[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