Alternatives to the Use of External Credit Ratings in the Regulations of the OCC: Final Rules and Guidance

The Office of the Comptroller of the Currency (OCC) has published final rules 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, 28, and 160. The OCC also has revised its regulations pertaining to financial subsidiaries of national banks at 12 CFR 5 to better reflect the language of the underlying statute, as amended by section 939(d) of the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd–Frank Act).

The OCC also has published related guidance to assist national banks and federal savings associations (collectively, banks) in their exercise of due diligence to determine whether particular securities are “investment grade” when assessing credit risk for portfolio investments.

The final rules and guidance were published in the Federal Register on June 13, 2012. The revisions to the OCC’s rules at 12 CFR 1, 16, 28, and 160 will become effective on January 1, 2013. The amendments to the OCC’s regulations pertaining to financial subsidiaries of national banks became effective immediately upon publication.

Background

Section 939A of the Dodd–Frank Act requires federal agencies to review regulations that require the use of an assessment of creditworthiness of a security or money market instrument and any references to, or requirements in, those regulations regarding credit ratings. Section 939A then requires the agencies to modify the regulations identified during the review to substitute any references to, or requirements of, reliance on credit ratings with such standards of creditworthiness that each agency determines to be appropriate.

Summary

Investment Securities

In this rulemaking, the OCC has amended the regulatory definition of “investment grade” in 12 CFR 1 and 160 by removing references to credit ratings. 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. To comply with the new standard, banks may not rely exclusively on external credit ratings, but they may continue to use such ratings as part of their determinations. Consistent with existing rules and guidance, an institution should supplement any consideration of external ratings with due diligence processes and additional analyses that are appropriate for the institution’s risk profile and for the size and complexity of the instrument. In other words, a security rated in the top four rating categories by a nationally recognized statistical rating organization is not automatically deemed to satisfy the revised “investment grade” standard.

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.

In addition to following the standard under the final rules, banks are expected to continue to maintain appropriate ongoing reviews of their investment portfolios to verify that they meet safety and soundness requirements appropriate for the institution’s risk profile and for the size and complexity of the portfolios. The OCC is publishing guidance to assist banks in meeting these requirements. The guidance is designed as an aid to banks, particularly community banks and federal savings associations, regarding the factors they should consider in their due diligence when assessing securities of different degrees of complexity.

Additionally, when purchasing corporate debt securities, federal savings associations will need to follow requirements to be established by the Federal Deposit Insurance Corporation pursuant to 12 USC 1831e(d) (a provision originally pertaining to federal savings associations’ investment in securities not of investment grade, but amended by section 939(a)(2) of the Dodd–Frank Act).

Securities Offerings

The revised definition of “investment grade” also applies to the OCC regulations governing securities issued by national banks. Securities issued by national banks are not covered by the registration provisions and SEC regulations governing other issuers’ securities under the Securities Act of 1933. However, the OCC adopted 12 CFR 16 to require disclosures related to national bank-issued securities. For example, 12 CFR 16.6, which provides an optional abbreviated registration system for debt securities that meet certain criteria, requires that a security be “investment grade” to qualify for the abbreviated registration system.

Foreign Bank Capital Equivalency Deposits

The OCC’s foreign bank capital equivalency deposit regulation at 12 CFR 28.15 previously allowed for the use of certificates of deposit or bankers’ acceptances as part of the deposit if the issuer of the instrument is rated “investment grade” by an internationally recognized rating organization. This rulemaking removes the reference to credit ratings. Under the revised regulation, the issuer of the certificate of deposit or banker’s acceptance must have “an adequate capacity to meet financial commitments for the projected life of the asset or exposure.”

Financial Subsidiaries of National Banks

Finally, the OCC has made a technical change to 12 CFR 5.39, which pertains to financial subsidiaries of national banks, to conform with section 939(d) of the Dodd-Frank Act, which amends the criteria applicable to national banks seeking to control or hold an interest in a financial subsidiary set forth at 12 USC 24a.

Pursuant to section 939(d) of the Dodd–Frank Act, a national bank that is one of the 100 largest insured banks may control a financial subsidiary, directly or indirectly, or hold an interest in a financial subsidiary if the bank has not fewer than one issue of outstanding debt that meets such standards of creditworthiness or other criteria as the Secretary of the Treasury and the Federal Reserve Board may jointly establish. As is the case under current law, this statutory creditworthiness requirement does not apply to an insured depository institution that is not among the 100 largest insured depository institutions. Therefore, this revision will not affect the ability of such an institution to control or hold an interest in a financial subsidiary.

The Secretary of the Treasury and Federal Reserve Board have not yet established alternative non-ratings-based creditworthiness requirements applicable to the 100 largest insured banks under this revised provision of the National Bank Act. Until specific creditworthiness standards are established under 12 USC 24a, as modified by the Dodd-Frank Act, no specific creditworthiness requirements will be required of national banks applying to control or hold an interest in a financial subsidiary. Importantly, however, the requirements at 12 CFR 5.39(g)(1) and (2) still apply. These provisions generally provide that a national bank may control or hold an interest in a financial subsidiary only if it and each depository institution affiliate is well-capitalized and well-managed, and the aggregate consolidated total assets of all financial subsidiaries of the national bank do not exceed the lesser of 45 percent of the consolidated total assets of the parent bank or $50 billion.

Further Information

Questions or comments may be directed to Kerri Corn, Director for Market Risk, Credit and Market Risk Division, at (202) 649-6360; Michael Drennan, Senior Advisor, Credit and Market Risk Division, at (202) 649-6360; Eugene H. Cantor, Counsel, Securities and Corporate Practices Division, at (202) 649-5510; or Carl Kaminski, Senior Attorney, Legislative and Regulatory Activities Division, at (202) 649-5869.

Julie L. Williams
First Senior Deputy Comptroller and Chief Counsel

Related Links

• Final Rules (PDF)
• Final Guidance (PDF)