Alert May 14, 2013

OCC Issues Bulletin Clarifying Treatment of Certain Sovereign and Securitization Positions Under Market Risk Capital Rule

On May 10, 2013, the OCC issued a bulletin (the “Bulletin”) to clarify two aspects of its final market risk capital rule (the “Rule”), which applies to

(a)        banks with aggregate trading assets and trading liabilities

            (i)         equal to 10% or more of their total assets; or

            (ii)        $1 billion or more; or

(b)        other specific banks to which the OCC determines to apply the Rule because of the applicable bank’s level of market risk or safety and soundness issues (“Covered Institutions”).

The Bulletin was issued by the OCC on August 30, 2012 and was issued in a similar form by the FRB and the FDIC.  The Rule, which amended the OCC’s market risk capital rule, is intended to, among other things, enhance the market risk capital provision’s sensitivity to certain risks, reduce pro-cyclicity, increase transparency through enhanced disclosures and “incorporate non-credit-ratings-based standards for the calculation of specific risk capital requirements for sovereign debt positions, certain other covered debt positions, and securitization positions.”  For a discussion of the Rule, see the September 4, 2012 Financial Services Alert.  In the Bulletin the OCC clarifies its treatment of certain foreign exposures and certain securitization exposures under the Rule.

FOREIGN POSITIONS

Under the Rule the risk capital requirement for a sovereign exposure depends, in part, on the Organization for Economic Cooperation and Development’s (“OECD”) Country Risk Classification (“CRC”) for the applicable country.  After the Rule was issued, the OECD decided that certain high-income countries that received a CRC of zero in 2012 would no longer be assigned a CRC rating, but would remain subject to the same market credit risk pricing disciplines that are applied to all Category Zero countries.  The OCC states in the Bulletin that for purposes of assigning specific risk capital requirements under the Rule, the OCC has decided that the OECD members that no longer are assigned a CRC should nonetheless be treated as having the functional equivalent of a CRC of zero.  In addition, the OCC said, for purposes of assigning specific risk capital requirements under the Rule, the same treatment will be applied “to exposures to public sector entities, depository institutions, foreign banks or credit unions for which the specific risk capital treatment is based on the creditworthiness of those sovereign entities [that are no longer assigned a CRC].”

SECURITIZATION POSITIONS

The OCC notes in the Bulletin that to measure the specific risk of a securitization position a Covered Institution may apply the Simplified Supervisory Formula Approach (“SSFA”), which takes into account the nature and quality of the collateral underlying the securitization.  The Bulletin points out that the SSFA “was designed to apply relatively higher capital requirements to the more risky junior tranches of a securitization that are the first to absorb losses and apply relatively lower requirements to the most senior positions.”  Under the Rule, the SSFA includes a variable “W” that is intended to increase the capital requirement for a securitization exposure as delinquencies in the underlying assets increase.  For purposes of calculating W, an exposure is delinquent  if it is 90 days or more past due, subject to a bankruptcy or insolvency proceeding, in the process of foreclosure, held as real estate owned, in default, or has contractually deferred interest payments for 90 days or more (12 CFR 3, appendix B, section 11(b)(2)(v)).  In the Bulletin the OCC clarifies, however, that for purposes of the SSFA, “deferrals of interest that are unrelated to the performance of the loan or the [creditworthiness of the] borrower, including contractually permitted payment deferrals provided for in certain federally guaranteed student loan programs” will not be regarded as delinquent.

POTENTIAL FURTHER CLARIFICATIONS

The OCC concludes the Bulletin by stating that, as the opportunity arises, it intends to issue further guidance to clarify any other ambiguities in the Rule.