Alert September 01, 2009

Federal Banking Agencies Issue NPR Regarding Regulatory Capital Standards Related to Adoption of FAS No. 166 and 167

The OCC, FRB, FDIC, and OTS (collectively, the “Agencies”) issued a notice of proposed rulemaking with request for public comment (the “NPR”) on a proposed regulatory capital rule related to the implementation of Financial Accounting Standards Board’s Statement of Financial Accounting Standards No. 166 and 167 (“FAS No. 166 and 167” or the “2009 GAAP Modifications”), which will be effective for most companies starting January 1, 2010.  (For further discussion of the 2009 GAAP Modifications, please see the June 16, 2009 Alert.)  The Agencies are proposing to modify their general risk-based and advanced risk-based capital adequacy frameworks to eliminate the exclusion of certain consolidated asset-backed commercial paper (“ABCP”) programs from risk-weighted assets.  The Agencies also propose to eliminate the associated provisions excluding from Tier 1 capital the minority interest in a consolidated ABCP program not included in a banking organization’s risk-weighted assets.  Furthermore, the Agencies note that there may be instances when a banking organization structures a financial transaction with a special purpose entity to avoid consolidation under FAS No. 166 and 167, and the resulting capital treatment is not commensurate with the actual risk relationship of the banking organization to the entity.  Accordingly, the NPR provides a reservation of authority in the capital adequacy frameworks that would permit the Agencies to require banking organizations to treat entities that are not consolidated under accounting standards as if they were consolidated for risk-based capital purposes, commensurate with the risk relationship of the banking organization.  The Agencies are issuing the NPR to better align regulatory capital requirements with the actual risks of certain exposures.

The Agencies noted in the NPR that their capital standards generally use GAAP treatment of an exposure as a starting point for assessing regulatory capital requirements for that exposure.  As the 2009 GAAP Modifications generally will increase the amount of exposures recognized on banking organizations’ balance sheets, which will generally result in higher regulatory capital requirements for those banking organizations affected by the new accounting standards.  The NPR notes that, in light of recent experience, the Agencies believe that the accounting consolidation requirements that will be implemented by the 2009 GAAP Modifications will result in a regulatory capital treatment that more appropriately reflects the risks to which banking organizations are exposed.  Accordingly, the Agencies provide in the NPR that they “do not, at this time, find a compelling basis exists for modifying their regulatory capital requirements to alter the effect of the 2009 GAAP Modifications on banking organizations’ minimum regulatory capital requirements.” 

The Agencies are seeking comment on all aspects of the NPR, including, (i) with respect to the types of variable interest entities a bank will have to consolidate, the features and characteristics of securitization transactions or other transactions with variable interest entities or other special purpose entities that are more or less likely to cause a bank to provide non-contractual (implicit) support, and (ii) the effect the 2009 GAAP Modifications will have on banking organizations’ financial positions, lending and activities.  The Agencies also specifically requested comment and supporting data on the impact of immediate application of the 2009 GAAP Modifications on the regulatory capital requirements of banking organizations, and whether the Agencies should consider a phase‑in of the capital requirements that would result from the 2009 GAAP Modifications (such as over the course of a four-quarter period).

Comments on the NPR are due within 30 days after its publication in the Federal Register, which is expected soon.