Investment Securities

SUMMARY: The Office of the Comptroller of the Currency (OCC) is

clarifying and updating its rules that prescribe the standards under

which national banks may purchase and sell, deal in, and underwrite

securities. This final rule is another component of the OCC's

Regulation Review Program, a project designed to review, modernize, and

simplify OCC regulations and reduce unnecessary regulatory burdens on

national banks. The final rule reorganizes the regulation by placing

related subjects together, clarifies certain areas, and updates various

provisions to address market developments and to incorporate

significant OCC interpretations, judicial decisions, and statutory

amendments.

EFFECTIVE DATE: December 31, 1996.

FOR FURTHER INFORMATION CONTACT: Lee Walzer, Senior Attorney,

Securities and Corporate Practices Division, 202-874-5210; Kurt

Wilhelm, Senior Investment Advisor, Capital Markets, 202-874-5070;

Daniel L. Cooke, Attorney, and Stuart E. Feldstein, Assistant Director,

Legislative and Regulatory Activities Division, 202-874-5090. Office of

the Comptroller of the Currency, 250 E Street, S.W., Washington, DC

20009.

SUPPLEMENTARY INFORMATION:

Background

Part 1 has historically prescribed the limitations and restrictions

on a national bank's purchase of investment securities for its own

account. Part 1 also addresses a national bank's ability to purchase

and sell, deal in, and underwrite certain investment securities. The

part 1 limitations on these activities are based on the Banking Act of

1933, section 16, Pub. L. 73-66, 48 Stat. 184 (codified as amended at

12 U.S.C. 24(Seventh)), and vary according to the characteristics of

the security.

In the past, part 1 grouped the securities identified in 12 U.S.C.

24(Seventh) into three categories, Types I, II, and III securities.

More recently, the Secondary Mortgage Market Enhancement Act of 1984,

(SMMEA) \1\ and the Riegle Community Development and Regulatory

Improvement Act of 1994 (CDRI) \2\ amended 12 U.S.C. 24(Seventh) and

removed quantitative limits on national banks'' purchases of certain

types of mortgage- and small business-related securities, subject to

regulations prescribed by the OCC.

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

\1\ Sec. 105(c), Pub. L. 98-440, Title I, 98 Stat. 1691

(codified as amended at 12 U.S.C. 24(Seventh) (1984)).

\2\ Pub. L. 103-325, 108 Stat. 2160 (1994).

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

On December 21, 1995, the OCC published a notice of proposed

rulemaking (60 FR 66152) (proposal) to revise part 1 and implement the

changes required by CDRI and SMMEA. The proposal sought to implement

the goals of the OCC's Regulation Review Program by updating and

streamlining the regulation and eliminating requirements that imposed

inefficient and costly regulatory burdens on national banks. The

proposal also sought to implement the amendments made by SMMEA and CDRI

and to update various provisions to address market developments and to

incorporate significant OCC interpretations and judicial decisions.

In the proposal, the OCC added two new classifications of

securities to characterize the changes made by SMMEA and CDRI and to

reflect developments in national banks'' treatment of their assets.

Specifically, the proposal added a new category of securities, Type IV

securities, that are defined as certain types of asset-backed

securities identified in SMMEA and CDRI, which are exempt from the 10

percent investment limitation of 12 U.S.C. 24(Seventh). Type IV

securities are: (1) residential and commercial mortgage-related

securities offered and sold pursuant to section 4(5) of the Securities

Act of 1933 (Securities Act), 15 U.S.C. 77d(5); (2) residential and

commercial mortgage-related securities described in section 3(a)(41) of

the Securities Exchange Act of 1934 (Exchange Act), 15 U.S.C.

78c(a)(41); and (3) small business-related securities as defined in

section 3(a)(53)(A) of the Exchange Act, 15 U.S.C. 78c(a)(53)(A).

The proposal also added Type V securities, which are investment

grade securities that are backed by pools of assets composed of

obligations in which a national bank may invest directly.

In addition to adding Type IV and Type V securities, the proposal

refined the definitions and limitations imposed on the three existing

types of securities. Finally, the proposal restructured part 1 to make

it easier to read and apply.

Comments and OCC Action

The OCC received 19 comment letters in response to the proposal.

The commenters included eight trade associations, one professional

association, six banks, two law firms, one private business, and one

unaffiliated individual. The commenters generally supported the

proposal but also recommended a number of specific modifications. Many

of the commenters offered reasons why the OCC should remove or lessen

structural limitations on investment in Type IV and Type V securities,

particularly aspects of the proposed diversification requirements.

In the final rule, the OCC has addressed many of the concerns of

the commenters and, in particular, has concluded that some of the

proposal's definitional restrictions on Type IV and Type V securities

are not necessary.

The final rule's structure is based on three core sections. Section

1.2 defines the five types of securities as well as other significant

terms such as ``investment grade,'' ``investment security,'' and

``marketable.'' Section 1.3 prescribes limitations on dealing in,

underwriting, purchasing, and selling each of the five types of

securities defined in Sec. 1.2, investment company shares, and

securities held based on estimates of an obligor's performance. Section

1.3 prescribes special provisions on aggregation of securities with a

common issuer and calculation of investment company holdings. Section

1.4 prescribes how a national bank must calculate the limits imposed by

Sec. 1.3.

The final rule also makes minor clarifying and technical changes.

The following section-by-section analysis discusses the comments and

substantive changes made by the final rule:

Authority, Purpose, and Scope (Sec. 1.1)

The proposal consolidated the former ``Scope and application''

section (Sec. 1.2) with the ``Authority'' section (Sec. 1.1). The

proposal also clarified that the limitations set forth in part 1 apply

to national banks, federal branches of foreign banks, District of

Columbia banks, and state banks that are members of the Federal Reserve

System.

The OCC received no comments on this section, which is adopted as

proposed with minor clarifying changes.

Definitions (Sec. 1.2)

The proposal substantially revised the definitions section to add

several new definitions and to update others. The proposal revised the

definitions of Type I, II, and III securities to define the securities

by their characteristics rather than by the statutory limitations on

the

[[Page 63973]]

extent to which national banks may deal in, underwrite, purchase, or

sell them. The proposal also defined two new types of securities, Type

IV and Type V securities, and added a definition of ``investment

company.''

The final rule adds a new defined term, ``NRSRO.'' The final rule

changes the paragraph letter designations for each definition

accordingly. Of particular note, the final rule makes the following

substantive changes:

Capital and Surplus (Sec. 1.2(a))

The proposal defined ``capital and surplus'' as the sum of Tier 1

and Tier 2 capital includable in risk-based capital under the Minimum

Capital Ratios in 12 CFR part 3 appendix A, plus the balance of a

bank's allowance for loan and lease losses that is not included in Tier

2 capital.

The OCC received three comments on this definition. The commenters

noted that, because part 1 applies to state banks that are members of

the Federal Reserve System, the OCC should adopt a definition of

``capital and surplus'' that applies the Board of Governors of the

Federal Reserve System's (FRB's) definition of ``capital and surplus''

to state member banks. The OCC agrees with these commenters and has,

therefore, changed the final rule to incorporate technical changes and

to provide that banks must use the appropriate Federal banking

agencies'' guidelines defining ``capital and surplus.''

Investment Grade (Sec. 1.2(d))

In many instances in the final rule, a security must be

``investment grade'' to be a permissible investment for a national

bank. The proposal defined a security as ``investment grade'' when each

nationally recognized statistical rating organization (NRSRO) that has

rated the security has given it a rating in one of the top four rating

categories. Thus, for purposes of this definition, if a security were

given different ratings by different NRSROs, the lowest rating would

govern. For example, if two NRSROs rated a security in one of their top

four categories, but a third NRSRO did not give the security a top four

rating (a so-called ``split- rated'' security), the security would not

qualify as ``investment grade.''

The OCC received ten comments on this section. Seven commenters

recommended that the OCC change the proposed definition to recognize a

security as ``investment grade'' if only one NRSRO rates the security

in one of the top four categories. These commenters asserted that

otherwise any one NRSRO could render a particular security non-

investment grade and, therefore, not permissible for a national bank to

purchase. One commenter recommended that, at a minimum, the OCC should

deem a security ``investment grade'' if a majority of the NRSROs that

rate the security rate it in one of the top four categories.

The OCC agrees that giving a single NRSRO the ability to deem an

investment impermissible for a national bank may be unnecessarily

restrictive. Thus, the final rule defines the term ``investment grade''

to mean a security that receives a top four rating from either: (a) Two

or more NRSROs; or (b) one NRSRO if the security has been rated by only

one NRSRO. This approach assures that a security is sufficiently

creditworthy while also allowing for some diversity in the evaluations

produced by different NRSROs.

Some commenters requested that the OCC exclude unsolicited ratings

from the definition. Under the proposal, an unsolicited non-investment

grade rating would have rendered the security an impermissible

investment for a national bank. However, the final rule recognizes

unsolicited ratings, but no longer will permit a single unsolicited

rating to render a security automatically ineligible for national bank

investment.

Investment Security (Sec. 1.2(e))

The proposal defined ``investment security'' as a security that is:

(1) An investment grade marketable debt obligation; or (2) the credit

equivalent of an investment grade marketable debt obligation if the

security is not rated. The OCC requested comment on whether to describe

more specifically the characteristics of securities that are the credit

equivalent of investment grade. The OCC also asked commenters to

address whether other securities with characteristics functionally

equivalent to a debt obligation might be classified as ``investment

securities.''

The OCC received four comments on this section. The commenters

generally supported the definition of ``investment security.'' Most

commenters felt that defining ``credit equivalency'' by identifying

specific characteristics would sacrifice flexibility.

The OCC agrees with the commenters and believes that to adopt

specific identifiable characteristics of credit equivalency would

unduly restrict flexibility in this area. Therefore, the OCC adopts the

final rule as proposed.

Marketable (Sec. 1.2(f))

At Sec. 1.5(a), the former rule defined a ``marketable'' security

as one that may be sold with reasonable promptness at a price that

corresponds reasonably to its fair value. The proposal replaced this

definition with a more objective test that lists particular indicators

of a ready market for a security. The proposal defined marketable as:

(1) Securities registered under the Securities Act; (2) certain

government securities exempt from Securities Act registration; (3)

municipal revenue bonds exempt from Securities Act registration; and

(4) securities that are investment grade and sold pursuant to

Securities Exchange Commission (SEC) Rule 144A (17 CFR 230.144A), which

exempts certain private resales of securities to institutional

investors from Securities Act registration.

The OCC requested comment on whether the proposed definition of

``marketable'' is sufficiently inclusive, particularly regarding other

exemptions under the Securities Act and whether the definition is

appropriately inclusive of foreign sovereign debt. The OCC also asked

commenters to suggest alternative definitions of marketable that would

address the OCC's concerns about liquidity.

The OCC received 12 comments on this issue. A majority of the

commenters recommended that the OCC expand the proposed definition or

retain the former definition of marketable. These commenters asserted

that the proposed definition was too restrictive and did not include

certain securities that are included within the definition in the

former regulation. For example, the commenters noted that foreign

sovereign debt, bank and savings and loan debt securities (which are

exempt from registration under the Securities Act), and commercial

paper were not identified in the proposed definition even though they

may have been included within the former marketability test.

The OCC did not intend to prescribe a marketability test that,

through its objectivity, eliminates flexibility available under the

former rule and unnecessarily excludes a broad range of securities.

Therefore, the final rule retains the list of marketable securities

contained in the proposal and adds to that list the definition of

marketable contained in the former regulation, i.e., a security that

may be sold with reasonable promptness at a price that corresponds

reasonably to its fair value. Thus, certain foreign sovereign debt and

other securities may qualify under the revised definition of

marketable. This approach also provides additional flexibility for the

OCC to review the permissibility of national bank investment in

particular securities on a case-by-case basis.

[[Page 63974]]

Several commenters also asked the OCC to remove the requirement

that Securities Exchange Commission Rule 144A, 17 CFR 230.144A (Rule

144A) securities be rated investment grade in order to fall within the

definition of ``marketable.'' These commenters stated that many

privately-placed securities are not rated. One commenter advocated that

the OCC should not adopt the proposal, because Rule 144A provides no

assurance of marketability.

The OCC agrees that a Rule 144A security need not be rated

investment grade to be marketable; but, if it is not rated investment

grade, it must be the credit equivalent of investment grade. The final

rule therefore does not adopt the proposed requirement that an NRSRO

rate a Rule 144A security investment grade in order for the security to

be marketable. Instead, consistent with other investment securities

under this part, a Rule 144A security may qualify as investment grade,

when not rated, and therefore qualify as marketable, if the bank

determines that it is the credit equivalent of an investment grade

security. The OCC expects that, as a matter of safe and sound banking

practices, a bank will conduct a thorough analysis of a security's

creditworthiness in order to satisfy itself that a particular security

is the credit equivalent of investment grade.

The OCC has also determined that proposed Sec. 1.2(f)(2) is

unnecessary. That provision listed as one component of the definition

of marketability each of the securities that is included in the

definition of a Type I security. Because Type I securities are not

required to satisfy a marketability test under section 24(Seventh), it

is unnecessary for the rule to include these Type I securities in the

definition of marketable. Therefore, the final rule is adopted without

proposed Sec. 1.2(f)(2). The remainder of paragraph Sec. 1.2(f) is

renumbered accordingly.

NRSRO (Sec. 1.2(g))

The OCC did not use the term ``NRSRO'' in the proposal. In making

changes to the final rule's definition of, and limitations on, Type IV

securities, the OCC found that referring to nationally recognized

statistical rating organizations (NRSROs) was the most direct and clear

means of drafting the rule. The final rule, therefore, adds ``NRSRO''

as a defined term.

The OCC has not listed the rating organizations that qualify as

NRSROs in this definition. The OCC generally follows the assessment of

the SEC in acknowledging the organizations that are currently NRSROs.

The SEC recognizes NRSROs through no-action letters. The most recent

SEC no action letter in which the SEC expressed no opposition to the

recognition of an NRSRO is Thomson Bankwatch, Inc., SEC No-Action

Letter, [1991 Transfer Binder] Fed. Sec. L. Rep. (CCH) paragraph 79,800

(August 6, 1991). See also 59 FR 46314 (September 7, 1994) (publishing

an SEC ``Concept release'' on NRSROs).3

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

3 Currently, the NRSROs recognized by the SEC are: Duff and

Phelps, Inc.; Fitch Investors Service, Inc.; IBCA Limited (and its

subsidiary, IBCA Inc.); Moody's Investors Services Incorporated;

Standard and Poor's Corporation; and Thomson Bankwatch, Inc.

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

Several commenters suggested that the OCC recognize foreign rating

organizations. The OCC finds that most significant foreign debt

securities are rated by the NRSROs to which the SEC has expressed no

objection and, at this time, sees no need to depart from the SEC's

assessment of the rating organizations that are nationally recognized.

Type I Security (Sec. 1.2(i))

The proposal used language similar to that in the former rule to

define ``Type I security'' to mean any one of specified government

securities. The former rule and the proposal also incorporated key

elements of an OCC interpretation regarding securities backed by the

full faith and credit of the U.S. Government.

The OCC received four comments on this definition. Three commenters

recommended that, consistent with 12 U.S.C. 24(Seventh), the OCC should

add qualified Canadian government obligations to the definition of a

Type I security. The OCC received one comment recommending that the OCC

add the debt securities of certain developed foreign sovereigns to the

list of Type I securities.

In accordance with 12 U.S.C. 24(Seventh), the final rule adds

qualified Canadian government obligations to the list of Type I

securities. The OCC acknowledges that, in the future, other securities

may fulfill the definitional requirements of a Type I security, and the

OCC will review securities, as appropriate, to determine if they meet

the statutory requirements.

Type II Security (Sec. 1.2(j))

The proposal redefined a ``Type II security'' to mean an investment

security that is issued by certain state, international, or

multilateral organizations or that is otherwise listed or described in

12 U.S.C. 24(Seventh). In contrast, the former rule defined a Type II

security by identifying the investment limits that apply to it and by

listing examples of qualifying types of issuers.

The OCC received no comments on this definition, which is adopted

as proposed. The OCC notes that the definition of Type II security also

includes other securities that the OCC deems eligible as Type II

securities in accordance with 12 U.S.C. 24(Seventh). This provision

gives the OCC flexibility, consistent with the authorizing statute, to

review securities that may fulfill the definitional requirements of a

Type II security but are not listed in the definition.

Type III Security (Sec. 1.2(k))

The former rule defined a Type III security as a security that a

bank may purchase and sell for its own account, subject to the 10

percent limitation in 12 U.S.C. 24(Seventh). The proposal redefined a

Type III security as an investment security that does not qualify as a

Type I, II, IV, or V security. The proposal listed corporate bonds and

municipal revenue bonds as examples of Type III securities.

The OCC requested comment on whether to reference specifically

other examples of Type III securities in addition to corporate bonds

and municipal revenue bonds. In particular, the OCC requested comment

on whether to include as Type III securities foreign securities that

are eligible for investment by foreign branches of U.S. banks.

The OCC received seven comments on the definition of a Type III

security. The majority of these commenters recommended that the OCC

include in the list of examples that qualify as Type III securities

foreign securities that are eligible for investment by foreign branches

of national banks and mortgage backed securities (MBSs) that do not

qualify as Type IV or Type V securities. One commenter also recommended

that the OCC permit national banks to underwrite and deal in municipal

revenue bonds.

The OCC has determined that the proposed definition of a Type III

security provides appropriate examples of the scope of qualifying Type

III securities. While certain mortgage backed securities and foreign

securities eligible for investment by foreign branches of national

banks will qualify as investment securities and are, therefore, Type

III securities, others may not. The OCC has not concluded that all

foreign securities eligible for investment by foreign branches of

national banks qualify as a Type III investment security. Nor does the

OCC want to imply that banks are precluded from purchasing other

classes of securities,

[[Page 63975]]

which may meet the definition of ``investment security'' but are not

specifically listed as a Type III security. This may be the case if,

for example, the OCC were to add further to the list of examples,

thereby appearing to create an exhaustive list of Type III securities.

The OCC does not intend to create an exclusive list of Type III

securities.

Type IV Security (Sec. 1.2(l))

The proposal added a new category of securities, Type IV

securities, which SMMEA and CDRI made eligible for purchase by national

banks in unlimited amounts. In 1984, the SMMEA amended 12 U.S.C.

24(Seventh) to permit national banks to purchase residential and

commercial mortgage-related securities offered and sold pursuant to

section 4(5) of the Securities Act of 1933 Act (Securities Act), 15

U.S.C. 77d(5), or residential mortgage-related securities as defined in

section 3(a)(41) of the Exchange Act, 15 U.S.C. 78c(a)(41). The final

rule incorporates the SMMEA amendments.

CDRI defined a new type of small business-related security in

section 3(a)(53)(A) of the Exchange Act, 15 U.S.C. 78c(a)(53)(A), and

added a class of commercial mortgage-related securities to section

3(a)(41) of the Exchange Act, 15 U.S.C. 78c(a)(41). CDRI's amendments

to 12 U.S.C. 24(Seventh) removed limitations on purchases by national

banks of certain small business-related and commercial mortgage-related

securities. However, CDRI requires that certain residential and

commercial mortgage-related securities must receive a rating from an

NRSRO in one of the top two rating categories. Small business-related

securities must receive a rating in one of the top four rating

categories.

CDRI also authorized the OCC to prescribe regulations to ensure

that acquisitions of statutorily defined residential and commercial

mortgage-related securities and small business-related securities are

conducted in a manner consistent with safe and sound banking practices.

In its proposed definition of a Type IV security, the OCC sought to

guard against undue concentration of risk that could arise were a bank

to invest in a security backed by a small number of loans or if a small

number of loans represents a large percentage of the assets in the

pool. Therefore, the proposal required Type IV securities that are

small business- or commercial mortgage-related securities to be fully

secured by interests in a pool of homogeneous loans of numerous

obligors.

To assure diversification, the proposal also provided that, for

small business-related securities and commercial mortgage-related

securities, the aggregate amount of collateral from loans of any one

obligor could not exceed 5 percent of the total amount of the loans in

the pool collateralizing the security (the ``5 percent collateral

concentration limit'').

The OCC requested specific comment on whether to define the term

``homogeneous loans'' and whether the 5 percent collateral

concentration limit was appropriate to assure adequate diversification

of the collateral.

The OCC received 17 comments on the proposed definition of a Type

IV security, particularly on the 5 percent collateral concentration

limit and the homogeneity and numerous obligor requirements. Most

commenters opposed the ``homogenous,'' ``numerous,'' and 5 percent

collateral concentration restrictions, stating that they were

impractical. Commenters opposing both the ``homogeneous'' and

``numerous obligor'' requirements asserted that those terms are vague

and difficult to apply because they are not defined. In particular, the

commenters asserted that the homogeneity requirement conflicts with the

diversification objective of pooling commercial loans. These commenters

stated that commercial loans, by their nature, are seldom homogeneous.

Most commenters also recommended that the OCC eliminate the 5

percent collateral concentration limit on loans of any one obligor in

Type IV security loan pools. The commenters emphasized that the plain

language of CDRI permits unlimited investment in commercial mortgage-

related and small business-related securities. These commenters

asserted that NRSROs consider concentration risk when they rate a

particular security, thereby making the 5 percent collateral

concentration limit unnecessary. They also asserted that the limit

fails to consider compensating factors such as credit enhancements,

stable cash flow, prime location of mortgage properties, construction

quality of mortgaged property, and barriers to competition, which are

all considered by rating agencies.

The commenters also cited the following reasons for their

opposition to the 5 percent collateral concentration limit: (1) The 5

percent collateral concentration limit mistakenly focuses solely on the

obligor, does not focus on the collateral for the security, and

therefore fails to ensure diversification of collateral. A collateral

pool that satisfies the 5 percent collateral concentration limit will

not necessarily contain diverse collateral; however, a single borrower/

obligor can produce a commercial mortgage-backed security pool that has

diverse collateral. (2) The majority of commercial mortgage loans are

nonrecourse to the borrower and, therefore, borrower diversity is less

relevant than tenant creditworthiness. (3) The 5 percent collateral

concentration limit will be unnecessarily burdensome and costly

relative to any benefits it provides because it will require a

transaction-by-transaction analysis and the production and maintenance

of voluminous reports regarding the make-up of each commercial

mortgage-related security pool.

Some commenters recommended raising the 5 percent collateral

concentration limit to a 20 percent limit. One commenter recommended

that the OCC use existing authority to assess a risk-based capital

surcharge when holdings of a Type IV security exceed the aggregate

amount of the appropriate percentage of capital and surplus.

The OCC agrees with many of the reasons cited by the commenters and

has not adopted the homogeneity and 5 percent collateral concentration

limit. In particular, the OCC believes that the statutory requirements

for residential and commercial mortgage-related securities defined in

3(a)(41) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(41),

to have an NRSRO rating in one of the top two categories and for small

business-related securities to receive a rating in one of the top four

rating categories provide sufficient safeguards against investment

risks. NRSRO ratings reduce the risk of investment posed to banks

because of the NRSROs' resources and ability to analyze such factors as

cash flow treatments, credit facilities, and collateral

diversification. To ensure that banks do not purchase, in unlimited

amounts, commercial and residential mortgage-related securities that

are offered or sold pursuant to section 4(5) of the Securities Act of

1933, 15 U.S.C. 77d(5), that are predominantly speculative in nature,

the final rule requires that these securities at least be investment

grade.

In addition, the final retains the requirement that the securities

be composed of interests in a pool of loans to ``numerous'' obligors.

The OCC believes that this requirement reflects an essential

diversified risk characteristic of a mortgage-related or small

business- related security and does not unduly limit a national bank's

ability to invest in these asset-backed securities.

[[Page 63976]]

Type V Security (Sec. 1.2(m))

The proposal created a new category of securities, Type V, that are

investment grade securities composed of loans in which a bank may

invest directly. This definition reflected the OCC's long-standing

interpretations that, in addition to the investments described in 12

U.S.C. 24(Seventh), a national bank may hold securitized forms of

assets in which it may invest directly.4

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

\4\ Securities Industry Ass'n v. Clarke, 885 F.2d 1034 (2d Cir.

1989), cert. denied, 493 U.S. 1070 (1990) (national bank authority

to securitize assets); Interpretive Letter No. 540 (December 12,

1990), reprinted in [1990-1991 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 83,252 (securitized credit card receivables);

Interpretive Letter No. 514 (May 5, 1990), reprinted in [1990-1991

Transfer Binder] Fed. Banking L. Rep. (CCH) para. 83,218

(securitized mortgages); Investment Securities Letter No. 29 (August

3, 1988), reprinted in [1988-1989 Transfer Binder] Fed. Banking L.

Rep. (CCH) para. 85,899 (investment limits for asset-backed

securities consisting of GMAC receivables); Interpretive Letter No.

416 (February 16, 1988), reprinted in [1988-1989 Transfer Binder]

Fed. Banking L. Rep. (CCH) para. 85,640 (securitized automobile

loans); No Objection Letter No. 87-9 (December 16, 1987), reprinted

in [1988-1989 Transfer Binder] Fed. Banking L. Rep. (CCH) para.

84,038 (securitization of commercial loans originated by the bank);

Interpretive Letter No. 388 (June 16, 1987), reprinted in [1988-1989

Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,612 (mortgage-

backed pass-through certificates); Interpretive Letter No. 362 (May

22, 1986), reprinted in [1985-1987 Transfer Binder] Fed. Banking L.

Rep. (CCH) para. 85,532 (bonds collateralized by mortgages).

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

Under the proposal, the definition of a Type V security included

the same limitations that were included in the definition of a Type IV

security (i.e., ``homogeneous loans'' from ``numerous obligors'' with

the obligations of any one obligor composing no more than 5 percent of

the pool). In order to assure the high quality of this type of asset-

backed security, the proposal also required that a Type V security be

rated investment grade.

The commenters recommended that the OCC eliminate these

requirements, citing many of the same reasons stated in their comments

on the definition of a Type IV security. For the same reasons discussed

in relation to Type IV securities previously, the OCC agrees with the

commenters. Thus, the final rule does not include the proposed

``homogeneity'' and 5 percent collateral concentration limits but does

retain the requirement that the securities be composed of a pool of

loans to ``numerous'' obligors.

In addition, in order to ensure safe and sound investment in these

securities, the final rule requires a Type V security to be

``marketable'' as defined in Sec. 1.2(f). The marketability requirement

is in addition to the investment grade requirement for a Type V

security and further ensures that national banks do not acquire asset-

backed securities that have speculative characteristics.

Limitations on Dealing in, Underwriting, and Purchasing and Selling

Securities (Sec. 1.3)

The proposal consolidated the part 1 provisions that limit dealing

in, underwriting, purchasing, and selling different types of

securities. The proposal limited ``the aggregate par value of the

obligations of any one obligor'' of a Type II, III, or V security that

a bank may hold to a specific percentage limit. For example, the

proposal restricted the aggregate par value of the obligations of any

one Type II obligor held by the bank to no more than 10 percent of the

bank's capital and surplus. The proposal also imposed a 10 percent

limit on Type III securities and a 15 percent limit on Type V

securities.

The OCC requested specific comment on whether using the aggregate

par value of obligations of any one obligor is an appropriate measure

of value.

Four commenters recommended that the OCC replace ``par value'' with

``market value,'' asserting that par value does not account for

obligations acquired either at a discount or premium.

The OCC has determined, however, that par value is the practical

and objective gauge by which to measure value in this context, and the

final rule therefore uses par value.

Some commenters also recommended that the OCC permit banks to use a

netting approach in calculating limitations by which a bank could

reduce its ownership exposure (long position) in a security by taking a

short position in that same security. The commenters suggested that the

OCC authorize banks to net their long and short positions in a security

because the investment limitations in part 1 apply not only to amounts

held by a bank but also to obligations that a bank is ``legally

committed to purchase and sell.'' These commenters assert that banks

should be able to exclude from their investment limit calculations any

securities for which there is both a commitment by a bank to sell and

by a third party to buy.

The OCC agrees that a netting of long and short position in a

particular security may be appropriate for purposes of calculations

under part 1, and the language of the final rule, noted above, will

accommodate this approach. However, the OCC's responses on this issue

are likely to be more detailed than is appropriate for a regulation,

and will be based on the transaction at issue. Therefore, specific

issues on this point will be addressed by the OCC on a case-by-case

basis.

The final rule also makes several minor clarifying changes to

Sec. 1.3.

Type II and III Securities; Other Investment Securities Limitations

(Sec. 1.3(d))

The proposal provided that a national bank may not hold Type II and

Type III securities of any one obligor that have a combined aggregate

par value exceeding 10 percent of the bank's capital and surplus.

However, the proposal did not require aggregation with respect to

industrial development bonds. Instead, the proposal applied the 10

percent limitation separately to each security issue of a single

obligor when the proceeds of that issuance are to be used to acquire

and lease real estate and related facilities to economically and

legally separate industrial tenants, and the issuance is payable solely

from and secured by a first lien on the revenues to be derived from

rentals paid by the lessee under net noncancellable leases.

The OCC received no comments on this section, which is adopted as

proposed.

Type IV Securities (Sec. 1.3(e))

The proposal provided that national banks could purchase, without

limitation, securities that meet the definition of a Type IV security.

This proposal relied on the authority granted to national banks by

SMMEA and CDRI to purchase and sell certain mortgage- and small

business-related securities in unlimited amounts.

The proposal also incorporated OCC interpretations concerning the

authority of a national bank to deal in obligations that are fully

secured by Type I securities.5 These interpretations reflect the

OCC's consistent approach of looking to the underlying substance of an

instrument to determine whether a bank may deal in, underwrite,

purchase, or sell the instrument. In the case of a Type IV security

that is fully secured by Type I securities, the ultimate source of

repayment is Type I securities. The proposal did not limit the

categories of Type IV securities in which banks may deal, if the

securities are fully collateralized by Type I securities. Thus, under

the proposal, a bank's authority to deal in these securities would be

determined with reference to the standards that apply to Type I

securities. (The ability of a bank to

[[Page 63977]]

securitize and sell loans and other obligations it holds, including

loans that qualify as collateral for Type IV securities, is addressed

in Sec. 1.3(g).)

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

\5\ See Interpretive Letter No. 514 (May 5, 1990), reprinted in

[1990-1991 Transfer Binder] Fed. Banking L. Rep. (CCH) para. 83,218;

Interpretive Letter No. 362 (May 22, 1986), reprinted in [1985-1987

Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,532.

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

Congress made clear that it intended the OCC and other bank

regulatory agencies to have authority to limit or restrict bank

purchases of securities in order to ensure the safety and soundness of

insured depository institutions. See H.R. Conf. Rep. No. 652, 103rd

Cong., 2nd Sess. sec. 347, at 184 (1994). The OCC believes that it can

ensure safe and sound investments involving purchases of small

business-related securities, as defined in section 3(a)(53)(A) of the

Exchange Act, 15 U.S.C. 78c(a)(53)(A), if the OCC permits purchases in

unlimited amounts only if the small business-related securities are

rated in one of the top two rating categories by an NRSRO. In addition,

however, the final rule permits a national bank to purchase small

business-related securities that an NRSRO has rated in the top third or

fourth rating category, provided the bank may not hold small business-

related securities from a single issuer if the aggregate par value of

the security exceeds 25 percent of the bank's capital and surplus. The

OCC has imposed this 25 percent limit as a safety and soundness-based

prudential limit.

Type V Securities (Sec. 1.3(f))

The proposal limited a national bank's holding of Type V securities

from any one obligor (or certain related issuers) to 15 percent of the

bank's capital and surplus. The OCC requested specific comment on

whether a higher limit, such as 25 percent, would be sufficient to

prevent excess concentration.

Four commenters questioned whether the OCC intended the term

``obligor,'' in this context, to mean the underlying borrowers whose

notes comprise a security. The OCC did not intend that result. The 15

percent limit applied to the entity that was issuer of the security,

not to each obligor on the loans that back a particular security. The

final rule clarifies this point by substituting the word ``issuer'' for

``obligor.''

One of these commenters noted that the OCC used the terms obligor

and issuer interchangeably in other sections of the rule and

recommended that the OCC clarify the terms. To address this concern,

the text of the final rule has been revised to use the two terms in a

more precise fashion and rephrase certain sections to enhance clarity.

Many commenters recommended that the OCC raise the capital

limitation for Type V securities from 15 percent to 25 percent. These

commenters asserted that Type V securities are analogous to secured

loans and therefore should be eligible for the 25 percent limit of 12

U.S.C. 84.

The OCC has carefully considered these comments, and the final rule

replaces the proposed 15 percent limitation with a 25 percent of

capital limitation. The OCC believes the 25 percent of capital limit is

a prudential limit that provides sufficient protection against undue

risk concentrations. This limit parallels the 25 percent credit

concentration benchmark in the Comptroller's Handbook for National Bank

Examiners. The Handbook identifies credit concentrations in excess of

25 percent of a bank's capital as raising potential safety and

soundness concerns. For this purpose, the Handbook guidance aggregates

direct and indirect obligations of an obligor or issuer and also

specifically contemplates application of the 25 percent benchmark to

concentrations that may result from an acquisition of a volume of loans

from a single source, regardless of the diversity of the individual

borrowers. See Comptroller's Handbook Sec. 215. Accordingly, national

banks are urged to monitor carefully their aggregate credit exposure to

any single obligor or issuer in order to avoid imprudent concentrations

of credit.

This provision is otherwise adopted as proposed.

Securitization (Sec. 1.3(g))

The proposal added this section to incorporate the OCC's long-

standing position that a national bank may securitize and sell loan

assets that it holds. The ability of a bank to sell loans and other

obligations through the issuance and sale of certificates evidencing

interests in pools of the assets provides flexibility that can enhance

bank safety and soundness.6 The provision is adopted substantially

as proposed and reflects the OCC's long-standing treatment of national

banks' securitization activities as affirmed by case law.7

National banks engaging in securitization activities should consult OCC

Bulletin 96-52 (September 25, 1996), which provides guidelines for

national banks on their securitization activities.

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

\6\ See, e.g., Remarks by Alan Greenspan, Chairman, Board of

Governors of the Federal Reserve System before the American Bankers

Association (October 8, 1994). See also Statement by Donald G.

Coonley, Chief National Bank Examiner, OCC, Asset Securitization and

Secondary Markets: Hearings Before the Subcomm. on Policy, Research,

and Insurance of the Comm. on Banking, Finance and Urban Affairs,

102d Cong., 1st Sess. 2-4 (1991), reprinted in OCC Quarterly Journal

(December 1991); and Joint Statement by Richard Spillenkothen,

Director, Division of Banking Supervision and Regulation, Board of

Governors of the Federal Reserve System, and Donald H. Wilson,

Financial Markets Officer, Federal Reserve Bank of Chicago,

Secondary Market for Commercial Real Estate Loans: Hearings Before

the Subcomm. on Policy, Research, and Insurance of the Comm. on

Banking, Finance and Urban Affairs, 102d Cong., 2d Sess. 16-19

(1992), reprinted in 78 Fed. Res. Bull. 492 (1992).

\7\ See, e.g., Interpretive Letter No. 585 (June 8, 1992),

reprinted in [1992-1993 Transfer Binder] Fed. Banking L. Rep. (CCH)

para. 83,406 (securitized motor vehicle retail installment sales

contracts purchased from automobile dealers); Interpretive Letter

No. 540 (December 12, 1990), reprinted in [1990-1991 Transfer

Binder] Fed. Banking L. Rep. (CCH) para. 83,252 (securitized credit

card receivables originated by bank or purchased from others);

Interpretive Letter No. 514 (May 5, 1990), reprinted in [1990-1991

Transfer Binder] Fed. Banking L. Rep. (CCH) para. 83,218

(securitized mortgages); Interpretive Letter No. 416 (February 16,

1988), reprinted in [1988-1989 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 85,640 (securitized automobile loans); Interpretive

Letter No. 388 (June 16, 1987), reprinted in [1988-1989 Transfer

Binder] Fed. Banking L. Rep. (CCH) para. 85,612 (sale of mortgage-

backed pass-through certificates); No Objection Letter No. 87-9

(December 16, 1987), reprinted in [1988-1989 Transfer Binder] Fed.

Banking L. Rep. (CCH) para. 84,038 (securitization of commercial

loans originated by the bank); Interpretive Letter No. 362 (May 22,

1986), reprinted in [1985-1987 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 85,532 (sales of bonds collateralized by mortgages).

Regarding sales of participations in pools of loans, see Letter from

Billy C. Wood, Deputy Comptroller, Multinational Banking (May 29,

1981), reprinted in [1981-82 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 85,275; Letter from Paul M. Homan, Senior Deputy

Comptroller for Bank Supervision (February 1, 1980), reprinted in

[1981-82 Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,213;

Letter from John M. Miller, Deputy Chief Counsel (July 31, 1979),

reprinted in [1978-79 Transfer Binder] Fed. Banking L. Rep. (CCH)

para. 85,182; Letter from Paul M. Homan, Senior Deputy Comptroller

for Bank Supervision (April 20, 1979), reprinted in [1978-79

Transfer Binder] Fed. Banking L. Rep. (CCH) para. 85,167; Letter

from H. Joe Selby, Deputy Comptroller for Operations (October 17,

1978), reprinted in [1978-79 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 85,144; Letter from John G. Heimann, Comptroller of the

Currency (May 18, 1978), reprinted in [1978-79 Transfer Binder] Fed.

Banking L. Rep. (CCH) para. 85,116; Letter from Charles B. Hall,

Deputy Comptroller for Banking Operations (February 14, 1978),

reprinted in [1978-79 Transfer Binder] Fed. Banking L. Rep. (CCH)

para. 85,100; Letter from Robert Bloom, Acting Comptroller of the

Currency (March 30, 1977), reprinted in [1973-78 Transfer Binder]

Fed. Banking L. Rep. (CCH) para. 97,093. Regarding national bank

authority to securitize assets, see Security Pacific v. Clarke, 885

F.2d 1034 (2d Cir. 1989), cert. denied, 493 U.S. 1070 (1990).

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

Investment Company Shares (Sec. 1.3(h))

The proposal incorporated OCC interpretations concerning the

authority of a national bank to hold instruments representing indirect

interests in assets in which the bank could invest directly.8

Former part 1 did not address a national bank's investment in an

investment company. The proposal permitted a national bank to purchase

and sell for its own account shares of a

[[Page 63978]]

registered investment company, subject to two requirements: First, the

investment company's portfolio must be composed entirely of assets in

which the bank could invest directly. Second, the amount of the bank's

investment in shares of any one investment company is subject to the

most stringent investment limitations applicable to the underlying

securities and loans that compose that investment company's portfolio.

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

\8\ Banking Circular 220 (November 21, 1986); An Examiner's

Guide to Investment Products and Practices at 23 (December 1992).

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

The proposal permitted banks to purchase shares in investment

companies, including mutual funds, that are registered under section 8

of the Investment Company Act of 1940 ('40 Act), 15 U.S.C. 80a-8. See

Sec. 1.2(c) (defining ``investment company''). The OCC requested

comment on whether the OCC should permit banks to purchase shares of

limited partnerships with fewer than 100 investors, i.e., a partnership

that would not qualify as an investment company within the meaning of

section 3(c)(1) of the '40 Act, if the partnerships' portfolios consist

solely of Type I securities that the bank may purchase and sell for its

own account. The '40 Act's definition of ``investment company''

excludes issuers whose outstanding securities are beneficially owned by

100 or fewer persons and who are not making, or do not presently

propose to make, a public offering of their securities.

Several commenters recommended that the OCC permit banks to

purchase shares in entities with 100 or fewer investors, although these

entities would not be subject to '40 Act regulation. The commenters

asserted that so long as the pass-through entity allows a bank to

invest solely in investments that the bank could purchase directly for

its own account, the number of investors should not matter.

One commenter opposed expanding the proposed definition asserting

that the '40 Act establishes a regulatory framework for investment

companies that addresses the unique risks posed by pooled investment

vehicles. The commenter asserted that to allow national banks to invest

in entities not subject to the '40 Act, for their own accounts, could

leave bank capital open to substantial risk.

The OCC agrees with this commenter that the absence of a regulatory

scheme, such as the '40 Act, could pose additional risk for national

banks. Therefore, the final rule adopts the definition of ``investment

company'' as proposed in Sec. 1.2(c). Further, the final rule does not

expressly permit banks to purchase shares from entities with 100 or

fewer investors that are exempt from '40 Act registration.

However, the OCC recognizes that there may be circumstances in

which a bank's purchase of interests in a certain exempt investment

fund would be acceptable. Therefore, the final rule provides that, on a

case-by-case basis, the OCC may determine that interests in other

entities, the portfolios of which consist exclusively of investments

eligible for national banks to hold directly, also are permissible for

national banks.

The final rule also relocates the provision that limited the amount

of the bank's investment in shares of any one investment company to the

most stringent investment limitations applicable to the underlying

securities that compose that investment company's portfolio. The OCC

has determined that, for clarity, this limitation belongs in Sec. 1.4,

which governs the calculation of limits. As discussed later, the final

rule also changes this limitation.

Securities Held Based on Estimates of Obligor's Performance

(Sec. 1.3(i))

The proposal retained the flexibility contained in the former rule

that permitted a bank, notwithstanding the general definition of an

investment security in Sec. 1.2(e), to treat certain debt securities,

(such as pools of mortgage or business loans in moderate and low-

income areas or community development loans), as investment securities

when the bank concludes, on the basis of estimates that the bank

reasonably believes are reliable, that the obligor will be able to meet

its obligations under that security.

The OCC requested comment on whether it should provide further

clarification of the standards applicable to securities held based on

estimates of obligor's performance and, if so, what clarification is

needed.

The majority of the commenters on this section asserted that it

would not be helpful for the OCC to provide further clarification of

the standards applicable to securities held based on estimates of an

obligor's performance. Therefore, the OCC adopts the final rule as

proposed.

Calculation of Limits (Sec. 1.4)

The proposal added a section that consolidated the calculation of

limits requirements of part 1.

Proposed paragraphs (a) and (b) Sec. 1.4 prescribed the dates for

calculating capital and surplus and stated the OCC's authority to

require more frequent calculations. The proposal required a bank to

calculate its investment limitations as of the most recent of: (1) The

date on which the bank's Consolidated Report of Condition and Income

(call report) is properly signed and submitted; (2) the date on which

the bank's call report is required to be submitted; or (3) the date on

which there is a change in the bank's capital category for purposes of

12 U.S.C. 1831o and 12 CFR 6.3.

The OCC received no significant comments on these paragraphs. The

final rule makes the following changes to the proposal to conform to

the OCC's recently proposed changes to its lending limit regulation, 12

CFR part 32. See 61 FR 37227 (July 17, 1996). The final rule requires a

bank to determine its investment limitations as of the most recent of:

(1) The last day of the preceding calendar quarter; or (2) the date on

which there is a change in the bank's capital category for purposes of

12 U.S.C. 1831o and 12 CFR 6.3.

The final rule prescribes an effective date for a bank's investment

limit. The final rule provides that an investment limit that is

calculated as of the last day of the preceding calendar quarter becomes

effective on the earlier of the date on which the bank's call report is

submitted or the date on which the bank's call report is required to be

submitted. An investment limit calculated as of the date on which there

is a change in the bank's capital category becomes effective on that

day.

The effective date requirements are added in a new paragraph

Sec. 1.4(b). The final rule moves proposed paragraph Sec. 1.4(b), which

stated the OCC's authority to require more frequent calculations, to

Sec. 1.4(c), to accommodate the insertion of new paragraph Sec. 1.4(b)

and otherwise adopts that paragraph Sec. 1.4(c) as it was proposed.

Calculation of Type III and Type V Securities Holdings (Sec. 1.4(d))

Proposed Sec. 1.4(c) limited a national bank's holdings of Type III

investment securities of any one issuer/obligor (or certain related

issuer/obligors) to 10 percent of the bank's capital and surplus. The

proposal limited a national bank's holdings of Type V securities of any

one issuer/obligor to 15 percent of the bank's capital and surplus. In

calculating these capital limits, the proposal required a bank to

combine: (1) Obligations of issuer/obligors that are related directly

or indirectly through common control; and (2) securities of issuer/

obligors that are credit-enhanced by the same entity.

The OCC requested comment on other bases upon which a bank should

combine its holdings when calculating its investment in Type III or

Type V securities of any one issuer/obligor. Specifically, the OCC

asked whether a bank should combine obligations that

[[Page 63979]]

are predominately collateralized by loans made by the same originator

or by originators that are related directly or indirectly through

common control. In addition, commenters were asked to address whether

and under what circumstances an issuer or affiliate of the issuer would

provide a guarantee or other form of credit enhancement for Type V

securities that could be a source of credit exposure of the investing

bank to the issuer or its affiliate. Comment was also invited on

whether the 15 percent investment limitation or a lower limitation is

appropriate under these circumstances.

Five commenters stated that the OCC should not require banks to

combine obligations of issuer/obligors of Type V securities that are

related through common control. These commenters asserted that the risk

assessment for the securities is based on the creditworthiness of the

underlying borrowers whose loans collateralize the issuance, and on the

credit enhancement rather than on the creditworthiness of the Type V

issuer/obligor. They stated that, if the parent company provides no

guarantee, there is no common source of risk and that applying a

limitation on common sources of credit enhancement is sufficient to

safeguard against risk concentrations. Similarly, a few commenters also

recommended that the OCC remove the requirement to aggregate holdings

of entities under direct or indirect common control for Type III

securities. They asserted that the requirement would be unduly

burdensome for banks.

The OCC continues to believe that combining obligations of issuer/

obligors that are related through common control represents a prudent

supervisory response, given the effect of common control on

underwriting standards and servicing effectiveness, and especially in

light of other burden reducing changes the OCC has made to the final

rule. Thus, the final rule retains the requirement that banks aggregate

issuer/obligors of Type III and Type V securities, respectively, that

are under common ownership or control.

The comments demonstrate that the proposal left unclear whether it

required banks to aggregate Type III and Type V securities issued by

the same issuer/obligor. The final rule adds a new provision to clarify

that the aggregation requirement applies separately to Type III and

Type V securities. The OCC emphasizes, however, that the Comptroller's

Handbook for National Bank Examiners identifies credit concentrations

in excess of 25 percent of a bank's capital as raising potential safety

and soundness concerns. For this purpose, the Handbook guidance does

aggregate direct and indirect obligations of an issuer/obligor. Thus,

if a bank's aggregate holdings of Type III and Type V securities issued

by the same issuer/obligor exceed 25 percent of the bank's capital, the

bank, as a matter of safety and soundness, should have carefully

considered whether, and be able to demonstrate why, the characteristics

of the Type III and Type V securities it holds do not entail an undue

concentration.9

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

\9\ Similarly, a bank may acquire debt obligations of an issuer/

obligor pursuant to the bank's authority to make loans, (provided

appropriate underwriting standards are met) rather than under its

authority to hold investment securities. See OCC Interpretive Letter

No. 663, reprinted in [1994-1995 Transfer Binder] Fed. Banking L.

Rep. (CCH) para. 83,611 (June 8, 1995); OCC Interpretive Letter No.

600, reprinted in [1992-1993 Transfer Binder] Fed. Banking L. Rep.

(CCH) para. 83,427 (July 31, 1992); OCC Banking Circular 181 (Rev)

(Purchase of loans in whole or in part-participations) (August 2,

1984). In such a case, the holding would be permissible under a

separate authority of the bank, but the credit concentration

standards described in the Comptroller's Handbook would still be

applicable and could curtail the amount of the bank's holdings under

the two different sources of authority.

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

As noted in the earlier discussion of Sec. 1.3(f), the final rule

changes the Type V limitation from 15 percent to 25 percent of capital

and surplus. The final rule also changes proposed paragraph Sec. 1.3(c)

to paragraph Sec. 1.3(d) to accommodate the insertion of new paragraph

Sec. 1.3(b).

Calculation of Investment Company Holdings (Sec. 1.4(e))

In Sec. 1.4(d), the proposal required a bank to use reasonable

efforts to calculate and combine its pro rata share of a particular

security in the portfolio of each investment company with the bank's

direct holdings of securities of that issuer. In Sec. 1.3(h), the

proposal required the bank to apply the most stringent investment limit

that would apply to the underlying securities in the investment

company's portfolio.

For example, if the investment company holds a Type III security,

the proposal limited the bank's holdings of shares of that investment

company to 10 percent of the bank's capital and surplus. The proposal

would thereby have codified Banking Circular 220 (BC 220) (Nov. 21,

1986), which authorizes national banks to purchase the shares of

investment companies whose portfolios are comprised entirely of bank-

eligible securities.

One commenter asserted that application of the most restrictive

limit at the investment company level unnecessarily constrains a

national bank's ability to buy investment company shares, especially

when the company's portfolio contains only a proportionately small

amount of securities subject to an investment limit. As the commenter

noted, the treatment prescribed by the proposal would restrict the

bank's purchase of the shares of the hypothetical mutual fund described

above to 10 percent of capital and surplus even if the fund's portfolio

was not evenly divided between Type I and Type III securities but

contained 95 percent Type I and 5 percent Type III securities.

The commenter recommended that the OCC permit banks to use a

``pass-through'' analysis instead, that is, that the OCC permit banks

to disregard the investment company level for purposes of applying the

investment limits and allow banks to apply the applicable limit only to

the pro rata portion of the underlying securities. This commenter also

noted that allowing pass-through treatment is more consistent with the

requirement in proposed Sec. 1.4(d), by which banks must make

``reasonable efforts'' to aggregate their direct and indirect holdings

of a security.

The final rule consolidates the two investment limit requirements

set forth in Secs. 1.3(h) and 1.4(d) into a single investment limit

calculation provision, paragraph Sec. 1.4(e). The final rule also

modifies these provisions significantly in consideration of the comment

received.

The OCC agrees that the OCC should give banks the flexibility to

apply a pass-through analysis to determine the applicable investment

limit if the bank aggregates its pro rata holdings of a security in an

investment company with the bank's direct and other indirect holdings

of that security. Therefore, the final rule permits banks to look

through to the securities in the portfolio of an investment company and

apply the appropriate limitation to the aggregate of the bank's pro

rata interest in securities of a particular issuer that are held in an

investment company's portfolio and the bank's direct holdings of the

same securities.

The OCC recognizes that some institutions may prefer the method set

forth in proposed Sec. 1.3(h), which implemented BC 220 and required

banks to apply the most stringent applicable investment limit to the

bank's entire holdings of a particular investment company. Because

calculating pro rata holdings of securities that the bank holds through

an investment company may be burdensome for some institutions, the

final rule gives a bank the option to apply the most stringent

investment limit to the bank's entire holdings of a

[[Page 63980]]

particular investment company if the investment company is diversified.

An investment company is diversified if its holdings of the securities

of any one issuer do not exceed 5 percent of the investment company's

total portfolio.

For institutions that choose to calculate an investment limit using

the most stringent applicable limit, the final rule does not require a

bank to aggregate the investment company's holdings of a security with

the bank's direct holdings of the security. The OCC believes that the 5

percent diversification requirement applicable to diversified

investment companies provides sufficient protection against risk

concentrations when a bank elects to apply the most stringent

investment limit to the bank's investment in the investment company.

Safe and Sound Banking Practices; Credit Information Required

(Sec. 1.5)

The proposal changed the requirement that, in addition to the

specific requirements of part 1, a bank must exercise ``prudent banking

judgment'' to a requirement that a bank must adhere to ``safe and sound

banking practices,'' and identified certain risks that a bank should

consider as part of safe and sound banking. The proposal also required

each bank to obtain credit information that demonstrates the ability of

issuer/obligors to satisfy their obligations and to maintain records

that document the bank's compliance with this section.

The OCC received no comments on this section. The proposal required

banks to consider market, interest rate, liquidity, legal, and

operations and systems risks, as well as credit risk. The final rule

conforms the list of risks identified by the proposal to the risks that

are now specified in the OCC's risk-based supervision approach. The

final rule requires banks to consider interest rate, credit, liquidity,

price, foreign exchange, transaction, compliance, strategic, and

reputation risks. The final rule also makes minor stylistic changes to

this section.

Convertible Securities (Sec. 1.6)

The proposal set forth the restrictions on investment in certain

convertible securities. The proposal required a bank to write down the

carrying value of a convertible security to an amount that represents

the value of the security considered independently of the conversion

feature or attached stock purchase warrant. The proposal also

prohibited a bank from purchasing securities convertible into stock at

the option of the issuer.

The OCC received no comments on this section. However, the OCC has

determined that requiring a bank to write down the carrying value of a

security independently of the conversion feature is not consistent with

generally accepted accounting principles (GAAP). Therefore, the final

rule eliminates this requirement. While the final rule does not

specifically state that a bank must account for convertible securities

in accordance with GAAP, it is the OCC's policy that if the OCC is

silent on accounting treatment, the OCC requires banks to conform with

GAAP.

The final rule adopts as proposed the provision prohibiting

national banks from purchasing securities convertible into stock at the

option of the issuer.

Securities Held in Satisfaction of Debts Previously Contracted; Holding

Period; Disposal; Accounting Treatment; Non-Speculative Purpose

(Sec. 1.7)

The proposal added new provisions to clarify how a bank must treat

securities held in satisfaction of debts previously contracted (DPC).

These provisions embodied standards prescribed in the OCC's regulation

on other real estate owned (OREO), 12 CFR part 34, and the OCC's

related interpretation, see Interpretive Letter No. 604 (October 8,

1992). The proposal provided that a national bank holding securities in

satisfaction of DPC may do so for a period of five years from the date

that ownership of the securities was originally transferred to the

bank, plus, if permitted by the OCC, an additional five years. The

proposal also required a bank to mark-to-market securities held in

satisfaction of DPC.

The OCC received one comment on this section. The commenter

suggested that the OCC should avoid specifying an accounting treatment

in the rule. Instead, the commenter recommended that a reference be

made to the call report instructions.

The OCC agrees that it is unnecessary to specify the accounting

treatment for DPC securities in the regulation. Accordingly, the final

rule removes the reference to mark-to-market accounting and simply says

that banks should account for DPC securities consistent with GAAP. In

addition, the OCC emphasizes that extensions of the five-year holding

period for shares acquired DPC are not automatic. While the five year

holding period, plus extensions up to an additional five years, is

based on the OCC's OREO standards, the OCC expects that a bank should,

in general, be able to dispose of DPC securities more quickly than real

estate. Accordingly, the OCC will require a clearly convincing

demonstration of why any additional holding period is needed for

securities acquired DPC.

Nonconforming Investments (Sec. 1.8)

The proposal clarified that a bank does not violate an applicable

investment limitation when an investment in securities that was legal

when made becomes nonconforming as a result of certain enumerated

events, if the bank exercises reasonable efforts to bring the

investment into conformity with applicable limitations.

The OCC asked commenters to address whether: (1) the phrase

``reasonable efforts'' needs additional clarification; (2) the OCC

should require a bank to make ``reasonable efforts'' to bring into

conformity an investment where the quality of a security deteriorates

so that the security is no longer an investment security; and (3) any

other events should be added to the list of circumstances that may

cause an investment in securities to become nonconforming.

Two commenters recommended that the OCC eliminate the requirement

that a bank must make reasonable efforts to conform an asset to the

appropriate investment limit. The commenters stated that the

requirement should not apply because the factor that caused

nonconformity is beyond the bank's ability to control. One commenter

noted that the reasonable efforts language might require a bank to sell

securities at an exaggerated loss. Similarly, two commenters asked the

OCC to clarify that a bank will have a substantial period of time

before it is required to sell a non-conforming investment if the sale

would result in a loss to the bank.

The OCC does not intend ``reasonable efforts'' to mean that a bank

should sell a nonconforming investment at an exaggerated or unnecessary

loss. The OCC intends a bank to use sound banking judgment to determine

when it would be inappropriate to sell or reduce its holdings of a

nonconforming investment. In the final rule, the OCC adopts the

requirement that a bank must use reasonable efforts to bring an

investment into conformity with the understanding that ``reasonable

efforts'' should not pose significant harm to the bank if a reasonable

probability exists that a loss can be avoided in the foreseeable

future. The final rule makes minor clarifying changes to this section.

Amortization of Premiums (Former Sec. 1.10)

The proposal removed former Sec. 1.10 because the OCC believes that

GAAP appropriately governs the treatment of premiums. GAAP requires

that a bank defer recognition of a premium paid for

[[Page 63981]]

an investment security and amortize the premium over the period to

maturity of the security. In contrast, former Sec. 1.10 permitted a

bank to charge off the entire premium at the time of purchase or to

amortize the premium in any manner the bank considers appropriate as

long as the premium is extinguished entirely at or before the maturity

of the security.

The OCC received no comments on the removal of this section, which

is therefore removed in the final rule.

Interpretations

Indirect General Obligations (Sec. 1.100)

The proposal clarified and shortened former Sec. 1.120 and

renumbered it Sec. 1.100. The proposal removed former paragraphs (f)

``Tax anticipation notes,'' and (g) ``Bond anticipation notes'' as

unnecessary.

The OCC received no significant comments on this section, which is

adopted as proposed.

Eligibility of Securities for Purchase, Dealing in, and Underwriting by

National Banks; General Guidelines (Former Sec. 1.100)

The proposal removed former Sec. 1.100, which contained

introductory and explanatory comments that the OCC believes are

unnecessary in light of other proposed changes to part 1.

The OCC received no comments on the proposal's removal of this

section.

Taxing Powers of a State or a Political Subdivision (Sec. 1.110)

The proposal shortened former Sec. 1.130, removed portions that are

no longer necessary, and renumbered it Sec. 1.110. The proposal added

new text to provide standards for determining when obligations that are

expressly or implicitly dependent upon voter or legislative

authorization of appropriations are considered supported by the full

faith and credit of a State or political subdivision.

The OCC received no significant comments on this section, which is

adopted as proposed.

Prerefunded or Escrowed Bonds and Obligations Secured by Type I

Securities (Sec. 1.120)

The proposal made former Sec. 1.120(e) proposed Sec. 1.120. The OCC

proposed no substantive changes to this provision.

The OCC received no comments on this section, which is adopted as

proposed.

Type II Securities; Guidelines for Obligations Issued for University

and Housing Purposes (Sec. 1.130)

The proposal streamlined former Sec. 1.140, clarified the types of

issuers whose obligations qualify as Type II securities, and renumbered

the section Sec. 1.130.

The OCC received no comments on this section, which is adopted as

proposed.

Effective Date

The final rule takes effect on December 31, 1996. The OCC finds

good cause for prescribing this year-end effective date in that it will

enable national banks to adjust their practices to conform with the

regulation at the beginning of a calendar quarter, which also marks the

beginning of a reporting period for purposes of the Consolidated Report

of Condition and Income (Call Report). 5 U.S.C. 553(d)(3).

Derivation Table

[Only substantive modifications, additions and changes are indicated]

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

Revised provision Original provision Comments

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

Sec. 1.1............................ Secs. 1.1, 1.2.............. Modified.

Sec. 1.2(a)......................... ............................. Added.

Sec. 1.2(b)......................... Sec. 1.3(g)................. Modified.

Sec. 1.2(c)......................... --........................... Added.

Sec. 1.2(d)......................... --........................... Added.

Sec. 1.2(e)......................... Sec. 1.3(b)................. Modified.

Sec. 1.2(f)......................... Sec. 1.5(a)................. Significant change.

Sec. 1.2(g)......................... --........................... Added.

Sec. 1.2(h)......................... Sec. 1.3(f)................. ..........................................

Sec. 1.2(i)......................... Secs. 1.3(c), 1.110......... Modified.

Sec. 1.2(j)......................... Sec. 1.3(d)................. Modified.

Sec. 1.2(k)......................... Sec. 1.3(e)................. Modified.

Sec. 1.2(l)......................... --........................... Added.

Sec. 1.2(m)......................... --........................... Added.

Sec. 1.3(a)................. Removed.

Sec. 1.3(a)......................... Sec. 1.4.................... Modified.

Sec. 1.3(b)......................... Secs. 1.3(d), 1.6, 1.7(a)... Modified.

Sec. 1.3(c)......................... Secs. 1.3(e), 1.7(a)........ Modified.

Sec. 1.3(d)......................... Sec. 1.7(a), 12 CFR 7.1021.. Modified.

Sec. 1.3(e)......................... --........................... Added.

Sec. 1.3(f)......................... --........................... Added.

Sec. 1.3(g)......................... --........................... Added.

Sec. 1.3(h)......................... --........................... Added.

Sec. 1.3(i)......................... Secs. 1.5(b), 1.7(b)........ Modified.

Sec. 1.4............................ --........................... Added.

Sec. 1.5............................ Sec. 1.8.................... Significant change.

Sec. 1.6............................ Sec. 1.9.................... Modified.

Sec. 1.7(a)......................... Sec. 1.11................... ..........................................

Sec. 1.7(b)......................... --........................... Added.

Sec. 1.7(c)................. Removed.

Sec. 1.7(d)................. Added.

Sec. 1.7(c)......................... --........................... Added.

Sec. 1.8............................ --........................... Added.

Sec. 1.10................... Removed.

Sec. 1.100.................. Removed.

Sec. 1.100(a)....................... Sec. 1.120.................. ..........................................

[[Page 63982]]

Sec. 1.100(b)(1).................... Sec. 1.120(a)............... ..........................................

Sec. 1.100(b)(2).................... Sec. 1.120(b)............... ..........................................

Sec. 1.100(b)(3).................... Sec. 1.120(c)............... ..........................................

Sec. 1.100(b)(4).................... Sec. 1.120(d)............... ..........................................

Sec. 1.110.......................... Sec. 1.130.................. Modified.

Sec. 1.120(f)............... Removed.

Sec. 1.120(g)............... Removed.

Sec. 1.120.......................... Sec. 1.120(e)............... ..........................................

Sec. 1.130(a)....................... Sec. 1.140(a)............... Modified.

Sec. 1.130(b)....................... Sec. 1.140(b)............... ..........................................

Sec. 1.130(c)....................... Sec. 1.140(c)............... Modified.

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

Regulatory Flexibility Act

It is hereby certified that this regulation will not have a

significant economic impact on a substantial number of small entities.

Accordingly, a regulatory flexibility analysis is not required. This

regulation will reduce the regulatory burden on national banks,

regardless of size, by simplifying and clarifying existing regulatory

requirements.

Paperwork Reduction Act of 1995

The OCC invites comments on:

(1) Whether the collections of information contained in this notice

of final rule are necessary for the proper performance of OCC

functions, including whether the information has practical utility;

(2) The accuracy of the estimate of the burden of the information

collections;

(3) Ways to enhance the quality, utility, and clarity of the

information to be collected;

(4) Ways to minimize the burden of the information collections on

respondents, including through the use of automated collection

techniques or other forms of information technology; and

(5) Estimates of capital or startup costs and costs of operation,

maintenance, and purchase of services to provide information.

Respondents/recordkeepers are not required to respond to these

collections of information unless this displays a currently valid OMB

control number.

The collection of information requirements contained in this final

rule have been approved by the Office of Management and Budget under

OMB control number 1557-0205 in accordance with the Paperwork Reduction

Act of 1995 (44 U.S.C. 3507(d)). Comments on the collections of

information should be sent to the Office of Management and Budget,

Paperwork Reduction Project (1557-0205), Washington, DC 20503, with

copies to the Legislative and Regulatory Activities Division, Office of

the Comptroller of the Currency, 250 E Street, SW, Washington, DC

20219.

The collection of information requirements in this final rule are

found in 12 CFR 1.3 and 1.7. This information is required to enable the

OCC to make determinations as to the safety and soundness of

activities. The likely respondents/recordkeepers are national banks.

Estimated average annual burden hours per respondent/recordkeeper:

18.4 hours.

Estimated number of respondents and/or recordkeepers: 25.

Estimated total annual reporting and recordkeeping burden: 460

hours.

Start-up costs to respondents: None.

Executive Order 12866

The OCC has determined that this final rule is not a significant

regulatory action.

Unfunded Mandates Act of 1995

Section 202 of the Unfunded Mandates Reform Act of 1995 (Unfunded

Mandates Act) (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 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. Because the OCC has

determined that this final rule will not result in expenditures by

State, local, and tribal governments or by the private sector of $100

million or more in any one year, the OCC has not prepared a budgetary

impact statement or specifically addressed the regulatory alternatives

considered. Nevertheless, as discussed in the preamble, the final rule

has the effect of reducing burden and increasing the discretion of

national banks regarding their sound investment activities.

List of Subjects

12 CFR Part 1

Banks, banking, National banks, Reporting and recordkeeping

requirements, Securities.

12 CFR Part 7

Credit, Insurance, Investments, National banks, Reporting and

recordkeeping requirements, Securities, Surety bonds.

Authority and Issuance

For the reasons set out in the preamble, chapter I of title 12 of

the Code of Federal Regulations is amended as set forth below:

1. Part 1 is revised to read as follows:

PART 1--INVESTMENT SECURITIES

Sec.

1.1 Authority, purpose, and scope.

1.2 Definitions.

1.3 Limitations on dealing in, underwriting, and purchase and sale

of securities.

1.4 Calculation of limits.

1.5 Safe and sound banking practices; credit information required.

1.6 Convertible securities.

1.7 Securities held in satisfaction of debts previously contracted;

holding period; disposal; accounting treatment; non-speculative

purpose.

1.8 Nonconforming investments.

Interpretations

1.100 Indirect general obligations.

1.110 Taxing powers of a State or political subdivision.

1.120 Prerefunded or escrowed bonds and obligations secured by Type

I securities.

1.130 Type II securities; guidelines for obligations issued for

university and housing purposes.

Authority: 12 U.S.C. 1 et seq., 24 (Seventh), and 93a.

[[Page 63983]]

Sec. 1.1 Authority, purpose, and scope.

(a) Authority. This part is issued pursuant to 12 U.S.C. 1 et seq.,

12 U.S.C. 24 (Seventh), and 12 U.S.C. 93a.

(b) Purpose This part prescribes standards under which national

banks may purchase, sell, deal in, underwrite, and hold securities,

consistent with the authority contained in 12 U.S.C. 24 (Seventh) and

safe and sound banking practices.

(c) Scope. The standards set forth in this part apply to national

banks, District of Columbia banks, and federal branches of foreign

banks. Further, pursuant to 12 U.S.C. 335, State banks that are members

of the Federal Reserve System are subject to the same limitations and

conditions that apply to national banks in connection with purchasing,

selling, dealing in, and underwriting securities and stock. In addition

to activities authorized under this part, foreign branches of national

banks are authorized to conduct international activities and invest in

securities pursuant to 12 CFR part 211.

Sec. 1.2 Definitions.

(a) Capital and surplus means:

(1) A bank's Tier 1 and Tier 2 capital calculated under the OCC's

risk-based capital standards set forth in appendix A to 12 CFR part 3

(or comparable capital guidelines of the appropriate Federal banking

agency) as reported in the bank's Consolidated Report of Condition and

Income filed under 12 U.S.C. 161 (or under 12 U.S.C. 1817 in the case

of a state member bank); plus

(2) The balance of a bank's allowance for loan and lease losses not

included in the bank's Tier 2 capital, for purposes of the calculation

of risk-based capital described in paragraph (a)(1) of this section, as

reported in the bank's Consolidated Report of Condition and Income

filed under 12 U.S.C. 161 (or under 12 U.S.C. 1817 in the case of a

state member bank).

(b) General obligation of a State or political subdivision means:

(1) An obligation supported by the full faith and credit of an

obligor possessing general powers of taxation, including property

taxation; or

(2) An obligation payable from a special fund or by an obligor not

possessing general powers of taxation, when an obligor possessing

general powers of taxation, including property taxation, has

unconditionally promised to make payments into the fund or otherwise

provide funds to cover all required payments on the obligation.

(c) Investment company means an investment company, including a

mutual fund, registered under section 8 of the Investment Company Act

of 1940, 15 U.S.C. 80a-8.

(d) Investment grade means a security that is rated in one of the

four highest rating categories by:

(1) Two or more NRSROs; or

(2) One NRSRO if the security has been rated by only one NRSRO.

(e) Investment security means a marketable debt obligation that is

not predominantly speculative in nature. A security is not

predominantly speculative in nature if it is rated investment grade.

When a security is not rated, the security must be the credit

equivalent of a security rated investment grade.

(f) Marketable means that the security:

(1) Is registered under the Securities Act of 1933, 15 U.S.C. 77a

et seq.;

(2) Is a municipal revenue bond exempt from registration under the

Securities Act of 1933, 15 U.S.C. 77c(a)(2);

(3) Is offered and sold pursuant to Securities and Exchange

Commission Rule 144A, 17 CFR 230.144A, and rated investment grade or is

the credit equivalent of investment grade; or

(4) Can be sold with reasonable promptness at a price that

corresponds reasonably to its fair value.

(g) NRSRO means a nationally recognized statistical rating

organization.

(h) Political subdivision means a county, city, town, or other

municipal corporation, a public authority, and generally any publicly-

owned entity that is an instrumentality of a State or of a municipal

corporation.

(i) Type I security means:

(1) Obligations of the United States;

(2) Obligations issued, insured, or guaranteed by a department or

an agency of the United States Government, if the obligation,

insurance, or guarantee commits the full faith and credit of the United

States for the repayment of the obligation;

(3) Obligations issued by a department or agency of the United

States, or an agency or political subdivision of a State of the United

States, that represent an interest in a loan or a pool of loans made to

third parties, if the full faith and credit of the United States has

been validly pledged for the full and timely payment of interest on,

and principal of, the loans in the event of non-payment by the third

party obligor(s);

(4) General obligations of a State of the United States or any

political subdivision;

(5) Obligations authorized under 12 U.S.C. 24 (Seventh) as

permissible for a national bank to deal in, underwrite, purchase, and

sell for the bank's own account, including qualified Canadian

government obligations; and

(6) Other securities the OCC determines to be eligible as Type I

securities under 12 U.S.C. 24 (Seventh).

(j) Type II security means an investment security that represents:

(1) Obligations issued by a State, or a political subdivision or

agency of a State, for housing, university, or dormitory purposes;

(2) Obligations of international and multilateral development banks

and organizations listed in 12 U.S.C. 24 (Seventh);

(3) Other obligations listed in 12 U.S.C. 24 (Seventh) as

permissible for a bank to deal in, underwrite, purchase, and sell for

the bank's own account, subject to a limitation per obligor of 10

percent of the bank's capital and surplus; and

(4) Other securities the OCC determines to be eligible as Type II

securities under 12 U.S.C. 24 (Seventh).

(k) Type III security means an investment security that does not

qualify as a Type I, II, IV, or V security, such as corporate bonds and

municipal revenue bonds.

(l) Type IV security means:

(1) A small business-related security as defined in section

3(a)(53)(A) of the Securities Exchange Act of 1934, 15 U.S.C.

78c(a)(53)(A), that is rated investment grade or is the credit

equivalent thereof, that is fully secured by interests in a pool of

loans to numerous obligors.

(2) A commercial mortgage-related security that is offered or sold

pursuant to section 4(5) of the Securities Act of 1933, 15 U.S.C.

77d(5), that is rated investment grade or is the credit equivalent

thereof, or a commercial mortgage-related security as described in

section 3(a)(41) of the Securities Exchange Act of 1934, 15 U.S.C.

78c(a)(41), that is rated investment grade in one of the two highest

investment grade rating categories, and that represents ownership of a

promissory note or certificate of interest or participation that is

directly secured by a first lien on one or more parcels of real estate

upon which one or more commercial structures are located and that is

fully secured by interests in a pool of loans to numerous obligors.

(3) A residential mortgage-related security that is offered and

sold pursuant to section 4(5) of the Securities Act of 1933, 15 U.S.C.

77d(5), that is rated investment grade or is the credit equivalent

thereof, or a residential mortgage-related security as described in

section 3(a)(41) of the Securities Exchange Act of 1934, 15 U.S.C.

78c(a)(41)), that is rated investment

[[Page 63984]]

grade in one of the two highest investment grade rating categories, and

that does not otherwise qualify as a Type I security.

(m) Type V security means a security that is:

(1) Rated investment grade;

(2) Marketable;

(3) Not a Type IV security; and

(4) Fully secured by interests in a pool of loans to numerous

obligors and in which a national bank could invest directly.

Sec. 1.3 Limitations on dealing in, underwriting, and purchase and

sale of securities.

(a) Type I securities. A national bank may deal in, underwrite,

purchase, and sell Type I securities for its own account. The amount of

Type I securities that the bank may deal in, underwrite, purchase, and

sell is not limited to a specified percentage of the bank's capital and

surplus.

(b) Type II securities. A national bank may deal in, underwrite,

purchase, and sell Type II securities for its own account, provided the

aggregate par value of Type II securities issued by any one obligor

held by the bank does not exceed 10 percent of the bank's capital and

surplus. In applying this limitation, a national bank shall take

account of Type II securities that the bank is legally committed to

purchase or to sell in addition to the bank's existing holdings.

(c) Type III securities. A national bank may purchase and sell Type

III securities for its own account, provided the aggregate par value of

Type III securities issued by any one obligor held by the bank does not

exceed 10 percent of the bank's capital and surplus. In applying this

limitation, a national bank shall take account of Type III securities

that the bank is legally committed to purchase or to sell in addition

to the bank's existing holdings.

(d) Type II and III securities; other investment securities

limitations. A national bank may not hold Type II and III securities

issued by any one obligor with an aggregate par value exceeding 10

percent of the bank's capital and surplus. However, if the proceeds of

each issue are to be used to acquire and lease real estate and related

facilities to economically and legally separate industrial tenants, and

if each issue is payable solely from and secured by a first lien on the

revenues to be derived from rentals paid by the lessee under net

noncancellable leases, the bank may apply the 10 percent investment

limitation separately to each issue of a single obligor.

(e) Type IV securities--(1) General. A national bank may purchase

and sell Type IV securities for its own account. A national bank may

deal in Type IV securities that are fully secured by Type I securities.

Except as described in paragraph (e)(2) of this section, the amount of

the Type IV securities that a bank may purchase and sell is not limited

to a specified percentage of the bank's capital and surplus.

(2) Limitation on small business-related securities rated in the

third and fourth highest rating categories by an NRSRO. A national bank

may hold small business-related securities, as defined in section

3(a)(53)(A) of the Securities Exchange Act of 1934, 15 U.S.C.

78c(a)(53)(A), of any one issuer with an aggregate par value not

exceeding 25 percent of the bank's capital and surplus if those

securities are rated investment grade in the third or fourth highest

investment grade rating categories. In applying this limitation, a

national bank shall take account of securities that the bank is legally

committed to purchase or to sell in addition to the bank's existing

holdings. No percentage of capital and surplus limit applies to small

business related securities rated investment grade in the highest two

investment grade rating categories.

(f) Type V securities. A national bank may purchase and sell Type V

securities for its own account provided that the aggregate par value of

Type V securities issued by any one issuer held by the bank does not

exceed 25 percent of the bank's capital and surplus. In applying this

limitation, a national bank shall take account of Type V securities

that the bank is legally committed to purchase or to sell in addition

to the bank's existing holdings.

(g) Securitization. A national bank may securitize and sell assets

that it holds, as a part of its banking business. The amount of

securitized loans and obligations that a bank may sell is not limited

to a specified percentage of the bank's capital and surplus.

(h) Investment company shares--(1) General. A national bank may

purchase and sell for its own account investment company shares

provided that:

(i) The portfolio of the investment company consists exclusively of

assets that the national bank may purchase and sell for its own account

under this part; and

(ii) The bank's holdings of investment company shares do not exceed

the limitations in Sec. 1.4(e).

(2) Other issuers. The OCC may determine that a national bank may

invest in an entity that is exempt from registration as an investment

company under section 3(c)(1) of the Investment Company Act of 1940,

provided that the portfolio of the entity consists exclusively of

assets that a national bank may purchase and sell for its own account

under this part.

(i) Securities held based on estimates of obligor's performance.

(1) Notwithstanding Secs. 1.2(d) and (e), a national bank may treat a

debt security as an investment security for purposes of this part if

the bank concludes, on the basis of estimates that the bank reasonably

believes are reliable, that the obligor will be able to satisfy its

obligations under that security, and the bank believes that the

security may be sold with reasonable promptness at a price that

corresponds reasonably to its fair value.

(2) The aggregate par value of securities treated as investment

securities under paragraph (i)(1) of this section may not exceed 5

percent of the bank's capital and surplus.

Sec. 1.4 Calculation of limits.

(a) Calculation date. For purposes of determining compliance with

12 U.S.C. 24 (Seventh) and this part, a bank shall determine its

investment limitations as of the most recent of the following dates:

(1) The last day of the preceding calendar quarter; or

(2) The date on which there is a change in the bank's capital

category for purposes of 12 U.S.C. 1831o and 12 CFR 6.3.

(b) Effective date. (1) A bank's investment limit calculated in

accordance with paragraph (a)(1) of this section will be effective on

the earlier of the following dates:

(i) The date on which the bank's Consolidated Report of Condition

and Income (Call Report) is submitted; or

(ii) The date on which the bank's Consolidated Report of Condition

and Income is required to be submitted.

(2) A bank's investment limit calculated in accordance with

paragraph (a)(2) of this section will be effective on the date that the

limit is to be calculated.

(c) Authority of OCC to require more frequent calculations. If the

OCC determines for safety and soundness reasons that a bank should

calculate its investment limits more frequently than required by

paragraph (a) of this section, the OCC may provide written notice to

the bank directing the bank to calculate its investment limitations at

a more frequent interval. The bank shall thereafter calculate its

investment limits at that interval until further notice.

(d) Calculation of Type III and Type V securities holdings--(1)

General. In calculating the amount of its investment in Type III or

Type V securities issued

[[Page 63985]]

by any one obligor, a bank shall aggregate:

(i) Obligations issued by obligors that are related directly or

indirectly through common control; and

(ii) Securities that are credit enhanced by the same entity.

(2) Aggregation by type. The aggregation requirement in paragraph

(d)(1) of this section applies separately to the Type III and Type V

securities held by a bank.

(e) Limit on investment company holdings--(1) General. In

calculating the amount of its investment in investment company shares

under this part, a bank shall use reasonable efforts to calculate and

combine its pro rata share of a particular security in the portfolio of

each investment company with the bank's direct holdings of that

security. The bank's direct holdings of the particular security and the

bank's pro rata interest in the same security in the investment

company's portfolio may not, in the aggregate, exceed the investment

limitation that would apply to that security.

(2) Alternate limit for diversified investment companies. A

national bank may elect not to combine its pro rata interest in a

particular security in an investment company with the bank's direct

holdings of that security if:

(i) The investment company's holdings of the securities of any one

issuer do not exceed 5 percent of its total portfolio; and

(ii) The bank's total holdings of the investment company's shares

do not exceed the most stringent investment limitation that would apply

to any of the securities in the company's portfolio if those securities

were purchased directly by the bank.

Sec. 1.5 Safe and sound banking practices; credit information

required.

(a) A national bank shall adhere to safe and sound banking

practices and the specific requirements of this part in conducting the

activities described in Sec. 1.3. The bank shall consider, as

appropriate, the interest rate, credit, liquidity, price, foreign

exchange, transaction, compliance, strategic, and reputation risks

presented by a proposed activity, and the particular activities

undertaken by the bank must be appropriate for that bank.

(b) In conducting these activities, the bank shall determine that

there is adequate evidence that an obligor possesses resources

sufficient to provide for all required payments on its obligations, or,

in the case of securities deemed to be investment securities on the

basis of reliable estimates of an obligor's performance, that the bank

reasonably believes that the obligor will be able to satisfy the

obligation.

(c) Each bank shall maintain records available for examination

purposes adequate to demonstrate that it meets the requirements of this

part. The bank may store the information in any manner that can be

readily retrieved and reproduced in a readable form.

Sec. 1.6 Convertible securities.

A national bank may not purchase securities convertible into stock

at the option of the issuer.

Sec. 1.7 Securities held in satisfaction of debts previously

contracted; holding period; disposal; accounting treatment; non-

speculative purpose.

(a) Securities held in satisfaction of debts previously contracted.

The restrictions and limitations of this part, other than those set

forth in paragraphs (b),(c), and (d) of this section, do not apply to

securities acquired:

(1) Through foreclosure on collateral;

(2) In good faith by way of compromise of a doubtful claim; or

(3) To avoid loss in connection with a debt previously contracted.

(b) Holding period. A national bank holding securities pursuant to

paragraph (a) of this section may do so for a period not to exceed five

years from the date that ownership of the securities was originally

transferred to the bank. The OCC may extend the holding period for up

to an additional five years if a bank provides a clearly convincing

demonstration as to why an additional holding period is needed.

(c) Accounting treatment. A bank shall account for securities held

pursuant to paragraph (a) of this section in accordance with Generally

Accepted Accounting Principles.

(d) Non-speculative purpose. A bank may not hold securities

pursuant to paragraph (a) of this section for speculative purposes.

Sec. 1.8 Nonconforming investments.

(a) A national bank's investment in securities that no longer

conform to this part but conformed when made will not be deemed in

violation but instead will be treated as nonconforming if the reason

why the investment no longer conforms to this part is because:

(1) The bank's capital declines;

(2) Issuers, obligors, or credit-enhancers merge;

(3) Issuers become related directly or indirectly through common

control;

(4) The investment securities rules change;

(5) The security no longer qualifies as an investment security; or

(6) Other events identified by the OCC occur.

(b) A bank shall exercise reasonable efforts to bring an investment

that is nonconforming as a result of events described in paragraph (a)

of this section into conformity with this part unless to do so would be

inconsistent with safe and sound banking practices.

Interpretations

Sec. 1.100 Indirect general obligations.

(a) Obligation issued by an obligor not possessing general powers

of taxation. Pursuant to Sec. 1.2(b), an obligation issued by an

obligor not possessing general powers of taxation qualifies as a

general obligation of a State or political subdivision for the purposes

of 12 U.S.C. 24 (Seventh), if a party possessing general powers of

taxation unconditionally promises to make sufficient funds available

for all required payments in connection with the obligation.

(b) Indirect commitment of full faith and credit. The indirect

commitment of the full faith and credit of a State or political

subdivision (that possesses general powers of taxation) in support of

an obligation may be demonstrated by any of the following methods,

alone or in combination, when the State or political subdivision

pledges its full faith and credit in support of the obligation.

(1) Lease/rental agreement. The lease agreement must be valid and

binding on the State or the political subdivision, and the State or

political subdivision must unconditionally promise to pay rentals that,

together with any other available funds, are sufficient for the timely

payment of interest on, and principal of, the obligation. These lease/

rental agreement may, for instance, provide support for obligations

financing the acquisition or operation of public projects in the areas

of education, medical care, transportation, recreation, public

buildings, and facilities.

(2) Service/purchase agreement. The agreement must be valid and

binding on the State or the political subdivision, and the State or

political subdivision must unconditionally promise in the agreement to

make payments for services or resources provided through or by the

issuer of the obligation. These payments, together with any other

available funds, must be sufficient for the timely payment of interest

on, and principal of, the obligation. An agreement to purchase

municipal sewer, water, waste disposal, or electric services may, for

instance, provide support for obligations financing the construction or

acquisition of facilities supplying those services.

[[Page 63986]]

(3) Refillable debt service reserve fund. The reserve fund must at

least equal the amount necessary to meet the annual payment of interest

on, and principal of, the obligation as required by applicable law. The

maintenance of a refillable reserve fund may be provided, for instance,

by statutory direction for an appropriation, or by statutory automatic

apportionment and payment from the State funds of amounts necessary to

restore the fund to the required level.

(4) Other grants or support. A statutory provision or agreement

must unconditionally commit the State or the political subdivision to

provide funds which, together with other available funds, are

sufficient for the timely payment of interest on, and principal of, the

obligation. Those funds may, for instance, be supplied in the form of

annual grants or may be advanced whenever the other available revenues

are not sufficient for the payment of principal and interest.

Sec. 1.110 Taxing powers of a State or political subdivision.

(a) An obligation is considered supported by the full faith and

credit of a State or political subdivision possessing general powers of

taxation when the promise or other commitment of the State or the

political subdivision will produce funds, which (together with any

other funds available for the purpose) will be sufficient to provide

for all required payments on the obligation. In order to evaluate

whether a commitment of a State or political subdivision is likely to

generate sufficient funds, a bank shall consider the impact of any

possible limitations regarding the State's or political subdivision's

taxing powers, as well as the availability of funds in view of the

projected revenues and expenditures. Quantitative restrictions on the

general powers of taxation of the State or political subdivision do not

necessarily mean that an obligation is not supported by the full faith

and credit of the State or political subdivision. In such case, the

bank shall determine the eligibility of obligations by reviewing, on a

case-by-case basis, whether tax revenues available under the limited

taxing powers are sufficient for the full and timely payment of

interest on, and principal of, the obligation. The bank shall use

current and reasonable financial projections in calculating the

availability of the revenues. An obligation expressly or implicitly

dependent upon voter or legislative authorization of appropriations may

be considered supported by the full faith and credit of a State or

political subdivision if the bank determines, on the basis of past

actions by the voters or legislative body in similar situations

involving similar types of projects, that it is reasonably probable

that the obligor will obtain all necessary appropriations.

(b) An obligation supported exclusively by excise taxes or license

fees is not a general obligation for the purposes of 12 U.S.C. 24

(Seventh). Nevertheless, an obligation that is primarily payable from a

fund consisting of excise taxes or other pledged revenues qualifies as

a ``general obligation,'' if, in the event of a deficiency of those

revenues, the obligation is also supported by the general revenues of a

State or a political subdivision possessing general powers of taxation.

Sec. 1.120 Prerefunded or escrowed bonds and obligations secured by

Type I securities.

(a) An obligation qualifies as a Type I security if it is secured

by an escrow fund consisting of obligations of the United States or

general obligations of a State or a political subdivision, and the

escrowed obligations produce interest earnings sufficient for the full

and timely payment of interest on, and principal of, the obligation.

(b) If the interest earnings from the escrowed Type I securities

alone are not sufficient to guarantee the full repayment of an

obligation, a promise of a State or a political subdivision possessing

general powers of taxation to maintain a reserve fund for the timely

payment of interest on, and principal of, the obligation may further

support a guarantee of the full repayment of an obligation.

(c) An obligation issued to refund an indirect general obligation

may be supported in a number of ways that, in combination, are

sufficient at all times to support the obligation with the full faith

and credit of the United States or a State or a political subdivision

possessing general powers of taxation. During the period following its

issuance, the proceeds of the refunding obligation may be invested in

U.S. obligations or municipal general obligations that will produce

sufficient interest income for payment of principal and interest. Upon

the retirement of the outstanding indirect general obligation bonds,

the same indirect commitment, such as a lease agreement or a reserve

fund, that supported the prior issue, may support the refunding

obligation.

Sec. 1.130 Type II securities; guidelines for obligations issued for

university and housing purposes.

(a) Investment quality. An obligation issued for housing,

university, or dormitory purposes is a Type II security only if it:

(1) Qualifies as an investment security, as defined in Sec. 1.2(e);

and

(2) Is issued for the appropriate purpose and by a qualifying

issuer.

(b) Obligation issued for university purposes. (1) An obligation

issued by a State or political subdivision or agency of a State or

political subdivision for the purpose of financing the construction or

improvement of facilities at or used by a university or a degree-

granting college-level institution, or financing loans for studies at

such institutions, qualifies as a Type II security. Facilities financed

in this manner may include student buildings, classrooms, university

utility buildings, cafeterias, stadiums, and university parking lots.

(2) An obligation that finances the construction or improvement of

facilities used by a hospital may be eligible as a Type II security, if

the hospital is a department or a division of a university, or

otherwise provides a nexus with university purposes, such as an

affiliation agreement between the university and the hospital, faculty

positions of the hospital staff, and training of medical students,

interns, residents, and nurses (e.g., a ``teaching hospital'').

(c) Obligation issued for housing purposes. An obligation issued

for housing purposes may qualify as a Type II security if the security

otherwise meets the criteria for a Type II security.

PART 7--INTERPRETIVE RULINGS

2. The authority citation for part 7 continues to read as follows:

Authority: 12 U.S.C. 1 et seq. and 93a.

Sec. 7.1021 [Removed]

3. Section 7.1021 is removed.

Dated: November 22, 1996.

Eugene A. Ludwig,

Comptroller of the Currency.

[FR Doc. 96-30779 Filed 11-29-96; 8:45 am]

BILLING CODE 4810-33-P