[Federal Register Volume 77, Number 211 (Wednesday, October 31, 2012)]
[Rules and Regulations]
[Pages 65999-66024]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-25943]
[[Page 65999]]
Vol. 77
Wednesday,
No. 211
October 31, 2012
Part III
Federal Deposit Insurance Corporation
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12 CFR Part 327
Assessments, Large Bank Pricing; Final Rule
Federal Register / Vol. 77 , No. 211 / Wednesday, October 31, 2012 /
Rules and Regulations
[[Page 66000]]
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FEDERAL DEPOSIT INSURANCE CORPORATION
12 CFR Part 327
RIN 3064-AD92
Assessments, Large Bank Pricing
AGENCY: Federal Deposit Insurance Corporation (FDIC).
ACTION: Final rule.
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SUMMARY: The FDIC is amending its regulations by revising some of the
definitions used to determine assessment rates for large and highly
complex insured depository institutions.
DATES: Effective date: April 1, 2013.
FOR FURTHER INFORMATION CONTACT: Scott Ciardi, Chief, Large Bank
Pricing Section, Division of Insurance and Research, (202) 898-7079;
Brenda Bruno, Senior Financial Analyst, Division of Insurance and
Research, (630) 241-0359 x 8312; Christopher Bellotto, Counsel, Legal
Division, (202) 898-3801.
SUPPLEMENTARY INFORMATION:
I. Background
On February 7, 2011, the FDIC Board adopted a final rule that
amended its assessment regulations, by, among other things,
establishing a new methodology for determining assessment rates for
large and highly complex institutions (the February 2011
rule).1 2 The February 2011 rule eliminated risk categories
for large banks \3\ and created two scorecards, one for highly complex
banks and another for all other large banks, that combine CAMELS
ratings and certain forward-looking financial ratios. The scorecards
calculate a total score for each institution.\4\ The total score is
then converted to the bank's initial base assessment rate, which, after
certain adjustments, results in the institution's total assessment
rate.\5\ To calculate the amount of the bank's quarterly assessment,
the total assessment rate is multiplied by the bank's assessment base
and the result is divided by four.
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\1\ 12 CFR 327.9.
\2\ A large institution is defined as an insured depository
institution: (1) That had assets of $10 billion or more as of
December 31, 2006 (unless, by reporting assets of less than $10
billion for four consecutive quarters since then, it has become a
small institution); or (2) that had assets of less than $10 billion
as of December 31, 2006, but has since had $10 billion or more in
total assets for at least four consecutive quarters, whether or not
the institution is new. A ``highly complex institution'' is defined
as: (1) An insured depository institution (excluding a credit card
bank) that has had $50 billion or more in total assets for at least
four consecutive quarters and that either is controlled by a U.S.
parent holding company that has had $500 billion or more in total
assets for four consecutive quarters, or is controlled by one or
more intermediate U.S. parent holding companies that are controlled
by a U.S. holding company that has had $500 billion or more in
assets for four consecutive quarters, and (2) a processing bank or
trust company. A processing bank or trust company is an insured
depository institution whose last three years' non-lending interest
income, fiduciary revenues, and investment banking fees, combined,
exceed 50 percent of total revenues (and its last three years
fiduciary revenues are non-zero), whose total fiduciary assets total
$500 billion or more and whose total assets for at least four
consecutive quarters have been $10 billion or more.
\3\ The terms ``bank'' and ``institution'' are used
interchangeably in the preamble of the final rule, unless the
context suggests otherwise. Again, unless the context suggests
otherwise, the terms include any insured depository institution that
meets the definition of a large institution or highly complex
institution as defined in 12 CFR 327.9(f) and (g).
\4\ A large or highly complex institution's total score may be
adjusted by the large bank adjustment. 12 CFR 327.9(b)(3).
\5\ An institution's initial base assessment rate can be
adjusted by the unsecured debt adjustment, the depository
institution debt adjustment, and, for some institutions, the
brokered deposit adjustment. 12 CFR 327.9(d).
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One of the financial ratios used in the scorecards is the ratio of
higher-risk assets to Tier 1 capital and reserves.\6\ Higher-risk
assets are defined in the February 2011 rule as the sum of construction
and land development (C&D) loans, leveraged loans, subprime loans, and
nontraditional mortgage loans. The FDIC used existing interagency
guidance to define leveraged loans, nontraditional mortgage loans, and
subprime loans but refined the definitions to ensure consistency in
reporting. In arriving at these definitions, the FDIC took into account
comments that were received in response to the two notices of proposed
rulemaking that led to adoption of the February 2011 rule.\7\
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\6\ Higher-risk assets are used to calculate the concentration
score, which is part of both the large bank scorecard and the highly
complex institution scorecard. For large banks, the concentration
score is defined as the higher of: (a) The higher-risk assets to
Tier 1 capital and reserves score or (b) the growth-adjusted
portfolio concentration score. For highly complex institutions, it
is defined as the higher of: (a) The higher-risk assets to Tier 1
capital and reserves score, (b) the largest counterparty exposure to
Tier 1 capital and reserves score, or (c) the top 20 counterparty
exposure to Tier 1 capital and reserves score.
\7\ 75 FR 23516 (May 3, 2010); 75 FR 72612 (November 24, 2010).
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While institutions already reported C&D loan data in their
quarterly reports of condition and income (the Call Reports and the
Thrift Financial Reports or TFRs), they did not report the data for the
other loans, thus requiring new line items in these reports. Therefore,
on March 16, 2011, the Office of the Comptroller of the Currency, the
Board of Governors of the Federal Reserve System, the Office of Thrift
Supervision, and the FDIC (collectively, the agencies) published a
Paperwork Reduction Act of 1995 (PRA) notice under normal PRA clearance
procedures requesting comment on proposed revisions to the reports that
would provide the data needed by the FDIC to implement the February
2011 rule beginning with the June 30, 2011, report date (March PRA
notice).\8\
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\8\ 76 FR 14460 (March 16, 2011).
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Commenters on the March PRA notice raised concerns about their
ability to report subprime and leveraged loan data consistent with the
definitions used in the February 2011 rule. They also stated that they
would be unable to report the required data by the June 30, 2011 report
date. These data concerns had not been raised during the rulemaking
process leading up to the February 2011 rule.\9\
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\9\ In response to the November 2010 NPR on the revised large
institution assessment system, the FDIC received a number of
comments recommending changes to the definitions of subprime and
leveraged loans, which the FDIC took into account in its February
2011 rule amending its assessment regulations. For example, several
commenters on the November 2010 NPR stated that updating data to
evaluate loans for subprime or leveraged status would be burdensome
and costly, and for certain types of retail loans, would be
impossible because existing loan agreements do not require borrowers
to routinely provide updated financial information. In response to
these comments, the FDIC's February 2011 rule stated that large
institutions should evaluate loans for subprime or leveraged status
upon origination, refinance, or renewal. No comments, however, were
received on the November 2010 NPR indicating that large institutions
would be unable to identify and report subprime or leveraged loans
in accordance with the final rule's definitions in their Call
Reports and TFRs beginning as of June 30, 2011. The data
availability concerns were first raised in comments on the March PRA
notice.
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As a consequence of this unexpected difficulty, the FDIC applied to
the Office of Management and Budget (OMB) for an emergency clearance
request to allow large and highly complex institutions to identify and
report subprime and leveraged loans and securitizations originated or
purchased prior to October 1, 2011, using either their existing
internal methodologies or the definitions in existing supervisory
guidance. The agencies also submitted corresponding reporting revisions
under normal PRA clearance procedures and requested public comment on
July 27, 2011 (July PRA notice).\10\
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\10\ 76 FR 44987 (July 27, 2011).
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In response to the PRA notices, commenters recommended extending
the transition guidance for reporting subprime and leveraged loans
until more workable and accurate definitions were developed.
On September 28, 2011, the FDIC informed large and highly complex
institutions via email (followed by
[[Page 66001]]
changes to Call Report instructions) that the deadline for the
transition guidance would be extended to April 1, 2012, and that the
FDIC would review the definitions of subprime and leveraged loans to
determine whether changes to the definitions would alleviate
commenters' concerns without sacrificing accuracy in determining risk
for deposit insurance pricing purposes. The FDIC subsequently extended
the deadline for the transition guidance to April 1, 2013.
The FDIC considered all comments related to the higher-risk asset
definitions that were submitted in response to the March and July 2011
PRA notices as part of its review. The FDIC also engaged in extensive
discussions with bankers and industry trade groups to better understand
their concerns and to solicit potential solutions to these concerns. As
a result, the FDIC issued a notice of proposed rulemaking on March 20,
2012 (NPR) to resolve the problems raised in comments on the March and
July PRA notices.
II. Comments Received
The FDIC sought comments on every aspect of the proposed rule. The
FDIC received a total of 14 comment letters.\11\ The FDIC also
conducted meetings with commenters and others. Summaries of these
meetings are posted on the FDIC's Web site.\12\
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\11\ The FDIC also received a number of emails from commenters
and other interested parties.
\12\ http://www.fdic.gov/regulations/laws/federal/2012/2012-ad92.html.
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Comments are discussed in the relevant sections that follow.
III. The Final Rule: Assessment System for Large and Highly Complex
Institutions
The FDIC has adopted this final rule to amend the assessment system
for large and highly complex institutions by: (1) Revising the
definitions of certain higher-risk assets, specifically leveraged
loans, which are renamed ``higher-risk C&I loans and securities,'' \13\
and subprime consumer loans, which are renamed ``higher-risk consumer
loans''; (2) clarifying when an asset must be classified as higher
risk; (3) clarifying the way securitizations are identified as higher
risk; and (4) further defining terms that are used in the large bank
pricing portions of 12 CFR 327.9. The names of the categories of assets
included in the higher-risk assets to Tier 1 capital and reserves ratio
have been changed to avoid confusion between the definitions used in
the deposit insurance assessment regulations and those used within the
industry and in other regulatory guidance. The FDIC has not amended the
definition of C&D loans and the final rule retains the definitions used
in the February 2011 rule. The FDIC also retains the definition of
nontraditional mortgage loans; however, the final rule clarifies how
securitizations of nontraditional mortgage loans are identified as
higher risk. The final rule aggregates all securitizations that contain
higher-risk assets into a newly defined category of higher-risk assets,
``higher-risk securitizations.'' While the nomenclature is new, the NPR
proposed including all assets that meet this newly defined category as
higher-risk assets. The FDIC believes that the final rule will result
in more consistent reporting, better reflect risk to the Deposit
Insurance Fund (DIF), significantly reduce reporting burden, and
satisfy many of the concerns voiced by the industry after adoption of
the February 2011 rule.
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\13\ ``C&I'' is an abbreviation for ``commercial and
industrial.''
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The final rule will be effective on April 1, 2013, predicated on
changes to the Call Report instructions having been made. The effective
date is discussed in Section E below.
A. Higher-Risk Assets
The FDIC uses the amount of an institution's higher-risk assets to
calculate the institution's higher-risk concentration measure,
concentration score and total score. As noted in the February 2011
rule, the higher-risk concentration measure captures the risk
associated with concentrated lending in higher-risk areas. This type of
lending contributed to the failure of a number of large banks during
the recent financial crisis and economic downturn.\14\
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\14\ 76 FR 10672, 10692-10693 (February 25, 2011).
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Higher-Risk C&I Loans and Securities
Basic definition of a higher-risk C&I loan and security
The definition of a ``higher-risk C&I loan and security'' in the
final rule incorporates suggestions from comment letters, including a
joint comment letter (the joint letter) from several industry trade
groups and discussions with a trade group; the definition differs from
the definition proposed in the NPR.
The final rule introduces a new term, a ``higher-risk C&I
borrower,'' which includes a borrower that owes the reporting bank
(i.e., the bank filing its Call Report) on a C&I loan originally made
on or after the effective date of the rule (April 1, 2013), if the
following conditions are met: \15\
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\15\ C&I loans are as defined as commercial and industrial loans
in the instructions to Call Report Schedule RC-C Part I--Loans and
Leases, as they may be amended from time to time. This definition
includes purchased credit impaired loans and overdrafts.
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The C&I loan must have an original amount (including
funded amounts and the amount of unfunded commitments, whether
irrevocable or unconditionally cancellable) of at least $5 million;
The loan must meet the purpose and materiality tests
described below; and
When the loan is made, the borrower must meet the leverage
test, also described below.
To ensure that the definition is equitably applied, all C&I loans
that a borrower owes to the reporting bank that meet the purpose test
when made and that are made within six months of each other must be
aggregated to determine whether they have an original amount of at
least $5 million; however, only loans in the original amount of $1
million or more need to be aggregated.\16\ Thus, for example, if a bank
makes a $4 million C&I loan and 5 months later makes a $2 million C&I
loan, both of which meet the purpose test, the loans will have an
original amount of $6 million. For a C&I loan that meets the purpose
test and that is syndicated or participated among banks, the original
amount of the loan (for purposes of determining whether the original
amount is at least $5 million and for purposes of applying the
materiality test) is the total original amount of the loan, not just
the syndicated or participated portion held by an individual bank.
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\16\ Loans made before the effective date of the rule need not
be aggregated.
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A ``higher-risk C&I borrower'' also includes a borrower that
obtains a refinance \17\ of an existing C&I loan, where the refinance
occurs on or after the effective date of the rule and the refinanced
loan is owed to the reporting
[[Page 66002]]
bank, if the following conditions are met:
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\17\ The definition of refinance is discussed in Appendix C. Two
commenters had suggested that the definition proposed in the NPR was
too broad and inconsistent with Regulation Z, Section 226.20. While
the definition in the final rule differs from the Regulation Z
definition, the two definitions serve different purposes. Regulation
Z states that a refinancing occurs when an existing obligation is
satisfied and replaced with a new obligation, and this new
transaction requires new disclosures to the consumer. The purpose of
Regulation Z is to determine when new disclosures should be required
to be given to consumers. The purpose of the definition in the final
rule is to determine when an institution should re-evaluate a loan
for higher-risk status. Prior to proposing its definition of
refinance in the NPR, the FDIC discussed it at length with the
industry and other interested parties.
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The refinanced loan must be in an amount (including funded
amounts and the amount of unfunded commitments, whether irrevocable or
unconditionally cancellable) of at least $5 million;
The C&I loan being refinanced must have met the purpose
and materiality tests when it was originally made;
The original loan must have been made no more than five
years before the refinanced loan (the look-back period); and
When the loan is refinanced, the borrower must meet the
leverage test.
Again, to ensure that the definition is equitably applied, when a
C&I loan is refinanced through more than one loan and the loans are
made within six months of each other, they must be aggregated to
determine whether they have an amount of at least $5 million. Thus, for
example, an $8 million C&I refinancing loan that is split into two $4
million loans, where both are made within six months of each other,
will still have an amount of $8 million.
A borrower ceases to be a ``higher-risk C&I borrower'' if: (1) The
borrower no longer has any C&I loans owed to the reporting bank that,
when originally made, met the purpose and materiality tests; (2) any
such loans outstanding owed by the borrower to the reporting bank have
all been refinanced more than five years after originally being made;
or (3) the reporting bank makes a new C&I loan or refinances an
existing C&I loan and the borrower no longer meets the leverage test. A
borrower cannot cease to be a higher-risk borrower except as provided
above.
Under the final rule, ``higher-risk C&I loans or securities''
include all C&I loans owed to the reporting bank by a higher-risk C&I
borrower, except loans subject to an exclusion described below, and all
securities issued by the higher-risk C&I borrower that are owned by the
reporting bank, except securities classified as trading book, without
regard to when the loans were made or the securities purchased.\18\
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\18\ The amount of a higher-risk C&I loan or security to be
reported on the Call Report as of the end of a quarter is the amount
of C&I loans, and unfunded C&I loan commitments, owed to the
reporting bank by a higher-risk C&I borrower and the amount of
securities issued by a higher-risk C&I borrower that are owned by
the reporting bank.
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Purpose Test
A loan or refinance meets the purpose test if it is to finance a
buyout, acquisition or capital distribution. Under the final rule, an
``acquisition'' is the purchase by the borrower of any equity interest
in another company or the purchase of all or a substantial portion of
the assets of another company; a ``buyout'' is the purchase or
repurchase by the borrower of the borrower's outstanding equity (a
buyout includes, but is not limited to, an equity buyout or funding of
an Employee Stock Ownership Plan (ESOP)); and a ``capital
distribution'' is a dividend payment or other transaction designed to
enhance shareholder value, such as repurchase of stock.\19\
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\19\ The NPR proposed to include as an acquisition ``any of the
assets and liabilities of another company.'' The final rule narrows
and clarifies this definition.
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The purpose test will help identify risk and reflect the method
used internally by most banks to identify higher-risk loans. The test
identifies those borrowers with certain higher-risk characteristics,
such as a heavy reliance on either enterprise value or improvement in
the borrower's profitability.\20\
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\20\ Enterprise value is a measure of the borrower's value as a
going concern.
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Materiality Test
A loan or refinance meets the materiality test if the amount of the
original loan (including funded amounts and the amount of unfunded
commitments, whether irrevocable or unconditionally cancellable) equals
or exceeds 20 percent of the total funded debt of the borrower. Total
funded debt of the borrower is to be determined as of the date of the
original loan and does not include the loan to which the materiality
test is being applied.\21\ A loan also meets the materiality test if,
before the loan was made, the borrower had no funded debt.
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\21\ When multiple loans must be aggregated to determine whether
they total at least $5 million, the materiality test is to be
applied as of the date of the last loan.
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At the time of refinance, whether the original loan met the purpose
or materiality tests may not be easily determined by a new lender. In
such a case, the new lender must use its best efforts and reasonable
due diligence to determine whether the original loan met these tests.
Leverage Test
A borrower meets the leverage test if the ratio of the borrower's
total debt to trailing twelve-month EBITDA (commonly known as the
operating leverage ratio) is greater than 4, or the ratio of the
borrower's senior debt to trailing twelve-month EBITDA (also commonly
known as the operating leverage ratio) is greater than 3.\22\
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\22\ EBITDA is defined as earnings before interest, taxes,
depreciation, and amortization.
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Appendix C provides detailed definitions of many of the terms used
in the foregoing definitions.
Comments on the Proposed Definition
In the joint letter, commenters took issue with several parts of
the NPR's proposed definitions related to higher-risk C&I loans.\23\
The NPR proposed that a C&I loan of any size that was made within the
past seven years and that met the purpose and materiality tests,
whether made by the reporting bank or another institution, would make
all C&I loans to a leveraged borrower higher risk if the borrower had a
total of at least $5 million in C&I loans owed to the reporting bank.
The commenters suggested that a $5 million threshold should be part of
the purpose test, on the grounds that a loan of less than $5 million at
origination or refinance would not be sufficiently material to be
``higher risk'' even if it financed an acquisition, buyout or capital
distribution, and that requiring a lender to consider loans under $5
million to a borrower would be expensive and time consuming. The
commenters further suggested that the look back at the
[[Page 66003]]
purpose and materiality of debt should apply only when currently
outstanding debt is refinanced, on the grounds that the definition of
higher-risk is intended to identify risk when it is created. Finally,
the commenters recommended that the look-back period should be, at
most, five years rather than the seven years proposed in the NPR, on
the grounds that most large banks track the past borrowing history of a
borrower only three years back through a review of their financial
statements and that the purpose of debt becomes murkier as it grows
older and as new debt is added.
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\23\ The NPR proposed the following definition of a ``higher-
risk C&I loan and security'':
Any commercial loan (funded or unfunded, including
irrevocable and revocable commitments) owed by a borrower to the
evaluating depository institution with an original amount greater
than $5 million if the conditions specified in (a) or (b) below are
met as of origination, or, if the loan has been refinanced, as of
refinance, and the loan does not meet the asset-based lending (ABL)
exclusion or the floor plan line of credit exclusion (discussed in
Appendix C).
(a)(i) The purpose of any of the borrower's debt (whether owed
to the evaluating insured depository institution or another lender)
that was incurred within the previous seven years was to finance a
buyout, acquisition or capital distribution and such debt was
material; and
(ii) The ratio of the borrower's total debt to trailing twelve-
month EBITDA (i.e., operating leverage ratio) is greater than 4 or
the ratio of the borrower's senior debt to trailing twelve-month
EBITDA (i.e., operating leverage ratio) is greater than 3; or
(b) Any of the borrower's debt (whether owed to the evaluating
institution or another lender) is designated as a highly leveraged
transaction (HLT) by a syndication agent.
All securities held by the evaluating institution that
are issued by a commercial borrower, if the conditions specified in
(a) or (b) above are met, except securities classified as trading
book; and
All securitizations held by the evaluating institution
that are more than 50 percent collateralized by commercial loans or
securities that would meet the higher-risk C&I loans and securities
definition if directly held by the evaluating institution, except
securities classified as trading book.
Under the proposed definition, multiple loans to one borrower
were to be aggregated to determine whether the outstanding amount
exceeded $5 million to the extent that the institution's loan data
systems could do so without undue cost. If the cost was excessive,
the institution could treat multiple loans to one borrower as
separate loans.
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The final rule adopts these suggestions with some modifications
primarily intended either to simplify the rule or to ensure that the
intent of the definitions cannot be easily circumvented.
In the joint letter and a subsequent email, commenters suggested
that debt incurred to fund ordinary business actions such as dividends
to make tax payments should be excluded from the definition of a
capital distribution in the purpose test. The final rule does not adopt
this suggestion because the materiality test should be sufficient to
exclude most loans made in the ordinary course of business.
Several industry trade groups and one bank commented that a
material increase in debt should be defined as a 50 percent increase in
funded debt within one year rather than the proposed 20 percent
increase, arguing that 20 percent would include loans made to firms for
routine acquisitions in the normal course of business. According to the
commenters, such loans might include financing for a modest stock
redemption or basic dividend program. Commenters also suggested that
the materiality test should apply only to debt that meets the purpose
test, rather than all debt. The final rule adopts the suggestion to
consider only purpose loans in the materiality test.
Because the materiality test will measure only the increase in
total funded debt that results from loans that meet the purpose test,
rather than the total increase in funded debt from any source, the
final rule continues to define a material increase as at least 20
percent. Increasing the threshold above 20 percent could exclude
borrowers that were highly leveraged before obtaining a loan that meets
the purpose test, even if the loan was large. Furthermore, the final
rule already adopts a narrower definition of higher-risk C&I loans than
existing and proposed regulatory guidelines on leveraged lending, which
do not contain any materiality test.\24\ The final rule also simplifies
the materiality test by requiring that a loan that meets the purpose
test must be at least 20 percent of total funded debt as of the date of
origination, rather than as of one year earlier.
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\24\ OCC's February 2008 Comptroller's Handbook on Leverage
Lending (pages 2 and 3) and the (interagency) Proposed Guidelines on
Leveraged Lending, 77 FR 19417 (March 30, 2012).
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The FDIC received no comments on the definition of the leverage
test proposed in the NPR.
Exclusions From the Definition of Higher-Risk C&I Loan and Security
As proposed in the NPR, the definition of a higher-risk C&I loan
and security in the final rule excludes the maximum amount that is
recoverable from the U.S. government under guarantee or insurance
provisions, as well as loans (including syndicated or participated
loans) that are fully secured by cash collateral.25 26
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\25\ To exclude a loan based on cash collateral, the cash must
be in the form of a savings or time deposit held by an insured
depository institution. The insured depository institution (or lead
institution or agent bank in the case of a participation or
syndication) must have a perfected first priority security interest,
a security agreement, and a collateral assignment of the deposit
account that is irrevocable for the remaining term of the loan or
commitment. In addition, the institution must place a hold on the
deposit account that alerts the institution's employees to an
attempted withdrawal. If the cash collateral is held at another
institution or at multiple institutions, a security agreement must
be in place and each institution must have in place an account
control agreement (as defined in Appendix C). For the exclusion to
apply to a revolving line of credit, the cash collateral must be
equal to or greater than the amount of the total loan commitment
(the aggregate funded and unfunded balance of the loan).
\26\ The NPR proposed excluding from the definition of a higher-
risk C&I loan and security ``the maximum amount that is recoverable
from * * * [GSEs] under guarantee or insurance provisions,'' but the
final rule omits this language because no GSE guarantees or insures
C&I loans or securities issued by a C&I borrower.
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In the joint letter, commenters recommended excluding loans that
are collateralized by securities issued by the U.S. government, its
agencies, or government-sponsored enterprises (GSEs). The final rule,
however, does not exclude loans so collateralized because the
collateral is subject to interest rate risk and collateral arrangements
are subject to operational risk. Commenters also recommended excluding
loans that are fully secured by brokerage account collateral
(securities-based loans). The final rule does not exclude these loans
because the value of the collateral is subject to several sources of
risk, including operational, credit and market risk.
A bank suggested that the definition of higher-risk C&I loans
exclude loans acquired at a discount or marked to fair value. Another
commenter suggested that the definition exclude modified loans. The
final rule does not adopt these suggestions. The higher-risk
concentration ratio is a forward looking financial measure aimed at
capturing the risk of concentrations in higher-risk assets,
irrespective of how the assets are valued on the balance sheet or
whether they are modified. These loans have the characteristics of
higher-risk loans, despite being recorded at a discount or at fair
value at the date of acquisition or having been modified from the
original terms. The future performance of these assets remains
uncertain; the institution still faces the risk of additional losses on
these assets.
In the joint letter, commenters recommended that unplanned
overdrafts not be included as higher-risk C&I loans, arguing that they
create exposures that are incidental and cured within a few days, if
not overnight. The final rule, however, defines C&I loans consistent
with the Call Report definition of such loans, which includes unplanned
overdrafts. An overdraft alone is unlikely to cause a borrower to be
considered higher risk, however; it is only likely to be included as
higher-risk to the extent that other loans cause a C&I borrower to be
considered higher risk.
Exclusions for Asset-Based Lending and Floor Plan Lending
The definition of higher-risk C&I loans and securities excludes
certain well-collateralized asset-based loans and floor plan loans.\27\
Excluding these loans should result in better differentiation of risk
among banks and will reduce reporting burden. Because these loans carry
significant operational risk, the exclusions apply only to loans that
are well secured by self-liquidating collateral (i.e., accounts
receivable and inventory), and only when the institution can
demonstrate that it has a history of strong risk management and
internal controls over these loans. The final rule provides that, if a
bank's primary federal regulator (PFR) has criticized (i.e., included
in Matters Requiring Attention or MRA) the bank's controls or
administration of its asset-based or floor plan loan portfolios, the
exclusion will not apply.
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\27\ The proposal included asset-based lending guidance. The
final rule, however, incorporates this guidance into the asset-based
lending exclusion conditions in Appendix C.
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The final rule details the conditions that institutions must meet
to be eligible for the asset-based and floor plan lending exclusions.
The differences
[[Page 66004]]
between the final rule and the NPR are generally the result of
recommendations from commenters. The final rule requires that a new
borrowing base certificate be obtained within 30 days before or after
each draw or advance on a loan, as opposed to requiring a new borrowing
base certificate at each draw or advance, as proposed in the NPR.\28\ A
bank is required to validate the borrowing base, but is not required to
do so at each draw, as was proposed in the NPR.\29\ In their joint
letter, commenters stated that it is not standard practice for lenders
to obtain a new borrowing base certificate at each advance or draw on a
loan, and noted that it is not unusual for draws to occur on a daily
basis. The commenters further stated that requiring lenders to obtain a
new borrowing base certificate at each advance or draw would impose a
major administrative burden on banks and their borrowers. In the joint
letter, commenters recommended that a new borrowing base certificate be
required within 60 days of each draw or advance. The final rule adopts
a 30-day requirement on the grounds that 60 days does not provide
sufficient assurance that the loan is fully secured.
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\28\ A ``borrowing base certificate'' is defined in Appendix C.
\29\ The requirements of the validation process are discussed
further in Appendix C.
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The final rule permits a bank to exclude an asset-based loan from
higher-risk C&I loans owed by a higher-risk C&I borrower, provided that
the advance rate on the accounts receivables that serve as collateral
for the loan does not exceed 85 percent. This is a change from the NPR,
which proposed that advance rates on accounts receivable should
generally not exceed 75 percent to 85 percent of eligible receivables.
One commenter noted that the term ``generally'' gave institutions the
option to allow advance rates of greater than 85 percent of eligible
accounts receivable when appropriate. Because advance rates in excess
of 85 percent expose the lender to the risk of loss from a relatively
small default rate on accounts receivable, however, the final rule
requires that advance rates never exceed 85 percent for the exclusion
to apply.
In response to comments, the final rule also provides that:
The borrowing base may include other assets, but a loan
must be fully secured by the portion of the borrowing base that is
composed of accounts receivable and inventory.
Appraisals will not be required for accounts receivable
collateral. In addition, when there is a readily available and
determinable market price for inventory from a recognized exchange or
third-party industry source, inventory may be valued using these
sources in lieu of an appraisal.
An institution need not have the unconditional ability to
take control of a borrower's deposit accounts to be eligible for the
asset-based lending exclusion; rather, it is sufficient if the lending
institution has the legally enforceable ability to take dominion over
the borrower's deposit accounts without further consent by the borrower
(or any other party). In all cases, the lending bank must have a
perfected first priority security interest in the deposit account, a
security agreement must be in place and, if the account is held at an
institution other than the lending institution, an account control
agreement must also be in place.\30\
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\30\ For the purposes of this rule, an account control agreement
means a written agreement between the lending bank (the secured
party), the borrower, and the institution that holds the deposit
account serving as collateral (the depository bank), that the
depository bank will comply with instructions originated by the
secured party directing disposition of the funds in the deposit
account without further consent by the borrower (or any other
party).
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The lending bank must have the ability to withhold funding
of a draw or loan advance if the outstanding balance on the loan is not
within the collateral formula prescribed by the loan agreement.
A bank's lending policies or procedures must address the
maintenance of an inventory loan agreement with the borrower,
consistent with the requirements for an accounts receivable loan
agreement.
Banks are required to obtain financial statements from
dealer floor plan borrowers, but the statements need not be audited.
Original Equipment Manufacturers (OEM) financial statements, otherwise
known as dealer statements, will be sufficient.
Higher-Risk Consumer Loans
``Higher-risk consumer loans'' are defined as all consumer loans
where, as of origination, or, if the loan has been refinanced, as of
refinance, the probability of default (PD) within two years (the two-
year PD) is greater than 20 percent, excluding those consumer loans
that meet the definition of a nontraditional mortgage
loan.31 32
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\31\ For the purposes of this rule, consumer loans consist of
all loans secured by 1-4 family residential properties as well as
loans and leases made to individuals for household, family, and
other personal expenditures, as defined in the instructions to the
Reports of Condition and Income, Schedule RC-C, as the instructions
may be amended from time to time.
\32\ A loan that meets both the definitions of a nontraditional
mortgage loan and a higher-risk consumer loan at the time of
origination should be reported as a nontraditional mortgage loan. If
the loan later ceases to meet the definition of nontraditional
mortgage loan but continues to qualify as a higher-risk consumer
loan, however, it must then be reported as a higher-risk consumer
loan.
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Higher-risk PD Threshold
As noted by commenters, the FDIC may need to adjust the higher-risk
PD threshold after reviewing data for the first reporting period, since
the 20 percent threshold in the definition was determined based on
preliminary score-to-default rate mappings received from a few credit
score providers.
The NPR proposed that the FDIC could change the PD threshold
without further notice-and-comment rulemaking. Several trade groups
commented that the higher-risk PD threshold, after a potential
adjustment following the first reporting period, should remain
invariant and not be changed without notice-and-comment rulemaking.
The final rule is generally consistent with these comments.\33\
Under the final rule, the FDIC retains the flexibility to change the 20
percent threshold without further notice-and-comment rulemaking, but
only as the result of reviewing data for up to the first two reporting
periods. The FDIC will give banks at least one quarter advance notice
of any change through a Financial Institution Letter. Any subsequent
changes to the threshold will be made through notice-and-comment
rulemaking.
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\33\ Several commenters also suggested that, if the FDIC were to
adjust the PD threshold, the new threshold should only apply to
loans originated or refinanced after the effective date of the
change, and the determination that a loan is or is not higher risk
will be based on the previous threshold. In the commenters' view,
this suggestion would allow institutions to adjust their pricing
policies prospectively to account for the cost of making a new loan
that meets the revised threshold. Because the final rule requires
notice-and-comment rulemaking before changing the PD threshold
(except for a potential change after the first or second reporting
period under the final rule), this issue would be addressed in any
such future rulemaking.
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A threshold of 20 percent was found to be generally consistent with
score-based definitions of subprime commonly used by the industry,
capturing the riskiest 10 to 20 percent of consumer loans on a national
basis. If, once the final rule is in effect, the overall proportion of
consumer loans reported as higher-risk among large institutions differs
materially from this preliminary estimate of 10 to 20 percent of
consumer loans, the FDIC may decide to adjust the 20 percent threshold.
The final rule, like the proposed rule, gives the FDIC the flexibility
to make this change without further notice-and-
[[Page 66005]]
comment rulemaking (as a result of reviewing data reported for the
first one or two reporting periods) so that a re-calibration of the
measure can be accomplished quickly to prevent banks from being
unfairly assessed. Before making any such change, the FDIC will analyze
the potential effect of changing the PD threshold on the distribution
of higher-risk consumer loans among institutions and the resulting
effect on assessments collected from the industry.
One bank commented that the higher-risk PD threshold should vary by
product type, and that volatility in default rates is more relevant
than the average level of default rates. As an example, the bank noted
that, although credit card default rates were higher than default rates
on some other products during the recent crisis, the default rates on
credit cards rose less than the default rates on other products. In
particular, the default rates on mortgages rose significantly and
unexpectedly, causing losses that threatened institutions and the
financial system. The bank also commented that other risk factors, such
as historic default rates, yields, and resilience to stress, should be
taken into account.
While the factors that the commenter mentioned are relevant, taking
them into account in the definition of a higher-risk consumer loan
would introduce excessive complexity with uncertain improvements in
risk differentiation. Under the final rule, as proposed in the NPR,
institutions must estimate the two-year PD for a consumer loan based on
how loans with similar risk characteristics performed during the recent
crisis. The FDIC chose to use the recent stress period for PD
estimation, as opposed to a longer history, to capture the consumer
behavior that generated significant unexpected losses. The PDs
estimated using the specified time periods are not intended to reflect
long-run mean default rates or capture product-by-product differences
in more favorable periods.
Methodology for Estimating PDs
Time period. Under the final rule, and as proposed in the NPR, an
institution must estimate the two-year PD for a consumer loan based on
the observed stress period default rate (defined below) for loans of a
similar product type made to consumers with credit risk comparable to
the borrower being evaluated, all as detailed in the estimation
guidelines in Appendix C. To capture the default behavior of consumers
during a period of economic stress, the default rate is to be
calculated as the average of the two, 24-month default rates from July
2007 to June 2009, and July 2009 to June 2011.\34\
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\34\ Institutions must use the formula in Appendix C to
calculate the average default rate.
---------------------------------------------------------------------------
Several trade groups and two institutions commented that the time
periods used for PD estimation should be updated bi-annually. These
commenters suggested that the average default rates could be calculated
on a rolling basis, using the two most recent consecutive 24-month
periods, or on a cumulative basis using all consecutive 24-month
periods from July 2007 forward. They noted that it is standard industry
practice to recalibrate credit models at least once a year, and that
model parameters more than two years old are generally considered
unreliable. Furthermore, the commenters stated that specifying a
regular interval for updating the time periods would make the process
more predictable and give institutions an opportunity to adjust their
credit policies and pricing in advance of any changes, thus promoting a
more stable flow of credit to consumers.
Identifying higher-risk consumer loans based on PD estimates from a
time of economic stress is consistent with the FDIC's objective of
assessing large institutions during favorable periods based on how they
are likely to perform during periods of stress, as explained in the
February 2011 rule. If the time period were to be updated on a rolling
or cumulative basis, as suggested, the resulting PD estimates would
eventually not reflect the performance of loans during the recent
crisis. While the updated default rates might be closer to realized
two-year default rates during favorable periods, they would generally
not capture the relative differences in default behavior among product
types that can be expected to occur under stress conditions (and that
actually did occur during the recent financial crisis). In addition,
unless changes were made to the higher-risk PD threshold of 20 percent,
any regular updating of the time period could introduce an undesirable
level of pro-cyclicality into the higher-risk concentration measure,
whereby the volume of higher-risk loans would tend to rise as credit
conditions deteriorated, and fall as conditions improved. This type of
volatility could occur even if the distribution of credit scores in a
loan portfolio remained static over time. The final rule avoids this
volatility by using a fixed historical period for measuring default
rates.
Default rates calculated using the recent crisis period may not
reflect future changes in macroeconomic factors, industry standards, or
consumer behavior that affect the riskiness of different product types.
To ensure that the PD methodology continues to accurately identify
higher-risk consumer loans, the FDIC may need to update the time period
used for PD estimation at some point. Under the final rule, unlike the
proposed rule, a change in the time period would require further
notice-and-comment rulemaking.
Default rate and definition of ``active loan.'' The final rule
requires institutions to calculate the default rate for each 24-month
time period as the number of active loans that experienced at least one
default event during the period divided by the total number of active
loans as of the observation date (i.e., the beginning of the 24-month
period). An ``active'' loan is defined as any loan that was open and
not in default as of the observation date, and on which a payment was
made within the 12 months prior to the observation date. This
definition differs from the one proposed in the NPR, which had defined
an active loan as a loan that was open and not in default as of the
observation date, and had a positive balance any time within the 12
months prior to the observation date. The FDIC had proposed this
balance-based definition to exclude accounts that, while open and
available for use, were generally not being used. Including these
accounts in the default rate calculation could result in PD estimates
that understate the default experience of truly active accounts. The
FDIC also based its proposal on indications that historical balance
data were available in the credit bureau data used by third-party
providers of consumer credit scores.
One credit reporting bureau, however, informed the FDIC that
historical data on account balances are often either unavailable or
difficult to obtain. The credit reporting bureau also suggested that
the proposed approach could miss active revolving loans where the
balance is completely paid off each month. As an alternative, the
credit reporting bureau suggested that an active account could be
defined as any loan reported by the lender in the 12 months prior to
the observation date, or any loan that has a positive balance as of the
observation date.
The FDIC concluded, based on discussions with the three major
credit reporting bureaus, that the date of last payment is information
that is generally reported and maintained historically. In addition,
defining an active loan using the date of last payment should better
capture active revolving accounts that pay off monthly compared to both
the proposed definition and a definition
[[Page 66006]]
that would rely on the balance only as of the observation date. While
the commenter's suggestion to include any loan reported by the lender
in the 12 months prior to the observation date would also capture these
revolving accounts, this definition could capture accounts that are no
longer open as of the observation date or are otherwise inactive.
Additional risk factors. The final rule requires that, at a
minimum, the PD estimate of a loan must be based on the product type
and credit score of the borrower. In response to a comment, the final
rule clarifies that institutions may consider risk factors other than
product type and credit score (e.g., geography) in estimating the PD of
a loan, because these factors may improve PD estimates. All estimation
requirements detailed in the final rule, including the minimum sample
size, however, must be satisfied regardless of the number of factors
used.
Mapping scores to default rates. The final rule requires
partitioning the entire credit score range generated by a given scoring
system into a minimum of 15 credit score bands. A PD for each credit
score band and loan product type (and for any other risk factor being
considered) must be estimated as the average of two particular 24-month
default rates as described in Appendix C. Each 24-month default rate
must be calculated using a random sample of at least 1,200 active
loans. Although each score band will likely include multiple credit
scores, each credit score will need to have a unique PD associated with
it. Therefore, when the number of score bands is less than the number
of unique credit scores (as will almost always be the case), banks must
use a linear interpolation between adjacent default rates to determine
the PD for a particular score. The observed default rate for each band
must be assumed to correspond to the midpoint of the range for that
band. For example, if one score band ranges from 621 to 625 and has an
observed default rate of 4 percent, while the next lowest band ranges
from 616 to 620 and has an observed default rate of 6 percent, a 620
score must be assigned a default rate of 5.2 percent, calculated as
[GRAPHIC] [TIFF OMITTED] TR31OC12.025
One provider of consumer credit scores recommended an alternative
to the proposed method of assigning PDs to individual score values.
This commenter suggested that the FDIC permit banks to use a least-
squares regression or other accepted statistical methodology to
estimate the score-to-default rate relationship. The commenter noted
that the relationship between the logarithm of the odds of not
defaulting and the FICO score is very close to linear. The commenter
argued that PDs estimated using a regression would be less dependent on
the way institutions structure score bins and provide more reliable
estimates of future default rates for a given score.
Depending on the nature of the data, least-squares regression and
alternative methods of estimating the score-to-default rate
relationship may, in fact, have certain advantages over the proposed
approach. Given the minimum sample size and score band requirements,
however, estimates generated using the proposed approach should be
similar to those generated using alternative statistical methods. While
the industry generally understands and uses linear interpolation, many
banks that try to develop their own PD estimates according to the
requirements may lack the expertise to apply more sophisticated fitting
methods to their data. To ensure consistency among estimation methods,
the final rule retains the linear interpolation approach.
Alternative methodology. Like the proposed rule, the final rule
allows institutions to request to use default rates calculated using
fewer observations or score bands than the specified minimums, either
in advance of, or concurrent with, actual reporting under the requested
approach. The request must explain in detail how the requested approach
differs from the rule specifications and include, at a minimum, a table
with default rates and the number of observations used in each score
and product segment. The FDIC will evaluate the proposed methodology
and may request additional information from the institution, which the
institution must provide. The institution may report using its approach
while the FDIC evaluates the request. If, after reviewing the request,
the FDIC determines that the institution's approach is unacceptable,
the institution may be required to amend its Call Reports and treat any
loan whose PD had been estimated using the disapproved methodology as
an unscorable domestic consumer loan subject to the de minimis approach
described above; the institution, however, will be required to submit
amended information for no more than the two most recently dated and
filed Call Reports preceding the FDIC's determination.
One trade group commented that the FDIC should publish its criteria
for evaluating methodologies that deviate from the PD estimation
requirements. The trade group stated that providing the criteria would
help smaller institutions evaluate their options before devoting time
and resources to developing an alternative methodology. Because the
final rule allows institutions to request the use of PD estimates that
differ from the specifications only in the two specific respects noted
previously (using fewer observations or score bands than the specified
minimums), institutions should not be expending resources developing an
entirely different methodology. While providing more specific guidance
on acceptable alternatives to the score band and sample size
requirements may make the decision process easier for institutions, the
range of potentially acceptable alternatives is broad enough to
preclude the final rule from providing predetermined criteria.
In the joint letter, commenters suggested that a simplified method
of reporting should be permitted for banks with minimal exposure to
higher-risk consumer loans. The commenters stated that the potential
benefit to the FDIC would be small relative to the cost these banks
would incur to comply with the new definition. The commenters suggested
that if a bank's subprime loans--defined based on the 2001 interagency
guidance--were less than one percent of Tier 1 capital and reserves,
they should be allowed to report the amount as higher-risk if it is
less costly for them to do so. One trade group suggested that if a
portfolio has a default rate consistently below 10 percent and the bank
maintains prudent underwriting criteria and appropriate monitoring for
loans placed in that portfolio, the bank should not be required to
estimate and report the PDs of loans in the portfolio. This same trade
group stated that loans made before the effective date of the rule
should be exempt from PD reporting, or the FDIC should provide a
transitional period of at least three years.
Under the final rule, as proposed in the NPR, banks must calculate
the PDs of all outstanding consumer loans following the effective date
of the rule. Because the 2001 interagency guidance for subprime lending
differs from the definition in the final rule, allowing banks to
determine their level of exposure using this alternative standard could
result in inconsistent treatment of loans across banks. This same
inconsistency could result if alternative criteria were used, such as
having a default rate consistently below 10 percent. While banks will
need some
[[Page 66007]]
time to modify systems and processes to report under the definitions in
the final rule, the suggested transition period of three years could
result in the assessment system failing to identify higher-risk
concentrations for too long. The effective date of April 1, 2013,
should give banks sufficient time to comply with the final rule.
Unscorable Consumer Loans
The final rule definition, like the definition proposed in the NPR,
requires institutions to estimate the two-year PD of a loan based, in
part, on the credit risk of the borrower as reflected in a credit
score.\35\ When a consumer loan has a co-signer or co-borrower, the PD
may be determined using the most favorable individual credit score. For
unscorable consumer loans--where the available information is
insufficient to determine a credit score--the final rule specifies the
following treatment: if the total outstanding balance of unscorable
consumer loans of a particular product type exceeds 5 percent of the
total outstanding balance for that product type, including both foreign
and domestic loans, the excess amount shall be treated as higher-risk
(the de minimis approach). Otherwise, the total outstanding balance of
unscorable consumer loans of a particular product type will not be
considered higher-risk. The consumer product types used to determine
whether the 5 percent test is satisfied shall correspond to the product
types listed in the table used for reporting PD estimates. If, after
the origination or refinance of the loan, an unscorable consumer loan
becomes scoreable, the final rule requires institutions to reclassify
the loan using the PD estimated according to the rule specifications.
Based upon that PD, the loan will be determined to be either higher
risk or not, and that determination will remain in effect until a
refinancing occurs, at which time the loan must be re-evaluated. An
unscorable loan must be reviewed at least annually to determine if a
credit score has become available.
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\35\ As detailed in Appendix C, the credit risk of the borrower
must be determined using a third-party or internal scoring system
that qualifies as empirically derived, demonstrably and
statistically sound (EDDSS), as defined in 12 CFR 202.2(p), as
amended from time to time, and that has been approved by the bank's
model risk oversight and governance process and internal audit
mechanism.
---------------------------------------------------------------------------
Several trade groups commented that the proposed rule did not
consider how large banks are to treat consumer credits with no credit
histories or scores. These groups noted that this issue is relevant for
all types of consumer loans, but especially for student and credit card
loans. One trade group argued that an institution should not be
automatically required to classify unscorable loans as higher-risk,
because doing so would cause some products, such as student loans, to
become more expensive or less available. In the joint letter,
commenters suggested that, to account for unscorable loans, large banks
with sufficient data on the performance of such loans should be allowed
to develop internal PD estimates using the same time period and sample
size requirements in the rule. For large banks that do not have
sufficient data to create such a mapping, the commenters stated that
unscorable loans could initially be treated as higher-risk and
subsequently re-evaluated according to the rule specifications once a
credit score becomes available for the borrower. The commenters also
noted that, although initially classifying unscorable loans as higher-
risk is excessively conservative, it would be considered generally
acceptable to large banks so long as a subsequent re-evaluation of
these loans is permitted. For unscorable student loans, however, the
commenters recommended that a PD distribution based on the bank's long-
term default experience be permitted as opposed to initially
classifying the loans as higher-risk.
Unscorable loans were not addressed in the proposed rule. In
evaluating treatment options for purposes of the final rule, the FDIC
sought information from a few credit score providers on the performance
of unscorable loans by product type as well as data from large banks on
the volume of unscorable loans outstanding. Data on the historical
performance of unscorable loans were generally unavailable. Further,
where data were available, the performance of unscorable loans relative
to their scored counterparts was found to vary significantly by product
type, and product definitions were not consistent with the Call Report
definitions expected to be used for reporting purposes. More
importantly, because credit scoring systems may differ in their ability
to score certain consumers, basing the treatment of all unscorable
loans on performance data from only a few score providers would be
inappropriate. For these reasons, the final rule adopts the
conservative approach suggested in the joint letter--initially treating
such loans as higher-risk (subject to the de minimis approach) and
requiring banks to re-evaluate the loans according to the PD
specifications once a credit score becomes available for the borrower.
The final rule does not permit institutions to develop PD estimates
for unscorable loans based on internal data, nor does the final rule
apply a separate standard for student loans as recommended in the joint
letter. To permit banks with sufficient internal data to apply PD
estimates to unscorable loans while requiring other banks to initially
classify the loans as higher-risk (subject to the de minimis approach)
could create an unfair advantage for those banks with sufficient
internal data. As the commenters acknowledged, many student loans are
either government guaranteed or co-signed by parents or other
individuals with a credit history and can be scored; therefore, the
volume of unscorable student loans that would be initially treated as
higher-risk is likely to be small. Nevertheless, to avoid capturing
immaterial exposures to unscorable student loans as well as other types
of unscorable loans in the higher-risk measure, the final rule
classifies only the outstanding balance of unscorable loans in a
portfolio that exceeds 5 percent of the total outstanding balance for
the portfolio as higher-risk (the de minimis approach). If the
outstanding balance of unscorable loans does not exceed 5 percent of
the total, the amount will be ignored for the purpose of calculating
higher-risk consumer loans.
Foreign consumer loans
The NPR did not discuss the treatment of foreign consumer loans, as
pointed out in the joint letter. Under the final rule, a bank must
estimate the PD of a foreign consumer loan according to the general
specifications described above (and in Appendix C) unless doing so
would be unduly complex or unduly burdensome (e.g., if a bank had to
develop separate PD mappings for many different countries). A bank may
request to use the alternative methodology described above (i.e., to
use default rates calculated using fewer observations or score bands
than the specified minimums), either in advance of or concurrent with
reporting under that methodology, but must comply with the requirements
detailed above for using an alternative methodology.
When estimating a PD according to the general specifications
described above and in Appendix C would be unduly complex or unduly
burdensome, a bank that is required to calculate PDs for foreign
consumer loans under the requirements of the Basel II capital framework
may: (1) Use the Basel II approach discussed below, subject to the
terms discussed below; (2) submit a written request to the FDIC to use
an alternate methodology, but may not use the methodology until
approved by the
[[Page 66008]]
FDIC; \36\ or (3) treat the loan as an unscorable consumer loan subject
to the de minimis approach described above.
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\36\ The FDIC may request additional information from the bank
regarding the proposed methodology and the bank must provide the
information. The FDIC may grant a bank tentative approval to use a
methodology while the FDIC considers it in more detail. If the FDIC
ultimately disapproves the methodology, the bank will be required to
amend Call Reports affected by the disapproved methodology treating
any loan whose PD had been estimated using the disapproved
methodology as an unscorable consumer loan subject to the de minimis
approach described above; however, the institution will be required
to amend no more than the two most recently dated and filed Call
Reports preceding the FDIC's determination.
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When estimating a PD according to the general specifications
described above and in Appendix C would be unduly complex or unduly
burdensome, a bank that is not required to calculate PDs for foreign
consumer loans under the requirements of the Basel II capital framework
may: (1) Treat the loan as an unscorable consumer loan subject to the
de minimis approach described above; or (2) submit a written request to
the FDIC to use an alternate methodology, but may not use the
methodology until approved by the FDIC.\37\
---------------------------------------------------------------------------
\37\ The provisions in the previous footnote also apply in this
case.
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Basel II approach. A bank that is required to calculate PDs for
foreign consumer loans under the requirements of the Basel II capital
framework may estimate the two-year PD of a foreign consumer loan based
on the one-year PD used for Basel II capital purposes.\38\ The bank
must submit a written request to the FDIC in advance of, or concurrent
with, reporting under that methodology. The request must explain in
detail how one-year PDs calculated under the Basel II framework are
translated to two-year PDs that meet the final rule specifications.
While the range of acceptable approaches is potentially broad, any
proposed methodology must meet the following requirements:
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\38\ Use of this method does not imply that a bank's PFR has
approved use of the PDs for the Basel II capital framework. If a
bank's PFR requires it to revise its Basel II PD methodology, the
bank must use revised Basel II PDs to calculate (or recalculate if
necessary) corresponding PDs under this Basel II approach.
---------------------------------------------------------------------------
The bank must use data on a sample of loans for which both
the one-year Basel II PDs and two-year final rule PDs can be
calculated. The sample may contain both foreign and domestic loans.
The bank must use the sample data to demonstrate that a
meaningful relationship exists between the two types of PD estimates,
and the significance and nature of the relationship must be determined
using accepted statistical principles and methodologies. For example,
to the extent that a linear relationship exists in the sample data, the
bank may use an ordinary least-squares regression to determine the best
linear translation of Basel II PDs to final rule PDs. The estimated
equation should fit the data reasonably well based on standard
statistics such as the coefficient of determination.
The method must account for any significant variation in
the relationship between the two types of PD estimates that exists
across consumer products based on the empirical analysis of the data.
For example, if the bank is using a linear regression to determine the
relationship between PD estimates, it should test whether the parameter
estimates are significantly different by product type.
The bank may report using this approach while the FDIC evaluates
the methodology. If, after reviewing the methodology, the FDIC
determines that the methodology is unacceptable, the institution will
be required to amend its Call Reports. The institution will be required
to submit amended information for no more than the two most recently
dated and filed Call Reports preceding the FDIC's determination.
Under the NPR, banks would not have been permitted to estimate the
two-year PD of a foreign consumer loan using the Basel II PD. The joint
letter commenters stated that the FDIC should consider issues specific
to the scoring of loans from foreign markets. These commenters
indicated that, due to the diversity of national credit markets,
pervasive lack of standardized industry risk scores in other countries,
and difficulty in applying U.S.-specific rules to many other markets,
banks should be permitted to use other information in assessing the PD
for a foreign loan. The commenters stated that such information could
include the Basel II PD ``or other measures that the banks consider to
be reasonable indications of a cyclical view adjusted for the
differences in the definition of default and timing of account risk
assessment.'' The commenters added that institutions should be allowed
to exercise judgment in making their determination given that not all
of the information required under the proposed definition may be
reasonably available.
The final rule builds upon the suggestion of allowing banks subject
to the Basel II framework to develop PD mappings for foreign consumer
loans based on the Basel II PDs used for capital purposes. The final
rule permits only banks subject to the Basel II framework to be able to
use an alternative approach based on the Basel II PD automatically
(provided that estimating a PD according to the general specifications
described above and in Appendix C would be unduly complex or unduly
burdensome), because the Basel II PD is well defined, subject to
supervisory review and approval for banks subject to the Basel II
approach, and likely to be correlated with PD estimates developed
according to the final rule requirements. In addition, those
institutions that operate in many foreign markets, and for which the
general methodology for determining PDs would likely be burdensome, are
subject to Basel II requirements.
Missing Data
Under the final rule, banks must determine the PD of a consumer
loan as of the date the loan was originated, or, if the loan has been
refinanced, as of the date it was refinanced. For loans originated or
refinanced by a bank before April 1, 2013, and all loans acquired by a
bank regardless of the date of acquisition, if information as of the
date the loan was originated or refinanced is not available, then the
institution must use the oldest available information to determine the
PD. If no information is available, then the institution must obtain
recent, refreshed data from the borrower or other appropriate third
party to determine the PD. Refreshed data is defined as the most recent
data available, and must be as of a date that is no earlier than three
months before the acquisition of the loan. In addition, for loans
acquired on or after April 1, 2013, the acquiring bank shall have six
months from the date of acquisition to determine the PD.
The joint letter commenters suggested that, if data as of
origination or refinance are unavailable for an acquired loan, a bank
should be able to use the oldest data on file or refreshed data to
determine if the loan was higher risk. The commenters further stated
that a bank should not be required to go to extraordinary lengths to
obtain a credit score or PD from the originating lender; the bank
should be able to use the best available data at the time of
acquisition. The commenters recommended that a bank be given, at most,
one year from the date a loan is acquired to determine the PD of the
loan, instead of the proposed timeframe of three months. The commenters
also recommended this approach--using refreshed data or the oldest data
available when data as of origination or refinance are unavailable--for
evaluating loans originated or purchased prior to the effective date of
the rule. The commenters argued that there has been
[[Page 66009]]
no reason in the past for large banks to maintain the data needed to
determine the PDs for loans already on the books.
Under the final rule, a bank is not required to go to extraordinary
lengths to obtain a credit score or PD for an existing or acquired
loan; however, the bank must use the available data closest to the date
of origination or refinance to minimize inconsistencies in PD
estimates. While banks may need additional time to gather and evaluate
the information for an acquired consumer loan, the joint letter
commenters offered no reason that a full year would be needed. If data
from the original lender are unavailable, banks should be able to
obtain a refreshed credit score for most borrowers at reasonable cost.
Further, allowing acquired loans that are truly higher risk to be
treated as non-higher risk for up to one year could result in a bank's
risk being under-assessed for too long. Therefore, the final rule gives
banks six months to complete this determination.
Exclusions
Consistent with the definition of a higher-risk C&I loan and
security, the final rule definition of a higher-risk consumer loan
excludes the maximum amount that is recoverable from the U.S.
government under guarantee or insurance provisions, as well as loans
that are fully secured by cash collateral.39 40
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\39\ To exclude a loan based on cash collateral, the cash must
be in the form of a savings or time deposit held by a bank. The
lending bank (or lead or agent bank in the case of a participation
or syndication) must, in all cases, (including instances in which
cash collateral is held at another bank or banks) have a perfected
first priority security interest under applicable state law, a
security agreement in place, and all necessary documents executed
and measures taken as required to result in such perfection and
priority. In addition, the lending bank must place a hold on the
deposit account that alerts the bank's employees to an attempted
withdrawal. For the exclusion to apply to a revolving line of
credit, the cash collateral must be equal to, or greater than, the
amount of the total loan commitment (the aggregate funded and
unfunded balance of the loan).
\40\ The NPR proposed excluding from the definition of a higher-
risk consumer loan ``the maximum amounts recoverable from * * *
[GSEs] under guarantee or insurance provisions,'' but the final rule
omits this language because no GSE guarantees or insures individual
consumer loans.
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In the joint letter, commenters recommended excluding loans that
are collateralized by securities issued by the U.S. government, its
agencies, or GSEs. The final rule, however, does not exclude loans so
collateralized because the collateral is subject to interest rate risk
and collateral arrangements are subject to operational risk.
Commenters also recommended excluding loans that are fully and
continuously secured by brokerage account collateral (securities-based
loans). As in the case of higher-risk C&I loans, several commenters
suggested that other factors, such as loan-to-value (LTV) ratios,
credit history, and borrower resources, should factor into the
definition of a higher-risk consumer loan.
The final rule definition, like the definition proposed in the NPR,
does account for a borrower's credit history, because the two-year PD
is based, in part, on the credit score of the borrower. The final rule
does not, however, adopt the other suggested exclusions. To ensure
consistency, excluding loans from the higher-risk totals based upon
these criteria would require the development of numerous thresholds,
such as appropriate LTVs for various asset types, frequent updating of
appraisals of collateral, and frequent updating of borrower's financial
statements. In addition, the final rule does not exclude loans secured
by brokerage account collateral because the value of the collateral is
subject to several sources of risk, including operational, credit, and
market risk.
Definition of ``Refinance''
One large bank sought clarification on whether re-aging a loan as a
loss mitigation activity would qualify as a refinancing of the loan.
The FDIC believes conservative re-aging programs are a loss mitigation
activity, not a refinance, provided the institution follows, at a
minimum, the re-aging guidelines recommended in the interagency
approved Uniform Retail Credit Classification and Account Management
Policy.\41\ Thus, among other things, for a loan to be considered for
re-aging, the following must be true: (1) The borrower must have
demonstrated a renewed willingness and ability to repay the loan; (2)
the loan must have existed for at least nine months; and (3) the
borrower must have made at least three consecutive minimum monthly
payments or the equivalent cumulative amount.\42\ In addition, for re-
aging to be considered as a loss mitigation activity, and not as a
refinance, the institution's program must have clearly defined policy
guidelines and parameters for re-aging, as well as internal methods of
ensuring the reasonableness of those guidelines and for monitoring
their effectiveness. Institutions must also monitor both the number and
dollar amount of re-aged accounts, collect and analyze data to assess
the performance of re-aged accounts, and determine the effect of re-
aging practices on past due ratios.
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\41\ 65 FR 36903 (June 13, 2000).
\42\ The definition of refinance is discussed in Appendix C.
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In the joint letter, commenters requested that an increase in a
credit card line of credit of up to 10 percent should not be considered
a refinance, as proposed for all other consumer loans. In addition, the
joint letter commenters requested that when a bank has internally
approved a higher credit line than it has made available to the
customer, providing access to this additional credit should not be
considered a refinance, as the bank has not underwritten new risk. The
final rule makes these changes; further, to be consistent with other
types of consumer loans, a non-temporary credit card line increase of
10 percent or greater, that is not the result of a loss mitigation
strategy, is a refinance under the final rule.\43\
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\43\ Under the final rule, a refinance excludes all temporary
credit card line increases.
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The joint letter commenters also requested that an increase or
decrease in the interest rate of a credit card loan should not be
considered a refinance on the grounds that rate changes for credit card
loans are commonplace (e.g., formulaic adjustments tied to underlying
indices, expirations of introductory rates and special rates for
balance transfers, and changes mandated by law such as the Credit CARD
Act). The final rule clarifies that a change to the interest rate on a
credit card loan that is consistent with the terms of the loan
agreement is not a refinance.
Paperwork Reduction Act (PRA) Notice for the Call Reports
The FDIC intends to collect the outstanding balance of consumer
loans, by two-year PD and product type, from large and highly complex
institutions. The types of information collected and the format of the
information collected on the Call Report will be subject to a PRA
notice, which will be published in the Federal Register with request
for comment. The FDIC anticipates that appropriate changes to the Call
Reports will be made and that institutions will report consumer loans
consistent with the definition in the final rule. Several commenters
stated that any PD data reported by the banks should be kept
confidential and not disclosed or used in public statements. Moreover,
these commenters stated that the final rule specifications for
calculating the PD, designed to provide a consistent measure across
large banks, will likely not reflect banks' internal PD estimates. The
FDIC agrees with these comments
[[Page 66010]]
and affirms that any PD data reported for purposes of this rule will
remain confidential.
The following table is an example of how the FDIC may collect the
consumer loan information. As suggested in the example table below,
institutions would report the outstanding amount of all consumer loans,
including those with a PD below the high-risk threshold, stratified by
the 10 product types and 12 two-year PD bands. In addition, for each
product type, institutions would report the amount of unscorable loans,
as defined in the final rule, and indicate whether the PDs were derived
using scores and default rate mappings provided by a third-party vendor
or an internal approach.\44\ Although not included in this table, banks
would report in their Call Reports the value of all securitizations
(except those classified as trading book) of consumer loans that are
more than 50 percent collateralized by consumer loans that would be
identified as higher-risk assets.
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\44\ An internal approach includes the use of an institution's
own default experience with a particular product and credit score,
whether that score was provided by a third party or was internally
derived.
[GRAPHIC] [TIFF OMITTED] TR31OC12.026
Nontraditional Mortgage Loans
The final rule retains the definition of a nontraditional mortgage
loan that was contained in the February 2011 rule; however, the final
rule clarifies how securitizations of nontraditional mortgage loans
will be identified under the definition. Securitizations are discussed
in the section that follows.
Several commenters on the NPR urged the FDIC to reconsider the
definition of nontraditional mortgage loans. As the FDIC stated in the
NPR, it will monitor future rulemakings regarding Qualified Residential
Mortgages, and the capital treatment of nontraditional mortgage loans,
to determine whether any changes to the definition should be
considered.
Higher-Risk Securitizations
As proposed in the NPR, the final rule requires securitizations,
except securitizations classified as trading book, to be reported as
higher-risk where, in aggregate, more than 50 percent of the assets
backing the securitization meet the criteria for higher-risk C&I loans
or securities, higher-risk consumer loans, or nontraditional mortgage
loans.\45\ Concentrations in higher-risk assets, whether they are in
the form of a whole loan or a securitization, increase the risk of loss
to the DIF during times of prolonged periods of economic stress.
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\45\ Unscorable consumer loans that exceed 5 percent of the
loans in a securitization are deemed higher-risk.
---------------------------------------------------------------------------
The final rule treatment of securitizations differs from the
proposed rule in a nonsubstantive way. In the final rule, higher-risk
securitizations constitute a new classification of higher-risk assets
rather than being included in higher-risk C&I loans or securities,
higher-risk consumer loans, or nontraditional mortgage loans.\46\
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\46\ The definition of a higher-risk securitization in the final
rule excludes the maximum amount that is recoverable from the U.S.
government under guarantee or insurance provisions. The NPR proposed
also excluding from the definition of a higher-risk C&I loan
securitization ``the maximum amount that is recoverable from * * *
[GSEs] under guarantee or insurance provisions,'' but the final rule
omits this language because no GSE guarantees or insures
securitizations containing C&I loans. The NPR also contained similar
language with regard to the proposed definition of a higher-risk
consumer loan securitization, and the final rule again omits this
language. No GSE currently guarantees or insures securitizations
where more than 50 percent of the assets backing the securitization
consist of higher-risk consumer loans or nontraditional mortgages,
and the definition of a higher-risk securitization in the final rule
does not apply to a securitization issued before April 1, 2013.
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In determining whether or not to report a securitization as higher
risk, a bank is required to use information reasonably available to a
sophisticated investor in reasonably determining whether the
securitization meets the 50 percent threshold.\47\ Information
reasonably available to a sophisticated investor includes, but is not
limited to, offering memoranda, indentures, trustee reports, and
requests for information from servicers, collateral managers, issuers,
trustees, or similar third parties. When determining whether a
revolving
[[Page 66011]]
trust or similar securitization meets the threshold, an institution may
use established criteria, model portfolios, or limitations published in
the offering memorandum, indenture, trustee report, or similar
documents.
---------------------------------------------------------------------------
\47\ A securitization is as defined in 12 CFR part 325, Appendix
A, Section II(B)(16), as it may be amended from time to time.
---------------------------------------------------------------------------
The joint letter commenters pointed out that continuously obtaining
updated information on actively managed open-ended securitizations
(those securitizations where the underlying assets of the
securitization may change) would not only be burdensome, but
unnecessary, because governing indentures require securitization
managers to maintain minimum credit quality. The final rule takes this
point into account and provides that a bank must determine whether a
securitization is higher-risk based upon information as of the date of
issuance (i.e., the date the securitization is sold on a market to the
public for the first time). The bank must make this determination
within the time limit that would apply under Appendix C to this final
rule if the bank were directly acquiring loans or securities of the
type underlying the securitization. In making the determination, a bank
must use one of the following methods:
For a securitization collateralized by a static pool of
loans, whose underlying collateral changes due to the sale or
amortization of these loans, the 50 percent threshold is to be
determined based upon the amount of higher-risk assets, as defined in
Appendix C to this final rule, owned by the securitization on the date
of issuance of the securitization.
For a securitization collateralized by a dynamic pool of
loans, whose underlying collateral may change by the purchase of
additional assets, including purchases made during a ramp-up period,
the 50 percent threshold is to be determined based upon the highest
amount of higher-risk assets, as defined in Appendix C to this final
rule, allowable under the portfolio guidelines of the securitization.
The final rule uses the term ``issuance'' rather than
``origination,'' as proposed in the NPR, because the term ``issuance''
is commonly used and understood in the securitization industry and is
less open to misinterpretation. To relieve burden on the industry, the
final rule does not adopt the proposal in the NPR that a securitization
be evaluated at purchase, because the most readily available
information will generally be that included in offering material
compiled as of the date of issuance.
In cases in which a securitization is required to be consolidated
on the balance sheet as a result of SFAS 166 and SFAS 167, and where a
bank has access to the necessary information, it may opt for an
alternative method of evaluating the securitization to determine
whether it is higher risk. The bank may evaluate individual loans in
the securitization on a loan-by-loan basis and only report as higher
risk those loans that meet the definition of a higher-risk asset; any
loan within the securitization that does not meet the definition of a
higher-risk asset need not be reported as such. Once an institution
evaluates a securitization for higher-risk asset designation using this
alternative evaluation method, it must continue to evaluate all
securitizations that it has consolidated on the balance sheet as a
result of SFAS 166 and SFAS 167, and for which it has the required
information using the alternative evaluation method. For
securitizations for which the institution does not have access to
information on a loan-by-loan basis, the institution must determine
whether the securitization meets the 50 percent threshold in the manner
previously described for other securitizations.
In the joint letter, commenters noted that some loan originators,
securitizers, and servicers, including non-bank loan originators,
securitizers, and servicers, may not currently collect the data needed
to evaluate loans as higher-risk under the final rule. In particular,
according to the trade groups, some may not collect data needed for the
purpose and materiality tests of the higher-risk C&I loan definition.
Some institutions that rely on loan securitization issuers or servicers
to determine the credit quality of securitizations may need additional
time to develop systems to collect the information necessary to make
their own higher-risk asset determinations under the final rule. For
these reasons, among others, the effective date of the final rule has
been extended from October 1, 2012, as proposed in the NPR, to April 1,
2013. Banks will not need to review securitizations issued before April
1, 2013, to determine whether they are higher risk under the final
rule. The new higher-risk definitions in the final rule will apply only
to securitizations issued on or after that date, regardless of the date
of origin of the underlying loans.
In the joint letter, commenters asserted that the proposed means of
identifying securitizations as higher-risk is unworkable and would make
banks reluctant to invest in securitizations, which would impede the
flow of credit to consumers and businesses and would further impair a
market that is struggling to recover. In this same letter, commenters
noted that securitizers have developed standards for the type and
quantity of information that they provide investors, but this
information may not be adequate for banks to make a higher-risk asset
determination. Further, the commenters noted that securitizations could
be issued by non-bank finance companies that are not subject to deposit
insurance pricing rules or definitions and may not have the required
data to provide to their investors. The commenters also added that
institutions that invest in these securitizations cannot simply request
the information needed to make a higher-risk asset determination or
compel the servicer or originator to make that determination.
The final rule, like the proposed rule, gives banks flexibility in
making higher-risk asset determinations for securitizations. The final
rule allows an institution to use information reasonably available to a
sophisticated investor in reasonably determining whether a
securitization meets the 50 percent threshold and suggests several
sources for this information. In most cases, this information should be
sufficient to make the determination, because banks must conduct
thorough due diligence prior to purchase. Moreover, large and highly
complex institutions are sophisticated investors and can typically
obtain the information needed to determine whether a securitization
meets the 50 percent threshold when they purchase interests in these
securitizations. The final rule, like the proposed rule, however, also
acknowledges that sufficient information necessary for an institution
to make a definitive determination may not, in every case, be
reasonably available to the institution as a sophisticated investor,
and allows an institution to exercise its judgment in making the
determination. A bank need not rely upon all of the aforementioned
pieces of information if fewer documents provide sufficient data to
make the determination.
Commenters, through the joint letter, and a bank recommended that
the FDIC allow banks to consider the structure of the securitization
and any credit enhancements to it. They argued that, by not doing so,
the FDIC is giving banks an incentive to acquire lesser quality,
subordinated interests in securitizations, because variations in
quality and subordination or the lack of it will not affect deposit
insurance assessment rates.
In the joint letter, commenters noted that, while the use of
external credit ratings to determine the credit quality of
securitization exposures is problematic due to Section 939A of the
Dodd-Frank
[[Page 66012]]
Act, banks could use the proposed revised regulatory capital risk-
weighting methodologies currently in development by the bank regulatory
agencies (the Standardized Approach for Risk-Weighted Assets \48\) to
determine if a securitization is higher risk. For example, the
commenters suggested that securitizations with risk weights of 200
percent to 250 percent or greater could be considered below investment
grade and therefore treated as higher-risk assets for deposit insurance
pricing purposes.
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\48\ 77 FR 52888 (Aug. 30, 2012).
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Like the proposed rule, the final rule does not allow exclusions
for higher-risk securitizations based upon structure or credit
enhancements. As noted in the proposed rule, the performance of a
securitization is highly correlated with the performance of the
underlying assets, even when the securitization contains terms or
conditions intended to reduce risk. During the crisis, a number of
highly rated senior securitization positions were subject to
significant downgrades and suffered substantial losses. Even where
losses have not yet been realized (as is the case in many
collateralized loans), the market value of these securitizations
declined precipitously during the crisis, reflecting the decline in the
market value of the underlying assets and the increased risk of loss.
While commenters on the NPR noted that ``based upon agency ratings, the
extensive downgrades and the market value reductions of collateralized
loan obligations and other securitizations in the recent financial
turmoil have, for the most part, been overcome,'' in fact, many
financial institutions suffered substantial losses due to these
securitizations. This decline in value contributed to the liquidity
crisis of 2008, which forced the U.S. government to provide
unprecedented support to financial institutions and liquidity markets.
Furthermore, the Standardized Approach for Risk-Weighted Assets is
still in development and has not yet been finalized. The proposed
implementation date is more than two years away (January 15, 2015,
although it may be implemented earlier); banks must have a method in
place to identify higher-risk securitizations for deposit insurance
pricing purposes by April 1, 2013. The FDIC will monitor implementation
of the Standardized Approach to determine whether all or parts of the
approach should be incorporated into the risk-based pricing system for
large banks and highly complex institutions.
B. Large Bank Adjustment Process
The FDIC has the ability to adjust a large or highly complex
institution's total score (which is used to determine its deposit
insurance assessment rate) by a maximum of 15 points (the large bank
adjustment).\49\ Because the revised definitions should result in
better risk identification and consistent application across the
industry, the FDIC anticipates that there will be limited circumstances
where the FDIC will consider a large bank adjustment as a result of
perceived mitigants to an institution's higher-risk concentration
measure. The revised definitions, which include specific exceptions for
well-collateralized loans, should result in generally equal treatment
of similar loans at different institutions.
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\49\ 12 CFR 327.9(b)(3).
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C. Audit
Several of the changes to the definitions could require periodic
auditing to ensure consistent reporting across the industry. For
example, the consumer loan PD calculation, whether through credit score
mapping or through an internal approach, if not properly monitored,
could potentially be done inconsistently. Also, institutions need to
carefully evaluate their controls for asset-based and floor plan
lending to determine whether they can exclude these loans from their
higher-risk C&I loans and securities totals. The FDIC expects
institutions to have appropriate systems in place for the proper
identification and reporting of higher-risk assets. Enhanced review
procedures for higher-risk asset reporting should be part of these
systems. Institutions' higher-risk asset identification and reporting
programs include applicable policies, procedures, reviews, and
validation (through internal or external audits). The results of any
internal reviews or external audits of higher-risk asset reporting must
be made available to the FDIC upon request. The FDIC may review
specific details of an institution's reporting, including loans that
are excluded from higher-risk assets. Any weakness identified in the
reporting of higher-risk assets may be considered in the application of
adjustments to an institution's total score as outlined in the
Assessment Rate Adjustment Guidelines for Large and Highly Complex
Institutions.\50\
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\50\ 76 FR 57992 (Sept. 19, 2011).
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D. Updating the Scorecard
The February 2011 final rule grants the FDIC the flexibility to
update the minimum and maximum cutoff values used in each scorecard
annually without further rulemaking as long as the method of selecting
cut-off values remains unchanged.\51\ The FDIC may add new data for
subsequent years to its analysis and may, from time to time, exclude
some earlier years from its analysis. Updating the minimum and maximum
cutoff values and weights will allow the FDIC to use the most recent
data, thereby improving the accuracy of the scorecard method.\52\
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\51\ 76 FR 10672, 10700 (Feb. 25, 2011) (H. Updating the
Scorecard).
\52\ If, as a result of its review and analysis, the FDIC
concludes that different measures should be used to determine risk-
based assessments, that the method of selecting additional or
alternative cutoff values should be revised, that the weights
assigned to the scorecard measures should be recalibrated, or that a
new method should be used to differentiate risk among large
institutions or highly complex institutions, changes would be made
through a future rulemaking.
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Unless the FDIC re-calibrates cutoff values for the higher-risk
assets to Tier 1 capital and reserves ratio, however, the changes to
the definitions of higher-risk assets may result in significant
increases or decreases in the amount of total deposit insurance
assessments collected from large and highly complex institutions. Each
scorecard measure, including the higher-risk assets to Tier 1 capital
and reserves ratio, is converted to a score between 0 and 100 based
upon minimum and maximum cutoff values for the measure (where the
minimum and maximum cutoff values get converted to a score of 0 or
100). Most of the minimum and maximum cutoff values represent the 10th
and 90th percentile values for each measure, which are derived using
data on large banks over a ten-year period beginning with the first
quarter of 2000 through the fourth quarter of 2009. Because the cutoff
values for the higher-risk assets to Tier 1 capital and reserves ratio
were calibrated using higher-risk assets data reported in accordance
with an institution's existing methodology for identifying leveraged or
subprime loans and securities, changing the definitions of these
higher-risk assets may result in significant differences in the volume
of higher-risk assets reported by institutions, and differences in the
amount of deposit insurance assessments collected by the FDIC.
The FDIC does not intend for the changes in the definitions in this
final rule to result in the FDIC collecting higher or lower deposit
insurance assessment revenue from large and highly complex institutions
as a whole (although it may result in individual institutions paying
higher or lower deposit insurance assessments). Consequently, the FDIC
anticipates that it may need to use its flexibility to
[[Page 66013]]
update cutoff values to update the minimum and maximum cutoff values
for the higher-risk assets to Tier 1 capital and reserves ratio.\53\
Changes in the distribution of the higher-risk assets to Tier 1 capital
and reserves ratio scores, and the resulting effect on total
assessments and risk differentiation between institutions, will be
taken into account in determining changes to the cutoffs. In addition,
because the FDIC has not collected any data under the revised
definitions, changes to cutoff values for the higher-risk assets to
Tier 1 capital and reserves ratio could be made more frequently than
annually. This review ensures proper risk differentiation between
institutions.\54\
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\53\ 76 FR 10672, 10700 (February 25, 2011).
\54\ The FDIC will provide large and highly complex institutions
with at least one quarter advance notice in their quarterly deposit
insurance invoice of changes in the cutoff values to ensure that the
industry can determine the effect that any changes may have on
assessments.
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E. Implementation and Effective Date
The final rule makes the amended definitions effective April 1,
2013, in place of the October 1, 2012 date proposed in the NPR.
Several industry trade groups and institutions expressed concerns
about their ability to report under the proposed definitions by October
1, 2012, stating that they did not have the systems in place to
calculate the PD for consumer loans and were not assured that third-
party providers would be able to develop PD mapping tables for
institutions to use by the proposed effective date. One industry trade
group noted that institutions would need time to develop internal PD
mapping models, or, if the institution decided to use a third-party
provider's PD mapping table, would need time to perform due diligence
and negotiate contracts with third-party providers. Commenters
recommended extending the effective date of the final rule from October
1, 2012, as proposed, by a range of dates, from one quarter to one
year; one industry trade group recommended that either loans made
before the effective date of the proposal should be exempt from PD
reporting altogether or that institutions be given three years to
report these loans as higher-risk.
To allow institutions time to revise their reporting systems to be
consistent with the revised definitions, the FDIC is postponing the
effective date of the final rule to April 1, 2013. This new date should
give institutions ample time to accurately report under the new
definitions.
Because the FDIC is not amending the definitions of C&D loans and
nontraditional mortgage loans (other than to clarify how
securitizations that meet the definition of a nontraditional mortgage
loan are to be identified), institutions should continue to define and
report these higher-risk assets as they have been doing under the
February 2011 rule.
Transition Guidance Until Effective Date
Prior to April 1, 2013, large and highly complex institutions will
continue to use the transition guidance for leveraged loans and
subprime loans as outlined in the General Instructions (Instructions)
for Schedule RC-O of the Consolidated Reports of Condition and Income,
Memorandum items 6 through 15. The Instructions have been updated to
reflect April 1, 2013 (formerly October 1, 2012) as the effective date
of this final rule.
This transition guidance provides that an institution may use
either the definition in the February 2011 rule or continue to use its
existing internal methodology for identifying loans and securities as
leveraged or subprime for Schedule RC-O assessment reporting purposes.
Some institutions do not have an existing methodology in place to
identify loans and securities as leveraged or subprime (because they
are not required to report these exposures to their PFR for examination
or other supervisory purposes or do not measure and monitor loans and
securities with these characteristics for internal risk management
purposes). These institutions may continue to apply existing guidance
provided by their PFR, by the agencies' 2001 Expanded Guidance for
Subprime Lending Programs (for consumer loans), or by the February 2008
Comptroller's Handbook on Leveraged Lending (for C&I loans and
securities).
Rules in Effect on the Effective Date and Thereafter
Effective April 1, 2013, the amended definitions described above
apply to:
(1) C&I loans owed to a reporting bank by a higher-risk C&I
borrower (as that term is defined in the final rule) and all
securities issued by a higher-risk C&I borrower (as that term is
defined in the final rule), except securitizations of C&I loans,
that are owned by the reporting bank;
(2) Consumer loans (as defined in the final rule), except
securitizations of consumer loans, whenever originated or purchased;
(3) Securitizations of C&I and consumer loans (as defined in the
final rule) issued on or after April 1, 2013, including those
securitizations issued on or after April 1, 2013, that are partially
or fully collateralized by loans originated before April 1, 2013.
For C&I loans that are either originated or refinanced by a
reporting bank before April 1, 2013, or purchased by a reporting bank
before April 1, 2013, in cases in which the loans are owed to the
reporting bank by a borrower that does not meet the definition of a
higher-risk C&I borrower as that term is defined in the final rule
(which requires, among other things, that the borrower have obtained a
C&I loan or refinanced an existing C&I loan on or after April 1, 2013),
and for securities purchased before April 1, 2013, that are issued by
an entity that does not meet the definition of a higher-risk C&I
borrower, as that term is defined in the final rule, banks must
continue to use the transition guidance in the September 2012 Call
Report instructions to determine whether to report the loan or security
as a higher-risk asset for purposes of the higher-risk assets to Tier 1
capital and reserves ratio. An institution may opt to apply the final
rule definition of higher-risk C&I loans and securities to all of its
C&I loans and securities, but, if it does so, it must also apply the
final rule definition of a higher-risk C&I borrower without regard to
when a loan is originally made or refinanced (i.e., whether made or
refinanced before or after April 1, 2013).
Under the final rule, banks will not need to reexamine their entire
existing C&I loan and security portfolios immediately to determine
whether the loans and securities meet the new definition of higher-risk
C&I loans and securities (although they may opt to do so as provided in
the last sentence of the preceding paragraph). Rather, they will be
able to wait until a borrower seeks a new C&I loan (or refinances an
existing one) on or after April 1, 2013, and meets the higher-risk C&I
borrower definition before applying the new higher-risk C&I loan and
security definition to all of that borrower's C&I loans and securities.
For consumer loans (other than securitizations of consumer loans)
originated or purchased prior to April 1, 2013, an institution must
determine whether the loan met the definition of a higher-risk consumer
loan no later than June 30, 2013.
For all securitizations issued before April 1, 2013, banks must
either (1) continue to use the transition guidance in the September
2012 Call Report instructions or (2) apply the definitions in the final
rule to all of its securitizations. If a bank applies the definition of
higher-risk C&I loans and securities in the final rule to its
securitizations, it must also apply the definition of a higher-risk C&I
borrower in the final rule to all C&I borrowers without regard to when
the loans to
[[Page 66014]]
those borrowers were originally made or refinanced (i.e., whether made
or refinanced before or after April 1, 2013).
The provisions of the final rule apply to all securitizations
issued on or after April 1, 2013 (including those securitizations that
are collateralized by loans originated before April 1, 2013).
III. Regulatory Analysis and Procedure
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) requires that each federal
agency either certify that a proposed rule would not, if adopted in
final form, have a significant economic impact on a substantial number
of small entities or prepare an initial regulatory flexibility analysis
of the rule and publish the analysis for comment.\55\ For RFA purposes
a small institution is defined as one with $175 million or less in
assets.
---------------------------------------------------------------------------
\55\ See 5 U.S.C. 603, 604 and 605.
---------------------------------------------------------------------------
As of June 30, 2012, of the 7,246 insured commercial banks and
savings institutions, there were 3,821 small insured depository
institutions, as that term is defined for purposes of the RFA. The
final rule, however, applies only to institutions with $10 billion or
greater in total assets. Consequently, small institutions for purposes
of the RFA will experience no significant economic impact from this
final rule.
B. Small Business Regulatory Enforcement Fairness Act
The OMB has determined that the final rule is not a ``major rule''
within the meaning of the Small Business Regulatory Enforcement
Fairness Act of 1996 (SBREFA) Public Law 110-28 (1996). As required by
law, the FDIC will file the appropriate reports with Congress and the
Government Accountability Office so that the final rule may be
reviewed.
C. Paperwork Reduction Act
1. Request for Comment on Information Collection
In accordance with the Paperwork Reduction Act (44 U.S.C. 3501 et
seq.) the FDIC may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid OMB control number. The collections of information
contained in this final rule are being submitted to OMB for review.
Interested parties may submit written comments to the FDIC
concerning the Paperwork Reduction Act (PRA) implications of this final
rule.\56\ Comments should be submitted within 60 days from the
publication date of this final rule in the Federal Register. Commenters
should refer to ``PRA Comments--Large Bank Definitions Modifications''
in the subject line. Comments may be submitted by any of the following
methods:
---------------------------------------------------------------------------
\56\ The Notice of Proposed Rulemaking did not include a
Paperwork Reduction Act notice for the Alternative Probability of
Default Methodologies or the Alternative Probability of Default
Methodologies for Foreign Loans; the former was inadvertently
omitted; the latter was not proposed in the NPR but was added at the
request of commenters on the NPR.
---------------------------------------------------------------------------
Agency Web Site: http://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on
the Agency Web site.
Email: Comments@FDIC.gov. Include ``PRA Comments--Large
and Highly Complex Institutions Definitions, 3064-AD92'' in the subject
line of the message.
Mail: Gary A. Kuiper, Counsel, F-1086, Federal Deposit
Insurance Corporation, 550 17th Street NW., Washington, DC 20429.
Hand Delivery/Courier: 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.
A copy of the comments may also be submitted to the OMB desk
officer for the FDIC, Office of Information and Regulatory Affairs,
Office of Management and Budget, New Executive Office Building,
Washington, DC 20503.
Comment is solicited on:
(1) Whether the collections of information are necessary for the
proper performance of the functions of the agency, including whether
the information will have practical utility;
(2) The accuracy of the agency's estimate of the burden of the
collections of information, including the validity of the methodology
and assumptions used;
(3) The quality, utility, and clarity of the information to be
collected;
(4) Ways to minimize the burden of the collections of information
on those who are to respond, including through the use of appropriate
automated, electronic, mechanical, or other technological collection
techniques or other forms of information technology; e.g., permitting
electronic submission of responses; and
(5) Estimates of capital or start-up costs and costs of operation,
maintenance, and purchases of services to provide information.
2. Amendment to Information Collection OMB Number: 3064-0179
(a) Alternative Probability of Default Methodologies. This final
rule, amending 12 CFR Part 327, to revise definitions used to determine
assessment rates for large and highly complex insured depository
institutions includes a provision allowing large and highly complex
institutions to make a written request to the FDIC to use alternative
methodologies when estimating two-year probabilities of default (PD).
Under the final rule, institutions may request to use default rates
calculated using fewer observations or score bands than the specified
minimums, either in advance of or concurrent with reporting under that
methodology. An institution's request must explain how the requested
approach differs from the rule specifications and include, at a
minimum, a table with default rates and the number of observations used
in each score and product segment. The FDIC will evaluate the proposed
methodology and may request additional information from the
institution, which the institution must provide. The institution may
report using its approach while the FDIC evaluates the request. After
reviewing the request, the FDIC may determine that the institution's
approach is unacceptable; if so, the institution will be required to
amend its Call Reports and report according to the generally applicable
specifications for PD estimation in the final rule; the institution
will be required to submit amended information for no more than the two
most recently dated and filed Call Reports preceding the FDIC's
determination.
(b) Alternative Probability of Default Methodologies for Foreign
Consumer Loans. The final rule also includes a provision allowing
institutions to determine whether certain foreign consumer loans are
higher-risk loans. One provision permits a bank that is required to
calculate PDs for foreign consumer loans under the requirements of the
Basel II capital framework to estimate the two-year PD of a foreign
consumer loan based on the one-year PD used for capital purposes when
it is unable to reasonably estimate the two-year PD according to the
final rule specifications. To do this, the bank must submit a written
request to the FDIC in advance of, or concurrent with, reporting under
that methodology. The request must explain in detail how one-year PDs
calculated under the Basel framework are translated to two-year PDs
that meet the final rule specifications. While the range of acceptable
approaches is potentially broad, any proposed methodology must meet
certain requirements spelled out in the final rule. The bank may report
[[Page 66015]]
using its proposed Basel II approach while the FDIC evaluates the
methodology. If, after reviewing the request, the FDIC determines that
the methodology is unacceptable, the institution will be required to
amend its Call Reports. The institution will be required to submit
amended information for no more than the two most recently dated and
filed Call Reports preceding the FDIC's determination. Another
provision of the final rule permits an institution to use its own
approach to determine whether certain foreign loans are higher-risk
loans, provided the FDIC first approves that approach. The bank must
submit its proposed approach to the FDIC and the FDIC will notify the
bank whether the approach is acceptable. The FDIC may request
additional information from the bank regarding the proposed methodology
and the bank must provide the information. The FDIC may grant a bank
tentative approval to use a methodology while the FDIC considers it in
more detail; if the FDIC ultimately disapproves the methodology, the
bank will be required to amend all Call Reports affected by the
disapproved methodology.
In conjunction with publication of this final rule amending 12 CFR
Part 327 to revise definitions used to determine assessment rates for
large and highly complex insured depository institutions, the FDIC has
submitted to OMB a request for clearance of the paperwork burden
associated with these processes for requesting a change in
methodologies. That request is pending.
(1) Title: ``Large and Highly Complex Institutions Definitions--
Alternative Probability of Default Methodologies.''
Respondents: Large and Highly Complex insured depository
institutions
Number of Responses: 0-20 per year
Frequency of Response: Occasional
Average number of hours to prepare a response: 10-40
Total Annual Burden: 0-800 hours
(2) Title: ``Large and Highly Complex Institutions Definitions--
Alternative Probability of Default for Foreign Loans.''
Respondents: Large and Highly Complex insured depository
institutions
Number of Responses: 0-20 per year
Frequency of Response: Occasional
Average number of hours to prepare a response: 10-40
Total Annual Burden: 0-800 hours
D. The Treasury and General Government Appropriations Act, 1999--
Assessment of Federal Regulations and Policies on Families
The FDIC has determined that the proposed rule will not affect
family well-being within the meaning of section 654 of the Treasury and
General Government Appropriations Act, enacted as part of the Omnibus
Consolidated and Emergency Supplemental Appropriations Act of 1999
(Pub. L. 105-277, 112 Stat. 2681).
List of Subjects in 12 CFR Part 327
Bank deposit insurance, Banks, Savings Associations.
For the reasons set forth above, the FDIC amends 12 CFR part 327 as
follows:
PART 327--ASSESSMENTS
0
1. The authority citation for part 327 continues to read as follows:
Authority: 12 U.S.C. 1441, 1813, 1815, 1817-19, 1821.
0
2. Revise Section VI of Appendix A to subpart A of part 327 to read as
follows:
Appendix A to Subpart A of Part 327--Method to Derive Pricing
Multipliers and Uniform Amount
* * * * *
VI. Description of Scorecard Measures
------------------------------------------------------------------------
Scorecard measures \1\ Description
------------------------------------------------------------------------
Tier 1 Leverage Ratio................ Tier 1 capital for Prompt
Corrective Action (PCA) divided
by adjusted average assets based
on the definition for prompt
corrective action.
Concentration Measure for Large The concentration score for large
Insured depository institutions institutions is the higher of
(excluding Highly Complex the following two scores:
Institutions).
(1) Higher-Risk Assets/Tier 1 Sum of construction and land
Capital and Reserves. development (C&D) loans (funded
and unfunded), higher-risk C&I
loans (funded and unfunded),
nontraditional mortgages, higher-
risk consumer loans, and higher-
risk securitizations divided by
Tier 1 capital and reserves. See
Appendix C for the detailed
description of the ratio.
(2) Growth-Adjusted Portfolio The measure is calculated in the
Concentrations. following steps:
(1) Concentration levels (as a
ratio to Tier 1 capital and
reserves) are calculated for
each broad portfolio
category:
C&D,
Other commercial
real estate loans,
First lien
residential mortgages
(including non-agency
residential mortgage-backed
securities),
Closed-end junior
liens and home equity lines
of credit (HELOCs),
Commercial and
industrial loans,
Credit card loans,
and
Cther consumer
loans.
(2) Risk weights are assigned
to each loan category based
on historical loss rates.
(3) Concentration levels are
multiplied by risk weights
and squared to produce a risk-
adjusted concentration ratio
for each portfolio.
(4) Three-year merger-adjusted
portfolio growth rates are
then scaled to a growth
factor of 1 to 1.2 where a 3-
year cumulative growth rate
of 20 percent or less equals
a factor of 1 and a growth
rate of 80 percent or greater
equals a factor of 1.2. If
three years of data are not
available, a growth factor of
1 will be assigned.
(5) The risk-adjusted
concentration ratio for each
portfolio is multiplied by
the growth factor and
resulting values are summed.
See Appendix C for the detailed
description of the measure.
Concentration Measure for Highly Concentration score for highly
Complex Institutions. complex institutions is the
highest of the following three
scores:
[[Page 66016]]
(1) Higher-Risk Assets/Tier 1 Sum of C&D loans (funded and
Capital and Reserves. unfunded), higher-risk C&I loans
(funded and unfunded),
nontraditional mortgages, higher-
risk consumer loans, and higher-
risk securitizations divided by
Tier 1 capital and reserves. See
Appendix C for the detailed
description of the measure.
(2) Top 20 Counterparty Exposure/ Sum of the total exposure amount
Tier 1 Capital and Reserves. to the largest 20 counterparties
(in terms of exposure amount)
divided by Tier 1 capital and
reserves. Counterparty exposure
is equal to the sum of Exposure
at Default (EAD) associated with
derivatives trading and
Securities Financing
Transactions (SFTs) and the
gross lending exposure
(including all unfunded
commitments) for each
counterparty or borrower at the
consolidated entity level.\2\
(3) Largest Counterparty Exposure/ The amount of exposure to the
Tier 1 Capital and Reserves. largest counterparty (in terms
of exposure amount) divided by
Tier 1 capital and reserves.
Counterparty exposure is equal
to the sum of EAD associated
with derivatives trading and
SFTs and the gross lending
exposure (including all unfunded
commitments) for each
counterparty or borrower at the
consolidated entity level.
Core Earnings/Average Quarter-End Core earnings are defined as net
Total Assets. income less extraordinary items
and tax-adjusted realized gains
and losses on available-for-sale
(AFS) and held-to-maturity (HTM)
securities, adjusted for
mergers. The ratio takes a four-
quarter sum of merger-adjusted
core earnings and divides it by
an average of five quarter-end
total assets (most recent and
four prior quarters). If four
quarters of data on core
earnings are not available, data
for quarters that are available
will be added and annualized. If
five quarters of data on total
assets are not available, data
for quarters that are available
will be averaged.
Credit Quality Measure............... The credit quality score is the
higher of the following two
scores:
(1) Criticized and Classified Sum of criticized and classified
Items/Tier 1 Capital and items divided by the sum of Tier
Reserves. 1 capital and reserves.
Criticized and classified items
include items an institution or
its primary federal regulator
have graded ``Special Mention''
or worse and include retail
items under Uniform Retail
Classification Guidelines,
securities, funded and unfunded
loans, other real estate owned
(ORE), other assets, and marked-
to-market counterparty
positions, less credit valuation
adjustments.\3\ Criticized and
classified items exclude loans
and securities in trading books,
and the amount recoverable from
the U.S. government, its
agencies, or government-
sponsored enterprises, under
guarantee or insurance
provisions.
(2) Underperforming Assets/Tier 1 Sum of loans that are 30 days or
Capital and Reserves. more past due and still accruing
interest, nonaccrual loans,
restructured loans (including
restructured 1-4 family loans),
and ORE, excluding the maximum
amount recoverable from the U.S.
government, its agencies, or
government-sponsored
enterprises, under guarantee or
insurance provisions, divided by
a sum of Tier 1 capital and
reserves.
Core Deposits/Total Liabilities...... Total domestic deposits excluding
brokered deposits and uninsured
non-brokered time deposits
divided by total liabilities.
Balance Sheet Liquidity Ratio........ Sum of cash and balances due from
depository institutions, federal
funds sold and securities
purchased under agreements to
resell, and the market value of
available for sale and held to
maturity agency securities
(excludes agency mortgage-backed
securities but includes all
other agency securities issued
by the U.S. Treasury, U.S.
government agencies, and U.S.
government-sponsored
enterprises) divided by the sum
of federal funds purchased and
repurchase agreements, other
borrowings (including FHLB) with
a remaining maturity of one year
or less, 5 percent of insured
domestic deposits, and 10
percent of uninsured domestic
and foreign deposits.\4\
Potential Losses/Total Domestic Potential losses to the DIF in
Deposits (Loss Severity Measure). the event of failure divided by
total domestic deposits.
Appendix D describes the
calculation of the loss severity
measure in detail.
Market Risk Measure for Highly The market risk score is a
Complex Institutions. weighted average of the
following three scores:
(1) Trading Revenue Volatility/ Trailing 4-quarter standard
Tier 1 Capital. deviation of quarterly trading
revenue (merger-adjusted)
divided by Tier 1 capital.
(2) Market Risk Capital/Tier 1 Market risk capital divided by
Capital. Tier 1 capital.\5\
(3) Level 3 Trading Assets/Tier 1 Level 3 trading assets divided by
Capital. Tier 1 capital.
Average Short-term Funding/Average Quarterly average of federal
Total Assets. funds purchased and repurchase
agreements divided by the
quarterly average of total
assets as reported on Schedule
RC-K of the Call Reports
------------------------------------------------------------------------
\1\ The FDIC retains the flexibility, as part of the risk-based
assessment system, without the necessity of additional notice-and-
comment rulemaking, to update the minimum and maximum cutoff values
for all measures used in the scorecard. The FDIC may update the
minimum and maximum cutoff values for the higher-risk assets to Tier 1
capital and reserves ratio in order to maintain an approximately
similar distribution of higher-risk assets to Tier 1 capital and
reserves ratio scores as reported prior to April 1, 2013, or to avoid
changing the overall amount of assessment revenue collected. 76 FR
10672, 10700 (February 25, 2011). The FDIC will review changes in the
distribution of the higher-risk assets to Tier 1 capital and reserves
ratio scores and the resulting effect on total assessments and risk
differentiation between banks when determining changes to the cutoffs.
The FDIC may update the cutoff values for the higher-risk assets to
Tier 1 capital and reserves ratio more frequently than annually. The
FDIC will provide banks with a minimum one quarter advance notice of
changes in the cutoff values for the higher-risk assets to Tier 1
capital and reserves ratio with their quarterly deposit insurance
invoice.
\2\ EAD and SFTs are defined and described in the compilation issued by
the Basel Committee on Banking Supervision in its June 2006 document,
``International Convergence of Capital Measurement and Capital
Standards.'' The definitions are described in detail in Annex 4 of the
document. Any updates to the Basel II capital treatment of
counterparty credit risk would be implemented as they are adopted.
http://www.bis.org/publ/bcbs128.pdf
[[Page 66017]]
\3\ A marked-to-market counterparty position is equal to the sum of the
net marked-to-market derivative exposures for each counterparty. The
net marked-to-market derivative exposure equals the sum of all
positive marked-to-market exposures net of legally enforceable netting
provisions and net of all collateral held under a legally enforceable
CSA plus any exposure where excess collateral has been posted to the
counterparty. For purposes of the Criticized and Classified Items/Tier
1 Capital and Reserves definition a marked-to-market counterparty
position less any credit valuation adjustment can never be less than
zero.
\4\ Deposit runoff rates for the balance sheet liquidity ratio reflect
changes issued by the Basel Committee on Banking Supervision in its
December 2010 document, ``Basel III: International Framework for
liquidity risk measurement, standards, and monitoring,'' http://www.bis.org/publ/bcbs188.pdf.
\5\ Market risk capital is defined in Appendix C of Part 325 of the FDIC
Rules and Regulations,. http://www.fdic.gov/regulations/laws/rules/2000-4800.html#fdic2000appendixctopart325.
0
3. Revise Appendix C to subpart A of part 327 to read as follows:
Appendix C to Subpart A to Part 327
I. Concentration Measures
The concentration score for large banks is the higher of the
higher-risk assets to Tier 1 capital and reserves score or the
growth-adjusted portfolio concentrations score.\1\ The concentration
score for highly complex institutions is the highest of the higher-
risk assets to Tier 1 capital and reserves score, the Top 20
counterparty exposure to Tier 1 capital and reserves score, or the
largest counterparty to Tier 1 capital and reserves score. The
higher-risk assets to Tier 1 capital and reserves ratio and the
growth-adjusted portfolio concentration measure are described
herein.
---------------------------------------------------------------------------
\1\ For the purposes of this Appendix, the term ``bank'' means
insured depository institution.
---------------------------------------------------------------------------
A. Higher-Risk Assets/Tier 1 Capital and Reserves
The higher-risk assets to Tier 1 capital and reserves ratio is
the sum of the concentrations in each of five risk areas described
below and is calculated as:
[GRAPHIC] [TIFF OMITTED] TR31OC12.027
Where:
Hi is bank i's higher-risk concentration measure and k is
a risk area.\2\ The five risk areas (k) are: construction and land
development (C&D) loans; higher-risk commercial and industrial (C&I)
loans and securities; higher-risk consumer loans; nontraditional
mortgage loans; and higher-risk securitizations.
---------------------------------------------------------------------------
\2\ The higher-risk concentration ratio is rounded to two
decimal points.
---------------------------------------------------------------------------
1. Construction and Land Development Loans
Construction and land development loans include construction and
land development loans outstanding and unfunded commitments to fund
construction and land development loans, whether irrevocable or
unconditionally cancellable.\3\
---------------------------------------------------------------------------
\3\ Construction and land development loans are as defined in
the instructions to Call Report Schedule RC-C Part I--Loans and
Leases, as they may be amended from time to time, and include items
reported on line items RC-C 1.a.1 (1-4 family residential
construction loans), RC-C 1.a.2. (Other construction loans and all
land development and other land loans), and RC-O M.10.a (Total
unfunded commitments to fund construction, land development, and
other land loans secured by real estate), and exclude RC-O M.10.b
(Portion of unfunded commitments to fund construction, land
development and other loans that are guaranteed or insured by the
U.S. government, including the FDIC), RC-O M.13.a (Portion of funded
construction, land development, and other land loans guaranteed or
insured by the U.S. government, excluding FDIC loss sharing
agreements), RC-M 13a.1.a.1 (1-4 family construction and land
development loans covered by loss sharing agreements with the FDIC),
and RC-M 13a.1.a.2 (Other construction loans and all land
development loans covered by loss sharing agreements with the FDIC).
---------------------------------------------------------------------------
2. Higher-Risk Commercial and Industrial (C&I) Loans and Securities
Definitions
Higher-Risk C&I Loans and Securities
Higher-risk C&I loans and securities are:
(a) All commercial and industrial (C&I) loans (including funded
amounts and the amount of unfunded commitments, whether irrevocable
or unconditionally cancellable) owed to the reporting bank (i.e.,
the bank filing its report of condition and income, or Call Report)
by a higher-risk C&I borrower, as that term is defined herein,
regardless when the loans were made; 4 5 and
---------------------------------------------------------------------------
\4\ Commercial and industrial loans are as defined as commercial
and industrial loans in the instructions to Call Report Schedule RC-
C Part I--Loans and Leases, as they may be amended from time to
time. This definition includes purchased credit impaired loans and
overdrafts.
\5\ Unfunded commitments are defined as unused commitments, as
this term is defined in the instructions to Call Report Schedule RC-
L, Derivatives and Off-Balance Sheet Items, as they may be amended
from time to time.
---------------------------------------------------------------------------
(b) All securities, except securities classified as trading
book, issued by a higher-risk C&I borrower, as that term is defined
herein, that are owned by the reporting bank, without regard to when
the securities were purchased; however, higher-risk C&I loans and
securities exclude:
(a) The maximum amount that is recoverable from the U.S.
government under guarantee or insurance provisions;
(b) Loans (including syndicated or participated loans) that are
fully secured by cash collateral as provided herein;
(c) Loans that are eligible for the asset-based lending
exclusion, described herein, provided the bank's primary federal
regulator (PFR) has not cited a criticism (included in the Matters
Requiring Attention, or MRA) of the bank's controls or
administration of its asset-based loan portfolio; and
(d) Loans that are eligible for the floor plan lending
exclusion, described herein, provided the bank's PFR has not cited a
criticism (included in the MRA) of the bank's controls or
administration of its floor plan loan portfolio.
Higher-Risk C&I Borrower
A ``higher-risk C&I borrower'' is a borrower that:
(a) Owes the reporting bank on a C&I loan originally made on or
after April 1, 2013, if:
(i) The C&I loan has an original amount (including funded
amounts and the amount of unfunded commitments, whether irrevocable
or unconditionally cancellable) of at least $5 million;
(ii) The loan meets the purpose and materiality tests described
herein; and
(iii) When the loan is made, the borrower meets the leverage
test described herein; or
(b) Obtains a refinance, as that term is defined herein, of an
existing C&I loan, where the refinance occurs on or after April 1,
2013, and the refinanced loan is owed to the reporting bank, if:
(i) The refinanced loan is in an amount (including funded
amounts and the amount of unfunded commitments, whether irrevocable
or unconditionally cancellable) of at least $5 million;
(ii) The C&I loan being refinanced met the purpose and
materiality tests (described herein) when it was originally made;
(iii) The original loan was made no more than 5 years before the
refinanced loan; and
(iv) When the loan is refinanced, the borrower meets the
leverage test.
When a bank acquires a C&I loan originally made on or after
April 1, 2013, by another lender, it must determine whether the
borrower is a higher-risk borrower as a result of the loan as soon
as reasonably practicable, but not later than one year after
acquisition. When a bank acquires loans from another entity on a
recurring or programmatic basis, however, the bank must determine
whether the borrower is a higher-risk borrower as a result of the
loan as soon as is practicable, but not later than three months
after the date of acquisition.
A borrower ceases to be a ``higher-risk C&I borrower'' only if:
[[Page 66018]]
(a) The borrower no longer has any C&I loans owed to the
reporting bank that, when originally made, met the purpose and
materiality tests described herein;
(b) The borrower has such loans outstanding owed to the
reporting bank, but they have all been refinanced more than 5 years
after originally being made; or
(c) The reporting bank makes a new C&I loan or refinances an
existing C&I loan and the borrower no longer meets the leverage test
described herein.
Original Amount
The original amount of a loan, including the amounts to
aggregate for purposes of arriving at the original amount, as
described herein, is:
(a) For C&I loans drawn down under lines of credit or loan
commitments, the amount of the line of credit or loan commitment on
the date of its most recent approval, extension or renewal prior to
the date of the most recent Call Report; if, however, the amount
currently outstanding on the loan as of the date of the bank's most
recent Call Report exceeds this amount, then the original amount of
the loan is the amount outstanding as of the date of the bank's most
recent Call Report.
(b) For syndicated or participated C&I loans, the total amount
of the loan, rather than just the syndicated or participated portion
held by the individual reporting bank.
(c) For all other C&I loans (whether term or non-revolver
loans), the total amount of the loan as of origination or the amount
outstanding as of the date of the bank's most recent Call Report,
whichever is larger.
For purposes of defining original amount and a higher-risk C&I
borrower:
(a) All C&I loans that a borrower owes to the reporting bank
that meet the purpose test when made, and that are made within six
months of each other, must be aggregated to determine the original
amount of the loan; however, only loans in the original amount of $1
million or more must be aggregated; and further provided, that loans
made before the April 1, 2013, need not be aggregated.
(b) When a C&I loan is refinanced through more than one loan,
and the loans are made within six months of each other, they must be
aggregated to determine the original amount.
Refinance
For purposes of a C&I loan, a refinance includes:
(a) Replacing an original obligation by a new or modified
obligation or loan agreement;
(b) Increasing the master commitment of the line of credit (but
not adjusting sub-limits under the master commitment);
(c) Disbursing additional money other than amounts already
committed to the borrower;
(d) Extending the legal maturity date;
(e) Rescheduling principal or interest payments to create or
increase a balloon payment;
(f) Releasing a substantial amount of collateral;
(g) Consolidating multiple existing obligations; or
(h) Increasing or decreasing the interest rate.
A refinance of a C&I loan does not include a modification or
series of modifications to a commercial loan other than as described
above or modifications to a commercial loan that would otherwise
meet this definition of refinance, but that result in the
classification of a loan as a troubled debt restructuring (TDR), as
this term is defined in the glossary of the Call Report
instructions, as they may be amended from time to time.
Purpose Test
A loan or refinance meets the purpose test if it is to finance:
(a) A buyout, defined as the purchase or repurchase by the
borrower of the borrower's outstanding equity, including, but not
limited to, an equity buyout or funding an Employee Stock Ownership
Plan (ESOP);
(b) An acquisition, defined as the purchase by the borrower of
any equity interest in another company, or the purchase of all or a
substantial portion of the assets of another company; or
(c) A capital distribution, defined as a dividend payment or
other transaction designed to enhance shareholder value, including,
but not limited to, a repurchase of stock.
At the time of refinance, whether the original loan met the
purpose test may not be easily determined by a new lender. In such a
case, the new lender must use its best efforts and reasonable due
diligence to determine whether the original loan met the test.
Materiality Test
A loan or refinance meets the materiality test if:
(a) The original amount of the loan (including funded amounts
and the amount of unfunded commitments, whether irrevocable or
unconditionally cancellable) equals or exceeds 20 percent of the
total funded debt of the borrower; total funded debt of the borrower
is to be determined as of the date of the original loan and does not
include the loan to which the materiality test is being applied; or
(b) Before the loan was made, the borrower had no funded debt.
When multiple loans must be aggregated to determine the original
amount, the materiality test is applied as of the date of the most
recent loan.
At the time of refinance, whether the original loan met the
materiality test may not be easily determined by a new lender. In
such a case, the new lender must use its best efforts and reasonable
due diligence to determine whether the original loan met the test.
Leverage Test
A borrower meets the leverage test if:
(a) The ratio of the borrower's total debt to trailing twelve-
month EBITDA (commonly known as the operating leverage ratio) is
greater than 4; or
(b) The ratio of the borrower's senior debt to trailing twelve-
month EBITDA (also commonly known as the operating leverage ratio)
is greater than 3.
EBITDA is defined as earnings before interest, taxes,
depreciation, and amortization.
Total debt is defined as all interest-bearing financial
obligations and includes, but is not limited to, overdrafts,
borrowings, repurchase agreements (repos), trust receipts, bankers
acceptances, debentures, bonds, loans (including those secured by
mortgages), sinking funds, capital (finance) lease obligations
(including those obligations that are convertible, redeemable or
retractable), mandatory redeemable preferred and trust preferred
securities accounted for as liabilities in accordance with ASC
Subtopic 480-10, Distinguishing Liabilities from Equity--Overall
(formerly FASB Statement No. 150, ``Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity''),
and subordinated capital notes. Total debt excludes pension
obligations, deferred tax liabilities and preferred equity.
Senior debt includes any portion of total debt that has a
priority claim on any of the borrower's assets. A priority claim is
a claim that entitles the holder to priority of payment over other
debt holders in bankruptcy.
When calculating either of the borrower's operating leverage
ratios, the only permitted EBITDA adjustments are those specifically
permitted for that borrower in the loan agreement (at the time of
underwriting) and only funded amounts of lines of credit must be
considered debt.
The debt-to-EBITDA ratio must be calculated using the
consolidated financial statements of the borrower. If the loan is
made to a subsidiary of a larger organization, the debt-to-EBITDA
ratio may be calculated using the financial statements of the
subsidiary or, if the parent company has unconditionally and
irrevocably guaranteed the borrower's debt, using the consolidated
financial statements of the parent company.
In the case of a merger of two companies or the acquisition of
one or more companies or parts of companies, pro-forma debt is to be
used as well as the trailing twelve-month pro-forma EBITDA for the
combined companies. When calculating the trailing pro-forma EBITDA
for the combined company, no adjustments are allowed for economies
of scale or projected cost savings that may be realized subsequent
to the acquisition unless specifically permitted for that borrower
under the loan agreement.
Exclusions
Cash Collateral Exclusion
To exclude a loan based on cash collateral, the cash must be in
the form of a savings or time deposit held by a bank. The bank (or
lead bank or agent bank in the case of a participation or
syndication) must have a perfected first priority security interest,
a security agreement, and a collateral assignment of the deposit
account that is irrevocable for the remaining term of the loan or
commitment. In addition, the bank must place a hold on the deposit
account that alerts the bank's employees to an attempted withdrawal.
If the cash collateral is held at another bank or at multiple banks,
a security agreement must be in place and each bank must have an
account control agreementin place.\6\ For the exclusion to apply to
a
[[Page 66019]]
revolving line of credit, the cash collateral must be equal to or
greater than the amount of the total loan commitment (the aggregate
funded and unfunded balance of the loan).
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\6\ An account control agreement, for purposes of this Appendix,
means a written agreement between the lending bank (the secured
party), the borrower, and the bank that holds the deposit account
serving as collateral (the depository bank), that the depository
bank will comply with instructions originated by the secured party
directing disposition of the funds in the deposit account without
further consent by the borrower (or any other party).
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Asset-Based and Floor Plan Lending Exclusions
The FDIC retains the authority to verify that banks have sound
internal controls and administration practices for asset-based and
floor plan loans that are excluded from a bank's reported higher-
risk C&I loans and securities totals. If the bank's PFR has cited a
criticism of the bank's controls or administration of its asset-
based or floor plan loan portfolios in an MRA, the bank is not
eligible for the asset-based or floor plan lending exclusions.
Asset-Based Lending Conditions
Asset-based loans (loans secured by accounts receivable and
inventory) that meet all the following conditions are excluded from
a bank's higher-risk C&I loan totals:
(a) The loan is managed by a loan officer or group of loan
officers at the reporting bank who have experience in asset-based
lending and collateral monitoring, including, but not limited to,
experience in reviewing the following: Collateral reports, borrowing
base certificates (which are discussed herein), collateral audit
reports, loan-to-collateral values (LTV), and loan limits, using
procedures common to the industry.
(b) The bank has taken, or has the legally enforceable ability
to take, dominion over the borrower's deposit accounts such that
proceeds of collateral are applied to the loan balance as collected.
Security agreements must be in place in all cases; in addition, if a
borrower's deposit account is held at a bank other than the lending
bank, an account control agreement must also be in place.
(c) The bank has a perfected first priority security interest in
all assets included in the borrowing base certificate.
(d) If the loan is a credit facility (revolving or term loan),
it must be fully secured by self-liquidating assets such as accounts
receivable and inventory.\7\ Other non-self-liquidating assets may
be part of the borrowing base, but the outstanding balance of the
loan must be fully secured by the portion of the borrowing base that
is composed of self-liquidating assets. Fully secured is defined as
a 100 percent or lower LTV ratio after applying the appropriate
discounts (determined by the loan agreement) to the collateral. If
an over advance (including a seasonal over advance) causes the LTV
to exceed 100 percent, the loan may not be excluded from higher-risk
C&I loans owed by a higher-risk C&I borrower. Additionally, the bank
must have the ability to withhold funding of a draw or advance if
the loan amount exceeds the amount allowed by the collateral
formula.
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\7\ An asset is self-liquidating if, in the event the borrower
defaults, the asset can be easily liquidated and the proceeds of the
sale of the assets would be used to pay down the loan. These assets
can include machinery, heavy equipment or rental equipment if the
machinery or equipment is inventory for the borrower's primary
business and the machinery or equipment is included in the borrowing
base.
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(e) A bank's lending policy or procedures must address the
maintenance of an accounts receivable loan agreement with the
borrower. This loan agreement must establish a maximum percentage
advance, which cannot exceed 85 percent, against eligible accounts
receivable, include a maximum dollar amount due from any one account
debtor, address the financial strength of debtor accounts, and
define eligible receivables. The definition of eligible receivables
must consider the receivable quality, the turnover and dilution
rates of receivables pledged, the aging of accounts receivable, the
concentrations of debtor accounts, and the performance of the
receivables related to their terms of sale.
Concentration of debtor accounts is the percentage value of
receivables associated with one or a few customers relative to the
total value of receivables. Turnover of receivables is the velocity
at which receivables are collected. The dilution rate is the
uncollectible accounts receivable as a percentage of sales.
Ineligibles must be established for any debtor account where
there is concern that the debtor may not pay according to terms.
Monthly accounts receivable agings must be received in sufficient
detail to allow the bank to compute the required ineligibles. At a
minimum, the following items must be deemed ineligible accounts
receivable:
(i) Accounts receivable balances over 90 days beyond invoice
date or 60 days past due, depending upon custom with respect to a
particular industry with appropriate adjustments made for dated
billings;
(ii) Entire account balances where over 50 percent of the
account is over 60 days past due or 90 days past invoice date;
(iii) Accounts arising from sources other than trade (e.g.,
royalties, rebates);
(iv) Consignment or guaranteed sales;
(v) Notes receivable;
(vi) Progress billings;
(vii) Account balances in excess of limits appropriate to
account debtor's credit worthiness or unduly concentrated by
industry, location or customer;
(viii) Affiliate and intercompany accounts; and
(ix) Foreign accounts receivable.
(f) Loans against inventory must be made with advance rates no
more than 65 percent of eligible inventory (at the lower of cost
valued on a first-in, first-out (FIFO) basis or market) based on an
analysis of realizable value. When an appraisal is obtained, or
there is a readily determinable market price for the inventory,
however, up to 85 percent of the net orderly liquidation value
(NOLV) or the market price of the inventory may be financed.
Inventory must be valued or appraised by an independent third-party
appraiser using NOLV, fair value, or forced sale value (versus a
``going concern'' value), whichever is appropriate, to arrive at a
net realizable value. Appraisals are to be prepared in accordance
with industry standards, unless there is a readily available and
determinable market price for the inventory (e.g., in the case of
various commodities), from a recognized exchange or third-party
industry source, and a readily available market (e.g., for aluminum,
crude oil, steel, and other traded commodities); in that case,
inventory may be valued using current market value. When relying
upon current market value rather than an independent appraisal, the
reporting bank's management must update the value of inventory as
market prices for the product change. Valuation updates must be as
frequent as needed to ensure compliance with margin requirements. In
addition, appropriate mark-to-market reserves must be established to
protect against excessive inventory price fluctuations. An asset has
a readily identifiable and publicly available market price if the
asset's price is quoted routinely in a widely disseminated
publication that is readily available to the general public.
(g) A bank's lending policy or procedures must address the
maintenance of an inventory loan agreement with the borrower. This
loan agreement must establish a maximum percentage advance rate
against acceptable inventory, address acceptable appraisal and
valuation requirements, and define acceptable and ineligible
inventory. Ineligibles must be established for inventory that
exhibit characteristics that make it difficult to achieve a
realizable value or to obtain possession of the inventory. Monthly
inventory agings must be received in sufficient detail to allow the
bank to compute the required ineligibles. At a minimum, ineligible
inventory must include:
(i) Slow moving, obsolete inventory and items turning materially
slower than industry average;
(ii) Inventory with value to the client only, which is generally
work in process, but may include raw materials used solely in the
client's manufacturing process;
(iii) Consigned inventory or other inventory where a perfected
security interest cannot be obtained;
(iv) Off-premise inventory subject to a mechanic's or other
lien; and
(v) Specialized, high technology or other inventory subject to
rapid obsolescence or valuation problems.
(h) The bank must maintain documentation of borrowing base
certificate reviews and collateral trend analyses to demonstrate
that collateral values are actively, routinely and consistently
monitored. A borrowing base certificate is a form prepared by the
borrower that reflects the current status of the collateral. A new
borrowing base certificate must be obtained within 30 days before or
after each draw or advance on a loan. A bank is required to validate
the borrowing base through asset-based tracking reports. The
borrowing base validation process must include the bank requesting
from the borrower a list of accounts receivable by creditor and a
list of individual items of inventory and the bank certifying that
the outstanding balance of the loan remains within the collateral
formula prescribed by the loan agreement. Any discrepancies between
the list of accounts receivable and
[[Page 66020]]
inventory and the borrowing base certificate must be reconciled with
the borrower. Periodic, but no less than annual, field examinations
(audits) must also be performed by individuals who are independent
of the credit origination or administration process. There must be a
process in place to ensure that the bank is correcting audit
exceptions.
Floor Plan Lending Conditions
Floor plan loans may include, but are not limited to, loans to
finance the purchase of various vehicles or equipment including
automobiles, boat or marine equipment, recreational vehicles (RV),
motorized watersports vehicles such as jet skis, or motorized lawn
and garden equipment such as tractor lawnmowers. Floor plan loans
that meet all the following conditions are excluded from a bank's
higher-risk C&I loan totals:
(a) The loan is managed by a loan officer or a group of loan
officers at the reporting bank who are experienced in floor plan
lending and monitoring collateral to ensure the borrower remains in
compliance with floor plan limits and repayment requirements. Loan
officers must have experience in reviewing certain items, including
but not limited to: Collateral reports, floor plan limits, floor
plan aging reports, vehicle inventory audits or inspections, and LTV
ratios. The bank must obtain and review financial statements of the
borrower (e.g., tax returns, company-prepared financial statements,
or dealer statements) on at least a quarterly basis to ensure that
adequate controls are in place. (A ``dealer statement'' is the
standard format financial statement issued by Original Equipment
Manufacturers (OEMs) and used by nationally recognized automobile
dealer floor plan lenders.)
(b) For automobile floor plans, each loan advance must be made
against a specific automobile under a borrowing base certificate
held as collateral at no more than 100 percent of (i) dealer invoice
plus freight charges (for new vehicles) or (ii) the cost of a used
automobile at auction or the wholesale value using the prevailing
market guide (e.g., NADA, Black Book, Blue Book). The advance rate
of 100 percent of dealer invoice plus freight charges on new
automobiles, and the advance rate of the cost of a used automobile
at auction or the wholesale value, may only be used where there is a
manufacturer repurchase agreement or an aggressive curtailment
program in place that is tracked by the bank over time and subject
to strong controls. Otherwise, permissible advance rates must be
lower than 100 percent.
(c) Advance rates on vehicles other than automobiles must
conform to industry standards for advance rates on such inventory,
but may never exceed 100 percent of dealer invoice plus freight
charges on new vehicles or 100 percent of the cost of a used vehicle
at auction or its wholesale value.
(d) Each loan is self-liquidating (i.e., if the borrower
defaulted on the loan, the collateral could be easily liquidated and
the proceeds of the sale of the collateral would be used to pay down
the loan advance).
(e) Vehicle inventories and collateral values are closely
monitored, including the completion of regular (at least quarterly)
dealership automotive or other vehicle dealer inventory audits or
inspections to ensure accurate accounting for all vehicles held as
collateral. The lending bank or a third party must prepare inventory
audit reports and inspection reports for loans to automotive
dealerships, or loans to other vehicle dealers, and the lending bank
must review the reports at least quarterly. The reports must list
all vehicles held as collateral and verify that the collateral is in
the dealer's possession.
(f) Floor plan aging reports must be reviewed by the bank as
frequently as required under the loan agreement, but no less
frequently than quarterly. Floor plan aging reports must reflect
specific information about each automobile or vehicle being financed
(e.g., the make, model, and color of the automobile or other
vehicle, and origination date of the loan to finance the automobile
or vehicle). Curtailment programs should be instituted where
necessary and banks must ensure that curtailment payments are made
on stale automotive or other vehicle inventory financed under the
floor plan loan.
Detailed Reports
Examples of detailed reports that must be provided to the asset-
based and floor plan lending bank include:
(a) Borrowing Base Certificates: Borrowing base certificates,
along with supporting information, must include:
(i) The accounts receivable balance (rolled forward from the
previous certificate);
(ii) Sales (reported as gross billings) with detailed
adjustments for returns and allowances to allow for proper tracking
of dilution and other reductions in collateral;
(iii) Detailed inventory information (e.g., raw materials, work-
in-process, finished goods); and
(iv) Detail of loan activity.
(b) Accounts Receivable and Inventory Detail: A listing of
accounts receivable and inventory that is included on the borrowing
base certificate. Monthly accounts receivable and inventory agings
must be received in sufficient detail to allow the lender to compute
the required ineligibles.
(c) Accounts Payable Detail: A listing of each accounts payable
owed to the borrower. Monthly accounts payable agings must be
received to monitor payable performance and anticipated working
capital needs.
(d) Covenant Compliance Certificates: A listing of each loan
covenant and the borrower's compliance with each one. Borrowers must
submit Covenant Compliance Certificates, generally on a monthly or
quarterly basis (depending on the terms of the loan agreement) to
monitor compliance with the covenants outlined in the loan
agreement. Non-compliance with any covenants must be promptly
addressed.
(e) Dealership Automotive Inventory or Other Vehicle Inventory
Audits or Inspections: The bank or a third party must prepare
inventory audit reports or inspection reports for loans to
automotive dealerships and other vehicle dealerships. The bank must
review the reports at least quarterly. The reports must list all
vehicles held as collateral and verify that the collateral is in the
dealer's possession.
(f) Floor Plan Aging Reports: Borrowers must submit floor plan
aging reports on a monthly or quarterly basis (depending on the
terms of the loan agreement). These reports must reflect specific
information about each automobile or other type of vehicle being
financed (e.g., the make, model, and color of the automobile or
other type of vehicle, and origination date of the loan to finance
the automobile or other type of vehicle).
3. Higher-Risk Consumer Loans
Definitions
Higher-risk consumer loans are defined as all consumer loans
where, as of origination, or, if the loan has been refinanced, as of
refinance, the probability of default (PD) within two years (the
two-year PD) is greater than 20 percent, excluding those consumer
loans that meet the definition of a nontraditional mortgage
loan.8 9
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\8\ For the purposes of this rule, consumer loans consist of all
loans secured by 1-4 family residential properties as well as loans
and leases made to individuals for household, family, and other
personal expenditures, as defined in the instructions to the Call
Report, Schedule RC-C, as the instructions may be amended from time
to time. Higher-risk consumer loans include purchased credit-
impaired loans that meet the definition of higher-risk consumer
loans.
\9\ The FDIC has the flexibility, as part of its risk-based
assessment system, to change the 20 percent threshold for
identifying higher-risk consumer loans without further notice-and-
comment rulemaking as a result of reviewing data for up to the first
two reporting periods after the effective date of this rule. Before
making any such change, the FDIC will analyze the potential effect
of changing the PD threshold on the distribution of higher-risk
consumer loans among banks and the resulting effect on assessments
collected from the industry. The FDIC will provide banks with at
least one quarter advance notice of any such change to the PD
threshold through a Financial Institution Letter.
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Higher-risk consumer loans exclude:
(a) The maximum amounts recoverable from the U.S. government
under guarantee or insurance provisions; and
(b) Loans fully secured by cash collateral. To exclude a loan
based on cash collateral, the cash must be in the form of a savings
or time deposit held by a bank. The lending bank (or lead or agent
bank in the case of a participation or syndication) must, in all
cases, (including instances in which cash collateral is held at
another bank or banks) have a perfected first priority security
interest under applicable state law, a security agreement in place,
and all necessary documents executed and measures taken as required
to result in such perfection and priority. In addition, the lending
bank must place a hold on the deposit account that alerts the bank's
employees to an attempted withdrawal. For the exclusion to apply to
a revolving line of credit, the cash collateral must be equal to, or
greater than, the amount of the total loan commitment (the aggregate
funded and unfunded balance of the loan).
Banks must determine the PD of a consumer loan as of the date
the loan was originated, or, if the loan has been refinanced, as of
the date it was refinanced. The two-year PD must be estimated using
an approach that conforms to the requirements detailed herein.
[[Page 66021]]
Loans Originated or Refinanced Before April 1, 2013, and all Acquired
Loans
For loans originated or refinanced by a bank before April 1,
2013, and all acquired loans regardless of the date of acquisition,
if information as of the date the loan was originated or refinanced
is not available, then the bank must use the oldest available
information to determine the PD. If no information is available,
then the bank must obtain recent, refreshed data from the borrower
or other appropriate third party to determine the PD. Refreshed data
is defined as the most recent data available, and must be as of a
date that is no earlier than three months before the acquisition of
the loan. In addition, for loans acquired on or after April 1, 2013,
the acquiring bank shall have six months from the date of
acquisition to determine the PD.
When a bank acquires loans from another entity on a recurring or
programmatic basis, the acquiring bank may determine whether the
loan meets the definition of a higher-risk consumer loan using the
origination criteria and analysis performed by the original lender
only if the acquiring bank verifies the information provided. Loans
acquired from another entity are acquired on a recurring basis if a
bank has acquired other loans from that entity at least once within
the calendar year of the acquisition of the loans in question or in
the previous calendar year. If the acquiring bank cannot or does not
verify the information provided by the original lender, the
acquiring bank must obtain the necessary information from the
borrower or other appropriate third party to make its own
determination of whether the purchased assets should be classified
as a higher-risk consumer loan.
Loans That Meet Both Higher-Risk Consumer Loans and Nontraditional
Mortgage Loans Definitions
A loan that meets both the nontraditional mortgage loan and
higher-risk consumer loan definitions at the time of origination,
or, if the loan has been refinanced, as of refinance, must be
reported only as a nontraditional mortgage loan. If, however, the
loan ceases to meet the nontraditional mortgage loan definition but
continues to meet the definition of a higher-risk consumer loan, the
loan is to be reported as a higher-risk consumer loan.
General Requirements for PD Estimation
Scorable Consumer Loans
Estimates of the two-year PD for a loan must be based on the
observed, stress period default rate (defined herein) for loans of a
similar product type made to consumers with credit risk comparable
to the borrower being evaluated. While a bank may consider
additional risk factors beyond the product type and credit score
(e.g., geography) in estimating the PD of a loan, it must at a
minimum account for these two factors. The credit risk assessment
must be determined using third party or internal scores derived
using a scoring system that qualifies as empirically derived,
demonstrably and statistically sound as defined in 12 CFR 202.2(p),
as it may be amended from time to time, and has been approved by the
bank's model risk oversight and governance process and internal
audit mechanism. In the case of a consumer loan with a co-signer or
co-borrower, the PD may be determined using the most favorable
individual credit score.
In estimating the PD based on such scores, banks must adhere to
the following requirements:
(a) The PD must be estimated as the average of the two, 24-month
default rates observed from July 2007 to June 2009, and July 2009 to
June 2011, where the average is calculated according to the
following formula and DRt is the observed default rate
over the 24-month period beginning in July of year t:
[GRAPHIC] [TIFF OMITTED] TR31OC12.028
(b) The default rate for each 24-month period must be calculated
as the number of active loans that experienced at least one default
event during the period divided by the total number of active loans
as of the observation date (i.e., the beginning of the 24-month
period). An ``active'' loan is defined as any loan that was open and
not in default as of the observation date, and on which a payment
was made within the 12 months prior to the observation date.
(c) The default rate for each 24-month period must be calculated
using a stratified random sample of loans that is sufficient in size
to derive statistically meaningful results for the product type and
credit score (and any additional risk factors) being evaluated. The
product strata must be as homogenous as possible with respect to the
factors that influence default, such that products with distinct
risk characteristics are evaluated separately. The loans should be
sampled based on the credit score as of the observation date, and
each 24-month default rate must be calculated using a random sample
of at least 1,200 active loans.
(d) Credit score strata must be determined by partitioning the
entire credit score range generated by a given scoring system into a
minimum of 15 bands. While the width of the credit score bands may
vary, the scores within each band must reflect a comparable level of
credit risk. Because performance data for scores at the upper and
lower extremes of the population distribution is likely to be
limited, however, the top and bottom bands may include a range of
scores that suggest some variance in credit quality.
(e) Each credit score will need to have a unique PD associated
with it. Therefore, when the number of score bands is less than the
number of unique credit scores (as will almost always be the case),
banks must use a linear interpolation between adjacent default rates
to determine the PD for a particular score. The observed default
rate for each band must be assumed to correspond to the midpoint of
the range for the band. For example, if one score band ranges from
621 to 625 and has an observed default rate of 4 percent, while the
next lowest band ranges from 616 to 620 and has an observed default
rate of 6 percent, a 620 score must be assigned a default rate of
5.2 percent, calculated as
[GRAPHIC] [TIFF OMITTED] TR31OC12.029
When evaluating scores that fall below the midpoint of the
lowest score band or above the midpoint of the highest score band,
the interpolation must be based on an assumed adjacent default rate
of 1 or 0, respectively.
(f) The credit scores represented in the historical sample must
have been produced by the same entity, using the same or
substantially similar methodology as the methodology used to derive
the credit scores to which the default rates will be applied. For
example, the default rate for a particular vendor score cannot be
evaluated based on the score-to-default rate relationship for a
different vendor, even if the range of scores under both systems is
the same. On the other hand, if the current and historical scores
were produced by the same vendor using slightly different versions
of the same scoring system and equivalent scores represent a similar
likelihood of default, then the historical experience could be
applied.
(g) A loan is to be considered in default when it is 90+ days
past due, charged-off, or the borrower enters bankruptcy.
Unscorable Consumer Loans
For unscorable consumer loans--where the available information
about a borrower is insufficient to determine a credit score--the
bank will be unable to assign a PD to the loan according to the
requirements described above. If the total outstanding balance of
the unscorable consumer loans of a particular product type
(including, but not limited to, student loans) exceeds 5 percent of
the total outstanding balance for that product type, including both
foreign and domestic loans, the excess amount shall be treated as
higher risk (the de minimis approach). Otherwise, the total
outstanding balance of unscorable consumer loans of a particular
product type will not be considered higher risk. The consumer
product types used to determine whether the 5 percent test is
satisfied shall correspond to the product types listed in the table
used for reporting PD estimates.
A bank may not develop PD estimates for unscorable loans based
on internal data.
If, after the origination or refinance of the loan, an
unscorable consumer loan becomes scorable, a bank must reclassify
the loan using a PD estimated according to the general requirements
above. Based upon that PD, the loan will be determined to be either
higher risk or not, and that determination will remain in effect
until a refinancing occurs, at which time the loan must be re-
evaluated. An unscorable loan must be reviewed at least annually to
determine if a credit score has become available.
Alternative Methodologies
A bank may use internally derived default rates that were
calculated using fewer observations or score bands than those
specified above under certain conditions. The bank must submit a
written request to the FDIC either in advance of, or concurrent
with, reporting under the requested approach. The request must
explain in detail how the proposed approach differs from the rule
specifications and the bank must provide support for the statistical
appropriateness of the proposed methodology. The request must
include, at a minimum, a table with the default rates and
[[Page 66022]]
number of observations used in each score and product segment. The
FDIC will evaluate the proposed methodology and may request
additional information from the bank, which the bank must provide.
The bank may report using its proposed approach while the FDIC
evaluates the methodology. If, after reviewing the request, the FDIC
determines that the bank's methodology is unacceptable, the bank
will be required to amend its Call Reports and report according to
the generally applicable specifications for PD estimation. The bank
will be required to submit amended information for no more than the
two most recently dated and filed Call Reports preceding the FDIC's
determination.
Foreign Consumer Loans
A bank must estimate the PD of a foreign consumer loan according
to the general requirements described above unless doing so would be
unduly complex or burdensome (e.g., if a bank had to develop
separate PD mappings for many different countries). A bank may
request to use default rates calculated using fewer observations or
score bands than the specified minimums, either in advance of, or
concurrent with, reporting under that methodology, but must comply
with the requirements detailed above for using an alternative
methodology.
When estimating a PD according to the general requirements
described above would be unduly complex or burdensome, a bank that
is required to calculate PDs for foreign consumer loans under the
requirements of the Basel II capital framework may: (1) Use the
Basel II approach discussed herein, subject to the terms discussed
herein; (2) submit a written request to the FDIC to use its own
methodology, but may not use the methodology until approved by the
FDIC; or (3) treat the loan as an unscorable consumer loan subject
to the de minimis approach described above.
When estimating a PD according to the general requirements
described above would be unduly complex or burdensome, a bank that
is not required to calculate PDs for foreign consumer loans under
the requirements of the Basel II capital framework may: (1) Treat
the loan as an unscorable consumer loan subject to the de minimis
approach described above; or (2) submit a written request to the
FDIC to use its own methodology, but may not use the methodology
until approved by the FDIC.
When a bank submits a written request to the FDIC to use its own
methodology, the FDIC may request additional information from the
bank regarding the proposed methodology and the bank must provide
the information. The FDIC may grant a bank tentative approval to use
the methodology while the FDIC considers it in more detail. If the
FDIC ultimately disapproves the methodology, the bank may be
required to amend its Call Reports; however, the bank will be
required to amend no more than the two most recently dated and filed
Call Reports preceding the FDIC's determination. In the amended Call
Reports, the bank must treat any loan whose PD had been estimated
using the disapproved methodology as an unscorable domestic consumer
loan subject to the de minimis approach described above.
Basel II Approach
A bank that is required to calculate PDs for foreign consumer
loans under the requirements of the Basel II capital framework may
estimate the two-year PD of a foreign consumer loan based on the
one-year PD used for Basel II capital purposes.\10\ The bank must
submit a written request to the FDIC in advance of, or concurrent
with, reporting under that methodology. The request must explain in
detail how one-year PDs calculated under the Basel II framework are
translated to two-year PDs that meet the requirements above. While
the range of acceptable approaches is potentially broad, any
proposed methodology must meet the following requirements:
---------------------------------------------------------------------------
\10\ Using these Basel II PDs for this purpose does not imply
that a bank's PFR has approved use of these PDs for the Basel II
capital framework. If a bank's PFR requires it to revise its Basel
II PD methodology, the bank must use revised Basel II PDs to
calculate (or recalculate if necessary) corresponding PDs under this
Basel II approach.
---------------------------------------------------------------------------
(a) The bank must use data on a sample of loans for which both
the one-year Basel II PDs and two-year final rule PDs can be
calculated. The sample may contain both foreign and domestic loans.
(b) The bank must use the sample data to demonstrate that a
meaningful relationship exists between the two types of PD
estimates, and the significance and nature of the relationship must
be determined using accepted statistical principles and
methodologies. For example, to the extent that a linear relationship
exists in the sample data, the bank may use an ordinary least-
squares regression to determine the best linear translation of Basel
II PDs to final rule PDs. The estimated equation should fit the data
reasonably well based on standard statistics such as the coefficient
of determination; and
(c) The method must account for any significant variation in the
relationship between the two types of PD estimates that exists
across consumer products based on the empirical analysis of the
data. For example, if the bank is using a linear regression to
determine the relationship between PD estimates, it should test
whether the parameter estimates are significantly different by
product type.
The bank may report using this approach (if it first notifies
the FDIC of its intention to do so), while the FDIC evaluates the
methodology. If, after reviewing the methodology, the FDIC
determines that the methodology is unacceptable, the bank will be
required to amend its Call Reports. The bank will be required to
submit amended information for no more than the two most recently
dated and filed Call Reports preceding the FDIC's determination.
Refinance
For purposes of higher-risk consumer loans, a refinance
includes:
(a) Extending new credit or additional funds on an existing
loan;
(b) Replacing an existing loan with a new or modified
obligation;
(c) Consolidating multiple existing obligations;
(d) Disbursing additional funds to the borrower. Additional
funds include a material disbursement of additional funds or, with
respect to a line of credit, a material increase in the amount of
the line of credit, but not a disbursement, draw, or the writing of
convenience checks within the original limits of the line of credit.
A material increase in the amount of a line of credit is defined as
a 10 percent or greater increase in the quarter-end line of credit
limit; however, a temporary increase in a credit card line of credit
is not a material increase;
(e) Increasing or decreasing the interest rate (except as noted
herein for credit card loans); or
(f) Rescheduling principal or interest payments to create or
increase a balloon payment or extend the legal maturity date of the
loan by more than six months.
A refinance for this purpose does not include:
(a) A re-aging, defined as returning a delinquent, open-end
account to current status without collecting the total amount of
principal, interest, and fees that are contractually due, provided:
(i) The re-aging is part of a program that, at a minimum,
adheres to the re-aging guidelines recommended in the interagency
approved Uniform Retail Credit Classification and Account Management
Policy;\11\
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\11\ Among other things, for a loan to be considered for re-
aging, the following must be true: (1) The borrower must have
demonstrated a renewed willingness and ability to repay the loan;
(2) the loan must have existed for at least nine months; and (3) the
borrower must have made at least three consecutive minimum monthly
payments or the equivalent cumulative amount.
---------------------------------------------------------------------------
(ii) The program has clearly defined policy guidelines and
parameters for re-aging, as well as internal methods of ensuring the
reasonableness of those guidelines and monitoring their
effectiveness; and
(iii) The bank monitors both the number and dollar amount of re-
aged accounts, collects and analyzes data to assess the performance
of re-aged accounts, and determines the effect of re-aging practices
on past due ratios;
(b) Modifications to a loan that would otherwise meet this
definition of refinance, but result in the classification of a loan
as a TDR;
(c) Any modification made to a consumer loan pursuant to a
government program, such as the Home Affordable Modification Program
or the Home Affordable Refinance Program;
(d) Deferrals under the Servicemembers Civil Relief Act;
(e) A contractual deferral of payments or change in interest
rate that is consistent with the terms of the original loan
agreement (e.g., as allowed in some student loans);
(f) Except as provided above, a modification or series of
modifications to a closed-end consumer loan;
(g) An advance of funds, an increase in the line of credit, or a
change in the interest rate that is consistent with the terms of the
loan agreement for an open-end or revolving line of credit (e.g.,
credit cards or home equity lines of credit);
(h) For credit card loans:
(i) Replacing an existing card because the original is expiring,
for security reasons, or
[[Page 66023]]
because of a new technology or a new system;
(ii) Reissuing a credit card that has been temporarily suspended
(as opposed to closed);
(iii) Temporarily increasing the line of credit;
(iv) Providing access to additional credit when a bank has
internally approved a higher credit line than it has made available
to the customer; or
(v) Changing the interest rate of a credit card line when
mandated by law (such as in the case of the Credit CARD Act).
4. Nontraditional mortgage loans
Nontraditional mortgage loans include all residential loan
products that allow the borrower to defer repayment of principal or
interest and include all interest-only products, teaser rate
mortgages, and negative amortizing mortgages, with the exception of
home equity lines of credit (HELOCs) or reverse mortgages. A teaser-
rate mortgage loan is defined as a mortgage with a discounted
initial rate where the lender offers a lower rate and lower payments
for part of the mortgage term. A mortgage loan is no longer
considered a nontraditional mortgage loan once the teaser rate has
expired. An interest-only loan is no longer considered a
nontraditional mortgage loan once the loan begins to amortize.
Banks must determine whether residential loans meet the
definition of a nontraditional mortgage loan as of origination, or,
if the loan has been refinanced, as of refinance, as refinance is
defined in this Appendix for purposes of higher-risk consumer loans.
When a bank acquires a residential loan, it must determine whether
the loan meets the definition of a nontraditional mortgage loan
using the origination criteria and analysis performed by the
original lender. If this information is unavailable, the bank must
obtain refreshed data from the borrower or other appropriate third
party. Refreshed data for residential loans is defined as the most
recent data available. The data, however, must be as of a date that
is no earlier than three months before the acquisition of the
residential loan. The acquiring bank must also determine whether an
acquired loan is higher risk not later than three months after
acquisition.
When a bank acquires loans from another entity on a recurring or
programmatic basis, however, the acquiring bank may determine
whether the loan meets the definition of a nontraditional mortgage
loan using the origination criteria and analysis performed by the
original lender only if the acquiring bank verifies the information
provided. Loans acquired from another entity are acquired on a
recurring basis if a bank has acquired other loans from that entity
at least once within the calendar year or the previous calendar year
of the acquisition of the loans in question.
5. Higher-Risk Securitizations
Higher-risk securitizations are defined as securitizations
(except securitizations classified as trading book), where, in
aggregate, more than 50 percent of the assets backing the
securitization meet either the criteria for higher-risk C&I loans or
securities, higher-risk consumer loans, or nontraditional mortgage
loans, except those classified as trading book. A securitization is
as defined in 12 CFR part 325, Appendix A, Section II(B)(16), as it
may be amended from time to time. A higher-risk securitization
excludes the maximum amount that is recoverable from the U.S.
government under guarantee or insurance provisions.
A bank must determine whether a securitization is higher risk
based upon information as of the date of issuance (i.e., the date
the securitization is sold on a market to the public for the first
time). The bank must make this determination within the time limit
that would apply under this Appendix if the bank were directly
acquiring loans or securities of the type underlying the
securitization. In making the determination, a bank must use one of
the following methods:
(a) For a securitization collateralized by a static pool of
loans, whose underlying collateral changes due to the sale or
amortization of these loans, the 50 percent threshold is to be
determined based upon the amount of higher-risk assets, as defined
in this Appendix, owned by the securitization on the date of
issuance of the securitization.
(b) For a securitization collateralized by a dynamic pool of
loans, whose underlying collateral may change by the purchase of
additional assets, including purchases made during a ramp-up period,
the 50 percent threshold is to be determined based upon the highest
amount of higher-risk assets, as defined in this Appendix, allowable
under the portfolio guidelines of the securitization.
A bank is not required to evaluate a securitization on a
continuous basis when the securitization is collateralized by a
dynamic pool of loans; rather, the bank is only required to evaluate
the securitization once.
A bank is required to use the information that is reasonably
available to a sophisticated investor in reasonably determining
whether a securitization meets the 50 percent threshold. Information
reasonably available to a sophisticated investor includes, but is
not limited to, offering memoranda, indentures, trustee reports, and
requests for information from servicers, collateral managers,
issuers, trustees, or similar third parties. When determining
whether a revolving trust or similar securitization meets the
threshold, a bank may use established criteria, model portfolios, or
limitations published in the offering memorandum, indenture, trustee
report, or similar documents.
Sufficient information necessary for a bank to make a definitive
determination may not, in every case, be reasonably available to the
bank as a sophisticated investor. In such a case, the bank may
exercise its judgment in making the determination. In some cases,
the bank need not rely upon all of the aforementioned pieces of
information to make a higher-risk determination if fewer documents
provide sufficient data to make the determination.
In cases in which a securitization is required to be
consolidated on the balance sheet as a result of SFAS 166 and SFAS
167, and a bank has access to the necessary information, a bank may
opt for an alternative method of evaluating the securitization to
determine whether it is higher risk. The bank may evaluate
individual loans in the securitization on a loan-by-loan basis and
only report as higher risk those loans that meet the definition of a
higher-risk asset; any loan within the securitization that does not
meet the definition of a higher-risk asset need not be reported as
such. When making this evaluation, the bank must follow the
provisions of section I.B herein. Once a bank evaluates a
securitization for higher-risk asset designation using this
alternative evaluation method, it must continue to evaluate all
securitizations that it has consolidated on the balance sheet as a
result of SFAS 166 and SFAS 167, and for which it has the required
information, using the alternative evaluation method. For
securitizations for which the bank does not have access to
information on a loan-by-loan basis, the bank must determine whether
the securitization meets the 50 percent threshold in the manner
previously described for other securitizations.
B. Application of Definitions
Section I of this Appendix applies to:
(1) All construction and land development loans, whenever
originated or purchased;
(2) C&I loans (as that term is defined in this Appendix) owed to
a reporting bank by a higher-risk C&I borrower (as that term is
defined in this Appendix) and all securities issued by a higher-risk
C&I borrower, except securitizations of C&I loans, that are owned by
the reporting bank;
(3) Consumer loans (as defined in this Appendix), except
securitizations of consumer loans, whenever originated or purchased;
(4) Securitizations of C&I and consumer loans (as defined in
this Appendix) issued on or after April 1, 2013, including those
securitizations issued on or after April 1, 2013, that are partially
or fully collateralized by loans originated before April 1, 2013.
For C&I loans that are either originated or refinanced by a
reporting bank before April 1, 2013, or purchased by a reporting
bank before April 1, 2013, where the loans are owed to the reporting
bank by a borrower that does not meet the definition of a higher-
risk C&I borrower as that term is defined in this Appendix (which
requires, among other things, that the borrower have obtained a C&I
loan or refinanced an existing C&I loan on or after April 1, 2013)
and securities purchased before April 1, 2013, that are issued by an
entity that does not meet the definition of a higher-risk C&I
borrower, as that term is defined in this Appendix, banks must
continue to use the transition guidance in the September 2012 Call
Report instructions to determine whether to report the loan or
security as a higher-risk asset for purposes of the higher-risk
assets to Tier 1 capital and reserves ratio. A bank may opt to apply
the definition of higher-risk C&I loans and securities in this
Appendix to all of its C&I loans and securities, but, if it does so,
it must also apply the definition of a higher-risk C&I borrower in
this Appendix without regard to when the loan is originally made or
refinanced (i.e., whether made or refinanced before or after April
1, 2013).
[[Page 66024]]
For consumer loans (other than securitizations of consumer
loans) originated or purchased prior to April 1, 2013, a bank must
determine whether the loan met the definition of a higher-risk
consumer loan no later than June 30, 2013.
For all securitizations issued before April 1, 2013, banks must
either (1) continue to use the transition guidance or (2) apply the
definitions in this Appendix to all of its securitizations. If a
bank applies the definition of higher-risk C&I loans and securities
in this Appendix to its securitizations, it must also apply the
definition of a higher-risk C&I borrower in this Appendix to all C&I
borrowers without regard to when the loans to those borrowers were
originally made or refinanced (i.e., whether made or refinanced
before or after April 1, 2013).
II. Growth-Adjusted Portfolio Concentration Measure
The growth-adjusted concentration measure is the sum of the
values of concentrations in each of the seven portfolios, each of
the values being first adjusted for risk weights and growth. The
product of the risk weight and the concentration ratio is first
squared and then multiplied by the growth factor. The measure is
calculated as:
[GRAPHIC] [TIFF OMITTED] TR31OC12.030
Where:
N is bank i's growth-adjusted portfolio concentration measure; \12\
---------------------------------------------------------------------------
\12\ The growth-adjusted portfolio concentration measure is
rounded to two decimal points.
---------------------------------------------------------------------------
k is a portfolio;
g is a growth factor for bank i's portfolio k; and,
w is a risk weight for portfolio k.
The seven portfolios (k) are defined based on the Call Report/
TFR data and they are:
Construction and land development loans;
Other commercial real estate loans;
First-lien residential mortgages and non-agency
residential mortgage-backed securities (excludes CMOs, REMICS, CMO
and REMIC residuals, and stripped MBS issued by non-U.S. government
issuers for which the collateral consists of MBS issued or
guaranteed by U.S. government agencies);
Closed-end junior liens and home equity lines of credit
(HELOCs);
Commercial and industrial loans;
Credit card loans; and
Other consumer loans.13 14
---------------------------------------------------------------------------
\13\ All loan concentrations should include the fair value of
purchased credit impaired loans.
\14\ Each loan concentration category should exclude the amount
of loans recoverable from the U.S. government under guarantee or
insurance provisions.
---------------------------------------------------------------------------
The growth factor, g, is based on a three-year merger-adjusted
growth rate for a given portfolio; g ranges from 1 to 1.2 where a 20
percent growth rate equals a factor of 1 and an 80 percent growth
rate equals a factor of 1.2.\15\ For growth rates less than 20
percent, g is 1; for growth rates greater than 80 percent, g is 1.2.
For growth rates between 20 percent and 80 percent, the growth
factor is calculated as:
---------------------------------------------------------------------------
\15\ The growth factor is rounded to two decimal points.
[GRAPHIC] [TIFF OMITTED] TR31OC12.031
---------------------------------------------------------------------------
Where:
[GRAPHIC] [TIFF OMITTED] TR31OC12.032
V is the portfolio amount as reported on the Call Report/TFR and t
is the quarter for which the assessment is being determined.
The risk weight for each portfolio reflects relative peak loss
rates for banks at the 90th percentile during the 1990-2009
period.\16\ These loss rates were converted into equivalent risk
weights as shown in Table C.1.
---------------------------------------------------------------------------
\16\ The risk weights are based on loss rates for each portfolio
relative to the loss rate for C&I loans, which is given a risk
weight of 1. The peak loss rates were derived as follows. The loss
rate for each loan category for each bank with over $5 billion in
total assets was calculated for each of the last twenty calendar
years (1990-2009). The highest value of the 90th percentile of each
loan category over the twenty year period was selected as the peak
loss rate.
Table C.1--90th Percentile Annual Loss Rates for 1990-2009 Period and
Corresponding Risk Weights
------------------------------------------------------------------------
Loss rates
Portfolio (90th Risk weights
percentile)
------------------------------------------------------------------------
First-Lien Mortgages.................... 2.3% 0.5
Second/Junior Lien Mortgages............ 4.6% 0.9
Commercial and Industrial (C&I) Loans... 5.0% 1.0
Construction and Development (C&D) Loans 15.0% 3.0
Commercial Real Estate Loans, excluding 4.3% 0.9
C&D....................................
Credit Card Loans....................... 11.8% 2.4
Other Consumer Loans.................... 5.9% 1.2
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By order of the Board of Directors.
Dated at Washington, DC, this 9th day of October 2012.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2012-25943 Filed 10-30-12; 8:45 am]
BILLING CODE 6714-01-P