Regulatory Capital: Intangible Assets

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

[No. 93-145]

RIN 1550-AA49

Regulatory Capital: Intangible Assets

AGENCY: Office of Thrift Supervision, Treasury.

ACTION: Final rule.

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SUMMARY: The Office of Thrift Supervision (OTS) is amending its risk-

based capital treatment of intangible assets held by savings

associations. These amendments implement section 475 of the Federal

Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), which

requires the OTS and each of the other federal banking regulators to

determine the amount of purchased mortgage servicing rights (PMSRs)

that insured depository institutions may include in capital. Section

475 also requires PMSRs to be included in capital at 90 percent of

market value, calculated at least quarterly. This rule defines

``qualifying intangible assets'' as PMSRs and purchased credit card

relationships (PCCRs). Such assets may be included in the aggregate in

core capital calculations up to 50 percent of core capital, provided

that PCCRs may not exceed a sublimit of 25 percent of core capital.

Savings associations may include the same dollar amount of PMSRs in

tangible capital that they include in core capital. These assets must

be valued at the lower of 90 percent of fair market value (in

accordance with section 475 of FDICIA) or 100 percent of remaining

unamortized book value computed in accordance with instructions to the

Thrift Financial Report. PMSRs and PCCRs in excess of applicable

limits, as well as core deposit intangibles (CDIs) and other types of

nonqualifying intangibles, must be deducted from both assets and

capital in calculating core and tangible capital.

EFFECTIVE DATE: March 4, 1994.

FOR FURTHER INFORMATION CONTACT: John F. Connolly, Program Manager,

Capital Policy, (202) 906-6465, Supervision Policy; Evelyne Bonhomme,

Counsel (Banking and Finance), (202) 906-7052, Deborah Dakin, Assistant

Chief Counsel, (202) 906-6445, Regulations and Legislation Division,

Chief Counsel's Office, Office of Thrift Supervision, 1700 G Street,

NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background and Description of Proposal

In April 1992, the OTS proposed to amend its capital treatment of

intangible assets. 57 FR 12761 (April 13, 1992). The public comment

period closed on May 13, 1992. The proposal was based on a tentative

agreement on the treatment of intangible assets reached by the OTS, the

Board of Governors of the Federal Reserve System (FRB), the Office of

the Comptroller of the Currency (OCC), and the Federal Deposit

Insurance Corporation (FDIC) (collectively with the OTS referred to as

the ``federal banking agencies'' or ``agencies'').

Previously, all of the agencies allowed PMSRs to count towards core

(Tier 1) capital calculations, with qualitative and quantitative limits

that varied among the agencies. Each agency had determined that PMSRs

generally met criteria comparable to those set forth in section

567.5(a)(2)(ii) of the OTS capital regulation, which provides that: (1)

The intangible asset must be able to be separated and sold apart from

the savings association or from the bulk of the association's assets;

(2) the market value of the intangible asset must be established on an

annual basis through an identifiable stream of cash flows, and there

must be a high degree of certainty that the asset will hold this market

value notwithstanding the future prospects of the savings association;

and (3) the savings association must demonstrate and document that a

market exists that will provide liquidity for the intangible asset.

The agencies differed on the extent to which other intangibles met

this three-part test and treated such assets differently in calculating

capital. The OTS policy, which is being modified with the adoption of

this rule, was that other identifiable intangible assets, specifically

CDIs, could satisfy the three-part test. The OTS did not require the

deduction of such other qualifying intangible assets from capital, but

limited them to 25 percent of core capital.

All the agencies limited the amount of qualifying intangibles that

institutions could include in capital.1 The FDIC and the OTS also

imposed certain PMSR valuation requirements and reduced the amount of

PMSRs reported on the balance sheet to the lesser of: (1) 90 percent of

fair market value; (2) 90 percent of original purchase price; or (3)

100 percent of remaining unamortized book value.

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\1\Before the enactment of section 475 of FDICIA, savings

associations' PMSR holdings were subject to quantitative limits set

by the FDIC, as well as by the qualitative standards of the FDIC and

OCC. Under the FDIC's PMSR rule, thrifts could include PMSRs up to

50 percent of core capital and 100 percent of tangible capital.

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The OTS proposed the following treatment for identifiable

intangible assets for purposes of the tangible, core, and risk-based

capital requirements:

1. PMSRs and PCCRs would be considered qualifying intangible

assets.2 As such, they would not be deducted from capital provided

that, in the aggregate, they did not exceed 50 percent of core capital

and provided that PCCRs did not exceed a sublimit of 25 percent of core

capital. Excess PMSRs and PCCRs would be deducted in determining core

capital.

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\2\In accordance with FIRREA and its statutorily specified

transition, savings associations are permitted to count qualifying

supervisory goodwill in core capital. The continued inclusion in

core capital of remaining qualifying supervisory goodwill is

unaffected by this rulemaking or the standards for PMSRs and PCCRs.

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To illustrate, assume that a savings association has total core

capital of $1,000,000. The association also has qualifying PCCRs of

$300,000 and qualifying PMSRs of $200,000. For capital computation

purposes, the association could include $250,000 of its PCCRs (25

percent of $1,000,000) and all $200,000 of its PMSRs because the total

of PMSRs and allowable PCCRs does not exceed 50 percent of core

capital.

2. Savings associations could include the same amount of PMSRs in

tangible capital that they include in core capital. Amounts excluded

from core capital must also be excluded from tangible capital.

3. PCCRs would be includable only in core capital, not tangible

capital.

4. The limits on PMSRs and PCCRs would be based on a percentage of

core capital before excess holdings of these assets are deducted, but

after nonqualifying identifiable intangible assets (i.e.,

nongrandfathered CDIs) are deducted.3

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\3\Remaining qualifying supervisory goodwill, grandfathered

CDIs, and grandfathered PMSRs are not deducted in calculating this

amount.

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5. Savings associations would be required to determine the fair

market value and to review the book value of their PMSRs and PCCRs at

least quarterly. Such assets could not be carried at a book value that

exceeds the discounted value of their future net income.

6. For purposes of calculating regulatory capital, the amount of

PMSRs and PCCRs reported as balance sheet assets would be reduced to

the lesser of 90 percent of their fair market value, 90 percent of

their original purchase price, or 100 percent of their remaining

unamortized book value.

7. Nongrandfathered CDIs and all identifiable intangible assets

other than qualifying intangible assets would be deducted from capital

in calculating core capital.

II. Summary of Comments and OTS Response

The OTS received twenty-seven comment letters on the proposed rule.

Commenters included eighteen savings associations, six trade

associations, a group of fifteen mortgage servicers, one commercial

bank, and one law firm. No comments addressed PCCRs. Comments focused

primarily on two areas: the treatment of PMSRs and the treatment of

CDIs. Issues raised by commenters are addressed below.

A. PMSR Treatment and Valuation

No commenters objected to the inclusion of PMSRs as qualifying

intangible assets.

1. Fifty Percent Capital Limitation

Some commenters objected to limiting qualifying intangibles to 50

percent of core capital. One suggested that less disruptive ways to

achieve the same goals exist such as substituting a case-by-case

supervisory approach to determine capital adequacy of depository

institutions holding PMSRs.

The OTS is adopting a 50 percent of core capital limit on PMSRs to

be consistent with the rules issued by the other federal banking

agencies.4 OTS capital rules are in the main patterned after those

of the other banking agencies, especially the OCC. The statute, as well

as sensible practice, dictates uniformity to the greatest extent

feasible.

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\4\See 58 FR 7973 (Feb. 11, 1993) (FRB); 58 FR 16481 (Mar. 29,

1993) (OCC); and 58 FR 6363 (Jan. 28, 1993) (FDIC).

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2. Annual Independent Market Valuation of PMSRs

Many commenters objected to an annual independent valuation of

PMSRs as excessively costly and unnecessarily burdensome when combined

with other limitations in the proposal, and suggested that the

requirement be eliminated. Many commenters noted that banks regulated

by the OCC and the FRB are not subject to this requirement. Some

commenters recommended establishing a minimum threshold below which OTS

would not require independent annual valuation of PMSRs. Other

commenters suggested that an independent valuation be required only

where an institution cannot produce a satisfactory internal valuation.

In response to these comments, the OTS is modifying Sec. 567.12(d)

to remove the independent valuation requirement. The OTS, however, will

reserve the right to require certain savings associations to obtain

independent valuations, either on a case-by-case basis or according to

general guidance issued in conjunction with the adoption of this rule.

3. PMSR Valuation Basis

Some commenters proposed that an association should be permitted to

calculate the discounted book value of qualifying intangibles on an

aggregate basis for the institution's total purchased servicing

portfolio rather than on a pool-by-pool basis. The OTS and the other

agencies will permit an institution to use either method. The

accounting practices otherwise required by this rule protect adequately

against potential abusive practices.

4. Discounting Approach

Some commenters stated that limiting PMSRs and PCCRs to 90 percent

of fair market value was arbitrary and that no other assets are subject

to such treatment. Two commenters argued that a constant discount rate

should be applied to book value, but not market value. One commenter

suggested using a case-by-case approach based on criteria such as

efficiency, effectiveness, and profitability.

Section 475 of FDICIA requires PMSRs included in capital to be

valued at no more than 90 percent of fair market value computed at

least quarterly. The agencies have chosen to apply the same limit to

PCCRs for consistency. The OTS and the other agencies never intended to

require institutions to use a constant discount rate in computing

market value. This rule, however, retains the proposed rule's

requirement that savings associations use a discounting approach in

calculating book value because the OTS believes that the nondiscounted

approach can result in inflated carrying values. The OTS has issued a

Thrift Bulletin regarding the valuation of PMSRs.5

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\5\See OTS Thrift Bulletin 60, June 23, 1993.

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5. Discount Rate

Some commenters believed that the proposed requirement to limit the

discount rate used in the quarterly PMSR valuation to a rate that is no

less than the discount rate used at the original acquisition of the

assets contradicts the concept of determining current market value. The

limitation on discount rate would only be used in calculating book

value. The agencies believe that requiring a discounting approach that

uses the discount rate embedded in the yield estimate at original

purchase is appropriate in calculating book value because it will deter

any overvaluation of the book value of PMSRs and is consistent with

historical cost accounting.

This final rule is consistent with the final rules of the other

agencies. These rules retain the requirement to use a discounting

approach but transfer the specific guidance on the applicable discount

rate and other valuation guidance to their Consolidated Reports of

Condition and Income (Call Reports).

The Thrift Financial Report will require PMSRs and PCCRs to be

carried at a book value that does not exceed the discounted amount of

estimated future net cash flows. Management of an association must

review the carrying value at least quarterly, adequately document this

review, and adjust the book value as necessary. If unanticipated

prepayments, defaults, account attrition, or other events reduce the

amount of expected future net cash flows, a write down of the book

value of the PMSRs or PCCRs must be made to the extent that the

discounted amount of future net cash flows is less than the assets'

carrying amounts. The discount rate used for this book value

calculation may not be less than the original discount rate inherent in

the intangible asset at the time of its acquisition based upon the

estimated net cash flows and the price paid at the time of purchase.

6. Valuation Limitation of 90 Percent of Original Cost

Some commenters recommended that the agencies drop the proposed

requirement that qualifying intangibles be carried at no more than 90

percent of their original purchase price. They argued that this

limitation provides no additional protection to the insurance fund from

economic risk and unfairly penalizes institutions with recently

acquired PMSRs or PCCRs. The agencies agree and believe that the other

valuation limitations should ensure that qualifying intangibles are

conservatively valued for capital purposes. Accordingly, the 90 percent

of original cost limitation has been removed.

7. OTS Transition Provision for PMSRs

The proposed transition provision would permit grandfathered PMSRs

that ``run-off'' to be replaced without loss of grandfathered status if

certain criteria are satisfied. Many commenters agreed with the

proposed transition provisions for PMSRs. Several commenters

recommended that the grandfathering provisions become effective as of

January 28, 1991 (the effective date of the FDIC's PMSR rule, 12 CFR

325.5) rather than February 9, 1990 (the date of publication of the

FDIC PMSR proposal for that rule) or on the effective date of this

regulation. One commenter suggested that the OTS consider allowing

large servicers to replace PMSR run-offs to minimize economic loss to

institutions from depletion of assets.

The final rule retains the February 9, 1990, grandfathering date.

This grandfathering date was used in the FDIC's PMSR rule, which was

applicable to both savings associations and state nonmember banks until

the enactment of section 475 in FDICIA. The OTS believes that no

distinction between large and small servicers is warranted. The OTS

has, however, retained the discretion to extend, on a case-by-case

basis, grandfathered treatment to all or some of an association's newly

acquired PMSRs if purchased to replace grandfathered PMSRs that have

prepaid or otherwise run off. This approach is designed to mitigate

harm to associations from precipitous drops in the level of their PMSR

portfolios. Because mortgage servicing is a business that has

relatively high fixed costs, its profitability is highly sensitive to

achieving and maintaining a certain volume of servicing. This

transition treatment will only be available if the OTS determines that:

(1) The association is phasing down PMSRs as a percentage of capital at

an acceptable rate, and (2) such treatment would be consistent with the

association's safe and sound operation.

B. CDI Treatment and Grandfathering

The OTS has previously allowed certain CDIs to be included in

assets and capital provided that they are conservatively valued and

meet the three-part test articulated in section 567.5(a)(2)(ii). The

OTS is concerned that excluding all CDIs from capital might impose an

artificial regulatory barrier to sound mergers and acquisitions. The

proposed uniform interagency proposal specifically excluded CDIs from

qualifying intangible assets.

Eleven commenters objected to the proposed treatment of CDIs and

argued that CDIs should be treated as qualifying intangible assets. One

commenter urged the OTS to apply the three-part test to CDIs, with

periodic reviews of CDIs and continuous evaluations of CDI

amortization. Another commenter proposed that the set of qualifying

intangibles be expanded to include CDIs, and that CDIs and PCCRs be

subjected to the sublimit of 25 percent of core capital, and that CDIs

should only be deducted from capital for undercapitalized institutions.

One commenter questioned the inclusion of the three-part test in the

regulation if PMSRs and PCCRs are the only acceptable qualifying

intangibles. Another commenter recommended that CDIs existing at the

time the proposal is finalized be grandfathered as a component of core

capital.

To minimize confusion, all the banking agencies agreed to delete

the three-part test from their capital regulations and guidelines.

Although the three criteria are no longer part of the agencies'

regulations and guidelines, they may be used in the future to determine

whether other intangibles should be added to the definition of

qualifying intangible assets.

In the interest of interagency uniformity, the OTS is changing its

current policy on CDIs and will henceforth no longer treat CDIs as

qualifying intangibles. The OTS is also rescinding Thrift Bulletin No.

38-1 regarding CDIs.

The OTS, however, will grandfather CDIs that result from prior

transactions or that will arise from transactions that are under firm

contract as of the effective date of this rule. Nongrandfathered CDIs

shall be deducted from assets and capital in computing core capital. No

CDIs or PCCRs are included in tangible capital.

Some commenters suggested that CDIs should not be subject to the

requirements for annual and quarterly market valuations, quarterly

determinations of book value, and value limitations set forth in 12 CFR

567.12(d), (e), and (f), respectively. They also said that these assets

should be recorded in accordance with GAAP. In response to those

comments, the OTS is modifying its treatment of grandfathered CDIs to

require associations to apply GAAP. The OTS, however, will require

associations to use credible and supportable assumptions in applying

GAAP to CDIs not deducted from assets and capital. Valuing CDIs depends

upon assumptions regarding interest rates for alternative funding,

costs other than interest associated with the core deposit base, the

decay rate for an acquired customer base, and a discount rate. The

amortization rate should be adjusted each year for changes in

experienced and expected decay in the acquired customer base.

Typically, the decay rate in the customer base is greater in the early

years. The OTS may restrict an association's inclusion of grandfathered

CDIs in capital if the OTS determines that the association is not using

prudent valuation assumptions.

III. Description of Final Rule

The final rule makes some significant changes from the proposal,

but follows the same general framework set forth in the proposal and

the previous FDIC rule. PMSRs and PCCRs will be considered qualifying

intangible assets and included in the aggregate in core capital up to

50 percent of core capital, provided that PCCRs may not exceed 25

percent of core capital. Associations may include the same amount of

PMSRs in tangible capital that they include in core capital. The

valuation requirements of this rule apply to PMSRs and PCCRs to be

included in assets and not deducted from capital.

The major differences between the final rule and the proposal,

then, are: (1) The deletion from section 567.5(a)(2)(ii) of the three

criteria used to determine whether an intangible asset qualifies for

inclusion in core capital; (2) the reservation by the OTS of the

authority to require an independent market valuation of PMSRs and PCCRs

on a case-by-case basis or by the issuance of separate policy guidance;

(3) the transfer of the requirements imposed in conducting the book

value test from this rule to the Thrift Financial Report; and (4) the

elimination of the 90 percent of original cost limitation for purposes

of calculating capital.

IV. Regulatory Flexibility Act

Pursuant to the requirements of the Regulatory Flexibility Act, 5

U.S.C. 605(b), it is hereby certified that this rule will not have a

significant or disproportionate economic impact on a substantial number

of small savings associations. Furthermore, this rule will not impose

any new recordkeeping or other requirements on any associations. It

generally will retain the current treatment of thrifts' PMSRs and will

allow PCCRs to be counted in thrifts' core capital. Accordingly, a

Regulatory Flexibility Act analysis is not required.

V. Executive Order 12866

The Director of the OTS has determined that this rule is not a

``significant regulatory action'' for purposes of Executive Order

12866.

List of Subjects in 12 CFR Part 567

Capital, Reporting and recordkeeping requirements, Savings

associations.

Accordingly, the Office of Thrift Supervision amends part 567,

subchapter D, title 12 of the Code of Federal Regulations as follows:

SUBCHAPTER D--REGULATIONS APPLICABLE TO ALL SAVINGS ASSOCIATIONS

PART 567--CAPITAL

1. The authority citation for part 567 is revised to read as

follows:

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

(note).

2. Section 567.5 is amended by revising paragraphs (a)(2)(i) and

(a)(2)(ii), and by removing and reserving paragraph (a)(2)(iii) to read

as follows:

Sec. 567.5 Components of capital.

(a) * * *

(2) Deductions from core capital: (i) Intangible assets are

deducted from assets for purposes of determining core capital except as

provided in paragraph (a)(2)(ii) of this section and Sec. 567.12 of

this part.

(ii) Paragraph (a)(2)(i) of this section does not apply to

qualifying supervisory goodwill held by an eligible savings association

(as defined in Sec. 567.1(h) of this part) to the extent permitted by

this paragraph. The amount of qualifying supervisory goodwill may not

exceed the applicable percentage of adjusted total assets as calculated

for the tangible capital requirement set forth in the following table:

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Percent

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Jan. 1, 1993--Dec. 31, 1993................................... 0.750

Jan. 1, 1994--Dec. 31, 1994................................... 0.375

Thereafter.................................................... 0

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(iii) [Reserved]

* * * * *

3. Section 567.6 is amended by revising paragraph (a)(1)(iv)(L) to

read as follows:

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

(a) * * *

(1) * * *

(iv) * * *

(L) Any intangible assets not deducted from capital pursuant to

Sec. 567.5(a)(2) of this part;

* * * * *

4. Section 567.9 is amended by revising paragraph (c)(1) to read as

follows:

Sec. 567.9 Tangible capital requirement.

* * * * *

(c) * * *

(1) Any intangible assets, except certain purchased mortgage

servicing rights as provided in Sec. 567.12 of this part.

* * * * *

5. A new Sec. 567.12 is added to read as follows:

Sec. 567.12 Qualifying intangible assets.

(a) Scope. This section prescribes the maximum amount of qualifying

intangible assets that savings associations may include in calculating

tangible and core capital.

(b) Definition. Qualifying intangible assets means purchased

mortgage servicing rights and purchased credit card relationships.

Purchased mortgage servicing rights may be included in (that is, not

deducted from) tangible and core capital calculations and purchased

credit card relationships may be included in core capital calculations.

These assets may be included in capital only to the extent they meet

the limitations and restrictions set forth in this section. Other

identifiable intangible assets, including core deposit intangibles not

grandfathered pursuant to paragraph (g)(3) of this section, must be

deducted from assets and capital, except as provided by

Sec. 567.5(a)(2)(ii) of this part.

(c) Market valuations. The OTS reserves the authority to require

any savings association to perform an independent market valuation of

qualifying intangible assets on a case-by-case basis or through the

issuance of policy guidance. An independent market valuation, if

required, shall be conducted in accordance with any policy guidance

issued by the OTS. A required valuation shall include adjustments for

any significant changes in original valuation assumptions, including

changes in prepayment estimates or attrition rates. The valuation shall

determine the current fair market value of the qualifying intangibles

by applying an appropriate market discount rate to the net cash flows

expected to be generated from the intangibles. This independent market

valuation may be conducted by an independent valuation expert

evaluating the reasonableness of the internal calculations and

assumptions used by the association in conducting its internal

analysis. The association shall calculate an estimated fair market

value for the qualifying intangibles at least quarterly regardless of

whether an independent valuation expert is required to perform an

independent market valuation.

(d) Value limitation. For purposes of calculating core capital

under this part (but not for financial statement purposes), each

qualifying intangible asset must be valued at the lesser of:

(1) 90 percent of the fair market value of the intangible assets

determined in accordance with paragraph (c) of this section; or

(2) 100 percent of the remaining unamortized book value of the

intangible assets determined in accordance with the instructions in the

Thrift Financial Report.

(e) Core capital limitation--(1) Aggregate limit. The maximum

aggregate amount of qualifying intangible assets that may be included

in core capital shall be limited to the lesser of:

(i) 50 percent of the amount of core capital computed before the

deduction of any disallowed qualifying intangible assets; or

(ii) The amount of qualifying intangible assets determined in

accordance with paragraph (d) of this section.

(2) Sublimit for purchased credit card relationships. In addition

to the aggregate limitation on qualifying intangible assets set forth

in paragraph (e)(1) of this section, a sublimit shall apply to

purchased credit card relationships. The maximum allowable amount of

purchased credit card relationships shall be limited to the lesser of:

(i) 25 percent of the amount of core capital, as computed before

the deduction of any disallowed qualifying intangible assets; or

(ii) The amount of qualifying intangible assets determined in

accordance with paragraph (d) of this section.

(f) Tangible capital limitation. The maximum amount of purchased

mortgage servicing rights that may be included in tangible capital

shall be the same amount includable in core capital in accordance with

the limitations set by paragraph (e)(1) of this section.

(g) Grandfathering. (1) Notwithstanding the core capital and

tangible capital limitations set forth in paragraphs (e) and (f) of

this section, any otherwise disallowed purchased mortgage servicing

rights that were acquired on or before February 9, 1990, and any

otherwise disallowed purchased mortgage servicing rights for which a

contract to purchase the servicing rights had been executed on or

before February 9, 1990, may be grandfathered and recognized for

regulatory capital purposes under this part to the extent permitted by

the OTS. Grandfathered purchased mortgage servicing rights must be

treated in accordance with generally accepted accounting principles and

the requirements of paragraphs (c) and (d) of this section.

Grandfathered purchased mortgage servicing rights will count toward the

core capital and tangible capital limitations described in paragraphs

(e) and (f) of this section.

(2) (i) On a case-by-case basis, the OTS may extend grandfathered

treatment prospectively to all or part of the purchased mortgage

servicing rights acquired by an association to replace its

grandfathered purchased mortgage servicing rights if OTS determines

that:

(A) The association is reducing, at an acceptable rate, its level

of purchased mortgage servicing rights to the levels permitted by this

section; and

(B) The granting of such grandfathered treatment is consistent with

the safe and sound operation of the association.

(ii) The OTS may terminate or limit such grandfathered treatment at

any time if it determines that either of the conditions in paragraph

(g)(2)(i) of this section is not being satisfied.

(3) Core deposit intangibles resulting from transactions

consummated or under firm contract on the effective date of this rule

may be grandfathered and recognized for capital purposes under this

part, to the extent permitted by OTS, provided that such core deposit

intangibles are valued in accordance with generally accepted accounting

principles, supported by credible assumptions, and have their

amortization adjusted at least annually to reflect decay rates (past

and projected) in the acquired customer base.

(h) Exemption for certain subsidiaries.--(1) Exemption standard. An

association holding purchased mortgage servicing rights in separately

capitalized, nonincludable subsidiaries may submit an application for

approval by the OTS for an exemption from the deductions and

limitations set forth in this section. The deductions and limitations

will apply to such purchased mortgage servicing rights, however, if the

OTS determines that:

(i) The thrift and subsidiary are not conducting activities on an

arm's length basis; or

(ii) The exemption is not consistent with the association's safe

and sound operation.

(2) Applicable requirements. If the OTS determines to grant or to

permit the continuation of an exemption under paragraph (h)(1) of this

section, the association receiving the exemption must ensure the

following:

(i) The association's investments in, and extensions of credit to,

the subsidiary are deducted from capital when calculating capital under

this part;

(ii) Extensions of credit and other transactions with the

subsidiary are conducted in compliance with the rules for covered

transactions with affiliates set forth in sections 23A and 23B of the

Federal Reserve Act, as applied to thrifts; and

(iii) Any contracts entered into by the subsidiary include a

written disclosure indicating that the subsidiary is not a bank or

savings association; the subsidiary is an organization separate and

apart from any bank or savings association; and the obligations of the

subsidiary are not backed or guaranteed by any bank or savings

association and are not insured by the FDIC.

Dated: August 2, 1993.

By the Office of Thrift Supervision.

Jonathan L. Fiechter,

Acting Director.

[FR Doc. 94-2297 Filed 2-1-94; 8:45 am]

BILLING CODE 6720-01-P