Guidance on Due Diligence Requirements for Savings Associations in Determining Whether a Corporate Debt Security Is Eligible for Investment, 78090-78092 [2011-31884]

Agencies

• FEDERAL DEPOSIT INSURANCE CORPORATION

[Federal Register Volume 76, Number 241 (Thursday, December 15, 2011)]
[Proposed Rules]
[Pages 78090-78092]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2011-31884]


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FEDERAL DEPOSIT INSURANCE CORPORATION

12 CFR Part 362


Guidance on Due Diligence Requirements for Savings Associations 
in Determining Whether a Corporate Debt Security Is Eligible for 
Investment

AGENCY: Federal Deposit Insurance Corporation.

ACTION: Proposed guidance with request for comment.

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SUMMARY: The FDIC is seeking comment on proposed guidance that would 
assist savings associations in conducting due diligence to determine 
whether a corporate debt security is eligible for investment under a 
proposed rule published elsewhere in this issue of the Federal 
Register.

DATES: Comments must be received by February 13, 2012.

ADDRESSES: You may submit comments by any of the following methods:
     Agency Web Site: https://www.fdic.gov/regulations/laws/federal/propose.html. Follow instructions for submitting comments on 
the Agency Web Site.
     Email: Comments@fdic.gov.
     Mail: Robert E. Feldman, Executive Secretary, Attention: 
Comments, Federal Deposit Insurance Corporation, 550 17th Street NW., 
Washington, DC 20429.
     Hand Delivery: Comments may be hand delivered to the guard 
station at the rear of the 550 17th Street Building (located on F 
Street) on business days between 7 a.m. and 5 p.m.
    Public Inspection: All comments received must include the agency 
name. All comments received will be posted without change to https://www.fdic.gov/regulations/laws/federal/propose.html, including any 
personal information provided. Paper copies of public comments may be 
ordered from the FDIC Public Information Center, 3501 North Fairfax 
Drive, Room E-1002, Arlington, VA 22226 by telephone at 1-(877) 275-
3342 or 1-(703) 562-2200.

FOR FURTHER INFORMATION CONTACT: Kyle Hadley, Section Chief, 
Examination Support, (202) 898-6532, Division of Risk Management 
Supervision; Eric Reither, Capital Markets Specialist, (202) 898-3707, 
Division of Risk Management Supervision; Mark Handzlik, Counsel, Bank 
Activities Section, (202) 898-3990; Michael Phillips, Counsel, Bank 
Activities Section, (202) 898-3581; Rachel Jones, Honors Attorney, 
Legal Division (202) 898-6858.

SUPPLEMENTARY INFORMATION:

Background

    Section 939(a) (``Section 939(a)'') of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act'') amends section 
28(d) (``Section 28(d)'') of the Federal Deposit Insurance Act (``FDI 
Act'') to prohibit a savings association from acquiring or retaining a 
corporate debt security that does not satisfy creditworthiness 
standards established by the Federal Deposit Insurance Corporation 
(``FDIC''). Elsewhere in today's Federal Register, the FDIC has 
published for public comment a proposed rule (``Proposed Rule'') to 
implement the requirements of Section 939(a). Under the Proposed Rule, 
an insured savings association would be prohibited from acquiring or 
retaining a corporate debt security unless it determines, prior to 
acquiring the security and periodically thereafter, that the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the investment.
    Under Section 28(d) of the FDI Act, Federal and state savings 
associations generally are prohibited from acquiring or retaining, 
either directly or indirectly through a subsidiary, a corporate debt 
security that is rated below investment grade. Section 939(a) amends 
Section 28(d) by replacing the investment-grade standard with a 
requirement that any corporate debt security investment by a savings 
association satisfy standards of creditworthiness established by the 
FDIC. This amendment is effective for all savings associations two 
years after the date of enactment of the Dodd-Frank Act, or as of July 
21, 2012.
    Elsewhere in today's Federal Register, the FDIC is seeking comment 
on the Proposed Rule to amend the FDIC's regulations in accordance with 
the requirements of Section 28(d), as amended by Section 939(a). 
Specifically, the Proposed Rule would amend section 362.11(b) of the 
FDIC's regulations to prohibit an insured savings association from 
acquiring or retaining a corporate debt security unless it determines, 
prior to acquisition and periodically thereafter, that the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the investment. For purposes of the 
Proposed Rule, an issuer would satisfy this requirement if, based on 
the assessment of the savings association, the issuer presents a low 
risk of default and is likely to make full and timely repayment of 
principal and interest. The FDIC does not expect the Proposed Rule to 
change the scope of permissible corporate debt securities investments 
for insured savings associations. In accordance with the requirements 
of the Dodd-Frank Act, if promulgated in final form, the Proposed Rule 
would be effective as of July 21, 2012.

Proposed Guidance

    The proposed guidance would provide supervisory expectations for 
savings associations conducting due diligence to determine whether a 
corporate debt securities investment satisfies the creditworthiness 
requirements of the Proposed Rule--that is, whether the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the investment. The FDIC expects 
savings associations to conduct appropriate ongoing reviews of their 
corporate debt investment portfolios to ensure that the composition of 
the portfolio is consistent with safety and soundness principles and 
appropriate for the risk profile of the institution as well as the size 
and complexity of the portfolio.

Text of Proposed Guidance

    The text of the proposed supervisory guidance regarding the FDIC's 
expectations for insured savings associations conducting due diligence 
to assess the credit risk of a corporate debt security, in accordance 
with the requirements of 12 CFR 362.11(b), follows.

Purpose

    The Federal Deposit Insurance Corporation (``FDIC'') is issuing 
this guidance document (``Guidance'') to establish supervisory 
expectations for savings associations conducting due diligence to 
determine whether a corporate debt security is eligible for investment 
under 12 CFR part 362. Section 362.11(b) of the FDIC's regulations 
implements Section 28(d) of the FDI Act (as amended by section 939(a) 
of the Dodd-Frank Wall Street Reform and Consumer Protection Act), and 
prohibits an insured savings association from acquiring or retaining a 
corporate debt security unless it

[[Page 78091]]

determines, prior to acquiring the security and periodically 
thereafter, that the issuer has adequate capacity to satisfy all 
financial commitments under the security for the projected life of the 
investment. An issuer satisfies this requirement if, based on the 
assessment of the savings association, the issuer presents a low risk 
of default and is likely to make full and timely repayment of principal 
and interest. The investment also must be consistent with safe and 
sound banking practices.

Background

    Part 362 of the FDIC's regulations sets forth the requirements for 
determining whether securities have appropriate credit quality and 
marketability characteristics to be purchased and held by insured 
savings associations. Under section 362.11(b), a savings association 
may acquire or retain a corporate debt security only if the issuer has 
adequate capacity to satisfy all financial commitments under the 
security for the projected life of the investment. An issuer satisfies 
this requirement if, based on the assessment of the savings 
association, the issuer presents a low risk of default and is likely to 
make full and timely repayment of principal and interest.
    Savings associations must be able to demonstrate that their 
investment securities meet applicable credit quality standards. This 
Guidance sets forth criteria that savings associations should consider 
when conducting due diligence to determine whether a security is 
eligible for investment under part 362.
    The federal banking agencies have maintained long-standing 
supervisory guidance that banks and savings associations implement a 
risk management process to ensure that credit risk, including the 
credit risk of an investment portfolio, is effectively identified, 
measured, monitored, and controlled. The 1998 Interagency Supervisory 
Policy Statement on Investment Securities and End-User Derivatives 
Activities (Policy Statement) provides risk management standards for 
the securities investment activities of banks and savings 
associations.\1\ The Policy Statement emphasizes the importance of an 
institution conducting a thorough credit risk analysis before and 
periodically after the acquisition of a security. Such analysis would 
allow an institution to understand and effectively manage the risks 
within its investment portfolio, including credit risk, and is an 
essential element of a sound investment portfolio risk management 
framework. The Policy Statement is generally consistent with the 
agencies' Uniform Agreement on the Classification of Assets and 
Appraisal of Securities Held by Banks and Thrifts, which describes the 
importance of management's credit risk analysis and its use in examiner 
decisions concerning investment security risk ratings and 
classifications.\2\
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    \1\ On April 23, 1998, the FDIC, together with the Federal 
Reserve Board, National Credit Union Administration, Office of the 
Comptroller of the Currency, and Office of Thrift Supervision, 
issued the ``Supervisory Policy Statement on Investment Securities 
and End-User Derivatives Activities.'' As issued by the OTS, the 
Policy Statement applied to both state and Federal savings 
associations.
    \2\ See, FDIC Financial Institution Letter, 70-2004 (June 15, 
2004).
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Determining Whether Securities Are Permissible Prior To Purchase

    The FDIC expects savings associations to conduct an appropriate 
level of due diligence in determining whether a corporate debt security 
is eligible for investment under 12 CFR 362.11(b). This may include 
consideration of internal analyses, third-party research and analytics 
including internal risk ratings, external credit ratings default 
statistics, and other sources of information appropriate for the 
particular security. The depth of the due diligence should be a 
function of the security's credit quality, the complexity of the 
issuer's financial structure, and the size of the investment. As an 
issuer's financial structure becomes more complex, the more credit-
related due diligence an institution should perform, even when the 
credit quality is perceived to be very high. Management should ensure 
they understand the security's structure and how the security will 
perform in various scenarios throughout the business cycle. The FDIC 
expects savings associations to consider a variety of factors relevant 
to the particular security when determining whether a security is a 
permissible and sound investment. The range and type of specific 
factors an institution should consider will vary depending on the 
particular type and nature of the security. As a general matter, a 
savings association will have a greater burden to support its 
determination if one factor is contradicted by a finding under another 
factor.
    Although part 362 does not provide specific investment quality 
requirements, savings associations should conduct an appropriate level 
of due diligence prior to purchasing a corporate debt security to 
ensure that it is eligible for investment under part 362. A savings 
association should review and update this analysis periodically, as 
appropriate for size and risk profile of the security. By way of 
example, appropriate factors a savings association should consider 
include, but should not be limited to, the following:

     Confirm spread to U.S. Treasuries is consistent with bonds 
of similar credit quality;
     Confirm risk of default is low and consistent with bonds 
of similar credit quality;
     Confirm capacity to pay through internal credit analysis 
that can be supplemented with other third-party analytics;
     Understand applicable market demographics/economics; and
     Understand current levels and trends in operating margins, 
operating efficiency, profitability, return on assets and return on 
equity.

Maintaining an Appropriate and Effective Portfolio Risk Management 
Framework

    Savings associations should have in place an appropriate risk 
management framework for the level of risk in their corporate debt 
investment portfolios. Failure to maintain an adequate investment 
portfolio risk management process, which includes understanding key 
portfolio risks, is considered an unsafe and unsound practice. Savings 
associations should conform to safe and sound banking practices and, 
similarly, should consider appropriate investment portfolio risks in 
connection with the acquisition of a corporate debt security.\3\
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    \3\ See supra footnote 1.
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    Having a strong and robust risk management framework appropriate 
for the level of risk of a savings association's investment portfolio 
is particularly critical for managing portfolio credit risk. A key role 
for management in the oversight process is to translate the risk 
tolerance levels established by the board of directors into a set of 
internal operating policies and procedures that govern the 
institution's investment activities. Specifically, investment policies 
should provide credit risk concentration limits. Such limits may apply 
to concentrations relating to a single or related issuer, a 
geographical area, and obligations with similar characteristics. 
Savings associations with investment portfolios that lack 
diversification in one of the aforementioned areas should enhance their 
monitoring and reporting systems. Safety and soundness principles 
warrant effective concentration risk management programs to ensure that 
credit exposures do not reach an excessive level.

[[Page 78092]]

    Savings associations should identify and measure the risks of their 
investments periodically after acquisition. Such analyses allow an 
institution to understand and effectively manage the risks of its 
investment portfolio, including credit risk, and are an essential 
element of a sound investment portfolio risk management framework. 
Exposure to each type of risk for each security should be measured and 
aggregated with similar exposures on an institution-wide basis. Risk 
measurement should be obtained from sources independent of sellers or 
counterparties and should be periodically validated. Irrespective of 
any contractual or other arrangements, savings associations are 
responsible for understanding and managing the risks of all of their 
investments.

Request for Comment

    The FDIC requests comment on all aspects of this proposed guidance. 
Specifically, the FDIC is seeking commenters' views on the following:
    1. Does the proposed guidance sufficiently assist savings 
associations in meeting their due diligence requirements? How could the 
guidance be improved?
    2. Should the guidance provide differentiation based on the size 
and scope of operations of a savings associations, specifically with 
respect to the factors a savings association should consider in 
conducting due diligence to determine the credit quality of a corporate 
debt security?

    By order of the Board of Directors.

    Dated at Washington, DC, this 7th day of December 2011.
Federal Deposit Insurance Corporation.
Robert E. Feldman,
Executive Secretary.
[FR Doc. 2011-31884 Filed 12-13-11; 11:15 am]
BILLING CODE 6714-01-P