[Federal Register Volume 71, Number 247 (Tuesday, December 26, 2006)]
[Proposed Rules]
[Pages 77446-77518]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 06-9738]



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Part II





Department of the Treasury





Office of the Comptroller of the Currency



12 CFR Part 3



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Federal Reserve System

12 CFR Parts 208 and 225



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Federal Deposit Insurance Corporation

12 CFR Part 325



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Department of the Treasury





Office of Thrift Supervision

12 CFR Parts 566 and 567



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Risk-Based Capital Guidelines; Capital Adequacy Guidelines; Capital 
Maintenance: Domestic Capital Modifications; Proposed Rules and Notice

Federal Register / Vol. 71, No. 247 / Tuesday, December 26, 2006 / 
Proposed Rules

[[Page 77446]]


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DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Part 3

[Docket No. 06-15]
RIN 1557-AC95

FEDERAL RESERVE SYSTEM

12 CFR Parts 208 and 225

[Regulations H and Y; Docket No. R-1238]

FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 325

RIN 3064-AC96

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 567

[No. 2006-49]
RIN 1550-AB98


Risk-Based Capital Guidelines; Capital Adequacy Guidelines; 
Capital Maintenance: Domestic Capital Modifications

AGENCIES: Office of the Comptroller of the Currency, Treasury; Board of 
Governors of the Federal Reserve System; Federal Deposit Insurance 
Corporation; and Office of Thrift Supervision, Treasury.

ACTION: Joint notice of proposed rulemaking.

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SUMMARY: The Office of the Comptroller of the Currency (OCC), Board of 
Governors of the Federal Reserve System (Board), Federal Deposit 
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS) 
(collectively, the Agencies) are proposing revisions to the existing 
risk-based capital framework that would enhance its risk sensitivity 
without unduly increasing regulatory burden. These changes would apply 
to banks, bank holding companies, and savings associations (banking 
organizations). A banking organization would be able to elect to adopt 
these proposed revisions or remain subject to the Agencies' existing 
risk-based capital rules, unless it uses the Advanced Capital Adequacy 
Framework proposed in the notice of proposed rulemaking published on 
September 25, 2006 (Basel II NPR).
    In this notice of proposed rulemaking (NPR or Basel IA), the 
Agencies are proposing to expand the number of risk weight categories, 
allow the use of external credit ratings to risk weight certain 
exposures, expand the range of recognized collateral and eligible 
guarantors, use loan-to-value ratios to risk weight most residential 
mortgages, increase the credit conversion factor for certain 
commitments with an original maturity of one year or less, assess a 
charge for early amortizations in securitizations of revolving 
exposures, and remove the 50 percent limit on the risk weight for 
certain derivative transactions. A banking organization would have to 
apply all the proposed changes if it chose to use these revisions.
    Finally, in Section III of this NPR, the Agencies seek further 
comment on possible alternatives for implementing the ``International 
Convergence of Capital Measurement and Capital Standards: A Revised 
Framework'' (Basel II) in the United States as proposed in the Basel II 
NPR.

DATES: Comments on this joint notice of proposed rulemaking must be 
received by March 26, 2007.

ADDRESSES: Comments should be directed to:
    OCC: You should include OCC and Docket Number 06-15 in your 
comment. You may submit comments by any of the following methods:
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> OCC Web Site: http://www.occ.treas.gov. Click on ``Contact 
the OCC,'' scroll down and click on ``Comments on Proposed 
Regulations.''
    <bullet> E-mail address: <a href="/cdn-cgi/l/email-protection#95e7f0f2e6bbf6faf8f8f0fbe1e6d5faf6f6bbe1e7f0f4e6bbf2fae3"><span class="__cf_email__" data-cfemail="ee9c8b899dc08d8183838b809a9dae818d8dc09a9c8b8f9dc0898198">[email protected]</span></a>.
    <bullet> Fax: (202) 874-4448.
    <bullet> Mail: Office of the Comptroller of the Currency, 250 E 
Street, SW., Mail Stop 1-5, Washington, DC 20219.
    <bullet> Hand Delivery/Courier: 250 E Street, SW., Attn: Public 
Information Room, Mail Stop 1-5, Washington, DC 20219.
    Instructions: All submissions received must include the Agency name 
(OCC) and docket number or Regulatory Information Number (RIN) for this 
notice of proposed rulemaking. In general, OCC will enter all comments 
received into the docket without change, including any business or 
personal information that you provide. You may review comments and 
other related materials by any of the following methods:
    <bullet> Viewing Comments Personally: You may personally inspect 
and photocopy comments at the OCC's Public Information Room, 250 E 
Street, SW., Washington, DC. You can make an appointment to inspect 
comments by calling (202) 874-5043.
    <bullet> Viewing Comments Electronically: You may request e-mail or 
CD-ROM copies of comments that the OCC has received by contacting the 
OCC's Public Information Room at <a href="/cdn-cgi/l/email-protection#cebcaba9bde0ada1a3a3aba0babd8ea1adade0babcabafbde0a9a1b8"><span class="__cf_email__" data-cfemail="7d0f181a0e531e1210101813090e3d121e1e53090f181c0e531a120b">[email protected]</span></a>.
    <bullet> Docket: You may also request available background 
documents and project summaries using the methods described above.
    Board: You may submit comments, identified by Docket No. R-1238, by 
any of the following methods:
    <bullet> Agency Web Site: http://www.federalreserve.gov. Follow the 
instructions for submitting comments at http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm.
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> E-mail: <a href="/cdn-cgi/l/email-protection#ea988f8d99c4898587878f849e99aa8c8f8e8f988b86988f998f989c8fc48d859c"><span class="__cf_email__" data-cfemail="394b5c5e4a175a5654545c574d4a795f5c5d5c4b58554b5c4a5c4b4f5c175e564f">[email protected]</span></a>. Include docket 
number in the subject line of the message.
    <bullet> FAX: (202) 452-3819 or (202) 452-3102.
    <bullet> Mail: Jennifer J. Johnson, Secretary, Board of Governors 
of the Federal Reserve System, 20th Street and Constitution Avenue, 
NW., Washington, DC 20551.
    All public comments are available from the Board's Web site at 
http://www.federalreserve.gov/generalinfo/foia/ProposedRegs.cfm as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room MP-500 of the Board's Martin Building (20th and C 
Street, NW.) between 9 a.m. and 5 p.m. on weekdays.
    FDIC: You may submit by any of the following methods:
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> Agency Web site: http://www.FDIC.gov/regulations/laws/federal/propose.html
    <bullet> Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments/Legal ESS, Federal Deposit Insurance Corporation, 550 17th 
Street, NW., Washington, DC 20429.
    <bullet> Hand Delivered/Courier: The guard station at the rear of 
the 550 17th Street Building (located on F Street), on business days 
between 7 a.m. and 5 p.m.
    <bullet> E-mail: <a href="/cdn-cgi/l/email-protection#6704080a0a020913142721232e2449000811"><span class="__cf_email__" data-cfemail="e88b8785858d869c9ba8aeaca1abc68f879e">[email protected]</span></a>.
    <bullet> Public Inspection: Comments may be inspected and 
photocopied in the FDIC Public Information Center, Room

[[Page 77447]]

E-1002, 3502 Fairfax Drive, Arlington, VA 22226, between 9 a.m. and 5 
p.m. on business days.
    Instructions: Submissions received must include the Agency name and 
title for this notice. Comments received will be posted without change 
to http://www.FDIC.gov/regulations/laws/federal/propose.html, 
including any personal information provided.
    OTS: You may submit comments, identified by No. 2006-49, by any of 
the following methods:
    <bullet> Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
    <bullet> E-mail address: <a href="/cdn-cgi/l/email-protection#295b4c4e5a074a4644444c475d5a69465d5a075d5b4c485a074e465f"><span class="__cf_email__" data-cfemail="04766163772a676b6969616a7077446b70772a70766165772a636b72">[email protected]</span></a>. Please 
include No. 2006-49 in the subject line of the message and include your 
name and telephone number in the message.
    <bullet> Fax: (202) 906-6518.
    <bullet> Mail: Regulation Comments, Chief Counsel's Office, Office 
of Thrift Supervision, 1700 G Street, NW., Washington, DC 20552, 
Attention: No. 2006-49.
    <bullet> Hand Delivery/Courier: Guard's Desk, East Lobby Entrance, 
1700 G Street, NW., from 9 a.m. to 4 p.m. on business days, Attention: 
Regulation Comments, Chief Counsel's Office, Attention: No. 2006-49.
    Instructions: All submissions received must include the Agency name 
and docket number or Regulatory Information Number (RIN) for this 
rulemaking. All comments received will be posted without change to the 
OTS Internet Site at http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1, including any personal 
information provided.
    Docket: For access to the docket to read background documents or 
comments received, go to http://www.ots.treas.gov/pagehtml.cfm?catNumber=67&an=1. In addition, you may inspect 
comments at the Public Reading Room, 1700 G Street, NW., by 
appointment. To make an appointment for access, call (202) 906-5922, 
send an e-mail to <a href="/cdn-cgi/l/email-protection#ffc39edf978d9a99c2" http: public.info">public.info</a>@ots.treas.gov">public.info@ots.treas.gov</a>, or send a facsimile 
transmission to (202) 906-7755. (Prior notice identifying the materials 
you will be requesting will assist us in serving you.) We schedule 
appointments on business days between 10 a.m. and 4 p.m. In most cases, 
appointments will be available the next business day following the date 
we receive a request.

FOR FURTHER INFORMATION CONTACT: OCC: Nancy Hunt, Risk Expert, (202) 
874-4923; or Kristin Bogue, Risk Expert, (202) 874-5411, Capital Policy 
Division; Ron Shimabukuro, Special Counsel, or Carl Kaminski, Attorney, 
Legislative and Regulatory Activities Division, (202) 874-5090; Office 
of the Comptroller of the Currency, 250 E Street, SW., Washington, DC 
20219.
    Board: Thomas R. Boemio, Senior Project Manager, Policy, (202) 452-
2982; Barbara Bouchard, Deputy Associate Director, (202) 452-3072; 
William Tiernay, Supervisory Financial Analyst (202) 872-7579; or Juan 
C. Climent, Supervisory Financial Analyst, (202) 872-7526, Division of 
Banking Supervision and Regulation; or Mark E. Van Der Weide, Senior 
Counsel, (202) 452-2263, Legal Division. For the hearing impaired only, 
Telecommunication Device for the Deaf (TDD), (202) 263-4869.
    FDIC: Karl R. Reitz, Capital Markets Specialist, (202) 898-3857, or 
Bobby R. Bean, Chief, Policy Section Capital Markets Branch, (202) 898-
3575, Division of Supervision and Consumer Protection; or Benjamin W. 
McDonough, Attorney, (202) 898-7411, or Michael B. Phillips, Counsel, 
(202) 898-3581, Supervision and Legislation Branch, Legal Division, 
Federal Deposit Insurance Corporation, 550 17th Street, NW., 
Washington, DC 20429.
    OTS: Teresa Scott, Senior Project Manager, Supervision Policy (202) 
906-6478; or Karen Osterloh, Special Counsel, Regulation and 
Legislation Division, Chief Counsel's Office, (202) 906-6639; Office of 
Thrift Supervision, 1700 G Street, NW., Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

    In 1989, the Office of the Comptroller of the Currency (OCC), Board 
of Governors of the Federal Reserve System (Board), Federal Deposit 
Insurance Corporation (FDIC), and Office of Thrift Supervision (OTS) 
(collectively, the Agencies) implemented a risk-based capital framework 
for U.S. banking organizations.\1\ The Agencies based the framework on 
the ``International Convergence of Capital Measurement and Capital 
Standards'' (Basel I), published by the Basel Committee on Banking 
Supervision (Basel Committee) in 1988.\2\ Basel I addressed certain 
weaknesses in the various regulatory capital regimes that were in force 
in most of the world's major banking jurisdictions. In the United 
States, the Basel I-based framework established a uniform regulatory 
capital system that captured some of the risks not otherwise captured 
by the regulatory capital to total assets ratio, provided some modest 
differentiation of regulatory capital based on broadly defined risk-
weight categories, and encouraged banking organizations to strengthen 
their capital positions.
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    \1\ 12 CFR part 3, appendix A (OCC); 12 CFR parts 208 and 225, 
appendix A (Board); 12 CFR part 325, appendix A (FDIC); and 12 CFR 
part 567 (OTS). The risk-based capital rules generally do not apply 
to bank holding companies with less than $500 million in assets. 71 
FR 9897 (Februray 28, 2006).
    \2\ The Basel Committee on Banking Supervision was established 
in 1974 by central banks and governmental authorities with bank 
supervisory responsibilities. Current member countries are Belgium, 
Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, 
Spain, Sweden, Switzerland, the United Kingdom, and the United 
States.
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    Consistent with Basel I, the Agencies' existing risk-based capital 
rules generally assign each credit exposure to one of five broad 
categories of credit risk, which allows for only limited 
differentiation in the assessment of credit risk for most exposures. 
Since the implementation of Basel I-based capital rules, the Agencies 
have made numerous revisions to these rules in response to changes in 
financial market practices and accounting standards as well as to 
implement legislative mandates and address safety and soundness issues. 
Over time, these revisions have modestly increased the degree of risk 
sensitivity of the Agencies' risk-based capital rules. The Agencies and 
the industry generally agree that the existing risk-based capital rules 
could be modified to better reflect the risks present in many banking 
organizations' portfolios without imposing undue regulatory burden. In 
recent years, however, the Agencies have limited modifications to the 
existing risk-based capital rules while international efforts to create 
a new risk-based capital framework were in process.
    In June 2004, the Basel Committee introduced a new, more risk-
sensitive capital adequacy framework, ``International Convergence of 
Capital Measurement and Capital Standards: A Revised Framework'' (Basel 
II).\3\ Basel II is designed to promote improved risk measurement and 
management processes and better align minimum capital requirements with 
risk. For credit risk, Basel II includes three approaches for 
regulatory capital: Standardized, foundation internal ratings-based, 
and advanced internal ratings-based. For operational risk, Basel II 
also includes three methodologies:

[[Page 77448]]

Basic indicator, standardized, and advanced measurement.
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    \3\ The complete text for Basel II as amended in November 2005 
is available on the Bank for International Settlements Web site at 
http://www.bis.org/publ/bcbs118.htm.
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    In August 2003, the Agencies issued an advance notice of proposed 
rulemaking (Basel II ANPR), which explained how the Agencies might 
implement Basel II in the United States.\4\ On September 25, 2006, the 
Agencies issued a notice of proposed rulemaking that provides the 
industry with a more definitive proposal for implementing Basel II in 
the United States (Basel II NPR).\5\
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    \4\ As stated in its preamble, the Base II ANPR was based on the 
consultative document ``The New Basel Capital Accord'' that was 
published by the Basel Committee on April 29, 2003. The Basel II 
ANPR anticipated the issuance of a final revised accord. See 68 FR 
45900 (August 4, 2003).
    \5\ 71 FR 55380 (September 25, 2006). The Basel II NPR would add 
new appendices to the Agencies' existing capital regulations. These 
new appendices would be found at 12 CFR Part 3, Appendix C (OCC); 12 
CFR Part 208, Appendix F and 12 CFR Part 225, Appendix F (FRB); 12 
CFR Part 325, Appendix D (FDIC); and 12 CFR part 566, subpart A 
(OTS).
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    The Basel II NPR identifies two types of U.S. banking organizations 
that would use the Basel II rules: Those for which application of the 
rules would be mandatory (core banks), and those that might voluntarily 
apply the rules (opt-in banks) (collectively referred to as Basel II 
banking organizations). In general, the Basel II NPR defines a core 
bank as a banking organization that has consolidated total assets of 
$250 billion or more, has consolidated on-balance sheet foreign 
exposure of $10 billion or more, or is a subsidiary of a Basel II 
banking organization. The Basel II NPR presents the advanced internal 
ratings-based approach for credit risk and the advanced measurement 
approach for operational risk. However, the Agencies did seek comment 
in the Basel II NPR on whether U.S. banking organizations subject to 
the advanced approaches in the proposed rule (that is, core banks and 
opt-in banks) should be permitted to use other credit and operational 
risk approaches provided for in Basel II. The Agencies are seeking 
further comment on possible alternatives for Basel II banking 
organizations in Section III of this NPR.
    The complexity and cost associated with implementing Basel II in 
the United States effectively limit its application to those banking 
organizations that are able to take advantage of economies of scale and 
absorb the costs associated with the enhanced risk management practices 
required of Basel II banking organizations. Thus, the implementation of 
Basel II would create a bifurcated regulatory capital framework in the 
United States: One set of rules for Basel II banking organizations, and 
another for banking organizations that do not use the proposed Basel II 
capital rules (non-Basel II banking organizations).
    In comments responding to the Basel II ANPR, Congressional 
testimony, and other industry communications, several banking 
organizations, trade associations, and others raised concerns about the 
competitive effects of a bifurcated regulatory framework on community 
and regional banking organizations. Among other broad concerns, these 
commenters asserted that implementing the Basel II capital regime in 
the United States could result in lower minimum regulatory capital 
requirements for Basel II banking organizations with respect to certain 
types of credit exposures. As a result, regulatory capital requirements 
for similar products could differ depending on the capital regime under 
which a banking organization operates. Community and regional banking 
organizations asserted that this would put them at a competitive 
disadvantage.
    To assist in quantifying the potential effects of implementing 
Basel II in the United States, the Agencies conducted a quantitative 
impact study during late 2004 and early 2005 (QIS 4).\6\ QIS 4 was a 
comprehensive survey completed on a best efforts basis by 26 of the 
largest U.S. banking organizations using their own internal estimates 
of the key risk parameters driving the capital requirements under the 
Basel II framework. The results of the study suggested that the 
aggregate minimum risk-based capital requirements for the 26 banking 
organizations could drop approximately 15.5 percent relative to the 
existing Basel I-based framework. The QIS 4 results also indicated 
dispersion in capital requirements across banking organizations and 
portfolios, which was attributed in part to differences in the 
underlying data and methodologies used by banking organizations to 
quantify risk and their overall readiness to implement a Basel II 
framework. The Basel II NPR contains several provisions designed to 
limit potential reductions in minimum regulatory capital, such as an 
extended transition period during which the Agencies can thoroughly 
review those Basel II systems that are subject to supervisory 
oversight.
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    \6\ ``Summary Findings of the Fourth Quantitative Impact 
Study,'' Joint Agency press release, February 24, 2006.
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    On October 20, 2005, the Agencies issued an advanced notice of 
proposed rulemaking soliciting public comment on possible revisions to 
U.S. risk-based capital rules that would apply to non-Basel II banking 
organizations (Basel IA ANPR).\7\ The proposals in this NPR are based 
on those initial conceptual approaches and take into consideration the 
public comments that the Agencies received.
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    \7\ 70 FR 61068 (October 20, 2005).
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    Together, the Agencies received 73 public comments from banking, 
trade, and other organizations and individuals. Generally, most 
commenters supported the Agencies' goal to make the risk-based capital 
rules more risk-sensitive. Several larger banking organizations and 
industry groups favored increased risk sensitivity, but argued that 
many of the proposed revisions should be optional so that banking 
organizations may weigh the costs and benefits of using the revisions. 
Several non-Basel II banking organizations and industry groups argued 
that the U.S. risk-based capital rules should allow banking 
organizations to use internal assessments of risk to determine their 
capital requirements. A few commenters endorsed a proposal for a four-
tier capital framework that would apply different approaches to banking 
organizations based on the size and complexity, and the robustness of a 
banking organization's internal ratings systems. The commenters' 
proposal included an approach that would permit some non-Basel II 
banking organizations to use internal rating-based systems.
    One commenter suggested tying Basel IA capital requirements 
directly to the aggregate results for Basel II calculations. This 
commenter suggested that Basel IA capital charges should link by loan 
category to the average risk-based capital requirements of the Basel II 
banking organizations for that loan category, plus a small premium to 
recognize the substantial costs of implementing Basel II.
    Most smaller and midsize banking organizations generally requested 
that any changes to the existing capital rules be simple and not 
require large data gathering and monitoring expenses. A number of the 
smallest banking organizations said that they do not wish to have any 
changes in the capital rules that apply to them. They noted that they 
already hold significantly more regulatory capital than the Agencies' 
risk-based capital rules require and, therefore, amending the rules 
would have little or no effect.
    This NPR makes a number of proposals that should improve the risk 
sensitivity of the existing risk-based capital rules. The Agencies, 
however, are not proposing to allow a non-Basel II banking organization 
to use internal risk ratings or to use its internal risk

[[Page 77449]]

measurement processes to calculate risk-based capital requirements for 
any new categories of exposures.\8\ The Agencies believe that the use 
of these internal ratings and measurement processes should require the 
systems controls, supervisory oversight, and other qualification 
requirements that are proposed in the Basel II NPR.
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    \8\ The Agencies' existing capital rules, however, would 
continue to permit the use of internal ratings for a direct credit 
substitute (but not a purchased credit-enhancing interest-only 
strip) assumed in connection with an asset-backed commercial paper 
program sponsored by a banking organization. 12 CFR part 3, appendix 
A section 4(g) (OCC); 12 CFR parts 208 and 225, appendix A, section 
III.B.3.F (Board); 12 CFR part 325, appendix A, section II.B.5(g)(1) 
(FDIC); and 12 CFR 567.6(b)(4) (OTS).
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    The Agencies also believe that any proposal to tie capital 
requirements under Basel IA to the capital charges that would result 
under the proposed Basel II rules is premature. The Agencies anticipate 
that the Basel II transition phase would not be completed until 2011 at 
the earliest. The Agencies also have other concerns about the 
commenter's proposal including the absence of a capital charge for 
operational risk; the method by which any premium over the Basel II 
charges would be determined; difficulties in defining comparable 
portfolios; and the need to periodically update capital requirements, 
which would significantly increase complexity and burden.

II. Proposed Changes

    In considering revisions to the existing risk-based capital rules, 
the Agencies were guided by five broad principles. A revised framework 
must: (1) Promote safe and sound banking practices and a prudent level 
of regulatory capital; (2) maintain a balance between risk sensitivity 
and operational feasibility; (3) avoid undue regulatory burden; (4) 
create appropriate incentives for banking organizations; and (5) 
mitigate material distortions in the risk-based capital requirements 
for large and small banking organizations.
    The Agencies are concerned about potential competitive 
disadvantages that could result from capital requirements that differ 
depending on the capital regime under which a banking organization 
operates. By allowing non-Basel II banking organizations the choice of 
adopting all of the provisions in this proposal or continuing to use 
the existing risk-based capital rules, the proposed regulation is 
intended to help maintain the competitive position of these banks 
relative to Basel II banking organizations. Moreover, the proposed rule 
strives for better alignment of capital and risk, with capital 
requirements potentially higher for organizations with riskier 
exposures and lower for those with safer exposures. The Agencies seek 
to achieve these objectives while balancing operational feasibility and 
regulatory burden considerations.
    In this NPR, the Agencies are proposing to:
    <bullet> Allow non-Basel II banking organizations the choice of 
adopting all of the revisions in this proposal or continuing to use the 
existing risk-based capital rules. The voluntary nature of this 
proposed rule gives banking organizations the opportunity to weigh the 
various costs and benefits to them of adopting the new system.
    <bullet> Increase the number of risk weight categories to which 
credit exposures may be assigned.
    <bullet> Use external credit ratings to risk weight certain 
exposures.
    <bullet> Expand the range of recognized collateral and eligible 
guarantors.
    <bullet> Use loan-to-value ratios to risk weight most residential 
mortgages.
    <bullet> Increase the credit conversion factor for various 
commitments with an original maturity of one year or less.
    <bullet> Assess a risk-based capital charge for early amortizations 
in securitizations of revolving exposures.
    <bullet> Remove the 50 percent limit on the risk weight for certain 
derivative transactions.
    The existing risk-based capital requirements focus primarily on 
credit risk and do not impose explicit capital charges for interest 
rate, operational, or other risks. These risks, however, are implicitly 
covered by the existing risk-based capital rules. The risk-based 
capital charges proposed in this NPR continue the implicit coverage of 
risks other than credit risk. Moreover, the Agencies are not proposing 
revisions to the existing leverage ratio requirement (that is, the 
ratio of Tier 1 capital to total assets).\9\
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    \9\ 12 CFR 3.6(b) and (c) (OCC); 12 CFR part 208, appendix B and 
12 CFR part 225, appendix D (Board); 12 CFR part 325.3 (FDIC); and 
12 CFR 567.8 (OTS).
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    To ensure safety and soundness, the Agencies intend to closely 
monitor the level of risk-based capital at those banking organizations 
that choose to opt in to Basel IA. Any significant decline in the 
aggregate level of risk-based capital for these banking organizations 
may warrant modifications to the proposed risk-based capital rules.
    Question 1: The Agencies welcome comments on all aspects of these 
proposals, especially suggestions for reducing the burden that may be 
associated with these proposals. The Agencies believe that a banking 
organization that chooses to adopt these proposals will generally be 
able to do so with data it currently uses as part of its credit 
approval and portfolio management processes. Commenters are 
particularly requested to address whether any of the proposed changes 
would require data that are not currently available as part of the 
organization's existing credit approval and portfolio management 
systems.

A. Opt-In Proposal

    In the Basel IA ANPR, the Agencies recognized that certain banking 
organizations might not want to assume the additional burden that might 
accompany a more risk-sensitive approach and might prefer to continue 
to apply the existing risk-based capital rules. Additionally, many 
commenters, particularly community bank respondents, favored an 
approach that would allow well-capitalized banking organizations to 
remain under the existing risk-based capital rules. For these 
commenters, limiting regulatory burden was a higher priority than 
increasing the risk sensitivity of their risk-based capital charges. 
One group of midsize banking organizations recommended applying the 
proposed rules only to banking organizations with assets of $500 
million or greater. Some commenters noted the risk of ``cherry 
picking'' in permitting a choice between the framework discussed in the 
Basel IA ANPR and the existing risk-based capital rules, or adoption of 
parts of each.
    The Agencies are proposing that a non-Basel II banking organization 
may, if it chooses, adopt the revisions in this proposed rule. If a 
banking organization chooses to use these proposed capital rules, 
however, it would be required to implement them in their entirety. The 
Agencies are proposing to permit a banking organization to adopt these 
proposals by notifying its primary Federal supervisor. Before a banking 
organization decides to opt in to these proposals, the Agencies expect 
that the organization would review its ability to collect and utilize 
the information required and evaluate the potential impact on its 
regulatory capital. A banking organization that chooses to adopt these 
proposals (that is, opts in) would also be able to request returning to 
the existing capital rules by first notifying its primary Federal 
supervisor. In its review of such a request, the primary Federal 
supervisor would ensure that the risk-based capital requirements 
appropriately reflect the risk profile of the banking organization and 
the change is not for purposes of

[[Page 77450]]

capital arbitrage. Further, the Agencies expect that a banking 
organization would not alternate between the existing and proposed 
risk-based capital rules. The Agencies would reserve the authority to 
require a banking organization to calculate its minimum risk-based 
capital requirements in accordance with this proposal or the existing 
risk-based capital rules.
    Under this proposal, a non-Basel II banking organization could 
continue to calculate its risk-based capital requirements using the 
existing risk-based capital rules. In this case, the banking 
organization would not need to notify its primary Federal supervisor or 
take any other action. As noted, above, however, the Agencies would 
retain the authority to require a non-Basel II banking organization to 
use either the existing or the proposed risk-based capital rules if the 
banking organization's primary Federal supervisor determines that a 
particular capital rule is more appropriate for the risk profile of the 
banking organization.
    Question 2: The Agencies seek comment on all aspects of the 
proposal to allow banks to opt in to and out of the proposed rules. 
Specifically, the Agencies seek comment on any operational challenges 
presented by the proposed rules. How far in advance should a banking 
organization be required to notify its primary Federal supervisor that 
it intends to implement the proposed rule? If a banking organization 
wishes to ``opt out'' of the proposed rule, what criteria should guide 
the review of a request to opt out? When should a banking 
organization's election to opt in or opt out be effective? In addition, 
the Agencies seek comment on the appropriateness of requiring a banking 
organization to apply the proposed Basel IA capital rules based on a 
banking organization's asset size, level of complexity, risk profile, 
or scope of operations.

B. Increase the Number of Risk Weight Categories

    The Agencies' existing risk-based capital rules contain five risk-
weight categories: Zero, 20, 50, 100, and 200 percent. Differentiation 
of credit quality among individual exposures is generally limited to 
these few risk-weight categories. In the Basel IA ANPR, the Agencies 
suggested adding four new risk-weight categories (35, 75, 150, and 350 
percent) and invited comment on whether: (1) Increasing the number of 
risk-weight categories would allow supervisors to more closely align 
capital requirements with risk; (2) the suggested additional risk-
weight categories would be appropriate; (3) the risk-based capital 
framework should include more risk-weight categories than the four 
suggested; and (4) increasing the number of risk-weight categories 
would impose unnecessary burden on banking organizations.
    Commenters generally supported increasing the number of risk-weight 
categories to enhance the overall risk-sensitivity of the risk-based 
capital rules. However, many commenters noted that adding too many 
categories could make the rules too complex. Several commenters argued 
that the 350 percent risk weight is too high and suggested that any new 
risk-weight categories should be lower than 100 percent to reflect the 
lower risks associated with certain mortgages and other high-quality 
assets. A few commenters suggested that the Agencies create a new 10 
percent risk weight category to account for very low-risk assets.
    The Agencies agree with the commenters that increasing the number 
of risk-weight categories would allow for greater risk sensitivity than 
the existing risk-based capital rules. Accordingly, the Agencies 
propose to add 35, 75, and 150 percent risk-weight categories. The 
Agencies believe that adding a 150 percent risk weight category and 
expanding the use of the existing 200 percent risk weight category 
would allow for somewhat greater differentiation of credit risk among 
more risky exposures than is permitted by the existing capital rules. 
At the same time, for certain types of relatively low-risk exposures, 
the existing risk-based capital charge may be higher than warranted. 
Therefore, the 35 and 75 percent risk weight categories provide an 
opportunity to increase the risk sensitivity of the regulatory capital 
charges for these exposures.
    The Agencies agree that the credit risks covered by this NPR 
generally do not warrant a 350 percent category, and are not proposing 
to add this risk weight. Question 3: The Agencies seek comment on 
whether these or any other new risk weight categories would be 
appropriate. More specifically, the Agencies are interested in any 
comments regarding whether any categories of assets might warrant a 
risk weight higher than 200 percent and what risk weight might be 
appropriate for such assets. The Agencies also solicit comment on 
whether a 10 percent risk weight category would be appropriate and what 
exposures should be included in this risk weight category.

C. Use of External Credit Ratings to Risk Weight Exposures

    The Agencies' existing risk-based capital rules permit the use of 
external credit ratings issued by a nationally recognized statistical 
rating organization (NRSRO) \10\ to assign risk weights to recourse 
obligations, direct credit substitutes (DCS), residual interests (other 
than a credit-enhancing interest-only strip), and asset- and mortgage-
backed securities.\11\ For example, AAA- and AA-rated mortgage-backed 
securities \12\ are assigned to the 20 percent risk weight category 
while BB-rated mortgage-backed securities are assigned to the 200 
percent risk weight category. When the Agencies revised the risk-based 
capital rules to allow for the use of external credit ratings issued by 
an NRSRO for the types of exposures listed above, the Agencies 
acknowledged that such ratings could be used to determine the risk-
based capital requirements for other types of debt instruments, such as 
rated corporate debt.
---------------------------------------------------------------------------

    \10\ An NRSRO is an entity recognized by the Division of Market 
Regulation of the Securities and Exchange Commission (SEC) as a 
nationally recognized statistical rating organization for various 
purposes, including the SEC's uniform net capital requirements for 
brokers and dealers 17 CFR 240.15c3-1). On September 29, 2006, the 
President signed the Credit Rating Agency Reform Act of 2006 (Reform 
Act) (Pub. L. 109-291) into law. The Reform Act requires a credit 
rating agency that wants to represent itself as an NRSRO to register 
with the SEC. The Agencies may review their risk-based capital 
rules, guidance and proposals from time to time in order to 
determine whether any modification of the Agencies' definition of an 
NRSRO is appropriate.
    \11\ Some synthetic structures may also be subject to the 
external rating approach. For example, certain credit-linked notes 
issued from a synthetic securitization are risk weighted according 
to the rating given to the notes. 66 FR 59614, 59622 (November 29, 
2001).
    \12\ The ratings designations (for example, ``AAA,'' ``BBB,'' 
``A-1,'' and ``P-1''), are illustrative and do not indicate any 
preference for, or endorsement of, any particular rating agency 
description system.
---------------------------------------------------------------------------

    In the Basel IA ANPR, the Agencies suggested expanding the use of 
NRSRO ratings to determine the risk-based capital charge for most 
categories of NRSRO-rated exposures, including sovereign and corporate 
debt securities and rated loans. The Agencies indicated, however, that 
they were considering retaining the existing risk-based capital 
treatment for U.S. government and agency exposures, U.S. government-
sponsored entity exposures, and municipal obligations. Tables 1 and 2 
in the Basel IA ANPR matched ratings and possible corresponding risk 
weights for long- and short-term exposures. The Agencies requested 
comment on the use of other methodologies to assign risk weights to 
unrated exposures.

[[Page 77451]]

    Many commenters supported the use of external ratings in principle 
but noted that non-Basel II banking organizations' holdings of 
securities and loans generally are not rated. Thus, they suggested that 
the expansion of the use of NRSRO ratings would have little impact on 
these banking organizations. A few commenters also asserted that using 
NRSRO ratings might discourage lending to non-rated entities.
    Many commenters argued that the risk weights suggested in the Basel 
IA ANPR were too high. In particular, many commenters said that the 350 
percent and 200 percent risk weights for exposures rated BB+ and lower 
would be unnecessarily punitive. A few commenters also expressed 
concerns about NRSRO ratings generally. These commenters said that 
there are too few NRSROs to ensure adequate market discipline, NRSROs 
are inadequately supervised, and NRSRO ratings often react too slowly 
to crises.
    A number of commenters suggested alternative methods for 
differentiating risk among commercial exposures and making the capital 
requirements for these exposures more risk sensitive. Many larger 
banking organizations suggested allowing an internal risk measurement 
approach to determine risk-based capital requirements. Some smaller 
banking organizations sought increased recognition of a variety of risk 
mitigation techniques, such as personal guarantees and collateral.
    The Agencies acknowledge that expanding the use of external ratings 
may have little effect on the risk-based capital requirements for 
existing loan portfolios at most banking organizations. To the extent 
that assets in a banking organization's investment portfolio are rated, 
however, the Agencies believe that using external ratings will improve 
risk sensitivity of the capital charges for these assets. Furthermore, 
implementing broader use of external ratings would also provide a basis 
for expanding recognition of eligible guarantees and recognized 
collateral. Accordingly, the Agencies are proposing to expand the use 
of external ratings for purposes of determining the risk-based capital 
charge for certain externally rated exposures as described below in the 
sections on direct exposures, recognized collateral, and eligible 
guarantees.
    An external rating would be defined as a credit rating that is 
assigned by an NRSRO, provided that the credit rating (1) fully 
reflects the entire amount of credit risk with regard to all payments 
owed to the holder and the credit risk associated with timely repayment 
of principal and interest; (2) is published in an accessible public 
form, for example, on the NRSRO's Web site and in financial media; (3) 
is monitored by the NRSRO; and (4) is, or will be, included in the 
issuing NRSRO's publicly available transition matrix.\13\ If an 
exposure has two or more external ratings, the banking organization 
must use the lowest assigned external rating to risk weight the 
exposure. If an exposure has components that are assigned different 
external ratings, a banking organization would be required to assign 
the lowest rating to the entire exposure. If a component is not 
externally rated, the entire exposure would be treated as unrated.
---------------------------------------------------------------------------

    \13\ A transition matrix tracks the performance and stability 
(or ratings migration) of an NRSRO's issued external ratings.
---------------------------------------------------------------------------

i. Direct Exposures
    The Agencies are proposing to use external ratings to risk weight 
(1) sovereign \14\ debt and debt securities, and (2) debt securities 
issued by and rated loans to non-sovereign entities including 
securities firms, insurance companies, bank holding companies, savings 
and loan holding companies, multilateral lending and regional 
development institutions, partnerships, limited liability companies, 
business trusts, special purpose entities, associations and other 
similar organizations. External ratings for direct exposures to 
sovereigns would be based on the external rating of the exposure or, if 
the exposure is unrated, on the sovereign's issuer rating. Direct 
exposures to non-sovereigns would be risk weighted based on the 
external rating of the exposure. For example, a banking organization 
would assign any AAA-rated debt security issued by a corporation, 
insurance company, or securities firm to the 20 percent risk weight 
category. The Agencies are, however, not proposing to permit the use of 
issuer ratings for non-sovereigns.
---------------------------------------------------------------------------

    \14\ A sovereign is defined as a central government, including 
its agencies, departments, ministries, and the central bank. A 
soverign does not include state, provincial, or local governments, 
or commercial enterprises owned by a central government.
---------------------------------------------------------------------------

    The risk weights for direct exposures are detailed in Table 1 
(long-term exposures) and Table 2 (short-term exposures) below. The 
Agencies are also proposing to replace the existing risk-weight tables 
for externally rated recourse obligations, DCS, residual interests 
(other than a credit-enhancing interest-only strip), and asset- and 
mortgage-backed securities \15\ with the risk weights in Tables 1 and 
2.\16\ This proposed treatment would apply to all externally rated 
exposures unless the banking organization uses a market risk rule.\17\ 
For a banking organization that uses a market risk rule, this treatment 
applies only to externally rated exposures held in the banking book.
---------------------------------------------------------------------------

    \15\ 12 CFR part 3, appendix A, section 4, Tables B and C (OCC); 
12 CFR parts 208 and 225, appendix A, section III.B.3.c.i. (Board); 
12 CFR part 325, appendix A, section II.B.5.(d) (FDIC); and 12 CFR 
567.6(b) (OTS) (the Recourse Rule).
    \16\ With the exception of the clarification of the definition 
of an external rating and the proposed risk-based capital charge for 
securitizations with early amortization features described in 
section F of this NPR, the Agencies are not proposing to make other 
changes to the existing risk-based capital rules for recourse 
obligations, DCS, and residual interests. See 12 CFR part 3, 
appendix A, section 4 (OCC); 12 CFR parts 208 and 225, appendix A, 
section III.B.3 (Board); 12 CFR part 325, appendix A, section II.B.5 
(FDIC); and 12 CFR 567.6(b) (OTS) (Recourse Rule).
    \17\ See 12 CFR part 3, appendix B (OCC); 12 CFR parts 208 and 
225, appendix E (Board); and 12 CFR part 325 appendix C (FDIC). The 
Agencies issued an NPR that proposes revisions to the Market Risk 
rules. OTS does not currently have a market risk rule, but has 
proposed to add a new rule on this topic in the Market Risk NPR. See 
71 FR 55958 (September 25, 2006).
---------------------------------------------------------------------------

    The Agencies intend to retain the existing risk-based capital 
treatment for direct exposures to public-sector entities,\18\ the U.S. 
government and its agencies, U.S. government-sponsored agencies, and 
depository institutions (U.S. and foreign) and for unrated loans made 
to non-sovereign entities. Exposures issued by these entities are not 
subject to Table 1 or 2.
---------------------------------------------------------------------------

    \18\ Public-sector entities include states, local authorities 
and governmental subdivisions below the central government level in 
an Organization for Economic Cooperation and Development (OECD) 
country. In the United States, this definition encompasses a state, 
county, city, town, or other municipal corporation, a public 
authority, and generally any publicly-owned entity that is an 
instrument of a state or municipal corporation. This definition does 
not include commercial companies owned by the public sector. The 
OECD-based group of countries comprises all full members of the 
OECD, as well as countries that have concluded special lending 
arrangements with the International Monetary Fund (IMF) associated 
with the Fund's General Arrangements to Borrow.

[[Page 77452]]



                Table 1.--Proposed Risk Weights Based on External Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                                  Securitization
                                                                  Sovereign risk   Non-sovereign   exposure \1\
       Long-term rating category                 Example            weight (in      risk weight     risk weight
                                                                     percent)      (in percent)    (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating........  AAA....................               0              20              20
Second-highest investment grade rating.  AA.....................              20              20              20
Third-highest investment grade rating..  A......................              20              35              35
Lowest-investment grade rating--plus...  BBB+...................              35              50              50
Lowest-investment grade rating.........  BBB....................              50              75              75
Lowest-investment grade rating--minus..  BBB-...................              75             100             100
One category below investment grade....  BB+, BB................              75             150             200
One category below investment grade--    BB-....................             100             200             200
 minus.
Two or more categories below investment  B, CCC.................             150             200             \1\
 grade.
Unrated \2\............................  n/a....................             200             200             \1\
----------------------------------------------------------------------------------------------------------------
\1\ A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and
  residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are
  externally rated more than one category below investment grade, short-term exposures that are rated below
  investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as
  described in the Agencies' Recourse Rule would be used.
\2\ Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
  weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
  would continue to be risk weighted under the existing risk-based capital rules.


               Table 2.--Proposed Risk Weights Based on External Ratings for Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                                  Securitization
                                                                  Sovereign risk   Non-sovereign   exposure \1\
       Short-term rating category                Example            weight (in      risk weight     risk weight
                                                                     percent)      (in percent)    (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating........  A-1, P-1...............               0              20              20
Second-highest investment grade rating.  A-2, P-2...............              20              35               3
Lowest investment grade................  A-3, P-3...............              50              75              75
Unrated \2\............................  n/a....................             100             100           (\1\)
----------------------------------------------------------------------------------------------------------------
\1\ A securitization exposure includes asset- and mortgage-backed securities, recourse obligations, DCS, and
  residuals (other than a credit-enhancing interest-only strip). For long-term securitization exposures that are
  externally rated more than one category below investment grade, short-term exposures that are rated below
  investment grade, or any unrated securitization exposures, the existing risk-based capital treatment as
  described in the Agencies' Recourse Rule would be used.
\2\ Unrated sovereign exposures and unrated debt securities issued by non-sovereigns would receive the risk
  weight indicated in Tables 1 and 2. Other unrated exposures, for example, unrated loans to non-sovereigns,
  would continue to be risk weighted under the existing risk-based capital rules.

    The proposed risk weights in Tables 1 and 2 are generally 
consistent with the historical default rates reported in the default 
studies published by NRSROs. The Agencies believe that the additional 
application of external ratings to the exposures specified above would 
improve the risk sensitivity of the capital treatment for those 
exposures. Furthermore, the Agencies believe that the revised risk-
weight tables for externally rated recourse obligations, DCS, residual 
interests (other than credit-enhancing interest only-strips), and 
asset- and mortgage-backed securities would also better reflect risk 
than the Agencies' existing risk-based capital rules.
    Under the proposal, the Agencies would retain their authority to 
reassign an exposure to a different risk weight on a case-by-case basis 
to address the risk of a particular exposure.
ii. Recognized Financial Collateral
    The Agencies' existing risk-based capital rules recognize limited 
types of collateral: (1) Cash on deposit; (2) securities issued or 
guaranteed by central governments of the OECD countries; (3) securities 
issued or guaranteed by the U.S. government or its agencies; (4) 
securities issued or guaranteed by U.S. government-sponsored agencies; 
and (5) securities issued by certain multilateral lending institutions 
or regional development banks.\19\ In the past, the banking industry 
has commented that the Agencies should recognize a wider array of 
collateral types for purposes of reducing risk-based capital 
requirements.
---------------------------------------------------------------------------

    \19\ The Agencies' rules for collateral transactions, however, 
differ somewhat as described in the Agencies' joint report to 
Congress. ``Joint Report: Differences in Accounting and Capital 
Standards among the Federal Banking Agences,'' 70 FR 15379 (March 
25, 2005).
---------------------------------------------------------------------------

    In the Basel IA ANPR, the Agencies noted that they were considering 
expanding the list of recognized collateral to include short-or long-
term debt securities (for example, corporate and asset- and mortgage-
backed securities) that are externally rated at least investment grade 
by an NRSRO, or issued or guaranteed by a sovereign central government 
that is externally rated at least investment grade by an NRSRO. 
Consistent with the proposed treatment for direct exposures, the Basel 
IA ANPR suggested assigning exposures or portions of exposures 
collateralized by financial collateral to risk-weight categories based 
on the external rating of that collateral. To use this expanded list of 
collateral, the Basel IA ANPR considered requiring a banking 
organization to have collateral management systems to track collateral 
and readily determine its realizable value. The Agencies sought comment 
on whether this approach for expanding the scope of recognized 
collateral would improve risk sensitivity without being overly 
burdensome.
    Many commenters supported expanding the list of recognized 
collateral, but several also noted that using NRSRO ratings would have 
little effect on most community banks. Some commenters suggested 
reducing the risk weights applied to exposures secured by

[[Page 77453]]

any collateral that is legally perfected and has objective methods of 
valuation or can be readily marked-to-market. Many commenters also 
stated that any collateral valuation and monitoring requirements likely 
would be too costly to benefit smaller community banks.
    To increase the risk sensitivity of the existing risk-based capital 
rules, the Agencies are proposing to revise the list of recognized 
collateral to include a broader array of externally rated, liquid, and 
readily marketable financial instruments. The revised list would 
incorporate long- and short-term debt securities and securitization 
exposures that are:
    a. Issued or guaranteed by a sovereign where such securities are 
externally rated at least investment grade by an NRSRO; or an exposure 
issued or guaranteed by a sovereign with an issuer rating that is at 
least investment grade; or
    b. Issued by non-sovereigns where such securities are externally 
rated at least investment grade by an NRSRO.

Consistent with the Agencies' existing risk-based capital rules, the 
Agencies propose to continue to recognize collateral that is either 
issued or guaranteed by certain sovereigns. For non-sovereign 
exposures, however, the Agencies propose that the collateral itself 
must be externally rated investment grade or better to qualify as 
recognized collateral. The Agencies believe that this more conservative 
approach for recognizing non-sovereign collateral is appropriate and 
expect that any guarantee provided by a non-sovereign would be 
reflected in the external rating of the collateral.
    A banking organization would assign exposures collateralized by 
financial collateral externally rated at least investment grade to the 
appropriate risk weight in Table 1 or 2 above. If an exposure is 
partially collateralized, a banking organization could assign the 
portions of exposures collateralized by the market value of the 
externally rated collateral to the appropriate risk weight category in 
Tables 1 and 2 of this NPR. For example, the portion of an exposure 
collateralized by the market value of a AAA-rated corporate debt 
security would be assigned to the 20 percent risk weight category. The 
Agencies are proposing a minimum risk weight of 20 percent for 
collateralized exposures except as noted below.
    The Agencies have decided to retain their respective risk-based 
capital rules that govern the following collateral: Cash, securities 
issued or guaranteed by the U.S. government or its agencies, and 
securities issued or guaranteed by U.S. government-sponsored agencies. 
The Agencies are also retaining the existing risk-based capital rules 
for exposures collateralized by securities issued or guaranteed by 
other OECD central governments that meet certain criteria.\20\
---------------------------------------------------------------------------

    \20\ 12 CFR part 3, appendix A, section 3(a)(1)(viii) (OCC); and 
12 CFR parts 208 and 225, appendix A, section III.C.1 (Board).
---------------------------------------------------------------------------

iii. Eligible Guarantors
    Under the Agencies' existing risk-based capital rules, the 
recognition of third party guarantees is limited to guarantees provided 
by central governments of OECD countries, U.S. government and 
government-sponsored entities, public-sector entities in OECD 
countries, multilateral lending institutions and regional development 
banks, depository institutions and qualifying securities firms in OECD 
countries, depository institutions in non-OECD countries (short-term 
claims), and central governments of non-OECD countries (local currency 
exposures only).
    In the Basel IA ANPR, the Agencies suggested expanding the scope of 
eligible guarantors to include any entity whose long-term senior debt 
has been assigned an external credit rating of at least investment 
grade by an NRSRO. The applicable risk weight for guaranteed exposures 
would be based on the risk weights corresponding to the rating of the 
long-term debt of the guarantor.
    Most commenters supported, in principle, expanding the list of 
eligible guarantors. However, many commenters noted that very few 
community and midsize banking organizations have exposures that are 
guaranteed by externally rated entities. Thus, many commenters 
suggested that this provision would have little impact unless the 
proposed revisions recognized more types of guarantees.
    The Agencies believe that the range of eligible third-party 
guarantors under the existing risk-based capital rules is restrictive 
and ignores market practice. As a result, the Agencies are proposing to 
expand the list of eligible guarantors by recognizing entities that 
have long-term senior debt (without credit enhancement) rated at least 
investment grade by an NRSRO or, in the case of a sovereign, an issuer 
rating that is at least investment grade. Under this NPR, a recognized 
third-party guarantee would have to:
    (1) Be written and unconditional, and, for a sovereign guarantee, 
be backed by the full faith and credit of the sovereign;
    (2) Cover all or a pro rata portion of contractual payments of the 
obligor on the reference exposure; \21\
---------------------------------------------------------------------------

    \21\ If an exposure is partially guaranteed, the pro rata 
portion not covered by the guarantee would be assigned to the risk 
weight category appropriate to the obligor, after consideration of 
collateral and external ratings.
---------------------------------------------------------------------------

    (3) Give the beneficiary a direct claim against the protection 
provider;
    (4) Be non-cancelable by the protection provider for reasons other 
than the breach of the contract by the beneficiary;
    (5) Be legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced; and
    (6) Require the protection provider to make payment to the 
beneficiary on the occurrence of a default (as defined in the 
guarantee) of the obligor on the reference exposure without first 
requiring the beneficiary to demand payment from the obligor.
    To be considered an eligible guarantor, a sovereign or its senior 
long-term debt (without credit enhancement) must be externally rated at 
least investment grade. Non-sovereigns must have long-term senior debt 
(without credit enhancement) that is externally rated at least 
investment grade. Under this proposal, a banking organization could 
assign the portions of exposures guaranteed by eligible guarantors to 
the proposed risk weight category corresponding to the external rating 
of the eligible guarantors' long-term senior debt in accordance with 
Table 1 above.
    The Agencies would retain the existing risk-weight treatment of 
exposures guaranteed by the U.S. government and its agencies, U.S. 
government-sponsored agencies, public-sector entities, depository 
institutions in OECD countries, and depository institutions in non-OECD 
countries (short-term exposures only).
    Question 4: The Agencies solicit comment on all aspects of the 
proposed use of external ratings including the appropriateness of the 
risk weights, expanded collateral, and additional eligible guarantors. 
The Agencies also seek comment on whether to exclude certain externally 
rated exposures from the ratings treatment as proposed or to use 
external ratings as a measure for all externally rated exposures, 
collateral, and guarantees. Alternatively, should the Agencies retain 
the existing risk-based capital treatment for certain types of 
exposures, for example, qualifying securities firms? The Agencies are 
also interested in comments on all aspects of the scope of the terms 
sovereign, non-

[[Page 77454]]

sovereign, and securitization exposures. Specifically, the Agencies 
seek comment on the scope of these terms, whether they should be 
expanded to cover other entities, or whether any entities included in 
these definitions should be excluded.
iv. Government-Sponsored Agencies
    One area of particular interest to the Agencies is the risk 
weighting of exposures to U.S. government-sponsored agencies, also 
commonly referred to as government-sponsored entities (GSEs). The 
Agencies' existing risk-based capital regulations assign a 20 percent 
risk weight to exposures issued or guaranteed by GSEs. The Basel IA NPR 
proposes to retain this risk-based capital treatment. The Agencies are 
aware that there are various types of ratings that might increase the 
risk sensitivity of risk weights assigned to GSE exposures. For 
example, NRSROs rate the creditworthiness of short-term senior debt, 
senior unsecured debt, subordinated debt and preferred stock of some 
GSEs. These ratings on individual exposures, however, are often based 
in part on the NRSROs' assessment of the extent to which the U.S. 
government might come to the financial aid of a GSE if necessary. In 
this context, and as indicated in the preamble to the Basel II NPR, the 
Agencies do not believe that risk weight determinations should be based 
on the possibility of U.S. government financial assistance, except for 
the financial assistance the U.S. government has legally committed to 
provide. The Agencies believe the existing approach has thus far met 
this objective. However, the Agencies also note that as part of the 
October 19, 2000 agreement with their regulator,\22\ both Fannie Mae 
and Freddie Mac agreed to obtain and disclose annually ratings that 
would ``assess the risk to the government, or the independent financial 
strength, of each of the companies.'' \23\
---------------------------------------------------------------------------

    \22\ ``Freddie Mac and Fannie Mae Enhancements to Capital 
Strength, Disclosure and Market Discipline'', October 19, 2000 
(agreement between the GSEs and the Office of Federal Housing 
Enterprise Oversight).
    \23\ Ibid, p. 2.
---------------------------------------------------------------------------

    In accordance with the agreement, Fannie Mae and Freddie Mac 
currently obtain and disclose separate ratings from two NRSROs--
``Standard & Poor's (S&P) and Moody's Investors Service (Moody's). The 
S&P ``risk to the government rating'' uses the same scale as its 
standard corporate credit ratings. Currently, Fannie Mae and Freddie 
Mac both have a risk to the government issuer rating of AA- from S&P, 
which is unchanged from the initial AA- issuer rating that S&P 
initially provided in 2001. Moody's ``bank financial strength rating'' 
(BFSR) uses a scale of A-E. In 2002, Moody's provided a BFSR of A- to 
both GSEs. On March 28, 2005, Moody's downgraded Fannie Mae's BFSR to 
B+. Based on Moody's mapping of BFSRs to Moody's basic credit 
assessment ratings, A− is the equivalent of an Aa1 and B+ maps to 
an Aa2.
    Both the risk to government rating and the BFSR (collectively, 
financial strength ratings) are issuer ratings that evaluate the 
financial strength of each GSE without respect to any implied financial 
assistance from the U.S. government. These financial strength ratings 
are published and monitored by the issuing NRSRO but they are not 
included in the NRSROs' transition matrices. These ratings are an 
indicator of each GSE's overall financial condition and safety and 
soundness and, thus, do not apply to any specific financial obligation 
or the probability of timely payment thereof.\24\ If the Agencies were 
to use these S&P and Moody's financial strength ratings to risk weight 
exposures to Fannie Mae and Freddie Mac in a manner similar to the use 
of external ratings for rated exposures as proposed in the Basel IA 
NPR, the current ratings would map to a 20 percent risk weight.
---------------------------------------------------------------------------

    \24\ Moody's and S&P's financial strength ratings would not meet 
the definition of an ``external rating'' as proposed in this NPR. 
Furthermore, the difficulty of defining an event of default and the 
lack of default data suggest that it would not be feasible to 
incorporate this type of rating into a transition matrix.
---------------------------------------------------------------------------

    Question 5: The Agencies are considering whether to use financial 
strength ratings to determine risk weights for exposures to GSEs, where 
this type of rating is available, and are seeking comment on how a 
financial strength rating might be applied. For example, should the 
financial strength rating be mapped to the non-sovereign risk weights 
in Tables 1 and 2? Should these ratings apply to all GSE exposures 
including short- and long-term debt, mortgage-backed securities, 
collateral, and guarantees? How should exposures to a GSE that lacks a 
financial strength rating be risk weighted? Are there any requirements 
in addition to publication and on-going monitoring that should be 
incorporated into the definition of an acceptable financial strength 
rating?
    Question 6: The Agencies also seek comment on whether to exclude 
certain other externally rated exposures from the ratings treatment as 
proposed or to use external ratings as a measure for additional 
externally rated exposures, collateral, and guarantees. Should the 
proposed ratings treatment be applicable for direct exposures to public 
sector entities or depository institutions? Likewise, should the 
proposed ratings treatment be applicable to exposures guaranteed by 
public sector entities or depository institutions, and to exposures 
collateralized by debt securities issued by those entities?

D. Mortgage Loans Secured by a Lien on a One-to-Four Family Residential 
Property

i. First Lien Risk Weights
    The Agencies' existing risk-based capital rules assign first-lien, 
one-to-four family residential mortgages to either the 50 percent or 
100 percent risk weight category. Most mortgage loans secured by a 
first lien on a one-to-four family residential property (first lien 
mortgages) meet the criteria to receive a 50 percent risk weight.\25\ 
The broad assignment of most first lien mortgages to the 50 percent 
risk weight category has been criticized for not being sufficiently 
risk sensitive.
---------------------------------------------------------------------------

    \25\ 12 CFR part 3 appendix A section 3(c)(iii) (OCC); 12 CFR 
parts 208 and 225 appendix A section III.C.3 (Board); 12 CFR part 
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition 
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50 
percent risk weight) (OTS).
---------------------------------------------------------------------------

    In the Basel IA ANPR, the Agencies stated they were considering 
options to make the risk-based capital requirement for residential 
mortgages more risk sensitive while not unnecessarily increasing 
regulatory burden. One option was to base the capital requirement on 
loan-to-value ratios (LTV), determined after consideration of private 
mortgage insurance (PMI). This option was illustrated by an LTV risk 
weight table that suggested risk weights of 20, 35, 50, and 100 
percent.
    Another option discussed in the Basel IA ANPR was to assign risk 
weights based on LTV in combination with an evaluation of borrower 
creditworthiness. Under this scenario, different ranges of LTV could be 
paired with specified credit assessments, such as credit scores. A 
first lien mortgage with a lower LTV made to a borrower with higher 
creditworthiness would receive a lower risk weight than a loan with 
higher LTV made to a borrower with lower creditworthiness.
    The Agencies received many comments about how to risk weight first 
lien mortgages. Many commenters cautioned against rules that would be 
burdensome and costly to implement. Commenters generally supported the 
use of LTV and stated that use of LTV in assigning risk weights would 
not be overly burdensome because LTV

[[Page 77455]]

information is collected when lenders originate mortgage loans.
    Some commenters supported the use of a matrix based on LTV and a 
measure of creditworthiness, to further improve the risk sensitivity of 
the risk weights assigned to residential mortgage loans. They stated 
that this approach would address both collateral and borrower risk and 
would mirror current practices among mortgage lenders. Other commenters 
expressed concern about the potential burden of this approach, 
particularly for smaller banking organizations. Some commenters noted 
that certain credit assessment measures such as credit-scoring models 
vary by region or credit reporting agency, and may harm lower income 
borrowers, borrowers without credit histories, and borrowers who have 
experienced unusual financial difficulties. Many of these commenters 
suggested that the use of credit scores as a measure of borrower 
creditworthiness be optional to alleviate the burden for some smaller 
banking organizations.
    To increase the risk sensitivity of the existing risk-based capital 
rules while minimizing the overall burden to banking organizations, the 
Agencies are proposing to risk weight first lien mortgages based on 
LTV. LTV is a meaningful indicator of potential loss and the likelihood 
of borrower default. Consequently, under this proposal a banking 
organization would assign a risk weight for a first lien mortgage, 
including mortgages held for sale and mortgages held in portfolio as 
outlined in Table 3.

   Table 3.--Proposed LTV and Risk Weights for 1-4 Family First Liens
------------------------------------------------------------------------
                                                             Risk weight
             Loan-to-Value ratios (in percent)                    (in
                                                               percent)
------------------------------------------------------------------------
60 or less.................................................           20
Greater than 60 and less than or equal to 80...............           35
Greater than 80 and less than or equal to 85...............           50
Greater than 85 and less than or equal to 90...............           75
Greater than 90 and less than or equal to 95...............          100
Greater than 95............................................          150
------------------------------------------------------------------------

    The Agencies believe the implementation of this proposed approach 
would not impose a significant burden on banking organizations because 
LTV information is readily available and is commonly used in the 
underwriting process.
    The Agencies believe that the use of LTV would enhance the risk 
sensitivity of regulatory capital but it remains a fairly simple 
measurement of risk. Use of LTV in risk weighting first lien mortgages 
does not substitute for, or otherwise release a banking organization 
from, its obligation to have prudent loan underwriting and risk 
management practices that are consistent with the size, type, and risk 
of a mortgage product. Through the supervisory process, the Agencies 
would continue to ensure that banking organizations engage in prudent 
underwriting and risk management practices consistent with existing 
rules, supervisory guidance, and safety and soundness. The Agencies 
would continue to reserve the authority to require banking 
organizations to hold additional capital where appropriate.
    In general, Table 3 would apply to first lien mortgages. The 
Agencies would maintain their respective risk-based capital criteria 
for a first lien mortgage (for example, prudent underwriting) to 
receive a risk weight less than 100 percent.\26\ Table 3 would not 
apply to loans to builders secured by certain pre-sold properties, 
which are subject to a statutory 50 percent risk weight.\27\ Other 
loans to builders for the construction of residential property would 
continue to be subject to a 100 percent risk weight. The Agencies would 
maintain their respective capital treatment for a one-to-four family 
residential mortgage loan to a borrower for the construction of the 
borrower's own home.\28\ Question 7: The Agencies seek comment on all 
aspects of using LTV to determine the risk weights for first lien 
mortgages.
---------------------------------------------------------------------------

    \26\ 12 CFR part 3 appendix A, section 3(3)(iii) (OCC); 12 CFR 
Parts 208 and 225, appendix A, section III.C.3 (Board); 12 CFR part 
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition 
of ``qualifying mortgage loan'') and 12 CFR 567.6(a)(1)(iii)(B) (50 
percent risk weight) (OTS).
    \27\ This statutory risk weight applies to loans to builders 
secured by one-to-four family residential properties with 
substantial project equity for the construction of one-to-four 
family residences that have been pre-sold under firm contracts to 
purchasers who have obtained firm commitments for permanent 
qualifying mortgage loans and have made substantial earnest money 
deposits. See Resolution Trust Corporation Refinancing, 
Restructuring, and Improvement Act of 1991, Pub. L. 102-233, Sec.  
618(a), 105 Stat. 1761, 1789-91 (codified at 12 U.S.C. 1831n note 
(1991)).
    \28\ 12 CFR part 3 appendix A, section 3(3)(iv) (OCC); 12 CFR 
parts 208 and 225, appendix A, section III.C.3. (Board); 12 CFR part 
325, appendix A, section II.C.3 (FDIC); and 12 CFR 567.1 (definition 
of ``qualifying mortgage loan'') (OTS).
---------------------------------------------------------------------------

    The Agencies' existing risk-based capital rules place certain 
privately-issued mortgage-backed securities that do not carry the 
guarantee of a government or a government-sponsored entity (for 
example, unrated senior positions) in the 50 percent risk weight 
category, provided the underlying mortgages would qualify for a 50 
percent risk weight. The Agencies intend to continue to risk weight 
these privately-issued mortgage-backed securities using the risk 
weights assigned to underlying mortgages under the Agencies' existing 
capital rules. Question 8: The Agencies seek comment on this treatment 
and other methods for risk-weighting these privately-issued mortgage-
backed securities, including the appropriateness of assigning risk 
weights to these securities based on the risk weights of the underlying 
mortgages as determined under Table 3.
    While the Agencies are not proposing to use LTV and borrower 
creditworthiness to risk weight mortgages, the Agencies continue to 
evaluate approaches that would consider borrower creditworthiness in 
risk weighting first lien mortgages. One such approach could use LTV 
and a measure of borrower creditworthiness to assign risk weights in a 
manner similar to that shown in Table 3A below. Table 3A would assign a 
lower risk weight to mortgages with a lower LTV that are underwritten 
to borrowers with a stronger credit history and a higher risk weight to 
mortgages with a higher LTV that are underwritten to borrowers with a 
weaker credit history.

[[Page 77456]]



              Table 3A.--Illustrative Risk-Weight Ranges for LTV and Credit History for 1-4 Family
                                                  [First liens]
----------------------------------------------------------------------------------------------------------------
                      First lien mortgages                                Illustrative risk weight ranges
----------------------------------------------------------------------------------------------------------------
                                                                  Credit history  Credit history  Credit history
                Loan-to-Value ratios (in percent)                   group 1 (in     group 2 (in     group 3 (in
                                                                     percent)        percent)        percent)
----------------------------------------------------------------------------------------------------------------
60 or less......................................................           20-35           20-35           20-35
Greater than 60 and less than or equal to 80....................           20-35           20-35           35-75
Greater than 80 and less than or equal to 90....................           20-50           35-75          75-150
Greater than 90 and less than or equal to 95....................           20-50          50-100         100-200
Greater than 95.................................................           35-75          50-100         150-200
----------------------------------------------------------------------------------------------------------------

    Table 3A presents three broad categories of relative credit 
performance (credit history groups). The Agencies would determine the 
credit history groups using default odds. The default odds would be 
based upon credit reporting agencies' validation charts (also known as 
odds tables). A banking organization would determine a borrower's 
default odds by mapping the borrower's credit score, as obtained from a 
credit reporting agency,\29\ to the credit reporting agency's 
validation chart. In order for a validation chart to qualify, it would 
be based on: (1) The same vendor and model as the credit scores used by 
the banking organization, (2) a nationally diverse group of credits, 
and (3) relevant default odds measured over no less than 18 months 
following the scoring date used in the validation chart. If the 
Agencies decide in the final rule to risk weight first lien mortgages 
based on LTV and borrower creditworthiness, the Agencies would 
generally determine a specific risk weight based on the ranges provided 
in Table 3A.
---------------------------------------------------------------------------

    \29\ See 15 U.S.C. 1681a(f), which defines a credit reporting 
agency.
---------------------------------------------------------------------------

    Question 9: While the Agencies are not proposing to use LTV and 
borrower creditworthiness to risk weight mortgages, the Agencies may 
decide to risk weight first lien mortgages based on LTV and borrower 
creditworthiness in the final rule. Accordingly, the Agencies continue 
to seek comment on an approach using LTV combined with credit scores 
for determining risk-based capital. More specifically, the Agencies 
seek comment on: operational aspects for assessing the use of default 
odds to determine creditworthiness qualifications to determine 
acceptable models for calculating the default odds; the negative 
performance criteria against which the default odds are determined 
(that is, 60-days past due, 90-days past due, etc.); regional 
disparity, especially for a banking organization whose borrowers are 
not geographically diverse; and how often credit scores should be 
updated. In addition, the Agencies seek comment on determining the 
proper credit history group for: an individual with multiple credit 
scores, a loan with multiple borrowers with different probabilities of 
default, an individual whose credit history was analyzed using 
inaccurate data, and individuals with insufficient credit history to 
calculate a probability of default.

ii. Calculation of LTV

    The Agencies sought comment on whether LTV should be based on LTV 
at origination or should be periodically updated. Some commenters 
supported using LTV at origination only. These commenters stated that 
regularly updating and monitoring LTV would be unduly burdensome and 
costly. Other commenters said the Agencies should require periodic 
updates, especially during significant declines in housing values in a 
banking organization's service area. Some commenters said that banking 
organizations should be able to update LTV at their discretion. Certain 
commenters suggested that updates be based on periodic property 
appraisals and loan balance updates. However, a number of commenters 
expressed concern about the reliability of appraisals, especially in 
over-heated markets.
    Commenters had varying opinions about how the Agencies should 
factor PMI into the LTV calculations. Most of the commenters that 
addressed the issue supported calculating LTV net of loan-level PMI 
coverage. However, some commenters suggested that the Agencies should 
also consider the risk mitigation benefits of pool-level PMI. A few 
commenters suggested considering PMI issued only by highly rated 
insurers. One commenter endorsed a Basel IA ANPR suggestion to create 
risk-weight floors for mortgages supported by loan-level PMI from 
highly rated insurers. Another commenter suggested considering PMI 
issued by non-affiliate insurers only.
    In proposing the LTV calculation method, the Agencies aim to 
balance burden and costs against the benefits of a more risk sensitive 
risk-weighting system. The Agencies propose to calculate LTV at 
origination of the first mortgage as follows. First, the value of the 
property would be equal to the lower of the purchase price for the 
property or the value at origination. The value at origination must be 
based on an appraisal or evaluation of the property in conformance with 
the Agencies' appraisal regulations \30\ and real estate lending 
guidelines.\31\ The value of the property could only be updated for 
risk-weight purposes when the borrower refinances its mortgage and the 
banking organization extends additional funds. Second, for loans that 
are positively amortizing, banking organizations may adjust the LTV 
quarterly to reflect any decrease in the principal balance. For loans 
that negatively amortize, banking organizations would be required to 
adjust the LTV quarterly to reflect the increase in principal balance 
and risk weight the loan based on the updated LTV. However, where 
property values in a banking organization's market subsequently 
experience a general decline in value, the Agencies continue to reserve 
their authority to require additional capital when warranted for 
supervisory reasons. The Agencies emphasize that the updating of LTV 
for regulatory capital purposes is not intended to replace good risk 
management practices at banking organizations for situations where more 
frequent updates of loan or property values might be appropriate.
---------------------------------------------------------------------------

    \30\ 12 CFR part 34 (OCC); 12 CFR part 208, subpart E and part 
225, subpart G (Board); 12 CFR part 323, 12 CFR part 365 (FDIC); and 
12 CFR part 564 (OTS).
    \31\ 12 CFR part 34 Subpart C.43 (OCC); 12 CFR part 208, subpart 
E and part 225, subpart G (Board); 12 CFR part 325, appendix A, 
section II.C.3 (FDIC);12 CFR 560.100--560.101 (OTS).
---------------------------------------------------------------------------

    Question 10: The Agencies seek comment on whether there are other 
circumstances under which LTV should be adjusted for risk-weight 
purposes.

[[Page 77457]]

    The Agencies believe that the risk mitigating impact of loan-level 
PMI should be reflected in calculating the LTV. Loan-level PMI is 
insurance that protects a mortgage lender in the event of borrower 
default up to a predetermined portion of the value of a one-to-four 
family residential property provided that there is no pool-level cap. A 
pool-level cap would effectively reduce coverage to any amount less 
than the predetermined portion. PMI would be recognized only if the 
loan-level insurer is not affiliated with the banking organization and 
has long-term senior debt (without credit enhancement) externally rated 
at least the third highest investment grade by an NRSRO. The Agencies 
believe that pool-level PMI should not generally reduce the LTV, 
because pool-level PMI absorbs losses based on a portfolio basis and is 
not attributable to a given loan.
    Question 11: The Agencies request comment on all aspects of PMI 
including, whether PMI providers must be non-affiliated companies of 
the banking organization. The Agencies also seek comment on the 
treatment of PMI in the calculation of LTV when the PMI provider is not 
an affiliate, but a portion of the mortgage insurance is reinsured by 
an affiliate of the banking organization.
iii. Non-Traditional Mortgage Products
    The Basel IA ANPR sought comment on whether mortgages with non-
traditional features pose unique risks that warrant higher risk-based 
capital requirements. Non-traditional loan features include the 
possibility of negative amortization of the loan balance, a borrower's 
option to make interest-only payments, and interest rate reset 
provisions that may result in significant payment shock to the 
borrower.
    Commenters generally supported risk weighting mortgage loans with 
non-traditional features consistently with the risk weighting for 
traditional first lien mortgages. These commenters suggested that any 
additional risks posed by these mortgage products were the result of 
imprudent underwriting practices or the combining of risks, not risks 
inherent in the products. One commenter, however, supported higher 
capital requirements for all non-traditional mortgage loans. Other 
commenters supported additional capital for specific products, such as 
negative amortization loans.
    The Agencies recognize the difficultly in providing a clear and 
consistent definition of higher-risk mortgage loans with non-
traditional features. Thus, the Agencies generally propose to risk 
weight first lien mortgages with non-traditional features in the manner 
described above. Notwithstanding this proposed treatment, the Agencies 
recognize that certain underwriting practices may increase the risk 
associated with a particular mortgage product. These practices may 
include underwriting of loans with less stringent income and asset 
verification requirements without offsetting mitigating factors; 
offering loans with very low introductory rates and short adjustment 
periods that may result in significant payment shock; and combining 
first lien loans with simultaneous junior lien loans that could result 
in an aggregate loan obligation with little borrower equity and the 
potential for a sizeable payment increase. The Agencies will continue 
to review banking organizations' lending practices on a case-by-case 
basis and may require additional capital or reserves in appropriate 
circumstances.
    Loans with a negative amortization feature pose additional risks to 
a banking organization in the form of an unfunded commitment. 
Therefore, the Agencies propose to risk weight mortgage loans with 
negative amortization features consistent with the risk-based capital 
treatment for other unfunded commitments (for example, lines of 
credit). Under the proposed approach, the unfunded portion of the 
maximum negative amortization amount would be risk weighted separately 
from the funded portion of the loan. The funded portion of the loan 
would be risk weighted according to the risk weights for first-lien 
mortgages, and the unfunded portion of the maximum negative 
amortization amount would be risk weighted as a commitment based on the 
LTV for the maximum contractual loan amount.
    Therefore, banking organizations would need to calculate two LTVs 
for a loan with a negative amortization feature for risk-based capital 
purposes: the LTV for the funded commitment and the LTV for the 
unfunded commitment. To demonstrate how loans with negative 
amortization features would be risk weighted, assume that a property is 
valued at $100,000 and the banking organization grants a first-lien 
loan for $81,000 that includes a negative amortization feature with a 
10 percent cap. The funded amount of $81,000 results in an 81 percent 
LTV, which is risk weighted at 50 percent based on Table 3. In 
addition, the off-balance sheet unfunded commitment of $8,100 would 
receive a 50 percent credit conversion factor (CCF) resulting in an on-
balance sheet credit equivalent amount of $4,050. The combined LTV of 
the funded and unfunded commitment would be 89.1 percent, hence $4,050 
would receive a 75 percent risk weight based on Table 3. The total 
risk-weighted assets for the first-lien mortgage with negative 
amortization feature would equal the risk-weighted assets for the 
funded amount plus the risk-weighted assets for the unfunded amount.
    That loan would be risk weighted at origination as follows:
BILLING CODE 6720-01-P

[[Page 77458]]

[GRAPHIC] [TIFF OMITTED] TP26DE06.000

BILLING CODE 6720-01-C
    The Agencies believe that this approach would result in a risk-
based capital charge that more accurately reflects the risk of mortgage 
loans with negative amortization features.
    Question 12: The Agencies seek comment on the proposed risk-based 
capital treatment for all mortgage loans with non-traditional features 
and, in particular the proposed approach for mortgage loans with 
negative amortization features. The Agencies also seek comment on 
whether the maximum contractual amount is the appropriate measure of 
the unfunded exposure to loans with negative amortization features. The 
Agencies seek comment on whether the unfunded commitment for a reverse 
mortgage should be subject to a similar risk-based capital charge.
iv. Junior Lien One-to-Four Family Residential Mortgages
    The Basel IA ANPR discussed the existing treatment for home equity 
lines of credit (HELOCs) and other junior lien mortgages.\32\ If a 
banking organization

[[Page 77459]]

holds both a first and a junior lien, and no other party holds an 
intervening lien, the Agencies' existing capital rules require these 
loans to be combined to determine the LTV and then risk weighted as a 
first lien mortgage. The Basel IA ANPR indicated that the Agencies 
intended to continue this approach.
---------------------------------------------------------------------------

    \32\ The unfunded portion of a HELOC that is a commitment for 
more than one year and that is not unconditionally cancelable is 
converted to an on-balance sheet asset using a 50 percent CCF. That 
amount plus the funded portion of the HELOC are added together to 
determine the amount of the HELOC that is combined with the first 
lien position and then risk weighted at either 50 percent or 100 
percent. See generally, 12 CFR part 3 appendix A, section (b)(2) and 
(a)(3)(iii) (OCC); 12 CFR parts 208 and 225, appendix A, section 
III.C.3 and 12 CFR parts 208 and 225, appendix A, section III.D.2 
(Board); 12 CFR part 325, appendix A, section II.D.2.b. (FDIC); and 
12 CFR 567.6(a)(2)(ii)(B) (OTS).
---------------------------------------------------------------------------

    Currently, stand-alone junior lien mortgages (a stand-alone junior 
lien mortgage is one where an institution holds a second or more junior 
lien without holding all of the more senior liens) receive a 100 
percent risk weight. The Basel IA ANPR indicated that the Agencies were 
considering retaining this risk weight for stand-alone junior lien 
mortgages where the LTV (computed by combining the loan amounts for the 
junior lien and all senior liens) does not exceed 90 percent. However, 
for stand-alone junior lien mortgages where the LTV of the combined 
liens exceeds 90 percent, the Agencies suggested that a risk weight 
higher than 100 percent might be appropriate in recognition of the 
elevated credit risk associated with these exposures.
    Many commenters opposed this approach and suggested that a more 
risk-sensitive approach, similar to that proposed for first lien 
mortgages, would be more appropriate because not all stand-alone junior 
lien mortgages are riskier than first lien mortgages. Other commenters 
stated that the risk-based capital treatment of first and junior lien 
mortgages, regardless of whether the same banking organization holds 
both, should be consistent. In addition, many commented that it would 
be illogical and unjustifiable to impose higher risk weights (for 
example, 150 percent) for secured mortgage loans than for unsecured 
retail loans (for example, 100 percent).
    Consistent with the existing risk-based capital rules, the Agencies 
propose that a banking organization that holds both the first and 
junior lien mortgages on a one-to-four family residential property, 
where there is no intervening lien, would assign the combined loans to 
the appropriate risk-weight category in Table 3 above, based on the 
loans' combined LTV. A banking organization that holds both the first 
and any subsequent liens may update the property value for calculation 
of the combined LTV of the senior loans and the junior lien if the 
organization obtains an appraisal or evaluation of the collateral in 
conformance with the Agencies' appraisal regulations and related 
guidelines at the origination of the junior lien mortgage.
    For a stand-alone junior lien mortgage, the Agencies propose that a 
banking organization use the combined LTV of that loan and all senior 
loans to determine the appropriate risk weight for the junior lien. 
Using the combined LTV, a banking organization would risk weight the 
stand-alone junior lien based on Table 5.

   Table 5.--Proposed LTV and Risk Weights for 1-4 Family Junior Liens
------------------------------------------------------------------------
                                                             Risk weight
        Combined loan-to-value ratios  (in percent)               (in
                                                               percent)
------------------------------------------------------------------------
60 or less.................................................           75
Greater than 60 and less than or equal to 90...............          100
Greater than 90............................................          150
------------------------------------------------------------------------

    The combined LTV for the funded portion of stand-alone junior liens 
where the first lien can negatively amortize would be calculated using 
the maximum contractual loan amount under the terms of the first lien 
mortgage plus the funded portion of the junior lien. The combined LTV 
for the unfunded portion of all junior liens where the first lien can 
negatively amortize would be calculated using the maximum contractual 
loan amount under the terms of the first lien mortgage plus the funded 
unfunded portions of the junior lien.
    The Agencies propose that banking organizations will be required to 
hold capital for both the funded and unfunded portion of a HELOC. 
Banking organizations that hold a HELOC where there is no intervening 
lien would assign the first lien and funded portion of the HELOC to the 
appropriate risk weight category in Table 3 above, based on the loans' 
combined LTV using the senior loans and the funded portion of the 
HELOC. The unfunded portion of the HELOC would be subject to the 
appropriate CCF \33\ and risk weighted, using Table 3, based on the 
combined LTV, (senior loans plus the funded and unfunded portions of 
the HELOC).
---------------------------------------------------------------------------

    \33\ The unfunded portion of a HELOC that is a commitment for 
more than one year and that is not unconditionally cancelable is 
converted to an on-balance sheet asset using a 50 percent CCF. If 
the unfunded portion of the HELOC is a commitment for less than a 
year or is unconditionally cancelable it is converted to an on-
balance sheet credit equivalent using a 0 percent CCF.
---------------------------------------------------------------------------

    For stand-alone HELOCs, the funded and unfunded portion of the 
stand-alone HELOC would be risk weighted based on Table 5. The funded 
portion of a HELOC would receive a risk weight based on the combined 
LTV of all senior loans and funded portion of the HELOC. The unfunded 
portion of the HELOC would be subject to the appropriate CCF and risk 
weighted, using Table 5, based on the combined LTV of all senior loans 
and the funded portion of the HELOC and the unfunded portion of the 
HELOC.
    Question 13: The Agencies request comment on the appropriateness of 
the proposed risk-based capital treatment for HELOCs including the 
burden of adjusting LTV as the borrower utilizes the HELOC.
    While the Agencies are not proposing in this NPR to use LTV and 
borrower creditworthiness, they also continue to evaluate approaches 
that would consider borrower creditworthiness in risk weighting junior 
lien mortgages. The Agencies believe that greater risk sensitivity can 
be achieved by evaluating not only LTV but also borrower 
creditworthiness. If the Agencies decide in the final rule to risk 
weight junior lien mortgages based on LTV and a measure of borrower 
creditworthiness, the Agencies would generally determine a specific 
risk weight based on the ranges provided in Table 5A.
    Question 14: Accordingly, the Agencies seek further comment on all 
aspects of the use of LTV and borrower creditworthiness to determine 
the risk weight for a junior lien mortgage.

[[Page 77460]]



   Table 5A.--Illustrative Risk-Weight Ranges for LTV and Credit History for Junior Lien 1-4 Family Mortgages
----------------------------------------------------------------------------------------------------------------
                       Junior liens/HELOCs                                Illustrative risk weight ranges
----------------------------------------------------------------------------------------------------------------
                                                                  Credit history  Credit history  Credit history
                      Loan-to-Value Ratios                         Group 1  (in    Group 2  (in    Group 3  (in
                                                                     percent)        percent)        percent)
----------------------------------------------------------------------------------------------------------------
60 or less......................................................           20-50          75-150         150-200
Greater than 60 and less than or equal to 80....................           35-50          75-150         150-200
Greater than 80 and less than or equal to 95....................           35-75          75-200             200
Greater than 90 and less than or equal to 95....................           35-75          75-200             200
Greater than 95.................................................           35-75          75-200             200
----------------------------------------------------------------------------------------------------------------

v. Transitional Rule
    Some commenters raised concerns about the cost and burden 
associated with recoding existing loans to conform to a new system. To 
minimize burden while moving toward a more risk-sensitive approach, the 
Agencies propose to allow banking organizations that choose to apply 
the proposed rule an option to continue to risk weight existing 
mortgage loans using the existing risk-based capital rules. The option 
would apply only to those loans that the banking organization owned at 
the time it chose to apply the proposed rules. The banking organization 
would be required to apply the transitional provision to all of its 
existing mortgage loans. A banking organization may not use this 
transitional treatment if it previously used Tables 3 or 5 to risk 
weight these existing loans.

E. Short-Term Commitments

    Under the Agencies' existing risk-based capital rules, commitments 
with an original maturity of one year or less (short-term commitments) 
and commitments that are unconditionally cancelable \34\ are generally 
converted to an on-balance sheet credit equivalent amount using a zero 
percent CCF. Accordingly, banking organizations extending short-term 
commitments or unconditionally cancelable commitments are not required 
to maintain risk-based capital against the credit risk inherent in 
these exposures. Short-term commitments that are eligible liquidity 
facilities that support asset-backed commercial paper (ABCP), however, 
are converted to on-balance sheet assets using a 10 percent CCF. 
Commitments with an original maturity of more than one year (long-term 
commitments), including eligible long-term liquidity facilities that 
support ABCP, are converted to on-balance sheet credit equivalent 
amounts using a 50 percent CCF.
---------------------------------------------------------------------------

    \34\ An unconditionally cancelable commitment is one that can be 
canceled for any reason at any time without prior notice. In the 
case of a home equity line of credit, the banking organization is 
deemed able to unconditionally cancel the commitment if it can, at 
its option, prohibit additional extensions of credit, reduce the 
line, and terminate the commitment to the full extent permitted by 
relevant Federal law.
---------------------------------------------------------------------------

    In the Basel IA ANPR, the Agencies noted that they were considering 
amending the risk-based capital requirements for short-term 
commitments. Even though commitments with an original maturity of one 
year or less expose banking organizations to a lower degree of credit 
risk than longer-term commitments, some credit risk exists. Thus, the 
Agencies suggested applying a 10 percent CCF to short-term commitments. 
The resulting credit equivalent amount would be risk-weighted according 
to the rating of the facility or the underlying asset(s) or the 
obligor, after considering any collateral and guarantees. The Agencies 
noted that they planned to retain the zero percent CCF for commitments 
that are unconditionally cancelable. The Agencies also sought comment 
on an alternative approach that would apply a single CCF (for example, 
20 percent) to all commitments, both short- and long-term.
    Almost universally, commenters agreed that unconditionally 
cancelable commitments should not receive a capital charge. However, 
commenters' recommendations varied about how to approach other short- 
and long-term commitments. Some commenters suggested that all 
commitments, except unconditionally cancelable commitments, should 
receive a 20 percent CCF, regardless of maturity. These commenters 
argued that this simple approach would ease burden and counterbalance 
new complexities within the Basel IA ANPR.
    Conversely, several commenters suggested that the capital treatment 
should reflect the fact that short-term commitments are less risky than 
long-term commitments. Of these commenters, a few argued that short-
term commitments should not receive any capital charge. A few others 
supported the Basel IA ANPR suggestion to apply a 10 percent CCF to 
short-term commitments and 50 percent CCF to long-term commitments. One 
commenter suggested using a 20 percent CCF for short-term commitments 
and a 50 percent CCF for long-term commitments.
    In the Agencies' view, banking organizations that provide short-
term commitments that are not unconditionally cancelable are exposed to 
credit risk that the existing risk-based capital rules do not 
adequately address. The Agencies also recognize that short-term 
commitments generally expose banking organizations to a lower degree of 
credit risk than long-term commitments, thereby justifying a CCF that 
is lower than the 50 percent CCF currently assigned to long-term 
commitments. Thus, the Agencies are proposing to assign a 10 percent 
CCF to short-term commitments. The resulting credit equivalent amount 
would then be risk-weighted according to the rating of the facility, 
the underlying assets, or the obligor, after considering any applicable 
collateral and guarantees. Commitments that are unconditionally 
cancelable would retain a zero percent CCF.
    Finally, the Agencies are not proposing to apply a CCF to 
commitments to originate one-to-four family residential mortgage loans 
that are provided in the ordinary course of business. The Agencies 
believe these types of commitments present only minimal credit risk 
because of their short durations, the significant number that expire 
before being funded, and the large percentage of originations that are 
held for resale. In addition, commitments on held-for-sale mortgages 
are treated as derivatives and are accounted for at fair value on the 
balance sheet of the issuer, and therefore already receive a capital 
charge. Given these mitigating factors, the Agencies do not wish to 
impose the burden of determining risk weights by LTV during the short 
commitment period.

[[Page 77461]]

    Question 15: The Agencies continue to seek comments on an 
alternative approach that would apply a single CCF of 20 percent to all 
commitments, both short- and long-term (that are not unconditionally 
cancelable), and the advantages and disadvantages of such an approach.

F. Assess a Risk-Based Capital Charge for Early Amortization

    The Agencies' existing risk-based capital rules do not assess a 
capital charge for risks associated with early amortization of 
securitizations of revolving credits (for example, credit card 
receivables). When assets are securitized, the extent to which the 
selling or sponsoring entity transfers the risks associated with the 
assets depends on the structure of the securitization and the nature of 
the underlying assets. Early amortization provisions \35\ in 
securitizations of revolving retail credit facilities increase the 
likelihood that investors will be repaid before being subject to any 
risk of significant credit losses. These provisions raise two concerns 
about the risks to banking organizations that sponsor securitizations 
with early amortization provisions: (1) The payment allocation formula 
can result in the subordination of the seller's interest in the 
securitized assets during early amortization, and (2) an early 
amortization event can increase a banking organization's capital and 
liquidity needs in order to finance new draws on the revolving credit 
facilities.
---------------------------------------------------------------------------

    \35\ An early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision is solely triggered by events not directly related to 
the performance of the underlying exposures or the originating 
banking organization (such as material changes in tax laws or 
regulations).
---------------------------------------------------------------------------

    In recognition of the risks associated with these structures, the 
Agencies have proposed a capital charge on securitizations of revolving 
credit exposures with early amortization provisions in prior 
rulemakings. On March 8, 2000, the Agencies published a proposed rule 
on recourse and direct credit substitutes.\36\ In that proposal, the 
Agencies proposed to apply a fixed CCF of 20 percent to the amount of 
assets under management in all revolving securitizations that contained 
early amortization features.\37\ The preamble to the final Recourse 
Rule \38\ reiterated the concerns with early amortization, indicating 
that the risks associated with securitization, including those posed by 
an early amortization feature, are not fully captured in the Agencies' 
capital rules. While the Agencies did not impose a risk-based capital 
charge for early amortization provisions in the final Recourse Rule, 
they indicated that they would revisit the issue at some point in the 
future.\39\
---------------------------------------------------------------------------

    \36\ 65 FR 12320 (March 8, 2000).
    \37\ Id. at 12330-12331.
    \38\ 66 FR 59614, 59619 (November 29, 2001).
    \39\ In October 2003, the Agencies issued another proposed rule 
that included a risk-based capital charge for early amortization. 
See 68 FR 56568, 56571-56573 (October 1, 2003). This proposal was 
based upon the Basel Committee's third consultative paper issued 
April 2003. When the Agencies finalized other unrelated aspects of 
this proposed rule in July 2004, they did not implement the early 
amortization proposal. The Agencies determined that the change was 
inappropriate because the capital treatment of retail credit, 
including securitizations of revolving credit, was subject to change 
as the Basel framework proceeded through the U.S. rulemaking 
process. 69 FR 44908, 44912-44913 (July 28, 2004).
---------------------------------------------------------------------------

    In the Basel IA ANPR, the Agencies suggested two approaches to 
address these risks. One option was to apply a flat CCF to off-balance 
sheet receivables in revolving securitizations with early amortization 
provisions. Alternatively, the Agencies suggested using a risk-
sensitive methodology based on excess spread \40\ compression. Under 
this methodology, the risk-based capital charge would increase as 
excess spread decreased and approached the early amortization trigger 
point.
---------------------------------------------------------------------------

    \40\ Excess spread means gross finance charge collections 
(including market interchange fees) and other income received by a 
trust or the special purpose entity (SPE) minus interest paid to 
investors in the securitization exposures, servicing fees, charge-
offs, and other similar trust or SPE expenses.
---------------------------------------------------------------------------

    Most commenters that addressed this issue opposed the application 
of any capital charge on the investors' interest in credit card 
securitizations. Of the few that supported such a charge, one 
recommended that the rules apply a flat CCF to securitizations with 
early amortization provisions, and four supported the approach based on 
excess spread.
    The Agencies are proposing to apply an approach based on excess 
spread to all revolving securitizations of credits with early-
amortization features. This capital charge would be assessed against 
the investors' interest (that is, the total amount of securities issued 
by a trust or special purpose entity to investors, which is the portion 
of the securitization that is not on the banking organization's balance 
sheet) and would be imposed only in the event that the excess spread 
has declined to a predetermined percentage of the trapping point. The 
capital required would increase as the level of excess spread 
approaches the early amortization trigger. The Agencies are proposing 
to compare the three-month average excess spread against the point at 
which the securitization trust would be required to trap excess spread 
in a spread or reserve account as a basis for the capital charge. To 
determine the excess spread trapping point and the appropriate CCF, a 
banking organization would divide the level of excess spread by the 
spread trapping point as described below. In securitizations that do 
not require excess spread to be trapped, or that specify a trapping 
point based primarily on performance measures other than the three-
month average excess spread, the excess spread trapping point would be 
set for purposes of this proposed rule at 4.5 percent.
    To calculate the securitization's excess spread trapping point 
ratio, a banking organization must first calculate the annualized three 
month ratio for excess spread as follows:
    a. For each of the three months, divide the month's excess spread 
by the outstanding principal balance of the underlying pool of 
exposures at the end of each month.
    b. Calculate the average ratio for the three months and convert the 
resulting ratio to a compound annual rate.
    Then a banking organization must divide the annualized three month 
ratio for excess spread by the excess spread trapping point that is 
specified in the documentation for the securitization. Finally, a 
banking organization must apply the appropriate CCF from Table 6 to the 
amount of investors' interest. The resulting on-balance sheet credit 
equivalent amount would be assigned to the risk weight category 
appropriate to the securitized assets.

         Table 6.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
                                                               CCF  (in
             Excess spread trapping point ratio                percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more...................            0
Less than 133.33 percent to 100 percent of trapping point..            5
Less than 100 percent to 75 percent of trapping point......           15
Less than 75 percent to 50 percent of trapping point.......           50
Less than 50 percent of trapping point.....................          100
------------------------------------------------------------------------

    Question 16: The Agencies solicit comment on the appropriateness of 
the 4.5 percent excess spread trapping point and on other types and 
levels of early amortization triggers used in securitizations of 
revolving exposures that should be considered, especially for HELOC 
securitizations. The Agencies also seek comment on whether a flat 10

[[Page 77462]]

percent CCF is a more appropriate capital charge for revolving 
securitizations with early amortization features.

G. Remove the 50 Percent Limit on the Risk Weight for Derivatives

    Currently, the Agencies' risk-based capital rules permit banks to 
apply a maximum 50 percent risk weight to the credit equivalent amount 
of certain derivative contracts. The risk weight assigned to 
derivatives contracts was limited to 50 percent when the derivatives 
counterparty credit risk rule was finalized in 1995 because most 
derivative counterparties were highly rated and were generally 
financial institutions.\41\ At the time, the Agencies noted that they 
intended to monitor the quality of credits in the interest rate and 
exchange rate markets to determine whether some transactions might 
merit a 100 percent risk weight.
---------------------------------------------------------------------------

    \41\ 60 FR 46169-46185 (September 5, 1995).
---------------------------------------------------------------------------

    As the market for derivatives has developed, the types of 
counterparties acceptable to participants have expanded to include 
counterparties that the Agencies believe should receive a risk weight 
greater than 50 percent. Although the Basel IA ANPR did not discuss the 
limit on the risk weight for derivatives contracts, the Agencies have 
determined that it is appropriate to propose removing the 50 percent 
risk weight limit that applies to certain derivative contracts. In this 
proposed rule, the risk weight assigned to the credit equivalent amount 
of a derivative contract would be the risk weight assigned to the 
counterparty after consideration of any collateral or guarantees.

H. Small Loans to Businesses

    The Agencies' existing risk-based capital rules generally assign 
business loans to the 100 percent risk weight category unless the 
credit risk is mitigated by an acceptable guarantee or collateral. 
Banking organizations and other industry participants have criticized 
the lack of sensitivity in the measurement of credit risk associated 
with these exposures and maintained that the current risk-based capital 
charge is greater than warranted for high quality loans to businesses.
    In the Basel IA ANPR, the Agencies noted that they were considering 
a lower risk weight for certain business loans under $1 million on a 
consolidated basis to a single borrower (small loans to businesses). 
One alternative discussed in the Basel IA ANPR would allow small loans 
to businesses to be eligible for a lower risk weight if certain 
requirements were satisfied. These requirements would include, for 
example, full amortization over a period of seven years or less, 
performance according to the contractual provisions of the loan 
agreement, and full protection by collateral. The banking organization 
would also have to originate the loans according to its underwriting 
policies (or purchase loans that have been underwritten in a manner 
consistent with the banking organization's underwriting policies), 
which would have to include an acceptable assessment of the collateral 
and the borrower's financial condition and ability to repay the debt. 
The Agencies sought comment on whether this potential change would 
improve the risk sensitivity of the risk-based capital rules without 
unduly increasing complexity and burden.
    The Agencies also suggested an alternative approach that would 
assess risk-based capital requirements for small loans to businesses 
based on a credit assessment of the principals of the business and 
their ability to service the debt. This alternative could be applied in 
those cases where the principals personally guarantee the loan. The 
Agencies sought comment on any alternative approaches for improving the 
risk sensitivity of the risk-based capital treatment for small loans to 
businesses, including the use of credit assessments, LTV, collateral, 
guarantees, or other methods for stratifying credit risk.
    Most commenters supported a lower risk weight for small loans to 
businesses. However, it was apparent from the comments that there is no 
universal set of risk drivers used to measure credit risk for these 
loans. In addition, there was little agreement among commenters about 
how credit risk for these loans should be measured without generating 
undue burden.
    One commenter asked the Agencies to create a small-business risk-
based capital model that takes into account various risk drivers, 
including financing leverage, use of funds, loss modeling, and lending 
shelf and securitization. Another commenter recommended measuring 
credit risk based on results obtained by the Fair Isaac Small Business 
Scoring Service, which the commenter claimed allows businesses to 
assess the creditworthiness of the principals of a small business and 
of the ability of the small business to make repayment on credit 
obligations up to $750,000.
    Another commenter suggested that small loans to businesses that are 
collateralized should be risk weighted according to the LTV using the 
ratio of the amount of the loan to the value of eligible collateral. 
This commenter suggested that non-collateralized loans should be risk-
weighted according to several factors, including credit assessments of 
personal guarantors, loan terms, size of the loan, amortization 
schedule, and past history of the borrower. Other commenters offered 
similar suggestions that would use risk measures such as credit 
assessments and debt-to-income ratios.
    Several commenters suggested that the dollar threshold for 
receiving a lower risk weight was too low. A few commenters suggested 
increasing the threshold to $2 million. One commenter suggested setting 
the threshold at $5 million and indexing it to inflation.
    Although the Agencies are not making a specific proposal in this 
NPR, they are exploring options for permitting certain small loans to 
businesses that meet certain criteria to qualify for a 75 percent risk 
weight. The Agencies believe that the application of the 75 percent 
risk weight to loans to businesses should be limited to situations 
where the banking organization's consolidated business credit exposure 
to the individual or company is $1 million or less.
    Second, the Agencies believe that to qualify for the lower risk 
weight, these loans should be personally guaranteed by the owner or 
owners of the business and that the loans should be fully 
collateralized by the assets of the business. The Agencies believe that 
these requirements provide prudential safeguards to ensure that the 
banking organization is in the position to minimize losses in the event 
of default.
    Third, the Agencies are considering requiring that qualifying loans 
fully amortize over a period of no more than seven years. The full 
amortization requirement encourages conservative cash management 
practices by the borrower and ensures that the banking organization can 
monitor the continued ability of the business to service the debt. The 
Agencies have chosen a seven-year limitation to coincide with the 
maturity structure of many loans used to finance equipment purchases.
    The Agencies are also considering criteria for short-term loans 
that do not amortize, such as working capital loans and other revolving 
lines of credit. Under one alternative, the Agencies would allow loans 
or draws from a revolving line of credit that matures within 18 months 
to forgo the amortization requirement to the extent that the loan is to 
be repaid from the anticipated proceeds of a previously established 
financial transaction and

[[Page 77463]]

such proceeds are pledged for the repayment of the loan.
    Fourth, the Agencies are considering requiring that the loans be 
(1) prudently underwritten in a manner that justifies the assessment of 
a lower-than-100 percent risk weight and (2) performing, that is, the 
loan payments must be current. Thus, consistent with prudential 
standards required for the underwriting of any small loans to 
businesses, the Agencies would require that a banking organization 
establish standards for assessing the quality and sufficiency of 
pledged collateral, the financial condition of the borrower, the 
financial condition of any guarantors to the loan, and the ability of 
the business to meet certain debt service coverage criteria. The 
Agencies would also set requirements for an acceptable debt service 
coverage ratio, that is, the ratio of net operating income divided by 
total loan payments or net operating cash flow divided by debt service 
cost. The Agencies are considering a minimum debt service coverage 
ratio of 1.3.
    Finally, the Agencies are analyzing the need for additional 
qualifying criteria. Among other criteria, the Agencies might require 
that the loans have not been restructured to prevent a past due 
occurrence and that none of the proceeds of the loans are used to 
service any other outstanding loan obligation.
    Question 17: The Agencies seek comment on this or other approaches 
that might improve the risk sensitivity of the existing risk-based 
capital rules for small loans to businesses.

I. Multifamily Residential Mortgages, Other Retail Exposures, Loans 90 
Days or More Past Due or In Nonaccrual, and Commercial Real Estate 
(CRE) Exposures

    In the Basel IA ANPR, the Agencies sought comment on the risk-based 
capital treatment for multifamily residential mortgages, other retail 
exposures, loans 90 days or more past due or in nonaccrual, and 
commercial real estate exposures. After considering the comments that 
addressed the Agencies' approaches to the risk-based capital treatment 
for these exposures, the Agencies have decided that any increase in 
risk sensitivity is outweighed by the additional burden that would 
result from the suggested approaches. Consequently, the Agencies are 
not proposing any changes in this NPR with respect to these exposures. 
The Agencies will continue to examine these issues and may address the 
risk-based capital treatment for these exposures at some future time.
    Question 18: The Agencies remain interested in industry comments on 
any methods that would increase the risk sensitivity of the risk-based 
capital requirements for other retail exposures, particularly through 
the use of credit assessments, such as the borrower's credit score or 
ability to service debt. The Agencies are particularly interested in 
whether and how credit assessments might be applied consistently and 
uniformly in the determination of risk weights without creating undue 
burden.

J. Other Issues Raised by Commenters

    Although the issue was not addressed in the Basel IA ANPR, several 
commenters suggested that the Agencies should conduct a study of the 
potential effects of any proposed revisions to the Agencies' existing 
risk-based capital rules. They asserted that such a study would help 
the Agencies better understand the potential costs and benefits of the 
potential revisions, and help compare the revisions to the Basel II 
framework.
    The Agencies intend to analyze the potential impact of these 
proposed changes, as well as any changes to the proposals that may 
result from the public comment process. The Agencies may make changes 
to these proposals if warranted based on this impact analysis.

III. Possible Alternatives for Basel II Banking Organizations

    As noted in the ``Background'' section, on September 25, 2006, the 
Agencies issued the Basel II NPR. The Basel II advanced capital 
adequacy framework proposed in the Basel II NPR is highly complex and 
is directed primarily at banking organizations with total consolidated 
assets of $250 billion or more, or total consolidated on-balance sheet 
foreign exposure of $10 billion or more, and other banks that opt in to 
the Basel II framework--referred to as ``Basel II banking 
organizations.'' In the Basel II NPR, the Agencies requested comment on 
whether Basel II banking organizations should be permitted to use other 
credit and operational risk approaches similar to those provided under 
Basel II.
    The Agencies seek comment on all aspects of the following questions 
and seek the perspectives of banking organizations of different sizes 
and complexity.
    Question 19: To what extent should the Agencies consider allowing 
Basel II banking organizations the option to calculate their risk based 
capital requirements using approaches other than the Advanced Internal 
Ratings Based (A-IRB) approach for credit risk and the Advanced 
Measurement Approach (AMA) for operational risk? What would be the 
appropriate length of time for such an option?
    Question 20: If Basel II banking organizations are provided the 
option to use alternatives to the advanced approaches, would either 
this Basel IA proposal or the standardized approach in Basel II be a 
suitable basis for a regulatory capital framework for credit risk for 
those organizations? What modifications would make either of these 
proposals more appropriate for use by large complex banking 
organizations? For example, what approaches should be considered for 
derivatives and other capital markets transactions, unsettled trades, 
equity exposures, and other significant risks and exposures typical of 
Basel II banking organizations?
    Question 21: The risk weights in this Basel IA proposal were 
designed with the assumption that there would be no accompanying 
capital charge for operational risk. Basel II, however, requires 
banking organizations to calculate capital requirements for exposure to 
both credit risk and operational risk. If the Agencies were to proceed 
with a rulemaking for a U.S. version of a standardized approach for 
credit risk, should operational risk be addressed using one of the 
three methods set forth in Basel II?
    Question 22: What additional requirements should the Agencies 
consider to encourage Basel II banking organizations to enhance their 
risk management practices or their financial disclosures, if they are 
provided the option to use alternatives to the advanced approaches of 
the Basel II NPR?

IV. Regulatory Analysis

Regulatory Flexibility Act Analysis

    Pursuant to section 605(b) of the Regulatory Flexibility Act, 5 
U.S.C. 605(b) (RFA), the regulatory flexibility analysis otherwise 
required under section 604 of the RFA is not required if an agency 
certifies that the rule will not have a significant economic impact on 
a substantial number of small entities (defined for purposes of the RFA 
to include banking organizations with assets less than or equal to $165 
million) and publishes its certification and a short, explanatory 
statement in the Federal Register along with its rule. Pursuant to 
section 605(b) of the RFA, the Agencies certify that this proposed rule 
will not have a significant economic impact on a substantial number of 
small entities. Accordingly, a regulatory flexibility analysis is not

[[Page 77464]]

needed. The amendments to the Agencies' regulations described above are 
elective. They will apply only to banking organizations that opt to 
take advantage of the proposed revisions to the existing domestic risk-
based capital framework and that will not be required to use the 
advanced approaches contained in the Basel II proposal.\42\ The 
Agencies believe that banking organizations that elect to adopt these 
proposals will generally be able to do so with data they currently use 
as part of their credit approval and portfolio management processes. 
Banking organizations not exercising this option would remain subject 
to the current capital framework. The proposal does not impose any new 
mandatory requirements or burdens. Moreover, industry groups 
representing small banking organizations that commented on the Basel IA 
ANPR noted that small banking organizations typically hold more capital 
than is required by the capital rules and would prefer to remain under 
the existing risk-based capital framework. For these reasons, the 
proposal will not result in a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \42\ 71 FR 55830 (September 25, 2006).
---------------------------------------------------------------------------

OCC Executive Order 12866 Determination

    Executive Order 12866 requires Federal agencies to prepare a 
regulatory impact analysis for agency actions that are found to be 
``significant regulatory actions.'' ``Significant regulatory actions'' 
include, among other things, rulemakings that ``have an annual effect 
on the economy of $100 million or more or adversely affect in a 
material way the economy, a sector of the economy, productivity, 
competition, jobs, the environment, public health or safety, or State, 
local, or tribal governments or communities.'' \43\ Regulatory actions 
that satisfy one or more of these criteria are referred to as 
``economically significant regulatory actions.''
---------------------------------------------------------------------------

    \43\ Executive Order 12866 (September 30, 1993), 58 FR 51735 
(October 4, 1993), as amended by Executive Order 13258, 67 FR 9385 
(February 28, 2002). For the complete text of the definition of 
``significant regulatory action,'' see E.O. 12866 at section 3(f). A 
``regulatory action'' is ``any substantive action by an agency 
(normally published in the Federal Register) that promulgates or is 
expected to lead to the promulgation of a final rule or regulation, 
including notices of inquiry, advance notices of proposed 
rulemaking, and notices of proposed rulemaking.'' E.O. 12866 at 
section 3(e).
---------------------------------------------------------------------------

    The OCC anticipates that the proposed rule will meet the $100 
million criterion and therefore is an economically significant 
regulatory action. In conducting the regulatory analysis for an 
economically significant regulatory action, Executive Order 12866 
requires each Federal agency to provide to the Administrator of the 
Office of Management and Budget's (OMB) Office of Information and 
Regulatory Affairs (OIRA):
    <bullet> The text of the draft regulatory action, together with a 
reasonably detailed description of the need for the regulatory action 
and an explanation of how the regulatory action will meet that need;
    <bullet> An assessment of the potential costs and benefits of the 
regulatory action, including an explanation of the manner in which the 
regulatory action is consistent with a statutory mandate and, to the 
extent permitted by law, promotes the President's priorities and avoids 
undue interference with State, local, and tribal governments in the 
exercise of their governmental functions;
    <bullet> An assessment, including the underlying analysis, of 
benefits anticipated from the regulatory action (such as, but not 
limited to, the promotion of the efficient functioning of the economy 
and private markets, the enhancement of health and safety, the 
protection of the natural environment, and the elimination or reduction 
of discrimination or bias) together with, to the extent feasible, a 
quantification of those benefits;
    <bullet> An assessment, including the underlying analysis, of costs 
anticipated from the regulatory action (such as, but not limited to, 
the direct cost both to the government in administering the regulation 
and to businesses and others in complying with the regulation, and any 
adverse effects on the efficient functioning of the economy, private 
markets (including productivity, employment, and competitiveness), 
health, safety, and the natural environment), together with, to the 
extent feasible, a quantification of those costs; and
    <bullet> An assessment, including the underlying analysis, of costs 
and benefits of potentially effective and reasonably feasible 
alternatives to the planned regulation, identified by the agencies or 
the public (including improving the current regulation and reasonably 
viable nonregulatory actions), and an explanation why the planned 
regulatory action is preferable to the identified potential 
alternatives.
    Set forth below is a summary of the OCC's regulatory impact 
analysis, which can be found in its entirety at http://www.occ.treas.gov/law/basel.htm.
i. The Need for Regulatory Action
    Federal banking law directs federal banking agencies including the 
Office of the Comptroller of the Currency (OCC) to require banking 
organizations to hold adequate capital. The law authorizes federal 
banking agencies to set minimum capital levels to ensure that banking 
organizations maintain adequate capital. The law also gives banking 
agencies broad discretion with respect to capital regulation by 
authorizing them to also use any other methods that they deem 
appropriate to ensure capital adequacy.
    Capital regulation seeks to address market failures that stem from 
several sources. Asymmetric information about the risk in a bank's 
portfolio creates a market failure by hindering the ability of 
creditors and outside monitors to discern a bank's actual risk and 
capital adequacy. Moral hazard creates market failure in which the 
bank's creditors fail to restrain the bank from taking excessive risks 
because deposit insurance either fully or partially protects them from 
losses. Public policy addresses these market failures because 
individual banks fail to adequately consider the positive externality 
or public benefit that adequate capital brings to financial markets and 
the economy as a whole.
    Capital regulations cannot be static. Innovation in and 
transformation of financial markets require periodic reassessments of 
what may count as capital and what amount of capital is adequate. 
Continuing changes in financial markets create both a need and an 
opportunity to refine capital standards in banking. The proposed 
revisions to U.S. risk-based capital rules, ``Risk-Based Capital 
Guidelines; Capital Adequacy Guidelines; Capital Maintenance: Domestic 
Capital Modifications'' (``Basel IA NPR''), which we address in this 
impact analysis, provide a new option for determining risk-based 
capital for banking organizations that would not be required to operate 
under the other risk-based capital adequacy proposal, ``Risk-Based 
Capital Standards: Advanced Capital Adequacy Framework'' (``Basel 
II'').
ii. Regulatory Background
    The proposed capital regulation examined in this analysis would 
apply to commercial banks and thrifts. Three banking agencies, the OCC, 
the Board of Governors of the Federal Reserve System (Board), and the 
FDIC regulate commercial banks, while the Office of Thrift Supervision 
(OTS) regulates all federally chartered and many state-chartered 
thrifts. Throughout this document, the four are jointly referred to as 
the federal banking agencies.

[[Page 77465]]

    The Basel IA proposal seeks to improve the risk sensitivity of the 
existing risk-based capital rules. This framework would be optional and 
would be available to banking organizations not covered by the Basel II 
proposal. Any institution that is not a Basel II bank would be able to 
remain under the existing risk-based capital rules or elect to adopt 
Basel IA. The proposed changes in Basel IA would:
    1. Increase the number of risk weight categories from five to 
eight.
    2. Allow the greater use of external credit ratings.
    3. Expand the range of recognized collateral and eligible 
guarantors.
    4. Use loan-to-value ratios to risk-weight residential mortgages.
    5. Increase the credit conversion factor for certain commitments 
with an original maturity of one year or less.
    6. Assess a capital charge for early amortizations in 
securitizations of revolving retail exposures.
    7. Remove the 50 percent limit on the risk weight for certain 
derivative transactions.
    The Agencies would continue to reserve the authority to require 
banking organizations to hold additional capital where appropriate.
iii. Benefit-Cost Analysis of the Proposed Rule
    A cost-benefit analysis considers the costs and benefits of a 
proposal as they relate to society as a whole. The social benefits of a 
proposal are benefits that accrue directly to those subject to a 
proposal plus benefits that might accrue indirectly to the rest of 
society. Similarly, the overall social costs of a proposal are costs 
incurred directly by those subject to the rule and costs incurred 
indirectly by others. In the case of Basel IA, direct costs and 
benefits are those that apply to the banking organizations that are 
subject to the proposal. Indirect costs and benefits then stem from 
banks and other financial institutions that are not subject to the 
proposal, bank customers, and, through the safety and soundness 
externality, society as a whole.
    The enormous social and economic benefit that derives from a safe 
and sound banking system supported by vigorous and comprehensive 
supervision, including ensuring adequate capital clearly dwarfs any 
direct benefits that might accrue to institutions adopting Basel IA. 
Similarly, the social and economic cost of any reduction in the safety 
and soundness of the banking system would dramatically overshadow any 
cost borne by banking organizations subject to the rule. The banking 
agencies are confident that the enhanced risk sensitivity of the 
proposed rule could allow banking organizations to more effectively 
achieve objectives that are consistent with a safe and sound banking 
system.
    Beyond the relatively minor societal benefit from the relatively 
minor enhancement to bank safety and soundness, we do not anticipate 
any benefits accruing other than directly to the banking organizations 
that elect to adopt Basel IA. Because many factors besides regulatory 
capital requirements affect pricing and lending decisions, we do not 
expect the adoption or non-adoption of Basel IA to affect pricing or 
lending. Hence, we do not anticipate any costs or benefits affecting 
the customers or competitors of Basel IA institutions. For these 
reasons, the cost and benefit analysis of Basel IA reduces to an 
analysis of the costs and benefits directly attributable to 
institutions that might elect to adopt Basel IA capital rules.

A. Organizations Affected by the Proposed Rule \44\
---------------------------------------------------------------------------

    \44\ Unless otherwise noted, the population of banks and thrifts 
used in this analysis consists of all FDIC-insured institutions. 
Banking organizations are aggregated to the top holding company 
level.
---------------------------------------------------------------------------

    As of June 30, 2006, eleven banking organizations meet the criteria 
that would require them to adopt the U.S. implementation of Basel II. 
Removing those 11 mandatory Basel II institutions from the 7,606 FDIC-
insured banking organizations active in June 2006 leaves 7,595 
organizations that would be eligible to adopt Basel IA. Among national 
banks, six of the eleven mandatory Basel II institutions are national 
banks. Out of 1,545 banking organizations with national banks, 1,539 
national banking organizations would thus be eligible to adopt Basel 
IA.

B. Benefits of the Proposed Rule

    The proposed rule aims to improve the risk sensitivity of 
regulatory capital requirements. The five benefits of the proposed rule 
are:
    1. Enhances the risk sensitivity of capital charges.
    2. More efficient use of required bank capital.
    3. Recognizes new developments in financial markets.
    4. Mitigates potential distortions in minimum regulatory capital 
requirements between large and small banking organizations.
    5. Ability to opt in offers long-term flexibility to banking 
organizations.

C. Costs of the Proposed Rule

    As with any rule, the costs of the proposal include expenditures by 
banks and thrifts necessary to comply with the new regulation and costs 
to the federal banking agencies of implementing the new rules. Because 
of a lack of cost estimates from banking organizations, the OCC found 
it necessary to use a scope-of-work comparison with Basel II in order 
to arrive at a cost estimate for Basel IA. Based on this rough 
assessment, we estimate that implementation costs for Basel IA could 
range from $100,000 at smaller institutions to $3 million at larger 
institutions.
1. Costs to Banking Organizations
    Explicit costs of implementing the proposed rule at banking 
organizations fall into two categories: setup costs and ongoing costs. 
Setup costs are typically one-time expenses associated with introducing 
the new programs and procedures necessary to achieve initial compliance 
with the proposed rule. Setup costs may also involve expenses related 
to tracking and retrieving data needed to implement the proposed rule. 
Ongoing costs are also likely to reflect data costs associated with 
retrieving and preserving data.
    The total cost to national banks of adopting Basel IA depends 
entirely on the number of institutions that elect to adopt the 
voluntary rule and the size of those institutions. Obviously, if no 
institutions adopt Basel IA, the cost will be zero. Based on comment 
letters and discussions with bank supervision staff, we sought to 
identify national banks that would be more likely to adopt Basel IA. We 
selected national banks with significant mortgage holdings (over $500 
million in 1-4 family first-lien mortgages and mortgages comprise at 
least 10 percent of their portfolio) as well as national banks that do 
not currently meet the well-capitalized threshold for their risk based 
capital-to-assets ratio. Using those criteria, we identified 46 
national banks. We estimate that the total cost of the rule for 
national banks will be approximately $78 million. Over time, Basel IA 
may become more appealing to a larger number of banks. The total cost 
of the proposed rule would consequently increase to the extent that 
more institutions opt into Basel IA over time. At present, it is 
unclear how many national banks will ultimately elect to adopt Basel 
IA.
2. Government Administrative Costs
    Like the banking organizations subject to new requirements, the 
costs to government agencies of implementing the proposed rule also 
involve both startup and ongoing costs. Startup costs include expenses 
related to the

[[Page 77466]]

development of the regulatory proposals, costs of establishing new 
programs and procedures, and costs of initial training of bank 
examiners in the new programs and procedures. Ongoing costs include 
maintenance expenses for any additional examiners and analysts needed 
to regularly apply the new supervisory processes. In the case of Basel 
IA, because modest changes to Call Reports will capture most of the 
rule changes, these ongoing costs are likely to be minor.
    OCC expenditures fall into three broad categories: training, 
guidance, and supervision. Training includes expenses for workshops and 
other training courses and seminars for examiners. Guidance expenses 
reflect expenditures on the development of Basel IA guidance. 
Supervision expenses reflect organization-specific supervisory 
activities. We estimate that OCC expenses for Basel IA will be 
approximately $2.4 million through 2006. We also expect expenditures of 
$1 million per year between 2007 and 2010. Applying a five percent 
discount rate to future expenditures, past expenses ($2.4 million) plus 
the present value of future expenditures ($3.6 million) equals total 
OCC expenditures of $6 million on Basel IA.
3. Total Cost Estimate of Proposed Rule
    The OCC's estimate of the total cost of the proposed rule includes 
expenditures by banking organizations and the OCC from the present 
through 2010. Based on our estimate that approximately 46 national 
banks will adopt Basel IA at a cost to each institution of between 
$100,000 and $3 million depending on the size of the institution, we 
estimate that national banks will spend approximately $78 million on 
Basel IA. Combining expenditures provides an estimate of $84 million 
for the total cost of the proposed rule for the OCC and national banks.
iv. Analysis of Baseline and Alternatives
    In order to place the costs and benefits of the proposed rule in 
context, Executive Order 12866 requires a comparison between the 
proposed rule, a baseline of what the world would look like without the 
proposed rule, and a reasonable alternative to the proposed rule. In 
this regulatory impact analysis, we analyze one baseline and one 
alternative to the proposed rule. The baseline considers the 
possibility that the proposed Basel IA rule is not adopted and current 
capital standards continue to apply.
    The baseline scenario appears in this analysis in order to estimate 
the effects of adopting the proposed rule relative to a hypothetical 
regulatory regime that might exist without Basel IA. Because the 
baseline scenario considers costs and benefits as if the proposed rule 
never existed, we set the costs and benefits of the baseline scenario 
to zero. Obviously, banking organizations face compliance costs and 
reap the benefits of a well-capitalized banking system even under the 
baseline. However, because we cannot quantify these costs and benefits, 
we normalize the baseline costs and benefits to zero and estimate the 
costs and benefits of the proposed rule and alternative as deviations 
from this zero baseline.
    1. Baseline Scenario: Current capital standards based on the 1988 
Basel Accord continue to apply.

Description of Baseline Scenario

    Under the Baseline Scenario, current capital rules would continue 
to apply to all banking organizations in the United States that are not 
subject to the U.S. implementation of Basel II. Under this scenario, 
the United States would not adopt the proposed Basel IA rule but the 
implementation of the Basel II framework would continue.

Change in Benefits: Baseline Scenario

    Staying with current capital rules instead of adopting the Basel IA 
proposal would eliminate essentially all of the benefits of the 
proposed rule listed above. Under the baseline, banking organizations 
not subject to Basel II would not be given the option of voluntarily 
selecting Basel IA. Institutions that would have adopted the proposed 
rule would not be able to take advantage of the enhanced risk 
sensitivity of Basel IA capital charges and the more efficient use of 
bank capital that implies.
    One benefit that would remain under the baseline is that there 
would be no rule changes instead of just simple and voluntary rule 
changes. Without Basel IA as an available option, an institution would 
have to choose between the advanced approaches of Basel II and the 
status quo. The baseline without Basel IA would leave a level playing 
field for all the non-Basel II banks. However, the absence of an 
opportunity to mitigate potential distortions in minimum required 
capital would likely diminish this benefit in the eyes of an 
institution concerned about potential distortions created by Basel II.

Changes in Costs: Baseline Scenario

    Continuing to use current capital rules eliminates the benefits and 
the costs of adopting the proposed rule. As discussed above, under the 
proposed rule we estimate that organizations would spend up to $78 
million on implementation-related expenditures. Retaining current 
capital rules would eliminate any costs associated with the proposed 
rule, even though banking organizations would only incur those costs if 
they elected to do so.
    2. Alternative: Require all U.S. banking organizations not subject 
to Basel II to adopt Basel IA.

Description of Alternative

    The only change under the alternative is that adoption of the 
proposed rule would be mandatory rather than voluntary. Under this 
alternative, the provisions of the proposed rule would remain intact 
and apply to all national banks that are not subject to Basel II. 
Institutions subject to Basel II would include mandatory Basel II 
institutions and those institutions that elect to adopt the U.S. 
implementation of the Basel II framework.

Change in Benefits: Alternative

    Because there are no changes to the elements of the proposed rule 
under the alternative, the list of benefits remains the same. Among 
these benefits, only one benefit is lost by making the proposed rule 
mandatory: the benefit derived from the fact that the proposed rule is 
voluntary. As for the benefits relating to the enhanced risk 
sensitivity of capital charges, because adoption of Basel IA is 
mandatory under the alternative, more banks will be subject to Basel IA 
provisions and the aggregate level of benefits will be higher. Because 
we anticipate that only 46 national banks would adopt Basel IA 
voluntarily, the difference in the aggregate benefit level could be 
considerable.

Changes in Costs: Alternative

    Clearly the most significant drawback to the alternative is the 
dramatically increased cost of applying a new set of capital rules to 
all U.S. banking organizations. Under the alternative, direct costs 
would increase for every U.S. banking organization that would have 
elected to continue to use current capital rules under the proposed 
rule. The cost estimate for the alternative is the total cost estimate 
for a 100 percent adoption rate of Basel IA. With 1,545 national 
banking organizations eligible for Basel IA, we estimate that the cost 
to national banking organizations of the alternative is approximately 
$662 million. The actual cost may be somewhat less depending on the 
number of national banks that elect to adopt Basel II capital rules, 
but it is much greater than our cost estimate of $78 million for the 
proposed rule.

[[Page 77467]]

    3. Overall Comparison of Proposed Rule with Baseline and 
Alternative.
    The objective of the proposed rule is to enhance the risk 
sensitivity of capital charges for institutions not subject to Basel II 
capital regulations. The proposal also seeks to mitigate any potential 
distortions in minimum regulatory capital requirements that the U.S. 
implementation of Basel II might create between large and small banking 
organizations. Like Basel II, the anticipated benefits of the Basel IA 
proposal are difficult to quantify in dollar terms. Nevertheless, the 
OCC believes that the proposed rule provides benefits without posing 
any threat to the safety and soundness of the banking industry or the 
security of the Federal Deposit Insurance system. To offset the costs 
of the proposed rule, its voluntary nature offers regulatory 
flexibility that will allow institutions to adopt Basel IA on a bank-
by-bank basis when an institution's anticipated benefits exceed the 
anticipated costs of adopting this regulation.
    The banking agencies are confident that the proposed rule could 
serve to strengthen institutions electing to adopt Basel IA while the 
safety and soundness of institutions electing to forgo Basel IA and 
Basel II will not diminish. On the basis of our analysis, we believe 
that the benefits of the proposed rule are sufficient to offset the 
costs of implementing the proposed rule. However, because there is no 
social cost to allowing institutions to remain subject to current 
capital rules, we believe it is best to make the proposed rule 
voluntary in order to let each national bank decide whether it is in 
that institution's best interest to adopt Basel IA. Because adoption is 
voluntary, the proposed rule offers an improvement over the baseline 
scenario and the alternative. The proposed rule offers an important 
degree of flexibility unavailable with either the baseline or the 
alternative. The baseline does not give banking organizations a way 
into Basel IA and the alternative does not offer them a way out. The 
alternative would compel most banking organizations to follow a new set 
of capital rules and require them to undertake the time and expense of 
adjusting to these new rules. The proposed rule offers a better balance 
between costs and benefits than either the baseline or the alternative. 
Overall, the OCC believes that the benefits of the proposed rule 
justify its costs.

OTS Executive Order 12866 Determination

    OTS concurs with OCC's RIA. Rather than replicate that analysis, 
OTS drafted an RIA incorporating OCC's analysis by reference and adding 
appropriate material reflecting the unique aspects of the thrift 
industry. The full text of OTS's RIA is available at the locations for 
viewing the OTS docket indicated in the ADDRESSES section above. OTS 
believes that its analysis meets the requirements of Executive Order 
12866. The following discussion supplements OCC's summary of its RIA.
    OTS is the primary federal regulator for 854 federal and state-
chartered savings associations with assets of $1.5 trillion as of June 
30, 2006. OTS-regulated savings associations assets are highly 
concentrated in residential mortgage-related assets. Approximately 68 
percent of total thrift assets are residential mortgage-related assets. 
As a result, the most important change made by the proposed rule for 
OTS-regulated savings associations involves the proposed changes to the 
risk weighting of residential mortgages. Other aspects of the Basel IA 
NPR should not have a significant effect on saving associations.\45\ 
Accordingly, OTS's analysis focuses on the proposed risk-weighting of 
residential mortgages.
---------------------------------------------------------------------------

    \45\ Savings associations, for example, do not have significant 
holdings that would be affected by the ratings-based approaches for 
exposures, collateral, or guarantors. Rather, savings associations' 
assets are more heavily concentrated in mortgage-backed securities 
issued or guaranteed by the government sponsored enterprises, whose 
risk weightings would not change under the Basel IA NPR.
---------------------------------------------------------------------------

Benefit-Cost Analysis

    Overall OTS believes that the benefits of the proposed rule justify 
its costs. Under OTS's analysis, direct costs and benefits include 
costs and benefits to savings associations that opt-in to the proposed 
rule. OTS estimates that approximately 115 savings associations will 
opt-in to the proposed rule.\46\ Direct costs and benefits also include 
OTS's costs of implementing the proposed rule. Indirect costs and 
benefits are those that may affect the economy as a whole. These 
indirect and direct costs arise from how the primary business of 
banking (i.e., credit availability) is impacted by requirements for 
risk-based capital adequacy.
---------------------------------------------------------------------------

    \46\ This is the number of well-capitalized thrifts that hold 
total assets of $500 million or more, and that have a total risk-
based capital ratio of 15 percent or less.
---------------------------------------------------------------------------

A. Direct Benefits

    In general, the proposed rule seeks to improve the risk sensitivity 
of minimum regulatory capital requirements and, by doing so, to address 
some of the shortcomings of the current regulatory minimum capital 
requirements.\47\ For OTS-regulated savings associations, the most 
important change involves the risk weighting of residential mortgages. 
Well-underwritten residential mortgages with LTV ratios at origination 
of less than 90 percent are all currently risk weighed for regulatory 
capital purposes at 50 percent. Data from a variety of sources, 
including the security markets, indicate that this risk weight may be 
too high for the credit risk of low LTV mortgages and insufficient for 
the credit risk of higher LTV mortgages. As a result, to the extent 
that minimum regulatory capital requirements affect savings 
associations' investment decisions, the current rules may discourage 
saving associations from retaining higher quality low LTV mortgages in 
their portfolios or encourage them to retain lower quality high LTV 
mortgages.
---------------------------------------------------------------------------

    \47\ The other benefits of the Basel IA NPR are more fully 
discussed in the OCC analysis.
---------------------------------------------------------------------------

    In addition, for the largest banking organizations, the recently 
published Basel II NPR addresses the credit risks of exposures more 
directly than under the current capital requirement regime by relating 
their probability of default and loss given default to minimum 
regulatory capital requirements. Preliminary survey results suggest 
that, on average, residential mortgages are likely to receive a lower 
credit risk weight under the Basel II NPR than under the current 
regime. The Basel IA NPR is intended to offer savings associations not 
covered under the Basel II NPR a more risk sensitive weighting scheme 
for residential mortgages, and, if adopted, may offer saving 
associations a more level playing field on which to compete against 
Basel II banking organizations in offering residential mortgage related 
products.

B. Direct Costs

    OTS estimates that the total direct costs of the proposed rule for 
the six-year period from design through implementation will be $72 
million. This includes direct costs of $67 million for the 115 savings 
associations that may opt-in to the proposed rule, and direct costs of 
$5 million for OTS implementation expenses.

C. Indirect Benefits and Costs

    The primary business of banking is making credit available to 
borrowers. A myriad of considerations affect credit decisions by 
individual institutions. Among these considerations are the regulatory 
cost of capital and how closely the regulatory cost matches an 
institution's internal assessment of its

[[Page 77468]]

capital needs. To the extent that regulatory risk-based capital 
requirements for capital adequacy may overstate (or understate) the 
amount of capital that an institution must otherwise hold to support 
its credit decisions, the regulatory requirements add costs of 
compliance and, thus, introduce inefficiencies to the extent that a 
savings association is unable to price its credit products consistent 
with the underlying credit risk.
    The Basel II NPR attempted to develop a models-based system that 
more closely harmonized risk-based capital at the largest 
internationally active banks with their internal capital allocation 
models. For residential mortgages, the underwriting, risk 
differentiation, and system tracking processes described in the Basel 
II NPR are much closer to industry practice than the simple risk weight 
bucket system based on Basel I. The centerpiece of the Basel IA NPR is 
the expansion of the number of risk buckets and the establishment of 
new risk-based capital criteria that should, for residential mortgages, 
more closely mirror the underwriting, risk differentiation, and system 
tracking at likely opt-in institutions.
    To the extent that the Basel IA NPR achieves its goal of more 
closely aligning risk-based capital requirements to real credit risk, 
it should reduce the inefficiency inherent in the simpler Basel I-based 
framework. This should enable adopters to price their mortgage credits 
more closely to their internal assessment of credit risk. Competitive 
equity would be easier to maintain, particularly vis-a-vis the largest 
institutions. Moreover, there may be fewer forced consolidations, which 
could also help maintain a more competitive mortgage credit 
environment. Credit decisions could be made more rationally, and could 
be based more exclusively on sound underwriting since capital adequacy 
requirements would more closely match internal risk assessments.
    Smaller institutions that choose to hold risk-based capital in 
excess of the well-capitalized level could continue to operate under 
their distinct business model. These institutions hold those capital 
levels primarily due to concentration risk, their localized needs for 
liquidity, and other factors. Because their capital levels already 
exceed the regulatory minimums, these institutions have already 
harmonized their own assessment of risk with a Basel I-based system, 
and can presumably price their mortgage credits efficiently and 
competitively in the current environment.
    It would be nearly impossible to estimate a dollar amount of the 
potential indirect cost or benefit to the economy derived from 
introduction of an optional risk-based capital framework that more 
closely aligns capital requirements with credit risk for residential 
mortgages. However, since the decision to opt in or not would be made 
by thousands of banks, even partial success at harmonizing risk-based 
capital with internal risk assessment should improve the efficiency of 
the mortgage credit decision and therefore reduce the cost to the 
economy.

Analysis of Baseline and Alternatives

    The OCC analysis includes a comparison between the Basel IA NPR, a 
baseline scenario of what the world would look like without the Basel 
IA NPR, and an alternative to the Basel IA NPR. The alternative would 
require all banking organizations that are not subject to the Basel II 
NPR to apply the Basel IA NPR. Except for the discussions focusing on 
the benefit derived from the recognition of new developments in 
financial markets, which is only a minor benefit for savings 
associations, OTS believes that the OCC analysis is reasonable and 
equally applicable to savings associations. OTS supports the OCC's 
conclusion that the Basel IA NPR offers a better balance between costs 
and benefits than the alternative. OTS has the following additional 
comments:

A. Baseline Scenario

    In its analysis of the baseline scenario, which would leave the 
current risk-based capital rules unchanged, OCC determines that 
national banks could avoid $78 million of implementation-related 
expenditures that would otherwise be required by the Basel IA NPR. As 
noted above, OTS estimates that 115 savings associations would spend up 
to $67 million to implement the Basel IA NPR. Retaining the current 
capital rules without adopting Basel IA would permit these savings 
associations to avoid these new expenditures.
    As an indirect cost to the economy, the baseline scenario of 
maintaining a less risk-sensitive capital framework would continue to 
pose some cost of inefficiency and compliance for some institutions. 
This may lead to less competitive equity for those institutions, and 
less efficiently and mis-priced mortgage credits for borrowers 
generally.

B. Alternative Scenario

    In its analysis of the alternative scenario, OCC concludes that the 
aggregate benefits would considerably increase because 1,539, rather 
than 46, national banks would implement the alternative. Under the 
alternative scenario, OTS estimates that the aggregate costs to savings 
associations would also increase considerably. Specifically, OTS 
estimates that these costs would increase from $67 million (for 115 
savings associations) to $164 million (for 850 savings associations).
    The alternative scenario would impose direct costs on institutions 
and indirect costs on the economy generally. Many savings associations 
elect to hold capital in excess of the well-capitalized levels to 
address other risks. This is a prudent decision regulators should 
encourage and not discourage. For these institutions, the mandatory 
imposition of the Basel IA NPR would only increase capital compliance 
costs. These institutions would not obtain an offsetting benefit in the 
form of lower capital requirements for mortgage credit risk. In such a 
scenario, some of these institutions could choose to pass on the 
increased costs, which would render them less competitive and could 
lead to inefficiently and mis-priced mortgage credits for borrowers, 
and hence, the economy generally. Alternatively, some of these 
institutions might choose to absorb the costs in the form of weaker 
earnings, which would make them more vulnerable targets for 
consolidation, and reduce the competitive environment in that manner.

OCC Executive Order 13132 Determination

    The OCC has determined that this proposed rule does not have any 
Federalism implications, as required by Executive Order 13132.

Paperwork Reduction Act

    Implementation of these proposed rules would require revisions to 
the Agencies' quarterly regulatory reports \48\ to reflect the program 
and system changes required for a banking organization that adopts 
Basel IA. The Agencies project issuing a Federal Register notice for 
certain upcoming changes to the quarterly regulatory reports in early 
2007. This notice will separately present a detailed discussion of the 
program and system changes and associated burden estimates for the 
potential future changes to the quarterly regulatory reports for 
banking organizations that decide to adopt Basel IA. This will afford 
the public ample

[[Page 77469]]

opportunity to consider potential future reporting changes associated 
with the Basel IA proposed rule before the comment period for this 
proposed rulemaking closes. Prior to the publication of the upcoming 
notice, public commenters may submit comments on aspects of this notice 
that may affect reporting requirements at the addresses listed in the 
ADDRESSES section of this NPR. The Agencies will submit such required 
revisions to the quarterly regulatory reports to the Office of 
Management and Budget (OMB) for review and approval under the Paperwork 
Reduction Act.
---------------------------------------------------------------------------

    \48\ Consolidated Reports of Condition and Income (Call Report) 
(OMB Nos. 7100-0036, 3064-0052, 1557-0081), Thrift Financial Report 
(TFR) (OMB No. 1550-0023), Consolidated Financial Statemetns for 
Bank Holding Companies (FR Y-9C) (OMB No. 7100-0128).
---------------------------------------------------------------------------

OCC and OTS Unfunded Mandates Reform Act of 1995 Determination

    Section 202 of the Unfunded Mandates Reform Act of 1995, Public Law 
104-4 (Unfunded Mandates Act) requires that an agency prepare a 
budgetary impact statement before promulgating a rule that includes a 
Federal mandate that may result in expenditure by State, local, and 
tribal governments, in the aggregate, or by the private sector, of $100 
million or more in any one year. If a budgetary impact statement is 
required, section 205 of the Unfunded Mandates Act also requires an 
agency to identify and consider a reasonable number of regulatory 
alternatives before promulgating a rule. The OCC and OTS each has 
determined that this proposed rule will not result in expenditures by 
State, local, and tribal governments, or by the private sector, of $100 
million or more. Accordingly, neither the OCC nor the OTS has prepared 
a budgetary impact statement or specifically addressed the regulatory 
alternatives considered.

Solicitation of Comments on Use of Plain Language

    Section 722 of the GLBA requires the Federal banking agencies to 
use plain language in all proposed and final rules published after 
January 1, 2000. The Federal banking agencies invite comment on how to 
make this proposed rule easier to understand. For example:
    <bullet> Have we organized the material to suit your needs? If not, 
how could this material be better organized?
    <bullet> Are the requirements in the rule clearly stated? If not, 
how could the rule be more clearly stated?
    <bullet> Do the regulations contain technical language or jargon 
that is not clear? If so, which language requires clarification?
    <bullet> Would a different format (grouping and order of sections, 
use of headings, paragraphing) make the regulation easier to 
understand? If so, what changes to the format would make the regulation 
easier to understand?
    <bullet> Would more, but shorter, sections be better? If so, which 
sections should be changed?
    <bullet> What else could we do to make the regulation easier to 
understand?

List of Subjects

12 CFR Part 3

    Administrative practice and procedure, Capital, National banks, 
Reporting and recordkeeping requirements, Risk.

12 CFR Part 208

    Accounting, Agriculture, Banks, Banking, Confidential business 
information, Crime, Currency, Mortgages, Reporting and recordkeeping 
requirements, Securities.

12 CFR Part 225

    Administrative practice and procedure, Banks, Banking, Holding 
companies, Reporting and recordkeeping requirements, Securities.

12 CFR Part 325

    Administrative practice and procedure, Bank deposit insurance, 
Banks, banking, Capital adequacy, Reporting and recordkeeping 
requirements, Savings associations, State non-member banks.

12 CFR Part 567

    Capital, Reporting and recordkeeping requirements, Savings 
associations.

DEPARTMENT OF THE TREASURY

Office of the Comptroller of the Currency

12 CFR Chapter I

Authority and Issuance

    For the reasons set out in the preamble, part 3 of chapter I of 
title 12 of the Code of Federal Regulations is proposed to be amended 
as follows:

PART 3--MINIMUM CAPITAL RATIOS; ISSUANCE OF DIRECTIVES

    1. The authority citation for part 3 continues to read as follows:

    Authority: 12 U.S.C. 93a, 161, 1818, 1828(n), 1828 note, 1831n 
note, 1835, 3907, and 3909.

    2. Amend Sec.  3.4 by revising paragraph (b) and adding paragraphs 
(c) and (d) to read as follows:


Sec.  3.4  Reservation of Authority.

* * * * *
    (b) Risk-weight categories. Notwithstanding the risk categories in 
appendices A and D of this part, the OCC will look to the substance of 
the transaction and may find that the assigned risk weight for any 
asset, the credit equivalent amount or credit conversion factor for any 
off-balance sheet item, or the use of an external rating or the 
external rating on any instrument does not appropriately reflect the 
risks imposed on a bank and may require another risk weight, credit 
equivalent amount, credit conversion factor or external rating that the 
OCC deems appropriate. Similarly, if no risk weight, credit equivalent 
amount, credit conversion factor, or external rating is specifically 
assigned, the OCC may assign any risk weight, credit equivalent amount, 
credit conversion factor, or external rating that the OCC deems 
appropriate. In making its determination, the OCC considers risks 
associated with the asset or off-balance sheet item as well as other 
relevant factors.
    (c) In addition to the reservations of authority described in 
paragraph (b) of this section, the OCC reserves the authority to assign 
different risk weights to exposures as set forth in sections 
1(c)(2)(i), and (ii) of appendix C and section 6 of appendix B of this 
part.
    (d) Applicability. The OCC reserves the authority to require a bank 
calculate its minimum risk-based capital ratio according to either 
appendix A, appendix C, or appendix D of this part. In making this 
determination, the OCC will consider the bank's information systems and 
risk profile and apply notice and response procedures in the same 
manner and to the same extent as the notice and response procedures in 
Sec.  3.12. Additionally, the OCC reserves the authority to require any 
bank to apply the market risk capital adjustment set forth in appendix 
B of this part.
    3. Revise Sec.  3.6 to read as follows:


Sec.  3.6  Minimum capital ratios.

    (a) General. A national bank must maintain a capital to total 
assets leverage ratio and a risk-based capital ratio. The risk-based 
capital ratio may be subject to a market risk adjustment.
    (b) Total assets leverage ratio. All national banks must have and 
maintain Tier 1 capital in an amount equal to at least 3.0 percent of 
adjusted total assets.
    (c) Additional leverage ratio requirement. An institution operating 
at or near the level in paragraph (a) of this section should have well-
diversified risks, including no undue interest rate risk exposure; 
excellent control systems; good earnings; high asset quality; high 
liquidity; and well managed on- and off-balance sheet activities; and 
in general be considered a strong banking organization, rated composite 
1 under the Uniform Financial Institutions

[[Page 77470]]

Rating System (CAMELS) rating system of banks. For all but the most 
highly-rated banks meeting the conditions set forth in this paragraph 
(c), the minimum Tier 1 leverage ratio is 4 percent. In all cases, 
banking institutions should hold capital commensurate with the level 
and nature of all risks.
    (d) Risk-based capital ratio. A national bank must have and 
maintain the minimum risk-based capital ratio in either appendix A 
(risk-based capital ratio), appendix C (internal ratings-based and 
advanced measurement approaches), or appendix D (alternative risk-based 
capital ratio), and, for certain banks, in appendix B of this part 
(market risk capital adjustment).
    (1) Risk-based capital ratio requirement. Except as provided by 
paragraph (d)(2) (alternative risk-based capital ratio) and paragraph 
(f) of this section (internal ratings-based and advanced measurement 
approaches), a bank must maintain a minimum risk-based capital ratio as 
calculated in accordance with appendix A of this part.
    (2) Alternative risk-based capital ratio requirement. A bank that 
is not subject (either mandatorily or by election) to the internal 
ratings-based and advanced measurement approaches under Appendix C, may 
adopt the alternative risk-based capital ratio requirements pursuant to 
section 1(c) of appendix D of this part. A bank subject to appendix D 
must maintain a minimum alternative risk-based capital ratio as 
calculated in accordance with appendix D of this part.
    (3) Internal ratings-based and advanced measurement approaches 
requirement. (i) Applicability. A bank that meets any of the following 
internal ratings-based and advanced measurement approaches 
applicability requirements must apply appendix C of this part in 
determining its minimum risk-based capital ratio:
    (A) The bank's consolidated total assets, as reported on its most 
recent year-end Call Report, equal to $250 billion or more;
    (B) The bank's most recent year-end consolidated total on-balance 
sheet foreign exposure equals to $10 billion or more (where total on-
balance sheet foreign exposure equals total cross-border claims less 
claims with head office or guarantor located in another country plus 
redistributed guaranteed amounts to the country of head office or 
guarantor plus local country claims on local residents plus revaluation 
gains on foreign exchange and derivative products, calculated in 
accordance with the Federal Financial Institutions Examination Council 
(FFIEC) 009 Country Exposure Report);
    (C) The bank is a subsidiary of a depository institution that is 
subject to 12 CFR Part 3, Appendix C, 12 CFR Part 208, Appendix F, 12 
CFR Part 325, Appendix D, or 12 CFR Part 566, subpart A; or
    (D) The bank is a subsidiary of a bank holding company (as defined 
in 12 U.S.C. 1841) that is subject to 12 CFR Part 225, Appendix F.
    (ii) Mandatory banks. A bank that meets the applicability 
requirements under paragraph (d)(3)(i) of this section must maintain a 
minimum risk-based capital ratio as calculated in accordance with 
appendix C of this part.
    (iii) Opt-in banks. A bank not otherwise required to use appendix 
C, may elect to use the internal ratings-based and advanced measurement 
approaches to calculate its minimum risk-based capital ratio, subject 
to prior OCC approval as provided by section 21 of appendix C of this 
part. A bank approved to use the internal ratings-based and advanced 
measurement approaches, must maintain a minimum risk-based capital 
ratio as calculated in accordance with appendix C of this part [Basel 
II].
    (4) Market risk capital adjustment requirement. (i) Market risk 
capital adjustment applicability requirement. A bank that meets any of 
the following applicability requirements, as determined by the bank's 
most recent year-end Call Report, must apply the additional market risk 
capital adjustment as provided by appendix B of this part:
    (A) The bank has trading activities (on a worldwide consolidated 
basis) equals to, or greater than, 10 percent of its total assets; or
    (B) The bank has trading activities (on a worldwide consolidated 
basis) equal to $1 billion or more.
    (ii) Mandatory market risk bank. A bank that meets the market risk 
applicability requirements under paragraph (d)(4) of this section must 
apply the additional market risk capital adjustment in determining its 
minimum risk-based capital ratio (or alternative risk-based capital 
ratio, if applicable), as calculated in accordance with appendix B of 
this part.
    (iii) Opt-in market risk bank. A bank not otherwise required to use 
appendix B, may elect to use the market risk capital adjustment, 
subject to prior OCC approval as provided by section 3(c) of appendix B 
of this part. A bank approved to use the market risk capital 
adjustment, must apply the additional market risk capital adjustment in 
determining its minimum risk-based capital ratio (or alternative risk-
based capital ratio, if applicable), as calculated in accordance with 
appendix B of this part.
    4. Appendix C to Part 3 is added and reserved.
    5. Add Appendix D to Part 3 to read as follows:

Appendix D To Part 3--Alternative Risk-Based Capital Guidelines

Section 1. Purpose, Applicability of Guidelines, and Definitions

    (a) Scope. This Appendix applies to all banks that have opted-in 
in accordance with section 1(b) of this appendix D.
    (b) Opt-in procedures. (1) Initial opt-in. Unless otherwise 
subject to appendix C of this part, any bank may adopt the capital 
requirements set forth in this appendix D by notifying the OCC of 
its intent to do so.
    (2) Opt-Out. Any bank that has opted into the capital 
requirements of this appendix D subsequently may elect to adopt the 
capital requirements set forth in appendix A by filing a notice with 
the appropriate supervisory office.
    (c) Reservation of authority. (1) The OCC may apply this 
appendix D to any bank if the OCC deems it necessary or appropriate 
for safe and sound banking practices or if the OCC determines that 
this appendix D would produce risk-based capital requirements that 
more accurately reflect the risk profile of the bank. In making a 
determination under this paragraph, the OCC will apply notice and 
response procedures in the same manner and to the same extent as the 
notice and response procedures in Sec.  3.12.
    (2) The OCC may exclude a bank that has otherwise opted-in 
according to section 1(b)(1) of this appendix from applying the 
capital requirements of this appendix D, if the OCC determines such 
action is consistent with safe and sound banking practices. In 
making a determination under this paragraph, the OCC will apply 
notice and response procedures in the same manner and to the same 
extent as the notice and response procedures in Sec.  3.12.
    (d) Definitions. (1) Except where noted, the definitions listed 
in sections 1 and 4 of appendix A to this part 3 shall apply to this 
appendix D to this part 3. For the purposes of this appendix D, 
where the definitions in appendix A include cross references to 
other sections in appendix A, the OCC will construe them to refer to 
the appropriate sections in this appendix D.
    (2) For the purposes of this appendix D, the following 
additional definitions apply:
    Affiliate means, with respect to a company, any company that 
controls, is controlled by, or is under common control with, the 
company. For the purposes of this definition, a person or company 
controls a company if it:
    (A) Owns, controls, or holds with power to vote 25 percent or 
more of a class of voting securities of the company; or
    (B) Consolidates the company for financial reporting purposes.
    Company means a corporation, partnership, limited liability 
company,

[[Page 77471]]

business trust, special purpose entity, association, or similar 
organization.
    Early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision is solely triggered by events not directly related to 
the performance of the underlying exposures or the originating 
banking organization (such as material changes in tax laws or 
regulations).
    Eligible guarantee means a guarantee provided by a third party 
eligible guarantor that is:
    (A) Written and unconditional; and if extended by a central 
government, is backed by the full faith and credit of the central 
government;
    (B) Covers all or a pro rata portion of the contractual payments 
of the obligor on the reference exposure;
    (C) Gives the beneficiary a direct claim against the protection 
provider;
    (D) Is non-cancelable by the protection provider for reasons 
other than the breach of the contract by the beneficiary;
    (E) Is legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced;
    (F) Requires the protection provider to make payment to the 
beneficiary on the occurrence of a default (as defined in the 
guarantee) of the obligor on the reference exposure without first 
requiring the beneficiary to demand payment from the obligor.
    Eligible guarantor means:
    (A) A foreign central government with senior long-term debt 
externally rated at least investment grade by a NRSRO; or
    (B) An entity, other than a central government, (for example, 
securities firms, insurance companies, bank holding companies, 
savings and loan holding companies, multilateral lending and 
regional development institutions, partnerships, limited liability 
companies, business trusts, special purpose entities, associations 
and other similar organizations) with senior long-term debt 
externally rated at least investment grade by a NRSRO.
    Excess spread means gross finance charge collections (including 
market interchange fees) and other income received by a trust or the 
special purpose entity (SPE) minus interest paid to investors in the 
securitization exposures, servicing fees, charge-offs, and other 
similar trust or SPE expenses.
    Excess spread trapping point means the point at which the bank 
is required by the documentation governing a securitization to 
divert and hold excess spread in a spread or reserve account, 
expressed as a percentage.
    External rating means:
    (A) A credit rating that is assigned by an NRSRO to a claim, 
provided that the credit rating:
    (1) Fully reflects the entire amount of credit risk with regard 
to all payments owed on the claim (that is, the rating must fully 
reflect the credit risk associated with timely repayment of 
principal and interest);
    (2) Is monitored by the issuing NRSRO;
    (3) Is published in an accessible public form; and
    (4) Is, or will be, included in the issuing NRSRO's publicly 
available transition matrix, which tracks the performance and 
stability (or ratings migrations) of an NRSRO's issued external 
ratings for the specific type of claim (for example, corporate 
debt); or
    (B) An unrated claim on a foreign central government shall be 
deemed to have an external rating equal to the foreign central 
government's issuer rating assigned by an NRSRO.
    Investor's interest means the total amount of securitization 
exposures represented by securities issued by a trust or special 
purpose entity to investors.
    Loan-level private mortgage insurance means insurance provided 
by a regulated mortgage insurance company that protects the mortgage 
lender in the event of a default of a mortgage borrower up to a 
predetermined portion of the value of a single one-to-four 
residential property, provided there is no pool-level cap that would 
effectively reduce coverage.
    Non-central government entity means an entity that is not a 
central government as that term is defined in this section. This 
term includes securities firms, insurance companies, bank holding 
companies, savings and loan holding companies, multilateral lending 
and regional development institutions, partnerships, limited 
liability companies, business trusts, special purpose entities, 
associations and other similar organizations.
    Revolving credit means a line of credit where the borrower is 
permitted to vary both the drawn amount and the amount of repayment.

Section 2. Components of Capital

    (a) A national bank's qualifying capital base is comprised as 
set forth in section 2 of appendix A to this part 3.
    (b) For the purposes of this appendix D, the OCC will construe 
cross references in appendix A of this part to other sections in 
appendix A as cross references to the appropriate sections in this 
appendix D.

Section 3. Risk Categories/Weights for On-Balance Sheet Assets and 
Off-Balance Sheet Items.

    (a) General. (1) Calculations. The denominator of the risk-based 
capital ratio, i.e., a national bank's risk-weighted assets, is 
derived by assigning that bank's assets and off-balance sheet items 
to one of the risk categories set out in this appendix D. Each 
category has a specific risk weight. Off-balance sheet items are 
converted to on-balance sheet equivalent amounts according to 
section 3(c) of this appendix D and then assigned a risk category. 
The risk weight assigned to a particular asset or on-balance sheet 
credit equivalent amount determines the percentage of that asset/
credit equivalent that is included in the denominator of the bank's 
risk-based capital ratio. Any asset deducted from a bank's capital 
in computing the numerator of the risk-based capital ratio is not 
included as part of the bank's risk-weighted assets. The OCC 
reserves the right to require a bank to compute its risk-based 
capital ratio on the basis of average, rather than period-end, risk-
weighted assets when necessary to carry out the purposes of these 
guidelines.
    (2) Indirect Holdings. Some of the assets on a bank's balance 
sheet may represent an indirect holding of a pool of assets, e.g., 
mutual funds, that encompasses more than one risk weight within the 
pool. In those situations, the bank may assign the asset to the 
risk-weight category applicable to the highest risk-weighted asset 
that pool is permitted to hold pursuant to its stated investment 
objectives in the fund's prospectus. Alternatively, the bank may 
assign the asset on a pro rata basis to different risk categories 
according to the investment limits in the fund's prospectus. In 
either case, the minimum risk weight that may be assigned to such a 
pool is 20 percent. If a bank assigns the asset on a pro rata basis, 
and the sum of the investment limits in the fund's prospectus 
exceeds 100 percent, the bank must assign the highest pro rata 
amounts of its total investment to the higher risk-weight category. 
If, in order to maintain a necessary degree of liquidity, the fund 
is permitted to hold an insignificant amount of its assets in short-
term, highly-liquid securities of superior credit quality (that do 
not qualify for a preferential risk weight), such securities 
generally will not be taken into account in determining the risk 
category into which the bank's holding in the overall pool should be 
assigned. The prudent use of hedging instruments by a fund to reduce 
the risk of its assets will not increase the risk weighting of the 
investment in that fund above the 20 percent category. However, if a 
fund engages in any activities that are deemed to be speculative in 
nature or has any other characteristics that are inconsistent with 
the preferential risk weighting assigned to the fund's assets, the 
bank's investment in the fund will be assigned to the 100 percent 
risk-weight category. More detail on the treatment of mortgage-
backed securities is provided in sections 3(b)(1)(ii)(F) and (G), 
3(b)(1)(iv)(D), and 4(c) and (d) of this appendix D.
    (b) On-Balance Sheet Assets. (1) Risk-Weight Categories. Unless 
otherwise provided by sections 3(b)(2) or 3(b)(3) of this appendix, 
a bank must assign a risk weight to an on-balance sheet asset 
according to the following risk-weight categories.
    (i) Zero percent risk weight. (A) Cash, including domestic and 
foreign currency owned and held in all offices of a national bank or 
in transit. Any foreign currency held by a national bank should be 
converted into U.S. dollar equivalents.
    (B) Deposit reserves and other balances at Federal Reserve 
Banks.
    (C) Gold bullion held in the bank's own vaults or in another 
bank's vaults on an allocated basis, to the extent it is backed by 
gold bullion liabilities.
    (D) The book value of paid-in Federal Reserve Bank stock.
    (E) Securities issued by, and other direct claims on, the United 
States Government or its agencies.
    (F) That portion of assets directly and unconditionally 
guaranteed by the United States Government or its agencies.

[[Page 77472]]

    (G) That portion of assets and off-balance sheet transactions 
\1\ collateralized by cash or securities issued or directly and 
unconditionally guaranteed by the United States Government or its 
agencies, or the central government of an OECD country, provided 
that: \2\
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    \1\ See footnote 18 in section 3(c)(1)(vii)(C) of this appendix 
D (collateral held against derivative contracts).
    \2\ Assets and off-balance sheet transactions collateralized by 
securities issued or guaranteed by the United States Government or 
its agencies include, but are not limited to, securities lending 
transactions, repurchase agreements, collateralized letters of 
credit, such as reinsurance letters of credit, and other similar 
financial guarantees. Swaps, forwards, futures, and options 
transactions are also eligible, if they meet the collateral 
requirements. However, the OCC may at its discretion require that 
certain collateralized transactions be risk weighted at 20 percent 
if they involve more than a minimal risk.
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    (1) The bank maintains control over the collateral:
    (i) If the collateral consists of cash, the cash must be held on 
deposit by the bank or by a third-party for the account of the bank;
    (ii) If the collateral consists of OECD government securities, 
then the securities must be held by the bank or by a third-party 
acting on behalf of the bank;
    (2) The bank maintains a daily positive margin of collateral 
fully taking into account any change in the market value of the 
collateral held as security;
    (3) Where the bank is acting as a customer's agent in a 
transaction involving the loan or sale of securities that is 
collateralized by cash or OECD government securities delivered to 
the bank, any obligation by the bank to indemnify the customer is 
limited to no more than the difference between the market value of 
the securities lent and the market value of the collateral received, 
and any reinvestment risk associated with the collateral is borne by 
the customer; and
    (4) The transaction involves no more than minimal risk.
    (H) Externally rated debt securities issued by, certain other 
externally rated claims on, and that portion of assets supported by 
an eligible guarantee of, a foreign central government that receive 
a zero percent risk weight, as provided in section 3(b)(3) of this 
appendix D.
    (ii) Twenty Percent Risk Weight. (A) All claims on depository 
institutions incorporated in an OECD country, and all assets backed 
by the full faith and credit of depository institutions incorporated 
in an OECD country. This includes the credit equivalent amount of 
participations in commitments and standby letters of credit sold to 
other depository institutions incorporated in an OECD country, but 
only if the originating bank remains liable to the customer or 
beneficiary for the full amount of the commitment or standby letter 
of credit. Also included in this category are the credit equivalent 
amounts of risk participations in bankers' acceptances conveyed to 
other depository institutions incorporated in an OECD country. 
However, bank-issued securities that qualify as capital of the 
issuing bank are not included in this risk category, but are 
assigned to the 100 percent risk category.
    (B) Claims on, or guaranteed by depository institutions, other 
than the central bank, incorporated in a non-OECD country, with a 
residual maturity of one year or less.
    (C) Cash items in the process of collection.
    (D) That portion of assets collateralized by cash or by 
securities issued or directly and unconditionally guaranteed by the 
United States Government or its agencies that does not qualify for 
the zero percent risk-weight category.
    (E) That portion of assets conditionally guaranteed by the 
United States government or its agencies.
    (F) Securities issued by, or other direct claims on, United 
States Government-sponsored agencies.
    (G) That portion of assets guaranteed by United States 
Government-sponsored agencies.\3\
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    \3\ Privately issued mortgage-backed securities, e.g., CMOs and 
REMICs, where the underlying pool is comprised solely of mortgage-
related securities issued by GNMA, FNMA and FHLMC, will be treated 
as an indirect holding of the underlying assets and assigned to the 
20 percent risk category. If the underlying pool is comprised of 
assets which attract different risk weights, e.g., FNMA securities 
and conventional mortgages, the bank should generally assign the 
security to the highest risk category appropriate for any asset in 
the pool. However, on a case-by-case basis, the OCC may allow the 
bank to assign the security proportionately to the various risk 
categories based on the proportion in which the risk categories are 
represented by the composition cash flows of the underlying pool of 
assets. Before the OCC will consider a request to proportionately 
risk-weight such a security, the bank must have current information 
for the reporting date that details the composition and cash flows 
of the underlying pool of assets.
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    (H) That portion of assets collateralized by the current market 
value of securities issued or guaranteed by United States 
Government-sponsored agencies.
    (I) Claims representing general obligations of any public-sector 
entity in an OECD country, and that portion of any claims guaranteed 
by any such public-sector entity. In the United States, these 
obligations must meet the requirements of 12 CFR 1.2(b).
    (J) Unrated loans to official multilateral lending institutions 
or regional development institutions in which the United States 
Government is a shareholder or contributing member.\4\ Rated loans 
to, debt securities issued by, claims guaranteed by, and claims 
collateralized by debt securities issued by, official multilateral 
lending institutions or regional development institutions shall be 
risk weighted according to section 3(b)(3) of this appendix D.
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    \4\ These institutions include, but are not limited to, the 
International Bank for Reconstruction and Development (World Bank), 
the Inter-American Development Bank, the Asian Development Bank, the 
European Investments Bank, the International Monetary Fund, and the 
Bank for International Settlements.
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    (K) An unrated loan to a securities firm incorporated in an OECD 
country, that satisfies the following conditions:
    (1) If the securities firm is incorporated in the United States, 
then the firm must be a broker-dealer that is registered with the 
SEC and must be in compliance with the SEC's net capital regulation 
(17 CFR 240.15c3(1)).
    (2) If the securities firm is incorporated in any other OECD 
country, then the bank must be able to demonstrate that the firm is 
subject to consolidated supervision and regulation, including its 
subsidiaries, comparable to that imposed on depository institutions 
in OECD countries; such regulation must include risk-based capital 
standards comparable to those applied to depository institutions 
under the Basel Capital Accord.
    (3) The securities firm, whether incorporated in the United 
States or another OECD country, must also have a long-term credit 
rating in accordance with section 3(b)(1)(ii)(K)(3)(i) of this 
appendix D; a parent company guarantee in accordance with section 
3(b)(1)(ii)(K)(3)(ii) of this appendix D; or a collateralized claim 
in accordance with section 3(b)(1)(ii)(K)(3)(iii) of this appendix 
D. Claims representing capital of a securities firm must be risk 
weighted at 100 percent.
    (i) Credit rating. The securities firm must have either a long-
term issuer credit rating or a credit rating on at least one issue 
of long-term unsecured debt, from a NRSRO that is in one of the 
three highest investment-grade categories used by the NRSRO. If the 
securities firm has a credit rating from more than one NRSRO, the 
lowest credit rating must be used to determine the credit rating 
under this paragraph.
    (ii) Parent company guarantee. The claim on the securities firm 
must be guaranteed by the firm's parent company, and the parent 
company must have either a long-term issuer credit rating or a 
credit rating on at least one issue of long-term unsecured debt, 
from a NRSRO that is in one of the three highest investment-grade 
categories used by the NRSRO.
    (iii) Collateralized claim. The claim on the securities firm 
must be collateralized subject to all of the following requirements:
    (A) The claim must arise from a reverse repurchase/repurchase 
agreement or securities lending/borrowing contract executed using 
standard industry documentation.
    (B) The collateral must consist of debt or equity securities 
that are liquid and readily marketable.
    (C) The claim and collateral must be marked-to-market daily.
    (D) The claim must be subject to daily margin maintenance 
requirements under standard industry documentation.
    (E) The contract from which the claim arises can be liquidated, 
terminated, or accelerated immediately in bankruptcy or similar 
proceedings, and the security or collateral agreement will not be 
stayed or avoided under the applicable law of the relevant 
jurisdiction. To be exempt from the automatic stay in bankruptcy in 
the United States, the claim must arise from a securities contract 
or a repurchase agreement under section 555 or 559, respectively, of 
the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial 
contract under section 11(e)(8) of the Federal Deposit Insurance Act 
(12 U.S.C. 1821(e)(8)), or a netting contract between or among 
financial institutions under sections 401-407 of the Federal Deposit 
Insurance Corporation Improvement

[[Page 77473]]

Act of 1991 (12 U.S.C. 4407), or Regulation EE (12 CFR part 231). 
Externally rated loans to, externally rated debt securities issued 
by, claims guaranteed by, and claims collateralized by externally 
rated debt securities issued by, securities firms shall be risk 
weighted according to section 3(b)(3) of this appendix.
    (L) Externally rated debt securities issued by, certain other 
externally rated claims on, and that portion of assets supported by 
an eligible guarantee from, a foreign central government that 
receive a 20 percent risk weight as provided in section 3(b)(3) of 
this appendix D.
    (M) Externally rated debt securities issued by, certain other 
rated claims on, and that portion of assets supported by an eligible 
guarantee of, a non-central government entity, that receive a 20 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (N) Assets collateralized by liquid and readily marketable 
externally rated debt securities that receive a 20 percent risk 
weight as provided in section 3(b)(3) of this appendix D, and 
recourse obligations, direct credit substitutes, residual interests, 
and asset- and mortgage-backed securities that receive a 20 percent 
risk weight as provided in section 4(c)(1) of this appendix D.
    (O) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 20 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (iii) Thirty Five Percent Risk Weight. (A) Externally rated debt 
securities issued by, certain other externally rated claims on, and 
that portion of assets supported by an eligible guarantee of, a 
foreign central government, that receive a 35 percent risk weight as 
provided in section 3(b)(3) of this appendix D.
    (B) Externally rated debt securities issued by, certain other 
rated claims on, and that portion of assets supported by an eligible 
guarantee of, a non-central government entity, that receive a 35 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (C) Assets collateralized by liquid and readily marketable 
externally rated debt securities that receive a 35 percent risk 
weight as provided in section 3(b)(3) of this appendix D, and 
recourse obligations, direct credit substitutes, residual interests, 
and asset- and mortgage-backed securities that receive a 35 percent 
risk weight as provided in section 4(c)(1) of this appendix D.
    (D) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 35 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (iv) Fifty Percent Risk Weight. (A) Revenue obligations of any 
public-sector entity in an OECD country for which the underlying 
obligor is the public-sector entity, but which are repayable solely 
from the revenues generated by the project financed through the 
issuance of the obligations.
    (B) Loans to residential real estate builders for one-to-four 
family residential property construction, if the bank obtains 
sufficient documentation demonstrating that the buyer of the home 
intends to purchase the home (i.e., a legally binding written sales 
contract) and has the ability to obtain a mortgage loan sufficient 
to purchase the home (i.e., a firm written commitment for permanent 
financing of the home upon completion), subject to the following 
additional criteria:
    (1) The builder must incur at least the first 10 percent of the 
direct costs (i.e., actual costs of the land, labor, and material) 
before any drawdown is made under the construction loan and the 
construction loan may not exceed 80 percent of the sales price of 
the resold home;
    (2) The individual purchaser has made a substantial earnest 
money deposit of no less than 3 percent of the sales price of the 
home that must be subject to forfeiture by the individual purchaser 
if the sales contract is terminated by the individual purchaser; 
however, the earnest money deposit shall not be subject to 
forfeiture by reason of breach or termination of the sales contract 
on the part of the builder;
    (3) The earnest money deposit must be held in escrow by the bank 
financing the builder or by an independent party in a fiduciary 
capacity; the escrow agreement must provide that in the event of 
default the escrow funds must be used to defray any cost incurred 
relating to any cancellation of the sales contract by the buyer;
    (4) If the individual purchaser terminates the contract or if 
the loan fails to satisfy any other criterion under this section, 
then the bank must immediately recategorize the loan at a 100 
percent risk weight and must accurately report the loan in the 
bank's next quarterly Consolidated Reports of Condition and Income 
(Call Report);
    (5) The individual purchaser must intend that the home will be 
owner-occupied;
    (6) The loan is made by the bank in accordance with prudent 
underwriting standards;
    (7) The loan is not more than 90 days past due, or on 
nonaccrual; and
    (8) The purchaser is an individual(s) and not a partnership, 
joint venture, trust, corporation, or any other entity (including an 
entity acting as a sole proprietorship) that is purchasing one or 
more of the homes for speculative purposes.
    (C) Loans secured by a first mortgage on multifamily residential 
properties: \5\
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    \5\ The portion of multifamily residential property loans that 
is sold subject to a pro rata loss sharing arrangement may be 
treated by the selling bank as sold to the extent that the sales 
agreement provides for the purchaser of the loan to share in any 
loss incurred on the loan on a pro rata basis with the selling bank. 
The portion of multifamily residential property loans sold subject 
to any loss sharing arrangement other than pro rata sharing of the 
loss shall be accorded the same treatment as any other asset sold 
under an agreement to repurchase or sold with recourse under section 
4(b) of appendix D.
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    (1) The amortization of principal and interest occurs in not 
more than 30 years;
    (2) The minimum original maturity for repayment of principal is 
not less than 7 years;
    (3) All principal and interest payments have been made on a 
timely basis in accordance with the terms of the loan for at least 
one year immediately preceding the risk weighting of the loan in the 
50 percent risk-weight category, and the loan is not otherwise 90 
days or more past due, or on nonaccrual status;
    (4) The loan is made in accordance with all applicable 
requirements and prudent underwriting standards;
    (5) If the rate of interest does not change over the term of the 
loan:
    (i) The current loan amount outstanding does not exceed 80 
percent of the current value of the property, as measured by either 
the value of the property at origination of the loan (which is the 
lower of the purchase price or the value as determined by the 
initial appraisal, or if appropriate, the initial evaluation) or the 
most current appraisal, or if appropriate, the most current 
evaluation; and
    (ii) In the most recent fiscal year, the ratio of annual net 
operating income generated by the property (before payment of any 
debt service on the loan) to annual debt service on the loan is not 
less than 120 percent; \6\
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    \6\ For the purposes of the debt service requirements in 
sections 3(b)(1)(iv)(C)(5)(ii) and 3(b)(1)(iv)(C)(6)(ii) of this 
Appendix D, other forms of debt service coverage that generate 
sufficient cash flows to provide comparable protection to the 
institution may be considered for (a) a loan secured by cooperative 
housing or (b) a multifamily residential property loan if the 
purpose of the loan is for the development or purchase of 
multifamily residential property primarily intended to provide low- 
to moderate-income housing, including special operating reserve 
accounts or special operating subsidies provided by federal, state, 
local or private sources. However, the OCC reserves the right, on a 
case-by-case basis, to review the adequacy of any other forms of 
comparable debt service coverage relied on by the bank.
---------------------------------------------------------------------------

    (6) If the rate of interest changes over the term of the loan:
    (i) The current loan amount outstanding does not exceed 75 
percent of the current value of the property, as measured by either 
the value of the property at origination of the loan (which is the 
lower of the purchase price or the value as determined by the 
initial appraisal, or if appropriate, the initial evaluation) or the 
most current appraisal, or if appropriate, the most current 
evaluation; and
    (ii) In the most recent fiscal year, the ratio of annual net 
operating income generated by the property (before payment of any 
debt service on the loan) to annual debt service on the loan is not 
less than 115 percent; and
    (7) If the loan was refinanced by the borrower:
    (i) All principal and interest payments on the loan being 
refinanced which were made in the preceding year prior to 
refinancing shall apply in determining the one-year timely payment 
requirement under section 3(b)(1)(iv)(C)(3) of this appendix D; and
    (ii) The net operating income generated by the property in the 
preceding year prior to refinancing shall apply in determining the 
applicable debt service requirements under sections 
3(b)(1)(iv)(C)(5) and (a)(2)(iv)(C)(6) of this appendix D.
    (D) Unrated privately-issued mortgage-backed securities, i.e. 
those that do not carry the guarantee of a government or government-
sponsored agency, if the unrated privately-issued mortgage-backed 
securities are at the time the mortgage-backed securities are 
originated fully secured by or otherwise

[[Page 77474]]

represent a sufficiently secure interest in mortgages secured by 
multifamily residential properties that qualify for the 50 percent 
risk weight under section 3(b)(1)(iv)(C) of this appendix D; loans 
to residential real estate builders for one-to-four family 
residential property construction that qualify for the fifty percent 
risk weight under section 3(b)(1)(iv)(B) of this appendix D; and 
mortgages secured by residential properties that are either owner-
occupied or rented, meet prudent underwriting standards in 
accordance with 12 CFR Part 34, and are not 90 days or more past 
due, have not been placed in nonaccrual status, and have not been 
restructured, provided that they meet the following criteria: \7\
---------------------------------------------------------------------------

    \7\ If all of the underlying mortgages in the pool do not 
qualify, the bank should generally assign the entire value of the 
unrated security to the 200 percent risk category of this appendix 
D; however, on a case-by-case basis, the OCC may allow the bank to 
assign only the portion of the security which represents an interest 
in, and the cash flows of, nonqualifying mortgages to the 200 
percent risk category, with the remainder being assigned a risk 
weight of 50 percent. Before the OCC will consider a request to risk 
weight a mortgage-backed security on a proportionate basis, the bank 
must have current information for the reporting date that details 
the composition and cash flows of the underlying pool of mortgages.
---------------------------------------------------------------------------

    (1) The underlying assets must be held by an independent trustee 
that has a first priority, perfected security interest in the 
underlying assets for the benefit of the holders of the security;
    (2) The holder of the security must have an undivided pro rata 
ownership interest in the underlying assets or the trust that issues 
the security must have no liabilities unrelated to the issued 
securities;
    (3) The trust that issues the security must be structured such 
that the cash flows from the underlying assets fully meet the cash 
flows requirements of the security without undue reliance on any 
reinvestment income; and
    (4) There must not be any material reinvestment risk associated 
with any funds awaiting distribution to the holder of the security.
    (E) Externally rated debt securities issued by, certain other 
externally rated claims on, and that portion of assets supported by 
an eligible guarantee of, a foreign central government, that receive 
a 50 percent risk weight as provided in section 3(b)(3) of this 
appendix D.
    (F) Externally rated debt securities issued by, certain other 
rated claims on, and that portion of assets supported by an eligible 
guarantee of, a non-central government entity, that receive a 50 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (G) Assets collateralized by liquid and readily marketable 
externally rated debt securities that receive a 50 percent risk 
weight as provided in section 3(b)(3) of this appendix D, and 
recourse obligations, direct credit substitutes, residual interests, 
and asset- and mortgage-backed securities that receive a 50 percent 
risk weight as provided in section 4(c)(1) of this appendix D.
    (H) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 50 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (v) Seventy Five Percent Risk Weight. (A) Externally rated debt 
securities issued by, certain other externally rated claims on, and 
that portion of assets supported by an eligible guarantee of, a 
foreign central government, that receive a 75 percent risk weight as 
provided in section 3(b)(3) of this appendix D.
    (B) Externally rated debt securities issued by, certain other 
rated claims on, and that portion of assets supported by an eligible 
guarantee of non-central government entity, that receive a 75 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (C) Assets collateralized by liquid and readily marketable 
externally rated debt securities that receive a 75 percent risk 
weight as provided in section 3(b)(3) of this appendix D, and 
recourse obligations, direct credit substitutes, residual interests, 
and asset- and mortgage-backed securities that receive a 75 percent 
risk weight as provided in section 4(c)(1) of this appendix D.
    (D) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 75 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (vi) One Hundred Percent Risk Weight. All other assets not 
specified in this appendix D,\8\ including:
---------------------------------------------------------------------------

    \8\ A bank subject to the market risk capital requirements 
pursuant to Appendix B of this part 3 may calculate the capital 
requirement for qualifying securities borrowing transactions 
pursuant to section 3(a)(1)(ii) of appendix B of this part 3.
---------------------------------------------------------------------------

    (A) Asset- or mortgage-backed securities that are externally 
rated are risk weighted in accordance with section 4 of this 
appendix D.
    (B) All stripped mortgage-backed securities, including interest 
only portions (IOs), principal only portions (POs) and other similar 
instruments, regardless of the issuer or guarantor.
    (C) Obligations issued by any state or any political subdivision 
thereof for the benefit of a private party or enterprise where that 
party or enterprise, rather than the issuing state or political 
subdivision, is responsible for the timely payment of principal and 
interest on the obligation, e.g., industrial development bonds.
    (D) Claims on commercial enterprises owned by foreign central 
governments.
    (E) Any investment in an unconsolidated subsidiary that is not 
required to be deducted from total capital pursuant to section 2(c) 
of this appendix D.
    (F) Instruments issued by depository institutions incorporated 
in OECD and non-OECD countries that qualify as capital of the 
issuer.
    (G) Investments in fixed assets, premises, and other real estate 
owned.
    (H) Claims representing capital of a securities firm.
    (I) Bank-issued securities that qualify as capital of the 
issuing bank.
    (J) Externally rated debt securities issued by, certain other 
externally rated claims on, and that portion of assets supported by 
an eligible guarantee of, a foreign central government, that receive 
a 100 percent risk weight as provided in section 3(b)(3) of this 
appendix D.
    (K) Externally rated marketable debt securities issued by, 
certain other rated claims on, and that portion of assets supported 
by an eligible guarantee of, a non-central government entity, that 
receive a 100 percent risk weight as provided in section 3(b)(3) of 
this appendix D.
    (L) Assets collateralized by liquid and readily marketable 
externally rated debt securities that receive a 100 percent risk 
weight as provided in section 3(b)(3) of this appendix D, and 
recourse obligations, direct credit substitutes, residual interests, 
and asset- and mortgage-backed securities that receive a 100 percent 
risk weight as provided in section 4(c)(1) of this appendix D.
    (M) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 100 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (vii) One Hundred and Fifty Percent Risk Weight. (A) Externally 
rated debt securities issued by, certain other externally rated 
claims on, and that portion of assets supported by an eligible 
guarantee of, a foreign central government, that receive a 150 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (B) Externally rated debt securities issued by, certain other 
rated claims on, and that portion of assets supported by an eligible 
guarantee of, a non-central government entity, that receive a 150 
percent risk weight as provided in section 3(b)(3) of this appendix 
D.
    (C) Mortgage loans secured by liens on one-to-four family 
residential properties that receive a 150 percent risk weight as 
provided in section 3(b)(2) of this appendix D.
    (viii) Two Hundred Percent Risk Weight. (A) Unrated debt 
securities issued by, certain other unrated and rated claims on, and 
that portion of assets supported by an eligible guarantee of, a 
foreign central government, that receive a 200 percent risk weight 
as provided in section 3(b)(3) of this appendix D.
    (B) Externally rated and unrated debt securities issued by, 
certain other externally rated and unrated claims on, and that 
portion of assets supported by an eligible guarantee of, a non-
central government entity, that receive a 200 percent risk weight as 
provided in section 3(b)(3) of this appendix D.
    (2) Mortgage Loans Secured by Liens on One-to-Four Family 
Residential Properties. (i) First Lien Mortgages. (A) Risk-Weight 
Table. Unless otherwise provided in section 3(b)(2)(iii) (mortgage 
loans with negative amortization features) of this appendix D, a 
bank shall assign a mortgage loan secured by a first lien on a one-
to-four family residential property to a risk weight based on its 
loan-to-value ratio, in accordance with Table 1 of this appendix D.
    (B) Minimum Risk Weight for Certain Mortgage Loans Secured by 
Liens on One-to-Four Family Residential Properties. Notwithstanding 
section 3(b)(2)(i)(A) of this appendix D, a loan secured by a one-
to-four family residential property that is not either owner-
occupied or rented, that is 90 days or more past due, that has been 
placed in

[[Page 77475]]

nonaccrual status, has been restructured, or that does not meet 
prudent underwriting standards, shall receive a risk weight of 100 
percent, or higher if warranted by the loan-to-value ratio, 
according to Table 1 of this appendix D.
    (C) First and Junior Liens. If a bank holds a first lien and 
junior lien on a one-to-four family residential property and no 
other party holds an intervening lien, the combined exposure is 
treated as a single loan secured by a first lien for the purposes of 
both determining the loan-to-value ratio and assigning a risk weight 
to the combined exposure.
    (D) Loan-to-value ratio. (1) Initial loan-to-value ratio 
calculation. (i) Generally. For the purpose of determining the 
appropriate risk weight in accordance with Table 1 of this appendix 
D, a bank shall determine the loan-to-value ratio for a mortgage 
loan secured by first lien mortgage on a one-to-four family 
residential property using the lower of the purchase price or the 
appraisal or evaluation at origination.
    (ii) Loan level private mortgage insurance. In determining the 
loan-to-value ratio, a bank may take in to account loan-level 
private mortgage insurance, provided the insurer is not affiliated 
with the bank and has long-term debt rated at least third highest 
investment grade (without credit enhancements) by an NRSRO.
    (iii) Appraisal or Evaluation. Any appraisal or evaluation used 
by a bank for the purposes of this appendix D must satisfy the real 
estate lending and appraisal requirements set forth in subpart C of 
12 CFR part 34.
    (2) Adjustments to the loan-to-value ratio. After origination of 
a mortgage loan, a bank may update the value of a one-to-four family 
residential property based on an appraisal or evaluation only if the 
borrower refinances the mortgage loan and the bank extends 
additional funds. On a quarterly basis, a bank may adjust the amount 
of the loan to reflect any decrease in the principal balance. In the 
case of a home equity line of credit, the bank shall adjust the 
amount of the loan quarterly to reflect any increase in the balance 
of the loan.

  Table 1.--Risk Weights Applicable to Mortgage Loans Secured by First
           Liens on One-to-Four Family Residential Properties
------------------------------------------------------------------------
                                                             Risk weight
                    Loan-to-value ratio                          (in
                                                               percent)
------------------------------------------------------------------------
Less than or equal to 60 percent...........................           20
Greater than 60 percent but less than or equal to 80                  35
 percent...................................................
Greater than 80 percent but less than or equal to 85                  50
 percent...................................................
Greater than 85 percent but less than or equal to 90                  75
 percent...................................................
Greater than 90 percent but less than or equal to 95                 100
 percent...................................................
Greater than 95 percent....................................          150
------------------------------------------------------------------------

    (ii) Junior lien mortgages. (A) Risk-weight table. Unless 
otherwise provided in section 3(b)(2)(i) (when a junior lien 
mortgages and all senior lien mortgages are held by same bank, the 
transaction is treated as a single loan), or section 3(b)(2)(iii) 
(mortgage loans with negative amortization features) of this 
appendix D, a bank shall assign a mortgage loan secured by a junior 
lien on a one-to-four family residential property to a risk weight 
based on its loan-to-value ratio, in accordance with Table 2 of this 
appendix D.
    (B) Minimum Risk Weight for Certain Mortgage Loans Secured by 
Junior Liens on One-to-Four Family Residential Properties. 
Notwithstanding paragraph (b)(2)(ii)(A) of this section, a loan 
secured by a one-to-four family residential property that is not 
either owner-occupied or rented, that is 90 days or more past due, 
that has been placed in nonaccrual status, has been restructured, or 
that does not meet prudent underwriting standards, shall receive a 
risk weight of 100 percent or higher, if warranted by the loan-to-
value ratio, according to Table 2 of this appendix D.
    (C) Loan-to-value ratio calculation. (1) Initial loan-to-value 
ratio calculation. (i) Generally. For the purpose of determining the 
appropriate risk weight in accordance with Table 2 of this appendix 
D, a bank shall determine the loan-to-value ratio for a mortgage 
loan secured by junior lien a one-to-four family residential 
property, including a structured mortgage or a home equity line of 
credit, by dividing the aggregate principal outstanding on the 
junior lien mortgage and all senior lien mortgages by the appraisal 
or evaluation at the origination of the junior lien. For the 
purposes of this calculation, if a third party holds a senior or 
intervening lien mortgage with a negative amortization feature, the 
bank must adjust the principal amount of the senior or intervening 
lien mortgage to reflect the amount of that loan if it were to fully 
negatively amortize under the applicable contract.
    (ii) Loan level private mortgage insurance. In determining the 
loan-to-value ratio, a bank may take into account loan-level private 
mortgage insurance, provided the insurer is not affiliated with the 
bank and has long term debt rated at least third highest investment 
grade (without credit enhancements) by an NRSRO.
    (iii) Appraisal or evaluation. Any appraisal or evaluation used 
by a bank for the purposes of this section must satisfy the real 
estate lending and appraisal requirements set forth in subpart C of 
12 CFR part 34.
    (2) Adjustments to the loan-to-value ratio. After origination of 
a mortgage loan, a bank may update the value of a one-to-four family 
residential property based on an appraisal or evaluation only if the 
borrower refinances the mortgage loan and the bank extends 
additional funds. On a quarterly basis, a bank may adjust the amount 
of the loan to reflect any decrease in the principal balance. In the 
case of a home equity line of credit, the bank shall adjust the 
amount of the loan quarterly to reflect any increase in the balance 
of the loan.

  Table 2.--Risk Weights Applicable to Mortgage Loans Secured by Stand-
     Alone Junior Liens on One-to-Four Family Residential Properties
------------------------------------------------------------------------
                                                             Risk weight
                Combined loan-to-value ratio                     (in
                                                               percent)
------------------------------------------------------------------------
Less than 60 percent.......................................           75
Greater than 60 percent but less than or equal to 90                 100
 percent...................................................
Greater than 90 percent....................................          150
------------------------------------------------------------------------

    (iii) Mortgage loans with negative amortization features. (A) 
Risk weight table. The funded portion of a mortgage loan secured by 
a lien on a one-to-four family residential property that includes a 
negative amortization feature shall be assigned to a risk-weight 
category based on that portion's loan-to-value ratio, in accordance 
with Table 1 or Table 2. The amount equal to the maximum unfunded 
amount of the loan if it were to negatively amortize to the fullest 
extent allowed under the applicable loan contract shall be treated 
as a commitment, as set forth in section 3(c) of this appendix D. 
The risk weight applicable to the unfunded amount is the risk weight 
that would be assigned to a loan with a LTV ratio computed using a 
loan amount that is equal to the funded amount of the loan plus the 
maximum unfunded amount of the loan if it were to negatively 
amortize to the fullest extent allowed under the applicable 
contract.
    (B) Loan-to-value ratio calculation. (1) Initial LTV ratio 
calculation. (i) Generally. For the purpose of determining the 
appropriate risk weight for a mortgage loan secured by lien on a 
one-to-four family residential property in accordance with Table 1 
or Table 2 of this appendix D, a bank initially shall determine the 
loan-to-value ratio using the lower of the purchase price or the 
appraisal or evaluation at origination.
    (ii) Loan level private mortgage insurance. In determining the 
loan-to-value ratio, a bank may take into account loan-level private 
mortgage insurance, provided the insurer is not affiliated with the 
bank and has long-term debt rated at least third highest investment 
grade (without credit enhancements) by an NRSRO.
    (iii) Appraisal or evaluation. Any appraisal or evaluation used 
by a bank for the purposes of this appendix D must satisfy the real 
estate lending and appraisal requirements set forth in subpart C of 
part 34 of this title 12.
    (2) Adjustments to the loan-to-value ratio. After origination of 
a mortgage loan, a bank may update the value of a one-to-four family 
residential property based on an appraisal or evaluation only if the 
borrower refinances the mortgage loan and the bank extends 
additional funds. As the loan balance increases, banks must 
recalculate the LTV ratio on a quarterly basis.
    (iv) Grandfathered loans. (A) If a bank owns mortgage loans 
secured by liens on one-to-four-family residential properties prior 
to electing to apply the requirements set forth in this appendix D 
of this Part 3, the bank may elect to determine the risk weights

[[Page 77476]]

applicable to all such mortgage loans according to the requirements 
set forth in appendix A of this part 3.
    (B) If a bank has previously applied the requirements set forth 
in this appendix D to determine the risk weight applicable to a 
mortgage loan secured by a lien on a one-to-four family residential 
property, the bank may not thereafter elect to determine the risk 
weight applicable the mortgage loan according to the requirements 
set forth in section 3(b)(2)(iv)(A) of this appendix D.
    (3) Externally rated exposures. (i) Claims on foreign central 
governments. A bank shall determine the risk weight applicable to an 
externally rated short-or long-term foreign central government 
security or claim based on the external rating of the issued 
security or claim in accordance with Table 3 or Table 4 of this 
appendix D. The lowest single rating shall apply if there are two or 
more relevant external ratings. If the security or loan is not 
rated, a bank shall determine the risk weight based on the external 
rating of the issuing central government in accordance with Table 3 
of this appendix D. The lowest single rating shall apply if the 
central government receives two or more external ratings.
    (ii) Claims collateralized by foreign central government debt 
securities. A bank may determine the risk weight applicable to the 
portion of a claim collateralized by a liquid and readily marketable 
short-or long-term foreign central government security based on the 
external rating of the issued security, provided that either the 
central government or the security is externally rated at least 
investment grade by an NRSRO, in accordance with Table 3 or Table 4 
of this Appendix D. The lowest single rating shall apply if the 
collateral receives more than one external rating. If the collateral 
is not rated, a bank may determine the risk weight applicable to the 
collateralized portion of the claim based on the risk weight of the 
central government that issued the security, in accordance with 
Table 3 or Table 4 of this appendix D. The lowest single rating 
shall apply if the central government receives two or more external 
ratings.
    (iii) Claims guaranteed by foreign central governments. A bank 
may determine the risk weight applicable to the portion of a claim 
supported by an eligible guarantee from a foreign central government 
based on the long-term external rating of the central government or 
the external rating of the foreign central government's senior long-
term debt (without credit enhancement), provided that it is rated at 
least investment grade by an NRSRO, in accordance with Table 3 of 
this appendix D. The lowest single rating shall apply if there are 
two or more relevant external ratings.
    (iv) Other externally rated claims. Unless otherwise provided in 
section 3(b)(1) in this Appendix D (risk-weight categories), a bank 
shall determine the risk weight applicable to a claim on non-central 
government entity \9\ based on the external rating of the claim, in 
accordance with Table 3 or Table 4 of this appendix D. The lowest 
single rating shall apply if the claim receives more than one 
external rating. This section does not apply to asset- and mortgage-
backed securities, direct credit substitutes, and residual 
interests. Asset- and mortgage-backed securities, direct credit 
substitutes and residual interests are risk-weighted according to 
section 4 of this appendix D.
---------------------------------------------------------------------------

    \9\ Non-central government entities include securities firms, 
insurance companies, bank holding companies, savings and loan 
holding companies, multilateral lending and regional development 
institutions, partnerships, limited liability companies, business 
trusts, special purpose entities, associations and other similar 
organizations.
---------------------------------------------------------------------------

    (v) Other collateralized claims. Unless otherwise provided in 
section 3(b)(1) in this appendix D (risk-weight categories), a bank 
may determine the risk weight applicable to the portion of a claim 
collateralized by a liquid and readily marketable externally rated 
debt security based on the external rating of the security, provided 
that the security is externally rated at least investment grade by 
an NRSRO, in accordance with Table 3 or Table 4 of this appendix D. 
A bank may determine the risk weight applicable to a claim 
collateralized by an externally rated recourse obligation, direct 
credit substitute, residual interest, or asset-or mortgage-backed 
security, provided the collateral is rated at least investment grade 
by an NRSRO, in accordance with section 4(c)(1) and Table 6 of this 
appendix D. The lowest single rating shall apply if the collateral 
receives more than one external rating.
    (vi) Other guaranteed claims. Unless otherwise provided in 
section 3(b)(1) in this appendix D (risk-weight categories), a bank 
may determine the risk weight applicable to the portion of a claim 
supported by an eligible guarantee based on the external rating of 
the guarantor's senior long-term debt (without credit enhancement), 
provided that it is rated at least investment grade by an NRSRO, in 
accordance with Table 3 of this appendix D. The lowest single rating 
shall apply if the guarantor's externally rated senior long-term 
debt receives more than one external rating.

                    Table 3.--Risk Weights Based on External Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                      Central       Non-central
                                                                                    government      government
          Long-term rating category                         Examples                risk weight     risk weight
                                                                                   (in percent)    (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating..............  AAA..............................               0              20
Second-highest investment grade rating.......  AA...............................              20              20
Third-highest investment grade rating........  A................................              20              35
Lowest-investment grade rating--plus.........  BBB+.............................              35              50
Lowest-investment grade rating...............  BBB..............................              50              75
Lowest-investment grade rating--minus........  BBB-.............................              75             100
One category below investment grade..........  BB+,BB...........................              75             150
One category below investment grade--minus...  BB-..............................             100             200
Two or more categories below investment grade  B, CCC...........................             150             200
Unrated (excludes unrated loans to non-        n/a..............................             200             200
 central government \1\.
----------------------------------------------------------------------------------------------------------------
\1\ Unrated claims on foreign central governments and unrated debt securities issued by non-central governments
  would receive the risk weight indicated in Table 3. Other unrated claims, for example, unrated loans to non-
  central governments, would continue to be risk weighted under the existing risk-based capital rules.


                    Table 4.--Risk Weights Based on External Ratings for Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                      Central       Non-central
                                                                                    government      government
           Short-term rating category                        Examples               risk weight     risk weight
                                                                                   (in percent)    (in percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating................  A-1, P-1.......................               0              20
Second-highest investment grade rating.........  A-2, P-2.......................              20              35
Lowest investment grade rating.................  A-3, P-3.......................              50              75

[[Page 77477]]

 
Unrated (excludes unrated loans to non-          n/a............................             100             100
 sovereigns) \1\.
----------------------------------------------------------------------------------------------------------------
\1\ Unrated claims on foreign central governments and unrated debt securities issued by non-central governments
  would receive the risk weight indicated in Table 4. Other unrated claims, for example, unrated loans to non-
  central governments, would continue to be risk weighted under the existing risk-based capital rules.

    (c) Off-Balance Sheet Activities. (1) The risk weights assigned 
to off-balance sheet activities are determined by a two-step 
process. First, the face amount of the off-balance sheet item is 
multiplied by the appropriate credit conversion factor specified in 
this section. This calculation translates the face amount of an off-
balance sheet item into an on-balance sheet credit equivalent 
amount. Second, the resulting credit equivalent amount is then 
assigned to the proper risk-weight category using the criteria 
regarding obligors, guarantors, and collateral listed in sections 
3(b)(1) and 3(b)(3) of this appendix D. Collateral and guarantees 
are applied to the face amount of an off-balance sheet item; 
however, with respect to derivative contracts, collateral and 
guarantees are applied to the credit equivalent amounts of such 
derivative contracts. The following are the off-balance sheet items 
subject to this appendix D, and their respective credit conversion 
factors.
    (i) 100 percent credit conversion factor. (A) Risk 
participations purchased in bankers' acceptances.
    (B) Contingent obligations with a certain draw down, e.g., 
legally binding agreements to purchase assets at a specified future 
date.
    (C) Indemnification of customers whose securities the bank has 
lent as agent. If the customer is not indemnified against loss by 
the bank, the transaction is excluded from the risk-based capital 
calculation.\10\
---------------------------------------------------------------------------

    \10\ When a bank lends its own securities, the transaction is 
treated as a loan. When a bank lends its own securities or, acting 
as agent, agrees to indemnify a customer, the transaction is 
assigned to the risk weight appropriate to the obligor or collateral 
that is delivered to the lending or indemnifying institution or to 
an indepdent custodian acting on their behalf.
---------------------------------------------------------------------------

    (ii) 50 percent credit conversion factor. (A) Transaction-
related contingencies including, among other things, performance 
bonds and performance-based standby letters of credit related to a 
particular transaction.\11\ To the extent permitted by law or 
regulation, performance-based standby letters of credit include such 
things as arrangements backing subcontractors' and suppliers' 
performance, labor and materials contracts, and construction bids;
---------------------------------------------------------------------------

    \11\ For purposes of this section, a ``performance-based standby 
letter of credit'' is any letter of credit, or similar arrangement, 
however named or described, which represents an irrevocable 
obligation to the beneficiary on the part of the issuer to make 
payment on account of any default by the account party in the 
performance of a non-financial or commercial obligation. 
Participations in performance-based standy letters of credit are 
treated in accordance with 4 of this appendix D.
---------------------------------------------------------------------------

    (B) Unused portions of commitments with an original maturity 
exceeding one-year that are not unconditionally cancelable; \12\ 
however, commitments that are asset-backed commercial paper 
liquidity facilities must satisfy the eligibility requirements under 
section 3(c)(1)(vi)(B) of this appendix D.
---------------------------------------------------------------------------

    \12\ Participations in commitments are treated in accordance 
with section 4 of appendix D.
---------------------------------------------------------------------------

    (C) Unused portions of negatively amortizing mortgage loans with 
an original maturity exceeding one-year that are secured by liens on 
one-to-four family residential properties and are not 
unconditionally cancelable. If a mortgage loan secured by a lien on 
a one-to-four family residential property may negatively amortize, 
the bank shall calculate the risk-weighted asset amount for the 
unfunded portion of the loan by multiplying the amount of the off-
balance sheet exposure by the applicable credit conversion factor.
    (1) The amount of the off-balance sheet exposure is the maximum 
unfunded amount of the loan if it were to negatively amortize to the 
fullest extent allowed under the applicable contract; and
    (2) The applicable risk weight is the risk weight that would be 
assigned under section 3(b)(2) of this appendix D to a loan with an 
LTV computed using a loan amount that is equal to the funded amount 
of the loan plus the maximum unfunded amount of the loan if it were 
to negatively amortize to the fullest extent allowed under the 
applicable contract.
    (D) Revolving underwriting facilities, note issuance facilities, 
and similar arrangements pursuant to which the bank's customer can 
issue short-term debt obligations in its own name, but for which the 
bank has a legally binding commitment to either:
    (1) Purchase the obligations the customer is unable to sell by a 
stated date; or
    (2) Advance funds to its customer if the obligations cannot be 
sold.
    (iii) 20 percent credit conversion factor. (A) Trade-related 
contingencies. These are short-term self-liquidating instruments 
used to finance the movement of goods and are collateralized by the 
underlying shipment. A commercial letter of credit is an example of 
such an instrument.
    (B) [Reserved].
    (iv) 10 percent credit conversion factor. (A) Unused portion of 
asset-backed commercial paper liquidity facilities with an original 
maturity of one year or less that satisfy the eligibility 
requirements under section 3(c)(1)(vi)(B) of this appendix.
    (B) Unused portions of commitments with maturities of one year 
or less that are not unconditionally cancelable,\13\ except for 
commitments to originate mortgage loans secured by one-to-four 
family residential properties provided in the ordinary course of 
business.
---------------------------------------------------------------------------

    \13\ Participations in commitments are treated in accordance 
with section of appendix D.
---------------------------------------------------------------------------

    (C) Unused portions of negatively amortizing mortgage loans with 
an original maturity of one-year or less that are secured by liens 
on one-to-four family residential properties and that are not 
unconditionally cancelable. If a mortgage loan secured by a lien on 
a one-to-four family residential property may negatively amortize, 
the bank shall calculate the risk-weighted asset amount for the 
unfunded portion of the loan by multiplying the amount of the off-
balance sheet exposure by the applicable credit conversion factor.
    (1) The amount of the off-balance sheet exposure is the maximum 
unfunded amount of the loan if it were to negatively amortize to the 
fullest extent allowed under the applicable contract; and
    (2) The applicable risk weight is the risk weight that would be 
assigned under section 3(b)(2) of this appendix D to a loan with a 
loan-to-value ratio computed using a loan amount that is equal to 
the funded amount of the loan plus the maximum unfunded amount of 
the loan if it were to negatively amortize to the fullest extent 
allowed under the applicable contract.
    (v) Zero percent credit conversion factor. (A) Unused portion of 
commitments, regardless of maturity, if they are unconditionally 
cancelable \14\ at any time at the option of the bank and the bank 
has the contractual right to make, and in fact does make, either--
---------------------------------------------------------------------------

    \14\ See section 1(c)(35) of appendix A to this part 3.
---------------------------------------------------------------------------

    (1) A separate credit decision based upon the borrower's current 
financial condition, before each drawing under the lending facility; 
or
    (2) An annual (or more frequent) credit review based upon the 
borrower's current financial condition to determine whether or not 
the lending facility should be continued.
    (B) The unused portion of retail credit card lines or other 
related plans that are unconditionally cancelable by the bank in 
accordance with applicable law.
    (vi) Liquidity facility provided to asset-backed commercial 
paper. (A) Noneligible asset-backed commercial paper liquidity 
facilities treated as recourse or direct credit substitute. Unused 
portion of asset-backed commercial paper liquidity facilities that 
do not meet the criteria for an eligible liquidity

[[Page 77478]]

facility provided to asset-backed commercial paper in accordance 
with section 3(c)(1)(vi)(B) of this appendix must be treated as 
recourse or as a direct credit substitute, and assessed the 
appropriate risk-based capital charge in accordance with section 4 
of this appendix.
    (B) Eligible asset-backed commercial paper liquidity facility. 
Except as provided in section 3(c)(1)(vi)(C) of this appendix D, in 
order for the unused portion of an asset-backed commercial paper 
liquidity facility to be eligible for either the 50 percent or 10 
percent credit conversion factors under sections 3(c)(1)(ii)(B) or 
3(c)(1)(iv)(A) of this appendix D, the asset-backed commercial paper 
liquidity facility must satisfy the following criteria:
    (1) At the time of draw, the asset-backed commercial paper 
liquidity facility must be subject to an asset quality test that:
    (i) Precludes funding of assets that are 90 days or more past 
due or in default; and
    (ii) If the assets that an asset-backed commercial paper 
liquidity facility is required to fund are externally rated 
securities at the time they are transferred into the program, the 
asset-backed commercial paper liquidity facility must be used to 
fund only securities that are externally rated investment grade at 
the time of funding. If the assets are not externally rated at the 
time they are transferred into the program, then they are not 
subject to this investment grade requirement.
    (2) The asset-backed commercial paper liquidity facility must 
provide that, prior to any draws, the bank's funding obligation is 
reduced to cover only those assets that satisfy the funding criteria 
under the asset quality test as provided in section 
3(c)(1)(vi)(B)(1) of this appendix D.
    (C) Exception to eligibility requirements for assets guaranteed 
by the United States Government or its agencies, or the central 
government of an OECD country. Notwithstanding the eligibility 
requirements for asset-backed commercial paper program liquidity 
facilities in section 3(c)(1)(vi)(B), the unused portion of an 
asset-backed commercial paper liquidity facility may still qualify 
for either the 50 percent or 10 percent credit conversion factors 
under sections 3(c)(1)(ii)(B) or 3(c)(1)(iv)(A) of this appendix D, 
if the assets required to be funded by the asset-backed commercial 
paper liquidity facility are guaranteed, either conditionally or 
unconditionally, by the United States Government or its agencies, or 
the central government of an OECD country.
    (vii) Derivative contracts. (A) Calculation of credit equivalent 
amounts. The credit equivalent amount of a derivative contract 
equals the sum of the current credit exposure and the potential 
future credit exposure of the derivative contract. The calculation 
of credit equivalent amounts must be measured in U.S. dollars, 
regardless of the currency or currencies specified in the derivative 
contract.
    (1) Current credit exposure. The current credit exposure for a 
single derivative contract is determined by the mark-to-market value 
of the derivative contract. If the mark-to-market value is positive, 
then the current credit exposure equals that mark-to-market value. 
If the mark-to-market is zero or negative, then the current credit 
exposure is zero. The current credit exposure for multiple 
derivative contracts executed with a single counterparty and subject 
to a qualifying bilateral netting contract is determined as provided 
by section 3(c)(1)(vii)(B) of this appendix D.
    (2) Potential future credit exposure. The potential future 
credit exposure for a single derivative contract, including a 
derivative contract with negative mark-to-market value, is 
calculated by multiplying the notional principal \15\ of the 
derivative contract by one of the credit conversion factors in Table 
5 of this appendix D, for the appropriate category.\16\ The 
potential future credit exposure for gold contracts shall be 
calculated using the foreign exchange rate conversion factors. For 
any derivative contract that does not fall within one of the 
specified categories in Table 5 of this appendix D, the potential 
future credit exposure shall be calculated using the other commodity 
conversion factors. Subject to examiner review, banks should use the 
effective rather than the apparent or stated notional amount in 
calculating the potential future credit exposure. The potential 
future credit exposure for multiple derivatives contracts executed 
with a single counterparty and subject to a qualifying bilateral 
netting contract is determined as provided by section 
3(c)(1)(vii)(B)(1) of this appendix D.
---------------------------------------------------------------------------

    \15\ For purposes of calculating either the potential future 
credit exposure under section 3(c)(1)(vii)(A)(2) of this appendix D 
or the gross potential future credit exposure under section 
3(c)(1)(vii)(B)(1)(ii) of this appendix D for foreign exchange 
contracts and other similar contracts in which the notional 
principal is equivalent to the cash flows, total notional principal 
is the net receipts to each party falling due on each value date in 
each currency.
    \16\ No potential future credit exposure is calculated for 
single currency interest rate swaps in which payments are made based 
upon two floating indices, so-called floating/floating or basis 
swaps; the credit equivalent amount is measured solely on the basis 
of the current credit exposure.

                                     Table 5.--Conversion Factor Matrix \1\
----------------------------------------------------------------------------------------------------------------
                                                      Foreign
                                   Interest rate   exchange rate    Equity (in       Precious          Other
     Remaining maturity \2\        (in percent)    and gold (in      percent)       metals (in     commodity (in
                                                     percent)                        percent)        percent)
----------------------------------------------------------------------------------------------------------------
One year or less................             0.0             1.0             6.0             7.0            10.0
Over one year to five...........             0.5             5.0             8.0             7.0            12.0
Over five years.................             1.5             7.5            10.0             8.0            15.0
----------------------------------------------------------------------------------------------------------------
\1\ For derivative contracts with multiple exchanges of principal, the conversion factors are multiplied by the
  number of remaining payments in the derivative contract.
\2\ For derivative contracts that automatically reset to zero value following a payment, the remaining maturity
  equals the time until the next payment. However, interest rate contracts with remaining maturities of greater
  than one year shall be subject to a minimum conversion factor of 0.5 percent.

    (B) Derivative contracts subject to a qualifying bilateral 
netting contract. (1) Netting calculation. The credit equivalent 
amount for multiple derivative contracts executed with a single 
counterparty and subject to a qualifying bilateral netting contract 
as provided by section (3)(c)(1)(vii)(B)(2) of this appendix D is 
calculated by adding the net current credit exposure and the 
adjusted sum of the potential future credit exposure for all 
derivative contracts subject to the qualifying bilateral netting 
contract.
    (i) Net current credit exposure. The net current credit exposure 
is the net sum of all positive and negative mark-to-market values of 
the individual derivative contracts subject to a qualifying 
bilateral netting contract. If the net sum of the mark-to-market 
value is positive, then the net current credit exposure equals that 
net sum of the mark-to-market value. If the net sum of the mark-to-
market value is zero or negative, then the net current credit 
exposure is zero.
    (ii) Adjusted sum of the potential future credit exposure. The 
adjusted sum of the potential future credit exposure is calculated 
as:

    A<INF>net</INF>=0.4xA<INF>gross</INF>+(0.6xNGRxA<INF>gross</INF>)


    A<INF>net</INF> is the adjusted sum of the potential future 
credit exposure, A<INF>gross</INF> is the gross potential future 
credit exposure, and NGR is the net to gross ratio. 
A<INF>gross</INF> is the sum of the potential future credit exposure 
(as determined under section 3(c)(1)(vii)(A)(2) of this appendix D) 
for each individual derivative contract subject to the qualifying 
bilateral netting contract. The NGR is the ratio of the net current 
credit exposure to the gross current credit exposure. In calculating

[[Page 77479]]

the NGR, the gross current credit exposure equals the sum of the 
positive current credit exposures (as determined under section 
3(c)(1)(vii)(A)(1) of this appendix D) of all individual derivative 
contracts subject to the qualifying bilateral netting contract.
    (2) Qualifying bilateral netting contract. In determining the 
current credit exposure for multiple derivative contracts executed 
with a single counterparty, a bank may net derivative contracts 
subject to a qualifying bilateral netting contract by offsetting 
positive and negative mark-to-market values, provided that:
    (i) The qualifying bilateral netting contract is in writing.
    (ii) The qualifying bilateral netting contract is not subject to 
a walkaway clause.
    (iii) The qualifying bilateral netting contract creates a single 
legal obligation for all individual derivative contracts covered by 
the qualifying bilateral netting contract. In effect, the qualifying 
bilateral netting contract must provide that the bank would have a 
single claim or obligation either to receive or to pay only the net 
amount of the sum of the positive and negative mark-to-market values 
on the individual derivative contracts covered by the qualifying 
bilateral netting contract. The single legal obligation for the net 
amount is operative in the event that a counterparty, or a 
counterparty to whom the qualifying bilateral netting contract has 
been assigned, fails to perform due to any of the following events: 
default, insolvency, bankruptcy, or other similar circumstances.
    (iv) The bank obtains a written and reasoned legal opinion(s) 
that represents, with a high degree of certainty, that in the event 
of a legal challenge, including one resulting from default, 
insolvency, bankruptcy, or similar circumstances, the relevant court 
and administrative authorities would find the bank's exposure to be 
the net amount under:
    (A) The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities, and if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    (B) The law of the jurisdiction that governs the individual 
derivative contracts covered by the bilateral netting contract; and
    (C) The law of the jurisdiction that governs the qualifying 
bilateral netting contract.
    (v) The bank establishes and maintains procedures to monitor 
possible changes in relevant law and to ensure that the qualifying 
bilateral netting contract continues to satisfy the requirement of 
this section.
    (vi) The bank maintains in its files documentation adequate to 
support the netting of a derivative contract.\17\
---------------------------------------------------------------------------

    \17\ By netting individual derivative contracts for the purpose 
of calculating its credit equivalent amount, a bank represents that 
documentation adequate to support the netting of a set of derivative 
contract is in the bank's files and available for inspection by the 
OCC. Upon determination by the OCC that a bank's files are 
inadequate or that a qualifying bilateral netting contract may not 
be legally enforceable in any one of the bodies of law described in 
sections 3(c)(1)(vii)(B)(2)(i) through (iii) of this appendix D, the 
underlying derivative contracts may not be netted for the purposes 
of this section.
---------------------------------------------------------------------------

    (C) Risk weighting. Once the bank determines the credit 
equivalent amount for a derivative contract or a set of derivative 
contracts subject to a qualifying bilateral netting contract, the 
bank assigns that amount to the risk weight category appropriate to 
the counterparty, or, if relevant, the nature of any collateral or 
guarantee.\18\
---------------------------------------------------------------------------

    \18\ Derivative contracts are an exception to the general rule 
of applying collateral and guarantees to the face value of off-
balance sheet items. The sufficiency of collateral and guarantees is 
determined on the basis of the credit equivalent amount of 
derivative contracts. However, collateral and guarantees held 
against a qualifying bilateral netting contract is not recognized 
for capital purposes unless it is legally available for all 
contracts included in the qualifying bilateral netting contract.
---------------------------------------------------------------------------

    (D) Exceptions. The following derivative contracts are not 
subject to the above calculation, and therefore, are not part of the 
denominator of a national bank's risk-based capital ratio:
    (1) An exchange rate contract with an original maturity of 14 
calendar days or less; \19\ and
---------------------------------------------------------------------------

    \19\ Notwithstanding section 3(c)(1)(v)(A) of this appendix D, 
gold contracts do not qualify for this exception.
---------------------------------------------------------------------------

    (2) A derivative contract that is traded on an exchange 
requiring the daily payment of any variations in the market value of 
the contract.

Section 4. Securitizations.

    (a) Credit equivalent amounts and risk weights of recourse 
obligations and direct credit substitutes. (1) Credit-equivalent 
amount. Except as otherwise provided, the credit-equivalent amount 
for a recourse obligation or direct credit substitute is the full 
amount of the credit-enhanced assets for which the bank directly or 
indirectly retains or assumes credit risk multiplied by a 100 
percent conversion factor.
    (2) Risk-weight factor. To determine the bank's risk-weighted 
assets for off-balance sheet recourse obligations and direct credit 
substitutes, the credit equivalent amount is assigned to the risk 
category appropriate to the obligor in the underlying transaction, 
after considering any associated guarantees or collateral. For a 
direct credit substitute that is an on-balance sheet asset (e.g., a 
purchased subordinated security), a bank must calculate risk-
weighted assets using the amount of the direct credit substitute and 
the full amount of the assets it supports, i.e., all the more senior 
positions in the structure.
    (b) Credit equivalent amount and risk weight of participations 
in, and syndications of, direct credit substitutes. The credit 
equivalent amount for a participation interest in, or syndication 
of, a direct credit substitute is calculated and risk weighted as 
follows:
    (1) In the case of a direct credit substitute in which a bank 
has conveyed a risk participation, the full amount of the assets 
that are supported by the direct credit substitute is converted to a 
credit equivalent amount using a 100 percent conversion factor. The 
pro rata share of the credit equivalent amount that has been 
conveyed through a risk participation is then assigned to whichever 
risk-weight category is lower: the risk-weight category appropriate 
to the obligor in the underlying transaction, after considering any 
associated guarantees or collateral, or the risk-weight category 
appropriate to the party acquiring the participation. The pro rata 
share of the credit equivalent amount that has not been participated 
out is assigned to the risk-weight category appropriate to the 
obligor after considering any associated guarantees or collateral.
    (2) In the case of a direct credit substitute in which the bank 
has acquired a risk participation, the acquiring bank's pro rata 
share of the direct credit substitute is multiplied by the full 
amount of the assets that are supported by the direct credit 
substitute and converted using a 100 percent credit conversion 
factor. The resulting credit equivalent amount is then assigned to 
the risk-weight category appropriate to the obligor in the 
underlying transaction, after considering any associated guarantees 
or collateral.
    (3) In the case of a direct credit substitute that takes the 
form of a syndication where each bank or participating entity is 
obligated only for its pro rata share of the risk and there is no 
recourse to the originating entity, each bank's credit equivalent 
amount will be calculated by multiplying only its pro rata share of 
the assets supported by the direct credit substitute by a 100 
percent conversion factor. The resulting credit equivalent amount is 
then assigned to the risk-weight category appropriate to the obligor 
in the underlying transaction, after considering any associated 
guarantees or collateral.
    (c) Externally rated positions: credit-equivalent amounts and 
risk weights. (1) Traded positions. With respect to a recourse 
obligation, direct credit substitute, residual interest (other than 
a credit-enhancing interest-only strip) or asset-or mortgage-backed 
security that is a ``traded position'' and that has received an 
external rating on a long-term position that is one grade below 
investment grade or better or a short-term position that is 
investment grade, the bank may multiply the face amount of the 
position by the appropriate risk weight, determined in accordance 
with Table 6 or Table 7 of this appendix D.\20\ If a traded position 
receives more than one external rating, the lowest single rating 
will apply.
---------------------------------------------------------------------------

    \20\ Stripped mortgage-backed securities or other similar 
instruments, such as interest-only or principal-only strips, that 
are not credit enhancing must be assigned to the 100 percent risk 
category.

[[Page 77480]]



Table 6.--Risk Weights Based on External Ratings for Long-Term Exposures
 
------------------------------------------------------------------------
                                                            Risk weight
  Long-term rating category            Examples            (in percent)
------------------------------------------------------------------------
Highest investment grade....  AAA.......................              20
Second highest investment     AA........................              20
 grade.
Third highest investment      A.........................              35
 grade.
Lowest investment grade--     BBB+......................              50
 plus.
Lowest investment grade.....  BBB.......................              75
Lowest-investment grade--     BBB-......................             100
 minus.
One category below            BB+, BB...................             200
 investment grade.
One category below            BB-.......................             200
 investment grade--minus.
------------------------------------------------------------------------


     Table 7.--Risk Weights Based on External Ratings for Short-Term
                                Exposures
 
------------------------------------------------------------------------
                                                            Risk Weight
 Short-term rating category            Examples            (in percent)
------------------------------------------------------------------------
Highest investment grade....  A-1, P-1..................              20
Second highest investment     A-2, P-2..................              35
 grade.
Lowest investment grade.....  A-3, P-3..................              75
------------------------------------------------------------------------

    (2) Non-traded positions. A recourse obligation, direct credit 
substitute, residual interest (but not a credit-enhancing interest-
only strip) or asset-or mortgage-backed security extended in 
connection with a securitization that is not a ``traded position'' 
may be assigned a risk weight in accordance with section 4(c)(1) of 
this appendix D if:
    (i) It has been externally rated by more than one NRSRO;
    (ii) It has received an external rating on a long-term position 
that is one category below investment grade or better or a short-
term position that is investment grade by all NRSROs providing a 
rating;
    (iii) The ratings are publicly available; and
    (iv) The ratings are based on the same criteria used to rate 
traded positions.
    If the ratings are different, the lowest rating will determine 
the risk category to which the recourse obligation, residual 
interest or direct credit substitute will be assigned.
    (d) Senior positions not externally rated. For a recourse 
obligation, direct credit substitute, residual interest or asset- or 
mortgage-backed security that is not externally rated but is senior 
or preferred in all features to a traded position (including 
collateralization and maturity), a bank may apply a risk weight to 
the face amount of the senior position in accordance with section 
4(c)(1) of this appendix D, based upon the traded position, subject 
to any current or prospective supervisory guidance and the bank 
satisfying the OCC that this treatment is appropriate. This section 
will apply only if the traded position provides substantive credit 
support to the unrated position until the unrated position matures.
    (e) Residual Interests--(1) Concentration limit on credit-
enhancing interest-only strips. In addition to the capital 
requirement provided by section 4(e)(2) of this appendix D, a bank 
must deduct from Tier 1 capital all credit-enhancing interest-only 
strips in excess of 25 percent of Tier 1 capital in accordance with 
section 2(c)(2)(iv) of appendix A of this part.
    (2) Credit-enhancing interest-only strip capital requirement. 
After applying the concentration limit to credit-enhancing interest-
only strips in accordance with section 4(e)(1) of this appendix D, a 
bank must maintain risk-based capital for a credit-enhancing 
interest-only strip equal to the remaining amount of the credit-
enhancing interest-only strip (net of any existing associated 
deferred tax liability), even if the amount of risk-based capital 
required to be maintained exceeds the full risk-based capital 
requirement for the assets transferred. Transactions that, in 
substance, result in the retention of credit risk associated with a 
transferred credit-enhancing interest-only strip will be treated as 
if the credit-enhancing interest-only strip was retained by the bank 
and not transferred.
    (3) Other residual interests capital requirement. Except as 
provided in sections 3(d) or (e) of this appendix D, a bank must 
maintain risk-based capital for a residual interest (excluding a 
credit-enhancing interest-only strip) equal to the face amount of 
the residual interest that is retained on the balance sheet (net of 
any existing associated deferred tax liability), even if the amount 
of risk-based capital required to be maintained exceeds the full 
risk-based capital requirement for the assets transferred. 
Transactions that, in substance, result in the retention of credit 
risk associated with a transferred residual interest will be treated 
as if the residual interest was retained by the bank and not 
transferred.
    (4) Residual interests and other recourse obligations. Where the 
aggregate capital requirement for residual interests (including 
credit-enhancing interest-only strips) and recourse obligations 
arising from the same transfer of assets exceed the full risk-based 
capital requirement for those assets, a bank must maintain risk-
based capital equal to the greater of the risk-based capital 
requirement for the residual interest as calculated under section 
4(e)(1)-(3) of this appendix D or the full risk-based capital 
requirement for the assets transferred.
    (f) Positions that are not rated by an NRSRO. A position (but 
not a residual interest) extended in connection with a 
securitization and that is not rated by an NRSRO may be risk-
weighted based on the bank's determination of the credit rating of 
the position, as specified in Table 8 of this appendix D, multiplied 
by the face amount of the position. In order to qualify for this 
treatment, the bank's system for determining the credit rating of 
the position must meet one of the three alternative standards set 
out in section 4(f)(1)through (3) of this appendix D.

            Table 8.--Risk Weights Based on Internal Ratings
------------------------------------------------------------------------
                                                            Risk weight
       Rating category                 Examples            (in percent)
------------------------------------------------------------------------
Investment grade............  BBB or better.............             100
One category below            BB........................             200
 investment grade.
------------------------------------------------------------------------


[[Page 77481]]

    (1) Internal risk rating used for asset-backed programs. A 
direct credit substitute (but not a purchased credit-enhancing 
interest-only strip) is assumed by a bank in connection with an 
asset-backed commercial paper program sponsored by the bank and the 
bank is able to demonstrate to the satisfaction of the OCC, prior to 
relying upon its use, that the bank's internal credit risk rating 
system is adequate. Adequate internal credit risk rating systems 
usually contain the following criteria:
    (i) The internal credit risk system is an integral part of the 
bank's risk management system that explicitly incorporates the full 
range of risks arising from a bank's participation in securitization 
activities;
    (ii) Internal credit ratings are linked to measurable outcomes, 
such as the probability that the position will experience any loss, 
the position's expected loss given default, and the degree of 
variance in losses given default on that position;
    (iii) The bank's internal credit risk system must separately 
consider the risk associated with the underlying loans or borrowers, 
and the risk associated with the structure of a particular 
securitization transaction;
    (iv) The bank's internal credit risk system must identify 
gradations of risk among ``pass'' assets and other risk positions;
    (v) The bank must have clear, explicit criteria that are used to 
classify assets into each internal risk grade, including subjective 
factors;
    (vi) The bank must have independent credit risk management or 
loan review personnel assigning or reviewing the credit risk 
ratings;
    (vii) An internal audit procedure should periodically verify 
that internal risk ratings are assigned in accordance with the 
bank's established criteria;
    (viii) The bank must monitor the performance of the internal 
credit risk ratings assigned to nonrated, nontraded direct credit 
substitutes over time to determine the appropriateness of the 
initial credit risk rating assignment and adjust individual credit 
risk ratings, or the overall internal credit risk ratings system, as 
needed; and
    (ix) The internal credit risk system must make credit risk 
rating assumptions that are consistent with, or more conservative 
than, the credit risk rating assumptions and methodologies of 
NRSROs.
    (2) Program Ratings. A direct credit substitute or recourse 
obligation (but not a residual interest) is assumed or retained by a 
bank in connection with a structured finance program and a NRSRO has 
reviewed the terms of the program and stated a rating for positions 
associated with the program. If the program has options for 
different combinations of assets, standards, internal credit 
enhancements and other relevant factors, and the NRSRO specifies 
ranges of rating categories to them, the bank may apply the rating 
category applicable to the option that corresponds to the bank's 
position. In order to rely on a program rating, the bank must 
demonstrate to the OCC's satisfaction that the credit risk rating 
assigned to the program meets the same standards generally used by 
NRSROs for rating traded positions. The bank must also demonstrate 
to the OCC's satisfaction that the criteria underlying the NRSRO's 
assignment of ratings for the program are satisfied for the 
particular position. If a bank participates in a securitization 
sponsored by another party, the OCC may authorize the bank to use 
this approach based on a program rating obtained by the sponsor of 
the program.
    (3) Computer Program. The bank is using an acceptable credit 
assessment computer program to determine the rating of a direct 
credit substitute or recourse obligation (but not a residual 
interest) extended in connection with a structured finance program. 
A NRSRO must have developed the computer program and the bank must 
demonstrate to the OCC's satisfaction that ratings under the program 
correspond credibly and reliably with the rating of traded 
positions.
    (g) Limitations on risk-based capital requirements. (1) Low-
level exposure rule. If the maximum contractual exposure to loss 
retained or assumed by a bank is less than the effective risk-based 
capital requirement, as determined in accordance with section 4(a) 
of this appendix D, for the asset supported by the bank's position, 
the risk based capital required under this appendix D is limited to 
the bank's contractual exposure, less any recourse liability account 
established in accordance with generally accepted accounting 
principles. This limitation does not apply when a bank provides 
credit enhancement beyond any contractual obligation to support 
assets that it has sold.
    (2) Related on-balance sheet assets. If an asset is included in 
the calculation of the risk-based capital requirement under this 
section 4 of this appendix D and also appears as an asset on a 
bank's balance sheet, the asset is risk-weighted only under this 
section 4 of this appendix D, except in the case of loan servicing 
assets and similar arrangements with embedded recourse obligations 
or direct credit substitutes. In that case, both the on-balance 
sheet servicing assets and the related recourse obligations or 
direct credit substitutes must both be separately risk weighted and 
incorporated into the risk-based capital calculation.
    (h) Alternative Capital Calculation for Small Business 
Obligations. (1) Definitions. For purposes of this section 4(h):
    Qualified bank means a bank that:
    (A) Is well capitalized as defined in 12 CFR 6.4 without 
applying the capital treatment described in this section 4(h), or
    (B) Is adequately capitalized as defined in 12 CFR 6.4 without 
applying the capital treatment described in this section 4(h) and 
has received written permission from the appropriate district office 
of the OCC to apply the capital treatment described in this section 
4(h).
    Recourse has the meaning given to such term under generally 
accepted accounting principles.
    Small business means a business that meets the criteria for a 
small business concern established by the Small Business 
Administration in 13 CFR part 121 pursuant to 15 U.S.C. 632.
    (2) Capital and reserve requirements. Notwithstanding the risk-
based capital treatment outlined in section 2(c)(4) and any other 
paragraph (other than paragraph (h)) of this section 4, with respect 
to a transfer of a small business loan or a lease of personal 
property with recourse that is a sale under generally accepted 
accounting principles, a qualified bank may elect to apply the 
following treatment:
    (i) The bank establishes and maintains a non-capital reserve 
under generally accepted accounting principles sufficient to meet 
the reasonable estimated liability of the bank under the recourse 
arrangement; and
    (ii) For purposes of calculating the bank's risk-based capital 
ratio, the bank includes only the face amount of its recourse in its 
risk-weighted assets.
    (3) Limit on aggregate amount of recourse. The total outstanding 
amount of recourse retained by a qualified bank with respect to 
transfers of small business loans and leases of personal property 
and included in the risk-weighted assets of the bank as described in 
section 4(h)(2) of this appendix D may not exceed 15 percent of the 
bank's total capital after adjustments and deductions, unless the 
OCC specifies a greater amount by order.
    (4) Bank that ceases to be qualified or that exceeds aggregate 
limit. If a bank ceases to be a qualified bank or exceeds the 
aggregate limit in section 4(h)(3) of this appendix D, the bank may 
continue to apply the capital treatment described in section 4(h)(2) 
of this appendix D to transfers of small business loans and leases 
of personal property that occurred when the bank was qualified and 
did not exceed the limit.
    (5) Prompt Corrective Action not affected. (i) A bank shall 
compute its capital without regard to this section 4(h) for purposes 
of prompt corrective action (12 U.S.C. 1831o and 12 CFR part 6) 
unless the bank is an adequately or well capitalized bank (without 
applying the capital treatment described in this section 4(h)) and, 
after applying the capital treatment described in this section 4(h), 
the bank would be well capitalized.
    (ii) A bank shall compute its capital without regard to this 
section 4(h) for purposes of 12 U.S.C. 1831o(g) regardless of the 
bank's capital level.
    (i) Additional capital charge for revolving securitizations with 
an early amortization trigger. A bank that securitizes revolving 
credits where the securitization structure contains an early 
amortization provision must maintain risk-based capital against the 
investors' interest as required under this section.
    (1) Capital for securitizations of revolving credit exposures 
that incorporate early-amortization provisions will be assessed 
based on a comparison of the securitization's annualized three-month 
average excess spread against the excess spread trapping point.
    (2) To calculate the securitization's excess spread trapping 
point ratio:
    (i) A bank must first calculate the annualized three month ratio 
for excess spread as follows:
    (A) For each of the three months, divide the month's excess 
spread by the outstanding principal balance of the underlying pool 
of exposures at the end of each month.

[[Page 77482]]

    (B) Calculate the average ratio for the three months, then 
convert the result to a compound annual rate.
    (ii) Then the bank must divide the annualized three month ratio 
for excess spread by the excess spread trapping point that is 
specified in the documentation for the securitization.
    (3) Banks shall compare the excess spread trapping point ratio 
to the ratios contained in Table 9 in appendix D to determine the 
appropriate conversion factor to apply to the investor's interest. 
The amount of investor's interest after conversion is then assigned 
to a risk-weight category in accordance with that appropriate to the 
underlying obligor, collateral, or guarantor. For securitizations 
that do not require excess spread to be trapped, or that specify 
trapping points based primarily on performance measures other than 
the three-month average excess spread, the excess spread trapping 
point is 4.5 percent.

         Table 9.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
                                                             CCF  (in
              3-month average excess spread                  percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more................               0
Less than 133.33 percent to 100 percent of trapping                    5
 point..................................................
Less than 100 percent to 75 percent of trapping point...              15
Less than 75 percent to 50 percent of trapping point....              50
Less than 50 percent of trapping point..................             100
------------------------------------------------------------------------

    (4) Limitations on risk-based capital requirements. For a bank 
subject to the early amortization requirements in this section, the 
total risk-based capital requirement for all of the bank's exposures 
to a securitization of revolving retail credits is limited to the 
greater of the risk-based capital requirement for residual interests 
plus any early amortization charges as described in this section 
4(i), or the risk-based capital requirement for the underlying 
securitized assets calculated as if the bank continued to hold the 
assets on its balance sheet.

Section 5. Target Ratios

    (a) All national banks are expected to maintain a minimum ratio 
of total capital (after deductions) to risk-weighted assets of 8.0 
percent.
    (b) Tier 2 capital elements qualify as part of a national bank's 
total capital base up to a maximum of 100 percent of that bank's 
Tier 1 capital.
    (c) In addition to the standards established by these risk-based 
capital guidelines, all national banks must maintain a minimum 
capital-to-total assets ratio in accordance with the provisions of 
12 CFR part 3.

Federal Reserve System

12 CFR Chapter II

Authority and Issuance

    For the reasons set forth in the joint preamble, the Board of 
Governors of the Federal Reserve System proposes to amend parts 208 and 
225 of chapter II of title 12 of the Code of Federal Regulations as 
follows:

PART 208--MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE FEDERAL 
RESERVE SYSTEM (REGULATION H)

    1. The authority citation for part 208 continues to read as 
follows:

    Authority: 12 U.S.C. 24, 36, 92a, 93a, 248(a), 248(c), 321-338a, 
371d, 461, 481-486, 601, 611, 1814, 1816, 1818, 1820(d)(9), 1823(j), 
1828(o), 1831, 1831o, 1831p-1, 1831r-1, 1831w, 1831x, 1835a, 1882, 
2901-2907, 3105, 3310, 3331-3351, and 3906-3909; 15 U.S.C. 78b, 
78l(b), 78l(g), 78l(i), 78o-4(c)(5), 78q, 78q-1, and 78w; 31 U.S.C. 
5318; 42 U.S.C. 4012a, 4104a, 4104b, 4106, and 4128.

    2. In appendix A to part 208, the following amendments are 
proposed:
    a. Section I, Overview, is revised.
    b. In section II, Definition of Qualifying Capital for the Risk-
Based Capital Ratio, the first paragraph is revised.
    c. In section III.A, Procedures, the first paragraph is revised, 
the fifth paragraph is redesignated as the sixth paragraph, and a new 
fifth paragraph is added.
    d. In section III.C, the first paragraph is revised.
    e. Section IV is removed and a new section IV, Alternative Approach 
for Computing Weighted Risk Assets and Off-Balance-Sheet Items, is 
added.
    f. Attachment I is removed.

Appendix A To Part 208--Capital Adequacy Guidelines For State Member 
Banks: Risk-Based Measure

I. Overview

    The Board of Governors of the Federal Reserve System has adopted 
a risk-based capital measure to assist in the assessment of the 
capital adequacy of state member banks.\1\ The principal objectives 
of this measure are to: (i) Make regulatory capital requirements 
more sensitive to differences in risk profiles among banks; (ii) 
factor off-balance sheet exposures into the assessment of capital 
adequacy; (iii) minimize disincentives to holding liquid, low-risk 
assets; and (iv) achieve greater consistency in the evaluation of 
the capital adequacy of major banks throughout the world.\2\
---------------------------------------------------------------------------

    \1\ A leverage capital measure for state member banks is 
outlined in appendix B of this part.
    \2\ The risk-based capital measure is based upon a framework 
developed jointly by supervisory authorities from the countries 
represented on the Basel Committee on Banking Supervision (Basel 
Supervisors' Committee) and endorsed by the Group of Ten Central 
Bank Governors. The framework is described in a paper prepared by 
the Basel Supervisors' Committee entitled ``International 
Convergence of Capital Measurement,'' July 1988.
---------------------------------------------------------------------------

    The risk-based capital guidelines include both a definition of 
capital and a framework for calculating weighted risk assets by 
assigning assets and off-balance sheet items to broad risk 
categories. A bank's risk-based capital ratio is calculated by 
dividing its qualifying capital (the numerator of the ratio) by its 
weighted risk assets (the denominator).\3\ The definition of 
qualifying capital is outlined in section II, and the procedures for 
calculating weighted risk assets are discussed in sections III and 
IV.
---------------------------------------------------------------------------

    \3\ Banks will initially be expected to utilize period-end 
amounts in calculating their risk-based capital ratios. When 
necessary and appropriate, ratios based on average balances may also 
be calculated on a case-by-case basis. Moreover, to the extent banks 
have data on average balances that can be used to calculate risk-
based ratios, the Federal Reserve will take such data into account.
---------------------------------------------------------------------------

    In addition, when certain banks that engage in trading 
activities calculate their risk-based capital ratios under this 
appendix A, they must also refer to appendix E of this part, which 
incorporates capital charges for certain market risks into the risk-
based capital ratios. When calculating their risk-based capital 
ratios under this appendix A, such banks are required to refer to 
appendix E of this part for supplemental rules to determine 
qualifying and excess capital, calculate weighted risk assets, 
calculate market risk equivalent assets, and calculate risk-based 
capital ratios adjusted for market risk.
    The risk-based capital guidelines apply to all state member 
banks on a consolidated basis. They are to be used in the 
examination and supervisory process as well as in the analysis of 
applications acted upon by the Federal Reserve. Thus, in considering 
an application filed by a state member bank, the Federal Reserve 
will take into account the bank's risk-based capital ratios, the 
reasonableness of its capital plans, and the extent to which it 
meets the risk-based capital standards.
    The risk-based capital ratios focus principally on broad 
categories of credit risk, although the framework for assigning 
assets and off-balance-sheet items to risk categories does 
incorporate elements of transfer risk, as well as limited instances 
of interest rate and market risk. The framework incorporates risks 
arising from traditional banking

[[Page 77483]]

activities as well as risks arising from nontraditional activities. 
The risk-based capital ratios do not, however, incorporate other 
factors that can affect an institution's financial condition. These 
factors include overall interest-rate exposure; liquidity, funding 
and market risks; the quality and level of earnings; investment, 
loan portfolio, and other concentrations of credit; certain risks 
arising from nontraditional activities; the quality of loans and 
investments; the effectiveness of loan and investment policies; and 
management's overall ability to monitor and control financial and 
operating risks, including the risks presented by concentrations of 
credit and nontraditional activities.
    In addition to evaluating capital ratios, an overall assessment 
of capital adequacy must take account of those factors, including, 
in particular, the level and severity of problem and classified 
assets as well as a bank's exposure to declines in the economic 
value of its capital due to changes in interest rates. For this 
reason, the final supervisory judgment on a bank's capital adequacy 
may differ significantly from conclusions that might be drawn solely 
from the level of its risk-based capital ratios.
    The risk-based capital guidelines establish a minimum ratio of 
qualifying total capital to weighted risk assets of 8 percent, of 
which at least 4 percentage points must be in the form of tier 1 
capital. In light of the considerations just discussed, banks 
generally are expected to operate well above the minimum risk-based 
ratios. In particular, banks contemplating significant expansion 
proposals are expected to maintain strong capital levels 
substantially above the minimum ratios and should not allow 
significant diminution of financial strength below these strong 
levels to fund their expansion plans. Institutions with high or 
inordinate levels of risk are also expected to operate well above 
minimum capital standards. In all cases, institutions should hold 
capital commensurate with the level and nature of the risks to which 
they are exposed. Banks that do not meet the minimum risk-based 
capital standard, or that are otherwise considered to be 
inadequately capitalized, are expected to develop and implement 
plans acceptable to the Federal Reserve for achieving adequate 
levels of capital within a reasonable period of time.
    The Board will monitor the implementation and effect of these 
guidelines in relation to domestic and international developments in 
the banking industry. When necessary and appropriate, the Board will 
consider the need to modify the guidelines in light of any 
significant changes in the economy, financial markets, banking 
practices, or other relevant factors.

II. * * *

    A bank's qualifying total capital consists of two types of 
capital components: ``core capital elements'' (comprising tier 1 
capital) and ``supplementary capital elements'' (comprising tier 2 
capital). These capital elements and the various limits, 
restrictions, and deductions to which they are subject, are 
discussed in this section II.
* * * * *

III. * * *

A. * * *

    Assets and credit-equivalent amounts of off-balance-sheet items 
of state member banks are assigned to one of several broad risk 
categories, according to the obligor, or, if relevant, the 
guarantor, the nature of the collateral, or an external rating. The 
aggregate dollar value of the amount in each category is then 
multiplied by the risk weight associated with the category. The 
resulting weighted values from each of the risk categories are added 
together, and this sum is the bank's total weighted risk assets that 
comprise the denominator of the risk-based capital ratios.
* * * * *
    A bank may elect to apply the alternative procedures for 
computing weighted risk assets set forth in section IV of this 
appendix A (``Alternative Approach''). The Federal Reserve also may 
require a bank to apply the Alternative Approach if the Federal 
Reserve determines that the Alternative Approach would produce risk-
based capital requirements that more accurately reflect the risk 
profile of the bank or would otherwise enhance the safety and 
soundness of the bank. A bank that applies the Alternative Approach 
must apply all the procedures set forth in section IV of this 
appendix A and also must apply all the procedures set forth in this 
section that are not inconsistent with the procedures in section IV.
* * * * *

C. * * *

    Assets and on-balance-sheet credit equivalent amounts are 
assigned to the following risk weight categories: 0 percent, 20 
percent, 50 percent, or 100 percent. A brief explanation of the 
components of each category follows.
* * * * *

IV. Alternative Approach for Computing Weighted Risk Assets and 
Off-Balance-sheet Items

A. Scope of Application

    A bank may elect to use the Alternative Approach for computing 
weighted risk assets and off-balance sheet items set forth in this 
section IV by giving the Federal Reserve written notice on the first 
day of the quarter during which the bank elects to begin using the 
Alternative Approach. A bank that has elected to apply the 
Alternative Approach may opt out of the Alternative Approach after 
it has given the Federal Reserve 30 days prior written notice. The 
Federal Reserve may require a bank to apply the Alternative Approach 
if the Federal Reserve determines that the Alternative Approach 
would produce risk-based capital requirements that more accurately 
reflect the risk profile of the bank or would otherwise enhance the 
safety and soundness of the bank.
    A bank that applies the Alternative Approach must apply all the 
procedures set forth in this section IV and also must apply all the 
procedures set forth in section III that are not inconsistent with 
the procedures in section IV.

B. External Ratings, Collateral, Guarantees, and Other Considerations

    1. External Credit Ratings. A bank must use Table 1 in this 
section IV.B.1. to assign risk weights to covered claims with an 
original maturity of one year or more and Table 2 in this section 
IV.B.1. to assign risk weights to covered claims with an original 
maturity of less than one year. Covered claims are all claims other 
than (i) claims on an excluded entity, (ii) loans to non-sovereigns 
that do not have an external rating, and (iii) OTC derivative 
contracts. Excluded entities are (i) the U.S. central government and 
U.S. government agencies, (ii) state and local governments of the 
United States and other countries of the OECD, (iii) U.S. 
government-sponsored agencies, and (iv) U.S. depository institutions 
and foreign banks.
    A bank must use column three of the tables for covered claims on 
a non-U.S. sovereign \58\ and column four of the tables for covered 
claims on an entity other than a non-U.S. sovereign (excluding 
securitization exposures). A bank must use column five of the tables 
for covered claims that are securitization exposures, which include 
asset-backed securities, mortgage-backed securities, recourse 
obligations, direct credit substitutes, and residual interests 
(other than credit-enhancing interest-only strips).
---------------------------------------------------------------------------

    \58\ For purposes of this section IV, a sovereign is defined as 
a central government, including its agencies, departments, 
ministries, and the central bank. This definition does not include 
state, provincial, or local governments, or commercial enterprises 
owned by a central government.

                           Table 1.--Risk Weights Based on Long-Term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                     Non-U.S.                     Securitization
                                                                  sovereign risk   Non-sovereign   exposure risk
      Long-term rating category                  Rating               weight        risk weight       weight
                                                                     (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating......  AAA......................               0              20              20
Second-highest investment grade        AA.......................              20              20              20
 rating.
Third-highest investment grade rating  A........................              20              35              35
Lowest investment grade rating--plus.  BBB+.....................              35              50              50

[[Page 77484]]

 
Lowest investment grade rating--       BBB......................              50              75              75
 naught.
Lowest investment grade rating--       BBB-.....................              75             100             100
 negative.
One category below investment grade--  BB+, BB..................              75             150             200
 plus & naught.
One category below investment grade--  BB-......................             100             200             200
 negative.
Two or more categories below           B, CCC...................             150             200             \2\
 investment grade.
Unrated..............................  n/a......................             200             200             \2\
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 percent risk weight
  category.
\2\ Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A.


                           Table 2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                     Non-U.S.        Non-U.S.
                                                                  sovereign risk  sovereign risk  Securitization
      Short-term rating category                Examples              weight*          weigh       exposure risk
                                                                     (percent)       (percent)        weight
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\..  A-1, P-1.................               0              20              20
Second-highest investment grade        A-2, P-2.................              20              35              35
 rating.
Lowest investment grade rating.......  A-3, P-3.................              50              75              75
Unrated..............................  .........................             100             100            100
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight
  category.

    For purposes of this section IV, an external rating is defined 
as a credit rating that is assigned by an NRSRO, provided that the 
credit rating:
    a. Fully reflects the entire amount of credit risk with regard 
to all payments owed on the claim (that is, the rating must fully 
reflect the credit risk associated with timely repayment of 
principal and interest);
    b. Is monitored by the issuing NRSRO;
    c. Is published in an accessible public form (for example, on 
the NRSRO's Web site or in financial media); and
    d. Is, or will be, included in the issuing NRSRO's publicly 
available ratings transition matrix which tracks the performance and 
stability (or ratings migration) of an NRSRO's issued external 
ratings for the specific type of claim (for example, corporate 
debt).
    In addition, an unrated covered claim on a non-U.S. sovereign 
that has an external rating from an NRSRO should be deemed to have 
an external rating equal to the sovereign's issuer rating. If a 
claim has two or more external ratings, the bank must use the least 
favorable external rating to risk weight the claim. Similarly, if a 
claim has components that are assigned different external ratings, 
the lowest component rating must be applied to the entire claim. For 
example, if a securitization exposure has a principal component 
externally rated BBB, but the interest component is externally rated 
B, the entire exposure will be subject to the gross-up treatment 
accorded to a securitization exposure rated B or lower. Similarly, 
if a portion of a specific claim is unrated, then the entire claim 
must be treated as if it were unrated. The Federal Reserve retains 
the authority to override the use of certain ratings or the ratings 
on certain instruments, either on a case-by-case basis or through 
broader supervisory policy, if necessary or appropriate to address 
the risk that an instrument poses to banking organizations.
    2. Collateral. In addition to the forms of recognized financial 
collateral set forth in section III.B.1. of this appendix A, a bank 
also may recognize as collateral (i) covered claims in the form of 
liquid and readily marketable debt securities that are externally 
rated no less than investment grade and (ii) liquid and readily 
marketable debt securities guaranteed by non-U.S. sovereigns whose 
issuer rating is at least investment grade. Claims, or portions of 
claims, collateralized by such collateral may be assigned to the 
risk weight appropriate to the collateral's external rating as set 
forth in Table 1 or 2 of section IV.B.1. For example, the portion of 
a claim collateralized with an AA-rated mortgage-backed security is 
assigned to the 20 percent risk weight category.
    Subject to the final sentence of this paragraph, there is, 
however, a 20 percent risk weight floor on collateralized claims 
under this section IV. Thus, the portion of a claim collateralized 
by a security issued by a non-U.S. sovereign with an issuer rating 
of AAA would be assigned to the 20 percent risk weight category 
instead of the zero percent risk weight category. The procedures set 
forth in section III of this appendix A continue to apply, however, 
to claims collateralized by securities issued or guaranteed by OECD 
central governments for which a positive margin of collateral is 
maintained on a daily basis, fully taking into account any change in 
the bank's exposure to the obligor and counterparty under the claim 
in relation to the market value of the collateral held to support 
the claim.
    In the event that the external rating of a security used to 
collateralize a claim results in a higher risk weight than would 
have otherwise been assigned to the claim, then the lower risk 
weight appropriate to the underlying claim could be applied.
    3. Guarantees. Claims, or portions of claims, guaranteed by a 
third-party entity (other than an excluded entity) whose unsecured 
long-term senior debt (without credit enhancements) is externally 
rated at least investment grade or by a non-U.S. sovereign that has 
an issuer rating of at least investment grade may be assigned to the 
risk weight of the guarantor as set forth in Table 1 of section 
IV.B.1., corresponding to the protection provider's long-term senior 
debt rating (or issuer rating in the case of a non-U.S. sovereign), 
provided that the guarantee:
    a. Is written and unconditional,
    b. Covers all or a pro rata portion of contractual payments of 
the obligor on the underlying claim,
    c. Gives the beneficiary a direct claim against the protection 
provider,
    d. Is non-cancelable by the protection provider for reasons 
other than the breach of contract by the beneficiary,
    e. Is legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced, and
    f. Requires the protection provider to make payment to the 
beneficiary upon default of the obligor on the underlying claim 
without first requiring the beneficiary to demand payment from the 
obligor.

C. Residential Mortgages

    1. A bank may separate its residential mortgage portfolio into 
two subportfolios, where the first subportfolio includes mortgage 
loans originated by the bank or acquired by the bank prior to the 
date the bank becomes subject to this section IV and the second 
includes mortgage loans originated or acquired by the bank after 
that date. The bank may apply the risk-based capital treatment set 
forth in section III of this appendix A to the first subportfolio 
while applying the requirements set forth in

[[Page 77485]]

this section IV to the second subportfolio. A bank that does not so 
separate its residential mortgage portfolio must apply the capital 
treatment in this section IV to all of its qualifying residential 
mortgage exposures. If a bank at any time opts-out of the 
Alternative Approach and, subsequently, again becomes subject to 
this section IV, it may not apply the procedures set forth in this 
section IV.C.1.
    2. Subject to section IV.C.1., a bank assigns its residential 
mortgage exposures to risk weight categories based on their loan-to-
value (LTV) or combined loan-to-value (CLTV) ratios, as appropriate, 
in accordance with Tables 3 and 4 of sections IV.C.3.a. and 
IV.C.3.b., respectively, but must risk-weight a nonqualifying 
residential mortgage exposure at no less than 100 percent. 
Residential mortgage exposures include all loans secured by a lien 
on a one- to four-family residential property \59\ that is either 
owner-occupied or rented. Qualifying residential mortgage exposures 
are residential mortgage exposures that (1) have been made in 
accordance with prudent underwriting standards; (2) are performing 
in accordance with their original terms; (3) are not 90 days or more 
past due or carried in nonaccrual status; and (4) are not made for 
the purpose of speculative property development. Nonqualifying 
residential mortgage exposures are residential mortgage exposures 
other than qualifying residential mortgage exposures.
---------------------------------------------------------------------------

    \59\ Loans that qualify as mortgages that are secured by 1- to 
4-family residential properties are listed in the instructions to 
the commercial bank Call Reports.
---------------------------------------------------------------------------

    3. For purposes of Tables 3 and 4, LTV is defined as (i) the 
current outstanding principal balance of the loan less the amount 
covered by any loan-level private mortgage insurance (``PMI'') 
divided by (ii) the most recent purchase price of the property or 
the most recent appraisal or evaluation value of the property (if 
the appraisal or evaluation is more recent than the most recent 
purchase and was obtained by the bank in connection with an 
extension of new credit). Loan-level PMI means insurance (i) 
provided by a non-affiliated PMI provider whose unsecured long-term 
senior debt (without credit enhancements) is externally rated at 
least the third highest investment grade by an NRSRO, and (ii) which 
protects a mortgage lender in the event of the default of a mortgage 
borrower up to a predetermined portion of the value of a residential 
mortgage exposure. For purposes of the loan-level PMI definition, 
(i) an affiliate of a company means any company that controls, is 
controlled by, or is under common control with, the company; and 
(ii) a person or company controls a company if it owns, controls, or 
has power to vote 25 percent or more of a class of voting securities 
of the company or consolidates the company for financial reporting 
purposes. CLTV for a junior lien mortgage is defined as (i) the 
current outstanding principal balance of the junior mortgage and all 
more senior mortgages less the amount covered by any loan-level PMI 
covering the junior lien divided by (ii) the most recent purchase 
price of the property or the most recent appraisal or evaluation 
value of the property (if the appraisal or evaluation is more recent 
than the most recent purchase and was obtained by the bank in 
connection with an extension of new credit). The procedures for 
residential mortgage exposures that have negative amortization 
features are set forth in section IV.C.3.c.

a. First Lien Residential Mortgage Exposures

    First lien residential mortgage exposures are risk-weighted in 
accordance with Table 3 of this section IV.C.3.a. (with 
nonqualifying residential mortgage exposures subject to a risk 
weight floor of 100 percent). If a bank holds both the senior and 
junior lien(s) on a residential property and no other party holds an 
intervening lien, the bank's claims are treated as a single claim 
secured by a senior lien for purposes of determining the LTV ratio 
and assigning a risk weight.

  Table 3.--Risk Weights for First Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                             Risk weight
                    Loan-to-Value ratio                        (percent)
------------------------------------------------------------------------
Up to 60%..................................................           20
>60% and up to 80%.........................................           35
>80% and up to 85%.........................................           50
>85% and up to 90%.........................................           75
>90% and up to 95%.........................................          100
>95%.......................................................          150
------------------------------------------------------------------------

b. Stand-Alone Junior Liens

    Stand-alone junior lien residential mortgage exposures, 
including structured mortgages and home equity lines of credit, must 
be risk weighted using the CLTV ratio of the stand-alone junior lien 
and all senior liens in accordance with Table 4 (with nonqualifying 
residential mortgage exposures subject to a risk weight floor of 100 
percent).

 Table 4.--Risk Weights for Stand-Alone Junior Lien Residential Mortgage
                                Exposures
------------------------------------------------------------------------
                                                             Risk weight
                Combined Loan-to-Value ratio                   (percent)
------------------------------------------------------------------------
Up to 60%..................................................           75
>60% and up to 90%.........................................          100
>90%.......................................................          150
------------------------------------------------------------------------

c. Residential Mortgage Exposures With Negative Amortization Features

    Residential mortgage exposures with negative amortization 
features are assigned to a risk weight category using a loan's 
current LTV ratio in accordance with Table 3 of section IV.C.3.a. 
Any remaining potential increase in the mortgage's principal balance 
permitted through the negative amortization feature is to be treated 
as a long-term commitment and converted to an on-balance sheet 
credit equivalent amount as set forth in section III.D.2. of this 
appendix. The credit equivalent amount of the commitment is then 
risk-weighted according to Table 3 based on the loan's ``highest 
contractual LTV ratio.'' The highest contractual LTV ratio of a 
mortgage loan equals the current outstanding principal balance of 
the loan plus the credit equivalent amount of the remaining negative 
amortization ``commitment'' less the amount covered by any loan-
level PMI divided by the most recent purchase price of the property 
or the most recent appraisal or evaluation value of the property (if 
the appraisal or evaluation is more recent than the most recent 
purchase and was obtained by the bank in connection with an 
extension of new credit). A bank with a stand-alone second lien 
where the more senior lien(s) can negatively amortize must first 
adjust the principal amount of those senior or intervening liens 
that can negatively amortize to reflect the maximum contractual loan 
amount as if it were to fully negatively amortize under the 
applicable contract. The adjusted LTV would then be added to the 
stand-alone junior lien to calculate the appropriate CLTV.

D. Short-Term Commitments

    Unused portions of commitments with an original maturity of one 
year or less (including eligible asset backed commercial paper 
liquidity facilities) (that is, short-term commitments) are 
converted using the 10 percent conversion factor. Unconditionally 
cancelable commitments, as defined in section III.D.2.b. of this 
appendix, retain the zero percent conversion factor. Short-term 
commitments to originate one-to four-family residential mortgage 
loans provided in the ordinary course of business that are not 
treated as a derivative under GAAP will continue to be converted to 
an on-balance-sheet credit equivalent amount using the zero percent 
conversion factor.

E. Securitizations of Revolving Credit with Early Amortization 
Provisions

    1. Definitions
    a. Early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision is triggered solely by events not directly related to 
the performance of the underlying exposures or the originating bank 
(such as material changes in tax laws or regulations).
    b. Excess spread means gross finance charge collections and 
other income received by a trust or special purpose entity minus 
interest paid to the investors in the securitization exposures, 
servicing fees, charge-offs, and other similar trust or special 
purpose entity expenses.
    c. Excess spread trapping point is the point at which the bank 
is required by the documentation governing a securitization to 
divert and hold excess spread in a spread or reserve account, 
expressed as a percentage.
    d. Investors' interest is the total amount of securitization 
exposures issued by a trust or special purpose entity to investors.
    e. Revolving credit means a line of credit where the borrower is 
permitted to vary both the drawn amount and the amount of repayment 
within an agreed limit.
    2. A bank that securitizes revolving credits where the 
securitization structure contains an early amortization provision 
must maintain risk-based capital against the investors' interest as 
required under this section. Capital for securitizations of

[[Page 77486]]

revolving credit exposures that incorporate early-amortization 
provisions will be assessed based on a comparison of the 
securitization's annualized three-month average excess spread 
against the excess spread trapping point. To calculate the 
securitization's excess spread trapping point ratio, a bank must 
calculate the three-month average of (1) the dollar amount of excess 
spread divided by (2) the outstanding principal balance of 
underlying pool of exposures at the end of each of the prior three 
months. The annualized three month average of excess spread is then 
divided by the excess spread trapping point that is required by the 
securitization structure. The excess spread trapping point ratio is 
compared to the ratios contained in Table 5 of section IV.E.3 to 
determine the appropriate conversion factor to apply to the 
investor's interest. The amount of investor's interest after 
conversion is then assigned capital in accordance with that 
appropriate to the underlying obligor, collateral or guarantor. For 
securitizations that do not require excess spread to be trapped, or 
that specify trapping points based primarily on performance measures 
other than the three-month average excess spread, the excess spread 
trapping point is 4.5 percent.
    3. For a bank subject to the early amortization requirements in 
this section IV.E., if the aggregate risk-based capital requirement 
for residual interests, direct credit substitutes, other 
securitization exposures, and early amortization provisions in 
connection with the same securitization of revolving credit 
exposures exceeds the risk-based capital requirement on the 
underlying securitized assets, then the capital requirement for the 
securitization transaction will be limited to the greater of the 
risk-based capital requirement for (1) residual interests or (2) the 
underlying securitized assets calculated as if the bank continued to 
hold the assets on its balance sheet.

          Table 5.--Early Amortization Credit Conversion Factor
------------------------------------------------------------------------
                                                                Credit
                                                              conversion
             Excess spread trapping point ratio                 factor
                                                                (CCF)
                                                              (percent)
------------------------------------------------------------------------
133.33 percent or more.....................................            0
less than 133.33 percent to 100 percent....................            5
less than 100 percent to 75 percent........................           15
less than 75 percent to 50 percent.........................           50
less than 50 percent.......................................          100
------------------------------------------------------------------------

F. Risk Weights for Derivatives

    A bank may not apply the 50 percent risk weight cap for 
derivative contract counterparties set forth in section III.E. of 
this appendix A.

PART 225--BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL 
(REGULATION Y)

    1. The authority citation for part 225 continues to read as 
follows:

    Authority: 12 U.S.C. 1817(j)(13), 1818, 1828(o), 1831i, 1831p-1, 
1843( c)(8), 1844(b), 1972(1), 3106, 3108, 3310, 3331-3351, 3907, 
and 3909; 15 U.S.C. 6801 and 6805.1.

    2. In Appendix A to part 225, the following amendments are 
proposed:
    a. Section I, Overview, is revised.
    b. In section III.A, Procedures, the first paragraph is revised, 
the fourth paragraph is redesignated as the fifth paragraph, and a new 
fourth paragraph is added.
    c. In section III.C, the first paragraph is revised.
    d. Section IV is removed and a new section IV, Alternative Approach 
for Computing Weighted Risk Assets and Off-Balance-Sheet Items, is 
added.
    e. Attachment I is removed.

Appendix A to Part 225--Capital Adequacy Guidelines for Bank Holding 
Companies: Risk-Based Measure

I. Overview

    The Board of Governors of the Federal Reserve System has adopted 
a risk-based capital measure to assist in the assessment of the 
capital adequacy of bank holding companies (banking 
organizations).\1\ The principal objectives of this measure are to: 
(i) Make regulatory capital requirements more sensitive to 
differences in risk profiles among banking organizations; (ii) 
factor off-balance sheet exposures into the assessment of capital 
adequacy; (iii) minimize disincentives to holding liquid, low-risk 
assets; and (iv) achieve greater consistency in the evaluation of 
the capital adequacy of major banking organizations throughout the 
world.\2\
---------------------------------------------------------------------------

    \1\ A leverage capital measure for state member banks is 
outlined in appendix D of this part.
    \2\ The risk-based capital measure is based upon a framework 
developed jointly by supervisory authorities from the countries 
represented on the Basel Committee on Banking Supervision (Basel 
Supervisors' Committee) and endorsed by the Group of Ten Central 
Bank Governors. The framework is described in a paper prepared by 
the Basel Supervisors' Committee entitled ``International 
Convergence of Capital Measurement,'' July 1988.
---------------------------------------------------------------------------

    The risk-based capital guidelines include both a definition of 
capital and a framework for calculating weighted risk assets by 
assigning assets and off-balance sheet items to broad risk 
categories. An institution's risk-based capital ratio is calculated 
by dividing its qualifying capital (the numerator of the ratio) by 
its weighted risk assets (the denominator).\3\ The definition of 
qualifying capital is outlined in section II, and the procedures for 
calculating weighted risk assets are discussed in sections III and 
IV.
---------------------------------------------------------------------------

    \3\ Banking organizations will initially be expected to utilize 
period-end amounts in calculating their risk-based capital ratios. 
When necessary and appropriate, ratios based on average balances may 
also be calculated on a case-by-case basis. Moreover, to the extent 
banking organizations have data on average balances that can be used 
to calculate risk-based ratios, the Federal Reserve will take such 
data into account.
---------------------------------------------------------------------------

    In addition, when certain organizations that engage in trading 
activities calculate their risk-based capital ratios under this 
appendix A, they must also refer to appendix E of this part, which 
incorporates capital charges for certain market risks into the risk-
based capital ratios. When calculating their risk-based capital 
ratios under this appendix A, such organizations are required to 
refer to appendix E of this part for supplemental rules to determine 
qualifying and excess capital, calculate weighted risk assets, 
calculate market risk equivalent assets, and calculate risk-based 
capital ratios adjusted for market risk.
    The risk-based capital guidelines apply on a consolidated basis 
to bank holding companies with consolidated assets of $500 million 
or more. For bank holding companies with less than $500 million in 
consolidated assets, the guidelines will be applied on a bank-only 
basis unless: (a) The parent bank holding company is engaged in 
nonbank activity involving significant leverage; \4\ or (b) the 
parent company has a significant amount of outstanding debt that is 
held by the general public.
---------------------------------------------------------------------------

    \4\ A parent company that is engaged in significant off-balance 
sheet activities would generally be deemed to be engaged in 
activities that involve significant leverage.
---------------------------------------------------------------------------

    The risk-based capital guidelines are to be used in the 
inspection and supervisory process as well as in the analysis of 
applications acted upon by the Federal Reserve. Thus, in considering 
an application filed by a bank holding company, the Federal Reserve 
will take into account the organization's risk-based capital ratio, 
the reasonableness of its capital plans, and the extent to which it 
meets the risk-based capital standards.
    The risk-based capital ratios focus principally on broad 
categories of credit risk, although the framework for assigning 
assets and off-balance-sheet items to risk categories does 
incorporate elements of transfer risk, as well as limited instances 
of interest rate and market risk. The risk-based capital ratio does 
not, however, incorporate other factors that can affect an 
organization's financial condition. These factors include overall 
interest-rate exposure; liquidity, funding and market risks; the 
quality and level of earnings; investment or loan portfolio 
concentrations; the quality of loans and investments, the 
effectiveness of loan and investment policies; and management's 
ability to monitor and control financial and operating risks.
    In addition to evaluating capital ratios, an overall assessment 
of capital adequacy must take account of these other factors, 
including, in particular, the level and severity of problem and 
classified assets. For this reason, the final supervisory judgment 
on an organization's capital adequacy may differ significantly from 
conclusions that might be drawn solely from the level of the 
organization's risk-based capital ratio.
    The risk-based capital guidelines establish a minimum ratio of 
qualifying total capital to weighted risk assets of 8 percent, of 
which at least 4 percentage points must be in the form of tier 1 
capital. In light of the considerations just discussed, banking 
organizations generally are expected to

[[Page 77487]]

operate well above the minimum risk-based ratios. In particular, 
banking organizations contemplating significant expansion proposals 
are expected to maintain strong capital levels substantially above 
the minimum ratios and should not allow significant diminution of 
financial strength below these strong levels to fund their expansion 
plans. Institutions with high or inordinate levels of risk are also 
expected to operate well above minimum capital standards. In all 
cases, institutions should hold capital commensurate with the level 
and nature of the risks to which they are exposed. Banking 
organizations that do not meet the minimum risk-based capital 
standard, or that are otherwise considered to be inadequately 
capitalized, are expected to develop and implement plans acceptable 
to the Federal Reserve for achieving adequate levels of capital 
within a reasonable period of time.
    The Board will monitor the implementation and effect of these 
guidelines in relation to domestic and international developments in 
the banking industry. When necessary and appropriate, the Board will 
consider the need to modify the guidelines in light of any 
significant changes in the economy, financial markets, banking 
practices, or other relevant factors.
* * * * *

III. * * *

A. * * *

    Assets and credit-equivalent amounts of off-balance-sheet items 
of bank holding companies are assigned to one of several broad risk 
categories, according to the obligor, or, if relevant, the 
guarantor, the nature of the collateral, or an external rating. The 
aggregate dollar value of the amount in each category is then 
multiplied by the risk weight associated with the category. The 
resulting weighted values from each of the risk categories are added 
together, and this sum is the banking organization's total weighted 
risk assets that comprise the denominator of the risk-based capital 
ratios.
* * * * *
    A bank holding company may elect to apply the alternative 
procedures for computing weighted risk assets set forth in section 
IV of this appendix A (``Alternative Approach''). The Federal 
Reserve also may require a bank holding company to apply the 
Alternative Approach if the Federal Reserve determines that the 
Alternative Approach would produce risk-based capital requirements 
that more accurately reflect the risk profile of the banking 
organization or would otherwise enhance the safety and soundness of 
the institution. A bank holding company that applies the Alternative 
Approach must apply all the procedures set forth in section IV of 
this appendix A and also must apply all the procedures set forth in 
this section that are not inconsistent with the procedures in 
section IV.
* * * * *

C. * * *

    Assets and on-balance-sheet credit equivalent amounts are 
assigned to the following risk weight categories: 0 percent, 20 
percent, 50 percent, or 100 percent. A brief explanation of the 
components of each category follows.
* * * * *

IV. Alternative Approach for Computing Weighted Risk Assets and 
Off-Balance-Sheet Items

A. Scope of Application

    A bank holding company may elect to use the Alternative Approach 
for computing weighted risk assets and off-balance sheet items set 
forth in this section IV by giving the Federal Reserve written 
notice on the first day of the quarter during which the banking 
organization elects to begin using the Alternative Approach. A bank 
holding company that has elected to apply the Alternative Approach 
may opt out of the Alternative Approach after it has given the 
Federal Reserve 30 days prior written notice. The Federal Reserve 
may require a bank holding company to apply the Alternative Approach 
if the Federal Reserve determines that the Alternative Approach 
would produce risk-based capital requirements that more accurately 
reflect the risk profile of the banking organization or would 
otherwise enhance the safety and soundness of the institution.
    A bank holding company that applies the Alternative Approach 
must apply all the procedures set forth in this section IV and also 
must apply all the procedures set forth in section III that are not 
inconsistent with the procedures in section IV.

B. External Ratings, Collateral, Guarantees, and Other Considerations

    1. External Credit Ratings. A bank holding company must use 
Table 1 in this section IV.B.1. to assign risk weights to covered 
claims with an original maturity of one year or more and Table 2 in 
this section IV.B.1. to assign risk weights to covered claims with 
an original maturity of less than one year. Covered claims are all 
claims other than (i) claims on an excluded entity, (ii) loans to 
non-sovereigns that do not have an external rating, and (iii) OTC 
derivative contracts. Excluded entities are (i) the U.S. central 
government and U.S. government agencies, (ii) state and local 
governments of the United States and other countries of the OECD, 
(iii) U.S. government-sponsored agencies, and (iv) U.S. depository 
institutions and foreign banks.
    A bank holding company must use column three of the tables for 
covered claims on a non-U.S. sovereign \58\ and column four of the 
tables for covered claims on an entity other than a non-U.S. 
sovereign (excluding securitization exposures). A bank holding 
company must use column five of the tables for covered claims that 
are securitization exposures, which include asset-backed securities, 
mortgage-backed securities, recourse obligations, direct credit 
substitutes, and residual interests (other than credit-enhancing 
interest-only strips).
---------------------------------------------------------------------------

    \58\ For purposes of this section IV, a sovereign is defined as 
a central government, including its agencies, departments, 
ministries, and the central bank. This definition does not include 
state, provincial, or local governments, or commercial enterprises 
owned by a central government.

                           Table 1.--Risk Weights Based on Long-Term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                     Non-U.S.                     Securitization
                                                                  sovereign risk   Non-sovereign   exposure risk
      Long-term rating category                  Rating             weight \1\      risk weight       weight
                                                                     (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating......  AAA......................               0              20              20
Second-highest investment grade        AA.......................              20              20              20
 rating.
Third-highest investment grade rating  A........................              20              35              35
Lowest investment grade rating--plus.  BBB+.....................              35              50              50
Lowest investment grade rating--       BBB......................              50              75              75
 naught.
Lowest investment grade rating--       BBB-.....................              75             100             100
 negative.
One category below investment grade--  BB+, BB..................              75             150             200
 plus & naught.
One category below investment grade--  BB-......................             100             200             200
 negative.
Two or more categories below           B, CCC...................             150             200             \2\
 investment grade.
Unrated..............................  n/a......................             200             200             \2\
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by AAA-rated non-U.S. sovereign debt would be assigned to the 20 risk weight category.
 
\2\ Apply the risk-based capital requirements set forth in section III.B.3.b. of this appendix A.


[[Page 77488]]


                           Table 2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                     Non-U.S.                     Securitization
                                                                  sovereign risk   Non-sovereign   exposure risk
      Short-term rating category                Examples            weight \1\      risk weight       weight
                                                                     (percent)       (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating *.....  A-1, P-1................               0              20              20
Second-highest investment grade rating  A-2, P-2................              20              35              35
Lowest investment grade rating........  A-3, P-3................              50              75              75
Unrated...............................  ........................             100             100            100
----------------------------------------------------------------------------------------------------------------
\1\ Claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk weight
  category.

    For purposes of this section IV, an external rating is defined 
as a credit rating that is assigned by an NRSRO, provided that the 
credit rating:
    a. Fully reflects the entire amount of credit risk with regard 
to all payments owed on the claim (that is, the rating must fully 
reflect the credit risk associated with timely repayment of 
principal and interest);
    b. Is monitored by the issuing NRSRO;
    c. Is published in an accessible public form (for example, on 
the NRSRO's Web site or in financial media); and
    d. Is, or will be, included in the issuing NRSRO's publicly 
available ratings transition matrix which tracks the performance and 
stability (or ratings migration) of an NRSRO's issued external 
ratings for the specific type of claim (for example, corporate 
debt).
    In addition, an unrated covered claim on a non-U.S. sovereign 
that has an external rating from an NRSRO should be deemed to have 
an external rating equal to the sovereign's issuer rating. If a 
claim has two or more external ratings, the bank holding company 
must use the least favorable external rating to risk weight the 
claim. Similarly, if a claim has components that are assigned 
different external ratings, the lowest component rating must be 
applied to the entire claim. For example, if a securitization 
exposure has a principal component externally rated BBB, but the 
interest component is externally rated B, the entire exposure will 
be subject to the gross-up treatment accorded to a securitization 
exposure rated B or lower. Similarly, if a portion of a specific 
claim is unrated, then the entire claim must be treated as if it 
were unrated. The Federal Reserve retains the authority to override 
the use of certain ratings or the ratings on certain instruments, 
either on a case-by-case basis or through broader supervisory 
policy, if necessary or appropriate to address the risk that an 
instrument poses to banking organizations.
    2. Collateral. In addition to the forms of recognized financial 
collateral set forth in section III.B.1 of this appendix A, a bank 
holding company also may recognize as collateral (i) covered claims 
in the form of liquid and readily marketable debt securities that 
are externally rated no less than investment grade and (ii) liquid 
and readily marketable debt securities guaranteed by non-U.S. 
sovereigns whose issuer rating is at least investment grade. Claims, 
or portions of claims, collateralized by such collateral may be 
assigned to the risk weight appropriate to the collateral's external 
rating as set forth in Table 1 or 2 of section IV.B.1. For example, 
the portion of a claim collateralized with an AA-rated mortgage-
backed security is assigned to the 20 percent risk weight category.
    Subject to the final sentence of this paragraph, there is, 
however, a 20 percent risk weight floor on collateralized claims 
under this section IV. Thus, the portion of a claim collateralized 
by a security issued by a non-U.S. sovereign with an issuer rating 
of AAA would be assigned to the 20 percent risk weight category 
instead of the zero percent risk weight category. The procedures set 
forth in section III of this appendix A continue to apply, however, 
to claims collateralized by securities issued or guaranteed by OECD 
central governments for which a positive margin of collateral is 
maintained on a daily basis, fully taking into account any change in 
the banking organization's exposure to the obligor and counterparty 
under the claim in relation to the market value of the collateral 
held to support the claim.
    In the event that the external rating of a security used to 
collateralize a claim results in a higher risk weight than would 
have otherwise been assigned to the claim, then the lower risk 
weight appropriate to the underlying claim could be applied.
    3. Guarantees. Claims, or portions of claims, guaranteed by a 
third party entity (other than an excluded entity) whose unsecured 
long-term senior debt (without credit enhancements) is externally 
rated at least investment grade or by a non-U.S. sovereign that has 
an issuer rating of at least investment grade may be assigned to the 
risk weight of the guarantor as set forth in Table 1 of section 
IV.B.1 corresponding to the protection provider's long-term senior 
debt rating (or issuer rating in the case of a non-U.S. sovereign), 
provided that the guarantee:
    a. Is written and unconditional,
    b. Covers all or a pro rata portion of contractual payments of 
the obligor on the underlying claim,
    c. Gives the beneficiary a direct claim against the protection 
provider,
    d. Is non-cancelable by the protection provider for reasons 
other than the breach of contract by the beneficiary,
    e. Is legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced, and
    f. Requires the protection provider to make payment to the 
beneficiary upon default of the obligor on the underlying claim 
without first requiring the beneficiary to demand payment from the 
obligor.

C. Residential Mortgages

    1. A bank holding company may separate its residential mortgage 
portfolio into two subportfolios, where the first subportfolio 
includes mortgage loans originated by the banking organization or 
acquired by the banking organization prior to the date the 
institution becomes subject to this section IV and the second 
includes mortgage loans originated or acquired by the bank holding 
company after that date. The bank holding company may apply the 
risk-based capital treatment set forth in section III of this 
appendix A to the first subportfolio while applying the requirements 
set forth in this section IV to the second subportfolio. A bank 
holding company that does not so separate its residential mortgage 
portfolio must apply the capital treatment in this section IV to all 
of its qualifying residential mortgage exposures. If a banking 
organization at any time opts-out of the Alternative Approach and, 
subsequently, again becomes subject to this section IV, it may not 
apply the procedures set forth in this section IV.C.1.
    2. Subject to section IV.C.1., a bank holding company assigns 
its residential mortgage exposures to risk weight categories based 
on their loan-to-value (LTV) or combined loan-to-value (CLTV) 
ratios, as appropriate, in accordance with Tables 3 and 4 of 
sections IV C.3.a. and IV.C.3.b., respectively, but must risk-weight 
a nonqualifying residential mortgage exposure at no less than 100 
percent. Residential mortgage exposures include all loans secured by 
a lien on a one-to four-family residential property \59\ that is 
either owner-occupied or rented. Qualifying residential mortgage 
exposures are residential mortgage exposures that (1) have been made 
in accordance with prudent underwriting standards; (2) are 
performing in accordance with their original terms; (3) are not 90 
days or more past due or carried in nonaccrual status; and (4) are 
not made for the purpose of speculative property development. 
Nonqualifying residential mortgage exposures are residential 
mortgage exposures other than qualifying residential mortgage 
exposures.
---------------------------------------------------------------------------

    \59\ Loans that qualify as mortgages that are secured by 1- to 
4-family residential properties are listed in the instructions to 
the commercial bank Call Reports.
---------------------------------------------------------------------------

    3. For purposes of Tables 3 and 4, LTV is defined as (i) the 
current outstanding principal balance of the loan less the amount 
covered by any loan-level private mortgage insurance (``PMI'') 
divided by (ii) the most recent purchase price of the property or 
the most recent appraisal or evaluation value of

[[Page 77489]]

the property (if the appraisal or evaluation is more recent than the 
most recent purchase and was obtained by the bank holding company in 
connection with an extension of new credit). Loan-level PMI means 
insurance (i) provided by a non-affiliated PMI provider whose 
unsecured long-term senior debt (without credit enhancements) is 
externally rated at least the third highest investment grade by an 
NRSRO, and (ii) which protects a mortgage lender in the event of the 
default of a mortgage borrower up to a predetermined portion of the 
value of residential mortgage exposure. For purposes of the loan 
level PMI definition, (i) an affiliate of a company means any 
company that controls, is controlled by, or is under common control 
with, the company; and (ii) a person or company controls a company 
if it owns, controls, or has power to vote 25 percent or more of a 
class of voting securities of the company or consolidates the 
company for financial reporting purposes. CLTV for a junior lien 
mortgage is defined as (i) the current outstanding principal balance 
of the junior mortgage and all more senior mortgages less the amount 
covered by any loan-level PMI covering the junior lien divided by 
(ii) the most recent purchase price of the property or the most 
recent appraisal or evaluation value of the property (if the 
appraisal or evaluation is more recent than the most recent purchase 
and was obtained by the bank holding company in connection with an 
extension of new credit). The procedures for residential mortgage 
exposures that have negative amortization features are set forth in 
section IV.C.3.c.
    a. First Lien Residential Mortgage Exposures
    First lien residential mortgage exposures are risk-weighted in 
accordance with Table 3 of this section IV.C.3.a (with nonqualifying 
residential mortgage exposures subject to a risk weight floor of 100 
percent). If a banking organization holds both the senior and junior 
lien(s) on a residential property and no other party holds an 
intervening lien, the banking organization's claims are treated as a 
single claim secured by a senior lien for purposes of determining 
the LTV ratio and assigning a risk weight.

  Table 3.--Risk Weights for First Lien Residential Mortgage Exposures
------------------------------------------------------------------------
                                                             Risk weight
                    Loan-to-value ratio                        (percent)
------------------------------------------------------------------------
Up to 60%..................................................           20
>60% and up to 80%.........................................           35
>80% and up to 85%.........................................           50
>85% and up to 90%.........................................           75
>90% and up to 95%.........................................          100
>95%.......................................................          150
------------------------------------------------------------------------

    b. Stand-Alone Junior Liens
    Stand-alone junior lien residential mortgage exposures, 
including structured mortgages and home equity lines of credit, must 
be risk weighted using the CLTV ratio of the stand-alone junior lien 
and all senior liens in accordance with Table 4 (with nonqualifying 
residential mortgage exposures subject to a risk weight floor of 100 
percent).

 Table 4.--Risk Weights for Stand-Alone Junior Lien Residential Mortgage
                                Exposures
------------------------------------------------------------------------
                                                             Risk weight
                Combined loan-to-value ratio                   (percent)
------------------------------------------------------------------------
Up to 60%..................................................           75
>60% and up to 90%.........................................          100
>90%.......................................................          150
------------------------------------------------------------------------

    c. Residential Mortgage Exposures With Negative Amortization 
Features
    Residential mortgage exposures with negative amortization 
features are assigned to a risk weight category using a loan's 
current LTV ratio in accordance with Table 3 of section IV.C.3.a. 
Any remaining potential increase in the mortgage's principal balance 
permitted through the negative amortization feature is to be treated 
as a long-term commitment and converted to an on-balance sheet 
credit equivalent amount as set forth in section III.D.2. of this 
appendix. The credit equivalent amount of the commitment is then 
risk-weighted according to Table 3 based on the loan's ``highest 
contractual LTV ratio.'' The highest contractual LTV ratio of a 
mortgage loan equals the current outstanding principal balance of 
the loan plus the credit equivalent amount of the remaining negative 
amortization ``commitment'' less the amount covered by any loan-
level PMI divided by the most recent purchase price of the property 
or the most recent appraisal or evaluation value of the property (if 
the appraisal or evaluation is more recent than the most recent 
purchase and was obtained by the bank holding company in connection 
with an extension of new credit). A bank holding company with a 
stand-alone second lien where the more senior lien(s) can negatively 
amortize must first adjust the principal amount of those senior or 
intervening liens that can negatively amortize to reflect the 
maximum contractual loan amount as if it were to fully negatively 
amortize under the applicable contract. The adjusted LTV would then 
be added to the stand-alone junior lien to calculate the appropriate 
CLTV.

D. Short-Term Commitments

    Unused portions of commitments with an original maturity of one 
year or less (including eligible asset backed commercial paper 
liquidity facilities) (that is, short-term commitments) are 
converted using the 10 percent conversion factor. Unconditionally 
cancelable commitments, as defined in section III.D.2.b. of this 
appendix, retain the zero percent conversion factor. Short-term 
commitments to originate one- to four-family residential mortgage 
loans provided in the ordinary course of business that are not 
treated as a derivative under GAAP will continue to be converted to 
an on-balance-sheet credit equivalent amount using the zero percent 
conversion factor.

E. Securitizations of Revolving Credit with Early Amortization 
Provisions

    1. Definitions
    a. Early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision is triggered solely by events not directly related to 
the performance of the underlying exposures or the originating 
banking organization (such as material changes in tax laws or 
regulations).
    b. Excess spread means gross finance charge collections and 
other income received by a trust or special purpose entity minus 
interest paid to the investors in the securitization exposures, 
servicing fees, charge-offs, and other similar trust or special 
purpose entity expenses.
    c. Excess spread trapping point is the point at which the 
banking organization is required by the documentation governing a 
securitization to divert and hold excess spread in a spread or 
reserve account, expressed as a percentage.
    d. Investors' interest is the total amount of securitization 
exposure issued by a trust or special purpose entity to investors.
    e. Revolving credit means a line of credit where the borrower is 
permitted to vary both the drawn amount and the amount of repayment 
within an agreed limit.
    2. A bank holding company that securitizes revolving credits 
where the securitization structure contains an early amortization 
provision must maintain risk-based capital against the investors' 
interest as required under this section. Capital for securitizations 
of revolving credit exposures that incorporate early-amortization 
provisions will be assessed based on a comparison of the 
securitization's annualized three-month average excess spread 
against the excess spread trapping point. To calculate the 
securitization's excess spread trapping point ratio, a bank holding 
company must calculate the three-month average of (1) the dollar 
amount of excess spread divided by (2) the outstanding principal 
balance of underlying pool of exposures at the end of each of the 
prior three months. The annualized three month average of excess 
spread is then divided by the excess spread trapping point that is 
required by the securitization structure. The excess spread trapping 
point ratio is compared to the ratios contained in Table 5 of 
section IV.E.3 to determine the appropriate conversion factor to 
apply to the investor's interest. The amount of investor's interest 
after conversion is then assigned capital in accordance with that 
appropriate to the underlying obligor, collateral or guarantor. For 
securitizations that do not require excess spread to be trapped, or 
that specify trapping points based primarily on performance measures 
other than the three-month average excess spread, the excess spread 
trapping point is 4.5 percent.
    3. For a banking organization subject to the early amortization 
requirements in this section IV.E., if the aggregate risk-based 
capital requirement for residual interests, direct credit 
substitutes, other securitization exposures, and early amortization 
provisions in connection with the same securitization of revolving 
credit exposures exceeds the risk-based capital requirement on the 
underlying securitized assets, then the capital requirement for the 
securitization transaction will be limited to the greater of the 
risk-based capital requirement for (1) residual interests

[[Page 77490]]

or (2) the underlying securitized assets calculated as if the 
banking organization continued to hold the assets on its balance 
sheet.

          Table 5.--Early Amortization Credit Conversion Factor
------------------------------------------------------------------------
                                                                Credit
                                                              conversion
             Excess spread trapping point ratio                 factor
                                                                (CCF)
                                                              (percent)
------------------------------------------------------------------------
133.33 percent or more.....................................            0
Less than 133.33 percent to 100 percent....................            5
Less than 100 percent to 75 percent........................           15
Less than 75 percent to 50 percent.........................           50
Less than 50 percent.......................................          100
------------------------------------------------------------------------

F. Risk Weights for Derivatives

    A bank holding company may not apply the 50 percent risk weight 
cap for derivative contract counterparties set forth in section 
III.E. of this appendix A.
* * * * *

Federal Deposit Insurance Corporation

12 CFR Part 325

    For the reasons set out in the preamble, part 325 of chapter III of 
title 12 of the Code of Federal Regulations is proposed to be amended 
as follows:

PART 325--CAPITAL MAINTENANCE

    1. The authority citation for part 325 continues to read as 
follows:

    Authority: U.S.C. 1815(a), 1815(b), 1816, 1818(a), 1818(b), 
1818(c), 1818(t), 1819 (Tenth), 1828(c), 1828(d), 1828(i), 1828(n), 
1828(o), 1831o, 1835, 3907, 3909, 4808; Pub. L. 102-233, 105 Stat. 
1761, 1789, 1790 (12 U.S.C. 1831n note); Pub. L. 102-242, 105 Stat. 
2236, 2355, as amended by Pub. L. 103-325, 108 Stat. 2160, 2233 (12 
U.S.C. 1828 note); Pub. L. 102-242, 105 Stat. 2236, 2386, as amended 
by Pub. L. 102-550, 106 Stat. 3672, 4089 (12 U.S.C. 1828 note).

    2. Revise Sec.  325.1 of subpart A to read as follows:


Sec.  325.1  Scope.

    The provisions of this part apply to those circumstances for which 
the Federal Deposit Insurance Act or this chapter requires an 
evaluation of the adequacy of an insured depository institution's 
capital structure. The FDIC is required to evaluate capital before 
approving various applications by insured depository institutions. The 
FDIC also must evaluate capital, as an essential component, in 
determining the safety and soundness of state nonmember banks it 
insures and supervises and in determining whether depository 
institutions are in an unsafe or unsound condition. This subpart A 
establishes the criteria and standards FDIC will use in calculating the 
minimum leverage capital requirement and in determining capital 
adequacy. In addition, appendices A, D, and E to part 325 (appendices 
A, D, and E) set forth the FDIC's risk-based capital policy statements 
and appendix B to this subpart includes a statement of policy on 
capital adequacy that provides interpretational guidance as to how this 
subpart will be administered and enforced. In accordance with subpart B 
of part 325, the FDIC also must evaluate an institution's capital for 
purposes of determining whether the institution is subject to the 
prompt corrective action provisions set forth in section 38 of the 
Federal Deposit Insurance Act (12 U.S.C. 1831o).
    3. Revise Sec.  325.2(s), (w) and (y) of subpart A to read as 
follows:


Sec.  325.2  Definitions

* * * * *
    (s) Risk-weighted assets means total risk-weighted assets, as 
calculated in accordance with appendices A, D, or E to part 325.
* * * * *
    (w) Tier 1 risk-based capital ratio means the ratio of Tier 1 
capital to risk-weighted assets, as calculated in accordance with 
appendices A, D, or E to part 325.
* * * * *
    (y) Total risk-based capital ratio means the ratio of qualifying 
total capital to risk-weighted assets, as calculated in accordance with 
appendices A, D, or E to part 325.
* * * * *
    4. Revise Sec.  325.6(d) of subpart A to read as follows:


Sec.  325.6  Issuance of directives

* * * * *
    (d) Enforcement of a directive. (1) Whenever a bank fails to follow 
the directive or to submit or adhere to its capital adequacy plan, the 
FDIC may seek enforcement of the directive in the appropriate United 
States district court, pursuant to 12 U.S.C. 3907(b)(2)(B)(ii), in the 
same manner and to the same extent as if the directive were a final 
cease-and-desist order. In addition to enforcement of the directive, 
the FDIC may seek assessment of civil money penalties for violation of 
the directive against any bank, any officer, director, employee, agent, 
or other person participating in the conduct of the affairs of the 
bank, pursuant to 12 U.S.C. 3909(d).
    (2) The directive may be issued separately, in conjunction with, or 
in addition to, any other enforcement mechanisms available to the FDIC, 
including cease-and-desist orders, orders of correction, the approval 
or denial of applications, or any other actions authorized by law. In 
addition to addressing a bank's minimum leverage capital requirement, 
the capital directive may also address minimum risk-based capital 
requirements that are to be maintained and calculated in accordance 
with appendices A, D, and E to this part 325.
    5. Revise Sec.  325.103(a) of subpart B to read as follows:


Sec.  325.103  Capital measures and capital category definitions.

    (a) Capital measures (1) For purposes of section 38 and this 
subpart the relevant capital measures shall be:
    (i) The total risk-based capital ratio;
    (ii) The Tier 1 risk-based capital ratio; and
    (iii) The leverage ratio.
    (2) Risk-based capital ratios. All state nonmember banks must 
maintain the minimum risk-based capital ratios as calculated under 
appendices A, D, or E to part 325 (and under appendix C to part 325, as 
applicable).
    (i) Except as provided in paragraph (a)(2)(ii) of this section, any 
state nonmember bank that does not use appendix D, as provided in 
section 1(b) of appendix D to part 325, must calculate its minimum 
risk-based capital ratios under appendix A.
    (ii) Any state nonmember bank that uses appendix D to part 325 must 
calculate its minimum risk-based capital ratios under appendix D.
    (iii) Any state nonmember bank that does not use appendix D to part 
325 may elect to calculate its minimum risk-based capital ratios under 
appendix E to part 325. Any state nonmember bank that makes this 
election must comply with the notice procedures in appendix E.
* * * * *
    6. Add Appendix E to part 325 to read as follows:

Appendix E to Part 325--Statement of Policy on Risk-Based Capital: 
Alternative Approach for Computing Risk-Weighted Assets and Off-
Balance-Sheet Items

I-1. Risk-Based Capital Framework

A. Introduction

    1. Capital adequacy is one of the critical factors that the FDIC 
is required to analyze when taking action on various types of 
applications and when conducting supervisory activities related to 
the safety and soundness of individual banks and the banking system. 
In view of this, the FDIC's Board of Directors has adopted part 325 
of its regulations (12 CFR part 325), which sets

[[Page 77491]]

forth minimum standards of capital adequacy for insured state 
nonmember banks and standards for determining when an insured bank 
is in an unsafe or unsound condition by reason of the amount of its 
capital.
    2. This capital maintenance regulation was designed to 
establish, in conjunction with other federal bank regulatory 
agencies, uniform capital standards for all federally-regulated 
banking organizations, regardless of size. The uniform capital 
standards were based on ratios of capital to total assets. While 
those leverage ratios have served as a useful tool for assessing 
capital adequacy, the FDIC believes there is a need for a capital 
measure that is more explicitly and systematically sensitive to the 
risk profiles of individual banks. As a result, the FDIC's Board of 
Directors has adopted appendices A, D, and E that establish the 
minimum risk-based capital requirements for banks. This statement of 
policy does not replace or eliminate the existing part 325 capital-
to-total assets leverage ratios.
    3. The framework set forth in appendices A, D, and E to this 
part 325 consists of a definition of capital for risk-based capital 
purposes, and a system for calculating risk-weighted assets. A 
bank's risk-based capital ratio is calculated by dividing its 
qualifying total capital base (the numerator of the ratio) by its 
risk-weighted assets (the denominator).\1\
---------------------------------------------------------------------------

    \1\ Period-end amounts, rather than average balances, normally 
will be used when calculating risk-based capital ratios. However, on 
a case-by-case basis, ratios based on average balances may also be 
required if supervisory concerns render it appropriate.
---------------------------------------------------------------------------

    4. In addition, when certain banks that engage in trading 
activities calculate their risk-based capital ratio under these 
appendices A, D, and E, they must also refer to appendix C of this 
part, which incorporates capital charges for certain market risks 
into the risk-based capital ratio. When calculating their risk-based 
capital ratio under these appendices A, D, and E, such banks are 
required to refer to appendix C of this part for supplemental rules 
to determine qualifying and excess capital, calculate risk-weighted 
assets, calculate market risk equivalent assets and add them to 
risk-weighted assets, and calculate risk-based capital ratios as 
adjusted for market risk.
    5. This statement of policy applies to all FDIC-insured state-
chartered banks (excluding insured branches of foreign banks) that 
have elected to use this appendix E and that are not members of the 
Federal Reserve System, hereafter referred to as ``state nonmember 
banks,'' regardless of size, and to all circumstances in which the 
FDIC is required to evaluate the capital of a banking organization. 
Therefore, the risk-based capital framework set forth in this 
statement of policy will be used in the examination and supervisory 
process as well as in the analysis of applications that the FDIC is 
required to act upon.
    6. The risk-based capital ratio focuses principally on broad 
categories of credit risk, however, the ratio does not take account 
of many other factors that can affect a bank's financial condition. 
These factors include overall interest rate risk exposure, 
liquidity, funding and market risks; the quality and level of 
earnings; investment, loan portfolio, and other concentrations of 
credit risk, certain risks arising from nontraditional activities; 
the quality of loans and investments; the effectiveness of loan and 
investment policies; and management's overall ability to monitor and 
control financial and operating risks, including the risk presented 
by concentrations of credit and nontraditional activities. In 
addition to evaluating capital ratios, an overall assessment of 
capital adequacy must take account of each of these other factors, 
including, in particular, the level and severity of problem and 
adversely classified assets as well as a bank's interest rate risk 
as measured by the bank's exposure to declines in the economic value 
of its capital due to changes in interest rates. For this reason, 
the final supervisory judgment on a bank's capital adequacy may 
differ significantly from the conclusions that might be drawn solely 
from the absolute level of the bank's risk-based capital ratio.

B. Election Into and Exit From Appendix E

    1. Unless a bank uses appendix D of this part, any state 
nonmember bank may elect to use the capital requirements set forth 
in this appendix E by filing the appropriate Schedule of the 
Consolidated Reports of Condition and Income (Call Reports) to 
calculate its risk-based capital requirements. After a bank has 
filed its quarterly Call Reports under this appendix E, the bank's 
election to use appendix E will be effective on the date of filing 
its Call Reports and will apply retrospectively to the quarter 
covered by the filing.
    2. Any bank that has elected to use this appendix E to calculate 
its risk-based capital ratios may elect to use appendix A of this 
part to calculate its risk-based capital ratios by giving the FDIC 
prior notice. This election will not apply retrospectively to the 
current quarter, but will apply prospectively for the next quarter. 
After the notice becomes effective, the bank must use appendix A, 
and the bank must file all subsequent Call Reports in accordance 
with appendix A.

C. Reservation of Authority

    The FDIC reserves the authority to exclude a bank from coverage 
under this appendix E if the FDIC determines that the exclusion is 
appropriate based on the risk profile of the bank or would otherwise 
enhance the safety and soundness of the bank. The FDIC also reserves 
the authority to: Require a bank that has elected to use the capital 
requirements in this appendix E to continue to use appendix E; or 
require a bank that uses appendix A to calculate its risk-based 
capital requirements to instead use appendix E to calculate its 
capital requirements, if the FDIC determines that the exclusion from 
coverage under appendix A to this part 325 is appropriate based on 
the risk profile of the bank or would otherwise enhance the safety 
and soundness of the bank. In making a determination under this 
paragraph, the FDIC will apply notice and response procedures in the 
same manner as the notice and response procedures in 12 CFR 
325.6(c).

D. Definitions

    1. Affiliate means, with respect to a company, any company that 
controls, is controlled by, or is under common control with, the 
company. For purposes of this definition, a person or company 
controls a company if it:
    (a) Owns, controls, or holds with power to vote 25 percent or 
more of a class of voting securities of the company; or
    (b) Consolidates the company for financial reporting purposes.
    2. Company means a corporation, partnership, limited liability 
company, business trust, special purpose entity, association, or 
similar organization.
    3. Eligible guarantee means a guarantee provided by a third 
party eligible guarantor that:
    (a) Is written and unconditional;
    (b) Covers all or a pro rata portion of the contractual payments 
of the obligor on the reference exposure;
    (c) Gives the beneficiary a direct claim against the protection 
provider;
    (d) Is non-cancelable by the protection provider for reasons 
other than the breach of the contract by the beneficiary;
    (e) Is legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced;
    (f) Requires the protection provider to make payment to the 
beneficiary on the occurrence of a default (as defined in the 
guarantee) of the obligor on the reference exposure without first 
requiring the beneficiary to demand payment from the obligor; and
    (g) If extended by a sovereign, is backed by the full faith and 
credit of the sovereign.
    4. Eligible guarantor means a sovereign with senior long-term 
debt externally rated at least investment grade (without credit 
enhancements) by a nationally recognized statistical rating 
organization (NRSRO) \2\ or a non-sovereign with senior long-term 
debt externally rated at least investment grade (without credit 
enhancements) by a NRSRO. A sovereign or non-sovereign rated less 
than investment grade by any NRSRO is not an eligible guarantor for 
purposes of this definition.
---------------------------------------------------------------------------

    \2\ A nationally recognized statistical rating organization is 
an entity recognized by the Division of Market Regulation of the 
Securities and Exchange Commission (or any successor Division) 
(Commission) as a nationally recognized statistical rating 
organization for various purposes, including the Commission's 
uniform net capital requirements for brokers and dealers (17 CFR 
240.15c3-1).
---------------------------------------------------------------------------

    5. External rating means a credit rating that is assigned by a 
NRSRO to a claim or issuer, provided that the credit rating:
    (a) Fully reflects the entire amount of credit risk with regard 
to all payments owed on the claim (that is, the rating must fully 
reflect the credit risk associated with timely repayment of 
principal and interest);
    (b) Is monitored by the issuing NRSRO;
    (c) Is published in an accessible public forum, for example, on 
the NRSRO's Web site and in financial media; and
    (d) Is, or will be, included in the issuing NRSRO's publicly 
available ratings transition

[[Page 77492]]

matrix which tracks the performance and stability (or ratings 
migration) of an NRSRO's issued external ratings for the specific 
type of claim (for example, corporate debt).
    6. Loan level private mortgage insurance (PMI) means insurance 
provided by a regulated mortgage insurance company, with senior 
long-term debt rated at least third-highest investment grade 
(without credit enhancements) by a NRSRO, that protects a mortgage 
lender in the event of the default of a mortgage borrower up to a 
predetermined portion of the value of a single one-to four-family 
residential property, provided the mortgage insurance company is not 
an affiliate of the bank and provided there is no pool-level cap 
that would effectively reduce coverage.
    7. Non-sovereign.
    (a) Non-sovereign means:
    (i) A company (including a securities firm, insurance company, 
bank holding company, and savings and loan holding company), or
    (ii) A multilateral lending institution or regional development 
institution.
    (b) For purposes of this definition, non-sovereign does not 
include the United States (including U.S. Government Agencies); 
states or other political subdivisions of the United States and 
other OECD countries; U.S. Government-sponsored Agencies; or U.S. 
depository institutions and foreign banks. In addition, for purposes 
of determining the appropriate risk weight of claims on or 
guaranteed by qualifying securities firms that are collateralized by 
cash or securities issued or guaranteed by OECD central governments 
and that meet the requirements of section II.C.1(c) of this appendix 
E, non-sovereign also does not include a qualifying securities 
firm.\3\
---------------------------------------------------------------------------

    \3\ See footnote 31.
---------------------------------------------------------------------------

    8. Securitization exposures include asset- and mortgage-backed 
securities, recourse obligations, direct credit substitutes, and 
residual interests (other than credit-enhancing interest-only 
strips).
    9. Sovereign.
    (a) Sovereign means a central government, including its 
departments and ministries, and the central bank. It does not 
include states, provinces, local governments, or other political 
subdivisions of a country, or commercial enterprises owned by a 
central government.
    (b) For purposes of this appendix E, sovereign does not include 
the United States, U.S. Government agencies, or the U.S. central 
bank (including the twelve Federal Reserve banks). In addition, for 
purposes of determining the appropriate risk weight of claims on 
qualifying securities firms that are collateralized by securities 
issued or guaranteed by OECD central governments that meet the 
requirements of section II.C.1(c) of this appendix E, sovereign does 
not include an OECD central government (including the United 
States).
    10. Unconditionally cancelable means, with respect to a 
commitment-type lending arrangement, that a bank may, at any time, 
with or without cause, refuse to advance funds or extend credit 
under the facility. In the case of home equity lines of credit or 
mortgage lines of credit, a commitment is unconditionally cancelable 
if the bank can, at its option, prohibit additional extensions of 
credit, reduce the line, and terminate the commitment to the full 
extent permitted by applicable Federal law.

I-2. Definition of Capital for the Risk-Based Capital Ratio

    A bank's qualifying total capital base consists of two types of 
capital elements: ``core capital elements'' (Tier 1) and 
``supplementary capital elements'' (Tier 2). To qualify as an 
element of Tier 1 or Tier 2 capital, a capital instrument should not 
contain or be subject to any conditions, covenants, terms, 
restrictions, or provisions that are inconsistent with safe and 
sound banking practices.

A. The Components of Qualifying Capital (see Table I)

    1. Core capital elements (Tier 1) consists of: Common 
stockholders' equity capital (includes common stock and related 
surplus, undivided profits, disclosed capital reserves that 
represent a segregation of undivided profits, and foreign currency 
translation adjustments, less net unrealized holding losses on 
available for-sale equity securities with readily determinable fair 
values); noncumulative perpetual preferred stock,\4\ including any 
related surplus; and minority interests in the equity capital 
accounts of consolidated subsidiaries.
---------------------------------------------------------------------------

    \4\ Preferred stock issues where the dividend is reset 
periodically based, in whole or in part, upon the bank's current 
credit standing, including but not limited to, auction rate, money 
market or remarketable preferred stock, are assigned to Tier 2 
capital, regardless of whether the dividends are cumulative or 
noncumulative.
---------------------------------------------------------------------------

    (a) At least 50 percent of the qualifying total capital base 
should consist of Tier 1 capital. Core (Tier 1) capital is defined 
as the sum of core capital elements minus all intangible assets 
(other than mortgage servicing assets, nonmortgage servicing assets 
and purchased credit card relationships eligible for inclusion in 
core capital pursuant to Sec.  325.5(f)),\5\ minus credit-enhancing 
interest-only strips that are not eligible for inclusion in core 
capital pursuant to Sec.  325.5(f)), minus any disallowed deferred 
tax assets, and minus any amount of nonfinancial equity investments 
required to be deducted pursuant to section II.B.6 of this appendix 
E.
---------------------------------------------------------------------------

    \5\ An exception is allowed for intangible assets that are 
explicitly approved by the FDIC as part of the bank's regulatory 
capital on a specific case basis. These intangibles will be included 
in capital for risk-based capital purposes under the terms and 
conditions that are specifically approved by the FDIC.
---------------------------------------------------------------------------

    (b) Although nonvoting common stock, noncumulative perpetual 
preferred stock, and minority interests in the equity capital 
accounts of consolidated subsidiaries are normally included in Tier 
1 capital, voting common stockholders' equity generally will be 
expected to be the dominant form of Tier 1 capital. Thus, banks 
should avoid undue reliance on nonvoting equity, preferred stock and 
minority interests.
    (c) Although minority interests in consolidated subsidiaries are 
generally included in regulatory capital, exceptions to this general 
rule will be made if the minority interests fail to provide 
meaningful capital support to the consolidated bank. Such a 
situation could arise if the minority interests are entitled to a 
preferred claim on essentially low risk assets of the subsidiary. 
Similarly, although credit-enhancing interest-only strips and 
intangible assets in the form of mortgage servicing assets, 
nonmortgage servicing assets and purchased credit card relationships 
are generally recognized for risk-based capital purposes, the 
deduction of part or all of the credit-enhancing interest-only 
strips, mortgage servicing assets, nonmortgage servicing assets and 
purchased credit card relationships may be required if the carrying 
amounts of these assets are excessive in relation to their market 
value or the level of the bank's capital accounts. Credit-enhancing 
interest-only strips, mortgage servicing assets, nonmortgage 
servicing assets, purchased credit card relationships and deferred 
tax assets that do not meet the conditions, limitations and 
restrictions described in Sec.  325.5(f) and (g) of this part will 
not be recognized for risk-based capital purposes.
    (d) Minority interests in small business investment companies, 
investment funds that hold nonfinancial equity investments (as 
defined in section II.B.6(b) of this appendix E), and subsidiaries 
that are engaged in nonfinancial activities are not included in a 
bank's Tier 1 or total capital base if the bank excludes the 
consolidated assets of such programs from risk-weighted assets 
pursuant to section II.B.6(b) of this appendix.
    2. Supplementary capital elements (Tier 2). The maximum amount 
of Tier 2 capital that may be recognized for risk-based capital 
purposes is limited to 100 percent of Tier 1 capital (after any 
deductions for disallowed intangibles and disallowed deferred tax 
assets). In addition, the combined amount of term subordinated debt 
and intermediate-term preferred stock that may be treated as part of 
Tier 2 capital for risk-based capital purposes is limited to 50 
percent of Tier 1 capital. Amounts in excess of these limits may be 
issued but are not included in the calculation of the risk-based 
capital ratio. Supplementary capital elements (Tier 2) consist of: 
Allowance for loan and lease losses, up to a maximum of 1.25 percent 
of risk-weighted assets; cumulative perpetual preferred stock, long-
term preferred stock (original maturity of at least 20 years) and 
any related surplus; perpetual preferred stock (and any related 
surplus) where the dividend is reset periodically based, in whole or 
part, on the bank's current credit standing, regardless of whether 
the dividends are cumulative or noncumulative; hybrid capital 
instruments, including mandatory convertible debt securities; term 
subordinated debt and intermediate-term preferred stock (original 
average maturity of five years or more) and any related surplus; and 
net unrealized holding gains on equity securities (subject to the 
limitations discussed in paragraph I-2.A.2(f) of this section).
    (a) Allowance for loan and lease losses. (i) Allowances for loan 
and lease losses are reserves that have been established through a 
charge against earnings to absorb future

[[Page 77493]]

losses on loans or lease financing receivables. Allowances for loan 
and lease losses exclude ``allocated transfer risk reserves.'' \6\ 
and reserves created against identified losses.
---------------------------------------------------------------------------

    \6\ Allocated transfer risk reserves are reserves that have been 
established in accordance with section 905(a) of the International 
Lending Supervision Act of 1983 against certain assets whose value 
has been found by the U.S. supervisory authorities to have been 
significantly impaired by protracted transfer risk problems.
---------------------------------------------------------------------------

    (ii) This risk-based capital framework provides a phasedown 
during the transition period of the extent to which the allowance 
for loan and lease losses may be included in an institution's 
capital base. By year-end 1990, the allowance for loan and lease 
losses, as an element of supplementary capital, may constitute no 
more than 1.5 percent of risk-weighted assets and, by year-end 1992, 
no more than 1.25 percent of risk-weighted assets.\7\
---------------------------------------------------------------------------

    \7\ The amount of the allowance for loan and lease losses that 
may be included as a supplementary capital element is based on a 
percentage of gross risk-weighted assets. A bank may deduct reserves 
for loan and lease losses that are in excess of the amount permitted 
to be included in capital, as well as allocated transfer risk 
reserves, from gross risk-weighted assets when computing the 
denominator of the risk-based capital ratio.
---------------------------------------------------------------------------

    (b) Preferred stock. (i) Perpetual preferred stock is defined as 
preferred stock that does not have a maturity date, that cannot be 
redeemed at the option of the holder, and that has no other 
provisions that will require future redemption of the issue. Long-
term preferred stock includes limited-life preferred stock with an 
original maturity of 20 years or more, provided that the stock 
cannot be redeemed at the option of the holder prior to maturity, 
except with the prior approval of the FDIC.
    (ii) Cumulative perpetual preferred stock and long-term 
preferred stock qualify for inclusion in supplementary capital 
provided that the instruments can absorb losses while the issuer 
operates as a going concern (a fundamental characteristic of equity 
capital) and provided the issuer has the option to defer payment of 
dividends on these instruments. Given these conditions, and the 
perpetual or long-term nature of the instruments, there is no limit 
on the amount of these preferred stock instruments that may be 
included with Tier 2 capital.
    (iii) Noncumulative perpetual preferred stock where the dividend 
is reset periodically based, in whole or in part, on the bank's 
current credit standing, including auction rate, money market, or 
remarketable preferred stock, are also assigned to Tier 2 capital 
without limit, provided the above conditions are met.
    (c) Hybrid capital instruments. (i) Hybrid capital instruments 
include instruments that have certain characteristics of both debt 
and equity. In order to be included as supplementary capital 
elements, these instruments should meet the following criteria:
    (A) The instrument should be unsecured, subordinated to the 
claims of depositors and general creditors, and fully paid-up.
    (B) The instrument should not be redeemable at the option of the 
holder prior to maturity, except with the prior approval of the 
FDIC. This requirement implies that holders of such instruments may 
not accelerate the payment of principal except in the event of 
bankruptcy, insolvency, or reorganization.
    (C) The instrument should be available to participate in losses 
while the issuer is operating as a going concern. (Term subordinated 
debt would not meet this requirement.) To satisfy this requirement, 
the instrument should convert to common or perpetual preferred stock 
in the event that the sum of the undivided profits and capital 
surplus accounts of the issuer results in a negative balance.
    (D) The instrument should provide the option for the issuer to 
defer principal and interest payments if: the issuer does not report 
a profit in the preceding annual period, defined as combined profits 
(i.e., net income) for the most recent four quarters; and the issuer 
eliminates cash dividends on its common and preferred stock.
    (ii) Mandatory convertible debt securities, which are 
subordinated debt instruments that require the issuer to convert 
such instruments into common or perpetual preferred stock by a date 
at or before the maturity of the debt instruments, will qualify as 
hybrid capital instruments provided the maturity of these 
instruments is 12 years or less and the instruments meet the 
criteria set forth below for ``term subordinated debt.'' There is no 
limit on the amount of hybrid capital instruments that may be 
included within Tier 2 capital.
    (d) Term subordinated debt and intermediate-term preferred 
stock. The aggregate amount of term subordinated debt (excluding 
mandatory convertible debt securities) and intermediate-term 
preferred stock (including any related surplus) that may be treated 
as Tier 2 capital for risk-based capital purposes is limited to 50 
percent of Tier 1 capital. Term subordinated debt and intermediate-
term preferred stock should have an original average maturity of at 
least five years to qualify as supplementary capital and should not 
be redeemable at the option of the holder prior to maturity, except 
with the prior approval of the FDIC. For state nonmember banks, a 
``term subordinated debt'' instrument is an obligation other than a 
deposit obligation that:
    (i) Bears on its face, in boldface type, the following: This 
obligation is not a deposit and is not insured by the Federal 
Deposit Insurance Corporation;
    (ii)(A) Has a maturity of at least five years; or
    (B) In the case of an obligation or issue that provides for 
scheduled repayments of principal, has an average maturity of at 
least five years; provided that the Director of the Division of 
Supervision may permit the issuance of an obligation or issue with a 
shorter maturity or average maturity if the Director has determined 
that exigent circumstances require the issuance of such obligation 
or issue; provided further that the provisions of this paragraph 
I.A.2(d)(2) shall not apply to mandatory convertible debt 
obligations or issues;
    (iii) States expressly that the obligation:
    (A) Is subordinated and junior in right of payment to the 
issuing bank's obligations to its depositors and to the bank's other 
obligations to its general and secured creditors; and
    (B) Is ineligible as collateral for a loan by the issuing bank;
    (iv) Is unsecured;
    (v) States expressly that the issuing bank may not retire any 
part of its obligation without any prior written consent of the FDIC 
or other primary federal regulator; and
    (vi) Includes, if the obligation is issued to a depository 
institution, a specific waiver of the right of offset by the lending 
depository institution.
    (e) Subordinated debt obligations issued prior to December 2, 
1987 that satisfied the definition of the term ``subordinated note 
and debenture'' that was in effect prior to that date also will be 
deemed to be term subordinated debt for risk-based capital purposes. 
An optional redemption (``call'') provision in a subordinated debt 
instrument that is exercisable by the issuing bank in less than five 
years will not be deemed to constitute a maturity of less than five 
years, provided that the obligation otherwise has a stated 
contractual maturity of at least five years; the call is exercisable 
solely at the discretion or option of the issuing bank, and not at 
the discretion or option of the holder of the obligation; and the 
call is exercisable only with the express prior written consent of 
the FDIC under 12 U.S.C. 1828(i)(1) at the time early redemption or 
retirement is sought, and such consent has not been given in advance 
at the time of issuance of the obligation. Optional redemption 
provisions will be accorded similar treatment when determining the 
perpetual nature and/or maturity of preferred stock and other 
capital instruments.
    (f) Discount of limited-life supplementary capital instruments. 
As a limited-life capital instrument approaches maturity, the 
instrument begins to take on characteristics of a short-term 
obligation and becomes less like a component of capital. Therefore, 
for risk-based capital purposes, the outstanding amount of term 
subordinated debt and limited-life preferred stock eligible for 
inclusion in capital will be adjusted downward, or discounted, as 
the instruments approach maturity. Each limited-life capital 
instrument will be discounted by reducing the outstanding amount of 
the capital instrument eligible for inclusion as supplementary 
capital by a fifth of the original amount (less redemptions) each 
year during the instrument's last five years before maturity. Such 
instruments, therefore, will have no capital value when they have a 
remaining maturity of less than a year.
    (g) Unrealized gains on equity securities and unrealized gains 
(losses) on other assets. Up to 45 percent of pretax net unrealized 
holding gains (that is, the excess, if any, of the fair value over 
historical cost) on available-for-sale equity securities with 
readily determinable fair values may be included in supplementary 
capital. However, the FDIC may exclude all or a portion of these 
unrealized gains from Tier 2 capital if the FDIC determines that the 
equity securities are not prudently valued. Unrealized gains 
(losses) on other types of assets, such as bank premises and 
available-

[[Page 77494]]

for-sale debt securities, are not included in supplementary capital, 
but the FDIC may take these unrealized gains (losses) into account 
as additional factors when assessing a bank's overall capital 
adequacy.
    B. Deductions from Capital and Other Adjustments. Certain assets 
are deducted from a bank's capital base for the purpose of 
calculating the numerator of the risk-based capital ratio.\8\ These 
assets include:
---------------------------------------------------------------------------

    \8\ Any assets deducted from capital when computing the 
numerator of the risk-based capital ratio will also be excluded from 
risk-weighted assets when computing the denominator of the ratio.
---------------------------------------------------------------------------

    (1) All intangible assets other than mortgage servicing assets, 
nonmortgage servicing assets and purchased credit card 
relationships.\9\ These disallowed intangibles are deducted from the 
core capital (Tier 1) elements.
---------------------------------------------------------------------------

    \9\ In addition to mortgage servicing assets, nonmortgage 
servicing assets and purchased credit card relationships, certain 
other intangibles may be allowed if explicitly approved by the FDIC 
as part of the bank's regulatory capital on a specific case basis. 
In evaluating whether other types of intangibles should be 
recognized for regulatory capital purposes on a specific case basis, 
the FDIC will accord special attention to the general 
characteristics of the intangibles, including: (1) the separability 
of the intangible asset and the ability to sell it separate and 
apart from the bank or the bulk of the bank's assets, (2) the 
certainty that a readily identifiable stream of cash flows 
associated with the intangible asset can hold its value 
notwithstanding the future prospects of the bank, and (3) the 
existence of a market of sufficient depth to provide liquidity for 
the intangible asset.
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    (2) Investments in unconsolidated banking and finance 
subsidiaries.\10\ This includes any equity or debt capital 
investments in banking or finance subsidiaries if the subsidiaries 
are not consolidated for regulatory capital requirements.\11\ 
Generally, these investments include equity and debt capital 
securities and any other instruments or commitments that are deemed 
to be capital of the subsidiary. These investments are deducted from 
the bank's total (Tier 1 plus Tier 2) capital base.
---------------------------------------------------------------------------

    \10\ For risk-based capital purposes, these subsidiaries are 
generally defined as any company that is primarily engaged in 
banking or finance and in which the bank, either directly or 
indirectly, owns more than 50 percent of the outstanding voting 
stock but does not consolidate the company for regulatory capital 
purposes. In addition to investments in unconsolidated banking and 
finance subsidiaries, the FDIC may, on a case-by-case basis, deduct 
investments in associated companies or joint ventures, which are 
generally defined as any companies in which the bank, either 
directly or indirectly, owns 20 to 50 percent of the outstanding 
voting stock. Alternatively, the FDIC may, in certain cases, apply 
an appropriate risk-weighted capital charge against a bank's 
proportionate interest in the assets of associated companies and 
joint ventures. The definitions for subsidiaries, associated 
companies and joint ventures are contained in the instructions for 
the preparation of the Consolidated Reports of Condition and Income.
    \11\ Consolidation requirements for regulatory capital purposes 
generally follow the consolidation requirements set forth in the 
instructions for preparation of the consolidated Reports of 
Condition and Income. However, although investments in subsidiaries 
representing majority ownership in another federally-insured 
depository institution are not consolidated for purposes of the 
consolidated Reports of Condition and Income that are filed by the 
parent bank, they are generally consolidated for purposes of 
determining FDIC regulatory capital requirements. Therefore, 
investments in these depository institution subsidiaries generally 
will not be deducted for risk-based capital purposes; rather, assets 
and liabilities of such subsidiaries will be consolidated with those 
of the parent bank when calculating the risk-based capital ratio. In 
addition, although securities subsidiaries established pursuant to 
12 CFR 337.4 are consolidated for Report of Condition and Income 
purposes, they are not consolidated for regulatory capital purposes.
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    (3) Investments in securities subsidiaries established pursuant 
to 12 CFR 337.4. The FDIC may also consider deducting investments in 
other subsidiaries, either on a case-by-case basis or, as with 
securities subsidiaries, based on the general characteristics or 
functional nature of the subsidiaries.
    (4) Reciprocal holdings of capital instruments of banks that 
represent intentional cross-holdings by the banks. These holdings 
are deducted from the bank's total capital base.
    (5) Deferred tax assets in excess of the limit set forth in 
Sec.  325.5(g). These disallowed deferred tax assets are deducted 
from the core capital (Tier 1) elements. On a case-by-case basis, 
and in conjunction with supervisory examinations, other deductions 
from capital may also be required, including any adjustments deemed 
appropriate for assets classified as loss.

II. Procedures For Computing Risk-Weighted Assets

A. General Procedures

    1. Under the risk-based capital framework, a bank's balance 
sheet assets and credit equivalent amounts of off-balance sheet 
items are assigned to one of eight broad risk categories according 
to the obligor or, if relevant, the guarantor or the nature of the 
collateral. The aggregate dollar amount in each category is then 
multiplied by the risk weight assigned to that category. The 
resulting weighted values from each of the eight risk categories are 
added together and this sum is the risk-weighted assets total that, 
as adjusted,\12\ comprises the denominator of the risk-based capital 
ratio.
---------------------------------------------------------------------------

    \12\ Any asset deducted from a bank's capital accounts when 
computing the numerator of the risk-based capital ratio will also be 
excluded from risk-weighted assets when calculating the denominator 
for the ratio.
---------------------------------------------------------------------------

    2. The risk-weighted amounts for all off-balance sheet items are 
determined by a two-step process. First, the notional principal, or 
face value, amount of each off-balance sheet item generally is 
multiplied by a credit conversion factor to arrive at a balance 
sheet ``credit equivalent amount.'' Second, the credit equivalent 
amount generally is assigned to the appropriate risk category, like 
any balance sheet asset, according to the obligor or, if relevant, 
the guarantor or the nature of the collateral.
    3. The Director of the Division of Supervision and Consumer 
Protection (Director) of DSC may, on a case-by-case basis, determine 
the appropriate risk weight for any asset or credit equivalent 
amount that does not fit wholly within one of the risk categories 
set forth in this appendix E or that imposes risks on a bank that 
are not commensurate with the risk weight otherwise specified in 
this appendix E for the asset or credit equivalent amount. In 
addition, the Director of DSC may, on a case-by-case basis, 
determine the appropriate credit conversion factor for any off-
balance sheet item that does not fit wholly within one of the credit 
conversion factors set forth in this appendix E or that imposes 
risks on a bank that are not commensurate with the credit conversion 
factor otherwise specified in this appendix E for the off-balance 
sheet item. In making such a determination, the Director of DSC will 
consider the similarity of the asset or off-balance sheet item to 
assets or off-balance sheet items explicitly treated in sections 
II.B and II.C of this appendix E, as well as other relevant factors.

B. Other Considerations

    1. Indirect Holdings of Assets. Some of the assets on a bank's 
balance sheet may represent an indirect holding of a pool of assets; 
for example, mutual funds. An investment in shares of a mutual fund 
whose portfolio consists solely of various securities or money 
market instruments that, if held separately, would be assigned to 
different risk categories, generally is assigned to the risk 
category appropriate to the highest risk-weighted asset that the 
fund is permitted to hold in accordance with the stated investment 
objectives set forth in its prospectus. The bank may, at its option, 
assign the investment on a pro rata basis to different risk 
categories according to the investment limits in the fund's 
prospectus, but in no case will indirect holdings through shares in 
any mutual fund be assigned to a risk weight less than 20 percent. 
If the bank chooses to assign its investment on a pro rata basis, 
and the sum of the investment limits in the fund's prospectus 
exceeds 100 percent, the bank must assign risk weights in descending 
order. If, in order to maintain a necessary degree of short-term 
liquidity, a fund is permitted to hold an insignificant amount of 
its assets in short-term, highly liquid securities of superior 
credit quality that do not qualify for a preferential risk weight, 
such securities will generally be disregarded in determining the 
risk category to which the bank's holdings in the overall fund 
should be assigned. The prudent use of hedging instruments by a 
mutual fund to reduce the risk of its assets will not increase the 
risk weighting of the mutual fund investment. For example, the use 
of hedging instruments by a mutual fund to reduce the interest rate 
risk of its government bond portfolio will not increase the risk 
weight of that fund above the 20 percent category. Nonetheless, if 
the fund engages in any activities that appear speculative in nature 
or has any other characteristics that are inconsistent with the 
preferential risk weighting assigned to the fund's assets, holdings 
in the fund will be assigned to the 100 percent risk category.
    2. Collateral (a) Cash and securities issued or guaranteed by 
the United States, other OECD central Governments and U.S. 
Government-sponsored entities. In determining risk weights of 
various assets, the following forms of collateral are formally 
recognized under this appendix E: cash on

[[Page 77495]]

deposit in the lending bank; securities issued or guaranteed by the 
United States, other central governments of the OECD-based group of 
countries,\13\ U.S. Government agencies, and U.S. Government-
sponsored agencies. Claims fully secured by such collateral are 
assigned to the 20 percent risk category.\14\ The extent to which 
these securities are recognized as collateral for risk-based capital 
purposes is determined by their current market value. If a claim is 
partially secured, the portion of the claim that is not covered by 
the collateral is assigned to the risk category appropriate to the 
obligor or, if relevant, the guarantor.
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    \13\ Securities issued or guaranteed by OECD central governments 
are only recognized under the zero percent risk weight if they meet 
the collateral requirements of section II.C.1 of appendix E. The 
OECD-based group of countries comprises all full members of the 
Organization for Economic Cooperation and Development (OECD) 
regardless of entry date, as well as countries that have concluded 
special lending arrangements with the International Monetary Fund 
(IMF) associated with the IMF's General Arrangements to Borrow, but 
excludes any country that has rescheduled its external sovereign 
debt within the previous five years. As of November 1995, the OECD 
included the following countries: Australia, Austria, Belgium, 
Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, 
Italy, Japan, Luxembourg, Mexico, the Netherlands, New Zealand, 
Norway, Portugal, Spain, Sweden, Switzerland, Turkey, the United 
Kingdom and the United States; and Saudi Arabia had concluded 
special lending arrangements with the IMF associated with the IMF's 
General Arrangements to Borrow. A rescheduling of external sovereign 
debt generally would include any renegotiation of terms arising from 
a country's inability or unwillingness to meet its external debt 
service obligations, but generally would not include renegotiations 
of debt in the normal course of business, such as renegotiation to 
allow the borrower to take advantage of a decline in interest rates 
or other change in market conditions.
    \14\ However, claims on or guaranteed by qualifying securities 
firms may receive a zero percent risk weight if such claims are: (i) 
collateralized by cash or securities issued by an OECD central 
government (including the United States) and (ii) meet the other 
requirements of section II.C.1(c) of this appendix E. See footnote 
31.
---------------------------------------------------------------------------

    (b) Collateral that requires an external rating. The following 
forms of liquid and readily marketable financial collateral also are 
recognized: both short- and long-term debt securities that are 
either issued or guaranteed by sovereigns where either the sovereign 
or the issued debt security are externally rated at least than 
investment grade by a NRSRO; issued by non-sovereigns where the 
issued security is externally rated at least investment grade by a 
NRSRO; or securitization exposures rated at least investment grade 
by a NRSRO. Claims or portion of claims collateralized by financial 
collateral externally rated at least investment grade are assigned 
to the risk weight appropriate to the collateral's external rating 
as set forth in section II.C.9(a) and Tables F1 and F2, or section 
II.B.5 and Tables A and B.\15\ The extent to which externally rated 
securities are recognized as collateral for risk-based capital 
purposes is determined by their current market value. If a claim is 
partially secured, the pro rata portion of the claim that is not 
covered by the collateral is assigned to the risk category 
appropriate to the obligor or, if relevant, the guarantor. 
Notwithstanding Tables F1 and F2 there is a 20 percent risk weight 
floor on collateral.
---------------------------------------------------------------------------

    \15\ In the event that the external rating of a security used to 
collateralize a claim results in a higher risk weight than would 
have otherwise been assigned based on the claim's underlying asset 
type, obligor, or external rating, if applicable, then the lower 
risk weight appropriate to the underlying asset type or the obligor 
may be applied.
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    3. Guarantees (a) Guarantees of the United States, U.S. 
Government-sponsored entities, OECD state and local governments, and 
certain banking organizations. Guarantees of the United States, U.S. 
Government agencies, U.S. Government-sponsored agencies, state and 
local governments of the OECD-based group of countries, U.S. 
depository institutions, and foreign banks in OECD countries are 
recognized under this appendix E. If a claim is partially 
guaranteed, the portion of the claim that is not fully covered by 
the guarantee is assigned to the risk category appropriate to the 
obligor or, if relevant, the collateral.
    (b) Eligible guarantees by sovereigns and non-sovereigns. A 
claim backed by an eligible guarantee may be assigned to the risk 
weight in section II.C.9(a) and Table F1 of this appendix E 
corresponding to the eligible guarantor(s)' senior long-term debt 
rating or issuer rating, in the case of a sovereign. Portions of 
claims backed by an eligible guarantee may be assigned to the risk-
weight category appropriate to the external credit rating of the 
eligible guarantor(s)' senior long-term debt or issuer rating in 
accordance with section II.C.9(a) and Table F1 of this appendix E.
    4. Maturity. Maturity is generally not a factor in assigning 
items to risk categories with the exceptions of claims on non-OECD 
banks, commitments, and interest rate and foreign exchange rate 
related contracts. Except for commitments, short-term is defined as 
one year or less remaining maturity and long-term is defined as over 
one year remaining maturity. In the case of commitments, short-term 
is defined as one year or less original maturity and long-term is 
defined as over one year original maturity.
    5. Recourse, Direct Credit Substitutes, Residual Interests and 
Mortgage- and Asset-Backed Securities. For purposes of this section 
II.B.5 of this appendix E, the following definitions will apply.
    (a) Definitions. (i) Credit derivative means a contract that 
allows one party (``the protection purchaser'') to transfer the 
credit risk of an asset or off-balance sheet credit exposure to 
another party (the protection provider). The value of a credit 
derivative is dependent, at least in part, on the credit performance 
of the ``reference asset.''
    (ii) Credit-enhancing interest-only strip is defined in Sec.  
325.2(g).
    (iii) Credit-enhancing representations and warranties means 
representations and warranties that are made or assumed in 
connection with a transfer of assets (including loan servicing 
assets) and that obligate a bank to protect investors from losses 
arising from credit risk in the assets transferred or the loans 
serviced. Credit-enhancing representations and warranties include 
promises to protect a party from losses resulting from the default 
or nonperformance of another party or from an insufficiency in the 
value of the collateral. Credit-enhancing representations and 
warranties do not include:
    (A) Early default clauses and similar warranties that permit the 
return of, or premium refund clauses covering, 1-4 family 
residential first mortgage loans that qualify for a 50 percent risk 
weight for a period not to exceed 120 days from the date of 
transfer. These warranties may cover only those loans that were 
originated within 1 year of the date of transfer;
    (B) Premium refund clauses that cover assets guaranteed, in 
whole or in part, by the U.S. Government, a U.S. Government agency 
or a government-sponsored enterprise, provided the premium refund 
clauses are for a period not to exceed 120 days from the date of 
transfer; or
    (C) Warranties that permit the return of assets in instances of 
misrepresentation, fraud or incomplete documentation.
    (iv) Direct credit substitute means an arrangement in which a 
bank assumes, in form or in substance, credit risk associated with 
an on- or off-balance sheet credit exposure that was not previously 
owned by the bank (third-party asset) and the risk assumed by the 
bank exceeds the pro rata share of the bank's interest in the third-
party asset. If the bank has no claim on the third-party asset, then 
the bank's assumption of any credit risk with respect to the third 
party asset is a direct credit substitute. Direct credit substitutes 
include, but are not limited to:
    (A) Financial standby letters of credit, which includes any 
letter of credit or similar arrangement, however named or described, 
that support financial claims on a third party that exceeds a bank's 
pro rata share of losses in the financial claim;
    (B) Guarantees, surety arrangements, credit derivatives, and 
similar instruments backing financial claims;
    (C) Purchased subordinated interests or securities that absorb 
more than their pro rata share of credit losses from the underlying 
assets;
    (D) Credit derivative contracts under which the bank assumes 
more than its pro rata share of credit risk on a third party asset 
or exposure;
    (E) Loans or lines of credit that provide credit enhancement for 
the financial obligations of an account party;
    (F) Purchased loan servicing assets if the servicer: is 
responsible for credit losses associated with the loans being 
serviced; is responsible for making mortgage servicer cash advances 
(unless the advances are not direct credit substitutes because they 
meet the conditions specified in II.B.5 (a)(ix) of this appendix E), 
or makes or assumes credit-enhancing representations and warranties 
with respect to the loans serviced;
    (G) Clean-up calls on third party assets. Clean-up calls that 
are exercisable at the option of the bank (as servicer or as an 
affiliate of the servicer) when the pool balance is 10 percent or 
less of the original pool balance are not direct credit substitutes; 
and
    (v) Eligible ABCP liquidity facility means a liquidity facility 
supporting ABCP, in form or in substance, that is subject to an 
asset

[[Page 77496]]

quality test at the time of draw that precludes funding against 
assets that are 90 days or more past due or in default. In addition, 
if the assets that an eligible ABCP liquidity facility is required 
to fund against are externally rated assets or exposures at the 
inception of the facility, the facility can be used to fund only 
those assets or exposures that are externally rated investment grade 
at the time of funding. Notwithstanding the eligibility requirements 
set forth in the two preceding sentences, a liquidity facility will 
be considered an eligible ABCP liquidity facility if the assets that 
are funded under the liquidity facility and which do not meet the 
eligibility requirements are guaranteed, either conditionally or 
unconditionally, by the U.S. government or its agencies, or by the 
central government of an OECD country.
    (vi) External rating is defined above in the definitions to this 
appendix E.
    (vii) Face amount means the notional principal, or face value, 
amount of an off-balance sheet item; the amortized cost of an asset 
not held for trading purposes; and the fair value of a trading 
asset.
    (viii) Financial asset means cash or other monetary instrument, 
evidence of debt, evidence of an ownership interest in an entity, or 
a contract that conveys a right to receive or exchange cash or 
another financial instrument from another party.
    (ix) Financial standby letter of credit means a letter of credit 
or similar arrangement that represents an irrevocable obligation to 
a third-party beneficiary:
    (A) To receive money borrowed by, or advanced to, or for the 
account of, a second party (the account party), or
    (B) To make payment on behalf of the account party, in the event 
that the account party fails to fulfill its obligation to the 
beneficiary.
    (x) Liquidity facility means a legally binding commitment to 
provide liquidity support to ABCP by lending to, or purchasing 
assets from, any structure, program, or conduit in the event that 
funds are required to repay maturing ABCP.
    (xi) Mortgage servicer cash advance means funds that a 
residential mortgage servicer advances to ensure an uninterrupted 
flow of payments, including advances made to cover foreclosure costs 
or other expenses to facilitate the timely collection of the loan. A 
mortgage servicer cash advance is not a recourse obligation or a 
direct credit substitute if:
    (A) The mortgage servicer is entitled to full reimbursement and 
this right is not subordinated to other claims on the cash flows 
from the underlying asset pool; or
    (B) For any one loan, the servicer's obligation to make 
nonreimbursable advances is contractually limited to an 
insignificant amount of the outstanding principal of that loan.
    (xii) Nationally recognized statistical rating organization 
(NRSRO) means an entity recognized by the Division of Market 
Regulation of the Securities and Exchange Commission (or any 
successor Division) (Commission) as a nationally recognized 
statistical rating organization for various purposes, including the 
Commission's uniform net capital requirements for brokers and 
dealers (17 CFR 240.15c3-1).
    (xiii) Recourse means an arrangement in which a bank retains, in 
form or in substance, of any credit risk directly or indirectly 
associated with an asset it has sold (in accordance with generally 
accepted accounting principles) that exceeds a pro rata share of the 
bank's claim on the asset. If a bank has no claim on an asset it has 
sold, then the retention of any credit risk is recourse. A recourse 
obligation typically arises when an institution transfers assets in 
a sale and retains an obligation to repurchase the assets or absorb 
losses due to a default of principal or interest or any other 
deficiency in the performance of the underlying obligor or some 
other party. Recourse may exist implicitly where a bank provides 
credit enhancement beyond any contractual obligation to support 
assets it has sold. The following are examples of recourse 
arrangements:
    (A) Credit-enhancing representations and warranties made on the 
transferred assets;
    (B) Loan servicing assets retained pursuant to an agreement 
under which the bank: is responsible for losses associated with the 
loans being serviced; or is responsible for making mortgage servicer 
cash advances (unless the advances are not a recourse obligation 
because they meet the conditions specified in section II.B.5(a)(xi) 
of this appendix E).
    (C) Retained subordinated interests that absorb more than their 
pro rata share of losses from the underlying assets;
    (D) Assets sold under an agreement to repurchase, if the assets 
are not already included on the balance sheet;
    (E) Loan strips sold without contractual recourse where the 
maturity of the transferred portion of the loan is shorter than the 
maturity of the commitment under which the loan is drawn;
    (F) Credit derivative contracts under which the bank retains 
more than its pro rata share of credit risk on transferred assets;
    (G) Clean-up calls at inception that are greater than 10 percent 
of the balance of the original pool of transferred loans. Clean-up 
calls that are 10 percent or less of the original pool balance that 
are exercisable at the option of the bank are not recourse 
arrangements; and
    (H) Liquidity facilities that provide liquidity support to ABCP 
(other than eligible ABCP liquidity facilities).
    (xiv) Residual interest means any on-balance sheet asset that 
represents an interest (including a beneficial interest) created by 
a transfer that qualifies as a sale (in accordance with generally 
accepted accounting principles (GAAP)) of financial assets, whether 
through a securitization or otherwise, and that exposes a bank to 
credit risk directly or indirectly associated with the transferred 
assets that exceeds a pro rata share of the bank's claim on the 
assets, whether through subordination provisions or other credit 
enhancement techniques. Residual interests generally include credit-
enhancing I/Os, spread accounts, cash collateral accounts, retained 
subordinated interests, other forms of over-collateralization, and 
similar assets that function as a credit enhancement. Residual 
interests further include those exposures that, in substance, cause 
the bank to retain the credit risk of an asset or exposure that had 
qualified as a residual interest before it was sold. Residual 
interests generally do not include interests purchased from a third 
party, except that purchased credit-enhancing I/Os are residual 
interests for purposes of the risk-based capital treatment in this 
appendix.
    (xv) Risk participation means a participation in which the 
originating party remains liable to the beneficiary for the full 
amount of an obligation (e.g., a direct credit substitute) 
notwithstanding that another party has acquired a participation in 
that obligation.
    (xvi) Securitization means the pooling and repackaging by a 
special purpose entity of assets or other credit exposures into 
securities that can be sold to investors. Securitization includes 
transactions that create stratified credit risk positions whose 
performance is dependent upon an underlying pool of credit 
exposures, including loans and commitments.
    (xvii) Sponsor means a bank that establishes an ABCP program; 
approves the sellers permitted to participate in the program; 
approves the asset pools to be purchased by the program; or 
administers the ABCP program by monitoring the assets, arranging for 
debt placement, compiling monthly reports, or ensuring compliance 
with the program documents and with the program's credit and 
investment policy.
    (xviii) Structured finance program means a program where 
receivable interests and asset-backed securities issued by multiple 
participants are purchased by a special purpose entity that 
repackages those exposures into securities that can be sold to 
investors. Structured finance programs allocate credit risks, 
generally, between the participants and credit enhancement provided 
to the program.
    (xix) Traded position means a position that has an external 
rating and is retained, assumed or issued in connection with an 
asset securitization, where there is a reasonable expectation that, 
in the near future, the rating will be relied upon by unaffiliated 
investors to purchase the position; or an unaffiliated third party 
to enter into a transaction involving the position, such as a 
purchase, loan, or repurchase agreement.
    (b) Credit equivalent amounts and risk weights of recourse 
obligations and direct credit substitutes--(i) General rule for 
determining the credit-equivalent amount. Except as otherwise 
provided, the credit-equivalent amount for a recourse obligation or 
direct credit substitute is the full amount of the credit-enhanced 
assets for which the bank directly or indirectly retains or assumes 
credit risk multiplied by a 100% conversion factor. Thus, a bank 
that extends a partial direct credit substitute, e.g., a financial 
standby letter of credit that absorbs the first 10 percent of loss 
on a transaction, must maintain capital against the full amount of 
the assets being supported.
    (ii) Risk-weight factor. To determine the bank's risk-weighted 
assets for an off-balance sheet recourse obligation or a direct 
credit substitute, the credit equivalent amount is

[[Page 77497]]

assigned to the risk category appropriate to the obligor in the 
underlying transaction, after considering any associated guarantees 
or collateral. For a direct credit substitute that is an on-balance 
sheet asset, e.g., a purchased subordinated security, a bank must 
calculate risk-weighted assets using the amount of the direct credit 
substitute and the full amount of the assets it supports, i.e., all 
the more senior positions in the structure. The treatment covered in 
this paragraph (ii) is subject to the low-level exposure rule 
provided in section II.B.5(h)(i) of this appendix E.
    (c) Credit equivalent amount and risk weight of participations 
in, and syndications of, direct credit substitutes. Subject to the 
low-level exposure rule provided in section II.B.5(h)(i) of this 
appendix E, the credit equivalent amount for a participation 
interest in, or syndication of, a direct credit substitute 
(excluding purchased credit-enhancing interest-only strips) is 
calculated and risk weighted as follows:
    (i) Treatment for direct credit substitutes for which a bank has 
conveyed a risk participation. In the case of a direct credit 
substitute in which a bank has conveyed a risk participation, the 
full amount of the assets that are supported by the direct credit 
substitute is converted to a credit equivalent amount using a 100% 
conversion factor. However, the pro rata share of the credit 
equivalent amount that has been conveyed through a risk 
participation is then assigned to whichever risk-weight category is 
lower: the risk-weight category appropriate to the obligor in the 
underlying transaction, after considering any associated guarantees 
or collateral, or the risk-weight category appropriate to the party 
acquiring the participation. The pro rata share of the credit 
equivalent amount that has not been participated out is assigned to 
the risk-weight category appropriate to the obligor guarantor, or 
collateral. For example, the pro rata share of the full amount of 
the assets supported, in whole or in part, by a direct credit 
substitute conveyed as a risk participation to a U.S. domestic 
depository institution or an OECD bank is assigned to the 20 percent 
risk category.\16\
---------------------------------------------------------------------------

    \16\ A risk participation with a remaining maturity of one year 
or less that is conveyed to a non-OECD bank is also assigned to the 
20 percent risk category.
---------------------------------------------------------------------------

    (ii) Treatment for direct credit substitutes in which the bank 
has acquired a risk participation. In the case of a direct credit 
substitute in which the bank has acquired a risk participation, the 
acquiring bank's pro rata share of the direct credit substitute is 
multiplied by the full amount of the assets that are supported by 
the direct credit substitute and converted using a 100% credit 
conversion factor. The resulting credit equivalent amount is then 
assigned to the risk-weight category appropriate to the obligor in 
the underlying transaction, after considering any associated 
guarantees or collateral.
    (iii) Treatment for direct credit substitutes related to 
syndications. In the case of a direct credit substitute that takes 
the form of a syndication where each party is obligated only for its 
pro rata share of the risk and there is no recourse to the 
originating entity, each bank's credit equivalent amount will be 
calculated by multiplying only its pro rata share of the assets 
supported by the direct credit substitute by a 100% conversion 
factor. The resulting credit equivalent amount is then assigned to 
the risk-weight category appropriate to the obligor in the 
underlying transaction, after considering any associated guarantees 
or collateral.
    (d) Positions with external ratings: credit-equivalent amounts 
and risk weights.--(i) Traded positions. With respect to a recourse 
obligation, direct credit substitute, residual interest (other than 
a credit-enhancing interest-only strip) or mortgage- or asset-backed 
security that is a ``traded position'' and that has received an 
external rating on a long-term position that is one grade below 
investment grade or better or a short-term position that is 
investment grade, the bank may multiply the face amount of the 
position by the appropriate risk weight, determined in accordance 
with Table A or B of this appendix E, as appropriate.\17\ If a 
traded position receives more than one external rating, the lowest 
rating will apply and that external rating must apply to the claim 
or exposure in its entirety. Thus, for banks that hold split or 
partially-rated instruments, the risk weight that corresponds to the 
lowest component rating will apply to the entire exposure. For 
example, a purchased subordinated security where the principal 
component is rated BBB, but the interest component is rated B, will 
be subject to the gross-up treatment accorded to residual interests 
rated B or lower. Similarly, if a portion of an instrument is 
unrated, the entire position will be treated as if it were unrated. 
The FDIC reserves the authority to override the use of certain 
ratings or the ratings on certain instruments, either on a case-by-
case basis or through broader supervisory policy, if necessary or 
appropriate to address the risk that an instrument poses to a bank.
---------------------------------------------------------------------------

    \17\ Stripped mortgage-backed securities and similar 
instruments, such as interest-only strips that are not credit-
enhancing and principal-only strips, must be assigned to the 100% 
risk category.

 Table A.--Risk Weights for Long-Term External Ratings of Securitization
                                Exposures
------------------------------------------------------------------------
                                                            Risk weight
    Long-term rating category             Examples           (percent)
------------------------------------------------------------------------
Highest investment grade rating..  AAA..................              20
Second-highest investment grade    AA...................              20
 rating.
Third-highest investment grade     A....................              35
 rating.
Lowest-investment grade rating--   BBB+.................              50
 plus.
Lowest-investment grade rating--   BBB..................              75
 naught.
Lowest-investment grade rating--   BBB-.................             100
 negative.
One category below investment      BB+, BB..............             200
 grade--plus & naught.
One category below investment      BB-..................             200
 grade--negative.
Two or more categories below       B, CCC...............      Dollar for
 investment grade.                                                Dollar
Unrated..........................  n/a                        Dollar for
                                                                  Dollar
------------------------------------------------------------------------


Table B.--Risk Weights For Short-Term External Ratings of Securitization
                                Exposures
------------------------------------------------------------------------
                                                            Risk weight
    Short-term rating category            Examples           (percent)
------------------------------------------------------------------------
Highest investment grade rating..  A-1, P-1.............              20
Second-highest investment grade    A-2, P-2.............              35
 rating.
Lowest investment grade rating...  A-3, P-3.............              75
Unrated..........................  n/a                    ..............
------------------------------------------------------------------------


[[Page 77498]]

    (ii) Non-traded positions. A recourse obligation, direct credit 
substitute, residual interest (but not a credit-enhancing interest-
only strip) or mortgage- or asset-backed security extended in 
connection with a securitization that is not a ``traded position'' 
may be assigned a risk weight in accordance with section 
II.B.5(d)(i) of this appendix E if:
    (A) It has been externally rated by more than one NRSRO;
    (B) It has received an external rating on a long-term position 
that is one category below investment grade or better or a short-
term position that is investment grade by all NRSROs providing a 
rating;
    (C) The ratings are publicly available; and
    (D) The ratings are based on the same criteria used to rate 
traded positions. If the ratings are different, the lowest rating 
will determine the risk category to which the recourse obligation, 
direct credit substitute, residual interest, or mortgage- or asset-
backed security will be assigned.
    (e) Senior positions not externally rated. For a recourse 
obligation, direct credit substitute, residual interest or mortgage-
or asset-backed security that is not externally rated but is senior 
in all features to a traded position (including collateralization 
and maturity), a bank may apply a risk weight to the face amount of 
the senior position in accordance with section II.B.5(d)(i) of this 
appendix E, based upon the risk weight of the traded position, 
subject to any current or prospective supervisory guidance and the 
bank satisfying the FDIC that this treatment is appropriate. This 
section will apply only if the traded position provides substantial 
credit support for the entire life of the unrated position.
    (f) Residual interests--(i) Concentration limit on credit-
enhancing interest-only strips. In addition to the capital 
requirement provided by section II.B.5(f)(ii) of this appendix E, a 
bank must deduct from Tier 1 capital the face amount of all credit-
enhancing interest-only strips in excess of 25 percent of Tier 1 
capital in accordance with Sec.  325.5(f)(3).
    (ii) Credit-enhancing interest-only strip capital requirement. 
After applying the concentration limit to credit-enhancing interest-
only strips in accordance with Sec.  325.5(f)(3), a bank must 
maintain risk-based capital for a credit-enhancing interest-only 
strip, equal to the remaining face amount of the credit-enhancing 
interest-only strip (net of the remaining proportional amount of any 
existing associated deferred tax liability recorded on the balance 
sheet), even if the amount if risk-based capital required to be 
maintained exceeds the full risk-based capital requirement for the 
assets transferred. Transactions that, in substance, result in the 
retention of credit risk associated with a transferred credit-
enhancing interest-only strip will be treated as if the credit-
enhancing interest-only strip was retained by the bank and not 
transferred.
    (iii) Other residual interests capital requirement. Except as 
otherwise provided in section II.B.5(d) or (e) of this appendix E, a 
bank must maintain risk-based capital for a residual interest 
(excluding a credit-enhancing interest-only strip) equal to the face 
amount of the residual interest (net of any existing associated 
deferred tax liability recorded on the balance sheet), even if the 
amount of risk-based capital required to be maintained exceeds the 
full risk-based capital requirement for the assets transferred. 
Transactions that, in substance, result in the retention of credit 
risk associated with a transferred residual interest will be treated 
as if the residual interest was retained by the bank and not 
transferred.
    (iv) Residual interests and other recourse obligations. Where 
the aggregate capital requirement for residual interests (including 
credit-enhancing interest-only strips) and recourse obligations 
arising from the same transfer of assets exceed the full risk-based 
capital requirement for assets transferred, a bank must maintain 
risk-based capital equal to the greater of the risk-based capital 
requirement for the residual interest as calculated under sections 
II.B.5(f)(ii) through (iii) of this appendix E or the full risk-
based capital requirement for the assets transferred.
    (g) Positions that are not rated by an NRSRO. A bank's position 
(other than a residual interest) in a securitization or structured 
finance program that is not rated by an NRSRO may be risk-weighted 
based on the bank's determination of the credit rating of the 
position, as specified in Table C of this appendix E, multiplied by 
the face amount of the position. In order to qualify for this 
treatment, the bank's system for determining the credit rating of 
the position must meet one of the three alternative standards set 
out in section II.B.5(g)(i) through (iii) of this appendix E. Table 
C

------------------------------------------------------------------------
                                                            Risk weight
        Rating category                  Examples            (percent)
------------------------------------------------------------------------
Investment grade...............  BBB or other...........             100
One category below investment    BB.....................             200
 grade.
------------------------------------------------------------------------

    (i) Internal risk rating used for asset-backed programs. A bank 
extends a direct credit substitute (but not a purchased credit-
enhancing interest-only strip) to an asset-backed commercial paper 
program sponsored by the bank and the bank is able to demonstrate to 
the satisfaction of the FDIC, prior to relying upon its use, that 
the bank's internal credit risk rating system is adequate. Adequate 
internal credit risk rating systems usually contain the following 
criteria: \18\
---------------------------------------------------------------------------

    \18\ The adequacy of a bank's use of its internal credit risk 
system must be demonstrated to the FDIC considering the criteria 
listed on this section and the size and complexity of the credit 
exposures assumed by the bank.
---------------------------------------------------------------------------

    (A) The internal credit risk rating system is an integral part 
of the bank's risk management system that explicitly incorporates 
the full range of risks arising form a bank's participation in 
securitization activities;
    (B) Internal credit ratings are linked to measurable outcomes, 
such as the probability that the position will experience any loss, 
the position's expected loss given default, and the degree of 
variance in losses given default on that position;
    (C) The internal credit risk rating system must separately 
consider the risk associated with the underlying loans or borrowers, 
and the risk associated with the structure of a particular 
securitization transaction;
    (D) The internal credit risk rating system identifies gradations 
of risk among ``pass'' assets and other risk positions;
    (E) The internal credit risk rating system must have clear, 
explicit criteria (including for subjective factors), that are used 
to classify assets into each internal risk grade;
    (F) The bank must have independent credit risk management or 
loan review personnel assigning or reviewing the credit risk 
ratings;
    (G) An internal audit procedure should periodically verify that 
internal risk ratings are assigned in accordance with the bank's 
established criteria;
    (H) The bank must monitor the performance of the internal credit 
risk ratings assigned to nonrated, nontraded direct credit 
substitutes over time to determine the appropriateness of the 
initial credit risk rating assignment and adjust individual credit 
risk ratings, or the overall internal credit risk ratings system, as 
needed; and
    (I) The internal credit risk rating system must make credit risk 
rating assumptions that are consistent with, or more conservative 
than, the credit risk rating assumptions and methodologies of 
NRSROs.
    (ii) Program Ratings. A bank extends a direct credit substitute 
or retains a recourse obligation (but not a residual interest) in 
connection with a structured finance program and an NRSRO has 
reviewed the terms of the program and stated a rating for positions 
associated with the program. If the program has options for 
different combinations of assets, standards, internal credit 
enhancements and other relevant factors, and the NRSRO specified 
ranges of rating categories to them, the bank may apply the rating 
category applicable to the option that corresponds to the bank's 
position. In order to rely on a program rating, the bank must 
demonstrate to the FDIC's satisfaction that the credit risk rating 
assigned to the program meets the same standards generally used by 
NRSROs for rating traded positions. The bank must also demonstrate 
to the FDIC's satisfaction that the criteria underlying the NRSRO's 
assignment of ratings for the program are satisfied for the 
particular position issued by the bank. If a bank participates in a 
securitization sponsored by another party, the FDIC may authorize 
the bank to use this approach based

[[Page 77499]]

on a program rating obtained by the sponsor of the program.
    (iii) Computer Program. A bank is using an acceptable credit 
assessment computer program that has been developed by an NRSRO to 
determine the rating of a direct credit substitute or recourse 
obligation (but not a residual interest) extended in connection with 
a structured finance program. In order to rely on the rating 
determined by the computer program, the bank must demonstrate to the 
FDIC's satisfaction that ratings under the program correspond 
credibly and reliably with the ratings of traded positions. The bank 
must also demonstrate to the FDIC's satisfaction the credibility of 
the program in financial markets, the reliability of the program in 
assessing credit risk, the applicability of the program to the 
bank's position, and the proper implementation of the program.
    (h) Limitations on risk-based capital requirements--(i) Low-
level exposure rule. If the maximum exposure to loss retained or 
assumed by a bank in connection with a recourse obligation, a direct 
credit substitute, or a residual interest is less than the effective 
risk-based capital requirement for the credit-enhanced assets, the 
risk-based capital required under this appendix E is limited to the 
bank's maximum contractual exposure, less any recourse liability 
account established in accordance with generally accepted accounting 
principles. This limitation does not apply when a bank provides 
credit enhancement beyond any contractual obligation to support 
assets it has sold.
    (ii) Mortgage-related securities or participation certificates 
retained in a mortgage loan swap. If a bank holds a mortgage-related 
security or a participation certificate as a result of a mortgage 
loan swap with recourse, capital is required to support the recourse 
obligation plus the percentage of the mortgage-related security or 
participation certificate that is not covered by the recourse 
obligation. The total amount of capital required for the on-balance 
sheet asset and the recourse obligation, however, is limited to the 
capital requirement for the underlying loans, calculated as if the 
bank continued to hold these loans as an on-balance sheet asset.
    (iii) Related on-balance sheet assets. If a recourse obligation 
or direct credit substitute also appears as a balance sheet asset, 
the asset is risk-weighted only under this section II.B.5 of this 
appendix E, except in the case of loan servicing assets and similar 
arrangements with embedded recourse obligations or direct credit 
substitutes. In that case, the on-balance sheet servicing assets and 
the related recourse obligations or direct credit substitutes must 
both be separately risk weighted and incorporated into the risk-
based capital calculation.
    (i) Alternative Capital Calculation for Small Business 
Obligations.
    (i) Definitions. For purposes of this section II.B.5(i):
    (A) Qualified bank means a bank that: is well capitalized as 
defined in Sec.  325.103(b)(1) without applying the capital 
treatment described in this section II.B.5(i), or is adequately 
capitalized as defined in Sec.  325.103(b)(2) without applying the 
capital treatment described in this section II.B.5(i) and has 
received written permission by order of the FDIC to apply the 
capital treatment described in this section II.B.5(i).
    (B) Small business means a business that meets the criteria for 
a small business concern established by the Small Business 
Administration in 13 CFR part 121 pursuant to 15 U.S.C. 632.
    (ii) Capital and reserve requirements. Notwithstanding the risk-
based capital treatment outlined in any other paragraph (other than 
paragraph (i) of this section II.B.5), with respect to a transfer 
with recourse of a small business loan or a lease to a small 
business of personal property that is a sale under generally 
accepted accounting principles, and for which the bank establishes 
and maintains a non-capital reserve under generally accepted 
accounting principles sufficient to meet the reasonable estimated 
liability of the bank under the recourse arrangement; a qualified 
bank may elect to include only the face amount of its recourse in 
its risk-weighted assets for purposes of calculating the bank's 
risk-based capital ratio.
    (iii) Limit on aggregate amount of recourse. The total 
outstanding amount of recourse retained by a qualified bank with 
respect to transfers of small business loans and leases to small 
businesses of personal property and included in the risk-weighted 
assets of the bank as described in section II.B.5(i)(ii) of this 
appendix E may not exceed 15 percent of the bank's total risk-based 
capital, unless the FDIC specifies a greater amount by order.
    (iv) Bank that ceases to be qualified or that exceeds aggregate 
limit. If a bank ceases to be a qualified bank or exceeds the 
aggregate limit in section II.B.5(i)(iii) of this appendix E, the 
bank may continue to apply the capital treatment described in 
section II.B.5(i)(ii) of this appendix E to transfers of small 
business loans and leases to small businesses of personal property 
that occurred when the bank was qualified and did not exceed the 
limit.
    (v) Prompt correction action not affected. (A) A bank shall 
compute its capital without regard to this section II.B.5(i) for 
purposes of prompt corrective action (12 U.S.C. 1831o) unless the 
bank is a well capitalized bank (without applying the capital 
treatment described in this section II.B.5(i)) and, after applying 
the capital treatment described in this section II.B.5(i), the bank 
would be well capitalized.
    (B) A bank shall compute its capital without regard to this 
section II.B.5(i) for purposes of 12 U.S.C. 1831o(g) regardless of 
the bank's capital level.
    6. Nonfinancial equity investments. (a) General. A bank must 
deduct from its Tier 1 capital the sum of the appropriate percentage 
(as determined below) of the adjusted carrying value of all 
nonfinancial equity investments held by the bank or by its direct or 
indirect subsidiaries. For purposes of this section II.B.6, 
investments held by a bank include all investments held directly or 
indirectly by the bank or any of its subsidiaries.
    (b) Scope of nonfinancial equity investments. A nonfinancial 
equity investment means any equity investment held by the bank in a 
nonfinancial company: through a small business investment company 
(SBIC) under section 302(b) of the Small Business Investment Act of 
1958 (15 U.S.C. 682(b)); \19\ under the portfolio investment 
provisions of Regulation K issued by the Board of Governors of the 
Federal Reserve System (12 CFR 211.8(c)(3)); or under section 24 of 
the Federal Deposit Insurance Act (12 U.S.C. 1831a), other than an 
investment held in accordance with section 24(f) of that Act.\20\ A 
nonfinancial company is an entity that engages in any activity that 
has not been determined to be permissible for the bank to conduct 
directly, or to be financial in nature or incidental to financial 
activities under section 4(k) of the Bank Holding Company Act (12 
U.S.C. 1843(k)).
---------------------------------------------------------------------------

    \19\ An equity investment made under section 302(b) of the Small 
Business Investment Act of 1958 in a SBIC that is not consolidated 
with the bank is treated as a nonfinancial equity investment.
    \20\ The Board of Directors of the FDIC, acting directly, may, 
in exceptional cases and after a review of the proposed activity, 
permit a lower capital deduction for investments approved by the 
Board of Directors under section 24 of the FDI Act so long as the 
bank's investments under section 24 and SBIC investments represent, 
in the aggregate, less than 15 percent of the Tier 1 capital of the 
bank. The FDIC reserves the authority to impose higher capital 
charges on any investment where appropriate.
---------------------------------------------------------------------------

    (c) Amount of deduction from core capital. (i) The bank must 
deduct from its Tier 1 capital the sum of the appropriate 
percentages, as set forth in Table D following this paragraph, of 
the adjusted carrying value of all nonfinancial equity investments 
held by the bank. The amount of the percentage deduction increases 
as the aggregate amount of nonfinancial equity investments held by 
the bank increases as a percentage of the bank's Tier 1 capital.

[[Page 77500]]



         Table D.--Deduction for Nonfinancial Equity Investments
------------------------------------------------------------------------
                                                          Deduction from
                                                          Tier 1 Capital
                                                               (as a
  Aggregate adjusted carrying value of all nonfinancial    percentage of
  equity investments held directly or indirectly by the    the adjusted
bank (as a percentage of the Tier 1 capital of the bank)  carrying value
                           \1\                                of the
                                                            investment)
                                                             (percent)
------------------------------------------------------------------------
Less than 15 percent....................................               8
15 percent to 24.99 percent.............................              12
25 percent and above....................................              25
------------------------------------------------------------------------
\1\ For purposes of calculating the adjusted carrying value of
  nonfinancial equity investments as a percentage of Tier 1 capital.
  Tier 1 capital is defined as the sum of core capital elements net of
  goodwill and net of all identifiable intangible assets other than
  mortgage servicing assets, non-mortgage servicing assets and purchased
  credit card relationships, but prior to the deduction for any
  disallowed mortgage servicing assets, any disallowed nonmortgage
  servicing assets, any disallowed purchased credit card relationships,
  any disallowed credit-enhancing interest-only strips (both purchased
  and retained), any disallowed deferred tax assets, and any
  nonfinancial equity investments.

    (ii) These deductions are applied on a marginal basis to the 
portions of the adjusted carrying value of nonfinancial equity 
investments that fall within the specified ranges of the parent 
bank's Tier 1 capital. For example, if the adjusted carrying value 
of all nonfinancial equity investments held by a bank equals 20 
percent of the Tier 1 capital of the bank, then the amount of the 
deduction would be 8 percent of the adjusted carrying value of all 
investments up to 15 percent of the bank's Tier capital, and 12 
percent of the adjusted carrying value of all investments in excess 
of 15 percent of the bank's Tier 1 capital.
    (iii) The total adjusted carrying value of any nonfinancial 
equity investment that is subject to deduction under this paragraph 
is excluded from the bank's risk-weighted assets for purposes of 
computing the denominator of the bank's risk-based capital ratio and 
from total assets for purposes of calculating the denominator of the 
leverage ratio.\21\
---------------------------------------------------------------------------

    \21\ For example, if 8 percent of the adjusted carrying value of 
a nonfinancial equity investment is deducted from Tier 1 capital, 
the entire adjusted carrying value of the investment will be 
excluded from both risk-weighted assets and total assets in 
calculating the respective denominators for the risk-based capital 
and leverage ratios.
---------------------------------------------------------------------------

    (iv) This appendix E establishes minimum risk-based capital 
ratios and banks are at all times expected to maintain capital 
commensurate with the level and nature of the risks to which they 
are exposed. The risk to a bank from nonfinancial equity investments 
increases with its concentration in such investments and strong 
capital levels above the minimum requirements are particularly 
important when a bank has a high degree of concentration in 
nonfinancial equity investments (e.g., in excess of 50 percent of 
Tier 1 capital). The FDIC intends to monitor banks and apply 
heightened supervision to equity investment activities as 
appropriate, including where the bank has a high degree of 
concentration in nonfinancial equity investments, to ensure that 
each bank maintains capital levels that are appropriate in light of 
its equity investment activities. The FDIC also reserves authority 
to impose a higher capital charge in any case where the 
circumstances, such as the level of risk of the particular 
investment or portfolio of investments, the risk management systems 
of the bank, or other information, indicate that a higher minimum 
capital requirement is appropriate.
    (d) SBIC investments. (i) No deduction is required for 
nonfinancial equity investments that are held by a bank through one 
or more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank to the extent that all 
such investments, in the aggregate, do not exceed 15 percent of the 
bank's Tier 1 capital. Any nonfinancial equity investment that is 
held through an SBIC or in an SBIC and that is not required to be 
deducted from Tier 1 capital under this section II.B.6(d) will be 
assigned a 100 percent risk-weight and included in the bank's 
consolidated risk-weighted assets.\22\
---------------------------------------------------------------------------

    \22\ If a bank has an investment in a SBIC that is consolidated 
for accounting purposes but that is not wholly owned by the bank, 
the adjusted carrying value of the bank's nonfinancial equity 
investments through the SBIC is equal to the bank's proportionate 
share of the adjusted carrying value of the SBIC's investments in 
nonfinancial companies. The remainder of the SBIC's adjusted 
carrying value (i.e., the minority interest holders' proportionate 
share) is excluded from the risk-weighted assets of the bank. If a 
bank has an investment in a SBIC that is not consolidated for 
accounting purposes and has current information that identifies the 
percentage of the SBIC's assets that are equity investments in 
nonfinancial companies, the bank may reduce the adjusted carrying 
value of its investment in the SBIC proportionately to reflect the 
percentage of the adjusted carrying value of the SBIC's assets that 
are not equity investments in nonfinancial companies. If a bank 
reduces the adjusted carrying value of its investment in a non-
consolidated SBIC to reflect financial investments of the SBIC, the 
amount of the adjustment will be risk-weighted at 100 percent and 
included in the bank's risk-weighted assets.
---------------------------------------------------------------------------

    (ii) To the extent the adjusted carrying value of all 
nonfinancial equity investments that a bank holds through one or 
more SBICs that are consolidated with the bank or in one or more 
SBICs that are not consolidated with the bank exceeds, in the 
aggregate, 15 percent of the bank's Tier 1 capital, the appropriate 
percentage of such amounts (as set forth in the table in section 
II.B.6(c)(i)) must be deducted from the bank's common stockholders' 
equity in determining the bank's Tier 1 capital. In addition, the 
aggregate adjusted carrying value of all nonfinancial equity 
investments held by a bank through a consolidated SBIC and in a non-
consolidated SBIC (including any investments for which no deduction 
is required) must be included in determining, for purposes of the 
table in section II.B.6(c)(i), the total amount of nonfinancial 
equity investments held by the bank in relation to its Tier 1 
capital.
    (e) Transition provisions. No deduction under this section 
II.B.6 is required to be made with respect to the adjusted carrying 
value of any nonfinancial equity investment (or portion of such an 
investment) that was made by the bank prior to March 13, 2000, or 
that was made by the bank after such date pursuant to a binding 
written commitment \23\ entered into prior to March 13, 2000, 
provided that in either case the bank has continuously held the 
investment since the relevant investment date.\24\ For purposes of 
this section II.B.6(e) a nonfinancial equity investment made prior 
to March 13, 2000, includes any shares or other interests

[[Page 77501]]

received by the bank through a stock split or stock dividend on an 
investment made prior to March 13, 2000, provided the bank provides 
no consideration for the shares or interests received and the 
transaction does not materially increase the bank's proportional 
interest in the company. The exercise on or after March 13, 2000, of 
options or warrants acquired prior to March 13, 2000, is not 
considered to be an investment made prior to March 13, 2000, if the 
bank provides any consideration for the shares or interests received 
upon exercise of the options or warrants. Any nonfinancial equity 
investment (or portion thereof) that is not required to be deducted 
from Tier 1 capital under this section II.B.6(e) must be included in 
determining the total amount of nonfinancial equity investments held 
by the bank in relation to its Tier 1 capital for purposes of the 
table in section II.B.6(c)(i). In addition, any nonfinancial equity 
investment (or portion thereof) that is not required to be deducted 
from Tier 1 capital under this section II.B.6(e) will be assigned a 
100-percent risk weight and included in the bank's consolidated 
risk-weighted assets.
---------------------------------------------------------------------------

    \23\ A ``binding written commitment'' means a legally binding 
written agreement that requires the bank to acquire shares or other 
equity of the company, or make a capital contribution to the 
company, under terms and conditions set forth in the agreement. 
Options, warrants, and other agreements that give a bank the right 
to acquire equity or make an investment, but do not require the bank 
to take such actions, are not considered a binding written 
commitment for purposes of this section II.B.6(e).
    \24\ For example, if a bank made an equity investment in 100 
shares of a nonfinancial company prior to March 13, 2000, the 
adjusted carrying value of that investment would not be subject to a 
deduction under this section II.B.6. However, if the bank made any 
additional equity investment in the company after March 13, 2000, 
such as by purchasing additional shares of the company (including 
through the exercise of options or warrants acquired before or after 
March 13, 2000) or by making a capital contribution to the company 
and such investment was not made pursuant to a binding written 
commitment entered into before March 13, 2000, the adjusted carrying 
value of the additional investment would be subject to a deduction 
under this section II.B.6. In addition, if the bank sold and 
repurchased, after March 13, 2000, 40 shares of the company, the 
adjusted carrying value of those 40 shares would be subject to a 
deduction under this section II.B.6.
---------------------------------------------------------------------------

    (f) Adjusted carrying value. (i) For purposes of this section 
II.B.6, the ``adjusted carrying value'' of investments is the 
aggregate value at which the investments are carried on the balance 
sheet of the bank reduced by any unrealized gains on those 
investments that are reflected in such carrying value but excluded 
from the bank's Tier 1 capital and associated deferred tax 
liabilities. For example, for equity investments held as available-
for-sale (AFS), the adjusted carrying value of the investments would 
be the aggregate carrying value of those investments (as reflected 
on the consolidated balance sheet of the bank) less any unrealized 
gains on those investments that are included in other comprehensive 
income and not reflected in Tier 1 capital, and associated deferred 
tax liabilities.\25\
---------------------------------------------------------------------------

    \25\ Unrealized gains on available-for-sale equity investments 
may be included in Tier 2 capital to the extent permitted under 
section I-2.A(2)(f) of this appendix E. In addition, the net 
unrealized losses on available-for-sale equity investments are 
deducted from Tier 1 capital in accordance with section I-2.A(1) of 
this appendix E.
---------------------------------------------------------------------------

    (ii) As discussed above with respect to consolidated SBICs, some 
equity investments may be in companies that are consolidated for 
accounting purposes. For investments in a nonfinancial company that 
is consolidated for accounting purposes under generally accepted 
accounting principles, the bank's adjusted carrying value of the 
investment is determined under the equity method of accounting (net 
of any intangibles associated with the investment that are deducted 
from the bank's core capital in accordance with section I-2.B(a)(i) 
of this appendix E). Even though the assets of the nonfinancial 
company are consolidated for accounting purposes, these assets (as 
well as the credit equivalent amounts of the company's off-balance 
sheet items) should be excluded from the bank's risk-weighted assets 
for regulatory capital purposes.
    (g) Equity investments. For purposes of this section II.B.6, an 
equity investment means any equity instrument (including common 
stock, preferred stock, partnership interests, interests in limited 
liability companies, trust certificates and warrants and call 
options that give the holder the right to purchase an equity 
instrument), any equity feature of a debt instrument (such as a 
warrant or call option), and any debt instrument that is convertible 
into equity where the instrument or feature is held under one of the 
legal authorities listed in section II.B.6(b) of this appendix E. An 
investment in any other instrument (including subordinated debt) may 
be treated as an equity investment if, in the judgment of the FDIC, 
the instrument is the functional equivalent of equity or exposes the 
bank to essentially the same risks as an equity instrument.
    7. Asset-backed commercial paper programs. (a) An asset-backed 
commercial paper (ABCP) program means a program that primarily 
issues externally rated commercial paper backed by assets or other 
exposures held in a bankruptcy-remote, special purpose entity.
    (b) A bank that qualifies as a primary beneficiary and must 
consolidate an ABCP program that is defined as a variable interest 
entity under GAAP may exclude the consolidated ABCP program assets 
from risk-weighted assets provided that the bank is the sponsor of 
the ABCP program. If a bank excludes such consolidated ABCP program 
assets, the bank must assess the appropriate risk-based capital 
charge against any exposures of the bank arising in connection with 
such ABCP programs, including direct credit substitutes, recourse 
obligations, residual interests, liquidity facilities, and loans, in 
accordance with sections II.B.5, II.C, and II.D of this appendix E.
    (c) If a bank has multiple overlapping exposures (such as a 
program-wide credit enhancement and multiple pool-specific liquidity 
facilities) to an ABCP program that is not consolidated for risk-
based capital purposes, the bank is not required to hold capital 
under duplicative risk-based capital requirements under this 
appendix E against the overlapping position. Instead, the bank 
should apply to the overlapping position the applicable risk-based 
capital treatment that results in the highest capital charge.
    8. Securitizations of revolving credit with early amortization 
provisions.
    (a) Definitions. For purposes of this section II.B.8, the 
following definitions will apply:
    (i) Early amortization provision means a provision in the 
documentation governing a securitization that, when triggered, 
causes investors in the securitization exposures to be repaid before 
the original stated maturity of the securitization exposures, unless 
the provision is triggered solely by events not directly related to 
the performance of the underlying exposures or the originating bank 
(such as material changes in tax laws or regulations).
    (ii) Excess spread means gross finance charge collections and 
other income received by a trust or special purpose entity minus 
interest paid to the investors in the securitization exposures, 
servicing fees, charge-offs, and other similar trust or special 
purpose entity expenses.
    (iii) Excess spread trapping point means the point at which the 
bank is required by the documentation governing a securitization to 
divert and hold excess spread in a spread or reserve account, 
expressed as a percent.
    (iv) Investors' interest is the total securitization exposure 
represented by securities issued by a trust or special purpose 
entity to investors.
    (v) Revolving Credit means a line of credit where the borrower 
is permitted to vary both the drawn amount and the amount of 
repayment within an agreed limit.
    (b) Capital charge for revolving securitizations with an early 
amortizations trigger. A bank that securitizes revolving credits 
where the securitization structure contains an early amortization 
provision must maintain risk-based capital against the investors' 
interest as required under this section.
    (c) Calculation. Capital for securitizations of revolving credit 
exposures that incorporate early-amortization provisions will be 
assessed based on a comparison of the securitizations' three-month 
average excess spread against the excess spread trapping point.
    (i) To calculate the securitization's excess spread trapping 
point ratio, a bank must first calculate the three-month average of:
    (A) The dollar amount of excess spread divided by
    (B) The outstanding principal balance of the underlying pool of 
exposures at the end of each of the prior three months.
    (ii) This annualized three-month average of excess spread is 
then divided by the excess spread trapping point that is required by 
the securitization structure.
    (iii) The excess spread trapping point ratio is compared to the 
ratios contained in Table E to determine the appropriate conversion 
factor to apply to the investors' interest.
    (iv) The amount of investors' interest after conversion is then 
assigned capital based on the underlying obligor, collateral, or 
guarantor.
    (d) Default for certain securitizations. For purposes of section 
II.B.8 of this appendix E, for securitizations that do not require 
excess spread to be trapped, or that specify the trapping points 
based primarily on the performance measures other than the three-
month average excess spread, the excess spread trapping point is 
4.5.
    (e) Limit. For a bank subject to the early amortization 
requirements in this section II.B.8 of appendix E, the aggregate 
risk-based capital requirement for all of the bank's exposures to a 
securitization of revolving credit is limited to the greater of the 
risk-based capital requirement for residual interests (as calculated 
under section II.B.5 of this appendix E); or the risk-based capital 
requirement for the underlying securitized assets calculated as if 
the bank continued to hold the assets on its balance sheet.

[[Page 77502]]



         Table E.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
                                                                Credit
                                                              conversion
             Excess spread trapping point ratio                 factor
                                                                (CCF)
                                                              (percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more...................            0
less than 133.33 percent to 100 percent of trapping point..            5
less than 100 percent to 75 percent of trapping point......           15
less than 75 percent to 50 percent of trapping point.......           50
Less than 50 percent of trapping point.....................          100
------------------------------------------------------------------------

C. Risk Weights for Balance Sheet Assets (See Table J)

    The risk-based capital framework contains eight risk weight 
categories--0 percent, 20 percent, 35 percent, 50 percent, 75 
percent, 100 percent, 150 percent, and 200 percent.\26\ In general, 
if a particular item can be placed in more than one risk category, 
it is assigned to the category that has the lowest risk weight. An 
explanation of the components of each category follows:
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    \26\ In addition, certain items receive a dollar-for-dollar 
capital treatment under section II.B.5 of this appendix E.
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1--Zero Percent Risk Weight

    (a) This category includes cash (domestic and foreign) owned and 
held in all offices of the bank or in transit; balances due from 
Federal Reserve banks and central banks in other OECD countries; 
\27\ and gold bullion held in the bank's own vaults or in another 
bank's vaults on an allocated basis, to the extent it is offset by 
gold bullion liabilities.\28\
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    \27\ A central government is defined to include departments and 
ministries, including the central bank, of the central government. 
The U.S. central bank includes the 12 Federal Reserve banks. The 
definition of central government does not include state, provincial 
or local governments or commercial enterprises owned by the central 
government. In addition, it does not include local government 
entities or commercial enterprises whose obligations are guaranteed 
by the central government. OECD central governments are defined as 
central governments of the OECD-based group of countries. Non-OECD 
central governments are defined as central governments of countries 
that do not belong to the OECD-based group of countries.
    \28\ All other bullion holdings are to be assigned to the 100 
percent risk weight category.
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    (b) The zero percent risk category also includes direct claims 
\29\ (including securities, loans, and leases) on, and the portions 
of claims that are unconditionally guaranteed by the United States 
and U.S. Government agencies.\30\ Federal Reserve Bank stock also is 
included in this category.
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    \29\ For purposes of determining the appropriate risk weights 
for this risk-based capital framework, the terms ``claims'' and 
``securities'' refer to loans or other debt obligations of the 
entity on whom the claim is held. Investments in the form of stock 
or equity holdings in commercial or financial firms are generally 
assigned to the 100 percent risk category.
    \30\ For risk-based capital purposes U.S. Government agency is 
defined as an instrumentality of the U.S. Government whose debt 
obligations are fully and explicitly guaranteed as to the timely 
payment of principal and interest by the full faith and credit of 
the U.S. Government. These agencies include the Government National 
Mortgage Association (GNMA), the Veterans Administration (VA), the 
Federal Housing Administration (FHA), the Farmers Home 
Administration (FHA), the Export-Import Bank (Exim Bank), the 
Overseas Private Investment Corporation (OPIC), the Commodity Credit 
Corporation (CCC), and the Small Business Administration (SBA). U.S. 
Government agencies generally do not directly issue securities to 
the public; however, a number of U.S. Government agencies, such as 
GNMA, guarantee securities that are publicly held.
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    (c) This category also includes claims on, and claims guaranteed 
by, qualifying securities firms \31\ incorporated in the United 
States or other members of the OECD-based group of countries that 
are collateralized by cash on deposit in the lending bank or by 
securities issued or guaranteed by the United States (including U.S. 
government Agencies) or OECD central governments, provided that a 
positive margin of collateral is required to be maintained on such a 
claim on a daily basis, taking into account any change in a bank's 
exposure to the obligor or counterparty under the claim in relation 
to the market value of the collateral held in support of the claim.
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    \31\ With regard to securities firms incorporated in the United 
States, qualifying securities firms are those securities firms that 
are broker-dealers registered with the Securities and Exchange 
Commission (SEC) and are in compliance with the SEC's net capital 
rule, 17 CFR 240.15c3-1. With regard to securities firms 
incorporated in any other country in the OECD-based group of 
countries, qualifying securities firms are those securities firms 
that a bank is able to demonstrate are subject to consolidated 
supervision and regulation (covering their direct and indirect 
subsidiaries, but not necessarily their parent organizations) 
comparable to that imposed on banks in OECD countries. Such 
regulation must include risk-based capital requirements comparable 
to those applied to banks under the Accord on International 
Convergence of Capital Measurement and Capital Standards (1988, as 
amended in 1998) (Basel Accord). Claims on a qualifying securities 
firm that are instruments the firm, or its parent company, uses to 
satisfy its applicable capital requirements are not eligible for 
this risk weight and are generally assigned to at least a 100 
percent risk weight. In addition, certain claims on qualifying 
securities firms are eligible for a zero percent risk weight if the 
claims are collateralized by cash on deposit in the lending bank or 
by securities issued or guaranteed by the United States (including 
U.S. government agencies), provided that a positive margin of 
collateral is required to be maintained on such a claim on a daily 
basis, taking into account any change in a bank's exposure to the 
obligor or counterparty under the claim in relation to the market 
value of the collateral held in support of the claim.
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    (d) As provided in sections II.B.3 and II.C.9 of this appendix 
E, this category also includes securities issued by and other claims 
on a sovereign rated highest investment grade, e.g., AAA, by a 
NRSRO, in the case of long-term ratings, or highest rating category, 
e.g., A-1, P-1, in the case of short-term ratings; and claims 
guaranteed by a sovereign rated highest investment grade by a NRSRO.

2--20 Percent Risk Weight

    (a) This category includes short-term claims (including demand 
deposits) on, and portions of short-term claims that are guaranteed 
\32\ by, U.S. depository institutions \33\ and foreign banks; \34\ 
portions of claims collateralized by cash held in a segregated 
deposit account of the lending bank; cash items in process of 
collection, both foreign and domestic; and long-term claims on, and 
portions of long-term claims guaranteed by, U.S. depository 
institutions and OECD banks.\35\
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    \32\ Claims guaranteed by U.S. depository institutions include 
risk participations in both bankers acceptances and standby letters 
of credit, as well as participations in commitments, that are 
conveyed to other U.S. depository institutions.
    \33\ U.S. depository institutions are defined to include 
branches (foreign and domestic) of federally insured banks and 
depository institutions chartered and headquartered in the 50 states 
of the United States, the District of Columbia, Puerto Rico, and 
U.S. territories and possessions. The definition encompasses banks, 
mutual or stock savings banks, savings or building and loan 
associations, cooperative banks, credit unions, international 
banking facilities of domestic depository institutions, and U.S.-
chartered depository institutions owned by foreigners. However, this 
definition excludes branches and agencies of foreign banks located 
in the U.S. and bank holding companies.
    \34\ Foreign banks are distinguished as either OECD banks or 
non-OECD banks. OECD banks include banks and their branches (foreign 
and domestic) organized under the laws of countries (other than the 
U.S.) that belong to the OECD-based group of countries. Non-OECD 
banks include banks and their branches (foreign and domestic) 
organized under the laws of countries that do not belong to the 
OECD-based group of countries. For risk-based capital purposes, a 
bank is defined as an institution that engages in the business of 
banking; is recognized as a bank by the bank supervisory or monetary 
authorities of the country of its organization or principal banking 
operations; receives deposits to a substantial extent in the regular 
course of business; and has the power to accept demand deposits.
    \35\ Long-term claims on, or guaranteed by, non-OECD banks are 
assigned to the 100 percent risk weight category, as are holdings of 
bank-issued securities that qualify as capital of the issuing banks 
for risk-based capital purposes.
---------------------------------------------------------------------------

    (b) This category also includes claims on, or portions of claims 
guaranteed by U.S. Government-sponsored agencies; \36\ and portions 
of claims (including repurchase agreements) collateralized by 
securities issued or guaranteed by the United States, U.S. 
Government agencies, or U.S. Government-sponsored agencies. Also 
included in the 20 percent risk category are portions of claims that 
are conditionally guaranteed by U.S. Government agencies or U.S. 
Government-sponsored agencies.\37\
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    \36\ For risk-based capital purposes, U.S. Government-sponsored 
agencies are defined as agencies originally established or chartered 
by the U.S. Government to serve public purposes specified by the 
U.S. Congress but whose debt obligations are not explicitly 
guaranteed by the full faith and credit of the U.S. Government. 
These agencies include the Federal Home Loan Mortgage Corporation 
(FHLMC), the Federal National Mortgage Association (FNMA), the Farm 
Credit System, the Federal Home Loan Bank System, and the Student 
Loan Marketing Association (SLMA). For risk-based capital purposes, 
claims on U.S. Government-sponsored agencies also include capital 
stock in a Federal Home Loan Bank that is held as a condition of 
membership in that bank.
    \37\ For risk-based capital purposes, a conditional guarantee is 
deemed to exist if the validity of the guarantee by the U.S. 
Government agency is dependent upon some affirmative action (e.g., 
servicing requirements on the part of the beneficiary of the 
guarantee). Portions of claims that are unconditionally guaranteed 
by U.S. Government agencies are assigned to the zero percent risk 
category.

---------------------------------------------------------------------------

[[Page 77503]]

    (c) General obligation claims on, or portions of claims 
guaranteed by, the full faith and credit of states or other 
political subdivisions of the United States or other countries of 
the OECD-based group are also assigned to this 20 percent risk 
category, as well as portions of claims guaranteed by such 
organizations or collateralized by their securities.\38\
---------------------------------------------------------------------------

    \38\ Claims on, or guaranteed by, states or other political 
subdivisions of countries that do not belong to the OECD-based group 
of countries are to be placed in the 100 percent risk weight 
category.
---------------------------------------------------------------------------

    (d) As provided in sections II.B.2 and II.B.5 of this appendix 
E, this category also includes recourse obligations, direct credit 
substitutes, residual interests (other than a credit-enhancing 
interest-only strip) and asset- or mortgage-backed securities rated 
in the highest or second highest investment grade category, e.g., 
AAA, AA, in the case of long-term ratings, or the highest rating 
category, e.g., A-1, P-1, in the case of short-term ratings.
    (e) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a sovereign rated second-highest or third-highest 
investment grade by a NRSRO, e.g. AA or A, in the case of long-term 
ratings, or second-highest investment grade, e.g. A-2, P-2, in the 
case of short-term ratings; claims guaranteed by a sovereign rated 
second-highest or third-highest investment grade by a NRSRO; and 
claims and portions of claims collateralized by securities issued by 
a sovereign rated second-highest or third-highest investment grade 
by a NRSRO, in the case of long-term ratings, or second-highest 
investment grade, in the case of short-term ratings.
    (f) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a non-sovereign rated highest or second-highest 
investment grade by a NRSRO, e.g. AAA or AA, in the case of long-
term ratings, or highest investment grade, e.g. A-1, P-1, in the 
case of short-term ratings; claims guaranteed by a non-sovereign 
whose long-term senior debt is rated highest or second-highest 
investment grade by a NRSRO; and claims and portions of claims 
collateralized by securities issued by a non-sovereign rated highest 
or second-highest investment grade by a NRSRO, in the case of long-
term ratings, or highest-investment grade, in the case of short-term 
ratings.
    (g) As provided in section II.C.9(b) of this appendix E, this 
category also includes certain one-to-four family residential 
mortgages.

3--35 Percent Risk Weight

    (a) As provided in sections II.B.2 and II.B.5 of this appendix 
E, this category includes recourse obligations, direct credit 
substitutes, residual interests (other than a credit-enhancing 
interest-only strip) and asset- or mortgage-backed securities rated 
third-highest investment grade, e.g., A, in the case of long-term 
ratings, and second-highest investment grade, e.g. A-2, P-2, in the 
case of short-term ratings.
    (b) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a sovereign rated lowest-investment grade plus by a 
NRSRO, e.g. BBB+, in the case of long-term ratings; claims 
guaranteed by a sovereign rated lowest-investment grade plus by a 
NRSRO; and claims and portions of claims collateralized by 
securities issued by a sovereign rated lowest-investment grade plus 
by a NRSRO, in the case of long-term ratings.
    (c) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a non-sovereign rated third-highest investment grade 
by a NRSRO, e.g. A, in the case of long-term ratings, or second-
highest investment grade, e.g. A-2, P-2, in the case of short-term 
ratings; claims guaranteed by a non-sovereign whose long-term senior 
debt is rated third-highest investment grade by a NRSRO; and claims 
and portions of claims collateralized by securities issued by a non-
sovereign rated third-highest investment grade by a NRSRO, in the 
case of long-term ratings, or second-highest investment grade in the 
case of short-term ratings.
    (d) As provided in section II.C.9(b) of this appendix E, the 35 
percent risk-weight category also includes certain one-to-four 
family residential mortgages.

4--50 Percent Risk Weight

    (a) This category includes loans, secured by one-to-four family 
residential properties, to builders with substantial project equity 
for the construction of one-to-four family residences that have been 
presold under firm contracts to purchasers who have obtained firm 
commitments for permanent qualifying mortgage loans and have made 
substantial earnest money deposits.\39\ Such loans to builders will 
be considered prudently underwritten only if the bank has obtained 
sufficient documentation that the buyer of the home intends to 
purchase the home (i.e., has a legally binding written sales 
contract) and has the ability to obtain a mortgage loan sufficient 
to purchase the home (i.e., has a firm written commitment for 
permanent financing of the home upon completion), provided the 
following criteria are met:
---------------------------------------------------------------------------

    \39\ In addition, such loans must have been approved in 
accordance with prudent underwriting standards, including standards 
relating to the loan amount as a percent of the appraised value of 
the property, and the loans must not be past due 90 days or more or 
carried in nonaccrual status. The types of loans that qualify as 
loans secured by one-to-four family residential properties are 
listed in the instructions for preparation of the Consolidated 
Reports of Condition and Income.
---------------------------------------------------------------------------

    (i) The purchaser is an individual(s) who intends to occupy the 
residence and is not a partnership, joint venture, trust, 
corporation, or any other entity (including an entity acting as a 
sole proprietorship) that is purchasing one or more of the homes for 
speculative purposes;
    (ii) The builder must incur at least the first ten percent of 
the direct costs (i.e., actual costs of the land, labor, and 
material) before any drawdown is made under the construction loan 
and the construction loan may not exceed 80 percent of the sales 
price of the presold home;
    (iii) The purchaser has made a substantial ``earnest money 
deposit'' of no less than three percent of the sales price of the 
home and the deposit must be subject to forfeiture if the purchaser 
terminates the sales contract; and
    (iv) The earnest money deposit must be held in escrow by the 
bank financing the builder or by an independent party in a fiduciary 
capacity and the escrow agreement must provide that, in the event of 
default arising from the cancellation of the sales contract by the 
buyer, the escrow funds must first be used to defray any costs 
incurred by the bank.
    (b) This category also includes loans fully secured by first 
liens on multifamily residential properties, \40\ provided that:
---------------------------------------------------------------------------

    \40\ The types of loans that qualify as loans secured by 
multifamily residential properties are listed in the instructions 
for preparation of the Consolidated Reports of Condition and Income. 
In addition, from the stand point of the selling bank, when a 
multifamily residential property loan is sold subject to a pro rata 
loss sharing arrangement which provides for the purchaser of the 
loan to share in any loss incurred on the loan on a pro rata basis 
with the selling bank when that portion of the loan is not subject 
to the risk-based capital standards. In connection with sales of 
multifamily residential property loans in which the purchaser of a 
loan shares in any loss incurred on the loan with the selling bank 
on other than a pro rata basis, the selling bank must treat these 
other loss sharing arrangements in accordance with section II.B.5 of 
this appendix E.
---------------------------------------------------------------------------

    (i) The loan amount does not exceed 80 percent of the value \41\ 
of the property securing the loan as determined by the most current 
appraisal or evaluation, whichever may be appropriate (75 percent if 
the interest rate on the loan changes over the term of the loan);
---------------------------------------------------------------------------

    \41\ At the origination of a loan to purchase an existing 
property, the term ``value'' means the lesser of the actual 
acquisition cost or the estimate of value set forth in an appraisal 
or evaluation, whichever may be appropriate.
---------------------------------------------------------------------------

    (ii) For the property's most recent fiscal year, the ratio of 
annual net operating income generated by the property (before 
payment of any debt service on the loan) to annual debt service on 
the loan is not less than 120 percent (115 percent if the interest 
rate on the loan changes over the term of the loan) or in the case 
of a property owned by a cooperative housing corporation or 
nonprofit organization, the property generates sufficient cash flow 
to provide comparable protection to the bank;
    (iii) Amortization of principal and interest on the loan occurs 
over a period of not more than 30 years;
    (iv) The minimum original maturity for repayment of principal on 
the loan is not less than seven years;
    (v) All principal and interest payments have been made on a 
timely basis in accordance with the terms of the loan for at least 
one year before the loan is placed in this category; \42\
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    \42\ In the case where the existing owner of a multifamily 
residential property refinances a loan on that property, all 
principal and interest payments on the loan being refinanced must 
have been made on a timely basis in accordance with the terms of 
that loan for at least the preceding year. The new loan must meet 
all of the other eligiblity criteria in order to qualify for a 50 
percent risk weight.

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[[Page 77504]]

    (vi) The loan is not 90 days or more past due or carried in 
nonaccrual status; and
    (vii) The loan has been made in accordance with prudent 
underwriting standards.
    (c) This category also includes revenue (non-general obligation) 
bonds or similar obligations, including loans and leases, that are 
obligations of states or political subdivisions of the United States 
or other OECD countries, but for which the government entity is 
committed to repay the debt with revenues from the specific projects 
financed, rather than from general tax funds (e.g., municipal 
revenue bonds).
    (d) As provided in section II.B.2 and II.B.5 of this appendix E, 
this category also includes recourse obligations, direct credit 
substitutes, residual interests (other than a credit-enhancing 
interest-only strip) and asset- or mortgage-backed securities rated 
lowest investment grade plus, e.g., BBB+, in the case of long-term 
ratings.
    (e) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a sovereign rated lowest investment grade naught by 
a NRSRO, e.g. BBB, in the case of long-term ratings, or lowest 
investment grade, e.g. A-3, P-3, in the case of short-term ratings; 
claims guaranteed by a sovereign rated lowest investment grade 
naught by a NRSRO; and claims and portions of claims collateralized 
by securities issued by a sovereign rated at least lowest investment 
grade naught by a NRSRO, in the case of long-term ratings, or lowest 
investment grade, in the case of short-term ratings.
    (f) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a non-sovereign rated lowest investment grade plus 
by a NRSRO, e.g. BBB+, in the case of long-term ratings; claims 
guaranteed by a non-sovereign whose long-term senior debt is rated 
lowest investment grade plus by a NRSRO; and claims and portions of 
claims collateralized by securities issued by a non-sovereign rated 
lowest investment grade plus by a NRSRO, in the case of long-term 
ratings.
    (g) As provided in section II.C.9(b) of this appendix E, the 
fifty percent risk-weight category also includes certain one-to-four 
family residential mortgages.

5--75 Percent Risk Weight

    (a) As provided in section II.B.2 and II.B.5 of this appendix E, 
this category also includes recourse obligations, direct credit 
substitutes, residual interests (other than a credit-enhancing 
interest-only strip) and asset- or mortgage-backed securities rated 
lowest investment grade naught, e.g., BBB, in the case of long-term 
ratings.
    (b) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a sovereign rated lowest investment grade negative 
or one category below investment grade plus and naught by a NRSRO, 
e.g. BBB-, BB+, or BB, in the case of long-term ratings; claims 
guaranteed by a sovereign rated lowest investment grade negative by 
a NRSRO, in the case of long-term ratings; and claims and portions 
of claims collateralized by securities issued by a sovereign rated 
lowest investment grade negative by a NRSRO, in the case of long-
term ratings.
    (c) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes certain securities issued by 
and other claims on a non-sovereign rated lowest investment grade 
naught by a NRSRO, e.g. BBB, in the case of long-term ratings, or 
lowest investment grade, A-3, P-3, in the case of short-term 
ratings; claims guaranteed by a non-sovereign whose long-term debt 
is rated lowest investment grade naught by a NRSRO; and claims and 
portions of claims collateralized by securities issued by a non-
sovereign rated lowest investment grade naught by a NRSRO, in the 
case of long-term ratings, or lowest investment grade, in the case 
of short-term ratings.
    (d) As provided in section II.C.9(b), the seventy-five percent 
risk-weight category also includes certain one-to-four family 
residential mortgages.

6--100 Percent Risk Weight

    (a) All assets not included in the above categories in section 
II.C of this appendix E, except the assets specifically included in 
the 150 or 200 percent categories below in section II.C of this 
appendix E and the assets that are otherwise risk weighted in 
accordance with section II.B or II.C.9 of this appendix E, are 
assigned to this category, which comprises standard risk assets.
    (b) This category includes:
    (i) Long-term claims on, and the portions of long-term claims 
that are guaranteed by, non-OECD banks;\43\
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    \43\ Such assets include all non-local currency claims on, and 
the portions of claims that are guaranteed by, non-OECD central 
governments that exceed the local currency liabilities held by the 
bank.
---------------------------------------------------------------------------

    (ii) Claims on commercial firms owned by the public sector;
    (iii) Customer liabilities to the bank on acceptances 
outstanding involving standard risk claims;\44\
---------------------------------------------------------------------------

    \44\ Customer liabilities on acceptances outstanding involving 
non-standard risk claims, such as claims on U.S. depository 
institutions, are assigned to the risk category appropriate to the 
identity of the obligor or, if relevant, the nature of the 
collateral or guarantees backing the claims. Portions of acceptances 
conveyed as risk participations to U.S. depository institutions or 
foreign banks are assigned to the 20 percent risk category 
appropriate to short-term claims guaranteed by U.S. depository 
institutions and foreign banks.
---------------------------------------------------------------------------

    (iv) Investments in fixed assets, premises, and other real 
estate owned;
    (v) Common and preferred stock of corporations, including stock 
acquired for debts previously contracted;
    (vi) Commercial and consumer loans (except rated loans, loans to 
sovereigns, and mortgage loans as provided under section II.C.9 of 
this appendix E and those loans assigned to lower risk categories 
due to recognized guarantees or collateral)\45\;
---------------------------------------------------------------------------

    \45\ This category includes one-to-four family residential pre-
sold construction loans for a residence whose purchase contract is 
cancelled.
---------------------------------------------------------------------------

    (vii) As provided in sections II.B.2 and II.B.5 of this appendix 
E, recourse obligations, direct credit substitutes, residual 
interests (other than a credit-enhancing interest-only strip) and 
asset-or mortgage-backed securities rated lowest investment grade 
negative, e.g., BBB-, as well as certain positions (but not residual 
interests) which the bank rates pursuant to section II.B.5(g) of 
this appendix E;
    (viii) Industrial-development bonds and similar obligations 
issued under the auspices of states or political subdivisions of the 
OECD-based group of countries for the benefit of a private party or 
enterprise where that party or enterprise, not the government 
entity, is obligated to pay the principal and interest; and
    (ix) Stripped mortgage-backed securities and similar 
instruments, such as interest-only strips that are not credit-
enhancing and principal-only strips.
    (x) Claims representing capital of a qualifying securities firm.
    (c) The following assets also are assigned a risk weight of 100 
percent if they have not already been deducted from capital: 
investments in unconsolidated companies, joint ventures, or 
associated companies; instruments that qualify as capital issued by 
other banks; deferred tax assets; and mortgage servicing assets, 
nonmortgage servicing assets, and purchased credit card 
relationships.
    (d) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on a sovereign rated at least one category below 
investment grade negative by a NRSRO, e.g. BB-, in the case of long-
term ratings, or unrated, in the case of short-term ratings.
    (e) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes certain securities issued by 
and other claims on a non-sovereign rated lowest investment grade 
negative by a NRSRO, e.g. BBB-, in the case of long-term ratings, or 
unrated, in the case of short-term ratings; claims guaranteed by a 
non-sovereign whose long-term debt is rated lowest investment grade 
negative by a NRSRO; and claims and portions of claims 
collateralized by securities issued by a non-sovereign rated lowest 
investment grade negative by a NRSRO, in the case of long-term 
ratings.
    (f) As provided in section II.C.9(b) of this appendix E, the 100 
percent risk-weight category also includes certain one-to-four 
family residential mortgages.

7--150 Percent Risk Weight

    (a) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category includes securities issued by and other 
claims on a sovereign rated two or more categories below investment 
grade by a NRSRO, e.g. B or CCC, in the case of long-term ratings.
    (b) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category

[[Page 77505]]

also includes certain securities issued by and other claims on a 
non-sovereign rated one category below investment grade plus and 
naught by a NRSRO, e.g. BB+ or BB, in the case of long-term ratings.
    (c) As provided in section II.C.9(b) of this appendix E, the 150 
percent risk-weight category also includes certain one-to-four 
family residential mortgages.

8--200 Percent Risk Weight

    This category includes:
    (a) As provided in sections II.B.2 and II.B.5 of this appendix 
E, recourse obligations, direct credit substitutes, residual 
interests (other than a credit-enhancing interest-only strip) and 
asset-or mortgage-backed securities rated one category below 
investment grade plus, naught, and negative, e.g. BB+, BB, or BB-, 
in the case of long-term ratings.
    (b) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes securities issued by and 
other claims on an unrated sovereign.
    (c) As provided in sections II.B.2, II.B.3, and II.C.9 of this 
appendix E, this category also includes certain securities issued by 
and other claims on a non-sovereign rated one category below 
investment grade and below by a NRSRO, e.g. BB+, BB, BB-, B, CCC, 
and unrated, in the case of long-term ratings.
    (d) A position (but not a residual interest) in a securitization 
or structured finance program that is not rated by an NRSRO for 
which the bank determines that the credit risk is equivalent to one 
category below investment grade, e.g., BB, to the extent permitted 
in section II.B.5(g) of this appendix E.

9--Risk Weights for Certain Externally Rated Exposures and Certain 
Residential Mortgages

    (a) Externally Rated Exposures. (i) Banks must assign an 
exposure to a sovereign or non-sovereign to the appropriate risk 
weight category in accordance with Tables F1 and F2 of this appendix 
E. Such exposures include but are not limited to: sovereign bonds 
(which may be based on the external rating of the issuing country or 
of the issued bond); all loans to sovereigns, including unrated 
loans; securities issued by multilateral lending institutions or 
regional development banks; corporate debt obligations (senior and 
subordinated); rated loans \46\; and commercial paper.
---------------------------------------------------------------------------

    \46\ Except for loans to sovereigns, loans that are not 
externally rated are risk weighted under section II.C to appendix A 
to part 325.
---------------------------------------------------------------------------

    (ii) If a claim or exposure has two or more external ratings, 
the bank must use the lowest assigned external rating to risk weight 
the claim in accordance with Tables F1 and F2 of this appendix E, 
and that external rating must apply to the claim or exposure in its 
entirety. Thus, for banks that hold split or partially-rated 
instruments, the risk weight that corresponds to the lowest 
component rating will apply to the entire exposure. For example, a 
purchased subordinated security where the principal component is 
rated BBB, but the interest component is rated B, will be subject to 
the gross-up treatment accorded to residual interests rated B or 
lower. Similarly, if a portion of an instrument is unrated, the 
entire exposure will be treated as if it were unrated.
    (iii) For exposures to sovereigns, the bank must first look to 
the rating (if any) on the issue to risk weight the claim. If the 
issue is unrated, the bank must use the issuer rating to determine 
the appropriate risk weight.
    (iv) The FDIC reserves the authority to override the use of 
certain external ratings or the external ratings on certain 
instruments, either on a case-by-case basis or through broader 
supervisory policy, if necessary or appropriate to address the risk 
that an instrument or issuer poses to banks.

                           Table F1.--Risk Weights Based on Long-term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                                   Non-sovereign  Sovereign risk
         Long-term rating category                         Examples                 risk weight       weight
                                                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\........  AAA................................              20               0
Second-highest investment grade rating.....  AA.................................              20              20
Third-highest investment grade rating......  A..................................              35              20
Lowest-investment grade rating--plus.......  BBB+...............................              50              35
Lowest-investment grade rating--naught.....  BBB................................              75              50
Lowest-investment grade rating--negative...  BBB-...............................             100              75
One category below investment grade--plus &  BB+, BB............................             150              75
 naught.
One category below investment grade--        BB-................................             200             100
 negative.
Two or more categories below investment      B, CCC.............................             200             150
 grade.
Unrated (excludes unrated loans to non-      n/a................................             200            200
 sovereigns) \2\.
----------------------------------------------------------------------------------------------------------------
\1\ Long-term claims collateralized by AAA-rated sovereign debt would be assigned to the 20 percent risk weight
  category.
\2\ Unrated loans to non-sovereigns are risk weighted in accordance with section II.C of appendix A to part 325.


                          Table F2.--Risk Weights Based on Short-Term External Ratings
----------------------------------------------------------------------------------------------------------------
                                                                                   Non-sovereign  Sovereign risk
         Short-term rating category                        Examples                 risk weight       weight
                                                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating \1\........  A-1, P-1...........................              20               0
Second-highest investment grade rating.....  A-2, P-2...........................              35              20
Lowest investment grade rating.............  A-3, P-3...........................              75              50
Unrated....................................  n/a ...............................
----------------------------------------------------------------------------------------------------------------
\1\ Short-term claims collateralized by A1/P1 rated sovereign debt would be assigned to the 20 percent risk
  weight category.

    (b) Residential Mortgages. (i) This section II.C.9(b) (including 
Tables G1, G2, and G3) applies to all residential mortgages secured 
by a lien on a one-to-four family residential property, except for 
certain one-to-four family residential pre-sold construction loans, 
and certain one-to-four family residential pre-sold construction 
loans for residences for which the purchase contract is 
cancelled.\47\ The risk weights described in Tables G1 and G2 of 
this section II.C.9(b) are minimum risk weights. For a mortgage to 
qualify for these risk weights, it must meet certain minimum 
criteria: Be fully secured by a lien on a one-to four-family 
residential

[[Page 77506]]

property, either owner-occupied or rented, be prudently 
underwritten, and not be 90 days or more past due or carried in 
nonaccrual status. Mortgages that do not meet these criteria will be 
risk weighted in accordance with Table G3 of this appendix E.
---------------------------------------------------------------------------

    \47\ Qualifying one-to-four family residential pre-sold 
construction loans are risk weighted at 50% under section II.C.4, 
unless the purchase contract is cancelled, in which case, they are 
risk weighted at 100% under section II.C.6 of this appendix E. Loans 
that qualify as mortgages, including junior lien mortgages, that are 
secured by 1- to 4-family residential properties are listed in the 
instructions to the commercial bank Call Report. This section 
II.C.9(b) does not apply to transactions where a lien on a one-to-
four family residential property has been taken as collateral solely 
through an abundance of caution and where, as a consequence, the 
terms have not been made more favorable than they would have been in 
the absence of the lien. In such as case, the loan would not be 
considered to be secured by real estate in the Call Reports.
---------------------------------------------------------------------------

    (ii) Mortgages subject to this section are risk weighted based 
on their loan-to-value (LTV) ratio \48\ or combined loan-to-value 
(CLTV) ratio \49\ and in accordance with Table G1, Table G2, or 
Table G3 of this appendix E, as applicable, after consideration of 
any loan level private mortgage insurance (loan level PMI). To 
calculate the CLTV on a junior lien mortgage, a bank must divide the 
aggregate principle amount outstanding for the first and junior 
lien(s) by the appraised value of the property at origination of the 
first lien. LTV ratios can only be adjusted through loan 
amortization, except for a loan refinancing where the bank extends 
additional funds. However, for purposes of calculating the CLTV, 
banks may adjust the appraised value of the property, as determined 
at the time of origination of the first lien, based on a new 
appraisal or evaluation in accordance with the FDIC's appraisal 
regulations and real estate lending guidelines.\50\
---------------------------------------------------------------------------

    \48\ For purposes of this section II.C.9(b), the value of the 
property equals the lower of the purchase price for the property or 
the value at origination. The value of the property must be based on 
an appraisal or evaluation of the property in conformance with the 
FDIC's appraisal regulations and real estate lending guidelines. See 
12 CFR part 323, 12 CFR part 365.
    \49\ The CLTV represents the aggregate principle outstanding on 
a first lien mortgage and all applicable junior lien mortgages 
divided by the appraised value of the property at origination of the 
first lien.
    \50\ See 12 CFR part 323, 12 CFR part 365.
---------------------------------------------------------------------------

    (A) Mortgage loans secured by first liens on one-to four-family 
residential properties. Mortgage loans secured by first liens on 
one-to four-family residential properties (first lien mortgages) 
must be risk-weighted in accordance with Table G1 of this appendix 
E. If a bank holds both the first and junior lien(s) on a 
residential property and no other party holds an intervening lien, 
the transaction is treated as a first lien mortgage for purposes of 
determining the loan-to-value ratio and assigning a risk weight.

 Table G1.--Risk Weights for First Lien One- to Four-Family Residential
                                Mortgages
------------------------------------------------------------------------
                                                             Risk weight
               Loan-to-Value ratio (percent)                  (percent)
------------------------------------------------------------------------
Up to 60...................................................           20
>60 and up to 80...........................................           35
>80 and up to 85...........................................           50
>85 and up to 90...........................................           75
>90 and up to 95...........................................          100
>95........................................................          150
------------------------------------------------------------------------

    (B) Stand-Alone Junior Liens. Stand-alone junior liens on one- 
to four-family residential mortgages, including structured mortgages 
and the on-balance sheet portion of home equity lines of credit, 
must be risk weighted using the CLTV of the stand-alone junior and 
all senior liens in accordance with Table G2 of this appendix E. The 
CLTV of the stand-alone junior and all senior liens, where any of 
the senior liens has a negative amortization feature, must reflect 
the maximum contractual loan amount under the terms of these liens 
if they were to fully negatively amortize under the applicable 
contract.

     Table G2.--Risk Weights for Stand-Alone Junior Lien 1-4 Family
                          Residential Mortgages
------------------------------------------------------------------------
                                                             Risk weight
           Combined loan to value ratio (percent)             (percent)
------------------------------------------------------------------------
Up to 60...................................................           75
>60 and up to 90...........................................          100
>90........................................................          150
------------------------------------------------------------------------


   Table G3.--Risk Weights for Mortgages Not Meeting Minimum Criteria
------------------------------------------------------------------------
                                                             Risk weight
            Risk weight under Table G1 or G2 \1\              (percent)
------------------------------------------------------------------------
20%, 35%, 50%, 75%, or 100%................................          100
150%.......................................................          150
------------------------------------------------------------------------
\1\This column represents the risk weight a mortgage would have received
  under Table G1 or G2 if it had met the minimum criteria required by
  this section II.C.9(b).

    (C) One- to Four-Family Residential Mortgages With Negative 
Amortization Features. First lien mortgages with negative 
amortization features are risk weighted in accordance with Table G1 
of this appendix E. For loans with negative amortization features, 
the LTV of the loans must be adjusted quarterly to include the 
amount of any negative amortization. Any remaining potential 
increase in the mortgage's principal balance permitted through 
negative amortization is to be treated as a long-term commitment and 
converted to an on-balance sheet equivalent amount as set forth in 
section II.D. of this Appendix E. The credit equivalent amount of 
the commitment is then risk-weighted according to Table G1 based on 
the loan's ``highest contractual LTV ratio.'' The highest 
contractual LTV ratio of a first lien mortgage equals the current 
outstanding principal balance of the loan, \51\ plus the credit 
equivalent amount of the remaining negative amortization commitment, 
minus the amount covered by any loan-level PMI divided by the value 
of the property.\52\
---------------------------------------------------------------------------

    \51\ As the loan balance increases through negative 
amortization, the bank must recalculate the outstanding loan amount 
using the original loan amount plus any increases to the loan amount 
due to negative amortization.
    \52\ See footnote 48.
---------------------------------------------------------------------------

    (iii) Transitional Rule for Residential Mortgage Exposures. A 
bank may continue to use appendix A to risk weight those mortgage 
loans that it owns before it elects to use this appendix E. However, 
the bank must use appendix A to risk weight all such mortgage loans. 
Mortgage loans approved, acquired, or originated after a bank elects 
to use appendix E must be risk weighted under this appendix E. A 
bank may only rely on this subsection II.C.9(b)(iii) the first time 
it elects to use this appendix E.

D. Conversion Factors for Off-Balance Sheet Items (see Table H)

    The face amount of an off-balance sheet item is generally 
incorporated into the risk-weighted assets in two steps. The face 
amount is first multiplied by a credit conversion factor, except as 
otherwise specified in section II.B.5 of this appendix E for direct 
credit substitutes and recourse obligations. The resultant credit 
equivalent amount is assigned to the appropriate risk category 
according to the obligor or, if relevant, the guarantor, the nature 
of any collateral, or external credit ratings. \53\
---------------------------------------------------------------------------

    \53\ The sufficiency of collateral and guarantees for off-
balance-sheet items is determined by the market value of the 
collateral or the amount of the guarantee in relation to the face 
amount of the item, except for derivative contracts, for which this 
determination is generally made in relation to the credit equivalent 
amount. Collateral and guarantees are subject to the same provisions 
noted under section II.B of this appendix E.
---------------------------------------------------------------------------

    1. Items With a 100 Percent Conversion Factor. (a) Except as 
otherwise provided in section II.B.5 of this appendix E, the full 
amount of an asset or transaction supported, in whole or in part, by 
a direct credit substitute or a recourse obligation. Direct credit 
substitutes and recourse obligations are defined in section II.B.5 
of this appendix E.
    (b) Sale and repurchase agreements, if not already included on 
the balance sheet, and forward agreements. Forward agreements are 
legally binding contractual obligations to purchase assets with 
drawdown which is certain at a specified future date. Such 
obligations include forward purchases, forward forward deposits 
placed,\54\ and partly-paid shares and securities; they do not 
include commitments to make residential mortgage loans or forward 
foreign exchange contracts.
---------------------------------------------------------------------------

    \54\ Forward forward deposits accepted are treated as interest 
rate contracts.
---------------------------------------------------------------------------

    (c) Securities lent by a bank are treated in one of two ways, 
depending upon whether the lender is exposed to risk of loss. If a 
bank, as agent for a customer, lends the customer's securities and 
does not indemnify the customer against loss, then the securities 
transaction is excluded from the risk-based capital calculation. On 
the other hand, if a bank lends its own securities or, acting as 
agent for customer, lends the customer's securities and indemnifies 
the customer against loss, the transaction is converted at 100 
percent and assigned to the risk weight category appropriate to the 
obligor or, if applicable, to the collateral delivered to the 
lending bank or the independent custodian acting on the lending 
bank's behalf.
    2. Items With a 50 Percent Conversion Factor. (a) Transaction-
related contingencies are to be converted at 50 percent. Such 
contingencies include bid bonds, performance bonds, warranties, and 
performance standby letters of credit related to particular 
transactions, as well as acquisitions of risk participations in

[[Page 77507]]

performance standby letters of credits. Performance standby letters 
of credit (performance bonds) are irrevocable obligations of the 
bank to pay a third-party beneficiary when a customer (account 
party) fails to perform on some contractual nonfinancial obligation. 
Thus, performance standby letters of credit represent obligations 
backing the performance of nonfinancial or commercial contracts or 
undertakings. To the extent permitted by law or regulation, 
performance standby letters of credit include arrangements backing, 
among other things, subcontractors' and suppliers' performance, 
labor and materials contracts, and construction bids.
    (b) The unused portion of commitments with an original maturity 
exceeding one year. including underwriting commitments and 
commercial and consumer credit commitments, also are to be converted 
at 50 percent. Original maturity is defined as the length of time 
between the date the commitment is issued and the earliest date on 
which: The bank can at its option, unconditionally (without cause) 
cancel the commitment,\55\ and the bank is scheduled to (and as a 
normal practice actually does) review the facility to determine 
whether or not it should be extended and, on at least an annual 
basis, continues to regularly review the facility. Facilities that 
are unconditionally cancelable (without cause) at any time by the 
bank are not deemed to be commitments, provided the bank makes a 
separate credit decision before each drawing under the facility.
---------------------------------------------------------------------------

    \55\ In the case of home equity or mortgage lines of credit 
secured by liens on one- to four-family residential properties, a 
bank is deemed able to unconditionally cancel the commitment if, at 
its option, it can prohibit additional extensions of credit, reduce 
the credit line, and terminate the commitment to the full extent 
permitted by relevant federal law.
---------------------------------------------------------------------------

    (c)(i) Commitments are defined as any legally binding 
arrangements that obligate a bank to extend credit in the form of 
loans or lease financing receivables; to purchase loans, securities, 
or other assets; or to participate in loans and leases. Commitments 
also include overdraft facilities, revolving credit, home equity and 
mortgage lines of credit, eligible ABCP liquidity facilities, and 
similar transactions. Normally, commitments involve a written 
contract or agreement and a commitment fee, or some other form of 
consideration. Commitments are included in weighted-risk assets 
regardless of whether they contain material adverse change clauses 
or other provisions that are intended to relieve the issuer of its 
funding obligation under certain conditions. In the case of 
commitments structured as syndications, where the bank is obligated 
solely for its pro rata share, only the bank's proportional share of 
the syndicated commitment is taken into account in calculating the 
risk-based capital ratio.
    (ii) Banks that are subject to the market risk rules in appendix 
C to part 325 are required to convert the notional amount of 
eligible ABCP liquidity facilities, in form or in substance, with an 
original maturity of over one year that are carried in the trading 
account at 50 percent to determine the appropriate credit equivalent 
amount even though those facilities are structured or characterized 
as derivatives or other trading book assets. Liquidity facilities 
that support ABCP, in form or in substance, (including those 
positions to which the market risk rules may not be applied as set 
forth in section 2(a) of appendix C of this part) that are not 
eligible ABCP liquidity facilities are to be considered recourse 
obligations or direct credit substitutes, and assessed the 
appropriate risk-based capital treatment in accordance with section 
II.B.5 of this appendix E.
    (d) In the case of commitments structured as syndications where 
the bank is obligated only for its pro rata share, the risk-based 
capital framework includes only the bank's proportional share of 
such commitments. Thus, after a commitment has been converted at 50 
percent, portions of commitments that have been conveyed to other 
U.S. depository institutions or OECD banks, but for which the 
originating bank retains the full obligation to the borrower if the 
participating bank fails to pay when the commitment is drawn upon, 
will be assigned to the 20 percent risk category. The acquisition of 
such a participation in a commitment would be converted at 50 
percent and the credit equivalent amount would be assigned to the 
risk category that is appropriate for the account party obligor or, 
if relevant, to the nature of the collateral or guarantees.
    (e) Revolving underwriting facilities (RUFs), note issuance 
facilities (NIFs), and other similar arrangements also are converted 
at 50 percent. These are facilities under which a borrower can issue 
on a revolving basis short-term notes in its own name, but for which 
the underwriting banks have a legally binding commitment either to 
purchase any notes the borrower is unable to sell by the rollover 
date or to advance funds to the borrower.
    3. Items With a 20 Percent Conversion Factor. Short-term, self-
liquidating, trade-related contingencies which arise from the 
movement of goods are converted at 20 percent. Such contingencies 
include commercial letters of credit and other documentary letters 
of credit collateralized by the underlying shipments.
    4. Items With a 10 Percent Conversion Factor. (a) Unused 
portions of commitments with an original maturity of one year or 
less are converted using the 10 percent conversion factor.\56\ 
Unused portions of eligible ABCP liquidity facilities with an 
original maturity of one year or less that provide liquidity support 
to ABCP also are converted at 10 percent.
---------------------------------------------------------------------------

    \56\ Short-term commitments to originate one- to four-family 
residential mortgage loans, other than a derivative contract, will 
continue to be converted to an on-balance-sheet credit equivalent 
amount using the zero percent conversion factor.
---------------------------------------------------------------------------

    (b) Banks that are subject to the market risk rules in appendix 
C to part 325 are required to convert the notional amount of 
eligible ABCP liquidity facilities, in form or in substance, with an 
original maturity of one year or less that are carried in the 
trading account at 10 percent to determine the appropriate credit 
equivalent amount even through those facilities are structured or 
characterized as derivatives or other trading book assets. Liquidity 
facilities that provide liquidity support to ABCP, in form or in 
substance, (including those positions to which the market risk rules 
may not be applied as set forth in section 2(a) of appendix C of 
this part) that are not eligible ABCP liquidity facilities are to be 
considered recourse obligations or direct credit substitutes and 
assessed the appropriate risk-based capital requirement in 
accordance with section II.B.5 of this appendix.
    5. Items with a Zero Percent Conversion Factor. These include 
unused portions of retail credit card lines and related plans are 
deemed to be short-term commitments if the bank, in accordance with 
applicable law, has the unconditional option to cancel the credit 
line at any time.
    6. Derivative Contracts. The credit-equivalent amount for a 
derivative contract, or group of derivative contracts subject to a 
qualifying bilateral netting contract, is assigned to the risk 
weight category appropriate to the underlying obligor regardless of 
the type of transaction.

E. Derivative Contracts (Interest Rate, Exchange Rate, Commodity 
(Including Precious Metal) and Equity Derivative Contracts)

    1. Credit equivalent amounts are computed for each of the 
following off-balance-sheet derivative contracts:
    (a) Interest Rate Contracts
    (i) Single currency interest rate swaps.
    (ii) Basis swaps.
    (iii) Forward rate agreements.
    (iv) Interest rate options purchased (including caps, collars, 
and floors purchased).
    (v) Any other instrument linked to interest rates that gives 
rise to similar credit risks (including when-issued securities and 
forward deposits accepted).
    (b) Exchange Rate Contracts
    (i) Cross-currency interest rate swaps.
    (ii) Forward foreign exchange contracts.
    (iii) Currency options purchased.
    (iv) Any other instrument linked to exchange rates that gives 
rise to similar credit risks.
    (c) Commodity (including precious metal) or Equity Derivative 
Contracts
    (i) Commodity-or equity-linked swaps.
    (ii) Commodity-or equity-linked options purchased.
    (iii) Forward commodity-or equity-linked contracts.
    (iv) Any other instrument linked to commodities or equities that 
gives rise to similar credit risks.
    2. Exchange rate contracts with an original maturity of 14 
calendar days or less and derivative contracts traded on exchanges 
that require daily receipt and payment of cash variation margin may 
be excluded from the risk-based ratio calculation. Gold contracts 
are accorded the same treatment as exchange rate contracts except 
gold contracts with an original maturity of 14 calendar days or less 
are included in the risk-based calculation. Over-the-counter options 
purchased are included and treated in the same way as other 
derivative contracts.
    3. Credit Equivalent Amounts for Derivative Contracts. (a) The 
credit

[[Page 77508]]

equivalent amount of a derivative contract that is not subject to a 
qualifying bilateral netting contract in accordance with section 
II.E.5 of this appendix E is equal to the sum of:
    (i) The current exposure (which is equal to the mark-to-market 
value, \57\ if positive, and is sometimes referred to as the 
replacement cost) of the contract; and
---------------------------------------------------------------------------

    \57\ Mark-to-market values are measured in dollars, regardless 
of the currency or currencies specified in the contract and should 
reflect changes in both underlying rates, prices and indices, and 
counterparty credit quality.
---------------------------------------------------------------------------

    (ii) An estimate of the potential future credit exposure.
    (b) The current exposure is determined by the mark-to-market 
value of the contract. If the mark-to-market value is positive, then 
the current exposure is equal to that mark-to-market value. If the 
mark-to-market value is zero or negative, then the current exposure 
is zero.
    (c) The potential future credit exposure of a contract, 
including a contract with a negative mark-to-market value, is 
estimated by multiplying the notional principal amount of the 
contract by a credit conversion factor. Banks should, subject to 
examiner review, use the effective rather than the apparent or 
stated notional amount in this calculation. The credit conversion 
factors are:

                                       Table H.--Conversion Factor Matrix
----------------------------------------------------------------------------------------------------------------
                                                   Exchange rate                     Precious          Other
       Remaining maturity          Interest rate     and gold         Equity      metals, except    commodities
                                     (percent)       (percent)       (percent)    gold (percent)     (percent)
----------------------------------------------------------------------------------------------------------------
One year or less................             0.0             1.0             6.0             7.0            10.0
More than one year to five years             0.5             5.0             8.0             7.0            12.0
More than five years............             1.5             7.5            10.0             8.0            15.0
----------------------------------------------------------------------------------------------------------------

    (d) For contracts that are structured to settle outstanding 
exposure on specified dates and where the terms are reset such that 
the market value of the contract is zero on these specified dates, 
the remaining maturity is equal to the time until the next reset 
date. For interest rate contracts with remaining maturities of more 
than one year and that meet these criteria, the conversion factor is 
subject to a minimum value of 0.5 percent.
    (e) For contracts with multiple exchanges of principal, the 
conversion factors are to be multiplied by the number of remaining 
payments in the contract. Derivative contracts not explicitly 
covered by any of the columns of the conversion factor matrix are to 
be treated as ``other commodities.''
    (f) No potential future exposure is calculated for single 
currency interest rate swaps in which payments are made based upon 
two floating rate indices (so called floating/floating or basis 
swaps); the credit exposure on these contracts is evaluated solely 
on the basis of their mark-to-market values.
    4. Risk Weights and Avoidance of Double Counting. (a) Once the 
credit equivalent amount for a derivative contract, or a group of 
derivative contracts subject to a qualifying bilateral netting 
agreement, has been determined, that amount is assigned to the risk 
category appropriate to the counterparty, or, if relevant, the 
guarantor or the nature of any collateral. However, the maximum 
weight that will be applied to the credit equivalent amount of such 
contracts is 50 percent.
    (b) In certain cases, credit exposures arising from the 
derivative contracts covered by these guidelines may already be 
reflected, in part, on the balance sheet. To avoid double counting 
such exposures in the assessment of capital adequacy and, perhaps, 
assigning inappropriate risk weights, counterparty credit exposures 
arising from the types of instruments covered by these guidelines 
may need to be excluded from balance sheet assets in calculating a 
bank's risk-based capital ratio.
    (c) The FDIC notes that the conversion factors set forth in 
section II.E.3 of appendix E, which are based on observed 
volatilities of the particular types of instruments, are subject to 
review and modification in light of changing volatilities or market 
conditions.
    (d) Examples of the calculation of credit equivalent amounts for 
these types of contracts are contained in Table H of this appendix 
E.
    5. Netting. (a) For purposes of this appendix E, netting refers 
to the offsetting of positive and negative mark-to-market values 
when determining a current exposure to be used in the calculation of 
a credit equivalent amount. Any legally enforceable form of 
bilateral netting (that is, netting with a single counterparty) of 
derivative contracts is recognized for purposes of calculating the 
credit equivalent amount provided that:
    (i) The netting is accomplished under a written netting contract 
that creates a single legal obligation, covering all included 
individual contracts, with the effect that the bank would have a 
claim or obligation to receive or pay, respectively, only the net 
amount of the sum of the positive and negative mark-to-market values 
on included individual contracts in the event that a counterparty, 
or a counterparty to whom the contract has been validly assigned, 
fails to perform due to default, bankruptcy, liquidation, or similar 
circumstances;
    (ii) The bank obtains a written and reasoned legal opinion(s) 
representing that in the event of a legal challenge, including one 
resulting from default, insolvency, bankruptcy or similar 
circumstances, the relevant court and administrative authorities 
would find the bank's exposure to be such a net amount under:
    (A) The law of the jurisdiction in which the counterparty is 
chartered or the equivalent location in the case of noncorporate 
entities and, if a branch of the counterparty is involved, then also 
under the law of the jurisdiction in which the branch is located;
    (B) The law that governs the individual contracts covered by the 
netting contract; and
    (C) The law that governs the netting contract.
    (iii) The bank establishes and maintains procedures to ensure 
that the legal characteristics of netting contracts are kept under 
review in the light of possible changes in relevant law; and
    (iv) The bank maintains in its file documentation adequate to 
support the netting of derivative contracts, including a copy of the 
bilateral netting contract and necessary legal opinions.
    (b) A contract containing a walkaway clause is not eligible for 
netting for purposes of calculating the credit equivalent 
amount.\58\
---------------------------------------------------------------------------

    \58\ For purposes of this section, a walkaway clause means a 
provision in a netting contract that permits a non-defaulting 
counterparty to make lower payments than it would make otherwise 
under the contract, or no payment at all, to a defaulter or to the 
estate of a defaulter, even if a defaulter or the estate of a 
defaulter is a net creditor under the contract.
---------------------------------------------------------------------------

    (c) By netting individual contracts for the purpose of 
calculating its credit equivalent amount, a bank represents that it 
has met the requirements of this appendix E and all the appropriate 
documents are in the bank's files and available for inspection by 
the FDIC. Upon determination by the FDIC that a bank's files are 
inadequate or that a netting contract may not be legally enforceable 
under any one of the bodies of law described in paragraphs (ii)(1) 
through (3) of section II.E.5(a) of this appendix E, underlying 
individual contracts may be treated as though they were not subject 
to the netting contract.
    (d) The credit equivalent amount of derivative contracts that 
are subject to a qualifying bilateral netting contract is calculated 
by adding:
    (i) The net current exposure of the netting contract; and
    (ii) The sum of the estimates of potential future exposure for 
all individual contractors subject to the netting contract, adjusted 
to take into account the effects of the netting contract.\59\
---------------------------------------------------------------------------

    \59\ For purposes of calculating potential future credit 
exposure for foreign exchange contracts and other similar contracts 
in which notional principal is equivalent to cash flows, total 
notional principal is defined as the net receipts to each party 
falling due on each value date in each currency.

---------------------------------------------------------------------------

[[Page 77509]]

    (e) The net current exposure is the sum of all positive and 
negative mark-to-market values of the individual contracts subject 
to the netting contract. If the net sum of the mark-to-market values 
is positive, then the net current exposure is equal to that sum. If 
the net sum of the mark-to-market values is zero or negative, then 
the net current exposure is zero.
    (f) The effects of the bilateral netting contract on the gross 
potential future exposure are recognized through application of a 
formula, resulting in an adjusted add-on amount (Anet). The formula, 
which employs the ratio of net current exposure to gross current 
exposure (NGR) is expressed as:

Anet = (0.4 x A<INF>gross</INF>) + 0.6(NGR x A<INF>gross</INF>)

    The effect of this formula is that Anet is the weighted average 
of A<INF>gross</INF>, and A<INF>gross</INF> adjusted by the NGR.
    (g) The NGR may be calculated in either one of two ways--
referred to as the counterparty-by-counterparty approach and the 
aggregate approach.
    (i) Under the counterparty-by-counterparty approach, the NGR is 
the ratio of the net current exposure of the netting contract to the 
gross current exposure of the netting contract. The gross current 
exposure is the sum of the current exposure of all individual 
contracts subject to the netting contract calculated in accordance 
with section II.E of this appendix E.
    (ii) Under the aggregate approach, the NGR is the ratio of the 
sum of all of the net current exposures for qualifying bilateral 
netting contracts to the sum of all of the gross current exposures 
for those netting contracts (each gross current exposure is 
calculated in the same manner as in section II.E.5(g)(i) of this 
appendix E). Net negative mark-to-market values to individual 
counterparties cannot be used to offset net positive current 
exposures to other counterparties.
    (iii) A bank must use consistently either the counterparty-by-
counterparty approach or the aggregate approach to calculate the 
NGR. Regardless of the approach used, the NGR should be applied 
individually to each qualifying bilateral netting contract to 
determine the adjusted add-on for that netting contract.

III. Minimum Risk-Based Capital Ratio

    Subject to section II.B.5 of this appendix E, banks generally 
will be expected to meet a minimum ratio of qualifying total capital 
to risk-weighted assets of 8 percent, of which at least 4 percentage 
points should be in the form of core capital (Tier 1). Any bank that 
does not meet the minimum risk-based capital ratio, or whose capital 
is otherwise considered inadequate, generally will be expected to 
develop and implement a capital plan for achieving an adequate level 
of capital, consistent with the provisions of this risk-based 
capital framework and Sec.  325.104, the specific circumstances 
affecting the individual bank, and the requirements of any related 
agreements between the bank and the FDIC.

               Table I.--Definition of Qualifying Capital
------------------------------------------------------------------------
               Components                      Minimum requirements
------------------------------------------------------------------------
(1) Core Capital (Tier 1)..............  Must equal or exceed 4% of risk-
                                          weighted assets.
(a) Common stockholders' equity........  No limit.\1\
(b) Noncumulative perpetual preferred    No limit.\1\
 stock and any related surplus.
(c) Minority interest in equity          No limit.\1\
 accounts of consolidated.
(d) Less: All intangible assets other    (\2\)
 than certain mortgage servicing
 assets, nonmortgage servicing assets
 and purchased credit card
 relationships.
(e) Less: Certain credit-enhancing       (\3\)
 interest only strips and nonfinancial
 equity investments required to be
 deducted from capital.
(f) Less: Certain deferred tax assets..  (\4\)
(2) Supplementary Capital (Tier 2).....  Total of tier 2 is limited to
                                          100% of tier 1.\5\
(a) Allowance for loan and lease losses  Limited to 1.25% of weighted-
                                          risk assets.\5\
(b) Unrealized gains on certain equity   Limited to 45% of pretax net
 securities \6\.                          unrealized gains.\6\
(c) Cumulative perpetual and long-term   No limit within tier 2; long-
 preferred stock (original maturity of    term preferred is amortized
 20 years or more) and any related        for capital purposes as it
 surplus..                                approaches maturity.
(d) Auction rate and similar preferred   No limit within tier 2.
 stock (both cumulative and non-
 cumulative)..
(e) Hybrid capital instruments           No limit within tier 2.
 (including mandatory convertible debt
 securities)..
(f) Term subordinated debt and           Term subordinated debt and
 intermediate-term preferred stock        intermediate-term preferred
 (original weighted average maturity of   stock are limited to 50% of
 five years or more)..                    Tier 1 \5\ and amortized for
                                          capital purposes as they
                                          approach maturity.
(3) Deductions (from the sum of tier 1
 and tier 2).
(a) Investments in banking and finance
 subsidiaries that are not consolidated
 for regulatory capital purposes..
(b) Intentional, reciprocal cross-
 holdings of capital securities issued
 by banks..
(c) Other deductions (such as            On a case-by-case basis or as a
 investment in other subsidiaries or      matter of policy after formal
 joint ventures) as determined by         consideration of relevant
 supervisory authority..                  issues.
(4) Total Capital......................  Must equal or exceed 8% of
                                          weighted-risk assets.
------------------------------------------------------------------------
\1\ No express limits are placed on the amounts of nonvoting common,
  noncumulative perpetual preferred stock, and minority interests that
  may be recognized as part of Tier 1 capital. However, voting common
  stockholders' equity capital generally will be expected to be the
  dominant form of Tier 1 capital and banks should avoid undue reliance
  on other Tier 1 capital elements.
\2\ The amounts of mortgage servicing assets, nonmortgage servicing
  assets and purchased credit card relationships that can be recognized
  for purposes of calculating Tier 1 capital are subject to the
  limitations set forth in Sec.   325.5(f). All deductions are for
  capital purposes only; deductions would not affect accounting
  treatment.
\3\ The amounts of credit-enhancing interest-only strips that can be
  recognized for purposes of calculating Tier 1 capital are subject to
  the limitations set forth in Sec.   325.5(f). The amounts of
  nonfinancial equity investments that must be deducted for purposes of
  calculating Tier 1 capital are set forth in section II.B.6 of appendix
  E to part 325.
\4\ Deferred tax assets are subject to the capital limitations set forth
  in Sec.   325.5(g).
\5\ Amounts in excess of limitations are permitted but do not qualify as
  capital.
\6\ Unrealized gains on equity securities are subject to the capital
  limitations set forth in paragraph I-2.A.2.(f) of appendix E to part
  325.


[[Page 77510]]

IV. Calculation of the Risk-Based Capital Ratio

    1. When calculating the risk-based capital ratio under the 
framework set forth in this statement of policy, qualifying total 
capital (the numerator) is divided by risk-weighted assets (the 
denominator). The process of determining the numerator for the ratio 
is summarized in Table I. The calculation of the denominator is 
based on the risk weights and conversion factors that are summarized 
in Tables II and III.
    2. When determining the amount of risk-weighted assets, balance 
sheet assets are assigned an appropriate risk weight (see Table J) 
and off-balance sheet items are first converted to a credit 
equivalent amount (see Table H) and then assigned to one of the risk 
weight categories set forth in Table J.
    3. The balance sheet assets and the credit equivalent amount of 
off-balance sheet items are then multiplied by the appropriate risk 
weight percentages and the sum of these risk-weighted amounts is the 
gross risk-weighted asset figure used in determining the denominator 
of the risk-based capital ratio. Any items deducted from capital 
when computing the amount of qualifying capital may also be excluded 
from risk-weighted assets when calculating the denominator for the 
risk-based capital ratio.

Table J--Summary of Risk Weights and Risk Categories

Category 1--Zero Percent Risk Weight

    (1) Cash (domestic and foreign).
    (2) Balances due from Federal Reserve banks.
    (3) Direct claims on, and portions of claims unconditionally 
guaranteed by, the U.S. Treasury and U.S. Government agencies.\60\
---------------------------------------------------------------------------

    \60\ For the purpose of calculating the risk-based capital 
ratio, a U.S. Government agency is defined as an instrumentality of 
the U.S. Government whose obligations are fully and explicitly 
guaranteed as to the timely repayment of principal and interest by 
the full faith and credit of the U.S. Government.
---------------------------------------------------------------------------

    (4) Gold bullion held in the bank's own vaults or in another 
bank's vaults on an allocated basis, to the extent that it is offset 
by gold bullion liabilities.
    (5) Federal Reserve Bank stock.
    (6) Claims on, or guaranteed by, qualifying securities firms 
incorporated in the United States or other members of the OECD-based 
group of countries that are collateralized by cash on deposit in the 
lending bank or by securities issued or guaranteed by the United 
States (including U.S. government agencies) or OECD central 
governments, provided that a positive margin of collateral is 
required to be maintained on such a claim on a daily basis, taking 
into account any change in a bank's exposure to the obligor or 
counterparty under the claim in relation to the market value of the 
collateral held in support of the claim.
    (7) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.

Category 2--20 Percent Risk Weight

    (1) Cash items in the process of collection.
    (2) All claims (long- and short-term) on, and portions of claims 
(long- and short-term) guaranteed by, U.S. depository institutions 
and OECD banks.
    (3) Short-term (remaining maturity of one year or less) claims 
on, and portions of short-term claims guaranteed by, non-OECD banks.
    (4) Portions of loans and other claims conditionally guaranteed 
by the U.S. Treasury or U.S. Government agencies.\61\
---------------------------------------------------------------------------

    \61\ For the purpose of calculating the risk-based capital 
ratio, a U.S. Government agency is defined as an instrumentality of 
the U.S. Government whose obligations are fully and explicitly 
guaranteed as to the timely repayment of principal and interest by 
the full faith and credit of the U.S. Government.
---------------------------------------------------------------------------

    (5) Securities and other claims on, and portions of claims 
guaranteed by, U.S. Government-sponsored agencies.\62\
---------------------------------------------------------------------------

    \62\ For the purpose of calculating the risk-based capital 
ratio, a U.S. Government-sponsored agency is defined as an agency 
originally established or chartered to serve public purposes 
specified by the U.S. Congress but whose obligations are not 
explicitly guaranteed by the full faith and credit of the U.S. 
Government.
---------------------------------------------------------------------------

    (6) Portions of loans and other claims (including repurchase 
agreements) collateralized by securities issued or guaranteed by the 
U.S. Treasury, U.S. Government agencies, or U.S. Government-
sponsored agencies.
    (7) Portions of loans and other claims collateralized \63\ by 
cash on deposit in the lending bank.
---------------------------------------------------------------------------

    \63\ Degree of collateralization is determined by current market 
value.
---------------------------------------------------------------------------

    (8) General obligation claims on, and portions of claims 
guaranteed by, the full faith and credit of states or other 
political subdivisions of OECD countries, including U.S. state and 
local governments.
    (9) Investments in shares of mutual funds whose portfolios are 
permitted to hold only assets that qualify for the zero or 20 
percent risk categories.
    (10) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and 
asset-or mortgage-backed securities rated in either of the two 
highest investment grade categories, e.g., AAA or AA, in the case of 
long-term ratings, or the highest rating category, e.g., A-1, P-1, 
in the case of short-term ratings.
    (11) Certain externally rated exposures as provided under 
section II.C.9 of this appendix E.
    (12) Certain one-to-four family residential mortgages as 
provided under section II.C.9 of this appendix E.

Category 3--35 Percent Risk Weight

    (1) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and 
asset-or mortgage-backed securities rated in the third-highest 
investment grade category, e.g., A, in the case of long-term 
ratings, or the second highest rating category, e.g., A-2, P-2, in 
the case of short-term ratings.
    (2) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.
    (3) Certain one-to-four family residential mortgages as provided 
under section II.C.9 of this appendix E.

Category 4--50 Percent Risk Weight

    (1) Certain presold residential construction loans, provided 
that the loans were approved in accordance with prudent underwriting 
standards and are not past due 90 days or more or carried on a 
nonaccrual status.
    (2) Loans fully secured by first liens on multifamily 
residential properties that have been prudently underwritten and 
meet specified requirements with respect to loan-to-value ration, 
level of annual net operating income to required debt service, 
maximum amortization period, minimum original maturity, and 
demonstrated timely repayment performance.
    (3) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and 
asset-or mortgage-backed securities rated in the lowest-highest 
investment grade category plus, e.g., BBB+, in the case of long-term 
ratings.
    (4) Revenue bonds or similar obligations, including loans and 
leases, that are obligations of U.S. state or political subdivisions 
of the United States or other OECD countries but for which the 
government entity is committed to repay the debt only out of 
revenues from the specific projects financed.
    (5) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.
    (6) Certain one-to-four family residential mortgages as provided 
under section II.C.9 of this appendix E.

Category 5--75 Percent Risk Weight

    (1) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and 
asset-or mortgage-backed securities rated in the lowest highest 
investment grade category naught, e.g., BBB, in the case of long-
term ratings, or the lowest highest rating category, e.g., A-3, P-3, 
in the case of short-term ratings.
    (2) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.
    (3) Certain one-to-four family residential mortgages as provided 
under section II.C.9 of this appendix E.

Category 6--100 Percent Risk Weight

    (1) All other claims on private obligors.
    (2) Obligations issued by U.S. state or local governments or 
other OECD local governments (including industrial development 
authorities and similar entities) that are repayable solely by a 
private party or enterprise.
    (3) Premises, plant, and equipment; other fixed assets; and 
other real estate owned.
    (4) Investments in any unconsolidated subsidiaries, joint 
ventures, or associated companies--if not deducted from capital.
    (5) Instruments issued by other banking organizations that 
qualify as capital.
    (6) Claims on commercial firms owned by the U.S. Government or 
foreign governments.
    (7) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips) and 
asset-or mortgage-backed securities rated in the lowest investment 
grade category negative, e.g., BBB-, as well as certain

[[Page 77511]]

positions (but not residual interests) which the bank rates pursuant 
to section II.B.5(g) of this appendix E.
    (8) Other assets, including any intangible assets that are not 
deducted from capital, and the credit equivalent amounts \64\ of 
off-balance sheet items not assigned to a different risk category, 
except for certain externally rated exposures and certain one-to-
four family residential mortgages as provided under section II.C.9 
of this appendix E.
---------------------------------------------------------------------------

    \64\ In general for each off-balance sheet item, a conversion 
factor (see Table H) must be applied to determine the ``credit 
equivalent amount'' prior to assigning the off-balance sheet item to 
a risk weight category.
---------------------------------------------------------------------------

Category 7--150 Percent Risk Weight

    (1) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.
    (2) Certain one-to-four family residential mortgages as provided 
under section II.C.9 of this appendix E.

Category 8--200 Percent Risk Weight

    (1) Externally rated recourse obligations, direct credit 
substitutes, residual interests (other than credit-enhancing 
interest-only strips), and asset- and mortgage-backed securities 
that are rated one category below the lowest investment grade 
category--negative, e.g., BB, to the extent permitted in section 
II.B.5(d) of this appendix E.
    (2) A position (but not a residual interest) extended in 
connection with a securitization or structured financing program 
that is not rated by an NRSRO for which the bank determines that the 
credit risk is equivalent to one category below investment grade, 
e.g., BB, to the extent permitted in section II.B.5(g) of this 
appendix E.
    (3) Certain externally rated exposures as provided under section 
II.C.9 of this appendix E.

Department of the Treasury

Office of Thrift Supervision

12 CFR Chapter V.

Authority and Issuance

    For the reasons stated in the common preamble, the Office of 
Thrift Supervision proposes to amend part 567 of chapter V of title 
12 of the Code of Federal Regulations as follows:

PART 567--CAPITAL

    1. The authority citation for part 567 continues to read as 
follows:

    Authority: 12 U.S.C. 1462, 1462a, 1463, 1464, 1467a, 1828 
(note).

    2. In Sec.  567.1, revise the definition of risk-weighted assets to 
read as follows:


Sec.  567.1.  Definitions.

* * * * *
    Risk-weighted assets. Risk-weighted assets means risk-weighted 
assets computed under Sec.  567.6 or Sec.  567.7 of this part.
* * * * *
    3. Revise paragraph (a)(1)(i) of Sec.  567.2 to read as follows:


Sec.  567.2  Minimum regulatory capital requirement.

    (a) * * *
    (1) * * *
    (i) Risk-based capital requirement. A savings association's minimum 
risk-based capital requirement shall be an amount equal to 8 percent of 
its risk-weighted assets.
* * * * *
    4. Revise the section heading and add a new introductory paragraph 
to Sec.  567.6 to read as follows:


Sec.  567.6  Risk-weighted assets.

    Unless the savings association uses 12 CFR part 566, Appendix A or 
elects to use Sec.  567.7 of this part, a savings association must 
compute risk-weighted assets as described in this section.
* * * * *
    5. Add a new Sec.  567.7 to read as follows:


Sec.  567.7  Alternate computation of risk-weighted assets.

    (a) Opt-in. (1) Any savings association, other than a savings 
association that uses 12 CFR part 566, Appendix A, may elect to compute 
risk-weighted assets under this section rather than Sec.  567.6 of this 
part. If a savings association elects to apply this section, it must 
apply all of the requirements of this section.
    (2) To elect to apply this section, a savings association must 
notify OTS. The election will remain in effect until the savings 
association withdraws the election by notifying OTS.
    (b) Definitions. The following definitions apply to this section:
    (1) External rating. (i) An external rating is a credit rating 
assigned by a NRSRO that:
    (A) Fully reflects the entire amount of the credit risk with regard 
to all payments owed on the claim (that is, the rating must fully 
reflect the credit risk associated with timely repayment of principal 
and interest);
    (B) Is published in an accessible public form;
    (C) Is monitored by the issuing NRSRO; and
    (D) Is, or will be, included in the issuing NRSRO's publicly 
available transition matrix, which tracks the performance and stability 
(or rating migration) of an NRSRO's issued external ratings for the 
specific type of claim (for example, corporate debt).
    (ii) If an exposure has two or more external ratings, the external 
rating is the lowest assigned rating. If an exposure has components 
that are assigned different external ratings, the savings association 
must assign the lowest component rating to the entire exposure. If an 
exposure has a component that is not externally rated, the exposure is 
not externally rated.
    (2) Non-sovereign. A non-sovereign includes a securities firm, 
insurance company, bank holding company, savings and loan holding 
company, multi-lateral lending and regional development institution, 
partnership, limited liability company, business trust, special purpose 
entity, association, and similar organization.
    (3) Public-sector entity. A public-sector entity means a state, 
local authority or governmental subdivision below the central 
government level in an OECD country. In the United States, this 
definition encompasses a state, county, city, town, or other municipal 
corporation, a public authority, and generally any publicly-owned 
entity that is an instrumentality of a state or municipal corporation. 
This definition does not include commercial companies owned by a 
public-sector entity.
    (4) Sovereign. Sovereign means a central government or an agency, 
department, ministry, or central bank of a central government. It does 
not include state, provincial or local governments, or commercial 
enterprises owned by a central government.
    (c) Computation. Under this section, risk-weighted assets equal 
risk-weighted on-balance sheet assets computed under paragraph (d) of 
this section, plus risk-weighted off-balance sheet items computed under 
paragraph (e) of this section, plus risk-weighted recourse obligations, 
direct credit substitutes and certain other positions computed under 
paragraph (f) of this section. Assets not included (i.e., deducted from 
capital) for the purposes of calculating capital under Sec.  567.5 are 
not included in calculating risk-weighted assets.
    (d) On-balance sheet assets. Except as provided in paragraph (f) of 
this section, risk-weighted on-balance sheet assets are computed by 
multiplying the on-balance sheet asset amounts times the appropriate 
risk weight categories described in this section.
    (1) The risk weight categories are:
    (i) Zero percent risk weight.
    (A) Cash, including domestic and foreign currency owned and held in 
all offices of a savings association or in transit. Any foreign 
currency held by a savings association must be converted into U.S. 
dollar equivalents;
    (B) Securities issued by and other direct claims on the United 
States Government or its agencies (to the extent such securities or 
claims are unconditionally backed by the full faith

[[Page 77512]]

and credit of the United States Government);
    (C) Notes and obligations issued by either the Federal Savings and 
Loan Insurance Corporation or the Federal Deposit Insurance Corporation 
and backed by the full faith and credit of the United States 
Government;
    (D) Deposit reserves at, claims on, and balances due from Federal 
Reserve Banks;
    (E) The book value of paid-in Federal Reserve Bank stock;
    (F) That portion of assets that is fully covered against capital 
loss or yield maintenance agreements by the Federal Savings and Loan 
Insurance Corporation or any successor agency;
    (G) That portion of assets directly and unconditionally guaranteed 
by the United States Government or its agencies;
    (H) Claims on, and claims guaranteed by, a qualifying securities 
firm that are collateralized by cash on deposit in the savings 
association or by securities issued or guaranteed by the United States 
Government or its agencies or the central government of an OECD 
country. To be eligible for this risk weight, the savings association 
must maintain a positive margin of collateral on the claim on a daily 
basis, taking into account any change in a savings association's 
exposure to the obligor or counterparty under the claim in relation to 
the market value of the collateral held in support of the claim;
    (I) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
zero percent risk weight, as provided in paragraphs (d)(3) and (5) of 
this section.
    (ii) 20 percent risk weight.
    (A) Cash items in the process of collection;
    (B) That portion of assets collateralized by the current market 
value of securities issued or guaranteed by the United States 
Government or its agencies;
    (C) That portion of assets conditionally guaranteed by the United 
States Government or its agencies;
    (D) Securities (not including equity securities) issued by and 
other claims on the U.S. Government or its agencies that are not backed 
by the full faith and credit of the United States Government;
    (E) Securities (not including equity securities) issued by, or 
other direct claims on, United States Government-sponsored agencies;
    (F) That portion of assets guaranteed by United States Government-
sponsored agencies;
    (G) That portion of assets collateralized by the current market 
value of securities issued or guaranteed by United States Government-
sponsored agencies;
    (H) Loans that are not externally rated that are issued to a 
qualifying securities firm, subject to the conditions set forth below. 
Externally rated loans to, debt securities of, claims collateralized by 
claims on, and guarantees by a qualifying securities firm are subject 
to paragraphs (d)(1)(i)(H), and (d)(3) through (5) of this section.
    (1) A qualifying securities firm must have a long-term issuer 
credit rating, or a rating on at least one issue of long-term unsecured 
debt, from a NRSRO. The rating must be in one of the three highest 
investment grade categories used by the NRSRO. If two or more NRSROs 
assign ratings to the qualifying securities firm, the savings 
association must use the lowest rating to determine whether the rating 
requirement of this paragraph is met. A qualifying securities firm may 
rely on the rating of its parent consolidated company, if the parent 
consolidated company guarantees the claim.
    (2) A collateralized claim on a qualifying securities firm does not 
have to comply with the rating requirements under paragraph 
(d)(1)(ii)(H)(1) of this section if the claim arises under a contract 
that:
    (i) Is a reverse repurchase/repurchase agreement or securities 
lending/borrowing transaction executed using standard industry 
documentation;
    (ii) Is collateralized by debt or equity securities that are liquid 
and readily marketable;
    (iii) Is marked-to-market daily;
    (iv) Is subject to a daily margin maintenance requirement under the 
standard industry documentation; and
    (v) Can be liquidated, terminated or accelerated immediately in 
bankruptcy or similar proceeding, and the security or collateral 
agreement will not be stayed or avoided under applicable law of the 
relevant jurisdiction. For example, a claim is exempt from the 
automatic stay in bankruptcy in the United States if it arises under a 
securities contract or a repurchase agreement subject to section 555 or 
559 of the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified 
financial contract under section 11(e)(8) of the Federal Deposit 
Insurance Act (12 U.S.C. 1821(e)(8)), or a netting contract between or 
among financial institutions under sections 401-407 of the Federal 
Deposit Insurance Corporation Improvement Act of 1991 (12 U.S.C. 4401-
4407), or Regulation EE (12 CFR part 231).
    (3) If the securities firm uses the claim to satisfy its applicable 
capital requirements, the claim is not eligible for a risk weight under 
this paragraph (d)(1)(ii)(H);
    (I) Claims representing general obligations of any public-sector 
entity in an OECD country, and that portion of any claims guaranteed by 
any such public-sector entity;
    (J) Bonds issued by the Financing Corporation or the Resolution 
Funding Corporation;
    (K) Balances due from and all claims on domestic depository 
institutions. This includes demand deposits and other transaction 
accounts, savings deposits and time certificates of deposit, federal 
funds sold, loans to other depository institutions, including 
overdrafts and term federal funds, holdings of the savings 
association's own discounted acceptances for which the account party is 
a depository institution, holdings of bankers acceptances of other 
institutions and securities issued by depository institutions, except 
those that qualify as capital;
    (L) The book value of paid-in Federal Home Loan Bank stock;
    (M) Deposit reserves at, claims on and balances due from the 
Federal Home Loan Banks;
    (N) Assets collateralized by cash held in a segregated deposit 
account by the reporting savings association;
    (O) Loans that are not externally rated that are issued to official 
multilateral lending institutions or regional development institutions 
in which the United States Government is a shareholder or contributing 
member. Externally rated loans to, debt securities of, claims 
collateralized by claims on, and guarantees by such official 
multilateral lending institutions, or regional development institutions 
are subject to paragraph (d)(3) through (5) of this section;
    (P) All claims on depository institutions incorporated in an OECD 
country, and all assets backed by the full faith and credit of 
depository institutions incorporated in an OECD country. This includes 
the credit equivalent amount of participations in commitments and 
standby letters of credit sold to other depository institutions 
incorporated in an OECD country, but only if the originating bank 
remains liable to the customer or beneficiary for the full amount of 
the commitment or standby letter of credit. Also included in this 
category are the credit equivalent amounts of risk participations in 
bankers' acceptances conveyed to other depository institutions 
incorporated in an OECD country. However, bank-issued securities that 
qualify as capital of the

[[Page 77513]]

issuing bank are not included in this risk category;
    (Q) Claims on, or guaranteed by depository institutions other than 
the central bank, incorporated in a non-OECD country, with a remaining 
maturity of one year or less;
    (R) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
20 percent risk weight under paragraphs (d)(3) and (5) of this section;
    (S) Debt securities issued by, certain other externally rated 
claims on, and that portion of assets backed by an eligible guarantee 
of, a non-sovereign that receive a 20 percent risk weight under 
paragraphs (d)(3) and (5) of this section;
    (T) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset-or mortgage-backed securities with long-term external ratings in 
the highest or second highest investment grade category or short-term 
external ratings in the highest investment rating category, as provided 
under paragraph (f) of this section;
    (U) Assets collateralized by exposures that receive a 20 percent 
risk weight under paragraph (d)(4) of this section;
    (V) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 20 percent risk weight under 
paragraph (d)(2) of this section.
    (iii) 35 percent risk weight.
    (A) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
35 percent risk weight under paragraphs (d)(3) and (5) of this section;
    (B) Debt securities issued by, certain other externally rated 
claims on, and that portion of assets backed by an eligible guarantee 
of, a non-sovereign that receive a 35 percent risk weight under 
paragraphs (d)(3) and (5) of this section;
    (C) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset-or mortgage-backed securities with long-term external ratings in 
the third highest investment grade category or short-term external 
ratings in the second highest investment rating category, as provided 
under paragraph (f) of this section;
    (D) Assets collateralized by exposures that receive a 35 percent 
risk weight under paragraph (d)(4) of this section;
    (E) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 35 percent risk weight under 
paragraph (d)(2) of this section.
    (iv) 50 percent risk weight.
    (A) Revenue bonds issued by any public-sector entity in an OECD 
country, for which the underlying obligor is a public-sector entity, 
but which are repayable solely from the revenues generated from the 
project financed through the issuance of the obligations;
    (B) Qualifying multifamily mortgage loans;
    (C) Privately-issued mortgage-backed securities (i.e., those that 
do not carry the guarantee of a government or government-sponsored 
agency) representing an interest in qualifying mortgage loans or 
qualifying multifamily mortgage loans. If the security is backed by 
qualifying multifamily mortgage loans, the savings association must 
receive timely payments of principal and interest in accordance with 
the terms of the security. Payments will generally be considered timely 
if they are not 30 days past due;
    (D) Qualifying residential construction loans;
    (E) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
50 percent risk weight under paragraphs (d)(3) and (5) of this section;
    (F) Debt securities issued by, certain other externally rated 
claims on, and that portion of assets backed by an eligible guarantee 
of, a non-sovereign that receive a 50 percent risk weight under 
paragraphs (d)(3) and (5) of this section;
    (G) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset-or mortgage-backed securities with long-term external ratings in 
the lowest investment `` plus grade category, as provided under 
paragraph (f) of this section;
    (H) Assets collateralized by exposures that receive a 50 percent 
risk weight under paragraph (d)(4) of this section;
    (I) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 50 percent risk weight under 
paragraph (d)(2) of this section.
    (v) 75 percent risk weight.
    (A) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
75 percent risk weight under paragraphs (d)(3) and (5) of this section;
    (B) Debt securities issued by, certain other externally rated 
claims on, and that portion of assets backed by an eligible guarantee 
of, a non-sovereign that receive a 75 percent risk weight under 
paragraphs (d)(3) and (5) of this section;
    (C) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset-or mortgage-backed securities with long-term external ratings in 
the lowest investment grade `` naught category or short-term external 
ratings in the lowest investment rating category, as provided under 
paragraph (f) of this section;
    (D) Assets collateralized by exposures that receive a 75 percent 
risk weight under paragraph (d)(4) of this section;
    (E) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 75 percent risk weight under 
paragraph (d)(2) of this section.
    (vi) 100 percent risk weight. All assets not otherwise specified in 
this section or deducted from calculations of capital under to Sec.  
567.5 of this part, including, but not limited to:
    (A) Consumer loans;
    (B) Commercial loans that are not externally rated;
    (C) Non-qualifying multifamily mortgage loans;
    (D) Residential construction loans;
    (E) Land loans;
    (F) Nonresidential construction loans;
    (G) Obligations issued by any public-sector entity in an OECD 
country, for the benefit of a private party or enterprise provided that 
the party or enterprise, rather than the issuing public-sector entity, 
is responsible for the timely payment of principal and interest on the 
obligations, e.g., industrial development bonds;
    (H) Investments in fixed assets and premises;
    (I) Certain nonsecurity financial instruments including servicing 
assets and intangible assets includable in core capital under Sec.  
567.12 of this part;
    (J) That portion of equity investments not deducted pursuant to 
Sec.  567.5 of this part;
    (K) The prorated assets of subsidiaries (except for the assets of 
includable, fully consolidated subsidiaries) to the extent such assets 
are included in adjusted total assets;
    (L) All repossessed assets or assets (other than mortgage loans 
secured by liens on one-to four-family residential properties) that are 
more than 90 days past due;
    (M) Equity investments that the Office determines have the same 
risk characteristics as foreclosed real estate by the savings 
association;
    (N) Equity investments permissible for a national bank;

[[Page 77514]]

    (O) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
100 percent risk weight under paragraphs (d)(3) and (5) of this 
section;
    (P) Debt securities issued by, certain other rated claims on, and 
that portion of assets backed by an eligible guarantee of, non-
sovereign that receive a 100 percent risk weight under paragraphs 
(d)(3) and (5) of this section;
    (Q) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset- or mortgage-backed securities with long-term external ratings in 
the lowest investment grade--negative category, as provided under 
paragraph (f) of this section;
    (R) Assets collateralized by exposures that receive a 100 percent 
risk weight under paragraph (d)(4) of this section;
    (S) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 100 percent risk weight under 
paragraph (d)(2) of this section.
    (vii) 150 percent risk weight.
    (A) Debt securities issued by, certain other rated claims on, and 
that portion of assets backed by an eligible guarantee of a non-
sovereign that receive a 150 percent risk weight under paragraphs 
(d)(3) and (5) of this section;
    (B) Assets collateralized by exposures that receive a 150 percent 
risk weight under paragraph (d)(4) of this section;
    (C) Certain mortgage loans secured by liens on one-to four-family 
residential properties that receive a 150 percent risk weight under 
paragraph (d)(2) of this section.
    (viii) 200 percent risk weight.
    (A) Debt securities issued by, other claims on, and that portion of 
assets backed by an eligible guarantee of, a sovereign that receive a 
200 percent risk weight under paragraphs (d)(3) and (5) of this 
section;
    (B) Debt securities issued by, certain other rated claims on, and 
that portion of assets backed by an eligible guarantee of, a non-
sovereign that receive a 200 percent risk weight under paragraphs 
(d)(3) and (5) of this section;
    (C) Recourse obligations, direct credit substitutes, residual 
interests (other than credit-enhancing interest-only strips), and 
asset-or mortgage-backed securities with long-term external ratings one 
category below investment grade, as provided under paragraph (f) of 
this section;
    (D) Assets collateralized by exposures that receive a 200 percent 
risk weight under paragraph (d)(4) of this section.
    (2) Mortgage loans secured by a lien on one-to four-family 
residential property. A savings association must risk-weight mortgage 
loans secured by liens on one-to four-family residential properties 
under this paragraph (d)(2).
    (i) First liens. A savings association must apply the risk weight 
in Table 1 that corresponds to the loan-to-value (LTV) ratio of a 
mortgage loan secured by a first lien on one-to four-family residential 
property. If a loan is not prudently underwritten, is not performing, 
or is more than 90 days past due, the savings association must apply a 
risk weight of 150 percent if the loan has an LTV that is greater than 
95 percent, and must apply a risk weight of 100 percent to all other 
loans.

Table 1.--Risk Weights for Mortgage Loans Secured by First Liens on One-
                  to Four-Family Residential Properties
------------------------------------------------------------------------
                                                             Risk weight
                    Loan-to-Value ratio                       (percent)
------------------------------------------------------------------------
60% or less................................................           20
Greater than 60% and less than or equal to 80%.............           35
Greater than 80% and less than or equal to 85%.............           50
Greater than 85% and less than or equal to 90%.............           75
Greater than 90% and less than or equal to 95%.............          100
Greater than 95%...........................................          150
------------------------------------------------------------------------

    (ii) Junior liens.
    (A) If a savings association holds the first lien and a junior lien 
on a one-to four family residential property and no other party holds 
an intervening lien, the savings association must treat the two loans 
as a single loan secured by a first lien and risk-weight the loans 
under paragraph (d)(2)(i) of this section.
    (B) If a third party holds a senior or intervening lien, the 
savings association must apply the risk weight in Table 2 that 
corresponds the LTV ratio of the loan. If a loan is not prudently 
underwritten, is not performing, or is more than 90 days past due, the 
savings association must apply a risk weight of 150 percent if the loan 
has an LTV that is greater than 90 percent, and must apply a risk 
weight of 100 percent to all other loans.

Table 2.--Risk Weights for Mortgage Loans Secured by Junior Liens on One-
                  to Four-Family Residential Properties
------------------------------------------------------------------------
                    Loan-to-Value ratio                      Risk weight
------------------------------------------------------------------------
60% or less................................................           75
Greater than 60% and less than or equal to 90%.............          100
Greater than 90%...........................................          150
------------------------------------------------------------------------

    (iii) LTV computation. To compute the LTV ratio under this 
paragraph (d)(2):
    (A) The loan amount is the original principal amount of the loan 
and of all senior loans, subject to the following adjustments:
    (1) If a loan has positively amortized, the savings association may 
adjust the original principal amount of the loan quarterly to reflect 
the positive amortization.
    (2) If a loan has a negative amortization feature, the savings 
association must adjust the original principal amount of the loan 
quarterly to include amount of the negative amortization. If a third 
party holds a senior or intervening lien with a negative amortization 
feature, the savings association must adjust the original principal 
amount of the senior or intervening loan to reflect the amount of that 
loan if it were to fully negatively amortize under the applicable 
contract.
    (3) If a loan is a home equity line of credit, the savings 
association must adjust the original principal amount of the loan 
quarterly to reflect the current funded amount of the line of credit.
    (B) At the origination of the loan, the value of the property is 
the lower of the purchase price or the estimate of the property's 
value. The savings association may update the value of the property 
only when it extends additional funds in connection with refinancing 
the loan or originating another loan secured by a junior lien that is 
treated as a single loan under paragraph (d)(2)(ii)(A) of this section, 
and it obtains a new appraisal or evaluation of the value of the 
property as a part of that transaction. All estimates of the property's 
value must be based on an appraisal or evaluation of the property in 
conformance with 12 CFR part 564 and 12 CFR 560.100-560.101.
    (C) The savings association may compute the LTV ratio after 
consideration of loan level private mortgage insurance (PMI) provided 
by non-affiliated insurer with long-term senior debt (without credit 
enhancement) that is externally-rated at least the third highest 
investment grade. Loan level PMI is insurance that protects a mortgage 
lender in the event of borrower default up to a predetermined portion 
of the value of a one-to four-family residential property and that has 
no pool-level cap that would effectively reduce coverage below the 
predetermined portion of the value of the property. An affiliated 
company is any company that controls, is controlled by, or is in common 
control with the savings association. A

[[Page 77515]]

company or person controls a company if it owns, controls, or holds 
with power to vote 25 percent or more of a class of voting securities 
of the company, or consolidates the company for financial reporting 
purposes.
    (iv) Negatively amortizing loans and home equity lines of credit. 
This paragraph (d)(2) applies to the funded portions of negatively 
amortizing loans and home equity lines of credit that are secured by a 
first or junior lien on one-to four-family residential property. The 
unfunded portions of these loans are addressed at paragraph (e)(2) of 
this section.
    (v) Construction loans. This paragraph (d)(2) applies to a mortgage 
loan to an individual borrower that is secured by a lien on land to be 
used for the construction of the borrower's home. It does not apply to 
``qualifying residential construction loans,'' as defined in Sec.  
567.1, which are addressed under paragraph (d)(1)(iv)(D) of this 
section or other residential construction loans, which are addressed 
under paragraph (d)(1)(vi)(D) of this section.
    (vi) Transition provision. If a savings association owns a mortgage 
loan secured by a lien on one-to four-family residential property on 
the date that it elects to opt-in under paragraph (a) of this section, 
it may apply a 50 percent risk weight if the mortgage loan is a 
``qualifying mortgage loan'' as defined in Sec.  567.1, and apply a 100 
percent risk weight if the mortgage loan is not a qualifying mortgage 
loan. If the savings association elects to apply this paragraph 
(d)(2)(vi), it must apply this transitional risk-weight treatment to 
all mortgage loans that it owns on the date that it elects to opt-in 
under paragraph (a). A savings association may only rely on this 
transitional provision the first time it elects to compute risk-weights 
under this Sec.  567.7.
    (3) Direct claims--ratings-based approach. (i) A savings 
association must risk-weight claims described in paragraph (d)(3)(ii) 
of this section using the risk weights indicated on Table 3 (claims 
with an original maturity of one year or more) or Table 4 (claims with 
an original maturity of less than one year). To determine the 
applicable risk weight for a claim, the savings association must use 
the external rating for the claim. If a sovereign exposure has no 
external rating, the exposure is deemed to have an external rating 
equal to the sovereign's issuer rating assigned by an NRSRO.
    (ii)(A) This paragraph (d)(3) applies to claims on sovereigns, 
other than the United States Government and its agencies. Claims on the 
United States Government and its agencies are risk-weighted under 
paragraph (d)(1) of this section.
    (B) This paragraph (d)(3) also applies to all claims on non-
sovereigns, other than loans that are not externally rated and claims 
on United States Government-sponsored agencies, public-sector entities 
in OECD countries, and depository institutions. Loans to non-sovereigns 
that are not externally rated and claims on United States Government-
sponsored agencies, public sector entities in OECD countries and 
depository institutions are risk-weighted under paragraph (d)(1) of 
this section.
    (C) This paragraph (d)(3) does not apply to recourse obligations, 
direct credit substitutes, and other positions that are subject to 
paragraph (f) of this section.
    (D) This paragraph (d)(3) also does not apply to OTC derivative 
counter-party risk. OTC derivative counter-party risk is addressed in 
paragraph (e) of this section.

                         Table 3.--Risk Weights Based on Ratings for Long-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                  Sovereign risk   Non-Sovereign
         Long-term rating category                         Example                    weight        risk weight
                                                                                     (percent)       (percent)
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating............  AAA                                               0              20
Second-highest investment grade rating.....  AA                                               20              20
Third-highest investment grade rating......  A                                                20              35
Lowest-investment grade rating--plus.......  BBB+                                             35              50
Lowest-investment grade rating.............  BBB                                              50              75
Lowest-investment grade rating--minus......  BBB-                                             75             100
One category below investment grade........  BB+, BB                                          75             150
One category below investment grade--minus.  BB-                                             100             200
Two or more categories below investment      B, CCC                                          150             200
 grade.
Unrated....................................  n/a                                             200          200\1\
----------------------------------------------------------------------------------------------------------------


                        Table 4.--Risk Weights Based on Ratings For Short-Term Exposures
----------------------------------------------------------------------------------------------------------------
                                                                                  Sovereign risk   Non-Sovereign
         Short-term rating category                        Example                    weight        risk weight
----------------------------------------------------------------------------------------------------------------
Highest investment grade rating............  A-1, P-1                                          0              20
Second-highest investment grade rating.....  A-2, P-2                                         20              35
Lowest investment grade rating.............  A-3, P-3                                         50              75
Unrated....................................  n/a                                             100          100\1\
----------------------------------------------------------------------------------------------------------------
\1\Unrated debt securities issued by non-sovereigns receive the risk-weight indicated. Unrated loans to non-
  sovereigns are risk-weighted under paragraph (d)(1) of this section.

    (4) Claims collateralized by certain debt securities or asset-
backed or mortgage-backed securities. (i) In addition to collateralized 
claims addressed in paragraph (d)(1) of this section, a savings 
association may risk-weight a claim that is collateralized by:
    (A) A debt security that may be risk-weighted under paragraph 
(d)(3) of this section, by applying the risk-weight that would be 
assigned directly to the debt security under that paragraph. The 
minimum risk-weight that may be assigned to an asset collateralized by 
a debt security that is issued by a sovereign is 20 percent;
    (B) A debt security backed by a guarantee of a sovereign (other 
than the United States and its agencies) that may be risk-weighted 
under paragraph (d)(5) of this section, by applying the risk-

[[Page 77516]]

weight that would be assigned directly to the debt security under that 
paragraph. The minimum risk-weight that may be assigned to an asset 
collateralized by a debt security that is guaranteed by a sovereign is 
20 percent; or
    (C) A security that may be risk-weighted under Table A or B of 
paragraph (f) of this section, by applying the risk-weight that would 
be assigned directly to the security under paragraph (f).
    (ii) To be eligible for risk-weighting under this paragraph (d)(4), 
the collateral must be liquid and readily marketable and must have an 
external rating (or, if applicable, a sovereign issuer rating assigned 
by an NRSRO) of at least investment grade.
    (iii) If an asset is partially collateralized, only that portion of 
the asset that is collateralized by the market value of the collateral 
may be risk-weighted under this paragraph (d)(4).
    (5) Guaranteed assets or claims. (i) A savings association may 
risk-weight a claim that is backed by an eligible guarantee by applying 
the risk-weight indicated in Table 3 of this section. To determine the 
applicable risk weight for an exposure, the savings association must 
use the external rating assigned to the guarantor's long-term senior 
debt (without credit enhancement) or, if the guarantor is a sovereign, 
an external rating that is equal to the sovereign's issuer rating 
assigned by an NRSRO. The applicable external rating must be at least 
investment grade.
    (ii) This paragraph (d)(5) applies to eligible guarantees of:
    (A) Sovereigns, other than the United States Government and its 
agencies. Guarantees of the United States Government and its agencies 
are risk-weighted under paragraph (d)(1) of this section; and
    (B) Non-sovereigns, other than United States Government-sponsored 
agencies, public-sector entities in OECD countries, and depository 
institutions. Guarantees of United States Government-sponsored 
agencies, public-sector entities in OECD countries, and depository 
institutions are risk-weighted under paragraph (d)(1) of this section.
    (iii) To be an eligible guarantee, the guarantee must be issued by 
a third party guarantor and must:
    (A) Be written and unconditional and, for a sovereign guarantee, be 
backed by the full faith and credit of the sovereign;
    (B) Cover all or a pro rata portion of contractual payments of the 
obligor on the reference asset or claim. If an asset or claim is 
partially guaranteed, only the pro rata portion of the asset or claim 
that is guaranteed may be assigned a risk-weight under this paragraph 
(d)(5);
    (C) Give the beneficiary a direct claim against the protection 
provider;
    (D) Be non-cancelable by the protection provider for reasons other 
than the breach of the contract by the beneficiary;
    (E) Be legally enforceable against the protection provider in a 
jurisdiction where the protection provider has sufficient assets 
against which a judgment may be attached and enforced; and
    (F) Require the protection provider to make payment to the 
beneficiary on the occurrence of a default of the obligor on the 
reference asset or claim without first requiring the beneficiary to 
demand payment from the obligor.
    (6) Indirect ownership interests in pools of assets. Assets 
representing an indirect holding of a pool of assets, e.g., mutual 
funds, are assigned to risk-weight categories based upon the risk 
weight that would be assigned to the assets in the portfolio of the 
pool. An investment in shares of a mutual fund whose portfolio consists 
primarily of various securities or money market instruments that, if 
held separately, would be assigned to different risk-weight categories, 
generally is assigned to the risk-weight category appropriate to the 
highest risk-weighted asset that the fund is permitted to hold in 
accordance with the investment objectives set forth in its prospectus. 
The savings association may, at its option, assign the investment on a 
pro rata basis to different risk-weight categories according to the 
investment limits in its prospectus. In no case will an investment in 
shares in any such fund be assigned to a total risk weight less than 20 
percent. If the savings association chooses to assign investments on a 
pro rata basis, and the sum of the investment limits of assets in the 
fund's prospectus exceeds 100 percent, the savings association must 
assign the highest pro rata amounts of its total investment to the 
higher risk categories. If, in order to maintain a necessary degree of 
short-term liquidity, a fund is permitted to hold an insignificant 
amount of its assets in short-term, highly liquid securities of 
superior credit quality that do not qualify for a preferential risk 
weight, such securities will generally be disregarded in determining 
the risk-weight category into which the savings association's holding 
in the overall fund should be assigned. The prudent use of hedging 
instruments by a mutual fund to reduce the risk of its assets will not 
increase the risk-weighting of the mutual fund investment. For example, 
the use of hedging instruments by a mutual fund to reduce the interest 
rate risk of its government bond portfolio will not increase the risk 
weight of that fund above the 20 percent category. Nonetheless, if the 
fund engages in any activities that appear speculative in nature or has 
any other characteristics that are inconsistent with the preferential 
risk-weighting assigned to the fund's assets, holdings in the fund will 
be assigned to the 100 percent risk-weight category.
    (e) Off balance sheet items. A savings association must calculate 
the risk-weighted off-balance sheet items as described at Sec.  567.6 
of this part, with the following modifications:
    (1) Short-term commitments. A savings association must apply the 
following credit conversion factors to the unused portion of 
commitments with an original maturity of one year or less:
    (i) Zero percent for commitments that are unconditionally 
cancelable and commitments to originate a loan secured by a lien on 
one- to four-family residential property; and
    (ii) 10 percent for all other short-term commitments.
    (2) Unfunded amount of negatively amortizing mortgage loans and 
home equity lines of credit. If a mortgage loan secured by a lien on 
one- to four-family residential property may negatively amortize or is 
a home equity line of credit, a savings association must calculate the 
risk-weighted asset amount for the unfunded amount of the loan by 
multiplying the amount of the off-balance sheet exposure times the 
applicable credit conversion factor times the applicable risk weight. 
For the purposes of this paragraph (e)(2):
    (i) The amount of the off-balance sheet exposure is the unfunded 
amount of the loan if it were to fully negatively amortize under the 
applicable contract or the maximum unfunded amount of the home equity 
line of credit; and
    (ii) The applicable risk weight is the risk weight prescribed in 
paragraph (d)(2) of this section using an LTV computed under that 
paragraph, except that the loan amount must include an additional 
amount equal to the unfunded amount of the loan if it were to fully 
negative amortize under the applicable contract or equal to the maximum 
unfunded amount of the home equity line of credit.
    (3) Risk weight for derivatives. A savings association must 
calculate the risk-weighted asset amount for off-balance sheet 
derivative contracts without reference to the 50 percent maximum risk-
weight cap described at 12 CFR 567.6(a)(2).

[[Page 77517]]

    (f) Ratings-based approach for recourse obligations, direct credit 
substitutes and certain other positions. (1) General. A savings 
association must apply Sec.  567.6(b) of this part to determine the 
risk weights for recourse obligations, direct credit substitutes, and 
other described positions, except the savings association must 
calculate risk-weights for recourse obligations, direct credit 
substitutes, residual interests (other than credit enhancing interest-
on strips) described in Sec.  567.6(b)(3) by referring to the 
exposure's external rating and using the following tables:

                                 Table 5
------------------------------------------------------------------------
   Long-term external rating                                Risk weight
            category                     Example             (percent)
------------------------------------------------------------------------
Highest investment grade rating  AAA                                  20
Second-highest investment grade  AA                                   20
 rating.
Third-highest investment grade   A                                    35
 rating.
Lowest-investment grade rating-- BBB+                                 50
 plus.
Lowest-investment grade rating-- BBB                                  75
 naught.
Lowest-investment grade rating-- BBB-                                100
 negative.
One category below investment    BB+, BB                             200
 grade--plus & naught.
One category below investment    BB-                                 200
 grade--negative.
------------------------------------------------------------------------


                                 Table 6
------------------------------------------------------------------------
   Short-term external rating                               Risk weight
            category                     Example             (percent)
------------------------------------------------------------------------
Highest investment grade rating  A-1, P-1                             20
Second-highest investment grade  A-2, P-2                             35
 rating.
Lowest investment grade rating.  A-3, P-3                             75
------------------------------------------------------------------------

    (2) Securitizations of revolving credit with early amortization 
provisions.
    (i) A savings association must risk-weight the off-balance sheet 
amount of the investor's interest in a securitization if:
    (A) The savings association securitizes revolving credits in the 
securitization. A revolving credit is a line of credit where the 
borrower is permitted to vary the drawn amount and the amount of 
repayment within an agreed limit; and
    (B) The securitization structure includes an early amortization 
provision. An early amortization provision is a provision in the 
documentation governing a securitization that, when triggered, causes 
investors in the securitization exposures to be repaid before the 
original stated maturity of the securitization exposures. An early 
amortization provision does not include a provision that is triggered 
solely by events that are not directly related to the performance of 
the underlying exposures or the originating savings association (such 
as material changes in tax laws or regulations).
    (ii) The risk-based asset amount for the investors' interest in a 
securitization described in this paragraph (f)(2) is equal to the off-
balance sheet investors' interest times the applicable credit 
conversion factor times the risk-weight applicable to the underlying 
obligor, collateral or guarantor. For the purposes of this paragraph 
(f)(2):
    (A) The off-balance sheet investors' interest is the total amount 
of the securitization exposures issued by a trust or a special purpose 
entity to investors.
    (B) The applicable credit conversion factor is determined by 
reference to Table 5, which is based upon a comparison of the 
securitization's annualized three month average excess spread against 
the excess spread trapping point. This excess spread trapping ratio is 
computed as follows:
    (1) The savings association must calculate the three-month average 
of the dollar amount of excess spread divided by the outstanding 
principal balance of the underlying pool of exposures at the end of 
each month. Excess spread is equal to the gross finance charge 
collections (including market interchange fees) and other income 
received by a trust or special purpose entity minus interest paid to 
the investors in the securitization exposures, servicing fees, charge-
offs, and other trust or special purpose entity expenses.
    (2) The three-month average excess spread is converted to a 
compound annual rate and is then divided by the excess spread trapping 
point. The excess spread trapping point is the point at which the 
savings association is required by the documentation for the 
securitization to divert and hold excess spread in spread or reserve 
account, expressed as a percentage. The excess spread trapping point is 
4.5 percent for securitizations that do not require excess spread to be 
trapped or that specify a trapping point that is based primarily on 
performance features other than the three-month average excess spread.
    (iii) If the aggregate risk-based capital requirement for all of a 
savings association's exposures to a securitization (including the 
risk-based capital requirements for residual interests, recourse 
obligations, direct credit substitutes, the investor's interest 
computed under this paragraph (f)(2), and other securitization 
exposures) exceeds the risk-based capital requirement for the 
underlying securitized assets, the aggregate risk-based capital for all 
of the exposures is the greater of the risk-based capital requirement 
for:
    (A) The residual interest; or
    (B) The underlying securitized assets calculated as if the savings 
association continued to hold the assets on its balance sheet.

         Table 7.--Early Amortization Credit Conversion Factors
------------------------------------------------------------------------
                                                                 CCF
             Excess spread trapping point ratio               (percent)
------------------------------------------------------------------------
133.33 percent of trapping point or more...................            0
Less than 133.33 percent to 100 percent of trapping point..            5
Less than 100 percent to 75 percent of trapping point......           15

[[Page 77518]]

 
Less than 75 percent to 50 percent of trapping point.......           50
Less than 50 percent of trapping point.....................          100
------------------------------------------------------------------------

    6. In Sec.  567.11, revise paragraph (c)(2), redesignate paragraph 
(c)(3) as paragraph (c)(4) and add new paragraph (c)(3) to read as 
follows:


Sec.  567.11  Reservation of authority.

* * * * *
    (c) * * *
    (2) Notwithstanding Sec. Sec.  567.6 and 567.7 of this part, OTS 
will look to the substance of a transaction and may find that the 
assigned risk-weight for any asset, or credit equivalent amount or 
credit conversion factor for any off-balance sheet item does not 
appropriately reflect the risks imposed on the savings association. OTS 
may require the savings association to apply another risk weight, 
credit equivalent amount, or credit conversion factor that the OTS 
deems appropriate. Similarly, OTS may override the use of certain 
ratings or ratings on certain instruments, if necessary or appropriate 
to reflect the risk that that an instrument poses to a savings 
association.
    (3) OTS may require a savings association to use Sec.  567.6 or 
Sec.  567.7 of this part to compute risk-weighted assets, if OTS 
determines that the risk-weighted capital requirement computed under 
that section is more appropriate for the risk profile of the savings 
association or would otherwise enhance the safety and soundness of the 
savings association. In making a determination under this paragraph 
(c)(3), OTS will apply notice and response procedures in the same 
manner and to the same extent as the notice procedures in 12 CFR 
567.3(d).
* * * * *

    Dated: December 12, 2006.

John C. Dugan,
Comptroller of the Currency.


    By order of the Board of Governors of the Federal Reserve 
System, December 8, 2006.
Jennifer J. Johnson,
Secretary of the Board.


    Dated at Washington, D.C., this 5th Day of December, 2006.
    By order of the Board of Directors.

Federal Deposit Insurance Corporation.
Valerie J. Best,
Assistant Executive Secretary.


    Dated: December, 11, 2006.

    By the Office of Thrift Supervision
John Reich,
Director.
[FR Doc. 06-9738 Filed 12-22-06; 8:45 am]
BILLING CODE 4810-33-P(25%); 6210-01-P(25%); 6714-01-P(25%); 6720-01-
P(25%)


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