This section of the FEDERAL REGISTER

contains notices to the public of the proposed

issuance of rules and regulations. The

purpose of these notices is to give interested

persons an opportunity to participate in the

rule making prior to the adoption of the final

rules.

Proposed Rules Federal Register

18109 

Vol. 77, No. 59 

Tuesday, March 27, 2012 

1Section 7(b)(1) of the Federal Deposit Insurance 

Act (12 U.S.C. 1817(b)(1)). 

2Section 7(b)(1)(D) of the Federal Deposit 

Insurance Act (12 U.S.C. 1817(b)(1)(D)). 

3Assessments, Large Bank Pricing, 76 FR 10672 

(February 25, 2011) (to be codified at 12 CFR 327.9). 

4A large institution is defined as an insured 

depository institution: (1) That had assets of $10 

billion or more as of December 31, 2006 (unless, by 

reporting assets of less than $10 billion for four 

consecutive quarters since then, it has become a 

small institution); or (2) that had assets of less than 

$10 billion as of December 31, 2006, but has since 

had $10 billion or more in total assets for at least 

four consecutive quarters, whether or not the 

institution is new. A ‘‘highly complex institution’’ 

is defined as: (1) An insured depository institution 

(excluding a credit card bank) that has had $50 

billion or more in total assets for at least four 

consecutive quarters and that either is controlled by 

a U.S. parent holding company that has had $500 

billion or more in total assets for four consecutive 

quarters, or is controlled by one or more 

intermediate U.S. parent holding companies that 

are controlled by a U.S. holding company that has 

had $500 billion or more in assets for four 

consecutive quarters, and (2) a processing bank or 

trust company. A processing bank or trust company 

is an insured depository institution whose last three 

years’ non-lending interest income, fiduciary 

revenues, and investment banking fees, combined, 

exceed 50 percent of total revenues (and its last 

three years fiduciary revenues are non-zero), whose 

total fiduciary assets total $500 billion or more and 

whose total assets for at least four consecutive 

quarters have been $10 billion or more. 

5A large or highly-complex institution’s total 

score may also be adjusted by the large bank 

adjustment. 76 FR 10672, 10714 (February 25, 2011) 

(to be codified at 12 CFR 327.9(b)(3)). 

6An institution’s initial base assessment rate can 

be adjusted by the unsecured debt adjustment, the 

depository institution debt adjustment, and the 

brokered deposit adjustment. 76 FR 10672, 10715 

(February 25, 2011) (to be codified at 12 CFR 

327.9(d)). 

7Higher-risk assets are used to calculate the 

concentration score, which is part of both the large 

bank scorecard and the highly complex institution 

scorecard. For large institutions, the concentration 

score is defined as the higher of: (a) The higher-risk 

assets to Tier 1 capital and reserves score or (b) the 

growth-adjusted portfolio concentrations score. For 

highly complex institutions, it is defined as the 

higher of: (a) The higher-risk assets to Tier 1 capital 

and reserves score or (b) the largest or top 20 

counterparty exposures to Tier 1 capital and 

reserves score. 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

12 CFR Part 327 

RIN 3064–AD92 

Assessments, Large Bank Pricing 

AGENCY: Federal Deposit Insurance 

Corporation (FDIC). 

ACTION: Notice of proposed rulemaking 

and request for comment. 

SUMMARY: The FDIC proposes to amend 

its regulations to revise some of the 

definitions used to determine 

assessment rates for large and highly 

complex insured depository 

institutions. The FDIC believes these 

proposed amendments will result in 

more consistent reporting, better reflect 

risk to the FDIC, significantly reduce 

reporting burden, and satisfy many 

concerns voiced by the banking 

industry. 

DATES: Comments must be received on 

or before May 29, 2012. 

ADDRESSES: You may submit comments 

on the notice of proposed rulemaking, 

identified by RIN number and the words 

‘‘Assessments, Large Bank Pricing 

Definition Revisions Notice of Proposed 

Rulemaking,’’ by any of the following 

methods: 

• Agency Web Site: http:// 

www.FDIC.gov/regulations/laws/ 

federal/propose.html. Follow the 

instructions for submitting comments 

on the Agency Web Site. 

• Email: Comments@FDIC.gov. 

Include the RIN number in the subject 

line of the message. 

• Mail: Robert E. Feldman, Executive 

Secretary, Attention: Comments, Federal 

Deposit Insurance Corporation, 550 17th 

Street NW., Washington, DC 20429. 

• Hand Delivery: 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. 

Instructions: All submissions received 

must include the agency name and RIN 

for this rulemaking. Comments will be 

posted to the extent practicable and, in 

some instances, the FDIC may post 

summaries of categories of comments, 

with the comments themselves available 

in the FDIC’s reading room. Comments 

will be posted at: http://www.fdic.gov/ 

regulations/laws/federal/propose.html, 

including any personal information 

provided with the comment. 

FOR FURTHER INFORMATION CONTACT: 

Patrick Mitchell, Chief, Large Bank 

Pricing Section, Division of Insurance 

and Research, (202) 898–3943; Brenda 

Bruno, Senior Financial Analyst, 

Division of Insurance and Research, 

(630) 241–0359 x 8312; Christopher 

Bellotto, Counsel, Legal Division, (202) 

898–3801; Sheikha Kapoor, Counsel, 

Legal Division, (202) 898–3960. 

SUPPLEMENTARY INFORMATION: 

I. Background 

Legal Authority 

The Federal Deposit Insurance Act 

(the FDI Act) requires that the deposit 

insurance assessment system be riskbased.1 It defines a risk-based system as 

one based on an institution’s probability 

of causing a loss to the Deposit 

Insurance Fund (the DIF), taking into 

account the composition and 

concentration of the institution’s assets 

and liabilities and any other factors that 

the FDIC determines are relevant, the 

likely amount of any such loss, and the 

revenue needs of the DIF. The FDI Act 

allows the FDIC to ‘‘establish separate 

risk-based assessment systems for large 

and small members of the Deposit 

Insurance Fund.’’ 2

Large Bank Pricing Rule 

On February 7, 2011, the FDIC Board 

adopted a final rule that amended its 

assessment regulations, by, among other 

things, establishing a new methodology 

for determining assessment rates for 

large and highly complex institutions 

(the February rule).3 4 The February rule 

eliminated risk categories for large 

institutions and combined CAMELS 

ratings and certain forward-looking 

financial ratios into one of two 

scorecards, one for highly-complex 

institutions and another for all other 

large institutions. The scorecards 

calculate a total score for each 

institution.5 The total score is then 

converted to the institution’s initial base 

assessment rate, which, after certain 

adjustments, results in the institution’s 

total assessment rate.6 To calculate the 

amount of the institution’s quarterly 

assessment, the total base assessment 

rate is multiplied by the institution’s 

assessment base and the result divided 

by four. 

One of the financial ratios used in the 

scorecards is the ratio of higher-risk 

assets to Tier 1 capital and reserves.7

Higher-risk assets are defined as the 

sum of construction and land 

development (C&D) loans, leveraged 

loans, subprime loans, and 

nontraditional mortgage loans. The 

February rule used existing interagency 

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8 75 FR 23516 (May 3, 2010); 75 FR 72612 

(November 24, 2010). 

9 76 FR 14460 (March 16, 2011). 

10 In response to the November 2010 NPR on the 

revised large institution assessment system, the 

FDIC received a number of comments 

recommending changes to the definitions of 

subprime and leveraged loans, which the FDIC 

addressed in its February rule amending its 

assessment regulations. For example, several 

commenters to the November 2010 NPR stated that 

regular (quarterly) updating of data to evaluate 

loans for subprime or leveraged status would be 

burdensome and costly and, for certain types of 

retail loans, would not be possible because existing 

loan agreements do not require borrowers to 

routinely provide updated financial information. In 

response to these comments, the FDIC’s February 

rule stated that large institutions should evaluate 

loans for subprime or leveraged status upon 

origination, refinance, or renewal. However, no 

comments were received on the November 2010 

NPR indicating that large institutions would be 

unable to identify and report subprime or leveraged 

loans in accordance with the final rule’s definitions 

in their Call Reports and TFRs beginning as of June 

30, 2011. The data availability concerns were first 

expressed in comments on the PRA notice. 

11 76 FR 44987 (July 27, 2011). 

guidance to define leveraged loans, 

nontraditional mortgage loans, and 

subprime loans but refined the 

definitions to minimize reporting 

discrepancies. In arriving at these 

definitions, the FDIC took into account 

comments that were received in 

response to the two notices of proposed 

rulemaking that led to adoption of the 

February rule.8

While institutions already reported 

C&D loan data in their quarterly reports 

of condition and income (the Call 

Reports and the Thrift Financial Reports 

or TFRs), they did not report the needed 

data for the other loans, thus requiring 

new line items in these reports. 

Therefore, on March 16, 2011, the Office 

of the Comptroller of the Currency, the 

Board of the Federal Reserve System, 

the Office of Thrift Supervision, the 

Treasury, and the FDIC (collectively, the 

agencies) published a Paperwork 

Reduction Act of 1995 (PRA) notice 

under normal PRA clearance procedures 

requesting comment on proposed 

revisions to the Call Reports, the TFRs, 

and the Federal Financial Institutions 

Examination Council (FFIEC) 002/002S 

reports that would provide the data 

needed by the FDIC to implement the 

February 2011 rule beginning with the 

June 30, 2011, report date (March PRA 

notice).9

The agencies received 19 comments 

in response to the March PRA notice. Of 

these 19 comments, 17 addressed the 

new items for subprime and leveraged 

loans added to Call Reports and TFRs. 

The commenters stated that institutions 

generally do not maintain data on these 

loans consistent with the definitions 

used in the February rule and would be 

unable to report the required data by the 

June 30, 2011, report date. These data 

availability concerns had not been 

raised during the rulemaking process 

leading up to the February rule.10

As a consequence of this unexpected 

difficulty, the agencies applied to the 

Office of Management and Budget 

(OMB) under emergency clearance 

procedures to allow institutions to 

identify and report subprime and 

leveraged loans and securitizations 

originated or purchased prior to October 

1, 2011, using either their existing 

internal methodologies or the 

definitions contained in existing 

supervisory guidance. The reporting 

options are referred to as ‘‘transition 

guidance’’ and are outlined in the 

General Instructions for Schedule RC–O 

of the Reports of Condition and Income, 

Memorandum Items 6 through 15 for 

leveraged loans and subprime loans. 

Because the assessment-related 

reporting revisions needed to remain in 

effect beyond the limited approval 

period associated with an emergency 

clearance request, the agencies, under 

the auspices of the FFIEC, submitted the 

reporting revisions under normal PRA 

clearance procedures and requested 

public comment on July 27, 2011 (July 

PRA notice).11

The agencies collectively received 

four comments in response to the July 

PRA notice before the comment period 

closed on September 26, 2011. The 

commenters recommended extending 

the transition guidance for reporting 

subprime and leveraged loans until 

more workable and accurate definitions 

were developed. The commenters 

requested that the definitions of 

subprime and leveraged loans be revised 

because they do not effectively measure 

the risk that the FDIC intended to 

capture. Rather, commenters maintained 

that the definitions would capture loans 

that are not subprime or leveraged (i.e., 

are not higher-risk assets) and require 

burdensome reporting that could result 

in inconsistencies among banks. A joint 

comment letter from three industry 

trade groups also recommended that the 

definition of nontraditional mortgage 

loans be revised. 

On September 28, 2011, the FDIC 

informed large and highly complex 

institutions via email (followed by 

changes to Call Report instructions) that 

the deadline for the transition guidance 

would be extended to April 1, 2012, and 

that the FDIC would review the 

definitions of subprime and leveraged 

loans to determine whether changes to 

the definitions would alleviate 

commenters’ concerns without 

sacrificing accuracy in risk 

determination for deposit insurance 

pricing purposes. 

As part of its review, the FDIC 

considered all comments related to the 

higher-risk asset definitions that were 

submitted in response to the March and 

July PRA notices. The FDIC also 

engaged in extensive discussions with 

the industry and industry trade groups 

over the last few months to better 

understand their concerns and to solicit 

potential solutions to these concerns. 

II. Assessment System for Large and 

Highly Complex Institutions 

The FDIC proposes amendments to 

the assessment system for large and 

highly complex institutions that would: 

(1) Revise the definitions of certain 

higher risk assets, specifically leveraged 

loans, which would be renamed 

‘‘higher-risk C&I loans and securities,’’ 

and subprime consumer loans, which 

would be renamed ‘‘higher-risk 

consumer loans and securities’’; (2) 

clarify the timing of classifying an asset 

as higher risk; (3) clarify the way 

securitizations (including those that 

meet the definition of nontraditional 

mortgage loans) are to be identified; and 

(4) further define terms that are used in 

the large bank pricing rule. The names 

of the categories of assets included in 

the higher-risk assets to Tier 1 capital 

and reserves ratio have been changed to 

avoid confusion between the definitions 

used in the deposit insurance 

assessment regulations and the terms 

that generally are used within the 

industry and in other regulatory 

guidance. The definitions of C&D loans 

would not be amended under the NPR 

and these loans would continue to be 

defined as in the February rule. 

Nontraditional mortgage loans would 

continue to be defined as in the 

February rule, but the NPR clarifies how 

securitizations of nontraditional 

mortgage loans would be identified 

under the definition. The FDIC believes 

that the proposed amendments would 

result in more consistent reporting, 

better reflect risk to the FDIC, 

significantly reduce reporting burden, 

and satisfy many of the concerns voiced 

by the industry after adoption of the 

February 2011 rule. 

The proposed amendments would be 

effective on October 1, 2012, predicated 

on changes to the Call Report. The 

effective date is discussed in detail in 

Section F below. 

A. Higher-Risk Assets 

The FDIC uses the amount of an 

institution’s higher-risk assets to 

calculate the institution’s concentration 

score and total score. The concentration 

measure captures the institution’s 

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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18111 

12For purposes of this definition, the ‘‘purpose of 

the borrower’s debt’’ is determined at the time the 

debt was incurred by the borrower. An institution 

would be required to determine if the borrower has 

incurred any debt in the last seven years that meets 

the purpose test. 

13Following are definitions of some of the terms 

used under the proposed rule: 

1. Acquisition means the purchase by the 

borrower of any equity interest in another company 

or the purchase of any of the assets and liabilities 

of another company. 

2. Buyout for purposes of calculating higher-risk 

C&I assets means the issuance of debt to finance the 

purchase or repurchase by the borrower of the 

borrower’s outstanding equity. A buyout could 

include, but is not limited to, an equity buyout or 

funding of an Employee Stock Ownership Plan 

(ESOP). 

3. Capital distribution means that the borrower 

incurs debt to finance a dividend payment or to 

finance other transactions designed to enhance 

shareholder value, such as repurchase of stock. 

4. Material means resulting in a 20 percent or 

greater increase anytime within 12 months in the 

total funded debt of the borrower (including all 

funded debt assumed, created, or refinanced). Debt 

is also material if, before the debt was incurred, the 

borrower had no funded debt. 

14EBITDA is defined as earnings before interest, 

taxes, depreciation, and amortization. 

15 In order to exclude a loan based on cash 

collateral, the cash would be required to be in the 

form of a savings or time deposit held by the 

insured depository institution. The insured 

depository institution would be required to have in 

place a signed collateral assignment of the deposit 

account, which is irrevocable for the remaining 

term of the loan or commitment, and the insured 

depository institution would be required to place a 

hold on the deposit account that alerts the 

institution’s employees to an attempted withdrawal. 

For the exclusion to apply to a revolving line of 

credit, the cash collateral would be required to be 

equal to or greater than the amount of the total loan 

commitment (the aggregate funded and unfunded 

balance of the loan). 

16A securitization would be as defined in 

Appendix A, Section II(B)(16) of Part 325 of the 

FDIC’s Rules and Regulations, as it may be 

amended from time to time. 

17Somewhat more stringent requirements would 

apply when an institution acquires loans or 

securities from another entity on a recurring or 

programmatic basis. 

lending (and securities owned) in 

higher-risk areas; concentrations in 

these higher-risk assets contributed to 

the failure of some institutions during 

the recent financial crisis and economic 

downturn. 

Higher-Risk C&I Loans and Securities 

Under the proposal, higher-risk 

commercial and industrial (C&I) loans 

and securities would include: 

• Any commercial loan (funded or 

unfunded, including irrevocable and 

revocable commitments) owed by a 

borrower to the evaluating depository 

institution with an original amount 

greater than $5 million if the conditions 

specified in (a) or (b) below are met as 

of origination, or, if the loan has been 

refinanced, as of refinance, and the loan 

does not meet the asset based lending 

(ABL) exclusion or the floor plan line of 

credit exclusion (discussed in Appendix 

C). 

(a)(i) The purpose of any of the 

borrower’s debt (whether owed to the 

evaluating insured depository 

institution or another lender) that was 

incurred within the previous seven 

years was to finance a buyout, 

acquisition or capital distribution and 

such debt was material;12 13 and 

(ii) The ratio of the borrower’s total 

debt to trailing twelve-month EBITDA 

(i.e., operating leverage ratio) is greater 

than 4 or the ratio of the borrower’s 

senior debt to trailing twelve-month 

EBITDA (i.e., operating leverage ratio) is 

greater than 3; 14 or 

(b) Any of the borrower’s debt 

(whether owed to the evaluating 

institution or another lender) is 

designated as a highly leveraged 

transaction (HLT) by a syndication 

agent. 

• All securities held by the evaluating 

institution that are issued by a 

commercial borrower, if the conditions 

specified in (a) or (b) above are met, 

except securities classified as trading 

book; and 

• All securitizations held by the 

evaluating institution that are more than 

50 percent collateralized by commercial 

loans or securities that would meet the 

higher-risk C&I loans and securities 

definition if directly held by the 

evaluating institution, except securities 

classified as trading book. 

The definition of a higher-risk C&I 

loan and security would exclude the 

maximum amount that is recoverable 

from the U.S. government, its agencies, 

or government-sponsored agencies 

under guarantee or insurance 

provisions, and loans that are fully 

secured by cash collateral.15

An institution would be required to 

use information reasonably available to 

a sophisticated investor in reasonably 

determining whether a securitization 

meets the 50 percent threshold.16

Information reasonably available to a 

sophisticated investor should include, 

but is not limited to, offering 

memorandums, indentures, trustee 

reports, and requests for information 

from servicers, collateral managers, 

issuers, trustees, or similar third parties. 

When determining whether a revolving 

trust or similar securitization would 

meet the threshold, an institution could 

use established criteria, model 

portfolios, or limitations published in 

the offering memorandum, indenture, 

trustee report or similar documents. 

Sufficient information necessary for 

an institution to make a definitive 

determination may not, in every case, be 

reasonably available to the institution as 

a sophisticated investor. In such a case, 

the institution may exercise its 

judgment in making the determination. 

Nevertheless, the FDIC would retain the 

right to review and audit for compliance 

with the rule any determination that a 

securitization does not meet the 50 

percent threshold. 

In cases where a securitization is 

required to be consolidated on the 

balance sheet as a result of SFAS 166 

and SFAS 167, and a large institution or 

highly complex institution has access to 

the necessary information, an institution 

may evaluate individual loans in the 

securitization on a loan-by-loan basis. 

Any loan within the securitization that 

meets the definition of a higher-risk 

asset would be reported as a higher-risk 

asset and any loan within the 

securitization that does not meet the 

definition of a higher-risk asset would 

not be reported as such. When making 

this evaluation, the institution would 

have to follow the transition guidance 

described in Appendix C, Section C. 

Once an institution evaluated a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it 

would have to continue to evaluate all 

securitizations for which it has the 

required information in a similar 

manner (i.e., on a loan-by-loan basis). 

For securitizations for which the 

institution does not have access to 

information on a loan-by-loan basis, the 

institution would be required to 

determine whether the securitization 

meets the 50 percent threshold as 

described previously for other 

securitizations. 

When an institution acquires a C&I 

loan or security, it would have to 

determine whether the loan or security 

meets the definition of a higher-risk C&I 

loan or security using the origination 

criteria and analysis performed by the 

original lender. If this information were 

unavailable, however, the institution 

would have to obtain recent, refreshed 

data from the borrower or other 

appropriate third-party.17

Appendix C provides detailed 

definitions of many of the terms used in 

the foregoing definition. 

In arriving at its proposal, the FDIC 

carefully reviewed the comments 

submitted in response to the March and 

July PRA notices on the leveraged loan 

definition contained in the February 

rule. Of the 19 respondents commenting 

on the March PRA notice, 17 raised 

concerns over the leveraged loan 

definition; 6 of the 8 respondents to the 

July PRA notice raised such concerns. 

Further, as the FDIC noted in the public 

comment file for the July PRA notice, 

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18The operating leverage ratio is the borrower’s 

total or senior debt to trailing twelve-month 

EBITDA. 

19Enterprise value is a measure of the borrower’s 

value as a going concern. 

20This debt would also be material if, before the 

debt was incurred, the borrower had no funded 

debt. 

the FDIC met with representatives of 

four industry trade groups and twice 

with large and highly complex 

institutions prior to the close of the 

comment period on the PRA notice. 

Three industry trade groups 

commented on the July PRA notice that 

the minimum size for leveraged loans 

included in the February rule ($1 

million or higher) is too low since it 

would capture a large number of small 

business loans that are not normally 

considered leveraged. These trade 

groups commented that the $1 million 

level overstates leveraged exposures and 

creates a significant reporting burden, 

since banks do not generally gather the 

data required to make a leveraged loan 

determination for these smaller loans. 

The commenters further noted that 

loans under $5 million are typically 

characterized by additional riskreducing requirements, such as 

borrower’s guarantees and additional 

collateral. When these risk-reducing 

mitigants are prevalent, relying solely 

on the debt-to-EBITDA test could be a 

less accurate measure of the risk of these 

borrowers. 

The proposal would increase the 

threshold level to $5 million. The 

increased threshold would result in 

better identification of higher-risk C&I 

loans and would also reduce the 

reporting burden. 

In response to the July PRA Notice, 

three banking industry trade groups in 

a joint letter to the FDIC stated that the 

definition of leveraged loans used in the 

February rule does not capture risk as 

intended and is not a reliable measure 

of a leveraged loan. They maintained 

that an institution’s debt-to-EBITDA 

ratio is not, by itself, a reliable indicator 

of risk, particularly if the loans are asset 

based or are to companies or industries 

that traditionally have higher leverage 

levels. They added that the definition of 

leveraged loans in the February rule 

captures such a large portion of an 

institution’s loan portfolio that it does 

not provide a meaningful differentiation 

of risk among institutions and creates a 

reporting burden. The trade groups 

suggested that considering the purpose 

of the loan in conjunction with the 

borrower’s operating leverage ratio 

would result in more accurate 

identification of risk.18

The proposed definition would 

combine a test of the borrower’s 

operating leverage ratio with a purpose 

test, namely, that if the purpose of any 

of the borrower’s debt (whether owed to 

the evaluating insured depository 

institution or another lender) was to 

finance a buyout, acquisition, or capital 

distribution, and that debt was material, 

a C&I loan or security to that borrower 

would be classified as higher risk. The 

purpose of the debt would help identify 

risk to the FDIC and reflect the method 

used internally by most banks to 

identify higher-risk loans. The purpose 

test would identify those borrowers 

with certain higher-risk characteristics, 

such as a heavy reliance on either 

enterprise value or improvement in the 

borrower’s operating efficiencies.19

The industry suggested in a comment 

letter to the July PRA Notice and in 

subsequent discussions that banks 

should look back to the original purpose 

of debt only if the debt was originally 

incurred during the previous five years. 

Under the proposal, however, banks 

would have to look back to the original 

purpose of any of the borrower’s debt 

incurred during the previous seven 

years. During the most recent buyout 

boom of the mid to late 2000s, a sevenyear maturity was often the longest 

dated maturity for loans that facilitated 

a leveraged buyout. Under the proposal, 

where the purpose test is met, loans 

originated in 2007 (near the end of the 

leveraged buyout boom) to a borrower 

that remains above the proposed debtto-EBITDA ratio thresholds would 

continue to be classified as higher-risk 

assets, even when they are refinanced; 

loans that are refinanced from the same 

time period but where the borrower has 

de-levered through either EBITDA 

growth or debt repayment would not be 

defined as higher-risk under the 

proposal. 

Under the proposal, debt to finance a 

buyout, acquisition, or capital 

distribution would also have to be 

material. Such debt would be material if 

it resulted in a 20 percent or greater 

increase anytime within 12 months in 

the total funded debt of the borrower.20

During discussions with the industry, 

bankers have suggested that total funded 

debt should have to increase by 50 

percent or more to be considered a 

material buyout, acquisition, or capital 

distribution. Under the proposal, only a 

20 percent increase is required. A 20 

percent increase would be high enough 

to ensure that the FDIC does not capture 

transactions that do not materially 

increase the risk profile of the borrower, 

but low enough to capture transactions 

such as capital distributions that benefit 

the borrower’s shareholders while 

increasing the risk to the lending 

institutions. 

The joint comment letter to the July 

PRA Notice also noted that collateral 

was not appropriately considered in the 

leveraged loan definition included in 

the February rule. The commenters 

stated that loans would be classified as 

leveraged even though they had strong 

collateral backing them, which should 

result in significantly lower loss rates 

than loans that are dependent primarily 

on the enterprise value of a highlyleveraged company. Examples of the 

loans commenters thought should be 

excluded from the leveraged loan 

definition were asset-based loans and 

dealer floor plan loans. 

After considering the comments, the 

proposed rule would exclude certain 

well-collateralized asset-based loans 

and floor plan loans from the definition 

of higher-risk C&I loans and securities. 

Because these loans carry significant 

operational risk, the exclusions would 

apply only to loans that are well secured 

by self-liquidating collateral (i.e., 

accounts receivable and inventory) and 

only when the institution can 

demonstrate that it has a history of 

strong risk management and internal 

controls over these loans. Excluding 

loans under these conditions should 

result in better differentiation of credit 

risk among institutions and should 

reduce reporting burden. 

Under the February rule, higher-risk 

assets included securitizations where 

more than 50 percent of the assets 

backing the securitization meet the 

criteria for leveraged loans. In their joint 

comment letter, three industry trade 

groups stated that the reporting criteria 

for securitizations in the February rule 

is problematic given the challenges in 

evaluating individual loans in the 

securitization given the lack of 

standardized disclosure requirements 

that align with the FDIC’s definition of 

higher-risk assets. 

Under the proposal, higher-risk C&I 

loans and securities would continue to 

include securitizations where more than 

50 percent of the assets backing the 

securitization meet the criteria for 

higher-risk C&I loans or securities. 

Concentrations in higher-risk assets, 

whether they are in the form of a whole 

loan or a securitization, increase the risk 

of loss to the FDIC during times of 

prolonged periods of economic stress. 

Large and highly complex institutions 

are sophisticated investors and can 

typically obtain the information needed 

to determine whether a securitization 

meets the 50 percent threshold 

described above when they purchase 

interests in these securitizations. 

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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18113 

21Risk-Based Capital Guidelines: Market Risk: 

Alternatives to Credit Ratings for Debt and 

Securitization Positions 76 FR 79380, 79395 

(December 21, 2011). 

22A loan that meets both the definitions of a 

nontraditional mortgage loan and a higher-risk 

consumer loan at the time of origination should be 

reported as a nontraditional mortgage loan. 

However, if the loan later ceases to meet the 

definition of nontraditional mortgage loan but 

continues to still qualify as a higher-risk consumer 

loan, it would then be reported as a higher-risk 

consumer loan. 

23A securitization would be as defined in 

Appendix A, Section II(B)(16) of Part 325 of the 

FDIC’s Rules and Regulations as it may be amended 

from time to time. 

24Somewhat more stringent requirements would 

apply when an institution acquires loans or 

securities from another entity on a recurring or 

programmatic basis. 

25These data availability concerns, particularly as 

they relate to institutions’ existing loan portfolios, 

had not been raised as an issue during the 

rulemaking process on large bank pricing that 

culminated in the February rule. 

Trade groups also commented that 

categorizing securitizations as higherrisk assets based solely on the 

underlying collateral ignores important 

risk mitigants such as credit 

enhancements. The performance of a 

securitization, however, is highly 

correlated with the performance of the 

underlying assets, even when the 

securitization contains terms or 

conditions intended to reduce risk. As 

stated in an interagency NPR issued in 

December 2011, ‘‘during the crisis, a 

number of highly rated senior 

securitization positions were subject to 

significant downgrades and suffered 

substantial losses.’’ 21 Even where losses 

have not yet been realized (as in many 

collateralized loan obligations), the 

market value of these securitizations 

declined precipitously during the crisis, 

reflecting the decline in the market 

value of the underlying assets and the 

increased risk of loss. 

Higher-Risk Consumer Loans and 

Securities 

Under the proposal, higher-risk 

consumer loans and securities would be 

defined as: 

(a) All consumer loans where, as of 

origination, or, if the loan has been 

refinanced, as of refinance, the 

probability of default (PD) within two 

years (the two-year PD) was greater than 

20 percent, excluding those consumer 

loans that meet the definition of a 

nontraditional mortgage loan; 22 and 

(b) Securitizations that are more than 

50 percent collateralized by consumer 

loans meeting the criteria in (a), except 

those classified as trading book.23

An institution would be required to 

use the information that is or would be 

reasonably available to a sophisticated 

investor in reasonably determining 

whether a securitization meets the 50 

percent threshold. Information 

reasonably available to a sophisticated 

investor should include, but is not 

limited to, offering memorandums, 

indentures, trustee reports, and requests 

for information from servicers, collateral 

managers, issuers, trustees, or similar 

third parties. When determining 

whether a revolving trust or similar 

securitization would meet the threshold, 

an institution could use established 

criteria, model portfolios, or limitations 

published in the offering memorandum, 

indenture, trustee report or similar 

documents. 

Sufficient information necessary for 

an institution to make a definitive 

determination may not, in every case, be 

reasonably available to the institution as 

a sophisticated investor. In such a case, 

the institution may exercise its 

judgment in making the determination. 

Nevertheless, the FDIC would retain the 

right to review and audit for compliance 

with the rule any determination that a 

securitization does not meet the 50 

percent threshold. 

In cases where a securitization is 

required to be consolidated on the 

balance sheet as a result of SFAS 166 

and SFAS 167, and a large institution or 

highly complex institution has access to 

the necessary information, an institution 

may evaluate individual loans in the 

securitization on a loan-by-loan basis. 

Any loan within the securitization that 

meets the definition of a higher-risk 

asset would be reported as a higher-risk 

asset and any loan within the 

securitization that does not meet the 

definition of a higher-risk asset would 

not be reported as such. When making 

this evaluation, the institution would 

have to follow the transition guidance 

described in Appendix C, Section C. 

Once an institution evaluated a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it 

would have to continue to evaluate all 

securitizations for which it has the 

required information in a similar 

manner (i.e., on a loan-by-loan basis). 

For securitizations for which the 

institution does not have access to 

information on a loan-by-loan basis, the 

institution would be required to 

determine whether the securitization 

meets the 50 percent threshold as 

described previously for other 

securitizations. 

Institutions would have to determine 

the PD of a consumer loan as of 

origination, or, if the loan has been 

refinanced, as of refinance. When an 

institution acquires a consumer loan or 

security, it would have to determine 

whether the loan or security meets the 

definition of a higher-risk consumer 

loan or security using the origination 

criteria and analysis performed by the 

original lender. If this information is 

unavailable, however, the institution 

would have to obtain recent, refreshed 

data from the borrower or other 

appropriate third-party.24

In arriving at its proposal, the FDIC 

carefully reviewed the comments 

submitted in response to the March and 

July PRA notices on the subprime loan 

definition contained in the February 

rule. Of the 19 respondents commenting 

on the March PRA notice, 17 raised 

concerns over the subprime loan 

definition; 6 of the 8 respondents to the 

July PRA notice raised such concerns. 

Further, as the FDIC noted in the public 

comment file for the July PRA notice, 

the FDIC met with representatives of 

four industry trade groups and twice 

with large and highly complex 

institutions prior to the close of the 

comment period on the PRA notice. 

The representatives stated that 

institutions generally do not maintain 

the data necessary to identify consumer 

loans as higher-risk under the February 

rule, and would not be able to collect 

such data prior to filing their Call 

Reports for the June 30, 2011, report 

date. Commenters also stated that 

adapting current reporting systems to 

capture such loans automatically would, 

in some cases, be impossible and would 

require ongoing manual intervention, 

which is costly and burdensome.25

A group representing the industry 

also asserted that the definition of 

subprime loans does not correlate with 

more sophisticated risk-grading systems 

generally used by banks internally. 

While these systems consider the factors 

included in the subprime definition, 

they consider these jointly rather than 

individually, and incorporate other 

information such as the size and type of 

delinquency and other measures of the 

borrower’s debt capacity. As a 

consequence, the group believed that 

using the definition contained in the 

February rule would greatly overstate 

institutions’ exposure to subprime loans 

and relative risk. In the group’s view, 

this overstatement of exposure and 

relative risk could reduce credit or 

increase its cost for some types of 

consumers, such as students, since an 

institution factors the cost of 

assessments into its credit and pricing 

decisions. 

The proposed definition would better 

capture and differentiate higher-risk 

consumer loans and securities among 

banks compared to the current 

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18114 Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 

26All reported amounts would exclude the 

maximum amounts recoverable from the U.S. 

government, its agencies, or government-sponsored 

agencies under guarantee or insurance provisions, 

as well as loans that are fully secured by cash 

collateral. In order to exclude a loan based on cash 

collateral, the cash would be required to be in the 

form of a savings or time deposit held by the 

insured depository institution, the insured 

depository institution would be required to have a 

signed collateral assignment of the deposit account, 

which is irrevocable for the remaining term of the 

loan or commitment, and the insured depository 

institution would be required to place a hold on the 

deposit account, which alerts the institution’s 

employees to an attempted withdrawal. In the case 

of a revolving line of credit, the cash collateral 

would have to be equal to or greater than the 

amount of the total loan commitment (the aggregate 

funded and unfunded balance of the loan) for the 

exclusion to apply. 

27An internal approach would include the use of 

an institution’s own default experience with a 

particular product and credit score, whether that 

score was provided by a third party or was 

internally derived. 

definition. In addition, the proposal 

should be easier for institutions to adopt 

and implement as it more closely aligns 

with how they currently measure risk. 

This same industry group proposed 

an alternative definition of subprime 

consumer loans based on PD within one 

year from origination. Under the 

proposal, institutions would report the 

outstanding balance of consumer loans 

in their retail portfolios stratified by a 

specified number of products and PD 

bands. The FDIC has engaged in 

extensive discussions with industry 

representatives regarding this proposal 

and incorporated many of the proposal’s 

major elements into the NPR. 

The FDIC chose to propose a twoyear, instead of a one-year, PD in order 

to more closely align with the time 

horizon used by recognized third party 

vendors that produce standard 

validation charts. These charts include 

observed default rates over a specified 

two-year period by credit score and 

product type. If these charts were 

modified to conform to the PD 

estimation guidelines in Appendix C, 

institutions could use them to classify 

consumer loans under the proposed 

definition. 

A PD estimated according to the 

guidelines should reflect the average 

two-year, stress period performance of 

loans across a range of remaining 

maturities, as opposed to the 

performance of loans within the first 

two years of origination. The FDIC is 

concerned with potential default risk 

throughout the life of the loan and not 

just over the first two years following 

origination. By considering different 

origination time periods and various 

remaining maturities, the proposed 

approach should better represent the 

default risk throughout the life of the 

loan. Different product types tend to 

have different default profiles over time, 

with some products resulting in peak 

default rates sooner after origination 

than other products. An approach that 

considers various remaining maturities 

should mitigate the default timing bias 

between products following origination 

of a loan. 

The FDIC intends to collect two-year 

PD information on various types of 

consumer loans from large and highly 

complex institutions. However, the 

types of information collected and the 

format of the information collected on 

the Call Report would be subject to a 

PRA notice, providing an opportunity 

for comment, published in the Federal 

Register. The following table is an 

example of how the FDIC may collect 

the consumer loan information. Once 

the definition of higher-risk consumer 

loans is adopted in a final rule, the FDIC 

anticipates that appropriate changes to 

the Call Reports would be made and 

that institutions would report consumer 

loans according to the definition in the 

final rule. As suggested in the example 

table below and in Appendix 1, 

institutions would report the 

outstanding amount of all consumer 

loans, including those with a PD below 

the subprime threshold, stratified by the 

10 product types and 12 two-year PD 

bands.26 In addition, for each product 

type, institutions would indicate 

whether the PDs were derived using 

scores and default rate mappings 

provided by a third party vendor or an 

internal approach.27 Institutions would 

report the value of all securitizations 

that are more than 50 percent 

collateralized by higher-risk consumer 

loans (other than trading book) as a 

separate item. 

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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18115 

28See 76 FR 10672, 10700 (February 25, 2011) (H. 

Updating the Scorecard). 

The proposed 20 percent PD 

threshold was determined based on an 

evaluation of performance data 

provided by a couple of large third party 

vendors of consumer credit scores. 

Specifically, for each vendor, this data 

contained observed, two-year default 

rates and the proportion of consumer 

accounts captured by credit score and 

product type. Default rates were 

calculated in a manner similar to the 

guidelines in Appendix C. The FDIC 

considered the proportion of consumer 

accounts and range of scores that would 

be deemed higher-risk under different 

PD thresholds, overall and by product 

type, and how those results compare to 

score-based definitions of subprime 

commonly used by the industry. The 

FDIC would use the information that 

would be included in the Call Report to 

determine whether the PD threshold 

should be changed in the future.28

The FDIC anticipates that it may 

receive additional or updated 

information from third party vendors 

prior to the Board adopting a final rule. 

The FDIC would consider any 

additional information received before it 

proposes that a particular PD threshold 

be adopted in the final rule. In 

reviewing the PD threshold, the FDIC 

would use a methodology similar to the 

methodology described above. The 

methodology used would include 

consideration of the proportion of 

consumer accounts and range of scores 

that would be deemed higher risk under 

different PD thresholds and how those 

compare to score-based definitions of 

subprime commonly used in the 

industry. 

During discussions with the industry, 

a few institutions suggested that the 

FDIC have the flexibility to modify the 

time periods used for PD estimation 

without further notice-and-comment 

rulemaking. The institutions suggested 

that the FDIC could either change the 

time period considered or add 

additional time periods to the existing 

time period. The FDIC agrees that 

having the flexibility to modify the time 

periods, as part of the risk-based 

assessment system, would allow the 

FDIC to better differentiate risk among 

institutions. For example, a material 

change in consumer behavior or the 

development of new consumer products 

or default data might suggest changes to 

what should be considered a higher-risk 

consumer loan. Under these 


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18116 Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 

29Reporting all consumer loans by product and 

PD bands was part of the industry’s proposal to 

strengthen identification of higher-risk consumer 

loans. 

30A securitization would be as defined in 

Appendix A, Section II(B)(16) of Part 325 of the 

FDIC’s Rules and Regulations, as it may be 

amended from time to time. 

31Somewhat more stringent requirements would 

apply when an institution acquires loans or 

securities from another entity on a recurring or 

programmatic basis. 

32 76 FR 10714 (February 25, 2011) to be codified 

at 12 CFR 327.9(b)(3). 

circumstances, incorporating new or 

additional time periods might better 

capture either the changes in consumer 

behavior or new potentially higher-risk 

consumer products so that FDIC can 

better identify and measure emerging 

risks. The FDIC would also have, as part 

of the risk-based assessment system, the 

flexibility to increase or decrease the PD 

threshold of 20 for identifying higherrisk consumer loans to reflect the 

updated consumer default data from the 

different time periods selected without 

the necessity of further notice-andcomment rulemaking. Before making 

changes to the established PD threshold, 

the FDIC would analyze resulting 

potential changes in the distribution of 

the higher-risk consumer loans and 

would consider the resulting effect on 

total deposit insurance assessments and 

risk differentiation among institutions. 

The FDIC would provide institutions 

with at least one quarter advance notice 

of any changes to the PD estimation 

time periods or the PD threshold. 29

Nontraditional Mortgage Loans 

The proposal does not make changes 

to the definition of a nontraditional 

mortgage loan; however, it does clarify 

how securitizations of nontraditional 

mortgage loans would be identified 

under the current definition.30

In a comment letter in response to the 

March and July PRA notices, three 

industry trade groups stated that the 

criteria outlined for identifying 

nontraditional mortgage loans in the 

February rule do not fully differentiate 

risk among banks or among 

nontraditional mortgage loans. The 

commenters maintained that not all 

nontraditional mortgage loans contain 

the same level of risk. The industry 

suggested that banks identify and report 

nontraditional mortgage loans by the PD 

within one year from origination as 

determined as of origination by a credit 

scoring system, similar to their 

recommendation for reporting subprime 

consumer loans. 

After reviewing the merits of the 

industry’s suggestions, the FDIC has 

concluded that identifying a mortgage 

loan using a one-year PD would be 

inappropriate given the unique risks of 

nontraditional mortgage loans. Unlike 

leveraged loans and subprime loans, 

institutions have not indicated any 

difficulty complying with the existing 

definition of nontraditional mortgage 

loans and the FDIC believes that 

changes to the definition would not 

result in better risk determination for 

deposit insurance pricing purposes. The 

FDIC will monitor future rulemakings 

regarding Qualified Residential 

Mortgages and the capital treatment of 

nontraditional mortgage loans to 

determine whether any changes to the 

definition should be considered. 

Large and highly complex institutions 

are sophisticated investors and can 

typically obtain the information needed 

to determine whether a securitization 

meets the 50 percent threshold 

described above when they purchase 

interests in these securitizations. The 

proposal clarifies that an institution 

would be required to use information 

reasonably available to a sophisticated 

investor in reasonably determining 

whether a securitization meets the 50 

percent threshold of the assets backing 

a securitization contain nontraditional 

mortgage loans. 

Information reasonably available to a 

sophisticated investor should include, 

but is not limited to, offering 

memorandums, indentures, trustee 

reports, and requests for information 

from servicers, collateral managers, 

issuers, trustees, or similar third parties. 

When determining whether a revolving 

trust or similar securitization would 

meet the threshold, an institution could 

use established criteria, model 

portfolios, or limitations published in 

the offering memorandum, indenture, 

trustee report or similar documents. 

Sufficient information necessary for 

an institution to make a definitive 

determination may not, in every case, be 

reasonably available to the institution as 

a sophisticated investor. In such a case, 

the institution may exercise its 

judgment in making the determination. 

Nevertheless, the FDIC would retain the 

right to review and audit for compliance 

with the rule any determination that a 

securitization does not meet the 50 

percent threshold. 

In cases where a securitization is 

required to be consolidated on the 

balance sheet as a result of SFAS 166 

and SFAS 167, and a large institution or 

highly complex institution has access to 

the necessary information, an institution 

may evaluate individual loans in the 

securitization on a loan-by-loan basis. 

Any loan within the securitization that 

meets the definition of a higher-risk 

asset would be reported as a higher-risk 

asset and any loan within the 

securitization that does not meet the 

definition of a higher-risk asset would 

not be reported as such. When making 

this evaluation, the institution would 

have to follow the transition guidance 

described in Appendix C, Section C. 

Once an institution evaluated a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it 

would have to continue to evaluate all 

securitizations for which it has the 

required information in a similar 

manner (i.e., on a loan-by-loan basis). 

For a securitizations for which the 

institution does not have access to 

information on a loan-by-loan basis, the 

institution would be required to 

determine whether the securitization 

meets the 50 percent threshold as 

described previously for other 

securitizations. 

Under the proposal, institutions 

would also have to determine whether 

residential loans and securities meet the 

definition of a nontraditional mortgage 

loan as of origination, or, if the loan has 

been refinanced, as of refinance, subject 

to requirements similar to those 

proposed for higher-risk consumer 

loans. 

When an institution acquires a 

residential loan or security, it would 

have to determine whether the loan or 

security meets the definition of a 

nontraditional mortgage loan using the 

origination criteria and analysis 

performed by the original lender. If this 

information were unavailable, however, 

the institution would have to obtain 

recent, refreshed data from the borrower 

or other appropriate third-party.31

B. Evaluation of Higher-Risk Assets 

The FDIC proposes that institutions 

evaluate C&I and consumer loans as of 

origination and refinance to determine 

whether they meet the criteria for 

higher-risk assets. A loan that is 

determined to be both a higher-risk 

consumer and a nontraditional mortgage 

loan should be reported only as a 

nontraditional mortgage loan, not both. 

C. Large Bank Adjustment Process 

The FDIC currently has the ability to 

adjust a large or highly complex 

institution’s total score (which is used 

to determine its deposit insurance 

assessment rate) by a maximum of 15 

points (the large bank adjustment).32

Because the proposed definitions 

should result in better risk identification 

and consistent application across the 

industry, the FDIC anticipates that there 

would be limited circumstances where 

the FDIC would consider a large bank 

adjustment as a result of perceived 

mitigants to an institution’s higher-risk 

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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18117 

33 76 FR 10672, 10700 (February 25, 2011) (H. 

Updating the Scorecard). 

34 If, as a result of its review and analysis, the 

FDIC concludes that different measures should be 

used to determine risk-based assessments, that the 

method of additional or alternative selecting cutoff 

values should be revised, that the weights assigned 

to the scorecard measures should be recalibrated, or 

that a new method should be used to differentiate 

risk among large institutions or highly complex 

institutions, changes would be made through a 

future rulemaking. 

35 76 FR 10672, 10700 (February 25, 2011). 

36The FDIC would provide large and highlycomplex institutions with at least one quarter 

advance notice in their quarterly deposit insurance 

invoice of changes in the cutoff values to ensure 

that the industry can determine the effect that any 

changes may have on its assessments. 

concentration measure. The proposed 

revised definitions, which include 

specific exceptions for wellcollateralized loans, should result in 

generally equal treatment of similar 

loans at different institutions. 

D. Audit 

Several of the proposed changes could 

require periodic auditing to ensure 

consistent reporting across the industry. 

For example, the PD calculation, 

whether through credit score mapping 

or through an internal approach, if not 

properly monitored, could potentially 

result in inconsistent application. Also, 

institutions would need to carefully 

evaluate their controls for asset-based 

and floor plan lending to determine 

whether they can exclude these loans 

from their higher-risk C&I loans and 

securities totals. The FDIC expects 

institutions will have appropriate 

systems in place for the proper 

identification and reporting of higherrisk assets. Enhanced review procedures 

for higher-risk asset reporting should be 

part of these systems. Institutions’ 

higher-risk identification and reporting 

programs should include applicable 

policies, procedures, reviews, and 

validation (through internal or external 

audits). The results of any internal 

reviews or external audits of higher-risk 

assets reporting should be made 

available to the FDIC upon request. The 

FDIC may review and audit for 

compliance all determinations made by 

insured institutions for assessment 

purposes. The FDIC may also review 

specific details of an institution’s 

reporting, including loans that are 

excluded from higher-risk assets. Any 

weakness identified in the reporting of 

higher-risk assets may be considered 

when forming supervisory strategies or 

in the application of adjustments to an 

institution’s total score as outlined in 

the Guidelines. 

E. Updating the Scorecard 

As set forth in the February rule, the 

FDIC has the flexibility to update the 

minimum and maximum cutoff values 

used in each scorecard annually without 

further rulemaking as long as the 

method of selecting cut-off values 

remains unchanged.33 The FDIC can add 

new data for subsequent years to its 

analysis and can, from time to time, 

exclude some earlier years from its 

analysis. Updating the minimum and 

maximum cutoff values and weights 

allows the FDIC to use the most recent 

data, thereby improving the accuracy of 

the scorecard method.34

The new definitions would allow the 

FDIC to better measure the risk present 

in large and highly-complex 

institutions, but they do not change that 

risk. Unless the FDIC re-calibrates cutoff 

values for the higher-risk assets to Tier 

1 capital and reserves ratio, however, 

the proposed changes to the definitions 

of higher-risk assets could result in 

significant increases or decreases in the 

amount of total deposit insurance 

assessments collected from large and 

highly complex banks. Each scorecard 

measure, including the higher-risk 

assets to Tier 1 capital and reserves 

ratio, is converted to a score between 0 

and 100 based upon minimum and 

maximum cutoff values for the measure 

(where the minimum and maximum 

cutoff values get converted to a score of 

0 or 100). Most of the minimum and 

maximum cutoff values represent the 

10th and 90th percentile values for each 

measure, which are derived using data 

on large institutions over a ten-year 

period beginning with the first quarter 

of 2000 through the fourth quarter of 

2009. Since the cutoff values for the 

higher-risk assets to Tier 1 capital and 

reserves ratio were calibrated using 

higher-risk assets data reported in 

accordance with an institution’s existing 

methodology for identifying leveraged 

or subprime loans and securities, 

changing the definitions of these higherrisk assets may result in significant 

differences in the volume of higher-risk 

assets reported by institutions, and 

differences in the amount of deposit 

insurance assessments collected by the 

FDIC. 

The FDIC does not intend for the 

proposed changes in definitions to 

result in the FDIC collecting higher or 

lower deposit insurance assessment 

revenue from large and highly complex 

institutions as a whole (although it may 

result in individual institutions paying 

higher or lower deposit insurance 

assessments). Consequently, the FDIC 

anticipates that it may need to use its 

flexibility to update cutoff values to 

update the minimum and maximum 

cutoff values for the higher-risk assets to 

Tier 1 capital and reserves ratio.35

Changes in the distribution of the 

higher-risk assets to Tier 1 capital and 

reserves ratio scores and the resulting 

effect on total assessments and risk 

differentiation between institutions 

would be taken into account in 

determining changes to the cutoffs. In 

addition, because the FDIC has not 

collected any data under the proposed 

definitions, changes to cutoff values for 

the higher-risk assets to Tier 1 capital 

and reserves ratio could be made more 

frequently than annually. This review 

would ensure proper risk differentiation 

between institutions.36

F. Implementation and Effective Date 

To allow time for institutions to 

implement systems to comply with the 

revised definitions, predicated on Call 

Report changes, the proposed 

amendments would become effective 

October 1, 2012. Because the FDIC is 

proposing no amendments to the 

definitions of construction and land 

development loans and nontraditional 

mortgage loans (other than to clarify 

how securitizations that meet the 

definition of a nontraditional mortgage 

loan are to be identified), the FDIC 

proposes that institutions continue to 

define and report these higher-risk 

assets as they have been doing under the 

February rule. 

Transition Guidance Until Effective 

Date 

Prior to October 1, 2012, large 

institutions and highly complex 

institutions will continue to use the 

transition guidance for leveraged loans 

and subprime loans as outlined in the 

General Instructions (Instructions) for 

Schedule RC–O of the Consolidated 

Reports of Condition and Income, 

Memorandum items 6 through 15. The 

Instructions will be updated as of March 

31, 2012 to reflect October 1, 2012 

(formerly April 1, 2012) as the date to 

begin identifying newly originated loans 

and securities according to the proposed 

definitions of these two higher-risk asset 

categories. 

This transition guidance provides 

that, for loans or securities originated or 

purchased before October 1, 2012, an 

institution may use either the definition 

in the February rule or continue to use 

its existing internal methodology for 

identifying loans and securities as 

leveraged or subprime for Schedule RC– 

O assessment reporting purposes. 

Institutions that do not have an existing 

methodology in place to identify loans 

and securities as leveraged or subprime 

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18118 Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 

37 Institutions had to determine whether loans 

and securities originated or purchased prior to 

October 1, 2012, met the definition of a 

construction and land development loan or a 

nontraditional mortgage loan in time to file accurate 

reports of condition as of June 30, 2012, and 

September 30, 2012. 38See 5 U.S.C. 603, 604 and 605. 

(because they are not required to report 

these exposures to their primary federal 

regulator for examination or other 

supervisory purposes or do not measure 

and monitor loans and securities with 

these characteristics for internal risk 

management purposes) may continue to 

apply existing guidance provided by 

their primary federal regulator, by the 

agencies’ 2001 Expanded Guidance for 

Subprime Lending Programs, (for 

consumer loans and securities) or by the 

February 2008 Comptroller’s Handbook 

on Leveraged Lending (for C&I loans 

and securities). 

Rules in Effect on the Effective Date and 

Thereafter 

Effective October 1, 2012, the 

proposed definitions described above 

would apply to: 

(1) All C&I loans and securities 

originated or purchased on or after 

October 1, 2012; 

(2) All consumer loans and securities, 

except securitizations of consumer loans 

and securities, whenever originated or 

purchased; 

(3) All residential real estate loans 

and securities, except securitizations of 

residential real estate loans, whenever 

originated or purchased; and 

(4) All securitizations of C&I, 

consumer, and residential real estate 

loans originated or purchased on or after 

October 1, 2012. 

For consumer and residential real 

estate loans and securities (other than 

securitizations) originated or purchased 

prior to October 1, 2012, an institution 

would have to determine whether the 

loan or security met the definition of a 

higher-risk consumer loan or security no 

later than December 31, 2012, using 

information as of the date of the 

origination of the loan or security if the 

institution had that information.37 If the 

institution did not have that 

information, it would have to use 

refreshed data to determine whether a 

loan or security met the definition. 

Refreshed data would be defined as the 

most recent data available as if the loan 

or security were being originated in the 

fourth quarter of 2012. In all instances, 

the refreshed data used would have to 

be as of July 1, 2012 or later. 

For C&I loans and securities 

originated or purchased before October 

1, 2012, and all securitizations 

originated or purchased before October 

1, 2012, institutions would be required 

to either continue to use their existing 

internal methodology or existing 

guidance provided by their primary 

federal regulator or use the proposed 

definitions to determine whether to 

include the loan, security or 

securitization as a concentration in a 

risk area for purposes of the higher-risk 

assets to Tier 1 capital and reserves 

ratio. 

III. Request for Comments 

The FDIC seeks comment on every 

aspect of this proposed rule. In 

particular, the FDIC seeks comment on 

the questions set out below. The FDIC 

asks commenters to include specific 

reasons for their positions. 

1. Deposit Insurance Pricing Definitions 

a. Is the collateral test in the higherrisk C&I loans and securities definition 

appropriately specified? 

b. Is the purpose test in the higherrisk C&I loans and securities definition 

appropriately specified? 

c. Can institutions identify and report 

C&I loans as higher-risk? 

d. Is the definition of material 

appropriate? 

e. Should other risk measures, besides 

PD, be considered to define higher-risk 

consumer loans and securities? 

f. Can institutions report all of their 

consumer loans into the proposed 

products and PD bands? 

g. Is the proposed PD level of 20 

appropriate to identify higher-risk 

consumer loans? 

h. Is the definition of refinance 

appropriate? 

i. Are all definitions clear and are 

institutions able to implement the 

definitions as proposed? 

2. Regulatory Matters 

a. What are the costs and what is the 

extent of regulatory burden of the 

proposal compared to the February rule? 

b. Will the new effective date for the 

transition guidance (October 1, 2012) 

allow institutions sufficient time to 

update systems to accurately identify 

and report higher-risk assets as defined 

in the proposed definitions? If not, what 

date should the transition guidance be 

extended to? 

c. Are the requirements in the 

proposed regulation clearly stated? If 

not, how could the regulation be more 

clearly stated? 

d. Does the proposed regulation 

contain language that is not clear? If so, 

which language requires clarification? 

e. Large institutions and highlycomplex institutions would be required 

to define their higher-risk assets as 

outlined in Appendix C. Is the direction 

and language used in Appendix C clear? 

IV. Regulatory Analysis and Procedure 

A. Solicitation of Comments on Use of 

Plain Language 

Section 722 of the Gramm-LeachBliley Act, Public Law 106–102, 113 

Stat. 1338, 1471 (Nov. 12, 1999), 

requires the federal banking agencies to 

use plain language in all proposed and 

final rules published after January 1, 

2000. The FDIC invites your comments 

on how to make this proposal easier to 

understand. For example: 

• Are the requirements in the 

proposed regulation clearly stated? If 

not, how could the regulation be more 

clearly stated? 

• Does the proposed regulation 

contain language or jargon that is not 

clear? If so, which language requires 

clarification? 

• 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? 

• What else could the FDIC do to 

make the regulation easier to 

understand? 

B. Regulatory Flexibility Act 

The Regulatory Flexibility Act (RFA) 

requires that each federal agency either 

certify that a proposed rule would not, 

if adopted in final form, have a 

significant economic impact on a 

substantial number of small entities or 

prepare an initial regulatory flexibility 

analysis of the rule and publish the 

analysis for comment.38 For RFA 

purposes a small institution is defined 

as one with $175 million or less in 

assets. 

As of September 30, 2011, of the 7,436 

insured commercial banks and savings 

associations, there were 3,989 small 

insured depository institutions, as that 

term is defined for purposes of the RFA. 

The proposed rule, however, would 

apply only to institutions with $10 

billion or greater in total assets. 

Consequently, small institutions for 

purposes of the RFA will experience no 

significant economic impact should the 

FDIC implement the proposal in a final 

rule. 

C. Paperwork Reduction Act 

No collections of information 

pursuant to the Paperwork Reduction 

Act of 1995, 44 U.S.C. 3501–3521 (PRA), 

are contained in the proposed rule. 

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1The higher-risk concentration ratio is rounded 

to two decimal points. 

2Construction and land development loans are as 

defined in the instructions to Call Report schedule 

RC–C Part I—Loans and Leases, as they may be 

amended from time to time, and include items 

reported on line items RC–C 1.a.1 (1–4 family 

residential construction loans), RC–C 1.a.2. (Other 

construction loans and all land development and 

other land loans), and RC–O M.10.a (Total 

unfunded commitments to fund construction, land 

development, and other land loans secured by real 

estate), and exclude RC–O M.10.b (Portion of 

unfunded commitments to fund construction, land 

development and other loans that are guaranteed or 

insured by the U.S. government, including the 

FDIC), RC–O M.13.a (Portion of funded 

construction, land development, and other land 

loans guaranteed or insured by the U.S. 

government, excluding FDIC loss sharing 

agreements), RC–M 13a.1.a.1 (1–4 family 

construction and land development loans covered 

by loss sharing agreements with the FDIC), and RC– 

M 13a.1.a.2 (Other construction loans and all land 

development loans covered by loss sharing 

agreements with the FDIC). 

3Commercial loans are as defined as commercial 

and industrial loans in the instructions to Call 

Report Schedule RC–C Part I—Loans and Leases, as 

they may be amended from time to time. An 

overdraft is a higher-risk C&I loan or security, 

provided the overdraft is extended to a company 

and not an individual and it otherwise meets the 

Call Report definition of a C&I loan. 

4Unfunded commitments are defined as unused 

commitments, as this term is defined in the 

instructions to Call Report Schedule RC–L, 

Derivatives and Off-Balance Sheet Items, as they 

may be amended from time to time. 

5As used in this definition of higher-risk C&I 

loans and securities, debt includes all forms of 

obligation and liability, including loans and 

securities. 

6A securitization is defined in Appendix A, 

Section II(B)(16) of Part 325 of the FDIC’s Rules and 

Regulations, as it may be amended from time to 

time. 

7Loans or securities acquired from another entity 

are acquired on a recurring basis if an institution 

has acquired other loans or securities from that 

entity at least once within the calendar year or the 

previous calendar year of the acquisition of the 

loans or securities in question. 

D. The Treasury and General 

Government Appropriations Act, 1999— 

Assessment of Federal Regulations and 

Policies on Families 

The FDIC has determined that the 

proposed rule will not affect family 

well-being within the meaning of 

section 654 of the Treasury and General 

Government Appropriations Act, 

enacted as part of the Omnibus 

Consolidated and Emergency 

Supplemental Appropriations Act of 

1999 (Pub. L. 105–277, 112 Stat. 2681). 

List of Subjects in 12 CFR Part 327 

Bank deposit insurance, Banks, 

Savings associations. 

For the reasons set forth above, the 

FDIC proposes to amend 12 CFR part 

327 as follows: 

PART 327—ASSESSMENTS 

1. The authority citation for part 327 

continues to read as follows: 

Authority: 12 U.S.C. 1441, 1813, 1815, 

1817–19, 1821. 

2. Revise appendix C to subpart A of 

part 327 to read as follows: 

Appendix C to Subpart A to Part 327— 

Concentration Measures 

The concentration score for large 

institutions is the higher of the higher-risk 

assets to Tier 1 capital and reserves score or 

the growth-adjusted portfolio concentrations 

score. The concentration score for highly 

complex institutions is the highest of the 

higher-risk assets to Tier 1 capital and 

reserves score, the Top 20 counterparty 

exposure to Tier 1 capital and reserves score, 

or the largest counterparty to Tier 1 capital 

and reserves score. The higher-risk assets to 

Tier 1 capital and reserves ratio and the 

growth-adjusted portfolio concentration 

measure are described below. 

A. Higher-Risk Assets/Tier 1 Capital and 

Reserves 

The higher-risk assets to Tier 1 capital and 

reserves ratio is the sum of the 

concentrations in each of four risk areas 

described below and is calculated as: 

Where: 

Hi is institution i’s higher-risk 

concentration measure and k is a risk area.1

The four risk areas (k) are construction and 

land development loans, higher-risk 

commercial and industrial (C&I) loans and 

securities, higher-risk consumer loans and 

securities, and nontraditional mortgage loans. 

1. Construction and land development 

loans include construction and land 

development loans outstanding and 

unfunded commitments to fund construction 

and land development loans, whether 

revocable or irrevocable.2

2. Higher-risk commercial and industrial 

(C&I) loans and securities include: 

• Any commercial loan (funded or 

unfunded, including irrevocable and 

revocable commitments) owed by a borrower 

to the evaluating depository institution with 

an original amount greater than $5 million if 

the conditions specified in (a) or (b) below 

are met as of origination, or, if the loan has 

been refinanced, as of refinance, and the loan 

does not meet the asset based lending (ABL) 

exclusion or the floor plan line of credit 

exclusion (defined below).3 4

(a)(i) The purpose of any of the borrower’s 

debt 5 (whether owed to the evaluating 

insured depository institution or another 

lender) that was incurred within the previous 

seven years was to finance a buyout (e.g., to 

fund an equity buyout or fund an Employee 

Stock Ownership Plan (ESOP)), acquisition 

(e.g., merger or tender offer), or capital 

distribution (e.g., dividends, stock 

repurchase, or cash-out) and such debt was 

material as defined below; and 

(ii) The ratio of the borrower’s total debt to 

trailing twelve-month EBITDA (i.e., operating 

leverage ratio) is greater than 4 or the ratio 

of the borrower’s senior debt to trailing 

twelve-month EBITDA (i.e., operating 

leverage ratio) is greater than 3; or 

(b) Any of the borrower’s debt (whether 

owed to the evaluating institution or another 

lender) is designated as a highly leveraged 

transaction (HLT) by a syndication agent. 

• All securities held by the evaluating 

institution that are issued by a commercial 

borrower, if the conditions specified in (a) or 

(b) above are met, except securities classified 

as trading book; and 

• All securitizations held by the evaluating 

institution that are more than 50 percent 

collateralized by commercial loans or 

securities that would meet the foregoing 

higher-risk C&I loans and securities 

definition if directly held by the evaluating 

institution, except securities classified as 

trading book.6

Institutions must determine whether C&I 

loans and securities meet the definition of a 

higher-risk C&I loan and security as of 

origination, or, if the loan has been 

refinanced, as of refinance, as discussed in 

Section A of this Appendix. When an 

institution acquires a C&I loan or security, it 

must determine whether the loan or security 

meets the definition of a higher-risk C&I loan 

or security using the origination criteria and 

analysis performed by the original lender. If 

this information is unavailable, the 

institution must obtain refreshed data from 

the borrower or other appropriate third-party. 

Refreshed data for C&I loans and securities is 

defined as the most recent data available. 

However, the data must be as of a date that 

is no earlier than one year before the 

acquisition of the C&I loan or security. The 

acquiring institution must also determine 

whether an acquired loan or securitization is 

higher risk as soon as reasonably practicable, 

but not later than one year after acquisition. 

However, when an institution acquires 

loans or securities from another entity on a 

recurring or programmatic basis, the 

acquiring institution may determine whether 

the loan or security meets the definition of 

a higher-risk C&I loan or security using the 

origination criteria and analysis performed 

by the original lender only if the acquiring 

institution verifies the information 

provided.7 Otherwise, the acquiring 

institution must obtain the necessary 

information from the borrower or other 

appropriate third party to make its own 


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determination of whether the acquired assets 

should be classified as a higher-risk C&I loan 

and security. If the financial information is 

not available as of the origination date or 

refinance, the institution must obtain 

refreshed data from the borrower or other 

appropriate third-party. Refreshed data for 

C&I loans or securities acquired on a 

recurring or programmatic basis is defined as 

the most recent data available, and in any 

case, the refreshed data used must be as of 

a date that is no earlier than three months 

before the acquisition of the C&I loan or 

security. The acquiring institution must also 

determine whether a loan or securitization 

acquired on a recurring or programmatic 

basis is higher risk as soon as is practicable, 

but not later than three months after the date 

of acquisition. 

Higher-risk C&I loans and securities 

include purchased credit impaired loans that 

meet the definition of higher-risk C&I loans 

and exclude the following: 

• Residential, commercial or farmland 

loans secured by real estate; 

• Loans to finance agricultural production; 

• Loans to equity REITS; 

• Lease financing receivables; 

• Loans to individuals for commercial, 

industrial, or professional purposes; 

• Loans to foreign governments and 

official institutions; 

• Obligations of states and political 

subdivisions of the U.S.; 

• Loans to depository and nondepository 

financial institutions; 

• The maximum amount of any loan that 

is recoverable from the U.S. government, its 

agencies, or government-sponsored agencies 

under guarantee or insurance provisions; 

• Loans that are fully secured by cash 

collateral, provided that the cash is in the 

form of a savings or time deposit held by the 

insured depository institution, the insured 

depository institution has in place a 

collateral assignment of the deposit account 

signed by the borrower, the assignment is 

irrevocable as long as the loan or 

commitment is outstanding, and a hold is 

placed on the deposit account that alerts the 

institution’s employees to an attempted 

withdrawal; in the case of a revolving line of 

credit, the cash collateral must be equal to or 

greater than the amount of the total loan 

commitment (the aggregate funded and 

unfunded balance of the loan); 

C&I loans that are secured by liquid assets 

other than cash are not excluded from the 

higher-risk loan designation. 

An institution must use the information 

reasonably available to a sophisticated 

investor in reasonably determining whether a 

securitization meets the 50 percent threshold. 

Information reasonably available to a 

sophisticated investor includes, but is not 

limited to, offering memorandums, 

indentures, trustee reports, and requests for 

information from servicers, collateral 

managers, issuers, trustees, or similar third 

parties. When determining whether a 

revolving trust or similar securitization meets 

the 50 percent threshold, an institution may 

use established criteria, model portfolios, or 

limitations published in the offering 

memorandum, indenture, trustee report or 

similar documents. 

Sufficient information necessary for an 

institution to make a definitive determination 

may not, in every case, be reasonably 

available to the institution as a sophisticated 

investor. In such a case, the institution may 

exercise judgment in making its 

determination. Generally, the FDIC may 

review and audit for compliance all 

determinations made by insured depository 

institutions for assessment purposes, 

including a determination that a 

securitization does not meet the 50 percent 

threshold. 

In cases where a securitization is required 

to be consolidated on the balance sheet as a 

result of SFAS 166 and SFAS 167, and a large 

institution or highly complex institution has 

access to the necessary information, an 

institution may evaluate individual loans in 

the securitization on a loan-by-loan basis. 

Any loan within the securitization that meets 

the definition of a higher-risk asset must be 

reported as a higher-risk asset and any loan 

within the securitization that does not meet 

the definition of a higher-risk asset need not 

be reported as such. When making this 

evaluation, the institution must follow the 

transition guidance described in Appendix C, 

Section C. Once an institution evaluates a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it must 

continue to evaluate all securitizations for 

which it has the required information in a 

similar manner (i.e., on a loan-by-loan basis). 

For securitizations for which the institution 

does not have access to information on a 

loan-by-loan basis, the institution must 

determine whether the securitization meets 

the 50 percent threshold. 

Definition of Terms Used Within the 

Definition of Higher-Risk C&I Loans and 

Securities 

An acquisition means the purchase by the 

borrower of any equity interest in another 

company or the purchase of any of the assets 

and liabilities of another company. 

A buyout means the issuance of debt to 

finance the purchase or repurchase by the 

borrower of the borrower’s outstanding 

equity. A buyout could include, but is not 

limited to, an equity buyout or funding of an 

ESOP. 

A capital distribution means that the 

borrower incurs debt to finance a dividend 

payment or to finance other transactions 

designed to enhance shareholder value, such 

as repurchase of stock. 

For purposes of the definition of a higherrisk C&I loan and security, a debt is material 

if it results in a 20 percent or greater increase 

any time within 12 months in the total 

funded debt of the borrower (including all 

funded debt assumed, created or refinanced). 

Debt is also material if, before the debt was 

incurred, the borrower had no funded debt. 

When calculating either of the borrower’s 

operating leverage ratios, the only permitted 

EBITDA adjustments are those specifically 

permitted for that borrower at the time of 

underwriting and only funded amounts of 

lines of credit must be considered debt. 

The debt-to-EBITDA ratio must be 

calculated using the consolidated financial 

statements of the borrower unless the loan is 

to a subsidiary of a larger organization. In 

that case, the ratio may be calculated using 

consolidated financial statements of the 

parent company provided that the parent 

company and all of its major operating 

subsidiaries have unconditionally and 

irrevocably guaranteed the borrower’s debt to 

the reporting large institution or highly 

complex institution. 

In the case of a merger of two companies 

or the acquisition of one or more companies 

or parts of companies, the pro-forma debt is 

to be used as well as the trailing twelvemonth pro-forma EBITDA for the combined 

companies. When calculating the trailing 

pro-forma EBITDA for the combined 

company, no adjustments are allowed for 

economies of scale or projected cost savings 

that may be realized subsequent to the 

acquisition unless specifically permitted for 

that borrower under the loan agreement. 

The original amount of the loan is defined 

as: 

(1) For loans drawn down under lines of 

credit or loan commitments, the amount of 

the line of credit or loan commitment on the 

date of its most recent approval, extension or 

renewal prior to the date of the most recent 

Call Report. If the amount currently 

outstanding as of the date of the most recent 

Call Report exceeds this amount, then the 

original amount is the amount outstanding as 

of the Call Report date. 

(2) For loan participations and 

syndications, the original amount of the loan 

participation or syndication is the total 

amount of the credit originated by the lead 

lender. 

(3) For all other loans, the original amount 

is the total amount of the loan as of 

origination or the amount outstanding as of 

the Call Report date, whichever is larger. 

Multiple loans to one borrower are to be 

aggregated to the extent that the institution’s 

loan data systems can do so without undue 

cost. If the cost is excessive, the institution 

may treat multiple loans to one borrower as 

separate loans. 

The purpose of the borrower’s debt for 

purposes of meeting the definition of higherrisk C&I loans is determined at the time the 

debt was incurred by the borrower. 

A securitization is as defined in Appendix 

A, Section II(B)(16) of Part 325 of the FDIC’s 

Rules and Regulations, as it may be amended 

from time to time. 

Senior debt includes any portion of total 

debt that has a priority claim on any of the 

borrower’s assets. A priority claim is a claim 

that entitles the holder to priority of payment 

over other debt holders in bankruptcy. 

Total debt is defined as all interest-bearing 

financial obligations and includes, but is not 

limited to, overdrafts, borrowings, repurchase 

agreements (repos), trust receipts, bankers 

acceptances, debentures, bonds, loans 

(including those secured by mortgages), 

sinking funds, capital (finance) lease 

obligations (including those obligations that 

are convertible, redeemable or retractable), 

mandatory redeemable preferred and trust 

preferred securities accounted for as 

liabilities in accordance with ASC Subtopic 

480–10, Distinguishing Liabilities from 

Equity—Overall (formerly FASB Statement 

No. 150, ‘‘Accounting for Certain Financial 

Instruments with Characteristics of both 

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8Borrowing base certificates are defined in 

Appendix C, Section D. 

9 Guidelines that address acceptable industrystandard controls over asset based lending are 

included in Appendix C, Section D. Loans must 

adhere to these guidelines to be eligible for the ABL 

exclusion. 

10An asset is self-liquidating if, in the event the 

borrower defaults, the asset can be easily liquidated 

and the proceeds of the sale of the assets would be 

used to pay down the loan. These assets can 

include machinery, heavy equipment or rental 

equipment if the machinery or equipment is 

inventory for the borrower’s primary business and 

the machinery or equipment is included in the 

borrowing base. 

11Additional guidelines covering acceptable 

industry-standard controls over automobile dealer 

floor plan lending are included in Appendix C, 

Section D. Loans must also adhere to these 

guidelines to be eligible for the floor plan line of 

credit exclusion. 

12Curtailment programs ensure that the lender 

receives regular principal payments on floor plan 

loans in situations where the underlying collateral 

is not selling as quickly as expected. Under such 

programs, when vehicles that serve as collateral on 

a floor plan loan do not sell within a reasonable and 

specific timeframe, the borrower is required to 

begin repaying the lender a certain dollar amount 

(to be determined by the loan agreement) on a 

monthly or quarterly basis. 

13A securitization is defined in Appendix A, 

Section II(B)(16) of Part 325 of the FDIC’s Rules and 

Regulations, as it may be amended from time to 

time. 

Liabilities and Equity’’), and subordinated 

capital notes. Total debt excludes pension 

obligations, deferred tax liabilities and 

preferred equity. 

Asset-Based Lending Exclusion 

Asset-based loans that meet certain 

conditions are excluded from an institution’s 

higher-risk C&I loan totals. An excluded 

asset-based loan is defined as any loan, new 

or existing, in which all of the following 

conditions are present: 

• The loan is managed by a lender or 

group of lenders with experience in assetbased lending and collateral monitoring, 

including, but not limited to, experience in 

reviewing the following: Collateral reports, 

borrowing base certificates,8 collateral audit 

reports, loan to collateral values, and loan 

limits, using procedures common to the 

industry.9

• The insured depository institution has 

taken, or has the legally enforceable 

unconditional ability to take, dominion of 

cash through account control agreements 

over the borrower’s depository accounts such 

that proceeds of collateral are applied to the 

loan balance as collected. 

• The insured depository institution has a 

perfected first priority security interest in all 

assets included in the borrowing base 

certificate. 

• If the loan is a credit facility (revolving 

or term loan), it must be fully secured by selfliquidating assets such as accounts receivable 

and inventory.10 Fully secured is defined as 

a 100 percent or lower loan-to-value ratio 

after applying the appropriate discounts 

(determined by the loan agreement) to the 

collateral. For purposes of calculating the 

ratio, a revolving loan amount is the amount 

of the loan if fully drawn to the maximum 

permitted borrowing base. 

• Advance rates on accounts receivable 

should generally not exceed 75 percent to 85 

percent of eligible receivables and 65 percent 

of eligible inventory and the bank’s lending 

policy should address maintenance of an 

accounts receivable and inventory loan 

agreement that includes the items detailed in 

the Accounts Receivable and Automobile 

Dealer Floor Plan Lending Guidance 

included in Section D of this Appendix. 

• Assets must be valued or appraised by an 

independent third-party appraiser using net 

orderly liquidation value (NOLV), fair value, 

or forced sale value (versus a ‘‘going 

concern’’ value), whichever is appropriate, to 

arrive at a net realizable value. Appraisals are 

to be prepared in accordance with industry 

standards. 

• The insured depository institution must 

maintain documentation of borrowing base 

certificate reviews and collateral trend 

analyses to demonstrate that collateral values 

are actively, routinely and consistently 

monitored. A new borrowing base certificate 

is required at each draw or advance on the 

loan. At the time of each draw the insured 

depository institution must validate the 

assets that compose the borrowing base 

certificate (by requesting from the borrower 

a listing of accounts receivable by creditor 

and a listing of individual pieces of 

inventory) and certify that the outstanding 

balance of the loan remains within the 

collateral formula prescribed by the loan 

agreement. Borrowing base reporting must be 

performed and validated (through asset-based 

tracking reports) at least on a monthly basis 

and supplemented by periodic, but no less 

than annual, field examinations (audits) to be 

performed by individuals who are 

independent of the credit origination or 

administration process. There must be a 

process in place to ensure that the insured 

depository institution is correcting audit 

exceptions. 

The FDIC retains the authority to verify 

that institutions are in compliance with 

sound internal controls and administration 

practices for asset based loans, as discussed 

in Section D of this Appendix. Generally, the 

FDIC may review and audit for compliance 

all determinations made by insured 

depository institutions for assessment 

purposes, including the exclusion of an asset 

based loan from an institution’s reported 

higher-risk C&I loans and securities totals. 

Floor Plan Lines of Credit Exclusion 

Floor plan loans that meet certain 

conditions are excluded from an institution’s 

higher-risk loan totals. An excluded 

automotive dealer floor plan loan is defined 

as any loan, new or existing, used to finance 

the purchase of automobile inventory by an 

automotive dealer in which all of the 

following conditions are present: 

• The loan is managed by a lender or 

group of lenders experienced in automobile 

dealer floor plan lending and monitoring 

collateral to ensure the borrower remains in 

compliance with floor plan limits and 

repayment requirements. Lenders should 

have experience in reviewing certain items, 

including but not limited to: Collateral 

reports, floor plan limits, floor plan aging 

reports, automobile inventory audits or 

inspections, and loan-to-collateral value 

(LTV) ratios. The insured depository 

institution must obtain and review audited 

financial statements of the borrower on an 

annual basis to ensure that adequate controls 

are in place.11

• Each loan advance is made against a 

specific automobile or under a borrowing 

base certificate held as collateral at no more 

than 100 percent of (i) dealer invoice plus 

freight charges (for new vehicles) or (ii) the 

cost of a used vehicle at auction or the 

wholesale value (using the prevailing market 

guide, e.g., NADA, Black Book, Blue Book). 

Permissible advance rates depend upon the 

types of risk mitigation systems the insured 

depository institution has in place for a 

particular credit facility. The advance rate of 

100 percent of dealer invoice plus freight 

charges on new vehicles and the advance rate 

of the cost of a used vehicle at auction or the 

wholesale value may only be used where 

there is a manufacturer repurchase agreement 

or an aggressive curtailment program in place 

that is tracked by the institution over time 

and subject to strict controls. 

• Each loan is self liquidating (i.e., if the 

borrower defaulted on the loan, the collateral 

could be easily liquidated and the proceeds 

of the sale of the collateral would be used to 

pay down the loan advance). 

• Vehicle inventories and collateral values 

are closely monitored, including the 

completion of regular (at least quarterly) 

dealership automotive inventory audits or 

inspections to ensure accurate accounting for 

all vehicles held as collateral. Floor plan 

aging reports must be reviewed by the 

institution. Curtailment programs should be 

instituted where necessary and institutions 

must ensure that curtailment payments are 

made on stale automotive vehicle inventory 

financed under the floor plan loan.12

The FDIC retains the authority to verify 

that institutions are in compliance with 

sound internal controls and administration 

practices for floor plan loans, as discussed in 

Section D of this Appendix. Generally, the 

FDIC may review and audit for compliance 

all determinations made by insured 

depository institutions for assessment 

purposes, including the exclusion of a floor 

plan loan from an institution’s reported 

higher-risk C&I loans and securities totals. 

3. Higher-risk consumer loans and 

securities are defined as: 

(a) All consumer loans where, as of 

origination, or, if the loan has been 

refinanced, as of refinance, the probability of 

default (PD) within two years (the two-year 

PD) was greater than 20 percent, excluding 

those consumer loans that meet the 

definition of a nontraditional mortgage loan; 

and 

(b) all securitizations that are more than 

50 percent collateralized by consumer loans 

meeting the criteria in (a), except those 

classified as trading book.13

Institutions must determine whether 

consumer loans meet the definition of a 

higher-risk consumer loan as of origination, 

or, if the loan has been refinanced, as of 

refinance, as discussed in Section A of this 

Appendix. The two-year PD must be 

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18122 Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 

14Loans or securities acquired from another 

entity are acquired on a recurring basis if an 

institution has acquired other loans or securities 

from that entity at least once within the calendar 

year of the acquisition of the loans or securities in 

question or the previous calendar year. 

estimated using an approach that conforms to 

the requirements detailed below. When an 

institution acquires a consumer loan or 

security, it must determine whether the loan 

or security meets the definition of a higherrisk consumer loan or security using the 

origination criteria and analysis performed 

by the original lender. If this information is 

unavailable, the institution must obtain 

refreshed data from the borrower or other 

appropriate third-party. Refreshed data for 

consumer loans and securities is defined as 

the most recent data available. However, the 

data must be as of a date that is no earlier 

than three months before the acquisition of 

the consumer loan or security. The acquiring 

institution must also determine whether an 

acquired loan or securitization is higher risk 

as soon as reasonably practicable, but not 

later than three months after acquisition. 

However, when an institution acquires 

loans or securities from another entity on a 

recurring or programmatic basis, the 

acquiring institution may determine whether 

the loan or security meets the definition of 

a higher-risk consumer loan or security using 

the origination criteria and analysis 

performed by the original lender only if the 

acquiring institution verifies the information 

provided.14 Otherwise, the acquiring 

institution must obtain the necessary 

information from the borrower or other 

appropriate third party to make its own 

determination of whether the purchased 

assets should be classified as a higher-risk 

consumer loan and security. If the financial 

information is not available as of the 

origination date or refinance, the institution 

must obtain refreshed data from the borrower 

or other appropriate third-party. Refreshed 

data for consumer loans or securities 

acquired on a recurring or programmatic 

basis is defined as the most recent data 

available, and in any case, the refreshed data 

used must be as of a date that is no earlier 

than three months before the acquisition of 

the consumer loan or security. The acquiring 

institution must also determine whether a 

loan or securitization acquired on a recurring 

or programmatic basis is higher risk as soon 

as is practicable, but not later than three 

months after the date of acquisition. 

Higher-risk consumer loans include 

purchased credit-impaired loans that meet 

the definition of higher-risk consumer loans 

and exclude the maximum amounts 

recoverable from the U.S. government, its 

agencies, or government-sponsored agencies 

under guarantee or insurance provisions, and 

loans that are fully secured by cash collateral, 

provided that the cash collateral is in the 

form of a savings or time deposit held by the 

insured depository institution. In the case of 

a revolving line of credit, the cash collateral 

must be equal to or greater than the amount 

of the total loan commitment (the aggregate 

funded and unfunded balance of the loan). 

Loans that are fully secured by savings and 

time deposits are not higher-risk consumer 

loans, provided that the insured depository 

institution has in place a collateral 

assignment of the deposit account signed by 

the borrower, the assignment is irrevocable as 

long as the term or commitment is 

outstanding, and a hold is placed on the 

deposit account that alerts the institution’s 

employees to an attempted withdrawal. 

Consumer loans that are secured by liquid 

assets other than cash are not excluded from 

the higher-risk consumer loan definition. 

A loan that meets both the nontraditional 

mortgage loan and higher-risk consumer loan 

and security definitions at the time of 

origination, or, if the loan has been 

refinanced, as of refinance, must be reported 

only as a nontraditional mortgage loan. 

However, if the loan ceases to meet the 

nontraditional mortgage loan definition but 

continues to meet the definition of a higherrisk consumer loan and security, the loan is 

to be reported as a higher-risk consumer loan 

and security. 

An institution must use the information 

that is reasonably available to a sophisticated 

investor in reasonably determining whether a 

securitization meets the 50 percent threshold. 

Information reasonably available to a 

sophisticated investor includes, but is not 

limited to, offering memorandums, 

indentures, trustee reports, and requests for 

information from servicers, collateral 

managers, issuers, trustees, or similar third 

parties. When determining whether a 

revolving trust or similar securitization meets 

the threshold, an institution may use 

established criteria, model portfolios, or 

limitations published in the offering 

memorandum, indenture, trustee report or 

similar documents. 

Sufficient information necessary for an 

institution to make a definitive determination 

may not, in every case, be reasonably 

available to the institution as a sophisticated 

investor, and, in such a case, the institution 

may exercise judgment in making its 

determination. Generally, the FDIC may 

review and audit for compliance all 

determinations made by insured depository 

institutions for assessment purposes, 

including a determination that a 

securitization does not meet the 50 percent 

threshold. 

In cases where a securitization is required 

to be consolidated on the balance sheet as a 

result of SFAS 166 and SFAS 167, and a large 

institution or a highly complex institution 

has access to the necessary information, an 

institution may evaluate individual loans in 

the securitization on a loan-by-loan basis. 

Any loan within the securitization that meets 

the definition of a higher-risk asset must be 

reported as a higher-risk asset and any loan 

within the securitization that does not meet 

the definition of a higher-risk asset need not 

be reported as such. When making this 

evaluation, the institution must follow the 

transition guidance described in Appendix C, 

Section C. Once an institution evaluates a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it must 

continue to evaluate all securitizations for 

which it has the required information in a 

similar manner (i.e., on a loan-by-loan basis). 

For securitizations for which the institution 

does not have access to information on a 

loan-by-loan basis, the institution must 

determine whether the securitization meets 

the 50 percent threshold. 

Requirements for PD Estimation 

Estimates of the two-year PD for a loan 

must be based on the observed, stress period 

default rate for loans of a similar product 

type made to consumers with credit risk 

comparable to the borrower being evaluated. 

The credit risk assessment must be 

determined using third party or internal 

scores derived using a scoring system that 

qualifies as empirically derived, 

demonstrably and statistically sound as 

defined in 12 CFR 202.2(p)(2011), and has 

been approved by the bank’s model risk 

oversight and governance process and 

internal audit mechanism. In the case of a 

consumer loan with a co-signer or coborrower, the PD may be determined using 

the most favorable individual credit score. In 

estimating the PD based on such scores, 

institutions must adhere to the following 

requirements: 

(1) The PD must be estimated as the 

average of the two, 24-month default rates 

observed from July 2007 to June 2009, and 

July 2009 to June 2011, where the average is 

calculated according to the following formula 

and DRt is the observed default rate over the 

24-month period beginning in July of year t: 

(2) The default rate for each 24-month 

period must be calculated as the number of 

active loans that experienced at least one 

default event during the period divided by 

the total number of active loans as of the 

observation date (i.e., the beginning of the 

period). A loan is considered active if it was 

open and not in default as of the observation 

date and had a positive balance any time 

within the 12 months prior to the observation 

date. 

(3) The default rate for each 24-month 

period must be calculated using a stratified 

random sample of loans that is sufficient in 

size to derive statistically meaningful results 

for the product type and credit score being 

evaluated. The product strata must be as 

homogenous as possible with respect to the 

factors that influence default, such that 

products with distinct risk characteristics are 

evaluated separately. The loans should be 

sampled based on the credit score as of the 

observation date and, for any single product 

and credit score group, the sample size must 

be no less than 1,200 loans. 

Credit score strata must be determined by 

partitioning the score range into a minimum 

of 15 bands. While the width of the credit 

score bands may vary, the scores within each 

band must reflect a comparable level of credit 

risk. However, since performance data for 

scores at the upper and lower extremes of the 

population distribution is likely to be 

limited, the top and bottom bands may 

include a range of scores that suggest some 

variance in credit quality. 

When the number of score bands is less 

than the number of credit scores represented 

in the population, an observed default rate 

for some scores will not be available. In that 

case, institutions must estimate the default 

rate for a particular score using a linear 


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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18123 

15A teaser-rate mortgage loan is defined as a 

mortgage with a discounted initial rate where the 

lender offers a lower rate and lower payments for 

part of the mortgage term. 

16http://www.fdic.gov/regulations/laws/federal/ 

2006/06noticeFINAL.html. 

17A mortgage loan is no longer considered a 

nontraditional mortgage loan once the teaser rate 

has expired. An interest only loan is no longer 

considered a nontraditional mortgage loan once the 

loan begins to amortize. 

18A securitization is defined in Appendix A, 

Section II(B)(16) of Part 325 of the FDIC’s Rules and 

Regulations, as it may be amended from time to 

time. 

19Loans or securities acquired from another 

entity are acquired on a recurring basis if an 

institution has acquired other loans or securities 

from that entity at least once within the calendar 

year or the previous calendar year of the acquisition 

of the loans or securities in question. 

interpolation between adjacent, observed 

default rates, where the observed default rate 

is assumed to correspond with the score at 

the midpoint of the range for the band. For 

example, if one score band ranges from 621 

to 625 and has an observed default rate of 4 

percent, while the next lowest band ranges 

from 616 to 620 and has an observed default 

rate of 6 percent, a 620 score must be 

assigned a default rate of 5.2 percent, 

calculated as 

When evaluating scores that fall below the 

midpoint of the lowest score band or above 

the midpoint of the highest score band, the 

interpolation must be based on an assumed 

adjacent default rate of 1 or 0, respectively. 

An institution may use internally derived 

default rates that were calculated using fewer 

observations or score bands than those 

specified above under certain conditions. 

The institution must submit a written request 

to the FDIC in advance of or concurrent with 

reporting under that methodology. The 

request must explain in detail how the 

proposed approach differs from the rule 

specifications and the institution must 

provide support for the statistical 

appropriateness of the proposed 

methodology. The request must include, at a 

minimum, a table with the default rates and 

number of observations used in each score 

and product segment. The FDIC will evaluate 

the proposed methodology and may request 

additional information from the institution, 

which the institution must provide. The 

institution may report using its proposed 

approach while the FDIC evaluates the 

methodology. If, after reviewing the request, 

the FDIC determines that the institution’s 

methodology is unacceptable, the institution 

will be required to amend its Call Reports 

and resubmit higher-risk consumer loan 

amounts according to the FDIC’s 

requirements for PD estimation. The 

institution will be required to submit 

corrected information for no more than the 

two most recently dated and filed Call 

Reports preceding the FDIC’s determination 

and for any Call Reports after the 

determination. 

(4) The credit scores represented in the 

historical sample must have been produced 

by the same entity, using the same or 

substantially similar methodology as the 

methodology used to derive the credit scores 

to which the default rates will be applied. 

For example, the default rate for a particular 

vendor score cannot be evaluated based on 

the score-to-default rate relationship for a 

different vendor, even if the range of scores 

under both systems is the same. On the other 

hand, if the current and historical scores 

were produced by the same vendor using 

slightly different versions of the same scoring 

system and equivalent scores represent a 

similar likelihood of default, then the 

historical experience could be applied. 

(5) A loan is considered to be in default 

when it is 90+ days past due, charged-off, or 

the consumer enters bankruptcy during the 

24-month performance window. 

The FDIC has the flexibility, as part of its 

risk-based assessment system, to modify the 

time periods used for PD estimation without 

further notice-and-comment rulemaking. The 

FDIC also has the authority, as part of the 

risk-based assessment system, to increase or 

decrease the PD threshold of 20 percent, for 

identifying higher-risk consumer loans to 

reflect the updated consumer default data 

from the different time periods selected 

without further notice-and-comment 

rulemaking. Before changing the PD 

threshold, the FDIC will analyze resulting 

potential changes in the distribution of 

higher-risk consumer loans and the resulting 

effect on total deposit insurance assessments 

and risk differentiation among institutions. 

The FDIC will provide institutions with at 

least one quarter advance notice with their 

quarterly deposit insurance invoice of any 

changes to the PD estimation time periods or 

the PD threshold. 

4. Nontraditional mortgage loans include 

all residential loan products that allow the 

borrower to defer repayment of principal or 

interest and include all interest-only 

products, teaser rate mortgages, and negative 

amortizing mortgages, with the exception of 

home equity lines of credit (HELOCs) or 

reverse mortgages.15 16 17

For purposes of the higher-risk assets to 

Tier 1 capital and reserves ratio, 

nontraditional mortgage loans include 

securitizations where more than 50 percent 

of the assets backing the securitization meet 

the preceding definition of a nontraditional 

mortgage loan, with the exception of those 

securities classified as trading book.18

Institutions must determine whether 

residential loans and securities meet the 

definition of a nontraditional mortgage loan 

as of origination, or, if the loan has been 

refinanced, as of refinance, as discussed in 

Section A of this Appendix. When an 

institution acquires a residential loan or 

security, it must determine whether the loan 

or security meets the definition of a 

nontraditional mortgage loan using the 

origination criteria and analysis performed 

by the original lender. If this information is 

unavailable, the institution must obtain 

refreshed data from the borrower or other 

appropriate third-party. Refreshed data for 

residential loans and securities is defined as 

the most recent data available. However, the 

data must be as of a date that is no earlier 

than three months before the acquisition of 

the residential loan or security. The acquiring 

institution must also determine whether an 

acquired loan or securitization is higher-risk 

not later than three months after acquisition. 

However, when an institution acquires 

loans or securities from another entity on a 

recurring or programmatic basis, the 

acquiring institution may determine whether 

the loan or security meets the definition of 

a nontraditional mortgage loan using the 

origination criteria and analysis performed 

by the original lender only if the acquiring 

institution verifies the information 

provided.19 Otherwise, the acquiring 

institution must obtain the necessary 

information from the borrower or other 

appropriate third party to make its own 

determination of whether the acquired assets 

should be classified as a nontraditional 

mortgage loan. If the financial information is 

not available as of the origination date or 

refinance, the institution must obtain 

refreshed data from the borrower or other 

appropriate third-party. Refreshed data for 

residential loans or securities acquired on a 

recurring or programmatic basis is defined as 

the most recent data available, and in any 

case, the refreshed data used must be as of 

a date that is no earlier than three months 

before the acquisition of the residential loan 

or security. The acquiring institution must 

also determine whether a loan or 

securitization acquired on a recurring or 

programmatic basis is higher-risk not later 

than three months after the date of 

acquisition. 

An institution is required to use the 

information that is reasonably available to a 

sophisticated investor in reasonably 

determining whether a securitization meets 

the 50 percent threshold. Information 

reasonably available to a sophisticated 

investor includes, but is not limited to, 

offering memorandums, indentures, trustee 

reports, and requests for information from 

servicers, collateral managers, issuers, 

trustees, or similar third parties. When 

determining whether a revolving trust or 

similar securitization meets the threshold, an 

institution may use established criteria, 

model portfolios, or limitations published in 

the offering memorandum, indenture, trustee 

report or similar documents. 

Sufficient information necessary for an 

institution to make a definitive determination 

may not, in every case, be reasonably 

available to the institution as a sophisticated 

investor. In such a case, the institution may 

exercise judgment in making its 

determination. Generally, the FDIC may 

review and audit for compliance all 

determinations made by insured depository 

institutions for assessment purposes, 

including a determination that a 

securitization does not meet the 50 percent 

threshold. 

In cases where a securitization is required 

to be consolidated on the balance sheet as a 

result of SFAS 166 and SFAS 167, and a large 

institution or highly complex institution has 

access to the necessary information, an 

institution may evaluate individual loans in 

the securitization on a loan-by-loan basis. 

Any loan within the securitization that meets 

the definition of a higher-risk asset must be 

reported as a higher-risk asset and any loan 


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20Troubled debt restructuring (TDR) is defined as 

this term is defined in the glossary of the Call 

Report instructions, as it may be amended from 

time to time. 21 76 FR 10672, 10700 (February 25, 2011). 

22 Institutions had to determine whether loans 

and securities originated or purchased prior to 

October 1, 2012, met the definition of a 

construction and land development loan or a 

nontraditional mortgage loan in time to file accurate 

reports of condition as of June 30, 2012, and 

September 30, 2012. 

23 76 FR 10672 (February 25, 2011). 

within the securitization that does not meet 

the definition of a higher-risk asset would not 

be reported as such. When making this 

evaluation, the institution must follow the 

transition guidance described in Appendix C, 

Section C. Once an institution evaluates a 

securitization for higher-risk asset 

designation on a loan-by-loan basis, it must 

continue to evaluate all securitizations for 

which it has the required information in a 

similar manner (i.e., on a loan-by-loan basis). 

For securitizations for which the institution 

does not have access to information on a 

loan-by-loan basis, the institution must 

determine whether the securitization meets 

the 50 percent threshold. 

Definition of Refinance/Timing of 

Classification as a Higher-Risk Asset 

1. ‘‘Refinance’’ Definition for Consumer 

Loans 

For all consumer loans and securities 

(including nontraditional mortgage loans), an 

institution must determine whether the loan 

or security meets the definition of a higherrisk consumer loan or a nontraditional 

mortgage loan and must do so as of 

origination, or, if the loan has been 

refinanced, as of refinance. 

A refinance for this purpose is an 

extension of new credit or additional funds 

on an existing loan or the replacement of an 

existing loan by a new or modified 

obligation. A refinance includes the 

consolidation of multiple existing 

obligations, disbursement of additional funds 

to the borrower, an increase or decrease in 

the interest rate, or rescheduling of principal 

or interest payments to create or increase a 

balloon payment or extend the legal maturity 

date of the loan by more than six months. 

Additional funds include a material 

disbursement of additional funds or, with 

respect to a line of credit, a material increase 

in the amount of the line of credit, but not 

a disbursement, draw, or the writing of 

convenience checks within the original limits 

of the line of credit. Except as noted below 

for credit cards, a material increase in the 

amount of the line of credit is defined as a 

10 percent or greater increase in the quarterend line of credit limit. 

Modifications to a loan that would 

otherwise meet this definition of refinance, 

but result in the classification of a loan as a 

troubled debt restructuring (TDR), do not 

constitute a refinance.20 Any modification 

made to a consumer loan pursuant to a 

government program, for example the Home 

Affordable Modification Program or the 

Home Affordable Refinance Program, is also 

not considered a refinance. 

An extension of the maturity date of a loan 

is not, per se, a refinance. A contractual 

deferral of payments that is consistent with 

the terms of the original loan agreement (for 

example, as allowed in some student loans), 

is not a refinance. For an open-end or 

revolving line of credit, an advance of funds 

consistent with the terms of the loan 

agreement is not a refinance. Deferrals under 

the Servicemembers Civil Relief Act do not 

constitute a refinance. Except as provided 

above, a modification or series of 

modifications to a closed-end consumer loan 

do not constitute a refinance. 

For credit card loans, replacing an existing 

card because the original is expiring, for 

security reasons, or because of a new 

technology or a new system does not 

constitute a refinance. Reissuing a credit card 

that has been temporarily suspended (as 

opposed to closed) is not a refinance. A nontemporary credit card credit line increase 

that is not a result of, or related to, a loss 

mitigation strategy is a refinance. 

2. ‘‘Refinance’’ Definition for Commercial 

Loans 

For all commercial loans and securities, an 

institution must determine whether the loan 

or security meets the definition of a higherrisk C&I loan and security and must do so as 

of origination or, or, if the loan has been 

refinanced, as of refinance. 

A refinance occurs when the original 

obligation has been replaced by a new or 

modified obligation or loan agreement. A 

refinance includes an increase in the master 

commitment of the line of credit (not 

including adjustments to sub-limits under 

the master commitment), disbursement of 

additional money other than amounts already 

committed to the borrower, extension of the 

legal maturity date, rescheduling of principal 

or interest payments to create or increase a 

balloon payment, substantial release of 

collateral, consolidation of multiple existing 

obligations, or an increase or decrease in the 

interest rate. A modification or series of 

modifications to a commercial loan other 

than as described in this paragraph does not 

constitute a refinance. 

Modifications to a commercial loan that 

would otherwise meet this definition of 

refinance, but result in the classification of a 

loan as a TDR, do not constitute a refinance. 

Any modification made to a consumer loan 

pursuant to a government program, for 

example the ‘‘Home Affordable Modification 

Program or the Home Affordable Refinance 

Program, will not be considered a refinance 

for these purposes. 

B. Updating Scorecard 

The FDIC retains the flexibility, as part of 

the risk-based assessment system, without 

the necessity of additional notice-andcomment rulemaking, to update the 

minimum and maximum cutoff values for all 

measures used in the scorecard. The FDIC 

may update the minimum and maximum 

cutoff values for the higher-risk assets to Tier 

1 capital and reserves ratio in order to 

maintain an approximately similar 

distribution of higher-risk assets to Tier 1 

capital and reserves ratio scores as reported 

prior to the implementation of the proposed 

amendments or to avoid changing the overall 

amount of assessment revenue collected.21

The FDIC will review changes in the 

distribution of the higher-risk assets to Tier 

1 capital and reserves ratio scores and the 

resulting effect on total assessments and risk 

differentiation between institutions when 

determining changes to the cutoffs. The FDIC 

may update changes to the higher-risk assets 

to Tier 1 capital and reserves ratio cutoffs 

more frequently than annually. The FDIC 

will provide institutions with a minimum 

one quarter advance notice of changes in the 

cutoff values for the higher-risk assets to Tier 

1 capital and reserves ratio with their 

quarterly deposit insurance invoice. 

C. Application and Transition Guidance 

Sections A through C of this Appendix C 

apply to: 

(1) All construction and land development 

loans, whenever originated or purchased; 

(2) All C&I loans and securities originated 

or purchased on or after October 1, 2012; 

(3) All consumer loans and securities, 

except securitizations of consumer loans and 

securities, whenever originated or purchased; 

(4) All residential real estate loans and 

securities, except securitizations of 

residential real estate loans, whenever 

originated or purchased; and 

(5) All securitizations of C&I loans, 

consumer, or residential loans originated or 

purchased on or after October 1, 2012. 

For consumer and residential real estate 

loans and securities (other than 

securitizations) originated or purchased prior 

to October 1, 2012, an institution must 

determine whether the loan or security meets 

the definition of a higher-risk consumer loan 

and security no later than December 31, 

2012, using information as of the date of the 

origination of the loan or security if the 

institution has that information.22 If the 

institution does not have that information, it 

must use refreshed data to determine 

whether a loan or security meets the 

definition. Refreshed data is defined as the 

most recent data available as if the loan or 

security were being originated in the fourth 

quarter of 2012. In all instances, the refreshed 

data used must be as of July 1, 2012 or later. 

For C&I loans and securities originated or 

purchased before October 1, 2012, and all 

securitizations originated or purchased 

before October 1, 2012, institutions must 

either continue to use their existing internal 

methodology or existing guidance provided 

by their primary federal regulator, or use the 

definitions detailed in the February rule to 

determine whether to include the loan, 

security, or securitization as a concentration 

in a risk area for purposes of the higher-risk 

assets to Tier 1 capital and reserves ratio.23

D. Accounts Receivable and Automobile 

Dealer Floor Plan Lending Guidance 

1. Accounts Receivable 

Loans secured by accounts receivable 

should be made with advance rates at or 

below 75 percent to 85 percent of eligible 

receivables, based on the receivable quality, 

concentration level of account debtors, and 

performance of receivables as related to the 

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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18125 

24Concentration of account debtors is the 

percentage value of receivables associated with one 

or a few customers relative to the total value of 

receivables. Compared to a lender with numerous 

debtors, a lender with few debtors is exposed to a 

greater level of risk if one of these debtors does not 

pay according to its account agreement. 

Consequently, high levels of concentration reflect 

higher risk for a lender and must cause the lender 

to hold higher reserves (advance a lesser 

percentage) all else equal. 

25Turnover of receivables is the velocity at which 

receivables are collected. In general, faster turnover 

increases the advance rate imposed by the lender. 

The dilution rate is the uncollectible accounts 

receivable as a percentage of sales. The historical 

dilution rate will impact advance rates. Higher 

uncollectible accounts will translate into a larger 

reserve account and less funds advanced to the 

company. 

26The growth-adjusted portfolio concentration 

measure is rounded to two decimal points. 

terms of sale.24 An institution’s lending 

policy should address the maintenance of an 

accounts receivable loan agreement with the 

borrower. This loan agreement should 

establish a percentage advance against 

acceptable receivables, include a maximum 

dollar amount due from any one account 

debtor, address the financial strength of 

debtor accounts, and define acceptable 

receivables. The definition of acceptable 

receivables should consider the turnover and 

dilution rates of receivables pledged, the 

aging of accounts receivable, and the 

concentrations of debtor accounts.25

Ineligibles must be established for any 

debtor account where there is concern that 

the debtor may not pay according to terms. 

Examples of ineligibles include: 

• Accounts receivable balances over 90 

days beyond invoice date or 60 days past 

due, depending upon custom with respect to 

a particular industry with appropriate 

adjustments made for dated billings; 

• Entire account balances where over 50 

percent of the account is over 60 days past 

due or 90 days past invoice date; 

• Accounts arising from other than trade 

(e.g., royalties, rebates); 

• Consignment or guaranteed sales; 

• Notes receivable; 

• Progress billings; 

• Account balances in excess of limits 

appropriate to account debtor’s credit 

worthiness or unduly concentrated by 

industry, location or customer; and 

• Affiliate and intercompany accounts. 

2. Inventory 

Loans against inventory should normally 

be made with advance rates no more than 65 

percent of eligible inventory (at the lower of 

cost valued on a FIFO basis or market) based 

on an analysis of realizable value. When an 

appraisal is obtained, up to 85 percent of the 

NOLV of the inventory may be financed. 

Ineligibles must be established for 

inventory that exhibit characteristics that 

make it difficult to achieve a realizable value 

or to obtain possession of the inventory. The 

following are examples of when inventory is 

considered ineligible as collateral: 

• Slow moving, obsolete inventory and 

items turning materially slower than industry 

average; 

• Inventory with value to the client only, 

which is generally work in process; however, 

it may include raw materials used solely in 

the client’s manufacturing process; 

• Consigned inventory or other inventory 

where a perfected lien cannot be obtained; 

• Off-premise inventory subject to a 

mechanic’s or other lien; and 

• Specialized, high technology or other 

inventory subject to rapid obsolescence or 

valuation problems. 

3. Minimum Account Management and 

Monitoring Standards for Asset Based and 

Floor Plan Lenders 

Accounts receivable and floor plan lending 

require a rigorous level of account 

management compared to other forms of 

lending. A hands-on approach to collateral 

evaluation and intense financial and client 

monitoring must be used in order to properly 

manage these relationships. Clients must 

submit periodic detailed reports that are 

routinely analyzed. A staff of specially 

trained field auditors should visit clients on 

a regular basis to inspect the collateral and 

verify the accuracy of the reporting. 

Examples of detailed reports that must be 

routinely provided to the asset-based lender 

include: 

Borrowing Base Certificates: A form 

prepared by the borrower that reflects the 

current status of the collateral. Certificates, 

along with supporting information, must be 

provided on a daily, weekly or monthly 

basis, depending on the terms of the loan 

agreement, the financial strength of the 

borrower and the amount of availability 

under the revolver. Once received by the 

lender, this certificate, along with the 

supporting information, must be reconciled 

with internal collateral management systems 

to ensure the accuracy of the collateral base, 

with any discrepancies reconciled with the 

borrower. Key information contained in the 

certificate must include: 

• The accounts receivable balance (rolled 

forward from the previous certificate); 

• Sales (reported as gross billings) with 

detailed adjustments for returns and 

allowances to allow for proper tracking of 

dilution and other reductions in collateral; 

• Detailed inventory information (e.g., raw 

materials, work-in-process, finished goods); 

and 

• Detail of loan activity. 

Accounts Receivable and Inventory Detail: 

Monthly accounts receivable and inventory 

agings must be received in sufficient detail to 

allow the lender to compute the required 

ineligibles. 

Accounts Payable Detail: Monthly 

accounts payable agings must be received to 

monitor payable performance and anticipated 

working capital needs. 

Covenant Compliance Certificates: 

Borrowers should submit Covenant 

Compliance Certificates, generally on a 

monthly or quarterly basis (depending on the 

terms of the loan agreement) to monitor 

compliance with the covenants outlined in 

the loan agreement. Non-compliance with 

any covenants should be promptly addressed 

to cure any defaults, with actions taken (e.g., 

waiver, amendment, default pricing, blocking 

advance privileges) dependent on the nature 

of each situation. 

Definition of Terms Used in the Accounts 

Receivable and Automobile Dealer Floor 

Plan Lending Guidance 

Blocked Account: An account that is 

controlled by an agreement that stipulates 

that all cash transferred out of the account 

must go to the lender. Blocked accounts are 

controlled by the lender. The borrower can 

make deposits into the blocked account, but 

maintains no signature authority on the 

account. Funds flowing into the blocked 

account originate from (i) direct deposit 

checks; (ii) lock box deposits; or (iii) wire 

transfers from other institutions. In the direct 

deposit or bulk method, the client receives 

checks from its customers, batches them, and 

deposits them in kind to the blocked account. 

Lock Box: An agreement whereby the 

borrower’s account debtors mail their 

payment checks to a specified Post Office box 

controlled by the lender. The lender opens 

the mail, processes the checks for collection, 

and forwards a copy or other record of the 

checks to the borrower. Lock box proceeds 

are deposited into the borrower’s blocked 

account. 

E. Growth-Adjusted Portfolio Concentration 

Measure 

The growth-adjusted concentration 

measure is the sum of the values of 

concentrations in each of the seven 

portfolios, each of the values being first 

adjusted for risk weights and growth. The 

product of the risk weight and the 

concentration ratio is first squared and then 

multiplied by the growth factor. The measure 

is calculated as: 

Where: N is institution i’s growth-adjusted portfolio 

concentration measure; 26

k is a portfolio; 


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18126 Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 

27All loan concentrations should include the fair 

value of purchased credit impaired loans. 28Each loan concentration category should 

exclude the amount of loans recoverable from the 

U.S. government, its agencies, or governmentsponsored agencies, under guarantee or insurance 

provisions. 

29The growth factor is rounded to two decimal 

points. 

30The risk weights are based on loss rates for 

each portfolio relative to the loss rate for C&I loans, 

which is given a risk weight of 1. The peak loss 

rates were derived as follows. The loss rate for each 

loan category for each bank with over $5 billion in 

total assets was calculated for each of the last 

twenty calendar years (1990–2009). The highest 

value of the 90th percentile of each loan category 

over the twenty year period was selected as the 

peak loss rate. 

31All figures would exclude the maximum 

amounts recoverable from the U.S. government, its 

agencies, or government-sponsored agencies under 

guarantee or insurance provisions, as well as loans 

that are fully secured by cash collateral. In order to 

exclude a loan based on cash collateral, the cash 

would have to be in the form of a savings or time 

deposit held by the insured depository institution. 

The insured depository institution would also have 

to have a signed collateral assignment of the deposit 

account, which was irrevocable for the remaining 

term of the loan or commitment, and the insured 

depository institution would have to have placed a 

hold on the deposit account, which alerts the 

institution if there are attempts to withdraw or 

transfer the deposit funds. In the case of a revolving 

line of credit, the cash collateral would have to be 

equal to or greater than the amount of the total loan 

commitment (funded and unfunded balance of the 

loan) for the exclusion to apply. 

32An internal approach would include the use of 

an institution’s own default experience with a 

particular product and credit score, whether that 

score was provided by a third party or was 

internally derived. 

g is a growth factor for institution i’s portfolio 

k; and, 

w is a risk weight for portfolio k. 

The seven portfolios (k) are defined based 

on the Call Report/TFR data and they are: 

• Construction and land development 

loans; 

• Other commercial real estate loans; 

• First-lien residential mortgages and nonagency residential mortgage-backed securities 

(excludes CMOs, REMICS, CMO and REMIC 

residuals, and stripped MBS issued by nonU.S. Government issuers for which the 

collateral consists of MBS issued or 

guaranteed by U.S. government agencies); 

• Closed-end junior liens and home equity 

lines of credit (HELOCs); 

• Commercial and industrial loans; 

• Credit card loans; and 

• Other consumer loans.27 28

The growth factor, g, is based on a threeyear merger-adjusted growth rate for a given 

portfolio; g ranges from 1 to 1.2 where a 20 

percent growth rate equals a factor of 1 and 

an 80 percent growth rate equals a factor of 

1.2.29 For growth rates less than 20 percent, 

g is 1; for growth rates greater than 80 

percent, g is 1.2. For growth rates between 20 

percent and 80 percent, the growth factor is 

calculated as: 

Where: 

V is the portfolio amount as reported on the 

Call Report/TFR and it is the quarter for 

which the assessment is being determined. 

The risk weight for each portfolio reflects 

relative peak loss rates for banks at the 90th 

percentile during the 1990–2009 period.30

These loss rates were converted into 

equivalent risk weights as shown in Table 

C.1. 

TABLE C.1—90TH PERCENTILE ANNUAL LOSS RATES FOR 1990–2009 PERIOD AND CORRESPONDING RISK WEIGHTS

Portfolio 

Loss rates 

(90th 

percentile) 

Risk weights 

First-Lien Mortgages ................................................................................................................................................ 2.3% 0.5 

Second/Junior Lien Mortgages ................................................................................................................................ 4.6% 0.9 

Commercial and Industrial (C&I) Loans .................................................................................................................. 5.0% 1.0 

Construction and Development (C&D) Loans ......................................................................................................... 15.0% 3.0 

Commercial Real Estate Loans, excluding C&D ..................................................................................................... 4.3% 0.9 

Credit Card Loans ................................................................................................................................................... 11.8% 2.4 

Other Consumer Loans ........................................................................................................................................... 5.9% 1.2 

Note: The following appendix will not 

appear in the Code of Federal Regulations. 

Appendix 1—Two-Year Probability of 

Default Information for Consumer 

Loans 

The FDIC intends to collect two-year PD 

information on various types of consumer 

loans from large and highly complex 

institutions. However, the types of 

information collected and the format of the 

information collected will be subject to a 

Paperwork Reduction Act notice (with an 

opportunity for comment) published in the 

Federal Register. The following table is an 

example of how the FDIC may collect the 

consumer loan information and the kind of 

information that may be collected. Once the 

definition of higher-risk consumer loans is 

adopted in a final rule, appropriate changes 

to the Call Reports will be made and 

institutions will be expected to begin 

reporting consumer loans according to the 

definition in the final rule. In addition, as 

suggested in the example table, institutions 

would report the outstanding amount of all 

consumer loans, including those with a PD 

below the subprime threshold, stratified by 

the 10 product types and 12 two-year PD 

bands.31 In addition, for each product type, 

institutions would indicate whether the PDs 

were derived using scores and default rate 

mappings provided by a third party vendor 

or an internal approach.32 If an internal 

approach was used, the institution will also 

have to indicate whether or not the internal 

approach meets the minimum number of PD 

bands and observations required as described 

in the Requirements for PD Estimation in 

Appendix C, Section A. Institutions would 

report as a separate item the value of all 

securitizations of consumer loans that are 

more than 50 percent collateralized by 

consumer loans that would be identified as 

higher-risk assets (except those classified as 

trading book). 


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Federal Register / Vol. 77, No. 59 / Tuesday, March 27, 2012 / Proposed Rules 18127 

By order of the Board of Directors. 

Dated at Washington, DC, this 20th day of 

March 2012. 

Federal Deposit Insurance Corporation. 

Robert E. Feldman, 

Executive Secretary. 

[FR Doc. 2012–7268 Filed 3–26–12; 8:45 am] 

BILLING CODE 6714–01–P 

FEDERAL DEPOSIT INSURANCE 

CORPORATION 

12 CFR Part 380 

RIN 3064–AD94 

Enforcement of Subsidiary and 

Affiliate Contracts by the FDIC as 

Receiver of a Covered Financial 

Company 

AGENCY: Federal Deposit Insurance 

Corporation (FDIC). 

ACTION: Notice of proposed rulemaking. 

SUMMARY: The FDIC is proposing a rule 

(‘‘Proposed Rule’’), with request for 

comments, that implements section 

210(c)(16) of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act 

(the ‘‘Dodd-Frank Act’’ or the ‘‘Act’’), 

codified at 12 U.S.C. section 

5390(c)(16), which permits the 

Corporation, as receiver for a financial 

company whose failure would pose a 

significant risk to the financial stability 

of the United States (a ‘‘covered 

financial company’’), to enforce 

contracts of subsidiaries or affiliates of 

the covered financial company despite 

contract clauses that purport to 

terminate, accelerate, or provide for 

other remedies based on the insolvency, 

financial condition or receivership of 

the covered financial company. As a 

condition to maintaining these 

subsidiary contracts in full force and 

effect, the Corporation as receiver must 

either: transfer any supporting 

obligations of the covered financial 

company that back the obligations of the 

subsidiary or affiliate under the contract 

(along with all assets and liabilities that 


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