Date: December 13, 1999 Page 1

Office of the Comptroller of the Currency

Federal Deposit Insurance Corporation

Board of Governors of the Federal Reserve System

Office of Thrift Supervision

INTERAGENCY GUIDANCE ON ASSET SECURITIZATION ACTIVITIES

BACKGROUND AND PURPOSE

Recent examinations have disclosed significant weaknesses in the asset securitization practices

of some insured depository institutions. These weaknesses raise concerns about the general level

of understanding and controls among institutions that engage in such activities. The most

frequently encountered problems stem from: (1) the failure to recognize and hold sufficient

capital against explicit and implicit recourse obligations that frequently accompany

securitizations, (2) the excessive or inadequately supported valuation of “retained interests,”1

 (3)

the liquidity risk associated with over reliance on asset securitization as a funding source, and (4)

the absence of adequate independent risk management and audit functions.

The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the

Board of Governors of the Federal Reserve System, and the Office of Thrift Supervision,

hereafter referred to as “the Agencies,” are jointly issuing this statement to remind financial

institution managers and examiners of the importance of fundamental risk management practices

governing asset securitization activities. This guidance supplements existing policy statements

and examination procedures issued by the Agencies and emphasizes the specific expectation that

any securitization-related retained interest claimed by a financial institution will be supported by

documentation of the interest’s fair value, utilizing reasonable, conservative valuation

assumptions that can be objectively verified. Retained interests that lack such objectively

verifiable support or that fail to meet the supervisory standards set forth in this document will be

classified as loss and disallowed as assets of the institution for regulatory capital purposes. 

The Agencies are reviewing institutions' valuation of retained interests and the concentration of

these assets relative to capital. Consistent with existing supervisory authority, the Agencies may,

on a case-by-case basis, require institutions that have high concentrations of these assets relative

to their capital, or are otherwise at risk from impairment of these assets, to hold additional capital

commensurate with their risk exposures. Furthermore, given the risks presented by these

 

1 In securitizations, a seller typically retains one or more interests in the assets sold. Retained interests represent

the right to cash flows and other assets not used to extinguish bondholder obligations and pay credit losses, servicing

fees and other trust related fees. For the purposes of this statement, retained interests include over-collateralization,

spread accounts, cash collateral accounts, and interest only strips (IO strips). Although servicing assets and

liabilities also represent a retained interest of the seller, they are currently determined based on different criteria and y

have different accounting and risk-based capital requirements. See applicable comments in Statement of Financial l

Accounting Standard No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of

Liabilities" (FAS 125), for additional information about these interests and associated accounting requirements.
Date: December 13, 1999 Page 2

activities, the Agencies are actively considering the establishment of regulatory restrictions that

would limit or eliminate the amount of certain retained interests that may be recognized in

determining the adequacy of regulatory capital. An excessive dependence on securitizations for

day-to-day core funding can also present significant liquidity problems - either during times of

market turbulence or if there are difficulties specific to the institution itself. As applicable, the

Agencies will provide further guidance on the liquidity risk associated with over reliance on asset

securitizations as a funding source and implicit recourse obligations. 

CONTENTS Page

Description of Activity ...................................................................................................2

Independent Risk Management Function .......................................................................4

Valuation and Modeling Process ....................................................................................6

Use of Outside Parties .....................................................................................................7

Internal Controls ..............................................................................................................7

Audit Function or Internal Review ..................................................................................7

Regulatory Reporting ......................................................................................................8

Market Discipline and Disclosures ..................................................................................9

Risk-Based Capital for Recourse and Low Level Recourse Transactions ......................9

Institution Imposed Concentration Limits on Retained Interests ..................................10

Summary ........................................................................................................................11

DESCRIPTION OF ACTIVITY

Asset securitization typically involves the transfer of on-balance sheet assets to a third party or

trust. In turn the third party or trust issues certificates or notes to investors. The cash flow from

the transferred assets supports repayment of the certificates or notes. For several years, large

financial institutions, and a growing number of regional and community institutions, have been

using asset securitization to access alternative funding sources, manage concentrations, improve

financial performance ratios, and more efficiently meet customer needs. In many cases, the

discipline imposed by investors who buy assets at their fair value has sharpened selling

institutions’ credit risk selection, underwriting, and pricing practices. Assets typically securitized

by institutions include credit card receivables, automobile receivable paper, commercial and

residential first mortgages, commercial loans, home equity loans, and student loans.

While the Agencies continue to view the use of securitization as an efficient means of financial

intermediation, we are concerned about events and trends uncovered at recent examinations. Of

particular concern are institutions that are relatively new users of securitization techniques and

institutions whose senior management and directors do not have the requisite knowledge of the

effect of securitization on the risk profile of the institution or are not fully aware of the

accounting, legal and risk-based capital nuances of this activity. Similarly, the Agencies are

concerned that some institutions have not fully and accurately distinguished and measured the

risks that have been transferred versus those retained, and accordingly are not adequately

managing the retained portion. It is essential that institutions engaging in securitization activities

have appropriate front and back office staffing, internal and external accounting and legal
Date: December 13, 1999 Page 3

support, audit or independent review coverage, information systems capacity, and oversight

mechanisms to execute, record, and administer these transactions correctly.

Additionally, we are concerned about the use of inappropriate valuation and modeling

methodologies to determine the initial and ongoing value of retained interests. Accounting rules

provide a method to recognize an immediate gain (or loss) on the sale through booking a

“retained interest;” however, the carrying value of that interest must be fully documented, based

on reasonable assumptions, and regularly analyzed for any subsequent value impairment. The

best evidence of fair value is a quoted market price in an active market. In circumstances where

quoted market prices are not available, accounting rules allow fair value to be estimated. This

estimate must be based on the "best information available in the circumstances."2 An estimate of

fair value must be supported by reasonable and current assumptions. If a best estimate of fair

value is not practicable, the asset is to be recorded at zero in financial and regulatory reports.

History shows that unforeseen market events that affect the discount rate or performance of

receivables supporting a retained interest can swiftly and dramatically alter its value. Without

appropriate internal controls and independent oversight, an institution that securitizes assets may

inappropriately generate “paper profits” or mask actual losses through flawed loss assumptions,

inaccurate prepayment rates, and inappropriate discount rates. Liberal and unsubstantiated

assumptions can result in material inaccuracies in financial statements, substantial write-downs

of retained interests, and, if interests represent an excessive concentration of the institution’s

capital, the demise of the sponsoring institution.

Recent examinations point to the need for institution managers and directors to ensure that:

• Independent risk management processes are in place to monitor securitization pool

performance on an aggregate and individual transaction level. An effective risk management

function includes appropriate information systems to monitor securitization activities. 

• Conservative valuation assumptions and modeling methodologies are used to establish,

evaluate and adjust the carrying value of retained interests on a regular and timely basis.

• Audit or internal review staffs periodically review data integrity, model algorithms, key

underlying assumptions, and the appropriateness of the valuation and modeling process for

the securitized assets retained by the institution. The findings of such reviews should be

reported directly to the board or an appropriate board committee.

• Accurate and timely risk-based capital calculations are maintained, including recognition and

reporting of any recourse obligation resulting from securitization activity. 

• Internal limits are in place to govern the maximum amount of retained interests as a

percentage of total equity capital.

• The institution has a realistic liquidity plan in place in case of market disruptions.

 

2 FAS 125, at par. 43
Date: December 13, 1999 Page 4

The following sections provide additional guidance relating to these and other critical areas of

concern. Institutions that lack effective risk management programs or that maintain exposures in

retained interests that warrant supervisory concern may be subject to more frequent supervisory

review, more stringent capital requirements, or other supervisory action.

INDEPENDENT RISK MANAGEMENT FUNCTION

Institutions engaged in securitizations should have an independent risk management function

commensurate with the complexity and volume of their securitizations and their overall risk

exposures. The risk management function should ensure that securitization policies and

operating procedures, including clearly articulated risk limits, are in place and appropriate for the

institution’s circumstances. A sound asset securitization policy should include or address, at a

minimum:

• A written and consistently applied accounting methodology;

• Regulatory reporting requirements;

• Valuation methods, including FAS 125 residual value assumptions, and procedures to

formally approve changes to those assumptions;

• Management reporting process; and

• Exposure limits and requirements for both aggregate and individual transaction monitoring.

It is essential that the risk management function monitor origination, collection, and default

management practices. This includes regular evaluations of the quality of underwriting,

soundness of the appraisal process, effectiveness of collections activities, ability of the default

management staff to resolve severely delinquent loans in a timely and efficient manner, and the

appropriateness of loss recognition practices. Because the securitization of assets can result in

the current recognition of anticipated income, the risk management function should pay

particular attention to the types, volumes, and risks of assets being originated, transferred and

serviced. Both senior management and the risk management staff must be alert to any pressures

on line managers to originate abnormally large volumes or higher risk assets in order to sustain

ongoing income needs. Such pressures can lead to a compromise of credit underwriting

standards. This may accelerate credit losses in future periods, impair the value of retained

interests and potentially lead to funding problems.

The risk management function should also ensure that appropriate management information

systems (MIS) exist to monitor securitization activities. Reporting and documentation methods

must support the initial valuation of retained interests and ongoing impairment analyses of these

assets. Pool performance information has helped well-managed institutions to ensure, on a

qualitative basis, that a sufficient amount of economic capital is being held to cover the various

risks inherent in securitization transactions. The absence of quality MIS hinders management’s

ability to monitor specific pool performance and securitization activities more broadly. At a

minimum, MIS reports should address the following:
Date: December 13, 1999 Page 5

Securitization summaries for each transaction - The summary should include relevant

transaction terms such as collateral type, facility amount, maturity, credit enhancement and

subordination features, financial covenants (termination events and spread account capture

“triggers”), right of repurchase, and counterparty exposures. Management should ensure that

the summaries are distributed to all personnel associated with securitization activities.

Performance reports by portfolio and specific product type - Performance factors include

gross portfolio yield, default rates and loss severity, delinquencies, prepayments or payments,

and excess spread amounts. The reports should reflect performance of assets, both on an

individual pool basis and total managed assets. These reports should segregate specific

products and different marketing campaigns.

Vintage analysis for each pool using monthly data - Vintage analysis helps management

understand historical performance trends and their implications for future default rates,

prepayments, and delinquencies, and therefore retained interest values. Management can use

these reports to compare historical performance trends to underwriting standards, including

the use of a validated credit scoring model, to ensure loan pricing is consistent with risk

levels. Vintage analysis also helps in the comparison of deal performance at periodic

intervals and validates retained interest valuation assumptions.

Static pool cash collection analysis - This analysis entails reviewing monthly cash receipts

relative to the principal balance of the pool to determine the cash yield on the portfolio,

comparing the cash yield to the accrual yield, and tracking monthly changes. Management

should compare the timing and amount of cash flows received from the trust with those

projected as part of the FAS 125 retained interest valuation analysis on a monthly basis. 

Some master trust structures allow excess cash flow to be shared between series or pools. 

For revolving asset trusts with this master trust structure, management should perform a cash

collection analysis for each master trust structure. These analyses are essential in assessing

the actual performance of the portfolio in terms of default and prepayment rates. If cash

receipts are less than those assumed in the original valuation of the retained interest, this

analysis will provide management and the board with an early warning of possible problems

with collections or extension practices, and impairment of the retained interest.

Sensitivity analysis - Measuring the effect of changes in default rates, prepayment or

payment rates, and discount rates will assist management in establishing and validating the

carrying value of the retained interest. Stress tests should be performed at least quarterly. 

Analyses should consider potential adverse trends and determine “best,” “probable,” and

“worst case” scenarios for each event. Other factors to consider are the impact of increased

defaults on collections staffing, the timing of cash flows, “spread account” capture triggers,

over-collateralization triggers, and early amortization triggers. An increase in defaults can

result in higher than expected costs and a delay in cash flows, decreasing the value of the

retained interests. Management should periodically quantify and document the potential

impact to both earnings and capital, and report the results to the board of directors. 

Management should incorporate this analysis into their overall interest rate risk measurement
Date: December 13, 1999 Page 6

system.3 Examiners will review the analysis conducted by the institution and the volatility

associated with retained interests when assessing the Sensitivity to Market Risk component

rating.

Statement of covenant compliance - Ongoing compliance with deal performance triggers as

defined by the pooling and servicing agreements should be affirmed at least monthly. 

Performance triggers include early amortization, spread capture, changes to overcollateralization requirements, and events that would result in servicer removal.

VALUATION AND MODELING PROCESSES

The method and key assumptions used to value the retained interests and servicing assets or

liabilities must be reasonable and fully documented. The key assumptions in all valuation

analyses include prepayment or payment rates, default rates, loss severity factors, and discount

rates. The Agencies expect institutions to take a logical and conservative approach when

developing securitization assumptions and capitalizing future income flows. It is important that

management quantifies the assumptions on a pool-by-pool basis and maintains supporting

documentation for all changes to the assumptions as part of the valuation process, which should

be done no less than quarterly. Policies should define the acceptable reasons for changing

assumptions and require appropriate management approval.

An exception to this pool-by-pool valuation analysis may be applied to revolving asset trusts if

the master trust structure allows excess cash flows to be shared between series. In a master trust,

each certificate of each series represents an undivided interest in all of the receivables in the trust.

Therefore, valuations are appropriate at the master trust level.

In order to determine the value of the retained interest at inception, and make appropriate

adjustments going forward, the institution must implement a reasonable modeling process to

comply with FAS 125. The Agencies expect management to employ reasonable and

conservative valuation assumptions and projections, and to maintain verifiable objective

documentation of the fair value of the retained interest. Senior management is responsible for

ensuring the valuation model accurately reflects the cash flows according to the terms of the

securitization’s structure. For example, the model should account for any cash collateral or overcollateralization triggers, trust fees, and insurance payments if appropriate. The board and

management are accountable for the “model builders” possessing the necessary expertise and

technical proficiency to perform the modeling process. Senior management should ensure that

internal controls are in place to provide for the ongoing integrity of MIS associated with

securitization activities.

As part of the modeling process, the risk management function should ensure that periodic

validations are performed in order to reduce vulnerability to model risk. Validation of the model

includes testing the internal logic, ensuring empirical support for the model assumptions, and

 

3 Under the Joint Agency Policy Statement on Interest Rate Risk, institutions with a high level of exposure to

interest rate risk relative to capital will be directed to take corrective action. Savings associations can find OTS

guidance on interest rate risk in Thrift Bulletin 13a - Management of Interest Rate Risk, Investment Securities, and

Derivative Activities.
Date: December 13, 1999 Page 7

back-testing the models with actual cash flows on a pool-by-pool basis. The validation process

should be documented to support conclusions. Senior management should ensure the validation

process is independent from line management as well as the modeling process. The audit scope

should include procedures to ensure that the modeling process and validation mechanisms are

both appropriate for the institution’s circumstances and executed consistent with the institution's

asset securitization policy.

USE OF OUTSIDE PARTIES

Third parties are often engaged to provide professional guidance and support regarding an

institution's securitization activities, transactions, and valuing of retained interests. The use of

outside resources does not relieve directors of their oversight responsibility, or senior

management of its responsibilities to provide supervision, monitoring, and oversight of

securitization activities, and the management of the risks associated with retained interests in

particular. Management is expected to have the experience, knowledge, and abilities to

discharge its duties and understand the nature and extent of the risks presented by retained

interests and the policies and procedures necessary to implement an effective risk management

system to control such risks. Management must have a full understanding of the valuation

techniques employed, including the basis and reasonableness of underlying assumptions and

projections.

INTERNAL CONTROLS

Effective internal controls are essential to an institution’s management of the risks associated

with securitization. When properly designed and consistently enforced, a sound system of

internal controls will help management safeguard the institution’s resources, ensure that financial

information and reports are reliable, and comply with contractual obligations, including

securitization covenants. It will also reduce the possibility of significant errors and irregularities,

as well as assist in their timely detection when they do occur. Internal controls typically: (1) limit

authorities, (2) safeguard access to and use of records, (3) separate and rotate duties, and (4)

ensure both regular and unscheduled reviews, including testing.

The Agencies have established operational and managerial standards for internal control and

information systems.4

 An institution should maintain a system of internal controls appropriate to

its size and the nature, scope, and risk of its activities. Institutions that are subject to the

requirements of FDIC regulation 12 CFR Part 363 should include an assessment of the

effectiveness of internal controls over their asset securitization activities as part of management’s

report on the overall effectiveness of the system of internal controls over financial reporting. 

This assessment implicitly includes the internal controls over financial information that is

included in regulatory reports.

AUDIT FUNCTION OR INTERNAL REVIEW

 

4 Safety and Soundness Standards 12 CFR Part 30 (OCC), 12 CFR Part 570 (OTS).
Date: December 13, 1999 Page 8

It is the responsibility of an institution’s board of directors to ensure that its audit staff or

independent review function is competent regarding securitization activities. The audit function

should perform periodic reviews of securitization activities, including transaction testing and

verification, and report all findings to the board or appropriate board committee. The audit

function also may be useful to senior management in identifying and measuring risk related to

securitization activities. Principal audit targets should include compliance with securitization

policies, operating and accounting procedures (FAS 125), and deal covenants, and accuracy of

MIS and regulatory reports. The audit function should also confirm that the institution’s

regulatory reporting process is designed and managed in such a way to facilitate timely and

accurate report filing. Furthermore, when a third party services loans, the auditors should perform

an independent verification of the existence of the loans to ensure balances reconcile to internal

records.

REGULATORY REPORTING

The securitization and subsequent removal of assets from an institution’s balance sheet requires

additional reporting as part of the regulatory reporting process. Common regulatory reporting

errors stemming from securitization activities include:

• Failure to include off-balance sheet assets subject to recourse treatment when calculating

risk-based capital ratios;

• Failure to recognize retained interests and retained subordinate security interests as a form of

credit enhancement;

• Failure to report loans sold with recourse in the appropriate section of the regulatory report;

and

• Over-valuing retained interests.

An institution’s directors and senior management are responsible for the accuracy of its

regulatory reports. Because of the complexities associated with securitization accounting and

risk-based capital treatment, attention should be directed to ensuring that personnel who prepare

these reports maintain current knowledge of reporting rules and associated interpretations. This

often will require ongoing support by qualified accounting and legal personnel.

Institutions that file the Report of Condition and Income (Call Report) should pay particular

attention to the following schedules on the Call Report when institutions are involved in

securitization activities: Schedule RC-F: Other Assets; Schedule RC-L: Off Balance Sheet Items;

and Schedule RC-R: Regulatory Capital. Institutions that file the Thrift Financial Report (TFR)

should pay particular attention to the following TFR schedules: Schedule CC: Consolidated

Commitments and Contingencies, Schedule CCR: Consolidated Capital Requirement, and

Schedule CMR: Consolidated Maturity and Rate.

Under current regulatory report instructions, when an institution’s supervisory agency’s

interpretation of how generally accepted accounting principles (GAAP) should be applied to a
Date: December 13, 1999 Page 9

specified event or transaction differs from the institution’s interpretation, the supervisory agency

may require the institution to reflect the event or transaction in its regulatory reports in

accordance with the agency’s interpretation and amend previously submitted reports.

MARKET DISCIPLINE AND DISCLOSURES

Transparency through public disclosure is crucial to effective market discipline and can reinforce

supervisory efforts to promote high standards in risk management. Timely and adequate

information on the institution’s asset securitization activities should be disclosed. The

information contained in the disclosures should be comprehensive; however, the amount of

disclosure that is appropriate will depend on the volume of securitizations and complexity of the

institution. Well-informed investors, depositors, creditors and other bank counterparties can

provide a bank with strong incentives to maintain sound risk management systems and internal

controls. Adequate disclosure allows market participants to better understand the financial

condition of the institution and apply market discipline, creating incentives to reduce

inappropriate risk taking or inadequate risk management practices. Examples of sound

disclosures include:

• Accounting policies for measuring retained interests, including a discussion of the impact of

key assumptions on the recorded value;

• Process and methodology used to adjust the value of retained interests for changes in key

assumptions;

• Risk characteristics, both quantitative and qualitative, of the underlying securitized assets;

• Role of retained interests as credit enhancements to special purpose entities and other

securitization vehicles, including a discussion of techniques used for measuring credit risk;

and

• Sensitivity analyses or stress testing conducted by the institution showing the effect of

changes in key assumptions on the fair value of retained interests.

RISK-BASED CAPITAL FOR RECOURSE AND LOW LEVEL RECOURSE

TRANSACTIONS

For regulatory purposes, recourse is generally defined as an arrangement in which an institution

retains the risk of credit loss in connection with an asset transfer, if the risk of credit loss exceeds

a pro rata share of the institution’s claim on the assets.5

 In addition to broad contractual language

that may require the selling institution to support a securitization, recourse can also arise from

retained interests, retained subordinated security interests, the funding of cash collateral accounts,

or other forms of credit enhancements that place an institution’s earnings and capital at risk. 

 

5 The risk-based capital treatment for sales with recourse can be found at 12 CFR Part 3 Appendix A, Section

(3)(b)(1)(iii) {OCC}, 12 CFR Part 567.6(a)(2)(i)(c) {OTS}. For a further explanation of recourse see the glossary

entry "Sales of Assets for Risk-Based Capital Purposes" in the instructions for the Call Report.
Date: December 13, 1999 Page 10

These enhancements should generally be aggregated to determine the extent of an institution’s

support of securitized assets. Although an asset securitization qualifies for sales treatment under

GAAP, the underlying assets may still be subject to regulatory risk-based capital requirements. 

Assets sold with recourse should generally be risk-weighted as if they had not been sold.

Securitization transactions involving recourse may be eligible for “low level recourse”

treatment.6 The Agencies’ risk-based capital standards provide that the dollar amount of riskbased capital required for assets transferred with recourse should not exceed the maximum dollar

amount for which an institution is contractually liable. The “low level recourse” treatment

applies to transactions accounted for as sales under GAAP in which an institution contractually

limits its recourse exposure to less than the full risk-based capital requirements for the assets

transferred. Under the low level recourse principle, the institution holds capital on approximately

a dollar-for-dollar basis up to the amount of the aggregate credit enhancements.

Low level recourse transactions should be reported in Schedule RC-R of the Call Report or

Schedule CCR of the TFR using either the “direct reduction method” or the “gross-up method”

in accordance with the regulatory report instructions.

If an institution does not contractually limit the maximum amount of its recourse obligation, or if

the amount of credit enhancement is greater than the risk-based capital requirement that would

exist if the assets were not sold, the low level recourse treatment does not apply. Instead, the

institution must hold risk-based capital against the securitized assets as if those assets had not

been sold.

Finally, as noted earlier, retained interests that lack objectively verifiable support or that fail to

meet the supervisory standards set for in this document will be classified as loss and disallowed

as assets of the institution for regulatory capital purposes.

INSTITUTION IMPOSED CONCENTRATION LIMITS ON RETAINED INTERESTS

The creation of a retained interest (the debit) typically also results in an offsetting “gain on sale”

(the credit) and thus generation of an asset. Institutions that securitize high yielding assets with

long durations may create a retained interest asset value that exceeds the risk-based capital

charge that would be in place if the institution had not sold the assets (under the existing riskbased capital guidelines, capital is not required for the amount over eight percent of the

securitized assets). Serious problems can arise for institutions that distribute contrived earnings

only later to be faced with a downward valuation and charge-off of part or all of the retained

interests. 

As a basic example, an institution could sell $100 in subprime home equity loans and book a

retained interest of $20 using liberal “gain on sale” assumptions. Under the current capital rules,

 

6 The banking agencies’ low level recourse treatment is described in the Federal Register in the following locations: 

60 Fed. Reg. 17986 (April 10, 1995) (OCC); 60 Fed. Reg. 8177 (February 13, 1995)(FRB); 60 Fed. Reg. 15858

(March 28,1995)(FDIC). OTS has had a low level recourse rule in 12 CFR Part 567.6(a)(2)(i)(c) since 1989. A brief

explanation is also contained in the instructions for regulatory reporting in section RC-R for the Call Report or

schedule CCR for the TFR.
Date: December 13, 1999 Page 11

the institution is required to hold approximately $8 in capital. This $8 is the current capital

requirement if the loans were never removed from the balance sheet (eight percent of $100 = $8).

However, the institution is still exposed to substantially all of the credit risk, plus the additional

risk to earnings and capital from the volatility of the retained interest. If the value of the retained

interest decreases to $10 due to inaccurate assumptions or changes in market conditions, the $8

in capital is insufficient to cover the entire loss.

Normally, the sponsoring institution will eventually receive any excess cash flow remaining from

securitizations after investor interests have been met. However, recent experience has shown that

retained interests are vulnerable to sudden and sizeable write-downs that can hinder an

institution’s access to the capital markets, damage its reputation in the market place, and in some

cases, threaten its solvency. Accordingly, the Agencies expect an institution's board of directors

and management to develop and implement policies that limit the amount of retained interests

that may be carried as a percentage of total equity capital, based on the results of their valuation

and modeling processes. Well constructed internal limits also serve to lessen the incentive of

institution personnel to engage in activities designed to generate near term “paper profits” that

may be at the expense of the institution’s long term financial position and reputation.

SUMMARY

Asset securitization has proven to be an effective means for institutions to access new and

diverse funding sources, manage concentrations, improve financial performance ratios, and

effectively serve borrowing customers. However, securitization activities also present unique

and sometimes complex risks that require board and senior management attention. Specifically,

the initial and ongoing valuation of retained interests associated with securitization, and the

limitation of exposure to the volatility represented by these assets, warrant immediate attention

by management.

Moreover, as mentioned earlier in this statement, the Agencies are studying various issues

relating to securitization practices, including whether restrictions should be imposed that would

limit or eliminate the amount of retained interests that qualify as regulatory capital. In the

interim, the Agencies will review affected institutions on a case-by-case basis and may require, in

appropriate circumstances, that institutions hold additional capital commensurate with their risk

exposure. In addition, the Agencies will study, and issue further guidance on, institutions'

exposure to implicit recourse obligations and the liquidity risk associated with over reliance on

asset securitization as a funding source.