacy; (iii) minimize disincentives to holding liquid, low-risk
assets; and (iv) achieve greater consistency in the evaluation of
the capital adequacy of major banks throughout the world.\2\
---------------------------------------------------------------------------
\1\ A leverage capital measure for state member banks is
outlined in appendix B of this part.
\2\ The risk-based capital measure is based upon a framework
developed jointly by supervisory authorities from the countries
represented on the Basel Committee on Banking Supervision (Basel
Supervisors' Committee) and endorsed by the Group of Ten Central
Bank Governors. The framework is described in a paper prepared by
the Basel Supervisors' Committee entitled ``International
Convergence of Capital Measurement,'' July 1988.
---------------------------------------------------------------------------
The risk-based capital guidelines include both a definition of
capital and a framework for calculating weighted risk assets by
assigning assets and off-balance sheet items to broad risk
categories. A bank's risk-based capital ratio is calculated by
dividing its qualifying capital (the numerator of the ratio) by its
weighted risk assets (the denominator).\3\ The definition of
qualifying capital is outlined in section II, and the procedures for
calculating weighted risk assets are discussed in sections III and
IV.
---------------------------------------------------------------------------
\3\ Banks will initially be expected to utilize period-end
amounts in calculating their risk-based capital ratios. When
necessary and appropriate, ratios based on average balances may also
be calculated on a case-by-case basis. Moreover, to the extent banks
have data on average balances that can be used to calculate risk-
based ratios, the Federal Reserve will take such data into account.
---------------------------------------------------------------------------
In addition, when certain banks that engage in trading
activities calculate their risk-based capital ratios under this
appendix A, they must also refer to appendix E of this part, which
incorporates capital charges for certain market risks into the risk-
based capital ratios. When calculating their risk-based capital
ratios under this appendix A, such banks are required to refer to
appendix E of this part for supplemental rules to determine
qualifying and excess capital, calculate weighted risk assets,
calculate market risk equivalent assets, and calculate risk-based
capital ratios adjusted for market risk.
The risk-based capital guidelines apply to all state member
banks on a consolidated basis. They are to be used in the
examination and supervisory process as well as in the analysis of
applications acted upon by the Federal Reserve. Thus, in considering
an application filed by a state member bank, the Federal Reserve
will take into account the bank's risk-based capital ratios, the
reasonableness of its capital plans, and the extent to which it
meets the risk-based capital standards.
The risk-based capital ratios focus principally on broad
categories of credit risk, although the framework for assigning
assets and off-balance-sheet items to risk categories does
incorporate elements of transfer risk, as well as limited instances
of interest rate and market risk. The framework incorporates risks
arising from traditional banking
[[Page 77483]]
activities as well as risks arising from nontraditional activities.
The risk-based capital ratios do not, however, incorporate other
factors that can affect an institution's financial condition. These
factors include overall interest-rate exposure; liquidity, funding
and market risks; the quality and level of earnings; investment,
loan portfolio, and other concentrations of credit; certain risks
arising from nontraditional activities; the quality of loans and
investments; the effectiveness of loan and investment policies; and
management's overall ability to monitor and control financial and
operating risks, including the risks presented by concentrations of
credit and nontraditional activities.
In addition to evaluating capital ratios, an overall assessment
of capital adequacy must take account of those factors, including,
in particular, the level and severity of problem and classified
assets as well as a bank's exposure to declines in the economic
value of its capital due to changes in interest rates. For this
reason, the final supervisory judgment on a bank's capital adequacy
may differ significantly from conclusions that might be drawn solely
from the level of its risk-based capital ratios.
The risk-based capital guidelines establish a minimum ratio of
qualifying total capital to weighted risk assets of 8 percent, of
which at least 4 percentage points must be in the form of tier 1
capital. In light of the considerations just discussed, banks
generally are expected to operate well above the minimum risk-based
ratios. In particular, banks contemplating significant expansion
proposals are expected to maintain strong capital levels
substantially above the minimum ratios and should not allow
significant diminution of financial strength below these strong
levels to fund their expansion plans. Institutions with high or
inordinate levels of risk are also expected to operate well above
minimum capital standards. In all cases, institutions should hold
capital commensurate with the level and nature of the risks to which
they are exposed. Banks that do not meet the minimum risk-based
capital standard, or that are otherwise considered to be
inadequately capitalized, are expected to develop and implement
plans acceptable to the Federal Reserve for achieving adequate
levels of capital within a reasonable period of time.
The Board will monitor the implementation and effect of these
guidelines in relation to domestic and international developments in
the banking industry. When necessary and appropriate, the Board will
consider the need to modify the guidelines in light of any
significant changes in the economy, financial markets, banking
practices, or other relevant factors.
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 in this section II.
* * * * *
III. * * *
A. * * *
Assets and credit-equivalent amounts of off-balance-sheet items
of state member banks are assigned to one of several broad risk
categories, according to the obligor, or, if relevant, the
guarantor, the nature of the collateral, or an external rating. The
aggregate dollar value of the amount in each category is then
multiplied by the risk weight associated with the category. The
resulting weighted values from each of the risk categories are added
together, and this sum is the bank's total weighted risk assets that
comprise the denominator of the risk-based capital ratios.
* * * * *
A bank may elect to apply the alternative procedures for
computing weighted risk assets set forth in section IV of this
appendix A (``Alternative Approach''). The Federal Reserve also may
require a bank to apply the Alternative Approach if the Federal
Reserve determines that the Alternative Approach would produce risk-
based capital requirements that more accurately reflect the risk
profile of the bank or would otherwise enhance the safety and
soundness of the bank. A bank that applies the Alternative Approach
must apply all the procedures set forth in section IV of this
appendix A and also must apply all the procedures set forth in this
section that are not inconsistent with the procedures in section IV.
* * * * *
C. * * *
Assets and on-balance-sheet credit equivalent amounts are
assigned to the following risk weight categories: 0 percent, 20
percent, 50 percent, or 100 percent. A brief explanation of the
components of each category follows.
* * * * *
IV. Alternative Approach for Computing Weighted Risk Assets and
Off-Balance-sheet Items
A. Scope of Application
A bank may elect to use the Alternative Approach for computing
weighted risk assets and off-balance sheet items set forth in this
section IV by giving the Federal Reserve written notice on the first
day of the quarter during which the bank elects to begin using the
Alternative Approach. A bank that has elected to apply the
Alternative Approach may opt out of the Alternative Approach after
it has given the Federal Reserve 30 days prior written notice. The
Federal Reserve may require a bank to apply the Alternative Approach
if the Federal Reserve determines that the Alternative Approach
would produce risk-based capital requirements that more accurately
reflect the risk profile of the bank or would otherwise enhance the
safety and soundness of the bank.
A bank that applies the Alternative Approach must apply all the
procedures set forth in this section IV and also must apply all the
procedures set forth in section III that are not inconsistent with
the procedures in section IV.
B. External Ratings, Collateral, Guarantees, and Other Considerations
1. External Credit Ratings. A bank must use Table 1 in this
section IV.B.1. to assign risk weights to covered claims with an
original maturity of one year or more and Table 2 in this section
IV.B.1. to assign risk weights to covered claims with an original
maturity of less than one year. Covered claims are all claims other
than (i) claims on an excluded entity, (ii) loans to non-sovereigns
that do not have an external rating, and (iii) OTC derivative
contracts. Excluded entities are (i) the U.S. central government and
U.S. government agencies, (ii) state and local governments of the
United States and other countries of the OECD, (iii) U.S.
government-sponsored agencies, and (iv) U.S. depository institutions
and foreign banks.
A bank must use column three of the tables for covered claims on
a non-U.S. sovereign \58\ and column four of the tables for covered
claims on an entity other than a non-U.S. sovereign (excluding
securitization exposures). A bank must use column five of the tables
for covered claims that are securitization exposures, which include
asset-backed securities, mortgage-backed securities, recourse
obligations, direct credit substitutes, and residual interests
(other than credit-enhancing interest-only strips).
---------------------------------------------------------------------------
\58\ For purposes of this section IV, a sovereign is defined as
a central government, including its agencies, departments,
ministries, and the central bank. This definition does not include
state, provincial, or local governments, or commercial enterprises
owned by a central government.
Table 1.--Risk Weights Based on Long-Term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-U.S. Securitization
sovereign risk Non-sovereign exposure risk
Long-term rating category Rating weight risk weight weight
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating...... AAA...................... 0 20 20
Second-highest investment grade AA....................... 20 20 20
rating.
Third-highest investment grade rating A........................ 20 35 35
Lowest investment grade rating--plus. BBB+..................... 35 50 50
[[Page 77484]]
Lowest investment grade rating-- BBB...................... 50 75 75
naught.
Lowest investment grade rating-- BBB-..................... 75 100 100
negative.
One category below investment grade-- BB+, BB.................. 75 150 200
plus & naught.
One category below investment grade-- BB-...................... 100 200 200
negative.
Two or more categories below B, CCC................... 150 200 \2\
investment grade.
Unrated.............................. n/a...................... 200 200 \2\
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 percent risk weight
category.
\2\ Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A.
Table 2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-U.S. Non-U.S.
sovereign risk sovereign risk Securitization
Short-term rating category Examples weight* weigh exposure risk
(percent) (percent) weight
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\.. A-1, P-1................. 0 20 20
Second-highest investment grade A-2, P-2................. 20 35 35
rating.
Lowest investment grade rating....... A-3, P-3................. 50 75 75
Unrated.............................. ......................... 100 100 100
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight
category.
For purposes of this section IV, an external rating is defined
as a credit rating that is assigned by an NRSRO, provided that the
credit rating:
a. Fully reflects the entire amount of credit risk with regard
to all payments owed on the claim (that is, the rating must fully
reflect the credit risk associated with timely repayment of
principal and interest);
b. Is monitored by the issuing NRSRO;
c. Is published in an accessible public form (for example, on
the NRSRO's Web site or in financial media); and
d. Is, or will be, included in the issuing NRSRO's publicly
available ratings transition matrix which tracks the performance and
stability (or ratings migration) of an NRSRO's issued external
ratings for the specific type of claim (for example, corporate
debt).
In addition, an unrated covered claim on a non-U.S. sovereign
that has an external rating from an NRSRO should be deemed to have
an external rating equal to the sovereign's issuer rating. If a
claim has two or more external ratings, the bank must use the least
favorable external rating to risk weight the claim. Similarly, if a
claim has components that are assigned different external ratings,
the lowest component rating must be applied to the entire claim. For
example, if a securitization exposure has a principal component
externally rated BBB, but the interest component is externally rated
B, the entire exposure will be subject to the gross-up treatment
accorded to a securitization exposure rated B or lower. Similarly,
if a portion of a specific claim is unrated, then the entire claim
must be treated as if it were unrated. The Federal Reserve retains
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.
2. Collateral. In addition to the forms of recognized financial
collateral set forth in section III.B.1. of this appendix A, a bank
also may recognize as collateral (i) covered claims in the form of
liquid and readily marketable debt securities that are externally
rated no less than investment grade and (ii) liquid and readily
marketable debt securities guaranteed by non-U.S. sovereigns whose
issuer rating is at least investment grade. Claims, or portions of
claims, collateralized by such collateral may be assigned to the
risk weight appropriate to the collateral's external rating as set
forth in Table 1 or 2 of section IV.B.1. For example, the portion of
a claim collateralized with an AA-rated mortgage-backed security is
assigned to the 20 percent risk weight category.
Subject to the final sentence of this paragraph, there is,
however, a 20 percent risk weight floor on collateralized claims
under this section IV. Thus, the portion of a claim collateralized
by a security issued by a non-U.S. sovereign with an issuer rating
of AAA would be assigned to the 20 percent risk weight category
instead of the zero percent risk weight category. The procedures set
forth in section III of this appendix A continue to apply, however,
to claims collateralized by securities issued or guaranteed by OECD
central governments for which a positive margin of collateral is
maintained on a daily basis, fully taking into account any change in
the bank's exposure to the obligor and counterparty under the claim
in relation to the market value of the collateral held to support
the claim.
In the event that the external rating of a security used to
collateralize a claim results in a higher risk weight than would
have otherwise been assigned to the claim, then the lower risk
weight appropriate to the underlying claim could be applied.
3. Guarantees. Claims, or portions of claims, guaranteed by a
third-party entity (other than an excluded entity) whose unsecured
long-term senior debt (without credit enhancements) is externally
rated at least investment grade or by a non-U.S. sovereign that has
an issuer rating of at least investment grade may be assigned to the
risk weight of the guarantor as set forth in Table 1 of section
IV.B.1., corresponding to the protection provider's long-term senior
debt rating (or issuer rating in the case of a non-U.S. sovereign),
provided that the guarantee:
a. Is written and unconditional,
b. Covers all or a pro rata portion of contractual payments of
the obligor on the underlying claim,
c. Gives the beneficiary a direct claim against the protection
provider,
d. Is non-cancelable by the protection provider for reasons
other than the breach of contract by the beneficiary,
e. Is legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced, and
f. Requires the protection provider to make payment to the
beneficiary upon default of the obligor on the underlying claim
without first requiring the beneficiary to demand payment from the
obligor.
C. Residential Mortgages
1. A bank may separate its residential mortgage portfolio into
two subportfolios, where the first subportfolio includes mortgage
loans originated by the bank or acquired by the bank prior to the
date the bank becomes subject to this section IV and the second
includes mortgage loans originated or acquired by the bank after
that date. The bank may apply the risk-based capital treatment set
forth in section III of this appendix A to the first subportfolio
while applying the requirements set forth in
[[Page 77485]]
this section IV to the second subportfolio. A bank that does not so
separate its residential mortgage portfolio must apply the capital
treatment in this section IV to all of its qualifying residential
mortgage exposures. If a bank at any time opts-out of the
Alternative Approach and, subsequently, again becomes subject to
this section IV, it may not apply the procedures set forth in this
section IV.C.1.
2. Subject to section IV.C.1., a bank assigns its residential
mortgage exposures to risk weight categories based on their loan-to-
value (LTV) or combined loan-to-value (CLTV) ratios, as appropriate,
in accordance with Tables 3 and 4 of sections IV.C.3.a. and
IV.C.3.b., respectively, but must risk-weight a nonqualifying
residential mortgage exposure at no less than 100 percent.
Residential mortgage exposures include all loans secured by a lien
on a one- to four-family residential property \59\ that is either
owner-occupied or rented. Qualifying residential mortgage exposures
are residential mortgage exposures that (1) have been made in
accordance with prudent underwriting standards; (2) are performing
in accordance with their original terms; (3) are not 90 days or more
past due or carried in nonaccrual status; and (4) are not made for
the purpose of speculative property development. Nonqualifying
residential mortgage exposures are residential mortgage exposures
other than qualifying residential mortgage exposures.
---------------------------------------------------------------------------
\59\ Loans that qualify as mortgages that are secured by 1- to
4-family residential properties are listed in the instructions to
the commercial bank Call Reports.
---------------------------------------------------------------------------
3. For purposes of Tables 3 and 4, LTV is defined as (i) the
current outstanding principal balance of the loan less the amount
covered by any loan-level private mortgage insurance (``PMI'')
divided by (ii) the most recent purchase price of the property or
the most recent appraisal or evaluation value of the property (if
the appraisal or evaluation is more recent than the most recent
purchase and was obtained by the bank in connection with an
extension of new credit). Loan-level PMI means insurance (i)
provided by a non-affiliated PMI provider whose unsecured long-term
senior debt (without credit enhancements) is externally rated at
least the third highest investment grade by an NRSRO, and (ii) which
protects a mortgage lender in the event of the default of a mortgage
borrower up to a predetermined portion of the value of a residential
mortgage exposure. For purposes of the loan-level PMI definition,
(i) an affiliate of a company means any company that controls, is
controlled by, or is under common control with, the company; and
(ii) a person or company controls a company if it owns, controls, or
has power to vote 25 percent or more of a class of voting securities
of the company or consolidates the company for financial reporting
purposes. CLTV for a junior lien mortgage is defined as (i) the
current outstanding principal balance of the junior mortgage and all
more senior mortgages less the amount covered by any loan-level PMI
covering the junior lien divided by (ii) the most recent purchase
price of the property or the most recent appraisal or evaluation
value of the property (if the appraisal or evaluation is more recent
than the most recent purchase and was obtained by the bank in
connection with an extension of new credit). The procedures for
residential mortgage exposures that have negative amortization
features are set forth in section IV.C.3.c.
a. First Lien Residential Mortgage Exposures
First lien residential mortgage exposures are risk-weighted in
accordance with Table 3 of this section IV.C.3.a. (with
nonqualifying residential mortgage exposures subject to a risk
weight floor of 100 percent). If a bank holds both the senior and
junior lien(s) on a residential property and no other party holds an
intervening lien, the bank's claims are treated as a single claim
secured by a senior lien for purposes of determining the LTV ratio
and assigning a risk weight.
Table 3.--Risk Weights for First Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-Value ratio (percent)
------------------------------------------------------------------------
Up to 60%.................................................. 20
>60% and up to 80%......................................... 35
>80% and up to 85%......................................... 50
>85% and up to 90%......................................... 75
>90% and up to 95%......................................... 100
>95%....................................................... 150
------------------------------------------------------------------------
b. Stand-Alone Junior Liens
Stand-alone junior lien residential mortgage exposures,
including structured mortgages and home equity lines of credit, must
be risk weighted using the CLTV ratio of the stand-alone junior lien
and all senior liens in accordance with Table 4 (with nonqualifying
residential mortgage exposures subject to a risk weight floor of 100
percent).
Table 4.--Risk Weights for Stand-Alone Junior Lien Residential Mortgage
Exposures
------------------------------------------------------------------------
Risk weight
Combined Loan-to-Value ratio (percent)
------------------------------------------------------------------------
Up to 60%.................................................. 75
>60% and up to 90%......................................... 100
>90%....................................................... 150
------------------------------------------------------------------------
c. Residential Mortgage Exposures With Negative Amortization Features
Residential mortgage exposures with negative amortization
features are assigned to a risk weight category using a loan's
current LTV ratio in accordance with Table 3 of section IV.C.3.a.
Any remaining potential increase in the mortgage's principal balance
permitted through the negative amortization feature is to be treated
as a long-term commitment and converted to an on-balance sheet
credit equivalent amount as set forth in section III.D.2. of this
appendix. The credit equivalent amount of the commitment is then
risk-weighted according to Table 3 based on the loan's ``highest
contractual LTV ratio.'' The highest contractual LTV ratio of a
mortgage loan equals the current outstanding principal balance of
the loan plus the credit equivalent amount of the remaining negative
amortization ``commitment'' less the amount covered by any loan-
level PMI divided by the most recent purchase price of the property
or the most recent appraisal or evaluation value of the property (if
the appraisal or evaluation is more recent than the most recent
purchase and was obtained by the bank in connection with an
extension of new credit). A bank with a stand-alone second lien
where the more senior lien(s) can negatively amortize must first
adjust the principal amount of those senior or intervening liens
that can negatively amortize to reflect the maximum contractual loan
amount as if it were to fully negatively amortize under the
applicable contract. The adjusted LTV would then be added to the
stand-alone junior lien to calculate the appropriate CLTV.
D. Short-Term Commitments
Unused portions of commitments with an original maturity of one
year or less (including eligible asset backed commercial paper
liquidity facilities) (that is, short-term commitments) are
converted using the 10 percent conversion factor. Unconditionally
cancelable commitments, as defined in section III.D.2.b. of this
appendix, retain the zero percent conversion factor. Short-term
commitments to originate one-to four-family residential mortgage
loans provided in the ordinary course of business that are not
treated as a derivative under GAAP will continue to be converted to
an on-balance-sheet credit equivalent amount using the zero percent
conversion factor.
E. Securitizations of Revolving Credit with Early Amortization
Provisions
1. Definitions
a. Early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision is triggered solely by events not directly related to
the performance of the underlying exposures or the originating bank
(such as material changes in tax laws or regulations).
b. Excess spread means gross finance charge collections and
other income received by a trust or special purpose entity minus
interest paid to the investors in the securitization exposures,
servicing fees, charge-offs, and other similar trust or special
purpose entity expenses.
c. Excess spread trapping point is the point at which the bank
is required by the documentation governing a securitization to
divert and hold excess spread in a spread or reserve account,
expressed as a percentage.
d. Investors' interest is the total amount of securitization
exposures issued by a trust or special purpose entity to investors.
e. Revolving credit means a line of credit where the borrower is
permitted to vary both the drawn amount and the amount of repayment
within an agreed limit.
2. A bank that securitizes revolving credits where the
securitization structure contains an early amortization provision
must maintain risk-based capital against the investors' interest as
required under this section. Capital for securitizations of
[[Page 77486]]
revolving credit exposures that incorporate early-amortization
provisions will be assessed based on a comparison of the
securitization's annualized three-month average excess spread
against the excess spread trapping point. To calculate the
securitization's excess spread trapping point ratio, a bank must
calculate the three-month average of (1) the dollar amount of excess
spread divided by (2) the outstanding principal balance of
underlying pool of exposures at the end of each of the prior three
months. The annualized three month average of excess spread is then
divided by the excess spread trapping point that is required by the
securitization structure. The excess spread trapping point ratio is
compared to the ratios contained in Table 5 of section IV.E.3 to
determine the appropriate conversion factor to apply to the
investor's interest. The amount of investor's interest after
conversion is then assigned capital in accordance with that
appropriate to the underlying obligor, collateral or guarantor. For
securitizations that do not require excess spread to be trapped, or
that specify trapping points based primarily on performance measures
other than the three-month average excess spread, the excess spread
trapping point is 4.5 percent.
3. For a bank subject to the early amortization requirements in
this section IV.E., if the aggregate risk-based capital requirement
for residual interests, direct credit substitutes, other
securitization exposures, and early amortization provisions in
connection with the same securitization of revolving credit
exposures exceeds the risk-based capital requirement on the
underlying securitized assets, then the capital requirement for the
securitization transaction will be limited to the greater of the
risk-based capital requirement for (1) residual interests or (2) the
underlying securitized assets calculated as if the bank continued to
hold the assets on its balance sheet.
Table 5.--Early Amortization Credit Conversion Factor
------------------------------------------------------------------------
Credit
conversion
Excess spread trapping point ratio factor
(CCF)
(percent)
------------------------------------------------------------------------
133.33 percent or more..................................... 0
less than 133.33 percent to 100 percent.................... 5
less than 100 percent to 75 percent........................ 15
less than 75 percent to 50 percent......................... 50
less than 50 percent....................................... 100
------------------------------------------------------------------------
F. Risk Weights for Derivatives
A bank may not apply the 50 percent risk weight cap for
derivative contract counterparties set forth in section III.E. of
this appendix A.
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1,
1843( c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907,
and 3909; 15 U.S.C. 6801 and 6805.1.
2. In Appendix A to part 225, the following amendments are
proposed:
a. Section I, Overview, is revised.
b. In section III.A, Procedures, the first paragraph is revised,
the fourth paragraph is redesignated as the fifth paragraph, and a new
fourth paragraph is added.
c. In section III.C, the first paragraph is revised.
d. Section IV is removed and a new section IV, Alternative Approach
for Computing Weighted Risk Assets and Off-Balance-Sheet Items, is
added.
e. Attachment I is removed.
Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
I. Overview
The Board of Governors of the Federal Reserve System has adopted
a risk-based capital measure to assist in the assessment of the
capital adequacy of bank holding companies (banking
organizations).\1\ The principal objectives of this measure are to:
(i) Make regulatory capital requirements more sensitive to
differences in risk profiles among banking organizations; (ii)
factor off-balance sheet exposures into the assessment of capital
adequacy; (iii) minimize disincentives to holding liquid, low-risk
assets; and (iv) achieve greater consistency in the evaluation of
the capital adequacy of major banking organizations throughout the
world.\2\
---------------------------------------------------------------------------
\1\ A leverage capital measure for state member banks is
outlined in appendix D of this part.
\2\ The risk-based capital measure is based upon a framework
developed jointly by supervisory authorities from the countries
represented on the Basel Committee on Banking Supervision (Basel
Supervisors' Committee) and endorsed by the Group of Ten Central
Bank Governors. The framework is described in a paper prepared by
the Basel Supervisors' Committee entitled ``International
Convergence of Capital Measurement,'' July 1988.
---------------------------------------------------------------------------
The risk-based capital guidelines include both a definition of
capital and a framework for calculating weighted risk assets by
assigning assets and off-balance sheet items to broad risk
categories. An institution's risk-based capital ratio is calculated
by dividing its qualifying capital (the numerator of the ratio) by
its weighted risk assets (the denominator).\3\ The definition of
qualifying capital is outlined in section II, and the procedures for
calculating weighted risk assets are discussed in sections III and
IV.
---------------------------------------------------------------------------
\3\ Banking organizations will initially be expected to utilize
period-end amounts in calculating their risk-based capital ratios.
When necessary and appropriate, ratios based on average balances may
also be calculated on a case-by-case basis. Moreover, to the extent
banking organizations have data on average balances that can be used
to calculate risk-based ratios, the Federal Reserve will take such
data into account.
---------------------------------------------------------------------------
In addition, when certain organizations that engage in trading
activities calculate their risk-based capital ratios under this
appendix A, they must also refer to appendix E of this part, which
incorporates capital charges for certain market risks into the risk-
based capital ratios. When calculating their risk-based capital
ratios under this appendix A, such organizations are required to
refer to appendix E of this part for supplemental rules to determine
qualifying and excess capital, calculate weighted risk assets,
calculate market risk equivalent assets, and calculate risk-based
capital ratios adjusted for market risk.
The risk-based capital guidelines apply on a consolidated basis
to bank holding companies with consolidated assets of $500 million
or more. For bank holding companies with less than $500 million in
consolidated assets, the guidelines will be applied on a bank-only
basis unless: (a) The parent bank holding company is engaged in
nonbank activity involving significant leverage; \4\ or (b) the
parent company has a significant amount of outstanding debt that is
held by the general public.
---------------------------------------------------------------------------
\4\ A parent company that is engaged in significant off-balance
sheet activities would generally be deemed to be engaged in
activities that involve significant leverage.
---------------------------------------------------------------------------
The risk-based capital guidelines are to be used in the
inspection and supervisory process as well as in the analysis of
applications acted upon by the Federal Reserve. Thus, in considering
an application filed by a bank holding company, the Federal Reserve
will take into account the organization's risk-based capital ratio,
the reasonableness of its capital plans, and the extent to which it
meets the risk-based capital standards.
The risk-based capital ratios focus principally on broad
categories of credit risk, although the framework for assigning
assets and off-balance-sheet items to risk categories does
incorporate elements of transfer risk, as well as limited instances
of interest rate and market risk. The risk-based capital ratio does
not, however, incorporate other factors that can affect an
organization's financial condition. These factors include overall
interest-rate exposure; liquidity, funding and market risks; the
quality and level of earnings; investment or loan portfolio
concentrations; the quality of loans and investments, the
effectiveness of loan and investment policies; and management's
ability to monitor and control financial and operating risks.
In addition to evaluating capital ratios, an overall assessment
of capital adequacy must take account of these other factors,
including, in particular, the level and severity of problem and
classified assets. For this reason, the final supervisory judgment
on an organization's capital adequacy may differ significantly from
conclusions that might be drawn solely from the level of the
organization's risk-based capital ratio.
The risk-based capital guidelines establish a minimum ratio of
qualifying total capital to weighted risk assets of 8 percent, of
which at least 4 percentage points must be in the form of tier 1
capital. In light of the considerations just discussed, banking
organizations generally are expected to
[[Page 77487]]
operate well above the minimum risk-based ratios. In particular,
banking organizations contemplating significant expansion proposals
are expected to maintain strong capital levels substantially above
the minimum ratios and should not allow significant diminution of
financial strength below these strong levels to fund their expansion
plans. Institutions with high or inordinate levels of risk are also
expected to operate well above minimum capital standards. In all
cases, institutions should hold capital commensurate with the level
and nature of the risks to which they are exposed. Banking
organizations that do not meet the minimum risk-based capital
standard, or that are otherwise considered to be inadequately
capitalized, are expected to develop and implement plans acceptable
to the Federal Reserve for achieving adequate levels of capital
within a reasonable period of time.
The Board will monitor the implementation and effect of these
guidelines in relation to domestic and international developments in
the banking industry. When necessary and appropriate, the Board will
consider the need to modify the guidelines in light of any
significant changes in the economy, financial markets, banking
practices, or other relevant factors.
* * * * *
III. * * *
A. * * *
Assets and credit-equivalent amounts of off-balance-sheet items
of bank holding companies are assigned to one of several broad risk
categories, according to the obligor, or, if relevant, the
guarantor, the nature of the collateral, or an external rating. The
aggregate dollar value of the amount in each category is then
multiplied by the risk weight associated with the category. The
resulting weighted values from each of the risk categories are added
together, and this sum is the banking organization's total weighted
risk assets that comprise the denominator of the risk-based capital
ratios.
* * * * *
A bank holding company may elect to apply the alternative
procedures for computing weighted risk assets set forth in section
IV of this appendix A (``Alternative Approach''). The Federal
Reserve also may require a bank holding company to apply the
Alternative Approach if the Federal Reserve determines that the
Alternative Approach would produce risk-based capital requirements
that more accurately reflect the risk profile of the banking
organization or would otherwise enhance the safety and soundness of
the institution. A bank holding company that applies the Alternative
Approach must apply all the procedures set forth in section IV of
this appendix A and also must apply all the procedures set forth in
this section that are not inconsistent with the procedures in
section IV.
* * * * *
C. * * *
Assets and on-balance-sheet credit equivalent amounts are
assigned to the following risk weight categories: 0 percent, 20
percent, 50 percent, or 100 percent. A brief explanation of the
components of each category follows.
* * * * *
IV. Alternative Approach for Computing Weighted Risk Assets and
Off-Balance-Sheet Items
A. Scope of Application
A bank holding company may elect to use the Alternative Approach
for computing weighted risk assets and off-balance sheet items set
forth in this section IV by giving the Federal Reserve written
notice on the first day of the quarter during which the banking
organization elects to begin using the Alternative Approach. A bank
holding company that has elected to apply the Alternative Approach
may opt out of the Alternative Approach after it has given the
Federal Reserve 30 days prior written notice. The Federal Reserve
may require a bank holding company to apply the Alternative Approach
if the Federal Reserve determines that the Alternative Approach
would produce risk-based capital requirements that more accurately
reflect the risk profile of the banking organization or would
otherwise enhance the safety and soundness of the institution.
A bank holding company that applies the Alternative Approach
must apply all the procedures set forth in this section IV and also
must apply all the procedures set forth in section III that are not
inconsistent with the procedures in section IV.
B. External Ratings, Collateral, Guarantees, and Other Considerations
1. External Credit Ratings. A bank holding company must use
Table 1 in this section IV.B.1. to assign risk weights to covered
claims with an original maturity of one year or more and Table 2 in
this section IV.B.1. to assign risk weights to covered claims with
an original maturity of less than one year. Covered claims are all
claims other than (i) claims on an excluded entity, (ii) loans to
non-sovereigns that do not have an external rating, and (iii) OTC
derivative contracts. Excluded entities are (i) the U.S. central
government and U.S. government agencies, (ii) state and local
governments of the United States and other countries of the OECD,
(iii) U.S. government-sponsored agencies, and (iv) U.S. depository
institutions and foreign banks.
A bank holding company must use column three of the tables for
covered claims on a non-U.S. sovereign \58\ and column four of the
tables for covered claims on an entity other than a non-U.S.
sovereign (excluding securitization exposures). A bank holding
company must use column five of the tables for covered claims that
are securitization exposures, which include asset-backed securities,
mortgage-backed securities, recourse obligations, direct credit
substitutes, and residual interests (other than credit-enhancing
interest-only strips).
---------------------------------------------------------------------------
\58\ For purposes of this section IV, a sovereign is defined as
a central government, including its agencies, departments,
ministries, and the central bank. This definition does not include
state, provincial, or local governments, or commercial enterprises
owned by a central government.
Table 1.--Risk Weights Based on Long-Term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-U.S. Securitization
sovereign risk Non-sovereign exposure risk
Long-term rating category Rating weight \1\ risk weight weight
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating...... AAA...................... 0 20 20
Second-highest investment grade AA....................... 20 20 20
rating.
Third-highest investment grade rating A........................ 20 35 35
Lowest investment grade rating--plus. BBB+..................... 35 50 50
Lowest investment grade rating-- BBB...................... 50 75 75
naught.
Lowest investment grade rating-- BBB-..................... 75 100 100
negative.
One category below investment grade-- BB+, BB.................. 75 150 200
plus & naught.
One category below investment grade-- BB-...................... 100 200 200
negative.
Two or more categories below B, CCC................... 150 200 \2\
investment grade.
Unrated.............................. n/a...................... 200 200 \2\
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 risk weight category.
\2\ Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A.
[[Page 77488]]
Table 2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-U.S. Securitization
sovereign risk Non-sovereign exposure risk
Short-term rating category Examples weight \1\ risk weight weight
(percent) (percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating *..... A-1, P-1................ 0 20 20
Second-highest investment grade rating A-2, P-2................ 20 35 35
Lowest investment grade rating........ A-3, P-3................ 50 75 75
Unrated............................... ........................ 100 100 100
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight
category.
For purposes of this section IV, an external rating is defined
as a credit rating that is assigned by an NRSRO, provided that the
credit rating:
a. Fully reflects the entire amount of credit risk with regard
to all payments owed on the claim (that is, the rating must fully
reflect the credit risk associated with timely repayment of
principal and interest);
b. Is monitored by the issuing NRSRO;
c. Is published in an accessible public form (for example, on
the NRSRO's Web site or in financial media); and
d. Is, or will be, included in the issuing NRSRO's publicly
available ratings transition matrix which tracks the performance and
stability (or ratings migration) of an NRSRO's issued external
ratings for the specific type of claim (for example, corporate
debt).
In addition, an unrated covered claim on a non-U.S. sovereign
that has an external rating from an NRSRO should be deemed to have
an external rating equal to the sovereign's issuer rating. If a
claim has two or more external ratings, the bank holding company
must use the least favorable external rating to risk weight the
claim. Similarly, if a claim has components that are assigned
different external ratings, the lowest component rating must be
applied to the entire claim. For example, if a securitization
exposure has a principal component externally rated BBB, but the
interest component is externally rated B, the entire exposure will
be subject to the gross-up treatment accorded to a securitization
exposure rated B or lower. Similarly, if a portion of a specific
claim is unrated, then the entire claim must be treated as if it
were unrated. The Federal Reserve retains 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.
2. Collateral. In addition to the forms of recognized financial
collateral set forth in section III.B.1 of this appendix A, a bank
holding company also may recognize as collateral (i) covered claims
in the form of liquid and readily marketable debt securities that
are externally rated no less than investment grade and (ii) liquid
and readily marketable debt securities guaranteed by non-U.S.
sovereigns whose issuer rating is at least investment grade. Claims,
or portions of claims, collateralized by such collateral may be
assigned to the risk weight appropriate to the collateral's external
rating as set forth in Table 1 or 2 of section IV.B.1. For example,
the portion of a claim collateralized with an AA-rated mortgage-
backed security is assigned to the 20 percent risk weight category.
Subject to the final sentence of this paragraph, there is,
however, a 20 percent risk weight floor on collateralized claims
under this section IV. Thus, the portion of a claim collateralized
by a security issued by a non-U.S. sovereign with an issuer rating
of AAA would be assigned to the 20 percent risk weight category
instead of the zero percent risk weight category. The procedures set
forth in section III of this appendix A continue to apply, however,
to claims collateralized by securities issued or guaranteed by OECD
central governments for which a positive margin of collateral is
maintained on a daily basis, fully taking into account any change in
the banking organization's exposure to the obligor and counterparty
under the claim in relation to the market value of the collateral
held to support the claim.
In the event that the external rating of a security used to
collateralize a claim results in a higher risk weight than would
have otherwise been assigned to the claim, then the lower risk
weight appropriate to the underlying claim could be applied.
3. Guarantees. Claims, or portions of claims, guaranteed by a
third party entity (other than an excluded entity) whose unsecured
long-term senior debt (without credit enhancements) is externally
rated at least investment grade or by a non-U.S. sovereign that has
an issuer rating of at least investment grade may be assigned to the
risk weight of the guarantor as set forth in Table 1 of section
IV.B.1 corresponding to the protection provider's long-term senior
debt rating (or issuer rating in the case of a non-U.S. sovereign),
provided that the guarantee:
a. Is written and unconditional,
b. Covers all or a pro rata portion of contractual payments of
the obligor on the underlying claim,
c. Gives the beneficiary a direct claim against the protection
provider,
d. Is non-cancelable by the protection provider for reasons
other than the breach of contract by the beneficiary,
e. Is legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced, and
f. Requires the protection provider to make payment to the
beneficiary upon default of the obligor on the underlying claim
without first requiring the beneficiary to demand payment from the
obligor.
C. Residential Mortgages
1. A bank holding company may separate its residential mortgage
portfolio into two subportfolios, where the first subportfolio
includes mortgage loans originated by the banking organization or
acquired by the banking organization prior to the date the
institution becomes subject to this section IV and the second
includes mortgage loans originated or acquired by the bank holding
company after that date. The bank holding company may apply the
risk-based capital treatment set forth in section III of this
appendix A to the first subportfolio while applying the requirements
set forth in this section IV to the second subportfolio. A bank
holding company that does not so separate its residential mortgage
portfolio must apply the capital treatment in this section IV to all
of its qualifying residential mortgage exposures. If a banking
organization at any time opts-out of the Alternative Approach and,
subsequently, again becomes subject to this section IV, it may not
apply the procedures set forth in this section IV.C.1.
2. Subject to section IV.C.1., a bank holding company assigns
its residential mortgage exposures to risk weight categories based
on their loan-to-value (LTV) or combined loan-to-value (CLTV)
ratios, as appropriate, in accordance with Tables 3 and 4 of
sections IV C.3.a. and IV.C.3.b., respectively, but must risk-weight
a nonqualifying residential mortgage exposure at no less than 100
percent. Residential mortgage exposures include all loans secured by
a lien on a one-to four-family residential property \59\ that is
either owner-occupied or rented. Qualifying residential mortgage
exposures are residential mortgage exposures that (1) have been made
in accordance with prudent underwriting standards; (2) are
performing in accordance with their original terms; (3) are not 90
days or more past due or carried in nonaccrual status; and (4) are
not made for the purpose of speculative property development.
Nonqualifying residential mortgage exposures are residential
mortgage exposures other than qualifying residential mortgage
exposures.
---------------------------------------------------------------------------
\59\ Loans that qualify as mortgages that are secured by 1- to
4-family residential properties are listed in the instructions to
the commercial bank Call Reports.
---------------------------------------------------------------------------
3. For purposes of Tables 3 and 4, LTV is defined as (i) the
current outstanding principal balance of the loan less the amount
covered by any loan-level private mortgage insurance (``PMI'')
divided by (ii) the most recent purchase price of the property or
the most recent appraisal or evaluation value of
[[Page 77489]]
the property (if the appraisal or evaluation is more recent than the
most recent purchase and was obtained by the bank holding company in
connection with an extension of new credit). Loan-level PMI means
insurance (i) provided by a non-affiliated PMI provider whose
unsecured long-term senior debt (without credit enhancements) is
externally rated at least the third highest investment grade by an
NRSRO, and (ii) which protects a mortgage lender in the event of the
default of a mortgage borrower up to a predetermined portion of the
value of residential mortgage exposure. For purposes of the loan
level PMI definition, (i) an affiliate of a company means any
company that controls, is controlled by, or is under common control
with, the company; and (ii) a person or company controls a company
if it owns, controls, or has power to vote 25 percent or more of a
class of voting securities of the company or consolidates the
company for financial reporting purposes. CLTV for a junior lien
mortgage is defined as (i) the current outstanding principal balance
of the junior mortgage and all more senior mortgages less the amount
covered by any loan-level PMI covering the junior lien divided by
(ii) the most recent purchase price of the property or the most
recent appraisal or evaluation value of the property (if the
appraisal or evaluation is more recent than the most recent purchase
and was obtained by the bank holding company in connection with an
extension of new credit). The procedures for residential mortgage
exposures that have negative amortization features are set forth in
section IV.C.3.c.
a. First Lien Residential Mortgage Exposures
First lien residential mortgage exposures are risk-weighted in
accordance with Table 3 of this section IV.C.3.a (with nonqualifying
residential mortgage exposures subject to a risk weight floor of 100
percent). If a banking organization holds both the senior and junior
lien(s) on a residential property and no other party holds an
intervening lien, the banking organization's claims are treated as a
single claim secured by a senior lien for purposes of determining
the LTV ratio and assigning a risk weight.
Table 3.--Risk Weights for First Lien Residential Mortgage Exposures
------------------------------------------------------------------------
Risk weight
Loan-to-value ratio (percent)
------------------------------------------------------------------------
Up to 60%.................................................. 20
>60% and up to 80%......................................... 35
>80% and up to 85%......................................... 50
>85% and up to 90%......................................... 75
>90% and up to 95%......................................... 100
>95%....................................................... 150
------------------------------------------------------------------------
b. Stand-Alone Junior Liens
Stand-alone junior lien residential mortgage exposures,
including structured mortgages and home equity lines of credit, must
be risk weighted using the CLTV ratio of the stand-alone junior lien
and all senior liens in accordance with Table 4 (with nonqualifying
residential mortgage exposures subject to a risk weight floor of 100
percent).
Table 4.--Risk Weights for Stand-Alone Junior Lien Residential Mortgage
Exposures
------------------------------------------------------------------------
Risk weight
Combined loan-to-value ratio (percent)
------------------------------------------------------------------------
Up to 60%.................................................. 75
>60% and up to 90%......................................... 100
>90%....................................................... 150
------------------------------------------------------------------------
c. Residential Mortgage Exposures With Negative Amortization
Features
Residential mortgage exposures with negative amortization
features are assigned to a risk weight category using a loan's
current LTV ratio in accordance with Table 3 of section IV.C.3.a.
Any remaining potential increase in the mortgage's principal balance
permitted through the negative amortization feature is to be treated
as a long-term commitment and converted to an on-balance sheet
credit equivalent amount as set forth in section III.D.2. of this
appendix. The credit equivalent amount of the commitment is then
risk-weighted according to Table 3 based on the loan's ``highest
contractual LTV ratio.'' The highest contractual LTV ratio of a
mortgage loan equals the current outstanding principal balance of
the loan plus the credit equivalent amount of the remaining negative
amortization ``commitment'' less the amount covered by any loan-
level PMI divided by the most recent purchase price of the property
or the most recent appraisal or evaluation value of the property (if
the appraisal or evaluation is more recent than the most recent
purchase and was obtained by the bank holding company in connection
with an extension of new credit). A bank holding company with a
stand-alone second lien where the more senior lien(s) can negatively
amortize must first adjust the principal amount of those senior or
intervening liens that can negatively amortize to reflect the
maximum contractual loan amount as if it were to fully negatively
amortize under the applicable contract. The adjusted LTV would then
be added to the stand-alone junior lien to calculate the appropriate
CLTV.
D. Short-Term Commitments
Unused portions of commitments with an original maturity of one
year or less (including eligible asset backed commercial paper
liquidity facilities) (that is, short-term commitments) are
converted using the 10 percent conversion factor. Unconditionally
cancelable commitments, as defined in section III.D.2.b. of this
appendix, retain the zero percent conversion factor. Short-term
commitments to originate one- to four-family residential mortgage
loans provided in the ordinary course of business that are not
treated as a derivative under GAAP will continue to be converted to
an on-balance-sheet credit equivalent amount using the zero percent
conversion factor.
E. Securitizations of Revolving Credit with Early Amortization
Provisions
1. Definitions
a. Early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision is triggered solely by events not directly related to
the performance of the underlying exposures or the originating
banking organization (such as material changes in tax laws or
regulations).
b. Excess spread means gross finance charge collections and
other income received by a trust or special purpose entity minus
interest paid to the investors in the securitization exposures,
servicing fees, charge-offs, and other similar trust or special
purpose entity expenses.
c. Excess spread trapping point is the point at which the
banking organization is required by the documentation governing a
securitization to divert and hold excess spread in a spread or
reserve account, expressed as a percentage.
d. Investors' interest is the total amount of securitization
exposure issued by a trust or special purpose entity to investors.
e. Revolving credit means a line of credit where the borrower is
permitted to vary both the drawn amount and the amount of repayment
within an agreed limit.
2. A bank holding company that securitizes revolving credits
where the securitization structure contains an early amortization
provision must maintain risk-based capital against the investors'
interest as required under this section. Capital for securitizations
of revolving credit exposures that incorporate early-amortization
provisions will be assessed based on a comparison of the
securitization's annualized three-month average excess spread
against the excess spread trapping point. To calculate the
securitization's excess spread trapping point ratio, a bank holding
company must calculate the three-month average of (1) the dollar
amount of excess spread divided by (2) the outstanding principal
balance of underlying pool of exposures at the end of each of the
prior three months. The annualized three month average of excess
spread is then divided by the excess spread trapping point that is
required by the securitization structure. The excess spread trapping
point ratio is compared to the ratios contained in Table 5 of
section IV.E.3 to determine the appropriate conversion factor to
apply to the investor's interest. The amount of investor's interest
after conversion is then assigned capital in accordance with that
appropriate to the underlying obligor, collateral or guarantor. For
securitizations that do not require excess spread to be trapped, or
that specify trapping points based primarily on performance measures
other than the three-month average excess spread, the excess spread
trapping point is 4.5 percent.
3. For a banking organization subject to the early amortization
requirements in this section IV.E., if the aggregate risk-based
capital requirement for residual interests, direct credit
substitutes, other securitization exposures, and early amortization
provisions in connection with the same securitization of revolving
credit exposures exceeds the risk-based capital requirement on the
underlying securitized assets, then the capital requirement for the
securitization transaction will be limited to the greater of the
risk-based capital requirement for (1) residual interests
[[Page 77490]]
or (2) the underlying securitized assets calculated as if the
banking organization continued to hold the assets on its balance
sheet.
Table 5.--Early Amortization Credit Conversion Factor
------------------------------------------------------------------------
Credit
conversion
Excess spread trapping point ratio factor
(CCF)
(percent)
------------------------------------------------------------------------
133.33 percent or more..................................... 0
Less than 133.33 percent to 100 percent.................... 5
Less than 100 percent to 75 percent........................ 15
Less than 75 percent to 50 percent......................... 50
Less than 50 percent....................................... 100
------------------------------------------------------------------------
F. Risk Weights for Derivatives
A bank holding company may not apply the 50 percent risk weight
cap for derivative contract counterparties set forth in section
III.E. of this appendix A.
* * * * *
Federal Deposit Insurance Corporation
12 CFR Part 325
For the reasons set out in the preamble, part 325 of chapter III of
title 12 of the Code of Federal Regulations is proposed to be amended
as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 continues to read as
follows:
Authority: U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),
1818(c), 1818(t), 1819 (Tenth), 1828(c), 1828(d), 1828(i), 1828(n),
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat.
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).
2. Revise Sec. 325.1 of subpart A to read as follows:
Sec. 325.1 Scope.
The provisions of this part apply to those circumstances for which
the Federal Deposit Insurance Act or this chapter requires an
evaluation of the adequacy of an insured depository institution's
capital structure. The FDIC is required to evaluate capital before
approving various applications by insured depository institutions. The
FDIC also must evaluate capital, as an essential component, in
determining the safety and soundness of state nonmember banks it
insures and supervises and in determining whether depository
institutions are in an unsafe or unsound condition. This subpart A
establishes the criteria and standards FDIC will use in calculating the
minimum leverage capital requirement and in determining capital
adequacy. In addition, appendices A, D, and E to part 325 (appendices
A, D, and E) set forth the FDIC's risk-based capital policy statements
and appendix B to this subpart includes a statement of policy on
capital adequacy that provides interpretational guidance as to how this
subpart will be administered and enforced. In accordance with subpart B
of part 325, the FDIC also must evaluate an institution's capital for
purposes of determining whether the institution is subject to the
prompt corrective action provisions set forth in section 38 of the
Federal Deposit Insurance Act (12 U.S.C. 1831o).
3. Revise Sec. 325.2(s), (w) and (y) of subpart A to read as
follows:
Sec. 325.2 Definitions
* * * * *
(s) Risk-weighted assets means total risk-weighted assets, as
calculated in accordance with appendices A, D, or E to part 325.
* * * * *
(w) Tier 1 risk-based capital ratio means the ratio of Tier 1
capital to risk-weighted assets, as calculated in accordance with
appendices A, D, or E to part 325.
* * * * *
(y) Total risk-based capital ratio means the ratio of qualifying
total capital to risk-weighted assets, as calculated in accordance with
appendices A, D, or E to part 325.
* * * * *
4. Revise Sec. 325.6(d) of subpart A to read as follows:
Sec. 325.6 Issuance of directives
* * * * *
(d) Enforcement of a directive. (1) Whenever a bank fails to follow
the directive or to submit or adhere to its capital adequacy plan, the
FDIC may seek enforcement of the directive in the appropriate United
States district court, pursuant to 12 U.S.C. 3907(b)(2)(B)(ii), in the
same manner and to the same extent as if the directive were a final
cease-and-desist order. In addition to enforcement of the directive,
the FDIC may seek assessment of civil money penalties for violation of
the directive against any bank, any officer, director, employee, agent,
or other person participating in the conduct of the affairs of the
bank, pursuant to 12 U.S.C. 3909(d).
(2) The directive may be issued separately, in conjunction with, or
in addition to, any other enforcement mechanisms available to the FDIC,
including cease-and-desist orders, orders of correction, the approval
or denial of applications, or any other actions authorized by law. In
addition to addressing a bank's minimum leverage capital requirement,
the capital directive may also address minimum risk-based capital
requirements that are to be maintained and calculated in accordance
with appendices A, D, and E to this part 325.
5. Revise Sec. 325.103(a) of subpart B to read as follows:
Sec. 325.103 Capital measures and capital category definitions.
(a) Capital measures (1) For purposes of section 38 and this
subpart the relevant capital measures shall be:
(i) The total risk-based capital ratio;
(ii) The Tier 1 risk-based capital ratio; and
(iii) The leverage ratio.
(2) Risk-based capital ratios. All state nonmember banks must
maintain the minimum risk-based capital ratios as calculated under
appendices A, D, or E to part 325 (and under appendix C to part 325, as
applicable).
(i) Except as provided in paragraph (a)(2)(ii) of this section, any
state nonmember bank that does not use appendix D, as provided in
section 1(b) of appendix D to part 325, must calculate its minimum
risk-based capital ratios under appendix A.
(ii) Any state nonmember bank that uses appendix D to part 325 must
calculate its minimum risk-based capital ratios under appendix D.
(iii) Any state nonmember bank that does not use appendix D to part
325 may elect to calculate its minimum risk-based capital ratios under
appendix E to part 325. Any state nonmember bank that makes this
election must comply with the notice procedures in appendix E.
* * * * *
6. Add Appendix E to part 325 to read as follows:
Appendix E to Part 325--Statement of Policy on Risk-Based Capital:
Alternative Approach for Computing Risk-Weighted Assets and Off-
Balance-Sheet Items
I-1. Risk-Based Capital Framework
A. Introduction
1. Capital adequacy is one of the critical factors that the FDIC
is required to analyze when taking action on various types of
applications and when conducting supervisory activities related to
the safety and soundness of individual banks and the banking system.
In view of this, the FDIC's Board of Directors has adopted part 325
of its regulations (12 CFR part 325), which sets
[[Page 77491]]
forth minimum standards of capital adequacy for insured state
nonmember banks and standards for determining when an insured bank
is in an unsafe or unsound condition by reason of the amount of its
capital.
2. This capital maintenance regulation was designed to
establish, in conjunction with other federal bank regulatory
agencies, uniform capital standards for all federally-regulated
banking organizations, regardless of size. The uniform capital
standards were based on ratios of capital to total assets. While
those leverage ratios have served as a useful tool for assessing
capital adequacy, the FDIC believes there is a need for a capital
measure that is more explicitly and systematically sensitive to the
risk profiles of individual banks. As a result, the FDIC's Board of
Directors has adopted appendices A, D, and E that establish the
minimum risk-based capital requirements for banks. This statement of
policy does not replace or eliminate the existing part 325 capital-
to-total assets leverage ratios.
3. The framework set forth in appendices A, D, and E to this
part 325 consists of a definition of capital for risk-based capital
purposes, and a system for calculating risk-weighted assets. A
bank's risk-based capital ratio is calculated by dividing its
qualifying total capital base (the numerator of the ratio) by its
risk-weighted assets (the denominator).\1\
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\1\ Period-end amounts, rather than average balances, normally
will be used when calculating risk-based capital ratios. However, on
a case-by-case basis, ratios based on average balances may also be
required if supervisory concerns render it appropriate.
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4. In addition, when certain banks that engage in trading
activities calculate their risk-based capital ratio under these
appendices A, D, and E, they must also refer to appendix C of this
part, which incorporates capital charges for certain market risks
into the risk-based capital ratio. When calculating their risk-based
capital ratio under these appendices A, D, and E, such banks are
required to refer to appendix C of this part for supplemental rules
to determine qualifying and excess capital, calculate risk-weighted
assets, calculate market risk equivalent assets and add them to
risk-weighted assets, and calculate risk-based capital ratios as
adjusted for market risk.
5. This statement of policy applies to all FDIC-insured state-
chartered banks (excluding insured branches of foreign banks) that
have elected to use this appendix E and that are not members of the
Federal Reserve System, hereafter referred to as ``state nonmember
banks,'' regardless of size, and to all circumstances in which the
FDIC is required to evaluate the capital of a banking organization.
Therefore, the risk-based capital framework set forth in this
statement of policy will be used in the examination and supervisory
process as well as in the analysis of applications that the FDIC is
required to act upon.
6. The risk-based capital ratio focuses principally on broad
categories of credit risk, however, the ratio does not take account
of many other factors that can affect a bank's financial condition.
These factors include overall interest rate risk exposure,
liquidity, funding and market risks; the quality and level of
earnings; investment, loan portfolio, and other concentrations of
credit risk, certain risks arising from nontraditional activities;
the quality of loans and investments; the effectiveness of loan and
investment policies; and management's overall ability to monitor and
control financial and operating risks, including the risk presented
by concentrations of credit and nontraditional activities. In
addition to evaluating capital ratios, an overall assessment of
capital adequacy must take account of each of these other factors,
including, in particular, the level and severity of problem and
adversely classified assets as well as a bank's interest rate risk
as measured by the bank's exposure to declines in the economic value
of its capital due to changes in interest rates. For this reason,
the final supervisory judgment on a bank's capital adequacy may
differ significantly from the conclusions that might be drawn solely
from the absolute level of the bank's risk-based capital ratio.
B. Election Into and Exit From Appendix E
1. Unless a bank uses appendix D of this part, any state
nonmember bank may elect to use the capital requirements set forth
in this appendix E by filing the appropriate Schedule of the
Consolidated Reports of Condition and Income (Call Reports) to
calculate its risk-based capital requirements. After a bank has
filed its quarterly Call Reports under this appendix E, the bank's
election to use appendix E will be effective on the date of filing
its Call Reports and will apply retrospectively to the quarter
covered by the filing.
2. Any bank that has elected to use this appendix E to calculate
its risk-based capital ratios may elect to use appendix A of this
part to calculate its risk-based capital ratios by giving the FDIC
prior notice. This election will not apply retrospectively to the
current quarter, but will apply prospectively for the next quarter.
After the notice becomes effective, the bank must use appendix A,
and the bank must file all subsequent Call Reports in accordance
with appendix A.
C. Reservation of Authority
The FDIC reserves the authority to exclude a bank from coverage
under this appendix E if the FDIC determines that the exclusion is
appropriate based on the risk profile of the bank or would otherwise
enhance the safety and soundness of the bank. The FDIC also reserves
the authority to: Require a bank that has elected to use the capital
requirements in this appendix E to continue to use appendix E; or
require a bank that uses appendix A to calculate its risk-based
capital requirements to instead use appendix E to calculate its
capital requirements, if the FDIC determines that the exclusion from
coverage under appendix A to this part 325 is appropriate based on
the risk profile of the bank or would otherwise enhance the safety
and soundness of the bank. In making a determination under this
paragraph, the FDIC will apply notice and response procedures in the
same manner as the notice and response procedures in 12 CFR
325.6(c).
D. Definitions
1. Affiliate means, with respect to a company, any company that
controls, is controlled by, or is under common control with, the
company. For purposes of this definition, a person or company
controls a company if it:
(a) Owns, controls, or holds with power to vote 25 percent or
more of a class of voting securities of the company; or
(b) Consolidates the company for financial reporting purposes.
2. Company means a corporation, partnership, limited liability
company, business trust, special purpose entity, association, or
similar organization.
3. Eligible guarantee means a guarantee provided by a third
party eligible guarantor that:
(a) Is written and unconditional;
(b) Covers all or a pro rata portion of the contractual payments
of the obligor on the reference exposure;
(c) Gives the beneficiary a direct claim against the protection
provider;
(d) Is non-cancelable by the protection provider for reasons
other than the breach of the contract by the beneficiary;
(e) Is legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced;
(f) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligor on the reference exposure without first
requiring the beneficiary to demand payment from the obligor; and
(g) If extended by a sovereign, is backed by the full faith and
credit of the sovereign.
4. Eligible guarantor means a sovereign with senior long-term
debt externally rated at least investment grade (without credit
enhancements) by a nationally recognized statistical rating
organization (NRSRO) \2\ or a non-sovereign with senior long-term
debt externally rated at least investment grade (without credit
enhancements) by a NRSRO. A sovereign or non-sovereign rated less
than investment grade by any NRSRO is not an eligible guarantor for
purposes of this definition.
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\2\ A nationally recognized statistical rating organization is
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).
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5. External rating means a credit rating that is assigned by a
NRSRO to a claim or issuer, provided that the credit rating:
(a) Fully reflects the entire amount of credit risk with regard
to all payments owed on the claim (that is, the rating must fully
reflect the credit risk associated with timely repayment of
principal and interest);
(b) Is monitored by the issuing NRSRO;
(c) Is published in an accessible public forum, for example, on
the NRSRO's Web site and in financial media; and
(d) Is, or will be, included in the issuing NRSRO's publicly
available ratings transition
[[Page 77492]]
matrix which tracks the performance and stability (or ratings
migration) of an NRSRO's issued external ratings for the specific
type of claim (for example, corporate debt).
6. Loan level private mortgage insurance (PMI) means insurance
provided by a regulated mortgage insurance company, with senior
long-term debt rated at least third-highest investment grade
(without credit enhancements) by a NRSRO, that protects a mortgage
lender in the event of the default of a mortgage borrower up to a
predetermined portion of the value of a single one-to four-family
residential property, provided the mortgage insurance company is not
an affiliate of the bank and provided there is no pool-level cap
that would effectively reduce coverage.
7. Non-sovereign.
(a) Non-sovereign means:
(i) A company (including a securities firm, insurance company,
bank holding company, and savings and loan holding company), or
(ii) A multilateral lending institution or regional development
institution.
(b) For purposes of this definition, non-sovereign does not
include the United States (including U.S. Government Agencies);
states or other political subdivisions of the United States and
other OECD countries; U.S. Government-sponsored Agencies; or U.S.
depository institutions and foreign banks. In addition, for purposes
of determining the appropriate risk weight of claims on or
guaranteed by qualifying securities firms that are collateralized by
cash or securities issued or guaranteed by OECD central governments
and that meet the requirements of section II.C.1(c) of this appendix
E, non-sovereign also does not include a qualifying securities
firm.\3\
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\3\ See footnote 31.
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8. Securitization exposures include asset- and mortgage-backed
securities, recourse obligations, direct credit substitutes, and
residual interests (other than credit-enhancing interest-only
strips).
9. Sovereign.
(a) Sovereign means a central government, including its
departments and ministries, and the central bank. It does not
include states, provinces, local governments, or other political
subdivisions of a country, or commercial enterprises owned by a
central government.
(b) For purposes of this appendix E, sovereign does not include
the United States, U.S. Government agencies, or the U.S. central
bank (including the twelve Federal Reserve banks). In addition, for
purposes of determining the appropriate risk weight of claims on
qualifying securities firms that are collateralized by securities
issued or guaranteed by OECD central governments that meet the
requirements of section II.C.1(c) of this appendix E, sovereign does
not include an OECD central government (including the United
States).
10. Unconditionally cancelable means, with respect to a
commitment-type lending arrangement, that a bank may, at any time,
with or without cause, refuse to advance funds or extend credit
under the facility. In the case of home equity lines of credit or
mortgage lines of credit, a commitment is unconditionally cancelable
if the bank can, at its option, prohibit additional extensions of
credit, reduce the line, and terminate the commitment to the full
extent permitted by applicable Federal law.
I-2. Definition of Capital for the Risk-Based Capital Ratio
A bank's qualifying total capital base consists of two types of
capital elements: ``core capital elements'' (Tier 1) and
``supplementary capital elements'' (Tier 2). To qualify as an
element of Tier 1 or Tier 2 capital, a capital instrument should not
contain or be subject to any conditions, covenants, terms,
restrictions, or provisions that are inconsistent with safe and
sound banking practices.
A. The Components of Qualifying Capital (see Table I)
1. Core capital elements (Tier 1) consists of: 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); noncumulative perpetual preferred stock,\4\ including any
related surplus; and minority interests in the equity capital
accounts of consolidated subsidiaries.
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\4\ 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.
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(a) 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)),\5\ minus credit-enhancing
interest-only strips that are not eligible for inclusion in core
capital pursuant to Sec. 325.5(f)), minus any disallowed deferred
tax assets, and minus any amount of nonfinancial equity investments
required to be deducted pursuant to section II.B.6 of this appendix
E.
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\5\ 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.
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(b) Although nonvoting common stock, noncumulative perpetual
preferred stock, and minority interests in the equity capital
accounts of consolidated subsidiaries are normally included in Tier
1 capital, voting common stockholders' equity generally will be
expected to be the dominant form of Tier 1 capital. Thus, banks
should avoid undue reliance on nonvoting equity, preferred stock and
minority interests.
(c) 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.
(d) Minority interests in small business investment companies,
investment funds that hold nonfinancial equity investments (as
defined in section II.B.6(b) of this appendix E), and subsidiaries
that are engaged in nonfinancial activities are not included in a
bank's Tier 1 or total capital base if the bank excludes the
consolidated assets of such programs from risk-weighted assets
pursuant to section II.B.6(b) of this appendix.
2. Supplementary capital elements (Tier 2). The maximum amount
of Tier 2 capital that may be recognized for risk-based capital
purposes is limited to 100 percent of Tier 1 capital (after any
deductions for disallowed intangibles and disallowed deferred tax
assets). In addition, the combined amount of term subordinated debt
and intermediate-term preferred stock that may be treated as part of
Tier 2 capital for risk-based capital purposes is limited to 50
percent of Tier 1 capital. Amounts in excess of these limits may be
issued but are not included in the calculation of the risk-based
capital ratio. Supplementary capital elements (Tier 2) consist of:
Allowance for loan and lease losses, up to a maximum of 1.25 percent
of risk-weighted assets; cumulative perpetual preferred stock, long-
term preferred stock (original maturity of at least 20 years) and
any related surplus; perpetual preferred stock (and any related
surplus) where the dividend is reset periodically based, in whole or
part, on the bank's current credit standing, regardless of whether
the dividends are cumulative or noncumulative; hybrid capital
instruments, including mandatory convertible debt securities; term
subordinated debt and intermediate-term preferred stock (original
average maturity of five years or more) and any related surplus; and
net unrealized holding gains on equity securities (subject to the
limitations discussed in paragraph I-2.A.2(f) of this section).
(a) Allowance for loan and lease losses. (i) Allowances for loan
and lease losses are reserves that have been established through a
charge against earnings to absorb future
[[Page 77493]]
losses on loans or lease financing receivables. Allowances for loan
and lease losses exclude ``allocated transfer risk reserves.'' \6\
and reserves created against identified losses.
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\6\ Allocated transfer risk reserves are reserves that have been
established in accordance with section 905(a) of the International
Lending Supervision Act of 1983 against certain assets whose value
has been found by the U.S. supervisory authorities to have been
significantly impaired by protracted transfer risk problems.
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(ii) This risk-based capital framework provides a phasedown
during the transition period of the extent to which the allowance
for loan and lease losses may be included in an institution's
capital base. By year-end 1990, the allowance for loan and lease
losses, as an element of supplementary capital, may constitute no
more than 1.5 percent of risk-weighted assets and, by year-end 1992,
no more than 1.25 percent of risk-weighted assets.\7\
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\7\ The amount of the allowance for loan and lease losses that
may be included as a supplementary capital element is based on a
percentage of gross risk-weighted assets. A bank may deduct reserves
for loan and lease losses that are in excess of the amount permitted
to be included in capital, as well as allocated transfer risk
reserves, from gross risk-weighted assets when computing the
denominator of the risk-based capital ratio.
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(b) Preferred stock. (i) Perpetual preferred stock is defined as
preferred stock that does not have a maturity date, that cannot be
redeemed at the option of the holder, and that has no other
provisions that will require future redemption of the issue. Long-
term preferred stock includes limited-life preferred stock with an
original maturity of 20 years or more, provided that the stock
cannot be redeemed at the option of the holder prior to maturity,
except with the prior approval of the FDIC.
(ii) Cumulative perpetual preferred stock and long-term
preferred stock qualify for inclusion in supplementary capital
provided that the instruments can absorb losses while the issuer
operates as a going concern (a fundamental characteristic of equity
capital) and provided the issuer has the option to defer payment of
dividends on these instruments. Given these conditions, and the
perpetual or long-term nature of the instruments, there is no limit
on the amount of these preferred stock instruments that may be
included with Tier 2 capital.
(iii) Noncumulative perpetual preferred stock where the dividend
is reset periodically based, in whole or in part, on the bank's
current credit standing, including auction rate, money market, or
remarketable preferred stock, are also assigned to Tier 2 capital
without limit, provided the above conditions are met.
(c) Hybrid capital instruments. (i) Hybrid capital instruments
include instruments that have certain characteristics of both debt
and equity. In order to be included as supplementary capital
elements, these instruments should meet the following criteria:
(A) The instrument should be unsecured, subordinated to the
claims of depositors and general creditors, and fully paid-up.
(B) The instrument should not be redeemable at the option of the
holder prior to maturity, except with the prior approval of the
FDIC. This requirement implies that holders of such instruments may
not accelerate the payment of principal except in the event of
bankruptcy, insolvency, or reorganization.
(C) The instrument should be available to participate in losses
while the issuer is operating as a going concern. (Term subordinated
debt would not meet this requirement.) To satisfy this requirement,
the instrument should convert to common or perpetual preferred stock
in the event that the sum of the undivided profits and capital
surplus accounts of the issuer results in a negative balance.
(D) The instrument should provide the option for the issuer to
defer principal and interest payments if: the issuer does not report
a profit in the preceding annual period, defined as combined profits
(i.e., net income) for the most recent four quarters; and the issuer
eliminates cash dividends on its common and preferred stock.
(ii) Mandatory convertible debt securities, which are
subordinated debt instruments that require the issuer to convert
such instruments into common or perpetual preferred stock by a date
at or before the maturity of the debt instruments, will qualify as
hybrid capital instruments provided the maturity of these
instruments is 12 years or less and the instruments meet the
criteria set forth below for ``term subordinated debt.'' There is no
limit on the amount of hybrid capital instruments that may be
included within Tier 2 capital.
(d) Term subordinated debt and intermediate-term preferred
stock. The aggregate amount of term subordinated debt (excluding
mandatory convertible debt securities) and intermediate-term
preferred stock (including any related surplus) that may be treated
as Tier 2 capital for risk-based capital purposes is limited to 50
percent of Tier 1 capital. Term subordinated debt and intermediate-
term preferred stock should have an original average maturity of at
least five years to qualify as supplementary capital and should not
be redeemable at the option of the holder prior to maturity, except
with the prior approval of the FDIC. For state nonmember banks, a
``term subordinated debt'' instrument is an obligation other than a
deposit obligation that:
(i) Bears on its face, in boldface type, the following: This
obligation is not a deposit and is not insured by the Federal
Deposit Insurance Corporation;
(ii)(A) Has a maturity of at least five years; or
(B) In the case of an obligation or issue that provides for
scheduled repayments of principal, has an average maturity of at
least five years; provided that the Director of the Division of
Supervision may permit the issuance of an obligation or issue with a
shorter maturity or average maturity if the Director has determined
that exigent circumstances require the issuance of such obligation
or issue; provided further that the provisions of this paragraph
I.A.2(d)(2) shall not apply to mandatory convertible debt
obligations or issues;
(iii) States expressly that the obligation:
(A) Is subordinated and junior in right of payment to the
issuing bank's obligations to its depositors and to the bank's other
obligations to its general and secured creditors; and
(B) Is ineligible as collateral for a loan by the issuing bank;
(iv) Is unsecured;
(v) States expressly that the issuing bank may not retire any
part of its obligation without any prior written consent of the FDIC
or other primary federal regulator; and
(vi) Includes, if the obligation is issued to a depository
institution, a specific waiver of the right of offset by the lending
depository institution.
(e) Subordinated debt obligations issued prior to December 2,
1987 that satisfied the definition of the term ``subordinated note
and debenture'' that was in effect prior to that date also will be
deemed to be term subordinated debt for risk-based capital purposes.
An optional redemption (``call'') provision in a subordinated debt
instrument that is exercisable by the issuing bank in less than five
years will not be deemed to constitute a maturity of less than five
years, provided that the obligation otherwise has a stated
contractual maturity of at least five years; the call is exercisable
solely at the discretion or option of the issuing bank, and not at
the discretion or option of the holder of the obligation; and the
call is exercisable only with the express prior written consent of
the FDIC under 12 U.S.C. 1828(i)(1) at the time early redemption or
retirement is sought, and such consent has not been given in advance
at the time of issuance of the obligation. Optional redemption
provisions will be accorded similar treatment when determining the
perpetual nature and/or maturity of preferred stock and other
capital instruments.
(f) Discount of limited-life supplementary capital instruments.
As a limited-life capital instrument approaches maturity, the
instrument begins to take on characteristics of a short-term
obligation and becomes less like a component of capital. Therefore,
for risk-based capital purposes, the outstanding amount of term
subordinated debt and limited-life preferred stock eligible for
inclusion in capital will be adjusted downward, or discounted, as
the instruments approach maturity. Each limited-life capital
instrument will be discounted by reducing the outstanding amount of
the capital instrument eligible for inclusion as supplementary
capital by a fifth of the original amount (less redemptions) each
year during the instrument's last five years before maturity. Such
instruments, therefore, will have no capital value when they have a
remaining maturity of less than a year.
(g) Unrealized gains on equity securities and unrealized gains
(losses) on other assets. Up to 45 percent of pretax net unrealized
holding gains (that is, the excess, if any, of the fair value over
historical cost) on available-for-sale equity securities with
readily determinable fair values may be included in supplementary
capital. However, the FDIC may exclude all or a portion of these
unrealized gains from Tier 2 capital if the FDIC determines that the
equity securities are not prudently valued. Unrealized gains
(losses) on other types of assets, such as bank premises and
available-
[[Page 77494]]
for-sale debt securities, are not included in supplementary capital,
but the FDIC may take these unrealized gains (losses) into account
as additional factors when assessing a bank's overall capital
adequacy.
B. Deductions from Capital and Other Adjustments. Certain assets
are deducted from a bank's capital base for the purpose of
calculating the numerator of the risk-based capital ratio.\8\ These
assets include:
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\8\ Any assets deducted from capital when computing the
numerator of the risk-based capital ratio will also be excluded from
risk-weighted assets when computing the denominator of the ratio.
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(1) All intangible assets other than mortgage servicing assets,
nonmortgage servicing assets and purchased credit card
relationships.\9\ These disallowed intangibles are deducted from the
core capital (Tier 1) elements.
---------------------------------------------------------------------------
\9\ In addition to mortgage servicing assets, nonmortgage
servicing assets and purchased credit card relationships, certain
other intangibles may be allowed if explicitly approved by the FDIC
as part of the bank's regulatory capital on a specific case basis.
In evaluating whether other types of intangibles should be
recognized for regulatory capital purposes on a specific case basis,
the FDIC will accord special attention to the general
characteristics of the intangibles, including: (1) the separability
of the intangible asset and the ability to sell it separate and
apart from the bank or the bulk of the bank's assets, (2) the
certainty that a readily identifiable stream of cash flows
associated with the intangible asset can hold its value
notwithstanding the future prospects of the bank, and (3) the
existence of a market of sufficient depth to provide liquidity for
the intangible asset.
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(2) Investments in unconsolidated banking and finance
subsidiaries.\10\ This includes any equity or debt capital
investments in banking or finance subsidiaries if the subsidiaries
are not consolidated for regulatory capital requirements.\11\
Generally, these investments include equity and debt capital
securities and any other instruments or commitments that are deemed
to be capital of the subsidiary. These investments are deducted from
the bank's total (Tier 1 plus Tier 2) capital base.
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\10\ For risk-based capital purposes, these subsidiaries are
generally defined as any company that is primarily engaged in
banking or finance and in which the bank, either directly or
indirectly, owns more than 50 percent of the outstanding voting
stock but does not consolidate the company for regulatory capital
purposes. In addition to investments in unconsolidated banking and
finance subsidiaries, the FDIC may, on a case-by-case basis, deduct
investments in associated companies or joint ventures, which are
generally defined as any companies in which the bank, either
directly or indirectly, owns 20 to 50 percent of the outstanding
voting stock. Alternatively, the FDIC may, in certain cases, apply
an appropriate risk-weighted capital charge against a bank's
proportionate interest in the assets of associated companies and
joint ventures. The definitions for subsidiaries, associated
companies and joint ventures are contained in the instructions for
the preparation of the Consolidated Reports of Condition and Income.
\11\ Consolidation requirements for regulatory capital purposes
generally follow the consolidation requirements set forth in the
instructions for preparation of the consolidated Reports of
Condition and Income. However, although investments in subsidiaries
representing majority ownership in another federally-insured
depository institution are not consolidated for purposes of the
consolidated Reports of Condition and Income that are filed by the
parent bank, they are generally consolidated for purposes of
determining FDIC regulatory capital requirements. Therefore,
investments in these depository institution subsidiaries generally
will not be deducted for risk-based capital purposes; rather, assets
and liabilities of such subsidiaries will be consolidated with those
of the parent bank when calculating the risk-based capital ratio. In
addition, although securities subsidiaries established pursuant to
12 CFR 337.4 are consolidated for Report of Condition and Income
purposes, they are not consolidated for regulatory capital purposes.
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(3) Investments in securities subsidiaries established pursuant
to 12 CFR 337.4. The FDIC may also consider deducting investments in
other subsidiaries, either on a case-by-case basis or, as with
securities subsidiaries, based on the general characteristics or
functional nature of the subsidiaries.
(4) Reciprocal holdings of capital instruments of banks that
represent intentional cross-holdings by the banks. These holdings
are deducted from the bank's total capital base.
(5) Deferred tax assets in excess of the limit set forth in
Sec. 325.5(g). These disallowed deferred tax assets are deducted
from the core capital (Tier 1) elements. On a case-by-case basis,
and in conjunction with supervisory examinations, other deductions
from capital may also be required, including any adjustments deemed
appropriate for assets classified as loss.
II. Procedures For Computing Risk-Weighted Assets
A. General Procedures
1. Under the risk-based capital framework, a bank's balance
sheet assets and credit equivalent amounts of off-balance sheet
items are assigned to one of eight broad risk categories according
to the obligor or, if relevant, the guarantor or the nature of the
collateral. The aggregate dollar amount in each category is then
multiplied by the risk weight assigned to that category. The
resulting weighted values from each of the eight risk categories are
added together and this sum is the risk-weighted assets total that,
as adjusted,\12\ comprises the denominator of the risk-based capital
ratio.
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\12\ Any asset deducted from a bank's capital accounts when
computing the numerator of the risk-based capital ratio will also be
excluded from risk-weighted assets when calculating the denominator
for the ratio.
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2. The risk-weighted amounts for all off-balance sheet items are
determined by a two-step process. First, the notional principal, or
face value, amount of each off-balance sheet item generally is
multiplied by a credit conversion factor to arrive at a balance
sheet ``credit equivalent amount.'' Second, the credit equivalent
amount generally is assigned to the appropriate risk category, like
any balance sheet asset, according to the obligor or, if relevant,
the guarantor or the nature of the collateral.
3. The Director of the Division of Supervision and Consumer
Protection (Director) of DSC 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 E or that imposes risks on a bank that
are not commensurate with the risk weight otherwise specified in
this appendix E for the asset or credit equivalent amount. In
addition, the Director of DSC 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 E or that imposes
risks on a bank that are not commensurate with the credit conversion
factor otherwise specified in this appendix E for the off-balance
sheet item. In making such a determination, the Director of DSC 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 E, as well as other relevant factors.
B. Other Considerations
1. Indirect Holdings of Assets. Some of the assets on a bank's
balance sheet may represent an indirect holding of a pool of assets;
for example, mutual funds. An investment in shares of a mutual fund
whose portfolio consists solely of various securities or money
market instruments that, if held separately, would be assigned to
different risk categories, generally is assigned to the risk
category appropriate to the highest risk-weighted asset that the
fund is permitted to hold in accordance with the stated investment
objectives set forth in its prospectus. The bank may, at its option,
assign the investment on a pro rata basis to different risk
categories according to the investment limits in the fund's
prospectus, but in no case will indirect holdings through shares in
any mutual fund be assigned to a risk weight less than 20 percent.
If the bank chooses to assign its investment on a pro rata basis,
and the sum of the investment limits in the fund's prospectus
exceeds 100 percent, the bank must assign risk weights in descending
order. If, in order to maintain a necessary degree of short-term
liquidity, a fund is permitted to hold an insignificant amount of
its assets in short-term, highly liquid securities of superior
credit quality that do not qualify for a preferential risk weight,
such securities will generally be disregarded in determining the
risk category to which the bank's holdings in the overall fund
should be assigned. The prudent use of hedging instruments by a
mutual fund to reduce the risk of its assets will not increase the
risk weighting of the mutual fund investment. For example, the use
of hedging instruments by a mutual fund to reduce the interest rate
risk of its government bond portfolio will not increase the risk
weight of that fund above the 20 percent category. Nonetheless, if
the fund engages in any activities that appear speculative in nature
or has any other characteristics that are inconsistent with the
preferential risk weighting assigned to the fund's assets, holdings
in the fund will be assigned to the 100 percent risk category.
2. Collateral (a) Cash and securities issued or guaranteed by
the United States, other OECD central Governments and U.S.
Government-sponsored entities. In determining risk weights of
various assets, the following forms of collateral are formally
recognized under this appendix E: cash on
[[Page 77495]]
deposit in the lending bank; securities issued or guaranteed by the
United States, other central governments of the OECD-based group of
countries,\13\ U.S. Government agencies, and U.S. Government-
sponsored agencies. Claims fully secured by such collateral are
assigned to the 20 percent risk category.\14\ The extent to which
these securities are recognized as collateral for risk-based capital
purposes is determined by their current market value. If a claim is
partially secured, the portion of the claim that is not covered by
the collateral is assigned to the risk category appropriate to the
obligor or, if relevant, the guarantor.
---------------------------------------------------------------------------
\13\ Securities issued or guaranteed by OECD central governments
are only recognized under the zero percent risk weight if they meet
the collateral requirements of section II.C.1 of appendix E. The
OECD-based group of countries comprises all full members of the
Organization for Economic Cooperation and Development (OECD)
regardless of entry date, as well as countries that have concluded
special lending arrangements with the International Monetary Fund
(IMF) associated with the IMF's General Arrangements to Borrow, but
excludes any country that has rescheduled its external sovereign
debt within the previous five years. As of November 1995, the OECD
included the following countries: Australia, Austria, Belgium,
Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland,
Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand,
Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United
Kingdom and the United States; and Saudi Arabia had concluded
special lending arrangements with the IMF associated with the IMF's
General Arrangements to Borrow. A rescheduling of external sovereign
debt generally would include any renegotiation of terms arising from
a country's inability or unwillingness to meet its external debt
service obligations, but generally would not include renegotiations
of debt in the normal course of business, such as renegotiation to
allow the borrower to take advantage of a decline in interest rates
or other change in market conditions.
\14\ However, claims on or guaranteed by qualifying securities
firms may receive a zero percent risk weight if such claims are: (i)
collateralized by cash or securities issued by an OECD central
government (including the United States) and (ii) meet the other
requirements of section II.C.1(c) of this appendix E. See footnote
31.
---------------------------------------------------------------------------
(b) Collateral that requires an external rating. The following
forms of liquid and readily marketable financial collateral also are
recognized: both short- and long-term debt securities that are
either issued or guaranteed by sovereigns where either the sovereign
or the issued debt security are externally rated at least than
investment grade by a NRSRO; issued by non-sovereigns where the
issued security is externally rated at least investment grade by a
NRSRO; or securitization exposures rated at least investment grade
by a NRSRO. Claims or portion of claims collateralized by financial
collateral externally rated at least investment grade are assigned
to the risk weight appropriate to the collateral's external rating
as set forth in section II.C.9(a) and Tables F1 and F2, or section
II.B.5 and Tables A and B.\15\ The extent to which externally rated
securities are recognized as collateral for risk-based capital
purposes is determined by their current market value. If a claim is
partially secured, the pro rata portion of the claim that is not
covered by the collateral is assigned to the risk category
appropriate to the obligor or, if relevant, the guarantor.
Notwithstanding Tables F1 and F2 there is a 20 percent risk weight
floor on collateral.
---------------------------------------------------------------------------
\15\ In the event that the external rating of a security used to
collateralize a claim results in a higher risk weight than would
have otherwise been assigned based on the claim's underlying asset
type, obligor, or external rating, if applicable, then the lower
risk weight appropriate to the underlying asset type or the obligor
may be applied.
---------------------------------------------------------------------------
3. Guarantees (a) Guarantees of the United States, U.S.
Government-sponsored entities, OECD state and local governments, and
certain banking organizations. Guarantees of the United States, U.S.
Government agencies, U.S. Government-sponsored agencies, state and
local governments of the OECD-based group of countries, U.S.
depository institutions, and foreign banks in OECD countries are
recognized under this appendix E. If a claim is partially
guaranteed, the portion of the claim that is not fully covered by
the guarantee is assigned to the risk category appropriate to the
obligor or, if relevant, the collateral.
(b) Eligible guarantees by sovereigns and non-sovereigns. A
claim backed by an eligible guarantee may be assigned to the risk
weight in section II.C.9(a) and Table F1 of this appendix E
corresponding to the eligible guarantor(s)' senior long-term debt
rating or issuer rating, in the case of a sovereign. Portions of
claims backed by an eligible guarantee may be assigned to the risk-
weight category appropriate to the external credit rating of the
eligible guarantor(s)' senior long-term debt or issuer rating in
accordance with section II.C.9(a) and Table F1 of this appendix E.
4. Maturity. Maturity is generally not a factor in assigning
items to risk categories with the exceptions of claims on non-OECD
banks, commitments, and interest rate and foreign exchange rate
related contracts. Except for commitments, short-term is defined as
one year or less remaining maturity and long-term is defined as over
one year remaining maturity. In the case of commitments, short-term
is defined as one year or less original maturity and long-term is
defined as over one year original maturity.
5. Recourse, Direct Credit Substitutes, Residual Interests and
Mortgage- and Asset-Backed Securities. For purposes of this section
II.B.5 of this appendix E, the following definitions will apply.
(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 interest-only strip is defined in Sec.
325.2(g).
(iii) 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:
(A) 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;
(B) 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
(C) Warranties that permit the return of assets in instances of
misrepresentation, fraud or incomplete documentation.
(iv) 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:
(A) 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 exceeds a bank's
pro rata share of losses in the financial claim;
(B) Guarantees, surety arrangements, credit derivatives, and
similar instruments backing financial claims;
(C) Purchased subordinated interests or securities that absorb
more than their pro rata share of credit losses from the underlying
assets;
(D) Credit derivative contracts under which the bank assumes
more than its pro rata share of credit risk on a third party asset
or exposure;
(E) Loans or lines of credit that provide credit enhancement for
the financial obligations of an account party;
(F) Purchased loan servicing assets if the servicer: is
responsible for credit losses associated with the loans being
serviced; is responsible for making mortgage servicer cash advances
(unless the advances are not direct credit substitutes because they
meet the conditions specified in II.B.5 (a)(ix) of this appendix E),
or makes or assumes credit-enhancing representations and warranties
with respect to the loans serviced;
(G) 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;
and
(v) Eligible ABCP liquidity facility means a liquidity facility
supporting ABCP, in form or in substance, that is subject to an
asset
[[Page 77496]]
quality test at the time of draw that precludes funding against
assets that are 90 days or more past due or in default. In addition,
if the assets that an eligible ABCP liquidity facility is required
to fund against are externally rated assets or exposures at the
inception of the facility, the facility can be used to fund only
those assets or exposures that are externally rated investment grade
at the time of funding. Notwithstanding the eligibility requirements
set forth in the two preceding sentences, a liquidity facility will
be considered an eligible ABCP liquidity facility if the assets that
are funded under the liquidity facility and which do not meet the
eligibility requirements are guaranteed, either conditionally or
unconditionally, by the U.S. government or its agencies, or by the
central government of an OECD country.
(vi) External rating is defined above in the definitions to this
appendix E.
(vii) 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.
(viii) 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.
(ix) Financial standby letter of credit means a letter of credit
or similar arrangement that represents an irrevocable obligation to
a third-party beneficiary:
(A) To receive money borrowed by, or advanced to, or for the
account of, a second party (the account party), or
(B) To make payment on behalf of the account party, in the event
that the account party fails to fulfill its obligation to the
beneficiary.
(x) Liquidity facility means a legally binding commitment to
provide liquidity support to ABCP by lending to, or purchasing
assets from, any structure, program, or conduit in the event that
funds are required to repay maturing ABCP.
(xi) 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:
(A) The mortgage servicer is entitled to full reimbursement and
this right is not subordinated to other claims on the cash flows
from the underlying asset pool; or
(B) For any one loan, the servicer's obligation to make
nonreimbursable advances is contractually limited to an
insignificant amount of the outstanding principal of that loan.
(xii) 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).
(xiii) Recourse means an arrangement in which a bank retains, 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 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:
(A) Credit-enhancing representations and warranties made on the
transferred assets;
(B) Loan servicing assets retained pursuant to an agreement
under which the bank: is responsible for losses associated with the
loans being serviced; or is responsible for making mortgage servicer
cash advances (unless the advances are not a recourse obligation
because they meet the conditions specified in section II.B.5(a)(xi)
of this appendix E).
(C) Retained subordinated interests that absorb more than their
pro rata share of losses from the underlying assets;
(D) Assets sold under an agreement to repurchase, if the assets
are not already included on the balance sheet;
(E) 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;
(F) Credit derivative contracts under which the bank retains
more than its pro rata share of credit risk on transferred assets;
(G) 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; and
(H) Liquidity facilities that provide liquidity support to ABCP
(other than eligible ABCP liquidity facilities).
(xiv) 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 (GAAP)) of financial assets, whether
through a securitization or otherwise, and that exposes a 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 the risk-based capital treatment in this
appendix.
(xv) 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.
(xvi) 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.
(xvii) Sponsor means a bank that establishes an ABCP program;
approves the sellers permitted to participate in the program;
approves the asset pools to be purchased by the program; or
administers the ABCP program by monitoring the assets, arranging for
debt placement, compiling monthly reports, or ensuring compliance
with the program documents and with the program's credit and
investment policy.
(xviii) 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.
(xix) Traded position means a position that has an external
rating 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 weights of recourse
obligations and direct credit substitutes--(i) 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 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.
(ii) 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
[[Page 77497]]
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 (ii) is subject to the low-level exposure rule
provided in section II.B.5(h)(i) of this appendix E.
(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)(i) of this
appendix E, 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:
(i) 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.\16\
---------------------------------------------------------------------------
\16\ A risk participation with a remaining maturity of one year
or less that is conveyed to a non-OECD bank is also assigned to the
20 percent risk category.
---------------------------------------------------------------------------
(ii) 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.
(iii) 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) Positions with external ratings: credit-equivalent amounts
and risk weights.--(i) 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 E, as appropriate.\17\ If a
traded position receives more than one external rating, the lowest
rating will apply and that external rating must apply to the claim
or exposure in its entirety. Thus, for banks that hold split or
partially-rated instruments, the risk weight that corresponds to the
lowest component rating will apply to the entire exposure. For
example, a purchased subordinated security where the principal
component is rated BBB, but the interest component is rated B, will
be subject to the gross-up treatment accorded to residual interests
rated B or lower. Similarly, if a portion of an instrument is
unrated, the entire position will be treated as if it were unrated.
The FDIC reserves 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 a bank.
---------------------------------------------------------------------------
\17\ 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 Weights for Long-Term External Ratings of Securitization
Exposures
------------------------------------------------------------------------
Risk weight
Long-term rating category Examples (percent)
------------------------------------------------------------------------
Highest investment grade rating.. AAA.................. 20
Second-highest investment grade AA................... 20
rating.
Third-highest investment grade A.................... 35
rating.
Lowest-investment grade rating-- BBB+................. 50
plus.
Lowest-investment grade rating-- BBB.................. 75
naught.
Lowest-investment grade rating-- BBB-................. 100
negative.
One category below investment BB+, BB.............. 200
grade--plus & naught.
One category below investment BB-.................. 200
grade--negative.
Two or more categories below B, CCC............... Dollar for
investment grade. Dollar
Unrated.......................... n/a Dollar for
Dollar
------------------------------------------------------------------------
Table B.--Risk Weights For Short-Term External Ratings of Securitization
Exposures
------------------------------------------------------------------------
Risk weight
Short-term rating category Examples (percent)
------------------------------------------------------------------------
Highest investment grade rating.. A-1, P-1............. 20
Second-highest investment grade A-2, P-2............. 35
rating.
Lowest investment grade rating... A-3, P-3............. 75
Unrated.......................... n/a ..............
------------------------------------------------------------------------
[[Page 77498]]
(ii) 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)(i) of this appendix E if:
(A) It has been externally rated by more than one NRSRO;
(B) 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;
(C) The ratings are publicly available; and
(D) 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)(i) of this
appendix E, 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--(i) Concentration limit on credit-
enhancing interest-only strips. In addition to the capital
requirement provided by section II.B.5(f)(ii) of this appendix E, 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).
(ii) 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 if 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.
(iii) Other residual interests capital requirement. Except as
otherwise provided in section II.B.5(d) or (e) of this appendix E, 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.
(iv) 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)(ii) through (iii) of this appendix E 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 E, 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)(i) through (iii) of this appendix E. Table
C
------------------------------------------------------------------------
Risk weight
Rating category Examples (percent)
------------------------------------------------------------------------
Investment grade............... BBB or other........... 100
One category below investment BB..................... 200
grade.
------------------------------------------------------------------------
(i) 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: \18\
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\18\ The adequacy of a bank's use of its internal credit risk
system must be demonstrated to the FDIC considering the criteria
listed on this section and the size and complexity of the credit
exposures assumed by the bank.
---------------------------------------------------------------------------
(A) 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 form a bank's participation in
securitization activities;
(B) Internal credit ratings are linked to measurable outcomes,
such as the probability that the position will experience any loss,
the position's expected loss given default, and the degree of
variance in losses given default on that position;
(C) The 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;
(D) The internal credit risk rating system identifies gradations
of risk among ``pass'' assets and other risk positions;
(E) 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;
(F) The bank must have independent credit risk management or
loan review personnel assigning or reviewing the credit risk
ratings;
(G) An internal audit procedure should periodically verify that
internal risk ratings are assigned in accordance with the bank's
established criteria;
(H) The bank must monitor the performance of the internal credit
risk ratings assigned to nonrated, nontraded direct credit
substitutes over time to determine the appropriateness of the
initial credit risk rating assignment and adjust individual credit
risk ratings, or the overall internal credit risk ratings system, as
needed; and
(I) The internal credit risk 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.
(ii) 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 specified
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
[[Page 77499]]
on a program rating obtained by the sponsor of the program.
(iii) 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--(i) 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 E 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.
(ii) Mortgage-related securities or participation certificates
retained in a mortgage loan swap. If a bank holds a mortgage-related
security or a participation certificate as a result of a mortgage
loan swap with recourse, capital is required to support the recourse
obligation plus the percentage of the mortgage-related security or
participation certificate that is not covered by the recourse
obligation. The total amount of capital required for the on-balance
sheet asset and the recourse obligation, however, is limited to the
capital requirement for the underlying loans, calculated as if the
bank continued to hold these loans as an on-balance sheet asset.
(iii) Related on-balance sheet assets. If a recourse obligation
or direct credit substitute also appears as a balance sheet asset,
the asset is risk-weighted only under this section II.B.5 of this
appendix E, 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.
(i) Definitions. For purposes of this section II.B.5(i):
(A) Qualified bank means a bank that: 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 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).
(B) Small business means a business that meets the criteria for
a small business concern established by the Small Business
Administration in 13 CFR part 121 pursuant to 15 U.S.C. 632.
(ii) Capital 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.
(iii) 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)(ii) of this
appendix E may not exceed 15 percent of the bank's total risk-based
capital, unless the FDIC specifies a greater amount by order.
(iv) 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)(iii) of this appendix E, the
bank may continue to apply the capital treatment described in
section II.B.5(i)(ii) of this appendix E 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.
(v) Prompt correction action not affected. (A) 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 II.B.5(i)) and, after applying
the capital treatment described in this section II.B.5(i), the bank
would be well capitalized.
(B) 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.
6. Nonfinancial equity investments. (a) General. A bank must
deduct from its Tier 1 capital the sum of the appropriate percentage
(as determined below) of the adjusted carrying value of all
nonfinancial equity investments held by the bank or by its direct or
indirect subsidiaries. For purposes of this section II.B.6,
investments held by a bank include all investments held directly or
indirectly by the bank or any of its subsidiaries.
(b) Scope of nonfinancial equity investments. A nonfinancial
equity investment means any equity investment held by the bank in a
nonfinancial company: through a small business investment company
(SBIC) under section 302(b) of the Small Business Investment Act of
1958 (15 U.S.C. 682(b)); \19\ under the portfolio investment
provisions of Regulation K issued by the Board of Governors of the
Federal Reserve System (12 CFR 211.8(c)(3)); or under section 24 of
the Federal Deposit Insurance Act (12 U.S.C. 1831a), other than an
investment held in accordance with section 24(f) of that Act.\20\ A
nonfinancial company is an entity that engages in any activity that
has not been determined to be permissible for the bank to conduct
directly, or to be financial in nature or incidental to financial
activities under section 4(k) of the Bank Holding Company Act (12
U.S.C. 1843(k)).
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\19\ An equity investment made under section 302(b) of the Small
Business Investment Act of 1958 in a SBIC that is not consolidated
with the bank is treated as a nonfinancial equity investment.
\20\ The Board of Directors of the FDIC, acting directly, may,
in exceptional cases and after a review of the proposed activity,
permit a lower capital deduction for investments approved by the
Board of Directors under section 24 of the FDI Act so long as the
bank's investments under section 24 and SBIC investments represent,
in the aggregate, less than 15 percent of the Tier 1 capital of the
bank. The FDIC reserves the authority to impose higher capital
charges on any investment where appropriate.
---------------------------------------------------------------------------
(c) Amount of deduction from core capital. (i) The bank must
deduct from its Tier 1 capital the sum of the appropriate
percentages, as set forth in Table D following this paragraph, of
the adjusted carrying value of all nonfinancial equity investments
held by the bank. The amount of the percentage deduction increases
as the aggregate amount of nonfinancial equity investments held by
the bank increases as a percentage of the bank's Tier 1 capital.
[[Page 77500]]
Table D.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
Deduction from
Tier 1 Capital
(as a
Aggregate adjusted carrying value of all nonfinancial percentage of
equity investments held directly or indirectly by the the adjusted
bank (as a percentage of the Tier 1 capital of the bank) carrying value
\1\ of the
investment)
(percent)
------------------------------------------------------------------------
Less than 15 percent.................................... 8
15 percent to 24.99 percent............................. 12
25 percent and above.................................... 25
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
nonfinancial equity investments as a percentage of Tier 1 capital.
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, non-mortgage servicing assets and purchased
credit card relationships, but prior to the deduction for any
disallowed mortgage servicing assets, any disallowed nonmortgage
servicing assets, any disallowed purchased credit card relationships,
any disallowed credit-enhancing interest-only strips (both purchased
and retained), any disallowed deferred tax assets, and any
nonfinancial equity investments.
(ii) These deductions are applied on a marginal basis to the
portions of the adjusted carrying value of nonfinancial equity
investments that fall within the specified ranges of the parent
bank's Tier 1 capital. For example, if the adjusted carrying value
of all nonfinancial equity investments held by a bank equals 20
percent of the Tier 1 capital of the bank, then the amount of the
deduction would be 8 percent of the adjusted carrying value of all
investments up to 15 percent of the bank's Tier capital, and 12
percent of the adjusted carrying value of all investments in excess
of 15 percent of the bank's Tier 1 capital.
(iii) The total adjusted carrying value of any nonfinancial
equity investment that is subject to deduction under this paragraph
is excluded from the bank's risk-weighted assets for purposes of
computing the denominator of the bank's risk-based capital ratio and
from total assets for purposes of calculating the denominator of the
leverage ratio.\21\
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\21\ For example, if 8 percent of the adjusted carrying value of
a nonfinancial equity investment is deducted from Tier 1 capital,
the entire adjusted carrying value of the investment will be
excluded from both risk-weighted assets and total assets in
calculating the respective denominators for the risk-based capital
and leverage ratios.
---------------------------------------------------------------------------
(iv) This appendix E establishes minimum risk-based capital
ratios and banks are at all times expected to maintain capital
commensurate with the level and nature of the risks to which they
are exposed. The risk to a bank from nonfinancial equity investments
increases with its concentration in such investments and strong
capital levels above the minimum requirements are particularly
important when a bank has a high degree of concentration in
nonfinancial equity investments (e.g., in excess of 50 percent of
Tier 1 capital). The FDIC intends to monitor banks and apply
heightened supervision to equity investment activities as
appropriate, including where the bank has a high degree of
concentration in nonfinancial equity investments, to ensure that
each bank maintains capital levels that are appropriate in light of
its equity investment activities. The FDIC also reserves authority
to impose a higher capital charge in any case where the
circumstances, such as the level of risk of the particular
investment or portfolio of investments, the risk management systems
of the bank, or other information, indicate that a higher minimum
capital requirement is appropriate.
(d) SBIC investments. (i) No deduction is required for
nonfinancial equity investments that are held by a bank through one
or more SBICs that are consolidated with the bank or in one or more
SBICs that are not consolidated with the bank to the extent that all
such investments, in the aggregate, do not exceed 15 percent of the
bank's Tier 1 capital. Any nonfinancial equity investment that is
held through an SBIC or in an SBIC and that is not required to be
deducted from Tier 1 capital under this section II.B.6(d) will be
assigned a 100 percent risk-weight and included in the bank's
consolidated risk-weighted assets.\22\
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\22\ If a bank has an investment in a SBIC that is consolidated
for accounting purposes but that is not wholly owned by the bank,
the adjusted carrying value of the bank's nonfinancial equity
investments through the SBIC is equal to the bank's proportionate
share of the adjusted carrying value of the SBIC's investments in
nonfinancial companies. The remainder of the SBIC's adjusted
carrying value (i.e., the minority interest holders' proportionate
share) is excluded from the risk-weighted assets of the bank. If a
bank has an investment in a SBIC that is not consolidated for
accounting purposes and has current information that identifies the
percentage of the SBIC's assets that are equity investments in
nonfinancial companies, the bank may reduce the adjusted carrying
value of its investment in the SBIC proportionately to reflect the
percentage of the adjusted carrying value of the SBIC's assets that
are not equity investments in nonfinancial companies. If a bank
reduces the adjusted carrying value of its investment in a non-
consolidated SBIC to reflect financial investments of the SBIC, the
amount of the adjustment will be risk-weighted at 100 percent and
included in the bank's risk-weighted assets.
---------------------------------------------------------------------------
(ii) To the extent the adjusted carrying value of all
nonfinancial equity investments that a bank holds through one or
more SBICs that are consolidated with the bank or in one or more
SBICs that are not consolidated with the bank exceeds, in the
aggregate, 15 percent of the bank's Tier 1 capital, the appropriate
percentage of such amounts (as set forth in the table in section
II.B.6(c)(i)) must be deducted from the bank's common stockholders'
equity in determining the bank's Tier 1 capital. In addition, the
aggregate adjusted carrying value of all nonfinancial equity
investments held by a bank through a consolidated SBIC and in a non-
consolidated SBIC (including any investments for which no deduction
is required) must be included in determining, for purposes of the
table in section II.B.6(c)(i), the total amount of nonfinancial
equity investments held by the bank in relation to its Tier 1
capital.
(e) Transition provisions. No deduction under this section
II.B.6 is required to be made with respect to the adjusted carrying
value of any nonfinancial equity investment (or portion of such an
investment) that was made by the bank prior to March 13, 2000, or
that was made by the bank after such date pursuant to a binding
written commitment \23\ entered into prior to March 13, 2000,
provided that in either case the bank has continuously held the
investment since the relevant investment date.\24\ For purposes of
this section II.B.6(e) a nonfinancial equity investment made prior
to March 13, 2000, includes any shares or other interests
[[Page 77501]]
received by the bank through a stock split or stock dividend on an
investment made prior to March 13, 2000, provided the bank provides
no consideration for the shares or interests received and the
transaction does not materially increase the bank's proportional
interest in the company. The exercise on or after March 13, 2000, of
options or warrants acquired prior to March 13, 2000, is not
considered to be an investment made prior to March 13, 2000, if the
bank provides any consideration for the shares or interests received
upon exercise of the options or warrants. Any nonfinancial equity
investment (or portion thereof) that is not required to be deducted
from Tier 1 capital under this section II.B.6(e) must be included in
determining the total amount of nonfinancial equity investments held
by the bank in relation to its Tier 1 capital for purposes of the
table in section II.B.6(c)(i). In addition, any nonfinancial equity
investment (or portion thereof) that is not required to be deducted
from Tier 1 capital under this section II.B.6(e) will be assigned a
100-percent risk weight and included in the bank's consolidated
risk-weighted assets.
---------------------------------------------------------------------------
\23\ A ``binding written commitment'' means a legally binding
written agreement that requires the bank to acquire shares or other
equity of the company, or make a capital contribution to the
company, under terms and conditions set forth in the agreement.
Options, warrants, and other agreements that give a bank the right
to acquire equity or make an investment, but do not require the bank
to take such actions, are not considered a binding written
commitment for purposes of this section II.B.6(e).
\24\ For example, if a bank made an equity investment in 100
shares of a nonfinancial company prior to March 13, 2000, the
adjusted carrying value of that investment would not be subject to a
deduction under this section II.B.6. However, if the bank made any
additional equity investment in the company after March 13, 2000,
such as by purchasing additional shares of the company (including
through the exercise of options or warrants acquired before or after
March 13, 2000) or by making a capital contribution to the company
and such investment was not made pursuant to a binding written
commitment entered into before March 13, 2000, the adjusted carrying
value of the additional investment would be subject to a deduction
under this section II.B.6. In addition, if the bank sold and
repurchased, after March 13, 2000, 40 shares of the company, the
adjusted carrying value of those 40 shares would be subject to a
deduction under this section II.B.6.
---------------------------------------------------------------------------
(f) Adjusted carrying value. (i) For purposes of this section
II.B.6, the ``adjusted carrying value'' of investments is the
aggregate value at which the investments are carried on the balance
sheet of the bank reduced by any unrealized gains on those
investments that are reflected in such carrying value but excluded
from the bank's Tier 1 capital and associated deferred tax
liabilities. For example, for equity investments held as available-
for-sale (AFS), the adjusted carrying value of the investments would
be the aggregate carrying value of those investments (as reflected
on the consolidated balance sheet of the bank) less any unrealized
gains on those investments that are included in other comprehensive
income and not reflected in Tier 1 capital, and associated deferred
tax liabilities.\25\
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\25\ Unrealized gains on available-for-sale equity investments
may be included in Tier 2 capital to the extent permitted under
section I-2.A(2)(f) of this appendix E. In addition, the net
unrealized losses on available-for-sale equity investments are
deducted from Tier 1 capital in accordance with section I-2.A(1) of
this appendix E.
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(ii) As discussed above with respect to consolidated SBICs, some
equity investments may be in companies that are consolidated for
accounting purposes. For investments in a nonfinancial company that
is consolidated for accounting purposes under generally accepted
accounting principles, the bank's adjusted carrying value of the
investment is determined under the equity method of accounting (net
of any intangibles associated with the investment that are deducted
from the bank's core capital in accordance with section I-2.B(a)(i)
of this appendix E). Even though the assets of the nonfinancial
company are consolidated for accounting purposes, these assets (as
well as the credit equivalent amounts of the company's off-balance
sheet items) should be excluded from the bank's risk-weighted assets
for regulatory capital purposes.
(g) Equity investments. For purposes of this section II.B.6, an
equity investment means any equity instrument (including common
stock, preferred stock, partnership interests, interests in limited
liability companies, trust certificates and warrants and call
options that give the holder the right to purchase an equity
instrument), any equity feature of a debt instrument (such as a
warrant or call option), and any debt instrument that is convertible
into equity where the instrument or feature is held under one of the
legal authorities listed in section II.B.6(b) of this appendix E. An
investment in any other instrument (including subordinated debt) may
be treated as an equity investment if, in the judgment of the FDIC,
the instrument is the functional equivalent of equity or exposes the
bank to essentially the same risks as an equity instrument.
7. Asset-backed commercial paper programs. (a) An asset-backed
commercial paper (ABCP) program means a program that primarily
issues externally rated commercial paper backed by assets or other
exposures held in a bankruptcy-remote, special purpose entity.
(b) A bank that qualifies as a primary beneficiary and must
consolidate an ABCP program that is defined as a variable interest
entity under GAAP may exclude the consolidated ABCP program assets
from risk-weighted assets provided that the bank is the sponsor of
the ABCP program. If a bank excludes such consolidated ABCP program
assets, the bank must assess the appropriate risk-based capital
charge against any exposures of the bank arising in connection with
such ABCP programs, including direct credit substitutes, recourse
obligations, residual interests, liquidity facilities, and loans, in
accordance with sections II.B.5, II.C, and II.D of this appendix E.
(c) If a bank has multiple overlapping exposures (such as a
program-wide credit enhancement and multiple pool-specific liquidity
facilities) to an ABCP program that is not consolidated for risk-
based capital purposes, the bank is not required to hold capital
under duplicative risk-based capital requirements under this
appendix E against the overlapping position. Instead, the bank
should apply to the overlapping position the applicable risk-based
capital treatment that results in the highest capital charge.
8. Securitizations of revolving credit with early amortization
provisions.
(a) Definitions. For purposes of this section II.B.8, the
following definitions will apply:
(i) Early amortization provision means a provision in the
documentation governing a securitization that, when triggered,
causes investors in the securitization exposures to be repaid before
the original stated maturity of the securitization exposures, unless
the provision is triggered solely by events not directly related to
the performance of the underlying exposures or the originating bank
(such as material changes in tax laws or regulations).
(ii) Excess spread means gross finance charge collections and
other income received by a trust or special purpose entity minus
interest paid to the investors in the securitization exposures,
servicing fees, charge-offs, and other similar trust or special
purpose entity expenses.
(iii) Excess spread trapping point means the point at which the
bank is required by the documentation governing a securitization to
divert and hold excess spread in a spread or reserve account,
expressed as a percent.
(iv) Investors' interest is the total securitization exposure
represented by securities issued by a trust or special purpose
entity to investors.
(v) Revolving Credit means a line of credit where the borrower
is permitted to vary both the drawn amount and the amount of
repayment within an agreed limit.
(b) Capital charge for revolving securitizations with an early
amortizations trigger. A bank that securitizes revolving credits
where the securitization structure contains an early amortization
provision must maintain risk-based capital against the investors'
interest as required under this section.
(c) Calculation. Capital for securitizations of revolving credit
exposures that incorporate early-amortization provisions will be
assessed based on a comparison of the securitizations' three-month
average excess spread against the excess spread trapping point.
(i) To calculate the securitization's excess spread trapping
point ratio, a bank must first calculate the three-month average of:
(A) The dollar amount of excess spread divided by
(B) The outstanding principal balance of the underlying pool of
exposures at the end of each of the prior three months.
(ii) This annualized three-month average of excess spread is
then divided by the excess spread trapping point that is required by
the securitization structure.
(iii) The excess spread trapping point ratio is compared to the
ratios contained in Table E to determine the appropriate conversion
factor to apply to the investors' interest.
(iv) The amount of investors' interest after conversion is then
assigned capital based on the underlying obligor, collateral, or
guarantor.
(d) Default for certain securitizations. For purposes of section
II.B.8 of this appendix E, for securitizations that do not require
excess spread to be trapped, or that specify the trapping points
based primarily on the performance measures other than the three-
month average excess spread, the excess spread trapping point is
4.5.
(e) Limit. For a bank subject to the early amortization
requirements in this section II.B.8 of appendix E, the aggregate
risk-based capital requirement for all of the bank's exposures to a
securitization of revolving credit is limited to the greater of the
risk-based capital requirement for residual interests (as calculated
under section II.B.5 of this appendix E); or the risk-based capital
requirement for the underlying securitized assets calculated as if
the bank continued to hold the assets on its balance sheet.
[[Page 77502]]
Table E.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
Credit
conversion
Excess spread trapping point ratio factor
(CCF)
(percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more................... 0
less than 133.33 percent to 100 percent of trapping point.. 5
less than 100 percent to 75 percent of trapping point...... 15
less than 75 percent to 50 percent of trapping point....... 50
Less than 50 percent of trapping point..................... 100
------------------------------------------------------------------------
C. Risk Weights for Balance Sheet Assets (See Table J)
The risk-based capital framework contains eight risk weight
categories--0 percent, 20 percent, 35 percent, 50 percent, 75
percent, 100 percent, 150 percent, and 200 percent.\26\ In general,
if a particular item can be placed in more than one risk category,
it is assigned to the category that has the lowest risk weight. An
explanation of the components of each category follows:
---------------------------------------------------------------------------
\26\ In addition, certain items receive a dollar-for-dollar
capital treatment under section II.B.5 of this appendix E.
---------------------------------------------------------------------------
1--Zero Percent Risk Weight
(a) This category includes cash (domestic and foreign) owned and
held in all offices of the bank or in transit; balances due from
Federal Reserve banks and central banks in other OECD countries;
\27\ and gold bullion held in the bank's own vaults or in another
bank's vaults on an allocated basis, to the extent it is offset by
gold bullion liabilities.\28\
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\27\ A central government is defined to include departments and
ministries, including the central bank, of the central government.
The U.S. central bank includes the 12 Federal Reserve banks. The
definition of central government does not include state, provincial
or local governments or commercial enterprises owned by the central
government. In addition, it does not include local government
entities or commercial enterprises whose obligations are guaranteed
by the central government. OECD central governments are defined as
central governments of the OECD-based group of countries. Non-OECD
central governments are defined as central governments of countries
that do not belong to the OECD-based group of countries.
\28\ All other bullion holdings are to be assigned to the 100
percent risk weight category.
---------------------------------------------------------------------------
(b) The zero percent risk category also includes direct claims
\29\ (including securities, loans, and leases) on, and the portions
of claims that are unconditionally guaranteed by the United States
and U.S. Government agencies.\30\ Federal Reserve Bank stock also is
included in this category.
---------------------------------------------------------------------------
\29\ For purposes of determining the appropriate risk weights
for this risk-based capital framework, the terms ``claims'' and
``securities'' refer to loans or other debt obligations of the
entity on whom the claim is held. Investments in the form of stock
or equity holdings in commercial or financial firms are generally
assigned to the 100 percent risk category.
\30\ For risk-based capital purposes U.S. Government agency is
defined as an instrumentality of the U.S. Government whose debt
obligations are fully and explicitly guaranteed as to the timely
payment of principal and interest by the full faith and credit of
the U.S. Government. These agencies include the Government National
Mortgage Association (GNMA), the Veterans Administration (VA), the
Federal Housing Administration (FHA), the Farmers Home
Administration (FHA), the Export-Import Bank (Exim Bank), the
Overseas Private Investment Corporation (OPIC), the Commodity Credit
Corporation (CCC), and the Small Business Administration (SBA). U.S.
Government agencies generally do not directly issue securities to
the public; however, a number of U.S. Government agencies, such as
GNMA, guarantee securities that are publicly held.
---------------------------------------------------------------------------
(c) This category also includes claims on, and claims guaranteed
by, qualifying securities firms \31\ incorporated in the United
States or other members of the OECD-based group of countries that
are collateralized by cash on deposit in the lending bank or by
securities issued or guaranteed by the United States (including U.S.
government Agencies) or OECD central governments, provided that a
positive margin of collateral is required to be maintained on such a
claim on a daily basis, taking into account any change in a bank's
exposure to the obligor or counterparty under the claim in relation
to the market value of the collateral held in support of the claim.
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\31\ With regard to securities firms incorporated in the United
States, qualifying securities firms are those securities firms that
are broker-dealers registered with the Securities and Exchange
Commission (SEC) and are in compliance with the SEC's net capital
rule, 17 CFR 240.15c3-1. With regard to securities firms
incorporated in any other country in the OECD-based group of
countries, qualifying securities firms are those securities firms
that a bank is able to demonstrate are subject to consolidated
supervision and regulation (covering their direct and indirect
subsidiaries, but not necessarily their parent organizations)
comparable to that imposed on banks in OECD countries. Such
regulation must include risk-based capital requirements comparable
to those applied to banks under the Accord on International
Convergence of Capital Measurement and Capital Standards (1988, as
amended in 1998) (Basel Accord). Claims on a qualifying securities
firm that are instruments the firm, or its parent company, uses to
satisfy its applicable capital requirements are not eligible for
this risk weight and are generally assigned to at least a 100
percent risk weight. In addition, certain claims on qualifying
securities firms are eligible for a zero percent risk weight if the
claims are collateralized by cash on deposit in the lending bank or
by securities issued or guaranteed by the United States (including
U.S. government agencies), provided that a positive margin of
collateral is required to be maintained on such a claim on a daily
basis, taking into account any change in a bank's exposure to the
obligor or counterparty under the claim in relation to the market
value of the collateral held in support of the claim.
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(d) As provided in sections II.B.3 and II.C.9 of this appendix
E, this category also includes securities issued by and other claims
on a sovereign rated highest investment grade, e.g., AAA, by a
NRSRO, in the case of long-term ratings, or highest rating category,
e.g., A-1, P-1, in the case of short-term ratings; and claims
guaranteed by a sovereign rated highest investment grade by a NRSRO.
2--20 Percent Risk Weight
(a) This category includes short-term claims (including demand
deposits) on, and portions of short-term claims that are guaranteed
\32\ by, U.S. depository institutions \33\ and foreign banks; \34\
portions of claims collateralized by cash held in a segregated
deposit account of the lending bank; cash items in process of
collection, both foreign and domestic; and long-term claims on, and
portions of long-term claims guaranteed by, U.S. depository
institutions and OECD banks.\35\
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\32\ Claims guaranteed by U.S. depository institutions include
risk participations in both bankers acceptances and standby letters
of credit, as well as participations in commitments, that are
conveyed to other U.S. depository institutions.
\33\ U.S. depository institutions are defined to include
branches (foreign and domestic) of federally insured banks and
depository institutions chartered and headquartered in the 50 states
of the United States, the District of Columbia, Puerto Rico, and
U.S. territories and possessions. The definition encompasses banks,
mutual or stock savings banks, savings or building and loan
associations, cooperative banks, credit unions, international
banking facilities of domestic depository institutions, and U.S.-
chartered depository institutions owned by foreigners. However, this
definition excludes branches and agencies of foreign banks located
in the U.S. and bank holding companies.
\34\ Foreign banks are distinguished as either OECD banks or
non-OECD banks. OECD banks include banks and their branches (foreign
and domestic) organized under the laws of countries (other than the
U.S.) that belong to the OECD-based group of countries. Non-OECD
banks include banks and their branches (foreign and domestic)
organized under the laws of countries that do not belong to the
OECD-based group of countries. For risk-based capital purposes, a
bank is defined as an institution that engages in the business of
banking; is recognized as a bank by the bank supervisory or monetary
authorities of the country of its organization or principal banking
operations; receives deposits to a substantial extent in the regular
course of business; and has the power to accept demand deposits.
\35\ Long-term claims on, or guaranteed by, non-OECD banks are
assigned to the 100 percent risk weight category, as are holdings of
bank-issued securities that qualify as capital of the issuing banks
for risk-based capital purposes.
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(b) This category also includes claims on, or portions of claims
guaranteed by U.S. Government-sponsored agencies; \36\ and portions
of claims (including repurchase agreements) collateralized by
securities issued or guaranteed by the United States, U.S.
Government agencies, or U.S. Government-sponsored agencies. Also
included in the 20 percent risk category are portions of claims that
are conditionally guaranteed by U.S. Government agencies or U.S.
Government-sponsored agencies.\37\
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\36\ For risk-based capital purposes, U.S. Government-sponsored
agencies are defined as agencies originally established or chartered
by the U.S. Government to serve public purposes specified by the
U.S. Congress but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. Government.
These agencies include the Federal Home Loan Mortgage Corporation
(FHLMC), the Federal National Mortgage Association (FNMA), the Farm
Credit System, the Federal Home Loan Bank System, and the Student
Loan Marketing Association (SLMA). For risk-based capital purposes,
claims on U.S. Government-sponsored agencies also include capital
stock in a Federal Home Loan Bank that is held as a condition of
membership in that bank.
\37\ For risk-based capital purposes, a conditional guarantee is
deemed to exist if the validity of the guarantee by the U.S.
Government agency is dependent upon some affirmative action (e.g.,
servicing requirements on the part of the beneficiary of the
guarantee). Portions of claims that are unconditionally guaranteed
by U.S. Government agencies are assigned to the zero percent risk
category.
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[[Page 77503]]
(c) General obligation claims on, or portions of claims
guaranteed by, the full faith and credit of states or other
political subdivisions of the United States or other countries of
the OECD-based group are also assigned to this 20 percent risk
category, as well as portions of claims guaranteed by such
organizations or collateralized by their securities.\38\
---------------------------------------------------------------------------
\38\ Claims on, or guaranteed by, states or other political
subdivisions of countries that do not belong to the OECD-based group
of countries are to be placed in the 100 percent risk weight
category.
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(d) As provided in sections II.B.2 and II.B.5 of this appendix
E, 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.
(e) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a sovereign rated second-highest or third-highest
investment grade by a NRSRO, e.g. AA or A, in the case of long-term
ratings, or second-highest investment grade, e.g. A-2, P-2, in the
case of short-term ratings; claims guaranteed by a sovereign rated
second-highest or third-highest investment grade by a NRSRO; and
claims and portions of claims collateralized by securities issued by
a sovereign rated second-highest or third-highest investment grade
by a NRSRO, in the case of long-term ratings, or second-highest
investment grade, in the case of short-term ratings.
(f) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a non-sovereign rated highest or second-highest
investment grade by a NRSRO, e.g. AAA or AA, in the case of long-
term ratings, or highest investment grade, e.g. A-1, P-1, in the
case of short-term ratings; claims guaranteed by a non-sovereign
whose long-term senior debt is rated highest or second-highest
investment grade by a NRSRO; and claims and portions of claims
collateralized by securities issued by a non-sovereign rated highest
or second-highest investment grade by a NRSRO, in the case of long-
term ratings, or highest-investment grade, in the case of short-term
ratings.
(g) As provided in section II.C.9(b) of this appendix E, this
category also includes certain one-to-four family residential
mortgages.
3--35 Percent Risk Weight
(a) As provided in sections II.B.2 and II.B.5 of this appendix
E, this category includes recourse obligations, direct credit
substitutes, residual interests (other than a credit-enhancing
interest-only strip) and asset- or mortgage-backed securities rated
third-highest investment grade, e.g., A, in the case of long-term
ratings, and second-highest investment grade, e.g. A-2, P-2, in the
case of short-term ratings.
(b) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a sovereign rated lowest-investment grade plus by a
NRSRO, e.g. BBB+, in the case of long-term ratings; claims
guaranteed by a sovereign rated lowest-investment grade plus by a
NRSRO; and claims and portions of claims collateralized by
securities issued by a sovereign rated lowest-investment grade plus
by a NRSRO, in the case of long-term ratings.
(c) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a non-sovereign rated third-highest investment grade
by a NRSRO, e.g. A, in the case of long-term ratings, or second-
highest investment grade, e.g. A-2, P-2, in the case of short-term
ratings; claims guaranteed by a non-sovereign whose long-term senior
debt is rated third-highest investment grade by a NRSRO; and claims
and portions of claims collateralized by securities issued by a non-
sovereign rated third-highest investment grade by a NRSRO, in the
case of long-term ratings, or second-highest investment grade in the
case of short-term ratings.
(d) As provided in section II.C.9(b) of this appendix E, the 35
percent risk-weight category also includes certain one-to-four
family residential mortgages.
4--50 Percent Risk Weight
(a) This category includes loans, secured by one-to-four family
residential properties, to builders with substantial project equity
for the construction of one-to-four family residences that have been
presold under firm contracts to purchasers who have obtained firm
commitments for permanent qualifying mortgage loans and have made
substantial earnest money deposits.\39\ Such loans to builders will
be considered prudently underwritten only if the bank has obtained
sufficient documentation that the buyer of the home intends to
purchase the home (i.e., has a legally binding written sales
contract) and has the ability to obtain a mortgage loan sufficient
to purchase the home (i.e., has a firm written commitment for
permanent financing of the home upon completion), provided the
following criteria are met:
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\39\ In addition, such loans must have been approved in
accordance with prudent underwriting standards, including standards
relating to the loan amount as a percent of the appraised value of
the property, and the loans must not be past due 90 days or more or
carried in nonaccrual status. The types of loans that qualify as
loans secured by one-to-four family residential properties are
listed in the instructions for preparation of the Consolidated
Reports of Condition and Income.
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(i) The purchaser is an individual(s) who intends to occupy the
residence and is not a partnership, joint venture, trust,
corporation, or any other entity (including an entity acting as a
sole proprietorship) that is purchasing one or more of the homes for
speculative purposes;
(ii) The builder must incur at least the first ten percent of
the direct costs (i.e., actual costs of the land, labor, and
material) before any drawdown is made under the construction loan
and the construction loan may not exceed 80 percent of the sales
price of the presold home;
(iii) The purchaser has made a substantial ``earnest money
deposit'' of no less than three percent of the sales price of the
home and the deposit must be subject to forfeiture if the purchaser
terminates the sales contract; and
(iv) The earnest money deposit must be held in escrow by the
bank financing the builder or by an independent party in a fiduciary
capacity and the escrow agreement must provide that, in the event of
default arising from the cancellation of the sales contract by the
buyer, the escrow funds must first be used to defray any costs
incurred by the bank.
(b) This category also includes loans fully secured by first
liens on multifamily residential properties, \40\ provided that:
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\40\ 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 stand point 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 when 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 a
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 E.
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(i) The loan amount does not exceed 80 percent of the value \41\
of the property securing the loan as determined by the most current
appraisal or evaluation, whichever may be appropriate (75 percent if
the interest rate on the loan changes over the term of the loan);
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\41\ At the origination of a loan to purchase an existing
property, the term ``value'' means the lesser of the actual
acquisition cost or the estimate of value set forth in an appraisal
or evaluation, whichever may be appropriate.
---------------------------------------------------------------------------
(ii) For the property's most recent fiscal year, the ratio of
annual net operating income generated by the property (before
payment of any debt service on the loan) to annual debt service on
the loan is not less than 120 percent (115 percent if the interest
rate on the loan changes over the term of the loan) or in the case
of a property owned by a cooperative housing corporation or
nonprofit organization, the property generates sufficient cash flow
to provide comparable protection to the bank;
(iii) Amortization of principal and interest on the loan occurs
over a period of not more than 30 years;
(iv) The minimum original maturity for repayment of principal on
the loan is not less than seven years;
(v) All principal and interest payments have been made on a
timely basis in accordance with the terms of the loan for at least
one year before the loan is placed in this category; \42\
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\42\ In the case where the existing owner of a multifamily
residential property refinances a loan on that property, all
principal and interest payments on the loan being refinanced must
have been made on a timely basis in accordance with the terms of
that loan for at least the preceding year. The new loan must meet
all of the other eligiblity criteria in order to qualify for a 50
percent risk weight.
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[[Page 77504]]
(vi) The loan is not 90 days or more past due or carried in
nonaccrual status; and
(vii) The loan has been made in accordance with prudent
underwriting standards.
(c) This category also includes revenue (non-general obligation)
bonds or similar obligations, including loans and leases, that are
obligations of states or political subdivisions of the United States
or other OECD countries, but for which the government entity is
committed to repay the debt with revenues from the specific projects
financed, rather than from general tax funds (e.g., municipal
revenue bonds).
(d) As provided in section II.B.2 and II.B.5 of this appendix E,
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
lowest investment grade plus, e.g., BBB+, in the case of long-term
ratings.
(e) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a sovereign rated lowest investment grade naught by
a NRSRO, e.g. BBB, in the case of long-term ratings, or lowest
investment grade, e.g. A-3, P-3, in the case of short-term ratings;
claims guaranteed by a sovereign rated lowest investment grade
naught by a NRSRO; and claims and portions of claims collateralized
by securities issued by a sovereign rated at least lowest investment
grade naught by a NRSRO, in the case of long-term ratings, or lowest
investment grade, in the case of short-term ratings.
(f) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a non-sovereign rated lowest investment grade plus
by a NRSRO, e.g. BBB+, in the case of long-term ratings; claims
guaranteed by a non-sovereign whose long-term senior debt is rated
lowest investment grade plus by a NRSRO; and claims and portions of
claims collateralized by securities issued by a non-sovereign rated
lowest investment grade plus by a NRSRO, in the case of long-term
ratings.
(g) As provided in section II.C.9(b) of this appendix E, the
fifty percent risk-weight category also includes certain one-to-four
family residential mortgages.
5--75 Percent Risk Weight
(a) As provided in section II.B.2 and II.B.5 of this appendix E,
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
lowest investment grade naught, e.g., BBB, in the case of long-term
ratings.
(b) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a sovereign rated lowest investment grade negative
or one category below investment grade plus and naught by a NRSRO,
e.g. BBB-, BB+, or BB, in the case of long-term ratings; claims
guaranteed by a sovereign rated lowest investment grade negative by
a NRSRO, in the case of long-term ratings; and claims and portions
of claims collateralized by securities issued by a sovereign rated
lowest investment grade negative by a NRSRO, in the case of long-
term ratings.
(c) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes certain securities issued by
and other claims on a non-sovereign rated lowest investment grade
naught by a NRSRO, e.g. BBB, in the case of long-term ratings, or
lowest investment grade, A-3, P-3, in the case of short-term
ratings; claims guaranteed by a non-sovereign whose long-term debt
is rated lowest investment grade naught by a NRSRO; and claims and
portions of claims collateralized by securities issued by a non-
sovereign rated lowest investment grade naught by a NRSRO, in the
case of long-term ratings, or lowest investment grade, in the case
of short-term ratings.
(d) As provided in section II.C.9(b), the seventy-five percent
risk-weight category also includes certain one-to-four family
residential mortgages.
6--100 Percent Risk Weight
(a) All assets not included in the above categories in section
II.C of this appendix E, except the assets specifically included in
the 150 or 200 percent categories below in section II.C of this
appendix E and the assets that are otherwise risk weighted in
accordance with section II.B or II.C.9 of this appendix E, are
assigned to this category, which comprises standard risk assets.
(b) This category includes:
(i) Long-term claims on, and the portions of long-term claims
that are guaranteed by, non-OECD banks;\43\
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\43\ Such assets include all non-local currency claims on, and
the portions of claims that are guaranteed by, non-OECD central
governments that exceed the local currency liabilities held by the
bank.
---------------------------------------------------------------------------
(ii) Claims on commercial firms owned by the public sector;
(iii) Customer liabilities to the bank on acceptances
outstanding involving standard risk claims;\44\
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\44\ Customer liabilities on acceptances outstanding involving
non-standard 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.
---------------------------------------------------------------------------
(iv) Investments in fixed assets, premises, and other real
estate owned;
(v) Common and preferred stock of corporations, including stock
acquired for debts previously contracted;
(vi) Commercial and consumer loans (except rated loans, loans to
sovereigns, and mortgage loans as provided under section II.C.9 of
this appendix E and those loans assigned to lower risk categories
due to recognized guarantees or collateral)\45\;
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\45\ This category includes one-to-four family residential pre-
sold construction loans for a residence whose purchase contract is
cancelled.
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(vii) As provided in sections II.B.2 and II.B.5 of this appendix
E, recourse obligations, direct credit substitutes, residual
interests (other than a credit-enhancing interest-only strip) and
asset-or mortgage-backed securities rated lowest investment grade
negative, 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 E;
(viii) 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
(ix) Stripped mortgage-backed securities and similar
instruments, such as interest-only strips that are not credit-
enhancing and principal-only strips.
(x) Claims representing capital of a qualifying securities firm.
(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.
(d) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on a sovereign rated at least one category below
investment grade negative by a NRSRO, e.g. BB-, in the case of long-
term ratings, or unrated, in the case of short-term ratings.
(e) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes certain securities issued by
and other claims on a non-sovereign rated lowest investment grade
negative by a NRSRO, e.g. BBB-, in the case of long-term ratings, or
unrated, in the case of short-term ratings; claims guaranteed by a
non-sovereign whose long-term debt is rated lowest investment grade
negative by a NRSRO; and claims and portions of claims
collateralized by securities issued by a non-sovereign rated lowest
investment grade negative by a NRSRO, in the case of long-term
ratings.
(f) As provided in section II.C.9(b) of this appendix E, the 100
percent risk-weight category also includes certain one-to-four
family residential mortgages.
7--150 Percent Risk Weight
(a) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category includes securities issued by and other
claims on a sovereign rated two or more categories below investment
grade by a NRSRO, e.g. B or CCC, in the case of long-term ratings.
(b) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category
[[Page 77505]]
also includes certain securities issued by and other claims on a
non-sovereign rated one category below investment grade plus and
naught by a NRSRO, e.g. BB+ or BB, in the case of long-term ratings.
(c) As provided in section II.C.9(b) of this appendix E, the 150
percent risk-weight category also includes certain one-to-four
family residential mortgages.
8--200 Percent Risk Weight
This category includes:
(a) As provided in sections II.B.2 and II.B.5 of this appendix
E, recourse obligations, direct credit substitutes, residual
interests (other than a credit-enhancing interest-only strip) and
asset-or mortgage-backed securities rated one category below
investment grade plus, naught, and negative, e.g. BB+, BB, or BB-,
in the case of long-term ratings.
(b) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes securities issued by and
other claims on an unrated sovereign.
(c) As provided in sections II.B.2, II.B.3, and II.C.9 of this
appendix E, this category also includes certain securities issued by
and other claims on a non-sovereign rated one category below
investment grade and below by a NRSRO, e.g. BB+, BB, BB-, B, CCC,
and unrated, in the case of long-term ratings.
(d) 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 E.
9--Risk Weights for Certain Externally Rated Exposures and Certain
Residential Mortgages
(a) Externally Rated Exposures. (i) Banks must assign an
exposure to a sovereign or non-sovereign to the appropriate risk
weight category in accordance with Tables F1 and F2 of this appendix
E. Such exposures include but are not limited to: sovereign bonds
(which may be based on the external rating of the issuing country or
of the issued bond); all loans to sovereigns, including unrated
loans; securities issued by multilateral lending institutions or
regional development banks; corporate debt obligations (senior and
subordinated); rated loans \46\; and commercial paper.
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\46\ Except for loans to sovereigns, loans that are not
externally rated are risk weighted under section II.C to appendix A
to part 325.
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(ii) If a claim or exposure has two or more external ratings,
the bank must use the lowest assigned external rating to risk weight
the claim in accordance with Tables F1 and F2 of this appendix E,
and that external rating must apply to the claim or exposure in its
entirety. Thus, for banks that hold split or partially-rated
instruments, the risk weight that corresponds to the lowest
component rating will apply to the entire exposure. For example, a
purchased subordinated security where the principal component is
rated BBB, but the interest component is rated B, will be subject to
the gross-up treatment accorded to residual interests rated B or
lower. Similarly, if a portion of an instrument is unrated, the
entire exposure will be treated as if it were unrated.
(iii) For exposures to sovereigns, the bank must first look to
the rating (if any) on the issue to risk weight the claim. If the
issue is unrated, the bank must use the issuer rating to determine
the appropriate risk weight.
(iv) The FDIC reserves the authority to override the use of
certain external ratings or the external 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 or issuer poses to banks.
Table F1.--Risk Weights Based on Long-term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-sovereign Sovereign risk
Long-term rating category Examples risk weight weight
(percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\........ AAA................................ 20 0
Second-highest investment grade rating..... AA................................. 20 20
Third-highest investment grade rating...... A.................................. 35 20
Lowest-investment grade rating--plus....... BBB+............................... 50 35
Lowest-investment grade rating--naught..... BBB................................ 75 50
Lowest-investment grade rating--negative... BBB-............................... 100 75
One category below investment grade--plus & BB+, BB............................ 150 75
naught.
One category below investment grade-- BB-................................ 200 100
negative.
Two or more categories below investment B, CCC............................. 200 150
grade.
Unrated (excludes unrated loans to non- n/a................................ 200 200
sovereigns) \2\.
----------------------------------------------------------------------------------------------------------------
\1\ Long-term claims collateralized by AAA-rated sovereign debt would be assigned to the 20 percent risk weight
category.
\2\ Unrated loans to non-sovereigns are risk weighted in accordance with section II.C of appendix A to part 325.
Table F2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
Non-sovereign Sovereign risk
Short-term rating category Examples risk weight weight
(percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\........ A-1, P-1........................... 20 0
Second-highest investment grade rating..... A-2, P-2........................... 35 20
Lowest investment grade rating............. A-3, P-3........................... 75 50
Unrated.................................... n/a ...............................
----------------------------------------------------------------------------------------------------------------
\1\ Short-term claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk
weight category.
(b) Residential Mortgages. (i) This section II.C.9(b) (including
Tables G1, G2, and G3) applies to all residential mortgages secured
by a lien on a one-to-four family residential property, except for
certain one-to-four family residential pre-sold construction loans,
and certain one-to-four family residential pre-sold construction
loans for residences for which the purchase contract is
cancelled.\47\ The risk weights described in Tables G1 and G2 of
this section II.C.9(b) are minimum risk weights. For a mortgage to
qualify for these risk weights, it must meet certain minimum
criteria: Be fully secured by a lien on a one-to four-family
residential
[[Page 77506]]
property, either owner-occupied or rented, be prudently
underwritten, and not be 90 days or more past due or carried in
nonaccrual status. Mortgages that do not meet these criteria will be
risk weighted in accordance with Table G3 of this appendix E.
---------------------------------------------------------------------------
\47\ Qualifying one-to-four family residential pre-sold
construction loans are risk weighted at 50% under section II.C.4,
unless the purchase contract is cancelled, in which case, they are
risk weighted at 100% under section II.C.6 of this appendix E. Loans
that qualify as mortgages, including junior lien mortgages, that are
secured by 1- to 4-family residential properties are listed in the
instructions to the commercial bank Call Report. This section
II.C.9(b) does not apply to transactions where a lien on a one-to-
four family residential property has been taken as collateral solely
through an abundance of caution and where, as a consequence, the
terms have not been made more favorable than they would have been in
the absence of the lien. In such as case, the loan would not be
considered to be secured by real estate in the Call Reports.
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(ii) Mortgages subject to this section are risk weighted based
on their loan-to-value (LTV) ratio \48\ or combined loan-to-value
(CLTV) ratio \49\ and in accordance with Table G1, Table G2, or
Table G3 of this appendix E, as applicable, after consideration of
any loan level private mortgage insurance (loan level PMI). To
calculate the CLTV on a junior lien mortgage, a bank must divide the
aggregate principle amount outstanding for the first and junior
lien(s) by the appraised value of the property at origination of the
first lien. LTV ratios can only be adjusted through loan
amortization, except for a loan refinancing where the bank extends
additional funds. However, for purposes of calculating the CLTV,
banks may adjust the appraised value of the property, as determined
at the time of origination of the first lien, based on a new
appraisal or evaluation in accordance with the FDIC's appraisal
regulations and real estate lending guidelines.\50\
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\48\ For purposes of this section II.C.9(b), the value of the
property equals the lower of the purchase price for the property or
the value at origination. The value of the property must be based on
an appraisal or evaluation of the property in conformance with the
FDIC's appraisal regulations and real estate lending guidelines. See
12 CFR part 323, 12 CFR part 365.
\49\ The CLTV represents the aggregate principle outstanding on
a first lien mortgage and all applicable junior lien mortgages
divided by the appraised value of the property at origination of the
first lien.
\50\ See 12 CFR part 323, 12 CFR part 365.
---------------------------------------------------------------------------
(A) Mortgage loans secured by first liens on one-to four-family
residential properties. Mortgage loans secured by first liens on
one-to four-family residential properties (first lien mortgages)
must be risk-weighted in accordance with Table G1 of this appendix
E. If a bank holds both the first and junior lien(s) on a
residential property and no other party holds an intervening lien,
the transaction is treated as a first lien mortgage for purposes of
determining the loan-to-value ratio and assigning a risk weight.
Table G1.--Risk Weights for First Lien One- to Four-Family Residential
Mortgages
------------------------------------------------------------------------
Risk weight
Loan-to-Value ratio (percent) (percent)
------------------------------------------------------------------------
Up to 60................................................... 20
>60 and up to 80........................................... 35
>80 and up to 85........................................... 50
>85 and up to 90........................................... 75
>90 and up to 95........................................... 100
>95........................................................ 150
------------------------------------------------------------------------
(B) Stand-Alone Junior Liens. Stand-alone junior liens on one-
to four-family residential mortgages, including structured mortgages
and the on-balance sheet portion of home equity lines of credit,
must be risk weighted using the CLTV of the stand-alone junior and
all senior liens in accordance with Table G2 of this appendix E. The
CLTV of the stand-alone junior and all senior liens, where any of
the senior liens has a negative amortization feature, must reflect
the maximum contractual loan amount under the terms of these liens
if they were to fully negatively amortize under the applicable
contract.
Table G2.--Risk Weights for Stand-Alone Junior Lien 1-4 Family
Residential Mortgages
------------------------------------------------------------------------
Risk weight
Combined loan to value ratio (percent) (percent)
------------------------------------------------------------------------
Up to 60................................................... 75
>60 and up to 90........................................... 100
>90........................................................ 150
------------------------------------------------------------------------
Table G3.--Risk Weights for Mortgages Not Meeting Minimum Criteria
------------------------------------------------------------------------
Risk weight
Risk weight under Table G1 or G2 \1\ (percent)
------------------------------------------------------------------------
20%, 35%, 50%, 75%, or 100%................................ 100
150%....................................................... 150
------------------------------------------------------------------------
\1\This column represents the risk weight a mortgage would have received
under Table G1 or G2 if it had met the minimum criteria required by
this section II.C.9(b).
(C) One- to Four-Family Residential Mortgages With Negative
Amortization Features. First lien mortgages with negative
amortization features are risk weighted in accordance with Table G1
of this appendix E. For loans with negative amortization features,
the LTV of the loans must be adjusted quarterly to include the
amount of any negative amortization. Any remaining potential
increase in the mortgage's principal balance permitted through
negative amortization is to be treated as a long-term commitment and
converted to an on-balance sheet equivalent amount as set forth in
section II.D. of this Appendix E. The credit equivalent amount of
the commitment is then risk-weighted according to Table G1 based on
the loan's ``highest contractual LTV ratio.'' The highest
contractual LTV ratio of a first lien mortgage equals the current
outstanding principal balance of the loan, \51\ plus the credit
equivalent amount of the remaining negative amortization commitment,
minus the amount covered by any loan-level PMI divided by the value
of the property.\52\
---------------------------------------------------------------------------
\51\ As the loan balance increases through negative
amortization, the bank must recalculate the outstanding loan amount
using the original loan amount plus any increases to the loan amount
due to negative amortization.
\52\ See footnote 48.
---------------------------------------------------------------------------
(iii) Transitional Rule for Residential Mortgage Exposures. A
bank may continue to use appendix A to risk weight those mortgage
loans that it owns before it elects to use this appendix E. However,
the bank must use appendix A to risk weight all such mortgage loans.
Mortgage loans approved, acquired, or originated after a bank elects
to use appendix E must be risk weighted under this appendix E. A
bank may only rely on this subsection II.C.9(b)(iii) the first time
it elects to use this appendix E.
D. Conversion Factors for Off-Balance Sheet Items (see Table H)
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 E 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, the nature
of any collateral, or external credit ratings. \53\
---------------------------------------------------------------------------
\53\ 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 E.
---------------------------------------------------------------------------
1. Items With a 100 Percent Conversion Factor. (a) Except as
otherwise provided in section II.B.5 of this appendix E, 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 E.
(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,\54\ and partly-paid shares and securities; they do not
include commitments to make residential mortgage loans or forward
foreign exchange contracts.
---------------------------------------------------------------------------
\54\ 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 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.
2. Items With a 50 Percent Conversion Factor. (a) Transaction-
related contingencies are to be converted at 50 percent. Such
contingencies include bid bonds, performance bonds, warranties, and
performance standby letters of credit related to particular
transactions, as well as acquisitions of risk participations in
[[Page 77507]]
performance standby letters of credits. Performance standby letters
of credit (performance bonds) are irrevocable obligations of the
bank to pay a third-party beneficiary when a customer (account
party) fails to perform on some contractual nonfinancial obligation.
Thus, performance standby letters of credit represent obligations
backing the performance of nonfinancial or commercial contracts or
undertakings. To the extent permitted by law or regulation,
performance standby letters of credit include arrangements backing,
among other things, subcontractors' and suppliers' performance,
labor and materials contracts, and construction bids.
(b) The unused portion of commitments with an original maturity
exceeding one year. including underwriting commitments and
commercial and consumer credit commitments, also are to be converted
at 50 percent. Original maturity is defined as the length of time
between the date the commitment is issued and the earliest date on
which: The bank can at its option, unconditionally (without cause)
cancel the commitment,\55\ and the bank is scheduled to (and as a
normal practice actually does) review the facility to determine
whether or not it should be extended and, on at least an annual
basis, continues to regularly review the facility. Facilities that
are unconditionally cancelable (without cause) at any time by the
bank are not deemed to be commitments, provided the bank makes a
separate credit decision before each drawing under the facility.
---------------------------------------------------------------------------
\55\ In the case of home equity or mortgage lines of credit
secured by liens on one- to four-family residential properties, a
bank is deemed able to unconditionally cancel the commitment if, at
its option, it can prohibit additional extensions of credit, reduce
the credit line, and terminate the commitment to the full extent
permitted by relevant federal law.
---------------------------------------------------------------------------
(c)(i) Commitments are defined as any legally binding
arrangements that obligate a bank to extend credit in the form of
loans or lease financing receivables; to purchase loans, securities,
or other assets; or to participate in loans and leases. Commitments
also include overdraft facilities, revolving credit, home equity and
mortgage lines of credit, eligible ABCP liquidity facilities, and
similar transactions. Normally, commitments involve a written
contract or agreement and a commitment fee, or some other form of
consideration. Commitments are included in weighted-risk assets
regardless of whether they contain material adverse change clauses
or other provisions that are intended to relieve the issuer of its
funding obligation under certain conditions. In the case of
commitments structured as syndications, where the bank is obligated
solely for its pro rata share, only the bank's proportional share of
the syndicated commitment is taken into account in calculating the
risk-based capital ratio.
(ii) Banks that are subject to the market risk rules in appendix
C to part 325 are required to convert the notional amount of
eligible ABCP liquidity facilities, in form or in substance, with an
original maturity of over one year that are carried in the trading
account at 50 percent to determine the appropriate credit equivalent
amount even though those facilities are structured or characterized
as derivatives or other trading book assets. Liquidity facilities
that support ABCP, in form or in substance, (including those
positions to which the market risk rules may not be applied as set
forth in section 2(a) of appendix C of this part) that are not
eligible ABCP liquidity facilities are to be considered recourse
obligations or direct credit substitutes, and assessed the
appropriate risk-based capital treatment in accordance with section
II.B.5 of this appendix E.
(d) In the case of commitments structured as syndications where
the bank is obligated only for its pro rata share, the risk-based
capital framework includes only the bank's proportional share of
such commitments. Thus, after a commitment has been converted at 50
percent, portions of commitments that have been conveyed to other
U.S. depository institutions or OECD banks, but for which the
originating bank retains the full obligation to the borrower if the
participating bank fails to pay when the commitment is drawn upon,
will be assigned to the 20 percent risk category. The acquisition of
such a participation in a commitment would be converted at 50
percent and the credit equivalent amount would be assigned to the
risk category that is appropriate for the account party obligor or,
if relevant, to the nature of the collateral or guarantees.
(e) Revolving underwriting facilities (RUFs), note issuance
facilities (NIFs), and other similar arrangements also are converted
at 50 percent. These are facilities under which a borrower can issue
on a revolving basis short-term notes in its own name, but for which
the underwriting banks have a legally binding commitment either to
purchase any notes the borrower is unable to sell by the rollover
date or to advance funds to the borrower.
3. Items With a 20 Percent Conversion Factor. Short-term, self-
liquidating, trade-related contingencies which arise from the
movement of goods are converted at 20 percent. Such contingencies
include commercial letters of credit and other documentary letters
of credit collateralized by the underlying shipments.
4. Items With a 10 Percent Conversion Factor. (a) Unused
portions of commitments with an original maturity of one year or
less are converted using the 10 percent conversion factor.\56\
Unused portions of eligible ABCP liquidity facilities with an
original maturity of one year or less that provide liquidity support
to ABCP also are converted at 10 percent.
---------------------------------------------------------------------------
\56\ Short-term commitments to originate one- to four-family
residential mortgage loans, other than a derivative contract, will
continue to be converted to an on-balance-sheet credit equivalent
amount using the zero percent conversion factor.
---------------------------------------------------------------------------
(b) Banks that are subject to the market risk rules in appendix
C to part 325 are required to convert the notional amount of
eligible ABCP liquidity facilities, in form or in substance, with an
original maturity of one year or less that are carried in the
trading account at 10 percent to determine the appropriate credit
equivalent amount even through those facilities are structured or
characterized as derivatives or other trading book assets. Liquidity
facilities that provide liquidity support to ABCP, in form or in
substance, (including those positions to which the market risk rules
may not be applied as set forth in section 2(a) of appendix C of
this part) that are not eligible ABCP liquidity facilities are to be
considered recourse obligations or direct credit substitutes and
assessed the appropriate risk-based capital requirement in
accordance with section II.B.5 of this appendix.
5. Items with a Zero Percent Conversion Factor. These include
unused portions of retail credit card lines and related plans are
deemed to be short-term commitments if the bank, in accordance with
applicable law, has the unconditional option to cancel the credit
line at any time.
6. Derivative Contracts. The credit-equivalent amount for a
derivative contract, or group of derivative contracts subject to a
qualifying bilateral netting contract, is assigned to the risk
weight category appropriate to the underlying obligor regardless of
the type of transaction.
E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity
(Including Precious Metal) and Equity Derivative Contracts)
1. Credit equivalent amounts are computed for each of the
following off-balance-sheet derivative contracts:
(a) Interest Rate Contracts
(i) Single currency interest rate swaps.
(ii) Basis swaps.
(iii) Forward rate agreements.
(iv) Interest rate options purchased (including caps, collars,
and floors purchased).
(v) Any other instrument linked to interest rates that gives
rise to similar credit risks (including when-issued securities and
forward deposits accepted).
(b) Exchange Rate Contracts
(i) Cross-currency interest rate swaps.
(ii) Forward foreign exchange contracts.
(iii) Currency options purchased.
(iv) Any other instrument linked to exchange rates that gives
rise to similar credit risks.
(c) Commodity (including precious metal) or Equity Derivative
Contracts
(i) Commodity-or equity-linked swaps.
(ii) Commodity-or equity-linked options purchased.
(iii) Forward commodity-or equity-linked contracts.
(iv) Any other instrument linked to commodities or equities that
gives rise to similar credit risks.
2. Exchange rate contracts with an original maturity of 14
calendar days or less and derivative contracts traded on exchanges
that require daily receipt and payment of cash variation margin may
be excluded from the risk-based ratio calculation. Gold contracts
are accorded the same treatment as exchange rate contracts except
gold contracts with an original maturity of 14 calendar days or less
are included in the risk-based calculation. Over-the-counter options
purchased are included and treated in the same way as other
derivative contracts.
3. Credit Equivalent Amounts for Derivative Contracts. (a) The
credit
[[Page 77508]]
equivalent amount of a derivative contract that is not subject to a
qualifying bilateral netting contract in accordance with section
II.E.5 of this appendix E is equal to the sum of:
(i) The current exposure (which is equal to the mark-to-market
value, \57\ if positive, and is sometimes referred to as the
replacement cost) of the contract; and
---------------------------------------------------------------------------
\57\ Mark-to-market values are measured in dollars, regardless
of the currency or currencies specified in the contract and should
reflect changes in both underlying rates, prices and indices, and
counterparty credit quality.
---------------------------------------------------------------------------
(ii) An estimate of the potential future credit exposure.
(b) The current exposure is determined by the mark-to-market
value of the contract. If the mark-to-market value is positive, then
the current exposure is equal to that mark-to-market value. If the
mark-to-market value is zero or negative, then the current exposure
is zero.
(c) The potential future credit exposure of a contract,
including a contract with a negative mark-to-market value, is
estimated by multiplying the notional principal amount of the
contract by a credit conversion factor. Banks should, subject to
examiner review, use the effective rather than the apparent or
stated notional amount in this calculation. The credit conversion
factors are:
Table H.--Conversion Factor Matrix
----------------------------------------------------------------------------------------------------------------
Exchange rate Precious Other
Remaining maturity Interest rate and gold Equity metals, except commodities
(percent) (percent) (percent) gold (percent) (percent)
----------------------------------------------------------------------------------------------------------------
One year or less................ 0.0 1.0 6.0 7.0 10.0
More than one year to five years 0.5 5.0 8.0 7.0 12.0
More than five years............ 1.5 7.5 10.0 8.0 15.0
----------------------------------------------------------------------------------------------------------------
(d) For contracts that are structured to settle outstanding
exposure on specified dates and where the terms are reset such that
the market value of the contract is zero on these specified dates,
the remaining maturity is equal to the time until the next reset
date. For interest rate contracts with remaining maturities of more
than one year and that meet these criteria, the conversion factor is
subject to a minimum value of 0.5 percent.
(e) For contracts with multiple exchanges of principal, the
conversion factors are to be multiplied by the number of remaining
payments in the contract. Derivative contracts not explicitly
covered by any of the columns of the conversion factor matrix are to
be treated as ``other commodities.''
(f) No potential future exposure is calculated for single
currency interest rate swaps in which payments are made based upon
two floating rate indices (so called floating/floating or basis
swaps); the credit exposure on these contracts is evaluated solely
on the basis of their mark-to-market values.
4. Risk Weights and Avoidance of Double Counting. (a) Once the
credit equivalent amount for a derivative contract, or a group of
derivative contracts subject to a qualifying bilateral netting
agreement, has been determined, that amount is assigned to the risk
category appropriate to the counterparty, or, if relevant, the
guarantor or the nature of any collateral. However, the maximum
weight that will be applied to the credit equivalent amount of such
contracts is 50 percent.
(b) In certain cases, credit exposures arising from the
derivative contracts covered by these guidelines may already be
reflected, in part, on the balance sheet. To avoid double counting
such exposures in the assessment of capital adequacy and, perhaps,
assigning inappropriate risk weights, counterparty credit exposures
arising from the types of instruments covered by these guidelines
may need to be excluded from balance sheet assets in calculating a
bank's risk-based capital ratio.
(c) The FDIC notes that the conversion factors set forth in
section II.E.3 of appendix E, which are based on observed
volatilities of the particular types of instruments, are subject to
review and modification in light of changing volatilities or market
conditions.
(d) Examples of the calculation of credit equivalent amounts for
these types of contracts are contained in Table H of this appendix
E.
5. Netting. (a) For purposes of this appendix E, netting refers
to the offsetting of positive and negative mark-to-market values
when determining a current exposure to be used in the calculation of
a credit equivalent amount. Any legally enforceable form of
bilateral netting (that is, netting with a single counterparty) of
derivative contracts is recognized for purposes of calculating the
credit equivalent amount provided that:
(i) The netting is accomplished under a written netting contract
that creates a single legal obligation, covering all included
individual contracts, with the effect that the bank would have a
claim or obligation to receive or pay, respectively, only the net
amount of the sum of the positive and negative mark-to-market values
on included individual contracts in the event that a counterparty,
or a counterparty to whom the contract has been validly assigned,
fails to perform due to default, bankruptcy, liquidation, or similar
circumstances;
(ii) The bank obtains a written and reasoned legal opinion(s)
representing that in the event of a legal challenge, including one
resulting from default, insolvency, bankruptcy or similar
circumstances, the relevant court and administrative authorities
would find the bank's exposure to be such a net amount under:
(A) The law of the jurisdiction in which the counterparty is
chartered or the equivalent location in the case of noncorporate
entities and, if a branch of the counterparty is involved, then also
under the law of the jurisdiction in which the branch is located;
(B) The law that governs the individual contracts covered by the
netting contract; and
(C) The law that governs the netting contract.
(iii) The bank establishes and maintains procedures to ensure
that the legal characteristics of netting contracts are kept under
review in the light of possible changes in relevant law; and
(iv) The bank maintains in its file documentation adequate to
support the netting of derivative contracts, including a copy of the
bilateral netting contract and necessary legal opinions.
(b) A contract containing a walkaway clause is not eligible for
netting for purposes of calculating the credit equivalent
amount.\58\
---------------------------------------------------------------------------
\58\ For purposes of this section, a walkaway clause means a
provision in a netting contract that permits a non-defaulting
counterparty to make lower payments than it would make otherwise
under the contract, or no payment at all, to a defaulter or to the
estate of a defaulter, even if a defaulter or the estate of a
defaulter is a net creditor under the contract.
---------------------------------------------------------------------------
(c) By netting individual contracts for the purpose of
calculating its credit equivalent amount, a bank represents that it
has met the requirements of this appendix E and all the appropriate
documents are in the bank's files and available for inspection by
the FDIC. Upon determination by the FDIC that a bank's files are
inadequate or that a netting contract may not be legally enforceable
under any one of the bodies of law described in paragraphs (ii)(1)
through (3) of section II.E.5(a) of this appendix E, underlying
individual contracts may be treated as though they were not subject
to the netting contract.
(d) The credit equivalent amount of derivative contracts that
are subject to a qualifying bilateral netting contract is calculated
by adding:
(i) The net current exposure of the netting contract; and
(ii) The sum of the estimates of potential future exposure for
all individual contractors subject to the netting contract, adjusted
to take into account the effects of the netting contract.\59\
---------------------------------------------------------------------------
\59\ For purposes of calculating potential future credit
exposure for foreign exchange contracts and other similar contracts
in which notional principal is equivalent to cash flows, total
notional principal is defined as the net receipts to each party
falling due on each value date in each currency.
---------------------------------------------------------------------------
[[Page 77509]]
(e) The net current exposure is the sum of all positive and
negative mark-to-market values of the individual contracts subject
to the netting contract. If the net sum of the mark-to-market values
is positive, then the net current exposure is equal to that sum. If
the net sum of the mark-to-market values is zero or negative, then
the net current exposure is zero.
(f) The effects of the bilateral netting contract on the gross
potential future exposure are recognized through application of a
formula, resulting in an adjusted add-on amount (Anet). The formula,
which employs the ratio of net current exposure to gross current
exposure (NGR) is expressed as:
Anet = (0.4 x Agross) + 0.6(NGR x Agross)
The effect of this formula is that Anet is the weighted average
of Agross, and Agross adjusted by the NGR.
(g) The NGR may be calculated in either one of two ways--
referred to as the counterparty-by-counterparty approach and the
aggregate approach.
(i) Under the counterparty-by-counterparty approach, the NGR is
the ratio of the net current exposure of the netting contract to the
gross current exposure of the netting contract. The gross current
exposure is the sum of the current exposure of all individual
contracts subject to the netting contract calculated in accordance
with section II.E of this appendix E.
(ii) Under the aggregate approach, the NGR is the ratio of the
sum of all of the net current exposures for qualifying bilateral
netting contracts to the sum of all of the gross current exposures
for those netting contracts (each gross current exposure is
calculated in the same manner as in section II.E.5(g)(i) of this
appendix E). Net negative mark-to-market values to individual
counterparties cannot be used to offset net positive current
exposures to other counterparties.
(iii) A bank must use consistently either the counterparty-by-
counterparty approach or the aggregate approach to calculate the
NGR. Regardless of the approach used, the NGR should be applied
individually to each qualifying bilateral netting contract to
determine the adjusted add-on for that netting contract.
III. Minimum Risk-Based Capital Ratio
Subject to section II.B.5 of this appendix E, 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 risk-
weighted assets.
(a) Common stockholders' equity........ No limit.\1\
(b) Noncumulative perpetual preferred No limit.\1\
stock and any related surplus.
(c) Minority interest in equity No limit.\1\
accounts of consolidated.
(d) Less: All intangible assets other (\2\)
than certain mortgage servicing
assets, nonmortgage servicing assets
and purchased credit card
relationships.
(e) Less: Certain credit-enhancing (\3\)
interest only strips and nonfinancial
equity investments required to be
deducted from capital.
(f) Less: Certain deferred tax assets.. (\4\)
(2) Supplementary Capital (Tier 2)..... Total of tier 2 is limited to
100% of tier 1.\5\
(a) Allowance for loan and lease losses Limited to 1.25% of weighted-
risk assets.\5\
(b) Unrealized gains on certain equity Limited to 45% of pretax net
securities \6\. unrealized gains.\6\
(c) Cumulative perpetual and long-term No limit within tier 2; long-
preferred stock (original maturity of term preferred is amortized
20 years or more) and any related for capital purposes as it
surplus.. approaches maturity.
(d) Auction rate and similar preferred No limit within tier 2.
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 maturity of stock are limited to 50% of
five years or more).. Tier 1 \5\ and amortized for
capital purposes as they
approach maturity.
(3) Deductions (from the 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 or matter of policy after formal
joint ventures) as determined by consideration of relevant
supervisory authority.. issues.
(4) Total Capital...................... Must equal or exceed 8% of
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). The amounts of
nonfinancial equity investments that must be deducted for purposes of
calculating Tier 1 capital are set forth in section II.B.6 of appendix
E to part 325.
\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-2.A.2.(f) of appendix E to part
325.
[[Page 77510]]
IV. Calculation of the Risk-Based Capital Ratio
1. When calculating the risk-based capital ratio under the
framework set forth in this statement of policy, qualifying total
capital (the numerator) is divided by risk-weighted assets (the
denominator). The process of determining the numerator for the ratio
is summarized in Table I. The calculation of the denominator is
based on the risk weights and conversion factors that are summarized
in Tables II and III.
2. When determining the amount of risk-weighted assets, balance
sheet assets are assigned an appropriate risk weight (see Table J)
and off-balance sheet items are first converted to a credit
equivalent amount (see Table H) and then assigned to one of the risk
weight categories set forth in Table J.
3. The balance sheet assets and the credit equivalent amount of
off-balance sheet items are then multiplied by the appropriate risk
weight percentages and the sum of these risk-weighted amounts is the
gross risk-weighted asset figure used in determining the denominator
of the risk-based capital ratio. Any items deducted from capital
when computing the amount of qualifying capital may also be excluded
from risk-weighted assets when calculating the denominator for the
risk-based capital ratio.
Table J--Summary of Risk Weights and Risk Categories
Category 1--Zero Percent Risk Weight
(1) Cash (domestic and foreign).
(2) Balances due from Federal Reserve banks.
(3) Direct claims on, and portions of claims unconditionally
guaranteed by, the U.S. Treasury and U.S. Government agencies.\60\
---------------------------------------------------------------------------
\60\ For the purpose of calculating the risk-based capital
ratio, a U.S. Government agency is defined as an instrumentality of
the U.S. Government whose obligations are fully and explicitly
guaranteed as to the timely repayment of principal and interest by
the full faith and credit of the U.S. Government.
---------------------------------------------------------------------------
(4) Gold bullion held in the bank's own vaults or in another
bank's vaults on an allocated basis, to the extent that it is offset
by gold bullion liabilities.
(5) Federal Reserve Bank stock.
(6) Claims on, or guaranteed by, qualifying securities firms
incorporated in the United States or other members of the OECD-based
group of countries that are collateralized by cash on deposit in the
lending bank or by securities issued or guaranteed by the United
States (including U.S. government agencies) or OECD central
governments, provided that a positive margin of collateral is
required to be maintained on such a claim on a daily basis, taking
into account any change in a bank's exposure to the obligor or
counterparty under the claim in relation to the market value of the
collateral held in support of the claim.
(7) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
Category 2--20 Percent Risk Weight
(1) Cash items in the process of collection.
(2) All claims (long- and short-term) on, and portions of claims
(long- and short-term) guaranteed by, U.S. depository institutions
and OECD banks.
(3) Short-term (remaining maturity of one year or less) claims
on, and portions of short-term claims guaranteed by, non-OECD banks.
(4) Portions of loans and other claims conditionally guaranteed
by the U.S. Treasury or U.S. Government agencies.\61\
---------------------------------------------------------------------------
\61\ For the purpose of calculating the risk-based capital
ratio, a U.S. Government agency is defined as an instrumentality of
the U.S. Government whose obligations are fully and explicitly
guaranteed as to the timely repayment of principal and interest by
the full faith and credit of the U.S. Government.
---------------------------------------------------------------------------
(5) Securities and other claims on, and portions of claims
guaranteed by, U.S. Government-sponsored agencies.\62\
---------------------------------------------------------------------------
\62\ For the purpose of calculating the risk-based capital
ratio, a U.S. Government-sponsored agency is defined as an agency
originally established or chartered to serve public purposes
specified by the U.S. Congress but whose obligations are not
explicitly guaranteed by the full faith and credit of the U.S.
Government.
---------------------------------------------------------------------------
(6) Portions of loans and other claims (including repurchase
agreements) collateralized by securities issued or guaranteed by the
U.S. Treasury, U.S. Government agencies, or U.S. Government-
sponsored agencies.
(7) Portions of loans and other claims collateralized \63\ by
cash on deposit in the lending bank.
---------------------------------------------------------------------------
\63\ Degree of collateralization is determined by current market
value.
---------------------------------------------------------------------------
(8) General obligation claims on, and portions of claims
guaranteed by, the full faith and credit of states or other
political subdivisions of OECD countries, including U.S. state and
local governments.
(9) Investments in shares of mutual funds whose portfolios are
permitted to hold only assets that qualify for the zero or 20
percent risk categories.
(10) 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.
(11) Certain externally rated exposures as provided under
section II.C.9 of this appendix E.
(12) Certain one-to-four family residential mortgages as
provided under section II.C.9 of this appendix E.
Category 3--35 Percent Risk Weight
(1) 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.
(2) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
(3) Certain one-to-four family residential mortgages as provided
under section II.C.9 of this appendix E.
Category 4--50 Percent Risk Weight
(1) Certain presold residential construction loans, provided
that the loans were approved in accordance with prudent underwriting
standards and are not past due 90 days or more or carried on a
nonaccrual status.
(2) Loans fully secured by first liens on multifamily
residential properties that have been prudently underwritten and
meet specified requirements with respect to loan-to-value ration,
level of annual net operating income to required debt service,
maximum amortization period, minimum original maturity, and
demonstrated timely repayment performance.
(3) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and
asset-or mortgage-backed securities rated in the lowest-highest
investment grade category plus, e.g., BBB+, in the case of long-term
ratings.
(4) Revenue bonds or similar obligations, including loans and
leases, that are obligations of U.S. state or political subdivisions
of the United States or other OECD countries but for which the
government entity is committed to repay the debt only out of
revenues from the specific projects financed.
(5) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
(6) Certain one-to-four family residential mortgages as provided
under section II.C.9 of this appendix E.
Category 5--75 Percent Risk Weight
(1) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips) and
asset-or mortgage-backed securities rated in the lowest highest
investment grade category naught, e.g., BBB, in the case of long-
term ratings, or the lowest highest rating category, e.g., A-3, P-3,
in the case of short-term ratings.
(2) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
(3) Certain one-to-four family residential mortgages as provided
under section II.C.9 of this appendix E.
Category 6--100 Percent Risk Weight
(1) All other claims on private obligors.
(2) Obligations issued by U.S. state or local governments or
other OECD local governments (including industrial development
authorities and similar entities) that are repayable solely by a
private party or enterprise.
(3) Premises, plant, and equipment; other fixed assets; and
other real estate owned.
(4) Investments in any unconsolidated subsidiaries, joint
ventures, or associated companies--if not deducted from capital.
(5) Instruments issued by other banking organizations that
qualify as capital.
(6) Claims on commercial firms owned by the U.S. Government or
foreign governments.
(7) 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 negative, e.g., BBB-, as well as certain
[[Page 77511]]
positions (but not residual interests) which the bank rates pursuant
to section II.B.5(g) of this appendix E.
(8) Other assets, including any intangible assets that are not
deducted from capital, and the credit equivalent amounts \64\ of
off-balance sheet items not assigned to a different risk category,
except for certain externally rated exposures and certain one-to-
four family residential mortgages as provided under section II.C.9
of this appendix E.
---------------------------------------------------------------------------
\64\ In general for each off-balance sheet item, a conversion
factor (see Table H) must be applied to determine the ``credit
equivalent amount'' prior to assigning the off-balance sheet item to
a risk weight category.
---------------------------------------------------------------------------
Category 7--150 Percent Risk Weight
(1) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
(2) Certain one-to-four family residential mortgages as provided
under section II.C.9 of this appendix E.
Category 8--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--negative, e.g., BB, to the extent permitted in section
II.B.5(d) of this appendix E.
(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 E.
(3) Certain externally rated exposures as provided under section
II.C.9 of this appendix E.
Department of the Treasury
Office of Thrift Supervision
12 CFR Chapter V.
Authority and Issuance
For the reasons stated in the common preamble, the Office of
Thrift Supervision proposes to amend part 567 of chapter V of title
12 of the Code of Federal Regulations 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. In Sec. 567.1, revise the definition of risk-weighted assets to
read as follows:
Sec. 567.1. Definitions.
* * * * *
Risk-weighted assets. Risk-weighted assets means risk-weighted
assets computed under Sec. 567.6 or Sec. 567.7 of this part.
* * * * *
3. Revise paragraph (a)(1)(i) of Sec. 567.2 to read as follows:
Sec. 567.2 Minimum regulatory capital requirement.
(a) * * *
(1) * * *
(i) Risk-based capital requirement. A savings association's minimum
risk-based capital requirement shall be an amount equal to 8 percent of
its risk-weighted assets.
* * * * *
4. Revise the section heading and add a new introductory paragraph
to Sec. 567.6 to read as follows:
Sec. 567.6 Risk-weighted assets.
Unless the savings association uses 12 CFR part 566, Appendix A or
elects to use Sec. 567.7 of this part, a savings association must
compute risk-weighted assets as described in this section.
* * * * *
5. Add a new Sec. 567.7 to read as follows:
Sec. 567.7 Alternate computation of risk-weighted assets.
(a) Opt-in. (1) Any savings association, other than a savings
association that uses 12 CFR part 566, Appendix A, may elect to compute
risk-weighted assets under this section rather than Sec. 567.6 of this
part. If a savings association elects to apply this section, it must
apply all of the requirements of this section.
(2) To elect to apply this section, a savings association must
notify OTS. The election will remain in effect until the savings
association withdraws the election by notifying OTS.
(b) Definitions. The following definitions apply to this section:
(1) External rating. (i) An external rating is a credit rating
assigned by a NRSRO that:
(A) Fully reflects the entire amount of the credit risk with regard
to all payments owed on the claim (that is, the rating must fully
reflect the credit risk associated with timely repayment of principal
and interest);
(B) Is published in an accessible public form;
(C) Is monitored by the issuing NRSRO; and
(D) Is, or will be, included in the issuing NRSRO's publicly
available transition matrix, which tracks the performance and stability
(or rating migration) of an NRSRO's issued external ratings for the
specific type of claim (for example, corporate debt).
(ii) If an exposure has two or more external ratings, the external
rating is the lowest assigned rating. If an exposure has components
that are assigned different external ratings, the savings association
must assign the lowest component rating to the entire exposure. If an
exposure has a component that is not externally rated, the exposure is
not externally rated.
(2) Non-sovereign. A non-sovereign includes a securities firm,
insurance company, bank holding company, savings and loan holding
company, multi-lateral lending and regional development institution,
partnership, limited liability company, business trust, special purpose
entity, association, and similar organization.
(3) Public-sector entity. A public-sector entity means a state,
local authority or governmental subdivision below the central
government level in an OECD country. In the United States, this
definition encompasses a state, county, city, town, or other municipal
corporation, a public authority, and generally any publicly-owned
entity that is an instrumentality of a state or municipal corporation.
This definition does not include commercial companies owned by a
public-sector entity.
(4) Sovereign. Sovereign means a central government or an agency,
department, ministry, or central bank of a central government. It does
not include state, provincial or local governments, or commercial
enterprises owned by a central government.
(c) Computation. Under this section, risk-weighted assets equal
risk-weighted on-balance sheet assets computed under paragraph (d) of
this section, plus risk-weighted off-balance sheet items computed under
paragraph (e) of this section, plus risk-weighted recourse obligations,
direct credit substitutes and certain other positions computed under
paragraph (f) of this section. Assets not included (i.e., deducted from
capital) for the purposes of calculating capital under Sec. 567.5 are
not included in calculating risk-weighted assets.
(d) On-balance sheet assets. Except as provided in paragraph (f) 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 described in this section.
(1) The risk weight categories are:
(i) Zero percent risk weight.
(A) Cash, including domestic and foreign currency owned and held in
all offices of a savings association or in transit. Any foreign
currency held by a savings association must be converted into U.S.
dollar equivalents;
(B) Securities issued by and other direct claims on the United
States Government or its agencies (to the extent such securities or
claims are unconditionally backed by the full faith
[[Page 77512]]
and credit of the United States Government);
(C) Notes and obligations issued by either the Federal Savings and
Loan Insurance Corporation or the Federal Deposit Insurance Corporation
and backed by the full faith and credit of the United States
Government;
(D) Deposit reserves at, claims on, and balances due from Federal
Reserve Banks;
(E) The book value of paid-in Federal Reserve Bank stock;
(F) That portion of assets that is fully covered against capital
loss or yield maintenance agreements by the Federal Savings and Loan
Insurance Corporation or any successor agency;
(G) That portion of assets directly and unconditionally guaranteed
by the United States Government or its agencies;
(H) Claims on, and claims guaranteed by, a qualifying securities
firm that are collateralized by cash on deposit in the savings
association or by securities issued or guaranteed by the United States
Government or its agencies or the central government of an OECD
country. To be eligible for this risk weight, the savings association
must maintain a positive margin of collateral on the claim on a daily
basis, taking into account any change in a savings association's
exposure to the obligor or counterparty under the claim in relation to
the market value of the collateral held in support of the claim;
(I) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
zero percent risk weight, as provided in paragraphs (d)(3) and (5) of
this section.
(ii) 20 percent risk weight.
(A) Cash items in the process of collection;
(B) That portion of assets collateralized by the current market
value of securities issued or guaranteed by the United States
Government or its agencies;
(C) That portion of assets conditionally guaranteed by the United
States Government or its agencies;
(D) Securities (not including equity securities) issued by and
other claims on the U.S. Government or its agencies that are not backed
by the full faith and credit of the United States Government;
(E) Securities (not including equity securities) issued by, or
other direct claims on, United States Government-sponsored agencies;
(F) That portion of assets guaranteed by United States Government-
sponsored agencies;
(G) That portion of assets collateralized by the current market
value of securities issued or guaranteed by United States Government-
sponsored agencies;
(H) Loans that are not externally rated that are issued to a
qualifying securities firm, subject to the conditions set forth below.
Externally rated loans to, debt securities of, claims collateralized by
claims on, and guarantees by a qualifying securities firm are subject
to paragraphs (d)(1)(i)(H), and (d)(3) through (5) of this section.
(1) A qualifying securities firm must have a long-term issuer
credit rating, or a rating on at least one issue of long-term unsecured
debt, from a NRSRO. The rating must be in one of the three highest
investment grade categories used by the NRSRO. If two or more NRSROs
assign ratings to the qualifying securities firm, the savings
association must use the lowest rating to determine whether the rating
requirement of this paragraph is met. A qualifying securities firm may
rely on the rating of its parent consolidated company, if the parent
consolidated company guarantees the claim.
(2) A collateralized claim on a qualifying securities firm does not
have to comply with the rating requirements under paragraph
(d)(1)(ii)(H)(1) of this section if the claim arises under a contract
that:
(i) Is a reverse repurchase/repurchase agreement or securities
lending/borrowing transaction executed using standard industry
documentation;
(ii) Is collateralized by debt or equity securities that are liquid
and readily marketable;
(iii) Is marked-to-market daily;
(iv) Is subject to a daily margin maintenance requirement under the
standard industry documentation; and
(v) Can be liquidated, terminated or accelerated immediately in
bankruptcy or similar proceeding, and the security or collateral
agreement will not be stayed or avoided under applicable law of the
relevant jurisdiction. For example, a claim is exempt from the
automatic stay in bankruptcy in the United States if it arises under a
securities contract or a repurchase agreement subject to section 555 or
559 of the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified
financial contract under section 11(e)(8) of the Federal Deposit
Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between or
among financial institutions under sections 401-407 of the Federal
Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-
4407), or Regulation EE (12 CFR part 231).
(3) If the securities firm uses the claim to satisfy its applicable
capital requirements, the claim is not eligible for a risk weight under
this paragraph (d)(1)(ii)(H);
(I) Claims representing general obligations of any public-sector
entity in an OECD country, and that portion of any claims guaranteed by
any such public-sector entity;
(J) Bonds issued by the Financing Corporation or the Resolution
Funding Corporation;
(K) Balances due from and all claims on domestic depository
institutions. This includes demand deposits and other transaction
accounts, savings deposits and time certificates of deposit, federal
funds sold, loans to other depository institutions, including
overdrafts and term federal funds, holdings of the savings
association's own discounted acceptances for which the account party is
a depository institution, holdings of bankers acceptances of other
institutions and securities issued by depository institutions, except
those that qualify as capital;
(L) The book value of paid-in Federal Home Loan Bank stock;
(M) Deposit reserves at, claims on and balances due from the
Federal Home Loan Banks;
(N) Assets collateralized by cash held in a segregated deposit
account by the reporting savings association;
(O) Loans that are not externally rated that are issued to official
multilateral lending institutions or regional development institutions
in which the United States Government is a shareholder or contributing
member. Externally rated loans to, debt securities of, claims
collateralized by claims on, and guarantees by such official
multilateral lending institutions, or regional development institutions
are subject to paragraph (d)(3) through (5) of this section;
(P) All claims on depository institutions incorporated in an OECD
country, and all assets backed by the full faith and credit of
depository institutions incorporated in an OECD country. This includes
the credit equivalent amount of participations in commitments and
standby letters of credit sold to other depository institutions
incorporated in an OECD country, but only if the originating bank
remains liable to the customer or beneficiary for the full amount of
the commitment or standby letter of credit. Also included in this
category are the credit equivalent amounts of risk participations in
bankers' acceptances conveyed to other depository institutions
incorporated in an OECD country. However, bank-issued securities that
qualify as capital of the
[[Page 77513]]
issuing bank are not included in this risk category;
(Q) 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;
(R) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
20 percent risk weight under paragraphs (d)(3) and (5) of this section;
(S) Debt securities issued by, certain other externally rated
claims on, and that portion of assets backed by an eligible guarantee
of, a non-sovereign that receive a 20 percent risk weight under
paragraphs (d)(3) and (5) of this section;
(T) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset-or mortgage-backed securities with long-term external ratings in
the highest or second highest investment grade category or short-term
external ratings in the highest investment rating category, as provided
under paragraph (f) of this section;
(U) Assets collateralized by exposures that receive a 20 percent
risk weight under paragraph (d)(4) of this section;
(V) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 20 percent risk weight under
paragraph (d)(2) of this section.
(iii) 35 percent risk weight.
(A) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
35 percent risk weight under paragraphs (d)(3) and (5) of this section;
(B) Debt securities issued by, certain other externally rated
claims on, and that portion of assets backed by an eligible guarantee
of, a non-sovereign that receive a 35 percent risk weight under
paragraphs (d)(3) and (5) of this section;
(C) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset-or mortgage-backed securities with long-term external ratings in
the third highest investment grade category or short-term external
ratings in the second highest investment rating category, as provided
under paragraph (f) of this section;
(D) Assets collateralized by exposures that receive a 35 percent
risk weight under paragraph (d)(4) of this section;
(E) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 35 percent risk weight under
paragraph (d)(2) of this section.
(iv) 50 percent risk weight.
(A) Revenue bonds issued by any public-sector entity in an OECD
country, for which the underlying obligor is a public-sector entity,
but which are repayable solely from the revenues generated from the
project financed through the issuance of the obligations;
(B) Qualifying multifamily mortgage loans;
(C) Privately-issued mortgage-backed securities (i.e., those that
do not carry the guarantee of a government or government-sponsored
agency) 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;
(D) Qualifying residential construction loans;
(E) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
50 percent risk weight under paragraphs (d)(3) and (5) of this section;
(F) Debt securities issued by, certain other externally rated
claims on, and that portion of assets backed by an eligible guarantee
of, a non-sovereign that receive a 50 percent risk weight under
paragraphs (d)(3) and (5) of this section;
(G) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset-or mortgage-backed securities with long-term external ratings in
the lowest investment `` plus grade category, as provided under
paragraph (f) of this section;
(H) Assets collateralized by exposures that receive a 50 percent
risk weight under paragraph (d)(4) of this section;
(I) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 50 percent risk weight under
paragraph (d)(2) of this section.
(v) 75 percent risk weight.
(A) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
75 percent risk weight under paragraphs (d)(3) and (5) of this section;
(B) Debt securities issued by, certain other externally rated
claims on, and that portion of assets backed by an eligible guarantee
of, a non-sovereign that receive a 75 percent risk weight under
paragraphs (d)(3) and (5) of this section;
(C) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset-or mortgage-backed securities with long-term external ratings in
the lowest investment grade `` naught category or short-term external
ratings in the lowest investment rating category, as provided under
paragraph (f) of this section;
(D) Assets collateralized by exposures that receive a 75 percent
risk weight under paragraph (d)(4) of this section;
(E) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 75 percent risk weight under
paragraph (d)(2) of this section.
(vi) 100 percent risk weight. All assets not otherwise specified in
this section or deducted from calculations of capital under to Sec.
567.5 of this part, including, but not limited to:
(A) Consumer loans;
(B) Commercial loans that are not externally rated;
(C) Non-qualifying multifamily mortgage loans;
(D) Residential construction loans;
(E) Land loans;
(F) Nonresidential construction loans;
(G) Obligations issued by any public-sector entity in an OECD
country, for the benefit of a private party or enterprise provided that
the party or enterprise, rather than the issuing public-sector entity,
is responsible for the timely payment of principal and interest on the
obligations, e.g., industrial development bonds;
(H) Investments in fixed assets and premises;
(I) Certain nonsecurity financial instruments including servicing
assets and intangible assets includable in core capital under Sec.
567.12 of this part;
(J) That portion of equity investments not deducted pursuant to
Sec. 567.5 of this part;
(K) The prorated assets of subsidiaries (except for the assets of
includable, fully consolidated subsidiaries) to the extent such assets
are included in adjusted total assets;
(L) All repossessed assets or assets (other than mortgage loans
secured by liens on one-to four-family residential properties) that are
more than 90 days past due;
(M) Equity investments that the Office determines have the same
risk characteristics as foreclosed real estate by the savings
association;
(N) Equity investments permissible for a national bank;
[[Page 77514]]
(O) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
100 percent risk weight under paragraphs (d)(3) and (5) of this
section;
(P) Debt securities issued by, certain other rated claims on, and
that portion of assets backed by an eligible guarantee of, non-
sovereign that receive a 100 percent risk weight under paragraphs
(d)(3) and (5) of this section;
(Q) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset- or mortgage-backed securities with long-term external ratings in
the lowest investment grade--negative category, as provided under
paragraph (f) of this section;
(R) Assets collateralized by exposures that receive a 100 percent
risk weight under paragraph (d)(4) of this section;
(S) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 100 percent risk weight under
paragraph (d)(2) of this section.
(vii) 150 percent risk weight.
(A) Debt securities issued by, certain other rated claims on, and
that portion of assets backed by an eligible guarantee of a non-
sovereign that receive a 150 percent risk weight under paragraphs
(d)(3) and (5) of this section;
(B) Assets collateralized by exposures that receive a 150 percent
risk weight under paragraph (d)(4) of this section;
(C) Certain mortgage loans secured by liens on one-to four-family
residential properties that receive a 150 percent risk weight under
paragraph (d)(2) of this section.
(viii) 200 percent risk weight.
(A) Debt securities issued by, other claims on, and that portion of
assets backed by an eligible guarantee of, a sovereign that receive a
200 percent risk weight under paragraphs (d)(3) and (5) of this
section;
(B) Debt securities issued by, certain other rated claims on, and
that portion of assets backed by an eligible guarantee of, a non-
sovereign that receive a 200 percent risk weight under paragraphs
(d)(3) and (5) of this section;
(C) Recourse obligations, direct credit substitutes, residual
interests (other than credit-enhancing interest-only strips), and
asset-or mortgage-backed securities with long-term external ratings one
category below investment grade, as provided under paragraph (f) of
this section;
(D) Assets collateralized by exposures that receive a 200 percent
risk weight under paragraph (d)(4) of this section.
(2) Mortgage loans secured by a lien on one-to four-family
residential property. A savings association must risk-weight mortgage
loans secured by liens on one-to four-family residential properties
under this paragraph (d)(2).
(i) First liens. A savings association must apply the risk weight
in Table 1 that corresponds to the loan-to-value (LTV) ratio of a
mortgage loan secured by a first lien on one-to four-family residential
property. If a loan is not prudently underwritten, is not performing,
or is more than 90 days past due, the savings association must apply a
risk weight of 150 percent if the loan has an LTV that is greater than
95 percent, and must apply a risk weight of 100 percent to all other
loans.
Table 1.--Risk Weights for Mortgage Loans Secured by First Liens on One-
to Four-Family Residential Properties
------------------------------------------------------------------------
Risk weight
Loan-to-Value ratio (percent)
------------------------------------------------------------------------
60% or less................................................ 20
Greater than 60% and less than or equal to 80%............. 35
Greater than 80% and less than or equal to 85%............. 50
Greater than 85% and less than or equal to 90%............. 75
Greater than 90% and less than or equal to 95%............. 100
Greater than 95%........................................... 150
------------------------------------------------------------------------
(ii) Junior liens.
(A) If a savings association holds the first lien and a junior lien
on a one-to four family residential property and no other party holds
an intervening lien, the savings association must treat the two loans
as a single loan secured by a first lien and risk-weight the loans
under paragraph (d)(2)(i) of this section.
(B) If a third party holds a senior or intervening lien, the
savings association must apply the risk weight in Table 2 that
corresponds the LTV ratio of the loan. If a loan is not prudently
underwritten, is not performing, or is more than 90 days past due, the
savings association must apply a risk weight of 150 percent if the loan
has an LTV that is greater than 90 percent, and must apply a risk
weight of 100 percent to all other loans.
Table 2.--Risk Weights for Mortgage Loans Secured by Junior Liens on One-
to Four-Family Residential Properties
------------------------------------------------------------------------
Loan-to-Value ratio Risk weight
------------------------------------------------------------------------
60% or less................................................ 75
Greater than 60% and less than or equal to 90%............. 100
Greater than 90%........................................... 150
------------------------------------------------------------------------
(iii) LTV computation. To compute the LTV ratio under this
paragraph (d)(2):
(A) The loan amount is the original principal amount of the loan
and of all senior loans, subject to the following adjustments:
(1) If a loan has positively amortized, the savings association may
adjust the original principal amount of the loan quarterly to reflect
the positive amortization.
(2) If a loan has a negative amortization feature, the savings
association must adjust the original principal amount of the loan
quarterly to include amount of the negative amortization. If a third
party holds a senior or intervening lien with a negative amortization
feature, the savings association must adjust the original principal
amount of the senior or intervening loan to reflect the amount of that
loan if it were to fully negatively amortize under the applicable
contract.
(3) If a loan is a home equity line of credit, the savings
association must adjust the original principal amount of the loan
quarterly to reflect the current funded amount of the line of credit.
(B) At the origination of the loan, the value of the property is
the lower of the purchase price or the estimate of the property's
value. The savings association may update the value of the property
only when it extends additional funds in connection with refinancing
the loan or originating another loan secured by a junior lien that is
treated as a single loan under paragraph (d)(2)(ii)(A) of this section,
and it obtains a new appraisal or evaluation of the value of the
property as a part of that transaction. All estimates of the property's
value must be based on an appraisal or evaluation of the property in
conformance with 12 CFR part 564 and 12 CFR 560.100-560.101.
(C) The savings association may compute the LTV ratio after
consideration of loan level private mortgage insurance (PMI) provided
by non-affiliated insurer with long-term senior debt (without credit
enhancement) that is externally-rated at least the third highest
investment grade. Loan level PMI is insurance that protects a mortgage
lender in the event of borrower default up to a predetermined portion
of the value of a one-to four-family residential property and that has
no pool-level cap that would effectively reduce coverage below the
predetermined portion of the value of the property. An affiliated
company is any company that controls, is controlled by, or is in common
control with the savings association. A
[[Page 77515]]
company or person controls a company if it owns, controls, or holds
with power to vote 25 percent or more of a class of voting securities
of the company, or consolidates the company for financial reporting
purposes.
(iv) Negatively amortizing loans and home equity lines of credit.
This paragraph (d)(2) applies to the funded portions of negatively
amortizing loans and home equity lines of credit that are secured by a
first or junior lien on one-to four-family residential property. The
unfunded portions of these loans are addressed at paragraph (e)(2) of
this section.
(v) Construction loans. This paragraph (d)(2) applies to a mortgage
loan to an individual borrower that is secured by a lien on land to be
used for the construction of the borrower's home. It does not apply to
``qualifying residential construction loans,'' as defined in Sec.
567.1, which are addressed under paragraph (d)(1)(iv)(D) of this
section or other residential construction loans, which are addressed
under paragraph (d)(1)(vi)(D) of this section.
(vi) Transition provision. If a savings association owns a mortgage
loan secured by a lien on one-to four-family residential property on
the date that it elects to opt-in under paragraph (a) of this section,
it may apply a 50 percent risk weight if the mortgage loan is a
``qualifying mortgage loan'' as defined in Sec. 567.1, and apply a 100
percent risk weight if the mortgage loan is not a qualifying mortgage
loan. If the savings association elects to apply this paragraph
(d)(2)(vi), it must apply this transitional risk-weight treatment to
all mortgage loans that it owns on the date that it elects to opt-in
under paragraph (a). A savings association may only rely on this
transitional provision the first time it elects to compute risk-weights
under this Sec. 567.7.
(3) Direct claims--ratings-based approach. (i) A savings
association must risk-weight claims described in paragraph (d)(3)(ii)
of this section using the risk weights indicated on Table 3 (claims
with an original maturity of one year or more) or Table 4 (claims with
an original maturity of less than one year). To determine the
applicable risk weight for a claim, the savings association must use
the external rating for the claim. If a sovereign exposure has no
external rating, the exposure is deemed to have an external rating
equal to the sovereign's issuer rating assigned by an NRSRO.
(ii)(A) This paragraph (d)(3) applies to claims on sovereigns,
other than the United States Government and its agencies. Claims on the
United States Government and its agencies are risk-weighted under
paragraph (d)(1) of this section.
(B) This paragraph (d)(3) also applies to all claims on non-
sovereigns, other than loans that are not externally rated and claims
on United States Government-sponsored agencies, public-sector entities
in OECD countries, and depository institutions. Loans to non-sovereigns
that are not externally rated and claims on United States Government-
sponsored agencies, public sector entities in OECD countries and
depository institutions are risk-weighted under paragraph (d)(1) of
this section.
(C) This paragraph (d)(3) does not apply to recourse obligations,
direct credit substitutes, and other positions that are subject to
paragraph (f) of this section.
(D) This paragraph (d)(3) also does not apply to OTC derivative
counter-party risk. OTC derivative counter-party risk is addressed in
paragraph (e) of this section.
Table 3.--Risk Weights Based on Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
Sovereign risk Non-Sovereign
Long-term rating category Example weight risk weight
(percent) (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating............ AAA 0 20
Second-highest investment grade rating..... AA 20 20
Third-highest investment grade rating...... A 20 35
Lowest-investment grade rating--plus....... BBB+ 35 50
Lowest-investment grade rating............. BBB 50 75
Lowest-investment grade rating--minus...... BBB- 75 100
One category below investment grade........ BB+, BB 75 150
One category below investment grade--minus. BB- 100 200
Two or more categories below investment B, CCC 150 200
grade.
Unrated.................................... n/a 200 200\1\
----------------------------------------------------------------------------------------------------------------
Table 4.--Risk Weights Based on Ratings For Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
Sovereign risk Non-Sovereign
Short-term rating category Example weight risk weight
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating............ A-1, P-1 0 20
Second-highest investment grade rating..... A-2, P-2 20 35
Lowest investment grade rating............. A-3, P-3 50 75
Unrated.................................... n/a 100 100\1\
----------------------------------------------------------------------------------------------------------------
\1\Unrated debt securities issued by non-sovereigns receive the risk-weight indicated. Unrated loans to non-
sovereigns are risk-weighted under paragraph (d)(1) of this section.
(4) Claims collateralized by certain debt securities or asset-
backed or mortgage-backed securities. (i) In addition to collateralized
claims addressed in paragraph (d)(1) of this section, a savings
association may risk-weight a claim that is collateralized by:
(A) A debt security that may be risk-weighted under paragraph
(d)(3) of this section, by applying the risk-weight that would be
assigned directly to the debt security under that paragraph. The
minimum risk-weight that may be assigned to an asset collateralized by
a debt security that is issued by a sovereign is 20 percent;
(B) A debt security backed by a guarantee of a sovereign (other
than the United States and its agencies) that may be risk-weighted
under paragraph (d)(5) of this section, by applying the risk-
[[Page 77516]]
weight that would be assigned directly to the debt security under that
paragraph. The minimum risk-weight that may be assigned to an asset
collateralized by a debt security that is guaranteed by a sovereign is
20 percent; or
(C) A security that may be risk-weighted under Table A or B of
paragraph (f) of this section, by applying the risk-weight that would
be assigned directly to the security under paragraph (f).
(ii) To be eligible for risk-weighting under this paragraph (d)(4),
the collateral must be liquid and readily marketable and must have an
external rating (or, if applicable, a sovereign issuer rating assigned
by an NRSRO) of at least investment grade.
(iii) If an asset is partially collateralized, only that portion of
the asset that is collateralized by the market value of the collateral
may be risk-weighted under this paragraph (d)(4).
(5) Guaranteed assets or claims. (i) A savings association may
risk-weight a claim that is backed by an eligible guarantee by applying
the risk-weight indicated in Table 3 of this section. To determine the
applicable risk weight for an exposure, the savings association must
use the external rating assigned to the guarantor's long-term senior
debt (without credit enhancement) or, if the guarantor is a sovereign,
an external rating that is equal to the sovereign's issuer rating
assigned by an NRSRO. The applicable external rating must be at least
investment grade.
(ii) This paragraph (d)(5) applies to eligible guarantees of:
(A) Sovereigns, other than the United States Government and its
agencies. Guarantees of the United States Government and its agencies
are risk-weighted under paragraph (d)(1) of this section; and
(B) Non-sovereigns, other than United States Government-sponsored
agencies, public-sector entities in OECD countries, and depository
institutions. Guarantees of United States Government-sponsored
agencies, public-sector entities in OECD countries, and depository
institutions are risk-weighted under paragraph (d)(1) of this section.
(iii) To be an eligible guarantee, the guarantee must be issued by
a third party guarantor and must:
(A) Be written and unconditional and, for a sovereign guarantee, be
backed by the full faith and credit of the sovereign;
(B) Cover all or a pro rata portion of contractual payments of the
obligor on the reference asset or claim. If an asset or claim is
partially guaranteed, only the pro rata portion of the asset or claim
that is guaranteed may be assigned a risk-weight under this paragraph
(d)(5);
(C) Give the beneficiary a direct claim against the protection
provider;
(D) Be non-cancelable by the protection provider for reasons other
than the breach of the contract by the beneficiary;
(E) Be legally enforceable against the protection provider in a
jurisdiction where the protection provider has sufficient assets
against which a judgment may be attached and enforced; and
(F) Require the protection provider to make payment to the
beneficiary on the occurrence of a default of the obligor on the
reference asset or claim without first requiring the beneficiary to
demand payment from the obligor.
(6) Indirect ownership interests in pools of assets. Assets
representing an indirect holding of a pool of assets, e.g., mutual
funds, are assigned to risk-weight categories based upon the risk
weight that would be assigned to the assets in the portfolio of the
pool. An investment in shares of a mutual fund whose portfolio consists
primarily of various securities or money market instruments that, if
held separately, would be assigned to different risk-weight categories,
generally is assigned to the risk-weight category appropriate to the
highest risk-weighted asset that the fund is permitted to hold in
accordance with the investment objectives set forth in its prospectus.
The savings association may, at its option, assign the investment on a
pro rata basis to different risk-weight categories according to the
investment limits in its prospectus. In no case will an investment in
shares in any such fund be assigned to a total risk weight less than 20
percent. If the savings association chooses to assign investments on a
pro rata basis, and the sum of the investment limits of assets in the
fund's prospectus exceeds 100 percent, the savings association must
assign the highest pro rata amounts of its total investment to the
higher risk categories. If, in order to maintain a necessary degree of
short-term liquidity, a fund is permitted to hold an insignificant
amount of its assets in short-term, highly liquid securities of
superior credit quality that do not qualify for a preferential risk
weight, such securities will generally be disregarded in determining
the risk-weight category into which the savings association's holding
in the overall fund should be assigned. The prudent use of hedging
instruments by a mutual fund to reduce the risk of its assets will not
increase the risk-weighting of the mutual fund investment. For example,
the use of hedging instruments by a mutual fund to reduce the interest
rate risk of its government bond portfolio will not increase the risk
weight of that fund above the 20 percent category. Nonetheless, if the
fund engages in any activities that appear speculative in nature or has
any other characteristics that are inconsistent with the preferential
risk-weighting assigned to the fund's assets, holdings in the fund will
be assigned to the 100 percent risk-weight category.
(e) Off balance sheet items. A savings association must calculate
the risk-weighted off-balance sheet items as described at Sec. 567.6
of this part, with the following modifications:
(1) Short-term commitments. A savings association must apply the
following credit conversion factors to the unused portion of
commitments with an original maturity of one year or less:
(i) Zero percent for commitments that are unconditionally
cancelable and commitments to originate a loan secured by a lien on
one- to four-family residential property; and
(ii) 10 percent for all other short-term commitments.
(2) Unfunded amount of negatively amortizing mortgage loans and
home equity lines of credit. If a mortgage loan secured by a lien on
one- to four-family residential property may negatively amortize or is
a home equity line of credit, a savings association must calculate the
risk-weighted asset amount for the unfunded amount of the loan by
multiplying the amount of the off-balance sheet exposure times the
applicable credit conversion factor times the applicable risk weight.
For the purposes of this paragraph (e)(2):
(i) The amount of the off-balance sheet exposure is the unfunded
amount of the loan if it were to fully negatively amortize under the
applicable contract or the maximum unfunded amount of the home equity
line of credit; and
(ii) The applicable risk weight is the risk weight prescribed in
paragraph (d)(2) of this section using an LTV computed under that
paragraph, except that the loan amount must include an additional
amount equal to the unfunded amount of the loan if it were to fully
negative amortize under the applicable contract or equal to the maximum
unfunded amount of the home equity line of credit.
(3) Risk weight for derivatives. A savings association must
calculate the risk-weighted asset amount for off-balance sheet
derivative contracts without reference to the 50 percent maximum risk-
weight cap described at 12 CFR 567.6(a)(2).
[[Page 77517]]
(f) Ratings-based approach for recourse obligations, direct credit
substitutes and certain other positions. (1) General. A savings
association must apply Sec. 567.6(b) of this part to determine the
risk weights for recourse obligations, direct credit substitutes, and
other described positions, except the savings association must
calculate risk-weights for recourse obligations, direct credit
substitutes, residual interests (other than credit enhancing interest-
on strips) described in Sec. 567.6(b)(3) by referring to the
exposure's external rating and using the following tables:
Table 5
------------------------------------------------------------------------
Long-term external rating Risk weight
category Example (percent)
------------------------------------------------------------------------
Highest investment grade rating AAA 20
Second-highest investment grade AA 20
rating.
Third-highest investment grade A 35
rating.
Lowest-investment grade rating-- BBB+ 50
plus.
Lowest-investment grade rating-- BBB 75
naught.
Lowest-investment grade rating-- BBB- 100
negative.
One category below investment BB+, BB 200
grade--plus & naught.
One category below investment BB- 200
grade--negative.
------------------------------------------------------------------------
Table 6
------------------------------------------------------------------------
Short-term external rating Risk weight
category Example (percent)
------------------------------------------------------------------------
Highest investment grade rating A-1, P-1 20
Second-highest investment grade A-2, P-2 35
rating.
Lowest investment grade rating. A-3, P-3 75
------------------------------------------------------------------------
(2) Securitizations of revolving credit with early amortization
provisions.
(i) A savings association must risk-weight the off-balance sheet
amount of the investor's interest in a securitization if:
(A) The savings association securitizes revolving credits in the
securitization. A revolving credit is a line of credit where the
borrower is permitted to vary the drawn amount and the amount of
repayment within an agreed limit; and
(B) The securitization structure includes an early amortization
provision. An early amortization provision is a provision in the
documentation governing a securitization that, when triggered, causes
investors in the securitization exposures to be repaid before the
original stated maturity of the securitization exposures. An early
amortization provision does not include a provision that is triggered
solely by events that are not directly related to the performance of
the underlying exposures or the originating savings association (such
as material changes in tax laws or regulations).
(ii) The risk-based asset amount for the investors' interest in a
securitization described in this paragraph (f)(2) is equal to the off-
balance sheet investors' interest times the applicable credit
conversion factor times the risk-weight applicable to the underlying
obligor, collateral or guarantor. For the purposes of this paragraph
(f)(2):
(A) The off-balance sheet investors' interest is the total amount
of the securitization exposures issued by a trust or a special purpose
entity to investors.
(B) The applicable credit conversion factor is determined by
reference to Table 5, which is based upon a comparison of the
securitization's annualized three month average excess spread against
the excess spread trapping point. This excess spread trapping ratio is
computed as follows:
(1) The savings association must calculate the three-month average
of the dollar amount of excess spread divided by the outstanding
principal balance of the underlying pool of exposures at the end of
each month. Excess spread is equal to the gross finance charge
collections (including market interchange fees) and other income
received by a trust or special purpose entity minus interest paid to
the investors in the securitization exposures, servicing fees, charge-
offs, and other trust or special purpose entity expenses.
(2) The three-month average excess spread is converted to a
compound annual rate and is then divided by the excess spread trapping
point. The excess spread trapping point is the point at which the
savings association is required by the documentation for the
securitization to divert and hold excess spread in spread or reserve
account, expressed as a percentage. The excess spread trapping point is
4.5 percent for securitizations that do not require excess spread to be
trapped or that specify a trapping point that is based primarily on
performance features other than the three-month average excess spread.
(iii) If the aggregate risk-based capital requirement for all of a
savings association's exposures to a securitization (including the
risk-based capital requirements for residual interests, recourse
obligations, direct credit substitutes, the investor's interest
computed under this paragraph (f)(2), and other securitization
exposures) exceeds the risk-based capital requirement for the
underlying securitized assets, the aggregate risk-based capital for all
of the exposures is the greater of the risk-based capital requirement
for:
(A) The residual interest; or
(B) The underlying securitized assets calculated as if the savings
association continued to hold the assets on its balance sheet.
Table 7.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
CCF
Excess spread trapping point ratio (percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more................... 0
Less than 133.33 percent to 100 percent of trapping point.. 5
Less than 100 percent to 75 percent of trapping point...... 15
[[Page 77518]]
Less than 75 percent to 50 percent of trapping point....... 50
Less than 50 percent of trapping point..................... 100
------------------------------------------------------------------------
6. In Sec. 567.11, revise paragraph (c)(2), redesignate paragraph
(c)(3) as paragraph (c)(4) and add new paragraph (c)(3) to read as
follows:
Sec. 567.11 Reservation of authority.
* * * * *
(c) * * *
(2) Notwithstanding Sec. Sec. 567.6 and 567.7 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 the OTS
deems appropriate. Similarly, OTS may override the use of certain
ratings or ratings on certain instruments, if necessary or appropriate
to reflect the risk that that an instrument poses to a savings
association.
(3) OTS may require a savings association to use Sec. 567.6 or
Sec. 567.7 of this part to compute risk-weighted assets, if OTS
determines that the risk-weighted capital requirement computed under
that section is more appropriate for the risk profile of the savings
association or would otherwise enhance the safety and soundness of the
savings association. In making a determination under this paragraph
(c)(3), OTS will apply notice and response procedures in the same
manner and to the same extent as the notice procedures in 12 CFR
567.3(d).
* * * * *
Dated: December 12, 2006.
John C. Dugan,
Comptroller of the Currency.
By order of the Board of Governors of the Federal Reserve
System, December 8, 2006.
Jennifer J. Johnson,
Secretary of the Board.
Dated at Washington, D.C., this 5th Day of December, 2006.
By order of the Board of Directors.
Federal Deposit Insurance Corporation.
Valerie J. Best,
Assistant Executive Secretary.
Dated: December, 11, 2006.
By the Office of Thrift Supervision
John Reich,
Director.
[FR Doc. 06-9738 Filed 12-22-06; 8:45 am]
BILLING CODE 4810-33-P(25%); 6210-01-P(25%); 6714-01-P(25%); 6720-01-
P(25%)