The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
4
Federal R eserve
N E W
Y O R K ,
Bank of
N.Y.
N e w Yo r k
1 0 0 4 5
AREA CODE 212 7 2 0 - 5 5 4 5
Fr e d
erick
C. S
chadrack
E x e c u t iv e V ic e P r e s i d e n t
Ju ly 30, 1990
TO:
Chief Executive Officer of Each Bank Holding
Company in the Second Federal Reserve District
SUBJECT:
Request for Comment on Issues
Related to Recourse Arrangements
The Federal Financial Institutions Examination
Council is requesting public comment on the definition of
"recourse" and the appropriate regulatory 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 five agencies represented on the Examination
Council are considering the issuance of regulations or
guidelines that would deal with the regulatory capital
treatment of, and revise the regulatory reporting standards
for, recourse arrangements for depository institutions and
bank holding companies. Comments from the public will
assist the agencies in developing, to the extent practicable,
a comprehensive and uniform treatment of recourse arrange
ments.
A copy of the Examination Council's Federal
Register Notice on recourse arrangements is enclosed.
Comments on the proposal are due by August 28, 1990, and
should be addressed to the Federal Financial Institutions
Examination Council, 1776 G Street N.W., Suite 850B,
Washington, D.C. 20006.
We would appreciate receiving a duplicate copy of
any comments that you may make on this proposal.
Sincerely,
Enclosure
26766
Federal Register / Vol. 5 , No. 126 / Frid y June 2 , 1990 / Notices
5
a,
9
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.
ADDRESSES: 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.
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 a3 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
FEDERAL FINANCIAL INSTITUTIONS
has become increasingly popular, as in
EXAMINATION COUNCIL
some cases it has enabled financial
institutions and bank holding companies
Recourse Arrangements
to remove assets, or portions of assets,
from their books. Asset securitization
agency : Federal Financial Institutions
may allow a financial institution to
Examination Council.
reduce the capital necessary to meet
actio n : Request for comment.
regulatory minimums or to reduce the
total amount of outstanding loans to an
SUMMARY: The five member agencies of
individual borrower. Further, asset
the Federal Financial Institutions
securitization can provide a financial
Examination Council (the “FFIEC”),
institution a source of funds through the
which include the Board of Governors of
sale of its assets, which enables the
the Federal Reserve System (“FRB”), the
institution to increase its liquidity. Asset
Federal Deposit Insurance Corporation
securitization may also provide an
(“FDIC”), the National Credit Union
adidtional source of continuing income
Administration (“NCUA”), the Office of
to a financial institution that acts as
the Comptroller of the Currency
servicer of a pool of securitized assets.
(“OCC”), and the Office of Thrift
Supervision (“OTS”) (collectively, the
Early securititized programs, dating
FOR FURTHER INFORMATION CONTACT:
“Agencies”), are considering issuing
from the 1970’s, were usually federally
At the FRB: Roger H. Pugh, Manager,
regulations or Guidelines to address the
sponsored, and were generally intended
regulatory capital treatment of recourse
Policy Development Division of Banking to enhance the secondary residential
Supervision and Regulation (202) 728arrangements for depository institutions
mortgage market. Three federally5883; Thomas R. Boemio, Senior
and bank holding companies. The
sponsored agencies, the Governmental
Financial Analyst, Division of Banking
Agencies are also considering revising
National Mortgage Association
Supervision and Regulation (202) 452the regulatory reporting requirements
(“GNMA”), the Federal National
2982. At the FDIC: Robert F. Storch,
applicable to asset transfers with
Mortgage Association (“FNMA”), and
Chief, Accounting Section, Division of
recourse and revising the lending limit
the Federal Home Loan Mortgage
treatment of recourse arrangements for ' Supervision (202) 898-8906. At the
^ Corporation (“FHLMC”), were each
NCUA: Alonzo Swann, Director,
national banks and savings
provided statutory authority to
associations. The Agencies plan to work Department of Operations, Office of
guarantee the payment of principal and
Examination and Insurance, (202) 682together to develop common definitions
interest to investors in pools of
9640. At the OCC: Owen Carney, (202)
and treatments of recourse
qualifying residential mortgages.
447-1901; Richard Cleva, Senior
arrangements, where appropriate.
Generally, the Federal government may
Attorney, Legal Advisory Services
"Recourse” refers to a financial
bear some of the risk of loss in these
Division (202) 447-1883; or Laura H.
institution’s acceptance, assumption or
agency asset securitization programs, by
Plaze, Senior Attorney, Legal Advisory
providing federal insurance for certain
retention of some or all of the risk of
Services Division (202) 447-1883. At the
loss generally associated with
of the underlying mortgages and through
OTS: Robert Fishman, Senior Project
the GNMA guarantee, which is backed
ownership of an asset, whether or not
Manager (202) 906-5672; Carol
the institution owns or has ever owned
by the full faith and credit of the United
Wambeke, Financial Economist (202)
the asset. As the primary federal
States.
Federal Register / Vol. 5 , No. 126 / Frid y June 2 , 1990 / Notices
5
a,
9
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, eg., 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 FR 4186
(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
Guidelines, 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 567)
(collectively, the "risk-based capital
standards"). While 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 o f the OCC,
FRB and FDIC are b a s e d on the international
framework for capital standards established in July
1988. by the Basle Committee on Banking
Regulations and Supervisory Practices (since
arrangements exposeta 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 * 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.
renam ed the B asle C om m ittee on Banking
Supervision). T h e In te rn a tio n a l fram ew ork is
described in a p a p e r e n titled the International
C onvergence o f C a p ital M easurem ent a n d C apital
S ta n d a rd s d a te d July 198&
* See generally, 12 U.&.C. 64 (limiting the total
loans an d e x ten sio n s of cred it a n atio n al bank m ay
h ave o utstanding to on e borro w er a t one time); 12
U.S.C. 1484(u), a s a d d e d by the Financial
Institutions Reform. R ecovery a n d E nforcem ent A ct
o f 1989. Pub. L 101-73, 301.103 S t a t 183 (August 9.
1989) f'FIR R E A ") (providing th a t the lending limits
ap p licab le to n atio n a l b a n k s u nder 12 U.S.C. 84
shall apply in the sa m e m an n er an d to the sam e
ex te n t 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." 8 Together, the Glossary and
Schedule RC-L establish four separate
reporting treatments for asset transfers
with recourse.
First, a general rule is provided for the
transfer of most assets other 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 conditions are met: (1) The
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
• Schedule RC-L was previously named
"Commitments and Contingencies." Effective March
31.199a this schedule was renamed “Off-Balance
Sheet Items."
* Item 9 was numbered Memorandum Item 4 prior
to the changes made to Schedule RC-L, effective
March 31.199a
26768
Federal Register / VoL 5 , No. 126 / Friday, June 2 , 1990 / Notices
5
9
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. *
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.* 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
except pursuant to the recourse
provision, and establishes a liability
account or specific reserve to absorb the
estimated loss.7
B. 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 M arch, 1989, the FFIEC issu ed reporting
guidance for certain n ew item s being a d d e d to the
Call R eport’s Schedule RC-L, w hich h a s now been
in co rp o rated in the Call R eport Instructions. See
p ages 7 a n d 8 o f th e enclosure to the F F IE C • Bank
L etter d a te d M arch 9,1989 (BL-10-89) a n d Call
R eport Instructions (Schedule RC-L. In stru ctio n s to
Item 9(b)(1)). Am ong o th er provisions, this guidance
clarified the m eaning o f “significant risk of lo ss,”
statin g th a t if “th e m axim um co n tractu al ex p o su re
u n d er th e recourse provision (or through the
reten tio n o f a su b o rd in ated in terest in the
m ortgages) a t the tim e o f the tran sfer is g reater than
the am ount of p ro b ab le loss th at the b an k h a s
re a so n a b ly estim ated th at it w ill incur.” then the
“issuing b an k " h a s re tain ed the entire risk o f loss,
an d the m ortgage tran sfers m ay n ot b e rep o rted a s
sales. Id.
• See 12 U.S.C. 2279aa et seq. (establishing the
F ed eral A gricultural M ortgage C o rp o ra tio a know n
a s “F a n n e r M ac”).
i
See infra sectio n IV(B) (1) for d iscussion of
GA A P treatm en t of asse t sales w ith 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.
IL Capital Treatment of Recourse
Arrangements
A. Current Leverage ratio Requirem ents
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
capital support is explicitly required for
the asset as a function of the current
leverage ratios.* Consequently, because
* The risk-based capital guidelines issu ed b y the
FRB, the FDIC an d the O CC in early 1888 w ill be
p h ased in over a tw o -y ear transitional period
beginning D ecem ber 31,1990. P roposed n ew
leverage ratio s a re discussed infra.
• T his result ste m s from the definitions of term s
used in each agency's regulations. For exam ple, the
O C C 's regulations require th at n atio n a l ban k s
m aintain total c a p ita l equal to a t le a st 6% of
“adju ste d total a s s e ts ” a n d prim ary cap ital equal to
a t least 5.5% o f “ad ju ste d total a s se ts .” See 12 CFR
3.8. “A djusted to ta l a s s e ts ” is defined by reference
to the average to ta l a s se ts figure” com puted for an d
sta te d in a b a n k 's m ost recen t q u a rterly C all R e p o rt
Id. a t ( 3.2(a). A ssets th a t a n a tio n al ban k h a s not
transferred, an d a s se t transfers th a t a re not
accorded sa le tr e a tm e n t are included in. the average
total a ssets rep o rted in the C all R e p o rt C onversely,
a s se t transfers th a t a re given sa le treatm en t a re not
rep o rted a s p a rt o f the b a n k ’s a s s e t b ase, an d thus
are not factored into the d enom inator o f the prim ary
a n d total capital ratios.
Sim ilarly, the FRB guidelines an d the FDIC
regulations for federally-insured sta te -ch artered
m em ber an d nonm em ber b anks require these
institutions to m aintain m inim um levels o f total
cap ital to “to tal a s s e ts ” of 6% an d o f prim ary capital
to “total a s se ts” o f 5.5%. See 12 CFR 206.13 an d
appen d ix B to 12 CFR p a rt 225. S ee a lso 12 CFR
325.3(b). The to tal a s se ts figure u se d in calculating
these ratio s is defined w ith reference to the
q uarterly average total a sse ts figure reported on a
b a n k 's Call R e p o rt See appendix B to 12 CFR p a rt
225, "C apital R atios.” See also 12 CFR 325^(k). If a n
■ a s se t is n o t reported in a federally-insured sta te chartered m em ber o r nonm em ber b a n k 's Call
R e p o rt the a sse t is not factored into the calculation
o f the b an k ’s “to tal a s se ts .”
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 varous 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 always
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 OCCs 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 FDIc.
contain similar provisions. See
Federal Register / Vol. 5 , No. 126 / Friday, June 2 , 1990 / Notices
5
9
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.
S e e 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. P r o p o s e d N e w L e v e r a g e R a tio s f o r
N a tio n a l B a n k s a n d F e d e r a lly -I n s u r e d
S ta te - C h a r te r e d B a n k s
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
m in im u m amount of capital calculated
as a percentage of its asset base
reported in the Call Report.1* The FRB,
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.1*
IIL Current Lending Limit Treatment of
Recourse Arrangements
Banks and savings associations are
subject to statutory limits on the toted
loans or extensions of credit that may
be outstanding to a borrower at one
time.1 Among other purposes, the
14
*
1
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.1* 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.1* 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
10
T he ex p lan atio n o f thia provision in each o f the with recourse under the lending limit is
premised on the theory that when a
th ree ag en cies' guidelines refers to th e C all R eport
to esta b lish a definition o f ’’a s se t s a le s w ith
bank transfers a loan with recourse, it
reco u rse.” a n d h a s a p p aren tly c re a te d som e
in terp retiv e confusion. The FRB, the FDIC an d the
11 By contraaL b ecau se the O TS regulations do
OCC in ten d to publish technical am en d m en ts to
not require a savings a sso ciatio n 's leverage ratio to
th eir risk -b ased cap ital guidelines to clarify the
b e calculated w ith reference to its reported asse t
scope o f this provision.
b ase, changes in the reporting treatm en t of an a sse t
>i See FIRREA. section 301 (am ending the Hom e
tran sfer w ith recourse w ould not affect a savings
O w n ers' Loan A ct of 1833 by add in g a n ew section
a sso ciatio n 's leverage ratio.
5{t), requiring O TS to e stab lish cap ital sta n d a rd s
14 See supra note 2 accom panying te x t
“no less stringent th an th e cap ital sta n d a rd s
>• FIRREA provides certain add itio n al lending
ap p licab le to n atio n al b a n k s” ).
authority to savings associations u n d er “Special
>* See 54 FR 46394 (N ovem ber 3.1989) (OCC
Rule.” See 12 U.S.C. 1464(u).
N otice of P roposed Rulem aking); 55 FR 562 (January
»• See 12 CFR 32.107. See also 54 FR 43398
8,1990) (FRB N otice o f P roposed Rulemaking). The
(O ctober 24.1989) (N otice of Proposed R ulem aking
O CC p roposal w ould use a n atio n al b a n k ’s
am ending 12 CFR p a rt 32. proposing to m ove the
’’a d ju ste d to tal a s s e ts ” a n d the FRB proposal w ould
tex t of 12 CFR 32.107, w ithout su b stan tiv e change).
u se a sta te -ch artered m em ber b an k or b an k holding
See also 12 CFR 7.7519 (loan repurchase
co m p an y 's “to tal a s s e ts ” a s the a sse t b ase against
agreem ents).
w hich th e n ew leverage ratio w ould b e calculated.
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 pro 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 . D e fin itio n o f " R ec o u rse
A r r a n g e m e n t"
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 f VoL 5, Na. 126 f> Friday, June 2 y 1 9 , / Notices
5.
9 90
used for purposes of the lending limit
applicable to nafionalbanks and
savings assadtians.17
1. Explicit Recourse
A financial institution may accept or
re tain, recourse, pursuant to an explicit
and legally binding agreement in many
ways. The traditional concept o f
“recourse”*is that of the loan seller's
retention o f 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 e 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 witfr
consumer protection laws as of the date
of the safe If the triggering event is
within* the seller’s control, the selling
institution may b e able to adequately
protect itself* and tt may Be
inappropriate tor regulate the
arrangement a s a recourse arrangement.
The Agencies therefore request
comment on what types of standard?
representations and warranties should
be excluded from regulatory treatment
as recourse arrangements.
The Agencies are concerned1
,
however, that som e financial institutions
have also offered unusual warranties
and representations in situations that
they cannot control. For ex ample, some
financial institutions have assumed risks
associated with a borrower’s failure to
maintain loan collateral in compliance
with environmental or health and safety
laws, or have agreed to substitute terns
in the event o f prepayment The
Agencies request comment on foe extent
to which foe definition o f "recoursearrangement” should include exposure
to risks other than credit risk.
The Agencies also recognize that inapplying the risk-based capital
standards and possibly for other
regulatory purposes, it may be
*» Am in d ic a te d infra a t n ote 28. th e ap p licatio n o f
the le a d in g lim it to reco u rse arran g em an ts-i^b ein g
co n sid ered oniy. in s o f a r e s th e se arraag em an t*
ex p o se a b a n k .o r a w d n ^ a s a o c ia tio n to-crackt riek.
T hus, to t h e e x te n t th a t th e d efin itio n o f re c o u rse
a rra n g e m e n t d ev elo p ed for use hi the c a p ita lo r
regulatory rep evtiiiscoB texV hrehider arran g em en t*
th at e x p o s e in stitu tio n * to tid es o th e r th a n c re d it
risk,, th e same definition w ould-not b e ap p ro p riate
for use in-the lending lim it c o n te x t To the ex tan t
th a t th e definition c o v ers arran g em en ts th at expose
a n institution o » c re d it risk, co m m en t is. req u ested
on w h eth er th o s e sam e a rra n g em en ts sh e u id be
co n sid ered re c o u rse for. landing lim it 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
limited1
recourse- arrangements fbrwhicb
separate regulatory treabnent might be1
appropriate.
In. addition to recourse! arrangements,
that may arise from. a.financial
institution's-sale.of it&own assets; a
financial institution may also, provide
explicit assurances against the risk of
loss a ssociated with, a, third party’s:
assets. For example, as. the servicer o f a
pool o f assets,, a financial, institution,
may accept some, exposure to credit risk,
from the pool, Aa 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 ta certain
market-making activities. The Agencies
request comment cm. 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 am
explicit contractual agreement Implicit
recourse is usually demonstrated by an
institution’s action subsequent to foe
sale of an a sset Implicit recourse may
arise as a result o f a loan seller’s desire
for a continuing relationship with a
borrower, or for protection o f its.
reputation with investors. Far example,
having, packaged and sold a portfbfio o f
loans without' recourse, a financial
institution may elect to rewriter foe
defaulted loan o f a valued borrower that
the institution beKeverfe having
temporary difficulties in repayment. A
financial institution may also be
tempted to repurchase assets it has sold
into s pool foat are not performing well*
in order ta protect foe institution’s
reputation with, investors and foe public
generally. The Agencies request
comment on how the-definition e f
“recourse arrangement* should address
implicit recourse.
3. Method# o f Providing Recourse'
Assurances against
he
provided through a variety e# means. In
some cases, recourse is provided'
through recourse clauses in sales
contracts, oe put. options panted in.
connection with, asset sales. Recourse
may also be provided through
transactions that involve the creation o f
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
senior securities’b y being first in line to,
absorb losses on the pool. Similarly. 8
second mortgage might function a s a,
recourse arrangement. If e financial
institution originates first and second
mortgages on the same property and
sells foe firat mortgage but retains; foe
second mortgage;, foe financial
institution: is first in line to- absorb losses
in the event of the borrower’s default
Claims, under the second mortgage will
only b e met after foe holder’s claims
under the first; mortgage are satisfied.
A tetter of credit intended to; absorb
losses on an asset or pool of assets
originated: or pooled by n third party
may also effectively constitute recourse.
If the third party seller is. not obligated:
to reimburse the institution providing
the letter o f credit for any payments
made under the tetter of credit, then- the
tetter of credit institution will have
assumed a risk of loss an the assets.
Alternatively, if foe third party seller
must reimburse tiie tetter of credit
institution,, then, that third party seller
has effectively retained recourse on the
assets sold equal to the amount of foe
letter of credit. In addition, the letter of
credit institution would be. exposed to a
risk of lose on the asset* in: the event
that the third party should’fail ta
reimburse as requiredby foe contract.1*
The Agencies request comment on
methods available ta a financial
institution ta accept, assume or retain
recourse. For example, aa discussed
herein* foe Agendas request comment
on whether subordinated securities;
second mortgages or letter of credit
enhancements should be treated a s
recourse arrangements, both, where
these interests m s retained or acquired:
by foe seller and where they are
purchased or provided by a third party
financial institution- With respect ta
subordinated securities; the Agendas
specifically request comment on>how *
2
1
*• Although, letter afi credit enhancement*; may.
ultimately b* foundhr b a ’recmiree arrangBrnants"
for regulatory reporting, capital,« lending Unde
considerations. tha OCC doe* not.ccm»true such
letters- of credit to.create. “recourse’’ in oonneetion.
with, salea-of credit-onhancedsecuritiea-farthe
purposes of section: l t o f the1
Glass-Steagall.AcL. Sae
12 U.S.C. 24 (Seventh}..Thi»section.aulharicas,
national banks-to sell “aecuritieaandstackwithaut
Securities
recourse" foe their customer*. See,
Industry; Association v.. Comptroller of th»
Currency. & F. Supp..23£(nD.£L l963);\Awail/rv,
7Z
Adas Exchange National flank,, 295U.S.209(1935);
and OCC.Intarpretive. Latter No. 212-repnh tod,in
[T981-82 Transfer Binder] Fed-BankingL. Rap..
(CCH) 185^93- (July- 2-1981).
Federal Register / Vol. 5 . No. 126 / Friday, June 2 , 1990 / Notices
5
9
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
B. R e p o r tin g T r e a tm e n t o f A s s e t
asset with recourse to accrue by a - T r a n s fe r s W ith R e c o u r s e
charge to income an amount sufficient to
As already discussed, the current Call
absorb the transferor’s estimated
Report treatment of an asset transfer
obligations under the recourse
with recourse for national and federally- provision. The recourse obligation must
insured, state-chartered banks varies,
be accrued as a liability or specific
depending upon a range of factors. The
reserve,90 and may not be included as
Call Report requirements differ from the
part of the general allowance for loan
GAAP reporting requirements, which
and lease losses.91*
are generally applicable to savings
After the Financial Accounting
associations. The FRB, the FDIC and the
Standards Board adopted FAS 77, the
OCC believe that the present Call
FRB, the FDIC and the OCC, as
Report Instructions for asset transfers
members of the FFIEC, considered
with recourse should be reevaluated.
incorporating this accounting standard
These agencies intend to work through
into their regiilatory reporting
the FFIEC in order to amend the Call
requirements for assets transferred with
Report requirements, as necessary. See
recourse. At that time, the FFIEC chose
12 U.S.C. 3305(a).
not to follow FAS 77, concluding that it
The FRB, the FDIC and the OCC
emphasized the transfer of future
request comment on how assets
economic benefits, whereas the agencies
transferred with recourse should be
were most concerned with a financial
reported, including (1) Whether these
institution’s retention of a risk of loss.
agencies should consider adopting the
The FFIEC also expressed concern that
GAAP approach for asset transfers with
it might be difficult to reasonably
recourse, either in part or in its entirety,
estimate the risk of loss on some assets,
or some other wholly consistent
such as commercial, construction and
approach, and (2) how changes to
international loans.99
regulatory reporting will or should affect
Although the FRB, the FDIC and the
these agencies’ leverage ratios.
OCC have previously rejected the FAS
1. Possible Adoption of GAAP Reporting 77 reporting treatment for most asset
transfers with recourse, these agencies
Treatment of Asset Transfers with
are also committed to an ongoing effort
Recourse by the FRB, the FDIC, and the
to minimize the differences between
OCC
generally accepted accounting principles
The GAAP definition of "sale” for
and regulatory reporting requirements
transfers of receivables with recourse is
where possible. For example, one
discussed in the Financial Accounting
possibility is that the agencies might
Standards Board’s Statement of
adopt the GAAP approach for some
Financial Accounting Standards No. 77
types of assets, such as loans
("FAS 77”).19 According to FAS 77, a
considered subject to reasonable
transfer of receivables with recourse is
estimations of loss, but not necessarily
to be reported as a sale if the reporting
for all types of assets.
entity meets three conditions: (1) The
In addition, the FRB, the FDIC and the
transferor must surrender control of the
OCC note that once their risk-based
future economic benefits embodied in
capital guidelines are implemented, the
the a sset (2) the tranferor must be able
adoption of the GAAP reporting
to reasonably estimate its obligations
under the recourse provision; and (3) the approach would not affect bank capital
ratios to the same extent it would have
transferor must not be obligated to
repurchase the assets except pursuant to
*° See S tatem ent of F inancial A ccounting
the recourse provisions.
S ta n d a rd s No. 105, “D isclosure of Inform ation about
FAS 77 further provides: “If a transfer
Financial Instrum ents w ith O ff-B alance-Sheet Risk
qualifies to be recognized as a sale, all
a n d Financial Instrum ents w ith C o ncentrations of
probable adjustments in connection
C redit Risk.” (M arch. 1990). parag rap h 92. w hich
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.
'* See S tatem en t o f Financial A ccounting
S ta n d a rd s No. 77, “Reporting by T ran sfero rs for
T ra n sfe rs o f R eceivables w ith R ecourse”
(D ecem ber, 1983). For the purpose of FAS 77
“re c o u rse ” is defined a s the “right of a tran sferee of
rec e iv a b le s to receive paym ent from the tran sfero r
o f th o se receiv ab les for (a) Failure o f the d eb to rs to
p a y w h e n due. (b) the effects of prepaym ents, or (c)
a d ju stm e n ts resulting from d efects in the eligibility
o f the tra n sferred receiv ab les.” See appen d ix A,
FA S 77.
sta te s “(t]he [Financial A ccounting S tandards]
B oard believes th a t generally a cce p te d accounting
principles proscribe inclusion of an a ccru al for
credit loss on a financial instrum ent w ith offb alan ce-sh eet risk in a v aluation account
(allow ance for loan losses) re lated to a recognized
financial in stru m e n t"
ai B ecause accru ed recourse obligations are
specifically id entifiable to the sold a ssets, they are
n o t included in capital.
• • See O ctober 28.1985 FFIEC le tte r to C hief
E xecutive O fficers of B anks (A ppendix).
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. Capital Support Required for a Recourse
Arrangement
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 5 , No- 126 / Friday, fume 2 , 1990 / Notices
5
9
considering Cor 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
a result o f 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 o f an a sse t
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. Ia addition* the
Agencies request that commenters
address how insured financial
institutions and bank holding
companies’ need for adequate capital
should be balanced against their need to
compete ia markets that include
participants subject to less stringent
capital standards
(a)
Consistent Capital Charges fo r
Recourse on Previously Owned Assets.
The risk-based capital standards da 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
For 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 cf a recourse
clause. To illustrate, if a financial
o institution originates a $KXMJ00
,
qualifying, first lien residential
mortgage, it w ill be required to hold
S40GG in capital support against the loan
($100,000X 50% risk-weight X 8%) If the
originating institution sells this mortgage
loan 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 b e no capital charge against the first
-mortgage and the charge against the
second mortgage will only be $800
($10,000 X 100%X8%). 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 forma
retained recourse. Is general terms,, a
residual interest in an interest ia any
excess cash flow stemming bom a
securitized asset pool aver and above
the amounts required to pay investors
and applicable administrative expenses.
Residual interests. Idee subordinated
interests or other recourse
arrangements, may absorb more then
their pro rata share of Ies*. 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 forme o f
recourse it must hold capital against the
entire amount o f the assets sold.
(b)
Equivalent Capitaf Charges fo r
Recourse on Third Party Assets. The
risk-based capitaf guidelines o f the bank
supervisory agencies do not explicitly
address recourse, arrangements that do
not arise as &result of a financial
institution’s prior ownership o f an. a sset
For example, mortgage servicing rights
that a financial institution purchases
from another party may include various
types o f recourse, including the
requirement that the purchasing
institution absorb credit losses on the
loans il has agreed to service. E is,
t
important that the risks associated with
these transactions, be understood,
quantified and risk-weighted aa with
any other off-balance, sheet credit
exposure. The QTS capital, rule currently
requires savings associations with,
mortgage servicing rights that include
exposure to credit losses ta hold capital
against the full amount of the underlying
loans through tha application, of the
100% credit conversion factor.
As another example, the risk-baaed
capital guidelines erf the bank
supervisory agencies treat subordinated
interests differently dependingupon;
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 QTS, all
require financial institutions retaining
the subordinated portion of a senior/
subordinated structure, to hold capital1
against the fill! amount o f tha 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 to a
100% risk-weight category. Ncr capitaL is
required for the senior portions
supported by the purchased
subordinated portions.2* By contrast,
the QTS treats purchased subordinated
securities the same as originated
subordinated securities* usd tons .
requires savings, associations to hold
capital against the whole asset p ool
(c)
Capital Charges Tailored to
R elative 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-hased capital
guidelines o f the bank supervisory
agencies, as opposed to those o f the
OTS, do not distinguish between limited
and unlimited recourse arrangements.
The bank supervisory agencies require
capital to be held against toe 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 QTS differ to that
they generally permit a savings
association to maintain capital equal to
the amount of the recourse exposure on
an asset transferred with recourse if that
exposure is less than the capital charge
the asset would otherwise incur.
The Agencies befieve 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 to
transferring assets with recourse. This is
because buyers may pay more for assets
sold with greater recourse than far 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
asset3 with, full rather than limited
recourse to 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 m ay 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:*
** T his discussion o f th e “purchaser* o f a:
subordinated, security' ia undertaken, solely aa-anillustration, and should-not be v iew ed a r a ir
ind icatio n th a t such securitiea-w ould b e eligible for
b a n k investm ent u nder fe d e ra l or sta te law ; or. th at
ban k holdings-of such, se c u ritie r w o u ld n o t be*
subject to examiner criticisms or classifications.
Federal Register / Vol. 5 , No. 126 / Friday, June 2 , 1990 / Notices
5
9
Fcr 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 die
full amount of the loans transferred.
Thus, the total amount of the loans
o u ts ta n d in g for capital purposes would
be reduced to $97CW
XX), 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£00.
The risk-based capital standards also
do not necessarily recognize differences
in the degree to which an asset
transferred with recourse is
collateralized.*2 For example, assume
»• U nder th e c urren t C ell R eport Instruction*,
such a tra n sa c tio n w o u ld n o t receive sa le treatm en t
b ecau se the b an k w o u ld re ta in m o re th a n a
“■ignifirjm t risk o f lo s s " on th e lo an s tran sferred .
H ow ever, if th e FFIEC w a re to a d o p t th e GA A P
a p p ro ach for reporting a s s e t tra n sfers w ith recourse,
the issu es ra ise d in th is ex am p le w ould arise .
*» T his situ atio n is n o t unique to a ssets
tran sferred w ith reco u rse, b u t also applies to onb ala n c e sh e et a s s e ts th a t a re co llateralised (other
th an by ao-called “qualifying collateral"). T he ris k -
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 an 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 $50jOGQ, may
result in the institution’s absorbing its
total potential loss.
Finally, the risk-based capital
standards do not necessarily distinguish
between recourse arrangements
b aaed c a p ita l ra tio focueee principally o n b ro ad
categories o f cred it risk . T he ra tio d oee n o t ta k e
account of m an y oth er factors th a t ca n affect a n
in stitution's financial condition su c h a s th e quality
of indiv id u al loan* a n d investm ents a n d the d egree
to w hich they are p rotected 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 capita! 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 fin a n c ia l 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 haa adequate
excess capital to book the a sset 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 fin a n c ia l
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
28774
Federal Register / Vol. 5 . No. 128 / Friday, June 2 , 1990 / Notices
5
9
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.*6
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
capital standards should be applied
once it is determined that an institution
clearly has assumed implicit recourse in
a transaction or series of transactions.
v D. L e n d in g L im it T r e a tm e n t o f R e c o u r s e
m Arrangements
r.
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*7 The
*• T he A gencies em phasize th a t they do n o t
in ten d to discourage a financial in stitu tio n w ith
a d q n a te cap ital from in d ep en d en tly deciding to
rep u rc h ase o r rew rite a so ld lo an th a t is perform ing
poorly, w h en the institution in ten d s to w ork w ith
the underlying borro w er a n d the accom m o d atio n is
clearly in the b est in terests of the in stitu tio n a n d the
b o rro w er.
*’ Som e sta te s apply the lending lim it for natio n al
b a n k s to sta te -ch artered banka. T herefore, changes
in th e O C C 's lending limit treatm en t of reco u rse
arran g em en ts could affect som e sta te -ch artered
b a n k s a s w ell as n atio n al b an k s a n d savings
asso ciatio n s.
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.*6
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 state 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*
** T his discussion of the lending limit treatm en t of
recourse arrangem ents is in ten d ed to apply only to
arrangem ents th at expose a ban k or savings
association to the credit risk of a borrow er. It is not
intended th a t the lending limit w ould apply to
recourse arrangem ents th at expose a n institution to
other types of risk..
considered in view of the fact that
capital 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 briefly summarize, the Agencies
request comment on the following
issues:
The definition of “recourse
arrangement”:
?$ ? y
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 j VoL 5 , No. 128 / Friday, June 2 , 1990 / Notices
5
9
4. What effect would a change to the
17. When a bank or savings
reporting treatment have on the leverage associations transfers a loan with
ratios of the FRB, the FDIC and the
limited recourse, should be the lending
OCC? Should the reporting treatment of
limit be applied to the full amount of the
assets transferred with recourse have an assets, as though it had not been
transferred?
effect on the leverage ratio?
18. Should be lending limit calculation
The appropriate capital requirement
result in the same treatment for
for explicit recourse arrangements:
transactions structured differently, but
5. Should the Agencies impose the
with the same potential risk of loss on
same capital requirement on
nonpayment?
transactions structured differently but
19. Is is appropriate to indude the full
with the same potential effect on a
outstanding balance of a loan
financial institution’s income, assets or
transferred with recourse in the
capital?
calculation of loans outstanding to the
6. Should the risk-based capital
borrower when banks and savings
standards distinguish between limited
assotiations are also required to hold
and unlimited recourse arrangements?
capital against the full amount of the
7. Should the risk-based capital
asset?
standards take into account an
20. Should the treatment of recourse
established recourse liability account or
arangements in legal lending limit
third party guarantees or insurance? If
calculations applicable to federallyso, how?
6.
Should application of the risk-basedinsured, state-chartered banks under
state laws be made more uniform? If so,
capital standards to recourse
how?
arrangements take into account
Dated: June 25,199a
differences in the degree to which an
Robert J. Lawrence,
asset transferred with recourse is
collateralized?
Executive Secretary, Federal Financial
Institutions Examination Council.
9. Should the risk-based capital
standards fully recognize recourse
[FR Doc. 90-15093 Filed 6-28-90; 8:45]
arrangements that do not arise as a
BILL!NO CODE 6210-01-41
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:
26775
@FedFRASER