[Federal Register Volume 77, Number 142 (Tuesday, July 24, 2012)]
[Rules and Regulations]
[Pages 43155-43157]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17854]


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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 362


Guidance on Due Diligence Requirements for Savings Associations 
in Determining Whether a Corporate Debt Security Is Eligible for 
Investment

AGENCY: Federal Deposit Insurance Corporation.

ACTION: Final guidance.

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SUMMARY: On December 15, 2011, the FDIC proposed guidance to assist 
savings associations in conducting due diligence to determine whether a 
corporate debt security is eligible for investment under the Proposed 
Rule. Today, the FDIC is finalizing the guidance. The final guidance 
document includes clarifying language adopted in the final rule, but 
otherwise, is being finalized as proposed.

DATES: Effective Date: This guidance is effective July 21, 2012.

FOR FURTHER INFORMATION CONTACT: Kyle Hadley, Chief, Examination 
Support Section, (202) 898-6532, Division of Risk Management 
Supervision; Eric Reither, Capital Markets Specialist, (202) 898-3707, 
Division of Risk Management Supervision; Suzanne Dawley, Senior 
Attorney, Bank Activities Section, (202) 898-6509; or Rachel Jones, 
Attorney, Bank Activities Section, (202) 898-6858.

SUPPLEMENTARY INFORMATION:

Background

    Effective on July 21, 2012, section 939(a) (``section 939(a)'') of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank Act'') amends section 28(d) (``section 28(d)'') of the Federal 
Deposit Insurance Act (``FDI Act'') to prohibit a savings association 
from acquiring or retaining a corporate debt security that does not 
satisfy creditworthiness standards established by the Federal Deposit 
Insurance Corporation (``FDIC''). On December 15, 2011, the FDIC 
published for public comment a proposed rule (``Proposed Rule'' or 
``NPR'') to implement the requirements of section 939(a). Under the 
Proposed Rule, an insured savings association would be prohibited from 
acquiring or retaining a corporate debt security unless it determines, 
prior to acquiring the security and periodically thereafter, that the 
issuer has adequate capacity to satisfy all financial commitments under 
the security for the projected life of the investment. The final rule 
clarifies the proposed creditworthiness standard; in the final rule, 
the phrase ``the projected life of the investment'' has been revised to 
``the projected life of the security'' to more closely track the 
language in the Office of the Comptroller of the Currency's (OCC) final 
rule. Today, the final rule is being published in the Federal Register.
    Under Section 28(d) of the FDI Act, federal and state savings 
associations generally are prohibited from acquiring or retaining, 
either directly or indirectly through a subsidiary, a corporate debt 
security that is rated below investment

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grade. Section 939(a) amends Section 28(d) by replacing the investment-
grade standard with a requirement that any corporate debt security 
investment by a savings association satisfy standards of 
creditworthiness established by the FDIC. This amendment is effective 
for all savings associations on July 21, 2012.
    On December 15, 2011, the FDIC issued the proposed guidance 
document together with the Proposed Rule, to seek comment on the FDIC's 
proposed implementation of Section 939(a). Specifically, the NPR 
proposed to amend section 362.11(b) of the FDIC's regulations to 
prohibit an insured savings association from acquiring or retaining a 
corporate debt security unless it determines, prior to acquisition and 
periodically thereafter, that the issuer has adequate capacity to 
satisfy all financial commitments under the security for the projected 
life of the investment. For purposes of the NPR, an issuer would 
satisfy this requirement if, based on the assessment of the savings 
association, the issuer presents a low risk of default and is likely to 
make full and timely repayment of principal and interest. The proposed 
guidance document sets forth the criteria a savings association should 
expect to consider in making such a determination.
    The FDIC received five comments on the proposed rule and guidance 
document from bank trade groups, a bank, and an individual. The 
commenters generally supported the Proposed Rule and stated that it 
presented a workable alternative to the use of credit ratings.
    Some commenters stated that the ``one-size fits-all'' due diligence 
requirements would create an undue burden for smaller savings 
associations. The FDIC believes that the proposed standard of 
creditworthiness and the due diligence required to meet it are 
consistent with those under prior ratings-based standards and existing 
due diligence requirements and guidance. Even under the prior ratings-
based standards, savings associations of all sizes should not rely 
solely on a credit rating to evaluate the credit risk of a security, 
and consistently have been advised through guidance and other 
supervisory materials to supplement any use of credit ratings with 
additional research on the credit risk of a particular security. 
Savings associations, regardless of size, should not purchase 
securities for which they do not understand the relevant risks.
    After considering the comments and the issues raised, the FDIC has 
decided to finalize the guidance with the clarifying revisions adopted 
in the final rule, but otherwise as proposed. Elsewhere in today's 
Federal Register, the FDIC also has published a final rule to amend the 
FDIC's regulations in accordance with the requirements of Section 
28(d). Both the final rule and final guidance document are effective as 
of July 21, 2012. The final rule provides for a transition period until 
January 1, 2013 to provide savings associations time to come into 
compliance with the final rule and guidance.

Final Guidance

    The final guidance document provides supervisory expectations for 
savings associations conducting due diligence to determine whether a 
corporate debt securities investment satisfies the creditworthiness 
requirements of the final rule--that is, whether the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the security. The FDIC expects 
savings associations to conduct appropriate ongoing reviews of their 
corporate debt investment portfolios to ensure that the composition of 
the portfolio is consistent with safety and soundness principles and 
appropriate for the risk profile of the institution as well as the size 
and complexity of the portfolio.

Text of Final Guidance

    The text of the final supervisory guidance regarding the FDIC's 
expectations for insured savings associations conducting due diligence 
to assess the credit risk of a corporate debt security, in accordance 
with the requirements of 12 CFR 362.11(b), follows.

Purpose

    The Federal Deposit Insurance Corporation (``FDIC'') is issuing 
this guidance document (``Guidance'') to establish supervisory 
expectations for savings associations conducting due diligence to 
determine whether a corporate debt security is eligible for investment 
under 12 CFR part 362. Section 362.11(b) of the FDIC's regulations 
implements Section 28(d) of the FDI Act (as amended by section 939(a) 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act), and 
prohibits an insured savings association from acquiring or retaining a 
corporate debt security unless it determines, prior to acquiring the 
security and periodically thereafter, that the issuer has adequate 
capacity to satisfy all financial commitments under the security for 
the projected life of the security. An issuer satisfies this 
requirement if, based on the assessment of the savings association, the 
issuer presents a low risk of default and is likely to make full and 
timely repayment of principal and interest. The investment also must be 
consistent with safe and sound banking practices.

Background

    Part 362 of the FDIC's regulations sets forth the requirements for 
determining whether securities have appropriate credit quality and 
marketability characteristics to be purchased and held by insured 
savings associations. Under section 362.11(b), a savings association 
may acquire or retain a corporate debt security only if the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the security. An issuer satisfies 
this requirement if, based on the assessment of the savings 
association, the issuer presents a low risk of default and is likely to 
make full and timely repayment of principal and interest.
    Savings associations must be able to demonstrate that their 
investment securities meet applicable credit quality standards. This 
Guidance sets forth criteria that savings associations should consider 
when conducting due diligence to determine whether a security is 
eligible for investment under part 362.
    The federal banking agencies have maintained long-standing 
supervisory guidance that banks and savings associations implement a 
risk management process to ensure that credit risk, including the 
credit risk of an investment portfolio, is effectively identified, 
measured, monitored, and controlled. The 1998 Interagency Supervisory 
Policy Statement on Investment Securities and End-User Derivatives 
Activities (Policy Statement) provides risk management standards for 
the securities investment activities of banks and savings 
associations.\1\ The Policy Statement emphasizes the importance of an 
institution conducting a thorough credit risk analysis before and 
periodically after the acquisition of a security. Such analysis would 
allow an institution to understand and effectively manage the risks 
within its investment portfolio, including credit risk, and is an 
essential element of a sound investment portfolio risk management 
framework. The Policy

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Statement is generally consistent with the agencies' Uniform Agreement 
on the Classification of Assets and Appraisal of Securities Held by 
Banks and Thrifts, which describes the importance of management's 
credit risk analysis and its use in examiner decisions concerning 
investment security risk ratings and classifications.\2\
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    \1\ On April 23, 1998, the FDIC, together with the Federal 
Reserve Board, National Credit Union Administration, Office of the 
Comptroller of the Currency, and Office of Thrift Supervision, 
issued the ``Supervisory Policy Statement on Investment Securities 
and End-User Derivatives Activities.'' As issued by the OTS, the 
Policy Statement applied to both state and Federal savings 
associations.
    \2\ See, FDIC Financial Institution Letter, 70-2004 (June 15, 
2004).
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Determining Whether Securities Are Permissible Prior to Purchase

    The FDIC expects savings associations to conduct an appropriate 
level of due diligence in determining whether a corporate debt security 
is eligible for investment under 12 CFR 362.11(b). This may include 
consideration of internal analyses, third-party research and analytics 
including internal risk ratings, external credit ratings, default 
statistics, and other sources of information appropriate for the 
particular security. The depth of the due diligence should be a 
function of the security's credit quality, the complexity of the 
issuer's financial structure, and the size of the investment. As an 
issuer's financial structure becomes more complex, the more credit-
related due diligence an institution should perform, even when the 
credit quality is perceived to be very high. Management should ensure 
they understand the security's structure and how the security will 
perform in various scenarios throughout the business cycle. The FDIC 
expects savings associations to consider a variety of factors relevant 
to the particular security when determining whether a security is a 
permissible and sound investment. The range and type of specific 
factors an institution should consider will vary depending on the 
particular type and nature of the security. As a general matter, a 
savings association will have a greater burden to support its 
determination if one factor is contradicted by a finding under another 
factor.
    Although part 362 does not provide specific investment quality 
requirements, savings associations should conduct an appropriate level 
of due diligence prior to purchasing a corporate debt security to 
ensure that it is eligible for investment under part 362. A savings 
association should review and update this analysis periodically, as 
appropriate for the size and risk profile of the security. By way of 
example, appropriate factors a savings association should consider 
include, but should not be limited to, the following:
    [ssquf] Confirm spread to U.S. Treasuries is consistent with bonds 
of similar credit quality;
    [ssquf] Confirm risk of default is low and consistent with bonds of 
similar credit quality;
    [ssquf] Confirm capacity to pay through internal credit analysis 
that can be supplemented with other third-party analytics;
    [ssquf] Understand applicable market demographics/economics; and
    [ssquf] Understand current levels and trends in operating margins, 
operating efficiency, profitability, return on assets and return on 
equity.

Maintaining an Appropriate and Effective Portfolio Risk Management 
Framework

    Savings associations should have in place an appropriate risk 
management framework for the level of risk in their corporate debt 
investment portfolios. Failure to maintain an adequate investment 
portfolio risk management process, which includes understanding key 
portfolio risks, is considered an unsafe and unsound practice. Savings 
associations should conform to safe and sound banking practices and, 
similarly, should consider appropriate investment portfolio risks in 
connection with the acquisition of a corporate debt security.\3\
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    \3\ See supra footnote 1.
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    Having a strong and robust risk management framework appropriate 
for the level of risk of a savings association's investment portfolio 
is particularly critical for managing portfolio credit risk. A key role 
for management in the oversight process is to translate the risk 
tolerance levels established by the board of directors into a set of 
internal operating policies and procedures that govern the 
institution's investment activities. Specifically, investment policies 
should provide credit risk concentration limits. Such limits may apply 
to concentrations relating to a single or related issuer, a 
geographical area, and obligations with similar characteristics. 
Savings associations with investment portfolios that lack 
diversification in one of the aforementioned areas should enhance their 
monitoring and reporting systems. Safety and soundness principles 
warrant effective concentration risk management programs to ensure that 
credit exposures do not reach an excessive level.
    Savings associations should identify and measure the risks of their 
investments periodically after acquisition. Such analyses allow an 
institution to understand and effectively manage the risks of its 
investment portfolio, including credit risk, and are an essential 
element of a sound investment portfolio risk management framework. 
Exposure to each type of risk for each security should be measured and 
aggregated with similar exposures on an institution-wide basis. Risk 
measurement should be obtained from sources independent of sellers or 
counterparties and should be periodically validated. Irrespective of 
any contractual or other arrangements, savings associations are 
responsible for understanding and managing the risks of all of their 
investments.

    By order of the Board of Directors.

    Dated at Washington, DC, this 18th day of July, 2012.

Federal Deposit Insurance Corporation
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2012-17854 Filed 7-20-12; 11:15 am]
BILLING CODE 6714-01-P