On June 7, 2012, US banking regulators released three notices of proposed rulemaking (the
“ Proposals ”) and one notice of final rule, which together would substantially revise the current capital rules in the U.S. Comments on the Proposals are due no later than September 7, 2012. The Proposals would implement the regulatory capital reforms recommended in December 2010 by the Basel
Committee on Banking Supervision, commonly referred to as “Basel III,” as well as additional capital reforms required by the Dodd-Frank Act. Among other things, the Proposals revise minimum capital adequacy standards and propose changes to existing risk-weights, including through the introduction of new risk-weighting methodology with respect to securitization exposures.
Comment Period Deadline: September 7, 2012
Proposed Effectiveness Dates:

Capital Ratios: January 1, 2013, subject to phase-in and various commencement dates, with full compliance with most aspects of the rule not required until January 1, 2019.

Standardized Approach: January 1, 2015 (subject to early opt-in).

Advanced Approaches: no specified effective date.

Market Risk Capital Rule: January 1, 2013
Implementation: The Proposals would implement Basel III framework subject to some notable distinctions drawn under the Dodd-Frank Act and as a policy matter:

Dodd-Frank 939A – Requires the U.S. banking agencies to remove all reference to external credit ratings from federal regulations and replace with alternative standards of creditworthiness. The
U.S. banking agencies shall seek to establish, to the extent feasible, uniform standards of creditworthiness.

Collins Amendment – Generally requires that insured depository institutions and depository institution holding companies be subject to the same generally applicable risk-based capital and leverage rules. The framework articulated under the Basel III Proposal and the Standardized
Approach Proposal would be the “generally applicable risk-based capital rules” for purposes of the Collins Amendment, and would be the floor for calculation of capital requirements.

Other (exclusion of monoline insurers as eligible guarantors, changes to definition of financial collateral, etc.)
Basel III Proposal :

Scope of Application: o All U.S. federal and state-chartered banks and savings associations. o U.S. bank holding companies with more than $500 million in total consolidated assets.
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o U.S. savings and loan holding companies (including those with total consolidated assets of less than $500 million).

Effectiveness Dates: Capital ratios would be effective as of January 1, 2013, but full compliance with most aspects of the rule would not be required until January 1, 2018.

Regulatory Capital – effect is to increase minimum regulatory capital requirements and require overall higher quality capital: o Three capital ratios

New common equity tier 1 capital ratio (4.5%)

Common equity tier 1 capital – tracks Basel III definition and generally means paid-in common equity plus retained earnings plus accumulated other comprehensive income plus certain common equity tier 1 minority interests.

Most new/revised regulatory adjustments and deductions will be applied to common equity tier 1 capital, and include: o Goodwill; o mortgage servicing assets (MSAs); o certain deferred tax assets (DTAs); and o Unrealized gains and losses on available-for-sale (AFS) securities, which would flow through to common equity tier 1 capital.

Higher tier 1 capital ratio (increased from 4% to 6%)

Tier 1 capital ratio numerator equals common equity tier 1 capital plus additional tier 1 capital.

Deductions and adjustments would include after-tax gain on sale associated with a securitization exposure.

Additional tier 1 capital would continue to include non-cumulative perpetual preferred stock.

Trust-preferred securities and cumulative perpetual preferred stock would be phased out of tier 1 capital as required under the Collins
Amendment.
 Unchanged total capital ratio (8%)
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o New Capital Buffers

Capital Conservation Buffer:

Must equal at least 2.5% of risk-weighted assets in order to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers.

Would increase the three risk-based capital ratios by 2.5% (applies to tier
1 common equity capital).

Phase-in begins January 1, 2016.

Countercyclical Capital Buffer (for advanced approaches banking organizations)
– must be maintained in order to avoid being subject to limitations on capital distributions and discretionary bonuses to executive officers o Leverage Ratios (two leverage ratios):

Tier 1 Leverage Ratio: Higher minimum tier 1 leverage ratio (now 4% for all; previously certain banking organizations could apply 3%).

Supplementary Leverage Ratio (for advanced approaches banking organizations):

Denominator would include certain off-balance sheet exposures.

Not applicable until January 1, 2018, but must be calculated and reported beginning January 1, 2015.

Prompt Corrective Action (PCA) framework: o Applies to insured depository institutions. o Would incorporate new risk-based capital and leverage ratios. o Revised definition of tangible equity. o Changes effective January 1, 2015.

Treatment of mortgage servicing assets (MSAs): o Currently banking organizations may include MSAs (when calculated with certain other assets) generally up to 100% before deduction is required. o Under the Proposals, only 10% of the value of MSAs may be counted (and up to 15% when counted with deferred tax assets arising from temporary differences that an organization could not realize through net operating loss carry backs and significant investments in other common shares of unconsolidated financial institutions) before deduction is required.
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o The amount of readily marketable MSAs that a banking organization may include in regulatory capital cannot be valued at more than 90% of their fair market value. o Subject to phase-in over 5 years. o 250% risk weight for MSAs that are not deducted (currently 100%).
Standardized Approach Proposal

Scope of Application o All U.S. federal and state-chartered banks and savings associations. o U.S. bank holding companies with more than $500 million in total consolidated assets. o U.S. savings and loan holding companies.

Proposed Effective Date: January 15, 2015 (subject to early opt-in).

Formula: A banking organization’s total risk-weighted assets would be the sum of: (i) its riskweighted assets for general credit risk, off-balance sheet items, OTC derivative contracts, transactions cleared through central counterparties, unsettled transactions, securitization exposures and equity exposures; plus (ii) its risk-weighted assets for market risk calculated under the market risk rules (as amended by the Market Risk Capital Rule), if applicable; less (iii) the portion of its allowance for loan and lease losses that is not included in Tier 2 capital.

Risk-Weights Generally Applicable to Commercial Real Estate Assets – As noted below, calculation of the risk weights applicable to securitization exposures under the gross-up approach or simplified supervisory formula approach typically will require calculation of the risk weights of the underlying exposures. o Commercial Real Estate exposures – generally 100% or 150% risk weight

HVCREs (defined in Annex A) – 150% risk-weight.
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
Non-HVCRE – would generally be treated as a corporate exposure subject to
100% risk weight. o GSE exposures:

Ginnie Mae multifamily securities – zero risk weight so long as they are unconditionally guaranteed by the US government (currently such securities would be assigned a 20% risk weight).

Fannie Mae and Freddie Mac multifamily pass-through securities that do not involve the tranching of credit risk – generally may be assigned a 20% risk weight.
1 The agencies have solicited comment on the treatment of HVCRE exposures.
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
Fannie Mae and Freddie Mac non-credit enhancing IO securities – 100% risk weight. o “Statutory” multifamily loans –50% risk weight. o Past Due Exposures – 150% risk weight for the unguaranteed and unsecured portion of past due exposures (other than non-sovereign and non-residential mortgage exposures).

Risk-Weighting for Securitization Exposures: o General:

Elimination of Ratings-Based Approach, which relies on external credit ratings, and replacement with alternative standards of creditworthiness, as required under
Section 939A of Dodd-Frank.

Minimum risk weight of 20%. o Hierarchy of Approaches to Risk-Weighting Securitization Exposures (as defined in
Annex A):

A banking entity must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from a securitization and must apply a 1,250% risk weight to the portion of any credit-enhancing interest only strip (CEIO) that does not constitute after tax gain-on-sale.

Two options for determining risk weights for other securitization exposures
(must choose one or the other and apply consistently, and may not choose grossup approach if banking organization is subject to the Market Risk Capital Rule):

Gross-Up Approach: Banking organizations that are not subject to the
Market Risk Capital Rule may elect to follow a gross-up approach, similar to existing rules. Under this approach, senior securitization tranches generally are assigned the risk weight associated with the underlying exposures. For subordinate securitization tranches, a banking organization must hold capital for the subordinated tranche and each tranche for which it provides credit support.

Simplified Supervisory Formula Approach (SSFA): The risk weight for a position is determined by a formula and is based on the risk weight applicable to the underlying exposures, the relative position of the securitization position in the structure (subordination), and measures of delinquency and loss on the securitized assets. Resecuritization exposures also may be calculated under SSFA, subject to higher capital requirements than that applicable to securitization exposures.
The agencies state that “[a]t the inception of a securitization, the SSFA as proposed would require more capital on a transaction-wide basis than would be required if the pool of assets had not been securitized. That is, if the banking organization held every tranche of a securitization, its
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overall capital charge would be greater than if the banking organization held the underlying assets in portfolio.”

Alternatively, a banking organization may generally apply a 1,250% risk weight. o Operational Requirements for Securitization Exposures:

Due Diligence Requirements: 2

If an investing banking organization is unable to demonstrate to the satisfaction of the applicable regulator a comprehensive understanding of the features of a securitization exposure that would materially affect the performance of the exposure, the investing banking organization must assign the securitization exposure a risk weight of 1,250% (except for exposures that are deducted from common equity tier 1 capital).

Must conduct an analysis of the risk characteristics of a securitization exposure prior to acquiring the exposure, and document such analysis within three business days after acquiring the exposure, in addition to satisfying other conditions.

Requires ongoing analysis, review and update (no less frequently than quarterly).

Operational Requirements for Traditional Securitizations (see definition in
Annex A) – If a banking organization that transfers exposures it has originated or purchased to a securitization special purpose entity or other third party in connection with a traditional securitization fails to satisfy the applicable conditions, then it must hold risk capital against the underlying exposures as if they had not been securitized.

The underlying exposures must not be reported on the banking organization’s consolidated balance sheet under GAAP.

The banking organization has transferred to one or more third parties credit risk associated with the underlying exposures.

Any clean-up calls must be “eligible clean-up calls” (see Annex A for definition).

The securitization does not (i) include one or more underlying exposures in which the borrower is permitted to vary the drawn amount within an agreed limit under a line of credit; and (ii) contains an early amortization provision.
 Other operational requirements are specified for synthetic securitizations.
2 The agencies request comment on challenges involved with meeting due diligence requirements and for which securitization exposures.
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o Exceptions: Certain ABCP, OTC derivative contracts and securitizations of small business loans, among others.

Credit Risk Mitigation: o May substitute the risk weight of an eligible guarantor for the risk weight otherwise applicable to the portion of the exposure guaranteed if conditions are satisfied. o Expands scope of eligible guarantors in the second prong of the definition to include
“investment-grade” corporate entities, subject to certain limitations. Monoline insurers, re-insurers and special purpose entities are excluded. o Provides certain adjustments for maturity mismatches and currency mismatches. o Expands definition of financial collateral to include, among other things, investmentgrade corporate debt securities and publicly traded equity securities and convertible bonds. With the exception of cash on deposit, a banking organization would be required to have a perfected, first-priority security interest in collateral.

Servicer Cash Advance Facilities: o Treated as securitization exposures. o A banking organization would be required either to apply the SSFA or the gross-up approach (if permitted), or assign a 1,250% risk weight to its exposure under the servicer cash advance facility. o If the servicer cash advance facility is an eligible servicer cash advance facility, the servicing banking organization would not be required to hold risk-based capital against the undrawn portion of an eligible servicer cash advance facility. o If the servicer cash advance facility is not an eligible servicer cash advance facility, then the servicer generally would be required to apply 1,250% risk weight to undrawn portion of the facility (based on the notional amount and the rules for calculation of off-balance sheet exposures).

Risk-Weighting for Certain Off-Balance Sheet Exposures: o General: A banking organization must calculate the exposure amount of an off-balance sheet item by multiplying the off-balance sheet component, which is usually the notional amount, by the applicable credit conversion factor (CCF). o Credit enhancing representations and warranties: Credit enhancing representations and warranties on assets sold or otherwise transferred to third parties would be treated as offbalance sheet guarantees subject to a 100% CCF. Credit enhancing representations and warranties in the form of early default clauses or premium-refund clauses would no longer be carved out.

Disclosure Requirements – Apply only to banking organizations representing the top consolidated level of the banking group with $50 billion or more in total consolidated assets or that is subject to the advanced approaches rules.
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Advanced Approaches Proposal

Scope of Application: o Banking organizations described above and their subsidiaries with $250 billion or more in total consolidated assets. o Banking organizations described above and their subsidiaries that have consolidated total on-balance sheet foreign exposure at the most recent year-end equal to $10 billion or more. o Banking organizations that opt in and are permitted to use advanced approaches. o Also would extend Market Risk Capital Rule to savings and loan holding companies with significant trading activity.

General: o Elimination of ratings-based approach and internal assessments approach.

Securitization Exposures: 3 o Hierarchy of Approaches:

Supervisory Formula Approach (SFA): If a securitization exposure does not require deduction or a 1,250% risk weight, the banking entity must apply SFA to the exposure if the banking entity and the exposure qualify for SFA.

Simplified Supervisory Formula Approach (SSFA): If a securitization exposure does not require deduction or a 1,250% risk weight and does not qualify for SFA, the banking entity may apply SSFA. A banking organization should be able to explain and justify circumstances in which it uses the SSFA rather than the SFA for its securitization exposures.

If none of the above apply, the banking entity must apply a 1,250% risk weight to the securitization exposure. o Revised standard supervisory market price volatility haircuts for “investment grade” securitization exposures in the exposure-at-default (EAD) adjustment approach. o Due Diligence Requirements: generally tracks that specified under Standardized
Approach Proposal. o Enhanced Disclosure Requirements. o Application of 1,250% risk weight to CEIOs, low-rated securitization exposures and high-risk securitization exposures subject to SFA instead of the deduction.
3 Definitions of “securitization exposure” and “traditional securitization” track those specified under the
Standardized Approach Proposal.
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
Minimum risk weight of 20%.

Maximum risk-based capital requirement for all securitization exposures held by a single banking entity associated with a single securitization (excluding any risk-based capital requirements that relate to the banking entity’s gain-on-sale or CEIOs associated with the securitization) may not exceed the sum of: o The total risk-based capital requirement for the underlying exposures as if the banking entity directly held the underlying exposures; and o total ECL (expected credit loss) of the underlying exposures.

Credit Risk Mitigation: o May apply PD substitution approach or LGD adjustment approach to wholesale exposure for which credit risk is fully covered by an eligible guarantee or eligible credit derivative. o Eligible guarantor – same definition as under Standardized Approach Proposal. o Eligible double default guarantor – reference to insurance companies in the business of providing credit protection (such as a monoline bond insurer or re-insurer) has been removed.
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Annex A – Certain Definitions
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating [BANK] or servicer;
(2) Is not structured to avoid allocating losses to securitization exposures held by investors or otherwise structured to provide credit enhancement to the securitization; and
(3) (i) For a traditional securitization, is only exercisable when 10 percent or less of the principal amount of the underlying exposures or securitization exposures (determined as of the inception of the securitization) is outstanding; or
(ii) For a synthetic securitization, is only exercisable when 10 percent or less of the principal amount of the reference portfolio of underlying exposures (determined as of the inception of the securitization) is outstanding.
High volatility commercial real estate (HVCRE) exposure means a credit facility that finances or has financed the acquisition, development, or construction (ADC) of real property, unless the facility finances:
(1) One- to four-family residential properties; or
(2) Commercial real estate projects in which:
(i) The loan-to-value ratio is less than or equal to the applicable maximum supervisory loan-to-value ratio in the [federal agency]’s real estate lending standards at 12 CFR part 34, subpart D and 12 CFR part 160, subparts A and B (OCC); 12 CFR part 208, Appendix C (Board);
12 CFR part 365, subpart D and 12 CFR 390.264-390.265 (FDIC);
(ii) The borrower has contributed capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out-of-pocket) of at least 15 percent of the real estate’s appraised “as completed” value; and
(iii) The borrower contributed the amount of capital required by paragraph (2)(ii) of this definition before the [banking organization] advances funds under the credit facility, and the capital contributed by the borrower, or internally generated by the project, is contractually required to remain in the project throughout the life of the project. The life of a project concludes only when the credit facility is converted to permanent financing or is sold or paid in full.
Permanent financing may be provided by the [banking organization] that provided the ADC facility as long as the permanent financing is subject to the [banking organization]’s underwriting criteria for long-term mortgage loans.
Securitization exposure means:
(1) An on-balance sheet or off-balance sheet credit exposure (including credit-enhancing representations and warranties) that arises from a traditional securitization or synthetic securitization
(including a resecuritization), or
(2) An exposure that directly or indirectly references a securitization exposure described in paragraph (1) of this definition.
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Traditional securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties other than through the use of credit derivatives or guarantees;
(2) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority;
(3) Performance of the securitization exposures depends upon the performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are financial exposures (such as loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities;
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business investment company described in section
302 of the Small Business Investment Act;
(7) The underlying exposures are not owned by a firm an investment in which qualifies as a community development investment under section 24 (Eleventh) of the National Bank Act;
(8) The [AGENCY] may determine that a transaction in which the underlying exposures are owned by an investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures is not a traditional securitization based on the transaction’s leverage, risk profile, or economic substance;
(9) The [AGENCY] may deem a transaction that meets the definition of a traditional securitization, notwithstanding paragraph (5), (6), or (7) of this definition, to be a traditional securitization based on the transaction’s leverage, risk profile, or economic substance; and
(10) The transaction is not: (i) an investment fund; (ii) a collective investment fund; (iii) a pension fund regulated under the ERISA or a foreign equivalent thereof; or (iv) regulated under the Investment
Company Act of 1940 or a foreign equivalent thereof.
Tranche means all securitization exposures associated with a securitization that have the same seniority level.
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