Recently, the Office of the Comptroller of the Currency (OCC) issued a final rule consolidating prior OCC and Office of Thrift Supervision (OTS) lending limit regulations for national banks and federal thrift institutions, respectively, and updating the rule to conform to the requirements of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). The final rule updated the interim final rule (the "interim rule") that was issued, along with a request for comments, approximately one year ago.

Section 610 of Dodd-Frank amended the National Bank Act and the Home Owners' Loan Act and expanded the statutory definition of "loans and extensions of credit" in each Act to include certain credit exposures arising from derivatives transactions, repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. 

Miscellaneous Issues

The final rule amends Part 32 of OCC's regulations and clears up some overlaps, ambiguities, and unintended consequences of consolidating OCC and OTS lending limit regulations (such as loans to GAAP-consolidated and non-consolidated subsidiaries, aggregation of loans by GAAP-consolidated service corporations with loans by the parent federal thrift, and including within that aggregation loans by a federal thrift's foreign subsidiaries).

The traditional approach of OCC's lending limit regulations for attributing loans nominally made to one borrower to another borrower has included two tests. One test, the "direct benefit" test, would allow attribution and aggregation under circumstances that are relatively clear in the loan and extension of credit context but unclear and difficult to monitor in the complex world of credit exposures arising from derivatives transactions and securities financing transactions.

While acknowledging these difficulties, OCC will continue to impose the "direct benefit" test to derivatives and securities financing transactions, with careful attention to factual nuances, and to review application of this test to such transactions at a later date once the agency has more experience applying such attribution rules to these more complex credit exposures. 

Implementation of Dodd-Frank Section 610

The final rule extends the compliance deadline for the Dodd-Frank Section 610 requirements until October 1, 2013. The rule also exempts from lending limit coverage options that are sold and fully paid for (as there is no ongoing credit risk) and makes other alterations to the interim rule, the most significant of which are summarized below. 

Credit Exposure Calculation Methods

Under the interim rule, national banks and federal thrifts were required to use the same method for calculating credit exposure arising from all derivative transactions and the same method for all securities financing transactions. OCC is adhering to its policy of not giving these institutions unbridled discretion to pick and choose among calculation methods for different derivatives and securities financing transactions. In the final rule, however, OCC acknowledges, in response to comments received, the possibility that using only one calculation method for all transactions might present safety and soundness concerns. Accordingly, OCC will allow an institution to request, and the examiners to permit, use of particular calculation methods for a particular transaction or a particular type of transaction. 

After minor adjustments to the interim rule, OCC will permit calculation of credit exposure for derivative transactions and securities financing transactions through an internal model if all three of the following conditions are met:

  • It has been approved for purposes of the Advanced Approaches Appendix of the agency's capital rule.
  • It has been specifically approved by the agency for purposes of the lending limits rule.
  • The institution has provided prior written notice of its use of the model for purposes of the Part 32 regulations.

In response to comments filed on non-model credit exposure calculation methods, OCC has, regarding derivatives transactions, substituted for the interim rule's Remaining Maturity Method (for institutions that do not model their exposures) a Current Exposure Methodology (CEM). This is akin to what has been used in all the banking agencies' regulatory capital rules since Basel I and is being retained under all the Basel III proposals released by those agencies. With respect to securities financing transactions, OCC, again responding to commenters' suggestions, will permit measurement of credit exposures using the standard supervisory haircuts for such transactions under the pre-existing capital rules and the Basel III Advanced Approaches rules.

Exposures to Central Counterparties

A number of comments argued that exposures to central counterparties should be excluded from lending limits or assigned a higher lending limit for a variety of reasons, including a Dodd-Frank mandate of migration of many derivatives transactions to central counterparties. OCC will monitor the situation but has declined at this juncture to adopt any changes to the interim rule other than to clarify, consistent with earlier agency interpretive positions, that the measure of exposure to a central counterparty must include the sum of the initial margin posted, plus any contribution to a guaranty fund at the time such contribution is made (unless already reflected in the calculation). 

Exposures from Credit Derivatives

A credit derivative is a transaction in which an institution buys or sells credit protection against loss on a third-party reference entity. OCC has rejected commenters' requests to allow institutions to obtain relief for the purchase of credit protection using standard tranched index credit derivatives by including the latter in the definition of "eligible credit derivative" (which does include standard non-tranched index credit derivatives). OCC has, however, agreed to clarify the definition of "eligible credit derivatives" in the case of sovereign or municipality reference obligors to include contracts in which the credit event is a restructuring where the obligor is not subject to bankruptcy or insolvency. 

Under the interim rule, an institution's purchase of credit protection (such as default or total return swaps) to reduce all types of credit exposure to a borrower could only reduce credit derivative exposure to a reference obligor, not other exposures such as traditional loans and extensions of credit. After considering comments on this point, OCC has agreed to permit purchased credit protection to offset these other exposures if

  • the protection is accomplished through a single-name credit derivative that meets the requirements for an "eligible credit derivative";
  • the credit derivative is purchased from an eligible protection provider;
  • the reference obligor is identical; and
  • the amount and maturity of the protection purchased equals or exceeds the amount and maturity of the loan or extension of credit, provided that the foregoing offset is limited to 10 percent of the institution's capital and surplus. 

Even if all of these requirements are satisfied, the total amount of this offset may not exceed 10 percent of the bank's or savings association's capital and surplus.

Securities Financing Transactions

Responding favorably to comments requesting clarification that the terms "repurchase agreement" and "reverse repurchase agreement" as used in the interim rule's definition of "securities financing transactions" be limited to transactions in securities and not include other types of repos and reverse repos, OCC has added a definition of "security" that cross-references the one in Section 3(a)(10) of the Securities Exchange Act of 1934. 

Under the "Non-Model Method" in the interim rule (relabeled "Basic Method" in the final rule), credit exposure arising from securities borrowing or lending transactions where the collateral is other securities is and will remain pegged at the product of:

  • The higher of the two "haircuts" associated with the two securities as determined in what is now Table 2 of the final rule (Table 3 of the interim rule)
  • The higher of the two par values of the securities

Commenters expressed confusion about such a calculation in circumstances where more than one type of securities collateral is provided. OCC has amended the final rule to provide that, in such an instance, the applicable haircut is the higher of the discount associated with the security borrowed and the notional-weighted average of the discounts associated with the securities provided as collateral. 

Nonconforming Loans and Extensions of Credit

Traditionally under the lending limit regulations, a loan or extension of credit that was not made in violation of the limit does not become so if the exposure should increase over time and exceed the institution's lending limit. Instead, such transactions are treated as "nonconforming," and existing regulation requires the affected institution to use reasonable efforts to bring the loan or extension of credit into conformity with the lending limit unless doing so would be inconsistent with safety and soundness.

One commenter suggested that credit exposures from derivative or securities financing transactions and determined by an appropriate internal model should be treated as violations, rather than as nonconforming, where the exposure subsequently increases, because to do otherwise would create an incentive to "game" the system. OCC disagreed and has kept that fact pattern as nonconforming. 

Another commenter highlighted the problem that credit exposure from derivative transactions calculated using a non-model method might, where the exposure increases after execution of the transaction, be treated as a violation of the lending limit, while comparable exposures for institutions using internal models would merely be treated as nonconforming. To remove this disparity, OCC has added a reference to the CEM as well as the Basel Collateral Haircut Method (which was added to the final rule as an additional non-model method for securities financing transactions). 

Ballard Spahr's Bank Regulation and Supervision Group includes experienced lawyers who, among other things, counsel banking clients on capital and lending limit issues and assist clients in the preparation and filing of comments in agency rulemaking proceedings. For more information, please contact Alan S. Kaplinsky at 215.864.8544 or, or Keith R. Fisher at 202.661.2284 or


Copyright © 2013 by Ballard Spahr LLP.
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This alert is a periodic publication of Ballard Spahr LLP and is intended to notify recipients of new developments in the law. It should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own attorney concerning your situation and specific legal questions you have.















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