BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON, D. C. 20551
DIVISION OF BANKING
SUPERVISION AND REGULATION
SR 96-30 (SUP)
November 7, 1996
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT: Risk-Based Capital Treatment for Spread Accounts that Provide Credit Enhancement for Securitized Receivables
This letter provides guidance on the risk-based capital treatment for transactions in which a bank holding company sells assets and recognizes on its balance sheet a spread account that furnishes credit enhancement to the assets sold. Such transactions are most commonly found in connection with the securitization of credit card receivables and are deemed to be asset sales with recourse. The treatment set forth in this letter is a clarification and reiteration of existing policy and is consistent with the effective risk-based capital treatment of spread accounts for commercial banks.
In accordance with the Federal Reserve's capital adequacy guidelines, a bank holding company that has recorded on its balance sheet a spread account associated with assets it has sold must hold 8 percent capital against the full amount of assets transferred, and not just against the amount of the spread account. However, in most cases, the total capital charge may be limited to the dollar amount of the spread account in accordance with the low level recourse capital treatment.
Role of Spread Accounts in Absorbing Losses
A spread account is an escrow account that a banking organization typically establishes to absorb losses on receivables it has sold in a securitization, thereby providing credit enhancement to investors in the securities backed by the receivables. The account is funded up to a pre-determined specified amount by the excess spread created when the expenses of the trust -- including the yield passed on to investors, the servicing fee (typically 200 basis points for credit card receivables), and the expected credit losses -- are less than the yield earned on the assets in the pool. The funds in the escrow or spread account are used to absorb losses on the underlying receivables and must be exhausted before investors in the securities backed by those receivables are exposed to losses.
Regulatory Reporting and Capital Treatment
Despite the fact that holding companies file their regulatory reports (e.g., the FR Y-9C) in accordance with generally accepted accounting principles (GAAP), which allows transferred assets to be removed from the balance sheet even if the related spread amount is booked, these assets are still subject to a capital charge under the Federal Reserve's risk-based capital guidelines for bank holding companies.
Under the bank holding company risk-based capital guidelines (12 CFR 225, appendix A), a sale of assets is not deemed to be a true sale unless it meets the same criteria that apply to banks. These criteria are set forth in the instructions to the commercial bank Reports of Income and Condition (Call Reports). The Call Report instructions state that a transfer of assets is not a true sale for capital adequacy purposes unless the transferring institution (1) retains no risk of loss from the assets transferred from any cause and (2) has no obligation to any party for the payment of principal or interest on the assets transferred.1
Since a bank holding company is at risk of loss in a transaction in which it has transferred assets and recorded on its balance sheet a spread account serving as a credit enhancement, the company must treat the transaction as an asset sale with recourse for risk-based capital purposes. Under the guidelines, capital must be held against the entire risk-weighted amount of any assets sold with recourse. Since assets that bank holding companies have sold with recourse usually have been removed from the balance sheet, the risk-weighted amount of such assets is typically calculated by converting the assets to an on-balance sheet credit equivalent amount and assigning that amount to the appropriate risk category.
For asset transfers that involve recognition of a spread account on the balance sheet, a bank holding company may use the low level recourse capital treatment that applies to asset sales with recourse in general.2 Under the low level recourse rule, a banking organization that contractually limits its maximum recourse obligation to less than the full effective risk-based capital requirement for the transferred assets would be required to hold risk-based capital equal only to the contractual maximum amount of its recourse obligation. For example, under this dollar-for-dollar capital requirement, the capital charge for a 100 percent risk-weighted asset transferred with 1 percent recourse would be 1 percent of the value of the transferred assets, rather than the 8 percent requirement that would be applied to the assets if they were retained on the transferring institution's balance sheet.
The size of spread accounts (relative to the assets that they protect) is often smaller than the effective risk-based capital requirement, e.g., 8 percent, on the securitized assets. Thus, the low level recourse capital rule typically would apply. In addition, an institution may reduce the dollar-for-dollar capital charge held against the recourse exposure on assets transferred with low level recourse for a transaction recognized as a sale under GAAP and for regulatory reporting purposes by the balance of any associated non-capital GAAP recourse liability account.3
In March 1997, commercial banks will begin filing their Call Reports in accordance with GAAP. However, this reporting change will not change the effective treatment of recourse transactions under the banking agencies' risk-based capital guidelines.4 To compensate for the change in reporting treatment beginning with the March 1997 Call Report, the Federal Reserve and the other banking agencies intend to apply to commercial banks the risk-based capital off-balance sheet treatment for recourse transactions that is currently applied to bank holding companies. Included in the application of this treatment are transactions where the transferring institution has recognized on its balance sheet a spread account that provides credit protection to the transferred assets.
In order to facilitate the dissemination of this guidance to bank holding companies engaged in securitization activities, a suggested transmittal letter is attached. If you have any questions, please contact Tom Boemio, Supervisory Financial Analyst, at 202/452-2982 or David Elkes, Supervisory Financial Analyst, at 202/452-5218.
ATTACHMENT TRANSMITTED ELECTRONICALLY BELOW
SUGGESTED TRANSMITTAL LETTER TO
BANK HOLDING COMPANIES ENGAGED
IN SECURITIZATION ACTIVITIES TO
COMMUNICATE GUIDANCE ON THE APPROPRIATE
RISK-BASED CAPITAL TREATMENT FOR SPREAD
ACCOUNTS THAT PROVIDE CREDIT ENHANCEMENT
TO THE CHIEF EXECUTIVE OFFICER OF BANK HOLDING COMPANIES
Attached is a supervisory letter regarding the appropriate risk-based capital treatment for transactions in which a bank holding company recognizes on its balance sheet a spread account that provides credit enhancement to assets the organization has securitized. Such transactions are most commonly found in connection with the securitization of credit card receivables and are deemed to be asset sales with recourse. The treatment set forth in the attached supervisory letter is a clarification and reiteration of existing policy and is consistent with the effective risk-based capital treatment of spread accounts for commercial banks.
The supervisory guidance notes that a bank holding company that has recorded on its balance sheet a spread account providing credit protection to assets it has sold must hold a minimum of 8 percent capital against the full amount of assets transferred, and not just against the amount of the spread account. Additionally, such transactions may qualify for the low level recourse capital treatment that applies to asset sales with limited recourse. Under the low level recourse rule, a banking organization that contractually limits its maximum recourse obligation to less than the full effective risk-based capital requirement for the transferred assets would be required to hold risk-based capital equal only to the contractual maximum amount of its recourse obligation.
If you have any questions about this guidance on spread accounts that provide credit enhancement, please contact (Insert name of appropriate Reserve Bank staff.)
1. A bank that transfers loans "without recourse" and maintains a residual interest in an escrow account established to absorb losses on the transferred loans (e.g., a spread account) has not retained the risk of loss or an obligation for payment for purposes of the Call Report as long as the spread account is not recognized on the balance sheet. (See Federal Financial Institution Examination Council (FFIEC) press release dated November 26, 1986.) Return to text
2. See parts 208 and 225, appendix A, section III.B for the specific capital requirements that apply to small business obligations that are transferred with recourse by qualifying banking organizations. Return to text
4. Under the current regulatory reporting requirements for commercial banks set forth in the instructions to the Call Reports, banks selling assets with recourse generally are required to treat the transaction as a financing. Thus, until the March Call Report date, assets a bank has sold with recourse typically are incorporated directly into the on-balance sheet portion of the bank's calculation of its risk-weighted assets. Return to text
SR letters | 1996