[Federal Register Volume 76, Number 229 (Tuesday, November 29, 2011)]
[Notices]
[Pages 73777-73780]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2011-30420]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

[Docket No. OCC-2011-0022]
RIN 1557-AD36


Guidance on Due Diligence Requirements in Determining Whether 
Investment Securities Are Eligible for Investment

AGENCY: Office of the Comptroller of the Currency, Treasury (OCC).

ACTION: Proposed guidance with request for comment.

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SUMMARY: The Office of the Comptroller of the Currency (OCC) is 
proposing guidance to assist national banks and Federal savings 
associations in meeting due diligence requirements in assessing credit 
risk for portfolio investments.

DATES: Comments must be received December 29, 2011.

ADDRESSES: Because paper mail in the Washington, DC area and at the OCC 
is subject to delay, commenters are encouraged to submit comments by 
the Federal eRulemaking Portal or email, if possible. Please use the 
title ``Guidance on Due Diligence Requirements in Determining Whether 
Investment Securities Are Eligible for Investment'' to facilitate the 
organization and review of the comments. You may submit comments by any 
of the following methods:
     Email: [email protected].
     Mail: Office of the Comptroller of the Currency, 250 E 
Street SW., Mail Stop 2-3, Washington, DC 20219.

[[Page 73778]]

     Fax: (202) 874-5274.
     Hand Delivery/Courier: 250 E Street SW., Mail Stop 2-3, 
Washington, DC 20219.
    Instructions: You must include ``OCC'' as the agency name and 
``Docket Number OCC-2011-0022'' in your comment. In general, OCC will 
enter all comments received into the docket and publish them on the 
Regulations.gov Web site without change, including any business or 
personal information that you provide such as name and address 
information, email addresses, or phone numbers. Comments received, 
including attachments and other supporting materials, are part of the 
public record and subject to public disclosure. Do not enclose any 
information in your comment or supporting materials that you consider 
confidential or inappropriate for public disclosure.
    You may review comments and other related materials that pertain to 
this proposed rulemaking by any of the following methods:
     Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC, 250 E Street SW., Washington, DC. 
For security reasons, the OCC requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 874-
4700. Upon arrival, visitors will be required to present valid 
government-issued photo identification and submit to security screening 
in order to inspect and photocopy comments.
     Docket: You may also view or request available background 
documents and project summaries using the methods described above.

FOR FURTHER INFORMATION CONTACT: Kerri Corn, Director for Market Risk, 
Credit and Market Risk Division, (202) 874-4660; or Carl Kaminski, 
Senior Attorney, or Kevin Korzeniewski, Attorney, Legislative and 
Regulatory Activities Division, (202) 874-5090; or Eugene H. Cantor, 
Counsel, Securities and Corporate Practices Division, (202) 874-5202, 
Office of the Comptroller of the Currency, 250 E Street SW., 
Washington, DC 20219.

SUPPLEMENTARY INFORMATION: Section 939A of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act \1\ requires each Federal agency, 
within one year of enactment, to review: (1) Any regulations that 
require the use of an assessment of the creditworthiness of a security 
or money market instrument, and (2) any references to or requirements 
in those regulations regarding credit ratings. Section 939A then 
requires the Federal agencies to modify the regulations identified 
during the review to substitute any references to or requirements of 
reliance on credit ratings with such standards of creditworthiness that 
each agency determines to be appropriate. The statute provides that the 
agencies shall seek to establish, to the extent feasible, uniform 
standards of creditworthiness, taking into account the entities the 
agencies regulate and the purposes for which those entities would rely 
on such standards.
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    \1\ Public Law 111-203, Section 939A (July 21, 2010) (Dodd-Frank 
Act).
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    The Office of the Comptroller of the Currency (OCC) is issuing a 
notice of proposed rulemaking (NPRM), published on the same date as 
this proposed guidance. The NPRM proposes to remove references to 
credit ratings in the OCC's non-capital regulations. In particular, the 
OCC proposes to amend the definition of ``investment grade'' in 12 CFR 
part 1 to no longer reference credit ratings. Instead, ``investment 
grade'' securities would be those where the issuer has an adequate 
capacity to meet the financial commitments under the security for the 
projected life of the investment. An issuer has an adequate capacity to 
meet financial commitments if the risk of default by the obligor is low 
and the full and timely repayment of principal and interest is 
expected. Generally, securities with good to very strong credit quality 
will meet this standard. National banks will have to meet this new 
standard before purchasing investment securities.
    OCC also is proposing to define the term ``investment grade,'' for 
Federal savings associations, as it is used in Part 160, to refer to 12 
U.S.C. 1831e. This effectively will reference the current ratings-based 
requirement until such time as the requirement is replaced by the FDIC. 
In addition, the OCC is proposing to remove references to credit 
ratings applicable to commercial paper and corporate debt securities 
contained in Sec. Sec.  160.40 and 160.93(e)(5)(ii). Under the revised 
rules, savings associations would be permitted to invest in commercial 
paper if it meets the standards set forth at 12 U.S.C. 1831e(d)(1), 
which currently limits savings associations to purchasing corporate 
debt securities that are of investment grade, but will, after July 21, 
2012, include a new creditworthiness standard established by the FDIC.
    In addition, national banks and Federal savings associations should 
continue to maintain appropriate ongoing reviews of their investment 
portfolios to verify that their portfolios meet safety and soundness 
requirements that are appropriate for the institution's risk profile 
and for the size and complexity of their portfolios. The OCC is issuing 
this proposed supervisory guidance explaining the due diligence 
national banks and Federal savings associations should conduct in 
purchasing investment securities for their investment portfolios and to 
reiterate supervisory expectations for the securities the institution 
actually purchases.

Text of Proposed Guidance

    The text of the proposed supervisory guidance on due diligence 
national banks and Federal savings associations should conduct in 
assessing credit risk for portfolio investments as required by 12 CFR 
Part 1and 12 CFR part 160 (specifically, 12 CFR 1.5 and 12 CFR 160.1(b) 
and 160.40(c)) follows:

Purpose

    The Office of the Comptroller of the Currency (OCC) is issuing this 
guidance (``Guidance'') to clarify steps national banks ordinarily 
should take to demonstrate they have properly verified their 
investments meet the newly established credit quality standards under 
12 CFR part 1 and steps national banks and Federal savings associations 
should take to demonstrate they met due diligence requirements when 
purchasing investment securities and conducting ongoing reviews of 
their investment portfolios. Federal savings associations will need to 
follow FDIC requirements when that Agency promulgates credit quality 
standards under 12 U.S.C. 1831e. These standards determine whether 
national banks may purchase, sell, deal in, underwrite, and hold 
securities consistent with the authority contained in 12 U.S.C. 
24(Seventh), and whether Federal saving associations may invest in, 
sell, or otherwise deal in securities consistent with the authority 
contained in 12 U.S.C. 1464(c). The activities of national banks and 
Federal savings associations also must be consistent with safe and 
sound banking practices, and this guidance reminds national banks and 
Federal savings associations of the supervisory risk management 
expectations associated with permissible investment portfolio holdings 
under Part 1 and Part 160.

Background

    Parts 1 and 160 provide standards for determining whether 
securities have appropriate credit quality and marketability 
characteristics to be purchased and held by national banks or Federal 
savings associations. These requirements also establish concentration 
limits on the amount of investment securities an institution may

[[Page 73779]]

hold for its own account. An investment security must be ``investment 
grade.'' For the purpose of Part 1, ``investment grade'' securities are 
those where the issuer has an adequate capacity to meet the financial 
commitments under the security for the projected life of the 
investment. An issuer has an adequate capacity to meet financial 
commitments if the risk of default by the obligor is low and the full 
and timely repayment of principal and interest is expected. Generally, 
securities with good to very strong credit quality will meet this 
standard.
    National banks and Federal savings associations must be able to 
demonstrate that their investment securities meet applicable credit 
quality standards. This Guidance provides criteria that national banks 
can use in meeting Part 1 credit quality standards and that national 
banks and Federal savings associations can use in meeting due diligence 
requirements.
    The OCC has had a long-standing expectation that national banks 
implement a risk management process to ensure credit risk, including 
credit risk in the investment portfolio, is effectively identified, 
measured, monitored, and controlled. The 1998 Interagency Supervisory 
Policy Statement on Investment Securities and End-User Derivatives 
Activities (Policy Statement) contains risk management standards for 
the investment activities of banks and savings associations.\2\ The 
Policy Statement emphasizes the importance of an institution conducting 
a thorough credit risk analysis before and periodically after the 
acquisition of a security. Such analyses allow an institution to 
understand and effectively manage the risks within its investment 
portfolio, including credit risk, and are an essential element of a 
sound investment portfolio risk management framework. Other previously 
issued guidance that supplements OCC investment standards are OCC 2009-
15, ``Risk Management and Lessons Learned'' (which highlights lessons 
learned during the market disruption and re-emphasizes the key 
principles discussed in previously issued OCC guidance on portfolio 
risk management); OCC 2004-25, ``Uniform Agreement on the 
Classification of Securities'' (which describes the importance of 
management's credit risk analysis and its use in examiner decisions 
concerning investment security risk ratings and classifications); and 
OCC 2002-19, ``Supplemental Guidance, Unsafe and Unsound Investment 
Portfolio Practices'' (which alerts banks to the potential risk to 
future earnings and capital from poor investment decisions made during 
periods of low levels of interest rates and emphasizes the importance 
of maintaining prudent credit, interest rate, and liquidity risk 
management practices to control risk in the investment portfolio).\3\
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    \2\ On April 23, 1998, the FRB, FDIC, NCUA, OCC, and OTS issued 
the ``Supervisory Policy Statement on Investment Securities and End-
User Derivatives Activities.'' As issued by the OTS, the Policy 
Statement applied to both state and Federal savings associations.
    \3\ Similar requirements also apply to Federal savings 
associations as set forth in OTS Examination Handbook Section 540, 
Investment Securities (January 2010).
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Determining Whether Securities Are Permissible Prior to Purchase

    The OCC's elimination of references to credit ratings, in 
accordance with the Dodd-Frank Act, does not substantively change the 
standards institutions should use when deciding whether securities are 
eligible for purchase under Part 1. To be eligible for purchase under 
Part 1, investments must meet the standard of being ``investment 
grade.'' Investments are considered ``investment grade'' if they meet 
the regulatory standard for credit quality. To meet this standard, a 
national bank must be able to determine that an investment security has 
(1) Low risk of default by the obligor, and (2) the full and timely 
repayment of principal and interest is expected, over the expected life 
of the investment.\4\ A Federal savings association must meet the same 
standard when purchasing certain municipal revenue bonds pursuant to 12 
CFR 160.24, and they must meet the standards in 12 U.S.C. 1831e when 
purchasing corporate debt securities.
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    \4\ Federal savings associations may invest in and hold 
investment securities under section 5(c) of the Home Owners' Loan 
Act (HOLA), to the extent specified in regulations of the OCC. While 
OCC regulations imposing investment limitations generally apply to 
Federal savings associations, the Federal Deposit Insurance Act 
(FDIA), 12 U.S.C. 1831e(d)(1) also applies. Under this provision, 
savings associations currently are prohibited from investing in 
corporate debt securities unless they are rated ``investment 
grade.'' However, the Dodd-Frank Act provides that as of July 21, 
2012, this statutory requirement will be replaced by standards of 
creditworthiness established by the FDIC. Pub. L. 111-203, Section 
939(a)(2) (July 21, 2010).
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    The OCC expects national banks and Federal savings associations to 
conduct an appropriate level of due diligence to determine that an 
investment security is a permissible investment. This may include 
consideration of internal analyses, third party research and analytics 
including external credit ratings, internal risk ratings, default 
statistics, and other sources of information as appropriate for the 
particular security. The depth of the due diligence should be a 
function of the security's credit quality, the complexity of the 
structure, and the size of the investment. The more complex a 
security's structure is, the more credit-related due diligence an 
institution should perform, even when the credit quality is perceived 
to be very high. Bank management should ensure they understand the 
security's structure and how the security will perform in different 
default environments, and should be particularly diligent when 
purchasing structured securities.\5\ The OCC expects national banks and 
Federal savings associations to consider a variety of factors relevant 
to the particular security when determining whether a security is a 
permissible and sound investment. The range and type of specific 
factors an institution should consider will vary depending on the 
particular type and nature of the securities. As a general matter, a 
national bank or Federal savings association will have a greater burden 
to support its determination if one factor is contradicted by a finding 
under another factor.
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    \5\ For example, a national bank or Federal savings association 
should be able to demonstrate an understanding of the effects on 
cash flows of a structured security assuming varying default levels 
in the underlying assets.
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    Although Part 1 has no specified quality requirements for type I 
securities, as a matter of prudent banking practice, national banks 
should conduct an appropriate level of due diligence prior to 
purchasing a material amount (to the institution) of these type I 
securities.
    By way of example, appropriate factors for designated types of 
instruments may include but not be limited to the following:

[[Page 73780]]



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                                                                  Municipal
                                                                  government                        Structured
                 Key factors                  Corporate bonds      general       Revenue bonds       products
                                                                 obligations
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Confirm spread to U.S. Treasuries is                       X                X                X                X
 consistent with bonds of similar credit
 quality....................................
Confirm risk of default is low and                         X                X                X                X
 consistent with bonds of similar credit
 quality....................................
Confirm capacity to pay through internal                   X                X                X                X
 credit analysis and/or other third party
 analytics, as appropriate for the
 particular security........................
Evaluate the soundness of a municipal's       ...............               X   ...............  ...............
 budgetary position and stability of its tax
 revenues...................................
Understand local demographics/economics.....               X                X                X   ...............
Assess the source and strength of revenue     ...............  ...............               X   ...............
 structure for municipal authorities........
Understand the class or tranche and its       ...............  ...............  ...............               X
 relative position in the securitization
 structure..................................
Assess the position in the cash flow          ...............  ...............  ...............               X
 waterfall..................................
Understand loss allocation rules, the         ...............  ...............  ...............               X
 potential impact of performance triggers,
 and support provided by credit enhancements
Evaluate and understand the quality of the    ...............  ...............  ...............               X
 underwriting of the underlying collateral
 as well as any risk concentrations.........
Determine whether current underwriting is     ...............  ...............  ...............               X
 consistent with the original underwriting
 underlying the historical performance of
 the collateral and consider the affect of
 any changes................................
Assess the structural subordination and       ...............  ...............  ...............               X
 determine if adequate given current
 underwriting standards.....................
Analyze and understand the impact of          ...............  ...............  ...............               X
 collateral deterioration on tranche
 performance and potential credit losses
 under stress scenarios.....................
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Maintaining an Appropriate and Effective Portfolio Risk Management 
Framework

    National banks and Federal savings associations must have in place 
an appropriate risk management framework for the level of risk in their 
investment portfolios. Failure to maintain an adequate investment 
portfolio risk management process, which includes understanding key 
portfolio risks, is considered an unsafe and unsound practice. Twelve 
CFR part 1 emphasizes that national bank purchases of investment 
securities must comply with safe and sound banking practices. Under 12 
CFR 1.5, national banks must consider, as appropriate, liquidity and 
price risk, as well as other risks presented by proposed securities 
activities. Federal savings associations also must conform to safe and 
sound banking practices and similarly must consider appropriate 
investment portfolio risks in their purchases of investment securities. 
Applicable guidance includes TB 73a, Thrift Activities Asset Quality, 
Investment Securities (December 18, 2001) and TB 13a, Thrift Activities 
Interest Rate Risk, Investment Securities, and Derivatives Activities 
(December 1, 1998).
    Having a strong and robust risk management framework appropriate 
for the level of risk in an institution's investment portfolio is 
particularly critical for managing portfolio credit risk. A key role 
for management in the oversight process is to translate the board of 
directors' tolerance for risk into a set of internal operating policies 
and procedures that govern the institution's investment activities. 
Specifically, investment policies should provide credit risk 
concentration limits. Such limits may apply to concentrations relating 
to a single or related issuer, a geographical area, and obligations 
with similar characteristics. Institutions possessing investment 
portfolios that lack diversification in one of the aforementioned areas 
should enhance their monitoring and reporting systems. Safety and 
soundness principles warrant effective concentration risk management 
programs to ensure that credit exposures do not reach an excessive 
level.
    Institutions should identify and measure the risks of their 
investments periodically after purchase. Such analyses allow an 
institution to understand and effectively manage the risks within its 
investment portfolio, including credit risk, and are an essential 
element of a sound investment portfolio risk management framework. 
Exposure to each type of risk for each security should be measured and 
aggregated with similar exposures on an institution-wide basis. Risk 
measurement should be obtained from sources independent of sellers or 
counterparties and should be periodically validated. Irrespective of 
any contractual or other arrangements, institutions are responsible for 
understanding and managing the risks of all of their transactions.

Request for Comment

    The OCC requests comment on all aspects of this proposed guidance. 
Specifically, the OCC would like commenters' views on:
    1. Does the proposed guidance sufficiently assist national banks in 
making determinations of which securities would be considered 
``investment grade?'' Does it sufficiently assist Federal savings 
associations in meeting their due diligence requirements? How could the 
guidance be improved?
    2. Should the guidance provide differentiations based on size and 
scope of operations for national banks and Federal savings associations 
with respect to consideration of the factors relevant to whether a 
national bank or Federal savings association has satisfied its due 
diligence requirements or whether a particular security has good credit 
quality?
    3. Does the proposed guidance adequately reflect the bulk of 
investment securities purchased by national banks and Federal savings 
associations? Are there other investments that receive credit ratings 
that should be included?

    Dated: November 18, 2011.
John Walsh,
Acting Comptroller of the Currency.
[FR Doc. 2011-30420 Filed 11-28-11; 8:45 am]
BILLING CODE 4810-33-P