January 2010




U.S. Federal Banking Agencies Release Final
Rule on the Effect of FAS 166 and 167 on Risk-
Based Capital ...
permanent modifications to the risk-based capital rules that would minimize the
increase in capital requirements as a resu...
assets stemming from the bank’s contractual exposures to the related VIEs as of
the date of the bank’s implementation of F...
determine that the capital levels required by the rules are not sufficient given the
assets’ risk.




4     U.S. Federal ...
Contacts
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U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules

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U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules

  1. 1. January 2010 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk- Based Capital Rules. Contents Risk Based Capital Rules . 2 On January 21, 2010, four U.S. federal banking agencies: the Board of Governors of the Federal Reserve System, the Office of the Comptroller of the Transition Period: Delay Currency, the Federal Deposit Insurance Corporation (“FDIC”) and the Office of and Phase-In .................... 2 Thrift Supervision (collectively, the “Federal Banking Agencies”) jointly issued Transition for ALLL ........... 3 a final rule (the “Final Rule”) amending their risk-based capital rules in connection with changes to U.S. generally accepted accounting principles ABCP Programs ............... 3 (“GAAP”) introduced by the Financial Accounting Standard Board’s (“FASB”) Statements of Financial Accounting Standards Nos. 166 and 167 (“FAS 166 and Reservation of Authority ... 3 167”). FAS 166 and 167 are expected to result in the consolidation of many existing and future securitization vehicles onto the balance sheets of banks. As a result, the Federal Banking Agencies have acknowledged that the implementation of FAS 166 and 167 by banks will likely adversely affect the banks’ risk-based capital and leverage ratios. In brief, FAS 166 and 167 amend U.S. GAAP by (i) eliminating the “qualifying special purpose entity” (“QSPE”) status used by sponsors of securitization structures to deconsolidate securitization vehicles from their balance sheets and (ii) changing the way that securitization structures are analyzed for purposes of determining whether they should be consolidated and by who. The types of securitization structures particularly at risk for consolidation under FAS 166 and 167 include asset-backed commercial paper (“ABCP”) programs, revolving securitizations, some mortgage-backed securitizations and some term loan securitizations. Banks are required to comply with FAS 166 and 167 at the beginning of their first annual reporting period that begins after November 15, 2009. The Federal Banking Agencies previously issued a Proposed Notice of Rulemaking on September 15, 2009 that requested public comment on several questions and proposals. In response they subsequently received approximately forty-one comment letters. In crafting the Final Rule, the Federal Banking Agencies appear to have largely rejected comments requesting a substantial delay in the effectiveness of FAS 166 and 167 on banks’ risk-based capital and leverage ratios as well as calls for 1 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules
  2. 2. permanent modifications to the risk-based capital rules that would minimize the increase in capital requirements as a result of these accounting changes. The Final Rule’s effective date will be sixty days after it is published in the Federal Register (which is expected shortly). Risk Based Capital Rules The Federal Banking Agencies decided against granting permanent relief to banks from the increased capital requirements resulting from FAS 166 and 167, despite numerous comment letters requesting such changes. The decision was in part grounded in concerns that the existing rules were already insufficient to account for non-contractual risks inherent in certain securitized assets and thus their effectiveness should not be further diluted. The Federal Banking Agencies also rejected requests to modify their leverage ratios to provide similar relief. However, the Federal Banking Agencies have agreed to create a transition period during which banks may obtain some temporary relief from the increased risk-based capital requirements. Transition Period: Delay and Phase-In The Final Rule provides for (i) an optional two-quarter delay of recognition of FAS 166 and 167’s effect on risk-weighted assets and allowance for loan and lease losses (“ALLL”) includable in Tier 2 capital (the “Delay Period”) and (ii) an optional phase-in of increased capital requirements for the next two quarters (the “Phase-In Period”). Any bank that elects to take advantage of the transition mechanism must apply this treatment to all relevant entities that it would be required to consolidate under FAS 166 and 167. Banks will also be required to maintain two sets of records (one for GAAP reporting and one for regulatory capital purposes) during the transition period. The risk-weighted assets that may be excluded are those that (i) the bank did not previously consolidate and (ii) the bank is required to consolidate as a result of FAS 166 and 167. In addition, the related variable interest entity (“VIE”) must have existed prior to the bank’s implementation date for FAS 166 and 167. During the transition period, banks may also exclude assets held by ABCP program VIEs as long as the bank is the sponsor of the ABCP program, the bank consolidated the ABCP program VIE onto its balance sheet under GAAP and the bank excluded the VIE’s assets from its risk-weighted assets prior to its implementation of FAS 166 and 167. One important caveat is that banks may not exclude any VIE assets to which they have provided “implicit support” – that is, support that extends beyond the bank’s contractual obligations to a VIE. Such practices were common during the recent credit crisis and were particularly troubling to the Federal Banking Agencies because they were not sufficiently accounted for by the existing risk- based capital rules. During the third and fourth quarters of the transition period, fifty percent of the amount excluded during the two-quarter delay period may continue to be excluded, subject to a floor of an amount equal to the aggregate risk-weighted 2 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules
  3. 3. assets stemming from the bank’s contractual exposures to the related VIEs as of the date of the bank’s implementation of FAS 166 and 167. The Federal Banking Agencies specifically rejected requests for a longer transition period despite acknowledging that “affected banking organizations’ risk-based and leverage capital ratios likely will decrease with their implementation of FAS 166 and 167.” In choosing a year-long transition period, however, the Federal Banking Agencies did acknowledge the uncertainty facing banks during 2010 from “securitization reform” proposals under consideration by Congress and some regulators (including the FDIC). Transition for ALLL A bank electing to utilize the transition period may also include without limit in Tier 2 capital the full amount of the ALLL calculated as of the date of the bank’s implementation of FAS 166 and 167 that is attributable to excluded assets (the “Inclusion Amount”). This overrides the limits on ALLL that may be included in Tier 2 capital found in the Federal Banking Agencies’ general and advanced risk-based capital rules (the “Existing Limits”). During the Phase-in Period, a bank that has elected to utilize the transition period may then include fifty percent of the Inclusion Amount in Tier 2 capital without regard to the Existing Limits. Any ALLL in excess of this amount may still be included in Tier 2 capital subject to the 1.25 percent limit found in the Federal Banking Agencies’ general risk-based capital rules. Once again, these rules do not apply to VIEs to which a bank has provided implicit support. ABCP Programs Prior to the effectiveness of the Final Rule, banks are and have been permitted to exclude the assets of an ABCP program VIE which was consolidated under GAAP and sponsored by the bank and assess its risk-capital capital requirements based solely on the bank’s contractual exposure to such ABCP program. Noting that “recent events have raised serious questions about the original rationale for” such exclusion, the Federal Banking Agencies have decided to eliminate it. Concluding that no viable alternative proposals exist, the Final Rule eliminates the ABCP exclusion, subject to the transition period described above. Reservation of Authority In an effort to combat regulatory arbitrage, the Final Rule also contains a new reservation of authority for the Federal Banking Agencies which states that a bank may be required to hold regulatory capital against an off balance sheet exposure as if it were consolidated “if the primary federal supervisor determine[s] that the banking organization’s exposure or other relationship to the entity [is] not commensurate with the actual risk relationship of the banking organization to the entity.” The new language is an extension of an existing concept found in the risk-based capital rules that allow the Federal Banking Agencies to override the regulatory capital treatment of an asset whenever they 3 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules
  4. 4. determine that the capital levels required by the rules are not sufficient given the assets’ risk. 4 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules
  5. 5. Contacts In the event you have any questions regarding the preceding and its consequences to you, please do not hesitate to contact the Linklaters lawyers whose contact information is set forth below. New York Gary Barnett, National Practice Head, Structured Finance and Derivatives (+1) 212-903 9025 gary.barnett@linklaters.com Robin Maxwell, National Practice Head, Financial Regulation Group (+1) 212 903 9147 robin.maxwell@linklaters.com Christopher Marvin, Structured Finance and Derivatives (+1) 212 903 9217 christopher.marvin@linklaters. com This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. © Linklaters LLP. All Rights reserved 2010 Linklaters in the U.S. provides leading global financial organizations and corporations with legal advice on a wide range of domestic and cross-border deals and cases. Our offices are located at 1345 Avenue of the Americas, New York, New York 10105. Linklaters LLP is a multinational limited liability partnership registered in England and Wales with registered number OC326345. The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP and of the non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ, England or on www.linklaters.com. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. 1345 Avenue of the Americas We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. New York, NY 10105 If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. Telephone (+1) 212 903 9000 Facsimile (+1) 212 903 9100 Linklaters.com 5 U.S. Federal Banking Agencies Release Final Rule on the Effect of FAS 166 and 167 on Risk-Based Capital Rules

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