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BOARD OF GOVERNORS

OF THE

FEDERAL RESERVE SYSTEM

WASHINGTON, D.C. 20551

DIVISION OF BANKING

SUPERVISION AND REGULATION

SR 12-15

November 15, 2012

TO THE OFFICER IN CHARGE OF SUPERVISION

 AT EACH FEDERAL RESERVE BANK

SUBJECT: Investing in Securities without Reliance on Nationally Recognized Statistical 

Rating Organization Ratings

Applicability to Community Banking Organizations: This guidance applies to all state 

member banks, including those with $10 billion or less in consolidated assets. 

The Federal Reserve is issuing this letter to advise state member banks that effective 

January 1, 2013, they may no longer rely solely on credit ratings issued by nationally recognized 

statistical rating organizations (external credit ratings) to determine whether a particular security 

is an “investment security” that is permissible for investment by a state member bank. Under 

regulations of the Office of the Comptroller of the Currency (OCC), securities qualify for 

investment by national banks only if they are determined by the bank to be “investment grade” 

and not predominantly speculative in nature. This letter provides background on recent statutory 

changes and actions of the OCC to amend its regulation on investment securities, which also 

applies to state member banks. 

Under the Federal Reserve Act (12 USC 335) and the Federal Reserve’s Regulation H 

(12 CFR 208.21), state member banks are subject to the same limitations and conditions with 

respect to the purchasing, selling, underwriting, and holding of investment securities and stock as 

national banks under the National Banking Act (12 USC 24 (Seventh)). Therefore, when 

investing in securities, state member banks must comply with the provisions of the National 

Banking Act and the OCC regulations in 12 CFR part 1. In addition to this federal requirement, 

a state member bank may purchase, sell, underwrite, or hold securities and stock only to the 

extent permitted under applicable state law.

Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 

2010 requires each federal agency to remove references to, and requirements of reliance on, 

external credit ratings in any regulation issued by the agency that requires the assessment of the 

creditworthiness of a security or money market instrument. The agencies also are required to 
 

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substitute an alternative standard of creditworthiness.1 Pursuant to this requirement, the OCC 

published a final rule and guidance on June 13, 2012, that revises 12 CFR part 1 by removing 

references to external credit ratings and generally requiring national banks to make assessments 

of a security’s creditworthiness to determine if it is “investment grade.”2

 This requirement is 

similar to existing OCC standards for the purchase of unrated securities by national banks. The 

final rule is effective January 1, 2013 for existing and future national bank holdings of 

investment securities.

Under the revised rule, a security meets the “investment grade” test only if the issuer has 

an adequate capacity to meet its financial commitments under the security for the projected life 

of the asset or exposure. Under this definition, the issuer has an adequate capacity to meet 

financial commitments if (1) the risk of default by the obligor is low and (2) the full and timely 

repayment of principal and interest is expected.3 As explained in the Federal Register

publication of the final rule, the OCC expects national banks to consider a number of factors, to 

the extent appropriate in making this determination. While a national bank may continue to take 

into account external credit ratings and assessments as a valuable source of information, the bank 

is expected to supplement these ratings with a degree of due diligence processes and additional 

analyses appropriate for the bank’s risk profile and for the size and complexity of the 

instrument.4

Concurrent with the final rule, the OCC published final guidance, also effective January 

1, 2013 (OCC investment guidance), to clarify regulatory expectations with respect to investment 

purchase decisions and ongoing portfolio due diligence processes. The guidance, which is 

attached, clarifies that generally, investment securities are expected to have good to very strong 

credit quality. In the case of structured securities, this determination may be influenced more by 

the quality of the underlying collateral, the cash flow rules, and the structure of the security itself 

than by the condition of the issuer. 

The OCC also expects national banks to conduct an appropriate level of due diligence to 

understand the inherent risks of a security and determine that it is a permissible investment. The 

extent of the due diligence should be sufficient to support the institution’s conclusion that a 

security meets the “investment-grade” standards. The depth of the due diligence should be a 

function of the security’s credit quality, the complexity of the structure, and the size of the 

investment. Third-party analytics may be part of this analysis, although the national bank’s 

management remains responsible for the investment decision and should ensure that prospective 

third parties are independent, reliable, and qualified. The guidance also sets forth an expectation 

that the board of directors should oversee management to make sure appropriate decision-making 

processes are in place.5

 1 See 15 USC 78o-7, note. 

2 For the OCC’s final rules, see 77 FR 35253 (June 13, 2012). For the OCC’s guidance, see 77 FR 35259 (June 13, 

2012) and OCC Bulletin 2012-18 (June 26, 2012). 

3 See 77 FR 35257 (June 13, 2012).

4 See 77 FR 35254 (June 13, 2012).

5 See 77 FR 35259 (June 13, 2012).
 

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Investment in securities and stock by state member banks are required under the Federal 

Reserve Act and Regulation H to comply with the revised 12 CFR part 1 and should also meet 

the supervisory expectations set forth in the OCC investment guidance and this guidance. In 

addition, state member banks are expected to continue to meet long-established supervisory 

expectations for risk-management processes to ensure that the credit risk of the bank, including 

the credit risk of the investment portfolio, is effectively identified, measured, monitored, and 

controlled. As noted above, investments by state member banks must also comply with 

applicable state law.

Many of these expectations are set forth in the 1998 interagency Supervisory Policy 

Statement on Investment Securities and End-User Derivatives Activities (SR letter 98-12, 

“FFIEC Policy Statement on Investment Securities and End-User Derivatives Activities”), which 

provides risk-management standards for the securities investment activities of banks and savings 

associations. SR 98-12 emphasizes the importance of an institution conducting a thorough 

credit-risk analysis before and periodically after the acquisition of a security. Such analysis 

would allow an institution to understand and effectively manage the risks within its investment 

portfolio, including credit risk, and is an essential element of a sound investment portfolio riskmanagement framework. The supervisory expectations set forth in SR 98-12 provide criteria that 

institutions can use in meeting the requirements of 12 CFR part 1, and state member banks 

should use the expectations set forth in that guidance with respect to investing in nonrated 

securities when determining to invest in any security.

Reserve Banks are asked to distribute this letter to state member banks supervised by the 

Federal Reserve in their districts, as well as to their own application, supervisory, and 

examination staff. Questions regarding the attached guidance should be addressed to the 

following staff in the Credit, Market & Liquidity Risk Policy section: Christopher McBride, 

Senior Supervisory Financial Analyst, at (202) 452-3814; or Mary Aiken, Manager, at 

(202) 721-4534. In addition, questions may be sent via the Board’s public website.6

Michael S. Gibson

Director

Cross-reference:

• SR Letter 98-12, “FFIEC Policy Statement on Investment Securities and End-User 

Derivatives Activities”

Attachment:

• OCC Guidance on Due Diligence Requirements in Determining Whether Securities Are 

Eligible for Investment

 6 See http://www.federalreserve.gov/apps/contactus/feedback.aspx.