CAPITAL TREATMENT OF RESIDUAL INTERESTS IN ASSET SECURITIZATIONS
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FDIC Financial Institution Letters › CAPITAL TREATMENT OF RESIDUAL INTERESTS IN ASSET SECURITIZATIONS
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This section of the FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of these notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.
Proposed Rules
Federal Register
57993
Vol. 65, No. 188
Wednesday, September 27, 2000
DEPARTMENT OF THE TREASURY
Office of the Comptroller of the
Currency
12 CFR Part 3
[Docket No. 00–17]
RIN 1557–AB14
FEDERAL RESERVE SYSTEM
12 CFR Parts 208 and 225
[Regulations H and Y; Docket No. R–1080]
FEDERAL DEPOSIT INSURANCE
CORPORATION
12 CFR Part 325
RIN 3064–AC34
DEPARTMENT OF THE TREASURY
Office of Thrift Supervision
12 CFR Part 565 and 567
[Docket No. 2000–70]
RIN 1550–AB11
Capital; Leverage and Risk-Based
Capital Guidelines; Capital Adequacy
Guidelines; Capital Maintenance:
Residual Interests in Asset
Securitizations or Other Transfers of
Financial Assets
AGENCIES: Office of the Comptroller of
the Currency (OCC), Treasury; Board of
Governors of the Federal Reserve
System (Board); Federal Deposit
Insurance Corporation (FDIC); and
Office of Thrift Supervision (OTS),
Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: The Office of the Comptroller
of the Currency (OCC), the Board of
Governors of the Federal Reserve
System (Board), the Federal Deposit
Insurance Corporation (FDIC), and the
Office of Thrift Supervision (OTS)
(collectively, the Agencies) propose to
amend their capital adequacy standards
for banks, bank holding companies and
thrifts (collectively, banking
organizations) concerning the treatment
of certain residual interests in asset
securitizations or other transfers of
financial assets
l Reserve
System (Board), the Federal Deposit
Insurance Corporation (FDIC), and the
Office of Thrift Supervision (OTS)
(collectively, the Agencies) propose to
amend their capital adequacy standards
for banks, bank holding companies and
thrifts (collectively, banking
organizations) concerning the treatment
of certain residual interests in asset
securitizations or other transfers of
financial assets. Residual interests are
defined as those on-balance sheet assets
that represent interests (including
beneficial interests) in the transferred
financial assets retained by a seller (or
transferor) after a securitization or other
transfer of financial assets; and are
structured to absorb more than a pro
rata share of credit loss related to the
transferred assets through subordination
provisions or other credit enhancement
techniques (credit enhancement).
Examples of residual interests include,
but are not limited to, interest only
strips receivable (I/O strips), spread
accounts, cash collateral accounts,
retained subordinated interests, and
other similar forms of on-balance sheet
assets that function as a credit
enhancement. Residual interests as
defined in the proposed rule do not
include interests purchased from a third
party.
Generally, these residual interests are
non-investment grade or unrated assets
retained by the issuing institution in
order to provide ‘‘first-loss’’ credit
support for the senior positions in a
securitization or other financial asset
transfer. They generally lack an active
market through which a readily
available market price can be obtained.
In addition, many of these residual
interests are exposed, on a leveraged
basis, to a significant level of credit and
interest rate risk that make their
valuation extremely sensitive to changes
in the underlying credit and
prepayment assumptions. As a result,
such residual interests present valuation
and liquidity concerns
tive
market through which a readily
available market price can be obtained.
In addition, many of these residual
interests are exposed, on a leveraged
basis, to a significant level of credit and
interest rate risk that make their
valuation extremely sensitive to changes
in the underlying credit and
prepayment assumptions. As a result,
such residual interests present valuation
and liquidity concerns. High
concentrations of such illiquid and
volatile assets in relation to capital can
threaten the safety and soundness of
banking organizations.
This proposed rule is intended to
better align regulatory capital
requirements with the risk exposure of
these types of residual interests,
encourage conservative valuation
methods, and restrict excessive
concentrations in these assets. The
proposed rule would require that risk-
based capital be held in an amount
equal to the amount of the residual
interest that is retained on the balance
sheet by a banking organization in a
securitization or other transfer of
financial assets, even if the capital
charge exceeds the full risk-based
capital charge typically held against the
transferred assets. The proposed rule
also would restrict excessive
concentrations in residual interests by
limiting the amount that may be
included in Tier 1 capital for both
leverage and risk-based capital
purposes. When aggregated with
nonmortgage servicing assets and
purchased credit card relationships
(PCCRs), the balance sheet amount of
residual interests would be limited to 25
percent of Tier 1 capital, with any
amount in excess of this limitation
deducted in determining the amount of
a banking organization’s Tier 1 capital.
DATES: Comments must be received by
December 26, 2000.
ADDRESSES: Comments should be
directed to:
OCC: Comments may be submitted to
Docket No. 00–17, Communications
Division, Third Floor, Office of the
Comptroller of the Currency, 250 E
Street, SW., Washington, DC 20219.
Comments will be available for
inspection and photocopying at that
address
he amount of
a banking organization’s Tier 1 capital.
DATES: Comments must be received by
December 26, 2000.
ADDRESSES: Comments should be
directed to:
OCC: Comments may be submitted to
Docket No. 00–17, Communications
Division, Third Floor, Office of the
Comptroller of the Currency, 250 E
Street, SW., Washington, DC 20219.
Comments will be available for
inspection and photocopying at that
address. In addition, comments may be
sent by facsimile transmission to FAX
number (202/874–5274), or by
electronic mail to
regs.comment@occ.treas.gov.
Board: Comments directed to the
Board should refer to Docket No. R–
1080 and may be mailed to Ms. Jennifer
J. Johnson, Secretary, Board of
Governors of the Federal Reserve
System, 20th Street and Constitution
Avenue, NW., Washington DC 20551 or
mailed electronically to
regs.comments@federalreserve.gov.
Comments addressed to the attention of
Ms. Johnson may also be delivered to
Room B–2222 of the Eccles Building
between 8:45 a.m. and 5:15 p.m.
weekdays, or the security control room
in the Eccles Building courtyard on 20th
Street, N.W. (between Constitution
Avenue and C Street) at any time.
Comments may be inspected in Room
MP–500 of the Martin Building between
9 a.m. and 5 p.m. weekdays, except as
provided in 12 CFR 261.8 of the Board’s
Rules Regarding Availability of
Information.
FDIC: Send written comments to
Robert E. Feldman, Executive Secretary,
Attention: Comments/OES, Federal
Deposit Insurance Corporation, 550 17th
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etween
9 a.m. and 5 p.m. weekdays, except as
provided in 12 CFR 261.8 of the Board’s
Rules Regarding Availability of
Information.
FDIC: Send written comments to
Robert E. Feldman, Executive Secretary,
Attention: Comments/OES, Federal
Deposit Insurance Corporation, 550 17th
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57994
Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
1 See OCC Bulletin 99–46 (December 14, 1999)
(OCC); FDIC FIL 109–99 (December 13, 1999)
(FCIC); SR 99–37(SUP) (December 13, 1999) (FRB);
and CEO LTR 99–119 (December 14, 1999) (OTS).
See this guidance for a more detailed discussion of
the risk management processes applicable to
securitization activities.
Street, NW., Washington, DC 20429.
Comments may be hand-delivered to the
guard station at the rear of the 550 17th
Street Building (located on F Street), on
business days between 7 a.m. and 5 p.m.
Send facsimile transmissions to FAX
number (202/898–3838); Internet
address: comments@fdic.gov.)
Comments may be inspected and
photocopied in the FDIC Public
Information Center, Room 100, 801 17th
Street, NW., Washington, DC 20429,
between 9 a.m. and 4:30 p.m. on
business days.
OTS: Send comments to Manager,
Dissemination Branch, Information
Management and Services Division,
Office of Thrift Supervision, 1700 G
Street, NW, Washington, DC 20552,
Attention Docket No. 2000–70. Hand
deliver comments to the Guard’s Desk,
East Lobby Entrance, 1700 G Street,
NW., from 9 a.m. to 4 p.m. on business
days. Send facsimile transmissions to
FAX Number (202) 906–7755; or (202)
906–6956 (if comments are over 25
pages). Send e-mails to
public.info@ots.treas.gov, and include
your name and telephone number.
Interested persons may inspect
comments at the Public Reference
Room, 1700 G Street, NW., from 10 a.m.
until 4 p.m. on Tuesdays and
Thursdays
, 1700 G Street,
NW., from 9 a.m. to 4 p.m. on business
days. Send facsimile transmissions to
FAX Number (202) 906–7755; or (202)
906–6956 (if comments are over 25
pages). Send e-mails to
public.info@ots.treas.gov, and include
your name and telephone number.
Interested persons may inspect
comments at the Public Reference
Room, 1700 G Street, NW., from 10 a.m.
until 4 p.m. on Tuesdays and
Thursdays.
FOR FURTHER INFORMATION CONTACT:
OCC: Amrit Sekhon, Risk Specialist
(202/874–5211), Capital Policy; Ron
Shimabukuro, Senior Attorney, or Laura
Goldman, Senior Attorney, Legislative
and Regulatory Activities Division (202/
874–5090).
Board: Thomas R. Boemio, Senior
Supervisory Financial Analyst (202/
452–2982); Arleen Lustig, Supervisory
Financial Analyst (202/452–2987),
Division of Banking Supervision and
Regulation; and Mark E. Van Der Weide,
Counsel, (202/452–2263), Legal
Division. For the hearing impaired only,
Telecommunication Device for the Deaf
(TDD), Janice Simms (202/872–4984),
Board of Governors of the Federal
Reserve System, 20th and C Streets,
NW., Washington, DC 20551.
FDIC: William A. Stark, Assistant
Director, Division of Supervision (202/
898–6972); Stephen G. Pfeifer, Senior
Examination Specialist, Division of
Supervision (202/898–8904); Keith A.
Ligon, Chief, Policy Unit, Division of
Supervision (202/898–3618); and Marc
J. Goldstrom, Counsel, Legal Division
(202/898–8807).
OTS: Michael D. Solomon, Senior
Program Manager for Capital Policy
(202/906–5654), and Teresa A. Scott,
Counsel, Banking and Finance (202/
906–6478), Regulation and Legislation
Division, Office of the Chief Counsel,
Office of Thrift Supervision, 1700 G
Street, NW., Washington, DC 20552.
SUPPLEMENTARY INFORMATION: This
preamble consists of the following
sections:
I. Introduction
II. Nature of Supervisory Concerns
III. Current Capital Treatment for Residual
Interests
IV. Residual Interests Subject to the Proposal
V. Proposed Amendments to the Capital
Standards
VI. Request for Public Comment
VII. Plain Language
VIII
ce of Thrift Supervision, 1700 G
Street, NW., Washington, DC 20552.
SUPPLEMENTARY INFORMATION: This
preamble consists of the following
sections:
I. Introduction
II. Nature of Supervisory Concerns
III. Current Capital Treatment for Residual
Interests
IV. Residual Interests Subject to the Proposal
V. Proposed Amendments to the Capital
Standards
VI. Request for Public Comment
VII. Plain Language
VIII. Regulatory Analysis
I. Introduction
The proposed rule addresses the
supervisory concerns arising from the
illiquid and volatile nature of residual
interests that are retained by the
securitizer or other seller of financial
assets, when those residual interests are
used as a credit enhancement to support
the financial assets transferred. The
proposal also reduces the risk from
excessive concentrations in these
residual interests, including those
situations where large residual interests
are retained in connection with the sale
or securitization of low quality, higher
risk loans. As discussed in more detail
in section V, the proposed rule would
(1) require capital to be maintained in
an amount equal to the amount of the
residual interest that is retained on the
balance sheet for risk-based capital
purposes, and (2) require the amount of
any such residual interests to be
included in the 25 percent of Tier 1
capital sublimit that currently applies to
nonmortgage servicing assets and
purchased credit card relationships
(PCCRs), with any amounts in excess of
this limit deducted from Tier 1 capital
for both leverage and risk-based capital
purposes.
II. Nature of Supervisory Concerns
Securitizations and other financial
asset transfers provide an efficient
mechanism for banking organizations to
sell loan assets or credit exposures. The
benefits of these transactions must be
balanced against the significant risks
that such activities can pose to banking
organizations and to the deposit
insurance funds
h leverage and risk-based capital
purposes.
II. Nature of Supervisory Concerns
Securitizations and other financial
asset transfers provide an efficient
mechanism for banking organizations to
sell loan assets or credit exposures. The
benefits of these transactions must be
balanced against the significant risks
that such activities can pose to banking
organizations and to the deposit
insurance funds. Recent examinations
have disclosed significant weaknesses
in the risk management processes
related to securitization activities at
certain institutions. The most frequently
encountered problems stem from: (1)
The failure to recognize recourse
obligations that frequently accompany
securitizations and to hold sufficient
capital against such obligations; (2) the
excessive or inadequately supported
valuation of residual interests; (3) the
liquidity risk associated with over
reliance on asset securitization as a
funding source; and (4) the absence of
adequate independent risk management
and audit functions.
The Agencies addressed these
concerns in the Interagency Guidance
on Asset Securitization (Securitization
Guidance) issued in December 1999.1
The Securitization Guidance
highlighted some of the risks associated
with asset securitization and
emphasized the Agencies’ concerns
with certain residual interests generated
from the securitization and sale of
assets.
The Securitization Guidance
addressed the fundamental risk
management practices that should be in
place at institutions that engage in
securitization activities and stressed the
need for bank management to
implement policies and procedures that
include limits on the amount of residual
interests that may be carried as a
percentage of capital. In particular, the
Securitization Guidance set forth the
supervisory expectation that the value
of a residual interest in a securitization
must be supported by objectively
verifiable documentation of the asset’s
fair market value utilizing reasonable,
conservative valuation assumptions
rocedures that
include limits on the amount of residual
interests that may be carried as a
percentage of capital. In particular, the
Securitization Guidance set forth the
supervisory expectation that the value
of a residual interest in a securitization
must be supported by objectively
verifiable documentation of the asset’s
fair market value utilizing reasonable,
conservative valuation assumptions.
Under this guidance, residual interests
that do not meet this expectation, or that
fail to meet the supervisory standards
set forth in the Securitization Guidance,
should be classified as ‘‘loss’’ and
disallowed as assets of the banking
organization for regulatory capital
purposes.
Moreover, the Agencies indicated in
this guidance that institutions found
lacking effective risk management
programs or engaging in practices that
present safety and soundness concerns
would be subject to more frequent
supervisory review, limitations on
residual interest holdings, more
stringent capital requirements, or other
supervisory response. The
Securitization Guidance further advised
the industry that given the risks
presented by securitization activities,
and the illiquidity and potential
volatility of residual interests, the
Agencies were actively considering the
establishment of regulatory restrictions
that would limit or eliminate the
amount of certain residual interests that
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risks
presented by securitization activities,
and the illiquidity and potential
volatility of residual interests, the
Agencies were actively considering the
establishment of regulatory restrictions
that would limit or eliminate the
amount of certain residual interests that
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
2 FAS 125 establishes certain transfer of control,
accounting, and valuation criteria surrounding the
transfer of financial assets as a benchmark for
determining whether a transfer is recorded as a
‘‘sale’’ and, if so, at what value it is recorded. Under
FAS 125, the transferring financial institution
generally will immediately recognize gains from the
sale of the transferred assets and record retained
interests in a manner that captures all of the
financial components of, including the residual
interests that arise in connection with, the
securitization or other asset transfer.
3 The fair value reflects the expected future cash
flows discounted in an appropriate market interest
rate, and is calculated using assumptions regarding
estimated credit loss rates and prepayment speeds.
4 When the securitization or other transfer of
financial assets is treated as a financing, under
GAAP and for regulatory capital purposes, rather
than a sale, the assets continue to be reflected on
the balance sheet of the transferring institution. In
these circumstances, the assets continue to be
subject to the minimum capital requirement
(generally 8 percent). The level of supervisory
concern is diminished in these circumstances
because there is no residual interest created to pose
valuation or liquidity concerns. Importantly, a
financing transaction does not generate earnings
leading to the creation of capital
he transferring institution. In
these circumstances, the assets continue to be
subject to the minimum capital requirement
(generally 8 percent). The level of supervisory
concern is diminished in these circumstances
because there is no residual interest created to pose
valuation or liquidity concerns. Importantly, a
financing transaction does not generate earnings
leading to the creation of capital. For this reason,
the proposal only changes the regulatory capital
requirements for banking organizations when they
securitize or otherwise transfer financial assets and
treat the transactions as sales under GAAP.
5 Consolidated Reports of Condition and Income
(Call Report) instructions issued by the Federal
Financial Institutions Examination Council provide
examples of transfers of assets that involve recourse
arrangements. See the Call Report Glossary entry for
‘‘Sales of Assets for Risk-Based Capital Purposes.’’
These examples address the risk of loss retained in
connection with transfers of assets. OTS currently
defines the term ‘‘recourse’’ more broadly in its
capital rules at 12 CFR 567.1 to include the
‘‘acceptance, assumption or retention’’ of the risk of
loss. The Agencies have issued a separate proposal
that, among other things, would provide a uniform
definition of ‘‘recourse.’’ See 65 FR 12319 (March
8, 2000).
6 Under the Agencies’ current capital rules, assets
transferred with recourse in a transaction that is
reported as a sale under generally accepted
accounting principles (GAAP) are removed from the
balance sheet and are treated as off-balance sheet
exposures for risk-based capital purposes. For
transactions reported as a sale, the entire amount
of the assets sold (not just the contractual amount
of the recourse obligation) is normally converted
into an on-balance sheet credit equivalent amount
using a 100 percent conversion factor. This credit
equivalent amount is then risk weighted for risk-
based capital calculation purposes
-balance sheet
exposures for risk-based capital purposes. For
transactions reported as a sale, the entire amount
of the assets sold (not just the contractual amount
of the recourse obligation) is normally converted
into an on-balance sheet credit equivalent amount
using a 100 percent conversion factor. This credit
equivalent amount is then risk weighted for risk-
based capital calculation purposes.
7 For assets that are assigned to the 100 percent
risk-weight category, the full capital charge is 8
percent of the amount of assets transferred, and
Continued
may be recognized in determining the
adequacy of regulatory capital.
The Agencies have identified three
areas of continuing supervisory concern:
(1) Inappropriate or aggressive
valuations of residual interests;
(2) Inadequate capital in relation to
the risk exposure of the organization
retaining residual interests; and
(3) Excessive concentrations of
residual interests in relation to capital.
The Statement of Financial
Accounting Standards No. 125,
‘‘Accounting for Transfers and Servicing
of Financial Assets and Extinguishment
of Liabilities’’ (FAS 125) 2 governs the
recognition of a residual interest in a
securitization as an asset of the
sponsoring institution. Under these
generally accepted accounting
principles (GAAP), when a transfer of
assets is treated as a sale, the
securitizing or selling institution carries
any residual interests as an asset on its
books at an estimate of fair value.3
Retaining this residual interest on the
balance sheet in connection with a sale
generally has the effect of increasing the
amount of current earnings generated by
the gains from the sale.
The Agencies have become
increasingly concerned with fair value
estimates that are based on unwarranted
assumptions of expected cash flows. No
active market exists for many residual
interests. As a result, there is no
marketplace from which an arm’s length
market price can readily be obtained to
support the residual interest valuation
mount of current earnings generated by
the gains from the sale.
The Agencies have become
increasingly concerned with fair value
estimates that are based on unwarranted
assumptions of expected cash flows. No
active market exists for many residual
interests. As a result, there is no
marketplace from which an arm’s length
market price can readily be obtained to
support the residual interest valuation.
Recent examinations have highlighted
the inherent uncertainty and volatility
regarding the initial and ongoing
valuation of residual interests. A
banking organization that securitizes
assets may overvalue its residual
interests and thereby inappropriately
generate ‘‘paper profits’’ (or mask actual
losses) through incorrect cash flow
modeling, flawed loss assumptions,
inaccurate prepayment estimates, and
inappropriate discount rates. Residual
interests are exposed to a significant
level of credit and interest rate risk that
make their valuation extremely sensitive
to changes in the underlying
assumptions. Market events can affect
the discount rate or performance of
assets supporting residual interests and
can swiftly and dramatically alter their
value. Should the institution hold an
excessive concentration of such assets
in relation to capital, the safety and
soundness of the institution may be
threatened.
The Agencies believe that the current
regulatory capital requirements do not
adequately reflect the risk of unexpected
losses associated with these
transactions. The booking of a residual
interest using gain-on-sale accounting
can increase the selling institution’s
capital and thereby allow the bank to
leverage the capital created from the
securitization. This increased leverage
resulting from the current recognition of
uncertain future cash flows is a
supervisory concern. Accordingly, the
proposed rule focuses on those transfers
of financial assets treated as sales under
GAAP.4
A related concern is the adequacy of
capital held by institutions that
securitize or sell assets and retain
residual interests
the capital created from the
securitization. This increased leverage
resulting from the current recognition of
uncertain future cash flows is a
supervisory concern. Accordingly, the
proposed rule focuses on those transfers
of financial assets treated as sales under
GAAP.4
A related concern is the adequacy of
capital held by institutions that
securitize or sell assets and retain
residual interests. First, the lack of
liquidity of residual interests and the
potential volatility of residual interests
arising from their leveraged credit and
interest rate risk limits their ability to
support the institution, especially in
times of stress. Second, any weaknesses
in the valuation of the residual interest
can translate into weaknesses in the
quality of capital available to support
the institution. Liberal or
unsubstantiated assumptions can result
in material inaccuracies in financial
statements. Even when such residual
interests have been appropriately
valued, relatively small changes in the
underlying assumptions can lead to
material changes in the residual
interest’s fair value. Inaccuracies in the
initial valuation of residual interests, as
well as changes in the underlying
assumptions over time, can result in
substantial write-downs of residual
interests. If these generally illiquid and
volatile residual interests represent an
excessive concentration of the
sponsoring institution’s capital, they
can contribute to the ultimate failure of
the institution.
The concerns regarding excessive
concentration and adequacy of capital
are heightened where the residual
interests are generated from the
securitization of certain assets, such as
low-quality or high loan-to-value loans.
Recent examinations have shown that in
order to provide adequate credit
enhancement to the senior positions in
securitizations involving low quality
assets, institutions generally must retain
relatively greater credit risk exposure
dequacy of capital
are heightened where the residual
interests are generated from the
securitization of certain assets, such as
low-quality or high loan-to-value loans.
Recent examinations have shown that in
order to provide adequate credit
enhancement to the senior positions in
securitizations involving low quality
assets, institutions generally must retain
relatively greater credit risk exposure. In
such transactions, the sponsoring
institutions may retain residual interests
in amounts that exceed the risk-based
capital that would have been associated
with the loans had they not been
transferred.
Because of these continuing
supervisory concerns, the Agencies
believe it is appropriate to propose these
revisions to their respective capital
adequacy rules in order to limit the
amount of residual interests that are
retained by banking organizations and
require adequate capital for the risk
exposure created.
III. Current Capital Treatment for
Residual Interests
Assets Sold ‘‘With Recourse’’ 5
Under current risk-based capital
guidelines, banking organizations that
retain ‘‘recourse’’ on assets sold
generally are required to hold capital as
though the loans remained on the
institution’s books,6 up to the ‘‘full
capital charge’’.7 For regulatory capital
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
institutions are required to hold 8 cents of capital
for every dollar of assets transferred with recourse.
For assets that are assigned to the 50 percent risk-
weight category, the full capital charge is 4 cents
of capital for every dollar of assets transferred with
recourse
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
institutions are required to hold 8 cents of capital
for every dollar of assets transferred with recourse.
For assets that are assigned to the 50 percent risk-
weight category, the full capital charge is 4 cents
of capital for every dollar of assets transferred with
recourse.
8 The risk-based capital treatment for sales with
recourse can be found at 12 CFR 3, appendix A,
section (3)(b)(1)(iii) (OCC); 12 CFR 208, appendix A,
section III.D.1 and 12 CFR 225, appendix A, section
III.D.1 (FRB); 12 CFR 325, appendix A, section
II.D.1 (FDIC); and 12 CFR 567.6(a)(2)(i)(C) (OTS).
9 Low-level recourse treatment is mandated by
section 350 of the Riegle Community Development
and Regulatory Improvement Act, 12 U.S.C. 4808,
which generally provides that: ‘‘the amount of risk-
based capital required to be maintained * * * by
any insured depository institution with respect to
assets transferred with recourse by such institution
may not exceed the maximum amount of recourse
for which such institution is contractually liable
under the recourse agreement.’’
10 The Agencies’ low-level resourse rules appear
at: 12 CFR 3, appendix A, section 3(d) (OCC); 12
CFR 208, appendix A, section III.D.1.g and 225,
appendix A, section III.D.1.g (FRB); 12 CFR 325,
appendix A, section II.D.1 (FDIC); and 12 CFR
567.6(a)(2)(i)(C) (OTS). A brief explanation is also
contained in the instructions for regulatory
reporting in section RC–R for the Call Report or
schedule CCR for the Thrift Financial Report.
11 See 63 FR 42668 (August 10, 1998).
12 Id. at 42672.
13 Id
12
CFR 208, appendix A, section III.D.1.g and 225,
appendix A, section III.D.1.g (FRB); 12 CFR 325,
appendix A, section II.D.1 (FDIC); and 12 CFR
567.6(a)(2)(i)(C) (OTS). A brief explanation is also
contained in the instructions for regulatory
reporting in section RC–R for the Call Report or
schedule CCR for the Thrift Financial Report.
11 See 63 FR 42668 (August 10, 1998).
12 Id. at 42672.
13 Id.
purposes, recourse is generally defined
as an arrangement in which a banking
organization retains the risk of credit
loss in connection with an asset
transfer, if the risk of credit loss exceeds
a pro rata share of the institution’s claim
on the assets.8
As required by statute,9 the Agencies
have adopted rules that provide ‘‘low-
level recourse’’ treatment for those
institutions that securitize or sell assets
and retain recourse in dollar amounts
less than the full capital charge.10 Before
the issuance of the low-level recourse
rules, these institutions could have been
required to hold a greater level of capital
than their maximum contractual
exposure to loss on the transferred
assets. The low-level recourse treatment
applies to transactions accounted for as
sales under FAS 125 in which a banking
organization contractually limits its
recourse exposure to less than the full
capital charge for the assets transferred.
Under the low-level recourse rule, a
banking organization generally holds
capital on a dollar-for-dollar basis up to
the amount of the maximum contractual
exposure. In the absence of any other
recourse provisions, the on-balance
sheet amount of the residual interests
represents the maximum contractual
exposure. For example, assume that a
banking organization securitizes $100
million of credit card loans and records
a residual interest on the balance sheet
of $5 million that serves as a credit
enhancement for the assets transferred
aximum contractual
exposure. In the absence of any other
recourse provisions, the on-balance
sheet amount of the residual interests
represents the maximum contractual
exposure. For example, assume that a
banking organization securitizes $100
million of credit card loans and records
a residual interest on the balance sheet
of $5 million that serves as a credit
enhancement for the assets transferred.
Before the low-level recourse rule was
issued, the institution would be
required to hold $8 million of risk-based
capital against the $100 million in loans
sold, as though the loans had not been
sold. Under the low-level recourse rule,
the institution would be required to
hold $5 million in capital, that is,
‘‘dollar-for-dollar’’ capital up to the
institution’s maximum contractual
exposure.
Existing regulatory capital rules,
however, do not require institutions to
hold ‘‘dollar-for-dollar’’ capital against
residual interests that exceed the full
capital charge ($8 million in the above
example). Typically, institutions that
securitize and sell higher risk assets are
required to retain a large residual
interest (often greater than the full
capital charge of 8 percent on 100
percent risk-weighted assets) in order to
ensure that the more senior positions in
the securitization or other asset sale can
receive the desired investment ratings.
Write-downs of the recorded value of
the residual interest, due to unrealistic
(or changing) loss or prepayment
assumptions, can result in residual
losses that exceed the amount of capital
held against these assets, thereby
impairing the safety and soundness of
the institution.
For example, assume that a banking
organization securitizes $100 million of
subprime credit card loans and records
a residual interest on the balance sheet
of $15 million that serves as a credit
enhancement for the securitization
ent
assumptions, can result in residual
losses that exceed the amount of capital
held against these assets, thereby
impairing the safety and soundness of
the institution.
For example, assume that a banking
organization securitizes $100 million of
subprime credit card loans and records
a residual interest on the balance sheet
of $15 million that serves as a credit
enhancement for the securitization.
Under the current risk-based capital
rules, the transferred loans would be
treated as sold with recourse, and an 8
percent risk-based capital charge for
these 100 percent risk-weighted loans
would be required; that is, $8 million in
risk-based capital would be required to
be held against the $100 million of
transferred loans. In this hypothetical
example, however, the amount of
residual interests retained on the
balance sheet ($15 million) exceeds the
full equivalent risk-based capital charge
held against the assets transferred ($8
million). Accordingly, the amount of the
residual interest is not fully covered by
dollar-for-dollar risk-based capital; only
$8 million in capital is required to be
held by the institution against the $15
million residual interest exposure.
This example demonstrates that, for
residual interests that exceed the dollar
amount of the full capital charge on the
assets transferred, current capital
standards do not require dollar-for-
dollar capital protection for the full
contractual exposure to loss retained by
the selling institution. Any losses in
excess of the full capital charge (8
percent in the example above) could
negatively affect the capital adequacy of
the institution. Should the asset be
written down from $15 million to $5
million, the $8 million of required
capital would be insufficient to absorb
the full loss of $10 million.
B
protection for the full
contractual exposure to loss retained by
the selling institution. Any losses in
excess of the full capital charge (8
percent in the example above) could
negatively affect the capital adequacy of
the institution. Should the asset be
written down from $15 million to $5
million, the $8 million of required
capital would be insufficient to absorb
the full loss of $10 million.
B. Prior Consideration of Concentration
Limits on Residual Interests
In 1998, the Agencies amended their
capital rules to change the regulatory
capital treatment of servicing assets.11
This rulemaking increased from 50
percent to 100 percent the amount of
mortgage servicing assets that could be
included in Tier 1 capital. The Agencies
imposed more restrictive limits on the
amount of nonmortgage servicing assets
and PCCRs that could be included in
Tier 1 capital. These stricter limitations
were imposed due to the lack of depth
and maturity of the marketplace for
such assets, and related concerns about
their valuation, liquidity, and volatility.
At the time the Agencies issued the
final rule on servicing assets, the
Agencies declined to adopt similar
capital limits for I/O strips, a form of
residual interest, notwithstanding that
certain I/O strips possessed cash flow
characteristics similar to servicing assets
and presented similar valuation,
liquidity, and volatility concerns. At
that time, the Agencies chose not to
impose such limitations in recognition
of the ‘‘prudential effects of banking
organizations relying on their own risk
assessment and valuation tools,
particularly their interest rate risk,
market risk, and other analytical
models.’’ 12 The Agencies expressly
indicated that they would continue to
review banking organizations’ valuation
of I/O strips and the concentrations of
these assets relative to capital
ch limitations in recognition
of the ‘‘prudential effects of banking
organizations relying on their own risk
assessment and valuation tools,
particularly their interest rate risk,
market risk, and other analytical
models.’’ 12 The Agencies expressly
indicated that they would continue to
review banking organizations’ valuation
of I/O strips and the concentrations of
these assets relative to capital.
Moreover, the Agencies noted that they
‘‘may, on a case-by-case basis, require
banking organizations that the Agencies
determine have high concentrations of
these assets relative to their capital, or
are otherwise at risk from these assets,
to hold additional capital commensurate
with their risk exposures’’.13 In
addition, most of the residual interests
at that time that were used as credit
enhancements did not exceed the full
capital charge on the transferred assets
and thus were subject to ‘‘dollar-for-
dollar’’ capital requirements under the
Agencies’’ existing low-level recourse
rules. However, a trend toward the
securitization of higher risk loans has
now resulted in residual interests that
exceed the full capital charge and for
which ‘‘dollar-for-dollar’’ capital is not
required under the current risk-based
capital rules. This trend has also
resulted in certain banking
organizations engaged in such
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igher risk loans has
now resulted in residual interests that
exceed the full capital charge and for
which ‘‘dollar-for-dollar’’ capital is not
required under the current risk-based
capital rules. This trend has also
resulted in certain banking
organizations engaged in such
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
14 The proposed rule would extend to all residual
interests as defined, whether included in the
banking book or included in the trading book and
subject to the market risk rules.
15 The unrealized gains that may be recorded by
an institution with respect to residual interests that
are accounted for as available-for-sale securities are
presently not included in Tier 1 capital and would
not be subject to further deduction under this rule.
securitization transactions having large
concentrations in residual interests as a
percentage of capital.
IV. Residual Interests Subject to the
Proposal
Included in this proposal are residual
interests that are structured to absorb
more than a pro rata share of credit loss
related to the securitized or sold assets
through subordination provisions or
other credit enhancement techniques.
Such residual interests can take many
forms. Generally, these residual
interests are non-investment grade or
unrated ‘‘first-loss’’ positions that
provide credit support for the senior
positions of the securitization or other
asset sale. A key aspect of such residual
interests is that they reflect an
arrangement in which the institution
retains risk of credit loss in connection
with an asset transfer
h residual interests can take many
forms. Generally, these residual
interests are non-investment grade or
unrated ‘‘first-loss’’ positions that
provide credit support for the senior
positions of the securitization or other
asset sale. A key aspect of such residual
interests is that they reflect an
arrangement in which the institution
retains risk of credit loss in connection
with an asset transfer. In addition to
recourse provisions that may require the
selling institution to support a
securitization, residual interests can
take the form of spread accounts, over-
collateralization, subordinated
securities, cash collateral accounts, or
other similar forms of on-balance sheet
assets that function as a credit
enhancement. Servicing assets that
function as credit enhancements would
be subject to the proposed rule.
The definition of residual interests
excludes those interests that do not
serve as credit enhancements. In this
regard, highly rated, liquid, marketable
residual interests where the institution
assumes only the interest rate risk
associated with the assets transferred in
the securitization (e.g., Fannie Mae or
Freddie Mac I/O strips) do not serve as
a credit enhancement for the transferred
assets and thus do not expose the
institution to a concentrated level of
credit risk. Further, such instruments
are traded in a currently active
marketplace and thus do not present the
same degree of liquidity and valuation
concerns.
The residual interests covered by the
proposed rule are generally retained by
the securitizing institution rather than
sold because they are generally illiquid
and volatile in nature and thus present
liquidity and valuation concerns
vel of
credit risk. Further, such instruments
are traded in a currently active
marketplace and thus do not present the
same degree of liquidity and valuation
concerns.
The residual interests covered by the
proposed rule are generally retained by
the securitizing institution rather than
sold because they are generally illiquid
and volatile in nature and thus present
liquidity and valuation concerns. The
proposed rule extends only to residual
interests that have been retained by a
banking organization as a result of a
securitization or other sale transaction
and does not cover residual interests
that a banking organization has
purchased from another party.14
Purchased residual interests can
present the same degree of concentrated
credit risk associated with retained
residual interests. The exclusion of
purchased residual interests from the
proposed rule could establish a different
capital treatment for the same asset,
depending on whether the interest is
purchased from a third party or retained
in connection with the transfer of
financial assets to a third party. The
Agencies are particularly concerned
about the possible ‘‘swapping’’ of
residual interests, where there is
otherwise limited breadth and depth of
the market for these residual interests,
and both parties stand to gain from
accommodation valuations of each
asset.
However, residual interests purchased
in an arm’s length transaction may not
pose the same degree of liquidity risk as
interests that are retained. In addition,
purchased interests do not present the
same opportunity to create capital as do
interests that are originated and retained
by a securitizing institution
interests,
and both parties stand to gain from
accommodation valuations of each
asset.
However, residual interests purchased
in an arm’s length transaction may not
pose the same degree of liquidity risk as
interests that are retained. In addition,
purchased interests do not present the
same opportunity to create capital as do
interests that are originated and retained
by a securitizing institution. Further,
unlike retained residual interests where
an overvaluation of the residual interest
can lead to a higher gain on sale and the
creation of additional capital, there is a
marketplace discipline on the initial
amount at which a purchased residual
interest is recorded (that is, it is limited
to the purchase price), and there is no
incentive on the part of the purchaser to
pay a price above market because such
a purchase does not create any capital
for the purchaser.
The Agencies are considering
including such purchased interests
within the scope of the rule and are
requesting comment on this issue.
V. Proposed Amendments to the Capital
Standards
A. Proposed Treatment of Residual
Interests
The Agencies propose to amend the
regulatory risk-based capital standards
by eliminating the distinction between
the treatment of low-level recourse
obligations and the treatment of assets
securitized or sold with recourse in
those cases where the amount of the
residual interest retained on balance
sheet exceeds the full capital charge for
the assets transferred. The current rules
essentially place a ceiling on the
‘‘dollar-for-dollar’’ capital requirement
for recourse obligations. Removal of this
‘‘cap’’ will ensure that all residual
interests are subject to the same ‘‘dollar-
for-dollar’’ capital standard that is
applied to residual interests in low-level
recourse transactions and that capital is
held for the organization’s total
contractual exposure to loss
current rules
essentially place a ceiling on the
‘‘dollar-for-dollar’’ capital requirement
for recourse obligations. Removal of this
‘‘cap’’ will ensure that all residual
interests are subject to the same ‘‘dollar-
for-dollar’’ capital standard that is
applied to residual interests in low-level
recourse transactions and that capital is
held for the organization’s total
contractual exposure to loss.
In addition to modifying the risk-
based capital treatment for residual
interests, the Agencies propose limiting
the amount of residual interests that can
be recognized in determining Tier 1
capital under the Agencies’ leverage and
risk-based capital standards. The
purpose of the limit is to prevent
excessive concentrations in holdings of
residual interests. The Agencies propose
including residual interests within the
25 percent of Tier 1 capital sublimit
already placed upon nonmortgage
servicing assets and PCCRs. Under this
restriction, any amounts of residual
interests, when aggregated with
nonmortgage servicing assets and
PCCRs, that exceed of 25 percent of Tier
1 capital, would be deducted from Tier
1 capital for purposes of calculating
both the risk-based and leverage capital
ratios.15
In addition to including residual
interests in the sublimit currently
applied to PCCRs and nonmortgage
servicing assets, residual interests
would also be included in the
calculation of the overall 100 percent
limit on servicing assets. Under this
proposal, the maximum allowable
amount of mortgage servicing assets,
PCCRs, nonmortgage servicing assets,
and residual interests, in the aggregate,
would be limited to 100 percent of the
amount of Tier 1 capital that exists
before the deduction of any disallowed
mortgage servicing assets, any
disallowed PCCRs, any disallowed
nonmortgage servicing assets, any
disallowed residual interests, and any
disallowed deferred tax assets. The
residual interests, however, would not
be subject to the 90 percent of fair value
limitation that applies to servicing
assets and PCCRs
percent of the
amount of Tier 1 capital that exists
before the deduction of any disallowed
mortgage servicing assets, any
disallowed PCCRs, any disallowed
nonmortgage servicing assets, any
disallowed residual interests, and any
disallowed deferred tax assets. The
residual interests, however, would not
be subject to the 90 percent of fair value
limitation that applies to servicing
assets and PCCRs. Under the proposed
rule, residual interests would already be
subject to a ‘‘dollar-for-dollar’’ capital
requirement. Any residual interests
deducted in determining the Tier 1
capital numerator for the leverage and
risk-based capital ratios also would be
excluded from the denominators of
these ratios.
In summary, under the proposed rule,
institutions generally would be required
to hold ‘‘dollar-for-dollar’’ capital for
residual interests and additionally
would be required to deduct from Tier
1 capital the amount of any residual
interests (when aggregated with
nonmortgage servicing assets and
PCCRs) that exceed the established 25
percent sublimit. In combination, the
proposal is intended to ensure that all
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
16 The Agencies are also proposing minor
technical changes. For example, this proposal does
not effect the calculation of tangible equity the
under prompt corrective action regulations.
However, because the Agencies define tangible
equity using different core capital concepts (i.e.,
‘‘core capital’’ vs. ‘‘core capital elements’’), the OTS
is proposing a technical revision to its definition of
tangible equity (12 CFR 565.2(f)) to ensure that this
calculation is not effected by the proposal.
In addition, the FDIC is also amending its
regulations to remove an obsolete provision
concerning the transitional 7.25 percent risk-based
capital standard that was only effective until
December 31, 1992
’’ vs. ‘‘core capital elements’’), the OTS
is proposing a technical revision to its definition of
tangible equity (12 CFR 565.2(f)) to ensure that this
calculation is not effected by the proposal.
In addition, the FDIC is also amending its
regulations to remove an obsolete provision
concerning the transitional 7.25 percent risk-based
capital standard that was only effective until
December 31, 1992. This provision currently
appears in section III.B of appendix A to part 325.
Similarly, OTS is making technical revisions to
related regulatory provisions at 12 CFR 565.2(f).
17 The proposed treatment is consistent with that
permitted for low-level recourse exposures,
disallowed servicing assets, and disallowed
intangible assets in non-taxable business
combinations.
18 For example, see § 325.5(g) of the FDIC’s capital
regulations (12 CFR 325.5(g)), which sets forth the
limitations on the amount of deferred tax assets that
state nonmember banks can recognize for purposes
of calculating Tier 1 capital under the leverage and
risk-based capital rules.
19 Two additional treatments are possible. Under
the first approach, the amount of residual interests
subject to a ‘‘dollar-for-dollar’’ deduction for risk-
based capital purposes, and a concentration limit
for leverage capital purposes, would be the ‘‘at-risk’’
amount; that is, the residual interests reduced by
any associated deferred tax liability. For example,
assume residual interests of $100 with an associated
deferred tax liability of $35. Under this approach,
the amount of residual interests subject to a ‘‘dollar-
for-dollar’’ capital charge and a concentration limit
is $65 ($100¥$35). In a worst-case scenario, if the
value of the residual interests drops to zero, then
the corresponding deferred tax liability would also
drop to zero, and therefore capital would decline
by $65—the net-of-tax amount. If the 25% of Tier
1 concentration limitation is $50, then the
deduction would be $15 ($65¥$50)
to a ‘‘dollar-
for-dollar’’ capital charge and a concentration limit
is $65 ($100¥$35). In a worst-case scenario, if the
value of the residual interests drops to zero, then
the corresponding deferred tax liability would also
drop to zero, and therefore capital would decline
by $65—the net-of-tax amount. If the 25% of Tier
1 concentration limitation is $50, then the
deduction would be $15 ($65¥$50). Under the
second approach, the amount of residual interests
subject to the ‘‘dollar-for-dollar’’ capital
requirement and 25% of Tier 1 capital
concentration limit would be determined on a gross
basis, that is, without netting the associated
deferred tax liability.
20 See 65 FR 12320 (March 8, 2000) for the text
of the proposed revisions to the risk-based capital
treatment of recourse arrangements, direct credit
substitutes, and asset securitizations.
residual interests are supported by
‘‘dollar-for-dollar’’ capital and that
excessive concentrations (over 25
percent) in residual interests relative to
capital are avoided.16
B. Net-of-Tax Treatment
The Agencies propose to extend the
current net-of-tax treatment permitted in
their existing capital standards to
residual interests.17 Thus, the proposed
rule would permit: (1) Disallowed
amounts of residual interests (that is,
those amounts in excess of the 25
percent of Tier 1 capital sublimit) to be
determined on a basis that is net of any
associated deferred tax liability, and (2)
any amounts of residual interests that
are subject to the ‘‘dollar-for-dollar’’
capital requirement (that is, those
amounts included in the 25 percent of
Tier 1 capital sublimit) to be determined
on a basis that is net of any associated
deferred tax liability. In instances where
there is no difference between the book
basis and the tax basis of the residual
interest, no deferred tax liability would
be created
of residual interests that
are subject to the ‘‘dollar-for-dollar’’
capital requirement (that is, those
amounts included in the 25 percent of
Tier 1 capital sublimit) to be determined
on a basis that is net of any associated
deferred tax liability. In instances where
there is no difference between the book
basis and the tax basis of the residual
interest, no deferred tax liability would
be created. Any deferred tax liability
used to reduce the capital requirement
for a residual interest would not be
available for the organization to use in
determining the amount of net deferred
tax assets that may be included in the
calculation of Tier 1 capital.18
The following example helps
illustrate the proposed tax treatment.
Assume residual interests of $100 with
an associated deferred tax liability of
$35 and Tier 1 capital (before the
deduction of any disallowed residual
interests) of $200. In this example, the
25 percent concentration limit on
residual interests (when combined with
nonmortgage servicing assets and
PCCRs) would be $50 (i.e., 25 percent
times $200). The amount of disallowed
residual interests (before considering
the associated deferred tax liability)
would have been $50. The deferred tax
liability associated with the otherwise
disallowed residual interests of $50
would be $17.50 (a $35 associated
deferred tax liability against $100 in
residual interests drives a 35 percent tax
effect against the $50 disallowed
residual interest). Thus, the amount of
disallowed residual interests to be
deducted in determining Tier 1 capital
under the leverage and risk-based
capital standards net of the associated
deferred tax liability would be $32.50
(i.e., the $50 in disallowed residual
interests minus the $17.50 tax effect
associated with the disallowed residual
interests)
percent tax
effect against the $50 disallowed
residual interest). Thus, the amount of
disallowed residual interests to be
deducted in determining Tier 1 capital
under the leverage and risk-based
capital standards net of the associated
deferred tax liability would be $32.50
(i.e., the $50 in disallowed residual
interests minus the $17.50 tax effect
associated with the disallowed residual
interests).
In determining risk-weighted assets,
the remaining $50 amount of residual
interests allowable in Tier 1 would be
subject to a ‘‘dollar-for-dollar’’ capital
on a basis that is also net of the deferred
tax liability associated with the $50
residual interest. The deferred tax
liability associated with the $50 not
deducted from Tier 1 capital would be
$17.50 (i.e., the 35 percent tax effect as
calculated above times $50). Thus, the
amount of residual interests that would
be subjected to ‘‘dollar-for-dollar’’
treatment would be $32.50 ($50 less the
$17.50 in deferred tax liabilities).
Calculation of this ‘‘dollar-for-dollar’’
capital charge is consistent with the
‘‘dollar-for-dollar’’ capital requirements
that are currently required for low-level
recourse transactions.
Other alternative calculations are
possible and will be considered by the
Agencies.19 The Agencies seek comment
on whether the complexity of a ‘‘net-of-
tax’’ approach is necessary and justified,
and if so, what, if any, alternative
calculations should be allowed.
C. Reservation of Authority
While this proposal should help
remedy some of the major concerns
associated with the generally illiquid
and volatile nature of residual interests,
the Agencies are also proposing to add
language to the risk-based capital
standards that will provide greater
flexibility in administering the
standards. Institutions are developing
novel transactions that do not fit well
into the risk-weight categories set forth
in the standards
elp
remedy some of the major concerns
associated with the generally illiquid
and volatile nature of residual interests,
the Agencies are also proposing to add
language to the risk-based capital
standards that will provide greater
flexibility in administering the
standards. Institutions are developing
novel transactions that do not fit well
into the risk-weight categories set forth
in the standards. Institutions are also
devising novel instruments that
nominally fit into a particular risk-
weight category, but that impose risks
on the banking organization at levels
that are not commensurate with the
nominal risk-weight for the asset,
exposure, or instrument. Accordingly,
the Agencies are proposing to add
language to the standards to clarify the
Agencies’ authority, on a case-by-case
basis, to determine the appropriate risk-
weight asset amount in these
circumstances. Exercise of this authority
by the Agencies may result in a higher
or lower risk weight for an asset. This
reservation of authority explicitly
recognizes the Agencies’ retention of
sufficient discretion to ensure that
institutions, as they develop novel
financial assets, will be treated
appropriately under the risk-based
capital standards.
D. Relationship of This Residual Interest
Proposal to the March 2000
Securitization Proposal
This proposed rule regarding residual
interests (residual interest proposal) and
the March 2000 notice of proposed
rulemaking on the risk-based capital
treatment of recourse arrangements,
direct credit substitutes, and asset
securitizations (the securitization
proposal) are interrelated in that both
proposals would address the regulatory
capital treatment for residual interests
that are retained in connection with
securitizations and other transfers of
financial assets.20 The capital treatment
of residual interests under the
securitization proposal differs in certain
respects from the treatment proposed in
this residual interest proposal
securitization
proposal) are interrelated in that both
proposals would address the regulatory
capital treatment for residual interests
that are retained in connection with
securitizations and other transfers of
financial assets.20 The capital treatment
of residual interests under the
securitization proposal differs in certain
respects from the treatment proposed in
this residual interest proposal. In any
final rule that addresses the regulatory
capital treatment of residual interests,
the Agencies will ensure that any
regulatory capital treatment of residual
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interests resulting from these two
proposals will be consistent.
In the securitization proposal, the
Agencies propose using external credit
ratings to match the risk-based capital
requirement more closely to the relative
risk of loss in asset securitizations.
Highly rated investment-grade positions
in securitizations would receive a
favorable (less than 100 percent) risk-
weight. Below-investment grade or
unrated positions in securitizations
would receive a less favorable risk-
weight (greater than 100 percent risk-
weight or gross-up treatment). A
residual interest retained by an
institution in an asset securitization (as
well as residual interests that are
purchased) would be subject to this
capital framework under the
securitization proposal.
The residual interest proposal differs
from the securitization proposal in
several respects. For example, under the
residual interest proposal, all residual
interests that are retained by the
institution and that fall within the 25
percent of Tier 1 capital limit would be
subject to ‘‘dollar-for-dollar’’ capital
treatment regardless of rating (and
comment is sought on whether
purchased interests should be treated
similarly)
sal differs
from the securitization proposal in
several respects. For example, under the
residual interest proposal, all residual
interests that are retained by the
institution and that fall within the 25
percent of Tier 1 capital limit would be
subject to ‘‘dollar-for-dollar’’ capital
treatment regardless of rating (and
comment is sought on whether
purchased interests should be treated
similarly). To date, the Agencies believe
that residual interests in asset
securitizations generally are unrated
and illiquid interests; however, as the
market evolves, residual interests may
in the future take the form of rated,
liquid, certificated securities. If the
rating provided to such a residual
interest were investment grade (or no
more than one category below
investment grade) the securitization
proposal would afford that residual
interest more favorable capital treatment
than the dollar-for-dollar capital
requirement set forth in this residual
interest proposal. In addition, the risk-
based capital requirement for unrated
residual interests that are subject to
gross-up treatment under the
securitization proposal would not
exceed the full risk-based capital charge
for the underlying assets that are being
supported by the residual interest.
Under this residual interest proposal,
however, ‘‘dollar-for-dollar’’ capital
would be required for the amount of the
residual interest that is retained and
falls within the 25 percent of Tier 1
capital limit, even if this amount
exceeds the full capital charge typically
held against the underlying assets that
have been transferred with recourse.
Also, unlike the residual interest
proposal, the securitization proposal
does not establish any concentration
limit for residual interests as a
percentage of capital.
These differences between the
residual interest proposal and the
securitization proposal will be taken
into account in any final rule published
under either proposal
nst the underlying assets that
have been transferred with recourse.
Also, unlike the residual interest
proposal, the securitization proposal
does not establish any concentration
limit for residual interests as a
percentage of capital.
These differences between the
residual interest proposal and the
securitization proposal will be taken
into account in any final rule published
under either proposal. In developing a
final rule on residual interests, the
Agencies specifically invite comment on
how the capital treatment for residual
interests under this residual interest
proposal should be reconciled with the
capital treatment set forth in the
securitization proposal.
E. Effective Date
The Agencies intend to apply this
proposal to existing as well as future
transactions. Because banking
organizations may need additional time
to adapt to any new capital treatment,
the Agencies may delay the effective
date for a specific period of time
(transition period). The Agencies view
this transition period as an opportunity
for institutions to consider the
proposal’s impact on their balance sheet
structure and capital position. The
Agencies invite comment on the need
for and duration of a transition period.
VI. Request for Public Comment
The Agencies invite public comment
on all aspects of the proposed rule. In
particular, the Agencies request
comment on the definition of residual
interest, the treatment of residual
interests in determining compliance
with minimum capital requirements, the
conditions established in the proposal,
and the implementation of the proposal.
The Agencies also specifically request
comment on the ‘‘dollar-for-dollar’’ risk-
based capital charge for residual
interests, the 25 percent of Tier 1 capital
concentration limit on the amount of
residual interests that can be recognized
for leverage and risk-based capital
purposes, and the issue of whether a
‘‘net-of-associated deferred tax liability’’
approach is appropriate in determining
the capital requirements for residual
interests.
VII
n the ‘‘dollar-for-dollar’’ risk-
based capital charge for residual
interests, the 25 percent of Tier 1 capital
concentration limit on the amount of
residual interests that can be recognized
for leverage and risk-based capital
purposes, and the issue of whether a
‘‘net-of-associated deferred tax liability’’
approach is appropriate in determining
the capital requirements for residual
interests.
VII. Plain Language
Section 722 of the Gramm-Leach-
Bliley (GLB) Act (12 U.S.C. 4809)
requires federal banking agencies to use
‘‘plain language’’ in all proposed and
final rules published after January 1,
2000. We invite your comments on how
to make this proposed rule easier to
understand. For example:
(1) Have we organized the material to
suit your needs?
(2) Are the requirements in the rule
clearly stated?
(3) Does the rule contain technical
language or jargon that isn’t clear?
(4) Would a different format (grouping
and order of sections, use of headings,
paragraphing) make the rule easier to
understand?
(5) Would more (but shorter) sections
be better?
(6) What else could we do to make the
rule easier to understand?
VIII. Regulatory Analysis
A. Regulatory Flexibility Act Analysis
Board: Pursuant to section 605(b) of
the Regulatory Flexibility Act, the Board
has determined that this proposal will
not have a significant impact on a
substantial number of small business
entities within the meaning of the
Regulatory Flexibility Act (5 U.S.C. 601
et seq.). The Board’s comparison of the
applicability section of this proposal
with Call Report data on all existing
banks shows that application of the
proposal to small entities will be rare.
Accordingly, a regulatory flexibility
analysis is not required. In addition,
because the risk-based capital standards
generally do not apply to bank holding
companies with consolidated assets of
less than $150 million, this proposal
will not affect such companies’’.
FDIC: Pursuant to section 605(b) of
the Regulatory Flexibility Act (5 U.S.C
plication of the
proposal to small entities will be rare.
Accordingly, a regulatory flexibility
analysis is not required. In addition,
because the risk-based capital standards
generally do not apply to bank holding
companies with consolidated assets of
less than $150 million, this proposal
will not affect such companies’’.
FDIC: Pursuant to section 605(b) of
the Regulatory Flexibility Act (5 U.S.C.
601 et seq.) the FDIC hereby certifies
that the final rule will not have a
significant economic impact on a
substantial number of small entities.
Comparison of Call Report data on
FDIC-supervised banks to the items
covered by the proposal that result in
increased capital requirements shows
that application of the proposal to small
entities will be the infrequent exception.
OTS: Pursuant to section 605(b) of the
Regulatory Flexibility Act (5 U.S.C. 601
et seq.) the OTS certifies that the
proposed rule will not have a significant
economic impact on a substantial
number of small entities. Comparison of
TFR data on OTS supervised savings
associations regarding the items that
would result in increased capital
requirements indicate that the
application of the proposal to small
entities will be the infrequent exception.
OCC: Pursuant to section 605(b) of the
Regulatory Flexibility Act (5 U.S.C. 601
et seq.) the OCC certifies that the
proposed rule will not have a significant
economic impact on a substantial
number of small entities. Call Report
data indicate that generally small banks
do not have large residual interests that
exceed the full risk-based capital charge
required for transferred assets, and
typically do not hold residual interests
in amounts that would exceed the 25
percent of Tier 1 capital limitation. For
these reasons, the OCC believes that
application of the proposed rule to
small entities will be rare.
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capital charge
required for transferred assets, and
typically do not hold residual interests
in amounts that would exceed the 25
percent of Tier 1 capital limitation. For
these reasons, the OCC believes that
application of the proposed rule to
small entities will be rare.
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
Consequently, a regulatory flexibility
analysis is not required.
B. Paperwork Reduction Act
The Agencies have determined that
this proposal does not involve a
collection of information pursuant to
the provisions of the Paperwork
Reduction Act (44 U.S.C. 3501 et seq.).
C. OCC and OTS Executive Order 12866
Statement
The Comptroller of the Currency and
the Director of the OTS have determined
that the proposal described in this
notice is not a significant regulatory
action under Executive Order 12866.
Accordingly, a regulatory impact
analysis is not required. Nonetheless the
OCC specifically invites comment on
the dollar impact of the proposed rule.
D. OCC and OTS Unfunded Mandates
Act Statement
Section 202 of the Unfunded
Mandates Reform Act of 1995, Public
Law 104–4, (Unfunded Mandates Act),
requires that an agency prepare a
budgetary impact statement before
promulgating a rule that includes a
federal mandate that may result in the
expenditure by state, local, and tribal
governments, in the aggregate, or by the
private sector, of $100 million or more
in any one year. If a budgetary impact
statement is required, section 205 of the
Unfunded Mandates Act also requires
an agency to identify and consider a
reasonable number of regulatory
alternatives before promulgating a rule.
The OCC and OTS have determined that
this proposed rule will not result in
expenditures by state, local, and tribal
government, or by the private sector, of
more than $100 million or more in any
one year
y impact
statement is required, section 205 of the
Unfunded Mandates Act also requires
an agency to identify and consider a
reasonable number of regulatory
alternatives before promulgating a rule.
The OCC and OTS have determined that
this proposed rule will not result in
expenditures by state, local, and tribal
government, or by the private sector, of
more than $100 million or more in any
one year. Based on the Call Report, TFR
and other data, OTS and OCC estimate
that those banks and savings
associations that would be required to
increase capital under the proposed rule
will not incur additional expenses in
this amount in any one year. Therefore,
the OCC and OTS have not prepared a
budgetary impact statement or
specifically addressed the regulatory
alternatives considered. Nonetheless the
OCC specifically invites comment on
the dollar impact of the proposed rule.
E. The Treasury and General
Government Appropriations Act, 1999—
Assessment of Federal Regulations and
Policies on Families
The Agencies have determined that
this proposed rule will not affect family
well-being within the meaning of
section 654 of the Treasury and
Government Appropriations Act, 1999,
Pub. L. 105–277, 112 Stat. 2681 (1998).
List of Subjects
12 CFR Part 3
Administrative practice and
procedure, Capital, National banks,
Reporting and recordkeeping
requirements, Risk.
12 CFR Part 208
Accounting, Agriculture, Banks,
banking, Confidential business
information, Crime, Currency, Federal
Reserve System, Mortgages, Reporting
and recordkeeping requirements,
Securities.
12 CFR Part 225
Administrative practice and
procedure, Banks, banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and
procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping
requirements, Savings associations,
State non-member banks.
12 CFR Part 565
Administrative practice and
procedures, Capital, Savings
associations
practice and
procedure, Banks, banking, Federal
Reserve System, Holding companies,
Reporting and recordkeeping
requirements, Securities.
12 CFR Part 325
Administrative practice and
procedure, Banks, banking, Capital
adequacy, Reporting and recordkeeping
requirements, Savings associations,
State non-member banks.
12 CFR Part 565
Administrative practice and
procedures, Capital, Savings
associations.
12 CFR Part 567
Capital, Reporting and recordkeeping
requirements, Savings associations.
Department of the Treasury
Office of the Comptroller of the
Currency
12 CFR Chapter I
Authority and Issuance
For the reasons set out in the joint
preamble, the Office of the Comptroller
of the Currency proposes to amend part
3 of chapter I of title 12 of the Code of
Federal Regulations as follows:
PART 3—MINIMUM CAPITAL RATIOS;
ISSUANCE OF DIRECTIVES
1. The authority citation for part 3
continues to read as follows:
Authority: 12 U.S.C. 93a, 161, 1818,
1828(n), 1828 note, 1831n note, 1835, 3907,
and 3909.
§ 3.4
[Amended]
2. In § 3.4:
A. The existing text is designated as
paragraph (a);
B. The second sentence in the newly
designated paragraph (a) is revised; and
C. New paragraph (b) is added to read
as follows:
§ 3.4
Reservation of authority.
(a) * * * Similarly, the OCC may find
that a particular intangible asset need
not be deducted from Tier 1 or Tier 2
capital. * * *
(b) Notwithstanding the risk
categories in section 3 of appendix A to
this part, the OCC may find that the
assigned risk weight for any asset does
not appropriately reflect the risks
imposed on a bank and may require
another risk weight that the OCC deems
appropriate. Similarly, if no risk weight
is specifically assigned, the OCC may
assign any risk weight that the OCC
deems appropriate. In making its
determination, the OCC considers risks
associated with the asset as well as
other relevant factors.
3. In appendix A to part 3:
A. In section 1:
i
appropriately reflect the risks
imposed on a bank and may require
another risk weight that the OCC deems
appropriate. Similarly, if no risk weight
is specifically assigned, the OCC may
assign any risk weight that the OCC
deems appropriate. In making its
determination, the OCC considers risks
associated with the asset as well as
other relevant factors.
3. In appendix A to part 3:
A. In section 1:
i. Redesignate paragraphs (c)(25)
through (c)(31) as paragraphs (c)(28)
through (c)(34), paragraph (c)(24) as
paragraph (c)(26), and paragraphs (c)(13)
through (c)(23) as paragraphs (c)(14)
through (c)(24);
ii. Add new paragraphs (c)(13),
(c)(25), and (c)(27);
B. In section 2, revise paragraphs
(c)(1)(ii), (c)(2) introductory text,
(c)(2)(i), (c)(2)(ii) introductory text,
(c)(2)(iii), and (c)(2)(iv);
C. In section 3, add new paragraph (e)
to read as follows:
Appendix A To Part 3—Risk-Based
Capital Guidelines
Section 1. Purpose, Applicability of
Guidelines, and Definitions
*
*
*
*
*
(c) * * *
(13) Financial asset means cash, evidence
of an ownership interest in an entity, or a
contract that conveys to a second entity a
contractual right to receive cash or another
financial instrument from a first entity or to
exchange other financial instruments on
potentially favorable terms with the first
entity.
*
*
*
*
*
(25) Residual interest means any on-
balance sheet asset that represents an interest
(including a beneficial interest) created by
the transfer of financial assets, whether
through a securitization or otherwise, and
structured to absorb more than a pro rata
share of credit loss related to the transferred
assets through subordination provisions or
other credit enhancement techniques.
Residual interests generally include interest
only strips receivable, spread accounts, cash
collateral accounts, retained subordinated
interests and other similar forms of on-
balance sheet assets that function as a credit
enhancement. Residual interests do not
include residual interests purchased from a
third party
ed
assets through subordination provisions or
other credit enhancement techniques.
Residual interests generally include interest
only strips receivable, spread accounts, cash
collateral accounts, retained subordinated
interests and other similar forms of on-
balance sheet assets that function as a credit
enhancement. Residual interests do not
include residual interests purchased from a
third party.
*
*
*
*
*
(27) Securitization. Securitization means
the pooling and repackaging of loans or other
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
6 Intangible assets are defined to exclude any IO
strips receivable related to these mortgage and non-
mortgage servicing assets. See section 1(c)(14) of
this appendix A. Consequently, IO strips receivable
related to mortgage and non-mortgage servicing
assets are not required to be deducted under section
2(2)(2) of this appendix A. However, these IO strips
receivable are subject to a 100 percent risk weight
under section 3(a)(4) of this appendix A.
5 [Reserved]
credit exposures into securities that can be
sold to investors.
*
*
*
*
*
Section 2. Components of Capital
*
*
*
*
*
(c) * * *
(1) * * *
*
*
*
*
*
(ii) Other intangible assets and residual
interests, except as provided in section
2(c)(2) of this appendix A; and * * *
(2) Qualifying intangible assets and
residual interests. Subject to the following
conditions, mortgage servicing assets,
nonmortgage servicing assets,6 purchased
credit card relationships and residual
interests need not be deducted from Tier 1
capital:
*
(1) * * *
*
*
*
*
*
(ii) Other intangible assets and residual
interests, except as provided in section
2(c)(2) of this appendix A; and * * *
(2) Qualifying intangible assets and
residual interests. Subject to the following
conditions, mortgage servicing assets,
nonmortgage servicing assets,6 purchased
credit card relationships and residual
interests need not be deducted from Tier 1
capital:
(i) The total of all intangible assets and
residual interests that are included in Tier 1
capital is limited to 100 percent of Tier 1
capital, of which no more than 25 percent of
Tier 1 capital can consist of purchased credit
card relationships, nonmortgage servicing
assets and residual interests in the aggregate.
Calculation of these limitations must be
based on Tier 1 capital net of goodwill, and
all identifiable intangible assets, other than
mortgage servicing assets, nonmortgage
servicing assets, purchased credit card
relationships and residual interests.
(ii) Banks must value each intangible asset
and residual interest included in Tier 1
capital at least quarterly. In addition,
intangible assets included in Tier 1 capital
must also be valued at the lesser of:
*
*
*
*
*
(iii) The quarterly determination of the
current fair value of the intangible asset or
residual interest must include adjustments
for any significant changes in original
valuation assumptions, including changes in
prepayment estimates.
(iv) Banks may elect to deduct disallowed
servicing assets and residual interests on a
basis that is net of any associated deferred tax
liability. Deferred tax liabilities netted in this
manner cannot also be netted against
deferred tax assets when determining the
amount of deferred tax assets that are
dependent upon future taxable income.
*
*
*
*
*
Section 3. Risk Categories/Weights for On-
Balance Sheet Assets and Off-Balance Sheet
Items
*
*
*
*
*
d residual interests on a
basis that is net of any associated deferred tax
liability. Deferred tax liabilities netted in this
manner cannot also be netted against
deferred tax assets when determining the
amount of deferred tax assets that are
dependent upon future taxable income.
*
*
*
*
*
Section 3. Risk Categories/Weights for On-
Balance Sheet Assets and Off-Balance Sheet
Items
*
*
*
*
*
(e) Residual interests. (1) General capital
requirement. All residual interests are subject
to both a capital concentration limit and a
residual interest capital requirement in
accordance with sections 3(e)(2) and 3(e)(3)
of this appendix A. In determining the
general capital requirement for a residual
interest, the amount of all residual interests
in excess of the capital concentration limit
must be deducted from Tier 1 capital, in
accordance with section 3(e)(2) of this
appendix A, before the residual interest
capital requirement in section 3(e)(3) of this
appendix A is applied.
(2) Capital concentration limit. In addition
to the residual interest capital requirement
provided by section 3(e)(3) of this appendix
A, a bank must deduct from Tier 1 capital all
residual interest in excess of the 25 percent
sublimit on qualifying intangible assets and
residual interests in accordance with section
2(c)(2)(i) of this appendix A.
(3) Residual interests capital requirement.
A bank must maintain risk-based capital for
a residual interest equal to the amount of the
residual interest that is retained on the
balance sheet (less any amount disallowed in
accordance with section 3(e)(2) of this
appendix A and net of any associated
deferred tax liability), even if the amount of
risk-based capital required to be maintained
exceeds the full risk-based capital
requirement for the assets transferred.
isk-based capital for
a residual interest equal to the amount of the
residual interest that is retained on the
balance sheet (less any amount disallowed in
accordance with section 3(e)(2) of this
appendix A and net of any associated
deferred tax liability), even if the amount of
risk-based capital required to be maintained
exceeds the full risk-based capital
requirement for the assets transferred.
(4) Residual interests and other recourse
obligations. Where a bank holds a residual
interest and another recourse obligation
(such as a standby letter of credit) in
connection with the same asset transfer, the
bank must maintain risk-based capital equal
to the greater of the risk-based capital
requirement for the residual interest as
calculated under section 3(e)(3) of this
appendix A or the full risk-based capital
requirement for the assets transferred, subject
to the low-level recourse rules under section
3(d) of this appendix A.
*
*
*
*
*
Dated: August 16, 2000.
John D. Hawke, Jr.,
Comptroller of the Currency.
Federal Reserve System
12 CFR Chapter II
Authority and Issuance
For the reasons set forth in the joint
preamble, the Board of Governors of the
Federal Reserve System proposes to
amend parts 208 and 225 of chapter II
of title 12 of the Code of Federal
Regulations as follows:
PART 208—MEMBERSHIP OF STATE
BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
(REGULATION H)
1. The authority citation for part 208
continues to read as follows:
Authority: 12 U.S.C. 24, 36, 92a, 93a,
248(a), 248(c), 321–338a, 371d, 461, 481–486,
601, 611, 1814, 1816, 1818, 1820(d)(9),
1823(j), 1828(o), 1831o, 1831p–1, 1831r–1,
1835a, 1882, 2901–2907, 3105, 3310, 3331–
3351 and 3906–3909; 15 U.S.C. 78b, 78l(b),
78l(g), 78l(i), 78o–4(c)(5), 78q, 78q–l, and
78w; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a,
4104b, 4106, and 4128.
2. In appendix A to part 208:
A. Section II.A.1. and the first seven
paragraphs of section II.A.2. are revised,
and footnote 5 is removed and reserved;
B
)(9),
1823(j), 1828(o), 1831o, 1831p–1, 1831r–1,
1835a, 1882, 2901–2907, 3105, 3310, 3331–
3351 and 3906–3909; 15 U.S.C. 78b, 78l(b),
78l(g), 78l(i), 78o–4(c)(5), 78q, 78q–l, and
78w; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a,
4104b, 4106, and 4128.
2. In appendix A to part 208:
A. Section II.A.1. and the first seven
paragraphs of section II.A.2. are revised,
and footnote 5 is removed and reserved;
B. In sections II, III and IV, footnotes
13 through 52 are redesignated as
footnotes 14 through 53.
C. In section II.B., a new paragraph
(i)(c) and new footnote 14 are added,
section II.B.1.b. and newly designated
footnote 15 are revised, new sections
II.B.1.c. through II.B.1.g. are added, and
section II.B.4. is revised;
D. In section III.A, the four
undesignated paragraphs are designated
as sections III.A.1. through III.A.4., and
a new section III.A.5. is added.
E. Section III.B.6. is added.
F. Attachment II is revised.
Appendix A To Part 208—Capital
Adequacy Guidelines for State Member
Banks: Risk-Based Measure
*
*
*
*
*
II. * * *
A. * * *
1. Core capital elements (tier 1 capital).
The tier 1 component of a bank’s qualifying
capital must represent at least 50 percent of
qualifying total capital and may consist of the
following items that are defined as core
capital elements:
(i) Common stockholders’ equity;
(ii) Qualifying noncumulative perpetual
preferred stock (including related surplus);
(iii) Minority interest in the equity
accounts of consolidated subsidiaries.
Tier 1 capital is generally defined as the
sum of core capital elements 5 less goodwill,
other intangible assets, and residual interests
required to be deducted in accordance with
section II.B.1. of this appendix A.
*
*
*
*
*
2. Supplementary capital elements (tier 2
capital). The tier 2 component of a bank’s
qualifying capital may consist of the
following items that are defined as
supplementary capital elements:
nerally defined as the
sum of core capital elements 5 less goodwill,
other intangible assets, and residual interests
required to be deducted in accordance with
section II.B.1. of this appendix A.
*
*
*
*
*
2. Supplementary capital elements (tier 2
capital). The tier 2 component of a bank’s
qualifying capital may consist of the
following items that are defined as
supplementary capital elements:
(i) Allowance for loan and lease losses
(subject to limitations discussed below);
(ii) Perpetual preferred stock and related
surplus (subject to conditions discussed
below);
(iii) Hybrid capital instruments (as defined
below) and mandatory convertible debt
securities;
(iv) Term subordinated debt and
intermediate-term preferred stock, including
related surplus (subject to limitations
discussed below);
(v) Unrealized holding gains on equity
securities (subject to limitations discussed in
section II.A.2.e. of this appendix A).
The maximum amount of tier 2 capital that
may be included in a bank’s qualifying total
capital is limited to 100 percent of tier 1
capital (net of goodwill, other intangible
assets, and residual interests required to be
deducted in accordance with section II.B.1.
of this appendix A).
*
*
*
*
*
B. * * *
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
14 Residual interests consist of balance sheet
assets that: (a) Represent interests (including
beneficial interests) in transferred financial assets
retained by a seller (or transferor) after a
securitization or other transfer of financial assets;
and (b) are structured to absorb more than a pro rata
share of credit loss related to the transferred assets
through subordination provisions or other credit
enhancement techniques. Residual interests do not
include interests purchased from a third party
ial interests) in transferred financial assets
retained by a seller (or transferor) after a
securitization or other transfer of financial assets;
and (b) are structured to absorb more than a pro rata
share of credit loss related to the transferred assets
through subordination provisions or other credit
enhancement techniques. Residual interests do not
include interests purchased from a third party.
Residual interests generally include interest-only
strips receivable, spread accounts, cash collateral
accounts, retained subordinated interests, and other
similar forms of on-balance sheet assets that
function as a credit enhancement.
15 Amounts of servicing assets, purchased credit
card relationships, and residual interests in excess
of these limitations, as well as all other identifiable
intangible assets, including core deposit intangibles
and favorable leaseholds, are to be deducted from
a bank’s core capital elements in determining tier
1 capital. However, identifiable intangible assets
(other than mortgage servicing assets and purchased
credit card relationships) acquired on or before
February 19, 1992, generally will not be deducted
from capital for supervisory purposes, although
they will continue to be deducted for applications
purposes.
21 To determine the amount of expected deferred-
tax assets realizable in the next 12 months, an
institution should assume that all existing
temporary differences fully reverse as of the report
date. Projected future taxable income should not
include net operating loss carry-forwards to be used
during that year or the amount of existing
temporary differences a bank expects to reverse
within the year. Such projections should include
the estimated effect of tax-planning strategies that
the organization expects to implement to realize net
operating losses or tax-credit carry-forwards that
would otherwise expire during the year. Institutions
do not have to prepare a new 12-month projection
each quarter
year or the amount of existing
temporary differences a bank expects to reverse
within the year. Such projections should include
the estimated effect of tax-planning strategies that
the organization expects to implement to realize net
operating losses or tax-credit carry-forwards that
would otherwise expire during the year. Institutions
do not have to prepare a new 12-month projection
each quarter. Rather, on interim report dates,
institutions may use the future-taxable income
projections for their current fiscal year, adjusted for
any significant changes that have occurred or are
expected to occur.
(i) * * *
(c) Certain on-balance sheet residual
interests—deducted from the sum of core
capital elements in accordance with sections
II.B.1.c. through e. of this appendix A.14
*
*
*
*
*
1. Goodwill, other intangible assets, and
residual interests. * * *
b. Other intangible assets. i. All servicing
assets, including servicing assets on assets
other than mortgages (i.e., nonmortgage
servicing assets), are included in this
appendix as identifiable intangible assets.
The only types of identifiable intangible
assets that may be included in, that is, not
deducted from, a bank’s capital are readily
marketable mortgage servicing assets,
nonmortgage servicing assets, and purchased
credit card relationships. The total amount of
these assets that may be included in capital
is subject to the limitations described below
in sections II.B.1.d. and e. of this appendix
A.
ii. The treatment of identifiable intangible
assets set forth in this section generally will
be used in the calculation of a bank’s capital
ratios for supervisory and applications
purposes. However, in making an overall
assessment of a bank’s capital adequacy for
applications purposes, the Board may, if it
deems appropriate, take into account the
quality and composition of a bank’s capital,
together with the quality and value of its
tangible and intangible assets.
c. Residual interests
ll
be used in the calculation of a bank’s capital
ratios for supervisory and applications
purposes. However, in making an overall
assessment of a bank’s capital adequacy for
applications purposes, the Board may, if it
deems appropriate, take into account the
quality and composition of a bank’s capital,
together with the quality and value of its
tangible and intangible assets.
c. Residual interests. Residual interests
may be included in, that is, not deducted
from, a bank’s capital subject to the
limitations described below in sections
II.B.1.d. and e. of this appendix A.
d. Fair value limitation. The amount of
mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card
relationships that a bank may include in
capital shall be the lesser of 90 percent of
their fair value, as determined in accordance
with section II.B.1.f. of this appendix A, or
100 percent of their book value, as adjusted
for capital purposes in accordance with the
instructions in the commercial bank
Consolidated Reports of Condition and
Income (Call Reports). The amount of
residual interests a bank may include in
capital shall be 100 percent of its book value.
If both the application of the limits on
mortgage servicing assets, nonmortgage
servicing assets, purchased credit card
relationships, and residual interests and the
adjustment of the balance sheet amount for
these assets would result in an amount being
deducted from capital, the bank would
deduct only the greater of the two amounts
from its core capital elements in determining
tier 1 capital.
e. Tier 1 capital limitation. i. The total
amount of mortgage and nonmortgage
servicing assets, purchased credit card
relationships, and residual interests that may
be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital.
Nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, in the aggregate, are subject to a
separate sublimit of 25 percent of tier 1
capital.15
ii
The total
amount of mortgage and nonmortgage
servicing assets, purchased credit card
relationships, and residual interests that may
be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital.
Nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, in the aggregate, are subject to a
separate sublimit of 25 percent of tier 1
capital.15
ii. For purposes of calculating these
limitations on mortgage servicing assets,
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, tier 1 capital is defined as the sum
of core capital elements, net of goodwill, and
net of all identifiable intangible assets other
than mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card
relationships, prior to the deduction of any
disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any
disallowed purchased credit card
relationships, any disallowed residual
interests, and any disallowed deferred-tax
assets, regardless of the date acquired.
iii. Banks may elect to deduct disallowed
mortgage servicing assets, disallowed
nonmortgage servicing assets, and disallowed
residual interests on a basis that is net of any
associated deferred tax liability. Deferred tax
liabilities netted in this manner cannot also
be netted against deferred-tax assets when
determining the amount of deferred-tax
assets that are dependent upon future taxable
income.
f. Valuation. Banks must review the book
value of all intangible assets and residual
interests at least quarterly and make
adjustments to these values as necessary. The
fair value of mortgage servicing assets,
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests also must be determined at least
quarterly. This determination shall include
adjustments for any significant changes in
original valuation assumptions, including
changes in prepayment estimates or account
attrition rates
ke
adjustments to these values as necessary. The
fair value of mortgage servicing assets,
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests also must be determined at least
quarterly. This determination shall include
adjustments for any significant changes in
original valuation assumptions, including
changes in prepayment estimates or account
attrition rates. Examiners will review both
the book value and the fair value assigned to
these assets, together with supporting
documentation, during the examination
process. In addition, the Federal Reserve may
require, on a case-by-case basis, an
independent valuation of a bank’s intangible
assets or residual interests.
g. Growing organizations. Consistent with
long-standing Board policy, banks
experiencing substantial growth, whether
internally or by acquisition, are expected to
maintain strong capital positions
substantially above minimum supervisory
levels, without significant reliance on
intangible assets or residual interests.
*
*
*
*
*
4. Deferred-tax assets. The amount of
deferred-tax assets that is dependent upon
future taxable income, net of the valuation
allowance for deferred-tax assets, that may be
included in, that is, not deducted from, a
bank’s capital may not exceed the lesser of:
(i) The amount of these deferred-tax assets
that the bank is expected to realize within
one year of the calendar quarter-end date,
based on its projections of future taxable
income for that year,21 or
at is dependent upon
future taxable income, net of the valuation
allowance for deferred-tax assets, that may be
included in, that is, not deducted from, a
bank’s capital may not exceed the lesser of:
(i) The amount of these deferred-tax assets
that the bank is expected to realize within
one year of the calendar quarter-end date,
based on its projections of future taxable
income for that year,21 or
(ii) 10 percent of tier 1 capital. The
reported amount of deferred-tax assets, net of
any valuation allowance for deferred-tax
assets, in excess of the lesser of these two
amounts is to be deducted from a bank’s core
capital elements in determining tier 1 capital.
For purposes of calculating the 10 percent
limitation, tier 1 capital is defined as the sum
of core capital elements, net of goodwill and
net of all identifiable intangible assets other
than mortgage and nonmortgage servicing
assets, purchased credit card relationships,
prior to the deduction of any disallowed
mortgage servicing assets, any disallowed
nonmortgage servicing assets, any disallowed
purchased credit card relationships, any
disallowed residual interests, and any
disallowed deferred-tax assets. There
generally is no limit in tier 1 capital on the
amount of deferred-tax assets that can be
realized from taxes paid in prior carry-back
years or from future reversals of existing
taxable temporary differences, but, for banks
that have a parent, this may not exceed the
amount the bank could reasonably expect its
parent to refund.
III. * * *
A. * * *
5. The Federal Reserve will, on a case-by-
case basis, determine the appropriate risk-
weight for any asset that does not fit wholly
within one of the risk categories set forth
below or that imposes risks on a bank that
are not commensurate with the risk weight
otherwise specified below for the asset.
B. * * *
6. Residual interests—a. General capital
requirement
rent to refund.
III. * * *
A. * * *
5. The Federal Reserve will, on a case-by-
case basis, determine the appropriate risk-
weight for any asset that does not fit wholly
within one of the risk categories set forth
below or that imposes risks on a bank that
are not commensurate with the risk weight
otherwise specified below for the asset.
B. * * *
6. Residual interests—a. General capital
requirement. All residual interests are subject
to both a residual interest capital requirement
and a capital concentration limitation in
accordance with sections II.B.1.e. and
III.B.6.b. of this appendix A. In determining
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
2 Tier 1 capital for state member banks includes
common equity, minority interest in the equity
accounts of consolidated subsidiaries, and
qualifying noncumulative perpetual preferred stock.
In addition, as a general matter, Tier 1 capital
excludes goodwill; amounts of mortgage servicing
assets, nonmortgage servicing assets, purchased
credit card relationships, and residual interests that,
in the aggregate, exceed 100 percent of Tier 1
capital; nonmortgage servicing assets, purchased
credit card relationships, and residual interests that,
in the aggregate, exceed 25 percent of Tier 1 capital;
other identifiable intangible assets; and deferred tax
assets that are dependent upon future taxable
income, net of their valuation allowance, in excess
of certain limitations. The Federal Reserve may
exclude certain investments in subsidiaries or
associated companies as appropriate.
3 Deductions from Tier 1 capital and other
adjustments are discussed more fully in section II.B.
of appendix A of this part.
the capital requirement for a residual
interest, the amount of all residual interests
in excess of the capital concentration limit
must be deducted from tier 1 capital, in
accordance with section II.B.1.e
in investments in subsidiaries or
associated companies as appropriate.
3 Deductions from Tier 1 capital and other
adjustments are discussed more fully in section II.B.
of appendix A of this part.
the capital requirement for a residual
interest, the amount of all residual interests
in excess of the capital concentration limit
must be deducted from tier 1 capital, in
accordance with section II.B.1.e. of this
appendix A, before the residual interest
capital requirement in this section is applied.
b. Residual interest capital requirement.
Notwithstanding section III.D.1.g. of this
appendix A, a bank must maintain capital for
a residual interest equal to the amount of the
residual interest that is retained on the
balance sheet (less any amount disallowed in
accordance with section II.B.1.e. of this
appendix A and net of any associated
deferred tax liability), even if the amount of
capital required to be maintained exceeds the
standard capital charge that would be
required under section IV.A. of this appendix
A for assets transferred.
c. Multiple recourse obligations. Where a
bank holds a residual interest and another
recourse obligation (such as a standby letter
of credit) in connection with the same asset
transfer, the bank must maintain risk-based
capital equal to the greater of:
(i) The risk-based capital requirement for
the residual interest as calculated under
section III.B.6.b. of this appendix A; or
(ii) The full risk-based capital requirement
for the assets transferred, subject to the low-
level recourse rules (section III.D.1.g. of this
appendix A).
*
*
*
*
*
ATTACHMENT II.—SUMMARY OF DEFINITION OF QUALIFYING CAPITAL FOR STATE MEMBER BANKS*
[Using the Year-End 1992 Standards]
Components
Minimum requirements after transition period
Core Capital (tier 1) ..................................................................................
Must equal or exceed 4% of weighted-risk assets.
Common stockholders’ equity ...........................................................
No limit
DEFINITION OF QUALIFYING CAPITAL FOR STATE MEMBER BANKS*
[Using the Year-End 1992 Standards]
Components
Minimum requirements after transition period
Core Capital (tier 1) ..................................................................................
Must equal or exceed 4% of weighted-risk assets.
Common stockholders’ equity ...........................................................
No limit.
Qualifying noncumulative perpetual preferred stock .........................
No limit; banks should avoid undue reliance on preferred stock in tier
1.
Minority interest in equity accounts of consolidated Subsidiaries ....
Banks should avoid using minority interests to introduce elements not
otherwise qualifying for tier 1 capital.
Less: Goodwill, other intangible assets, and residual interests re-
quired to be deducted from capital 1
Supplementary Capital (tier 2) .................................................................
Total of tier 2 is limited to 100% of tier 1.2
Allowance for loan and lease losses ................................................
Limited to 1.25% of weighted-risk assets.2
Perpetual preferred stock ..................................................................
No limit within tier 2.
Hybrid capital instruments and equity contract notes .......................
No limit within tier 2.
Subordinated debt and intermediate-term preferred stock (original
weighted average maturity of 5 years or more).
Subordinated debt and intermediate-term preferred stock are limited to
50% of tier 1,2 amortized for capital purposes as they approach ma-
turity.
Revaluation reserves (equity and building) .......................................
Not included; banks encouraged to disclose; may be evaluated on a
case-by-case basis for international comparisons; and taken into ac-
count in making and overall assessment of capital.
Deductions (from sum of tier 1 and tier 2):
Investments in unconsolidated subsidiaries .....................................
urity.
Revaluation reserves (equity and building) .......................................
Not included; banks encouraged to disclose; may be evaluated on a
case-by-case basis for international comparisons; and taken into ac-
count in making and overall assessment of capital.
Deductions (from sum of tier 1 and tier 2):
Investments in unconsolidated subsidiaries ......................................
As a general rule, one-half of the aggregate investments will be de-
ducted from tier 1 capital and one-half from tier 2 capital.3
Reciprocal holdings of banking organizations’ capital securities.
Other deductions (such as other subsidiaries or joint ventures) as
determined by supervisory authority.
On a case-by-case basis or as a matter of policy after formal rule-
making.
Total Capital (tier 1+tier 2¥deductions) ..................................................
Must equal or exceed 8% of weighted-risk assets.
1 Requirements for the deduction of other intangible assets and residual interests are set forth in section II.B.1. of this appendix.
2 Amounts in excess of limitations are permitted but do not qualify as capital.
3 A proportionately greater amount may be deducted from tier 1 capital, if the risks associated with the subsidiary so warrant.
* See discussion in section II of the guidelines for a complete description of the requirements for, and the limitations on, the components of
qualifying capital.
3. In appendix B to part 208, section
II. b. is revised to read as follows:
Appendix B To Part 208—Capital
Adequacy Guidelines for State Member
Banks: Tier 1 Leverage Measure
*
*
*
*
*
II. b. A bank’s Tier 1 leverage ratio is
calculated by dividing its Tier 1 capital (the
numerator of the ratio) by its average total
consolidated assets (the denominator of the
ratio). The ratio will also be calculated using
period-end assets whenever necessary, on a
case-by-case basis
Appendix B To Part 208—Capital
Adequacy Guidelines for State Member
Banks: Tier 1 Leverage Measure
*
*
*
*
*
II. b. A bank’s Tier 1 leverage ratio is
calculated by dividing its Tier 1 capital (the
numerator of the ratio) by its average total
consolidated assets (the denominator of the
ratio). The ratio will also be calculated using
period-end assets whenever necessary, on a
case-by-case basis. For the purpose of this
leverage ratio, the definition of Tier 1 capital
as set forth in the risk-based capital
guidelines contained in appendix A of this
part will be used.2 As a general matter,
average total consolidated assets are defined
as the quarterly average total assets (defined
net of the allowance for loan and lease losses)
reported on the bank’s Reports of Condition
and Income (Call Reports), less goodwill;
amounts of mortgage servicing assets,
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests that, in the aggregate, are in excess
of 100 percent of Tier 1 capital; amounts of
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests that, in the aggregate, are in excess
of 25 percent of Tier 1 capital; all other
identifiable intangible assets; any
investments in subsidiaries or associated
companies that the Federal Reserve
determines should be deducted from Tier 1
capital; and deferred tax assets that are
dependent upon future taxable income, net of
their valuation allowance, in excess of the
limitation set forth in section II.B.4 of
appendix A of this part.3
*
*
*
*
*
PART 225—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
1. The authority citation for part 225
continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818,
1828(o) 1831i, 1831p–1, 1843(c)(8), 1844(b),
1972(l), 3106, 3108, 3310, 3331–3351, 3907,
and 3909.
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—BANK HOLDING
COMPANIES AND CHANGE IN BANK
CONTROL (REGULATION Y)
1. The authority citation for part 225
continues to read as follows:
Authority: 12 U.S.C. 1817(j)(13), 1818,
1828(o) 1831i, 1831p–1, 1843(c)(8), 1844(b),
1972(l), 3106, 3108, 3310, 3331–3351, 3907,
and 3909.
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
6 [Reserved]
15 Residual interests consist of balance sheet
assets that: (a) Represent interests (including
beneficial interests) in transferred financial assets
retained by a seller (or transferor) after a
securitization or other transfer of financial assets;
and (b) are structured to absorb more than a pro rata
share of credit loss related to the transferred assets
through subordination provisions or other credit
enhancement techniques. Residual interests do not
include interests purchased from a third party.
Residual interest include interest-only strips
receivable, spread accounts, cash collateral
accounts, retained subordinated interests, and
similar on-balance sheet assets that function as a
credit enhancement.
16 Amounts of servicing assets, purchased credit
card relationships, and residual interests in excess
of these limitations, as well as all other identifiable
intangible assets, including core deposit intangibles
and favorable leaseholds, are to be deducted from
an organization’s core capital elements in
determining tier 1 capital. However, identifiable
intangible assets (other than mortgage servicing
assets and purchased credit card relationships)
acquired on or before February 19, 1992, generally
will not be deducted from capital for supervisory
purposes, although they will continue to be
deducted for applications purposes.
2. In appendix A to part 225:
A. Section II.A.1. and the first seven
paragraphs of section II.A.2. are revised,
and footnote 6 is removed and reserved;
B
ortgage servicing
assets and purchased credit card relationships)
acquired on or before February 19, 1992, generally
will not be deducted from capital for supervisory
purposes, although they will continue to be
deducted for applications purposes.
2. In appendix A to part 225:
A. Section II.A.1. and the first seven
paragraphs of section II.A.2. are revised,
and footnote 6 is removed and reserved;
B. In sections II, III and IV, footnotes
13 through 57 are redesignated as
footnotes 14 through 58.
C. In section II.B., a new paragraph
(i)(c) and new footnote 15 are added,
section II.B.1.b and newly designated
footnote 16 are revised, new sections
II.B.1.c. through II.B.1.g. are added, and
section II.B.4. is revised.
D. In section III.A, the four
undesignated paragraphs are designated
as sections III.A.1. through III.A.4. and
a new section III.A.5, is added.
E. Section III.B.6. is added.
F. Attachment II is revised.
Appendix A To Part 225—Capital
Adequacy Guidelines for Bank Holding
Companies: Risk-Based Measure
*
*
*
*
*
II. * * *
A. * * *
1. Core capital elements (tier 1 capital).
The tier 1 component of an institution’s
qualifying capital must represent at least 50
percent of qualifying total capital and may
consist of the following items that are
defined as core capital elements:
(i) Common stockholders’ equity;
(ii) Qualifying noncumulative perpetual
preferred stock (including related surplus);
(iii) Qualifying cumulative perpetual
preferred stock (including related surplus);
subject to certain limitations described
below;
apital must represent at least 50
percent of qualifying total capital and may
consist of the following items that are
defined as core capital elements:
(i) Common stockholders’ equity;
(ii) Qualifying noncumulative perpetual
preferred stock (including related surplus);
(iii) Qualifying cumulative perpetual
preferred stock (including related surplus);
subject to certain limitations described
below;
(iv) Minority interest in the equity
accounts of consolidated subsidiaries. Tier 1
capital is generally defined as the sum of core
capital elements 6 less goodwill, other
intangible assets, and residual interests
required to be deducted in accordance with
section II.B.1. of this appendix A.
*
*
*
*
*
2. Supplementary capital elements (tier 2
capital). The tier 2 component of an
institution’s qualifying capital may consist of
the following items that are defined as
supplementary capital elements:
(i) Allowance for loan and lease losses
(subject to limitations discussed below);
(ii) Perpetual preferred stock and related
surplus (subject to conditions discussed
below);
(iii) Hybrid capital instruments (as defined
below), perpetual debt, and mandatory
convertible debt securities;
(iv) Term subordinated debt and
intermediate-term preferred stock, including
related surplus (subject to limitations
discussed below);
(v) Unrealized holding gains on equity
securities (subject to limitations discussed in
section II.A.2.e. of this appendix A).
The maximum amount of tier 2 capital that
may be included in an organization’s
qualifying total capital is limited to 100
percent of tier 1 capital (net of goodwill,
other intangible assets, and residual interests
required to be deducted in accordance with
section II.B.1. of this appendix A).
*
*
*
*
*
B. * * *
(i) * * *
ubject to limitations discussed in
section II.A.2.e. of this appendix A).
The maximum amount of tier 2 capital that
may be included in an organization’s
qualifying total capital is limited to 100
percent of tier 1 capital (net of goodwill,
other intangible assets, and residual interests
required to be deducted in accordance with
section II.B.1. of this appendix A).
*
*
*
*
*
B. * * *
(i) * * *
(c) Certain on-balance sheet residual
interests deducted from the sum of core
capital elements in accordance with sections
II.B.1.c. through e. of this appendix A.15
*
*
*
*
*
1. Goodwill, other intangible assets, and
residual interests. * * *
b. Other intangible assets. i. All servicing
assets, including servicing assets on assets
other than mortgages (i.e., nonmortgage
servicing assets), are included in this
appendix as identifiable intangible assets.
The only types of identifiable intangible
assets that may be included in, that is, not
deducted from, an organization’s capital are
readily marketable mortgage servicing assets,
nonmortgage servicing assets, and purchased
credit card relationships. The total amount of
these assets that may be included in capital
is subject to the limitations described below
in sections II.B.1.d. and e. of this appendix
A.
ii. The treatment of identifiable intangible
assets set forth in this section generally will
be used in the calculation of a bank holding
company’s capital ratios for supervisory and
applications purposes. However, in making
an overall assessment of an organization’s
capital adequacy for applications purposes,
the Board may, if it deems appropriate, take
into account the quality and composition of
an organization’s capital, together with the
quality and value of its tangible and
intangible assets.
c. Residual interests. Residual interests
may be included in, that is, not deducted
from, an organization’s capital subject to the
limitations described below in sections
II.B.1.d. and e. of this appendix A.
d. Fair value limitation
ems appropriate, take
into account the quality and composition of
an organization’s capital, together with the
quality and value of its tangible and
intangible assets.
c. Residual interests. Residual interests
may be included in, that is, not deducted
from, an organization’s capital subject to the
limitations described below in sections
II.B.1.d. and e. of this appendix A.
d. Fair value limitation. The amount of
mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card
relationships that a bank holding company
may include in capital shall be the lesser of
90 percent of their fair value, as determined
in accordance with section II.B.1.f. of this
appendix A, or 100 percent of their book
value, as adjusted for capital purposes in
accordance with the instructions to the
Consolidated Financial Statements for Bank
Holding Companies (FR Y–9C Report). The
amount of residual interests a bank holding
company may include in capital shall be 100
percent of its book value. If both the
application of the limits on mortgage
servicing assets, nonmortgage servicing
assets, purchased credit card relationships,
and residual interests and the adjustment of
the balance sheet amount for these assets
would result in an amount being deducted
from capital, the bank holding company
would deduct only the greater of the two
amounts from its core capital elements in
determining tier 1 capital.
e. Tier 1 capital limitation. i. The total
amount of mortgage and nonmortgage
servicing assets, purchased credit card
relationships, and residual interests that may
be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital.
Nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, in the aggregate, are subject to a
separate sublimit of 25 percent of tier 1
capital.16
ii
The total
amount of mortgage and nonmortgage
servicing assets, purchased credit card
relationships, and residual interests that may
be included in capital, in the aggregate,
cannot exceed 100 percent of tier 1 capital.
Nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, in the aggregate, are subject to a
separate sublimit of 25 percent of tier 1
capital.16
ii. For purposes of calculating these
limitations on mortgage servicing assets,
nonmortgage servicing assets, purchased
credit card relationships, and residual
interests, tier 1 capital is defined as the sum
of core capital elements, net of goodwill, and
net of all identifiable intangible assets other
than mortgage servicing assets, nonmortgage
servicing assets, and purchased credit card
relationships, prior to the deduction of any
disallowed mortgage servicing assets, any
disallowed nonmortgage servicing assets, any
disallowed purchased credit card
relationships, any disallowed residual
interests, and any disallowed deferred-tax
assets, regardless of the date acquired.
iii. Bank holding companies may elect to
deduct disallowed mortgage servicing assets,
disallowed nonmortgage servicing assets, and
disallowed residual interests on a basis that
is net of any associated deferred tax liability.
Deferred tax liabilities netted in this manner
cannot also be netted against deferred tax
assets when determining the amount of
deferred tax assets that are dependent upon
future taxable income.
f. Valuation. Bank holding companies must
review the book value of all intangible assets
and residual interests at least quarterly and
make adjustments to these values as
necessary. The fair value of mortgage
servicing assets, nonmortgage servicing
assets, purchased credit card relationships,
and residual interests also must be
determined at least quarterly. This
determination shall include adjustments for
any significant changes in original valuation
assumptions, including changes in
prepayment estimates or account attrition
rates
ke adjustments to these values as
necessary. The fair value of mortgage
servicing assets, nonmortgage servicing
assets, purchased credit card relationships,
and residual interests also must be
determined at least quarterly. This
determination shall include adjustments for
any significant changes in original valuation
assumptions, including changes in
prepayment estimates or account attrition
rates. Examiners will review both the book
value and the fair value assigned to these
assets, together with supporting
documentation, during the inspection
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
24 To determine the amount of expected deferred-
tax assets realizable in the next 12 months, an
institution should assume that all existing
temporary differences fully reverse as of the report
date. Projected future taxable income should not
include net operating loss carry-forwards to be used
during that year or the amount of existing
temporary differences a bank holding company
expects to reverse within the year. Such projections
should include the estimated effect of tax-planning
strategies that the organization expects to
implement to realize net operating losses or tax-
credit carry-forwards that would otherwise expire
during the year. Institutions do not have to prepare
a new 12-month projection each quarter. Rather, on
interim report dates, institutions may use the
future-taxable income projections for their current
fiscal year, adjusted for any significant changes that
have occurred or are expected to occur.
process. In addition, the Federal Reserve may
require, on a case-by-case basis, an
independent valuation of an organization’s
intangible assets or residual interests.
g. Growing organizations
er. Rather, on
interim report dates, institutions may use the
future-taxable income projections for their current
fiscal year, adjusted for any significant changes that
have occurred or are expected to occur.
process. In addition, the Federal Reserve may
require, on a case-by-case basis, an
independent valuation of an organization’s
intangible assets or residual interests.
g. Growing organizations. Consistent with
long-standing Board policy, banking
organizations experiencing substantial
growth, whether internally or by acquisition,
are expected to maintain strong capital
positions substantially above minimum
supervisory levels, without significant
reliance on intangible assets or residual
interests.
*
*
*
*
*
4. Deferred-tax assets. The amount of
deferred-tax assets that is dependent upon
future taxable income, net of the valuation
allowance for deferred-tax assets, that may be
included in, that is, not deducted from, a
banking organization’s capital may not
exceed the lesser of:
(i) The amount of these deferred-tax assets
that the banking organization is expected to
realize within one year of the calendar
quarter-end date, based on its projections of
future taxable income for that year,24 or
(ii) 10 percent of tier 1 capital. The
reported amount of deferred-tax assets, net of
any valuation allowance for deferred-tax
assets, in excess of the lesser of these two
amounts is to be deducted from a banking
organization’s core capital elements in
determining tier 1 capital. For purposes of
calculating the 10 percent limitation, tier 1
capital is defined as the sum of core capital
elements, net of goodwill and net of all
identifiable intangible assets other than
mortgage and nonmortgage servicing assets,
purchased credit card relationships, prior to
the deduction of any disallowed mortgage
servicing assets, any disallowed nonmortgage
servicing assets, any disallowed purchased
credit card relationships, any disallowed
residual interests, and any disallowed
deferred-tax assets
lements, net of goodwill and net of all
identifiable intangible assets other than
mortgage and nonmortgage servicing assets,
purchased credit card relationships, prior to
the deduction of any disallowed mortgage
servicing assets, any disallowed nonmortgage
servicing assets, any disallowed purchased
credit card relationships, any disallowed
residual interests, and any disallowed
deferred-tax assets. There generally is no
limit in tier 1 capital on the amount of
deferred-tax assets that can be realized from
taxes paid in prior carry-back years or from
future reversals of existing taxable temporary
differences.
III. * * *
A. * * *
5. The Federal Reserve will, on a case-by-
case basis, determine the appropriate risk
weight for any asset that does not fit wholly
within one of the risk categories set forth
below or that imposes risks on a bank
holding company that are not commensurate
with the risk weight otherwise specified
below for the asset.
B. * * *
6. Residual interests—a. General capital
requirement. All residual interests are subject
to both a residual interest capital requirement
and a capital concentration limitation in
accordance with sections II.B.1.e. and
III.B.6.b. of this appendix A. In determining
the capital requirement for a residual
interest, the amount of all residual interests
in excess of the capital concentration limit
must be deducted from tier 1 capital, in
accordance with section II.B.1.e. of this
appendix A, before the residual interest
capital requirement in this section is applied.
b. Residual interest capital requirement.
Notwithstanding section III.D.1.g. of this
appendix A, organizations must maintain
capital for a residual interest equal to the
amount of the residual interest (less any
amount disallowed in accordance with
section II.B.1.e. of this appendix A and net
of any associated deferred tax liability), even
if the amount of capital required to be
maintained exceeds the standard capital
charge under section IV.A. of this appendix
A for the assets transferred.
c
organizations must maintain
capital for a residual interest equal to the
amount of the residual interest (less any
amount disallowed in accordance with
section II.B.1.e. of this appendix A and net
of any associated deferred tax liability), even
if the amount of capital required to be
maintained exceeds the standard capital
charge under section IV.A. of this appendix
A for the assets transferred.
c. Multiple recourse obligations. Where an
organization holds a residual interest and
another recourse obligation (such as a
standby letter of credit) in connection with
the same asset transfer, the organization must
maintain risk-based capital equal to the
greater of:
(i) The risk-based capital requirement for
the residual interest as calculated under
section III.B.6.b of this appendix A; or
(ii) The full risk-based capital requirement
for the assets transferred, subject to the low-
level recourse rules (section III.D.1.g. of this
appendix A).
*
*
*
*
*
ATTACHMENT II—SUMMARY DEFINITION OF QUALIFYING CAPITAL FOR BANK HOLDING COMPANIES*
[Using the year-end 1992 standards]
Components
Minimum requirements after transition period
Core Capital (tier 1) ..................................................................................
Must equal or exceed 4% of weighted-risk assets.
Common stockholders’ equity ...........................................................
No limit.
Qualifying noncumulative perpetual preferred stock .........................
No limit.
Qualifying cumulative perpetual preferred stock ...............................
Limited to 25% of the sum of common stock, qualifying perpetual pre-
ferred stock, and minority interests.
Minority interest in equity accounts of consolidated subsidiaries .....
Organizations should avoid using minority interests to introduce ele-
ments not otherwise qualifying for tier 1 capital
...........
No limit.
Qualifying cumulative perpetual preferred stock ...............................
Limited to 25% of the sum of common stock, qualifying perpetual pre-
ferred stock, and minority interests.
Minority interest in equity accounts of consolidated subsidiaries .....
Organizations should avoid using minority interests to introduce ele-
ments not otherwise qualifying for tier 1 capital.
Less: Goodwill, other intangible assets, and residual interests re-
quired to be deducted from capital 1
Supplementary Capital (tier 2) .................................................................
Total of tier 2 is limited to 100% of tier 1.2
Allowance for loan and lease losses ................................................
Limited to 1.25% of weighted-risk assets.2
Perpetual preferred stock ..................................................................
No limit within tier 2.
Hybrid capital instruments, perpetual debt, and mandatory convert-
ible securities.
No limit within tier 2.
Subordinated debt and intermediate-term preferred stock (original
weighted average maturity of 5 years or more).
Subordinated debt and intermediate-term preferred stock are limited to
50% of tier 1; 2 amortized for capital purposes as they approach ma-
turity.
Revaluation reserves (equity and building) .......................................
Not included; organization encouraged to disclose; may be evaluated
on a case-by-case basis for international comparisons; and taken
into account in making and overall assessment of capital.
Deductions (from sum of tier 1 and tier 2):
Investments in unconsolidated subsidiaries ......................................
As a general rule, one-half of the aggregate investments will be de-
ducted from tier 1 capital and one-half from tier 2 capital.3
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ment of capital.
Deductions (from sum of tier 1 and tier 2):
Investments in unconsolidated subsidiaries ......................................
As a general rule, one-half of the aggregate investments will be de-
ducted from tier 1 capital and one-half from tier 2 capital.3
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
3 Tier 1 capital for banking organizations includes
common equity, minority interest in the equity
accounts of consolidated subsidiaries, qualifying
noncumulative perpetual preferred stock, and
qualifying cumulative perpetual preferred stock.
(Cumulative perpetual preferred stock is limited to
25 percent of tier 1 capital.) In addition, as a general
matter, tier 1 capital excludes goodwill; amounts of
mortgage servicing assets, nonmortgage servicing
assets, purchased credit card relationships, and
residual interests that, in the aggregate, exceed 100
percent of tier 1 capital; nonmortgage servicing
assets, purchased credit card relationships, and
residual interests that, in the aggregate, exceed 25
percent of tier 1 capital; all other identifiable
intangible assets; and deferred-tax assets that are
dependent upon future taxable income, net of their
valuation allowance, in excess of certain
limitations. The Federal Reserve may exclude
certain investments in subsidiaries or associated
companies as appropriate.
4 Deductions from tier 1 capital and other
adjustments are discussed more fully in section II.B.
of appendix A of this part
entifiable
intangible assets; and deferred-tax assets that are
dependent upon future taxable income, net of their
valuation allowance, in excess of certain
limitations. The Federal Reserve may exclude
certain investments in subsidiaries or associated
companies as appropriate.
4 Deductions from tier 1 capital and other
adjustments are discussed more fully in section II.B.
of appendix A of this part.
ATTACHMENT II—SUMMARY DEFINITION OF QUALIFYING CAPITAL FOR BANK HOLDING COMPANIES*—Continued
[Using the year-end 1992 standards]
Components
Minimum requirements after transition period
Reciprocal holdings of banking organizations’ capital securities
Other deductions (such as other subsidiaries or joint ventures) as
determined by supervisory authority
Total Capital (tier 1 + tier 2¥deductions) ................................................
Must equal or exceed 8% of weighted-risk assets.
1 Requirements for the deduction of other intangible assets and residual interests are set forth in section II.B.1.e. of this appendix.
2 Amounts in excess of limitations are permitted but do not qualify as capital.
3 A proportionally greater amount may be deducted from tier 1 capital.
* See discussion in section II of this appendix for a complete description of the requirements for, and the limitations on, the components of
qualifying capital.
3. In appendix D to part 225, section
II.b. is revised to read as follows:
Appendix D to Part 225—Capital
Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
*
*
*
*
*
II. * * *
b. A banking organization’s tier 1 leverage
ratio is calculated by dividing its tier 1
capital (the numerator of the ratio) by its
average total consolidated assets (the
denominator of the ratio). The ratio will also
be calculated using period-end assets
whenever necessary, on a case-by-case basis
pital
Adequacy Guidelines for Bank Holding
Companies: Tier 1 Leverage Measure
*
*
*
*
*
II. * * *
b. A banking organization’s tier 1 leverage
ratio is calculated by dividing its tier 1
capital (the numerator of the ratio) by its
average total consolidated assets (the
denominator of the ratio). The ratio will also
be calculated using period-end assets
whenever necessary, on a case-by-case basis.
For the purpose of this leverage ratio, the
definition of tier 1 capital as set forth in the
risk-based capital guidelines contained in
appendix A of this part will be used.3 As a
general matter, average total consolidated
assets are defined as the quarterly average
total assets (defined net of the allowance for
loan and lease losses) reported on the
organization’s Consolidated Financial
Statements (FR Y–9C Report), less goodwill;
amounts of mortgage-servicing assets,
nonmortgage-servicing assets, purchased
credit-card relationships, and residual
interests that, in the aggregate, are in excess
of 100 percent of tier 1 capital; amounts of
nonmortgage-servicing assets, purchased
credit-card relationships, and residual
interests that, in the aggregate, are in excess
of 25 percent of tier 1 capital; all other
identifiable intangible assets; any
investments in subsidiaries or associated
companies that the Federal Reserve
determines should be deducted from tier 1
capital; and deferred-tax assets that are
dependent upon future taxable income, net of
their valuation allowance, in excess of the
limitation set forth in section II.B.4 of
appendix A of this part. 4
*
*
*
*
*
By order of the Board of Governors of the
Federal Reserve System, September 13, 2000.
Jennifer J. Johnson,
Secretary of the Board.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons set out in the joint
preamble, the Board of Directors of the
Federal Deposit Insurance Corporation
proposes to amend part 325 of chapter
III of title 12 of the Code of Federal
Regulations as follows:
PART 325—CAPITAL MAINTENANCE
1
System, September 13, 2000.
Jennifer J. Johnson,
Secretary of the Board.
Federal Deposit Insurance Corporation
12 CFR Chapter III
Authority and Issuance
For the reasons set out in the joint
preamble, the Board of Directors of the
Federal Deposit Insurance Corporation
proposes to amend part 325 of chapter
III of title 12 of the Code of Federal
Regulations as follows:
PART 325—CAPITAL MAINTENANCE
1. The authority citation for part 325
is revised to read as follows:
Authority: 12 U.S.C. 1815(a), 1815(b),
1816, 1818(a), 1818(b), 1818(c), 1818(t),
1819(Tenth), 1828(c), 1828(d), 1828(i),
1828(n), 1828(o), 1831o, 1835, 3907, 3909,
4808; Pub. L. 102–233, 105 Stat. 1761, 1789,
1790 (12 U.S.C. 1831n note); Pub. L. 102–
242, 105 Stat. 2236, 2355, as amended by
Pub. L. 103–325, 108 Stat. 2160, 2233 (12
U.S.C. 1828 note); Pub. L. 102–242, 105 Stat.
2236, 2386, as amended by Pub. L. 102–550,
106 Stat. 3672, 4089 (12 U.S.C. 1828 note).
§ 325.2
[Amended]
2. In § 325.2:
A. Redesignate paragraphs (s) through
(x) as paragraphs (v) through (aa),
paragraphs (q) through (r) as paragraphs
(s) through (t), and paragraphs (g)
through(p) as pragraphs (h) through (q);
B. Add new paragraphs (g), (r), and
(u);
C. Revise newly designated
paragraphs (w) and (y) to read as
follows:
§ 325.2
Definitions.
*
*
*
*
*
(g) Financial assets means cash,
evidence of an ownership interest in an
entity, or a contract that conveys to a
second entity a contractual right:
(1) To receive cash or another
financial instrument from a first entity;
or
(2) To exchange other financial
instruments on potentially favorable
terms with the first entity.
*
*
*
*
*
(r) Residual interests means:
(1) Balance sheet assets that:
*
(g) Financial assets means cash,
evidence of an ownership interest in an
entity, or a contract that conveys to a
second entity a contractual right:
(1) To receive cash or another
financial instrument from a first entity;
or
(2) To exchange other financial
instruments on potentially favorable
terms with the first entity.
*
*
*
*
*
(r) Residual interests means:
(1) Balance sheet assets that:
(i) Represent interests (including
beneficial interests) in transferred
financial assets retained by a seller (or
transferor) after a securitization or other
transfer of financial assets; and
(ii) Are structured to absorb more than
a pro rata share of credit loss related to
the transferred assets through
subordination provisions or other credit
enhancement techniques.
(2) Exclusion. Residual interests do
not include interests purchased from a
third party.
(3) Examples. Residual interests
include interest only strips receivable,
spread accounts, cash collateral
accounts, retained subordinated
interests, and other similar forms of on-
balance sheet assets that function as a
credit enhancement.
*
*
*
*
*
(u) Securitization means the pooling
and repackaging of loans or other credit
exposures into securities that can be
sold to investors.
*
*
*
*
*
(w) Tier 1 capital or core capital
means the sum of common
stockholders’ equity, noncumulative
perpetual preferred stock (including any
related surplus), and minority interests
in consolidated subsidiaries, minus all
intangible assets (other than mortgage
servicing assets, nonmortgage servicing
assets, and purchased credit card
relationships eligible for inclusion in
core capital pursuant to § 325.5(f) and
qualifying supervisory goodwill eligible
for inclusion in core capital pursuant to
12 CFR part 567), minus residual
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age
servicing assets, nonmortgage servicing
assets, and purchased credit card
relationships eligible for inclusion in
core capital pursuant to § 325.5(f) and
qualifying supervisory goodwill eligible
for inclusion in core capital pursuant to
12 CFR part 567), minus residual
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
interests (other than residual interests
eligible for inclusion in core capital
pursuant to § 325.5(f)), minus deferred
tax assets in excess of the limit set forth
in § 325.5(g), minus identified losses (to
the extent that Tier 1 capital would have
been reduced if the appropriate
accounting entries to reflect the
identified losses had been recorded on
the insured depository institution’s
books), and minus investments in
securities subsidiaries subject to 12 CFR
337.4.
*
*
*
*
*
(y) Total assets means the average of
total assets required to be included in a
banking institution’s ‘‘Reports of
Condition and Income’’ (Call Report) or,
for savings associations, the
consolidated total assets required to be
included in the ‘‘Thrift Financial
Report,’’ as these reports may from time
to time be revised, as of the most recent
report date (and after making any
necessary subsidiary adjustments for
state nonmember banks as described in
§§ 325.5(c) and 325.5(d) of this part),
minus intangible assets (other than
mortgage servicing assets, nonmortgage
servicing assets, and purchased credit
card relationships eligible for inclusion
in core capital pursuant to § 325.5(f) and
qualifying supervisory goodwill eligible
for inclusion in core capital pursuant to
12 CFR part 567), minus residual
interests (other than residual interests
eligible for inclusion in core capital
pursuant to § 325.5(f)), minus deferred
tax assets in excess of the limit set forth
in § 325.5(g), and minus assets classified
loss and any other assets that are
deducted in deter
rsuant to § 325.5(f) and
qualifying supervisory goodwill eligible
for inclusion in core capital pursuant to
12 CFR part 567), minus residual
interests (other than residual interests
eligible for inclusion in core capital
pursuant to § 325.5(f)), minus deferred
tax assets in excess of the limit set forth
in § 325.5(g), and minus assets classified
loss and any other assets that are
deducted in determining Tier 1 capital.
For banking institutions, the average of
total assets is found in the Call Report
schedule of quarterly averages. For
savings associations, the consolidated
total assets figure is found in Schedule
CSC of the Thrift Financial Report.
3. In § 325.5, revise paragraphs (f) and
(g)(2) to read as follows:
§ 325.5
Miscellaneous.
*
*
*
*
*
(f) Treatment of mortgage servicing
assets, purchased credit card
relationships, nonmortgage servicing
assets, and residual interests. For
purposes of determining Tier 1 capital
under this part, mortgage servicing
assets, purchased credit card
relationships, nonmortgage servicing
assets, and residual interests will be
deducted from assets and from common
stockholders’ equity to the extent that
these items do not meet the conditions,
limitations, and restrictions described in
this section. Banks may elect to deduct
disallowed servicing assets and
disallowed residual interests on a basis
that is net of any associated deferred tax
liability. Any deferred tax liability
netted in this manner cannot also be
netted against deferred tax assets when
determining the amount of deferred tax
assets that are dependent upon future
taxable income and calculating the
maximum allowable amount of these
assets under paragraph (g) of this
section.
assets and
disallowed residual interests on a basis
that is net of any associated deferred tax
liability. Any deferred tax liability
netted in this manner cannot also be
netted against deferred tax assets when
determining the amount of deferred tax
assets that are dependent upon future
taxable income and calculating the
maximum allowable amount of these
assets under paragraph (g) of this
section.
(1) Valuation. The fair value of
mortgage servicing assets, purchased
credit card relationships, nonmortgage
servicing assets, and residual interests
shall be estimated at least quarterly. The
quarterly fair value estimate shall
include adjustments for any significant
changes in the original valuation
assumptions, including changes in
prepayment estimates or attrition rates.
The FDIC in its discretion may require
independent fair value estimates on a
case-by-case basis where it is deemed
appropriate for safety and soundness
purposes.
(2) Fair value limitation. For purposes
of calculating Tier 1 capital under this
part (but not for financial statement
purposes), the balance sheet assets for
mortgage servicing assets, purchased
credit card relationships, and
nonmortgage servicing assets will each
be reduced to an amount equal to the
lesser of:
(i) 90 percent of the fair value of these
assets, determined in accordance with
paragraph (f)(1) of this section; or
(ii) 100 percent of the remaining
unamortized book value of these assets
(net of any related valuation
allowances), determined in accordance
with the instructions for the preparation
of the Consolidated Reports of Income
and Condition (Call Reports).
(3) Tier 1 capital limitation. The
maximum allowable amount of
mortgage servicing assets, purchased
credit card relationships, nonmortgage
servicing assets, and residual interests
in the aggregate, will be limited to the
lesser of:
ny related valuation
allowances), determined in accordance
with the instructions for the preparation
of the Consolidated Reports of Income
and Condition (Call Reports).
(3) Tier 1 capital limitation. The
maximum allowable amount of
mortgage servicing assets, purchased
credit card relationships, nonmortgage
servicing assets, and residual interests
in the aggregate, will be limited to the
lesser of:
(i) 100 percent of the amount of Tier
1 capital that exists before the deduction
of any disallowed mortgage servicing
assets, any disallowed purchased credit
card relationships, any disallowed
nonmortgage servicing assets, any
disallowed residual interests, and any
disallowed deferred tax assets; or
(ii) The sum of the amounts of
mortgage servicing assets, purchased
credit card relationships, and
nonmortgage servicing assets,
determined in accordance with
paragraph (f)(2) of this section, plus the
amount of residual interests determined
in accordance with paragraph
(f)(1) of the section.
(4) Tier 1 capital sublimit. In addition
to the aggregate limitation on mortgage
servicing assets, purchased credit card
relationships, nonmortgage servicing
assets, and residual interests set forth in
paragraph (f)(3) of this section, a
sublimit will apply to purchased credit
card relationships, nonmortgage
servicing assets, and residual interests.
The maximum allowable amount of the
aggregate of purchased credit card
relationships, nonmortgage servicing
assets, and residual interests, will be
limited to the lesser of:
tionships, nonmortgage servicing
assets, and residual interests set forth in
paragraph (f)(3) of this section, a
sublimit will apply to purchased credit
card relationships, nonmortgage
servicing assets, and residual interests.
The maximum allowable amount of the
aggregate of purchased credit card
relationships, nonmortgage servicing
assets, and residual interests, will be
limited to the lesser of:
(i) Twenty-five percent of the amount
of Tier 1 capital that exists before the
deduction of any disallowed mortgage
servicing assets, any disallowed
purchased credit card relationships, any
disallowed nonmortgage servicing
assets, any disallowed residual interests,
and any disallowed deferred tax assets;
or
(ii) The sum of the amounts of
purchased credit card relationships and
nonmortgage servicing assets
determined in accordance with
paragraph (f)(2) of this section, plus the
amount of residual interests determined
in accordance with paragraph (f)(1) of
the section.
(g)(2) * * *
(2) Tier 1 capital limitations. (i) The
maximum allowable amount of deferred
tax assets that are dependent upon
future taxable income, net of any
valuation allowance for deferred tax
assets, will be limited to the lesser of:
(A) The amount of deferred tax assets
that are dependent upon future taxable
income that is expected to be realized
within one year of the calendar quarter-
end date, based on projected future
taxable income for that year; or
(B) Ten percent of the amount of Tier
1 capital that exists before the deduction
of any disallowed mortgage servicing
assets, any disallowed nonmortgage
servicing assets, any disallowed
purchased credit card relationships, any
disallowed residual interests and any
disallowed deferred tax assets.
one year of the calendar quarter-
end date, based on projected future
taxable income for that year; or
(B) Ten percent of the amount of Tier
1 capital that exists before the deduction
of any disallowed mortgage servicing
assets, any disallowed nonmortgage
servicing assets, any disallowed
purchased credit card relationships, any
disallowed residual interests and any
disallowed deferred tax assets.
(iii) For purposes of this limitation, all
existing temporary differences should
be assumed to fully reverse at the
calendar quarter-end date. The recorded
amount of deferred tax assets that are
dependent upon future taxable income,
net of any valuation allowance for
deferred tax assets, in excess of this
limitation will be deducted from assets
and from equity capital for purposes of
determining Tier 1 capital under this
part. The amount of deferred tax assets
that can be realized from taxes paid in
prior carryback years and from the
reversal of existing taxable temporary
differences generally would not be
deducted from assets and from equity
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Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules
2 Preferred stock issues where the dividend is
reset periodically based, in whole or in part, upon
the bank’s current credit standing, including but not
limited to, auction rate, money market or
remarketable preferred stock, are assigned to Tier 2
capital, regardless of whether the dividends are
cumulative or noncumulative.
3 In addition to the core capital elements, Tier 1
may also include certain supplementary capital
elements during the transition period subject to
certain limitations set forth in section III of this
statement of policy.
4 An exception is allowed for intangible assets
that are explicitly approved by the FDIC as part of
the bank’s regulatory capital on a specific case
basis
lative or noncumulative.
3 In addition to the core capital elements, Tier 1
may also include certain supplementary capital
elements during the transition period subject to
certain limitations set forth in section III of this
statement of policy.
4 An exception is allowed for intangible assets
that are explicitly approved by the FDIC as part of
the bank’s regulatory capital on a specific case
basis. These intangibles will be included in capital
for risk-based capital purposes under the terms and
conditions that are specifically approved by the
FDIC.
14 A privately-issued mortgage-backed security
may be treated as an indirect holding of the
underlying assets provided that (1) the underlying
assets are held by an independent trustee and the
trustee has a first priority, perfected security
interest in the underlying assets on behalf of the
holders of the security, (2) either the holder of the
security has an undivided pro rata ownership
interest in the underlying mortgage assets or the
trust or single purpose entity (or conduit) that
issues the security has no liabilities unrelated to the
issued securities (3) the security is structured such
that the cash flow from the underlying assets in all
cases fully meets the cash flow requirements of the
security without undue reliance on any
reinvestment income, and (4) there is no material
reinvestment risk associated with any funds
awaiting distribution to the holders of the security.
In addition, if the underlying assets of a mortgage-
backed security are composed of more than one
type of asset, the entire mortgage-backed security is
generally assigned to the category appropriate to the
highest risk-weighted asset underlying the issue.
capital. However, notwithstanding the
above, the amount of carryback
potential that may be considered in
calculating the amount of deferred tax
assets that a member of a consolidated
group (for tax purposes) may include in
Tier 1 capital may not exceed the
amount which the member could
reasonably expect to have refunded by
its parent
opriate to the
highest risk-weighted asset underlying the issue.
capital. However, notwithstanding the
above, the amount of carryback
potential that may be considered in
calculating the amount of deferred tax
assets that a member of a consolidated
group (for tax purposes) may include in
Tier 1 capital may not exceed the
amount which the member could
reasonably expect to have refunded by
its parent.
*
*
*
*
*
4. In appendix A to part 325:
A. Revise section I.A.l.;
B. In section II:
i. Designate the first two undesignated
paragraphs as sections II.A.l. and II.A.2.,
respectively, and add a new section
II.A.3.;
ii. Revise section II.B.5., and add new
section II.B.7.;
iii. Amend paragraph II.C. by revising
the second paragraph under ‘‘Category
4—100 Percent Risk Weight’’;
C. Revise section III; and
D. Revise Table I to read as follows:
Appendix A to Part 325—Statement of
Policy on Risk-Based Capital
*
*
*
*
*
I. * * *
A. * * *
1. Core capital elements (Tier 1) consists
of:
i. Common stockholders’ equity capital
(includes common stock and related surplus,
undivided profits, disclosed capital reserves
that represent a segregation of undivided
profits, and foreign currency translation
adjustments, less net unrealized holding
losses on available-for-sale equity securities
with readily determinable fair values);
ii. Noncumulative perpetual preferred
stock,2 including any related surplus; and
iii. Minority interests in the equity capital
accounts of consolidated subsidiaries.
At least 50 percent of the qualifying total
capital base should consist of Tier 1 capital.
Core (Tier 1) capital is defined as the sum of
core capital elements3 minus all intangible
assets (other than mortgage servicing assets,
nonmortgage servicing assets and purchased
credit card relationships eligible for
inclusion in core capital pursuant to
§ 325.5(f)) 4 minus residual interests (other
than residual interests eligible for inclusion
in core capital pursuant to § 325.5(f)) and
minus any disallowed deferred tax assets
s the sum of
core capital elements3 minus all intangible
assets (other than mortgage servicing assets,
nonmortgage servicing assets and purchased
credit card relationships eligible for
inclusion in core capital pursuant to
§ 325.5(f)) 4 minus residual interests (other
than residual interests eligible for inclusion
in core capital pursuant to § 325.5(f)) and
minus any disallowed deferred tax assets.
Although nonvoting common stock,
noncumulative perpetual preferred stock,
and minority interests in the equity capital
accounts of consolidated subsidiaries are
normally included in Tier 1 capital, voting
common stockholders’ equity generally will
be expected to be the dominant form of Tier
1 capital. Thus, banks should avoid undue
reliance on nonvoting equity, preferred stock
and minority interests.
Although minority interests in
consolidated subsidiaries are generally
included in regulatory capital, exceptions to
this general rule will be made if the minority
interests fail to provide meaningful capital
support to the consolidated bank. Such a
situation could arise if the minority interests
are entitled to a preferred claim on
essentially low risk assets of the subsidiary.
Similarly, although residual interests and
intangible assets in the form of mortgage
servicing assets, nonmortgage servicing assets
and purchased credit card relationships are
generally recognized for risk-based capital
purposes, the deduction of part or all of the
residual interests, mortgage servicing assets,
nonmortgage servicing assets and purchased
credit card relationships may be required if
the carrying amounts of these rights are
excessive in relation to their market value or
the level of the bank’s capital accounts.
Residual interests, mortgage servicing assets,
nonmortgage servicing assets and purchased
credit card relationships that do not meet the
conditions, limitations and restrictions
described in § 325.5(g) of this part will not
be recognized for risk-based capital purposes.
*
*
*
*
*
II. * * *
A. * * *
3
s are
excessive in relation to their market value or
the level of the bank’s capital accounts.
Residual interests, mortgage servicing assets,
nonmortgage servicing assets and purchased
credit card relationships that do not meet the
conditions, limitations and restrictions
described in § 325.5(g) of this part will not
be recognized for risk-based capital purposes.
*
*
*
*
*
II. * * *
A. * * *
3. The Director of the Division of
Supervision may, on a case-by-case basis,
determine the appropriate risk weight for any
asset that does not fit wholly within one of
the risk categories set forth in sections II.B.
and II.C. of this appendix A or that imposes
risks on a bank that are not commensurate
with the risk weight otherwise specified in
sections II.B. and II.C. of this appendix A for
the asset.
*
*
*
*
*
B. * * *
5. Mortgage-Backed Securities. Mortgage-
backed securities, including pass-throughs
and collateralized mortgage obligations (but
not stripped mortgage-backed securities) that
are issued or guaranteed by a U.S.
Government agency or a U.S. Government-
sponsored agency, normally are assigned to
the risk weight category appropriate to the
issuer or guarantor. Generally, a privately-
issued mortgage-backed security is treated as
essentially an indirect holding of the
underlying assets, and assigned to the same
risk category as the underlying assets, in
accordance with the provisions and criteria
spelled out in detail in the accompanying
footnote;14 however, such privately-issued
mortgage-backed securities may not be
assigned to the zero percent risk category.
Privately-issued mortgage-backed securities
whose structures do not comply with the
specified provisions set forth in the footnote
are assigned to the 100 percent risk category
g assets, in
accordance with the provisions and criteria
spelled out in detail in the accompanying
footnote;14 however, such privately-issued
mortgage-backed securities may not be
assigned to the zero percent risk category.
Privately-issued mortgage-backed securities
whose structures do not comply with the
specified provisions set forth in the footnote
are assigned to the 100 percent risk category.
In addition, any class of a mortgage-backed
security, other than a residual interest, that
can absorb more than its pro rata share of
loss without the whole issue being in default
(for example, a subordinated class) will also
be assigned to the 100 percent risk weight
category. All stripped mortgage-backed
securities, including interest-only strips (IOs)
(unless covered under section II.B.7. of this
appendix A), principal-only strips (POs), and
similar instruments, are assigned to the 100
percent risk weight category, regardless of the
issuer or guarantor.
*
*
*
*
*
7. Residual interests—a. General capital
requirement. All residual interests are subject
to both a residual interest capital requirement
and a capital concentration limitation in
accordance with § 325.5 of this part. In
determining the general capital requirement
for a residual interest, the amount of all
residual interest in excess of the capital
concentration limit must be deducted from
Tier 1 capital, in accordance with § 325.5 of
this part, before the residual interest capital
requirement in this section is applied.
b. Residual interest capital requirement.
Notwithstanding section III. of this appendix
A, a bank must maintain risk-based capital
for a residual interest equal to the amou
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