Circular
Capital Rules for the Treatment of Residual Interests
October 5, 2000
Circular No. 11278

To All State Member Banks and Bank Holding Companies in the Second Federal Reserve District:

The following is from an interagency press release issued September 27:

The Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision today requested public comment on proposed revisions to their capital rules for residual interests in asset securitizations or other transfers of financial assets. The proposed rule was published in today's Federal Register.

Comments are due December 26, 2000.

The proposal by the agencies addresses concerns with residual interests raised in the December 1999 Interagency Guidance on Asset Securitization [see this Bank's Circular No. 11223]. In that guidance, the agencies expressed concern with institutions that were holding inadequate capital against residual interests, were valuing the assets improperly, and were holding excessive amounts of these assets in relation to capital. In that document, the agencies indicated that they were considering limiting the amount of certain residual interests recognized in regulatory capital.

The capital proposal is intended to apply to balance-sheet assets retained by a seller (or transferor) that are structured, through subordination provisions or other credit enhancement techniques, to absorb more than a pro rata share of credit loss related to the transferred assets.

The agencies believe that these residual interests expose institutions to concentrated credit risk, and may present valuation and liquidity concerns. Recent experience has shown that high concentrations of such residual interests can threaten the safety and soundness of insured depository institutions.

The proposed treatment would amend the leverage and risk-based capital requirements by:

Requiring that "dollar-for-dollar" risk-based capital be held against residual interests from securitization activities or other transfers of financial assets that are retained on the balance sheet, even it the amount exceeds the full capital charge typically held against the assets transferred.

Restricting undue concentrations in such residual interests by placing them within the 25 percent Tier 1 capital sublimit already established for nonmortgage servicing assets and purchased credit card relationships. Any amounts above this limit will be deducted from Tier 1 capital.