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FIL-19-99 Attachment

[Federal Register: March 2, 1999 (Volume 64, Number 40)]

[Rules and Regulations]

[Page 10193-10201]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr02mr99-8]


 

[[Page 10193]]


 

_______________________________________________________________________


 

Part III


 

Department of the Treasury

Office of the Comptroller of the Currency


 

12 CFR Part 3


 

Federal Reserve System


 

12 CFR Part 208, 225


 

Federal Deposit Insurance Corporation


 

12 CFR Part 325


 

Department of the Treasury

Office of Thrift Supervision


 

12 CFR Part 567


 

Risk-Based Capital Standards: Construction Loans on Presold Residential

Properties; Junior Liens on 1- to 4-Family Residential Properties; and

Investments in Mutual Funds; Leverage Capital Standards: Tier 1

Leverage Ratio; Final Rules


 

[[Page 10194]]


 

DEPARTMENT OF THE TREASURY


 

Office of the Comptroller of the Currency


 

12 CFR Part 3


 

Office of Thrift Supervision


 

12 CFR Part 567


 

[Docket No. 99-01]

RIN 1557-AB14


 

FEDERAL RESERVE SYSTEM


 

12 CFR Part 208


 

[Regulation H; Docket No. R-0947]


 

FEDERAL DEPOSIT INSURANCE CORPORATION


 

12 CFR Part 325


 

RIN 3064-AB 96


 

DEPARTMENT OF THE TREASURY


 

Office of Thrift Supervision


 

12 CFR Part 567


 

[Docket No. 98-125]

RIN 1550-AB11



 

Risk-Based Capital Standards: Construction Loans on Presold

Residential Properties; Junior Liens on 1-to 4-Family Residential

Properties; and Investments in Mutual Funds; Leverage Capital

Standards: Tier 1 Leverage Ratio


 

AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of

Governors of the Federal Reserve System; Federal Deposit Insurance

Corporation; and Office of Thrift Supervision, Treasury.


 

ACTION: Final rule.


 

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SUMMARY: The Office of the Comptroller of the Currency (OCC), the Board

of Governors of the Federal Reserve System (Board), the Federal Deposit

Insurance Corporation (FDIC), and the Office of Thrift Supervision

(OTS) (collectively, the agencies) are amending their respective risk-

based and leverage capital standards for banks and thrifts

(institutions).1 This final rule represents a significant

step in implementing section 303 of the Riegle Community Development

and Regulatory Improvement Act of 1994, which requires the agencies to

work jointly to make uniform their regulations and guidelines

implementing common statutory or supervisory policies. The intended

effect of this final rule is to make the risk-based capital treatments

for construction loans on presold residential properties, real estate

loans secured by junior liens on 1-to 4-family residential properties,

and investments in mutual funds consistent among the agencies. It is

also intended to simplify and make uniform the agencies' Tier 1

leverage capital standards.

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\1\ An amended risk-based capital standard for bank holding

companies is included in a separate Board notice published elsewhere

in today's Federal Register; references to ``institutions'' in this

final rule generally do not apply to bank holding companies.


 

EFFECTIVE DATE: This final rule is effective April 1, 1999. The

agencies will not object if an institution wishes to apply the

provisions of this final rule beginning with the date it is published

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in the Federal Register.


 

FOR FURTHER INFORMATION CONTACT: OCC: Roger Tufts, Senior Economic

Advisor (202/874-5070), Capital Policy Division; or Ronald Shimabukuro,

Senior Attorney (202/874-5090), Legislative and Regulatory Activities

Division, Office of the Comptroller of the Currency, 250 E Street,

S.W., Washington, DC 20219.

Board: Norah Barger, Assistant Director (202/452-2402), Barbara

Bouchard, Manager (202/452-3072), T. Kirk Odegard, Financial Analyst

(202/530-6225), Division of Banking Supervision and Regulation. For the

hearing impaired only, Telecommunication Device for the Deaf (TDD),

Diane Jenkins (202/452-3544), Board of Governors of the Federal Reserve

System, 20th and C Streets, N.W., Washington, DC 20551.

FDIC: For supervisory issues, Stephen G. Pfeifer, Examination

Specialist (202/898-8904), or Carol L. Liquori, Examination Specialist

(202/898-7289), Accounting Section, Division of Supervision; for legal

issues, Jamey Basham, Counsel, Legal Division (202/898-7265), Federal

Deposit Insurance Corporation, 550 17th Street, N.W., Washington, DC

20429.

OTS: Michael D. Solomon, Senior Program Manager for Capital Policy

(202/906-5654), Supervision Policy; or Vern McKinley, Senior Attorney

(202/906-6241), Regulations and Legislation Division, Office of the

Chief Counsel, Office of Thrift Supervision, 1700 G Street, N.W.,

Washington, DC 20552.


 

SUPPLEMENTARY INFORMATION:


 

I. Background


 

Section 303(a)(1) of the Riegle Community Development and

Regulatory Improvement Act of 1994 (12 U.S.C. 4803(a)) (CDRI Act)

requires the agencies to review their regulations and policies and to

streamline those regulations where possible. Section 303(a)(3) of the

CDRI Act directs the agencies, consistent with the principles of safety

and soundness, statutory law and policy, and the public interest, to

work jointly to make uniform all regulations and guidelines

implementing common statutory or supervisory policies. Although the

agencies' risk-based and leverage capital standards are already very

similar, the agencies have nevertheless reviewed these standards,

internally and on an interagency basis, to fulfill the CDRI Act section

303 mandate and identify areas where they have different capital

treatments or where streamlining is appropriate.

As a result of this review, the agencies identified inconsistencies

in their respective risk-based capital treatments for certain types of

transactions and determined that their minimum Tier 1 leverage capital

standards could be streamlined and made uniform. Accordingly, on

October 27, 1997, the agencies issued a joint proposal (62 FR 55686) to

amend their respective risk-based and leverage capital standards to

address the following: (1) construction loans on presold residential

properties; (2) junior liens on 1-to 4-family residential properties;

(3) investments in mutual funds; and (4) the Tier 1 leverage ratio.

The agencies received 15 public comments on the proposal (six from

industry trade groups, two each from thrifts, bank holding companies,

and national banks, and one each from a savings bank, a state nonmember

bank, and a concerned individual). These comments are discussed in

greater detail in the material that follows.

After consideration of these comments and further deliberation of

the issues involved, the agencies are adopting this final rule to make

their risk-based and leverage capital standards uniform with respect to

the aforementioned items. The capital treatments for construction loans

on presold residential properties, investments in mutual funds, and the

Tier 1 leverage ratio are adopted essentially as proposed. The capital

treatment for junior liens on 1- to 4-family residential properties,

however, differs from the proposed treatment.


 

II. Proposal, Comments Received, and Final Rule


 

A. Construction Loans on Presold Residential Properties


 

Proposal

Certain qualifying construction loans on presold residential

properties currently are eligible for the 50 percent


 

[[Page 10195]]


 

risk weight.\2\ Under OCC and OTS rules, a qualifying construction loan

on presold residential property is eligible for a 50 percent risk

weight if, prior to the extension of credit to the builder, the

property is sold to an individual who will occupy the residence upon

completion of construction. In contrast, the Board and FDIC consider

such a loan to be eligible for a 50 percent risk weight once the

property is sold, regardless of whether the institution made the loan

to the builder before or after the individual purchased the residence

from the builder. Consistent with the capital treatment accorded such

loans by the Board and FDIC, the agencies proposed that qualifying

construction loans on presold residential property would be eligible

for a 50 percent risk weight at the time the property was sold,

regardless of when the institution made the loan to the builder.

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


 

\2\ Qualifying construction loans on presold residential

property generally are those in which the borrower has substantial

equity in the project, the property has been presold under a binding

contract, the purchaser has a firm commitment for a permanent

qualifying mortgage loan, and the purchaser has made a substantial

earnest money deposit.

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Comments Received

The nine commenters who addressed this issue expressed unanimous

support for the proposal. Four commenters noted that presold

residential loans were equally safe whether the property was sold

before or after the initial extension of credit to the builder. One of

these commenters added that the quality of the loan was of greater

importance than the timing of the property sale. Five commenters did

not provide reasons for supporting the proposal.\3\

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\3\ One commenter noted that the OTS, through guidance in the

Thrift Financial Report, interprets the earnest money deposit

requirement more stringently than guidance in the Call Report. On an

ongoing basis, the agencies review their reporting instructions to

move toward greater consistency among the agencies.

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


 

Final Rule

The agencies concur with commenters and believe that qualifying

construction loans on presold residential property have the same credit

risk regardless of the timing of the property sale. Consequently, as

proposed, the agencies will permit a qualifying residential

construction loan to be eligible for the 50 percent risk category at

the time the property is sold, regardless of when the institution made

the loan to the builder. The OCC and OTS are revising their risk-based

capital standards to permit this treatment. The Board is revising its

regulatory language to conform its discussion of qualifying

construction loans to that of the FDIC.


 

B. Junior Liens on 1- to 4-Family Residential Properties


 

Proposal

The current agency rules are not uniform with respect to the risk

based capital treatment for junior liens on 1- to 4-family residential

properties. Under Board and FDIC rules, first and junior liens on 1- to

4-family residential properties are combined to determine loan-to-value

(LTV) ratios.\4\ The Board treats these liens as a single extension of

credit and assigns the combined loan to either the 50 percent or 100

percent risk category, depending on whether or not the loan is

``qualifying'' under other criteria in the capital standards.\5\ The

FDIC risk-weights the first lien at 50 percent, unless the combined

loan amount is not qualifying, in which case the first lien is risk-

weighted at 100 percent. All junior liens are risk-weighted at 100

percent. The OCC also risk-weights all junior liens at 100 percent,

qualifying first liens at 50 percent, and nonqualifying first liens at

100 percent, but does not combine liens when calculating LTV ratios.

The OTS definition of qualifying loans parallels that of the OCC, but

in response to specific inquiries, the OTS has interpreted this

provision to treat first and second mortgage loans to a single borrower

with no intervening liens as a single extension of credit secured by a

first lien.

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


 

\4\ As the LTV ratio increases, the risk profile of a loan is

generally considered to increase as well. In the event of a loan

default, a high LTV may indicate that the value of the underlying

collateral will not be sufficient to cover the amount of the loan.

In addition, borrowers who have a greater equity stake in their

property are generally less willing to default on their loans. Since

high-LTV loans are considered to carry greater risk, institutions

are expected to hold more capital against these loans.

\5\ Generally, a loan is qualifying when it meets prudent

underwriting criteria, including appropriate LTV ratios, and is

considered to be performing adequately. A loan that is 90 days or

more past due, or is in nonaccrual status, is not considered to be

performing adequately.

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


 

Under the proposal, when an institution holds a first lien and

junior lien(s) on a 1- to 4-family residential property, and no other

party holds an intervening lien, the liens would be treated separately

for LTV and risk-weighting purposes. Liens would not be combined for

LTV purposes. Qualifying first liens would be risk-weighted at 50

percent and nonqualifying first liens and all junior liens would be

risk-weighted at 100 percent. This is the capital treatment currently

accorded by the OCC. The agencies note that this rulemaking does not

affect the risk-based capital treatment of junior liens where an

institution does not hold the first lien, or where there are

intervening liens; such junior liens remain subject to the 100 percent

risk weight.

Comments Received

The agencies received ten comments on the junior lien component of

the proposal. Three commenters supported the proposed capital treatment

for junior liens, six commenters were opposed, and one commenter

expressed neither support nor opposition.

Of the three commenters that supported the proposal, one offered

support without explanation. The other two agreed with the proposal's

simplicity and ease of understanding and implementation, but disagreed

about whether first and junior liens should be combined for LTV

purposes. One supported the separate treatment for first and junior

liens for the purposes of calculating LTV ratios, while the other

suggested that the liens should be combined.

Of the six commenters opposing the junior lien proposal, two

opposed the separate treatment of loans for LTV purposes, stating that

all liens should be combined when calculating the LTV ratio for a

single borrower. According to these commenters, failure to combine

liens when calculating LTV ratios would increase the incentive for

lenders to utilize creative lending arrangements to reduce capital

charges without a corresponding reduction of risk. One further

suggested that the presence of any form of junior financing should

result in the entire loan receiving a 100 percent risk weight.

The other four commenters opposing the junior lien proposal

indicated that the degree of risk associated with junior liens varies

widely and that a 100 percent risk weight for all junior liens could be

too high in some instances. Two of these commenters essentially

endorsed the current approach taken by the Board, suggesting that first

and junior liens held by the same lender should be treated as a single

extension of credit that would be risk-weighted in its entirety at

either 50 percent or 100 percent, depending on LTV ratios and loan

performance. Another commenter suggested that the definition of

``qualifying mortgage loans'' should include junior liens that meet the

same performance criteria as first liens, and that qualifying junior

liens with a combined LTV of 80 percent or less--regardless of who

holds the first lien--should receive a 50 percent risk weight. A fourth

commenter suggested that first and junior liens by the same lender be

combined and placed in the 50 percent


 

[[Page 10196]]


 

risk category if the combined LTV ratio at loan inception is below 75

percent.

Finally, one commenter neither supported nor opposed the proposal,

but indicated that it was inappropriate because a 100 percent risk

weight was too high for a single-family first mortgage loan. This

commenter suggested that limitations, such as a $200 thousand maximum,

could be placed on certain nonqualifying first liens that would allow

them to be risk-weighted at 50 percent.

Final Rule

The agencies are adopting a capital treatment for junior liens on

1-to 4-family residential properties that differs from the proposal.

Although the proposed treatment is the simplest of the agencies'

current approaches to apply, the agencies believe that the goal of

simplicity is outweighed by other concerns. The agencies believe that,

when an institution holds first and junior liens to a single borrower

with no intervening liens, placing all of these junior liens in the 100

percent risk category--regardless of the quality of the individual

loans--places an unfair capital burden on institutions. Where junior

liens held by the first lienholder (with no intervening liens) do not

pose an undue risk, the agencies agree with the commenters that the 100

percent risk weight may be excessive.

The agencies also agree with the commenters who believe that it is

appropriate to combine first and junior liens when calculating the LTV

ratio. The agencies are concerned that institutions could use creative

lending arrangements to reduce capital charges without reducing risk.

Moreover, where an institution holds first and junior liens to a single

borrower with no intervening liens, it is the economic equivalent of a

single extension of credit that is secured by the same collateral and

should be treated accordingly. The agencies believe that it is

therefore appropriate that first and junior liens be combined when

calculating the LTV ratio.

Consequently, the agencies are adopting the current Board treatment

for such loans. When a lending institution holds the first lien and

junior liens on a 1-to 4-family residential property and no other party

holds an intervening lien, the loans will be viewed as a single

extension of credit secured by a first lien on the underlying property

for the purpose of determining the LTV ratio, as well as for risk

weighting. The institution's combined loan amount will be assigned to

either the 50 percent or 100 percent risk category, depending on

whether the credit satisfies the criteria for a 50 percent risk

weighting.

To qualify for the 50 percent risk category, the combined loan must

be made in accordance with prudent underwriting standards, including an

appropriate LTV ratio.\6\ In addition, none of the combined loans may

be 90 days or more past due, or be in nonaccrual status. Loans that do

not meet all of these criteria must be assigned in their entirety to

the 100 percent risk category. The OCC, FDIC, and OTS are revising

their respective risk-based capital standards to conform with this

capital treatment.

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\6\ Prudent underwriting standards include an appropriate ratio

of the loan balance to the value of the property. A loan secured by

a 1-to 4-family residential property has such a ratio if the loan

complies with the Interagency Guidelines for Real Estate Lending

(guidelines). See 12 CFR part 34, subpart D (OCC); 12 CFR part 208,

subpart C (Board); 12 CFR part 365 (FDIC); and 12 CFR 560.100-101

(OTS). A loan may comply with these guidelines despite having a

ratio above the supervisory limit if, for example, the loan is

supported by other credit factors, is an excluded transaction, or is

a prudently underwritten exception to the lender's policies. The

aggregate amount of (1) all loans in excess of the supervisory loan-

to-value limits, and (2) all loans made via exceptions to the

general lending policy is limited to 100 percent of total capital.

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C. Investments in Mutual Funds


 

Proposal

The current agency rules are not uniform with respect to the risk-

based capital treatment for investments in mutual funds. The Board,

FDIC, and OCC generally assign a risk weight to an institution's mutual

fund investment according to the highest risk-weighted asset allowable

under the fund's prospectus. The OCC also permits institutions, on a

case-by-case basis, to allocate mutual fund investments among the

various risk weight categories based on a pro rata distribution of

allowable investments under the fund's prospectus. The OTS assigns a

risk weight to a mutual fund investment based on the highest risk-

weighted asset actually held by the fund, but also allows, on a case-

by-case basis, an institution's investment in a mutual fund to be

allocated among risk weight categories based on a pro rata distribution

of actual fund holdings. All four agencies apply a 20 percent minimum

risk weight to such investments.

Mirroring the OCC's treatment for investments in mutual funds, the

agencies proposed that an institution's investment in a mutual fund

generally would be assigned a risk weight according to the highest

risk-weighted asset allowable in the fund's prospectus. The proposal

also would permit institutions the option of assigning mutual fund

investments on a pro rata basis to different risk weight categories

according to the limits set forth in the fund's prospectus. In no case

could the risk weight of a mutual fund investment be less than 20

percent. If, for purposes of liquidity, a fund holds an insignificant

amount of its assets in short-term, highly liquid securities, the

institution could disregard these securities in determining the proper

risk weight.

Comments Received

The agencies received eight comments on this component of the

proposal. Six commenters supported the proposal--with two suggesting

further modifications--while two commenters opposed the proposal.

Commenters supporting the proposal noted that it would provide

flexibility and would encourage investment in lower-risk mutual funds.

One of these commenters suggested that, to reflect the volatility of

mutual fund values, the minimum risk weight on mutual fund investments

should be raised from 20 percent to 50 percent. Another commenter

stated that the 20 percent risk weight floor was too high, and that up

to half of a mutual fund's authorized investment in U.S. Government

securities should be accorded a zero percent risk weight. One commenter

requested that the risk-based capital standards clarify precisely what

constitutes an ``insignificant quantity of highly liquid securities of

superior quality,'' suggesting a cap of 5 percent on such investments.

The two commenters that opposed the proposal stated that instead of

assigning risk weights based on the maximum investment limits permitted

under the fund's prospectus, institutions should have the option of

assigning risk weights based on pro rata calculations of actual fund

holdings. Both commenters asserted that this approach would assign risk

weights based on the actual risk of the underlying fund assets instead

of their potential risk. One commenter added that the proposal would

disproportionately affect smaller institutions, which are more likely

to invest in mutual funds than are large institutions.

Final Rule

After consideration of these comments, the agencies are adopting

the final rule as proposed. The final rule assigns an institution's

total investment in a mutual fund to the risk category appropriate to

the highest risk-weighted asset the fund may hold in accordance with

its stated investment limits set


 

[[Page 10197]]


 

forth in the prospectus. The agencies concur with commenters that

permitting the option of assigning risk weights for mutual fund

investments on a pro rata basis provides greater flexibility.

Consequently, under the final rule, institutions also have the option

of assigning the investment on a pro rata basis to different risk

categories according to the investment limits in the fund's prospectus.

Because actual fund holdings can change significantly from day-to-day,

the agencies believe that it is more prudent to base risk weight

distributions on investment limits than on a fund's actual underlying

assets. The agencies note that this should not impose an additional

burden on small institutions because all institutions will have a

choice between the two risk weight calculation methods for investments

in mutual funds.

Regardless of the risk-weighting method used, the total risk weight

of a mutual fund must be no less than 20 percent. While the agencies

are sensitive to the concern that the 20 percent minimum risk weight

may be higher than the standard risk weight of some of the assets held

by a mutual fund, the agencies nevertheless believe that a mutual fund

has certain credit, operational, and legal risks that necessitate a

risk weight greater than zero percent. The agencies are also aware that

the sum of investment limits in a mutual fund prospectus may exceed 100

percent. If this is the case, then institutions may not reduce their

capital requirements by assigning the highest proportion of the total

fund investment to the lowest risk weight categories. Instead,

institutions must assign risk weights in descending order, beginning

with the highest risk-weighted assets.7

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\7\ For example, assume that a fund's prospectus permits 100

percent risk-weighted assets up to 30 percent of the fund, 50

percent risk-weighted assets up to 40 percent of the fund, and 20

percent risk-weighted assets up to 60 percent of the fund. In such a

case, the institution must assign 30 percent of the total investment

to the 100 percent risk category, 40 percent to the 50 percent risk

category, and 30 percent to the 20 percent risk category. The

institution may not minimize its capital requirement by assigning 60

percent of the total investment to the 20 percent risk category and

40 percent to the 50 percent risk category.

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In addition, if a mutual fund can hold an immaterial amount of

highly liquid, high quality securities that do not qualify for a

preferential risk weight, then those securities may be disregarded in

determining the fund's risk weight. The agencies are not designating a

specific level below which an amount of such securities is immaterial,

as this may vary on a case-by-base basis depending on the particular

mutual fund. As a general matter, however, this amount is immaterial if

it is reasonably necessary to ensure the short-term liquidity of the

fund, and the securities do not materially affect the risk profile of

the fund.

The prudent use of hedging instruments by a mutual fund to reduce

its risk exposure will not increase the mutual fund's risk weighting.

Mutual fund investments are assigned to the 100 percent risk category

if they are speculative in nature or otherwise inconsistent with the

preferential risk weighting assigned to the fund's assets.

The Board, FDIC, and OTS are revising their risk-based capital

standards to reflect the capital treatment accorded investments in

mutual funds by the OCC.


 

D. Tier 1 Leverage Ratio


 

Proposal

The Tier 1 leverage ratio--that is, the ratio of Tier 1 capital to

total assets--is an indicator of an institution's capital adequacy and

places a constraint on the degree to which an institution can leverage

its capital base. The Board, FDIC, and OCC currently require

institutions with a composite rating of ``1'' under the Uniform

Financial Institutions Rating System to have a minimum leverage ratio

of 3.0 percent. Institutions that are not ``1''-rated must have a

minimum leverage ratio of 3.0 percent, plus an additional cushion of at

least 100 to 200 basis points. The OTS currently requires all

institutions to maintain core capital in an amount equal to 3.0 percent

of adjusted total assets.\8\

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\8\ The OTS core capital ratio is the equivalent of the other

agencies' Tier 1 leverage ratio. This final rule will add

definitions of Tier 1 and Tier 2 capital to the OTS capital rule to

clarify that these are the equivalents of core and supplemental

capital, respectively.

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In order to streamline and clarify the leverage ratio requirement,

the agencies proposed to revise the leverage ratio requirement to make

clear that ``1''-rated institutions would be required to maintain a

minimum Tier 1 leverage ratio of 3.0 percent, while all other

institutions would be required to maintain a minimum leverage ratio of

4.0 percent. These thresholds are the same as required to be

``adequately capitalized'' under the agencies' prompt corrective action

(PCA) guidelines.

Comments Received

The agencies received nine comments with regard to this component

of the proposal, seven of which supported the more consistent leverage

capital treatment among the agencies. Two commenters neither supported

nor opposed the proposal. One of these commenters stated that the

proposal was essentially meaningless because an institution with a

leverage ratio of 3.0 percent would be unlikely to receive a composite

rating of ``1'', while the other commenter encouraged the agencies to

continue working together to make the capital standards more simple and

consistent.

Four of the commenters that supported the proposal nevertheless

expressed concerns about the use of the leverage ratio as a supervisory

tool. All four questioned the appropriateness of leverage requirements

in light of comprehensive risk-based capital requirements, noting that

banks were at a competitive disadvantage relative to securities firms,

foreign banking organizations, and secondary market agencies. One of

these commenters proposed that PCA guidelines be modified so that

institutions that have either adopted a risk-based capital market risk

measure or are ``1''-rated be subject to a 3.0 percent minimum leverage

ratio to be considered ``adequately capitalized,'' and a 4.0 percent

minimum leverage ratio to be considered ``well capitalized.'' Three

commenters recommended that the agencies consider discontinuing

entirely the use of the leverage ratio, noting that risk-based capital

requirements now incorporate credit and market risks.

Final Rule

The agencies are adopting the final rule as proposed. Consequently,

under this final rule the most highly-rated institutions must maintain

a minimum Tier 1 leverage ratio of 3.0 percent, with all other

institutions required to maintain a minimum leverage ratio of 4.0

percent. In addition, as proposed, the OTS is amending its leverage

capital standard to be consistent with the other three agencies by

stating that higher-than-minimum capital levels may be required if

warranted, and that institutions should maintain capital levels

consistent with their risk exposures.

The agencies acknowledge commenter concerns about the usefulness of

the leverage ratio as a supervisory tool for those institutions that

have adopted market risk capital measures. Nevertheless, the agencies

note that a leverage requirement for PCA purposes is mandated under the

provisions of the Federal Deposit Insurance Corporation Improvement Act

of 1991. Moreover, the agencies believe that the Tier 1 leverage ratio,

when used in conjunction with risk-based capital ratios, is a useful

supervisory tool in assessing an institution's capital adequacy. While

a


 

[[Page 10198]]


 

change to the PCA leverage ratio guidelines is beyond the scope of this

final rule, the agencies may consider whether the leverage requirements

under PCA should be further modified in the future.


 

III. Regulatory Flexibility Act Analysis


 

OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act,

the OCC certifies that this final rule will not have a significant

impact on a substantial number of small entities. This final rule makes

no changes with respect to the capital treatment of mutual funds or

with respect to the minimum leverage ratio for national banks. However,

with respect to the capital treatment of construction loans the final

rule eases the regulatory burden on national banks by providing a more

favorable risk-based capital treatment. As to the capital treatment of

junior liens on 1- to 4-family residences, the OCC believes that while

certain loans may be subject to an increased capital requirement, other

loans may be subject to a lower capital charge. However, the OCC does

not believe that the impact of this provision will be significant.

Therefore, the OCC believes that the net economic impact of these

changes on national banks, regardless of size, is expected to be

minimal and a regulatory flexibility analysis is not required.

Board: Pursuant to section 605(b) of the Regulatory Flexibility

Act, the Board has determined that this final rule will not have a

significant economic impact on a substantial number of small entities

within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et

seq.). The treatment of construction loans, junior liens, and the

leverage ratio does not differ from the Board's current treatment. The

treatment of mutual fund risk weights differs from current treatment,

but affected institutions are not required to adopt the new treatment.

Accordingly, a regulatory flexibility analysis is not required, because

the economic impact of the final rule on institutions, regardless of

size, is expected to be minimal.

FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act,

the FDIC has determined that this final rule will not have a

significant economic impact on a substantial number of small entities

within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et

seq.). The treatment of construction loans and the leverage ratio does

not differ from the FDIC's current treatment. The treatment of junior

liens under the final rule is the same as current treatment to the

extent affected institutions must combine the loans in evaluating the

prudence of the loan-to-value ratio, and the change in treatment (lower

risk weighting of the junior lien) is optional. The treatment of mutual

fund risk weights differs from current treatment, but this change is

also optional. Accordingly, a regulatory flexibility analysis is not

required, because the economic impact of the final rule on

institutions, regardless of size, is expected to be minimal.

OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act,

the OTS certifies that this final rule will not have a significant

impact on a substantial number of small entities. The final rule

relaxes regulatory burdens on all savings associations by providing a

more favorable risk-based capital treatment for construction loans. The

changed treatment of mutual funds should have minimal impact on small

savings associations, as the new treatment is consistent with most

thrifts' current actual practice. The increased monitoring and

recordkeeping necessary to use OTS' current regulatory treatment was

not cost-effective for small thrifts. While the rule also increases the

leverage ratio requirement, this change should have little impact since

it is consistent with requirements for an ``adequately capitalized''

institution under the prompt corrective action rules. The current

treatment of junior liens on 1-to 4-family residences is unchanged.

Accordingly, the economic impact of these changes on savings

associations, regardless of size, is expected to be minimal and a

regulatory flexibility analysis is not required.


 

IV. Paperwork Reduction Act


 

The agencies have determined that the final rule will not involve a

collection of information pursuant to the provisions of the Paperwork

Reduction Act of 1995 (44 U.S.C. 3501 et seq.).


 

V. Small Business Regulatory Enforcement Fairness Act


 

The Small Business Regulatory Enforcement Fairness Act of 1996

(SBREFA) (Title II, Pub. L. 104-121) provides generally for agencies to

report rules to Congress for review. The reporting requirement is

triggered when a federal agency issues a final rule. Accordingly, the

agencies filed the appropriate reports with Congress as required by

SBREFA.

The Office of Management and Budget has determined that this final

rule does not constitute a ``major rule'' as defined by SBREFA.


 

VI. OCC and OTS Executive Order 12866 Determination


 

The OCC and the OTS have determined that this final rule does not

constitute a ``significant regulatory action'' for the purposes of

Executive Order 12866.


 

VII. OCC and OTS Unfunded Mandates Reform Act of 1995

Determinations


 

Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L.

104-4 (Unfunded Mandates Act) requires that an agency prepare a

budgetary impact statement before promulgating a rule that includes a

Federal mandate that may result in expenditure by State, local, and

tribal governments, in the aggregate, or by the private sector, of $100

million or more in any one year. If a budgetary impact statement is

required, section 205 of the Unfunded Mandates Act also requires an

agency to identify and consider a reasonable number of regulatory

alternatives before promulgating a rule. As discussed in the preamble,

this final rule is limited to making the risk weighting of presold

residential construction loans, second liens, and mutual fund

investments consistent under the agencies' risk-based capital rules. It

also establishes a uniform, simplified leverage requirement for all

institutions. In addition, with respect to the OCC, this final rule

clarifies and makes uniform existing regulatory requirements for

national banks. The OCC and OTS, therefore, have determined that the

final rule will not result in expenditures by State, local, or tribal

governments or by the private sector of $100 million or more.

Accordingly, the OCC and OTS have not prepared a budgetary impact

statement or specifically addressed the regulatory alternatives

considered.


 

List of Subjects


 

12 CFR Part 3


 

Administrative practice and procedure, Capital, National banks,

Reporting and recordkeeping requirements, Risk.


 

12 CFR Part 208


 

Accounting, Agriculture, Banks, banking, Confidential business

information, Crime, Currency, Federal Reserve System, Mortgages,

Reporting and recordkeeping requirements, Securities.


 

12 CFR Part 325


 

Bank deposit insurance, Banks, banking, Capital adequacy, Reporting

and recordkeeping requirements,


 

[[Page 10199]]


 

Savings associations, State non-member banks.


 

12 CFR Part 567


 

Capital, Reporting and recordkeeping requirements, Savings

associations.


 

Authority and Issuance


 

Office of the Comptroller of the Currency


 

12 CFR CHAPTER I


 

For the reasons set out in the joint preamble, part 3 of chapter I

of title 12 of the Code of Federal Regulations is amended as follows:


 

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES


 

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


 

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

note, 1835, 3907 and 3909.


 

2. In Sec. 3.6, paragraph (c) is revised to read as follows:


 

Sec. 3.6 Minimum capital ratios.


 

* * * * *

(c) Additional leverage ratio requirement. An institution operating

at or near the level in paragraph (b) of this section should have well-

diversified risks, including no undue interest rate risk exposure;

excellent control systems; good earnings; high asset quality; high

liquidity; and well managed on-and off-balance sheet activities; and in

general be considered a strong banking organization, rated composite 1

under the Uniform Financial Institutions Rating System (CAMELS) rating

system of banks. For all but the most highly-rated banks meeting the

conditions set forth in this paragraph (c), the minimum Tier 1 leverage

ratio is 4 percent. In all cases, banking institutions should hold

capital commensurate with the level and nature of all risks.

3. In appendix A to part 3, section 3, the second undesignated

paragraph and paragraphs (a)(3)(iii) and (a)(3)(iv) introductory text

are revised to read as follows:


 

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


 

* * * * *


 

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

Off-Balance Sheet Items


 

* * * * *

Some of the assets on a bank's balance sheet may represent an

indirect holding of a pool of assets, e.g., mutual funds, that

encompasses more than one risk weight within the pool. In those

situations, the bank may assign the asset to the risk category

applicable to the highest risk-weighted asset that pool is permitted

to hold pursuant to its stated investment objectives in the fund's

prospectus. Alternatively, the bank may assign the asset on a pro

rata basis to different risk categories according to the investment

limits in the fund's prospectus. In either case, the minimum risk

weight that may be assigned to such a pool is 20%. If a bank assigns

the asset on a pro rata basis, and the sum of the investment limits

in the fund's prospectus exceeds 100%, the bank must assign the

highest pro rata amounts of its total investment to the higher risk

category. If, in order to maintain a necessary degree of liquidity,

the fund is permitted to hold an insignificant amount of its assets

in short-term, highly-liquid securities of superior credit quality

(that do not qualify for a preferential risk weight), such

securities generally will not be taken into account in determining

the risk category into which the bank's holding in the overall pool

should be assigned. The prudent use of hedging instruments by a fund

to reduce the risk of its assets will not increase the risk

weighting of the investment in that fund above the 20% category.

However, if a fund engages in any activities that are deemed to be

speculative in nature or has any other characteristics that are

inconsistent with the preferential risk weighting assigned to the

fund's assets, the bank's investment in the fund will be assigned to

the 100% risk category. More detail on the treatment of mortgage-

backed securities is provided in section 3(a)(3)(vi) of this

appendix A.

(a) * * *

(3) * * *

(iii) Loans secured by first mortgages on one-to-four family

residential properties, either owner-occupied or rented, provided

that such loans are not otherwise 90 days or more past due, or on

nonaccrual or restructured. It is presumed that such loans will meet

prudent underwriting standards. If a bank holds a first lien and

junior lien on a one-to-four family residential property and no

other party holds an intervening lien, the transaction is treated as

a single loan secured by a first lien for the purposes of both

determining the loan-to-value ratio and assigning a risk weight to

the transaction. Furthermore, residential property loans made for

the purpose of construction financing are assigned to the 100% risk

category of section 3(a)(4) of this appendix A; however, these loans

may be included in the 50% risk category of this section 3(a)(3) of

this appendix A if they are subject to a legally binding sales

contract and satisfy the requirements of section 3(a)(3)(iv) of this

appendix A.

(iv) Loans to residential real estate builders for one-to-four

family residential property construction, if the bank obtains

sufficient documentation demonstrating that the buyer of the home

intends to purchase the home (i.e., a legally binding written sales

contract) and has the ability to obtain a mortgage loan sufficient

to purchase the home (i.e., a firm written commitment for permanent

financing of the home upon completion), subject to the following

additional criteria:

* * * * *

Dated: February 23, 1999.

John D. Hawke, Jr.,

Comptroller of the Currency.


 

Federal Reserve System


 

12 CFR CHAPTER II


 

For the reasons set forth in the joint preamble, part 208 of

chapter II of title 12 of the Code of Federal Regulations is amended as

set forth below:


 

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL

RESERVE SYSTEM (REGULATION H)


 

1. The authority citation for part 208 is revised to read as

follows:


 

Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,

371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d), 1823(j),

1828(o), 1831o, 1831p-1, 1831r-1, 1835a, 1882, 2901-2907, 3105,

3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 78l(b), 78l(g),

78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 5318; 42 U.S.C.

4012a, 4104a, 4104b, 4106, and 4128.


 

2. In appendix A to part 208, section III. A., footnote 21 is

revised to read as follows:


 

Appendix A to Part 208--Capital Adequacy Guidelines for State

Member Banks: Risk-Based Measure


 

* * * * *

III. * * *

A. * * * 21

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


 

\21\ An investment in shares of a fund whose portfolio consists

primarily of various securities or money market instruments that, if

held separately, would be assigned to different risk categories,

generally is assigned to the risk category appropriate to the

highest risk-weighted asset that the fund is permitted to hold in

accordance with the stated investment objectives set forth in its

prospectus. A bank may, at its option, assign a fund investment on a

pro rata basis to different risk categories according to the

investment limits in the fund's prospectus. In no case will an

investment in shares in any fund be assigned to a total risk weight

less than 20 percent. If a bank chooses to assign a fund investment

on a pro rata basis, and the sum of the investment limits of assets

in the fund's prospectus exceeds 100 percent, the bank must assign

risk weights in descending order. If, in order to maintain a

necessary degree of short-term liquidity, a fund is permitted to

hold an insignificant amount of its assets in short-term, highly

liquid securities of superior credit quality that do not qualify for

a preferential risk weight, such securities generally will be

disregarded when determining the risk category into which the bank's

holding in the overall fund should be assigned. The prudent use of

hedging instruments by a fund to reduce the risk of its assets also

will not increase the risk weighting of the fund investment. For

example, the use of hedging instruments by a fund to reduce the

interest rate risk of its government bond portfolio will not

increase the risk weight of that fund above the 20 percent category.

Nonetheless, if a fund engages in any activities that appear

speculative in nature or has any other characteristics that are

inconsistent with the preferential risk weighting assigned to the

fund's assets, holdings in the fund will be assigned to the 100

percent risk category.

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


 

* * * * *


 

[[Page 10200]]


 

3. In appendix A to part 208, section III.C.3., footnote 34 is

revised to read as follows:

* * * * *

III. * * *

C. * * *

3. * * *34

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


 

\34\ If a bank holds the first and junior lien(s) on a

residential property and no other party holds an intervening lien,

the transaction is treated as a single loan secured by a first lien

for the purposes of determining the loan-to-value ratio and

assigning a risk weight.

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


 

* * * * *

4. In appendix A to part 208, section III.C.3. is amended by adding

a new sentence to the end of the first paragraph of footnote 35 to read

as follows:

* * * * *

III. * * *

C. * * *

3. * * *35

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


 

\35\ * * * Such loans to builders will be considered prudently

underwritten only if the bank has obtained sufficient documentation

that the buyer of the home intends to purchase the home (i.e., has a

legally binding written sales contract) and has the ability to

obtain a mortgage loan sufficient to purchase the home (i.e., has a

firm written commitment for permanent financing of the home upon

completion). * * *

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


 

* * * * *

4. In appendix B to part 208, section II.a. is revised to read as

follows:


 

Appendix B to Part 208--Capital Adequacy Guidelines for State

Member Banks: Tier 1 Leverage Measure


 

* * * * *

II. * * *

a. The minimum ratio of Tier 1 capital to total assets for

strong banking institutions (rated composite ``1'' under the UFIRS

rating system of banks) is 3.0 percent. For all other institutions,

the minimum ratio of Tier 1 capital to total assets is 4.0 percent.

Banking institutions with supervisory, financial, operational, or

managerial weaknesses, as well as institutions that are anticipating

or experiencing significant growth, are expected to maintain capital

ratios well above the minimum levels. Moreover, higher capital

ratios may be required for any banking institution if warranted by

its particular circumstances or risk profile. In all cases,

institutions should hold capital commensurate with the level and

nature of the risks, including the volume and severity of problem

loans, to which they are exposed.

* * * * *

By order of the Board of Governors of the Federal Reserve

System, February 24, 1999.

Jennifer J. Johnson,

Secretary of the Board.


 

Federal Deposit Insurance Corporation


 

12 CFR CHAPTER III


 

For the reasons set forth in the preamble, part 325 of chapter III

of title 12 of the Code of Federal Regulations is proposed to be

amended as follows:


 

PART 325--CAPITAL MAINTENANCE


 

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

follows:


 

Authority: 12 U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b),

1818(c), 1818(t), 1819(Tenth), 1828(c), 1828(d), 1828(i), 1828(n),

1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat.

1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat.

2236, 2355, 2386 (12 U.S.C. 1828 note).


 

2. Paragraph (b)(2) in Sec. 325.3 is revised to read as follows:


 

Sec. 325.3 Minimum leverage capital requirement.


 

* * * * *

(b) * * *

(2) For all but the most highly-rated institutions meeting the

conditions set forth in paragraph (b)(1) of this section, the minimum

leverage capital requirement for a bank (or for an insured depository

institution making an application to the FDIC) shall consist of a ratio

of Tier 1 capital to total assets of not less than 4 percent.

* * * * *

3. In appendix A to part 325, section II.B., paragraph 1. is

revised to read as follows:


 

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


 

* * * * *

II. * * *

B. * * *


 

1. Indirect Holdings of Assets. Some of the assets on a bank's

balance sheet may represent an indirect holding of a pool of assets;

for example, mutual funds. An investment in shares of a mutual fund

whose portfolio consists solely of various securities or money

market instruments that, if held separately, would be assigned to

different risk categories, generally is assigned to the risk

category appropriate to the highest risk-weighted asset that the

fund is permitted to hold in accordance with the stated investment

objectives set forth in its prospectus. The bank may, at its option,

assign the investment on a pro rata basis to different risk

categories according to the investment limits in the fund's

prospectus, but in no case will indirect holdings through shares in

any mutual fund be assigned to a risk weight less than 20 percent.

If the bank chooses to assign its investment on a pro rata basis,

and the sum of the investment limits in the fund's prospectus

exceeds 100 percent, the bank must assign risk weights in descending

order. If, in order to maintain a necessary degree of short-term

liquidity, a fund is permitted to hold an insignificant amount of

its assets in short-term, highly liquid securities of superior

credit quality that do not qualify for a preferential risk weight,

such securities will generally be disregarded in determining the

risk category to which the bank's holdings in the overall fund

should be assigned. The prudent use of hedging instruments by a

mutual fund to reduce the risk of its assets will not increase the

risk weighting of the mutual fund investment. For example, the use

of hedging instruments by a mutual fund to reduce the interest rate

risk of its government bond portfolio will not increase the risk

weight of that fund above the 20 percent category. Nonetheless, if

the fund engages in any activities that appear speculative in nature

or has any other characteristics that are inconsistent with the

preferential risk weighting assigned to the fund's assets, holdings

in the fund will be assigned to the 100 percent risk category.


 

4. In appendix A to part 325, section II.C., footnote number 26 is

revised to read as follows:

* * * * *

II. * * *

C. * * * 26


 

\26\ If a bank holds the first and junior lien(s) on a

residential property and no other party holds an intervening lien,

the transactions are treated as a single loan secured by a first

lien for purposes of determining the loan-to-value ratio and

assigning a risk weight.

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


 

By order of the Board of Directors.


 

Dated at Washington, DC, this 18th day of December, 1998.


 

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.


 

Office of Thrift Supervision


 

12 CFR CHAPTER V


 

Accordingly, the Office of Thrift Supervision hereby amends title

12, chapter V, of the Code of Federal Regulations, as set forth below:


 

PART 567--CAPITAL


 

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

follows:


 

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

(note).


 

2. Section 567.1 is amended by adding a new sentence following the

third sentence in the definition of qualifying mortgage loan, revising

paragraphs (1)(ii) and (1)(iii) introductory text in the definition of

qualifying residential construction loan and adding the definitions of

Tier 1 capital and Tier 2 capital as follows:


 

Sec. 567.1 Definitions.


 

* * * * *

Qualifying mortgage loan. * * * If a savings association holds the

first and junior lien(s) on a residential property and no other party

holds an intervening lien, the transaction is treated as a single loan

secured by a first lien for the purposes of determining the loan-to-


 

[[Page 10201]]


 

value ratio and the appropriate risk weight under Sec. 567.6(a).

* * * * *

Qualifying residential construction loan. (1) * * *

(ii) The residence being constructed must be a 1-4 family residence

sold to a home purchaser;

(iii) The lending savings association must obtain sufficient

documentation from a permanent lender (which may be the construction

lender) demonstrating that:

* * * * *

Tier 1 capital. The term Tier 1 capital means core capital as

computed in accordance with Sec. 567.5(a) of this part.

Tier 2 capital. The term Tier 2 capital means supplementary capital

as computed in accordance with Sec. 567.5 of this part.

* * * * *

3. Section 567.2(a)(2)(ii) is revised to read as follows:


 

Sec. 567.2 Minimum regulatory capital requirement.


 

(a) * * *

(2) Leverage ratio requirement. * * *

(ii) A savings association must satisfy this requirement with core

capital as defined in Sec. 567.5(a) of this part.

* * * * *

4. Section 567.6(a)(1)(vi) is revised to read as follows:


 

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


 

(a) * * *

(1) * * *

(vi) Indirect ownership interests in pools of assets. Assets

representing an indirect holding of a pool of assets, e.g., mutual

funds, are assigned to risk-weight categories under this section based

upon the risk weight that would be assigned to the assets in the

portfolio of the pool. An investment in shares of a mutual fund whose

portfolio consists primarily of various securities or money market

instruments that, if held separately, would be assigned to different

risk-weight categories, generally is assigned to the risk-weight

category appropriate to the highest risk-weighted asset that the fund

is permitted to hold in accordance with the investment objectives set

forth in its prospectus. The savings association may, at its option,

assign the investment on a pro rata basis to different risk-weight

categories according to the investment limits in its prospectus. In no

case will an investment in shares in any such fund be assigned to a

total risk weight less than 20 percent. If the savings association

chooses to assign investments on a pro rata basis, and the sum of the

investment limits of assets in the fund's prospectus exceeds 100

percent, the savings association must assign the highest pro rata

amounts of its total investment to the higher risk categories. If, in

order to maintain a necessary degree of short-term liquidity, a fund is

permitted to hold an insignificant amount of its assets in short-term,

highly liquid securities of superior credit quality that do not qualify

for a preferential risk weight, such securities will generally be

disregarded in determining the risk-weight category into which the

savings association's holding in the overall fund should be assigned.

The prudent use of hedging instruments by a mutual fund to reduce the

risk of its assets will not increase the risk weighting of the mutual

fund investment. For example, the use of hedging instruments by a

mutual fund to reduce the interest rate risk of its government bond

portfolio will not increase the risk weight of that fund above the 20

percent category. Nonetheless, if the fund engages in any activities

that appear speculative in nature or has any other characteristics that

are inconsistent with the preferential risk-weighting assigned to the

fund's assets, holdings in the fund will be assigned to the 100 percent

risk-weight category.

* * * * *

5. Section 567.8 is revised to read as follows:


 

Sec. 567.8 Leverage ratio.


 

(a) The minimum leverage capital requirement for a savings

association assigned a composite rating of 1, as defined in Sec. 516.3

of this chapter, shall consist of a ratio of core capital to adjusted

total assets of 3 percent. These generally are strong associations that

are not anticipating or experiencing significant growth and have well-

diversified risks, including no undue interest rate risk exposure,

excellent asset quality, high liquidity, and good earnings.

(b) For all savings associations not meeting the conditions set

forth in paragraph (a) of this section, the minimum leverage capital

requirement shall consist of a ratio of core capital to adjusted total

assets of 4 percent. Higher capital ratios may be required if warranted

by the particular circumstances or risk profiles of an individual

savings association. In all cases, savings associations should hold

capital commensurate with the level and nature of all risks, including

the volume and severity of problem loans, to which they are exposed.


 

Dated: December 15, 1998.


 

By the Office of Thrift Supervision.

Ellen Seidman,

Director.

[FR Doc. 99-5012 Filed 3-1-99; 8:45 am]

BILLING CODE OCC: 4810-33-P (25%); Board: 6210-01-P (25%); FDIC: 6714-

01-P (25%); OTS: 6720-01-P (25%)

Last Updated: March 23, 2024