TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
Introduction and Overview
In recent years, some banking organizations have substantially increased
their secondary market credit activities such as loan syndications, loan sales and
participations, credit derivatives, and asset securitizations, as well as the provision of
credit enhancements and liquidity facilities to such transactions. These activities can
enhance both credit availability and bank profitability, but managing the risks of these
activities poses increasing challenges. This is because the risks involved, while not
new to banking, may be less obvious and more complex than the risks of traditional
lending activities. Some secondary market credit activities involve credit, liquidity,
operational, legal, and reputational risks in concentrations and forms that may not be
fully recognized by bank management or adequately incorporated in an institution's
risk management systems. In reviewing these activities, supervisors and examiners
should assess whether banking organizations fully understand and adequately manage
the full range of the risks involved in secondary market credit activities.
The heightened need for management attention to these risks is
underscored by reports from examiners, senior lending officer surveys, and
discussions with trade and advisory groups that have indicated that competitive
conditions over the past few years have encouraged an easing of credit terms and
conditions in both commercial and consumer lending. In addition, indications are that
some potential participants in loan syndications have felt it necessary to make
complex credit decisions within a much shorter timeframe than has been customary.
Although the recent easing may not be imprudent, the incentives and pressures to
lower credit standards have increased as competition has intensified and borrowers
have experienced generally favorable business and economic conditions. Supervisors
and bank management alike should remain alert to the possibility that loan
performance could deteriorate if certain sectors of the economy experience problems.
The recent rise in consumer bankruptcies, credit card delinquencies, and credit
charge-offs illustrates this concern. These types of developments could have
significant implications for the risks associated with secondary market credit activities.
This letter identifies some of the important risks involved in several of the
more common types of secondary market credit activities. It also provides guidance
on sound practices and discusses special considerations supervisors should take into
account in assessing the risk management systems for these activities. A copy of
this letter should be sent to each state member bank, bank holding company, Edge
corporation, and U.S. branch or agency of a foreign bank. A suggest transmittal letter
is attached.
A fundamental principle advanced by this guidance is that banking
institutions should explicitly incorporate the full range of risks of their secondary market
credit activities into their overall risk management systems. In particular, supervisors
and examiners should determine whether institutions are recognizing the risks of
secondary market credit activities by: 1) adequately identifying, quantifying, and
monitoring these risks; 2) clearly communicating the extent and depth of these risks in
reports to senior management and the board of directors and in regulatory reports; 3)
conducting ongoing stress testing to identify potential losses and liquidity needs under
adverse circumstances; and 4) setting adequate minimum internal standards for
allowances or liabilities for losses, capital, and contingency funding. Incorporating
secondary market credit activities into banking organizations' risk management
systems and internal capital adequacy allocations is particularly important since the
current regulatory capital rules do not fully capture the economic substance of the risk
exposures arising from many of these activities.
Failure to understand adequately the risks inherent in secondary market
credit activities and to incorporate them into risk management systems and internal
capital allocations may constitute an unsafe and unsound banking practice.
Scope
This guidance applies to the secondary market credit activities conducted
by state member banks, bank holding companies, Edge corporations and U.S.
branches and agencies of foreign banks.1 For purposes of this guidance, secondary
market credit activities include, but are not limited to, loan syndications, loan
participations, loan sales and purchases, credit derivatives, asset securitization, and
both implied and direct credit enhancements that may support these or the related
activities of the institution, its affiliates, or third parties. Asset securitization activities
refer to issuance, underwriting, and servicing of asset-backed securities; provision of
credit or liquidity enhancements to securitized transactions; and investment in asset-backed securities. This guidance builds on, supports, and is fully consistent with
existing guidance on risk management issued by the Federal Reserve.2
Background
Improvements in technology, greater standardization of lending products,
and the use of credit enhancements have helped to increase dramatically the volume
of loan syndications, loan sales, loan participations, asset securitizations, and credit
guarantees undertaken by commercial banks, affiliates of bank holding companies,
and some U.S. branches and agencies of foreign banks. In addition, the advent of
credit derivatives permits banking organizations to trade credit risk, manage it in
isolation from other types of risk, and maintain credit relationships while transferring
the associated credit risk. These developments have improved the availability of credit
to businesses and consumers, allowed management to better tailor the mix of credit
risk within loan and securities portfolios, and helped to improve overall bank
profitability.
At the same time, however, certain credit and liquidity enhancements that
banking organizations provide to facilitate various secondary market credit activities
may make the evaluation of the risks of these activities less straightforward than the
risks involved in traditional banking activities in which assets are held in their entirety
on the balance sheet of the originating institution. These enhancements, or
guarantees, generally manifest themselves as recourse provisions, securitization
structures that entail credit-linked early amortization and collateral replacement events,
and direct credit substitutes such as letters of credit and subordinated interests that, in
effect, provide credit support to secondary market instruments and transactions.3
The transactions that such enhancements are associated with tend to be
complex and may expose institutions extending the enhancements to hidden
obligations that may not become evident until the transactions deteriorate. In
substance, such activities move the credit risk off the balance sheet by shifting risks
associated with traditional on-balance-sheet assets into off-balance-sheet contingent
liabilities. Given the potential complexity and, in some cases, the indirect nature of
these enhancements, the actual credit risk exposure can be difficult to assess,
especially in the context of traditional credit risk limit, measurement, and reporting
systems.
Moreover, many secondary market credit activities involve new and
compounded dimensions of reputational, liquidity, operational and legal risks that are
not readily identifiable and may be difficult to control. For example, recourse
provisions and certain asset-backed security structures can give rise to significant
reputational and liquidity risk exposures and ongoing management of underlying
collateral in securitization transactions can expose an institution to unique operating
and legal risks.
Accordingly, for those institutions involved in providing credit
enhancements in connection with loan sales and securitizations, and those involved in
credit derivatives and loan syndications, supervisors and examiners should assess
whether the institutions' systems and processes adequately identify, measure, monitor,
and control all of the risks involved in the secondary market credit activities. In
particular, the risk management systems employed should include the identification,
measurement, and monitoring of these risks as well as an appropriate methodology for
the internal allocation of capital and reserves. The stress testing conducted within the
risk measurement element of the management system should fully incorporate the risk
exposures of these activities under various scenarios to identify their potential effect on
an institution's liquidity, earnings, and capital adequacy. Moreover, management
reports should adequately communicate to senior management and the board of
directors the risks associated with these activities and the contingency plans that are
in place to deal with adverse conditions. Credit Risks in Secondary Market Credit Activities
Institutions should be aware that the credit risk involved in many
secondary market credit activities may not always be obvious. For certain types of
loan sales and securitization transactions, a banking organization may actually be
exposed to essentially the same credit risk as in traditional lending activities, even
though a particular transaction may, superficially, appear to have isolated the
institution from any risk exposure. In such cases, removal of an asset from the
balance sheet may not result in a commensurate reduction in credit risk. Transactions
that can give rise to such instances include loan sales with recourse, credit
derivatives, direct credit substitutes, such as letters of credit, and liquidity facilities
extended to securitization programs, as well as certain asset securitization structures,
such as the structure typically used to securitize credit card receivables.
Loan Syndications - Recently, the underwriting standards of some
syndications have been relaxed through the easing or elimination of certain covenants
or the use of interest-only arrangements. Bank management should continually review
syndication underwriting standards and pricing practices to ensure that they remain
consistent over time with the degree of risk associated with the activity and the
potential for unexpected economic developments to affect adversely borrower
creditworthiness.
In some cases, potential participants in loan syndications have felt it
necessary to make decisions to commit to the syndication within a shorter period of
time than is customary. Supervisors and examiners should determine whether
syndicate participants are performing their own independent credit analysis of the
syndicated credit and make sure they are not placing undue reliance on the analysis
of the lead underwriter or commercial loan credit ratings. Banking organizations
should not feel pressured to make an irrevocable commitment to participate in a
syndication until such an analysis is complete.
Credit Derivatives - Credit derivatives are off-balance sheet financial
instruments that are used by banking organizations to assume or mitigate the credit
risk of loans and other assets.4 Banking organizations are increasingly employing
these instruments either as end-users, purchasing credit protection from--or providing
credit protection to--third parties, or as dealers intermediating such protection. In
reviewing credit derivatives, supervisors should consider the credit risk associated with
the reference asset, as well as general market risk and the risk of the counterparty to
the contract.
With respect to credit derivative transactions where banking organizations
are mitigating their assets' credit risk, supervisors and examiners should carefully
review those situations where the reference assets are not identical to the assets
actually owned by the institutions. Supervisors should consider whether the reference
asset is an appropriate proxy for the loan or other asset whose credit exposure the
banking organizations intend to offset.
Recourse Obligations and Direct Credit Substitutes - Partial, first loss
recourse obligations retained when selling assets, and the extension of partial credit
enhancements (e.g., 10 percent letters of credit) can be a source of concentrated
credit risk by exposing institutions to the full amount of expected losses on the
protected assets. For instance, the credit risk associated with whole loans or pools of
assets that are sold to secondary market investors can often be concentrated within
the partial, first loss recourse obligations retained by banking organizations selling and
securitizing the assets. In these situations, even though institutions may have reduced
their exposure to catastrophic loss on the assets sold, they generally retain the same
credit risk exposure as if they continued to hold the assets on their balance sheets.
In addition to recourse obligations, institutions assume concentrated
credit risk through the extension of partial direct credit substitutes such as through the
purchase of subordinated interests and extension of letters of credit. For example,
banking organizations that sponsor certain asset-backed commercial paper programs,
or so-called "remote origination" conduits, can be exposed to high degrees of credit
risk even though it may seem that their notional exposure is minimal. Such a remote
origination conduit lends directly to corporate customers referred to it by the
sponsoring banking organization that used to lend directly to these same borrowers.
The conduit funds this lending activity by issuing commercial paper that, in turn, is
guaranteed by the sponsoring banking organization. The net result is that the
sponsoring institution has much the same credit risk exposure through this guarantee
as if it had made the loans directly and held them on its books. However, such credit
extension is an off-balance-sheet transaction and the associated risks may not be fully
reflected in the institution's risk management system.
Furthermore, banking organizations that extend liquidity facilities to
securitized transactions, particularly asset-backed commercial paper programs, may be
exposed to high degrees of credit risk which may be subtly embedded within the
facilities' provisions. Liquidity facilities are commitments to extend short-term credit to
cover temporary shortfalls in cash flow. While all commitments embody some degree
of credit risk, certain commitments extended to asset-backed commercial paper
programs in order to provide liquidity may subject the extending institution to the credit
risk of the underlying asset pool, often trade receivables, or of a specific company
using the program for funding. Often the stated purpose of such liquidity facilities is to
provide funds to the program to retire maturing commercial paper when a mismatch
occurs in the maturities of the underlying receivables and the commercial paper, or
when a disruption occurs in the commercial paper market. However, depending upon
the provisions of the facility--such as whether the facility covers dilution of the
underlying receivable pool--credit risk can be shifted from the program's explicit credit
enhancements to the liquidity facility.5 Such provisions may enable certain programs
to fund riskier assets and yet maintain the credit rating on the program's commercial
paper without increasing the program's credit enhancement levels.
Asset Securitization Structures - The structure of various securitization
transactions can also result in an institution retaining the underlying credit risk in a sold
pool of assets. Examples of this contingent credit risk retention include credit card
securitizations where the securitizing organization explicitly sells the credit card
receivables to a master trust, but, in substance, retains the majority of the economic
risk of loss associated with the assets because of the credit protection provided to
investors by the excess yield, spread accounts, and structural provisions of the
securitization. Excess yield provides the first level of credit protection that can be
drawn upon to cover cash shortfalls between the principal and coupon owed to
investors and the investors' pro rata share of the master trust's net cash flows. The
excess yield is equal to the difference between the overall yield on the underlying
credit card portfolio and the master trust's operating expenses.6 The second level of
credit protection is provided by the spread account, which is essentially a reserve
funded initially from the excess yield.
In addition, the structural provisions of credit card securitizations
generally provide credit protection to investors through the triggering of early
amortization events. Such an event usually is triggered when the underlying pool of
credit card receivables deteriorates beyond a certain point and requires that the
outstanding credit card securities begin amortizing early in order to pay off investors
before the prior credit enhancements are exhausted. As the early amortization
accelerates the redemption of principal (paydown) on the security, the credit card
accounts that were assigned to the master credit card trust return to the securitizing
institution more quickly than had originally been anticipated, thus, exposing the
institution to liquidity pressures and any further credit losses on the returned accounts. Reputational Risks
The secondary market credit activities of many institutions may also
expose them to significant reputational risks. Loan syndication underwriting may
present significant reputational risk exposure to lead underwriters because syndicate
participants may seek to hold the lead underwriter responsible for actual or perceived
inadequacies in the loan's underwriting even though participants are responsible for
conducting an independent due diligence evaluation of the credit. Such risk may be
compounded by the rapid growth of new investors in this market, usually nonbanks
that may not have previously endured a downturn in the loan market.
There is the potential that pressure may be brought to bear on the lead
participant to repurchase portions of the syndication if the credit deteriorates in order
to protect its reputation in the market even though the syndication was sold without
recourse. In addition, the deterioration of the syndicated credit also exposes the lead
organization to possible litigation, as well as increased operational and credit risk.
One way to mitigate reputational risk with respect to syndications is for banking
organizations to know their customers and to determine whether syndication
customers are in a position to conduct their own evaluation of the credit risks involved
in the transaction.
Asset securitization programs also can be a source of increasing
reputational risk. Often, banking organizations sponsoring the issuance of asset-backed securities act as servicer, administrator, or liquidity provider in the
securitization transaction. It is imperative that these institutions are aware of the
potential losses and risk exposure associated with reputational risk. The securitization
of assets whose performance has deteriorated may result in a negative market
reaction that could increase the spreads on an institution's subsequent issuances. In
order to avoid a possible increase in their funding costs, institutions have supported
their securitization transactions by improving the performance of the securitized asset
pool. This has been accomplished, for example, by selling discounted receivables or
adding higher quality assets to the securitized asset pool. Thus, an institution's
voluntary support of its securitization in order to protect its reputation can adversely
affect the sponsoring/issuing organization's earnings and capital.
These and other methods of improving the credit quality of securitized
asset pools have been used recently by banking organizations providing voluntary
support to their securitizations, especially for credit card master trusts. Such actions
generally are taken to avoid either a rating downgrade or an early amortization of the
outstanding asset-backed securities. Liquidity Risks
The existence of recourse provisions in asset sales, the extension of
liquidity facilities to securitization programs, and the early amortization triggers of
certain asset securitization transactions can involve significant liquidity risk to
institutions engaged in these secondary market credit activities. Institutions should
ensure that their liquidity contingency plans fully incorporate the potential risk posed by
their secondary market credit activities. With the issuance of new asset-backed
securities, the issuing banking organization should determine the potential effect on its
liquidity at the inception of each transaction and throughout the life of the securities in
order to better ascertain its future funding needs.
An institution's contingency plans should take into consideration the need
to obtain replacement funding, and specify the possible alternative funding sources, in
the event of the amortization of outstanding asset-backed securities. This is
particularly important for securitizations with revolving receivables, such as credit
cards, where an early amortization of the asset-backed securities could unexpectedly
return the outstanding balances of the securitized accounts to the issuing institution's
balance sheet. It should be recognized that an early amortization of a banking
organization's asset-backed securities could impede its ability to fund itself--either
through re-issuance or other borrowings--since the institution's reputation with
investors and lenders may be adversely affected.
Incorporating the Risks of Secondary Market Credit Activities
Supervisors should verify that an institution incorporates in its overall risk
management system the risks involved in its secondary market credit activities. The
system should entail: 1) inclusion of risk exposures in reports to the institution's senior
management and board to ensure proper management oversight; 2) adoption of
appropriate policies, procedures, and guidelines to manage the risks involved;
3) appropriate measurement and monitoring of risks; and 4) assurance of appropriate
internal controls to verify the integrity of the management process with respect to
these activities. The formality and sophistication with which the risks of these activities
are incorporated into an institution's risk management system should be
commensurate with the nature and volume of its secondary market credit activities.
Institutions with significant activities in this area are expected to have more elaborate
and formal approaches to manage the risk of their secondary market credit activities.
Both the board of directors and senior management are responsible for
ensuring that they fully understand the degree to which the organization is exposed to
the credit, market, liquidity, operational, legal, and reputational risks involved in the
institution's secondary market credit activities. They are also responsible for ensuring
that the formality and sophistication of the techniques used to manage these risks are
commensurate with the level of the organization's activities. The board should
approve all significant polices relating to the management of risk arising from
secondary market credit activities and should ensure that the risk exposures are fully
incorporated in board reports and risk management reviews.
Senior management is responsible for ensuring that the risks arising from
secondary market credit activities are adequately managed on both a short-term and
long-run basis. Management should ensure that there are adequate policies and
procedures in place for incorporating the risk of these activities into the overall risk
management process of the institution. Such policies should ensure that the economic
substance of the risk exposures generated by these activities is fully recognized and
appropriately managed. In addition, banking organizations involved in securitization
activities should have appropriate policies, procedures, and controls with respect to
underwriting asset-backed securities; funding the possible return of revolving
receivables (e.g., credit card receivables and home equity lines); and establishing
limits on exposures to individual institutions, types of collateral, and geographic and
industrial concentrations. Lead banking organizations in loan syndications should have
policies and procedures in place that address whether or in what situations portions of
syndications may be repurchased. Furthermore, banking organizations participating in
a loan syndication should not place undue reliance on the credit analysis performed by
the lead organization. Rather, the participant should have clearly defined policies and
procedures to ensure that it performs its own due diligence in analyzing the risks
inherent in the transaction.
An institution's management information and risk measurement systems
should fully incorporate the risks involved in its secondary market credit activities.
Banking organizations must be able to identify credit exposures from all secondary
market credit activities, and be able to measure, quantify, and control those exposures
on a fully consolidated basis. The economic substance of the credit exposures of
secondary market credit activities should be fully incorporated into the institution's
efforts to quantify its credit risk, including efforts to establish more formal grading of
credits to allow for statistical estimation of loss probability distributions. Secondary
market credit activities should also be included in any aggregations of credit risk by
borrower, industry, or economic sector.
It is particularly important that an institution's information systems can
identify and segregate those credit exposures arising from the institution's loan sale
and securitization activities. Such exposures include the sold portions of participations
and syndications; exposures arising from the extension of credit enhancement and
liquidity facilities; the effects of an early amortization event; and the investment in
asset-backed securities. The management reports should provide the board and
senior management with timely and sufficient information to monitor the institution's
exposure limits and overall risk profile.
Stress Testing
The use of stress testing, including combinations of market events that
could affect a banking organization's credit exposures and securization activities, is
another important element of risk management. Such testing involves identifying
possible events or changes in market behavior that could have unfavorable effects on
the institution and assessing the organization's ability to withstand them. Stress
testing should not only consider the probability of adverse events, but also likely "worst
case" scenarios. Such an analysis should be done on a consolidated basis and
consider, for instance, the effect of higher than expected levels of delinquencies and
defaults as well as the consequences of early amortization events with respect to
credit card securities that could raise concerns regarding the institution's capital
adequacy and its liquidity and funding capabilities. Stress test analyses should also
include contingency plans regarding the actions management might take given certain
situations.
One of management's most important responsibilities is establishing and
maintaining an effective system of internal controls that, among other things, enforces
the official lines of authority and the appropriate separation of duties in managing the
risks of the institution. These internal controls must be suitable for the type and level
of risks given the nature and scope of the institution's activities. Moreover, these
internal controls should provide reasonable assurance of reliable financial reporting (in
published financial reports and regulatory reports), including adequate allowances or
liabilities for expected losses.
Capital Adequacy
As with all risk-bearing activities, institutions should fully support the risk
exposures of their secondary market credit activities with adequate capital. Banking
organizations should ensure that their capital positions are sufficiently strong to
support all of the risks associated with these activities on a fully consolidated basis
and should maintain adequate capital in all affiliated entities engaged in these
activities. The Federal Reserve's risk-based capital guidelines establish minimum
capital ratios, and those banking organizations exposed to a high or above average
degrees of risk are, therefore, expected to operate significantly above the minimum
capital standards.
The current regulatory capital rules do not fully incorporate the economic
substance of the risk exposures involved in many secondary market credit activities.
Therefore, when evaluating capital adequacy, supervisors should ensure that banking
organizations that sell assets with recourse, assume or mitigate credit risk through the
use of credit derivatives, and provide direct credit substitutes and liquidity facilities to
securitization programs, are accurately identifying and measuring these exposures and
maintaining capital at aggregate levels sufficient to support the associated credit,
market, liquidity, reputational, operational, and legal risks.
Supervisors and examiners should review the substance of secondary
market transactions when assessing underlying risk exposures. For example, partial,
first loss direct credit substitutes providing credit protection to a securitization
transaction can, in substance, involve much the same credit risk as that involved in
holding the entire asset pool on the institution's balance sheet. However, under
current rules, regulatory capital is explicitly required only against the amount of the
direct credit substitute, which can be significantly different from the amount of capital
that the institution should maintain against the concentrated credit risk in the
guarantee. Supervisors and examiners should ensure that banking organizations
have implemented reasonable methods for allocating capital against the economic
substance of credit exposures arising from early amortization events and liquidity
facilities associated with securitized transactions since such facilities are usually
structured as short-term commitments in order to avoid a risk-based capital
requirement, even though the inherent credit risk may be approaching that of a
guarantee.7
If, in the supervisor's judgment, an institution's capital level is not
sufficient to provide protection against potential losses from such credit exposures, this
deficiency should be reflected in the banking organization's CAMELS or BOPEC
ratings. Furthermore, supervisors and examiners should discuss the capital deficiency
with the institution's management and, if necessary, its board of directors. Such an
institution will be expected to develop and implement a plan for strengthening the
organization's overall capital adequacy to levels deemed appropriate given all the risks
to which it is exposed.
Please forward this letter to each state member bank, bank holding
company, Edge corporation and U.S. branch or agency of a foreign bank located in
your District--a suggested transmittal letter is attached. If you have any questions,
please contact Roger Cole, Deputy Associate Director (202/452-2618), Tom Boemio,
Supervisory Financial Analyst, (202/452-2982) or Jim Embersit, Manager, (202/452-5249).
Director
BANK, BANK HOLDING COMPANY, EDGE CORPORATION AND U.S. BRANCH AND AGENCY OF A FOREIGN BANK TO COMMUNICATE GUIDANCE ON RISK MANAGEMENT AND CAPITAL ADEQUACY OF EXPOSURES ARISING FROM SECONDARY MARKET CREDIT ACTIVITIES
The supervisory guidance notes that institutions should incorporate all of
the risks arising from their secondary market credit activities into their consolidated risk
management systems. The sophistication with which the risks of these activities are
incorporated into an institution's risk management system should be commensurate
with the nature and volume of its secondary market credit activities. In addition, the
guidance indicates that banking organizations involved in secondary market credit
activities should maintain adequate capital against the associated exposures and
should have implemented reasonable methods for allocating capital internally.
If you have any questions about this guidance, please contact (Insert
name of appropriate Reserve Bank staff.)
Footnotes 1. This guidance applies to U.S. branches and agencies of foreign banks with recognition that appropriate adaptations may be necessary to reflect that: 1) those offices are an integral part of a foreign bank, which should be managing its risks on a consolidated basis and recognizing possible obstacles to cash movements among branches, and 2) the foreign bank is subject to overall supervision by its home country authorities. Return to text 2. For a more detailed discussion of risk management, refer to SR letter 95-51, "Rating the Adequacy of Risk Management Processes and Internal Controls at State Member Banks and Bank Holding Companies;" SR letter 95-17, "Evaluating the Risk Management and Internal Controls of Securities and Derivative Contracts Used in Nontrading Activities;" SR letter 93-69, "Risk Management and Internal Controls for Trading Activities of Banking Organizations;" and SR letter 90-16, "Implementation of Examination Guidelines for the Review of Asset Securitization Activities." Return to text 3. Examiners should also review SR letter 96-30, "Risk-Based Capital Treatment for Spread Accounts that Provide Credit Enhancement for Securitized Receivables." In addition, banking organizations have retained the risk of loss, i.e., recourse, on sales and securitizations of assets when, in accordance with generally accepted accounting principles, they record on their balance sheets interest-only strip receivables or other assets that serve as credit enhancements. For more information, see Statement of Financial Accounting Standard No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" and the instructions to the Reports of Income and Condition. Return to text 4. See SR letter 96-17, "Supervisory Guidance for Credit Derivatives," for a discussion of supervisory issues regarding credit derivatives, including the risk-based capital treatment of credit derivatives held in the banking book. SR letter 97-18, "Application of Market Risk Capital Requirements to Credit Derivatives," provides guidance on the risk-based capital treatment of credit derivatives held in the trading book. Return to text 5. Dilution essentially occurs when the receivables in the underlying asset pool--prior to collection--are no longer viable financial obligations of the customer. For example, dilution can arise from returns of consumer goods or unsold merchandise by retailers to manufacturers or distributors. Return to text 6. The monthly excess yield is the difference between the overall yield on the underlying credit card portfolio and the master trust's operating expenses. It is calculated by subtracting from the gross portfolio yield the (1) coupon paid to investors, (2) charge-offs for that month, and (3) servicing fee, usually 200 basis points paid to the banking organization sponsoring the securitization. Return to text 7. For further guidance on distinguishing, for risk-based capital purposes, whether a facility is a short-term commitment or a direct credit substitute, refer to SR letter 92-11, "Asset-Backed Commercial Paper Programs." Essentially, facilities that provide liquidity, but which also provide credit protection to secondary market investors, are to be treated as direct credit substitutes for purposes of risk-based capital. Return to text |
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