FDIC Board Approves Two Notice of Proposed Rulemakings
At a FDIC Board Meeting on March 20, board members of the Federal Deposit Insurance Corporation (FDIC) unanimously approved two notices of proposed rules (NPR) on large bank assessments and enforcement of subsidiary and affiliate contracts by the FDIC as receiver.
- Notice of Proposed Rulemaking on Assessments, Large Bank Pricing
- Notice of Proposed Rulemaking Regarding the Enforcement of Subsidiary and Affiliate Contracts by the FDIC as Receiver for a Covered Financial Company
Notice of Proposed Rulemaking on Assessments, Large Bank Pricing (Approved by Voice Vote)
On February 7, 2011, the FDIC adopted a Final Rule that creates a new methodology for governing assessment rates for large and highly complex institutions. Under that rule, leveraged loans and subprime loans are used to identify concentrations in higher-risk assets. FDIC Acting Chairman Martin Gruenberg said today’s NPR on large bank assessments amends the definitions of leveraged loans and subprime loans and makes limited clarifications and definitional changes to the deposit insurance assessment system for insured depository institutions with more than $10 billion in assets. According to FDIC staff, the proposed changes are “more consistent with the industry’s own usage and would better reflect risks to the FDIC.”
Commenters had requested “that the definitions of subprime and leveraged loans be revised” as the “definitions would capture loans that are not subprime or leveraged (i.e., are not higher-risk assets) and require burdensome reporting that could result in inconsistencies among banks.”
The proposed rule amends the assessment system by: 1) revising the definitions of certain higher-risk assets, specifically leveraged loans, which would be renamed “higher-risk commercial and industrial (C&I) loans and securities,” and subprime consumer loans, which would be renamed “higher-risk consumer loans and securities”; 2) clarifying the timing of classifying an asset as higher risk; 3) clarifying the way securitizations are to be identified; and 4) further defining terms that are used in the large bank pricing rule.
The proposal changes the term “leveraged loans” to “higher-risk C&I loans and securities” and increases the threshold of loans excluded from the definition to $5 million from the current $1 million, to exclude small business borrowers. The operating leverage ratio threshold remains the same.
The proposed rule adds a “purpose test.” To meet the proposed rule’s definition of “high risk C&I loans and securities” in addition to exceeding the operating leverage ratio threshold, “the purpose of at least some of the borrower’s debt must have been to finance a material buyout, acquisition or capital distribution.”
The proposed rule also excludes “certain well-collateralized loans” such as asset-based lending (ABL) and floor plan loans. This “narrow exclusion” only applies to lenders “who meet specific operational standards” and only to loans secured by liquid collateral.
The proposal changes the term “subprime consumer loans” to “higher-risk consumer loans and securities,” which would replace a list of characteristics under the current rule with a single criteria: consumer loans with a two-year probability of default greater than 20 percent, determined by “observed historical default rates over the recent crisis.” Institutions can use their own internal methodology or third-party vendors to determine probabilities of default “as long as they meet the minimum requirements” in the proposed rule.
The proposed rule would require institutions to use information “reasonably available” to determine whether a securitization is a high-risk asset. The rule also allows the FDIC to retain the authority to update the minimum and maximum cut-off values for the higher-risk asset concentration measure “without the necessity of additional notice and comment rulemaking.”
The proposed rule would become effective on October 1. However, “the new rule would not necessarily apply to C&I loans and securities or securitizations of any kind originated, or purchased before that date.” Institutions would have the option of continuing to use their existing internal methodology or guidance.
“Until October 1, institutions can continue to use the transition guidance previously provided,” FDIC staff said.
Acting Comptroller of the Currency John Walsh was supportive of the rule, but said he remains concerned about the complexity of the model. Walsh said he looked forward to comments on “whether it captures risk in a manner that is consistent with prevailing industry practice.” He said he was pleased to hear that the FDIC is not “contemplating the sort of separate validation regime for supporting the exemption for loans that are well secured by collateral.”
NPR Regarding the Enforcement of Subsidiary and Affiliate Contracts by the FDIC as Receiver for a Covered Company (Approved by Voice Vote)
The proposed rule implements Section 210(c)(16) of the Dodd-Frank Act. FDIC staff noted that previous commenters had requested the FDIC clarify its authority under this section, which permits the receiver to enforce contracts of subsidiaries or affiliates that are guaranteed, supported by, or linked to the failed systemically important financial institution (SIFI) “in the event that such contracts would otherwise be terminable by the counterparty as a result of the appointment of the receiver for the failed company.”
The proposed rule provides definitions of the terms “supported by” and “linked to.” Contracts linked to a failed company “are those that treat the appointment of the receiver, or exercise of the orderly liquidation authority (OLA) as an event of default that would give counterparties the right to terminate or exercise other remedies.” Contracts supported by the failed company “involve a guarantee of collateral or other financial support.”
The proposed rule “would likely provide” the receiver more flexibility in forming a resolution strategy. If contracts of the subsidiaries and affiliates are maintained, a receiver is more likely to execute a resolution strategy in which the parent company is placed in receivership while its subsidiaries remain open and operating.
The rule also includes built in protections for the contracting party. The rule “would require that any support provided by the referenced party be protected by the receiver, either through the transfer of the support to a third party, including a bridge financial company, or the receiver undertaking to provide alternative adequate protection, to the extent the support is not transferred.”
The statute requires the receiver make a determination of whether to enforce the contract within one business day of its appointment. FDIC staff recommends that a “notice of provision be included in the proposed regulation so that the contracting party is clear that it may not terminate in how the receiver will maintain the necessary support.” Under the proposed rule, “if the FDIC appointed a receiver for the parent, the counterparty would be unable to terminate the contract and stop providing services if the receiver transferred the guarantee obligation to a solvent bridge financial company and assumed the supporting obligation.”
Walsh supported the rule, and said the rule underscores that the point of entry for the FDIC is “increasingly at the holding company level,” especially for the systemically important institutions. He added, “This does have implications for how we think about other rulemakings … and how we deal with the bank since the point of attack is going to be for the whole company.”
FDIC Director Thomas Curry supported the proposal, but questioned the staff regarding the 24 hours the receiver has to determine whether to enforce the contract. He said, “There are a significant number of potential contracts subject to this provision, and you have 24 hours to basically make those decisions. Do you envision an across-the-board type of application, or how selective do you actually think this power might be utilized?”
FDIC staff said this power is “somewhat dependent on how much time we have had to do resolution planning leading up to the failure.” Staff said “to a large extent, it will probably be on a wholesale basis, but if we’ve had the time in the company and through our other planning exercises, if we’ve identified certain parent contracts, then those could be left to the receiver.”
Staff added that if the FDIC is entering at the parent level, “we would not have the opportunity to cancel those contracts or reject those contracts. We could choose not to provide the parent support, which may or may not lead to a cancellation of that contract, but it would not be in our control.”
For more information on the meeting, please click here.
FDIC Press Release on the votes.
At a FDIC Board Meeting on March 20, board members of the Federal Deposit Insurance Corporation (FDIC) unanimously approved two notices of proposed rules (NPR) on large bank assessments and enforcement of subsidiary and affiliate contracts by the FDIC as receiver.
- Notice of Proposed Rulemaking on Assessments, Large Bank Pricing
- Notice of Proposed Rulemaking Regarding the Enforcement of Subsidiary and Affiliate Contracts by the FDIC as Receiver for a Covered Financial Company
Notice of Proposed Rulemaking on Assessments, Large Bank Pricing (Approved by Voice Vote)
On February 7, 2011, the FDIC adopted a Final Rule that creates a new methodology for governing assessment rates for large and highly complex institutions. Under that rule, leveraged loans and subprime loans are used to identify concentrations in higher-risk assets. FDIC Acting Chairman Martin Gruenberg said today’s NPR on large bank assessments amends the definitions of leveraged loans and subprime loans and makes limited clarifications and definitional changes to the deposit insurance assessment system for insured depository institutions with more than $10 billion in assets. According to FDIC staff, the proposed changes are “more consistent with the industry’s own usage and would better reflect risks to the FDIC.”
Commenters had requested “that the definitions of subprime and leveraged loans be revised” as the “definitions would capture loans that are not subprime or leveraged (i.e., are not higher-risk assets) and require burdensome reporting that could result in inconsistencies among banks.”
The proposed rule amends the assessment system by: 1) revising the definitions of certain higher-risk assets, specifically leveraged loans, which would be renamed “higher-risk commercial and industrial (C&I) loans and securities,” and subprime consumer loans, which would be renamed “higher-risk consumer loans and securities”; 2) clarifying the timing of classifying an asset as higher risk; 3) clarifying the way securitizations are to be identified; and 4) further defining terms that are used in the large bank pricing rule.
The proposal changes the term “leveraged loans” to “higher-risk C&I loans and securities” and increases the threshold of loans excluded from the definition to $5 million from the current $1 million, to exclude small business borrowers. The operating leverage ratio threshold remains the same.
The proposed rule adds a “purpose test.” To meet the proposed rule’s definition of “high risk C&I loans and securities” in addition to exceeding the operating leverage ratio threshold, “the purpose of at least some of the borrower’s debt must have been to finance a material buyout, acquisition or capital distribution.”
The proposed rule also excludes “certain well-collateralized loans” such as asset-based lending (ABL) and floor plan loans. This “narrow exclusion” only applies to lenders “who meet specific operational standards” and only to loans secured by liquid collateral.
The proposal changes the term “subprime consumer loans” to “higher-risk consumer loans and securities,” which would replace a list of characteristics under the current rule with a single criteria: consumer loans with a two-year probability of default greater than 20 percent, determined by “observed historical default rates over the recent crisis.” Institutions can use their own internal methodology or third-party vendors to determine probabilities of default “as long as they meet the minimum requirements” in the proposed rule.
The proposed rule would require institutions to use information “reasonably available” to determine whether a securitization is a high-risk asset. The rule also allows the FDIC to retain the authority to update the minimum and maximum cut-off values for the higher-risk asset concentration measure “without the necessity of additional notice and comment rulemaking.”
The proposed rule would become effective on October 1. However, “the new rule would not necessarily apply to C&I loans and securities or securitizations of any kind originated, or purchased before that date.” Institutions would have the option of continuing to use their existing internal methodology or guidance.
“Until October 1, institutions can continue to use the transition guidance previously provided,” FDIC staff said.
Acting Comptroller of the Currency John Walsh was supportive of the rule, but said he remains concerned about the complexity of the model. Walsh said he looked forward to comments on “whether it captures risk in a manner that is consistent with prevailing industry practice.” He said he was pleased to hear that the FDIC is not “contemplating the sort of separate validation regime for supporting the exemption for loans that are well secured by collateral.”
NPR Regarding the Enforcement of Subsidiary and Affiliate Contracts by the FDIC as Receiver for a Covered Company (Approved by Voice Vote)
The proposed rule implements Section 210(c)(16) of the Dodd-Frank Act. FDIC staff noted that previous commenters had requested the FDIC clarify its authority under this section, which permits the receiver to enforce contracts of subsidiaries or affiliates that are guaranteed, supported by, or linked to the failed systemically important financial institution (SIFI) “in the event that such contracts would otherwise be terminable by the counterparty as a result of the appointment of the receiver for the failed company.”
The proposed rule provides definitions of the terms “supported by” and “linked to.” Contracts linked to a failed company “are those that treat the appointment of the receiver, or exercise of the orderly liquidation authority (OLA) as an event of default that would give counterparties the right to terminate or exercise other remedies.” Contracts supported by the failed company “involve a guarantee of collateral or other financial support.”
The proposed rule “would likely provide” the receiver more flexibility in forming a resolution strategy. If contracts of the subsidiaries and affiliates are maintained, a receiver is more likely to execute a resolution strategy in which the parent company is placed in receivership while its subsidiaries remain open and operating.
The rule also includes built in protections for the contracting party. The rule “would require that any support provided by the referenced party be protected by the receiver, either through the transfer of the support to a third party, including a bridge financial company, or the receiver undertaking to provide alternative adequate protection, to the extent the support is not transferred.”
The statute requires the receiver make a determination of whether to enforce the contract within one business day of its appointment. FDIC staff recommends that a “notice of provision be included in the proposed regulation so that the contracting party is clear that it may not terminate in how the receiver will maintain the necessary support.” Under the proposed rule, “if the FDIC appointed a receiver for the parent, the counterparty would be unable to terminate the contract and stop providing services if the receiver transferred the guarantee obligation to a solvent bridge financial company and assumed the supporting obligation.”
Walsh supported the rule, and said the rule underscores that the point of entry for the FDIC is “increasingly at the holding company level,” especially for the systemically important institutions. He added, “This does have implications for how we think about other rulemakings … and how we deal with the bank since the point of attack is going to be for the whole company.”
FDIC Director Thomas Curry supported the proposal, but questioned the staff regarding the 24 hours the receiver has to determine whether to enforce the contract. He said, “There are a significant number of potential contracts subject to this provision, and you have 24 hours to basically make those decisions. Do you envision an across-the-board type of application, or how selective do you actually think this power might be utilized?”
FDIC staff said this power is “somewhat dependent on how much time we have had to do resolution planning leading up to the failure.” Staff said “to a large extent, it will probably be on a wholesale basis, but if we’ve had the time in the company and through our other planning exercises, if we’ve identified certain parent contracts, then those could be left to the receiver.”
Staff added that if the FDIC is entering at the parent level, “we would not have the opportunity to cancel those contracts or reject those contracts. We could choose not to provide the parent support, which may or may not lead to a cancellation of that contract, but it would not be in our control.”
For more information on the meeting, please click here.
FDIC Press Release on the votes.