65146 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

due to changes in economic conditions

during the life of the receivership.

Finally, the proposed rule provides

that post-insolvency interest

distributions would be calculated using

a simple interest method, rather than a

compound interest method. The simple

interest method is proposed because it

appears to provide a reasonable amount

of interest to compensate receivership

creditors for the time value of money

owed from the time the receivership is

established until dividend payments are

received.

III. Request for Public Comment

The FDIC hereby solicits comments

on all aspects of the proposed rule, and

specifically whether post-insolvency

interest should be paid according to the

order of priority described in the

national depositor preference statute or

alternatively pro rata to all creditors

regardless of priority.

IV. Paperwork Reduction Act

The proposed rule will not involve

any collection of information under the

Paperwork Reduction Act (44 U.S.C.

3501 et seq.). Consequently, no

information has been submitted to the

Office of Management and Budget for

review.

V. Regulatory Flexibility Act

Pursuant to section 605(b) of the

Regulatory Flexibility Act (5 U.S.C. 601

et seq.) the FDIC certifies that the

proposed rule will not have a significant

economic impact on a substantial

number of small entities. The proposed

rule will only apply to FDICadministered receiverships established

after the effective date of the rule, and

it does not impose new reporting,

recordkeeping or other compliance

requirements on receivership creditors.

The proposed rule continues the FDIC’s

existing practice of making postinsolvency interest distributions to

creditors holding proven claims in

surplus receiverships prior to making

distributions to equityholders, based on

their equity interests, in a failed insured

depository institution. In addition, the

proposed rule will provide interested

parties, including small entities, with

greater certainty in future FDICadministered receiverships by

establishing a single uniform interest

rate and method for making postinsolvency interest distributions.

Accordingly, the Act’s requirements

relating to an initial regulatory

flexibility analysis are not applicable.

VI. 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 (Public Law 105–277, 112 Stat.

2681).

List of Subjects in 12 CFR Part 360

Banks, banking, Savings associations.

For the reasons set forth in the

preamble, the FDIC Board of Directors

proposes to amend 12 CFR part 360 as

follows:

PART 360—RESOLUTION AND

RECEIVERSHIP RULES

1. The authority for part 360 is revised

to read as follows:

Authority: 12 U.S.C. 1821(d)(1),

1821(d)(10)(C), 1821(d)(11), 1821(e)(1),

1821(e)(8)(D)(i), 1823(c)(4), 1823(e)(2); Sec.

401(h), Pub. L .101–73, 103 Stat. 357.

2. Section 360.7 is added to part 360

to read as follows:

§ 360.7 Post-insolvency interest.

(a) Purpose and scope. This section

establishes rules governing the

calculation and distribution of postinsolvency interest to creditors with

proven claims in all FDIC-administered

receiverships established after [effective

date of final rule].

(b) Definitions—(1) Equityholder. The

owner of an equity interest in a failed

depository institution, whether such

ownership is represented by stock,

membership in a mutual association, or

otherwise.

(2) Post-insolvency interest. Interest

calculated from the date the

receivership is established on proven

creditor claims in receiverships with

surplus funds.

(3) Post-insolvency interest rate. For

any calendar quarter, the coupon

equivalent yield of the average discount

rate set on the three-month Treasury bill

at the last auction held by the United

States Treasury Department during the

preceding calendar quarter, and

adjusted each quarter thereafter.

(4) Principal amount. The proven

claim amount and any interest accrued

thereon as of the date the receivership

is established.

(5) Proven claim. A claim that is

allowed by a receiver or upon which a

final non-appealable judgment has been

entered in favor of a claimant against a

receivership by a court with jurisdiction

to adjudicate the claim.

(c) Post-insolvency interest

distributions. (1) Post-insolvency

interest shall only be distributed

following satisfaction by the receiver of

the principal amount of all creditor

claims.

(2) The receiver shall distribute postinsolvency interest at the postinsolvency interest rate prior to making

any distribution to equityholders. Postinsolvency interest distributions shall

be made in the order of priority set forth

in section 11(d)(11)(A) of the Federal

Deposit Insurance Act, 12 U.S.C.

1821(d)(11)(A).

(3) Post-insolvency interest

distributions shall be made at such time

as the receiver determines that such

distributions are appropriate and only to

the extent of funds available in the

receivership estate. Post-insolvency

interest shall be distributed on the

outstanding balance of a proven claim,

as reduced from time to time by any

interim dividend distributions, from the

date the receivership is established until

such time as the principal amount of a

proven claim has been distributed but

not thereafter.

(4) Post-insolvency interest shall be

determined using a simple interest

method of calculation.

By order of the Board of Directors.

Dated at Washington, DC this 10th day of

December, 2001.

Federal Deposit Insurance Corporation.

Robert E. Feldman,

Executive Secretary.

[FR Doc. 01–31162 Filed 12–17–01; 8:45 am]

BILLING CODE 6714–01–P

DEPARTMENT OF HOUSING AND

URBAN DEVELOPMENT

Office of Federal Housing Enterprise

Oversight

12 CFR Part 1750

RIN 2550–AA23

Risk-Based Capital

AGENCY: Office of Federal Housing

Enterprise Oversight, HUD.

ACTION: Proposed regulation.

SUMMARY: The Office of Federal Housing

Enterprise Oversight (OFHEO) is

proposing to amend Appendix A to

Subpart B of 12 CFR Part 1750 RiskBased Capital. The effect of these

amendments would be to modify

provisions relating to counterparty

haircuts, multifamily loans, and

refunding and to make several technical

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65147

1Risk-based Capital, 66 FR 47730 (September 13,

2001).

2For purposes of this proposal, Moody’s Investors

Service provided information on ‘‘Letter

Cumulative Default Rates (from 01/01/29 to 01/01/

31)’’ on October 16, 2001. Data may be obtained

from Moody’s Investors Service by contacting Mr.

Steve Liebling at Liebling@Moody’s.com.

3W. Braddock Hickman, ‘‘Corporate Bond

Quality and Investor Experience,’’ 190 National

Bureau of Economic Research (1958).

adjustments and corrections. These

amendments are intended to refine the

stress test model to tie capital more

closely to risk.

DATES: Written comments must be

received by January 17, 2002.

ADDRESSES: Send written comments

concerning the proposal to Alfred

Pollard, General Counsel, Office of

Federal Housing Enterprise Oversight,

Fourth Floor, 1700 G Street, NW.,

Washington, DC 20552. Written

comments may also be sent to Mr.

Pollard by electronic mail at

RegComments@ofheo.gov. OFHEO

requests that written comments

submitted in hard copy also be

accompanied by the electronic version

in MS Word or in portable document

format (PDF) on 3.5′′ disk.

FOR FURTHER INFORMATION CONTACT:

Edward J. Szymanoski, Acting Associate

Director, Office of Risk Analysis and

Model Development, telephone (202)

414–3763 (not a toll-free number), or

David Felt, Associate General Counsel,

telephone (202) 414–3750 (not a toll-free

number), Office of Federal Housing

Enterprise Oversight, Fourth Floor, 1700

G Street, NW., Washington, DC 20552.

The telephone number for the

Telecommunications Device for the Deaf

is (800) 877–8339.

SUPPLEMENTARY INFORMATION:

Comments

The Office of Federal Housing

Enterprise Oversight (OFHEO) invites

comments on the proposed regulation

and will take all comments into

consideration before issuing the final

regulation. Copies of all comments will

be posted on the OFHEO internet web

site at http://www.ofheo.gov. In

addition, copies of all comments

received will be available for

examination by the public at the Office

of Federal Housing Enterprise

Oversight, Fourth Floor, 1700 G Street,

NW., Washington, DC 20552.

Background

On September 13, 2001, OFHEO

published a final regulation setting forth

a risk-based capital stress test, (Rule) 1

that is the basis for determining the riskbased capital requirement for the

Federally sponsored housing

enterprises—Federal National Mortgage

Association (Fannie Mae) and Federal

Home Loan Mortgage Corporation

(Freddie Mac) (collectively, the

Enterprises). The risk-based capital

stress test set forth in the Rule simulates

the performance of each Enterprise’s

assets, liabilities, and off-balance-sheet

obligations under severe credit and

interest rate stress for a period of ten

years (stress period). The stress test

projects rates of default and prepayment

for the mortgages guaranteed by the

Enterprises, as well as cash flows from

these and other assets, liabilities, and

off-balance-sheet obligations. Using

these cash flows, the stress test

produces monthly balance sheets for the

120 months of the stress period in order

to determine the amount of starting

capital that would be necessary to

maintain positive capital during the tenyear stress period. Thirty percent of the

amount of capital so determined is then

added to that amount to protect against

management and operations risk.

OFHEO continuously seeks to

improve its measurements and formulas

to tie capital more closely to risk and

works to ensure that the Rule supports

the safety and soundness regime created

by Congress. In the preamble to the

Rule, OFHEO expressed its intention to

review, on an ongoing basis, the

operation of the stress test and its

various components and to evaluate the

need for revisions and improvements.

Also, OFHEO committed to act

expeditiously to remedy any technical

and operational issues that arise during

the one-year implementation period

following promulgation. OFHEO is now

proposing to make refinements and

technical adjustments and corrections to

the Rule to tie capital more closely to

risk. Technical changes are included in

this proposal rather than issued as a

final regulation to provide a

comprehensive package of changes.

A. Proposed Changes to Counterparty

Haircuts

The Rule gives the Enterprises credit

for cash payments that would be

received during the stress period from

securities and various counterparties,

such as mortgage insurance companies

and derivative counterparties. However,

because Enterprise counterparties are

themselves likely to be adversely

affected by the economic conditions of

the stress period and to default on some

or all of their obligations, the stress test

discounts the value of cash payments

received during the stress period by a

specified percentage, based on the

public credit rating of the security or

counterparty. The amount by which

cash payments from a counterparty or

security are discounted in each month

of the stress period is the haircut. The

specified haircut percentages increase as

the credit rating declines—the lower

that rating, the more severe the haircut.

In the Rule, the haircuts are phased in

over the first five years of the stress

period, except for haircuts for belowinvestment-grade providers and

instruments, which are applied fully in

the first month of the stress period.

The Rule applies one set of haircuts

for non-derivative counterparties and

securities, based on analysis of

historical bond default rates, and a

different set of haircuts for derivative

counterparties, reflecting lower

expected loss severities associated with

the use of strong collateral agreements.

To further refine the Rule’s treatment of

haircuts, OFHEO proposes to improve

consistency between haircuts for

derivative counterparties and securities

and non-derivative counterparties and

securities by specifying default and

severity rates separately; to extend the

phase-in period from five to ten years;

to provide for netting of exposures to

the same derivative counterparty; and to

provide for an exception to the BBB

haircut for certain unrated seller/

servicers as described in the proposed

rule.

Default Rates. OFHEO proposes to use

the Rule’s haircut rates for nonderivative counterparties and securities

as the cumulative default rates for all

counterparties and securities, but to

lower slightly the default rate for AArated firms. After re-evaluating the

historical data on differences in

performance of AA-rated and AAArated firms, including data that recently

has become available to OFHEO, the

Rule’s default ratio of three to one

(based largely on the average exposure

over the past 80 years) appears to be

more than is warranted for a period of

economic stress. Data were recently

made available to OFHEO by Moody’s

Investors Service 2 for the worst annual

cohorts of U.S. investment-grade issuers

since 1920, the cohorts formed at the

beginning of 1929, 1930, and 1931. The

average 10-year default rate for AA-rated

issuers (12.25 percent) was 2.6 times as

large as the average default rate for

AAA-rated issuers (4.72 percent), and

the ratio for the worst of those years was

only 2.2. Furthermore, a study of

corporate bond quality by W. Braddock

Hickman shows 12-year default rates for

the cohort formed at the beginning of

1928 for AA-rated issuers (12.3 percent)

to be 1.5 times as large as that for AAArated issuers (8.1 percent).3 More recent

data, in relatively favorable economic

65148 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

4 ‘‘Default Recovery Rates of Corporate Bond

Issues: 2000,’’ 26 Moody’s Investor’s Service

(February 2001).

5 ‘‘Ratings Performance 1997: Stability of

Transition,’’ 3 Standard and Poor’s (August 1998).

6Hickman, at 460.

7Hickman, at 119.

8 ‘‘Historical Default Rates of Corporate Bond

Issuers, 1920–1996,’’ 12 Moody’s Investor Service

(January 1997).

9 Moody’s (2001), at 24–25.

10These percentages correspond to absolute

changes of 61 and 41 basis points, on average,

during the period, but would be less than half as

much at recent yield levels.

11Loss severities of counterparty defaults are

typically expressed as percentages of derivative

market value at the time of default. However, the

stress test model reflects such losses as reductions

in net derivative cash flows. For example, in the uprate stress scenario, after a 75 percent increase in

interest rates, a swap with a market value of zero

at the start of the stress test (i.e., a fixed-pay rate

equal to the then-market rate) will have a

significantly increased market value during the

stress period. Since short- and long-term rates are

the same in the last nine years of the stress period

in the up-rate scenario, net derivative cash flows

roughly equal the scenario-based change in longterm interest rates multiplied by the notional value,

and the market value of the swap is the discounted

present value of these cash flows. A ten percent

reduction in those cash flows thus reflects the

impact on market value of a 7.5 percent change in

interest rates.

circumstances, also show greater

similarity in the performance of issuers

in these two rating categories. However,

a partially offsetting factor is that

Moody’s data for both depression

cohorts and averages of all cohorts show

that defaults of AAA-rated issuers that

occur within 10 years after the cohort is

formed occur later in the 10-year period

than those of AA-rated issuers.

The relationship between AA and

AAA defaults is particularly relevant

because most Enterprise counterparty

and security exposures are either AAAor AA-rated. An excessive differential

between these ratings in the stress test

could create inappropriate business

incentives for the Enterprises. After

weighing the above considerations,

OFHEO proposes to lower the

cumulative default rate for AA-rated

counterparties and securities to 12.5

percent (from 15 percent), which will be

2.5 times the rate for AAA-rated

counterparties and securities.

Severity Rates. To further refine risk

measurement in the stress test, OFHEO

proposes to take explicit account of

potential recoveries in the event of

default by introducing a loss severity

factor. Before issuing the Rule, OFHEO

received mixed comments regarding

incorporation of recovery projections for

non-derivative security and

counterparty obligations after default.

Such recoveries were not part of the

proposed rule, however, and OFHEO

decided not to include them at that

time, pending further consideration.

Historically, corporate bond recoveries

have averaged about 40 percent (i.e., a

60 percent loss severity rate) over long

periods of time. A study of default and

recovery rates by Moody’s shows an

average recovery rate of 39 percent over

the past 20 years.4 A study of defaulted

bond recoveries by Standard and Poor’s

shows an average recovery rate of 44

percent from 1981 to 1997.5 The

Hickman study shows an average

recovery rate of 43 percent for large

issues from 1900 to 1943.6 Recoveries

on Enterprise holdings of mortgage and

other asset-backed securities and on

mortgage insurance claims would likely

be substantial also, benefiting from asset

values in the former case and premium

income in the latter.

Data on recoveries in unusually

stressful times are less favorable.

Hickman reported an average recovery

rate of 34 percent for large issues for

defaults in 1930 to 1943.7 Moody’s has

reported average recovery rate estimates

that are substantially lower during

recessions, and fall as low as 20 percent

during the 1930s.8 For 1930 to 1943,

Moody’s average was 36 percent,

despite higher rates during the latter

years of that period. A somewhat lower

projection for the stress period used in

the rule is, therefore, appropriate.

All of the recovery studies show some

differences in recovery rates depending

on the presence or absence of secured or

subordinated status. However, such

status is a factor used in determining

ratings. Moody’s expressly states that

securities with different status may have

similar probabilities of default, but be

rated differently in recognition of the

effect of security or subordination on

likely recoveries.9 Thus, a secured

instrument may have a somewhat higher

probability of default than average for

its rating, but also have a somewhat

higher expectation of recovery.

Accordingly, OFHEO proposes to

specify a recovery rate of 30 percent (70

percent loss severity rate) for all nonderivative counterparties and securities

with investment-grade ratings.

OFHEO also proposes to maintain,

with alteration, special treatment for

derivative counterparty exposures.

Current exposures are marked to market

at least weekly, and high quality

collateral is posted against any

significant exposures by counterparties

with less than a AAA rating. The

Enterprises retain the right to require

substantial over-collateralization or to

transfer the contract to a new

counterparty if a counterparty’s rating is

lowered to low investment-grade levels

or worse. Thus, the principal risk is that

a relatively highly rated counterparty

may fail suddenly and that exposures

rise between the time a contract was last

collateralized and the time the

Enterprise takes action to transfer or

replace the contract. This period may be

as much as ten business days.

The credit exposures on fixed-floating

interest rate swaps and swaptions (the

vast majority of Enterprise derivative

contracts) are closely tied to changes in

market yields of securities with

maturities equal to those of the swap or

swaptions. When interest rates rise, an

Enterprise’s exposure rises on swaps for

which it receives the floating-rate side

of the swap. When interest rates fall, an

Enterprises’s exposure rises on swaps

for which it receives the fixed-rate side.

To develop loss severity rates for

defaulted derivative contracts, OFHEO

examined changes in Treasury security

interest rates over periods of ten

business days during the past 25 years.

For five-year Treasury securities,

increases in yields of more than 7.5

percent and decreases of more than 5.0

percent, respectively, have occurred

infrequently-roughly 1 percent and 4

percent, respectively, of the time.10

Thus, severity rates that reflect losses

associated with yield changes of these

magnitudes should be reasonably

conservative.

For application in the stress test’s

cash flow model, OFHEO must translate

such changes into impacts on net

derivative cash flows. During the stress

period, net derivative cash flows are

related to changes in the ten-year

Treasury yield-75 percent in the up-rate

scenario and 50 percent in the downrate scenario. For example, in the uprate scenario, with its flat yield curve,

the pay side of a ten-year pay-fixed/

receive-floating swap implemented just

before the start of the stress test would

remain at its original rate and the

receive side would rise to 175 percent

of the original pay-side rate. Thus, the

swap would have net annual cash flows

for the last nine years of the stress test

roughly equal to 75 percent of the initial

fixed rate used in the swap multiplied

by the notional value. This is ten times

the 7.5 percent market yield change that

may be associated with losses on a

derivative counterparty default in the

up-rate scenario. Accordingly, OFHEO

proposes to set severity rates for

derivative exposures at ten percent.11

OFHEO recognizes that losses could

be greater than ten percent if interest

rates move exceptionally after a sudden

default, or if an Enterprise failed to

replace a contract with a defaulting

counterparty and market yields

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65149

12NPR2 refers to the Second Notice of Proposed

Rulemaking issued by OFHEO before the Rule. 64

FR 18084, 18159 (April 13, 1999).

continued to move unfavorably.

However, OFHEO also recognizes that

yield changes near the time of a default

could easily be less unfavorable than the

7.5 percent increase or 5 percent

decrease contemplated, and some

recoveries beyond the collateral already

held might be available. Thus, OFHEO

judges that a ten percent severity rate for

derivatives is adequate.

Haircuts. Under the proposal, haircuts

would be determined by multiplying the

default rate for each rating category by

the severity rate. The resulting haircuts

that are proposed are set forth in Table

1 below.

TABLE 1—STRESS TEST HAIRCUT BY RATINGS CLASSIFICATION

Ratings Classification

Derivative

Contract

Counterparties

Non-Derivative

Contract

Counterparties

or Instruments

Cash 0% 0%

AAA 0.5% 3.5%

AA 1.25% 8.75%

A 2% 14%

BBB 4% 28%

Below BBB and Unrated 100% 100%

Phase-In. Under the Rule, haircuts for

investment-grade counterparties and

securities are phased-in over the first

five years of the stress period, so that

haircuts are close to zero in the first

month of the stress period and rise to

their maximums in the 60th month,

where they remain for the last five

years. In effect, all defaults occur within

the first five years, and later haircuts to

cash flows simply reflect the

consequences of previous defaults, as

defaulted counterparties are unable to

meet their obligations. This conservative

approach takes into account that the

interest rate shocks and house price

shocks all occur in the first half of the

stress period. Long-term average

historical data show more evenly

distributed defaults over time, but

available data for especially stressful

periods (e.g., the 1910s and 1930s) give

little indication of timing. The recently

obtained unpublished data from

Moody’s shows that for the worst cohort

(starting in the beginning of 1930), only

57 percent of ten-year investment-grade

defaults occurred during the first five

years. While the principal shocks may

occur somewhat earlier in the stress

period than they did for issuers in the

1930s, a closer approximation of the

historical patterns may better reflect the

ability of most highly rated firms to

survive severe stresses for many years.

Some of those that ultimately fail during

the stress period may reasonably be

expected to fail during its final years.

Accordingly, OFHEO proposes to

extend the phase-in period from five

years to ten years for investment-grade

counterparties and securities. Thus, for

credit exposures to firms and securities

rated BBB and higher, defaults will

occur evenly throughout the stress

period.

Netting of derivative counterparty

exposures. The Enterprises regularly

enter into derivatives contracts,

typically swaps, for debt and portfolio

risk management purposes. These

contracts expose the Enterprises to the

risk of failure by a derivative

counterparty to perform its obligations

as anticipated by the terms of the

contract. The Enterprises, consistent

with accepted risk management and

market practice, attempt to mitigate

their derivative counterparty credit

exposure through a number of methods,

including the use of master netting

agreements. Master netting agreements

are used by the Enterprises when they

engage in multiple swap transactions

with the same counterparty. A master

netting agreement permits an Enterprise

to determine its aggregate total credit

exposure to a particular counterparty by

netting the gains and losses across all of

the contracts with that counterparty.

This approach allows the Enterprises to

net their exposures at the counterparty

level, rather than netting at the

individual contract level.

In NPR2, OFHEO proposed a

methodology to recognize this practice

by modeling the terms of master netting

agreements and then applying specified

haircuts to the resulting net amount

due, if any, from each derivatives

counterparty.12 No comments were

received on the proposal, and the Rule,

reflecting OFHEO’s intent to model

master netting agreements, did not

specify a change from NPR2. However,

due to a technical omission, OFHEO’s

intent to model master netting

agreements was not operationalized in

the Rule. Recognition of master netting

agreements would result in a more

accurate measurement of the

Enterprises’ exposure to derivative

counterparties. Further, recognition of

master netting agreements is consistent

with OFHEO’s intent to model

Enterprise contracts according to their

respective terms, and such recognition

allows OFHEO to tie capital to risk with

greater precision. The proposal would

amend the Rule to model master netting

agreements explicitly, as originally

contemplated in NPR2.

OFHEO notes that this technical

correction will require an

implementation period to allow for

development and completion of the

software changes that will allow OFHEO

to model master netting agreements.

Therefore, during the implementation of

the technical correction, OFHEO will

recognize the risk mitigation effects of

such agreements by reducing the

haircuts for derivatives contracts. Upon

implementation of the technical

correction, maximum haircuts for

derivative contract counterparties will

be readjusted and netting by

counterparty will be implemented in the

software. The interim treatment will

remain effective only for the period

65150 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

13The terms ‘‘benchmark region and period’’ refer

to the regional credit loss experience identified by

OFHEO in compliance with the ‘‘Credit Loss’’

parameters outlined in Title XIII of the Housing and

Community Development Act of 1992, Pub. L. No.

102–550, known as the Federal Housing Enterprises

Financial Safety and Soundness Act of 1992 (1992

Act), as described in additional detail in NPR2.

14 In the Rule’s single-family default and

prepayment models, the level of borrower equity in

the property (property value less mortgage debt) is

analogous to multifamily DCR in that both measures

capture economic stress. The circumstance of a

single-family mortgage borrower having negative

equity is similar to that of a multifamily loan having

required to complete the technical

software modifications necessary to

model master netting agreements. The

interim and final haircuts for derivative

contract counterparties are as shown in

the Table 2 below:

TABLE 2—STRESS TEST HAIRCUTS FOR DERIVATIVE CONTRACT COUNTERPARTIES

Ratings Classification

Haircuts for

Derivative

Counterparties

prior to Implementation of

Netting

Haircuts for

Derivative

Counterparties

upon Implementation of

Netting

Number of

Phase-in

Months

Cash 0% 0% N/A

AAA 0.3% 0.5% 120

AA 0.75% 1.25% 120

A 1.2% 2.0% 120

BBB 2.4% 4.0% 120

Below BBB and Unrated 100% 100%1

Unrated Seller/servicers. The Rule

treats unrated seller/servicers as BBBrated counterparties. OFHEO recognizes

that certain unrated seller-servicers to

whom underwriting and servicing

authority has been delegated enter into

loss-sharing agreements with the

Enterprises and collateralize these losssharing obligations with fully funded

reserve accounts pledged to the

Enterprise. OFHEO is proposing to

amend the Rule to permit a higher rating

than BBB for these seller-servicers if the

fully funded reserve account is equal to

or greater than an amount determined

by OFHEO to be adequate to support the

risk borne by the seller-servicer under

the loss sharing agreement. For

example, if the loss-sharing obligation of

a seller-servicer participating in Fannie

Mae’s Delegated Underwriting and

Servicing (DUS) Program is

collateralized by a fully funded reserve

account that is equal to or greater than

one percent of the seller-servicer’s

aggregate unpaid principal balance

covered by the loss-sharing agreement at

the start of the stress test, the rating of

the issuer of the instrument backing the

reserve account may be used, in lieu of

BBB, as the rating of the unrated sellerservicer, except that in no event will the

rating exceed AA. Determinations of the

required reserve amount and the rating

permitted would be made on a programby-program and Enterprise-byEnterprise basis.

B. Proposed Changes to Multifamily

Model

OFHEO is proposing a number of

changes to the multifamily default

model, multifamily loss severity

parameters, and multifamily

prepayment speeds specified in the

Rule. Proposed changes to the default

model include (1) a respecification of

explanatory variables which has the

effects of reducing the model’s

sensitivity to debt-service coverage

ratios (DCRs) falling below one and

reducing predicted cumulative default

rates on adjustable rate mortgages

(ARMs) in the up-rate stress test, and (2)

an increase to the initial vacancy rate

used to update DCR during the stress

test making this rate consistent with the

benchmark region’s vacancy rate from

the month prior to the start of the

benchmark period.13 OFHEO is also

proposing changes for the multifamily

loss severity parameters that reflect the

costs, timing, and recoveries associated

with a larger and more broad-based set

of Enterprise foreclosures. The Rule

reflects a decision not to model the

complexities of prepayment premiums

that may or may not be received by the

Enterprises during stressful periods

without further study. The proposed

multifamily prepayment speeds are

more consistent with that decision than

existing pre-payment speeds. Each

proposed change is discussed in turn.

Underwater Debt Coverage Ratio flag

(UWDCRF). In the Rule, the multifamily

default model included an Underwater

Debt Coverage Ratio Flag (UWDCRF),

intended to cover the additional default

risk posed when the projected debt

service coverage ratio-net operating

income (NOI) divided by mortgage

payment-falls below one during the

stress test. A debt coverage ratio less

than one means that the NOI is

insufficient to cover the required

mortgage payment, an occurrence that

suggests a high probability of default.

The stress test projects the DCR in each

month of the stress period from the

prior month’s value by updating NOI,

using rent growth rates and rental

vacancy rates that reflect the economic

conditions of the benchmark region and

period, and adjusting mortgage

payments monthly according to the note

terms and the stress test interest rate

scenario. When this method is used to

project DCR, the types of loans for

which the projected DCR falls below

one tend to be fixed rate mortgages

(FRMs) that started the stress test with

a low DCR and, in the up-rate scenario,

most ARM loans, resulting in

comparatively high cumulative default

rates for these loans in the stress test.

OFHEO has found that the UWDCRF

adds value to the multifamily default

model by capturing the additional risk

of default when NOI is insufficient to

cover mortgage payments, but is

concerned that the sensitivity of

predicted monthly defaults to projected

DCR falling below one may be too great,

for two reasons. First, the UWDCRF is

an indicator that is only turned on when

DCR is projected to be below one, and

is turned off otherwise. There are no

finer gradations for this explanatory

variable such as those that might be

captured if the projected DCR accounted

for individual property dispersion

around the mean.14 In the application of

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65151

a DCR below one because both are associated with

increased likelihood of default. However, in the

single-family model, negative equity is captured as

a probability and enters the model as categorical

variable having eight possible values. These eight

gradations for the probability of negative equity

improve the single-family model by avoiding abrupt

predicted transitions from positive to negative

equity. OFHEO is able to calculate the probability

of negative equity for single-family loans because

projected property value changes are based on

OFHEO’s House Price Index and its associated

dispersion parameters. No similar measures of

dispersion are currently available to project

multifamily DCR or the probability of DCR falling

below one.

15The Rule includes a New Book ARM flag (NAF)

and a New Book Balloon flag (NBLF) as producttype offsets to the New Book flag (NBF), which is

a categorical (or dummy) variable that distinguishes

between ‘‘Old Book’’ loans that were made when

the Enterprises first entered into the multifamily

business (before 1988 for Fannie Mae and before

1993 for Freddie Mac) and ‘‘New Book’’ loans made

under their more recent restructured programs.

OFHEO’s research indicates that New Book loans

have shown lower defaults than Old Book loans in

general, although the amount of improvement

varies significantly among product types.

Specifically, New Book fixed-rate balloon loans

outperformed Old Book fixed-rate balloon loans to

a lesser degree than their fixed-rate fully amortizing

counterparts. ARM loan performance differentials

were even smaller. These differences are reflected

in the Rule in the NBLF and NAF offsets to the

NBF.

16This effect is captured in the Rule by the Ratio

Update Flag (RUF). Specifically, the RUF identifies

a subset of New Book loans—those for which the

loan-to-value ratio (LTV) and debt-service coverage

ratio (DCR) have been calculated or delegated to

have been calculated by the Enterprises at loan

origination or for which the LTV and DCR have

been recalculated or delegated to have been

Continued

the stress test, many multifamily loan

groups will have DCRs projected to fall

below one—some only slightly below

one, while others fall well below one.

The additional risk of default may be

overstated for those loan groups with

DCRs projected to fall only slightly

below one by the abrupt transition of

the UWDCRF variable. Second, even

when a multifamily property’s DCR

does fall below one, only a fraction of

borrowers default, indicating that those

who do not default may carry their

properties with funds from other

sources for a period of time while they

try to remedy the negative cash flow

position.

For these reasons, OFHEO decided to

re-estimate the multifamily default

model with a revised definition of the

UWDCRF that turns the flag on only

when the DCR is projected to be well

below one. As a result of that reestimation, OFHEO proposes to redefine

the UWDCRF to be equal to one (that is,

to turn the flag on) when projected DCR

is less than 0.98 (that is, when NOI is

more than two percentage points below

the mortgage payment), rather than

setting the flag equal to one immediately

when the projected DCR falls below one.

The re-estimated multifamily default

model has a slightly lower coefficient on

UWDCR, and the coefficients for the

other explanatory variables do not

change materially. Simulations using

the revised UWDCRF definition result

in lower predicted default rates for

ARMs in the up-rate scenario and for

FRMs with low initial DCR in both

scenarios, making the model less

sensitive to the UWDCRF than the

existing model. The revised definition

does not substantially affect the

predicted default rates for most FRMs or

for ARMs in the down-rate scenario.

OFHEO believes the respecified model

more accurately captures the added

risks associated with loans that have

negative cash flow in the stress test.

ARM Flags. OFHEO is concerned that

predicted cumulative default rates for

ARM loans are excessive in the up-rate

scenario. For example, a typical ARM

purchased by an Enterprise could have

a cumulative default rate of 95 percent

in the up-rate scenario. These excessive

default rates for ARMs in the up-rate

stress test arise from two principal

sources. First, the up-rate stress test

projects declining DCRs for ARMs, and

two explanatory variables in the default

model translate declining DCRs into

higher default rates: the DCR variable,

itself, and the UWDCRF, where

applicable. The second source is from

the application of an ARM product-type

flag—New Book ARM Flag (NAF)—

which further raises the predicted ARM

default rates. OFHEO included the ARM

product flag in the Rule because it

observed in the historical data from the

Enterprises that ARM defaults appear to

be higher than those of otherwise

comparable FRMs even after controlling

for DCR changes due to interest rate

changes.

The stress test projects DCR in each

month of the stress period from the

prior month’s value using rent growth

rates and vacancy rates that reflect the

economic conditions of the benchmark

region and period along with monthly

mortgage payment adjustments

according to the note terms and the

stress test interest rate scenarios. In the

up-rate scenario, the mortgage payment

adjustments on ARMs cause the

projected DCR to fall much more than

that of an otherwise comparable FRM.

This more rapid decline in DCR causes

predicted defaults on ARMs to be higher

than those of otherwise comparable

FRMs, as one would expect, because

mortgage payments on an ARM may

grow to exceed net operating income

from the property. In addition, the NAF

further raises new book ARM defaults

relative to comparable new book FRMs

to capture performance differences not

related to projected changes in DCR.15

The theoretical justification for the

inclusion of an ARM flag to account for

performance differences not related to

ARM payment changes is that ARM

borrowers may possess higher credit

risk qualities than their fixed-rate

counterparts. Arguing against the

inclusion of an ARM flag is the

improvement in the Enterprises’

multifamily ARM underwriting in

recent years, which means that, over

time, differences in risk between loan

types due to differences in borrower

characteristics will disappear. That is,

the choice of ARM versus FRM in the

multifamily mortgage market may be

becoming a strategic business decision

related to professional financial

management considerations and may, as

a result, have a declining relationship to

borrower credit quality.

OFHEO decided that the excessive

predicted default rates for ARM loans in

the up-rate stress test warranted

investigation of the default model’s

specification of ARM product type flags.

OFHEO sought to determine if a

respecification of the model could

maintain a reasonable relationship to

the historical data while producing

more reasonable results in the stress

test. First, the estimation was performed

without either of the two product type

flags, the NAF and the New Book

Balloon Flag (NBLF). If the only

additional risk associated with ARMs

relative to FRMs resulted from the

impact of rate changes on mortgage

payments and DCR, then this

specification for the default model

might be appropriate. OFHEO found,

however, that this model specification

caused another explanatory variable, the

Ratio Update Flag (RUF) to be no longer

statistically significant. Next, OFHEO

re-estimated the model without the

Ratio Update Flag. The result of the

second re-estimation produced, as

expected, an averaging effect between

New Book ARM and FRM default

rates—that is, the size of the coefficient

for New Book loans decreased (the

coefficient remained negative but had a

smaller absolute value), reflecting the

fact that the NBF was now averaging the

product type differences that are

currently separated out by the product

type flags in the Rule. This specification

also reduced the sensitivity of defaults

to the distinction between New Book

and Old Book loans, holding other

factors constant, because it no longer

distinguished between loans for which

loan-to-value ratio (LTV) and DCR ratios

are updated and those for which they

are not.16

65152 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

recalculated by the Enterprises at Enterprise

acquisition according to current underwriting

standards. New Book loans for which origination

and/or acquisition LTV and DCR are unknown

cannot be considered to be ratio-updated.

17Specifically, the twelfth root of month over

same month previous year rent indices minus one.

18Reporting of vacancy rate data for Metropolitan

Statistical Area located in the WSC Census division

began in 1986. As a result, 1984 and 1985 rates

were estimated based on national rates using the

ratio of WSC Census division rates to U.S. rental

vacancy rates in 1986, a factor of 2.3. For 1983, a

lower factor of 1.8 is assumed because it predates

the WSC Census division’s recession.

19REO is real estate owned as a result of loan

default. 20The ‘‘baseline’’ consists of a simple adding up

of the cost components of the rate, without

considering discounting, credit enhancements, or

passthrough interest on sold loans.

OFHEO rejected the above model respecification, which eliminates the

NAF, the NBLF, and the RUF, because

it ignored two important factors that

OFHEO has observed in Enterprise

historical data. First, OFHEO considered

the evidence of higher Enterprise ARM

default rates, compared with FRM

default rates during historical periods

when interest rates were flat to

declining. Since flat-to-declining

interest rates lead to stable or lower

ARM payments and therefore stable or

higher DCRs, all else equal, OFHEO

suspected that factors unrelated to

interest-rate-related ARM payment

changes (such as borrower credit

quality) may still be underlying the

higher observed ARM default rates.

Second, OFHEO found substantial

differences in observed default rates for

ratio-updated versus not-ratio-updated

loans in Enterprise historical data.

Ratio-updated loans appear to perform

better than those that are not, holding

other factors constant.

Therefore, OFHEO proposes to respecify its multifamily default model as

follows. The proposed model has the

same explanatory variables as the model

in the Rule, except that NAF, NBLF, and

RUF are removed, and a respecified flag

is introduced that captures both the

distinction between ARMs and FRMs

and the distinction between ratioupdated and not-ratio-updated loans.

Specifically, the new variable OFHEO is

proposing in its respecified default

model is a Not-Ratio-updated ARM Flag

(NRAF) which takes a value of one (that

is, it is turned on) if a loan is both an

ARM and not ratio-updated, and zero

otherwise. Because nearly all of the

ARM loans in Enterprise historical data

are not ratio-updated, but nearly all of

the FRMs are ratio-updated, OFHEO

determined that it is statistically

difficult to fully separate these effects as

measures of historical performance. The

proposed model with the NRAF variable

would apply this new variable

coefficient during the stress test

simulation only to ARM loans that are

not ratio-updated, capturing the

historical performance differences of

these ARMs after controlling for

payment changes. ARM loans that have

undergone the ratio-update process

would not be subject to higher default

risk imposed by the NRAF, thereby

reducing the differential between ARM

and FRM defaults in the up-rate

scenario for those loans.

OFHEO believes that a similar

distinction between ratio-updated FRMs

and not-ratio-updated FRMs should

exist even though there are too few notratio-updated FRMs in the Enterprises’

historical data to confirm the

hypothesis. As a result, OFHEO

proposes to multiply monthly

conditional default rates for not-ratioupdated FRMs by a factor of 1.2 times

the rates for otherwise comparable ratioupdated FRMs to reflect the marginally

higher risk expected with those loans.

OFHEO believes that, given the

Enterprise data, the proposal handles a

very complicated issue fairly and with

statistical soundness and good

judgment. If, in the future, Enterprise

data show no differences between ARM

and FRM risk other than the adverse

effect of rising interest rates on ARM

payments and ARM DCR, OFHEO may

revisit this issue.

Initial Vacancy Rate. Estimated rent

growth for the first month of the stress

test is based on the relative change in a

rent index from immediately prior to the

stress test to month one of the stress

test.17 However, the estimated vacancy

rate change in the first month of the

stress test does not look back to the

value of the vacancy rate immediately

prior to the stress test, but rather

compares the vacancy rate in month one

of the stress test with a long-term

national historical average vacancy rate.

To be consistent, the change in vacancy

rates between the period immediately

prior to the stress test and month one of

the stress test should be based on the

change in the benchmark region

vacancy rate from the month prior to the

benchmark period to the first month of

the benchmark period. OFHEO views

this change as a technical correction.

Specifically, the vacancy rate change

in the Rule in the initial month of the

stress test is from the Census Bureau’s

long-term national historical average of

6.23 percent to the West South Central

(WSC) Census division’s estimated

January, 1984, rate of 13.6 percent, with

changes thereafter based upon changes

in rates through 1993 in that region.18

This specification has the effect of

imposing a greater percentage increase

in vacancies than appears to have

occurred during the benchmark loss

experience.

The proposed change is to set the

initial vacancy rate at ten percent,

which is the estimated WSC Census

division vacancy rate in 1983. Thus, the

vacancy rate change in the initial month

of the stress test would be from ten

percent to 13.6 percent.

Loss Severity. Loss severity

parameters in the Rule were based upon

the experience of 705 Freddie Mac

multifamily REO 19 properties from the

1980s. OFHEO has now analyzed data

reflecting the costs, timing, and recovery

rates associated with additional REO

that has been made available from both

Enterprises. Based upon that analysis,

OFHEO is proposing to modify the

multifamily severity parameters to take

into consideration the performance of

Fannie Mae REO in the 1980s and both

Enterprises’ more recent multifamily

REO. The multifamily loss severity

calculations that use the severity

parameters in the Rule would not

change. Specifically, OFHEO proposes

reducing net REO holding costs to seven

percent from 13.33 percent and

increasing REO sales proceeds from

58.88 percent to 63 percent of the

unpaid principal balance as of the

default date. Additionally, OFHEO

proposes reducing the time from default

to foreclosure completion from 18 to 9

months while increasing the time from

REO acquisition to REO disposition

from 13 to 15 months. Changing these

severity parameters yields a 44 percent

‘‘baseline’’ severity rate, as compared to

the 55 percent ‘‘baseline’’ produced by

the model in the Rule. ‘‘Baseline’’

severity is a simple way to compare one

set of severity parameters with

another.20

Prepayment Penalties. In the Rule, no

credit is given for cash flows from

prepayment penalties and yield

maintenance provisions. Nevertheless,

the Rule provides that two percent of

loans that are subject to such penalties

or provisions prepay each year of the

stress test in the down-rate scenario. In

the preamble to the Rule, OFHEO

explained that the data indicated that a

small percentage of loans did prepay

while subject to yield maintenance

provisions and that OFHEO had no data

indicating to what extent prepayment

penalties were actually paid by

borrowers, as opposed to waived by the

Enterprises or added to the balances of

refinanced loans. Because it is likely

that some prepayment penalties are paid

or other compensating consideration is

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65153

received by the Enterprises, OFHEO

decided to include some prepayments

on these loans in the down-rate

scenario, but at a lower rate than

indicated by the data in order to take

prepayment penalties into account.

OFHEO is proposing to modify the

Rule to provide for no prepayments in

the down-rate scenario inside

prepayment penalty or yield

maintenance periods. This approach is

more consistent with OFHEO’s

preference to model contractual

instruments according to their terms,

but recognizes that modeling these

penalties according to their terms would

be immensely complicated, because

those terms vary greatly from loan to

loan. The proposed approach is a

reasonable simplification because

prepayment penalty provisions are

actually liquidated damages clauses,

which are intended to give the lender

the benefit of full performance on the

loan.

C. Proposed Changes to Yields on

Enterprise Debt

The Rule does not impose a premium

upon an Enterprise’s cost of funds to

reflect the reaction of the debt markets

to the financial stress imposed upon the

Enterprise. However, the preamble to

the Rule suggested that a premium

might be appropriate and that this

would likely be an area of future

change. Upon further study, OFHEO has

found that it is appropriate for the stress

test to recognize an increased cost of

debt of ten basis points for an Enterprise

in the stress test vis-a-vis other

borrowers in the debt markets.

OFHEO proposed in NPR2 to impose

a 50-basis-point premium on new

Enterprise debt for the last nine years of

the stress period. The analysis that

OFHEO performed for NPR2 indicated

that debt spreads to Treasury rates have

widened in times of financial stress for

Government-sponsored enterprises

(GSEs). NPR2 did not propose

adjustments to reflect unusual stress for

any other interest rate series in the

stress test.

In the final rule, OFHEO took note of

the comments received in response to

NPR2, some of which questioned the

appropriateness of a premium on new

Enterprise debt and the size of that

premium. OFHEO conceded that data

upon which to base such a premium

may be too sparse to determine

definitively whether other spreads to

Treasuries would widen as much as the

Enterprises’ spreads or to estimate how

much the Enterprises’ spreads would

widen. The preamble to the final rule

also noted that some commenters felt

that no premium on new debt should be

charged because many of the

Enterprises’ hedging instruments are

based upon rates other than Treasuries

(e.g., LIBOR, COFI). The spreads

between these rates and Treasuries

could be expected to widen during

stressful conditions, thus mitigating the

Enterprises’ risk. In light of these

comments, OFHEO postponed

imposition of any new debt premium

pending later refinements of the Rule.

Nevertheless, OFHEO indicated that the

implicit assumption in the stress test

that the spreads of an Enterprise’s debt

yields to other interest rates would be

unaffected by the deteriorating

condition of the Enterprise ignored an

area of significant risk.

The risk of wider spreads in a

stressful period is important if asset

lives, which are unusually long in the

up-rate scenario, exceed terms-tomaturity of outstanding debt. In support

of this proposal, OFHEO notes that

some funding strategies employed by

the Enterprises depend significantly on

their ability to borrow in the future at

relatively favorable interest rates. For

example, the Enterprises often fund a

portion of their mortgage asset portfolio

with short-term debt accompanied by

interest rate swaps, in which they pay

a fixed rate and receive a floating rate.

If the floating rate they pay on their own

short-term debt is close to the floating

rate they receive on the swap, the net

effect is roughly the same as if they had

issued long-term fixed-rate debt at the

rate they pay on the swap. If, however,

their cost of short-term funds rises

significantly, relative to the index on

which the swap’s floating rate is based,

their cost will be higher than if they had

issued long-term fixed-rate debt. Use of

fixed-pay swaptions to hedge against the

effect of rising interest rates on expected

asset lives creates a similar risk.

Although the spreads to Treasury rates

of other interests rates may also widen

in a stressful economic environment,

the stress test is designed to be

especially stressful to the Enterprises.

The stress test involves factors, such as

a decline in housing prices, that might

not affect the debt costs in other sectors

of the economy as much. OFHEO has

chosen to propose a ten-basis-point

spread for the final nine years of the

stress period, in part to reflect these

risks.

A ten-basis-point borrowing premium

incorporates these risks in a modest

way. Firms in very stressful

circumstances frequently face premiums

of several hundred basis points, if they

are able to borrow at all. GSEs, though,

have always been able to borrow, even

when they are in very poor financial

condition, because of their perceived

special status. It is reasonable, therefore,

to use a much smaller premium than

might be appropriate for a non-GSE in

a similar stress test. OFHEO also

considers it appropriate to consider that

the stresses affecting the Enterprises in

the stress test would also be affecting

other borrowers in the market place. To

assume that they do not, as was the case

in NPR2, which proposed a 50-basispoint premium, is inconsistent with the

stress implied in the haircuts that the

stress test applies to all counterparties

of the Enterprises. An ideal stress test

might model different spreads for

different interest rate series, a complex

approach that OFHEO could not

implement in the foreseeable future.

The ten-basis-point premium, therefore,

can be viewed as a simplifying

assumption, which gives some effect to

the possibility that stress period market

conditions could impact an Enterprise

more adversely than the rest of the

market.

D. Proposed Changes to New Debt Mix

The Rule provides for the funding of

all cash deficits by the issuance of new

long-or short-term debt, whichever is in

shorter supply, until a 50/50 balance of

short-to long-term debt is reached in

each Enterprise’s portfolio. Thereafter,

long- and short-term debt are issued in

whatever ratio best contributes to

maintaining that balance. This approach

was chosen because OFHEO did not

wish to include an assumption about

any particular behavioral preference by

the Enterprises during the stress period.

On further consideration, however,

OFHEO proposes to change the target

balance embodied in this approach. A

50/50 balance is generally unsuitable for

funding a portfolio of largely fixed-rate

mortgage assets, and it could often

result in a substantial change in an

Enterprise’s funding structure during

the stress period. OFHEO proposes to

replace the 50/50 target with the actual

ratio of Enterprise debt obligations (as

adjusted by interest rate swaps) at the

start of the stress period. Typically, the

Enterprises have a long-term debt to

total debt ratio (swap adjusted) of 70

percent to 90 percent. Use of such ratios

in the stress test will result in a more

realistic debt structure.

E. Miscellaneous Technical Changes

Operating Expenses. In the Rule, one

third of an Enterprise’s operating

expenses at the start of the stress test

remain fixed throughout the stress

period, while the remainder decline in

proportion to the decline in the

mortgage portfolio. The total of the fixed

and variable components is then

reduced by one-third to recognize that a

65154 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

21 1992 Act, section 1302(2) (12 U.S.C. 4501(2)).

22 ‘‘Managing Risk in Housing Finance Markets:

Perspective from the Experience of the United

States of America and Mexico,’’ Mortgage Bankers

Association of America (June 11, 1998).

cessation of new business would have a

significant impact upon operating

expenses. The variable portion of the

operating expenses for a given month is

determined by calculating the

Enterprise’s mortgage portfolio at the

end of each month of the stress period

as a percentage of the portfolio at the

start of the stress test. Starting-position

fixed-asset balances are held constant

over the ten-year stress period, while

related depreciation is included in the

base on which operating expenses are

calculated for each month of the stress

period. The implication of this

treatment is that fixed assets are being

regularly replaced throughout the

period, which appears inconsistent with

the decline in financial assets as

mortgages amortize and prepay.

To address this inconsistency,

OFHEO is proposing to modify the

stress test treatment of operating

expenses by converting 75 percent of

starting-position fixed-asset balances to

cash over the ten-year stress period. The

proposal would retain 25 percent of the

fixed assets on the Enterprise books

throughout the stress period to reflect

the acquisition of some new fixed

assets, such as computer equipment,

which is likely even in a ‘‘wind-down’’

scenario. The effect of this change is to

reduce the Enterprises’ need for debt to

carry nonearning fixed assets.

Float Income. The Rule provides for

the modeling of float income associated

with passthrough payments on

securities issued by the Enterprises.

Float income can be positive or negative

depending on whether the Enterprise

holds the funds for a period of time

before remitting them to security

holders or remits funds to security

holders before they are actually

received. When an Enterprise owns its

own passthrough securities, the timing

of payment to itself is not relevant.

However, the Rule includes these

securities in the calculation of float

income, resulting in an overstatement of

float income. OFHEO proposes to

correct this overstatement by reducing

the float income on passthrough

securities issued by the reporting

Enterprise by the percentage of the

Enterprise’s ownership interest.

However, when an Enterprise receives

prepayments and holds the funds for a

number of days during which investors

accrue interest at the coupon rate of the

security, the difference between the

yield the Enterprise can earn on

invested funds at that time of the stress

period and the coupon rate will

continue to be reflected for the relevant

number of days.

Currency Swaps. As a simplifying

assumption in the Rule, OFHEO applied

no haircut to foreign currency swaps,

but stated its intention to continue to

explore appropriate methodologies for

applying an appropriate haircut. In

furtherance of its commitment to

continue to refine the stress test,

OFHEO now proposes to eliminate the

simplifying assumption and apply

haircuts to foreign currency swap

counterparties. Because the stress test

does not project foreign currency values,

the haircut is applied by adjusting the

pay (dollar-denominated) side of the

swap upward by the amount of the

haircut percentage rather than

haircutting the foreign-currency receive

side of the swap.

American Call Option. As a

simplifying assumption in the Rule, an

American call option, which allows the

issuer to exercise the option at any time,

is treated as a Bermudan call option,

which allows the issuer to exercise the

call only on a coupon date. However, in

the preamble to the Rule, OFHEO

signaled its intention to consider how

American call options might be

modeled more precisely. OFHEO is now

proposing to modify the stress test to

evaluate American calls on the first

option date in the exercise schedule and

subsequent monthly anniversaries of the

instrument’s first coupon date.

House Price Growth Factor

Clarification. The Rule requires the use

of OFHEO’s most recent House Price

Index as of the reporting date to

determine the house price growth factor

used to calculate current loan-to-value

ratios. The proposal expands the

instructions in Section 3.6 to clarify,

consistent with Section 3.7, that when

a loan was originated since the

publication of that report, a cumulative

house price growth factor of one is used.

Technical Correction. The proposal

adds a Prepayment Penalty Flag as an

additional classification variable for

multifamily loan groups, to distinguish

loans with active prepayment penalties

or yield maintenance provisions from

those without in the calculation of

prepayment penalty duration for loan

groups.

Regulatory Impact

Executive Order 12866, Regulatory

Planning and Review

The proposed amendment would

amend a rule designated as a major rule

by the Office of Management and

Budget (OMB). The proposed

amendment is a refinement of that rule

that would tie the capital more closely

to risk. Although the impact of that

refinement is not economically

significant, OMB has reviewed the

proposed amendment to determine

whether the proposed changes may raise

novel policy issues. OFHEO is not

required to provide the type of

regulatory impact analysis that is

required for an economically significant

rule. Nevertheless, in accordance with

OMB’s guidance that all regulatory

actions should be consistent with the

principles of E.O. 12866, OFHEO has

determined, after review by agency

economists, financial analysts, and

attorneys, that the benefits of the

proposed changes to the Rule

substantially outweigh any economic

costs.

It is impossible to estimate precisely

the particular benefits and costs

associated with the risk-based capital

requirement. While OFHEO believes

this group of enhancements and

refinements to the stress test will not

generally increase or decrease the

amount of required capital for an

Enterprise to any substantial degree, the

effect in any particular quarter depends

upon how well that Enterprise is hedged

against the risks and conditions

specified in the stress test. OFHEO

cannot know whether or not hedges in

place at an Enterprise at the beginning

of any quarter would have been in place

in the absence of specific provisions of

the risk-based capital rule or were put

in place because of the test. Speculating

as to what the Enterprises would do in

the absence of specific provisions in

future quarters is even more difficult.

Therefore, a detailed economic cost/

benefit analysis is not practical.

Rather than trying to assess the costs

and benefits of every change to the

stress test, OFHEO looks to whether or

not the changes it is proposing make the

Rule better reflect the risks faced by the

Enterprises. Improving the Rule in this

manner should reduce the potential for

Enterprise insolvency by protecting

better against interest rate, credit, and

management and operations risk. By

helping to ensure the safety and

soundness of the Enterprises, the

regulation allows them to continue to

carry out their public purposes, which

include providing stability in the

secondary market for residential

mortgages and providing access to

mortgage credit in central cities, rural

areas, and underserved areas.21 In

addition, the regulation helps ensure

that the Enterprises will continue to

provide benefits to the primary

mortgage market, such as standardizing

business practices.22

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65155

23Final Report of Standard & Poor’s to OFHEO,

Contract No. HE09602C (February 3, 1997).

24Contract No. HE09602C, at 10.

Adopting the proposed amendment

will result in a capital requirement that

corresponds more closely to capital

levels that the marketplace would

demand in the absence of the benefits

afforded by the Government

sponsorship of the Enterprises, leading

to gains in overall economic efficiency.

By improving the Rule’s ability to reflect

actual risks at the Enterprises, the

amendment also may enhance investor

confidence in the ability of the stress

test to forewarn investors and regulators

of financial weaknesses. This result

would be consistent with a study by

Standard & Poor’s (S&P) that provided

risk-to-the-government credit ratings for

the Enterprises.23 Although S&P had

rated Fannie Mae A- and Freddie Mac

A+ in 1991, the 1997 report upgraded

the ratings of both Enterprises to AA-.

S&P cited increased governmental

oversight by OFHEO as an important

factor in these higher ratings. It further

noted that ‘‘OFHEO’s regulatory

oversight [of Freddie Mac] also gives

comfort that appropriate interest rate

risk mitigation steps would be taken as

needed.’’24

OFHEO can identify no significant

costs associated with implementing the

proposed amendments. No new reports

are required, and net effects on required

capital likely will be very small. In sum,

the benefits to the public, including the

Enterprises and other private-sector

concerns, of the proposed changes far

outweigh the already expended costs of

implementing those changes.

Paperwork Reduction Act

This proposed regulation does not

contain any information collection

requirements that require the approval

of the Office of Management and Budget

under the Paperwork Reduction Act (44

U.S.C. 3501 et seq.).

Regulatory Flexibility Act

The Regulatory Flexibility Act (5

U.S.C. 601 et seq.) requires that a

regulation that has a significant

economic impact on a substantial

number of small entities, small

businesses, or small organizations must

include an initial regulatory flexibility

analysis describing the regulation’s

impact on small entities. Such an

analysis need not be undertaken if the

agency has certified that the regulation

will not have a significant economic

impact on a substantial number of small

entities. 5 U.S.C. 605(b). OFHEO has

considered the impact of the proposed

regulation under the Regulatory

Flexibility Act. The General Counsel of

OFHEO certifies that the proposed

regulation, if adopted, is not likely to

have a significant economic impact on

a substantial number of small business

entities because the regulation is

applicable only to the Enterprises,

which are not small entities for

purposes of the Regulatory Flexibility

Act.

List of Subjects in 12 CFR Part 1750

Capital classification, Mortgages,

Risk-based capital.

Accordingly, for the reasons stated in

the preamble, OFHEO proposes to

amend 12 CFR part 1750 as follows:

PART 1750—RISK-BASED CAPITAL

1. The authority citation for part 1750

continues to read as follows:

Authority: 12 U.S.C. 4513, 4514, 4611,

4612, 4614, 4618.

2. Amend Appendix A to subpart B of

part 1750 as follows:

a. Revise Table 3–1 in paragraph

3.1.1;

b. Revise Table 3–4 in paragraph

3.1.2.1;

c. Revise paragraph 3.3.1 [b];

d. Revise paragraph 3.3.3 [a] 3.c.;

e. Add new paragraph 3.5.3 [a] 2.d.;

f. Revise paragraph 3.5.3 [a] 3. and

Table 3–31;

g. In sentence six of paragraph 3.6.1

[e], remove the comma after the words

‘‘Credit Losses’’, add the word ‘‘and’’ in

its place, and remove the words ‘‘and

the Float Income’’ after the words

‘‘Guarantee Fee’’;

h. Revise paragraph 3.6.3.4.3.1 [a] 2.a.;

i. Revise paragraph 3.6.3.5.1 [b];

j. In paragraph 3.6.3.5.2, revise Table

3–38;

k. Revise paragraph 3.6.3.5.3.1 [a] 2.;

l. In paragraph 3.6.3.5.3.1 [a] 4,

remove the first equation: ‘‘UWDCRFm =

1 if DCRm < 1 in month m’’ and add the

equation ‘‘UWDCRFm = 1 if DCRm < 0.98

in month m’’ in its place;

m. Revise paragraph 3.6.3.5.3.2 [a] 1.

and Table 3–39;

n. Revise paragraph 3.6.3.5.3.2 [a]

2.b.;

o. Revise paragraph 3.6.3.5.3.2 [a] 3.;

p. Revise Table 3–44, in paragraph

3.6.3.6.3.2;

q. In section 3.6.3.6.4.3, revise the

four paragraphs: [a] 1., [a] 3.b., [a] 4.b.

and [a] 5.;

r. Revise paragraph 3.6.3.7.3 [a] 9.b.;

s. Revise paragraph 3.7.3.1 [g] 1.;

t. In paragraphs 3.7.3.2 [a] 5. and

3.7.3.3 [a] 3., add the words ‘‘, as

appropriate’’ at the end of the sentence

in each paragraph;

u. In paragraph 3.7.4 [a] remove

reference to ‘‘Table 3–55’’ and add

‘‘Table 3–61’’ in its place;

v. Redesignate Tables 3–65 through 3–

70 as Tables 3–66 through 3–71;

w. After paragraph 3.8.1 [e], add new

paragraph 3.8.1 [f], new footnote 5, and

new Table 3–65;

x. In paragraphs 3.8.2 [a] and [b]

remove references to ‘‘Table 3–65’’ and

add ‘‘Table 3–66’’ in their place;

y. Revise paragraph 3.8.3.1 [a] 3.a.;

z. In paragraph 3.8.3.4 remove

reference to ‘‘Table 3–66’’ and add

‘‘Table 3–67’’ in its place;

aa. In paragraphs 3.8.3.6.1 [e] 1. and

[e] 2. remove both references to ‘‘Table

3–67’’ and add ‘‘Table 3–68’’ in their

place;

bb. In redesignated Table 3–69 in

paragraph 3.8.3.9, remove both

references to ‘‘Table 3–65’’ and add

‘‘Table 3–66’’ in their place;

cc. Revise paragraphs 3.8.3.10 [a], [b]

and [c];

dd. In paragraph 3.9.2 remove

reference to ‘‘Table 3–69’’ and add

‘‘Table 3–70’’ in its place;

ee. In paragraph 3.10.2 [a] remove

reference to ‘‘Table 3–70’’ and add

‘‘Table 3–71’’ in its place;

ff. Revise paragraphs 3.10.3.1 [b] 2.

and [b] 3.;

gg. Revise paragraph 3.10.3.6.2 [a] 5.;

and

hh. Revise the definition of Enterprise

Cost of Funds in paragraph 4.0 Glossary.

The revisions and additions read as

follows:

Appendix A to Subpart B of Part 1750—

Risk-Based Capital Text Methodology

and Specifications

* * * * *

3.1.2.1 * * *

65156 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

TABLE 3–1-SOURCES OF STRESS TEST INPUT DATA

Section of this Appendix Table

Data Source(s)

R = RBC Report

P = Public Data

F = Fixed Values

R P F Intermediate Outputs

3.1.3, Public Data 3–19, Stress Test Single Family Quarterly

House Price Growth Rates

F

3–20, Multifamily Monthly Rent Growth and Vacancy RatesF

3.2.2., Commitments Inputs Characteristics of securitized single family loans

originated and delivered within 6 months prior

to the Start of the Stress Test

R 3.3.4, Interest Rates Outputs

3.2.3., Commitments Procedures 3–25, Monthly Deliveries as a Percentage of

Commitments Outstanding (MDP)

F

3.3.2, Interest Rates Inputs 3–18, Interest Rate and Index Inputs P

3.3.3, Interest Rates Procedures 3–26, CMT Ratios to the Ten-Year CMT F

3.4.2., Property Valuation Inputs 3–28, Property Valuation Inputs 3.1.3, Public Data

3.3.4, Interest Rates Outputs

3.5.3., Counterparty Defaults Procedures 3–30, Rating Agencies Mappings to OFHEO

Ratings Categories

P

3–31, Stress Test Maximum Haircut by Ratings

Classification

F

3.6.3.3.2, Mortgage Amortization Schedule Inputs3–32, Loan Group Inputs for Mortgage Amortization Calculation3.3.4, Interest Rates Outputs

3.6.3.4.2, Single Family Default and Prepayment

Inputs

3–34, Single Family Default and Prepayment

Inputs

R F 3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.4.3.2, Prepayment and Default Rates and

Performance Fractions

3–35, Coefficients for Single Family Default and

Prepayment Explanatory Variables

F

3.6.3.5.2, Multifamily Default and Prepayment

Inputs

3–38, Loan Group Inputs for Multifamily Default

and Prepayment Calculations

R F

3.6.3.5.3.2, Default and Prepayment Rates and

Performance Fractions

3–39, Explanatory Variable Coefficients for Multifamily DefaultF 3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.6.2.2, Single Family Gross Loss Severity

Inputs

3–42, Loan Group Inputs for Gross Loss SeverityF 3.3.4, Interest Rates Outputs

3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.4.4, Single Family Default and Prepayment Outputs

3.6.3.6.3.2, Multifamily Gross Loss Severity Inputs3–44, Loan Group Inputs for Multifamily Gross

Loss Severity

F 3.3.4, Interest Rates Outputs

3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.6.4.2, Mortgage Credit Enhancement Inputs3–46, CE Inputs for each Loan Group R 3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.4.4, Single Family Default and Prepayment Outputs

3.6.3.5.4, Multifamily Default and Prepayment

Outputs

3.6.3.6.2.4, Single Family Gross Loss Severity

Outputs

3.6.3.6.3.4, Multifamily Gross Loss Severity

Outputs

3–47, Inputs for each Distinct CE Combination

(DCC)

R

3.6.3.7.2, Stress Test Whole Loan Cash Flow

Inputs

3–51, Inputs for Final Calculation of Stress Test

Whole Loan Cash Flows

R 3.3.4, Interest Rates Outputs

3.6.3.3.4, Mortgage Amortization Schedule Outputs

3.6.3.4.4, Single Family Default and Prepayment Outputs

3.6.3.5.4, Multifamily Default and Prepayment

Outputs

3.6.3.6.5.2, Single Family and Multifamily Net

Loss Severity Outputs

3.6.3.8.2, Whole Loan Accounting Flows Inputs 3–54, Inputs for Whole Loan Accounting Flows R 3.6.3.7.4, Stress Test Whole Loan Cash Flow

Outputs

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65157

TABLE 3–1-SOURCES OF STRESS TEST INPUT DATA—Continued

Section of this Appendix Table

Data Source(s)

R = RBC Report

P = Public Data

F = Fixed Values

R P F Intermediate Outputs

3.7.2., Mortgage-Related Securities Inputs 3–56, RBC Report Inputs for Single Class MBS

Cash Flows

R

3–57, RBC Report Inputs for Multi-Class and

Derivative MBS Cash Flows

R

3–58, RBC Report Inputs for MRBs and Derivative MBS Cash FlowsR

3.8.2., Nonmortgage Instrument Inputs 3–66, Input Variables for Nonmortgage Instrument Cash flowsR

3.9.2., Alternative Modeling Treatments Inputs 3–70, Alternative Modeling Treatment Inputs R

3.10.2., Operations, Taxes, and Accounting Inputs3–71, Operations, Taxes, and Accounting InputsR 3.3.4, Interest Rates Outputs

3.6.3.7.4, Stress Test Whole Loan Cash Flow

Outputs

3.7.4., Mortgage-Related Securities Outputs

3.8.4., Nonmortgage Instrument Outputs

3.12.2., Risk-Based Capital Requirement Inputs R 3.3.4, Interest Rates Outputs

3.9.4., Alternative Modeling Treatments Outputs

3.10.4., Operations, Taxes, and Accounting

Outputs

* * * * * 3.1.2.1 * * *

TABLE 3–4.—ADDITIONAL MULTIFAMILY LOAN CLASSIFICATION VARIABLES

Variable Description Range

Multifamily Product Code Identifies the mortgage product types for multifamily

loans

Fixed Rate Fully Amortizing

Adjustable Rate Fully Amortizing

5 Year Fixed Rate Balloon

7 Year Fixed Rate Balloon

10 Year Fixed Rate Balloon

15 Year Fixed Rate Balloon

Balloon ARM

Other

New Book Flag ’’New Book’’ is applied to Fannie Mae loans acquired

beginning in 1988 and Freddie Mac loans acquired

beginning in 1993, except for loans that were refinanced to avoid a default on a loan originated or

acquired earlier.

New Book

Old Book

Ratio Update Flag Indicates if the LTV and DCR were updated at origination or at Enterprise acquisitionYes

No

Interest Only Flag Indicates if the loan is currently paying interest only.

Loans that started as I/Os and are currently amortizing should be flagged as ‘N’.

Yes

No

Current DCR Assigned classes for the Debt Service Coverage

Ratio based on the most recent annual operating

statement

DCR < 1.00

1.00 <=DCR<1.10

1.10 <=DCR<1.20

1.20 <=DCR<1.30

1.30 <=DCR<1.40

1.40 <=DCR<1.50

1.50 <=DCR<1.60

1.60 <=DCR<1.70

1.70 <=DCR<1.80

1.80 <=DCR<1.90

1.90 <=DCR<2.00

2.00 <=DCR<2.50

2.50 <=DCR<4.00

DCR >= 4.00

Prepayment Penalty Flag Indicates if prepayment of the loan is subject to active prepayment penalties or yield maintenance

provisions

Yes

No

* * * * * 3.3.1 * * *

[b] The process for determining interest

rates is as follows: first, identify values for

the necessary Interest Rates at time zero;

second, project the ten-year CMT for each

month of the Stress Period as specified in the

1992 Act; third, project the 1-month Treasury

yield, the 3-month, 6-month, 1-, 2-, 3-, 5-, 20-

65158 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

and 30-year CMTs; fourth, project nonTreasury Interest Rates, including the Federal

Agency Cost of Funds Index; and fifth,

project the Enterprises Cost of Funds Index,

which provides borrowing rates for the

Enterprises during the Stress Period, by

increasing the Agency Cost of Funds Index

by 10 basis points for the last 108 months of

the Stress Test.

* * * * *

3.3.3 * * *

[a] * * *

3. * * *

c. Enterprise Borrowing Rates. In the Stress

Test, the Federal Agency Cost of Funds

Index is the same as the Enterprise Cost

of Funds Index during the Stress Period,

except that the Stress Test adds a 10

basis-point credit spread to the Federal

Agency Cost of Funds rates to project

Enterprise Cost of Funds rates for the last

108 months of the Stress Period.

* * * * *

3.5.3 * * *

[a] * * *

2. * * *

d. The Stress Test will permit a higher

rating to be used for an unrated sellerservicer who participates in a delegated

underwriting and servicing program that

requires a loss-sharing agreement when:

(1) The loss sharing agreement is

collateralized by a fully funded reserve

account pledged to the Enterprise; and

(2) the reserve account is in an amount

that is equal to or exceeds the amount

that OFHEO has determined to be

adequate to support the seller-servicer’s

loss-sharing obligation under the

program. Determinations of the reserve

requirement and of the rating that will be

permitted will be made on a program-byprogram and Enterprise-by-Enterprise

basis by the Director.

3. Determine Maximum Haircuts. The Stress

Test specifies the Maximum Haircut (i.e.,

the maximum reduction applied to cash

flows during the Stress Test to reflect the

risk of loss due to counterparty

(including security) default) by rating

category and counterparty type as shown

in Table 3–31.

a. The Maximum Haircut for a rating

category is the product of its default rate

and its loss severity rate. For all

counterparties the default rates are 5

percent for AAA, 12.5 percent for AA, 20

percent for A, 40 percent for BBB and

100 percent for Below BBB and Unrated.

For non-derivative counterparties, the

loss severity rate is 70 percent; for

derivative counterparties, it is 10

percent. For all Below BBB and Unrated

counterparties, the loss severity rate is

100 percent.

b. For periods prior to the implementation

of netting, a separate set of Maximum

Haircuts (set forth in Table 3–31) will be

applied to derivative contract cash flows

to approximate the impact of the net

exposures to derivative contract

counterparties (see section 3.8.3,

Nonmortgage Instrument Procedures).

After the implementation of netting,

exposures will be netted as described in

section 3.8.3 before the haircut is

applied.

c. With the exception of haircuts for the

Below BBB and Unrated category,

haircuts for all counterparty categories

are phased-in linearly over the 120

months of the Stress Period. The

Maximum Haircut is applied in month

120 of the Stress Period. Haircuts for the

Below BBB and Unrated category are

applied fully starting in the first month

of the Stress Test.

TABLE 3–31.—STRESS TEST MAXIMUM HAIRCUT BY RATINGS CLASSIFICATION

Ratings Classification

Derivative

Contract

Counterparties

prior to Implementation of

Netting

Derivative

Contract

Counterparties

after Implementation of

Netting

Non-Derivative

Contract

Counterparties

or Instruments

Number of

Phase-in

Months

Cash 0% 0% 0% N/A

AAA 0.3% 0.5% 3.5% 120

AA 0.75% 1.25% 8.75% 120

A 1.2% 2% 14% 120

BBB 2.4% 4% 28% 120

Below BBB and Unrated 100% 100% 100% 1

* * * * *

3.6.3.4.3.1 * * *

[a] * * *

2. * * *

a. LTVq is evaluated for a quarter q as:

LTVORIG ×













































Ratio of current

Loan Group UPB

to Original UPB

Ratio of current property

value (based on HPI in

quarter q) to original

property value (based on 

HPI at Origination)

The HPI at Origination is updated to the

beginning of the Stress Test using actual

historical experience as measured by the

OFHEO HPI; and then updated within the

Stress Test using House Price Growth Factors

from the Benchmark region and time period:

LTV LTV

UPB

UPB

CHPGF HPGR

q ORIG

m q

ORIG

LG

k

k

q

=

×





 





× 



























= −

=

∑

 

3 3

0

1

exp

Where:

UPBm=3q-3 = UPB for the month at the end of

the quarter prior to quarter q

CHPGFoLG= 1.0 if the loan was originated in

the same quarter as or after the most

recently available HPI as of the reporting

date

* * * * *

3.6.3.5.1

[b] Explanatory Variables for Default Rates.

Eight explanatory variables are used as

specified in the equations section 3.6.3.5.3.1,

of this Appendix, to determine Default rates

for multifamily loans: Mortgage Age,

Mortgage Age Squared, New Book indicator,

Not Ratio-updated ARM indicator, current

Debt-Service Coverage Ratio, Underwater

Current Debt-Service Coverage indicator,

Loan-To-Value Ratio at origination/

acquisition, and a Balloon Maturity indicator.

Regression coefficients (weights) are

associated with each variable. All of this

information is used to compute conditional

annual Default rates throughout the Stress

Test. The annualized Default rates are

converted to monthly conditional Default

rates and are used together with monthly

conditional Prepayment rates to calculate

Stress Test Whole Loan Cash Flows. (See

section 3.6.3.7, Stress Test Whole Loan Cash

Flows, of this appendix).

* * * * *

3.6.3.5.2

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65159

TABLE 3-38—LOAN GROUP INPUTS FOR MULTIFAMILY DEFAULT AND PREPAYMENT CALCULATIONS

Variable Description Source

Mortgage Product Type RBC Report

A0 Age immediately prior to start of Stress Test, in months (weighted average for Loan Group) RBC Report

NBF New Book Flag RBC Report

RUF Ratio Update Flag RBC Report

LTVORIG Loan-to-Value ratio at loan Origination RBC Report

DCR0 Debt Service Coverage Ratio at the start of the Stress Test RBC Report

PMT0 Amount of the mortgage Payment (principal and interest) prior to the start of the Stress

Test, or first Payment for new loans (aggregate for Loan Group)

RBC Report

PPEM Prepayment Penalty End Month number in the Stress Test (weighted average for Loan

Group)

RBC Report

RM Remaining term to Maturity in months (i.e., number of contractual payments due between

the start of the Stress Test and the contractual maturity date of the loan) (weighted average for Loan Group)

RBC Report

RGRm Benchmark Rent Growth for months m = 1 120 of the Stress Test section 3.4.4, Property Valuation Outputs

RVRm Benchmark Vacancy Rates for months m = 1 120 of the Stress Test section 3.4.4, Property Valuation Outputs

PMTm Scheduled Payment for months m = 1 RM 3.6.3.3.4, Mortgage Amortization Schedule

Outputs

OE Operating expenses as a share of gross potential rents (0.472) fixed decimal from Benchmark region and

time period

RVRo Initial rental vacancy rate 0.10

* * * * *

3.6.3.5.3.1 * * *

[a] * * *

2. Assign product and ratio update flags

(NBF, NRAF). Note: these values do not

change over time for a given Loan Group.

a. New Book Flag (NBF):

NBF = 1 for Fannie Mae loans acquired after

1987 and Freddie Mac loans acquired after

1992, except for loans that were refinanced

to avoid a Default on a loan originated or

acquired earlier.

NBF = 0 otherwise.

b. Not Ratio-updated Arm Flag (NRAF):

NRAF = 1 if both ARMF = 1 and RUF = 0,

NRAF = 0 otherwise.

Where:

ARMF = 1 for ARMs (including Balloon

ARMs)

ARMF = 0 otherwise, and

RUF = 1 if the LTV and DCR were calculated

or delegated to have been calculated at

origination or recalculated or delegated to

have been recalculated at Enterprise

acquisition according to current Enterprise

standards.

RUF = 0 otherwise

* * * * *

3.6.3.5.3.2 * * *

[a] * * *

1. Compute the logits for multifamily Default

using inputs from Table 3–38 and

coefficients from Table 3–39. For

indexing purposes, the Default rate for a

period m is the likelihood of missing the

mth payment; calculate its corresponding

logit (Xδm) based on Loan Group

characteristics as of the period prior to

m, i.e. prior to making the mth payment.

X AY AY

NBF NRAF

DCR

UWDCRF

LTV

BMF

m AY m AY m

NBF NRAF

DCR m

UWDCRF m

LTV ORIG

BMF m

δδ δ

δ δ

δ

δ

δ

δ δ

= +

+ +

+ ( )

+

+ ( )

+ +

− −

−

−

−

1

2

1

1

1 0

2 1

 

 

 

 

 

ln

ln

TABLE 3–39—EXPLANATORY VARIABLE

COEFFICIENTS FOR MULTIFAMILY DEFAULT

Explanatory Variable Default Weight (δv)

AY 0.5256

AY2 ¥0.0284

NBF ¥1.219

NRAF 0.4193

DCR ¥2.368

TABLE 3–39—EXPLANATORY VARIABLE

COEFFICIENTS FOR MULTIFAMILY DEFAULT—Continued

Explanatory Variable Default Weight (δv)

UWDCRF 1.220

LTV 0.8165

BMF 1.518

Intercept (δ0) ¥4.553

* * * * *

2. * * *

b. For the down-rate scenario, APRm = 0

percent during the Prepayment penalty

period (i.e., when m ≤ PPEM)

APRm = 25 percent after the Prepayment

penalty period (i.e., when m > PPEM)

* * * * *

3. Convert annual Prepayment and Default

rates to monthly rates (MPR and MDR)

using the following formulas for

simultaneous processes:

MPR APR

ADR APR

ADR APR

m m

m m

m m

= +

×−− − ( ) 



 



 1 1

1

12

If both ARMF = 0 and RUF = 0, then

65160 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

MDR ADR

ADR APR

ADR APR

m m

m m

m m

= +

×−− − ( ) 



 





×

 

 

1 1

1 2

1

12

.

otherwise,

MDR ADR

ADR APR

ADR APR

m m

m m

m m

= +

×−− − ( ) 



 



 1 1

1

12

* * * * *

3.6.3.6.3.2 * * *

TABLE 3–44—LOAN GROUP INPUTS FOR MULTIFAMILY GROSS LOSS SEVERITY

Variable Description Value or Source

Government Flag RBC Report

DRm Discount Rate in month m (decimal per annum) 6-month Enterprise Cost of Funds from Section 3.3, Interest Rates

MQ Time during which delinquent loan interest is passed-through to MBS holders 4 for sold loans

0 otherwise

PTRm Pass Through Rate applicable to payment due in month m (decimal per annum) section 3.6.3.3.4, Mortgage Amortization

Schedule Outputs

NYRm Net Yield Rate applicable to payment due in month m (decimal per annum) section 3.6.3.3.4, Mortgage Amortization

Schedule Outputs

RHC Net REO holding costs as a decimal fraction of Defaulted UPB 0.07

MF Time from Default to completion of foreclosure (REO acquisition) 9 months

MR Months from REO acquisition to REO disposition 15 months

RP REO proceeds as a decimal fraction of Defaulted UPB 0.63

* * * * *

3.6.3.6.4.3 * * *

[a] * * *

1. Determine Mortgage Insurance Payment

(MIm) for single family loans in the DCC,

or Loss Sharing Payment (LSAm) for

multifamily loans in the DCC, as a

percentage of Defaulted UPB, applying

appropriate counterparty Haircuts from

section 3.5, of this Appendix:

MI MIExp

C CLM

m MaxHct R

m

DCC mLG

MI DCC

m

MI LG

MI DCC

= − ( )

× ×

× − ′ × ( ) 



 





1

1

120

 

 

, ,

,

LSA C CLM

m MaxHct R

m

DCC LSA DCC

m

LSA LG

LSA DCC

= ×

× − ′ × ( ) 



 





, ,

, 1

120

Where:

m′ = m, except for counterparties rated below

BBB, where m’ = 120

MIExp

UPB

UPB

MIExp

m

LG

m

LG

ORIG

LG

m

LG

=

× 









 <

=

=

1

0 78

0

 if

 LTV

 otherwise

0.78 (78%) the LTV at which MI is 

 cancelled if payments are

 current

ORIG .

* * * * *

3.* * *

b. Determine CE Payment in Dollars after

application of Haircuts:

PD PD

m MaxHct R

m

DCC C H mDCC C

DCC C

,, ,

,

1 1

1

120

=

× − ′ × ( ) 



 



 1

Where:

m′ = m, except for counterparties rated below

BBB, where m′ = 120

* * * * *

4.* * *

b. Determine CE Payment in Dollars after

application of Haircuts:

PD PD

m MaxHct R

m

DCC C H

m

DCC C

DCC C

,, ,

,

2 2

2

120

=

× − ′ × ( ) 



 



 1

Where:

m′ = m, except for counterparties rated below

BBB, where m′ = 120

* * * * *

5. Convert Aggregate Limit First and Second

Priority Contract receipts in Dollars for

each DCC in month m to a percentage of

DCC Defaulted UPB:

ALPD

PD ELPI PD ELPI

DEF UPB P m

DCC m

DCC C H DCC C mDCC C H DCC C

m m

LG DCC = ( ) × + × ( )

× × −

,, , , , , 1 12 2

1

Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules 65161

5 Ibid.

Where:

ELPIDCC,C = 0 if ELPFDCC,C = Y (Yes,

indicating that Contract C is an Enterprise

Loss Position)

ELPIDCC,C = 1 otherwise

* * * * *

3.6.3.7.3. * * *

[a] * * *

9. * * *

b. Float Income (FI) received in month m

FI SPR NIR GF

FDS PPR FDP

FREP PIS

m m mm

m

m

= +− [([( )

× 



 + × 



 











× ×− ( )] −

 

 FERm

365 365

1

Where:

Prepayment Interest Shortfall (PIS) in month

m is:

PIS UPB PRE PTR

FER

PIS UPB PRE PTR

FER

mm m m

m

mm m m

m

= ××

−××

≥

= ××

−××

≤ <

−

−

1

1

12

12

24

24

 FREP PPR

 if FDP 30

 FREP PPR

 if 15 FDP 30

m

m

* * * * *

3.7.3.1 * * *

[g] * * *

1. Compute:

HctFac m m = MaxHct R ′ ×

120 ( )

Where:

m’ = m, except for MBS credit rating below

BBB where m’=120

R = MBS credit rating

* * * * *

3.8.1 * * *

[f] In a currency swap, the Enterprise

receives payments that are denominated in a

foreign currency and it makes payments in

U.S. dollars. The main difference between

currency swaps and the type of swaps

discussed above is that in a currency swap

principal amounts are actually exchanged

between the two counterparties. Currency

swaps are divided into two classes, as shown

in Table 3–65 below.5

TABLE 3–65—CURRENCY SWAP CONTRACT CLASSIFICATION

Classification Description of Contract

Fixed-for-Fixed Currency Swap Enterprise receives fixed interest payments denominated in a foreign currency and makes fixed, US$-denominated payments

Fixed-for Floating Currency Swap Enterprise receives fixed interest payments denominated in a foreign currency and makes payments in US$

based on a floating interest rate

* * * * *

3.8.3.1 * * *

[a] * * *

3. When applying the option exercise rule:

a. For zero coupon and discount securities,

instruments with European options, and

zero coupon swaps, evaluate option

exercise only on dates listed in the

instrument’s option exercise schedule.

For Bermudan options, evaluate option

exercise on the first option date in the

instrument’s option exercise schedule

and subsequent coupon dates (coupon

dates on the fixed-rate leg for swaps). For

American options, evaluate option

exercise on the first option date in the

instrument’s option exercise schedule

and subsequent monthly anniversaries of

the instrument’s first coupon date.

* * * * *

3.8.3.10 * * *

[a] Finally, the interest and principal cash

flows received by the Enterprises for nonmortgage instruments other than swaps and

foreign currency-related instruments are

Haircut (i.e., reduced) by a percentage to

account for the risk of counterparty

insolvency, if a counterparty obligation

exists. The amount of the Haircut is

calculated based on the public rating of the

counterparty and time during the stress

period in which the cash flow occurs, as

specified in section 3.5, Counterparty

Defaults, of this Appendix.

[b] An Enterprise may issue debt

denominated in, or indexed to, foreign

currencies, and eliminate the resulting

foreign currency exposure by entering into

currency swap agreements. The combination

of the debt and the swap creates synthetic

debt with principal and interest payments

denominated in U.S. dollars. The Haircuts for

currency swaps are applied to the pay

(dollar-denominated) side of the currency

swaps, or to the cash outflows of the

synthetic debt instrument. Therefore, the

payments made by the Enterprise on a

foreign currency contract are increased by the

haircut amount. The Haircuts and the Phasein periods for currency swaps are detailed in

Table 3–31, under Derivative Contracts.

[c] Haircuts for swaps that are not foreign

currency related are applied to the Monthly

Interest Accruals (as calculated in section

3.8.3.8, of this Appendix) on the receive leg

minus the Monthly Interest Accruals on the

pay leg when this difference is positive. Use

the maximum haircut from Table 3–31 for

periods before and after the implementation

of netting, as appropriate. After the

implementation of netting, net the swap

proceeds for each counterparty before

applying the haircuts. The following example

applies to an Enterprise having two swaps

with the same counterparty. On the first

swap, the Enterprise pays fixed and receives

floating and on the second swap it pays

floating and receives fixed. If the

counterparty is a net payer to the Enterprise,

the haircuts will be applied to the sum of the

two receive legs net of the sum of the two pay

legs.

* * * * *

3.10.3.1 * * *

[b] * * *

2. In any month in which the cash position

is negative at the end of the month, the

Stress Test issues a mix of new short-term

and long-term debt on the 15th day of that

month. New short-term debt issued is sixmonth discount notes with a discount rate

at the six-month Enterprise Cost of Funds

as specified in section 3.3, Interest Rates,

of this Appendix, with interest accruing on

a 30/360 basis. New long-term debt issued

is five-year bonds not callable for the first

year (‘‘five-year-no call-one’’) with an

American call at par after the end of the

first year, semiannual coupons on a 30/360

basis with principal paid at maturity or

call, and a coupon rate set at the five year

Enterprise Cost of Funds as specified in

section 3.3, Interest Rates, of this

Appendix, plus a 50 basis point premium

for the call option. An issuance cost of 2.5

basis points is assessed on new short-term

debt at issue and an issuance cost of 20

basis points is assessed on new long-term

debt at issue. New long-term debt is issued

to target a total debt mix of short to long

term debt that is the same as the short to

long term debt mix at the beginning of the

Stress Test. Issuance fees for new debt are

amortized on a straight line basis to the

maturity of the appropriate instrument.

3. Given the Net Cash Deficit (NCDm) in

month m, use the following constants

and method to calculate the amount of

short-term and long-term debt to issue in

month m:

a. Set the Issuance Cost on new short-term

debt at issue (ISCOST):

ISCOST = 0.00025

b. Set the Issuance Cost on new long-term

debt at issue (ILCOST):

ILCOST = 0.002

c. Calculate Net Short-term Debt

Outstanding (NSDO0) and Total Debt

Outstanding (TDO0) at the start of the

65162 Federal Register / Vol. 66, No. 243 / Tuesday, December 18, 2001 / Proposed Rules

Stress Test (m = 0) using the following

methodology:

(1) For each month m and each debt and

swap instrument i (each swap leg is

considered a separate instrument),

determine the Month of Next Repricing

(MNRm) defined as the first month

greater than m in which the instrument

matures, an option is exercised, or

repricing can occur whether or not the

coupon rate actually changes. Set the

Principal Balance (PBm) to be:

(a) the principal (or notional principal)

outstanding if the instrument cash flows

are paid by the Enterprise,

(b) minus the principal (or notional

principal) outstanding if the instrument

cash flows are received by the

Enterprise.

(2) Calculate NSDOm by summing PBm,i for

all instruments where MNRm,i is less

than or equal to m plus 12.

(3) Calculate TDOm by summing PBm,i for

instruments where MNRm,i is greater

than m.

d. Set the Maximum Proportion of Total

Debt (MPD):

MPD TDO NSDO

TDO = 0 0 −

0

e. Calculate Discount Rate Factor (DRFm):

DRF CF m m = + 





 1

12

6

Where: CFm = six month Enterprise Cost of

Funds for month m

f. Calculate the Adjustment Factor for

Short-Term Debt Issuance Fees (AFSIFm):

AFSIF DRF

ISCOST DRF m m

m

= 1− ×

g. Calculate the Adjustment Factor for

Long-Term Debt Issuance Fees (AFLIFm):

AFLIF

ILCOST m = −

1

1

h. Calculate the Maximum Long-Term

Issuance (MLTIm):

MLTI NCD AFLIF mm m = ×

i. Calculate Net Short-Term Debt

Outstanding (NSDOm) and Total Debt

Outstanding (TDOm) for month m using

the methodology described in section

3.c. of this section. Note: This

calculation must reflect all new

issuances, option exercises, and

maturities between the beginning of the

Stress Test and month m.

j. Calculate Interim Face Amount of LongTerm Debt to be issued this month

(IFALDm):

IFALD

MPD TDO NSDO MPD AFSIF NCD

MPD AFSIF MPD

AFLIF

m

m m mm

m

m

= ( ) ( ) − × + +× × ( )

−+ × 



 





1

1

k. Calculate Face Amount of Long-Term Debt to be issued (FALDm):

FALDm m = min max MLTI IFALD ( ) m, , ( ) 0

l. Calculate Face Amount of Short-Term Debt to be issued (FASDm):

FASD AFSIF FALD

AFLIF m m m

m

=× − 



 



 NCD max 0, m

* * * * *

3.10.3.6.2***

[a] * * *

5. Fixed Assets. 25 percent of fixed assets

(net of accumulated depreciation) as of

the beginning of the Stress Test remain

constant over the Stress Test. The

remaining 75 percent is converted to

cash on a straight line basis over the tenyear Stress Period. Depreciation is

included in the base on which operating

expenses are calculated for each month

during the Stress Period.

* * * * *

4.0 * * *

Enterprise Cost of Funds: Cost of funds

used in computing the cost of new debt for

the Enterprises during the Stress Test, as

specified in section 3.3.3[a]3.c., of this

Appendix.

* * * * *

Dated: December 11, 2001.

Armando Falcon, Jr.,

Director, Office of Federal Housing Enterprise

Oversight.

[FR Doc. 01–30898 Filed 12–17–01; 8:45 am]

BILLING CODE 4220–01–P

DEPARTMENT OF HOUSING AND

URBAN DEVELOPMENT

24 CFR Parts 5 and 202

[Docket No. FR–4681–C–02]

Uniform Financial Reporting

StandardsFor HUD Housing Programs,

Additional Entity Filing Requirements;

Correction

AGENCY: Office of the General Counsel,

HUD.

ACTION: Proposed rule; correction.

SUMMARY: On November 30, 2001, HUD

published a proposed rule entitled

‘‘Uniform Financial Reporting

Standards for HUD Housing Programs,

Additional Entity Filing Requirements.’’

The preamble to the rule (although not

the rule text) misstates the date by

which the financial statements of

entities covered by the rule must submit

their financial statements electronically.

This notice corrects the preamble.

FOR FURTHER INFORMATION CONTACT: For

further information about the entities

covered by the proposed rule and this

correction notice, Lynn Herbert, the

Office of Housing, U.S. Department of

Housing and Urban Development, 451

Seventh Street, SW., Washington, DC

20410, telephone 202–708–3976 (this is

not a toll-free number). For general

information about this notice and the

proposed rule, Stacey Kniff, Real Estate

Assessment Center, U.S. Department of

Housing and Urban Development, 1280

Maryland Avenue, SW., Suite 800,

Washington, DC 20024, telephone

Technical Assistance Center, 1–888–

245–4860 (this is a toll-free number).

Persons with hearing or speech

impairments may access these

telephone numbers via TTY by calling

the Federal Information Relay Service at

(800) 877–8339. Additional information

is available from the REAC Web site at

http://www.hud.gov/reac/.

SUPPLEMENTARY INFORMATION: On

November 30, 2001, HUD published a

proposed rule entitled ‘‘Uniform

Financial Reporting Standards for HUD

Housing Programs, Additional Entity

Filing Requirements’’ at 66 FR 60132.

The preamble to the proposed rule, in

the third column of that page,

immediately above the ‘‘Findings and

Certifications’’ section, states: