Agencies Release Final and Proposed Capital Rules
As reported in our 6/13/2012 Ad Hoc LRA, the Office of the Currency of the Comptroller (OCC), Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) announced the finalization of the market risk capital rules that were proposed in 2011. While BOLI assets generally do not fall within the scope of this rule since they are not deemed “trading assets,” we were tracking changes to the market risk rules for any possible implications on the general risk-based capital rules.
The agencies also issued three notices of proposed rulemaking (NPR) that would revise and replace the agencies’ current capital rules. The “Basel III NPR” which is applicable to all banking organizations, would revise the definition of capital (the numerator of the risk-based capital ratios), establish the new minimum ratio requirements, and make other changes to the agencies’ general risk-based capital rules related to regulatory capital. In addition, the Basel III NPR proposes that certain elements of Basel III apply only to institutions using the advanced approaches rule, including a supplementary Basel III leverage ratio and a countercyclical capital buffer.
The “Standardized Approach NPR” proposes to revise and harmonize the agencies’ rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses identified over recent years, including by incorporating aspects of Basel II. The Standardized Approach NPR also includes alternatives to credit ratings, consistent with Dodd-Frank section 939A and new disclosure requirements that would apply to banking organizations domiciled in the United States with $50 billion or more in total assets. The requirements proposed in the Basel III NPR and Standardized Approach NPR would become the “generally applicable” capital requirements for purposes of Dodd-Frank section 171. They would be the capital requirements applied to insured depository institutions without regard to asset size or foreign financial exposure.
In the “Advanced Approaches and Market Risk NPR,” the OCC and FDIC propose that the market risk capital rules apply to federal and state savings associations, and the Federal Reserve proposes that the advanced approaches and market risk capital rules apply to top-tier savings and loan holding companies domiciled in the United States, if stated thresholds for trading activity are met. The comment period for all three NPRs ends on September 7, 2012.
OCC Releases Final Rules Removing Credit Ratings in Regulations
On June 13, final rules and guidance were published in the Federal Register that remove references to credit ratings from its regulations pertaining to investment securities, securities offerings, and foreign bank capital equivalency deposits at 12 CFR 1, 16, 18, and 160. The OCC also published related guidance to assist banks in their exercise of due diligence to determine whether particular securities are “investment grade” when assessing credit risk for portfolio investments.
Under the revised regulations, to determine whether a security is “investment grade,” banks must determine that the probability of default by the obligor is low and the full and timely repayment of principal and interest is expected. Importantly, the final rules do not require banks to consider external credit ratings to make an “investment grade” determination. Therefore, banks may rely on other sources of information, including their own internal systems or analytics provided by third parties, when conducting due diligence and determining whether a particular security is a permissible and appropriate investment. The final rules become effective on January 1, 2013, except those that pertain to financial subsidiaries of national banks which become effective July 21, 2012.
Agencies Sign Memo on Supervisory Coordination
On June 4, five federal supervisory agencies released a Memorandum of Understanding (MOU) that clarifies how the agencies will coordinate their supervisory activities, consistent with Dodd-Frank. Dodd-Frank §1025 requires the Consumer Financial Protection Bureau (CFPB) and the prudential regulators – Federal Reserve, Federal Deposit Insurance Corporation (FDIC), the National Credit Union Administration (NCUA) and the Office of the Comptroller of the Currency (OCC) – to coordinate important aspects of their supervision of insured depository institutions with more than $10 billion in assets and their affiliates. Such coordination includes scheduling examinations, conducting simultaneous examinations of covered depository institutions unless an institution requests separate examinations, and sharing draft reports of examination for comment.
The MOU is intended to establish arrangements for coordination and cooperation between the CFPB and the prudential regulators, minimize unnecessary regulatory burden, avoid unnecessary duplication of effort, and decrease the risk of conflicting supervisory directives.
SEC Names Director of New Office of Credit Ratings
The Securities and Exchange Commission (SEC) announced that Thomas J. Butler has been appointed Director of the agency’s new Office of Credit Ratings. Butler will oversee a staff of approximately 25 lawyers, accountants, and examiners responsible for examining and monitoring the nine registered Nationally Recognized Statistical Rating Organizations (NRSROs). Among these required responsibilities is conducting an annual exam of each credit rating agency and issuing a public report.
New Private Systemic Risk Council
The Systemic Risk Council is a new private sector, volunteer group led by former Federal Deposit Insurance Corp. chair Shelia Bair. The Systemic Risk Council will monitor and evaluate the activities of those with the congressional mandate to develop and implement Dodd-Frank provisions related to systemic risk, including the Financial Stability Oversight Council (FSOC) and the Office of Financial Research. Council activities will include reports and commentary to the FSOC and its member regulators as they adopt regulations to prevent the type of severe financial disruptions which occurred in 2008 when global financial markets began to unravel. The council is made up of former regulators and congressional members and financial and legal experts. The independent, non-partisan council was formed by the CFA Institute, a global association of investment professionals and The Pew Charitable Trusts, a nonprofit, public interest organization.
FASB Proposal on Liquidity and Interest Rate Risk Disclosures
On June 27, the Financial Accounting Standards Board (FASB) issued a proposed Accounting Standards Update for public comment related to new liquidity risk and interest rate risk disclosures. The proposed liquidity risk disclosures are intended to provide information about the risk that the reporting organization will encounter when meeting its financial obligations, and would apply to all public, private, and not-for-profit organizations. However, the nature of the disclosures will depend on whether tshe reporting organization is considered a financial institution, as defined by the proposed Update. Some of the new required disclosures include a table of available liquid funds, a table of financial assets and financial liabilities segregated by their expected maturities, and a table on expected cash flow obligations among other requirements.
The proposed interest rate risk disclosures would apply only to financial institutions and are intended to provide information about the exposure of financial assets and financial liabilities to fluctuations in market interest rates. Among the new disclosures is an interest rate sensitivity table and quantitative or narrative disclosures of the organization’s exposure to interest rate risks. It is unclear at this time whether and to what extent the proposed rules will have an impact on BOLI or the benefit obligations BOLI is used to finance. The comment period ends on September 25, 2012.
Collier v. American Greetings (Update)
American Greetings filed a motion to transfer this matter, which is presently in the federal court in Oklahoma, to Baker v. American Greetings which is in federal court in Ohio. Both class action lawsuits allege American Greetings wrongfully obtained life insurance on is employees without the employees’ knowledge. The transfer motion was referred to a magistrate judge for a report and recommendation. The magistrate judge recommended that the case be transferred to Baker (Ohio). The report explained that the decisive factor was the fact that there is another case pending in Ohio (Baker) which relates to the same conduct by American Greetings and covers all of the states except Oklahoma and Arkansas (Collier’s class action covers those two states). Plaintiff’s objections to the report must be filed by July 3, 2012. If written objections are filed, then the district judge must review and consider any objected to part of the report and recommendation. If no objections are filed, it is probable that the district court will act upon the recommendation.
Case Reference: Collier v. American Greetings Corp, D. Okla. No. 4:10-cv-625
State National Bank of Big Spring, et al. v. Geithner, et al.
On June 21, the State National Bank of Big Spring, the 60 Plus Association and the Competitive Enterprise Institute filed a lawsuit challenging the constitutionality of the two agencies created by the Dodd-Frank Act – the Financial Stability Oversight Council (FSOC) and the Consumer Financial Protection Bureau (CFPB). The plaintiffs allege that the Dodd-Frank sections governing the creation and operation of FSOC and CFPB comprise unprecedented violations of the separation of powers and the checks and balances scheme. Namely, that each of the agencies have unbounded power and unprecedented discretion without any judicial review and further that members were appointed without the Senate’s advice and consent. The defendants include the FSOC, the CFPB, Treasury Secretary Timothy Geithner, and the chair of each of the banking agencies who also serve as members of the FSOC. The matter is in federal court in the District of Columbia.
Case Reference: State National Bank of Big Spring, et al. v. Geithner, et al, D.D.C. No. 1:12cv1032
National Federation of Independent Business et al. v. Sebelius
On June 28, the U.S. Supreme Court held most of the Patient Protection and Affordable Care Act to be constitutional (the Act). Congress enacted the Act in 2010 to increase the number of Americans covered by health insurance. One key provision is the individual mandate, which requires most Americans to maintain minimum essential health insurance coverage. While the Act does not require businesses to provide health benefits to their workers, starting in 2014 large employers will face penalties if they do not make affordable coverage available.
Case Reference: National Federation of Independent Business et al. v. Sebelius, Secretary of Health and Human Services, et al., 567 U.S. __ (2012)
Changes to DMF May Impact Experience-Rating Calculations
The Public Death Master File (DMF) is a file of all deaths reported to the Social Security Administration (SSA). While the DMF has been in existence since 1936, it did not include deaths reported by states until 2002. After a review of the DMF, the SSA determined that the Social Security Act prohibits the SSA from disclosing state death records it received through contracts with the states, except in limited circumstances. As a result, effective November 1, 2011, the DMF no longer included such information. The expected effect will be a decrease of approximately 1 million available DMF death records annually.
Insurance carriers have reportedly seen a significant decrease in the number of matched records between their administrative records and the DMF. One possible consequence of this change would be an increase in the number of incurred but not reported (IBNR) death claims. This in turn will likely prompt BOLI/COLI carriers to make adjustments to their existing experience-rating computations. Any such adjustments would typically be explained by carriers as part of the annual communication of experience-rating results.
Ad Hoc LRA – June 12, 2012
Agencies Release Final and Proposed Capital Rules
On June 12, 2012 the Office of the Currency of the Comptroller (OCC), Federal Reserve, and the Federal Deposit Insurance Corporation (FDIC) announced the finalization of the market risk capital rules that were proposed in 2011. The agencies also issued three notices of proposed rulemaking (NPR) that would revise and replace the agencies’ current capital rules. The requirements proposed in the Basel III NPR and Standardized Approach NPR (summarized below) are proposed to become the “generally applicable” capital requirements for purposes of Dodd-Frank section 171 because they would be the capital requirements applied to insured depository institutions without regard to asset size or foreign financial exposure.
Below, we briefly summarize each of the proposals. We will review each of these closely in order to determine how they might impact the applicable risk weighting for BOLI assets.
Market Risk Capital Rules Finalized 2012-06-12
The market risk capital rule supplements both the agencies’ general risk-based capital rules and the advanced capital adequacy guidelines (advanced approaches rules) (collectively, the credit risk capital rules) by requiring any bank subject to the market risk capital rule to adjust its risk-based capital ratios to reflect the market risk in its trading activities. The final rule does not include all of the methodologies adopted by the Basel Committee on Banking Supervision for calculating the standardized specific risk capital requirements for debt and securitization positions due to their reliance on credit ratings, which is impermissible under Dodd-Frank. Instead, the final rule includes alternative methodologies for calculating standardized specific risk capital requirements for debt and securitization positions. The market risk capital rule applies to banks with aggregate trading assets and trading liabilities equal to 10 percent or more of total assets or $1 billion or more. BOLI assets generally do not fall within the scope of this rule since they are not deemed “trading assets.” The final rule will be effective on January 1, 2013.
Basel III NPR 2012-06-12
In this notice, the agencies are proposing to revise their risk-based and leverage capital requirements consistent with agreements reached by the Basel Committee on Banking Supervision (BCBS) in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (Basel III). The NPR which is applicable to all banking organizations, would revise the definition of capital (the numerator of the risk-based capital ratios), establish the new minimum ratio requirements, and make other changes to the agencies’ general risk-based capital rules related to regulatory capital. In addition, the Basel II NPR proposes that certain elements of Basel III apply only to institutions using the advanced approaches rule, including a supplementary Basel III leverage ratio and a countercyclical capital buffer. This NPR also would establish more conservative standards for including an instrument in regulatory capital. As discussed in the proposal, the revisions set forth in this NPR are consistent with Dodd-Frank section 171, which requires the agencies to establish minimum risk-based and leverage capital requirements.
Advanced Approaches and Market Risk NPR 2012-06-12
In this notice, the agencies are proposing to revise the advanced approaches risk-based capital rules consistent with Basel III and other changes to the BCBS’s capital standards. The agencies also propose to revise the advanced approaches risk-based capital rules to be consistent with Dodd-Frank sections 939A and 171. Additionally in this NPR, the OCC and FDIC propose that the market risk capital rules apply to federal and state savings associations, and the Board proposes that the advanced approaches and market risk capital rules apply to top-tier savings and loan holding companies domiciled in the United States, if stated thresholds for trading activity are met. Generally, the advanced approaches rules would apply to such institutions with $250 billion or more in consolidated assets or $10 billion or more in foreign exposure, and the market risk rule would apply to savings and loan holding companies with significant trading activity.
Standardized Approach NPR 2012-06-12
In this notice, the agencies are proposing to revise and harmonize their rules for calculating risk-weighted assets to enhance risk sensitivity and address weaknesses identified over recent years, including by incorporating aspects of the BCBS’s Basel II standardized framework in the “International Convergence of Capital Measurement and Capital Standards: A Revised Framework,” including subsequent amendments to that standard, and recent BCBS consultative papers. The Standardized Approach NPR also includes alternatives to credit ratings, consistent with Dodd-Frank section 939A. The revisions include methodologies for determining risk-weighted assets for residential mortgages, securitization exposures, and counterparty credit risk. The Standardized Approach NPR also would introduce disclosure requirements that would apply to top-tier banking organizations domiciled in the United States with $50 billion or more in total assets, including disclosures related to regulatory capital instruments.