FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Questions and Answers on the Definitions of
“Higher-Risk” Assets under FDIC Large Bank Pricing
The FDIC “Questions and Answers Pertaining to the 2011 Final Rule on Assessments, Dividends,
Assessment Base and Large Bank Pricing, Including the 2012 Changes to the Definitions of
Higher-Risk Assets Effective as of April 1, 2013”on the “higher-risk” definitions is posted here.
The FDIC Large Bank Pricing rule, the “higher-risk” definitions rule, summaries of both, and
corresponding changes to the Call Report (and instructions) are linked here.
Sections:
 Scope of Balance Sheet Items to be Evaluated Against “Higher-Risk”
 Higher-Risk Consumer Loans
 Types of Loans to Evaluate
 Determination of the FDIC-PD
 Unscorable Loans
 Exemptions
 FDIC-PD Mappings from the Credit Bureaus
 Modeling FDIC-PDs Internally
 Qualification as a Refinance
 Higher-Risk C&I Loans and Securities
 Grandfathering of “Leveraged” Exposures
 Types of C&I Loans to be Evaluated
 “Higher-Risk C&I Borrowers”
 Loan Amount Test
 Purpose Test
 Materiality Test (in the Purpose Test)
 Leverage Test
 Cash Deposit & Government Guarantee Exemptions
 Qualification as a Refinance
 Asset-Based and Dealer Floor Plan Exclusions
 Higher-Risk Securitizations
 Nontraditional Mortgage Loans and Other Issues
This “FAQ” is intended to provide accurate and authoritative information in regard to the “higherrisk” definitions in FDIC Large Bank Pricing. It is provided with the understanding that the ABA is
not engaged in rendering legal, accounting, or other professional service. If legal advice or other
expert assistance is required, the services of a competent professional person should be sought.
I welcome questions or comments on the rule. If I cannot answer your question, I can submit it
anonymously on your behalf to the FDIC.
Rob Strand, Senior Economist, American Bankers Association
w: 202.663.5350, c: 540.424.8600, h: 540.785.0030, rstrand@aba.com
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Scope of Balance Sheet Items to be Evaluated against Higher-Risk
1. In the LBP assessment pricing formula, “higher-risk exposures” include only:
 “construction, land development, and other land loans” as reported on Call Report Schedule
RC-C Part I. line 1.a;
 loans “secured by 1–4 family residential properties”1 reported on line 1.c of Schedule RC-C –
excluding those reported as “trading assets” on lines 6.a(3) of Schedule RC-D2 – but only
those that satisfy the definition of “nontraditional mortgage loans”; and
 “loans to individuals for household, family, and other personal expenditures” reported on
line 6 of Schedule RC-C – excluding those reported as “trading assets” on lines 6.c(1)-6.c(4)
of Schedule RC-D3 – and loans “secured by 1–4 family residential properties” reported on
line 1.c of Schedule RC-C4 – excluding those reported as “trading assets” on lines 6.a(3) of
Schedule RC-D – but only those that satisfy the definition of “higher-risk consumer loans”;
 commercial & industrial loans, unfunded commitments and bonds that satisfy the definition
of “higher-risk c&i loans and securities” from what is reported in the Call Report under:
 c&i loans reported on line 4 of Schedule RC-C for “commercial and industrial loans,”
 “unused commitments” reported on line 1 of Schedule RC-L, and
 “other debt securities” reported on line 6 of Schedule RC-B – excluding those reported as
“trading assets” on line 5 of Schedule RC-D.5
 “mortgage-backed securities” reported on line 4 of Schedule RC-B and “asset-backed
securities and structured financial products” reported on line 5 of Schedule RC-B – excluding
those reported as “trading assets” on lines 4.a–4.c of Schedule RC-D – but only those that
satisfy the definition of “higher-risk securitizations.”
The rule specifies: “Nontraditional mortgage loans include all residential loan products that allow the
borrower to defer repayment of principal or interest and include all interest-only products, teaser rate
mortgages, and negative amortizing mortgages, with the exception of home equity lines of credit (HELOCs)
or reverse mortgages.” (66023, left column) This would seem to imply that all residential mortgages are to
be evaluated against “nontraditional mortgage loans.” However, the draft Call Report instructions define
“nontraditional 1-4 family residential mortgage loans” as the “amount of nontraditional 1-4 family
residential mortgage loans, as defined for [FDIC] assessment purposes only …” (FFIEC, “Draft
Instructions for the Proposed New and Revised Call Report Items for June and December 2013, page 17)
2 “Nontraditional mortgage loans do not include loans reported as trading assets…” (Ibid.)
3 The draft Call Report instructions specify: “The amount to be reported [as “higher-risk consumer loans”]
should exclude … [c]onsumer loans reported as trading assets…” (FFIEC, “Draft Instructions for the
Proposed New and Revised Call Report Items for June and December 2013, page 19)
4 Only 1-4 family, and not multi-family, residential mortgages are to be evaluated against “higher-risk
consumer loans. In the rule: “For the purposes of this rule, consumer loans consist of all loans secured by
1–4 family residential properties as well as loans and leases made to individuals for household, family, and
other personal expenditures, as defined in the instructions to the Reports of Condition and Income,
Schedule RC-C…” (66004, footnote 31, and 66020, footnote 8) Also in the draft Call Report instructions:
“For assessment purposes, higher-risk consumer loans are loans secured by 1-4 family residential properties
… and loans and leases to individuals for household, family, and other personal expenditures …” (FFIEC,
“Draft Instructions for the Proposed New and Revised Call Report …, page 18)
5 Trading book securities are not to be graded against the “higher-risk” definitions. In the rule, “higher-risk
c&i loans and securities” include “all securities, except securities classified as trading book …” (66017, left
column) and “higher-risk securitizations” include “securitizations (except securitizations classified as trading
book) where …” (66023, left column).
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Higher-Risk Consumer Loans
2. When will the new Call Report Schedule RC-O FDIC-PD6 distribution form for reporting the
FDIC-PD distribution of consumer and residential mortgage loans, be finalized?
The final rule, issued May 23, 2013, is posted here.
For LBP banks, the rule changed the Schedule RC-O Memorandum items for “higher-risk
consumer loans” (replacing “subprime loans and securities”) and “higher-risk c&i loans and
securities” (replacing “leveraged loans and securities”) and the new consumer and 1-4 family
residential mortgage FDIC-PD distribution form. These items will remain confidential.
Types of Consumer and Residential Mortgage Loans to Evaluate
3. This quarter LBP institutions will report FDIC-PDs (in bands) for their entire portfolios of
consumer and residential mortgage loans – those originated prior to April 1, 2013, as well as
loans originated between April 1, 2013 and June 30, 2013 – the entire portfolio as of June 30,
2013. Going forward, beginning with third quarter 2014, should the institutions report the
FDIC-PD distribution of (a) the entire loan portfolio as of the end of the quarter, or (b) just the
loans originated during that quarter?
Starting in second quarter 2013 and each quarter thereafter, each LBP institution will report the
FDIC-PD distribution of its entire portfolio of consumer and residential mortgage loans as of
quarter-end – not the distribution just for loans originated during the quarter. It is difficult to
find a definitive statement in the FDIC rule or Q&A to support this case. However, the new Call
Report Schedule RC-O Memorandum item 18 (www.aba.com/Groups/FDICdocs/DCR.pdf)
specifies that LBP institutions will report the FDIC-PD distribution for the “outstanding
balance of 1-4 family residential mortgage loans, consumer loans, and consumer leases by twoyear probability of default.”
4. Will loans that were not reported under “Subprime Consumer Loans and Securities” on
Memorandum line 8 on Call Report Schedule RC-O in first quarter 2013 be grandfathered as not
“higher-risk consumer loans” starting with second quarter 2013 Call Reports, or will LBP banks
have to reassess their entire consumer loan portfolios against the new “higher-risk” definition?
The status of consumer loans reported as “subprime “prior to April 1, 2013, is not
grandfathered. Instead:
 the entire portfolios of consumer and residential mortgage loans is to be distributed across
FDIC-PD bands in the new Call Report Schedule RC-O Memorandum item 18FDIC-PD
distribution form, and
 the balance of such loans where the FDIC-PD exceeds 20 percent is to be reported as
“higher-risk consumer loans” on Memorandum line 8.a in Schedule RC-O, starting in second
quarter 2013.
6
The acronym “FDIC-PD” is used throughout this document to refer to the two-year probability of default
measurement that is determined according to pages 66005-66007 in the rule.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
FDIC Response: In second quarter 2013, banks will be required to reassess their entire
consumer loan portfolios so that they can report on Call Reports beginning on June 30, 2013 in
accordance with Appendix C to Subpart A to Part 327. Consumer loans that were not identified
as “subprime” under the February rule definition will not be grandfathered under the revisions
to Appendix C to Subpart A to Part 327. Instead, as of June 30, 2013, large and highly-complex
institutions will be required to identify the probability of default of all consumer loans in their
loan portfolios. All consumer loans with a probability of default of 20 percent or greater should
be reported as a higher-risk consumer loan on the bank’s Call Reports.
Securitizations of subprime consumer loans that were reported as subprime consumer loans
before April 1, 2013 should continue to be reported as higher risk after April 1, 2013.Going
forward, banks will only need to review securitizations of consumer loans that are issued on or
after April 1, 2013 to determine if these securitizations meet the definition of a higher risk
consumer loan.
5. Are balances reported in the new Call Report Schedule RC-O Memorandum item 18FDIC-PD
distribution form by loan category expected to tie to balances reported on the corresponding
Call Report Schedule RC-C lines? A variety of payment clearing, deferred origination cost, items
in process, etc., general ledger accounts are included in the Schedule RC-C totals. These amounts
in most cases cannot be tied to specific customers, and, therefore, not to specific FDIC-PD
bands. Are these amounts to be allocated in some way across the FDIC-PD bands, or can they
be excluded and what is reported to be strictly the loan system balances?
Similar question: For the new Call Report form for reporting the FDIC-PD distribution of
consumer and 1-4 family residential mortgage loans by product types and PD band (Schedule
RC-O item 18), most of the data will come from our bank’s Risk Management, not Financial
Reporting, systems. There will therefore be small differences in the aggregate product-level
balances reported in Call Report Schedule RC-C. How will LBP banks address this issue? Will
some gross up the Risk Management numbers across product bands and report the gross-up
additions under the “unscorable” column?
Similar question: Differences in Schedule RC-C balances as compared to Schedule RC-O FDICPD form balances that result from suspense accounts can be documented (for auditors). Is it
acceptable to omit these suspense account balances from Schedule RC-O, recognizing that
FDIC-PDs cannot be assigned to them?
FDIC Response: It is likely that the FDIC-PD reporting table for consumer loans will not
reconcile to the line items on Schedule RC-C because the table will not include loans guaranteed
by the U.S. Government, loans secured by cash, or loans acquired within the prior six months.
Regarding items such as payment clearing items, deferred origination costs, and items in process,
banks should be allocating such items to individual loans for Call Report purposes so that they
can accurately file schedule RC-C. Since banks are required to allocate such items to individual
loans, they should be able to include these amounts in the FDIC-PD table as well.
The balances by asset class in the new Schedule RC-O Memorandum item 18 FDIC-PD
distribution form are expected to generally tie to – but be “less than or equal to” –corresponding
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Schedule RC-C balances(as noted by the FDIC above).7Some LBP institutions will be prepared
to justify the differences in the two balances to auditors and examiners.
LBP institutions differ in how they will allocate suspense account balances for payment clearing,
deferred origination cost, items in process, etc. to specific loans so that they can be factored into
the “higher-risk” balances.
6. The demonstration FDIC-PD reporting form (66010) seems to imply that nontraditional
residential mortgages should be placed into the FDIC-PD bands. However, our understanding is
that nontraditional mortgages would continue to be reported as a single number. Please clarify.
In the new Call Report Schedule RC-O Memorandum item 18FDIC-PD distribution form, LBP
banks will report the FDIC-PD distribution for “nontraditional residential mortgages” even
though this information will not be used to calculate the “higher-risk consumer loans” balance
(consumer and “traditional” residential mortgage loans with PDs in excess of two percent). This
data will demonstrate to the FDIC that such loans should not be universally rated as “higherrisk” in FDIC Large Bank Pricing of assessments.
FDIC Response: Institutions will also be required to report the total volume of nontraditional
mortgage loans on Call Report Schedule RC-O Memorandum item 7.a.In addition, in the
[FDIC-PD] reporting table, institutions would be required to segment and report the total
volume of nontraditional mortgage loans by PD band.
7. Must a commercial loan that is secured by a 1-4 family residential property be evaluated against
“higher-risk consumer loans” and included in the FDIC-PD distribution form?
There is no acknowledgement in the FDIC's definition that any loans reported under Call
Report Schedule RC-C item 1(c) could be to borrowers who are other than individuals.
However, the OCC seems to disagree with the FDIC's definition. OCC 2012-27 specifically
acknowledges that “investor-owned, one- to four-family residential real estate” is to be reported
here.8 Since the definition of “higher-risk consumer loans” clearly intends to capture only loans
to individuals – whether secured by residential real estate or not – where an FDIC-PD can be
determined based on a consumer credit score, should business loans reported under Schedule
RC-C item 1.c. – where there is no consumer credit score – be excluded from the FDIC-PD
distribution table and evaluation against “higher-risk consumer loans”?
FDIC Response (reversing its previous position): Business loans should be excluded from the
definition of “higher-risk consumer loans” for purposes of Call Report Schedule RC-O
Memoranda item 8.a and should also be excluded from balances reported in Call Report
Schedule RC-O Memoranda item 18. Such loans meeting the definition of “loans secured by real
estate” should continue to be reported in the appropriate sub-item of Call Report Schedule RCC Part I, item 1, according to outstanding Call Report instructions.
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8
See draft instructions for the Call Report changes, www.aba.com/Groups/FDICdocs/DCRI.pdf, pp. 24-28.
OCC, “Supervisory Guidance on Risk Management and Reporting Requirements,” OCC 2012-27,
September 17, 2012, www.occ.gov/news-issuances/bulletins/2012/bulletin-2012-27.html.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
8. Consumer overdrafts are reported under Schedule RC-C item 6.d. Must they therefore be
reported on the FDIC-PD distribution form, Schedule RC-O Memorandum item 18.h? Are LBP
banks expected to pull consumer credit scores and determine FDIC-PDs for customers with
unplanned overdrafts on their deposit accounts? Since few such consumers have established
lines of credit to cover overdrafts or otherwise, this is going to be a significant burden.
The “higher-risk” rule specifies, “For the purposes of this rule, consumer loans consist of all
loans secured by 1–4 family residential properties as well as loans and leases made to individuals
for household, family, and other personal expenditures, as defined in the instructions to the Call
Report, Schedule RC–C, as the instructions may be amended from time to time.” (66020,
footnote 8)The instructions for Call Report Schedule RC-C item 6 specify that “loans to
individuals for household, family, and other personal expenditures” should include “all credit
extended to individuals for household, family, and other personal expenditures that does not
meet the definition of a “loan secured by real estate,” whether direct loans or purchased paper.
Exclude loans to individuals for the purpose of purchasing or carrying securities.” It appears that
if an overdraft on a consumer deposit account is included in the reported Schedule RC-C item 6
balance (as per these instructions), then it should be evaluated against “higher-risk consumer
loans.” In this case, whether it is “higher-risk” or not, it should be reported in the Call Report
Schedule RC-O Memorandum item 18 table for the FDIC-PD distribution of consumer and
residential mortgage loans.
Note that the “higher-risk” rule indicates that this loan should not be graded as “unscoreable”
until and unless the bank determines that there is no consumer credit score or other information
available on the deposit account holder to determine an FDIC-PD.
9. An “active loan” is defined in the rule as one that was open and not in default as of the
reporting date, and on which a payment was made within the prior twelve months. (66005, right
column) Should first-pay defaulters (i.e., loans where no payment is received so the loan goes
straight to default) be rated against “higher-risk” and included in the new Call Report Schedule
RC-O Memorandum item 18FDIC-PD distribution form?
First-pay defaulters are not uncommon when the first loan payment is due after a deferment
period (e.g., student loans). The entire balance of consumer and residential mortgage loans, as
reported on Call Report Schedule RC-C, is to be graded against “higher-risk” and also reported
in the new Call Report Schedule RC-O Memorandum item 18FDIC-PD distribution form.
The rule refers to “active loans” only in the specifications of data for modeling FDIC-PDs; firstpay defaulters are not to be included in this data.9The data standards organized by Fair Isaac for
the generic FICO FDIC-PD mappings from Equifax, Experian and TransUnion do not break
out first-pay defaulters. With a sample of 10,000,000, Fair Isaac feels that such cases like will not
have a significant effect on the mappings.
9
Note that this definition was changed in the final rule from the earlier proposal in response comments from
bankers and credit bureaus concerning system capabilities.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
10. Should loans in deferment be graded against “higher-risk” and included in the new Call Report
Schedule RC-O Memorandum item 18FDIC-PD distribution form? For example, for student
loans, most choose the deferment option whereby repayment begins six months after the
borrower has separated from school.
If there is a credit score or internally derived FDIC-PD for a consumer loan, then it should be
graded against “higher-risk consumer loans” and included in the new Call Report Schedule RCO Memorandum item 18FDIC-PD distribution form. Otherwise, the loan can be included in the
“unscorable” group – up to five percent per product category. (66010, demonstration form and
footnote 45) The deferment is irrelevant in this context.
11. There is no distinction in the rule between consumer credit cards and business credit cards. Are
consumer credit cards to be considered as consumer loans and business credit cards to be
considered as c&i loans?
The rule specifies that “higher-risk consumer loans are defined as all consumer loans … For the
purposes of this rule, consumer loans consist of all loans secured by 1–4 family residential
properties as well as loans and leases made to individuals for household, family, and other
personal expenditures, as defined in the instructions to the Call Report, Schedule RC–C…”
(66020, right column)This passage indicates that consumer credit card account balances should
be graded against the definition of “higher risk consumer loans.”
The rule specifies that “higher-risk c&i loans and securities are: (a) all commercial and industrial
(c&i) loans … by a higher-risk c&i borrower… and (b) all securities, except securities classified
as trading book, issued by a higher-risk c&i borrower…” (66017, left column)This passage
indicates that business credit card account balances should be graded against the definition of
“higher-risk c&i loans and securities.”
12. Are commercial accounts included if they fall within the specified Call Report categories?
FDIC Response: Consumer loans consist of all loans secured by 1-4 family residential properties
as well as loans and leases made to individuals for household, family, and other personal
expenditures, as defined in Schedule RC-C of the Call Report [66004, footnote 31]. Banks must
assess all consumer loans to determine if they meet the “higher-risk consumer loans” definition.
13. How is a “foreign consumer loan” defined relative to “higher-risk consumer loans”?
FDIC Response: For purposes of the deposit insurance pricing rule, a foreign consumer loan is
defined as a consumer loan made to a customer whose principal residence address is outside of
the United States, Puerto Rico, District of Columbia and any U.S. territories/possessions. If a
bank can estimate the PD of the foreign consumer loan following the specifications included in
Appendix C of the final rule, they must do so. However, if a bank cannot follow the
specifications for estimating a PD in accordance with the final rule, the bank must use the
alternative options for estimating the PD of a foreign consumer loan which are also outlined in
Appendix C of the final rule.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
14. Should loans be presented net of purchase accounting marks, given the complexity of identifying
those marks on a loan-level basis to assign FDIC-PD bands?
Since the expectation is that the balance of loans reported on Call Report Schedule RC-C should
square with what is graded against “higher-risk,” a LBP bank is expected to distribute purchase
accounting marks. Different institutions are handling purchase accounting marks differently;
they do not seek a specification of a single acceptable approach from regulators.
15. In what cases could all or a portion of a portfolio home equity loans be dismissed without
evaluation of the FDIC-PD?
No evaluation of the FDIC-PD would be required for:
 all loans with government insurance (e.g., FHA),
 80 percent of the portfolio under an 80/20 loss share agreement with the FDIC,
 the amount of purchase accounting marks for loans acquired in acquiring another bank,
 pools of whole loans acquired within six months of the report date (the FDIC-PD of
acquired loans must be assessed within six months of being acquired) (66021, left
column), and
 loans secured by cash deposits.
Note that the bank can report up to five percent of the total balance of its home equity loans
as “unscorable.” However, it is required try to determine the FDIC-PD of a loan before
rating it as “unscorable,” and thereafter at least annually. (66021, right column)
16. If a loan is originated on the afternoon of June 30, must a LBP bank capture the credit score and
report the FDIC-PD in its June 30 Call Report?
This is the same case as above.
Determination of the FDIC-PD
17. If a consumer credit score is used to determine the FDIC-PD of a loan, must it be the score at
origination of the loan or can a current score be used?
The credit score at origination (or refinance, if there has been one) is to be used to determine a
FDIC-PD to place a consumer loan or 1-4 family residential mortgage in the new FDIC-PD
distribution form. If no origination (or refinance) score is available, the oldest available score is
to be used. If there is no score on file, a current score is to be obtained.
18. A LBP bank is to report in the new Call Report Schedule RC-O item 18the FDIC-PDs of all
consumer and residential mortgage loans on its books as of the end of the reporting period,
where the FDIC-PDs can be based on consumer credit scores. Should the original credit score
or the score at the start of the observation period be used?
The FDIC-PD for each consumer loan or line of credit and for each residential mortgage is to
be recorded as of origination. This determination can be based on an internal model or on a
credit bureau credit score when the loan is created. (When this rule is first implemented, a LBP
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
bank is permitted to use either the oldest score or a current score.) However, there is flexibility
to use credit scores at quarter-end, if a bank pulls scores on an end-of-quarter basis.
If a loan or credit line is acquired, the bank can use the credit score as of origination, if available,
or else can pull a current score. Unless and until there is a refinance of the loan or material
(i.e., over ten percent) change in the credit line, that FDIC-PD remains until the loan is paid off
or the credit line terminates.
Where the rule says that “loans should be sampled based on the credit score as of the
observation date” (66021, middle column), the intention is not that recent, updated credit scores
would need to be pulled. This passage intends that, for institutions that will develop internal
FDIC-PD mappings (instead of securing them from one of the credit bureaus); the data sample
should include all of the consumer loans on the books as of the observation date (with their atorigination credit scores).
A LBP institution should use the credit score for each consumer and residential mortgage loan
as of origination to determine its FDIC-PD. This is true unless there has been a “refinance” (as
defined in the rule) of the loan. In that case, the bank should use the credit score as of that
refinance – the most recent refinance if there was more than one. However, if the bank does not
have an at-origination-or-refinance credit score for the loan, it should use the oldest one on file.
If there isn’t one on file, the bank must get a current one. If one is not available, the bank can
report up to five percent per loan category as “unscorable”; anything over five percent must be
reported as “higher-risk.”
19. The rule requires loans originated before April 1, 2013 be bucketed by FDIC-PD based on the
score at origination or the oldest possible score. If no origination score is available, then we can
use a current credit score to obtain a PD. For many accounts, it may not be possible to determine exactly which of the credit score models was used at the time of origination, or which
credit reporting agency the score was obtained from, and it might be more cost efficient to use
the current credit scores and related PDs. Is it acceptable for the bank to use the current credit
score even if an older score is available, when the older score has uncertainty regarding source
and model used?
This rule mandates that a bank is to use information (e.g., a credit score) on a consumer credit at
origination or refinance; only in the case where this is not available, the bank must use the oldest
available information. It says: “Banks must determine the PD of a consumer loan as of the date
the loan was originated, or, if the loan has been refinanced, as of the date it was refinanced. For
loans originated or refinanced by a bank before April 1, 2013, and all loans acquired by a bank
regardless of the date of acquisition, if information as of the date the loan was originated or
refinanced is not available, then the institution must use the oldest available information to
determine the PD… The bank must use the available data closest to the date of origination or
refinance to minimize inconsistencies in PD estimates.” (66008-09)
As addressed below, a generic FDIC-PD mapping obtained from any of the credit bureaus can
be used to determine the FDIC-PD from any generation of credit score from any of the credit
bureaus.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
20. There is a two-step process to determine whether a residential mortgage loan qualifies as
“higher-risk.” First, the mortgage must be evaluated against the definition of “nontraditional
mortgage loans.” Second, if the loan is not “nontraditional,” it must be evaluated against the
definition of “higher-risk consumer loans.” There appears to be a contradiction in the rule as to
the period over which determination of “higher-risk” is to be determined after a residential
mortgage is acquired. Page 66023 (left column) requires the determination to be made within
three months, while page 66021 (left column) allows six months. Is the intent that a LBP bank
has three months to determine whether a residential mortgage is “nontraditional” then, if not
“nontraditional,” up to three more months to determine whether it is “higher-risk consumer”?
FDIC Response: Yes, the bank has three months to determine if the mortgage is nontraditional,
and up to three more months to determine if it is a higher-risk consumer loan.
21. How should FDIC-PDs be determined for student loans in deferment?
If there is a credit score for a student, the loan can be mapped using that with a FDIC-PD
mapping obtained from one of the credit bureaus. A FDIC-PD can also be determined using an
internal model, as long as the bank has sufficient historical data to satisfy the modeling
specifications of the rule. If there is insufficient data, the bank can apply to the FDIC for
permission to use an alternative methodology to develop an internal FDIC-PD mapping.
The broader question is: how can a FDIC-PD be determined for classes of loans where there is
insufficient historical data to satisfy the rule’s modeling specifications? Some LBP bankers have
indicated intent to use internal models under such circumstances, but most will use credit bureau
credit scores if available. Moreover, up to five percent per consumer loan product category can
be reported as “unscorable” in the new Call Report Schedule RC-O Memorandum item
18FDIC-PD distribution form and not graded as “higher-risk.”
22. In many cases, purchased credit-impaired loans are accounted for in pools, such that a FDICPD cannot be associated with a specific loan. How should these loans be handled in the new
Call Report Schedule RC-O Memorandum item 18FDIC-PD distribution form?
If a LBP bank does not have credit scores or information to determine a FDIC-PD for an
acquired loan, and cannot obtain it from the seller, it must, within three months of the
acquisition, determine a current FDIC-PD based on information from the consumer or else
based on a new credit score from a credit bureau. If no FDIC-PD can be determined, up to five
percent by product category can be reported as “unscorable” and the rest must be rated as
“higher-risk.”
FDIC Response: The loan balance that is to be reported on Schedule RC-C of the Call Report is
the amount of the PCI loan that should be reported in the PD table under the applicable PD
column for that particular loan. In cases where an entire loan pool is evaluated and a mark (or a
discount) is applied to the entire pool to determine the resulting fair value of the pool, the bank
must determine what percentage mark (or discount) was taken on the particular pool of loans.
This percentage mark (or discount) must then be applied to individual loans in the pool when
reporting these individual loans in the PD table.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Banks have six months from the date of acquisition to determine the PD of loans acquired
on or after April 1, 2013. Loans without a credit score should be reported consistent with the
method for reporting unscorable loans outlined in the final rule.
23. How is the FDIC-PD to be determined is cases where the balance is not carried at a loan or
personal level, such as trust or business loans secured by residential property. Such loans are not
uncommon for wealth management lending, particularly through a trust.
One possibility may be to map obligor ratings to credit scores. Another would be to base the
FDIC-PD on the credit score of the strongest borrower.
24. Do the terms “product type” and “product” used in the rule under “Scorable Consumer Loans”
(66021, left column) refer specifically to the ten categories in the demonstration FDIC-PD
distribution table? (66010) Can this refer to some other product designations or groupings?
The Call Report Schedule RC-O Memorandum item 18FDIC-PD distribution form has ten
product categories.
An institution is permitted, if it so chooses, to develop FDIC-PD mappings in finer granularity.
For example, if it has sufficient data to meet the rule’s specifications, the institution can develop
separate FDIC-PD mappings for auto loans for red, green, blue and all-other colors of autos.
The results of the different mappings would be aggregated into the auto loan category in the
new FDIC-PD distribution form and in compiling the “higher-risk” balance.
The three credit bureaus have developing mappings based on seven product categories. Thus,
some of the credit bureau FDIC-PD mapping tables will apply to more than one product
category.
25. Should TDR loans be distinguished from non-TDR loans in compiling the “higher-risk
consumer loans” balance to be reported on Call Report Schedule RC-O (and on the new
Schedule RC-O Memorandum item 18 FDIC-PD distribution form)? That is, should TDR loans
be run through the same FDIC-PD scoring matrix by product type as non-TDR loans, or are
they simply assumed to be “higher-risk”?
The rule allows that a TDR is not a refinance that triggers reevaluation of the borrower as
potentially a “higher-risk c&i borrower.” (66022, right column) Thus, a TDR loan is not
presumed to be “higher-risk.” The FDIC-PD should be evaluated as of origination of the loan
or credit line – not the TDR event – based on either the original credit score (and a FDIC-PD
mapping from a credit bureau) or an internal model assignment as if that origination.
No separate FDIC-PD scoring system is needed for TDR loans. Consistent with this
interpretation, the data standards organized by Fair Isaac for the generic FICO FDIC-PD
mappings from the three credit bureaus do not treat TDR loans separately.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Unscorable Loans
The FDIC has emphasized to several the obligation for LBP banks to find FDIC-PDs for every
loan in the consumer and residential mortgage loan portfolios. Only in cases where a FDIC-PD
cannot be obtained should a loan be reported as “unscorable.” While a bank is allowed to report
up to five percent of its loans per category in the FDIC-PD distribution table as “unscorable,”
the intent is not that loans can be slotted there without an effort to determine whether a FDICPD can be determined.
The existence of “unscorables” will require LBP institutions to augment their consumer and
residential mortgage loan record systems to record when the last attempt was made to determine
whether an “unscorable” consumer has established sufficient credit history to be scored. The
“higher-risk” rule requires: “An unscorable loan must be reviewed at least annually to determine
if a credit score has become available.” (66007, left column)
26. The rule seems to limit unscorable loans to those with insufficient information to score and
requires that any unscorable loan be reviewed at least annually to determine if a credit score has
become available. In certain limited products, the bank has made the decision not to obtain a
credit score for underwriting purposes. One such product is full recourse, where there is no
credit risk to the bank. (The recourse entity is a commercial customer and the risk is underwritten in that manner). In some instances, it might actually be more cost-effective to pay more in
FDIC assessments rather than obtain the probability of default. Can the bank elect to not obtain
a credit score and related probability of default and simply report in the unscorable bucket for
the life of the loan without trying to obtain a score?
There does not appear to be any leeway in the rule to permit a LBP bank not to determine a
probability of default (PD) for a consumer loan, either using an internal model or from a
consumer credit score obtained externally. It specifies: “Banks must determine the PD of a
consumer loan as of the date the loan was originated, or, if the loan has been refinanced, as of
the date it was refinanced… If information as of the date the loan was originated or refinanced
is not available, then the bank must use the oldest available information to determine the PD. If
no information is available, then the bank must obtain recent, refreshed data from the borrower
or other appropriate third party to determine the PD.” (66020-21) Moreover, the bank cannot
skip determination of a PD at origination or refinance, call the credit “unscorable,” and then
leave it alone. The rule specifies: “An unscorable loan must be reviewed at least annually to
determine if a credit score has become available.” (66021, right column) In short, a LBP bank is
not permitted to simply elect not to determine a PD for a consumer loan when the loan could be
scored and park it in the “unscorable” bucket.
However, if the bank feels that its portfolio of such loans is of low risk, it can develop an
internal model of the PD – if there is sufficient data to satisfy the modeling requirements of the
rule. (66021) Even if there is not enough data, the bank can apply to the FDIC for permission to
develop an internal model. (66021, right column)
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
27. We are in the process of mapping our consumer loan portfolio based on the credit bureau
FDIC-PD maps that corresponds to the originating FICO score on file (for accounts originated
post April 1, 2013). For the majority of asset classes, we have the originating bureau name on
file. However, the mortgage portfolio can be driven by third parties (e.g., brokers) and it's
common for banks to get only the name of the company used to pull the FICO scores (e.g.,
LandAmerica). We are reaching out to the providers to determine if they can provide this data.
If we have valid names for some threshold portion of the portfolio, such as 85 percent, can we
map the remainder to our default map?
For all consumer loans, including those originated or acquired prior to April 1, 2013, a bank
subject to Large Bank Pricing must attempt to determine an FDIC-PD. (66021, left column) For
loans acquired or originated after April 1, 2013, if using a FICO score, the score must be
mapped based on a mapping table corresponding to the FICO score. The rule says “If no
information is available, then the bank must obtain recent, refreshed data from the borrower or
other appropriate third party to determine the PD.” (66021) In other words, if the bank cannot
obtain the source of a FICO score from a loan originator then it cannot simply map the score
based on one credit bureau’s mapping or put the loan in the “unscorable” bucket; it must
acquire a new FICO score.
28. When SallieMae services a portfolio of student loans, the bank does not have quick access to the
loans and, in fact, has to pay $300 to obtain a detailed list of its loans. Since “student loans” is a
separate product type in the new Call Report Schedule RC-O Memorandum item 18FDIC-PD
distribution form, if the bank cannot obtain credit scores for these loans, must the balance of in
excess of the five percent threshold be reported as “higher-risk”?
For example, it appears that a bank with $15 million in student loans is only allowed to report
$750 thousand as unscorable and the remaining $14 million as “higher-risk.” Is that correct?
This seems to be unfair if these student loans are fully guaranteed by the U.S. Department of
Education.
FDIC Response: Because the bank does not want to incur the cost to obtain information about
the loans so that it may obtain credit scores does not make these loans unscorable. Under our
definition unscorable means that available information is insufficient to determine a credit score
– this definition of unscorable was intended to capture borrowers without any or very little
credit history. Unless the loans are truly unscorable, the 5 percent rule doesn’t apply and the
bank needs to obtain the information on credit scores.
[Your example is] correct, but if the loans are fully guaranteed by the U.S. Government, the
bank can exclude the maximum amount that is guaranteed.
Exemptions
29. In the statement “maximum amount that is recoverable from the U.S. Government or its
agencies under guarantee or insurance provisions” (66009, left column), does this refer to loans
that are covered under loss share?
FDIC Response: Yes, but it also includes loans guaranteed by the U.S. Government or its
agencies.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
30. Can loans secured by a securities portfolio, with suitable haircuts, be exempted from grading
against “higher-risk”?
Exemption for securities collateral was brought up to and rejected by the FDIC. The rule states:
“In the joint letter, commenters recommended excluding loans that are collateralized by
securities issued by the U.S. government, its agencies, or government-sponsored enterprises
(GSEs). The final rule, however, does not exclude loans so collateralized because the collateral is
subject to interest rate risk and collateral arrangements are subject to operational risk.
Commenters also recommended excluding loans that are fully secured by brokerage account
collateral (securities-based loans). The final rule does not exclude these loans because the value
of the collateral is subject to several sources of risk, including operational, credit and market
risk.” (66003, middle column)
FDIC-PD Mappings from the Credit Bureaus
31. It was clear in the discussions to move to the FDIC-PD approach that mapping tables would be
available to link third party consumer credit scores (from FICO and VantageScore) to FDIC-PD
ranges by product category. When will these be available?
Equifax, Experian and TransUnion developed FICO FDIC-PD mappings under specifications
consistent with the rule and coordinated through Fair Isaac and VantageScore. There will not be
just one set of universal, generic FICO FDIC-PD mappings.10 Instead, Equifax, Experian and
TransUnion each developed sets (checked through Fair Isaac and VantageScore) to distribute to
banking firms.
The three credit bureaus submitted draft sets of FICO FDIC-PD mappings to Fair Isaac, and
Fair Isaac has accepted for distribution these mappings. These are now available. VantageScore
FDIC-PD mappings are also ready at all three credit bureaus.
If you are looking for someone to call at the credit bureaus, you can contact the following:
Rich Vogt
Equifax Inc.
richard.vogt@equifax.com
770.740.7259
Brodie Oldham
Experian Info. Solutions, Inc.
brodie.oldham@experian.com
972. 547.6045
Sara Drescher
TransUnion LLC
sdresch@transunion.com
312.466.6434
32. The FDIC report is broken out into ten product types. Why are the credit bureaus producing
FDIC-PD mapping tables representing only seven product types?
Starting April 1, to report in second quarter 2013 Call Reports, LBP banks will report the
distributions of their consumer and residential loan portfolios in a grid with ten products and 15
FDIC-PD bands. However, the credit bureaus have not in the past produced PD tables for all of
the ten product categories, and would not be able to do so now because some of the product
categories are not consistently or uniformly reported to the credit bureaus. Accordingly, ABA,
10 A
set will include seven separate FDIC-PD mappings for automobile loans, credit card lines, home equity
lines, residential first mortgages, second lien residential mortgages, student loans, and all other consumer
loans and leases.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
LBP bankers, Fair Isaac, VantageScore Solutions and the credit bureaus, consulting with the
FDIC, came up with seven product categories for which the credit bureaus will produce generic
FDIC-PD mapping tables. A LBP bank can slot any consumer or residential mortgage loan with
one of these mappings – meaning that some of the mappings cover more than one of the FDIC
product categories. For example, the generic HELOC FDIC-PD mapping table will apply to
both junior and senior lien HELOCs (two of the ten FDIC product categories).
33. Is a LBP bank permitted to use a generic set of FDIC-PD tables for scores from different credit
bureaus?
FDIC Response: The rule specifies: “The credit scores represented in the historical sample must
have been produced by the same entity, using the same or substantially similar methodology as
the methodology used to derive the credit scores to which the default rates will be applied. For
example, the default rate for a particular vendor score cannot be evaluated based on the scoreto-default rate relationship for a different vendor, even if the range of scores under both systems
is the same.” (66021, right column)
The FDIC recognizes that multiple credit bureaus may be using customized or proprietary
versions of the same credit scoring model developed by a single vendor to produce credit scores.
If a bank determines that these different versions share the same fundamental methodology,
such that the credit risk associated with a particular score is substantially similar across bureaus,
then a bank may use the PD mapping from any bureau when evaluating such scores.
34. Will LBP institutions need to implement, or at a minimum validate, multiple FDIC-PD mapping
models based on the originating bureau?
[Similar Question] Some banks obtain the credit scores from all three credit bureaus, use the
median score for underwriting purposes, and capture only this median on their systems. Will it
be acceptable for a bank to use, for example, the TransUnion set of FICO-PD mappings for its
entire consumer and residential loan portfolio, even though some of the loan files have median
credit scores from Equifax or Experian?
ABA made a strong case to the FDIC that an LBP institution should not have to acquire FDICPD mappings from more than one credit bureau. The FDIC wrote to ABA on January 23, 2013,
that “If a bank determines that these different versions share the same fundamental
methodology, such that the credit risk associated with a particular score is substantially similar
across bureaus, then a bank may use the PD mapping from any bureau when evaluating such
scores.” The FDIC response suggests that it will not be necessary for a LBP institution to
acquire multiple sets of FDIC-PD mappings if it can verify that “different versions share the
same fundamental methodology, such that the credit risk associated with a particular score is
substantially similar across bureaus.”
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
35. LBP institutions should be permitted to acquire one set of FDIC-PD mappings from Equifax,
Experian or TransUnion and use this for all the credit scores on record to compile FDIC-PDs
for all consumer and residential mortgage loans – without regard to the generation of the scores
or which credit bureau they came from. To do this, the rule requires that “the credit scores
represented in the historical sample must have been produced by the same entity, using the same
or substantially similar methodology as the methodology used to derive the credit scores to
which the default rates will be applied.” (66021, right column) What evidence is needed for this
purpose?
Before Fair Isaac allowed the credit bureaus to issue FICO FDIC-PD mappings, each was
required to submit its mappings for careful review and comparison -- a process that lasted
several weeks. Fair Isaac was asked to help LBP institutions by issuing a statement on this
process which the bankers could show to auditors and supervisors. The following message was
sent to LBP Institutions on April 3, 2013. The parts in blue seem to help, whereas the parts in
green do not.
As your organization prepares to comply with the FDIC Large Bank Pricing (LBP) rule,
FICO has been working with the consumer reporting agencies to finalize the Standard
Probability of Default (PD) Mapping Tables. The PD estimates in the tables have been built
by each consumer reporting agency (bureau) with guidance from FICO for the specific
purpose of helping you comply with the FDIC final rule.
The FICO® Score is aligned across bureaus and with prior versions of a scoring model at
the time we develop the model. Nevertheless, the PDs also can vary for any of several
reasons. These include:
 Changes in relationship between score and default rates over time are normal:
Although rank ordering and predictive lift of the score remains, over time a drift in
the relationship between score and default rates can occur that causes the models to
be less aligned with prior versions or across bureaus. These drifts or shifts in
alignment can be detected and compensated for during your organization’s periodic
validations of the score based on your own portfolio.
 Score cutoffs may differ from a lender’s actual experience: The LBP rule is based on
generic PD estimates. These estimates are not based on the identical specifications
under which the FICO® Score models were developed, such as time periods,
product definitions, performance classification, exclusions, and so on. As a result, the
PD estimates in the FDIC tables do not provide a precise prediction of actual PDs
that a lender will experience. Actual PDs vary by lender due to a variety of factors
including differences in market position relative to product offerings, competition,
targeted population segments, marketing and customer management strategies, and
economic factors. The PD Mapping tables are not applicable for use by lenders for
any purpose other than complying with the FDIC LBP rule.
 PDs may vary slightly across bureaus: The LBP rule specifies how the PD Mapping
Tables are to be developed. FICO has provided further guidance to the consumer
reporting agencies in order to keep the tables as consistent as possible. However,
there may be slight variations in the PD’s across bureaus due to differences in each
consumer reporting agency’s database as well as differences in sampling process and
size, binning of score bands, handling of exclusions.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing

November 9, 2015
FICO® 8 model is more sophisticated: FICO® 8 models provide a more predictive
risk assessment than prior models. The sophisticated design blueprint used in
FICO® 8 Score balances the competing objectives of achieving a superior predictive
model while at the same time containing large shifts in the resulting distribution.
Although FICO® 8 Score models are aligned with earlier FICO® Score versions on
the general development population, in independent validations slight misalignment
from prior versions has been observed in the lowest score ranges.
The score cutoff which represents a 20% probability of default is slightly higher for the
FICO® 8 Score than prior FICO® Score versions, but still results in similar volumes
above/below. This has allowed lenders to migrate from prior versions to FICO® 8 with
little disruption to their existing strategies.
Some lenders have asked us whether they may use a single PD Mapping Table to comply
with the rule. This question arises because the FDIC has recognized that lenders may be
using multiple versions of the same credit scoring model developed by a single vendor. If a
lender determines that these different versions share the same fundamental methodology,
such that the credit risk associated with a particular score is substantially similar across
bureaus, then the lender may use the PD mapping from any consumer reporting agency
when evaluating such scores.
FICO is unable to provide you with PD comparisons across consumer reporting agencies
due to the proprietary nature of the each bureau’s data. You may want to consult with your
organization’s legal and compliance staff to properly interpret what is meant by
“substantially similar” and related aspects of the FDIC rules. FICO is not in a position to
define “substantially similar” for compliance purposes. However, we do encourage financial
service providers to look to their own experience with the FICO® Score for the best
guidance.
LBP bankers are not comfortable that this statement provides an acceptable defense to use the
FDIC-PD tables from a single credit bureau. Some will use all three and report based on the
lowest FDIC-PD for each loan’s consumer credit score. One institution indicated that it can
defend that the FDIC-PD mappings from different credit bureaus are “substantially similar”
through its model validation process.
Note: FDIC staff have reviewed 53 sets of tables representing different generations of FICO
scores from the credit bureaus to determine whether different generations of scores from
different credit bureaus are “substantially similar.” Comparing mappings from the three bureaus
based on the most recent generation of scores, they note as much as 20 point shifts in the
scores. The shifts are much larger, as much as 80 points, for different generations of scores from
single credit bureaus. Of concern is that the larger shifts appear in the lower score, higher risk
range.
They have also discovered that about a third of LBP banks report are using internal FDICPD mappings (rather than only mappings from a credit bureau).11 Moreover, for some
institutions the balance of “higher-risk consumer loans” reported under Schedule RC-O
11As
reported on Schedule RC-O under Memorandum item 18 column O.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Memorandum item 8 is less than or inconsistent with the balance with FDIC-PDs of 20 percent
or more reported in the FDIC-PD distribution table under RC-O Memorandum item 18.
They still have in mind an adjustment to the 20 percent cut-off for “higher-risk consumer
loans,” likely after seeing two quarters of filings under the new definition. While the FDIC has
insisted on the ability to change this cut-off, the understanding is that this will be a one-time
occurrence.
FDIC Q&A
For consumer loans originated prior to April 1, 2013 in which the bank is unable to determine,
without going to extraordinary lengths, which version of a vendor model or which credit bureau
was used to produce a credit score, or cannot obtain a vendor mapping table for that specific
model version, a bank can use the vendor mapping table that is associated with the current
version of the vendor model that they are using for newly originated or refinanced consumer
loans.
Credit bureaus have produced score-to-default-rate mappings for current and older versions of a
vendor model. A score from one bureau using the current version of a vendor model may not in
some cases represent a similar likelihood of default as the same score from either the same
bureau or another bureau using an older version of the vendor model. Therefore, for consumer
loans originated on or after April 1, 2013, it is expected that banks will collect and retain
information on applicable model versions and credit bureaus so that banks can ensure
they are using the appropriate mapping tables for these loans.
36. Is a LBP bank permitted to group together all versions of credit scores (e.g., FICO scores)
provided by a single credit bureau – e.g., mix all the Equifax FICO generations together?
[Similar Question] If a LBP institution uses Classic FICO 02 and 08 for various products, can it
compute FDIC-PDs based one set of FDIC-PD mappings for FICO 08?
ABA has made a strong case to the FDIC that LBP institutions should not have to acquire
multiple sets of FDIC-PD mappings from the same or multiple credit bureaus to correspond
with different versions and generations of credit scores in its portfolios. Responses to ABA’s
appeal, as recorded in the ABA FAQ, appear to cede to this point.
FDIC Response: The rule says: “If the current and historical scores were produced by the same
vendor using slightly different versions of the same scoring system and equivalent scores
represent a similar likelihood of default, then the historical experience could be applied.” (66021,
right column) Thus, a bank can use legacy versions of the same credit score to develop a
mapping table provided that the various legacy versions are substantially similar to each other
and various versions would produce a similar likelihood of default.
Addendum relative to the last three questions: LBP bankers read the FDIC response to mean
that a LBP institution can use one set of generic FDIC-PD mappings −i.e., one set from one
credit bureau − to map credit scores from all different generations of scores from all different
credit bureaus.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
37. If a LBP institution obtains FDIC-PD mappings from Equifax, Experian, TransUnion or
VantageScore, what documentation will they need from the source to satisfy auditors and
examiners that the mappings satisfy the FDIC specifications? Will the FDIC certify the FDICPD mappings provided by Equifax, Experian, TransUnion and VantageScore?
FDIC staff have indicated that they will not certify anything from the credit bureaus, but they
are sensitive to the validation required for modeling, including the use of information from the
models of external vendors. Discussions with ABA, FDIC and the credit bureaus are underway.
ABA has heard from the credit bureaus to date that they have not considered producing any
form of document to support their FDIC-PD mappings. However, Experian indicates that the
FICO, VantageScore and generic FDIC-PD scores are validated annually. All documents, as
pertains to these models, are available to our clients. Each FDIC-PD mapping is a one-time
chart created on a specific period of time, for which the rule does not indicate how to revalidate
or a time period in which to do so.
38. Should a current FICO score be pulled if the original score is outside of the range of scores in
the FDIC-PD table provided by one of the credit bureaus? For example, if a credit card line’s
original FICO is 860 but the credit card FICO range is 316-850, should 860 be considered as
invalid or “unscored”? What if the current FICO is 853 and still falls outside of the range of the
FDIC-PD table? Is this loan now considered “unscorable”? If the same customer also had an
automobile loan, an 860 FICO score is scorable under one of the credit bureau’s PD tables, so
the credit card could be “unscorable” while the auto loan is not. Since there are different score
ranges with each of the credit bureau FDIC-PD tables, should the specified ranges for each of
the different products be used? What are other institutions doing in this situation?
LBP institutions will treat credit scores above the top score band in a FDIC-PD mappings as if
it were in the top band, and those below the bottom score band as in that band.
However, some systems have recorded 999 as a no-score in the past. Institutions must note such
cases and treat them accordingly.
Modeling FDIC-PDs Internally
39. If a LBP institution intends to develop an internal FDIC-PD model, does it need to work this
out in advance with the FDIC?
No advance discussion with FDIC staff is required for an institution to model FDICPDs internally. In fact, the rule does not even require the institution to get clearance from the
FDIC. It requires simply (or not) that “the credit risk assessment must be determined using third
party or internal scores derived using a scoring system that qualifies as empirically derived,
demonstrably and statistically sound as defined in 12 CFR 202.2 (p) … and has been approved
by the bank’s model risk oversight and governance process and internal audit mechanism.”
(66021, left-middle columns)
Even in a case where there the institution intends to develop an internal model but does
not have enough observations to satisfy the rule’s specifications (66021), it may proceed
without prior clearance. In this case, the rule requires the institution to “submit a written
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
request to the FDIC either in advance of, or concurrent with, reporting under the requested
approach. The request must explain in detail how the proposed approach differs from the rule
specifications and the bank must provide support for the statistical appropriateness of the
proposed methodology… The FDIC will evaluate the proposed methodology and may request
additional information from the bank… The bank may report using its proposed approach while
the FDIC evaluates the methodology.” (66021-22)
Note, however, that while an institution is not required to get the FDIC’s blessing prior to using
an internal model based on less than 1,200 observations, it will have submit all sorts of data
when it submits a Call Report that uses output from the model, and, at that point, get clearance
from the FDIC. (See 66022.) After reviewing this input, the FDIC may reject the model and
require the institution to submit an amended Call Report that does not use the model’s output.
On this basis, institutions may wish to speak with FDIC staff early in the model development
process.
40. Please clarify the statement: “The loans should be sampled based on the credit score as of the
observation date.” (66021, middle column)
FDIC Response: Banks should use the credit score on file that the consumer had as of the
beginning of the two year window (July 2007 to June 2009 or July 2009- June 2011).Banks
should then track the performance (i.e. default or no default) over the two years. For example,
the credit score should be as of June or early July of 2007 and June or early July of 2009.
41. The definition of an “active loan” (66005, right column) appears to exclude newly booked loans
where the first payment has not been received. Is this interpretation correct?
Newly booked loans should not be included in the dataset of “active loans” used to develop
FDIC-PD mapping (whether for a LBP institution’s internal use or in the generic mappings
under development by the credit bureaus). Such loans should, however, be graded against
“higher-risk” and included in the new Call Report Schedule RC-O Memorandum item 18FDICPD distribution form.
The data standards organized by Fair Isaac for the credit bureaus’ generic FICO FDIC-PD
mappings do not specify a definition, but instead direct the credit bureaus to use definitions
consistent with the rule.
42. For institutions developing internal FDIC-PD models, under the definition of an “active” loan,
the term “default” is used to exclude those loans in default or that have not made payments in
the previous twelve months. What is the definition of “default” specifically referred to in this
situation? Would this include any loan in past due status or potentially just those cancelled
accounts awaiting write-off??
The rule specifies: “A loan is to be considered in default when it is 90+ days past due, chargedoff, or the borrower enters bankruptcy.” (66021, right column)
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
43. In cases where institutions opt to develop internal FDIC-PD models, is there a conflict as to the
dating of consumer credit scores to be used in the estimation?

The ABA FAQ says: “Where the rule says that “loans should be sampled based on the credit
score as of the observation date” (66021, middle column), the intention is not that recent,
updated credit scores would need to be pulled. This passage intends that, for institutions that
will develop internal FDIC-PD mappings (instead of securing them from one of the credit
bureaus); the data sample should include all of the consumer loans on the books as of the
observation date (with their at-origination credit scores).”

In response to the question: “Of the requirements for estimating PDs, what is meant by the
statement: ‘The loans should be sampled based on the credit score as of the observation
date’?” the FDIC Q&A says: “Banks should use the credit score on file that the consumer
had as of the beginning of the two year performance period (July 2007 to June 2009 or July
2009 to June 2011). Banks should then track the performance (i.e., default or no default)
over the two years. For example, the credit score should be as of June or early July of 2007
and June or early July of 2009.”
Based on the industry discussion of May 8, there does not appear to be a conflict between these
two statements. LBP banks feel that the intent is that data on the same basis should be used for
FDIC-PD modeling as to determine FDIC-PDs based on those models; that data is the
consumer credit score as of origination of each loan or, if unavailable, the oldest credit score on
file – or a new credit score only if none is recorded.
44. How do TDRs affect the determination of FDIC-PDs by score band? Should they be
considered default events, since they could delay the occurrence of a 90+-day delinquency until
it is outside the two-year observation window?
The rule does not require special treatment for loans with TDRs in the determination of FDICPD mappings. Based on the data standards organized by Fair Isaac, the three credit bureaus
developed generic FICO FDIC-PD mappings that do not count TDRs as defaults.
45. With respect to a default (as defined on 66005, right column), is delinquency to be measured on
an OTS or MBA basis?
Most LBP institutions appear to be using OTS; none has reported using MBA. Bankers have
asked to hear what specifications the credit bureaus are using in developing generic FDIC-PD
mappings.
FDIC Response: For the purpose of calculating historical default rates in accordance with the
final rule specifications, institutions may measure delinquency using either the OTS or MBA
method.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
46. Should the cohorts used for mapping FDIC-PDs include loans that were sold (i.e., portfolio sales
that are not part of the normal business model) within the performance periods?
FDIC Response: If a loan was sold during the performance period, such that the bank cannot
make a determination as to whether the borrower defaulted at any time within the two year
period, then it should exclude the loan from the default rate calculation.
47. To create FDIC-PD mapping, is 1,200 active loans needed for each of the 15 bands, or is it
1,200 across all 15 bands?
The rule requires that a LBP institution have data on at least 1,200 active loans per FDIC-PD
band. (66021, middle column) However, it may request FDIC’s permission to use less.
48. To create the FDIC-PD mapping, at least 15 score bands with at least 1,200 observations per
time period are required. How should this be handled for portfolios with insufficient
observations for the July-2007-to-June-2009 period?
In this situation, a LBP institution can (1) use a generic FDIC-PD mapping from one of the
credit bureaus or VantageScore, (2) report up to five percent of the balance as “unscorable” and
the rest as “higher-risk,” or (3) develop an internal FDIC-PD mapping based on a portfolio of
similar products (with the FDIC’s permission). (Note below that the intent of the rule is not that
a LBP bank can simply elect to report a loan as “unscorable” when it has insufficient data to do
a FDIC-PD mapping; a loan is to be reported as “unscorable” only if there is no means to
determine a FDIC-PD.) Several LBP bankers have indicated intent to use the first approach.
FDIC Response: The options [listed above] are not entirely correct. The final rule does not
permit a bank to treat loans as unscorables simply because it does not have sufficient data to
create an internal mapping. The five percent allowance for unscorable consumer loans was
intended to apply to borrowers that lack sufficient credit history to determine a credit score.
Regarding option (3), if the mapping is based on a portfolio of products with similar risk
characteristics and this enables the bank to meet the sample size requirement, the bank need not
request the FDIC’s permission to use it… A bank may use a generic mapping for some
segments/products and an internal mapping for those segments where it can meet the
requirements.
49. How should FDIC-PDs be determined for a new loan product originated after the July-2007June-2009 observation period?
This question was similarly posed as: We have a consumer lending product that was
implemented in May 2012. We do not have a representative sample of accounts in the
observation periods to draw PDs from, and the criteria for underwriting may make development
of PDs from credit bureau data problematic. How can we go about developing PDs in this
situation?
Can the FDIC provide additional instructions as to what would be required for an institution to
develop an internal PD mapping if it does not have 1,200 observations per 15 PD bands, for
example for a product created after April 1, 2013?
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
FDIC Response: Estimates of PDs must be based on the observed, stress period default rate for
loans of a similar product type. If this new loan product is significantly different than existing
product types, the institution can use the generic score to default rate mappings provided by
credit reporting bureaus for a similar loan product type.
A bank is required to have 1,200 observations per product type, per credit score band.
Consequently, the minimum number of observations a bank must have per product type is
18,000 (1,200 x 15). If a bank does not have this data, they can use mappings provided by a third
party as long as the mappings are in conformance with the final rule specifications.
50. In developing an internal FDIC-PD mapping, should we include securitizations that we have
since sold but which were in portfolio during the time period specified, if the loans were
securitized during 2008-2010?
As long as complete data is available, such observations should be included when developing
internal FDIC-PD mappings.
Qualification as a Refinance
51. For loans on the books as of April 1, 2013, do LBP banks need to determine if the loan was ever
refinanced? If yes:
a. If to our knowledge the loan did not refinance, we score it using origination credit score?
b. If the loan was unscorable at origination, we score it using the oldest available scorable
observation?
c. If the loan was unscorable at refinance, we score it using the oldest available scorable
observation after refinance?
FDIC Response: Yes to all the questions.
52. For credit cards, is a special offer period at an interest rate below the contract APR a refinance?
(As examples, offering balance consolidation at a low interest rate for a period of time, or a 5.99
percent interest rate for spending between April and December.)
The rule says, “A refinance for this purpose does not include … [a]n advance of funds, an
increase in the line of credit, or a change in the interest rate that is consistent with the terms of
the loan agreement for an open-end or revolving line of credit (e.g., credit cards or home equity
lines of credit) …” (66022, right column) LBP bankers feel that a special promotion that does
not alter the contract is not a “refinance.”
53. Is bank-initiated force-placed insurance considered a refinance?
No. Relative to the “higher-risk” definitions, “refinance” of a consumer loan is defined as
extending new funds or credit, increasing a credit line by over 10 percent, replacing one loan
with another (except not a TDR), consolidating loans, changing the interest rate, or increasing
the loan term by over six months or the balloon payment. (66022, middle-right columns) Forceplaced insurance is not on this list.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
54. Are collection activities resulting in changes to the loan terms considered a refinance? Consumer
credit scores are generally unnecessary and not pulled during such activities.
The rule has a conservative definition of “refinance” to broadly encompass changes in loan
terms. For a consumer loan, if the loan maturity is extended by over six months, new funds are
extended, a credit line is increased by over 10 percent, the interest rate changes, then this counts
as a “refinance.” (66022, middle-right columns)
Refresh of the credit score does not determine whether a change in account terms constitutes a
“refinance.” However, if a change in terms qualifies as a refinance, then a refresh credit score
will be required to establish a new FDIC-PD.
55. Changes in terms occur periodically within revolving lines of credit (e.g., credit cards). Does this
qualify as a refinance?
The bankers negotiating the “higher-risk” definitions with the FDIC made a strong case that
credit cards should be treated differently from other types of accounts. In particular, the bankers
argued that routine changes in account terms are part of the business model and should not
qualify as “refinances.” The rule itself acknowledges that the FDIC heard that “an increase or
decrease in the interest rate of a credit card loan should not be considered a refinance on the
grounds that rate changes for credit card loans are commonplace (e.g., formulaic adjustments tied
to underlying indices, expirations of introductory rates and special rates for balance transfers,
and changes mandated by law such as the Credit CARD Act).” (66009, right column) However,
the FDIC would not go there.
There are, however, some concessions in the rule. The most important is that up to a 10 percent
increase or decrease in the account interest rate is not a “refinance.” (The initial proposal was
that this would apply to all types of credits except credit cards.) Moreover, the rule recognizes
“that a change to the interest rate on a credit card loan that is consistent with the terms of the
loan agreement is not a refinance.” (66009, right column)
As above, the bank can no longer use the origination credit score or FDIC-PD after a change in
account terms that qualifies as a “refinance.” A refresh credit score must be pulled to determine
a new FDIC-PD.
56. For credit cards, additional credit when a bank has internally approved a higher credit line than
has been reported to the customer does not count as a “refinance.” (66023, left column) Does
this exclusion refer to over-limit charges?
The rule provides: “For purposes of higher-risk consumer loans, a refinance includes … a
material increase in the amount of the line of credit… A material increase in the amount of a line
of credit is defined as a 10 percent or greater increase in the quarter-end line of credit limit;
however, a temporary increase in a credit card line of credit is not a material increase…” (66022,
middle-right column) Thus, if an over-limit charge is temporary and/or does not exceed 10
percent of the approved line, it does not qualify as a refinance.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
57. A “refinance” for a consumer loan is defined in the rule to include an extension of the maturity
date by more than six months. (For a c&i loan, any extension constitutes a “refinance.”) Would
multiple extensions over time of, for example, four months not qualify as a “refinance”? What is
the starting point to calculate if the maturity date has been extended by more than 6 months?
The rule defines a refinance to include “rescheduling principal or interest payments to … extend
the legal maturity date of the loan by more than six months.” (66022, right column) The
question appears to ask whether, for example, the loan term could be increased by four months
once a year without being classified as a refinance. Such a position seems inconsistent with the
intent of the rule, but the specific wording is not clear on this point.
FDIC Response: The maturity date is defined as the maturity date assigned as of the origination
date of the loan or, if the loan has been refinanced, the maturity date assigned as of refinance.
Multiple extensions which in aggregate exceed the maturity date by more 6 months would be
considered a refinance.
58. The rule seems to imply that a bank should pull the original credit score if a “refinance” results
in a TDR classification, and not use the refinance credit score. If this is true then a refinance
under a TDR is still being evaluated as potentially “higher-risk” because the original credit score
will be used instead of the refinance score. Is this correct?
If a LBP bank makes a loan to a consumer or homebuyer and, at origination, the FDIC-PD is
below 20 percent then this loan will not be rated as a “higher-risk consumer loan” to start with.
And if problems develop later such that the bank does a TDR on that loan (or even successive
TDRs), the loan should not be reevaluated and would remain not “higher-risk. “This is the case
even though the bank would likely pull a new credit score and grade down the loan for internal
purposes and for reporting for other regulatory purposes.
On the other hand, if the loan is originally evaluated to have a FDIC-PD over 20 percent, and
therefore as “higher-risk,” then it would continue to be rated as “higher-risk” through one or
more TDRs.
In short, one or more TDRs do not justify or even allow reevaluation of a consumer or
residential mortgage loan as or as not “a higher-risk consumer loan.” If the bank wants to
reevaluate a loan as no longer “higher-risk” after a TDR, the loan terms must be altered or
refinanced in a way that does not qualify the refinance as a TDR.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Higher-Risk C&I Loans and Securities
Grandfathering of “Leveraged” Exposures
59. Is a LBP institution permitted to revise its definition of “leveraged loans” for reporting on Call
Report Schedule RC-O Memorandum item 9 through first quarter 2013 (before the “higherrisk” definitions go into effect starting with second quarter 2013 Call Reports)?
Some institutions have considered revising their internal definitions of “leveraged” in light of the
rule and the Guidance on Leveraged Lending.12 For example, an institution might consider
exclusion of asset-based lending from what it reports as “leveraged.”
The rule in place through first quarter 2013 requires that the balance of “leveraged loans and
securities” be defined consistent with how a bank calculates this for supervisory purposes. Thus,
if an institution changes its internal definition, it must change the definition used to report the
Schedule RC-O Memorandum item 9 balance of “leveraged loans and securities.”
Representatives from several LBP institutions have acknowledged intent to alter their definitions
prior to April 1. One said his bank had done so and had been asked by the FDIC to defend the
change. FDIC staff have confirmed that they would want to see a justification if there is a
significant reduction in the reported balance of “leveraged loans and securities.”
FDIC Response: The final rule is clear that the new definitions become effective on April 1,
2013. A [LBP] bank can report leveraged loans using the definition in the February 2011 rule or
by using the guidance provided in the transition guidance until April 1, 2013. Beginning on April
1, 2013, [LBP] banks must report higher-risk c&i loans under the definitions in the final rule.
60. If on April 1, 2013, a bank held a c&i loan that has been reported as “leveraged” under the
definitions in the February 2011 rule or the transition guidance, could that loan subsequently be
reevaluated as not “higher-risk” if it satisfies the asset-based lending, dealer floor plan financing,
cash collateral, or federal guarantee exclusion provisions?
The risk-grading for all c&i loans on the books as of April 1, 2013, as reported (or not) on the
“leveraged loans and securities” balance on Call Report Schedule RC-O Memorandum item 9
through first quarter 2013 will be grandfathered. This will not require reassessment of loans
made, credit lines originated, or securities obtained prior to this date. This means that c&i loans
and securities that are risk-graded as “leveraged” through first quarter 2013 reporting will
thereafter be risk-graded as “higher-risk” for reporting under the new “higher-risk c&i loans and
securities” balance starting in second quarter 2013, and vice versa.
There is a caveat, however. Starting in second quarter 2013, if a LBP bank makes a new loan or
refinances an existing loan to a commercial customer then that firm must be judged to be or not
to be a “higher-risk c&i borrower.” If the firm is judged to be a “higher-risk c&i borrower,” then
all of the bank’s loans, credit lines, and debt securities for that firm still on the books – including
12 OCC,
Fed and FDIC, “Interagency Guidance on Leveraged Lending,” 78 Federal Register 17766, March
22, 2013, www.gpo.gov/fdsys/pkg/fr-2013-03-22/pdf/2013-06567.pdf.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
those originated or obtained prior to April 1 and previously rated as not “leveraged” – except
those subject to the cash collateral, government guarantee, asset-backed lending, or dealer floor
plan financing exemptions – become “higher-risk.” In parallel, if the firm is judged to be not a
“higher-risk c&i borrower,” then all of the exposures to that firm – including those created
before April 1 and previously rated as “leveraged” – become not “higher-risk.”
As a result, a lot of exposure to a firm can all-at-once become “higher-risk” or else drop from
“higher-risk.” The increase in volatility of the reported “higher-risk c&i loans and securities”
balance (and, potentially, FDIC assessments) is the trade-off for a significant reduction in
reporting burden.
FDIC Response: It depends. Banks have two options:
(1) As of April 1, 2013, banks should continue to report c&i loans as they were reporting them
prior to April 1, 2013 using either the February 2011 rule definitions or the transition
guidance. If the borrower obtains a new c&i loan or refinances an existing c&i loan on or
after April 1, 2013 and at that time the borrower does not meet the criteria to be considered
a higher-risk c&i borrower, then c&i loans to that borrower would not be reported as
higher-risk. If the borrower obtains a new c&i loan or refinances an existing c&i loan on or
after April 1, 2013 and is considered to be a higher-risk borrower at the time the new loan is
originated or the existing loan is refinanced, then all c&i loans to that borrower should be
reported as higher-risk.
(2) However, an institution may opt to apply the March 2012 final rule definition of higher-risk
c&i loans and securities to all of its c&i loans and securities (including those loans originated,
refinanced, or purchased before April 1, 2013), but, if it does so, it must also apply the final
rule definition of a higher-risk c&i borrower without regard to when a loan is originally made
or refinanced (i.e., whether made or refinanced before or after April 1, 2013).
61. The rule appears to permit but not require a LBP institution to evaluate its entire portfolio of
c&i loans against the “higher-risk” definition, such that loans that have been reported as
“leveraged” in the past may become not “higher-risk” and vice versa. Is a LBP institution
permitted to reevaluate some but not all of its c&i loans against the “higher-risk” definition?
The FDIC Q&A13 clarifies that reevaluation of a portion of the c&i portfolio is not permitted. It
says, “If a bank decides not to re-evaluate its entire C&I loan and securities portfolio, then,
beginning with the June 30, 2013 Call Report, it must continue to report C&I loans originated,
refinanced, or purchased before April 1, 2013 as they were reported before the second quarter of
2013. Under these circumstances, the bank will generally not be permitted to stop reporting
loans reported through the first quarter 2013 in the RC-O “leveraged” balance that do not meet
the new higher-risk definition (even if, for example, the loans would otherwise meet the assetbased lending exclusion, the floor plan lending exclusion, are government guaranteed or are
under $5 million in original principal amount).”
13
www.fdic.gov/deposit/insurance/qas_assessments_dividends_assessment_base_and_large_bank_pricing_(updated_9-4-13).pdf
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
62. Assume we approve a new loan on March 20, 2013, whereby it would qualify as a “highly
leveraged transaction” (HLT) given our current definition. However, if the loan does not close
with our borrower before April 1st, and is subsequently booked to our loan system, would we
have to re-evaluate under the new “higher-risk” definition?
Through first quarter 2013 – March 31, 2013 – a LBP bank is to classify loans as “leveraged”
and report them on Call Report Schedule RC-O Memorandum item 9 as “leveraged loans and
securities” consistently how it report “leveraged loans” for supervisory purposes. The status of a
loan as “leveraged” will be grandfathered into “higher-risk c&i loans and securities” starting
April 1. It will remain “higher-risk” until it is paid off or (non-TDR) refinanced.
If the loan is on the books as of March 31, to be graded for supervisory purposes and reported
in the first quarter Call Report, its status is set and, thereafter, grandfathered. If it is not recorded
and included in the first quarter call report, it will not be grandfathered and should be evaluated
under the definition of “higher-risk c&i loans and securities” after March 31.
63. Suppose that a LBP bank originates a new loan to an existing commercial borrower after April 1,
and that this loan does not finance an acquisition, buyout or capital distribution (so it does not
satisfy the Purpose Test). (An example would be a new corporate card.) However, the borrower
has been a grandfathered leveraged borrower since before April 1 based on internal evaluation.
Must the bank reclassify loans legacy LFT if the firm’s leverage exceeds the Leverage Test 3X or
4X thresholds?
 According to the rule, “banks will not need to reexamine their entire existing C&I loan and
security portfolios immediately to determine whether the loans and securities meet the new
definition of higher-risk C&I loans and securities (although they may opt to do so…). Rather,
they will be able to wait until a borrower seeks a new C&I loan (or refinances an existing one)
on or after April 1, 2013, and meets the higher-risk C&I borrower definition before applying
the new higher-risk C&I loan and security definition to all of that borrower’s C&I loans and
securities.” (66013, right column) This passage may suggest that a bank must evaluate the
purpose even of grandfathered loans after April 1 if a new loan is originated.
 However, note also that “[t]he final rule introduces a new term, a ‘higher-risk borrower,’
which includes a borrower that owes the reporting bank…on a C&I loan originally made on
or after the effective date of the rule (April 1, 2013)…” (66001, middle column) This suggests
that a borrower cannot become a “higher-risk c&i borrower” by virtue of a loan made prior
to April 1, 2013.
 In sum, it appears that the bank would reevaluate the LFT loan against the Purpose Test to
determine if the borrower is a “higher-risk c&i borrower” when it originates a non-purpose
loan after April 1. Is this correct?
There is no “higher-risk c&i borrower” today and there will not be one before April 1. There are
firms whose loans have been classified and reported as “leveraged,” but the concept of a
“higher-risk c&i borrower” does not go into effect until April 1.
Starting on April 1, whenever a LBP makes a commercial loan, it must consider whether the
borrower is a “higher-risk c&i borrower.” Any loan made before that date has no relevance in
this analysis. Instead, the firm must review only the loan or credit facility under consideration to
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
decide whether, with that credit, the firm would become, for the first time, a “higher-risk c&i
borrower” (if the loan passes the Size, Purpose and Materiality Tests and, at that time, the
borrower passes the Leverage Test).
Therefore, if a new or refinanced credit is not for “purpose” then it cannot change a firm into a
“higher-risk c&i borrower.” The firm will remain not a “higher-risk c&i borrower” – even if
loans to it that are still on the books have been classified and reported as “leveraged” and
thereafter are reported under “higher-risk c&i loans and securities” – and all new non-”purpose”
credits to that firm will not be “higher-risk c&i loans.” Only a new or refinanced credit that
qualifies as “purpose” (and passes the Materiality Test) will reclassify the firm.
64. The rule provides that a loan or credit line to a c&i borrower cannot deteriorate into a “higherrisk” exposure. In other words, if its leverage rises when EBITDA falls (even with no increase in
debt), this would not trigger reclassification of credits to that borrower as “higher-risk.”
However, a borrower can deteriorate into a “higher-risk c&i borrower” for a specific LBP bank
if there is a “refinance” (as defined in the rule) of a credit from the bank to the firm. If the bank
“refinances” a deal such that leverage at that point exceeds the 3X or 4X debt/EBITDA
threshold, would the borrower then become a “higher-risk c&i borrower” and all credits to it
“higher-risk c&i loans” – even if the higher leverage was not caused by the new or refinanced
debt?
A specific credit cannot deteriorate into being a “higher-risk c&i loan.” However, if a borrower’s
operating leverage deteriorates and there is a refinance –one that does not count as a TDR – of a
credit that was originated within the past five years and satisfied the Purpose Test (albeit not the
Leverage Test) at that time, then all of the bank’s credits to that borrower become “higher-risk”
– even the TDRs. The same is true if the credit is a general-purpose credit line which has been
observed to be used for a “purpose” action within the last five years.
The end result is that any new loan or refinance that satisfies the Purpose Test at a point where
the borrower’s operating leverage exceeds the Leverage Test thresholds would flag the borrower
as “higher-risk” – even if rise in leverage resulted from cash flow deterioration and not increased
debt. Note that this position conflicts with the industry view of when a rise in leverage can cause
a transaction to be classified as “leveraged.”
Types of C&I Loans to be Evaluated
65. Should a commercial loan or credit facility be evaluated against “higher-risk” if there is an
agreement at the time of reporting but the contract has yet to be signed?
Such loans are reported as c&i loans on Schedule RC-C item 4, so they should be evaluated
against “higher-risk c&i loans and securities.”
66. How should loans to the proprietors of small firms be evaluated against the “higher-risk”
definition?
The Call Report instructions that applied through first quarter 2013 for Schedule RC-O
Memorandum item 9, for “leveraged loans and securities,” defines this item to include “all
commercial and industrial loans (funded and unfunded) (as defined for Schedule RC-C, part I,
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
item 4, but excluding loans to individuals for commercial, industrial, and professional
purposes” (emphasis added).14
This provision was excluded in the draft instructions for the Call Report changes for Schedule
RC-O Memorandum item 9.a for “higher-risk c&i loans and securities,” which went into effect
in second quarter 2013. However, following recommendations from ABA and others, the
FFIEC reinserted it, as confirmed by the following statement released May 21:15
[The bankers’ associations] recommended clarification of the definition of “higher-risk c&i
loans and securities” in the draft of the revised Call Report instructions for Schedule RC-O,
Memorandum item 9.a, to exclude loans to individuals for commercial, industrial, and
professional purposes. The bankers’ associations also commented that commercial loans of
at least $5 million to individuals to finance material acquisitions, buyouts, or capital
distributions are exceedingly rare, so excluding loans to individuals from being reported as
“higher-risk c&i loans and securities” will not have a noticeable impact on the aggregate
amount of such higher-risk assets. Adding an exclusion for loans to individuals for
commercial, industrial, and professional purposes to the draft revised Memorandum item 9.a
instructions would be consistent with the existing instructions for reporting leveraged loans
and securities in Memorandum item 9.a. The Agencies plan to clarify the draft revised
Memorandum item 9.a.
The bankers’ associations also commented that it is unclear how an institution could evaluate
loans to proprietorships and partnerships against the definition of “higher- risk C&I loans
and securities,” asserting that the financial statements of such firms do not include the data
needed to calculate the leverage and Materiality Tests included in the definition. However,
because “higher-risk c&i loans and securities,” as defined, include certain loans with an
original amount of at least $5 million, the Agencies do not agree with this assertion and
would expect that institutions, when lending such an amount to a commercial borrower,
including a sole proprietorship or partnership, would regularly obtain financial statements
that include the necessary data to determine debt levels and calculate debt-to-EBITDA
ratios. The decision to exclude loans to individuals for commercial, industrial, and
professional purposes from “higher-risk c&i loans and securities” was based upon the fact
that EBITDA cannot be calculated for an individual; however, this is not the case for a
commercial borrower operating as a sole proprietorship or partnership. Therefore, the
definition of higher-risk c&i loans will not exclude loans to sole proprietorships and
partnerships.
On May 24, 2013, ABA noted to the regulators that sole proprietorships are indistinguishable
from their individual owners, citing the U.S. Small Business Administration; therefore loans to
proprietorships should receive the same exclusion from evaluation against “higher-risk c&i
loans” as loans to individuals for commercial, industrial, and professional purposes. In a
telephone conversation on June 25, 2013, FDIC staff indicated that the Call Report instructions
will not be adjusted to recognize ABA’s point. They feel that loans to proprietorships should be
evaluated as potentially “higher-risk” because such credits in excess of $5 million that finance
14 Call
Report Instructions for Schedule RC-O Memorandum Item No. 9, “leveraged loans and securities,”
March 31, 2013, www.ffiec.gov/pdf/ffiec_forms/ffiec031_ffiec041_201303_i.pdf, page RC-O-25.
15 FFIEC announcement of May 21, 2013, www.aba.com/groups/fdicdocs/ffiec130521.pdf.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
acquisitions, buyouts or capital distributions are “higher-risk” loans. Moreover, they believe that
loans to sole proprietorships differ from commercial loans to individuals because
debt/EBITDA can be determined for the former, especially those above $5 million.
67. Can personal loans to proprietors of small firms be treated as consumer loans for classification
of “higher-risk” assets?
See the response to the previous question.
68. There is no distinction in the rule between consumer credit cards and business credit cards. Are
consumer credit cards to be considered as consumer loans and business credit cards to be
considered as c&i loans?
This question is copied from and addressed above.
69. Should a small business loan where the owner’s home is put up as extra collateral be rated
against “higher-risk c&i loans and securities” or against “nontraditional mortgages?
A commercial loan is a residential mortgage if at least half of the balance is secured by residential
property; it is a c&i loan if the proportion is less than half, according to Call Report
instructions.16 The “higher-risk” definition that the loan should be evaluated against should
follow this principle.
However, the Call Report Instructions provide the following exemptions from evaluation against
“higher-risk consumer loans”:
(1) consumer loans reported as trading assets in Schedule RC, item 5.
(2) the maximum amounts recoverable on higher-risk consumer loans under guarantee or
insurance provisions from the U.S. Government, including the maximum amount
recoverable under FDIC loss-sharing agreements.
(3) loans fully secured by cash collateral…
(4) business-purpose loans secured by one or more 1-4 family residential properties.
Item (4) in this list provides an exemption for residential loans to individuals for business
purposes. This is consistent with the Call Report Instructions that exempts c&i “loans to
individuals for commercial, industrial, and professional purposes” as potential “higher-risk c&i
loans and securities.”17
70. Take the case of a small business loans secured by 1-4 family residential property, where the
property value represents more than half the principal of the loan at origination. If there is a
guarantor for the loan, should the guarantor’s consumer credit score, if available, be used to
evaluate whether the loan is “higher-risk”? Alternately, should the bank use the borrowers’ (sole
proprietor, partners, or company) credit score (s)? The rule indicates that loans (or portions
16 Glossary
to the Call Report Instructions, www.ffiec.gov/pdf/ffiec_forms/ffiec031_ffiec041_201209_i.pdf,
under “Loan Secured by Real Estate.”
17 Call Report Instructions for Schedule RC-O Memorandum Item No. 9, “leveraged loans and securities,”
March 31, 2013, www.ffiec.gov/pdf/ffiec_forms/ffiec031_ffiec041_201303_i.pdf, page RC-O-25.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
thereof) that are guaranteed or insured by the U.S. Government or a Federal Agency are
excluded from “higher-risk,” but it does not mentioned non-government guarantees.
Most LBP institutions would classify this loan as a “1-4 family residential mortgage loan”
because it is secured by 1-4 family residential property. There is no provision in the rule, FDIC
Q&A, or Call Report Instructions for the personal guarantee to affect this classification.
A residential real estate loan must first be evaluated as potentially a “nontraditional residential
mortgage.” If it is not “nontraditional” then it must be evaluated as potentially a “higher-risk
consumer loan.” However, the Call Report Instructions provide an exemption for “businesspurpose loans secured by one or more 1-4 family residential properties.”
If the bank does not model FDIC-PDs internally, an appropriate consumer credit score must be
determined as the basis for establishing the FDIC-PD. If the firm is a sole proprietorship, the
owner’s credit score would work. If the firm is a partnership, Subchapter S, LLC or some other
form of closely held operation, the bank will have to use its own discretion, as there is no
guidance in the rule, FDIC Q&A, or Call Report Instructions.
71. All consumer loans and loans secured by 1-4 family residential property are to be evaluated as
potential “higher-risk consumer loans” and included in the FDIC-PD distribution table – except
that the Call Report Instructions provide an exemption for “business-purpose loans secured by
one or more 1-4 family residential properties.” Is there a problem if we have not been excluding
business-purpose residential mortgage loans?
If an institution chooses to factor real estate loans secured by residential property into its
evaluation of “higher-risk consumer loans,” this would be a conservative approach that would
tend to inflate the amount of “higher-risk” assets reported. As such, the FDIC likely would not
object. However, the exemption for business-purpose residential mortgages was negotiated by
the banking industry after release of the rule and initial draft of Call Report Instructions. It is
there for LBP institutions to take advantage of if they choose.
72. Which of the following types of exposure to a “higher-risk c&i borrower” are to be evaluated as
potentially “higher-risk c&i loans and securities” – commercial real estate loans, business loans
secured by residential real estate, commercial leases, leases financing receivables, credit card
facilities, unfunded commitments, standby letters of credit, derivatives?
The following exposures are to be evaluated against the definition of “higher-risk c&i loans and
securities” (except those that qualify for the asset-based lending, dealer floor plan financing, cash
collateral and government guarantee exemptions) (66017, left-middle column):
(a) All commercial and industrial (c&i) loans (including funded amounts and the amount of
unfunded commitments, whether irrevocable or unconditionally cancellable) owed to the
reporting bank … by a higher-risk c&i borrower …, regardless when the loans were
made; and
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
(b) All securities, except securities classified as trading book, issued by a higher-risk c&i
borrower … that are owned by the reporting bank, without regard to when the securities
were purchased.
The key point is how “c&i loans” are defined relative to “higher-risk c&i loans and securities.”
For this purpose, the rule defines c&i loans based on the definition “in the instructions for Call
Report Schedule RC–C Part I—Loans and Leases” (66001, footnote 15; 66017, footnote 4) – i.e.,
for item 4, “commercial and industrial loans.” These instructions list 13 categories of c&i loans
and 11 exclusions:18
(1) Loans for commercial, industrial, and professional purposes to:
(a) mining, oil- and gas-producing, and quarrying companies;
(b) manufacturing companies of all kinds, including those which process agricultural
commodities;
(c) construction companies;
(d) transportation and communications companies and public utilities;
(e) wholesale and retail trade enterprises and other dealers in commodities;
(f) cooperative associations including farmers’ cooperatives;
(g) service enterprises such as hotels, motels, laundries, automotive service stations, and
nursing homes and hospitals operated for profit;
(h) insurance agents; and
(i) practitioners of law, medicine, and public accounting.
(2) Loans for the purpose of financing capital expenditures and current operations.
(3) Loans to business enterprises guaranteed by the Small Business Administration.
(4) Loans to farmers for commercial and industrial purposes (when farmers operate a
(cont.) business enterprise as well as a farm).
(5) Loans supported by letters of commitment from the Agency for International
Development.
(6) Loans made to finance construction that are not secured by real estate.
(7) Loans to merchants or dealers on their own promissory notes secured by the pledge of
their own installment paper.
(8) Loans extended under credit cards and related plans that are readily identifiable as being
issued in the name of a commercial or industrial enterprise.
(9) Dealer flooring or floor-plan loans.
(10) Loans collateralized by production payments (e.g., oil or mining production payments).
Treat as a loan to the original seller of the production payment rather than to the holder
of the production payment. For example, report in this item, as a loan to an oil
company, a loan made to a nonprofit organization collateralized by an oil production
payment; do not include in Schedule RC-C, part I, item 9, as a loan to the nonprofit
organization.
(11) Loans and participations in loans secured by conditional sales contracts made to finance
the purchase of commercial transportation equipment.
(12) Commercial and industrial loans guaranteed by foreign governmental institutions.
(13) Overnight lending for commercial and industrial purposes.
18 See
“FFIEC 031 and 041: Schedule RC-C – Loans and Lease Financing
Receivables,”www.fdic.gov/regulations/resources/call/crinst/601rc-c11.pdf, pages RC-C-10 through RCC-12.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Exclude from commercial and industrial loans:
(1) Loans secured by real estate, even if for commercial and industrial purposes (report in
Schedule RC-C, part I, item 1).
(2) Loans to depository institutions (report in Schedule RC-C, part I, item 2).
(3) Loans to non-depository financial institutions such as real estate investment trusts,
mortgage companies, and insurance companies (report as all other loans in Schedule
RC-C, part I, item 9).
(4) Loans for the purpose of purchasing or carrying securities (report in Schedule RC-C,
part I, item 9).
(5) Loans for the purpose of financing agricultural production, whether made to farmers or
to nonagricultural businesses (report in Schedule RC-C, part I, item 3).
(6) Loans to nonprofit organizations, such as hospitals or educational institutions (report as
all other loans in Schedule RC-C, part I, item 9), except those for which oil or mining
production payments serve as collateral which are to be reported in this item.
(7) Holdings of acceptances accepted by other banks (report in Schedule RC-C, part I,
(cont.) item 2).
(8) Holdings of the bank’s own acceptances when the account party is another bank (report
in Schedule RC-C, part I, item 2) or a foreign government or official institution (report
in Schedule RC-C, part I, item 7).
(9) Equipment trust certificates (report in Schedule RC-B, item 6, “Other debt securities”).
(10) Any commercial or industrial loans held by the reporting bank for trading purposes
(report in Schedule RC, item 5, “Trading assets”).
(11) Commercial paper (report in Schedule RC-B, item 5, “Asset-backed securities,” or item
6, “Other debt securities,” or in Schedule RC, item 5, “Trading assets,” as appropriate).
Commercial real estate loans: CRE loans to “higher-risk c&i borrowers” are not to be
considered as potentially “higher-risk c&i loans” because they are not on the list of “c&i loans.”
“Higher-risk assets” in the LBP formula equals the “sum of construction and land development
(C&D) loans (funded and unfunded), higher-risk c&i loans (funded and unfunded),
nontraditional mortgages, higher-risk consumer loans, and higher-risk securitizations.” (66015)
Thus, the only commercial real estate loans that are rated as “higher-risk” are C&D loans, as
reported on Call Report Schedule RC-C line 1 (a) (2) for “other construction loans and all land
development and other land loans.”
Business loans secured by 1-4 family residential properties: It is not unusual for loans to
proprietorships to carry residential real estate as extra collateral. However, evaluation of the risk
for the bank’s purposes considers more than whether the loan is “nontraditional” and the
consumer credit score of the proprietor. The Call Report instructions define a “loan secured by
real estate” as one where “the estimated value of the real estate collateral at origination (after
deducting any more senior liens held by others) must be greater than 50 percent of the principal
amount of the loan at origination.”19 Accordingly, if the real estate collateral represents over half
of a commercial loan balance then the loan should be evaluated against the definition of “higherrisk” commercial real estate (i.e., is reported as a construction and development loan” under Call
19 Glossary
to the Call Report Instructions under “Loan Secured by Real Estate.”
www.ffiec.gov/pdf/ffiec_forms/ffiec031_ffiec041_201209_i.pdf.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Report Schedule RC-C item 1 (a) (2)). If the collateral represents less than half the loan balance,
the loan should be evaluated against the definition of “higher-risk c&i loans and securities.”
Commercial leases: LBP bankers generally agree that close reading of the rule seems to indicate
that commercial leases and leases financing receivables are not to be graded against “higher-risk”
because they are not on the list of “c&i loans.” In every case where the rule lists the c&i loans
and securities to be graded, it specifically does not refer to leases. Note that where the rule refers
to leases in this context, the reference is only to the title of a section of the Call Report
instructions. Bankers can read the rule carefully to make their own interpretation.
Credit card facilities, as reported on Call Report Schedule RC-L: Credit card facilities to “higherrisk c&i borrowers” are not to be considered as potentially “higher-risk c&i loans” because they
are not on the list of “c&i loans.” “Leases financing receivables” are reported on Schedule RC-C
item 10 (b), not line 4.
Unfunded commitments: The “unfunded commitments” to be considered for this purpose “are
defined as unused commitments, as this term is defined in the instructions to Call Report
Schedule RC–L, Derivatives and Off-Balance Sheet Items.” (66017, footnote 5) “Unused
commitments,” as reported on line 1 of Schedule RC-L, include “revolving, open-end lines
secured by 1–4 family residential properties; credit card lines, commitments to fund commercial
real estate, construction and land development loans; securities underwriting; and other unused
commitments for commercial and industrial loans, loans to financial institutions, all other
unused commitments.” However, the only elements here that would appear to count as c&i
exposures are business credit card lines and other unused commitments for c&i loans.
Standby letters of credit: The “unfunded commitments” to be considered this purpose “are
defined as unused commitments, as this term is defined in the instructions to Call Report
Schedule RC–L, Derivatives and Off-Balance Sheet Items.” (66017, footnote 5) Standby letters
of credit are not reported on Schedule RC-L as “unused commitments” (line 1), but instead are
reported separately (on lines 2 and 3). Thus, it appears that standby L/Cs are not to be
considered as potentially “higher-risk c&i loans.”
Letters of credit. Since LCs are reported under Schedule RC-L items 2 and 3, they are not
potential “higher-risk c&i loans.”
Derivatives: LBP bankers generally agree that close reading of the rule seems to indicate that
derivatives are not to be graded against “higher-risk c&i loans and securities” Where the rule
refers to derivatives in this context, the reference is only to the title of a section of the Call
Report instructions. Bankers can read the rule carefully to make their own interpretation.
A loan to a securitization. If the “investment” in a CLO, MBS, or other form of securitization is
a loan, not an equity stake, it would not be evaluated against “higher-risk.” This loans would be
reported under Call Report Schedule RC-C item 9 for “loans to nondepository financial
institutions,” not item 4, so it could not be classified under “higher-risk c&i loans and
securities.” Clearly, no other “higher-risk” category could apply either.
 This position is unresolved; note the discussion under “higher-risk securitizations.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
73. Should a commercial loan to a consumer finance company be evaluated against “higher-risk
consumer loans” if the finance company’s business is to make “higher-risk consumer loans”?
Similarly, what about loans to an entity doing “higher-risk” commercial lending?
Whether the borrower is a consumer finance company, a commercial finance company or a
business development company, the answer is the same. The borrower is not a consumer, so the
loan would not be evaluated against “higher-risk consumer loans.” Nor would it be evaluated
against “higher-risk c&i loans and securities.” The only loans to be evaluated against this latter
definition are c&i loans as reported under Call Report Schedule RC-C item 4. Loans to a finance
company or a BDC are reported under Schedule RC-C item 9 for “loans to nondepository
financial institutions.”
74. It appears that call bridge/subscription credits in Fund Finance may qualify as “higher-risk c&i
loans and securities” and there is no exclusion for this type of lending. However, the portfolio is
considered low risk. How would this type of exposure be evaluated?
There was much discussion on March 21 as to whether this financing would satisfy the Purpose
Test if the underlying loans typically finance acquisitions. Nonetheless, it would be difficult to
define debt/EBITDA in the Leverage Test, so it’s not clear how such credits could be evaluated.
These issues are irrelevant if the financing is to a mutual or investment fund such that it would
be reported under Call Report Schedule RC-C item 9 for “loans to nondepository financial
institutions.” If it is not reported under item 4 for “commercial and industrial loans,” evaluation
against “higher-risk c&i loans and securities” would not be required. However, there is an
argument that this type of bridge financing should be viewed as a securitization under the capital
rules for market risk. In this case, it would need to be evaluated against “higher-risk
securitizations” based on evaluation of the fund portfolio. In this case, the “higher-risk”
definitions cover only consumer and commercial loans and corporate bonds; there are no
“higher-risk” definitions for equity securities other types of bonds.
75. When a LBP bank buys a corporate bond (not a CLO), must it evaluate whether the bond is
“higher-risk”?
A corporate bond is to be classified as “higher-risk” only if it is issued by a firm that is a
“higher-risk c&i borrower” to the investing bank. That cannot be the case unless the bank has
made loans to the firm and those loans qualify the firm as a “higher-risk c&i borrower” for
that bank. If the firm does not provide financing to the firm (aside from investing in its bonds)
then no evaluation of the bonds as potentially “higher-risk” is needed.
Note that that bonds themselves cannot make the issuing firm a “higher-risk c&i borrower.” A
firm is to be evaluated as potentially “higher-risk” based only on loans from the bank.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Higher-Risk C&I Borrowers
76. If a borrower is considered to be a “higher-risk c&i borrower” at one bank, does that mean that
the borrower would automatically be considered a “higher-risk c&i borrower” at all banks where
it borrows?
FDIC Response: No. A “higher-risk c&i borrower” is a borrower that owes the reporting
bank on a c&i loan made on or after April 1, 2013, or on a refinanced c&i loan that is
refinanced on or after April 1, 2013 if certain conditions are met. The definition has been
simplified in the final rule in that each bank must only consider c&i loans, refinancings, or
commitments made by their bank (except in the case of a syndicated loan) to determine whether
or not a borrower meets the criteria to be considered a “higher-risk c&i borrower.”
77. If a firm is classified as a “higher-risk c&i borrower” to one LBP bank, would a different LBP
bank necessarily rate loans to this firm or bonds issued by it “higher-risk”?
An important change in the rule is the concept of a “higher-risk c&i borrower” specific to each
bank – i.e., a firm can be a “higher-risk c&i borrower” to one LBP bank and not to another. A
“higher-risk c&i borrower” is one that (66017, middle column, emphasis added):
(a) owes the reporting bank on a c&i loan originally made on or after April 1, 2013, if:
[citation of the $5 million, Purpose and Materiality Tests]; or
(b) obtains a refinance, as that term is defined herein, of an existing c&i loan, where the
refinance occurs on or after April 1, 2013, and the refinanced loan is owed to the reporting
bank, if: [citation of the $5 million, Purpose and Materiality Tests].
Therefore, the firm could be a “higher-risk c&i borrower” relative to one LBP bank and not to
another. The firm is a “higher-risk c&i borrower” to a second LBP bank only if that bank has
made loans that satisfy the $5 million, Purpose and Materiality Tests for that bank. If the
financing is part of a syndication, the firm is likely to be a “higher-risk c&i borrower” to all
participants.
FDIC Response: No. A “higher-risk c&i borrower” is defined as a borrower that owes the
reporting bank on a c&i loan or obtains a refinanced loan that meets certain specifications. Since
bonds are not c&i loans, as defined in the Call Report, debt securities cannot trigger
classification of a “higher-risk c&i borrower”.
However, all securities issued by a higher-risk borrower, except securities classified as trading
book, that are owned by the reporting bank would be considered higher-risk c&i loans and
securities.
78. Suppose that a LBP bank acquires bonds issued by a firm where the total value of debt acquired
exceeds $5 million, the bond issuance raised the funded debt of the firm by over 20 percent, and
the bonds finance a leveraged buyout, such that the firm’s debt exceeds the 3X and 4X
thresholds. Is that firm a “higher-risk c&i borrower” and are the bonds “higher-risk securities”?
While the firm appears to satisfy the $5 million, Purpose, Materiality and Leverage Tests, the
bonds do not classify it as a “higher-risk c&i borrower.” The rule defines a “higher-risk c&i
borrower” based on loans to that borrower, never referring to securities (bonds) in this context:
a “higher-risk c&i borrower” is one that: “ (a) owes the reporting bank on a c&i loan originally
37
FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
… or (b) obtains a refinance … of a c&i loan …” (66017, middle column, emphasis added) Since
bonds are not c&i loans, as defined for reporting in the Call Report, debt securities cannot
trigger classification of a firm as a “higher-risk c&i borrower.”
Thus, unless a LBP bank makes loans to a firm and those loans classify the firm as a “higherrisk c&i borrower,” bonds issued by the firm are not “higher-risk securities.” Securities are
“higher-risk” only if issued by a firm that the bank evaluates as a “higher-risk c&i borrower” (to
that bank), and that evaluation is not based on holdings of the borrower’s securities.
FDIC Response: No. A higher-risk c&i borrower is defined as a borrower that owes the
reporting bank on a c&i loan or obtains a refinanced loan that meets certain specifications. Since
bonds are not c&i loans, as defined in the Call Report, debt securities cannot trigger
classification of a higher-risk c&i borrower. However, all securities issued by a higher-risk
borrower, except securities classified as trading book, that are owned by the reporting bank
would be considered higher-risk c&i loans and securities.
79. If a loan to a borrower goes through a TDR, does the loan or borrower become “higher-risk”?
A firm is to be graded against “higher-risk c&i borrower” at the time of origination of a new
loan or refinance of an existing loan. (66017, middle-right columns) However, “a refinance of a
c&i loan does not include a modification or series of modifications to a commercial loan other
than as described above or modifications to a commercial loan that would otherwise meet this
definition of refinance, but that result in the classification of a loan as a troubled debt
restructuring (TDR), as this term is defined in the glossary of the Call Report instructions”
(66018, middle column). Since a TDR is not a refinance in the sense of the rule, the bank is not
to reevaluate the firm at the time of the TDR. This remains the case if the loan continues under
TDR review and re-review.
A TDR has no bearing on whether a borrower is or is not a “higher-risk c&i borrower,” such
that all loans and credit lines to that firm (except those subject to the asset-backed loan, dealer
floor plan, cash collateral, or government guarantee exemptions) are “higher-risk c&i loans and
securities.” The firm may or may not be a “higher-risk c&i borrower,” but a TDR action is
neither the cause nor the occasion to grade it one way or the other.
However, a TDR refinancing does not provide permanent protection from “higher-risk c&i
borrower” status. If a LBP bank has done a TDR for a borrower and letter does a refinancing or
some other form of recontracting that does not qualify as a TDR, then the firm must be
reevaluated against the definition of a “higher-risk c&i borrower.”
80. A “refinance” resulting in a TDR is not a triggering event to reevaluate a firm as a “higher-risk
c&i borrower” (or not as one). However, can a TDR itself make a firm a “higher-risk c&i
borrower”?
No, a TDR would not qualify a firm as a “higher-risk c&i borrower.” The criteria for assigning a
firm as a “higher-risk c&i borrower” include a size, purpose, materiality, and Leverage Tests on
the firm’s borrowing. (66017, middle column) There is no test for TDRs on the firm’s debt. This
was an element of the former “leveraged” definition that was negotiated away in the revised,
“higher-risk” definition.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
81. In the definition of a “higher-risk c&i borrower,” the Leverage Test is applied at closing of a
new loan or a refinancing. If the firm does not meet the Leverage Tests at a closing – and
therefore is not initially a “higher-risk c&i borrower” – but its leverage rises thereafter, would it
then become a “higher-risk c&i borrower”? If so, would all loans to that firm from LBP banks
become “higher-risk” (except those that meet the four exclusions)?
A “fallen angel” with increasing leverage would not become a “higher-risk c&i borrower” due to
rising Debt/EBITDA alone. This is true even if the debt finances an acquisition, buyout or
capital distribution (i.e., satisfies the Purpose Test, 66018, middle column, emphasis added). For
the firm to become a “higher-risk c&i borrower,” it would have to also have some new or
refinanced debt. Even in this case, it would become a “higher-risk c&i borrower” only for the
LBP bank that financed new debt or refinanced existing debt.
82. Is analysis of the leverage of a firm with subsidiaries to be done at the UMLO (consolidated
parent) or borrower (subsidiary) level?
The rule says: “The debt-to-EBITDA ratio must be calculated using the consolidated financial
statements of the borrower. If the loan is made to a subsidiary of a larger organization, the debtto-EBITDA ratio may be calculated using the financial statements of the subsidiary or, if the
parent company has unconditionally and irrevocably guaranteed the borrower’s debt, using the
consolidated financial statements of the parent company.” (66018, right column)This allows
some flexibility to evaluate leverage at the subsidiary level, recognizing the difficulty of obtaining
consolidated financial information for some firms.
83. When a loan that qualified a firm as a “higher-risk c&i borrower” pays down such that the total
exposure falls below $5 million, do exposures to that borrower cease being “higher-risk”?
No. A firm does not cease being a “higher-risk c&i borrower” until it satisfies one of the three
conditions on 66002, left column – including that the total exposure must be paid off. The
original amount, not the outstanding balance, of loans and credit lines to a firm is one of the
conditions for deciding whether the firm is “higher-risk c&i borrower.” Thus, the firm does not
cease to be a “higher-risk c&i borrower” – and non-exempt loans to the firm do not cease to be
“higher-risk c&i loans” – when the total debt of the firm is paid down.
FDIC Response: No. The bank can discontinue reporting a c&i loan as higher-risk when the
loan has been paid off or extinguished (charged off), or at the time a borrower is no longer
considered to be a “higher-risk c&i borrower.” As noted in the final rule, a borrower ceases to
be a “higher-risk c&i borrower” only if:
 The borrower no longer has any c&i loans owed to the reporting bank that, when originally
made, met the purpose and Materiality Tests described herein;
 The borrower has such loans outstanding owed to the reporting bank, but they have all been
refinanced more than 5 years after originally being made; or
 The reporting bank makes a new c&i loan or refinances an existing one and the borrower no
longer meets the Leverage Test.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Clarification: The three conditions cited above are listed on page 66002 (left column) of the rule.
However, this list should be adjusted in light of some interpretations the FDIC
issued after the rule was released, as follows:
A borrower ceases to be a ‘‘higher-risk C&I borrower’’ if any of the following conditions holds:
 The borrower no longer has any outstanding c&i loans to the reporting bank, or credit lines
with that bank, that, when originated, met the Purpose and Materiality Tests.
 Any such loans outstanding owed by the borrower to the reporting bank have been
refinanced within the last five years and any such remaining credit lines have been renewed
within the last five years, were not to be used for a "Purpose" action (an acquisition, buyout
or capital distribution) at that renewal, and at that renewal had not been drawn on to finance
a “Purpose” action within the preceding five years..
 The reporting bank makes a new c&i loan, refinances an existing c&i loan, or renews a credit
line and the borrower no longer meets the Leverage Test.
A borrower cannot cease to be a higher-risk borrower except if one of these three conditions is
met.
84. Suppose that a borrower was classified as a “higher-risk c&i borrower” on a financing that
occurred six years ago, but that no financings or refinancings have occurred since then and now
the firm has emerged from bankruptcy but still has high leverage (debt over 10x EBIDTA). Can
this borrower be declassified from “higher-risk” if the loan is refinanced?
Yes, this borrower may be declassified from being a “higher-risk c&i borrower” and all loans
and credit lines to that firm can be declassified from being “higher-risk c&i loans and securities.”
Classification as a “higher-risk c&i borrower” is NOT based solely on high leverage; the
financing must also have been for a “Purpose” action (acquisition, buyout or capital
distribution). This important point was negotiated with the FDIC in recognition that some
industries (e.g., utilities) run on higher leverage but are not high-risk borrowers. Thus, if no
financing for the borrower within the last five years satisfied the Purpose Test (and Materiality
Test) then a refinance of a loan to that borrower can allow the bank to declassify the borrower
from being a "higher-risk c&i borrower."
A caveat is that the situation is quite complex if there is an outstanding credit line to the c&i
borrower. In this case, the credit line could keep the firm as a “higher-risk c&i borrower” if the
credit line has been used for a “Purpose” action within the last five years, or if it was renewed
within the last five years and had been used for a “Purpose” action within the preceding five
years.
85. A loan ceases to be “higher-risk” when the borrower “no longer has any c&i loans owed to the
reporting bank that, when originally made, met the purpose and Materiality Tests” or “has such
loans outstanding owed to the reporting bank, but they have all been refinanced more than five
years after originally being made…” (66018, left column) Must the refinance have been for the
loan(s) that qualified the firm as a “higher-risk c&i borrower” by meeting the Purpose Test and
Materiality Test? (66018, middle column)
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
No. Any new loan originated by the borrower, or refinancing of any loan by the borrower,
requires reevaluation of the firm as a “higher-risk c&i borrower” (or not). The rule says: “A
borrower ceases to be a ‘higher-risk c&i borrower’ if … (3) the reporting bank makes a new c&i
loan or refinances an existing c&i loan and the borrower no longer meets the Leverage Test.”
(66002, left column)
If any of the outstanding loans made by a LBP bank to a particular borrower in the last five
years met the Purpose Test and Materiality Test when originated, and if the Leverage Test was
and continues to be met, then the borrower would continue to be a “higher-risk c&i borrower”
even if one or more of the exposures is refinanced. However, if a borrower ceases to meet the
Leverage Test, the bank can make a new loan or refinance any outstanding loan to that borrower
– not necessarily the one that met the “Purpose” and “Materiality Tests” – and then
declassify the borrower as a “higher-risk c&i borrower” and all exposures to that firm would
become not “higher-risk.”
FDIC Response: No. If the bank refinances any outstanding c&i loan to a “higher-risk c&i
borrower,” or makes a new c&i loan to a higher-risk borrower (not necessarily a loan that meets
the purpose and Materiality Tests), the bank must re-evaluate the borrower to determine if the
borrower continues to meet the criteria of a “higher-risk c&i borrower.” If the borrower does
not meet the criteria for a “higher-risk c&i borrower” when evaluated at the time a new c&i loan
is made or refinanced, then all loans to the borrower can cease to be reported as higher-risk.
86. If a credit facility being originated or renewed does not meet the Purpose Test, would a bank
even need to calculate the Leverage Test for the borrower?
Every origination provides an opportunity – and obligation – to review whether the borrower is
a “higher-risk borrower” (and all credit extended to that borrower qualify as “higher-risk c&i
loans and leases”). This may not be difficult in many cases.
If the borrower has been designated as a “higher-risk borrower,” the bank may appreciate the
opportunity to test whether the borrower and credit to it can be “delisted.” If there is existing
“purpose” debt outstanding to the borrower, or if the new/renewal facility is “purpose,” then
the borrower can be “delisted” only through a rerun of the leverage test to see if the borrower’s
debt (including that to be originated or renewed) has fallen below the 3X and 4X thresholds. If
there is no outstanding “purpose” credit and the new/renewal facility is not “purpose,” then the
borrower can be delisted.
On the other hand, if the borrower has not been designated as a “higher-risk borrower,” then if
the facility is not “purpose” or else is not “material” then nothing more needs to be done and
the borrower remains not “higher-risk.” Only in the case that the new/renewal facility is
“purpose” and “material” must the leverage test be calculated to see if the borrower must be
“listed” as “higher-risk.”
Higher-Risk C&I Borrower – Loan Amount Test
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
87. The definition of “original amount” for a credit line to a firm, to determine whether the firm is a
“higher-risk c&i borrower,” refers to “the date of the bank’s most recent Call Report.” (66018,
left column, parts (a) and (c))20 Please clarify the meaning of this phrase.
As a demonstration of the confusion, suppose that the bank is compiling its September 30 Call
Report. At that point, its most recent Call Report is for June 30. When an institution is preparing
a Call Report, “the date of the bank’s most recent Call Report” is always at least a quarter old.
Thus, this phrasing would seem to require a bank to use the balance in a firm’s credit line from
more than a quarter ago in determining the “original amount.” Bankers suspect that this may not
be the FDIC’s intent. If this is the case, they would appreciate if the wording in the rule would
be changed, or else the FDIC Q&A could clarify, that “the date of the bank’s most recent Call
Report” means the end of quarter for which the Call Report that is being produced.
FDIC Response: The phrase means as of the date that [the bank is] filing [its] Call Report, or as
of the current Call Report date. The bank should comb its commercial loan portfolio as of
September 30 to determine if any of its loans meet the higher-risk c&i loan definition. So for
example, if a bank is compiling its September 30 Call Report, the bank should look at what the
original balance of an open line or loan was as of the date of the bank’s most recent approval or
renewal that occurred closest to (but not after) September 30.To further illustrate this, if a $6
million non-revolver line of credit was approved on August 30 and still open/active as of
September 30, then the bank would use $6 million as the original amount to determine if the line
meets the $5 million test.
To illustrate another point that you did not ask about, but is closely related to this example,
suppose that on September 1 the same borrower in the above example had drawn up the line
but then paid it down to a balance of $4.5 million as of September 30.The bank would reflect
the $4.5 million as higher-risk on the Call Reports, not $6 million because the borrower can no
longer draw on the line. However, if the borrower could draw up to the full $6 million as of
September 30, the bank should reflect the $6 million as higher risk on its Call Reports (must
include funded and unfunded amounts in the higher-risk totals).
In the case of a line of credit, the original amount of the line of credit (for purposes of filing
the September 30 Call Report) would be the total amount of the line that was last approved or
renewed closest to (but not after) September 30.If the borrower happened to be in an overadvance position on the line of credit as of September 30, then the balance to use for Call
Reporting purposes would be the actual balance outstanding as of September 30 (since that
balance is greater than what was originally approved to be extended to the borrower).
20 Quoted
from 66018, left column, parts (a) and (c)
(a) For c&i loans drawn down under lines of credit or loan commitments, the amount of the line of credit or
loan commitment on the date of its most recent approval, extension or renewal prior to the date of the
most recent Call Report; if, however, the amount currently outstanding on the loan as of the date of the
bank’s most recent Call Report exceeds this amount, then the original amount of the loan is the amount
outstanding as of the date of the bank’s most recent Call Report. …
(c) For all other c&i loans (whether term or non-revolver loans), the total amount of the loan as of
origination or the amount outstanding as of the date of the bank’s most recent Call Report, whichever is
larger.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
88. If a LBP bank purchases a loan, is the “original amount” to judge against the $5 million
threshold, to see if the borrower is a “higher-risk c&i borrower,” the amount that the original
lender extended or the balance at the time of the acquisition?
LBP bankers generally interpret the rule to say that the loan needs to be evaluated based on the
outstanding balance upon acquisition.
89. A “higher-risk c&i borrower” is one that owes a LBP bank on an outstanding loan where the
original amount, including funded amounts and unfunded commitments (whether irrevocable or
unconditionally cancellable), is $5 million or more. (66017, middle column) Should
unconditionally cancellable unfunded commitments be excluded?
FDIC Response: Unfunded commitments (whether irrevocable or unconditionally cancellable)
are to be included when determining if a borrower meets the $5 million threshold and they are
to be reported as higher-risk along with all other c&i loans and unfunded commitments to a
higher-risk borrower. Such commitments do present risk to the bank in the event they are
funded. A bank would not necessarily cancel the commitment upon discovering that the
commitment meets the higher-risk c&i loan definition. Unfunded commitments are included in
Schedule RC-L of the Call Reports and are defined in the Call Report instructions. Banks must
maintain systems to track the amount of unfunded commitments issued to a borrower for both
Call Report and for risk management/credit administration purposes. Therefore, including such
unfunded commitments in the bank’s higher-risk asset analysis should not add undue burden.
Both the February 2011 rule and the 2012 NPR for the higher-risk c&i loan definition
included unfunded commitments as a higher-risk asset, and the FDIC received no comments
regarding this issue in the 2012 NPR. Furthermore, treatment of an unfunded commitment as
higher-risk is consistent with the way regulatory agencies and banks themselves view unfunded
commitments for criticized and classified asset purposes. Unfunded commitments are listed as a
criticized or classified item based upon the repayment prospects of the borrower. This is similar
to the way unfunded commitments are viewed in the higher-risk c&i loan and security definition.
If a borrower is determined to be a “higher-risk c&i borrower,” all loans and unfunded
commitments to that borrower must also be reported as higher-risk, since these obligations
represent risk to the bank. If the commitment is cancelled and no longer exists, the bank would
not report the commitment as higher-risk.
Clarification
The FDIC’s intent is that all loans to a “higher-risk c&i borrower” are to be included in the
balance of “higher-risk c&i loans and securities” reported on Schedule RC-O Memorandum
item 9.aexcept:
 Those that qualify for the asset-based lending, dealer floor plan financing, governmentguaranteed or cash collateral exemptions, and
 Those classified as commercial real estate loans.21
21 Whether
or not the borrower is a “higher-risk c&i borrower” has no relevance for commercial real estate
loans. Commercial real estate loans are not potentially “higher-risk c&i loans and securities.” CRE loans are
classified as “higher-risk” only if they are “construction and development loans” as reported on Call Report
Schedule RC-C item 1(a)(2).
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
The FDIC’s position is that commitments, as reported on Schedule RC-L, are to be graded
against the “higher-risk c&i loans and securities” definition. An unconditionally cancellable
unfunded commitment is “advised” and therefore not a commitment to be recorded on Call
Report Schedule RC-L, in accordance with the Call Report Instructions. Therefore, it appears
that such lines are not to be graded against “higher-risk c&i loans and securities.”
Moreover, unconditionally cancellable unfunded commitments include “guidance lines” and the
like. Such items are not reported on Federal Reserve Form Y-9C Schedule HC-L for holding
companies. On this basis, LBP institutions feel that such items are not to be included in the list
of exposures to be rated against “higher-risk.” On the other hand, “demand L/Cs” are reported
in the Y-9C and, therefore, should be rated against “higher-risk.”
90. Should loans in the pipeline be reviewed against the “higher-risk” definition? A pipeline loan is
where a commitment letter is issued to a commercial borrower, which may or may not ultimately
turn into an actual loan. A pipeline loan is not recorded on any loan system; that would not
occur until the loan is closed and boarded. We track against “higher-risk” once a loan is boarded
and in our system. Is this consistent with FDIC expectations?
A LBP bank is required to report as “higher-risk c&i loans and securities” “all … C&I loans
(including funded amounts and the amount of unfunded commitments, whether irrevocable or
unconditionally cancellable) owed to the reporting bank… by a higher-risk c&i borrower.”
(66017, left column) The key issue is what counts as “unfunded commitments.” The rule
specifies that “unfunded commitments are defined as unused commitments, as this term is
defined in the instructions to Call Report Schedule RC–L, Derivatives and Off-Balance Sheet
Items, as they may be amended from time to time.” (66017, footnote 5) This reference refers to
what is reported on Call Report Schedule RC-L for “unused commitments” (Item 1). Thus, it
appears that if a commitment of a loan to a c&i borrower is reported under Schedule RC-L Item
1 then it should be evaluated against the “higher-risk” definition; conversely, if a commitment is
not reported then it should not be evaluated as potentially “higher-risk.”
91. Suppose that $4 million of a $7 million c&i loan is federally guaranteed. Should the residual
$3 million be graded against “higher-risk” or ignored as being less than $5 million?
This question is repeated and answered below, below the heading “Cash Deposit and
Government Guarantee Exemptions.”
92. In a refinance of a $10 million multi-purpose line of credit where $4 million of that line was
previously drawn for an acquisition, does the borrower meet the Loan Amount Test? In other
words, is the “purpose” loan amount $4 million or $10 million in this situation?
The rule defines the “original amount” to be compared against the $5 million threshold as “the
amount of the line of credit or loan commitment on the date of its most recent approval,
extension or renewal prior to the date of the most recent Call Report; if, however, the amount
currently outstanding on the loan as of the date of the bank’s most recent Call Report
exceeds this amount, then the original amount of the loan is the amount outstanding as of the
date of the bank’s most recent Call Report.” (66018, left column) In this case, the amount to be
compared against $5 million is neither $4 million nor $10 million; the critical balance is the draw
on the line either currently or on the most recent renewal, whichever is larger.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
93. If a borrower originally qualified as a “higher-risk c&i borrower” as a result of aggregating all
c&i loans to that borrower to reach the $5 million threshold, and that, as the result of payments,
the aggregate debt owed by that borrower falls below $5 million, can that borrower then be
delisted as a “higher-risk c&i borrower” and all loans to it no longer counted as “higher-risk c&i
loans”?
FDIC response (from the “Q&A” under “Removing loans from higher-risk category”):
No. The bank can only discontinue reporting a c&i loan as “higher-risk” when the loan has been
paid off or extinguished (charged off), or at the time a borrower is no longer considered to be a
“higher-risk c&i borrower.”
As noted in the final rule, a borrower ceases to be a “higher-risk c&i borrower” only if:
(a) the borrower no longer has any c&i loans owed to the reporting bank that, when originally
made, met the purpose and Materiality Tests described herein;
(b) the borrower has such loans outstanding owed to the reporting bank, but they have all been
refinanced more than 5 years after originally being made; or
(c) the reporting bank makes a new c&i loan or refinances an existing c&i loan and the
borrower no longer meets the Leverage Test.
94. If a borrower is known to have done an acquisition in the past but it is not clear whether a
multi-purpose line of credit was drawn for the acquisition or, if it was, how much was drawn for
that purpose, should the entire line be compared against the $5 million Loan Amount Test
threshold? Applying the entire line against the Loan Amount Test can cause investment grade
firms to be classified as “higher risk c&i borrowers.”
The answer is the same as above. Evaluation of whether a credit line satisfies the Purpose Test
has no bearing on determination of the “original amount” of the loan for the Loan Size Test.
95. Would a participation in a $20 million loan syndication aggregate against the $5 million cut-off if
it is less than $1 million? If the $20 million is composed of only participations smaller than $1
million, would the borrower be a “higher-risk c&i borrower”?
The rule states: “for syndicated or participated c&i loans, the total amount of the loan, rather
than just the syndicated or participated portion held by the individual reporting bank…” (66018,
left column)This passage dictates that the total amount of the syndication, including all
participations – no matter how small – are to be aggregated against the $5 million cut-off.
If the syndication meets the qualifications to classify the firm as a “higher-risk c&i borrower,”
then the size of the participation in the syndication is irrelevant. Any participation – even under
$5 million, or even $1 million – would be “higher-risk.”
FDIC Response: If the syndicated loan meets the definition of a higher-risk c&i loan, all
participants (if the participant is a large or highly complex bank) must reflect their portion of the
syndicated loan as higher-risk, regardless of the size of the loan held by the reporting bank.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
In the example above, if the syndicated loan meets the criteria of a higher-risk c&i loan (total
amount of the syndication is $5 million or more, and the loan meets the purpose, materiality,
and leveraged tests), each bank that owns a portion of that syndicated loan would report the
dollar amount of the portion they own as “higher-risk,” regardless of the size of that portion
held. So the bank that owns a $900,000 portion of the loan would reflect the $900,000 as higherrisk on its Call Reports.
This feature of the definition is to ensure that all participating banks are reporting “higherrisk” loans consistently.
96. In the case of a syndicated loan, does the agent have a fiduciary responsibility to inform
participating banks wherever the loan is considered “higher-risk”?
A legal interpretation would be required on this point. The following is merely a naive opinion.
Any participant in a syndication should be able to determine whether:
 the total loan exceeds $5 million (likely in every case);
 the loan finances an acquisition, buyout or capital distribution (the Purpose Test);
 if so, whether the loan increases the borrower’s debt by at least 20 percent (the Materiality
Test), and;
 if all of the above are satisfied, whether the borrower’s total and senior debt exceed 3X and
4X the six-month trailing EBITDA, respectively (the Leverage Test).
If the borrower passes all of these tests, it is a “higher-risk c&i borrower” for all syndicate
participants.
While all participants should be able to make this determination, it may be more efficient for the
syndicate Agent to do it. Particularly if the loan is a refinance (as defined in the rule) of previous
funding, it may be easier for the Agent to determine whether the borrower has financed a
Purpose Test activity in the prior five years (as per the rule). Therefore, the fiduciary
responsibility of the Agent bank to make the determination and inform the syndication
participants is unclear.
The rule requires lenders to use “best efforts and reasonable due diligence” to make “higher-risk
c&i borrower” determinations. Same standard of care exists here. For example, a syndicate
participant may simply have to ask the Agent for its determination.
At some point, syndication contracts may evolve to include language that binds the Agent to
make the assessment for the sake of convenience.
97. Is a loan syndication agent obliged to reveal whether a loan is rated as a HLT (highly leveraged
transaction)?
The HLT criterion was considered when the “higher-risk” definitions were proposed, but
dropped in the final rule.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
The March 19 discussion considered the responsibility of the syndication agent to report
information to the syndication, and similarly the responsibility of a CLO securitizing agent. The
general feeling was that final responsibility lies with a bank to make its own evaluations.
98. Does an agent bank have an obligation/duty to disclose whether it has classified a borrower as
“higher-risk”?
LBP bankers polled feel that the answer to this question is “no.” Here are some reasons given:
Given that under the rule, each bank makes its own determination as to whether a borrower
is “higher risk,” I would say no. The only “general” information a participant needs to know
is the total amount of the syndicated credit, to determine “original amount.” Information
that another bank might have is on a “best efforts” basis. The participant bank would have
every other piece of information it would need to make its own determination.
Definitely “no.” These are reserve-based loans monitored via a borrowing base. The bank is
responsible for paying the FDIC insurance and the how or why that gets done is really none
of the client’s business. I also see no restriction on disclosing that they are higher-risk for
purposes of computing FDIC insurance assessments; However, I note the FDIC has issued
guidance in the past regarding disclosing that certain fees are due to FDIC insurance – they
generally don’t like to be tied to fees even though they create them).
Higher-Risk C&I Borrower – Purpose Test
99. We have many middle-to-lower-middle market customers (most S-Chapter corporations and
LLCs) where there are annual dividends to owners and partners (to pay for personal taxes,
compensation, etc.). Do these dividends meet the Purpose Test? The Purpose Test specifically
references dividends with regards to capital distributions that enhance shareholder value, but it is
not clear that the rule intends to include this kind of dividends.
The rule defines a “capital distribution” that qualifies for the Purpose Test as “a dividend
payment or other transaction, including, but not limited to, a repurchase of stock.” (660018,
middle column) It also says: “In the joint letter and a subsequent email, commenters suggested
that debt incurred to fund ordinary business actions such as dividends to make tax payments
should be excluded from the definition of a capital distribution in the purpose test. The final rule
does not adopt this suggestion because the Materiality Test should be sufficient to exclude most
loans made in the ordinary course of business.” (66003, left column)
Most small firms (including partnerships, LLCs, LLPs and Subchapter S firms) have multipurpose credit lines with banks, and most such firms also pay dividends. A question has
therefore arisen as to whether the above wording means that origination or renewal of such
credit lines must necessarily be seen as satisfying the Purpose Test. LBP bankers generally feel
that this is not the case.
Here is one line of reasoning:
Most small firms (including partnerships, LLCs, LLPs and Subchapter S firms) have multipurpose credit lines with banks, and most such firms also pay dividends in the ordinary
47
FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
course of business for owners’ tax liabilities and other reasons specific to the structure of
these firms, dividends that are within the income and cash-generating capacity of the firm.
Similarly, C-Corporations often declare and pay regularly-scheduled dividends, dividends
that are within the income and cash-generating capacity of the firm; and they also have
multi-purpose lines of credit that are used for a variety of working capital/cash management
needs.
Should funding of such ordinary course of business dividends be considered a “purpose”
use?
The rule defines a “capital distribution” that qualifies for the Purpose Test as “a dividend
payment or other transaction, including, but not limited to, a repurchase of stock.” (660018,
middle column) It also says: “In the joint letter and a subsequent email, commenters
suggested that debt incurred to fund ordinary business actions such as dividends to make tax
payments should be excluded from the definition of a capital distribution in the purpose test.
The final rule does not adopt this suggestion because the Materiality Test should be
sufficient to exclude most loans made in the ordinary course of business.” (66003, left
column)
Note that there is nothing in this answer that affirms that funding ordinary business actions,
including dividends, fundamentally should be in scope; rather, it assumes the issue away
because such “loans” would not meet the Materiality Test. However, working capital/cash
management financing of ordinary business needs are almost always handled through lines
of credit advances, not discrete loans; and given the requirements around lines of credit, it
can be assumed that many or most lines would meet the Materiality Test. Thus the issue
cannot be assumed away.
It seems clear what the FDIC is trying to capture with the Purpose Test: transactions which
inherently increase the risk of a firm by layering on material amounts of debt and/or
substituting debt for equity. As stated broadly in the rule: “Higher-Risk Assets. The FDIC
uses the amount of an institution’s higher-risk assets to calculate the institution’s higher-risk
concentration measure, concentration score and total score. As noted in the February 2011
rule, the higher-risk concentration measure captures the risk associated with concentrated
lending in higher-risk areas. This type of lending contributed to the failure of a number of
large banks during the recent financial crisis and economic downturn.” (66001)
There are “capital distributions” that clearly would meet this standard, such as dividends or
stock repurchases of a magnitude beyond the income generating capacity of the firm,
resulting in a need to finance these transactions in an amount representing a recapitalization
of the firm, using debt to replace equity. Such is not the case with dividends within the
paying capacity of the firm not requiring “permanent” financing. These situations are easily
distinguishable from one another.
Consequently, at the origination of a multi-purpose line of credit, the prospect that a firm
might, as part of its working capital/cash management, use advances to temporarily fund
ordinary course of business uses, including dividends, should NOT be considered a
“purpose” use. On the other hand, if it is expected that advances will be used for “capital
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
distributions” that result in fundamental restructuring of the capital structure of the firm,
this should be considered “purpose” use.
Similarly, this distinction holds at refinance as a reporting bank “looked back” at the use of
the line of credit during the previous term.
Here is another line of reasoning:
The rule makes clear that, if debt is “incurred to fund ordinary business actions such as
dividends to make tax payments” then this counts as a “capital distribution” in the sense of
the Purpose Test. (66003, left column) Similarly, the FDIC Q&A clarifies: “Multi-purpose
lines of credit would not be deemed to meet the purpose test at origination unless the
borrower specifically plans to use the line of credit to finance an acquisition, buyout or
capital distribution. If the borrower eventually draws on the line of credit for the purpose
of financing an acquisition, buyout or capital distribution, the bank would identify this as
a purpose loan at the time the line is renewed.” (page 9, emphasis added) The apparent intent
of these two passages is that, if a firm has to take a draw from a credit line to pay a dividend,
then this draw is a “capital distribution” and the credit line satisfies the Purpose Test.
However, this would be an unusual situation. The simple fact is that firms pay dividends out
of earnings; if they don’t have earnings then they don’t pay dividends. In contrast, a firm
opens a bank credit line so that it can take draws as needed, which it will do routinely. Thus,
should a draw occur during tax season, it cannot be singularly identified with a dividend
capital distribution (for whatever purpose) when the dividend does not exceed earnings. As
per the FDIC guidance, such a draw is not incurred to fund a dividend if the firm’s earnings
are sufficient to cover the dividend without the draw.
In sum, in evaluating whether a new or renewed credit line to a Subchapter S, LLC, LLP, or
partnership firm will be used for a “capital distribution” in the sense of the Purpose Test, a
LBP banker can normally expect that it will not be. Because firm’s seldom pay dividends not
supported by earnings, the bank can anticipate a priori this restraint on the part of the firm –
unless it has reason to expect otherwise. The banker can rate the credit line as not “purpose”
in anticipation that dividends will be paid out of earnings, not from credit line draws.
The same apples at refinance or renewal under the look-back provision. It is reasonable to
conclude that an operating/revolving line of credit was not used for “capital distributions”
as long as dividends paid did not exceed the firm’s earnings over the look-back period. As
such, the refinanced/renewed credit line would again not satisfy the Purpose Test.
LBP bankers will want to review the wording in the rule and FDIC Q&A to decide for
themselves what is appropriate in this situation.
100.The rule specifies that a credit satisfies the Purpose Test if, among other things, it finances “the
purchase by the borrower of any equity interest in another company, or the purchase of all or a
substantial portion of the assets of another company” (66018, middle columns, emphasis added)
What constitutes “a substantial portion”? Is it a controlling interest or else 50 percent? How
about 80 percent (as applied in the Call Report for Push Down Accounting)? Is there guidance
on what constitutes a “substantial portion” of another company’s asset? For example, if a
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
borrower acquires four franchise units from a seller that owns 10,000 units, that would not seem
to be a “substantial portion.” On the other hand, if the borrower acquires four units from a
seller that owns 20 units, that could or could not be considered a “substantial portion.”?
This question arises frequently with respect to the pipeline and energy industry. LBP bankers
feel that there is no “bright line” test; rather, each case must be considered individually. The rule
appears aimed at situations where a borrower acquires another firm, regardless of whether it
acquires the firm’s charter. In this sense, the purchase could be seen as not “a substantial
portion” if the firm purchased from remains a meaningful operating residual of the former
enterprise. Under this interpretation, significantly more than half of the firm would have to be
acquired for this situation to be viewed as “a substantial portion.” On the other hand, the
purchase can be evaluated based on whether the borrower is adding debt that will impact its cash
flows. Under this interpretation, the trigger portion purchased could be more or less than half.
Again, the situation must be evaluated based on its own merits.
In discussing this question on May 7, 2013, LBP bankers agreed that there is no general
definition of “substantial” in this context. LBP bankers should use their good judgment.
101.In extending a term loan and a revolving working capital line for a transaction that satisfies the
Purpose Test, should the revolving line be considered “purpose” if it truly will be used
specifically for working capital and cash management? Some might classify the revolver as
“purpose” even though it is not specifically used to finance an acquisition, buyout or capital
distribution. However, it is not a stretch to not consider the revolver as “purpose,” since the
FDIC definition talks about specific loans being used for certain purposes. This issue matters in
deciding how much of the revolving line to add to the numerator of debt/EBITDA in the
Leverage Test calculation.
A working capital line of credit does not satisfy the Purpose Test if it is not expected to be used
to finance an acquisition, buyout or capital distribution. On renewal of a credit line, even if it is
not expected to be used to finance and acquisition, buyout or capital distribution, if it has been
used for such purpose over the last five years (or as long as it has been in existence), then it
satisfies the Purpose Test. Thus, on renewal, a LBP bank must make a reasonable effort to
review past usage of a credit line.
It will be important to note when a credit line satisfies the Purpose Test, in case it can be
“delisted” on renewal five years later. LBP banks should augment their systems to record this
element.
102.In renewing a commercial credit line hereafter where the line was originated prior to April 1,
2013, does an LBP bank have to evaluate whether the line was used in the prior five years for an
acquisition, buyout or capital distribution in order to determine if a renewed line would meet the
Purpose Test?
In renewing a credit line created prior to April 1, if it is expected to be used to finance an
acquisition, buyout or capital distribution in the future then it satisfies the Purpose Test.
Moreover, even if it is not expected to be used for such purpose in the future, a LBP bank must
look back to see whether the line was used for such purpose over the past five years (or since it
was originated).
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Even though the status of loans and credit lines classified as “leveraged” through first quarter
2013 becoming “higher-risk c&i loans” thereafter – and vice versa – is “grandfathered,” this is not
the case for the status of borrowers as “higher-risk c&i borrowers” (or not). All firms were not
“higher-risk c&i borrowers” on April 1, 2013. However, this classification can change hereafter.
103.Over a five year period, there may well have been multiple refinances of a commercial credit or
renewals of a credit line. When evaluating a refinance or renewal more than five years after the
original credit/line was incurred, could the borrower be delisted as a “higher-risk c&i borrower”
even though it would have been classified as one during one of the interim refinances?
If the question is whether a credit on refinancing, or a credit line on renewal, could disqualify
from the Purpose Test, the answer is NO. At a refinance or renewal, if a loan or credit line has
been used to finance an acquisition, buyout or capital distribution during the past five years then
it continues to satisfy the Purpose Test.
If the question is about “delisting” a firm as a “higher-risk c&i borrower,” even though it would
have been classified as one in a refinance or renewal that occurred during the interim, if all of the
credits and credit lines that satisfied the Purpose Test have closed and are not being refinanced
or renewed, or the borrower’s leverage has dropped below the 3X and 4X thresholds, then the
firm would no longer be a “higher-risk c&i borrower.”
104.If a LBP bank makes a loan to an ESOP, is this “purpose” financing?
It would seem that an ESOP should be considered as a “capital distribution” and therefore
financing an ESOP should satisfy the Purpose Test. If a LBP bank makes a loan to a firm and
the firm uses the funds for an ESOP, the loan would be reported under Call Report Schedule
RC-C item 4 as a c&i loan and there is no issue. On the other hand, if the loan is directly to an
ESOP then it would be reported instead under RC-C item 9 for “loans to non-depository
financial institutions and other loans.” In this case, the loan would not satisfy the Purpose Test.
The rule specifies the Purpose Test as: “A ‘higher-risk C&I borrower’ is a borrower that: (a)
owes the reporting bank on a C&I loan [under specified conditions] … or (b) obtains a refinance
… of an existing C&I loan [under specified conditions].” (66017, middle-right columns) Since a
loan to an ESOP is not a C&I loan, it would seem that this financing is not “purpose.”
Actually, this is not quite correct. Instead, the interpretation is that, since the loan is not a c&i
loan, it does not qualify as financing to be considered as “purpose” and, moreover, this non-c&i
loan should not even be considered against the $5 million size threshold.
105.A good commercial customer is often afforded a credit line as a general liquidity backstop to be
used as it sees fit. The firm may, at some point, draw on the line to finance a variety of activities,
including something that meets the Purpose Test (i.e., for an acquisition, buyout or capital
distribution). Would such a credit line be deemed to meet the Purpose Test if there is no specific
covenant against it being used for a “material” acquisition, buyout or capital distribution as
defined in the rule (66018)? Alternately, would the credit line not meet the Purpose Test at
origination but begin to when a draw is used for a “material” acquisition, buyout or capital
distribution?
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
FDIC Response: Multi-purpose lines of credit would not be deemed to meet the purpose test at
origination unless the borrower specifically plans to use the line of credit to finance an
acquisition, buyout or capital distribution. If the borrower eventually draws on the line of credit
for the purpose of financing an acquisition, buyout or capital distribution, the bank would
identify this as a purpose loan at the time the line is renewed. If the line meets the purpose test
(at origination or renewal), the bank must determine if the borrower meets the other tests
outlined in the higher-risk c&i loan definition.
106.Suppose an open-ended line of credit meets the Purpose Test (because it can be used for
acquisitions, capital distributions, etc.) but does not meet the Materiality Test or Leverage Test at
origination – but could at some point in the future. Must the bank track this line or does it just
become part of the look-back process at refinance or when a new loan is made to that customer?
Under these circumstances, this credit line in and of itself, would not qualify the borrower as a
“higher-risk c&i borrower” at the outset, because the firm meets some but not all of the criteria.
Any new credit to the firm would have to be evaluated on its own to see if it qualifies the firm as
a “higher-risk c&i borrower.” The only tie to the original “purpose” credit line would be in the
Materiality Test, to see if the new credit, plus this credit line, plus any other credits originated or
refinanced by the bank for the firm over the prior six months increased the firm’s debt by over
20 percent. The fact that the credit line was for a “purpose” action would be irrelevant.
However, if it extends, renegotiates or otherwise refinances this “purpose” credit line sometime
in the next five years, the bank will have to see if the line was, in fact, used for a “purpose”
action over that period – or if the expectation is that it will be in the future. In either case, the
firm must be evaluated at that point to see if it satisfies the other criteria for a “higher-risk c&i
borrower.”
107.We occasionally make one master credit facility that could cover working capital, acquisition,
and real estate financing. According to an FDIC response to a banker question, this type of
master facility satisfies the Purpose Test, even if the primary collateral and purpose is real estate
finance. Would cross-collateralization of real estate and non-real-estate financing have any
impact?
If, by contract, all draws from the facility are collateralized by real estate, this facility would
appear to fall out of the scope of “higher-risk c&i loans and securities.” In this case, the facility
would be judged against the “construction and development” definition for grading against
“higher-risk.” Otherwise, there is no clear reason to think that cross-collateralization would
matter.
108.Would it matter if this exposure were originated prior to the Purpose Test event?
No, this would not make a difference.
All c&i assets on the balance sheet as of April 1, 2013 that are reported as “leveraged” in Call
Reports through first quarter 2013 will thereafter be rated as “higher-risk” and those not
previously rated as “leveraged” will thereafter not be reported as “higher-risk” – unless the
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
firm takes out a new loan or line of credit, or there is a refinancing, with the particular
bank that changes the status borrowing firm relative to the “higher-risk c&i borrower”
definition.
Once a firm meets the qualifications for a “higher-risk c&i borrower” for a LBP bank, all of that
bank’s loans to that firm – except those that satisfy the ABL, dealer floor plan, cash security, and
government guarantee exclusions – are “higher-risk.” This is true even for loans still on the
books that were made prior to the Purpose Test financing.
109.For private companies, how does a LBP bank look back five years if the data is not public?
Looking back five years is required only for a “refinance” (of a loan originated by the bank or by
another). (66018, middle column) For an original loan, the bank would need to evaluate the
purpose only of that loan. To make the determination in the case of a “refinance,” the bank
should review several years of financial statements for the borrower and ask the borrower for
details on salient loans still on the books. The rule allows for “higher-risk” determinations using
“best efforts and reasonable due diligence.” (66002, middle column)
Higher-Risk C&I Borrower – Materiality Test (in the Purpose Test)
110.In evaluating the “higher-risk” status of a multi-purpose credit facility that is expected to be
used to finance an acquisition, buyout or capital distribution (among other things), so that it
meets the Purpose Test, how much of the credit line should the bank assume in the Materiality
Test?
The calculation should be based on a fully drawn credit line. The rule says: “A loan or refinance
meets the Materiality Test if … [t]he original amount of the loan (including funded amounts and
the amount of unfunded commitments, whether irrevocable or unconditionally cancellable)
equals or exceeds 20 percent of the total funded debt of the borrower …” (emphasis added, 66018,
middle column). In short, a credit line passes the Materiality Test if, when the credit package is
evaluated, the entire line (plus any other credits in the funding package) exceeds 20 percent of
the firm’s debt outstanding.
111.Does the “funded debt” in the definition of a “higher-risk c&i borrower” apply only to the debt
owed to the lending bank, or to all debt the owed by the counterparty (regardless to whom)?
A loan or credit line financing an acquisition, buyout, or capital distribution (i.e., one that
satisfies the Purpose Test) must also satisfy the Materiality Test as part of the qualification of a
commercial credit customer as a “higher-risk c&i borrower.” The Materiality Test is as follows:
“A loan or refinance meets the Materiality Test if the amount of the original loan (including
funded amounts and the amount of unfunded commitments, whether irrevocable or
unconditionally cancellable) equals or exceeds 20 percent of the total funded debt of the
borrower…” (66002, middle column, emphasis added) For this purpose, “total funded debt”
means all of the borrowings – from every lender – on the books of the counterparty.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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112.Is the six-month look back-period that is used to see if the $5 million threshold has been met
also used in calculating the 20 percent increase in debt for the Materiality Test?
For example, suppose that a firm has a total debt of $35 million (including $4 million the bank
loaned the firm three months ago) and borrows $3 million more; is the increase in debt equal to
($4 + $3) / ($35 – $4) = 23 percent or $3 / $35 = 9 percent?
The rule appears to require that the amount to be compared against both the $5 million
threshold and the 20 percent Materiality Test is the total of loans and credit lines (fully drawn)
that satisfy the Purpose Test (i.e., those to finance acquisitions, buyouts and capital distributions)
originated or refinanced over the prior six months. (66018, left column)
The two loans within six months would aggregate to $7 million, exceeding the $5 million
threshold, so a LBP bank would have to proceed to look at the “purpose” and “materiality” of
the credits, and leverage of the firm, to see if the firm is a “higher-risk c&i borrower.”
As to the Materiality Test, the “amount of the original loan” must exceed 20 percent of the
borrower’s total funded debt. (66002, middle column) The “original amount” includes “all c&i
loans that a borrower owes to the reporting bank that meet the purpose test when made, and
that are made within six months of each other …” (66018, left column)
Thus, in the above example, the increase in debt would be 23 percent and the loan would satisfy
the Materiality Test.
113.With reference to the definition of “total debt” in the Materiality Test, can subordinated debt
due to a parent firm or due to individual(s) that represent the shareholders of the borrower be
excluded? If not, since the definition includes “all interest bearing financial obligations,” what if
the subordinated debt due to the parent or individual shareholders was not interest-bearing;
could this debt be excluded from the “total funded debt” definition?
For the purpose of the rule, “[t]otal debt is defined as all interest-bearing financial obligations
and includes, but is not limited to, overdrafts, borrowings, repurchase agreements (repos), trust
receipts, bankers acceptances, debentures, bonds, loans (including those secured by
mortgages),sinking funds, capital (finance) lease obligations (including those obligations that are
convertible, redeemable or retractable),mandatory redeemable preferred and trust preferred
securities accounted for as liabilities … and subordinated capital notes. Total debt excludes
pension obligations, deferred tax liabilities and preferred equity.” (66018, right column) It
appears that “interest-bearing” intends to capture true loans, as opposed to accounts payable or
non-balance sheet exposures. All subordinated debt would be included.
114.Take the case of syndicated credit facilities to be used for an acquisition, wherein certain bank
groups make two separate loans to the borrower but some lenders participate in only one of the
loans. Suppose that both loans exceed $5 million but one of the loans does and one does not
satisfy the Materiality Test. Could a LBP bank that participates in only the “non-material” loan
rate the borrower as not a “higher-risk c&i borrower” even though the bank group knows that
all of the debt otherwise satisfies the Purpose Test?
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
If a firm participates in a syndicated credit facility that does not satisfy the Purpose Test – not
because it is not expected to be used to finance an acquisition, buyout or capital distribution but
instead because the acquisition, buyout or capital distribution would not constitute a “material”
increase in credit for the borrower – then the borrower does not qualify as a “higher-risk c&i
borrower” based on that facility.
Higher-Risk C&I Borrower – Leverage Test
115.For the purpose of the Leverage Test, does an “earn-out provision” count as debt?
An “earn-out provision” does not count as debt for the Leverage Test because it is provisional
and often does not bear interest.
116.For the purpose of the Leverage Test, “senior debt” is defined as to include “any portion of
total debt that has a priority claim on any of the borrower’s assets. A priority claim is a claim that
entitles the holder to priority of payment over other debt holders in bankruptcy.” (66018, right
column) What counts as “senior debt” when there are multiple classes of debt with seniority but
different lien tranches (e.g., first lien senior, junior lien senior, unsecured senior)?
For the Leverage Test, the rule defines “senior debt” to include “any portion of total debt that
has a priority claim on any of the borrower’s assets. A priority claim is a claim that entitles the
holder to priority of payment over other debt holders in bankruptcy.” (66018, right column)
Confusion as to what is “senior” can arise if there are multiple classes of senior debt based on
lien position. In such circumstances, LBP bankers feel that only the most senior tranche
should be included as “senior debt” in Leverage Test calculations.
While this position may work when there is clear stepwise priority in lien position, it does not
resolve all questions. For example, if some debt is secured by cash and accounts receivable while
other debt is secured by fixed assets, is one “senior” to the other? Some LBP bankers feel that
any debt that has first priority and perfected liens, including mortgages on real estate and not just
a blanket lien on all assets, has priority over other debt holders and can be viewed as “senior.”
However, there are so many conceivable cases where overlapping prioritization of liens on
different assets is so complex that delineation of seniority cannot be defined by a general
principle. In such cases, LBP bankers should evaluate which debt is “senior” based on the
specific situation.
The following passage in the earlier FDIC Q&A may shed light on this issue. For the question,
“Are second lien debt and unsecured debt excluded from ‘senior debt’ in the debt-to-EBITDA
calculation?” the Q&A responds, “Yes. However, they are included in total debt when
calculating the debt-to-EBITDA ratio.”22
22 FDIC,
“Questions and Answers Pertaining to the Final Rule on Assessments, Dividends, Assessment Base
and Large Bank Pricing” (www.fdic.gov/deposit/insurance/final_rule_qanda.pdf), September 28, 2011,
Q13 on page 17.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
117.What if there are various lien tranches but also subordinated debt? What counts as “senior debt”
when all funded debt is pari passu (a common situation in small business lending)?
Where there is no subordinate debt such that all debt is pari passu, arguments can be made that
either all debt is “senior” or that none is. Some LBP bankers feel that industry convention is to
consider no debt as “senior” and that treating all debt as simply part of “total debt” can lead to a
contradictory situation. Under this interpretation, the borrowing firm would qualify as leveraged
– i.e., pass the Leverage Test – if its total debt-to-EBITDA ratio exceeds 3, not 4.
As a demonstration, suppose that the trailing-12-month EBITDA for a firm is $10 million and
that the firm has $39 million of total debt. If $32 million of this is senior debt and $7 million is
subordinated, then the firm would be classified as “leveraged” – it would meet the Leverage Test
because senior debt–to-EBITDA of 3.2 exceeds 3. If, on the other hand, all of the debt were,
would it be reasonable to say that the firm is not “leveraged” because its total debt-to-EBITDA
is only 3.9, which is less than 4?
118.When there are multiple borrowers but one primary borrower is responsible for principal or
interest payments, which financial statements should be used for the Leverage Test?
FDIC Response: The final rule states that the Leverage Test must be calculated using the
consolidated financial statements of the borrower. In the case of multiple borrowers, an
institution can use the primary borrower’s financial statements to calculate the Leverage Test. In
the case of multiple borrowers who each have joint and several liability for a loan, an institution
can use the consolidated financial statements of any one of the borrowers to calculate the
Leverage Test. Moreover, if one such borrower does not meet the criteria for a “higher-risk c&i
borrower,” the loan would not be considered a “higher-risk loan.” Finally, if a loan is made to a
subsidiary whose parent company has unconditionally and irrevocably guaranteed the borrower’s
debt, the Leverage Test may be calculated using the consolidated financial statements of the
subsidiary or the consolidated financial statements of the parent company.
119.Can a “normalized” EBITDA be used in calculating debt/EBITDA in the Leverage Test?
“Normalized” in this case refers to instances where a borrower may have a significant one-time
charge for a restructuring or other event that severely depresses EBITDA. In such cases, can
large, one-time loss events be excluded in determining EBITDA, or does the rule disallow any
adjustments to reported EBITDA?
The rule specifies, “When calculating either of the borrower’s operating leverage ratios, the only
permitted EBITDA adjustments are those specifically permitted for that borrower in the loan
agreement (at the time of underwriting)…” (66018, right column)
120.When calculating a borrower’s operating leverage ratios, the only permitted EBITDA
adjustments are those specifically permitted in the original loan agreement. There have been
several occasions where adjusted-EBITDA or “consolidated EBITDA” is used when calculating
Leverage or Fixed Charge ratios. Could language like the following be used for add-backs:
“extraordinary, unusual or non-recurring cash or non-cash expenses or losses less extraordinary
gains”?
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
121.For purposes of calculating leverage, the covenant definition in the credit agreement will
sometimes allow the borrower to net cash against funded debt in the calculation of leverage. Is
netting of this kind permitted in calculation of leverage for the Leverage Test? We have a
borrower that has senior leverage of more than 3X if cash is not netted against total senior
funded debt, but less than 3X if cash is netted. Assuming all the other tests are met, would this
borrower be a “higher-risk c&i borrower”? Can cash be netted against the amount of debt in the
numerators of the Leverage Test?
122.What level of usage of a credit facility should a LBP institution assume in calculating
Debt/EBITDA in the Leverage Test?
The Leverage Test requires a bank to compare “total debt” and “senior debt” to trailing-12month-EBITDA. The rule does not specifically say that the loan and/or line of credit to be
funded should be included in the “total debt” and “senior debt” balances. (66018, right column)
However, the FDIC Q&A pertaining to the Leverage Test for a “leveraged loan” (applicable
through first quarter 2013) responds to the following question: “When calculating the debt-toEBITDA ratio for purposes of determining if a loan is leveraged, would an institution include
the pro forma debt (the debt or the loan that the borrower is applying for) in the debt-toEBITDA calculation?” with the following response: “Yes. An institution should calculate the
borrower’s post financing debt-to-EBITDA and determine if it meets the criteria for leveraged.”
Thus, the FDIC’s intent appears that the credit being originated should be included.
From the FDIC Q&A of March 25, 2013, as revised on May 8, 2013:
The Leverage Test must be calculated by including the debt the borrower is applying for. If
the debt the borrower is applying for is a line of credit (on its own or as part of a lending
facility), the reporting bank should also assume that the line is fully drawn when the bank
performs its debt to EBITDA calculations, unless the line of credit contains covenants that
would, in effect, prevent the borrower’s debt to EBITDA ratios from exceeding the
Leverage Test thresholds for a higher-risk C&I borrower. The final rule defines total and
senior debt and provides that only funded amounts of lines of credit must be considered
debt for purposes of the definition, but this provision refers only to existing debt of the
borrower and not to the debt the borrower is applying for.
In short, a LBP bank must assume full utilization of a credit facility being applied for under the
Leverage Test. On the other hand, the debt/EBITDA calculation should use only the outstanding balance for any existing credit facilities for the firm (including those to that LBP bank).
LBP bankers find assumption of full usage for a new credit facility unreasonable. For example, it
does not seem reasonable to assume full usage when a firm is applying for renewal of an existing
credit line from which it has never drawn over half of the total line. The following alternate
wording was suggested to the FDIC– and rejected.
The Leverage Test must be calculated by including the debt the borrower is applying for.
The final rule defines total and senior debt and provides that only funded amounts of lines
of credit must be considered debt for purposes of the definition, but this provision refers
only to existing debt of the borrower and not to the debt the borrower is applying for. If the
debt the borrower is applying for is a term loan, the reporting bank should assume the line is
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
fully drawn when it performs debt-to-EBITDA calculations. For a line of revolving credit,
the reporting bank should assume pro forma funded debt for prospective credit, where pro
forma funded debt equals a supportable estimate of the maximum outstanding draw on the
line over the following six months.
FDIC Response: [I]t’s important to remember that a multi-purpose lines of credit typically
would not meet the Purpose Test unless the borrower specifically states up front that they plan
to use it for an acquisition, buyout or capital distribution. According to the ABA, this would be
rare. If a bank subsequently determines that the line of credit was used for an acquisition, buyout
or capital distribution, it would only be considered “purpose” upon refinancing. Given the fact
that most lines of credit would not meet the Purpose Test, the application of the Leverage Test
would not be applicable. As such, I don’t fully understand the concern.
[I]f bankers are planning to use lines of credit for “purpose” loans − a situation that ABA
says is very rare − the bank will need to use the full amount of the line of credit when applying
the Leverage Test. It is a reasonable approach from our perspective. Moreover, the idea of
allowing banks to use an expected draw amount would be impossible to police and would
introduce significant inconsistencies to the reporting process, thus making a relative risk ranking
process very difficult.
123.Suppose that a firm applies for both a term loan (which meets the $5 million threshold, Purpose
and Materiality tests) and a line of credit, but that the credit line is for working capital and does
not meet the Purpose Test. Should the new credit line be considered fully funded when
calculating debt/EBITDA in the Leverage Test if it does not meet the Purpose test?
A line of credit extended at the same time as a term loan would be viewed as a lending facility. In
this case, debt for the debt/EBITDA calculation would equal a fully drawn credit line plus the
term loan balance.
However, if the credit line was extended some time before the term loan, the two could be
considered as not a credit facility. In this case, debt for the debt/EBITDA calculation would
equal only the drawn balance of the credit line plus the term loan balance. And if the term loan
was extended some time before the credit line, there would be no issue because the credit line
does not pass the Purpose Test (so no debt/EBITDA calculation would be need for the FDIC).
Neither the rule nor the FDIC Q&A specifies a length of time between extension of a term loan
and credit line such that the two would (or would not) be considered a credit facility. (Under the
rule’s de minimis test, the “outstanding balance” of a loan (to compare to $5 million) equals credit
extended to the borrower cumulatively over the past six months, but this provision does not
apply to the Purpose and Materiality Tests.) A bank must use its own judgment as to a reasonable timespan between extension of a term loan and credit facility as whether the two should be
considered together as a facility. Some bankers suggest that 90 days may be a reasonable period
to not consider credit applications conjointly.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
124.In the following understanding correct?
 In the majority of leveraged acquisitions and recapitalizations, financing is provided or
refinanced via term loans (A+B) plus high-yield notes that clearly satisfy the Purpose Test.
The total amount of credit facilities directly involved must be included in the debt/EBITDA
Leverage Test calculations, even if not yet funded.
 A committed revolving credit facility (RCF) is often put in place in tandem to cover working
capital needs, but it is undrawn at the outset of the acquisition or recapitalization. This RCF
would not meet the Purpose Test, so any undrawn portion should not be included in the
debt/EBITDA Leverage Test calculation.
 If an RCF is partially used at the outset to directly fund an acquisition or recapitalization,
then the committed RCF meets the Purpose Test and any undrawn element must be taken
into account in the debt/EBITDA Leverage Test calculation.
This is not the FDIC’s position. No matter whether the RCF would be used completely,
partially or not at all at the outset to directly fund an acquisition or recapitalization, in any case
the entire credit line must be taken into account in the debt/EBITDA Leverage Test calculation.
Some institutions noted during the banker discussion of May 7, 2013, that they are adjusting
their contracts for commercial credit lines to restrict usage for acquisitions, buyouts or capital
distributions (forcing borrowers to apply for separate credit lines if they want to finance such
actions).
125.A multi-purpose line of credit does not meet the Purpose Test if there is no specific expectation
that it will be used to finance an acquisition, buyout or capital distribution. If a borrower is not
expected to tap a credit line being originated to finance an acquisition, buyout or capital
distribution – so the line does not meet the Purpose Test– then should only the projected usage
be used in Materiality and Leverage Test calculations?
The FDIC requires that the entire multi-purpose credit line be included in the numerators of the
Leverage Test.
126.If a new line of credit does not meet the Purpose Test but there is a term loan that does, what
should a LBP institution assume for usage of the new line?
127.A new or refinanced c&i transaction triggers evaluation of the borrower as a “higher-risk c&i
borrower.” For a new or refinanced credit that does not meet the Purpose Test to a borrower
not already rated as a “higher-risk c&i borrower,” the bank does not need to go to the Leverage
Test. On the other hand, suppose that a bank extends a new $20 million credit line to a “higherrisk c&i borrower” where the new line does not meet the Purpose Test. If the borrower does
not meet the Leverage Test at that time, the bank can delist the firm as a “higher-risk c&i
borrower” and reevaluate all exposures to it as not “higher-risk c&i loans and securities.” How
much of the prospective non-“purpose” line of credit should the bank include in the Leverage
Test calculation? Can a LBP bank assume that, in renewal of a credit line that does not meet the
Purpose Test, only the outstanding balance of that line should be included in the Leverage Test
calculation?
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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128.How do covenants in the loan agreement impact the Leverage Test? For example, what if a
borrower would meet the Leverage Test on assumption of a fully drawn multi-purpose revolving
credit line, yet a covenant in its facility agreement prohibits the borrower from making any
acquisition that would cause its leverage ratio to exceed 2.8?
FDIC response: The leverage test must be calculated by including the debt the borrower is
applying for. If the debt the borrower is applying for is a line of credit (on its own or as a part of
a lending facility), the reporting bank should also assume that the line is fully drawn when the
bank performs its debt to EBITDA calculations, unless the line of credit contains covenants that
would, in effect, prevent the borrower’s debt to EBITDA ratios from exceeding the leverage test
thresholds as defined in Appendix C to Subpart A of Part 327 for a higher-risk C&I borrower.
Cash Deposit and Government Guarantee Exemptions
129.Would a loan under the SBA or Export-Import Bank guaranty programs fall under the allowable
“higher-risk c&i” exclusion of “the maximum amount that is recoverable from the U.S.
Government or its agencies under guarantee or insurance provisions”? (“Over the years, I have
sat through debates over what is and is not a Government agency.”)
There is general agreement among LBP bankers that the Small Business Administration (SBA)
and U.S. Export-Import Bank are U.S. Government agencies whose guarantees qualify for
exclusion from “higher-risk.”
The following list has been suggested as a basis for determination:23
Subchapter A: Board of Governors of the Federal Reserve System
Part 201: Extensions of Credit by Federal Reserve Banks (Regulation A)
12 CFR 201.108 – Obligations Eligible as Collateral for Advances…
(A) Under section 14 (b) direct obligations of, and obligations fully guaranteed as to
principal and interest by, the United States are eligible for purchase by Reserve Banks.
Such obligations include certificates issued by the trustees of Penn Central
Transportation Co. that are fully guaranteed by the Secretary of Transportation. Under
section 14 (b) direct obligations of, and obligations fully guaranteed as to principal and
interest by, any agency of the United States are also eligible for purchase by Reserve
Banks. Following are the principal agency obligations eligible as collateral for advances:
(1) Federal Intermediate Credit Bank debentures;
(2) Federal Home Loan Bank notes and bonds;
(3) Federal Land Bank bonds;
(4) Bank for Cooperative debentures;
(5) Federal National Mortgage Association notes, debentures and guaranteed
certificates of participation;
(6) Obligations of or fully guaranteed by the Government National Mortgage
Association;
(7) Merchant Marine bonds;
23 This
list is also referenced by the Federal Reserve in its Regulation W for Affiliate Transactions (67 Federal
Register 76571).
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(8) Export-Import Bank notes and guaranteed participation certificates;
(9) Farmers Home Administration insured notes;
(10) Notes fully guaranteed as to principal and interest by the Small Business
Administration;
(11) Federal Housing Administration debentures;
(12) District of Columbia Armory Board bonds;
(13) Tennessee Valley Authority bonds and notes;
(14) Bonds and notes of local urban renewal or public housing agencies fully supported
as to principal and interest by the full faith and credit of the United States pursuant
to section 302 of the Housing Act of 1961 (42 U.S.C. 1421aI, 1452I).
(15) Commodity Credit Corporation certificates of interest in a price-support loan pool.
(16) Federal Home Loan Mortgage Corporation notes, debentures, and guaranteed
certificates of participation.
(17) U.S. Postal Service obligations.
(18) Participation certificates evidencing undivided interests in purchase contracts
entered into by the General Services Administration.
(19) Obligations entered into by the Secretary of Health, Education, and Welfare under
the Public Health Service Act, as amended by the Medical Facilities Construction
and Modernization Amendments of 1970.
(20) Obligations guaranteed by the Overseas Private Investment Corp., pursuant to the
provisions of the Foreign Assistance Act of 1961, as amended.
The guarantee should not have to be a full guarantee; partial guarantees (e.g., from the SBA)
should count.
FDIC Response: The FDIC is not going to provide a list of recognized government agencies.
Lending institutions should know if their loans are guaranteed by the U.S. Government.
However, it should be noted that loans guaranteed by U.S. Government sponsored enterprises,
including FNMA, FHLMC, FHLB, and the Farm Credit System, are not excluded from the
definition of higher-risk assets.
130.SBA and EX-IM Guarantees on c&i facilities. The rule and the FDIC response to a banker
question offer little guidance on the exclusion from “higher-risk” for government-guaranteed
c&i credits. SBA-guaranteed loans are included in c&i loans according to the Call Report
instructions, but there is no reference to loans guaranteed by the Export-Import Bank. Will the
FDIC provide more clarity on this?
The FDIC has indicated that it will not provide a list of recognized government agencies.
However, there appears to be general agreement among LBP bankers that the Small Business
Administration (SBA) and U.S. Export-Import Bank are U.S. Government agencies whose
guarantees qualify for exclusion from “higher-risk.”
To be clear, the SBA- or ExIm-guaranteed portion of a loan is exempted from qualification as a
“higher-risk c&i loan.” Nonetheless, it appears that a bank must still consider include the
SBA/ExIm-guaranteed portion of loans to a firm when evaluating if it is a “higher-risk c&i
borrower.”
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131.Is there an exclusion from “higher-risk” for a loan with foreign asset-based collateral and a SBA
guarantee?
The FDIC has explicitly denied the ABL exclusion when the collateral is not in the U.S., but the
exclusion for a U.S. Government (or agency) guarantee would apply.
132.Suppose that $4 million of a $7 million c&i loan is federally guaranteed. Should the residual
$3 million be graded against “higher-risk” or ignored as being less than $5 million?
A similar question arises if the $4 million, instead of satisfying the government guarantee
exclusion, satisfies the cash collateral, asset-based lending, or dealer floor plan financing
exclusion. Therefore, all of these situations are addressed here.
A c&i loan is to be graded as “higher-risk” only if it is to a “higher-risk c&i borrower.” Thus, the
$5 million threshold is relevant only in classifying a c&i credit customer as a “higher-risk c&i
borrower” (or not).
A ‘‘higher-risk c&i borrower’’ is defined in the rule (66017, middle-right columns) as one that:
(a) Owes the reporting bank on a c&i loan originally made on or after April 1, 2013, if:
(i) The c&i loan has an original amount (including funded amounts and the amount of
unfunded commitments, whether irrevocable or unconditionally cancellable) of at
least $5 million;
(ii) The loan meets the purpose and Materiality Tests described herein; and
(iii)When the loan is made, the borrower meets the Leverage Test described herein; or
(b) Obtains a refinance, as that term is defined herein, of an existing c&i loan, where the
refinance occurs on or after April 1, 2013, and the refinanced loan is owed to the
reporting bank, if:
(i) The refinanced loan is in an amount (including funded amounts and the amount of
unfunded commitments, whether irrevocable or unconditionally cancellable) of at
least $5 million;
(ii) The c&i loan being refinanced met the purpose and Materiality Tests (described
herein) when it was originally made;
(iii)The original loan was made no more than 5 years before the refinanced loan; and
(iv) When the loan is refinanced, the borrower meets the Leverage Test.
The critical point is whether the “original amount” of the loan:
(A)exceeds $5 million, and
(B) meets the purpose and Materiality Tests (or if it is a refinance of a loan originally in
excess of $5 million and that met the purpose and Materiality Tests).
(A)The “original amount” is defined in the rule (66018, left column) as the total drawn over
the preceding six months of:
(a) For c&i loans drawn down under lines of credit or loan commitments, the amount
of the line of credit or loan commitment on the date of its most recent approval,
extension or renewal prior to the date of the most recent Call Report…
(b) For syndicated or participated c&i loans, the total amount of the loan, rather than
just the syndicated or participated portion held by the individual reporting bank.
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(c) For all other c&i loans (whether term or non-revolver loans), the total amount of the
loan as of origination or the amount outstanding as of the date of the bank’s most
recent Call Report, whichever is larger.
There is no mention in this definition of excluding from the “original amount” any
balance that would satisfy the cash collateral, government guarantee, asset-based lending,
or dealer floor plan financing exclusions. The conclusion must be that all exposures in
excess of $1 million made to the firm within the preceding six months must be included
in the aggregation of exposures to the firm to determine whether it is a “higher-risk c&i
borrower.” This is true even though some of what is aggregated can later be excluded
from classification as “higher-risk” by satisfying one of the allowable exclusions.
(B) The over-$5-million exposure that qualifies a firm as a “higher-risk c&i borrower” must
also satisfy the Purpose Test and Materiality Test. It is easy to imagine that a part of the
financing for a “material” acquisition could be used for asset-based lending or dealer
floor plan financing. (Could part of the acquisition financing be collateralized by cash or
have a government guarantee?) Actually, it is not even necessary for the loan to be part
of the acquisition financing.
In conclusion, if a LBP bank originates or refinances credit to a firm and at least some of that
financing satisfies the Purpose Test and Materiality Test, and the total financing to that firm over
the last six months – including anything, no matter how small, that satisfies any exclusion – is at
least $5 million, then the firm is a “higher-risk c&i borrower” for that bank. In this case, all of
the exposures of that bank to that firm, including those less than $5 million, are “higher-risk” –
except those that qualify for the one of the four exclusions.
The key point here is that the cash-secured, government-guaranteed, asset-based lending, and
dealer floor plan exclusions do not apply to determining a “higher-risk c&i borrower.” They
only come into play once a borrower has been characterized as a “higher-risk c&i borrower” to
calculate what higher-risk c&i loans and securities must be reported.24
Qualification as a Refinance
133.Would a covenant amendment or temporary waiver with no other action represent a
“refinance”?
Several LBP bankers polled feel that the answer to this question is “no.”
24 A
point of confusion is that this is a change from the earlier proposal for the “higher-risk” definitions. That
proposal defined “higher-risk c&i loans and securities” as: “Any commercial loan (funded or unfunded,
including irrevocable and revocable commitments) owed by a borrower to the evaluating depository
institution with an original amount greater than $5 million if the conditions specified in (a) or (b) below are
met as of origination, or, if the loan has been refinanced, as of refinance, and the loan does not meet the
asset-based lending (ABL) exclusion or the floor plan line of credit exclusion …” (66002, footnote 23)
Inclusion of exposures that satisfy the exclusions was introduced with the concept of a “higher-risk c&i
borrower” in the rule.
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134.Suppose that a loan made in June 2010 was a $3,000,000 working capital credit line that did not
satisfy the Purpose Test. Suppose that in June 2013 the bank makes a $20,000,000 loan to that
firm where the new loan refinances/pays off the original loan and also finances a “material”
“purpose” action (e.g., a $10,000,000 dividend recapitalization or acquisition) at a point when the
borrower’s leverage exceeds the 3X or 4X thresholds. Should the new $20,000,000 loan be
classified as “higher-risk” even though the original loan was just $3,000,000 and not “purpose”?
In other words, when a loan pays off a non-”purpose” loan, which is used as the “original loan”
to test “purpose”?
The “higher-risk” status as of April 1 of c&i loans are grandfathered under the rule – except that
if the borrower is later classified as a “higher-risk c&i borrower” then all c&i loans and credit
lines to that firm become “higher-risk c&i loans.” In the case described here, the refinance
would trigger reevaluation of the firm and it would qualify as a “higher-risk c&i borrower,” so all
c&i loans to it would be classified as “higher-risk c&i loans.”
135.If a LBP bank makes a loan to a firm replacing a loan made by another bank, must the bank
making the second loan consider this a “refinance” such that it must consider whether the
original loan met the Purpose Test?
It may seem that the replacement should not be considered a refinance because the second
lender is making a new loan, not refinancing its own loan. However, this situation would qualify
as a “refinance” under the rule. If the original loan was made within five years, the new lender
must evaluate whether that loan met the Purpose Test. While this can be a challenge, since the
new lender did not make the original loan, the rule allows analysis on a “best efforts” basis.
(66018, middle column)
136.If a LBP bank makes a new loan to a firm and the firm uses some – perhaps a small portion – of
the funds to pay off an existing loan, does this count as a “refinance” under the rule?
This question does not appear to be relevant to determination of whether the firm is a “higherrisk c&i borrower” (and loans to it are “higher-risk c&i loans”). Whether or not the new loan
counts as a “refinance,” if it exceeds the $5 million size threshold then the borrower (and, thus,
all loans to it) must be (re)evaluated as potentially “higher-risk.” If, on the other hand, the new
loan is for less than $5 million, then again the question of whether this is a “refinance” is
irrelevant because no (re)evaluation of the firm is required when either a new or refinanced loan
is for less than this amount. (66017, middle-right columns)
137.Does review of a Demand Line of Credit qualify as a refinance? We have an internal system
(expiration) date, but there is no extension/renewal for the customer.
Review of a commercial credit line where there is no new contract, contractual increase or
extension of the line, rescheduling of principal payments, release of collateral, consolidation of
credits, or change in interest rate does not meet any of the qualifications of a refinance for a
commercial credit line. (66018, left column) Therefore, it appears that the situation descried
would not require reevaluation of the borrower as potentially a “higher-risk c&i borrower.”
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138.In a syndicated facility where the borrowing base is periodically set by the bank group (subject
to an overall limit), rather than automatically set based on an advance rate for certain collateral
types, does setting the borrowing base constitute a “refinance”? For example, assume no other
changes to the facility, but the increased line is expected to be used for an acquisition.
A change within the scope of the contract, such as setting the borrowing base within the
prescribed overall limit, does not constitute a “refinance” in the sense of the rule. The rule
specifies: “For purposes of a C&I loan, a refinance includes … [i]ncreasing the master
commitment of the line of credit (but not adjusting sub-limits
under the master commitment) …” (66018, left column)
139.Does an unplanned overdraft qualify as a “refinance” that calls for reassessment against “higherrisk”? The rule says that a “refinance” includes “disbursing additional money other than
amounts already committed to the borrower …” (66018, left column)
An unplanned overdraft is not a “refinance” that triggers reevaluation against “higher-risk.”
“Higher-risk loans and securities” includes loans that are “defined as commercial and industrial
loans in the instructions to Call Report Schedule RC-C Part I - Loans and Leases…” (66017,
footnote 4) and that meet the “higher-risk” qualifications. The Call Report instructions do not
call for unplanned overdrafts to be reported as c&i loans. Therefore, an unplanned overdraft
does not qualify as a refinance.
140.If a commercial loan is evaluated as not “higher-risk” at origination but later goes through a
TDR, does this count as a “refinance” and would the loan then become “higher-risk”?
A TDR does not qualify as a “refinance” under the rule. (66022, right column) A TDR does not
automatically qualify a loan as a “higher-risk” loan or a firm as a “higher-risk c&i borrower.”
141.What if the loan goes through multiple TDRs?
The rule does not specify that only the first TDR does not count as a “refinance.” (66022, right
column) Therefore it appears that no TDR, even if a second or third on the same loan, qualifies
as a “refinance” that calls for reevaluation of the “higher-risk” status of the loan.
142.Should a modification event that would classify as a TDR were it not on an SOP 03-3 acquired
loan be considered a “refinancing”? “Refinancing” excludes loans that result in classification as
TDRs. (66022, right column) However, for SOP 03-3 acquired loans with credit marks against
them, when there is a modification event that would otherwise classify them as TDRs, GAAP
mandates that they are not reported as TDRs for Call Report and SEC reporting.
The rule allows that “a refinance of a c&i loan does not include a modification or series of
modifications to a commercial loan other than as described above or modifications to a
commercial loan that would otherwise meet this definition of refinance, but that result in the
classification of a loan as a troubled debt restructuring (TDR), as this term is defined in the
glossary of the Call Report instructions…” (66018, middle column)The Call Report instructions
define a TDR consistent as per GAAP. This definition does not encompass an SOP 03-3
acquired loan.
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Nonetheless, this situation is tightly defined and consistent with a TDR loan. LBP institutions
therefore seek permission from the FDIC that refinance of an SOP 03-3 acquired loan be
treated as a TDR loan, such that reevaluation against “higher-risk” is not required. The former
owner would not be required to treat the loan modification as a “refinance.” In that the stated
intent of the rule is to treat exposures consistently across LBP institutions, it would seem
appropriate to afford the same interpretation for an acquiring LBP bank. Moreover, it would be
an operational challenge to parse out such loans from other loans that had the same
modification that qualify as TDRs.
FDIC Response: Banks should follow the guidance in the glossary of the Call Report
instructions when determining whether or not a loan should be considered a TDR for purposes
of the pricing definitions of higher-risk assets. There is a distinction in the way loans within a
pool of purchased credit-impaired loans and purchased credit-impaired loans accounted for
individually must be evaluated to determine if they would be considered a TDR. Here is an
excerpt of the appropriate instructions.
A refinancing or restructuring of a loan within a pool of purchased credit-impaired loans
should not result in the removal of the loan from the pool. In addition, a modification of the
terms of a loan within a pool of purchased credit-impaired loans is not considered a troubled
debt restructuring under the scope exceptions in ASC Subtopic 310-40, Receivables –
Troubled Debt Restructurings by Creditors (formerly FASB Statement No. 15, “Accounting
by Debtors and Creditors for Troubled Debt Restructurings,” as amended). However, a
modification of the terms of a purchased credit-impaired loan accounted for individually
must be evaluated to determine whether the modification represents a troubled debt
restructuring that should be accounted for in accordance with ASC 310-40. For further
information, see the Glossary entry for “troubled debt restructurings.”
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Asset-Based Lending and Dealer Floor Plan Financing Exclusions
143.If on April 1, 2013, a LBP bank is holding a c&i loan graded as “leveraged,” could that loan
subsequently be re-graded as not “higher-risk” if it satisfies the asset-based lending, dealer floor
plan, cash security, or government guarantee exclusion provisions?
The status of “leveraged” loans and securities as of April 1, 2013, as “higher-risk” assets (or not)
will be grandfathered. A LBP bank is not permitted to re-evaluate an asset after that date.
The exception is that new financing to a firm or a refinancing requires that the firm must be
graded against the “higher-risk c&i borrower” definition. In this case, the bank can revaluate all
exposures to that firm. Thus, even if the firm becomes a “higher-risk c&i borrower” to the bank,
the bank can reclassify as not “higher-risk” any exposures that were previously reported as
“leveraged” but that satisfy the asset-based lending, dealer floor plan, cash collateral, and
government guarantee exclusions.
FDIC Response: It depends. As of April 1, 2013, banks should continue to report c&i loans as
they were reporting them prior to April 1, 2013 using either the February 2011 rule definitions
or the transition guidance. If the borrower obtains a new c&i loan or refinances an existing c&i
loan on or after April 1, 2013 and at that time the borrower does not meet the criteria to be
considered a “higher-risk c&i borrower,” then c&i loans to that borrower would not be reported
as higher-risk. If the borrower obtains a new c&i loan or refinances an existing c&i loan on or
after April 1, 2013 and is considered to be a higher-risk borrower at the time the new loan is
originated or the existing loan is refinanced, then all c&i loans to that borrower should be
reported as higher-risk.
However, an institution may opt to apply the final rule definition of higher-risk c&i loans
and securities to all of its c&i loans and securities (including those loans originated, refinanced,
or purchased before April 1, 2013), but, if it does so, it must also apply the final rule definition
of a “higher-risk c&i borrower” without regard to when a loan is originally made or refinanced
(i.e., whether made or refinanced before or after April 1, 2013).
144.There is an exclusion from classification as “higher-risk c&i loans” for asset-based lending and
dealer flooring facilities, provided they meet certain criteria. Must each of the sub-bullets listed in
the rule ((a)–(g) on 66019) be in place for the facility to qualify for the exclusion – i.e., are these
“and” statements?
The rule specifies that “asset-based loans (loans secured by accounts receivable and inventory)
that meet all the following conditions are excluded from a bank’s higher-risk c&i loan totals…
[then proceeds to list seven broad conditions].” (66019, emphasis added) Similarly, the rule
specifies that “floor plan loans that meet all the following conditions are excluded from a
bank’s higher-risk c&i loan totals… [then proceeds to list six broad conditions].” (66020,
emphasis added) The intent is that each of the “sub-bullet” criteria must be satisfied for the
exclusion to apply.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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145.The asset-based lending exclusion “requires that advance rates never exceed 85 percent.”
(66019, center column) However, a 90 percent advance rate against both accounts receivable and
inventory is standard industry practice for loans to retailers. Could the FDIC explain further
(than what is provided on 66019) the rejection in the rule of this industry norm?
FDIC Response: The FDIC considers a 90 percent advance rate on accounts receivable and
inventory to be high, regardless of standard industry practice. Such an advance rate does not
provide significant cushion to absorb losses in the event that the collateral cannot be liquidated
in full. The higher-risk definitions are meant to capture those assets that exhibit a greater than
normal risk of loss and the FDIC believes that a 90 percent advance rate is one criteria which
signals a greater than normal risk of loss.
146.For the Asset-Based Lending Exemption, the rule states that “fully secured is defined as a 100
percent or lower LTV ratio after applying the appropriate discounts (determined by the loan
agreement) to the collateral.” Would discounts include advance rates, credit memos, or
markdown allowances?
The overarching limit is the limit on the advance rate specified in the rule.
147.Could there be an exception to the list of ineligible accounts receivable and inventory (66019,
middle column) on a case-by-case basis? Specifically, is there any recourse for collateral in
Canada to count as eligible accounts receivable, particularly with trade credit insurance?
Accounts receivable lending against Canadian collateral is standard practice due to the similarity
of law, legal collectability, and ability to perfect in Canada.
The rule states: “The following items must be deemed ineligible accounts receivable: …
(ix) foreign accounts receivable.” The ineligibility of Canadian accounts receivable is clear.
FDIC Response: The final rule indicates that foreign accounts receivable must be deemed
ineligible. Accounts receivable from Canada would be deemed ineligible.
148.Since Canadian receivables are considered foreign and ineligible for purposes of the asset-based
lending exclusion, can a separate facility be established for Canadian receivables as collateral so
that the bank may receive the exclusion for the primary asset-based lending facility (as long as it
adheres to all necessary requirements)?
Yes. There is no requirement to consolidate all credit facilities for the asset-based lending
exclusion. Therefore, facilities can be constructed so that some do and some do not qualify.
149.Would foreign accounts receivable that are guaranteed by the Export-Import Bank be eligible to
include as collateral for purposes of the asset-based lending exclusion?
FDIC Response: Yes. Institutions can include foreign accounts receivable that are guaranteed or
insured by the Export-Import Bank as collateral in their borrowing base when determining loanto-value for purposes of the asset-based lending exclusion. The maximum amount of foreign
accounts receivable that is guaranteed or insured by the export-Import Bank is the amount that
can be included in the borrowing base as collateral. For example, if only 90 percent of the
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accounts receivable are guaranteed or insured, the bank can only include the 90 percent that is
guarant4eeed or insured as eligible.
150.To qualify for the asset-based lending exclusion, it seems that the inventory advance rate is not a
lesser of cost or NOLV measure (under condition (f) on 66019, middle column). For example, if
the loan agreement allows for advances up to the lesser of 75 percent of cost or 85 percent of
NOLV of inventory, does this qualify since a third party appraisal is obtained and the 85 percent
of NOLV limitation is satisfied?
No banker in the March 21 discussion objected to a conclusion that this situation would qualify
for the exemption.
The rule says: “Loans against inventory must be made with advance rates no more than 65
percent of eligible inventory (at the lower of cost valued on a first-in, first-out (FIFO) basis or
market) based on an analysis of realizable value. When an appraisal is obtained, or there is a
readily determinable market price for the inventory, however, up to 85 percent of the net orderly
liquidation value (NOLV) or the market price of the inventory may be financed. Inventory must
be valued or appraised by an independent third-party appraiser using NOLV, fair value, or
forced sale value (versus a ‘‘going concern’’ value), whichever is appropriate, to arrive at a net
realizable value.” (66019, middle column)
151.In the same section, in order to be fully secured by self-liquidating assets, is the general
interpretation that the outstanding amount must be fully covered by accounts receivable and
inventory even if the borrowing base allows for advances to be made against real estate or fixed
assets? For example, if a loan facility is for $100,000,000 and the borrowing base allows for
advances against A/R, inventory and real estate (capped at $10,000,000). Excess availability is
expected to average $50,000,000 such that no reliance would be placed on real estate advances.
Would the loan qualify for the ABL exclusion until such time that the facility becomes reliant on
the real estate (i.e., the outstanding balance exceeds $90,000,000 in this example)?
This issue was a point of contention with the FDIC, but the bankers negotiated a reasonable
position. The rule allows: “If the loan is a credit facility (revolving or term loan), it must be fully
secured by self-liquidating assets such as accounts receivable and inventory. Other non-selfliquidating assets may be part of the borrowing base, but the outstanding balance of the loan
must be fully secured by the portion of the borrowing base that is composed of self-liquidating
assets.” (66019, left column)The point is that the bank is allowed to take extra collateral for its
own purposes, but there is no recognition of these in qualifying for the ABL exclusion.
However, terms (e) and (f) on page 66019 say that, for the ABL exemption to apply, the contract
for the credit facility must limit the outstanding balance of advances to no more than 85 percent
of A/R and NOLV of inventory. In this case, the facility in the above example would not
qualify for the exemption until the outstanding balance reaches $90,000,000. Instead, the facility
would qualify only if the outstanding balance is limited in writing to 85 percent of ($100,000,000
– $10,000,000) = $76,500,000.
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152.The automobile dealer floor plan exclusion requires that “each loan advance must be … at no
more than 100 percent of (i) dealer invoice plus freight charges (for new vehicles) or (ii) the cost
of a used automobile at auction or the wholesale value using the prevailing market guide
(e.g., NADA, Black Book, Blue Book).” (66020, left column) How much is allowed as “freight
charges”?
FDIC Response: For new vehicles, banks typically lend 100 percent of the dealer/manufacturer
invoice price, which generally already includes “triple net” charges (e.g. destination charge, hold
back, and advertising).Therefore, in such cases no additional freight charges should be
advanced/added to the dealer invoice price. However, if these charges are not included in the
new vehicle manufacturing invoice, it would be reasonable for the bank to add the typical “triple
net” fee (which generally amounts to five-to-seven percent of dealer invoice) to the amount that
is advanced to the borrower. For used vehicle floor plan financing, the advance rate must be the
cost of a used automobile at auction or the wholesale value using the prevailing market guide.
No “freight charges” on used vehicles would be allowed for the exclusion requirement.
153.The automobile dealer floor plan exclusion requires that “each loan advance must be made
against a specific automobile under a borrowing base certificate held as collateral …” (66020, left
column) Typically for such financing, the note and credit agreement govern advances where the
manufacturer automobile draft is the main advance notice and the security agreement (usually an
all-assets filing) is what evidences collateral. We seek clarification that this standard industry
practice is consistent with the provisions of the exclusion.
FDIC Response: The industry standard for monitoring floor plan lending collateral is that each
loan advance is made against specifically identifiable vehicles (i.e. each vehicle has a vehicle
identification number (VIN)).As the dealer sells each piece of collateral (vehicle), the dealer
repays the loan advance against that specific piece of collateral (vehicle).The security agreement
evidences collateral and will usually indicate that all assets of the borrower serve as collateral on
the loan. However, the bank must also maintain a listing of each vehicle (including each vehicle’s
VIN) that it has advanced funds on so that the bank can continuously monitor which vehicles
serve as collateral for the loan.
154.The automobile dealer floor plan exclusion requires “the lending bank or a third party must
prepare inventory audit reports and inspection reports … The reports must list all vehicles held
as collateral and verify that the collateral is in the dealer’s possession.” (66020, center column)
Such reports frequently show the dealer’s name and each advance by VIN. However, sometimes
units are out on test drives, loaners to service customers, or demos for dealership
personnel. Lenders generally monitor those units to make sure the numbers in each category are
in line with expectations. Thus, while all units financed will be owned by the dealer, some may
not always be in the dealer’s possession. We seek clarification that this standard industry practice
is consistent with the dealer floor plan exception.
LBP bankers asked that a message be conveyed to the FDIC that this is just not the way the
industry does it. The FDIC should clarify that, for the exclusion to apply, a bank must verify that
the automobile dealer has legal, not necessarily physical, ownership of the vehicles financed.
FDIC Response: The FDIC realizes that not every vehicle will be in the dealer’s physical
possession for the reasons listed above (test drives, loaners, demos), but the dealer should be
able to document that all of the vehicles held as collateral are owned by the dealer and are
accounted for at any given point in time.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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155.The automobile dealer floor plan exclusion requires that “borrowers must submit floor plan
aging reports…” (66020, right column) However, automobile dealer borrowers generally do not
submit aging reports; most banks use internal aging report and curtail aged units. We seek
clarification that the requirement is that the bank providing the financing has access to aging
reports.
FDIC Response: Although the rule states that borrowers must submit floor plan aging reports,
aging reports that are developed by the lender are sufficient to satisfy the requirements of the
floor plan lending exclusion provided that the records include the following: a listing of each
vehicle or unit of inventory financed through the floor plan loan, the date the inventory was
financed, and an identification number so that banks may track the length of time it takes to sell
a particular unit of inventory. If the information is provided by the dealer/borrower, the bank
must also periodically verify the accuracy of the floor plan aging reports via an on-site
inspection.
156.For the asset-based lending and automobile dealer floor plan financing exclusions, the lending
bank is required to receive borrowing base certificates; accounts receivable, inventory and,
accounts payable detail; and covenant compliance certificates. (66020, center column) However,
while borrowing base certificates and accounts receivable, inventory and accounts payable detail
are common for asset-based lending, this is not the case for dealer floor plan financing.
Moreover covenant compliance certificates are not provided as part of all floor plan lines, as
some lenders use a demand feature without covenants. We request clarification that these items
are required for the asset-based lending exclusion but not for the dealer floor plan exclusion.
FDIC Response: An automobile dealer floor plan line with the demand feature will generally not
have covenants, as some legal professionals feel that event-of-default covenants within a demand
feature dilute the demand nature of the note. Therefore, most institutions pick either demand
with no covenants or maturity dates with covenants.
The demand feature does have payment requirements that are validated through frequent
collateral checks and those payment requirements provide much more timely feedback of
troubled financial performance, as opposed to waiting until after financial statements are
received to check covenants and call a default. (These payment requirements are also included in
deals with maturity dates and covenants.)
As far as “knowing when to call,” the same financial analysis and account monitoring should
be occurring regardless of which credit structure is used. If the bank detects that financial
performance is trending down, payment performance has becomes unacceptable, or an
unacceptable event has occurred within the dealership management team, then that regular
account monitoring is the trigger to call or demand.
Regardless of credit structure, banks still need to be “commercially reasonable” with their
reactions where a loan has been demanded or there has been a covenant breach that results in a
request to refinance. Reactions can include anything from “bringing in the wreckers” to haul off
inventory in a severe SOT situation to “demanding with forbearance” to allow time for
refinance.
Therefore, either credit structure allows the bank to take the necessary actions to protect its
credit.
Accordingly, the dealer floor plan exclusion should be clarified to recognize that covenant
compliance is required only when covenants are part of the deal.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
FDIC Response: Banks are required to receive borrowing base certificates, accounts receivable
and inventory detail, accounts payable detail, and covenant compliance certificates on all assetbased loans to be eligible for the asset-based lending exclusion. However, borrowing base
certificates, accounts receivable and inventory detail,25 and accounts payable detail are not
necessarily required to be received by banks on floor plan loans to be eligible for the floor plan
lending exclusion. If the loan agreement for a floor plan loan does not require the receipt of
these items, or does not require the receipt of covenant compliance certificates because the loan
includes a demand feature instead of covenants, then the bank is not required to receive such
documents to be eligible for the floor plan lending exclusion.
157.A LBP bank cannot use the asset-based lending or floor plan financing exclusions if a supervisor
has criticized the management of these programs. (66017, center column) Can the FDIC clarify
that a bank would be allowed to again use these exclusions as soon as an MRA is cleared?
FDIC Response: A bank cannot use the asset-based lending or floor plan financing exclusions
during a period in which an MRA is in place that criticizes the bank’s controls or administration
of its asset-based or floor plan loan portfolios. Once the MRA is removed (because the bank has
corrected the deficiencies that caused the MRA), all loans that meet the requirements of the
exclusions, including those made when the MRA was in place, can be excluded from higher-risk
C&I loans.
158.If there is an MRA on the asset-based lending operations of the agent bank, does that disqualify
syndications in its asset-based loans for the asset-based exclusion, even for participants whose
asset-based operations have not been criticized by supervisors?
The rule says that “loans that are eligible for the asset-based lending exclusion, described herein,
provided the bank’s [primary federal regulator] has not cited a criticism (included in the Matters
Requiring Attention, or MRA) of the bank’s controls or administration of its asset-based loan
portfolio.” (66017, center column) Thus, the exclusion is available to a LBP bank provided the
MRA is not on that bank.
25 Note
that regardless of what the loan agreement allows, to be eligible for the floor plan lending exclusion,
the bank must maintain a listing of each vehicle or unit of inventory financed through the floor plan loan,
the date the inventory was financed, and an identification number.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
Higher-Risk Securitizations
159.How has the classification for securitizations that are “higher-risk” improved in the final rule?
The final rule did not change the fundamental definition of “higher-risk” with respect to
securitizations: a LBP bank will still have to use best efforts and reasonably available information
to determine whether over half of the underlying collateral is “higher-risk” loans or securities or
“nontraditional mortgages”; if it reports on a consolidated basis due to SFAS 166/167 then it
can assess the underlying collateral individually. However, there were improvements:
 “Higher-risk securitizations are defined as securitizations (except securitizations classified as
trading book), where, in aggregate, more than 50 percent of the assets backing the
securitization meet either the criteria for higher-risk c&i loans or securities, higher-risk
consumer loans, or nontraditional mortgage loans, except those classified as trading book.”
(66023, left column) Thus, a LBP bank must determine whether over half of the underlying
collateral is “higher-risk consumer loans” or “higher-risk c&i loans and securities,” or
“nontraditional mortgage loans.” (This provision has not changed.)
 Securitization securities created and acquired before April 1, 2013 do not have to be evaluated
against the “higher-risk” criteria. The “higher-risk” grading of such securities will be
grandfathered thereafter. This means that a LBP bank will not have to go back after that time
to make a determination. (LBP institutions can use the “interim reporting” basis for
securitizations obtained before then – if any.)
 It appears that a LBP bank may not be required to evaluate a securitization as potentially
“higher-risk” if it is created prior to April 1, 2013, but acquired after that date. The rule
specifies: “Banks will not need to review securitizations issued before April 1, 2013, to
determine whether they are higher risk under the final rule. The new higher-risk definitions in
the final rule will apply only to securitizations issued on or after that date, regardless of the
date of origin of the underlying loans.” (66011, middle column) The rule also states that it
applies, in the case of securitizations, only to “securitizations of c&i and consumer loans …
issued on or after April 1, 2013, including those securitizations issued on or after April 1,
2013, that are partially or fully collateralized by loans originated before April 1, 2013.” (66023,
right column) It is unclear whether a LBP bank can simply not rate such securities as “higherrisk” or else be obliged to accept a “higher-risk” evaluation from the bond seller.
 However, will securitization securities become illiquid starting next April – especially
those created before then? Any LBP bank that acquires one thenceforth will have to
make a new determination. If, as the FDIC assumes, securitizers develop information
systems to allow evaluation of securitizations by April 1, then this may not be a problem
for securitizations created later (note below). In this case, the major issue is for
securitizations created earlier.
 “Higher-risk” for a securitization security is to be evaluated as of origination, not on a
continuing basis. This is particularly important where the underlying collateral changes over
time (e.g., securitizations of credit card receivables).
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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 A security from a securitization of c&i loans and/or securities is “higher-risk” for a LBP bank
only if over half of the underlying assets are “higher-risk” for itself; whether they would be
“higher-risk” to another bank is irrelevant. Thus, a bank will not have to evaluate any of the
underlying assets other than those that it created.
This definition specifically refers to loans owed to and securities owned by the reporting bank.
As noted above, a “higher-risk c&i borrower” is to be classified LBP bank by LBP bank –
such that a specific firm may be a “higher-risk c&i borrower” for one LBP bank but not
others. Thus, a CLO is to be classified as a “higher-risk securitization” for the LBP bank
holding it only if over half of the underlying collateral is (1) loans originated by the bank and
(2) the borrowers are “higher-risk c&i borrowers” specifically for that bank. The CLO could
therefore easily be a “higher-risk securitization” for one investor but not for others.
 In a February 27, 2013, meeting with FDIC staff, a group of bankers sought to confirm
this reading of the rule. They categorically rejected this interpretation.

Securitizations are to be reported under new Call Report Schedule RC-O items 7.b
(securitizations of nontraditional 1–4 family residential mortgage loans), 8.b (securitizations
of higher-risk consumer loans), and 9.b (securitizations of higher-risk commercial and
industrial loans and securities). This differentiation will support evaluation of the validity of
the regulatory definition of “higher-risk securitizations” in the future.
160.Will “higher-risk securitizations” include only what LBP institutions report on Call Report
Schedule RC-S as securitizations or will this be inclusive of loans that the institutions consolidate
on their books under FAS 166 and 167?
The rule is not clear on this issue and the FDIC Q&A does not address it. However, the rule
appears to require that loans consolidated on the books under FAS 166 and 167 must be
evaluated as potential “higher-risk securitizations.” It says only, “In cases in which a
securitization is required to be consolidated on the balance sheet as a result of SFAS 166 and
SFAS 167, and a bank has access to the necessary information, a bank may opt for an alternative
method of evaluating the securitization to determine whether it is higher risk.” (66023, leftmiddle columns)
161.FDIC supervisors are asking us to justify how we evaluated CLOs acquired prior to April 1,
2013, as “leveraged” or not. What shall we tell them?
162.For purposes of determining whether or not a securitization is a higher-risk securitization, how
should banks interpret the portion of the definition of a higher-risk c&i borrower that states “a
higher-risk c&i borrower is a borrower that owes the reporting bank on a c&i loan”?
FDIC Response: A bank that owns a securitization or that owns a portion of a securitization has
an indirect interest in the underlying loans backing the securitization. For purposes of
determining whether the loans meet the definition of a higher-risk c&i loan and whether the
borrower on a loan is a higher-risk c&i borrower, the underlying loans backing the securitization
are deemed to be owed to the reporting bank, i.e., a bank with such an indirect interest.
(Otherwise, no c&i securitization would ever be higher-risk.)
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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163.We expected that the revised Call Report for June 2013 would include a new line on Schedule
RC-O Memorandum item for “higher-risk securitizations.” However, this was not included in
the pending proposal. Will LBP banks be asked to report these “higher-risk” assets in second
quarter Call Reports?
FDIC Response: The FDIC will continue to collect information on higher-risk securitizations in
the same manner that we have since June 2011. There will not be a separate line item for
securitizations of each loan category (higher-risk c&i, consumer, or nontraditional mortgage
(NTM) loans); rather banks will report higher-risk loans and securitizations of each higher-risk
loan category in the same line item.
On May 21, 2013, the Banking Agencies announced several amendments to the proposed Call
Report changes specifically recognizing the suggestions in the ABA/CBA/FSR response to the
proposal. As amended, “higher-risk securitizations” of “nontraditional 1-4 family residential
mortgage loans,” “higher-risk consumer loans,” and “higher-risk c&i loans and securities” will
not be integrated into those balances, as proposed, but instead will be reported in a new,
separate item.
164.Is it reasonable for the FDIC to expect LBP banks to report the FDIC-PD distribution of
securitization collateral?
The proposed Call Report Schedule RC-O changes do not include a new item for “higher-risk
securitizations,” which the “higher-risk” rule calls for. Instead, LBP banks will report
securitizations rated as “higher-risk” (if over half of the underlying collateral is) in the
nontraditional residential mortgages, “higher-risk c&i loans and securities,” and “higher-risk
consumer loans” balances. This raises a question as to whether LBP banks will be asked to
report the FDIC-PD distributions of the underlying collateral for securitizations of consumer
and residential mortgage loans.
FDIC Response (paraphrased from a telephone conversation):The rule states: “Although not
included in this table, banks would report in their Call Reports the value of all securitizations
(except those classified as trading book) of consumer loans that are more than 50 percent
collateralized by consumer loans that would be identified as higher-risk assets.” (66010, right
column) The reference in this sentence to “this table” refers to the PD distribution table. This
sentence confirms that LBP institutions will not be required to report in the new Call Report
Schedule RC-O Memorandum item 18 PD distribution form the FDIC-PD distribution for
securitizations of consumer and residential mortgage loans.
165.If a LBP bank acquires a securitization security after April 1, 2013, one that was originated
before April 1, 2013, must it evaluate whether the security is “higher-risk”? If it must, how can it
do that?
The “higher-risk” status of a securitization security obtained by a LBP bank prior to April 1,
2012 will be grandfathered; if it was rated as “subprime,” “leveraged,” or “nontraditional
mortgage” up to that date, it will be a “higher-risk securitization” thereafter (and vice versa).
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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If acquired after that date, it must make a determination. The rule provides that the
determination can be on a “best efforts” basis. Moreover, the “higher-risk” status is to be
evaluated as of the date of origination of the securitization, not on a current basis.
For a securitization of consumer loans or residential mortgages, the bank can make the
determination based on the offering memorandum for the security.
FDIC Response: Securitizations of subprime consumer loans that were reported as subprime
consumer loans before April 1, 2013 should continue to be reported as higher risk after April 1,
2013.Going forward, banks will only need to review securitizations of consumer loans that are
issued on or after April 1, 2013 to determine if these securitizations meet the definition of a
higher risk consumer loan.
166.Does grandfathering against “higher-risk” apply the same for corporate and securitization
bonds?
If an LBP institution acquires a corporate bond issued prior to April 1, 2013mand it is not
reported under “leveraged loans” in the March 2013 Call Report, it will be grandfathered as not
to report under “higher-risk c&i loans and securities” thereafter. However, it could become
“high-risk” (and reported under “higher-risk c&i loans and securities”) in the future. This would
occur if the reporting bank makes a loan to the bond issuer in the future, and that loan causes
the firm to be graded as a “higher-risk c&i borrower” and all of bank’s loans to and bonds
issued by the firm to become “higher-risk c&i loans and securities.”
On the other hand, the status of a securitization bond will be fully grandfathered. If it was not
reported under “leveraged loans” in the past then it will not be reevaluated against “higher-risk
securitizations” in the future. (Nor would a securitization bond reported under “leveraged loans”
in the past ever escape being a “higher-risk securitization” in the future.)
167.How would commercial MBS be evaluated under the “higher-risk securitizations” definition?
A LBP bank would have to determine if over half of the underlying collateral, the commercial
mortgages, are “higher-risk.” How are commercial mortgages graded?
 Not under the “nontraditional mortgages” definition. That’s for residential (1-4 family)
mortgages.
 Not under the “higher-risk c&i loans and securities” definition. Commercial mortgages are
not c&i loans.
 It must be under the “construction and land development loans” category – i.e., loans
reported on Call Report Schedule RC-C line 1 (a) (2) for “other construction loans and all
land development and other land loans.”
Thus, unless most of the underlying CRE is construction and land development financing, a
commercial MBS is not a “higher-risk securitization.”
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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168.If a CLO is to be evaluated against “higher-risk securitizations” based on whether the
underlying collateral loans would be rated as “higher-risk c&i loans” to some bank (because the
borrowers would be “higher-risk c&i borrowers” to that bank), does the same hold if the lenders
are not LBP banks or not banks at all (and therefore have no experience with the “higher-risk”
definitions)?
The FDIC expects that the underlying collateral loans will be evaluated against “higher-risk c&i
loans” – no matter whether the lenders are LBP banks or not.
169.How should an investment in an AAA-rated CLO backed by “higher-risk” commercial loans be
evaluated against “higher-risk”?
All investments in securitizations, including CLOs, are to be rated against the definition of
“higher-risk securitizations.” Unless the LBP bank consolidates the underlying exposures on its
balance sheet under SFAS 166/167, the securitization must be rated as “higher-risk” if over half
of the underlying exposures are “higher-risk consumer loans,” “higher-risk or c&i loans and
securities,” or “nontraditional mortgage loans” (and reported under the corresponding Call
Report Schedule RC-O Memorandum items 7.b, 8.b. and 9.b). The rule does not allow for any
recognition of trenching, overcollateralization, insurance, guarantees, or bond rating in this
evaluation.
If the “investment” is a loan (to the SPE) instead of a securitization security acquired, it would
appear that the loan should not be evaluated against “higher-risk.” If this loans is reported under
Call Report Schedule RC-C item 9 for “loans to nondepository financial institutions,” not under
item 4 for “commercial and industrial loans,” then it would not need to be evaluated against
“higher-risk c&i loans and securities.” (Clearly, no other “higher-risk” category could apply
either.) However, there is an argument that the loan should be viewed as a securitization
investment under the capital rules for market risk. In this case, the loan would be classified
against the definition of “higher-risk securitizations” based on evaluation of the securitization
collateral.
Response from an LBP institution
Loans to SPVs are generally reported on line 9 of Call Report Schedule RC-C. Such loans would
not be evaluated against “higher-risk c&i loans and securities.” However, sometimes such loans
are reported on line 4 of Schedule RC-C, and would therefore be evaluated.
Assume that a loan is reported as a c&i loan on line 4 of Schedule RC-C and would be evaluated.
In this case, we would evaluate the loan as not meeting the Purpose Test. This is because a loan
to finance a SPV acquiring loans does not finance an acquisition, buyout, or capital distribution.
Note that an acquisition is defined as purchase of an equity interest, and loans are not equities.
In other words, if we originate a loan to a SPV so that SPV may acquire loans, the SPV’s
acquisition of loans does not satisfy the Purpose Test.
In conclusion a loan to an SPV to finance purchase of loans, even if classified as a c&i loan, does
not count toward the Size Test and Materiality Test in evaluating the SPV as potentially a
“higher-risk c&i borrower.” Therefore, the loan is not get classified under “higher-risk c&i loans
and securities.”
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
170.In the rule, securitizations collateralized by a dynamic pool of loans need to be analyzed based
on the highest amount of “higher-risk” assets allowable under the portfolio guidelines of the
securitization. However banks are not required to evaluate such securitizations on a continuous
basis. (66023, middle column) Does this mean that the analysis needs to be done once based on
the portfolio guidelines when the securitization is likely to have the highest amount of “higherrisk” assets?
The rule provides that “[a] bank is not required to evaluate a securitization on a continuous basis
when the securitization is collateralized by a dynamic pool of loans; rather, the bank is only
required to evaluate the securitization once.” (66023, middle column) This determination is to be
made using “information that is reasonably available to a sophisticated investor in reasonably
determining whether a securitization meets the 50 percent threshold.” (66023, middle column)
The portfolio guideline provided in the offering prospectus would appear to satisfy this
requirement. As noted, these guidelines would likely indicate the maximum percentage of the
changing portfolio over time that would be “higher-risk.” While this may bias evaluations
toward securitizations being rated as “higher-risk,” this is the basis provided for in the rule to
make these determinations.
171.For MBS in which over 50 percent of the underlying assets are “nontraditional mortgage loans”
(e.g., IOs or ARMS) at the time of issuance but subsequently that percentage declines below 50
percent, does that securitization need to continue to be reported as higher risk?
The rule addresses this situation: “The joint letter commenters pointed out that continuously
obtaining updated information on actively managed open-ended securitizations (those
securitizations where the underlying assets of the securitization may change) would not only be
burdensome, but unnecessary, because governing indentures require securitization managers to
maintain minimum credit quality. The final rule takes this point into account and provides that a
bank must determine whether a securitization is higher-risk based upon information as of the
date of issuance (i.e., the date the securitization is sold on a market to the public for the first
time).” (66014, left column) In short, once “higher-risk securitization” (or not) always a “higherrisk securitization” (or not); a securitization is rated only once, at issuance.
172.It appears that call bridge/subscription credits in Fund Finance may qualify as “higher-risk c&i
loans and securities” and there is no exclusion for this type of lending. However, the portfolio is
considered low risk. How would this type of exposure be evaluated?
This issue is addressed above.
173.For securitizations of residential mortgages (MBS), must there be an evaluation of whether the
securitization is a “higher-risk securitization” of “nontraditional mortgage loans” and then, if
not, an evaluation of whether it is a “higher-risk securitization” of “higher-risk consumer loans”?
Yes, this is the case.
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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Nontraditional Mortgage Loans and Other Issues
174.If through a TDR the interest rate on a 1-4 family residential loan is reduced to a level below
market, would this action be considered a refinancing? If so, would the reduced rate be
considered a teaser rate, thereby requiring this loan to be reported as a “nontraditional mortgage
loan” for purposes of the assessment calculation? (Please refer to Question 6 under
“Determination of Higher-Risk Assets” and Question 1 under “Teaser Rates” in the FDIC
Q&A dated 9/28/11.)
FDIC Response: No. Modifications to a loan that would otherwise meet the definition of
refinance but would result in the classification of a loan as a TDR are not considered
refinancings.
175.Is a balloon payment considered to be a deferment such that the loan would be considered a
“nontraditional mortgage loan”?
FDIC Response: No. A balloon payment is not considered a deferment of repayment of
principal or interest. Therefore, loans that contain balloon payments are not necessarily
considered nontraditional mortgage loans… However, if the loan met the other characteristics
of a nontraditional mortgage loan, then it would be considered [as one].
176.Bank employees are given (free of charge) a one percent discount on the interest rate for
residential mortgage loans, as long as they remain employed by the bank. We report these loans
as “nontraditional mortgage loans” because of the teaser rate. If a borrower leaves the bank then
the discount terminates and the mortgage ceases to be classified as “nontraditional.” If we were
to report on a borrowing employee’s W-2 the discount as compensation over the life of the loan
and he/she can keep the discounted rate upon departure, can the loans be considered as not
“nontraditional”? Our point of view is that this would be similar to an outsider paying points to
get a reduced rate on their mortgage, and not a teaser rate.
Classifying employees’ mortgages with discounted mortgage rates as “nontraditional” with
“teaser rates” is conservative. In the rule, “a teaser-rate mortgage loan is defined as a mortgage
with a discounted initial rate where the lender offers a lower rate and lower payments for part of
the mortgage term. A mortgage loan is no longer considered a nontraditional mortgage loan
once the teaser rate has expired.” (66023, left column) One could argue that the employee
discount is not a teaser rate in that the interest rate will not change if the borrower never leaves
the firm. On the other hand, a conservative interpretation is not unreasonable in that there is
greater risk in the mortgage if the borrower leaves the firm and so that the interest rate and
monthly payments rise. Would it be reasonable to say that few such borrower leave the bank, at
least not before the mortgage is paid off or refinanced, because the discount is such a good deal,
and on this basis the employee discount should not be regarded as a “teaser rate” making the
mortgage “nontraditional”?
However, if the discounted rate is reported as employee compensation and that discount does
not terminate when the employee leaves, this does not seem to be a “teaser rate” making the
mortgage “nontraditional.” As noted, this is equivalent to anyone buying down the mortgage
rate, which does not constitute a “teaser rate” (unless the buy-down does not last for the
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
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mortgage term). However, it seems irrelevant whether the discount counts as employee
compensation. Since the discounted rate would be permanent, even if the borrower leaves the
bank, this would not count as an “initial rate where the lender offers a lower rate and lower
payments for part of the mortgage term” (as per the definition of a “teaser rate”).
177.How are loans to states, municipalities and other government to be graded against the “higherrisk” definitions?
The list of the assets to be evaluated against all of the “higher-risk” definitions (see Question 1)
does not include loans or securities to states or municipalities.
178.Based on the mapping of the FDIC assessment calculator from the Large Bank Pricing rule,
TDRs, past due, and nonaccrual loans are included in “Underperforming Assets” in the Credit
Quality Measure in the Concentration Measure in the scorecard. However, the “higher-risk” rule
also includes TDRs, past due, and nonaccrual loans as “higher-risk assets” in the Concentration
Measure. It looks like the FDIC is charging banks twice on the assessment from including
TDRs, past due, and nonaccrual loans in both “higher-risk assets” and “underperforming
assets.” Is this the FDIC’s intent?
Yes, this is the intent. As noted, TDRs, past due, and nonaccrual loans are included in the
“underperforming assets” measure of the LBP scorecard. At the same time, all consumer,
residential mortgage, c&i and commercial real estate loans are to be evaluated against one of
three “higher-risk” definitions, so may qualify as “higher-risk assets” under the “concentration
measure” of the LBP scorecard. To the extent that TDRs, past due, and nonaccrual loans qualify
as “higher-risk,” there is double counting.
The only concession that the FDIC allowed is that refinancing under a TDR does not require
reevaluation as potentially “higher-risk.”
179.With so little time and so many open questions, it is going to be very difficult for LBP banks to
follow the rule precisely in filing second quarter 2013 Call Reports. Will there be any leeway?
The following statement appears in the proposal to change the Call Report:
For the June 30, 2013, and December 31, 2013, report dates, as applicable, institutions may
provide reasonable estimates for any new or revised Call Report data item initially required
to be reported as of that date for which the requested information is not readily available.
The specific wording of the captions for the new or revised Call Report data items discussed
in this proposal and the numbering of these data items should be regarded as preliminary.
(78 Federal Register 12143, February 21, 2013, www.gpo.gov/fdsys/pkg/fr-2013-0221/pdf/2013-04035.pdf)
Moreover, the ABA response to the proposal to change the Call Report starting in second
quarter 2013 will include something like the following:
Major definitional issues with respect to revised Schedule RC-O Memorandum items 7-9 and
18 are being discovered and gradually resolved as the FDIC’s new “higher-risk assets”
definitions go into effect this quarter. The institutions that will report these items, those
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FAQ on the Definitions of “Higher-Risk” Assets under FDIC Large Bank Pricing
November 9, 2015
subject to FDIC Large Bank Pricing, have committed and continue to devoted considerable
time and attention to assure the accuracy of reporting these items. Nonetheless, these
institutions cannot be expected to have automated, audited systems in place to report these
items in the second quarter. They therefore request that their supervisors have reasonable
expectations in reviewing reporting of these items in June 30 Call Reports.
Our answers do not provide, nor are they substitutes for, professional legal advice.
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