Background
A bank
formally appealed the OCC's interpretation of the risk-based capital
treatment of assigned residual interests in asset
securitizations.
Specifically, the bank appealed the supervisory office
decision that the assignment of a portion of the residual
interest would not result in a lower capital charge for the bank on
the recourse exposure created by those residuals.
The bank
asserted that because the assigned residual interests share in the
losses on the underlying loans sold into the securitization, the
bank should be permitted to lower its total risk-weighted
assets for risk-based capital purposes by a similar proportion. The bank further
indicated that the transferred portions of the residuals
creating the recourse obligation to third parties is structured in a
manner that assures a pro-rata sharing of all risk and
losses. In support of
this contention, the bank refers to the glossary section of the
March 1998 Call Report Instructions under the heading, "Sales of
Assets for Risk-Based Capital Purposes" (p. A-72)
(http://www.fdic.gov/banknews/callrept/crinst/398gloss.pdf). The instructions state the
following:
"...if the risk retained by the seller is
limited to some fixed percentage of any losses that might be
incurred and there are no other provisions resulting in
retention of risk, either directly or indirectly, by the
seller, the maximum amount of possible loss for which the
selling bank is at risk (the stated percentage times the amount of
assets to which the percentage applies) is subject to risk-based
capital and reportable in Schedule RC-R and the remaining amount of
the assets transferred would be treated as a sale that is not
subject to the risk-based capital requirements. For example, a
seller would treat a sale of $1,000,000 in assets, with a recourse
provision that the seller and buyer proportionately share in losses
incurred on a ten percent and 90 percent basis, and with no other
retention of risk by the seller, as a $100,000 asset sale with
recourse and a $900,000 sale not subject to risk-based capital".
Discussion
The OCC's
interpretation was that the bank's assignment of a portion of
its retained residual interest in securitization transactions should
not result in a reduction of the bank's overall level of
required capital. As a
class, both the assigned and retained residual interests are wholly
subordinate to the claims of certificate holders, and there is
no pro-rata loss sharing with those senior interests. The bank has not
sufficiently limited its losses to a fixed percentage of losses
on the underlying loans.
Consequently, the full amount of underlying loans are
considered sold with recourse, and should be included in the bank's
calculation of risk-weighted assets.
In order to
appropriately resolve the issues identified in the appeal, it was
essential that the ombudsman consider them in the context of
on-going interagency capital policy deliberations and the
resolution of similar issues with other institutions. An interagency working group
was scheduled to review this issue at a meeting in March 1999.
Conclusion
Until such
time as a joint interagency decision was reached on the underlying
issues, the ombudsman opted to permit the bank to continue its
current risk-based capital treatment. The bank's treatment reduced
the capital requirement in proportion to the percentage of the
residuals assigned to third parties and reached a consensus that
conforms to the OCC's original interpretation as conveyed to
the bank. This
consensus reaffirms that when a bank retains risk of credit loss in
connection with a transfer of assets, those assets must be included
in the bank's calculation of risk-weighted assets, subject to the
low-level recourse rule.
Notwithstanding the assignment of a portion of a residual
interest in a securitization, the retained residual interest
continues to give rise to a concentration of credit risk,
relative to the underlying pool, for which the recourse capital
requirement remains appropriate.
Consequently,
for each pool of securitized loans, the banks should hold risk-based
capital equal to the lesser of (a) 8
percent of the risk weighted amounts of the outstanding loans in the
pool, or (b) the bank's maximum loss in the event the entire pool of
loans defaulted. For
this purpose, the bank's maximum loss exposure includes the book
value (determined under GAAP) of any interest it holds in the pool,
as well as any contractual obligation to reimburse the pool or
investors for losses in the pool. If the bank's maximum loss
exposure exceeds 8 percent of a pool's risk-weighted assets, the
full amount of the underlying loans are considered sold with
recourse and should be included in the bank's calculation of
risk-weighted assets.
However, should the bank's maximum loss exposure fall below 8
percent of the risk-weighted amount of the outstanding loan balances
in the pool, the position would be eligible for more
advantageous treatment under the low-level recourse rule.
The bank was
informed of this decision.
The bank was
to be informed when the agencies reached a final decision, and of
any risk-based capital adjustments, which The Federal Reserve
Board, the Federal Deposit Insurance Corporation, the Office of
Thrift Supervision, and the OCC reviewed this policy issue in March
1999, may be necessary.
Subsequent Event
The Federal
Reserve Board, the Federal Deposit Insurance Corporation, the Office
of Thrift Supervision, the OCC reviewed this policy issue in March
1999, and reached a consensus that conforms to the OCC's original
interpretation as conveyed to the bank. This consensus reaffirms
that when a bank retains risk of credit loss in connection with a
transfer of assets, those assets must be included in the bank's
calculation of risk-weighted assets, subject to the low-level
recourse rule.
Notwithstanding the assignment of a portion of a residual
interest in a securitization, the retained residual interest
continues to give rise to a concentration of credit risk, relative
to the underlying pool, for which the recourse capital requirement
remains appropriate.
Consequently, for
each pool of securitized loans, the banks should hold risk-based
capital equal to the lesser of (a) 8
percent of the risk weighted amounts of the outstanding loans in the
pool, or (b) the bank's maximum loss in the event the entire pool of
loans defaulted. For
this purpose, the bank's maximum loss exposure includes the book
value (determined under GAAP) of any interest it holds in the pool,
as well as any contractual obligation to reimburse the pool or
investors for losses in the pool. If the bank's maximum loss
exposure exceeds 8 percent of a pool's risk-weighted assets, the
full amount of the underlying loans are considered sold with
recourse and should be included in the bank's calculation of
risk-weighted assets.
However, should the bank's maximum loss exposure fall below 8
percent of the risk-weighted amount of the outstanding loan balances
in the pool, the position would be eligible for more advantageous
treatment under the low-level recourse rule.
The bank was
informed of this decision.