Risk-Based Capital Requirements Transfer of Assets With Recourse

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

based capital standards as required by sections 208 and 350 of the

Riegle Community Development and Regulatory Improvement Act of 1994

(the Riegle Act).

Section 208 of the Riegle Act is intended to facilitate the

origination and sale of small business loans and leases of personal

property by providing a more favorable risk-based capital treatment for

transfers of such loans and leases with recourse. The OTS is amending

12 CFR Part 567 to permit qualifying institutions to elect to use this

more favorable capital treatment.

Because the OTS capital rules already incorporate the requirements

of section 350 of the Riegle Act, the agency does not propose

regulatory revisions implementing this provision.

DATES: The interim rule is effective August 31, 1995. Comments on this

interim rule must be received by October 30, 1995.

ADDRESSES: Written comments should be submitted to Chief, Dissemination

Branch, Office of Thrift Supervision, 1700 G Street NW., Washington, DC

20552, Attention: Docket No. 95-159. These submissions may be hand

delivered to 1700 G Street NW., from 9:00 a.m. to 5:00 p.m. on business

days; they may be sent by facsimile transmission to FAX number (202)

906-7755. Comments will be available for inspection at 1700 G Street

NW., from 1:00 p.m. until 4:00 p.m., on business days.

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

Manager for Capital Policy (202/906-6465), Supervision; or Karen

Osterloh, Counsel, Banking and Finance (202/906-6639), Regulations and

Legislation Division, Chief Counsel's Office, Office of Thrift

Supervision, 1700 G Street, NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

The OTS is amending its risk-based capital requirements, as

necessary, to implement sections 208 and 350 of the Riegle Community

Development and Regulatory Improvement Act of 1994, Pub. L. 103-325,

108 Stat 2160 (Riegle Act). These sections address the treatment of

recourse obligations under the risk-based capital rules. A recourse

obligation arises, for example, when a savings association transfers a

loan or mortgage-related security subject to an agreement to repurchase

or replace the loan or security if the underlying borrower defaults.

The Office of the Comptroller of the Currency, the Federal Reserve

Board and the Federal Deposit Insurance Corporation 1 are also in

the process of developing and issuing rules implementing sections 208

and 350 of the Riegle Act.

\1\ These agencies with the OTS are collectively referred to as

``the Banking Agencies.''

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II. Current Treatment of Recourse Obligations Under OTS Risk-Based

Capital Regulations

Under current OTS risk-based capital regulations, the full value of

assets sold with recourse must be included in total assets and

multiplied by the appropriate risk-weight percentage. Savings

associations are required to hold capital equal to 8 percent of the

risk-weighted value of the assets sold.2

\2\ 12 CFR 567.6(a)(2)(i)(C).

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However, an alternative rule (commonly called the ``low-level

recourse rule'') applies whenever the foregoing requirements would

result in a capital charge greater than the savings association's

maximum recourse liability on the assets sold. Under these

circumstances, instead of including the assets sold in an association's

risk-weighted assets, the savings association's risk-based capital

requirement is simply increased by an amount equal to the association's

maximum recourse liability.3

\3\ 12 CFR 567.6(a)(2)(i)(C).

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Additionally, if the association is required under generally

accepted accounting principles (GAAP) to establish a recourse liability

account to absorb estimated probable losses from the recourse

obligation, the amount of capital required is reduced.4 When the

low-level recourse rule applies, the amount of the recourse obligation

would be deducted from the maximum contractual obligation. When the

low-level recourse rule does not apply, the amount of the recourse

liability account would be deducted from the amount of the transferred

assets.

\4\ 59 FR 27116, 27122, n.17 (May 25, 1994).

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The following example illustrates how the foregoing rules work. If

an association transfers a $1,000 pool of small business loans with

unlimited recourse, it would be required to hold capital equal to 8

percent of $1,000 (an $80 capital charge). However, if the association

limits its maximum contractual recourse obligation to $30, the capital

requirement would be limited to $30 under the low-level recourse rule.

Moreover, if the association is required to establish a recourse

liability account of $10 under GAAP, the capital charge would be

reduced to $20.

III. Section 350 of the Riegle Act

Section 350(b)(1) of the Riegle Act provides that ``[t]he amount of

risk-based capital required to be maintained, under regulations

prescribed by the appropriate Federal banking agency, 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.'' The OTS capital rule, described above, already

incorporates this ``low-level recourse'' approach at 12 CFR

567.6(a)(2)(i)(C).

Section 350(b)(2) permits the OTS to impose a higher capital charge

if it determines that a higher capital requirement is necessary for the

savings association's safety and soundness. Consistent with this

section, the OTS has retained the authority to increase this capital

charge under appropriate circumstances.5

\5\ 12 CFR 567.3.

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Accordingly, the OTS has determined that it does not need to take

further action to implement section 350 of the Riegle Act.

The OTS, however, solicits comment on its current approach for

factoring associations' capital requirements under the low-level

recourse approach into their total risk-based capital ratio and Tier 1

(core) risk-based capital ratio. The numerator in these ratios is the

actual amount of risk-based or core capital, respectively, held by an

association. The denominator is the total risk-weighted assets held by

an association. These ratios are used to assess associations' capital

positions and to determine capital categories for purposes of the

prompt corrective action (PCA) provisions of section 38(b) of the

Federal Deposit Insurance Act. 12 U.S.C. 1831o.6 As OTS

regulations are

[[Page 45619]]

currently worded, an association that utilizes the low-level recourse

rule merely adds the amount of its maximum contractual recourse

obligation to its capital requirement. Furthermore, the amount of

assets sold subject to the low-level recourse is not included in the

association's total risk-weighted assets. Thus, when the aforementioned

capital ratios under the PCA provisions are computed, adjustments must

be made to ensure that the ratios take into account a savings

association's low-level recourse exposure.

\6\ See 12 CFR Part 565.

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The OTS currently permits associations to use the more favorable of

two adjustment computations. A savings association may either: (1)

Deduct its aggregate low-level recourse capital requirement from the

capital amount (i.e., the numerator) in calculating these ratios; or

(2) add its low-level recourse capital requirement multiplied by 12.5

(i.e., the reciprocal of the 8 percent capital requirement) to its

risk-weighted assets (i.e., the denominator) in calculating the ratios.

These alternative methods for calculating an association's Tier 1 risk-

based capital ratio and total risk-based capital ratio are set forth in

Appendix B to section 120, ``Capital Adequacy,'' of the OTS Regulatory

Handbook: Thrift Activities (January, 1994). The Banking Agencies are

considering other alternatives including requiring all institutions to

follow option (2) described above. The OTS specifically requests

comment on this approach.

IV. Section 208 of the Riegle Act

Section 208 of the Riegle Act prescribes accounting principles and

establishes modified capital rules for transfers of small business

loans and leases of personal property with recourse (small business

obligations) by qualified insured depository institutions. The term

``small business'' means a business that meets the criteria for a small

business concern established by the Small Business Administration under

section 3(a) of the Small Business Act.7 Under section 208(c), an

insured depository institution is a qualified institution, if it: (1)

Is well capitalized for PCA purposes, or (2) is adequately capitalized

for PCA purposes and has obtained approval to apply the modified

capital rules from the appropriate Federal banking agency.8 The

OTS solicits comments on how it should determine whether an adequately

capitalized association should be permitted to use the modified capital

rule under section 208.

\7\ See 15 U.S.C. 632(a) and 13 CFR Part 121 (1995).

\8\ See Section 208(i)(1) and (7). Determinations as to whether

a savings association is a qualified institution are made without

regard to the accounting principles or capital requirements set

forth in section 208(a) and (b). See Section 208(c).

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Under section 208(a), accounting principles applicable to the

transfer of a small business loan or lease of personal property with

recourse and contained in reports or statements required to be filed

with the appropriate Federal banking agency by a qualified insured

depository institution, must be consistent with GAAP. The OTS currently

requires savings associations to comply with GAAP in their financial

reports and statements, including the reporting of transfers of assets

with recourse.9 Accordingly, no regulatory amendments are required

to implement section 208(a).

\9\ 12 CFR 562.2(b)(1995).

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Section 208(b) prescribes modified risk-based capital requirements

for transfers of small business loans or leases of personal property

with recourse that are sales under GAAP. This modified risk-based

capital treatment permits a qualified insured depository institution to

include in its risk-weighted assets, for the purposes of applicable

capital standards and other capital measures, only the amount of the

retained recourse multiplied by the appropriate risk-weight percentage.

For example, if an association sold a $1,000 pool of small business

loans with recourse, but limited its recourse liability to the first

$100 dollars of loss on the pool, section 208(b) would limit the

applicable capital charge to $8.00 (8 percent of the $100 of retained

recourse).

By contrast, current OTS risk-based capital regulations require

savings associations to include in risk-weighted assets the full value

of assets transferred with recourse multiplied by the appropriate risk-

weight percentage. If the current rule were applied to the foregoing

example, the association's capital charge would be 8 percent of the

$1,000 pool of transferred assets resulting in an $80 capital charge,

rather than the $8.00 capital charge under section 208(b).

To be eligible for the preferential capital treatment under section

208(b), a qualified institution must ``establish and maintain a reserve

equal to an amount sufficient to meet the reasonable estimated

liability of the institution under the recourse arrangement.'' The OTS

capital rule follows GAAP in determining when to treat transfers with

recourse as sales and how those sales must be accounted for.

Accordingly, the OTS already requires transferors of assets with

recourse to accrue, as a separate liability, an amount sufficient to

absorb their estimated probable losses under the recourse provision for

the life of the assets transferred.

Section 208(d) limits the aggregate amount of recourse that may be

retained by a qualified insured depository institution with respect to

transactions that are accorded the modified capital treatment. Under

this provision, the total outstanding amount of recourse retained by

the institution and accorded the modified capital treatment may not

exceed 15 percent of the association's risk-based capital or such

greater amount as may be established by the appropriate Federal banking

agency by regulation or order. The rule sets the limit under section

208(d) at 15 percent of the association's total capital under 12 CFR

567.5(c)(4).

Furthermore, section 208(e) provides that if an institution exceeds

the aggregate limit or if it loses its qualified status, transactions

completed while the institution was qualified continue to receive the

favorable capital treatment. This provision is incorporated in the rule

at 12 CFR 567.6(a)(3)(iv).

Section 208 contains two provisions that permit the agency, by

regulation, to modify the requirements specified in the statute. As

noted above, section 208(d)(2) permits the agency to increase the 15

percent aggregate limit. In addition, section 208(h) authorizes the OTS

to establish an alternative system governing the amount of capital and

reserves for small business obligations. The OTS has elected not to

implement these discretionary alternative provisions at this time.

Section 208(f) states, ``The capital of an insured depository

institution shall be computed without regard [to section 208] in

determining whether the institution is adequately capitalized,

undercapitalized, significantly undercapitalized, or critically

undercapitalized under section 38 of the Federal Deposit Insurance Act

(12 U.S.C. 1831o).'' Section 1831o addresses prompt corrective action.

The caption to section 208(f), ``Prompt Corrective Action Not

Affected,'' and the legislative history indicate that section 208 was

not intended to affect the prompt corrective action system.10

However, the statute does not include ``well capitalized'' in the list

of capital categories not affected.

\10\ See S. Rep. No. 103-169, 103d Cong., 1st Sess. 38, 69

(1993).

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The prompt corrective action system deals primarily with imposing

corrective sanctions on associations that are less than adequately

capitalized. Therefore, allowing an association that

[[Page 45620]]

is adequately capitalized without section 208 11 to use the

modified capital treatment under section 208 for purposes of

determining whether it is well capitalized generally would not affect

the application of the prompt corrective action sanctions to the

association. Other statutes and regulations treat an association more

favorably if it is well capitalized (as defined under the prompt

corrective action statute), but these provisions are not part of the

prompt corrective action system of sanctions. Permitting an association

be treated as well capitalized for purposes of these other provisions

also will not affect the imposition of prompt corrective action

sanctions.

\11\ It is very unlikely, but theoretically possible that an

association that is undercapitalized without section 208 would

become well capitalized if it applied the modified capital treatment

under section 208. Because section 208 was not intended to affect

prompt corrective action and because allowing an undercapitalized

association to become well capitalized would affect prompt

corrective action, the OTS believes that section 208 does not allow

an undercapitalized association to use the modified capital

treatment to become well capitalized for the purposes of prompt

corrective action.

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There is one provision of the prompt corrective action system that

could be affected by treating an association as well capitalized,

rather than adequately capitalized. If the OTS determines that an

association is in an unsafe or unsound condition or is engaging in an

unsafe or unsound practice, section 1831o(g) authorizes the OTS--(1) to

reclassify a well capitalized association as adequately capitalized,

and (2) to require an adequately capitalized association to comply with

certain prompt corrective action provisions as if the association were

undercapitalized. Because the text and legislative history of section

208 clearly indicate that Congress did not intend to affect prompt

corrective action, the OTS believes that section 208 does not affect

the capital calculation for purposes of section 1831o(g), regardless of

the association's capital level.

Thus, an association may use the capital treatment described in

section 208 when determining whether it is well capitalized for

purposes of prompt corrective action (except 12 U.S.C. 1831o(g)), as

well as for other regulations that reference the well capitalized

capital category.12 An association may not use the capital

treatment described in section 208 when determining whether it is

adequately capitalized, undercapitalized, significantly

undercapitalized, or critically undercapitalized for purposes of prompt

corrective action or other regulations that directly or indirectly

reference the prompt corrective action capital categories.13 No

association may use the capital treatment under section 208 for

purposes of 12 U.S.C. 1831o(g). The following is a summary of the

applicable rules:

\12\ An association that is subject to a written agreement or

capital directive as discussed in the OTS's prompt corrective action

regulation would not be considered to be well capitalized.

\13\ Under section 208, the capital calculation used to

determine whether an association is well capitalized differs from

the calculation used to determine whether an association is

adequately capitalized. As a result, it is possible that an

institution could be well capitalized using one calculation and

adequately capitalized using the other. In this situation, the

institution would be considered well capitalized.

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(1) Associations that are well capitalized without using section

208. These associations are ``qualifying'' and may apply section 208 to

any transfers of small business obligations with recourse (up to the

15% of capital limit), for all purposes except 12 U.S.C. 1830o(g).

(2) Associations that are adequately capitalized without using

section 208, but have written permission from the OTS to use section

208. These associations are also ``qualifying'' and may apply section

208 to any transfers of small business obligations with recourse (up to

the 15% of capital limit), for all purposes except 12 U.S.C. 1830o(g).

(3) All other associations. Other types of associations are not

``qualifying'' and cannot apply section 208 to new obligations.

However, if the association qualified in the past, it may continue to

apply section 208 to obligations arising out of transfers that occurred

while the association was qualified, for purposes of determining

capital under Part 567.14 However, section 208 may not be used by

these associations for purposes of prompt corrective action or other

regulations that directly or indirectly reference prompt corrective

action capital categories.

\14\ E.g., 12 CFR 567.2 (minimum capital requirements) and other

regulations keyed to the OTS minimum capital requirements rather

than the prompt corrective action categories.

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The OTS will not object if an association decides to apply the

capital treatment described in this rule as of March 22, 1995, because

this is the date by which the regulatory changes prescribed by the

Riegle Act were to have become effective.

The OTS solicits comment on all aspects of this rule and any other

issues related to its implementation of sections 208 and 350.

The Banking Agencies are in the process of reviewing other

regulations and written policies relating to transfers of assets with

recourse. They intend to make comprehensive revisions of their

regulations and written policies addressing the exposure of insured

depository institutions to credit risk from transfers of assets with

recourse. A notice of proposed rulemaking and advance notice of

proposed rulemaking were published in the Federal Register on May 25,

1994.15 The Banking Agencies are working together on this

rulemaking and intend to take further action as quickly as feasible.

\15\ See 59 FR 27116 (May 25, 1994).

V. Regulatory Flexibility Act

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

OTS hereby certifies that this interim rule will not have a significant

economic impact on a substantial number of small entities. The changes

are required by statute and will not affect savings associations' risk-

based capital for prompt corrective actions purposes. Accordingly, a

regulatory flexibility analysis is not required.

VI. Executive Order 12866

The OTS has determined that this interim rule is not a significant

regulatory action as defined in Executive Order 12866. Under the

interim rule, some associations' measured risk-based capital ratios may

improve. This change, however, should have no material effect on the

safety and soundness of affected associations and will not affect their

measured risk-based capital for prompt corrective action purposes.

VII. Unfunded Mandates Reform Act of 1995

Section 202 of the Unfunded Mandates Reform Act of 1995, 104 Pub.

L. 104-4 (signed into law on March 22, 1995), requires that an agency

prepare a budgetary impact statement before promulgating a rule that

includes a Federal mandate that may result in expenditure by State,

local, and tribal governments, in the aggregate, or by the private

sector of $100 million or more in one year. If the budgetary impact

statement is required, section 205 of the Act also requires an agency

to identify and consider a reasonable number of regulatory alternatives

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

rule authorizes an alternative method of calculating capital that

permits savings associations to elect to hold less capital for certain

recourse obligations. The OTS has therefore determined that the interim

rule will not result in expenditure by State, local, or tribal

governments or by the private

[[Page 45621]]

sector of more than $100 million. Accordingly, sections 202 and 205 do

not apply.

VIII. Paperwork Reduction Act and Regulatory Burden

The OTS has determined that this interim rule will not increase the

regulatory paperwork burden on savings associations under the Paperwork

Reduction Act of 1980 (44 U.S.C. 3501 et seq.). Consequently, no

information has been submitted to the Office of Management and Budget

for review.

Section 302 of the Riegle Act requires that new regulations and

amendments to regulations that impose additional reporting,

disclosures, or other new requirements take effect on the first date of

the calendar quarter following publication of the rule unless, among

other things, the agency determines, for good cause, that the

regulations should become effective on a day other than the first day

of the next quarter. The OTS believes that an immediate effective date

is appropriate since the interim rule relieves a regulatory burden on

qualifying savings associations that transfer small business

obligations with recourse by significantly reducing the capital

requirements on such obligations. This immediate effective date will

permit qualifying institutions to reduce the amount of capital they

must maintain to support the risk retained in these transfers.

Moreover, the OTS does not anticipate that the immediate application of

the rules will present a hardship to institutions in terms of

compliance. Also, there is a statutory requirement for the OTS to

promulgate final regulations implementing the provisions of section 208

by March 22, 1995. For these reasons, the OTS has determined that this

effective date is appropriate.

IX. Administrative Procedure Act

Section 208(g) of the Riegle Act requires that the OTS promulgate

final rules implementing section 208 no later than March 22, 1995. The

OTS has determined that the notice and public participation that are

ordinarily required by the Administrative Procedure Act (5 U.S.C. 553)

(the APA) before a regulation may take effect would, in this case, be

impracticable due to the time constraints imposed by section 208(g). In

addition, advance public notice and comment is unnecessary because the

interim rule substantially restates the provisions of the statute.

Further, the interim rule would permit qualifying institutions to

reduce their capital levels, thereby providing these institutions with

greater lending flexibility. Consequently, the added delay that would

result from seeking advance notice and public participation could

potentially adversely impact credit availability.

Section 553(d) of the APA permits the waiver of the 30-day delayed

effective date requirement for good cause, or where a rule relieves a

restriction. The OTS believes that the limitations of time and the

potential loss of benefit to affected parties during the pendency of

this rulemaking constitutes good cause to waive the 30-day delayed

effective date requirement. The OTS further believes that the 30-day

effective date may be waived because the rule relieves a restriction.

Accordingly, the interim rule will be immediately effective upon

publication in the Federal Register. Nevertheless, the OTS seeks the

benefit of public comment before adopting a final rule on this subject.

Accordingly, the OTS invites interested persons to submit comments

during the 60-day comment period. The OTS will revise the interim rule

as appropriate based on these comments.

List of Subjects in 12 CFR Part 567

Capital, Reporting and recordkeeping requirements, Savings

associations.

For the reasons set forth in the preamble, the Office of Thrift

Supervision hereby amends Part 567, chapter V, title 12, Code of

Federal Regulation as set forth below:

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, 1835, 1848

(note), 4808.

2. Section 567.6(a) is revised by adding a fourth and fifth

sentence between the phrase `` `recourse servicing'.'' and the

parenthetical in (a)(2)(i)(C), and by adding a new paragraph (a)(3) to

read as follows:

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

(a) * * *

(2) * * *

(i) * * *

(C) * * * This category also includes transfers of small business

loans or leases of personal property with recourse. Such transfers,

however, may be subject to the alternative capital computation set

forth in paragraph (a)(3) of this section. * * *

* * * * *

(3) Alternative capital computation for small business

obligations-- (i) Definitions. For the purposes of this paragraph

(a)(3):

(A) Qualified savings association means a savings association that:

(1) Is well capitalized as defined in 12 CFR 565.4 without applying

the capital treatment described in paragraph (a)(3)(ii) of this

section; or

(2) Is adequately capitalized as defined in 12 CFR 565.4 without

applying the capital treatment described in paragraph (a)(3)(ii) of

this section and has received written permission from the OTS to apply

that capital calculation.

(B) Small business means a business that meets the criteria for a

small business concern established by the Small Business Administration

in 12 CFR 121 pursuant to 15 U.S.C. 632.

(ii) Capital requirement. With respect to a transfer of a small

business loan or lease of personal property with recourse that is a

sale under generally accepted accounting principles, a qualified

savings association may elect to include only the amount of its

retained recourse in its risk-weighted assets for the purposes of

paragraph (a)(2)(i)(C) of this section. To qualify for this election,

the savings association must establish and maintain a reserve under

generally accepted accounting principles sufficient to meet the

reasonable estimated liability of the savings association under the

recourse arrangement.

(iii) Aggregate amount of recourse. The total outstanding amount of

recourse retained by a qualified savings association with respect to

transfers of small business loans and leases of personal property and

included in the risk-weighted assets of the savings association as

described in paragraph (a)(3)(ii) of this section, may not exceed 15

percent of the association's total capital computed under

Sec. 567.5(c)(4).

(iv) Savings association that ceases to be a qualified savings

association or that exceeds aggregate limits. If a savings association

ceases to be a qualified savings association or exceeds the aggregate

limit described in paragraph (a)(3)(iii) of this section, the savings

association may continue to apply the capital treatment described in

paragraph (a)(3)(ii) of this section to transfers of small business

loans and leases of personal property that occurred when the

association was a qualified savings association and did not exceed the

limit.

(v) Prompt corrective action not affected. (A) A savings

association shall compute its capital without regard to this paragraph

(a)(3) of this section for purposes of prompt corrective action (12

U.S.C. 1831o), unless the savings association is adequately or well

capitalized without applying the capital

[[Page 45622]]

treatment described in this paragraph (a)(3) and would be well

capitalized after applying that capital treatment.

(B) A savings association shall compute its capital without regard

to this paragraph (a)(3) for the purposes of applying 12 U.S.C.

1831o(g), regardless of the association's capital level.

* * * * *

Dated: August 21, 1995.

By the Office of Thrift Supervision.

John F. Downey,

Director, Supervision.

[FR Doc. 95-21564 Filed 8-30-95; 8:45 am]

BILLING CODE 6720-01-P