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FEDERAL RESERVE BANK OF NEW YORK [ Circular No. 10686 January 24, 1994 ~| CAPITAL ADEQUACY GUIDELINES Amendments to Regulations H and Y To All Depository Institutions, and Others Concerned, in the Second Federal Reserve District: The following statem ent has been issued by the Board of Governors of the Federal Reserve System: The Federal Reserve Board announced adoption of amendments to its risk-based capital guidelines affecting the treatment of certain multifamily housing loans. This rule is effective December 31, 1993. The revised guidelines for state member banks and bank holding companies lower the risk weight from 100 percent to 50 percent for multifamily housing loans meeting criteria that are specified in the proposal. This change was directed by a provision of section 618(b) of the Resolution Trust Corporation Refinancing, Restructuring, and Improvement Act of 1991 (RTCRRIA). The Board’s notice is attached. In a separate action on December 16, 1993, the Board approved a recommendation from the Federal Financial Institution Examination Council to seek public comment on a Notice of Proposed Rulemaking and an Advanced Notice of Proposed Rulemaking concerning the regulatory treatment of recourse arrangements and direct credit substitutes which, to the extent they apply to multifamily housing loans, would, if adopted, also satisfy the requirements of certain provisions of section 618(b) of RTCRRIA. This notice will be issued at a later date. E nclosed — for depository institutions in the Second Federal Reserve D istrict and others who m aintain sets of regulations of the Board of Governors — is the text of the am endm ents to Regulations H and Y, which have been reprinted in the Federal Register of D ecem ber 29, 1993; additional, single copies may be obtained at this Bank (33 Liberty Street) from the Issues Division on the first floor, or by contacting the Circulars Division (Tel. No. 212-720-5215 or 5216). Questions regarding the regulations may be directed to Stephanie M artin, Financial Specialist, Bank Analysis Function (Tel. No. 212-720-1418). W illiam J. M cD onough , President. / O (o Board of Governors of the Federal Reserve System CAPITAL ADEQUACY GUIDELINES Amendments to Regulations H and Y Effective December 31, 1993 12C F R Parts 208 and 225 SUPPLEMENTARY INFORMATION: [Regulations H and Y; Docket No. R-0756] Background (3) The annual net operating income generated by the property (before debt service) is not less than 120 percent of On April 10, 1992, the Federal the annual debt service on the loan (115 Capital; Capital Adequacy Guidelines Reserve Board (Board) issued for public percent if the loan is based on a floating comment a proposal to amend its xiskAGENCY: Board of Governors of the interest rate); based capital guidelines that would Federal Reserve System. (4) Amortization of principal and lower the risk weight from 100 percent interest is over a period of not more ACTION: Final rule. to 50 percent for certain multifamily than 30 years and the minimum housing loans meeting specified criteria. maturity for repayment of principal is SUMMARY: The Board of Governors of the This proposal was made to satisfy the not less than 7 years; and Federal Reserve System is amending its requirements of section 618(b) of the (5) All principal and interest risk-based capital guidelines for state Resolution Trust Corporation payments have been made on the loan member banks and bank holding Refinancing, Restructuring, and on time for a period of not less than one companies. This final rule implements Improvement Act of 1991 (RTCRRIA). In year prior to placement in the 50 section 618(b) of the Resolution Trust addition, this proposal would percent risk category. Corporation Refinancing, Restructuring, implement section 305(b)(1)(B) of the and Improvement Act of 1991 and Federal Deposit Insurance Corporation Section 618(b) also provides that the section 305(b)(1)(B) of the Federal Improvement Act of 1991 (FDICLA) appropriate Federal banking agencies Deposit Insurance Corporation which requires the Federal banking may establish additional criteria that a Improvement Act of 1991. The effect of agencies 1 to revise their risk-based multifamily housing loan must meet the final rule will be to permit state before being accorded a 50 percent risk capital guidelines to reflect the actual member banks and bank holding companies to lower from 100 percent to performance and expected risk of loss of weight. In this regard, and in agreement with the other Federal banking agencies, multifamily housing loans. 50 percent the risk weight assigned to Section 618(b) of RTCRRIA mandates the Board's proposed amendment set certain multifamily housing loans. that a 50 percent risk weight be forth the following four additional accorded to loans for multifamily criteria to ensure that only those EFFECTIVE DATE: This final rule is housing meeting certain criteria. These multifamily housing loans that expose effective as of December 31, 1993. statutory criteria were incorporated into an institution to minimal levels of credit the Board’s proposal and include the risk would receive a 50 percent risk FOR FURTHER INFORMATION CONTACT: weight: Rhoger H. Pugh, Assistant Director (202/ following: (1) The loan is secured by a first lien; (1) The loan-to-value ratio used for 728-5883), Norah M. Barger, Manager (2) The ratio of the principal the purpose of the statutory criterion (202/452-2402), Robert E. Motyka, obligation to the appraised value of the cited above is based upon the most Supervisory Financial Analyst (202/ property, that is, the loan-to-valua (LTV) current appraised value of the property 452-3621), or Barbara J. Bouchard, ratio does not exceed 80 percent (75 (which normally would be the Senior Financial Analyst (202/4523072), Division of Banking Supervision percent if the loan is based on a floating appraised value at the time the loan was interest rate); originated, unless a more recent and Regulation, Board of Governors of evaluation or appraisal has been the Federal Reserve System, 20th Street ' The three other Federal banking agencies have performed); and Constitution Avenue NW„ also issued for public com m ent similar proposals to (2) The loan is performing in Washington, DC 20551. For the hearing low er the risk weight for m ultifam ily housing loans accordance with its original terms and m eeting the specified criteria. The Office of Thrift impaired only. Telecommunication Supervision (OTS) currently permits certain is not more than 90 days past due or Device for the Deaf (TDD), Dorothea m ultifam ily loans to be included in the 50 percent carried in nonaccrual status; Thompson (202/452-3544), Board of risk w eight category. The proposal issued by the (3) The average annual occupancy for Governors of the Federal Reserve, 20th OTS w ould m odify its existing criteria for such the property securing the loan has been & C Street NW., Washington, DC 20551. loans to qualify for a 50 percent risk weight. PRINTED IN NEW YORK, FROM FEDERAL REGISTER. VOL. 58, NO. 248, pp. 68735-40 [Enc. Cir. No. 10686] 63736 Federal Register / Vol. 56, No. 246 / Wednesday, December 29, 1393 t Rules and Regulations at le a st 80 p e rc e n t for th e p r e c e d in g y ea r; a n d (4) T h e lo a n h a s b e e n m a d e in a c c o rd a n c e w ith p r u d e n t u n d e r w r itin g s ta n d a r d s . T h e e x is tin g rfsk -b a s e d c a p ita l g u id e lin e s p r o v id e th a t lo a n s s e c u re d by m o rtg ag es on I - to 4 -fa m iiy re s id e n tia l p ro p e rtie s m u s t m e e t th e first, s e c o n d , a n d fo u rth a d d itio n a l c rite ria in o r d e r to be a s sig n e d a 50 p e r c e n t risk w e ig h t. T h e th ir d p ro p o s e d c rite rio n is a re q u ire m e n t u n d e r th e O T S g u id e lin e s for lo a n s for m u ltifa m ify h o u s in g a w a r d e d a 50 p e rc e n t r is k w eig h t. U n d e r th e p ro p o s e d re v is io n to th e risk -b a se d c a p ita l g u id e lin e s , p riv a te ly is s u e d s e c u ritie s b a c k e d b y m u ltifa m ify h o u s in g lo a n s th a t m e e t th e a b o v e c ite d c rite ria at th e tim e th e s e c u ritie s a re o rig in a te d w o u ld a lso q u a lify fo r in c lu s io n in th e 5 0 p e rc e n t risk cate g o ry p r o v id e d th a t th e s tr u c tu re o f th e s e c u rity m e ets c e rta in te c h n ic a l c rite ria set fo rth in th e g u id e lin e s . T h is tre a tm e n t w o u ld p a ra lle l th e tre a tm e n t for p riv a te ly -is s u e d s e c u r itie s b a c k e d by lo a n s fo r 1- to 4 -fa m iiy r e s id e n tia l p ro p e rtie s u n d e r th e ris k -b a s e d c a p ita ! g u id e lin e s. A p p lic a tio n o f th is tre a tm e n t to a s e c u rity b a c k e d by m u ftifa m ily h o u s in g lo a n s m e a n s th a t th e s e c u rity w o u ld n o t q u a lify fo r in c lu s io n in th e 50 p e rc e n t risk c a te g o ry u n le s s a!! th e u n d e r ly in g m o rtg a g e s h a v e b e e n o u ts ta n d in g a n d p e rfo rm in g fo r a t le a st o n e y e a r p r io r to o rig in a tio n o f th e se cu rity . S e c tio n 613fbH 2) o f RTCRRIA r e q u ire s th e a g e n c ie s to a m e n d th e ir c a p ita l re g u la tio n s a n d g u id e lin e s to p r o v id e th a t a n y lo a n fu lly s e c u re d b y a first lie n o n a m u ltifa m ily h o u s in g p ro p e rty th a t is so ld su b je c t to a p r o rata lo ss sh a rin g a rra n g e m e n t s h o u ld b e tr e a te d a s so ld to t h e e x te n t th a t lo s s is in c u rre d b y th e p u rc h a s e r o f th e lo an . S e c tio n 618(b)(3) o f RTCRRIA d ire c ts t h e a g e n c ie s to ta k e in to a c c o u n t o th e r lo s s sh a rin g a rra n g e m e n ts , in c o n n e c tio n w ith th e sa fe o f a n y lo a n th a t is fully s e c u re d b y a first Kerr on m u ltifa m ily h o u s in g p ro p e rty , to d e te rm in e th e e x te n t to w h ic h su c h lo a n s s h o u ld b e tr e a te d a s so id . T h e B o a rd 's e x is tin g g u id e lin e s se t forth g u id a n c e on th e tre a tm e n t o f assets so ld w ith ra c o u rse , in c lu d in g th o s e so ld su b je ct to lo ss s h a rin g a rra n g e m e n ts. T h e risk -b a se d c a p ita l g u id e lin e s for s ta te m e m b e r b a n k s s ta te th a t th e risk b a s e d c a p ita l d efin itio n , o f th e sa le o f a s s e ts w ith re c o u rse , in c lu d in g a s se ts so ld su b je c t to lo ss s h a rin g a rra n g e m e n ts, is th e sa m e a s th e d e fin itio n c o n ta in e d m th e in s tru c tio n s to th e c o m m e rc ia l b a n k C o n s o lid a te d R e p o rts o f C o n d itio n a n d In c o m e (C all R eport)' g lo ss a ry e n try for " s a le s o f a s s e ts .” T h o se in s tru c tio n s s e t o u t c o n d itio n s th a t m u s t b e m e t in o rd e r for a b a n k to tre a t a s a le a i a s s e ts a s a tr u e sa le a n d , th u s , to re m o v e fro m its b a la n c e sh e e t a s s e ts it h a s so ld . A sse ts th a t h a v e b e e n s o ld a n d re m o v e d fro m a b a n k 's b a la n c e s h e e t in a c c o rd a n c e w ith th e C all R e p o rt in s tru c tio n s a ra e x c lu d e d from th e c a lc u la tio n o f risk w e ig h te d a s se ts . S p e c ific a lly w ith re g a rd to th e sa le of a s s e ts , th e C a ll R e p o rt in s tru c tio n s p ro v id e : if th e ris k re ta in e d h y th e s e lle r is lim ite d to so m e fix e d p e rc e n ta g e o f an y lo s s e s th a t m ig h t b e in c u rr e d a n d th e re are n o o th e r p ro v is io n s r e s u ltin g in re te n tio n o f ris k , e ith e r d ir e c tly o r in d ire c tly , b y th e s e lle r, th e m a x im u m a m o u n t o f p o ssib le lo s s for w h ic h th e s e llin g b a n k is a t risk (th e s ta te d p e rc e n ta g e tim e s th e s a le p ro c e e d s ) s h a ll b e re p o r te d es a b o rro w in g a n d th e re m a in in g a m o u n t o f th e a s s e ts tra n s fe rre d re p o rte d a s a sa le . T h is tr e a tm e n t, w h ic h a p p h e s to s a le s o f m u ltifa m ily h o u s in g lo a n s s u b je c t t o p ro rata lo ss s h a rin g a rra n g e m e n ts, is c o n s is te n t w ith th e la n g u a g e o f s e c tio n 61 8 (b )(2 ) o f RTCRRIA. T h e C a ll R e p o rt in s tru c tio n s a lso p ro v id e th a t o th e r tra n sfe rs o f a s s e ts , in c lu d in g th e sa le o f assets, su b je c t to o th e r lo ss s h a rin g a rra n g e m e n ts , g e n e ra lly are r e p o r te d a s s a le s o n ly if th e s e llin g in s titu tio n : (1) R e ta in s n o ris k o f lo s s fro m a s s e ts tra n s fe rre d r e s u ltin g fro m a n y c a u s e , and (Zl H as n o o b lig a tio n to a n y p a rty for th e p a y m e n t o f p r in c ip a l o r in te r e s t o n th e a s se ts tra n s fe rre d re s u ltin g fro m a n y ca u se . T h is tre a tm e n t, w h ic h a p p lie s to s a le s o f m uL tifam ify h o u s in g lo a n s su b je c t to o th e r lo ss sh a rin g a rra n g e m e n ts , is c o n s is te n t w ith th e la n g u ag e of se c tio n 618(b)(3) of RTCRRIA. B ank h o ld in g c o m p a n ie s g e n e ra lly file th e ir re g u la to ry re p o rts in a c c o rd a n c e w ith g e n e ra lly a c c e p te d a c c o u n tin g p r in c ip le s (GAAP). U n d e r G A A P, b a n k b o ld in g c o m p a n ie s a re p e rm itte d to tre a t so m e a sse t s a le s w ith re c o u rse , in c lu d in g th o se so ld su b je c t to lo ss s h a rin g a rra n g e m e n ts, a s " t r u e ” s a le s a n d , th u s, m a y re m o v e th e a s se ts fro m th e b a la n c e sh e et. T h e risk -b a se d c a p ita l g u id e lin e s for b a n k h o ld in g c o m p a n ie s s ta te th a t w h e r e su c h tra n s a c tio n s h a v e b e e n re m o v e d from th e b a la n c e s h e e t b u t m e e t th e d e fin itio n o f a s se ts so ld w ith re c o u rs e c o n ta in e d in th e in s tru c tio n s to th e C all R e p o rt, th e a s se ts s o ld m u s t b e in c lu d e d in th e c a lc u la tio n o f risk -w e ig h te d a ssets. F o r th is p u rp o s e th e asse ts th a t a r e s o id a re tre a te d a s a n o ff-b alan ce s h e e t e x p o s u re a n d axe c o n v e rta d a t 10Q p e rc e n t to a c r e d it e q u iv a le n t a m o u n t a n d a s s ig n e d to th e a p p r o p r ia te r is k w e ig h t. T h is e x is tin g tre a tm e n t, w h ic h a p p lie s to sa le s o f m u ltifa m ily h o u s in g lo a n s s u b je c t to p ro rata a n d o th e r lo ss s h a rin g a rra n g e m e n ts, is c o n s is te n t w ith th e re q u ir e m e n ts o f RTCRRIA s e c tio n s 618(b) (2) a n d (3). C o m m e n ts R e c e iv e d P u b lic c o m m e n ts w e re re c e iv e d fro m tw e n ty -th re e re s p o n d e n ts : te n b a n k in g o rg a n iz a tio n s , th re e sa v in g s in s titu tio n s , n in e tr a d e a s so c ia tio n s , a n d o n e Taw firm . O f th e tw e n ty -th re e c o m m e n te rs, e ig h te e n fa v o re d lo w e rin g th e ris k w e ig h t for q u a lify in g m u ltifa m ify m o rtg a g es from 100 p e rc e n t to 5 0 p e rc e n t; an® o p p o s e d t h e lo w e r risk w e ig h t; a n d fo u r g a v e n o o v e ra ll o p in io n o n th e p ro p o s a l. C o m m e n te rs r e s p o n d in g fav o rab ly to th e p ro p o sa l g e n e ra lly a g re e d th a t, a lth o u g h lo a n s far m u ltifa m ily r e s id e n tia l p ro p e rtie s co u ld b e ris k ie r th a n lo a n s fo r 1- to 4 -fe m iiy p ro p e rtie s , th e c o m b in a tio n o f th e c rite ria re q u fre d b y se c tio n 6 1 5 fb ) o f RTCRRIA a n d th e a d d itio n a l c rite ria p ro p o s e d b y th e H o ard s h o u ld a s s u re th a t o n ly h ig h q u a lity m u ltifa m ify h o u s in g lo a n s w o u ld b e in c lu d e d in th e 50 p e rc e n t risk w e ig h t cate g o ry . T h e one c o m m e n te r th a t d id n o t s u p p o r t th e p ro p o s a l e x p re s s e d th e v ie w th a t ce rta in m u ltifa m ily lo a n s s h o u ld sta y in th e 100 p e r c e n t risk c a te g o ry b e c a u s e o f th e h is to ric a lly h ig h e r c h a rg e -o ff ra te s a s s o c ia te d w ith th e s e a s se ts . S e v e ra l c o m m e n te rs re q u e s te d c la rific a tio n a s to w h e th e r th e q u a lify in g c rite ria w o u ld b e a p p lie d o n ly o n c e at th e tim e o f lo a n o rig in a tio n or o n a c o n tin u o u s b a s is . T h re e re s p o n d e n ts a d d r e s s e d th e a p p lic a tio n o f th e a n n u a l n e t o p e ra tin g in c o m e -to -d e b t se rv ic e r a tio a s a p p lie d to lo a n s to fin a n c e m u ltifa m ify b u ild in g s o w n e d b y c o o p e ra tiv e h o u s in g c o rp o ra tio n s. T hey n o te d th a t s in c e th is ty p e o f p ro p e rty is g e n e ra lly o p e ra te d a s a n o t-fo r-p ro fit e n te rp ris e , it w o u ld n o t m e e t th e p ro p o s e d a n n u a l n e t o p e ra tin g in c o m eto -d e b t s e rv ic e c o v e ra g e s ta n d a r d a n d th u s , lo a n s to fin a n c e a c q u is itio n o f s u c h p r o p e r tie s c o u ld n o t q u a lify fo r th e 50 p e rc e n t risk w e ig h t categ o ry . T w o c o m m e n te rs d is c u s s e d th e tre a tm e n t of s e c u ritie s b a c k e d b y m u ltifa m ify h o u s in g lo a n s. O n e o f th e s e c o m m e n te rs e x p re s s e d th e v ie w th a t th e re q u ire m e n t th a t a m u ltifa m ify h o u s in g lo a n m u st p e rfo rm in a c c o rd a n c e w ith its te rm s for a t le a s t o n e y e a r before: it c o u ld q u alify for a 50 p e rc e n t risk w e ig h t w o u ld p re v e n t s e c u ritiz a tio n o f m u ltifa m ify lo a n s at o rig in a tio n . T h is c o m m e n te r a ls o n o te d th a t it w o u ld b e d iffic u lt to m o n ito r e a c h u n d e r ly in g lo a n in a Federal Register / Vol. 58, No. 248 / Wednesday, December 29, 1993 / Rules and Regulations 68737 se cu rity for c o n tin u o u s c o m p lia n c e w ith th e q u alify in g criteria. F in a l R u le A fter re v ie w o f th e p u b lic c o m m e n ts, a n d in a g re e m e n t w ith th e o th e r F e d e ra l b a n k in g ag e n cies, th e B o a rd is a d o p tin g a fin al ru le a m e n d in g th e risk -b a se d ca p ita l g u id e lin e s to lo w e r th e risk w eig h t from 100 p e rc e n t to 50 p e rc e n t for lo a n s se c u re d by m o rtg a g es on m u ltifa m ily re s id e n tia l p ro p e rtie s m e etin g c e rta in c o n d itio n s as w e ll as for se c u ritie s b a c k e d by s u c h q u a lify in g m ortgages. T h is final ru le im p le m e n ts se c tio n 618(b) of RTCRRIA a n d se c tio n 305(b)(1)(B) o f FDICIA. T h e c rite ria a m u ltifa m ily h o u s in g lo a n m u s t m e e t to be in c lu d e d in th e 50 p e rc e n t ris k categ o ry are th e sam e as th o se p ro p o se d , e x c e p t th a t th e 80 p e rc e n t av e rag e a n n u a l o c c u p a n c y re q u ire m e n t h a s b e e n e lim in a te d a n d c la rific a tio n h a s b e e n m a d e w ith reg a rd to o th e r c rite ria . F o llo w in g c o n s u lta tio n s w ith th e o th e r ag e n cies, th e B oard h a s d e c id e d to e lim in a te th e r e q u ire m e n t th a t th e p ro p e rty fin a n c e d m u s t h a v e m a in ta in e d an av erag e a n n u a l o c c u p a n c y ra te of at le a st 80 p e rc e n t for th e p re v io u s y ear. C o m m e n ts re c e iv e d by th e o th e r a g e n c ie s in d ic a te d th a t th e a d d itio n a l sa fe g u a rd s th is o c c u p a n c y c rite rio n m ig h t p ro v id e w o u ld b e m in im a l in c o m p a ris o n to th e in c re a s e d re c o rd -k e e p in g b u rd e n it w o u ld c re ate . T h e B o ard b e lie v e s th a t th e re m a in in g c rite ria s h o u ld b e su ffic ie n t to sa tisfy c o n c e rn s re la te d to sa fe ty a n d s o u n d n e s s o f lo a n s s e c u re d by m u ltifa m ily r e s id e n tia l p ro p e rty th a t are assig n ed a 50 p e rc e n t risk w eig h t. S ev eral c o m m e n te rs n o te d th a t c e rta in c o o p e ra tiv e p ro p e rtie s a n d o th e r n o t-fo rp ro fit m u ltifa m ily re s id e n tia l p ro p e rtie s inav n o t be ab le to g e n e ra te su ffic ie n t c a sh flow to sa tisfy th e a n n u a l n e t o p e ra tin g m c o m e -to -d e b t se rv ic e ra tio re q u ire d in th e q u a lify in g c rite ria . In light of th e se c o m m e n ts, th e fin a l ru le sp e c ifie s th a t c o o p e ra tiv e a n d o th e r n o tfor-p ro fit m u ltifa m ily re s id e n tia l p ro p e rtie s m ay b e d e e m e d to sa tisfy th e a n n u a l n e t o p e ra tin g in c c m e -to -d e b t serv ice ra tio r e q u ire m e n t if th e y g en e rate su ffic ie n t c a sh flow to p ro v id e c o m p a ra b le p ro te c tio n to th e in s titu tio n . S u fficien t c a sh flow to p ro v id e c o m p a ra b le p ro te c tio n m ay b e g e n e ra te d n a v a rie ty of w ay s, for e x a m p le , t h r o u g h a d d itio n s to sp e c ia l o p e ra tin g rese rv e a c c o u n ts or sp e c ia l su b s id ie s p ro v id e d by F e d e ra l, state, lo c al, or p riv a te so u rce s. T h is c o m p a ra b le o ro te c tio n a c c o m m o d a tio n c o u ld a llo w aw - a n d m o d e ra te -in c o m e n o t-fo r-p ro fit m u ltifa m ily h o u s in g p ro je c ts to q u a lify for th e 50 p e rc e n t risk ca te g o ry , p r o v id e d th a t th e y m e e t th e o th e r c rite ria . T h e B o ard n o te s th a t th e a n n u a l d e b t se rv ic e ra tio r e q u ire m e n ts m u st b e sa tisfie d o n an o n -g o in g b a sis for a m u ltifa m ily h o u sin g lo a n to c o n tin u e to re c e iv e a 50 p e rc e n t risk w eig h t. In a d d itio n , th e fin al ru le sta te s th a t for p u rp o s e s o f sa tisfy in g th e o n e y e a r's tim e ly p e rfo rm a n c e c rite rio n in th e case w h e re th e e x istin g o w n e r o f a m u ltifa m ily re s id e n tia l p ro p e rty is re fin a n c in g a lo a n on th a t p ro p e rty , all p r in c ip a l a n d in te re s t p a y m e n ts o n th e lo a n b e in g re fin a n c e d m u st h a v e b e e n m a d e o n a tim e ly b a sis in a c c o rd a n c e w ith th e te rm s of th e lo a n for at le a st th e p re c e d in g year. T h e e x istin g risk -b a se d c a p ita l g u id e lin e s sp e cify th a t p r u d e n t u n d e rw ritin g s ta n d a rd s in c lu d e a c o n s e rv a tiv e lo a n -to -v a lu e ra tio , a n d th e p ro p o s e d ru le s ta te d th a t, in th e ca se of a lo a n s e c u re d b y m u ltifa m ily re s id e n tia l p ro p e rty , th e lo a n -to -v a lu e ra tio w o u ld n o t b e d e e m e d c o n s e rv a tiv e if it e x c e e d e d 80 p e rc e n t (75 p e rc e n t if th e lo a n is b a se d o n a flo a tin g in te re s t rate). T h e fin a l ru le n o te s th a t p r u d e n t u n d e rw ritin g s ta n d a rd s d ic ta te th a t a lo a n -to -v a lu e ra tio u s e d in th e ca se o f a lo a n to a c q u ire a p ro p e rty w o u ld n o t b e d e e m e d c o n s e rv a tiv e u n le s s th e v a lu e is b a se d on th e lo w e r of th e p u rc h a s e p ric e o f th e p ro p e rty o r th e v a lu e as d e te rm in e d b y th e m o st c u rre n t a p p ra is a l or, if a p p ro p ria te , th e m o st c u rre n t e v a lu a tio n . O th e rw ise , th e loanto -v a lu e ratio g e n e ra lly w o u ld be b a s e d u p o n th e v alu e of th e p ro p e rty as d e te rm in e d by th e m o st c u rre n t a p p ra is a l or, if a p p ro p ria te , th e m o st c u rre n t e v a lu a tio n . S u b s e q u e n t a p p ra is a ls (or e v a lu a tio n s) of a m u ltifa m ily p ro p e rty w ill n o t be re q u ire d for th e p u rp o s e o f c o n tin u in g to in c lu d e th e lo an s e c u re d by su c h p ro p e rty in th e 50 p e rc e n t risk categ o ry . H o w ev er, if a s u b s e q u e n t a p p ra is a l (or e v a lu a tio n ) is o b ta in e d a n d it in d ic a te s th a t th e lo a n -to -v a lu e ra tio e x c e e d s th e s ta tu to ry re q u ire m e n ts, th e lo a n w o u ld h a v e to be re a ssig n e d to th e 100 p e rc e n t risk categ o ry . In c o n n e c tio n w ith th e lo a n -to -v a lu e ra tio c rite rio n , th e B o ard also n o te s th a t u n d e r th e a g e n c ie s ’ 1992 rea l e state le n d in g s ta n d a rd s re g u la tio n s a n d g u id e lin e s , as a g e n e ra l m a tte r, in s titu tio n s m ay e x te n d lo a n s to im p ro v e d p ro p e rty , w h ic h in c lu d e s e x istin g m u ltifa m ily re s id e n tia l p ro p e rty , w ith lo a n -to -v a lu e ra tio s o f u p to 85 p e rc e n t. T h e se g u id e lin e s , w h ic h im p le m e n t se c tio n 304 o f FDICIA, b e c a m e effec tiv e o n M a rc h 1 9 ,1 9 9 3 . W h ile th e se g u id e lin e s p e rm it in s titu tio n s to m a k e lo a n s se c u re d by e x istin g m u ltifa m ily p ro p e rty w ith lo an - to -v a lu e ra tio s th a t e x c e e d 80 p e rc e n t, su c h lo a n s w o u ld n o t q u a lify for th e 50 p e rc e n t risk ca te g o ry . R a th e r, th e y s h o u ld b e a s sig n e d to th e 100 p erc en t risk categ o ry . T h e fin a l ru le p ro v id e s th a t s e c u ritie s b a c k e d by m o rtg a g es on m u ltifa m ily r e s id e n tia l p ro p e rtie s m a y b e a c co rd ed a 50 p e rc e n t risk w e ig h t if each u n d e rly in g m o rtg a g e sa tisfie s all th e c rite ria for e lig ib ility for th e 50 p e rc e n t risk w e ig h t at th e tim e th e p o o l is o rig in a te d a n d th e s tru c tu re o f th e s e c u rity m e e ts c e rta in te c h n ic a l criteria se t fo rth in th e g u id e lin e s. T h is tre a tm e n t p a ra lle ls th a t a c c o rd e d to s e c u ritie s b a c k e d by m o rtg ag es on 1- to 4 -fa m ily r e s id e n tia l p ro p e rtie s th a t q u a lify for a 50 p e rc e n t risk w eig h t. In lig h t of is s u e s ra is e d b y c o m m en ters, th e B o ard is c la rify in g th a t th e fin al ru le d o e s n o t re q u ire m o n ito rin g of e a c h loan th a t h a s b e e n p o o le d in to a s e c u rity for c o n tin u o u s c o m p lia n c e w ith all th e q u a lify in g c rite ria . A s a sa fe g u ard a g a in st d e te rio ra tio n in th e u n d e rly in g asse ts, h o w e v e r, th e fin a l ru le stip u la te s th a t a s e c u rity b a c k e d b y m u ltifa m ily m o rtg ag e lo a n s m a y b e a c c o rd e d a 50 p e rc e n t risk w e ig h t o n ly as lo n g as p r in c ip a l a n d in te re s t p a y m e n ts on th e s e c u rity are n o t m o re th a n 30 d ay s p ast d u e. F in a lly , in o rd e r to co n fo rm th e B o a rd ’s re g u la to ry la n g u a g e to th a t of th e o th e r a g e n c ie s, th e fin a l ru le a m e n d s th e risk -b a se d c a p ita l g u id e lin e s for sta te m e m b e r b a n k s b y cla rify in g in a fo o tn o te th a t a m u ltifa m ily h o u s in g loan th a t is s o ld su b je c t to a p ro ra ta loss sh a rin g a rra n g e m e n t is to b e tre a te d by th e s e llin g b a n k as so ld (an d e x c lu d e d fro m th e b a la n c e sh e e t assets), to th e e x te n t th a t th e sa le s a g re e m e n t p ro v id e s for th e p u r c h a s e r of th e lo a n to sh a re in an y lo ss in c u rr e d on th e lo a n on a pro ra ta b a sis w ith th e se llin g b an k . T h is m e a n s th a t, in s u c h a tra n s a c tio n , th e p o rtio n of th e lo a n th a t is tre a te d as so ld b y th e se llin g b a n k is e x c lu d e d from th e c a lc u la tio n of th e risk -b a se d c a p ita l ratio . W ith re g a rd to b a n k h o ld in g c o m p a n ie s , a fo o tn o te in th e final ru le c la rifie s th a t m u ltifa m ily h o u sin g lo an s so ld su b je c t to su c h p ro ra ta lo ss sh a rin g a rra n g e m e n ts , m ay b e tre a te d as so ld , for risk -b a se d c a p ita l p u rp o se s, to the sa m e e x te n t as for b an k s. T h e p o rtio n th a t is s o ld w o u ld n o t be su b je ct to the 100 p e rc e n t c o n v e rsio n fac to r n o rm a lly a p p lie d to a s se ts so ld w ith re c o u rse but ra th e r w o u ld b e e x c lu d e d from th e c a lc u la tio n of th e risk -b a se d c a p ita l ratio . T h e c la rify in g fo o tn o te s also p ro v id e g u id a n c e o n th e risk -b a se d c a p ita l tre a tm e n t o f sa le s o f m u ltifa m ily h o u s in g lo a n s in w h ic h th e p u rc h a s e r of /06ZG 68738 Federal Register / Vol. 58, No. 248 / Wednesday, December 29, 1993 / Rules and Regulations a lo a n s h a re s in a n y lo ss in c u rr e d on th e lo an w ith th e s e llin g in s titu tio n o n o th e r th a n a p ro rata b asis. T h e se o th e r lo ss sh a rin g a rra n g e m e n ts are ta k e n in to a c c o u n t, for p u rp o s e s o f d e te rm in in g th e e x te n t to w h ic h s u c h lo a n s are tre a te d by th e se llin g b a n k in g o rg a n iz a tio n as so ld for risk -b a se d c a p ita l p u rp o s e s , a n d e x c lu d e d from a b a n k ’s b a la n c e sh e e t as se ts o r th e c re d it e q u iv a le n t a m o u n t of a b a n k h o ld in g c o m p a n y ’s o ff-b alan ce sh e et ite m s, in th e sa m e m a n n e r as p re sc rib e d in th e in s tru c tio n s to th e Call R eport. A s n o te d e a rlie r, th e se fo o tn o te s reflect th e e x istin g C all R e p o rt a n d riskb a se d c a p ita l tre a tm e n t w ith re sp e c t to s u c h as se ts so ld su b je c t to lo ss sh a rin g arra n g e m e n ts. In a d d itio n , th e B o a rd n o te s th a t th e B oard a n d th e o th e r b a n k in g a g e n c ie s, u n d e r th e a u s p ic e s o f th e F e d e ra l F in a n c ia l In s titu tio n s E x a m in a tio n C o u n se l (FFIEC), h a v e b e e n w o rk in g to g e th e r to d e v e lo p re v is io n s to th e a g e n c ie s ’ risk -b a se d c a p ita l s ta n d a rd s th a t w ill b e tte r d is tin g u is h b e tw e e n th e d eg rees o f risk in lo ss sh a rin g a rra n g e m e n ts in v o lv in g a sse t sa les in g en eral. In th is reg a rd , o n D ec em b e r 16. 1993, th e B o ard a p p ro v e d a re c o m m e n d a tio n from th e F e d e ra l F in a n c ia l In s titu tio n E x a m in a tio n C o u n c il to seek p u b lic c o m m e n t on a N o tice o f P ro p o se d R u le m a k in g a n d an A d v a n c e d N o tic e o f P ro p o se d R u lem a k in g c o n c e rn in g th e re g u la to ry tre a tm e n t of as se ts so ld su b je c t to loss sh a rin g a rra n g e m e n ts. T o th e e x te n t th e se p ro p o s a ls a p p ly to m u ltifa m ily h o u sin g lo a n s, th e y w o u ld , if a d o p te d , also sa tisfy th e re q u ire m e n ts of se c tio n 618(b)(3) of RTCRRIA. F in a lly , th e B oard fin d s, for good ca u se , tliat an im m e d ia te e ffec tiv e d ate is n e c e s sa ry in o rd e r to se rv e th e p u b lic in te re st, a v o id c o n fu s io n , a n d e x p e d ite th e re p o rtin g o f a c a p ita l ch a rg e th a t is c o m m e n s u ra te w ith th e risk s a sso c ia te d w ith m u ltifa m ily h o u s in g lo a n s th a t m e et th e s p e c ifie d c rite ria . A D ecem b er 31. 1993 effec tiv e d a te w ill e n a b le b a n k in g o rg a n iz a tio n s to u se th e re d u c e d risk w e ig h t for m u ltifa m ily h o u s in g lo a n s in th e ir e n d -o f-y e a r re g u la to ry re p o rts. In a d d itio n , th e B oard b e lie v e s th is effec tiv e d a te is a p p ro p ria te b e c a u s e th e re v isio n w o u ld re d u c e , ra th e r th a n e x p a n d , re g u la to ry b u rd e n . Regulatory Flexibility Act Analysis T h e F e d e ra l R eserv o B o ard d o e s n o t b eliev e a d o p tio n o f th is fin al ru le w o u ld h av e a s ig n ific a n t e c o n o m ic im p a c t on a s u b s ta n tia l n u m b e r o f sm a ll b u s in e s s e n titie s (in th is case , sm a ll b a n k in g o rg a n iz a tio n s), in a c c o rd w ith th e s p irit a n d p u rp o s e s of th e R e g u la to ry F le x ib ility A ct (5 U .S.C. 601 et seq ). In th is reg ard , th e fin a l ru le w o u ld re d u c e c e rta in re g u la to ry b u rd e n s o n b a n k h o ld in g c o m p a n ie s as it w o u ld re d u c e th e c a p ita l ch a rg e on c e rta in tra n sa c tio n s. In a d d itio n , b e c a u se th e risk -b a se d c a p ita l g u id e lin e s g e n e ra lly do n o t a p p ly to b a n k h o ld in g c o m p a n ie s w ith c o n s o lid a te d a sse ts o f le ss th a n $15 0 m illio n , th is p ro p o sa l w ill n o t affect su c h c o m p a n ie s. L ist of Subjects 12 CFR P art 208 A c c o u n tin g , A g ric u ltu re , B an k s, b a n k in g , C o n fid e n tia l b u s in e s s in fo rm a tio n , C u rre n c y , R e p o rtin g a n d re c o rd k e e p in g re q u ire m e n ts, S e c u ritie s. 12 CFR P art 225 A d m in is tra tiv e p ra c tic e a n d p ro c e d u re , B anks, b a n k in g , H o ld in g c o m p a n ie s, R e p o rtin g a n d re c o rd k e e p in g re q u ire m e n ts , S e c u ritie s. F or th e re a so n s se t fo rth in th e p re a m b le th e B o ard is a m e n d in g 12 CFR p a rts 208 a n d 225 to re a d as fo llo w s: PART 208— MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL RESERVE SYSTEM (REGULATION H) 1. T h e a u th o rity c ita tio n for p a rt 208 c o n tin u e s to re a d as follow s: Authority: 12 U.S.C. 36, 248(a) and (c). 321-338, 461,431-486, 601, 611, 1814, 1823(i), 18310, 1831p-l. 3906-3909, 3310, 3331-3351; 15 U.S.C. 78b, 78o-4(c)(5), 78q, 78q-l, 78w, 781(b), 781(i), and 1781(g). 2. A p p e n d ix A to p a rt 208 is a m e n d e d by re v isin g th e first p a ra g ra p h o f se c tio n III.C.3., a n d C ateg o ry 3 Item 1. of A tta c h m e n t III to re a d as fo llo w s: Appendix A to Part 208— Capital Adequacy Guidelines for State Member Banks: Risk-Based Measure * * * * * III. Procedures for Computing Weighted Risk Assets and Off-Balance Sheet Items * * * * * C. Risk Weights * * * * * 3. C a te g o r y 3. 5 0 p e r c e n t. This category includes loans fully secured by first liens34 on 1- to 4-familv residential properties, either owner-occupied or rented, or on multifamily residential properties,3s that meet certain 34 !f a bank holds the first and junior liens(s) on a residential property and no other party holds an intervening lien, the transaction is treated as a single loan secured by a first lien for the purpose of determining the loan-to-value ratio. 35 Loans that qualify as loans secured by 1- to 4family residential properties or m ultifam ily residential properties are listed in the instructions to the com m ercial bank Call Report. In addition, for risk-based capital purposes, loans secured by 1- to 4-family residential properties inclu de loans to criteria.36 Loans included in this category , must have been made in accordance with prudent underwriting standards:37 bo performing in accordance with their original terms; and not be 90 days or more past due or carried in nonaccrual status. The following additional criteria must also be applied to a loan secured by a multifamily residential property that is included in this category: all principal and interest payments on the loan must have been made on time for at least the year preceding placement in this category, or in the case where the existing property owns is refinancing a loan on that property, all principal and interest payments on the loan being refinanced must have been made on time for at least the year preceding placemen in this category; amortization of the principal and interest must occur over a period of not more than 30 years and the minimum original maturity for repayment of principal must not be less than 7 years; and the annua net operating income (before debt service) generated by the property during its most recent fiscal year must not be less than 120 percent of the loan’s current annual debt service (115 percent if the loan is based on a floating interest rate) or, in the case of a builders w ith substantial project equity for the construction of 1- to 4-fam ily residences that have been presold under firm contracts to purchasers w ho have obtained firm com m itm ents for permanent qualifying mortgage loans and have made substantia] earnest m oney deposits. The instructions to the Call Report also discuss the treatment of loans, inclu ding m ultifam ily housing loans, tliat are sold subject to a pro rata lo sharing arrangement. Such an arrangement should be treated by the selling bank as sold (and exclude from balance sheet assets) to the extent that the sales agreement provides for the purchaser of the. loan to share in any loss incurred on the loan on a pro rata basis w ith the selling bank. In such a transaction, from the standpoint of the selling ban the portion of the loan that is treated as sold is r.ci subject to the risk-based capital standards. In connection w ith sales of m ultifam ilv housing loar in w hich the purchaser of a loan shares m any los incurred on the loan w ith the selling instituuon o other than a pro rata basis, these other loss sharini arrangements are taken into account for purposes determ ining the extent to w hich such loans are treated by the selling bank as sold [and excluded from balance sheet assets) under the risk-based capital framework in the same manner as present for reporting purposes in the instructions to the C R eport 36 Residential property loans that do not meet a the specified criteria or that are m ade for the purpose of specu lative property developm ent are placed in the 100 percent risk category. 37 Prudent underwriting standards include a conservative ratio of the current loan balance to !' value of the property. In the case of a loan secure by m ultifam ily residential property, the loan-tovalue ratio is not conservative if it exceeds 80 percent (75 percent if the loan is based on a fioati interest ratej. Prudent underwriting standards ais dictate that a loan-to-value ratio used in the case originating a loan to acquire a property w ould no be deem ed conservative un less the value is based on the low er of the acquisition cost of the proper or appraised (or if appropriate, evaluated) value. Otherwise, the loan-to-value ratio generally woul be based upon the value of the property as determ ined by the most current appraisal, or if appropriate, the most current evaluation. All appraisals m ust be made in a manner consistent with the Federal banking agencies real estate appraisal regulations and guidelines and w ith th bank's ow n appraisal g u id elin es Federal Register / Vol. 58, No. 248 / Wednesday, December 29, cooperative or other not-for-profit housing project, the property must generate sufficient cash flow to provide comparable protection to the institution. Also included in this category are privately-issued mortgagebacked securities provided that (1) The structure of the security meets the criteria described in section 111(B)(3) above; (2) If the security is backed by a pool of conventional mortgages, on 1- to 4-family residential or multifamily residential properties each underlying mortgage meets the criteria described above in this section for eligibility for the 50 percent risk category at the time the pool is originated; (3) If the security is backed by privatelyissued mortgage-backed securities, each underlying security qualifies for the 50 percent risk category; and (4) If the security is backed by a pool of multifamily residential mortgages, principal and interest payments on the security are not 30 days or more past due. Privately-issued mortgage-backed securities that do not meet these criteria or that do not qualify for a lower risk weight are generally assigned to the 100 percent risk category. * * * * * Attachment III—Summary of Risk Weights and Risk Categories for State Member Banks * * * * * C a te g o r y 3: 50 Percent 1. Loans fully secured by first liens on 1to 4-family residential properties or on multifamily residential properties that have been made in accordance with prudent underwriting standards, that are performing in accordance with their original terms, that are not past due or in nonaccrual status, and that meet other qualifying criteria, and certain privately-issued mortgage-backed securities representing indirect ownership of such loans. (Loans made for speculative purposes are excluded.) * * * * * PART 225— BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL (REGULATION Y) 1. T h e a u th o rity c ita tio n for p a rt 225 ;o n tin u e s to re a d as follo w s: Authority: 12 U.S.C. 1817(j)(13), 1818, 18311. 1831p—1, 1843(c)(8), 1844(b), 1972(1), 1106, 3108, 3907, 3909, 3310, and 33311351 2. A p p e n d ix A to p a rt 225 is a m e n d e d iy re v isin g th e first p a ra g ra p h of se c tio n II.C .3., fo o tn o te 48 in se c tio n III.D .l., n d C ategory 3 Item 1. o f A tta c h m e n t III o rea d as follow s: Appendix A to Part 225— Capital adequacy Guidelines for Bank Holding iompanies: Risk-Based Measure * * * * [I. Procedures for Computing Weighted Risk .ssets and Off-Balance Sheet Items * * * * CL Risk Weights * * * * * 3. Category 3:5 0 percent. This category includes loans fully secured by first liens *7 on 1- to 4-family residential properties, either owner-occupied or rented, or on m ultifam ily residential properties,38 that meet certain criteria.*3*1 Loans included in this category m ust have been made in accordance w ith prudent underw riting standards;48 be performing in accordance w ith their original terms; and not be 90 days or more past due or carried in nonaccrual status. The following additional criteria m ust also be applied to a loan secured by a m ultifam ily residential property that is included in this category: all principal and interest payments on the loan must have been made on tim e for at least the year preceding placem ent in this category, or in the case where the existing property ow ner is refinancing a loan on that property, all principal and interest paym ents on the loan being refinanced m ust have been m ade on time for at least the year preceding placem ent in this category, am ortization of the principal and interest m ust occur over a period of not more than 30 years and the m inim um original maturity for repaym ent of principal must not be less than 7 years; and the annual net operating income (before debt service) generated by the property during its most recent fiscal year m ust not be less than 120 percent of the loan's current annual debt service (115 percent if the loan is based on a floating interest rate) or, in the case of a cooperative or other not-for-profit housing project, the property m ust generate sufficient cash flow to provide comparable protection 37 If a banking organization holds the Erst and junior lian(s) on a residential property and no other party holds an intervening lien, the transaction is treated as a single loan secured by a first lien for the purpose of determining the loan-to-value ratio. Loans that qualify as loans secured by 1- to 4 family residential properties or muLtifamily residential properties are Listed in the instructions to the FR Y-9C Report In addition, for risk-based capital purposes, loans secured by 1- to 4-family residential properties include loans to builders with s u b s ta n tia l p ro je c t e q u ity for the c o n s tr u c tio n of 1to 4-family residences that have been presold under firm contracts to purchasers who have obtained firm commitments for permanent qualifying mortgage loans and have made substantial earnest money deposits. 3» Residential property loans that do not meet all the specified criteria or that are made for the purpose of speculative property development are placed in the 100 percent risk category. *o Prudent underwriting standards include a conservative ratio of the current loan balance to the value of the property. In the case of a loan secured by multifamily residential property, the ioan-tovalue ratio is not conservative if it exceeds 80 percent (75 percent if the loan is based on a floating interest rate). Prudent underwriting standards also dictate that a loan-to-value ratio used in the case of originating a loan to acquire a property would not be deemed conservative unless the value is based on the lower of the acquisition cost of the property or appraised (or if appropriate, evaluated) value. Otherwise, the ioan-to-vaiue ratio generally would be based upon the value of the property as determined by the most current appraisal, or if appropriate, the most current evaluation. All appraisals must be made in a manner consistent with the Federal banking agencies' real estate appraisal regulations and guidelines and with the banking organization's own appraisal guidelines. jO<b & (o 1993 / Rules and Regulations 68739 to the institution. Also included in this category are privately-issued mortgagebacked securities provided that: (1) The structure of the security meets the criteria described in section. 111(B)(3) above; (2) if the security is backed by a pool of conventional mortgages, on 1- to 4-family residential or multifamily residential properties, each underlying mortgage meets the criteria described above in this section for eligibility for the 50 percent risk category at the tim e the pool is originated; (3) If the security is backed by privatelyissued mortgage-backed securities, each underlying security qualifies for the 50 percent risk category; and (4) If the security is backed by a pool of m ultifam ily residential mortgages, principal and interest paym ents on the security are not 30 days or more past due. Privately-issued mortgage-backed securities that do not meet these criteria or that do not qualify for a lower risk weight are generally assigned to the 100 percent risk category. * * * * * D. Off-Balance Sheet Items * * * * * * 1. * * * 48 * * * * Attachm ent in —Summary o f R isk W eights and R isk Categories for Bank Holding Companies * * * * * Category 3: 50 Percent 1. Loans fully secured by first liens on 1to 4-family residential properties or on m ultifam ily residential properties that have been made in accordance w ith prudent underw riting standards, that are performing in accordance w ith their original terms, that are not past due or in nonaccrual status, and that meet other qualifying criteria, and certain privately-issued mortgage-backed securities representing indirect ow nership of 48 In regulatory reports and under GAAP, bank holding companies are permitted to treat some asset sales with recourse as "true” sales. For risk-based capital purposes, however, such assets sold with recourse and reported as "true" sales by bank holding companies are converted at 100 percent and assigned to the risk category appropriate to the underlying obligor or, if relevant the guarantor or nature of the collateral, provided that the transactions meet the definition of assets sold with recourse (including assets sold subject to pro rata and other loss sharing arrangements), that is contained in the instructions to the commercial bank Consolidated Reports of Condition and Income (Call Report). This treatment applies to any assets, including the sale of 1- to 4-family and multifamily residential mortgages, sold with recourse. Accordingly, the entire amount of any assets transferred with recourse that are not already included on the balance sheet, including pools of 1- to 4-family residential mortgages, are to be converted at 100 percent and assigned to the risk category appropriate to the obligor, or if relevant, the nature of any collateral or guarantees. The only exception involves transfers of pools of residential mortgages that have been made with insignificant recourse for which a liability or specific non-capital reserve has been established and is maintained for the maximum amount of possible loss under the recourse provision. , it fcSrg. . 68740 Federal Register / Vol. 58, No. 248 / Wednesday, December 29, 1993 / Rules and Regulations such loans. (Loans made for speculative purposes are excluded.) * * * if * Board of Governors of the Federal Reserve System, December 17, 1993. William W. Wiles, S e c r e ta r y o f th e B o a r d . 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