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F
ed er a l
R
e s e r v e
B
a nk
O F DALLAS
W ILLIAM
H. WALLACE
FIRST V IC E PR ES ID EN T
July 27, 1990
DALLAS, TEXAS 7 5 2 2 2
AND C H IE F O PER ATIN G O FFICER
Circular 90-51
TO:
The Chief Executive Officer of each
member bank and others concerned in
the Eleventh Federal Reserve District
SUBJECT
Request fo r Comment on Recourse Arrangements
DETAILS
The Federal Financial Institutions Examination Council (FFIEC) has
requested public comment on the definition of "recourse" and the appropriate
reporting and capital treatments to be applied to recourse arrangements.
Comment is also requested on how recourse arrangements should be treated under
the lending limits applicable to banks and savings associations. The comment
period ends August 28, 1990.
The five agencies represented on the FFIEC are
considering the
issuance of regulations or guidelines that would deal with
the regulatory
capital treatment of, and revise the reporting standards for, recourse
arrangements for depository institutions and bank holding companies. The
agencies have targeted year-end 1990 as the effective date for any changes to
the regulatory treatment of recourse arrangements.
ATTACHMENT
A copy of the FFIEC’s Federal Register notice is attached.
MORE INFORMATION
For more information, please contact Jane Anne Schmoker at (214)
651-6228. For additional copies of this circular, please contact the Public
Affairs Department at (214) 651-6289.
Sincerely yours,
For additional copies of any circular, please contact the Public Affairs Department at (214) 651-6289. Bankers and others are encouraged to use the following
toll-free number in contacting the Federal Reserve Bank of Dallas: (800) 333-4460.
This publication was digitized and made available by the Federal Reserve Bank of Dallas' Historical Library (FedHistory@dal.frb.org)
26766
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
FEDERAL FINANCIAL INSTITUTIONS
EXAMINATION COUNCIL
Recourse Arrangements
Federal Financial Institutions
Examination Council.
ACTiON: Rsquest f o r c o m m e n t .
agency:
s u m m a r y : The five member agencies of
the Federal Financial Institutions
Examination Council (the "FFIEC”),
which include the Board of Governors of
the Federal Reserve System ("FRB”), the
Federal Deposit Insurance Corporation
("FDIC”), the National Credit Union
Administration (“NCUA”), the Office of
the Comptroller of the Currency
(“OCC”), and the Office of Thrift
Supervision (“OTS”) (collectively, the
“Agencies”), are considering issuing
regulations or Guidelines to address the
regulatory capital treatment of recourse
arrangements for depository institutions
and bank holding companies. The
Agencies are also considering revising
the regulatory reporting requirements
applicable to asset transfers with
recourse and revising the lending limit
treatment of recourse arrangements for
national banks and savings
associations. The Agencies plan to work
together to develop common definitions
and treatments of recourse
arrangements, where appropriate.
"Recourse” refers to a financial
institution’s acceptance, assumption or
retention of some or all of the risk of
loss generally associated with
ownership of an asset, whether or not
the institution owns or has ever owned
the asset. As the primary federal
supervisors of insured financial
institutions and bank holding
companies, the Agencies have observed
that recourse arrangements are
occurring with increasing frequency,
particularly in the context of asset
securitization programs. The Agencies
recognize that recourse arrangements
impose risks on financial institutions
and believe it appropriate to report the
existence of these risks and to include
these risks when evaluating capital
adequacy.
The federal bank supervisory agencies
(the FRB, the FDIC, and the OCC) and
the NCUA have not previously provided
a comprehensive regulatory definition of
“recourse”. The OTS, the federal
supervisor of savings associations, has a
definition of the term "with recourse”
which it plans to amend through
rulemaking action. See 12 CFR 561.55. In
the interest of a uniform treatment, the
Agencies are soliciting public comment
on the definition of “recourse,” and the
appropriate reporting and capital
treatments to be applied to recourse
arrangements. Public comment is also
requested on how these arrangements
should be treated under the lending
limits applicable to banks and savings
associations. The Agencies are targeting
December 31,1990, as the date by which
resulting changes in the regulatory
treatment of recourse arrangements
would become effective.
DATES: Comments must be received by
August 28,1990.
a d d r e s s e s : Comments should be
directed to: Robert J. Lawrence,
Executive Secretary, Federal Financial
Institutions Examination Council, 1776 G
Street, NW., Suite 850B, Washington DC
20006. Comments will be available for
public inspection and photocopying at
the same location.
FOR FURTHER INFORMATION CONTACT:
At the FRB: Roger H. Pugh, Manager,
Policy Development, Division of Banking
Supervision and Regulation (202) 7285883; Thomas R. Boemio, Senior
Financial Analyst, Division of Banking
Supervision and Regulation (202) 4522982. At the FDIC: Robert F. Storch,
Chief, Accounting Section, Division of
Supervision (202) 898-8906. At the
NCUA: Alonzo Swann, Director,
Department of Operations, Office of
Examination and Insurance, (202) 6829640. At the OCC: Owen Carney, (202)
447-1901; Richard Cleva, Senior
Attorney, Legal Advisory Services
Division (202) 447-1883; or Laura H.
Plaze, Senior Attorney, Legal Advisory
Services Division (202) 447-1883. At the
OTS: Robert Fishman, Senior Project
Manager (202) 906-5672; Carol
Wambeke, Financial Economist (202)
906-6758; Deborah Dakin, Regulatory
Counsel (202) 906-6445.
SUPPLEMENTARY INFORMATION:
Introduction
In its broadest terms, “recourse"
refers to the acceptance, assumption or
retention of some or all of the risk of
loss generally associated with
ownership of an asset. Recourse is not
necessarily a function of ownership or
prior ownership of an asset, nor does it
arise only as an incident of an asset
sale. Morever, recourse may arise even
without a contractual obligation.
For many financial institutions,
recourse is most frequently associated
with asset sales, and particularly with
asset securitization programs. Loans,
receivables or other assets are
securitized by first combining similar
assets in a pool and then selling to
investors either securities that represent
ownership interest in the pool or debt
obligations that are serviced by the cash
flow from the pool. Asset securitization
has become increasingly popular, as in
some cases it has enabled financial
institutions and bank holding companies
to remove assets, or portions of assets,
from their books. Asset securitization
may allow a financial institution to
reduce the capital necessary to meet
regulatory minimums or to reduce the
total amount of outstanding loans to an
individual borrower. Further, asset
securitization can provide a financial
institution a source of funds through the
sale of its assets, which enables the
institution to increase its liquidity. Asset
securitization may also provide an
adidtional source of continuing income
to a financial institution that acts as
servicer of a pool of securitized assets.
Early securititized programs, dating
from the 1970’s, were usually federally
sponsored, and were generally intended
to enhance the secondary residential
mortgage market. Three federallysponsored agencies, the Governmental
National Mortgage Association
("GNMA”), the Federal National
Mortgage Association (“FNMA”), and
the Federal Home Loan Mortgage
Corporation ("FHLMC”), were each
provided statutory authority to
guarantee the payment of principal and
interest to investors in pools of
qualifying residential mortgages.
Generally, the Federal government may
bear some of the risk of loss in these
agency asset securitization programs, by
providing federal insurance for certain
of the underlying mortgages and through
the GNMA guarantee, which is backed
by the full faith and credit of the United
States.
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
While the sale of loan participations
has been a longstanding bank practice,
during the 1980’s, financial institutions
began to securitize and sell an
increasing variety of loan portfolios and
other assets to a wider group of public
investors. These asset securitizations
differ from the Federally-sponsored
agency programs in that they are not
necessarily backed by Federal insurance
or Federal guarantees. In order to
market these securitized assets to
investors, who demand a stable,
predictably performing investment
product, some finanical institutions have
provided assurances against virtually all
risk or loss.
The Agencies have observed an
increasing use and variety of recourse
arrangements in asset securitization
programs. Some financial institutions
have provided assurances against risks
of loss that extend beyond credit risk to
include losses due to interest rate and
prepayment risk, foreign exchange risk,
liquidity and marketability risks, and
risks associated with statutory or
regulatory compliance or uninsurable
hazards. The Agencies have also
observed that some financial institutions
have assumed risks of loss implicitly,
without entering into explicit
contractual recourse agreements.
The Agencies believe, and have
previously stated their belief, that
quantifiable risks to a financial
institution should be supported by
capital. See, e.g., OCC Final Rule
Establishing Risk-Based Capital
Guidelines, 54 FR 4168 (January 27,1989)
(codified at appendix A to 12 CFR part
3); FRB Final Rule Establishing RiskBased Capital Guidelines, 54 FR4186
(January 27,1989) (codified at 12 CFR
208.13, appendix A to 12 CFR part 208,
and appendix A to 12 CFR part 225);
FDIC Final Policy Statement
Establishing Risk-Based Capital
CuideSines, 54 FR 11500 (March 21,1989)
(codified at appendix A to 12 CFR part
325); and OTS Final Rule or Risk-Based
Capital, 54 FR 46845 (November 8,1989)
(codified at 12 CFR part 5G7)
(collectively, the "risk-based capital
standards”). WMle the risk-based
capital standards in their current form
focus primarily on credit risk, whether
or not represented by an asset on the
balance sheet, such standards embody
the principle that all risks require capital
support consistent with the degree to
which they expose an institution to
potential loss.1 As recourse
1 The risk-based capital guidelines of the OCC,
FRB and FDIC are based on the international
framework for capital standards established in July
1QS8, by the Basle Committee on Banking
Regulations and Supervisory Practices (since
arrangements expose,a financial
institution or bank holding company to
the risk of loss generally, the Agencies
believe that these arrangements should
be supported by capital.
In addition, the Agencies believe that
a financial institution's exposure to a
particular borrower should be monitored
and limited. This fundamental tenet of
safety and soundness is a statutory
requirement under Federal law for
national banks and savings
associations 2 and under state law for
state-chartered banks. As certain
recourse arrangements expose a
national bank or savings association to
the individual risks of an underlying
borrower, the OCC and the OTS believe
that these risks should be addressed in
the calculation of loans outstanding to
one borrower. The staffs of the FRB and
the FDIC also believe that the state laws
limiting loans outstanding from statechartered banks to one borrower should
address the risks posed by recourse
arrangements.
While these positions are not new, the
Agencies consider it timely and
appropriate to examine the general issue
of recourse arrangements and the
regulatory treatments they should be
accorded. The current reporting and
capital treatments accorded recourse
arrangements by the various agencies
and the lending limit treatments
applicable to recourse arrangements of
national banks and savings associations
are briefly summarized below.
Following that discussion, the specific
issues for comment are presented.
Finally, all questions are listed in a
summary section,
I. Current Reporting Treatment of Asset
Transfers With Recourse
A. National Banks and FederallyInsured, State-Chartered Banks
National banks and federally-insured,
state-chartered member and nonmember
banks are required to file quarterly
Reports of Condition and Income (“Call
Reports"), reporting to the OCC, FRB
and FDIC respectively. The FFIEC is
responsible for developing the reporting
rules. See 12 U.S.C. 3305.
renamed the Basle Committee on Banking
Supervision). The International framework is
described in a paper entitled the International
Convergence of Capital Measurement and Capital
Standards dated July 1988.
* See generally, 12 U.S.C. 84 (limiting the total
loans and extensions of credit a national bank may
have outstanding to one borrower at one time); 12
U.S.C. 1464(u), as added by the Financial
Institutions Reform, Recovery and Enforcement Act
of 1989. Pub. L 101-73, 301.103 Stat 183 (August 9,
1989) ("FIRREA") (providing that the lending limits
applicable to national banks under 12 U.S.C. 84
shall apply in the same manner and to the same
extent to savings associations).
26767
Under the current reporting rules,
which are contained in the Instructions
for Consolidated Reports of Condition
and Income (“Call Report Instructions"),
the reporting treatment of an asset
transferred subject to a recourse
arrangement varies depending on the
type of asset sold, whether the transfer
is through a federally-sponsored agency
program, and, in some cases, on the
level of the risk of loss retained. The
reporting rules have the effect of
allowing some asset transfers with
recourse to be reported as sales, while
requiring others to be reported as
financing transactions with the assets
retained on the balance sheet.
The Call Report Instructions include a
Glossary of terms and instructions for
various supporting schedules, including
Schedule RC-L, “Off Balance Sheet
Items.” 3 Together, the Glossary and
Schedule RC-L establish four separate
reporting treatments for asset transfers
with recourse.
First, a genera! rule is provided for the
transfer of most assets ot.ner than
transfers involving the issuance of
certificates of participation in pools of
certain residential or agricultural
mortgages. Under the general rule, an
asset transfer may be reported as a sale
only if two conditioiis are met: (1) l’he
transferring bank must not retain any
risk of loss from the asset transferred;
and (2) the transferring bank must have
no obligation to any party for the
payment of principal or interest on the
asset transferred. See Glossary, Call
Report Instructions (entry for “Sales of
Assets").
Next, two different rules are
established for transfers involving the
issuance of certificates of participation
in pools of residential mortgages. See
id.. "Participations in Pools of
Residential Mortgages," If the
participations are issued or guaranteed
under specified GNMA, FNMA, or
FHLMC programs, the Glossary states
that a bank disposing of its mortgages
through such programs may treat the
transaction as a sale of the underlying
mortgages. Banks report mortgage
transfers through these government
agency programs as sales even when the
transfers are with 100% recourse. See
id., and Schedule RC-L, Item 9(a).4
3 Schedule RC-L was previously named
“Commitments and Contingencies." Effective March
31,1990, this schedule was renamed “Off-Balancs
Sheet Items."
4 Item 9 was numbered Memorandum Item 4 prior
to the changes made to Schedule RC-L, effective
March 31,1990.
26768
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
A different treatment applies if the
certificates of participation are privately
issued by the bank. For these issuances,
the bank's ability to treat the transfer of
the underlying mortgages as a sale
depends upon the level of risk it has
retained. The Glossary provides that
*'[o]nly when the issuing bank does not
retain any significant risk of loss, either
directly or indirectly, is the transaction
to be reported as a sale of the
underlying mortgages by the bank." Id. 8
Finally, Schedule RC-L establishes a
fourth reporting treatment for an asset
transfer with recourse that applies only
to transfers of agricultural mortgage
loans through a Farmer Mac certified
program.8 The instructions to Item
9(c)(1) of Schedule RC-L state that
transfers of agricultural mortgage loans
under a Farmer Mac program in which
the bank retains a subordinated
participation interest (a form of
recourse), may be “reported as sales for
Call Report purposes to the same extent
that the transactions are reported as
sales under generally accepted
accounting principles ['GAAP'].” In
general, this means that the transfer
may be reported as a sale only if the
bank surrenders control of the future
economic benefits from the asset, can
reasonably estimate its probable loss
under the recourse provision, has no
obligation to repurchase the asset
cxcept pursuant to the recourse
provision, and establishes a liability
account or specific reserve to absorb the
estimated loss.7
D. Savings Associations
The regulatory reporting of savings
associations is provided to OTS on the
Thrift Financial Report (“TFR”), an OTS
form. Unlike the bank supervisory
agencies’ Call Report, which establishes
special supervisory rules for reporting
transfers of four different types of assets
with recourse, the TFR generally
• In March, 19G9. the FFIEC issued reporting
guidance for certain new items being added to the
Call Report's Schedule RC-L, which has now been
incorporated in the Call Report Instructions. See
pages 7 and 8 of the enclosure to the FFIEC’s Bank
Letter dated March 9,1989 (BL-10-89) and Call
Report Instructions (Schedule RC-L, instructions to
Item 9(b)(1)). Among other provisions, this guidance
clarified the meaning of “significant risk of loss,”
stating that if "the maximum contractual exposure
under the recourse provision (or through the
retention of a subordinated interest in the
mortgages) at the time of the transfer is greater than
the amount of probable loss that the bank has
reasonably estimated that it will incur." then the
"issuing bank" has retained the entire risk of loss,
and the mortgage transfers may not be reported as
sales. Id.
* See 12 U.S.C. 2279aa et seq. (establishing the
Federal Agricultural Mortgage Corporation, known
as "Farmer Mac”).
1 See infra section IV(B) (1) for discussion of
GAAP treatment of asset sales with recourse.
requires savings associations to report
these transactions in accordance with
GAAP. In general, this means that a
savings association may report an asset
transfer with recourse as a sale only if
the institution surrenders control of the
future economic benefits from the asset,
is able to reasonably estimate its
probable loss under the recourse
provision, has no obligation to
repurchase the asset except pursuant to
the recourse provision, and establishes a
liability account or specific reserve to
absorb the estimated loss.
II. Capital Treatment of Rocourso
Arrangements
A. Current Leverage ratio Requirements
Under the current leverage ratio
capital requirements of the FRB, the
FDIC, and the OCC, the treatment of an
asset transferred with recourse is
directly related to the reporting
treatement of the transfer.® Simply
speaking, for national banks and
federally-insured, state-chartered
member and nonmember banks, if an
asset transfer is reported as a sale, no
capita! support is explicitly required for
the asset as a function of the current
leverage ratios.® Consequently, because
* The risk-based capital guidelines issued by the
FRB, the FDIC and the OCC In early 1989 will be
phased in over a two-year transitional period
beginning December 31.1990. Proposed new
leverage ratios are discussed infra.
8 This result stems from the definitions of terms
used in each agency's regulations. For example, the
OCC’s regulations require that national banks
maintain total capital equal to at least 6% of
"adjusted total assets" and primary capital equal to
at least 5.5% of “adjusted total assets." See 12 CFR
3.8. "Adjusted total assets” is defined by reference
to the average total assets figure” computed for and
stated in a bank’s most recent quarterly Call Report.
Id. at $ 3.2(a). Assets that a national bank has not
transferred, and asset transfers that are not
accorded sale treatment, are included in the average
total assets reported in the Call Report. Conversely,
asset transfers that are given sale treatment are not
reported as part of the bank's asset base, and thus
are not factored into the denominator of the primary
and total capital ratios.
Similarly, the FRB guidelines and the FDIC
regulations for federally-insured state-chartered
member and nonmember banks require these
institutions to maintain minimum levels of total
capital to “total assets" of 6% and of primary capital
to “total assets” of 5.5%. See 12 CFR 208.13 and
appendix B to 12 CFR part 225. See also 12 CFR
325.3(b). The total assets figure used in calculating
these ratios is defined with reference to the
quarterly average total assets figure reported on a
bank's Call Report. See appendix B to 12 CFR part
225, "Capital Ratios.” See also 12 CFR 325.2(k). If an
asset is not reported in a federally-insured statechartered member or nonmember bank's Call
Report the asset is not factored into the calculation
of the bank’s “total assets.”
the Call Report establishes four distinct
rules for determining whether an asset
transfer with recourse will receive sale
treatment, capital support is required for
some recourse arrangements but not for
others. In addition, the varou3 captial
charges, like the different reporting
treatments, do not take into account a
bank’s relative exposure to risk of loss.
In recognition of off-balance sheet
exposures, such as the potential risk of
loss from asset transfers with recourse
that are reported as sales, the FRB, the
FDIC and the OCC have alwrays
reserved the right to require banks to
increase their capital. However, the
regulations require a bank that has
limited its recourse exposure on an asset
transfer with recourse which cannot be
reported as a sale to maintain capital
against the full amount of the asset.
The OTS currently requires each
savings association to maintain a
leverage ratio, which is calculated as a
percentage of its adjusted total assets as
reported in the "Consolidated Capital
Requirement” form, filed with the TFR.
For purposes of its leverage ratio, the
OTS uses “tangible assets” and
"adjusted tangible assets”, as defined in
its capital regulation. These terms do
not include assets that have been
reported as sold in accordance with
GAAP. The OTS regulation does not
refer a savings association to its
reported asset base for purposes of
calculating its leverage ratio.
B. Risk-Based Capital
The risk-based capital guidelines of
the FRB, the FDIC and the OCC
establish a uniform definition of capital
and a minimum riskbased capital ratio
which is intended to enhance
competitive equality among financial
institutions. The guidelines specifically
recognize the relative credit risk of
different types of bank assets and offbalance sheet items.
Under the risk-based capital
guidelines, a bank will be required to
hold capital against an asset transferred
with recourse even if the transfer is
reported as a sale. For example, in
addressing the risk-weighting of offbalance sheet exposures of national
banks, the OCC’s risk-based capital
guidelines state that capital must be
held against the full value of “assets
sold under an agreement to repurchase
and assets sold with recourse, to the
extent that these assets are not reported
on a national bank’s statement of
condition * * *.” Appendix A to 12 CFR
part 3, section 3(b)(l)(iii) (emphasis
added). The risk-based capital
guidelines of the FRB and the FDIo
contain similar provisions. See
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
Appendix A to 12 CFR part 208,
Attachment IV and appendix A to 12
CFR part 325,11(D)(1).10 Thus, the
treatment of a recourse arrangement
and the calculation of a bank’s minimum
risk-based capital ratio under the
banking agencies’ guidelines is
independent of the reporting treatment
of an asset transfer.
The OTS currently applies a riskbased capital standard to the recourse
arrangements of savings associations.
See 12 CFR Part 567. These capital
standards were adopted pursuant to
FIRREA, and became effective on
December 7,1989, subject to a threeyear phase-in period.11 Under the OTS's
rules, similar to the bank supervisory
agencies' risk-based capital guidelines,
any capital charge associated with an
asset transfer is determined
independently of its reporting treatment.
Generally, savings associations that
transfer assets with recourse must hold
the amount of capital that would be
required if they had not transferred the
assets. An exception is provided for
transactions in which the amount of
recourse retained is less than the capital
that would be required to support the
credit risk associated with the
transferred asset. In such cases, the
savings association must only maintain
capital equal to the amount of the
recourse.
C. Proposed New Leverage Ratios for
National Banks and Federally-Insured
State-Chartered Banks
The OCC and the FRB have recently
proposed, and the FDIC expects to
propose, new leverage ratios which, in
conjunction with the risk-based capital
guidelines, would replace the current
leverage ratios. As with the current
leverage ratios, the new leverage ratios
would require a bank to maintain a
minimum amount of capital calculated
as a percentage of its asset base
reported in the Call Report.12 The FRB,
10 The explanation of this provision in each of the
three agencies’ guidelines refers to the Call Report
to establish a definition of “asset sales with
recourse,’’ and has apparently created some
interpretive confusion. The FRB, the FDIC and the
OCC intend to publish technical amendments to
their risk-based capital guidelines to clarify the
scope of this provision.
11 See FIRREA, section 301 (amending the Home
Owners’ Loan Act of 1933 by adding a new section
5{t), requiring OTS to establish capital standards
“no less stringent than the capital standards
applicable to national banks”).
»* See 54 FR 46394 (November 3,1989) (OCC
Notice of Proposed Rulemaking); 55 FR 582 (January
5,1990) (FRB Notice of Proposed Rulemaking). The
OCC proposal would use a national bank's
“adjusted total assets'* and the FRB proposal would
use a state-chartered member bank or bank holding
company’s “total assets" as the asset base against
which the new leverage ratio would be calculated-
the FDIC and the OCC recognize that
any revisions to the Call Report
Instructions that would affect the
reporting treatment of an asset transfer
with recourse might also affect the
calculation of the leverage ratio.13
III. Current Lending Limit Treatment of
Recourse Arrangements
Banks and savings associations are
subject to statutory limits on the total
loans or extensions of credit that may
be outstanding to a borrower at one
time.14 Among other purposes, the
lending limit is intended to safeguard
depositors by promoting credit risk
diversification. Generally, for a national
bank or savings association, total
unsecured loans or extensions of credit
outstanding to any one borrower at one
time may not exceed 15% of the
institution’s unimpaired capital and
unimpaired surplus. Amounts up to an
additional 10% of unimpaired capital
and surplus may be extended for loans
and extensions of credit secured by
readily marketable collateral.15 Statechartered banks are subject to stateimposed lending limits which are also
expressed as percentages of capital.
The current lending limit calculation
for national banks and savings
associations measures the amount
outstanding to a borrower as a function
of the total dollars lent plus, under some
circumstances, the amount committed.
With respect to loan transfers with
recourse, the OCC's regulations provide
that when a bank sells a whole loan or
loan participation in a transaction that
does not result in a pro rata sharing of
credit risk between the bank and the
purchaser, the total amount of the loan
transferred must still be included in the
lending limit calculation of the amount
outstanding to the underlying
borrower.16 In effect, if a bank transfers
a loan with recourse, the lending limit is
applied to the full amount of the loan as
though it has not been transferred.
The OCC's treatment of loan transfers
with recourse under the lending limit is
premised on the theory that when a
bank transfers a loan with recourse, it
18 By contrast, because the OTS regulations do
not require a savings association's leverage ratio to
be calculated with reference to its reported asset
base, changes in the reporting treatment of an asset
transfer with recourse would not affect a savings
association's leverage ratio.
14 See supra note 2 accompanying text
** FIRREA provides certain additional lending
authority to savings associations under “Special
Rule.” See 12 U.S.C. 1464(u).
*• See 12 CFR 32.107. See also 54 FR 43398
(October 24,1989) (Notice of Proposed Rulemaking
amending 12 CFR part 32, proposing to move the
text of 12 CFR 32.107, without substantive change).
See also 12 CFR 7.7519 (loan repurchase
agreements).
26769
may have retained a concentration of
the risk of nonpayment from the loan.
For example, assume that a bank makes
a $100,000 loan. If the bank sells the loan
with 10% recourse, it will have retained
the risk of the first $10,000 of loss on the
entire loan. By accepting the first dollars
of loss rather than agreeing to share
losses with the purchaser on a pio rata
basis, the bank has clearly retained a
disproportionate amount of the risk in
the whole loan. The current lending limit
treatment of recourse arrangements
prevent a bank from being able to sell a
borrower's loans in order to be able to
continue making new loans to that
borrower, when the bank has actually
retained a disproportionate exposure to
that borrower’s risk of default. This
approach encourages risk diversification
by preventing the bank from leveraging
and concentrating risk in the same
borrower.
IV. Issues for Comment
The Agencies consider it timely and
appropriate to review the regulatory
treatment of recourse arrangements,
particularly in the context of the riskbased capital framework which affords
an opportunity for the separate
determination of reporting and capital
treatments. As the risk-based capital
guidelines of the FRB, the FDIC and the
OCC become effective as of December
31.1990, the Agencies are considering
using the same fate as the effective date
for changes made to the regulatory
treatment of recourse arrangements.
As set forth below, the Agencies
request comment on how the term
“recourse arrangement" should be
defined, how such arrangements should
be reported, and how the required
capital support should be determined.
Additionally, comment is requested on
how recourse arrangements should be
treated for purposes of the lending limit
applicable to national banks and
savings associations.
A. Definition o f “Recourse
Arrangement"
The Agencies are considering
developing a broad definition of the
term “recourse arrangement” that will
recognize the potential effects of any
arrangement that exposes a financial
institution to a risk of loss. The Agencies
request comment on how “recourse
arrangement" should be defined,
including how the issues discussed
below should be addressed. The
Agencies also request comment on the
feasibility and appropriateness of
developing a single definition for capital
and reporting purposes, and on whether
such a single definition could also be
26770
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
used for purposes of the lending limit
applicable to national banks and
savings associtions.17
1. Explicit Recourse
A financial institution may accept or
retain recourse pursuant to an explicit
and legally binding agreement in many
ways. The traditional concept of
“recourse” is that of the loan seller's
retention of some credit risk. Today,
seller assurances against loss are
increasingly extended to other types of
risk, including interest rate and
prepayment risk, foreign exchange risk,
liquidity or marketability risks, and risks
associated with a borrower's regulatory
noncompliance or uninsurable hazards.
The Agencies recognize that asset
sales are typically accompanied by
certain standard representations and
warranties concerning items within the
seller’s control. For example, the seller
may warrant that a loan is not
delinquent or is in compliance v.ith
consumer protection laws as of t h e date
of the sale. If the triggering event is
within the seller’s control, the selling
institution may be able to adequately
protect itself, and it may be
inappropriate to regulate the
arrangement as a recourse arrangement.
The Agencies therefore request
comment on what t y p e 3 of standard
representations and warranties should
be excluded from regulatory treatment
8 s recourse arrangements.
The Agencies are concerned,
however, that some financial institutions
have also offered unusual warranties
and representations in situations that
tney cannot control. For example, some
financial institutions have assumed risks
associated with a borrower’s failure to
maintain loan collateral in compliance
with environmental or health and safety
lavvs. or have agreed to substitute loans
in the event of prepayment. The
Agencies request comment on the extent
to which the definition of “recourse
arrangement" should include exposure
to risks other than credit risk.
The Agencies also recognize that in
applying the risk-based capital
standards and possibly for other
regulatory purposes, it may be
: 7 As indicated infra at note 28, the application of
the lending limit to recourse arrangements is being
considered only insofar as these arrangements
exDose a bank or savings association to credit risk.
Thus, to the extent that the definition of recourse
arrangement developed for use in the capital or
regulatory reporting context includes arrangements
that expose institutions to risks other than credit
risk, the same definition would not be appropriate
for use in the lending Hmit context. To the extent
that the definition cover* arrangements that expose
an institution on credit risk, comment is requested
on whether those same arrangements should be
considered recourse for lending limit purposes.
appropriate to treat certain limited
recourse arrangements differently than
full recourse arrangements. The
Agencies request comment on the
methods available to financial
institutions for providing limited
recourse and on how to identify those
limited recourse arrangements for which
separate regulatory treatment might be
appropriate.
In addition to recourse arrangements
that may arise from a financial
institution’s sale of its own assets, a
financial institution may also provide
explicit assurances against the risk of
loss associated with a third party’s
assets. For example, as the servicer of a
poo! of assets, a financial institution
may accept some exposure to credit risk
from the pool. As part of a brokering
agreement, an institution may provide
credit enhancement to ensure the
performance of an issue, designed to
absorb loss to the extent of the
enhancement, or may commit to certain
market-making activities. The Agencies
request comment on how risks that do
not arise from a financial institution’s
ownership or prior ownership of assets
should be addressed in the definition of
"recourse arrangement."
2. Implicit Recourse
A financial institution may also
effectively assume recourse without an
explicit contractual agreement. Implicit
recourse is usually demonstrated by an
institution's action subsequent to the
sale of an asset. Implicit recourse may
arise as a result of a loan seller’s desire
for a continuing relationship with a
borrower, or for protection of its
reputation with investors. For example,
having packaged and sold a portfolio of
loans without recourse, s financial
institution may elect to rewrite the
defaulted loan of a valued borrower that
the institution believes is having
temporary difficulties in repayment. A
financial institution may also be
tempted to repurchase assets it has sold
into a pool that are not performing well,
in order to protect the institution’s
reputation with investors and the public
generally. The Agencies request
comment on how the definition of
"recourse arrangement” should address
implicit recourse.
3. M ethods o f Providing Recourse
Assurances against loss may be
provided through a variety of means. In
some cases, recourse is provided
through recourse clauses in sales
contracts or put options granted in
connection with asset sales. Recourse
may also be provided through
transactions that involve the creation of
separate financial products.
For example, subordinated securities
issued when loans are pooled and senior
and subordinated classes of securities
are created can operate analogously to
recourse provisions on individual loans.
The subordinated securities protect the
Benior securities by being first in line to
absorb losses on the pool. Similarly, a
second mortgage might function as a
recourse arrangement. If a financial
institution originates first and second
mortgages on the same property and
sells the first mortgage but retains the
second mortgage, the financial
institution is first in line to absorb losees
in the event of the borrower's default.
Claims under the second mortgage will
only be met after the holder’s claims
under the first mortgage are satisfied.
A letter of credit intended to absorb
losses on an asset or poo! of assets
originated or pooled by a third party
may also effectively constitute recourse.
If the third party seller is not obligated
to reimburse the institution providing
the letter of credit for any payments
made under the letter of credit, then the
letter of credit institution will have
assumed a risk of loss on the assets.
Alternatively, if the third party seller
must reimburse the letter of credit
institution, then that third party seller
has effectively retained recourse on the
assets sold equal to the amount of the
letter of credit. In addition, the letter of
credit institution would be exposed tc 8
risk of loss on the assets in the event
that the third party should fail to
reimburse as required by the contract.'*
The Agencies request comment on
methods available to e financial
institution to accept, assume or retain
recourse. For example, as discussed
herein, the Agencies request comment
on whether subordinated securities,
second mortgages or letter of credit
enhancements should be treated as
recourse arrangements, both where
these interests are retained or acquired
by the seller and where they are
purchased or provided by a third party
financial institution. With respect to
subordinated securities, the Agencies
specifically request comment on how
“ Although letter of credit enhancements may
ultimately be found to be “recourse arrangements"
for regulatory reporting, capital or lending limit
considerations, the OCC does not construe such
letters of credit to create "recourse** in connection
with sales of credit-enhanced securities for the
purposes of section 16 of the Glass-Steagall Act. See
12 U.S.C. 24 (Seventh). This section authorizes
national banlo to sell "securities and stock without
recourse" for their customers. See. e.g.. Securities
Industry Association v. Comptroller o f the
Currency, 577 F. Supp. 252 (DD.C 1983); Awotin v.
A tlas Exchange National Bank, 295 U.S. 200 (1935);
end OCC Interpretive Letter No. 212, reprinted in
[1981-82 Transfer Binder] Fed. Banking L Rep.
(CCH) 185,293 (July 2,1981).
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
the definition of recourse should treat
the middle classes, i.e., the higher tier
subordinated pieces, of issues that have
more than two classes of securities.
B. Reporting Treatment o f Asset
Transfers With Recourse
As already discussed, the current Call
Report treatment of an asset transfer
with recourse for national and federallyinsured, state-chartered banks varies,
depending upon a range of factors. The
Call Report requirements differ from the
GAAP reporting requirements, which
are generally applicable to savings
associations. The FRB, the FDIC and the
OCC believe that the present Call
Report Instructions for asset transfers
with recourse should be reevaluated.
These agencies intend to work through
the FFIEC in order to amend the Call
Report requirements, as necessary. See
12 U.S.C. 3305(a).
The FRB, the FDIC and the OCC
request comment on how assets
transferred with recourse should be
reported, including (1) Whether these
agencies should consider adopting the
GAAP approach for asset transfers with
recourse, either in part or in its entirety,
or some other wholly consistent
approach, and (2) how changes to
regulatory reporting will or should affect
these agencies’ leverage ratios.
1. Possible Adoption of GAAP Reporting
Treatment of Asset Transfers with
Recourse by the FRB, the FDIC, and the
OCC
The GAAP definition of "sale” for
transfers of receivables with recourse is
discussed in the Financial Accounting
Standards Board’s Statement of
Financial Accounting Standards No. 77
(“FAS 77”).19 According to FAS 77, a
transfer of receivables with recourse is
to be reported as a sale if the reporting
entity meets three conditions: (1) The
transferor must surrender control of the
future economic benefits embodied in
the asset; (2) the tranferor must be able
to reasonably estimate its obligations
under the recourse provision; and (3) the
transferor must not be obligated to
repurchase the assets except pursuant to
the recourse provisions.
FAS 77 further provides: “If a transfer
qualifies to be recognized as a sale, all
probable adjustments in connection
19 See Statement of Financial Accounting
Standards No. 77. "Reporting by Transferors for
Transfers of Receivables with Recourse"
(December, 1983). For the purpose of FAS 77
"recourse" is defined as the "right of a transferee of
receivables to receive payment from the transferor
of those receivables for (a) Failure of the debtors to
pay when due, (b) the effects of prepayments, or (c)
adjustments resulting from defects in the eligibility
of the transferred receivables." See appendix A,
FAS 77.
with the recourse obligations to the
transferor shall be accrued in
accordance with FASB Statement No. 5,
‘Accounting for Contingencies' [’FAS
5’].” FAS 5 requires the transferor of an
asset with recourse to accrue by a
charge to income an amount sufficient to
absorb the transferor’s estimated
obligations under the recourse
provision. The recourse obligation must
be accrued as a liability or specific
reserve,80 and may not be included as
part of the general allowance for loan
and lease losses.*1
After the Financial Accounting
Standards Board adopted FAS 77, the
FRB, the FDIC and the OCC, as
members of the FFIEC, considered
incorporating this accounting standard
into their regulatory reporting
requirements for assets transferred with
recourse. At that time, the FFIEC chose
not to follow FAS 77, concluding that it
emphasized the transfer of future
economic benefits, whereas the agencies
were most concerned with a financial
institution’s retention of a risk of loss.
The FFIEC also expressed concern that
it might be difficult to reasonably
estimate the risk of loss on some assets,
such as commercial, construction and
international loans.22
Although the FRB, the FDIC and the
OCC have previously rejected the FAS
77 reporting treatment for most asset
transfers with recourse, these agencies
are also committed to an ongoing effort
to minimize the differences between
generally accepted accounting principles
and regulatory reporting requirements
where possible. For example, one
possibility is that the agencies might
adopt the GAAP approach for some
types of assets, such as loans
considered subject to reasonable
estimations of loss, but not necessarily
for all types of assets.
In addition, the FRB, the FDIC and the
OCC note that once their risk-based
capital guidelines are implemented, the
adoption of the GAAP reporting
approach would not affect bank capital
ratios to the same extent it would have
*° See Statement of Financial Accounting
Standards No. 105, "Disclosure of Information about
Financial Instruments with Off-Balance-Sheet Risk
and Financial Instruments with Concentrations of
Credit Risk/' (March, 1990), paragraph 92, which
states "(t]he [Financial Accounting Standards]
Board believes that generally accepted accounting
principles proscribe inclusion of an accrual for
credit loss on a financial instrument with offbalance-sheet risk in a valuation account
(allowance for loan losses) related to a recognized
financial instrument."
1,1 Because accrued recourse obligations are
specifically identifiable to the sold assets, they are
not included in capital.
** See October 28,1985 FFIEC letter to Chief
Executive Officers of Banks (Appendix).
26771
when the FFIEC originally considered
FAS 77 in 1985. The requirement of
capital support for an asset transfer at
that time depended solely upon its
reporting treatment. As discussed
above, under the risk-based capital
standards, national and federallyinsured, state-chartered banks will be
required to hold capital against an asset
transferred with recourse even when the
transfer is reported as a sale.
2. Possible Impact on the FRB, FDIC, and
OCC Leverage Ratios
If the FRB, the FDIC and the OCC
adopt the FAS 77 approach for reporting
asset transfers with recourse, some
asset transfers not currently reported as
sales for Call Report purposes would
qualify for sale treatment. If some other
reporting treatment is adopted, it is also
possible that some asset transfers
currently reported as sales in the Call
Report might no longer qualify for sale
treatment. Either of these outcomes
would potentially affect the capital
required to meet the leverage ratios.
Removing assets from the Call Report
balance sheet would have the effect of
lowering the reported asset base against
which capital must be held for leverage
purposes, thereby lowering the amount
of capital required to meet the leverage
ratios. Retaining additional assets on
the balance sheet would have the effect
of increasing the reported asset base,
thereby increasing the capital necessary
to meet the leverage ratios. The
Agencies request comment on whether
the leverage ratio calculation should be
adjusted to include assets removed from
the balance sheet and/or to exclude
assets added to the balance sheet as a
result of changes in the regulatory
reporting treatment of recourse
arrangements.
C. C apital S upport Required for a Recourse
A rrangem ent
1. Explicit Recourse Arrangements
The Agencies are considering
requiring a financial institution that
enters into an explicit, contractually
binding, recourse arrangement to
quantify its maximum possible risk of
loss and to hold capital commensurate
with that risk. This approach is
consistent with the direction taken for
asset transfers with recourse in
establishing the risk-based capital
standards. Nonetheless, the Agencies
recognize the possible utility of some
adjustments in the application of their
risk-based capital standards, as
presently drafted, to asset transfers with
recourse.
The Agencies request comment on the
general approach that they are
26772
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
considering for capital charges against
explicit recourse arrangements. As
discussed below, the Agencies
specifically request comment on the
feasibility and appropriateness of (a)
Applying consistent capital charges to
similar recourse exposures that arise as
e result of a financial institution's prior
ownership of an asset; (b) requiring
equivalent capital charges for
comparable recourse exposures that do
not arise as a result of the financial
institution’s prior ownership of an asset;
and (c) tailoring the capital charges to
the relative exposure of particular
recourse arrangements. The Agencies
request that commenters give particular
focus to ways of addressing limited
recourse arrangements. In addition, the
Agencies request that commenters
eddress how insured financial
institutions and bank holding
companies' need for adequate capital
should be balanced against their need to
compete in markets that include
participants subject to less stringent
capital standards.
(a) Consistent Capital Charges for
Recourse on Previously Owned Assets.
The risk-based capital standards do not
necessarily apply the same capital
treatment to differently structured asset
transfers that have the same potential
effect on an institution’s earnings, assets
or capital.
Fcr example, the risk-based capital
standards require different capital
support for a mortgage transferred with
recourse and a second mortgage, which
may be used in place of a recourse
clause. To illustrate, if a financial
institution originates a $100,000
qualifying, first lien residential
mortgage, it will be required to hold
S4000 in capital support against the loan
($100,000 X 50% risk-weighiX8%) If the
originating institution sells this mortgage
loen subject to a 10% recourse provision,
the capital charge will not change.
Alternatively, the same institution might
originate two separate mortgages, a frist
mortgage for $90,000 and a second
mortgage for $10,000. If the institution
sells the first mortgage without recourse
but retains the second mortgage, there
will be no capital charge against the first
mortgage and the charge against the
second mortgage will only be $800
($10,000 x 100% X 8%). Because the
financial institution will absorb the first
$10,000 of losses under either of these
arrangements, the maximum possible
risk of loss on the two transactions is
the same.
As another example of inconsistent
capital treatments for asset transfers,
the risk-based capital standards treat a
seller’s retained residual interest in a
pool of assets differently than
subordinated interests or other forms
retained recourse. In general terms, a
residual interest in an interest in any
excess cash flow stemming from a
securitized asset pool over and above
the amounts required to pay investors
and applicable administrative expenses.
Residual interests, like subordinated
interests or other recourse
arrangements, may absorb more than
their pro rata share of loss. However, in
certain cases, a financial institution that
sells assets and retains a residual
interest in them need hold capital only
against that interest. By contrast, if the
institution sells assets and retains
subordinated securities or other forms of
recourse it must hold capital against the
entire amount of the assets sold.
(b) Equivalent Capital Charges for
Recourse on Third Party Assets. The
risk-based capital guidelines of the bank
supervisory agencies do not explicitly
address recourse arrangements that do
not arise as a result of a financial
institution’s prior ownership of an asset.
For example, mortgage servicing rights
that a financial institution purchases
from another party may include various
types of recourse, including the
requirement that the purchasing
institution absorb credit losses on the
loans it has agreed to service. It is
important that the risks associated with
these transactions be understood,
quantified and risk-weighted as with
any other off-balance sheet credit
exposure. The OTS capital rule currently
requires savings associations with
mortgage servicing rights that include
exposure to credit losses to hold capital
against the full amount of the underlying
loans through the application of the
100% credit conversion factor.
As another example, the risk-based
capital guidelines of the bank
supervisory agencies treat subordinated
interests differently depending upon
whether the bank retains a subordinated
interest in assets it has owned and
transferred, or purchases a subordinated
interest in third party assets. The FRB,
the FDIC, the OCC and the OTS all
require financial institutions retaining
the subordinated portion of a senior/
subordinated structure to hold capital
against the full amount of the assets
transferred. However, if a bank
purchases subordinated securities
representing interests in loans that it has
not originated or owned, the FRB, the
FDIC and the OCC place only the
purchased subordinated securities in a
100% risk-weight category. No capital is
required for the senior portions
supported by the purchased
subordinated portions.28 By contrast,
the OTS treats purchased subordinated
securities the same as originated
subordinated securities, and thus
requires savings associations to hold
capital against the whole asset pool.
(a) Capital Charges Tailored to
Relative Risks. The risk-based capital
standards do not necessarily require
capital support commensurate with the
relative risk exposure of a particular
recourse arrangement.
For example, the risk-based capital
guidelines of the bank supervisory
agencies, as opposed to those of the
OTS, do not distinguish between limited
and unlimited recourse arrangements.
The bank supervisory agencies require
capital to be held against the full
amount of an asset transferred with
recourse, even if the transferring bank
has limited its risk of loss on the
recourse provision. The risk-based
capital rules of the OTS differ in that
they generally permit a savings
association to maintain capital equal to
the amount of the recourse exposure cn
an asset transferred with recourse if that
exposure is less than the capital charge
the asset would otherwise incur.
The Agencies believe that failing to
give capital credit for any form of
limited recourse may actually create an
incentive for financial institutions to
maximize their risk of loss in
transferring assets with recourse. This is
because buyers may pay more for assets
sold with greater recourse than for the
same assets sold with less recourse. If
there are no additional capital charges
for sales with full recourse, financial
institutions may decide to transfer
assets with full rather than limited
recourse in order to benefit from higher
sale prices.
The risk-based capital guidelines of
the bank supervisory agencies also do
not permit a reduction in the capital
charge when a bank establishes a
recourse liability account for its
estimated obligations under the recourse
provision. Similarly, the risk-based
capital standards of the bank
supervisory agencies and OTS may not
fully address the interaction of third
party guarantees or insurance that may
be obtained by insured financial
institutions to reduce their potential
losses on assets they transfer with
recourse.
*8 This discussion of the “purchase” of a
subordinated security is undertaken solely as an
illustration, and should not be viewed as an
indication that such securities would be eligible for
bank investment under federal or state law, or that
bank holdings of such securities would not be
subject to examiner criticisms or classifications.
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
For example, assume that a bank
transfers by means of a privately-issued
certificate of participation a $1,000,000
pool of qualifying, first lien residential
mortgage loans subject to 10% recourse
in a transaction that may be treated as a
sale for Call Report purposes.24
Estimating its probable losses on the
loans to be only 3%. the bank
establishes a recourse liability account
for $30,000. Under the risk-based capital
guidelines of the bank supervisory
agencies, however, the creation of the
recourse liability account would not
operate to reduce the amount of the
loans for determining the capital charge.
Thus, notwithstanding the $30,000
recourse liability account, the bank
would still be required to maintain
capital against the full amount of the
loans, or capital of $40,000 ($1,000,000 X
50% risk-weight X 8%). This treatment
may actually discourage a bank from
establishing an adequate recourse
liability account
By contrast, under the risk-based
capital rules of the OTS, a savings
association transferring the same pool of
loans and establishing the same liability
account may net the account against the
full amount of the loans transferred.
Thus, the total amount of the loans
outstanding for capital purposes would
be reduced to $970,000, and the net
recourse exposure would drop from
$100,000 to $70,000. Because the liability
account is netted against the total
outstanding amount of the loans rather
than the capital requirement, the savings
association would be required to hold
capital of $38,800 ($970,000 X 50% riskweight X 8%). If the recourse liability
account had reduced the net recourse
exposure below the capital requirement
for the full amount of the loans less the
recourse liability account, then the
capital charge would have been reduced
to the level of the net recourse exposure.
For example, if the association had
established a recourse liability account
of $80,000, then the required capital
would have been limited to the amount
of the net recourse exposure of $20,000.
The risk-based capital standards also
do not necessarily recognize differences
in the degree to which an asset
transferred with recourse is
collateralized*8 For example, assume
M Under the current Cali Report Instructions,
such a transaction would not receive sale treatment
because the bank would retain more than a
“significant risk of loss" on the loans transferred.
However, if the FFIEC were to adopt the GAAP
approach for reporting asset transfers with recourse,
the issues raised in this example would arise.
*• This situation is not unique to assets
transferred with recourse, but also applies to onbalance sheet assets that are collateralized (other
than by so-called “qualifying collateral”). The ritak-
that a savings association originated
two $100,000 mortgage loans, one with a
loan-to-collateral value ratio of 50%, and
the other with a loan-to-collateral value
ratio of 75%. If the savings association
subsequently transferred both loans,
each with 10% recourse, it would be
required to hold the same minimum
captial against each loan, despite the
differences in the underlying collateral
values.
Another example of a collateralized
recourse arrangement involves the
lending of customers’ securities.
Financial institutions that lend their
customers’ securities to third parties
may provide protection against loss to
the customers. The degree of such
protection may vary from total
indemnification to simply a guarantee
that the customer will not lose money as
a result of a decline in the market value
of the pledged collateral should the
borrower fail to return the securities.
Thus, when a financial institution lends
its customer’s securities the degree of
risk retained can vary from a very low
percentage of 100% of the value of the
lent securities. Nevertheless, if the
financial institution provides any loss
protection to the customer, the riskbased capital standards require that
capital be held for the entire amount of
the securities lent regardless of the level
of the guarantee that is provided.
The risk-based capital standards also
do not distinguish between recourse
arrangements with different
probabilities of loss. Thus, if a savings
association or bank transfers ten loans,
each with a balance of $100,000, subject
to 10% recourse per loan, or transfers the
same loans with 10% recourse on the
pool, the bank's total potential liability
in each case is $100,000 (10 loans X
$100,000 X 10%). The total capital
required in each case would be $80,000
(10 loans X $100,000 X 8%).
Nonetheless, the probability of loss in
the latter instance is greater. If the
recourse is on a "per loan" basis, the
institution cannot lose the full $100,000
unless each of the ten loans loses
$10,000. By contrast if the recourse is on
a “pool” basis, various combinations of
loss, e.g., one loan losing $100,000, or
two loans each losing $50,000, may
result in the institution's absorbing its
total potential loss.
Finally, the risk-based capital
standards do not necessarily distinguish
between recourse arrangements
bawd capital ratio focuses principally on broad
categories of credit risk. The ratio does not taka
account of many other factor* that can affect an
institution's financial condition such as the quality
of individual loans and Investments and the degree
to which they are protected by collateral.
26773
structured as second dollars of loss and
recourse arrangements structured as
first dollars of loss. For example, in
certain recourse arrangements, a
financial institution undertakes to cover
losses only after another party has
already absorbed some loss. Even
though the actual risk of loss is less than
if the financial institution were obligated
to absorb the first dollars of loss, the
risk-based capital standards may
require identical treatment of these
recourse arrangements, depending on
the particular factual situation.
2. Implicit Recourse Arrangements
The Agencies believe that financial
institutions should not assume implicit
recourse unless capital support is
provided. The Agencies also recognize
that the exposure arising from an
implicit recourse arrangement as
opposed to an explicit arrangement, is
difficult to quantify, and that it may not
be feasible to apply the risk-based
capital ratios to implicit arrangements.
Accordingly, the Agencies will consider
whether alternative approaches should
be employed to control financial
institutions’ use of implicit recourse
arrangements.
The Agencies note that existing
regulatory constraints may already
afford financial institutions some
protection against the risks of assuming
implicit recourse. For example, the
requirement that a Financial institution
maintain specified capital ratios may
limit the degree to which an institution
can actually reacquire assets as a result
of assuming implicit recourse. Prior to
purchasing a poorly performing asset
from a pool, the institution ordinarily
must determine that it has adequate
excess capital to book the asset. In
addition, the desire for a particular tax
treatment of a trust or single-purpose
entity created to issue asset-backed
securities may restrict a financial
institution’s ability to repurchase or
exchange poorly performing assets.
The Agencies believe that implicit
recourse arrangements are frequently
associated with asset transfers, and
especially securitized asset sales in
which the issuing or selling institution
may seek to ensure the issue's
performance. To address this problem,
the Agencies are considering requiring
issuing and selling institutions to
provide disclosures to purchasers that
disclaim any financial institution's
obligation for the performance of the
transferred assets (other than
obligations that may be explicitly
assumed).
In addition, as has been their past
practice, the Agencies will seek to
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Federal Register / Vol. 55, No. 12G / Friday, June 29, 1990 / Notices
identify implicit recourse arrangements
in the course of their examination and
supervision of individual institutions.
If the primary federal supervisory
agency for an individual financial
institution determines that the
institution habitually or consistently
repurchases or rewrites assets it has
sold that subsequently perform poorly,
that agency will require that institution
to maintain additional capital. The
institution may also be required to treat
the outstanding amount of other similar
assets sold as though transferred with
recourse for regulatory reporting
purposes. A repetitive pattern of
renewals or rewrites may also be
determined to be an unsafe and unsound
banking practice.28
The Agencies request comment on
their consideration of a disclosure
requirement as one approach to
discouraging financial institutions from
assuming implicit recourse in connection
with securitized asset sales and other
asset transfers. The Agencies also
request comment on any methods that
may be used to estimate exposure
arising from implicit recourse
arrangements and on any other ways of
addressing implicit recourse
arrangements. Finally, the Agencies
request comment on how the risk-based
capita! standards should be applied
once it is determined that an institution
clearly has assumed implicit recourse in
a transaction or series of transactions.
D. Lending Limit Treatment of Recourse
Arrangements
As discussed above, the lending limit
calculation generally requires a national
bank or savings association that
transfers a loan with recourse to include
the full amount of that loan in
calculating the total loans and
extensions of credit outstanding to the
underlying borrower. The OCC and the
OTS recognize, however, that other
methods of computing the lending limit
may be appropriate when an institution
transfers a loan with partial recourse or
otherwise limits its credit risk exposure
from a recourse arrangement.27 The
••The Agencies emphasize that they do not
intend to discourage a Financial institution with
adquate capital from independently deciding to
repurchase or rewrite a sold loan that is performing
poorly, when the institution intends to work with
the underlying borrower and the accommodation is
clearly in the best interests of the institution and the
borrower.
17 Some states apply the lending limit for national
banks to state-chartered banks. Therefore, changes
in the OCC's lending limit treatment of recourse
arrangements could affect some state-chartered
banks as well as national banks and savings
associations.
OCC and the OTS also recognize some
inconsistencies in the current
application of the lending limit to
recourse arrangements. As for federallyinsured, state-chartered banks, the staffs
of the FRB and the FDIC believe that
recourse exposure should be combined
in some manner with all loans to one
borrower for purposes of applying legal
lending limits under state laws.28
Comment is requested on how the
lending limit calculation for national
banks and savings associations should
treat recourse arrangements generally,
including the questions listed below.
Comment is also requested on how
lending limit calculations for federallyinsured, state-chartered banks should
treat such arrangements, including the
questions listed below. Comment is also
solicited on whether and how to achieve
a more uniform treatment of recourse
arrangements in lending limit
calculations under the various
applicable 3tate laws.
1. If an institution transfers a loan
with partial recourse, would it be
appropriate to include less than the full
outstanding amount of the loan
transferred in the calculation of loans
and extensions of credit outstanding to
the borrower? More specifically, should
the lending limit recognize that while the
institution may have retained a
disproportionate amount of the risk of
loss in the loan, it has nonetheless
shifted the risk of catastrophic loss by
reducing its exposure from the full
amount of the loan to the amount of the
resource provision? Also, should the
current treatment for national banks and
savings associations be revised to
permit an institution which establishes a
recourse liability account covering all or
part of its recourse exposure to deduct
the amount of the account from the
calculation of loans outstanding to the
borrower? Should the establishment of
such a liability account affect the
calculation of loans outstanding to one
borrower at federally-insured, statechartered banks?
2. Is it appropriate to require the full
outstanding balance of a loan
transferred with recourse to be included
in the calculation of loans outstanding to
the borrower if banks and savings
associations must also support the
retained risk by holding capital against
the full outstanding balance of the
asset? This question should be
••This discussion of the lending limit treatment of
recourse arrangements is intended to apply only to
arrangements that expose a bank or savings
association to the credit risk of a borrower. It is not
intended that the lending limit would apply to
recourse arrangements that expose an institution to
other types of risk.
considered in view of the fact that
capita! requirements are specifically
intended to address the risk contained
in an institution’s assets and off-balance
sheet items, whereas the lending limit is
designed to promote credit risk
diversification.
3. Should the lending limit be applied
to achieve a more consistent treatment
of different types of transactions that
may expose an institution to the same
degree of credit risk from an underlying
borrower? For example, for national
banks and savings associations, there is
a discrepancy between the lending limit
treatment accorded subordinated loans
and the treatment accorded
subordinated participations. If an
institution originates first and second
mortgages, on the same property and
sells only the first mortgage, the second
mortgage will function as a recourse
arrangement on the first mortgage. Yet,
the institution is required to include only
the amount of the second mortgage in its
calculation of loans outstanding to the
borrower. By contrast, if the institution
made a single loan to the same borrower
for the same total amount, and then sold
the loan with recourse equal to the
amount of the second mortgage, the
entire loan would be included in the
lending limit calculation. Arguably,
despite the differing lending limit
treatments, the institution's exposure to
the borrower's credit risk in the two
transactions is the same.
V. Listing of Questions for Comment
To briefiy summarize, the Agencies
request comment on the following
issues:
The definition of “recourse
arrangement”:
1. How should "recourse
arrangement” be defined? What types of
risk should be construed as creating a
recourse arrangement? Should the same
definition be developed for use in the
capital, reporting and, as appropriate,
lending limit contexts?
2. What methods are available to a
financial institution to accept, assume or
retain recourse? For example, should the
following items, in some circumstances,
be considered "recourse arrangements”:
(a) Subordinated interests; (b) second
mortgages: and (c) letter of credit
enhancements?
The regulatory reporting treatment of
a “recourse arrangement”:
3. Should the FRB, the FDIC and the
OCC adopt generally accepted
accounting principles, in whole or in
part, or adopt some other wholly
consistent approach for the reporting
treatment of asset transfers with
recourse?
Federal Register / Vol. 55, No. 126 / Friday, June 29, 1990 / Notices
4. What effect would a change to the
reporting treatment have on the leverage
ratios of the FRB, the FDIC and the
OCC? Should the reporting treatment of
assets transferred with recourse have an
effect on the leverage ratio?
The appropriate capital requirement
for explicit recourse arrangements:
5. Should the Agencies impose the
same capital requirement on
transactions structured differently but
with the same potential effect on a
financial institution’s income, assets or
capital?
6. Should the risk-based capital
standards distinguish between limited
and unlimited recourse arrangements?
7. Should the risk-based capital
standards take into account an
established recourse liability account or
third party guarantees or insurance? If
so, how?
8. Should application of the risk-based
capital standards to recourse
arrangements take into account
differences in the degree to which an
asset transferred with recourse is
collateralized?
9. Should the risk-based capital
standards fully recognize recourse
arrangements that do not arise as a
result of a financial institution’s prior
ownership of an asset?
10. What other types of explicit
recourse arrangements not discussed in
this solicitation are available to
financial institutions?
11. Should the risk-based capital
standards distinguish between recourse
arrangements with different
probabilities of loss?
12. How should the need for insured
depository institutions and bank holding
companies to maintain adequate capital
be balanced against their need to
compete in markets that include
participants that are subject to less
stringent capital standards?
The appropriate treatment of implicit
recourse arrangements:
13. Should the Agencies adopt
disclosure requirements to discourage
implicit recourse arrangements?
14. Are there methods available to
estimate potential exposure from
implicit recourse arrangements?
15. Are there ways, other than
disclosure requirements, to address and
discourage implicit recourse?
16. How should the risk-based capital
standards be aplied to a financial
institution that has clearly assumed
implicit recourse in a transaction or
series of transactons?
Comment is requested on the
following issues concerning the lending
limit applicable to banks and savings
associations:
17. When a bank or savings
associations transfers a loan with
limited recourse, should be the lending
limit be applied to the full amount of the
assets, as though it had not been
transferred?
18. Should be lending limit calculation
result in the same treatment for
transactions structured differently, but
with the same potential risk of loss on
nonpayment?
19. Is is appropriate to include the full
outstanding balance of a loan
transferred with recourse in the
calculation of loans outstanding to the
borrower when banks and savings
associations are also required to hold
capital against the full amount of the
asset?
20. Should the treatment of recourse
arangements in legal lending limit
calculations applicable to federallyinsured, state-chartered banks under
state laws be made more uniform? If so,
how?
Dated: June 25,1990.
R obert J. Law rence,
Executive Secretary, Federal Financial
Institutions Examination Council.
[FR Doc. 90-15093 Filed 6-28-90; 8:45]
BIU.IKQ CODE 6210-01-M
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@FedFRASER