[Federal Register Volume 60, Number 59 (Tuesday, March 28, 1995)]
[Rules and Regulations]
[Pages 15858-15861]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-7535]
=======================================================================
-----------------------------------------------------------------------
FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 325
RIN 3064-AB60
Capital Maintenance
AGENCY: Federal Deposit Insurance Corporation (FDIC).
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The FDIC is amending its risk-based capital standards for
insured state nonmember banks to implement section 350 of the Riegle
Community Development and Regulatory Improvement Act of 1994 (Riegle
Act). Section 350 states that the amount of risk-based capital required
to be maintained by any insured depository institution, with respect to
assets transferred with recourse, may not exceed the maximum amount of
recourse for which the institution is contractually liable under the
recourse agreement. This rule will have the effect of correcting the
anomaly that currently exists in the risk-based capital treatment of
recourse transactions under which an institution could be required to
hold capital in excess of the maximum amount of loss possible under the
contractual terms of the recourse obligation.
EFFECTIVE DATE: April 27, 1995.
FOR FURTHER INFORMATION CONTACT: Robert F. Storch, Chief, Accounting
Section, Division of Supervision, (202) 898-8906, or Cristeena G.
Naser, Attorney, Legal Division, (202) 898-3587, Federal Deposit
Insurance Corporation, 550 17th Street, NW., Washington, D.C. 20429.
SUPPLEMENTARY INFORMATION:
I. Background
The FDIC's current regulatory capital standards are intended to
ensure that FDIC-supervised banks that transfer assets and retain the
credit risk inherent in the assets maintain adequate capital to support
that risk. This is generally accomplished by requiring that bank assets
transferred with recourse continue to be reported on the balance sheet
in the Reports of Condition and Income (Call Reports). These amounts
are thus included in the calculation of banks' risk-based and leverage
capital ratios. The regulatory reporting treatment for most asset
transfers with recourse differs from the treatment of such transactions
under generally accepted accounting principles (GAAP).\1\
\1\The GAAP treatment focuses on the transfer of benefits rather
than the retention of risk and, thus, allows a transfer of
receivables with recourse to be accounted for as a sale if the
transferor: (1) Surrenders control of the future economic benefits
of the assets; (2) is able to reasonably estimate its obligations
under the recourse provision; and (3) is not obligated to repurchase
the assets except pursuant to the recourse provision. In addition,
the transferor must establish a separate liability account equal to
the estimated probable losses under the recourse provision (GAAP
recourse liability account). [[Page 15859]]
---------------------------------------------------------------------------
In cases where an institution retains a low level of recourse, the
amount of capital required under the FDIC's risk-based capital
standards could exceed the institution's maximum contractual liability
under the recourse agreement. This can occur in transactions in which a
bank contractually limits its recourse exposure to less than the full
effective risk-based capital requirement for the assets transferred--
generally, four percent for residential mortgage loans and eight
percent for most other assets.
The FDIC and the other federal banking agencies have long
recognized this anomaly in the risk-based capital standards. On May 25,
1994, the banking agencies, acting upon a recommendation by the Federal
Financial Institutions Examination Council, issued a Notice of Proposed
Rulemaking (NPR) (59 FR 27116) addressing the risk-based capital
treatment of recourse and direct credit substitutes. One of the
principal features of the NPR was a proposal to amend the banking
agencies' risk-based capital standards to limit the capital charge in
low level recourse transactions to an institution's maximum contractual
recourse liability. The proposal for these types of transactions would
effectively result in a one dollar capital charge for each dollar of
low level recourse exposure, up to the full effective risk-based
capital requirement on the underlying assets.
The proposal requested specific comment on whether an institution
should be able to use the balance of the GAAP recourse liability
account to reduce the dollar-for-dollar capital charge for the recourse
exposure on assets transferred with low level recourse in a transaction
reported as a sale for Call Report purposes. In addition, the proposal
indicated that the capital requirement for an exposure to low level
recourse retained in a transaction associated with a swap of mortgage
loans for mortgage-related securities would be the lower of the capital
charge for the swapped mortgages or the combined capital charge for the
low level recourse exposure and the mortgage-related securities,
adjusted for any double counting.
The NPR also addressed other issues related to recourse
transactions, including equivalent capital treatment of recourse
arrangements and direct credit substitutes that provide first dollar
loss protection and definitions for ``recourse'' and associated terms
such as ``standard representations and warranties.'' The NPR was issued
in conjunction with an Advance Notice of Proposed Rulemaking (ANPR)
that outlined a possible alternative approach to deal comprehensively
with the risk-based capital treatment of asset securitizations and any
associated recourse arrangements and direct credit substitutes. The
comment period for the NPR and ANPR ended on July 25, 1994.
During the agencies' review of the comments received, the Riegle
Act was signed into law on September 23, 1994. Section 350 of the Act
requires the federal banking agencies to issue regulations not later
than March 22, 1995, limiting the amount of risk-based capital an
insured depository institution is required to hold for assets
transferred with recourse to the maximum amount of recourse for which
the institution is contractually liable. In order to meet the statutory
requirements of section 350, the FDIC is now issuing a rule that puts
into final form only those portions of the NPR dealing with low level
recourse transactions.
II. Comments Received
In response to the NPR and ANPR, the FDIC received comment letters
from 37 entities. Of these respondents, 25 addressed issues related to
the NPR's proposed low level recourse capital treatment. These
commenters included 12 banking organizations, nine trade associations,
one government-sponsored agency, and three other commenters. Of these
25 respondents, 22 provided a favorable overall assessment of the low
level recourse proposal. In general, these respondents viewed the low
level proposal as a way of correcting an anomaly in the existing risk-
based capital standards so that institutions would not be required to
hold capital in excess of their contractual liability.
Nevertheless, seven of the commenters further indicated that, while
the proposed low level recourse capital treatment was a positive step,
it still would result in too high of a capital requirement for assets
sold with limited recourse. These respondents, which included five of
the 12 banking organizations and two of the nine trade associations,
expressed the view that the banking agencies should adopt the GAAP
treatment of assets sold with recourse for purposes of calculating the
regulatory capital ratios. These commenters maintained that the GAAP
recourse liability account provides adequate protection against the
risk of loss on assets sold with recourse, obviating the need for
additional capital.
The NPR specifically sought comment on five issues related to the
proposed capital treatment of low level recourse transactions. Twelve
of the 25 respondents commented on the first issue, which concerned the
treatment of the GAAP recourse liability account established for assets
sold with recourse reported as sales in the Call Report. These 12
commenters favored reducing the capital requirement for low level
recourse transactions by the balance of the related GAAP recourse
liability account, which would continue to be excluded from an
institution's regulatory capital. In their view, not taking the GAAP
recourse liability account into consideration would result in double
coverage of the portion of the risk provided for in that account.
Twelve commenters, including five banking organizations and five
trade associations, responded to the second issue, which sought comment
on whether a dollar-for-dollar capital requirement would be too high
for low level recourse transactions. Ten commenters indicated that such
a capital charge would be too high since it was unlikely that an
institution would incur losses up to its maximum contractual liability.
Two others responded that whether the capital treatment was too high
depended upon the credit quality of the underlying asset pool and the
structure of the securitization.
The third issue dealt with ways of demonstrating that the dollar-
for-dollar capital requirement might be too high and possible methods
for reducing this requirement without jeopardizing safety and
soundness. The nine commenters on this issue indicated that historical
analysis, examiner review, and ``depression scenario'' stress testing
would show whether the capital requirement would be too high relative
to historical losses.
The fourth issue concerned ways the banking agencies could handle
the increased probability of loss to the insurance funds administered
by the FDIC if less than dollar-for-dollar capital is maintained
against low level recourse transactions. The eight commenters on this
issue stated that as long as the amount of required capital held
against the low level recourse transactions was prudently assessed
based upon expected losses, actual losses would seldom, if ever, exceed
the capital requirement. [[Page 15860]] Thus, the insurance funds would
not likely experience losses.
The fifth issue sought comment on whether the proposed low level
recourse capital treatment would reduce transaction costs or otherwise
help to facilitate the sale or securitization of banks' assets. The
eight commenters that responded to this issue were all of the opinion
that the low level capital treatment generally would help lower
transaction costs and help facilitate securitization.
III. Final Rule
After considering the comments received, further deliberating on
the issues involved, particularly the requirements of section 350 of
the Riegle Act, and consulting with the other banking agencies, the
FDIC is adopting a final rule amending its risk-based capital standards
with respect to the treatment of low level recourse transactions.
Specifically, the final amendment implements section 350 by reducing
the risk-based capital requirements for all recourse transactions in
which an FDIC-supervised bank contractually limits its recourse
exposure to less than the full, effective risk-based capital
requirement for the assets transferred.
This rule applies to low level recourse transactions involving all
types of assets, including small business loans, commercial loans,
multifamily housing loans, and residential mortgages. In this regard,
the FDIC notes that previously under the risk-based capital standards
certain residential mortgage loans transferred with recourse were
excluded from risk-weighted assets if the institution did not retain
significant risk of loss.\2\ As proposed, this treatment would be
superseded by the broader low level recourse rule that the FDIC is
adopting.
\2\Under this treatment, a pool of residential mortgages that
had been transferred with recourse was excluded from risk-weighted
assets if the transferring institution did not retain significant
risk of loss, i.e., the institution's maximum contractual recourse
exposure did not exceed its reasonably estimated probable losses on
the transferred mortgages, and the institution established and
maintained a recourse liability account equal to the maximum amount
of its recourse obligation. Under the low level recourse rule, this
type of sale transaction would effectively continue to be excluded
from risk-weighted assets because of the size of the recourse
liability account that must be maintained.
---------------------------------------------------------------------------
Under the final low level recourse rule, an FDIC-supervised bank
that contractually limits its maximum recourse obligation to less than
the full effective risk-based capital requirement for the transferred
assets would be required to hold risk-based capital equal to the
contractual maximum amount of its recourse obligation. This requirement
limits to one dollar the capital charge for each dollar of low-level
recourse exposure. Under this dollar-for-dollar capital requirement,
the capital charge for a 100 percent risk-weighted asset transferred
with three percent recourse would be three percent of the amount of the
transferred assets, rather than the eight percent previously required.
Thus, a bank's risk-based capital requirement on a low level recourse
transaction would not exceed the contractual maximum amount it could
lose under the recourse obligation.
Under the final rule, an institution may reduce the dollar-for-
dollar capital charge held against the recourse exposure on assets
transferred with low level recourse for a transaction reported as a
sale for Call Report purposes by the balance of any associated
noncapital GAAP recourse liability account. In adopting this aspect of
the final rule, the FDIC concurs with commenters that indicated that
nonrecognition of the liability account would result in double coverage
of the portion of the credit risk provided for in that account.
In applying the final rule, the FDIC will, as proposed, limit the
risk-based capital requirement for an exposure to low level recourse
retained in a transaction associated with a swap of mortgage loans for
mortgage-related securities to the lower of the capital charge for the
swapped mortgages or the combined capital charge for the low level
recourse exposure and the mortgage-related securities, adjusted for any
double counting.
In setting forth this final rule, the FDIC has considered the
arguments that several commenters made for adopting for regulatory
capital purposes the GAAP treatment for all assets sold with recourse,
including those sold with low levels of recourse. Under such a
treatment, assets sold with recourse in accordance with GAAP would have
no capital requirement, but the GAAP recourse liability account would
provide some level of protection against losses. Nevertheless, the FDIC
continues to believe it would not be appropriate to adopt for
regulatory capital purposes the GAAP treatment of recourse
transactions, even if the transferring bank retains only a low level of
recourse.
In the FDIC's view, the GAAP recourse liability account would be an
inadequate substitute for maintaining capital at a level commensurate
with the risks. One of the principal purposes of regulatory capital is
to provide a cushion against unexpected losses. In contrast, the GAAP
recourse liability account is, in effect, a specific reserve that is
intended to cover only an institution's probable expected losses under
the recourse provision. In this regard, the FDIC notes that the risk-
based capital standards explicitly state that specific reserves created
against identified losses may not be included in regulatory capital.
In addition, the amount of credit risk that is typically retained
in a recourse transaction greatly exceeds the normal expected losses
associated with the transferred assets. Thus, even though a
transferring institution may reduce its exposure to potential
catastrophic losses by limiting the amount of recourse it provides, it
may still retain, in many cases, the bulk of the risk inherent in the
assets. For example, an institution transferring high quality assets
with a reasonably estimated expected loss rate of one percent that
retains ten percent recourse in the normal course of business will
sustain the same amount of losses it would have had the assets not been
transferred. This occurs because the amount of exposure under the
recourse provision is very high relative to the amount of expected
losses. The FDIC believes that in such transactions the transferor has
not significantly reduced its risk for purposes of assessing regulatory
capital and should continue to be assessed regulatory capital as though
the assets had not been transferred.
The FDIC is issuing this final rule now in order to implement
section 350 of the Riegle Act in accordance with the statutory
deadline. Consequently, the rule deals with only those portions of the
NPR concerned with low level recourse transactions. The FDIC will
continue to consider, on an interagency basis, other aspects of the
NPR, as well as all aspects of the ANPR that was issued in conjunction
with the NPR.
This final rule is effective April 27, 1995. However, FDIC-
supervised banks may choose to apply the low level recourse rule when
completing the risk-based capital schedule (Schedule RC-R) in their
Reports of Condition and Income (Call Reports) for March 31, 1995.
IV. Regulatory Flexibility Act Analysis
The purpose of this final rule is to reduce the risk-based capital
requirement on transfers of assets with low levels of recourse.
Therefore, pursuant to section 605(b) of the Regulatory Flexibility
Act, the FDIC hereby certifies that this rule will have a beneficial
economic impact on small business entities (in this case, small banks)
that sell assets with low levels of recourse. [[Page 15861]]
V. Paperwork Reduction Act
The FDIC has determined that, in comparison to the existing risk-
based capital treatment of low level recourse transactions, this final
rule will not increase the regulatory paperwork burden of FDIC-
supervised banks pursuant to the provisions of the Paperwork Reduction
Act (44 U.S.C. 3501 et seq.).
List of Subjects in 12 CFR Part 325
Bank deposit insurance, Banks, banking, Capital adequacy, Reporting
and recordkeeping requirements, Savings associations, State nonmember
banks.
For the reasons set forth in the preamble, the Board of Directors
of the Federal Deposit Insurance Corporation hereby amends part 325 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, 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, 2386 (12 U.S.C. 1828 note).
2. Section II.D.1. of appendix A to part 325 is amended by removing
the sixth paragraph and adding in its place two new paragraphs to read
as follows:
Appendix A to Part 325--Statement of Policy on Risk-Based Capital
* * * * *
II. * * *
D. * * *
1. * * *
Sale and repurchase agreements and asset sales with recourse, if
not already included on the balance sheet, are also converted at 100
percent. For risk-based capital purposes, the definition of sales of
assets with recourse, including the sale of one-to-four family
residential mortgages, is consistent with the definition contained in
the instructions for the preparation of the Consolidated Reports of
Condition and Income. Accordingly, except as noted below, the entire
amount of any assets transferred with recourse that are not already
included on the balance sheet, including pools of one-to-four family
residential mortgages, is to be converted at 100 percent and assigned
to the risk weight category appropriate to the obligor or, if relevant,
the guarantor or the nature of the collateral. The terms of a transfer
of assets with recourse may contractually limit the amount of the
bank's liability to an amount less than the effective risk-based
capital requirement for the assets being transferred with recourse. If
such a transaction (including one that, in accordance with the
instructions for the preparation of the Consolidated Reports of
Condition and Income, is reported as a financing, i.e., the assets are
not removed from the balance sheet) meets the criteria for sale
treatment under generally accepted accounting principles, the amount of
total capital required is equal to the maximum amount of loss possible
under the recourse provision. If the transaction is also treated as a
sale in accordance with the instructions for the preparation of the
Consolidated Reports of Condition and Income, then the required amount
of capital may be reduced by the balance of any associated noncapital
liability account established pursuant to generally accepted accounting
principles to cover estimated probable losses under the recourse
provision. So-called ``loan strips'' (that is, short-term advances sold
under long-term commitments without direct recourse) are defined in the
instructions for the preparation of the Consolidated Reports of
Condition and Income and for risk-based capital purposes as assets sold
with recourse.
In addition, a 100 percent conversion factor applies to forward
agreements. Forward agreements are legally binding contractual
obligations to purchase assets with drawdown which is certain at a
specified future date. These obligations include forward purchases,
forward deposits placed, and partly paid shares and securities, but do
not include forward foreign exchange rate contracts or commitments to
make residential mortgage loans.
* * * * *
By order of the Board of Directors.
Dated at Washington, D.C., this 21st day of March, 1995.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Acting Executive Secretary.
[FR Doc. 95-7535 Filed 3-27-95; 8:45 am]
BILLING CODE 6714-01-P
