Enhanced Disclosure of the Models Used in the Federal Reserve's Supervisory Stress Test, 59547-59555 [2017-26856]

Agencies

• FEDERAL RESERVE SYSTEM

[Federal Register Volume 82, Number 240 (Friday, December 15, 2017)]
[Proposed Rules]
[Pages 59547-59555]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2017-26856]


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FEDERAL RESERVE SYSTEM

12 CFR Chapter II

[Docket No. OP-1586]


Enhanced Disclosure of the Models Used in the Federal Reserve's 
Supervisory Stress Test

AGENCY: Board of Governors of the Federal Reserve System (Board).

ACTION: Notification with request for public comment.

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SUMMARY: The Board is inviting comment on an enhanced disclosure of the 
models used in the Federal Reserve's supervisory stress test conducted 
under the Board's Regulation YY pursuant to the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act) and the Board's 
capital plan rule.

DATES: Comments must be received by January 22, 2018.

ADDRESSES: You may submit comments, identified by Docket No. OP-1586 by 
any of the following methods:
     Agency website: https://www.federalreserve.gov. Follow the 
instructions for submitting comments at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.aspx.
     Federal eRulemaking Portal: https://www.regulations.gov. 
Follow the instructions for submitting comments.
     Email: [email protected]. Include the 
docket number and RIN number in the subject line of the message.
     Fax: (202) 452-2819 or (202) 452-3102.
     Mail: Ann Misback, Secretary, Board of Governors of the 
Federal Reserve System, 20th Street and Constitution Avenue NW, 
Washington, DC 20551.
    All public comments will be made available on the Board's website 
at https://www.federalreserve.gov/generalinfo/foia/ProposedRegs.aspx as 
submitted, unless modified for technical reasons. Accordingly, your 
comments will not be edited to remove any identifying or contact 
information. Public comments may also be viewed electronically or in 
paper form in Room 3515, 1801 K St. NW (between 18th and 19th Streets 
NW), Washington, DC 20006 between 9:00 a.m. and 5:00 p.m. on weekdays. 
For security reasons, the Board requires that visitors make an 
appointment to inspect comments. You may do so by calling (202) 452-
3684. Upon arrival, visitors will be required to present valid 
government-issued photo identification and to submit to security 
screening in order to inspect and photocopy comments.

FOR FURTHER INFORMATION CONTACT: Lisa Ryu, Associate Director, (202) 
263-4833, Kathleen Johnson, Assistant Director, (202) 452-3644, Robert 
Sarama, Manager (202) 973-7436, Division of Supervision and Regulation; 
Benjamin W. McDonough, Assistant General Counsel, (202) 452-2036, or 
Julie Anthony, Counsel, (202) 475-6682, Legal Division, Board of 
Governors of the Federal Reserve System, 20th Street and Constitution 
Avenue NW, Washington, DC 20551. Users of Telecommunication Device for 
Deaf (TDD) only, call (202) 263-4869.

SUPPLEMENTARY INFORMATION: 

Table of Contents

I. Overview
II. Description of Enhanced Model Disclosure
    A. Enhanced Description of Models
    B. Modeled Loss Rates on Pools of Loans
    C. Portfolios of Hypothetical Loans and Associated Loss Rates
    D. Explanatory Notes on Enhanced Model Disclosures
III. Request for Comment
IV. Example of Enhanced Model Disclosure
    A. Enhanced Description of Models
    B. Modeled Loss Rates on Pools of Loans
    C. Portfolios of Hypothetical Loans and Associated Loss Rates

I. Overview

    Each year the Federal Reserve publicly discloses the results of the 
supervisory stress test.\1\ The disclosures include revenues, expenses, 
losses, pre-tax net income, and capital ratios that would result under 
two sets of adverse economic and financial conditions. As part of the 
disclosures, the Federal Reserve also describes the broad framework and 
methodology used in the supervisory stress test, including information 
about the models used to estimate the revenues, losses, and capital 
ratios in the stress test. The annual disclosures of both the stress 
test results and supervisory model framework and methodology represent 
a significant increase in the public transparency of large bank 
supervision in the U.S.\2\ Indeed, prior to the first supervisory 
stress test in 2009, many analysts and institutions cautioned against 
these disclosures, arguing that releasing bank-specific loss estimates 
to the public would be destabilizing. However, experience to date has 
shown the opposite to be true--disclosing these details to the public 
has garnered public and market confidence in the process.
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    \1\ See, for example, Dodd-Frank Act Stress Test 2017: 
Supervisory Stress Test Methodology and Results, June 2017 and 
Comprehensive Capital Analysis and Review 2017: Assessment Framework 
and Results, June 2017.
    \2\ In addition to those public disclosures, the Federal Reserve 
has published detailed information about its scenario design 
framework and annual letters detailing material model changes. The 
Federal Reserve also hosts an annual symposium in which supervisors 
and financial industry practitioners share best practices in 
modeling, model risk management, and governance.
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    The Federal Reserve routinely reviews its stress testing and 
capital planning programs, and during those reviews the Federal Reserve 
has received feedback regarding the transparency of the supervisory 
stress test models.\3\ Some of those providing feedback requested more 
detail on modeling methodologies with a focus on year-over-year changes 
in the supervisory models.\4\ Others, however, cautioned against 
disclosing too much information about the supervisory models because 
doing so could permit firms to reverse-engineer the stress test.
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    \3\ During a review that began in 2015, the Federal Reserve 
received feedback from senior management at firms subject to the 
Board's capital plan rule, debt and equity market analysts, 
representatives from public interest groups, and academics in the 
fields of economics and finance. That review also included an 
internal assessment.
    \4\ Some of the comments in favor of additional disclosure 
included requests that the Federal Reserve provide additional 
information to firms only, without making the additional disclosures 
public. Doing so would be contrary to the Federal Reserve's 
established practice of not disclosing information related to the 
stress test to firms if that information is not also publicly 
disclosed.
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    The Federal Reserve recognizes that disclosing additional 
information about supervisory models and methodologies has significant 
public benefits, and is committed to finding ways to further increase 
the transparency of the supervisory stress test. More detailed 
disclosures could further enhance the credibility of the stress test by 
providing the public with information on the fundamental soundness of 
the models and their alignment with best modeling practices. These 
disclosures would also facilitate comments on the models from the 
public, including academic experts. These comments could lead to 
improvements, particularly in the data most useful to understanding the 
risks of particular loan types. More detailed disclosures could also 
help the public understand and interpret the results of the stress 
test, furthering the goal of maintaining market and public confidence 
in the U.S. financial system. Finally, more detailed disclosures of how 
the Federal Reserve's models assign losses to particular positions

[[Page 59548]]

could help those financial institutions that are subject to the stress 
test understand the capital implications of changes to their business 
activities, such as acquiring or selling a portfolio of assets.
    The Federal Reserve also believes there are material risks 
associated with fully disclosing the models to the firms subject to the 
supervisory stress test. One implication of releasing all details of 
the models is that firms could conceivably use them to make 
modifications to their businesses that change the results of the stress 
test without changing the risks they face. In the presence of such 
behavior, the stress test could give a misleading picture of the actual 
vulnerabilities faced by firms. Further, such behavior could increase 
correlations in asset holdings among the largest banks, making the 
financial system more vulnerable to adverse financial shocks.\5\ 
Another implication is that full model disclosure could incent banks to 
simply use models similar to the Federal Reserve's, rather than build 
their own capacity to identify, measure, and manage risk. That 
convergence to the Federal Reserve's model would create a ``model 
monoculture,'' in which all firms have similar internal stress testing 
models which may miss key idiosyncratic risks faced by the firms.\6\
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    \5\ For example, if firms were to deem a specific asset as more 
advantageous to hold based on the particulars of the supervisory 
models, were an exogenous shock to occur to that specific asset 
class, the firms' losses would be magnified because they held 
correlated assets.
    \6\ See, Schuermann, T. (March 19, 2013). The Fed's Stress Tests 
Add Risk to the Financial System. Wall Street Journal, which 
highlights bank incentives to mimic Federal Reserve's stress test 
models.
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    In the next section of the paper, three proposed enhancements to 
the supervisory stress test model disclosures are described, with an 
example of the enhanced disclosure for the Federal Reserve's corporate 
loan loss model. If the proposed enhancements were implemented, the 
Federal Reserve would expect to publish the enhanced disclosures in the 
first quarter of each year, starting with selected loan portfolios in 
2018. The Federal Reserve expects that the annual disclosure would 
reflect any updates to supervisory models, for applicable portfolios, 
in a given year, but would be based on data and scenarios from the 
prior year.
    The proposed enhancements are designed to balance the costs and 
benefits discussed above in a way that would further enhance the 
public's understanding of the supervisory stress test models without 
undermining the effectiveness of the stress test as a supervisory tool.

II. Description of Enhanced Model Disclosure

    The proposed enhanced disclosures have three components: (1) 
Enhanced descriptions of supervisory models, including key variables; 
(2) modeled loss rates on loans grouped by important risk 
characteristics and summary statistics associated with the loans in 
each group; and, (3) portfolios of hypothetical loans and the estimated 
loss rates associated with the loans in each portfolio.\7\
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    \7\ The second and third components would be provided for the 
models used to project losses on the most material loan portfolios.
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    Collectively, the additional information is designed to facilitate 
the public's ability to understand the workings of the models and 
provide meaningful feedback.

A. Enhanced Description of Models

    The Federal Reserve currently discloses descriptions of the 
supervisory stress test models in an appendix in the annual Dodd-Frank 
Act supervisory stress test methodology and results document. For each 
modeling area, the appendix includes a description of the structure of 
the model, key features, and the most important explanatory variables 
in the model.
    The proposed enhanced descriptions of the models would expand these 
descriptions in two ways. First, they would provide more detailed 
information about the structure of the models. For example, the 
existing disclosure for corporate loans explains that the model 
estimates expected losses using models of probability of default (PD), 
loss given default (LGD), and exposure at default (EAD). It further 
explains that PDs are projected using a series of equations fitted to 
the historical relationship between changes in the PD and macroeconomic 
variables, including growth in real gross domestic product, changes in 
the unemployment rate, and changes in the spread on BBB-rated corporate 
bonds. The proposed enhanced model description would include certain 
important equations that characterize aspects of the model. Second, the 
proposed enhanced descriptions would include a table that contains a 
list of the key loan characteristics and macroeconomic variables that 
influence the results of a given model. The table would show the 
relevant variables for each component of the model (e.g., PD, LGD, 
EAD), and information about the source of the variables (see Table 1).

B. Modeled Loss Rates on Pools of Loans

    The proposed enhanced disclosure would include estimated loss rates 
for groups of loans with distinct characteristics. Those loss rates 
would allow the public to directly see how the supervisory models treat 
specific assets under stress. The corporate loan example included below 
illustrates how this new loss rate disclosure could operate in 
practice. The modeled loss rates are reported for eight groups of loans 
that have combinations of three loan characteristics: sector (financial 
and nonfinancial), security status (secured and unsecured), and rating 
class (investment grade and non-investment grade). The average (mean) 
estimated loss rate and 25th and 75th percentiles of the estimated 
loan-level loss rates are presented for each group of loans. By 
presenting the modeled loss rates in ranges as well as the average for 
each group, the disclosure highlights that loans within the same group 
may have different loss rates because of differences in other risk 
characteristics. For example, nonfinancial sector loans would include 
loans to companies in a range of sectors, which may have different 
sensitivities to the macroeconomic environment associated with any 
given scenario.
    To shed more light on the degree of heterogeneity of loans within a 
given group, the enhanced disclosure could also include summary 
statistics associated with the loans in each group. Combined, the 
modeled loss rates and summary statistics would allow a firm to compare 
the characteristics of its own portfolio to those of the aggregate 
portfolio for all firms subject to the stress test and to better 
understand differences in loss rates between the two. The modeled loss 
rates could be reported for both the supervisory adverse and 
supervisory severely adverse scenarios, which would help to illustrate 
the effect of variation in macroeconomic conditions on modeled loss 
rates.

C. Portfolios of Hypothetical Loans and Associated Loss Rates

    Publishing portfolios of hypothetical loans is another way to 
enhance transparency. This approach would allow outside parties to use 
their own suites of models to estimate losses on the portfolios and 
compare loss rates across different models.
    The portfolios the Federal Reserve may publish for certain asset 
classes could comprise three sets of hypothetical loans designed to 
mimic the characteristics of the actual loans reported by firms 
participating in the

[[Page 59549]]

stress test. The first set could be based on the full sample of loans 
observed in the data, the second could capture characteristics 
associated with lower-than-average risk loans, and the third could 
capture characteristics associated with higher-than-average risk loans. 
Importantly, those portfolios would not contain any individual firm's 
actual loan portfolio or any actual loans reported by firms, but rather 
would be portfolios of hypothetical loans designed to illustrate the 
effect of loan characteristics on estimated loss rates. The set of 
variables included for each portfolio would be designed such that the 
public could independently estimate loss rates for these portfolios, 
although this set would not necessarily include every variable that 
might be included in a loss model for the relevant loan type. The 
disclosure could also include the loss rates estimated by the 
supervisory models for each portfolio of hypothetical loans under the 
supervisory adverse and supervisory severely adverse scenarios.

D. Explanatory Notes on Enhanced Model Disclosures \8\
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    \8\ This section highlights definitional differences between the 
proposed enhanced disclosures and the loss rate disclosures in the 
annual Dodd-Frank Act stress test methodology and results document. 
Those differences are intended to facilitate the stated goal of the 
proposed enhanced disclosure to illustrate more clearly how the 
Federal Reserve's models translate firms' portfolio characteristics 
and the scenarios into loss rates.
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    The proposed enhanced model disclosures described in this document 
focus on the design of and projections from particular models, whereas 
the current disclosures of supervisory stress test results include 
projections aggregated to the portfolio level that in most cases 
contain the outputs from multiple supervisory models. As such, the two 
different disclosures will not align exactly.
    The proposed enhanced model disclosures would also differ from the 
current stress testing results disclosures in that they would not 
include accounting and other adjustments used to translate projected 
credit losses into net income. In the current supervisory stress test 
results disclosure, accounting adjustments are used to translate 
supervisory model estimates into provisions and other income or expense 
items needed to calculate stressed pre-tax net income. These 
adjustments often depend on factors that vary across participating 
banks, such as the write-down amounts on loans purchased with credit 
impairments.

III. Request for Comment

    The Board requests comment on the proposed enhanced disclosure of 
the models used in the Federal Reserve's supervisory stress test. Where 
possible, commenters should provide both quantitative data and detailed 
analysis in their comments. Commenters should also explain the 
rationale for their suggestions. Specifically, feedback is requested on 
the following questions:
     Does the enhanced disclosure appropriately balance the 
benefits and costs of additional disclosure as outlined above?
     Would the enhanced disclosure allow the public, including 
academics, to comment on the soundness of the models and their 
alignment with best modeling practices?
     Are there specific ways the enhanced disclosures could be 
tailored to limit the potential for increased correlation of risks in 
the system?
     Are there additional disclosures that would be more 
helpful to the public without increasing the potential for increased 
correlation of risks in the system?

IV. Example of Enhanced Model Disclosure

    This section contains an illustrative example of what an enhanced 
model disclosure could look like for the supervisory corporate loan 
model.

A. Enhanced Description of Models

Overview of Corporate Loan Model
    Losses stemming from the default of corporate loans are projected 
using a model that assigns a specific loss amount to each corporate 
loan held by a firm subject to the supervisory stress test. The model 
projects losses as the product of three components: Probability of 
default (PD), loss given default (LGD), and exposure at default (EAD). 
The PD component measures the likelihood that a borrower will stop 
repaying the loan. The other two components capture the lender's loss 
on the loan if the borrower enters default. The LGD component measures 
the percent of the loan balance that the lender will not be able to 
recover after the loan defaults, and the EAD component measures the 
total expected outstanding balance on the loan at the time of default.
    The model is estimated using historical data on corporate loan 
losses, loan characteristics, and economic conditions. Losses are 
projected using the estimated model, firm-reported loan 
characteristics, and economic conditions defined in the Federal 
Reserve's supervisory stress scenarios. Some of the key loan 
characteristics that affect projected losses include:
     The loan's credit rating;
     The industry of the borrower;
     The country in which the borrower is domiciled; and
     Whether or not the loan is secured.
    The losses projected by the model for a given loan vary based on 
changes in the defined economic conditions over the nine quarters of 
the projection horizon. Those include:
     Growth in real gross domestic product (GDP);
     Changes in the unemployment rate; and
     Changes in the spread on BBB-rated loans relative to 
Treasuries.
Loan Coverage and Model Structure
    Corporate loans modeled using the expected loss modeling framework 
described in this document consist of a number of different categories 
of loans, as defined by the Consolidated Financial Statements for 
Holding Companies--FR Y-9C report. The largest group of these loans 
includes commercial and industrial (C&I) loans with more than $1 
million in committed balances that are ``graded'' using a firm's 
corporate rating process. The corporate loan model is designed to 
project quarterly losses on those loans over the projection horizon of 
each stress test scenario.
    Expected loss (EL) is the product of the three components described 
above (PD, LGD, and EAD), and for loan i in quarter t of the projection 
horizon it can be expressed as: \9\
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    \9\ For example, if the probability of default is 1 percent, the 
loss given default is 20 percent, and the expected outstanding 
balance at default is $1,000,000 the expected loss is: EL = 
0.01*0.20*1,000,000 = $2,000.
[GRAPHIC] [TIFF OMITTED] TP15DE17.083


[[Page 59550]]


    Each of the three components is modeled separately. The three 
component models are described below.
Probability of Default
    The PD model assumes that the probability that a loan defaults 
depends on macroeconomic factors, such as the unemployment rate. The 
model first calculates the loan's PD at the beginning of the projection 
horizon and then projects it forward using the estimated relationship 
between historical changes in PD and changes in the macroeconomic 
environment.\10\
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    \10\ Loans that are 90 days past due, in non-accrual status, or 
that have a Financial Accounting Standards Board Accounting 
Standards Codification Subtopic 310-10 (ASC 310-10) reserve as of 
the reference date for the stress test are considered in default.
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    Calculating the Initial PD: The initial PD, which is the PD at the 
beginning of the projection horizon (i.e., PD(i,t=0)), is calculated as 
the long-run average of daily expected default frequencies (EDFs). EDFs 
are measures of the probability of default based on a structural model 
that links the value of a firm to credit risk. The initial PD for 
publicly traded borrowers for which a CUSIP is available in the firm-
reported data reflects a borrower-specific EDF. The initial PD for 
other borrowers is based on the average EDF for the industry and rating 
category group in which the borrower is classified. A borrower's 
industry category is directly observed in the firm-reported data, and 
the rating category is derived from the firm-reported internal credit 
rating for the borrower and a firm-reported table that maps the 
internal rating to a standardized rating scale.
    Projecting the PD: The initial PDs are then projected over the 
projection horizon using equations fitted to the historical 
relationship between changes in the EDFs and changes in macroeconomic 
variables. The equations are estimated separately by borrower industry, 
rating category, and country of borrower domicile. The macroeconomic 
variables used to project changes in PDs over the projection horizon 
are GDP growth, changes in the unemployment rate, and changes in the 
spread on BBB-rated loans relative to Treasuries (BBB spread). GDP 
growth and the rate of unemployment reflect economy-wide changes in 
demand for goods and services which affect firms' probabilities of 
default, while the BBB spread represents factors that affect firms' 
profitability and investment opportunities, such as aggregate credit 
risk and the cost of borrowing.
    For loan i, which is in country-industry group j, and rating 
category k, the change in PD from period t-1 to t is given by:
[GRAPHIC] [TIFF OMITTED] TP15DE17.000

Where [beta]jk(m) is the estimated sensitivity of the probability of 
default to macroeconomic factor m, for country-industry segment j and 
rating category k, and S(t,m) is macroeconomic factor m in period t.
Loss Given Default
    Similar to the PD model, the LGD model first calculates the loan's 
LGD at the beginning of the projection horizon and then projects it 
forward using the estimated relationship between historical changes in 
LGD and changes in the macroeconomic environment.
    Calculating the Initial LGD: Firm-reported data on line of business 
and whether the loan is secured or unsecured are used to set the 
initial LGD for performing loans. In cases in which the loan has 
already been identified as troubled, i.e., the firm has already put 
aside a reserve to cover the expected loss, the initial LGD is based on 
the size of the reserve. Further adjustments are made to the initial 
LGDs of loans that are in default at inception.\11\ For foreign loans, 
initial LGDs are also adjusted based on the country in which the 
obligor is domiciled, capturing differences in collateral recovery 
rates across countries.
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    \11\ Loans that are in default at inception of the stress period 
(i.e., t=0) are assigned a PD of 100%, and a LGD using the ASC 310-
10 reserves reported by the firm.
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    Projecting LGD: The LGD is then projected forward by relating the 
change in the LGD to changes in the PD following Frye and Jacobs 
(2012).\12\ Under that approach, changes in LGD are explicitly 
calculated as an increasing function of PD. Specifically, loan i's LGD 
from period t-1 to period t is given by:
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    \12\ See, Frye, J., & Jacobs Jr, M. (2012). Credit loss and 
systematic loss given default. The Journal of Credit Risk, 8(1), 
109.
[GRAPHIC] [TIFF OMITTED] TP15DE17.001

Where [Phi][[sdot]] denotes the standard normal cumulative distribution 
function and [Phi]-\1\[[sdot]] is its inverse. LGD in period 
t depends on PD in period t and on PD and LGD in period t-1. If PD(i,t) 
= PD(i,t-1), then LGD(i,t) = LGD(i,t-1).
Exposure at Default
    For closed-end loans, the EAD is the utilized exposure.
    For lines of credit and other revolving commitments, the EAD equals 
the utilized exposure plus a portion of the unfunded commitment (i.e., 
the difference between the committed exposure and utilized exposure), 
which reflects the amount that is likely to be drawn down by the 
borrower in the event of default. The amount that is likely to be drawn 
down is calibrated to the historical drawdown experience for defaulted 
U.S. syndicated revolving lines of credit that are in the Shared 
National Credit (SNC) database.\13\
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    \13\ SNC loans have commitments of greater than $20 million and 
are held by three or more regulated participating entities. For 
additional information, see ``Shared National Credit Program,'' 
Board of Governors of the Federal Reserve System, 
www.federalreserve.gov/supervisionreg/snc.htm.
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    Formally, the EAD for a line of credit or other revolving product i 
is set to:

[[Page 59551]]

[GRAPHIC] [TIFF OMITTED] TP15DE17.002

Where LEQ is the calibrated drawdown amount, OB(i,t=0) is the line's 
outstanding exposure at the start of the projection horizon, and 
CB(i,t=0) is the line's committed exposure at the start of the 
projection horizon.
    For standby letters of credit and trade finance credits, EADs are 
conservatively assumed to equal the total commitment, since typically 
these types of credits are fully drawn when they enter default status.

              Table 1--List of Key Variables in the Corporate Loan Models and Sources of Variables
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           Variable                        Description                 Variable type              Source
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                                                  PD model \1\
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U.S. BBB corporate yield        The difference between quarterly  Macroeconomic.........  FR supervisory
 spread.                         average of the yield on 10-year                           scenarios.
                                 BBB corporate bonds and
                                 quarterly average of the yield
                                 on 10-year U.S. Treasury bonds.
U.S. Real GDP growth..........  Percent change in real gross      Macroeconomic.........  FR supervisory
                                 domestic product in chained                               scenarios.
                                 dollars, expressed at
                                 annualized rate.
U.S. unemployment rate........  Quarterly average of seasonally-  Macroeconomic.........  FR supervisory
                                 adjusted monthly data for the                             scenarios.
                                 unemployment rate of civilian,
                                 non-institutional population of
                                 age 16 years and older.
Country.......................  The two letter country code for   Loan/borrower           FR Y-14.
                                 the country in which the          characteristic.
                                 obligor is headquartered.
Industry of obligor...........  Numeric code that describes the   Loan/borrower           FR Y-14.
                                 primary business activity of      characteristic.
                                 the obligor.
Internal obligor rating.......  The obligor rating grade from     Loan/borrower           FR Y-14.
                                 the reporting entity's internal   characteristic.
                                 risk rating system.
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                                                    LGD model
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Country.......................  The two letter country code for   Loan/borrower           FR Y-14.
                                 the country in which the          characteristic.
                                 obligor is headquartered.
Lien position.................  The type of lien. Options         Loan/borrower           FR Y-14.
                                 include first lien senior,        characteristic.
                                 second lien, senior unsecured,
                                 or contractually subordinated.
Line of business..............  The name of the internal line of  Loan/borrower           FR Y-14.
                                 business that originated the      characteristic.
                                 credit facility using the
                                 institution's own department
                                 descriptions.
Type of facility..............  The type of credit facility.      Loan/borrower           FR Y-14.
                                 Potential types are defined in    characteristic.
                                 the FR Y-14Q H.1 corporate
                                 schedule.
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                                                    EAD model
----------------------------------------------------------------------------------------------------------------
Committed exposure amount.....  The current dollar amount the     Loan/borrower           FR Y-14.
                                 obligor is legally allowed to     characteristic.
                                 borrow according to the credit
                                 agreement.
Type of facility..............  The type of credit facility.      Loan/borrower           FR Y-14
                                 Potential types are defined in    characteristic.
                                 the FR Y-14Q H.1 corporate
                                 schedule.
Utilized exposure amount......  The current dollar amount the     Loan/borrower           FR Y-14.
                                 obligor has drawn which has not   characteristic.
                                 been repaid, net of any charge-
                                 offs, ASC 310-30 (originally
                                 issued as SOP 03-03)
                                 adjustments, or fair value
                                 adjustments taken by the
                                 reporting institution, but
                                 gross of ASC 310-10 reserve
                                 amounts.
----------------------------------------------------------------------------------------------------------------
\1\ Other variables used to calculate initial loan status include days past due, non-accrual date, and ASC 310-
  10 amount.

B. Modeled Loss Rates on Pools of Loans

    The output of the corporate loan model is the expected loss on each 
loan. As described above, estimated corporate loan loss rates depend on 
a number of variables. This section groups loans according to three of 
the most important variables in the model: Sector (financial and 
nonfinancial), security status (secured and unsecured), and rating 
class (investment grade and non-investment grade).\14\ Categorizing 
corporate loans reported on schedule H.1 of the FR Y-14Q report as of 
the fourth quarter of 2016 by sector, security status, and rating class 
results in eight groups of loans: \15\
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    \14\ Financial loans have a NAICS category 
(``naics_two_digit_cat'') of 52; all other loans are marked 
nonfinancial. Secured loans are defined as loans with lien positions 
(``lien_position_cat'') marked as ``first-lien senior''; all other 
loans are marked as unsecured. Investment grade loans are defined as 
loans with a credit rating (``rating'') higher than and including 
BBB; all other loans are marked as non-investment grade.
    \15\ The set of loans on which loss rates are calculated 
excludes loans held for sale or accounted for under the fair value 
option, loan observations missing data fields used in the model, 
lines of credit that were undrawn as of 2016:Q4, and other types of 
loans that are not modeled using the corporate loan model (e.g., 
loans to financial depositories).

 Financial, secured, investment grade
 Financial, secured, non-investment grade
 Financial, unsecured, investment grade
 Financial, unsecured, non-investment grade
 Nonfinancial, secured, investment grade
 Nonfinancial, secured, non-investment grade
 Nonfinancial, unsecured, investment grade
 Nonfinancial, unsecured, non-investment grade.

    The remainder of this section reports summary statistics and 
modeled loss rates for these eight groups of corporate loans.
    Table 2 reports summary statistics for the eight groups of loans. 
The summary statistics cover a wide set of variables

[[Page 59552]]

that capture important characteristics of the loans and borrowers in 
the set of loans.
    Tables 3 and 4 show the modeled loss rates for the eight groups of 
loans for the DFAST 2017 supervisory severely adverse and supervisory 
adverse scenarios, respectively. Each entry in the table shows the 
average (mean) estimated loss rate for the loans in one of the eight 
groups, as well as the 25th and 75th percentiles of the estimated loss 
rates.
    Certain groups of loans generally have wider ranges of losses than 
other groups. Although the loans are grouped according to the most 
important characteristics in the model, other loan characteristics in 
the model also affect loss rates, albeit in more limited manner. 
Differences in these other characteristics within each loan group are 
responsible for the range of loss rates shown in the tables. Greater 
variation in these other characteristics within a group will generally 
lead to larger ranges of loss rates. For example, among secured, non-
investment grade loans, the loss rates shown in Table 3 range from 8.7 
to 12.1 for financial firms, but range from 2.7 to 9.8 for nonfinancial 
firms, which include a wider variety of industries. Secured, non-
investment grade loans to nonfinancial firms are predominantly loans to 
firms in the manufacturing, transportation, and technology sectors, but 
also include loans to firms in other sectors like education and 
utilities (Table 2).

              Table 2--Summary Statistics of Selected Variables in the Corporate Loan Data Grouped by Loan and Borrower Characteristics \1\
                                                               [Percent, except as noted]
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                 Non-investment grade                                  Investment grade
                                                 -------------------------------------------------------------------------------------------------------
                    Variables                        Nonfinancial sector        Financial sector         Nonfinancial sector        Financial sector
                                                 -------------------------------------------------------------------------------------------------------
                                                   Unsecured     Secured     Unsecured     Secured     Unsecured     Secured     Unsecured     Secured
--------------------------------------------------------------------------------------------------------------------------------------------------------
Number of loans (thousands).....................        15.60       101.80         1.28         8.20        21.34        52.80         2.11         5.91
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Facility type, share of utilized balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
Revolving.......................................        37.14        41.52        33.37        45.28        32.27        37.17        51.78        71.39
Term loan.......................................        45.06        40.33        34.08        20.83        44.48        42.20        35.54        14.57
Other...........................................        17.80        18.15        32.55        33.89        23.25        20.63        12.67        14.04
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Credit rating, share of utilized balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
AAA.............................................         0.00         0.00         0.00         0.00         1.22         0.92         3.36         4.89
AA..............................................         0.00         0.00         0.00         0.00         6.55         7.17        12.12        11.05
A...............................................         0.00         0.00         0.00         0.00        22.23        23.63        25.16        39.80
BBB.............................................         0.00         0.00         0.00         0.00        70.00        68.28        59.35        44.26
BB..............................................        80.06        76.66        88.97        81.82         0.00         0.00         0.00         0.00
B...............................................        19.63        22.28        10.89        18.05         0.00         0.00         0.00         0.00
CCC or below....................................         0.31         1.07         0.14         0.13         0.00         0.00         0.00         0.00
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Lien position, share of utilized balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
First-lien senior...............................         0.00       100.00         0.00       100.00         0.00       100.00         0.00       100.00
Senior unsecured................................        95.10         0.00        98.51         0.00        98.26         0.00        98.75         0.00
Other...........................................         4.90         0.00         1.49         0.00         1.74         0.00         1.25         0.00
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                  Interest rate variability, share of utilized balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
Fixed...........................................        23.04        14.45        13.11         6.17        24.93        27.97        17.69         6.92
Floating........................................        71.61        79.99        81.29        88.65        68.75        68.72        77.52        90.21
Mixed...........................................         5.33         5.54         5.59         5.15         6.22         2.74         4.73         2.74
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                         Industry, share of utilized balance \2\
--------------------------------------------------------------------------------------------------------------------------------------------------------
Agriculture, fishing, and hunting...............         0.66         1.50         0.00         0.00         0.28         0.50         0.00         0.00
Natural resources, utilities, and construction..        13.02         7.92         0.00         0.00         8.89         5.21         0.00         0.00
Manufacturing...................................        25.70        18.82         0.00         0.00        28.19        13.73         0.00         0.00
Trade and transportation........................        28.30        32.57         0.00         0.00        15.95        29.17         0.00         0.00
Technological and business services.............        22.28        22.18         0.00         0.00        28.91        19.54         0.00         0.00
Finance and insurance...........................         0.00         0.00       100.00       100.00         0.00         0.00       100.00       100.00
Education, health care, and social assistance...         3.76         6.45         0.00         0.00         8.08        13.84         0.00         0.00
Entertainment and lodging.......................         2.46         6.06         0.00         0.00         2.13         4.39         0.00         0.00
Other services..................................         3.82         4.49         0.00         0.00         7.57        13.62         0.00         0.00
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                        Guarantor flag, share of utilized balance
--------------------------------------------------------------------------------------------------------------------------------------------------------
Full guarantee..................................        41.24        41.83        42.22        29.09        30.23        29.95        42.22        12.02

[[Page 59553]]

 
U.S. government guarantee.......................         5.03         0.18         0.23         0.03         0.52         0.26         0.00         0.00
Partial guarantee...............................         2.62         4.23         3.09         3.28         1.77         2.41         3.86         4.99
No guarantee....................................        51.11        53.74        54.47        67.60        67.49        67.31        53.92        82.99
Domestic obligor, share of utilized balance.....        63.53        91.35        65.10        72.29        71.58        91.46        65.93        81.37
Remaining maturity, average in months 3 4.......        38.34        48.44        28.95        23.89        38.26        57.59        38.55        30.44
Interest rate, average in percent \4\...........         2.77         3.24         2.36         2.68         2.17         2.48         2.26         2.32
Committed exposure, average in millions of              15.24         8.32        25.22        17.43        24.79        10.81        43.24        57.37
 dollars........................................
Utilized exposure, average in millions of               10.89         6.17        19.89        14.17        16.46         8.35        28.36        39.64
 dollars........................................
--------------------------------------------------------------------------------------------------------------------------------------------------------
\1\ The set of loans presented in this table excludes loans held for sale or accounted for under the fair value option, loan observations missing data
  fields used in the model, lines of credit that were undrawn as of 2016:Q4, and other types of loans that are not modeled using the corporate loan
  model (e.g., loans to financial depositories).
\2\ Industries are collapsed using the first digit of the NAICS 2007 code, except for finance and insurance.
\3\ Maturity excludes demand loans.
\4\ Averages for remaining maturity and interest rate are weighted by utilized exposure.


       Table 3--Projected Average Loan Loss Rates and 25th and 75th Percentile Ranges by Loan and Borrower
                     Characteristics, 2017:Q1-2019:Q1, DFAST 2017 Severely Adverse Scenario
----------------------------------------------------------------------------------------------------------------
              Sector                   Security status         Rating class            Loss rates (percent)
----------------------------------------------------------------------------------------------------------------
Financial.........................  Secured..............  Investment grade....  2.5 [1.6 to 3.3].
Financial.........................  Secured..............  Non-investment grade  10.4 [8.7 to 12.1].
Financial.........................  Unsecured............  Investment grade....  3.3 [1.9 to 5.3].
Financial.........................  Unsecured............  Non-investment grade  12.6 [8.3 to 17.0].
Nonfinancial......................  Secured..............  Investment grade....  0.8 [0.3 to 1.0].
Nonfinancial......................  Secured..............  Non-investment grade  5.4 [2.7 to 9.8].
Nonfinancial......................  Unsecured............  Investment grade....  1.2 [0.5 to 1.7].
Nonfinancial......................  Unsecured............  Non-investment grade  6.0 [3.6 to 11.7].
----------------------------------------------------------------------------------------------------------------
Note: Loan-level loss rates are calculated as cumulative nine-quarter losses on a given loan divided by initial
  utilized balance on that loan. Average loss rates reported in the table are the average of the loan-level loss
  rates weighted by initial utilized balances. The set of loans on which loss rates are calculated excludes
  loans held for sale or accounted for under the fair value option, loan observations missing data fields used
  in the model, lines of credit that were undrawn as of 2016:Q4, and other types of loans that are not modeled
  using the corporate loan model (e.g., loans to financial depositories).


       Table 4--Projected Average Loan Loss Rates and 25th and 75th Percentile Ranges by Loan and Borrower
                          Characteristics, 2017:Q1-2019:Q1, DFAST 2017 Adverse Scenario
----------------------------------------------------------------------------------------------------------------
              Sector                   Security status         Rating class            Loss rates (percent)
----------------------------------------------------------------------------------------------------------------
Financial.........................  Secured..............  Investment grade....  1.5 [1.0 to 2.0].
Financial.........................  Secured..............  Non-investment grade  5.9 [4.7 to 6.7].
Financial.........................  Unsecured............  Investment grade....  2.0 [1.2 to 3.3].
Financial.........................  Unsecured............  Non-investment grade  7.3 [4.7 to 9.8].
Nonfinancial......................  Secured..............  Investment grade....  0.5 [0.2 to 0.6].
Nonfinancial......................  Secured..............  Non-investment grade  3.2 [1.6 to 5.8].
Nonfinancial......................  Unsecured............  Investment grade....  0.8 [0.4 to 1.1].
Nonfinancial......................  Unsecured............  Non-investment grade  3.7 [2.1 to 7.1].
----------------------------------------------------------------------------------------------------------------
Note: Loan-level loss rates are calculated as cumulative nine-quarter losses on a given loan divided by initial
  utilized balance on that loan. Average loss rates reported in the table are the average of the loan-level loss
  rates weighted by initial utilized balances. The set of loans on which loss rates are calculated excludes
  loans held for sale or accounted for under the fair value option, loan observations missing data fields used
  in the model, lines of credit that were undrawn as of 2016:Q4, and other types of loans that are not modeled
  using the corporate loan model (e.g., loans to financial depositories).


[[Page 59554]]

C. Portfolios of Hypothetical Loans and Associated Loss Rates

    The effect of borrower and loan characteristics on the losses 
estimated by the corporate loan model can also be illustrated by the 
differences in the estimated loss rate on specific sets of hypothetical 
loans. This section contains descriptive statistics from three 
portfolios of hypothetical loans (Table 6) and the modeled loss rates 
for the three portfolios under the DFAST 2017 supervisory adverse and 
supervisory severely adverse scenarios (Table 7).
    The portfolios of hypothetical loans are designed to have 
characteristics similar to the actual loans reported in schedule H.1 of 
the FR Y-14Q report. Three portfolios containing 200 loans each are 
provided, and they are designed to capture characteristics associated 
with:
    1. Typical set of loans reported in the FR Y-14Q;
    2. Higher-than-average-risk loans (in this case, non-investment 
grade loans); and,
    3. Lower-than-average-risk loans (in this case, investment grade 
loans).
    The portfolios of hypothetical loans include 12 variables that 
describe characteristics of corporate loans that are generally used to 
estimate corporate loan losses (Table 5).\16\
---------------------------------------------------------------------------

    \16\ The sets of loans are available for download on the Federal 
Reserve's website: Higher-than-average-risk loans (https://www.federalreserve.gov/newsevents/pressreleases/files/HigherRisk.csv); typical-risk loans (https://www.federalreserve.gov/newsevents/pressreleases/files/Typical.csv); and lower-than-average-
risk loans (https://www.federalreserve.gov/newsevents/pressreleases/files/LowerRisk.csv).
---------------------------------------------------------------------------

    Table 6 contains summary statistics for the portfolios of 
hypothetical loans in the same format as Table 2. The portfolios of 
hypothetical loans are constructed to capture characteristics of 
certain sets of loans, but are not fully representative of the 
population of loans reported in Table 2. Table 7 contains the loss 
rates for the portfolios of hypothetical loans calculated under the 
DFAST 2017 supervisory severely adverse and supervisory adverse 
scenarios. The rank ordering of the loss rates is consistent with the 
ranges of loss rates reported in Tables 3 and 4. The portfolio of 
higher-risk loans has higher loss rates under both the severely adverse 
and adverse scenarios and is also more sensitive to changes in 
macroeconomic conditions (loss rate of 7.2 percent in the severely 
adverse scenario and 4.2 percent in the adverse scenario) than the 
portfolio of typical loans (loss rate of 5.4 percent in the severely 
adverse scenario and 3.2 percent in the adverse scenario). Conversely, 
the portfolio of lower-risk loans has lower losses under both 
scenarios, and is less sensitive to changes in macroeconomic conditions 
(loss rate of 1.8 percent in the severely adverse scenario and 1.1 
percent in the adverse scenario).

                     Table 5--List of Variables Included in Portfolios of Hypothetical Loans
----------------------------------------------------------------------------------------------------------------
                Variable                            Mnemonic                          Description
----------------------------------------------------------------------------------------------------------------
Origination year........................  orig_year..................  Year loan was originated.
Type of facility........................  facility_type_cat..........  The type of credit facility.
                                                                       1 is revolving;
                                                                       5 is non-revolving; and
                                                                       0 is other.
Lien position...........................  lien_position_cat..........  The type of lien.
                                                                       1 is first-lien senior;
                                                                       2 is second-lien;
                                                                       3 is senior unsecured; and,
                                                                       4 is contractually subordinated.
Credit rating...........................  rating.....................  Credit rating of obligor. Categories
                                                                        include AAA, AA, A, BBB, BB, B, CCC, CC,
                                                                        C, and D.
Domestic flag...........................  domestic_flag..............  Equal to 1 if obligor is domiciled in the
                                                                        U.S.
Industry code (2-digit).................  naics_two_digit_cat........  Two-digit industry code based on 2007
                                                                        NAICS definitions.
Committed exposure amount...............  committed_exposure_amt.....  Committed exposure in dollars.
Utilized exposure amount................  utilized_exposure_amt......  Utilized exposure in dollars.
Interest rate...........................  interest_rate..............  Interest rate on credit facility.
Interest rate variability...............  interest_rate_variability..  Interest rate type.
                                                                       0 is fully undrawn (interest rate not
                                                                        provided);
                                                                       1 is fixed;
                                                                       2 is floating;
                                                                       3 is mixed.
Remaining maturity......................  term.......................  Remaining term of the loan in months.
Guarantor flag..........................  guarantor_flag.............  Indicates the type of guarantee of the
                                                                        guarantor.
                                                                       1 is full guarantee;
                                                                       2 is partial guarantee;
                                                                       3 is U.S. government agency guarantee;
                                                                       4 is no guarantee.
----------------------------------------------------------------------------------------------------------------
Note: Some of the variables included in the portfolios of hypothetical loans are presented in a more aggregated
  form than they are reported in the FR Y-14.


            Table 6--Summary Statistics of Selected Variables in the Portfolios of Hypothetical Loans
                                           [Percent, except as noted]
----------------------------------------------------------------------------------------------------------------
                            Variables                               Higher-risk     Lower-risk        Typical
----------------------------------------------------------------------------------------------------------------
                                    Facility type, share of utilized balance
----------------------------------------------------------------------------------------------------------------
Revolving.......................................................           36.52           46.02           50.77
Term loan.......................................................           42.67           39.97           33.32

[[Page 59555]]

 
Other...........................................................           20.81           14.02           15.91
----------------------------------------------------------------------------------------------------------------
                                    Credit rating, share of utilized balance
----------------------------------------------------------------------------------------------------------------
AAA.............................................................            0.00            0.00            0.45
AA..............................................................            0.00            6.79            1.06
A...............................................................            0.00            9.72            4.48
BBB.............................................................            0.00           83.49           41.32
BB..............................................................           78.68            0.00           40.91
B...............................................................           20.85            0.00           10.57
CCC or below....................................................            0.47            0.00            1.21
----------------------------------------------------------------------------------------------------------------
                                    Lien position, share of utilized balance
----------------------------------------------------------------------------------------------------------------
First-lien senior...............................................           82.79           61.31           76.61
Senior unsecured................................................           17.21           38.69           23.39
Other...........................................................            0.00            0.00            0.00
----------------------------------------------------------------------------------------------------------------
                              Interest rate variability, share of utilized balance
----------------------------------------------------------------------------------------------------------------
Fixed...........................................................           16.26           26.36           11.72
Floating........................................................           83.44           71.99           86.04
Mixed...........................................................            0.30            1.64            2.24
----------------------------------------------------------------------------------------------------------------
                                     Industry, share of utilized balance \1\
----------------------------------------------------------------------------------------------------------------
Agriculture, fishing, and hunting...............................            0.42            0.00            0.16
Natural resources, utilities, and construction..................           10.71            9.34            4.03
Manufacturing...................................................           15.46            5.26           18.96
Trade and transportation........................................           19.30           31.32           20.64
Technological and business services.............................           26.36           11.52           13.74
Finance and insurance...........................................           16.36           15.51           20.15
Education, health care, and social assistance...................            6.40            7.67            7.05
Entertainment and lodging.......................................            1.96            1.66            1.52
Other services..................................................            3.03           17.73           13.75
----------------------------------------------------------------------------------------------------------------
                                    Guarantor flag, share of utilized balance
----------------------------------------------------------------------------------------------------------------
Full guarantee..................................................           41.61           50.93           32.40
U.S. government guarantee.......................................            1.50            0.00            0.38
Partial guarantee...............................................            1.57            0.06            2.15
No guarantee....................................................           55.32           49.01           65.08
Domestic obligor, share of utilized balance.....................           93.88           82.34           94.64
Remaining maturity, average in months 2 3.......................           48.57           56.35           39.23
Interest rate, average in percentage \3\........................            3.33            2.75            2.87
Committed exposure, average in millions of dollars..............            7.87           17.94           17.47
Utilized exposure, average in millions of dollars...............            5.76            7.35            5.86
----------------------------------------------------------------------------------------------------------------
\1\ Industries are collapsed using the first digit of the NAICS 2007 code, except for finance and insurance.
\2\ Maturity excludes demand loans.
\3\ Averages for remaining maturity and interest rate are weighted by utilized exposure.


  Table 7--Projected Portfolio Loss Rates, 2017:Q1-2019:Q1, DFAST 2017
                                Scenarios
                                [Percent]
------------------------------------------------------------------------
                                                          Scenario
                                                   ---------------------
              Hypothetical portfolio                 Severely
                                                     adverse    Adverse
------------------------------------------------------------------------
Typical...........................................        5.4        3.2
Lower-risk........................................        1.8        1.1
Higher-risk.......................................        7.2        4.2
------------------------------------------------------------------------
Note: Portfolio loss rates are calculated as sum of the cumulative nine-
  quarter losses divided by sum of initial utilized balances.


    By Order of the Board of Governors of the Federal Reserve 
System, December 7, 2017.
Ann E. Misback,
Secretary of the Board.
[FR Doc. 2017-26856 Filed 12-14-17; 8:45 am]
 BILLING CODE 6210-01-P