[Federal Register Volume 77, Number 211 (Wednesday, October 31, 2012)]
[Rules and Regulations]
[Pages 66000-66024]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-25943]



[[Page 65999]]

Vol. 77

Wednesday,

No. 211

October 31, 2012

Part III





Federal Deposit Insurance Corporation





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





12 CFR Part 327





Assessments, Large Bank Pricing; Final Rule

  Federal Register / Vol. 77 , No. 211 / Wednesday, October 31, 2012 / 
Rules and Regulations  

[[Page 66000]]


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

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 327

RIN 3064-AD92


Assessments, Large Bank Pricing

AGENCY: Federal Deposit Insurance Corporation (FDIC).

ACTION: Final rule.

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

SUMMARY: The FDIC is amending its regulations by revising some of the 
definitions used to determine assessment rates for large and highly 
complex insured depository institutions.

DATES: Effective date: April 1, 2013.

FOR FURTHER INFORMATION CONTACT: Scott Ciardi, Chief, Large Bank 
Pricing Section, Division of Insurance and Research, (202) 898-7079; 
Brenda Bruno, Senior Financial Analyst, Division of Insurance and 
Research, (630) 241-0359 x 8312; Christopher Bellotto, Counsel, Legal 
Division, (202) 898-3801.

SUPPLEMENTARY INFORMATION:

I. Background

    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 2011 
rule).1 2 The February 2011 rule eliminated risk categories 
for large banks \3\ and created two scorecards, one for highly complex 
banks and another for all other large banks, that combine CAMELS 
ratings and certain forward-looking financial ratios. The scorecards 
calculate a total score for each institution.\4\ The total score is 
then converted to the bank's initial base assessment rate, which, after 
certain adjustments, results in the institution's total assessment 
rate.\5\ To calculate the amount of the bank's quarterly assessment, 
the total assessment rate is multiplied by the bank's assessment base 
and the result is divided by four.
---------------------------------------------------------------------------

    \1\ 12 CFR 327.9.
    \2\ 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.
    \3\ The terms ``bank'' and ``institution'' are used 
interchangeably in the preamble of the final rule, unless the 
context suggests otherwise. Again, unless the context suggests 
otherwise, the terms include any insured depository institution that 
meets the definition of a large institution or highly complex 
institution as defined in 12 CFR 327.9(f) and (g).
    \4\ A large or highly complex institution's total score may be 
adjusted by the large bank adjustment. 12 CFR 327.9(b)(3).
    \5\ An institution's initial base assessment rate can be 
adjusted by the unsecured debt adjustment, the depository 
institution debt adjustment, and, for some institutions, the 
brokered deposit adjustment. 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.\6\ Higher-risk 
assets are defined in the February 2011 rule as the sum of construction 
and land development (C&D) loans, leveraged loans, subprime loans, and 
nontraditional mortgage loans. The FDIC used existing interagency 
guidance to define leveraged loans, nontraditional mortgage loans, and 
subprime loans but refined the definitions to ensure consistency in 
reporting. 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 2011 rule.\7\
---------------------------------------------------------------------------

    \6\ 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 banks, 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 concentration score. For highly complex institutions, it 
is defined as the higher of: (a) The higher-risk assets to Tier 1 
capital and reserves score, (b) the largest counterparty exposure to 
Tier 1 capital and reserves score, or (c) the top 20 counterparty 
exposure to Tier 1 capital and reserves score.
    \7\ 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 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 Governors of the Federal Reserve System, the Office of Thrift 
Supervision, 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 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).\8\
---------------------------------------------------------------------------

    \8\ 76 FR 14460 (March 16, 2011).
---------------------------------------------------------------------------

    Commenters on the March PRA notice raised concerns about their 
ability to report subprime and leveraged loan data consistent with the 
definitions used in the February 2011 rule. They also stated that they 
would be unable to report the required data by the June 30, 2011 report 
date. These data concerns had not been raised during the rulemaking 
process leading up to the February 2011 rule.\9\
---------------------------------------------------------------------------

    \9\ 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 took into account in its February 
2011 rule amending its assessment regulations. For example, several 
commenters on the November 2010 NPR stated that updating data to 
evaluate loans for subprime or leveraged status would be burdensome 
and costly, and for certain types of retail loans, would be 
impossible because existing loan agreements do not require borrowers 
to routinely provide updated financial information. In response to 
these comments, the FDIC's February 2011 rule stated that large 
institutions should evaluate loans for subprime or leveraged status 
upon origination, refinance, or renewal. No comments, however, 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 raised in comments on the March PRA 
notice.
---------------------------------------------------------------------------

    As a consequence of this unexpected difficulty, the FDIC applied to 
the Office of Management and Budget (OMB) for an emergency clearance 
request to allow large and highly complex 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 in existing supervisory 
guidance. The agencies also submitted corresponding reporting revisions 
under normal PRA clearance procedures and requested public comment on 
July 27, 2011 (July PRA notice).\10\
---------------------------------------------------------------------------

    \10\ 76 FR 44987 (July 27, 2011).
---------------------------------------------------------------------------

    In response to the PRA notices, commenters recommended extending 
the transition guidance for reporting subprime and leveraged loans 
until more workable and accurate definitions were developed.
    On September 28, 2011, the FDIC informed large and highly complex 
institutions via email (followed by

[[Page 66001]]

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 determining risk 
for deposit insurance pricing purposes. The FDIC subsequently extended 
the deadline for the transition guidance to April 1, 2013.
    The FDIC considered all comments related to the higher-risk asset 
definitions that were submitted in response to the March and July 2011 
PRA notices as part of its review. The FDIC also engaged in extensive 
discussions with bankers and industry trade groups to better understand 
their concerns and to solicit potential solutions to these concerns. As 
a result, the FDIC issued a notice of proposed rulemaking on March 20, 
2012 (NPR) to resolve the problems raised in comments on the March and 
July PRA notices.

II. Comments Received

    The FDIC sought comments on every aspect of the proposed rule. The 
FDIC received a total of 14 comment letters.\11\ The FDIC also 
conducted meetings with commenters and others. Summaries of these 
meetings are posted on the FDIC's Web site.\12\
---------------------------------------------------------------------------

    \11\ The FDIC also received a number of emails from commenters 
and other interested parties.
    \12\ http://www.fdic.gov/regulations/laws/federal/2012/2012-ad92.html.
---------------------------------------------------------------------------

    Comments are discussed in the relevant sections that follow.

III. The Final Rule: Assessment System for Large and Highly Complex 
Institutions

    The FDIC has adopted this final rule to amend the assessment system 
for large and highly complex institutions by: (1) Revising the 
definitions of certain higher-risk assets, specifically leveraged 
loans, which are renamed ``higher-risk C&I loans and securities,'' \13\ 
and subprime consumer loans, which are renamed ``higher-risk consumer 
loans''; (2) clarifying when an asset must be classified as higher 
risk; (3) clarifying the way securitizations are identified as higher 
risk; and (4) further defining terms that are used in the large bank 
pricing portions of 12 CFR 327.9. 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 those used within the 
industry and in other regulatory guidance. The FDIC has not amended the 
definition of C&D loans and the final rule retains the definitions used 
in the February 2011 rule. The FDIC also retains the definition of 
nontraditional mortgage loans; however, the final rule clarifies how 
securitizations of nontraditional mortgage loans are identified as 
higher risk. The final rule aggregates all securitizations that contain 
higher-risk assets into a newly defined category of higher-risk assets, 
``higher-risk securitizations.'' While the nomenclature is new, the NPR 
proposed including all assets that meet this newly defined category as 
higher-risk assets. The FDIC believes that the final rule will result 
in more consistent reporting, better reflect risk to the Deposit 
Insurance Fund (DIF), significantly reduce reporting burden, and 
satisfy many of the concerns voiced by the industry after adoption of 
the February 2011 rule.
---------------------------------------------------------------------------

    \13\ ``C&I'' is an abbreviation for ``commercial and 
industrial.''
---------------------------------------------------------------------------

    The final rule will be effective on April 1, 2013, predicated on 
changes to the Call Report instructions having been made. The effective 
date is discussed in Section E below.

A. Higher-Risk Assets

    The FDIC uses the amount of an institution's higher-risk assets to 
calculate the institution's higher-risk concentration measure, 
concentration score and total score. As noted in the February 2011 
rule, the higher-risk concentration measure captures the risk 
associated with concentrated lending in higher-risk areas. This type of 
lending contributed to the failure of a number of large banks during 
the recent financial crisis and economic downturn.\14\
---------------------------------------------------------------------------

    \14\ 76 FR 10672, 10692-10693 (February 25, 2011).
---------------------------------------------------------------------------

Higher-Risk C&I Loans and Securities
Basic definition of a higher-risk C&I loan and security
    The definition of a ``higher-risk C&I loan and security'' in the 
final rule incorporates suggestions from comment letters, including a 
joint comment letter (the joint letter) from several industry trade 
groups and discussions with a trade group; the definition differs from 
the definition proposed in the NPR.
    The final rule introduces a new term, a ``higher-risk C&I 
borrower,'' which includes a borrower that owes the reporting bank 
(i.e., the bank filing its Call Report) on a C&I loan originally made 
on or after the effective date of the rule (April 1, 2013), if the 
following conditions are met: \15\
---------------------------------------------------------------------------

    \15\ C&I 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. This definition 
includes purchased credit impaired loans and overdrafts.
---------------------------------------------------------------------------

     The C&I loan must have an original amount (including 
funded amounts and the amount of unfunded commitments, whether 
irrevocable or unconditionally cancellable) of at least $5 million;
     The loan must meet the purpose and materiality tests 
described below; and
     When the loan is made, the borrower must meet the leverage 
test, also described below.
    To ensure that the definition is equitably applied, all C&I loans 
that a borrower owes to the reporting bank that meet the purpose test 
when made and that are made within six months of each other must be 
aggregated to determine whether they have an original amount of at 
least $5 million; however, only loans in the original amount of $1 
million or more need to be aggregated.\16\ Thus, for example, if a bank 
makes a $4 million C&I loan and 5 months later makes a $2 million C&I 
loan, both of which meet the purpose test, the loans will have an 
original amount of $6 million. For a C&I loan that meets the purpose 
test and that is syndicated or participated among banks, the original 
amount of the loan (for purposes of determining whether the original 
amount is at least $5 million and for purposes of applying the 
materiality test) is the total original amount of the loan, not just 
the syndicated or participated portion held by an individual bank.
---------------------------------------------------------------------------

    \16\ Loans made before the effective date of the rule need not 
be aggregated.
---------------------------------------------------------------------------

    A ``higher-risk C&I borrower'' also includes a borrower that 
obtains a refinance \17\ of an existing C&I loan, where the refinance 
occurs on or after the effective date of the rule and the refinanced 
loan is owed to the reporting

[[Page 66002]]

bank, if the following conditions are met:
---------------------------------------------------------------------------

    \17\ The definition of refinance is discussed in Appendix C. Two 
commenters had suggested that the definition proposed in the NPR was 
too broad and inconsistent with Regulation Z, Section 226.20. While 
the definition in the final rule differs from the Regulation Z 
definition, the two definitions serve different purposes. Regulation 
Z states that a refinancing occurs when an existing obligation is 
satisfied and replaced with a new obligation, and this new 
transaction requires new disclosures to the consumer. The purpose of 
Regulation Z is to determine when new disclosures should be required 
to be given to consumers. The purpose of the definition in the final 
rule is to determine when an institution should re-evaluate a loan 
for higher-risk status. Prior to proposing its definition of 
refinance in the NPR, the FDIC discussed it at length with the 
industry and other interested parties.
---------------------------------------------------------------------------

     The refinanced loan must be in an amount (including funded 
amounts and the amount of unfunded commitments, whether irrevocable or 
unconditionally cancellable) of at least $5 million;
     The C&I loan being refinanced must have met the purpose 
and materiality tests when it was originally made;
     The original loan must have been made no more than five 
years before the refinanced loan (the look-back period); and
     When the loan is refinanced, the borrower must meet the 
leverage test.
    Again, to ensure that the definition is equitably applied, when a 
C&I loan is refinanced through more than one loan and the loans are 
made within six months of each other, they must be aggregated to 
determine whether they have an amount of at least $5 million. Thus, for 
example, an $8 million C&I refinancing loan that is split into two $4 
million loans, where both are made within six months of each other, 
will still have an amount of $8 million.
    A borrower ceases to be a ``higher-risk C&I borrower'' if: (1) The 
borrower no longer has any C&I loans owed to the reporting bank that, 
when originally made, met the purpose and materiality tests; (2) any 
such loans outstanding owed by the borrower to the reporting bank have 
all been refinanced more than five years after originally being made; 
or (3) the reporting bank makes a new C&I loan or refinances an 
existing C&I loan and the borrower no longer meets the leverage test. A 
borrower cannot cease to be a higher-risk borrower except as provided 
above.
    Under the final rule, ``higher-risk C&I loans or securities'' 
include all C&I loans owed to the reporting bank by a higher-risk C&I 
borrower, except loans subject to an exclusion described below, and all 
securities issued by the higher-risk C&I borrower that are owned by the 
reporting bank, except securities classified as trading book, without 
regard to when the loans were made or the securities purchased.\18\
---------------------------------------------------------------------------

    \18\ The amount of a higher-risk C&I loan or security to be 
reported on the Call Report as of the end of a quarter is the amount 
of C&I loans, and unfunded C&I loan commitments, owed to the 
reporting bank by a higher-risk C&I borrower and the amount of 
securities issued by a higher-risk C&I borrower that are owned by 
the reporting bank.
---------------------------------------------------------------------------

Purpose Test
    A loan or refinance meets the purpose test if it is to finance a 
buyout, acquisition or capital distribution. Under the final rule, an 
``acquisition'' is the purchase by the borrower of any equity interest 
in another company or the purchase of all or a substantial portion of 
the assets of another company; a ``buyout'' is the purchase or 
repurchase by the borrower of the borrower's outstanding equity (a 
buyout includes, but is not limited to, an equity buyout or funding of 
an Employee Stock Ownership Plan (ESOP)); and a ``capital 
distribution'' is a dividend payment or other transaction designed to 
enhance shareholder value, such as repurchase of stock.\19\
---------------------------------------------------------------------------

    \19\ The NPR proposed to include as an acquisition ``any of the 
assets and liabilities of another company.'' The final rule narrows 
and clarifies this definition.
---------------------------------------------------------------------------

    The purpose test will help identify risk and reflect the method 
used internally by most banks to identify higher-risk loans. The test 
identifies those borrowers with certain higher-risk characteristics, 
such as a heavy reliance on either enterprise value or improvement in 
the borrower's profitability.\20\
---------------------------------------------------------------------------

    \20\ Enterprise value is a measure of the borrower's value as a 
going concern.
---------------------------------------------------------------------------

Materiality Test
    A loan or refinance meets the materiality test if the amount of the 
original loan (including funded amounts and the amount of unfunded 
commitments, whether irrevocable or unconditionally cancellable) equals 
or exceeds 20 percent of the total funded debt of the borrower. Total 
funded debt of the borrower is to be determined as of the date of the 
original loan and does not include the loan to which the materiality 
test is being applied.\21\ A loan also meets the materiality test if, 
before the loan was made, the borrower had no funded debt.
---------------------------------------------------------------------------

    \21\ When multiple loans must be aggregated to determine whether 
they total at least $5 million, the materiality test is to be 
applied as of the date of the last loan.
---------------------------------------------------------------------------

    At the time of refinance, whether the original loan met the purpose 
or materiality tests may not be easily determined by a new lender. In 
such a case, the new lender must use its best efforts and reasonable 
due diligence to determine whether the original loan met these tests.
Leverage Test
    A borrower meets the leverage test if the ratio of the borrower's 
total debt to trailing twelve-month EBITDA (commonly known as the 
operating leverage ratio) is greater than 4, or the ratio of the 
borrower's senior debt to trailing twelve-month EBITDA (also commonly 
known as the operating leverage ratio) is greater than 3.\22\
---------------------------------------------------------------------------

    \22\ EBITDA is defined as earnings before interest, taxes, 
depreciation, and amortization.
---------------------------------------------------------------------------

    Appendix C provides detailed definitions of many of the terms used 
in the foregoing definitions.
Comments on the Proposed Definition
    In the joint letter, commenters took issue with several parts of 
the NPR's proposed definitions related to higher-risk C&I loans.\23\ 
The NPR proposed that a C&I loan of any size that was made within the 
past seven years and that met the purpose and materiality tests, 
whether made by the reporting bank or another institution, would make 
all C&I loans to a leveraged borrower higher risk if the borrower had a 
total of at least $5 million in C&I loans owed to the reporting bank. 
The commenters suggested that a $5 million threshold should be part of 
the purpose test, on the grounds that a loan of less than $5 million at 
origination or refinance would not be sufficiently material to be 
``higher risk'' even if it financed an acquisition, buyout or capital 
distribution, and that requiring a lender to consider loans under $5 
million to a borrower would be expensive and time consuming. The 
commenters further suggested that the look back at the

[[Page 66003]]

purpose and materiality of debt should apply only when currently 
outstanding debt is refinanced, on the grounds that the definition of 
higher-risk is intended to identify risk when it is created. Finally, 
the commenters recommended that the look-back period should be, at 
most, five years rather than the seven years proposed in the NPR, on 
the grounds that most large banks track the past borrowing history of a 
borrower only three years back through a review of their financial 
statements and that the purpose of debt becomes murkier as it grows 
older and as new debt is added.
---------------------------------------------------------------------------

    \23\ The NPR proposed the following definition of a ``higher-
risk C&I loan and security'':
     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; and
    (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 higher-risk C&I loans and securities 
definition if directly held by the evaluating institution, except 
securities classified as trading book.
    Under the proposed definition, multiple loans to one borrower 
were to be aggregated to determine whether the outstanding amount 
exceeded $5 million to the extent that the institution's loan data 
systems could do so without undue cost. If the cost was excessive, 
the institution could treat multiple loans to one borrower as 
separate loans.
---------------------------------------------------------------------------

    The final rule adopts these suggestions with some modifications 
primarily intended either to simplify the rule or to ensure that the 
intent of the definitions cannot be easily circumvented.
    In the joint letter and a subsequent email, commenters suggested 
that debt incurred to fund ordinary business actions such as dividends 
to make tax payments should be excluded from the definition of a 
capital distribution in the purpose test. The final rule does not adopt 
this suggestion because the materiality test should be sufficient to 
exclude most loans made in the ordinary course of business.
    Several industry trade groups and one bank commented that a 
material increase in debt should be defined as a 50 percent increase in 
funded debt within one year rather than the proposed 20 percent 
increase, arguing that 20 percent would include loans made to firms for 
routine acquisitions in the normal course of business. According to the 
commenters, such loans might include financing for a modest stock 
redemption or basic dividend program. Commenters also suggested that 
the materiality test should apply only to debt that meets the purpose 
test, rather than all debt. The final rule adopts the suggestion to 
consider only purpose loans in the materiality test.
    Because the materiality test will measure only the increase in 
total funded debt that results from loans that meet the purpose test, 
rather than the total increase in funded debt from any source, the 
final rule continues to define a material increase as at least 20 
percent. Increasing the threshold above 20 percent could exclude 
borrowers that were highly leveraged before obtaining a loan that meets 
the purpose test, even if the loan was large. Furthermore, the final 
rule already adopts a narrower definition of higher-risk C&I loans than 
existing and proposed regulatory guidelines on leveraged lending, which 
do not contain any materiality test.\24\ The final rule also simplifies 
the materiality test by requiring that a loan that meets the purpose 
test must be at least 20 percent of total funded debt as of the date of 
origination, rather than as of one year earlier.
---------------------------------------------------------------------------

    \24\ OCC's February 2008 Comptroller's Handbook on Leverage 
Lending (pages 2 and 3) and the (interagency) Proposed Guidelines on 
Leveraged Lending, 77 FR 19417 (March 30, 2012).
---------------------------------------------------------------------------

    The FDIC received no comments on the definition of the leverage 
test proposed in the NPR.
Exclusions From the Definition of Higher-Risk C&I Loan and Security
    As proposed in the NPR, the definition of a higher-risk C&I loan 
and security in the final rule excludes the maximum amount that is 
recoverable from the U.S. government under guarantee or insurance 
provisions, as well as loans (including syndicated or participated 
loans) that are fully secured by cash collateral.25 26
---------------------------------------------------------------------------

    \25\ To exclude a loan based on cash collateral, the cash must 
be in the form of a savings or time deposit held by an insured 
depository institution. The insured depository institution (or lead 
institution or agent bank in the case of a participation or 
syndication) must have a perfected first priority security interest, 
a security agreement, and a collateral assignment of the deposit 
account that is irrevocable for the remaining term of the loan or 
commitment. In addition, the institution must place a hold on the 
deposit account that alerts the institution's employees to an 
attempted withdrawal. If the cash collateral is held at another 
institution or at multiple institutions, a security agreement must 
be in place and each institution must have in place an account 
control agreement (as defined in Appendix C). For the exclusion to 
apply to 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).
    \26\ The NPR proposed excluding from the definition of a higher-
risk C&I loan and security ``the maximum amount that is recoverable 
from * * * [GSEs] under guarantee or insurance provisions,'' but the 
final rule omits this language because no GSE guarantees or insures 
C&I loans or securities issued by a C&I borrower.
---------------------------------------------------------------------------

    In the joint letter, commenters recommended excluding loans that 
are collateralized by securities issued by the U.S. government, its 
agencies, or government-sponsored enterprises (GSEs). The final rule, 
however, does not exclude loans so collateralized because the 
collateral is subject to interest rate risk and collateral arrangements 
are subject to operational risk. Commenters also recommended excluding 
loans that are fully secured by brokerage account collateral 
(securities-based loans). The final rule does not exclude these loans 
because the value of the collateral is subject to several sources of 
risk, including operational, credit and market risk.
    A bank suggested that the definition of higher-risk C&I loans 
exclude loans acquired at a discount or marked to fair value. Another 
commenter suggested that the definition exclude modified loans. The 
final rule does not adopt these suggestions. The higher-risk 
concentration ratio is a forward looking financial measure aimed at 
capturing the risk of concentrations in higher-risk assets, 
irrespective of how the assets are valued on the balance sheet or 
whether they are modified. These loans have the characteristics of 
higher-risk loans, despite being recorded at a discount or at fair 
value at the date of acquisition or having been modified from the 
original terms. The future performance of these assets remains 
uncertain; the institution still faces the risk of additional losses on 
these assets.
    In the joint letter, commenters recommended that unplanned 
overdrafts not be included as higher-risk C&I loans, arguing that they 
create exposures that are incidental and cured within a few days, if 
not overnight. The final rule, however, defines C&I loans consistent 
with the Call Report definition of such loans, which includes unplanned 
overdrafts. An overdraft alone is unlikely to cause a borrower to be 
considered higher risk, however; it is only likely to be included as 
higher-risk to the extent that other loans cause a C&I borrower to be 
considered higher risk.
Exclusions for Asset-Based Lending and Floor Plan Lending
    The definition of higher-risk C&I loans and securities excludes 
certain well-collateralized asset-based loans and floor plan loans.\27\ 
Excluding these loans should result in better differentiation of risk 
among banks and will reduce reporting burden. Because these loans carry 
significant operational risk, the exclusions 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. The final rule provides that, if a 
bank's primary federal regulator (PFR) has criticized (i.e., included 
in Matters Requiring Attention or MRA) the bank's controls or 
administration of its asset-based or floor plan loan portfolios, the 
exclusion will not apply.
---------------------------------------------------------------------------

    \27\ The proposal included asset-based lending guidance. The 
final rule, however, incorporates this guidance into the asset-based 
lending exclusion conditions in Appendix C.
---------------------------------------------------------------------------

    The final rule details the conditions that institutions must meet 
to be eligible for the asset-based and floor plan lending exclusions. 
The differences

[[Page 66004]]

between the final rule and the NPR are generally the result of 
recommendations from commenters. The final rule requires that a new 
borrowing base certificate be obtained within 30 days before or after 
each draw or advance on a loan, as opposed to requiring a new borrowing 
base certificate at each draw or advance, as proposed in the NPR.\28\ A 
bank is required to validate the borrowing base, but is not required to 
do so at each draw, as was proposed in the NPR.\29\ In their joint 
letter, commenters stated that it is not standard practice for lenders 
to obtain a new borrowing base certificate at each advance or draw on a 
loan, and noted that it is not unusual for draws to occur on a daily 
basis. The commenters further stated that requiring lenders to obtain a 
new borrowing base certificate at each advance or draw would impose a 
major administrative burden on banks and their borrowers. In the joint 
letter, commenters recommended that a new borrowing base certificate be 
required within 60 days of each draw or advance. The final rule adopts 
a 30-day requirement on the grounds that 60 days does not provide 
sufficient assurance that the loan is fully secured.
---------------------------------------------------------------------------

    \28\ A ``borrowing base certificate'' is defined in Appendix C.
    \29\ The requirements of the validation process are discussed 
further in Appendix C.
---------------------------------------------------------------------------

    The final rule permits a bank to exclude an asset-based loan from 
higher-risk C&I loans owed by a higher-risk C&I borrower, provided that 
the advance rate on the accounts receivables that serve as collateral 
for the loan does not exceed 85 percent. This is a change from the NPR, 
which proposed that advance rates on accounts receivable should 
generally not exceed 75 percent to 85 percent of eligible receivables. 
One commenter noted that the term ``generally'' gave institutions the 
option to allow advance rates of greater than 85 percent of eligible 
accounts receivable when appropriate. Because advance rates in excess 
of 85 percent expose the lender to the risk of loss from a relatively 
small default rate on accounts receivable, however, the final rule 
requires that advance rates never exceed 85 percent for the exclusion 
to apply.
    In response to comments, the final rule also provides that:
     The borrowing base may include other assets, but a loan 
must be fully secured by the portion of the borrowing base that is 
composed of accounts receivable and inventory.
     Appraisals will not be required for accounts receivable 
collateral. In addition, when there is a readily available and 
determinable market price for inventory from a recognized exchange or 
third-party industry source, inventory may be valued using these 
sources in lieu of an appraisal.
     An institution need not have the unconditional ability to 
take control of a borrower's deposit accounts to be eligible for the 
asset-based lending exclusion; rather, it is sufficient if the lending 
institution has the legally enforceable ability to take dominion over 
the borrower's deposit accounts without further consent by the borrower 
(or any other party). In all cases, the lending bank must have a 
perfected first priority security interest in the deposit account, a 
security agreement must be in place and, if the account is held at an 
institution other than the lending institution, an account control 
agreement must also be in place.\30\
---------------------------------------------------------------------------

    \30\ For the purposes of this rule, an account control agreement 
means a written agreement between the lending bank (the secured 
party), the borrower, and the institution that holds the deposit 
account serving as collateral (the depository bank), that the 
depository bank will comply with instructions originated by the 
secured party directing disposition of the funds in the deposit 
account without further consent by the borrower (or any other 
party).
---------------------------------------------------------------------------

     The lending bank must have the ability to withhold funding 
of a draw or loan advance if the outstanding balance on the loan is not 
within the collateral formula prescribed by the loan agreement.
     A bank's lending policies or procedures must address the 
maintenance of an inventory loan agreement with the borrower, 
consistent with the requirements for an accounts receivable loan 
agreement.
     Banks are required to obtain financial statements from 
dealer floor plan borrowers, but the statements need not be audited. 
Original Equipment Manufacturers (OEM) financial statements, otherwise 
known as dealer statements, will be sufficient.
Higher-Risk Consumer Loans
    ``Higher-risk consumer loans'' are defined as 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) is greater than 20 percent, excluding those consumer loans 
that meet the definition of a nontraditional mortgage 
loan.31 32
---------------------------------------------------------------------------

    \31\ For the purposes of this rule, consumer loans consist of 
all loans secured by 1-4 family residential properties as well as 
loans and leases made to individuals for household, family, and 
other personal expenditures, as defined in the instructions to the 
Reports of Condition and Income, Schedule RC-C, as the instructions 
may be amended from time to time.
    \32\ 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. If 
the loan later ceases to meet the definition of nontraditional 
mortgage loan but continues to qualify as a higher-risk consumer 
loan, however, it must then be reported as a higher-risk consumer 
loan.
---------------------------------------------------------------------------

Higher-risk PD Threshold
    As noted by commenters, the FDIC may need to adjust the higher-risk 
PD threshold after reviewing data for the first reporting period, since 
the 20 percent threshold in the definition was determined based on 
preliminary score-to-default rate mappings received from a few credit 
score providers.
    The NPR proposed that the FDIC could change the PD threshold 
without further notice-and-comment rulemaking. Several trade groups 
commented that the higher-risk PD threshold, after a potential 
adjustment following the first reporting period, should remain 
invariant and not be changed without notice-and-comment rulemaking.
    The final rule is generally consistent with these comments.\33\ 
Under the final rule, the FDIC retains the flexibility to change the 20 
percent threshold without further notice-and-comment rulemaking, but 
only as the result of reviewing data for up to the first two reporting 
periods. The FDIC will give banks at least one quarter advance notice 
of any change through a Financial Institution Letter. Any subsequent 
changes to the threshold will be made through notice-and-comment 
rulemaking.
---------------------------------------------------------------------------

    \33\ Several commenters also suggested that, if the FDIC were to 
adjust the PD threshold, the new threshold should only apply to 
loans originated or refinanced after the effective date of the 
change, and the determination that a loan is or is not higher risk 
will be based on the previous threshold. In the commenters' view, 
this suggestion would allow institutions to adjust their pricing 
policies prospectively to account for the cost of making a new loan 
that meets the revised threshold. Because the final rule requires 
notice-and-comment rulemaking before changing the PD threshold 
(except for a potential change after the first or second reporting 
period under the final rule), this issue would be addressed in any 
such future rulemaking.
---------------------------------------------------------------------------

    A threshold of 20 percent was found to be generally consistent with 
score-based definitions of subprime commonly used by the industry, 
capturing the riskiest 10 to 20 percent of consumer loans on a national 
basis. If, once the final rule is in effect, the overall proportion of 
consumer loans reported as higher-risk among large institutions differs 
materially from this preliminary estimate of 10 to 20 percent of 
consumer loans, the FDIC may decide to adjust the 20 percent threshold. 
The final rule, like the proposed rule, gives the FDIC the flexibility 
to make this change without further notice-and-

[[Page 66005]]

comment rulemaking (as a result of reviewing data reported for the 
first one or two reporting periods) so that a re-calibration of the 
measure can be accomplished quickly to prevent banks from being 
unfairly assessed. Before making any such change, the FDIC will analyze 
the potential effect of changing the PD threshold on the distribution 
of higher-risk consumer loans among institutions and the resulting 
effect on assessments collected from the industry.
    One bank commented that the higher-risk PD threshold should vary by 
product type, and that volatility in default rates is more relevant 
than the average level of default rates. As an example, the bank noted 
that, although credit card default rates were higher than default rates 
on some other products during the recent crisis, the default rates on 
credit cards rose less than the default rates on other products. In 
particular, the default rates on mortgages rose significantly and 
unexpectedly, causing losses that threatened institutions and the 
financial system. The bank also commented that other risk factors, such 
as historic default rates, yields, and resilience to stress, should be 
taken into account.
    While the factors that the commenter mentioned are relevant, taking 
them into account in the definition of a higher-risk consumer loan 
would introduce excessive complexity with uncertain improvements in 
risk differentiation. Under the final rule, as proposed in the NPR, 
institutions must estimate the two-year PD for a consumer loan based on 
how loans with similar risk characteristics performed during the recent 
crisis. The FDIC chose to use the recent stress period for PD 
estimation, as opposed to a longer history, to capture the consumer 
behavior that generated significant unexpected losses. The PDs 
estimated using the specified time periods are not intended to reflect 
long-run mean default rates or capture product-by-product differences 
in more favorable periods.
Methodology for Estimating PDs
    Time period. Under the final rule, and as proposed in the NPR, an 
institution must estimate the two-year PD for a consumer loan based on 
the observed stress period default rate (defined below) for loans of a 
similar product type made to consumers with credit risk comparable to 
the borrower being evaluated, all as detailed in the estimation 
guidelines in Appendix C. To capture the default behavior of consumers 
during a period of economic stress, the default rate is to be 
calculated as the average of the two, 24-month default rates from July 
2007 to June 2009, and July 2009 to June 2011.\34\
---------------------------------------------------------------------------

    \34\ Institutions must use the formula in Appendix C to 
calculate the average default rate.
---------------------------------------------------------------------------

    Several trade groups and two institutions commented that the time 
periods used for PD estimation should be updated bi-annually. These 
commenters suggested that the average default rates could be calculated 
on a rolling basis, using the two most recent consecutive 24-month 
periods, or on a cumulative basis using all consecutive 24-month 
periods from July 2007 forward. They noted that it is standard industry 
practice to recalibrate credit models at least once a year, and that 
model parameters more than two years old are generally considered 
unreliable. Furthermore, the commenters stated that specifying a 
regular interval for updating the time periods would make the process 
more predictable and give institutions an opportunity to adjust their 
credit policies and pricing in advance of any changes, thus promoting a 
more stable flow of credit to consumers.
    Identifying higher-risk consumer loans based on PD estimates from a 
time of economic stress is consistent with the FDIC's objective of 
assessing large institutions during favorable periods based on how they 
are likely to perform during periods of stress, as explained in the 
February 2011 rule. If the time period were to be updated on a rolling 
or cumulative basis, as suggested, the resulting PD estimates would 
eventually not reflect the performance of loans during the recent 
crisis. While the updated default rates might be closer to realized 
two-year default rates during favorable periods, they would generally 
not capture the relative differences in default behavior among product 
types that can be expected to occur under stress conditions (and that 
actually did occur during the recent financial crisis). In addition, 
unless changes were made to the higher-risk PD threshold of 20 percent, 
any regular updating of the time period could introduce an undesirable 
level of pro-cyclicality into the higher-risk concentration measure, 
whereby the volume of higher-risk loans would tend to rise as credit 
conditions deteriorated, and fall as conditions improved. This type of 
volatility could occur even if the distribution of credit scores in a 
loan portfolio remained static over time. The final rule avoids this 
volatility by using a fixed historical period for measuring default 
rates.
    Default rates calculated using the recent crisis period may not 
reflect future changes in macroeconomic factors, industry standards, or 
consumer behavior that affect the riskiness of different product types. 
To ensure that the PD methodology continues to accurately identify 
higher-risk consumer loans, the FDIC may need to update the time period 
used for PD estimation at some point. Under the final rule, unlike the 
proposed rule, a change in the time period would require further 
notice-and-comment rulemaking.
    Default rate and definition of ``active loan.'' The final rule 
requires institutions to calculate the default rate for each 24-month 
time period 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 24-month 
period). An ``active'' loan is defined as any loan that was open and 
not in default as of the observation date, and on which a payment was 
made within the 12 months prior to the observation date. This 
definition differs from the one proposed in the NPR, which had defined 
an active loan as a loan that 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. The FDIC had proposed this 
balance-based definition to exclude accounts that, while open and 
available for use, were generally not being used. Including these 
accounts in the default rate calculation could result in PD estimates 
that understate the default experience of truly active accounts. The 
FDIC also based its proposal on indications that historical balance 
data were available in the credit bureau data used by third-party 
providers of consumer credit scores.
    One credit reporting bureau, however, informed the FDIC that 
historical data on account balances are often either unavailable or 
difficult to obtain. The credit reporting bureau also suggested that 
the proposed approach could miss active revolving loans where the 
balance is completely paid off each month. As an alternative, the 
credit reporting bureau suggested that an active account could be 
defined as any loan reported by the lender in the 12 months prior to 
the observation date, or any loan that has a positive balance as of the 
observation date.
    The FDIC concluded, based on discussions with the three major 
credit reporting bureaus, that the date of last payment is information 
that is generally reported and maintained historically. In addition, 
defining an active loan using the date of last payment should better 
capture active revolving accounts that pay off monthly compared to both 
the proposed definition and a definition

[[Page 66006]]

that would rely on the balance only as of the observation date. While 
the commenter's suggestion to include any loan reported by the lender 
in the 12 months prior to the observation date would also capture these 
revolving accounts, this definition could capture accounts that are no 
longer open as of the observation date or are otherwise inactive.
    Additional risk factors. The final rule requires that, at a 
minimum, the PD estimate of a loan must be based on the product type 
and credit score of the borrower. In response to a comment, the final 
rule clarifies that institutions may consider risk factors other than 
product type and credit score (e.g., geography) in estimating the PD of 
a loan, because these factors may improve PD estimates. All estimation 
requirements detailed in the final rule, including the minimum sample 
size, however, must be satisfied regardless of the number of factors 
used.
    Mapping scores to default rates. The final rule requires 
partitioning the entire credit score range generated by a given scoring 
system into a minimum of 15 credit score bands. A PD for each credit 
score band and loan product type (and for any other risk factor being 
considered) must be estimated as the average of two particular 24-month 
default rates as described in Appendix C. Each 24-month default rate 
must be calculated using a random sample of at least 1,200 active 
loans. Although each score band will likely include multiple credit 
scores, each credit score will need to have a unique PD associated with 
it. Therefore, when the number of score bands is less than the number 
of unique credit scores (as will almost always be the case), banks must 
use a linear interpolation between adjacent default rates to determine 
the PD for a particular score. The observed default rate for each band 
must be assumed to correspond to the midpoint of the range for that 
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] TR31OC12.025

    One provider of consumer credit scores recommended an alternative 
to the proposed method of assigning PDs to individual score values. 
This commenter suggested that the FDIC permit banks to use a least-
squares regression or other accepted statistical methodology to 
estimate the score-to-default rate relationship. The commenter noted 
that the relationship between the logarithm of the odds of not 
defaulting and the FICO score is very close to linear. The commenter 
argued that PDs estimated using a regression would be less dependent on 
the way institutions structure score bins and provide more reliable 
estimates of future default rates for a given score.
    Depending on the nature of the data, least-squares regression and 
alternative methods of estimating the score-to-default rate 
relationship may, in fact, have certain advantages over the proposed 
approach. Given the minimum sample size and score band requirements, 
however, estimates generated using the proposed approach should be 
similar to those generated using alternative statistical methods. While 
the industry generally understands and uses linear interpolation, many 
banks that try to develop their own PD estimates according to the 
requirements may lack the expertise to apply more sophisticated fitting 
methods to their data. To ensure consistency among estimation methods, 
the final rule retains the linear interpolation approach.
    Alternative methodology. Like the proposed rule, the final rule 
allows institutions to request to use default rates calculated using 
fewer observations or score bands than the specified minimums, either 
in advance of, or concurrent with, actual reporting under the requested 
approach. The request must explain in detail how the requested approach 
differs from the rule specifications and include, at a minimum, a table 
with default rates and the 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 approach 
while the FDIC evaluates the request. If, after reviewing the request, 
the FDIC determines that the institution's approach is unacceptable, 
the institution may be required to amend its Call Reports and treat any 
loan whose PD had been estimated using the disapproved methodology as 
an unscorable domestic consumer loan subject to the de minimis approach 
described above; the institution, however, will be required to submit 
amended information for no more than the two most recently dated and 
filed Call Reports preceding the FDIC's determination.
    One trade group commented that the FDIC should publish its criteria 
for evaluating methodologies that deviate from the PD estimation 
requirements. The trade group stated that providing the criteria would 
help smaller institutions evaluate their options before devoting time 
and resources to developing an alternative methodology. Because the 
final rule allows institutions to request the use of PD estimates that 
differ from the specifications only in the two specific respects noted 
previously (using fewer observations or score bands than the specified 
minimums), institutions should not be expending resources developing an 
entirely different methodology. While providing more specific guidance 
on acceptable alternatives to the score band and sample size 
requirements may make the decision process easier for institutions, the 
range of potentially acceptable alternatives is broad enough to 
preclude the final rule from providing predetermined criteria.
    In the joint letter, commenters suggested that a simplified method 
of reporting should be permitted for banks with minimal exposure to 
higher-risk consumer loans. The commenters stated that the potential 
benefit to the FDIC would be small relative to the cost these banks 
would incur to comply with the new definition. The commenters suggested 
that if a bank's subprime loans--defined based on the 2001 interagency 
guidance--were less than one percent of Tier 1 capital and reserves, 
they should be allowed to report the amount as higher-risk if it is 
less costly for them to do so. One trade group suggested that if a 
portfolio has a default rate consistently below 10 percent and the bank 
maintains prudent underwriting criteria and appropriate monitoring for 
loans placed in that portfolio, the bank should not be required to 
estimate and report the PDs of loans in the portfolio. This same trade 
group stated that loans made before the effective date of the rule 
should be exempt from PD reporting, or the FDIC should provide a 
transitional period of at least three years.
    Under the final rule, as proposed in the NPR, banks must calculate 
the PDs of all outstanding consumer loans following the effective date 
of the rule. Because the 2001 interagency guidance for subprime lending 
differs from the definition in the final rule, allowing banks to 
determine their level of exposure using this alternative standard could 
result in inconsistent treatment of loans across banks. This same 
inconsistency could result if alternative criteria were used, such as 
having a default rate consistently below 10 percent. While banks will 
need some

[[Page 66007]]

time to modify systems and processes to report under the definitions in 
the final rule, the suggested transition period of three years could 
result in the assessment system failing to identify higher-risk 
concentrations for too long. The effective date of April 1, 2013, 
should give banks sufficient time to comply with the final rule.
Unscorable Consumer Loans
    The final rule definition, like the definition proposed in the NPR, 
requires institutions to estimate the two-year PD of a loan based, in 
part, on the credit risk of the borrower as reflected in a credit 
score.\35\ When a consumer loan has a co-signer or co-borrower, the PD 
may be determined using the most favorable individual credit score. For 
unscorable consumer loans--where the available information is 
insufficient to determine a credit score--the final rule specifies the 
following treatment: if the total outstanding balance of unscorable 
consumer loans of a particular product type exceeds 5 percent of the 
total outstanding balance for that product type, including both foreign 
and domestic loans, the excess amount shall be treated as higher-risk 
(the de minimis approach). Otherwise, the total outstanding balance of 
unscorable consumer loans of a particular product type will not be 
considered higher-risk. The consumer product types used to determine 
whether the 5 percent test is satisfied shall correspond to the product 
types listed in the table used for reporting PD estimates. If, after 
the origination or refinance of the loan, an unscorable consumer loan 
becomes scoreable, the final rule requires institutions to reclassify 
the loan using the PD estimated according to the rule specifications. 
Based upon that PD, the loan will be determined to be either higher 
risk or not, and that determination will remain in effect until a 
refinancing occurs, at which time the loan must be re-evaluated. An 
unscorable loan must be reviewed at least annually to determine if a 
credit score has become available.
---------------------------------------------------------------------------

    \35\ As detailed in Appendix C, the credit risk of the borrower 
must be determined using a third-party or internal scoring system 
that qualifies as empirically derived, demonstrably and 
statistically sound (EDDSS), as defined in 12 CFR 202.2(p), as 
amended from time to time, and that has been approved by the bank's 
model risk oversight and governance process and internal audit 
mechanism.
---------------------------------------------------------------------------

    Several trade groups commented that the proposed rule did not 
consider how large banks are to treat consumer credits with no credit 
histories or scores. These groups noted that this issue is relevant for 
all types of consumer loans, but especially for student and credit card 
loans. One trade group argued that an institution should not be 
automatically required to classify unscorable loans as higher-risk, 
because doing so would cause some products, such as student loans, to 
become more expensive or less available. In the joint letter, 
commenters suggested that, to account for unscorable loans, large banks 
with sufficient data on the performance of such loans should be allowed 
to develop internal PD estimates using the same time period and sample 
size requirements in the rule. For large banks that do not have 
sufficient data to create such a mapping, the commenters stated that 
unscorable loans could initially be treated as higher-risk and 
subsequently re-evaluated according to the rule specifications once a 
credit score becomes available for the borrower. The commenters also 
noted that, although initially classifying unscorable loans as higher-
risk is excessively conservative, it would be considered generally 
acceptable to large banks so long as a subsequent re-evaluation of 
these loans is permitted. For unscorable student loans, however, the 
commenters recommended that a PD distribution based on the bank's long-
term default experience be permitted as opposed to initially 
classifying the loans as higher-risk.
    Unscorable loans were not addressed in the proposed rule. In 
evaluating treatment options for purposes of the final rule, the FDIC 
sought information from a few credit score providers on the performance 
of unscorable loans by product type as well as data from large banks on 
the volume of unscorable loans outstanding. Data on the historical 
performance of unscorable loans were generally unavailable. Further, 
where data were available, the performance of unscorable loans relative 
to their scored counterparts was found to vary significantly by product 
type, and product definitions were not consistent with the Call Report 
definitions expected to be used for reporting purposes. More 
importantly, because credit scoring systems may differ in their ability 
to score certain consumers, basing the treatment of all unscorable 
loans on performance data from only a few score providers would be 
inappropriate. For these reasons, the final rule adopts the 
conservative approach suggested in the joint letter--initially treating 
such loans as higher-risk (subject to the de minimis approach) and 
requiring banks to re-evaluate the loans according to the PD 
specifications once a credit score becomes available for the borrower.
    The final rule does not permit institutions to develop PD estimates 
for unscorable loans based on internal data, nor does the final rule 
apply a separate standard for student loans as recommended in the joint 
letter. To permit banks with sufficient internal data to apply PD 
estimates to unscorable loans while requiring other banks to initially 
classify the loans as higher-risk (subject to the de minimis approach) 
could create an unfair advantage for those banks with sufficient 
internal data. As the commenters acknowledged, many student loans are 
either government guaranteed or co-signed by parents or other 
individuals with a credit history and can be scored; therefore, the 
volume of unscorable student loans that would be initially treated as 
higher-risk is likely to be small. Nevertheless, to avoid capturing 
immaterial exposures to unscorable student loans as well as other types 
of unscorable loans in the higher-risk measure, the final rule 
classifies only the outstanding balance of unscorable loans in a 
portfolio that exceeds 5 percent of the total outstanding balance for 
the portfolio as higher-risk (the de minimis approach). If the 
outstanding balance of unscorable loans does not exceed 5 percent of 
the total, the amount will be ignored for the purpose of calculating 
higher-risk consumer loans.
Foreign consumer loans
    The NPR did not discuss the treatment of foreign consumer loans, as 
pointed out in the joint letter. Under the final rule, a bank must 
estimate the PD of a foreign consumer loan according to the general 
specifications described above (and in Appendix C) unless doing so 
would be unduly complex or unduly burdensome (e.g., if a bank had to 
develop separate PD mappings for many different countries). A bank may 
request to use the alternative methodology described above (i.e., to 
use default rates calculated using fewer observations or score bands 
than the specified minimums), either in advance of or concurrent with 
reporting under that methodology, but must comply with the requirements 
detailed above for using an alternative methodology.
    When estimating a PD according to the general specifications 
described above and in Appendix C would be unduly complex or unduly 
burdensome, a bank that is required to calculate PDs for foreign 
consumer loans under the requirements of the Basel II capital framework 
may: (1) Use the Basel II approach discussed below, subject to the 
terms discussed below; (2) submit a written request to the FDIC to use 
an alternate methodology, but may not use the methodology until 
approved by the

[[Page 66008]]

FDIC; \36\ or (3) treat the loan as an unscorable consumer loan subject 
to the de minimis approach described above.
---------------------------------------------------------------------------

    \36\ The FDIC may request additional information from the bank 
regarding the proposed methodology and the bank must provide the 
information. The FDIC may grant a bank tentative approval to use a 
methodology while the FDIC considers it in more detail. If the FDIC 
ultimately disapproves the methodology, the bank will be required to 
amend Call Reports affected by the disapproved methodology treating 
any loan whose PD had been estimated using the disapproved 
methodology as an unscorable consumer loan subject to the de minimis 
approach described above; however, the institution will be required 
to amend no more than the two most recently dated and filed Call 
Reports preceding the FDIC's determination.
---------------------------------------------------------------------------

    When estimating a PD according to the general specifications 
described above and in Appendix C would be unduly complex or unduly 
burdensome, a bank that is not required to calculate PDs for foreign 
consumer loans under the requirements of the Basel II capital framework 
may: (1) Treat the loan as an unscorable consumer loan subject to the 
de minimis approach described above; or (2) submit a written request to 
the FDIC to use an alternate methodology, but may not use the 
methodology until approved by the FDIC.\37\
---------------------------------------------------------------------------

    \37\ The provisions in the previous footnote also apply in this 
case.
---------------------------------------------------------------------------

    Basel II approach. A bank that is required to calculate PDs for 
foreign consumer loans under the requirements of the Basel II capital 
framework may estimate the two-year PD of a foreign consumer loan based 
on the one-year PD used for Basel II capital purposes.\38\ The bank 
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 one-year PDs calculated under the Basel II framework are 
translated to two-year PDs that meet the final rule specifications. 
While the range of acceptable approaches is potentially broad, any 
proposed methodology must meet the following requirements:
---------------------------------------------------------------------------

    \38\ Use of this method does not imply that a bank's PFR has 
approved use of the PDs for the Basel II capital framework. If a 
bank's PFR requires it to revise its Basel II PD methodology, the 
bank must use revised Basel II PDs to calculate (or recalculate if 
necessary) corresponding PDs under this Basel II approach.
---------------------------------------------------------------------------

     The bank must use data on a sample of loans for which both 
the one-year Basel II PDs and two-year final rule PDs can be 
calculated. The sample may contain both foreign and domestic loans.
     The bank must use the sample data to demonstrate that a 
meaningful relationship exists between the two types of PD estimates, 
and the significance and nature of the relationship must be determined 
using accepted statistical principles and methodologies. For example, 
to the extent that a linear relationship exists in the sample data, the 
bank may use an ordinary least-squares regression to determine the best 
linear translation of Basel II PDs to final rule PDs. The estimated 
equation should fit the data reasonably well based on standard 
statistics such as the coefficient of determination.
     The method must account for any significant variation in 
the relationship between the two types of PD estimates that exists 
across consumer products based on the empirical analysis of the data. 
For example, if the bank is using a linear regression to determine the 
relationship between PD estimates, it should test whether the parameter 
estimates are significantly different by product type.
    The bank may report using this approach while the FDIC evaluates 
the methodology. If, after reviewing the methodology, the FDIC 
determines that the methodology is unacceptable, the institution will 
be required to amend its Call Reports. The institution will be required 
to submit amended information for no more than the two most recently 
dated and filed Call Reports preceding the FDIC's determination.
    Under the NPR, banks would not have been permitted to estimate the 
two-year PD of a foreign consumer loan using the Basel II PD. The joint 
letter commenters stated that the FDIC should consider issues specific 
to the scoring of loans from foreign markets. These commenters 
indicated that, due to the diversity of national credit markets, 
pervasive lack of standardized industry risk scores in other countries, 
and difficulty in applying U.S.-specific rules to many other markets, 
banks should be permitted to use other information in assessing the PD 
for a foreign loan. The commenters stated that such information could 
include the Basel II PD ``or other measures that the banks consider to 
be reasonable indications of a cyclical view adjusted for the 
differences in the definition of default and timing of account risk 
assessment.'' The commenters added that institutions should be allowed 
to exercise judgment in making their determination given that not all 
of the information required under the proposed definition may be 
reasonably available.
    The final rule builds upon the suggestion of allowing banks subject 
to the Basel II framework to develop PD mappings for foreign consumer 
loans based on the Basel II PDs used for capital purposes. The final 
rule permits only banks subject to the Basel II framework to be able to 
use an alternative approach based on the Basel II PD automatically 
(provided that estimating a PD according to the general specifications 
described above and in Appendix C would be unduly complex or unduly 
burdensome), because the Basel II PD is well defined, subject to 
supervisory review and approval for banks subject to the Basel II 
approach, and likely to be correlated with PD estimates developed 
according to the final rule requirements. In addition, those 
institutions that operate in many foreign markets, and for which the 
general methodology for determining PDs would likely be burdensome, are 
subject to Basel II requirements.
Missing Data
    Under the final rule, banks must determine the PD of a consumer 
loan as of the date the loan was originated, or, if the loan has been 
refinanced, as of the date it was refinanced. For loans originated or 
refinanced by a bank before April 1, 2013, and all loans acquired by a 
bank regardless of the date of acquisition, if information as of the 
date the loan was originated or refinanced is not available, then the 
institution must use the oldest available information to determine the 
PD. If no information is available, then the institution must obtain 
recent, refreshed data from the borrower or other appropriate third 
party to determine the PD. Refreshed data is defined as the most recent 
data available, and must be as of a date that is no earlier than three 
months before the acquisition of the loan. In addition, for loans 
acquired on or after April 1, 2013, the acquiring bank shall have six 
months from the date of acquisition to determine the PD.
    The joint letter commenters suggested that, if data as of 
origination or refinance are unavailable for an acquired loan, a bank 
should be able to use the oldest data on file or refreshed data to 
determine if the loan was higher risk. The commenters further stated 
that a bank should not be required to go to extraordinary lengths to 
obtain a credit score or PD from the originating lender; the bank 
should be able to use the best available data at the time of 
acquisition. The commenters recommended that a bank be given, at most, 
one year from the date a loan is acquired to determine the PD of the 
loan, instead of the proposed timeframe of three months. The commenters 
also recommended this approach--using refreshed data or the oldest data 
available when data as of origination or refinance are unavailable--for 
evaluating loans originated or purchased prior to the effective date of 
the rule. The commenters argued that there has been

[[Page 66009]]

no reason in the past for large banks to maintain the data needed to 
determine the PDs for loans already on the books.
    Under the final rule, a bank is not required to go to extraordinary 
lengths to obtain a credit score or PD for an existing or acquired 
loan; however, the bank must use the available data closest to the date 
of origination or refinance to minimize inconsistencies in PD 
estimates. While banks may need additional time to gather and evaluate 
the information for an acquired consumer loan, the joint letter 
commenters offered no reason that a full year would be needed. If data 
from the original lender are unavailable, banks should be able to 
obtain a refreshed credit score for most borrowers at reasonable cost. 
Further, allowing acquired loans that are truly higher risk to be 
treated as non-higher risk for up to one year could result in a bank's 
risk being under-assessed for too long. Therefore, the final rule gives 
banks six months to complete this determination.
Exclusions
    Consistent with the definition of a higher-risk C&I loan and 
security, the final rule definition of a higher-risk consumer loan 
excludes the maximum amount that is recoverable from the U.S. 
government under guarantee or insurance provisions, as well as loans 
that are fully secured by cash collateral.39 40
---------------------------------------------------------------------------

    \39\ To exclude a loan based on cash collateral, the cash must 
be in the form of a savings or time deposit held by a bank. The 
lending bank (or lead or agent bank in the case of a participation 
or syndication) must, in all cases, (including instances in which 
cash collateral is held at another bank or banks) have a perfected 
first priority security interest under applicable state law, a 
security agreement in place, and all necessary documents executed 
and measures taken as required to result in such perfection and 
priority. In addition, the lending bank must place a hold on the 
deposit account that alerts the bank's employees to an attempted 
withdrawal. For the exclusion to apply to 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).
    \40\ The NPR proposed excluding from the definition of a higher-
risk consumer loan ``the maximum amounts recoverable from * * * 
[GSEs] under guarantee or insurance provisions,'' but the final rule 
omits this language because no GSE guarantees or insures individual 
consumer loans.
---------------------------------------------------------------------------

    In the joint letter, commenters recommended excluding loans that 
are collateralized by securities issued by the U.S. government, its 
agencies, or GSEs. The final rule, however, does not exclude loans so 
collateralized because the collateral is subject to interest rate risk 
and collateral arrangements are subject to operational risk.
    Commenters also recommended excluding loans that are fully and 
continuously secured by brokerage account collateral (securities-based 
loans). As in the case of higher-risk C&I loans, several commenters 
suggested that other factors, such as loan-to-value (LTV) ratios, 
credit history, and borrower resources, should factor into the 
definition of a higher-risk consumer loan.
    The final rule definition, like the definition proposed in the NPR, 
does account for a borrower's credit history, because the two-year PD 
is based, in part, on the credit score of the borrower. The final rule 
does not, however, adopt the other suggested exclusions. To ensure 
consistency, excluding loans from the higher-risk totals based upon 
these criteria would require the development of numerous thresholds, 
such as appropriate LTVs for various asset types, frequent updating of 
appraisals of collateral, and frequent updating of borrower's financial 
statements. In addition, the final rule does not exclude loans secured 
by brokerage account collateral because the value of the collateral is 
subject to several sources of risk, including operational, credit, and 
market risk.
Definition of ``Refinance''
    One large bank sought clarification on whether re-aging a loan as a 
loss mitigation activity would qualify as a refinancing of the loan. 
The FDIC believes conservative re-aging programs are a loss mitigation 
activity, not a refinance, provided the institution follows, at a 
minimum, the re-aging guidelines recommended in the interagency 
approved Uniform Retail Credit Classification and Account Management 
Policy.\41\ Thus, among other things, for a loan to be considered for 
re-aging, the following must be true: (1) The borrower must have 
demonstrated a renewed willingness and ability to repay the loan; (2) 
the loan must have existed for at least nine months; and (3) the 
borrower must have made at least three consecutive minimum monthly 
payments or the equivalent cumulative amount.\42\ In addition, for re-
aging to be considered as a loss mitigation activity, and not as a 
refinance, the institution's program must have clearly defined policy 
guidelines and parameters for re-aging, as well as internal methods of 
ensuring the reasonableness of those guidelines and for monitoring 
their effectiveness. Institutions must also monitor both the number and 
dollar amount of re-aged accounts, collect and analyze data to assess 
the performance of re-aged accounts, and determine the effect of re-
aging practices on past due ratios.
---------------------------------------------------------------------------

    \41\ 65 FR 36903 (June 13, 2000).
    \42\ The definition of refinance is discussed in Appendix C.
---------------------------------------------------------------------------

    In the joint letter, commenters requested that an increase in a 
credit card line of credit of up to 10 percent should not be considered 
a refinance, as proposed for all other consumer loans. In addition, the 
joint letter commenters requested that when a bank has internally 
approved a higher credit line than it has made available to the 
customer, providing access to this additional credit should not be 
considered a refinance, as the bank has not underwritten new risk. The 
final rule makes these changes; further, to be consistent with other 
types of consumer loans, a non-temporary credit card line increase of 
10 percent or greater, that is not the result of a loss mitigation 
strategy, is a refinance under the final rule.\43\
---------------------------------------------------------------------------

    \43\ Under the final rule, a refinance excludes all temporary 
credit card line increases.
---------------------------------------------------------------------------

    The joint letter commenters also requested that an increase or 
decrease in the interest rate of a credit card loan should not be 
considered a refinance on the grounds that rate changes for credit card 
loans are commonplace (e.g., formulaic adjustments tied to underlying 
indices, expirations of introductory rates and special rates for 
balance transfers, and changes mandated by law such as the Credit CARD 
Act). The final rule clarifies that a change to the interest rate on a 
credit card loan that is consistent with the terms of the loan 
agreement is not a refinance.
Paperwork Reduction Act (PRA) Notice for the Call Reports
    The FDIC intends to collect the outstanding balance of consumer 
loans, by two-year PD and product type, from large and highly complex 
institutions. The types of information collected and the format of the 
information collected on the Call Report will be subject to a PRA 
notice, which will be published in the Federal Register with request 
for comment. The FDIC anticipates that appropriate changes to the Call 
Reports will be made and that institutions will report consumer loans 
consistent with the definition in the final rule. Several commenters 
stated that any PD data reported by the banks should be kept 
confidential and not disclosed or used in public statements. Moreover, 
these commenters stated that the final rule specifications for 
calculating the PD, designed to provide a consistent measure across 
large banks, will likely not reflect banks' internal PD estimates. The 
FDIC agrees with these comments

[[Page 66010]]

and affirms that any PD data reported for purposes of this rule will 
remain confidential.
    The following table is an example of how the FDIC may collect the 
consumer loan information. As suggested in the example table below, 
institutions would report the outstanding amount of all consumer loans, 
including those with a PD below the high-risk threshold, stratified by 
the 10 product types and 12 two-year PD bands. In addition, for each 
product type, institutions would report the amount of unscorable loans, 
as defined in the final rule, and indicate whether the PDs were derived 
using scores and default rate mappings provided by a third-party vendor 
or an internal approach.\44\ Although not included in this table, banks 
would report in their Call Reports the value of all securitizations 
(except those classified as trading book) of consumer loans that are 
more than 50 percent collateralized by consumer loans that would be 
identified as higher-risk assets.
---------------------------------------------------------------------------

    \44\ An internal approach includes 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.
[GRAPHIC] [TIFF OMITTED] TR31OC12.026

Nontraditional Mortgage Loans
    The final rule retains the definition of a nontraditional mortgage 
loan that was contained in the February 2011 rule; however, the final 
rule clarifies how securitizations of nontraditional mortgage loans 
will be identified under the definition. Securitizations are discussed 
in the section that follows.
    Several commenters on the NPR urged the FDIC to reconsider the 
definition of nontraditional mortgage loans. As the FDIC stated in the 
NPR, it 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.
Higher-Risk Securitizations
    As proposed in the NPR, the final rule requires securitizations, 
except securitizations classified as trading book, to be reported as 
higher-risk where, in aggregate, more than 50 percent of the assets 
backing the securitization meet the criteria for higher-risk C&I loans 
or securities, higher-risk consumer loans, or nontraditional mortgage 
loans.\45\ 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 DIF during times of prolonged periods of economic stress.
---------------------------------------------------------------------------

    \45\ Unscorable consumer loans that exceed 5 percent of the 
loans in a securitization are deemed higher-risk.
---------------------------------------------------------------------------

    The final rule treatment of securitizations differs from the 
proposed rule in a nonsubstantive way. In the final rule, higher-risk 
securitizations constitute a new classification of higher-risk assets 
rather than being included in higher-risk C&I loans or securities, 
higher-risk consumer loans, or nontraditional mortgage loans.\46\
---------------------------------------------------------------------------

    \46\ The definition of a higher-risk securitization in the final 
rule excludes the maximum amount that is recoverable from the U.S. 
government under guarantee or insurance provisions. The NPR proposed 
also excluding from the definition of a higher-risk C&I loan 
securitization ``the maximum amount that is recoverable from * * * 
[GSEs] under guarantee or insurance provisions,'' but the final rule 
omits this language because no GSE guarantees or insures 
securitizations containing C&I loans. The NPR also contained similar 
language with regard to the proposed definition of a higher-risk 
consumer loan securitization, and the final rule again omits this 
language. No GSE currently guarantees or insures securitizations 
where more than 50 percent of the assets backing the securitization 
consist of higher-risk consumer loans or nontraditional mortgages, 
and the definition of a higher-risk securitization in the final rule 
does not apply to a securitization issued before April 1, 2013.
---------------------------------------------------------------------------

    In determining whether or not to report a securitization as higher 
risk, a bank is required to use information reasonably available to a 
sophisticated investor in reasonably determining whether the 
securitization meets the 50 percent threshold.\47\ Information 
reasonably available to a sophisticated investor includes, but is not 
limited to, offering memoranda, indentures, trustee reports, and 
requests for information from servicers, collateral managers, issuers, 
trustees, or similar third parties. When determining whether a 
revolving

[[Page 66011]]

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.
---------------------------------------------------------------------------

    \47\ A securitization is as defined in 12 CFR part 325, Appendix 
A, Section II(B)(16), as it may be amended from time to time.
---------------------------------------------------------------------------

    The joint letter commenters pointed out that continuously obtaining 
updated information on actively managed open-ended securitizations 
(those securitizations where the underlying assets of the 
securitization may change) would not only be burdensome, but 
unnecessary, because governing indentures require securitization 
managers to maintain minimum credit quality. The final rule takes this 
point into account and provides that a bank must determine whether a 
securitization is higher-risk based upon information as of the date of 
issuance (i.e., the date the securitization is sold on a market to the 
public for the first time). The bank must make this determination 
within the time limit that would apply under Appendix C to this final 
rule if the bank were directly acquiring loans or securities of the 
type underlying the securitization. In making the determination, a bank 
must use one of the following methods:
     For a securitization collateralized by a static pool of 
loans, whose underlying collateral changes due to the sale or 
amortization of these loans, the 50 percent threshold is to be 
determined based upon the amount of higher-risk assets, as defined in 
Appendix C to this final rule, owned by the securitization on the date 
of issuance of the securitization.
     For a securitization collateralized by a dynamic pool of 
loans, whose underlying collateral may change by the purchase of 
additional assets, including purchases made during a ramp-up period, 
the 50 percent threshold is to be determined based upon the highest 
amount of higher-risk assets, as defined in Appendix C to this final 
rule, allowable under the portfolio guidelines of the securitization.
    The final rule uses the term ``issuance'' rather than 
``origination,'' as proposed in the NPR, because the term ``issuance'' 
is commonly used and understood in the securitization industry and is 
less open to misinterpretation. To relieve burden on the industry, the 
final rule does not adopt the proposal in the NPR that a securitization 
be evaluated at purchase, because the most readily available 
information will generally be that included in offering material 
compiled as of the date of issuance.
    In cases in which a securitization is required to be consolidated 
on the balance sheet as a result of SFAS 166 and SFAS 167, and where a 
bank has access to the necessary information, it may opt for an 
alternative method of evaluating the securitization to determine 
whether it is higher risk. The bank may evaluate individual loans in 
the securitization on a loan-by-loan basis and only report as higher 
risk those loans that meet the definition of a higher-risk asset; any 
loan within the securitization that does not meet the definition of a 
higher-risk asset need not be reported as such. Once an institution 
evaluates a securitization for higher-risk asset designation using this 
alternative evaluation method, it must continue to evaluate all 
securitizations that it has consolidated on the balance sheet as a 
result of SFAS 166 and SFAS 167, and for which it has the required 
information using the alternative evaluation method. 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 in the manner 
previously described for other securitizations.
    In the joint letter, commenters noted that some loan originators, 
securitizers, and servicers, including non-bank loan originators, 
securitizers, and servicers, may not currently collect the data needed 
to evaluate loans as higher-risk under the final rule. In particular, 
according to the trade groups, some may not collect data needed for the 
purpose and materiality tests of the higher-risk C&I loan definition. 
Some institutions that rely on loan securitization issuers or servicers 
to determine the credit quality of securitizations may need additional 
time to develop systems to collect the information necessary to make 
their own higher-risk asset determinations under the final rule. For 
these reasons, among others, the effective date of the final rule has 
been extended from October 1, 2012, as proposed in the NPR, to April 1, 
2013. Banks will not need to review securitizations issued before April 
1, 2013, to determine whether they are higher risk under the final 
rule. The new higher-risk definitions in the final rule will apply only 
to securitizations issued on or after that date, regardless of the date 
of origin of the underlying loans.
    In the joint letter, commenters asserted that the proposed means of 
identifying securitizations as higher-risk is unworkable and would make 
banks reluctant to invest in securitizations, which would impede the 
flow of credit to consumers and businesses and would further impair a 
market that is struggling to recover. In this same letter, commenters 
noted that securitizers have developed standards for the type and 
quantity of information that they provide investors, but this 
information may not be adequate for banks to make a higher-risk asset 
determination. Further, the commenters noted that securitizations could 
be issued by non-bank finance companies that are not subject to deposit 
insurance pricing rules or definitions and may not have the required 
data to provide to their investors. The commenters also added that 
institutions that invest in these securitizations cannot simply request 
the information needed to make a higher-risk asset determination or 
compel the servicer or originator to make that determination.
    The final rule, like the proposed rule, gives banks flexibility in 
making higher-risk asset determinations for securitizations. The final 
rule allows an institution to use information reasonably available to a 
sophisticated investor in reasonably determining whether a 
securitization meets the 50 percent threshold and suggests several 
sources for this information. In most cases, this information should be 
sufficient to make the determination, because banks must conduct 
thorough due diligence prior to purchase. Moreover, 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 when they purchase interests in these 
securitizations. The final rule, like the proposed rule, however, also 
acknowledges that 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 allows an institution to exercise its judgment in making the 
determination. A bank need not rely upon all of the aforementioned 
pieces of information if fewer documents provide sufficient data to 
make the determination.
    Commenters, through the joint letter, and a bank recommended that 
the FDIC allow banks to consider the structure of the securitization 
and any credit enhancements to it. They argued that, by not doing so, 
the FDIC is giving banks an incentive to acquire lesser quality, 
subordinated interests in securitizations, because variations in 
quality and subordination or the lack of it will not affect deposit 
insurance assessment rates.
    In the joint letter, commenters noted that, while the use of 
external credit ratings to determine the credit quality of 
securitization exposures is problematic due to Section 939A of the 
Dodd-Frank

[[Page 66012]]

Act, banks could use the proposed revised regulatory capital risk-
weighting methodologies currently in development by the bank regulatory 
agencies (the Standardized Approach for Risk-Weighted Assets \48\) to 
determine if a securitization is higher risk. For example, the 
commenters suggested that securitizations with risk weights of 200 
percent to 250 percent or greater could be considered below investment 
grade and therefore treated as higher-risk assets for deposit insurance 
pricing purposes.
---------------------------------------------------------------------------

    \48\ 77 FR 52888 (Aug. 30, 2012).
---------------------------------------------------------------------------

    Like the proposed rule, the final rule does not allow exclusions 
for higher-risk securitizations based upon structure or credit 
enhancements. As noted in the proposed rule, the performance of a 
securitization is highly correlated with the performance of the 
underlying assets, even when the securitization contains terms or 
conditions intended to reduce risk. During the crisis, a number of 
highly rated senior securitization positions were subject to 
significant downgrades and suffered substantial losses. Even where 
losses have not yet been realized (as is the case in many 
collateralized loans), 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. 
While commenters on the NPR noted that ``based upon agency ratings, the 
extensive downgrades and the market value reductions of collateralized 
loan obligations and other securitizations in the recent financial 
turmoil have, for the most part, been overcome,'' in fact, many 
financial institutions suffered substantial losses due to these 
securitizations. This decline in value contributed to the liquidity 
crisis of 2008, which forced the U.S. government to provide 
unprecedented support to financial institutions and liquidity markets. 
Furthermore, the Standardized Approach for Risk-Weighted Assets is 
still in development and has not yet been finalized. The proposed 
implementation date is more than two years away (January 15, 2015, 
although it may be implemented earlier); banks must have a method in 
place to identify higher-risk securitizations for deposit insurance 
pricing purposes by April 1, 2013. The FDIC will monitor implementation 
of the Standardized Approach to determine whether all or parts of the 
approach should be incorporated into the risk-based pricing system for 
large banks and highly complex institutions.

B. Large Bank Adjustment Process

    The FDIC 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).\49\ Because the revised definitions should result in 
better risk identification and consistent application across the 
industry, the FDIC anticipates that there will be limited circumstances 
where the FDIC will consider a large bank adjustment as a result of 
perceived mitigants to an institution's higher-risk concentration 
measure. The revised definitions, which include specific exceptions for 
well-collateralized loans, should result in generally equal treatment 
of similar loans at different institutions.
---------------------------------------------------------------------------

    \49\ 12 CFR 327.9(b)(3).
---------------------------------------------------------------------------

C. Audit

    Several of the changes to the definitions could require periodic 
auditing to ensure consistent reporting across the industry. For 
example, the consumer loan PD calculation, whether through credit score 
mapping or through an internal approach, if not properly monitored, 
could potentially be done inconsistently. Also, institutions 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 to 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 asset identification and reporting 
programs include applicable policies, procedures, reviews, and 
validation (through internal or external audits). The results of any 
internal reviews or external audits of higher-risk asset reporting must 
be made available to the FDIC upon request. The FDIC may 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 in the application of 
adjustments to an institution's total score as outlined in the 
Assessment Rate Adjustment Guidelines for Large and Highly Complex 
Institutions.\50\
---------------------------------------------------------------------------

    \50\ 76 FR 57992 (Sept. 19, 2011).
---------------------------------------------------------------------------

D. Updating the Scorecard

    The February 2011 final rule grants the FDIC 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.\51\ The FDIC may add new data for 
subsequent years to its analysis and may, from time to time, exclude 
some earlier years from its analysis. Updating the minimum and maximum 
cutoff values and weights will allow the FDIC to use the most recent 
data, thereby improving the accuracy of the scorecard method.\52\
---------------------------------------------------------------------------

    \51\ 76 FR 10672, 10700 (Feb. 25, 2011) (H. Updating the 
Scorecard).
    \52\ 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 selecting additional or 
alternative 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.
---------------------------------------------------------------------------

    Unless the FDIC re-calibrates cutoff values for the higher-risk 
assets to Tier 1 capital and reserves ratio, however, the changes to 
the definitions of higher-risk assets may result in significant 
increases or decreases in the amount of total deposit insurance 
assessments collected from large and highly complex institutions. 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 banks over a ten-year period beginning with the first 
quarter of 2000 through the fourth quarter of 2009. Because 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 changes in the definitions in this 
final rule 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

[[Page 66013]]

update cutoff values to update the minimum and maximum cutoff values 
for the higher-risk assets to Tier 1 capital and reserves ratio.\53\ 
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, will be 
taken into account in determining changes to the cutoffs. In addition, 
because the FDIC has not collected any data under the revised 
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 ensures proper risk differentiation between 
institutions.\54\
---------------------------------------------------------------------------

    \53\ 76 FR 10672, 10700 (February 25, 2011).
    \54\ The FDIC will 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 
assessments.
---------------------------------------------------------------------------

E. Implementation and Effective Date

    The final rule makes the amended definitions effective April 1, 
2013, in place of the October 1, 2012 date proposed in the NPR.
    Several industry trade groups and institutions expressed concerns 
about their ability to report under the proposed definitions by October 
1, 2012, stating that they did not have the systems in place to 
calculate the PD for consumer loans and were not assured that third-
party providers would be able to develop PD mapping tables for 
institutions to use by the proposed effective date. One industry trade 
group noted that institutions would need time to develop internal PD 
mapping models, or, if the institution decided to use a third-party 
provider's PD mapping table, would need time to perform due diligence 
and negotiate contracts with third-party providers. Commenters 
recommended extending the effective date of the final rule from October 
1, 2012, as proposed, by a range of dates, from one quarter to one 
year; one industry trade group recommended that either loans made 
before the effective date of the proposal should be exempt from PD 
reporting altogether or that institutions be given three years to 
report these loans as higher-risk.
    To allow institutions time to revise their reporting systems to be 
consistent with the revised definitions, the FDIC is postponing the 
effective date of the final rule to April 1, 2013. This new date should 
give institutions ample time to accurately report under the new 
definitions.
    Because the FDIC is not amending the definitions of C&D loans and 
nontraditional mortgage loans (other than to clarify how 
securitizations that meet the definition of a nontraditional mortgage 
loan are to be identified), institutions should continue to define and 
report these higher-risk assets as they have been doing under the 
February 2011 rule.
Transition Guidance Until Effective Date
    Prior to April 1, 2013, large 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 have been updated to 
reflect April 1, 2013 (formerly October 1, 2012) as the effective date 
of this final rule.
    This transition guidance provides that an institution may use 
either the definition in the February 2011 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. 
Some institutions do not have an existing methodology in place to 
identify loans and securities as leveraged or subprime (because they 
are not required to report these exposures to their PFR for examination 
or other supervisory purposes or do not measure and monitor loans and 
securities with these characteristics for internal risk management 
purposes). These institutions may continue to apply existing guidance 
provided by their PFR, by the agencies' 2001 Expanded Guidance for 
Subprime Lending Programs (for consumer loans), 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 April 1, 2013, the amended definitions described above 
apply to:

    (1) C&I loans owed to a reporting bank by a higher-risk C&I 
borrower (as that term is defined in the final rule) and all 
securities issued by a higher-risk C&I borrower (as that term is 
defined in the final rule), except securitizations of C&I loans, 
that are owned by the reporting bank;
    (2) Consumer loans (as defined in the final rule), except 
securitizations of consumer loans, whenever originated or purchased;
    (3) Securitizations of C&I and consumer loans (as defined in the 
final rule) issued on or after April 1, 2013, including those 
securitizations issued on or after April 1, 2013, that are partially 
or fully collateralized by loans originated before April 1, 2013.

    For C&I loans that are either originated or refinanced by a 
reporting bank before April 1, 2013, or purchased by a reporting bank 
before April 1, 2013, in cases in which the loans are owed to the 
reporting bank by a borrower that does not meet the definition of a 
higher-risk C&I borrower as that term is defined in the final rule 
(which requires, among other things, that the borrower have obtained a 
C&I loan or refinanced an existing C&I loan on or after April 1, 2013), 
and for securities purchased before April 1, 2013, that are issued by 
an entity that does not meet the definition of a higher-risk C&I 
borrower, as that term is defined in the final rule, banks must 
continue to use the transition guidance in the September 2012 Call 
Report instructions to determine whether to report the loan or security 
as a higher-risk asset for purposes of the higher-risk assets to Tier 1 
capital and reserves ratio. An institution may opt to apply the final 
rule definition of higher-risk C&I loans and securities to all of its 
C&I loans and securities, but, if it does so, it must also apply the 
final rule definition of a higher-risk C&I borrower without regard to 
when a loan is originally made or refinanced (i.e., whether made or 
refinanced before or after April 1, 2013).
    Under the final rule, banks will not need to reexamine their entire 
existing C&I loan and security portfolios immediately to determine 
whether the loans and securities meet the new definition of higher-risk 
C&I loans and securities (although they may opt to do so as provided in 
the last sentence of the preceding paragraph). Rather, they will be 
able to wait until a borrower seeks a new C&I loan (or refinances an 
existing one) on or after April 1, 2013, and meets the higher-risk C&I 
borrower definition before applying the new higher-risk C&I loan and 
security definition to all of that borrower's C&I loans and securities.
    For consumer loans (other than securitizations of consumer loans) 
originated or purchased prior to April 1, 2013, an institution must 
determine whether the loan met the definition of a higher-risk consumer 
loan no later than June 30, 2013.
    For all securitizations issued before April 1, 2013, banks must 
either (1) continue to use the transition guidance in the September 
2012 Call Report instructions or (2) apply the definitions in the final 
rule to all of its securitizations. If a bank applies the definition of 
higher-risk C&I loans and securities in the final rule to its 
securitizations, it must also apply the definition of a higher-risk C&I 
borrower in the final rule to all C&I borrowers without regard to when 
the loans to

[[Page 66014]]

those borrowers were originally made or refinanced (i.e., whether made 
or refinanced before or after April 1, 2013).
    The provisions of the final rule apply to all securitizations 
issued on or after April 1, 2013 (including those securitizations that 
are collateralized by loans originated before April 1, 2013).

III. Regulatory Analysis and Procedure

A. 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.\55\ For RFA purposes 
a small institution is defined as one with $175 million or less in 
assets.
---------------------------------------------------------------------------

    \55\ See 5 U.S.C. 603, 604 and 605.
---------------------------------------------------------------------------

    As of June 30, 2012, of the 7,246 insured commercial banks and 
savings institutions, there were 3,821 small insured depository 
institutions, as that term is defined for purposes of the RFA. The 
final rule, however, applies 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 from this 
final rule.

B. Small Business Regulatory Enforcement Fairness Act

    The OMB has determined that the final rule is not a ``major rule'' 
within the meaning of the Small Business Regulatory Enforcement 
Fairness Act of 1996 (SBREFA) Public Law 110-28 (1996). As required by 
law, the FDIC will file the appropriate reports with Congress and the 
Government Accountability Office so that the final rule may be 
reviewed.

C. Paperwork Reduction Act

1. Request for Comment on Information Collection
    In accordance with the Paperwork Reduction Act (44 U.S.C. 3501 et 
seq.) the FDIC may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid OMB control number. The collections of information 
contained in this final rule are being submitted to OMB for review.
    Interested parties may submit written comments to the FDIC 
concerning the Paperwork Reduction Act (PRA) implications of this final 
rule.\56\ Comments should be submitted within 60 days from the 
publication date of this final rule in the Federal Register. Commenters 
should refer to ``PRA Comments--Large Bank Definitions Modifications'' 
in the subject line. Comments may be submitted by any of the following 
methods:
---------------------------------------------------------------------------

    \56\ The Notice of Proposed Rulemaking did not include a 
Paperwork Reduction Act notice for the Alternative Probability of 
Default Methodologies or the Alternative Probability of Default 
Methodologies for Foreign Loans; the former was inadvertently 
omitted; the latter was not proposed in the NPR but was added at the 
request of commenters on the NPR.
---------------------------------------------------------------------------

     Agency Web Site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on 
the Agency Web site.
     Email: [email protected]. Include ``PRA Comments--Large 
and Highly Complex Institutions Definitions, 3064-AD92'' in the subject 
line of the message.
     Mail: Gary A. Kuiper, Counsel, F-1086, Federal Deposit 
Insurance Corporation, 550 17th Street NW., Washington, DC 20429.
     Hand Delivery/Courier: 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.
    A copy of the comments may also be submitted to the OMB desk 
officer for the FDIC, Office of Information and Regulatory Affairs, 
Office of Management and Budget, New Executive Office Building, 
Washington, DC 20503.
    Comment is solicited on:
    (1) Whether the collections of information are necessary for the 
proper performance of the functions of the agency, including whether 
the information will have practical utility;
    (2) The accuracy of the agency's estimate of the burden of the 
collections of information, including the validity of the methodology 
and assumptions used;
    (3) The quality, utility, and clarity of the information to be 
collected;
    (4) Ways to minimize the burden of the collections of information 
on those who are to respond, including through the use of appropriate 
automated, electronic, mechanical, or other technological collection 
techniques or other forms of information technology; e.g., permitting 
electronic submission of responses; and
    (5) Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchases of services to provide information.
2. Amendment to Information Collection OMB Number: 3064-0179
    (a) Alternative Probability of Default Methodologies. This final 
rule, amending 12 CFR Part 327, to revise definitions used to determine 
assessment rates for large and highly complex insured depository 
institutions includes a provision allowing large and highly complex 
institutions to make a written request to the FDIC to use alternative 
methodologies when estimating two-year probabilities of default (PD). 
Under the final rule, institutions may request to use default rates 
calculated using fewer observations or score bands than the specified 
minimums, either in advance of or concurrent with reporting under that 
methodology. An institution's request must explain how the requested 
approach differs from the rule specifications and include, at a 
minimum, a table with default rates and the 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 approach while the FDIC evaluates the request. After 
reviewing the request, the FDIC may determine that the institution's 
approach is unacceptable; if so, the institution will be required to 
amend its Call Reports and report according to the generally applicable 
specifications for PD estimation in the final rule; the institution 
will be required to submit amended information for no more than the two 
most recently dated and filed Call Reports preceding the FDIC's 
determination.
    (b) Alternative Probability of Default Methodologies for Foreign 
Consumer Loans. The final rule also includes a provision allowing 
institutions to determine whether certain foreign consumer loans are 
higher-risk loans. One provision permits a bank that is required to 
calculate PDs for foreign consumer loans under the requirements of the 
Basel II capital framework to estimate the two-year PD of a foreign 
consumer loan based on the one-year PD used for capital purposes when 
it is unable to reasonably estimate the two-year PD according to the 
final rule specifications. To do this, the bank 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 one-year PDs 
calculated under the Basel framework are translated to two-year PDs 
that meet the final rule specifications. While the range of acceptable 
approaches is potentially broad, any proposed methodology must meet 
certain requirements spelled out in the final rule. The bank may report

[[Page 66015]]

using its proposed Basel II approach while the FDIC evaluates the 
methodology. If, after reviewing the request, the FDIC determines that 
the methodology is unacceptable, the institution will be required to 
amend its Call Reports. The institution will be required to submit 
amended information for no more than the two most recently dated and 
filed Call Reports preceding the FDIC's determination. Another 
provision of the final rule permits an institution to use its own 
approach to determine whether certain foreign loans are higher-risk 
loans, provided the FDIC first approves that approach. The bank must 
submit its proposed approach to the FDIC and the FDIC will notify the 
bank whether the approach is acceptable. The FDIC may request 
additional information from the bank regarding the proposed methodology 
and the bank must provide the information. The FDIC may grant a bank 
tentative approval to use a methodology while the FDIC considers it in 
more detail; if the FDIC ultimately disapproves the methodology, the 
bank will be required to amend all Call Reports affected by the 
disapproved methodology.
    In conjunction with publication of this final rule amending 12 CFR 
Part 327 to revise definitions used to determine assessment rates for 
large and highly complex insured depository institutions, the FDIC has 
submitted to OMB a request for clearance of the paperwork burden 
associated with these processes for requesting a change in 
methodologies. That request is pending.
    (1) Title: ``Large and Highly Complex Institutions Definitions--
Alternative Probability of Default Methodologies.''
    Respondents: Large and Highly Complex insured depository 
institutions
    Number of Responses: 0-20 per year
    Frequency of Response: Occasional
    Average number of hours to prepare a response: 10-40
    Total Annual Burden: 0-800 hours
    (2) Title: ``Large and Highly Complex Institutions Definitions--
Alternative Probability of Default for Foreign Loans.''
    Respondents: Large and Highly Complex insured depository 
institutions
    Number of Responses: 0-20 per year
    Frequency of Response: Occasional
    Average number of hours to prepare a response: 10-40
    Total Annual Burden: 0-800 hours

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 amends 12 CFR part 327 as 
follows:

PART 327--ASSESSMENTS

0
1. The authority citation for part 327 continues to read as follows:

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

0
2. Revise Section VI of Appendix A to subpart A of part 327 to read as 
follows:

Appendix A to Subpart A of Part 327--Method to Derive Pricing 
Multipliers and Uniform Amount

* * * * *

VI. Description of Scorecard Measures

------------------------------------------------------------------------
        Scorecard measures \1\                    Description
------------------------------------------------------------------------
Tier 1 Leverage Ratio................  Tier 1 capital for Prompt
                                        Corrective Action (PCA) divided
                                        by adjusted average assets based
                                        on the definition for prompt
                                        corrective action.
Concentration Measure for Large        The concentration score for large
 Insured depository institutions        institutions is the higher of
 (excluding Highly Complex              the following two scores:
 Institutions).
    (1) Higher-Risk Assets/Tier 1      Sum of construction and land
     Capital and Reserves.              development (C&D) loans (funded
                                        and unfunded), higher-risk C&I
                                        loans (funded and unfunded),
                                        nontraditional mortgages, higher-
                                        risk consumer loans, and higher-
                                        risk securitizations divided by
                                        Tier 1 capital and reserves. See
                                        Appendix C for the detailed
                                        description of the ratio.
    (2) Growth-Adjusted Portfolio      The measure is calculated in the
     Concentrations.                    following steps:
                                          (1) Concentration levels (as a
                                           ratio to Tier 1 capital and
                                           reserves) are calculated for
                                           each broad portfolio
                                           category:
                                             C&D,
                                             Other commercial
                                             real estate loans,
                                             First lien
                                             residential mortgages
                                             (including non-agency
                                             residential mortgage-backed
                                             securities),
                                             Closed-end junior
                                             liens and home equity lines
                                             of credit (HELOCs),
                                             Commercial and
                                             industrial loans,
                                             Credit card loans,
                                             and
                                             Cther consumer
                                             loans.
                                          (2) Risk weights are assigned
                                           to each loan category based
                                           on historical loss rates.
                                          (3) Concentration levels are
                                           multiplied by risk weights
                                           and squared to produce a risk-
                                           adjusted concentration ratio
                                           for each portfolio.
                                          (4) Three-year merger-adjusted
                                           portfolio growth rates are
                                           then scaled to a growth
                                           factor of 1 to 1.2 where a 3-
                                           year cumulative growth rate
                                           of 20 percent or less equals
                                           a factor of 1 and a growth
                                           rate of 80 percent or greater
                                           equals a factor of 1.2. If
                                           three years of data are not
                                           available, a growth factor of
                                           1 will be assigned.
                                          (5) The risk-adjusted
                                           concentration ratio for each
                                           portfolio is multiplied by
                                           the growth factor and
                                           resulting values are summed.
                                       See Appendix C for the detailed
                                        description of the measure.
Concentration Measure for Highly       Concentration score for highly
 Complex Institutions.                  complex institutions is the
                                        highest of the following three
                                        scores:

[[Page 66016]]

 
    (1) Higher-Risk Assets/Tier 1      Sum of C&D loans (funded and
     Capital and Reserves.              unfunded), higher-risk C&I loans
                                        (funded and unfunded),
                                        nontraditional mortgages, higher-
                                        risk consumer loans, and higher-
                                        risk securitizations divided by
                                        Tier 1 capital and reserves. See
                                        Appendix C for the detailed
                                        description of the measure.
    (2) Top 20 Counterparty Exposure/  Sum of the total exposure amount
     Tier 1 Capital and Reserves.       to the largest 20 counterparties
                                        (in terms of exposure amount)
                                        divided by Tier 1 capital and
                                        reserves. Counterparty exposure
                                        is equal to the sum of Exposure
                                        at Default (EAD) associated with
                                        derivatives trading and
                                        Securities Financing
                                        Transactions (SFTs) and the
                                        gross lending exposure
                                        (including all unfunded
                                        commitments) for each
                                        counterparty or borrower at the
                                        consolidated entity level.\2\
    (3) Largest Counterparty Exposure/ The amount of exposure to the
     Tier 1 Capital and Reserves.       largest counterparty (in terms
                                        of exposure amount) divided by
                                        Tier 1 capital and reserves.
                                        Counterparty exposure is equal
                                        to the sum of EAD associated
                                        with derivatives trading and
                                        SFTs and the gross lending
                                        exposure (including all unfunded
                                        commitments) for each
                                        counterparty or borrower at the
                                        consolidated entity level.
Core Earnings/Average Quarter-End      Core earnings are defined as net
 Total Assets.                          income less extraordinary items
                                        and tax-adjusted realized gains
                                        and losses on available-for-sale
                                        (AFS) and held-to-maturity (HTM)
                                        securities, adjusted for
                                        mergers. The ratio takes a four-
                                        quarter sum of merger-adjusted
                                        core earnings and divides it by
                                        an average of five quarter-end
                                        total assets (most recent and
                                        four prior quarters). If four
                                        quarters of data on core
                                        earnings are not available, data
                                        for quarters that are available
                                        will be added and annualized. If
                                        five quarters of data on total
                                        assets are not available, data
                                        for quarters that are available
                                        will be averaged.
Credit Quality Measure...............  The credit quality score is the
                                        higher of the following two
                                        scores:
    (1) Criticized and Classified      Sum of criticized and classified
     Items/Tier 1 Capital and           items divided by the sum of Tier
     Reserves.                          1 capital and reserves.
                                        Criticized and classified items
                                        include items an institution or
                                        its primary federal regulator
                                        have graded ``Special Mention''
                                        or worse and include retail
                                        items under Uniform Retail
                                        Classification Guidelines,
                                        securities, funded and unfunded
                                        loans, other real estate owned
                                        (ORE), other assets, and marked-
                                        to-market counterparty
                                        positions, less credit valuation
                                        adjustments.\3\ Criticized and
                                        classified items exclude loans
                                        and securities in trading books,
                                        and the amount recoverable from
                                        the U.S. government, its
                                        agencies, or government-
                                        sponsored enterprises, under
                                        guarantee or insurance
                                        provisions.
    (2) Underperforming Assets/Tier 1  Sum of loans that are 30 days or
     Capital and Reserves.              more past due and still accruing
                                        interest, nonaccrual loans,
                                        restructured loans (including
                                        restructured 1-4 family loans),
                                        and ORE, excluding the maximum
                                        amount recoverable from the U.S.
                                        government, its agencies, or
                                        government-sponsored
                                        enterprises, under guarantee or
                                        insurance provisions, divided by
                                        a sum of Tier 1 capital and
                                        reserves.
Core Deposits/Total Liabilities......  Total domestic deposits excluding
                                        brokered deposits and uninsured
                                        non-brokered time deposits
                                        divided by total liabilities.
Balance Sheet Liquidity Ratio........  Sum of cash and balances due from
                                        depository institutions, federal
                                        funds sold and securities
                                        purchased under agreements to
                                        resell, and the market value of
                                        available for sale and held to
                                        maturity agency securities
                                        (excludes agency mortgage-backed
                                        securities but includes all
                                        other agency securities issued
                                        by the U.S. Treasury, U.S.
                                        government agencies, and U.S.
                                        government-sponsored
                                        enterprises) divided by the sum
                                        of federal funds purchased and
                                        repurchase agreements, other
                                        borrowings (including FHLB) with
                                        a remaining maturity of one year
                                        or less, 5 percent of insured
                                        domestic deposits, and 10
                                        percent of uninsured domestic
                                        and foreign deposits.\4\
Potential Losses/Total Domestic        Potential losses to the DIF in
 Deposits (Loss Severity Measure).      the event of failure divided by
                                        total domestic deposits.
                                        Appendix D describes the
                                        calculation of the loss severity
                                        measure in detail.
Market Risk Measure for Highly         The market risk score is a
 Complex Institutions.                  weighted average of the
                                        following three scores:
    (1) Trading Revenue Volatility/    Trailing 4-quarter standard
     Tier 1 Capital.                    deviation of quarterly trading
                                        revenue (merger-adjusted)
                                        divided by Tier 1 capital.
    (2) Market Risk Capital/Tier 1     Market risk capital divided by
     Capital.                           Tier 1 capital.\5\
    (3) Level 3 Trading Assets/Tier 1  Level 3 trading assets divided by
     Capital.                           Tier 1 capital.
Average Short-term Funding/Average     Quarterly average of federal
 Total Assets.                          funds purchased and repurchase
                                        agreements divided by the
                                        quarterly average of total
                                        assets as reported on Schedule
                                        RC-K of the Call Reports
------------------------------------------------------------------------
\1\ 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 April 1, 2013, or to avoid
  changing the overall amount of assessment revenue collected. 76 FR
  10672, 10700 (February 25, 2011). 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 banks when determining changes to the cutoffs.
  The FDIC may update the cutoff values for the higher-risk assets to
  Tier 1 capital and reserves ratio more frequently than annually. The
  FDIC will provide banks 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.
\2\ EAD and SFTs are defined and described in the compilation issued by
  the Basel Committee on Banking Supervision in its June 2006 document,
  ``International Convergence of Capital Measurement and Capital
  Standards.'' The definitions are described in detail in Annex 4 of the
  document. Any updates to the Basel II capital treatment of
  counterparty credit risk would be implemented as they are adopted.
  http://www.bis.org/publ/bcbs128.pdf

[[Page 66017]]

 
\3\ A marked-to-market counterparty position is equal to the sum of the
  net marked-to-market derivative exposures for each counterparty. The
  net marked-to-market derivative exposure equals the sum of all
  positive marked-to-market exposures net of legally enforceable netting
  provisions and net of all collateral held under a legally enforceable
  CSA plus any exposure where excess collateral has been posted to the
  counterparty. For purposes of the Criticized and Classified Items/Tier
  1 Capital and Reserves definition a marked-to-market counterparty
  position less any credit valuation adjustment can never be less than
  zero.
\4\ Deposit runoff rates for the balance sheet liquidity ratio reflect
  changes issued by the Basel Committee on Banking Supervision in its
  December 2010 document, ``Basel III: International Framework for
  liquidity risk measurement, standards, and monitoring,'' http://www.bis.org/publ/bcbs188.pdf.
\5\ Market risk capital is defined in Appendix C of Part 325 of the FDIC
  Rules and Regulations,. http://www.fdic.gov/regulations/laws/rules/2000-4800.html#fdic2000appendixctopart325.


0
3. Revise Appendix C to subpart A of part 327 to read as follows:

Appendix C to Subpart A to Part 327

I. Concentration Measures

    The concentration score for large banks is the higher of the 
higher-risk assets to Tier 1 capital and reserves score or the 
growth-adjusted portfolio concentrations score.\1\ 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 
herein.
---------------------------------------------------------------------------

    \1\ For the purposes of this Appendix, the term ``bank'' means 
insured depository institution.
---------------------------------------------------------------------------

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 five risk areas described 
below and is calculated as:
[GRAPHIC] [TIFF OMITTED] TR31OC12.027

Where:

Hi is bank i's higher-risk concentration measure and k is 
a risk area.\2\ The five risk areas (k) are: construction and land 
development (C&D) loans; higher-risk commercial and industrial (C&I) 
loans and securities; higher-risk consumer loans; nontraditional 
mortgage loans; and higher-risk securitizations.
---------------------------------------------------------------------------

    \2\ The higher-risk concentration ratio is rounded to two 
decimal points.
---------------------------------------------------------------------------

1. Construction and Land Development Loans

    Construction and land development loans include construction and 
land development loans outstanding and unfunded commitments to fund 
construction and land development loans, whether irrevocable or 
unconditionally cancellable.\3\
---------------------------------------------------------------------------

    \3\ 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

Definitions

Higher-Risk C&I Loans and Securities

    Higher-risk C&I loans and securities are:
    (a) All commercial and industrial (C&I) loans (including funded 
amounts and the amount of unfunded commitments, whether irrevocable 
or unconditionally cancellable) owed to the reporting bank (i.e., 
the bank filing its report of condition and income, or Call Report) 
by a higher-risk C&I borrower, as that term is defined herein, 
regardless when the loans were made; 4 5 and
---------------------------------------------------------------------------

    \4\ Commercial and industrial 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. This definition includes purchased credit impaired loans and 
overdrafts.
    \5\ 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.
---------------------------------------------------------------------------

    (b) All securities, except securities classified as trading 
book, issued by a higher-risk C&I borrower, as that term is defined 
herein, that are owned by the reporting bank, without regard to when 
the securities were purchased; however, higher-risk C&I loans and 
securities exclude:
    (a) The maximum amount that is recoverable from the U.S. 
government under guarantee or insurance provisions;
    (b) Loans (including syndicated or participated loans) that are 
fully secured by cash collateral as provided herein;
    (c) Loans that are eligible for the asset-based lending 
exclusion, described herein, provided the bank's primary federal 
regulator (PFR) has not cited a criticism (included in the Matters 
Requiring Attention, or MRA) of the bank's controls or 
administration of its asset-based loan portfolio; and
    (d) Loans that are eligible for the floor plan lending 
exclusion, described herein, provided the bank's PFR has not cited a 
criticism (included in the MRA) of the bank's controls or 
administration of its floor plan loan portfolio.

Higher-Risk C&I Borrower

    A ``higher-risk C&I borrower'' is a borrower that:
    (a) Owes the reporting bank on a C&I loan originally made on or 
after April 1, 2013, if:
    (i) The C&I loan has an original amount (including funded 
amounts and the amount of unfunded commitments, whether irrevocable 
or unconditionally cancellable) of at least $5 million;
    (ii) The loan meets the purpose and materiality tests described 
herein; and
    (iii) When the loan is made, the borrower meets the leverage 
test described herein; or
    (b) Obtains a refinance, as that term is defined herein, of an 
existing C&I loan, where the refinance occurs on or after April 1, 
2013, and the refinanced loan is owed to the reporting bank, if:
    (i) The refinanced loan is in an amount (including funded 
amounts and the amount of unfunded commitments, whether irrevocable 
or unconditionally cancellable) of at least $5 million;
    (ii) The C&I loan being refinanced met the purpose and 
materiality tests (described herein) when it was originally made;
    (iii) The original loan was made no more than 5 years before the 
refinanced loan; and
    (iv) When the loan is refinanced, the borrower meets the 
leverage test.
    When a bank acquires a C&I loan originally made on or after 
April 1, 2013, by another lender, it must determine whether the 
borrower is a higher-risk borrower as a result of the loan as soon 
as reasonably practicable, but not later than one year after 
acquisition. When a bank acquires loans from another entity on a 
recurring or programmatic basis, however, the bank must determine 
whether the borrower is a higher-risk borrower as a result of the 
loan as soon as is practicable, but not later than three months 
after the date of acquisition.
    A borrower ceases to be a ``higher-risk C&I borrower'' only if:

[[Page 66018]]

    (a) The borrower no longer has any C&I loans owed to the 
reporting bank that, when originally made, met the purpose and 
materiality tests described herein;
    (b) The borrower has such loans outstanding owed to the 
reporting bank, but they have all been refinanced more than 5 years 
after originally being made; or
    (c) The reporting bank makes a new C&I loan or refinances an 
existing C&I loan and the borrower no longer meets the leverage test 
described herein.

Original Amount

    The original amount of a loan, including the amounts to 
aggregate for purposes of arriving at the original amount, as 
described herein, is:
    (a) For C&I 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, however, the amount 
currently outstanding on the loan as of the date of the bank's most 
recent Call Report exceeds this amount, then the original amount of 
the loan is the amount outstanding as of the date of the bank's most 
recent Call Report.
    (b) For syndicated or participated C&I loans, the total amount 
of the loan, rather than just the syndicated or participated portion 
held by the individual reporting bank.
    (c) For all other C&I loans (whether term or non-revolver 
loans), the total amount of the loan as of origination or the amount 
outstanding as of the date of the bank's most recent Call Report, 
whichever is larger.
    For purposes of defining original amount and a higher-risk C&I 
borrower:
    (a) All C&I loans that a borrower owes to the reporting bank 
that meet the purpose test when made, and that are made within six 
months of each other, must be aggregated to determine the original 
amount of the loan; however, only loans in the original amount of $1 
million or more must be aggregated; and further provided, that loans 
made before the April 1, 2013, need not be aggregated.
    (b) When a C&I loan is refinanced through more than one loan, 
and the loans are made within six months of each other, they must be 
aggregated to determine the original amount.

Refinance

    For purposes of a C&I loan, a refinance includes:
    (a) Replacing an original obligation by a new or modified 
obligation or loan agreement;
    (b) Increasing the master commitment of the line of credit (but 
not adjusting sub-limits under the master commitment);
    (c) Disbursing additional money other than amounts already 
committed to the borrower;
    (d) Extending the legal maturity date;
    (e) Rescheduling principal or interest payments to create or 
increase a balloon payment;
    (f) Releasing a substantial amount of collateral;
    (g) Consolidating multiple existing obligations; or
    (h) Increasing or decreasing the interest rate.
    A refinance of a C&I loan does not include a modification or 
series of modifications to a commercial loan other than as described 
above or modifications to a commercial loan that would otherwise 
meet this definition of refinance, but that result in the 
classification of a loan as a troubled debt restructuring (TDR), as 
this term is defined in the glossary of the Call Report 
instructions, as they may be amended from time to time.

Purpose Test

    A loan or refinance meets the purpose test if it is to finance:
    (a) A buyout, defined as the purchase or repurchase by the 
borrower of the borrower's outstanding equity, including, but not 
limited to, an equity buyout or funding an Employee Stock Ownership 
Plan (ESOP);
    (b) An acquisition, defined as the purchase by the borrower of 
any equity interest in another company, or the purchase of all or a 
substantial portion of the assets of another company; or
    (c) A capital distribution, defined as a dividend payment or 
other transaction designed to enhance shareholder value, including, 
but not limited to, a repurchase of stock.
    At the time of refinance, whether the original loan met the 
purpose test may not be easily determined by a new lender. In such a 
case, the new lender must use its best efforts and reasonable due 
diligence to determine whether the original loan met the test.

Materiality Test

    A loan or refinance meets the materiality test if:
    (a) The original amount of the loan (including funded amounts 
and the amount of unfunded commitments, whether irrevocable or 
unconditionally cancellable) equals or exceeds 20 percent of the 
total funded debt of the borrower; total funded debt of the borrower 
is to be determined as of the date of the original loan and does not 
include the loan to which the materiality test is being applied; or
    (b) Before the loan was made, the borrower had no funded debt.
    When multiple loans must be aggregated to determine the original 
amount, the materiality test is applied as of the date of the most 
recent loan.
    At the time of refinance, whether the original loan met the 
materiality test may not be easily determined by a new lender. In 
such a case, the new lender must use its best efforts and reasonable 
due diligence to determine whether the original loan met the test.

Leverage Test

    A borrower meets the leverage test if:
    (a) The ratio of the borrower's total debt to trailing twelve-
month EBITDA (commonly known as the operating leverage ratio) is 
greater than 4; or
    (b) The ratio of the borrower's senior debt to trailing twelve-
month EBITDA (also commonly known as the operating leverage ratio) 
is greater than 3.
    EBITDA is defined as earnings before interest, taxes, 
depreciation, and amortization.
    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 Liabilities and Equity''), 
and subordinated capital notes. Total debt excludes pension 
obligations, deferred tax liabilities and preferred equity.
    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.
    When calculating either of the borrower's operating leverage 
ratios, the only permitted EBITDA adjustments are those specifically 
permitted for that borrower in the loan agreement (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. If the loan is 
made to a subsidiary of a larger organization, the debt-to-EBITDA 
ratio may be calculated using the financial statements of the 
subsidiary or, if the parent company has unconditionally and 
irrevocably guaranteed the borrower's debt, using the consolidated 
financial statements of the parent company.
    In the case of a merger of two companies or the acquisition of 
one or more companies or parts of companies, 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.

Exclusions

Cash Collateral Exclusion

    To exclude a loan based on cash collateral, the cash must be in 
the form of a savings or time deposit held by a bank. The bank (or 
lead bank or agent bank in the case of a participation or 
syndication) must have a perfected first priority security interest, 
a security agreement, and a collateral assignment of the deposit 
account that is irrevocable for the remaining term of the loan or 
commitment. In addition, the bank must place a hold on the deposit 
account that alerts the bank's employees to an attempted withdrawal. 
If the cash collateral is held at another bank or at multiple banks, 
a security agreement must be in place and each bank must have an 
account control agreementin place.\6\ For the exclusion to apply to 
a

[[Page 66019]]

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).
---------------------------------------------------------------------------

    \6\ An account control agreement, for purposes of this Appendix, 
means a written agreement between the lending bank (the secured 
party), the borrower, and the bank that holds the deposit account 
serving as collateral (the depository bank), that the depository 
bank will comply with instructions originated by the secured party 
directing disposition of the funds in the deposit account without 
further consent by the borrower (or any other party).
---------------------------------------------------------------------------

Asset-Based and Floor Plan Lending Exclusions

    The FDIC retains the authority to verify that banks have sound 
internal controls and administration practices for asset-based and 
floor plan loans that are excluded from a bank's reported higher-
risk C&I loans and securities totals. If the bank's PFR has cited a 
criticism of the bank's controls or administration of its asset-
based or floor plan loan portfolios in an MRA, the bank is not 
eligible for the asset-based or floor plan lending exclusions.

Asset-Based Lending Conditions

    Asset-based loans (loans secured by accounts receivable and 
inventory) that meet all the following conditions are excluded from 
a bank's higher-risk C&I loan totals:
    (a) The loan is managed by a loan officer or group of loan 
officers at the reporting bank who have experience in asset-based 
lending and collateral monitoring, including, but not limited to, 
experience in reviewing the following: Collateral reports, borrowing 
base certificates (which are discussed herein), collateral audit 
reports, loan-to-collateral values (LTV), and loan limits, using 
procedures common to the industry.
    (b) The bank has taken, or has the legally enforceable ability 
to take, dominion over the borrower's deposit accounts such that 
proceeds of collateral are applied to the loan balance as collected. 
Security agreements must be in place in all cases; in addition, if a 
borrower's deposit account is held at a bank other than the lending 
bank, an account control agreement must also be in place.
    (c) The bank has a perfected first priority security interest in 
all assets included in the borrowing base certificate.
    (d) 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.\7\ Other non-self-liquidating assets may 
be part of the borrowing base, but the outstanding balance of the 
loan must be fully secured by the portion of the borrowing base that 
is composed of self-liquidating assets. Fully secured is defined as 
a 100 percent or lower LTV ratio after applying the appropriate 
discounts (determined by the loan agreement) to the collateral. If 
an over advance (including a seasonal over advance) causes the LTV 
to exceed 100 percent, the loan may not be excluded from higher-risk 
C&I loans owed by a higher-risk C&I borrower. Additionally, the bank 
must have the ability to withhold funding of a draw or advance if 
the loan amount exceeds the amount allowed by the collateral 
formula.
---------------------------------------------------------------------------

    \7\ 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.
---------------------------------------------------------------------------

    (e) A bank's lending policy or procedures must address the 
maintenance of an accounts receivable loan agreement with the 
borrower. This loan agreement must establish a maximum percentage 
advance, which cannot exceed 85 percent, against eligible accounts 
receivable, include a maximum dollar amount due from any one account 
debtor, address the financial strength of debtor accounts, and 
define eligible receivables. The definition of eligible receivables 
must consider the receivable quality, the turnover and dilution 
rates of receivables pledged, the aging of accounts receivable, the 
concentrations of debtor accounts, and the performance of the 
receivables related to their terms of sale.
    Concentration of debtor accounts is the percentage value of 
receivables associated with one or a few customers relative to the 
total value of receivables. Turnover of receivables is the velocity 
at which receivables are collected. The dilution rate is the 
uncollectible accounts receivable as a percentage of sales.
    Ineligibles must be established for any debtor account where 
there is concern that the debtor may not pay according to terms. 
Monthly accounts receivable agings must be received in sufficient 
detail to allow the bank to compute the required ineligibles. At a 
minimum, the following items must be deemed ineligible accounts 
receivable:
    (i) 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;
    (ii) Entire account balances where over 50 percent of the 
account is over 60 days past due or 90 days past invoice date;
    (iii) Accounts arising from sources other than trade (e.g., 
royalties, rebates);
    (iv) Consignment or guaranteed sales;
    (v) Notes receivable;
    (vi) Progress billings;
    (vii) Account balances in excess of limits appropriate to 
account debtor's credit worthiness or unduly concentrated by 
industry, location or customer;
    (viii) Affiliate and intercompany accounts; and
    (ix) Foreign accounts receivable.
    (f) Loans against inventory must be made with advance rates no 
more than 65 percent of eligible inventory (at the lower of cost 
valued on a first-in, first-out (FIFO) basis or market) based on an 
analysis of realizable value. When an appraisal is obtained, or 
there is a readily determinable market price for the inventory, 
however, up to 85 percent of the net orderly liquidation value 
(NOLV) or the market price of the inventory may be financed. 
Inventory must be valued or appraised by an independent third-party 
appraiser using 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, unless there is a readily available and 
determinable market price for the inventory (e.g., in the case of 
various commodities), from a recognized exchange or third-party 
industry source, and a readily available market (e.g., for aluminum, 
crude oil, steel, and other traded commodities); in that case, 
inventory may be valued using current market value. When relying 
upon current market value rather than an independent appraisal, the 
reporting bank's management must update the value of inventory as 
market prices for the product change. Valuation updates must be as 
frequent as needed to ensure compliance with margin requirements. In 
addition, appropriate mark-to-market reserves must be established to 
protect against excessive inventory price fluctuations. An asset has 
a readily identifiable and publicly available market price if the 
asset's price is quoted routinely in a widely disseminated 
publication that is readily available to the general public.
    (g) A bank's lending policy or procedures must address the 
maintenance of an inventory loan agreement with the borrower. This 
loan agreement must establish a maximum percentage advance rate 
against acceptable inventory, address acceptable appraisal and 
valuation requirements, and define acceptable and ineligible 
inventory. 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. Monthly 
inventory agings must be received in sufficient detail to allow the 
bank to compute the required ineligibles. At a minimum, ineligible 
inventory must include:
    (i) Slow moving, obsolete inventory and items turning materially 
slower than industry average;
    (ii) Inventory with value to the client only, which is generally 
work in process, but may include raw materials used solely in the 
client's manufacturing process;
    (iii) Consigned inventory or other inventory where a perfected 
security interest cannot be obtained;
    (iv) Off-premise inventory subject to a mechanic's or other 
lien; and
    (v) Specialized, high technology or other inventory subject to 
rapid obsolescence or valuation problems.
    (h) The bank must maintain documentation of borrowing base 
certificate reviews and collateral trend analyses to demonstrate 
that collateral values are actively, routinely and consistently 
monitored. A borrowing base certificate is a form prepared by the 
borrower that reflects the current status of the collateral. A new 
borrowing base certificate must be obtained within 30 days before or 
after each draw or advance on a loan. A bank is required to validate 
the borrowing base through asset-based tracking reports. The 
borrowing base validation process must include the bank requesting 
from the borrower a list of accounts receivable by creditor and a 
list of individual items of inventory and the bank certifying that 
the outstanding balance of the loan remains within the collateral 
formula prescribed by the loan agreement. Any discrepancies between 
the list of accounts receivable and

[[Page 66020]]

inventory and the borrowing base certificate must be reconciled with 
the borrower. Periodic, but no less than annual, field examinations 
(audits) must also 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 bank is correcting audit 
exceptions.

Floor Plan Lending Conditions

    Floor plan loans may include, but are not limited to, loans to 
finance the purchase of various vehicles or equipment including 
automobiles, boat or marine equipment, recreational vehicles (RV), 
motorized watersports vehicles such as jet skis, or motorized lawn 
and garden equipment such as tractor lawnmowers. Floor plan loans 
that meet all the following conditions are excluded from a bank's 
higher-risk C&I loan totals:
    (a) The loan is managed by a loan officer or a group of loan 
officers at the reporting bank who are experienced in floor plan 
lending and monitoring collateral to ensure the borrower remains in 
compliance with floor plan limits and repayment requirements. Loan 
officers must have experience in reviewing certain items, including 
but not limited to: Collateral reports, floor plan limits, floor 
plan aging reports, vehicle inventory audits or inspections, and LTV 
ratios. The bank must obtain and review financial statements of the 
borrower (e.g., tax returns, company-prepared financial statements, 
or dealer statements) on at least a quarterly basis to ensure that 
adequate controls are in place. (A ``dealer statement'' is the 
standard format financial statement issued by Original Equipment 
Manufacturers (OEMs) and used by nationally recognized automobile 
dealer floor plan lenders.)
    (b) For automobile floor plans, each loan advance must be made 
against a specific automobile 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 
automobile at auction or the wholesale value using the prevailing 
market guide (e.g., NADA, Black Book, Blue Book). The advance rate 
of 100 percent of dealer invoice plus freight charges on new 
automobiles, and the advance rate of the cost of a used automobile 
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 bank over time and subject 
to strong controls. Otherwise, permissible advance rates must be 
lower than 100 percent.
    (c) Advance rates on vehicles other than automobiles must 
conform to industry standards for advance rates on such inventory, 
but may never exceed 100 percent of dealer invoice plus freight 
charges on new vehicles or 100 percent of the cost of a used vehicle 
at auction or its wholesale value.
    (d) 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).
    (e) Vehicle inventories and collateral values are closely 
monitored, including the completion of regular (at least quarterly) 
dealership automotive or other vehicle dealer inventory audits or 
inspections to ensure accurate accounting for all vehicles held as 
collateral. The lending bank or a third party must prepare inventory 
audit reports and inspection reports for loans to automotive 
dealerships, or loans to other vehicle dealers, and the lending bank 
must review the reports at least quarterly. The reports must list 
all vehicles held as collateral and verify that the collateral is in 
the dealer's possession.
    (f) Floor plan aging reports must be reviewed by the bank as 
frequently as required under the loan agreement, but no less 
frequently than quarterly. Floor plan aging reports must reflect 
specific information about each automobile or vehicle being financed 
(e.g., the make, model, and color of the automobile or other 
vehicle, and origination date of the loan to finance the automobile 
or vehicle). Curtailment programs should be instituted where 
necessary and banks must ensure that curtailment payments are made 
on stale automotive or other vehicle inventory financed under the 
floor plan loan.

Detailed Reports

    Examples of detailed reports that must be provided to the asset-
based and floor plan lending bank include:
    (a) Borrowing Base Certificates: Borrowing base certificates, 
along with supporting information, must include:
    (i) The accounts receivable balance (rolled forward from the 
previous certificate);
    (ii) Sales (reported as gross billings) with detailed 
adjustments for returns and allowances to allow for proper tracking 
of dilution and other reductions in collateral;
    (iii) Detailed inventory information (e.g., raw materials, work-
in-process, finished goods); and
    (iv) Detail of loan activity.
    (b) Accounts Receivable and Inventory Detail: A listing of 
accounts receivable and inventory that is included on the borrowing 
base certificate. Monthly accounts receivable and inventory agings 
must be received in sufficient detail to allow the lender to compute 
the required ineligibles.
    (c) Accounts Payable Detail: A listing of each accounts payable 
owed to the borrower. Monthly accounts payable agings must be 
received to monitor payable performance and anticipated working 
capital needs.
    (d) Covenant Compliance Certificates: A listing of each loan 
covenant and the borrower's compliance with each one. Borrowers must 
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 must be promptly 
addressed.
    (e) Dealership Automotive Inventory or Other Vehicle Inventory 
Audits or Inspections: The bank or a third party must prepare 
inventory audit reports or inspection reports for loans to 
automotive dealerships and other vehicle dealerships. The bank must 
review the reports at least quarterly. The reports must list all 
vehicles held as collateral and verify that the collateral is in the 
dealer's possession.
    (f) Floor Plan Aging Reports: Borrowers must submit floor plan 
aging reports on a monthly or quarterly basis (depending on the 
terms of the loan agreement). These reports must reflect specific 
information about each automobile or other type of vehicle being 
financed (e.g., the make, model, and color of the automobile or 
other type of vehicle, and origination date of the loan to finance 
the automobile or other type of vehicle).

3. Higher-Risk Consumer Loans

Definitions

    Higher-risk consumer loans are defined as 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) is greater than 20 percent, excluding those consumer 
loans that meet the definition of a nontraditional mortgage 
loan.8 9
---------------------------------------------------------------------------

    \8\ For the purposes of this rule, consumer loans consist of all 
loans secured by 1-4 family residential properties as well as loans 
and leases made to individuals for household, family, and other 
personal expenditures, as defined in the instructions to the Call 
Report, Schedule RC-C, as the instructions may be amended from time 
to time. Higher-risk consumer loans include purchased credit-
impaired loans that meet the definition of higher-risk consumer 
loans.
    \9\ The FDIC has the flexibility, as part of its risk-based 
assessment system, to change the 20 percent threshold for 
identifying higher-risk consumer loans without further notice-and-
comment rulemaking as a result of reviewing data for up to the first 
two reporting periods after the effective date of this rule. Before 
making any such change, the FDIC will analyze the potential effect 
of changing the PD threshold on the distribution of higher-risk 
consumer loans among banks and the resulting effect on assessments 
collected from the industry. The FDIC will provide banks with at 
least one quarter advance notice of any such change to the PD 
threshold through a Financial Institution Letter.
---------------------------------------------------------------------------

    Higher-risk consumer loans exclude:
    (a) The maximum amounts recoverable from the U.S. government 
under guarantee or insurance provisions; and
    (b) Loans fully secured by cash collateral. To exclude a loan 
based on cash collateral, the cash must be in the form of a savings 
or time deposit held by a bank. The lending bank (or lead or agent 
bank in the case of a participation or syndication) must, in all 
cases, (including instances in which cash collateral is held at 
another bank or banks) have a perfected first priority security 
interest under applicable state law, a security agreement in place, 
and all necessary documents executed and measures taken as required 
to result in such perfection and priority. In addition, the lending 
bank must place a hold on the deposit account that alerts the bank's 
employees to an attempted withdrawal. For the exclusion to apply to 
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).
    Banks must determine the PD of a consumer loan as of the date 
the loan was originated, or, if the loan has been refinanced, as of 
the date it was refinanced. The two-year PD must be estimated using 
an approach that conforms to the requirements detailed herein.

[[Page 66021]]

Loans Originated or Refinanced Before April 1, 2013, and all Acquired 
Loans

    For loans originated or refinanced by a bank before April 1, 
2013, and all acquired loans regardless of the date of acquisition, 
if information as of the date the loan was originated or refinanced 
is not available, then the bank must use the oldest available 
information to determine the PD. If no information is available, 
then the bank must obtain recent, refreshed data from the borrower 
or other appropriate third party to determine the PD. Refreshed data 
is defined as the most recent data available, and must be as of a 
date that is no earlier than three months before the acquisition of 
the loan. In addition, for loans acquired on or after April 1, 2013, 
the acquiring bank shall have six months from the date of 
acquisition to determine the PD.
    When a bank acquires loans from another entity on a recurring or 
programmatic basis, the acquiring bank may determine whether the 
loan meets the definition of a higher-risk consumer loan using the 
origination criteria and analysis performed by the original lender 
only if the acquiring bank verifies the information provided. Loans 
acquired from another entity are acquired on a recurring basis if a 
bank has acquired other loans from that entity at least once within 
the calendar year of the acquisition of the loans in question or in 
the previous calendar year. If the acquiring bank cannot or does not 
verify the information provided by the original lender, the 
acquiring bank 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.

Loans That Meet Both Higher-Risk Consumer Loans and Nontraditional 
Mortgage Loans Definitions

    A loan that meets both the nontraditional mortgage loan and 
higher-risk consumer loan 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. If, however, the 
loan ceases to meet the nontraditional mortgage loan definition but 
continues to meet the definition of a higher-risk consumer loan, the 
loan is to be reported as a higher-risk consumer loan.

General Requirements for PD Estimation

Scorable Consumer Loans

    Estimates of the two-year PD for a loan must be based on the 
observed, stress period default rate (defined herein) for loans of a 
similar product type made to consumers with credit risk comparable 
to the borrower being evaluated. While a bank may consider 
additional risk factors beyond the product type and credit score 
(e.g., geography) in estimating the PD of a loan, it must at a 
minimum account for these two factors. 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), 
as it may be amended from time to time, 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, banks must adhere to 
the following requirements:
    (a) 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] TR31OC12.028

    (b) 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 24-month 
period). An ``active'' loan is defined as any loan that was open and 
not in default as of the observation date, and on which a payment 
was made within the 12 months prior to the observation date.
    (c) 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 (and any additional risk factors) 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 
each 24-month default rate must be calculated using a random sample 
of at least 1,200 active loans.
    (d) Credit score strata must be determined by partitioning the 
entire credit score range generated by a given scoring system 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. Because performance data for scores at the upper and 
lower extremes of the population distribution is likely to be 
limited, however, the top and bottom bands may include a range of 
scores that suggest some variance in credit quality.
    (e) Each credit score will need to have a unique PD associated 
with it. Therefore, when the number of score bands is less than the 
number of unique credit scores (as will almost always be the case), 
banks must use a linear interpolation between adjacent default rates 
to determine the PD for a particular score. The observed default 
rate for each band must be assumed to correspond to 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] TR31OC12.029

    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.
    (f) 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.
    (g) A loan is to be considered in default when it is 90+ days 
past due, charged-off, or the borrower enters bankruptcy.

Unscorable Consumer Loans

    For unscorable consumer loans--where the available information 
about a borrower is insufficient to determine a credit score--the 
bank will be unable to assign a PD to the loan according to the 
requirements described above. If the total outstanding balance of 
the unscorable consumer loans of a particular product type 
(including, but not limited to, student loans) exceeds 5 percent of 
the total outstanding balance for that product type, including both 
foreign and domestic loans, the excess amount shall be treated as 
higher risk (the de minimis approach). Otherwise, the total 
outstanding balance of unscorable consumer loans of a particular 
product type will not be considered higher risk. The consumer 
product types used to determine whether the 5 percent test is 
satisfied shall correspond to the product types listed in the table 
used for reporting PD estimates.
    A bank may not develop PD estimates for unscorable loans based 
on internal data.
    If, after the origination or refinance of the loan, an 
unscorable consumer loan becomes scorable, a bank must reclassify 
the loan using a PD estimated according to the general requirements 
above. Based upon that PD, the loan will be determined to be either 
higher risk or not, and that determination will remain in effect 
until a refinancing occurs, at which time the loan must be re-
evaluated. An unscorable loan must be reviewed at least annually to 
determine if a credit score has become available.

Alternative Methodologies

    A bank may use internally derived default rates that were 
calculated using fewer observations or score bands than those 
specified above under certain conditions. The bank must submit a 
written request to the FDIC either in advance of, or concurrent 
with, reporting under the requested approach. The request must 
explain in detail how the proposed approach differs from the rule 
specifications and the bank 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

[[Page 66022]]

number of observations used in each score and product segment. The 
FDIC will evaluate the proposed methodology and may request 
additional information from the bank, which the bank must provide. 
The bank may report using its proposed approach while the FDIC 
evaluates the methodology. If, after reviewing the request, the FDIC 
determines that the bank's methodology is unacceptable, the bank 
will be required to amend its Call Reports and report according to 
the generally applicable specifications for PD estimation. The bank 
will be required to submit amended information for no more than the 
two most recently dated and filed Call Reports preceding the FDIC's 
determination.

Foreign Consumer Loans

    A bank must estimate the PD of a foreign consumer loan according 
to the general requirements described above unless doing so would be 
unduly complex or burdensome (e.g., if a bank had to develop 
separate PD mappings for many different countries). A bank may 
request to use default rates calculated using fewer observations or 
score bands than the specified minimums, either in advance of, or 
concurrent with, reporting under that methodology, but must comply 
with the requirements detailed above for using an alternative 
methodology.
    When estimating a PD according to the general requirements 
described above would be unduly complex or burdensome, a bank that 
is required to calculate PDs for foreign consumer loans under the 
requirements of the Basel II capital framework may: (1) Use the 
Basel II approach discussed herein, subject to the terms discussed 
herein; (2) submit a written request to the FDIC to use its own 
methodology, but may not use the methodology until approved by the 
FDIC; or (3) treat the loan as an unscorable consumer loan subject 
to the de minimis approach described above.
    When estimating a PD according to the general requirements 
described above would be unduly complex or burdensome, a bank that 
is not required to calculate PDs for foreign consumer loans under 
the requirements of the Basel II capital framework may: (1) Treat 
the loan as an unscorable consumer loan subject to the de minimis 
approach described above; or (2) submit a written request to the 
FDIC to use its own methodology, but may not use the methodology 
until approved by the FDIC.
    When a bank submits a written request to the FDIC to use its own 
methodology, the FDIC may request additional information from the 
bank regarding the proposed methodology and the bank must provide 
the information. The FDIC may grant a bank tentative approval to use 
the methodology while the FDIC considers it in more detail. If the 
FDIC ultimately disapproves the methodology, the bank may be 
required to amend its Call Reports; however, the bank will be 
required to amend no more than the two most recently dated and filed 
Call Reports preceding the FDIC's determination. In the amended Call 
Reports, the bank must treat any loan whose PD had been estimated 
using the disapproved methodology as an unscorable domestic consumer 
loan subject to the de minimis approach described above.

Basel II Approach

    A bank that is required to calculate PDs for foreign consumer 
loans under the requirements of the Basel II capital framework may 
estimate the two-year PD of a foreign consumer loan based on the 
one-year PD used for Basel II capital purposes.\10\ The bank 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 one-year PDs calculated under the Basel II framework are 
translated to two-year PDs that meet the requirements above. While 
the range of acceptable approaches is potentially broad, any 
proposed methodology must meet the following requirements:
---------------------------------------------------------------------------

    \10\ Using these Basel II PDs for this purpose does not imply 
that a bank's PFR has approved use of these PDs for the Basel II 
capital framework. If a bank's PFR requires it to revise its Basel 
II PD methodology, the bank must use revised Basel II PDs to 
calculate (or recalculate if necessary) corresponding PDs under this 
Basel II approach.
---------------------------------------------------------------------------

    (a) The bank must use data on a sample of loans for which both 
the one-year Basel II PDs and two-year final rule PDs can be 
calculated. The sample may contain both foreign and domestic loans.
    (b) The bank must use the sample data to demonstrate that a 
meaningful relationship exists between the two types of PD 
estimates, and the significance and nature of the relationship must 
be determined using accepted statistical principles and 
methodologies. For example, to the extent that a linear relationship 
exists in the sample data, the bank may use an ordinary least-
squares regression to determine the best linear translation of Basel 
II PDs to final rule PDs. The estimated equation should fit the data 
reasonably well based on standard statistics such as the coefficient 
of determination; and
    (c) The method must account for any significant variation in the 
relationship between the two types of PD estimates that exists 
across consumer products based on the empirical analysis of the 
data. For example, if the bank is using a linear regression to 
determine the relationship between PD estimates, it should test 
whether the parameter estimates are significantly different by 
product type.
    The bank may report using this approach (if it first notifies 
the FDIC of its intention to do so), while the FDIC evaluates the 
methodology. If, after reviewing the methodology, the FDIC 
determines that the methodology is unacceptable, the bank will be 
required to amend its Call Reports. The bank will be required to 
submit amended information for no more than the two most recently 
dated and filed Call Reports preceding the FDIC's determination.

Refinance

    For purposes of higher-risk consumer loans, a refinance 
includes:
    (a) Extending new credit or additional funds on an existing 
loan;
    (b) Replacing an existing loan with a new or modified 
obligation;
    (c) Consolidating multiple existing obligations;
    (d) Disbursing additional funds to the borrower. 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. 
A material increase in the amount of a line of credit is defined as 
a 10 percent or greater increase in the quarter-end line of credit 
limit; however, a temporary increase in a credit card line of credit 
is not a material increase;
    (e) Increasing or decreasing the interest rate (except as noted 
herein for credit card loans); or
    (f) Rescheduling 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.
    A refinance for this purpose does not include:
    (a) A re-aging, defined as returning a delinquent, open-end 
account to current status without collecting the total amount of 
principal, interest, and fees that are contractually due, provided:
    (i) The re-aging is part of a program that, at a minimum, 
adheres to the re-aging guidelines recommended in the interagency 
approved Uniform Retail Credit Classification and Account Management 
Policy;\11\
---------------------------------------------------------------------------

    \11\ Among other things, for a loan to be considered for re-
aging, the following must be true: (1) The borrower must have 
demonstrated a renewed willingness and ability to repay the loan; 
(2) the loan must have existed for at least nine months; and (3) the 
borrower must have made at least three consecutive minimum monthly 
payments or the equivalent cumulative amount.
---------------------------------------------------------------------------

    (ii) The program has clearly defined policy guidelines and 
parameters for re-aging, as well as internal methods of ensuring the 
reasonableness of those guidelines and monitoring their 
effectiveness; and
    (iii) The bank monitors both the number and dollar amount of re-
aged accounts, collects and analyzes data to assess the performance 
of re-aged accounts, and determines the effect of re-aging practices 
on past due ratios;
    (b) Modifications to a loan that would otherwise meet this 
definition of refinance, but result in the classification of a loan 
as a TDR;
    (c) Any modification made to a consumer loan pursuant to a 
government program, such as the Home Affordable Modification Program 
or the Home Affordable Refinance Program;
    (d) Deferrals under the Servicemembers Civil Relief Act;
    (e) A contractual deferral of payments or change in interest 
rate that is consistent with the terms of the original loan 
agreement (e.g., as allowed in some student loans);
    (f) Except as provided above, a modification or series of 
modifications to a closed-end consumer loan;
    (g) An advance of funds, an increase in the line of credit, or a 
change in the interest rate that is consistent with the terms of the 
loan agreement for an open-end or revolving line of credit (e.g., 
credit cards or home equity lines of credit);
    (h) For credit card loans:
    (i) Replacing an existing card because the original is expiring, 
for security reasons, or

[[Page 66023]]

because of a new technology or a new system;
    (ii) Reissuing a credit card that has been temporarily suspended 
(as opposed to closed);
    (iii) Temporarily increasing the line of credit;
    (iv) Providing access to additional credit when a bank has 
internally approved a higher credit line than it has made available 
to the customer; or
    (v) Changing the interest rate of a credit card line when 
mandated by law (such as in the case of the Credit CARD Act).
    4. Nontraditional mortgage loans
    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. 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. 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.
    Banks must determine whether residential loans meet the 
definition of a nontraditional mortgage loan as of origination, or, 
if the loan has been refinanced, as of refinance, as refinance is 
defined in this Appendix for purposes of higher-risk consumer loans. 
When a bank acquires a residential loan, it must determine whether 
the loan 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 bank must 
obtain refreshed data from the borrower or other appropriate third 
party. Refreshed data for residential loans is defined as the most 
recent data available. The data, however, must be as of a date that 
is no earlier than three months before the acquisition of the 
residential loan. The acquiring bank must also determine whether an 
acquired loan is higher risk not later than three months after 
acquisition.
    When a bank acquires loans from another entity on a recurring or 
programmatic basis, however, the acquiring bank may determine 
whether the loan meets the definition of a nontraditional mortgage 
loan using the origination criteria and analysis performed by the 
original lender only if the acquiring bank verifies the information 
provided. Loans acquired from another entity are acquired on a 
recurring basis if a bank has acquired other loans from that entity 
at least once within the calendar year or the previous calendar year 
of the acquisition of the loans in question.

5. Higher-Risk Securitizations

    Higher-risk securitizations are defined as securitizations 
(except securitizations classified as trading book), where, in 
aggregate, more than 50 percent of the assets backing the 
securitization meet either the criteria for higher-risk C&I loans or 
securities, higher-risk consumer loans, or nontraditional mortgage 
loans, except those classified as trading book. A securitization is 
as defined in 12 CFR part 325, Appendix A, Section II(B)(16), as it 
may be amended from time to time. A higher-risk securitization 
excludes the maximum amount that is recoverable from the U.S. 
government under guarantee or insurance provisions.
    A bank must determine whether a securitization is higher risk 
based upon information as of the date of issuance (i.e., the date 
the securitization is sold on a market to the public for the first 
time). The bank must make this determination within the time limit 
that would apply under this Appendix if the bank were directly 
acquiring loans or securities of the type underlying the 
securitization. In making the determination, a bank must use one of 
the following methods:
    (a) For a securitization collateralized by a static pool of 
loans, whose underlying collateral changes due to the sale or 
amortization of these loans, the 50 percent threshold is to be 
determined based upon the amount of higher-risk assets, as defined 
in this Appendix, owned by the securitization on the date of 
issuance of the securitization.
    (b) For a securitization collateralized by a dynamic pool of 
loans, whose underlying collateral may change by the purchase of 
additional assets, including purchases made during a ramp-up period, 
the 50 percent threshold is to be determined based upon the highest 
amount of higher-risk assets, as defined in this Appendix, allowable 
under the portfolio guidelines of the securitization.
    A bank is not required to evaluate a securitization on a 
continuous basis when the securitization is collateralized by a 
dynamic pool of loans; rather, the bank is only required to evaluate 
the securitization once.
    A bank 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 memoranda, 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, a bank may use established criteria, model portfolios, or 
limitations published in the offering memorandum, indenture, trustee 
report, or similar documents.
    Sufficient information necessary for a bank to make a definitive 
determination may not, in every case, be reasonably available to the 
bank as a sophisticated investor. In such a case, the bank may 
exercise its judgment in making the determination. In some cases, 
the bank need not rely upon all of the aforementioned pieces of 
information to make a higher-risk determination if fewer documents 
provide sufficient data to make the determination.
    In cases in which a securitization is required to be 
consolidated on the balance sheet as a result of SFAS 166 and SFAS 
167, and a bank has access to the necessary information, a bank may 
opt for an alternative method of evaluating the securitization to 
determine whether it is higher risk. The bank may evaluate 
individual loans in the securitization on a loan-by-loan basis and 
only report as higher risk those loans that meet the definition of a 
higher-risk asset; 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 bank must follow the 
provisions of section I.B herein. Once a bank evaluates a 
securitization for higher-risk asset designation using this 
alternative evaluation method, it must continue to evaluate all 
securitizations that it has consolidated on the balance sheet as a 
result of SFAS 166 and SFAS 167, and for which it has the required 
information, using the alternative evaluation method. For 
securitizations for which the bank does not have access to 
information on a loan-by-loan basis, the bank must determine whether 
the securitization meets the 50 percent threshold in the manner 
previously described for other securitizations.

B. Application of Definitions

    Section I of this Appendix applies to:
    (1) All construction and land development loans, whenever 
originated or purchased;
    (2) C&I loans (as that term is defined in this Appendix) owed to 
a reporting bank by a higher-risk C&I borrower (as that term is 
defined in this Appendix) and all securities issued by a higher-risk 
C&I borrower, except securitizations of C&I loans, that are owned by 
the reporting bank;
    (3) Consumer loans (as defined in this Appendix), except 
securitizations of consumer loans, whenever originated or purchased;
    (4) Securitizations of C&I and consumer loans (as defined in 
this Appendix) issued on or after April 1, 2013, including those 
securitizations issued on or after April 1, 2013, that are partially 
or fully collateralized by loans originated before April 1, 2013.
    For C&I loans that are either originated or refinanced by a 
reporting bank before April 1, 2013, or purchased by a reporting 
bank before April 1, 2013, where the loans are owed to the reporting 
bank by a borrower that does not meet the definition of a higher-
risk C&I borrower as that term is defined in this Appendix (which 
requires, among other things, that the borrower have obtained a C&I 
loan or refinanced an existing C&I loan on or after April 1, 2013) 
and securities purchased before April 1, 2013, that are issued by an 
entity that does not meet the definition of a higher-risk C&I 
borrower, as that term is defined in this Appendix, banks must 
continue to use the transition guidance in the September 2012 Call 
Report instructions to determine whether to report the loan or 
security as a higher-risk asset for purposes of the higher-risk 
assets to Tier 1 capital and reserves ratio. A bank may opt to apply 
the definition of higher-risk C&I loans and securities in this 
Appendix to all of its C&I loans and securities, but, if it does so, 
it must also apply the definition of a higher-risk C&I borrower in 
this Appendix without regard to when the loan is originally made or 
refinanced (i.e., whether made or refinanced before or after April 
1, 2013).

[[Page 66024]]

    For consumer loans (other than securitizations of consumer 
loans) originated or purchased prior to April 1, 2013, a bank must 
determine whether the loan met the definition of a higher-risk 
consumer loan no later than June 30, 2013.
    For all securitizations issued before April 1, 2013, banks must 
either (1) continue to use the transition guidance or (2) apply the 
definitions in this Appendix to all of its securitizations. If a 
bank applies the definition of higher-risk C&I loans and securities 
in this Appendix to its securitizations, it must also apply the 
definition of a higher-risk C&I borrower in this Appendix to all C&I 
borrowers without regard to when the loans to those borrowers were 
originally made or refinanced (i.e., whether made or refinanced 
before or after April 1, 2013).

II. 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] TR31OC12.030

Where:

N is bank i's growth-adjusted portfolio concentration measure; \12\
---------------------------------------------------------------------------

    \12\ The growth-adjusted portfolio concentration measure is 
rounded to two decimal points.
---------------------------------------------------------------------------

k is a portfolio;
g is a growth factor for bank 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.13 14
---------------------------------------------------------------------------

    \13\ All loan concentrations should include the fair value of 
purchased credit impaired loans.
    \14\ Each loan concentration category should exclude the amount 
of loans recoverable from the U.S. government 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.\15\ 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:
---------------------------------------------------------------------------

    \15\ The growth factor is rounded to two decimal points.
    [GRAPHIC] [TIFF OMITTED] TR31OC12.031
    
---------------------------------------------------------------------------
Where:

[GRAPHIC] [TIFF OMITTED] TR31OC12.032

V is the portfolio amount as reported on the Call Report/TFR and t 
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.\16\ These loss rates were converted into equivalent risk 
weights as shown in Table C.1.
---------------------------------------------------------------------------

    \16\ 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
------------------------------------------------------------------------


    By order of the Board of Directors.
    Dated at Washington, DC, this 9th day of October 2012.

Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2012-25943 Filed 10-30-12; 8:45 am]
BILLING CODE 6714-01-P