[Federal Register: September 27, 2000 (Volume 65, Number 188)]
[Proposed Rules]
[Page 57993-58011]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27se00-18]
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Proposed Rules
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains notices to the public of
the proposed issuance of rules and regulations. The purpose of these
notices is to give interested persons an opportunity to participate in
the rule making prior to the adoption of the final rules.
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[[Page 57993]]
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the Currency
12 CFR Part 3
[Docket No. 00-17]
RIN 1557-AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R-1080]
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AC34
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 565 and 567
[Docket No. 2000-70]
RIN 1550-AB11
Capital; Leverage and Risk-Based Capital Guidelines; Capital
Adequacy Guidelines; Capital Maintenance: Residual Interests in Asset
Securitizations or Other Transfers of Financial Assets
AGENCIES: Office of the Comptroller of the Currency (OCC), Treasury;
Board of Governors of the Federal Reserve System (Board); Federal
Deposit Insurance Corporation (FDIC); and Office of Thrift Supervision
(OTS), Treasury.
ACTION: Notice of proposed rulemaking.
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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) propose to amend their capital
adequacy standards for banks, bank holding companies and thrifts
(collectively, banking organizations) concerning the treatment of
certain residual interests in asset securitizations or other transfers
of financial assets. Residual interests are defined as those on-balance
sheet assets that represent interests (including beneficial interests)
in the transferred financial assets retained by a seller (or
transferor) after a securitization or other transfer of financial
assets; and are structured to absorb more than a pro rata share of
credit loss related to the transferred assets through subordination
provisions or other credit enhancement techniques (credit enhancement).
Examples of residual interests include, but are not limited to,
interest only strips receivable (I/O strips), spread accounts, cash
collateral accounts, retained subordinated interests, and other similar
forms of on-balance sheet assets that function as a credit enhancement.
Residual interests as defined in the proposed rule do not include
interests purchased from a third party.
Generally, these residual interests are non-investment grade or
unrated assets retained by the issuing institution in order to provide
"first-loss" credit support for the senior positions in a
securitization or other financial asset transfer. They generally lack
an active market through which a readily available market price can be
obtained. In addition, many of these residual interests are exposed, on
a leveraged basis, to a significant level of credit and interest rate
risk that make their valuation extremely sensitive to changes in the
underlying credit and prepayment assumptions. As a result, such
residual interests present valuation and liquidity concerns. High
concentrations of such illiquid and volatile assets in relation to
capital can threaten the safety and soundness of banking organizations.
This proposed rule is intended to better align regulatory capital
requirements with the risk exposure of these types of residual
interests, encourage conservative valuation methods, and restrict
excessive concentrations in these assets. The proposed rule would
require that risk-based capital be held in an amount equal to the
amount of the residual interest that is retained on the balance sheet
by a banking organization in a securitization or other transfer of
financial assets, even if the capital charge exceeds the full risk-
based capital charge typically held against the transferred assets. The
proposed rule also would restrict excessive concentrations in residual
interests by limiting the amount that may be included in Tier 1 capital
for both leverage and risk-based capital purposes. When aggregated with
nonmortgage servicing assets and purchased credit card relationships
(PCCRs), the balance sheet amount of residual interests would be
limited to 25 percent of Tier 1 capital, with any amount in excess of
this limitation deducted in determining the amount of a banking
organization's Tier 1 capital.
DATES: Comments must be received by December 26, 2000.
ADDRESSES: Comments should be directed to:
OCC: Comments may be submitted to Docket No. 00-17, Communications
Division, Third Floor, Office of the Comptroller of the Currency, 250 E
Street, SW., Washington, DC 20219. Comments will be available for
inspection and photocopying at that address. In addition, comments may
be sent by facsimile transmission to FAX number (202/874-5274), or by
electronic mail to regs.comment@occ.treas.gov.
Board: Comments directed to the Board should refer to Docket No. R-
1080 and may be mailed to Ms. Jennifer J. Johnson, Secretary, Board of
Governors of the Federal Reserve System, 20th Street and Constitution
Avenue, NW., Washington DC 20551 or mailed electronically to
regs.comments@federalreserve.gov. Comments addressed to the attention
of Ms. Johnson may also be delivered to Room B-2222 of the Eccles
Building between 8:45 a.m. and 5:15 p.m. weekdays, or the security
control room in the Eccles Building courtyard on 20th Street, N.W.
(between Constitution Avenue and C Street) at any time. Comments may be
inspected in Room MP-500 of the Martin Building between 9 a.m. and 5
p.m. weekdays, except as provided in 12 CFR 261.8 of the Board's Rules
Regarding Availability of Information.
FDIC: Send written comments to Robert E. Feldman, Executive
Secretary, Attention: Comments/OES, Federal Deposit Insurance
Corporation, 550 17th
[[Page 57994]]
Street, NW., Washington, DC 20429. Comments may be hand-delivered to
the guard station at the rear of the 550 17th Street Building (located
on F Street), on business days between 7 a.m. and 5 p.m. Send facsimile
transmissions to FAX number (202/898-3838); Internet address:
comments@fdic.gov.) Comments may be inspected and photocopied in the
FDIC Public Information Center, Room 100, 801 17th Street, NW.,
Washington, DC 20429, between 9 a.m. and 4:30 p.m. on business days.
OTS: Send comments to Manager, Dissemination Branch, Information
Management and Services Division, Office of Thrift Supervision, 1700 G
Street, NW, Washington, DC 20552, Attention Docket No. 2000-70. Hand
deliver comments to the Guard's Desk, East Lobby Entrance, 1700 G
Street, NW., from 9 a.m. to 4 p.m. on business days. Send facsimile
transmissions to FAX Number (202) 906-7755; or (202) 906-6956 (if
comments are over 25 pages). Send e-mails to public.info@ots.treas.gov,
and include your name and telephone number. Interested persons may
inspect comments at the Public Reference Room, 1700 G Street, NW., from
10 a.m. until 4 p.m. on Tuesdays and Thursdays.
FOR FURTHER INFORMATION CONTACT:
OCC: Amrit Sekhon, Risk Specialist (202/874-5211), Capital Policy;
Ron Shimabukuro, Senior Attorney, or Laura Goldman, Senior Attorney,
Legislative and Regulatory Activities Division (202/874-5090).
Board: Thomas R. Boemio, Senior Supervisory Financial Analyst (202/
452-2982); Arleen Lustig, Supervisory Financial Analyst (202/452-2987),
Division of Banking Supervision and Regulation; and Mark E. Van Der
Weide, Counsel, (202/452-2263), Legal Division. For the hearing
impaired only, Telecommunication Device for the Deaf (TDD), Janice
Simms (202/872-4984), Board of Governors of the Federal Reserve System,
20th and C Streets, NW., Washington, DC 20551.
FDIC: William A. Stark, Assistant Director, Division of Supervision
(202/898-6972); Stephen G. Pfeifer, Senior Examination Specialist,
Division of Supervision (202/898-8904); Keith A. Ligon, Chief, Policy
Unit, Division of Supervision (202/898-3618); and Marc J. Goldstrom,
Counsel, Legal Division (202/898-8807).
OTS: Michael D. Solomon, Senior Program Manager for Capital Policy
(202/906-5654), and Teresa A. Scott, Counsel, Banking and Finance (202/
906-6478), Regulation and Legislation Division, Office of the Chief
Counsel, Office of Thrift Supervision, 1700 G Street, NW., Washington,
DC 20552.
SUPPLEMENTARY INFORMATION: This preamble consists of the following
sections:
I. Introduction
II. Nature of Supervisory Concerns
III. Current Capital Treatment for Residual Interests
IV. Residual Interests Subject to the Proposal
V. Proposed Amendments to the Capital Standards
VI. Request for Public Comment
VII. Plain Language
VIII. Regulatory Analysis
I. Introduction
The proposed rule addresses the supervisory concerns arising from
the illiquid and volatile nature of residual interests that are
retained by the securitizer or other seller of financial assets, when
those residual interests are used as a credit enhancement to support
the financial assets transferred. The proposal also reduces the risk
from excessive concentrations in these residual interests, including
those situations where large residual interests are retained in
connection with the sale or securitization of low quality, higher risk
loans. As discussed in more detail in section V, the proposed rule
would (1) require capital to be maintained in an amount equal to the
amount of the residual interest that is retained on the balance sheet
for risk-based capital purposes, and (2) require the amount of any such
residual interests to be included in the 25 percent of Tier 1 capital
sublimit that currently applies to nonmortgage servicing assets and
purchased credit card relationships (PCCRs), with any amounts in excess
of this limit deducted from Tier 1 capital for both leverage and risk-
based capital purposes.
II. Nature of Supervisory Concerns
Securitizations and other financial asset transfers provide an
efficient mechanism for banking organizations to sell loan assets or
credit exposures. The benefits of these transactions must be balanced
against the significant risks that such activities can pose to banking
organizations and to the deposit insurance funds. Recent examinations
have disclosed significant weaknesses in the risk management processes
related to securitization activities at certain institutions. The most
frequently encountered problems stem from: (1) The failure to recognize
recourse obligations that frequently accompany securitizations and to
hold sufficient capital against such obligations; (2) the excessive or
inadequately supported valuation of residual interests; (3) the
liquidity risk associated with over reliance on asset securitization as
a funding source; and (4) the absence of adequate independent risk
management and audit functions.
The Agencies addressed these concerns in the Interagency Guidance
on Asset Securitization (Securitization Guidance) issued in December
1999.\1\ The Securitization Guidance highlighted some of the risks
associated with asset securitization and emphasized the Agencies'
concerns with certain residual interests generated from the
securitization and sale of assets.
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\1\ See OCC Bulletin 99-46 (December 14, 1999) (OCC); FDIC FIL
109-99 (December 13, 1999) (FCIC); SR 99-37(SUP) (December 13, 1999)
(FRB); and CEO LTR 99-119 (December 14, 1999) (OTS). See this
guidance for a more detailed discussion of the risk management
processes applicable to securitization activities.
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The Securitization Guidance addressed the fundamental risk
management practices that should be in place at institutions that
engage in securitization activities and stressed the need for bank
management to implement policies and procedures that include limits on
the amount of residual interests that may be carried as a percentage of
capital. In particular, the Securitization Guidance set forth the
supervisory expectation that the value of a residual interest in a
securitization must be supported by objectively verifiable
documentation of the asset's fair market value utilizing reasonable,
conservative valuation assumptions. Under this guidance, residual
interests that do not meet this expectation, or that fail to meet the
supervisory standards set forth in the Securitization Guidance, should
be classified as "loss" and disallowed as assets of the banking
organization for regulatory capital purposes.
Moreover, the Agencies indicated in this guidance that institutions
found lacking effective risk management programs or engaging in
practices that present safety and soundness concerns would be subject
to more frequent supervisory review, limitations on residual interest
holdings, more stringent capital requirements, or other supervisory
response. The Securitization Guidance further advised the industry that
given the risks presented by securitization activities, and the
illiquidity and potential volatility of residual interests, the
Agencies were actively considering the establishment of regulatory
restrictions that would limit or eliminate the amount of certain
residual interests that
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may be recognized in determining the adequacy of regulatory capital.
The Agencies have identified three areas of continuing supervisory
concern:
(1) Inappropriate or aggressive valuations of residual interests;
(2) Inadequate capital in relation to the risk exposure of the
organization retaining residual interests; and
(3) Excessive concentrations of residual interests in relation to
capital.
The Statement of Financial Accounting Standards No. 125,
"Accounting for Transfers and Servicing of Financial Assets and
Extinguishment of Liabilities" (FAS 125) \2\ governs the recognition
of a residual interest in a securitization as an asset of the
sponsoring institution. Under these generally accepted accounting
principles (GAAP), when a transfer of assets is treated as a sale, the
securitizing or selling institution carries any residual interests as
an asset on its books at an estimate of fair value.\3\ Retaining this
residual interest on the balance sheet in connection with a sale
generally has the effect of increasing the amount of current earnings
generated by the gains from the sale.
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\2\ FAS 125 establishes certain transfer of control, accounting,
and valuation criteria surrounding the transfer of financial assets
as a benchmark for determining whether a transfer is recorded as a
"sale" and, if so, at what value it is recorded. Under FAS 125,
the transferring financial institution generally will immediately
recognize gains from the sale of the transferred assets and record
retained interests in a manner that captures all of the financial
components of, including the residual interests that arise in
connection with, the securitization or other asset transfer.
\3\ The fair value reflects the expected future cash flows
discounted in an appropriate market interest rate, and is calculated
using assumptions regarding estimated credit loss rates and
prepayment speeds.
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The Agencies have become increasingly concerned with fair value
estimates that are based on unwarranted assumptions of expected cash
flows. No active market exists for many residual interests. As a
result, there is no marketplace from which an arm's length market price
can readily be obtained to support the residual interest valuation.
Recent examinations have highlighted the inherent uncertainty and
volatility regarding the initial and ongoing valuation of residual
interests. A banking organization that securitizes assets may overvalue
its residual interests and thereby inappropriately generate "paper
profits" (or mask actual losses) through incorrect cash flow modeling,
flawed loss assumptions, inaccurate prepayment estimates, and
inappropriate discount rates. Residual interests are exposed to a
significant level of credit and interest rate risk that make their
valuation extremely sensitive to changes in the underlying assumptions.
Market events can affect the discount rate or performance of assets
supporting residual interests and can swiftly and dramatically alter
their value. Should the institution hold an excessive concentration of
such assets in relation to capital, the safety and soundness of the
institution may be threatened.
The Agencies believe that the current regulatory capital
requirements do not adequately reflect the risk of unexpected losses
associated with these transactions. The booking of a residual interest
using gain-on-sale accounting can increase the selling institution's
capital and thereby allow the bank to leverage the capital created from
the securitization. This increased leverage resulting from the current
recognition of uncertain future cash flows is a supervisory concern.
Accordingly, the proposed rule focuses on those transfers of financial
assets treated as sales under GAAP.\4\
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\4\ When the securitization or other transfer of financial
assets is treated as a financing, under GAAP and for regulatory
capital purposes, rather than a sale, the assets continue to be
reflected on the balance sheet of the transferring institution. In
these circumstances, the assets continue to be subject to the
minimum capital requirement (generally 8 percent). The level of
supervisory concern is diminished in these circumstances because
there is no residual interest created to pose valuation or liquidity
concerns. Importantly, a financing transaction does not generate
earnings leading to the creation of capital. For this reason, the
proposal only changes the regulatory capital requirements for
banking organizations when they securitize or otherwise transfer
financial assets and treat the transactions as sales under GAAP.
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A related concern is the adequacy of capital held by institutions
that securitize or sell assets and retain residual interests. First,
the lack of liquidity of residual interests and the potential
volatility of residual interests arising from their leveraged credit
and interest rate risk limits their ability to support the institution,
especially in times of stress. Second, any weaknesses in the valuation
of the residual interest can translate into weaknesses in the quality
of capital available to support the institution. Liberal or
unsubstantiated assumptions can result in material inaccuracies in
financial statements. Even when such residual interests have been
appropriately valued, relatively small changes in the underlying
assumptions can lead to material changes in the residual interest's
fair value. Inaccuracies in the initial valuation of residual
interests, as well as changes in the underlying assumptions over time,
can result in substantial write-downs of residual interests. If these
generally illiquid and volatile residual interests represent an
excessive concentration of the sponsoring institution's capital, they
can contribute to the ultimate failure of the institution.
The concerns regarding excessive concentration and adequacy of
capital are heightened where the residual interests are generated from
the securitization of certain assets, such as low-quality or high loan-
to-value loans. Recent examinations have shown that in order to provide
adequate credit enhancement to the senior positions in securitizations
involving low quality assets, institutions generally must retain
relatively greater credit risk exposure. In such transactions, the
sponsoring institutions may retain residual interests in amounts that
exceed the risk-based capital that would have been associated with the
loans had they not been transferred.
Because of these continuing supervisory concerns, the Agencies
believe it is appropriate to propose these revisions to their
respective capital adequacy rules in order to limit the amount of
residual interests that are retained by banking organizations and
require adequate capital for the risk exposure created.
III. Current Capital Treatment for Residual Interests
Assets Sold "With Recourse" \5\
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\5\ Consolidated Reports of Condition and Income (Call Report)
instructions issued by the Federal Financial Institutions
Examination Council provide examples of transfers of assets that
involve recourse arrangements. See the Call Report Glossary entry
for "Sales of Assets for Risk-Based Capital Purposes." These
examples address the risk of loss retained in connection with
transfers of assets. OTS currently defines the term "recourse"
more broadly in its capital rules at 12 CFR 567.1 to include the
"acceptance, assumption or retention" of the risk of loss. The
Agencies have issued a separate proposal that, among other things,
would provide a uniform definition of "recourse." See 65 FR 12319
(March 8, 2000).
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Under current risk-based capital guidelines, banking organizations
that retain "recourse" on assets sold generally are required to hold
capital as though the loans remained on the institution's books,\6\ up
to the "full capital charge".\7\ For regulatory capital
[[Page 57996]]
purposes, recourse is generally defined as an arrangement in which a
banking organization retains the risk of credit loss in connection with
an asset transfer, if the risk of credit loss exceeds a pro rata share
of the institution's claim on the assets.\8\
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\6\ Under the Agencies' current capital rules, assets
transferred with recourse in a transaction that is reported as a
sale under generally accepted accounting principles (GAAP) are
removed from the balance sheet and are treated as off-balance sheet
exposures for risk-based capital purposes. For transactions reported
as a sale, the entire amount of the assets sold (not just the
contractual amount of the recourse obligation) is normally converted
into an on-balance sheet credit equivalent amount using a 100
percent conversion factor. This credit equivalent amount is then
risk weighted for risk-based capital calculation purposes.
\7\ For assets that are assigned to the 100 percent risk-weight
category, the full capital charge is 8 percent of the amount of
assets transferred, and institutions are required to hold 8 cents of
capital for every dollar of assets transferred with recourse. For
assets that are assigned to the 50 percent risk-weight category, the
full capital charge is 4 cents of capital for every dollar of assets
transferred with recourse.
\8\ The risk-based capital treatment for sales with recourse can
be found at 12 CFR 3, appendix A, section (3)(b)(1)(iii) (OCC); 12
CFR 208, appendix A, section III.D.1 and 12 CFR 225, appendix A,
section III.D.1 (FRB); 12 CFR 325, appendix A, section II.D.1
(FDIC); and 12 CFR 567.6(a)(2)(i)(C) (OTS).
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As required by statute,\9\ the Agencies have adopted rules that
provide "low-level recourse" treatment for those institutions that
securitize or sell assets and retain recourse in dollar amounts less
than the full capital charge.\10\ Before the issuance of the low-level
recourse rules, these institutions could have been required to hold a
greater level of capital than their maximum contractual exposure to
loss on the transferred assets. The low-level recourse treatment
applies to transactions accounted for as sales under FAS 125 in which a
banking organization contractually limits its recourse exposure to less
than the full capital charge for the assets transferred.
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\9\ Low-level recourse treatment is mandated by section 350 of
the Riegle Community Development and Regulatory Improvement Act, 12
U.S.C. 4808, which generally provides that: "the amount of risk-
based capital required to be maintained * * * by any insured
depository institution with respect to assets transferred with
recourse by such institution may not exceed the maximum amount of
recourse for which such institution is contractually liable under
the recourse agreement."
\10\ The Agencies' low-level resource rules appear at: 12 CFR 3,
appendix A, section 3(d) (OCC); 12 CFR 208, appendix A, section
III.D.1.g and 225, appendix A, section III.D.1.g (FRB); 12 CFR 325,
appendix A, section II.D.1 (FDIC); and 12 CFR 567.6(a)(2)(i)(C)
(OTS). A brief explanation is also contained in the instructions for
regulatory reporting in section RC-R for the Call Report or schedule
CCR for the Thrift Financial Report.
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Under the low-level recourse rule, a banking organization generally
holds capital on a dollar-for-dollar basis up to the amount of the
maximum contractual exposure. In the absence of any other recourse
provisions, the on-balance sheet amount of the residual interests
represents the maximum contractual exposure. For example, assume that a
banking organization securitizes $100 million of credit card loans and
records a residual interest on the balance sheet of $5 million that
serves as a credit enhancement for the assets transferred. Before the
low-level recourse rule was issued, the institution would be required
to hold $8 million of risk-based capital against the $100 million in
loans sold, as though the loans had not been sold. Under the low-level
recourse rule, the institution would be required to hold $5 million in
capital, that is, "dollar-for-dollar" capital up to the institution's
maximum contractual exposure.
Existing regulatory capital rules, however, do not require
institutions to hold "dollar-for-dollar" capital against residual
interests that exceed the full capital charge ($8 million in the above
example). Typically, institutions that securitize and sell higher risk
assets are required to retain a large residual interest (often greater
than the full capital charge of 8 percent on 100 percent risk-weighted
assets) in order to ensure that the more senior positions in the
securitization or other asset sale can receive the desired investment
ratings. Write-downs of the recorded value of the residual interest,
due to unrealistic (or changing) loss or prepayment assumptions, can
result in residual losses that exceed the amount of capital held
against these assets, thereby impairing the safety and soundness of the
institution.
For example, assume that a banking organization securitizes $100
million of subprime credit card loans and records a residual interest
on the balance sheet of $15 million that serves as a credit enhancement
for the securitization. Under the current risk-based capital rules, the
transferred loans would be treated as sold with recourse, and an 8
percent risk-based capital charge for these 100 percent risk-weighted
loans would be required; that is, $8 million in risk-based capital
would be required to be held against the $100 million of transferred
loans. In this hypothetical example, however, the amount of residual
interests retained on the balance sheet ($15 million) exceeds the full
equivalent risk-based capital charge held against the assets
transferred ($8 million). Accordingly, the amount of the residual
interest is not fully covered by dollar-for-dollar risk-based capital;
only $8 million in capital is required to be held by the institution
against the $15 million residual interest exposure.
This example demonstrates that, for residual interests that exceed
the dollar amount of the full capital charge on the assets transferred,
current capital standards do not require dollar-for-dollar capital
protection for the full contractual exposure to loss retained by the
selling institution. Any losses in excess of the full capital charge (8
percent in the example above) could negatively affect the capital
adequacy of the institution. Should the asset be written down from $15
million to $5 million, the $8 million of required capital would be
insufficient to absorb the full loss of $10 million.
B. Prior Consideration of Concentration Limits on Residual Interests
In 1998, the Agencies amended their capital rules to change the
regulatory capital treatment of servicing assets.\11\ This rulemaking
increased from 50 percent to 100 percent the amount of mortgage
servicing assets that could be included in Tier 1 capital. The Agencies
imposed more restrictive limits on the amount of nonmortgage servicing
assets and PCCRs that could be included in Tier 1 capital. These
stricter limitations were imposed due to the lack of depth and maturity
of the marketplace for such assets, and related concerns about their
valuation, liquidity, and volatility.
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\11\ See 63 FR 42668 (August 10, 1998).
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At the time the Agencies issued the final rule on servicing assets,
the Agencies declined to adopt similar capital limits for I/O strips, a
form of residual interest, notwithstanding that certain I/O strips
possessed cash flow characteristics similar to servicing assets and
presented similar valuation, liquidity, and volatility concerns. At
that time, the Agencies chose not to impose such limitations in
recognition of the "prudential effects of banking organizations
relying on their own risk assessment and valuation tools, particularly
their interest rate risk, market risk, and other analytical models."
\12\ The Agencies expressly indicated that they would continue to
review banking organizations' valuation of I/O strips and the
concentrations of these assets relative to capital. Moreover, the
Agencies noted that they "may, on a case-by-case basis, require
banking organizations that the Agencies determine have high
concentrations of these assets relative to their capital, or are
otherwise at risk from these assets, to hold additional capital
commensurate with their risk exposures".\13\ In addition, most of the
residual interests at that time that were used as credit enhancements
did not exceed the full capital charge on the transferred assets and
thus were subject to "dollar-for-dollar" capital requirements under
the Agencies" existing low-level recourse rules. However, a trend
toward the securitization of higher risk loans has now resulted in
residual interests that exceed the full capital charge and for which
"dollar-for-dollar" capital is not required under the current risk-
based capital rules. This trend has also resulted in certain banking
organizations engaged in such
[[Page 57997]]
securitization transactions having large concentrations in residual
interests as a percentage of capital.
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\12\ Id. at 42672.
\13\ Id.
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IV. Residual Interests Subject to the Proposal
Included in this proposal are residual interests that are
structured to absorb more than a pro rata share of credit loss related
to the securitized or sold assets through subordination provisions or
other credit enhancement techniques. Such residual interests can take
many forms. Generally, these residual interests are non-investment
grade or unrated "first-loss" positions that provide credit support
for the senior positions of the securitization or other asset sale. A
key aspect of such residual interests is that they reflect an
arrangement in which the institution retains risk of credit loss in
connection with an asset transfer. In addition to recourse provisions
that may require the selling institution to support a securitization,
residual interests can take the form of spread accounts, over-
collateralization, subordinated securities, cash collateral accounts,
or other similar forms of on-balance sheet assets that function as a
credit enhancement. Servicing assets that function as credit
enhancements would be subject to the proposed rule.
The definition of residual interests excludes those interests that
do not serve as credit enhancements. In this regard, highly rated,
liquid, marketable residual interests where the institution assumes
only the interest rate risk associated with the assets transferred in
the securitization (e.g., Fannie Mae or Freddie Mac I/O strips) do not
serve as a credit enhancement for the transferred assets and thus do
not expose the institution to a concentrated level of credit risk.
Further, such instruments are traded in a currently active marketplace
and thus do not present the same degree of liquidity and valuation
concerns.
The residual interests covered by the proposed rule are generally
retained by the securitizing institution rather than sold because they
are generally illiquid and volatile in nature and thus present
liquidity and valuation concerns. The proposed rule extends only to
residual interests that have been retained by a banking organization as
a result of a securitization or other sale transaction and does not
cover residual interests that a banking organization has purchased from
another party.\14\
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\14\ The proposed rule would extend to all residual interests as
defined, whether included in the banking book or included in the
trading book and subject to the market risk rules.
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Purchased residual interests can present the same degree of
concentrated credit risk associated with retained residual interests.
The exclusion of purchased residual interests from the proposed rule
could establish a different capital treatment for the same asset,
depending on whether the interest is purchased from a third party or
retained in connection with the transfer of financial assets to a third
party. The Agencies are particularly concerned about the possible
"swapping" of residual interests, where there is otherwise limited
breadth and depth of the market for these residual interests, and both
parties stand to gain from accommodation valuations of each asset.
However, residual interests purchased in an arm's length
transaction may not pose the same degree of liquidity risk as interests
that are retained. In addition, purchased interests do not present the
same opportunity to create capital as do interests that are originated
and retained by a securitizing institution. Further, unlike retained
residual interests where an overvaluation of the residual interest can
lead to a higher gain on sale and the creation of additional capital,
there is a marketplace discipline on the initial amount at which a
purchased residual interest is recorded (that is, it is limited to the
purchase price), and there is no incentive on the part of the purchaser
to pay a price above market because such a purchase does not create any
capital for the purchaser.
The Agencies are considering including such purchased interests
within the scope of the rule and are requesting comment on this issue.
V. Proposed Amendments to the Capital Standards
A. Proposed Treatment of Residual Interests
The Agencies propose to amend the regulatory risk-based capital
standards by eliminating the distinction between the treatment of low-
level recourse obligations and the treatment of assets securitized or
sold with recourse in those cases where the amount of the residual
interest retained on balance sheet exceeds the full capital charge for
the assets transferred. The current rules essentially place a ceiling
on the "dollar-for-dollar" capital requirement for recourse
obligations. Removal of this "cap" will ensure that all residual
interests are subject to the same "dollar-for-dollar" capital
standard that is applied to residual interests in low-level recourse
transactions and that capital is held for the organization's total
contractual exposure to loss.
In addition to modifying the risk-based capital treatment for
residual interests, the Agencies propose limiting the amount of
residual interests that can be recognized in determining Tier 1 capital
under the Agencies' leverage and risk-based capital standards. The
purpose of the limit is to prevent excessive concentrations in holdings
of residual interests. The Agencies propose including residual
interests within the 25 percent of Tier 1 capital sublimit already
placed upon nonmortgage servicing assets and PCCRs. Under this
restriction, any amounts of residual interests, when aggregated with
nonmortgage servicing assets and PCCRs, that exceed of 25 percent of
Tier 1 capital, would be deducted from Tier 1 capital for purposes of
calculating both the risk-based and leverage capital ratios.\15\
---------------------------------------------------------------------------
\15\ The unrealized gains that may be recorded by an institution
with respect to residual interests that are accounted for as
available-for-sale securities are presently not included in Tier 1
capital and would not be subject to further deduction under this
rule.
---------------------------------------------------------------------------
In addition to including residual interests in the sublimit
currently applied to PCCRs and nonmortgage servicing assets, residual
interests would also be included in the calculation of the overall 100
percent limit on servicing assets. Under this proposal, the maximum
allowable amount of mortgage servicing assets, PCCRs, nonmortgage
servicing assets, and residual interests, in the aggregate, would be
limited to 100 percent of the amount of Tier 1 capital that exists
before the deduction of any disallowed mortgage servicing assets, any
disallowed PCCRs, any disallowed nonmortgage servicing assets, any
disallowed residual interests, and any disallowed deferred tax assets.
The residual interests, however, would not be subject to the 90 percent
of fair value limitation that applies to servicing assets and PCCRs.
Under the proposed rule, residual interests would already be subject to
a "dollar-for-dollar" capital requirement. Any residual interests
deducted in determining the Tier 1 capital numerator for the leverage
and risk-based capital ratios also would be excluded from the
denominators of these ratios.
In summary, under the proposed rule, institutions generally would
be required to hold "dollar-for-dollar" capital for residual
interests and additionally would be required to deduct from Tier 1
capital the amount of any residual interests (when aggregated with
nonmortgage servicing assets and PCCRs) that exceed the established 25
percent sublimit. In combination, the proposal is intended to ensure
that all
[[Page 57998]]
residual interests are supported by "dollar-for-dollar" capital and
that excessive concentrations (over 25 percent) in residual interests
relative to capital are avoided.\16\
---------------------------------------------------------------------------
\16\ The Agencies are also proposing minor technical changes.
For example, this proposal does not effect the calculation of
tangible equity the under prompt corrective action regulations.
However, because the Agencies define tangible equity using different
core capital concepts (i.e., "core capital" vs. "core capital
elements"), the OTS is proposing a technical revision to its
definition of tangible equity (12 CFR 565.2(f)) to ensure that this
calculation is not effected by the proposal.
In addition, the FDIC is also amending its regulations to remove
an obsolete provision concerning the transitional 7.25 percent risk-
based capital standard that was only effective until December 31,
1992. This provision currently appears in section III.B of appendix
A to part 325. Similarly, OTS is making technical revisions to
related regulatory provisions at 12 CFR 565.2(f).
---------------------------------------------------------------------------
B. Net-of-Tax Treatment
The Agencies propose to extend the current net-of-tax treatment
permitted in their existing capital standards to residual
interests.\17\ Thus, the proposed rule would permit: (1) Disallowed
amounts of residual interests (that is, those amounts in excess of the
25 percent of Tier 1 capital sublimit) to be determined on a basis that
is net of any associated deferred tax liability, and (2) any amounts of
residual interests that are subject to the "dollar-for-dollar"
capital requirement (that is, those amounts included in the 25 percent
of Tier 1 capital sublimit) to be determined on a basis that is net of
any associated deferred tax liability. In instances where there is no
difference between the book basis and the tax basis of the residual
interest, no deferred tax liability would be created. Any deferred tax
liability used to reduce the capital requirement for a residual
interest would not be available for the organization to use in
determining the amount of net deferred tax assets that may be included
in the calculation of Tier 1 capital.\18\
---------------------------------------------------------------------------
\17\ The proposed treatment is consistent with that permitted
for low-level recourse exposures, disallowed servicing assets, and
disallowed intangible assets in non-taxable business combinations.
\18\ For example, see Sec. 325.5(g) of the FDIC's capital
regulations (12 CFR 325.5(g)), which sets forth the limitations on
the amount of deferred tax assets that state nonmember banks can
recognize for purposes of calculating Tier 1 capital under the
leverage and risk-based capital rules.
---------------------------------------------------------------------------
The following example helps illustrate the proposed tax treatment.
Assume residual interests of $100 with an associated deferred tax
liability of $35 and Tier 1 capital (before the deduction of any
disallowed residual interests) of $200. In this example, the 25 percent
concentration limit on residual interests (when combined with
nonmortgage servicing assets and PCCRs) would be $50 (i.e., 25 percent
times $200). The amount of disallowed residual interests (before
considering the associated deferred tax liability) would have been $50.
The deferred tax liability associated with the otherwise disallowed
residual interests of $50 would be $17.50 (a $35 associated deferred
tax liability against $100 in residual interests drives a 35 percent
tax effect against the $50 disallowed residual interest). Thus, the
amount of disallowed residual interests to be deducted in determining
Tier 1 capital under the leverage and risk-based capital standards net
of the associated deferred tax liability would be $32.50 (i.e., the $50
in disallowed residual interests minus the $17.50 tax effect associated
with the disallowed residual interests).
In determining risk-weighted assets, the remaining $50 amount of
residual interests allowable in Tier 1 would be subject to a "dollar-
for-dollar" capital on a basis that is also net of the deferred tax
liability associated with the $50 residual interest. The deferred tax
liability associated with the $50 not deducted from Tier 1 capital
would be $17.50 (i.e., the 35 percent tax effect as calculated above
times $50). Thus, the amount of residual interests that would be
subjected to "dollar-for-dollar" treatment would be $32.50 ($50 less
the $17.50 in deferred tax liabilities). Calculation of this "dollar-
for-dollar" capital charge is consistent with the "dollar-for-
dollar" capital requirements that are currently required for low-level
recourse transactions.
Other alternative calculations are possible and will be considered
by the Agencies.\19\ The Agencies seek comment on whether the
complexity of a "net-of-tax" approach is necessary and justified, and
if so, what, if any, alternative calculations should be allowed.
---------------------------------------------------------------------------
\19\ Two additional treatments are possible. Under the first
approach, the amount of residual interests subject to a "dollar-
for-dollar" deduction for risk-based capital purposes, and a
concentration limit for leverage capital purposes, would be the
"at-risk" amount; that is, the residual interests reduced by any
associated deferred tax liability. For example, assume residual
interests of $100 with an associated deferred tax liability of $35.
Under this approach, the amount of residual interests subject to a
"dollar-for-dollar" capital charge and a concentration limit is
$65 ($100-$35). In a worst-case scenario, if the value of the
residual interests drops to zero, then the corresponding deferred
tax liability would also drop to zero, and therefore capital would
decline by $65--the net-of-tax amount. If the 25% of Tier 1
concentration limitation is $50, then the deduction would be $15
($65-$50). Under the second approach, the amount of residual
interests subject to the "dollar-for-dollar" capital requirement
and 25% of Tier 1 capital concentration limit would be determined on
a gross basis, that is, without netting the associated deferred tax
liability.
---------------------------------------------------------------------------
C. Reservation of Authority
While this proposal should help remedy some of the major concerns
associated with the generally illiquid and volatile nature of residual
interests, the Agencies are also proposing to add language to the risk-
based capital standards that will provide greater flexibility in
administering the standards. Institutions are developing novel
transactions that do not fit well into the risk-weight categories set
forth in the standards. Institutions are also devising novel
instruments that nominally fit into a particular risk-weight category,
but that impose risks on the banking organization at levels that are
not commensurate with the nominal risk-weight for the asset, exposure,
or instrument. Accordingly, the Agencies are proposing to add language
to the standards to clarify the Agencies' authority, on a case-by-case
basis, to determine the appropriate risk-weight asset amount in these
circumstances. Exercise of this authority by the Agencies may result in
a higher or lower risk weight for an asset. This reservation of
authority explicitly recognizes the Agencies' retention of sufficient
discretion to ensure that institutions, as they develop novel financial
assets, will be treated appropriately under the risk-based capital
standards.
D. Relationship of This Residual Interest Proposal to the March 2000
Securitization Proposal
This proposed rule regarding residual interests (residual interest
proposal) and the March 2000 notice of proposed rulemaking on the risk-
based capital treatment of recourse arrangements, direct credit
substitutes, and asset securitizations (the securitization proposal)
are interrelated in that both proposals would address the regulatory
capital treatment for residual interests that are retained in
connection with securitizations and other transfers of financial
assets.\20\ The capital treatment of residual interests under the
securitization proposal differs in certain respects from the treatment
proposed in this residual interest proposal. In any final rule that
addresses the regulatory capital treatment of residual interests, the
Agencies will ensure that any regulatory capital treatment of residual
[[Page 57999]]
interests resulting from these two proposals will be consistent.
---------------------------------------------------------------------------
\20\ See 65 FR 12320 (March 8, 2000) for the text of the
proposed revisions to the risk-based capital treatment of recourse
arrangements, direct credit substitutes, and asset securitizations.
---------------------------------------------------------------------------
In the securitization proposal, the Agencies propose using external
credit ratings to match the risk-based capital requirement more closely
to the relative risk of loss in asset securitizations. Highly rated
investment-grade positions in securitizations would receive a favorable
(less than 100 percent) risk-weight. Below-investment grade or unrated
positions in securitizations would receive a less favorable risk-weight
(greater than 100 percent risk-weight or gross-up treatment). A
residual interest retained by an institution in an asset securitization
(as well as residual interests that are purchased) would be subject to
this capital framework under the securitization proposal.
The residual interest proposal differs from the securitization
proposal in several respects. For example, under the residual interest
proposal, all residual interests that are retained by the institution
and that fall within the 25 percent of Tier 1 capital limit would be
subject to "dollar-for-dollar" capital treatment regardless of rating
(and comment is sought on whether purchased interests should be treated
similarly). To date, the Agencies believe that residual interests in
asset securitizations generally are unrated and illiquid interests;
however, as the market evolves, residual interests may in the future
take the form of rated, liquid, certificated securities. If the rating
provided to such a residual interest were investment grade (or no more
than one category below investment grade) the securitization proposal
would afford that residual interest more favorable capital treatment
than the dollar-for-dollar capital requirement set forth in this
residual interest proposal. In addition, the risk-based capital
requirement for unrated residual interests that are subject to gross-up
treatment under the securitization proposal would not exceed the full
risk-based capital charge for the underlying assets that are being
supported by the residual interest. Under this residual interest
proposal, however, "dollar-for-dollar" capital would be required for
the amount of the residual interest that is retained and falls within
the 25 percent of Tier 1 capital limit, even if this amount exceeds the
full capital charge typically held against the underlying assets that
have been transferred with recourse. Also, unlike the residual interest
proposal, the securitization proposal does not establish any
concentration limit for residual interests as a percentage of capital.
These differences between the residual interest proposal and the
securitization proposal will be taken into account in any final rule
published under either proposal. In developing a final rule on residual
interests, the Agencies specifically invite comment on how the capital
treatment for residual interests under this residual interest proposal
should be reconciled with the capital treatment set forth in the
securitization proposal.
E. Effective Date
The Agencies intend to apply this proposal to existing as well as
future transactions. Because banking organizations may need additional
time to adapt to any new capital treatment, the Agencies may delay the
effective date for a specific period of time (transition period). The
Agencies view this transition period as an opportunity for institutions
to consider the proposal's impact on their balance sheet structure and
capital position. The Agencies invite comment on the need for and
duration of a transition period.
VI. Request for Public Comment
The Agencies invite public comment on all aspects of the proposed
rule. In particular, the Agencies request comment on the definition of
residual interest, the treatment of residual interests in determining
compliance with minimum capital requirements, the conditions
established in the proposal, and the implementation of the proposal.
The Agencies also specifically request comment on the "dollar-for-
dollar" risk-based capital charge for residual interests, the 25
percent of Tier 1 capital concentration limit on the amount of residual
interests that can be recognized for leverage and risk-based capital
purposes, and the issue of whether a "net-of-associated deferred tax
liability" approach is appropriate in determining the capital
requirements for residual interests.
VII. Plain Language
Section 722 of the Gramm-Leach-Bliley (GLB) Act (12 U.S.C. 4809)
requires federal banking agencies to use "plain language" in all
proposed and final rules published after January 1, 2000. We invite
your comments on how to make this proposed rule easier to understand.
For example:
(1) Have we organized the material to suit your needs?
(2) Are the requirements in the rule clearly stated?
(3) Does the rule contain technical language or jargon that isn't
clear?
(4) Would a different format (grouping and order of sections, use
of headings, paragraphing) make the rule easier to understand?
(5) Would more (but shorter) sections be better?
(6) What else could we do to make the rule easier to understand?
VIII. Regulatory Analysis
A. Regulatory Flexibility Act Analysis
Board: Pursuant to section 605(b) of the Regulatory Flexibility
Act, the Board has determined that this proposal will not have a
significant impact on a substantial number of small business entities
within the meaning of the Regulatory Flexibility Act (5 U.S.C. 601 et
seq.). The Board's comparison of the applicability section of this
proposal with Call Report data on all existing banks shows that
application of the proposal to small entities will be rare.
Accordingly, a regulatory flexibility analysis is not required. In
addition, because the risk-based capital standards generally do not
apply to bank holding companies with consolidated assets of less than
$150 million, this proposal will not affect such companies".
FDIC: Pursuant to section 605(b) of the Regulatory Flexibility Act
(5 U.S.C. 601 et seq.) the FDIC hereby certifies that the final rule
will not have a significant economic impact on a substantial number of
small entities. Comparison of Call Report data on FDIC-supervised banks
to the items covered by the proposal that result in increased capital
requirements shows that application of the proposal to small entities
will be the infrequent exception.
OTS: Pursuant to section 605(b) of the Regulatory Flexibility Act
(5 U.S.C. 601 et seq.) the OTS certifies that the proposed rule will
not have a significant economic impact on a substantial number of small
entities. Comparison of TFR data on OTS supervised savings associations
regarding the items that would result in increased capital requirements
indicate that the application of the proposal to small entities will be
the infrequent exception.
OCC: Pursuant to section 605(b) of the Regulatory Flexibility Act
(5 U.S.C. 601 et seq.) the OCC certifies that the proposed rule will
not have a significant economic impact on a substantial number of small
entities. Call Report data indicate that generally small banks do not
have large residual interests that exceed the full risk-based capital
charge required for transferred assets, and typically do not hold
residual interests in amounts that would exceed the 25 percent of Tier
1 capital limitation. For these reasons, the OCC believes that
application of the proposed rule to small entities will be rare.
[[Page 58000]]
Consequently, a regulatory flexibility analysis is not required.
B. Paperwork Reduction Act
The Agencies have determined that this proposal does not involve a
collection of information pursuant to the provisions of the Paperwork
Reduction Act (44 U.S.C. 3501 et seq.).
C. OCC and OTS Executive Order 12866 Statement
The Comptroller of the Currency and the Director of the OTS have
determined that the proposal described in this notice is not a
significant regulatory action under Executive Order 12866. Accordingly,
a regulatory impact analysis is not required. Nonetheless the OCC
specifically invites comment on the dollar impact of the proposed rule.
D. OCC and OTS Unfunded Mandates Act Statement
Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law
104-4, (Unfunded Mandates Act), requires that an agency prepare a
budgetary impact statement before promulgating a rule that includes a
federal mandate that may result in the expenditure by state, local, and
tribal governments, in the aggregate, or by the private sector, of $100
million or more in any one year. If a budgetary impact statement is
required, section 205 of the Unfunded Mandates Act also requires an
agency to identify and consider a reasonable number of regulatory
alternatives before promulgating a rule. The OCC and OTS have
determined that this proposed rule will not result in expenditures by
state, local, and tribal government, or by the private sector, of more
than $100 million or more in any one year. Based on the Call Report,
TFR and other data, OTS and OCC estimate that those banks and savings
associations that would be required to increase capital under the
proposed rule will not incur additional expenses in this amount in any
one year. Therefore, the OCC and OTS have not prepared a budgetary
impact statement or specifically addressed the regulatory alternatives
considered. Nonetheless the OCC specifically invites comment on the
dollar impact of the proposed rule.
E. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
The Agencies have determined that this proposed rule will not
affect family well-being within the meaning of section 654 of the
Treasury and Government Appropriations Act, 1999, Pub. L. 105-277, 112
Stat. 2681 (1998).
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 225
Administrative practice and procedure, Banks, banking, Federal
Reserve System, Holding companies, Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping requirements, Savings
associations, State non-member banks.
12 CFR Part 565
Administrative practice and procedures, Capital, Savings
associations.
12 CFR Part 567
Capital, Reporting and recordkeeping requirements, Savings
associations.
Department of the Treasury
Office of the Comptroller of the Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set out in the joint preamble, the Office of the
Comptroller of the Currency proposes to amend part 3 of chapter I of
title 12 of the Code of Federal Regulations 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.
Sec. 3.4 [Amended]
2. In Sec. 3.4:
A. The existing text is designated as paragraph (a);
B. The second sentence in the newly designated paragraph (a) is
revised; and
C. New paragraph (b) is added to read as follows:
Sec. 3.4 Reservation of authority.
(a) * * * Similarly, the OCC may find that a particular intangible
asset need not be deducted from Tier 1 or Tier 2 capital. * * *
(b) Notwithstanding the risk categories in section 3 of appendix A
to this part, the OCC may find that the assigned risk weight for any
asset does not appropriately reflect the risks imposed on a bank and
may require another risk weight that the OCC deems appropriate.
Similarly, if no risk weight is specifically assigned, the OCC may
assign any risk weight that the OCC deems appropriate. In making its
determination, the OCC considers risks associated with the asset as
well as other relevant factors.
3. In appendix A to part 3:
A. In section 1:
i. Redesignate paragraphs (c)(25) through (c)(31) as paragraphs
(c)(28) through (c)(34), paragraph (c)(24) as paragraph (c)(26), and
paragraphs (c)(13) through (c)(23) as paragraphs (c)(14) through
(c)(24);
ii. Add new paragraphs (c)(13), (c)(25), and (c)(27);
B. In section 2, revise paragraphs (c)(1)(ii), (c)(2) introductory
text, (c)(2)(i), (c)(2)(ii) introductory text, (c)(2)(iii), and
(c)(2)(iv);
C. In section 3, add new paragraph (e) to read as follows:
Appendix A To Part 3--Risk-Based Capital Guidelines
Section 1. Purpose, Applicability of Guidelines, and Definitions
* * * * *
(c) * * *
(13) Financial asset means cash, evidence of an ownership
interest in an entity, or a contract that conveys to a second entity
a contractual right to receive cash or another financial instrument
from a first entity or to exchange other financial instruments on
potentially favorable terms with the first entity.
* * * * *
(25) Residual interest means any on-balance sheet asset that
represents an interest (including a beneficial interest) created by
the transfer of financial assets, whether through a securitization
or otherwise, and structured to absorb more than a pro rata share of
credit loss related to the transferred assets through subordination
provisions or other credit enhancement techniques. Residual
interests generally include interest only strips receivable, spread
accounts, cash collateral accounts, retained subordinated interests
and other similar forms of on-balance sheet assets that function as
a credit enhancement. Residual interests do not include residual
interests purchased from a third party.
* * * * *
(27) Securitization. Securitization means the pooling and
repackaging of loans or other
[[Page 58001]]
credit exposures into securities that can be sold to investors.
* * * * *
Section 2. Components of Capital
* * * * *
(c) * * *
(1) * * *
* * * * *
(ii) Other intangible assets and residual interests, except as
provided in section 2(c)(2) of this appendix A; and * * *
(2) Qualifying intangible assets and residual interests. Subject
to the following conditions, mortgage servicing assets, nonmortgage
servicing assets,\6\ purchased credit card relationships and
residual interests need not be deducted from Tier 1 capital:
---------------------------------------------------------------------------
\6\ Intangible assets are defined to exclude any IO strips
receivable related to these mortgage and non-mortgage servicing
assets. See section 1(c)(14) of this appendix A. Consequently, IO
strips receivable related to mortgage and non-mortgage servicing
assets are not required to be deducted under section 2(2)(2) of this
appendix A. However, these IO strips receivable are subject to a 100
percent risk weight under section 3(a)(4) of this appendix A.
---------------------------------------------------------------------------
(i) The total of all intangible assets and residual interests
that are included in Tier 1 capital is limited to 100 percent of
Tier 1 capital, of which no more than 25 percent of Tier 1 capital
can consist of purchased credit card relationships, nonmortgage
servicing assets and residual interests in the aggregate.
Calculation of these limitations must be based on Tier 1 capital net
of goodwill, and all identifiable intangible assets, other than
mortgage servicing assets, nonmortgage servicing assets, purchased
credit card relationships and residual interests.
(ii) Banks must value each intangible asset and residual
interest included in Tier 1 capital at least quarterly. In addition,
intangible assets included in Tier 1 capital must also be valued at
the lesser of:
* * * * *
(iii) The quarterly determination of the current fair value of
the intangible asset or residual interest must include adjustments
for any significant changes in original valuation assumptions,
including changes in prepayment estimates.
(iv) Banks may elect to deduct disallowed servicing assets and
residual interests on a basis that is net of any associated deferred
tax liability. Deferred tax liabilities netted in this manner cannot
also be netted against deferred tax assets when determining the
amount of deferred tax assets that are dependent upon future taxable
income.
* * * * *
Section 3. Risk Categories/Weights for On-Balance Sheet Assets and
Off-Balance Sheet Items
* * * * *
(e) Residual interests. (1) General capital requirement. All
residual interests are subject to both a capital concentration limit
and a residual interest capital requirement in accordance with
sections 3(e)(2) and 3(e)(3) of this appendix A. In determining the
general capital requirement for a residual interest, the amount of
all residual interests in excess of the capital concentration limit
must be deducted from Tier 1 capital, in accordance with section
3(e)(2) of this appendix A, before the residual interest capital
requirement in section 3(e)(3) of this appendix A is applied.
(2) Capital concentration limit. In addition to the residual
interest capital requirement provided by section 3(e)(3) of this
appendix A, a bank must deduct from Tier 1 capital all residual
interest in excess of the 25 percent sublimit on qualifying
intangible assets and residual interests in accordance with section
2(c)(2)(i) of this appendix A.
(3) Residual interests capital requirement. A bank must maintain
risk-based capital for a residual interest equal to the amount of
the residual interest that is retained on the balance sheet (less
any amount disallowed in accordance with section 3(e)(2) of this
appendix A and net of any associated deferred tax liability), even
if the amount of risk-based capital required to be maintained
exceeds the full risk-based capital requirement for the assets
transferred.
(4) Residual interests and other recourse obligations. Where a
bank holds a residual interest and another recourse obligation (such
as a standby letter of credit) in connection with the same asset
transfer, the bank must maintain risk-based capital equal to the
greater of the risk-based capital requirement for the residual
interest as calculated under section 3(e)(3) of this appendix A or
the full risk-based capital requirement for the assets transferred,
subject to the low-level recourse rules under section 3(d) of this
appendix A.
* * * * *
Dated: August 16, 2000.
John D. Hawke, Jr.,
Comptroller of the Currency.
Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the joint preamble, the Board of
Governors of the Federal Reserve System proposes to amend parts 208 and
225 of chapter II of title 12 of the Code of Federal Regulations as
follows:
PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL
RESERVE SYSTEM (REGULATION H)
1. The authority citation for part 208 continues to read as
follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a,
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j),
1828(o), 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-l, and 78w; 31 U.S.C. 5318; 42 U.S.C.
4012a, 4104a, 4104b, 4106, and 4128.
2. In appendix A to part 208:
A. Section II.A.1. and the first seven paragraphs of section
II.A.2. are revised, and footnote 5 is removed and reserved;
B. In sections II, III and IV, footnotes 13 through 52 are
redesignated as footnotes 14 through 53.
C. In section II.B., a new paragraph (i)(c) and new footnote 14 are
added, section II.B.1.b. and newly designated footnote 15 are revised,
new sections II.B.1.c. through II.B.1.g. are added, and section II.B.4.
is revised;
D. In section III.A, the four undesignated paragraphs are
designated as sections III.A.1. through III.A.4., and a new section
III.A.5. is added.
E. Section III.B.6. is added.
F. Attachment II is revised.
Appendix A To Part 208--Capital Adequacy Guidelines for State
Member Banks: Risk-Based Measure
* * * * *
II. * * *
A. * * *
1. Core capital elements (tier 1 capital). The tier 1 component
of a bank's qualifying capital must represent at least 50 percent of
qualifying total capital and may consist of the following items that
are defined as core capital elements:
(i) Common stockholders' equity;
(ii) Qualifying noncumulative perpetual preferred stock
(including related surplus);
(iii) Minority interest in the equity accounts of consolidated
subsidiaries.
Tier 1 capital is generally defined as the sum of core capital
elements \5\ less goodwill, other intangible assets, and residual
interests required to be deducted in accordance with section II.B.1.
of this appendix A.
---------------------------------------------------------------------------
\5\ [Reserved]
---------------------------------------------------------------------------
* * * * *
2. Supplementary capital elements (tier 2 capital). The tier 2
component of a bank's qualifying capital may consist of the
following items that are defined as supplementary capital elements:
(i) Allowance for loan and lease losses (subject to limitations
discussed below);
(ii) Perpetual preferred stock and related surplus (subject to
conditions discussed below);
(iii) Hybrid capital instruments (as defined below) and
mandatory convertible debt securities;
(iv) Term subordinated debt and intermediate-term preferred
stock, including related surplus (subject to limitations discussed
below);
(v) Unrealized holding gains on equity securities (subject to
limitations discussed in section II.A.2.e. of this appendix A).
The maximum amount of tier 2 capital that may be included in a
bank's qualifying total capital is limited to 100 percent of tier 1
capital (net of goodwill, other intangible assets, and residual
interests required to be deducted in accordance with section II.B.1.
of this appendix A).
* * * * *
B. * * *
[[Page 58002]]
(i) * * *
(c) Certain on-balance sheet residual interests--deducted from
the sum of core capital elements in accordance with sections
II.B.1.c. through e. of this appendix A.\14\
---------------------------------------------------------------------------
\14\ Residual interests consist of balance sheet assets that:
(a) Represent interests (including beneficial interests) in
transferred financial assets retained by a seller (or transferor)
after a securitization or other transfer of financial assets; and
(b) are structured to absorb more than a pro rata share of credit
loss related to the transferred assets through subordination
provisions or other credit enhancement techniques. Residual
interests do not include interests purchased from a third party.
Residual interests generally include interest-only strips
receivable, spread accounts, cash collateral accounts, retained
subordinated interests, and other similar forms of on-balance sheet
assets that function as a credit enhancement.
---------------------------------------------------------------------------
* * * * *
1. Goodwill, other intangible assets, and residual interests. *
* *
b. Other intangible assets. i. All servicing assets, including
servicing assets on assets other than mortgages (i.e., nonmortgage
servicing assets), are included in this appendix as identifiable
intangible assets. The only types of identifiable intangible assets
that may be included in, that is, not deducted from, a bank's
capital are readily marketable mortgage servicing assets,
nonmortgage servicing assets, and purchased credit card
relationships. The total amount of these assets that may be included
in capital is subject to the limitations described below in sections
II.B.1.d. and e. of this appendix A.
ii. The treatment of identifiable intangible assets set forth in
this section generally will be used in the calculation of a bank's
capital ratios for supervisory and applications purposes. However,
in making an overall assessment of a bank's capital adequacy for
applications purposes, the Board may, if it deems appropriate, take
into account the quality and composition of a bank's capital,
together with the quality and value of its tangible and intangible
assets.
c. Residual interests. Residual interests may be included in,
that is, not deducted from, a bank's capital subject to the
limitations described below in sections II.B.1.d. and e. of this
appendix A.
d. Fair value limitation. The amount of mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships that a bank may include in capital shall be the lesser
of 90 percent of their fair value, as determined in accordance with
section II.B.1.f. of this appendix A, or 100 percent of their book
value, as adjusted for capital purposes in accordance with the
instructions in the commercial bank Consolidated Reports of
Condition and Income (Call Reports). The amount of residual
interests a bank may include in capital shall be 100 percent of its
book value. If both the application of the limits on mortgage
servicing assets, nonmortgage servicing assets, purchased credit
card relationships, and residual interests and the adjustment of the
balance sheet amount for these assets would result in an amount
being deducted from capital, the bank would deduct only the greater
of the two amounts from its core capital elements in determining
tier 1 capital.
e. Tier 1 capital limitation. i. The total amount of mortgage
and nonmortgage servicing assets, purchased credit card
relationships, and residual interests that may be included in
capital, in the aggregate, cannot exceed 100 percent of tier 1
capital. Nonmortgage servicing assets, purchased credit card
relationships, and residual interests, in the aggregate, are subject
to a separate sublimit of 25 percent of tier 1 capital.\15\
---------------------------------------------------------------------------
\15\ Amounts of servicing assets, purchased credit card
relationships, and residual interests in excess of these
limitations, as well as all other identifiable intangible assets,
including core deposit intangibles and favorable leaseholds, are to
be deducted from a bank's core capital elements in determining tier
1 capital. However, identifiable intangible assets (other than
mortgage servicing assets and purchased credit card relationships)
acquired on or before February 19, 1992, generally will not be
deducted from capital for supervisory purposes, although they will
continue to be deducted for applications purposes.
---------------------------------------------------------------------------
ii. For purposes of calculating these limitations on mortgage
servicing assets, nonmortgage servicing assets, purchased credit
card relationships, and residual interests, tier 1 capital is
defined as the sum of core capital elements, net of goodwill, and
net of all identifiable intangible assets other than mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships, prior to the deduction of any disallowed
mortgage servicing assets, any disallowed nonmortgage servicing
assets, any disallowed purchased credit card relationships, any
disallowed residual interests, and any disallowed deferred-tax
assets, regardless of the date acquired.
iii. Banks may elect to deduct disallowed mortgage servicing
assets, disallowed nonmortgage servicing assets, and disallowed
residual interests on a basis that is net of any associated deferred
tax liability. Deferred tax liabilities netted in this manner cannot
also be netted against deferred-tax assets when determining the
amount of deferred-tax assets that are dependent upon future taxable
income.
f. Valuation. Banks must review the book value of all intangible
assets and residual interests at least quarterly and make
adjustments to these values as necessary. The fair value of mortgage
servicing assets, nonmortgage servicing assets, purchased credit
card relationships, and residual interests also must be determined
at least quarterly. This determination shall include adjustments for
any significant changes in original valuation assumptions, including
changes in prepayment estimates or account attrition rates.
Examiners will review both the book value and the fair value
assigned to these assets, together with supporting documentation,
during the examination process. In addition, the Federal Reserve may
require, on a case-by-case basis, an independent valuation of a
bank's intangible assets or residual interests.
g. Growing organizations. Consistent with long-standing Board
policy, banks experiencing substantial growth, whether internally or
by acquisition, are expected to maintain strong capital positions
substantially above minimum supervisory levels, without significant
reliance on intangible assets or residual interests.
* * * * *
4. Deferred-tax assets. The amount of deferred-tax assets that
is dependent upon future taxable income, net of the valuation
allowance for deferred-tax assets, that may be included in, that is,
not deducted from, a bank's capital may not exceed the lesser of:
(i) The amount of these deferred-tax assets that the bank is
expected to realize within one year of the calendar quarter-end
date, based on its projections of future taxable income for that
year,\21\ or
---------------------------------------------------------------------------
\21\ To determine the amount of expected deferred-tax assets
realizable in the next 12 months, an institution should assume that
all existing temporary differences fully reverse as of the report
date. Projected future taxable income should not include net
operating loss carry-forwards to be used during that year or the
amount of existing temporary differences a bank expects to reverse
within the year. Such projections should include the estimated
effect of tax-planning strategies that the organization expects to
implement to realize net operating losses or tax-credit carry-
forwards that would otherwise expire during the year. Institutions
do not have to prepare a new 12-month projection each quarter.
Rather, on interim report dates, institutions may use the future-
taxable income projections for their current fiscal year, adjusted
for any significant changes that have occurred or are expected to
occur.
---------------------------------------------------------------------------
(ii) 10 percent of tier 1 capital. The reported amount of
deferred-tax assets, net of any valuation allowance for deferred-tax
assets, in excess of the lesser of these two amounts is to be
deducted from a bank's core capital elements in determining tier 1
capital. For purposes of calculating the 10 percent limitation, tier
1 capital is defined as the sum of core capital elements, net of
goodwill and net of all identifiable intangible assets other than
mortgage and nonmortgage servicing assets, purchased credit card
relationships, prior to the deduction of any disallowed mortgage
servicing assets, any disallowed nonmortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
residual interests, and any disallowed deferred-tax assets. There
generally is no limit in tier 1 capital on the amount of deferred-
tax assets that can be realized from taxes paid in prior carry-back
years or from future reversals of existing taxable temporary
differences, but, for banks that have a parent, this may not exceed
the amount the bank could reasonably expect its parent to refund.
III. * * *
A. * * *
5. The Federal Reserve will, on a case-by-case basis, determine
the appropriate risk-weight for any asset that does not fit wholly
within one of the risk categories set forth below or that imposes
risks on a bank that are not commensurate with the risk weight
otherwise specified below for the asset.
B. * * *
6. Residual interests--a. General capital requirement. All
residual interests are subject to both a residual interest capital
requirement and a capital concentration limitation in accordance
with sections II.B.1.e. and III.B.6.b. of this appendix A. In
determining
[[Page 58003]]
the capital requirement for a residual interest, the amount of all
residual interests in excess of the capital concentration limit must
be deducted from tier 1 capital, in accordance with section
II.B.1.e. of this appendix A, before the residual interest capital
requirement in this section is applied.
b. Residual interest capital requirement. Notwithstanding
section III.D.1.g. of this appendix A, a bank must maintain capital
for a residual interest equal to the amount of the residual interest
that is retained on the balance sheet (less any amount disallowed in
accordance with section II.B.1.e. of this appendix A and net of any
associated deferred tax liability), even if the amount of capital
required to be maintained exceeds the standard capital charge that
would be required under section IV.A. of this appendix A for assets
transferred.
c. Multiple recourse obligations. Where a bank holds a residual
interest and another recourse obligation (such as a standby letter
of credit) in connection with the same asset transfer, the bank must
maintain risk-based capital equal to the greater of:
(i) The risk-based capital requirement for the residual interest
as calculated under section III.B.6.b. of this appendix A; or
(ii) The full risk-based capital requirement for the assets
transferred, subject to the low-level recourse rules (section
III.D.1.g. of this appendix A).
* * * * *
Attachment II.--Summary of Definition of Qualifying Capital for State
Member Banks*
[Using the Year-End 1992 Standards]
------------------------------------------------------------------------
Minimum requirements after
Components transition period
------------------------------------------------------------------------
Core Capital (tier 1).................. Must equal or exceed 4% of
weighted-risk assets.
Common stockholders' equity........ No limit.
Qualifying noncumulative perpetual No limit; banks should avoid
preferred stock. undue reliance on preferred
stock in tier 1.
Minority interest in equity Banks should avoid using
accounts of consolidated minority interests to
Subsidiaries. introduce elements not
otherwise qualifying for tier
1 capital.
Less: Goodwill, other intangible
assets, and residual interests
required to be deducted from
capital \1\
Supplementary Capital (tier 2)......... Total of tier 2 is limited to
100% of tier 1.\2\
Allowance for loan and lease losses Limited to 1.25% of weighted-
risk assets.\2\
Perpetual preferred stock.......... No limit within tier 2.
Hybrid capital instruments and No limit within tier 2.
equity contract notes.
Subordinated debt and intermediate- Subordinated debt and
term preferred stock (original intermediate-term preferred
weighted average maturity of 5 stock are limited to 50% of
years or more). tier 1,\2\ amortized for
capital purposes as they
approach maturity.
Revaluation reserves (equity and Not included; banks encouraged
building). to disclose; may be evaluated
on a case-by-case basis for
international comparisons; and
taken into account in making
and overall assessment of
capital.
Deductions (from sum of tier 1 and tier
2):
Investments in unconsolidated As a general rule, one-half of
subsidiaries. the aggregate investments will
be deducted from tier 1
capital and one-half from tier
2 capital.\3\
Reciprocal holdings of banking
organizations' capital securities.
Other deductions (such as other On a case-by-case basis or as a
subsidiaries or joint ventures) as matter of policy after formal
determined by supervisory rulemaking.
authority.
Total Capital (tier 1+tier 2- Must equal or exceed 8% of
deductions). weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets and
residual interests are set forth in section II.B.1. of this appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\3\ A proportionately greater amount may be deducted from tier 1
capital, if the risks associated with the subsidiary so warrant.
\*\ See discussion in section II of the guidelines for a complete
description of the requirements for, and the limitations on, the
components of qualifying capital.
3. In appendix B to part 208, section II. b. is revised to read as
follows:
Appendix B To Part 208--Capital Adequacy Guidelines for State
Member Banks: Tier 1 Leverage Measure
* * * * *
II. b. A bank's Tier 1 leverage ratio is calculated by dividing
its Tier 1 capital (the numerator of the ratio) by its average total
consolidated assets (the denominator of the ratio). The ratio will
also be calculated using period-end assets whenever necessary, on a
case-by-case basis. For the purpose of this leverage ratio, the
definition of Tier 1 capital as set forth in the risk-based capital
guidelines contained in appendix A of this part will be used.\2\ As
a general matter, average total consolidated assets are defined as
the quarterly average total assets (defined net of the allowance for
loan and lease losses) reported on the bank's Reports of Condition
and Income (Call Reports), less goodwill; amounts of mortgage
servicing assets, nonmortgage servicing assets, purchased credit
card relationships, and residual interests that, in the aggregate,
are in excess of 100 percent of Tier 1 capital; amounts of
nonmortgage servicing assets, purchased credit card relationships,
and residual interests that, in the aggregate, are in excess of 25
percent of Tier 1 capital; all other identifiable intangible assets;
any investments in subsidiaries or associated companies that the
Federal Reserve determines should be deducted from Tier 1 capital;
and deferred tax assets that are dependent upon future taxable
income, net of their valuation allowance, in excess of the
limitation set forth in section II.B.4 of appendix A of this
part.\3\
* * * * *
---------------------------------------------------------------------------
\2\ Tier 1 capital for state member banks includes common
equity, minority interest in the equity accounts of consolidated
subsidiaries, and qualifying noncumulative perpetual preferred
stock. In addition, as a general matter, Tier 1 capital excludes
goodwill; amounts of mortgage servicing assets, nonmortgage
servicing assets, purchased credit card relationships, and residual
interests that, in the aggregate, exceed 100 percent of Tier 1
capital; nonmortgage servicing assets, purchased credit card
relationships, and residual interests that, in the aggregate, exceed
25 percent of Tier 1 capital; other identifiable intangible assets;
and deferred tax assets that are dependent upon future taxable
income, net of their valuation allowance, in excess of certain
limitations. The Federal Reserve may exclude certain investments in
subsidiaries or associated companies as appropriate.
\3\ Deductions from Tier 1 capital and other adjustments are
discussed more fully in section II.B. of appendix A of this part.
---------------------------------------------------------------------------
PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
(REGULATION Y)
1. The authority citation for part 225 continues to read as
follows:
Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o) 1831i, 1831p-1,
1843(c)(8), 1844(b), 1972(l), 3106, 3108, 3310, 3331-3351, 3907, and
3909.
[[Page 58004]]
2. In appendix A to part 225:
A. Section II.A.1. and the first seven paragraphs of section
II.A.2. are revised, and footnote 6 is removed and reserved;
B. In sections II, III and IV, footnotes 13 through 57 are
redesignated as footnotes 14 through 58.
C. In section II.B., a new paragraph (i)(c) and new footnote 15 are
added, section II.B.1.b and newly designated footnote 16 are revised,
new sections II.B.1.c. through II.B.1.g. are added, and section II.B.4.
is revised.
D. In section III.A, the four undesignated paragraphs are
designated as sections III.A.1. through III.A.4. and a new section
III.A.5, is added.
E. Section III.B.6. is added.
F. Attachment II is revised.
Appendix A To Part 225--Capital Adequacy Guidelines for Bank
Holding Companies: Risk-Based Measure
* * * * *
II. * * *
A. * * *
1. Core capital elements (tier 1 capital). The tier 1 component
of an institution's qualifying capital must represent at least 50
percent of qualifying total capital and may consist of the following
items that are defined as core capital elements:
(i) Common stockholders' equity;
(ii) Qualifying noncumulative perpetual preferred stock
(including related surplus);
(iii) Qualifying cumulative perpetual preferred stock (including
related surplus); subject to certain limitations described below;
(iv) Minority interest in the equity accounts of consolidated
subsidiaries. Tier 1 capital is generally defined as the sum of core
capital elements \6\ less goodwill, other intangible assets, and
residual interests required to be deducted in accordance with
section II.B.1. of this appendix A.
---------------------------------------------------------------------------
\6\ [Reserved]
---------------------------------------------------------------------------
* * * * *
2. Supplementary capital elements (tier 2 capital). The tier 2
component of an institution's qualifying capital may consist of the
following items that are defined as supplementary capital elements:
(i) Allowance for loan and lease losses (subject to limitations
discussed below);
(ii) Perpetual preferred stock and related surplus (subject to
conditions discussed below);
(iii) Hybrid capital instruments (as defined below), perpetual
debt, and mandatory convertible debt securities;
(iv) Term subordinated debt and intermediate-term preferred
stock, including related surplus (subject to limitations discussed
below);
(v) Unrealized holding gains on equity securities (subject to
limitations discussed in section II.A.2.e. of this appendix A).
The maximum amount of tier 2 capital that may be included in an
organization's qualifying total capital is limited to 100 percent of
tier 1 capital (net of goodwill, other intangible assets, and
residual interests required to be deducted in accordance with
section II.B.1. of this appendix A).
* * * * *
B. * * *
(i) * * *
(c) Certain on-balance sheet residual interests deducted from
the sum of core capital elements in accordance with sections
II.B.1.c. through e. of this appendix A.\15\
---------------------------------------------------------------------------
\15\ Residual interests consist of balance sheet assets that:
(a) Represent interests (including beneficial interests) in
transferred financial assets retained by a seller (or transferor)
after a securitization or other transfer of financial assets; and
(b) are structured to absorb more than a pro rata share of credit
loss related to the transferred assets through subordination
provisions or other credit enhancement techniques. Residual
interests do not include interests purchased from a third party.
Residual interest include interest-only strips receivable, spread
accounts, cash collateral accounts, retained subordinated interests,
and similar on-balance sheet assets that function as a credit
enhancement.
---------------------------------------------------------------------------
* * * * *
1. Goodwill, other intangible assets, and residual interests. *
* *
b. Other intangible assets. i. All servicing assets, including
servicing assets on assets other than mortgages (i.e., nonmortgage
servicing assets), are included in this appendix as identifiable
intangible assets. The only types of identifiable intangible assets
that may be included in, that is, not deducted from, an
organization's capital are readily marketable mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships. The total amount of these assets that may be included
in capital is subject to the limitations described below in sections
II.B.1.d. and e. of this appendix A.
ii. The treatment of identifiable intangible assets set forth in
this section generally will be used in the calculation of a bank
holding company's capital ratios for supervisory and applications
purposes. However, in making an overall assessment of an
organization's capital adequacy for applications purposes, the Board
may, if it deems appropriate, take into account the quality and
composition of an organization's capital, together with the quality
and value of its tangible and intangible assets.
c. Residual interests. Residual interests may be included in,
that is, not deducted from, an organization's capital subject to the
limitations described below in sections II.B.1.d. and e. of this
appendix A.
d. Fair value limitation. The amount of mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships that a bank holding company may include in capital
shall be the lesser of 90 percent of their fair value, as determined
in accordance with section II.B.1.f. of this appendix A, or 100
percent of their book value, as adjusted for capital purposes in
accordance with the instructions to the Consolidated Financial
Statements for Bank Holding Companies (FR Y-9C Report). The amount
of residual interests a bank holding company may include in capital
shall be 100 percent of its book value. If both the application of
the limits on mortgage servicing assets, nonmortgage servicing
assets, purchased credit card relationships, and residual interests
and the adjustment of the balance sheet amount for these assets
would result in an amount being deducted from capital, the bank
holding company would deduct only the greater of the two amounts
from its core capital elements in determining tier 1 capital.
e. Tier 1 capital limitation. i. The total amount of mortgage
and nonmortgage servicing assets, purchased credit card
relationships, and residual interests that may be included in
capital, in the aggregate, cannot exceed 100 percent of tier 1
capital. Nonmortgage servicing assets, purchased credit card
relationships, and residual interests, in the aggregate, are subject
to a separate sublimit of 25 percent of tier 1 capital.\16\
---------------------------------------------------------------------------
\16\ Amounts of servicing assets, purchased credit card
relationships, and residual interests in excess of these
limitations, as well as all other identifiable intangible assets,
including core deposit intangibles and favorable leaseholds, are to
be deducted from an organization's core capital elements in
determining tier 1 capital. However, identifiable intangible assets
(other than mortgage servicing assets and purchased credit card
relationships) acquired on or before February 19, 1992, generally
will not be deducted from capital for supervisory purposes, although
they will continue to be deducted for applications purposes.
---------------------------------------------------------------------------
ii. For purposes of calculating these limitations on mortgage
servicing assets, nonmortgage servicing assets, purchased credit
card relationships, and residual interests, tier 1 capital is
defined as the sum of core capital elements, net of goodwill, and
net of all identifiable intangible assets other than mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships, prior to the deduction of any disallowed
mortgage servicing assets, any disallowed nonmortgage servicing
assets, any disallowed purchased credit card relationships, any
disallowed residual interests, and any disallowed deferred-tax
assets, regardless of the date acquired.
iii. Bank holding companies may elect to deduct disallowed
mortgage servicing assets, disallowed nonmortgage servicing assets,
and disallowed residual interests on a basis that is net of any
associated deferred tax liability. Deferred tax liabilities netted
in this manner cannot also be netted against deferred tax assets
when determining the amount of deferred tax assets that are
dependent upon future taxable income.
f. Valuation. Bank holding companies must review the book value
of all intangible assets and residual interests at least quarterly
and make adjustments to these values as necessary. The fair value of
mortgage servicing assets, nonmortgage servicing assets, purchased
credit card relationships, and residual interests also must be
determined at least quarterly. This determination shall include
adjustments for any significant changes in original valuation
assumptions, including changes in prepayment estimates or account
attrition rates. Examiners will review both the book value and the
fair value assigned to these assets, together with supporting
documentation, during the inspection
[[Page 58005]]
process. In addition, the Federal Reserve may require, on a case-by-
case basis, an independent valuation of an organization's intangible
assets or residual interests.
g. Growing organizations. Consistent with long-standing Board
policy, banking organizations experiencing substantial growth,
whether internally or by acquisition, are expected to maintain
strong capital positions substantially above minimum supervisory
levels, without significant reliance on intangible assets or
residual interests.
* * * * *
4. Deferred-tax assets. The amount of deferred-tax assets that
is dependent upon future taxable income, net of the valuation
allowance for deferred-tax assets, that may be included in, that is,
not deducted from, a banking organization's capital may not exceed
the lesser of:
(i) The amount of these deferred-tax assets that the banking
organization is expected to realize within one year of the calendar
quarter-end date, based on its projections of future taxable income
for that year,\24\ or
---------------------------------------------------------------------------
\24\ To determine the amount of expected deferred-tax assets
realizable in the next 12 months, an institution should assume that
all existing temporary differences fully reverse as of the report
date. Projected future taxable income should not include net
operating loss carry-forwards to be used during that year or the
amount of existing temporary differences a bank holding company
expects to reverse within the year. Such projections should include
the estimated effect of tax-planning strategies that the
organization expects to implement to realize net operating losses or
tax-credit carry-forwards that would otherwise expire during the
year. Institutions do not have to prepare a new 12-month projection
each quarter. Rather, on interim report dates, institutions may use
the future-taxable income projections for their current fiscal year,
adjusted for any significant changes that have occurred or are
expected to occur.
---------------------------------------------------------------------------
(ii) 10 percent of tier 1 capital. The reported amount of
deferred-tax assets, net of any valuation allowance for deferred-tax
assets, in excess of the lesser of these two amounts is to be
deducted from a banking organization's core capital elements in
determining tier 1 capital. For purposes of calculating the 10
percent limitation, tier 1 capital is defined as the sum of core
capital elements, net of goodwill and net of all identifiable
intangible assets other than mortgage and nonmortgage servicing
assets, purchased credit card relationships, prior to the deduction
of any disallowed mortgage servicing assets, any disallowed
nonmortgage servicing assets, any disallowed purchased credit card
relationships, any disallowed residual interests, and any disallowed
deferred-tax assets. There generally is no limit in tier 1 capital
on the amount of deferred-tax assets that can be realized from taxes
paid in prior carry-back years or from future reversals of existing
taxable temporary differences.
III. * * *
A. * * *
5. The Federal Reserve will, on a case-by-case basis, determine
the appropriate risk weight for any asset that does not fit wholly
within one of the risk categories set forth below or that imposes
risks on a bank holding company that are not commensurate with the
risk weight otherwise specified below for the asset.
B. * * *
6. Residual interests--a. General capital requirement. All
residual interests are subject to both a residual interest capital
requirement and a capital concentration limitation in accordance
with sections II.B.1.e. and III.B.6.b. of this appendix A. In
determining the capital requirement for a residual interest, the
amount of all residual interests in excess of the capital
concentration limit must be deducted from tier 1 capital, in
accordance with section II.B.1.e. of this appendix A, before the
residual interest capital requirement in this section is applied.
b. Residual interest capital requirement. Notwithstanding
section III.D.1.g. of this appendix A, organizations must maintain
capital for a residual interest equal to the amount of the residual
interest (less any amount disallowed in accordance with section
II.B.1.e. of this appendix A and net of any associated deferred tax
liability), even if the amount of capital required to be maintained
exceeds the standard capital charge under section IV.A. of this
appendix A for the assets transferred.
c. Multiple recourse obligations. Where an organization holds a
residual interest and another recourse obligation (such as a standby
letter of credit) in connection with the same asset transfer, the
organization must maintain risk-based capital equal to the greater
of:
(i) The risk-based capital requirement for the residual interest
as calculated under section III.B.6.b of this appendix A; or
(ii) The full risk-based capital requirement for the assets
transferred, subject to the low-level recourse rules (section
III.D.1.g. of this appendix A).
* * * * *
Attachment II--Summary Definition of Qualifying Capital for Bank Holding
Companies*
[Using the year-end 1992 standards]
------------------------------------------------------------------------
Minimum requirements after
Components transition period
------------------------------------------------------------------------
Core Capital (tier 1).................. Must equal or exceed 4% of
weighted-risk assets.
Common stockholders' equity........ No limit.
Qualifying noncumulative perpetual No limit.
preferred stock.
Qualifying cumulative perpetual Limited to 25% of the sum of
preferred stock. common stock, qualifying
perpetual preferred stock, and
minority interests.
Minority interest in equity Organizations should avoid
accounts of consolidated using minority interests to
subsidiaries. introduce elements not
otherwise qualifying for tier
1 capital.
Less: Goodwill, other intangible
assets, and residual interests
required to be deducted from
capital \1\
Supplementary Capital (tier 2)......... Total of tier 2 is limited to
100% of tier 1.\2\
Allowance for loan and lease losses Limited to 1.25% of weighted-
risk assets.\2\
Perpetual preferred stock.......... No limit within tier 2.
Hybrid capital instruments, No limit within tier 2.
perpetual debt, and mandatory
convertible securities.
Subordinated debt and intermediate- Subordinated debt and
term preferred stock (original intermediate-term preferred
weighted average maturity of 5 stock are limited to 50% of
years or more). tier 1; \2\ amortized for
capital purposes as they
approach maturity.
Revaluation reserves (equity and Not included; organization
building). encouraged to disclose; may be
evaluated on a case-by-case
basis for international
comparisons; and taken into
account in making and overall
assessment of capital.
Deductions (from sum of tier 1 and tier
2):
Investments in unconsolidated As a general rule, one-half of
subsidiaries. the aggregate investments will
be deducted from tier 1
capital and one-half from tier
2 capital.\3\
[[Page 58006]]
Reciprocal holdings of banking
organizations' capital securities
Other deductions (such as other
subsidiaries or joint ventures) as
determined by supervisory
authority
Total Capital (tier 1 + tier 2- Must equal or exceed 8% of
deductions). weighted-risk assets.
------------------------------------------------------------------------
\1\ Requirements for the deduction of other intangible assets and
residual interests are set forth in section II.B.1.e. of this
appendix.
\2\ Amounts in excess of limitations are permitted but do not qualify as
capital.
\3\ A proportionally greater amount may be deducted from tier 1 capital.
\*\ See discussion in section II of this appendix for a complete
description of the requirements for, and the limitations on, the
components of qualifying capital.
3. In appendix D to part 225, section II.b. is revised to read as
follows:
Appendix D to Part 225--Capital Adequacy Guidelines for Bank
Holding Companies: Tier 1 Leverage Measure
* * * * *
II. * * *
b. A banking organization's tier 1 leverage ratio is calculated
by dividing its tier 1 capital (the numerator of the ratio) by its
average total consolidated assets (the denominator of the ratio).
The ratio will also be calculated using period-end assets whenever
necessary, on a case-by-case basis. For the purpose of this leverage
ratio, the definition of tier 1 capital as set forth in the risk-
based capital guidelines contained in appendix A of this part will
be used.\3\ As a general matter, average total consolidated assets
are defined as the quarterly average total assets (defined net of
the allowance for loan and lease losses) reported on the
organization's Consolidated Financial Statements (FR Y-9C Report),
less goodwill; amounts of mortgage-servicing assets, nonmortgage-
servicing assets, purchased credit-card relationships, and residual
interests that, in the aggregate, are in excess of 100 percent of
tier 1 capital; amounts of nonmortgage-servicing assets, purchased
credit-card relationships, and residual interests that, in the
aggregate, are in excess of 25 percent of tier 1 capital; all other
identifiable intangible assets; any investments in subsidiaries or
associated companies that the Federal Reserve determines should be
deducted from tier 1 capital; and deferred-tax assets that are
dependent upon future taxable income, net of their valuation
allowance, in excess of the limitation set forth in section II.B.4
of appendix A of this part. \4\
---------------------------------------------------------------------------
\3\ Tier 1 capital for banking organizations includes common
equity, minority interest in the equity accounts of consolidated
subsidiaries, qualifying noncumulative perpetual preferred stock,
and qualifying cumulative perpetual preferred stock. (Cumulative
perpetual preferred stock is limited to 25 percent of tier 1
capital.) In addition, as a general matter, tier 1 capital excludes
goodwill; amounts of mortgage servicing assets, nonmortgage
servicing assets, purchased credit card relationships, and residual
interests that, in the aggregate, exceed 100 percent of tier 1
capital; nonmortgage servicing assets, purchased credit card
relationships, and residual interests that, in the aggregate, exceed
25 percent of tier 1 capital; all other identifiable intangible
assets; and deferred-tax assets that are dependent upon future
taxable income, net of their valuation allowance, in excess of
certain limitations. The Federal Reserve may exclude certain
investments in subsidiaries or associated companies as appropriate.
\4\ Deductions from tier 1 capital and other adjustments are
discussed more fully in section II.B. of appendix A of this part.
---------------------------------------------------------------------------
* * * * *
By order of the Board of Governors of the Federal Reserve
System, September 13, 2000.
Jennifer J. Johnson,
Secretary of the Board.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons set out in the joint preamble, the Board of
Directors of the Federal Deposit Insurance Corporation proposes to
amend part 325 of chapter III of title 12 of the Code of Federal
Regulations as follows:
PART 325--CAPITAL MAINTENANCE
1. The authority citation for part 325 is revised 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, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).
Sec. 325.2 [Amended]
2. In Sec. 325.2:
A. Redesignate paragraphs (s) through (x) as paragraphs (v) through
(aa), paragraphs (q) through (r) as paragraphs (s) through (t), and
paragraphs (g) through(p) as paragraphs (h) through (q);
B. Add new paragraphs (g), (r), and (u);
C. Revise newly designated paragraphs (w) and (y) to read as
follows:
Sec. 325.2 Definitions.
* * * * *
(g) Financial assets means cash, evidence of an ownership interest
in an entity, or a contract that conveys to a second entity a
contractual right:
(1) To receive cash or another financial instrument from a first
entity; or
(2) To exchange other financial instruments on potentially
favorable terms with the first entity.
* * * * *
(r) Residual interests means:
(1) Balance sheet assets that:
(i) Represent interests (including beneficial interests) in
transferred financial assets retained by a seller (or transferor) after
a securitization or other transfer of financial assets; and
(ii) Are structured to absorb more than a pro rata share of credit
loss related to the transferred assets through subordination provisions
or other credit enhancement techniques.
(2) Exclusion. Residual interests do not include interests
purchased from a third party.
(3) Examples. Residual interests include interest only strips
receivable, spread accounts, cash collateral accounts, retained
subordinated interests, and other similar forms of on-balance sheet
assets that function as a credit enhancement.
* * * * *
(u) Securitization means the pooling and repackaging of loans or
other credit exposures into securities that can be sold to investors.
* * * * *
(w) Tier 1 capital or core capital means the sum of common
stockholders' equity, noncumulative perpetual preferred stock
(including any related surplus), and minority interests in consolidated
subsidiaries, minus all intangible assets (other than mortgage
servicing assets, nonmortgage servicing assets, and purchased credit
card relationships eligible for inclusion in core capital pursuant to
Sec. 325.5(f) and qualifying supervisory goodwill eligible for
inclusion in core capital pursuant to 12 CFR part 567), minus residual
[[Page 58007]]
interests (other than residual interests eligible for inclusion in core
capital pursuant to Sec. 325.5(f)), minus deferred tax assets in excess
of the limit set forth in Sec. 325.5(g), minus identified losses (to
the extent that Tier 1 capital would have been reduced if the
appropriate accounting entries to reflect the identified losses had
been recorded on the insured depository institution's books), and minus
investments in securities subsidiaries subject to 12 CFR 337.4.
* * * * *
(y) Total assets means the average of total assets required to be
included in a banking institution's "Reports of Condition and Income"
(Call Report) or, for savings associations, the consolidated total
assets required to be included in the "Thrift Financial Report," as
these reports may from time to time be revised, as of the most recent
report date (and after making any necessary subsidiary adjustments for
state nonmember banks as described in Secs. 325.5(c) and 325.5(d) of
this part), minus intangible assets (other than mortgage servicing
assets, nonmortgage servicing assets, and purchased credit card
relationships eligible for inclusion in core capital pursuant to
Sec. 325.5(f) and qualifying supervisory goodwill eligible for
inclusion in core capital pursuant to 12 CFR part 567), minus residual
interests (other than residual interests eligible for inclusion in core
capital pursuant to Sec. 325.5(f)), minus deferred tax assets in excess
of the limit set forth in Sec. 325.5(g), and minus assets classified
loss and any other assets that are deducted in determining Tier 1
capital. For banking institutions, the average of total assets is found
in the Call Report schedule of quarterly averages. For savings
associations, the consolidated total assets figure is found in Schedule
CSC of the Thrift Financial Report.
3. In Sec. 325.5, revise paragraphs (f) and (g)(2) to read as
follows:
Sec. 325.5 Miscellaneous.
* * * * *
(f) Treatment of mortgage servicing assets, purchased credit card
relationships, nonmortgage servicing assets, and residual interests.
For purposes of determining Tier 1 capital under this part, mortgage
servicing assets, purchased credit card relationships, nonmortgage
servicing assets, and residual interests will be deducted from assets
and from common stockholders' equity to the extent that these items do
not meet the conditions, limitations, and restrictions described in
this section. Banks may elect to deduct disallowed servicing assets and
disallowed residual interests on a basis that is net of any associated
deferred tax liability. Any deferred tax liability netted in this
manner cannot also be netted against deferred tax assets when
determining the amount of deferred tax assets that are dependent upon
future taxable income and calculating the maximum allowable amount of
these assets under paragraph (g) of this section.
(1) Valuation. The fair value of mortgage servicing assets,
purchased credit card relationships, nonmortgage servicing assets, and
residual interests shall be estimated at least quarterly. The quarterly
fair value estimate shall include adjustments for any significant
changes in the original valuation assumptions, including changes in
prepayment estimates or attrition rates. The FDIC in its discretion may
require independent fair value estimates on a case-by-case basis where
it is deemed appropriate for safety and soundness purposes.
(2) Fair value limitation. For purposes of calculating Tier 1
capital under this part (but not for financial statement purposes), the
balance sheet assets for mortgage servicing assets, purchased credit
card relationships, and nonmortgage servicing assets will each be
reduced to an amount equal to the lesser of:
(i) 90 percent of the fair value of these assets, determined in
accordance with paragraph (f)(1) of this section; or
(ii) 100 percent of the remaining unamortized book value of these
assets (net of any related valuation allowances), determined in
accordance with the instructions for the preparation of the
Consolidated Reports of Income and Condition (Call Reports).
(3) Tier 1 capital limitation. The maximum allowable amount of
mortgage servicing assets, purchased credit card relationships,
nonmortgage servicing assets, and residual interests in the aggregate,
will be limited to the lesser of:
(i) 100 percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
nonmortgage servicing assets, any disallowed residual interests, and
any disallowed deferred tax assets; or
(ii) The sum of the amounts of mortgage servicing assets, purchased
credit card relationships, and nonmortgage servicing assets, determined
in accordance with paragraph (f)(2) of this section, plus the amount of
residual interests determined in accordance with paragraph
(f)(1) of the section.
(4) Tier 1 capital sublimit. In addition to the aggregate
limitation on mortgage servicing assets, purchased credit card
relationships, nonmortgage servicing assets, and residual interests set
forth in paragraph (f)(3) of this section, a sublimit will apply to
purchased credit card relationships, nonmortgage servicing assets, and
residual interests. The maximum allowable amount of the aggregate of
purchased credit card relationships, nonmortgage servicing assets, and
residual interests, will be limited to the lesser of:
(i) Twenty-five percent of the amount of Tier 1 capital that exists
before the deduction of any disallowed mortgage servicing assets, any
disallowed purchased credit card relationships, any disallowed
nonmortgage servicing assets, any disallowed residual interests, and
any disallowed deferred tax assets; or
(ii) The sum of the amounts of purchased credit card relationships
and nonmortgage servicing assets determined in accordance with
paragraph (f)(2) of this section, plus the amount of residual interests
determined in accordance with paragraph (f)(1) of the section.
(g)(2) * * *
(2) Tier 1 capital limitations. (i) The maximum allowable amount of
deferred tax assets that are dependent upon future taxable income, net
of any valuation allowance for deferred tax assets, will be limited to
the lesser of:
(A) The amount of deferred tax assets that are dependent upon
future taxable income that is expected to be realized within one year
of the calendar quarter-end date, based on projected future taxable
income for that year; or
(B) Ten percent of the amount of Tier 1 capital that exists before
the deduction of any disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any disallowed purchased
credit card relationships, any disallowed residual interests and any
disallowed deferred tax assets.
(iii) For purposes of this limitation, all existing temporary
differences should be assumed to fully reverse at the calendar quarter-
end date. The recorded amount of deferred tax assets that are dependent
upon future taxable income, net of any valuation allowance for deferred
tax assets, in excess of this limitation will be deducted from assets
and from equity capital for purposes of determining Tier 1 capital
under this part. The amount of deferred tax assets that can be realized
from taxes paid in prior carryback years and from the reversal of
existing taxable temporary differences generally would not be deducted
from assets and from equity
[[Page 58008]]
capital. However, notwithstanding the above, the amount of carryback
potential that may be considered in calculating the amount of deferred
tax assets that a member of a consolidated group (for tax purposes) may
include in Tier 1 capital may not exceed the amount which the member
could reasonably expect to have refunded by its parent.
* * * * *
4. In appendix A to part 325:
A. Revise section I.A.l.;
B. In section II:
i. Designate the first two undesignated paragraphs as sections
II.A.l. and II.A.2., respectively, and add a new section II.A.3.;
ii. Revise section II.B.5., and add new section II.B.7.;
iii. Amend paragraph II.C. by revising the second paragraph under
"Category 4--100 Percent Risk Weight";
C. Revise section III; and
D. Revise Table I to read as follows:
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
I. * * *
A. * * *
1. Core capital elements (Tier 1) consists of:
i. Common stockholders' equity capital (includes common stock
and related surplus, undivided profits, disclosed capital reserves
that represent a segregation of undivided profits, and foreign
currency translation adjustments, less net unrealized holding losses
on available-for-sale equity securities with readily determinable
fair values);
ii. Noncumulative perpetual preferred stock,\2\ including any
related surplus; and
---------------------------------------------------------------------------
\2\ Preferred stock issues where the dividend is reset
periodically based, in whole or in part, upon the bank's current
credit standing, including but not limited to, auction rate, money
market or remarketable preferred stock, are assigned to Tier 2
capital, regardless of whether the dividends are cumulative or
noncumulative.
---------------------------------------------------------------------------
iii. Minority interests in the equity capital accounts of
consolidated subsidiaries.
At least 50 percent of the qualifying total capital base should
consist of Tier 1 capital. Core (Tier 1) capital is defined as the
sum of core capital elements\3\ minus all intangible assets (other
than mortgage servicing assets, nonmortgage servicing assets and
purchased credit card relationships eligible for inclusion in core
capital pursuant to Sec. 325.5(f)) \4\ minus residual interests
(other than residual interests eligible for inclusion in core
capital pursuant to Sec. 325.5(f)) and minus any disallowed deferred
tax assets.
---------------------------------------------------------------------------
\3\ In addition to the core capital elements, Tier 1 may also
include certain supplementary capital elements during the transition
period subject to certain limitations set forth in section III of
this statement of policy.
\4\ An exception is allowed for intangible assets that are
explicitly approved by the FDIC as part of the bank's regulatory
capital on a specific case basis. These intangibles will be included
in capital for risk-based capital purposes under the terms and
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------
Although nonvoting common stock, noncumulative perpetual
preferred stock, and minority interests in the equity capital
accounts of consolidated subsidiaries are normally included in Tier
1 capital, voting common stockholders' equity generally will be
expected to be the dominant form of Tier 1 capital. Thus, banks
should avoid undue reliance on nonvoting equity, preferred stock and
minority interests.
Although minority interests in consolidated subsidiaries are
generally included in regulatory capital, exceptions to this general
rule will be made if the minority interests fail to provide
meaningful capital support to the consolidated bank. Such a
situation could arise if the minority interests are entitled to a
preferred claim on essentially low risk assets of the subsidiary.
Similarly, although residual interests and intangible assets in the
form of mortgage servicing assets, nonmortgage servicing assets and
purchased credit card relationships are generally recognized for
risk-based capital purposes, the deduction of part or all of the
residual interests, mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships may be required if
the carrying amounts of these rights are excessive in relation to
their market value or the level of the bank's capital accounts.
Residual interests, mortgage servicing assets, nonmortgage servicing
assets and purchased credit card relationships that do not meet the
conditions, limitations and restrictions described in Sec. 325.5(g)
of this part will not be recognized for risk-based capital purposes.
* * * * *
II. * * *
A. * * *
3. The Director of the Division of Supervision may, on a case-
by-case basis, determine the appropriate risk weight for any asset
that does not fit wholly within one of the risk categories set forth
in sections II.B. and II.C. of this appendix A or that imposes risks
on a bank that are not commensurate with the risk weight otherwise
specified in sections II.B. and II.C. of this appendix A for the
asset.
* * * * *
B. * * *
5. Mortgage-Backed Securities. Mortgage-backed securities,
including pass-throughs and collateralized mortgage obligations (but
not stripped mortgage-backed securities) that are issued or
guaranteed by a U.S. Government agency or a U.S. Government-
sponsored agency, normally are assigned to the risk weight category
appropriate to the issuer or guarantor. Generally, a privately-
issued mortgage-backed security is treated as essentially an
indirect holding of the underlying assets, and assigned to the same
risk category as the underlying assets, in accordance with the
provisions and criteria spelled out in detail in the accompanying
footnote;\14\ however, such privately-issued mortgage-backed
securities may not be assigned to the zero percent risk category.
Privately-issued mortgage-backed securities whose structures do not
comply with the specified provisions set forth in the footnote are
assigned to the 100 percent risk category. In addition, any class of
a mortgage-backed security, other than a residual interest, that can
absorb more than its pro rata share of loss without the whole issue
being in default (for example, a subordinated class) will also be
assigned to the 100 percent risk weight category. All stripped
mortgage-backed securities, including interest-only strips (IOs)
(unless covered under section II.B.7. of this appendix A),
principal-only strips (POs), and similar instruments, are assigned
to the 100 percent risk weight category, regardless of the issuer or
guarantor.
* * * * *
---------------------------------------------------------------------------
\14\ A privately-issued mortgage-backed security may be treated
as an indirect holding of the underlying assets provided that (1)
the underlying assets are held by an independent trustee and the
trustee has a first priority, perfected security interest in the
underlying assets on behalf of the holders of the security, (2)
either the holder of the security has an undivided pro rata
ownership interest in the underlying mortgage assets or the trust or
single purpose entity (or conduit) that issues the security has no
liabilities unrelated to the issued securities (3) the security is
structured such that the cash flow from the underlying assets in all
cases fully meets the cash flow requirements of the security without
undue reliance on any reinvestment income, and (4) there is no
material reinvestment risk associated with any funds awaiting
distribution to the holders of the security. In addition, if the
underlying assets of a mortgage-backed security are composed of more
than one type of asset, the entire mortgage-backed security is
generally assigned to the category appropriate to the highest risk-
weighted asset underlying the issue.
---------------------------------------------------------------------------
7. Residual interests--a. General capital requirement. All
residual interests are subject to both a residual interest capital
requirement and a capital concentration limitation in accordance
with Sec. 325.5 of this part. In determining the general capital
requirement for a residual interest, the amount of all residual
interest in excess of the capital concentration limit must be
deducted from Tier 1 capital, in accordance with Sec. 325.5 of this
part, before the residual interest capital requirement in this
section is applied.
b. Residual interest capital requirement. Notwithstanding
section III. of this appendix A, a bank must maintain risk-based
capital for a residual interest equal to the amount of the residual
interest that is retained on the balance sheet (less any amount
disallowed in accordance with Sec. 325.5 and net of any associated
deferred tax liability), even if the amount of risk-based capital
required to be maintained exceeds the full risk-based capital
requirement for the assets transferred.
c. Recourse Obligation. Where a bank holds a residual interest
and another recourse obligation (such as a standby letter of credit)
in connection with the same asset transfer, the bank must maintain
risk-based capital equal to the greater of: The risk-based capital
requirement for the residual interest as calculated under section
II.B.7.b. of this appendix A; or the full risk-based capital
requirement for the assets transferred, subject to the low-level
recourse rules (section II.D.1.of this appendix A).
* * * * *
C. * * *
[[Page 58009]]
Category 4--100 Percent Risk Weight
* * * * *
This category also includes all claims on foreign and domestic
private sector obligors that are not assigned to lower risk weight
categories, including: loans to nondepository financial institutions
and bank holding companies; claims on commercial firms owned by the
bank on acceptances outstanding involving standard risk claims; \34\
fixed assets, premises and other real estate owned; common and
preferred stock of corporations, including stock acquired for debt
previously contracted; commercial and consumer loans (except those
loans assigned to lower risk categories due to recognized guarantees
or collateral); real estate loans and mortgage-backed securities
that do not meet the criteria for assignment to a lower risk weight
(including any classes of mortgage-backed securities that can absorb
more than their pro rata share of loss without the whole issue being
in-default, such as subordinated classes, but not including residual
interests); and all stripped mortgage-backed securities, including
interest-only (IOs) (unless covered under section II.B.7. of this
appendix A) and the principal-only (POs) strips.
---------------------------------------------------------------------------
\34\ Customer liabilities on acceptances outstanding involving
non-standard risk claims, such as claims on U.S. depository
institutions, are assigned to the identity of the obligor or, if
relevant, the nature of the collateral or guaranties backing the
claim. Portions of acceptances conveyed as risk participations to
U.S. depository institutions or foreign banks should be assigned to
the 20 percent risk category that is appropriate for short-term
claims guaranteed by U.S. depository institutions and foreign banks.
---------------------------------------------------------------------------
* * * * *
III. Minimum Risk-Based Capital Ratio
Subject to section II.B.7. of this appendix A, banks generally
will be expected to meet a minimum ratio of qualifying total capital
to risk-weighted assets of 8 percent, of which at least 4 percentage
points should be in the form of core capital (Tier 1). Any bank that
does not meet the minimum risk-based capital ratio, or whose capital
is otherwise considered inadequate, generally will be expected to
develop and implement a capital plan for achieving an adequate level
of capital, consistent with the provisions of this risk-based
capital framework, the specific circumstances affecting the
individual bank, and the requirements of any related agreements
between the bank and the FDIC.
* * * * *
Table I--Definition of Qualifying Capital
------------------------------------------------------------------------
Minimum requirements and
Components limitations
------------------------------------------------------------------------
(1) Core Capital (Tier 1).............. Must equal or exceed 4% of risk-
weighted assets.
(2) Common stockholders' equity capital No Limit.\1\
(3) Noncumulative perpetual preferred No Limit.\1\
stock and any related surplus.
(4) Minority interest in equity capital No Limit.\1\
accounts of consolidated subsidiaries.
(5) Less: All intangible assets other (\2\)
than mortgage servicing assets,
nonmortgage servicing assets and
purchased credit card relationships.
(6) Less: Certain residual interests... (\3\)
(7) Less: Certain deferred tax assets.. (\4\)
(8) Supplementary Capital (Tier 2)..... Total of Tier 2 is limited to
100% of Tier 1.\5\
(9) Allowance for loan and lease losses Limited to 1.25% of risk-
weighted assets.\5\
(10) Unrealized gains on certain equity Limited to 45% of pretax net
securities \6\. unrealized gains.\6\
(11) Cumulative perpetual and longterm No limit within Tier 2; long-
preferred stock (original maturity of term preferred is amortized
20 years or more) and any related for capital purposes as it
surplus. approaches maturity.
(12) Auction rate and similar preferred No limit within Tier 2.
stock (both cumulative and non-
cumulative).
(13) Hybrid capital instruments No limit within Tier 2.
(including mandatory convertible debt
securities).
(14) Term subordinated debt and Term subordinated debt and
intermediate-term preferred stock intermediate term preferred
(original weighted average maturity of stock are limited to 50% of
five years or more). Tier 1 \5\ and amortized for
capital purposes as they
approach maturity.
(15) Deductions (from the sum of Tier 1
plus Tier 2).
(16) Investments in banking and finance
subsidiaries that are not consolidated
for regulatory capital purposes.
(17) Intentional, reciprocal cross-
holdings of capital securities issued
by banks.
(18) Other deductions (such as On a case-by-case basis or as a
investments in other subsidiaries or matter of policy after formal
in joint ventures) as determined by consideration