Office of Thrift Supervision October 5, 2000 Department of ... · Street, N.W. (between...

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Office of Thrift Supervision October 5, 2000Department of the Treasury

Transmittal

TR–235

Federal Register, Vol. 65, No. 188, pp. 57993-58011 Number: TR–235

In the attached notice of proposed rulemaking, the Office of Thrift Supervision (OTS), the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, and the Federal Deposit Insurance Corporation propose revisions to their capital rules for residual interests in asset securitizations or other transfers of financial assets. The capital proposal is intended to apply to balance-sheet assets retained by a seller (or transferor) that are structured, through subordination provisions or other credit enhancement techniques, to absorb more than a pro rata share of credit loss related to the transferred assets. The agencies expressed concern that institutions were holding inadequate capital against these residual interests in relation to their risk exposure, were valuing the assets improperly, and were holding excessive amounts of these assets in relation to capital. The proposed treatment would amend the leverage and risk-based capital requirements by:

• Requiring that "dollar-for-dollar" risk-based capital be held against residual interests from securitization activities or other transfers of financial assets that are retained on the balance sheet, even if the amount exceeds the full capital charge for the assets transferred, and

• Restricting undue concentrations in such residual interests by placing them within the 25

percent Tier 1 capital sublimit already established for nonmortgage servicing assets and purchased credit card relationships. Any amounts above this limit will be deducted from Tier 1 capital.

The notice of proposed rulemaking was published in the September 27, 2000, edition of the Federal Register, Vol. 65, No. 188, pp. 57993-58011. Written comments must be received on or before December 26, 2000, and should be addressed to: Manager, Dissemination Branch, Information Management and Services Division, Office of Thrift Supervision, 1700 G Street, N.W., Washington, DC 20552. Comments may be mailed, hand-delivered, faxed to 202/906-7755 or e-mailed to: [email protected]. All commenters should include their name and telephone number.

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This rescission does not change the applicability of the conveyed document. To determine the applicability of the conveyed document, refer to the original issuer of the document.

Transmittal 235

Page 2 of 3 Office of Thrift Supervision

For further information contact: Michael D. Solomon 202/906-5654 Senior Program Manager for Capital Policy Teresa A. Scott 202/906-6478 Counsel, Banking and Finance, Regulation and Legislation Division, Office of the chief Counsel

— Ellen Seidman

Director Office of Thrift Supervision

Attachment

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This section of the FEDERAL REGISTERcontains notices to the public of the proposedissuance of rules and regulations. Thepurpose of these notices is to give interestedpersons an opportunity to participate in therule making prior to the adoption of the finalrules.

Proposed Rules Federal Register

57993

Vol. 65, No. 188

Wednesday, September 27, 2000

DEPARTMENT OF THE TREASURY

Office of the Comptroller of theCurrency

12 CFR Part 3

[Docket No. 00–17]

RIN 1557–AB14

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R–1080]

FEDERAL DEPOSIT INSURANCECORPORATION

12 CFR Part 325

RIN 3064–AC34

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 565 and 567

[Docket No. 2000–70]

RIN 1550–AB11

Capital; Leverage and Risk-BasedCapital Guidelines; Capital AdequacyGuidelines; Capital Maintenance:Residual Interests in AssetSecuritizations or Other Transfers ofFinancial Assets

AGENCIES: Office of the Comptroller ofthe Currency (OCC), Treasury; Board ofGovernors of the Federal ReserveSystem (Board); Federal DepositInsurance Corporation (FDIC); andOffice of Thrift Supervision (OTS),Treasury.ACTION: Notice of proposed rulemaking.

SUMMARY: The Office of the Comptrollerof the Currency (OCC), the Board ofGovernors of the Federal ReserveSystem (Board), the Federal DepositInsurance Corporation (FDIC), and theOffice of Thrift Supervision (OTS)(collectively, the Agencies) propose toamend their capital adequacy standards

for banks, bank holding companies andthrifts (collectively, bankingorganizations) concerning the treatmentof certain residual interests in assetsecuritizations or other transfers offinancial assets. Residual interests aredefined as those on-balance sheet assetsthat represent interests (includingbeneficial interests) in the transferredfinancial assets retained by a seller (ortransferor) after a securitization or othertransfer of financial assets; and arestructured to absorb more than a prorata share of credit loss related to thetransferred assets through subordinationprovisions or other credit enhancementtechniques (credit enhancement).Examples of residual interests include,but are not limited to, interest onlystrips receivable (I/O strips), spreadaccounts, cash collateral accounts,retained subordinated interests, andother similar forms of on-balance sheetassets that function as a creditenhancement. Residual interests asdefined in the proposed rule do notinclude interests purchased from a thirdparty.

Generally, these residual interests arenon-investment grade or unrated assetsretained by the issuing institution inorder to provide ‘‘first-loss’’ creditsupport for the senior positions in asecuritization or other financial assettransfer. They generally lack an activemarket through which a readilyavailable market price can be obtained.In addition, many of these residualinterests are exposed, on a leveragedbasis, to a significant level of credit andinterest rate risk that make theirvaluation extremely sensitive to changesin the underlying credit andprepayment assumptions. As a result,such residual interests present valuationand liquidity concerns. Highconcentrations of such illiquid andvolatile assets in relation to capital canthreaten the safety and soundness ofbanking organizations.

This proposed rule is intended tobetter align regulatory capitalrequirements with the risk exposure ofthese types of residual interests,encourage conservative valuationmethods, and restrict excessiveconcentrations in these assets. Theproposed rule would require that risk-based capital be held in an amountequal to the amount of the residualinterest that is retained on the balancesheet by a banking organization in a

securitization or other transfer offinancial assets, even if the capitalcharge exceeds the full risk-basedcapital charge typically held against thetransferred assets. The proposed rulealso would restrict excessiveconcentrations in residual interests bylimiting the amount that may beincluded in Tier 1 capital for bothleverage and risk-based capitalpurposes. When aggregated withnonmortgage servicing assets andpurchased credit card relationships(PCCRs), the balance sheet amount ofresidual interests would be limited to 25percent of Tier 1 capital, with anyamount in excess of this limitationdeducted in determining the amount ofa banking organization’s Tier 1 capital.DATES: Comments must be received byDecember 26, 2000.ADDRESSES: Comments should bedirected to:

OCC: Comments may be submitted toDocket No. 00–17, CommunicationsDivision, Third Floor, Office of theComptroller of the Currency, 250 EStreet, SW., Washington, DC 20219.Comments will be available forinspection and photocopying at thataddress. In addition, comments may besent by facsimile transmission to FAXnumber (202/874–5274), or byelectronic mail [email protected].

Board: Comments directed to theBoard should refer to Docket No. R–1080 and may be mailed to Ms. JenniferJ. Johnson, Secretary, Board ofGovernors of the Federal ReserveSystem, 20th Street and ConstitutionAvenue, NW., Washington DC 20551 ormailed electronically [email protected] addressed to the attention ofMs. Johnson may also be delivered toRoom B–2222 of the Eccles Buildingbetween 8:45 a.m. and 5:15 p.m.weekdays, or the security control roomin the Eccles Building courtyard on 20thStreet, N.W. (between ConstitutionAvenue and C Street) at any time.Comments may be inspected in RoomMP–500 of the Martin Building between9 a.m. and 5 p.m. weekdays, except asprovided in 12 CFR 261.8 of the Board’sRules Regarding Availability ofInformation.

FDIC: Send written comments toRobert E. Feldman, Executive Secretary,Attention: Comments/OES, FederalDeposit Insurance Corporation, 550 17th

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57994 Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules

1 See OCC Bulletin 99–46 (December 14, 1999)(OCC); FDIC FIL 109–99 (December 13, 1999)(FCIC); SR 99–37(SUP) (December 13, 1999) (FRB);and CEO LTR 99–119 (December 14, 1999) (OTS).See this guidance for a more detailed discussion ofthe risk management processes applicable tosecuritization activities.

Street, NW., Washington, DC 20429.Comments may be hand-delivered to theguard station at the rear of the 550 17thStreet Building (located on F Street), onbusiness days between 7 a.m. and 5 p.m.Send facsimile transmissions to FAXnumber (202/898–3838); Internetaddress: [email protected].)Comments may be inspected andphotocopied in the FDIC PublicInformation Center, Room 100, 801 17thStreet, NW., Washington, DC 20429,between 9 a.m. and 4:30 p.m. onbusiness days.

OTS: Send comments to Manager,Dissemination Branch, InformationManagement and Services Division,Office of Thrift Supervision, 1700 GStreet, NW, Washington, DC 20552,Attention Docket No. 2000–70. Handdeliver comments to the Guard’s Desk,East Lobby Entrance, 1700 G Street,NW., from 9 a.m. to 4 p.m. on businessdays. Send facsimile transmissions toFAX Number (202) 906–7755; or (202)906–6956 (if comments are over 25pages). Send e-mails [email protected], and includeyour name and telephone number.Interested persons may inspectcomments at the Public ReferenceRoom, 1700 G Street, NW., from 10 a.m.until 4 p.m. on Tuesdays andThursdays.

FOR FURTHER INFORMATION CONTACT:OCC: Amrit Sekhon, Risk Specialist

(202/874–5211), Capital Policy; RonShimabukuro, Senior Attorney, or LauraGoldman, Senior Attorney, Legislativeand Regulatory Activities Division (202/874–5090).

Board: Thomas R. Boemio, SeniorSupervisory Financial Analyst (202/452–2982); Arleen Lustig, SupervisoryFinancial Analyst (202/452–2987),Division of Banking Supervision andRegulation; and Mark E. Van Der Weide,Counsel, (202/452–2263), LegalDivision. For the hearing impaired only,Telecommunication Device for the Deaf(TDD), Janice Simms (202/872–4984),Board of Governors of the FederalReserve System, 20th and C Streets,NW., Washington, DC 20551.

FDIC: William A. Stark, AssistantDirector, Division of Supervision (202/898–6972); Stephen G. Pfeifer, SeniorExamination Specialist, Division ofSupervision (202/898–8904); Keith A.Ligon, Chief, Policy Unit, Division ofSupervision (202/898–3618); and MarcJ. Goldstrom, Counsel, Legal Division(202/898–8807).

OTS: Michael D. Solomon, SeniorProgram Manager for Capital Policy(202/906–5654), and Teresa A. Scott,Counsel, Banking and Finance (202/906–6478), Regulation and Legislation

Division, Office of the Chief Counsel,Office of Thrift Supervision, 1700 GStreet, NW., Washington, DC 20552.SUPPLEMENTARY INFORMATION: Thispreamble consists of the followingsections:I. IntroductionII. Nature of Supervisory ConcernsIII. Current Capital Treatment for Residual

InterestsIV. Residual Interests Subject to the ProposalV. Proposed Amendments to the Capital

StandardsVI. Request for Public CommentVII. Plain LanguageVIII. Regulatory Analysis

I. IntroductionThe proposed rule addresses the

supervisory concerns arising from theilliquid and volatile nature of residualinterests that are retained by thesecuritizer or other seller of financialassets, when those residual interests areused as a credit enhancement to supportthe financial assets transferred. Theproposal also reduces the risk fromexcessive concentrations in theseresidual interests, including thosesituations where large residual interestsare retained in connection with the saleor securitization of low quality, higherrisk loans. As discussed in more detailin section V, the proposed rule would(1) require capital to be maintained inan amount equal to the amount of theresidual interest that is retained on thebalance sheet for risk-based capitalpurposes, and (2) require the amount ofany such residual interests to beincluded in the 25 percent of Tier 1capital sublimit that currently applies tononmortgage servicing assets andpurchased credit card relationships(PCCRs), with any amounts in excess ofthis limit deducted from Tier 1 capitalfor both leverage and risk-based capitalpurposes.

II. Nature of Supervisory ConcernsSecuritizations and other financial

asset transfers provide an efficientmechanism for banking organizations tosell loan assets or credit exposures. Thebenefits of these transactions must bebalanced against the significant risksthat such activities can pose to bankingorganizations and to the depositinsurance funds. Recent examinationshave disclosed significant weaknessesin the risk management processesrelated to securitization activities atcertain institutions. The most frequentlyencountered problems stem from: (1)The failure to recognize recourseobligations that frequently accompanysecuritizations and to hold sufficientcapital against such obligations; (2) theexcessive or inadequately supported

valuation of residual interests; (3) theliquidity risk associated with overreliance on asset securitization as afunding source; and (4) the absence ofadequate independent risk managementand audit functions.

The Agencies addressed theseconcerns in the Interagency Guidanceon Asset Securitization (SecuritizationGuidance) issued in December 1999.1The Securitization Guidancehighlighted some of the risks associatedwith asset securitization andemphasized the Agencies’ concernswith certain residual interests generatedfrom the securitization and sale ofassets.

The Securitization Guidanceaddressed the fundamental riskmanagement practices that should be inplace at institutions that engage insecuritization activities and stressed theneed for bank management toimplement policies and procedures thatinclude limits on the amount of residualinterests that may be carried as apercentage of capital. In particular, theSecuritization Guidance set forth thesupervisory expectation that the valueof a residual interest in a securitizationmust be supported by objectivelyverifiable documentation of the asset’sfair market value utilizing reasonable,conservative valuation assumptions.Under this guidance, residual intereststhat do not meet this expectation, or thatfail to meet the supervisory standardsset forth in the Securitization Guidance,should be classified as ‘‘loss’’ anddisallowed as assets of the bankingorganization for regulatory capitalpurposes.

Moreover, the Agencies indicated inthis guidance that institutions foundlacking effective risk managementprograms or engaging in practices thatpresent safety and soundness concernswould be subject to more frequentsupervisory review, limitations onresidual interest holdings, morestringent capital requirements, or othersupervisory response. TheSecuritization Guidance further advisedthe industry that given the riskspresented by securitization activities,and the illiquidity and potentialvolatility of residual interests, theAgencies were actively considering theestablishment of regulatory restrictionsthat would limit or eliminate theamount of certain residual interests that


57995Federal Register / Vol. 65, No. 188 / Wednesday, September 27, 2000 / Proposed Rules

2 FAS 125 establishes certain transfer of control,accounting, and valuation criteria surrounding thetransfer of financial assets as a benchmark fordetermining whether a transfer is recorded as a‘‘sale’’ and, if so, at what value it is recorded. UnderFAS 125, the transferring financial institutiongenerally will immediately recognize gains from thesale of the transferred assets and record retainedinterests in a manner that captures all of thefinancial components of, including the residualinterests that arise in connection with, thesecuritization or other asset transfer.

3 The fair value reflects the expected future cashflows discounted in an appropriate market interestrate, and is calculated using assumptions regardingestimated credit loss rates and prepayment speeds.

4 When the securitization or other transfer offinancial assets is treated as a financing, underGAAP and for regulatory capital purposes, ratherthan a sale, the assets continue to be reflected onthe balance sheet of the transferring institution. Inthese circumstances, the assets continue to besubject to the minimum capital requirement(generally 8 percent). The level of supervisoryconcern is diminished in these circumstancesbecause there is no residual interest created to posevaluation or liquidity concerns. Importantly, afinancing transaction does not generate earningsleading to the creation of capital. For this reason,the proposal only changes the regulatory capitalrequirements for banking organizations when theysecuritize or otherwise transfer financial assets andtreat the transactions as sales under GAAP.

5 Consolidated Reports of Condition and Income(Call Report) instructions issued by the FederalFinancial Institutions Examination Council provideexamples of transfers of assets that involve recoursearrangements. See the Call Report Glossary entry for‘‘Sales of Assets for Risk-Based Capital Purposes.’’These examples address the risk of loss retained inconnection with transfers of assets. OTS currentlydefines the term ‘‘recourse’’ more broadly in itscapital rules at 12 CFR 567.1 to include the‘‘acceptance, assumption or retention’’ of the risk ofloss. The Agencies have issued a separate proposalthat, among other things, would provide a uniformdefinition of ‘‘recourse.’’ See 65 FR 12319 (March8, 2000).

6 Under the Agencies’ current capital rules, assetstransferred with recourse in a transaction that isreported as a sale under generally acceptedaccounting principles (GAAP) are removed from thebalance sheet and are treated as off-balance sheetexposures for risk-based capital purposes. Fortransactions reported as a sale, the entire amountof the assets sold (not just the contractual amountof the recourse obligation) is normally convertedinto an on-balance sheet credit equivalent amountusing a 100 percent conversion factor. This creditequivalent amount is then risk weighted for risk-based capital calculation purposes.

7 For assets that are assigned to the 100 percentrisk-weight category, the full capital charge is 8percent of the amount of assets transferred, and

Continued

may be recognized in determining theadequacy of regulatory capital.

The Agencies have identified threeareas of continuing supervisory concern:

(1) Inappropriate or aggressivevaluations of residual interests;

(2) Inadequate capital in relation tothe risk exposure of the organizationretaining residual interests; and

(3) Excessive concentrations ofresidual interests in relation to capital.

The Statement of FinancialAccounting Standards No. 125,‘‘Accounting for Transfers and Servicingof Financial Assets and Extinguishmentof Liabilities’’ (FAS 125) 2 governs therecognition of a residual interest in asecuritization as an asset of thesponsoring institution. Under thesegenerally accepted accountingprinciples (GAAP), when a transfer ofassets is treated as a sale, thesecuritizing or selling institution carriesany residual interests as an asset on itsbooks at an estimate of fair value.3Retaining this residual interest on thebalance sheet in connection with a salegenerally has the effect of increasing theamount of current earnings generated bythe gains from the sale.

The Agencies have becomeincreasingly concerned with fair valueestimates that are based on unwarrantedassumptions of expected cash flows. Noactive market exists for many residualinterests. As a result, there is nomarketplace from which an arm’s lengthmarket price can readily be obtained tosupport the residual interest valuation.Recent examinations have highlightedthe inherent uncertainty and volatilityregarding the initial and ongoingvaluation of residual interests. Abanking organization that securitizesassets may overvalue its residualinterests and thereby inappropriatelygenerate ‘‘paper profits’’ (or mask actuallosses) through incorrect cash flowmodeling, flawed loss assumptions,inaccurate prepayment estimates, andinappropriate discount rates. Residualinterests are exposed to a significantlevel of credit and interest rate risk thatmake their valuation extremely sensitiveto changes in the underlying

assumptions. Market events can affectthe discount rate or performance ofassets supporting residual interests andcan swiftly and dramatically alter theirvalue. Should the institution hold anexcessive concentration of such assetsin relation to capital, the safety andsoundness of the institution may bethreatened.

The Agencies believe that the currentregulatory capital requirements do notadequately reflect the risk of unexpectedlosses associated with thesetransactions. The booking of a residualinterest using gain-on-sale accountingcan increase the selling institution’scapital and thereby allow the bank toleverage the capital created from thesecuritization. This increased leverageresulting from the current recognition ofuncertain future cash flows is asupervisory concern. Accordingly, theproposed rule focuses on those transfersof financial assets treated as sales underGAAP.4

A related concern is the adequacy ofcapital held by institutions thatsecuritize or sell assets and retainresidual interests. First, the lack ofliquidity of residual interests and thepotential volatility of residual interestsarising from their leveraged credit andinterest rate risk limits their ability tosupport the institution, especially intimes of stress. Second, any weaknessesin the valuation of the residual interestcan translate into weaknesses in thequality of capital available to supportthe institution. Liberal orunsubstantiated assumptions can resultin material inaccuracies in financialstatements. Even when such residualinterests have been appropriatelyvalued, relatively small changes in theunderlying assumptions can lead tomaterial changes in the residualinterest’s fair value. Inaccuracies in theinitial valuation of residual interests, aswell as changes in the underlyingassumptions over time, can result insubstantial write-downs of residualinterests. If these generally illiquid andvolatile residual interests represent anexcessive concentration of the

sponsoring institution’s capital, theycan contribute to the ultimate failure ofthe institution.

The concerns regarding excessiveconcentration and adequacy of capitalare heightened where the residualinterests are generated from thesecuritization of certain assets, such aslow-quality or high loan-to-value loans.Recent examinations have shown that inorder to provide adequate creditenhancement to the senior positions insecuritizations involving low qualityassets, institutions generally must retainrelatively greater credit risk exposure. Insuch transactions, the sponsoringinstitutions may retain residual interestsin amounts that exceed the risk-basedcapital that would have been associatedwith the loans had they not beentransferred.

Because of these continuingsupervisory concerns, the Agenciesbelieve it is appropriate to propose theserevisions to their respective capitaladequacy rules in order to limit theamount of residual interests that areretained by banking organizations andrequire adequate capital for the riskexposure created.

III. Current Capital Treatment forResidual Interests

Assets Sold ‘‘With Recourse’’ 5

Under current risk-based capitalguidelines, banking organizations thatretain ‘‘recourse’’ on assets soldgenerally are required to hold capital asthough the loans remained on theinstitution’s books,6 up to the ‘‘fullcapital charge’’.7 For regulatory capital



institutions are required to hold 8 cents of capitalfor every dollar of assets transferred with recourse.For assets that are assigned to the 50 percent risk-weight category, the full capital charge is 4 centsof capital for every dollar of assets transferred withrecourse.

8 The risk-based capital treatment for sales withrecourse can be found at 12 CFR 3, appendix A,section (3)(b)(1)(iii) (OCC); 12 CFR 208, appendix A,section III.D.1 and 12 CFR 225, appendix A, sectionIII.D.1 (FRB); 12 CFR 325, appendix A, sectionII.D.1 (FDIC); and 12 CFR 567.6(a)(2)(i)(C) (OTS).

9 Low-level recourse treatment is mandated bysection 350 of the Riegle Community Developmentand Regulatory Improvement Act, 12 U.S.C. 4808,which generally provides that: ‘‘the amount of risk-based capital required to be maintained * * * byany insured depository institution with respect toassets transferred with recourse by such institutionmay not exceed the maximum amount of recoursefor which such institution is contractually liableunder the recourse agreement.’’

10 The Agencies’ low-level resourse rules appearat: 12 CFR 3, appendix A, section 3(d) (OCC); 12CFR 208, appendix A, section III.D.1.g and 225,appendix A, section III.D.1.g (FRB); 12 CFR 325,appendix A, section II.D.1 (FDIC); and 12 CFR567.6(a)(2)(i)(C) (OTS). A brief explanation is alsocontained in the instructions for regulatoryreporting in section RC–R for the Call Report orschedule CCR for the Thrift Financial Report.

11 See 63 FR 42668 (August 10, 1998).12 Id. at 42672.13 Id.

purposes, recourse is generally definedas an arrangement in which a bankingorganization retains the risk of creditloss in connection with an assettransfer, if the risk of credit loss exceedsa pro rata share of the institution’s claimon the assets.8

As required by statute,9 the Agencieshave adopted rules that provide ‘‘low-level recourse’’ treatment for thoseinstitutions that securitize or sell assetsand retain recourse in dollar amountsless than the full capital charge.10 Beforethe issuance of the low-level recourserules, these institutions could have beenrequired to hold a greater level of capitalthan their maximum contractualexposure to loss on the transferredassets. The low-level recourse treatmentapplies to transactions accounted for assales under FAS 125 in which a bankingorganization contractually limits itsrecourse exposure to less than the fullcapital charge for the assets transferred.

Under the low-level recourse rule, abanking organization generally holdscapital on a dollar-for-dollar basis up tothe amount of the maximum contractualexposure. In the absence of any otherrecourse provisions, the on-balancesheet amount of the residual interestsrepresents the maximum contractualexposure. For example, assume that abanking organization securitizes $100million of credit card loans and recordsa residual interest on the balance sheetof $5 million that serves as a creditenhancement for the assets transferred.Before the low-level recourse rule wasissued, the institution would berequired to hold $8 million of risk-basedcapital against the $100 million in loans

sold, as though the loans had not beensold. Under the low-level recourse rule,the institution would be required tohold $5 million in capital, that is,‘‘dollar-for-dollar’’ capital up to theinstitution’s maximum contractualexposure.

Existing regulatory capital rules,however, do not require institutions tohold ‘‘dollar-for-dollar’’ capital againstresidual interests that exceed the fullcapital charge ($8 million in the aboveexample). Typically, institutions thatsecuritize and sell higher risk assets arerequired to retain a large residualinterest (often greater than the fullcapital charge of 8 percent on 100percent risk-weighted assets) in order toensure that the more senior positions inthe securitization or other asset sale canreceive the desired investment ratings.Write-downs of the recorded value ofthe residual interest, due to unrealistic(or changing) loss or prepaymentassumptions, can result in residuallosses that exceed the amount of capitalheld against these assets, therebyimpairing the safety and soundness ofthe institution.

For example, assume that a bankingorganization securitizes $100 million ofsubprime credit card loans and recordsa residual interest on the balance sheetof $15 million that serves as a creditenhancement for the securitization.Under the current risk-based capitalrules, the transferred loans would betreated as sold with recourse, and an 8percent risk-based capital charge forthese 100 percent risk-weighted loanswould be required; that is, $8 million inrisk-based capital would be required tobe held against the $100 million oftransferred loans. In this hypotheticalexample, however, the amount ofresidual interests retained on thebalance sheet ($15 million) exceeds thefull equivalent risk-based capital chargeheld against the assets transferred ($8million). Accordingly, the amount of theresidual interest is not fully covered bydollar-for-dollar risk-based capital; only$8 million in capital is required to beheld by the institution against the $15million residual interest exposure.

This example demonstrates that, forresidual interests that exceed the dollaramount of the full capital charge on theassets transferred, current capitalstandards do not require dollar-for-dollar capital protection for the fullcontractual exposure to loss retained bythe selling institution. Any losses inexcess of the full capital charge (8percent in the example above) couldnegatively affect the capital adequacy ofthe institution. Should the asset bewritten down from $15 million to $5million, the $8 million of required

capital would be insufficient to absorbthe full loss of $10 million.

B. Prior Consideration of ConcentrationLimits on Residual Interests

In 1998, the Agencies amended theircapital rules to change the regulatorycapital treatment of servicing assets.11

This rulemaking increased from 50percent to 100 percent the amount ofmortgage servicing assets that could beincluded in Tier 1 capital. The Agenciesimposed more restrictive limits on theamount of nonmortgage servicing assetsand PCCRs that could be included inTier 1 capital. These stricter limitationswere imposed due to the lack of depthand maturity of the marketplace forsuch assets, and related concerns abouttheir valuation, liquidity, and volatility.

At the time the Agencies issued thefinal rule on servicing assets, theAgencies declined to adopt similarcapital limits for I/O strips, a form ofresidual interest, notwithstanding thatcertain I/O strips possessed cash flowcharacteristics similar to servicing assetsand presented similar valuation,liquidity, and volatility concerns. Atthat time, the Agencies chose not toimpose such limitations in recognitionof the ‘‘prudential effects of bankingorganizations relying on their own riskassessment and valuation tools,particularly their interest rate risk,market risk, and other analyticalmodels.’’ 12 The Agencies expresslyindicated that they would continue toreview banking organizations’ valuationof I/O strips and the concentrations ofthese assets relative to capital.Moreover, the Agencies noted that they‘‘may, on a case-by-case basis, requirebanking organizations that the Agenciesdetermine have high concentrations ofthese assets relative to their capital, orare otherwise at risk from these assets,to hold additional capital commensuratewith their risk exposures’’.13 Inaddition, most of the residual interestsat that time that were used as creditenhancements did not exceed the fullcapital charge on the transferred assetsand thus were subject to ‘‘dollar-for-dollar’’ capital requirements under theAgencies’’ existing low-level recourserules. However, a trend toward thesecuritization of higher risk loans hasnow resulted in residual interests thatexceed the full capital charge and forwhich ‘‘dollar-for-dollar’’ capital is notrequired under the current risk-basedcapital rules. This trend has alsoresulted in certain bankingorganizations engaged in such



14 The proposed rule would extend to all residualinterests as defined, whether included in thebanking book or included in the trading book andsubject to the market risk rules.

15 The unrealized gains that may be recorded byan institution with respect to residual interests thatare accounted for as available-for-sale securities arepresently not included in Tier 1 capital and wouldnot be subject to further deduction under this rule.

securitization transactions having largeconcentrations in residual interests as apercentage of capital.

IV. Residual Interests Subject to theProposal

Included in this proposal are residualinterests that are structured to absorbmore than a pro rata share of credit lossrelated to the securitized or sold assetsthrough subordination provisions orother credit enhancement techniques.Such residual interests can take manyforms. Generally, these residualinterests are non-investment grade orunrated ‘‘first-loss’’ positions thatprovide credit support for the seniorpositions of the securitization or otherasset sale. A key aspect of such residualinterests is that they reflect anarrangement in which the institutionretains risk of credit loss in connectionwith an asset transfer. In addition torecourse provisions that may require theselling institution to support asecuritization, residual interests cantake the form of spread accounts, over-collateralization, subordinatedsecurities, cash collateral accounts, orother similar forms of on-balance sheetassets that function as a creditenhancement. Servicing assets thatfunction as credit enhancements wouldbe subject to the proposed rule.

The definition of residual interestsexcludes those interests that do notserve as credit enhancements. In thisregard, highly rated, liquid, marketableresidual interests where the institutionassumes only the interest rate riskassociated with the assets transferred inthe securitization (e.g., Fannie Mae orFreddie Mac I/O strips) do not serve asa credit enhancement for the transferredassets and thus do not expose theinstitution to a concentrated level ofcredit risk. Further, such instrumentsare traded in a currently activemarketplace and thus do not present thesame degree of liquidity and valuationconcerns.

The residual interests covered by theproposed rule are generally retained bythe securitizing institution rather thansold because they are generally illiquidand volatile in nature and thus presentliquidity and valuation concerns. Theproposed rule extends only to residualinterests that have been retained by abanking organization as a result of asecuritization or other sale transactionand does not cover residual intereststhat a banking organization haspurchased from another party.14

Purchased residual interests canpresent the same degree of concentratedcredit risk associated with retainedresidual interests. The exclusion ofpurchased residual interests from theproposed rule could establish a differentcapital treatment for the same asset,depending on whether the interest ispurchased from a third party or retainedin connection with the transfer offinancial assets to a third party. TheAgencies are particularly concernedabout the possible ‘‘swapping’’ ofresidual interests, where there isotherwise limited breadth and depth ofthe market for these residual interests,and both parties stand to gain fromaccommodation valuations of eachasset.

However, residual interests purchasedin an arm’s length transaction may notpose the same degree of liquidity risk asinterests that are retained. In addition,purchased interests do not present thesame opportunity to create capital as dointerests that are originated and retainedby a securitizing institution. Further,unlike retained residual interests wherean overvaluation of the residual interestcan lead to a higher gain on sale and thecreation of additional capital, there is amarketplace discipline on the initialamount at which a purchased residualinterest is recorded (that is, it is limitedto the purchase price), and there is noincentive on the part of the purchaser topay a price above market because sucha purchase does not create any capitalfor the purchaser.

The Agencies are consideringincluding such purchased interestswithin the scope of the rule and arerequesting comment on this issue.

V. Proposed Amendments to the CapitalStandards

A. Proposed Treatment of ResidualInterests

The Agencies propose to amend theregulatory risk-based capital standardsby eliminating the distinction betweenthe treatment of low-level recourseobligations and the treatment of assetssecuritized or sold with recourse inthose cases where the amount of theresidual interest retained on balancesheet exceeds the full capital charge forthe assets transferred. The current rulesessentially place a ceiling on the‘‘dollar-for-dollar’’ capital requirementfor recourse obligations. Removal of this‘‘cap’’ will ensure that all residualinterests are subject to the same ‘‘dollar-for-dollar’’ capital standard that isapplied to residual interests in low-levelrecourse transactions and that capital isheld for the organization’s totalcontractual exposure to loss.

In addition to modifying the risk-based capital treatment for residualinterests, the Agencies propose limitingthe amount of residual interests that canbe recognized in determining Tier 1capital under the Agencies’ leverage andrisk-based capital standards. Thepurpose of the limit is to preventexcessive concentrations in holdings ofresidual interests. The Agencies proposeincluding residual interests within the25 percent of Tier 1 capital sublimitalready placed upon nonmortgageservicing assets and PCCRs. Under thisrestriction, any amounts of residualinterests, when aggregated withnonmortgage servicing assets andPCCRs, that exceed of 25 percent of Tier1 capital, would be deducted from Tier1 capital for purposes of calculatingboth the risk-based and leverage capitalratios.15

In addition to including residualinterests in the sublimit currentlyapplied to PCCRs and nonmortgageservicing assets, residual interestswould also be included in thecalculation of the overall 100 percentlimit on servicing assets. Under thisproposal, the maximum allowableamount of mortgage servicing assets,PCCRs, nonmortgage servicing assets,and residual interests, in the aggregate,would be limited to 100 percent of theamount of Tier 1 capital that existsbefore the deduction of any disallowedmortgage servicing assets, anydisallowed PCCRs, any disallowednonmortgage servicing assets, anydisallowed residual interests, and anydisallowed deferred tax assets. Theresidual interests, however, would notbe subject to the 90 percent of fair valuelimitation that applies to servicingassets and PCCRs. Under the proposedrule, residual interests would already besubject to a ‘‘dollar-for-dollar’’ capitalrequirement. Any residual interestsdeducted in determining the Tier 1capital numerator for the leverage andrisk-based capital ratios also would beexcluded from the denominators ofthese ratios.

In summary, under the proposed rule,institutions generally would be requiredto hold ‘‘dollar-for-dollar’’ capital forresidual interests and additionallywould be required to deduct from Tier1 capital the amount of any residualinterests (when aggregated withnonmortgage servicing assets andPCCRs) that exceed the established 25percent sublimit. In combination, theproposal is intended to ensure that all



16 The Agencies are also proposing minortechnical changes. For example, this proposal doesnot effect the calculation of tangible equity theunder prompt corrective action regulations.However, because the Agencies define tangibleequity using different core capital concepts (i.e.,‘‘core capital’’ vs. ‘‘core capital elements’’), the OTSis proposing a technical revision to its definition oftangible equity (12 CFR 565.2(f)) to ensure that thiscalculation is not effected by the proposal.

In addition, the FDIC is also amending itsregulations to remove an obsolete provisionconcerning the transitional 7.25 percent risk-basedcapital standard that was only effective untilDecember 31, 1992. This provision currentlyappears in section III.B of appendix A to part 325.Similarly, OTS is making technical revisions torelated regulatory provisions at 12 CFR 565.2(f).

17 The proposed treatment is consistent with thatpermitted for low-level recourse exposures,disallowed servicing assets, and disallowedintangible assets in non-taxable businesscombinations.

18 For example, see § 325.5(g) of the FDIC’s capitalregulations (12 CFR 325.5(g)), which sets forth thelimitations on the amount of deferred tax assets thatstate nonmember banks can recognize for purposesof calculating Tier 1 capital under the leverage andrisk-based capital rules.

19 Two additional treatments are possible. Underthe first approach, the amount of residual interestssubject to a ‘‘dollar-for-dollar’’ deduction for risk-based capital purposes, and a concentration limitfor leverage capital purposes, would be the ‘‘at-risk’’amount; that is, the residual interests reduced byany associated deferred tax liability. For example,assume residual interests of $100 with an associateddeferred tax liability of $35. Under this approach,the amount of residual interests subject to a ‘‘dollar-for-dollar’’ capital charge and a concentration limitis $65 ($100¥$35). In a worst-case scenario, if thevalue of the residual interests drops to zero, thenthe corresponding deferred tax liability would alsodrop to zero, and therefore capital would declineby $65—the net-of-tax amount. If the 25% of Tier1 concentration limitation is $50, then thededuction would be $15 ($65¥$50). Under thesecond approach, the amount of residual interestssubject to the ‘‘dollar-for-dollar’’ capitalrequirement and 25% of Tier 1 capitalconcentration limit would be determined on a grossbasis, that is, without netting the associateddeferred tax liability.

20 See 65 FR 12320 (March 8, 2000) for the textof the proposed revisions to the risk-based capitaltreatment of recourse arrangements, direct creditsubstitutes, and asset securitizations.

residual interests are supported by‘‘dollar-for-dollar’’ capital and thatexcessive concentrations (over 25percent) in residual interests relative tocapital are avoided.16

B. Net-of-Tax TreatmentThe Agencies propose to extend the

current net-of-tax treatment permitted intheir existing capital standards toresidual interests.17 Thus, the proposedrule would permit: (1) Disallowedamounts of residual interests (that is,those amounts in excess of the 25percent of Tier 1 capital sublimit) to bedetermined on a basis that is net of anyassociated deferred tax liability, and (2)any amounts of residual interests thatare subject to the ‘‘dollar-for-dollar’’capital requirement (that is, thoseamounts included in the 25 percent ofTier 1 capital sublimit) to be determinedon a basis that is net of any associateddeferred tax liability. In instances wherethere is no difference between the bookbasis and the tax basis of the residualinterest, no deferred tax liability wouldbe created. Any deferred tax liabilityused to reduce the capital requirementfor a residual interest would not beavailable for the organization to use indetermining the amount of net deferredtax assets that may be included in thecalculation of Tier 1 capital.18

The following example helpsillustrate the proposed tax treatment.Assume residual interests of $100 withan associated deferred tax liability of$35 and Tier 1 capital (before thededuction of any disallowed residualinterests) of $200. In this example, the25 percent concentration limit onresidual interests (when combined withnonmortgage servicing assets and

PCCRs) would be $50 (i.e., 25 percenttimes $200). The amount of disallowedresidual interests (before consideringthe associated deferred tax liability)would have been $50. The deferred taxliability associated with the otherwisedisallowed residual interests of $50would be $17.50 (a $35 associateddeferred tax liability against $100 inresidual interests drives a 35 percent taxeffect against the $50 disallowedresidual interest). Thus, the amount ofdisallowed residual interests to bededucted in determining Tier 1 capitalunder the leverage and risk-basedcapital standards net of the associateddeferred tax liability would be $32.50(i.e., the $50 in disallowed residualinterests minus the $17.50 tax effectassociated with the disallowed residualinterests).

In determining risk-weighted assets,the remaining $50 amount of residualinterests allowable in Tier 1 would besubject to a ‘‘dollar-for-dollar’’ capitalon a basis that is also net of the deferredtax liability associated with the $50residual interest. The deferred taxliability associated with the $50 notdeducted from Tier 1 capital would be$17.50 (i.e., the 35 percent tax effect ascalculated above times $50). Thus, theamount of residual interests that wouldbe subjected to ‘‘dollar-for-dollar’’treatment would be $32.50 ($50 less the$17.50 in deferred tax liabilities).Calculation of this ‘‘dollar-for-dollar’’capital charge is consistent with the‘‘dollar-for-dollar’’ capital requirementsthat are currently required for low-levelrecourse transactions.

Other alternative calculations arepossible and will be considered by theAgencies.19 The Agencies seek commenton whether the complexity of a ‘‘net-of-tax’’ approach is necessary and justified,

and if so, what, if any, alternativecalculations should be allowed.

C. Reservation of Authority

While this proposal should helpremedy some of the major concernsassociated with the generally illiquidand volatile nature of residual interests,the Agencies are also proposing to addlanguage to the risk-based capitalstandards that will provide greaterflexibility in administering thestandards. Institutions are developingnovel transactions that do not fit wellinto the risk-weight categories set forthin the standards. Institutions are alsodevising novel instruments thatnominally fit into a particular risk-weight category, but that impose riskson the banking organization at levelsthat are not commensurate with thenominal risk-weight for the asset,exposure, or instrument. Accordingly,the Agencies are proposing to addlanguage to the standards to clarify theAgencies’ authority, on a case-by-casebasis, to determine the appropriate risk-weight asset amount in thesecircumstances. Exercise of this authorityby the Agencies may result in a higheror lower risk weight for an asset. Thisreservation of authority explicitlyrecognizes the Agencies’ retention ofsufficient discretion to ensure thatinstitutions, as they develop novelfinancial assets, will be treatedappropriately under the risk-basedcapital standards.

D. Relationship of This Residual InterestProposal to the March 2000Securitization Proposal

This proposed rule regarding residualinterests (residual interest proposal) andthe March 2000 notice of proposedrulemaking on the risk-based capitaltreatment of recourse arrangements,direct credit substitutes, and assetsecuritizations (the securitizationproposal) are interrelated in that bothproposals would address the regulatorycapital treatment for residual intereststhat are retained in connection withsecuritizations and other transfers offinancial assets.20 The capital treatmentof residual interests under thesecuritization proposal differs in certainrespects from the treatment proposed inthis residual interest proposal. In anyfinal rule that addresses the regulatorycapital treatment of residual interests,the Agencies will ensure that anyregulatory capital treatment of residual



interests resulting from these twoproposals will be consistent.

In the securitization proposal, theAgencies propose using external creditratings to match the risk-based capitalrequirement more closely to the relativerisk of loss in asset securitizations.Highly rated investment-grade positionsin securitizations would receive afavorable (less than 100 percent) risk-weight. Below-investment grade orunrated positions in securitizationswould receive a less favorable risk-weight (greater than 100 percent risk-weight or gross-up treatment). Aresidual interest retained by aninstitution in an asset securitization (aswell as residual interests that arepurchased) would be subject to thiscapital framework under thesecuritization proposal.

The residual interest proposal differsfrom the securitization proposal inseveral respects. For example, under theresidual interest proposal, all residualinterests that are retained by theinstitution and that fall within the 25percent of Tier 1 capital limit would besubject to ‘‘dollar-for-dollar’’ capitaltreatment regardless of rating (andcomment is sought on whetherpurchased interests should be treatedsimilarly). To date, the Agencies believethat residual interests in assetsecuritizations generally are unratedand illiquid interests; however, as themarket evolves, residual interests mayin the future take the form of rated,liquid, certificated securities. If therating provided to such a residualinterest were investment grade (or nomore than one category belowinvestment grade) the securitizationproposal would afford that residualinterest more favorable capital treatmentthan the dollar-for-dollar capitalrequirement set forth in this residualinterest proposal. In addition, the risk-based capital requirement for unratedresidual interests that are subject togross-up treatment under thesecuritization proposal would notexceed the full risk-based capital chargefor the underlying assets that are beingsupported by the residual interest.Under this residual interest proposal,however, ‘‘dollar-for-dollar’’ capitalwould be required for the amount of theresidual interest that is retained andfalls within the 25 percent of Tier 1capital limit, even if this amountexceeds the full capital charge typicallyheld against the underlying assets thathave been transferred with recourse.Also, unlike the residual interestproposal, the securitization proposaldoes not establish any concentrationlimit for residual interests as apercentage of capital.

These differences between theresidual interest proposal and thesecuritization proposal will be takeninto account in any final rule publishedunder either proposal. In developing afinal rule on residual interests, theAgencies specifically invite comment onhow the capital treatment for residualinterests under this residual interestproposal should be reconciled with thecapital treatment set forth in thesecuritization proposal.

E. Effective DateThe Agencies intend to apply this

proposal to existing as well as futuretransactions. Because bankingorganizations may need additional timeto adapt to any new capital treatment,the Agencies may delay the effectivedate for a specific period of time(transition period). The Agencies viewthis transition period as an opportunityfor institutions to consider theproposal’s impact on their balance sheetstructure and capital position. TheAgencies invite comment on the needfor and duration of a transition period.

VI. Request for Public CommentThe Agencies invite public comment

on all aspects of the proposed rule. Inparticular, the Agencies requestcomment on the definition of residualinterest, the treatment of residualinterests in determining compliancewith minimum capital requirements, theconditions established in the proposal,and the implementation of the proposal.The Agencies also specifically requestcomment on the ‘‘dollar-for-dollar’’ risk-based capital charge for residualinterests, the 25 percent of Tier 1 capitalconcentration limit on the amount ofresidual interests that can be recognizedfor leverage and risk-based capitalpurposes, and the issue of whether a‘‘net-of-associated deferred tax liability’’approach is appropriate in determiningthe capital requirements for residualinterests.

VII. Plain LanguageSection 722 of the Gramm-Leach-

Bliley (GLB) Act (12 U.S.C. 4809)requires federal banking agencies to use‘‘plain language’’ in all proposed andfinal rules published after January 1,2000. We invite your comments on howto make this proposed rule easier tounderstand. For example:

(1) Have we organized the material tosuit your needs?

(2) Are the requirements in the ruleclearly stated?

(3) Does the rule contain technicallanguage or jargon that isn’t clear?

(4) Would a different format (groupingand order of sections, use of headings,

paragraphing) make the rule easier tounderstand?

(5) Would more (but shorter) sectionsbe better?

(6) What else could we do to make therule easier to understand?

VIII. Regulatory Analysis

A. Regulatory Flexibility Act Analysis

Board: Pursuant to section 605(b) ofthe Regulatory Flexibility Act, the Boardhas determined that this proposal willnot have a significant impact on asubstantial number of small businessentities within the meaning of theRegulatory Flexibility Act (5 U.S.C. 601et seq.). The Board’s comparison of theapplicability section of this proposalwith Call Report data on all existingbanks shows that application of theproposal to small entities will be rare.Accordingly, a regulatory flexibilityanalysis is not required. In addition,because the risk-based capital standardsgenerally do not apply to bank holdingcompanies with consolidated assets ofless than $150 million, this proposalwill not affect such companies’’.

FDIC: Pursuant to section 605(b) ofthe Regulatory Flexibility Act (5 U.S.C.601 et seq.) the FDIC hereby certifiesthat the final rule will not have asignificant economic impact on asubstantial number of small entities.Comparison of Call Report data onFDIC-supervised banks to the itemscovered by the proposal that result inincreased capital requirements showsthat application of the proposal to smallentities will be the infrequent exception.

OTS: Pursuant to section 605(b) of theRegulatory Flexibility Act (5 U.S.C. 601et seq.) the OTS certifies that theproposed rule will not have a significanteconomic impact on a substantialnumber of small entities. Comparison ofTFR data on OTS supervised savingsassociations regarding the items thatwould result in increased capitalrequirements indicate that theapplication of the proposal to smallentities will be the infrequent exception.

OCC: Pursuant to section 605(b) of theRegulatory Flexibility Act (5 U.S.C. 601et seq.) the OCC certifies that theproposed rule will not have a significanteconomic impact on a substantialnumber of small entities. Call Reportdata indicate that generally small banksdo not have large residual interests thatexceed the full risk-based capital chargerequired for transferred assets, andtypically do not hold residual interestsin amounts that would exceed the 25percent of Tier 1 capital limitation. Forthese reasons, the OCC believes thatapplication of the proposed rule tosmall entities will be rare.



Consequently, a regulatory flexibilityanalysis is not required.

B. Paperwork Reduction ActThe Agencies have determined that

this proposal does not involve acollection of information pursuant tothe provisions of the PaperworkReduction Act (44 U.S.C. 3501 et seq.).

C. OCC and OTS Executive Order 12866Statement

The Comptroller of the Currency andthe Director of the OTS have determinedthat the proposal described in thisnotice is not a significant regulatoryaction under Executive Order 12866.Accordingly, a regulatory impactanalysis is not required. Nonetheless theOCC specifically invites comment onthe dollar impact of the proposed rule.

D. OCC and OTS Unfunded MandatesAct Statement

Section 202 of the UnfundedMandates Reform Act of 1995, PublicLaw 104–4, (Unfunded Mandates Act),requires that an agency prepare abudgetary impact statement beforepromulgating a rule that includes afederal mandate that may result in theexpenditure by state, local, and tribalgovernments, in the aggregate, or by theprivate sector, of $100 million or morein any one year. If a budgetary impactstatement is required, section 205 of theUnfunded Mandates Act also requiresan agency to identify and consider areasonable number of regulatoryalternatives before promulgating a rule.The OCC and OTS have determined thatthis proposed rule will not result inexpenditures by state, local, and tribalgovernment, or by the private sector, ofmore than $100 million or more in anyone year. Based on the Call Report, TFRand other data, OTS and OCC estimatethat those banks and savingsassociations that would be required toincrease capital under the proposed rulewill not incur additional expenses inthis amount in any one year. Therefore,the OCC and OTS have not prepared abudgetary impact statement orspecifically addressed the regulatoryalternatives considered. Nonetheless theOCC specifically invites comment onthe dollar impact of the proposed rule.

E. The Treasury and GeneralGovernment Appropriations Act, 1999—Assessment of Federal Regulations andPolicies on Families

The Agencies have determined thatthis proposed rule will not affect familywell-being within the meaning ofsection 654 of the Treasury andGovernment Appropriations Act, 1999,Pub. L. 105–277, 112 Stat. 2681 (1998).

List of Subjects

12 CFR Part 3

Administrative practice andprocedure, Capital, National banks,Reporting and recordkeepingrequirements, Risk.

12 CFR Part 208

Accounting, Agriculture, Banks,banking, Confidential businessinformation, Crime, Currency, FederalReserve System, Mortgages, Reportingand recordkeeping requirements,Securities.

12 CFR Part 225

Administrative practice andprocedure, Banks, banking, FederalReserve System, Holding companies,Reporting and recordkeepingrequirements, Securities.

12 CFR Part 325

Administrative practice andprocedure, Banks, banking, Capitaladequacy, Reporting and recordkeepingrequirements, Savings associations,State non-member banks.

12 CFR Part 565

Administrative practice andprocedures, Capital, Savingsassociations.

12 CFR Part 567

Capital, Reporting and recordkeepingrequirements, Savings associations.

Department of the Treasury

Office of the Comptroller of theCurrency

12 CFR Chapter I

Authority and Issuance

For the reasons set out in the jointpreamble, the Office of the Comptrollerof the Currency proposes to amend part3 of chapter I of title 12 of the Code ofFederal Regulations as follows:

PART 3—MINIMUM CAPITAL RATIOS;ISSUANCE OF DIRECTIVES

1. The authority citation for part 3continues to read as follows:

Authority: 12 U.S.C. 93a, 161, 1818,1828(n), 1828 note, 1831n note, 1835, 3907,and 3909.

§ 3.4 [Amended]

2. In § 3.4:A. The existing text is designated as

paragraph (a);B. The second sentence in the newly

designated paragraph (a) is revised; andC. New paragraph (b) is added to read

as follows:

§ 3.4 Reservation of authority.(a) * * * Similarly, the OCC may find

that a particular intangible asset neednot be deducted from Tier 1 or Tier 2capital. * * *

(b) Notwithstanding the riskcategories in section 3 of appendix A tothis part, the OCC may find that theassigned risk weight for any asset doesnot appropriately reflect the risksimposed on a bank and may requireanother risk weight that the OCC deemsappropriate. Similarly, if no risk weightis specifically assigned, the OCC mayassign any risk weight that the OCCdeems appropriate. In making itsdetermination, the OCC considers risksassociated with the asset as well asother relevant factors.

3. In appendix A to part 3:A. In section 1:i. Redesignate paragraphs (c)(25)

through (c)(31) as paragraphs (c)(28)through (c)(34), paragraph (c)(24) asparagraph (c)(26), and paragraphs (c)(13)through (c)(23) as paragraphs (c)(14)through (c)(24);

ii. Add new paragraphs (c)(13),(c)(25), and (c)(27);

B. In section 2, revise paragraphs(c)(1)(ii), (c)(2) introductory text,(c)(2)(i), (c)(2)(ii) introductory text,(c)(2)(iii), and (c)(2)(iv);

C. In section 3, add new paragraph (e)to read as follows:

Appendix A To Part 3—Risk-BasedCapital Guidelines

Section 1. Purpose, Applicability ofGuidelines, and Definitions

* * * * *(c) * * *(13) Financial asset means cash, evidence

of an ownership interest in an entity, or acontract that conveys to a second entity acontractual right to receive cash or anotherfinancial instrument from a first entity or toexchange other financial instruments onpotentially favorable terms with the firstentity.

* * * * *(25) Residual interest means any on-

balance sheet asset that represents an interest(including a beneficial interest) created bythe transfer of financial assets, whetherthrough a securitization or otherwise, andstructured to absorb more than a pro ratashare of credit loss related to the transferredassets through subordination provisions orother credit enhancement techniques.Residual interests generally include interestonly strips receivable, spread accounts, cashcollateral accounts, retained subordinatedinterests and other similar forms of on-balance sheet assets that function as a creditenhancement. Residual interests do notinclude residual interests purchased from athird party.

* * * * *(27) Securitization. Securitization means

the pooling and repackaging of loans or other



6 Intangible assets are defined to exclude any IOstrips receivable related to these mortgage and non-mortgage servicing assets. See section 1(c)(14) ofthis appendix A. Consequently, IO strips receivablerelated to mortgage and non-mortgage servicingassets are not required to be deducted under section2(2)(2) of this appendix A. However, these IO stripsreceivable are subject to a 100 percent risk weightunder section 3(a)(4) of this appendix A. 5 [Reserved]

credit exposures into securities that can besold to investors.

* * * * *

Section 2. Components of Capital

* * * * *(c) * * *(1) * * *

* * * * *(ii) Other intangible assets and residual

interests, except as provided in section2(c)(2) of this appendix A; and * * *

(2) Qualifying intangible assets andresidual interests. Subject to the followingconditions, mortgage servicing assets,nonmortgage servicing assets,6 purchasedcredit card relationships and residualinterests need not be deducted from Tier 1capital:

(i) The total of all intangible assets andresidual interests that are included in Tier 1capital is limited to 100 percent of Tier 1capital, of which no more than 25 percent ofTier 1 capital can consist of purchased creditcard relationships, nonmortgage servicingassets and residual interests in the aggregate.Calculation of these limitations must bebased on Tier 1 capital net of goodwill, andall identifiable intangible assets, other thanmortgage servicing assets, nonmortgageservicing assets, purchased credit cardrelationships and residual interests.

(ii) Banks must value each intangible assetand residual interest included in Tier 1capital at least quarterly. In addition,intangible assets included in Tier 1 capitalmust also be valued at the lesser of:

* * * * *(iii) The quarterly determination of the

current fair value of the intangible asset orresidual interest must include adjustmentsfor any significant changes in originalvaluation assumptions, including changes inprepayment estimates.

(iv) Banks may elect to deduct disallowedservicing assets and residual interests on abasis that is net of any associated deferred taxliability. Deferred tax liabilities netted in thismanner cannot also be netted againstdeferred tax assets when determining theamount of deferred tax assets that aredependent upon future taxable income.

* * * * *

Section 3. Risk Categories/Weights for On-Balance Sheet Assets and Off-Balance SheetItems

* * * * *(e) Residual interests. (1) General capital

requirement. All residual interests are subjectto both a capital concentration limit and aresidual interest capital requirement inaccordance with sections 3(e)(2) and 3(e)(3)of this appendix A. In determining thegeneral capital requirement for a residualinterest, the amount of all residual interests

in excess of the capital concentration limitmust be deducted from Tier 1 capital, inaccordance with section 3(e)(2) of thisappendix A, before the residual interestcapital requirement in section 3(e)(3) of thisappendix A is applied.

(2) Capital concentration limit. In additionto the residual interest capital requirementprovided by section 3(e)(3) of this appendixA, a bank must deduct from Tier 1 capital allresidual interest in excess of the 25 percentsublimit on qualifying intangible assets andresidual interests in accordance with section2(c)(2)(i) of this appendix A.

(3) Residual interests capital requirement.A bank must maintain risk-based capital fora residual interest equal to the amount of theresidual interest that is retained on thebalance sheet (less any amount disallowed inaccordance with section 3(e)(2) of thisappendix A and net of any associateddeferred tax liability), even if the amount ofrisk-based capital required to be maintainedexceeds the full risk-based capitalrequirement for the assets transferred.

(4) Residual interests and other recourseobligations. Where a bank holds a residualinterest and another recourse obligation(such as a standby letter of credit) inconnection with the same asset transfer, thebank must maintain risk-based capital equalto the greater of the risk-based capitalrequirement for the residual interest ascalculated under section 3(e)(3) of thisappendix A or the full risk-based capitalrequirement for the assets transferred, subjectto the low-level recourse rules under section3(d) of this appendix A.

* * * * *Dated: August 16, 2000.

John D. Hawke, Jr.,Comptroller of the Currency.

Federal Reserve System

12 CFR Chapter II


For the reasons set forth in the jointpreamble, the Board of Governors of theFederal Reserve System proposes toamend parts 208 and 225 of chapter IIof title 12 of the Code of FederalRegulations as follows:

PART 208—MEMBERSHIP OF STATEBANKING INSTITUTIONS IN THEFEDERAL RESERVE SYSTEM(REGULATION H)


Authority: 12 U.S.C. 24, 36, 92a, 93a,248(a), 248(c), 321–338a, 371d, 461, 481–486,601, 611, 1814, 1816, 1818, 1820(d)(9),1823(j), 1828(o), 1831o, 1831p–1, 1831r–1,1835a, 1882, 2901–2907, 3105, 3310, 3331–3351 and 3906–3909; 15 U.S.C. 78b, 78l(b),78l(g), 78l(i), 78o–4(c)(5), 78q, 78q–l, and78w; 31 U.S.C. 5318; 42 U.S.C. 4012a, 4104a,4104b, 4106, and 4128.

2. In appendix A to part 208:

A. Section II.A.1. and the first sevenparagraphs of section II.A.2. are revised,and footnote 5 is removed and reserved;

B. In sections II, III and IV, footnotes13 through 52 are redesignated asfootnotes 14 through 53.

C. In section II.B., a new paragraph(i)(c) and new footnote 14 are added,section II.B.1.b. and newly designatedfootnote 15 are revised, new sectionsII.B.1.c. through II.B.1.g. are added, andsection II.B.4. is revised;

D. In section III.A, the fourundesignated paragraphs are designatedas sections III.A.1. through III.A.4., anda new section III.A.5. is added.

E. Section III.B.6. is added.F. Attachment II is revised.

Appendix A To Part 208—CapitalAdequacy Guidelines for State MemberBanks: Risk-Based Measure

* * * * *II. * * *A. * * *1. Core capital elements (tier 1 capital).

The tier 1 component of a bank’s qualifyingcapital must represent at least 50 percent ofqualifying total capital and may consist of thefollowing items that are defined as corecapital elements:

(i) Common stockholders’ equity;(ii) Qualifying noncumulative perpetual

preferred stock (including related surplus);(iii) Minority interest in the equity

accounts of consolidated subsidiaries.Tier 1 capital is generally defined as the

sum of core capital elements 5 less goodwill,other intangible assets, and residual interestsrequired to be deducted in accordance withsection II.B.1. of this appendix A.

* * * * *2. Supplementary capital elements (tier 2

capital). The tier 2 component of a bank’squalifying capital may consist of thefollowing items that are defined assupplementary capital elements:

(i) Allowance for loan and lease losses(subject to limitations discussed below);

(ii) Perpetual preferred stock and relatedsurplus (subject to conditions discussedbelow);

(iii) Hybrid capital instruments (as definedbelow) and mandatory convertible debtsecurities;

(iv) Term subordinated debt andintermediate-term preferred stock, includingrelated surplus (subject to limitationsdiscussed below);

(v) Unrealized holding gains on equitysecurities (subject to limitations discussed insection II.A.2.e. of this appendix A).

The maximum amount of tier 2 capital thatmay be included in a bank’s qualifying totalcapital is limited to 100 percent of tier 1capital (net of goodwill, other intangibleassets, and residual interests required to bededucted in accordance with section II.B.1.of this appendix A).

* * * * *B. * * *



14 Residual interests consist of balance sheetassets that: (a) Represent interests (includingbeneficial interests) in transferred financial assetsretained by a seller (or transferor) after asecuritization or other transfer of financial assets;and (b) are structured to absorb more than a pro ratashare of credit loss related to the transferred assetsthrough subordination provisions or other creditenhancement techniques. Residual interests do notinclude interests purchased from a third party.Residual interests generally include interest-onlystrips receivable, spread accounts, cash collateralaccounts, retained subordinated interests, and othersimilar forms of on-balance sheet assets thatfunction as a credit enhancement.

15 Amounts of servicing assets, purchased creditcard relationships, and residual interests in excessof these limitations, as well as all other identifiableintangible assets, including core deposit intangiblesand favorable leaseholds, are to be deducted froma bank’s core capital elements in determining tier1 capital. However, identifiable intangible assets(other than mortgage servicing assets and purchasedcredit card relationships) acquired on or beforeFebruary 19, 1992, generally will not be deductedfrom capital for supervisory purposes, althoughthey will continue to be deducted for applicationspurposes.

21 To determine the amount of expected deferred-tax assets realizable in the next 12 months, aninstitution should assume that all existingtemporary differences fully reverse as of the reportdate. Projected future taxable income should notinclude net operating loss carry-forwards to be usedduring that year or the amount of existingtemporary differences a bank expects to reversewithin the year. Such projections should includethe estimated effect of tax-planning strategies thatthe organization expects to implement to realize netoperating losses or tax-credit carry-forwards thatwould otherwise expire during the year. Institutionsdo not have to prepare a new 12-month projectioneach quarter. Rather, on interim report dates,institutions may use the future-taxable incomeprojections for their current fiscal year, adjusted forany significant changes that have occurred or areexpected to occur.

(i) * * *(c) Certain on-balance sheet residual

interests—deducted from the sum of corecapital elements in accordance with sectionsII.B.1.c. through e. of this appendix A.14

* * * * *1. Goodwill, other intangible assets, and

residual interests. * * *b. Other intangible assets. i. All servicing

assets, including servicing assets on assetsother than mortgages (i.e., nonmortgageservicing assets), are included in thisappendix as identifiable intangible assets.The only types of identifiable intangibleassets that may be included in, that is, notdeducted from, a bank’s capital are readilymarketable mortgage servicing assets,nonmortgage servicing assets, and purchasedcredit card relationships. The total amount ofthese assets that may be included in capitalis subject to the limitations described belowin sections II.B.1.d. and e. of this appendixA.

ii. The treatment of identifiable intangibleassets set forth in this section generally willbe used in the calculation of a bank’s capitalratios for supervisory and applicationspurposes. However, in making an overallassessment of a bank’s capital adequacy forapplications purposes, the Board may, if itdeems appropriate, take into account thequality and composition of a bank’s capital,together with the quality and value of itstangible and intangible assets.

c. Residual interests. Residual interestsmay be included in, that is, not deductedfrom, a bank’s capital subject to thelimitations described below in sectionsII.B.1.d. and e. of this appendix A.

d. Fair value limitation. The amount ofmortgage servicing assets, nonmortgageservicing assets, and purchased credit cardrelationships that a bank may include incapital shall be the lesser of 90 percent oftheir fair value, as determined in accordancewith section II.B.1.f. of this appendix A, or100 percent of their book value, as adjustedfor capital purposes in accordance with theinstructions in the commercial bankConsolidated Reports of Condition andIncome (Call Reports). The amount ofresidual interests a bank may include incapital shall be 100 percent of its book value.If both the application of the limits onmortgage servicing assets, nonmortgageservicing assets, purchased credit cardrelationships, and residual interests and theadjustment of the balance sheet amount forthese assets would result in an amount beingdeducted from capital, the bank woulddeduct only the greater of the two amounts

from its core capital elements in determiningtier 1 capital.

e. Tier 1 capital limitation. i. The totalamount of mortgage and nonmortgageservicing assets, purchased credit cardrelationships, and residual interests that maybe included in capital, in the aggregate,cannot exceed 100 percent of tier 1 capital.Nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests, in the aggregate, are subject to aseparate sublimit of 25 percent of tier 1capital.15

ii. For purposes of calculating theselimitations on mortgage servicing assets,nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests, tier 1 capital is defined as the sumof core capital elements, net of goodwill, andnet of all identifiable intangible assets otherthan mortgage servicing assets, nonmortgageservicing assets, and purchased credit cardrelationships, prior to the deduction of anydisallowed mortgage servicing assets, anydisallowed nonmortgage servicing assets, anydisallowed purchased credit cardrelationships, any disallowed residualinterests, and any disallowed deferred-taxassets, regardless of the date acquired.

iii. Banks may elect to deduct disallowedmortgage servicing assets, disallowednonmortgage servicing assets, and disallowedresidual interests on a basis that is net of anyassociated deferred tax liability. Deferred taxliabilities netted in this manner cannot alsobe netted against deferred-tax assets whendetermining the amount of deferred-taxassets that are dependent upon future taxableincome.

f. Valuation. Banks must review the bookvalue of all intangible assets and residualinterests at least quarterly and makeadjustments to these values as necessary. Thefair value of mortgage servicing assets,nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests also must be determined at leastquarterly. This determination shall includeadjustments for any significant changes inoriginal valuation assumptions, includingchanges in prepayment estimates or accountattrition rates. Examiners will review boththe book value and the fair value assigned tothese assets, together with supportingdocumentation, during the examinationprocess. In addition, the Federal Reserve mayrequire, on a case-by-case basis, anindependent valuation of a bank’s intangibleassets or residual interests.

g. Growing organizations. Consistent withlong-standing Board policy, banksexperiencing substantial growth, whetherinternally or by acquisition, are expected to

maintain strong capital positionssubstantially above minimum supervisorylevels, without significant reliance onintangible assets or residual interests.

* * * * *4. Deferred-tax assets. The amount of

deferred-tax assets that is dependent uponfuture taxable income, net of the valuationallowance for deferred-tax assets, that may beincluded in, that is, not deducted from, abank’s capital may not exceed the lesser of:

(i) The amount of these deferred-tax assetsthat the bank is expected to realize withinone year of the calendar quarter-end date,based on its projections of future taxableincome for that year,21 or

(ii) 10 percent of tier 1 capital. Thereported amount of deferred-tax assets, net ofany valuation allowance for deferred-taxassets, in excess of the lesser of these twoamounts is to be deducted from a bank’s corecapital elements in determining tier 1 capital.For purposes of calculating the 10 percentlimitation, tier 1 capital is defined as the sumof core capital elements, net of goodwill andnet of all identifiable intangible assets otherthan mortgage and nonmortgage servicingassets, purchased credit card relationships,prior to the deduction of any disallowedmortgage servicing assets, any disallowednonmortgage servicing assets, any disallowedpurchased credit card relationships, anydisallowed residual interests, and anydisallowed deferred-tax assets. Theregenerally is no limit in tier 1 capital on theamount of deferred-tax assets that can berealized from taxes paid in prior carry-backyears or from future reversals of existingtaxable temporary differences, but, for banksthat have a parent, this may not exceed theamount the bank could reasonably expect itsparent to refund.

III. * * *A. * * *5. The Federal Reserve will, on a case-by-

case basis, determine the appropriate risk-weight for any asset that does not fit whollywithin one of the risk categories set forthbelow or that imposes risks on a bank thatare not commensurate with the risk weightotherwise specified below for the asset.

B. * * *6. Residual interests—a. General capital

requirement. All residual interests are subjectto both a residual interest capital requirementand a capital concentration limitation inaccordance with sections II.B.1.e. andIII.B.6.b. of this appendix A. In determining



2 Tier 1 capital for state member banks includescommon equity, minority interest in the equityaccounts of consolidated subsidiaries, andqualifying noncumulative perpetual preferred stock.In addition, as a general matter, Tier 1 capitalexcludes goodwill; amounts of mortgage servicing

assets, nonmortgage servicing assets, purchasedcredit card relationships, and residual interests that,in the aggregate, exceed 100 percent of Tier 1capital; nonmortgage servicing assets, purchasedcredit card relationships, and residual interests that,in the aggregate, exceed 25 percent of Tier 1 capital;other identifiable intangible assets; and deferred taxassets that are dependent upon future taxableincome, net of their valuation allowance, in excessof certain limitations. The Federal Reserve mayexclude certain investments in subsidiaries orassociated companies as appropriate.

3 Deductions from Tier 1 capital and otheradjustments are discussed more fully in section II.B.of appendix A of this part.

the capital requirement for a residualinterest, the amount of all residual interestsin excess of the capital concentration limitmust be deducted from tier 1 capital, inaccordance with section II.B.1.e. of thisappendix A, before the residual interestcapital requirement in this section is applied.

b. Residual interest capital requirement.Notwithstanding section III.D.1.g. of thisappendix A, a bank must maintain capital fora residual interest equal to the amount of theresidual interest that is retained on the

balance sheet (less any amount disallowed inaccordance with section II.B.1.e. of thisappendix A and net of any associateddeferred tax liability), even if the amount ofcapital required to be maintained exceeds thestandard capital charge that would berequired under section IV.A. of this appendixA for assets transferred.

c. Multiple recourse obligations. Where abank holds a residual interest and anotherrecourse obligation (such as a standby letterof credit) in connection with the same asset

transfer, the bank must maintain risk-basedcapital equal to the greater of:

(i) The risk-based capital requirement forthe residual interest as calculated undersection III.B.6.b. of this appendix A; or

(ii) The full risk-based capital requirementfor the assets transferred, subject to the low-level recourse rules (section III.D.1.g. of thisappendix A).

* * * * *

ATTACHMENT II.—SUMMARY OF DEFINITION OF QUALIFYING CAPITAL FOR STATE MEMBER BANKS*[Using the Year-End 1992 Standards]

Components Minimum requirements after transition period

Core Capital (tier 1) .................................................................................. Must equal or exceed 4% of weighted-risk assets.Common stockholders’ equity ........................................................... No limit.Qualifying noncumulative perpetual preferred stock ......................... No limit; banks should avoid undue reliance on preferred stock in tier

1.Minority interest in equity accounts of consolidated Subsidiaries .... Banks should avoid using minority interests to introduce elements not

otherwise qualifying for tier 1 capital.Less: Goodwill, other intangible assets, and residual interests re-

quired to be deducted from capital 1

Supplementary Capital (tier 2) ................................................................. Total of tier 2 is limited to 100% of tier 1.2Allowance for loan and lease losses ................................................ Limited to 1.25% of weighted-risk assets.2Perpetual preferred stock .................................................................. No limit within tier 2.Hybrid capital instruments and equity contract notes ....................... No limit within tier 2.Subordinated debt and intermediate-term preferred stock (original

weighted average maturity of 5 years or more).Subordinated debt and intermediate-term preferred stock are limited to

50% of tier 1,2 amortized for capital purposes as they approach ma-turity.

Revaluation reserves (equity and building) ....................................... Not included; banks encouraged to disclose; may be evaluated on acase-by-case basis for international comparisons; and taken into ac-count in making and overall assessment of capital.

Deductions (from sum of tier 1 and tier 2):Investments in unconsolidated subsidiaries ...................................... As a general rule, one-half of the aggregate investments will be de-

ducted from tier 1 capital and one-half from tier 2 capital.3Reciprocal holdings of banking organizations’ capital securities.Other deductions (such as other subsidiaries or joint ventures) as

determined by supervisory authority.On a case-by-case basis or as a matter of policy after formal rule-

making.Total Capital (tier 1+tier 2¥deductions) .................................................. Must equal or exceed 8% of weighted-risk assets.

1 Requirements for the deduction of other intangible assets and residual interests are set forth in section II.B.1. of this appendix.2 Amounts in excess of limitations are permitted but do not qualify as capital.3 A proportionately greater amount may be deducted from tier 1 capital, if the risks associated with the subsidiary so warrant.* See discussion in section II of the guidelines for a complete description of the requirements for, and the limitations on, the components of

qualifying capital.

3. In appendix B to part 208, sectionII. b. is revised to read as follows:

Appendix B To Part 208—CapitalAdequacy Guidelines for State MemberBanks: Tier 1 Leverage Measure

* * * * *II. b. A bank’s Tier 1 leverage ratio is

calculated by dividing its Tier 1 capital (thenumerator of the ratio) by its average totalconsolidated assets (the denominator of theratio). The ratio will also be calculated usingperiod-end assets whenever necessary, on acase-by-case basis. For the purpose of thisleverage ratio, the definition of Tier 1 capitalas set forth in the risk-based capitalguidelines contained in appendix A of thispart will be used.2 As a general matter,

average total consolidated assets are definedas the quarterly average total assets (definednet of the allowance for loan and lease losses)reported on the bank’s Reports of Conditionand Income (Call Reports), less goodwill;amounts of mortgage servicing assets,nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests that, in the aggregate, are in excessof 100 percent of Tier 1 capital; amounts ofnonmortgage servicing assets, purchasedcredit card relationships, and residualinterests that, in the aggregate, are in excessof 25 percent of Tier 1 capital; all other

identifiable intangible assets; anyinvestments in subsidiaries or associatedcompanies that the Federal Reservedetermines should be deducted from Tier 1capital; and deferred tax assets that aredependent upon future taxable income, net oftheir valuation allowance, in excess of thelimitation set forth in section II.B.4 ofappendix A of this part.3

* * * * *

PART 225—BANK HOLDINGCOMPANIES AND CHANGE IN BANKCONTROL (REGULATION Y)


Authority: 12 U.S.C. 1817(j)(13), 1818,1828(o) 1831i, 1831p–1, 1843(c)(8), 1844(b),1972(l), 3106, 3108, 3310, 3331–3351, 3907,and 3909.



6 [Reserved]

15 Residual interests consist of balance sheetassets that: (a) Represent interests (includingbeneficial interests) in transferred financial assetsretained by a seller (or transferor) after asecuritization or other transfer of financial assets;and (b) are structured to absorb more than a pro ratashare of credit loss related to the transferred assetsthrough subordination provisions or other creditenhancement techniques. Residual interests do notinclude interests purchased from a third party.Residual interest include interest-only stripsreceivable, spread accounts, cash collateralaccounts, retained subordinated interests, andsimilar on-balance sheet assets that function as acredit enhancement.

16 Amounts of servicing assets, purchased creditcard relationships, and residual interests in excessof these limitations, as well as all other identifiableintangible assets, including core deposit intangiblesand favorable leaseholds, are to be deducted froman organization’s core capital elements indetermining tier 1 capital. However, identifiableintangible assets (other than mortgage servicingassets and purchased credit card relationships)acquired on or before February 19, 1992, generallywill not be deducted from capital for supervisorypurposes, although they will continue to bededucted for applications purposes.

2. In appendix A to part 225:A. Section II.A.1. and the first seven

paragraphs of section II.A.2. are revised,and footnote 6 is removed and reserved;

B. In sections II, III and IV, footnotes13 through 57 are redesignated asfootnotes 14 through 58.

C. In section II.B., a new paragraph(i)(c) and new footnote 15 are added,section II.B.1.b and newly designatedfootnote 16 are revised, new sectionsII.B.1.c. through II.B.1.g. are added, andsection II.B.4. is revised.

D. In section III.A, the fourundesignated paragraphs are designatedas sections III.A.1. through III.A.4. anda new section III.A.5, is added.

E. Section III.B.6. is added.F. Attachment II is revised.

Appendix A To Part 225—CapitalAdequacy Guidelines for Bank HoldingCompanies: Risk-Based Measure

* * * * *II. * * *A. * * *1. Core capital elements (tier 1 capital).

The tier 1 component of an institution’squalifying capital must represent at least 50percent of qualifying total capital and mayconsist of the following items that aredefined as core capital elements:

(i) Common stockholders’ equity;(ii) Qualifying noncumulative perpetual

preferred stock (including related surplus);(iii) Qualifying cumulative perpetual

preferred stock (including related surplus);subject to certain limitations describedbelow;

(iv) Minority interest in the equityaccounts of consolidated subsidiaries. Tier 1capital is generally defined as the sum of corecapital elements 6 less goodwill, otherintangible assets, and residual interestsrequired to be deducted in accordance withsection II.B.1. of this appendix A.

* * * * *2. Supplementary capital elements (tier 2

capital). The tier 2 component of aninstitution’s qualifying capital may consist ofthe following items that are defined assupplementary capital elements:

(i) Allowance for loan and lease losses(subject to limitations discussed below);

(ii) Perpetual preferred stock and relatedsurplus (subject to conditions discussedbelow);

(iii) Hybrid capital instruments (as definedbelow), perpetual debt, and mandatoryconvertible debt securities;

(iv) Term subordinated debt andintermediate-term preferred stock, includingrelated surplus (subject to limitationsdiscussed below);

(v) Unrealized holding gains on equitysecurities (subject to limitations discussed insection II.A.2.e. of this appendix A).

The maximum amount of tier 2 capital thatmay be included in an organization’squalifying total capital is limited to 100percent of tier 1 capital (net of goodwill,

other intangible assets, and residual interestsrequired to be deducted in accordance withsection II.B.1. of this appendix A).

* * * * *B. * * *(i) * * *(c) Certain on-balance sheet residual

interests deducted from the sum of corecapital elements in accordance with sectionsII.B.1.c. through e. of this appendix A.15

* * * * *1. Goodwill, other intangible assets, and

residual interests. * * *b. Other intangible assets. i. All servicing

assets, including servicing assets on assetsother than mortgages (i.e., nonmortgageservicing assets), are included in thisappendix as identifiable intangible assets.The only types of identifiable intangibleassets that may be included in, that is, notdeducted from, an organization’s capital arereadily marketable mortgage servicing assets,nonmortgage servicing assets, and purchasedcredit card relationships. The total amount ofthese assets that may be included in capitalis subject to the limitations described belowin sections II.B.1.d. and e. of this appendixA.

ii. The treatment of identifiable intangibleassets set forth in this section generally willbe used in the calculation of a bank holdingcompany’s capital ratios for supervisory andapplications purposes. However, in makingan overall assessment of an organization’scapital adequacy for applications purposes,the Board may, if it deems appropriate, takeinto account the quality and composition ofan organization’s capital, together with thequality and value of its tangible andintangible assets.

c. Residual interests. Residual interestsmay be included in, that is, not deductedfrom, an organization’s capital subject to thelimitations described below in sectionsII.B.1.d. and e. of this appendix A.

d. Fair value limitation. The amount ofmortgage servicing assets, nonmortgageservicing assets, and purchased credit cardrelationships that a bank holding companymay include in capital shall be the lesser of90 percent of their fair value, as determinedin accordance with section II.B.1.f. of thisappendix A, or 100 percent of their bookvalue, as adjusted for capital purposes inaccordance with the instructions to theConsolidated Financial Statements for BankHolding Companies (FR Y–9C Report). Theamount of residual interests a bank holdingcompany may include in capital shall be 100percent of its book value. If both theapplication of the limits on mortgage

servicing assets, nonmortgage servicingassets, purchased credit card relationships,and residual interests and the adjustment ofthe balance sheet amount for these assetswould result in an amount being deductedfrom capital, the bank holding companywould deduct only the greater of the twoamounts from its core capital elements indetermining tier 1 capital.

e. Tier 1 capital limitation. i. The totalamount of mortgage and nonmortgageservicing assets, purchased credit cardrelationships, and residual interests that maybe included in capital, in the aggregate,cannot exceed 100 percent of tier 1 capital.Nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests, in the aggregate, are subject to aseparate sublimit of 25 percent of tier 1capital.16

ii. For purposes of calculating theselimitations on mortgage servicing assets,nonmortgage servicing assets, purchasedcredit card relationships, and residualinterests, tier 1 capital is defined as the sumof core capital elements, net of goodwill, andnet of all identifiable intangible assets otherthan mortgage servicing assets, nonmortgageservicing assets, and purchased credit cardrelationships, prior to the deduction of anydisallowed mortgage servicing assets, anydisallowed nonmortgage servicing assets, anydisallowed purchased credit cardrelationships, any disallowed residualinterests, and any disallowed deferred-taxassets, regardless of the date acquired.

iii. Bank holding companies may elect todeduct disallowed mortgage servicing assets,disallowed nonmortgage servicing assets, anddisallowed residual interests on a basis thatis net of any associated deferred tax liability.Deferred tax liabilities netted in this mannercannot also be netted against deferred taxassets when determining the amount ofdeferred tax assets that are dependent uponfuture taxable income.

f. Valuation. Bank holding companies mustreview the book value of all intangible assetsand residual interests at least quarterly andmake adjustments to these values asnecessary. The fair value of mortgageservicing assets, nonmortgage servicingassets, purchased credit card relationships,and residual interests also must bedetermined at least quarterly. Thisdetermination shall include adjustments forany significant changes in original valuationassumptions, including changes inprepayment estimates or account attritionrates. Examiners will review both the bookvalue and the fair value assigned to theseassets, together with supportingdocumentation, during the inspection



24 To determine the amount of expected deferred-tax assets realizable in the next 12 months, aninstitution should assume that all existingtemporary differences fully reverse as of the reportdate. Projected future taxable income should notinclude net operating loss carry-forwards to be usedduring that year or the amount of existing

temporary differences a bank holding companyexpects to reverse within the year. Such projectionsshould include the estimated effect of tax-planningstrategies that the organization expects toimplement to realize net operating losses or tax-credit carry-forwards that would otherwise expireduring the year. Institutions do not have to prepare

a new 12-month projection each quarter. Rather, oninterim report dates, institutions may use thefuture-taxable income projections for their currentfiscal year, adjusted for any significant changes thathave occurred or are expected to occur.

process. In addition, the Federal Reserve mayrequire, on a case-by-case basis, anindependent valuation of an organization’sintangible assets or residual interests.

g. Growing organizations. Consistent withlong-standing Board policy, bankingorganizations experiencing substantialgrowth, whether internally or by acquisition,are expected to maintain strong capitalpositions substantially above minimumsupervisory levels, without significantreliance on intangible assets or residualinterests.

* * * * *4. Deferred-tax assets. The amount of

deferred-tax assets that is dependent uponfuture taxable income, net of the valuationallowance for deferred-tax assets, that may beincluded in, that is, not deducted from, abanking organization’s capital may notexceed the lesser of:

(i) The amount of these deferred-tax assetsthat the banking organization is expected torealize within one year of the calendarquarter-end date, based on its projections offuture taxable income for that year,24 or

(ii) 10 percent of tier 1 capital. Thereported amount of deferred-tax assets, net ofany valuation allowance for deferred-taxassets, in excess of the lesser of these twoamounts is to be deducted from a bankingorganization’s core capital elements indetermining tier 1 capital. For purposes ofcalculating the 10 percent limitation, tier 1

capital is defined as the sum of core capitalelements, net of goodwill and net of allidentifiable intangible assets other thanmortgage and nonmortgage servicing assets,purchased credit card relationships, prior tothe deduction of any disallowed mortgageservicing assets, any disallowed nonmortgageservicing assets, any disallowed purchasedcredit card relationships, any disallowedresidual interests, and any disalloweddeferred-tax assets. There generally is nolimit in tier 1 capital on the amount ofdeferred-tax assets that can be realized fromtaxes paid in prior carry-back years or fromfuture reversals of existing taxable temporarydifferences.

III. * * *A. * * *5. The Federal Reserve will, on a case-by-

case basis, determine the appropriate riskweight for any asset that does not fit whollywithin one of the risk categories set forthbelow or that imposes risks on a bankholding company that are not commensuratewith the risk weight otherwise specifiedbelow for the asset.

B. * * *6. Residual interests—a. General capital

requirement. All residual interests are subjectto both a residual interest capital requirementand a capital concentration limitation inaccordance with sections II.B.1.e. andIII.B.6.b. of this appendix A. In determiningthe capital requirement for a residual

interest, the amount of all residual interestsin excess of the capital concentration limitmust be deducted from tier 1 capital, inaccordance with section II.B.1.e. of thisappendix A, before the residual interestcapital requirement in this section is applied.

b. Residual interest capital requirement.Notwithstanding section III.D.1.g. of thisappendix A, organizations must maintaincapital for a residual interest equal to theamount of the residual interest (less anyamount disallowed in accordance withsection II.B.1.e. of this appendix A and netof any associated deferred tax liability), evenif the amount of capital required to bemaintained exceeds the standard capitalcharge under section IV.A. of this appendixA for the assets transferred.

c. Multiple recourse obligations. Where anorganization holds a residual interest andanother recourse obligation (such as astandby letter of credit) in connection withthe same asset transfer, the organization mustmaintain risk-based capital equal to thegreater of:

(i) The risk-based capital requirement forthe residual interest as calculated undersection III.B.6.b of this appendix A; or

(ii) The full risk-based capital requirementfor the assets transferred, subject to the low-level recourse rules (section III.D.1.g. of thisappendix A).

* * * * *

ATTACHMENT II—SUMMARY DEFINITION OF QUALIFYING CAPITAL FOR BANK HOLDING COMPANIES*[Using the year-end 1992 standards]


Core Capital (tier 1) .................................................................................. Must equal or exceed 4% of weighted-risk assets.Common stockholders’ equity ........................................................... No limit.Qualifying noncumulative perpetual preferred stock ......................... No limit.Qualifying cumulative perpetual preferred stock ............................... Limited to 25% of the sum of common stock, qualifying perpetual pre-

ferred stock, and minority interests.Minority interest in equity accounts of consolidated subsidiaries ..... Organizations should avoid using minority interests to introduce ele-

ments not otherwise qualifying for tier 1 capital.Less: Goodwill, other intangible assets, and residual interests re-

quired to be deducted from capital 1

Supplementary Capital (tier 2) ................................................................. Total of tier 2 is limited to 100% of tier 1.2

Allowance for loan and lease losses ................................................ Limited to 1.25% of weighted-risk assets.2

Perpetual preferred stock .................................................................. No limit within tier 2.Hybrid capital instruments, perpetual debt, and mandatory convert-

ible securities.No limit within tier 2.

Subordinated debt and intermediate-term preferred stock (originalweighted average maturity of 5 years or more).

Subordinated debt and intermediate-term preferred stock are limited to50% of tier 1; 2 amortized for capital purposes as they approach ma-turity.

Revaluation reserves (equity and building) ....................................... Not included; organization encouraged to disclose; may be evaluatedon a case-by-case basis for international comparisons; and takeninto account in making and overall assessment of capital.

Deductions (from sum of tier 1 and tier 2):Investments in unconsolidated subsidiaries ...................................... As a general rule, one-half of the aggregate investments will be de-

ducted from tier 1 capital and one-half from tier 2 capital.3



3 Tier 1 capital for banking organizations includescommon equity, minority interest in the equityaccounts of consolidated subsidiaries, qualifyingnoncumulative perpetual preferred stock, andqualifying cumulative perpetual preferred stock.(Cumulative perpetual preferred stock is limited to25 percent of tier 1 capital.) In addition, as a generalmatter, tier 1 capital excludes goodwill; amounts ofmortgage servicing assets, nonmortgage servicingassets, purchased credit card relationships, andresidual interests that, in the aggregate, exceed 100percent of tier 1 capital; nonmortgage servicingassets, purchased credit card relationships, andresidual interests that, in the aggregate, exceed 25percent of tier 1 capital; all other identifiableintangible assets; and deferred-tax assets that aredependent upon future taxable income, net of theirvaluation allowance, in excess of certainlimitations. The Federal Reserve may excludecertain investments in subsidiaries or associatedcompanies as appropriate.

4 Deductions from tier 1 capital and otheradjustments are discussed more fully in section II.B.of appendix A of this part.

ATTACHMENT II—SUMMARY DEFINITION OF QUALIFYING CAPITAL FOR BANK HOLDING COMPANIES*—Continued[Using the year-end 1992 standards]


Reciprocal holdings of banking organizations’ capital securitiesOther deductions (such as other subsidiaries or joint ventures) as

determined by supervisory authorityTotal Capital (tier 1 + tier 2¥deductions) ................................................ Must equal or exceed 8% of weighted-risk assets.

1 Requirements for the deduction of other intangible assets and residual interests are set forth in section II.B.1.e. of this appendix.2 Amounts in excess of limitations are permitted but do not qualify as capital.3 A proportionally greater amount may be deducted from tier 1 capital.* See discussion in section II of this appendix for a complete description of the requirements for, and the limitations on, the components of

qualifying capital.

3. In appendix D to part 225, sectionII.b. is revised to read as follows:

Appendix D to Part 225—CapitalAdequacy Guidelines for Bank HoldingCompanies: Tier 1 Leverage Measure

* * * * *II. * * *b. A banking organization’s tier 1 leverage

ratio is calculated by dividing its tier 1capital (the numerator of the ratio) by itsaverage total consolidated assets (thedenominator of the ratio). The ratio will alsobe calculated using period-end assetswhenever necessary, on a case-by-case basis.For the purpose of this leverage ratio, thedefinition of tier 1 capital as set forth in therisk-based capital guidelines contained inappendix A of this part will be used.3 As ageneral matter, average total consolidatedassets are defined as the quarterly averagetotal assets (defined net of the allowance forloan and lease losses) reported on theorganization’s Consolidated FinancialStatements (FR Y–9C Report), less goodwill;amounts of mortgage-servicing assets,nonmortgage-servicing assets, purchasedcredit-card relationships, and residualinterests that, in the aggregate, are in excessof 100 percent of tier 1 capital; amounts ofnonmortgage-servicing assets, purchasedcredit-card relationships, and residualinterests that, in the aggregate, are in excessof 25 percent of tier 1 capital; all otheridentifiable intangible assets; anyinvestments in subsidiaries or associatedcompanies that the Federal Reservedetermines should be deducted from tier 1capital; and deferred-tax assets that are

dependent upon future taxable income, net oftheir valuation allowance, in excess of thelimitation set forth in section II.B.4 ofappendix A of this part. 4

* * * * *By order of the Board of Governors of the

Federal Reserve System, September 13, 2000.Jennifer J. Johnson,Secretary of the Board.

Federal Deposit Insurance Corporation

12 CFR Chapter III

Authority and IssuanceFor the reasons set out in the joint

preamble, the Board of Directors of theFederal Deposit Insurance Corporationproposes to amend part 325 of chapterIII of title 12 of the Code of FederalRegulations as follows:

PART 325—CAPITAL MAINTENANCE

1. The authority citation for part 325is revised to read as follows:

Authority: 12 U.S.C. 1815(a), 1815(b),1816, 1818(a), 1818(b), 1818(c), 1818(t),1819(Tenth), 1828(c), 1828(d), 1828(i),1828(n), 1828(o), 1831o, 1835, 3907, 3909,4808; Pub. L. 102–233, 105 Stat. 1761, 1789,1790 (12 U.S.C. 1831n note); Pub. L. 102–242, 105 Stat. 2236, 2355, as amended byPub. L. 103–325, 108 Stat. 2160, 2233 (12U.S.C. 1828 note); Pub. L. 102–242, 105 Stat.2236, 2386, as amended by Pub. L. 102–550,106 Stat. 3672, 4089 (12 U.S.C. 1828 note).

§ 325.2 [Amended]2. In § 325.2:A. Redesignate paragraphs (s) through

(x) as paragraphs (v) through (aa),paragraphs (q) through (r) as paragraphs(s) through (t), and paragraphs (g)through(p) as pragraphs (h) through (q);

B. Add new paragraphs (g), (r), and(u);

C. Revise newly designatedparagraphs (w) and (y) to read asfollows:

§ 325.2 Definitions.

* * * * *

(g) Financial assets means cash,evidence of an ownership interest in anentity, or a contract that conveys to asecond entity a contractual right:

(1) To receive cash or anotherfinancial instrument from a first entity;or

(2) To exchange other financialinstruments on potentially favorableterms with the first entity.* * * * *

(r) Residual interests means:(1) Balance sheet assets that:(i) Represent interests (including

beneficial interests) in transferredfinancial assets retained by a seller (ortransferor) after a securitization or othertransfer of financial assets; and

(ii) Are structured to absorb more thana pro rata share of credit loss related tothe transferred assets throughsubordination provisions or other creditenhancement techniques.

(2) Exclusion. Residual interests donot include interests purchased from athird party.

(3) Examples. Residual interestsinclude interest only strips receivable,spread accounts, cash collateralaccounts, retained subordinatedinterests, and other similar forms of on-balance sheet assets that function as acredit enhancement.* * * * *

(u) Securitization means the poolingand repackaging of loans or other creditexposures into securities that can besold to investors.* * * * *

(w) Tier 1 capital or core capitalmeans the sum of commonstockholders’ equity, noncumulativeperpetual preferred stock (including anyrelated surplus), and minority interestsin consolidated subsidiaries, minus allintangible assets (other than mortgageservicing assets, nonmortgage servicingassets, and purchased credit cardrelationships eligible for inclusion incore capital pursuant to § 325.5(f) andqualifying supervisory goodwill eligiblefor inclusion in core capital pursuant to12 CFR part 567), minus residual



interests (other than residual interestseligible for inclusion in core capitalpursuant to § 325.5(f)), minus deferredtax assets in excess of the limit set forthin § 325.5(g), minus identified losses (tothe extent that Tier 1 capital would havebeen reduced if the appropriateaccounting entries to reflect theidentified losses had been recorded onthe insured depository institution’sbooks), and minus investments insecurities subsidiaries subject to 12 CFR337.4.* * * * *

(y) Total assets means the average oftotal assets required to be included in abanking institution’s ‘‘Reports ofCondition and Income’’ (Call Report) or,for savings associations, theconsolidated total assets required to beincluded in the ‘‘Thrift FinancialReport,’’ as these reports may from timeto time be revised, as of the most recentreport date (and after making anynecessary subsidiary adjustments forstate nonmember banks as described in§§ 325.5(c) and 325.5(d) of this part),minus intangible assets (other thanmortgage servicing assets, nonmortgageservicing assets, and purchased creditcard relationships eligible for inclusionin core capital pursuant to § 325.5(f) andqualifying supervisory goodwill eligiblefor inclusion in core capital pursuant to12 CFR part 567), minus residualinterests (other than residual interestseligible for inclusion in core capitalpursuant to § 325.5(f)), minus deferredtax assets in excess of the limit set forthin § 325.5(g), and minus assets classifiedloss and any other assets that arededucted in determining Tier 1 capital.For banking institutions, the average oftotal assets is found in the Call Reportschedule of quarterly averages. Forsavings associations, the consolidatedtotal assets figure is found in ScheduleCSC of the Thrift Financial Report.

3. In § 325.5, revise paragraphs (f) and(g)(2) to read as follows:

§ 325.5 Miscellaneous.* * * * *

(f) Treatment of mortgage servicingassets, purchased credit cardrelationships, nonmortgage servicingassets, and residual interests. Forpurposes of determining Tier 1 capitalunder this part, mortgage servicingassets, purchased credit cardrelationships, nonmortgage servicingassets, and residual interests will bededucted from assets and from commonstockholders’ equity to the extent thatthese items do not meet the conditions,limitations, and restrictions described inthis section. Banks may elect to deductdisallowed servicing assets anddisallowed residual interests on a basis

that is net of any associated deferred taxliability. Any deferred tax liabilitynetted in this manner cannot also benetted against deferred tax assets whendetermining the amount of deferred taxassets that are dependent upon futuretaxable income and calculating themaximum allowable amount of theseassets under paragraph (g) of thissection.

(1) Valuation. The fair value ofmortgage servicing assets, purchasedcredit card relationships, nonmortgageservicing assets, and residual interestsshall be estimated at least quarterly. Thequarterly fair value estimate shallinclude adjustments for any significantchanges in the original valuationassumptions, including changes inprepayment estimates or attrition rates.The FDIC in its discretion may requireindependent fair value estimates on acase-by-case basis where it is deemedappropriate for safety and soundnesspurposes.

(2) Fair value limitation. For purposesof calculating Tier 1 capital under thispart (but not for financial statementpurposes), the balance sheet assets formortgage servicing assets, purchasedcredit card relationships, andnonmortgage servicing assets will eachbe reduced to an amount equal to thelesser of:

(i) 90 percent of the fair value of theseassets, determined in accordance withparagraph (f)(1) of this section; or

(ii) 100 percent of the remainingunamortized book value of these assets(net of any related valuationallowances), determined in accordancewith the instructions for the preparationof the Consolidated Reports of Incomeand Condition (Call Reports).

(3) Tier 1 capital limitation. Themaximum allowable amount ofmortgage servicing assets, purchasedcredit card relationships, nonmortgageservicing assets, and residual interestsin the aggregate, will be limited to thelesser of:

(i) 100 percent of the amount of Tier1 capital that exists before the deductionof any disallowed mortgage servicingassets, any disallowed purchased creditcard relationships, any disallowednonmortgage servicing assets, anydisallowed residual interests, and anydisallowed deferred tax assets; or

(ii) The sum of the amounts ofmortgage servicing assets, purchasedcredit card relationships, andnonmortgage servicing assets,determined in accordance withparagraph (f)(2) of this section, plus theamount of residual interests determinedin accordance with paragraph

(f)(1) of the section.

(4) Tier 1 capital sublimit. In additionto the aggregate limitation on mortgageservicing assets, purchased credit cardrelationships, nonmortgage servicingassets, and residual interests set forth inparagraph (f)(3) of this section, asublimit will apply to purchased creditcard relationships, nonmortgageservicing assets, and residual interests.The maximum allowable amount of theaggregate of purchased credit cardrelationships, nonmortgage servicingassets, and residual interests, will belimited to the lesser of:

(i) Twenty-five percent of the amountof Tier 1 capital that exists before thededuction of any disallowed mortgageservicing assets, any disallowedpurchased credit card relationships, anydisallowed nonmortgage servicingassets, any disallowed residual interests,and any disallowed deferred tax assets;or

(ii) The sum of the amounts ofpurchased credit card relationships andnonmortgage servicing assetsdetermined in accordance withparagraph (f)(2) of this section, plus theamount of residual interests determinedin accordance with paragraph (f)(1) ofthe section.

(g)(2) * * *(2) Tier 1 capital limitations. (i) The

maximum allowable amount of deferredtax assets that are dependent uponfuture taxable income, net of anyvaluation allowance for deferred taxassets, will be limited to the lesser of:

(A) The amount of deferred tax assetsthat are dependent upon future taxableincome that is expected to be realizedwithin one year of the calendar quarter-end date, based on projected futuretaxable income for that year; or

(B) Ten percent of the amount of Tier1 capital that exists before the deductionof any disallowed mortgage servicingassets, any disallowed nonmortgageservicing assets, any disallowedpurchased credit card relationships, anydisallowed residual interests and anydisallowed deferred tax assets.

(iii) For purposes of this limitation, allexisting temporary differences shouldbe assumed to fully reverse at thecalendar quarter-end date. The recordedamount of deferred tax assets that aredependent upon future taxable income,net of any valuation allowance fordeferred tax assets, in excess of thislimitation will be deducted from assetsand from equity capital for purposes ofdetermining Tier 1 capital under thispart. The amount of deferred tax assetsthat can be realized from taxes paid inprior carryback years and from thereversal of existing taxable temporarydifferences generally would not bededucted from assets and from equity



2 Preferred stock issues where the dividend isreset periodically based, in whole or in part, uponthe bank’s current credit standing, including but notlimited to, auction rate, money market orremarketable preferred stock, are assigned to Tier 2capital, regardless of whether the dividends arecumulative or noncumulative.

3 In addition to the core capital elements, Tier 1may also include certain supplementary capitalelements during the transition period subject tocertain limitations set forth in section III of thisstatement of policy.

4 An exception is allowed for intangible assetsthat are explicitly approved by the FDIC as part ofthe bank’s regulatory capital on a specific casebasis. These intangibles will be included in capitalfor risk-based capital purposes under the terms andconditions that are specifically approved by theFDIC.

14 A privately-issued mortgage-backed securitymay be treated as an indirect holding of theunderlying assets provided that (1) the underlyingassets are held by an independent trustee and thetrustee has a first priority, perfected security

interest in the underlying assets on behalf of theholders of the security, (2) either the holder of thesecurity has an undivided pro rata ownershipinterest in the underlying mortgage assets or thetrust or single purpose entity (or conduit) thatissues the security has no liabilities unrelated to theissued securities (3) the security is structured suchthat the cash flow from the underlying assets in allcases fully meets the cash flow requirements of thesecurity without undue reliance on anyreinvestment income, and (4) there is no materialreinvestment risk associated with any fundsawaiting distribution to the holders of the security.In addition, if the underlying assets of a mortgage-backed security are composed of more than onetype of asset, the entire mortgage-backed security isgenerally assigned to the category appropriate to thehighest risk-weighted asset underlying the issue.

capital. However, notwithstanding theabove, the amount of carrybackpotential that may be considered incalculating the amount of deferred taxassets that a member of a consolidatedgroup (for tax purposes) may include inTier 1 capital may not exceed theamount which the member couldreasonably expect to have refunded byits parent.* * * * *

4. In appendix A to part 325:A. Revise section I.A.l.;B. In section II:i. Designate the first two undesignated

paragraphs as sections II.A.l. and II.A.2.,respectively, and add a new sectionII.A.3.;

ii. Revise section II.B.5., and add newsection II.B.7.;

iii. Amend paragraph II.C. by revisingthe second paragraph under ‘‘Category4—100 Percent Risk Weight’’;

C. Revise section III; andD. Revise Table I to read as follows:

Appendix A to Part 325—Statement ofPolicy on Risk-Based Capital

* * * * *I. * * *A. * * *1. Core capital elements (Tier 1) consists

of:i. Common stockholders’ equity capital

(includes common stock and related surplus,undivided profits, disclosed capital reservesthat represent a segregation of undividedprofits, and foreign currency translationadjustments, less net unrealized holdinglosses on available-for-sale equity securitieswith readily determinable fair values);

ii. Noncumulative perpetual preferredstock,2 including any related surplus; and

iii. Minority interests in the equity capitalaccounts of consolidated subsidiaries.

At least 50 percent of the qualifying totalcapital base should consist of Tier 1 capital.Core (Tier 1) capital is defined as the sum ofcore capital elements3 minus all intangibleassets (other than mortgage servicing assets,nonmortgage servicing assets and purchasedcredit card relationships eligible forinclusion in core capital pursuant to§ 325.5(f)) 4 minus residual interests (otherthan residual interests eligible for inclusion

in core capital pursuant to § 325.5(f)) andminus any disallowed deferred tax assets.

Although nonvoting common stock,noncumulative perpetual preferred stock,and minority interests in the equity capitalaccounts of consolidated subsidiaries arenormally included in Tier 1 capital, votingcommon stockholders’ equity generally willbe expected to be the dominant form of Tier1 capital. Thus, banks should avoid unduereliance on nonvoting equity, preferred stockand minority interests.

Although minority interests inconsolidated subsidiaries are generallyincluded in regulatory capital, exceptions tothis general rule will be made if the minorityinterests fail to provide meaningful capitalsupport to the consolidated bank. Such asituation could arise if the minority interestsare entitled to a preferred claim onessentially low risk assets of the subsidiary.Similarly, although residual interests andintangible assets in the form of mortgageservicing assets, nonmortgage servicing assetsand purchased credit card relationships aregenerally recognized for risk-based capitalpurposes, the deduction of part or all of theresidual interests, mortgage servicing assets,nonmortgage servicing assets and purchasedcredit card relationships may be required ifthe carrying amounts of these rights areexcessive in relation to their market value orthe level of the bank’s capital accounts.Residual interests, mortgage servicing assets,nonmortgage servicing assets and purchasedcredit card relationships that do not meet theconditions, limitations and restrictionsdescribed in § 325.5(g) of this part will notbe recognized for risk-based capital purposes.

* * * * *II. * * *A. * * *3. The Director of the Division of

Supervision may, on a case-by-case basis,determine the appropriate risk weight for anyasset that does not fit wholly within one ofthe risk categories set forth in sections II.B.and II.C. of this appendix A or that imposesrisks on a bank that are not commensuratewith the risk weight otherwise specified insections II.B. and II.C. of this appendix A forthe asset.

* * * * *B. * * *5. Mortgage-Backed Securities. Mortgage-

backed securities, including pass-throughsand collateralized mortgage obligations (butnot stripped mortgage-backed securities) thatare issued or guaranteed by a U.S.Government agency or a U.S. Government-sponsored agency, normally are assigned tothe risk weight category appropriate to theissuer or guarantor. Generally, a privately-issued mortgage-backed security is treated asessentially an indirect holding of theunderlying assets, and assigned to the samerisk category as the underlying assets, inaccordance with the provisions and criteriaspelled out in detail in the accompanyingfootnote;14 however, such privately-issued

mortgage-backed securities may not beassigned to the zero percent risk category.Privately-issued mortgage-backed securitieswhose structures do not comply with thespecified provisions set forth in the footnoteare assigned to the 100 percent risk category.In addition, any class of a mortgage-backedsecurity, other than a residual interest, thatcan absorb more than its pro rata share ofloss without the whole issue being in default(for example, a subordinated class) will alsobe assigned to the 100 percent risk weightcategory. All stripped mortgage-backedsecurities, including interest-only strips (IOs)(unless covered under section II.B.7. of thisappendix A), principal-only strips (POs), andsimilar instruments, are assigned to the 100percent risk weight category, regardless of theissuer or guarantor.

* * * * *7. Residual interests—a. General capital

requirement. All residual interests are subjectto both a residual interest capital requirementand a capital concentration limitation inaccordance with § 325.5 of this part. Indetermining the general capital requirementfor a residual interest, the amount of allresidual interest in excess of the capitalconcentration limit must be deducted fromTier 1 capital, in accordance with § 325.5 ofthis part, before the residual interest capitalrequirement in this section is applied.

b. Residual interest capital requirement.Notwithstanding section III. of this appendixA, a bank must maintain risk-based capitalfor a residual interest equal to the amount ofthe residual interest that is retained on thebalance sheet (less any amount disallowed inaccordance with § 325.5 and net of anyassociated deferred tax liability), even if theamount of risk-based capital required to bemaintained exceeds the full risk-basedcapital requirement for the assets transferred.

c. Recourse Obligation. Where a bank holdsa residual interest and another recourseobligation (such as a standby letter of credit)in connection with the same asset transfer,the bank must maintain risk-based capitalequal to the greater of: The risk-based capitalrequirement for the residual interest ascalculated under section II.B.7.b. of thisappendix A; or the full risk-based capitalrequirement for the assets transferred, subjectto the low-level recourse rules (sectionII.D.1.of this appendix A).

* * * * *C. * * *



34 Customer liabilities on acceptances outstandinginvolving non-standard risk claims, such as claimson U.S. depository institutions, are assigned to theidentity of the obligor or, if relevant, the nature of

the collateral or guaranties backing the claim.Portions of acceptances conveyed as riskparticipations to U.S. depository institutions orforeign banks should be assigned to the 20 percent

risk category that is appropriate for short-termclaims guaranteed by U.S. depository institutionsand foreign banks.

Category 4—100 Percent Risk Weight

* * * * *This category also includes all claims on

foreign and domestic private sector obligorsthat are not assigned to lower risk weightcategories, including: loans to nondepositoryfinancial institutions and bank holdingcompanies; claims on commercial firmsowned by the bank on acceptancesoutstanding involving standard risk claims; 34

fixed assets, premises and other real estateowned; common and preferred stock ofcorporations, including stock acquired fordebt previously contracted; commercial andconsumer loans (except those loans assignedto lower risk categories due to recognized

guarantees or collateral); real estate loans andmortgage-backed securities that do not meetthe criteria for assignment to a lower riskweight (including any classes of mortgage-backed securities that can absorb more thantheir pro rata share of loss without the wholeissue being in-default, such as subordinatedclasses, but not including residual interests);and all stripped mortgage-backed securities,including interest-only (IOs) (unless coveredunder section II.B.7. of this appendix A) andthe principal-only (POs) strips.

* * * * *

III. Minimum Risk-Based Capital RatioSubject to section II.B.7. of this appendix

A, banks generally will be expected to meet

a minimum ratio of qualifying total capital torisk-weighted assets of 8 percent, of which atleast 4 percentage points should be in theform of core capital (Tier 1). Any bank thatdoes not meet the minimum risk-basedcapital ratio, or whose capital is otherwiseconsidered inadequate, generally will beexpected to develop and implement a capitalplan for achieving an adequate level ofcapital, consistent with the provisions of thisrisk-based capital framework, the specificcircumstances affecting the individual bank,and the requirements of any relatedagreements between the bank and the FDIC.

* * * * *

TABLE I—DEFINITION OF QUALIFYING CAPITAL

Components Minimum requirements and limitations

(1) Core Capital (Tier 1) ........................................................................... Must equal or exceed 4% of risk-weighted assets.(2) Common stockholders’ equity capital ................................................. No Limit.1(3) Noncumulative perpetual preferred stock and any related surplus .... No Limit.1(4) Minority interest in equity capital accounts of consolidated subsidi-

aries.No Limit.1

(5) Less: All intangible assets other than mortgage servicing assets,nonmortgage servicing assets and purchased credit card relation-ships.

(2)

(6) Less: Certain residual interests .......................................................... (3)(7) Less: Certain deferred tax assets ....................................................... (4)(8) Supplementary Capital (Tier 2) ........................................................... Total of Tier 2 is limited to 100% of Tier 1.5(9) Allowance for loan and lease losses .................................................. Limited to 1.25% of risk-weighted assets.5(10) Unrealized gains on certain equity securities 6 ................................. Limited to 45% of pretax net unrealized gains.6(11) Cumulative perpetual and longterm preferred stock (original matu-

rity of 20 years or more) and any related surplus.No limit within Tier 2; long-term preferred is amortized for capital pur-

poses as it approaches maturity.(12) Auction rate and similar preferred stock (both cumulative and non-

cumulative).No limit within Tier 2.

(13) Hybrid capital instruments (including mandatory convertible debtsecurities).

No limit within Tier 2.

(14) Term subordinated debt and intermediate-term preferred stock(original weighted average maturity of five years or more).

Term subordinated debt and intermediate term preferred stock are lim-ited to 50% of Tier 1 5 and amortized for capital purposes as theyapproach maturity.

(15) Deductions (from the sum of Tier 1 plus Tier 2).(16) Investments in banking and finance subsidiaries that are not con-

solidated for regulatory capital purposes.(17) Intentional, reciprocal cross-holdings of capital securities issued by

banks.(18) Other deductions (such as investments in other subsidiaries or in

joint ventures) as determined by supervisory authority.On a case-by-case basis or as a matter of policy after formal consider-

ation of relevant issues.(19) Total Capital (Tier 1 + Tier 2—Deductions). .................................... Must equal or exceed 8% of risk-weighted as sets.

1 No express limits are placed on the amounts of nonvoting common, noncumulative perpetual preferred stock, and minority interests that maybe recognized as part of Tier 1 capital. However, voting common stockholders’ equity capital generally will be expected to be the dominant formof Tier 1 capital and banks should avoid undue reliance on other Tier 1 capital elements.

2 The amounts of mortgage servicing assets, nonmortgage servicing assets and purchased credit card relationships that can be recognized forpurposes of calculating Tier 1 capital are subject to the limitations set forth in § 325.5(f). All deductions are for capital purposes only; deductionswould not affect accounting treatment.

3 The amounts of residual interests that can be recognized for purposes of calculating Tier 1 capital are subject to the limitations set forth in§ 325.5(f).

4 Deferred tax assets are subject to the capital limitations set forth in § 325.5(g).5 Amounts in excess of limitations are permitted but do not qualify as capital.6 Unrealized gains on equity securities are subject to the capital limitations set for in paragraph I.A2.(f) of appendix A to part 325.



* * * * *By order of the Board of Directors.Dated at Washington, DC, this 14th day of

August, 2000.Federal Deposit Insurance Corporation.James D. LaPierre,Deputy Executive Secretary.

Office of Thrift Supervision

12 CFR Chapter V


For the reasons set out in the jointpreamble, The Office of ThriftSupervision proposes to amend parts565 and 567 of chapter V of title 12 ofthe Code of Federal Regulations asfollows:

PART 565—PROMPT CORRECTIVEACTION


Authority: 12 U.S.C. 1831o.

2. Amend § 565.2 by revisingparagraph (f) to read as follows:


* * * * *(f) Tangible equity means the amount

of a savings association’s core capital ascomputed in part 567 of this chapterplus the amount of its outstandingcumulative perpetual preferred stock(including related surplus) anddisallowed residual interests minusintangible assets as defined in § 567.1 ofthis chapter and nonmortgage servicingassets that have not been previouslydeducted in calculating core capital.* * * * *

PART 567—CAPITAL


Authority: 12 U.S.C. 1462, 1462a, 1463,1464, 1467a, 1828(note).

4. Amend § 567.1 by addingdefinitions of ‘‘financial asset’’,‘‘residual interests,’’ and‘‘securitization’’ to read as follows:


* * * * *Financial asset. The term financial

asset means cash, evidence of anownership interest in an entity, or acontract that conveys to a second entitya contractual right:

(1) To receive cash or anotherfinancial instrument from a first entity;or

(2) To exchange other financialinstruments on potentially favorableterms with the first entity.* * * * *

Residual interests. (1) The termresidual interests means balance sheetassets that:

(i) Represent interests (includingbeneficial interests) in transferredfinancial assets retained by a seller (ortransferor) after a securitization or othertransfer of financial assets; and

(ii) Are structured to absorb more thana pro rata share of credit loss related tothe transferred assets throughsubordination provisions or other creditenhancement techniques.

(2) Residual interests do not includeinterests purchased from a third party.

(3) Residual interests include interestonly on strips receivable, spreadaccounts, cash collateral accounts,retained subordinated interests, andsimilar on-balance sheet assets thatfunction as a credit enhancement.* * * * *

Securitization. The termsecuritization means the pooling andrepackaging of loans or other creditexposures into securities that can besold to investors.* * * * *

5. Amend § 567.5 by adding newparagraph (a)(2)(iii) to read as follows:

§ 567.5 Components of capital.(a) * * *(2) * * *(iii) Residual interests that are not

includable in core capital under§ 567.12 of this part are deducted fromassets and capital in computing corecapital.* * * * *

6. Amend § 567.6 by revisingparagraph (a) introductory text andparagraph (a)(1) introductory text, andadding paragraph (b) to read as follows:

§ 567.6 Risk-based capital credit risk-weight categories.

(a) Risk-weighted assets. Risk-weighted assets equal risk-weighted on-balance-sheet assets (as computed underparagraph (a)(1) of this section), plusrisk-weighted off-balance-sheetactivities (as computed under paragraph(a)(2) of this section). Assets notincluded for purposes of calculatingcapital under § 567.5 are not included incalculating risk-weighted assets.

(1) On-balance-sheet assets. Risk-weighted on-balance-sheet assets arecomputed by multiplying the on-balance-sheet asset amounts times theappropriate risk weight categories,except for residual interests, which arediscussed in paragraph (b) of thissection. The risk weight categories foron-balance-sheet assets are:* * * * *

(b) Residual interests. (1) In general. Asavings association must maintain risk-

based capital for a residual interestequal to the amount of the residualinterest that is retained on the balancesheet (less any amount disallowedunder § 567.12(e) and net of anyassociated deferred tax liability), eventhough this risk-based capitalrequirement may exceed the fullequivalent risk-based capitalrequirement for the assets transferred.

(2) Recourse obligation. Where asavings association holds a residualinterest and another recourse obligation(such as a standby letter of credit) inconnection with the same asset transfer,the savings association must maintainrisk-based capital equal to the greater of:

(i) The risk-based capital requirementfor the residual interest as calculatedunder paragraph (b)(1) of this section; or

(ii) The full risk-based capitalrequirement for the assets transferred,subject to the low-level recourse rules(paragraph 6(a)(2)(i)(C) of this section).

7. Amend § 567.9 by revisingparagraph (c)(1) to read as follows:

§ 567.9 Tangible capital requirement.

* * * * *(c) * * *(1) Intangible assets as defined in

§ 567.1 of this part, and servicing assetsand residual interests not includable intangible capital under § 567.12 of thispart.* * * * *

8. Amend § 567.11 by redesignatingparagraph (c) as paragraph (c)(1) andadding a new paragraph (c)(2) to read asfollows:

§ 567.11 Reservation of authority.

* * * * *(c) * * *(2) If a savings association has

calculated the risk-weighted assetamount under § 567.6, OTS maydetermine that risk-weighted assetamount does not adequately reflect thecredit risk that the savings associationretained in the transaction and requirethe institution to revise the risk-weighted asset amount to reflect the riskof, and other relevant factors associatedwith, the residual interest.

9. Amend § 567.12 by revising thesection heading and paragraphs (a), (b),and (e) and by removing and reservingparagraph (f) to read as follows:

§ 567.12 Intangible assets, servicingassets, and residual interests.

(a) Scope. This section prescribes themaximum amount of intangible assets,servicing assets, and residual intereststhat savings associations may include incalculating tangible and core capital.

(b) Computation of core and tangiblecapital. (1) Intangible assets, as defined



in § 567.1 of this part (other thanpurchased credit card relationshipsdescribed under paragraph (b)(2) of thissection and core deposit intangiblesdescribed at paragraph (g)(3) of thissection), are deducted in computingtangible and core capital.

(2) Purchase card relationships maybe included (that is not deducted) incomputing core capital subject to therestrictions of this section, but must bededucted in computing tangible capital.

(3) Mortgage servicing assets may beincluded (that is not deducted) incomputing core capital subject to therestrictions in this section, and may beincluded in tangible capital in the sameamount.

(4) Nonmortgage servicing assets maybe included (that is not deducted) incomputing core capital subject to therestrictions in this section. Allnonmortgage servicing assets must bededucted in computing tangible capital.

(5) Residual interests may be included(that is not deducted) in computing corecapital subject to the restrictions of thissection, and may be included in tangiblecapital in the same amount.* * * * *

(e) Core capital limitation. (1)Aggregate limit. The maximumaggregate amount of servicing assets,purchased credit card relationships, andresidual interests that may be includedin core capital shall be limited to thelesser of:

(i) 100 percent of the amount of corecapital computed before the deductionof any disallowed servicing assets,disallowed purchased credit cardrelationships, and disallowed residualinterests; or

(ii) The amount of servicing assetsand purchased credit card relationshipsdetermined in accordance withparagraph (d) of this section plus theamount of residual interests.

(2) Reduction by deferred tax liability.Associations may elect to deductdisallowed servicing assets and residualinterests on a basis that is net of anyassociated deferred tax liability.

(3) Sublimit for purchased credit cardrelationships, non mortgage-relatedservicing assets, and residual interests.In addition to the aggregate limitation inparagraph (e)(1) of this section, asublimit shall apply to purchased creditcard relationships, non mortgage-relatedservicing assets, and residual interests.The maximum allowable amount ofthese three types of assets combinedshall be limited to the lesser of:

(i) 25 percent of the amount of corecapital computed before the deductionof any disallowed servicing assets,purchased credit card relationships, andresidual interests; or

(ii) The amount of purchased creditcard relationships and non mortgage-related servicing assets determined inaccordance with paragraph (d) of thissection plus the amount of residualinterests.

(f) [Reserved]* * * * *

Dated: August 4, 2000.By the Office of Thrift Supervision.

Ellen Seidman,Director.[FR Doc. 00–24203 Filed 9–26–00; 8:45 am]BILLING CODES 4810–33–P, 6210–01–P, 6714–01–P,6720–01–P

DEPARTMENT OF TRANSPORTATION

Federal Aviation Administration

14 CFR Part 39

[Docket No. 2000–NM–15–AD]

RIN 2120–AA64

Airworthiness Directives; BombardierModel DHC–8–100, –200, and –300Series Airplanes

AGENCY: Federal AviationAdministration, DOT.ACTION: Notice of proposed rulemaking(NPRM).

SUMMARY: This document proposes theadoption of a new airworthinessdirective (AD) that is applicable tocertain Bombardier Model DHC–8–100,–200, and –300 series airplanes. Thisproposal would require inspecting theendcaps of the main landing gearselector valve for leaks of hydraulic oiland, if leaks are detected, replacing theleaking endcaps or the entire selectorvalve. This proposal would also requireeventual replacement or rework ofcertain selector valves, which wouldterminate the repetitive inspections.This action is prompted by a report ofthe collapse of the main landing geardue to an external leak of hydraulic oilin the landing gear selector valve,resulting from a fracture of the endcap.This action is intended to prevent leaksof hydraulic oil from the main landinggear selector valve, which could resultin the collapse of the main landing gear.DATES: Comments must be received byOctober 27, 2000.ADDRESSES: Submit comments intriplicate to the Federal AviationAdministration (FAA), TransportAirplane Directorate, ANM–114,Attention: Rules Docket No. 2000–NM–15–AD, 1601 Lind Avenue, SW.,Renton, Washington 98055–4056.Comments may be inspected at this

location between 9:00 am and 3:00 pm,Monday through Friday, except Federalholidays. Comments may be submittedvia fax to (425) 227–1232. Commentsmay also be sent via the Internet usingthe following address: [email protected]. Comments sentvia fax or the Internet must contain‘‘Docket No. 2000–NM–15–AD’’ in thesubject line and need not be submittedin triplicate. Comments sent via theInternet as attached electronic files mustbe formatted in Microsoft Word 97 forWindows or ASCII text.

The service information referenced inthe proposed rule may be examined atthe FAA, Transport AirplaneDirectorate, 1601 Lind Avenue, SW.,Renton, Washington, or at the FAA,New York Aircraft Certification Office,10 Fifth Street, Third Floor, ValleyStream, New York.FOR FURTHER INFORMATION CONTACT:James E. Delisio, Aerospace Engineer,Airframe and Propulsion Branch, ANE–171, FAA, New York AircraftCertification Office, 10 Fifth Street,Third Floor, Valley Stream, New York11581; telephone (516) 256–7521; fax(516) 568–2716.SUPPLEMENTARY INFORMATION:

Comments Invited

Interested persons are invited toparticipate in the making of theproposed rule by submitting suchwritten data, views, or arguments asthey may desire. Communications shallidentify the Rules Docket number andbe submitted in triplicate to the addressspecified above. All communicationsreceived on or before the closing datefor comments, specified above, will beconsidered before taking action on theproposed rule. The proposals containedin this notice may be changed in lightof the comments received.

Submit comments using the followingformat:

• Organize comments issue-by-issue.For example, discuss a request tochange the compliance time and arequest to change the service bulletinreference as two separate issues.

• For each issue, state what specificchange to the proposed AD is beingrequested.

• Include justification (e.g., reasons ordata) for each request.

Comments are specifically invited onthe overall regulatory, economic,environmental, and energy aspects ofthe proposed rule. All commentssubmitted will be available, both beforeand after the closing date for comments,in the Rules Docket for examination byinterested persons. A reportsummarizing each FAA-public contact


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Office of Thrift Supervision October 5, 2000 Department of ... · Street, N.W. (between...

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