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May 1993

I

UPERVISORY
I

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ssu

E

Supervisory
News and Views
for the Eighth District

s

Revised Reg F Becomes
--

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Effective Next Month
Selecting and Evalu·
ating Correspondents

In response to comments and
-- suggestions offered by bankers,
the Federal Reserve revised
Regulation F-Limitations on
Interbank Liabilities. The final
JUNE
1995
- __-=- - - ---=---- - regulation, which becomes
~ ~=- -effective June 19, 1993, places
primary emphasis on each
- bank's analysis of the credit
quality of its correspondents
and reduces the emphasis on
regulatory limits to control
J U N E
1 9 9 4
_..:.. --- ----=---interbank exposure. Specifi- --::::-. :-- cally, the final regulation
: - _- ~-=-""~
;i
establishes standards for banks
~·~ -. ~.=-~
to use in selecting and evalu~~---::..
•
ating correspondents, setting
~ - - ~-= internal limits on exposure,
.:-=-=--- --and calculating and limiting
~..::..
1 9 9 3
J U N E
credit exposure.

By June 19, each bank must
have written policies and procedures that consider credit,
liquidity and operational risks
in selecting and using correspondents. These prudential
standards may be flexible and
should reflect the size, form
and maturity of the exposure
as well as the financial condition of the correspondent.
They should require periodic
reviews of the overall financial
condition of any correspondent
to which the bank has significant exposure.
To evaluate the financial
condition of domestic corre-

he real estate lending guidelines which became effective
on March 19, 1993, include
supervisory loan-to-value (LTV)
limits. While banks have flexibility in establishing limits in
their lending policies, these
internal limits may not exceed
the supervisory guidelines.
According to the guidelines
a bank can make loans that do

not meet the supervisory LTV
limits. When appropriate,
and after consideration of
other relevant credit factors, a
bank may make an exception
or nonconforming loan.
This is a loan that exceeds the
supervisory limits stated in the
guidelines. If a bank chooses
to set internal LTV limits lower
than the maximum allowed

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Credit
Extensions
Allowed
Outside LTV
Limits


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Federal Reserve Bank of St. Louis

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spondents, a bank may rely on
publicly available information
such as annual reports, call
reports or uniform bank performance reports. In addition,
the bank may rely on a third
party-such as a parent
holding company, a bank
rating agency or another
correspondent-to provide
financial analysis as long as
(continued on next page)

and a loan exceeds the internal
limit, the loan does not have
to be considered an exception
unless it also exceeds the supervisory limit.
The aggregate amount of
exception loans is limited.
Depending on the type of
loan, it will fall into one of
(continued on nert page)

Reg F
(continuedfrom front page)

the bank's board of directors
approves the assessment criteria used. Once these standards
are established, the bank's
board of directors must review
the policies and procedures
at least annually.

Setting Internal
limits on Exposure
Regulation F does not establish a general limit for exposure to each correspondent.
Abank's policies and procedures, however, must provide
internal limits in cases where
the financial condition of the
correspondent and the form
or maturity of the exposure
create a significant risk that
, payments will not be made in
full or on time. These internal
limits should be consistent
with the ri k undertaken but
may be flexible and reflect the
credit exposure or financial
condition of the correspondent.

Calculating and
limiting Credit
Exposur'e
While interbank risk includes
credit, liquidity and operational
risks related to intraday and
interday transactions, the
regulation defines "credit
exposure" as the bank's assets
and off-balance sheet items
that are subject to capital
requirements under federal
capital adequacy guidelines
and that reflect claims on
the correspondent or capital
instruments issued by the
correspondent.
In calculating credit exposure to correspondents, banks
may exclude:
• exposure related to the
settlement of transactions,

intraday exposure, transactions in an agency or similar
capacity where losses will
be passed back to the principal or other party, or other
sources of exposure that are
not covered by the capital
adequacy guidelines;
• transactions secured by
government securities, the
Internal limits should
be consistent with the
risk undertaken.

proceeds of checks or cash
items not yet available for
withdrawal and certain
quality assets on which
the correspondent is secondarily liable, such as loans
purchased with recourse or
secured by stand-by letters
of credit; and
• exposure covered by federal
deposit insurance.

Banks are not required to
limit credit risk to banks that
they can demonstrate are at
least adequately capitalized.
When a correspondent is not
adequately capitalized, however, the bank must conform
the credit risk of that correspondent to the appropriate
regulatory limit within 120
days. Effective June 19, 1994,
that limit is 50 percent of capital; in June 1995, that limit
falls to 25 percent.
If you have questions about
establishing a program to
comply with Regulation F,
call Timothy A. Bosch at
(314) 444-8440 or Dennis W.
Blase at (314) 444-8435.

LTV limits
(continuedfrom front page)

two groups or "baskets." The
first basket includes all loans
for non-one-to-four-family
residential properties; these
loans may not exceed 30 percent of the bank's total capital
structure. The second basket,
which includes all loans for
one-to-four-family residential
properties, can equal up to
100 percent of the bank's capital structure depending on the
percentage in the first basket.
The amount of exception
loans in the first basket directly
affects the allowable percentage in the second basket. For
example, a bank with 30 percent in basket one could only
have 70 percent of capital in

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Federal Reserve Bank of St. Louis

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In addition, different limits
may be set for different forms
of exposure, different products
and different maturities.

basket two; a bank with 20 percent of capital in the first basket
could have up to 80 percent of
capital in the second basket.
The amount of
exception loans
in the first basket
directly affects the
allowable percentage in the second
basket.

Banks will be expected to document all exception loans and
report the aggregate amount at
least quarterly to their boards of
directors. Additionally, banks

must report each individual
exception loan of a significant
size to their boards.
The application of LTV ratios
in situations where mixed
collateral secures one loan
warrants clarification. When
several parcels of real estate
with different LTV ratios are
taken as collateral to secure
a loan, the maximum loan
amount is determined by
applying the appropriate LTV
ratio to the collateral value
of each parcel of property
and adding the resulting
values. Any prior liens are
deducted from the aggregate
value. This sum will be the
maximum amount a bank

can lend without the credit
becoming an exception.
In addition to allowing for
exception or nonconforming
loans, the guidelines also
exempt some loans entirely
from the LTV limits. Examples
include loans that are government-guaranteed, promptly sold
in the secondary market and
made prior to March 19, 1993.
Loans made prior to March 19
will remain exempt even if they
are renewed, refinanced or
restructured, as long as no additional funds are advanced.

Examiners Answer Additional Reg DD Questions
s the June 21 compliance date nears,
Fed examiners
continue to receive
questions about
Regulation DD. Here are some
answers to the most commonly
asked questions.

A
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Federal Reserve Bank of St. Louis

Must a bank's soft•
ware system calculate
interest on a 365-day
basis on all accounts
as of June 21, 1993?
I

Yes. The interest payment
provisions apply to existing
consumer accounts as well
as new accounts. For time
accounts opened before June 21,
however, banks can keep current interest calculations for
the remaining term of the
account. If an account is
renewed on or after that date,
all aspects of the regulation
will then apply.
May a bank apply
the 20·day advance
notice as a grace
period on automatically renewable time
a«ountslongerthan
30 days, and mail
the advance notice
disclosures and the
interest check the
day before maturity?

No. While the Regulation DD
alternate timing rule provides
flexibility in sending required
disclosures closer to the maturity date, Regulation DReserve Requirements of
Depository Institutionsprohibits a grace period longer
than 10 days for withdrawal
of funds without penalty on
automatically renewable
certificates of deposit. This

restricts a bank from mailing
the interest check and advance
notice disclosures on the day
before maturity.

activity fee. This is true if
the bank marks up the fee,
passes on the exact fee or
absorbs part of the fee.

In order to calculate
an' APY using the for•
mula in Appendix A,
a bank must first
have a dollar amount
for interest paid on
a deposit account.
How can this dollar
amount be calculated?

To comply with the
periodic statement
fee disclosure require·
ments, must a bank
itemize fees sepa•
rately (for example,
"certified check $250,
certified check fee
$5") or is a single
item on a statement
permissible (for
example, 11 certified
check $255")?

Formulas for computing
interest can be found in the
Fed's "Board Interpretation
to Regulation Q (2-412
Computation of InterestCompounding)." Although
these formulas were provided
when Reg Qrequired limits on
interest rates paid on deposits,
they also have relevance in
computing interest on deposit
accounts for Reg DD purposes.
If you would like a copy of
this interpretation, call Janice
Harris at (314) 444-8439.
If a bank passes on
to the customer a
charge imposed by
a third party bank
or network for the
use of a nonpropri•
etary ATM, and there
are no other charges
associated with the
account, may the
bank advertise the
deposit account as
"free"?

No. If the bank charges a
maintenance or activity fee
on the account, the account
cannot be advertised as "free."
Afee assessed for the use of
a third party ATM would constitute a maintenance or

The periodic statement must
disclose the amount of any
fees or charges imposed on the
account. Additionally, the statement must provide sufficient
detail to enable the consumer
to identify fees. Therefore, fees
for certifying checks must be
disclosed separately (for example,
"certified check $250, certified
check fee $5") .
Must a bank provide
new account and
other disclosures for
accounts that are no
longer offered?

Generally no. New account
disclosures are not required
for accounts that are no
longer offered, even if the
bank maintains existing
accounts and accounts
acquired through merger or
acquisition. Abank must,
( continued)

however, provide the necessary
periodic statements and changein-term notices for all existing
accounts.

Must a bank provide
new account disclo·
sures to existing
account holders?
Generally yes. Account
holders who receive periodic

Applications
Issues:
Exemptions
Possible
from Stock
Redemption
Notices


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Federal Reserve Bank of St. Louis

statements on or after June 21,
1993, must be given either
a notice of the availability
of disclosures or the actual
disclosures. One or the other
must be included on or with
the first periodic statement
sent on or after June 21, 1993,
or the periodic statement for
the first cycle beginning after
that date. The disclosures

are the same as those provided
before opening a new account.

s part of an ongoing
effort to limit information
needed for bank holding company applications, the Federal
Reserve Board announced
last fall several changes to
its applications process.
1\vo of those changes were
discussed in detail in the
November issue of Supervisory
Issues: the introduction of
pre-filing notices and proposals
for expansion. This issue takes
a look at a third change-the
eliminatiun of stock redemption
notices for well-capitalized
bank holding companies.
As prescribed in section
225.4(b) of Regulation Y, a
company is exempt from the
prior notice requirement when
redeeming shares representing

more than 10 percent of its
equity if that company can
demonstrate that it will
remain well-capitalized after
these shares are redeemed.
The test for determining
whether or not a company is
well-capitalized is the same
for all companies, regardless
of asset size, and is based
on consolidated capital ratios.
The minimum ratios reflect
the Prompt Corrective Action
provisions of the Federal
Deposit Insurance Corporation Improvement Act of
1991 (FD ICIA). Specifically,
a company is considered
well-capitalized if, after the
redemption, it has a consolidated leverage ratio of at least
5 percent, and consolidated

A

May a bank pay
interest on a collected
balance?

Act and Regulation CC. The
regulation does, however,
prohibit the payment of interest based upon a "reservable"
or "investable" balance.

Yes. Abank may pay interest
on a collected balance as
long as credit is given within
the deadlines required by the
Expedited Funds Availability
tier 1 and total capital to riskweighted assets ratios of at
least 6percent and 10 percent,
respectively.
Also, to qualify for the
exemption, a company must
have received a composite
BOPEC rating of 1 or 2 at its
most recent inspection, and
have no major supervisory
matters pending.
Abank holding company that
does redeem equity securities
should keep appropriate documentation showing that when
the stock was redeemed the
company was qualified for the
exemption. Documentation
should include a pro forma
consolidated balance sheet
for the company and calculations of pro forma consolidated
risk-based capital ratios. This
information should be available for examiners to review
during an inspection.
If you have any questions
regarding the eligibility requirements for this exemption,
call Carl Anderson at
(314) 444-8481.

BANK PERFORMANCE
District Banks Outperform National
Peers
istrict bank
performance
displayed positive
trends in 1992 in
categories such
as higher earnings, improved
asset quality and appreciable
equity growth. The year was
marked by record profits and
the highest Return on Average
Assets (ROA) posted in recent
years. Net income for District
banks totaled $1.66 billion, producing an ROA of 1.14 percent.
Earnings were boosted primarily through higher net
interest income. The net interest margin increased each
quarter during the year, hitting
4.48 percent at year-end. In
addition to the strong core earnings, slightly lower loan loss
provision expense and sizable
gains on the sale of investment

D

Net Interest Income
Percent of average earning assets
Percent

12/90 3/91 6/91 9/91 12/91 3/92 6/92 9/92 12/92

securities provided an additional boost to net profits.
Perhaps the most noticeable
area of improvement was in
asset quality. Nonperforming
loans declined to the lowest
level in years, as did loan losses.
The declining level of nonperReserve for loan losses &
forming loans combined with
Nonperforming loans
provision expenses in excess of
Billions of dollars
loan losses, led to the buildup
1.6
of reserves to 138.7 percent of
nonperforming loans as of
1.4
~
year-end
1992. District asset
1.2
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quality indicators compared
1.0
very favorably with the U.S. peer
0.8
group averages. Ratios for
both nonperforming loans and
0.6
net loan losses were approxi0.4
mately 40 percent lower than
0.2
the national average.
0
As a result of strong earnings
12/90 3/91 6/91 9/91 12/91 3/92 6/92 9/92 12/92
performance, District banks
Reserve
Nonperforming loans
achieved significant growth
~ - - - - - - - - - - - - - - - - - - - ' _ in equity. Cumulative equity
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Federal Reserve Bank of St. Louis

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growth was 9.9 percent for
1992, compared with asset
growth of 4.7 percent. New
equity issues accounted for
less than 5 percent of the total
equity growth.
With such strong showings,
District bankers should have
a challenging year ahead as
they attempt to build on the
success of 1992.

BHC Supervision Manual Available to Bankers

BHC
Reporting
Instructions
Revised

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Post Office Box 442
St. Louis, Missouri 63166

Supervisory Issues is published bimonthly by the Banking Supervision
and Regulation Division of the
Federal Reserve Bank of St. Louis.
Views expressed are not necessarily
official opinions of the Federal
Reserve System or the Federal
Reserve Bank of St. Louis. Questions
regarding this publication should
be directed to Dawn C. Ligibel,
editor, 314-444-8909.

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Federal Reserve Bank of St. Louis

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he Federal Reserve's
Bank Holding Company
Supervision Manual, which
specifies the objectives and
procedures Fed examiners use
for bank holding company
inspections, was recently updated and reprinted. Many
companies have found this
to be a useful resource in under-

standing examiner expectations
during inspections.
Copies of the manual are
available for $50; there will
be an additional charge for
updates. Requests for copies
should be mailed to: Publications Services, Division of
Support Services, Board of
Governors of the Federal

B

updates and use only the new
instructions when filing these
reports. If you have not yet
received copies, please call
Jim Mack at (314) 444-8599.

y now, all bank holding
companies in the Eighth
District should have received
updated instructions for the
following reports: FR Y-9C,
FR Y-9LP and FR Y-llQ.
Please discard all previous

Reserve System, Washington,
D.C. 20551. All requests must
be accompanied by a check
or money order made payable
to the Board of Governors of
the Federal Reserve System.