Alert January 08, 2008

OCC and FRB Provide Guidance Concerning Risk-Based Capital Treatment for Synthetic Securitizations

The OCC and FRB released a joint interpretive letter (the “Joint Letter,” OCC Letter #1091), examining the risk-based capital treatment of certain synthetic securitizations of home equity lines of credit and home equity loans.  In the case of the described synthetic securitization, the bank regulators stated that the arrangement generally qualified for the risk-based capital treatment described in earlier issuances from the regulators.  (See, Joint Agency Guidance on Synthetic Collateralized Loan Obligations, OCC Bulletin 99-43, FRB SR Letter 99-32; Capital Treatment of Recourse, Direct Credit Substitutes, and Residual Interests in Assets Securitizations, 66 Fed. Reg. 59,613 (Nov. 29, 2001) (“Capital Rule”); OCC Letters # 945 (Nov. 2002) & 988 (Apr. 2004); FRB Letter (July 14, 2005)).  For externally-rated retained subordinated and senior positions held by the bank that complied with the requirements outlined in the earlier agency guidance, the bank was permitted to apply risk-based capital formulas.  Where the bank retained an unrated equity position, the bank was required to hold dollar-for-dollar capital against that position.

The Joint Letter notes that eligibility of externally-rated positions for risk-based capital treatment is determined by the Capital Rule issued by the federal banking regulatory agencies in 2001.  The external ratings must come from at least two nationally recognized statistical rating organizations and be based on the same criteria used to rate traded positions.  If the ratings criteria are met, required capital will be determined based on the risk weight of the assets. 

In the situation described in the Joint Letter, the maturity of the synthetic securitization would occur prior to the maturity of the reference assets.  As a result, the bank was permitted to apply lower risk weights to only a portion of the outstanding notional value of certain trances near the end of the arrangement.