Alert December 13, 2011

OCC Proposes Rule Amendments to Remove References to Credit Ratings and Provides Guidance on Due Diligence Requirements in Determining Whether Investment Securities Are Eligible for Investment

The OCC announced the issuance of proposed amendments to remove references to credit ratings from various OCC regulations and related proposed guidance designed to assist national banks and federal savings associations in meeting due diligence requirements for assessing credit risk for portfolio investments.  In particular, the OCC is proposing to amend the definition of “investment grade” to remove the current reference to credit ratings and to replace other references to credit ratings with alternative standards of creditworthiness for the purposes of its regulations at 12 CFR parts 1, 16, 28, and 160.

National Bank Regulations.   Under the proposed amendments to parts 1 and 16, a security would be “investment grade” if the issuer of the security has an adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure.  The “adequate capacity to meet financial commitments” standard would replace language in §§ 1.2 and 16.2 which currently reference NRSRO credit ratings.  To meet this new standard, national banks would be required to determine that the risk of default by the obligor is low and the full and timely repayment of principal and interest is expected.

While a bank would be permitted to consider external credit ratings and assessments, it would be required to supplement external ratings with due diligence processes and analyses that are appropriate for the bank’s risk profile and for the size and complexity of the instrument.

Foreign Banking Institutions.   The OCC’s capital equivalency deposit regulation at 12 CFR 28.15 currently allows for the use of certificates of deposit or bankers’ acceptances as part of the deposit, if the issuer is rated investment grade by an internationally recognized rating organization.  The OCC is proposing to remove the requirement referencing credit ratings provided by ratings organizations. Instead, the issuer of the certificate of deposit or banker’s acceptance must have “an adequate capacity to meet financial commitments for the projected life of the asset or exposure.”

Diligence Requirements for Assessing Credit Risk for Portfolio Investments.  The proposed guidance sets forth the OCC’s expectation that national banks and Federal savings associations should conduct an appropriate level of due diligence to determine that an investment security is a permissible investment, which may include consideration of internal analyses, third party research and analytics including external credit ratings, internal risk ratings, default statistics, and other sources of information as appropriate for the particular security.  Under the proposed guidance, the depth of the due diligence would be a function of the security’s credit quality, the complexity of the structure, and the size of the investment.  The more complex a security’s structure, the more credit-related due diligence an institution would need to perform, even when the credit quality is perceived to be very high.  Bank management would need to ensure that it understands the security’s structure and how the security will perform in different default environments, and be particularly diligent when purchasing structured securities.  National banks and federal savings associations would have to consider a variety of factors relevant to the particular security when determining whether a security is a permissible and sound investment.  The range and type of specific factors would vary depending on the particular type and nature of the securities.  The proposed guidance includes a list of factors that may be relevant to evaluating potential purchases of Corporate Bonds, Municipal Government General Obligations, Revenue Bonds or Structured Products.

Public Comment.  Comments on the proposed amendments and guidance must be submitted no later than December 29, 2011.