[Federal Register Volume 77, Number 59 (Tuesday, March 27, 2012)]
[Proposed Rules]
[Pages 18109-18127]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-7268]


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

  Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / 
Proposed Rules  

[[Page 18109]]



FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AD92


Assessments, Large Bank Pricing

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Notice of proposed rulemaking and request for comment.

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

SUMMARY: The FDIC proposes to amend its regulations to revise some of 
the definitions used to determine assessment rates for large and highly 
complex insured depository institutions. The FDIC believes these 
proposed amendments will result in more consistent reporting, better 
reflect risk to the FDIC, significantly reduce reporting burden, and 
satisfy many concerns voiced by the banking industry.

DATES: Comments must be received on or before May 29, 2012.

ADDRESSES: You may submit comments on the notice of proposed 
rulemaking, identified by RIN number and the words ``Assessments, Large 
Bank Pricing Definition Revisions Notice of Proposed Rulemaking,'' by 
any of the following methods:
     Agency Web Site: http://www.FDIC.gov/regulations/laws/federal/propose.html. Follow the instructions for submitting comments 
on the Agency Web Site.
     Email: [email protected]. Include the RIN number in the 
subject line of the message.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., 
Washington, DC 20429.
     Hand Delivery: 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.
    Instructions: All submissions received must include the agency name 
and RIN for this rulemaking. Comments will be posted to the extent 
practicable and, in some instances, the FDIC may post summaries of 
categories of comments, with the comments themselves available in the 
FDIC's reading room. Comments will be posted at: http://www.fdic.gov/
regulations/laws/federal/propose.html, including any personal 
information provided with the comment.

FOR FURTHER INFORMATION CONTACT: Patrick Mitchell, Chief, Large Bank 
Pricing Section, Division of Insurance and Research, (202) 898-3943; 
Brenda Bruno, Senior Financial Analyst, Division of Insurance and 
Research, (630) 241-0359 x 8312; Christopher Bellotto, Counsel, Legal 
Division, (202) 898-3801; Sheikha Kapoor, Counsel, Legal Division, 
(202) 898-3960.

SUPPLEMENTARY INFORMATION:

I. Background

Legal Authority

    The Federal Deposit Insurance Act (the FDI Act) requires that the 
deposit insurance assessment system be risk-based.\1\ It defines a 
risk-based system as one based on an institution's probability of 
causing a loss to the Deposit Insurance Fund (the DIF), taking into 
account the composition and concentration of the institution's assets 
and liabilities and any other factors that the FDIC determines are 
relevant, the likely amount of any such loss, and the revenue needs of 
the DIF. The FDI Act allows the FDIC to ``establish separate risk-based 
assessment systems for large and small members of the Deposit Insurance 
Fund.'' \2\
---------------------------------------------------------------------------

    \1\ Section 7(b)(1) of the Federal Deposit Insurance Act (12 
U.S.C. 1817(b)(1)).
    \2\ Section 7(b)(1)(D) of the Federal Deposit Insurance Act (12 
U.S.C. 1817(b)(1)(D)).
---------------------------------------------------------------------------

Large Bank Pricing Rule

    On February 7, 2011, the FDIC Board adopted a final rule that 
amended its assessment regulations, by, among other things, 
establishing a new methodology for determining assessment rates for 
large and highly complex institutions (the February 
rule).3 4 The February rule eliminated risk categories for 
large institutions and combined CAMELS ratings and certain forward-
looking financial ratios into one of two scorecards, one for highly-
complex institutions and another for all other large institutions. The 
scorecards calculate a total score for each institution.\5\ The total 
score is then converted to the institution's initial base assessment 
rate, which, after certain adjustments, results in the institution's 
total assessment rate.\6\ To calculate the amount of the institution's 
quarterly assessment, the total base assessment rate is multiplied by 
the institution's assessment base and the result divided by four.
---------------------------------------------------------------------------

    \3\ Assessments, Large Bank Pricing, 76 FR 10672 (February 25, 
2011) (to be codified at 12 CFR 327.9).
    \4\ A large institution is defined as an insured depository 
institution: (1) That had assets of $10 billion or more as of 
December 31, 2006 (unless, by reporting assets of less than $10 
billion for four consecutive quarters since then, it has become a 
small institution); or (2) that had assets of less than $10 billion 
as of December 31, 2006, but has since had $10 billion or more in 
total assets for at least four consecutive quarters, whether or not 
the institution is new. A ``highly complex institution'' is defined 
as: (1) An insured depository institution (excluding a credit card 
bank) that has had $50 billion or more in total assets for at least 
four consecutive quarters and that either is controlled by a U.S. 
parent holding company that has had $500 billion or more in total 
assets for four consecutive quarters, or is controlled by one or 
more intermediate U.S. parent holding companies that are controlled 
by a U.S. holding company that has had $500 billion or more in 
assets for four consecutive quarters, and (2) a processing bank or 
trust company. A processing bank or trust company is an insured 
depository institution whose last three years' non-lending interest 
income, fiduciary revenues, and investment banking fees, combined, 
exceed 50 percent of total revenues (and its last three years 
fiduciary revenues are non-zero), whose total fiduciary assets total 
$500 billion or more and whose total assets for at least four 
consecutive quarters have been $10 billion or more.
    \5\ A large or highly-complex institution's total score may also 
be adjusted by the large bank adjustment. 76 FR 10672, 10714 
(February 25, 2011) (to be codified at 12 CFR 327.9(b)(3)).
    \6\ An institution's initial base assessment rate can be 
adjusted by the unsecured debt adjustment, the depository 
institution debt adjustment, and the brokered deposit adjustment. 76 
FR 10672, 10715 (February 25, 2011) (to be codified at 12 CFR 
327.9(d)).
---------------------------------------------------------------------------

    One of the financial ratios used in the scorecards is the ratio of 
higher-risk assets to Tier 1 capital and reserves.\7\ Higher-risk 
assets are defined as the sum of construction and land development 
(C&D) loans, leveraged loans, subprime loans, and nontraditional 
mortgage loans. The February rule used existing interagency

[[Page 18110]]

guidance to define leveraged loans, nontraditional mortgage loans, and 
subprime loans but refined the definitions to minimize reporting 
discrepancies. In arriving at these definitions, the FDIC took into 
account comments that were received in response to the two notices of 
proposed rulemaking that led to adoption of the February rule.\8\
---------------------------------------------------------------------------

    \7\ Higher-risk assets are used to calculate the concentration 
score, which is part of both the large bank scorecard and the highly 
complex institution scorecard. For large institutions, the 
concentration score is defined as the higher of: (a) The higher-risk 
assets to Tier 1 capital and reserves score or (b) the growth-
adjusted portfolio concentrations score. For highly complex 
institutions, it is defined as the higher of: (a) The higher-risk 
assets to Tier 1 capital and reserves score or (b) the largest or 
top 20 counterparty exposures to Tier 1 capital and reserves score.
    \8\ 75 FR 23516 (May 3, 2010); 75 FR 72612 (November 24, 2010).
---------------------------------------------------------------------------

    While institutions already reported C&D loan data in their 
quarterly reports of condition and income (the Call Reports and the 
Thrift Financial Reports or TFRs), they did not report the needed data 
for the other loans, thus requiring new line items in these reports. 
Therefore, on March 16, 2011, the Office of the Comptroller of the 
Currency, the Board of the Federal Reserve System, the Office of Thrift 
Supervision, the Treasury, and the FDIC (collectively, the agencies) 
published a Paperwork Reduction Act of 1995 (PRA) notice under normal 
PRA clearance procedures requesting comment on proposed revisions to 
the Call Reports, the TFRs, and the Federal Financial Institutions 
Examination Council (FFIEC) 002/002S reports that would provide the 
data needed by the FDIC to implement the February 2011 rule beginning 
with the June 30, 2011, report date (March PRA notice).\9\
---------------------------------------------------------------------------

    \9\ 76 FR 14460 (March 16, 2011).
---------------------------------------------------------------------------

    The agencies received 19 comments in response to the March PRA 
notice. Of these 19 comments, 17 addressed the new items for subprime 
and leveraged loans added to Call Reports and TFRs. The commenters 
stated that institutions generally do not maintain data on these loans 
consistent with the definitions used in the February rule and would be 
unable to report the required data by the June 30, 2011, report date. 
These data availability concerns had not been raised during the 
rulemaking process leading up to the February rule.\10\
---------------------------------------------------------------------------

    \10\ In response to the November 2010 NPR on the revised large 
institution assessment system, the FDIC received a number of 
comments recommending changes to the definitions of subprime and 
leveraged loans, which the FDIC addressed in its February rule 
amending its assessment regulations. For example, several commenters 
to the November 2010 NPR stated that regular (quarterly) updating of 
data to evaluate loans for subprime or leveraged status would be 
burdensome and costly and, for certain types of retail loans, would 
not be possible because existing loan agreements do not require 
borrowers to routinely provide updated financial information. In 
response to these comments, the FDIC's February rule stated that 
large institutions should evaluate loans for subprime or leveraged 
status upon origination, refinance, or renewal. However, no comments 
were received on the November 2010 NPR indicating that large 
institutions would be unable to identify and report subprime or 
leveraged loans in accordance with the final rule's definitions in 
their Call Reports and TFRs beginning as of June 30, 2011. The data 
availability concerns were first expressed in comments on the PRA 
notice.
---------------------------------------------------------------------------

    As a consequence of this unexpected difficulty, the agencies 
applied to the Office of Management and Budget (OMB) under emergency 
clearance procedures to allow institutions to identify and report 
subprime and leveraged loans and securitizations originated or 
purchased prior to October 1, 2011, using either their existing 
internal methodologies or the definitions contained in existing 
supervisory guidance. The reporting options are referred to as 
``transition guidance'' and are outlined in the General Instructions 
for Schedule RC-O of the Reports of Condition and Income, Memorandum 
Items 6 through 15 for leveraged loans and subprime loans. Because the 
assessment-related reporting revisions needed to remain in effect 
beyond the limited approval period associated with an emergency 
clearance request, the agencies, under the auspices of the FFIEC, 
submitted the reporting revisions under normal PRA clearance procedures 
and requested public comment on July 27, 2011 (July PRA notice).\11\
---------------------------------------------------------------------------

    \11\ 76 FR 44987 (July 27, 2011).
---------------------------------------------------------------------------

    The agencies collectively received four comments in response to the 
July PRA notice before the comment period closed on September 26, 2011. 
The commenters recommended extending the transition guidance for 
reporting subprime and leveraged loans until more workable and accurate 
definitions were developed. The commenters requested that the 
definitions of subprime and leveraged loans be revised because they do 
not effectively measure the risk that the FDIC intended to capture. 
Rather, commenters maintained that the definitions would capture loans 
that are not subprime or leveraged (i.e., are not higher-risk assets) 
and require burdensome reporting that could result in inconsistencies 
among banks. A joint comment letter from three industry trade groups 
also recommended that the definition of nontraditional mortgage loans 
be revised.
    On September 28, 2011, the FDIC informed large and highly complex 
institutions via email (followed by changes to Call Report 
instructions) that the deadline for the transition guidance would be 
extended to April 1, 2012, and that the FDIC would review the 
definitions of subprime and leveraged loans to determine whether 
changes to the definitions would alleviate commenters' concerns without 
sacrificing accuracy in risk determination for deposit insurance 
pricing purposes.
    As part of its review, the FDIC considered all comments related to 
the higher-risk asset definitions that were submitted in response to 
the March and July PRA notices. The FDIC also engaged in extensive 
discussions with the industry and industry trade groups over the last 
few months to better understand their concerns and to solicit potential 
solutions to these concerns.

II. Assessment System for Large and Highly Complex Institutions

    The FDIC proposes amendments to the assessment system for large and 
highly complex institutions that would: (1) Revise the definitions of 
certain higher risk assets, specifically leveraged loans, which would 
be renamed ``higher-risk C&I loans and securities,'' and subprime 
consumer loans, which would be renamed ``higher-risk consumer loans and 
securities''; (2) clarify the timing of classifying an asset as higher 
risk; (3) clarify the way securitizations (including those that meet 
the definition of nontraditional mortgage loans) are to be identified; 
and (4) further define terms that are used in the large bank pricing 
rule. The names of the categories of assets included in the higher-risk 
assets to Tier 1 capital and reserves ratio have been changed to avoid 
confusion between the definitions used in the deposit insurance 
assessment regulations and the terms that generally are used within the 
industry and in other regulatory guidance. The definitions of C&D loans 
would not be amended under the NPR and these loans would continue to be 
defined as in the February rule. Nontraditional mortgage loans would 
continue to be defined as in the February rule, but the NPR clarifies 
how securitizations of nontraditional mortgage loans would be 
identified under the definition. The FDIC believes that the proposed 
amendments would result in more consistent reporting, better reflect 
risk to the FDIC, significantly reduce reporting burden, and satisfy 
many of the concerns voiced by the industry after adoption of the 
February 2011 rule.
    The proposed amendments would be effective on October 1, 2012, 
predicated on changes to the Call Report. The effective date is 
discussed in detail in Section F below.

A. Higher-Risk Assets

    The FDIC uses the amount of an institution's higher-risk assets to 
calculate the institution's concentration score and total score. The 
concentration measure captures the institution's

[[Page 18111]]

lending (and securities owned) in higher-risk areas; concentrations in 
these higher-risk assets contributed to the failure of some 
institutions during the recent financial crisis and economic downturn.
Higher-Risk C&I Loans and Securities
    Under the proposal, higher-risk commercial and industrial (C&I) 
loans and securities would include:
     Any commercial loan (funded or unfunded, including 
irrevocable and revocable commitments) owed by a borrower to the 
evaluating depository institution with an original amount greater than 
$5 million if the conditions specified in (a) or (b) below are met as 
of origination, or, if the loan has been refinanced, as of refinance, 
and the loan does not meet the asset based lending (ABL) exclusion or 
the floor plan line of credit exclusion (discussed in Appendix C).
    (a)(i) The purpose of any of the borrower's debt (whether owed to 
the evaluating insured depository institution or another lender) that 
was incurred within the previous seven years was to finance a buyout, 
acquisition or capital distribution and such debt was 
material;12 13 and
---------------------------------------------------------------------------

    \12\ For purposes of this definition, the ``purpose of the 
borrower's debt'' is determined at the time the debt was incurred by 
the borrower. An institution would be required to determine if the 
borrower has incurred any debt in the last seven years that meets 
the purpose test.
    \13\ Following are definitions of some of the terms used under 
the proposed rule:
    1. Acquisition means the purchase by the borrower of any equity 
interest in another company or the purchase of any of the assets and 
liabilities of another company.
    2. Buyout for purposes of calculating higher-risk C&I assets 
means the issuance of debt to finance the purchase or repurchase by 
the borrower of the borrower's outstanding equity. A buyout could 
include, but is not limited to, an equity buyout or funding of an 
Employee Stock Ownership Plan (ESOP).
    3. Capital distribution means that the borrower incurs debt to 
finance a dividend payment or to finance other transactions designed 
to enhance shareholder value, such as repurchase of stock.
    4. Material means resulting in a 20 percent or greater increase 
anytime within 12 months in the total funded debt of the borrower 
(including all funded debt assumed, created, or refinanced). Debt is 
also material if, before the debt was incurred, the borrower had no 
funded debt.
---------------------------------------------------------------------------

    (ii) The ratio of the borrower's total debt to trailing twelve-
month EBITDA (i.e., operating leverage ratio) is greater than 4 or the 
ratio of the borrower's senior debt to trailing twelve-month EBITDA 
(i.e., operating leverage ratio) is greater than 3; \14\ or
---------------------------------------------------------------------------

    \14\ EBITDA is defined as earnings before interest, taxes, 
depreciation, and amortization.
---------------------------------------------------------------------------

    (b) Any of the borrower's debt (whether owed to the evaluating 
institution or another lender) is designated as a highly leveraged 
transaction (HLT) by a syndication agent.
     All securities held by the evaluating institution that are 
issued by a commercial borrower, if the conditions specified in (a) or 
(b) above are met, except securities classified as trading book; and
     All securitizations held by the evaluating institution 
that are more than 50 percent collateralized by commercial loans or 
securities that would meet the higher-risk C&I loans and securities 
definition if directly held by the evaluating institution, except 
securities classified as trading book.
    The definition of a higher-risk C&I loan and security would exclude 
the maximum amount that is recoverable from the U.S. government, its 
agencies, or government-sponsored agencies under guarantee or insurance 
provisions, and loans that are fully secured by cash collateral.\15\
---------------------------------------------------------------------------

    \15\ In order to exclude a loan based on cash collateral, the 
cash would be required to be in the form of a savings or time 
deposit held by the insured depository institution. The insured 
depository institution would be required to have in place a signed 
collateral assignment of the deposit account, which is irrevocable 
for the remaining term of the loan or commitment, and the insured 
depository institution would be required to place a hold on the 
deposit account that alerts the institution's employees to an 
attempted withdrawal. For the exclusion to apply to a revolving line 
of credit, the cash collateral would be required to be equal to or 
greater than the amount of the total loan commitment (the aggregate 
funded and unfunded balance of the loan).
---------------------------------------------------------------------------

    An institution would be required to use information reasonably 
available to a sophisticated investor in reasonably determining whether 
a securitization meets the 50 percent threshold.\16\ Information 
reasonably available to a sophisticated investor should include, but is 
not limited to, offering memorandums, indentures, trustee reports, and 
requests for information from servicers, collateral managers, issuers, 
trustees, or similar third parties. When determining whether a 
revolving trust or similar securitization would meet the threshold, an 
institution could use established criteria, model portfolios, or 
limitations published in the offering memorandum, indenture, trustee 
report or similar documents.
---------------------------------------------------------------------------

    \16\ A securitization would be as defined in Appendix A, Section 
II(B)(16) of Part 325 of the FDIC's Rules and Regulations, as it may 
be amended from time to time.
---------------------------------------------------------------------------

    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor. In such a 
case, the institution may exercise its judgment in making the 
determination. Nevertheless, the FDIC would retain the right to review 
and audit for compliance with the rule any determination that a 
securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated on 
the balance sheet as a result of SFAS 166 and SFAS 167, and a large 
institution or highly complex institution has access to the necessary 
information, an institution may evaluate individual loans in the 
securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset would 
be reported as a higher-risk asset and any loan within the 
securitization that does not meet the definition of a higher-risk asset 
would not be reported as such. When making this evaluation, the 
institution would have to follow the transition guidance described in 
Appendix C, Section C. Once an institution evaluated a securitization 
for higher-risk asset designation on a loan-by-loan basis, it would 
have to continue to evaluate all securitizations for which it has the 
required information in a similar manner (i.e., on a loan-by-loan 
basis). For securitizations for which the institution does not have 
access to information on a loan-by-loan basis, the institution would be 
required to determine whether the securitization meets the 50 percent 
threshold as described previously for other securitizations.
    When an institution acquires a C&I loan or security, it would have 
to determine whether the loan or security meets the definition of a 
higher-risk C&I loan or security using the origination criteria and 
analysis performed by the original lender. If this information were 
unavailable, however, the institution would have to obtain recent, 
refreshed data from the borrower or other appropriate third-party.\17\
---------------------------------------------------------------------------

    \17\ Somewhat more stringent requirements would apply when an 
institution acquires loans or securities from another entity on a 
recurring or programmatic basis.
---------------------------------------------------------------------------

    Appendix C provides detailed definitions of many of the terms used 
in the foregoing definition.
    In arriving at its proposal, the FDIC carefully reviewed the 
comments submitted in response to the March and July PRA notices on the 
leveraged loan definition contained in the February rule. Of the 19 
respondents commenting on the March PRA notice, 17 raised concerns over 
the leveraged loan definition; 6 of the 8 respondents to the July PRA 
notice raised such concerns. Further, as the FDIC noted in the public 
comment file for the July PRA notice,

[[Page 18112]]

the FDIC met with representatives of four industry trade groups and 
twice with large and highly complex institutions prior to the close of 
the comment period on the PRA notice.
    Three industry trade groups commented on the July PRA notice that 
the minimum size for leveraged loans included in the February rule ($1 
million or higher) is too low since it would capture a large number of 
small business loans that are not normally considered leveraged. These 
trade groups commented that the $1 million level overstates leveraged 
exposures and creates a significant reporting burden, since banks do 
not generally gather the data required to make a leveraged loan 
determination for these smaller loans. The commenters further noted 
that loans under $5 million are typically characterized by additional 
risk-reducing requirements, such as borrower's guarantees and 
additional collateral. When these risk-reducing mitigants are 
prevalent, relying solely on the debt-to-EBITDA test could be a less 
accurate measure of the risk of these borrowers.
    The proposal would increase the threshold level to $5 million. The 
increased threshold would result in better identification of higher-
risk C&I loans and would also reduce the reporting burden.
    In response to the July PRA Notice, three banking industry trade 
groups in a joint letter to the FDIC stated that the definition of 
leveraged loans used in the February rule does not capture risk as 
intended and is not a reliable measure of a leveraged loan. They 
maintained that an institution's debt-to-EBITDA ratio is not, by 
itself, a reliable indicator of risk, particularly if the loans are 
asset based or are to companies or industries that traditionally have 
higher leverage levels. They added that the definition of leveraged 
loans in the February rule captures such a large portion of an 
institution's loan portfolio that it does not provide a meaningful 
differentiation of risk among institutions and creates a reporting 
burden. The trade groups suggested that considering the purpose of the 
loan in conjunction with the borrower's operating leverage ratio would 
result in more accurate identification of risk.\18\
---------------------------------------------------------------------------

    \18\ The operating leverage ratio is the borrower's total or 
senior debt to trailing twelve-month EBITDA.
---------------------------------------------------------------------------

    The proposed definition would combine a test of the borrower's 
operating leverage ratio with a purpose test, namely, that if the 
purpose of any of the borrower's debt (whether owed to the evaluating 
insured depository institution or another lender) was to finance a 
buyout, acquisition, or capital distribution, and that debt was 
material, a C&I loan or security to that borrower would be classified 
as higher risk. The purpose of the debt would help identify risk to the 
FDIC and reflect the method used internally by most banks to identify 
higher-risk loans. The purpose test would identify those borrowers with 
certain higher-risk characteristics, such as a heavy reliance on either 
enterprise value or improvement in the borrower's operating 
efficiencies.\19\
---------------------------------------------------------------------------

    \19\ Enterprise value is a measure of the borrower's value as a 
going concern.
---------------------------------------------------------------------------

    The industry suggested in a comment letter to the July PRA Notice 
and in subsequent discussions that banks should look back to the 
original purpose of debt only if the debt was originally incurred 
during the previous five years. Under the proposal, however, banks 
would have to look back to the original purpose of any of the 
borrower's debt incurred during the previous seven years. During the 
most recent buyout boom of the mid to late 2000s, a seven-year maturity 
was often the longest dated maturity for loans that facilitated a 
leveraged buyout. Under the proposal, where the purpose test is met, 
loans originated in 2007 (near the end of the leveraged buyout boom) to 
a borrower that remains above the proposed debt-to-EBITDA ratio 
thresholds would continue to be classified as higher-risk assets, even 
when they are refinanced; loans that are refinanced from the same time 
period but where the borrower has de-levered through either EBITDA 
growth or debt repayment would not be defined as higher-risk under the 
proposal.
    Under the proposal, debt to finance a buyout, acquisition, or 
capital distribution would also have to be material. Such debt would be 
material if it resulted in a 20 percent or greater increase anytime 
within 12 months in the total funded debt of the borrower.\20\ During 
discussions with the industry, bankers have suggested that total funded 
debt should have to increase by 50 percent or more to be considered a 
material buyout, acquisition, or capital distribution. Under the 
proposal, only a 20 percent increase is required. A 20 percent increase 
would be high enough to ensure that the FDIC does not capture 
transactions that do not materially increase the risk profile of the 
borrower, but low enough to capture transactions such as capital 
distributions that benefit the borrower's shareholders while increasing 
the risk to the lending institutions.
---------------------------------------------------------------------------

    \20\ This debt would also be material if, before the debt was 
incurred, the borrower had no funded debt.
---------------------------------------------------------------------------

    The joint comment letter to the July PRA Notice also noted that 
collateral was not appropriately considered in the leveraged loan 
definition included in the February rule. The commenters stated that 
loans would be classified as leveraged even though they had strong 
collateral backing them, which should result in significantly lower 
loss rates than loans that are dependent primarily on the enterprise 
value of a highly-leveraged company. Examples of the loans commenters 
thought should be excluded from the leveraged loan definition were 
asset-based loans and dealer floor plan loans.
    After considering the comments, the proposed rule would exclude 
certain well-collateralized asset-based loans and floor plan loans from 
the definition of higher-risk C&I loans and securities. Because these 
loans carry significant operational risk, the exclusions would apply 
only to loans that are well secured by self-liquidating collateral 
(i.e., accounts receivable and inventory) and only when the institution 
can demonstrate that it has a history of strong risk management and 
internal controls over these loans. Excluding loans under these 
conditions should result in better differentiation of credit risk among 
institutions and should reduce reporting burden.
    Under the February rule, higher-risk assets included 
securitizations where more than 50 percent of the assets backing the 
securitization meet the criteria for leveraged loans. In their joint 
comment letter, three industry trade groups stated that the reporting 
criteria for securitizations in the February rule is problematic given 
the challenges in evaluating individual loans in the securitization 
given the lack of standardized disclosure requirements that align with 
the FDIC's definition of higher-risk assets.
    Under the proposal, higher-risk C&I loans and securities would 
continue to include securitizations where more than 50 percent of the 
assets backing the securitization meet the criteria for higher-risk C&I 
loans or securities. Concentrations in higher-risk assets, whether they 
are in the form of a whole loan or a securitization, increase the risk 
of loss to the FDIC during times of prolonged periods of economic 
stress. Large and highly complex institutions are sophisticated 
investors and can typically obtain the information needed to determine 
whether a securitization meets the 50 percent threshold described above 
when they purchase interests in these securitizations.

[[Page 18113]]

    Trade groups also commented that categorizing securitizations as 
higher-risk assets based solely on the underlying collateral ignores 
important risk mitigants such as credit enhancements. The performance 
of a securitization, however, is highly correlated with the performance 
of the underlying assets, even when the securitization contains terms 
or conditions intended to reduce risk. As stated in an interagency NPR 
issued in December 2011, ``during the crisis, a number of highly rated 
senior securitization positions were subject to significant downgrades 
and suffered substantial losses.'' \21\ Even where losses have not yet 
been realized (as in many collateralized loan obligations), the market 
value of these securitizations declined precipitously during the 
crisis, reflecting the decline in the market value of the underlying 
assets and the increased risk of loss.
---------------------------------------------------------------------------

    \21\ Risk-Based Capital Guidelines: Market Risk: Alternatives to 
Credit Ratings for Debt and Securitization Positions 76 FR 79380, 
79395 (December 21, 2011).
---------------------------------------------------------------------------

Higher-Risk Consumer Loans and Securities
    Under the proposal, higher-risk consumer loans and securities would 
be defined as:
    (a) All consumer loans where, as of origination, or, if the loan 
has been refinanced, as of refinance, the probability of default (PD) 
within two years (the two-year PD) was greater than 20 percent, 
excluding those consumer loans that meet the definition of a 
nontraditional mortgage loan; \22\ and
---------------------------------------------------------------------------

    \22\ A loan that meets both the definitions of a nontraditional 
mortgage loan and a higher-risk consumer loan at the time of 
origination should be reported as a nontraditional mortgage loan. 
However, if the loan later ceases to meet the definition of 
nontraditional mortgage loan but continues to still qualify as a 
higher-risk consumer loan, it would then be reported as a higher-
risk consumer loan.
---------------------------------------------------------------------------

    (b) Securitizations that are more than 50 percent collateralized by 
consumer loans meeting the criteria in (a), except those classified as 
trading book.\23\
---------------------------------------------------------------------------

    \23\ A securitization would be as defined in Appendix A, Section 
II(B)(16) of Part 325 of the FDIC's Rules and Regulations as it may 
be amended from time to time.
---------------------------------------------------------------------------

    An institution would be required to use the information that is or 
would be reasonably available to a sophisticated investor in reasonably 
determining whether a securitization meets the 50 percent threshold. 
Information reasonably available to a sophisticated investor should 
include, but is not limited to, offering memorandums, indentures, 
trustee reports, and requests for information from servicers, 
collateral managers, issuers, trustees, or similar third parties. When 
determining whether a revolving trust or similar securitization would 
meet the threshold, an institution could use established criteria, 
model portfolios, or limitations published in the offering memorandum, 
indenture, trustee report or similar documents.
    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor. In such a 
case, the institution may exercise its judgment in making the 
determination. Nevertheless, the FDIC would retain the right to review 
and audit for compliance with the rule any determination that a 
securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated on 
the balance sheet as a result of SFAS 166 and SFAS 167, and a large 
institution or highly complex institution has access to the necessary 
information, an institution may evaluate individual loans in the 
securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset would 
be reported as a higher-risk asset and any loan within the 
securitization that does not meet the definition of a higher-risk asset 
would not be reported as such. When making this evaluation, the 
institution would have to follow the transition guidance described in 
Appendix C, Section C. Once an institution evaluated a securitization 
for higher-risk asset designation on a loan-by-loan basis, it would 
have to continue to evaluate all securitizations for which it has the 
required information in a similar manner (i.e., on a loan-by-loan 
basis). For securitizations for which the institution does not have 
access to information on a loan-by-loan basis, the institution would be 
required to determine whether the securitization meets the 50 percent 
threshold as described previously for other securitizations.
    Institutions would have to determine the PD of a consumer loan as 
of origination, or, if the loan has been refinanced, as of refinance. 
When an institution acquires a consumer loan or security, it would have 
to determine whether the loan or security meets the definition of a 
higher-risk consumer loan or security using the origination criteria 
and analysis performed by the original lender. If this information is 
unavailable, however, the institution would have to obtain recent, 
refreshed data from the borrower or other appropriate third-party.\24\
---------------------------------------------------------------------------

    \24\ Somewhat more stringent requirements would apply when an 
institution acquires loans or securities from another entity on a 
recurring or programmatic basis.
---------------------------------------------------------------------------

    In arriving at its proposal, the FDIC carefully reviewed the 
comments submitted in response to the March and July PRA notices on the 
subprime loan definition contained in the February rule. Of the 19 
respondents commenting on the March PRA notice, 17 raised concerns over 
the subprime loan definition; 6 of the 8 respondents to the July PRA 
notice raised such concerns. Further, as the FDIC noted in the public 
comment file for the July PRA notice, the FDIC met with representatives 
of four industry trade groups and twice with large and highly complex 
institutions prior to the close of the comment period on the PRA 
notice.
    The representatives stated that institutions generally do not 
maintain the data necessary to identify consumer loans as higher-risk 
under the February rule, and would not be able to collect such data 
prior to filing their Call Reports for the June 30, 2011, report date. 
Commenters also stated that adapting current reporting systems to 
capture such loans automatically would, in some cases, be impossible 
and would require ongoing manual intervention, which is costly and 
burdensome.\25\
---------------------------------------------------------------------------

    \25\ These data availability concerns, particularly as they 
relate to institutions' existing loan portfolios, had not been 
raised as an issue during the rulemaking process on large bank 
pricing that culminated in the February rule.
---------------------------------------------------------------------------

    A group representing the industry also asserted that the definition 
of subprime loans does not correlate with more sophisticated risk-
grading systems generally used by banks internally. While these systems 
consider the factors included in the subprime definition, they consider 
these jointly rather than individually, and incorporate other 
information such as the size and type of delinquency and other measures 
of the borrower's debt capacity. As a consequence, the group believed 
that using the definition contained in the February rule would greatly 
overstate institutions' exposure to subprime loans and relative risk. 
In the group's view, this overstatement of exposure and relative risk 
could reduce credit or increase its cost for some types of consumers, 
such as students, since an institution factors the cost of assessments 
into its credit and pricing decisions.
    The proposed definition would better capture and differentiate 
higher-risk consumer loans and securities among banks compared to the 
current

[[Page 18114]]

definition. In addition, the proposal should be easier for institutions 
to adopt and implement as it more closely aligns with how they 
currently measure risk.
    This same industry group proposed an alternative definition of 
subprime consumer loans based on PD within one year from origination. 
Under the proposal, institutions would report the outstanding balance 
of consumer loans in their retail portfolios stratified by a specified 
number of products and PD bands. The FDIC has engaged in extensive 
discussions with industry representatives regarding this proposal and 
incorporated many of the proposal's major elements into the NPR.
    The FDIC chose to propose a two-year, instead of a one-year, PD in 
order to more closely align with the time horizon used by recognized 
third party vendors that produce standard validation charts. These 
charts include observed default rates over a specified two-year period 
by credit score and product type. If these charts were modified to 
conform to the PD estimation guidelines in Appendix C, institutions 
could use them to classify consumer loans under the proposed 
definition.
    A PD estimated according to the guidelines should reflect the 
average two-year, stress period performance of loans across a range of 
remaining maturities, as opposed to the performance of loans within the 
first two years of origination. The FDIC is concerned with potential 
default risk throughout the life of the loan and not just over the 
first two years following origination. By considering different 
origination time periods and various remaining maturities, the proposed 
approach should better represent the default risk throughout the life 
of the loan. Different product types tend to have different default 
profiles over time, with some products resulting in peak default rates 
sooner after origination than other products. An approach that 
considers various remaining maturities should mitigate the default 
timing bias between products following origination of a loan.
    The FDIC intends to collect two-year PD information on various 
types of consumer loans from large and highly complex institutions. 
However, the types of information collected and the format of the 
information collected on the Call Report would be subject to a PRA 
notice, providing an opportunity for comment, published in the Federal 
Register. The following table is an example of how the FDIC may collect 
the consumer loan information. Once the definition of higher-risk 
consumer loans is adopted in a final rule, the FDIC anticipates that 
appropriate changes to the Call Reports would be made and that 
institutions would report consumer loans according to the definition in 
the final rule. As suggested in the example table below and in Appendix 
1, institutions would report the outstanding amount of all consumer 
loans, including those with a PD below the subprime threshold, 
stratified by the 10 product types and 12 two-year PD bands.\26\ In 
addition, for each product type, institutions would indicate whether 
the PDs were derived using scores and default rate mappings provided by 
a third party vendor or an internal approach.\27\ Institutions would 
report the value of all securitizations that are more than 50 percent 
collateralized by higher-risk consumer loans (other than trading book) 
as a separate item.
---------------------------------------------------------------------------

    \26\ All reported amounts would exclude the maximum amounts 
recoverable from the U.S. government, its agencies, or government-
sponsored agencies under guarantee or insurance provisions, as well 
as loans that are fully secured by cash collateral. In order to 
exclude a loan based on cash collateral, the cash would be required 
to be in the form of a savings or time deposit held by the insured 
depository institution, the insured depository institution would be 
required to have a signed collateral assignment of the deposit 
account, which is irrevocable for the remaining term of the loan or 
commitment, and the insured depository institution would be required 
to place a hold on the deposit account, which alerts the 
institution's employees to an attempted withdrawal. In the case of a 
revolving line of credit, the cash collateral would have to be equal 
to or greater than the amount of the total loan commitment (the 
aggregate funded and unfunded balance of the loan) for the exclusion 
to apply.
    \27\ An internal approach would include the use of an 
institution's own default experience with a particular product and 
credit score, whether that score was provided by a third party or 
was internally derived.

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

[[Page 18115]]

[GRAPHIC] [TIFF OMITTED] TP27MR12.119

    The proposed 20 percent PD threshold was determined based on an 
evaluation of performance data provided by a couple of large third 
party vendors of consumer credit scores. Specifically, for each vendor, 
this data contained observed, two-year default rates and the proportion 
of consumer accounts captured by credit score and product type. Default 
rates were calculated in a manner similar to the guidelines in Appendix 
C. The FDIC considered the proportion of consumer accounts and range of 
scores that would be deemed higher-risk under different PD thresholds, 
overall and by product type, and how those results compare to score-
based definitions of subprime commonly used by the industry. The FDIC 
would use the information that would be included in the Call Report to 
determine whether the PD threshold should be changed in the future.\28\
---------------------------------------------------------------------------

    \28\ See 76 FR 10672, 10700 (February 25, 2011) (H. Updating the 
Scorecard).
---------------------------------------------------------------------------

    The FDIC anticipates that it may receive additional or updated 
information from third party vendors prior to the Board adopting a 
final rule. The FDIC would consider any additional information received 
before it proposes that a particular PD threshold be adopted in the 
final rule. In reviewing the PD threshold, the FDIC would use a 
methodology similar to the methodology described above. The methodology 
used would include consideration of the proportion of consumer accounts 
and range of scores that would be deemed higher risk under different PD 
thresholds and how those compare to score-based definitions of subprime 
commonly used in the industry.
    During discussions with the industry, a few institutions suggested 
that the FDIC have the flexibility to modify the time periods used for 
PD estimation without further notice-and-comment rulemaking. The 
institutions suggested that the FDIC could either change the time 
period considered or add additional time periods to the existing time 
period. The FDIC agrees that having the flexibility to modify the time 
periods, as part of the risk-based assessment system, would allow the 
FDIC to better differentiate risk among institutions. For example, a 
material change in consumer behavior or the development of new consumer 
products or default data might suggest changes to what should be 
considered a higher-risk consumer loan. Under these

[[Page 18116]]

circumstances, incorporating new or additional time periods might 
better capture either the changes in consumer behavior or new 
potentially higher-risk consumer products so that FDIC can better 
identify and measure emerging risks. The FDIC would also have, as part 
of the risk-based assessment system, the flexibility to increase or 
decrease the PD threshold of 20 for identifying higher-risk consumer 
loans to reflect the updated consumer default data from the different 
time periods selected without the necessity of further notice-and-
comment rulemaking. Before making changes to the established PD 
threshold, the FDIC would analyze resulting potential changes in the 
distribution of the higher-risk consumer loans and would consider the 
resulting effect on total deposit insurance assessments and risk 
differentiation among institutions. The FDIC would provide institutions 
with at least one quarter advance notice of any changes to the PD 
estimation time periods or the PD threshold. \29\
---------------------------------------------------------------------------

    \29\ Reporting all consumer loans by product and PD bands was 
part of the industry's proposal to strengthen identification of 
higher-risk consumer loans.
---------------------------------------------------------------------------

Nontraditional Mortgage Loans
    The proposal does not make changes to the definition of a 
nontraditional mortgage loan; however, it does clarify how 
securitizations of nontraditional mortgage loans would be identified 
under the current definition.\30\
---------------------------------------------------------------------------

    \30\ A securitization would be as defined in Appendix A, Section 
II(B)(16) of Part 325 of the FDIC's Rules and Regulations, as it may 
be amended from time to time.
---------------------------------------------------------------------------

    In a comment letter in response to the March and July PRA notices, 
three industry trade groups stated that the criteria outlined for 
identifying nontraditional mortgage loans in the February rule do not 
fully differentiate risk among banks or among nontraditional mortgage 
loans. The commenters maintained that not all nontraditional mortgage 
loans contain the same level of risk. The industry suggested that banks 
identify and report nontraditional mortgage loans by the PD within one 
year from origination as determined as of origination by a credit 
scoring system, similar to their recommendation for reporting subprime 
consumer loans.
    After reviewing the merits of the industry's suggestions, the FDIC 
has concluded that identifying a mortgage loan using a one-year PD 
would be inappropriate given the unique risks of nontraditional 
mortgage loans. Unlike leveraged loans and subprime loans, institutions 
have not indicated any difficulty complying with the existing 
definition of nontraditional mortgage loans and the FDIC believes that 
changes to the definition would not result in better risk determination 
for deposit insurance pricing purposes. The FDIC will monitor future 
rulemakings regarding Qualified Residential Mortgages and the capital 
treatment of nontraditional mortgage loans to determine whether any 
changes to the definition should be considered.
    Large and highly complex institutions are sophisticated investors 
and can typically obtain the information needed to determine whether a 
securitization meets the 50 percent threshold described above when they 
purchase interests in these securitizations. The proposal clarifies 
that an institution would be required to use information reasonably 
available to a sophisticated investor in reasonably determining whether 
a securitization meets the 50 percent threshold of the assets backing a 
securitization contain nontraditional mortgage loans.
    Information reasonably available to a sophisticated investor should 
include, but is not limited to, offering memorandums, indentures, 
trustee reports, and requests for information from servicers, 
collateral managers, issuers, trustees, or similar third parties. When 
determining whether a revolving trust or similar securitization would 
meet the threshold, an institution could use established criteria, 
model portfolios, or limitations published in the offering memorandum, 
indenture, trustee report or similar documents.
    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor. In such a 
case, the institution may exercise its judgment in making the 
determination. Nevertheless, the FDIC would retain the right to review 
and audit for compliance with the rule any determination that a 
securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated on 
the balance sheet as a result of SFAS 166 and SFAS 167, and a large 
institution or highly complex institution has access to the necessary 
information, an institution may evaluate individual loans in the 
securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset would 
be reported as a higher-risk asset and any loan within the 
securitization that does not meet the definition of a higher-risk asset 
would not be reported as such. When making this evaluation, the 
institution would have to follow the transition guidance described in 
Appendix C, Section C. Once an institution evaluated a securitization 
for higher-risk asset designation on a loan-by-loan basis, it would 
have to continue to evaluate all securitizations for which it has the 
required information in a similar manner (i.e., on a loan-by-loan 
basis). For a securitizations for which the institution does not have 
access to information on a loan-by-loan basis, the institution would be 
required to determine whether the securitization meets the 50 percent 
threshold as described previously for other securitizations.
    Under the proposal, institutions would also have to determine 
whether residential loans and securities meet the definition of a 
nontraditional mortgage loan as of origination, or, if the loan has 
been refinanced, as of refinance, subject to requirements similar to 
those proposed for higher-risk consumer loans.
    When an institution acquires a residential loan or security, it 
would have to determine whether the loan or security meets the 
definition of a nontraditional mortgage loan using the origination 
criteria and analysis performed by the original lender. If this 
information were unavailable, however, the institution would have to 
obtain recent, refreshed data from the borrower or other appropriate 
third-party.\31\
---------------------------------------------------------------------------

    \31\ Somewhat more stringent requirements would apply when an 
institution acquires loans or securities from another entity on a 
recurring or programmatic basis.
---------------------------------------------------------------------------

B. Evaluation of Higher-Risk Assets

    The FDIC proposes that institutions evaluate C&I and consumer loans 
as of origination and refinance to determine whether they meet the 
criteria for higher-risk assets. A loan that is determined to be both a 
higher-risk consumer and a nontraditional mortgage loan should be 
reported only as a nontraditional mortgage loan, not both.

C. Large Bank Adjustment Process

    The FDIC currently has the ability to adjust a large or highly 
complex institution's total score (which is used to determine its 
deposit insurance assessment rate) by a maximum of 15 points (the large 
bank adjustment).\32\ Because the proposed definitions should result in 
better risk identification and consistent application across the 
industry, the FDIC anticipates that there would be limited 
circumstances where the FDIC would consider a large bank adjustment as 
a result of perceived mitigants to an institution's higher-risk

[[Page 18117]]

concentration measure. The proposed revised definitions, which include 
specific exceptions for well-collateralized loans, should result in 
generally equal treatment of similar loans at different institutions.
---------------------------------------------------------------------------

    \32\ 76 FR 10714 (February 25, 2011) to be codified at 12 CFR 
327.9(b)(3).
---------------------------------------------------------------------------

D. Audit

    Several of the proposed changes could require periodic auditing to 
ensure consistent reporting across the industry. For example, the PD 
calculation, whether through credit score mapping or through an 
internal approach, if not properly monitored, could potentially result 
in inconsistent application. Also, institutions would need to carefully 
evaluate their controls for asset-based and floor plan lending to 
determine whether they can exclude these loans from their higher-risk 
C&I loans and securities totals. The FDIC expects institutions will 
have appropriate systems in place for the proper identification and 
reporting of higher-risk assets. Enhanced review procedures for higher-
risk asset reporting should be part of these systems. Institutions' 
higher-risk identification and reporting programs should include 
applicable policies, procedures, reviews, and validation (through 
internal or external audits). The results of any internal reviews or 
external audits of higher-risk assets reporting should be made 
available to the FDIC upon request. The FDIC may review and audit for 
compliance all determinations made by insured institutions for 
assessment purposes. The FDIC may also review specific details of an 
institution's reporting, including loans that are excluded from higher-
risk assets. Any weakness identified in the reporting of higher-risk 
assets may be considered when forming supervisory strategies or in the 
application of adjustments to an institution's total score as outlined 
in the Guidelines.

E. Updating the Scorecard

    As set forth in the February rule, the FDIC has the flexibility to 
update the minimum and maximum cutoff values used in each scorecard 
annually without further rulemaking as long as the method of selecting 
cut-off values remains unchanged.\33\ The FDIC can add new data for 
subsequent years to its analysis and can, from time to time, exclude 
some earlier years from its analysis. Updating the minimum and maximum 
cutoff values and weights allows the FDIC to use the most recent data, 
thereby improving the accuracy of the scorecard method.\34\
---------------------------------------------------------------------------

    \33\ 76 FR 10672, 10700 (February 25, 2011) (H. Updating the 
Scorecard).
    \34\ If, as a result of its review and analysis, the FDIC 
concludes that different measures should be used to determine risk-
based assessments, that the method of additional or alternative 
selecting cutoff values should be revised, that the weights assigned 
to the scorecard measures should be recalibrated, or that a new 
method should be used to differentiate risk among large institutions 
or highly complex institutions, changes would be made through a 
future rulemaking.
---------------------------------------------------------------------------

    The new definitions would allow the FDIC to better measure the risk 
present in large and highly-complex institutions, but they do not 
change that risk. Unless the FDIC re-calibrates cutoff values for the 
higher-risk assets to Tier 1 capital and reserves ratio, however, the 
proposed changes to the definitions of higher-risk assets could result 
in significant increases or decreases in the amount of total deposit 
insurance assessments collected from large and highly complex banks. 
Each scorecard measure, including the higher-risk assets to Tier 1 
capital and reserves ratio, is converted to a score between 0 and 100 
based upon minimum and maximum cutoff values for the measure (where the 
minimum and maximum cutoff values get converted to a score of 0 or 
100). Most of the minimum and maximum cutoff values represent the 10th 
and 90th percentile values for each measure, which are derived using 
data on large institutions over a ten-year period beginning with the 
first quarter of 2000 through the fourth quarter of 2009. Since the 
cutoff values for the higher-risk assets to Tier 1 capital and reserves 
ratio were calibrated using higher-risk assets data reported in 
accordance with an institution's existing methodology for identifying 
leveraged or subprime loans and securities, changing the definitions of 
these higher-risk assets may result in significant differences in the 
volume of higher-risk assets reported by institutions, and differences 
in the amount of deposit insurance assessments collected by the FDIC.
    The FDIC does not intend for the proposed changes in definitions to 
result in the FDIC collecting higher or lower deposit insurance 
assessment revenue from large and highly complex institutions as a 
whole (although it may result in individual institutions paying higher 
or lower deposit insurance assessments). Consequently, the FDIC 
anticipates that it may need to use its flexibility to update cutoff 
values to update the minimum and maximum cutoff values for the higher-
risk assets to Tier 1 capital and reserves ratio.\35\ Changes in the 
distribution of the higher-risk assets to Tier 1 capital and reserves 
ratio scores and the resulting effect on total assessments and risk 
differentiation between institutions would be taken into account in 
determining changes to the cutoffs. In addition, because the FDIC has 
not collected any data under the proposed definitions, changes to 
cutoff values for the higher-risk assets to Tier 1 capital and reserves 
ratio could be made more frequently than annually. This review would 
ensure proper risk differentiation between institutions.\36\
---------------------------------------------------------------------------

    \35\ 76 FR 10672, 10700 (February 25, 2011).
    \36\ The FDIC would provide large and highly-complex 
institutions with at least one quarter advance notice in their 
quarterly deposit insurance invoice of changes in the cutoff values 
to ensure that the industry can determine the effect that any 
changes may have on its assessments.
---------------------------------------------------------------------------

F. Implementation and Effective Date

    To allow time for institutions to implement systems to comply with 
the revised definitions, predicated on Call Report changes, the 
proposed amendments would become effective October 1, 2012. Because the 
FDIC is proposing no amendments to the definitions of construction and 
land development loans and nontraditional mortgage loans (other than to 
clarify how securitizations that meet the definition of a 
nontraditional mortgage loan are to be identified), the FDIC proposes 
that institutions continue to define and report these higher-risk 
assets as they have been doing under the February rule.
Transition Guidance Until Effective Date
    Prior to October 1, 2012, large institutions and highly complex 
institutions will continue to use the transition guidance for leveraged 
loans and subprime loans as outlined in the General Instructions 
(Instructions) for Schedule RC-O of the Consolidated Reports of 
Condition and Income, Memorandum items 6 through 15. The Instructions 
will be updated as of March 31, 2012 to reflect October 1, 2012 
(formerly April 1, 2012) as the date to begin identifying newly 
originated loans and securities according to the proposed definitions 
of these two higher-risk asset categories.
    This transition guidance provides that, for loans or securities 
originated or purchased before October 1, 2012, an institution may use 
either the definition in the February rule or continue to use its 
existing internal methodology for identifying loans and securities as 
leveraged or subprime for Schedule RC-O assessment reporting purposes. 
Institutions that do not have an existing methodology in place to 
identify loans and securities as leveraged or subprime

[[Page 18118]]

(because they are not required to report these exposures to their 
primary federal regulator for examination or other supervisory purposes 
or do not measure and monitor loans and securities with these 
characteristics for internal risk management purposes) may continue to 
apply existing guidance provided by their primary federal regulator, by 
the agencies' 2001 Expanded Guidance for Subprime Lending Programs, 
(for consumer loans and securities) or by the February 2008 
Comptroller's Handbook on Leveraged Lending (for C&I loans and 
securities).
Rules in Effect on the Effective Date and Thereafter
    Effective October 1, 2012, the proposed definitions described above 
would apply to:
    (1) All C&I loans and securities originated or purchased on or 
after October 1, 2012;
    (2) All consumer loans and securities, except securitizations of 
consumer loans and securities, whenever originated or purchased;
    (3) All residential real estate loans and securities, except 
securitizations of residential real estate loans, whenever originated 
or purchased; and
    (4) All securitizations of C&I, consumer, and residential real 
estate loans originated or purchased on or after October 1, 2012.
    For consumer and residential real estate loans and securities 
(other than securitizations) originated or purchased prior to October 
1, 2012, an institution would have to determine whether the loan or 
security met the definition of a higher-risk consumer loan or security 
no later than December 31, 2012, using information as of the date of 
the origination of the loan or security if the institution had that 
information.\37\ If the institution did not have that information, it 
would have to use refreshed data to determine whether a loan or 
security met the definition. Refreshed data would be defined as the 
most recent data available as if the loan or security were being 
originated in the fourth quarter of 2012. In all instances, the 
refreshed data used would have to be as of July 1, 2012 or later.
---------------------------------------------------------------------------

    \37\ Institutions had to determine whether loans and securities 
originated or purchased prior to October 1, 2012, met the definition 
of a construction and land development loan or a nontraditional 
mortgage loan in time to file accurate reports of condition as of 
June 30, 2012, and September 30, 2012.
---------------------------------------------------------------------------

    For C&I loans and securities originated or purchased before October 
1, 2012, and all securitizations originated or purchased before October 
1, 2012, institutions would be required to either continue to use their 
existing internal methodology or existing guidance provided by their 
primary federal regulator or use the proposed definitions to determine 
whether to include the loan, security or securitization as a 
concentration in a risk area for purposes of the higher-risk assets to 
Tier 1 capital and reserves ratio.

III. Request for Comments

    The FDIC seeks comment on every aspect of this proposed rule. In 
particular, the FDIC seeks comment on the questions set out below. The 
FDIC asks commenters to include specific reasons for their positions.

1. Deposit Insurance Pricing Definitions

    a. Is the collateral test in the higher-risk C&I loans and 
securities definition appropriately specified?
    b. Is the purpose test in the higher-risk C&I loans and securities 
definition appropriately specified?
    c. Can institutions identify and report C&I loans as higher-risk?
    d. Is the definition of material appropriate?
    e. Should other risk measures, besides PD, be considered to define 
higher-risk consumer loans and securities?
    f. Can institutions report all of their consumer loans into the 
proposed products and PD bands?
    g. Is the proposed PD level of 20 appropriate to identify higher-
risk consumer loans?
    h. Is the definition of refinance appropriate?
    i. Are all definitions clear and are institutions able to implement 
the definitions as proposed?

2. Regulatory Matters

    a. What are the costs and what is the extent of regulatory burden 
of the proposal compared to the February rule?
    b. Will the new effective date for the transition guidance (October 
1, 2012) allow institutions sufficient time to update systems to 
accurately identify and report higher-risk assets as defined in the 
proposed definitions? If not, what date should the transition guidance 
be extended to?
    c. Are the requirements in the proposed regulation clearly stated? 
If not, how could the regulation be more clearly stated?
    d. Does the proposed regulation contain language that is not clear? 
If so, which language requires clarification?
    e. Large institutions and highly-complex institutions would be 
required to define their higher-risk assets as outlined in Appendix C. 
Is the direction and language used in Appendix C clear?

IV. Regulatory Analysis and Procedure

A. Solicitation of Comments on Use of Plain Language

    Section 722 of the Gramm-Leach-Bliley Act, Public Law 106-102, 113 
Stat. 1338, 1471 (Nov. 12, 1999), requires the federal banking agencies 
to use plain language in all proposed and final rules published after 
January 1, 2000. The FDIC invites your comments on how to make this 
proposal easier to understand. For example:
     Are the requirements in the proposed regulation clearly 
stated? If not, how could the regulation be more clearly stated?
     Does the proposed regulation contain 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?
     What else could the FDIC do to make the regulation easier 
to understand?

B. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA) requires that each federal 
agency either certify that a proposed rule would not, if adopted in 
final form, have a significant economic impact on a substantial number 
of small entities or prepare an initial regulatory flexibility analysis 
of the rule and publish the analysis for comment.\38\ For RFA purposes 
a small institution is defined as one with $175 million or less in 
assets.
---------------------------------------------------------------------------

    \38\ See 5 U.S.C. 603, 604 and 605.
---------------------------------------------------------------------------

    As of September 30, 2011, of the 7,436 insured commercial banks and 
savings associations, there were 3,989 small insured depository 
institutions, as that term is defined for purposes of the RFA. The 
proposed rule, however, would apply only to institutions with $10 
billion or greater in total assets. Consequently, small institutions 
for purposes of the RFA will experience no significant economic impact 
should the FDIC implement the proposal in a final rule.

C. Paperwork Reduction Act

    No collections of information pursuant to the Paperwork Reduction 
Act of 1995, 44 U.S.C. 3501-3521 (PRA), are contained in the proposed 
rule.

[[Page 18119]]

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

    The FDIC has determined that the proposed rule will not affect 
family well-being within the meaning of section 654 of the Treasury and 
General Government Appropriations Act, enacted as part of the Omnibus 
Consolidated and Emergency Supplemental Appropriations Act of 1999 
(Pub. L. 105-277, 112 Stat. 2681).

List of Subjects in 12 CFR Part 327

    Bank deposit insurance, Banks, Savings associations.

    For the reasons set forth above, the FDIC proposes to amend 12 CFR 
part 327 as follows:

PART 327--ASSESSMENTS

    1. The authority citation for part 327 continues to read as 
follows:

    Authority: 12 U.S.C. 1441, 1813, 1815, 1817-19, 1821.

    2. Revise appendix C to subpart A of part 327 to read as follows:

Appendix C to Subpart A to Part 327--Concentration Measures

    The concentration score for large institutions is the higher of 
the higher-risk assets to Tier 1 capital and reserves score or the 
growth-adjusted portfolio concentrations score. The concentration 
score for highly complex institutions is the highest of the higher-
risk assets to Tier 1 capital and reserves score, the Top 20 
counterparty exposure to Tier 1 capital and reserves score, or the 
largest counterparty to Tier 1 capital and reserves score. The 
higher-risk assets to Tier 1 capital and reserves ratio and the 
growth-adjusted portfolio concentration measure are described below.

A. Higher-Risk Assets/Tier 1 Capital and Reserves

    The higher-risk assets to Tier 1 capital and reserves ratio is 
the sum of the concentrations in each of four risk areas described 
below and is calculated as:
[GRAPHIC] [TIFF OMITTED] TP27MR12.120

Where:

    Hi is institution i's higher-risk concentration measure and k is 
a risk area.\1\ The four risk areas (k) are construction and land 
development loans, higher-risk commercial and industrial (C&I) loans 
and securities, higher-risk consumer loans and securities, and 
nontraditional mortgage loans.
---------------------------------------------------------------------------

    \1\ The higher-risk concentration ratio is rounded to two 
decimal points.
---------------------------------------------------------------------------

    1. Construction and land development loans include construction 
and land development loans outstanding and unfunded commitments to 
fund construction and land development loans, whether revocable or 
irrevocable.\2\
---------------------------------------------------------------------------

    \2\ Construction and land development loans are as defined in 
the instructions to Call Report schedule RC-C Part I--Loans and 
Leases, as they may be amended from time to time, and include items 
reported on line items RC-C 1.a.1 (1-4 family residential 
construction loans), RC-C 1.a.2. (Other construction loans and all 
land development and other land loans), and RC-O M.10.a (Total 
unfunded commitments to fund construction, land development, and 
other land loans secured by real estate), and exclude RC-O M.10.b 
(Portion of unfunded commitments to fund construction, land 
development and other loans that are guaranteed or insured by the 
U.S. government, including the FDIC), RC-O M.13.a (Portion of funded 
construction, land development, and other land loans guaranteed or 
insured by the U.S. government, excluding FDIC loss sharing 
agreements), RC-M 13a.1.a.1 (1-4 family construction and land 
development loans covered by loss sharing agreements with the FDIC), 
and RC-M 13a.1.a.2 (Other construction loans and all land 
development loans covered by loss sharing agreements with the FDIC).
---------------------------------------------------------------------------

    2. Higher-risk commercial and industrial (C&I) loans and 
securities include:
     Any commercial loan (funded or unfunded, including 
irrevocable and revocable commitments) owed by a borrower to the 
evaluating depository institution with an original amount greater 
than $5 million if the conditions specified in (a) or (b) below are 
met as of origination, or, if the loan has been refinanced, as of 
refinance, and the loan does not meet the asset based lending (ABL) 
exclusion or the floor plan line of credit exclusion (defined 
below).3 4
---------------------------------------------------------------------------

    \3\ Commercial loans are as defined as commercial and industrial 
loans in the instructions to Call Report Schedule RC-C Part I--Loans 
and Leases, as they may be amended from time to time. An overdraft 
is a higher-risk C&I loan or security, provided the overdraft is 
extended to a company and not an individual and it otherwise meets 
the Call Report definition of a C&I loan.
    \4\ Unfunded commitments are defined as unused commitments, as 
this term is defined in the instructions to Call Report Schedule RC-
L, Derivatives and Off-Balance Sheet Items, as they may be amended 
from time to time.
---------------------------------------------------------------------------

    (a)(i) The purpose of any of the borrower's debt \5\ (whether 
owed to the evaluating insured depository institution or another 
lender) that was incurred within the previous seven years was to 
finance a buyout (e.g., to fund an equity buyout or fund an Employee 
Stock Ownership Plan (ESOP)), acquisition (e.g., merger or tender 
offer), or capital distribution (e.g., dividends, stock repurchase, 
or cash-out) and such debt was material as defined below; and
---------------------------------------------------------------------------

    \5\ As used in this definition of higher-risk C&I loans and 
securities, debt includes all forms of obligation and liability, 
including loans and securities.
---------------------------------------------------------------------------

    (ii) The ratio of the borrower's total debt to trailing twelve-
month EBITDA (i.e., operating leverage ratio) is greater than 4 or 
the ratio of the borrower's senior debt to trailing twelve-month 
EBITDA (i.e., operating leverage ratio) is greater than 3; or
    (b) Any of the borrower's debt (whether owed to the evaluating 
institution or another lender) is designated as a highly leveraged 
transaction (HLT) by a syndication agent.
     All securities held by the evaluating institution that 
are issued by a commercial borrower, if the conditions specified in 
(a) or (b) above are met, except securities classified as trading 
book; and
     All securitizations held by the evaluating institution 
that are more than 50 percent collateralized by commercial loans or 
securities that would meet the foregoing higher-risk C&I loans and 
securities definition if directly held by the evaluating 
institution, except securities classified as trading book.\6\
---------------------------------------------------------------------------

    \6\ A securitization is defined in Appendix A, Section II(B)(16) 
of Part 325 of the FDIC's Rules and Regulations, as it may be 
amended from time to time.
---------------------------------------------------------------------------

    Institutions must determine whether C&I loans and securities 
meet the definition of a higher-risk C&I loan and security as of 
origination, or, if the loan has been refinanced, as of refinance, 
as discussed in Section A of this Appendix. When an institution 
acquires a C&I loan or security, it must determine whether the loan 
or security meets the definition of a higher-risk C&I loan or 
security using the origination criteria and analysis performed by 
the original lender. If this information is unavailable, the 
institution must obtain refreshed data from the borrower or other 
appropriate third-party. Refreshed data for C&I loans and securities 
is defined as the most recent data available. However, the data must 
be as of a date that is no earlier than one year before the 
acquisition of the C&I loan or security. The acquiring institution 
must also determine whether an acquired loan or securitization is 
higher risk as soon as reasonably practicable, but not later than 
one year after acquisition.
    However, when an institution acquires loans or securities from 
another entity on a recurring or programmatic basis, the acquiring 
institution may determine whether the loan or security meets the 
definition of a higher-risk C&I loan or security using the 
origination criteria and analysis performed by the original lender 
only if the acquiring institution verifies the information 
provided.\7\ Otherwise, the acquiring institution must obtain the 
necessary information from the borrower or other appropriate third 
party to make its own

[[Page 18120]]

determination of whether the acquired assets should be classified as 
a higher-risk C&I loan and security. If the financial information is 
not available as of the origination date or refinance, the 
institution must obtain refreshed data from the borrower or other 
appropriate third-party. Refreshed data for C&I loans or securities 
acquired on a recurring or programmatic basis is defined as the most 
recent data available, and in any case, the refreshed data used must 
be as of a date that is no earlier than three months before the 
acquisition of the C&I loan or security. The acquiring institution 
must also determine whether a loan or securitization acquired on a 
recurring or programmatic basis is higher risk as soon as is 
practicable, but not later than three months after the date of 
acquisition.
---------------------------------------------------------------------------

    \7\ Loans or securities acquired from another entity are 
acquired on a recurring basis if an institution has acquired other 
loans or securities from that entity at least once within the 
calendar year or the previous calendar year of the acquisition of 
the loans or securities in question.
---------------------------------------------------------------------------

    Higher-risk C&I loans and securities include purchased credit 
impaired loans that meet the definition of higher-risk C&I loans and 
exclude the following:
     Residential, commercial or farmland loans secured by 
real estate;
     Loans to finance agricultural production;
     Loans to equity REITS;
     Lease financing receivables;
     Loans to individuals for commercial, industrial, or 
professional purposes;
     Loans to foreign governments and official institutions;
     Obligations of states and political subdivisions of the 
U.S.;
     Loans to depository and nondepository financial 
institutions;
     The maximum amount of any loan that is recoverable from 
the U.S. government, its agencies, or government-sponsored agencies 
under guarantee or insurance provisions;
     Loans that are fully secured by cash collateral, 
provided that the cash is in the form of a savings or time deposit 
held by the insured depository institution, the insured depository 
institution has in place a collateral assignment of the deposit 
account signed by the borrower, the assignment is irrevocable as 
long as the loan or commitment is outstanding, and a hold is placed 
on the deposit account that alerts the institution's employees to an 
attempted withdrawal; in the case of a revolving line of credit, the 
cash collateral must be equal to or greater than the amount of the 
total loan commitment (the aggregate funded and unfunded balance of 
the loan);

C&I loans that are secured by liquid assets other than cash are not 
excluded from the higher-risk loan designation.

    An institution must use the information reasonably available to 
a sophisticated investor in reasonably determining whether a 
securitization meets the 50 percent threshold. Information 
reasonably available to a sophisticated investor includes, but is 
not limited to, offering memorandums, indentures, trustee reports, 
and requests for information from servicers, collateral managers, 
issuers, trustees, or similar third parties. When determining 
whether a revolving trust or similar securitization meets the 50 
percent threshold, an institution may use established criteria, 
model portfolios, or limitations published in the offering 
memorandum, indenture, trustee report or similar documents.
    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor. In such a 
case, the institution may exercise judgment in making its 
determination. Generally, the FDIC may review and audit for 
compliance all determinations made by insured depository 
institutions for assessment purposes, including a determination that 
a securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated 
on the balance sheet as a result of SFAS 166 and SFAS 167, and a 
large institution or highly complex institution has access to the 
necessary information, an institution may evaluate individual loans 
in the securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset must 
be reported as a higher-risk asset and any loan within the 
securitization that does not meet the definition of a higher-risk 
asset need not be reported as such. When making this evaluation, the 
institution must follow the transition guidance described in 
Appendix C, Section C. Once an institution evaluates a 
securitization for higher-risk asset designation on a loan-by-loan 
basis, it must continue to evaluate all securitizations for which it 
has the required information in a similar manner (i.e., on a loan-
by-loan basis). For securitizations for which the institution does 
not have access to information on a loan-by-loan basis, the 
institution must determine whether the securitization meets the 50 
percent threshold.

Definition of Terms Used Within the Definition of Higher-Risk C&I Loans 
and Securities

    An acquisition means the purchase by the borrower of any equity 
interest in another company or the purchase of any of the assets and 
liabilities of another company.
    A buyout means the issuance of debt to finance the purchase or 
repurchase by the borrower of the borrower's outstanding equity. A 
buyout could include, but is not limited to, an equity buyout or 
funding of an ESOP.
    A capital distribution means that the borrower incurs debt to 
finance a dividend payment or to finance other transactions designed 
to enhance shareholder value, such as repurchase of stock.
    For purposes of the definition of a higher-risk C&I loan and 
security, a debt is material if it results in a 20 percent or 
greater increase any time within 12 months in the total funded debt 
of the borrower (including all funded debt assumed, created or 
refinanced). Debt is also material if, before the debt was incurred, 
the borrower had no funded debt.
    When calculating either of the borrower's operating leverage 
ratios, the only permitted EBITDA adjustments are those specifically 
permitted for that borrower at the time of underwriting and only 
funded amounts of lines of credit must be considered debt.
    The debt-to-EBITDA ratio must be calculated using the 
consolidated financial statements of the borrower unless the loan is 
to a subsidiary of a larger organization. In that case, the ratio 
may be calculated using consolidated financial statements of the 
parent company provided that the parent company and all of its major 
operating subsidiaries have unconditionally and irrevocably 
guaranteed the borrower's debt to the reporting large institution or 
highly complex institution.
    In the case of a merger of two companies or the acquisition of 
one or more companies or parts of companies, the pro-forma debt is 
to be used as well as the trailing twelve-month pro-forma EBITDA for 
the combined companies. When calculating the trailing pro-forma 
EBITDA for the combined company, no adjustments are allowed for 
economies of scale or projected cost savings that may be realized 
subsequent to the acquisition unless specifically permitted for that 
borrower under the loan agreement.
    The original amount of the loan is defined as:
    (1) For loans drawn down under lines of credit or loan 
commitments, the amount of the line of credit or loan commitment on 
the date of its most recent approval, extension or renewal prior to 
the date of the most recent Call Report. If the amount currently 
outstanding as of the date of the most recent Call Report exceeds 
this amount, then the original amount is the amount outstanding as 
of the Call Report date.
    (2) For loan participations and syndications, the original 
amount of the loan participation or syndication is the total amount 
of the credit originated by the lead lender.
    (3) For all other loans, the original amount is the total amount 
of the loan as of origination or the amount outstanding as of the 
Call Report date, whichever is larger.
    Multiple loans to one borrower are to be aggregated to the 
extent that the institution's loan data systems can do so without 
undue cost. If the cost is excessive, the institution may treat 
multiple loans to one borrower as separate loans.
    The purpose of the borrower's debt for purposes of meeting the 
definition of higher-risk C&I loans is determined at the time the 
debt was incurred by the borrower.
    A securitization is as defined in Appendix A, Section II(B)(16) 
of Part 325 of the FDIC's Rules and Regulations, as it may be 
amended from time to time.
    Senior debt includes any portion of total debt that has a 
priority claim on any of the borrower's assets. A priority claim is 
a claim that entitles the holder to priority of payment over other 
debt holders in bankruptcy.
    Total debt is defined as all interest-bearing financial 
obligations and includes, but is not limited to, overdrafts, 
borrowings, repurchase agreements (repos), trust receipts, bankers 
acceptances, debentures, bonds, loans (including those secured by 
mortgages), sinking funds, capital (finance) lease obligations 
(including those obligations that are convertible, redeemable or 
retractable), mandatory redeemable preferred and trust preferred 
securities accounted for as liabilities in accordance with ASC 
Subtopic 480-10, Distinguishing Liabilities from Equity--Overall 
(formerly FASB Statement No. 150, ``Accounting for Certain Financial 
Instruments with Characteristics of both

[[Page 18121]]

Liabilities and Equity''), and subordinated capital notes. Total 
debt excludes pension obligations, deferred tax liabilities and 
preferred equity.

Asset-Based Lending Exclusion

    Asset-based loans that meet certain conditions are excluded from 
an institution's higher-risk C&I loan totals. An excluded asset-
based loan is defined as any loan, new or existing, in which all of 
the following conditions are present:
     The loan is managed by a lender or group of lenders 
with experience in asset-based lending and collateral monitoring, 
including, but not limited to, experience in reviewing the 
following: Collateral reports, borrowing base certificates,\8\ 
collateral audit reports, loan to collateral values, and loan 
limits, using procedures common to the industry.\9\
---------------------------------------------------------------------------

    \8\ Borrowing base certificates are defined in Appendix C, 
Section D.
    \9\ Guidelines that address acceptable industry-standard 
controls over asset based lending are included in Appendix C, 
Section D. Loans must adhere to these guidelines to be eligible for 
the ABL exclusion.
---------------------------------------------------------------------------

     The insured depository institution has taken, or has 
the legally enforceable unconditional ability to take, dominion of 
cash through account control agreements over the borrower's 
depository accounts such that proceeds of collateral are applied to 
the loan balance as collected.
     The insured depository institution has a perfected 
first priority security interest in all assets included in the 
borrowing base certificate.
     If the loan is a credit facility (revolving or term 
loan), it must be fully secured by self-liquidating assets such as 
accounts receivable and inventory.\10\ Fully secured is defined as a 
100 percent or lower loan-to-value ratio after applying the 
appropriate discounts (determined by the loan agreement) to the 
collateral. For purposes of calculating the ratio, a revolving loan 
amount is the amount of the loan if fully drawn to the maximum 
permitted borrowing base.
---------------------------------------------------------------------------

    \10\ An asset is self-liquidating if, in the event the borrower 
defaults, the asset can be easily liquidated and the proceeds of the 
sale of the assets would be used to pay down the loan. These assets 
can include machinery, heavy equipment or rental equipment if the 
machinery or equipment is inventory for the borrower's primary 
business and the machinery or equipment is included in the borrowing 
base.
---------------------------------------------------------------------------

     Advance rates on accounts receivable should generally 
not exceed 75 percent to 85 percent of eligible receivables and 65 
percent of eligible inventory and the bank's lending policy should 
address maintenance of an accounts receivable and inventory loan 
agreement that includes the items detailed in the Accounts 
Receivable and Automobile Dealer Floor Plan Lending Guidance 
included in Section D of this Appendix.
     Assets must be valued or appraised by an independent 
third-party appraiser using net orderly liquidation value (NOLV), 
fair value, or forced sale value (versus a ``going concern'' value), 
whichever is appropriate, to arrive at a net realizable value. 
Appraisals are to be prepared in accordance with industry standards.
     The insured depository institution must maintain 
documentation of borrowing base certificate reviews and collateral 
trend analyses to demonstrate that collateral values are actively, 
routinely and consistently monitored. A new borrowing base 
certificate is required at each draw or advance on the loan. At the 
time of each draw the insured depository institution must validate 
the assets that compose the borrowing base certificate (by 
requesting from the borrower a listing of accounts receivable by 
creditor and a listing of individual pieces of inventory) and 
certify that the outstanding balance of the loan remains within the 
collateral formula prescribed by the loan agreement. Borrowing base 
reporting must be performed and validated (through asset-based 
tracking reports) at least on a monthly basis and supplemented by 
periodic, but no less than annual, field examinations (audits) to be 
performed by individuals who are independent of the credit 
origination or administration process. There must be a process in 
place to ensure that the insured depository institution is 
correcting audit exceptions.
    The FDIC retains the authority to verify that institutions are 
in compliance with sound internal controls and administration 
practices for asset based loans, as discussed in Section D of this 
Appendix. Generally, the FDIC may review and audit for compliance 
all determinations made by insured depository institutions for 
assessment purposes, including the exclusion of an asset based loan 
from an institution's reported higher-risk C&I loans and securities 
totals.

Floor Plan Lines of Credit Exclusion

    Floor plan loans that meet certain conditions are excluded from 
an institution's higher-risk loan totals. An excluded automotive 
dealer floor plan loan is defined as any loan, new or existing, used 
to finance the purchase of automobile inventory by an automotive 
dealer in which all of the following conditions are present:
     The loan is managed by a lender or group of lenders 
experienced in automobile dealer floor plan lending and monitoring 
collateral to ensure the borrower remains in compliance with floor 
plan limits and repayment requirements. Lenders should have 
experience in reviewing certain items, including but not limited to: 
Collateral reports, floor plan limits, floor plan aging reports, 
automobile inventory audits or inspections, and loan-to-collateral 
value (LTV) ratios. The insured depository institution must obtain 
and review audited financial statements of the borrower on an annual 
basis to ensure that adequate controls are in place.\11\
---------------------------------------------------------------------------

    \11\ Additional guidelines covering acceptable industry-standard 
controls over automobile dealer floor plan lending are included in 
Appendix C, Section D. Loans must also adhere to these guidelines to 
be eligible for the floor plan line of credit exclusion.
---------------------------------------------------------------------------

     Each loan advance is made against a specific automobile 
or under a borrowing base certificate held as collateral at no more 
than 100 percent of (i) dealer invoice plus freight charges (for new 
vehicles) or (ii) the cost of a used vehicle at auction or the 
wholesale value (using the prevailing market guide, e.g., NADA, 
Black Book, Blue Book). Permissible advance rates depend upon the 
types of risk mitigation systems the insured depository institution 
has in place for a particular credit facility. The advance rate of 
100 percent of dealer invoice plus freight charges on new vehicles 
and the advance rate of the cost of a used vehicle at auction or the 
wholesale value may only be used where there is a manufacturer 
repurchase agreement or an aggressive curtailment program in place 
that is tracked by the institution over time and subject to strict 
controls.
     Each loan is self liquidating (i.e., if the borrower 
defaulted on the loan, the collateral could be easily liquidated and 
the proceeds of the sale of the collateral would be used to pay down 
the loan advance).
     Vehicle inventories and collateral values are closely 
monitored, including the completion of regular (at least quarterly) 
dealership automotive inventory audits or inspections to ensure 
accurate accounting for all vehicles held as collateral. Floor plan 
aging reports must be reviewed by the institution. Curtailment 
programs should be instituted where necessary and institutions must 
ensure that curtailment payments are made on stale automotive 
vehicle inventory financed under the floor plan loan.\12\
---------------------------------------------------------------------------

    \12\ Curtailment programs ensure that the lender receives 
regular principal payments on floor plan loans in situations where 
the underlying collateral is not selling as quickly as expected. 
Under such programs, when vehicles that serve as collateral on a 
floor plan loan do not sell within a reasonable and specific 
timeframe, the borrower is required to begin repaying the lender a 
certain dollar amount (to be determined by the loan agreement) on a 
monthly or quarterly basis.
---------------------------------------------------------------------------

    The FDIC retains the authority to verify that institutions are 
in compliance with sound internal controls and administration 
practices for floor plan loans, as discussed in Section D of this 
Appendix. Generally, the FDIC may review and audit for compliance 
all determinations made by insured depository institutions for 
assessment purposes, including the exclusion of a floor plan loan 
from an institution's reported higher-risk C&I loans and securities 
totals.
    3. Higher-risk consumer loans and securities are defined as:
    (a) All consumer loans where, as of origination, or, if the loan 
has been refinanced, as of refinance, the probability of default 
(PD) within two years (the two-year PD) was greater than 20 percent, 
excluding those consumer loans that meet the definition of a 
nontraditional mortgage loan; and
    (b) all securitizations that are more than 50 percent 
collateralized by consumer loans meeting the criteria in (a), except 
those classified as trading book.\13\
---------------------------------------------------------------------------

    \13\ A securitization is defined in Appendix A, Section 
II(B)(16) of Part 325 of the FDIC's Rules and Regulations, as it may 
be amended from time to time.
---------------------------------------------------------------------------

    Institutions must determine whether consumer loans meet the 
definition of a higher-risk consumer loan as of origination, or, if 
the loan has been refinanced, as of refinance, as discussed in 
Section A of this Appendix. The two-year PD must be

[[Page 18122]]

estimated using an approach that conforms to the requirements 
detailed below. When an institution acquires a consumer loan or 
security, it must determine whether the loan or security meets the 
definition of a higher-risk consumer loan or security using the 
origination criteria and analysis performed by the original lender. 
If this information is unavailable, the institution must obtain 
refreshed data from the borrower or other appropriate third-party. 
Refreshed data for consumer loans and securities is defined as the 
most recent data available. However, the data must be as of a date 
that is no earlier than three months before the acquisition of the 
consumer loan or security. The acquiring institution must also 
determine whether an acquired loan or securitization is higher risk 
as soon as reasonably practicable, but not later than three months 
after acquisition.
    However, when an institution acquires loans or securities from 
another entity on a recurring or programmatic basis, the acquiring 
institution may determine whether the loan or security meets the 
definition of a higher-risk consumer loan or security using the 
origination criteria and analysis performed by the original lender 
only if the acquiring institution verifies the information 
provided.\14\ Otherwise, the acquiring institution must obtain the 
necessary information from the borrower or other appropriate third 
party to make its own determination of whether the purchased assets 
should be classified as a higher-risk consumer loan and security. If 
the financial information is not available as of the origination 
date or refinance, the institution must obtain refreshed data from 
the borrower or other appropriate third-party. Refreshed data for 
consumer loans or securities acquired on a recurring or programmatic 
basis is defined as the most recent data available, and in any case, 
the refreshed data used must be as of a date that is no earlier than 
three months before the acquisition of the consumer loan or 
security. The acquiring institution must also determine whether a 
loan or securitization acquired on a recurring or programmatic basis 
is higher risk as soon as is practicable, but not later than three 
months after the date of acquisition.
---------------------------------------------------------------------------

    \14\ Loans or securities acquired from another entity are 
acquired on a recurring basis if an institution has acquired other 
loans or securities from that entity at least once within the 
calendar year of the acquisition of the loans or securities in 
question or the previous calendar year.
---------------------------------------------------------------------------

    Higher-risk consumer loans include purchased credit-impaired 
loans that meet the definition of higher-risk consumer loans and 
exclude the maximum amounts recoverable from the U.S. government, 
its agencies, or government-sponsored agencies under guarantee or 
insurance provisions, and loans that are fully secured by cash 
collateral, provided that the cash collateral is in the form of a 
savings or time deposit held by the insured depository institution. 
In the case of a revolving line of credit, the cash collateral must 
be equal to or greater than the amount of the total loan commitment 
(the aggregate funded and unfunded balance of the loan). Loans that 
are fully secured by savings and time deposits are not higher-risk 
consumer loans, provided that the insured depository institution has 
in place a collateral assignment of the deposit account signed by 
the borrower, the assignment is irrevocable as long as the term or 
commitment is outstanding, and a hold is placed on the deposit 
account that alerts the institution's employees to an attempted 
withdrawal. Consumer loans that are secured by liquid assets other 
than cash are not excluded from the higher-risk consumer loan 
definition.
    A loan that meets both the nontraditional mortgage loan and 
higher-risk consumer loan and security definitions at the time of 
origination, or, if the loan has been refinanced, as of refinance, 
must be reported only as a nontraditional mortgage loan. However, if 
the loan ceases to meet the nontraditional mortgage loan definition 
but continues to meet the definition of a higher-risk consumer loan 
and security, the loan is to be reported as a higher-risk consumer 
loan and security.
    An institution must use the information that is reasonably 
available to a sophisticated investor in reasonably determining 
whether a securitization meets the 50 percent threshold. Information 
reasonably available to a sophisticated investor includes, but is 
not limited to, offering memorandums, indentures, trustee reports, 
and requests for information from servicers, collateral managers, 
issuers, trustees, or similar third parties. When determining 
whether a revolving trust or similar securitization meets the 
threshold, an institution may use established criteria, model 
portfolios, or limitations published in the offering memorandum, 
indenture, trustee report or similar documents.
    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor, and, in 
such a case, the institution may exercise judgment in making its 
determination. Generally, the FDIC may review and audit for 
compliance all determinations made by insured depository 
institutions for assessment purposes, including a determination that 
a securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated 
on the balance sheet as a result of SFAS 166 and SFAS 167, and a 
large institution or a highly complex institution has access to the 
necessary information, an institution may evaluate individual loans 
in the securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset must 
be reported as a higher-risk asset and any loan within the 
securitization that does not meet the definition of a higher-risk 
asset need not be reported as such. When making this evaluation, the 
institution must follow the transition guidance described in 
Appendix C, Section C. Once an institution evaluates a 
securitization for higher-risk asset designation on a loan-by-loan 
basis, it must continue to evaluate all securitizations for which it 
has the required information in a similar manner (i.e., on a loan-
by-loan basis). For securitizations for which the institution does 
not have access to information on a loan-by-loan basis, the 
institution must determine whether the securitization meets the 50 
percent threshold.

Requirements for PD Estimation

    Estimates of the two-year PD for a loan must be based on the 
observed, stress period default rate for loans of a similar product 
type made to consumers with credit risk comparable to the borrower 
being evaluated. The credit risk assessment must be determined using 
third party or internal scores derived using a scoring system that 
qualifies as empirically derived, demonstrably and statistically 
sound as defined in 12 CFR 202.2(p)(2011), and has been approved by 
the bank's model risk oversight and governance process and internal 
audit mechanism. In the case of a consumer loan with a co-signer or 
co-borrower, the PD may be determined using the most favorable 
individual credit score. In estimating the PD based on such scores, 
institutions must adhere to the following requirements:
    (1) The PD must be estimated as the average of the two, 24-month 
default rates observed from July 2007 to June 2009, and July 2009 to 
June 2011, where the average is calculated according to the 
following formula and DRt is the observed default rate 
over the 24-month period beginning in July of year t:
[GRAPHIC] [TIFF OMITTED] TP27MR12.121

    (2) The default rate for each 24-month period must be calculated 
as the number of active loans that experienced at least one default 
event during the period divided by the total number of active loans 
as of the observation date (i.e., the beginning of the period). A 
loan is considered active if it was open and not in default as of 
the observation date and had a positive balance any time within the 
12 months prior to the observation date.
    (3) The default rate for each 24-month period must be calculated 
using a stratified random sample of loans that is sufficient in size 
to derive statistically meaningful results for the product type and 
credit score being evaluated. The product strata must be as 
homogenous as possible with respect to the factors that influence 
default, such that products with distinct risk characteristics are 
evaluated separately. The loans should be sampled based on the 
credit score as of the observation date and, for any single product 
and credit score group, the sample size must be no less than 1,200 
loans.
    Credit score strata must be determined by partitioning the score 
range into a minimum of 15 bands. While the width of the credit 
score bands may vary, the scores within each band must reflect a 
comparable level of credit risk. However, since performance data for 
scores at the upper and lower extremes of the population 
distribution is likely to be limited, the top and bottom bands may 
include a range of scores that suggest some variance in credit 
quality.
    When the number of score bands is less than the number of credit 
scores represented in the population, an observed default rate for 
some scores will not be available. In that case, institutions must 
estimate the default rate for a particular score using a linear

[[Page 18123]]

interpolation between adjacent, observed default rates, where the 
observed default rate is assumed to correspond with the score at the 
midpoint of the range for the band. For example, if one score band 
ranges from 621 to 625 and has an observed default rate of 4 
percent, while the next lowest band ranges from 616 to 620 and has 
an observed default rate of 6 percent, a 620 score must be assigned 
a default rate of 5.2 percent, calculated as
[GRAPHIC] [TIFF OMITTED] TP27MR12.122

    When evaluating scores that fall below the midpoint of the 
lowest score band or above the midpoint of the highest score band, 
the interpolation must be based on an assumed adjacent default rate 
of 1 or 0, respectively.
    An institution may use internally derived default rates that 
were calculated using fewer observations or score bands than those 
specified above under certain conditions. The institution must 
submit a written request to the FDIC in advance of or concurrent 
with reporting under that methodology. The request must explain in 
detail how the proposed approach differs from the rule 
specifications and the institution must provide support for the 
statistical appropriateness of the proposed methodology. The request 
must include, at a minimum, a table with the default rates and 
number of observations used in each score and product segment. The 
FDIC will evaluate the proposed methodology and may request 
additional information from the institution, which the institution 
must provide. The institution may report using its proposed approach 
while the FDIC evaluates the methodology. If, after reviewing the 
request, the FDIC determines that the institution's methodology is 
unacceptable, the institution will be required to amend its Call 
Reports and resubmit higher-risk consumer loan amounts according to 
the FDIC's requirements for PD estimation. The institution will be 
required to submit corrected information for no more than the two 
most recently dated and filed Call Reports preceding the FDIC's 
determination and for any Call Reports after the determination.
    (4) The credit scores represented in the historical sample must 
have been produced by the same entity, using the same or 
substantially similar methodology as the methodology used to derive 
the credit scores to which the default rates will be applied. For 
example, the default rate for a particular vendor score cannot be 
evaluated based on the score-to-default rate relationship for a 
different vendor, even if the range of scores under both systems is 
the same. On the other hand, if the current and historical scores 
were produced by the same vendor using slightly different versions 
of the same scoring system and equivalent scores represent a similar 
likelihood of default, then the historical experience could be 
applied.
    (5) A loan is considered to be in default when it is 90+ days 
past due, charged-off, or the consumer enters bankruptcy during the 
24-month performance window.
    The FDIC has the flexibility, as part of its risk-based 
assessment system, to modify the time periods used for PD estimation 
without further notice-and-comment rulemaking. The FDIC also has the 
authority, as part of the risk-based assessment system, to increase 
or decrease the PD threshold of 20 percent, for identifying higher-
risk consumer loans to reflect the updated consumer default data 
from the different time periods selected without further notice-and-
comment rulemaking. Before changing the PD threshold, the FDIC will 
analyze resulting potential changes in the distribution of higher-
risk consumer loans and the resulting effect on total deposit 
insurance assessments and risk differentiation among institutions. 
The FDIC will provide institutions with at least one quarter advance 
notice with their quarterly deposit insurance invoice of any changes 
to the PD estimation time periods or the PD threshold.
    4. Nontraditional mortgage loans include all residential loan 
products that allow the borrower to defer repayment of principal or 
interest and include all interest-only products, teaser rate 
mortgages, and negative amortizing mortgages, with the exception of 
home equity lines of credit (HELOCs) or reverse 
mortgages.15 16 17
---------------------------------------------------------------------------

    \15\ A teaser-rate mortgage loan is defined as a mortgage with a 
discounted initial rate where the lender offers a lower rate and 
lower payments for part of the mortgage term.
    \16\ http://www.fdic.gov/regulations/laws/federal/2006/06noticeFINAL.html.
    \17\ A mortgage loan is no longer considered a nontraditional 
mortgage loan once the teaser rate has expired. An interest only 
loan is no longer considered a nontraditional mortgage loan once the 
loan begins to amortize.
---------------------------------------------------------------------------

    For purposes of the higher-risk assets to Tier 1 capital and 
reserves ratio, nontraditional mortgage loans include 
securitizations where more than 50 percent of the assets backing the 
securitization meet the preceding definition of a nontraditional 
mortgage loan, with the exception of those securities classified as 
trading book.\18\
---------------------------------------------------------------------------

    \18\ A securitization is defined in Appendix A, Section 
II(B)(16) of Part 325 of the FDIC's Rules and Regulations, as it may 
be amended from time to time.
---------------------------------------------------------------------------

    Institutions must determine whether residential loans and 
securities meet the definition of a nontraditional mortgage loan as 
of origination, or, if the loan has been refinanced, as of 
refinance, as discussed in Section A of this Appendix. When an 
institution acquires a residential loan or security, it must 
determine whether the loan or security meets the definition of a 
nontraditional mortgage loan using the origination criteria and 
analysis performed by the original lender. If this information is 
unavailable, the institution must obtain refreshed data from the 
borrower or other appropriate third-party. Refreshed data for 
residential loans and securities is defined as the most recent data 
available. However, the data must be as of a date that is no earlier 
than three months before the acquisition of the residential loan or 
security. The acquiring institution must also determine whether an 
acquired loan or securitization is higher-risk not later than three 
months after acquisition.
    However, when an institution acquires loans or securities from 
another entity on a recurring or programmatic basis, the acquiring 
institution may determine whether the loan or security meets the 
definition of a nontraditional mortgage loan using the origination 
criteria and analysis performed by the original lender only if the 
acquiring institution verifies the information provided.\19\ 
Otherwise, the acquiring institution must obtain the necessary 
information from the borrower or other appropriate third party to 
make its own determination of whether the acquired assets should be 
classified as a nontraditional mortgage loan. If the financial 
information is not available as of the origination date or 
refinance, the institution must obtain refreshed data from the 
borrower or other appropriate third-party. Refreshed data for 
residential loans or securities acquired on a recurring or 
programmatic basis is defined as the most recent data available, and 
in any case, the refreshed data used must be as of a date that is no 
earlier than three months before the acquisition of the residential 
loan or security. The acquiring institution must also determine 
whether a loan or securitization acquired on a recurring or 
programmatic basis is higher-risk not later than three months after 
the date of acquisition.
---------------------------------------------------------------------------

    \19\ Loans or securities acquired from another entity are 
acquired on a recurring basis if an institution has acquired other 
loans or securities from that entity at least once within the 
calendar year or the previous calendar year of the acquisition of 
the loans or securities in question.
---------------------------------------------------------------------------

    An institution is required to use the information that is 
reasonably available to a sophisticated investor in reasonably 
determining whether a securitization meets the 50 percent threshold. 
Information reasonably available to a sophisticated investor 
includes, but is not limited to, offering memorandums, indentures, 
trustee reports, and requests for information from servicers, 
collateral managers, issuers, trustees, or similar third parties. 
When determining whether a revolving trust or similar securitization 
meets the threshold, an institution may use established criteria, 
model portfolios, or limitations published in the offering 
memorandum, indenture, trustee report or similar documents.
    Sufficient information necessary for an institution to make a 
definitive determination may not, in every case, be reasonably 
available to the institution as a sophisticated investor. In such a 
case, the institution may exercise judgment in making its 
determination. Generally, the FDIC may review and audit for 
compliance all determinations made by insured depository 
institutions for assessment purposes, including a determination that 
a securitization does not meet the 50 percent threshold.
    In cases where a securitization is required to be consolidated 
on the balance sheet as a result of SFAS 166 and SFAS 167, and a 
large institution or highly complex institution has access to the 
necessary information, an institution may evaluate individual loans 
in the securitization on a loan-by-loan basis. Any loan within the 
securitization that meets the definition of a higher-risk asset must 
be reported as a higher-risk asset and any loan

[[Page 18124]]

within the securitization that does not meet the definition of a 
higher-risk asset would not be reported as such. When making this 
evaluation, the institution must follow the transition guidance 
described in Appendix C, Section C. Once an institution evaluates a 
securitization for higher-risk asset designation on a loan-by-loan 
basis, it must continue to evaluate all securitizations for which it 
has the required information in a similar manner (i.e., on a loan-
by-loan basis). For securitizations for which the institution does 
not have access to information on a loan-by-loan basis, the 
institution must determine whether the securitization meets the 50 
percent threshold.

Definition of Refinance/Timing of Classification as a Higher-Risk Asset

1. ``Refinance'' Definition for Consumer Loans

    For all consumer loans and securities (including nontraditional 
mortgage loans), an institution must determine whether the loan or 
security meets the definition of a higher-risk consumer loan or a 
nontraditional mortgage loan and must do so as of origination, or, 
if the loan has been refinanced, as of refinance.
    A refinance for this purpose is an extension of new credit or 
additional funds on an existing loan or the replacement of an 
existing loan by a new or modified obligation. A refinance includes 
the consolidation of multiple existing obligations, disbursement of 
additional funds to the borrower, an increase or decrease in the 
interest rate, or rescheduling of principal or interest payments to 
create or increase a balloon payment or extend the legal maturity 
date of the loan by more than six months. Additional funds include a 
material disbursement of additional funds or, with respect to a line 
of credit, a material increase in the amount of the line of credit, 
but not a disbursement, draw, or the writing of convenience checks 
within the original limits of the line of credit. Except as noted 
below for credit cards, a material increase in the amount of the 
line of credit is defined as a 10 percent or greater increase in the 
quarter-end line of credit limit.
    Modifications to a loan that would otherwise meet this 
definition of refinance, but result in the classification of a loan 
as a troubled debt restructuring (TDR), do not constitute a 
refinance.\20\ Any modification made to a consumer loan pursuant to 
a government program, for example the Home Affordable Modification 
Program or the Home Affordable Refinance Program, is also not 
considered a refinance.
---------------------------------------------------------------------------

    \20\ Troubled debt restructuring (TDR) is defined as this term 
is defined in the glossary of the Call Report instructions, as it 
may be amended from time to time.
---------------------------------------------------------------------------

    An extension of the maturity date of a loan is not, per se, a 
refinance. A contractual deferral of payments that is consistent 
with the terms of the original loan agreement (for example, as 
allowed in some student loans), is not a refinance. For an open-end 
or revolving line of credit, an advance of funds consistent with the 
terms of the loan agreement is not a refinance. Deferrals under the 
Servicemembers Civil Relief Act do not constitute a refinance. 
Except as provided above, a modification or series of modifications 
to a closed-end consumer loan do not constitute a refinance.
    For credit card loans, replacing an existing card because the 
original is expiring, for security reasons, or because of a new 
technology or a new system does not constitute a refinance. 
Reissuing a credit card that has been temporarily suspended (as 
opposed to closed) is not a refinance. A non-temporary credit card 
credit line increase that is not a result of, or related to, a loss 
mitigation strategy is a refinance.

2. ``Refinance'' Definition for Commercial Loans

    For all commercial loans and securities, an institution must 
determine whether the loan or security meets the definition of a 
higher-risk C&I loan and security and must do so as of origination 
or, or, if the loan has been refinanced, as of refinance.
    A refinance occurs when the original obligation has been 
replaced by a new or modified obligation or loan agreement. A 
refinance includes an increase in the master commitment of the line 
of credit (not including adjustments to sub-limits under the master 
commitment), disbursement of additional money other than amounts 
already committed to the borrower, extension of the legal maturity 
date, rescheduling of principal or interest payments to create or 
increase a balloon payment, substantial release of collateral, 
consolidation of multiple existing obligations, or an increase or 
decrease in the interest rate. A modification or series of 
modifications to a commercial loan other than as described in this 
paragraph does not constitute a refinance.
    Modifications to a commercial loan that would otherwise meet 
this definition of refinance, but result in the classification of a 
loan as a TDR, do not constitute a refinance. Any modification made 
to a consumer loan pursuant to a government program, for example the 
``Home Affordable Modification Program or the Home Affordable 
Refinance Program, will not be considered a refinance for these 
purposes.

B. Updating Scorecard

    The FDIC retains the flexibility, as part of the risk-based 
assessment system, without the necessity of additional notice-and-
comment rulemaking, to update the minimum and maximum cutoff values 
for all measures used in the scorecard. The FDIC may update the 
minimum and maximum cutoff values for the higher-risk assets to Tier 
1 capital and reserves ratio in order to maintain an approximately 
similar distribution of higher-risk assets to Tier 1 capital and 
reserves ratio scores as reported prior to the implementation of the 
proposed amendments or to avoid changing the overall amount of 
assessment revenue collected.\21\ The FDIC will review changes in 
the distribution of the higher-risk assets to Tier 1 capital and 
reserves ratio scores and the resulting effect on total assessments 
and risk differentiation between institutions when determining 
changes to the cutoffs. The FDIC may update changes to the higher-
risk assets to Tier 1 capital and reserves ratio cutoffs more 
frequently than annually. The FDIC will provide institutions with a 
minimum one quarter advance notice of changes in the cutoff values 
for the higher-risk assets to Tier 1 capital and reserves ratio with 
their quarterly deposit insurance invoice.
---------------------------------------------------------------------------

    \21\ 76 FR 10672, 10700 (February 25, 2011).
---------------------------------------------------------------------------

C. Application and Transition Guidance

    Sections A through C of this Appendix C apply to:
    (1) All construction and land development loans, whenever 
originated or purchased;
    (2) All C&I loans and securities originated or purchased on or 
after October 1, 2012;
    (3) All consumer loans and securities, except securitizations of 
consumer loans and securities, whenever originated or purchased;
    (4) All residential real estate loans and securities, except 
securitizations of residential real estate loans, whenever 
originated or purchased; and
    (5) All securitizations of C&I loans, consumer, or residential 
loans originated or purchased on or after October 1, 2012.
    For consumer and residential real estate loans and securities 
(other than securitizations) originated or purchased prior to 
October 1, 2012, an institution must determine whether the loan or 
security meets the definition of a higher-risk consumer loan and 
security no later than December 31, 2012, using information as of 
the date of the origination of the loan or security if the 
institution has that information.\22\ If the institution does not 
have that information, it must use refreshed data to determine 
whether a loan or security meets the definition. Refreshed data is 
defined as the most recent data available as if the loan or security 
were being originated in the fourth quarter of 2012. In all 
instances, the refreshed data used must be as of July 1, 2012 or 
later.
---------------------------------------------------------------------------

    \22\ Institutions had to determine whether loans and securities 
originated or purchased prior to October 1, 2012, met the definition 
of a construction and land development loan or a nontraditional 
mortgage loan in time to file accurate reports of condition as of 
June 30, 2012, and September 30, 2012.
---------------------------------------------------------------------------

    For C&I loans and securities originated or purchased before 
October 1, 2012, and all securitizations originated or purchased 
before October 1, 2012, institutions must either continue to use 
their existing internal methodology or existing guidance provided by 
their primary federal regulator, or use the definitions detailed in 
the February rule to determine whether to include the loan, 
security, or securitization as a concentration in a risk area for 
purposes of the higher-risk assets to Tier 1 capital and reserves 
ratio.\23\
---------------------------------------------------------------------------

    \23\ 76 FR 10672 (February 25, 2011).
---------------------------------------------------------------------------

D. Accounts Receivable and Automobile Dealer Floor Plan Lending 
Guidance

1. Accounts Receivable

    Loans secured by accounts receivable should be made with advance 
rates at or below 75 percent to 85 percent of eligible receivables, 
based on the receivable quality, concentration level of account 
debtors, and performance of receivables as related to the

[[Page 18125]]

terms of sale.\24\ An institution's lending policy should address 
the maintenance of an accounts receivable loan agreement with the 
borrower. This loan agreement should establish a percentage advance 
against acceptable receivables, include a maximum dollar amount due 
from any one account debtor, address the financial strength of 
debtor accounts, and define acceptable receivables. The definition 
of acceptable receivables should consider the turnover and dilution 
rates of receivables pledged, the aging of accounts receivable, and 
the concentrations of debtor accounts.\25\
---------------------------------------------------------------------------

    \24\ Concentration of account debtors is the percentage value of 
receivables associated with one or a few customers relative to the 
total value of receivables. Compared to a lender with numerous 
debtors, a lender with few debtors is exposed to a greater level of 
risk if one of these debtors does not pay according to its account 
agreement. Consequently, high levels of concentration reflect higher 
risk for a lender and must cause the lender to hold higher reserves 
(advance a lesser percentage) all else equal.
    \25\ Turnover of receivables is the velocity at which 
receivables are collected. In general, faster turnover increases the 
advance rate imposed by the lender.
    The dilution rate is the uncollectible accounts receivable as a 
percentage of sales. The historical dilution rate will impact 
advance rates. Higher uncollectible accounts will translate into a 
larger reserve account and less funds advanced to the company.
---------------------------------------------------------------------------

    Ineligibles must be established for any debtor account where 
there is concern that the debtor may not pay according to terms. 
Examples of ineligibles include:
     Accounts receivable balances over 90 days beyond 
invoice date or 60 days past due, depending upon custom with respect 
to a particular industry with appropriate adjustments made for dated 
billings;
     Entire account balances where over 50 percent of the 
account is over 60 days past due or 90 days past invoice date;
     Accounts arising from other than trade (e.g., 
royalties, rebates);
     Consignment or guaranteed sales;
     Notes receivable;
     Progress billings;
     Account balances in excess of limits appropriate to 
account debtor's credit worthiness or unduly concentrated by 
industry, location or customer; and
     Affiliate and intercompany accounts.

2. Inventory

    Loans against inventory should normally be made with advance 
rates no more than 65 percent of eligible inventory (at the lower of 
cost valued on a FIFO basis or market) based on an analysis of 
realizable value. When an appraisal is obtained, up to 85 percent of 
the NOLV of the inventory may be financed.
    Ineligibles must be established for inventory that exhibit 
characteristics that make it difficult to achieve a realizable value 
or to obtain possession of the inventory. The following are examples 
of when inventory is considered ineligible as collateral:
     Slow moving, obsolete inventory and items turning 
materially slower than industry average;
     Inventory with value to the client only, which is 
generally work in process; however, it may include raw materials 
used solely in the client's manufacturing process;
     Consigned inventory or other inventory where a 
perfected lien cannot be obtained;
     Off-premise inventory subject to a mechanic's or other 
lien; and
     Specialized, high technology or other inventory subject 
to rapid obsolescence or valuation problems.

3. Minimum Account Management and Monitoring Standards for Asset 
Based and Floor Plan Lenders

    Accounts receivable and floor plan lending require a rigorous 
level of account management compared to other forms of lending. A 
hands-on approach to collateral evaluation and intense financial and 
client monitoring must be used in order to properly manage these 
relationships. Clients must submit periodic detailed reports that 
are routinely analyzed. A staff of specially trained field auditors 
should visit clients on a regular basis to inspect the collateral 
and verify the accuracy of the reporting. Examples of detailed 
reports that must be routinely provided to the asset-based lender 
include:
    Borrowing Base Certificates: A form prepared by the borrower 
that reflects the current status of the collateral. Certificates, 
along with supporting information, must be provided on a daily, 
weekly or monthly basis, depending on the terms of the loan 
agreement, the financial strength of the borrower and the amount of 
availability under the revolver. Once received by the lender, this 
certificate, along with the supporting information, must be 
reconciled with internal collateral management systems to ensure the 
accuracy of the collateral base, with any discrepancies reconciled 
with the borrower. Key information contained in the certificate must 
include:
     The accounts receivable balance (rolled forward from 
the previous certificate);
     Sales (reported as gross billings) with detailed 
adjustments for returns and allowances to allow for proper tracking 
of dilution and other reductions in collateral;
     Detailed inventory information (e.g., raw materials, 
work-in-process, finished goods); and
     Detail of loan activity.
    Accounts Receivable and Inventory Detail: Monthly accounts 
receivable and inventory agings must be received in sufficient 
detail to allow the lender to compute the required ineligibles.
    Accounts Payable Detail: Monthly accounts payable agings must be 
received to monitor payable performance and anticipated working 
capital needs.
    Covenant Compliance Certificates: Borrowers should submit 
Covenant Compliance Certificates, generally on a monthly or 
quarterly basis (depending on the terms of the loan agreement) to 
monitor compliance with the covenants outlined in the loan 
agreement. Non-compliance with any covenants should be promptly 
addressed to cure any defaults, with actions taken (e.g., waiver, 
amendment, default pricing, blocking advance privileges) dependent 
on the nature of each situation.

Definition of Terms Used in the Accounts Receivable and Automobile 
Dealer Floor Plan Lending Guidance

    Blocked Account: An account that is controlled by an agreement 
that stipulates that all cash transferred out of the account must go 
to the lender. Blocked accounts are controlled by the lender. The 
borrower can make deposits into the blocked account, but maintains 
no signature authority on the account. Funds flowing into the 
blocked account originate from (i) direct deposit checks; (ii) lock 
box deposits; or (iii) wire transfers from other institutions. In 
the direct deposit or bulk method, the client receives checks from 
its customers, batches them, and deposits them in kind to the 
blocked account.
    Lock Box: An agreement whereby the borrower's account debtors 
mail their payment checks to a specified Post Office box controlled 
by the lender. The lender opens the mail, processes the checks for 
collection, and forwards a copy or other record of the checks to the 
borrower. Lock box proceeds are deposited into the borrower's 
blocked account.

E. Growth-Adjusted Portfolio Concentration Measure

    The growth-adjusted concentration measure is the sum of the 
values of concentrations in each of the seven portfolios, each of 
the values being first adjusted for risk weights and growth. The 
product of the risk weight and the concentration ratio is first 
squared and then multiplied by the growth factor. The measure is 
calculated as:
[GRAPHIC] [TIFF OMITTED] TP27MR12.123

Where:

N is institution i's growth-adjusted portfolio concentration 
measure; \26\
---------------------------------------------------------------------------

    \26\ The growth-adjusted portfolio concentration measure is 
rounded to two decimal points.
---------------------------------------------------------------------------

k is a portfolio;

[[Page 18126]]

g is a growth factor for institution i's portfolio k; and,
w is a risk weight for portfolio k.

    The seven portfolios (k) are defined based on the Call Report/
TFR data and they are:
     Construction and land development loans;
     Other commercial real estate loans;
     First-lien residential mortgages and non-agency 
residential mortgage-backed securities (excludes CMOs, REMICS, CMO 
and REMIC residuals, and stripped MBS issued by non-U.S. Government 
issuers for which the collateral consists of MBS issued or 
guaranteed by U.S. government agencies);
     Closed-end junior liens and home equity lines of credit 
(HELOCs);
     Commercial and industrial loans;
     Credit card loans; and
     Other consumer loans.27 28
---------------------------------------------------------------------------

    \27\ All loan concentrations should include the fair value of 
purchased credit impaired loans.
    \28\ Each loan concentration category should exclude the amount 
of loans recoverable from the U.S. government, its agencies, or 
government-sponsored agencies, under guarantee or insurance 
provisions.
---------------------------------------------------------------------------

    The growth factor, g, is based on a three-year merger-adjusted 
growth rate for a given portfolio; g ranges from 1 to 1.2 where a 20 
percent growth rate equals a factor of 1 and an 80 percent growth 
rate equals a factor of 1.2.\29\ For growth rates less than 20 
percent, g is 1; for growth rates greater than 80 percent, g is 1.2. 
For growth rates between 20 percent and 80 percent, the growth 
factor is calculated as:
---------------------------------------------------------------------------

    \29\ The growth factor is rounded to two decimal points.
    [GRAPHIC] [TIFF OMITTED] TP27MR12.124
    
---------------------------------------------------------------------------
Where:

[GRAPHIC] [TIFF OMITTED] TP27MR12.125

V is the portfolio amount as reported on the Call Report/TFR and it 
is the quarter for which the assessment is being determined.

    The risk weight for each portfolio reflects relative peak loss 
rates for banks at the 90th percentile during the 1990-2009 
period.\30\ These loss rates were converted into equivalent risk 
weights as shown in Table C.1.
---------------------------------------------------------------------------

    \30\ The risk weights are based on loss rates for each portfolio 
relative to the loss rate for C&I loans, which is given a risk 
weight of 1. The peak loss rates were derived as follows. The loss 
rate for each loan category for each bank with over $5 billion in 
total assets was calculated for each of the last twenty calendar 
years (1990-2009). The highest value of the 90th percentile of each 
loan category over the twenty year period was selected as the peak 
loss rate.

  Table C.1--90th Percentile Annual Loss Rates for 1990-2009 Period and
                       Corresponding Risk Weights
------------------------------------------------------------------------
                                            Loss rates
                Portfolio                      (90th       Risk weights
                                            percentile)
------------------------------------------------------------------------
First-Lien Mortgages....................            2.3%             0.5
Second/Junior Lien Mortgages............            4.6%             0.9
Commercial and Industrial (C&I) Loans...            5.0%             1.0
Construction and Development (C&D) Loans           15.0%             3.0
Commercial Real Estate Loans, excluding             4.3%             0.9
 C&D....................................
Credit Card Loans.......................           11.8%             2.4
Other Consumer Loans....................            5.9%             1.2
------------------------------------------------------------------------


    Note: The following appendix will not appear in the Code of 
Federal Regulations.

Appendix 1--Two-Year Probability of Default Information for Consumer 
Loans

    The FDIC intends to collect two-year PD information on various 
types of consumer loans from large and highly complex institutions. 
However, the types of information collected and the format of the 
information collected will be subject to a Paperwork Reduction Act 
notice (with an opportunity for comment) published in the Federal 
Register. The following table is an example of how the FDIC may 
collect the consumer loan information and the kind of information 
that may be collected. Once the definition of higher-risk consumer 
loans is adopted in a final rule, appropriate changes to the Call 
Reports will be made and institutions will be expected to begin 
reporting consumer loans according to the definition in the final 
rule. In addition, as suggested in the example table, institutions 
would report the outstanding amount of all consumer loans, including 
those with a PD below the subprime threshold, stratified by the 10 
product types and 12 two-year PD bands.\31\ In addition, for each 
product type, institutions would indicate whether the PDs were 
derived using scores and default rate mappings provided by a third 
party vendor or an internal approach.\32\ If an internal approach 
was used, the institution will also have to indicate whether or not 
the internal approach meets the minimum number of PD bands and 
observations required as described in the Requirements for PD 
Estimation in Appendix C, Section A. Institutions would report as a 
separate item the value of all securitizations of consumer loans 
that are more than 50 percent collateralized by consumer loans that 
would be identified as higher-risk assets (except those classified 
as trading book).
---------------------------------------------------------------------------

    \31\ All figures would exclude the maximum amounts recoverable 
from the U.S. government, its agencies, or government-sponsored 
agencies under guarantee or insurance provisions, as well as loans 
that are fully secured by cash collateral. In order to exclude a 
loan based on cash collateral, the cash would have to be in the form 
of a savings or time deposit held by the insured depository 
institution. The insured depository institution would also have to 
have a signed collateral assignment of the deposit account, which 
was irrevocable for the remaining term of the loan or commitment, 
and the insured depository institution would have to have placed a 
hold on the deposit account, which alerts the institution if there 
are attempts to withdraw or transfer the deposit funds. In the case 
of a revolving line of credit, the cash collateral would have to be 
equal to or greater than the amount of the total loan commitment 
(funded and unfunded balance of the loan) for the exclusion to 
apply.
    \32\ An internal approach would include the use of an 
institution's own default experience with a particular product and 
credit score, whether that score was provided by a third party or 
was internally derived.

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

[[Page 18127]]

[GRAPHIC] [TIFF OMITTED] TP27MR12.126


    By order of the Board of Directors.

    Dated at Washington, DC, this 20th day of March 2012.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2012-7268 Filed 3-26-12; 8:45 am]
BILLING CODE 6714-01-P