The United States federal bank regulators are proposing to revise their risk-based capital standards. The proposal would significantly change the risk-based capital treatment of most securitization transactions. The OCC, the Federal Reserve Board, the FDIC and the OTC have all initiated this proposal.
The most significant provisions of the proposal would:
assess equivalent risk-based capital charges to recourse obligations and direct credit substitutes;
vary the risk-based capital assessed to banks in securitization transactions on the basis of ratings assigned by rating agencies to the positions of the banks in these transactions; and
require the sponsor of a revolving credit securitization that involves an early amortization feature to hold capital against all of the assets under management.
Background
The current proposal is an extension of a November 1997 proposal by the U.S. bank regulators that had two principal goals:
First, to amend the risk-based capital standards applied to U.S. banking institutions to treat recourse transactions the same as direct credit substitutes for purposes of risk-based capital; and
Second, to use credit ratings assigned by rating agencies to determine the capital requirement for recourse obligations, direct credit substitutes and senior asset-backed securities.
A number of comments regarding the 1997 proposal were submitted to the regulators, but until now they had not responded to these comments or moved the 1997 proposal forward.
In June 1999, the Basel Committee on Banking Supervision issued a consultative paper that proposed revisions to the 1988 Basel Accord. The Basel consultative paper discusses potential modifications to the current capital standards applied by banks worldwide, including the capital treatment of securitizations. The suggested changes in the Basel consultative paper would also look to external credit ratings issued by qualifying credit rating agencies as a basis for determining the credit quality and the resulting capital treatment of securitizations. Comments with respect to the Basel consultative paper are due by March 31, 2000.
The Current Proposal -- Key Elements
Proposed Treatment of Recourse and Direct Credit Substitutes
The regulators are again proposing to extend the current risk-based capital treatment of asset transfers with recourse, including the low-level recourse rule, to direct credit substitutes. The proposal indicates that the agencies have considered each of the objections that have been raised with respect to this approach. They have attempted to address one of the points -- the competitive disadvantage that U.S. banks and thrifts would suffer at the international level if this approach were adopted solely by the U.S. agencies -- by encouraging the bank supervisory authorities from the other countries represented on the Basel Committee to adopt this approach as well. The Basel Committee's 1999 consultative paper has not adopted this approach, but it does acknowledge that the current Basel Capital Accord treats recourse transactions and direct credit substitutes differently.
Proposed Treatment for Rated Positions
Under the ratings-based approach contained in the proposal, the capital requirement for a recourse obligation, direct credit substitute or traded asset-backed security would be determined as follows:
- Rating Category
- Examples
- Risk Weight
- Highest or second highest investment grade
- AAA or AA
- 20%
- Third highest investment grade
- A
- 50%
- Lowest investment grade
- BBB
- 100%
- One catagory below investment grade
- BB
- 200%
- More than one catagory below investment grade, or unrated
- B or unrated
- "Gross-up" Treatment
To determine the risk-based capital charge, a bank would multiply the balance of financed assets by the appropriate risk weight and then by 8%. The capital charge would be the lesser of this amount and:
if the risk weight is 100% or lower, the amount of credit support provided by the bank, or
if the risk weight is greater than 100%, the product of the risk weight and the amount of credit support provided by the bank.
Under the proposal, the ratings-based approach is available for traded asset-backed securities and for traded and non-traded recourse obligations and direct credit substitutes. However, the ability to apply this approach to non-traded positions is subject to some limitations. A position is considered "traded" if, at the time it is rated by an external rating agency, there is a reasonable expectation that in the near future: (1) the position may be sold to investors relying on the rating; or (2) a third party may enter into a transaction, such as a loan or repurchase agreement, involving the position in which the third party relies on the rating of the position. If external rating agencies rate a traded position differently, the single highest rating applies.
Proposed Treatment for Non-traded and Unrated Positions
The distinction between traded and non-traded positions arose out of a single comment provided by a single rating agency with respect to the 1997 proposal. The rating agency felt that ratings of non-traded positions could be inflated if "ratings shopping" occurred, as there was not sufficient "market risk" pressure to ensure rating agencies kept the rating levels at appropriate levels. The 1997 proposal included criteria to reduce the possibility of inflated ratings and inappropriate risk weights if ratings are used for a position that is not traded. Under the terms of the 1997 proposal a non-traded position could qualify for the ratings-based approach only if:
it qualified under ratings obtained from two different rating agencies;
the ratings were publicly available;
the ratings were based on the same criteria used to rate securities sold to the public; and
at least one position in the securitization was traded.
In comments responding to the 1997 proposal, banks expressed concern about the cost and delay associated with obtaining ratings, particularly for direct credit substitutes, that they would not otherwise need.
In the proposal, the regulators have retained the first three of the 1997 proposal's four criteria for rated non-traded positions, but have eliminated the fourth criterion, the requirement that one position in the securitization be traded. To address concerns expressed by commenters on the 1997 proposal, however, the agencies have now proposed several alternative approaches for determining the capital requirements for unrated direct credit substitutes. Under each of these approaches, the banking organization must satisfy its supervisory agency that use of the approach is appropriate for the particular banking organization. Each of these approaches could be used to qualify a direct credit substitute, but not a retained recourse provision, for a risk weight of 100% or 200% of the face value of the position under the ratings-based approach, but not for a risk weight of less than 100%.
One such approach would permit a banking organization with a qualifying internal risk rating system to use that system to apply the ratings-based approach to the banking organization's unrated direct credit substitutes in asset-backed commercial paper programs.
A second approach would be to authorize a banking organization to use a rating obtained from a rating agency or other appropriate third party of unrated direct credit substitutes that satisfy specifications set by the rating agency.
A third approach would allow banking organizations, particularly those with limited involvement in securitization activities, to rely on qualifying credit assessment computer programs that the rating agencies or other appropriate third parties have developed for rating otherwise unrated direct credit substitutes in asset securitizations.
Recourse transactions will be eligible for the ratings-based approach only if they are rated and satisfy each of the other requirements for non-traded positions.
Managed Assets Approach
The proposal would apply a managed assets approach that would require a banking organization to hold additional capital with respect to "revolving" credit securitization structures, such as credit card securitizations effected through a master trust arrangement, that include early amortization provisions. The approach would require securitized (off-balance sheet) receivables to be included in risk-weighted assets when determining its risk-based capital requirements. The securitized, off-balance sheet assets would be assigned to the 20 percent risk category, thereby effectively applying a 1.6% risk-based capital charge to those assets.
If the sponsoring banking organization in a revolving credit securitization provides credit protection to investors, the sum of the regulatory capital requirements for the credit protection and the 1.6% charge on the off-balance sheet securitized assets would not, under the terms of the proposal, exceed 8% of securitized assets for that particular securitization transaction.
The regulators have requested comment on the proposed managed assets approach, and have suggested that another approach -- possibly providing greater public disclosure of the performance of securitized transactions -- may be appropriate.
Representations and Warranties
The proposal addresses those particular representations and warranties that function as credit enhancement -- that is, where a banking organization, by making such representations and warranties, agrees to protect purchasers or some other party from losses due to the default or non-performance of the obligor or insufficiency in the value of collateral. To the extent a banking organization's representations and warranties function as credit enhancement in this manner, the proposal treats them as recourse or direct credit substitutes.
Other
The proposal also addresses a variety of other topics, including the proper capital treatment of derivative instruments.
Effective Date of a Final Rule Resulting from the Proposal
Any final rules adopted as a result of the proposal that result in increased risk-based capital requirements for banking organizations will apply only to securitization activities as defined in the proposal entered into or acquired after the effective date of the final rules. Conversely, any final rules that result in reduced risk-based capital requirements for banking organizations may be applied to all transactions outstanding as of the effective date of the final rules and to all subsequent transactions. Because some ongoing securitization conduits may need additional time to adopt any new capital treatments, the proposal states that the agencies intend to permit banking organizations to apply the existing capital rules to asset securitizations with no fixed term, such as asset-backed commercial paper conduits, for up to two years after the effective date of any final rule.
The agencies have requested comment by May 26, 2000 on all aspects of the proposal. *