Enterprise Regulatory Capital Framework, 39274-39406 [2020-11279]

Download as PDF 39274 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules FEDERAL HOUSING FINANCE AGENCY 12 CFR Parts 1206, 1225, and 1240 DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT Office of Federal Housing Enterprise Oversight 12 CFR Part 1750 RIN 2590–AA95 Enterprise Regulatory Capital Framework Federal Housing Finance Agency; Office of Federal Housing Enterprise Oversight. ACTION: Notice of proposed rulemaking; request for comments. AGENCY: The Federal Housing Finance Agency (FHFA or the Agency) is seeking comments on a new regulatory capital framework for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac, and with Fannie Mae, each an Enterprise). The proposed rule would also make conforming amendments to definitions in FHFA’s regulations for assessments and minimum capital and would also remove the Office of Federal Housing Enterprise Oversight’s (OFHEO) regulation on capital for the Enterprises. DATES: Comments must be received on or before August 31, 2020. ADDRESSES: You may submit your comments on the proposed rule, identified by regulatory information number (RIN) 2590–AA95, by any one of the following methods: • Agency Website: www.fhfa.gov/ open-for-comment-or-input. • Federal eRulemaking Portal: https:// www.regulations.gov. Follow the instructions for submitting comments. If you submit your comment to the Federal eRulemaking Portal, please also send it by email to FHFA at RegComments@fhfa.gov to ensure timely receipt by FHFA. Include the following information in the subject line of your submission: Comments/RIN 2590–AA95. • Hand Delivered/Courier: The hand delivery address is: Alfred M. Pollard, General Counsel, Attention: Comments/ RIN 2590–AA95, Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, Washington, DC 20219. Deliver the package at the Seventh Street entrance Guard Desk, First Floor, on business days between 9 a.m. and 5 p.m. khammond on DSKJM1Z7X2PROD with PROPOSALS2 SUMMARY: VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 • U.S. Mail, United Parcel Service, Federal Express, or Other Mail Service: The mailing address for comments is: Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590–AA95, Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW, Washington, DC 20219. Please note that all mail sent to FHFA via U.S. Mail is routed through a national irradiation facility, a process that may delay delivery by approximately two weeks. For any time-sensitive correspondence, please plan accordingly. FOR FURTHER INFORMATION CONTACT: Naa Awaa Tagoe, Senior Associate Director, Office of Financial Analysis, Modeling & Simulations, (202) 649–3140, NaaAwaa.Tagoe@fhfa.gov; Andrew Varrieur, Associate Director, Office of Financial Analysis, Modeling & Simulations, (202) 649–3141, Andrew.Varrieur@fhfa.gov; or Miriam Smolen, Associate General Counsel, Office of General Counsel, (202) 649– 3182, Miriam.Smolen@fhfa.gov. These are not toll-free numbers. The telephone number for the Telecommunications Device for the Deaf is (800) 877–8339. SUPPLEMENTARY INFORMATION: Comments FHFA invites comments on all aspects of the proposed rule and will take all comments into consideration before issuing a final rule. Copies of all comments will be posted without change, and will include any personal information you provide such as your name, address, email address, and telephone number, on the FHFA website at https://www.fhfa.gov. In addition, copies of all comments received will be available for examination by the public through the electronic rulemaking docket for this proposed rule also located on the FHFA website. Table of Contents I. Introduction II. Overview of the Proposed Rule A. Regulatory Capital Requirements B. Capital Buffers C. Key Enhancements D. Sizing of Regulatory Capital Expectations 1. Aggregate Regulatory Capital 2. 2018 Proposal’s Capital Requirements 3. 2008 Financial Crisis Loss Experience III. Background A. Pre-Crisis Regulatory Capital Framework B. Lessons of the 2008 Financial Crisis 1. Capital Adequacy 2. Going-Concern Standard 3. High-Quality Capital 4. Stability of the National Housing Finance Markets C. Post-Crisis Changes to Regulatory Capital Frameworks PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 IV. Rationale for Re-Proposal A. Responsibly Ending the Conservatorships B. Ensuring Capital Adequacy 1. Quality of Capital 2. Quantity of Capital C. Addressing Pro-Cyclicality V. Definitions of Regulatory Capital A. Statutory Definitions B. Supplemental Definitions 1. Loss-Absorbing Capacity 2. Components of Regulatory Capital 3. Regulatory Adjustments and Deductions VI. Capital Requirements A. Risk-Based Capital Requirements 1. Supplemental Requirements 2. Risk-Weighted Assets B. Leverage Ratio Requirements 1. Adjusted Total Assets 2. Tier 1 Leverage Ratio Requirement 3. Sizing of the Requirements C. Enforcement VII. Capital Buffers A. Prescribed Capital Conservation Buffer Amount (PCCBA) 1. Stress Capital Buffer 2. Countercyclical Capital Buffer 3. Stability Capital Buffer B. Leverage Buffer C. Payout Restrictions VIII. Credit Risk Capital: Standardized Approach A. Single-Family Mortgage Exposures 1. Single-Family Business Models 2. Calibration Framework 3. Base Risk Weights 4. Countercyclical Adjustment 5. Risk Multipliers 6. Credit Enhancement Multipliers 7. Minimum Adjusted Risk Weight B. Multifamily Mortgage Exposures 1. Multifamily Business Models 2. Calibration Framework 3. Base Risk Weights 4. Countercyclical Adjustment 5. Risk Multipliers 6. Minimum Adjusted Risk Weight C. CRT and Other Securitization Exposures 1. Background 2. PLS and Other Non-CRT Securitization Exposures 3. Retained CRT Exposures D. Other Exposures 1. Commitments and Other Off-Balance Sheet Exposures 2. Exposures to Sovereigns 3. Crossholdings of Enterprise MBS 4. Corporate Exposures 5. OTC Derivative Contracts 6. Cleared Transactions 7. Credit Risk Mitigation IX. Credit Risk Capital: Advanced Approach X. Market Risk Capital A. Standardized Approach 1. Single Point Approach 2. Spread Duration Approach 3. Internal Models Approach B. Advanced Approach C. Market Risk Management XI. Operational Risk Capital XII. Impact of the Enterprise Capital Rule A. Enterprise-Wide B. Single-Family Business C. Multifamily Business D. Other Assets XIII. Comparisons to the U.S. Banking Framework E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules XIV. Compliance Period XV. Temporary Increases of Minimum Capital Requirements and Other Conforming Amendments XVI. Paperwork Reduction Act XVII. Regulatory Flexibility Act XVIII. Proposed Rule khammond on DSKJM1Z7X2PROD with PROPOSALS2 I. Introduction FHFA is seeking comments on a new regulatory capital framework for the Enterprises. This notice of proposed rulemaking (proposed rule) is a reproposal of the regulatory capital framework set forth in the notice of proposed rulemaking published in the Federal Register on July 17, 2018 (2018 proposal).1 The 2018 proposal, which remains the foundation of the proposed rule, contemplated risk-based capital requirements based on a granular assessment of credit risk specific to different mortgage loan categories, as well as two alternatives for an updated leverage ratio requirement. With this reproposal, FHFA is proposing enhancements to establish a postconservatorship regulatory capital framework that ensures that each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle, in particular during periods of financial stress.2 Pursuant to the Federal Housing Enterprises Financial Safety and Soundness Act of 1992 3 (Safety and Soundness Act), as amended by the Housing and Economic Recovery Act of 2008 4 (HERA), the FHFA Director’s principal duties include, among other duties, ensuring that each Enterprise operates in a safe and sound manner, that the operations and activities of each Enterprise foster liquid, efficient, competitive, and resilient national housing finance markets, and that each Enterprise carries out its statutory mission only through activities that are authorized under and consistent with the Safety and Soundness Act and its charter.5 Pursuant to their charters, the statutory purposes of the Enterprises are, among other purposes, to provide stability in, and ongoing assistance to, the secondary market for residential mortgages.6 Consistent with these statutory duties and purposes, FHFA’s 1 FHFA Enterprise Capital Requirements, 83 FR 33312 (Jul. 17, 2018). 2 Other enhancements to the Enterprises’ supervisory and regulatory framework might also be necessary, for example with respect to the Enterprises’ liquidity risk management. 3 Public Law 102–550, 106 Stat. 3941 (1992). 4 Public Law 110–289, 122 Stat. 2654 (2008). 5 12 U.S.C. 4513(a)(1). 6 Id. sections 1451 note, 1716. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 enhancements contemplated by the proposed rule are intended to achieve three primary objectives: • Preserve the mortgage risk-sensitive framework of the 2018 proposal, with simplifications and refinements; • Increase the quantity and quality of the regulatory capital of the Enterprises to ensure that, during and after conservatorship, each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle; and • Address the pro-cyclicality of the risk-based capital requirements of the 2018 proposal, also in furtherance of the safety and soundness of the Enterprises and their countercyclical mission. FHFA believes it is important to repropose the regulatory capital framework to afford interested parties an opportunity to comment on the enhancements contemplated by the proposed rule in its entirety in light of FHFA’s intent to responsibly end the conservatorships of the Enterprises. This policy change is a departure from FHFA’s stated policy at the time of the 2018 proposal, when the prospects for indefinite conservatorships might have informed the expectations of interested parties, their decision to comment, and the nature of comments submitted. Despite this, the comments received on the 2018 proposal were valuable and important. FHFA emphasizes that the purpose of the proposed rule is to establish a regulatory capital framework that ensures the safety and soundness of each Enterprise and its ability to fulfill its statutory mission across the economic cycle. II. Overview of the Proposed Rule A. Regulatory Capital Requirements In response to the comments and feedback on the 2018 proposal and in furtherance of FHFA’s stated objectives, the regulatory capital framework contemplated by the proposed rule would require each Enterprise to maintain the following risk-based capital: • Total capital not less than 8.0 percent of risk-weighted assets, determined as described below; • Adjusted total capital not less than 8.0 percent of risk-weighted assets; • Tier 1 capital not less than 6.0 percent of risk-weighted assets; and • Common equity tier 1 (CET1) capital not less than 4.5 percent of riskweighted assets. Each Enterprise also would be required to satisfy the following leverage ratios: PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 39275 • Core capital not less than 2.5 percent of adjusted total assets; and • Tier 1 capital not less than 2.5 percent of adjusted total assets. Adjusted total assets would be defined as total assets under generally accepted accounting principles (GAAP), with adjustments to include certain offbalance sheet exposures. Total capital and core capital would have the meaning given in the Safety and Soundness Act. Adjusted total capital, tier 1 capital, and CET1 capital would be defined based on the definitions of total capital, tier 1 capital, and CET1 capital set forth in the regulatory capital framework (the Basel framework) developed by the Basel Committee on Bank Supervision (BCBS) that is the basis for the United States banking regulators’ regulatory capital framework (U.S. banking framework). These supplemental regulatory capital definitions would fill certain gaps in the statutory definitions of core capital and total capital by making customary deductions and other adjustments for certain deferred tax assets (DTAs), goodwill, intangibles, and other assets that tend to have less loss-absorbing capacity during a financial stress. To calculate its risk-based capital requirements, an Enterprise would determine its risk-weighted assets under two approaches—a standardized approach and an advanced approach— with the greater of the two used to determine its risk-based capital requirements. Under both approaches, an Enterprise’s risk-weighted assets would equal the sum of its credit riskweighted assets, market risk-weighted assets, and operational risk-weighted assets. Under the standardized approach, the credit risk-weighted assets for mortgage loans secured by 1–4 unit residences (single-family mortgage exposures) and mortgage loans secured by five or more unit residences (multifamily mortgage exposures) would be determined using lookup grids and multipliers that assign an exposure-specific risk weight based on the risk characteristics of the mortgage exposure. The underlying exposure-specific credit risk capital requirements generally would be similar to those in the grids and multipliers of the 2018 proposal, subject to some simplifications and refinements discussed in Sections VIII.A and VIII.B.7 7 This base risk weight would be equal to the unadjusted credit risk capital requirement for the mortgage exposure expressed in basis points and divided by 800, which is the 8.0 percent adjusted total capital requirement also expressed in basis points. For example, the credit risk capital requirement for a mortgage exposure with a base E:\FR\FM\30JNP2.SGM Continued 30JNP2 39276 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Like the 2018 proposal, the base risk weight would be a function of the mortgage exposure’s loan-to-value (LTV) ratio with the property value generally marked to market (MTMLTV). For single-family mortgage exposures, the MTMLTV would be subject to a countercyclical adjustment to the extent that national house prices are 5.0 percent greater or less than an inflationadjusted long-term trend. For both single-family and multifamily mortgage exposures, this base risk weight would then be adjusted to reflect additional risk attributes of the mortgage exposure and any loan-level credit enhancement, with the associated risk multipliers also generally similar to those of the 2018 proposal. To ensure an appropriate level of capital, this adjusted risk weight would be subject to a minimum floor of 15 percent. As of September 30, 2019, under the proposed rule’s standardized approach, the Enterprises’ average risk weight for single-family mortgage exposures would have been 26 percent, and the Enterprises’ average risk weight for multifamily mortgage exposures would have been 51 percent.8 The average risk weights for single-family and multifamily mortgage exposures originated and acquired by an Enterprise in the previous six months would have been approximately 36 percent and 67 percent, respectively.9 While the standardized approach would utilize FHFA-prescribed lookup grids and risk multipliers, the advanced approach for credit risk-weighted assets would rely on each Enterprise’s internal models. The advanced approach requirements would require each Enterprise to maintain its own processes for identifying and assessing credit risk, market risk, and operational risk. These requirements should ensure that each Enterprise continues to enhance its risk management system and also that neither Enterprise simply relies on the standardized approach’s lookup grids and multipliers to define credit risk tolerances, measure its credit risk, or allocate capital. In the course of FHFA’s supervision of each Enterprise’s internal models for credit risk, FHFA also could identify opportunities to update or otherwise enhance the standardized risk weight of 50 percent would be 400 basis points (800 multiplied by 50 percent). 8 These average risk weights are determined based on the credit risk capital requirement for singlefamily and multifamily mortgage exposures after adjustments for mortgage insurance and other loanlevel credit enhancement but before any adjustment for credit risk transfers. 9 While not shown, new originations are a subset of the mortgage exposures included in Tables 26 and 29. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 approach’s lookup grids and multipliers in a future rulemaking. Under both the standardized and advanced approaches, an Enterprise would determine the capital treatment for eligible credit risk transfers (CRT) under a securitization framework by assigning risk weights to retained CRT exposures. Under the standardized approach, tranche-specific risk weights would be subject to a 10 percent floor. The proposed rule seeks comment on two approaches to determining the riskweighted assets for retained CRT exposures, one of which contemplates adjustments to the exposure amounts of the retained CRT exposures to reflect counterparty risk, loss timing risk, and a general adjustment for the differences between CRT and regulatory capital, and the other of which is based on the U.S. banking framework. Each Enterprise also would determine a market risk capital requirement for spread risk. Market risks other than spread risk would not be assigned a market risk capital requirement, but FHFA is seeking comment on more comprehensive approaches. Under the standardized approach, an Enterprise would determine its market riskweighted assets using FHFA-specified formulas for some covered positions and its own models for other covered positions. An Enterprise would separately determine its market riskweighted assets under an advanced approach that relies only on its own internal models for all covered positions. The proposed rule also would require each Enterprise to determine its operational risk capital requirement utilizing the U.S. banking framework’s advanced measurement approach, subject to a floor equal to 15 basis points of the Enterprise’s adjusted total assets. Each of these risk-based and leverage ratio requirements would be enforceable by FHFA under its general authority to order an Enterprise to cease and desist from a violation of law, which would include the proposed rule and its regulatory capital requirements. Pursuant to that authority, FHFA may require an Enterprise to develop and implement a capital restoration plan or take other appropriate corrective action. FHFA also could elect to enforce the risk-based and leverage ratio requirements pursuant to its authority to require an Enterprise to develop a plan to achieve compliance with prescribed prudential management and operational standards, and FHFA also could enforce the core capital leverage ratio requirement or the risk-based total capital requirement pursuant to its separate authority to require prompt PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 corrective action if an Enterprise fails to maintain certain prescribed regulatory levels. B. Capital Buffers To avoid limits on capital distributions and discretionary bonus payments, an Enterprise would have to maintain regulatory capital that exceeds each of its adjusted total capital, tier 1 capital, and CET1 capital requirements by at least the amount of its prescribed capital conservation buffer amount (PCCBA). That PCCBA would consist of three separate component buffers—a stress capital buffer, a countercyclical capital buffer, and a stability capital buffer. • The stress capital buffer would be 0.75 percent of the Enterprise’s adjusted total assets, with this buffer in effect replacing the 2018 proposal’s goingconcern buffer. The 2018 proposal’s going-concern buffer was a part of the Enterprise’s total capital requirement, such that an Enterprise would be subject to enforcement action if it drew down this going-concern buffer. In contrast, under the proposed rule, drawing down the stress capital buffer generally would trigger only limits on capital distributions and discretionary bonus payments. By prescribing less severe sanctions for drawing down this buffer during a period of financial stress, the proposed rule’s approach should help position an Enterprise to fulfill its statutory mission across the economic cycle and also dampen the procyclicality of the aggregate risk-based capital requirements. FHFA is also seeking comment on whether to periodically re-size the stress capital buffer, similar to the approach recently adopted by the U.S. banking regulators,10 to the extent that FHFA’s eventual program for supervisory stress tests determines that an Enterprise’s peak capital exhaustion under a severely adverse stress would exceed 0.75 percent of adjusted total assets. • The countercyclical capital buffer amount initially would be set at 0 percent of the Enterprise’s adjusted total assets. FHFA does not expect to adjust this buffer in the place of, or to supplement, the countercyclical adjustment to the risk-based capital requirements. Instead, as under the Basel and U.S. banking frameworks, FHFA would adjust the countercyclical capital buffer taking into account the macro-financial environment in which the Enterprises operate, such that it 10 See e.g. Federal Reserve Board Regulations Q, Y, and YY: Regulatory Capital, Capital Plan, and Stress Test Rules Final Rule, 85 FR 15576 (Mar. 18, 2020). E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules would be deployed only when excess aggregate credit growth is judged to be associated with a build-up of systemwide risk. This focus on excess aggregate credit growth means the countercyclical buffer likely would be deployed on an infrequent basis, and generally only when similar buffers are deployed by the U.S. banking regulators. • An Enterprise’s stability capital buffer would be tailored to the risk that the Enterprise’s default or other financial distress could have on the liquidity, efficiency, competitiveness, or resiliency of national housing finance markets. FHFA is proposing a stability capital buffer based on the Enterprise’s share of residential mortgage debt outstanding, and seeking comment on an alternative based on the U.S. banking framework’s methodology. Under either methodology, the stability capital buffer would be a percent of adjusted total assets. Under the market share approach, as of September 30, 2019, Freddie Mac’s and Fannie Mae’s stability capital buffers would have been, respectively, 0.64 and 1.05 percent of adjusted total assets. khammond on DSKJM1Z7X2PROD with PROPOSALS2 Fixing the PCCBA at a specified percent of an Enterprise’s adjusted total assets, instead of risk-weighted assets, is a notable departure from the Basel framework. FHFA intends a fixedpercent PCCBA, among other things, to reduce the impact that the PCCBA potentially could have on higher risk exposures, to avoid amplifying the secondary effects of any model or similar risks inherent to the calibration of granular risk weights for mortgage exposures, and to further mitigate the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 pro-cyclicality of the aggregate riskbased capital requirements. Finally, to avoid limits on capital distributions and discretionary bonus payments, the Enterprise also would be required to maintain tier 1 capital in excess of the amount required under its tier 1 leverage ratio requirement by at least the amount of its prescribed leverage buffer amount (PLBA). The PLBA would equal 1.5 percent of the Enterprise’s adjusted total assets, such that the PLBA-adjusted leverage ratio requirement would remain a credible backstop to the PCCBA-adjusted riskbased capital requirements. C. Key Enhancements The proposed rule contemplates a number of key enhancements to the 2018 proposal, including: • Simplifications and refinements of the grids and risk multipliers for the credit risk capital requirements for single-family mortgage exposures, including removal of the single-family risk multipliers for loan balance and the number of borrowers. • A countercyclical adjustment to the credit risk capital requirements for single-family mortgage exposures. • A prudential floor on the credit risk capital requirement for mortgage exposures. • Refinements to the capital treatment of CRT structures, including a minimum capital requirement on senior tranches of CRT retained by an Enterprise and an adjustment to reflect that CRT does not have the same loss-absorbing capacity as equity capital. • The addition of a credit risk capital requirement for Enterprise PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 39277 crossholdings of mortgage-backed securities (MBS). • Risk-based capital requirements for a number of other exposures not explicitly addressed by the 2018 proposal. • Supplemental capital requirements based on the Basel framework’s definitions of total capital, tier 1 capital, and CET1 capital. • Capital buffers that would subject an Enterprise to increasing limits on capital distributions and discretionary bonus payments to the extent that its regulatory capital falls below the prescribed buffer amounts. • A stability capital buffer tailored to the risk that an Enterprise’s default or other financial distress could have on the liquidity, efficiency, competitiveness, and resiliency of national housing finance markets. • A revised method for determining operational risk capital requirements, as well as a higher floor. • A requirement that each Enterprise maintain internal models for determining its own estimates of riskbased capital requirements. D. Sizing of Regulatory Capital Expectations 1. Aggregate Regulatory Capital Table 1 details how much regulatory capital the Enterprises together would have been required to maintain under the proposed rule as of September 30, 2019 to avoid restrictions on capital distributions and discretionary bonus payments.11 11 The analogous breakdown of requirements by Enterprise is included in Section XII.A. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Table 1 shows a combined Enterprise statutory total risk-based capital requirement of $135 billion (8 percent of risk-weighted assets). The statutory riskbased capital framework does not include any capital buffers. In contrast, the supplementary risk-based capital framework includes three capital requirements (CET1, tier 1, and adjusted total capital) along with three capital buffers (countercyclical, stress capital, and stability) that comprise the PCCBA. While the capital buffers are not strictly a capital requirement, they would materially increase the regulatory capital that each Enterprise would have to maintain to avoid restrictions on capital distributions and discretionary bonuses. Focusing on high-quality capital, the combined Enterprise CET1 capital requirement was $76 billion (4.5 percent of risk-weighted assets), the tier 1 capital requirement was $101 billion (6 percent of risk-weighted assets), and the adjusted total capital requirement was $135 billion (8 percent of risk-weighted VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 assets). The combined PCCBA was $99 billion, comprising the $46 billion stress capital buffer, $53 billion stability capital buffer, and $0 countercyclical capital buffer. The capital requirements and PCCBA totaled $175 billion for CET1 capital, $200 billion for tier 1 capital, and $234 billion for adjusted total capital. A more nuanced look at the importance of high-quality capital, and specifically how the Enterprises’ supplemental capital measures would have evolved in relation to their statutory capital measures leading up to the 2008 financial crisis, is included in Section III.B.3. Table 1 then shows a combined leverage ratio requirement of $152 billion under the proposed rule. Both the core capital and supplementary tier 1 leverage ratio requirements are equal to 2.5 percent of adjusted total assets, so there is no difference between the two leverage ratio requirements. However, there are important differences between core capital and tier 1 capital related to the loss-absorbing capacity of each PO 00000 Frm 00006 Fmt 4701 Sfmt 4702 capital metric, as discussed in Section V.B. The supplementary framework also includes a tier 1 capital PLBA equal to 1.5 percent of adjusted total assets, or $91 billion for the Enterprises combined. In aggregate, the Enterprises’ combined tier 1 leverage ratio requirement and PLBA would have been $243 billion as of September 30, 2019. 2. 2018 Proposal’s Capital Requirements Table 2 presents estimates of the Enterprises’ combined regulatory capital under the proposed rule broken out by risk category and asset category as of September 30, 2019. Table 2 also presents estimates of the Enterprises’ combined capital requirements under the 2018 proposal, both as of September 30, 2017—the as-of date in the 2018 proposal—and as of September 30, 2019.12 12 A more detailed walk-forward from the capital requirements in the 2018 proposal to the capital requirements under the proposed rule is presented for each Enterprise in Section XII. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.000</GPH> 39278 Table 2 shows an estimated combined risk-based capital requirement of $135.1 billion, or 2.22 percent of the Enterprises’ adjusted total assets, under the proposed rule as of September 30, 2019, then provides a further breakdown by risk category. Net credit risk capital accounts for $134.9 billion before CRT and $112.8 billion after CRT, market risk capital accounts for $13.6 billion, and operational risk capital accounts for $8.7 billion. The DTA requirement is zero as of September 30, 2019. Using the same September 30, 2019 portfolio date, the combined risk-based capital requirement under the 2018 proposal would have been similar to the combined risk-based capital requirement under the proposed rule. The differences in required regulatory capital between the two proposals are in post-CRT net credit risk capital (+45.0 billion), removal of the going-concern VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 buffer (¥$43.5 billion), operational risk (+$4.1 billion), and DTA (¥$7.4 billion). The capital requirement for market risk was unchanged. Primary drivers of the $45.0 billion increase in post-CRT net credit risk capital are a new prudential floor on the credit risk capital requirement for mortgage exposures and refinements to the capital treatment of CRT structures, including a minimum capital requirement on senior tranches of CRT retained by an Enterprise. A caveat to this comparison is that the 2018 proposal increased the total capital requirement by a DTA offset, while the proposed rule, consistent with the Basel framework, proposes instead to deduct the amount of that DTA offset from CET1 capital (and therefore tier 1 and adjusted total capital). The 2018 proposal’s $136.9 billion combined risk-based capital requirement would have been, in effect, PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 39279 $129.5 billion under the DTA approach of the proposed rule. In contrast to the 2018 proposal, the proposed rule includes a set of three buffers that would materially increase the regulatory capital that each Enterprise would have to maintain to avoid restrictions on capital distributions and discretionary bonuses. The proposed rule’s stress capital buffer of $45.5 billion replaces the 2018 proposal’s $43.5 billion going-concern buffer, and is complemented by the stability capital buffer of $53.3 billion and the countercyclical capital buffer that is currently set to zero. The three buffers in aggregate form the PCCBA, which totals $98.8 billion for the Enterprises combined, or 1.63 percent of the adjusted total assets. The aggregate risk-based capital requirement and PCCBA is a combined $234.3 billion under the proposed rule, or 3.86 percent of the Enterprises’ adjusted total assets. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.001</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Table 3 again shows an estimated combined risk-based capital requirement of $135.1 billion, or 2.22 percent of the Enterprises’ adjusted total assets under the proposed rule as of September 30, 2019, then provides a further breakdown by asset category. The Enterprises’ combined risk-based capital requirement for single-family mortgage exposures is $111.0 billion under the proposed rule, while the combined risk-based capital requirement for multifamily mortgage exposures is $17.8 billion. In addition, the combined risk-based capital requirements for DTA and other assets VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 under the proposed rule is zero and $6.3 billion, respectively. Excluding the going-concern buffer, which was a capital requirement in the 2018 proposal but has been replaced by the stress capital buffer in the proposed rule, the combined risk-based capital requirements under the 2018 proposal for the single-family and multifamily businesses were $67.8 billion and $12.2 billion, respectively, as of September 30, 2019. As discussed above and shown in Table 3, the enhancements in the proposed rule would have increased the required capital for single-family assets and multifamily assets by $43.2 billion and $5.6 billion, respectively. Similarly, PO 00000 Frm 00008 Fmt 4701 Sfmt 4702 the risk-based capital requirement for other assets has increased by $0.2 billion. Finally, the risk-based capital requirement for DTA decreased by $7.4 billion in the proposed rule due to its new capital treatment. The pro-cyclicality of the 2018 proposal’s risk-based capital requirements complicates comparisons to the proposed rule. Under the 2018 proposal, the Enterprises would have likely found it necessary to maintain a considerable capital surplus in anticipation of a financial stress. One Enterprise’s comment letter suggested that its total capital requirement would be expected to increase as much as 80 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.002</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39280 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules percent in a severely adverse stress.13 The amount of this managerial cushion would have depended on the extent to which the Enterprises viewed it to be potentially costly or difficult to raise new capital in the midst of a financial stress.14 The 2018 proposal’s enforcement framework amplified the necessity of a managerial cushion by incorporating the going-concern buffer into the capital requirements, a violation of which could trigger significant regulatory sanctions. In contrast, the proposed rule converts the going-concern buffer into a stress capital buffer that an Enterprise may draw down during a period of financial stress. Because a managerial cushion in anticipation of an eventual stress would have been a practical, if not legal, necessity for the Enterprises, comparisons to the 2018 proposal should start with a reasonable assumption regarding the amount of this capital surplus.15 FHFA is cognizant that the leverage ratio requirements would currently exceed the risk-based capital khammond on DSKJM1Z7X2PROD with PROPOSALS2 13 See Comment Letter from Fannie Mae at 2 (Nov. 15, 2018). 14 Id. at 2 (‘‘To ensure adequate capital in such a scenario, any Regulated Institution would need to hold a sizeable capital surplus during more normal economic environments. The need for such a surplus is real, because consistent with their mission, the Regulated Institutions must maintain a constant presence in the housing market and would want to avoid being forced to raise capital in times of stress.’’). 15 On the one hand, the managerial cushion likely to be held by an Enterprise to mitigate the problem of having to raise regulatory capital in a period of financial stress could be considered a mitigant to safety and soundness risk. On the other hand, significant reductions in credit risk capital requirements due to sustained periods of house price growth and favorable economic conditions could contribute to safety and soundness risk. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 requirements. FHFA has settled on this calibration of the leverage ratio requirements after considerable deliberation. The leverage ratio requirements are intended to serve as non-risk-based measures that provide a credible backstop to the risk-based capital requirements to safeguard against model risk and measurement error with a simple, transparent, independent measure of risk. The leverage ratio requirements would have the added benefit of dampening some of the pro-cyclicality inherent in the riskbased capital requirements. As discussed in Section VI.B.3, FHFA has sized the leverage ratio requirements to be a credible backstop to the risk-based capital requirements, taking into account considerations relating to the Enterprises’ historical loss experiences, the model and related risks posed by the calibration of the risk-based capital requirements, and the analogous leverage ratio requirements under the U.S. banking framework and of the Federal Home Loan Banks. If the leverage ratio requirements are to be a credible backstop, there will inevitably be periods when leverage ratio requirements require more regulatory capital than the risk-based capital requirements, as is the case as of September 30, 2019. FHFA believes that mortgage market conditions as of September 30, 2019 reflect circumstances consistent with a period under which a credible leverage ratio would be binding, given the exceptional single-family house price appreciation since 2012, the unemployment rate at an historically low level, the strong credit performance of mortgage exposures as of that time, the significant progress by the Enterprises to materially reduce legacy PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 39281 exposure to non-performing loans (NPLs) and re-performing loans, robust CRT market access enabling substantial risk transfer, and the generally strong condition of key counterparties, such as mortgage insurers. 3. 2008 Financial Crisis Loss Experience 16 This section examines the peak cumulative capital losses of each Enterprise relative to several different regulatory capital metrics: The statutory risk-based and leverage ratio requirements applicable to the Enterprise in 2007; the aggregate riskbased capital (requirement plus the PCCBA) under the proposed rule but without the contemplated single-family countercyclical adjustment; and the aggregate leverage capital (requirement plus the PLBA) under the proposed rule but without the contemplated singlefamily countercyclical adjustment.17 As discussed in Section IV.B.2, under the 2018 proposal, Fannie Mae’s and Freddie Mac’s peak losses would have left, respectively, only $3 billion and $12 billion in remaining capital, not enough to have sustained the market confidence necessary for either Enterprise to continue as a going concern. 16 In 2008, the entire net worth of both Enterprises was depleted by losses. The U.S. Department of the Treasury (Treasury Department) invested in senior preferred stock of both Enterprises to offset the losses. Fannie Mae drew $116 billion from the Treasury between 2008 and the fourth quarter of 2011, while Freddie Mac drew $71 billion between 2008 and the first quarter of 2012. 17 Peak cumulative capital losses are defined as cumulative losses, net of revenues earned, between 2008 and the respective date at which an Enterprise no longer required draws under the PSPA. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Table 4 shows that as of December 31, 2007, Fannie Mae’s statutory risk-based capital requirement was $25 billion, or 0.8 percent of adjusted total assets. The Enterprise’s statutory minimum leverage ratio requirement was $42 billion, or 1.4 percent of adjusted total assets. For comparison, as of the same date, Fannie Mae’s proposed risk-based measures (adjusted total capital requirement plus PCCBA) would have been $209 billion or 6.9 percent of adjusted total assets, VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 and the proposed leverage measures (leverage ratio requirement plus PLBA) would have been $122 billion or 4.0 percent of adjusted total assets. While the leverage measure would have fallen $45 billion short of Fannie Mae’s peak cumulative capital losses of $167 billion (5.5 percent of adjusted total assets), the proposed risk-based measures would have exceeded those peak losses by $42 billion. These comparisons are subject to the caveat that Fannie Mae’s $167 PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 billion in peak cumulative capital losses include a valuation allowance on DTAs of $64 billion. Because much of Fannie Mae’s DTAs would have been deducted from adjusted total capital and tier 1 capital, the adjusted total capital and tier 1 capital that actually would have been exhausted during the 2008 financial crisis would have been considerably less than the $167 billion in peak cumulative capital losses reflected in Table 4. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.003</GPH> 39282 Table 5 shows that as of December 31, 2007, Freddie Mac’s statutory risk-based capital requirement was $14 billion, or 0.6 percent of adjusted total assets. The Enterprise’s statutory minimum leverage ratio requirement was $34 billion, or 1.6 percent of adjusted total assets. For comparison, as of the same date, Freddie Mac’s proposed risk-based measures (adjusted total capital requirement plus PCCBA) would have been $128 billion or 5.9 percent of adjusted total assets, and the proposed leverage measures (leverage ratio requirement plus PLBA) would have been $87 billion or 4.0 percent of adjusted total assets. While the leverage measure would have fallen $11 billion short of Freddie Mac’s peak cumulative capital losses of $98 billion (4.5 percent of adjusted total assets), the proposed risk-based measures would have exceeded those peak losses by $30 billion. These comparisons are subject to the caveat that Freddie Mac’s $98 billion in peak cumulative capital losses include a valuation allowance on DTAs of $34 billion. Because much of Freddie Mac’s DTAs would have been deducted VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 from adjusted total capital and tier 1 capital, the adjusted total capital and tier 1 capital that actually would have been exhausted during the 2008 financial crisis would have been considerably less than the $98 billion in peak cumulative capital losses reflected in Table 5. As discussed in Section VIII.A.4, FHFA is proposing that the base risk weights for single-family mortgage exposures would be subject to a countercyclical adjustment due to MTMLTV adjustments an Enterprise would be required to make when national house prices deviate by more than 5.0 percent above or below an estimated inflation-adjusted long-term trend. It is important to note that any additional regulatory capital that would have been required under the proposed single-family countercyclical adjustment is not included in the estimates of regulatory capital in either Tables 4 or 5. Looking back, it is likely that, given the considerable house price appreciation in the decade before the financial crisis, this countercyclical adjustment would have been in effect as PO 00000 Frm 00011 Fmt 4701 Sfmt 4702 39283 of December 31, 2007. However, there are too many unknowns to quantify with any reasonable degree of certainty what that effect would have been, how the Enterprises’ actions might have changed because of it, and how changes in the actions of the Enterprises might have affected the overall market. Therefore, FHFA is presenting the estimates without including a countercyclical adjustment, and acknowledging that with the countercyclical adjustment in place, the Enterprises would likely have had an even larger capital surplus relative to their peak cumulative capital losses than is presented in Tables 4 and 5. III. Background A. Pre-Crisis Regulatory Capital Framework The Safety and Soundness Act established FHFA’s predecessor agency, the Office of Federal Housing Enterprise Oversight (OFHEO), as the safety and soundness regulator of the Enterprises. As originally enacted, the Safety and Soundness Act specified a minimum capital requirement for the Enterprises E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.004</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39284 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules in the form of a leverage ratio requirement set in statute at an amount equal to the sum of 2.5 percent of onbalance sheet assets and 0.45 percent of credit guarantees of MBS held by outside investors. OFHEO did not have the authority to adjust this minimum capital requirement. The Safety and Soundness Act also required OFHEO to establish by regulation a risk-based capital stress test such that each Enterprise could survive a ten-year period with credit losses arising out of a prolonged regional stress 18 and large movements in interest rates.19 Over a 7-year period, OFHEO issued a series of Federal Register notices to solicit public comments on the risk-based capital stress test regulation, eventually finalizing the rule in 2001. The final risk-based capital requirements, however, had little practical impact. The capital required under the statutory leverage ratio requirement consistently exceeded the capital required under OFHEO’s riskbased regulation, in large part due to the prescriptive restrictions imposed by statute on the underlying stress scenario and also due to model risk-related failures to update the underlying data and model calibrations.20 This pre-crisis regulatory capital framework would soon prove inadequate. khammond on DSKJM1Z7X2PROD with PROPOSALS2 B. Lessons of the 2008 Financial Crisis Starting in 2006, house prices in some regional markets began to decline, mortgage defaults began to rise, and the Enterprises began to incur credit and mark-to-market losses. In 2007, housing price declines spread across the nation, 18 The statutory stress scenarios contemplated a period in which ‘‘losses occur throughout the United States at a rate of default and severity (based on any measurements of default reasonably related to prevailing practice for that industry in determining capital adequacy) reasonably related to the rate and severity that occurred in contiguous areas of the United States containing an aggregate of not less than 5 percent of the total population of the United States that, for a period of not less than 2 years, experienced the highest rates of default and severity of mortgage losses, in comparison with such rates of default and severity of mortgage losses in other such areas for any period of such duration.’’ Safety and Soundness Act section 1361(a) (as in effect before amended by HERA). 19 The statutory stress scenarios contemplated two periods: (i) A period in which the 10-year Treasury yield decreased to the lesser of 600 basis points below the average yield during the preceding 9 months or 60 percent of the average yield during the preceding three years; and (ii) a period in which the 10-year Treasury yield increased to the greater of 600 basis points above the average yield during the preceding 9 months or 160 percent of the average yield during the preceding three years. Id. 20 See W. Scott Frame et al, The Failure of Supervisory Stress Testing: Fannie Mae, Freddie Mac, and OFHEO (Working Paper 2015–3) at 3, available at https://www.frbatlanta.org/-/media/ documents/research/publications/wp/2015/03.pdf. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 and issuances of private-label securities (PLS) largely ceased. The Enterprises’ losses continued to mount into 2008, their share prices rapidly fell, and the spreads on their unsecured debt and mortgage-backed securities (MBS) widened. In July 2008, following growing concern about the Enterprises’ solvency, Congress passed HERA, establishing FHFA as the regulator for the Enterprises and authorizing the Treasury Department to support the Enterprises through purchases of their obligations and other securities. On September 6, 2008, FHFA used its new authorities under HERA to place each Enterprise into conservatorship. The next day, the Treasury Department exercised its HERA authority to enter into Senior Preferred Stock Purchase Agreements (each a PSPA) to support the Enterprises. The Enterprises ultimately required $191.5 billion in cash draws from the Treasury Department under the PSPAs. 1. Capital Adequacy The scale of the Enterprises’ capital exhaustion during the 2008 financial crisis is critically relevant to the capital necessary to ensure that each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle. As discussed in Section II.D.3, the Enterprises’ crisis-era cumulative capital losses peaked at $265 billion, approximately 4.8 percent of their total assets as of December 31, 2007. Setting aside the valuation allowances on their DTAs, which are subject to deductions and other adjustments to regulatory capital under the proposed rule, the Enterprises’ peak cumulative capital losses were $167 billion, approximately 3.0 percent of their total assets as of December 31, 2007. The Enterprises’ crisis-era cumulative capital losses, while significant, could have been greater. The Enterprises’ losses were likely mitigated by unprecedented federal government support of the housing market and the economy during the crisis, including the Home Affordable Modification Program, the Troubled Asset Relief Program, the 2009 stimulus package,21 and the Federal Reserve System’s purchases of more than $1.2 trillion of the Enterprises’ debt and MBS from January 2009 to March 2010. The Enterprises’ losses also were likely dampened by the declining interest rate environment of the period, when the interest rates on 30-year fixed-rate mortgage loans 21 See American Recovery and Reinvestment Act of 2009, Public Law 111–5, 123 Stat. 115 (2009). PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 declined by approximately 200 basis points through the end of 2011, facilitating re-financings and loss mitigation programs.22 The Enterprises did later recoup a portion of the underlying valuation adjustments and other losses. However, peak cumulative capital losses are relevant to assessing the amount of capital that creditors and other counterparties would require to regard the Enterprises as viable going concerns throughout the duration of another severe economic downturn. Indeed, the Enterprises were still operating and able to recoup some of these losses only because the Treasury Department’s support through the PSPAs kept them solvent going concerns. 2. Going-Concern Standard The Enterprises’ crisis-era funding difficulties established that each Enterprise must be capitalized to remain a viable going concern both during and after a severe economic downturn. Calibrating capital adequacy based on ‘‘claims paying capacity’’ or an insurance-like or similar standard that does not emphasize a going-concern standard is inconsistent with this lesson of the crisis in at least two respects. First, the Enterprises fund themselves with a significant amount of short-term unsecured debt that must be regularly refinanced. Each Enterprise’s funding needs are very likely to increase during an economic downturn, all else equal, as the Enterprise funds purchases of NPLs out of securitization pools. This is a funding need that peaked at $345 billion in 2010. These ordinary course and procyclical funding needs can be met only if the Enterprise continues to be regarded as a viable going concern by creditors throughout the duration of a financial stress. Creditors will be most skeptical of an Enterprise’s continued solvency during periods of market turmoil, and it was the increase in the Enterprises’ borrowing costs and the associated difficulties that the Enterprises faced in refinancing their debt that were among the most immediate grounds for FHFA placing the Enterprises into conservatorship.23 22 The average interest rate on 30-year mortgage loans was approximately 6.14 percent at the end of 2007, and fell to 4.2 percent toward the end of October 2011. Over this period, yields on 10-year Treasuries fell from approximately 3.88 percent at the end of 2008 to 2.06 percent at the end of October 2011. 23 See Memorandum dated September 6, 2008 re: Proposed Appointment of the Federal Housing Finance Agency as Conservator for the Fannie Mae at 29 (‘‘The Enterprise’s practice of relying upon repo financing of its agency collateral to raise cash in the current credit and liquidity environment is E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Second, only a going-concern capital adequacy standard can ensure that each Enterprise will be positioned to fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle. The Enterprises were not positioned to effectively support the secondary mortgage market as their financial conditions deteriorated in 2007 and 2008.24 In an attempt to enable khammond on DSKJM1Z7X2PROD with PROPOSALS2 an unsafe or unsound practice that has led to an unsafe or unsound condition, given the unavailability of willing lenders to provide secured financing in significant size to reduce pressure on its discount notes borrowings.’’); and Memorandum dated September 6, 2008 re: Proposed Appointment of the Federal Housing Finance Agency as Conservator for the Freddie Mac at 28 (‘‘The Enterprise’s prolonged reliance almost exclusively on 30-day discount notes is an untenable long-term source of funding and an unsafe or unsound practice that poses abnormal risk to the viability of the Enterprise. Operating without an adequate liquidity funding contingency plan is an unsafe or unsound condition to transact business.’’); and Fin. Crisis Inquiry Comm’n, The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States at 316 (2011) (the FCIC Report), available at https://www.govinfo.gov/content/pkg/ GPO-FCIC/pdf/GPO-FCIC.pdf; (‘‘In July and August 2008, Fannie suffered a liquidity squeeze, because it was unable to borrow against its own securities to raise sufficient cash in the repo market.’’); see id. at 316 (‘‘By June 2008, the spread [between the yield on the GSEs’ long-term bonds and rates on Treasuries] had risen 65 percent over the 2007 level; by September 5, just before regulators parachuted in, the spread had nearly doubled from its 2007 level to just under 1 percent, making it more difficult and costly for the GSEs to fund their operations.’’). 24 See FCIC Report at 311, available at https:// www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPOFCIC.pdf; (‘‘Few doubted Fannie and Freddie were needed to support the struggling housing market. The question was how to do so safely. Purchasing and guaranteeing risky mortgage-backed securities helped make money available for borrowers, but it could also result in further losses for the two huge companies later on. ‘There’s a real tradeoff,’ Lockhart said in late 2007—a trade-off made all the more difficult by the state of the GSEs’ balance sheets.’’’); Statement of FHFA Director James B. Lockhart at News Conference Announcing Conservatorship of Fannie Mae and Freddie Mac (Sept. 7, 2008), available at https://www.fhfa.gov/ VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 the Enterprises to continue to support the secondary mortgage market, OFHEO relaxed the mortgage portfolio caps and reduced a capital buffer that had been imposed by consent order.25 3. High-Quality Capital Another lesson of the 2008 financial crisis is that it is not only the quantity but also the quality of the regulatory capital, especially its loss-absorbing capacity, that is critical to the Enterprises’ safety and soundness. Market confidence in the Enterprises came into doubt in mid-2008 when Fannie Mae and Freddie Mac had total capital of, respectively, $55.6 billion and $42.9 billion. Questions about the Enterprises’ solvency likely arose in part due to their sizeable DTAs, which counted toward total capital but had less loss-absorbing capacity during a period of negative income. Freddie Mac would have actually had a negative book value as of June 30, 2008 after deducting its DTAs. Besides the DTA valuation allowances, there was also uncertainty as to the sufficiency of the Media/PublicAffairs/Pages/Statement-of-FHFADirector-James-B--Lockhart-at-News-ConferenceAnnnouncing-Conservatorship-of-Fannie-Mae-andFreddie-Mac.aspx; (‘‘Unfortunately, as house prices, earnings and capital have continued to deteriorate, their ability to fulfill their mission has deteriorated . . . . The result has been that they have been unable to provide needed stability to the market. They also find themselves unable to meet their affordable housing mission.’’); id. (‘‘The lack of confidence has resulted in continuing spread widening of their MBS, which means that virtually none of the large drop in interest rates over the past year has been passed on to the mortgage markets.’’). 25 News Release, OFHEO, Fannie Mae and Freddie Mac Announce Initiative to Increase Mortgage Market Liquidity (Mar. 19, 2008), available at https://www.fhfa.gov/Media/PublicAffairs/Pages/ OFHEO,-Fannie-Mae-and-Freddie-Mac-AnnounceInitiative-to-Increase-Mortgage-MarketLiquidity.aspx; (‘‘OFHEO estimates that Fannie Mae’s and Freddie Mac’s existing capabilities, combined with this new initiative and the release of the portfolio caps announced in February, should allow the GSEs to purchase or guarantee about $2 trillion in mortgages this year.’’). PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 39285 Enterprises’ allowances for loan losses (ALLL).26 For these and other reasons, the Basel framework includes deductions and other adjustments for DTAs and ALLL, as well as other capital elements that might have less lossabsorbing capacity.27 Table 6 illustrates the importance of requiring high-quality capital by showing the evolution of CET1 capital, tier 1 capital, adjusted total capital, core capital, and total capital at each Enterprise leading up to the 2008 financial crisis. As the table indicates, the Enterprises’ combined core capital increased from $77.3 billion in 2006 to $84.1 billion in 2008, suggesting at first glance a position of some financial strength. However, over the same time period the Enterprises’ combined tier 1 capital decreased markedly from $76.3 billion to $24.1 billion, indicating a capital position with deteriorating and substantially less loss-absorbing capacity. Similarly, the Enterprises’ combined total capital increased from $78.7 billion in 2006 to $98.5 billion in 2008, while over the same time period the Enterprises’ adjusted total capital decreased from $85.9 billion to $29.6 billion. 26 See FCIC Report at 317, available at https:// www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPOFCIC.pdf; (‘‘[T]he Fed found that the GSEs were significantly ‘underreserved,’ with huge potential losses . . . The OCC rejected the forecasting methodologies on which Fannie and Freddie relied. Using its own metrics, it found insufficient reserves for future losses . . . .’’). 27 See BCBS, The Basel Framework CAP10 (Dec. 15, 2019), available at https://www.bis.org/basel_ framework/chapter/CAP/10.htm?inforce= 20191215&export=pdf; see also BCBS, Basel: A Global Regulatory Framework for More Resilient Banks and Banking Systems, paragraphs 8 and 9, (Dec. 2010; revised June 2011), available at https:// www.bis.org/publ/bcbs189.htm; (‘‘The crisis demonstrated that credit losses and writedowns come out of retained earnings, which is part of banks’ tangible common equity base . . . . To this end, the predominant form of Tier 1 capital must be common shares and retained earnings.’’). E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 4. Stability of the National Housing Finance Markets khammond on DSKJM1Z7X2PROD with PROPOSALS2 After the taxpayer-funded rescue of the Enterprises in 2008, there can be no doubt as to the risk posed by an insolvent or otherwise financially distressed Enterprise to the stability of the national housing finance markets. The Enterprises were then, and remain today, the dominant participants in the housing finance system, owning or guaranteeing 37 percent of residential mortgage debt outstanding as of December 31, 2007 and 44 percent of residential mortgage debt outstanding as of September 30, 2019. Both then and still today, banks, insurance firms, and securities broker-dealers own significant amounts of the Enterprises’ unsecured debt and MBS. Both then and still today, the Enterprises control critical infrastructure for securitizing and administering $5.5 trillion of outstanding single-family and multifamily conventional MBS.28 Given 28 During the conservatorship, some of that functionality has been moved to the Common Securitization Platform, which is jointly owned and operated by the Enterprises. In January 2020, FHFA announced that it had directed the Enterprises to amend the governance of the entity that operates the Common Securitization Platform to include an independent, non-executive chairman of the board of directors and add up to three additional independent directors. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 the nature, scope, size, scale, concentration, and interconnectedness of each Enterprise, the financial distress of an Enterprise could have significant adverse effects on the liquidity, efficiency, competitiveness, or resiliency of national housing finance markets. For these and related reasons, the Treasury Department ultimately invested $191.5 billion under the PSPAs in the Enterprises to keep them solvent going concerns. C. Post-Crisis Changes to Regulatory Capital Frameworks After the 2008 financial crisis, financial services regulators in the U.S. and internationally revisited their regulatory capital frameworks to address lessons learned. The international efforts of the leading banking regulators through the BCBS culminated in 2010 in enhancements to the Basel framework.29 That comprehensive reform package was designed to improve the quality and quantity of regulatory capital and to build additional capacity into the banking system to absorb losses during future periods of financial stress. Revisions to the international capital standards included a more restrictive definition of regulatory capital, higher regulatory capital requirements, a capital conservation buffer that could be drawn down during periods of financial stress, and also capital surcharges for systemic importance. With respect to the Enterprises, HERA gave FHFA greater authority to determine capital standards for the Enterprises by removing the Safety and Soundness Act’s restrictions on the riskbased capital requirements and by giving FHFA authority to increase leverage ratio requirements above the statutory minimum. Each Enterprise was placed into conservatorship shortly after enactment of HERA, and FHFA suspended the Enterprises’ statutory capital classifications and regulatory capital requirements. FHFA, in its capacity as conservator, then began to develop a framework known as the Conservatorship Capital Framework to ensure that each Enterprise assumed appropriate regulatory capital requirements in managing their businesses. The Conservatorship Capital Framework was implemented in 2017, and ultimately was the foundation of the 2018 proposal. IV. Rationale for Re-Proposal 29 See BCBS, Basel: A Global Regulatory Framework for More Resilient Banks and Banking Systems (Dec. 2010; revised June 2011), available at https://www.bis.org/publ/bcbs189.htm. PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 FHFA is re-proposing the regulatory capital framework for the Enterprises for three key reasons: E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.005</GPH> 39286 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 • First, FHFA has begun the process to responsibly end the conservatorships of the Enterprises. This policy change is a departure from the expectations of interested parties at the time of the 2018 proposal, when the prospects for indefinite conservatorships informed comments and perhaps even the decision whether to comment at all. • Second, FHFA is proposing to increase the quantity and quality of the regulatory capital at the Enterprises to ensure the safety and soundness of each Enterprise and that each Enterprise can fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle, in particular during periods of financial stress. • Third, to facilitate regulatory capital planning and also in furtherance of the safety and soundness of the Enterprises and their countercyclical mission, FHFA is proposing changes to mitigate the pro-cyclicality of the aggregate riskbased capital requirements of the 2018 proposal. While these enhancements preserve the 2018 proposal as the foundation of the Enterprises’ regulatory capital framework, FHFA has nonetheless determined to solicit comments on this revised framework in its entirety in light of the changed policy environment, the extent and nature of the enhancements, the technical nature of the underlying issues, the diverse range of interested parties, and the critical importance of the Enterprises’ regulatory capital framework to the national housing finance markets. A. Responsibly Ending the Conservatorships FHFA stated in the 2018 proposal that ‘‘this proposed rule is not a step towards recapitalizing the Enterprises and administratively releasing them from conservatorship.’’ 30 FHFA also noted that ‘‘[p]ublication of this proposed rule will assist with FHFA’s administration of the conservatorships of Fannie Mae and Freddie Mac by potentially refining the [Conservatorship Capital Framework].’’ 31 It is possible that these and other statements made by FHFA, as well as the generally prevailing uncertainty at the time as to the Enterprises’ prospects for exiting conservatorships, might have influenced interested parties’ views as to the practical relevance of the 2018 proposal or otherwise dissuaded the submission of some comments. In fact, more than half of the comments on the 2018 proposal related to the ongoing 30 83 FR at 33313. 31 Id. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 conservatorships rather than the proposed regulatory capital framework. The policy environment has since changed. In September 2019, the Treasury Department released its housing reform plan that recommended that FHFA begin the process to end each Enterprise’s conservatorship in a manner consistent with the preconditions set forth in that plan, and also recommended a recapitalization plan be developed for each Enterprise.32 Shortly thereafter, the Treasury Department and FHFA, on behalf of each Enterprise in its capacity as conservator, entered into letter agreements permitting the Enterprises to together retain up to $45 billion in capital. In October 2019, FHFA then issued a new Strategic Plan and Scorecard for the Enterprises that stated that ‘‘[e]nding the conservatorships of Fannie Mae and Freddie Mac is a central and necessary element of this new roadmap.’’ These developments were important factors in FHFA’s decision to re-propose the regulatory capital framework in its entirety. FHFA considered extensively the comments received on the 2018 proposal and made significant adjustments to multiple aspects of the proposed regulatory capital framework in response to the comments received. FHFA now hopes and expects that the clarity as to the Enterprises’ eventual exit from conservatorship will lead to new, different, and more extensive comments. To that end, FHFA emphasizes that the purpose of the proposed rule is to establish a regulatory capital framework that ensures the safety and soundness of each Enterprise and that each Enterprise is positioned to fulfill its statutory mission across the economic cycle, in particular during periods of financial stress. B. Ensuring Capital Adequacy 1. Quality of Capital As discussed in Section III.B.3, a lesson of the 2008 financial crisis is that the Enterprises’ safety and soundness depends not only on the quantity but also on the quality of their regulatory capital. In light of the lessons learned, FHFA has determined enhancements are necessary to address two key concerns with respect to the quality of the Enterprise’s regulatory capital. First, enhancements are necessary to limit the amount of regulatory capital that may consist of certain components of capital such as DTAs that might tend 32 Treasury, Housing Reform Plan at 27 (Sept. 2019), available at https://home.treasury.gov/ system/files/136/Treasury-Housing-FinanceReform-Plan.pdf. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 39287 to have less loss-absorbing capacity during a period of financial stress. FHFA noted in the 2018 proposal that the Enterprises’ DTAs, which are included in total capital and core capital by statute, ‘‘may provide minimal to no loss-absorbing capability during a period of [financial] stress as recoverability (via taxable income) may become uncertain.’’ 33 The 2018 proposal addressed this issue by establishing a risk-based capital requirement for DTAs. However, the 2018 proposal did not include adjustments for other capital elements that tend to have less loss-absorbing capacity during a financial stress (e.g., ALLL, goodwill, and intangibles). The 2018 proposal also did not adjust for accumulated other comprehensive income (AOCI), leaving open the possibility that an Enterprise could have positive total capital and core capital despite being insolvent under GAAP, though FHFA did request comment on whether to include offsetting capital requirements to AOCI similar to the treatment of DTAs. Second, the statutory definitions of regulatory capital used in the 2018 proposal did not limit the extent to which preferred shares could satisfy the risk-based capital requirements. Specifically, there was neither a riskbased capital requirement for core capital nor a requirement that retained earnings and other common equity be the predominant form of capital, as under the Basel framework.34 The 2018 proposal sought feedback on this issue and commenters recommended FHFA limit the inclusion of preferred shares in regulatory capital to align with the U.S. banking framework’s definition of tier 1 capital. To address these and related concerns, and as described in more detail in Section V.B., FHFA is proposing to supplement the total capital and core capital requirements with additional capital requirements 33 83 FR at 33388. Deducting the Enterprises’ DTAs from their $98.5 billion in total capital in mid-2008 in a manner generally consistent with the U.S. banking regulators’ approach would have left the Enterprises with little regulatory capital, reflective of the financial distress that the Enterprises were experiencing at the time and also consistent with the $53.8 billion in capital reductions realized a few months later with the valuation allowances on the Enterprises’ DTAs. 34 See BCBS, Basel: A Global Regulatory Framework for More Resilient Banks and Banking Systems, paragraphs 8 and 9 (Dec. 2010; revised June 2011), available at https://www.bis.org/publ/ bcbs189.htm; (‘‘It is critical that banks’ risk exposures are backed by a high quality capital base. The crisis demonstrated that credit losses and writedowns come out of retained earnings, which is part of banks’ tangible common equity base . . . . To this end, the predominant form of Tier 1 capital must be common shares and retained earnings.’’). E:\FR\FM\30JNP2.SGM 30JNP2 39288 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 based on the Basel framework’s definitions of total capital, tier 1 capital, and CET1 capital. These supplemental capital requirements would include customary deductions and other adjustments for certain DTAs, goodwill, intangibles, and other assets that tend to have less loss-absorbing capacity during a financial stress. The risk-based tier 1 and CET1 capital requirements also would ensure that retained earnings and other high-quality capital are the predominant form of regulatory capital. 2. Quantity of Capital FHFA has also determined enhancements to the 2018 proposal are necessary to ensure a safe and sound quantity of regulatory capital at each Enterprise. In particular, due in part to the lack of prudential floors on riskbased capital requirements and capital buffers, the 2018 proposal’s credit risk capital requirements were insufficient to ensure the safety and soundness of each Enterprise and that each Enterprise could continue to fulfill its statutory mission during a period of financial stress. In determining the need for these enhancements, FHFA considered the following facts, among others: • Cumulative Crisis-Era Capital Losses. Fannie Mae and Freddie Mac’s peak cumulative capital losses from 2008 through 2011 and the first quarter of 2012, respectively, were, respectively, $167 billion and $98 billion. Had the 2018 proposal been in effect at the end of 2007, the 2018 proposal’s risk-based capital requirements for Fannie Mae and Freddie Mac would have been, respectively, $171 billion and $110 billion. Fannie Mae and Freddie Mac’s peak losses would have left, respectively, only $3 billion and $12 billion in remaining capital. At 0.1 percent and 0.5 percent of their total assets and off-balance sheet guarantees respectively, these amounts would not have sustained the market confidence necessary for the Enterprises to continue as going concerns, particularly given the prevailing stress in the financial markets at that time and also given the uncertainty as to the potential for other write-downs and the adequacy of the Enterprises’ allowances for loan losses. Indeed, in October 2010, FHFA projected $90 billion in additional PSPA draws through 2013 under the baseline scenario, although only $34 billion in additional draws proved necessary.35 • Single-family Credit Losses. Freddie Mac’s estimated single-family credit risk 35 See Fed. Hous. Fin. Agency, Projections of the Enterprises’ Financial Performance at 10 (Oct. 2010), available at https://www.fhfa.gov/AboutUs/ Reports/ReportDocuments/2010-10_Projections_ 508.pdf. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 capital requirement under the 2018 proposal of $59 billion as of December 31, 2007 would have been less than its lifetime single-family credit losses of $64 billion on its December 31, 2007 guarantee portfolio. Even excluding loans that Freddie Mac no longer acquires, Freddie Mac’s estimated single-family credit risk capital requirement of $24 billion under the 2018 proposal would have exceeded projected lifetime losses of $20 billion by only $4 billion (0.4 percent of the unpaid principal balance on the singlefamily book as of December 31, 2007). Fannie Mae’s estimated single-family credit risk capital requirement under the 2018 proposal would have exceeded projected lifetime losses on its December 31, 2007 guarantee portfolio whether including or excluding loans that it no longer acquires, but only by $9 billion in both scenarios (0.4 percent and 0.7 percent, respectively, of the unpaid principal balance of the singlefamily book as of December 31, 2007). • Comparison to the Basel and U.S. Banking Frameworks. Had the 2018 proposal been in effect on September 30, 2019, the average pre-CRT net credit risk capital requirement on the Enterprises’ single-family mortgage exposures would have been 1.6 percent of unpaid principal balance, implying an average risk weight of 20 percent.36 The U.S. banking framework generally assigns a 50 percent risk weight to single-family mortgage exposures to determine the credit risk capital requirement (equivalent to a 4.0 percent adjusted total capital requirement), while the current Basel framework generally assigns a 35 percent risk weight (equivalent to a 2.8 percent adjusted total capital requirement). Before adjusting for the capital buffers under the proposed rule and the Basel and U.S. banking frameworks, the Enterprises’ regulatory capital requirements for single-family mortgage exposures under the 2018 proposal would have been 40 percent that of U.S. banking organizations and less than 60 percent that of non-U.S. banking organizations. The BCBS has finalized a more risk-sensitive set of risk weights for residential mortgage exposures, which are to be implemented by January 1, 2022.37 With those changes, the lowest standardized risk weight would be 20 percent for single-family 36 This average risk weight equals the average post-CRT net credit risk capital requirement, excluding the going-concern buffer, under the 2018 proposal of approximately 164 basis points, divided by a total capital requirement of 800 basis points. 37 BCBS, Basel III: Finalising Post-Crisis Reforms, paragraph 64, at 21 (Dec. 2017), available at https:// www.bis.org/bcbs/publ/d424.pdf. PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 residential mortgage loans with LTVs at origination less than 50 percent. The 20 percent average risk weight would have been the same as the Basel framework’s 20 percent minimum, notwithstanding the Enterprises having an average single-family original loan-to-value (OLTV) of approximately 77 percent as of September 30, 2019. These comparisons are complicated by the fact that the 20 percent average risk weight reflects capital relief for loan-level credit enhancement and MTMLTV. In particular, some meaningful portion of the gap between the credit risk capital requirements of the banking organizations and the Enterprises under the 2018 proposal is due to the 2018 proposal’s use of MTMLTV instead of OLTV, as under the U.S. banking framework, to assign credit risk capital requirements for mortgage exposures. In a different house price environment, perhaps after several years of declining house prices, the mark-to-market framework could have resulted in higher credit risk capital requirements than the Basel and U.S. banking frameworks. Similarly, some of this gap might have been expected to narrow had real property prices moved toward their long-term trend. However, the sizing of the current gap under the 2018 proposal is still an important consideration informing the enhancements to the 2018 proposal. Notably, the 20 percent average risk weight would have been the same as the Basel framework’s 20 percent risk weight assigned to exposures to sovereigns and central banks with ratings A+ to A¥ and claims on banks and corporates with ratings AAA to AA¥.38 The 20 percent average risk weight also would have been the same as the 20 percent risk weight assigned under the U.S. banking framework to Enterprise-guaranteed MBS. • Monoline businesses. As discussed in the 2018 proposal, comparisons to the U.S. banking framework’s capital requirements are complicated by the different risk profiles of the Enterprises and large banking organizations.39 The Enterprises, for example, transfer much of the interest rate and funding risk on their mortgage exposures through their sales of their guaranteed MBS, while large banking organizations generally must fund those loans through customer deposits and other sources. While the interest rate and funding risk profiles are different, that difference should not 38 See BCBS, The Basel Framework, paragraphs 20.4 and 20.14 (Dec. 15, 2019), available at https:// www.bis.org/basel_framework/index.htm?export= pdf. 39 83 FR at 33323. E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules preclude comparisons of the credit risk capital requirements of the U.S. banking framework to the credit risk capital requirements of the Enterprises. The Basel and U.S. banking frameworks generally do not contemplate an explicit capital requirement for interest rate risk on banking book exposures, leaving interest rate risk capital requirements to bank-specific tailoring through the supervisory process.40 If anything, the monoline nature of the Enterprises’ mortgage-focused businesses actually suggests that the concentration risk of an Enterprise might be greater than that of a diversified banking organization with a similar amount of credit risk. FHFA has not attempted to make a specific adjustment to the risk-based capital requirements to mitigate the Enterprises’ concentration risk, but the heightened risk associated with the Enterprises’ sector-specific concentration is nonetheless an important consideration in determining the need for the enhancements contemplated by the proposed rule. More generally, enhancements are necessary to mitigate certain risks and limitations associated with the underlying historical data and models used to calibrate the 2018 proposal’s credit risk capital requirements. For example: • Limitations of crisis-era data. Under the 2018 proposal, the credit risk capital requirement for a mortgage exposure was calibrated to be sufficient to absorb the lifetime unexpected losses incurred on loans of that type experiencing a shock to house prices similar to that observed during the 2008 financial crisis. As discussed in Section III.B, the Enterprises’ financial crisis-era losses likely were mitigated to at least some extent by the unprecedented support by the federal government of the housing market and the economy, and also by the declining interest rate environment of the period. There is therefore some risk that the 2018 proposal’s risk-based capital requirements, notwithstanding the required going-concern buffer, were not calibrated to ensure each Enterprise would be regarded as a viable going concern following an economic downturn that potentially entails more unexpected losses, whether because there is less or no Federal support of the economy, because there is less or no 40 See BCBS, Interest Rate Risk in the Banking Book, paragraph 1 (April 2016), available at https:// www.bis.org/bcbs/publ/d368.pdf; (‘‘Interest rate risk in the banking book (IRRBB) is part of the Basel capital framework’s Pillar 2 (Supervisory Review Process) and subject to the Committee’s guidance set out in the 2004 Principles for the management and supervision of interest rate risk (henceforth, the IRR Principles).’’). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 reduction in interest rates, or because of other causes. For example, post-crisis changes in federal, state, and local loss mitigation and other foreclosure requirements might increase the uncertainty as to loss estimations. • High-risk loan products. A disproportionate share of the Enterprises’ crisis-era credit losses (approximately $108 billion) arose from certain single-family mortgage exposures that are no longer eligible for acquisition by the Enterprises. The calibration of the 2018 proposal’s credit risk capital requirements attributed a significant portion of the Enterprises’ crisis-era losses to these product characteristics, including ‘‘Alt-A,’’ negative amortization, interest-only, and low or no documentation loans, as well as loans with debt-to-income ratio at origination greater than 50 percent, cash out refinances with total LTV greater than 85 percent, and investor loans with LTV greater than or equal to 90 percent. The statistical methods used to allocate losses between borrower-related risk attributes and product-related risk attributes pose significant model risk. To ensure safety and soundness, the capital requirements should mitigate the risk of potential underestimation of credit losses that would be incurred in an economic downturn with national housing price declines of similar magnitude, even absent those loan types and even assuming a repeat of Federal support of the economy and the declining interest rate environment.41 • Gaps in risk coverage. There are some material risks to the Enterprises that were not assigned a risk-based capital requirement under either the 2018 proposal and the proposed rule— for example, risks relating to uninsured or underinsured losses from flooding, earthquakes, or other natural disasters or radiological or biological hazards. There also is no risk-based capital requirement for the risks that climate change could pose to property values in some localities. Related to these capital adequacy concerns, the 2018 proposal’s required capital was not tailored to the risk that a default or other financial distress of an Enterprise could have on the liquidity, efficiency, competitiveness, or resiliency of national housing finance markets. As described in Section VII.A.3, the absence of a stability capital buffer poses not only a risk to the national housing finance markets but also a risk to the safety and soundness 41 Reliance on static look-up grids and multipliers might also introduce additional model risk as borrower behavior, mortgage products, underwriting practices, or the national housing markets continue to evolve. PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 39289 of the Enterprises by perpetuating their funding advantages and undermining market discipline over their risk taking. To address these and related concerns, and as described in more detail below, FHFA is proposing, among other changes: • A prudential floor on the credit risk capital requirement for mortgage exposures to mitigate the model and other risks associated with the methodology for calibrating the credit risk capital requirements. • A credit risk capital requirement on senior tranches of CRT held by an Enterprise, an adjustment to the CRT capital treatment to reflect that CRT is not equivalent in loss-absorbing capacity to equity financing, and operational criteria for CRT structures that together would mitigate the structuring, recourse, and other risks associated with these securitizations. • Risk-based capital requirements for a number of exposures not expressly addressed by the 2018 proposal, including credit risk on commitments to acquire mortgage loans, counterparty risk on interest rate and other derivatives, and credit risk on an Enterprise’s holdings or guarantees of the other Enterprise’s MBS. • A countercyclical adjustment for single-family credit risk that would result in greater capital retention when housing markets may be vulnerable to correction, while better enabling the Enterprises to play a countercyclical role. • A stress capital buffer that would, among other things, enhance the resiliency of the Enterprises and ensure that each Enterprise would continue to be regarded as a viable going concern by creditors and other counterparties after a severe economic downturn. • A stability capital buffer tailored to the risk that the Enterprise’s default or other financial distress could have on the liquidity, efficiency, competitiveness, and resiliency of national housing finance markets. • A revised method for determining operational risk capital requirements, as well as a higher floor. • A requirement that each Enterprise maintain internal models for determining its own risk-based capital requirements that would prompt each Enterprise to develop its own view of credit and other risks and not rely solely on the risk assessments underlying the standardized risk weights assigned under this regulatory capital framework. • A 2.5 percent leverage ratio and a 1.5 percent PLBA that would together serve as a credible backstop to the riskbased capital requirements and mitigate the inherent risks and limitations of any E:\FR\FM\30JNP2.SGM 30JNP2 39290 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 methodology for calibrating those requirements. C. Addressing Pro-Cyclicality Consistent with many of the comments on the 2018 proposal, FHFA has determined that mitigating the procyclicality of the 2018 proposal’s riskbased capital requirements would facilitate capital management, enhance the safety and soundness of the Enterprises by preventing risk-based capital requirements from decreasing to unsafe and unsound levels, and help position the Enterprises to fulfill their statutory mission to provide stability and ongoing assistance to the national housing finance markets across the economic cycle. A pro-cyclical framework could have incentivized the Enterprises to expand credit when house prices increased, potentially left the Enterprises without regulatory capital that could be drawn down during a period of financial stress, and perhaps even exacerbated the housing price cycle itself. A pro-cyclical framework also could have led to large swings in required capital, leading to the practical necessity that prudent management would maintain a managerial capital surplus well above the capital requirements. As described in more detail below, FHFA is proposing several enhancements to address this procyclicality while preserving the mortgage risk-sensitive framework of the 2018 proposal. Among other changes, FHFA is proposing: • A countercyclical adjustment to adjust each single-family mortgage exposure MTMLTV when national housing prices are 5.0 percent above or below the inflation-adjusted long-term trend. • A stress capital buffer and a separate leverage buffer that will, in addition to enhancing the resiliency of the Enterprises, dampen pro-cyclicality by encouraging each Enterprise to retain capital during good times while remaining able to provide stability and ongoing assistance to the secondary mortgage market during a period of financial stress by utilizing capital buffers as losses are experienced. • A prudential floor on the credit risk capital requirement for mortgage exposures that, in addition to mitigating the model and other risks associated with the methodology for calibrating the credit risk capital requirements, would also provide further stability to the riskbased capital requirements through the cycle. • A requirement that each Enterprise maintain its own view of credit and other risks, including as to the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 relationship between housing prices and market fundamentals, by maintaining its own internal models for determining risk-based capital. V. Definitions of Regulatory Capital A. Statutory Definitions As discussed in Sections VI.A and VI.B, the proposed rule would require each Enterprise to maintain required amounts of core capital and total capital, as defined in the Safety and Soundness Act. Core capital means, with respect to an Enterprise, the sum of the following (as determined in accordance with GAAP): • The par or stated value of outstanding common stock; • The par or stated value of outstanding perpetual, noncumulative preferred stock; • Paid-in capital; and • Retained earnings. Core capital does not include any amounts that the Enterprise could be required to pay, at the option of investors, to retire capital instruments. Total capital means, with respect to an Enterprise, the sum of the following: • The core capital of the Enterprise; • A general allowance for foreclosure losses, which: (i) Includes an allowance for portfolio mortgage losses, an allowance for non-reimbursable foreclosure costs on government claims, and an allowance for liabilities reflected on the balance sheet for the Enterprise for estimated foreclosure losses on mortgage-backed securities; and (ii) does not include any reserves of the Enterprise made or held against specific assets; and • Any other amounts from sources of funds available to absorb losses incurred by the Enterprise, that the Director by regulation determines are appropriate to include in determining total capital. Notably, as discussed in Section IV.B.1, these statutory definitions do not include deductions and other adjustments for capital elements that might tend to have less loss-absorbing capacity during a period of financial stress (e.g., DTAs, ALLL, goodwill, and intangibles). These statutory definitions also do not limit the extent to which preferred shares may satisfy the riskbased capital requirements. B. Supplemental Definitions 1. Loss-Absorbing Capacity Following HERA’s amendments to the Safety and Soundness Act, FHFA has wide authority to prescribe regulatory capital requirements for the Enterprises. The Safety and Soundness Act generally authorizes FHFA to prescribe by regulation risk-based capital PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 requirements for the Enterprises.42 The Safety and Soundness Act also authorizes FHFA to prescribe minimum capital levels that are greater than the levels prescribed by statute.43 The FHFA Director has general regulatory authority over the Enterprises, as well as the authority to issue regulations to carry out the duties of the FHFA Director.44 The FHFA Director also may establish such other operational and management standards as the FHFA Director determines to be appropriate.45 As amended by HERA, these and other provisions of the Safety and Soundness Act give the FHFA Director generally broad and flexible authority to tailor regulatory capital requirements for the Enterprises, including to prescribe additional capital requirements that supplement the statutory capital classifications based on total capital and core capital. FHFA is proposing to supplement the statutory definitions of total capital and core capital requirements with additional regulatory capital definitions based on the Basel framework’s definitions of total capital, tier 1 capital, and CET1 capital. These supplemental definitions would include customary deductions and other adjustments for certain DTAs, goodwill, intangibles, and other assets that tend to have less lossabsorbing capacity during a financial stress. As discussed in Section IV.B.1, the supplemental definitions of regulatory capital would fill certain gaps in the statutory definitions of core capital and total capital. For example, neither core capital nor total capital adjust for AOCI, leaving open the possibility that an Enterprise could have positive total capital and core capital but yet be insolvent under GAAP. The supplemental tier 1 and CET1 capital requirements also would ensure that retained earnings and other high-quality capital are the predominant form of regulatory capital. Because the supplemental definitions of regulatory capital in the proposed rule are adopted from the Basel framework, the supplemental definitions would be familiar to market participants. This familiarity should facilitate comparisons between the regulatory capital requirements of the Enterprises, banking organizations, and other market participants. The use of well-understood definitions of regulatory capital should also facilitate market discipline over the Enterprises’ risk-taking by positioning future 42 12 U.S.C. 4611. U.S.C. 4612. 44 12 U.S.C. 4511, 4526. 45 12 U.S.C. 4513b. 43 12 E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 shareholders, creditors, and other counterparties to more readily understand the regulatory capital that is available to absorb losses. Consistent with the 2018 proposal, neither the statutory definitions nor the supplemental definitions of regulatory capital would include a measure of future guarantee fees or other future revenues. Counting future revenues toward capital requirements could be appropriate under a ‘‘claims-paying capacity’’ or similar framework that seeks only to ensure that an Enterprise has the ability to perform its guarantee and other financial obligations over time, perhaps subject to a stay or other pause in the payment of claims and other financial obligations during a resolution proceeding. The proposed rule instead seeks to ensure that each Enterprise is capitalized to remain a viable going concern both during and after a severe economic downturn, as discussed in Section III.B.2. Historical experience has established that credit, market, and operational losses can be incurred quickly during a stress, and it is an Enterprise’s capacity to absorb those losses as incurred that defines creditors’ and other counterparties’ views as to whether the financial institution is a viable going concern. As discussed in Sections III.B.2 and III.B.3, market confidence in the Enterprises waned in mid-2008 when Fannie Mae and Freddie Mac had total capital of, respectively, $55.6 billion and $42.9 billion, notwithstanding their right to future guarantee fees. FHFA’s approach does, however, still give consideration to the loss-absorbing capacity of future guarantee fees or other revenues. As discussed in Section VII.A.1, FHFA has calibrated the stress capital buffer as the amount of regulatory capital sufficient for an Enterprise to withstand a severely adverse stress and still remain above the capital requirements.46 Under this 46 See BCBS, Calibrating Regulatory Minimum Capital Requirements and Capital Buffers: A Topdown Approach, paragraph I.A. (Oct. 2010) (‘‘[T]he regulatory minimum requirement is the amount of capital needed for a bank to be regarded as a viable going concern by creditors and counterparties, while a buffer can be seen as an amount sufficient for the bank to withstand a significant downturn period and still remain above minimum regulatory levels.’’), available at https://www.bis.org/publ/ bcbs180.pdf; and Regulatory Capital Rules: Regulatory Capital, Enhanced Supplementary Leverage Ratio Standards for Certain Bank Holding Companies and Their Subsidiary Insured Depository Institutions, 78 FR 51101, 51105 (Aug. 20, 2013) (Joint Agency Proposed Rule) (‘‘In calibrating the revised risk-based capital framework, the BCBS identified those elements of regulatory capital that would be available to absorb unexpected losses on a going-concern basis. The BCBS agreed that an appropriate regulatory minimum level for the risk-based capital VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 calibration methodology, the stress capital buffer has been sized based on net capital exhaustion in a severely adverse scenario. The determination of net capital exhaustion takes into account the guarantee fees and other revenues received during that stress. 2. Components of Regulatory Capital a. CET1 Capital Consistent with the Basel and U.S. banking frameworks, CET1 capital would be the sum of an Enterprise’s outstanding CET1 capital instruments that satisfy the criteria set forth below, related surplus (net of treasury stock), retained earnings, and AOCI, less regulatory adjustments and deductions. The criteria for CET1 capital instruments are intended to ensure that CET1 capital instruments do not possess features that would cause an Enterprise’s condition to further weaken during a period of financial stress. The CET1 capital instruments are any common stock instruments (plus any related surplus) issued by the Enterprise, net of treasury stock, that meet the criteria specified at § 1240.20(b)(1). b. Additional Tier 1 Capital Consistent with the Basel and U.S. banking frameworks, additional tier 1 capital would equal the sum of the additional tier 1 capital instruments that satisfy the criteria set forth at § 1240.20(c)(1) and related surplus, less applicable regulatory adjustments and deductions. The criteria are intended to ensure that additional tier 1 capital instruments would be available to absorb losses on a going-concern basis. An Enterprise would not be permitted to include an instrument in its additional tier 1 capital unless FHFA has determined that the Enterprise has made appropriate provision, including in any resolution plan of the Enterprise, to ensure that the instrument would not pose a material impediment to the ability of an Enterprise to issue common stock instruments following any future appointment of FHFA as conservator or receiver under the Safety and Soundness Act. c. Tier 2 Capital Adjusted total capital would be the sum of CET1 capital, additional tier 1 capital, and tier 2 capital. Generally consistent with the Basel and U.S. banking frameworks, tier 2 capital would equal the sum of: Tier 2 capital requirements should force banking organizations to hold enough loss-absorbing capital to provide market participants a high level of confidence in their viability.’’). PO 00000 Frm 00019 Fmt 4701 Sfmt 4702 39291 instruments that satisfy the criteria set forth at § 1240.20(d)(1); related surplus; and limited amounts of excess credit reserves, less any applicable regulatory adjustments and deductions. As under the U.S. banking framework for advanced approaches banking organizations, an Enterprise may include in tier 2 capital only the excess of its eligible credit reserves over its total expected credit loss, provided the amount does not exceed 0.6 percent of its credit risk-weighted assets. The limited inclusion of ALLL in tier 2 capital is a logical outgrowth of FHFA’s calibration methodology for mortgage exposures under which the base risk weights and risk multipliers are intended to require credit risk capital sufficient to absorb the lifetime unexpected losses incurred on mortgage exposures experiencing a shock to house prices similar to that observed during the 2008 financial crisis. The same is also true for non-mortgage exposures, where FHFA generally has adopted the credit risk capital requirements of the U.S. banking framework, which also calibrates credit risk capital requirements to absorb unexpected losses. An alternative approach perhaps could be to include general ALLL in adjusted total capital and then calibrate the credit risk capital requirements based on stress losses (i.e., unexpected and expected losses). The resulting required loss-absorbing capacity for a mortgage exposure would be substantially the same. That approach however would raise safety and soundness risk relating to the lossabsorbing capacity of each Enterprise’s ALLL in a period of financial stress, particularly if there is no limit on the share of total capital that may be ALLL. An approach that calibrates credit risk capital requirements based on stress losses also would limit FHFA’s ability to rely on the credit risk capital requirements under the U.S. banking framework for non-mortgage exposures, an important consideration to the extent that FHFA does not have the data or models to calibrate its own credit risk capital requirements for non-mortgage exposures. As with additional tier 1 capital, an Enterprise would not be permitted to include an instrument in its tier 2 capital unless FHFA has determined that the Enterprise has made appropriate provision, including in any resolution plan of the Enterprise, to ensure that the instrument would not pose a material impediment to the ability of an Enterprise to issue common stock instruments following any future appointment of FHFA as conservator or E:\FR\FM\30JNP2.SGM 30JNP2 39292 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules receiver under the Safety and Soundness Act. Question 1. Is each of the definitions of CET1 capital, tier 1 capital, and tier 2 capital appropriately formulated and tailored to the Enterprises? Question 2. Should FHFA include additional amounts of an Enterprise’s ALLL or excess credit reserves in any of the components of regulatory capital? Question 3. Should any other capital elements qualify as CET1 capital, additional tier 1 capital, or tier 2 capital elements? 3. Regulatory Adjustments and Deductions khammond on DSKJM1Z7X2PROD with PROPOSALS2 a. Deductions From CET1 Capital Under the U.S. banking framework, goodwill and other intangible assets have long been either fully or partially excluded from regulatory capital because of the high level of uncertainty regarding the ability of a banking organization to realize value from these assets, especially under adverse financial conditions. The regulatory capital treatment of DTAs has posed particular safety and soundness risks for the Enterprises, as discussed in Section IV.B.1. The proposed rule would require an Enterprise to deduct from CET1 capital elements: • Goodwill; • Intangible assets other than mortgage-servicing assets (MSA) net of associated deferred tax liabilities (DTLs); • DTAs that arise from net operating loss and tax credit carryforwards net of any related valuation allowances and net of DTLs in accordance with certain restrictions discussed under Section V.B.3.d; and • Any defined benefit pension fund net asset, net of DTLs in accordance with certain DTL-related restrictions, and subject to certain exceptions with FHFA’s approval. An Enterprise also would deduct from CET1 capital any after-tax gain-on-sale associated with a securitization exposure. Gain-on-sale would be defined as an increase in the equity capital of an Enterprise resulting from a traditional securitization other than an increase in equity capital resulting from (i) the Enterprise’s receipt of cash in connection with the securitization or (ii) reporting of a mortgage servicing asset. Finally, an Enterprise also would deduct from CET1 capital the amount of expected credit loss that exceeds the Enterprise’s eligible credit reserves. Eligible credit reserves would be defined as all general allowances that have been established through a charge against earnings to cover estimated VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 credit losses associated with on- or offbalance sheet wholesale and retail exposures, including the ALLL associated with such exposures, but excluding other specific reserves created against recognized losses. b. Adjustments to CET1 Capital An Enterprise would subtract from CET1 capital any accumulated net gains and add any accumulated net losses on cash-flow hedges included in AOCI that relate to the hedging of items that are not recognized at fair value on the balance sheet. This adjustment would remove an element that gives rise to artificial volatility in CET1 capital as it would avoid a situation in which the changes in the fair value of the cashflow hedge are reflected in regulatory capital but the changes in the fair value of the hedged item is not. An Enterprise also would be required to deduct any net gain and add any net loss related to changes in the fair value of liabilities that are due to changes in the Enterprise’s own credit risk. An Enterprise must deduct the difference between its credit spread premium and the risk-free rate for derivatives that are liabilities as part of this adjustment. To avoid the double-counting of regulatory capital, an Enterprise would deduct the amount of its investments in its own capital instruments, including direct and indirect exposures, to the extent such instruments are not already excluded from regulatory capital. Specifically, an Enterprise would deduct its investment in its own CET1, additional tier 1, and tier 2 capital instruments from the sum of its CET1, additional tier 1, and tier 2 capital, respectively. In addition, any CET1, additional tier 1, or tier 2 capital instrument issued by an Enterprise that the Enterprise could be contractually obligated to purchase also would be deducted from CET1, additional tier 1, or tier 2 capital elements, respectively. c. Items Subject to the 10 and 15 Percent CET1 Capital Threshold Deductions An Enterprise would deduct from its CET1 capital the amount of each of the following items that individually exceeds the 10 percent CET1 capital deduction threshold described below: • DTAs arising from temporary differences that could not be realized through net operating loss carrybacks (net of any related valuation allowances and net of DTLs in accordance with certain restrictions discussed under Section V.B.3.d); and • MSAs, net of associated DTLs in accordance with certain restrictions discussed under Section V.B.3.d. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 An Enterprise would calculate the 10 percent CET1 capital deduction threshold by taking 10 percent of the sum of an Enterprise’s CET1 elements, less the adjustments to, and deductions from, CET1 capital discussed above. The aggregate amount of the items subject to the threshold deductions that are not deducted as a result of the 10 percent CET1 capital deduction threshold must not exceed 15 percent of an Enterprise’s CET1 capital, as calculated after applying all regulatory adjustments and deductions required under the proposed rule (the 15 percent CET1 capital deduction threshold). That is, an Enterprise would deduct in full the amounts of the items subject to the threshold deductions on a combined basis that exceed 17.65 percent (the proportion of 15 percent to 85 percent) of CET1 capital, less all regulatory adjustments and deductions required for the calculation of the 10 percent CET1 capital deduction threshold mentioned above, and less the items subject to the 10 and 15 percent deduction thresholds. d. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and Other Deductible Assets An Enterprise would be permitted to net DTLs against assets (other than DTAs) subject to deduction under the proposed rule, provided the DTL is associated with the asset and the DTL would be extinguished if the associated asset becomes impaired or is derecognized under GAAP. An Enterprise would be prohibited from using the same DTL more than once for netting purposes. With respect to the netting of DTLs against DTAs, the amount of DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and the amount of DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks, net of any related valuation allowances, could be netted against DTLs if certain conditions are met. VI. Capital Requirements A. Risk-Based Capital Requirements 1. Supplemental Requirements FHFA is proposing to require the Enterprises to maintain the following risk-based capital: • Total capital not less than 8.0 percent of risk-weighted assets; • Adjusted total capital not less than 8.0 percent of risk-weighted assets; • Tier 1 capital not less than 6.0 percent of risk-weighted assets; and • CET1 capital not less than 4.5 percent of risk-weighted assets. E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules As discussed in Section III.B.3, a lesson of the 2008 financial crisis is that the Enterprises’ safety and soundness depends not only on the quantity but also on the quality of their capital. To that end, FHFA is proposing to supplement the risk-based capital requirement based on statutorily defined total capital with additional risk-based capital requirements based on the Basel framework’s definitions of total capital, tier 1 capital, and CET1 capital. As discussed in Section IV.B.1, FHFA noted in the 2018 proposal that the Enterprises’ DTAs, which are included in total capital and core capital by statute, ‘‘may provide minimal to no loss-absorbing capability during a period of [financial] stress as recoverability (via taxable income) may become uncertain.’’ 47 The 2018 proposal addressed this issue by establishing a risk-based capital requirement for DTAs. However, the 2018 proposal did not include adjustments for other capital elements that tend to have less loss-absorbing capacity during a financial stress (e.g., ALLL, goodwill, and intangibles), although FHFA did request comment on how best to compensate for the lossabsorbing deficiencies of ALLL and preferred stock within the framework of the 2018 proposal. The 2018 proposal also requested comment on, but did not adjust for, AOCI, leaving open the possibility that an Enterprise could have positive total capital and core capital despite being insolvent under GAAP. The supplemental risk-based capital requirements for adjusted total capital, tier 1 capital, and CET1 capital would address these safety and soundness issues to the extent, as discussed in Section V.B, the underlying regulatory capital definitions incorporate deductions and other adjustments for those capital elements that tend to have less loss-absorbing capacity. Related to this, one of the lessons of the 2008 financial crisis is that retained earnings and other high-quality capital should be the predominant form of regulatory capital. In addition to not limiting the extent to which general ALLL counted toward regulatory capital, the 2018 proposal did not limit the extent to which preferred shares could satisfy the risk-based capital requirements, although FHFA did solicit comment on these issues. Specifically, there was neither a risk-based capital requirement for core capital nor a requirement that retained earnings and other common equity be the predominant form of capital. The risk47 83 FR at 33388. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 based capital requirements for tier 1 capital and CET1 capital would address this safety and soundness issue in a way that should be familiar to market participants. 2. Risk-Weighted Assets An Enterprise would determine its risk-weighted assets under two approaches—a standardized approach and an advanced approach—with the greater of the two used to determine its risk-based capital requirements. Under both approaches, an Enterprise’s riskweighted assets would equal the sum of its credit risk-weighted assets, market risk-weighted assets, and operational risk-weighted assets. Specifying each of the aggregate riskbased capital requirements as a percent of risk-weighted assets is a change from the 2018 proposal, but the change itself would not impact the quantity of required total capital. Both under the 2018 proposal and the proposed rule, and consistent with the Basel and U.S. banking frameworks,48 the risk-based capital requirements should be calibrated to require each Enterprise to hold enough loss-absorbing capital to maintain the confidence of creditors and other counterparties in its viability as a going concern. More specifically, FHFA calibrated the credit risk capital requirements for mortgage exposures to require capital sufficient to absorb the lifetime unexpected losses incurred on exposures experiencing a shock to house prices similar to that observed during the 2008 financial crisis, as discussed in Sections VIII.A.2 and VIII.B.2. The base risk weight for a mortgage exposure is equal to the adjusted total capital requirement for the exposure expressed in basis points and divided by 800, which is the 8.0 percent adjusted total capital requirement also expressed in basis points. Expressing the risk-based capital requirement for an exposure as a risk weight, or the aggregate risk-based capital requirement as a percent of riskweighted assets, is simply a matter of terminology. Although the shift to a terminology of risk-weighted assets is more form than substance, FHFA has made this change for at least two reasons. First, the addition of three new risk-based capital requirements raises the need for a 48 78 FR at 51105 (‘‘In calibrating the revised riskbased capital framework, the BCBS identified those elements of regulatory capital that would be available to absorb unexpected losses on a goingconcern basis. The BCBS agreed that an appropriate regulatory minimum level for the risk-based capital requirements should force banking organizations to hold enough loss-absorbing capital to provide market participants a high level of confidence in their viability.’’). PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 39293 straightforward mechanism to specify the aggregate regulatory capital required for each. Risk-weighted assets accomplishes this by offering a common denominator across the 2018 proposal’s risk-based total capital requirement and the supplemental risked-based capital requirements contemplated by the proposed rule. Second, this approach and its associated terminology are wellunderstood by those familiar with the U.S. banking framework. Expressing the risk-based capital requirement for an exposure as a risk-weight will facilitate transparency and comparability with the U.S. banking framework and other regulatory capital frameworks. Because these concepts are well-understood, this approach also should facilitate market discipline over each Enterprise’s risktaking by its creditors and other counterparties. B. Leverage Ratio Requirements 1. Adjusted Total Assets Each Enterprise would be required to maintain capital sufficient to satisfy the following leverage ratio requirements: • Core capital not less than 2.5 percent of adjusted total assets; and • Tier 1 capital not less than 2.5 percent of adjusted total assets. Adjusted total assets would be defined as total assets under GAAP, with adjustments to include many of the off-balance sheet and other exposures that are included in the supplemental leverage ratio requirements of the U.S. banking framework. 2. Tier 1 Leverage Ratio Requirement As with the risk-based capital requirements, and as discussed in Section IV.B.1, the proposed rule would supplement the core capital leverage ratio requirement with a leverage ratio requirement based on a definition of regulatory capital, here tier 1 capital, that has deductions and other adjustments for capital elements that tend to have less loss-absorbing capacity during a period of financial stress. Tier 1 capital is also a well-understood concept for market participants familiar with the U.S. banking framework. That in turn would facilitate transparency and comparability with the leverage ratio requirements for U.S. banking organizations, as well as market discipline by the Enterprises’ creditors and other counterparties. 3. Sizing of the Requirements The primary purpose of the leverage ratio requirements is to provide a credible, non-risk-based backstop to the risk-based capital requirements to safeguard against model risk and E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39294 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules measurement error with a simple, transparent, independent measure of risk. From a safety-and-soundness perspective, each type of requirement offsets potential weaknesses of the other, and well-calibrated risk-based capital requirements working with a credible leverage ratio requirement are more effective than either type would be in isolation. The leverage ratio requirements would have the added benefit of dampening some of the procyclicality inherent in the aggregate risk-based capital requirements. The core capital leverage ratio requirement also would replace the current statutory leverage ratio requirement for purposes of the corrective action provisions of the Safety and Soundness Act. FHFA has sized the leverage ratio requirements to be a credible backstop to the risk-based capital requirements, taking into account the analogous leverage ratio requirements of U.S. banking organizations and the Federal Home Loan Banks, considerations relating to the Enterprises’ historical loss experiences, and the model and related risks posed by the calibration of the risk-based capital requirements. First, the proposed leverage ratio requirements are generally aligned with the analogous leverage ratio requirements of U.S. banking organizations and the Federal Home Loan Banks. The U.S. banking framework’s leverage ratio requirement requires banking organizations maintain tier 1 capital no less than 4.0 percent of total assets. Insured depository institutions subsidiaries of certain large U.S. bank holding companies also must maintain tier 1 capital no less than 6.0 percent of total assets to be ‘‘well capitalized.’’ 49 Using data for the 18 bank holding companies subject to the Federal Reserve Board’s supervisory stress testing program in 2018, FHFA determined that the average risk weight on the assets of these banks was 61 percent in the fourth quarter of 2018. Under the U.S. banking framework, the Enterprises’ mortgage assets generally would be assigned a 50 percent risk weight under the standardized approach. This suggests that the average risk weight on the assets of the Enterprises would have been approximately 81 percent (50 percent divided by 61 percent) of that of these large bank holding companies. That in turn implies a risk-adjusted analogous leverage ratio requirement for the Enterprises of 3.3 percent (81 percent of the 4.0 percent leverage ratio 49 See, e.g., 12 CFR 6.4(b)(1)(i)(D). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 requirement for U.S. banking organizations).50 While the interest rate and funding risks of the Enterprises and U.S. banking organizations are different, the Basel and U.S. banking frameworks generally do not contemplate an explicit capital requirement for interest rate risk on banking book exposures given the absence of a consensus as to how to quantify that capital requirement, instead leaving interest rate risk capital requirements to bank-specific tailoring through the supervisory process.51 The differences in the interest rate and funding risk profiles therefore should not preclude comparisons to the U.S. banking framework’s leverage ratio requirements, subject to adjustments for the different credit risk profiles of the Enterprises and U.S. banking organizations (as described above). Further, the monoline nature of the Enterprises’ mortgage-focused businesses suggests that the concentration risk of an Enterprise is greater than that of a diversified banking organization with a similar amount of mortgage credit risk, perhaps meriting a higher leverage ratio requirement, all else equal. The Federal Home Loan Banks also must maintain total capital no less than 4.0 percent of total assets. That 4.0 percent leverage ratio requirement should be considered in the context of the safety and soundness benefits of the statutory requirement that each Federal Home Loan Bank advance be fully secured. Related to that, the safety and soundness benefits of that collateral might be furthered by law, as any security interest granted to a Federal Home Loan Bank by a member (or affiliate of a member) is, with some exceptions, entitled by statute to priority over the claims and rights of any other party, including any receiver, conservator, trustee, or similar party having rights of a lien creditor. 50 That U.S. banking framework’s 3 percent supplemental leverage ratio requirement is an inappropriate comparable for sizing the Enterprises’ leverage ratio requirements. Approximately 95 percent of the Enterprises’ adjusted total assets are GAAP total assets that are subject to the U.S. banking framework’s 4 percent leverage ratio requirement. The primary exception is off-balance sheet guarantees on loans and securities, principally Freddie Mac’s K-deals, but these amounts are small relative to the Enterprises’ total assets under GAAP. 51 See BCBS, Interest Rate Risk in the Banking Book, paragraph 1, (April 2016), available at https:// www.bis.org/bcbs/publ/d368.pdf; (‘‘Interest rate risk in the banking book (IRRBB) is part of the Basel capital framework’s Pillar 2 (Supervisory Review Process) and subject to the Committee’s guidance set out in the 2004 Principles for the management and supervision of interest rate risk (henceforth, the IRR Principles).’’). PO 00000 Frm 00022 Fmt 4701 Sfmt 4702 Second, the proposed leverage ratio requirements are broadly consistent with the Enterprises’ historical loss experiences. As discussed in Sections II.D.3 and III.B.1, the Enterprises’ crisisera cumulative capital losses peaked at the end of 2011 at $265 billion, approximately 4.8 percent of their adjusted total assets as of December 31, 2007. Setting aside the valuation allowances on their DTAs, which are subject to deductions and other adjustments to CET1 capital (and therefore tier 1 and adjusted total capital) under the proposed rule, the Enterprises’ crisis-era peak cumulative capital losses were $167 billion, approximately 3.0 percent of their total assets as of December 31, 2007. Notably even these DTA-adjusted capital losses exceeded by $36 billion the tier 1 capital that would have been required under the 2.5 percent leverage ratio requirement as of December 31, 2007. FHFA recognizes that a portion of the crisis-era losses arose from single-family loans that are no longer eligible for acquisition by the Enterprises. However, the sizing of regulatory capital requirements must take into account the modeling risk posed by the attribution of such losses to specific product characteristics, as discussed in Section IV.B.2. The sizing of the regulatory capital requirements also must guard against potential future relaxation of underwriting standards and regulatory oversight over those underwriting standards. The Enterprises’ historical loss experiences actually might tend to understate the regulatory capital that would be necessary to remain a viable going concern to creditors and other counterparties. As discussed in Section III.B.1, the Enterprises’ crisis-era losses likely were mitigated to at least some extent by the unprecedented support by the federal government of the housing market and the economy and also by the declining interest rate environment of the period. The calibration of the leverage ratio requirement and other required capital requirements cannot assume a repeat of those loss mitigants. Also, as discussed in Section IV.B.2, there are some material risks to the Enterprises that are not assigned a riskbased capital requirement—for example, risks relating to uninsured or underinsured losses from flooding, earthquakes, or other natural disasters or radiological or biological hazards. There also is no risk-based capital requirement for the risks that climate change could pose to property values in some localities. Third, certain risks and limitations associated with the underlying E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules historical data and models used to calibrate the credit risk capital requirements reinforce the importance of leverage ratio requirements that safeguard against model risk and measurement error. There is inevitably a trade-off between, on the one hand, preserving the mortgage risk-sensitive framework of the 2018 proposal and, on the other hand, managing the model and related risks associated with any methodology for developing a granular assessment of credit risk specific to different mortgage loan categories. As discussed in Section IV.B.2, a disproportionate share of the Enterprises’ crisis-era losses arose from certain single-family mortgage exposures that are no longer eligible for acquisition by the Enterprises. The calibration of the credit risk capital requirements attributed a significant portion of the Enterprises’ crisis-era losses (approximately $108 billion) to these products. The statistical methods used to allocate losses between borrower-related risk attributes and product-related risk attributes pose significant model risk. It is possible that the calibration understates the credit losses that would be incurred in an economic downturn with national housing price declines of similar magnitude, even assuming a repeat of crisis-era Federal support of the economy and the declining interest rate environment. To this point, as discussed in Section VIII.A.7, had the proposed rule been in effect on December 31, 2007, the credit risk capital requirements still would not have been sufficient to absorb the projected lifetime credit losses on Freddie Mac’s single-family book. Under a dynamic framework, the aggregate credit risk capital requirements would have increased in subsequent years as losses were incurred, while there also would have been material uncertainty as to an Enterprise’s ability to raise sufficient quantities of new capital during a period of financial stress and significant losses. The risk-based capital requirements should, as a general rule, exceed the regulatory capital required under the leverage ratio requirements. At the same time, if the tier 1 leverage ratio requirement is to be an independently meaningful and credible backstop, there will inevitably be some exceptions in which the tier 1 leverage ratio requirement requires more regulatory capital than the risk-based capital requirements. In FHFA’s view, the measurement period of September 30, 2019 is, in fact, consistent with the circumstances under which a credible VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 leverage ratio would be binding, given the exceptional single-family house price appreciation since 2012, the strong credit performance of both single-family and multifamily mortgage exposures, the significant progress by the Enterprises to materially reduce legacy exposure to NPLs and re-performing loans, robust CRT market access enabling substantial risk transfer, and the generally strong condition of key counterparties, such as mortgage insurers. Question 4. Is the tier 1 leverage ratio requirement appropriately sized to serve as a credible backstop to the risk-based capital requirements? Question 5. Should the Enterprise’s leverage ratio requirements be based on total assets, as defined by GAAP, the Enterprise’s adjusted total assets, or some other basis? C. Enforcement FHFA may draw upon several authorities to address potential Enterprise failures to meet the proposed rule’s capital requirements set forth in VI.A and VI.B. A failure to maintain regulatory capital in excess of each of these capital requirements may result in one or more enforcement consequences. In all cases, the FHFA Director retains the authority to determine the appropriate enforcement consequence. The Safety and Soundness Act authorizes FHFA to establish capital levels for an Enterprise by regulation.52 An Enterprise failure to meet a capital threshold that is required by regulation may be addressed through enforcement mechanisms for regulatory violations including procedures for cease and desist and consent orders.53 Through a cease and desist or consent order, FHFA could require an Enterprise to develop and implement a capital restoration plan, restrict asset growth or activities, and take other appropriate action to remediate the violation of law. FHFA may also use the enforcement tools available under its authority to prescribe and enforce prudential management and operations standards (PMOS).54 The proposed rule, other than the PCCBA, the PLBA, and the associated payout restrictions, would be prescribed as a PMOS guideline that may be enforced under these PMOS authorities. The PMOS statute and rule include enforcement remedies similar, although not identical, to those under the Prompt Corrective Action (PCA) framework discussed below, focusing on a remediation plan and such other 52 12 U.S.C. 4526, 4611, 4612(c). U.S.C. 4581, 12 CFR part 1209. 54 12 U.S.C. 4513b; 12 CFR part 1236. measures as the Director deems appropriate, but not conservatorship or receivership. The FHFA Director may require as part of a remediation plan (which is to be developed within a timeline in the PMOS regulation) restrictions on capital distributions, restrictions on asset growth, activities, and acquisitions, a requirement for new capital-raising, and other restrictions as appropriate. The PCA framework set out in the Safety and Soundness Act 55 also provides for enforcement tools when a shortfall occurs in capital requirements that are set forth in the statute, using the statute’s prescribed capital concepts. The PCA establishes four capital categories with associated increasingly severe enforcement tools: ‘‘adequately capitalized,’’ ‘‘undercapitalized,’’ ‘‘significantly undercapitalized,’’ and ‘‘critically undercapitalized.’’ Under the PCA framework, the principal remedial tool is a recapitalization plan, and other tools include restrictions on capital distributions and asset growth, prior approval of acquisitions and new activities, improvement of management, and restriction on compensation. In serious enough conditions, such as critical undercapitalization, the PCA provides that an Enterprise can be placed in conservatorship or receivership. In addition, the PCA provisions provide for an Enterprise to be downgraded if alternative specified conditions are met. One of those conditions is that an Enterprise is in ‘‘an unsafe or unsound condition,’’ as determined by FHFA after notice and opportunity for a hearing. The proposed rule would include a leverage requirement and a risk-based capital requirement using the concepts of total capital and core capital as defined in the Safety and Soundness Act. The PCA enforcement framework applies to an Enterprise’s failure to meet either of these statutorily based capital requirements. In addition, FHFA could enforce the core capital and total capital requirements under its authority to issue an order to cease and desist from a violation of law or under its PMOS authority. FHFA recognizes that there may be very particular economic circumstances during which an Enterprise may meet its risk-based capital requirement to maintain total capital in excess of 8.0 percent of risk-weighted assets, but fails to meet the leverage ratio requirement of core capital in excess of 2.5 percent of adjusted total assets. This situation falls outside of the PCA capital classifications and enforcement 53 12 PO 00000 Frm 00023 Fmt 4701 Sfmt 4702 39295 55 12 E:\FR\FM\30JNP2.SGM U.S.C. 4614 et seq. 30JNP2 39296 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules framework, but FHFA could address a shortfall through its PMOS or other regulatory enforcement authorities. If appropriate to provide greater clarity to the Enterprises and other market participants, FHFA may issue supervisory guidance regarding progressive application of its enforcement authorities as the capital position of an Enterprise declines. Question 6. Should FHFA consider any changes to its contemplated enforcement framework? What supervisory guidance would be helpful to promote market understanding of how FHFA expects to apply its enforcement authorities? Question 7. Should any of the riskbased capital requirements or leverage ratio requirements be phased-in over a transition period? Question 8. Alternatively, should the enforcement of the risk-based capital requirements during the implementation of a capital restoration plan be tailored through a consent order or other similar regulatory arrangement, and if so how? VII. Capital Buffers khammond on DSKJM1Z7X2PROD with PROPOSALS2 A. Prescribed Capital Conservation Buffer Amount (PCCBA) FHFA is proposing to supplement certain of the risk-based capital requirements with a PCCBA. To avoid limits on capital distributions and discretionary bonus payments, an Enterprise would have to maintain regulatory capital that exceeds each of its adjusted total capital, tier 1 capital, and CET1 capital requirements by at least the amount of its PCCBA. That PCCBA would consist of three separate component buffers—a stress capital buffer, a countercyclical capital buffer, and a stability capital buffer. The PCCBA would be determined as a percent of an Enterprise’s adjusted total assets.56 Fixing the PCCBA at a specified percent of an Enterprise’s adjusted total assets, instead of riskweighted assets, is a notable departure from the Basel framework. FHFA intends a fixed-percent PCCBA, among other things, to reduce the impact that the PCCBA potentially could have on higher risk exposures, avoid amplifying the secondary effects of any model or similar risks inherent to the calibration of granular risk weights for single-family and multifamily mortgage exposures, and further mitigate the pro-cyclicality 56 The stress capital buffer and the countercyclical capital buffer amount could vary, which would then result in a change in the Enterprise’s PCCBA when expressed as a percent of the Enterprise’s adjusted total assets. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 of the aggregate risk-based capital requirements. 1. Stress Capital Buffer An Enterprise’s stress capital buffer would equal 0.75 percent of the Enterprise’s adjusted total assets. The proposed stress capital buffer is similar in amount and rationale to the 0.75 percent going-concern buffer contemplated by the 2018 proposal. The 2018 proposal acknowledged that each Enterprise is required by charter to provide stability and ongoing assistance to the secondary mortgage market during and after a period of severe financial stress. The 2018 proposal also observed that ‘‘[r]aising new capital during a period of severe housing market stress . . . would be very expensive, if not impossible; therefore, the [2018 proposal] would require the Enterprises to hold additional capital on an on-going basis (‘going-concern buffer’) in order to continue purchasing exposures and to maintain market confidence during a period of severe distress.’’ An important difference is that the 2018 proposal’s going-concern buffer would have been a component of the risk-based capital requirement, such that failure to maintain the regulatory capital required by the going-concern buffer could have triggered significant regulatory sanctions. In contrast, the proposed rule converts the 2018 proposal’s going-concern buffer into a component of the capital conservation buffer that FHFA intends to be available for an Enterprise to draw down during a period of financial stress. As discussed in Section II.D, the potential for less punitive sanctions for drawing down the capital conservation buffer should position each Enterprise to play a countercyclical role in the market, and would have the further benefit of reducing the managerial capital cushion that an Enterprise might be expected to maintain above the regulatory capital requirements. For the reasons given in Section III.B.2, and as contemplated for banking organizations by the Basel and U.S. banking frameworks,57 each Enterprise 57 78 FR at 51105 (‘‘In calibrating the revised riskbased capital framework, the BCBS identified those elements of regulatory capital that would be available to absorb unexpected losses on a goingconcern basis. The BCBS agreed that an appropriate regulatory minimum level for the risk-based capital requirements should force banking organizations to hold enough loss-absorbing capital to provide market participants a high level of confidence in their viability. The BCBS also determined that a buffer above the minimum risk-based capital requirements would enhance stability, and that such a buffer should be calibrated to allow banking organizations to absorb a severe level of loss, while PO 00000 Frm 00024 Fmt 4701 Sfmt 4702 should be capitalized to remain a viable going concern both during and after a severe economic downturn. While the proposed regulatory capital requirements are sized to ensure an Enterprise would be regarded as a viable going concern by creditors and other counterparties, the stress capital buffer is sized to ensure that the Enterprise would, in ordinary times, maintain regulatory capital that could be drawn down during a financial stress and still be regarded as a viable going concern after that stress. To a similar end, FHFA sized the 2018 proposal’s going-concern buffer based on the Enterprises’ Dodd Frank Act Stress Test (DFAST) results for the severely adverse scenario. Specifically, ‘‘FHFA calculated the amount of capital necessary for the Enterprises to meet a 2.5 percent leverage requirement at the end of each quarter of the simulation of the severely adverse DFAST scenario (without DTA valuation allowance) and compared that amount to the aggregate risk-based capital requirement. The difference between these two measures provided an indicator for the size of the going-concern buffer.’’ As further validation of the sizing of the stress capital buffer, FHFA’s 2018 proposal compared the regulatory capital obtained by applying the goingconcern buffer to the 2017 single-family book of business with the regulatory capital required to fund each Enterprise’s 2017 new acquisitions. FHFA found the proposed goingconcern buffer would provide sufficient capital for each Enterprise to fund an additional one to two years of new acquisitions comparable to their 2017 new acquisitions. FHFA continues to believe that 2018 proposal’s approach provides a strong indicator for the appropriate size of the stress capital buffer that replaces the going-concern buffer. FHFA has also looked to the sizing of analogous buffers under the Basel and U.S. banking frameworks. As recently amended by the Federal Reserve Board, the U.S. banking framework requires each U.S. banking organization to maintain a stress capital buffer that exceeds its regulatory capital requirements by at least 2.5 percent of its risk-weighted assets, potentially more depending on its peak cumulative capital exhaustion under its supervisory stress test. Under the current average risk weight for the Enterprises’ exposures of 28 percent, the proposed stress capital buffer is equivalent to 2.68 still remaining above the regulatory minimum requirements.’’). E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules percent of the Enterprises’ risk-weighted assets. While the proposed rule contemplates a stress capital buffer sized as a fixedpercent of an Enterprise’s adjusted total assets, FHFA is also seeking comment on an alternative under which FHFA would implement an approach similar to that of the Federal Reserve Board and periodically re-size the stress capital buffer to the extent that FHFA’s eventual program for supervisory stress tests determines that an Enterprise’s peak capital exhaustion under a severely adverse stress would exceed 0.75 percent of adjusted total assets. Under this approach, the stress capital buffer would still be determined as a percent of adjusted total assets, not riskweighted assets. A dynamically re-sized stress capital buffer would be more risksensitive than a fixed-percent stress capital buffer, varying in amount across the economic cycle and also varying with the riskiness of the Enterprise’s mortgage exposures. An approach that leverages a supervisory stress test could also incorporate assumptions as to the continued availability of CRT during a period of financial stress. Related to this, FHFA’s proposal to incorporate into each Enterprise’s PCCBA a stress capital buffer should not be construed to imply or otherwise suggest that a similar buffer would necessarily be appropriate for other market participants in the housing finance system. Some of the Enterprises’ counterparties, and some other market participants in the housing finance system, need not necessarily be capitalized to remain a viable going concern both during and after a severe economic downturn. For these market participants, calibrating capital adequacy based on ‘‘claims paying capacity’’ or an insurance-like or similar standard might be appropriate in light of their size and role in the housing finance system. Question 9. Is the stress capital buffer appropriately formulated and calibrated? Question 10. Should an Enterprise’s stress capital buffer be periodically resized to the extent that FHFA’s eventual program for supervisory stress tests determines that an Enterprise’s peak capital exhaustion under a severely adverse stress would exceed 0.75 percent of adjusted total assets? Question 11. Should an Enterprise’s stress capital buffer be adjusted as the average risk weight of its mortgage exposures and other exposures changes? Question 12. Should an Enterprise’s stress capital buffer be based on the Enterprise’s adjusted total assets or riskweighted assets? VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 39297 2. Countercyclical Capital Buffer 3. Stability Capital Buffer The U.S. banking regulators adopted a countercyclical capital buffer for certain large U.S. banking organizations in June 2013, which has been and remains set at 0 percent of risk-weighted assets. The countercyclical capital buffer aims to ensure that banking sector capital requirements take into account the macro-financial environment in which banks operate.58 The buffer is to be deployed when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk to ensure the banking system has a buffer of capital to protect it against future potential losses. This focus on excess aggregate credit growth means that the buffer is likely to be deployed on an infrequent basis. As is currently the case under the U.S. banking framework, the countercyclical capital buffer for the Enterprises would initially be set at 0 percent of adjusted total assets. FHFA does not expect to adjust this buffer in the place of, or to supplement, the countercyclical adjustment to the risk-based capital requirements for single-family mortgage exposures discussed in Section VIII.A.4. Instead, as under the Basel and U.S. banking frameworks, FHFA would adjust the countercyclical capital buffer taking into account the macro-financial environment in which the Enterprises operate, such that it would be deployed only when excess aggregate credit growth is judged to be associated with a build-up of system-wide risk. This focus on excess aggregate credit growth means the countercyclical buffer likely would be deployed on an infrequent basis, and generally only when similar buffers are deployed by the U.S. banking regulators. Any adjustment to the countercyclical capital buffer would be made in accordance with applicable law and after appropriate notice to the Enterprises. Question 13. Is the countercyclical capital buffer appropriately formulated? Question 14. What administrative or other process should govern FHFA’s adjustments to the countercyclical capital buffer? Question 15. Should FHFA more explicitly base its determination to adjust the countercyclical capital buffer to the determination of the U.S. banking regulators to adjust their similar buffer? a. Comments on the 2018 Proposal 58 BCBS, Basel: A Global Regulatory Framework for More Resilient Banks and Banking Systems, paragraph 137 (Dec. 2010; revised June 2011), available at https://www.bis.org/publ/bcbs189.htm. PO 00000 Frm 00025 Fmt 4701 Sfmt 4702 FHFA received several comment letters on the 2018 proposal that argued that FHFA did not adequately address the risk posed by the size and importance of the Enterprises, particularly in light of the fact that during the 2008 financial crisis, the Enterprises proved to be ‘‘too-big-tofail.’’ Multiple commenters recommended FHFA consider adding a capital buffer due to the size of the Enterprises’ footprints. Other commenters suggested FHFA address the Enterprises’ size and importance in different ways, such as through the leverage ratio, through the credit risk capital grids, or with an asset-level surcharge that differed by the riskiness of the activity. b. U.S. Banking Framework The Dodd-Frank Wall Street Reform and Consumer Protection Act (DoddFrank Act) mandates that the Federal Reserve Board adopt, among other prudential measures, enhanced capital standards to mitigate the risk posed to financial stability by systemically important financial institutions. The Federal Reserve Board has implemented a number of measures designed to strengthen firms’ capital positions in a manner consistent with the Dodd-Frank Act’s requirement that such measures increase in stringency based on the systemic importance of the firm. The Federal Reserve Board has also finalized capital surcharges for the U.S. banking organizations of the greatest systemic importance that have been deemed global systemically important bank holding companies (GSIBs). These GSIB capital surcharges are calibrated based on the Federal Reserve Board’s measures of each GSIB’s systemic footprint under an ‘‘expected impact’’ framework that considers the harm that the GSIB’s failure would cause to the financial system as adjusted by the likelihood that the GSIB will fail. Because the failure of a GSIB might undermine financial stability and thus cause greater negative externalities than might the failure of a firm that is not a GSIB, a probability of default that would be acceptable for a non-GSIB might be unacceptably high for a GSIB. Lowering the probability of a GSIB’s default reduces the risk to financial stability. The most straightforward means of lowering the probability of a GSIB’s default is to require it to hold more regulatory capital relative to its riskweighted assets than non-GSIBs are required to hold. E:\FR\FM\30JNP2.SGM 30JNP2 39298 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 c. Rationale and Sizing As discussed in Section III.B.4, the lessons of the 2008 financial crisis have established that the failure of an Enterprise could do significant harm to the national housing finance markets, as well as the U.S. economy more generally. The Enterprises remain the dominant participants in the housing finance system, owning or guaranteeing 44 percent of residential mortgage debt outstanding as of September 30, 2019. The Enterprises also continue to control critical infrastructure for securitizing and administering $5.5 trillion of singlefamily and multifamily MBS. The Enterprises’ imprudent risk-taking and inadequate capitalization led to their near collapse and were among the proximate causes of the 2008 financial crisis. The precipitous financial decline of the Enterprises was also among the most destabilizing events of the 2008 financial crisis, leading to their taxpayer-backed rescue in September 2008. Even today, a perception continues to persist that the Enterprises are ‘‘too big to fail.’’ This perception reduces the incentives of creditors and other counterparties to discipline risktaking by the Enterprises. This perception also produces competitive distortions to the extent that the Enterprises can fund themselves at a lower cost than other market participants. Pursuant to the Safety and Soundness Act, as amended by HERA, the FHFA Director’s principal duties are, among other duties, to ensure that each Enterprise operates in a safe and sound manner and that the operations and activities of each Enterprise foster liquid, efficient, competitive, and resilient national housing finance markets.59 For the reasons below, FHFA is proposing to incorporate into each Enterprise’s PCCBA an Enterprisespecific stability capital buffer that is tailored to the risk that the Enterprise’s default or other financial distress could have on the liquidity, efficiency, competitiveness, or resiliency of the national housing finance markets (housing finance market stability risk).60 First, an Enterprise-specific stability capital buffer would foster liquid, efficient, competitive, and resilient national housing finance markets by 59 12 U.S.C. 4513(a)(1). proposed stability capital buffer should not be construed to imply or otherwise suggest that a similar capital surcharge would necessarily be appropriate for the Enterprises’ counterparties or other market participants in the housing finance system. Some of these market participants do not pose much, if any, risk to the liquidity, efficiency, competitiveness, or resiliency of national housing finance markets. 60 FHFA’s VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 reducing the expected impact of the Enterprise’s failure on the national housing finance markets. Under a regulatory capital framework in which each Enterprise is subject to the same capital requirements and has the same probability of default, a larger Enterprise’s default would nonetheless still pose a greater expected impact due to the greater magnitude of the effects of its default on the national housing finance markets. As a result, a probability of default that might be acceptable for a smaller Enterprise might be unacceptably high for a larger Enterprise. By subjecting a larger Enterprise to a larger capital surcharge, an Enterprise-specific stability capital buffer would reduce the probability of a larger Enterprise’s default, aligning the expected impact of its default with that of a smaller Enterprise. Second, an Enterprise-specific stability capital buffer also would foster liquid, efficient, competitive, and resilient national housing finance markets by creating incentives for each Enterprise to reduce its housing finance market stability risk by curbing its market share and growth in ordinary times, preserving room for a larger role during a period of financial stress. Third, an Enterprise-specific stability capital buffer could offset any funding advantage that an Enterprise might have on account of being perceived as ‘‘too big to fail.’’ That, in turn, would remove the incentive for counterparties to shift risk to the Enterprise, where that incentive not only increases the housing finance market stability risk posed by the Enterprise but also undermines the competitiveness of the national housing finance markets. Fourth, a larger capital cushion at an Enterprise could afford the Enterprise and FHFA more time to address emerging weaknesses at the Enterprise that could adversely impact the national housing finance markets. In addition to mitigating national housing finance market risk, the additional time afforded by a larger capital cushion could help FHFA ensure that each Enterprise operates in a safe and sound manner. Finally, again with respect to safety and soundness, any perception that an Enterprise is ‘‘too big to fail’’ leads to moral hazard that undermines market discipline by creditors and other counterparties over the risk taking at an Enterprise. By increasing the regulatory capital at an Enterprise, the stability capital buffer would shift more tail risk back to the Enterprise’s shareholders, which should have the added benefit of offsetting any ‘‘too big to fail’’ funding advantage arising from unpriced tail risk. The resulting enhanced market PO 00000 Frm 00026 Fmt 4701 Sfmt 4702 discipline should enhance safety and soundness by increasing the likelihood that the Enterprise’s risks are appropriately managed. FHFA is proposing a stability capital buffer based on a market share approach. Alternatively, FHFA is seeking comment on an additional approach that would have the Enterprises compute their stability capital buffer in a manner analogous to the U.S. banking approach for determining the GSIB surcharge. d. Market Share Approach Under FHFA’s market share approach, an Enterprise’s stability capital buffer would depend on an Enterprise’s share of total residential mortgage debt outstanding that exceeds a threshold of 5.0 percent market share. The stability capital buffer, expressed as a percent of adjusted total assets, would increase by 5 basis points for each percentage point of market share exceeding that threshold. For purposes of determining the stability capital buffer, the Enterprise’s mortgage assets would mean the sum of: • The unpaid principal balance of its single-family mortgage exposures, including any single-family loans that secure MBS guaranteed by the Enterprise; • The unpaid principal balance of its multifamily mortgage exposures, including any multifamily loans that secure MBS guaranteed by the Enterprise; • The carrying value of its Enterprise MBS or Ginnie Mae MBS, PLS, and other securitization exposures (other than its retained CRT exposures); and • The exposure amount of any other mortgage assets. Residential mortgage debt outstanding would mean the amount of mortgage debt outstanding secured by singlefamily or multifamily residences that are located in the United States (excluding any mortgage debt outstanding secured by non-farm, nonresidential, or farm properties). FHFA would publish the residential mortgage debt outstanding as of the end of each calendar year, potentially using similar data published by the Federal Reserve Board. Among other considerations, FHFA developed this market share-based calibration of the stability capital buffer based on a linear interpolation between two points. First, FHFA began with an assumption that an Enterprise that has a share of total residential mortgage debt outstanding equal to 5.0 percent—as of September 30, 2019, roughly $632 billion in single-family and multifamily mortgage exposures owned or E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 guaranteed—would not merit a stability capital buffer to mitigate its national housing finance stability risk. An Enterprise with that 5.0 percent market share would have more assets than U.S. Bancorp ($487.6 billion in total assets, as of September 30, 2019), which is not a GSIB, but less assets than the next largest U.S. banking organization, Morgan Stanley ($902.6 billion in total assets as of September 30, 2019), which is a GSIB. At the other extreme, the largest GSIB surcharge for a U.S. GSIB is that of JPMorgan Chase, at 3.5 percent of riskweighted assets as of September 30, VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 2019. An Enterprise would roughly approximate an equivalent stability capital buffer if it had a 25 percent share of total residential mortgage debt outstanding. At that market share, the Enterprise’s stability capital buffer would be 1.00 percent of its adjusted total assets, approximately equivalent to the 3.5 percent surcharge expressed as a percent of risk-weighted assets under the September 30, 2019 average net credit risk weight on the Enterprises’ mortgage exposures of 28 percent. Under this market share approach, as of September 30, 2019, Fannie Mae and Freddie Mac would have had stability PO 00000 Frm 00027 Fmt 4701 Sfmt 4702 39299 capital buffers of, respectively, 1.05 and 0.64 percent of adjusted total assets. Under the September 30, 2019 28 percent average risk weight on their exposures, Fannie Mae and Freddie Mac’s stability capital buffers would have been 3.8 and 2.3 percent of riskweighted assets, respectively, roughly in line with U.S. GSIBs of similar size. The following Table 7 details the calculation of the proposed stability capital buffer as of December 31, 2007, September 30, 2017, and September 30, 2019. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Question 16. Is the market share approach appropriately formulated and calibrated to mitigate the national housing finance market stability risk posed by an Enterprise? If not, what modifications should FHFA consider to ensure an appropriate calibration? Question 17. Is the market share approach appropriately formulated and calibrated to ensure each Enterprise operates in a safe and sound manner? If not, what modifications should FHFA consider to ensure an appropriate calibration? VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 e. Alternative Approach FHFA is soliciting comment on whether to replace or supplement the market share approach discussed in Section VII.A.3.d with another approach that considers other indicators of the housing finance market stability risk posed by an Enterprise. Other such indicators could include the ownership of the Enterprise’s MBS and debt by other financial institutions, the degree of control by the Enterprise over key securitization infrastructure, the extent of the Enterprise’s role in aggregating PO 00000 Frm 00028 Fmt 4701 Sfmt 4702 and distributing credit risk through CRT, the Enterprise’s reliance on shortterm debt funding, or the Enterprise’s expected debt issuances during a financial stress to fund purchases of mortgage exposures out of securitization pools. One specific alternative approach under consideration by FHFA is to replace or supplement the market share approach with a modified version of the U.S. banking framework’s two methods for determining a GSIB’s capital E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.006</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39300 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules surcharge.61 Under method 1, a U.S. GSIB determines its capital surcharge using the sum of weighted indicator scores that span five categories correlated with systemic importance— size, interconnectedness, crossjurisdictional activity, substitutability, and complexity. For each indicator, the U.S. GSIB’s indicator score is its own measure of the indicator divided by the aggregate global measure of that indicator, which is based on other GSIBs’ measures. Method 2 uses similar inputs but replaces the substitutability indicators with metrics for the U.S. GSIB’s reliance on short-term wholesale funding. Method 2 is also calibrated in a manner that generally will result in GSIB capital surcharges that are higher than those calculated under method 1. FHFA is soliciting comment on whether to calibrate the stability capital buffer based on some subset of the U.S. banking framework’s five categories— for example, size, interconnectedness, and substitutability—and exclude the indicators for cross-jurisdictional activity or complexity. In particular, cross-jurisdictional activity might not be an important driver of the national housing finance market stability risk posed by an Enterprise. FHFA is also soliciting comment on whether modifications to the definitions or calculations of the U.S. banking framework’s specific GSIB surcharge indicators would be appropriate to ensure the resulting score or scores are correlated with an Enterprise’s national housing finance market stability risk. For example, the Enterprises play an integral role in the national housing finance market, and there are few, if any, natural substitutes for that role, but an Enterprise’s amount of underwritten transactions in debt and equity markets, one of the substitutability indicators under the U.S. banking framework, might not be strongly correlated with that risk. Another approach might be to adopt a modified version of the U.S. banking framework’s method and then use a similar measure of an Enterprise’s reliance on short-term debt funding (perhaps with adjustments for the expected debt issuances during a financial stress to fund purchases of NPLs out of securitization pools) as the basis for a replacement for the U.S. banking framework’s method 2. Question 18. Should the Enterprisespecific stability capital buffer be determined using the U.S. banking framework’s approach to calculating capital surcharges for GSIBs? 61 12 CFR part 217, subpart. H (Federal Reserve Board). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Question 19. What, if any, modifications to the U.S. banking framework’s approach to calculating capital surcharges for GSIBs are appropriate for determining the Enterprise-specific stability capital buffer? Question 20. Should the Enterprisespecific stability capital buffer be determined based on a sum of the weighted indicators for size, interconnectedness, and substitutability under the U.S. banking framework? Question 21. Which, if any, indicators of the housing finance market stability risk posed by an Enterprise, other than its market share, should be used to size the Enterprise’s stability capital buffer? How should those other indicators be measured and weighted to produce a score of the housing finance market stability risk posed by an Enterprise? Question 22. What, if any, measure of the Enterprise’s short-term debt funding or expected debt issuances during a financial stress to fund purchases of NPLs out of securitization pools should be used to size the Enterprise’s stability capital buffer? B. Leverage Buffer In addition to the payout restrictions posed by the PCCBA, to avoid limits on capital distributions and discretionary bonus payments, an Enterprise also would be required to maintain tier 1 capital in excess of the amount required under the tier 1 leverage ratio requirement by at least the amount of a PLBA equal to 1.5 percent of the Enterprise’s adjusted total assets. The primary purpose of the PLBA would be to serve as a non-risk-based supplementary measure that provides a credible backstop to the combined PCCBA and risk-based capital requirements. From a safety-andsoundness perspective, each of the riskbased and leverage ratio requirements offsets potential weaknesses of the other. Taken together, well-calibrated risk-based capital requirements working with a credible leverage ratio requirement are more effective than either would be in isolation. FHFA deems it important that the bufferadjusted risk-based and leverage requirements are also closely calibrated to each other so that they have an effective complementary relationship. To size the PLBA, FHFA looked first to the PCCBA of each Enterprise. At 1.5 percent of adjusted total assets, the PLBA for Fannie Mae and Freddie Mac would be, respectively, $53 billion and $38 billion as of September 30, 2019. For Fannie Mae, the PLBA would be less than its PCCBA, while for Freddie Mac the reverse is true. These results PO 00000 Frm 00029 Fmt 4701 Sfmt 4702 39301 suggest that 1.5 percent PLBA is calibrated to ensure that the PCCBA and PLBA have an effective complementary relationship such that each is independently meaningful. FHFA also looked to the sizing of similar leverage buffer requirements under the U.S. banking framework. Some large U.S. banking organizations are required to maintain a supplementary leverage ratio requirement of 3.0 percent of their total leverage exposure and, to avoid restrictions on distributions and discretionary bonuses, a leverage buffer requirement of 2.0 percent of their total leverage exposure. That 2.0 percent total leverage buffer requirement is 40 percent of the 5.0 percent bufferadjusted leverage ratio requirement to avoid payout restrictions. Similarly, a 1.5 percent PLBA for the Enterprises would be 37.5 percent of the 4.0 percent buffer-adjusted leverage ratio requirement to avoid payout restrictions. Question 23. Is the PLBA appropriately sized to backstop the PCCBA-adjusted risked-based capital requirements? Question 24. Should the PLBA for an Enterprise be sized as a fraction or other function of the PCCBA of the Enterprise? If so, how should the PLBA of an Enterprise be calibrated based on the Enterprise’s PCCBA? C. Payout Restrictions An Enterprise would be subject to limits on its capital distributions and discretionary bonus payments if either its capital conservation buffer is less than its PCCBA, as discussed in Section VII.A, or its leverage buffer is less than its PLBA, as discussed in Section VII.B. An Enterprise also may not make distributions or discretionary bonus payments during the current calendar quarter if, as of the end of the previous calendar quarter: (i) The eligible retained income of the Enterprise was negative; and (ii) either (A) the capital conservation buffer of the Enterprise was less than its stress capital buffer, or (B) the leverage buffer of the Enterprise was less than its PLBA. The capital conservation buffer is composed solely of CET1 capital. An Enterprise’s capital conservation buffer is equal to the lowest of the following, calculated as of the last day of the previous calendar quarter: • The Enterprise’s adjusted total capital minus the minimum amount of adjusted total capital required under the proposed rule; • The Enterprise’s tier 1 capital minus the minimum amount of tier 1 E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules capital required under the proposed rule; or • The Enterprise’s CET1 capital minus the minimum amount of CET1 capital required under the proposed rule. An Enterprise’s maximum payout ratio determines the extent to which it is subject to limits on capital distributions and discretionary bonuses. The maximum payout ratio is the percent of eligible retained income that an Enterprise can pay out in the form of distributions and discretionary bonus payments during the current calendar quarter. The eligible retained income of an Enterprise is the greater of: (i) The Enterprise’s net income for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income; and (ii) the average of the Enterprise’s net income, as applicable, for the four calendar quarters preceding the current calendar quarter. The maximum payout ratio is itself a function of the extent to which the applicable capital buffer is less than the applicable prescribed buffer amount, as set forth on Table 8. If an Enterprise is subject to a maximum payout ratio, the payout restrictions would apply to all capital distributions, which generally extends to dividends or payments on, or repurchases of, CET1, tier 1, or tier 2 capital instruments (except, with respect to a payment on a tier 2 capital instrument, if the Enterprise does not have full discretion to permanently or temporarily suspend such payments without triggering an event of default). The payout restrictions would also extend to discretionary bonuses, broadly defined to include any payment made to an executive officer of an Enterprise where the Enterprise retains discretion as to whether to make, and the amount of, the payment, the amount paid is determined by the Enterprise without prior promise to, or agreement with, the executive officer, and the executive officer has no contractual right to the payment. FHFA expects that each Enterprise generally will seek to avoid any payout restriction by maintaining regulatory capital in excess of its buffer-adjusted risk-based and leverage ratio requirements during ordinary times. FHFA also expects that, consistent with its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle, each Enterprise might draw down its buffers during a period of financial stress. However, it would not be consistent with the safe and sound operation of an Enterprise for the Enterprise to maintain regulatory capital less than its buffer-adjusted requirements in the ordinary course except for some reasonable period after a financial stress, pending the Enterprise’s efforts to raise and retain regulatory capital. Nothing in this proposed rule limits the authority of FHFA to take action to address unsafe or unsound practices or violations of law, including actions inconsistent with an Enterprise’s charter. FHFA could, depending on the facts and circumstances, determine that it is an unsafe or unsound practice, or that it is inconsistent with the Enterprise’s statutory mission, for an Enterprise to maintain regulatory capital that is less than its buffer-adjusted requirements during ordinary times. If FHFA were to make that determination, FHFA would have all of its enforcement and other authorities, including its authority to issue a cease-and-desist order, to require the Enterprise to remediate that unsafe or unsound practice—for example, by developing and implementing a plan to raise additional regulatory capital. FHFA is soliciting comments on whether some or all of the payout restrictions should be phased-in over a transition period. In anticipation of the potential development and implementation of a capital restoration plan by each Enterprise, tailored exceptions to the payout restrictions might be appropriate to facilitate an Enterprise’s issuances of equity to new investors, particularly to the extent that any tailored exception would shorten the time required for an Enterprise to achieve the regulatory capital amounts contemplated by the proposed rule or otherwise enhance its safety and soundness. For example, a tailored exception to allow for some distributions on an Enterprise’s newly issued preferred stock might increase investor demand for the offerings of those shares. Similarly, a tailored exception for some limited regular dividends on an Enterprise’s common stock might increase investor demand for those shares. Question 25. Are the payout restrictions appropriately formulated and calibrated? Question 26. Should there be any sanction or consequence other than payout restrictions triggered by an Enterprise not maintaining a capital conservation buffer or leverage buffer in 62 An Enterprise’s ‘‘capital buffer’’ means, as applicable, its capital conservation buffer or its leverage buffer. 63 An Enterprise’s ‘‘prescribed buffer amount’’ means, as applicable, its PCCBA or its PLBA. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00030 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.007</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39302 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules excess of the applicable PCCBA or PLBA? Question 27. Should the payout restrictions be phased-in over an appropriate transition period? If so, what is an appropriate transition period? Question 28. Should the payout restrictions provide exceptions for dividends on newly issued preferred stock, perhaps with any exceptions limited to some transition period following conservatorship? Question 29. Should the payout restrictions provide an exception for some limited dividends on common stock over some transition period? VIII. Credit Risk Capital: Standardized Approach khammond on DSKJM1Z7X2PROD with PROPOSALS2 A. Single-Family Mortgage Exposures The standardized credit risk-weighted assets for each single-family mortgage exposure would be determined using grids and risk multipliers that together would assign an exposure-specific risk weight based on the risk characteristics of the single-family mortgage exposure. The resulting exposure-specific credit risk capital requirements generally would be similar to those of the 2018 proposal, subject to some simplifications and refinements. As discussed in Section VIII.A.3, the base risk weight would be a function of the single-family mortgage exposure’s MTMLTV, among other things. The MTMLTV would be subject to a countercyclical adjustment to the extent that national house prices are 5.0 percent greater or less than an inflationadjusted long-term trend, as discussed in Section VIII.A.4. This base risk weight would then be adjusted based on other risk attributes, including any mortgage insurance or other loan-level credit enhancement and the counterparty strength on that enhancement, as discussed in Sections VIII.A.5 and VIII.A.6. Finally, as discussed in Section VIII.A.7, this adjusted risk weight would be subject to a floor of 15 percent. 1. Single-Family Business Models The core of an Enterprise’s singlefamily guarantee business is acquiring single-family mortgage loans from mortgage companies, commercial banks, credit unions, and other mortgage lenders, packaging those loans into MBS, and selling the MBS either back to the original lenders or to other private investors in exchange for a fee that represents a guarantee of timely principal and interest payments on those MBS. The Enterprises engage in the acquisition and securitization of single- VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 family mortgage exposures primarily through two types of transactions: Lender swap transactions; and cash window transactions. In a lender swap transaction, lenders pool eligible singlefamily loans together and deliver the pool of loans to an Enterprise in exchange for an MBS backed by those single-family mortgage loans, which the lenders generally then sell in order to use the proceeds to fund more mortgage loans. In a cash window transaction, an Enterprise purchases single-family loans from a large, diverse group of lenders and then, at a later date, securitizes the acquired loans into an MBS. For MBS issued as a result of either lender swap transactions or cash window transactions, the Enterprises provide investors with a guarantee of the payment of principal and interest payments in exchange for a guarantee fee. Single-family loans that have been purchased but have not yet been securitized are held in the Enterprises’ whole loan portfolios. In addition, the Enterprises also repurchase some delinquent loans from their guaranteed MBS subject to certain requirements and restrictions. Except to the extent that they transfer the risk to private investors, the Enterprises are exposed to credit risk through their ownership of single-family mortgage exposures and their guarantees of MBS. Consequently, the Enterprises attempt to mitigate the likelihood of incurring credit losses in a variety of ways. One way to reduce potential credit losses is through loan-level credit enhancements such as mortgage insurance. Another way of reducing potential credit losses is through the transfer of risk at the pool level through securitization or synthetic securitization transactions. 2. Calibration Framework In general, FHFA calibrated the base risk weights and risk multipliers for single-family mortgage exposures to require credit risk capital sufficient to absorb the lifetime unexpected losses incurred on single-family mortgage exposures experiencing a shock to house prices similar to that observed during the 2008 financial crisis. Lifetime unexpected losses are the difference between lifetime credit losses in such conditions (also known as stress losses) and expected losses. As adverse economic conditions are not explicitly defined, the loss projections that underpin the credit risk capital requirements in the proposed rule are based on several different economic scenarios. Each Enterprise used economic scenarios that it defined to project loan-level credit risk capital. PO 00000 Frm 00031 Fmt 4701 Sfmt 4702 39303 In addition, FHFA used the baseline and severely adverse scenario defined in DFAST to project unexpected losses. FHFA used these pre-existing scenarios as a starting point for its estimations in order to provide economic scenarios consistent with those of the U.S. banking framework for stress tests required under DFAST. FHFA also used these scenarios to ensure a straightforward, transparent approach to the proposed rule’s capital requirements. The DFAST scenarios include forecasts for macroeconomic variables, including house prices, interest rates, and unemployment rates. House prices are used to define the MTMLTV ratio, where the likelihood of a loss occurring upon default increases as the proportion of equity to loan value decreases. Therefore, the projected house price path is the predominant macroeconomic driver of single-family stress scenarios. The Enterprises used similar house price paths to project stress losses. In the stress scenarios used by FHFA and the Enterprises, nationally averaged house prices declined by 25 percent from peak to trough (the period of time between the shock and the recovery), which is consistent with the decline in house prices observed during the 2008 financial crisis. The 25 percent house price decline is also broadly consistent with assumptions used in the DFAST severely adverse scenario over the past several years, although the 2020 DFAST cycle assumes a 28 percent house price decline in its severely adverse scenario. However, the trough and recovery assumptions used by FHFA and the Enterprises are somewhat more conservative than the observed house price recoveries post crisis. Using these stress scenarios, the single-family grids were, as a general rule, calibrated based on estimates of unexpected losses from the Enterprises’ internal models and FHFA’s publicly available model.64 The Enterprises and FHFA ran synthetic and actual loans with a baseline risk profile through their own credit models using these stress scenarios. Each single-family segment has its own baseline risk profile, which is discussed segment-by-segment in VIII.A.3. Consequently, each cell of each single-family grid represents projected unexpected losses, converted to a risk weight, for a baseline loan with a 64 FHFA’s single-family loss model is available on its website at fhfa.gov. For performing loans, all three models were used to construct the singlefamily grid. For single-family mortgage exposures other than performing loans, FHFA relied primarily on the Enterprises’ estimates of unexpected losses. E:\FR\FM\30JNP2.SGM 30JNP2 39304 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 particular combination of primary risk factors. The risk multipliers were similarly calibrated based on estimates of unexpected losses from the Enterprises’ internal models and FHFA’s publicly available model. The Enterprises varied the secondary risk factors, specific to each single-family segment, to estimate each risk factor’s multiplicative effects on estimates of unexpected losses for the baseline loan in each single-family segment. FHFA considered the risk multipliers estimated by the Enterprises, which were generally consistent in magnitude and direction, in conjunction with its own estimated values in determining the proposed single-family risk multipliers. Question 30. Is the methodology used to calibrate the credit risk capital requirements for single-family mortgage exposures appropriate to ensure that the exposure is backed by capital sufficient to absorb the lifetime unexpected losses incurred on single-family mortgage exposures experiencing a shock to house prices similar to that observed during the 2008 financial crisis? Question 31. What, if any, changes should FHFA consider to the methodology for calibrating credit risk capital requirements for single-family mortgage exposures? 3. Base Risk Weights The proposed rule would require an Enterprise to determine a base risk weight for each single-family mortgage exposure using one of four grids, one for each single-family segment. These segments are based on payment performance because as a risk factor it is a material determinant of projected unexpected loss. Additional risk factors affect unexpected losses differently depending on where a single-family mortgage exposure is in its life cycle. The base risk weight for a single-family mortgage exposure would therefore change over the life cycle of the singlefamily mortgage exposure, generally decreasing when the single-family mortgage exposure is seasoned and performing, and increasing when the single-family mortgage exposure is delinquent or recently delinquent. The four single-family segments would be: • Non-performing loan (NPL): A single-family mortgage exposure that is 60 days or more past due. • Modified re-performing loan (modified RPL): A single-family mortgage exposure that is not an NPL and has previously been modified or entered a repayment plan. • Non-modified re-performing loan (non-modified RPL): A single-family VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 mortgage exposure that is not an NPL, has not been previously modified or entered a repayment plan, and has been an NPL at any time in the last 48 calendar months. • Performing loan: A single-family mortgage exposure that is not an NPL, a modified RPL, or a non-modified RPL. A non-modified RPL generally transitions to a performing loan after not being an NPL at any time in the prior 48 calendar months. Each single-family segment would have a unique, two-dimensional risk weight grid (single-family grid) that an Enterprise would use to determine its base risk weight before subsequently applying risk multipliers. The dimensions of the single-family grids would vary by single-family segment to allow the single-family grids to differentially incorporate key risk drivers into the base risk weights on a segment-by-segment basis. The single-family grids reflect several notable differences from the singlefamily grids in the 2018 proposal. First, FHFA combined the ‘‘New Originations’’ and ‘‘Performing Seasoned’’ base grids into one singlefamily grid for performing loans. Commenters recommended that the single-family segmentation could be simplified in this way without a meaningful loss of accuracy. Second, for purposes of the definition of NPL, the proposed rule would define delinquency as 60 days or more past due, while the 2018 proposal defined delinquency as 30 days past due. Commenters recommended this change in order to mitigate variations in regulatory capital requirements, and because a significant portion of 30-day past due loans become current in the following month or do not become more delinquent. The practical effect of this change is that the projected unexpected losses on 30-day past due loans has been reallocated from the single-family grid for NPLs to the single-family grid for performing loans, increasing the base credit risk capital requirements for performing loans above where they were in the 2018 proposal. In addition, following the redefinition of delinquency, the proposed rule does not contemplate a return to performing loan status for a non-modified RPL with 36 consecutive timely payments and no more than 1 missed payment in the 12 months preceding that 36-month period. Third, the single-family grids would reflect credit risk capital that was allocated using the ‘‘number of borrowers’’ and ‘‘loan balance’’ singlefamily risk multipliers of the 2018 proposal. As discussed in Section VIII.A.5, these risk multipliers are not PO 00000 Frm 00032 Fmt 4701 Sfmt 4702 included in the proposed rule. In order to ensure the risk-based capital requirements do not decrease by the amount of capital that would have otherwise been required due to these risk factors, FHFA has redistributed the capital requirements across cells of the single-family grids. Fourth, the MTMLTVs used to assign base risk weights in the proposed singlefamily grids would be subject to a countercyclical adjustment as described in VIII.A.4. Performing Loans The primary risk factors for performing loans are credit score and MTMLTV (after factoring in the loanlevel countercyclical adjustment). Credit score correlates strongly with the likelihood of a borrower default, while MTMLTV relates to both the likelihood of default and the severity of a potential loss should a borrower default (loss given default).65 For the first five scheduled payment dates, an Enterprise would use the credit score at origination to determine the base risk weight. After that time, an Enterprise would use the refreshed or updated credit score. As discussed in Section VIII.A.4, an Enterprise would use the adjusted or unadjusted MTMLTV, depending on whether the loan-level countercyclical adjustment is non-zero (except that for the first five scheduled payment dates after the origination of a single-family mortgage exposure, an Enterprise would use OLTV rather than MTMLTV). The single-family grid for performing loans is presented below in Table 9. For purposes of this table, credit score means the original credit score of the single-family mortgage exposure if the loan age is less than 6, or the refreshed credit score otherwise. 65 As in the 2018 proposal, FHFA notes that the Enterprises currently rely on Classic FICO for product eligibility, loan pricing, and financial disclosure purposes, and therefore the single-family grid for performing loans was estimated using Classic FICO credit scores. Throughout the proposed rule, the use of term ‘‘credit score’’ should be interpreted to mean Classic FICO credit scores. If the Enterprises were to begin using a different credit score for these purposes, or multiple scores, the single-family grids and multipliers might need to be recalibrated. Related to that, in February 2020, the Enterprises published a Joint Credit Score Solicitation that describes the process for credit score model developers to submit applications to the Enterprises. The validation and approval of credit score models will be a multi-year effort by the Enterprises under requirements established by FHFA’s final rule on the process for validation and approval of credit score models. 84 FR 41886 (Aug. 16, 2019). E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 The base risk weights for performing loans do not reflect credit enhancements such as mortgage insurance, which would generally lower an Enterprise’s risk-based capital requirement for a single-family mortgage exposure with an LTV greater than 80 percent. Risk weight adjustments for credit enhancements are discussed in Section VIII.A.6. Aside from the primary risk factors represented in the dimensions of the single-family grid for performing loans, there are several secondary risk factors accounted for in the risk profile of the synthetic loan used in the calibration of the base risk weights. Those secondary risk factors, along with the values that determine the baseline risk profile for performing loans, are: Loan age less than 24 months; 30-year fixed-rate; purchase; owner-occupied; single-unit; retail channel sourced; debt-to-income ratio between 25 percent and 40 percent; no second lien; full documentation; non-interest-only; not streamlined refinance loans; and zero cohort burnout (described below).66 66 The CFPB’s ability-to-repay rule generally prohibits interest-only and low-documentation loans. However, these risk factors may be present on single-family mortgage exposures originated prior to the 2008 financial crisis. PO 00000 Frm 00033 Fmt 4701 Sfmt 4702 Unlike the 2018 proposal, neither loan size (greater than $100,000) nor the number of borrowers (multiple) is a secondary risk factor. Variations in the credit risk capital requirements due to these secondary risk factors are captured using risk multipliers, as discussed in Section VIII.A.5. Non-Modified RPLs The primary risk factors for nonmodified RPLs are MTMLTV (after factoring in the loan-level countercyclical adjustment) and the reperforming duration. The re-performing duration is the number of scheduled payment dates since the non-modified RPL was last an NPL (60 days or more past due), and is a strong predictor of the likelihood of a subsequent default. MTMLTV is a strong predictor of the likelihood of default and loss given default for single-family mortgage exposures in this segment. The proposed single-family grid for nonmodified RPLs is presented below in Table 10. For purposes of this table, non-modified re-performing duration means the number of scheduled payment dates since the non-modified RPL was last an NPL. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.008</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Credit scores have values ranging from 300 to 850, and OLTVs typically range from 10 percent to 97 percent. MTMLTVs typically range from 10 percent to upwards of 120 percent. The Enterprises conduct most of their new single-family businesses within an OLTV range of 70 percent to 95 percent. FHFA included MTMLTV buckets beyond 95 percent to account for adverse changes in home prices subsequent to origination, as well as to account for the inclusion of streamlined refinance loans in the single-family segment. In the 2018 proposal, the singlefamily grid for new originations had a distinct treatment for loans with an 80 percent OLTV to account for the high volume and distinct features of these particular loans. FHFA determined that including 80 percent OLTV loans with other single-family mortgage exposures with LTVs between 75 percent and 80 percent did not result in a meaningful loss of accuracy, so the single-family grid for performing loans has combined their treatment. As previously discussed, the base risk weights for performing loans include projected unexpected losses for single-family mortgage exposures that are between 30 and 60 days past due. 39305 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Aside from the primary risk factors represented in the single-family grid for non-modified RPLs, there are many secondary risk factors accounted for in the risk profile of the synthetic loan used in the calibration of the base risk weights. These secondary risk factors, Aside from the primary risk factors represented in the dimensions of the single-family grid for modified RPLs, there are many secondary risk factors accounted for in the risk profile of the synthetic loan used in the calibration of the base risk weights. These secondary risk factors, along with the values that determine the baseline risk profile for modified RPLs, are the same as those for non-modified RPLs with one addition; a payment change from modification greater than or equal to -20 percent and VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 along with the values that determine the baseline risk profile for non-modified RPLs, are the same as those for performing loans with the inclusion of two additional features—refreshed credit scores between 660 and 700, and a maximum previous delinquency of less than 60 days—and the exclusion of loan age and cohort burnout. Variations in the credit risk capital requirements due to these secondary risk factors would be captured using risk multipliers, as discussed in Section VIII.A.5. Modified RPLs The primary risk factors for modified RPLs are similar to non-modified RPLs. However, along with MTMLTV (after factoring in the loan-level countercyclical adjustment), the second less than 0 percent. Variations in the credit risk capital requirements due to these secondary risk factors would be captured using risk multipliers, as discussed in Section VIII.A.5. Unlike non-modified RPLs, modified RPLs never revert to being classified as performing loans, even after four or more years of re-performance. NPLs The primary risk factors for NPLs are the days past due and MTMLTV (after PO 00000 Frm 00034 Fmt 4701 Sfmt 4702 primary risk factor in the segment would be either the re-performing duration or the performing duration, whichever is less. The re-performing duration is the number of scheduled payment dates since the modified RPL was last an NPL (60 days or more past due), while the performing duration measures the number of scheduled payment dates since the last modification of a modified RPL. The proposed single-family grid for modified RPLs is presented below in Table 11. For purposes of this table, modified reperforming duration means the lesser of: (i) The number of scheduled payment dates since the modified RPL was last modified; and (ii) the number of scheduled payments dates the modified RPL was last an NPL. factoring in the loan-level countercyclical adjustment). Days past due is the number of days a singlefamily mortgage exposure is past due and is a strong predictor of the likelihood of default for NPLs. MTMLTV is a strong predictor of loss given default for exposures in this segment. The proposed single-family grid for NPLs is presented below in Table 12. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.010</GPH> Re-performing duration is divided into four categories such that the base risk weights would generally decrease as re-performing duration increases. When the re-performing duration is greater than three years, the base risk weight for the non-modified RPL would begin to approximate the base risk weight for a performing loan. A singlefamily mortgage exposure that reperforms for greater than four years, and has not been modified, would revert to being classified as a performing loan. EP30JN20.009</GPH> 39306 The base risk weights detailed in the single-family grid for NPLs are noticeably non-monotonic as the number of days past due increases, particularly in the highest (right-most) MTMLTV column. This is because as the number of days past due increases for an NPL with higher LTV, so does the expected loss. Because the credit risk capital requirement has been calibrated as the difference between stress loss and expected loss, when expected loss increases and grows closer to stress loss, the projected unexpected loss (reflected by the base risk weight) decreases. The increase in expected loss should be reflected in commensurately higher ALLL. Aside from the primary risk factors represented in the single-family grid for NPLs, there are several secondary risk factors accounted for in the risk profile of the synthetic loan used in the calibration of the base risk weights. These secondary risk factors, along with the values that determine the baseline risk profile for NPLs, are: 30-year fixedrate; owner-occupied; single-unit; retail channel sourced; and a refreshed credit score between 640 (inclusive) and 700. Variations in the credit risk capital requirements due to these secondary risk factors would be captured using risk multipliers, as discussed in Section VIII.A.5. Question 32. Are the base risk weights for single-family mortgage exposures appropriately formulated and calibrated to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 33. Are there any adjustments, simplifications, or other refinements that FHFA should consider for the base risk weights for singlefamily mortgage exposures? Question 34. Should the base risk weight for a single-family mortgage exposure be assigned based on OLTV or MTMLTV of the single-family mortgage exposure, or perhaps on the LTV of the single-family mortgage exposure based on the original purchase price and after adjusting for any paydowns of the original principal balance? VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Question 35. Should the base risk weight for a single-family mortgage exposure be assigned based on the original credit score of the borrower or the refreshed credit score of the borrower? Question 36. What steps, including any process for soliciting public comment on an ongoing basis, should FHFA take to ensure that the singlefamily grids and the real house price trend are updated from time to time as market conditions evolve? Question 37. Should a delinquency associated with a COVID–19-related forbearance cause a single-family mortgage exposure to become an NPL? Question 38. Which, if any, types of forbearances, payment plans, or modifications should be excluded from those that cause a single-family mortgage exposure to become a modified RPL? Should a forbearance, payment plan, or modification arising out of a COVID–19-related forbearance request cause a single-family mortgage exposure to become a modified RPL? 4. Countercyclical Adjustment The MTMLTVs used to assign base risk weights to single-family mortgage exposures in the single-family grids would be subject to a countercyclical adjustment an Enterprise would be required to make when national house prices increase or decrease by more than 5.0 percent from an estimated inflationadjusted long-term trend. Many commenters noted the pro-cyclical nature of the aggregate risk-based capital requirements of the 2018 proposal. Certain commenters recommended FHFA replace MTMLTV and refreshed credit scores with OLTV and original credit scores to reduce pro-cyclicality. Other commenters recommended FHFA continue to use MTMLTV and refreshed credit scores in order to provide a more accurate view of risk and achieve rational pricing and proper incentives. Additional commenters recommended FHFA base capital requirements on fundamental house values, while still other commenters suggested FHFA introduce a countercyclical requirement either through a countercyclical capital buffer or a countercyclical risk-based capital requirement. PO 00000 Frm 00035 Fmt 4701 Sfmt 4702 39307 The proposed formulaic countercyclical adjustment to loan-level single-family MTMLTVs would be based on FHFA’s U.S. all-transactions house price index (HPI). The adjustment would restrict decreases in MTMLTV during periods of rising vulnerabilities in house prices and limits increases in MTMLTV when vulnerabilities recede. The adjustment is designed to increase the resilience of the Enterprises when there is an elevated risk of above-normal losses and to reduce the need for additional capital during a period of financial stress. An Enterprise would calculate the MTMLTV adjustment by first estimating a long-term trend of FHFA’s quarterly, not-seasonally-adjusted HPI using a prescribed trough-to-trough methodology, deflated by the Consumer Price Index for All Urban Consumers, All Items Less Shelter in U.S. City Average. If the deflated all-transactions HPI exceeds the estimated long-term trend by more than 5 percentage points, the Enterprise would adjust upward the MTMLTV of every single-family mortgage exposure by the difference between the deflated all-transactions HPI and 5.0 percent. Otherwise, the Enterprise would use the unadjusted MTMLTV. On the other hand, if the deflated all-transactions HPI falls below the estimated long-term trend by more than 5 percentage points, the Enterprise would adjust downward the MTMLTV of every single-family mortgage exposure by the difference between the deflated all-transactions HPI and 5.0 percent. Otherwise, the Enterprise would use the unadjusted MTMLTV. In other words, if the HPI exceeds its long-term trend by more than 5 percentage points, the Enterprise would adjust upward the MTMLTV by the ratio of the HPI index actual value to the HPI index if it were at 5.0 percent over longterm trend. This adjustment, in effect, would reduce the house price used to calculate MTMLTV to the level expected if all house prices nationally adjusted downward by the percent the index exceeds 5.0 percent above trend. FHFA chose collars of 5.0 percent above and below the long-term trend in house prices because it would allow for MTMLTVs to reflect the best estimate of E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.011</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules market value most of the time, while restricting excessive MTMLTV increases or decreases during periods where house prices appear to deviate more materially from their long-term trend. The figure below presents the historical deflated all-transactions HPI series with both an estimated long-term trend and 5.0 percent collars above and below the trendline. When the HPI series is above or below the collars, the MTMLTV adjustment would be non-zero. The following Figure 1 and Table 13 provide an illustration of the historical data used to calculate the long-term trend in HPI, along with the plus/minus 5.0 percent collars, as well as examples of how single-family MTMLTVs would be adjusted under the proposed framework.67 67 The parameters of the long-run trend are estimated using linear regression on the natural logarithm of real HPI from the Q3 1975 trough to the Q2 2012 trough. Figure 1 shows the fitted values from the estimated long-run trend from Q1 1975 to Q3 2019. FHFA might need to revisit the calibration of the parameters in the event of future troughs. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00036 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.013</GPH> Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules EP30JN20.012</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39308 39309 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Table 13 illustrates three scenarios. Under the first scenario, 2006, Real HPI exceeds the long-term trend by more than 5.0 percent, so single-family house prices would be adjusted downward such that adjusted MTMLTV would be greater than MTMLTV. A single-family mortgage exposure with a 60 percent MTMLTV would be assigned a base risk weight using its adjusted MTMLTV of 71 percent. Similarly, an 80 percent MTMLTV would correspond to a 95 percent adjusted MTMLTV, while a 95 percent MTMLTV would correspond to a 113 percent adjusted MTMLTV. Under the second scenario, 2012, Real HPI is less than the long-term trend by more than 5.0 percent, so single-family house prices would be adjusted upward such that adjusted MTMLTV would be less than MTMLTV. For example, a singlefamily mortgage exposure with an 80 percent MTMLTV would be assigned a base risk weight using its adjusted MTMLTV of 69 percent. In the final scenario, September 30, 2019, Real HPI exceeds the long-term trend by 3.0 percent. In this case, because 3.0 percent is less than 5.0 percent, singlefamily house prices would not be adjusted, and adjusted MTMLTV would equal MTMLTV for all values of MTMLTV. Question 39. Is the MTMLTV adjustment appropriately formulated and calibrated to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? If not, what modifications should FHFA consider to ensure an appropriate formulation and calibration? Question 40. Does the MTMLTV adjustment strike an appropriate balance in mitigating the pro-cyclicality of the aggregate risk-based capital requirements while preserving a mortgage risk-sensitive framework? Are the collars set appropriately at 5.0 percent above or below the long-term index trend? Question 41. How should the longterm house price trend be determined for the purpose of any countercyclical adjustment to a single-family mortgage exposure’s credit risk capital requirement? 5. Risk Multipliers The proposed rule would require an Enterprise to adjust the base risk weight for a single-family mortgage exposure to account for additional loan characteristics using a set of singlefamily-specific risk multipliers. The risk multipliers would refine the base risk weights to account for risk factors beyond the primary risk factors reflected in the single-family grids, and for variations in secondary risk factors not captured in the risk profiles of the synthetic loans used to calibrate the single-family grids. The adjusted risk weight for a single-family mortgage exposure would be the product of the base risk weight, the combined risk multiplier, and any credit enhancement multiplier, which is discussed in Section VIII.A.6. The risk multipliers correspond to common characteristics that increase or decrease the projected unexpected losses of a single-family mortgage exposure. Although the specified risk characteristics are not exhaustive, they capture key real estate loan performance drivers, and are commonly used in mortgage pricing and underwriting. The risk multipliers are substantially the same as those of the 2018 proposal, with some simplifications and refinements. In particular, FHFA eliminated the single-family risk multipliers for ‘‘number of borrowers’’ and ‘‘loan balance,’’ and reallocated the associated unexpected losses across the single-family grids. The practical effect of this change is that the base risk weights in the single-family grids are greater than they otherwise would have been if the two risk multipliers had not been eliminated. TABLE 14—RISK MULTIPLIERS Single-family segment Risk factor Value or range Loan Purpose .................................... Occupancy Type ............................... Property Type ................................... Origination Channel .......................... DTI .................................................... Product Type ..................................... khammond on DSKJM1Z7X2PROD with PROPOSALS2 Subordination .................................... Loan Age ........................................... VerDate Sep<11>2014 19:00 Jun 29, 2020 Performing loan Purchase .......................................... Cashout Refinance ........................... Rate/Term Refinance ....................... Owner Occupied or Second Home .. Investment ........................................ 1 Unit ................................................ 2–4 Unit ............................................ Condominium ................................... Manufactured Home ......................... Retail ................................................ TPO .................................................. DTI ≤25% ......................................... 25% <DTI ≤40% ............................... DTI >40% ......................................... FRM30 .............................................. ARM1/1 ............................................ FRM15 .............................................. FRM20 .............................................. No subordination .............................. 30% <OLTV ≤60% and 0% <subordination ≤5%. 30% <OLTV ≤60% and subordination >5%. OLTV >60% and 0% <subordination ≤5%. OLTV >60% and subordination >5% Loan age ≤24 months ...................... 24 months <loan age ≤36 months ... 36 months <loan Age ≤60 months ... Loan age >60 months ...................... Jkt 250001 PO 00000 Frm 00037 Fmt 4701 Sfmt 4702 Non-modified RPL Modified RPL NPL 1 1.4 1.3 1 1.2 1 1.4 1.1 1.3 1 1.1 0.8 1 1.2 1 1.7 0.3 0.6 1 1.1 1 1.4 1.2 1 1.5 1 1.4 1 1.8 1 1.1 0.9 1 1.2 1 1.1 0.3 0.6 1 0.8 1 1.4 1.3 1 1.3 1 1.3 1 1.6 1 1.1 0.9 1 1.1 1 1 0.5 0.5 1 1 ........................ ........................ ........................ 1 1.2 1 1.1 1 1.2 1 1 ........................ ........................ ........................ 1 1.1 0.5 0.8 ........................ ........................ 1.5 1.1 1.2 ........................ 1.1 1.2 1.1 ........................ 1.4 1 0.95 0.8 0.75 1.5 ........................ ........................ ........................ ........................ 1.3 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ E:\FR\FM\30JNP2.SGM 30JNP2 39310 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules TABLE 14—RISK MULTIPLIERS—Continued Single-family segment Risk factor Value or range Cohort Burnout .................................. Interest-only ...................................... Loan Documentation ......................... Streamlined Refi ............................... Refreshed Credit Score for Modified RPLs and Non-modified RPLs ...... Payment Change from Modification Previous Maximum Days Past Due .. khammond on DSKJM1Z7X2PROD with PROPOSALS2 Refreshed Credit Score for NPLs ..... No Burnout ....................................... Low ................................................... Medium ............................................. High .................................................. No IO ................................................ Yes IO .............................................. Full .................................................... None or low ...................................... No ..................................................... Yes ................................................... Refreshed credit score <620 ............ 620 ≤refreshed credit score <640 .... 640 ≤refreshed credit score <660 .... 660 ≤refreshed credit score <700 .... 700 ≤refreshed credit score <720 .... 720 ≤refreshed credit score <740 .... 740 ≤refreshed credit score <760 .... 760 ≤refreshed credit score <780 .... Refreshed credit score ≥780 ............ Payment change ≥0% ...................... ¥20% ≤payment change <0% ........ ¥30% ≤payment change <¥20% ... Payment change <¥30% ................ 0–59 days ......................................... 60–90 days ....................................... 91–150 days ..................................... 151+ days ......................................... Refreshed credit score < 580 .......... 580 ≤refreshed credit score <640 .... 640 ≤refreshed credit score <700 .... 700 ≤refreshed credit score <720 .... 720 ≤refreshed credit score <760 .... 760 <refreshed credit score <780 .... Refreshed credit score ≥780 ............ Table 14 is structured in the following way: the first column represents secondary risk factors, the second column represents the values or ranges each secondary risk factor can take, and the third through sixth columns represent risk multipliers for performing loans, non-modified RPLs, modified RPLs, and NPLs, respectively. Thus, there would be a different set of risk multipliers for each of the four singlefamily segments. Each secondary risk factor could take multiple values, and each value or range of values would have a risk multiplier associated with it. For any particular single-family mortgage exposure, each risk multiplier could take a value of 1.0, above 1.0, or below 1.0. A risk multiplier of 1.0 would imply that the risk factor value for a single-family mortgage exposure is similar to, or in a certain range of, the particular risk characteristic found in the single-family segment’s synthetic loan. A risk multiplier value above 1.0 would be assigned to a risk factor value that represents a riskier characteristic than the one found in the single-family VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Performing loan Non-modified RPL Modified RPL NPL 1 1.2 1.3 1.4 1 1.6 1 1.3 1 1 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ 1 1.4 1 1.3 1 1.2 1.6 1.3 1.2 1 0.7 0.6 0.5 0.4 0.3 ........................ ........................ ........................ ........................ 1 1.2 1.3 1.5 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ 1 1.1 1 1.2 1 1.1 1.4 1.2 1.1 1 0.8 0.7 0.6 0.5 0.4 1.1 1 0.9 0.8 1 1.1 1.1 1.1 ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ 1.2 1.1 1 0.9 0.8 0.7 0.5 segment’s synthetic loan, while a risk multiplier value below 1.0 would be assigned to a risk factor value that represents a less risky characteristic than the one found in the single-family segment’s synthetic loan. Finally, the risk multipliers would be multiplicative, so each single-family mortgage exposure in a single-family segment would receive a risk multiplier for every risk factor pertinent to that segment, even if the risk multiplier is 1.0 (implying no change to the base risk weight for that risk factor). The total combined risk multiplier for a singlefamily mortgage exposure would be, in general, the product of all individual risk multipliers pertinent to the singlefamily segment in which the exposure is classified. There are two general types of singlefamily risk factors for which risk multipliers are applied: Risk factors determined at origination and risk factors that change as a loan seasons or ages. Risk factors determined at origination include common characteristics such as loan purpose, occupancy type, and PO 00000 Frm 00038 Fmt 4701 Sfmt 4702 property type. The impacts of this type of risk factor on single-family mortgage performance and credit losses are generally well understood and commonly used in mortgage pricing and underwriting. Many of these risk factors can be quantified and applied in a straightforward manner using the proposed risk multipliers. The full set of single-family risk factors determined at origination for which the proposed rule would require risk multipliers is: • Loan purpose. Loan purpose reflects the purpose of the single-family mortgage exposure at origination. The risk multiplier would be at least 1.0 for any purpose other than ‘‘purchase.’’ • Occupancy type. Occupancy type reflects the borrower’s intended use of the property, with an owner-occupied property representing a baseline level of risk across all single-family segments (a risk multiplier of 1.0), and an investment property being higher risk (a risk multiplier greater than 1.0). • Property type. Property type describes the physical structure of the property, with a 1-unit property representing a baseline level of risk (a E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules risk multiplier of 1.0), and other property types such as 2–4 unit properties or manufactured homes being higher risk (a risk multiplier greater than 1.0). • Origination channel. Origination channel is the type of institution that originated the single-family mortgage exposure, and whether or not it originated from a third-party, including a broker or correspondent. Single-family mortgage exposures that did not originate from a third-party represent a baseline level of risk (a risk multiplier of 1.0). • Product type. Product type reflects the contractual terms of the singlefamily mortgage exposure as of the origination date, with a 30-year fixedrate mortgage and select adjustable-rate mortgages (including, for example, ARM 5/1 and ARM 7/1) representing a baseline level of risk (a risk multiplier of 1.0). Adjustable-rate loans with an initial one-year fixed-rate period followed by a rate that adjusts annually (ARM 1/1) are considered higher risk (a risk multiplier greater than 1.0), while shorter-term fixed-rate loans are considered lower risk (a risk multiplier less than 1.0). • Interest-only. Interest-only reflects whether or not a loan has an interestonly payment feature during all or part of the loan term. Interest-only loans are generally considered higher risk (a risk multiplier greater than 1.0) than non interest-only loans due to their slower principal accumulation and an increased risk of default driven by the potential increase in principal payments at the expiration of the interest-only period. • Loan documentation. Loan documentation refers to the completeness of the documentation used to underwrite the single-family mortgage exposure, as determined under the Guide of the Enterprise. Loans with low or no documentation have a high degree of uncertainty around a borrower’s ability to pay, and are considered higher risk (a risk multiplier greater than 1.0) than loans with full documentation where a lender is able to verify the income, assets, and employment of a borrower. • Streamlined refinance. Streamlined refinance is an indicator for a singlefamily mortgage exposure that was refinanced through a streamlined refinance program of an Enterprise, including HARP. These loans generally cannot be refinanced under normal circumstances due to high MTMLTV, and therefore would be considered higher risk (a risk multiplier greater than 1.0). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Risk factors that change dynamically and are updated as a single-family mortgage exposure seasons include characteristics such as loan age, current credit score, and delinquency or modification history. These risk factors are correlated with probability of default and/or loss given default, and are therefore important in projecting unexpected losses. The full set of dynamic single-family risk factors for which the proposed rule would require risk multipliers is: • DTI. DTI is the ratio of the borrower’s total monthly obligations (including housing expense) divided by the borrower’s monthly income, as calculated under the Guide of the Enterprise. DTI affects and reflects a borrower’s ability to make payments on a single-family mortgage exposure. A DTI between 25 percent and 40 percent would reflect a baseline level of risk (a risk multiplier of 1.0), and as a borrower’s income rises relative to the borrower’s debt obligations (a lower DTI), the single-family mortgage exposure would be considered lower risk (a risk multiplier less than 1.0). If a borrower’s income falls relative to the borrower’s debt obligations (a higher DTI), the single-family mortgage exposure would be considered higher risk (a risk multiplier greater than 1.0). • Subordination. Subordination is the amount equal to the original unpaid principal balance of any second lien single-family mortgage exposure divided by the lesser of the appraised value or sale price of the property that secures the single-family mortgage exposure. Single-family mortgage exposures with no subordination would represent a baseline level of risk (a risk multiplier of 1.0), whereas single-family mortgage exposures with varying combinations of OLTV and subordination percentage would be generally considered higher risk (a risk multiplier greater than 1.0). • Loan age. Loan age is the number of scheduled payment dates since the single-family mortgage exposure was originated. Older single-family mortgage exposures are considered less risky because in general as loans age the likelihood of events occurring that would trigger mortgage default decreases. • Cohort burnout. Cohort burnout reflects the number of refinance opportunities since the single-family mortgage exposure’s sixth scheduled payment date. A refinance opportunity is any calendar month in which the Primary Mortgage Market Survey (PMMS) rate for the month and year of the origination of the single-family mortgage exposure exceeds the PMMS PO 00000 Frm 00039 Fmt 4701 Sfmt 4702 39311 rate for that calendar month by more than 50 basis points. Cohort burnout is an indicator that a borrower is less likely to refinance in the future given the opportunity to do so. Borrowers that demonstrate a lower propensity to refinance have higher credit risk, and a single-family mortgage exposure with a cohort burnout greater than zero would receive a risk multiplier greater than 1.0. • Refreshed credit score for RPLs and NPLs. Refreshed credit scores refer to the most recently available credit scores as of the capital calculation date. In general, a credit score reflects the credit worthiness of a borrower, and a higher credit score implies lower risk and a lower risk multiplier. For RPLs, a refreshed credit score between 660 and 700 reflects a baseline level of risk (a risk multiplier of 1.0). For NPLs, a refreshed credit score between 640 and 700 represents a baseline level of risk (a risk multiplier of 1.0). • Payment change from modification. For modified RPLs, the payment change from modification reflects the change in the monthly payment, as a percent of the original monthly payment, resulting from a modification. In general, higher payment reductions tend to reduce the likelihood of future default, so singlefamily mortgage exposures with higher payment reductions from modifications would have a lower capital requirement (a risk multiplier less than 1.0). • Previous maximum days past due. For RPLs, previous maximum number of days past due reflects the maximum number of days a single-family mortgage exposure has been past due in the last 36 months. Days past due is positively correlated with the likelihood of future default. Therefore, a single-family mortgage exposure with a previous maximum delinquency between 0 and 59 days represent a baseline level of risk (a risk multiplier of 1.0), and a singlefamily mortgage exposure with a maximum delinquency greater than 59 days month would be considered higher risk (a risk multiplier greater than 1.0). Not all risk multipliers would apply to every single-family segment, because the risk multipliers were estimated separately for each single-family segment. In cases where a risk factor did not influence the projected unexpected loss of single-family mortgage exposures in a single-family segment, or a risk factor did not apply at all (payment change from modification, in the performing loan segment, for example), there would be no risk multiplier for that risk factor in that single-family segment. Question 42. Are the risk multipliers for single-family mortgage exposures appropriately formulated and calibrated E:\FR\FM\30JNP2.SGM 30JNP2 39312 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 43. Are there any adjustments, simplifications, or other refinements that FHFA should consider for the risk multipliers for single-family mortgage exposures? Question 44. Should the combined risk multiplier for a single-family mortgage exposure be subject to a cap (e.g., 3.0, as contemplated by the 2018 proposal)? 6. Credit Enhancement Multipliers The Enterprises’ charter acts generally require single-family mortgage exposures with an unpaid principal balance exceeding 80 percent of the value of the property to have one of three forms of loan-level credit enhancement at the time of acquisition. This requirement can be satisfied through: • The seller retaining a participation of at least 10 percent in the singlefamily loan (participation agreement); • The seller agreeing to repurchase or replace the single-family mortgage exposure, or reimburse losses, in the event of default (a recourse agreement); or • A guarantee or insurance on the unpaid principal balance which is in excess of 80 percent LTV (mortgage insurance or MI). Mortgage insurance is the most common form of loan-level credit enhancement. Loan-level credit enhancements sometimes provide credit enhancement beyond that required by the charter acts. To account for the decrease in an Enterprise’s exposure to unexpected loss on a single-family mortgage exposure subject to loan-level credit enhancement, an Enterprise would adjust the base risk weight using an adjusted credit enhancement multiplier. That adjusted credit enhancement multiplier would be based on a credit enhancement multiplier (CE multiplier) for the single-family mortgage exposure and then adjusted for the strength of the counterparty providing the loan-level credit enhancement. A smaller CE multiplier (and therefore a smaller adjusted credit enhancement multiplier) would correspond to a loan-level credit enhancement that transfers more of the projected unexpected loss to the counterparty and thus requires less credit risk capital of the Enterprise for the single-family mortgage exposure. For example, before any adjustment for counterparty strength, a CE multiplier of 0.65 for a single-family mortgage exposure subject to loan-level credit VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 enhancement means that an Enterprise is exposed to 65 percent of the projected unexpected loss of the single-family mortgage exposure and that the counterparty providing the loan-level credit enhancement is projected to absorb, assuming it is an effective counterparty, the remaining 35 percent of the projected unexpected loss. Participation agreements are rarely utilized by the Enterprises, and for reasons of simplicity, the proposed rule would not assign any benefit for these agreements (i.e., a CE multiplier of 1.0). Recourse agreements may be unlimited or limited. Full recourse agreements provide full coverage for the life of the loan, while partial recourse agreements provide partial coverage or have a limited duration. Because a counterparty would be responsible for all credit risk pursuant to a full recourse agreement, the single-family mortgage exposure would be assigned a CE multiplier of zero, subject to a counterparty haircut. For partial recourse agreements, the proposed rule would require an Enterprise to take into account the percent coverage, adjusted for the term of coverage, to determine the appropriate benefit. The CE multiplier for a single-family mortgage exposure subject to mortgage insurance would vary based on the mortgage insurance coverage and loan characteristics, including (i) whether the mortgage insurance is cancellable or non-cancellable, (ii) whether the mortgage insurance coverage is charterlevel or guide-level, and (iii) the loan characteristics, including OLTV, loan age, amortization term, and singlefamily segment. • Cancellation option. Noncancellable mortgage insurance (noncancellable MI) provides coverage for the life of the single-family mortgage exposure. Cancellable mortgage insurance (cancellable MI) allows for the cancellation of coverage upon a borrower’s request when the unpaid principal balance falls to 80 percent or less of the original property value, or automatic cancellation when either the loan balance falls below 78 percent of the original property value or the loan reaches the midpoint of the loan’s amortization schedule, if the loan is current. Due to the longer period of coverage, non-cancellable MI provides more credit risk protection than cancellable MI. CE multipliers for noncancellable MI therefore would be lower than CE multipliers for cancellable MI. • Coverage. Charter-level coverage provides mortgage insurance that satisfies the minimum requirements of the Enterprises’ charter acts. Guide-level coverage provides deeper coverage, PO 00000 Frm 00040 Fmt 4701 Sfmt 4702 roughly double the coverage provided by charter-level coverage. Therefore, the CE multipliers for guide-level coverage would be lower than the CE multipliers for charter-level coverage. • Original LTV. Single-family mortgage exposures with higher OLTV generally have greater coverage levels than loans with lower OLTV. Higher coverage levels imply greater credit risk protection. Therefore, single-family mortgage exposures with higher OLTVs would have lower CE multipliers. • Amortization term. For cancellable MI, single-family mortgage exposures with a 15- to 20-year amortization period might have cancellation triggered earlier than loans with a 30-year amortization period. Therefore, singlefamily mortgage exposures with longer amortization terms have a longer period of credit risk protection from mortgage insurance. Single-family mortgage exposures with a 30-year amortization period therefore have a lower CE multiplier than single-family mortgage exposures with a 15- to 20-year amortization period with cancellable mortgage insurance. • Single-family segment. Mortgage insurance coverage on delinquent loans cannot be cancelled. Cancellation of mortgage insurance coverage on modified RPLs is based on the modified LTV and the modified amortization term, which are typically higher than the OLTV and the original amortization term. In both of these cases, the mortgage insurance coverage is extended for a longer period, resulting in greater credit risk protection, relative to mortgage insurance coverage on performing loans. Therefore, in the proposed rule, delinquent and modified loans would have a lower CE multiplier than performing loans. • Loan age. Mortgage insurance cancellation is often triggered sooner for older loans than for younger loans. Therefore, older loans with cancellable MI generally have a shorter period of remaining mortgage insurance coverage and thus have less credit risk protection from mortgage insurance. Older singlefamily mortgage exposures with cancellable MI therefore have higher CE multipliers than younger single-family mortgage exposures. The following Tables 15 through 19 present the CE multipliers for singlefamily mortgage exposures subject to mortgage insurance. Table 15 contains CE multipliers for all single-family mortgage exposures subject to non-cancellable MI, except NPLs. The table differentiates CE multipliers by type of coverage (charterlevel and guide-level), OLTV, E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39313 amortization term, and coverage percent. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 performing loans and non-modified RPLs subject to cancellable MI. The table differentiates CE multipliers by PO 00000 Frm 00041 Fmt 4701 Sfmt 4702 type of coverage (charter-level and guide-level), OLTV, coverage percent, amortization term, and loan age. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.014</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 The proposed rule would have three sets of multipliers for cancellable MI. Table 16 contains CE multipliers for Table 17 contains CE multipliers for the modified RPLs with 30-year postmodification amortization and subject to cancellable MI. The table differentiates risk multipliers by type of coverage (charter-level and guide-level), OLTV, coverage percent, amortization term, and loan age. Table 18 contains CE multipliers for modified RPLs with 40-year postmodification amortization and subject to cancellable MI. Here, CE multipliers are differentiated by type of coverage (charter-level and guide-level), OLTV, coverage percent, and loan age. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00042 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.016</GPH> Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules EP30JN20.015</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39314 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 differentiation between cancellable MI and non-cancellable MI for the NPL segment. The table differentiates CE multipliers by type of coverage (charter- PO 00000 Frm 00043 Fmt 4701 Sfmt 4702 level and guide-level), OLTV, amortization term, and coverage percent. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.017</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Table 19, contains proposed CE multipliers for NPLs. Mortgage insurance on delinquent loans cannot be cancelled; therefore, there is no 39315 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Counterparty Credit Risk Adjustments khammond on DSKJM1Z7X2PROD with PROPOSALS2 Sharing losses with counterparties through loan-level credit enhancement exposes an Enterprise to counterparty credit risk. To account for this exposure, the proposed rule would reduce the recognized benefits from loan-level credit enhancement to incorporate the risk that a counterparty is unable to perform its claim obligations. To accomplish this, the proposed rule would implement a counterparty haircut risk multiplier (CP haircut multiplier) to be applied to the CE multiplier. The CP haircut multiplier would take values from zero to one. A VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 value of zero, the smallest haircut, would mean a counterparty is expected to fully perform its claim obligations, while a value of one, the largest haircut, would mean a counterparty is not expected to perform its claim obligations. A value between zero and one would mean a counterparty is expected to perform a portion of its claim obligations. The CP haircut multiplier would depend on a number of factors that reflect counterparty risk. The three main factors are the creditworthiness of the counterparty, the counterparty’s level of concentration in mortgage credit risk, PO 00000 Frm 00044 Fmt 4701 Sfmt 4702 and the counterparty’s status as an approved insurer under an Enterprise’s counterparty standards for private mortgage insurers. The proposed rule would require an Enterprise to assign counterparty financial strength ratings using a provided rating framework. In assigning a rating, an Enterprise would assign the counterparty financial strength rating that most closely aligns to the assessment of the counterparty from the Enterprise’s internal counterparty risk framework. Descriptions of the 8 different counterparty financial strength ratings are presented below in Table 20. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.018</GPH> 39316 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Counterparties whose primary lines of business are more concentrated in mortgage credit risk have a higher probability to default on payment VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 obligations when the mortgage default rate is high. The proposed rule would assign larger haircuts to counterparties with higher levels of mortgage credit risk concentration relative to diversified counterparties. An Enterprise would assess the level of mortgage credit risk concentration for each individual counterparty to determine whether the insurer is well diversified or whether it has a high concentration risk. Finally, an Enterprise would determine whether a mortgage insurance counterparty is in compliance with its own private mortgage eligibility standards. If the counterparty satisfies the set of requirements to be approved to insure loans acquired by an Enterprise, the insurer would be assigned a smaller counterparty haircut. To calculate the CP haircut, the proposed rule would use a modified version of the Basel framework’s IRB approach. The modified version leverages the IRB approach to account PO 00000 Frm 00045 Fmt 4701 Sfmt 4702 for the creditworthiness of the counterparty, but makes changes to reflect the level of mortgage credit risk concentration and the counterparty’s status as an approved insurer. The Basel IRB framework provides the ability to differentiate haircuts between counterparties with different levels of risk. The proposed rule would augment the IRB approach to capture risk across counterparties. In this way, the proposed adjustment would help capture wrong-way risk between the Enterprises and their counterparties. In particular, the proposed approach would calculate the counterparty haircut by multiplying stress loss given default by the probability of default and a maturity adjustment for the asset. The following Figure 2 details the counterparty haircut calculation, as well as the parameterization of the proposed approach: BILLING CODE 8070–01–P E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.019</GPH> Similarly, the proposed rule would require an Enterprise to utilize its counterparty risk management framework to assign each counterparty a rating of ‘‘not high’’ or ‘‘high’’ to reflect the counterparty’s concentration in mortgage credit risk. During the 2008 financial crisis, three out of the seven mortgage insurance companies were placed in run-off by their state regulators, and payments on the Enterprises’ claims were deferred by the state regulators. This exposed the Enterprises to counterparty risk and potential financial losses. More generally, the 2008 financial crisis highlighted that counterparty risk can be amplified when the counterparty’s credit exposure is highly correlated with an Enterprise’s credit exposure. 39317 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules As shown, stress loss given default (LGD) is calibrated to 45 percent according to the historic average stress severity rates. The maturity adjustment is calibrated to 5 years for 30-year products and to 3.5 years for 15- to 20year single-family mortgage exposures to approximately reflect the average life of the assets. The expected probability of default (PD) is calculated using a historical 1-year PD matrix for all financial institutions. As discussed above, counterparties with a lower concentration of mortgage credit risk and therefore a lower potential for wrong-way risk would be afforded a lower haircut relative to the counterparties with higher concentrations of mortgage credit risk. Similarly, approved insurers would be afforded a lower haircut relative to counterparties that do not satisfy an VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Enterprise’s eligibility requirements. These differences would be captured through the asset valuation correlation risk multiplier, AVCM. An AVCM of 1.75 would be assigned those counterparties which are not an approved insurer and have high exposure to mortgage credit risk, an AVCM of 1.50 would be assigned those counterparties which are an approved insurer and have high exposure to mortgage credit risk, and an AVCM of 1.25 would be assigned to diversified counterparties which do not have a high exposure to mortgage credit risk. The parameters of the Basel IRB formula, including the AVCM, were augmented to best fit the internal counterparty credit risk haircuts developed by the Enterprises. The proposed counterparty haircut would also differ by product type and PO 00000 Frm 00046 Fmt 4701 Sfmt 4702 segment. Performing loans, modified RPLs, and non-modified RPLs would be treated differently than NPLs, and within 30-year performing loans, modified RPLs, and non-modified RPLs would receive a larger haircut than 15or 20-year single-family mortgage exposures. The NPL segment represents a different level of counterparty risk relative to the performing and reperforming segments. Unlike performing loans, modified RPLs, and non-modified RPLs, an Enterprise would expect to submit claims for NPLs in the near future. The proposed rule would reduce the Basel framework’s effective maturity from 5 (or 3.5 for 15/20Yr) to 1.5 for all loans in the NPL segment. The reduced effective maturity would lower counterparty haircuts on loans in the NPL segment. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.020</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39318 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39319 khammond on DSKJM1Z7X2PROD with PROPOSALS2 BILLING CODE 8070–01–C Finally, FHFA notes that the proposed rule’s approach generally assigns more credit risk mitigation benefit to mortgage insurance and other loan-level credit enhancement than would be assigned under the U.S. banking framework, in particular with respect to those counterparties eligible to provide guarantees or insurance. FHFA is soliciting comment on the appropriateness of the differences between the proposed rule and the regulatory capital treatment of loanlevel credit enhancement (including with respect to the U.S. banking regulators’ stress test assumptions). Question 45. Are the CE multipliers and CP haircut multipliers for singlefamily mortgage exposures appropriately formulated and calibrated to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 46. Are there any adjustments, simplifications, or other refinements that FHFA should consider for the CE multipliers and the CP haircut multipliers for single-family mortgage exposures? Question 47. Are the differences between the proposed rule and the U.S. banking framework with respect to the credit risk mitigation benefit assigned to VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 loan-level credit enhancement appropriate? Which, if any, specific aspects should be aligned? 7. Minimum Adjusted Risk Weight The proposed rule would establish a floor on the adjusted risk weight for a single-family mortgage exposure equal to 15 percent. FHFA has determined that a minimum risk weight is necessary to ensure the safety and soundness of each Enterprise and that each Enterprise is positioned to fulfill its statutory mission across the economic cycle, including during a period of financial stress. First, absent this 15 percent risk weight floor, the proposed rule’s credit risk capital requirements as of the end of 2007 would not have been sufficient to absorb each Enterprise’s crisis-era cumulative capital losses on its singlefamily book. Absent the 15 percent risk weight floor, Freddie Mac’s estimated single-family credit risk capital requirement of $61 billion as of December 31, 2007 under the proposed rule would have been less than its crisis-era single-family cumulative capital losses. With the addition of the 15 percent risk weight floor, Freddie Mac’s estimated single-family credit risk capital requirement would have exceeded its crisis-era single-family cumulative capital losses. Absent the 15 percent risk weight floor, Fannie Mae’s PO 00000 Frm 00047 Fmt 4701 Sfmt 4702 estimated single-family credit risk capital requirement would have exceeded its crisis-era single-family cumulative capital losses, but by a relatively small amount. The addition of the 15 percent risk weight floor would have added approximately $8 billion to Fannie Mae’s single-family credit risk capital requirement, clearing cumulative capital losses by a more comfortable margin. Second, as discussed in Section IV.B, a risk weight floor is appropriate to mitigate certain risks and limitations associated with the underlying historical data and models used to calibrate the credit risk capital requirements. These risks and limitations are perhaps inherent to any methodology for calibrating granular credit risk capital requirements. In particular: • A disproportionate share of the Enterprises’ crisis-era credit losses arose from certain single-family mortgage exposures that are no longer eligible for acquisition by the Enterprises. The calibration of the credit risk capital requirements attributed a significant portion of the Enterprises’ crisis-era losses to these products. The statistical methods used to allocate losses between borrower-related risk attributes and product-related risk attributes pose significant model risk. The sizing of the regulatory capital requirements also E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.021</GPH> The proposed rule would utilize the following CP haircut multipliers in Table 21. khammond on DSKJM1Z7X2PROD with PROPOSALS2 39320 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules must guard against potential future relaxation of underwriting standards and regulatory oversight over those underwriting standards. • The Enterprises’ crisis-era losses likely were mitigated to at least some extent by the unprecedented support by the federal government of the housing market and the economy and also by the declining interest rate environment of the period. There is therefore some risk that the risk-based capital requirements are not specifically calibrated to ensure each Enterprise would be regarded as a viable going concern following a future severe economic downturn that potentially entails more unexpected losses, whether because there is less or no Federal support of the economy, because there is less or no reduction in interest rates, or because of other causes. • There are some potentially material risks to the Enterprises that are not assigned a risk-based capital requirement—for example, risks relating to uninsured or underinsured losses from flooding, earthquakes, or other natural disasters or radiological or biological hazards. There also is no riskbased capital requirement for the risks that climate change could pose to property values in some localities. Third, comparison to the Basel and U.S. banking framework’s credit risk capital requirements for similar exposures reinforces FHFA’s view that a risk weight floor is appropriate to mitigate certain risks and limitations associated with the underlying historical data and models used to calibrate the credit risk capital requirements.68 Absent this risk weight floor, as of September 30, 2019, the average pre-CRT net credit risk capital requirement on the Enterprises’ singlefamily mortgage exposures (which reflects the benefit of private mortgage insurance but no adjustments for CRT) would have been 1.7 percent of unpaid principal balance, implying an average risk weight of 21 percent. With the 15 percent risk weight floor, the average requirement would have increased by approximately 0.5 percent of unpaid principal balance to an average risk weight of 26 percent. The U.S. banking framework generally assigns a 50 percent risk weight to these exposures to determine the credit risk capital requirement (equivalent to a 4.0 percent adjusted total capital requirement), while the current Basel framework 68 As discussed in Section IV.B.2, while the interest rate and funding risk profiles of the Enterprises and large banking organizations are different, that difference should not preclude comparisons of the credit risk capital requirements of the U.S. banking framework to the credit risk capital requirements of the Enterprises. VerDate Sep<11>2014 21:55 Jun 29, 2020 Jkt 250001 generally assigns a 35 percent risk weight (equivalent to a 2.8 percent adjusted total capital requirement). Before the risk weight floor, before adjusting for CRT, and before adjusting for the capital buffers under the proposed rule and the Basel and U.S. banking frameworks, the Enterprises’ credit risk capital requirements for single-family mortgage exposures would have been roughly 40 percent that of U.S. banking organizations and roughly 60 percent that of non-U.S. banking organizations. The BCBS has finalized a more risksensitive set of risk weights for residential mortgage exposures, which are to be implemented by January 1, 2022. With those changes, the lowest standardized risk weight would be 20 percent for single-family residential mortgage loans with OLTVs less than 50 percent. The 21 percent average risk weight would have been about the same as this 20 percent minimum, notwithstanding the Enterprises having an average single-family OLTV of approximately 75 percent as of September 30, 2019. These comparisons are complicated by the fact that the 21 percent and 26 percent average risk weights reflect loan-level credit enhancement and adjustments for MTMLTV. In particular, some meaningful portion of the gap currently between the credit risk capital requirements of the Enterprises and banking organizations under the proposed rule is due to the proposed rule’s use of MTMLTV instead of OLTV, as under the U.S. banking framework, to assign credit risk capital requirements for mortgage exposures. On the one hand, the comparison illustrates how low risk-based capital requirements can become in a mark-to-market framework without prudential floors. On the other hand, in a different house price environment, perhaps after several years of declining house prices, the mark-tomarket framework could have resulted in higher credit risk capital requirements than the Basel and U.S. banking frameworks.69 Some of this gap 69 In consideration that the U.S. banking and Basel frameworks utilize OLTVs, a comparison of the credit risk capital requirements for newly acquired single-family mortgage exposures under the 2018 proposal and the proposed rule provides the most direct comparison of credit risk capital requirements for new originations. Under the proposed rule, gross credit risk capital (prior to adjustments for credit enhancements and CRT) on newly originated (i.e., loan age less than six months) single-family mortgage exposures as of September 30, 2019, with an average OLTV of 77 percent, would have been 3.8 percent of unpaid principal balance, implying an average risk weight of 47 percent. This compares to the 50 percent risk weight under the U.S. banking framework and 30 percent under the newest BCBS framework for PO 00000 Frm 00048 Fmt 4701 Sfmt 4702 might be expected to narrow were real property prices to move toward their long-term trend. However, the current sizing of that gap between the credit risk capital requirements of banking organizations and the Enterprises under the proposed rule is an important consideration informing the enhancements to the 2018 proposal. Reinforcing that point, the 21 percent average risk weight would have been about the same as the Basel framework’s 20 percent risk weight assigned to exposures to sovereigns and central banks with ratings A+ to A¥ and claims on banks and corporates with ratings AAA to AA¥.70 The 21 percent average risk weight also would have been about the same as the 20 percent risk weight assigned under the U.S. banking framework to Enterprise-guaranteed MBS. In light of these considerations, FHFA has determined that a minimum risk weight is necessary to ensure the safety and soundness of each Enterprise and that each Enterprise is positioned to fulfill its statutory mission during a period of financial stress. FHFA sized the 15 percent risk weight floor taking into consideration the 20 percent minimum risk weight contemplated by the amendments to the Basel framework for similar exposures, while also seeking to preserve the mortgage risk-sensitive framework by avoiding a risk weight floor that was, in effect, the binding constraint for a substantial portion of single-family mortgage exposures. FHFA is soliciting comment on the sizing of the risk weight floor, including whether to perhaps align the floor with the more risk-sensitive standardized risk weights assigned to similar exposures under the Basel framework. Question 48. Is the minimum floor on the adjusted risk weight for a singlefamily mortgage exposure appropriately calibrated to mitigate model and related risks associated with the calibration of the underlying base risk weights and risk multipliers and to otherwise ensure each Enterprise operates in a safe and sound manner and is positioned to loans with OLTV of 60 to 80 percent. After consideration of charter-required credit enhancements, the average net credit risk capital requirement on the Enterprises’ newly originated single-family mortgage exposures as of September 30, 2019 would have been 2.8 percent of unpaid principal balance, implying an average risk weight of 36 percent. These risk weights would then decline to the extent house prices appreciate or increase to the extent house prices depreciate. 70 See BCBS, The Basel Framework, paragraphs 20.4 and 20.14 at 181 and 185 (Dec. 15, 2019), available at https://www.bis.org/basel_framework/ index.htm?export=pdf. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules fulfill its statutory mission across the economic cycle? Question 49. Should the minimum floor on the adjusted risk weight for a single-family mortgage exposure be decreased or increased, perhaps to align the minimum floor with the more risksensitive standardized risk weights assigned to similar exposures under the Basel framework (e.g., 20 percent for a single-family residential mortgage loan with LTV at origination less than 50 percent)? Question 50. Should the floor or other limit used to determine a single-family mortgage exposure’s credit risk capital requirement be assessed against the base risk weight, the risk weight adjusted for the combined risk multipliers, or some other input used to determine that credit risk capital requirement? khammond on DSKJM1Z7X2PROD with PROPOSALS2 B. Multifamily Mortgage Exposures The standardized credit risk-weighted assets for each multifamily mortgage exposure would be determined using grids and risk multipliers that together would assign an exposure-specific risk weight based on the risk characteristics of the multifamily mortgage exposure. The resulting exposure-specific credit risk capital requirements generally would be similar to those in the 2018 proposal, subject to some simplifications and refinements. As discussed in Section VIII.B.3, the base risk weight generally would be a function of the multifamily mortgage exposure’s MTMLTV, among other things. This base risk weight would then be adjusted based on other risk attributes, as discussed in Section VIII.B.5. Finally, as discussed in Section VIII.B.6, this adjusted risk weight would be subject to a minimum floor of 15 percent. 1. Multifamily Business Models The proposed rule would apply to both Enterprises. However, when appropriate, the proposed rule would account for differences in the Enterprises’ multifamily business models. These differences are evident, for example, when considering certain elements of the proposed rule related to credit risk transfer. Multifamily mortgage exposures finance the acquisition and operation of commercial property collateral, typically apartment buildings. This section discusses multifamily mortgage exposures that take the form of whole loans and guarantees. Multifamily whole loans are those that an Enterprise keeps in its portfolio after acquisition. Multifamily guarantees are guarantees provided by an Enterprise of the payment of principal and interest VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 payments to investors in MBS that have been issued by an Enterprise or another security issuer and are backed by previously acquired multifamily whole loans. Except to the extent an Enterprise transfers credit risk to third-party private investors, the credit risk from multifamily mortgage exposures is retained. Fannie Mae’s multifamily business historically has generally relied on the Delegated Underwriting and Servicing (DUS) program. The DUS program is a loss-sharing program that seeks to facilitate the implementation of common underwriting and servicing guidelines across a defined group of multifamily lenders. The number of multifamily lenders in the DUS program has historically ranged between 25 and 30 since the program’s inception in the late 1980s. Fannie Mae typically transfers about one-third of the credit risk to those lenders, while retaining the remaining two-thirds of the credit risk and the counterparty risk associated with the DUS lender business relationship. The proportion of risk transferred to the lender may be more or less than one-third under a modified version of the typical DUS loss-sharing agreement. Fannie Mae has also reduced its exposure to the credit risk retained on DUS loans through programmatic ‘‘back-end’’ risk transfer activities, including reinsurance transactions (MCIRT) on multifamily mortgages with unpaid principal balances (UPBs) generally smaller than $30 million and note offerings (MCAS) on multifamily mortgages with UPBs generally greater than or equal to $30 million. In contrast, Freddie Mac’s multifamily model has focused on structured, multiclass securitizations. While Freddie Mac has a number of securitization programs for multifamily loans, the largest is the K-Deal program. Under the K-Deal program, which started in 2009, Freddie Mac sells a portion of unguaranteed bonds (mezzanine and subordinate), generally 10 to 15 percent, to private market participants. These sales typically result in a transfer of a high percentage of the credit risk. Freddie Mac generally assumes credit and market risk during the period between loan acquisition and securitization. After securitization, Freddie Mac generally retains a portion of the credit risk through ownership or guarantee of senior K-Deal tranches. As of 2019, the differences between the two business models have become somewhat less pronounced. The proposed rule is tailored to each Enterprise’s current lending practices, and would not preclude either from PO 00000 Frm 00049 Fmt 4701 Sfmt 4702 39321 evolving its business model in the future. Commenters on the 2018 proposal supported the inclusion of multifamilyspecific credit risk capital requirements in order to capture the unique nature of each Enterprise’s multifamily business and its particular risk drivers. In addition, commenters generally supported the structure and methodology of those proposed requirements. However, commenters also provided FHFA with critical feedback. Foremost among commenters’ concerns was a perceived imbalance of the 2018 proposal as related to the Enterprises’ different multifamily business models. Commenters on the 2018 proposal stressed the importance of having a multifamily market with multiple viable and competing execution methods. To this end, some commenters raised concerns that the multifamily capital requirements in the 2018 proposal would disadvantage the loss sharing business model relative to the securitization business model, potentially to the point where the loss sharing model would no longer be viable. Commenters suggested that the 2018 proposal did not sufficiently account for certain benefits or risk mitigants of the loss sharing business model, particularly relative to the historical loss experience of Fannie Mae’s DUS loans. Commenters also suggested that the 2018 proposal’s different market risk treatment of multifamily mortgage exposures compared to Enterprise- or Ginnie Maebacked MBS provided a further disadvantage to using a loss sharing model relative to a securitization model. FHFA has considered the commenters’ feedback and believes that the framework for calculating multifamily credit risk capital requirements under the 2018 proposal was generally appropriately tailored to accommodate both Enterprises’ historical business practices. However, FHFA has addressed the commenters’ concerns in two ways. First, FHFA has revised the capital treatment for contractual claims to atrisk servicing rights and clarified the capital treatment for restricted liquidity in Fannie Mae’s loss sharing model. The 2018 proposal would have afforded capital relief in multifamily loss sharing transactions by including restricted liquidity as collateral, and by reducing uncollateralized exposure to a counterparty by 50 percent if the Enterprise had a contractual claim to atrisk servicing rights. The proposed rule would retain this treatment of restricted liquidity, but would implement an E:\FR\FM\30JNP2.SGM 30JNP2 39322 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules updated treatment of servicing rights such that in the counterparty haircut calculation, an Enterprise may reduce uncollateralized exposure by 1 year of estimated servicing revenue if the Enterprise has a contractual claim to the at-risk servicing rights. Second, the proposed rule would introduce a prudential floor of 10 percent for the risk weight assigned to each tranche in a CRT. Such a floor would mitigate potential risks associated with CRT, including the structuring, recourse, and other risks associated with these securitizations. khammond on DSKJM1Z7X2PROD with PROPOSALS2 2. Calibration Framework As with single-family mortgage exposures, FHFA generally calibrated the base risk weights and risk multipliers for multifamily mortgage exposures to require credit risk capital sufficient to absorb the lifetime unexpected losses incurred on multifamily mortgage exposures experiencing a shock to property values similar to that observed during the 2008 financial crisis. The multifamilyspecific stress scenarios used to generate the base risk weights and risk multipliers involve two parameters: (i) Net operating income (NOI), where NOI represents gross potential income (gross rents) net of vacancy and operating expenses, and (ii) property values. Adverse economic conditions are generally accompanied by either a decrease in expected property revenue or an increase in perceived risk in the multifamily asset class, or both. A decrease in expected occupancy would lead to a decline in income generated by the property, or a lower NOI, while an increase in perceived risk would lead to an increase in the capitalization rate used to discount the NOI when assessing property value. A capitalization rate is defined as NOI divided by property value, so if NOI is held constant, an increase in the capitalization rate is directly related to a decrease in property values. For the purpose of the proposed rule, the multifamily-specific stress scenario assumes an NOI decline of 15 percent and a property value decline of 35 percent. This stress scenario is consistent with market conditions observed during the recent financial VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 crisis, views from third-party market participants and data vendors, and assumptions behind the DFAST severely adverse scenario. Using this stress scenario, the multifamily grids and multipliers were calibrated based on estimates of unexpected losses from the Enterprises’ internal models. Question 51. Is the methodology used to calibrate the credit risk capital requirements for multifamily mortgage exposures appropriate to ensure that the exposure is backed by capital sufficient to absorb the lifetime unexpected losses incurred on multifamily mortgage exposures experiencing a shock to house prices similar to that observed during the 2008 financial crisis? Question 52. What, if any, changes should FHFA consider to the methodology for calibrating credit risk capital requirements for multifamily mortgage exposures? 3. Base Risk Weights The proposed rule would require an Enterprise to determine a base risk weight for each multifamily mortgage exposure using a set of two multifamily grids—one for multifamily mortgage exposures with fixed rates (multifamily FRMs), and one for multifamily mortgage exposures with adjustable rates (multifamily ARMs). A multifamily mortgage exposure that has both a fixed-rate period and an adjustable-rate period (hybrid loans) would be deemed a multifamily FRM during the fixed-rate period and a multifamily ARM during the adjustablerate period. The multifamily grids reflect two important multifamily mortgage exposure characteristics: Debt-servicecoverage-ratio (DSCR) and MTMLTV. These two risk factors are key drivers of the future performance of multifamily mortgage exposures. DSCR is the ratio of property NOI to the loan payment. A DSCR greater than 1.0 indicates that the property generates funds sufficient to cover the loan obligation, while the opposite is true for a DSCR less than 1.0. The multifamily grids are quantitatively identical to the multifamily grids in the 2018 proposal, except the credit risk capital requirements are presented as base risk weights relative to the 8.0 percent PO 00000 Frm 00050 Fmt 4701 Sfmt 4702 adjusted total capital requirement rather than as a percent of UPB. The multifamily FRM grid was populated using projected unexpected losses for a multifamily FRM with varying DSCR and MTMLTV combinations and the following risk characteristics: $10 million loan amount, 10-year balloon with a 30-year amortization period, noninterest-only, not a special product, and never been delinquent or modified. Similarly, the multifamily ARM grid was populated using projected unexpected losses for a multifamily ARM with varying DSCR and MTMLTV combinations and the following risk characteristics: 3.0 percent origination interest rate, $10 million loan amount, 10-year balloon with a 30-year amortization period, non-interest-only, not a special product, and never been delinquent or modified. Thus, each cell of the multifamily grid represents the average estimated difference, in basis points, between stress losses and expected losses for these synthetic loans with a DSCR and LTV in the tabulated ranges, converted to a risk weight. For the first five scheduled payment dates after a multifamily mortgage exposure is acquired, an Enterprise would use the multifamily mortgage exposure’s LTV at acquisition or origination to determine the base risk weight. After that point, an Enterprise would use the multifamily mortgage exposure’s MTMLTV, which would be calculated by adjusting the acquisition LTV using a multifamily property value index or property value estimate based on net operating income and capitalization rate indices. Unlike single-family mortgage exposures, an Enterprise would not make a countercyclicality adjustment to a multifamily mortgage exposure’s MTMLTV. For the purposes of the multifamily grids, LTV means either MTMLTV or LTV at acquisition or origination, and DSCR means either MTMDSCR or DSCR at acquisition, depending on the age of the multifamily mortgage exposure. The multifamily grids for the multifamily FRM and multifamily ARM segments are presented in the following Table 22 and Table 23, respectively. BILLING CODE 8070–01–P E:\FR\FM\30JNP2.SGM 30JNP2 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 without sacrificing simplicity or mortgage risk sensitivity. An Enterprise also would use the multifamily grids to calculate the base risk weight for interest-only loans. Interest-only loans allow for payment of interest without any principal amortization during all or part of the loan term, potentially creating increased amortization risk and additional leveraging incentives for the borrower. To partially capture these increased risks, the proposed rule would require an Enterprise to use an interest-only loan’s fully amortized payment to calculate DSCR during the interest-only period in order to calculate the multifamily mortgage exposure’s base risk weight. That is, an Enterprise would assign each multifamily interest- PO 00000 Frm 00051 Fmt 4701 Sfmt 4702 only mortgage exposure into a multifamily segment, either multifamily FRM or multifamily ARM, and calculate the base risk capital requirement using the corresponding segment-specific multifamily grid, where the DSCR is based on the interest-only loan’s fully amortized payment. FHFA received a number of comments on the multifamily grids in the 2018 proposal. Some commenters stated that the multifamily credit risk capital requirements in the 2018 proposal were too high given the Enterprises’ historical multifamily losses. Similarly, some commenters suggested that the credit risk capital required under the 2018 proposal’s multifamily grids might be appropriate if FHFA included revenue as a source of E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.023</GPH> In both the multifamily FRM and multifamily ARM grids, the base risk weight would increase as DSCR decreases (moving toward the top of a grid) and as MTMLTV increases (moving toward the right of the grid). Thus, an Enterprise would generally be required to hold more credit risk capital for a higher-risk multifamily mortgage exposure with a low DSCR and a high MTMLTV (the upper-right corner of each grid) than for a lower-risk multifamily mortgage exposure with a high DSCR and a low MTMLTV (the lower-left corner of each grid). The DSCR and MTMLTV breakpoints and ranges represented along the dimensions of the multifamily grids combine to form granular buckets 39323 EP30JN20.022</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39324 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 loss-absorbing capital, or if FHFA benchmarked its credit risk capital requirements to those published by the National Association of Insurance Commissioners (NAIC), which include revenue offsets. After consideration of the commenters’ suggestions, FHFA believes the calibration of the multifamily grids is appropriate. The base risk weights in the multifamily grids represent estimates of lifetime losses (net of expected losses), so one should expect the base risk weights in the multifamily grids to be larger than observed losses experienced during the recent financial crisis. As discussed in Section V.B.1, consistent with the 2018 proposal, neither the statutory definitions nor the supplemental definitions of regulatory capital include a measure of future guarantee fees or other future revenues. One commenter recommended FHFA add granularity to the multifamily grids, particularly in the high MTMLTV ranges. FHFA notes that the multifamily grids were constructed using synthetic loans at acquisition, so data in the high MTMLTV range is limited due to the Enterprises’ acquisition history. Adding granularity to the outer ranges of the multifamily grids would necessitate further assumptions and extrapolations. Question 53. Are the base risk weights for multifamily mortgage exposures appropriately formulated and calibrated to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 54. Are there any adjustments, simplifications, or other refinements that FHFA should consider for the base risk weights for multifamily mortgage exposures? VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Question 55. Should the base risk weight for a multifamily mortgage exposure be assigned based on OLTV or MTMLTV of the multifamily mortgage exposure, or perhaps on the LTV of the multifamily mortgage exposure based on the original purchase price and after adjusting for any paydowns of the original principal balance? Question 56. What steps, including any process for soliciting public comment on an ongoing basis, should FHFA take to ensure that the multifamily grids are updated from time to time as market conditions evolve? 4. Countercyclical Adjustment In contrast to the single-family framework, the proposed multifamily credit risk capital framework does not include an adjustment to mitigate the pro-cyclicality of the aggregate riskbased capital requirements, although FHFA believes such an adjustment could be merited. The proposed singlefamily countercyclical adjustment is based on an estimated long-term trend in FHFA’s inflation-adjusted alltransactions HPI. FHFA does not currently produce a comparable multifamily series, and it is unclear whether there is sufficient data from which to develop a reliable long-term trend in multifamily property values. FHFA is aware of the pro-cyclicality that would be introduced by its multifamily credit risk capital framework, and FHFA could see considerable merit to a countercyclical or similar adjustment. FHFA is soliciting comments on options and available data for a countercyclical adjustment to the credit risk capital requirements for multifamily mortgage exposures. Question 57. What approach, if any, should FHFA consider to mitigate the pro-cyclicality of the credit risk capital PO 00000 Frm 00052 Fmt 4701 Sfmt 4702 requirements for multifamily mortgage exposures? 5. Risk Multipliers As with single-family mortgage exposures, the proposed rule would require an Enterprise to adjust the base risk weight for each multifamily mortgage exposure to account for additional loan characteristics using a set of multifamily-specific risk multipliers. The risk multipliers would refine the base risk weights to account for risk factors beyond the primary risk factors reflected in the multifamily grids, and for variations in secondary risk factors not captured in the risk profiles of the synthetic loans used to calibrate the multifamily grids. The adjusted risk weight for a multifamily mortgage exposure would be the product of the base risk weight and the combined risk multiplier. The risk multipliers represent common loan characteristics that increase or decrease the projected unexpected losses of a multifamily mortgage exposure. Although the specified risk characteristics are not exhaustive, they capture key commercial real estate loan performance drivers, and are commonly used in commercial real estate loan underwriting and rating. The risk multipliers are substantially the same as those of the 2018 proposal, with some simplifications and refinements. In particular, FHFA enhanced the risk multiplier for loan size to simultaneously make it more granular and less prone to large jumps in credit risk capital from moving from one bracket to the next. FHFA also removed the risk multiplier for multifamily loans with a government subsidy. The multifamily risk multipliers are presented below in Table 24. E:\FR\FM\30JNP2.SGM 30JNP2 BILLING CODE 8070–01–C As with the single-family risk multipliers, each risk factor could take multiple values, and each value or range VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 of values would have a risk multiplier associated with it. For any particular multifamily mortgage exposure, each PO 00000 Frm 00053 Fmt 4701 Sfmt 4702 39325 risk multiplier could take a value of 1.0, above 1.0, or below 1.0. A risk multiplier of 1.0 would imply that the E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.024</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 39326 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules risk factor value for a multifamily mortgage exposure is similar to, or in a certain range of, the particular risk characteristic found in the multifamily segment’s synthetic loan. A risk multiplier value above 1.0 would be assigned to a risk factor value that represents a riskier characteristic than the one found in the multifamily segment’s synthetic loan, while a risk multiplier value below 1.0 would be assigned to a risk factor value that represents a less risky characteristic than the one found in the multifamily segment’s synthetic loan. Finally, the risk multipliers would be multiplicative, so each multifamily mortgage exposure in a multifamily segment would receive a risk multiplier for every risk factor pertinent to that multifamily segment, even if the risk multiplier is 1.0 (implying no change to the base risk weight for that risk factor). The total combined risk multiplier for a multifamily mortgage exposure would be, in general, the product of all individual risk multipliers pertinent to the multifamily segment in which the exposure is classified. The proposed multifamily risk multipliers are: • Payment performance. The payment performance risk multiplier would capture risks associated with historical payment performance. Multifamily mortgage exposures would be assigned one of four values: Performing, delinquent, re-performing (without modification), and modified. A performing loan would be one that has never been delinquent in its payments; a delinquent loan would be one that is 60 days or more past due; a reperforming loan would be one that is current in its payments, but has been delinquent in its payments at least once since origination and has cured without modification; and a modified loan would be one that is current in its payments, but has been modified at least once since origination or has gone through a workout plan. An Enterprise would be required to hold more credit risk capital for multifamily mortgage exposures that have a delinquency and/ or modification history than for those that do not. Specifically, performing multifamily mortgage exposures would receive a risk multiplier of 1.0, while delinquent, re-performing, and modified exposures would receive a risk multiplier greater than 1.0. • Interest-only. The interest-only risk multiplier would capture risks associated with interest-only exposures during the interest-only period. Interestonly loans are generally riskier than non-interest-only loans, all else equal, and the proposed rule would partially account for this increased amortization VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 and leveraging risk by requiring an Enterprise to use its fully amortized payments to calculate DSCR. Using amortized payment would lower the DSCR, resulting in a higher credit risk capital requirement all else equal. In addition, the proposed rule would further account for interest-only risk with a risk multiplier. Specifically, noninterest-only exposures would receive a risk multiplier of 1.0, while interestonly exposures would receive a risk multiplier of 1.1 during the interest-only period. • Loan term. The loan term risk multiplier would capture risks associated with the remaining term of a multifamily mortgage exposure. The majority of the Enterprises’ multifamily mortgage exposures have a loan term of five years or longer, and in general, multifamily mortgage exposures with a shorter term are less risky than those with a longer term. Multifamily mortgage exposures with shorter loan terms carry relatively less uncertainty about eventual changes in property performance and future refinancing opportunities, while multifamily mortgage exposures with longer loan terms carry relatively higher uncertainty about the borrower’s ability to refinance in the future. In the proposed rule, a 10year loan term would be considered a baseline risk, so exposures with a remaining loan term between 7 years and 10 years would receive a risk multiplier of 1.0. The 7- to-10-year range represents a conservative range FHFA believes is appropriate. Multifamily mortgage exposures with remaining loan terms shorter than 7 years would receive risk multipliers less than 1.0, and multifamily mortgage exposures with remaining loan terms longer than 10 years would receive a risk multiplier greater than 1.0. At origination, the remaining loan term would equal the original loan term. • Original amortization term. The amortization term risk multiplier would capture risks associated with the amortization term of a multifamily mortgage exposure. In general, a multifamily mortgage exposure with a shorter repayment period faces less risk of a borrower defaulting on its payments than does a multifamily mortgage exposure with a longer repayment period. The most common amortization term for multifamily mortgage exposures is 30 years, even though most have an original loan term with a balloon payment due earlier, often in 10 years. While amortization terms can potentially take any value, FHFA believes that given the high number of multifamily mortgage exposures with an amortization term between 25 and 30 PO 00000 Frm 00054 Fmt 4701 Sfmt 4702 years, the values represented in the risk multiplier table would sufficiently account for the differences in risk associated with amortization term. In the proposed rule, a 30-year amortization term would represent a baseline level of risk, and a multifamily mortgage exposure with a 30-year amortization term would receive a risk multiplier of 1.0. A multifamily mortgage exposure with an amortization term less than 25 years would receive a risk multiplier less than 1.0, while a multifamily mortgage exposure with an amortization term greater than 30 years would receive a risk multiplier of 1.1. • Original loan size. Multifamily mortgage exposures with larger original loan balances are generally considered less risky than those with smaller balances, because larger balances are commonly associated with larger investors with more access to capital and experience. In addition, the collateral securing a large loan is often a larger, more established, and/or newer property. Alternatively, multifamily mortgage exposures with smaller original balances are often associated with investors with limited funding and smaller, less competitive properties. An original loan size of $10 million would represent a baseline level of risk, and multifamily mortgage exposures meeting that criterion would receive a risk multiplier of 1.0. In a change from the 2018 proposal, and in response to commenters that recommended FHFA add granularity to the loan size risk multiplier in part to avoid large jumps in the credit risk capital requirement when moving from one risk multiplier bucket to the next, multifamily mortgage exposures above or below $10 million would receive a loan size risk multiplier that changes in $1 million increments between $3 million and $25 million. The loan size risk multipliers in the proposed rule were calculated by extrapolating between the loan size risk multiplier breakpoints in the 2018 proposal. Multifamily mortgage exposures with an original loan balance greater than $10 million would receive a risk multiplier less than 1.0, and multifamily mortgage exposures with an original loan balance less than $10 million would receive a risk multiplier greater than 1.0. • Special products. The multifamily special products that would receive a multifamily risk multiplier were selected for their importance based on FHFA staff analysis and expertise, pursuant to discussions with the Enterprises and their collective multifamily business experiences, and in recognition of commenter feedback on the 2018 proposal. The special E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules products, discussed individually below, are student housing and rehab/valueadd/lease-up loans. Student housing loans provide financing for the operation of apartment buildings for college students. The rental periods for units in these properties often correspond to the institution’s academic calendar, so the properties have a high annual turnover of occupants. Student renters, by and large, might not be as careful with the use and maintenance of the rental units as more mature households. As a result, apartment buildings focusing on student housing customarily have more volatile occupancy and less predictable maintenance expenses. In the proposed rule, this would imply higher risk, which leads to a risk multiplier greater than 1.0 for student housing exposures. The second type of special product includes loans issued to finance rehab/ value-add/lease-up projects. Rehab and value-add projects refer to types of renovations, where a rehab project is a like-for-like renovation and a value-add project is one that increases a property’s value by adding a new feature to an existing property or converts one component of a property into a more marketable feature, such as converting unused storage units into a fitness center. A lease-up property is one that is recently constructed and still in the process of securing tenants for occupancy. Recently built properties, and those subject to improvements, typically require more intense marketing efforts in the early stages of property operation. It often takes longer for these properties to reach and stabilize at reasonable occupancy levels. These factors elevate the property’s risk, which in the proposed rule would lead to a risk multiplier greater than 1.0 for exposures backing these properties. Although not requiring a risk multiplier, a special type of multifamily mortgage exposure contemplated by the proposed rule is a supplemental loan. Supplemental loans refer to multifamily loans issued to a borrower for a property against which the borrower has previously received a loan. There can be more than one supplemental loan for any borrower/property combination. These loans, by definition, increase loan balances, which lead to higher LTVs and could lead to lower DSCRs, which could lead to higher risk. Therefore, the proposed rule would require an Enterprise to account for this potentially higher risk by recalculating DSCRs and LTVs for the original and supplemental loans using combined loan balances and income/payment information. The Enterprise would calculate risk weights for the original and supplemental loans VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 using the aggregate LTV and DSCR and the separate loan characteristics of each loan, with the exception of the loan size risk multiplier which would be determined using the aggregate UPB of the original loan and all supplemental loans. In a change from the 2018 proposal, the proposed rule would not include a risk multiplier for multifamily mortgage exposures with a government subsidy. FHFA sought feedback on the government subsidy risk multiplier in the 2018 proposal, and commenters recommended FHFA consider implementing the risk multiplier based on the level of subsidy. FHFA analyzed the available performance data for government-subsidized multifamily mortgage exposures, due to the relatively low instances of loss across multifamily loan programs that include a government subsidy, FHFA determined it was not feasible to accurately calibrate thresholds at which the level of government subsidy impacted the probability of loss occurring or the severity of that loss. As a result of that analysis, FHFA has determined to take the approach of eliminating the government subsidy risk multiplier from the proposed rule to avoid instances where a loan with a limited subsidy would qualify for the risk multiplier. FHFA received several additional comments on the multifamily risk multipliers in the 2018 proposal. Two commenters recommended FHFA add granularity to the interest-only risk multiplier, with one commenter suggesting gradations be added to the risk multiplier for the length of the interest-only term, or at least a differentiation for a partial interest-only versus a full interest-only. FHFA is proposing the interest-only risk multiplier as in the 2018 proposal because FHFA continues to believe in the validity of the analysis supporting the interest-only risk multiplier. In that analysis, historical data with which to calibrate an interest-only risk multiplier by interest-only term length was limited, and feedback from the industry participants with whom FHFA consulted disagreed as to the nature of a more granular risk multiplier. Another commenter recommended FHFA add risk multipliers for additional product types such as construction and modrehab loans, for loan features such as cross-collateralization, and for nonfinancial structural terms such as borrower covenants. While FHFA acknowledges different product types and features may represent differential levels of risk, the risk multipliers were selected in part due to data availability, PO 00000 Frm 00055 Fmt 4701 Sfmt 4702 39327 and in part because FHFA concluded that the risk multipliers would represent a simple and transparent way to adjust the base capital requirements for the most important multifamily risks faced by an Enterprise in a regulatory capital framework. Question 58. Are the risk multipliers for multifamily mortgage exposures appropriately formulated and calibrated to require credit risk capital sufficient to ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 59. Are there any adjustments, simplifications, or other refinements that FHFA should consider for the risk multipliers for multifamily exposures? Question 60. Should the combined risk multiplier for a multifamily mortgage exposure be subject to a floor or a cap? 6. Minimum Adjusted Risk Weight The 2018 proposal acknowledged that combinations of overlapping characteristics could potentially result in unduly low credit risk capital requirements for certain multifamily mortgage exposures. Under the 2018 proposal, the Enterprises were required to impose a floor of 0.5 to any combined multifamily risk multiplier. FHFA has taken a somewhat different approach in the proposed rule. As for single-family mortgage exposures, the proposed rule would establish a floor on the adjusted risk weight for a multifamily mortgage exposure equal to 15 percent. First, as discussed in Section IV.B, a risk weight floor is appropriate to mitigate certain risks and limitations associated with the underlying historical data and models. These risks include the potential that crisis-era losses were mitigated by the unprecedented federal government support of the economy and the impact of lower interest rates. In addition, they include potentially material risks that are not assigned a risk-based requirement, for example those that might arise from natural or other disasters. Second, comparison to the U.S. banking framework’s credit risk capital requirements for similar exposures contributed to FHFA’s view that a risk weight floor is appropriate, while also raising important questions as to the sizing of that risk weight floor. As of September 30, 2019, with the proposed 15 percent risk weight floor, the average pre-CRT net credit risk capital requirement on the Enterprises’ multifamily mortgage exposures would have been 4.1 percent of unpaid E:\FR\FM\30JNP2.SGM 30JNP2 39328 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 principal balance, implying an average risk weight of 51 percent. That 51 percent average risk weight is only modestly greater than the 50 percent average risk weight without the floor. The U.S. banking framework generally assigns a 100 percent risk weight to multifamily mortgage exposures to determine the credit risk capital requirement (equivalent to an 8.0 percent adjusted total capital requirement), although some multifamily mortgage exposures are eligible for a 50 percent risk weight. Before adjusting for the capital buffers under the proposed rule and the U.S. banking framework, the Enterprises’ credit risk capital requirements for multifamily mortgage exposures would have been roughly half that of the default risk weight under the U.S. banking framework. This comparison is complicated by the fact that the 51 percent average risk weight reflects adjustments for MTMLTV. In particular, some meaningful portion of the gap currently between the credit risk capital requirements of the Enterprises and U.S. banking organizations under the proposed rule is due to the proposed rule’s use of MTMLTV instead of OLTV, as under the U.S. banking framework, to assign credit risk capital requirements for mortgage exposures. In a different economic environment, perhaps after several years of declining multifamily property prices, the mark-to-market framework could have resulted in higher credit risk capital requirements than the U.S. banking framework.71 However, the current gap between the credit risk capital requirements of U.S. banking organizations and the Enterprises under the proposed rule is still informative to the calibration of an appropriate risk weight floor. FHFA sized the 15 percent risk weight floor to mirror the risk weight floor for singlefamily mortgage exposures. FHFA is soliciting comment on that sizing, in particular whether a multifamily71 In consideration that the U.S. banking framework utilizes OLTVs, a comparison of the credit risk capital requirements for newly acquired multifamily mortgage exposures under the 2018 proposal and the proposed rule provides the most direct comparison of credit risk capital requirements for new originations. Under the proposed rule, gross credit risk capital (prior to adjustments for CRT) on newly acquired multifamily mortgage exposures as of September 30, 2019, with an average MTMLTV of approximately 67 percent, would have been approximately 5.3 percent of unpaid principal balance, implying an average risk weight of 67 percent. This compares to the 100 percent default risk weight generally applicable under the U.S. banking framework. These risk weights would then decline to the extent multifamily property prices appreciate or increase to the extent multifamily property prices depreciate. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 specific risk-weight floor might be more appropriate. Question 61. Is the minimum floor on the adjusted risk weight for a multifamily mortgage exposure appropriately calibrated to mitigate model and related risks associated with the calibration of the underlying base risk weights and risk multipliers and to otherwise ensure each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission across the economic cycle? Question 62. Should the minimum floor on the adjusted risk weight for a multifamily mortgage exposure be decreased or increased, perhaps to align the minimum floor with the more risksensitive standardized risk weights assigned to similar exposures under the Basel or U.S. banking framework? Question 63. Should the risk weight floor for a multifamily mortgage exposure be different from the risk weight floor for a single-family mortgage exposure? Question 64. Should the floor or other limit used to determine a multifamily mortgage exposure’s credit risk capital requirement be assessed against the base risk weight, the risk weight adjusted for the risk multipliers, or some other input used to determine that credit risk capital requirement? C. CRT and Other Securitization Exposures 1. Background a. PLS and CMBS Investments The Enterprises have exposure to PLS and commercial mortgage-backed securities (CMBS) to the extent that they invest in PLS or CMBS or guarantee PLS or CMBS that have been re-securitized by an Enterprise. In the lead up to the 2008 financial crisis, each Enterprise substantially increased its investments in PLS, and those PLS investments were a source of a meaningful portion of each Enterprise’s initial crisis-era capital exhaustion. The Enterprises have not acquired material amounts of PLS since 2008. However, the Enterprises do retain some relatively small amount of legacy PLS, and each Enterprise might acquire PLS in the future, subject to any regulations that FHFA may prescribe. The proposed rule therefore contemplates regulatory capital requirements for the credit, spread, and operational risk posed by these PLS and CMBS exposures. b. Single-Family CRT CRT transactions provide credit protection beyond that provided by loan-level credit enhancements. CRT can be viewed as an Enterprise paying PO 00000 Frm 00056 Fmt 4701 Sfmt 4702 a portion of its guarantee fee as a cost of transferring credit risk to private sector investors. To date, single-family CRT have included transferring expected and unexpected losses. The Enterprises have developed a variety of single-family CRT product types, including structured debt issuances (known as Structured Agency Credit Risk (STACR) for Freddie Mac and Connecticut Avenue Securities (CAS) for Fannie Mae), insurance/reinsurance transactions (known as Agency Credit Insurance Structure (ACIS) for Freddie Mac and Credit Insurance Risk Transfer (CIRT) for Fannie Mae), and seniorsubordinate securities. The STACR and CAS securities account for the majority of single-family CRT to date. These securities are issued as notes from a trust and do not constitute the sale of mortgage loans or their cash flows. Instead, STACR and CAS are considered to be synthetic notes because their cash flows are determined by the credit risk performance of a notional reference pool of mortgage loans. For the STACR and CAS transactions, the Enterprises receive the proceeds of the note issuance at the time of sale to investors. The Enterprises pay interest to investors on a monthly basis and allocate principal to investors based on the repayment and credit performance of the single-family mortgage exposures in the underlying reference pool. Investors ultimately receive a return of their principal, less any covered credit losses. The transactions are fully collateralized since investors pay for the notes in full. Thus, the Enterprises do not bear any counterparty credit risk on debt transactions. Pool-level reinsurance transactions such as CIRT and ACIS, which generally cover hundreds or thousands of singlefamily mortgage loans, are considered CRT. Pool insurance transactions are typically structured with an aggregated loss amount. The Enterprises, as policy holders, typically retain some portion (or all) of the first loss. The cost of poollevel insurance is generally paid by the Enterprise, not the lender or borrower. In general, an Enterprise may bear counterparty credit risk because insurance transactions are not fully collateralized. This counterparty credit risk may be somewhat mitigated, however, by conducting transactions with diversified reinsurers that have books of business that may be less correlated with the Enterprises or with insurers in compliance with an Enterprise’s insurer eligibility standards. In a senior-subordinate (senior-sub) securitization, the Enterprise sells a E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 pool of single-family mortgage exposures to a trust that securitizes cash flows from the pool into several tranches of bonds, similar to PLS transactions. The subordinated bonds, also called mezzanine and first-loss bonds, provide the credit protection for the senior bond. Unlike STACR and CAS, the bonds created in a senior-sub transaction are MBS, not synthetic securities. In addition, unlike typical MBS issued by the Enterprises, generally only the senior tranche is guaranteed by the Enterprise. Historically the Enterprises have also engaged in front-end (or upfront) lender risk sharing transactions similar to CRT, but the single-family lender risk sharing programs will be discontinued by yearend 2020. c. Multifamily CRT The Enterprises also reduce the credit risk on their multifamily guarantee books of business by transferring and sharing risk through multifamily CRT. As discussed in Section VIII.B.1, the Enterprises have historically operated different multifamily business models, which has led to the utilization of two broad types of multifamily CRT: Loss sharing and securitizations. Within each type, individual CRT transactions can have unique structures. The proposed rule’s approach would be general enough to accommodate the full range of multifamily CRT currently utilized by the Enterprises. The loss sharing CRT structure is a front-end risk transfer, which is defined as a CRT an Enterprise enters into with a lender before the lender delivers the loan to the Enterprise. The Enterprise and lender share future losses according to a specified arrangement, commonly from the first dollar of loss, and in exchange the lender is compensated for taking on credit risk. Because these transactions are not always fully collateralized, a loss sharing CRT generally exposes the Enterprise to counterparty credit risk. In the multiclass securitization CRT structure, an Enterprise sells a pool of multifamily mortgage exposures to a trust that securitizes cash flows from the pool into several tranches of bonds. The subordinated bonds, also called mezzanine and first-loss bonds, are sold to market participants. These subordinated bonds provide credit protection for the senior bond, which is the only tranche that is guaranteed by the Enterprise. These sales typically result in a significant transfer of the credit risk on the underlying multifamily mortgage exposures. In addition to, and often on top of, loss sharing and securitization CRT VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 structures, the Enterprises also transfer multifamily credit risk using reinsurance CRT transactions. In these back-end transactions, such as Fannie Mae’s CIRT program, an Enterprise enters into agreements with third parties to cover losses on a pool of multifamily mortgage exposures up to a certain percentage. The Enterprise, as policy holder, typically retains some portion (or all) of the first losses on the pool and compensates the third parties, generally reinsurers, for bearing subsequent losses up to a detachment point. To the extent that these deals are not fully collateralized, the proposed rule would increase an Enterprise’s post-deal exposure to reflect counterparty risk. 2. PLS and Other Non-CRT Securitization Exposures As contemplated by the 2018 proposal, an Enterprise would determine its credit risk capital requirement for PLS and other securitization exposures under a securitization framework that would be substantially the same as that of the U.S. banking framework. As discussed in Section VIII.C.3, an Enterprise may elect to determine its credit risk capital requirement for a retained CRT exposure under a somewhat different framework, even if that retained CRT exposure might be similar to an exposure to a traditional or synthetic securitization under the securitization framework. The exposure amount of an Enterprise’s on-balance sheet securitization exposure generally would be the carrying value of the exposure, while the exposure amount of an offbalance sheet securitization exposure generally would be the notional amount of the exposure.72 An Enterprise generally would assign a risk weight for a PLS or other securitization exposure using the simplified supervisory formula approach (SSFA). Pursuant to the SSFA, an Enterprise would determine the risk weight for a securitization exposure using a formula that is based, among other things, on the subordination level of the securitization exposure and the adjusted aggregate credit risk capital requirement of the underlying exposures. A 1,250 percent risk weight would be assigned to any securitization exposure that absorbs losses up to the adjusted aggregate credit risk capital 72 For both on- and off-balance sheet securitization exposures, there would be special rules for determining the exposure amount and risk weights for repo-style transactions, eligible margin loans, OTC derivative contracts, and derivatives that are cleared transactions (other than credit derivatives). PO 00000 Frm 00057 Fmt 4701 Sfmt 4702 39329 requirement of the underlying exposures. After that point, the risk weight for a securitization exposure would be assigned pursuant to an exponential decay function that decreases as the detachment point or attachment point increases, subject to a minimum risk weight of 20 percent. At the inception of a securitization, the SSFA’s exponential decay function for risk weights, together with the 20 percent risk weight floor, would require more regulatory capital on a transactionwide basis than would be required if the underlying exposures had not been securitized. That is, if the Enterprise held every tranche of a securitization, its overall regulatory capital requirement would be greater than if the Enterprise owned all of the underlying exposures. Like the U.S. banking regulators, FHFA believes this outcome is important to reduce regulatory capital arbitrage through securitizations and to manage the structural and other risks that might be posed by a securitization.73 3. Retained CRT Exposures a. Assessment Framework As discussed in the 2018 proposal, FHFA has established certain core principles to guide the developments of the Enterprises’ CRT programs. Each CRT must transfer a meaningful amount of credit risk to private investors to reduce risk to the Enterprises, and the cost of the CRT must be economically sensible. In addition, a CRT must not interfere with the Enterprise’s core business, including the ability of borrowers to access credit. The CRT programs have been intended to attract a broad investor base, be scalable, and incorporate a regular program of issuances. In transactions where credit risk may not be fully collateralized, the CRT counterparties must be financially strong, post collateral for a portion of their exposure, and be expected to fulfill 73 See Regulatory Capital Rules: Regulatory Capital, Implementation of Basel III, Capital Adequacy, Transition Provisions, Prompt Corrective Action, Standardized Approach for Risk-weighted Assets, Market Discipline and Disclosure Requirements, Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital Rule, 78 FR 62018, 62119 (Oct. 11, 2013) (hereinafter Joint Agency Regulatory Capital Final Rule) (‘‘At the inception of a securitization, the SSFA requires more capital on a transaction-wide basis than would be required if the underlying assets had not been securitized. That is, if the banking organization held every tranche of a securitization, its overall capital requirement would be greater than if the banking organization held the underlying assets in portfolio. The agencies believe this overall outcome is important in reducing the likelihood of regulatory capital arbitrage through securitizations.’’). E:\FR\FM\30JNP2.SGM 30JNP2 39330 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 their commitments in adverse market conditions. FHFA has continued to refine the assessment framework based on its understanding of the safety and soundness risks and limits relating to the effectiveness of CRT in transferring credit risk on the underlying exposures. Commenters on the 2018 proposal argued that CRT has less loss-absorbing capacity than an equivalent amount of equity financing. FHFA agrees that CRT transfers credit risk only on a specified reference pool, while equity financing is available to ‘‘cross cover’’ credit risk on other exposures of the Enterprise. FHFA also agrees that CRT transfers only credit risk, while equity financing can absorb losses arising from operational and market risks. Related to this, an Enterprise generally may pause distributions on equity financing during a financial stress but typically must continue debt service or other payments on CRT instruments. Therefore, equity financing provides more robust safety and soundness benefits across exposures and risks than a similar amount of credit exposure transferred through CRT. One of the lessons of the 2008 financial crisis is that securitization structures, especially complex securitizations, might not perform as expected during a financial stress, with some large banking organizations even electing to reconsolidate some of their securitizations.74 Similarly, there might 74 See Risk-Based Capital Guidelines; Capital Adequacy Guidelines; Capital Maintenance: Regulatory Capital; Impact of Modifications to Generally Accepted Accounting Principles; Consolidation of Asset-Backed Commercial Paper Programs; and Other Related Issues, 74 FR 47138, 47142 (Sept. 15, 2009) (‘‘In the case of some structures that banking organizations were not required to consolidate prior to the 2009 GAAP modifications, the recent turmoil in the financial markets has demonstrated the extent to which the credit risk exposure of the sponsoring banking organization to such structures (and their related assets) has in fact been greater than the agencies estimated, and more associated with noncontractual considerations than the agencies had expected. For example, recent performance data on structures involving revolving assets show that banking organizations have often provided noncontractual (implicit) support to prevent senior securities of the structure from being downgraded, thereby mitigating reputational risk and the associated alienation of investors, and preserving access to cost-effective funding.’’); see also FCIC Report at 246, available at https://www.govinfo.gov/ content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (‘‘When the mortgage securities market dried up and money market mutual funds became skittish about broad categories of ABCP, the banks would be required under these liquidity puts to stand behind the paper and bring the assets onto their balance sheets, transferring losses back into the commercial banking system. In some cases, to protect relationships with investors, banks would support programs they had sponsored even when they had made no prior commitment to do so.’’); see also FCIC Report at 138–139 (‘‘The events of 2007 would VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 be unique legal risks posed by the contractual terms of CRT structures and by the practices associated with contractual enforcement. While the 2018 proposal already contemplated reductions to the capital relief provided by a CRT based on the counterparty risk and maturity-related risk of CRT, FHFA agrees that there are structural and other risks that were not reflected in those adjustments that could further limit the effectiveness of CRT in transferring credit risk. FHFA continues to look to opportunities to enhance its framework for assessing the Enterprises’ CRT programs to mitigate these safety and soundness risks. Besides safety and soundness, FHFA’s assessment framework also considers the extent to which an Enterprise’s CRT program could limit the Enterprise’s ability to fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle. As discussed in the 2018 proposal, a financial stress could reduce investor demand for, or increase the cost of, new CRT issuances or undermine the financial strength of some existing CRT counterparties. The pro-cyclicality of some CRT structures could adversely impact an Enterprise’s ability to support the secondary mortgage market if an Enterprise were not to have sufficient equity financing to support new acquisitions of mortgage exposures. To fulfill its mission, an Enterprise should avoid overreliance on CRT and should maintain at least enough equity capital to support new originations during a period of financial stress, when new CRT issuances might not be available. For these and other reasons, capital relief for CRT under the 2018 proposal did not extend to the going- concern buffer, and the proposed rule also would not provide CRT capital relief for the capital conservation buffer. FHFA’s assessment framework also seeks to prevent each Enterprise’s CRT program from undermining the liquidity, efficiency, competitiveness, or resiliency of the national housing finance markets. Some CRT structures might tend to increase the leverage in the housing finance system, especially to the extent some CRT investors themselves rely on short-term debt funding. The disruption in the CRT markets during the recent COVID–19related financial stress might have been driven in part by leveraged market participants that had invested in CRT reveal the fallacy of those assumptions and catapult the entire $25 billion in commercial paper straight onto the bank’s balance sheet, requiring it to come up with $25 billion in cash as well as more capital to satisfy bank regulators.’’). PO 00000 Frm 00058 Fmt 4701 Sfmt 4702 rapidly de-levering when confronted by margin calls on short-term financing. b. Enhancements to the 2018 Proposal FHFA is proposing enhancements to the 2018 proposal’s regulatory capital treatment of CRT to refine its balancing of the safety and soundness benefits of CRT against the potential safety and soundness, mission, and housing market stability risks that might be posed by CRT. Consistent with the U.S. banking framework, FHFA is proposing operational criteria to mitigate the risk that the terms or structure of the CRT would not be effective in transferring credit risk. FHFA’s proposed operational criteria would provide capital relief on a CRT only if certain conditions are satisfied, including: • The CRT is of a category of CRT structures that has been approved by FHFA as effective in transferring credit risk. • The terms and conditions in the CRT do not include provisions that might undermine the effectiveness of the transfer of the credit risk (e.g., by allowing for the termination of the CRT due to deterioration in the credit quality of the underlying exposures). • Clean-up calls relating to the CRT are limited to specified circumstances. • The Enterprise publicly discloses— Æ The material recourse or other risks that might reduce the effectiveness of the CRT in transferring credit risk; and Æ Each operational criterion for a traditional securitization or a synthetic securitization that is not satisfied by the CRT and the reasons that each such condition is not satisfied. These operational criteria for CRT are less restrictive than those applicable to traditional or synthetic securitizations under the U.S. banking framework. For example, a senior/subordinated structure need not be off-balance sheet under GAAP, as required for traditional securitizations under the U.S. banking framework, while a financial guarantee need not be provided by a company that is not predominantly engaged in the business of providing credit protection, as required for an eligible guarantee under the U.S. banking framework. To partially mitigate the safety and soundness risks posed by this less restrictive approach, FHFA would require an Enterprise to publicly disclose material risks to the effectiveness of the CRT so as to foster market discipline and FHFA’s supervision and regulation. FHFA is also seeking comment on other operational criteria it might adopt for CRT. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 FHFA is also proposing to prescribe the regulatory capital consequences of an Enterprise providing support to a CRT in excess of the Enterprise’s predetermined contractual obligations. As under the U.S. banking framework, if an Enterprise provides implicit support for a CRT, the Enterprise would be required to include in its risk-weighted assets all of the underlying exposures associated with the CRT as if the exposures were not covered by the CRT. The Enterprise also would be required to disclose publicly (i) that it has provided implicit support to the CRT and (ii) the riskbased capital impact to the Enterprise of providing that implicit support. These requirements are intended to discourage an Enterprise from providing implicit support during a financial stress or otherwise, for example by providing financing to CRT investors or by repurchasing CRT exposures during a financial stress. Generally consistent with the U.S. banking framework, FHFA also is proposing a prudential floor of 10 percent on the risk weight assigned to any retained CRT exposure. Under the 2018 proposal, a retained CRT exposure with a detachment point less than the net credit risk capital requirement of the underlying mortgage exposures would, in effect, have had a risk weight of 1,250 percent, while a retained exposure with an attachment point only marginally greater than that net credit risk capital requirement would have had a risk weight of 0 percent. A retained CRT exposure with an attachment point just beyond that cut-off point likely still would pose some credit risk as a result of the model risks associated with the calibration of the credit risk capital requirement of the underlying exposures, and also the risk that a CRT will not perform as expected in transferring credit risk to third parties.75 The prudential floor for a retained CRT exposure avoids treating that exposure as posing no credit risk. The 10 percent minimum risk weight is less than the 20 percent minimum risk weight under the U.S. banking framework for securitization exposures. FHFA’s sizing of the minimum risk weight seeks to strike an appropriate balance between permitting CRT while 75 For these and other reasons, the Basel and U.S. banking frameworks impose a prudential floor on the risk weight for any securitization exposure. BCBS, Revisions to the Securitisation Framework Consultative Document at 17 (Dec. 2013; final July 2016), available at https://www.bis.org/publ/ bcbs269.pdf. (‘‘The objectives of a risk-weight floor are: [m]itigate concerns related to incorrect model specifications and error from banks’ estimates of inputs to capital formulas ([i.e.] model risk); and [r]educe the variation in outcomes for similar risks.’’). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 also mitigating the safety and soundness, mission, and housing stability risk that might be posed by some CRT. FHFA is soliciting comment on whether to align the risk weight floor for retained CRT exposures with the various different floors for securitizations exposures under the Basel and U.S. banking frameworks. Finally, FHFA is proposing refinements to the adjustments to the regulatory capital treatment of CRT for the counterparty, loss-timing, and other risks that a CRT might not be effective in transferring credit risk to third parties. As discussed in Section VIII.C.3.c, FHFA is proposing to refine the 2018 proposal’s adjustments for counterparty risk and loss-timing risk, and proposing to add a general adjustment for the differences between CRT and regulatory capital. These CRTspecific adjustments do introduce some complexity, and as discussed in Section VIII.C.3.d, FHFA is also soliciting comment on an alternative approach based on the U.S. banking framework’s SSFA that is simpler but also less tailored. Under either FHFA’s proposed or alternative approach, at the inception of a CRT, FHFA generally would require more credit risk capital on a transactionwide basis than would be required if the underlying mortgage exposures had not been made subject to a CRT. That is, if an Enterprise held every tranche of a CRT, its credit risk capital requirement on the retained CRT exposures generally would be greater than the credit risk capital requirement of the underlying mortgage exposures. As under the securitization framework, this departure from strict capital neutrality is important to manage the potential safety and soundness risks of CRT. This approach would help mitigate the model risk associated with the calibration of the credit risk capital requirements of the underlying exposures and also the model risk posed by the calibration of the adjustments for loss-timing and counterparty risks.76 76 BCBS, Revisions to the Securitisation Framework Consultative Document at 4 (Dec. 2013; final July 2016), available at https://www.bis.org/ publ/bcbs269.pdf. (‘‘Capital requirements should be calibrated to reasonably conservative standards. This requires the framework to account for the model risk of determining the risks of specific exposures. Models for securitisation tranche performance depend in turn on models for underlying pools. In addition, securitisations have a wide range of structural features that do not exist for banks holding the underlying pool outright and that are impossible to capture in models. This layering of models and simplifying assumptions can exacerbate model risk, justifying a rejection of a strict ‘‘capital neutrality’’ premise ([i.e.] the total capital required after securitisation should not be PO 00000 Frm 00059 Fmt 4701 Sfmt 4702 39331 Complex CRT also may pose structural risk and other risks that merit a departure from capital neutrality.77 This departure from capital neutrality also is important to reducing the likelihood of regulatory capital arbitrage through CRT.78 One implication of departing from capital neutrality is that an Enterprise might have some existing CRT structures for which the aggregate credit risk capital requirement of the retained CRT exposures actually would be greater than the aggregate credit risk capital requirement of the underlying exposures. This outcome might be more likely, all else equal, where the underlying exposures have a lower average risk weight, for example, a CRT with respect to seasoned single-family mortgage exposures. As under the U.S. banking framework, an Enterprise may elect to not recognize a CRT for purposes of the credit risk capital requirements and instead hold riskbased capital against the underlying exposures. FHFA has assumed for purposes of the proposed rule that an Enterprise would make this election in those cases where the aggregate credit risk capital requirement of the underlying exposures is less than that of the retained CRT exposures. Question 65. What changes, if any, should FHFA consider to the operational criteria for CRT? Question 66. What changes, if any, should FHFA consider to the regulatory consequences of an Enterprise providing implicit support to a CRT? Question 67. Is the 10 percent prudential floor on the risk weight for a retained CRT exposure appropriately calibrated? Question 68. Should FHFA increase the prudential floor on the risk weight for a retained CRT exposure, for example so that it aligns with the 20 identical to the total capital before securitisation).’’). 77 BCBS, Revisions to the Securitisation Framework at 6 (Dec. 2014; rev. July 2016), available at https://www.bis.org/bcbs/publ/d374.pdf (‘‘All other things being equal, a securitisation with lower structural risk needs a lower capital surcharge than a securitisation with higher structural risk; and a securitisation with less risky underlying assets requires a lower capital surcharge than a securitisation with riskier underlying assets.’’). 78 See Joint Agency Regulatory Capital Final Rule, 78 FR at 62119 (‘‘At the inception of a securitization, the SSFA requires more capital on a transaction-wide basis than would be required if the underlying assets had not been securitized. That is, if the banking organization held every tranche of a securitization, its overall capital requirement would be greater than if the banking organization held the underlying assets in portfolio. The agencies believe this overall outcome is important in reducing the likelihood of regulatory capital arbitrage through securitizations.’’). E:\FR\FM\30JNP2.SGM 30JNP2 39332 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules percent minimum risk weight under the U.S. banking framework? Question 69. Should FHFA take a different approach to an Enterprise’s existing CRT? c. Adjustments to CRT Capital Relief khammond on DSKJM1Z7X2PROD with PROPOSALS2 The proposed rule would implement a framework through which an Enterprise would determine its credit risk-weighted assets for any retained CRT exposures and any other credit risk that might be retained on its CRT. An Enterprise would calculate credit riskweighted assets for retained credit risk in a CRT using risk weights and exposure amounts for each CRT tranche. The exposure amount of the retained CRT exposures for each tranche would be increased by adjustments to reflect counterparty credit risk and the length of CRT coverage (i.e., remaining time until maturity). The proposed rule would also set a credit risk capital requirement floor for retained risk effectuated through a tranche-level risk weight floor. In addition, the approach would reduce the risk-weighted assets for risk sold by 10 percent to account for the fact that CRT transactions do not provide the same protection as regulatory capital. As discussed by several commenters on the 2018 proposal, the credit protection from a VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 CRT is not fungible to cover losses on other exposures. Furthermore, during a financial stress the Enterprises can stop equity dividend payments whereas the cost of CRT credit protection, in many cases, is an ongoing liability. Therefore, for each tranche, an Enterprise would reduce the risk-weighted assets assigned to private investors or covered by a loss sharing agreement by 10 percent and add the reduction to the Enterprise’s apportioned exposure amount in the tranche. Overall, the proposed rule would require each Enterprise to hold either: (i) Credit risk capital on any credit risk which it has retained or to which it is otherwise exposed (including nontransferable counterparty credit risk on the CRT’s underlying mortgage exposures); or (ii) the aggregate credit risk capital on the CRT’s underlying mortgage exposures. If the Enterprise chooses the former, then in general, an Enterprise would be required to hold less regulatory capital for CRT transactions that provide coverage (i) on a higher percentage of unexpected losses, (ii) for a longer period, and (iii) with lower levels of counterparty credit risk. The following example provides an illustration of the proposed rule’s capital requirements if an Enterprise PO 00000 Frm 00060 Fmt 4701 Sfmt 4702 elects to hold capital against the credit risk from its retained CRT exposures. Consider the following inputs from an illustrative CRT (see Figure 3): • $1,000 million in unpaid principal balance of performing 30-year fixed rate single-family mortgage exposures with OLTVs greater than 60 percent and less than or equal to 80 percent; • CRT coverage term of 10 years; • Three tranches—B, M1, and AH— where tranche B attaches at 0% and detaches at 0.5%, tranche M1 attaches at 0.5% and detaches at 4.5%, and tranche AH attaches at 4.5% and detaches at 100%; • Tranches B and AH are retained by the Enterprise, and ownership of tranche M1 is split between capital markets (60 percent), a reinsurer (35 percent), and the Enterprise (5.0 percent); • The aggregate credit risk-weighted assets on the single-family mortgage exposures underlying the CRT are $343.8 million; • Aggregate expected losses on the single-family mortgage exposures underlying the CRT of $2.5 million; and • The reinsurer posts $2.8 million in collateral, has a counterparty financial strength rating of 3, and does not have a high level of mortgage concentration risk. E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules general, tranche risk weights are the highest for the riskiest, most junior tranches (such as tranche B), and lower for the more senior tranches (such as tranches M1 and AH). For the illustrative CRT, the overall risk weights for tranches AH, M1, and B are 10%, 781%, and 1,250%, where 10% reflects the minimum risk weight. EP30JN20.026</GPH> where VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00061 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.025</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 The Enterprises would first calculate the risk weights for each tranche assuming full effectiveness of the CRT in transferring credit risk on the underlying mortgage exposures. In 39333 39334 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules effectiveness adjustments, which are reflected in the Enterprise’s adjusted exposure amount: Loss sharing effectiveness adjustment (LSEA), loss timing effectiveness adjustment (LTEA), and overall effectiveness adjustment (OEA). To account for the effectiveness of loss sharing on tranche M1, the proposed rule would adjust its exposure amount on tranche M1 to reflect the retention of some of the counterparty credit risk that was nominally transferred to the counterparty. The proposed rule adjusts effectiveness for (i) uncollateralized unexpected loss (UnCollatUL) and (ii) uncollateralized risk-in-force above stress loss (SRIF). For the illustrative CRT, the counterparty haircut is 5.2% as per the proposed single-family CP haircuts, from Table 21, UnCollatUL is 42.5%, and SRIF is 37.5%. The proposed rule’s LTEA on tranche M1 would be 96.4%. To account for effectiveness from the timing of coverage, the proposed rule would adjust the Enterprise’s exposure amount for tranche M1 to reflect the retention of some loss timing risk that was nominally transferred. The loss timing factor addresses the mismatch between lifetime losses on the 30-year fixed-rate single-family mortgage exposures underlying the CRT and the CRT’s coverage. The loss timing factor for the illustrative CRT with 10 years of coverage and backed by 30-year fixedrate single-family whole loans and guarantees with OLTVs greater than 60 percent and less than or equal to 80 percent is 88 percent for both the capital markets transaction and loss sharing agreement. For the illustrative CRT, tranche M1’s LTEA is 85.6% and is derived by scaling stress loss by the 88% loss timing factor. where LTKA % = max((2.75% + 0.25%) * 88%¥0.25%, 0%) = 2.39% provide the same loss-absorbing capacity as regulatory capital (OEA). OEA% = (1¥10%) = 90% The adjusted exposure amounts (AEAs) combine the effectiveness adjustments, aggregate UPB, tranche thickness, and an adjustment for expected losses (to tranche B in the example). For the illustrative CRT, the proposed rule would calculate AEAs as follows: Next, the Enterprise would calculate the adjusted exposure amount of its retained CRT exposures to reflect the effectiveness of the CRT in transferring credit risk on the underlying mortgage exposures. For the illustrative CRT, tranches AH and B are retained by the Enterprise, and do not need further adjustment. Risk associated with tranche M1 is transferred through a capital markets transaction and a loss sharing agreement. Risk transfer on this tranche is subject to the following three VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00062 Fmt 4701 Sfmt 4702 EP30JN20.030</GPH> E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.028</GPH> EP30JN20.029</GPH> For the last adjustment, the proposed rule would include a 10% overall reduction in capital relief to reflect for the fact that CRT transactions do not EP30JN20.027</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 where Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Seasoned CRT A seasoned CRT differs from when it was newly issued due to the changing risk profile on the mortgage exposures underlying the CRT, and changes to the CRT structure which may have developed since issuance. Therefore, an Enterprise would be required to periodically re-calculate capital adjustments on its seasoned CRT transactions. For each seasoned CRT, the proposed rule would require the Enterprise to update the data elements originally considered. In particular, the proposed rule would require the Enterprise to update credit risk capital and expected losses on the underlying whole loans and guarantees, tranche structure, ownership, and counterparty credit risk. CRT Prepayments The rate at which principal on a CRT’s underlying exposures is paid down (principal paydowns) affects the allocation of credit losses between the Enterprises and investors/reinsurers. Principal paydowns include regularly scheduled principal payments and unscheduled principal prepayments. In general, a CRT’s tranches are paid down VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 in the order of their seniority outlined in the CRT’s transaction documents. For tranches with shared ownership, principal paydowns are allocated on a pro-rata basis. Under certain conditions unusually fast prepayments can erode the credit protection provided by the CRT by paying down the subordinate tranches and leave the Enterprises more vulnerable to credit losses. In particular, unexpectedly high prepayments can compromise the protection afforded by CRT and reduce the CRT’s benefit or capital relief. FHFA reviewed the effect on capital relief of applying stressful prepayment and loan delinquency projections to recent CRT. FHFA concluded that deal features, specifically triggers, mitigate the effects of fast prepayments by diverting unscheduled principal prepayments to the Enterprise-held senior tranche. For example, a minimum credit enhancement trigger redirects prepayments to the senior tranche when the senior credit enhancement falls below a pre-specified threshold. Similarly, a delinquency trigger diverts prepayments when the average monthly delinquency balance (i.e., underlying single-family mortgage exposures that are 90 days or more delinquent, in foreclosure, bankruptcy, or REO) exceeds a pre-specified threshold. FHFA considered whether it would be desirable to include language in the proposed rule requiring specific triggers in CRT transactions. However, FHFA decided against such language because variations across transactions complicate the establishment of fixed triggers that could be prudently applied uniformly across deals. Further, mandating a fixed set of triggers could reduce innovation in managing principal paydowns. For these reasons, FHFA believes that the proposed rule would appropriately consider singlefamily CRT prepayments. Multifamily Loss-Timing Factors One notable enhancement in the proposed CRT capital framework for multifamily mortgage exposures would be the application of multifamily loss PO 00000 Frm 00063 Fmt 4701 Sfmt 4702 timing factors. The loss timing factor would address the mismatch between lifetime multifamily losses on the whole loans and guarantees underlying a CRT and the term of coverage on the CRT. In the 2018 proposal, FHFA sought comment on how to implement a multifamily loss timing adjustment, but commenters did not suggest an approach. The proposed rule would implement a simple adjustment based on the contractual maturity of the CRT and the maturities of the underlying multifamily mortgage exposures. Multifamily Counterparty Risk In multifamily CRT transactions involving loss sharing and/or reinsurance agreements, an Enterprise is exposed to counterparty credit risk. In such instances, the Enterprise would consider posted collateral, concentration risk, and the financial strength of the counterparty before applying the counterparty haircut. In multifamily loss sharing agreements, the Enterprise would also consider at-risk servicing rights before applying the haircut. In the proposed CRT capital framework, an Enterprise would be permitted to offset counterparty credit risk with collateral by reducing the Enterprise’s uncollateralized exposure subject to a counterparty haircut. Fannie Mae has historically required DUS lenders to post collateral subject to certain terms and conditions, referred to as restricted liquidity, which Fannie Mae can access in the event of a lender default. In the proposed rule, restricted liquidity would be considered equivalent to other forms of collateral. In addition, as part of its DUS loss sharing agreements, Fannie Mae generally retains a contractual claim to the lenders’ at-risk servicing rights that can be exercised by Fannie Mae under different circumstances. The 2018 proposal included a provision for an Enterprise to decrease its uncollateralized exposure by 50 percent if the Enterprise had any contractual claim to at-risk servicing rights. In response to comments that suggested FHFA should clarify the treatment of E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.031</GPH> where the Enterprise’s adjusted exposures (EAEs) for tranches A and B are 100% and EAE%,M1 = 100%¥(60% * 85.6% * 90%)¥(35% * 96.4% * 85.6% * 90%) = 27.8%. Finally, to calculate risk weighted assets after CRT, the proposed rule combines AEAs with the tranche-level risk weights. For the illustrative CRT, the proposed rule would calculate risk weighted assets (RWA) as follows: RWA$,AH = AEA$,AH * RW%,AH = $955m * 10% = 95.5m RWA$,M1 = AEA$,M1 * RWA%,M1 = 11.1m * 781% = 86.7m RWA$,B = AEA$,B * RW%,B = 2.5m * 1250% = $31.3m with total RWAs on the retained CRT exposures at $213.5 million, a decline of $130.3 million from the aggregate credit risk-weighted assets on the underlying single-family mortgage exposures of $343.8 million. 39335 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules servicing rights, the proposed rule would include an updated treatment of servicing rights such that in the counterparty haircut calculation, an Enterprise may reduce its uncollateralized exposure by 1 year of estimated future servicing revenue if the Enterprise has a contractual claim to the at-risk servicing rights. FHFA believes that this more explicit accounting of the value of lender servicing rights would reduce the possibility of manipulation without materially affecting the magnitude of the adjustment to uncollateralized exposure in the CRT capital calculation. In response to comments on the 2018 proposal, FHFA considered additional potential risk mitigants that may be present in loss-sharing CRT transactions such as entity-based capital, lender CRT transactions, and intrinsic risk-retention benefits, but opted not to include counterparty credit risk offsets for these features in the proposed rule. While these features may lead to benefits that decrease the credit risk faced by an Enterprise, FHFA does not have sufficient information to accurately quantify the magnitude of these potential benefits. However, to the extent that features such as entity-based capital and lender CRT transactions lead to stronger counterparty financial strength ratings, these loss mitigating factors would be reflected in an Enterprise’s risk-based capital requirements in the form of smaller counterparty haircuts. To calculate the counterparty haircut in the proposed rule, an Enterprise would use a modified version of the Basel IRB approach that considers the creditworthiness of the counterparty. Similar to the single-family discussion of how counterparty risk is amplified due to the correlation between a counterparty’s credit exposure and the Enterprises’ credit exposure (concentration risk), the proposed rule would assign larger haircuts to multifamily counterparties with higher levels of concentration risk relative to diversified counterparties. An Enterprise would assess the level of multifamily mortgage risk concentration for each individual counterparty to determine whether the counterparty is well diversified or whether it has a high concentration risk, and counterparties with a lower concentration risk would be assigned a smaller counterparty haircut relative to counterparties with higher concentration risk. This difference is captured through the asset valuation correlation multiplier, AVCM. An Enterprise would assign an AVCM of 1.75 to counterparties with high concentration risk and an AVCM of 1.25 to more well-diversified counterparties. The counterparty haircut would be calculated as the product of stress loss given default (LGD), stress probability of default (PD), and a maturity adjustment for the asset. Along with the AVCM, other parameterization assumptions in the proposed rule include a stress LGD of 45 percent, a maturity adjustment calibrated to five years, a stringency level of 99.9 percent, and expected PDs calculated using an historical one-year PD matrix for all financial institutions. For each CRT that involves counterparty credit risk, an Enterprise would select a counterparty haircut and apply it to the uncollateralized exposure in the CRT. The proposed multifamily counterparty risk haircut multipliers are presented below in Table 25. Question 70. Is the proposed approach to determining the credit risk capital requirement for retained CRT exposures appropriately formulated? Question 71. Are the adjustments for counterparty risk appropriately calibrated? Question 72. Are the adjustments for loss-timing and other maturity-related risk appropriately calibrated? Question 73. Is the 10 percent adjustment for the general effectiveness of CRT appropriately calibrated? Question 74. Is the 10 percent adjustment for the general effectiveness of CRT appropriate in light of the proposed rule’s prudential floor on the risk weight for retained CRT exposures? Question 75. Should FHFA impose any restrictions on the collateral eligible to secure CRT that pose counterparty risk? d. Alternative Approach VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00064 Fmt 4701 Sfmt 4702 The proposed approach to CRT described under VIII.C.3.c has significant advantages over the approach to CRT taken by the Basel and U.S. banking framework’s SSFA to the extent that it provides a more granular and mortgage risk-sensitive framework for determining the capital relief from CRT. There is, however, a trade-off between a more risk-sensitive approach E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.032</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39336 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules and the complexity and other operational burdens of that more granular approach. FHFA is also soliciting comment on a simpler but less tailored alternative approach under which the Enterprise would determine the risk weight for a retained CRT exposure using the SSFA of the securitization framework. A 1,250 percent risk weight would be assigned to any retained CRT exposure that absorbs losses up to the adjusted aggregate credit risk capital requirement of the underlying exposures. After that point, the risk weight for the retained CRT exposure would be assigned pursuant to an exponential decay function that decreases as the detachment point or attachment point increases. The key difference from the SSFA under the securitization framework would be that the prudential floor for the risk weight for a retained CRT exposure would be 10 percent instead of 20 percent. Under this approach, there would be no specific, tailored adjustment for counterparty risk or loss-timing risk or a general adjustment for the differences between CRT and equity financing. Instead, as under the Basel and U.S. banking framework’s SSFA, FHFA proposes to use a supervisory adjustment factor, the constant term p, to determine the overall level of regulatory capital required for all tranches of a CRT under the SSFA. A higher value of p would increase the amount of regulatory capital required under the SSFA with detachment points beyond the adjusted aggregate credit risk capital requirement of the underlying exposures. As described by the BCBS, ‘‘[t]he supervisory adjustment factor in the SSFA is intended to reduce cliff effects and apply conservatism for tranches with detachment points beyond [the adjusted aggregate credit risk capital requirement of the underlying exposures]. In addition, the supervisory adjustment factor can be seen to account for imprecision or uncertainty associated with using standardized approach risk weights for underlying exposures. . . .’’ 79 Question 76. Should FHFA require an Enterprise to determine the credit risk capital requirement for retained CRT exposures using a modified version of the SSFA? Question 77. Is the SSFA properly formulated for retained CRT exposures or should other risk drivers, such as maturity, be incorporated? 79 BCBS, Revisions to the Basel Securisation Framework Consultative Document at 23 (Dec. 2012; final Dec. 2014) available at https:// www.bis.org/publ/bcbs236.pdf. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Question 78. Is the SSFA (particularly the supervisory adjustment factor, p) appropriately calibrated for retained CRT exposures? D. Other Exposures While substantially all of an Enterprise’s credit risk is posed by its single-family and multifamily mortgage exposures, each Enterprise does have some amount of credit risk arising from a wide variety of other exposures, including non-traditional mortgage exposures and non-mortgage exposures. Some of these non-mortgage exposures—for example, an Enterprise’s OTC and cleared derivatives and repostyle transactions—raise complex and technical issues to calibrating credit risk capital requirements. FHFA believes it is important to assign a credit risk capital requirement to all material exposures, even if small in amount relative to an Enterprise’s aggregate credit risk exposure. As under the 2018 proposal, FHFA proposes to incorporate into the proposed rule the extensive expertise of the U.S. and international banking regulators in calibrating credit risk capital requirements for these other exposures, with adjustments as appropriate for the Enterprises. The Basel framework has evolved over almost four decades of debate and collaboration among the world’s experts in regulatory capital. That framework also has been revamped to incorporate the lessons of the 2008 financial crisis. Moreover, the complex and technical issues posed by these other exposures risk distracting FHFA from its core area of relative expertise—fashioning a mortgage risk-sensitive framework for the Enterprises—were FHFA to endeavor to develop its own framework for assigning credit risk capital requirements for these other exposures. As discussed in this Section VIII.D, an Enterprise generally would assign risk weight for exposures other than mortgage exposures using the same risk weights assigned under the U.S. banking framework’s standardized approach, in particular the Federal Reserve Board’s regulatory capital requirements at subpart D of 12 CFR part 217 (Regulation Q).80 Exposures that would be assigned risk weights under the U.S. banking framework include corporate exposures, exposures to sovereigns, OTC derivatives, cleared transactions, 80 The proposed rule cross-references relevant sections of 12 CFR part 217 as in effect on April 23, 2020. For the final rule, FHFA will assess whether the final rule will cross-reference sections of 12 CFR part 217 as of that same date or as of a later date, taking into account the materiality and nature of any amendments to that part after April 23, 2020 and any restrictions under applicable law. PO 00000 Frm 00065 Fmt 4701 Sfmt 4702 39337 collateralized transactions, and offbalance sheet exposures. Similarly, some exposures that were assigned credit risk capital requirements under the 2018 proposal would instead have a risk weight assigned under the U.S. banking framework. These would include some DTAs, municipal debt, reverse mortgage loans, reverse MBS, and cash and cash equivalents. For any exposure that is not assigned a specific risk weight under the proposed rule, the default risk weight would be 100 percent, consistent with the U.S. banking framework. 1. Commitments and Other Off-Balance Sheet Exposures As under the U.S. banking framework, the proposed rule would require an Enterprise to calculate the exposure amount of an off-balance sheet item by multiplying the off-balance sheet component, which is usually the notional amount, by the applicable credit conversion factor (CCF). Offbalance sheet items subject to this approach would include guarantees, mortgage commitments, contingent items, certain repo-style transactions, financial standby letters of credit, and forward agreements. An Enterprise would apply a zero percent CCF to the unused portion of commitments that are unconditionally cancelable by the Enterprise. A commitment would be any legally binding arrangement that obligates an Enterprise to extend credit or to purchase assets. The CCF would increase to 20 percent for a commitment with an original maturity of one year or less that is not unconditionally cancelable by the Enterprise. The CCF would increase to 50 percent for a commitment with an original maturity of more than one year that is not unconditionally cancelable by the Enterprise. An Enterprise would apply a 100 percent CCF to off-balance sheet guarantees, repurchase agreements, securities lending or borrowing transactions, financial standby letters of credit, and forward agreements. The off-balance sheet component of a repurchase agreement would equal the sum of the current market values of all positions the Enterprise has sold subject to repurchase. The off-balance sheet component of a securities lending transaction would equal the sum of the current fair values of all positions the Enterprise has lent under the transaction. For securities borrowing transactions, the off-balance sheet component would equal the sum of the current fair values of all non-cash E:\FR\FM\30JNP2.SGM 30JNP2 39338 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules positions the Enterprise has posted as collateral under the transaction. khammond on DSKJM1Z7X2PROD with PROPOSALS2 2. Exposures to Sovereigns Consistent with the U.S. banking framework, exposures to the U.S. government, its central bank, or a U.S. government agency and the portion of an exposure that is directly and unconditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency would receive a zero percent risk weight. The portion of a deposit insured by the Federal Deposit Insurance Corporation (FDIC) or the National Credit Union Administration (NCUA) also may be assigned a zero percent risk weight. An exposure conditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency would receive a 20 percent risk weight. 3. Crossholdings of Enterprise MBS Under the 2018 proposal, an MBS guaranteed by an Enterprise would have had a credit risk capital requirement of 0 percent. Consistent with the U.S. banking framework, the proposed rule would assign a 20 percent risk weight to the exposures of an Enterprise to the other Enterprise or another GSE (other than equity exposures and acquired CRT exposures). The 20 percent risk weight would extend to an Enterprise’s exposures to MBS guaranteed by the other Enterprise. The Enterprises currently are in conservatorship and benefit from Treasury support under the PSPA. However, the Enterprises remain privately-owned corporations, and their obligations do not have the explicit guarantee of the full faith and credit of the United States. The U.S. banking regulators ‘‘have long held the view that obligations of the GSEs should not be accorded the same treatment as obligations that carry the explicit guarantee of the U.S. government.’’ 81 FHFA agrees that the MBS and other obligations of an Enterprise should be subject to a credit risk capital requirement that is greater than that assigned to those obligations that have an explicit guarantee of the full faith and credit of the United States. Under the direction of FHFA, the Enterprises have implemented a single security initiative that is intended to increase the liquidity of the to-beannounced (TBA) market. Under the initiative, each Enterprise has begun issuing a single MBS known as the Uniform Mortgage-Backed Security (UMBS). On March 12, 2019, UMBS trading began in the forward TBA 81 77 FR 52888, 52896 (Aug. 30, 2012). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 market, marking the consolidation of the formerly distinct markets for each Enterprise’s MBS. In June 2019, settlement of TBA trades for UMBS began. FHFA believes that the new, consolidated UMBS market will lead to a more efficient, resilient, and liquid secondary mortgage market and further FHFA’s statutory obligation and the Enterprises’ charter obligations to support the liquidity of U.S. housing finance markets. For the UMBS market to continue to work, market participants must continue to view UMBS as fungible with respect to the issuing Enterprise. That is, investors must generally agree that a UMBS of a certain coupon and maturity issued by one Enterprise is roughly equivalent to the corresponding UMBS issued by the other.82 To foster that fungibility, each Enterprise may issue a ‘‘Supers’’ mortgage-related security, which is a resecuritization of UMBS and certain other TBA-eligible securities, including other Supers. If an Enterprise guarantees a security backed in whole or in part by securities of the other Enterprise, the Enterprise is obligated under its guarantee to fund any shortfall in the event that the other Enterprise fails to make a payment due on its securities. The Enterprises have entered into an indemnification agreement relating to commingled securities issued by the Enterprises. The indemnification agreement obligates each Enterprise to reimburse the other for any such shortfall. Question 79. Should FHFA adjust the regulatory capital treatment for exposures to MBS guaranteed by the other Enterprise to mitigate any risk of disruption to the UMBS? Question 80. Should FHFA consider a different risk weight for second-level resecuritizations backed by UMBS? Question 81. What should be the regulatory capital treatment of any credit risk mitigation effect of any indemnification or similar arrangements between the Enterprises relating to UMBS re-securitizations? Question 82. Should FHFA adopt different risk weights for MBS guaranteed by an Enterprise and the unsecured debt of an Enterprise? 82 To support investor confidence in that fungibility, FHFA promulgated a final rule governing Enterprise actions that affect UMBS cash flows to investors, issues quarterly prepayment monitoring reports, and has used its powers as the Enterprises’ conservator to limit certain pooling practices with respect to the creation of UMBS. In November 2019, FHFA issued a request for input on Enterprise UMBS pooling practices. PO 00000 Frm 00066 Fmt 4701 Sfmt 4702 4. Corporate Exposures Consistent with the U.S. banking framework, credit exposures to companies that are not depository institutions or securitization vehicles generally would be assigned a 100 percent risk weight. A corporate exposure is an exposure to a company that is not an exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, the European Stability Mechanism, the European Financial Stability Facility, a multi-lateral development bank (MDB), a depository institution, a foreign bank, a credit union, or a public sector entity (PSE), a GSE, a mortgage exposure, a cleared transaction, a default fund contribution, a securitization exposure, an equity exposure, or an unsettled transaction. 5. OTC Derivative Contracts An Enterprise would determine its credit risk capital requirement for the counterparty risk for OTC derivative contracts as if it were a banking organization subject to the Federal Reserve Board’s risk-based capital requirements, in particular 12 CFR 217.34. An OTC derivative contract generally would not include a derivative contract that is a cleared transaction, which would be subject to a different approach as discussed in Section VIII.D.6. A derivative contract is a financial contract whose value is derived from the values of one or more underlying assets, reference rates, or indices of asset values or reference rates. Derivative contracts include interest rate derivative contracts, exchange rate derivative contracts, equity derivative contracts, commodity derivative contracts, credit derivative contracts, and any other instrument that poses similar counterparty credit risks. Derivative contracts also include unsettled securities, commodities, and foreign exchange transactions with a contractual settlement or delivery lag that is longer than the lesser of the market standard for the particular instrument or five business days. To determine the risk-weighted assets for an OTC derivative contract, an Enterprise would first determine its exposure amount for the OTC derivative contract and then apply to that amount a risk weight based on the counterparty, eligible guarantor, or recognized collateral. For a single OTC derivative contract that is not subject to a qualifying master netting agreement, the exposure amount would be the sum of (i) the current E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules credit exposure, which would be the greater of the mark-to-market value or zero, and (ii) the potential future exposure (PFE), which would be calculated by multiplying the notional principal amount of the OTC derivative contract by a prescribed conversion factor. For multiple OTC derivative contracts subject to a qualifying master netting agreement, the exposure amount would be calculated by adding the net current credit exposure and the adjusted sum of the PFE amounts for all OTC derivative contracts subject to the qualifying master netting agreement. The net current credit exposure would be the greater of zero and the net sum of all positive and negative mark-to-market values of the individual OTC derivative contracts subject to the qualifying master netting agreement. If an OTC derivative contract is collateralized by financial collateral, an Enterprise may recognize the credit risk mitigation benefits of the financial collateral pursuant to the rules governing collateralized transactions, as discussed in Section VIII.D.7. khammond on DSKJM1Z7X2PROD with PROPOSALS2 6. Cleared Transactions An Enterprise would determine its credit risk capital requirement for the counterparty risk for derivatives and repo-style transactions cleared through a central counterparty as if it were a banking organization subject to the Federal Reserve Board’s risk-based capital requirements, in particular 12 CFR 217.35. To determine the riskweighted assets for a cleared transaction, an Enterprise that is a clearing member client or a clearing member would multiply the trade exposure amount for the cleared transaction by the appropriate risk weight. An Enterprise also would be subject to a credit risk capital requirement for default fund contributions to CCPs. 7. Credit Risk Mitigation An Enterprise may recognize the riskmitigation effects of guarantees, credit derivatives, and collateral for purposes of its risk-based capital requirements in the same way a banking organization may under the Federal Reserve Board’s risk-based capital requirements, in particular 12 CFR 217.36 and 217.37. Under that approach, an Enterprise generally may use the substitution approach to recognize the credit riskmitigation effect of an eligible guarantee from an eligible guarantor or eligible credit derivative and the simple approach to recognize the effect of eligible collateral. Under the substitution approach, if the protection VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 amount of an eligible guarantee or eligible credit derivative is greater than or equal to the exposure amount of the hedged exposure, an Enterprise generally may substitute the risk weight applicable to the guarantor or credit derivative protection provider for the risk weight assigned to the hedged exposure. Under the simple approach, the collateralized portion of the exposure generally would receive the risk weight applicable to the eligible collateral (with an exception for repostyle transactions, eligible margin loans, collateralized derivative contracts, and single-product netting sets of such transactions). IX. Credit Risk Capital: Advanced Approach The proposed rule would require an Enterprise to comply with the risk-based capital requirements using the higher of its risk-weighted assets calculated under the standardized approach and the advanced approach, where riskweighted assets include credit risk, operational risk, and market risk components. The advanced approach requirements would require each Enterprise to maintain its own processes for identifying and assessing credit risk, market risk, and operational risk. These requirements should ensure that each Enterprise continues to enhance its risk management system and also that neither Enterprise simply relies on the standardized approach’s lookup grids and multipliers to define credit risk tolerances, measure its credit risk, or allocate economic capital. In the course of FHFA’s supervision of each Enterprise’s internal models for credit risk, FHFA also could identify opportunities to update or otherwise enhance the standardized approach’s lookup grids and multipliers through future rulemakings as market conditions evolve. Under the proposed rule’s advanced approach requirements, an Enterprise would be required to have a process for assessing its overall capital adequacy in relation to its risk profile and maintain infrastructure with risk measurement and management processes that are appropriate given the Enterprise’s size and complexity. An Enterprise’s senior management would be required to ensure that the Enterprise’s internal models, operational risk quantification systems, and related advanced systems functions comply with the proposed rule’s minimum requirements. The Enterprise’s board of directors (or a designated committee of the board) would be required to at least annually review the effectiveness of, and PO 00000 Frm 00067 Fmt 4701 Sfmt 4702 39339 approve, the Enterprise’s advanced systems. An Enterprise’s advanced systems would be required to include an internal risk rating and segmentation system that differentiates among degrees of credit risk for the Enterprise’s mortgage and other exposures. An Enterprise also would be required to have a process that estimates risk parameters for the Enterprise’s exposures. An Enterprise’s estimates of risk parameters must incorporate relevant and available data, and an Enterprise generally must demonstrate, among other things, that its estimates are representative of long run experience and take into account any changes in underwriting or recovery practices. Default, loss severity, and exposure amount data generally must include periods of economic downturn conditions. An Enterprise would be required to review—at least annually— its reference data. An Enterprise would be required to conduct an independent validation, on an ongoing basis, of its advanced systems. The validation must include an evaluation of the conceptual soundness of the advanced systems, an ongoing monitoring process that includes verification of processes and benchmarking, and an outcomes analysis process that includes backtesting. An Enterprise also would be required to periodically stress test its advanced systems including a consideration of how economic cycles, especially downturns, affect risk-based capital requirements. An Enterprise would be required to meet these minimum requirements on an ongoing basis. An Enterprise also would be required to notify FHFA when the Enterprise makes any material change to its advanced systems. In addition to the proposed rule’s requirements, an Enterprise’s advanced systems would be implemented under FHFA’s supervisory review. As part of that review process, FHFA issues advisory bulletins to communicate its supervisory expectations to FHFA supervision staff and to the Enterprises on specific supervisory matters and topics. Through FHFA’s supervision program, FHFA on-site examiners conduct supervisory activities to ensure safe and sound operations of the Enterprises. These supervisory activities may include the examination of the Enterprises to determine whether they meet the expectations set in the advisory bulletins. Examinations may also be conducted to determine whether the Enterprises comply with their own policies and procedures, regulatory and E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39340 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules statutory requirements, or FHFA directives. FHFA’s 2013–07 Advisory Bulletin reflects supervisory expectations for an Enterprise’s model risk management. The Advisory Bulletin sets minimum thresholds for model risk management and differentiates between large, complex entities and smaller, less complex entities. As the Enterprises are large complex entities, the Advisory Bulletin subjects them to heightened standards for internal audit, model risk management, model control framework, and model lifecycle management. The proposed rule would not provide a comprehensive set of guardrails and prescriptions for an Enterprise’s internal models outside of the minimum requirements discussed above and FHFA’s supervision. Question 83. Should FHFA require an Enterprise to separately determine its credit risk-weighted assets using its own internal models? Question 84. Should there be a prudential floor on the credit risk capital requirement for a mortgage exposure determined by an Enterprise using its internal models? Question 85. Should FHFA prescribe more specific requirements and restrictions governing the internal models and other procedures used by an Enterprise to determine its advanced credit risk-weighted assets? Question 86. Should FHFA require an Enterprise to determine its advanced credit risk-weighted assets under subpart E of the Federal Reserve Board’s Regulation Q? If so, what changes to that subpart E would be appropriate? Question 87. Alternatively, should compliance with subpart E of the Federal Reserve Board’s Regulation Q offer a safe harbor for compliance with the proposed rule’s advanced approaches requirements? Question 88. Should FHFA preserve the U.S. banking framework’s scalar factor of 1.06 for determining advanced credit risk-weighted assets calculated? Question 89. What transition period, if any, is appropriate for an Enterprise to comply with the proposed rule’s requirements governing the determination of the Enterprise’s advanced credit risk-weighted assets? Question 90. What transition period would be appropriate if an Enterprise were required to determine its advanced credit risk-weighted assets under subpart E of the Federal Reserve Board’s Regulation Q? Question 91. Should there be an additional capital requirement to mitigate any model risk associated with the internal models used by an VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Enterprise to determine its advanced credit risk-weighted assets? X. Market Risk Capital The proposed rule would require an Enterprise to calculate its market riskweighted assets for mortgage exposures and other exposures with spread risk. Single-family and multifamily loans and investments in securities held in an Enterprise’s portfolio have market risk from changes in value due to movements in interest rates and credit spreads, among other things. As the Enterprises currently hedge interest rate risk at the portfolio level, and under the assumption that the Enterprises’ hedging effectively manages that risk, the market risk capital requirements would be limited only to spread risk.83 This proposed approach is considerably different from that of the U.S. banking framework. Under the U.S. banking framework, covered banking organizations are required to measure and otherwise manage market risk and hold a commensurate amount of capital. Generally, an asset held by a covered banking organization for trading purposes is not included in the calculation of credit risk-weighted assets. Instead, the covered banking organization determines the market risk capital requirement for its trading assets using prescribed methodologies, multiplies that market risk capital requirement by 12.5 to determine the market risk-weighted assets for its covered positions, and then adds the market risk-weighted assets to its credit risk-weighted assets to determine its risk-based capital requirements. The prescribed methodologies under the U.S. banking framework determine market risk capital requirements for trading assets based on the general and specific market risk of the assets. General risk is the risk of loss in the market value of positions resulting from broad market movements (e.g., changes in interest rates), while specific risk is the risk of loss in the market value of positions due to factors other than broad market movements, including event risk or default risk. Notably, the U.S. banking framework’s approach to market risk capital is not limited only to spread risk, as is contemplated by the proposed rule. FHFA is seeking comment on whether to adopt a different approach, perhaps one more similar to that of the U.S. banking framework. Exposures subject to the market risk capital requirement would include any 83 FHFA’s supervision of each Enterprise includes examinations of the effectiveness of the Enterprise’s hedging of its interest rate risk. PO 00000 Frm 00068 Fmt 4701 Sfmt 4702 tangible asset that has more than de minimis spread risk, regardless of whether the position is marked-tomarket for financial statement reporting purposes and regardless of whether the position is held by the Enterprise for the purpose of short-term resale or with the intent of benefiting from actual or expected short-term price movements, or to lock in arbitrage profits. Covered positions include: • Any NPL, re-performing loan (RPL), reverse mortgage loan, or other mortgage exposure that, in any case, does not secure an MBS guaranteed by the Enterprise; • Any MBS guaranteed by an Enterprise, MBS guaranteed by Ginnie Mae, reverse mortgage security, PLS, CRT exposure, or other securitization exposure; and • Any other trading asset or trading liability, whether on- or off-balance sheet. A. Standardized Approach Under the standardized approach, an Enterprise would calculate market riskweighted assets using a prescribed single point approach, a spread duration approach, or the Enterprise’s internal models depending on the risk characteristics of the covered position. 1. Single Point Approach An Enterprise would utilize the single point approach for any RPL, NPL, reverse mortgage loan, or reverse mortgage security. The primary risk for these assets generally is credit risk. The underlying borrowers may have limited refinancing opportunities due to recent or current delinquencies, and these covered positions are often relatively insensitive to prepayment risk. For these reasons, FHFA believes the spread risk profile of these covered positions would be sufficiently represented by a single point estimate. An Enterprise would calculate the market risk-weighted assets for these covered positions as the product of the market value of the covered position, the applicable single point shock assumption for the covered position, and 12.5. The applicable single point shock assumptions would be: • 0.0475 for an RPL or an NPL; • 0.0160 for a reverse mortgage loan; and • 0.0410 for a reverse mortgage security. 2. Spread Duration Approach An Enterprise would utilize the spread duration approach for any multifamily mortgage exposure, any PLS, or any MBS guaranteed by an Enterprise or Ginnie Mae and secured E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules by multifamily mortgage exposures due to their increased complexity relative to exposures in the single point approach category. Despite their complexity, PLS represent only a small portion of the Enterprises’ portfolios, as the Enterprises’ purchases of PLS have been restricted during conservatorship. Under the spread duration approach, an Enterprise would multiply the amount of the applicable spread shock by the spread duration of the covered position. Spread shock is typically based on historical spread shocks. Spread duration, or the sensitivity of the market value of an asset to changes in the spread, is often determined by using models that involve assumptions about interest rate movements and prepayment sensitivity. An Enterprise would calculate the market risk-weighted assets for each of these covered positions as the product of the market value of the covered position, the spread duration as estimated by the Enterprise using its internal models, the applicable spread shock for the covered position, and 12.5. The applicable spread shocks would be: • 0.0015 for a multifamily mortgage exposure that does not secure an MBS guaranteed by an Enterprise; • 0.0265 for a PLS; and • 0.0100 for an MBS guaranteed by an Enterprise or by Ginnie Mae and secured by multifamily mortgage exposures (other than interest-only (IO) securities guaranteed by an Enterprise or Ginnie Mae). FHFA received a comment on the 2018 proposal suggesting the multifamily mortgage exposure spread shock of 15 basis points was too low relative to the 100 basis point spread shock prescribed for Enterprise- and Ginnie Mae-guaranteed multifamily MBS, considering that the Enterprises’ MBS are pass-through securities and that historically, multifamily mortgage exposures have been less liquid than multifamily MBS. The commenter recommended that FHFA, at a minimum, equate the spread shocks. FHFA analyzed the impact of increasing the multifamily mortgage exposure spread shock from 15 basis points to 100 basis points. In addition to a market risk capital requirement, multifamily mortgage exposures would also have a credit risk capital requirement, and in practice, perceptions of credit risk might be a component of market risk. In the proposed rule, Ginnie Mae-guaranteed MBS would not have a credit risk capital requirement, while Enterpriseguaranteed MBS would have a 20 percent risk weight for purposes of the credit risk capital requirements. FHFA VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 determined that if the market risk capital requirement for multifamily mortgage exposures were increased through the imposition of a 100 basis point spread shock, the total risk-based capital requirement (credit risk capital plus market risk capital plus operational risk capital) for multifamily mortgage exposures would exceed, to an undesirable degree, the total risk-based capital requirement for Enterprise- and Ginnie Mae-guaranteed multifamily MBS. For this reason, FHFA is opting not to implement the commenter’s recommendation. 3. Internal Models Approach An Enterprise would utilize the internal models approach for covered positions with spread risk not covered under the single point approach or the spread duration approach. This would include an Enterprise’s CMBS exposures, which in the 2018 proposal would have received a combined singlepoint capital requirement for credit risk and spread risk. In general, an Enterprise would use the internal models approach for covered positions with relatively higher levels of complexity or higher prepayment sensitivity. Single-family exposures in this category would include performing loans and Enterprise- and Ginnie Maeguaranteed single-family MBS. The spread risk profile on performing loans is relatively complex due to high prepayment sensitivity. Prepayment risk on performing loans might vary significantly across amortization terms, vintages, and mortgage rates. The high prepayment sensitivity might suggest that more simplified approaches, such as the single point approach, would not capture key risk drivers. Also, spread shocks may vary across a variety of single-family mortgage exposure characteristics. Thus, the spread duration approach, which relies on a constant spread shock, might not capture key single-family market movements. An internal models approach, however, would allow the Enterprises to differentiate spread risk across multiple risk characteristics such as amortization term, vintage, and mortgage rates. Further, the Enterprises could account for important market risk factors, such as updated spread shocks, to reflect market changes. Similarly, the spread risk profile on Enterprise- and Ginnie Mae-guaranteed single-family MBS is relatively complex due to high prepayment sensitivity of the underlying collateral. Further, CMOs can often contain complex features and structures that alter prepayments across different tranches PO 00000 Frm 00069 Fmt 4701 Sfmt 4702 39341 based on the CMO’s structure. As a result, spread durations might vary significantly across mortgage products, amortization terms, vintages and mortgage rates and tranches. The use of an Enterprise’s internal models to calculate market risk capital requirements would allow the Enterprise to account for important market risk factors that affect spreads and spread durations. One commenter on the 2018 proposal recommended FHFA allow the Enterprises to utilize internal models for complex multifamily MBS in order to maintain flexibility in allowing the spread shocks to vary according to each security’s features and structure, as well as underlying market conditions. FHFA determined that multifamily IO securities represent, in general, the more complex of Enterprise-guaranteed MBS. In consideration of the commenter’s suggestion and in alignment with the proposed market risk capital requirement for Enterprise- and Ginnie Mae-guaranteed single-family IO securities, the proposed rule would require an Enterprise to use its internal models to calculate the market riskweighted assets for Enterprise- and Ginnie Mae-guaranteed multifamily IO securities. Because an Enterprise would calculate the market risk-weighted assets for these covered positions using its internal models, the Enterprise would be subject to certain model risk management requirements, as discussed in Section X.B. In addition, an Enterprise utilizing its internal models would be subject to FHFA’s general regulatory oversight and supervisory review. Question 92. Are the point and spread measures used to determine spread risk capital requirements for certain covered positions appropriately calibrated for that purpose? Question 93. Should there be a minimum floor on the spread risk capital requirement for any covered position subject to the internal models approach? Question 94. Should FHFA adopt an approach to market risk capital that is more similar to the Basel framework, for example by limiting the scope of the market risk capital requirements to a smaller set of positions (e.g., those positions analogous to the trading book) or by requiring market risk capital for market risks other than spread risk (e.g., value-at-risk, stress value-at-risk, incremental risk, etc.)? If so, what positions and activities of the Enterprises should be subject to that approach? E:\FR\FM\30JNP2.SGM 30JNP2 39342 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 Question 95. Should the spread risk and other market risks for single-family and multifamily whole loans instead be set in an Enterprise-specific manner through the supervisory process, taking into account the market risk management strategies employed by the Enterprise? Question 96. Should FHFA assume interest rate risk is fully hedged for purposes of determining market risk capital requirements? Question 97. What requirements and restrictions should apply to the internal models used to determine standardized market risk-weighted assets? B. Advanced Approach An Enterprise also would calculate its advanced market risk-weighted assets using its own internal models. An Enterprise would have significant latitude in the scope and design of those internal models for measuring spread risk on its covered positions. FHFA is soliciting comment on whether to adopt a more prescriptive approach, perhaps requiring an Enterprise to determine a measure of market risk that includes a VaR-based capital requirement, a stressed VaR-based capital requirement, specific risk add-ons, incremental risk capital requirements, and comprehensive risk capital requirements, as under the U.S. banking framework. Given the central role of the Enterprises’ internal models in determining both standardized and advanced market risk capital requirements, the proposed rule includes a number of requirements and restrictions relating to the management of the related model risks. An independent risk control unit would be required to approve any internal model to calculate its risk-based capital requirement. An Enterprise must notify FHFA when the Enterprise plans to extend the use of a model to an additional business line or product type or the Enterprise makes any material change to its internal models. The Enterprise would be required to periodically review (and at least annually) its internal models, and enhance those models as appropriate. The Enterprise also must integrate the internal models used for calculating its spread risk measure into its daily risk management process. More generally, the sophistication of an Enterprise’s internal models would have to be commensurate with the complexity and amount of its covered positions. The Enterprise’s internal models must properly measure all the material risks. The Enterprise would be required to have a process for updating VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 its internal models to ensure continued applicability and relevance. The Enterprise also must have an independent risk control unit that reports directly to senior management. The Enterprise must have an independent validation process that includes an evaluation of the conceptual soundness of the internal models, an ongoing monitoring process that includes verification of processes and the comparison of the Enterprise’s model outputs with relevant internal and external data sources or estimation techniques, and an outcomes analysis process that includes backtesting. Question 98. Are the requirements governing an Enterprise’s internal models for determining spread risk capital requirements appropriately formulated? Question 99. Should FHFA adopt a more prescriptive approach to the determination of advanced market riskweighted assets, perhaps requiring an Enterprise to determine a measure of market risk that includes a VaR-based capital requirement, a stressed VaRbased capital requirement, specific risk add-ons, incremental risk capital requirements, and comprehensive risk capital requirements, as under the U.S. banking framework? C. Market Risk Management The reliability of the internal models used in determining an Enterprise’s standardized and advanced market riskweighted assets will depend in part on the Enterprise’s market risk management practices more generally. Consistent with the U.S. banking framework, the proposed rule includes a number of requirements and restrictions relating to the management of spread risk and also other market risks. An Enterprise would be required to have a process for assessing its overall capital adequacy in relation to its market risk. An Enterprise also would be required to have policies and procedures for actively managing all covered positions. At a minimum, these policies and procedures must require, among other things, marking covered positions to market or to model on a daily basis, daily assessment of the Enterprise’s ability to hedge position and portfolio risks, and establishment and daily monitoring of limits on covered positions by an independent risk control unit. An Enterprise also would be required to have a process for valuation of its covered positions that includes policies and procedures on marking positions to market or to model, independent price PO 00000 Frm 00070 Fmt 4701 Sfmt 4702 verification, and valuation adjustments or reserves. An Enterprise would be required to periodically (and at least quarterly) stress test the market risk of its covered positions. The stress tests must take into account concentration risk, illiquidity under stressed market conditions, and risks arising from the Enterprise’s trading activities that may not be adequately captured in its internal models. An Enterprise also must have an internal audit function that at least annually assesses the effectiveness of the controls supporting the Enterprise’s market risk measurement systems and reports its findings to the Enterprise’s board of directors (or a committee thereof). XI. Operational Risk Capital The proposed rule would establish an operational risk capital requirement to be calculated using the advanced measurement approach of the U.S. banking framework, but with a floor set at 15 basis points of adjusted total assets. The operational risk capital requirement would be included in an Enterprise’s risk-weighted assets for the purposes of calculating risk-based capital requirements. This approach has been developed in response to comments on the 2018 proposal. Commenters on the 2018 proposal suggested that the proposed Basel basic indicators approach was insufficient because the Enterprises were too complex to justify such a simple approach and also because FHFA’s implementation did not allow the requirement to vary appropriately under the basic indicators approach. Operational risk is the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events (including legal risk but excluding strategic and reputational risk). Under the proposed rule, the Enterprise’s risk-based capital requirement for operational risk generally would be its operational risk exposure minus any eligible operational risk offsets. That amount would potentially be subject to adjustments if the Enterprise qualifies to use operational risk mitigants. An Enterprise’s operational risk exposure would be the 99.9th percentile of the distribution of potential aggregate operational losses, as generated by the Enterprise’s operational risk quantification system over a one-year horizon (and not incorporating eligible operational risk offsets or qualifying operational risk mitigants). While the advanced measurement approach is risk-sensitive, the proposed E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 estimates were calculated using historical results achieved exclusively while in conservatorship. FHFA also calibrated this floor taking into account the operational risk capital requirements of large U.S. banking organizations. Of the U.S. bank holding companies with at least $500 billion in total assets at the end of 2019, the smallest operational risk capital requirement was 0.69 percent of that U.S. banking organization’s total leverage exposure. Question 100. Is the advanced measurement approach appropriately formulated and calibrated as a measure PO 00000 Frm 00071 Fmt 4701 Sfmt 4725 of operational risk capital for the Enterprises? Question 101. Should FHFA consider other approaches to calculating operational risk capital requirements (e.g., the Basel standardized approach)? Question 102. Is the minimum floor on an Enterprise’s operational risk capital appropriately calibrated? XII. Impact of the Enterprise Capital Rule A. Enterprise-Wide BILLING CODE 8070–01–P E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.033</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 operational risk capital requirement would be subject to a floor of 15 basis points of adjusted total assets. It is important that operational risk capital does not fall below a meaningful, credible amount. Fifteen (15) basis points of adjusted total assets would represent approximately double what FHFA originally proposed in the 2018 proposal, and approximately double the amount of operational risk capital estimated internally by the Enterprises using the Basel standardized approach. FHFA believes doubling the internally estimated figure is appropriate given the 39343 VerDate Sep<11>2014 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00072 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.034</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39344 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00073 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 39345 EP30JN20.035</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00074 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.036</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39346 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00075 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 39347 EP30JN20.037</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39348 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00076 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.038</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 B. Single-Family Business VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00077 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 39349 EP30JN20.039</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00078 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.040</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39350 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00079 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 39351 EP30JN20.041</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00080 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.042</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39352 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39353 EP30JN20.044</GPH> VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00081 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.043</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 C. Multifamily Business 39354 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules XIII. Comparisons to the U.S. Banking Framework As discussed in Section V.B.2 and also in the 2018 proposal, comparisons to the U.S. banking framework’s capital requirements are complicated by the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 different risk profiles of the Enterprises and large banking organizations.84 The Enterprises, for example, transfer much of the interest rate and funding risk on their mortgage exposures through their sales of guaranteed MBS, while banking 84 83 PO 00000 FR at 33323. Frm 00082 Fmt 4701 Sfmt 4702 organizations generally fund themselves through customer deposits and other sources. On the other hand, the monoline nature of the Enterprises’ mortgage-focused businesses suggests that the concentration risk profile of an Enterprise is generally greater than that of a diversified banking organization E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.086</GPH> BILLING CODE 8070–01–C EP30JN20.045</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 D. Other Assets khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules with a similar amount of mortgage credit risk. While the Enterprises and large banking organizations’ risk profiles are different with respect to some risks, those differences should not preclude a comparison of the credit risk capital requirement of a large U.S. banking organization for a specific mortgage exposure to the credit risk capital requirement of an Enterprise for a similar mortgage exposure. Under both frameworks, the credit risk capital requirements for mortgage exposures are calibrated to absorb unexpected losses. Comparisons of credit risk capital requirements of the large U.S. banking organizations to credit risk capital requirements of the Enterprises under the proposed rule are, however, still complicated by the fact that the proposed rule’s requirements could be very different depending on the economic environment. In a favorable economic environment, particularly after sustained periods of house price growth and strong employment such as experienced in the U.S. prior to the first quarter of 2020, the proposed rule’s mortgage risk-sensitive framework is likely to show lower credit risk capital requirements than the U.S. banking framework. Conversely, in a period of financial stress, the proposed rule’s mortgage risk-sensitive framework could show higher credit risk capital requirements than the U.S. banking framework. FHFA’s mortgage risk-sensitive framework results in a more granular calibration of credit risk capital requirements for mortgage exposures, and some meaningful portion of the current gap between the credit risk capital requirements of the Enterprises and large banking organizations under the proposed rule is due to the proposed rule’s use of MTMLTV instead of OLTV, as under the U.S. banking framework, to assign credit risk capital requirements. Adjusting for the appreciation in the value of the underlying real property generally has led to lower actual credit risk capital requirements at the Enterprises, and some of the gap between the credit risk capital requirements of the Enterprises and large U.S. banking organizations might be expected to narrow were real property prices to move toward their long-term trend. With that context, FHFA is seeking comment on the appropriateness of key differences between the credit risk capital requirements for mortgage exposures under the proposed rule and the U.S. banking framework. • Risk-based credit risk capital requirements. As discussed in Sections VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 VIII.A.7 and VIII.B.6, as of September 30, 2019 and before adjusting for CRT or the buffers under both frameworks, the average credit risk capital requirements for the Enterprises’ single-family and multifamily mortgage exposures generally were roughly half those of similar exposures under the U.S. banking framework. Those lower average credit risk capital requirements are before any capital relief afforded through CRT. • CRT capital treatment. As discussed in Sections VIII.C.3.c and VIII.C.3.d, the proposed rule solicits comments on two different approaches to determining the remaining credit risk on exposures of a CRT that are retained by the Enterprise and any credit risk in effect retained by the Enterprise as a result of the potential ineffectiveness of CRT in transferring credit risk. Under both approaches, the minimum risk weight assigned to retained CRT exposures would be 10 percent, which is less than the 20 percent risk weight floor for securitization exposures under the U.S. banking framework. • CRT eligibility. As discussed in Section VIII.C.3.b, the proposed rule provides credit risk capital relief for a number of CRT structures that would not be eligible for capital relief under the U.S. banking framework. The proposed rule also generally subjects CRT structures to less restrictive operational criteria. • Mortgage insurance. Similarly, as discussed in Section VIII.A.6, the proposed rule generally provides more credit risk capital relief for mortgage insurance and other loan-level credit enhancement, and for a broader range of counterparties, than the U.S. banking framework. In addition to these different credit risk capital requirements for mortgage exposures, FHFA is seeking comment on other aspects in which the proposed rule and the U.S. banking framework differs. For example: • Leverage ratio requirements. Under the proposed rule’s leverage ratio requirement, an Enterprise would be required to maintain tier 1 capital in excess of 2.5 percent of its adjusted total assets. An Enterprise also would be required to maintain tier 1 capital in excess of 4.0 percent of its adjusted total assets to avoid restrictions on capital distributions and discretionary bonus payments. A U.S. banking organization is required to maintain tier 1 capital greater than 4.0 percent of its total assets. A large U.S. banking organization also must maintain tier 1 capital in excess of 5.0 percent of its total leverage exposure to avoid restrictions on capital PO 00000 Frm 00083 Fmt 4701 Sfmt 4702 39355 distributions and discretionary bonus payments.85 • Market risk capital. The proposed rule and U.S. banking framework take considerably different approaches to market risk capital requirements. As discussed in Section X, the proposed rule generally assigns market risk capital requirements to a broader set of exposures, including ones already subject to credit risk capital requirements, while the U.S. banking framework requires market risk capital not just for spread risk but also a broader range of market risks. • Capital conservation buffer. As discussed in Section VII.A, the proposed rule’s PCCBA is assessed against adjusted total assets, not riskweighted assets. This risk-insensitive approach reduces the impact that the PCCBA potentially could have on higher risk exposures, avoids amplifying the secondary effects of any model or similar risks inherent to the calibration of granular risk weights for mortgage exposures, and further mitigates the procyclicality in aggregate risk-based capital requirements. • Stability capital buffer. The proposed rule’s stability capital buffer is tailored to the risk that an Enterprise’s default or other financial distress could have on the liquidity, efficiency, competitiveness, and resiliency of national housing finance markets. The U.S. banking framework’s GSIB surcharge is tailored to equalize the expected impact on the stability of the financial system of the failure of a GSIB with the expected systemic impact of the failure of a large bank holding company that is not a GSIB. Because the stability capital buffer is a component of the capital conservation buffer, the stability capital buffer is assessed against an Enterprise’s adjusted total assets, while the GSIB surcharge is more risk-sensitive in that it is assessed against risk-weighted assets. • Internal-ratings approach. Like the U.S. banking framework, each Enterprise would be required to determine its risk-weighted assets under two approaches—a standardized approach and an advanced approach— with the greater of the two risk-weighted assets used to determine its risk-based capital requirements. Unlike the U.S. banking framework, the proposed rule would be significantly less prescriptive as to requirements and restrictions governing the internal models used to 85 Insured depository institutions subsidiaries of certain large U.S. bank holding companies must maintain tier 1 capital of 6.0 percent or greater of total assets to be ‘‘well capitalized.’’ See, e.g., 12 CFR 6.4(b)(1)(i)(D). E:\FR\FM\30JNP2.SGM 30JNP2 39356 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules determine the advanced risk-weighted assets. Question 103. Are the differences between the credit risk capital requirements for mortgage exposures under the proposed rule and the U.S. banking framework appropriate? Question 104. Which, if any, aspects of the proposed rule should be further aligned with the U.S. banking framework? khammond on DSKJM1Z7X2PROD with PROPOSALS2 XIV. Compliance Period This proposed rule would establish a post-conservatorship regulatory capital framework that ensures that each Enterprise operates in a safe and sound manner and is positioned to fulfill its statutory mission to provide stability and ongoing assistance to the secondary mortgage market across the economic cycle. Given the Enterprises’ current conservatorship status and capitalization, certain sections and subparts of the proposed rule would be subject to delayed compliance dates as set forth in § 1240.4. The capital requirements and buffers set out in subpart B of the proposed rule would have a delayed compliance date, unless adjusted by FHFA as described below, of the later of one year from publication of the final rule or the date of the termination of conservatorship. FHFA recognizes that the path for transition out of conservatorship and meeting the full capital requirements and buffers is not settled at this time. Therefore, the proposed rule would provide FHFA with the discretion, based on FHFA’s assessment of capital market conditions and the likely feasibility of an Enterprise to achieve capital levels sufficient to comply with the capital requirements proposed at § 1240.10, to defer compliance with the capital requirements and thereby not subject an Enterprise to statutory prohibitions on capital distributions that would apply if those requirements were not met. During that deferral period, the PCCBA would be the CET1 capital that would otherwise be required under § 1240.10 plus the PCCBA that would otherwise apply under normal conditions under § 1240.11(a)(5); and the PLBA would be 4.0 percent of the adjusted total assets of the Enterprise. To benefit from the deferral period, an Enterprise would be required to comply with any corrective plan or agreement or order that sets out the actions by which an Enterprise will achieve compliance with the capital requirements by a specified date. In addition, the proposed rule would delay compliance for reporting under § 1240.1(f) for one year from the date of publication of the final rule. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Question 105. Are the delayed compliance dates tailored in a manner to promote the ability of an Enterprise to achieve compliant regulatory capital levels? XV. Temporary Increases of Minimum Capital Requirements and Other Conforming Amendments To reinforce its reserved authorities under § 1240.1(d), FHFA is proposing to amend its existing rule, 12 CFR part 1225, ‘‘Minimum Capital—Temporary Increase,’’ to clarify that the authority implemented in that rule to temporarily increase a regulated entity’s required capital minimums applies to risk-based minimum capital levels as well as to minimum leverage ratios. This amendment aligns the scope of this regulation, adopted under 12 U.S.C. 4612(d), with the FHFA Director’s authority under 12 U.S.C. 4612(e) to establish additional capital and reserve requirements for particular purposes, which authorizes risk-based adjustments to capital requirements for particular products and activities and is not limited to adjustments to the leverage ratio. FHFA is also proposing to amend the definition of ‘‘total exposure’’ in § 1206.2 to have the same meaning as ‘‘adjusted total assets’’ as defined in § 1240.2. FHFA is also proposing to remove 12 CFR part 1750. Question 106. Should FHFA conform the definition of ‘‘total exposure’’ in § 1206.2 to have the same meaning as ‘‘adjusted total assets’’ as defined in § 1240.2? Question 107. In addition to the questions asked above, FHFA requests comments on any aspect of the proposed rule. XVI. Paperwork Reduction Act The Paperwork Reduction Act (PRA) (44 U.S.C. 3501 et seq.) requires that regulations involving the collection of information receive clearance from the Office of Management and Budget (OMB). The proposed rule contains no such collection of information requiring OMB approval under the PRA. Therefore, no information has been submitted to OMB for review. XVII. Regulatory Flexibility Act The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) requires that a regulation that has a significant economic impact on a substantial number of small entities, small businesses, or small organizations must include an initial regulatory flexibility analysis describing the regulation’s impact on small entities. FHFA need not undertake such an analysis if the agency has certified that the regulation will not PO 00000 Frm 00084 Fmt 4701 Sfmt 4702 have a significant economic impact on a substantial number of small entities. 5 U.S.C. 605(b). FHFA has considered the impact of the proposed rule under the Regulatory Flexibility Act. The General Counsel of FHFA certifies that the proposed rule, if adopted as a final rule, would not have a significant economic impact on a substantial number of small entities because the proposed rule is applicable only to the Enterprises, which are not small entities for purposes of the Regulatory Flexibility Act. List of Subjects 12 CFR Part 1206 Assessments, Federal home loan banks, Government-sponsored enterprises, Reporting and recordkeeping requirements. 12 CFR Part 1225 Federal home loan banks, Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, Capital, Filings, Minimum capital, Procedures, Standards. 12 CFR Part 1240 Capital, Credit, Enterprise, Investments, Reporting and recordkeeping requirements. 12 CFR Part 1750 Banks, banking, Capital classification, Mortgages, Organization and functions (Government agencies), Risk-based capital, Securities. Authority and Issuance For the reasons stated in the preamble, under the authority of 12 U.S.C. 4511, 4513, 4513b, 4514, 4515– 17, 4526, 4611–4612, 4631–36, FHFA proposes to amend chapters XII and XVII, of title 12 of the Code of Federal Regulation as follows: CHAPTER XII—FEDERAL HOUSING FINANCE AGENCY SUBCHAPTER A—ORGANIZATION AND OPERATIONS PART 1206—ASSESSMENTS 1. The authority citation for part 1206 continues to read as follows: ■ Authority: 12 U.S.C. 4516. 2. Amend 12 CFR 1206.2 by revising the definition of ‘‘Total exposure’’ to read as follows: ■ § 1206.2 Definitions. * * * * * Total exposure has the same meaning given to adjusted total assets in 12 CFR 1240.2. * * * * * E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules SUBCHAPTER B—ENTITY REGULATIONS PART 1225—MINIMUM CAPITAL— TEMPORARY INCREASE 3. The authority citation for part 1225 continues to read as follows: ■ Authority: 12 U.S.C. 4513, 4526 and 4612. 4. Amend 12 CFR 1225.2 by revising the definition of ‘‘Minimum capital level’’ to read as follows: ■ § 1225.2 Definitions. * * * * * Minimum capital level means the lowest amount of capital meeting any regulation or orders issued pursuant to 12 U.S.C. 1426 and 12 U.S.C. 4612, or any similar requirement established by regulation, order or other action. * * * * * SUBCHAPTER C—ENTERPRISES 5. Add part 1240 to subchapter C to read as follows: ■ PART 1240—CAPITAL ADEQUACY OF ENTERPRISES Sec. Subpart A—General Provisions 1240.1 Purpose, applicability, reservations of authority, and reporting. 1240.2 Definitions. 1240.3 Operational requirements for counterparty credit risk. 1240.4 Compliance dates. Subpart B—Capital Requirements and Buffers 1240.10 Capital requirements. 1240.11 Capital conservation buffer and leverage buffer. khammond on DSKJM1Z7X2PROD with PROPOSALS2 Risk-Weighted Assets for General Credit Risk 1240.31 Mechanics for calculating riskweighted assets for general credit risk. 1240.32 General risk weights. 1240.33 Single-family mortgage exposures. 1240.34 Multifamily mortgage exposures. 1240.35 Off-balance sheet exposures. 1240.36 Derivative contracts. 1240.37 Cleared transactions. 1240.38 Guarantees and credit derivatives: Substitution treatment. 1240.39 Collateralized transactions. 19:00 Jun 29, 2020 Jkt 250001 Subpart E—Risk-Weighted Assets—Internal Ratings-Based and Advanced Measurement Approaches 1240.100 Purpose, applicability, and principle of conservatism. 1240.101 Definitions. 1240.121 Minimum requirements. 1240.122 Ongoing qualification. 1240.123 Advanced approaches credit riskweighted asset calculations. 1240.161 Qualification requirements for incorporation of operational risk mitigants. 1240.162 Mechanics of operational risk risk-weighted asset calculation. Subpart F—Risk-Weighted Assets—Market Risk 1240.201 Purpose, applicability, and reservation of authority. 1240.202 Definitions. 1240.203 Requirements for managing market risk. 1240.204 Measure for spread risk. Authority: 12 U.S.C. 4511, 4513, 4513b, 4514, 4515, 4517, 4526, 4611–4612, 4631–36. Subpart D—Risk-Weighted Assets— Standardized Approach 1240.30 Applicability. VerDate Sep<11>2014 Risk-Weighted Assets for Equity Exposures 1240.51 Exposure measurement. Subpart G—Stability Capital Buffer 1240.400 Stability capital buffer. Subpart C—Definition of Capital 1240.20 Capital components and eligibility criteria for regulatory capital instruments. 1240.21 [Reserved] 1240.22 Regulatory capital adjustments and deductions. Risk-Weighted Assets for Unsettled Transactions 1240.40 Unsettled transactions. Risk-Weighted Assets for CRT and Other Securitization Exposures 1240.41 Operational requirements for CRT and other securitization exposures. 1240.42 Risk-weighted assets for CRT and other securitization exposures. 1240.43 Simplified supervisory formula approach (SSFA). 1240.44 Credit risk transfer approach (CRTA). 1240.45 Securitization exposures to which the SSFA and the CRTA do not apply. 1240.46 Recognition of credit risk mitigants for securitization exposures. Subpart A—General Provisions § 1240.1 Purpose, applicability, reservations of authority, and reporting. (a) Purpose. This part establishes capital requirements and overall capital adequacy standards for the Enterprises. This part includes methodologies for calculating capital requirements. (b) Authorities—(1) Limitations of authority. Nothing in this part shall be read to limit the authority of FHFA to take action under other provisions of law, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law or regulation under the Safety and Soundness Act, and including action under sections 1313(a)(2), 1365–1367, 1371–1376 (12 U.S.C. 4513(a)(2), 4615– 4617, and 4631–4636). (2) Permissible activities. Nothing in this part may be construed to authorize, permit, or require an Enterprise to engage in any activity not authorized by its authorizing statute or that would PO 00000 Frm 00085 Fmt 4701 Sfmt 4702 39357 otherwise be inconsistent with its authorizing statute or the Safety and Soundness Act. (c) Applicability—(1) Covered regulated entities. This part applies on a consolidated basis to each Enterprise. (2) Capital requirements and overall capital adequacy standards. Each Enterprise must calculate its capital requirements and meet the overall capital adequacy standards in subpart B of this part. (3) Regulatory capital. Each Enterprise must calculate its regulatory capital in accordance with subpart C of this part. (4) Risk-weighted assets. (i) Each Enterprise must use the methodologies in subparts D and F of this part to calculate standardized total riskweighted assets. (ii) Each Enterprise must use the methodologies in subpart E and subpart F of this part to calculate advanced approaches total risk-weighted assets. (d) Reservation of authority regarding capital. Subject to applicable provisions of the Safety and Soundness Act— (1) Additional capital in the aggregate. FHFA may require an Enterprise to hold an amount of regulatory capital greater than otherwise required under this part if FHFA determines that the Enterprise’s capital requirements under this part are not commensurate with the Enterprise’s credit, market, operational, or other risks. (2) Regulatory capital elements. (i) If FHFA determines that a particular common equity tier 1 capital, additional tier 1 capital, or tier 2 capital element has characteristics or terms that diminish its ability to absorb losses, or otherwise present safety and soundness concerns, FHFA may require the Enterprise to exclude all or a portion of such element from common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, as appropriate. (ii) Notwithstanding the criteria for regulatory capital instruments set forth in subpart C of this part, FHFA may find that a capital element may be included in an Enterprise’s common equity tier 1 capital, additional tier 1 capital, or tier 2 capital on a permanent or temporary basis consistent with the loss absorption capacity of the element and in accordance with § 1240.20(e). (3) Risk-weighted asset amounts. If FHFA determines that the risk-weighted asset amount calculated under this part by the Enterprise for one or more exposures is not commensurate with the risks associated with those exposures, FHFA may require the Enterprise to assign a different risk-weighted asset amount to the exposure(s) or to deduct E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39358 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules the amount of the exposure(s) from its regulatory capital. (4) Total leverage. If FHFA determines that the adjusted total asset amount calculated by an Enterprise under § 1240.10 is inappropriate for the exposure(s) or the circumstances of the Enterprise, FHFA may require the Enterprise to adjust this exposure amount in the numerator and the denominator for purposes of the leverage ratio calculations. (5) Consolidation of certain exposures. FHFA may determine that the risk-based capital treatment for an exposure or the treatment provided to an entity that is not consolidated on the Enterprise’s balance sheet is not commensurate with the risk of the exposure and the relationship of the Enterprise to the entity. Upon making this determination, FHFA may require the Enterprise to treat the exposure or entity as if it were consolidated on the balance sheet of the Enterprise for purposes of determining the Enterprise’s risk-based capital requirements and calculating the Enterprise’s risk-based capital ratios accordingly. FHFA will look to the substance of, and risk associated with, the transaction, as well as other relevant factors FHFA deems appropriate in determining whether to require such treatment. (6) Other reservation of authority. With respect to any deduction or limitation required under this part, FHFA may require a different deduction or limitation, provided that such alternative deduction or limitation is commensurate with the Enterprise’s risk and consistent with safety and soundness. (e) Corrective action and enforcement. FHFA may enforce this part pursuant to sections 1371, 1372, and 1376 of the Safety and Soundness Act (12 U.S.C. 4631, 4632, 4636) and also may enforce the total capital requirement established under § 1240.10(a) and the core capital requirement established under § 1240.10(e) pursuant to section 1364 of the Safety and Soundness Act (12 U.S.C. 4614). This part is also a prudential standard adopted under section 1313b of the Safety and Soundness Act (12 U.S.C. 4513b), excluding § 1240.11, which is a prudential standard only for purposes of § 1240.4(d). That section authorizes the Director to require that an Enterprise submit a corrective plan under 12 CFR 1236.4 specifying the actions the Enterprise will take to correct the deficiency if the Director determines that an Enterprise is not in compliance with this part. (f) Reporting procedure and timing— (1) Capital Reports. Each Enterprise shall file a capital report with FHFA VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 every calendar quarter providing the information and data required by FHFA. The specifics of required information and data, and the report format, will be separately provided to the Enterprise by FHFA. The report shall include the ratio of capital requirement under § 1240.10 to the adjusted total assets of the Enterprise and the maximum payout ratio of the Enterprise. (2) Timing. The capital report shall be submitted not later than 60 days after calendar quarter end or at such other time as the Director requires. (3) Approval. The capital report must be approved by the Chief Risk Officer and the Chief Financial Officer of an Enterprise prior to submission to FHFA. (4) Adjustment. In the event an Enterprise makes an adjustment to its financial statements for a quarter or a date for which information was provided pursuant to this paragraph (f), which would cause an adjustment to a capital report, an Enterprise must file with the Director an amended capital report not later than 15 days after the date of such adjustment. § 1240.2 Definitions. As used in this part: 12 CFR 217 means the regulation published at 12 CFR part 217 as of April 23, 2020. Acquired CRT exposure means, with respect to an Enterprise: (1) Any exposure that arises from a credit risk transfer of the Enterprise and has been acquired by the Enterprise since the issuance or entry into the credit risk transfer by the Enterprise; or (2) Any exposure that arises from a credit risk transfer of the other Enterprise. Additional tier 1 capital is defined in § 1240.20(c). Adjusted allowances for credit losses (AACL) means valuation allowances that have been established through a charge against earnings or retained earnings for expected credit losses on financial assets measured at amortized cost and a lessor’s net investment in leases that have been established to reduce the amortized cost basis of the assets to amounts expected to be collected as determined in accordance with GAAP. For purposes of this part, adjusted allowances for credit losses include allowances for expected credit losses on off-balance sheet credit exposures not accounted for as insurance as determined in accordance with GAAP. Adjusted allowances for credit losses allowances created that reflect credit losses on purchased credit deteriorated assets and available-for-sale debt securities. PO 00000 Frm 00086 Fmt 4701 Sfmt 4702 Adjusted total assets means the sum of the items described in paragraphs (1) though (9) of this definition, as adjusted pursuant to paragraph (9) for a clearing member Enterprise: (1) The balance sheet carrying value of all of the Enterprise’s on-balance sheet assets, plus the value of securities sold under a repurchase transaction or a securities lending transaction that qualifies for sales treatment under GAAP, less amounts deducted from tier 1 capital under § 1240.22(a), (c), and (d), and less the value of securities received in security-for-security repo-style transactions, where the Enterprise acts as a securities lender and includes the securities received in its on-balance sheet assets but has not sold or rehypothecated the securities received, and less the fair value of any derivative contracts; (2) The potential future credit exposure (PFE) for each derivative contract or each single-product netting set of derivative contracts (including a cleared transaction except as provided in paragraph (9) of this definition and, at the discretion of the Enterprise, excluding a forward agreement treated as a derivative contract that is part of a repurchase or reverse repurchase or a securities borrowing or lending transaction that qualifies for sales treatment under GAAP), to which the Enterprise is a counterparty as determined under 12 CFR 217.34, but without regard to 12 CFR 217.34(b), provided that: (i) An Enterprise may choose to exclude the PFE of all credit derivatives or other similar instruments through which it provides credit protection when calculating the PFE under 12 CFR 217.34, but without regard to 12 CFR 217.34(b), provided that it does not adjust the net-to-gross ratio (NGR); and (ii) An Enterprise that chooses to exclude the PFE of credit derivatives or other similar instruments through which it provides credit protection pursuant to paragraph (2)(i) of this definition must do so consistently over time for the calculation of the PFE for all such instruments; (3) The amount of cash collateral that is received from a counterparty to a derivative contract and that has offset the mark-to-fair value of the derivative asset, or cash collateral that is posted to a counterparty to a derivative contract and that has reduced the Enterprise’s on-balance sheet assets, unless such cash collateral is all or part of variation margin that satisfies the following requirements: (i) The variation margin is used to reduce the current credit exposure of the derivative contract, calculated as E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules described in 12 CFR 217.34(b) and not the PFE; and (ii) For derivative contracts that are not cleared through a QCCP, the cash collateral received by the recipient counterparty is not segregated (by law, regulation, or an agreement with the counterparty); (iii) Variation margin is calculated and transferred on a daily basis based on the mark-to-fair value of the derivative contract; (iv) The variation margin transferred under the derivative contract or the governing rules of the CCP or QCCP for a cleared transaction is the full amount that is necessary to fully extinguish the net current credit exposure to the counterparty of the derivative contracts, subject to the threshold and minimum transfer amounts applicable to the counterparty under the terms of the derivative contract or the governing rules for a cleared transaction; (v) The variation margin is in the form of cash in the same currency as the currency of settlement set forth in the derivative contract, provided that for the purposes of this paragraph, currency of settlement means any currency for settlement specified in the governing qualifying master netting agreement and the credit support annex to the qualifying master netting agreement, or in the governing rules for a cleared transaction; and (vi) The derivative contract and the variation margin are governed by a qualifying master netting agreement between the legal entities that are the counterparties to the derivative contract or by the governing rules for a cleared transaction, and the qualifying master netting agreement or the governing rules for a cleared transaction must explicitly stipulate that the counterparties agree to settle any payment obligations on a net basis, taking into account any variation margin received or provided under the contract if a credit event involving either counterparty occurs; (4) The effective notional principal amount (that is, the apparent or stated notional principal amount multiplied by any multiplier in the derivative contract) of a credit derivative, or other similar instrument, through which the Enterprise provides credit protection, provided that: (i) The Enterprise may reduce the effective notional principal amount of the credit derivative by the amount of any reduction in the mark-to-fair value of the credit derivative if the reduction is recognized in common equity tier 1 capital; (ii) The Enterprise may reduce the effective notional principal amount of the credit derivative by the effective VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 notional principal amount of a purchased credit derivative or other similar instrument, provided that the remaining maturity of the purchased credit derivative is equal to or greater than the remaining maturity of the credit derivative through which the Enterprise provides credit protection and that: (A) With respect to a credit derivative that references a single exposure, the reference exposure of the purchased credit derivative is to the same legal entity and ranks pari passu with, or is junior to, the reference exposure of the credit derivative through which the Enterprise provides credit protection; or (B) With respect to a credit derivative that references multiple exposures, the reference exposures of the purchased credit derivative are to the same legal entities and rank pari passu with the reference exposures of the credit derivative through which the Enterprise provides credit protection, and the level of seniority of the purchased credit derivative ranks pari passu to the level of seniority of the credit derivative through which the Enterprise provides credit protection; (C) Where an Enterprise has reduced the effective notional amount of a credit derivative through which the Enterprise provides credit protection in accordance with paragraph (4)(i) of this definition, the Enterprise must also reduce the effective notional principal amount of a purchased credit derivative used to offset the credit derivative through which the Enterprise provides credit protection, by the amount of any increase in the mark-to-fair value of the purchased credit derivative that is recognized in common equity tier 1 capital; and (D) Where the Enterprise purchases credit protection through a total return swap and records the net payments received on a credit derivative through which the Enterprise provides credit protection in net income, but does not record offsetting deterioration in the mark-to-fair value of the credit derivative through which the Enterprise provides credit protection in net income (either through reductions in fair value or by additions to reserves), the Enterprise may not use the purchased credit protection to offset the effective notional principal amount of the related credit derivative through which the Enterprise provides credit protection; (5) Where an Enterprise acting as a principal has more than one repo-style transaction with the same counterparty and has offset the gross value of receivables due from a counterparty under reverse repurchase transactions by the gross value of payables under PO 00000 Frm 00087 Fmt 4701 Sfmt 4702 39359 repurchase transactions due to the same counterparty, the gross value of receivables associated with the repostyle transactions less any on-balance sheet receivables amount associated with these repo-style transactions included under paragraph (1) of this definition, unless the following criteria are met: (i) The offsetting transactions have the same explicit final settlement date under their governing agreements; (ii) The right to offset the amount owed to the counterparty with the amount owed by the counterparty is legally enforceable in the normal course of business and in the event of receivership, insolvency, liquidation, or similar proceeding; and (iii) Under the governing agreements, the counterparties intend to settle net, settle simultaneously, or settle according to a process that is the functional equivalent of net settlement, (that is, the cash flows of the transactions are equivalent, in effect, to a single net amount on the settlement date), where both transactions are settled through the same settlement system, the settlement arrangements are supported by cash or intraday credit facilities intended to ensure that settlement of both transactions will occur by the end of the business day, and the settlement of the underlying securities does not interfere with the net cash settlement; (6) The counterparty credit risk of a repo-style transaction, including where the Enterprise acts as an agent for a repo-style transaction and indemnifies the customer with respect to the performance of the customer’s counterparty in an amount limited to the difference between the fair value of the security or cash its customer has lent and the fair value of the collateral the borrower has provided, calculated as follows: (i) If the transaction is not subject to a qualifying master netting agreement, the counterparty credit risk (E*) for transactions with a counterparty must be calculated on a transaction by transaction basis, such that each transaction i is treated as its own netting set, in accordance with the following formula, where Ei is the fair value of the instruments, gold, or cash that the Enterprise has lent, sold subject to repurchase, or provided as collateral to the counterparty, and Ci is the fair value of the instruments, gold, or cash that the Enterprise has borrowed, purchased subject to resale, or received as collateral from the counterparty: Ei* = max {0, [Ei¥Ci]} E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39360 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (ii) If the transaction is subject to a qualifying master netting agreement, the counterparty credit risk (E*) must be calculated as the greater of zero and the total fair value of the instruments, gold, or cash that the Enterprise has lent, sold subject to repurchase or provided as collateral to a counterparty for all transactions included in the qualifying master netting agreement (SEi), less the total fair value of the instruments, gold, or cash that the Enterprise borrowed, purchased subject to resale or received as collateral from the counterparty for those transactions (SCi), in accordance with the following formula: E* = max {0, [SEi¥SCi]} (7) If an Enterprise acting as an agent for a repo-style transaction provides a guarantee to a customer of the security or cash its customer has lent or borrowed with respect to the performance of the customer’s counterparty and the guarantee is not limited to the difference between the fair value of the security or cash its customer has lent and the fair value of the collateral the borrower has provided, the amount of the guarantee that is greater than the difference between the fair value of the security or cash its customer has lent and the value of the collateral the borrower has provided; (8) The credit equivalent amount of all off-balance sheet exposures of the Enterprise, excluding repo-style transactions, repurchase or reverse repurchase or securities borrowing or lending transactions that qualify for sales treatment under GAAP, and derivative transactions, determined using the applicable credit conversion factor under 12 CFR 217.33(b), provided, however, that the minimum credit conversion factor that may be assigned to an off-balance sheet exposure under this paragraph is 10 percent; and (9) For an Enterprise that is a clearing member: (i) A clearing member Enterprise that guarantees the performance of a clearing member client with respect to a cleared transaction must treat its exposure to the clearing member client as a derivative contract for purposes of determining its adjusted total assets; (ii) A clearing member Enterprise that guarantees the performance of a CCP with respect to a transaction cleared on behalf of a clearing member client must treat its exposure to the CCP as a derivative contract for purposes of determining its adjusted total assets; (iii) A clearing member Enterprise that does not guarantee the performance of a CCP with respect to a transaction VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 cleared on behalf of a clearing member client may exclude its exposure to the CCP for purposes of determining its adjusted total assets; (iv) An Enterprise that is a clearing member may exclude from its adjusted total assets the effective notional principal amount of credit protection sold through a credit derivative contract, or other similar instrument, that it clears on behalf of a clearing member client through a CCP as calculated in accordance with paragraph (4) of this definition; and (v) Notwithstanding paragraphs (9)(i) through (iii) of this definition, an Enterprise may exclude from its adjusted total assets a clearing member’s exposure to a clearing member client for a derivative contract, if the clearing member client and the clearing member are affiliates and consolidated for financial reporting purposes on the Enterprise’s balance sheet. Adjusted total capital means the sum of tier 1 capital and tier 2 capital. Advanced approaches total riskweighted assets means: (1) The sum of: (i) Credit-risk-weighted assets for general credit risk (including for mortgage exposures), cleared transactions, default fund contributions, unsettled transactions, securitization exposures (including retained CRT exposures), equity exposures, and the fair value adjustment to reflect counterparty credit risk in valuation of OTC derivative contracts, each as calculated under § 1240.123. (ii) Risk-weighted assets for operational risk, as calculated under § 1240.162(c); and (iii) Advanced market risk-weighted assets; minus (2) Excess eligible credit reserves not included in the Enterprise’s tier 2 capital. Advanced market risk-weighted assets means the advanced measure for spread risk calculated under § 1240.204(a) multiplied by 12.5. Affiliate has the meaning given in section 1303(1) of the Safety and Soundness Act (12 U.S.C. 4502(1)). Allowances for loan and lease losses (ALLL) means valuation allowances that have been established through a charge against earnings to cover estimated credit losses on loans, lease financing receivables or other extensions of credit as determined in accordance with GAAP. For purposes of this part, ALLL includes allowances that have been established through a charge against earnings to cover estimated credit losses associated with off-balance sheet credit exposures as determined in accordance with GAAP. PO 00000 Frm 00088 Fmt 4701 Sfmt 4702 Carrying value means, with respect to an asset, the value of the asset on the balance sheet of an Enterprise as determined in accordance with GAAP. For all assets other than available-forsale debt securities or purchased credit deteriorated assets, the carrying value is not reduced by any associated credit loss allowance that is determined in accordance with GAAP. Central counterparty (CCP) means a counterparty (for example, a clearing house) that facilitates trades between counterparties in one or more financial markets by either guaranteeing trades or novating contracts. CFTC means the U.S. Commodity Futures Trading Commission. Clean-up call means a contractual provision that permits an originating Enterprise or servicer to call securitization exposures before their stated maturity or call date. Cleared transaction means an exposure associated with an outstanding derivative contract or repo-style transaction that an Enterprise or clearing member has entered into with a central counterparty (that is, a transaction that a central counterparty has accepted). (1) The following transactions are cleared transactions: (i) A transaction between a CCP and an Enterprise that is a clearing member of the CCP where the Enterprise enters into the transaction with the CCP for the Enterprise’s own account; (ii) A transaction between a CCP and an Enterprise that is a clearing member of the CCP where the Enterprise is acting as a financial intermediary on behalf of a clearing member client and the transaction offsets another transaction that satisfies the requirements set forth in § 1240.3(a); (iii) A transaction between a clearing member client Enterprise and a clearing member where the clearing member acts as a financial intermediary on behalf of the clearing member client and enters into an offsetting transaction with a CCP, provided that the requirements set forth in § 1240.3(a) are met; or (iv) A transaction between a clearing member client Enterprise and a CCP where a clearing member guarantees the performance of the clearing member client Enterprise to the CCP and the transaction meets the requirements of § 1240.3(a)(2) and (a)(3). (2) The exposure of an Enterprise that is a clearing member to its clearing member client is not a cleared transaction where the Enterprise is either acting as a financial intermediary and enters into an offsetting transaction with a CCP or where the Enterprise E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules provides a guarantee to the CCP on the performance of the client. Clearing member means a member of, or direct participant in, a CCP that is entitled to enter into transactions with the CCP. Clearing member client means a party to a cleared transaction associated with a CCP in which a clearing member acts either as a financial intermediary with respect to the party or guarantees the performance of the party to the CCP. Client-facing derivative transaction means a derivative contract that is not a cleared transaction where the Enterprise is either acting as a financial intermediary and enters into an offsetting transaction with a qualifying central counterparty (QCCP) or where the Enterprise provides a guarantee on the performance of a client on a transaction between the client and a QCCP. Collateral agreement means a legal contract that specifies the time when, and circumstances under which, a counterparty is required to pledge collateral to an Enterprise for a single financial contract or for all financial contracts in a netting set and confers upon the Enterprise a perfected, firstpriority security interest (notwithstanding the prior security interest of any custodial agent), or the legal equivalent thereof, in the collateral posted by the counterparty under the agreement. This security interest must provide the Enterprise with a right to close-out the financial positions and liquidate the collateral upon an event of default of, or failure to perform by, the counterparty under the collateral agreement. A contract would not satisfy this requirement if the Enterprise’s exercise of rights under the agreement may be stayed or avoided: (1) Under applicable law in the relevant jurisdictions, other than (i) In receivership, conservatorship, or resolution under the Federal Deposit Insurance Act, Title II of the DoddFrank Act, or under any similar insolvency law applicable to GSEs, or laws of foreign jurisdictions that are substantially similar to the U.S. laws referenced in this paragraph (1)(i) in order to facilitate the orderly resolution of the defaulting counterparty; (ii) Where the agreement is subject by its terms to, or incorporates, any of the laws referenced in paragraph (1)(i) of this definition; or (2) Other than to the extent necessary for the counterparty to comply with the requirements of subpart I of Federal Reserve Board’s Regulation YY (part 252 of this title), part 47 of this title, or part 382 of this title, as applicable. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Commitment means any legally binding arrangement that obligates an Enterprise to extend credit or to purchase assets. Common equity tier 1 capital is defined in § 1240.20(b). Company means a corporation, partnership, limited liability company, depository institution, business trust, special purpose entity, association, or similar organization. Core capital has the meaning given at section 1303(7) of the Safety and Soundness Act (12 U.S.C. 4502(7)). Corporate exposure means an exposure to a company that is not: (1) An exposure to a sovereign, the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, the European Stability Mechanism, the European Financial Stability Facility, a multi-lateral development bank (MDB), a depository institution, a foreign bank, a credit union, or a public sector entity (PSE); (2) An exposure to a GSE; (3) A mortgage exposure; (4) A cleared transaction; (5) A default fund contribution; (6) A securitization exposure; or (7) An equity exposure. Credit derivative means a financial contract executed under standard industry credit derivative documentation that allows one party (the protection purchaser) to transfer the credit risk of one or more exposures (reference exposure(s)) to another party (the protection provider) for a certain period of time. Credit-enhancing interest-only strip (CEIO) means an on-balance sheet asset that, in form or in substance: (1) Represents a contractual right to receive some or all of the interest and no more than a minimal amount of principal due on the underlying exposures of a securitization; and (2) Exposes the holder of the CEIO to credit risk directly or indirectly associated with the underlying exposures that exceeds a pro rata share of the holder’s claim on the underlying exposures, whether through subordination provisions or other credit-enhancement techniques. Credit risk mitigant means collateral, a credit derivative, or a guarantee. Credit union means an insured credit union as defined under the Federal Credit Union Act (12 U.S.C. 1752 et seq.). Credit risk transfer (CRT) means any traditional securitization, synthetic securitization, senior/subordinated structure, credit derivative, guarantee, or other structure or arrangement (other than primary mortgage insurance, a PO 00000 Frm 00089 Fmt 4701 Sfmt 4702 39361 traditional securitization that satisfies the conditions under § 1240.41(a), or a synthetic securitization that satisfies the conditions under § 1240.41(b)) that allows an Enterprise to transfer the credit risk of one or more mortgage exposures (reference exposure(s)) to another party (the protection provider). Current Expected Credit Losses (CECL) means the current expected credit losses methodology under GAAP. Default fund contribution means the funds contributed or commitments made by a clearing member to a CCP’s mutualized loss sharing arrangement. Depository institution means a depository institution as defined in section 3 of the Federal Deposit Insurance Act. Derivative contract means a financial contract whose value is derived from the values of one or more underlying assets, reference rates, or indices of asset values or reference rates. Derivative contracts include interest rate derivative contracts, exchange rate derivative contracts, equity derivative contracts, commodity derivative contracts, credit derivative contracts, and any other instrument that poses similar counterparty credit risks. Derivative contracts also include unsettled securities, commodities, and foreign exchange transactions with a contractual settlement or delivery lag that is longer than the lesser of the market standard for the particular instrument or five business days. Discretionary bonus payment means a payment made to an executive officer of an Enterprise, where: (1) The Enterprise retains discretion as to whether to make, and the amount of, the payment until the payment is awarded to the executive officer; (2) The amount paid is determined by the Enterprise without prior promise to, or agreement with, the executive officer; and (3) The executive officer has no contractual right, whether express or implied, to the bonus payment. Distribution means: (1) A reduction of tier 1 capital through the repurchase of a tier 1 capital instrument or by other means, except when an Enterprise, within the same quarter when the repurchase is announced, fully replaces a tier 1 capital instrument it has repurchased by issuing another capital instrument that meets the eligibility criteria for: (i) A common equity tier 1 capital instrument if the instrument being repurchased was part of the Enterprise’s common equity tier 1 capital, or (ii) A common equity tier 1 or additional tier 1 capital instrument if E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39362 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules the instrument being repurchased was part of the Enterprise’s tier 1 capital; (2) A reduction of tier 2 capital through the repurchase, or redemption prior to maturity, of a tier 2 capital instrument or by other means, except when an Enterprise, within the same quarter when the repurchase or redemption is announced, fully replaces a tier 2 capital instrument it has repurchased by issuing another capital instrument that meets the eligibility criteria for a tier 1 or tier 2 capital instrument; (3) A dividend declaration or payment on any tier 1 capital instrument; (4) A dividend declaration or interest payment on any tier 2 capital instrument if the Enterprise has full discretion to permanently or temporarily suspend such payments without triggering an event of default; or (5) Any similar transaction that FHFA determines to be in substance a distribution of capital. Dodd-Frank Act means the DoddFrank Wall Street Reform and Consumer Protection Act of 2010 (Pub. L. 111–203, 124 Stat. 1376). Early amortization provision means a provision in the documentation governing a securitization that, when triggered, causes investors in the securitization exposures to be repaid before the original stated maturity of the securitization exposures, unless the provision: (1) Is triggered solely by events not directly related to the performance of the underlying exposures or the originating Enterprise (such as material changes in tax laws or regulations); or (2) Leaves investors fully exposed to future draws by borrowers on the underlying exposures even after the provision is triggered. Effective notional amount means for an eligible guarantee or eligible credit derivative, the lesser of the contractual notional amount of the credit risk mitigant and the exposure amount of the hedged exposure, multiplied by the percentage coverage of the credit risk mitigant. Eligible clean-up call means a cleanup call that: (1) Is exercisable solely at the discretion of the originating Enterprise or servicer; (2) Is not structured to avoid allocating losses to securitization exposures held by investors or otherwise structured to provide credit enhancement to the securitization; and (3)(i) For a traditional securitization, is only exercisable when 10 percent or less of the principal amount of the underlying exposures or securitization exposures (determined as of the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 inception of the securitization) is outstanding; or (ii) For a synthetic securitization or credit risk transfer, is only exercisable when 10 percent or less of the principal amount of the reference portfolio of underlying exposures (determined as of the inception of the securitization) is outstanding. Eligible credit derivative means a credit derivative in the form of a credit default swap, nth-to-default swap, total return swap, or any other form of credit derivative approved by FHFA, provided that: (1) The contract meets the requirements of an eligible guarantee and has been confirmed by the protection purchaser and the protection provider; (2) Any assignment of the contract has been confirmed by all relevant parties; (3) If the credit derivative is a credit default swap or nth-to-default swap, the contract includes the following credit events: (i) Failure to pay any amount due under the terms of the reference exposure, subject to any applicable minimal payment threshold that is consistent with standard market practice and with a grace period that is closely in line with the grace period of the reference exposure; and (ii) Receivership, insolvency, liquidation, conservatorship or inability of the reference exposure issuer to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and similar events; (4) The terms and conditions dictating the manner in which the contract is to be settled are incorporated into the contract; (5) If the contract allows for cash settlement, the contract incorporates a robust valuation process to estimate loss reliably and specifies a reasonable period for obtaining post-credit event valuations of the reference exposure; (6) If the contract requires the protection purchaser to transfer an exposure to the protection provider at settlement, the terms of at least one of the exposures that is permitted to be transferred under the contract provide that any required consent to transfer may not be unreasonably withheld; (7) If the credit derivative is a credit default swap or nth-to-default swap, the contract clearly identifies the parties responsible for determining whether a credit event has occurred, specifies that this determination is not the sole responsibility of the protection provider, and gives the protection purchaser the right to notify the PO 00000 Frm 00090 Fmt 4701 Sfmt 4702 protection provider of the occurrence of a credit event; and (8) If the credit derivative is a total return swap and the Enterprise records net payments received on the swap as net income, the Enterprise records offsetting deterioration in the value of the hedged exposure (either through reductions in fair value or by an addition to reserves). Eligible credit reserves means all general allowances that have been established through a charge against earnings or retained earnings to cover expected credit losses associated with on- or off-balance sheet wholesale and retail exposures, including AACL associated with such exposures. Eligible credit reserves exclude allowances that reflect credit losses on purchased credit deteriorated assets and available-for-sale debt securities and other specific reserves created against recognized losses. Eligible CRT structure means any category of credit risk transfers that has been approved by FHFA as effective in transferring the credit risk of one or more mortgage exposures to another party, taking into account any counterparty, recourse, or other risk to the Enterprise and any capital, liquidity, or other requirements applicable to counterparties (including any arrangement under which an entity that is approved by an Enterprise to originate multifamily mortgage exposures retains credit risk of one or more multifamily mortgage exposures pari passu with the Enterprise on substantially the same terms and conditions as in effect on [the date the proposed rule is published] for Fannie Mae’s credit risk transfers known as the ‘‘Delegated Underwriting and Servicing program’’). Eligible guarantee means a guarantee that: (1) Is written; (2) Is either: (i) Unconditional, or (ii) A contingent obligation of the U.S. government or its agencies, the enforceability of which is dependent upon some affirmative action on the part of the beneficiary of the guarantee or a third party (for example, meeting servicing requirements); (3) Covers all or a pro rata portion of all contractual payments of the obligated party on the reference exposure; (4) Gives the beneficiary a direct claim against the protection provider; (5) Is not unilaterally cancelable by the protection provider for reasons other than the breach of the contract by the beneficiary; (6) Except for a guarantee by a sovereign, is legally enforceable against E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules the protection provider in a jurisdiction where the protection provider has sufficient assets against which a judgment may be attached and enforced; (7) Requires the protection provider to make payment to the beneficiary on the occurrence of a default (as defined in the guarantee) of the obligated party on the reference exposure in a timely manner without the beneficiary first having to take legal actions to pursue the obligor for payment; (8) Does not increase the beneficiary’s cost of credit protection on the guarantee in response to deterioration in the credit quality of the reference exposure; (9) Is not provided by an affiliate of the Enterprise; and (10) Is provided by an eligible guarantor. Eligible guarantor means: (1) A sovereign, the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage Corporation (Farmer Mac), the European Stability Mechanism, the European Financial Stability Facility, a multilateral development bank (MDB), a depository institution, a bank holding company as defined in section 2 of the Bank Holding Company Act of 1956, as amended (12 U.S.C. 1841 et seq.), a savings and loan holding company, a credit union, a foreign bank, or a qualifying central counterparty; or (2) An entity (other than a special purpose entity): (i) That at the time the guarantee is issued or anytime thereafter, has issued and outstanding an unsecured debt security without credit enhancement that is investment grade; (ii) Whose creditworthiness is not positively correlated with the credit risk of the exposures for which it has provided guarantees; and (iii) That is not an insurance company engaged predominately in the business of providing credit protection (such as a monoline bond insurer or re-insurer). Eligible margin loan means: (1) An extension of credit where: (i) The extension of credit is collateralized exclusively by liquid and readily marketable debt or equity securities, or gold; (ii) The collateral is marked-to-fair value daily, and the transaction is subject to daily margin maintenance requirements; and (iii) The extension of credit is conducted under an agreement that provides the Enterprise the right to accelerate and terminate the extension of credit and to liquidate or set-off VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 collateral promptly upon an event of default, including upon an event of receivership, insolvency, liquidation, conservatorship, or similar proceeding, of the counterparty, provided that, in any such case: (A) Any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than: (1) In receivership, conservatorship, or resolution under the Federal Deposit Insurance Act, Title II of the DoddFrank Act, or under any similar insolvency law applicable to GSEs,1 or laws of foreign jurisdictions that are substantially similar to the U.S. laws referenced in this paragraph (1)(iii)(A)(1) in order to facilitate the orderly resolution of the defaulting counterparty; or (2) Where the agreement is subject by its terms to, or incorporates, any of the laws referenced in paragraph (1)(iii)(A)(1) of this definition; and (B) The agreement may limit the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default of the counterparty to the extent necessary for the counterparty to comply with the requirements of subpart I of the Federal Reserve Board’s Regulation YY (part 252 of this title), part 47 of this title, or part 382 of this title, as applicable. (2) In order to recognize an exposure as an eligible margin loan for purposes of this subpart, an Enterprise must comply with the requirements of § 1240.3(b) with respect to that exposure. Equity exposure means: (1) A security or instrument (whether voting or non-voting) that represents a direct or an indirect ownership interest in, and is a residual claim on, the assets and income of a company, unless: (i) The issuing company is consolidated with the Enterprise under GAAP; (ii) The Enterprise is required to deduct the ownership interest from tier 1 or tier 2 capital under this part; (iii) The ownership interest incorporates a payment or other similar obligation on the part of the issuing company (such as an obligation to make periodic payments); or 1 This requirement is met where all transactions under the agreement are (i) executed under U.S. law and (ii) constitute ‘‘securities contracts’’ under section 555 of the Bankruptcy Code (11 U.S.C. 555), qualified financial contracts under section 11(e)(8) of the Federal Deposit Insurance Act, or netting contracts between or among financial institutions under sections 401–407 of the Federal Deposit Insurance Corporation Improvement Act or the Federal Reserve’s Regulation EE (12 CFR part 231). PO 00000 Frm 00091 Fmt 4701 Sfmt 4702 39363 (iv) The ownership interest is a securitization exposure; (2) A security or instrument that is mandatorily convertible into a security or instrument described in paragraph (1) of this definition; (3) An option or warrant that is exercisable for a security or instrument described in paragraph (1) of this definition; or (4) Any other security or instrument (other than a securitization exposure) to the extent the return on the security or instrument is based on the performance of a security or instrument described in paragraph (1) of this definition. ERISA means the Employee Retirement Income and Security Act of 1974 (29 U.S.C. 1001 et seq.). Executive officer means a person who holds the title or, without regard to title, salary, or compensation, performs the function of one or more of the following positions: President, chief executive officer, executive chairman, chief operating officer, chief financial officer, chief investment officer, chief legal officer, chief lending officer, chief risk officer, or head of a major business line, and other staff that the board of directors of the Enterprise deems to have equivalent responsibility. Exposure amount means: (1) For the on-balance sheet component of an exposure (including a mortgage exposure); an OTC derivative contract; a repo-style transaction or an eligible margin loan for which the Enterprise determines the exposure amount under § 1240.39; a cleared transaction; a default fund contribution; or a securitization exposure), the Enterprise’s carrying value of the exposure. (2) For the off-balance sheet component of an exposure (other than an OTC derivative contract; a repo-style transaction or an eligible margin loan for which the Enterprise calculates the exposure amount under § 1240.39; a cleared transaction; a default fund contribution; or a securitization exposure), the notional amount of the off-balance sheet component multiplied by the appropriate credit conversion factor (CCF) in § 1240.35. (3) For an exposure that is an OTC derivative contract, the exposure amount determined under § 1240.36. (4) For an exposure that is a cleared transaction, the exposure amount determined under § 1240.37. (5) For an exposure that is an eligible margin loan or repo-style transaction for which the Enterprise calculates the exposure amount as provided in § 1240.39, the exposure amount determined under § 1240.39. E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39364 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (6) For an exposure that is a securitization exposure, the exposure amount determined under § 1240.42. Federal Deposit Insurance Act means the Federal Deposit Insurance Act (12 U.S.C. 1813). Federal Deposit Insurance Corporation Improvement Act means the Federal Deposit Insurance Corporation Improvement Act (12 U.S.C. 4401). Federal Reserve Board means the Board of Governors of the Federal Reserve System. Financial collateral means collateral: (1) In the form of: (i) Cash on deposit with the Enterprise (including cash held for the Enterprise by a third-party custodian or trustee); (ii) Gold bullion; (iii) Long-term debt securities that are not resecuritization exposures and that are investment grade; (iv) Short-term debt instruments that are not resecuritization exposures and that are investment grade; (v) Equity securities that are publicly traded; (vi) Convertible bonds that are publicly traded; or (vii) Money market fund shares and other mutual fund shares if a price for the shares is publicly quoted daily; and (2) In which the Enterprise has a perfected, first-priority security interest or, outside of the United States, the legal equivalent thereof (with the exception of cash on deposit and notwithstanding the prior security interest of any custodial agent). Foreign bank means a foreign bank as defined in § 211.2 of the Federal Reserve Board’s Regulation K (12 CFR 211.2) (other than a depository institution). Gain-on-sale means an increase in the equity capital of an Enterprise resulting from a traditional securitization other than an increase in equity capital resulting from: (1) The Enterprise’s receipt of cash in connection with the securitization; or (2) The reporting of a mortgage servicing asset. General obligation means a bond or similar obligation that is backed by the full faith and credit of a public sector entity (PSE). Government-sponsored enterprise (GSE) means an entity established or chartered by the U.S. government to serve public purposes specified by the U.S. Congress but whose debt obligations are not explicitly guaranteed by the full faith and credit of the U.S. government, including an Enterprise. Guarantee means a financial guarantee, letter of credit, insurance, or other similar financial instrument (other VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 than a credit derivative) that allows one party (beneficiary) to transfer the credit risk of one or more specific exposures (reference exposure) to another party (protection provider). Investment grade means that the entity to which the Enterprise is exposed through a loan or security, or the reference entity with respect to a credit derivative, has adequate capacity to meet financial commitments for the projected life of the asset or exposure. Such an entity or reference entity has adequate capacity to meet financial commitments if the risk of its default is low and the full and timely repayment of principal and interest is expected. Mortgage-backed security (MBS) means a security collateralized by a pool or pools of mortgage exposures, including any pass-through or collateralized mortgage obligation. Mortgage exposure means either a single-family mortgage exposure or a multifamily mortgage exposure. Multifamily mortgage exposure means an exposure that is secured by a first or subsequent lien on a property with five or more residential units. Mortgage servicing assets (MSAs) means the contractual rights owned by an Enterprise to service for a fee mortgage loans that are owned by others. Multilateral development bank (MDB) means the International Bank for Reconstruction and Development, the Multilateral Investment Guarantee Agency, the International Finance Corporation, the Inter-American Development Bank, the Asian Development Bank, the African Development Bank, the European Bank for Reconstruction and Development, the European Investment Bank, the European Investment Fund, the Nordic Investment Bank, the Caribbean Development Bank, the Islamic Development Bank, the Council of Europe Development Bank, and any other multilateral lending institution or regional development bank in which the U.S. government is a shareholder or contributing member or which FHFA determines poses comparable credit risk. Netting set means a group of transactions with a single counterparty that are subject to a qualifying master netting agreement or a qualifying crossproduct master netting agreement. For purposes of calculating risk-based capital requirements using the internal models methodology in subpart E of this part, this term does not cover a transaction: (1) That is not subject to such a master netting agreement; or PO 00000 Frm 00092 Fmt 4701 Sfmt 4702 (2) Where the Enterprise has identified specific wrong-way risk. Nth-to-default credit derivative means a credit derivative that provides credit protection only for the nth-defaulting reference exposure in a group of reference exposures. Originating Enterprise, with respect to a securitization, means an Enterprise that directly or indirectly originated or securitized the underlying exposures included in the securitization. Over-the-counter (OTC) derivative contract means a derivative contract that is not a cleared transaction. An OTC derivative includes a transaction: (1) Between an Enterprise that is a clearing member and a counterparty where the Enterprise is acting as a financial intermediary and enters into a cleared transaction with a CCP that offsets the transaction with the counterparty; or (2) In which an Enterprise that is a clearing member provides a CCP a guarantee on the performance of the counterparty to the transaction. Protection amount (P) means, with respect to an exposure hedged by an eligible guarantee or eligible credit derivative, the effective notional amount of the guarantee or credit derivative, reduced to reflect any currency mismatch, maturity mismatch, or lack of restructuring coverage (as provided in § 1240.38). Publicly-traded means traded on: (1) Any exchange registered with the SEC as a national securities exchange under section 6 of the Securities Exchange Act; or (2) Any non-U.S.-based securities exchange that: (i) Is registered with, or approved by, a national securities regulatory authority; and (ii) Provides a liquid, two-way market for the instrument in question. Public sector entity (PSE) means a state, local authority, or other governmental subdivision below the sovereign level. Qualifying central counterparty (QCCP) means a central counterparty that: (1)(i) Is a designated financial market utility (FMU) under Title VIII of the Dodd-Frank Act; (ii) If not located in the United States, is regulated and supervised in a manner equivalent to a designated FMU; or (iii) Meets the following standards: (A) The central counterparty requires all parties to contracts cleared by the counterparty to be fully collateralized on a daily basis; (B) The Enterprise demonstrates to the satisfaction of FHFA that the central counterparty: E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (1) Is in sound financial condition; (2) Is subject to supervision by the Federal Reserve Board, the CFTC, or the Securities Exchange Commission (SEC), or, if the central counterparty is not located in the United States, is subject to effective oversight by a national supervisory authority in its home country; and (3) Meets or exceeds the riskmanagement standards for central counterparties set forth in regulations established by the Federal Reserve Board, the CFTC, or the SEC under Title VII or Title VIII of the Dodd-Frank Act; or if the central counterparty is not located in the United States, meets or exceeds similar risk-management standards established under the law of its home country that are consistent with international standards for central counterparty risk management as established by the relevant standard setting body of the Bank of International Settlements; and (2)(i) Provides the Enterprise with the central counterparty’s hypothetical capital requirement or the information necessary to calculate such hypothetical capital requirement, and other information the Enterprise is required to obtain under 12 CFR 217.35(d)(3); (ii) Makes available to FHFA and the CCP’s regulator the information described in paragraph (2)(i) of this definition; and (iii) Has not otherwise been determined by FHFA to not be a QCCP due to its financial condition, risk profile, failure to meet supervisory risk management standards, or other weaknesses or supervisory concerns that are inconsistent with the risk weight assigned to qualifying central counterparties under § 1240.37. (3) A QCCP that fails to meet the requirements of a QCCP in the future may still be treated as a QCCP under the conditions specified in § 1240.3(e). Qualifying master netting agreement means a written, legally enforceable agreement provided that: (1) The agreement creates a single legal obligation for all individual transactions covered by the agreement upon an event of default following any stay permitted by paragraph (2) of this definition, including upon an event of receivership, conservatorship, insolvency, liquidation, or similar proceeding, of the counterparty; (2) The agreement provides the Enterprise the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default, including upon an event of receivership, conservatorship, insolvency, VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 liquidation, or similar proceeding, of the counterparty, provided that, in any such case: (i) Any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than: (A) In receivership, conservatorship, or resolution under the Federal Deposit Insurance Act, Title II of the DoddFrank Act, or under any similar insolvency law applicable to GSEs, or laws of foreign jurisdictions that are substantially similar to the U.S. laws referenced in this paragraph (2)(i)(A) in order to facilitate the orderly resolution of the defaulting counterparty; or (B) Where the agreement is subject by its terms to, or incorporates, any of the laws referenced in paragraph (2)(i)(A) of this definition; and (ii) The agreement may limit the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default of the counterparty to the extent necessary for the counterparty to comply with the requirements of subpart I of the Federal Reserve Board’s Regulation YY (part 252 of this title), part 47 of this title, or part 382 of this title, as applicable. Repo-style transaction means a repurchase or reverse repurchase transaction, or a securities borrowing or securities lending transaction, including a transaction in which the Enterprise acts as agent for a customer and indemnifies the customer against loss, provided that: (1) The transaction is based solely on liquid and readily marketable securities, cash, or gold; (2) The transaction is marked-to-fair value daily and subject to daily margin maintenance requirements; (3)(i) The transaction is a ‘‘securities contract’’ or ‘‘repurchase agreement’’ under section 555 or 559, respectively, of the Bankruptcy Code (11 U.S.C. 555 or 559), a qualified financial contract under section 11(e)(8) of the Federal Deposit Insurance Act, or a netting contract between or among financial institutions under sections 401–407 of the Federal Deposit Insurance Corporation Improvement Act or the Federal Reserve Board’s Regulation EE (12 CFR part 231); or (ii) If the transaction does not meet the criteria set forth in paragraph (3)(i) of this definition, then either: (A) The transaction is executed under an agreement that provides the Enterprise the right to accelerate, terminate, and close-out the transaction on a net basis and to liquidate or set-off collateral promptly upon an event of PO 00000 Frm 00093 Fmt 4701 Sfmt 4702 39365 default, including upon an event of receivership, insolvency, liquidation, or similar proceeding, of the counterparty, provided that, in any such case: (1) Any exercise of rights under the agreement will not be stayed or avoided under applicable law in the relevant jurisdictions, other than: (i) In receivership, conservatorship, or resolution under the Federal Deposit Insurance Act, Title II of the DoddFrank Act, or under any similar insolvency law applicable to GSEs, or laws of foreign jurisdictions that are substantially similar to the U.S. laws referenced in this paragraph (3)(ii)(A)(1)(i) in order to facilitate the orderly resolution of the defaulting counterparty; (ii) Where the agreement is subject by its terms to, or incorporates, any of the laws referenced in paragraph (3)(ii)(A)(1)(i) of this definition; and (2) The agreement may limit the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to liquidate or set-off collateral promptly upon an event of default of the counterparty to the extent necessary for the counterparty to comply with the requirements of subpart I of the Federal Reserve Board’s Regulation YY (part 252 of this title), part 47 of this title, or part 382 of this title, as applicable; or (B) The transaction is: (1) Either overnight or unconditionally cancelable at any time by the Enterprise; and (2) Executed under an agreement that provides the Enterprise the right to accelerate, terminate, and close-out the transaction on a net basis and to liquidate or set-off collateral promptly upon an event of counterparty default; and (3) In order to recognize an exposure as a repo-style transaction for purposes of this subpart, an Enterprise must comply with the requirements of § 1240.3(e) with respect to that exposure. Resecuritization means a securitization which has more than one underlying exposure and in which one or more of the underlying exposures is a securitization exposure. Resecuritization exposure means: (1) An on- or off-balance sheet exposure to a resecuritization; or (2) An exposure that directly or indirectly references a resecuritization exposure. Retained CRT exposure means, with respect to an Enterprise, any exposure that arises from a credit risk transfer of the Enterprise and has been retained by the Enterprise since the issuance or E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39366 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules entry into the credit risk transfer by the Enterprise. Revenue obligation means a bond or similar obligation that is an obligation of a PSE, but which the PSE is committed to repay with revenues from the specific project financed rather than general tax funds. Securities and Exchange Commission (SEC) means the U.S. Securities and Exchange Commission. Securities Exchange Act means the Securities Exchange Act of 1934 (15 U.S.C. 78). Securitization exposure means: (1) An on-balance sheet or off-balance sheet credit exposure (including creditenhancing representations and warranties) that arises from a traditional securitization or synthetic securitization (including a resecuritization); (2) An exposure that directly or indirectly references a securitization exposure described in paragraph (1) of this definition; (3) A retained CRT exposure; or (4) An acquired CRT exposure. Securitization special purpose entity (securitization SPE) means a corporation, trust, or other entity organized for the specific purpose of holding underlying exposures of a securitization, the activities of which are limited to those appropriate to accomplish this purpose, and the structure of which is intended to isolate the underlying exposures held by the entity from the credit risk of the seller of the underlying exposures to the entity. Servicer cash advance facility means a facility under which the servicer of the underlying exposures of a securitization may advance cash to ensure an uninterrupted flow of payments to investors in the securitization, including advances made to cover foreclosure costs or other expenses to facilitate the timely collection of the underlying exposures. Single-family mortgage exposure means an exposure that is secured by a first or subsequent lien on a property with one to four residential units. Sovereign means a central government (including the U.S. government) or an agency, department, ministry, or central bank of a central government. Sovereign default means noncompliance by a sovereign with its external debt service obligations or the inability or unwillingness of a sovereign government to service an existing loan according to its original terms, as evidenced by failure to pay principal and interest timely and fully, arrearages, or restructuring. Sovereign exposure means: VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (1) A direct exposure to a sovereign; or (2) An exposure directly and unconditionally backed by the full faith and credit of a sovereign. Standardized market risk-weighted assets means the standardized measure for spread risk calculated under § 1240.204(a) multiplied by 12.5. Standardized total risk-weighted assets means: (1) The sum of: (i) Total risk-weighted assets for general credit risk as calculated under § 1240.31; (ii) Total risk-weighted assets for cleared transactions and default fund contributions as calculated under § 1240.37; (iii) Total risk-weighted assets for unsettled transactions as calculated under § 1240.40; (iv) Total risk-weighted assets for CRT and other securitization exposures as calculated under § 1240.42; (v) Total risk-weighted assets for equity exposures as calculated under § 1240.51; (vi) Risk-weighted assets for operational risk, as calculated under § 1240.162(c); and (vii) Standardized market riskweighted assets; minus (2) Excess eligible credit reserves not included in the Enterprise’s tier 2 capital. Subsidiary means, with respect to a company, a company controlled by that company. Synthetic securitization means a transaction in which: (1) All or a portion of the credit risk of one or more underlying exposures is retained or transferred to one or more third parties through the use of one or more credit derivatives or guarantees (other than a guarantee that transfers only the credit risk of an individual mortgage exposure or other retail exposure); (2) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (3) Performance of the securitization exposures depends upon the performance of the underlying exposures; and (4) All or substantially all of the underlying exposures are financial exposures (such as mortgage exposures, loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities). Tier 1 capital means the sum of common equity tier 1 capital and additional tier 1 capital. PO 00000 Frm 00094 Fmt 4701 Sfmt 4702 Tier 2 capital is defined in § 1240.20(d). Total capital has the meaning given at section 1303(23) of the Safety and Soundness Act (12 U.S.C. 4502(23)). Traditional securitization means a transaction in which: (1) All or a portion of the credit risk of one or more underlying exposures is transferred to one or more third parties other than through the use of credit derivatives or guarantees; (2) The credit risk associated with the underlying exposures has been separated into at least two tranches reflecting different levels of seniority; (3) Performance of the securitization exposures depends upon the performance of the underlying exposures; (4) All or substantially all of the underlying exposures are financial exposures (such as mortgage exposures, loans, commitments, credit derivatives, guarantees, receivables, asset-backed securities, mortgage-backed securities, other debt securities, or equity securities); (5) The underlying exposures are not owned by an operating company; (6) The underlying exposures are not owned by a small business investment company defined in section 302 of the Small Business Investment Act; (7) The underlying exposures are not owned by a firm an investment in which qualifies as a community development investment under section 24 (Eleventh) of the National Bank Act; (8) FHFA may determine that a transaction in which the underlying exposures are owned by an investment firm that exercises substantially unfettered control over the size and composition of its assets, liabilities, and off-balance sheet exposures is not a traditional securitization based on the transaction’s leverage, risk profile, or economic substance; (9) FHFA may deem a transaction that meets the definition of a traditional securitization, notwithstanding paragraph (5), (6), or (7) of this definition, to be a traditional securitization based on the transaction’s leverage, risk profile, or economic substance; and (10) The transaction is not: (i) An investment fund; (ii) A collective investment fund (as defined in 12 CFR 208.34); (iii) An employee benefit plan (as defined in 29 U.S.C. 1002(3)), a governmental plan (as defined in 29 U.S.C. 1002(32)) that complies with the tax deferral qualification requirements provided in the Internal Revenue Code; (iv) A synthetic exposure to the capital of a financial institution to the E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules extent deducted from capital under § 1240.22; or (v) Registered with the SEC under the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.) or foreign equivalents thereof. Tranche means all securitization exposures associated with a securitization that have the same seniority level. Underlying exposures means one or more exposures that have been securitized in a securitization transaction. Wrong-way risk means the risk that arises when an exposure to a particular counterparty is positively correlated with the probability of default of such counterparty itself. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.3 Operational requirements for counterparty credit risk. For purposes of calculating riskweighted assets under subpart D of this part: (a) Cleared transaction. In order to recognize certain exposures as cleared transactions pursuant to paragraphs (1)(ii), (iii), or (iv) of the definition of ‘‘cleared transaction’’ in § 1240.2, the exposures must meet the applicable requirements set forth in this paragraph (a). (1) The offsetting transaction must be identified by the CCP as a transaction for the clearing member client. (2) The collateral supporting the transaction must be held in a manner that prevents the Enterprise from facing any loss due to an event of default, including from a liquidation, receivership, insolvency, or similar proceeding of either the clearing member or the clearing member’s other clients. Omnibus accounts established under 17 CFR parts 190 and 300 satisfy the requirements of this paragraph (a). (3) The Enterprise must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that in the event of a legal challenge (including one resulting from a default or receivership, insolvency, liquidation, or similar proceeding) the relevant court and administrative authorities would find the arrangements of paragraph (a)(2) of this section to be legal, valid, binding and enforceable under the law of the relevant jurisdictions. (4) The offsetting transaction with a clearing member must be transferable under the transaction documents and applicable laws in the relevant jurisdiction(s) to another clearing member should the clearing member default, become insolvent, or enter VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 receivership, insolvency, liquidation, or similar proceedings. (b) Eligible margin loan. In order to recognize an exposure as an eligible margin loan as defined in § 1240.2, an Enterprise must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that the agreement underlying the exposure: (1) Meets the requirements of paragraph (1)(iii) of the definition of eligible margin loan in § 1240.2, and (2) Is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions. (c) Qualifying master netting agreement. In order to recognize an agreement as a qualifying master netting agreement as defined in § 1240.2, an Enterprise must: (1) Conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that: (i) The agreement meets the requirements of paragraph (2) of the definition of qualifying master netting agreement in § 1240.2; and (ii) In the event of a legal challenge (including one resulting from default or from receivership, insolvency, liquidation, or similar proceeding) the relevant court and administrative authorities would find the agreement to be legal, valid, binding, and enforceable under the law of the relevant jurisdictions; and (2) Establish and maintain written procedures to monitor possible changes in relevant law and to ensure that the agreement continues to satisfy the requirements of the definition of qualifying master netting agreement in § 1240.2. (d) Repo-style transaction. In order to recognize an exposure as a repo-style transaction as defined in § 1240.2, an Enterprise must conduct sufficient legal review to conclude with a well-founded basis (and maintain sufficient written documentation of that legal review) that the agreement underlying the exposure: (1) Meets the requirements of paragraph (3) of the definition of ‘‘repostyle transaction’’ in § 1240.2, and (2) Is legal, valid, binding, and enforceable under applicable law in the relevant jurisdictions. (e) Failure of a QCCP to satisfy the rule’s requirements. If an Enterprise determines that a CCP ceases to be a QCCP due to the failure of the CCP to satisfy one or more of the requirements set forth in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP in § 1240.2, the Enterprise may continue to treat the CCP as a QCCP for up to three months following the determination. If PO 00000 Frm 00095 Fmt 4701 Sfmt 4702 39367 the CCP fails to remedy the relevant deficiency within three months after the initial determination, or the CCP fails to satisfy the requirements set forth in paragraphs (2)(i) through (2)(iii) of the definition of a ‘‘QCCP’’ continuously for a three-month period after remedying the relevant deficiency, an Enterprise may not treat the CCP as a QCCP for the purposes of this part until after the Enterprise has determined that the CCP has satisfied the requirements in paragraphs (2)(i) through (2)(iii) of the definition of a QCCP for three continuous months. § 1240.4 Compliance dates. (a) Delayed compliance dates. Certain sections and subparts of this part are subject to delayed compliance dates under this section. (b) Reporting compliance. Section 1240.1(f) has a compliance date of one year from [DATE OF PUBLICATION OF FINAL RULE]. (c) Capital requirements and buffers. Subject to paragraph (d) of this section, subpart B of this part has a compliance date with respect to an Enterprise of the later of: (1) One year from [DATE OF PUBLICATION OF FINAL RULE]; and (2) The date of the termination of the conservatorship of the Enterprise. (d) Capital restoration plan or other interim order. (1) The Director may determine to direct a later compliance date for an Enterprise to achieve compliance with § 1240.10 based on his assessment of capital market conditions and the likely feasibility of the plan of the Enterprise to achieve capital levels sufficient to comply with § 1240.10 and avoid restrictions on capital distributions and discretionary bonuses under § 1240.11(b). (2) If the Director makes a determination under paragraph (d)(1) of this section: (i) For the period between the compliance date for § 1240.11 under paragraph (c) of this section and any later compliance date for § 1240.10 under this paragraph (d), the prescribed capital conservation buffer amount of the Enterprise will be the amount equal to: (A) The CET1 capital that would otherwise be required under § 1240.10(d); plus (B) The prescribed capital conservation buffer amount that would otherwise apply under § 1240.11(a)(5); (ii) For the period between the compliance date for § 1240.11 under paragraph (c) of this section and the later compliance date for § 1240.10 under this paragraph (d), the prescribed leverage buffer amount of the Enterprise E:\FR\FM\30JNP2.SGM 30JNP2 39368 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules will be equal to 4.0 percent of the adjusted total assets of the Enterprise; and (iii) The compliance date for § 1240.10 will be tolled if the Enterprise is in compliance with: (A) Any corrective plan pursuant to section 1313B of the Safety and Soundness Act (12 U.S.C. 4513b(b)(1)) and 12 CFR 1236.4(c), approved by FHFA, which may prescribe the feasible actions and milestones by which the Enterprise will achieve compliance with § 1240.10 by the date directed by FHFA; and (B) Any agreement or order pursuant to section 1371 of the Safety and Soundness Act (12 U.S.C. 4631), including any requirement under any plan required under that agreement or order to achieve compliance with § 1240.10. Subpart B—Capital Requirements and Buffers khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.10 Capital requirements. (a) Total capital. An Enterprise must maintain total capital not less than the amount equal to 8.0 percent of the greater of: (1) Standardized total risk-weighted assets; and (2) Advanced approaches total riskweighted assets. (b) Adjusted total capital. An Enterprise must maintain adjusted total capital not less than the amount equal to 8.0 percent of the greater of: (1) Standardized total risk-weighted assets; and (2) Advanced approaches total riskweighted assets. (c) Tier 1 capital. An Enterprise must maintain tier 1 capital not less than the amount equal to 6.0 percent of the greater of: (1) Standardized total risk-weighted assets; and (2) Advanced approaches total riskweighted assets. (d) Common equity tier 1 capital. An Enterprise must maintain common equity tier 1 capital not less than the amount equal to 4.5 percent of the greater of: (1) Standardized total risk-weighted assets; and (2) Advanced approaches total riskweighted assets. (e) Core capital. An Enterprise must maintain core capital not less than the amount equal to 2.5 percent of adjusted total assets. (f) Leverage ratio. An Enterprise must maintain tier 1 capital not less than the amount equal to 2.5 percent of adjusted total assets. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (g) Capital adequacy. (1) Notwithstanding the minimum requirements in this part, an Enterprise must maintain capital commensurate with the level and nature of all risks to which the Enterprise is exposed. The supervisory evaluation of an Enterprise’s capital adequacy is based on an individual assessment of numerous factors, including the character and condition of the Enterprise’s assets and its existing and prospective liabilities and other corporate responsibilities. (2) An Enterprise must have a process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive strategy for maintaining an appropriate level of capital. § 1240.11 Capital conservation buffer and leverage buffer. (a) Definitions. For purposes of this section, the following definitions apply: (1) Capital conservation buffer. An Enterprise’s capital conservation buffer is the amount calculated under paragraph (c)(2) of this section. (2) Eligible retained income. The eligible retained income of an Enterprise is the greater of: (i) The Enterprise’s net income, as defined under GAAP, for the four calendar quarters preceding the current calendar quarter, net of any distributions and associated tax effects not already reflected in net income; and (ii) The average of the Enterprise’s net income for the four calendar quarters preceding the current calendar quarter. (3) Leverage buffer. An Enterprise’s leverage buffer is the amount calculated under paragraph (d)(2) of this section. (4) Maximum payout ratio. The maximum payout ratio is the percentage of eligible retained income that an Enterprise can pay out in the form of distributions and discretionary bonus payments during the current calendar quarter. The maximum payout ratio is determined under paragraph (b)(2) of this section. (5) Prescribed capital conservation buffer amount. An Enterprise’s prescribed capital conservation buffer amount is equal to its stress capital buffer in accordance with paragraph (a)(7) of this section plus its applicable countercyclical capital buffer amount in accordance with paragraph (e) of this section plus its applicable stability capital buffer in accordance with paragraph (f) of this section. (6) Prescribed leverage buffer amount. An Enterprise’s prescribed leverage buffer amount is 1.5 percent of the Enterprise’s adjusted total assets, as of PO 00000 Frm 00096 Fmt 4701 Sfmt 4702 the last day of the previous calendar quarter. (7) Stress capital buffer. An Enterprise’s stress capital buffer is 0.75 percent of the Enterprise’s adjusted total assets, as of the last day of the previous calendar quarter. (b) Maximum payout amount. (1) Limits on distributions and discretionary bonus payments. An Enterprise shall not make distributions or discretionary bonus payments or create an obligation to make such distributions or payments during the current calendar quarter that, in the aggregate, exceed the amount equal to the Enterprise’s eligible retained income for the calendar quarter, multiplied by its maximum payout ratio. (2) Maximum payout ratio. The maximum payout ratio of an Enterprise is the lowest of the payout ratios determined by its capital conservation buffer and its leverage buffer, as set forth on Table 1 to paragraph (b)(5) of this section. (3) No maximum payout amount limitation. An Enterprise is not subject to a restriction under paragraph (b)(1) of this section if it has: (i) A capital conservation buffer that is greater than its prescribed capital conservation buffer amount; and (ii) A leverage buffer that is greater than its prescribed leverage buffer amount. (4) Negative eligible retained income. An Enterprise may not make distributions or discretionary bonus payments during the current calendar quarter if: (i) The eligible retained income of the Enterprise is negative; and (ii) Either: (A) The capital conservation buffer of the Enterprise was less than its stress capital buffer; or (B) The leverage buffer of the Enterprise was less than its prescribed leverage buffer amount. (5) Prior approval. Notwithstanding the limitations in paragraphs (b)(1) through (b)(3) of this section, FHFA may permit an Enterprise to make a distribution or discretionary bonus payment upon a request of the Enterprise, if FHFA determines that the distribution or discretionary bonus payment would not be contrary to the purposes of this section or to the safety and soundness of the Enterprise. In making such a determination, FHFA will consider the nature and extent of the request and the particular circumstances giving rise to the request. E:\FR\FM\30JNP2.SGM 30JNP2 (c) Capital conservation buffer—(1) Composition of the capital conservation buffer. The capital conservation buffer is composed solely of common equity tier 1 capital. (2) Calculation of capital conservation buffer. (i) An Enterprise’s capital conservation buffer is equal to the lowest of the following, calculated as of the last day of the previous calendar quarter: (A) The Enterprise’s adjusted total capital minus the minimum amount of adjusted total capital under § 1240.10(b); (B) The Enterprise’s tier 1 capital minus the minimum amount of tier 1 capital under § 1240.10(c); or (C) The Enterprise’s common equity tier 1 capital minus the minimum amount of common equity tier 1 capital under § 1240.10(d). (ii) Notwithstanding paragraphs (c)(2)(i)(A) through (C) of this section, if the Enterprise’s adjusted total capital, tier 1 capital, or common equity tier 1 capital is less than or equal to the Enterprise’s minimum adjusted total capital, tier 1 capital, or common equity tier 1 capital, respectively, the Enterprise’s capital conservation buffer is zero. (d) Leverage buffer—(1) Composition of the leverage buffer. The leverage buffer is composed solely of tier 1 capital. (2) Calculation of the leverage buffer. (i) An Enterprise’s leverage buffer is equal to the Enterprise’s tier 1 capital minus the minimum amount of tier 1 capital under § 1240.10(f), calculated as 2 An Enterprise’s ‘‘capital buffer’’ means, as applicable, its capital conservation buffer or its leverage buffer. 3 An Enterprise’s ‘‘prescribed buffer amount’’ means, as applicable, its prescribed capital conservation buffer amount or its leverage prescribed buffer amount. VerDate Sep<11>2014 20:22 Jun 29, 2020 Jkt 250001 of the last day of the previous calendar quarter. (ii) Notwithstanding paragraph (d)(2)(i) of this section, if the Enterprise’s tier 1 capital is less than or equal to the minimum amount of tier 1 capital under § 1240.10(d), the Enterprise’s leverage buffer is zero. (e) Countercyclical capital buffer amount—(1) Composition of the countercyclical capital buffer amount. The countercyclical capital buffer amount is composed solely of common equity tier 1 capital. (2) Amount—(i) Initial countercyclical capital buffer. The initial countercyclical capital buffer amount is zero. (ii) Adjustment of the countercyclical capital buffer amount. FHFA will adjust the countercyclical capital buffer amount in accordance with applicable law. (iii) Range of countercyclical capital buffer amount. FHFA will adjust the countercyclical capital buffer amount between zero percent and 0.75 percent of adjusted total assets. (iv) Adjustment determination. FHFA will base its decision to adjust the countercyclical capital buffer amount under this section on a range of macroeconomic, financial, and supervisory information indicating an increase in systemic risk, including the ratio of credit to gross domestic product, a variety of asset prices, other factors indicative of relative credit and liquidity expansion or contraction, funding spreads, credit condition surveys, indices based on credit default swap spreads, options implied volatility, and measures of systemic risk. (3) Effective date of adjusted countercyclical capital buffer amount— (i) Increase adjustment. A determination by FHFA under PO 00000 Frm 00097 Fmt 4701 Sfmt 4702 39369 paragraph (e)(2)(ii) of this section to increase the countercyclical capital buffer amount will be effective 12 months from the date of announcement, unless FHFA establishes an earlier effective date and includes a statement articulating the reasons for the earlier effective date. (ii) Decrease adjustment. A determination by FHFA to decrease the established countercyclical capital buffer amount under paragraph (e)(2)(ii) of this section will be effective on the day following announcement of the final determination or the earliest date permissible under applicable law or regulation, whichever is later. (iii) Twelve month sunset. The countercyclical capital buffer amount will return to zero percent 12 months after the effective date that the adjusted countercyclical capital buffer amount is announced, unless FHFA announces a decision to maintain the adjusted countercyclical capital buffer amount or adjust it again before the expiration of the 12-month period. (f) Stability capital buffer. An Enterprise must use its stability capital buffer calculated in accordance with subpart G of this part for purposes of determining its maximum payout ratio under Table 1 to paragraph (b)(5) of this section. Subpart C—Definition of Capital § 1240.20 Capital components and eligibility criteria for regulatory capital instruments. (a) Regulatory capital components. An Enterprise’s regulatory capital components are: (1) Common equity tier 1 capital; (2) Additional tier 1 capital; (3) Tier 2 capital; (4) Core capital; and (5) Total capital. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.046</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 39370 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (b) Common equity tier 1 capital. Common equity tier 1 capital is the sum of the common equity tier 1 capital elements in this paragraph (b), minus regulatory adjustments and deductions in § 1240.22. The common equity tier 1 capital elements are: (1) Any common stock instruments (plus any related surplus) issued by the Enterprise, net of treasury stock, that meet all the following criteria: (i) The instrument is paid-in, issued directly by the Enterprise, and represents the most subordinated claim in a receivership, insolvency, liquidation, or similar proceeding of the Enterprise; (ii) The holder of the instrument is entitled to a claim on the residual assets of the Enterprise that is proportional with the holder’s share of the Enterprise’s issued capital after all senior claims have been satisfied in a receivership, insolvency, liquidation, or similar proceeding; (iii) The instrument has no maturity date, can only be redeemed via discretionary repurchases with the prior approval of FHFA to the extent otherwise required by law or regulation, and does not contain any term or feature that creates an incentive to redeem; (iv) The Enterprise did not create at issuance of the instrument through any action or communication an expectation that it will buy back, cancel, or redeem the instrument, and the instrument does not include any term or feature that might give rise to such an expectation; (v) Any cash dividend payments on the instrument are paid out of the Enterprise’s net income, retained earnings, or surplus related to common stock, and are not subject to a limit imposed by the contractual terms governing the instrument. (vi) The Enterprise has full discretion at all times to refrain from paying any dividends and making any other distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of any other restrictions on the Enterprise; (vii) Dividend payments and any other distributions on the instrument may be paid only after all legal and contractual obligations of the Enterprise have been satisfied, including payments due on more senior claims; (viii) The holders of the instrument bear losses as they occur equally, proportionately, and simultaneously with the holders of all other common stock instruments before any losses are borne by holders of claims on the Enterprise with greater priority in a receivership, insolvency, liquidation, or similar proceeding; VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (ix) The paid-in amount is classified as equity under GAAP; (x) The Enterprise, or an entity that the Enterprise controls, did not purchase or directly or indirectly fund the purchase of the instrument; (xi) The instrument is not secured, not covered by a guarantee of the Enterprise or of an affiliate of the Enterprise, and is not subject to any other arrangement that legally or economically enhances the seniority of the instrument; (xii) The instrument has been issued in accordance with applicable laws and regulations; and (xiii) The instrument is reported on the Enterprise’s regulatory financial statements separately from other capital instruments. (2) Retained earnings. (3) Accumulated other comprehensive income (AOCI) as reported under GAAP.4 (4) Notwithstanding the criteria for common stock instruments referenced above, an Enterprise’s common stock issued and held in trust for the benefit of its employees as part of an employee stock ownership plan does not violate any of the criteria in paragraphs (b)(1)(iii), (b)(1)(iv) or (b)(1)(xi) of this section, provided that any repurchase of the stock is required solely by virtue of ERISA for an instrument of an Enterprise that is not publicly-traded. In addition, an instrument issued by an Enterprise to its employee stock ownership plan does not violate the criterion in paragraph (b)(1)(x) of this section. (c) Additional tier 1 capital. Additional tier 1 capital is the sum of additional tier 1 capital elements and any related surplus, minus the regulatory adjustments and deductions in § 1240.22. Additional tier 1 capital elements are: (1) Subject to paragraph (e)(2) of this section, instruments (plus any related surplus) that meet the following criteria: (i) The instrument is issued and paidin; (ii) The instrument is subordinated to general creditors and subordinated debt holders of the Enterprise in a receivership, insolvency, liquidation, or similar proceeding; (iii) The instrument is not secured, not covered by a guarantee of the Enterprise or of an affiliate of the Enterprise, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument; (iv) The instrument has no maturity date and does not contain a dividend 4 See § 1240.22 for specific adjustments related to AOCI. PO 00000 Frm 00098 Fmt 4701 Sfmt 4702 step-up or any other term or feature that creates an incentive to redeem; and (v) If callable by its terms, the instrument may be called by the Enterprise only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called earlier than five years upon the occurrence of a regulatory event that precludes the instrument from being included in additional tier 1 capital, a tax event, or if the issuing entity is required to register as an investment company pursuant to the Investment Company Act of 1940 (15 U.S.C. 80a–1 et seq.). In addition: (A) The Enterprise must receive prior approval from FHFA to exercise a call option on the instrument. (B) The Enterprise does not create at issuance of the instrument, through any action or communication, an expectation that the call option will be exercised. (C) Prior to exercising the call option, or immediately thereafter, the Enterprise must either: Replace the instrument to be called with an equal amount of instruments that meet the criteria under paragraph (b) of this section or this paragraph (c); 5 or demonstrate to the satisfaction of FHFA that following redemption, the Enterprise will continue to hold capital commensurate with its risk. (vi) Redemption or repurchase of the instrument requires prior approval from FHFA. (vii) The Enterprise has full discretion at all times to cancel dividends or other distributions on the instrument without triggering an event of default, a requirement to make a payment-in-kind, or an imposition of other restrictions on the Enterprise except in relation to any distributions to holders of common stock or instruments that are pari passu with the instrument. (viii) Any distributions on the instrument are paid out of the Enterprise’s net income, retained earnings, or surplus related to other additional tier 1 capital instruments. (ix) The instrument does not have a credit-sensitive feature, such as a dividend rate that is reset periodically based in whole or in part on the Enterprise’s credit quality, but may have a dividend rate that is adjusted periodically independent of the Enterprise’s credit quality, in relation to general market interest rates or similar adjustments. (x) The paid-in amount is classified as equity under GAAP. 5 Replacement can be concurrent with redemption of existing additional tier 1 capital instruments. E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (xi) The Enterprise, or an entity that the Enterprise controls, did not purchase or directly or indirectly fund the purchase of the instrument. (xii) The instrument does not have any features that would limit or discourage additional issuance of capital by the Enterprise, such as provisions that require the Enterprise to compensate holders of the instrument if a new instrument is issued at a lower price during a specified time frame. (xiii) If the instrument is not issued directly by the Enterprise or by a subsidiary of the Enterprise that is an operating entity, the only asset of the issuing entity is its investment in the capital of the Enterprise, and proceeds must be immediately available without limitation to the Enterprise or to the Enterprise’s top-tier holding company in a form which meets or exceeds all of the other criteria for additional tier 1 capital instruments.6 (xiv) The governing agreement, offering circular, or prospectus of an instrument issued after [the effective date of the final rule] must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the Enterprise enters into a receivership, insolvency, liquidation, or similar proceeding. (2) Notwithstanding the criteria for additional tier 1 capital instruments referenced above, an instrument issued by an Enterprise and held in trust for the benefit of its employees as part of an employee stock ownership plan does not violate any of the criteria in paragraph (c)(1)(iii) of this section, provided that any repurchase is required solely by virtue of ERISA for an instrument of an Enterprise that is not publicly-traded. In addition, an instrument issued by an Enterprise to its employee stock ownership plan does not violate the criteria in paragraphs (c)(1)(v) or (c)(1)(xi) of this section. (d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital elements and any related surplus, minus the regulatory adjustments and deductions in § 1240.22. Tier 2 capital elements are: (1) Subject to paragraph (e)(2) of this section, instruments (plus related surplus) that meet the following criteria: (i) The instrument is issued and paidin. (ii) The instrument is subordinated to general creditors of the Enterprise. (iii) The instrument is not secured, not covered by a guarantee of the Enterprise or of an affiliate of the 6 De minimis assets related to the operation of the issuing entity can be disregarded for purposes of this criterion. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Enterprise, and not subject to any other arrangement that legally or economically enhances the seniority of the instrument in relation to more senior claims. (iv) The instrument has a minimum original maturity of at least five years. At the beginning of each of the last five years of the life of the instrument, the amount that is eligible to be included in tier 2 capital is reduced by 20 percent of the original amount of the instrument (net of redemptions) and is excluded from regulatory capital when the remaining maturity is less than one year. In addition, the instrument must not have any terms or features that require, or create significant incentives for, the Enterprise to redeem the instrument prior to maturity.7 (v) The instrument, by its terms, may be called by the Enterprise only after a minimum of five years following issuance, except that the terms of the instrument may allow it to be called sooner upon the occurrence of an event that would preclude the instrument from being included in tier 2 capital, a tax event. In addition: (A) The Enterprise must receive the prior approval of FHFA to exercise a call option on the instrument. (B) The Enterprise does not create at issuance, through action or communication, an expectation the call option will be exercised. (C) Prior to exercising the call option, or immediately thereafter, the Enterprise must either: Replace any amount called with an equivalent amount of an instrument that meets the criteria for regulatory capital under this section; 8 or demonstrate to the satisfaction of FHFA that following redemption, the Enterprise would continue to hold an amount of capital that is commensurate with its risk. (vi) The holder of the instrument must have no contractual right to accelerate payment of principal or interest on the instrument, except in the event of a receivership, insolvency, liquidation, or similar proceeding of the Enterprise. (vii) The instrument has no creditsensitive feature, such as a dividend or interest rate that is reset periodically based in whole or in part on the Enterprise’s credit standing, but may have a dividend rate that is adjusted periodically independent of the Enterprise’s credit standing, in relation 7 An instrument that by its terms automatically converts into a tier 1 capital instrument prior to five years after issuance complies with the five-year maturity requirement of this criterion. 8 An Enterprise may replace tier 2 capital instruments concurrent with the redemption of existing tier 2 capital instruments. PO 00000 Frm 00099 Fmt 4701 Sfmt 4702 39371 to general market interest rates or similar adjustments. (viii) The Enterprise, or an entity that the Enterprise controls, has not purchased and has not directly or indirectly funded the purchase of the instrument. (ix) If the instrument is not issued directly by the Enterprise or by a subsidiary of the Enterprise that is an operating entity, the only asset of the issuing entity is its investment in the capital of the Enterprise, and proceeds must be immediately available without limitation to the Enterprise or the Enterprise’s top-tier holding company in a form that meets or exceeds all the other criteria for tier 2 capital instruments under this section.9 (x) Redemption of the instrument prior to maturity or repurchase requires the prior approval of FHFA. (xi) The governing agreement, offering circular, or prospectus of an instrument issued after [the effective date of the final rule] must disclose that the holders of the instrument may be fully subordinated to interests held by the U.S. government in the event that the Enterprise enters into a receivership, insolvency, liquidation, or similar proceeding. (2) Any eligible credit reserves that exceed expected credit losses to the extent that the excess reserve amount does not exceed 0.6 percent of credit risk-weighted assets. (e) FHFA approval of a capital element. (1) An Enterprise must receive FHFA prior approval to include a capital element (as listed in this section) in its common equity tier 1 capital, additional tier 1 capital, or tier 2 capital unless the element: (i) Was included in an Enterprise’s tier 1 capital or tier 2 capital prior to [the publication date of the proposed rule] and the underlying instrument may continue to be included under the criteria set forth in this section; or (ii) Is equivalent, in terms of capital quality and ability to absorb losses with respect to all material terms, to a regulatory capital element FHFA determined may be included in regulatory capital pursuant to paragraph (e)(3) of this section. (2) An Enterprise may not include an instrument in its additional tier 1 capital or a tier 2 capital unless FHFA has determined that the Enterprise has made appropriate provision, including in any resolution plan of the Enterprise, to ensure that the instrument would not pose a material impediment to the 9 An Enterprise may disregard de minimis assets related to the operation of the issuing entity for purposes of this criterion. E:\FR\FM\30JNP2.SGM 30JNP2 39372 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules ability of an Enterprise to issue common stock instruments following the appointment of FHFA as conservator or receiver under the Safety and Soundness Act. (3) After determining that a regulatory capital element may be included in an Enterprise’s common equity tier 1 capital, additional tier 1 capital, or tier 2 capital, FHFA will make its decision publicly available, including a brief description of the material terms of the regulatory capital element and the rationale for the determination. (f) FHFA prior approval. An Enterprise may not repurchase or redeem any common equity tier 1 capital, additional tier 1, or tier 2 capital instrument without the prior approval of FHFA to the extent such prior approval is required by paragraphs (b), (c), or (d) of this section, as applicable. § 1240.21 [Reserved] khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.22 Regulatory capital adjustments and deductions. (a) Regulatory capital deductions from common equity tier 1 capital. An Enterprise must deduct from the sum of its common equity tier 1 capital elements the items set forth in this paragraph (a): (1) Goodwill, net of associated deferred tax liabilities (DTLs) in accordance with paragraph (e) of this section, including goodwill that is embedded in the valuation of a significant investment in the capital of an unconsolidated financial institution in the form of common stock (and that is reflected in the consolidated financial statements of the Enterprise), in accordance with paragraph (d) of this section; (2) Intangible assets, other than MSAs, net of associated DTLs in accordance with paragraph (e) of this section; (3) Deferred tax assets (DTAs) that arise from net operating loss and tax credit carryforwards net of any related valuation allowances and net of DTLs in accordance with paragraph (e) of this section; (4) Any gain-on-sale in connection with a securitization exposure; (5) Any defined benefit pension fund net asset, net of any associated DTL in accordance with paragraph (e) of this section, held by the Enterprise. With the prior approval of FHFA, this deduction is not required for any defined benefit pension fund net asset to the extent the Enterprise has unrestricted and unfettered access to the assets in that fund. An Enterprise must risk weight any portion of the defined benefit pension fund asset that is not deducted under this paragraph (a) as if the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Enterprise directly holds a proportional ownership share of each exposure in the defined benefit pension fund. (6) The amount of expected credit loss that exceeds its eligible credit reserves. (b) Regulatory adjustments to common equity tier 1 capital. (1) An Enterprise must adjust the sum of common equity tier 1 capital elements pursuant to the requirements set forth in this paragraph (b). Such adjustments to common equity tier 1 capital must be made net of the associated deferred tax effects. (i) An Enterprise must deduct any accumulated net gains and add any accumulated net losses on cash flow hedges included in AOCI that relate to the hedging of items that are not recognized at fair value on the balance sheet. (ii) An Enterprise must deduct any net gain and add any net loss related to changes in the fair value of liabilities that are due to changes in the Enterprise’s own credit risk. An Enterprise must deduct the difference between its credit spread premium and the risk-free rate for derivatives that are liabilities as part of this adjustment. (c) Deductions from regulatory capital related to investments in capital instruments.10 An Enterprise must deduct an investment in the Enterprise’s own capital instruments as follows: (1) An Enterprise must deduct an investment in the Enterprise’s own common stock instruments from its common equity tier 1 capital elements to the extent such instruments are not excluded from regulatory capital under § 1240.20(b)(1); (2) An Enterprise must deduct an investment in the Enterprise’s own additional tier 1 capital instruments from its additional tier 1 capital elements; and (3) An Enterprise must deduct an investment in the Enterprise’s own tier 2 capital instruments from its tier 2 capital elements. (d) Items subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds. (1) An Enterprise must deduct from common equity tier 1 capital elements the amount of each of the items set forth in this paragraph (d) that, individually, exceeds 10 percent of the sum of the Enterprise’s common equity tier 1 capital elements, less adjustments to and deductions from common equity tier 1 capital required under paragraphs (a) through (c) of this section (the 10 percent common equity tier 1 capital deduction threshold). (i) DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks, net of any related valuation allowances and net of DTLs, in accordance with paragraph (e) of this section. An Enterprise is not required to deduct from the sum of its common equity tier 1 capital elements DTAs (net of any related valuation allowances and net of DTLs, in accordance with paragraph (e) of this section) arising from timing differences that the Enterprise could realize through net operating loss carrybacks. The Enterprise must risk weight these assets at 100 percent. (ii) MSAs net of associated DTLs, in accordance with paragraph (e) of this section. (2) An Enterprise must deduct from common equity tier 1 capital elements the items listed in paragraph (d)(1) of this section that are not deducted as a result of the application of the 10 percent common equity tier 1 capital deduction threshold, and that, in aggregate, exceed 17.65 percent of the sum of the Enterprise’s common equity tier 1 capital elements, minus adjustments to and deductions from common equity tier 1 capital required under paragraphs (a) through (c) of this section, minus the items listed in paragraph (d)(1) of this section (the 15 percent common equity tier 1 capital deduction threshold).11 (3) For purposes of calculating the amount of DTAs subject to the 10 and 15 percent common equity tier 1 capital deduction thresholds, an Enterprise may exclude DTAs and DTLs relating to adjustments made to common equity tier 1 capital under paragraph (b) of this section. An Enterprise that elects to exclude DTAs relating to adjustments under paragraph (b) of this section also must exclude DTLs and must do so consistently in all future calculations. An Enterprise may change its exclusion preference only after obtaining the prior approval of FHFA. (e) Netting of DTLs against assets subject to deduction. (1) Except as described in paragraph (e)(3) of this section, netting of DTLs against assets that are subject to deduction under this section is permitted, but not required, if the following conditions are met: (i) The DTL is associated with the asset; and 10 The Enterprise must calculate amounts deducted under paragraphs (c) through (f) of this section after it calculates the amount of ALLL or AACL, as applicable, includable in tier 2 capital under § 1240.20(d). 11 The amount of the items in paragraph (d) of this section that is not deducted from common equity tier 1 capital pursuant to this section must be included in the risk-weighted assets of the Enterprise and assigned a 250 percent risk weight. PO 00000 Frm 00100 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (ii) The DTL would be extinguished if the associated asset becomes impaired or is derecognized under GAAP. (2) A DTL may only be netted against a single asset. (3) For purposes of calculating the amount of DTAs subject to the threshold deduction in paragraph (d) of this section, the amount of DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and of DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks, net of any related valuation allowances, may be offset by DTLs (that have not been netted against assets subject to deduction pursuant to paragraph (e)(1) of this section) subject to the conditions set forth in this paragraph (e). (i) Only the DTAs and DTLs that relate to taxes levied by the same taxation authority and that are eligible for offsetting by that authority may be offset for purposes of this deduction. (ii) The amount of DTLs that the Enterprise nets against DTAs that arise from net operating loss and tax credit carryforwards, net of any related valuation allowances, and against DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks, net of any related valuation allowances, must be allocated in proportion to the amount of DTAs that arise from net operating loss and tax credit carryforwards (net of any related valuation allowances, but before any offsetting of DTLs) and of DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks (net of any related valuation allowances, but before any offsetting of DTLs), respectively. (4) An Enterprise must net DTLs against assets subject to deduction under this section in a consistent manner from reporting period to reporting period. An Enterprise may change its preference regarding the manner in which it nets DTLs against specific assets subject to deduction under this section only after obtaining the prior approval of FHFA. (f) Insufficient amounts of a specific regulatory capital component to effect deductions. Under the corresponding deduction approach, if an Enterprise does not have a sufficient amount of a specific component of capital to effect the required deduction after completing the deductions required under paragraph (d) of this section, the Enterprise must deduct the shortfall from the next higher (that is, more subordinated) component of regulatory capital. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (g) Treatment of assets that are deducted. An Enterprise must exclude from standardized total risk-weighted assets and advanced approaches total risk-weighted assets any item deducted from regulatory capital under paragraphs (a), (c), and (d) of this section. Subpart D—Risk-Weighted Assets— Standardized Approach § 1240.30 Applicability. (a) This subpart sets forth methodologies for determining riskweighted assets for purposes of the generally applicable risk-based capital requirements for the Enterprises. (b) This subpart is also applicable to covered positions, as defined in subpart F of this part. Risk-Weighted Assets For General Credit Risk § 1240.31 Mechanics for calculating riskweighted assets for general credit risk. (a) General risk-weighting requirements. An Enterprise must apply risk weights to its exposures as follows: (1) An Enterprise must determine the exposure amount of each mortgage exposure, each other on-balance sheet exposure, each OTC derivative contract, and each off-balance sheet commitment, trade and transaction-related contingency, guarantee, repo-style transaction, forward agreement, or other similar transaction that is not: (i) An unsettled transaction subject to § 1240.40; (ii) A cleared transaction subject to § 1240.37; (iii) A default fund contribution subject to § 1240.37; (iv) A retained CRT exposure, acquired CRT exposure, or other securitization exposure subject to §§ 1240.41 through 1240.46; or (v) An equity exposure (other than an equity OTC derivative contract) subject to § 1240.51. (2) An Enterprise must multiply each exposure amount by the risk weight appropriate to the exposure based on the exposure type or counterparty, eligible guarantor, or financial collateral to determine the risk-weighted asset amount for each exposure. (b) Total risk-weighted assets for general credit risk. Total risk-weighted assets for general credit risk equals the sum of the risk-weighted asset amounts calculated under this section. § 1240.32 General risk weights. (a) Exposures to the U.S. government. (1) Notwithstanding any other requirement in this subpart, an Enterprise must assign a zero percent risk weight to: PO 00000 Frm 00101 Fmt 4701 Sfmt 4702 39373 (i) An exposure to the U.S. government, its central bank, or a U.S. government agency; and (ii) The portion of an exposure that is directly and unconditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency. This includes a deposit or other exposure, or the portion of a deposit or other exposure, that is insured or otherwise unconditionally guaranteed by the FDIC or NCUA. (2) An Enterprise must assign a 20 percent risk weight to the portion of an exposure that is conditionally guaranteed by the U.S. government, its central bank, or a U.S. government agency. This includes an exposure, or the portion of an exposure, that is conditionally guaranteed by the FDIC or NCUA. (b) Certain supranational entities and multilateral development banks (MDBs). An Enterprise must assign a zero percent risk weight to an exposure to the Bank for International Settlements, the European Central Bank, the European Commission, the International Monetary Fund, the European Stability Mechanism, the European Financial Stability Facility, or an MDB. (c) Exposures to GSEs. (1) An Enterprise must assign a zero percent risk weight to any MBS guaranteed by the Enterprise (other than any retained CRT exposure). (2) An Enterprise must assign a 20 percent risk weight to an exposure to another GSE, including an MBS guaranteed by the other Enterprise, other than an equity exposure or preferred stock. (d) Exposures to depository institutions and credit unions. (1) An Enterprise must assign a 20 percent risk weight to an exposure to a depository institution or credit union that is organized under the laws of the United States or any state thereof, except as otherwise provided under paragraph (d)(2) of this section. (2) An Enterprise must assign a 100 percent risk weight to an exposure to a financial institution if the exposure may be included in that financial institution’s capital unless the exposure is: (i) An equity exposure; or (ii) Deducted from regulatory capital under § 1240.22. (e) Exposures to U.S. public sector entities (PSEs). (1) An Enterprise must assign a 20 percent risk weight to a general obligation exposure to a PSE that is organized under the laws of the United States or any state or political subdivision thereof. (2) An Enterprise must assign a 50 percent risk weight to a revenue E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39374 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules obligation exposure to a PSE that is organized under the laws of the United States or any state or political subdivision thereof. (f) Corporate exposures. An Enterprise must assign a 100 percent risk weight to all its corporate exposures. (g) Residential mortgage exposures— (1) Single-family mortgage exposures. An Enterprise must assign a risk weight to a single-family mortgage exposure in accordance with § 1240.33. (2) Multifamily mortgage exposures. An Enterprise must assign a risk weight to a multifamily mortgage exposure in accordance with § 1240.34. (h) Past due exposures. Except for an exposure to a sovereign entity or a mortgage exposure, if an exposure is 90 days or more past due or on nonaccrual: (1) An Enterprise must assign a 150 percent risk weight to the portion of the exposure that is not guaranteed or that is unsecured; (2) An Enterprise may assign a risk weight to the guaranteed portion of a past due exposure based on the risk weight that applies under § 1240.38 if the guarantee or credit derivative meets the requirements of that section; and (3) An Enterprise may assign a risk weight to the collateralized portion of a past due exposure based on the risk weight that applies under § 1240.39 if the collateral meets the requirements of that section. (i) Other assets. (1) An Enterprise must assign a zero percent risk weight to cash owned and held in the offices of an insured depository institution or in transit. (2) An Enterprise must assign a 20 percent risk weight to cash items in the process of collection. (3) An Enterprise must assign a 100 percent risk weight to DTAs arising from temporary differences that the Enterprise could realize through net operating loss carrybacks. (4) An Enterprise must assign a 250 percent risk weight to the portion of each of the following items to the extent it is not deducted from common equity tier 1 capital pursuant to § 1240.22(d): (i) MSAs; and (ii) DTAs arising from temporary differences that the Enterprise could not realize through net operating loss carrybacks. (5) An Enterprise must assign a 100 percent risk weight to all assets not specifically assigned a different risk weight under this subpart and that are not deducted from tier 1 or tier 2 capital pursuant to § 1240.22. (j) Insurance assets. (1) An Enterprise must risk-weight the individual assets held in a separate account that does not qualify as a non-guaranteed separate VerDate Sep<11>2014 20:22 Jun 29, 2020 Jkt 250001 account as if the individual assets were held directly by the Enterprise. (2) An Enterprise must assign a zero percent risk weight to an asset that is held in a non-guaranteed separate account. § 1240.33 Single-family mortgage exposures. (a) Definitions. Subject to any additional instructions set forth on Table 1 to this paragraph (a), for purposes of this section: Adjusted MTMLTV means, with respect to a single-family mortgage exposure, the amount equal to: (i) The MTMLTV of the single-family mortgage exposure (or, if the loan age of the single-family mortgage exposure is less than 6, the OLTV of the singlefamily mortgage exposure); divided by (ii) The amount equal to 1 plus the single-family countercyclical adjustment of the single-family mortgage exposure. Approved insurer means an insurance company that is currently approved by an Enterprise to guarantee or insure single-family mortgage exposures acquired by the Enterprise. Cancellable mortgage insurance means a mortgage insurance policy that, pursuant to its terms, may or will be terminated before the maturity date of the insured single-family mortgage exposure, including as required or permitted by the Homeowners Protection Act of 1998 (12 U.S.C. 4901). Charter-level coverage means mortgage insurance that satisfies the minimum requirements of the authorizing statute of an Enterprise. Cohort burnout means the number of refinance opportunities since the loan age of the single-family mortgage exposure was 6, categorized into ranges pursuant to the instructions set forth on Table 1 to this paragraph (a). Coverage percent means, with respect to mortgage insurance or a recourse agreement, the percent of the sum of the unpaid principal balance, any lost interest, and any foreclosure costs that is used to determine the benefit or other coverage under a mortgage insurance policy or recourse agreement. Days past due means the number of days a single-family mortgage exposure is past due. Debt-to-income ratio (DTI) means the ratio of a borrower’s total monthly obligations (including housing expense) divided by the borrower’s monthly income, as calculated under the Guide of the Enterprise. Deflated single-family house price index (DeflatedSFHPI) means the amount equal to: (i) The most recently available FHFA quarterly, not-seasonally-adjusted U.S. PO 00000 Frm 00102 Fmt 4701 Sfmt 4702 all transactions house price index; divided by (ii) The average quarterly observation from the Consumer Price Index for All Urban Consumers, All Items Less Shelter in U.S. City Average, that corresponds to the same quarter. Full recourse agreement means a recourse agreement that provides for a coverage percent of 100 percent and has a term of the coverage that is equal to the life of the single-family mortgage exposure. Guide means, as applicable, the Fannie Mae Single Family Selling Guide, the Fannie Mae Single Family Servicing Guide and the Freddie Mac Single-family Seller/Servicers Guide. Guide-level coverage means mortgage insurance that satisfies the requirements of the Guide of the Enterprise with respect to mortgage insurance that has a coverage percent that exceeds charterlevel coverage. Interest-only (IO) means a singlefamily mortgage exposure that requires only payment of interest without any principal amortization during all or part of the loan term. Loan age means the number of scheduled payment dates since the origination of a single-family mortgage exposure. Loan-level credit enhancement means: (i) Mortgage insurance; (ii) A recourse agreement; or (iii) A participation agreement. Loan documentation means the completeness of the documentation used to underwrite a single-family mortgage exposure, as determined under the Guide of the Enterprise. Loan purpose means the purpose of a single-family mortgage exposure at origination. Long-run single-family house price index trend (LRSFHPITrend) means, LRSFHPITrend = 1.0873681e0.00294746 * (Number of Quarters) where equal to the number of quarters from 1975Q1 to the given reporting quarter and where 1975Q1 is counted as one. MI cancellation feature means an indicator for whether mortgage insurance is cancellable mortgage insurance or non-cancellable mortgage insurance, assigned pursuant to the instructions set forth on Table 1 to this paragraph (a). Modification means: (i) Any permanent amendment or other change to the interest rate, maturity date, unpaid principal balance, or other contractual term of a singlefamily mortgage exposure; or (ii) Entry into any repayment plan with respect to any amounts that are E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules past due under the terms of a singlefamily mortgage exposure. Modified re-performing loan (modified RPL) means a single-family mortgage exposure (other than an NPL) that has been subject to a modification. Months since last modification means the number of scheduled payment dates since the effective date of the last modification of a single-family mortgage exposure. Mortgage concentration risk means the extent to which a mortgage insurer or other counterparty is exposed to mortgage credit risk relative to other risks. MTMLTV means, with respect to a single-family mortgage exposure, the amount equal to: (i) The unpaid principal balance of the single-family mortgage exposure; divided by (ii) The amount equal to: (A) The unpaid principal balance of the single-family mortgage exposure at origination; divided by (B) The OLTV of the single-family mortgage exposure; multiplied by (C) The most recently available FHFA Purchase-only State-level House Price Index of the State in which the property securing the singe-family mortgage exposure is located; divided by (D) The FHFA Purchase-only Statelevel House Price Index, as of date of the origination of the single-family mortgage exposure, in which the property securing the singe-family mortgage exposure is located. Non-cancellable mortgage insurance means a mortgage insurance policy that, pursuant to its terms, may not be terminated before the maturity date of the insured single-family mortgage exposure. Non-modified re-performing loan (non-modified RPL) means a singlefamily mortgage exposure (other than a modified RPL or an NPL) that was previously an NPL at any time in the prior 48 calendar months. Non-performing loan (NPL) means a single-family mortgage exposure that is 60 days or more past due. Occupancy type means the borrowers’ intended use of the property securing a single-family mortgage exposure. Original credit score means the borrower’s credit score as of the origination date of a single-family mortgage exposure. OLTV means, with respect to a singlefamily mortgage exposure, the amount equal to: (i) The unpaid principal balance of the single-family mortgage exposure at origination; divided by (ii) The lesser of: (A) The appraised value of the property securing the single-family mortgage exposure; and (B) The sale price of the property securing the single-family mortgage exposure. Origination channel means the type of institution that originated a singlefamily mortgage exposure, assigned pursuant to the instructions set forth on Table 1 to this paragraph (a). Partial recourse agreement means a recourse agreement that is not a full recourse agreement. Participation agreement means, with respect to a single-family mortgage exposure, any agreement between an Enterprise and the seller of the singlefamily mortgage exposure pursuant to which the seller retains a participation of not less than 10 percent in the singlefamily mortgage exposure. Past due means, with respect to a single-family mortgage exposure, that any amount required to be paid by the borrower under the terms of the singlefamily mortgage exposure has not been paid. Payment change from modification means the amount, expressed as a percent, equal to: (i) The amount equal to: (A) The monthly payment of a singlefamily mortgage exposure after a modification; divided by (B) The monthly payment of the single-family mortgage exposure before the modification; minus (ii) 1.0. Percentage difference between DeflatedSFHPI and LRSFHPITrend (DiffLRSFHPITrend%) means Performing loan means any singlefamily mortgage exposure that is not an NPL, a modified RPL, or a non-modified RPL. Property type means the physical structure of the property securing a single-family mortgage exposure. Recourse agreement means, with respect to a single-family mortgage exposure, any agreement (other than a participation agreement) between an Enterprise and the seller of the singlefamily mortgage exposure pursuant to which the seller agrees either to reimburse the Enterprise for any loss arising out of the default of singlefamily mortgage exposure or to repurchase or replace the single-family mortgage exposure in the event of the default of the single-family mortgage exposure. Refinance opportunity means, with respect to a single-family mortgage exposure, any calendar month in which the Primary Mortgage Market Survey (PMMS) rate for the month and year of the origination of the single-family mortgage exposure exceeds the PMMS rate for that calendar month by more than 50 basis points. Product type means an indicator reflecting the contractual terms of a single-family mortgage exposure as of the origination date, assigned pursuant to the instructions set forth on Table 1 to this paragraph (a). VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00103 Fmt 4701 Sfmt 4702 Refreshed credit score means the borrower’s most recently available credit score. Single-family countercyclical adjustment (SFCCyCAdj%) means E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.047</GPH> Previous maximum days past due means the maximum number of days a modified RPL or non-modified RPL was past due in the prior 36 calendar months. khammond on DSKJM1Z7X2PROD with PROPOSALS2 39375 39376 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules if DiffLRSFHPITrend% is greater than 5% then if DiffLRSFHPITrend% is less than ¥5% then Otherwise SFCCyCAdj% = 0%. Streamlined refi means a singlefamily mortgage exposure that was refinanced through a streamlined refinance program of an Enterprise, including the Home Affordable Refinance Program, Relief Refi, and Refi-Plus. Subordination means, with respect to a single-family mortgage exposure, the amount equal to the original unpaid principal balance of any second lien single-family mortgage exposure divided by the lesser of the appraised value or sale price of the property that secures the single-family mortgage exposure. Permissible values Cohort burnout ..................... Coverage percent ................ ‘‘No burnout,’’ if the single-family mortgage exposure has not had a refinance opportunity since the loan age of the single-family mortgage exposure was 6. ‘‘Low,’’ if the single-family mortgage exposure has had 12 or fewer refinance opportunities since the loan age of the single-family mortgage exposure was 6. ‘‘Medium,’’ if the single-family mortgage exposure has had between 13 and 24 refinance opportunities since the loan age of the single-family mortgage exposure was 6. ‘‘High,’’ if the single-family mortgage exposure has had more than 24 refinance opportunities since the loan age of the single-family mortgage exposure was 6. 0 percent <= coverage percent <= 100 percent ............. Days past due ...................... Debt-to-income (DTI) ratio ... Non-negative integer ....................................................... 0 percent < DTI < 100 percent ....................................... Interest-only (IO) .................. Loan age .............................. Yes, no ............................................................................ 0 <= loan age <= 500 ..................................................... Loan documentation ............ Loan purpose ....................... MTMLTV .............................. None, low, full ................................................................. Purchase, cashout refinance, rate/term refinance .......... 0 percent < MTMLTV <= 300 percent ............................ Mortgage concentration risk MI cancellation feature ......... High, not high .................................................................. Cancellable mortgage insurance, non-cancellable mortgage insurance. Investment, owner-occupied, second home ................... 0 percent < OLTV <= 300 percent .................................. Occupancy type ................... OLTV .................................... VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00104 Fmt 4701 Additional instructions Sfmt 4702 High if unable to determine. 0 percent if outside of permissible range or unable to determine. 210 if negative or unable to determine. 42 percent if outside of permissible range or unable to determine. Yes if unable to determine. 500 if outside of permissible range or unable to determine. None if unable to determine. Cashout refinance if unable to determine. If the property securing the single-family mortgage exposure is located in Puerto Rico or the U.S. Virgin Islands, use the FHFA House Price Index of the United States. If the property securing the single-family mortgage exposure is located in Hawaii, use the FHFA Purchaseonly State-level House Price Index of Guam. If the single-family mortgage exposure was originated before 1991, use the Enterprise’s proprietary housing price index. Use geometric interpolation to convert quarterly housing price index data to monthly data. 300 percent if outside of permissible range or unable to determine. High if unable to determine. Cancellable mortgage insurance, if unable to determine. Investment if unable to determine. 300 percent if outside of permissible range or unable to determine. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.049</GPH> Defined term EP30JN20.048</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 TABLE 1 TO PARAGRAPH (a): PERMISSIBLE VALUES AND ADDITIONAL INSTRUCTIONS Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39377 khammond on DSKJM1Z7X2PROD with PROPOSALS2 TABLE 1 TO PARAGRAPH (a): PERMISSIBLE VALUES AND ADDITIONAL INSTRUCTIONS—Continued Defined term Permissible values Additional instructions Original credit score ............. 300 <= original credit score <= 850 ................................ Origination channel .............. Retail, third-party origination (TPO) ................................ Payment change from modification. ¥80 percent < payment change from modification < 50 percent. Previous maximum days past due. Product type ......................... Non-negative integer ....................................................... If there are credit scores from multiple credit repositories for a borrower, use the following logic to determine a single original credit score: • If there are credit scores from two repositories, take the lower credit score. • If there are credit scores from three repositories, use the middle credit score. • If there are credit scores from three repositories and two of the credit scores are identical, use the identical credit score. If there are multiple borrowers, use the following logic to determine a single original credit score: • Using the logic above, determine a single credit score for each borrower. • Select the lowest single credit score across all borrowers. 600 if outside of permissible range or unable to determine. TPO includes broker and correspondent channels. TPO if unable to determine. If the single-family mortgage exposure initially had an adjustable or step-rate feature, the monthly payment after a permanent modification is calculated using the initial modified rate. 0 percent if unable to determine. ¥79 percent if less than or equal to ¥80 percent. 49 percent if greater than or equal to 50 percent. 181 months if negative or unable to determine. ‘‘FRM30’’ means a fixed-rate single-family mortgage exposure with an original amortization term greater than 309 months and less than or equal to 429 months. Property type ........................ ‘‘FRM20’’ means a fixed-rate single-family mortgage exposure with an original amortization term greater than 189 months and less than or equal to 309 months. ‘‘FRM15’’ means a fixed-rate single-family mortgage exposure with an original amortization term less than or equal to 189 months. ‘‘ARM1/1’’ is an adjustable-rate single-family mortgage exposure that has a mortgage rate and required payment that adjust annually. 1-unit, 2–4 units, condominium, manufactured home .... Refreshed credit score ......... 300 <= refreshed credit score <= 850 ............................ Streamlined refi .................... Subordination ....................... Yes, no ............................................................................ 0 percent <= Subordination <= 80 percent ..................... (b) Risk weight—(1) In general. Subject to paragraph (b)(2) of this section, an Enterprise must assign a risk VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Product types other than FRM30, FRM20, FRM15 or ARM1/1 should be assigned to FRM30. Use the post-modification product type for modified mortgage exposures. ARM1/1 if unable to determine. Use condominium for cooperatives. 2–4 units if unable to determine. If there are credit scores from multiple credit repositories for a borrower, use the following logic to determine a single refreshed credit score: • If there are credit scores from two repositories, take the lower credit score. • If there are credit scores from three repositories, use the middle credit score. • If there are credit scores from three repositories and two of the credit scores are identical, use the identical credit score. If there are multiple borrowers, use the following logic to determine a single Original Credit Score: • Using the logic above, determine a single credit score for each borrower. • Select the lowest single credit score across all borrowers. 600 if outside of permissible range or unable to determine. No if unable to determine. 80 percent if outside permissible range. weight to a single-family mortgage exposure equal to: (i) The base risk weight for the singlefamily mortgage exposure as determined PO 00000 Frm 00105 Fmt 4701 Sfmt 4702 under paragraph (c) of this section; multiplied by (ii) The combined risk multiplier for the single-family mortgage exposure as E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules determined under paragraph (b)(1) of this section, the risk weight assigned to a single-family mortgage exposure may not be less than 15 percent. (c) Base risk weight—(1) Performing loan. The base risk weight for a performing loan is set forth on Table 2 to this paragraph (c)(1). For purposes of this paragraph (c)(1), credit score means, with respect to a single-family mortgage exposure, (i) the original credit score of the single-family mortgage exposure, if the loan age of the single-family mortgage exposure is less than 6, or (ii) the refreshed credit score of the singlefamily mortgage exposure. (2) Non-modified RPL. The base risk weight for a non-modified RPL is set forth on Table 3 to this paragraph (c)(2). For purposes of this paragraph (c)(2), reperforming duration means, with respect to a non-modified RPL, the number of scheduled payment dates since the non-modified RPL was last an NPL. (3) Modified RPL. The base risk weight for a modified RPL is set forth on Table 4 to this paragraph (c)(3). For purposes of this paragraph (c)(3), re- performing duration means, with respect to a modified RPL, the lesser of: (i) The months since last modification of the modified RPL; and (ii) the number of scheduled payment dates since the modified RPL was last an NPL. EP30JN20.051</GPH> determined under paragraph (d) of this section; multiplied by (iii) The adjusted credit enhancement multiplier for the single-family mortgage exposure as determined under paragraph (e) of this section. (2) Minimum risk weight. Notwithstanding the risk weight VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00106 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.050</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39378 39379 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (4) NPL. The base risk weight for an NPL is set forth on Table 5 to this paragraph (c)(4). (d) Combined risk multiplier. The combined risk multiplier for a singlefamily mortgage exposure is equal to the product of each of the applicable risk multipliers set forth under the applicable single-family segment on Table 6 to this paragraph (d). TABLE 6 TO PARAGRAPH (d): RISK MULTIPLIERS Single-family segment Performing loan Non-modified RPL Modified RPL NPL Loan Purpose .................................... Purchase .......................................... Cashout refinance ............................ Rate/term refinance .......................... 1.0 1.4 1.3 1.0 1.4 1.2 1.0 1.4 1.3 Occupancy Type ............................... Owner-occupied or second home .... Investment ........................................ 1.0 1.2 1.0 1.5 1.0 1.3 1.0 1.2 Property Type ................................... 1-unit ................................................ 2–4 unit ............................................ Condominium ................................... Manufactured home ......................... 1.0 1.4 1.1 1.3 1.0 1.4 1.0 1.8 1.0 1.3 1.0 1.6 1.0 1.1 1.0 1.2 Origination Channel .......................... Retail ................................................ TPO .................................................. 1.0 1.1 1.0 1.1 1.0 1.1 1.0 1.0 DTI .................................................... DTI <= 25% ...................................... 25% < DTI <= 40% .......................... DTI > 40% ........................................ 0.8 1.0 1.2 0.9 1.0 1.2 0.9 1.0 1.1 Product Type ..................................... FRM30 .............................................. ARM1/1 ............................................ FRM15 .............................................. FRM20 .............................................. 1.0 1.7 0.3 0.6 1.0 1.1 0.3 0.6 1.0 1.0 0.5 0.5 Subordination .................................... No subordination .............................. 30% < OLTV <= 60% and ............... 0% < subordination <= 5% .............. 30% < OLTV <= 60% and subordination > 5%. OLTV > 60% and ............................. 0% < subordination <= 5% .............. 1.0 1.1 1.0 0.8 1.0 1.0 1.5 1.1 1.2 1.1 1.2 1.1 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00107 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 1.0 1.1 0.5 0.8 EP30JN20.053</GPH> Value or range EP30JN20.052</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Risk factor 39380 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules TABLE 6 TO PARAGRAPH (d): RISK MULTIPLIERS—Continued Single-family segment Risk factor Value or range OLTV > 60% and ............................. subordination > 5% .......................... 1.4 Loan age <= 24 months ................... 24 months < loan age <= 36 months 36 months < loan Age <= 60 months. Loan age > 60 months ..................... 1.0 0.95 0.80 Cohort Burnout .................................. No burnout ....................................... Low ................................................... Medium ............................................. High .................................................. 1.0 1.2 1.3 1.4 Interest-only ...................................... No IO ................................................ Yes IO .............................................. Loan Documentation ......................... Non-modified RPL Modified RPL 1.5 1.3 1.0 1.6 1.0 1.4 1.0 1.1 Full .................................................... None or low ...................................... 1.0 1.3 1.0 1.3 1.0 1.2 Streamlined Refi ............................... No ..................................................... Yes ................................................... 1.0 1.0 1.0 1.2 1.0 1.1 Refreshed Credit Score for Modified RPLs and Non-modified RPLs. Refreshed credit score < 620 .......... ........................ 1.6 1.4 620 <= refreshed credit score < 640 640 <= refreshed credit score < 660 660 <= refreshed credit score < 700 700 <= refreshed credit score < 720 720 <= refreshed credit score < 740 740 <= refreshed credit score < 760 760 <= refreshed credit score < 780 Refreshed credit score >= 780 ........ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ 1.3 1.2 1.0 0.7 0.6 0.5 0.4 0.3 1.2 1.1 1.0 0.8 0.7 0.6 0.5 0.4 Payment change >= 0% .................. ¥20% <= payment change < 0% .... ¥30% <= payment change < ¥20%. Payment change < ¥30% ............... ........................ ........................ ........................ ........................ ........................ ........................ 1.1 1.0 0.9 ........................ ........................ 0.8 Previous Maximum Days Past Due .. 0–59 days ......................................... 60–90 days ....................................... 91–150 days ..................................... 151+ days ......................................... ........................ ........................ ........................ ........................ 1.0 1.2 1.3 1.5 1.0 1.1 1.1 1.1 Refreshed Credit Score for NPLs ..... Refreshed credit score < 580 .......... 580 <= refreshed credit score < 640 640 <= refreshed credit score < 700 700 <= refreshed credit score < 720 720 <= refreshed credit score < 760 760 <= refreshed credit score < 780 Refreshed credit score >= 780 ........ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ ........................ Loan Age ........................................... Payment Change from Modification khammond on DSKJM1Z7X2PROD with PROPOSALS2 Performing loan (e) Credit enhancement multiplier— (1) Amount—(i) In general. The adjusted credit enhancement multiplier for a single-family mortgage exposure that is subject to loan-level credit enhancement is equal to 1.0 minus the product of: (A) 1.0 minus the credit enhancement multiplier for the single-family mortgage exposure as determined under paragraph (e)(2) of this section; multiplied by (B) 1.0 minus the counterparty haircut for the loan-level credit enhancement as VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 0.75 determined under paragraph (e)(3) of this section. (ii) No loan-level credit enhancement. The adjusted credit enhancement multiplier for a single-family mortgage exposure that is not subject to loan-level credit enhancement is equal to 1.0. (2) Credit enhancement multiplier. (i) The credit enhancement multiplier for a single-family mortgage exposure that is subject to a participation agreement is 1.0. PO 00000 Frm 00108 Fmt 4701 NPL Sfmt 4702 1.2 1.1 1.0 0.9 0.8 0.7 0.5 (ii) The credit enhancement multiplier for a single-family mortgage exposure that is subject to a full recourse agreement is 0. (iii) The credit enhancement multiplier for a single-family mortgage exposure that is subject to a partial recourse agreement is: (A) 1.0; minus (B) The amount equal to: (1) The coverage percent of the partial recourse agreement; multiplied by E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 paragraph (e)(2)(v)(E) of this section; and (E) NPL, whether subject to noncancellable mortgage insurance or cancellable mortgage insurance, is set forth on Table 11 to paragraph (e)(2)(v)(E) of this section. (v) Notwithstanding anything to the contrary in this paragraph (e), for purposes of paragraph (e)(2)(iv) of this section: (A) The OLTV of a single-family mortgage exposure will be deemed to be 80 percent if the single-family mortgage exposure has an OLTV less than or equal to 80 percent. (B) If the single-family mortgage exposure has an interest-only feature, any cancellable mortgage insurance will be deemed to be non-cancellable mortgage insurance. (C) If the coverage percent of the mortgage insurance is greater than charter-level coverage and less than guide-level coverage, the credit PO 00000 Frm 00109 Fmt 4701 Sfmt 4725 enhancement multiplier is the amount equal to a linear interpolation between the credit enhancement multiplier of the single-family mortgage exposure for charter-level coverage and the credit enhancement multiplier of the singlefamily mortgage exposure for guidelevel coverage. (D) If the coverage percent of the mortgage insurance is less than charterlevel coverage, the credit enhancement multiplier is the amount equal to the midpoint of a linear interpolation between a credit enhancement multiplier of 1.0 and the credit enhancement multiplier of the singlefamily mortgage exposure for charterlevel coverage. (E) If the coverage percent of the mortgage insurance is greater than guide-level coverage, the credit enhancement multiplier is determined as if the coverage percent were guidelevel coverage. BILLING CODE 8070–01–P E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.054</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 (2) A loss timing adjustment determined under § 1240.44(g) as if the partial recourse agreement were a CRT. (iv) Subject to paragraph (e)(2)(v) of this section, the credit enhancement multiplier for— (A) A performing loan, non-modified RPL, or modified RPL that is subject to non-cancellable mortgage insurance is set forth on Table 7 to paragraph (e)(2)(v)(E) of this section; (B) A performing loan or nonmodified RPL that is subject to cancellable mortgage insurance is set forth on Table 8 to paragraph (e)(2)(v)(E) of this section; (C) A modified RPL with a 30-year post-modification amortization that is subject to cancellable mortgage insurance is set forth on Table 9 to paragraph (e)(2)(v)(E) of this section; (D) A modified RPL with a 40-year post-modification amortization that is subject to cancellable mortgage insurance is set forth on Table 10 to 39381 EP30JN20.056</GPH> Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00110 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.055</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39382 VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00111 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 39383 EP30JN20.057</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39384 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 (3) Credit enhancement counterparty haircut—(i) Definitions. For purposes of this paragraph (e)(3), the counterparty rating for a counterparty is: (A) 1, if the Enterprise has determined that the counterparty is expected to perform all of its contractual obligations under foreseeable adverse events. (B) 2, if the Enterprise has determined that there is negligible risk the counterparty may not be able to perform all of its contractual obligations under foreseeable adverse events. (C) 3, if the Enterprise has determined that there is a slight risk the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 counterparty might not be able to perform all of its contractual obligations under foreseeable adverse events. (D) 4, if the Enterprise has determined that foreseeable adverse events will have a greater impact on ‘‘4’’ rated counterparties than higher rated counterparties. (E) 5, if the Enterprise has determined that the counterparty might not perform all of its contractual obligations under foreseeable adverse events. (F) 6, if the Enterprise has determined that the counterparty is not expected to meet its contractual obligations under foreseeable adverse events. PO 00000 Frm 00112 Fmt 4701 Sfmt 4702 (G) 7, if the Enterprise has determined that the counterparty’s ability to perform its contractual obligations is questionable. (H) 8, if the Enterprise has determined that the counterparty is in default on a material contractual obligation or is under a resolution proceeding or similar regulatory proceeding. (ii) Counterparty haircut. The counterparty haircut is set forth on Table 12 to this paragraph (e)(3)(ii). For purposes of this paragraph (e)(3)(ii), RPL means either a modified RPL or a nonmodified RPL. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.058</GPH> BILLING CODE 8070–01–C khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.34 Multifamily mortgage exposures. (a) Definitions. Subject to any additional instructions set forth on Table 1 to this paragraph (a), for purposes of this section: Acquisition debt-service-coverage ratio (acquisition DSCR) means, with respect to a multifamily mortgage exposure, the amount equal to: (i) The net operating income (NOI) (or, if not available, the net cash flow) of the multifamily property that secures the multifamily mortgage exposure, at the time of the acquisition by the Enterprise (or, if not available, at the time of the underwriting or origination) of the multifamily mortgage exposure; divided by (ii) The scheduled periodic payment on the multifamily mortgage exposure (or, if interest-only, fully amortizing payment), at the time of the acquisition by the Enterprise (or, if not available, at the time of the origination) of the multifamily mortgage exposure. Acquisition loan-to-value (acquisition LTV) means, with respect to a multifamily mortgage exposure, the amount, determined as of the time of the acquisition by the Enterprise (or, if not available, at the time of the underwriting or origination) of the multifamily mortgage exposure, equal to: (i) The unpaid principal balance of the multifamily mortgage exposure; divided by (ii) The value of the multifamily property securing the multifamily mortgage exposure. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 Debt-service-coverage ratio (DSCR) means, with respect to a multifamily mortgage exposure: (i) The acquisition DSCR of the multifamily mortgage exposure if the loan age of the multifamily mortgage exposure is less than 6; or (ii) The MTMDSCR of the multifamily mortgage exposure. Interest-only (IO) means a multifamily mortgage exposure that requires only payment of interest without any principal amortization during all or part of the loan term. Loan age means the number of scheduled payment dates since the origination of the multifamily mortgage exposure. Loan term means the number of years until final loan payment (which may be a balloon payment) under the terms of a multifamily mortgage exposure. LTV means, with respect to a multifamily mortgage exposure; (i) The acquisition LTV of the multifamily mortgage exposure if the loan age of the multifamily mortgage exposure is less than 6, or (ii) The MTMLTV of the multifamily mortgage exposure. Mark-to-market debt-service coverage ratio (MTMDSCR) means, with respect to a multifamily mortgage exposure, the amount equal to— (i) The net operating income (or, if not available, the net cash flow) of the multifamily property that secures the multifamily mortgage exposure, as reported on the most recently available property operating statement; divided by PO 00000 Frm 00113 Fmt 4701 Sfmt 4702 39385 (ii) The scheduled periodic payment on the multifamily mortgage exposure (or, for interest-only, fully amortizing payment), as reported on the most recently available property operating statement. Mark-to-market loan-to-value (MTMLTV) means, with respect to a multifamily mortgage exposure, the amount calculated by adjusting the acquisition LTV using a multifamily property value index or property value estimated based on net operating income and capitalization rate indices. Multifamily adjustable-rate exposure means a multifamily mortgage exposure that is not, at that time, a multifamily fixed-rate exposure. Multifamily fixed-rate exposure means a multifamily mortgage exposure that, at that time, has an interest rate that may not then increase or decrease based on a change in a reference index or other methodology, including: (i) A multifamily mortgage exposure that has an interest rate that is fixed over the life of the loan; and (ii) A multifamily mortgage exposure that has an interest rate that may increase or decrease in the future, but is fixed at that time. Net cash flow means, with respect to a multifamily mortgage exposure, the amount equal to: (i) The net operating income of the multifamily mortgage exposure; minus (ii) Reserves for capital improvements; minus (iii) Other expenses not included in net operating income required for the proper operation of the multifamily E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.059</GPH> Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39386 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 property securing the multifamily mortgage exposure, including any commissions paid to leasing agents in securing renters and special improvements to the property to accommodate the needs of certain renters. Net operating income means, with respect to a multifamily mortgage exposure, the amount equal to: (i) The rental income generated by the multifamily property securing the multifamily mortgage exposure; minus (ii) The vacancy and property operating expenses of the multifamily VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 property securing the multifamily mortgage exposure. Original amortization term means the number of years, determined as of the time of the origination of a multifamily mortgage exposure, that it would take a borrower to pay a multifamily mortgage exposure completely if the borrower only makes the scheduled payments, and without making any balloon payment. Original loan size means the dollar amount of the unpaid principal balance of a multifamily mortgage exposure at origination. PO 00000 Frm 00114 Fmt 4701 Sfmt 4702 Payment performance means the payment status of history of a multifamily mortgage exposure, assigned pursuant to the instructions set forth on Table 1 to this paragraph (a). Supplemental mortgage exposure means any multifamily fixed-rate exposure or multifamily adjustable-rate exposure that is originated after the origination of a multifamily mortgage exposure that is secured by all or part of the same multifamily property. Unpaid principal balance (UPB) means the outstanding loan amount of a multifamily mortgage exposure. E:\FR\FM\30JNP2.SGM 30JNP2 (b) Risk weight—(1) In general. Subject to paragraphs (b)(2) and (b)(3) of this section, an Enterprise must assign a risk weight to a multifamily mortgage exposure equal to: (i) The base risk weight for the multifamily mortgage exposure as determined under paragraph (c) of this section; multiplied by (ii) The combined risk multiplier for the multifamily mortgage exposure as VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 determined under paragraph (d) of this section. (2) Minimum risk weight. Notwithstanding the risk weight determined under paragraph (b)(1) of this section, the risk weight assigned to a multifamily mortgage exposure may not be less than 15 percent. (3) Loan groups. If a multifamily property that secures a multifamily PO 00000 Frm 00115 Fmt 4701 Sfmt 4702 39387 mortgage exposure also secures one or more supplemental mortgage exposures: (i) A multifamily mortgage exposurespecific base risk weight must be determined under paragraph (c) of this section using for each of these multifamily mortgage exposures a single DSCR and single LTV, both calculated as if all of the multifamily mortgage exposures secured by the multifamily E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.060</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules characteristics of the multifamily mortgage exposure (except with respect to the loan size multiplier, which would be determined using the aggregate unpaid principal balance of these multifamily mortgage exposures). (2) Multifamily adjustable-rate exposure. The base risk weight for a multifamily adjustable-rate exposure is set forth on Table 3 to this paragraph (c)(2). (d) Combined risk multiplier. The combined risk multiplier for a multifamily mortgage exposure is equal to the product of each of the applicable VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00116 Fmt 4701 Sfmt 4702 (c) Base risk weight—(1) Multifamily fixed-rate exposure. The base risk weight for a multifamily fixed-rate exposure is set forth on Table 2 to this paragraph (c)(1). BILLING CODE 8070–01–P risk multipliers set forth on Table 4 to this paragraph (d). E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.062</GPH> property were consolidated into a single multifamily mortgage exposure; and (ii) A multifamily mortgage exposurespecific combined risk multiplier must be determined under paragraph (d) of this section based on the risk EP30JN20.061</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39388 BILLING CODE 8070–01–C § 1240.35 Off-balance sheet exposures. (a) General. (1) An Enterprise must calculate the exposure amount of an off- VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00117 Fmt 4701 Sfmt 4702 39389 balance sheet exposure using the credit conversion factors (CCFs) in paragraph (b) of this section. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.063</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 39390 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (2) Where an Enterprise commits to provide a commitment, the Enterprise may apply the lower of the two applicable CCFs. (3) Where an Enterprise provides a commitment structured as a syndication or participation, the Enterprise is only required to calculate the exposure amount for its pro rata share of the commitment. (4) Where an Enterprise provides a commitment or enters into a repurchase agreement and such commitment or repurchase agreement, the exposure amount shall be no greater than the maximum contractual amount of the commitment, repurchase agreement, or credit-enhancing representation and warranty, as applicable. (b) Credit conversion factors—(1) Zero percent CCF. An Enterprise must apply a zero percent CCF to the unused portion of a commitment that is unconditionally cancelable by the Enterprise. (2) 20 percent CCF. An Enterprise must apply a 20 percent CCF to the amount of commitments with an original maturity of one year or less that are not unconditionally cancelable by the Enterprise. (3) 50 percent CCF. An Enterprise must apply a 50 percent CCF to the amount of commitments with an original maturity of more than one year that are not unconditionally cancelable by the Enterprise. (4) 100 percent CCF. An Enterprise must apply a 100 percent CCF to the amount of the following off-balance sheet items and other similar transactions: (i) Guarantees; (ii) Repurchase agreements (the offbalance sheet component of which equals the sum of the current fair values of all positions the Enterprise has sold subject to repurchase); (iii) Off-balance sheet securities lending transactions (the off-balance sheet component of which equals the sum of the current fair values of all positions the Enterprise has lent under the transaction); (iv) Off-balance sheet securities borrowing transactions (the off-balance sheet component of which equals the sum of the current fair values of all noncash positions the Enterprise has posted as collateral under the transaction); and (v) Forward agreements. § 1240.36 Derivative contracts. An Enterprise must determine its riskweighted assets for OTC derivative contracts as provided under 12 CFR 217.34, substituting ‘‘Enterprise’’ for ‘‘Board-regulated institution’’. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 § 1240.37 Cleared transactions. An Enterprise must determine its riskweighted assets for cleared transactions as provided under 12 CFR 217.35, substituting ‘‘Enterprise’’ for ‘‘Boardregulated institution.’’ § 1240.38 Guarantees and credit derivatives: Substitution treatment. An Enterprise may recognize the credit risk mitigation benefits of an eligible guarantee or eligible credit derivative by substituting the risk weight associated with the protection provider for the risk weight assigned to an exposure, as provided under 12 CFR 217.36, substituting ‘‘Enterprise’’ for ‘‘Board-regulated institution.’’ § 1240.39 Collateralized transactions. An Enterprise may recognize the riskmitigating effects of financial collateral as provided under 12 CFR 217.37, substituting ‘‘Enterprise’’ for ‘‘Boardregulated institution.’’ Risk-Weighted Assets for Unsettled Transactions § 1240.40 Unsettled transactions. An Enterprise must determine its riskweighted assets for unsettled transactions under 12 CFR 217.38, substituting ‘‘Enterprise’’ for ‘‘Boardregulated institution.’’ Risk-Weighted Assets for CRT and Other Securitization Exposures § 1240.41 Operational requirements for CRT and other securitization exposures. (a) Operational criteria for traditional securitizations. An Enterprise that transfers exposures it has purchased or otherwise acquired to a securitization SPE or other third party in connection with a traditional securitization may exclude the exposures from the calculation of its risk-weighted assets only if each condition in this section is satisfied. An Enterprise that meets these conditions must hold risk-based capital against any credit risk it retains in connection with the securitization. An Enterprise that fails to meet these conditions must hold risk-based capital against the transferred exposures as if they had not been securitized and must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from the transaction. The conditions are: (1) The exposures are not reported on the Enterprise’s consolidated balance sheet under GAAP; (2) The Enterprise has transferred to one or more third parties credit risk associated with the underlying exposures; PO 00000 Frm 00118 Fmt 4701 Sfmt 4702 (3) Any clean-up calls relating to the securitization are eligible clean-up calls; and (4) The securitization does not: (i) Include one or more underlying exposures in which the borrower is permitted to vary the drawn amount within an agreed limit under a line of credit; and (ii) Contain an early amortization provision. (b) Operational criteria for synthetic securitizations. For synthetic securitizations, an Enterprise may recognize for risk-based capital purposes the use of a credit risk mitigant to hedge underlying exposures only if each condition in this paragraph (b) is satisfied. An Enterprise that meets these conditions must hold risk-based capital against any credit risk of the exposures it retains in connection with the synthetic securitization. An Enterprise that fails to meet these conditions or chooses not to recognize the credit risk mitigant for purposes of this section must instead hold riskbased capital against the underlying exposures as if they had not been synthetically securitized. The conditions are: (1) The credit risk mitigant is: (i) Financial collateral; (ii) A guarantee that meets all criteria as set forth in the definition of ‘‘eligible guarantee’’ in § 1240.2, except for the criteria in paragraph (3) of that definition; or (iii) A credit derivative that meets all criteria as set forth in the definition of ‘‘eligible credit derivative’’ in § 1240.2, except for the criteria in paragraph (3) of the definition of ‘‘eligible guarantee’’ in § 1240.2. (2) The Enterprise transfers credit risk associated with the underlying exposures to one or more third parties, and the terms and conditions in the credit risk mitigants employed do not include provisions that: (i) Allow for the termination of the credit protection due to deterioration in the credit quality of the underlying exposures; (ii) Require the Enterprise to alter or replace the underlying exposures to improve the credit quality of the underlying exposures; (iii) Increase the Enterprise’s cost of credit protection in response to deterioration in the credit quality of the underlying exposures; (iv) Increase the yield payable to parties other than the Enterprise in response to a deterioration in the credit quality of the underlying exposures; or (v) Provide for increases in a retained first loss position or credit enhancement E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules provided by the Enterprise after the inception of the securitization; (3) The Enterprise obtains a wellreasoned opinion from legal counsel that confirms the enforceability of the credit risk mitigant in all relevant jurisdictions; and (4) Any clean-up calls relating to the securitization are eligible clean-up calls. (c) Operational criteria for credit risk transfers. For credit risk transfers, an Enterprise may recognize for risk-based capital purposes, the use of a credit risk transfer only if each condition in this paragraph (c) is satisfied. An Enterprise that meets these conditions must hold risk-based capital against any credit risk of the exposures it retains in connection with the credit risk transfer. An Enterprise that fails to meet these conditions or chooses not to recognize the credit risk transfer for purposes of this section must instead hold riskbased capital against the underlying exposures as if they had not been subject to the credit risk transfer. The conditions are: (1) The credit risk transfer is an eligible CRT structure. (2) The Enterprise transfers credit risk associated with the underlying exposures to one or more third parties, and the terms and conditions in the credit risk transfer employed do not include provisions that: (i) Allow for the termination of the credit risk transfer due to deterioration in the credit quality of the underlying exposures; (ii) Require the Enterprise to alter or replace the underlying exposures to improve the credit quality of the underlying exposures; (iii) Increase the Enterprise’s cost of credit protection in response to deterioration in the credit quality of the underlying exposures; (iv) Increase the yield payable to parties other than the Enterprise in response to a deterioration in the credit quality of the underlying exposures; or (v) Provide for increases in a retained first loss position or credit enhancement provided by the Enterprise after the inception of the credit risk transfer; (3) The Enterprise obtains a wellreasoned opinion from legal counsel that confirms the enforceability of the credit risk transfer in all relevant jurisdictions; and (4) Any clean-up calls relating to the credit risk transfer are eligible clean-up calls. (5) The Enterprise includes in its periodic disclosures under the Federal securities laws, or in other appropriate public disclosures, a reasonably detailed description of— VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (i) The material recourse or other risks that might reduce the effectiveness of the credit risk transfer in transferring the credit risk on the underlying exposures to third parties; and (ii) Each condition under paragraph (a) of this section (governing traditional securitizations) or paragraph (b) of this section (governing synthetic securitizations) that is not satisfied by the credit risk transfer and the reasons that each such condition is not satisfied. (d) Due diligence requirements for securitization exposures. (1) Except for exposures that are deducted from common equity tier 1 capital and exposures subject to § 1240.42(h), if an Enterprise is unable to demonstrate to the satisfaction of FHFA a comprehensive understanding of the features of a securitization exposure that would materially affect the performance of the exposure, the Enterprise must assign the securitization exposure a risk weight of 1,250 percent. The Enterprise’s analysis must be commensurate with the complexity of the securitization exposure and the materiality of the exposure in relation to its capital. (2) An Enterprise must demonstrate its comprehensive understanding of a securitization exposure under paragraph (c)(1) of this section, for each securitization exposure by: (i) Conducting an analysis of the risk characteristics of a securitization exposure prior to acquiring the exposure, and documenting such analysis within three business days after acquiring the exposure, considering: (A) Structural features of the securitization that would materially impact the performance of the exposure, for example, the contractual cash flow waterfall, waterfall-related triggers, credit enhancements, liquidity enhancements, fair value triggers, the performance of organizations that service the exposure, and deal-specific definitions of default; (B) Relevant information regarding the performance of the underlying credit exposure(s), for example, the percentage of loans 30, 60, and 90 days past due; default rates; prepayment rates; loans in foreclosure; property types; occupancy; average credit score or other measures of creditworthiness; average LTV ratio; and industry and geographic diversification data on the underlying exposure(s); (C) Relevant market data of the securitization, for example, bid-ask spread, most recent sales price and historic price volatility, trading volume, implied market rating, and size, depth and concentration level of the market for the securitization; and PO 00000 Frm 00119 Fmt 4701 Sfmt 4702 39391 (D) For resecuritization exposures, performance information on the underlying securitization exposures, for example, the issuer name and credit quality, and the characteristics and performance of the exposures underlying the securitization exposures; and (ii) On an on-going basis (no less frequently than quarterly), evaluating, reviewing, and updating as appropriate the analysis required under paragraph (c)(1) of this section for each securitization exposure. § 1240.42 Risk-weighted assets for CRT and other securitization exposures. (a) Securitization risk weight approaches. Except as provided elsewhere in this section or in § 1240.41: (1) An Enterprise must deduct from common equity tier 1 capital any aftertax gain-on-sale resulting from a securitization and apply a 1,250 percent risk weight to the portion of a CEIO that does not constitute after-tax gain-onsale. (2) If a securitization exposure does not require deduction under paragraph (a)(1) of this section, an Enterprise may assign a risk weight to the securitization exposure either using the simplified supervisory formula approach (SSFA) in accordance with §§ 1240.43(a) through 1240.43(d) for a securitization exposure that is not a retained CRT exposure or an acquired CRT exposure or using the credit risk transfer approach (CRTA) in accordance with § 1240.44 for a retained CRT exposure, and in either case, subject to the limitation under paragraph (e) of this section. (3) If a securitization exposure does not require deduction under paragraph (a)(1) of this section and the Enterprise cannot, or chooses not to apply the SSFA or the CRTA to the exposure, the Enterprise must assign a risk weight to the exposure as described in § 1240.45. (4) If a securitization exposure is a derivative contract (other than protection provided by an Enterprise in the form of a credit derivative) that has a first priority claim on the cash flows from the underlying exposures (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments), an Enterprise may choose to set the risk-weighted asset amount of the exposure equal to the amount of the exposure as determined in paragraph (c) of this section. (b) Total risk-weighted assets for securitization exposures. An Enterprise’s total risk-weighted assets for securitization exposures equals the sum of the risk-weighted asset amount E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39392 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules for securitization exposures that the Enterprise risk weights under §§ 1240.41(d), 1240.42(a)(1), 1240.43, 1240.44, or 1240.45, and paragraphs (e) through (h) of this section, as applicable. (c) Exposure amount of a CRT or other securitization exposure—(1) Onbalance sheet securitization exposures. Except as provided for retained CRT exposures in § 1240.44(f), the exposure amount of an on-balance sheet securitization exposure (excluding a repo-style transaction, eligible margin loan, OTC derivative contract, or cleared transaction) is equal to the carrying value of the exposure. (2) Off-balance sheet securitization exposures. Except as provided in paragraph (h) of this section or as provided for retained CRT exposures in § 1240.44(f), the exposure amount of an off-balance sheet securitization exposure that is not a repo-style transaction, eligible margin loan, cleared transaction (other than a credit derivative), or an OTC derivative contract (other than a credit derivative) is the notional amount of the exposure. (3) Repo-style transactions, eligible margin loans, and derivative contracts. The exposure amount of a securitization exposure that is a repo-style transaction, eligible margin loan, or derivative contract (other than a credit derivative) is the exposure amount of the transaction as calculated under § 1240.36 or § 1240.39, as applicable. (d) Overlapping exposures. If an Enterprise has multiple securitization exposures that provide duplicative coverage to the underlying exposures of a securitization, the Enterprise is not required to hold duplicative risk-based capital against the overlapping position. Instead, the Enterprise may apply to the overlapping position the applicable riskbased capital treatment that results in the highest risk-based capital requirement. (e) Implicit support. If an Enterprise provides support to a securitization (including a CRT) in excess of the Enterprise’s contractual obligation to provide credit support to the securitization (implicit support): (1) The Enterprise must include in risk-weighted assets all of the underlying exposures associated with the securitization as if the exposures had not been securitized and must deduct from common equity tier 1 capital any after-tax gain-on-sale resulting from the securitization; and (2) The Enterprise must disclose publicly: (i) That it has provided implicit support to the securitization; and VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (ii) The risk-based capital impact to the Enterprise of providing such implicit support. (f) Interest-only mortgage-backed securities. Regardless of any other provisions in this subpart, the risk weight for a non-credit-enhancing interest-only mortgage-backed security may not be less than 100 percent. (g) Nth-to-default credit derivatives— (1) Protection provider. An Enterprise may assign a risk weight using the SSFA in § 1240.43 to an nth-to-default credit derivative in accordance with this paragraph (g). An Enterprise must determine its exposure in the nth-todefault credit derivative as the largest notional amount of all the underlying exposures. (2) Attachment and detachment points. For purposes of determining the risk weight for an nth-to-default credit derivative using the SSFA, the Enterprise must calculate the attachment point and detachment point of its exposure as follows: (i) The attachment point (parameter A) is the ratio of the sum of the notional amounts of all underlying exposures that are subordinated to the Enterprise’s exposure to the total notional amount of all underlying exposures. The ratio is expressed as a decimal value between zero and one. In the case of a first-todefault credit derivative, there are no underlying exposures that are subordinated to the Enterprise’s exposure. In the case of a second-orsubsequent-to-default credit derivative, the smallest (n¥1) notional amounts of the underlying exposure(s) are subordinated to the Enterprise’s exposure. (ii) The detachment point (parameter D) equals the sum of parameter A plus the ratio of the notional amount of the Enterprise’s exposure in the nth-todefault credit derivative to the total notional amount of all underlying exposures. The ratio is expressed as a decimal value between zero and one. (3) Risk weights. An Enterprise that does not use the SSFA to determine a risk weight for its nth-to-default credit derivative must assign a risk weight of 1,250 percent to the exposure. (4) Protection purchaser—(i) First-todefault credit derivatives. An Enterprise that obtains credit protection on a group of underlying exposures through a firstto-default credit derivative that meets the rules of recognition of 12 CFR 217.36(b) must determine its risk-based capital requirement for the underlying exposures as if the Enterprise synthetically securitized the underlying exposure with the smallest riskweighted asset amount and had obtained no credit risk mitigant on the PO 00000 Frm 00120 Fmt 4701 Sfmt 4702 other underlying exposures. An Enterprise must calculate a risk-based capital requirement for counterparty credit risk according to 12 CFR 217.34 for a first-to-default credit derivative that does not meet the rules of recognition of 12 CFR 217.36(b). (ii) Second-or-subsequent-to-default credit derivatives. (A) An Enterprise that obtains credit protection on a group of underlying exposures through a nth-todefault credit derivative that meets the rules of recognition of 12 CFR 217.36(b) (other than a first-to-default credit derivative) may recognize the credit risk mitigation benefits of the derivative only if: (1) The Enterprise also has obtained credit protection on the same underlying exposures in the form of first-through-(n¥1)-to-default credit derivatives; or (2) If n¥1 of the underlying exposures have already defaulted. (B) If an Enterprise satisfies the requirements of paragraph (i)(4)(ii)(A) of this section, the Enterprise must determine its risk-based capital requirement for the underlying exposures as if the Enterprise had only synthetically securitized the underlying exposure with the nth smallest riskweighted asset amount and had obtained no credit risk mitigant on the other underlying exposures. (C) An Enterprise must calculate a risk-based capital requirement for counterparty credit risk according to 12 CFR 217.34 for a nth-to-default credit derivative that does not meet the rules of recognition of 12 CFR 217.36(b). (h) Guarantees and credit derivatives other than nth-to-default credit derivatives—(1) Protection provider. For a guarantee or credit derivative (other than an nth-to-default credit derivative) provided by an Enterprise that covers the full amount or a pro rata share of a securitization exposure’s principal and interest, the Enterprise must risk weight the guarantee or credit derivative as if it holds the portion of the reference exposure covered by the guarantee or credit derivative. (2) Protection purchaser. (i) An Enterprise that purchases a guarantee or OTC credit derivative (other than an nth-to-default credit derivative) that is recognized under § 1240.46 as a credit risk mitigant (including via collateral recognized under § 1240.39) is not required to compute a separate counterparty credit risk capital requirement under § 1240.31, in accordance with 12 CFR 217.34(c). (ii) If an Enterprise cannot, or chooses not to, recognize a purchased credit derivative as a credit risk mitigant under § 1240.46, the Enterprise must E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00121 Fmt 4701 Sfmt 4702 (ii) The weight assigned to 1,250 percent times KSSFA equals (iii) The risk weight will be set equal to: EP30JN20.067</GPH> (d) SFA equation. (1) The Enterprise must define the following parameters: EP30JN20.087</GPH> (a) General requirements for the SSFA. To use the SSFA to determine the risk weight for a securitization exposure, an Enterprise must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the securitization require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. An Enterprise that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a risk weight of 1,250 percent to the exposure. (b) SSFA parameters. To calculate the risk weight for a securitization exposure using the SSFA, an Enterprise must have accurate information on the following five inputs to the SSFA calculation: (1) KG is the weighted-average (with unpaid principal used as the weight for each exposure) adjusted total capital requirement of the underlying exposures calculated using this subpart. KG is expressed as a decimal value between zero and one (that is, an average risk weight of 100 percent represents a value of KG equal to 0.08). (2) Parameter W is expressed as a decimal value between zero and one. Parameter W is the ratio of the sum of the dollar amounts of any underlying exposures of the securitization that meet any of the criteria as set forth in paragraphs (b)(2)(i) through (vi) of this section to the balance, measured in dollars, of underlying exposures: (i) Ninety days or more past due; exposures. KA is defined in paragraph (d) of this section. The values of parameters A and D, relative to KA determine the risk weight assigned to a securitization exposure as described in paragraph (d) of this section. The risk weight assigned to a securitization exposure, or portion of a securitization exposure, as appropriate, is the larger of the risk weight determined in accordance with this paragraph (c) or paragraph (d) of this section and a risk weight of 20 percent. (1) When the detachment point, parameter D, for a securitization exposure is less than or equal to KA, the exposure must be assigned a risk weight of 1,250 percent. (2) When the attachment point, parameter A, for a securitization exposure is greater than or equal to KA, the Enterprise must calculate the risk weight in accordance with paragraph (d) of this section. (3) When A is less than KA and D is greater than KA, the risk weight is a weighted-average of 1,250 percent and 1,250 percent times KSSFA calculated in accordance with paragraph (d) of this section. For the purpose of this weighted-average calculation: (i) The weight assigned to 1,250 percent equals e = 2.71828, the base of the natural logarithms. (2) Then the Enterprise must calculate according to the following equation: E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.065</GPH> EP30JN20.066</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.43 Simplified supervisory formula approach (SSFA). (ii) Subject to a bankruptcy or insolvency proceeding; (iii) In the process of foreclosure; (iv) Held as real estate owned; (v) Has contractually deferred payments for 90 days or more, other than principal or interest payments deferred on: (A) Federally-guaranteed student loans, in accordance with the terms of those guarantee programs; or (B) Consumer loans, including nonfederally-guaranteed student loans, provided that such payments are deferred pursuant to provisions included in the contract at the time funds are disbursed that provide for period(s) of deferral that are not initiated based on changes in the creditworthiness of the borrower; or (vi) Is in default. (3) Parameter A is the attachment point for the exposure, which represents the threshold at which credit losses will first be allocated to the exposure. Except as provided in § 1240.42(g) for nth-todefault credit derivatives, parameter A equals the ratio of the current dollar amount of underlying exposures that are subordinated to the exposure of the Enterprise to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the Enterprise’s securitization exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a decimal value between zero and one. (4) Parameter D is the detachment point for the exposure, which represents the threshold at which credit losses of principal allocated to the exposure would result in a total loss of principal. Except as provided in § 1240.42(g) for nth-to-default credit derivatives, parameter D equals parameter A plus the ratio of the current dollar amount of the securitization exposures that are pari passu with the exposure (that is, have equal seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a decimal value between zero and one. (5) A supervisory calibration parameter, p, is equal to 0.5 for securitization exposures that are not resecuritization exposures and equal to 1.5 for resecuritization exposures (except p is equal to 0.5 for resecuritization exposures secured by MBS guaranteed by an Enterprise). (c) Mechanics of the SSFA. KG and W are used to calculate KA, the augmented value of KG, which reflects the observed credit quality of the underlying EP30JN20.064</GPH> determine the exposure amount of the credit derivative under § 1240.36. (A) If the Enterprise purchases credit protection from a counterparty that is not a securitization SPE, the Enterprise must determine the risk weight for the exposure according to this subpart D. (B) If the Enterprise purchases the credit protection from a counterparty that is a securitization SPE, the Enterprise must determine the risk weight for the exposure according to section § 1240.42, including § 1240.42(a)(4) for a credit derivative that has a first priority claim on the cash flows from the underlying exposures of the securitization SPE (notwithstanding amounts due under interest rate or currency derivative contracts, fees due, or other similar payments). 39393 39394 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules § 1240.44 (CRTA). Credit risk transfer approach khammond on DSKJM1Z7X2PROD with PROPOSALS2 (a) General requirements for the CRTA. To use the CRTA to determine the risk weighted assets for a retained CRT exposure, an Enterprise must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the credit risk transfer require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. An Enterprise that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a risk weight of 1,250 percent to the retained CRT exposure. (b) CRTA parameters. To calculate the risk weighted assets for a retained CRT exposure, an Enterprise must have accurate information on the following ten inputs to the CRTA calculation. (1) Parameter A is the attachment point for the exposure, which represents the threshold at which credit losses will first be allocated to the exposure. Parameter A equals the ratio of the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 current dollar amount of underlying exposures that are subordinated to the exposure of the Enterprise to the current dollar amount of underlying exposures. Any reserve account funded by the accumulated cash flows from the underlying exposures that is subordinated to the Enterprise’s exposure may be included in the calculation of parameter A to the extent that cash is present in the account. Parameter A is expressed as a value between 0 and 100 percent. (2) Parameter AggUPB$ is the aggregate unpaid principal balance of the underlying mortgage exposures. (3) Parameter CM% is the percentage of a tranche sold in the capital markets. CM% is expressed as a value between 0 and 100 percent. (4) Parameter Collat%RIF is the amount of financial collateral posted by a counterparty under a loss sharing contract expressed as a percentage of the risk in force. For multifamily lender loss sharing transactions where an Enterprise has the contractual right to receive future lender guarantee-fee revenue, the Enterprise may include up to 12 months of expected guarantee-fee revenue in collateral. Collat%RIF is expressed as a value between 0 and 100 percent. (5) Parameter D is the detachment point for the exposure, which represents the threshold at which credit losses of principal allocated to the exposure would result in a total loss of principal. Parameter D equals parameter A plus the ratio of the current dollar amount of the exposures that are pari passu with the exposure (that is, have equal PO 00000 Frm 00122 Fmt 4701 Sfmt 4725 seniority with respect to credit risk) to the current dollar amount of the underlying exposures. Parameter D is expressed as a value between 0 and 100 percent. (6) Parameter EL$ is the remaining lifetime net expected credit risk losses of the underlying mortgage exposures. EL$ must be calculated internally by an Enterprise. If the contractual terms of the CRT do not provide for the transfer of the counterparty credit risk associated with any loan-level credit enhancement or other loss sharing on the underlying mortgage exposures, then the Enterprise must calculate EL$ assuming no counterparty haircuts. Parameter EL$ is expressed in dollars. (7) Parameter HC is the haircut for the counterparty in contractual loss sharing transactions. (i) For a CRT with respect to singlefamily mortgage exposures, the counterparty haircut is set forth on Table 12 to paragraph (e)(3)(ii) of § 1240.33, determined as if the counterparty to the CRT were a counterparty to loan-level credit enhancement (as defined in § 1240.33(a)) and considering the counterparty rating and mortgage concentration risk of the counterparty to the CRT and the single-family segment and product of the underlying singlefamily mortgage exposures. (ii) For a CRT with respect to multifamily mortgage exposures, the counterparty haircut is set forth on Table 1 to this paragraph (b)(7)(ii), with counterparty rating and mortgage concentration risk having the meaning given in § 1240.33(a). E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.068</GPH> (3) The risk weight for the exposure (expressed as a percent) is equal to KSSFA * 1,250. (e) Limitations. Notwithstanding any other provision of this section, an Enterprise must assign a risk weight of not less than 20 percent to a securitization exposure. Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (8) Parameter LS% is the percentage of a tranche that is either insured, reinsured, or afforded coverage through lender reimbursement of credit losses of principal. LS% is expressed as a value between 0 and 100 percent. (9) Parameter LTF% is the loss timing factor which accounts for maturity differences between the CRT and the underlying mortgage exposures. Maturity differences arise when the maturity date of the CRT is before the maturity dates of the underlying mortgage exposures. LTF% is expressed as a value between 0 and 100 percent. (i) An Enterprise must have the following information to calculate LTF% for a CRT with respect to multifamily mortgage exposures: (A) The remaining months to the contractual maturity of the CRT (CRTRMM). (B) The remaining months to maturity of the underlying multifamily mortgage exposures (MMERMM). If the underlying multifamily mortgage exposures have different maturity dates, MMERMM should reflect the multifamily mortgage exposure with the longest maturity. (C) An Enterprise must use the following method to calculate LTF% for multifamily CRTs: between the CRT’s maturity date and original closing date. (i) If CRTMthstoMaturity is a multiple of 12, then an Enterprise must use the first column of Table 2 to paragraph (b)(9)(ii)(E)(2)(iii) of this section to identify the row matching CRTMthstoMaturity and take a weighted average of the three loss timing factors in columns 2, 3, and 4 as follows: LTF% = (CRTLT15 * CRTF15%) + (CRTLT80Not15 * CRT80NotF15%) + (CRTLTGT80Not15 * CRT80NotF15%) + (CRTLTGT80Not15 * (1¥CRT80NotF15% ¥CRTF15%)) (ii) If CRTMthstoMaturity is not a multiple of 12, an Enterprise must use the first column of Table 2 to paragraph (b)(9)(ii)(E)(2)(iii) of this section to identify the two rows that are closest to CRTMthstoMaturity and take a weighted average between the two rows of loss timing factors using linear interpolation, where the weights reflect CRTMthstoMaturity. (iii) For seasoned single-family CRTs, the LTF% is calculated: EP30JN20.070</GPH> where CRTLTM is the loss timing factor calculated under (ii) of this subsection. CRTLTS is the loss timing factor calculated under (ii) of this subsection replacing CRTMthstoMaturity with the duration of seasoning. VerDate Sep<11>2014 20:22 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00123 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.069</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 (ii) An Enterprise must have the following information to calculate LTF% for a newly issued CRT with respect to single-family mortgage exposures: (A) The original closing date (or effective date) of the CRT and the maturity date on the CRT. (B) UPB share of single-family mortgage exposures that have original amortization terms of less than or equal to 189 months (CRTF15%). (C) UPB share of single-family mortgage exposures that have original amortization terms greater than 189 months and OLTVs of less than or equal to 80 percent (CRT80NotF15%). (D) The duration of seasoning. (E) An Enterprise must use the following method to calculate LTF% for single-family CRTs: Calculate CRT months to maturity (CRTMthstoMaturity) using one of the following methods: (1) For single-family CRTs with reimbursement based upon occurrence or resolution of delinquency, CRTMthstoMaturity is the difference between the CRT’s maturity date and original closing date, except for the following: (i) If the coverage based upon delinquency is between one and three months, add 24 months to the difference between the CRT’s maturity date and original closing date; and (ii) If the coverage based upon delinquency is between four and six months, add 18 months to the difference between the CRT’s maturity date and original closing date. (2) For all other single-family CRTs, CRTMthstoMaturity is the difference 39395 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules BILLING CODE 8070–01–P (10) Parameter RWA$ is the aggregate credit risk-weighted assets associated with the underlying mortgage exposures. (11) Parameter CntptyRWA$ is the aggregate credit risk-weighted assets due VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 to counterparty haircuts from loan-level credit enhancements. CntptyRWA$ is the difference between: (i) Parameter RWA$; and (ii) Aggregate credit risk-weighted assets associated with the underlying PO 00000 Frm 00124 Fmt 4701 Sfmt 4702 mortgage exposures where the counterparty haircuts for loan-level credit enhancements are set to zero. (c) Mechanics of the CRTA. The risk weight assigned to a retained CRT exposure, or portion of a retained CRT E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.071</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 39396 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules 39397 exposure, as appropriate, is the larger of RW% determined in accordance with paragraph (d) of this section and a risk weight of 10 percent. (1) When the detachment point, parameter D, for a retained CRT exposure is less than or equal to the sum of KA and AggEL%, the exposure must be assigned a risk weight of 1,250 percent. (2) When the attachment point, parameter A, for a retained CRT exposure is greater than or equal to or equal to the sum of KA and AggEL%, determined in accordance with paragraph (d) of this section, the exposure must be assigned a risk weight of 10 percent. (3) When parameter A is less than or equal to the sum of KA and AggEL%, and parameter D is greater than the sum of KA and AggEL%, the Enterprise must calculate the risk weight as 1,250% multiplied by the ratio of (i) the sum of KA and AggEL% less parameter A to (ii) the difference between parameter D and parameter A. (d) CRTA equations. If the contractual terms of the CRT do not provide for the transfer of the counterparty credit risk associated with any loan-level credit enhancement or other loss sharing on the underlying mortgage exposures, then the Enterprise shall calculate KA as follows: (e) Limitations. Notwithstanding any other provision of this section, an Enterprise must assign an overall risk weight of not less than 10 percent to a retained CRT exposure. (f) Adjusted exposure amount (AEA)—(1) In general. The adjusted exposure amount (AEA) of a retained CRT exposure is equal to: (2) Inputs—(i) Enterprise Adjusted Exposure. The adjusted exposure (EAE) of an Enterprise with respect to a retained CRT exposure is as follows: EAE%,Tranche = 100% ¥ (CM%,Tranche * LTEA%,Tranche,CM * OEA%) ¥ (LS%,Tranche * LSEA%,Tranche,LS * LTEA%,Tranche,LS * OEA%), Where the loss timing effectiveness adjustments (LTEA) for a retained CRT exposure are determined under paragraph (g) of this section, the loss sharing effectiveness adjustment (LSEA) for a retained CRT exposure is determine under paragraph (h) of this section, and the overall effectiveness adjustment (OEA) is determined under paragraph (i) of this section. (ii) Expected Loss Share. The expected loss share is the share of a tranche that is covered by expected loss (ELS): VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00125 Fmt 4701 Sfmt 4725 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.076</GPH> EP30JN20.075</GPH> EP30JN20.073</GPH> EP30JN20.074</GPH> EP30JN20.072</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 Otherwise the Enterprise shall calculate KA as follows: Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (iii) Risk weight. The risk weight of a retained CRT exposure is determined under paragraph (d) of this section. (g) Loss timing effectiveness adjustments. The loss timing effectiveness adjustments (LTEA) for a retained CRT exposure is calculated according to the following calculation: if (SLS%,Tranche ¥ ELS%,Tranche) > 0 then Otherwise LTEA%,Tranche,CM = 100% and LTEA%,Tranche,LS = 100% where KA adjusted for loss timing (LTKA) is as follows: LTKA,CM = max ((KA + AggEL%) * LTF%,CM LTKA,LS = max ((KA + AggEL%) * LTF%,LS; LTF%,CM is LTF% calculated for the capital markets component of the tranche, LTF%,LS is LTF% calculated for the loss sharing component of the tranche, and the share of the tranche that is covered by expected loss (ELS) and the share of the tranche that is covered by stress loss (SLS) are (h) Loss sharing effectiveness adjustment. The loss sharing effectiveness adjustment (LSEA) for a retained CRT exposure is calculated according to the following calculation: if (RW%,Tranche ¥ ELS%,Tranche * 1250%) > 0 then Otherwise UnCollatUL%,Tranche = max (0%, SLS%,Tranche ¥ max (Collat%RIF,Tranche, ELS%,Tranche)) SRIF%,Tranche = 100% ¥ max (SLS%,Tranche, Collat%RIF,Tranche) and the share of the tranche that is covered by expected loss (ELS) and the share of the tranche that is covered by stress loss (SLS) are LESA%,Tranche = 100% EP30JN20.078</GPH> EP30JN20.079</GPH> VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 PO 00000 Frm 00126 Fmt 4701 Sfmt 4702 E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.077</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 where and EP30JN20.080</GPH> 39398 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules [Alternative: Modified SSFA] (a) General requirements. To use the CRT approach to determine the risk weight for a CRT exposure, an Enterprise must have data that enables it to assign accurately the parameters described in paragraph (b) of this section. Data used to assign the parameters described in paragraph (b) of this section must be the most currently available data; if the contracts governing the underlying exposures of the CRT require payments on a monthly or quarterly basis, the data used to assign the parameters described in paragraph (b) of this section must be no more than 91 calendar days old. An Enterprise that does not have the appropriate data to assign the parameters described in paragraph (b) of this section must assign a risk weight of 1,250 percent to the exposure. (b) CRTA parameters. To calculate the risk weight for a CRT exposure using the VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 CRTA, an Enterprise must have accurate information on the following five inputs to the CRTA calculation, each as defined and calculated under § 1240.43(b): KG; W; A; D; and p. (c) Mechanics of the CRTA. The risk weight assigned to a CRT exposure, or portion of a CRT exposure, as appropriate, is the larger of the risk weight determined in accordance with this paragraph (c) or paragraph (d) of § 1240.43 and a risk weight of 10 percent. (d) Limitations. Notwithstanding any other provision of this section, an Enterprise must assign a risk weight of not less than 10 percent to a CRT exposure. (e) Adjusted exposure amount. The exposure amount for a CRT exposure is not subject to an adjustment under this section. (f) RWA adjustment for retained loanlevel counterparty credit risk. If the Enterprise elects to use the CRTA for a retained CRT exposure and if the contractual terms of the CRT do not provide for the transfer of the counterparty credit risk associated with any loan-level credit enhancement or other loss sharing on the underlying mortgage exposures, then the Enterprise must increase the risk-weighted assets of the retained CRT exposure by the amount equal to the portion of aggregate RWAs on the underlying mortgage exposures associated with counterparty credit risk. § 1240.45 Securitization exposures to which the SSFA and the CRTA do not apply. An Enterprise must assign a 1,250 percent risk weight to any acquired CRT exposure and all securitization exposures to which the Enterprise does not apply the SSFA under § 1240.43 or the CRTA under § 1240.44. § 1240.46 Recognition of credit risk mitigants for securitization exposures. (a) General. (1) An originating Enterprise that has obtained a credit risk mitigant to hedge its exposure to a synthetic or traditional securitization that satisfies the operational criteria PO 00000 Frm 00127 Fmt 4701 Sfmt 4702 provided in § 1240.41 may recognize the credit risk mitigant under §§ 1240.38 or 1240.39, but only as provided in this section. (2) An investing Enterprise that has obtained a credit risk mitigant to hedge a securitization exposure may recognize the credit risk mitigant under §§ 1240.38 or 1240.39, but only as provided in this section. (b) Mismatches. An Enterprise must make any applicable adjustment to the protection amount of an eligible guarantee or credit derivative as required in 12 CFR 217.36(d) through (f) for any hedged securitization exposure. In the context of a synthetic securitization, when an eligible guarantee or eligible credit derivative covers multiple hedged exposures that have different residual maturities, the Enterprise must use the longest residual maturity of any of the hedged exposures as the residual maturity of all hedged exposures. Risk-Weighted Assets for Equity Exposures § 1240.51 Exposure measurement. An Enterprise must calculate its riskweighted assets for any equity exposures that are permissible under the Enterprise’s authorizing statute under 12 CFR 217.51 through 217.53 of this title, substituting ‘‘Enterprise for ‘‘Board-regulated institution.’’ Subpart E—Risk-Weighted Assets— Internal Ratings-Based and Advanced Measurement Approaches § 1240.100 Purpose, applicability, and principle of conservatism. (a) Purpose. This subpart E establishes: (1) Minimum requirements for using Enterprise-specific internal risk measurement and management processes for calculating risk-based capital requirements; and (2) Methodologies for the Enterprises to calculate their advanced approaches total risk-weighted assets. E:\FR\FM\30JNP2.SGM 30JNP2 EP30JN20.081</GPH> khammond on DSKJM1Z7X2PROD with PROPOSALS2 (i) Overall effectiveness adjustment. The overall effectiveness adjustment (OEA) for a retained CRT exposure is calculated according to the following calculation: OEA% = 90% (j) RWA supplement for retained loanlevel counterparty credit risk. If the Enterprise elects to use the CRTA for a retained CRT exposure and if the contractual terms of the CRT do not provide for the transfer of the counterparty credit risk associated with any loan-level credit enhancement or other loss sharing on the underlying mortgage exposures, then the Enterprise must add the following risk-weighted assets supplement (RWASup$) to risk weighted assets for the retained CRT exposure. RWASup$,Tranche = CntptyRWA$ * (D ¥ A) Otherwise the Enterprise shall add an RWASup$ of $0. (k) Credit risk-weighted assets for the retained CRT exposure are as follows: RWA$,Tranche = AEA$,Tranche * RW%,Tranche + RWASup$,Tranche 39399 39400 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules (b) Applicability. (1) This subpart applies to each Enterprise. (2) An Enterprise must also include in its calculation of advanced credit riskweighted assets under this subpart all covered positions, as defined in subpart F of this part. (c) Principle of conservatism. Notwithstanding the requirements of this subpart, an Enterprise may choose not to apply a provision of this subpart to one or more exposures provided that: (1) The Enterprise can demonstrate on an ongoing basis to the satisfaction of FHFA that not applying the provision would, in all circumstances, unambiguously generate a risk-based capital requirement for each such exposure greater than that which would otherwise be required under this subpart; (2) The Enterprise appropriately manages the risk of each such exposure; (3) The Enterprise notifies FHFA in writing prior to applying this principle to each such exposure; and (4) The exposures to which the Enterprise applies this principle are not, in the aggregate, material to the Enterprise. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.101 Definitions. (a) Terms that are set forth in § 1240.2 and used in this subpart have the definitions assigned thereto in § 1240.2. (b) For the purposes of this subpart, the following terms are defined as follows: Advanced internal ratings-based (IRB) systems means an Enterprise’s internal risk rating and segmentation system; risk parameter quantification system; data management and maintenance system; and control, oversight, and validation system for credit risk of exposures. Advanced systems means an Enterprise’s advanced IRB systems, operational risk management processes, operational risk data and assessment systems, operational risk quantification systems, and, to the extent used by the Enterprise, the internal models methodology, advanced CVA approach, double default excessive correlation detection process, and internal models approach (IMA) for equity exposures. Backtesting means the comparison of an Enterprise’s internal estimates with actual outcomes during a sample period not used in model development. In this context, backtesting is one form of outof-sample testing. Benchmarking means the comparison of an Enterprise’s internal estimates with relevant internal and external data or with estimates based on other estimation techniques. Business environment and internal control factors means the indicators of VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 an Enterprise’s operational risk profile that reflect a current and forwardlooking assessment of the Enterprise’s underlying business risk factors and internal control environment. Dependence means a measure of the association among operational losses across and within units of measure. Economic downturn conditions means, with respect to an exposure held by the Enterprise, those conditions in which the aggregate default rates for that exposure’s exposure subcategory (or subdivision of such subcategory selected by the Enterprise) in the exposure’s jurisdiction (or subdivision of such jurisdiction selected by the Enterprise) are significantly higher than average. Eligible operational risk offsets means amounts, not to exceed expected operational loss, that: (i) Are generated by internal business practices to absorb highly predictable and reasonably stable operational losses, including reserves calculated consistent with GAAP; and (ii) Are available to cover expected operational losses with a high degree of certainty over a one-year horizon. Expected operational loss (EOL) means the expected value of the distribution of potential aggregate operational losses, as generated by the Enterprise’s operational risk quantification system using a one-year horizon. External operational loss event data means, with respect to an Enterprise, gross operational loss amounts, dates, recoveries, and relevant causal information for operational loss events occurring at organizations other than the Enterprise. Internal operational loss event data means, with respect to an Enterprise, gross operational loss amounts, dates, recoveries, and relevant causal information for operational loss events occurring at the Enterprise. Operational loss means a loss (excluding insurance or tax effects) resulting from an operational loss event. Operational loss includes all expenses associated with an operational loss event except for opportunity costs, forgone revenue, and costs related to risk management and control enhancements implemented to prevent future operational losses. Operational loss event means an event that results in loss and is associated with any of the following seven operational loss event type categories: (i) Internal fraud, which means the operational loss event type category that comprises operational losses resulting from an act involving at least one internal party of a type intended to PO 00000 Frm 00128 Fmt 4701 Sfmt 4702 defraud, misappropriate property, or circumvent regulations, the law, or company policy excluding diversityand discrimination-type events. (ii) External fraud, which means the operational loss event type category that comprises operational losses resulting from an act by a third party of a type intended to defraud, misappropriate property, or circumvent the law. All third-party-initiated credit losses are to be treated as credit risk losses. (iii) Employment practices and workplace safety, which means the operational loss event type category that comprises operational losses resulting from an act inconsistent with employment, health, or safety laws or agreements, payment of personal injury claims, or payment arising from diversity- and discrimination-type events. (iv) Clients, products, and business practices, which means the operational loss event type category that comprises operational losses resulting from the nature or design of a product or from an unintentional or negligent failure to meet a professional obligation to specific clients (including fiduciary and suitability requirements). (v) Damage to physical assets, which means the operational loss event type category that comprises operational losses resulting from the loss of or damage to physical assets from natural disaster or other events. (vi) Business disruption and system failures, which means the operational loss event type category that comprises operational losses resulting from disruption of business or system failures. (vii) Execution, delivery, and process management, which means the operational loss event type category that comprises operational losses resulting from failed transaction processing or process management or losses arising from relations with trade counterparties and vendors. Operational risk means the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events (including legal risk but excluding strategic and reputational risk). Operational risk exposure means the 99.9th percentile of the distribution of potential aggregate operational losses, as generated by the Enterprise’s operational risk quantification system over a one-year horizon (and not incorporating eligible operational risk offsets or qualifying operational risk mitigants). Risk parameter means a variable used in determining risk-based capital requirements for exposures, such as E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules probability of default, loss given default, exposure at default, or effective maturity. Scenario analysis means a systematic process of obtaining expert opinions from business managers and risk management experts to derive reasoned assessments of the likelihood and loss impact of plausible high-severity operational losses. Scenario analysis may include the well-reasoned evaluation and use of external operational loss event data, adjusted as appropriate to ensure relevance to an Enterprise’s operational risk profile and control structure. Unexpected operational loss (UOL) means the difference between the Enterprise’s operational risk exposure and the Enterprise’s expected operational loss. Unit of measure means the level (for example, organizational unit or operational loss event type) at which the Enterprise’s operational risk quantification system generates a separate distribution of potential operational losses. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.121 Minimum requirements. (a) Process and systems requirements. (1) An Enterprise must have a rigorous process for assessing its overall capital adequacy in relation to its risk profile and a comprehensive strategy for maintaining an appropriate level of capital. (2) The systems and processes used by an Enterprise for risk-based capital purposes under this subpart must be consistent with the Enterprise’s internal risk management processes and management information reporting systems. (3) Each Enterprise must have an appropriate infrastructure with risk measurement and management processes that meet the requirements of this section and are appropriate given the Enterprise’s size and level of complexity. The Enterprise must ensure that the risk parameters and reference data used to determine its risk-based capital requirements are representative of long run experience with respect to its credit risk and operational risk exposures. (b) Risk rating and segmentation systems for exposures. (1) An Enterprise must have an internal risk rating and segmentation system that accurately, reliably, and meaningfully differentiates among degrees of credit risk for the Enterprise’s exposures. When assigning an internal risk rating, an Enterprise may consider a third-party assessment of credit risk, provided that the Enterprise’s internal risk rating VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 assignment does not rely solely on the external assessment. (2) If an Enterprise uses multiple rating or segmentation systems, the Enterprise’s rationale for assigning an exposure to a particular system must be documented and applied in a manner that best reflects the obligor or exposure’s level of risk. An Enterprise must not inappropriately allocate exposures across systems to minimize regulatory capital requirements. (3) In assigning ratings to exposures, an Enterprise must use all relevant and material information and ensure that the information is current. (c) Quantification of risk parameters for exposures. (1) The Enterprise must have a comprehensive risk parameter quantification process that produces accurate, timely, and reliable estimates of the risk parameters on a consistent basis for the Enterprise’s exposures. (2) An Enterprise’s estimates of risk parameters must incorporate all relevant, material, and available data that is reflective of the Enterprise’s actual exposures and of sufficient quality to support the determination of risk-based capital requirements for the exposures. In particular, the population of exposures in the data used for estimation purposes, the underwriting standards in use when the data were generated, and other relevant characteristics, should closely match or be comparable to the Enterprise’s exposures and standards. In addition, an Enterprise must: (i) Demonstrate that its estimates are representative of long run experience, including periods of economic downturn conditions, whether internal or external data are used; (ii) Take into account any changes in underwriting practice or the process for pursuing recoveries over the observation period; (iii) Promptly reflect technical advances, new data, and other information as they become available; (iv) Demonstrate that the data used to estimate risk parameters support the accuracy and robustness of those estimates; and (v) Demonstrate that its estimation technique performs well in out-ofsample tests whenever possible. (3) The Enterprise’s risk parameter quantification process must produce appropriately conservative risk parameter estimates where the Enterprise has limited relevant data, and any adjustments that are part of the quantification process must not result in a pattern of bias toward lower risk parameter estimates. (4) The Enterprise’s risk parameter estimation process should not rely on PO 00000 Frm 00129 Fmt 4701 Sfmt 4702 39401 the possibility of U.S. government financial assistance. (5) Default, loss severity, and exposure amount data must include periods of economic downturn conditions, or the Enterprise must adjust its estimates of risk parameters to compensate for the lack of data from periods of economic downturn conditions. (6) If an Enterprise uses internal data obtained prior to becoming subject to this subpart E or external data to arrive at risk parameter estimates, the Enterprise must demonstrate to FHFA that the Enterprise has made appropriate adjustments if necessary to be consistent with the Enterprise’s definition of default. Internal data obtained after the Enterprise becomes subject to this subpart E must be consistent with the Enterprise’s definition of default. (7) The Enterprise must review and update (as appropriate) its risk parameters and its risk parameter quantification process at least annually. (8) The Enterprise must, at least annually, conduct a comprehensive review and analysis of reference data to determine relevance of the reference data to the Enterprise’s exposures, quality of reference data to support risk parameter estimates, and consistency of reference data to the Enterprise’s definition of default. (d) Operational risk—(1) Operational risk management processes. An Enterprise must: (i) Have an operational risk management function that: (A) Is independent of business line management; and (B) Is responsible for designing, implementing, and overseeing the Enterprise’s operational risk data and assessment systems, operational risk quantification systems, and related processes; (ii) Have and document a process (which must capture business environment and internal control factors affecting the Enterprise’s operational risk profile) to identify, measure, monitor, and control operational risk in the Enterprise’s products, activities, processes, and systems; and (iii) Report operational risk exposures, operational loss events, and other relevant operational risk information to business unit management, senior management, and the board of directors (or a designated committee of the board). (2) Operational risk data and assessment systems. An Enterprise must have operational risk data and assessment systems that capture operational risks to which the E:\FR\FM\30JNP2.SGM 30JNP2 khammond on DSKJM1Z7X2PROD with PROPOSALS2 39402 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules Enterprise is exposed. The Enterprise’s operational risk data and assessment systems must: (i) Be structured in a manner consistent with the Enterprise’s current business activities, risk profile, technological processes, and risk management processes; and (ii) Include credible, transparent, systematic, and verifiable processes that incorporate the following elements on an ongoing basis: (A) Internal operational loss event data. The Enterprise must have a systematic process for capturing and using internal operational loss event data in its operational risk data and assessment systems. (1) The Enterprise’s operational risk data and assessment systems must include a historical observation period of at least five years for internal operational loss event data (or such shorter period approved by FHFA to address transitional situations, such as integrating a new business line). (2) The Enterprise must be able to map its internal operational loss event data into the seven operational loss event type categories. (3) The Enterprise may refrain from collecting internal operational loss event data for individual operational losses below established dollar threshold amounts if the Enterprise can demonstrate to the satisfaction of FHFA that the thresholds are reasonable, do not exclude important internal operational loss event data, and permit the Enterprise to capture substantially all the dollar value of the Enterprise’s operational losses. (B) External operational loss event data. The Enterprise must have a systematic process for determining its methodologies for incorporating external operational loss event data into its operational risk data and assessment systems. (C) Scenario analysis. The Enterprise must have a systematic process for determining its methodologies for incorporating scenario analysis into its operational risk data and assessment systems. (D) Business environment and internal control factors. The Enterprise must incorporate business environment and internal control factors into its operational risk data and assessment systems. The Enterprise must also periodically compare the results of its prior business environment and internal control factor assessments against its actual operational losses incurred in the intervening period. (3) Operational risk quantification systems. The Enterprise’s operational risk quantification systems: VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (i) Must generate estimates of the Enterprise’s operational risk exposure using its operational risk data and assessment systems; (ii) Must employ a unit of measure that is appropriate for the Enterprise’s range of business activities and the variety of operational loss events to which it is exposed, and that does not combine business activities or operational loss events with demonstrably different risk profiles within the same loss distribution; (iii) Must include a credible, transparent, systematic, and verifiable approach for weighting each of the four elements, described in paragraph (d)(2)(ii) of this section, that an Enterprise is required to incorporate into its operational risk data and assessment systems; (iv) May use internal estimates of dependence among operational losses across and within units of measure if the Enterprise can demonstrate to the satisfaction of FHFA that its process for estimating dependence is sound, robust to a variety of scenarios, and implemented with integrity, and allows for uncertainty surrounding the estimates. If the Enterprise has not made such a demonstration, it must sum operational risk exposure estimates across units of measure to calculate its total operational risk exposure; and (v) Must be reviewed and updated (as appropriate) whenever the Enterprise becomes aware of information that may have a material effect on the Enterprise’s estimate of operational risk exposure, but the review and update must occur no less frequently than annually. (e) Data management and maintenance. (1) An Enterprise must have data management and maintenance systems that adequately support all aspects of its advanced systems and the timely and accurate reporting of riskbased capital requirements. (2) An Enterprise must retain data using an electronic format that allows timely retrieval of data for analysis, validation, reporting, and disclosure purposes. (3) An Enterprise must retain sufficient data elements related to key risk drivers to permit adequate monitoring, validation, and refinement of its advanced systems. (f) Control, oversight, and validation mechanisms. (1) The Enterprise’s senior management must ensure that all components of the Enterprise’s advanced systems function effectively and comply with the minimum requirements in this section. (2) The Enterprise’s board of directors (or a designated committee of the board) must at least annually review the PO 00000 Frm 00130 Fmt 4701 Sfmt 4702 effectiveness of, and approve, the Enterprise’s advanced systems. (3) An Enterprise must have an effective system of controls and oversight that: (i) Ensures ongoing compliance with the minimum requirements in this section; (ii) Maintains the integrity, reliability, and accuracy of the Enterprise’s advanced systems; and (iii) Includes adequate governance and project management processes. (4) The Enterprise must validate, on an ongoing basis, its advanced systems. The Enterprise’s validation process must be independent of the advanced systems’ development, implementation, and operation, or the validation process must be subjected to an independent review of its adequacy and effectiveness. Validation must include: (i) An evaluation of the conceptual soundness of (including developmental evidence supporting) the advanced systems; (ii) An ongoing monitoring process that includes verification of processes and benchmarking; and (iii) An outcomes analysis process that includes backtesting. (5) The Enterprise must have an internal audit function or equivalent function that is independent of business-line management that at least annually: (i) Reviews the Enterprise’s advanced systems and associated operations, including the operations of its credit function and estimations of risk parameters; (ii) Assesses the effectiveness of the controls supporting the Enterprise’s advanced systems; and (iii) Documents and reports its findings to the Enterprise’s board of directors (or a committee thereof). (6) The Enterprise must periodically stress test its advanced systems. The stress testing must include a consideration of how economic cycles, especially downturns, affect risk-based capital requirements (including migration across rating grades and segments and the credit risk mitigation benefits of double default treatment). (g) Documentation. The Enterprise must adequately document all material aspects of its advanced systems. § 1240.122 Ongoing qualification. (a) Changes to advanced systems. An Enterprise must meet all the minimum requirements in § 1240.121 on an ongoing basis. An Enterprise must notify FHFA when the Enterprise makes any change to an advanced system that would result in a material change in the Enterprise’s advanced approaches total E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules risk-weighted asset amount for an exposure type or when the Enterprise makes any significant change to its modeling assumptions. (b) Failure to comply with qualification requirements. (1) If FHFA determines that an Enterprise fails to comply with the requirements in § 1240.121, FHFA will notify the Enterprise in writing of the Enterprise’s failure to comply. (2) The Enterprise must establish and submit a plan satisfactory to FHFA to return to compliance with the qualification requirements. (3) In addition, if FHFA determines that the Enterprise’s advanced approaches total risk-weighted assets are not commensurate with the Enterprise’s credit, market, operational, or other risks, FHFA may require such an Enterprise to calculate its advanced approaches total risk-weighted assets with any modifications provided by FHFA. § 1240.123 Advanced approaches credit risk-weighted asset calculations. (a) An Enterprise must use its advanced systems to determine its credit risk capital requirements for each of the following exposures: (1) General credit risk (including for mortgage exposures); (2) Cleared transactions; (3) Default fund contributions; (4) Unsettled transactions; (5) Securitization exposures; (6) Equity exposures; and (7) The fair value adjustment to reflect counterparty credit risk in valuation of OTC derivative contracts. (b) The credit-risk-weighted assets calculated under this subpart E equals the aggregate credit risk capital requirement under paragraph (a) of this section multiplied by 12.5. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.161 Qualification requirements for incorporation of operational risk mitigants. (a) Qualification to use operational risk mitigants. An Enterprise may adjust its estimate of operational risk exposure to reflect qualifying operational risk mitigants if: (1) The Enterprise’s operational risk quantification system is able to generate an estimate of the Enterprise’s operational risk exposure (which does not incorporate qualifying operational risk mitigants) and an estimate of the Enterprise’s operational risk exposure adjusted to incorporate qualifying operational risk mitigants; and (2) The Enterprise’s methodology for incorporating the effects of insurance, if the Enterprise uses insurance as an operational risk mitigant, captures through appropriate discounts to the amount of risk mitigation: VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (i) The residual term of the policy, where less than one year; (ii) The cancellation terms of the policy, where less than one year; (iii) The policy’s timeliness of payment; (iv) The uncertainty of payment by the provider of the policy; and (v) Mismatches in coverage between the policy and the hedged operational loss event. (b) Qualifying operational risk mitigants. Qualifying operational risk mitigants are: (1) Insurance that: (i) Is provided by an unaffiliated company that the Enterprise deems to have strong capacity to meet its claims payment obligations and the Enterprise assigns the company a probability of default equal to or less than 10 basis points; (ii) Has an initial term of at least one year and a residual term of more than 90 days; (iii) Has a minimum notice period for cancellation by the provider of 90 days; (iv) Has no exclusions or limitations based upon regulatory action or for the receiver or liquidator of a failed depository institution; and (v) Is explicitly mapped to a potential operational loss event; (2) In evaluating an operational risk mitigant other than insurance, FHFA will consider whether the operational risk mitigant covers potential operational losses in a manner equivalent to holding total capital. § 1240.162 Mechanics of operational risk risk-weighted asset calculation. (a) If an Enterprise does not qualify to use or does not have qualifying operational risk mitigants, the Enterprise’s dollar risk-based capital requirement for operational risk is its operational risk exposure minus eligible operational risk offsets (if any). (b) If an Enterprise qualifies to use operational risk mitigants and has qualifying operational risk mitigants, the Enterprise’s dollar risk-based capital requirement for operational risk is the greater of: (1) The Enterprise’s operational risk exposure adjusted for qualifying operational risk mitigants minus eligible operational risk offsets (if any); or (2) 0.8 multiplied by the difference between: (i) The Enterprise’s operational risk exposure; and (ii) Eligible operational risk offsets (if any). (c) The Enterprise’s risk-weighted asset amount for operational risk equals the greater of: (1) The Enterprise’s dollar risk-based capital requirement for operational risk PO 00000 Frm 00131 Fmt 4701 Sfmt 4702 39403 determined under paragraphs (a) or (b) multiplied by 12.5; and (2) The Enterprise’s adjusted total assets multiplied by 0.0015 multiplied by 12.5. Subpart F—Risk-Weighted Assets— Market Risk § 1240.201 Purpose, applicability, and reservation of authority. (a) Purpose. This subpart F establishes risk-based capital requirements for spread risk and provides methods for the Enterprises to calculate their measure for spread risk. (b) Applicability. This subpart applies to each Enterprise. (c) Reservation of authority. Subject to applicable provisions of the Safety and Soundness Act: (1) FHFA may require an Enterprise to hold an amount of capital greater than otherwise required under this subpart if FHFA determines that the Enterprise’s capital requirement for spread risk as calculated under this subpart is not commensurate with the spread risk of the Enterprise’s covered positions. (2) If FHFA determines that the riskbased capital requirement calculated under this subpart by the Enterprise for one or more covered positions or portfolios of covered positions is not commensurate with the risks associated with those positions or portfolios, FHFA may require the Enterprise to assign a different risk-based capital requirement to the positions or portfolios that more accurately reflects the risk of the positions or portfolios. (3) In addition to calculating riskbased capital requirements for specific positions or portfolios under this subpart, the Enterprise must also calculate risk-based capital requirements for covered positions under subpart D or subpart E of this part, as appropriate. (4) Nothing in this subpart limits the authority of FHFA under any other provision of law or regulation to take supervisory or enforcement action, including action to address unsafe or unsound practices or conditions, deficient capital levels, or violations of law. § 1240.202 Definitions. (a) Terms set forth in § 1240.2 and used in this subpart have the definitions assigned in § 1240.2. (b) For the purposes of this subpart, the following terms are defined as follows: Backtesting means the comparison of an Enterprise’s internal estimates with actual outcomes during a sample period not used in model development. For E:\FR\FM\30JNP2.SGM 30JNP2 39404 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules purposes of this subpart, backtesting is one form of out-of-sample testing. Covered position means, any asset that has more than de minimis spread risk (other than any intangible asset, such as any servicing asset), including: (i) Any NPL, RPL, reverse mortgage loan, or other mortgage exposure that, in any case, does not secure an MBS guaranteed by the Enterprise; (ii) Any MBS guaranteed by an Enterprise, MBS guaranteed by Ginnie Mae, reverse mortgage security, PLS, commercial MBS, CRT exposure, or other securitization exposure, regardless of whether the position is held by the Enterprise for the purpose of short-term resale or with the intent of benefiting from actual or expected short-term price movements, or to lock in arbitrage profits; and (iii) Any other trading asset or trading liability (whether on- or off-balance sheet).12 Market risk means the risk of loss on a position that could result from movements in market prices, including spread risk. Private label security (PLS) means any MBS that is collateralized by a pool or pools of single-family mortgage exposures and that is not guaranteed by an Enterprise or by Ginnie Mae. Reverse mortgage means a mortgage loan secured by a residential property in which a homeowner relinquishes equity in their home in exchange for regular payments. Reverse mortgage security means a security collateralized by reverse mortgages. Spread risk means the risk of loss on a position that could result from a change in the bid or offer price of such position relative to a risk free or funding benchmark, including when due to a change in perceptions of performance or liquidity of the position. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.203 Requirements for managing market risk. (a) Management of covered positions—(1) Active management. An Enterprise must have clearly defined policies and procedures for actively managing all covered positions. At a minimum, these policies and procedures must require: (i) Marking covered positions to market or to model on a daily basis; (ii) Daily assessment of the Enterprise’s ability to hedge position and portfolio risks, and of the extent of market liquidity; (iii) Establishment and daily monitoring of limits on covered 12 Securities subject to repurchase and lending agreements are included as if they are still owned by the Enterprise. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 positions by a risk control unit independent of the business unit; (iv) Routine monitoring by senior management of information described in paragraphs (a)(1)(i) through (a)(1)(iii) of this section; (v) At least annual reassessment of established limits on positions by senior management; and (vi) At least annual assessments by qualified personnel of the quality of market inputs to the valuation process, the soundness of key assumptions, the reliability of parameter estimation in pricing models, and the stability and accuracy of model calibration under alternative market scenarios. (2) Valuation of covered positions. The Enterprise must have a process for prudent valuation of its covered positions that includes policies and procedures on the valuation of positions, marking positions to market or to model, independent price verification, and valuation adjustments or reserves. The valuation process must consider, as appropriate, unearned credit spreads, close-out costs, early termination costs, investing and funding costs, liquidity, and model risk. (b) Requirements for internal models. (1) A risk control unit independent of the business unit must approve any internal model to calculate its risk-based capital requirement under this subpart. (2) An Enterprise must meet all of the requirements of this section on an ongoing basis. The Enterprise must promptly notify FHFA when: (i) The Enterprise plans to extend the use of a model to an additional business line or product type; (ii) The Enterprise makes any change to an internal model that would result in a material change in the Enterprise’s risk-weighted asset amount for a portfolio of covered positions; or (iii) The Enterprise makes any material change to its modeling assumptions. (3) FHFA may determine an appropriate capital requirement for the covered positions to which a model would apply, if FHFA determines that the model no longer complies with this subpart or fails to reflect accurately the risks of the Enterprise’s covered positions. (4) The Enterprise must periodically, but no less frequently than annually, review its internal models in light of developments in financial markets and modeling technologies, and enhance those models as appropriate to ensure that they continue to meet the Enterprise’s standards for model approval and employ risk measurement methodologies that are most appropriate for the Enterprise’s covered positions. PO 00000 Frm 00132 Fmt 4701 Sfmt 4702 (5) The Enterprise must incorporate its internal models into its risk management process and integrate the internal models used for calculating its market risk measure into its daily risk management process. (6) The level of sophistication of an Enterprise’s internal models must be commensurate with the complexity and amount of its covered positions. An Enterprise’s internal models may use any of the generally accepted approaches, including variancecovariance models, historical simulations, or Monte Carlo simulations, to measure market risk. (7) The Enterprise’s internal models must properly measure all the material risks in the covered positions to which they are applied. (8) The Enterprise’s internal models must conservatively assess the risks arising from less liquid positions and positions with limited price transparency under realistic market scenarios. (9) The Enterprise must have a rigorous and well-defined process for reestimating, re-evaluating, and updating its internal models to ensure continued applicability and relevance. (c) Control, oversight, and validation mechanisms. (1) The Enterprise must have a risk control unit that reports directly to senior management and is independent from the business units. (2) The Enterprise must validate its internal models initially and on an ongoing basis. The Enterprise’s validation process must be independent of the internal models’ development, implementation, and operation, or the validation process must be subjected to an independent review of its adequacy and effectiveness. Validation must include: (i) An evaluation of the conceptual soundness of (including developmental evidence supporting) the internal models; (ii) An ongoing monitoring process that includes verification of processes and the comparison of the Enterprise’s model outputs with relevant internal and external data sources or estimation techniques; and (iii) An outcomes analysis process that includes backtesting. (3) The Enterprise must stress test the market risk of its covered positions at a frequency appropriate to each portfolio, and in no case less frequently than quarterly. The stress tests must take into account concentration risk (including concentrations in single issuers, industries, sectors, or markets), illiquidity under stressed market conditions, and risks arising from the Enterprise’s trading activities that may E:\FR\FM\30JNP2.SGM 30JNP2 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules not be adequately captured in its internal models. (4) The Enterprise must have an internal audit function independent of business-line management that at least annually assesses the effectiveness of the controls supporting the Enterprise’s market risk measurement systems, including the activities of the business units and independent risk control unit, compliance with policies and procedures, and calculation of the Enterprise’s measures for spread risk under this subpart. At least annually, the internal audit function must report its findings to the Enterprise’s board of directors (or a committee thereof). (d) Internal assessment of capital adequacy. The Enterprise must have a rigorous process for assessing its overall capital adequacy in relation to its market risk. (e) Documentation. The Enterprise must adequately document all material aspects of its internal models, management and valuation of covered positions, control, oversight, validation and review processes and results, and internal assessment of capital adequacy. khammond on DSKJM1Z7X2PROD with PROPOSALS2 § 1240.204 Measure for spread risk. (a) General requirement—(1) In general. An Enterprise must calculate its standardized measure for spread risk by following the steps described in paragraph (a)(2) of this section. An Enterprise also must calculate an advanced measure for spread risk by following the steps in paragraph (a)(2) of this section. (2) Measure for spread risk. An Enterprise must calculate the standardized measure for spread risk, which equals the sum of the spread risk capital requirements of all covered positions using one or more of its internal models except as contemplated by paragraphs (b) or (c) of this section. An Enterprise also must calculate the advanced measure for spread risk, which equals the sum of the spread risk capital requirements of all covered positions calculated using one or more of its internal models. (b) Single point approach—(1) General. For purposes of the standardized measure for spread risk, the spread risk capital requirement for a covered position that is an RPL, an NPL, a reverse mortgage loan, or a reverse mortgage security is the amount equal to: (i) The market value of the covered position; multiplied by (ii) The applicable single point shock assumption for the covered position under paragraph (b)(2) of this section. VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 (2) Applicable single point shock assumption. The applicable single point shock assumption is: (i) 0.0475 for an RPL or an NPL; (ii) 0.0160 for a reverse mortgage loan; and (iii) 0.0410 for a reverse mortgage security. (c) Spread duration approach—(1) General. For purposes of the standardized measure for spread risk, the spread risk capital requirement for a covered position that is a multifamily mortgage exposure, a PLS, or an MBS guaranteed by an Enterprise or Ginnie Mae and secured by multifamily mortgage exposures is the amount equal to: (i) The market value of the covered position; multiplied by (ii) The spread duration of the covered position determined by the Enterprise using one or more of its internal models; multiplied by (iii) The applicable spread shock assumption under paragraph (c)(2) of this section. (2) Applicable spread shock assumption. The applicable spread shock is: (i) 0.0015 for a multifamily mortgage exposure; (ii) 0.0265 for a PLS; and (iii) 0.0100 for an MBS guaranteed by an Enterprise or by Ginnie Mae and secured by multifamily mortgage exposures (other than IO securities guaranteed by an Enterprise or Ginnie Mae). Subpart G—Stability Capital Buffer § 1240.400 Stability capital buffer. (a) Definitions. For purposes of this subpart: (1) Mortgage assets means, with respect to an Enterprise, the dollar amount equal to the sum of: (i) The unpaid principal balance of its single-family mortgage exposures, including any single-family loans that secure MBS guaranteed by the Enterprise; (ii) The unpaid principal balance of its multifamily mortgage exposures, including any multifamily mortgage exposures that secure MBS guaranteed by the Enterprise; (iii) The carrying value of its MBS guaranteed by an Enterprise or Ginnie Mae, PLS, and other securitization exposures (other than its retained CRT exposures); and (iv) The exposure amount of any other mortgage assets. (2) Residential mortgage debt outstanding means the dollar amount of mortgage debt outstanding secured by one- to four-family residences or PO 00000 Frm 00133 Fmt 4701 Sfmt 4702 39405 multifamily residences that are located in the United States (and excluding any mortgage debt outstanding secured by non-farm, non-residential or farm properties). (b) Amount. An Enterprise must calculate its stability capital buffer under this section on an annual basis by December 31 of each year. The stability capital buffer of an Enterprise is equal to: (1) The ratio of: (i) The mortgage assets of the Enterprise as of December 31 of the previous calendar year; to (ii) The residential mortgage debt outstanding as of December 31 of the previous calendar year, as published by FHFA; (2) Minus 0.05; (3) Multiplied by 5; (4) Divided by 100; and (5) Multiplied by the adjusted total assets of the Enterprise. (c) Effective date of an adjusted stability capital buffer—(1) Increase in stability capital buffer. An increase in the stability capital buffer of an Enterprise under this section will take effect (i.e., be incorporated into the maximum payout ratio under Table 1 to paragraph (b)(5) of § 1240.11) on January 1 of the year that is one full calendar year after the increased stability capital buffer was calculated. (2) Decrease in stability capital buffer. A decrease in the stability capital buffer of an Enterprise will take effect (i.e., be incorporated into the maximum payout ratio under Table 1 to paragraph (b)(5) of § 1240.11) on January 1 of the year immediately following the calendar year in which the decreased stability capital buffer was calculated. [Alternative Approach] § 1240.400 Stability capital buffer. (a) Amount. An Enterprise must calculate its stability capital buffer under this section on an annual basis by December 31 of each year. The stability capital buffer of an Enterprise is equal to: (1) Subject to paragraph (b) of this section, the GSIB surcharge as calculated under subpart H of 12 CFR 217 (expressed as a percent), as if the Enterprise were a globally systemic important BHC under 12 CFR 217.402; multiplied by (2) The weighted average of the risk weights of the mortgage exposures of the Enterprise (weighted by exposure amount) as of the effective date of the final rule; multiplied by (3) The adjusted total assets of the Enterprise. (b) Adjustment to systemic indicator score. In calculating the GSIB surcharge E:\FR\FM\30JNP2.SGM 30JNP2 39406 Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 / Proposed Rules khammond on DSKJM1Z7X2PROD with PROPOSALS2 under paragraph (a)(1) of this section, the Enterprise must: (1) Exclude from the sum of its systemic indicator scores the systemic indicators for substitutability (payments activity, assets under custody, and underwritten transactions in debt and equity markets) and cross-jurisdictional activity (cross-jurisdictional claims and cross-jurisdictional liabilities); and (2) Divide the sum of its systemic indicator scores, as adjusted under paragraph (b)(1) of this section, by the amount equal to 0.60. (c) Effective date of an adjusted stability buffer—(1) Increase in stability VerDate Sep<11>2014 19:00 Jun 29, 2020 Jkt 250001 capital buffer. An increase in the stability buffer of an Enterprise under this section will take effect (i.e., be incorporated into the maximum payout ratio under Table 1 to paragraph (b)(5) of § 1240.11) on January 1 of the year that is one full calendar year after the increased stability capital buffer was calculated. (2) Decrease in stability capital buffer. A decrease in the stability buffer of an Enterprise will take effect (i.e., be incorporated into the maximum payout ratio under Table 1 to paragraph (b)(5) of § 1240.11) on January 1 of the year immediately following the calendar year PO 00000 Frm 00134 Fmt 4701 Sfmt 9990 in which the decreased stability capital buffer was calculated. CHAPTER XII—FEDERAL HOUSING FINANCE AGENCY SUBCHAPTER C—SAFETY AND SOUNDNESS PART 1750—[REMOVED] ■ 6. Remove part 1750. Mark A. Calabria, Director, Federal Housing Finance Agency. [FR Doc. 2020–11279 Filed 6–29–20; 8:45 am] BILLING CODE 8070–01–P E:\FR\FM\30JNP2.SGM 30JNP2

Agencies

[Federal Register Volume 85, Number 126 (Tuesday, June 30, 2020)]
[Proposed Rules]
[Pages 39274-39406]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-11279]

[[Page 39273]]

Vol. 85

Tuesday,

No. 126

June 30, 2020

Part II

Federal Housing Finance Agency

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12 CFR Parts 1206, 1225, and 1240

Department of Housing and Urban Development

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Office of Federal Housing Enterprise Oversight

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12 CFR Part 1750

Enterprise Regulatory Capital Framework; Proposed Rule

Federal Register / Vol. 85, No. 126 / Tuesday, June 30, 2020 /
Proposed Rules

[[Page 39274]]

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FEDERAL HOUSING FINANCE AGENCY

12 CFR Parts 1206, 1225, and 1240

DEPARTMENT OF HOUSING AND URBAN DEVELOPMENT

Office of Federal Housing Enterprise Oversight

12 CFR Part 1750

RIN 2590-AA95

Enterprise Regulatory Capital Framework

AGENCY: Federal Housing Finance Agency; Office of Federal Housing
Enterprise Oversight.

ACTION: Notice of proposed rulemaking; request for comments.

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SUMMARY: The Federal Housing Finance Agency (FHFA or the Agency) is
seeking comments on a new regulatory capital framework for the Federal
National Mortgage Association (Fannie Mae) and the Federal Home Loan
Mortgage Corporation (Freddie Mac, and with Fannie Mae, each an
Enterprise). The proposed rule would also make conforming amendments to
definitions in FHFA's regulations for assessments and minimum capital
and would also remove the Office of Federal Housing Enterprise
Oversight's (OFHEO) regulation on capital for the Enterprises.

DATES: Comments must be received on or before August 31, 2020.

ADDRESSES: You may submit your comments on the proposed rule,
identified by regulatory information number (RIN) 2590-AA95, by any one
of the following methods:
Agency Website: www.fhfa.gov/open-for-comment-or-input.
Federal eRulemaking Portal: https://www.regulations.gov.
Follow the instructions for submitting comments. If you submit your
comment to the Federal eRulemaking Portal, please also send it by email
to FHFA at fhfa.gov">[email protected]fhfa.gov to ensure timely receipt by FHFA.
Include the following information in the subject line of your
submission: Comments/RIN 2590-AA95.
Hand Delivered/Courier: The hand delivery address is:
Alfred M. Pollard, General Counsel, Attention: Comments/RIN 2590-AA95,
Federal Housing Finance Agency, Eighth Floor, 400 Seventh Street SW,
Washington, DC 20219. Deliver the package at the Seventh Street
entrance Guard Desk, First Floor, on business days between 9 a.m. and 5
p.m.
U.S. Mail, United Parcel Service, Federal Express, or
Other Mail Service: The mailing address for comments is: Alfred M.
Pollard, General Counsel, Attention: Comments/RIN 2590-AA95, Federal
Housing Finance Agency, Eighth Floor, 400 Seventh Street SW,
Washington, DC 20219. Please note that all mail sent to FHFA via U.S.
Mail is routed through a national irradiation facility, a process that
may delay delivery by approximately two weeks. For any time-sensitive
correspondence, please plan accordingly.

FOR FURTHER INFORMATION CONTACT: Naa Awaa Tagoe, Senior Associate
Director, Office of Financial Analysis, Modeling & Simulations, (202)
649-3140, fhfa.gov">[email protected]fhfa.gov; Andrew Varrieur, Associate Director,
Office of Financial Analysis, Modeling & Simulations, (202) 649-3141,
fhfa.gov">[email protected]fhfa.gov; or Miriam Smolen, Associate General Counsel,
Office of General Counsel, (202) 649-3182, fhfa.gov">[email protected]fhfa.gov.
These are not toll-free numbers. The telephone number for the
Telecommunications Device for the Deaf is (800) 877-8339.

SUPPLEMENTARY INFORMATION:

Comments

FHFA invites comments on all aspects of the proposed rule and will
take all comments into consideration before issuing a final rule.
Copies of all comments will be posted without change, and will include
any personal information you provide such as your name, address, email
address, and telephone number, on the FHFA website at https://www.fhfa.gov. In addition, copies of all comments received will be
available for examination by the public through the electronic
rulemaking docket for this proposed rule also located on the FHFA
website.

Table of Contents

I. Introduction
II. Overview of the Proposed Rule
A. Regulatory Capital Requirements
B. Capital Buffers
C. Key Enhancements
D. Sizing of Regulatory Capital Expectations
1. Aggregate Regulatory Capital
2. 2018 Proposal's Capital Requirements
3. 2008 Financial Crisis Loss Experience
III. Background
A. Pre-Crisis Regulatory Capital Framework
B. Lessons of the 2008 Financial Crisis
1. Capital Adequacy
2. Going-Concern Standard
3. High-Quality Capital
4. Stability of the National Housing Finance Markets
C. Post-Crisis Changes to Regulatory Capital Frameworks
IV. Rationale for Re-Proposal
A. Responsibly Ending the Conservatorships
B. Ensuring Capital Adequacy
1. Quality of Capital
2. Quantity of Capital
C. Addressing Pro-Cyclicality
V. Definitions of Regulatory Capital
A. Statutory Definitions
B. Supplemental Definitions
1. Loss-Absorbing Capacity
2. Components of Regulatory Capital
3. Regulatory Adjustments and Deductions
VI. Capital Requirements
A. Risk-Based Capital Requirements
1. Supplemental Requirements
2. Risk-Weighted Assets
B. Leverage Ratio Requirements
1. Adjusted Total Assets
2. Tier 1 Leverage Ratio Requirement
3. Sizing of the Requirements
C. Enforcement
VII. Capital Buffers
A. Prescribed Capital Conservation Buffer Amount (PCCBA)
1. Stress Capital Buffer
2. Countercyclical Capital Buffer
3. Stability Capital Buffer
B. Leverage Buffer
C. Payout Restrictions
VIII. Credit Risk Capital: Standardized Approach
A. Single-Family Mortgage Exposures
1. Single-Family Business Models
2. Calibration Framework
3. Base Risk Weights
4. Countercyclical Adjustment
5. Risk Multipliers
6. Credit Enhancement Multipliers
7. Minimum Adjusted Risk Weight
B. Multifamily Mortgage Exposures
1. Multifamily Business Models
2. Calibration Framework
3. Base Risk Weights
4. Countercyclical Adjustment
5. Risk Multipliers
6. Minimum Adjusted Risk Weight
C. CRT and Other Securitization Exposures
1. Background
2. PLS and Other Non-CRT Securitization Exposures
3. Retained CRT Exposures
D. Other Exposures
1. Commitments and Other Off-Balance Sheet Exposures
2. Exposures to Sovereigns
3. Crossholdings of Enterprise MBS
4. Corporate Exposures
5. OTC Derivative Contracts
6. Cleared Transactions
7. Credit Risk Mitigation
IX. Credit Risk Capital: Advanced Approach
X. Market Risk Capital
A. Standardized Approach
1. Single Point Approach
2. Spread Duration Approach
3. Internal Models Approach
B. Advanced Approach
C. Market Risk Management
XI. Operational Risk Capital
XII. Impact of the Enterprise Capital Rule
A. Enterprise-Wide
B. Single-Family Business
C. Multifamily Business
D. Other Assets
XIII. Comparisons to the U.S. Banking Framework

[[Page 39275]]

XIV. Compliance Period
XV. Temporary Increases of Minimum Capital Requirements and Other
Conforming Amendments
XVI. Paperwork Reduction Act
XVII. Regulatory Flexibility Act
XVIII. Proposed Rule

I. Introduction

FHFA is seeking comments on a new regulatory capital framework for
the Enterprises. This notice of proposed rulemaking (proposed rule) is
a re-proposal of the regulatory capital framework set forth in the
notice of proposed rulemaking published in the Federal Register on July
17, 2018 (2018 proposal).\1\ The 2018 proposal, which remains the
foundation of the proposed rule, contemplated risk-based capital
requirements based on a granular assessment of credit risk specific to
different mortgage loan categories, as well as two alternatives for an
updated leverage ratio requirement. With this re-proposal, FHFA is
proposing enhancements to establish a post-conservatorship regulatory
capital framework that ensures that each Enterprise operates in a safe
and sound manner and is positioned to fulfill its statutory mission to
provide stability and ongoing assistance to the secondary mortgage
market across the economic cycle, in particular during periods of
financial stress.\2\
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\1\ FHFA Enterprise Capital Requirements, 83 FR 33312 (Jul. 17,
2018).
\2\ Other enhancements to the Enterprises' supervisory and
regulatory framework might also be necessary, for example with
respect to the Enterprises' liquidity risk management.
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Pursuant to the Federal Housing Enterprises Financial Safety and
Soundness Act of 1992 \3\ (Safety and Soundness Act), as amended by the
Housing and Economic Recovery Act of 2008 \4\ (HERA), the FHFA
Director's principal duties include, among other duties, ensuring that
each Enterprise operates in a safe and sound manner, that the
operations and activities of each Enterprise foster liquid, efficient,
competitive, and resilient national housing finance markets, and that
each Enterprise carries out its statutory mission only through
activities that are authorized under and consistent with the Safety and
Soundness Act and its charter.\5\ Pursuant to their charters, the
statutory purposes of the Enterprises are, among other purposes, to
provide stability in, and ongoing assistance to, the secondary market
for residential mortgages.\6\ Consistent with these statutory duties
and purposes, FHFA's enhancements contemplated by the proposed rule are
intended to achieve three primary objectives:
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\3\ Public Law 102-550, 106 Stat. 3941 (1992).
\4\ Public Law 110-289, 122 Stat. 2654 (2008).
\5\ 12 U.S.C. 4513(a)(1).
\6\ Id. sections 1451 note, 1716.
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Preserve the mortgage risk-sensitive framework of the 2018
proposal, with simplifications and refinements;
Increase the quantity and quality of the regulatory
capital of the Enterprises to ensure that, during and after
conservatorship, each Enterprise operates in a safe and sound manner
and is positioned to fulfill its statutory mission to provide stability
and ongoing assistance to the secondary mortgage market across the
economic cycle; and
Address the pro-cyclicality of the risk-based capital
requirements of the 2018 proposal, also in furtherance of the safety
and soundness of the Enterprises and their countercyclical mission.
FHFA believes it is important to re-propose the regulatory capital
framework to afford interested parties an opportunity to comment on the
enhancements contemplated by the proposed rule in its entirety in light
of FHFA's intent to responsibly end the conservatorships of the
Enterprises. This policy change is a departure from FHFA's stated
policy at the time of the 2018 proposal, when the prospects for
indefinite conservatorships might have informed the expectations of
interested parties, their decision to comment, and the nature of
comments submitted. Despite this, the comments received on the 2018
proposal were valuable and important. FHFA emphasizes that the purpose
of the proposed rule is to establish a regulatory capital framework
that ensures the safety and soundness of each Enterprise and its
ability to fulfill its statutory mission across the economic cycle.

II. Overview of the Proposed Rule

A. Regulatory Capital Requirements

In response to the comments and feedback on the 2018 proposal and
in furtherance of FHFA's stated objectives, the regulatory capital
framework contemplated by the proposed rule would require each
Enterprise to maintain the following risk-based capital:
Total capital not less than 8.0 percent of risk-weighted
assets, determined as described below;
Adjusted total capital not less than 8.0 percent of risk-
weighted assets;
Tier 1 capital not less than 6.0 percent of risk-weighted
assets; and
Common equity tier 1 (CET1) capital not less than 4.5
percent of risk-weighted assets.
Each Enterprise also would be required to satisfy the following
leverage ratios:
Core capital not less than 2.5 percent of adjusted total
assets; and
Tier 1 capital not less than 2.5 percent of adjusted total
assets.
Adjusted total assets would be defined as total assets under
generally accepted accounting principles (GAAP), with adjustments to
include certain off-balance sheet exposures. Total capital and core
capital would have the meaning given in the Safety and Soundness Act.
Adjusted total capital, tier 1 capital, and CET1 capital would be
defined based on the definitions of total capital, tier 1 capital, and
CET1 capital set forth in the regulatory capital framework (the Basel
framework) developed by the Basel Committee on Bank Supervision (BCBS)
that is the basis for the United States banking regulators' regulatory
capital framework (U.S. banking framework). These supplemental
regulatory capital definitions would fill certain gaps in the statutory
definitions of core capital and total capital by making customary
deductions and other adjustments for certain deferred tax assets
(DTAs), goodwill, intangibles, and other assets that tend to have less
loss-absorbing capacity during a financial stress.
To calculate its risk-based capital requirements, an Enterprise
would determine its risk-weighted assets under two approaches--a
standardized approach and an advanced approach--with the greater of the
two used to determine its risk-based capital requirements. Under both
approaches, an Enterprise's risk-weighted assets would equal the sum of
its credit risk-weighted assets, market risk-weighted assets, and
operational risk-weighted assets.
Under the standardized approach, the credit risk-weighted assets
for mortgage loans secured by 1-4 unit residences (single-family
mortgage exposures) and mortgage loans secured by five or more unit
residences (multifamily mortgage exposures) would be determined using
lookup grids and multipliers that assign an exposure-specific risk
weight based on the risk characteristics of the mortgage exposure. The
underlying exposure-specific credit risk capital requirements generally
would be similar to those in the grids and multipliers of the 2018
proposal, subject to some simplifications and refinements discussed in
Sections VIII.A and VIII.B.\7\
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\7\ This base risk weight would be equal to the unadjusted
credit risk capital requirement for the mortgage exposure expressed
in basis points and divided by 800, which is the 8.0 percent
adjusted total capital requirement also expressed in basis points.
For example, the credit risk capital requirement for a mortgage
exposure with a base risk weight of 50 percent would be 400 basis
points (800 multiplied by 50 percent).

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[[Page 39276]]

Like the 2018 proposal, the base risk weight would be a function of
the mortgage exposure's loan-to-value (LTV) ratio with the property
value generally marked to market (MTMLTV). For single-family mortgage
exposures, the MTMLTV would be subject to a countercyclical adjustment
to the extent that national house prices are 5.0 percent greater or
less than an inflation-adjusted long-term trend. For both single-family
and multifamily mortgage exposures, this base risk weight would then be
adjusted to reflect additional risk attributes of the mortgage exposure
and any loan-level credit enhancement, with the associated risk
multipliers also generally similar to those of the 2018 proposal. To
ensure an appropriate level of capital, this adjusted risk weight would
be subject to a minimum floor of 15 percent.
As of September 30, 2019, under the proposed rule's standardized
approach, the Enterprises' average risk weight for single-family
mortgage exposures would have been 26 percent, and the Enterprises'
average risk weight for multifamily mortgage exposures would have been
51 percent.\8\ The average risk weights for single-family and
multifamily mortgage exposures originated and acquired by an Enterprise
in the previous six months would have been approximately 36 percent and
67 percent, respectively.\9\
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\8\ These average risk weights are determined based on the
credit risk capital requirement for single-family and multifamily
mortgage exposures after adjustments for mortgage insurance and
other loan-level credit enhancement but before any adjustment for
credit risk transfers.
\9\ While not shown, new originations are a subset of the
mortgage exposures included in Tables 26 and 29.
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While the standardized approach would utilize FHFA-prescribed
lookup grids and risk multipliers, the advanced approach for credit
risk-weighted assets would rely on each Enterprise's internal models.
The advanced approach requirements would require each Enterprise to
maintain its own processes for identifying and assessing credit risk,
market risk, and operational risk. These requirements should ensure
that each Enterprise continues to enhance its risk management system
and also that neither Enterprise simply relies on the standardized
approach's lookup grids and multipliers to define credit risk
tolerances, measure its credit risk, or allocate capital. In the course
of FHFA's supervision of each Enterprise's internal models for credit
risk, FHFA also could identify opportunities to update or otherwise
enhance the standardized approach's lookup grids and multipliers in a
future rulemaking.
Under both the standardized and advanced approaches, an Enterprise
would determine the capital treatment for eligible credit risk
transfers (CRT) under a securitization framework by assigning risk
weights to retained CRT exposures. Under the standardized approach,
tranche-specific risk weights would be subject to a 10 percent floor.
The proposed rule seeks comment on two approaches to determining the
risk-weighted assets for retained CRT exposures, one of which
contemplates adjustments to the exposure amounts of the retained CRT
exposures to reflect counterparty risk, loss timing risk, and a general
adjustment for the differences between CRT and regulatory capital, and
the other of which is based on the U.S. banking framework.
Each Enterprise also would determine a market risk capital
requirement for spread risk. Market risks other than spread risk would
not be assigned a market risk capital requirement, but FHFA is seeking
comment on more comprehensive approaches. Under the standardized
approach, an Enterprise would determine its market risk-weighted assets
using FHFA-specified formulas for some covered positions and its own
models for other covered positions. An Enterprise would separately
determine its market risk-weighted assets under an advanced approach
that relies only on its own internal models for all covered positions.
The proposed rule also would require each Enterprise to determine
its operational risk capital requirement utilizing the U.S. banking
framework's advanced measurement approach, subject to a floor equal to
15 basis points of the Enterprise's adjusted total assets.
Each of these risk-based and leverage ratio requirements would be
enforceable by FHFA under its general authority to order an Enterprise
to cease and desist from a violation of law, which would include the
proposed rule and its regulatory capital requirements. Pursuant to that
authority, FHFA may require an Enterprise to develop and implement a
capital restoration plan or take other appropriate corrective action.
FHFA also could elect to enforce the risk-based and leverage ratio
requirements pursuant to its authority to require an Enterprise to
develop a plan to achieve compliance with prescribed prudential
management and operational standards, and FHFA also could enforce the
core capital leverage ratio requirement or the risk-based total capital
requirement pursuant to its separate authority to require prompt
corrective action if an Enterprise fails to maintain certain prescribed
regulatory levels.

B. Capital Buffers

To avoid limits on capital distributions and discretionary bonus
payments, an Enterprise would have to maintain regulatory capital that
exceeds each of its adjusted total capital, tier 1 capital, and CET1
capital requirements by at least the amount of its prescribed capital
conservation buffer amount (PCCBA). That PCCBA would consist of three
separate component buffers--a stress capital buffer, a countercyclical
capital buffer, and a stability capital buffer.
The stress capital buffer would be 0.75 percent of the
Enterprise's adjusted total assets, with this buffer in effect
replacing the 2018 proposal's going-concern buffer. The 2018 proposal's
going-concern buffer was a part of the Enterprise's total capital
requirement, such that an Enterprise would be subject to enforcement
action if it drew down this going-concern buffer. In contrast, under
the proposed rule, drawing down the stress capital buffer generally
would trigger only limits on capital distributions and discretionary
bonus payments. By prescribing less severe sanctions for drawing down
this buffer during a period of financial stress, the proposed rule's
approach should help position an Enterprise to fulfill its statutory
mission across the economic cycle and also dampen the pro-cyclicality
of the aggregate risk-based capital requirements. FHFA is also seeking
comment on whether to periodically re-size the stress capital buffer,
similar to the approach recently adopted by the U.S. banking
regulators,\10\ to the extent that FHFA's eventual program for
supervisory stress tests determines that an Enterprise's peak capital
exhaustion under a severely adverse stress would exceed 0.75 percent of
adjusted total assets.
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\10\ See e.g. Federal Reserve Board Regulations Q, Y, and YY:
Regulatory Capital, Capital Plan, and Stress Test Rules Final Rule,
85 FR 15576 (Mar. 18, 2020).
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The countercyclical capital buffer amount initially would
be set at 0 percent of the Enterprise's adjusted total assets. FHFA
does not expect to adjust this buffer in the place of, or to
supplement, the countercyclical adjustment to the risk-based capital
requirements. Instead, as under the Basel and U.S. banking frameworks,
FHFA would adjust the countercyclical capital buffer taking into
account the macro-financial environment in which the Enterprises
operate, such that it

[[Page 39277]]

would be deployed only when excess aggregate credit growth is judged to
be associated with a build-up of system-wide risk. This focus on excess
aggregate credit growth means the countercyclical buffer likely would
be deployed on an infrequent basis, and generally only when similar
buffers are deployed by the U.S. banking regulators.
An Enterprise's stability capital buffer would be tailored
to the risk that the Enterprise's default or other financial distress
could have on the liquidity, efficiency, competitiveness, or resiliency
of national housing finance markets. FHFA is proposing a stability
capital buffer based on the Enterprise's share of residential mortgage
debt outstanding, and seeking comment on an alternative based on the
U.S. banking framework's methodology. Under either methodology, the
stability capital buffer would be a percent of adjusted total assets.
Under the market share approach, as of September 30, 2019, Freddie
Mac's and Fannie Mae's stability capital buffers would have been,
respectively, 0.64 and 1.05 percent of adjusted total assets.
Fixing the PCCBA at a specified percent of an Enterprise's adjusted
total assets, instead of risk-weighted assets, is a notable departure
from the Basel framework. FHFA intends a fixed-percent PCCBA, among
other things, to reduce the impact that the PCCBA potentially could
have on higher risk exposures, to avoid amplifying the secondary
effects of any model or similar risks inherent to the calibration of
granular risk weights for mortgage exposures, and to further mitigate
the pro-cyclicality of the aggregate risk-based capital requirements.
Finally, to avoid limits on capital distributions and discretionary
bonus payments, the Enterprise also would be required to maintain tier
1 capital in excess of the amount required under its tier 1 leverage
ratio requirement by at least the amount of its prescribed leverage
buffer amount (PLBA). The PLBA would equal 1.5 percent of the
Enterprise's adjusted total assets, such that the PLBA-adjusted
leverage ratio requirement would remain a credible backstop to the
PCCBA-adjusted risk-based capital requirements.

C. Key Enhancements

The proposed rule contemplates a number of key enhancements to the
2018 proposal, including:
Simplifications and refinements of the grids and risk
multipliers for the credit risk capital requirements for single-family
mortgage exposures, including removal of the single-family risk
multipliers for loan balance and the number of borrowers.
A countercyclical adjustment to the credit risk capital
requirements for single-family mortgage exposures.
A prudential floor on the credit risk capital requirement
for mortgage exposures.
Refinements to the capital treatment of CRT structures,
including a minimum capital requirement on senior tranches of CRT
retained by an Enterprise and an adjustment to reflect that CRT does
not have the same loss-absorbing capacity as equity capital.
The addition of a credit risk capital requirement for
Enterprise crossholdings of mortgage-backed securities (MBS).
Risk-based capital requirements for a number of other
exposures not explicitly addressed by the 2018 proposal.
Supplemental capital requirements based on the Basel
framework's definitions of total capital, tier 1 capital, and CET1
capital.
Capital buffers that would subject an Enterprise to
increasing limits on capital distributions and discretionary bonus
payments to the extent that its regulatory capital falls below the
prescribed buffer amounts.
A stability capital buffer tailored to the risk that an
Enterprise's default or other financial distress could have on the
liquidity, efficiency, competitiveness, and resiliency of national
housing finance markets.
A revised method for determining operational risk capital
requirements, as well as a higher floor.
A requirement that each Enterprise maintain internal
models for determining its own estimates of risk-based capital
requirements.

D. Sizing of Regulatory Capital Expectations

1. Aggregate Regulatory Capital
Table 1 details how much regulatory capital the Enterprises
together would have been required to maintain under the proposed rule
as of September 30, 2019 to avoid restrictions on capital distributions
and discretionary bonus payments.\11\
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\11\ The analogous breakdown of requirements by Enterprise is
included in Section XII.A.

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[GRAPHIC] [TIFF OMITTED] TP30JN20.000

Table 1 shows a combined Enterprise statutory total risk-based
capital requirement of $135 billion (8 percent of risk-weighted
assets). The statutory risk-based capital framework does not include
any capital buffers. In contrast, the supplementary risk-based capital
framework includes three capital requirements (CET1, tier 1, and
adjusted total capital) along with three capital buffers
(countercyclical, stress capital, and stability) that comprise the
PCCBA. While the capital buffers are not strictly a capital
requirement, they would materially increase the regulatory capital that
each Enterprise would have to maintain to avoid restrictions on capital
distributions and discretionary bonuses.
Focusing on high-quality capital, the combined Enterprise CET1
capital requirement was $76 billion (4.5 percent of risk-weighted
assets), the tier 1 capital requirement was $101 billion (6 percent of
risk-weighted assets), and the adjusted total capital requirement was
$135 billion (8 percent of risk-weighted assets). The combined PCCBA
was $99 billion, comprising the $46 billion stress capital buffer, $53
billion stability capital buffer, and $0 countercyclical capital
buffer. The capital requirements and PCCBA totaled $175 billion for
CET1 capital, $200 billion for tier 1 capital, and $234 billion for
adjusted total capital. A more nuanced look at the importance of high-
quality capital, and specifically how the Enterprises' supplemental
capital measures would have evolved in relation to their statutory
capital measures leading up to the 2008 financial crisis, is included
in Section III.B.3.
Table 1 then shows a combined leverage ratio requirement of $152
billion under the proposed rule. Both the core capital and
supplementary tier 1 leverage ratio requirements are equal to 2.5
percent of adjusted total assets, so there is no difference between the
two leverage ratio requirements. However, there are important
differences between core capital and tier 1 capital related to the
loss-absorbing capacity of each capital metric, as discussed in Section
V.B.
The supplementary framework also includes a tier 1 capital PLBA
equal to 1.5 percent of adjusted total assets, or $91 billion for the
Enterprises combined. In aggregate, the Enterprises' combined tier 1
leverage ratio requirement and PLBA would have been $243 billion as of
September 30, 2019.
2. 2018 Proposal's Capital Requirements
Table 2 presents estimates of the Enterprises' combined regulatory
capital under the proposed rule broken out by risk category and asset
category as of September 30, 2019. Table 2 also presents estimates of
the Enterprises' combined capital requirements under the 2018 proposal,
both as of September 30, 2017--the as-of date in the 2018 proposal--and
as of September 30, 2019.\12\
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\12\ A more detailed walk-forward from the capital requirements
in the 2018 proposal to the capital requirements under the proposed
rule is presented for each Enterprise in Section XII.

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Table 2 shows an estimated combined risk-based capital requirement
of $135.1 billion, or 2.22 percent of the Enterprises' adjusted total
assets, under the proposed rule as of September 30, 2019, then provides
a further breakdown by risk category. Net credit risk capital accounts
for $134.9 billion before CRT and $112.8 billion after CRT, market risk
capital accounts for $13.6 billion, and operational risk capital
accounts for $8.7 billion. The DTA requirement is zero as of September
30, 2019.
Using the same September 30, 2019 portfolio date, the combined
risk-based capital requirement under the 2018 proposal would have been
similar to the combined risk-based capital requirement under the
proposed rule. The differences in required regulatory capital between
the two proposals are in post-CRT net credit risk capital (+45.0
billion), removal of the going-concern buffer (-$43.5 billion),
operational risk (+$4.1 billion), and DTA (-$7.4 billion). The capital
requirement for market risk was unchanged. Primary drivers of the $45.0
billion increase in post-CRT net credit risk capital are a new
prudential floor on the credit risk capital requirement for mortgage
exposures and refinements to the capital treatment of CRT structures,
including a minimum capital requirement on senior tranches of CRT
retained by an Enterprise. A caveat to this comparison is that the 2018
proposal increased the total capital requirement by a DTA offset, while
the proposed rule, consistent with the Basel framework, proposes
instead to deduct the amount of that DTA offset from CET1 capital (and
therefore tier 1 and adjusted total capital). The 2018 proposal's
$136.9 billion combined risk-based capital requirement would have been,
in effect, $129.5 billion under the DTA approach of the proposed rule.
In contrast to the 2018 proposal, the proposed rule includes a set
of three buffers that would materially increase the regulatory capital
that each Enterprise would have to maintain to avoid restrictions on
capital distributions and discretionary bonuses. The proposed rule's
stress capital buffer of $45.5 billion replaces the 2018 proposal's
$43.5 billion going-concern buffer, and is complemented by the
stability capital buffer of $53.3 billion and the countercyclical
capital buffer that is currently set to zero. The three buffers in
aggregate form the PCCBA, which totals $98.8 billion for the
Enterprises combined, or 1.63 percent of the adjusted total assets. The
aggregate risk-based capital requirement and PCCBA is a combined $234.3
billion under the proposed rule, or 3.86 percent of the Enterprises'
adjusted total assets.

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Table 3 again shows an estimated combined risk-based capital
requirement of $135.1 billion, or 2.22 percent of the Enterprises'
adjusted total assets under the proposed rule as of September 30, 2019,
then provides a further breakdown by asset category. The Enterprises'
combined risk-based capital requirement for single-family mortgage
exposures is $111.0 billion under the proposed rule, while the combined
risk-based capital requirement for multifamily mortgage exposures is
$17.8 billion. In addition, the combined risk-based capital
requirements for DTA and other assets under the proposed rule is zero
and $6.3 billion, respectively.
Excluding the going-concern buffer, which was a capital requirement
in the 2018 proposal but has been replaced by the stress capital buffer
in the proposed rule, the combined risk-based capital requirements
under the 2018 proposal for the single-family and multifamily
businesses were $67.8 billion and $12.2 billion, respectively, as of
September 30, 2019. As discussed above and shown in Table 3, the
enhancements in the proposed rule would have increased the required
capital for single-family assets and multifamily assets by $43.2
billion and $5.6 billion, respectively. Similarly, the risk-based
capital requirement for other assets has increased by $0.2 billion.
Finally, the risk-based capital requirement for DTA decreased by $7.4
billion in the proposed rule due to its new capital treatment.
The pro-cyclicality of the 2018 proposal's risk-based capital
requirements complicates comparisons to the proposed rule. Under the
2018 proposal, the Enterprises would have likely found it necessary to
maintain a considerable capital surplus in anticipation of a financial
stress. One Enterprise's comment letter suggested that its total
capital requirement would be expected to increase as much as 80

[[Page 39281]]

percent in a severely adverse stress.\13\ The amount of this managerial
cushion would have depended on the extent to which the Enterprises
viewed it to be potentially costly or difficult to raise new capital in
the midst of a financial stress.\14\ The 2018 proposal's enforcement
framework amplified the necessity of a managerial cushion by
incorporating the going-concern buffer into the capital requirements, a
violation of which could trigger significant regulatory sanctions. In
contrast, the proposed rule converts the going-concern buffer into a
stress capital buffer that an Enterprise may draw down during a period
of financial stress. Because a managerial cushion in anticipation of an
eventual stress would have been a practical, if not legal, necessity
for the Enterprises, comparisons to the 2018 proposal should start with
a reasonable assumption regarding the amount of this capital
surplus.\15\
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\13\ See Comment Letter from Fannie Mae at 2 (Nov. 15, 2018).
\14\ Id. at 2 (``To ensure adequate capital in such a scenario,
any Regulated Institution would need to hold a sizeable capital
surplus during more normal economic environments. The need for such
a surplus is real, because consistent with their mission, the
Regulated Institutions must maintain a constant presence in the
housing market and would want to avoid being forced to raise capital
in times of stress.'').
\15\ On the one hand, the managerial cushion likely to be held
by an Enterprise to mitigate the problem of having to raise
regulatory capital in a period of financial stress could be
considered a mitigant to safety and soundness risk. On the other
hand, significant reductions in credit risk capital requirements due
to sustained periods of house price growth and favorable economic
conditions could contribute to safety and soundness risk.
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FHFA is cognizant that the leverage ratio requirements would
currently exceed the risk-based capital requirements. FHFA has settled
on this calibration of the leverage ratio requirements after
considerable deliberation. The leverage ratio requirements are intended
to serve as non-risk-based measures that provide a credible backstop to
the risk-based capital requirements to safeguard against model risk and
measurement error with a simple, transparent, independent measure of
risk. The leverage ratio requirements would have the added benefit of
dampening some of the pro-cyclicality inherent in the risk-based
capital requirements. As discussed in Section VI.B.3, FHFA has sized
the leverage ratio requirements to be a credible backstop to the risk-
based capital requirements, taking into account considerations relating
to the Enterprises' historical loss experiences, the model and related
risks posed by the calibration of the risk-based capital requirements,
and the analogous leverage ratio requirements under the U.S. banking
framework and of the Federal Home Loan Banks. If the leverage ratio
requirements are to be a credible backstop, there will inevitably be
periods when leverage ratio requirements require more regulatory
capital than the risk-based capital requirements, as is the case as of
September 30, 2019. FHFA believes that mortgage market conditions as of
September 30, 2019 reflect circumstances consistent with a period under
which a credible leverage ratio would be binding, given the exceptional
single-family house price appreciation since 2012, the unemployment
rate at an historically low level, the strong credit performance of
mortgage exposures as of that time, the significant progress by the
Enterprises to materially reduce legacy exposure to non-performing
loans (NPLs) and re-performing loans, robust CRT market access enabling
substantial risk transfer, and the generally strong condition of key
counterparties, such as mortgage insurers.
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\16\ In 2008, the entire net worth of both Enterprises was
depleted by losses. The U.S. Department of the Treasury (Treasury
Department) invested in senior preferred stock of both Enterprises
to offset the losses. Fannie Mae drew $116 billion from the Treasury
between 2008 and the fourth quarter of 2011, while Freddie Mac drew
$71 billion between 2008 and the first quarter of 2012.
\17\ Peak cumulative capital losses are defined as cumulative
losses, net of revenues earned, between 2008 and the respective date
at which an Enterprise no longer required draws under the PSPA.
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3. 2008 Financial Crisis Loss Experience \16\
This section examines the peak cumulative capital losses of each
Enterprise relative to several different regulatory capital metrics:
The statutory risk-based and leverage ratio requirements applicable to
the Enterprise in 2007; the aggregate risk-based capital (requirement
plus the PCCBA) under the proposed rule but without the contemplated
single-family countercyclical adjustment; and the aggregate leverage
capital (requirement plus the PLBA) under the proposed rule but without
the contemplated single-family countercyclical adjustment.\17\ As
discussed in Section IV.B.2, under the 2018 proposal, Fannie Mae's and
Freddie Mac's peak losses would have left, respectively, only $3
billion and $12 billion in remaining capital, not enough to have
sustained the market confidence necessary for either Enterprise to
continue as a going concern.

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Table 4 shows that as of December 31, 2007, Fannie Mae's statutory
risk-based capital requirement was $25 billion, or 0.8 percent of
adjusted total assets. The Enterprise's statutory minimum leverage
ratio requirement was $42 billion, or 1.4 percent of adjusted total
assets. For comparison, as of the same date, Fannie Mae's proposed
risk-based measures (adjusted total capital requirement plus PCCBA)
would have been $209 billion or 6.9 percent of adjusted total assets,
and the proposed leverage measures (leverage ratio requirement plus
PLBA) would have been $122 billion or 4.0 percent of adjusted total
assets. While the leverage measure would have fallen $45 billion short
of Fannie Mae's peak cumulative capital losses of $167 billion (5.5
percent of adjusted total assets), the proposed risk-based measures
would have exceeded those peak losses by $42 billion. These comparisons
are subject to the caveat that Fannie Mae's $167 billion in peak
cumulative capital losses include a valuation allowance on DTAs of $64
billion. Because much of Fannie Mae's DTAs would have been deducted
from adjusted total capital and tier 1 capital, the adjusted total
capital and tier 1 capital that actually would have been exhausted
during the 2008 financial crisis would have been considerably less than
the $167 billion in peak cumulative capital losses reflected in Table
4.

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[GRAPHIC] [TIFF OMITTED] TP30JN20.004

Table 5 shows that as of December 31, 2007, Freddie Mac's statutory
risk-based capital requirement was $14 billion, or 0.6 percent of
adjusted total assets. The Enterprise's statutory minimum leverage
ratio requirement was $34 billion, or 1.6 percent of adjusted total
assets. For comparison, as of the same date, Freddie Mac's proposed
risk-based measures (adjusted total capital requirement plus PCCBA)
would have been $128 billion or 5.9 percent of adjusted total assets,
and the proposed leverage measures (leverage ratio requirement plus
PLBA) would have been $87 billion or 4.0 percent of adjusted total
assets. While the leverage measure would have fallen $11 billion short
of Freddie Mac's peak cumulative capital losses of $98 billion (4.5
percent of adjusted total assets), the proposed risk-based measures
would have exceeded those peak losses by $30 billion. These comparisons
are subject to the caveat that Freddie Mac's $98 billion in peak
cumulative capital losses include a valuation allowance on DTAs of $34
billion. Because much of Freddie Mac's DTAs would have been deducted
from adjusted total capital and tier 1 capital, the adjusted total
capital and tier 1 capital that actually would have been exhausted
during the 2008 financial crisis would have been considerably less than
the $98 billion in peak cumulative capital losses reflected in Table 5.
As discussed in Section VIII.A.4, FHFA is proposing that the base
risk weights for single-family mortgage exposures would be subject to a
countercyclical adjustment due to MTMLTV adjustments an Enterprise
would be required to make when national house prices deviate by more
than 5.0 percent above or below an estimated inflation-adjusted long-
term trend. It is important to note that any additional regulatory
capital that would have been required under the proposed single-family
countercyclical adjustment is not included in the estimates of
regulatory capital in either Tables 4 or 5. Looking back, it is likely
that, given the considerable house price appreciation in the decade
before the financial crisis, this countercyclical adjustment would have
been in effect as of December 31, 2007. However, there are too many
unknowns to quantify with any reasonable degree of certainty what that
effect would have been, how the Enterprises' actions might have changed
because of it, and how changes in the actions of the Enterprises might
have affected the overall market. Therefore, FHFA is presenting the
estimates without including a countercyclical adjustment, and
acknowledging that with the countercyclical adjustment in place, the
Enterprises would likely have had an even larger capital surplus
relative to their peak cumulative capital losses than is presented in
Tables 4 and 5.

III. Background

A. Pre-Crisis Regulatory Capital Framework

The Safety and Soundness Act established FHFA's predecessor agency,
the Office of Federal Housing Enterprise Oversight (OFHEO), as the
safety and soundness regulator of the Enterprises. As originally
enacted, the Safety and Soundness Act specified a minimum capital
requirement for the Enterprises

[[Page 39284]]

in the form of a leverage ratio requirement set in statute at an amount
equal to the sum of 2.5 percent of on-balance sheet assets and 0.45
percent of credit guarantees of MBS held by outside investors. OFHEO
did not have the authority to adjust this minimum capital requirement.
The Safety and Soundness Act also required OFHEO to establish by
regulation a risk-based capital stress test such that each Enterprise
could survive a ten-year period with credit losses arising out of a
prolonged regional stress \18\ and large movements in interest
rates.\19\ Over a 7-year period, OFHEO issued a series of Federal
Register notices to solicit public comments on the risk-based capital
stress test regulation, eventually finalizing the rule in 2001. The
final risk-based capital requirements, however, had little practical
impact. The capital required under the statutory leverage ratio
requirement consistently exceeded the capital required under OFHEO's
risk-based regulation, in large part due to the prescriptive
restrictions imposed by statute on the underlying stress scenario and
also due to model risk-related failures to update the underlying data
and model calibrations.\20\ This pre-crisis regulatory capital
framework would soon prove inadequate.
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\18\ The statutory stress scenarios contemplated a period in
which ``losses occur throughout the United States at a rate of
default and severity (based on any measurements of default
reasonably related to prevailing practice for that industry in
determining capital adequacy) reasonably related to the rate and
severity that occurred in contiguous areas of the United States
containing an aggregate of not less than 5 percent of the total
population of the United States that, for a period of not less than
2 years, experienced the highest rates of default and severity of
mortgage losses, in comparison with such rates of default and
severity of mortgage losses in other such areas for any period of
such duration.'' Safety and Soundness Act section 1361(a) (as in
effect before amended by HERA).
\19\ The statutory stress scenarios contemplated two periods:
(i) A period in which the 10-year Treasury yield decreased to the
lesser of 600 basis points below the average yield during the
preceding 9 months or 60 percent of the average yield during the
preceding three years; and (ii) a period in which the 10-year
Treasury yield increased to the greater of 600 basis points above
the average yield during the preceding 9 months or 160 percent of
the average yield during the preceding three years. Id.
\20\ See W. Scott Frame et al, The Failure of Supervisory Stress
Testing: Fannie Mae, Freddie Mac, and OFHEO (Working Paper 2015-3)
at 3, available at https://www.frbatlanta.org/-/media/documents/research/publications/wp/2015/03.pdf.
---------------------------------------------------------------------------

B. Lessons of the 2008 Financial Crisis

Starting in 2006, house prices in some regional markets began to
decline, mortgage defaults began to rise, and the Enterprises began to
incur credit and mark-to-market losses. In 2007, housing price declines
spread across the nation, and issuances of private-label securities
(PLS) largely ceased. The Enterprises' losses continued to mount into
2008, their share prices rapidly fell, and the spreads on their
unsecured debt and mortgage-backed securities (MBS) widened.
In July 2008, following growing concern about the Enterprises'
solvency, Congress passed HERA, establishing FHFA as the regulator for
the Enterprises and authorizing the Treasury Department to support the
Enterprises through purchases of their obligations and other
securities. On September 6, 2008, FHFA used its new authorities under
HERA to place each Enterprise into conservatorship. The next day, the
Treasury Department exercised its HERA authority to enter into Senior
Preferred Stock Purchase Agreements (each a PSPA) to support the
Enterprises. The Enterprises ultimately required $191.5 billion in cash
draws from the Treasury Department under the PSPAs.
1. Capital Adequacy
The scale of the Enterprises' capital exhaustion during the 2008
financial crisis is critically relevant to the capital necessary to
ensure that each Enterprise operates in a safe and sound manner and is
positioned to fulfill its statutory mission across the economic cycle.
As discussed in Section II.D.3, the Enterprises' crisis-era
cumulative capital losses peaked at $265 billion, approximately 4.8
percent of their total assets as of December 31, 2007. Setting aside
the valuation allowances on their DTAs, which are subject to deductions
and other adjustments to regulatory capital under the proposed rule,
the Enterprises' peak cumulative capital losses were $167 billion,
approximately 3.0 percent of their total assets as of December 31,
2007.
The Enterprises' crisis-era cumulative capital losses, while
significant, could have been greater. The Enterprises' losses were
likely mitigated by unprecedented federal government support of the
housing market and the economy during the crisis, including the Home
Affordable Modification Program, the Troubled Asset Relief Program, the
2009 stimulus package,\21\ and the Federal Reserve System's purchases
of more than $1.2 trillion of the Enterprises' debt and MBS from
January 2009 to March 2010. The Enterprises' losses also were likely
dampened by the declining interest rate environment of the period, when
the interest rates on 30-year fixed-rate mortgage loans declined by
approximately 200 basis points through the end of 2011, facilitating
re-financings and loss mitigation programs.\22\
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\21\ See American Recovery and Reinvestment Act of 2009, Public
Law 111-5, 123 Stat. 115 (2009).
\22\ The average interest rate on 30-year mortgage loans was
approximately 6.14 percent at the end of 2007, and fell to 4.2
percent toward the end of October 2011. Over this period, yields on
10-year Treasuries fell from approximately 3.88 percent at the end
of 2008 to 2.06 percent at the end of October 2011.
---------------------------------------------------------------------------

The Enterprises did later recoup a portion of the underlying
valuation adjustments and other losses. However, peak cumulative
capital losses are relevant to assessing the amount of capital that
creditors and other counterparties would require to regard the
Enterprises as viable going concerns throughout the duration of another
severe economic downturn. Indeed, the Enterprises were still operating
and able to recoup some of these losses only because the Treasury
Department's support through the PSPAs kept them solvent going
concerns.
2. Going-Concern Standard
The Enterprises' crisis-era funding difficulties established that
each Enterprise must be capitalized to remain a viable going concern
both during and after a severe economic downturn. Calibrating capital
adequacy based on ``claims paying capacity'' or an insurance-like or
similar standard that does not emphasize a going-concern standard is
inconsistent with this lesson of the crisis in at least two respects.
First, the Enterprises fund themselves with a significant amount of
short-term unsecured debt that must be regularly refinanced. Each
Enterprise's funding needs are very likely to increase during an
economic downturn, all else equal, as the Enterprise funds purchases of
NPLs out of securitization pools. This is a funding need that peaked at
$345 billion in 2010.
These ordinary course and pro-cyclical funding needs can be met
only if the Enterprise continues to be regarded as a viable going
concern by creditors throughout the duration of a financial stress.
Creditors will be most skeptical of an Enterprise's continued solvency
during periods of market turmoil, and it was the increase in the
Enterprises' borrowing costs and the associated difficulties that the
Enterprises faced in refinancing their debt that were among the most
immediate grounds for FHFA placing the Enterprises into
conservatorship.\23\
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\23\ See Memorandum dated September 6, 2008 re: Proposed
Appointment of the Federal Housing Finance Agency as Conservator for
the Fannie Mae at 29 (``The Enterprise's practice of relying upon
repo financing of its agency collateral to raise cash in the current
credit and liquidity environment is an unsafe or unsound practice
that has led to an unsafe or unsound condition, given the
unavailability of willing lenders to provide secured financing in
significant size to reduce pressure on its discount notes
borrowings.''); and Memorandum dated September 6, 2008 re: Proposed
Appointment of the Federal Housing Finance Agency as Conservator for
the Freddie Mac at 28 (``The Enterprise's prolonged reliance almost
exclusively on 30-day discount notes is an untenable long-term
source of funding and an unsafe or unsound practice that poses
abnormal risk to the viability of the Enterprise. Operating without
an adequate liquidity funding contingency plan is an unsafe or
unsound condition to transact business.''); and Fin. Crisis Inquiry
Comm'n, The Financial Crisis Inquiry Report: Final Report of the
National Commission on the Causes of the Financial and Economic
Crisis in the United States at 316 (2011) (the FCIC Report),
available at https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf; (``In July and August 2008, Fannie suffered a liquidity
squeeze, because it was unable to borrow against its own securities
to raise sufficient cash in the repo market.''); see id. at 316
(``By June 2008, the spread [between the yield on the GSEs' long-
term bonds and rates on Treasuries] had risen 65 percent over the
2007 level; by September 5, just before regulators parachuted in,
the spread had nearly doubled from its 2007 level to just under 1
percent, making it more difficult and costly for the GSEs to fund
their operations.'').

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[[Page 39285]]

Second, only a going-concern capital adequacy standard can ensure
that each Enterprise will be positioned to fulfill its statutory
mission to provide stability and ongoing assistance to the secondary
mortgage market across the economic cycle. The Enterprises were not
positioned to effectively support the secondary mortgage market as
their financial conditions deteriorated in 2007 and 2008.\24\ In an
attempt to enable the Enterprises to continue to support the secondary
mortgage market, OFHEO relaxed the mortgage portfolio caps and reduced
a capital buffer that had been imposed by consent order.\25\
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\24\ See FCIC Report at 311, available at https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf; (``Few
doubted Fannie and Freddie were needed to support the struggling
housing market. The question was how to do so safely. Purchasing and
guaranteeing risky mortgage-backed securities helped make money
available for borrowers, but it could also result in further losses
for the two huge companies later on. `There's a real tradeoff,'
Lockhart said in late 2007--a trade-off made all the more difficult
by the state of the GSEs' balance sheets.'''); Statement of FHFA
Director James B. Lockhart at News Conference Announcing
Conservatorship of Fannie Mae and Freddie Mac (Sept. 7, 2008),
available at https://www.fhfa.gov/Media/PublicAffairs/Pages/
Statement-of-FHFA-Director-James-B_Lockhart-at-News-Conference-
Annnouncing-Conservatorship-of-Fannie-Mae-and-Freddie-Mac.aspx;
(``Unfortunately, as house prices, earnings and capital have
continued to deteriorate, their ability to fulfill their mission has
deteriorated . . . . The result has been that they have been unable
to provide needed stability to the market. They also find themselves
unable to meet their affordable housing mission.''); id. (``The lack
of confidence has resulted in continuing spread widening of their
MBS, which means that virtually none of the large drop in interest
rates over the past year has been passed on to the mortgage
markets.'').
\25\ News Release, OFHEO, Fannie Mae and Freddie Mac Announce
Initiative to Increase Mortgage Market Liquidity (Mar. 19, 2008),
available at https://www.fhfa.gov/Media/PublicAffairs/Pages/OFHEO,-Fannie-Mae-and-Freddie-Mac-Announce-Initiative-to-Increase-Mortgage-Market-Liquidity.aspx; (``OFHEO estimates that Fannie Mae's and
Freddie Mac's existing capabilities, combined with this new
initiative and the release of the portfolio caps announced in
February, should allow the GSEs to purchase or guarantee about $2
trillion in mortgages this year.'').
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3. High-Quality Capital
Another lesson of the 2008 financial crisis is that it is not only
the quantity but also the quality of the regulatory capital, especially
its loss-absorbing capacity, that is critical to the Enterprises'
safety and soundness. Market confidence in the Enterprises came into
doubt in mid-2008 when Fannie Mae and Freddie Mac had total capital of,
respectively, $55.6 billion and $42.9 billion. Questions about the
Enterprises' solvency likely arose in part due to their sizeable DTAs,
which counted toward total capital but had less loss-absorbing capacity
during a period of negative income. Freddie Mac would have actually had
a negative book value as of June 30, 2008 after deducting its DTAs.
Besides the DTA valuation allowances, there was also uncertainty as to
the sufficiency of the Enterprises' allowances for loan losses
(ALLL).\26\ For these and other reasons, the Basel framework includes
deductions and other adjustments for DTAs and ALLL, as well as other
capital elements that might have less loss-absorbing capacity.\27\
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\26\ See FCIC Report at 317, available at https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf; (``[T]he Fed
found that the GSEs were significantly `underreserved,' with huge
potential losses . . . The OCC rejected the forecasting
methodologies on which Fannie and Freddie relied. Using its own
metrics, it found insufficient reserves for future losses . . .
.'').
\27\ See BCBS, The Basel Framework CAP10 (Dec. 15, 2019),
available at https://www.bis.org/basel_framework/chapter/CAP/10.htm?inforce=20191215&export=pdf; see also BCBS, Basel: A Global
Regulatory Framework for More Resilient Banks and Banking Systems,
paragraphs 8 and 9, (Dec. 2010; revised June 2011), available at
https://www.bis.org/publ/bcbs189.htm; (``The crisis demonstrated that
credit losses and writedowns come out of retained earnings, which is
part of banks' tangible common equity base . . . . To this end, the
predominant form of Tier 1 capital must be common shares and
retained earnings.'').
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Table 6 illustrates the importance of requiring high-quality
capital by showing the evolution of CET1 capital, tier 1 capital,
adjusted total capital, core capital, and total capital at each
Enterprise leading up to the 2008 financial crisis. As the table
indicates, the Enterprises' combined core capital increased from $77.3
billion in 2006 to $84.1 billion in 2008, suggesting at first glance a
position of some financial strength. However, over the same time period
the Enterprises' combined tier 1 capital decreased markedly from $76.3
billion to $24.1 billion, indicating a capital position with
deteriorating and substantially less loss-absorbing capacity.
Similarly, the Enterprises' combined total capital increased from $78.7
billion in 2006 to $98.5 billion in 2008, while over the same time
period the Enterprises' adjusted total capital decreased from $85.9
billion to $29.6 billion.

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4. Stability of the National Housing Finance Markets
After the taxpayer-funded rescue of the Enterprises in 2008, there
can be no doubt as to the risk posed by an insolvent or otherwise
financially distressed Enterprise to the stability of the national
housing finance markets. The Enterprises were then, and remain today,
the dominant participants in the housing finance system, owning or
guaranteeing 37 percent of residential mortgage debt outstanding as of
December 31, 2007 and 44 percent of residential mortgage debt
outstanding as of September 30, 2019. Both then and still today, banks,
insurance firms, and securities broker-dealers own significant amounts
of the Enterprises' unsecured debt and MBS. Both then and still today,
the Enterprises control critical infrastructure for securitizing and
administering $5.5 trillion of outstanding single-family and
multifamily conventional MBS.\28\ Given the nature, scope, size, scale,
concentration, and interconnectedness of each Enterprise, the financial
distress of an Enterprise could have significant adverse effects on the
liquidity, efficiency, competitiveness, or resiliency of national
housing finance markets. For these and related reasons, the Treasury
Department ultimately invested $191.5 billion under the PSPAs in the
Enterprises to keep them solvent going concerns.
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\28\ During the conservatorship, some of that functionality has
been moved to the Common Securitization Platform, which is jointly
owned and operated by the Enterprises. In January 2020, FHFA
announced that it had directed the Enterprises to amend the
governance of the entity that operates the Common Securitization
Platform to include an independent, non-executive chairman of the
board of directors and add up to three additional independent
directors.
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C. Post-Crisis Changes to Regulatory Capital Frameworks

After the 2008 financial crisis, financial services regulators in
the U.S. and internationally revisited their regulatory capital
frameworks to address lessons learned. The international efforts of the
leading banking regulators through the BCBS culminated in 2010 in
enhancements to the Basel framework.\29\ That comprehensive reform
package was designed to improve the quality and quantity of regulatory
capital and to build additional capacity into the banking system to
absorb losses during future periods of financial stress. Revisions to
the international capital standards included a more restrictive
definition of regulatory capital, higher regulatory capital
requirements, a capital conservation buffer that could be drawn down
during periods of financial stress, and also capital surcharges for
systemic importance.
---------------------------------------------------------------------------

\29\ See BCBS, Basel: A Global Regulatory Framework for More
Resilient Banks and Banking Systems (Dec. 2010; revised June 2011),
available at https://www.bis.org/publ/bcbs189.htm.
---------------------------------------------------------------------------

With respect to the Enterprises, HERA gave FHFA greater authority
to determine capital standards for the Enterprises by removing the
Safety and Soundness Act's restrictions on the risk-based capital
requirements and by giving FHFA authority to increase leverage ratio
requirements above the statutory minimum. Each Enterprise was placed
into conservatorship shortly after enactment of HERA, and FHFA
suspended the Enterprises' statutory capital classifications and
regulatory capital requirements. FHFA, in its capacity as conservator,
then began to develop a framework known as the Conservatorship Capital
Framework to ensure that each Enterprise assumed appropriate regulatory
capital requirements in managing their businesses. The Conservatorship
Capital Framework was implemented in 2017, and ultimately was the
foundation of the 2018 proposal.

IV. Rationale for Re-Proposal

FHFA is re-proposing the regulatory capital framework for the
Enterprises for three key reasons:

[[Page 39287]]

First, FHFA has begun the process to responsibly end the
conservatorships of the Enterprises. This policy change is a departure
from the expectations of interested parties at the time of the 2018
proposal, when the prospects for indefinite conservatorships informed
comments and perhaps even the decision whether to comment at all.
Second, FHFA is proposing to increase the quantity and
quality of the regulatory capital at the Enterprises to ensure the
safety and soundness of each Enterprise and that each Enterprise can
fulfill its statutory mission to provide stability and ongoing
assistance to the secondary mortgage market across the economic cycle,
in particular during periods of financial stress.
Third, to facilitate regulatory capital planning and also
in furtherance of the safety and soundness of the Enterprises and their
countercyclical mission, FHFA is proposing changes to mitigate the pro-
cyclicality of the aggregate risk-based capital requirements of the
2018 proposal.
While these enhancements preserve the 2018 proposal as the
foundation of the Enterprises' regulatory capital framework, FHFA has
nonetheless determined to solicit comments on this revised framework in
its entirety in light of the changed policy environment, the extent and
nature of the enhancements, the technical nature of the underlying
issues, the diverse range of interested parties, and the critical
importance of the Enterprises' regulatory capital framework to the
national housing finance markets.

A. Responsibly Ending the Conservatorships

FHFA stated in the 2018 proposal that ``this proposed rule is not a
step towards recapitalizing the Enterprises and administratively
releasing them from conservatorship.'' \30\ FHFA also noted that
``[p]ublication of this proposed rule will assist with FHFA's
administration of the conservatorships of Fannie Mae and Freddie Mac by
potentially refining the [Conservatorship Capital Framework].'' \31\ It
is possible that these and other statements made by FHFA, as well as
the generally prevailing uncertainty at the time as to the Enterprises'
prospects for exiting conservatorships, might have influenced
interested parties' views as to the practical relevance of the 2018
proposal or otherwise dissuaded the submission of some comments. In
fact, more than half of the comments on the 2018 proposal related to
the ongoing conservatorships rather than the proposed regulatory
capital framework.
---------------------------------------------------------------------------

\30\ 83 FR at 33313.
\31\ Id.
---------------------------------------------------------------------------

The policy environment has since changed. In September 2019, the
Treasury Department released its housing reform plan that recommended
that FHFA begin the process to end each Enterprise's conservatorship in
a manner consistent with the preconditions set forth in that plan, and
also recommended a recapitalization plan be developed for each
Enterprise.\32\ Shortly thereafter, the Treasury Department and FHFA,
on behalf of each Enterprise in its capacity as conservator, entered
into letter agreements permitting the Enterprises to together retain up
to $45 billion in capital. In October 2019, FHFA then issued a new
Strategic Plan and Scorecard for the Enterprises that stated that
``[e]nding the conservatorships of Fannie Mae and Freddie Mac is a
central and necessary element of this new roadmap.''
---------------------------------------------------------------------------

\32\ Treasury, Housing Reform Plan at 27 (Sept. 2019), available
at https://home.treasury.gov/system/files/136/Treasury-Housing-Finance-Reform-Plan.pdf.
---------------------------------------------------------------------------

These developments were important factors in FHFA's decision to re-
propose the regulatory capital framework in its entirety. FHFA
considered extensively the comments received on the 2018 proposal and
made significant adjustments to multiple aspects of the proposed
regulatory capital framework in response to the comments received. FHFA
now hopes and expects that the clarity as to the Enterprises' eventual
exit from conservatorship will lead to new, different, and more
extensive comments. To that end, FHFA emphasizes that the purpose of
the proposed rule is to establish a regulatory capital framework that
ensures the safety and soundness of each Enterprise and that each
Enterprise is positioned to fulfill its statutory mission across the
economic cycle, in particular during periods of financial stress.

B. Ensuring Capital Adequacy

1. Quality of Capital
As discussed in Section III.B.3, a lesson of the 2008 financial
crisis is that the Enterprises' safety and soundness depends not only
on the quantity but also on the quality of their regulatory capital. In
light of the lessons learned, FHFA has determined enhancements are
necessary to address two key concerns with respect to the quality of
the Enterprise's regulatory capital.
First, enhancements are necessary to limit the amount of regulatory
capital that may consist of certain components of capital such as DTAs
that might tend to have less loss-absorbing capacity during a period of
financial stress. FHFA noted in the 2018 proposal that the Enterprises'
DTAs, which are included in total capital and core capital by statute,
``may provide minimal to no loss-absorbing capability during a period
of [financial] stress as recoverability (via taxable income) may become
uncertain.'' \33\ The 2018 proposal addressed this issue by
establishing a risk-based capital requirement for DTAs. However, the
2018 proposal did not include adjustments for other capital elements
that tend to have less loss-absorbing capacity during a financial
stress (e.g., ALLL, goodwill, and intangibles). The 2018 proposal also
did not adjust for accumulated other comprehensive income (AOCI),
leaving open the possibility that an Enterprise could have positive
total capital and core capital despite being insolvent under GAAP,
though FHFA did request comment on whether to include offsetting
capital requirements to AOCI similar to the treatment of DTAs.
---------------------------------------------------------------------------

\33\ 83 FR at 33388. Deducting the Enterprises' DTAs from their
$98.5 billion in total capital in mid-2008 in a manner generally
consistent with the U.S. banking regulators' approach would have
left the Enterprises with little regulatory capital, reflective of
the financial distress that the Enterprises were experiencing at the
time and also consistent with the $53.8 billion in capital
reductions realized a few months later with the valuation allowances
on the Enterprises' DTAs.
---------------------------------------------------------------------------

Second, the statutory definitions of regulatory capital used in the
2018 proposal did not limit the extent to which preferred shares could
satisfy the risk-based capital requirements. Specifically, there was
neither a risk-based capital requirement for core capital nor a
requirement that retained earnings and other common equity be the
predominant form of capital, as under the Basel framework.\34\ The 2018
proposal sought feedback on this issue and commenters recommended FHFA
limit the inclusion of preferred shares in regulatory capital to align
with the U.S. banking framework's definition of tier 1 capital.
---------------------------------------------------------------------------

\34\ See BCBS, Basel: A Global Regulatory Framework for More
Resilient Banks and Banking Systems, paragraphs 8 and 9 (Dec. 2010;
revised June 2011), available at https://www.bis.org/publ/bcbs189.htm; (``It is critical that banks' risk exposures are backed
by a high quality capital base. The crisis demonstrated that credit
losses and writedowns come out of retained earnings, which is part
of banks' tangible common equity base . . . . To this end, the
predominant form of Tier 1 capital must be common shares and
retained earnings.'').
---------------------------------------------------------------------------

To address these and related concerns, and as described in more
detail in Section V.B., FHFA is proposing to supplement the total
capital and core capital requirements with additional capital
requirements

[[Page 39288]]

based on the Basel framework's definitions of total capital, tier 1
capital, and CET1 capital. These supplemental capital requirements
would include customary deductions and other adjustments for certain
DTAs, goodwill, intangibles, and other assets that tend to have less
loss-absorbing capacity during a financial stress. The risk-based tier
1 and CET1 capital requirements also would ensure that retained
earnings and other high-quality capital are the predominant form of
regulatory capital.
2. Quantity of Capital
FHFA has also determined enhancements to the 2018 proposal are
necessary to ensure a safe and sound quantity of regulatory capital at
each Enterprise. In particular, due in part to the lack of prudential
floors on risk-based capital requirements and capital buffers, the 2018
proposal's credit risk capital requirements were insufficient to ensure
the safety and soundness of each Enterprise and that each Enterprise
could continue to fulfill its statutory mission during a period of
financial stress. In determining the need for these enhancements, FHFA
considered the following facts, among others:
Cumulative Crisis-Era Capital Losses. Fannie Mae and
Freddie Mac's peak cumulative capital losses from 2008 through 2011 and
the first quarter of 2012, respectively, were, respectively, $167
billion and $98 billion. Had the 2018 proposal been in effect at the
end of 2007, the 2018 proposal's risk-based capital requirements for
Fannie Mae and Freddie Mac would have been, respectively, $171 billion
and $110 billion. Fannie Mae and Freddie Mac's peak losses would have
left, respectively, only $3 billion and $12 billion in remaining
capital. At 0.1 percent and 0.5 percent of their total assets and off-
balance sheet guarantees respectively, these amounts would not have
sustained the market confidence necessary for the Enterprises to
continue as going concerns, particularly given the prevailing stress in
the financial markets at that time and also given the uncertainty as to
the potential for other write-downs and the adequacy of the
Enterprises' allowances for loan losses. Indeed, in October 2010, FHFA
projected $90 billion in additional PSPA draws through 2013 under the
baseline scenario, although only $34 billion in additional draws proved
necessary.\35\
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\35\ See Fed. Hous. Fin. Agency, Projections of the Enterprises'
Financial Performance at 10 (Oct. 2010), available at https://www.fhfa.gov/AboutUs/Reports/ReportDocuments/2010-10_Projections_508.pdf.
---------------------------------------------------------------------------

Single-family Credit Losses. Freddie Mac's estimated
single-family credit risk capital requirement under the 2018 proposal
of $59 billion as of December 31, 2007 would have been less than its
lifetime single-family credit losses of $64 billion on its December 31,
2007 guarantee portfolio. Even excluding loans that Freddie Mac no
longer acquires, Freddie Mac's estimated single-family credit risk
capital requirement of $24 billion under the 2018 proposal would have
exceeded projected lifetime losses of $20 billion by only $4 billion
(0.4 percent of the unpaid principal balance on the single-family book
as of December 31, 2007). Fannie Mae's estimated single-family credit
risk capital requirement under the 2018 proposal would have exceeded
projected lifetime losses on its December 31, 2007 guarantee portfolio
whether including or excluding loans that it no longer acquires, but
only by $9 billion in both scenarios (0.4 percent and 0.7 percent,
respectively, of the unpaid principal balance of the single-family book
as of December 31, 2007).
Comparison to the Basel and U.S. Banking Frameworks. Had
the 2018 proposal been in effect on September 30, 2019, the average
pre-CRT net credit risk capital requirement on the Enterprises' single-
family mortgage exposures would have been 1.6 percent of unpaid
principal balance, implying an average risk weight of 20 percent.\36\
The U.S. banking framework generally assigns a 50 percent risk weight
to single-family mortgage exposures to determine the credit risk
capital requirement (equivalent to a 4.0 percent adjusted total capital
requirement), while the current Basel framework generally assigns a 35
percent risk weight (equivalent to a 2.8 percent adjusted total capital
requirement). Before adjusting for the capital buffers under the
proposed rule and the Basel and U.S. banking frameworks, the
Enterprises' regulatory capital requirements for single-family mortgage
exposures under the 2018 proposal would have been 40 percent that of
U.S. banking organizations and less than 60 percent that of non-U.S.
banking organizations. The BCBS has finalized a more risk-sensitive set
of risk weights for residential mortgage exposures, which are to be
implemented by January 1, 2022.\37\ With those changes, the lowest
standardized risk weight would be 20 percent for single-family
residential mortgage loans with LTVs at origination less than 50
percent. The 20 percent average risk weight would have been the same as
the Basel framework's 20 percent minimum, notwithstanding the
Enterprises having an average single-family original loan-to-value
(OLTV) of approximately 77 percent as of September 30, 2019. These
comparisons are complicated by the fact that the 20 percent average
risk weight reflects capital relief for loan-level credit enhancement
and MTMLTV. In particular, some meaningful portion of the gap between
the credit risk capital requirements of the banking organizations and
the Enterprises under the 2018 proposal is due to the 2018 proposal's
use of MTMLTV instead of OLTV, as under the U.S. banking framework, to
assign credit risk capital requirements for mortgage exposures. In a
different house price environment, perhaps after several years of
declining house prices, the mark-to-market framework could have
resulted in higher credit risk capital requirements than the Basel and
U.S. banking frameworks. Similarly, some of this gap might have been
expected to narrow had real property prices moved toward their long-
term trend. However, the sizing of the current gap under the 2018
proposal is still an important consideration informing the enhancements
to the 2018 proposal. Notably, the 20 percent average risk weight would
have been the same as the Basel framework's 20 percent risk weight
assigned to exposures to sovereigns and central banks with ratings A+
to A- and claims on banks and corporates with ratings AAA to AA-.\38\
The 20 percent average risk weight also would have been the same as the
20 percent risk weight assigned under the U.S. banking framework to
Enterprise-guaranteed MBS.
---------------------------------------------------------------------------

\36\ This average risk weight equals the average post-CRT net
credit risk capital requirement, excluding the going-concern buffer,
under the 2018 proposal of approximately 164 basis points, divided
by a total capital requirement of 800 basis points.
\37\ BCBS, Basel III: Finalising Post-Crisis Reforms, paragraph
64, at 21 (Dec. 2017), available at https://www.bis.org/bcbs/publ/d424.pdf.
\38\ See BCBS, The Basel Framework, paragraphs 20.4 and 20.14
(Dec. 15, 2019), available at https://www.bis.org/basel_framework/index.htm?export=pdf.
---------------------------------------------------------------------------

Monoline businesses. As discussed in the 2018 proposal,
comparisons to the U.S. banking framework's capital requirements are
complicated by the different risk profiles of the Enterprises and large
banking organizations.\39\ The Enterprises, for example, transfer much
of the interest rate and funding risk on their mortgage exposures
through their sales of their guaranteed MBS, while large banking
organizations generally must fund those loans through customer deposits
and other sources. While the interest rate and funding risk profiles
are different, that difference should not

[[Page 39289]]

preclude comparisons of the credit risk capital requirements of the
U.S. banking framework to the credit risk capital requirements of the
Enterprises. The Basel and U.S. banking frameworks generally do not
contemplate an explicit capital requirement for interest rate risk on
banking book exposures, leaving interest rate risk capital requirements
to bank-specific tailoring through the supervisory process.\40\ If
anything, the monoline nature of the Enterprises' mortgage-focused
businesses actually suggests that the concentration risk of an
Enterprise might be greater than that of a diversified banking
organization with a similar amount of credit risk. FHFA has not
attempted to make a specific adjustment to the risk-based capital
requirements to mitigate the Enterprises' concentration risk, but the
heightened risk associated with the Enterprises' sector-specific
concentration is nonetheless an important consideration in determining
the need for the enhancements contemplated by the proposed rule.
---------------------------------------------------------------------------

\39\ 83 FR at 33323.
\40\ See BCBS, Interest Rate Risk in the Banking Book, paragraph
1 (April 2016), available at https://www.bis.org/bcbs/publ/d368.pdf;
(``Interest rate risk in the banking book (IRRBB) is part of the
Basel capital framework's Pillar 2 (Supervisory Review Process) and
subject to the Committee's guidance set out in the 2004 Principles
for the management and supervision of interest rate risk
(henceforth, the IRR Principles).'').
---------------------------------------------------------------------------

More generally, enhancements are necessary to mitigate certain
risks and limitations associated with the underlying historical data
and models used to calibrate the 2018 proposal's credit risk capital
requirements. For example:
Limitations of crisis-era data. Under the 2018 proposal,
the credit risk capital requirement for a mortgage exposure was
calibrated to be sufficient to absorb the lifetime unexpected losses
incurred on loans of that type experiencing a shock to house prices
similar to that observed during the 2008 financial crisis. As discussed
in Section III.B, the Enterprises' financial crisis-era losses likely
were mitigated to at least some extent by the unprecedented support by
the federal government of the housing market and the economy, and also
by the declining interest rate environment of the period. There is
therefore some risk that the 2018 proposal's risk-based capital
requirements, notwithstanding the required going-concern buffer, were
not calibrated to ensure each Enterprise would be regarded as a viable
going concern following an economic downturn that potentially entails
more unexpected losses, whether because there is less or no Federal
support of the economy, because there is less or no reduction in
interest rates, or because of other causes. For example, post-crisis
changes in federal, state, and local loss mitigation and other
foreclosure requirements might increase the uncertainty as to loss
estimations.
High-risk loan products. A disproportionate share of the
Enterprises' crisis-era credit losses (approximately $108 billion)
arose from certain single-family mortgage exposures that are no longer
eligible for acquisition by the Enterprises. The calibration of the
2018 proposal's credit risk capital requirements attributed a
significant portion of the Enterprises' crisis-era losses to these
product characteristics, including ``Alt-A,'' negative amortization,
interest-only, and low or no documentation loans, as well as loans with
debt-to-income ratio at origination greater than 50 percent, cash out
refinances with total LTV greater than 85 percent, and investor loans
with LTV greater than or equal to 90 percent. The statistical methods
used to allocate losses between borrower-related risk attributes and
product-related risk attributes pose significant model risk. To ensure
safety and soundness, the capital requirements should mitigate the risk
of potential underestimation of credit losses that would be incurred in
an economic downturn with national housing price declines of similar
magnitude, even absent those loan types and even assuming a repeat of
Federal support of the economy and the declining interest rate
environment.\41\
---------------------------------------------------------------------------

\41\ Reliance on static look-up grids and multipliers might also
introduce additional model risk as borrower behavior, mortgage
products, underwriting practices, or the national housing markets
continue to evolve.
---------------------------------------------------------------------------

Gaps in risk coverage. There are some material risks to
the Enterprises that were not assigned a risk-based capital requirement
under either the 2018 proposal and the proposed rule--for example,
risks relating to uninsured or underinsured losses from flooding,
earthquakes, or other natural disasters or radiological or biological
hazards. There also is no risk-based capital requirement for the risks
that climate change could pose to property values in some localities.
Related to these capital adequacy concerns, the 2018 proposal's
required capital was not tailored to the risk that a default or other
financial distress of an Enterprise could have on the liquidity,
efficiency, competitiveness, or resiliency of national housing finance
markets. As described in Section VII.A.3, the absence of a stability
capital buffer poses not only a risk to the national housing finance
markets but also a risk to the safety and soundness of the Enterprises
by perpetuating their funding advantages and undermining market
discipline over their risk taking.
To address these and related concerns, and as described in more
detail below, FHFA is proposing, among other changes:
A prudential floor on the credit risk capital requirement
for mortgage exposures to mitigate the model and other risks associated
with the methodology for calibrating the credit risk capital
requirements.
A credit risk capital requirement on senior tranches of
CRT held by an Enterprise, an adjustment to the CRT capital treatment
to reflect that CRT is not equivalent in loss-absorbing capacity to
equity financing, and operational criteria for CRT structures that
together would mitigate the structuring, recourse, and other risks
associated with these securitizations.
Risk-based capital requirements for a number of exposures
not expressly addressed by the 2018 proposal, including credit risk on
commitments to acquire mortgage loans, counterparty risk on interest
rate and other derivatives, and credit risk on an Enterprise's holdings
or guarantees of the other Enterprise's MBS.
A countercyclical adjustment for single-family credit risk
that would result in greater capital retention when housing markets may
be vulnerable to correction, while better enabling the Enterprises to
play a countercyclical role.
A stress capital buffer that would, among other things,
enhance the resiliency of the Enterprises and ensure that each
Enterprise would continue to be regarded as a viable going concern by
creditors and other counterparties after a severe economic downturn.
A stability capital buffer tailored to the risk that the
Enterprise's default or other financial distress could have on the
liquidity, efficiency, competitiveness, and resiliency of national
housing finance markets.
A revised method for determining operational risk capital
requirements, as well as a higher floor.
A requirement that each Enterprise maintain internal
models for determining its own risk-based capital requirements that
would prompt each Enterprise to develop its own view of credit and
other risks and not rely solely on the risk assessments underlying the
standardized risk weights assigned under this regulatory capital
framework.
A 2.5 percent leverage ratio and a 1.5 percent PLBA that
would together serve as a credible backstop to the risk-based capital
requirements and mitigate the inherent risks and limitations of any

[[Page 39290]]

methodology for calibrating those requirements.

C. Addressing Pro-Cyclicality

Consistent with many of the comments on the 2018 proposal, FHFA has
determined that mitigating the pro-cyclicality of the 2018 proposal's
risk-based capital requirements would facilitate capital management,
enhance the safety and soundness of the Enterprises by preventing risk-
based capital requirements from decreasing to unsafe and unsound
levels, and help position the Enterprises to fulfill their statutory
mission to provide stability and ongoing assistance to the national
housing finance markets across the economic cycle. A pro-cyclical
framework could have incentivized the Enterprises to expand credit when
house prices increased, potentially left the Enterprises without
regulatory capital that could be drawn down during a period of
financial stress, and perhaps even exacerbated the housing price cycle
itself. A pro-cyclical framework also could have led to large swings in
required capital, leading to the practical necessity that prudent
management would maintain a managerial capital surplus well above the
capital requirements.
As described in more detail below, FHFA is proposing several
enhancements to address this pro-cyclicality while preserving the
mortgage risk-sensitive framework of the 2018 proposal. Among other
changes, FHFA is proposing:
A countercyclical adjustment to adjust each single-family
mortgage exposure MTMLTV when national housing prices are 5.0 percent
above or below the inflation-adjusted long-term trend.
A stress capital buffer and a separate leverage buffer
that will, in addition to enhancing the resiliency of the Enterprises,
dampen pro-cyclicality by encouraging each Enterprise to retain capital
during good times while remaining able to provide stability and ongoing
assistance to the secondary mortgage market during a period of
financial stress by utilizing capital buffers as losses are
experienced.
A prudential floor on the credit risk capital requirement
for mortgage exposures that, in addition to mitigating the model and
other risks associated with the methodology for calibrating the credit
risk capital requirements, would also provide further stability to the
risk-based capital requirements through the cycle.
A requirement that each Enterprise maintain its own view
of credit and other risks, including as to the relationship between
housing prices and market fundamentals, by maintaining its own internal
models for determining risk-based capital.

V. Definitions of Regulatory Capital

A. Statutory Definitions

As discussed in Sections VI.A and VI.B, the proposed rule would
require each Enterprise to maintain required amounts of core capital
and total capital, as defined in the Safety and Soundness Act.
Core capital means, with respect to an Enterprise, the sum of the
following (as determined in accordance with GAAP):
The par or stated value of outstanding common stock;
The par or stated value of outstanding perpetual,
noncumulative preferred stock;
Paid-in capital; and
Retained earnings.
Core capital does not include any amounts that the Enterprise could
be required to pay, at the option of investors, to retire capital
instruments.
Total capital means, with respect to an Enterprise, the sum of the
following:
The core capital of the Enterprise;
A general allowance for foreclosure losses, which: (i)
Includes an allowance for portfolio mortgage losses, an allowance for
non-reimbursable foreclosure costs on government claims, and an
allowance for liabilities reflected on the balance sheet for the
Enterprise for estimated foreclosure losses on mortgage-backed
securities; and (ii) does not include any reserves of the Enterprise
made or held against specific assets; and
Any other amounts from sources of funds available to
absorb losses incurred by the Enterprise, that the Director by
regulation determines are appropriate to include in determining total
capital.
Notably, as discussed in Section IV.B.1, these statutory
definitions do not include deductions and other adjustments for capital
elements that might tend to have less loss-absorbing capacity during a
period of financial stress (e.g., DTAs, ALLL, goodwill, and
intangibles). These statutory definitions also do not limit the extent
to which preferred shares may satisfy the risk-based capital
requirements.

B. Supplemental Definitions

1. Loss-Absorbing Capacity
Following HERA's amendments to the Safety and Soundness Act, FHFA
has wide authority to prescribe regulatory capital requirements for the
Enterprises. The Safety and Soundness Act generally authorizes FHFA to
prescribe by regulation risk-based capital requirements for the
Enterprises.\42\ The Safety and Soundness Act also authorizes FHFA to
prescribe minimum capital levels that are greater than the levels
prescribed by statute.\43\ The FHFA Director has general regulatory
authority over the Enterprises, as well as the authority to issue
regulations to carry out the duties of the FHFA Director.\44\ The FHFA
Director also may establish such other operational and management
standards as the FHFA Director determines to be appropriate.\45\ As
amended by HERA, these and other provisions of the Safety and Soundness
Act give the FHFA Director generally broad and flexible authority to
tailor regulatory capital requirements for the Enterprises, including
to prescribe additional capital requirements that supplement the
statutory capital classifications based on total capital and core
capital.
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\42\ 12 U.S.C. 4611.
\43\ 12 U.S.C. 4612.
\44\ 12 U.S.C. 4511, 4526.
\45\ 12 U.S.C. 4513b.
---------------------------------------------------------------------------

FHFA is proposing to supplement the statutory definitions of total
capital and core capital requirements with additional regulatory
capital definitions based on the Basel framework's definitions of total
capital, tier 1 capital, and CET1 capital. These supplemental
definitions would include customary deductions and other adjustments
for certain DTAs, goodwill, intangibles, and other assets that tend to
have less loss-absorbing capacity during a financial stress. As
discussed in Section IV.B.1, the supplemental definitions of regulatory
capital would fill certain gaps in the statutory definitions of core
capital and total capital. For example, neither core capital nor total
capital adjust for AOCI, leaving open the possibility that an
Enterprise could have positive total capital and core capital but yet
be insolvent under GAAP. The supplemental tier 1 and CET1 capital
requirements also would ensure that retained earnings and other high-
quality capital are the predominant form of regulatory capital.
Because the supplemental definitions of regulatory capital in the
proposed rule are adopted from the Basel framework, the supplemental
definitions would be familiar to market participants. This familiarity
should facilitate comparisons between the regulatory capital
requirements of the Enterprises, banking organizations, and other
market participants. The use of well-understood definitions of
regulatory capital should also facilitate market discipline over the
Enterprises' risk-taking by positioning future

[[Page 39291]]

shareholders, creditors, and other counterparties to more readily
understand the regulatory capital that is available to absorb losses.
Consistent with the 2018 proposal, neither the statutory
definitions nor the supplemental definitions of regulatory capital
would include a measure of future guarantee fees or other future
revenues. Counting future revenues toward capital requirements could be
appropriate under a ``claims-paying capacity'' or similar framework
that seeks only to ensure that an Enterprise has the ability to perform
its guarantee and other financial obligations over time, perhaps
subject to a stay or other pause in the payment of claims and other
financial obligations during a resolution proceeding. The proposed rule
instead seeks to ensure that each Enterprise is capitalized to remain a
viable going concern both during and after a severe economic downturn,
as discussed in Section III.B.2. Historical experience has established
that credit, market, and operational losses can be incurred quickly
during a stress, and it is an Enterprise's capacity to absorb those
losses as incurred that defines creditors' and other counterparties'
views as to whether the financial institution is a viable going
concern. As discussed in Sections III.B.2 and III.B.3, market
confidence in the Enterprises waned in mid-2008 when Fannie Mae and
Freddie Mac had total capital of, respectively, $55.6 billion and $42.9
billion, notwithstanding their right to future guarantee fees.
FHFA's approach does, however, still give consideration to the
loss-absorbing capacity of future guarantee fees or other revenues. As
discussed in Section VII.A.1, FHFA has calibrated the stress capital
buffer as the amount of regulatory capital sufficient for an Enterprise
to withstand a severely adverse stress and still remain above the
capital requirements.\46\ Under this calibration methodology, the
stress capital buffer has been sized based on net capital exhaustion in
a severely adverse scenario. The determination of net capital
exhaustion takes into account the guarantee fees and other revenues
received during that stress.
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\46\ See BCBS, Calibrating Regulatory Minimum Capital
Requirements and Capital Buffers: A Top-down Approach, paragraph
I.A. (Oct. 2010) (``[T]he regulatory minimum requirement is the
amount of capital needed for a bank to be regarded as a viable going
concern by creditors and counterparties, while a buffer can be seen
as an amount sufficient for the bank to withstand a significant
downturn period and still remain above minimum regulatory
levels.''), available at https://www.bis.org/publ/bcbs180.pdf; and
Regulatory Capital Rules: Regulatory Capital, Enhanced Supplementary
Leverage Ratio Standards for Certain Bank Holding Companies and
Their Subsidiary Insured Depository Institutions, 78 FR 51101, 51105
(Aug. 20, 2013) (Joint Agency Proposed Rule) (``In calibrating the
revised risk-based capital framework, the BCBS identified those
elements of regulatory capital that would be available to absorb
unexpected losses on a going-concern basis. The BCBS agreed that an
appropriate regulatory minimum level for the risk-based capital
requirements should force banking organizations to hold enough loss-
absorbing capital to provide market participants a high level of
confidence in their viability.'').
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2. Components of Regulatory Capital
a. CET1 Capital
Consistent with the Basel and U.S. banking frameworks, CET1 capital
would be the sum of an Enterprise's outstanding CET1 capital
instruments that satisfy the criteria set forth below, related surplus
(net of treasury stock), retained earnings, and AOCI, less regulatory
adjustments and deductions.
The criteria for CET1 capital instruments are intended to ensure
that CET1 capital instruments do not possess features that would cause
an Enterprise's condition to further weaken during a period of
financial stress. The CET1 capital instruments are any common stock
instruments (plus any related surplus) issued by the Enterprise, net of
treasury stock, that meet the criteria specified at Sec.
1240.20(b)(1).
b. Additional Tier 1 Capital
Consistent with the Basel and U.S. banking frameworks, additional
tier 1 capital would equal the sum of the additional tier 1 capital
instruments that satisfy the criteria set forth at Sec. 1240.20(c)(1)
and related surplus, less applicable regulatory adjustments and
deductions. The criteria are intended to ensure that additional tier 1
capital instruments would be available to absorb losses on a going-
concern basis.
An Enterprise would not be permitted to include an instrument in
its additional tier 1 capital unless FHFA has determined that the
Enterprise has made appropriate provision, including in any resolution
plan of the Enterprise, to ensure that the instrument would not pose a
material impediment to the ability of an Enterprise to issue common
stock instruments following any future appointment of FHFA as
conservator or receiver under the Safety and Soundness Act.
c. Tier 2 Capital
Adjusted total capital would be the sum of CET1 capital, additional
tier 1 capital, and tier 2 capital. Generally consistent with the Basel
and U.S. banking frameworks, tier 2 capital would equal the sum of:
Tier 2 capital instruments that satisfy the criteria set forth at Sec.
1240.20(d)(1); related surplus; and limited amounts of excess credit
reserves, less any applicable regulatory adjustments and deductions.
As under the U.S. banking framework for advanced approaches banking
organizations, an Enterprise may include in tier 2 capital only the
excess of its eligible credit reserves over its total expected credit
loss, provided the amount does not exceed 0.6 percent of its credit
risk-weighted assets. The limited inclusion of ALLL in tier 2 capital
is a logical outgrowth of FHFA's calibration methodology for mortgage
exposures under which the base risk weights and risk multipliers are
intended to require credit risk capital sufficient to absorb the
lifetime unexpected losses incurred on mortgage exposures experiencing
a shock to house prices similar to that observed during the 2008
financial crisis. The same is also true for non-mortgage exposures,
where FHFA generally has adopted the credit risk capital requirements
of the U.S. banking framework, which also calibrates credit risk
capital requirements to absorb unexpected losses.
An alternative approach perhaps could be to include general ALLL in
adjusted total capital and then calibrate the credit risk capital
requirements based on stress losses (i.e., unexpected and expected
losses). The resulting required loss-absorbing capacity for a mortgage
exposure would be substantially the same. That approach however would
raise safety and soundness risk relating to the loss-absorbing capacity
of each Enterprise's ALLL in a period of financial stress, particularly
if there is no limit on the share of total capital that may be ALLL. An
approach that calibrates credit risk capital requirements based on
stress losses also would limit FHFA's ability to rely on the credit
risk capital requirements under the U.S. banking framework for non-
mortgage exposures, an important consideration to the extent that FHFA
does not have the data or models to calibrate its own credit risk
capital requirements for non-mortgage exposures.
As with additional tier 1 capital, an Enterprise would not be
permitted to include an instrument in its tier 2 capital unless FHFA
has determined that the Enterprise has made appropriate provision,
including in any resolution plan of the Enterprise, to ensure that the
instrument would not pose a material impediment to the ability of an
Enterprise to issue common stock instruments following any future
appointment of FHFA as conservator or

[[Page 39292]]

receiver under the Safety and Soundness Act.
Question 1. Is each of the definitions of CET1 capital, tier 1
capital, and tier 2 capital appropriately formulated and tailored to
the Enterprises?
Question 2. Should FHFA include additional amounts of an
Enterprise's ALLL or excess credit reserves in any of the components of
regulatory capital?
Question 3. Should any other capital elements qualify as CET1
capital, additional tier 1 capital, or tier 2 capital elements?
3. Regulatory Adjustments and Deductions
a. Deductions From CET1 Capital
Under the U.S. banking framework, goodwill and other intangible
assets have long been either fully or partially excluded from
regulatory capital because of the high level of uncertainty regarding
the ability of a banking organization to realize value from these
assets, especially under adverse financial conditions. The regulatory
capital treatment of DTAs has posed particular safety and soundness
risks for the Enterprises, as discussed in Section IV.B.1. The proposed
rule would require an Enterprise to deduct from CET1 capital elements:
Goodwill;
Intangible assets other than mortgage-servicing assets
(MSA) net of associated deferred tax liabilities (DTLs);
DTAs that arise from net operating loss and tax credit
carryforwards net of any related valuation allowances and net of DTLs
in accordance with certain restrictions discussed under Section
V.B.3.d; and
Any defined benefit pension fund net asset, net of DTLs in
accordance with certain DTL-related restrictions, and subject to
certain exceptions with FHFA's approval.
An Enterprise also would deduct from CET1 capital any after-tax
gain-on-sale associated with a securitization exposure. Gain-on-sale
would be defined as an increase in the equity capital of an Enterprise
resulting from a traditional securitization other than an increase in
equity capital resulting from (i) the Enterprise's receipt of cash in
connection with the securitization or (ii) reporting of a mortgage
servicing asset.
Finally, an Enterprise also would deduct from CET1 capital the
amount of expected credit loss that exceeds the Enterprise's eligible
credit reserves. Eligible credit reserves would be defined as all
general allowances that have been established through a charge against
earnings to cover estimated credit losses associated with on- or off-
balance sheet wholesale and retail exposures, including the ALLL
associated with such exposures, but excluding other specific reserves
created against recognized losses.
b. Adjustments to CET1 Capital
An Enterprise would subtract from CET1 capital any accumulated net
gains and add any accumulated net losses on cash-flow hedges included
in AOCI that relate to the hedging of items that are not recognized at
fair value on the balance sheet. This adjustment would remove an
element that gives rise to artificial volatility in CET1 capital as it
would avoid a situation in which the changes in the fair value of the
cash-flow hedge are reflected in regulatory capital but the changes in
the fair value of the hedged item is not.
An Enterprise also would be required to deduct any net gain and add
any net loss related to changes in the fair value of liabilities that
are due to changes in the Enterprise's own credit risk. An Enterprise
must deduct the difference between its credit spread premium and the
risk-free rate for derivatives that are liabilities as part of this
adjustment.
To avoid the double-counting of regulatory capital, an Enterprise
would deduct the amount of its investments in its own capital
instruments, including direct and indirect exposures, to the extent
such instruments are not already excluded from regulatory capital.
Specifically, an Enterprise would deduct its investment in its own
CET1, additional tier 1, and tier 2 capital instruments from the sum of
its CET1, additional tier 1, and tier 2 capital, respectively. In
addition, any CET1, additional tier 1, or tier 2 capital instrument
issued by an Enterprise that the Enterprise could be contractually
obligated to purchase also would be deducted from CET1, additional tier
1, or tier 2 capital elements, respectively.
c. Items Subject to the 10 and 15 Percent CET1 Capital Threshold
Deductions
An Enterprise would deduct from its CET1 capital the amount of each
of the following items that individually exceeds the 10 percent CET1
capital deduction threshold described below:
DTAs arising from temporary differences that could not be
realized through net operating loss carrybacks (net of any related
valuation allowances and net of DTLs in accordance with certain
restrictions discussed under Section V.B.3.d); and
MSAs, net of associated DTLs in accordance with certain
restrictions discussed under Section V.B.3.d.
An Enterprise would calculate the 10 percent CET1 capital deduction
threshold by taking 10 percent of the sum of an Enterprise's CET1
elements, less the adjustments to, and deductions from, CET1 capital
discussed above.
The aggregate amount of the items subject to the threshold
deductions that are not deducted as a result of the 10 percent CET1
capital deduction threshold must not exceed 15 percent of an
Enterprise's CET1 capital, as calculated after applying all regulatory
adjustments and deductions required under the proposed rule (the 15
percent CET1 capital deduction threshold). That is, an Enterprise would
deduct in full the amounts of the items subject to the threshold
deductions on a combined basis that exceed 17.65 percent (the
proportion of 15 percent to 85 percent) of CET1 capital, less all
regulatory adjustments and deductions required for the calculation of
the 10 percent CET1 capital deduction threshold mentioned above, and
less the items subject to the 10 and 15 percent deduction thresholds.
d. Netting of Deferred Tax Liabilities Against Deferred Tax Assets and
Other Deductible Assets
An Enterprise would be permitted to net DTLs against assets (other
than DTAs) subject to deduction under the proposed rule, provided the
DTL is associated with the asset and the DTL would be extinguished if
the associated asset becomes impaired or is derecognized under GAAP. An
Enterprise would be prohibited from using the same DTL more than once
for netting purposes.
With respect to the netting of DTLs against DTAs, the amount of
DTAs that arise from net operating loss and tax credit carryforwards,
net of any related valuation allowances, and the amount of DTAs arising
from temporary differences that the Enterprise could not realize
through net operating loss carrybacks, net of any related valuation
allowances, could be netted against DTLs if certain conditions are met.

VI. Capital Requirements

A. Risk-Based Capital Requirements

1. Supplemental Requirements
FHFA is proposing to require the Enterprises to maintain the
following risk-based capital:
Total capital not less than 8.0 percent of risk-weighted
assets;
Adjusted total capital not less than 8.0 percent of risk-
weighted assets;
Tier 1 capital not less than 6.0 percent of risk-weighted
assets; and
CET1 capital not less than 4.5 percent of risk-weighted
assets.

[[Page 39293]]

As discussed in Section III.B.3, a lesson of the 2008 financial
crisis is that the Enterprises' safety and soundness depends not only
on the quantity but also on the quality of their capital. To that end,
FHFA is proposing to supplement the risk-based capital requirement
based on statutorily defined total capital with additional risk-based
capital requirements based on the Basel framework's definitions of
total capital, tier 1 capital, and CET1 capital.
As discussed in Section IV.B.1, FHFA noted in the 2018 proposal
that the Enterprises' DTAs, which are included in total capital and
core capital by statute, ``may provide minimal to no loss-absorbing
capability during a period of [financial] stress as recoverability (via
taxable income) may become uncertain.'' \47\ The 2018 proposal
addressed this issue by establishing a risk-based capital requirement
for DTAs. However, the 2018 proposal did not include adjustments for
other capital elements that tend to have less loss-absorbing capacity
during a financial stress (e.g., ALLL, goodwill, and intangibles),
although FHFA did request comment on how best to compensate for the
loss-absorbing deficiencies of ALLL and preferred stock within the
framework of the 2018 proposal. The 2018 proposal also requested
comment on, but did not adjust for, AOCI, leaving open the possibility
that an Enterprise could have positive total capital and core capital
despite being insolvent under GAAP. The supplemental risk-based capital
requirements for adjusted total capital, tier 1 capital, and CET1
capital would address these safety and soundness issues to the extent,
as discussed in Section V.B, the underlying regulatory capital
definitions incorporate deductions and other adjustments for those
capital elements that tend to have less loss-absorbing capacity.
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\47\ 83 FR at 33388.
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Related to this, one of the lessons of the 2008 financial crisis is
that retained earnings and other high-quality capital should be the
predominant form of regulatory capital. In addition to not limiting the
extent to which general ALLL counted toward regulatory capital, the
2018 proposal did not limit the extent to which preferred shares could
satisfy the risk-based capital requirements, although FHFA did solicit
comment on these issues. Specifically, there was neither a risk-based
capital requirement for core capital nor a requirement that retained
earnings and other common equity be the predominant form of capital.
The risk-based capital requirements for tier 1 capital and CET1 capital
would address this safety and soundness issue in a way that should be
familiar to market participants.
2. Risk-Weighted Assets
An Enterprise would determine its risk-weighted assets under two
approaches--a standardized approach and an advanced approach--with the
greater of the two used to determine its risk-based capital
requirements. Under both approaches, an Enterprise's risk-weighted
assets would equal the sum of its credit risk-weighted assets, market
risk-weighted assets, and operational risk-weighted assets.
Specifying each of the aggregate risk-based capital requirements as
a percent of risk-weighted assets is a change from the 2018 proposal,
but the change itself would not impact the quantity of required total
capital. Both under the 2018 proposal and the proposed rule, and
consistent with the Basel and U.S. banking frameworks,\48\ the risk-
based capital requirements should be calibrated to require each
Enterprise to hold enough loss-absorbing capital to maintain the
confidence of creditors and other counterparties in its viability as a
going concern. More specifically, FHFA calibrated the credit risk
capital requirements for mortgage exposures to require capital
sufficient to absorb the lifetime unexpected losses incurred on
exposures experiencing a shock to house prices similar to that observed
during the 2008 financial crisis, as discussed in Sections VIII.A.2 and
VIII.B.2. The base risk weight for a mortgage exposure is equal to the
adjusted total capital requirement for the exposure expressed in basis
points and divided by 800, which is the 8.0 percent adjusted total
capital requirement also expressed in basis points. Expressing the
risk-based capital requirement for an exposure as a risk weight, or the
aggregate risk-based capital requirement as a percent of risk-weighted
assets, is simply a matter of terminology.
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\48\ 78 FR at 51105 (``In calibrating the revised risk-based
capital framework, the BCBS identified those elements of regulatory
capital that would be available to absorb unexpected losses on a
going-concern basis. The BCBS agreed that an appropriate regulatory
minimum level for the risk-based capital requirements should force
banking organizations to hold enough loss-absorbing capital to
provide market participants a high level of confidence in their
viability.'').
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Although the shift to a terminology of risk-weighted assets is more
form than substance, FHFA has made this change for at least two
reasons. First, the addition of three new risk-based capital
requirements raises the need for a straightforward mechanism to specify
the aggregate regulatory capital required for each. Risk-weighted
assets accomplishes this by offering a common denominator across the
2018 proposal's risk-based total capital requirement and the
supplemental risked-based capital requirements contemplated by the
proposed rule. Second, this approach and its associated terminology are
well-understood by those familiar with the U.S. banking framework.
Expressing the risk-based capital requirement for an exposure as a
risk-weight will facilitate transparency and comparability with the
U.S. banking framework and other regulatory capital frameworks. Because
these concepts are well-understood, this approach also should
facilitate market discipline over each Enterprise's risk-taking by its
creditors and other counterparties.

B. Leverage Ratio Requirements

1. Adjusted Total Assets
Each Enterprise would be required to maintain capital sufficient to
satisfy the following leverage ratio requirements:
Core capital not less than 2.5 percent of adjusted total
assets; and
Tier 1 capital not less than 2.5 percent of adjusted total
assets.
Adjusted total assets would be defined as total assets under GAAP,
with adjustments to include many of the off-balance sheet and other
exposures that are included in the supplemental leverage ratio
requirements of the U.S. banking framework.
2. Tier 1 Leverage Ratio Requirement
As with the risk-based capital requirements, and as discussed in
Section IV.B.1, the proposed rule would supplement the core capital
leverage ratio requirement with a leverage ratio requirement based on a
definition of regulatory capital, here tier 1 capital, that has
deductions and other adjustments for capital elements that tend to have
less loss-absorbing capacity during a period of financial stress. Tier
1 capital is also a well-understood concept for market participants
familiar with the U.S. banking framework. That in turn would facilitate
transparency and comparability with the leverage ratio requirements for
U.S. banking organizations, as well as market discipline by the
Enterprises' creditors and other counterparties.
3. Sizing of the Requirements
The primary purpose of the leverage ratio requirements is to
provide a credible, non-risk-based backstop to the risk-based capital
requirements to safeguard against model risk and

[[Page 39294]]

measurement error with a simple, transparent, independent measure of
risk. From a safety-and-soundness perspective, each type of requirement
offsets potential weaknesses of the other, and well-calibrated risk-
based capital requirements working with a credible leverage ratio
requirement are more effective than either type would be in isolation.
The leverage ratio requirements would have the added benefit of
dampening some of the pro-cyclicality inherent in the aggregate risk-
based capital requirements. The core capital leverage ratio requirement
also would replace the current statutory leverage ratio requirement for
purposes of the corrective action provisions of the Safety and
Soundness Act.
FHFA has sized the leverage ratio requirements to be a credible
backstop to the risk-based capital requirements, taking into account
the analogous leverage ratio requirements of U.S. banking organizations
and the Federal Home Loan Banks, considerations relating to the
Enterprises' historical loss experiences, and the model and related
risks posed by the calibration of the risk-based capital requirements.
First, the proposed leverage ratio requirements are generally
aligned with the analogous leverage ratio requirements of U.S. banking
organizations and the Federal Home Loan Banks. The U.S. banking
framework's leverage ratio requirement requires banking organizations
maintain tier 1 capital no less than 4.0 percent of total assets.
Insured depository institutions subsidiaries of certain large U.S. bank
holding companies also must maintain tier 1 capital no less than 6.0
percent of total assets to be ``well capitalized.'' \49\ Using data for
the 18 bank holding companies subject to the Federal Reserve Board's
supervisory stress testing program in 2018, FHFA determined that the
average risk weight on the assets of these banks was 61 percent in the
fourth quarter of 2018. Under the U.S. banking framework, the
Enterprises' mortgage assets generally would be assigned a 50 percent
risk weight under the standardized approach. This suggests that the
average risk weight on the assets of the Enterprises would have been
approximately 81 percent (50 percent divided by 61 percent) of that of
these large bank holding companies. That in turn implies a risk-
adjusted analogous leverage ratio requirement for the Enterprises of
3.3 percent (81 percent of the 4.0 percent leverage ratio requirement
for U.S. banking organizations).\50\
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\49\ See, e.g., 12 CFR 6.4(b)(1)(i)(D).
\50\ That U.S. banking framework's 3 percent supplemental
leverage ratio requirement is an inappropriate comparable for sizing
the Enterprises' leverage ratio requirements. Approximately 95
percent of the Enterprises' adjusted total assets are GAAP total
assets that are subject to the U.S. banking framework's 4 percent
leverage ratio requirement. The primary exception is off-balance
sheet guarantees on loans and securities, principally Freddie Mac's
K-deals, but these amounts are small relative to the Enterprises'
total assets under GAAP.
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While the interest rate and funding risks of the Enterprises and
U.S. banking organizations are different, the Basel and U.S. banking
frameworks generally do not contemplate an explicit capital requirement
for interest rate risk on banking book exposures given the absence of a
consensus as to how to quantify that capital requirement, instead
leaving interest rate risk capital requirements to bank-specific
tailoring through the supervisory process.\51\ The differences in the
interest rate and funding risk profiles therefore should not preclude
comparisons to the U.S. banking framework's leverage ratio
requirements, subject to adjustments for the different credit risk
profiles of the Enterprises and U.S. banking organizations (as
described above). Further, the monoline nature of the Enterprises'
mortgage-focused businesses suggests that the concentration risk of an
Enterprise is greater than that of a diversified banking organization
with a similar amount of mortgage credit risk, perhaps meriting a
higher leverage ratio requirement, all else equal.
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\51\ See BCBS, Interest Rate Risk in the Banking Book, paragraph
1, (April 2016), available at https://www.bis.org/bcbs/publ/d368.pdf; (``Interest rate risk in the banking book (IRRBB) is part
of the Basel capital framework's Pillar 2 (Supervisory Review
Process) and subject to the Committee's guidance set out in the 2004
Principles for the management and supervision of interest rate risk
(henceforth, the IRR Principles).'').
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The Federal Home Loan Banks also must maintain total capital no
less than 4.0 percent of total assets. That 4.0 percent leverage ratio
requirement should be considered in the context of the safety and
soundness benefits of the statutory requirement that each Federal Home
Loan Bank advance be fully secured. Related to that, the safety and
soundness benefits of that collateral might be furthered by law, as any
security interest granted to a Federal Home Loan Bank by a member (or
affiliate of a member) is, with some exceptions, entitled by statute to
priority over the claims and rights of any other party, including any
receiver, conservator, trustee, or similar party having rights of a
lien creditor.
Second, the proposed leverage ratio requirements are broadly
consistent with the Enterprises' historical loss experiences. As
discussed in Sections II.D.3 and III.B.1, the Enterprises' crisis-era
cumulative capital losses peaked at the end of 2011 at $265 billion,
approximately 4.8 percent of their adjusted total assets as of December
31, 2007. Setting aside the valuation allowances on their DTAs, which
are subject to deductions and other adjustments to CET1 capital (and
therefore tier 1 and adjusted total capital) under the proposed rule,
the Enterprises' crisis-era peak cumulative capital losses were $167
billion, approximately 3.0 percent of their total assets as of December
31, 2007. Notably even these DTA-adjusted capital losses exceeded by
$36 billion the tier 1 capital that would have been required under the
2.5 percent leverage ratio requirement as of December 31, 2007.
FHFA recognizes that a portion of the crisis-era losses arose from
single-family loans that are no longer eligible for acquisition by the
Enterprises. However, the sizing of regulatory capital requirements
must take into account the modeling risk posed by the attribution of
such losses to specific product characteristics, as discussed in
Section IV.B.2. The sizing of the regulatory capital requirements also
must guard against potential future relaxation of underwriting
standards and regulatory oversight over those underwriting standards.
The Enterprises' historical loss experiences actually might tend to
understate the regulatory capital that would be necessary to remain a
viable going concern to creditors and other counterparties. As
discussed in Section III.B.1, the Enterprises' crisis-era losses likely
were mitigated to at least some extent by the unprecedented support by
the federal government of the housing market and the economy and also
by the declining interest rate environment of the period. The
calibration of the leverage ratio requirement and other required
capital requirements cannot assume a repeat of those loss mitigants.
Also, as discussed in Section IV.B.2, there are some material risks to
the Enterprises that are not assigned a risk-based capital
requirement--for example, risks relating to uninsured or underinsured
losses from flooding, earthquakes, or other natural disasters or
radiological or biological hazards. There also is no risk-based capital
requirement for the risks that climate change could pose to property
values in some localities.
Third, certain risks and limitations associated with the underlying

[[Page 39295]]

historical data and models used to calibrate the credit risk capital
requirements reinforce the importance of leverage ratio requirements
that safeguard against model risk and measurement error. There is
inevitably a trade-off between, on the one hand, preserving the
mortgage risk-sensitive framework of the 2018 proposal and, on the
other hand, managing the model and related risks associated with any
methodology for developing a granular assessment of credit risk
specific to different mortgage loan categories. As discussed in Section
IV.B.2, a disproportionate share of the Enterprises' crisis-era losses
arose from certain single-family mortgage exposures that are no longer
eligible for acquisition by the Enterprises. The calibration of the
credit risk capital requirements attributed a significant portion of
the Enterprises' crisis-era losses (approximately $108 billion) to
these products. The statistical methods used to allocate losses between
borrower-related risk attributes and product-related risk attributes
pose significant model risk. It is possible that the calibration
understates the credit losses that would be incurred in an economic
downturn with national housing price declines of similar magnitude,
even assuming a repeat of crisis-era Federal support of the economy and
the declining interest rate environment. To this point, as discussed in
Section VIII.A.7, had the proposed rule been in effect on December 31,
2007, the credit risk capital requirements still would not have been
sufficient to absorb the projected lifetime credit losses on Freddie
Mac's single-family book. Under a dynamic framework, the aggregate
credit risk capital requirements would have increased in subsequent
years as losses were incurred, while there also would have been
material uncertainty as to an Enterprise's ability to raise sufficient
quantities of new capital during a period of financial stress and
significant losses.
The risk-based capital requirements should, as a general rule,
exceed the regulatory capital required under the leverage ratio
requirements. At the same time, if the tier 1 leverage ratio
requirement is to be an independently meaningful and credible backstop,
there will inevitably be some exceptions in which the tier 1 leverage
ratio requirement requires more regulatory capital than the risk-based
capital requirements. In FHFA's view, the measurement period of
September 30, 2019 is, in fact, consistent with the circumstances under
which a credible leverage ratio would be binding, given the exceptional
single-family house price appreciation since 2012, the strong credit
performance of both single-family and multifamily mortgage exposures,
the significant progress by the Enterprises to materially reduce legacy
exposure to NPLs and re-performing loans, robust CRT market access
enabling substantial risk transfer, and the generally strong condition
of key counterparties, such as mortgage insurers.
Question 4. Is the tier 1 leverage ratio requirement appropriately
sized to serve as a credible backstop to the risk-based capital
requirements?
Question 5. Should the Enterprise's leverage ratio requirements be
based on total assets, as defined by GAAP, the Enterprise's adjusted
total assets, or some other basis?

C. Enforcement

FHFA may draw upon several authorities to address potential
Enterprise failures to meet the proposed rule's capital requirements
set forth in VI.A and VI.B. A failure to maintain regulatory capital in
excess of each of these capital requirements may result in one or more
enforcement consequences. In all cases, the FHFA Director retains the
authority to determine the appropriate enforcement consequence.
The Safety and Soundness Act authorizes FHFA to establish capital
levels for an Enterprise by regulation.\52\ An Enterprise failure to
meet a capital threshold that is required by regulation may be
addressed through enforcement mechanisms for regulatory violations
including procedures for cease and desist and consent orders.\53\
Through a cease and desist or consent order, FHFA could require an
Enterprise to develop and implement a capital restoration plan,
restrict asset growth or activities, and take other appropriate action
to remediate the violation of law.
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\52\ 12 U.S.C. 4526, 4611, 4612(c).
\53\ 12 U.S.C. 4581, 12 CFR part 1209.
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FHFA may also use the enforcement tools available under its
authority to prescribe and enforce prudential management and operations
standards (PMOS).\54\ The proposed rule, other than the PCCBA, the
PLBA, and the associated payout restrictions, would be prescribed as a
PMOS guideline that may be enforced under these PMOS authorities. The
PMOS statute and rule include enforcement remedies similar, although
not identical, to those under the Prompt Corrective Action (PCA)
framework discussed below, focusing on a remediation plan and such
other measures as the Director deems appropriate, but not
conservatorship or receivership. The FHFA Director may require as part
of a remediation plan (which is to be developed within a timeline in
the PMOS regulation) restrictions on capital distributions,
restrictions on asset growth, activities, and acquisitions, a
requirement for new capital-raising, and other restrictions as
appropriate.
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\54\ 12 U.S.C. 4513b; 12 CFR part 1236.
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The PCA framework set out in the Safety and Soundness Act \55\ also
provides for enforcement tools when a shortfall occurs in capital
requirements that are set forth in the statute, using the statute's
prescribed capital concepts. The PCA establishes four capital
categories with associated increasingly severe enforcement tools:
``adequately capitalized,'' ``undercapitalized,'' ``significantly
undercapitalized,'' and ``critically undercapitalized.'' Under the PCA
framework, the principal remedial tool is a recapitalization plan, and
other tools include restrictions on capital distributions and asset
growth, prior approval of acquisitions and new activities, improvement
of management, and restriction on compensation. In serious enough
conditions, such as critical undercapitalization, the PCA provides that
an Enterprise can be placed in conservatorship or receivership. In
addition, the PCA provisions provide for an Enterprise to be downgraded
if alternative specified conditions are met. One of those conditions is
that an Enterprise is in ``an unsafe or unsound condition,'' as
determined by FHFA after notice and opportunity for a hearing.
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\55\ 12 U.S.C. 4614 et seq.
---------------------------------------------------------------------------

The proposed rule would include a leverage requirement and a risk-
based capital requirement using the concepts of total capital and core
capital as defined in the Safety and Soundness Act. The PCA enforcement
framework applies to an Enterprise's failure to meet either of these
statutorily based capital requirements. In addition, FHFA could enforce
the core capital and total capital requirements under its authority to
issue an order to cease and desist from a violation of law or under its
PMOS authority.
FHFA recognizes that there may be very particular economic
circumstances during which an Enterprise may meet its risk-based
capital requirement to maintain total capital in excess of 8.0 percent
of risk-weighted assets, but fails to meet the leverage ratio
requirement of core capital in excess of 2.5 percent of adjusted total
assets. This situation falls outside of the PCA capital classifications
and enforcement

[[Page 39296]]

framework, but FHFA could address a shortfall through its PMOS or other
regulatory enforcement authorities. If appropriate to provide greater
clarity to the Enterprises and other market participants, FHFA may
issue supervisory guidance regarding progressive application of its
enforcement authorities as the capital position of an Enterprise
declines.
Question 6. Should FHFA consider any changes to its contemplated
enforcement framework? What supervisory guidance would be helpful to
promote market understanding of how FHFA expects to apply its
enforcement authorities?
Question 7. Should any of the risk-based capital requirements or
leverage ratio requirements be phased-in over a transition period?
Question 8. Alternatively, should the enforcement of the risk-based
capital requirements during the implementation of a capital restoration
plan be tailored through a consent order or other similar regulatory
arrangement, and if so how?

VII. Capital Buffers

A. Prescribed Capital Conservation Buffer Amount (PCCBA)

FHFA is proposing to supplement certain of the risk-based capital
requirements with a PCCBA. To avoid limits on capital distributions and
discretionary bonus payments, an Enterprise would have to maintain
regulatory capital that exceeds each of its adjusted total capital,
tier 1 capital, and CET1 capital requirements by at least the amount of
its PCCBA. That PCCBA would consist of three separate component
buffers--a stress capital buffer, a countercyclical capital buffer, and
a stability capital buffer.
The PCCBA would be determined as a percent of an Enterprise's
adjusted total assets.\56\ Fixing the PCCBA at a specified percent of
an Enterprise's adjusted total assets, instead of risk-weighted assets,
is a notable departure from the Basel framework. FHFA intends a fixed-
percent PCCBA, among other things, to reduce the impact that the PCCBA
potentially could have on higher risk exposures, avoid amplifying the
secondary effects of any model or similar risks inherent to the
calibration of granular risk weights for single-family and multifamily
mortgage exposures, and further mitigate the pro-cyclicality of the
aggregate risk-based capital requirements.
---------------------------------------------------------------------------

\56\ The stress capital buffer and the countercyclical capital
buffer amount could vary, which would then result in a change in the
Enterprise's PCCBA when expressed as a percent of the Enterprise's
adjusted total assets.
---------------------------------------------------------------------------

1. Stress Capital Buffer
An Enterprise's stress capital buffer would equal 0.75 percent of
the Enterprise's adjusted total assets. The proposed stress capital
buffer is similar in amount and rationale to the 0.75 percent going-
concern buffer contemplated by the 2018 proposal. The 2018 proposal
acknowledged that each Enterprise is required by charter to provide
stability and ongoing assistance to the secondary mortgage market
during and after a period of severe financial stress. The 2018 proposal
also observed that ``[r]aising new capital during a period of severe
housing market stress . . . would be very expensive, if not impossible;
therefore, the [2018 proposal] would require the Enterprises to hold
additional capital on an on-going basis (`going-concern buffer') in
order to continue purchasing exposures and to maintain market
confidence during a period of severe distress.''
An important difference is that the 2018 proposal's going-concern
buffer would have been a component of the risk-based capital
requirement, such that failure to maintain the regulatory capital
required by the going-concern buffer could have triggered significant
regulatory sanctions. In contrast, the proposed rule converts the 2018
proposal's going-concern buffer into a component of the capital
conservation buffer that FHFA intends to be available for an Enterprise
to draw down during a period of financial stress. As discussed in
Section II.D, the potential for less punitive sanctions for drawing
down the capital conservation buffer should position each Enterprise to
play a countercyclical role in the market, and would have the further
benefit of reducing the managerial capital cushion that an Enterprise
might be expected to maintain above the regulatory capital
requirements.
For the reasons given in Section III.B.2, and as contemplated for
banking organizations by the Basel and U.S. banking frameworks,\57\
each Enterprise should be capitalized to remain a viable going concern
both during and after a severe economic downturn. While the proposed
regulatory capital requirements are sized to ensure an Enterprise would
be regarded as a viable going concern by creditors and other
counterparties, the stress capital buffer is sized to ensure that the
Enterprise would, in ordinary times, maintain regulatory capital that
could be drawn down during a financial stress and still be regarded as
a viable going concern after that stress.
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\57\ 78 FR at 51105 (``In calibrating the revised risk-based
capital framework, the BCBS identified those elements of regulatory
capital that would be available to absorb unexpected losses on a
going-concern basis. The BCBS agreed that an appropriate regulatory
minimum level for the risk-based capital requirements should force
banking organizations to hold enough loss-absorbing capital to
provide market participants a high level of confidence in their
viability. The BCBS also determined that a buffer above the minimum
risk-based capital requirements would enhance stability, and that
such a buffer should be calibrated to allow banking organizations to
absorb a severe level of loss, while still remaining above the
regulatory minimum requirements.'').
---------------------------------------------------------------------------

To a similar end, FHFA sized the 2018 proposal's going-concern
buffer based on the Enterprises' Dodd Frank Act Stress Test (DFAST)
results for the severely adverse scenario. Specifically, ``FHFA
calculated the amount of capital necessary for the Enterprises to meet
a 2.5 percent leverage requirement at the end of each quarter of the
simulation of the severely adverse DFAST scenario (without DTA
valuation allowance) and compared that amount to the aggregate risk-
based capital requirement. The difference between these two measures
provided an indicator for the size of the going-concern buffer.''
As further validation of the sizing of the stress capital buffer,
FHFA's 2018 proposal compared the regulatory capital obtained by
applying the going-concern buffer to the 2017 single-family book of
business with the regulatory capital required to fund each Enterprise's
2017 new acquisitions. FHFA found the proposed going-concern buffer
would provide sufficient capital for each Enterprise to fund an
additional one to two years of new acquisitions comparable to their
2017 new acquisitions. FHFA continues to believe that 2018 proposal's
approach provides a strong indicator for the appropriate size of the
stress capital buffer that replaces the going-concern buffer.
FHFA has also looked to the sizing of analogous buffers under the
Basel and U.S. banking frameworks. As recently amended by the Federal
Reserve Board, the U.S. banking framework requires each U.S. banking
organization to maintain a stress capital buffer that exceeds its
regulatory capital requirements by at least 2.5 percent of its risk-
weighted assets, potentially more depending on its peak cumulative
capital exhaustion under its supervisory stress test. Under the current
average risk weight for the Enterprises' exposures of 28 percent, the
proposed stress capital buffer is equivalent to 2.68

[[Page 39297]]

percent of the Enterprises' risk-weighted assets.
While the proposed rule contemplates a stress capital buffer sized
as a fixed- percent of an Enterprise's adjusted total assets, FHFA is
also seeking comment on an alternative under which FHFA would implement
an approach similar to that of the Federal Reserve Board and
periodically re-size the stress capital buffer to the extent that
FHFA's eventual program for supervisory stress tests determines that an
Enterprise's peak capital exhaustion under a severely adverse stress
would exceed 0.75 percent of adjusted total assets. Under this
approach, the stress capital buffer would still be determined as a
percent of adjusted total assets, not risk-weighted assets. A
dynamically re-sized stress capital buffer would be more risk-sensitive
than a fixed-percent stress capital buffer, varying in amount across
the economic cycle and also varying with the riskiness of the
Enterprise's mortgage exposures. An approach that leverages a
supervisory stress test could also incorporate assumptions as to the
continued availability of CRT during a period of financial stress.
Related to this, FHFA's proposal to incorporate into each
Enterprise's PCCBA a stress capital buffer should not be construed to
imply or otherwise suggest that a similar buffer would necessarily be
appropriate for other market participants in the housing finance
system. Some of the Enterprises' counterparties, and some other market
participants in the housing finance system, need not necessarily be
capitalized to remain a viable going concern both during and after a
severe economic downturn. For these market participants, calibrating
capital adequacy based on ``claims paying capacity'' or an insurance-
like or similar standard might be appropriate in light of their size
and role in the housing finance system.
Question 9. Is the stress capital buffer appropriately formulated
and calibrated?
Question 10. Should an Enterprise's stress capital buffer be
periodically re-sized to the extent that FHFA's eventual program for
supervisory stress tests determines that an Enterprise's peak capital
exhaustion under a severely adverse stress would exceed 0.75 percent of
adjusted total assets?
Question 11. Should an Enterprise's stress capital buffer be
adjusted as the average risk weight of its mortgage exposures and other
exposures changes?
Question 12. Should an Enterprise's stress capital buffer be based
on the Enterprise's adjusted total assets or risk-weighted assets?
2. Countercyclical Capital Buffer
The U.S. banking regulators adopted a countercyclical capital
buffer for certain large U.S. banking organizations in June 2013, which
has been and remains set at 0 percent of risk-weighted assets. The
countercyclical capital buffer aims to ensure that banking sector
capital requirements take into account the macro-financial environment
in which banks operate.\58\ The buffer is to be deployed when excess
aggregate credit growth is judged to be associated with a build-up of
system-wide risk to ensure the banking system has a buffer of capital
to protect it against future potential losses. This focus on excess
aggregate credit growth means that the buffer is likely to be deployed
on an infrequent basis.
---------------------------------------------------------------------------

\58\ BCBS, Basel: A Global Regulatory Framework for More
Resilient Banks and Banking Systems, paragraph 137 (Dec. 2010;
revised June 2011), available at https://www.bis.org/publ/bcbs189.htm.
---------------------------------------------------------------------------

As is currently the case under the U.S. banking framework, the
countercyclical capital buffer for the Enterprises would initially be
set at 0 percent of adjusted total assets. FHFA does not expect to
adjust this buffer in the place of, or to supplement, the
countercyclical adjustment to the risk-based capital requirements for
single-family mortgage exposures discussed in Section VIII.A.4.
Instead, as under the Basel and U.S. banking frameworks, FHFA would
adjust the countercyclical capital buffer taking into account the
macro-financial environment in which the Enterprises operate, such that
it would be deployed only when excess aggregate credit growth is judged
to be associated with a build-up of system-wide risk. This focus on
excess aggregate credit growth means the countercyclical buffer likely
would be deployed on an infrequent basis, and generally only when
similar buffers are deployed by the U.S. banking regulators. Any
adjustment to the countercyclical capital buffer would be made in
accordance with applicable law and after appropriate notice to the
Enterprises.
Question 13. Is the countercyclical capital buffer appropriately
formulated?
Question 14. What administrative or other process should govern
FHFA's adjustments to the countercyclical capital buffer?
Question 15. Should FHFA more explicitly base its determination to
adjust the countercyclical capital buffer to the determination of the
U.S. banking regulators to adjust their similar buffer?
3. Stability Capital Buffer
a. Comments on the 2018 Proposal
FHFA received several comment letters on the 2018 proposal that
argued that FHFA did not adequately address the risk posed by the size
and importance of the Enterprises, particularly in light of the fact
that during the 2008 financial crisis, the Enterprises proved to be
``too-big-to-fail.'' Multiple commenters recommended FHFA consider
adding a capital buffer due to the size of the Enterprises' footprints.
Other commenters suggested FHFA address the Enterprises' size and
importance in different ways, such as through the leverage ratio,
through the credit risk capital grids, or with an asset-level surcharge
that differed by the riskiness of the activity.
b. U.S. Banking Framework
The Dodd-Frank Wall Street Reform and Consumer Protection Act
(Dodd-Frank Act) mandates that the Federal Reserve Board adopt, among
other prudential measures, enhanced capital standards to mitigate the
risk posed to financial stability by systemically important financial
institutions. The Federal Reserve Board has implemented a number of
measures designed to strengthen firms' capital positions in a manner
consistent with the Dodd-Frank Act's requirement that such measures
increase in stringency based on the systemic importance of the firm.
The Federal Reserve Board has also finalized capital surcharges for
the U.S. banking organizations of the greatest systemic importance that
have been deemed global systemically important bank holding companies
(GSIBs). These GSIB capital surcharges are calibrated based on the
Federal Reserve Board's measures of each GSIB's systemic footprint
under an ``expected impact'' framework that considers the harm that the
GSIB's failure would cause to the financial system as adjusted by the
likelihood that the GSIB will fail. Because the failure of a GSIB might
undermine financial stability and thus cause greater negative
externalities than might the failure of a firm that is not a GSIB, a
probability of default that would be acceptable for a non-GSIB might be
unacceptably high for a GSIB. Lowering the probability of a GSIB's
default reduces the risk to financial stability. The most
straightforward means of lowering the probability of a GSIB's default
is to require it to hold more regulatory capital relative to its risk-
weighted assets than non-GSIBs are required to hold.

[[Page 39298]]

c. Rationale and Sizing
As discussed in Section III.B.4, the lessons of the 2008 financial
crisis have established that the failure of an Enterprise could do
significant harm to the national housing finance markets, as well as
the U.S. economy more generally. The Enterprises remain the dominant
participants in the housing finance system, owning or guaranteeing 44
percent of residential mortgage debt outstanding as of September 30,
2019. The Enterprises also continue to control critical infrastructure
for securitizing and administering $5.5 trillion of single-family and
multifamily MBS. The Enterprises' imprudent risk-taking and inadequate
capitalization led to their near collapse and were among the proximate
causes of the 2008 financial crisis. The precipitous financial decline
of the Enterprises was also among the most destabilizing events of the
2008 financial crisis, leading to their taxpayer-backed rescue in
September 2008. Even today, a perception continues to persist that the
Enterprises are ``too big to fail.'' This perception reduces the
incentives of creditors and other counterparties to discipline risk-
taking by the Enterprises. This perception also produces competitive
distortions to the extent that the Enterprises can fund themselves at a
lower cost than other market participants.
Pursuant to the Safety and Soundness Act, as amended by HERA, the
FHFA Director's principal duties are, among other duties, to ensure
that each Enterprise operates in a safe and sound manner and that the
operations and activities of each Enterprise foster liquid, efficient,
competitive, and resilient national housing finance markets.\59\ For
the reasons below, FHFA is proposing to incorporate into each
Enterprise's PCCBA an Enterprise-specific stability capital buffer that
is tailored to the risk that the Enterprise's default or other
financial distress could have on the liquidity, efficiency,
competitiveness, or resiliency of the national housing finance markets
(housing finance market stability risk).\60\
---------------------------------------------------------------------------

\59\ 12 U.S.C. 4513(a)(1).
\60\ FHFA's proposed stability capital buffer should not be
construed to imply or otherwise suggest that a similar capital
surcharge would necessarily be appropriate for the Enterprises'
counterparties or other market participants in the housing finance
system. Some of these market participants do not pose much, if any,
risk to the liquidity, efficiency, competitiveness, or resiliency of
national housing finance markets.
---------------------------------------------------------------------------

First, an Enterprise-specific stability capital buffer would foster
liquid, efficient, competitive, and resilient national housing finance
markets by reducing the expected impact of the Enterprise's failure on
the national housing finance markets. Under a regulatory capital
framework in which each Enterprise is subject to the same capital
requirements and has the same probability of default, a larger
Enterprise's default would nonetheless still pose a greater expected
impact due to the greater magnitude of the effects of its default on
the national housing finance markets. As a result, a probability of
default that might be acceptable for a smaller Enterprise might be
unacceptably high for a larger Enterprise. By subjecting a larger
Enterprise to a larger capital surcharge, an Enterprise-specific
stability capital buffer would reduce the probability of a larger
Enterprise's default, aligning the expected impact of its default with
that of a smaller Enterprise.
Second, an Enterprise-specific stability capital buffer also would
foster liquid, efficient, competitive, and resilient national housing
finance markets by creating incentives for each Enterprise to reduce
its housing finance market stability risk by curbing its market share
and growth in ordinary times, preserving room for a larger role during
a period of financial stress.
Third, an Enterprise-specific stability capital buffer could offset
any funding advantage that an Enterprise might have on account of being
perceived as ``too big to fail.'' That, in turn, would remove the
incentive for counterparties to shift risk to the Enterprise, where
that incentive not only increases the housing finance market stability
risk posed by the Enterprise but also undermines the competitiveness of
the national housing finance markets.
Fourth, a larger capital cushion at an Enterprise could afford the
Enterprise and FHFA more time to address emerging weaknesses at the
Enterprise that could adversely impact the national housing finance
markets. In addition to mitigating national housing finance market
risk, the additional time afforded by a larger capital cushion could
help FHFA ensure that each Enterprise operates in a safe and sound
manner.
Finally, again with respect to safety and soundness, any perception
that an Enterprise is ``too big to fail'' leads to moral hazard that
undermines market discipline by creditors and other counterparties over
the risk taking at an Enterprise. By increasing the regulatory capital
at an Enterprise, the stability capital buffer would shift more tail
risk back to the Enterprise's shareholders, which should have the added
benefit of offsetting any ``too big to fail'' funding advantage arising
from unpriced tail risk. The resulting enhanced market discipline
should enhance safety and soundness by increasing the likelihood that
the Enterprise's risks are appropriately managed.
FHFA is proposing a stability capital buffer based on a market
share approach. Alternatively, FHFA is seeking comment on an additional
approach that would have the Enterprises compute their stability
capital buffer in a manner analogous to the U.S. banking approach for
determining the GSIB surcharge.
d. Market Share Approach
Under FHFA's market share approach, an Enterprise's stability
capital buffer would depend on an Enterprise's share of total
residential mortgage debt outstanding that exceeds a threshold of 5.0
percent market share. The stability capital buffer, expressed as a
percent of adjusted total assets, would increase by 5 basis points for
each percentage point of market share exceeding that threshold. For
purposes of determining the stability capital buffer, the Enterprise's
mortgage assets would mean the sum of:
The unpaid principal balance of its single-family mortgage
exposures, including any single-family loans that secure MBS guaranteed
by the Enterprise;
The unpaid principal balance of its multifamily mortgage
exposures, including any multifamily loans that secure MBS guaranteed
by the Enterprise;
The carrying value of its Enterprise MBS or Ginnie Mae
MBS, PLS, and other securitization exposures (other than its retained
CRT exposures); and
The exposure amount of any other mortgage assets.
Residential mortgage debt outstanding would mean the amount of
mortgage debt outstanding secured by single-family or multifamily
residences that are located in the United States (excluding any
mortgage debt outstanding secured by non-farm, non-residential, or farm
properties). FHFA would publish the residential mortgage debt
outstanding as of the end of each calendar year, potentially using
similar data published by the Federal Reserve Board.
Among other considerations, FHFA developed this market share-based
calibration of the stability capital buffer based on a linear
interpolation between two points. First, FHFA began with an assumption
that an Enterprise that has a share of total residential mortgage debt
outstanding equal to 5.0 percent--as of September 30, 2019, roughly
$632 billion in single-family and multifamily mortgage exposures owned
or

[[Page 39299]]

guaranteed--would not merit a stability capital buffer to mitigate its
national housing finance stability risk. An Enterprise with that 5.0
percent market share would have more assets than U.S. Bancorp ($487.6
billion in total assets, as of September 30, 2019), which is not a
GSIB, but less assets than the next largest U.S. banking organization,
Morgan Stanley ($902.6 billion in total assets as of September 30,
2019), which is a GSIB.
At the other extreme, the largest GSIB surcharge for a U.S. GSIB is
that of JPMorgan Chase, at 3.5 percent of risk-weighted assets as of
September 30, 2019. An Enterprise would roughly approximate an
equivalent stability capital buffer if it had a 25 percent share of
total residential mortgage debt outstanding. At that market share, the
Enterprise's stability capital buffer would be 1.00 percent of its
adjusted total assets, approximately equivalent to the 3.5 percent
surcharge expressed as a percent of risk-weighted assets under the
September 30, 2019 average net credit risk weight on the Enterprises'
mortgage exposures of 28 percent.
Under this market share approach, as of September 30, 2019, Fannie
Mae and Freddie Mac would have had stability capital buffers of,
respectively, 1.05 and 0.64 percent of adjusted total assets. Under the
September 30, 2019 28 percent average risk weight on their exposures,
Fannie Mae and Freddie Mac's stability capital buffers would have been
3.8 and 2.3 percent of risk-weighted assets, respectively, roughly in
line with U.S. GSIBs of similar size.
The following Table 7 details the calculation of the proposed
stability capital buffer as of December 31, 2007, September 30, 2017,
and September 30, 2019.

[[Page 39300]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.006

Question 16. Is the market share approach appropriately formulated
and calibrated to mitigate the national housing finance market
stability risk posed by an Enterprise? If not, what modifications
should FHFA consider to ensure an appropriate calibration?
Question 17. Is the market share approach appropriately formulated
and calibrated to ensure each Enterprise operates in a safe and sound
manner? If not, what modifications should FHFA consider to ensure an
appropriate calibration?
e. Alternative Approach
FHFA is soliciting comment on whether to replace or supplement the
market share approach discussed in Section VII.A.3.d with another
approach that considers other indicators of the housing finance market
stability risk posed by an Enterprise. Other such indicators could
include the ownership of the Enterprise's MBS and debt by other
financial institutions, the degree of control by the Enterprise over
key securitization infrastructure, the extent of the Enterprise's role
in aggregating and distributing credit risk through CRT, the
Enterprise's reliance on short-term debt funding, or the Enterprise's
expected debt issuances during a financial stress to fund purchases of
mortgage exposures out of securitization pools.
One specific alternative approach under consideration by FHFA is to
replace or supplement the market share approach with a modified version
of the U.S. banking framework's two methods for determining a GSIB's
capital

[[Page 39301]]

surcharge.\61\ Under method 1, a U.S. GSIB determines its capital
surcharge using the sum of weighted indicator scores that span five
categories correlated with systemic importance--size,
interconnectedness, cross-jurisdictional activity, substitutability,
and complexity. For each indicator, the U.S. GSIB's indicator score is
its own measure of the indicator divided by the aggregate global
measure of that indicator, which is based on other GSIBs' measures.
Method 2 uses similar inputs but replaces the substitutability
indicators with metrics for the U.S. GSIB's reliance on short-term
wholesale funding. Method 2 is also calibrated in a manner that
generally will result in GSIB capital surcharges that are higher than
those calculated under method 1.
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\61\ 12 CFR part 217, subpart. H (Federal Reserve Board).
---------------------------------------------------------------------------

FHFA is soliciting comment on whether to calibrate the stability
capital buffer based on some subset of the U.S. banking framework's
five categories--for example, size, interconnectedness, and
substitutability--and exclude the indicators for cross-jurisdictional
activity or complexity. In particular, cross-jurisdictional activity
might not be an important driver of the national housing finance market
stability risk posed by an Enterprise.
FHFA is also soliciting comment on whether modifications to the
definitions or calculations of the U.S. banking framework's specific
GSIB surcharge indicators would be appropriate to ensure the resulting
score or scores are correlated with an Enterprise's national housing
finance market stability risk. For example, the Enterprises play an
integral role in the national housing finance market, and there are
few, if any, natural substitutes for that role, but an Enterprise's
amount of underwritten transactions in debt and equity markets, one of
the substitutability indicators under the U.S. banking framework, might
not be strongly correlated with that risk.
Another approach might be to adopt a modified version of the U.S.
banking framework's method and then use a similar measure of an
Enterprise's reliance on short-term debt funding (perhaps with
adjustments for the expected debt issuances during a financial stress
to fund purchases of NPLs out of securitization pools) as the basis for
a replacement for the U.S. banking framework's method 2.
Question 18. Should the Enterprise-specific stability capital
buffer be determined using the U.S. banking framework's approach to
calculating capital surcharges for GSIBs?
Question 19. What, if any, modifications to the U.S. banking
framework's approach to calculating capital surcharges for GSIBs are
appropriate for determining the Enterprise-specific stability capital
buffer?
Question 20. Should the Enterprise-specific stability capital
buffer be determined based on a sum of the weighted indicators for
size, interconnectedness, and substitutability under the U.S. banking
framework?
Question 21. Which, if any, indicators of the housing finance
market stability risk posed by an Enterprise, other than its market
share, should be used to size the Enterprise's stability capital
buffer? How should those other indicators be measured and weighted to
produce a score of the housing finance market stability risk posed by
an Enterprise?
Question 22. What, if any, measure of the Enterprise's short-term
debt funding or expected debt issuances during a financial stress to
fund purchases of NPLs out of securitization pools should be used to
size the Enterprise's stability capital buffer?

B. Leverage Buffer

In addition to the payout restrictions posed by the PCCBA, to avoid
limits on capital distributions and discretionary bonus payments, an
Enterprise also would be required to maintain tier 1 capital in excess
of the amount required under the tier 1 leverage ratio requirement by
at least the amount of a PLBA equal to 1.5 percent of the Enterprise's
adjusted total assets. The primary purpose of the PLBA would be to
serve as a non-risk-based supplementary measure that provides a
credible backstop to the combined PCCBA and risk-based capital
requirements. From a safety-and-soundness perspective, each of the
risk-based and leverage ratio requirements offsets potential weaknesses
of the other. Taken together, well-calibrated risk-based capital
requirements working with a credible leverage ratio requirement are
more effective than either would be in isolation. FHFA deems it
important that the buffer-adjusted risk-based and leverage requirements
are also closely calibrated to each other so that they have an
effective complementary relationship.
To size the PLBA, FHFA looked first to the PCCBA of each
Enterprise. At 1.5 percent of adjusted total assets, the PLBA for
Fannie Mae and Freddie Mac would be, respectively, $53 billion and $38
billion as of September 30, 2019. For Fannie Mae, the PLBA would be
less than its PCCBA, while for Freddie Mac the reverse is true. These
results suggest that 1.5 percent PLBA is calibrated to ensure that the
PCCBA and PLBA have an effective complementary relationship such that
each is independently meaningful.
FHFA also looked to the sizing of similar leverage buffer
requirements under the U.S. banking framework. Some large U.S. banking
organizations are required to maintain a supplementary leverage ratio
requirement of 3.0 percent of their total leverage exposure and, to
avoid restrictions on distributions and discretionary bonuses, a
leverage buffer requirement of 2.0 percent of their total leverage
exposure. That 2.0 percent total leverage buffer requirement is 40
percent of the 5.0 percent buffer-adjusted leverage ratio requirement
to avoid payout restrictions. Similarly, a 1.5 percent PLBA for the
Enterprises would be 37.5 percent of the 4.0 percent buffer-adjusted
leverage ratio requirement to avoid payout restrictions.
Question 23. Is the PLBA appropriately sized to backstop the PCCBA-
adjusted risked-based capital requirements?
Question 24. Should the PLBA for an Enterprise be sized as a
fraction or other function of the PCCBA of the Enterprise? If so, how
should the PLBA of an Enterprise be calibrated based on the
Enterprise's PCCBA?

C. Payout Restrictions

An Enterprise would be subject to limits on its capital
distributions and discretionary bonus payments if either its capital
conservation buffer is less than its PCCBA, as discussed in Section
VII.A, or its leverage buffer is less than its PLBA, as discussed in
Section VII.B. An Enterprise also may not make distributions or
discretionary bonus payments during the current calendar quarter if, as
of the end of the previous calendar quarter: (i) The eligible retained
income of the Enterprise was negative; and (ii) either (A) the capital
conservation buffer of the Enterprise was less than its stress capital
buffer, or (B) the leverage buffer of the Enterprise was less than its
PLBA.
The capital conservation buffer is composed solely of CET1 capital.
An Enterprise's capital conservation buffer is equal to the lowest of
the following, calculated as of the last day of the previous calendar
quarter:
The Enterprise's adjusted total capital minus the minimum
amount of adjusted total capital required under the proposed rule;
The Enterprise's tier 1 capital minus the minimum amount
of tier 1

[[Page 39302]]

capital required under the proposed rule; or
The Enterprise's CET1 capital minus the minimum amount of
CET1 capital required under the proposed rule.
An Enterprise's maximum payout ratio determines the extent to which
it is subject to limits on capital distributions and discretionary
bonuses. The maximum payout ratio is the percent of eligible retained
income that an Enterprise can pay out in the form of distributions and
discretionary bonus payments during the current calendar quarter. The
eligible retained income of an Enterprise is the greater of: (i) The
Enterprise's net income for the four calendar quarters preceding the
current calendar quarter, net of any distributions and associated tax
effects not already reflected in net income; and (ii) the average of
the Enterprise's net income, as applicable, for the four calendar
quarters preceding the current calendar quarter. The maximum payout
ratio is itself a function of the extent to which the applicable
capital buffer is less than the applicable prescribed buffer amount, as
set forth on Table 8.
[GRAPHIC] [TIFF OMITTED] TP30JN20.007

If an Enterprise is subject to a maximum payout ratio, the payout
restrictions would apply to all capital distributions, which generally
extends to dividends or payments on, or repurchases of, CET1, tier 1,
or tier 2 capital instruments (except, with respect to a payment on a
tier 2 capital instrument, if the Enterprise does not have full
discretion to permanently or temporarily suspend such payments without
triggering an event of default). The payout restrictions would also
extend to discretionary bonuses, broadly defined to include any payment
made to an executive officer of an Enterprise where the Enterprise
retains discretion as to whether to make, and the amount of, the
payment, the amount paid is determined by the Enterprise without prior
promise to, or agreement with, the executive officer, and the executive
officer has no contractual right to the payment.
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\62\ An Enterprise's ``capital buffer'' means, as applicable,
its capital conservation buffer or its leverage buffer.
\63\ An Enterprise's ``prescribed buffer amount'' means, as
applicable, its PCCBA or its PLBA.
---------------------------------------------------------------------------

FHFA expects that each Enterprise generally will seek to avoid any
payout restriction by maintaining regulatory capital in excess of its
buffer-adjusted risk-based and leverage ratio requirements during
ordinary times. FHFA also expects that, consistent with its statutory
mission to provide stability and ongoing assistance to the secondary
mortgage market across the economic cycle, each Enterprise might draw
down its buffers during a period of financial stress. However, it would
not be consistent with the safe and sound operation of an Enterprise
for the Enterprise to maintain regulatory capital less than its buffer-
adjusted requirements in the ordinary course except for some reasonable
period after a financial stress, pending the Enterprise's efforts to
raise and retain regulatory capital.
Nothing in this proposed rule limits the authority of FHFA to take
action to address unsafe or unsound practices or violations of law,
including actions inconsistent with an Enterprise's charter. FHFA
could, depending on the facts and circumstances, determine that it is
an unsafe or unsound practice, or that it is inconsistent with the
Enterprise's statutory mission, for an Enterprise to maintain
regulatory capital that is less than its buffer-adjusted requirements
during ordinary times. If FHFA were to make that determination, FHFA
would have all of its enforcement and other authorities, including its
authority to issue a cease-and-desist order, to require the Enterprise
to remediate that unsafe or unsound practice--for example, by
developing and implementing a plan to raise additional regulatory
capital.
FHFA is soliciting comments on whether some or all of the payout
restrictions should be phased-in over a transition period. In
anticipation of the potential development and implementation of a
capital restoration plan by each Enterprise, tailored exceptions to the
payout restrictions might be appropriate to facilitate an Enterprise's
issuances of equity to new investors, particularly to the extent that
any tailored exception would shorten the time required for an
Enterprise to achieve the regulatory capital amounts contemplated by
the proposed rule or otherwise enhance its safety and soundness. For
example, a tailored exception to allow for some distributions on an
Enterprise's newly issued preferred stock might increase investor
demand for the offerings of those shares. Similarly, a tailored
exception for some limited regular dividends on an Enterprise's common
stock might increase investor demand for those shares.
Question 25. Are the payout restrictions appropriately formulated
and calibrated?
Question 26. Should there be any sanction or consequence other than
payout restrictions triggered by an Enterprise not maintaining a
capital conservation buffer or leverage buffer in

[[Page 39303]]

excess of the applicable PCCBA or PLBA?
Question 27. Should the payout restrictions be phased-in over an
appropriate transition period? If so, what is an appropriate transition
period?
Question 28. Should the payout restrictions provide exceptions for
dividends on newly issued preferred stock, perhaps with any exceptions
limited to some transition period following conservatorship?
Question 29. Should the payout restrictions provide an exception
for some limited dividends on common stock over some transition period?

VIII. Credit Risk Capital: Standardized Approach

A. Single-Family Mortgage Exposures

The standardized credit risk-weighted assets for each single-family
mortgage exposure would be determined using grids and risk multipliers
that together would assign an exposure-specific risk weight based on
the risk characteristics of the single-family mortgage exposure. The
resulting exposure-specific credit risk capital requirements generally
would be similar to those of the 2018 proposal, subject to some
simplifications and refinements. As discussed in Section VIII.A.3, the
base risk weight would be a function of the single-family mortgage
exposure's MTMLTV, among other things. The MTMLTV would be subject to a
countercyclical adjustment to the extent that national house prices are
5.0 percent greater or less than an inflation-adjusted long-term trend,
as discussed in Section VIII.A.4. This base risk weight would then be
adjusted based on other risk attributes, including any mortgage
insurance or other loan-level credit enhancement and the counterparty
strength on that enhancement, as discussed in Sections VIII.A.5 and
VIII.A.6. Finally, as discussed in Section VIII.A.7, this adjusted risk
weight would be subject to a floor of 15 percent.
1. Single-Family Business Models
The core of an Enterprise's single-family guarantee business is
acquiring single-family mortgage loans from mortgage companies,
commercial banks, credit unions, and other mortgage lenders, packaging
those loans into MBS, and selling the MBS either back to the original
lenders or to other private investors in exchange for a fee that
represents a guarantee of timely principal and interest payments on
those MBS.
The Enterprises engage in the acquisition and securitization of
single-family mortgage exposures primarily through two types of
transactions: Lender swap transactions; and cash window transactions.
In a lender swap transaction, lenders pool eligible single-family loans
together and deliver the pool of loans to an Enterprise in exchange for
an MBS backed by those single-family mortgage loans, which the lenders
generally then sell in order to use the proceeds to fund more mortgage
loans. In a cash window transaction, an Enterprise purchases single-
family loans from a large, diverse group of lenders and then, at a
later date, securitizes the acquired loans into an MBS. For MBS issued
as a result of either lender swap transactions or cash window
transactions, the Enterprises provide investors with a guarantee of the
payment of principal and interest payments in exchange for a guarantee
fee. Single-family loans that have been purchased but have not yet been
securitized are held in the Enterprises' whole loan portfolios. In
addition, the Enterprises also repurchase some delinquent loans from
their guaranteed MBS subject to certain requirements and restrictions.
Except to the extent that they transfer the risk to private
investors, the Enterprises are exposed to credit risk through their
ownership of single-family mortgage exposures and their guarantees of
MBS. Consequently, the Enterprises attempt to mitigate the likelihood
of incurring credit losses in a variety of ways. One way to reduce
potential credit losses is through loan-level credit enhancements such
as mortgage insurance. Another way of reducing potential credit losses
is through the transfer of risk at the pool level through
securitization or synthetic securitization transactions.
2. Calibration Framework
In general, FHFA calibrated the base risk weights and risk
multipliers for single-family mortgage exposures to require credit risk
capital sufficient to absorb the lifetime unexpected losses incurred on
single-family mortgage exposures experiencing a shock to house prices
similar to that observed during the 2008 financial crisis. Lifetime
unexpected losses are the difference between lifetime credit losses in
such conditions (also known as stress losses) and expected losses.
As adverse economic conditions are not explicitly defined, the loss
projections that underpin the credit risk capital requirements in the
proposed rule are based on several different economic scenarios. Each
Enterprise used economic scenarios that it defined to project loan-
level credit risk capital. In addition, FHFA used the baseline and
severely adverse scenario defined in DFAST to project unexpected
losses. FHFA used these pre-existing scenarios as a starting point for
its estimations in order to provide economic scenarios consistent with
those of the U.S. banking framework for stress tests required under
DFAST. FHFA also used these scenarios to ensure a straightforward,
transparent approach to the proposed rule's capital requirements. The
DFAST scenarios include forecasts for macroeconomic variables,
including house prices, interest rates, and unemployment rates.
House prices are used to define the MTMLTV ratio, where the
likelihood of a loss occurring upon default increases as the proportion
of equity to loan value decreases. Therefore, the projected house price
path is the predominant macroeconomic driver of single-family stress
scenarios.
The Enterprises used similar house price paths to project stress
losses. In the stress scenarios used by FHFA and the Enterprises,
nationally averaged house prices declined by 25 percent from peak to
trough (the period of time between the shock and the recovery), which
is consistent with the decline in house prices observed during the 2008
financial crisis. The 25 percent house price decline is also broadly
consistent with assumptions used in the DFAST severely adverse scenario
over the past several years, although the 2020 DFAST cycle assumes a 28
percent house price decline in its severely adverse scenario. However,
the trough and recovery assumptions used by FHFA and the Enterprises
are somewhat more conservative than the observed house price recoveries
post crisis.
Using these stress scenarios, the single-family grids were, as a
general rule, calibrated based on estimates of unexpected losses from
the Enterprises' internal models and FHFA's publicly available
model.\64\ The Enterprises and FHFA ran synthetic and actual loans with
a baseline risk profile through their own credit models using these
stress scenarios. Each single-family segment has its own baseline risk
profile, which is discussed segment-by-segment in VIII.A.3.
Consequently, each cell of each single-family grid represents projected
unexpected losses, converted to a risk weight, for a baseline loan with
a

[[Page 39304]]

particular combination of primary risk factors.
---------------------------------------------------------------------------

\64\ FHFA's single-family loss model is available on its website
at fhfa.gov. For performing loans, all three models were used to
construct the single-family grid. For single-family mortgage
exposures other than performing loans, FHFA relied primarily on the
Enterprises' estimates of unexpected losses.
---------------------------------------------------------------------------

The risk multipliers were similarly calibrated based on estimates
of unexpected losses from the Enterprises' internal models and FHFA's
publicly available model. The Enterprises varied the secondary risk
factors, specific to each single-family segment, to estimate each risk
factor's multiplicative effects on estimates of unexpected losses for
the baseline loan in each single-family segment. FHFA considered the
risk multipliers estimated by the Enterprises, which were generally
consistent in magnitude and direction, in conjunction with its own
estimated values in determining the proposed single-family risk
multipliers.
Question 30. Is the methodology used to calibrate the credit risk
capital requirements for single-family mortgage exposures appropriate
to ensure that the exposure is backed by capital sufficient to absorb
the lifetime unexpected losses incurred on single-family mortgage
exposures experiencing a shock to house prices similar to that observed
during the 2008 financial crisis?
Question 31. What, if any, changes should FHFA consider to the
methodology for calibrating credit risk capital requirements for
single-family mortgage exposures?
3. Base Risk Weights
The proposed rule would require an Enterprise to determine a base
risk weight for each single-family mortgage exposure using one of four
grids, one for each single-family segment. These segments are based on
payment performance because as a risk factor it is a material
determinant of projected unexpected loss. Additional risk factors
affect unexpected losses differently depending on where a single-family
mortgage exposure is in its life cycle. The base risk weight for a
single-family mortgage exposure would therefore change over the life
cycle of the single-family mortgage exposure, generally decreasing when
the single-family mortgage exposure is seasoned and performing, and
increasing when the single-family mortgage exposure is delinquent or
recently delinquent.
The four single-family segments would be:
Non-performing loan (NPL): A single-family mortgage
exposure that is 60 days or more past due.
Modified re-performing loan (modified RPL): A single-
family mortgage exposure that is not an NPL and has previously been
modified or entered a repayment plan.
Non-modified re-performing loan (non-modified RPL): A
single-family mortgage exposure that is not an NPL, has not been
previously modified or entered a repayment plan, and has been an NPL at
any time in the last 48 calendar months.
Performing loan: A single-family mortgage exposure that is
not an NPL, a modified RPL, or a non-modified RPL. A non-modified RPL
generally transitions to a performing loan after not being an NPL at
any time in the prior 48 calendar months.
Each single-family segment would have a unique, two-dimensional
risk weight grid (single-family grid) that an Enterprise would use to
determine its base risk weight before subsequently applying risk
multipliers. The dimensions of the single-family grids would vary by
single-family segment to allow the single-family grids to
differentially incorporate key risk drivers into the base risk weights
on a segment-by-segment basis.
The single-family grids reflect several notable differences from
the single-family grids in the 2018 proposal. First, FHFA combined the
``New Originations'' and ``Performing Seasoned'' base grids into one
single-family grid for performing loans. Commenters recommended that
the single-family segmentation could be simplified in this way without
a meaningful loss of accuracy.
Second, for purposes of the definition of NPL, the proposed rule
would define delinquency as 60 days or more past due, while the 2018
proposal defined delinquency as 30 days past due. Commenters
recommended this change in order to mitigate variations in regulatory
capital requirements, and because a significant portion of 30-day past
due loans become current in the following month or do not become more
delinquent. The practical effect of this change is that the projected
unexpected losses on 30-day past due loans has been reallocated from
the single-family grid for NPLs to the single-family grid for
performing loans, increasing the base credit risk capital requirements
for performing loans above where they were in the 2018 proposal. In
addition, following the redefinition of delinquency, the proposed rule
does not contemplate a return to performing loan status for a non-
modified RPL with 36 consecutive timely payments and no more than 1
missed payment in the 12 months preceding that 36-month period.
Third, the single-family grids would reflect credit risk capital
that was allocated using the ``number of borrowers'' and ``loan
balance'' single-family risk multipliers of the 2018 proposal. As
discussed in Section VIII.A.5, these risk multipliers are not included
in the proposed rule. In order to ensure the risk-based capital
requirements do not decrease by the amount of capital that would have
otherwise been required due to these risk factors, FHFA has
redistributed the capital requirements across cells of the single-
family grids.
Fourth, the MTMLTVs used to assign base risk weights in the
proposed single-family grids would be subject to a countercyclical
adjustment as described in VIII.A.4.
Performing Loans
The primary risk factors for performing loans are credit score and
MTMLTV (after factoring in the loan-level countercyclical adjustment).
Credit score correlates strongly with the likelihood of a borrower
default, while MTMLTV relates to both the likelihood of default and the
severity of a potential loss should a borrower default (loss given
default).\65\ For the first five scheduled payment dates, an Enterprise
would use the credit score at origination to determine the base risk
weight. After that time, an Enterprise would use the refreshed or
updated credit score. As discussed in Section VIII.A.4, an Enterprise
would use the adjusted or unadjusted MTMLTV, depending on whether the
loan-level countercyclical adjustment is non-zero (except that for the
first five scheduled payment dates after the origination of a single-
family mortgage exposure, an Enterprise would use OLTV rather than
MTMLTV). The single-family grid for performing loans is presented below
in Table 9. For purposes of this table, credit score means the original
credit score of the single-family mortgage exposure if the loan age is
less than 6, or the refreshed credit score otherwise.
---------------------------------------------------------------------------

\65\ As in the 2018 proposal, FHFA notes that the Enterprises
currently rely on Classic FICO for product eligibility, loan
pricing, and financial disclosure purposes, and therefore the
single-family grid for performing loans was estimated using Classic
FICO credit scores. Throughout the proposed rule, the use of term
``credit score'' should be interpreted to mean Classic FICO credit
scores. If the Enterprises were to begin using a different credit
score for these purposes, or multiple scores, the single-family
grids and multipliers might need to be recalibrated. Related to
that, in February 2020, the Enterprises published a Joint Credit
Score Solicitation that describes the process for credit score model
developers to submit applications to the Enterprises. The validation
and approval of credit score models will be a multi-year effort by
the Enterprises under requirements established by FHFA's final rule
on the process for validation and approval of credit score models.
84 FR 41886 (Aug. 16, 2019).

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[[Page 39305]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.008

Credit scores have values ranging from 300 to 850, and OLTVs
typically range from 10 percent to 97 percent. MTMLTVs typically range
from 10 percent to upwards of 120 percent. The Enterprises conduct most
of their new single-family businesses within an OLTV range of 70
percent to 95 percent. FHFA included MTMLTV buckets beyond 95 percent
to account for adverse changes in home prices subsequent to
origination, as well as to account for the inclusion of streamlined
refinance loans in the single-family segment.
In the 2018 proposal, the single-family grid for new originations
had a distinct treatment for loans with an 80 percent OLTV to account
for the high volume and distinct features of these particular loans.
FHFA determined that including 80 percent OLTV loans with other single-
family mortgage exposures with LTVs between 75 percent and 80 percent
did not result in a meaningful loss of accuracy, so the single-family
grid for performing loans has combined their treatment. As previously
discussed, the base risk weights for performing loans include projected
unexpected losses for single-family mortgage exposures that are between
30 and 60 days past due.
The base risk weights for performing loans do not reflect credit
enhancements such as mortgage insurance, which would generally lower an
Enterprise's risk-based capital requirement for a single-family
mortgage exposure with an LTV greater than 80 percent. Risk weight
adjustments for credit enhancements are discussed in Section VIII.A.6.
Aside from the primary risk factors represented in the dimensions
of the single-family grid for performing loans, there are several
secondary risk factors accounted for in the risk profile of the
synthetic loan used in the calibration of the base risk weights. Those
secondary risk factors, along with the values that determine the
baseline risk profile for performing loans, are: Loan age less than 24
months; 30-year fixed-rate; purchase; owner-occupied; single-unit;
retail channel sourced; debt-to-income ratio between 25 percent and 40
percent; no second lien; full documentation; non-interest-only; not
streamlined refinance loans; and zero cohort burnout (described
below).\66\ Unlike the 2018 proposal, neither loan size (greater than
$100,000) nor the number of borrowers (multiple) is a secondary risk
factor. Variations in the credit risk capital requirements due to these
secondary risk factors are captured using risk multipliers, as
discussed in Section VIII.A.5.
---------------------------------------------------------------------------

\66\ The CFPB's ability-to-repay rule generally prohibits
interest-only and low-documentation loans. However, these risk
factors may be present on single-family mortgage exposures
originated prior to the 2008 financial crisis.
---------------------------------------------------------------------------

Non-Modified RPLs
The primary risk factors for non-modified RPLs are MTMLTV (after
factoring in the loan-level countercyclical adjustment) and the re-
performing duration. The re-performing duration is the number of
scheduled payment dates since the non-modified RPL was last an NPL (60
days or more past due), and is a strong predictor of the likelihood of
a subsequent default. MTMLTV is a strong predictor of the likelihood of
default and loss given default for single-family mortgage exposures in
this segment. The proposed single-family grid for non-modified RPLs is
presented below in Table 10. For purposes of this table, non-modified
re-performing duration means the number of scheduled payment dates
since the non-modified RPL was last an NPL.

[[Page 39306]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.009

Re-performing duration is divided into four categories such that
the base risk weights would generally decrease as re-performing
duration increases. When the re-performing duration is greater than
three years, the base risk weight for the non-modified RPL would begin
to approximate the base risk weight for a performing loan. A single-
family mortgage exposure that re-performs for greater than four years,
and has not been modified, would revert to being classified as a
performing loan.
Aside from the primary risk factors represented in the single-
family grid for non-modified RPLs, there are many secondary risk
factors accounted for in the risk profile of the synthetic loan used in
the calibration of the base risk weights. These secondary risk factors,
along with the values that determine the baseline risk profile for non-
modified RPLs, are the same as those for performing loans with the
inclusion of two additional features--refreshed credit scores between
660 and 700, and a maximum previous delinquency of less than 60 days--
and the exclusion of loan age and cohort burnout. Variations in the
credit risk capital requirements due to these secondary risk factors
would be captured using risk multipliers, as discussed in Section
VIII.A.5.
Modified RPLs
The primary risk factors for modified RPLs are similar to non-
modified RPLs. However, along with MTMLTV (after factoring in the loan-
level countercyclical adjustment), the second primary risk factor in
the segment would be either the re-performing duration or the
performing duration, whichever is less. The re-performing duration is
the number of scheduled payment dates since the modified RPL was last
an NPL (60 days or more past due), while the performing duration
measures the number of scheduled payment dates since the last
modification of a modified RPL. The proposed single-family grid for
modified RPLs is presented below in Table 11. For purposes of this
table, modified re-performing duration means the lesser of: (i) The
number of scheduled payment dates since the modified RPL was last
modified; and (ii) the number of scheduled payments dates the modified
RPL was last an NPL.
[GRAPHIC] [TIFF OMITTED] TP30JN20.010

Aside from the primary risk factors represented in the dimensions
of the single-family grid for modified RPLs, there are many secondary
risk factors accounted for in the risk profile of the synthetic loan
used in the calibration of the base risk weights. These secondary risk
factors, along with the values that determine the baseline risk profile
for modified RPLs, are the same as those for non-modified RPLs with one
addition; a payment change from modification greater than or equal to -
20 percent and less than 0 percent. Variations in the credit risk
capital requirements due to these secondary risk factors would be
captured using risk multipliers, as discussed in Section VIII.A.5.
Unlike non-modified RPLs, modified RPLs never revert to being
classified as performing loans, even after four or more years of re-
performance.
NPLs
The primary risk factors for NPLs are the days past due and MTMLTV
(after factoring in the loan-level countercyclical adjustment). Days
past due is the number of days a single-family mortgage exposure is
past due and is a strong predictor of the likelihood of default for
NPLs. MTMLTV is a strong predictor of loss given default for exposures
in this segment. The proposed single-family grid for NPLs is presented
below in Table 12.

[[Page 39307]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.011

The base risk weights detailed in the single-family grid for NPLs
are noticeably non-monotonic as the number of days past due increases,
particularly in the highest (right-most) MTMLTV column. This is because
as the number of days past due increases for an NPL with higher LTV, so
does the expected loss. Because the credit risk capital requirement has
been calibrated as the difference between stress loss and expected
loss, when expected loss increases and grows closer to stress loss, the
projected unexpected loss (reflected by the base risk weight)
decreases. The increase in expected loss should be reflected in
commensurately higher ALLL.
Aside from the primary risk factors represented in the single-
family grid for NPLs, there are several secondary risk factors
accounted for in the risk profile of the synthetic loan used in the
calibration of the base risk weights. These secondary risk factors,
along with the values that determine the baseline risk profile for
NPLs, are: 30-year fixed-rate; owner-occupied; single-unit; retail
channel sourced; and a refreshed credit score between 640 (inclusive)
and 700. Variations in the credit risk capital requirements due to
these secondary risk factors would be captured using risk multipliers,
as discussed in Section VIII.A.5.
Question 32. Are the base risk weights for single-family mortgage
exposures appropriately formulated and calibrated to require credit
risk capital sufficient to ensure each Enterprise operates in a safe
and sound manner and is positioned to fulfill its statutory mission
across the economic cycle?
Question 33. Are there any adjustments, simplifications, or other
refinements that FHFA should consider for the base risk weights for
single-family mortgage exposures?
Question 34. Should the base risk weight for a single-family
mortgage exposure be assigned based on OLTV or MTMLTV of the single-
family mortgage exposure, or perhaps on the LTV of the single-family
mortgage exposure based on the original purchase price and after
adjusting for any paydowns of the original principal balance?
Question 35. Should the base risk weight for a single-family
mortgage exposure be assigned based on the original credit score of the
borrower or the refreshed credit score of the borrower?
Question 36. What steps, including any process for soliciting
public comment on an ongoing basis, should FHFA take to ensure that the
single-family grids and the real house price trend are updated from
time to time as market conditions evolve?
Question 37. Should a delinquency associated with a COVID-19-
related forbearance cause a single-family mortgage exposure to become
an NPL?
Question 38. Which, if any, types of forbearances, payment plans,
or modifications should be excluded from those that cause a single-
family mortgage exposure to become a modified RPL? Should a
forbearance, payment plan, or modification arising out of a COVID-19-
related forbearance request cause a single-family mortgage exposure to
become a modified RPL?
4. Countercyclical Adjustment
The MTMLTVs used to assign base risk weights to single-family
mortgage exposures in the single-family grids would be subject to a
countercyclical adjustment an Enterprise would be required to make when
national house prices increase or decrease by more than 5.0 percent
from an estimated inflation-adjusted long-term trend. Many commenters
noted the pro-cyclical nature of the aggregate risk-based capital
requirements of the 2018 proposal. Certain commenters recommended FHFA
replace MTMLTV and refreshed credit scores with OLTV and original
credit scores to reduce pro-cyclicality. Other commenters recommended
FHFA continue to use MTMLTV and refreshed credit scores in order to
provide a more accurate view of risk and achieve rational pricing and
proper incentives. Additional commenters recommended FHFA base capital
requirements on fundamental house values, while still other commenters
suggested FHFA introduce a countercyclical requirement either through a
countercyclical capital buffer or a countercyclical risk-based capital
requirement.
The proposed formulaic countercyclical adjustment to loan-level
single-family MTMLTVs would be based on FHFA's U.S. all-transactions
house price index (HPI). The adjustment would restrict decreases in
MTMLTV during periods of rising vulnerabilities in house prices and
limits increases in MTMLTV when vulnerabilities recede. The adjustment
is designed to increase the resilience of the Enterprises when there is
an elevated risk of above-normal losses and to reduce the need for
additional capital during a period of financial stress.
An Enterprise would calculate the MTMLTV adjustment by first
estimating a long-term trend of FHFA's quarterly, not-seasonally-
adjusted HPI using a prescribed trough-to-trough methodology, deflated
by the Consumer Price Index for All Urban Consumers, All Items Less
Shelter in U.S. City Average. If the deflated all-transactions HPI
exceeds the estimated long-term trend by more than 5 percentage points,
the Enterprise would adjust upward the MTMLTV of every single-family
mortgage exposure by the difference between the deflated all-
transactions HPI and 5.0 percent. Otherwise, the Enterprise would use
the unadjusted MTMLTV. On the other hand, if the deflated all-
transactions HPI falls below the estimated long-term trend by more than
5 percentage points, the Enterprise would adjust downward the MTMLTV of
every single-family mortgage exposure by the difference between the
deflated all-transactions HPI and 5.0 percent. Otherwise, the
Enterprise would use the unadjusted MTMLTV.
In other words, if the HPI exceeds its long-term trend by more than
5 percentage points, the Enterprise would adjust upward the MTMLTV by
the ratio of the HPI index actual value to the HPI index if it were at
5.0 percent over long-term trend. This adjustment, in effect, would
reduce the house price used to calculate MTMLTV to the level expected
if all house prices nationally adjusted downward by the percent the
index exceeds 5.0 percent above trend.
FHFA chose collars of 5.0 percent above and below the long-term
trend in house prices because it would allow for MTMLTVs to reflect the
best estimate of

[[Page 39308]]

market value most of the time, while restricting excessive MTMLTV
increases or decreases during periods where house prices appear to
deviate more materially from their long-term trend. The figure below
presents the historical deflated all-transactions HPI series with both
an estimated long-term trend and 5.0 percent collars above and below
the trendline. When the HPI series is above or below the collars, the
MTMLTV adjustment would be non-zero.
The following Figure 1 and Table 13 provide an illustration of the
historical data used to calculate the long-term trend in HPI, along
with the plus/minus 5.0 percent collars, as well as examples of how
single-family MTMLTVs would be adjusted under the proposed
framework.\67\
---------------------------------------------------------------------------

\67\ The parameters of the long-run trend are estimated using
linear regression on the natural logarithm of real HPI from the Q3
1975 trough to the Q2 2012 trough. Figure 1 shows the fitted values
from the estimated long-run trend from Q1 1975 to Q3 2019. FHFA
might need to revisit the calibration of the parameters in the event
of future troughs.
[GRAPHIC] [TIFF OMITTED] TP30JN20.012

[GRAPHIC] [TIFF OMITTED] TP30JN20.013

[[Page 39309]]

Table 13 illustrates three scenarios. Under the first scenario,
2006, Real HPI exceeds the long-term trend by more than 5.0 percent, so
single-family house prices would be adjusted downward such that
adjusted MTMLTV would be greater than MTMLTV. A single-family mortgage
exposure with a 60 percent MTMLTV would be assigned a base risk weight
using its adjusted MTMLTV of 71 percent. Similarly, an 80 percent
MTMLTV would correspond to a 95 percent adjusted MTMLTV, while a 95
percent MTMLTV would correspond to a 113 percent adjusted MTMLTV. Under
the second scenario, 2012, Real HPI is less than the long-term trend by
more than 5.0 percent, so single-family house prices would be adjusted
upward such that adjusted MTMLTV would be less than MTMLTV. For
example, a single-family mortgage exposure with an 80 percent MTMLTV
would be assigned a base risk weight using its adjusted MTMLTV of 69
percent. In the final scenario, September 30, 2019, Real HPI exceeds
the long-term trend by 3.0 percent. In this case, because 3.0 percent
is less than 5.0 percent, single-family house prices would not be
adjusted, and adjusted MTMLTV would equal MTMLTV for all values of
MTMLTV.
Question 39. Is the MTMLTV adjustment appropriately formulated and
calibrated to require credit risk capital sufficient to ensure each
Enterprise operates in a safe and sound manner and is positioned to
fulfill its statutory mission across the economic cycle? If not, what
modifications should FHFA consider to ensure an appropriate formulation
and calibration?
Question 40. Does the MTMLTV adjustment strike an appropriate
balance in mitigating the pro-cyclicality of the aggregate risk-based
capital requirements while preserving a mortgage risk-sensitive
framework? Are the collars set appropriately at 5.0 percent above or
below the long-term index trend?
Question 41. How should the long-term house price trend be
determined for the purpose of any countercyclical adjustment to a
single-family mortgage exposure's credit risk capital requirement?
5. Risk Multipliers
The proposed rule would require an Enterprise to adjust the base
risk weight for a single-family mortgage exposure to account for
additional loan characteristics using a set of single-family-specific
risk multipliers. The risk multipliers would refine the base risk
weights to account for risk factors beyond the primary risk factors
reflected in the single-family grids, and for variations in secondary
risk factors not captured in the risk profiles of the synthetic loans
used to calibrate the single-family grids. The adjusted risk weight for
a single-family mortgage exposure would be the product of the base risk
weight, the combined risk multiplier, and any credit enhancement
multiplier, which is discussed in Section VIII.A.6.
The risk multipliers correspond to common characteristics that
increase or decrease the projected unexpected losses of a single-family
mortgage exposure. Although the specified risk characteristics are not
exhaustive, they capture key real estate loan performance drivers, and
are commonly used in mortgage pricing and underwriting.
The risk multipliers are substantially the same as those of the
2018 proposal, with some simplifications and refinements. In
particular, FHFA eliminated the single-family risk multipliers for
``number of borrowers'' and ``loan balance,'' and reallocated the
associated unexpected losses across the single-family grids. The
practical effect of this change is that the base risk weights in the
single-family grids are greater than they otherwise would have been if
the two risk multipliers had not been eliminated.

Table 14--Risk Multipliers
----------------------------------------------------------------------------------------------------------------
Single-family segment
---------------------------------------------------------------
Risk factor Value or range Performing Non-modified
loan RPL Modified RPL NPL
----------------------------------------------------------------------------------------------------------------
Loan Purpose.................. Purchase........ 1 1 1 ..............
Cashout 1.4 1.4 1.4 ..............
Refinance.
Rate/Term 1.3 1.2 1.3 ..............
Refinance.
Occupancy Type................ Owner Occupied 1 1 1 1
or Second Home.
Investment...... 1.2 1.5 1.3 1.2
Property Type................. 1 Unit.......... 1 1 1 1
2-4 Unit........ 1.4 1.4 1.3 1.1
Condominium..... 1.1 1 1 1
Manufactured 1.3 1.8 1.6 1.2
Home.
Origination Channel........... Retail.......... 1 1 1 1
TPO............. 1.1 1.1 1.1 1
DTI........................... DTI <=25%....... 0.8 0.9 0.9 ..............
25% 40%........ 1.2 1.2 1.1 ..............
Product Type.................. FRM30........... 1 1 1 1
ARM1/1.......... 1.7 1.1 1 1.1
FRM15........... 0.3 0.3 0.5 0.5
FRM20........... 0.6 0.6 0.5 0.8
Subordination................. No subordination 1 1 1 ..............
30% 5%.
OLTV >60% and 0% 1.1 1.2 1.1 ..............
60% and 1.4 1.5 1.3 ..............
subordination
>5%.
Loan Age...................... Loan age <=24 1 .............. .............. ..............
months.
24 months 60 0.75 .............. .............. ..............
months.

[[Page 39310]]

Cohort Burnout................ No Burnout...... 1 .............. .............. ..............
Low............. 1.2 .............. .............. ..............
Medium.......... 1.3 .............. .............. ..............
High............ 1.4 .............. .............. ..............
Interest-only................. No IO........... 1 1 1 ..............
Yes IO.......... 1.6 1.4 1.1 ..............
Loan Documentation............ Full............ 1 1 1 ..............
None or low..... 1.3 1.3 1.2 ..............
Streamlined Refi.............. No.............. 1 1 1 ..............
Yes............. 1 1.2 1.1 ..............
Refreshed Credit Score for Refreshed credit .............. 1.6 1.4 ..............
Modified. score <620.
RPLs and Non-modified RPLs.. 620 <=refreshed .............. 1.3 1.2 ..............
credit score
<640.
640 <=refreshed .............. 1.2 1.1 ..............
credit score
<660.
660 <=refreshed .............. 1 1 ..............
credit score
<700.
700 <=refreshed .............. 0.7 0.8 ..............
credit score
<720.
720 <=refreshed .............. 0.6 0.7 ..............
credit score
<740.
740 <=refreshed .............. 0.5 0.6 ..............
credit score
<760.
760 <=refreshed .............. 0.4 0.5 ..............
credit score
<780.
Refreshed credit .............. 0.3 0.4 ..............
score >=780.
Payment Change from Payment change .............. .............. 1.1 ..............
Modification. >=0%.
-20% <=payment .............. .............. 1 ..............
change <0%.
-30% <=payment .............. .............. 0.9 ..............
change <-20%.
Payment change <- .............. .............. 0.8 ..............
30%.
Previous Maximum Days Past Due 0-59 days....... .............. 1 1 ..............
60-90 days...... .............. 1.2 1.1 ..............
91-150 days..... .............. 1.3 1.1 ..............
151+ days....... .............. 1.5 1.1 ..............
Refreshed Credit Score for Refreshed credit .............. .............. .............. 1.2
NPLs. score < 580.
580 <=refreshed .............. .............. .............. 1.1
credit score
<640.
640 <=refreshed .............. .............. .............. 1
credit score
<700.
700 <=refreshed .............. .............. .............. 0.9
credit score
<720.
720 <=refreshed .............. .............. .............. 0.8
credit score
<760.
760 =780.
----------------------------------------------------------------------------------------------------------------

Table 14 is structured in the following way: the first column
represents secondary risk factors, the second column represents the
values or ranges each secondary risk factor can take, and the third
through sixth columns represent risk multipliers for performing loans,
non-modified RPLs, modified RPLs, and NPLs, respectively. Thus, there
would be a different set of risk multipliers for each of the four
single-family segments.
Each secondary risk factor could take multiple values, and each
value or range of values would have a risk multiplier associated with
it. For any particular single-family mortgage exposure, each risk
multiplier could take a value of 1.0, above 1.0, or below 1.0. A risk
multiplier of 1.0 would imply that the risk factor value for a single-
family mortgage exposure is similar to, or in a certain range of, the
particular risk characteristic found in the single-family segment's
synthetic loan. A risk multiplier value above 1.0 would be assigned to
a risk factor value that represents a riskier characteristic than the
one found in the single-family segment's synthetic loan, while a risk
multiplier value below 1.0 would be assigned to a risk factor value
that represents a less risky characteristic than the one found in the
single-family segment's synthetic loan. Finally, the risk multipliers
would be multiplicative, so each single-family mortgage exposure in a
single-family segment would receive a risk multiplier for every risk
factor pertinent to that segment, even if the risk multiplier is 1.0
(implying no change to the base risk weight for that risk factor). The
total combined risk multiplier for a single-family mortgage exposure
would be, in general, the product of all individual risk multipliers
pertinent to the single-family segment in which the exposure is
classified.
There are two general types of single-family risk factors for which
risk multipliers are applied: Risk factors determined at origination
and risk factors that change as a loan seasons or ages.
Risk factors determined at origination include common
characteristics such as loan purpose, occupancy type, and property
type. The impacts of this type of risk factor on single-family mortgage
performance and credit losses are generally well understood and
commonly used in mortgage pricing and underwriting. Many of these risk
factors can be quantified and applied in a straightforward manner using
the proposed risk multipliers. The full set of single-family risk
factors determined at origination for which the proposed rule would
require risk multipliers is:
Loan purpose. Loan purpose reflects the purpose of the
single-family mortgage exposure at origination. The risk multiplier
would be at least 1.0 for any purpose other than ``purchase.''
Occupancy type. Occupancy type reflects the borrower's
intended use of the property, with an owner-occupied property
representing a baseline level of risk across all single-family segments
(a risk multiplier of 1.0), and an investment property being higher
risk (a risk multiplier greater than 1.0).
Property type. Property type describes the physical
structure of the property, with a 1-unit property representing a
baseline level of risk (a

[[Page 39311]]

risk multiplier of 1.0), and other property types such as 2-4 unit
properties or manufactured homes being higher risk (a risk multiplier
greater than 1.0).
Origination channel. Origination channel is the type of
institution that originated the single-family mortgage exposure, and
whether or not it originated from a third-party, including a broker or
correspondent. Single-family mortgage exposures that did not originate
from a third-party represent a baseline level of risk (a risk
multiplier of 1.0).
Product type. Product type reflects the contractual terms
of the single-family mortgage exposure as of the origination date, with
a 30-year fixed-rate mortgage and select adjustable-rate mortgages
(including, for example, ARM 5/1 and ARM 7/1) representing a baseline
level of risk (a risk multiplier of 1.0). Adjustable-rate loans with an
initial one-year fixed-rate period followed by a rate that adjusts
annually (ARM 1/1) are considered higher risk (a risk multiplier
greater than 1.0), while shorter-term fixed-rate loans are considered
lower risk (a risk multiplier less than 1.0).
Interest-only. Interest-only reflects whether or not a
loan has an interest-only payment feature during all or part of the
loan term. Interest-only loans are generally considered higher risk (a
risk multiplier greater than 1.0) than non interest-only loans due to
their slower principal accumulation and an increased risk of default
driven by the potential increase in principal payments at the
expiration of the interest-only period.
Loan documentation. Loan documentation refers to the
completeness of the documentation used to underwrite the single-family
mortgage exposure, as determined under the Guide of the Enterprise.
Loans with low or no documentation have a high degree of uncertainty
around a borrower's ability to pay, and are considered higher risk (a
risk multiplier greater than 1.0) than loans with full documentation
where a lender is able to verify the income, assets, and employment of
a borrower.
Streamlined refinance. Streamlined refinance is an
indicator for a single-family mortgage exposure that was refinanced
through a streamlined refinance program of an Enterprise, including
HARP. These loans generally cannot be refinanced under normal
circumstances due to high MTMLTV, and therefore would be considered
higher risk (a risk multiplier greater than 1.0).
Risk factors that change dynamically and are updated as a single-
family mortgage exposure seasons include characteristics such as loan
age, current credit score, and delinquency or modification history.
These risk factors are correlated with probability of default and/or
loss given default, and are therefore important in projecting
unexpected losses. The full set of dynamic single-family risk factors
for which the proposed rule would require risk multipliers is:
DTI. DTI is the ratio of the borrower's total monthly
obligations (including housing expense) divided by the borrower's
monthly income, as calculated under the Guide of the Enterprise. DTI
affects and reflects a borrower's ability to make payments on a single-
family mortgage exposure. A DTI between 25 percent and 40 percent would
reflect a baseline level of risk (a risk multiplier of 1.0), and as a
borrower's income rises relative to the borrower's debt obligations (a
lower DTI), the single-family mortgage exposure would be considered
lower risk (a risk multiplier less than 1.0). If a borrower's income
falls relative to the borrower's debt obligations (a higher DTI), the
single-family mortgage exposure would be considered higher risk (a risk
multiplier greater than 1.0).
Subordination. Subordination is the amount equal to the
original unpaid principal balance of any second lien single-family
mortgage exposure divided by the lesser of the appraised value or sale
price of the property that secures the single-family mortgage exposure.
Single-family mortgage exposures with no subordination would represent
a baseline level of risk (a risk multiplier of 1.0), whereas single-
family mortgage exposures with varying combinations of OLTV and
subordination percentage would be generally considered higher risk (a
risk multiplier greater than 1.0).
Loan age. Loan age is the number of scheduled payment
dates since the single-family mortgage exposure was originated. Older
single-family mortgage exposures are considered less risky because in
general as loans age the likelihood of events occurring that would
trigger mortgage default decreases.
Cohort burnout. Cohort burnout reflects the number of
refinance opportunities since the single-family mortgage exposure's
sixth scheduled payment date. A refinance opportunity is any calendar
month in which the Primary Mortgage Market Survey (PMMS) rate for the
month and year of the origination of the single-family mortgage
exposure exceeds the PMMS rate for that calendar month by more than 50
basis points. Cohort burnout is an indicator that a borrower is less
likely to refinance in the future given the opportunity to do so.
Borrowers that demonstrate a lower propensity to refinance have higher
credit risk, and a single-family mortgage exposure with a cohort
burnout greater than zero would receive a risk multiplier greater than
1.0.
Refreshed credit score for RPLs and NPLs. Refreshed credit
scores refer to the most recently available credit scores as of the
capital calculation date. In general, a credit score reflects the
credit worthiness of a borrower, and a higher credit score implies
lower risk and a lower risk multiplier. For RPLs, a refreshed credit
score between 660 and 700 reflects a baseline level of risk (a risk
multiplier of 1.0). For NPLs, a refreshed credit score between 640 and
700 represents a baseline level of risk (a risk multiplier of 1.0).
Payment change from modification. For modified RPLs, the
payment change from modification reflects the change in the monthly
payment, as a percent of the original monthly payment, resulting from a
modification. In general, higher payment reductions tend to reduce the
likelihood of future default, so single-family mortgage exposures with
higher payment reductions from modifications would have a lower capital
requirement (a risk multiplier less than 1.0).
Previous maximum days past due. For RPLs, previous maximum
number of days past due reflects the maximum number of days a single-
family mortgage exposure has been past due in the last 36 months. Days
past due is positively correlated with the likelihood of future
default. Therefore, a single-family mortgage exposure with a previous
maximum delinquency between 0 and 59 days represent a baseline level of
risk (a risk multiplier of 1.0), and a single-family mortgage exposure
with a maximum delinquency greater than 59 days month would be
considered higher risk (a risk multiplier greater than 1.0).
Not all risk multipliers would apply to every single-family
segment, because the risk multipliers were estimated separately for
each single-family segment. In cases where a risk factor did not
influence the projected unexpected loss of single-family mortgage
exposures in a single-family segment, or a risk factor did not apply at
all (payment change from modification, in the performing loan segment,
for example), there would be no risk multiplier for that risk factor in
that single-family segment.
Question 42. Are the risk multipliers for single-family mortgage
exposures appropriately formulated and calibrated

[[Page 39312]]

to require credit risk capital sufficient to ensure each Enterprise
operates in a safe and sound manner and is positioned to fulfill its
statutory mission across the economic cycle?
Question 43. Are there any adjustments, simplifications, or other
refinements that FHFA should consider for the risk multipliers for
single-family mortgage exposures?
Question 44. Should the combined risk multiplier for a single-
family mortgage exposure be subject to a cap (e.g., 3.0, as
contemplated by the 2018 proposal)?
6. Credit Enhancement Multipliers
The Enterprises' charter acts generally require single-family
mortgage exposures with an unpaid principal balance exceeding 80
percent of the value of the property to have one of three forms of
loan-level credit enhancement at the time of acquisition. This
requirement can be satisfied through:
The seller retaining a participation of at least 10
percent in the single-family loan (participation agreement);
The seller agreeing to repurchase or replace the single-
family mortgage exposure, or reimburse losses, in the event of default
(a recourse agreement); or
A guarantee or insurance on the unpaid principal balance
which is in excess of 80 percent LTV (mortgage insurance or MI).
Mortgage insurance is the most common form of loan-level credit
enhancement.
Loan-level credit enhancements sometimes provide credit enhancement
beyond that required by the charter acts.
To account for the decrease in an Enterprise's exposure to
unexpected loss on a single-family mortgage exposure subject to loan-
level credit enhancement, an Enterprise would adjust the base risk
weight using an adjusted credit enhancement multiplier. That adjusted
credit enhancement multiplier would be based on a credit enhancement
multiplier (CE multiplier) for the single-family mortgage exposure and
then adjusted for the strength of the counterparty providing the loan-
level credit enhancement. A smaller CE multiplier (and therefore a
smaller adjusted credit enhancement multiplier) would correspond to a
loan-level credit enhancement that transfers more of the projected
unexpected loss to the counterparty and thus requires less credit risk
capital of the Enterprise for the single-family mortgage exposure. For
example, before any adjustment for counterparty strength, a CE
multiplier of 0.65 for a single-family mortgage exposure subject to
loan-level credit enhancement means that an Enterprise is exposed to 65
percent of the projected unexpected loss of the single-family mortgage
exposure and that the counterparty providing the loan-level credit
enhancement is projected to absorb, assuming it is an effective
counterparty, the remaining 35 percent of the projected unexpected
loss.
Participation agreements are rarely utilized by the Enterprises,
and for reasons of simplicity, the proposed rule would not assign any
benefit for these agreements (i.e., a CE multiplier of 1.0).
Recourse agreements may be unlimited or limited. Full recourse
agreements provide full coverage for the life of the loan, while
partial recourse agreements provide partial coverage or have a limited
duration. Because a counterparty would be responsible for all credit
risk pursuant to a full recourse agreement, the single-family mortgage
exposure would be assigned a CE multiplier of zero, subject to a
counterparty haircut. For partial recourse agreements, the proposed
rule would require an Enterprise to take into account the percent
coverage, adjusted for the term of coverage, to determine the
appropriate benefit.
The CE multiplier for a single-family mortgage exposure subject to
mortgage insurance would vary based on the mortgage insurance coverage
and loan characteristics, including (i) whether the mortgage insurance
is cancellable or non-cancellable, (ii) whether the mortgage insurance
coverage is charter-level or guide-level, and (iii) the loan
characteristics, including OLTV, loan age, amortization term, and
single-family segment.
Cancellation option. Non-cancellable mortgage insurance
(non-cancellable MI) provides coverage for the life of the single-
family mortgage exposure. Cancellable mortgage insurance (cancellable
MI) allows for the cancellation of coverage upon a borrower's request
when the unpaid principal balance falls to 80 percent or less of the
original property value, or automatic cancellation when either the loan
balance falls below 78 percent of the original property value or the
loan reaches the midpoint of the loan's amortization schedule, if the
loan is current. Due to the longer period of coverage, non-cancellable
MI provides more credit risk protection than cancellable MI. CE
multipliers for non-cancellable MI therefore would be lower than CE
multipliers for cancellable MI.
Coverage. Charter-level coverage provides mortgage
insurance that satisfies the minimum requirements of the Enterprises'
charter acts. Guide-level coverage provides deeper coverage, roughly
double the coverage provided by charter-level coverage. Therefore, the
CE multipliers for guide-level coverage would be lower than the CE
multipliers for charter-level coverage.
Original LTV. Single-family mortgage exposures with higher
OLTV generally have greater coverage levels than loans with lower OLTV.
Higher coverage levels imply greater credit risk protection. Therefore,
single-family mortgage exposures with higher OLTVs would have lower CE
multipliers.
Amortization term. For cancellable MI, single-family
mortgage exposures with a 15- to 20-year amortization period might have
cancellation triggered earlier than loans with a 30-year amortization
period. Therefore, single-family mortgage exposures with longer
amortization terms have a longer period of credit risk protection from
mortgage insurance. Single-family mortgage exposures with a 30-year
amortization period therefore have a lower CE multiplier than single-
family mortgage exposures with a 15- to 20-year amortization period
with cancellable mortgage insurance.
Single-family segment. Mortgage insurance coverage on
delinquent loans cannot be cancelled. Cancellation of mortgage
insurance coverage on modified RPLs is based on the modified LTV and
the modified amortization term, which are typically higher than the
OLTV and the original amortization term. In both of these cases, the
mortgage insurance coverage is extended for a longer period, resulting
in greater credit risk protection, relative to mortgage insurance
coverage on performing loans. Therefore, in the proposed rule,
delinquent and modified loans would have a lower CE multiplier than
performing loans.
Loan age. Mortgage insurance cancellation is often
triggered sooner for older loans than for younger loans. Therefore,
older loans with cancellable MI generally have a shorter period of
remaining mortgage insurance coverage and thus have less credit risk
protection from mortgage insurance. Older single-family mortgage
exposures with cancellable MI therefore have higher CE multipliers than
younger single-family mortgage exposures.
The following Tables 15 through 19 present the CE multipliers for
single-family mortgage exposures subject to mortgage insurance.
Table 15 contains CE multipliers for all single-family mortgage
exposures subject to non-cancellable MI, except NPLs. The table
differentiates CE multipliers by type of coverage (charter-level and
guide-level), OLTV,

[[Page 39313]]

amortization term, and coverage percent.
[GRAPHIC] [TIFF OMITTED] TP30JN20.014

The proposed rule would have three sets of multipliers for
cancellable MI. Table 16 contains CE multipliers for performing loans
and non-modified RPLs subject to cancellable MI. The table
differentiates CE multipliers by type of coverage (charter-level and
guide-level), OLTV, coverage percent, amortization term, and loan age.

[[Page 39314]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.015

Table 17 contains CE multipliers for the modified RPLs with 30-year
post-modification amortization and subject to cancellable MI. The table
differentiates risk multipliers by type of coverage (charter-level and
guide-level), OLTV, coverage percent, amortization term, and loan age.
[GRAPHIC] [TIFF OMITTED] TP30JN20.016

Table 18 contains CE multipliers for modified RPLs with 40-year
post-modification amortization and subject to cancellable MI. Here, CE
multipliers are differentiated by type of coverage (charter-level and
guide-level), OLTV, coverage percent, and loan age.

[[Page 39315]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.017

Table 19, contains proposed CE multipliers for NPLs. Mortgage
insurance on delinquent loans cannot be cancelled; therefore, there is
no differentiation between cancellable MI and non-cancellable MI for
the NPL segment. The table differentiates CE multipliers by type of
coverage (charter-level and guide-level), OLTV, amortization term, and
coverage percent.

[[Page 39316]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.018

Counterparty Credit Risk Adjustments
Sharing losses with counterparties through loan-level credit
enhancement exposes an Enterprise to counterparty credit risk. To
account for this exposure, the proposed rule would reduce the
recognized benefits from loan-level credit enhancement to incorporate
the risk that a counterparty is unable to perform its claim
obligations. To accomplish this, the proposed rule would implement a
counterparty haircut risk multiplier (CP haircut multiplier) to be
applied to the CE multiplier. The CP haircut multiplier would take
values from zero to one. A value of zero, the smallest haircut, would
mean a counterparty is expected to fully perform its claim obligations,
while a value of one, the largest haircut, would mean a counterparty is
not expected to perform its claim obligations. A value between zero and
one would mean a counterparty is expected to perform a portion of its
claim obligations.
The CP haircut multiplier would depend on a number of factors that
reflect counterparty risk. The three main factors are the
creditworthiness of the counterparty, the counterparty's level of
concentration in mortgage credit risk, and the counterparty's status as
an approved insurer under an Enterprise's counterparty standards for
private mortgage insurers.
The proposed rule would require an Enterprise to assign
counterparty financial strength ratings using a provided rating
framework. In assigning a rating, an Enterprise would assign the
counterparty financial strength rating that most closely aligns to the
assessment of the counterparty from the Enterprise's internal
counterparty risk framework. Descriptions of the 8 different
counterparty financial strength ratings are presented below in Table
20.

[[Page 39317]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.019

Similarly, the proposed rule would require an Enterprise to utilize
its counterparty risk management framework to assign each counterparty
a rating of ``not high'' or ``high'' to reflect the counterparty's
concentration in mortgage credit risk. During the 2008 financial
crisis, three out of the seven mortgage insurance companies were placed
in run-off by their state regulators, and payments on the Enterprises'
claims were deferred by the state regulators. This exposed the
Enterprises to counterparty risk and potential financial losses. More
generally, the 2008 financial crisis highlighted that counterparty risk
can be amplified when the counterparty's credit exposure is highly
correlated with an Enterprise's credit exposure.
Counterparties whose primary lines of business are more
concentrated in mortgage credit risk have a higher probability to
default on payment obligations when the mortgage default rate is high.
The proposed rule would assign larger haircuts to counterparties with
higher levels of mortgage credit risk concentration relative to
diversified counterparties. An Enterprise would assess the level of
mortgage credit risk concentration for each individual counterparty to
determine whether the insurer is well diversified or whether it has a
high concentration risk.
Finally, an Enterprise would determine whether a mortgage insurance
counterparty is in compliance with its own private mortgage eligibility
standards. If the counterparty satisfies the set of requirements to be
approved to insure loans acquired by an Enterprise, the insurer would
be assigned a smaller counterparty haircut.
To calculate the CP haircut, the proposed rule would use a modified
version of the Basel framework's IRB approach. The modified version
leverages the IRB approach to account for the creditworthiness of the
counterparty, but makes changes to reflect the level of mortgage credit
risk concentration and the counterparty's status as an approved
insurer. The Basel IRB framework provides the ability to differentiate
haircuts between counterparties with different levels of risk. The
proposed rule would augment the IRB approach to capture risk across
counterparties. In this way, the proposed adjustment would help capture
wrong-way risk between the Enterprises and their counterparties.
In particular, the proposed approach would calculate the
counterparty haircut by multiplying stress loss given default by the
probability of default and a maturity adjustment for the asset. The
following Figure 2 details the counterparty haircut calculation, as
well as the parameterization of the proposed approach:
BILLING CODE 8070-01-P

[[Page 39318]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.020

As shown, stress loss given default (LGD) is calibrated to 45
percent according to the historic average stress severity rates. The
maturity adjustment is calibrated to 5 years for 30-year products and
to 3.5 years for 15- to 20-year single-family mortgage exposures to
approximately reflect the average life of the assets. The expected
probability of default (PD) is calculated using a historical 1-year PD
matrix for all financial institutions.
As discussed above, counterparties with a lower concentration of
mortgage credit risk and therefore a lower potential for wrong-way risk
would be afforded a lower haircut relative to the counterparties with
higher concentrations of mortgage credit risk. Similarly, approved
insurers would be afforded a lower haircut relative to counterparties
that do not satisfy an Enterprise's eligibility requirements. These
differences would be captured through the asset valuation correlation
risk multiplier, AVCM. An AVCM of 1.75 would be assigned those
counterparties which are not an approved insurer and have high exposure
to mortgage credit risk, an AVCM of 1.50 would be assigned those
counterparties which are an approved insurer and have high exposure to
mortgage credit risk, and an AVCM of 1.25 would be assigned to
diversified counterparties which do not have a high exposure to
mortgage credit risk. The parameters of the Basel IRB formula,
including the AVCM, were augmented to best fit the internal
counterparty credit risk haircuts developed by the Enterprises.
The proposed counterparty haircut would also differ by product type
and segment. Performing loans, modified RPLs, and non-modified RPLs
would be treated differently than NPLs, and within 30-year performing
loans, modified RPLs, and non-modified RPLs would receive a larger
haircut than 15- or 20-year single-family mortgage exposures.
The NPL segment represents a different level of counterparty risk
relative to the performing and re-performing segments. Unlike
performing loans, modified RPLs, and non-modified RPLs, an Enterprise
would expect to submit claims for NPLs in the near future. The proposed
rule would reduce the Basel framework's effective maturity from 5 (or
3.5 for 15/20Yr) to 1.5 for all loans in the NPL segment. The reduced
effective maturity would lower counterparty haircuts on loans in the
NPL segment.

[[Page 39319]]

The proposed rule would utilize the following CP haircut
multipliers in Table 21.
[GRAPHIC] [TIFF OMITTED] TP30JN20.021

BILLING CODE 8070-01-C
Finally, FHFA notes that the proposed rule's approach generally
assigns more credit risk mitigation benefit to mortgage insurance and
other loan-level credit enhancement than would be assigned under the
U.S. banking framework, in particular with respect to those
counterparties eligible to provide guarantees or insurance. FHFA is
soliciting comment on the appropriateness of the differences between
the proposed rule and the regulatory capital treatment of loan-level
credit enhancement (including with respect to the U.S. banking
regulators' stress test assumptions).
Question 45. Are the CE multipliers and CP haircut multipliers for
single-family mortgage exposures appropriately formulated and
calibrated to require credit risk capital sufficient to ensure each
Enterprise operates in a safe and sound manner and is positioned to
fulfill its statutory mission across the economic cycle?
Question 46. Are there any adjustments, simplifications, or other
refinements that FHFA should consider for the CE multipliers and the CP
haircut multipliers for single-family mortgage exposures?
Question 47. Are the differences between the proposed rule and the
U.S. banking framework with respect to the credit risk mitigation
benefit assigned to loan-level credit enhancement appropriate? Which,
if any, specific aspects should be aligned?
7. Minimum Adjusted Risk Weight
The proposed rule would establish a floor on the adjusted risk
weight for a single-family mortgage exposure equal to 15 percent. FHFA
has determined that a minimum risk weight is necessary to ensure the
safety and soundness of each Enterprise and that each Enterprise is
positioned to fulfill its statutory mission across the economic cycle,
including during a period of financial stress.
First, absent this 15 percent risk weight floor, the proposed
rule's credit risk capital requirements as of the end of 2007 would not
have been sufficient to absorb each Enterprise's crisis-era cumulative
capital losses on its single-family book. Absent the 15 percent risk
weight floor, Freddie Mac's estimated single-family credit risk capital
requirement of $61 billion as of December 31, 2007 under the proposed
rule would have been less than its crisis-era single-family cumulative
capital losses. With the addition of the 15 percent risk weight floor,
Freddie Mac's estimated single-family credit risk capital requirement
would have exceeded its crisis-era single-family cumulative capital
losses. Absent the 15 percent risk weight floor, Fannie Mae's estimated
single-family credit risk capital requirement would have exceeded its
crisis-era single-family cumulative capital losses, but by a relatively
small amount. The addition of the 15 percent risk weight floor would
have added approximately $8 billion to Fannie Mae's single-family
credit risk capital requirement, clearing cumulative capital losses by
a more comfortable margin.
Second, as discussed in Section IV.B, a risk weight floor is
appropriate to mitigate certain risks and limitations associated with
the underlying historical data and models used to calibrate the credit
risk capital requirements. These risks and limitations are perhaps
inherent to any methodology for calibrating granular credit risk
capital requirements. In particular:
A disproportionate share of the Enterprises' crisis-era
credit losses arose from certain single-family mortgage exposures that
are no longer eligible for acquisition by the Enterprises. The
calibration of the credit risk capital requirements attributed a
significant portion of the Enterprises' crisis-era losses to these
products. The statistical methods used to allocate losses between
borrower-related risk attributes and product-related risk attributes
pose significant model risk. The sizing of the regulatory capital
requirements also

[[Page 39320]]

must guard against potential future relaxation of underwriting
standards and regulatory oversight over those underwriting standards.
The Enterprises' crisis-era losses likely were mitigated
to at least some extent by the unprecedented support by the federal
government of the housing market and the economy and also by the
declining interest rate environment of the period. There is therefore
some risk that the risk-based capital requirements are not specifically
calibrated to ensure each Enterprise would be regarded as a viable
going concern following a future severe economic downturn that
potentially entails more unexpected losses, whether because there is
less or no Federal support of the economy, because there is less or no
reduction in interest rates, or because of other causes.
There are some potentially material risks to the
Enterprises that are not assigned a risk-based capital requirement--for
example, risks relating to uninsured or underinsured losses from
flooding, earthquakes, or other natural disasters or radiological or
biological hazards. There also is no risk-based capital requirement for
the risks that climate change could pose to property values in some
localities.
Third, comparison to the Basel and U.S. banking framework's credit
risk capital requirements for similar exposures reinforces FHFA's view
that a risk weight floor is appropriate to mitigate certain risks and
limitations associated with the underlying historical data and models
used to calibrate the credit risk capital requirements.\68\ Absent this
risk weight floor, as of September 30, 2019, the average pre-CRT net
credit risk capital requirement on the Enterprises' single-family
mortgage exposures (which reflects the benefit of private mortgage
insurance but no adjustments for CRT) would have been 1.7 percent of
unpaid principal balance, implying an average risk weight of 21
percent. With the 15 percent risk weight floor, the average requirement
would have increased by approximately 0.5 percent of unpaid principal
balance to an average risk weight of 26 percent. The U.S. banking
framework generally assigns a 50 percent risk weight to these exposures
to determine the credit risk capital requirement (equivalent to a 4.0
percent adjusted total capital requirement), while the current Basel
framework generally assigns a 35 percent risk weight (equivalent to a
2.8 percent adjusted total capital requirement). Before the risk weight
floor, before adjusting for CRT, and before adjusting for the capital
buffers under the proposed rule and the Basel and U.S. banking
frameworks, the Enterprises' credit risk capital requirements for
single-family mortgage exposures would have been roughly 40 percent
that of U.S. banking organizations and roughly 60 percent that of non-
U.S. banking organizations.
---------------------------------------------------------------------------

\68\ As discussed in Section IV.B.2, while the interest rate and
funding risk profiles of the Enterprises and large banking
organizations are different, that difference should not preclude
comparisons of the credit risk capital requirements of the U.S.
banking framework to the credit risk capital requirements of the
Enterprises.
---------------------------------------------------------------------------

The BCBS has finalized a more risk-sensitive set of risk weights
for residential mortgage exposures, which are to be implemented by
January 1, 2022. With those changes, the lowest standardized risk
weight would be 20 percent for single-family residential mortgage loans
with OLTVs less than 50 percent. The 21 percent average risk weight
would have been about the same as this 20 percent minimum,
notwithstanding the Enterprises having an average single-family OLTV of
approximately 75 percent as of September 30, 2019.
These comparisons are complicated by the fact that the 21 percent
and 26 percent average risk weights reflect loan-level credit
enhancement and adjustments for MTMLTV. In particular, some meaningful
portion of the gap currently between the credit risk capital
requirements of the Enterprises and banking organizations under the
proposed rule is due to the proposed rule's use of MTMLTV instead of
OLTV, as under the U.S. banking framework, to assign credit risk
capital requirements for mortgage exposures. On the one hand, the
comparison illustrates how low risk-based capital requirements can
become in a mark-to-market framework without prudential floors. On the
other hand, in a different house price environment, perhaps after
several years of declining house prices, the mark-to-market framework
could have resulted in higher credit risk capital requirements than the
Basel and U.S. banking frameworks.\69\ Some of this gap might be
expected to narrow were real property prices to move toward their long-
term trend.
---------------------------------------------------------------------------

\69\ In consideration that the U.S. banking and Basel frameworks
utilize OLTVs, a comparison of the credit risk capital requirements
for newly acquired single-family mortgage exposures under the 2018
proposal and the proposed rule provides the most direct comparison
of credit risk capital requirements for new originations. Under the
proposed rule, gross credit risk capital (prior to adjustments for
credit enhancements and CRT) on newly originated (i.e., loan age
less than six months) single-family mortgage exposures as of
September 30, 2019, with an average OLTV of 77 percent, would have
been 3.8 percent of unpaid principal balance, implying an average
risk weight of 47 percent. This compares to the 50 percent risk
weight under the U.S. banking framework and 30 percent under the
newest BCBS framework for loans with OLTV of 60 to 80 percent. After
consideration of charter-required credit enhancements, the average
net credit risk capital requirement on the Enterprises' newly
originated single-family mortgage exposures as of September 30, 2019
would have been 2.8 percent of unpaid principal balance, implying an
average risk weight of 36 percent. These risk weights would then
decline to the extent house prices appreciate or increase to the
extent house prices depreciate.
---------------------------------------------------------------------------

However, the current sizing of that gap between the credit risk
capital requirements of banking organizations and the Enterprises under
the proposed rule is an important consideration informing the
enhancements to the 2018 proposal.
Reinforcing that point, the 21 percent average risk weight would
have been about the same as the Basel framework's 20 percent risk
weight assigned to exposures to sovereigns and central banks with
ratings A+ to A- and claims on banks and corporates with ratings AAA to
AA-.\70\ The 21 percent average risk weight also would have been about
the same as the 20 percent risk weight assigned under the U.S. banking
framework to Enterprise-guaranteed MBS.
---------------------------------------------------------------------------

\70\ See BCBS, The Basel Framework, paragraphs 20.4 and 20.14 at
181 and 185 (Dec. 15, 2019), available at https://www.bis.org/basel_framework/index.htm?export=pdf.
---------------------------------------------------------------------------

In light of these considerations, FHFA has determined that a
minimum risk weight is necessary to ensure the safety and soundness of
each Enterprise and that each Enterprise is positioned to fulfill its
statutory mission during a period of financial stress. FHFA sized the
15 percent risk weight floor taking into consideration the 20 percent
minimum risk weight contemplated by the amendments to the Basel
framework for similar exposures, while also seeking to preserve the
mortgage risk-sensitive framework by avoiding a risk weight floor that
was, in effect, the binding constraint for a substantial portion of
single-family mortgage exposures. FHFA is soliciting comment on the
sizing of the risk weight floor, including whether to perhaps align the
floor with the more risk-sensitive standardized risk weights assigned
to similar exposures under the Basel framework.
Question 48. Is the minimum floor on the adjusted risk weight for a
single-family mortgage exposure appropriately calibrated to mitigate
model and related risks associated with the calibration of the
underlying base risk weights and risk multipliers and to otherwise
ensure each Enterprise operates in a safe and sound manner and is
positioned to

[[Page 39321]]

fulfill its statutory mission across the economic cycle?
Question 49. Should the minimum floor on the adjusted risk weight
for a single-family mortgage exposure be decreased or increased,
perhaps to align the minimum floor with the more risk-sensitive
standardized risk weights assigned to similar exposures under the Basel
framework (e.g., 20 percent for a single-family residential mortgage
loan with LTV at origination less than 50 percent)?
Question 50. Should the floor or other limit used to determine a
single-family mortgage exposure's credit risk capital requirement be
assessed against the base risk weight, the risk weight adjusted for the
combined risk multipliers, or some other input used to determine that
credit risk capital requirement?

B. Multifamily Mortgage Exposures

The standardized credit risk-weighted assets for each multifamily
mortgage exposure would be determined using grids and risk multipliers
that together would assign an exposure-specific risk weight based on
the risk characteristics of the multifamily mortgage exposure. The
resulting exposure-specific credit risk capital requirements generally
would be similar to those in the 2018 proposal, subject to some
simplifications and refinements. As discussed in Section VIII.B.3, the
base risk weight generally would be a function of the multifamily
mortgage exposure's MTMLTV, among other things. This base risk weight
would then be adjusted based on other risk attributes, as discussed in
Section VIII.B.5. Finally, as discussed in Section VIII.B.6, this
adjusted risk weight would be subject to a minimum floor of 15 percent.
1. Multifamily Business Models
The proposed rule would apply to both Enterprises. However, when
appropriate, the proposed rule would account for differences in the
Enterprises' multifamily business models. These differences are
evident, for example, when considering certain elements of the proposed
rule related to credit risk transfer.
Multifamily mortgage exposures finance the acquisition and
operation of commercial property collateral, typically apartment
buildings. This section discusses multifamily mortgage exposures that
take the form of whole loans and guarantees. Multifamily whole loans
are those that an Enterprise keeps in its portfolio after acquisition.
Multifamily guarantees are guarantees provided by an Enterprise of the
payment of principal and interest payments to investors in MBS that
have been issued by an Enterprise or another security issuer and are
backed by previously acquired multifamily whole loans. Except to the
extent an Enterprise transfers credit risk to third-party private
investors, the credit risk from multifamily mortgage exposures is
retained.
Fannie Mae's multifamily business historically has generally relied
on the Delegated Underwriting and Servicing (DUS) program. The DUS
program is a loss-sharing program that seeks to facilitate the
implementation of common underwriting and servicing guidelines across a
defined group of multifamily lenders. The number of multifamily lenders
in the DUS program has historically ranged between 25 and 30 since the
program's inception in the late 1980s. Fannie Mae typically transfers
about one-third of the credit risk to those lenders, while retaining
the remaining two-thirds of the credit risk and the counterparty risk
associated with the DUS lender business relationship. The proportion of
risk transferred to the lender may be more or less than one-third under
a modified version of the typical DUS loss-sharing agreement. Fannie
Mae has also reduced its exposure to the credit risk retained on DUS
loans through programmatic ``back-end'' risk transfer activities,
including reinsurance transactions (MCIRT) on multifamily mortgages
with unpaid principal balances (UPBs) generally smaller than $30
million and note offerings (MCAS) on multifamily mortgages with UPBs
generally greater than or equal to $30 million.
In contrast, Freddie Mac's multifamily model has focused on
structured, multi-class securitizations. While Freddie Mac has a number
of securitization programs for multifamily loans, the largest is the K-
Deal program. Under the K-Deal program, which started in 2009, Freddie
Mac sells a portion of unguaranteed bonds (mezzanine and subordinate),
generally 10 to 15 percent, to private market participants. These sales
typically result in a transfer of a high percentage of the credit risk.
Freddie Mac generally assumes credit and market risk during the period
between loan acquisition and securitization. After securitization,
Freddie Mac generally retains a portion of the credit risk through
ownership or guarantee of senior K-Deal tranches.
As of 2019, the differences between the two business models have
become somewhat less pronounced. The proposed rule is tailored to each
Enterprise's current lending practices, and would not preclude either
from evolving its business model in the future.
Commenters on the 2018 proposal supported the inclusion of
multifamily-specific credit risk capital requirements in order to
capture the unique nature of each Enterprise's multifamily business and
its particular risk drivers. In addition, commenters generally
supported the structure and methodology of those proposed requirements.
However, commenters also provided FHFA with critical feedback. Foremost
among commenters' concerns was a perceived imbalance of the 2018
proposal as related to the Enterprises' different multifamily business
models.
Commenters on the 2018 proposal stressed the importance of having a
multifamily market with multiple viable and competing execution
methods. To this end, some commenters raised concerns that the
multifamily capital requirements in the 2018 proposal would
disadvantage the loss sharing business model relative to the
securitization business model, potentially to the point where the loss
sharing model would no longer be viable. Commenters suggested that the
2018 proposal did not sufficiently account for certain benefits or risk
mitigants of the loss sharing business model, particularly relative to
the historical loss experience of Fannie Mae's DUS loans. Commenters
also suggested that the 2018 proposal's different market risk treatment
of multifamily mortgage exposures compared to Enterprise- or Ginnie
Mae-backed MBS provided a further disadvantage to using a loss sharing
model relative to a securitization model.
FHFA has considered the commenters' feedback and believes that the
framework for calculating multifamily credit risk capital requirements
under the 2018 proposal was generally appropriately tailored to
accommodate both Enterprises' historical business practices.
However, FHFA has addressed the commenters' concerns in two ways.
First, FHFA has revised the capital treatment for contractual claims to
at-risk servicing rights and clarified the capital treatment for
restricted liquidity in Fannie Mae's loss sharing model. The 2018
proposal would have afforded capital relief in multifamily loss sharing
transactions by including restricted liquidity as collateral, and by
reducing uncollateralized exposure to a counterparty by 50 percent if
the Enterprise had a contractual claim to at-risk servicing rights. The
proposed rule would retain this treatment of restricted liquidity, but
would implement an

[[Page 39322]]

updated treatment of servicing rights such that in the counterparty
haircut calculation, an Enterprise may reduce uncollateralized exposure
by 1 year of estimated servicing revenue if the Enterprise has a
contractual claim to the at-risk servicing rights.
Second, the proposed rule would introduce a prudential floor of 10
percent for the risk weight assigned to each tranche in a CRT. Such a
floor would mitigate potential risks associated with CRT, including the
structuring, recourse, and other risks associated with these
securitizations.
2. Calibration Framework
As with single-family mortgage exposures, FHFA generally calibrated
the base risk weights and risk multipliers for multifamily mortgage
exposures to require credit risk capital sufficient to absorb the
lifetime unexpected losses incurred on multifamily mortgage exposures
experiencing a shock to property values similar to that observed during
the 2008 financial crisis. The multifamily-specific stress scenarios
used to generate the base risk weights and risk multipliers involve two
parameters: (i) Net operating income (NOI), where NOI represents gross
potential income (gross rents) net of vacancy and operating expenses,
and (ii) property values.
Adverse economic conditions are generally accompanied by either a
decrease in expected property revenue or an increase in perceived risk
in the multifamily asset class, or both. A decrease in expected
occupancy would lead to a decline in income generated by the property,
or a lower NOI, while an increase in perceived risk would lead to an
increase in the capitalization rate used to discount the NOI when
assessing property value. A capitalization rate is defined as NOI
divided by property value, so if NOI is held constant, an increase in
the capitalization rate is directly related to a decrease in property
values. For the purpose of the proposed rule, the multifamily-specific
stress scenario assumes an NOI decline of 15 percent and a property
value decline of 35 percent. This stress scenario is consistent with
market conditions observed during the recent financial crisis, views
from third-party market participants and data vendors, and assumptions
behind the DFAST severely adverse scenario. Using this stress scenario,
the multifamily grids and multipliers were calibrated based on
estimates of unexpected losses from the Enterprises' internal models.
Question 51. Is the methodology used to calibrate the credit risk
capital requirements for multifamily mortgage exposures appropriate to
ensure that the exposure is backed by capital sufficient to absorb the
lifetime unexpected losses incurred on multifamily mortgage exposures
experiencing a shock to house prices similar to that observed during
the 2008 financial crisis?
Question 52. What, if any, changes should FHFA consider to the
methodology for calibrating credit risk capital requirements for
multifamily mortgage exposures?
3. Base Risk Weights
The proposed rule would require an Enterprise to determine a base
risk weight for each multifamily mortgage exposure using a set of two
multifamily grids--one for multifamily mortgage exposures with fixed
rates (multifamily FRMs), and one for multifamily mortgage exposures
with adjustable rates (multifamily ARMs). A multifamily mortgage
exposure that has both a fixed-rate period and an adjustable-rate
period (hybrid loans) would be deemed a multifamily FRM during the
fixed-rate period and a multifamily ARM during the adjustable-rate
period.
The multifamily grids reflect two important multifamily mortgage
exposure characteristics: Debt-service-coverage-ratio (DSCR) and
MTMLTV. These two risk factors are key drivers of the future
performance of multifamily mortgage exposures. DSCR is the ratio of
property NOI to the loan payment. A DSCR greater than 1.0 indicates
that the property generates funds sufficient to cover the loan
obligation, while the opposite is true for a DSCR less than 1.0.
The multifamily grids are quantitatively identical to the
multifamily grids in the 2018 proposal, except the credit risk capital
requirements are presented as base risk weights relative to the 8.0
percent adjusted total capital requirement rather than as a percent of
UPB. The multifamily FRM grid was populated using projected unexpected
losses for a multifamily FRM with varying DSCR and MTMLTV combinations
and the following risk characteristics: $10 million loan amount, 10-
year balloon with a 30-year amortization period, non-interest-only, not
a special product, and never been delinquent or modified. Similarly,
the multifamily ARM grid was populated using projected unexpected
losses for a multifamily ARM with varying DSCR and MTMLTV combinations
and the following risk characteristics: 3.0 percent origination
interest rate, $10 million loan amount, 10-year balloon with a 30-year
amortization period, non-interest-only, not a special product, and
never been delinquent or modified. Thus, each cell of the multifamily
grid represents the average estimated difference, in basis points,
between stress losses and expected losses for these synthetic loans
with a DSCR and LTV in the tabulated ranges, converted to a risk
weight.
For the first five scheduled payment dates after a multifamily
mortgage exposure is acquired, an Enterprise would use the multifamily
mortgage exposure's LTV at acquisition or origination to determine the
base risk weight. After that point, an Enterprise would use the
multifamily mortgage exposure's MTMLTV, which would be calculated by
adjusting the acquisition LTV using a multifamily property value index
or property value estimate based on net operating income and
capitalization rate indices. Unlike single-family mortgage exposures,
an Enterprise would not make a countercyclicality adjustment to a
multifamily mortgage exposure's MTMLTV. For the purposes of the
multifamily grids, LTV means either MTMLTV or LTV at acquisition or
origination, and DSCR means either MTMDSCR or DSCR at acquisition,
depending on the age of the multifamily mortgage exposure.
The multifamily grids for the multifamily FRM and multifamily ARM
segments are presented in the following Table 22 and Table 23,
respectively.
BILLING CODE 8070-01-P

[[Page 39323]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.022

[GRAPHIC] [TIFF OMITTED] TP30JN20.023

In both the multifamily FRM and multifamily ARM grids, the base
risk weight would increase as DSCR decreases (moving toward the top of
a grid) and as MTMLTV increases (moving toward the right of the grid).
Thus, an Enterprise would generally be required to hold more credit
risk capital for a higher-risk multifamily mortgage exposure with a low
DSCR and a high MTMLTV (the upper-right corner of each grid) than for a
lower-risk multifamily mortgage exposure with a high DSCR and a low
MTMLTV (the lower-left corner of each grid). The DSCR and MTMLTV
breakpoints and ranges represented along the dimensions of the
multifamily grids combine to form granular buckets without sacrificing
simplicity or mortgage risk sensitivity.
An Enterprise also would use the multifamily grids to calculate the
base risk weight for interest-only loans. Interest-only loans allow for
payment of interest without any principal amortization during all or
part of the loan term, potentially creating increased amortization risk
and additional leveraging incentives for the borrower. To partially
capture these increased risks, the proposed rule would require an
Enterprise to use an interest-only loan's fully amortized payment to
calculate DSCR during the interest-only period in order to calculate
the multifamily mortgage exposure's base risk weight. That is, an
Enterprise would assign each multifamily interest-only mortgage
exposure into a multifamily segment, either multifamily FRM or
multifamily ARM, and calculate the base risk capital requirement using
the corresponding segment-specific multifamily grid, where the DSCR is
based on the interest-only loan's fully amortized payment.
FHFA received a number of comments on the multifamily grids in the
2018 proposal. Some commenters stated that the multifamily credit risk
capital requirements in the 2018 proposal were too high given the
Enterprises' historical multifamily losses. Similarly, some commenters
suggested that the credit risk capital required under the 2018
proposal's multifamily grids might be appropriate if FHFA included
revenue as a source of

[[Page 39324]]

loss-absorbing capital, or if FHFA benchmarked its credit risk capital
requirements to those published by the National Association of
Insurance Commissioners (NAIC), which include revenue offsets.
After consideration of the commenters' suggestions, FHFA believes
the calibration of the multifamily grids is appropriate. The base risk
weights in the multifamily grids represent estimates of lifetime losses
(net of expected losses), so one should expect the base risk weights in
the multifamily grids to be larger than observed losses experienced
during the recent financial crisis. As discussed in Section V.B.1,
consistent with the 2018 proposal, neither the statutory definitions
nor the supplemental definitions of regulatory capital include a
measure of future guarantee fees or other future revenues.
One commenter recommended FHFA add granularity to the multifamily
grids, particularly in the high MTMLTV ranges. FHFA notes that the
multifamily grids were constructed using synthetic loans at
acquisition, so data in the high MTMLTV range is limited due to the
Enterprises' acquisition history. Adding granularity to the outer
ranges of the multifamily grids would necessitate further assumptions
and extrapolations.
Question 53. Are the base risk weights for multifamily mortgage
exposures appropriately formulated and calibrated to require credit
risk capital sufficient to ensure each Enterprise operates in a safe
and sound manner and is positioned to fulfill its statutory mission
across the economic cycle?
Question 54. Are there any adjustments, simplifications, or other
refinements that FHFA should consider for the base risk weights for
multifamily mortgage exposures?
Question 55. Should the base risk weight for a multifamily mortgage
exposure be assigned based on OLTV or MTMLTV of the multifamily
mortgage exposure, or perhaps on the LTV of the multifamily mortgage
exposure based on the original purchase price and after adjusting for
any paydowns of the original principal balance?
Question 56. What steps, including any process for soliciting
public comment on an ongoing basis, should FHFA take to ensure that the
multifamily grids are updated from time to time as market conditions
evolve?
4. Countercyclical Adjustment
In contrast to the single-family framework, the proposed
multifamily credit risk capital framework does not include an
adjustment to mitigate the pro-cyclicality of the aggregate risk-based
capital requirements, although FHFA believes such an adjustment could
be merited. The proposed single-family countercyclical adjustment is
based on an estimated long-term trend in FHFA's inflation-adjusted all-
transactions HPI. FHFA does not currently produce a comparable
multifamily series, and it is unclear whether there is sufficient data
from which to develop a reliable long-term trend in multifamily
property values. FHFA is aware of the pro-cyclicality that would be
introduced by its multifamily credit risk capital framework, and FHFA
could see considerable merit to a countercyclical or similar
adjustment. FHFA is soliciting comments on options and available data
for a countercyclical adjustment to the credit risk capital
requirements for multifamily mortgage exposures.
Question 57. What approach, if any, should FHFA consider to
mitigate the pro-cyclicality of the credit risk capital requirements
for multifamily mortgage exposures?
5. Risk Multipliers
As with single-family mortgage exposures, the proposed rule would
require an Enterprise to adjust the base risk weight for each
multifamily mortgage exposure to account for additional loan
characteristics using a set of multifamily-specific risk multipliers.
The risk multipliers would refine the base risk weights to account for
risk factors beyond the primary risk factors reflected in the
multifamily grids, and for variations in secondary risk factors not
captured in the risk profiles of the synthetic loans used to calibrate
the multifamily grids. The adjusted risk weight for a multifamily
mortgage exposure would be the product of the base risk weight and the
combined risk multiplier.
The risk multipliers represent common loan characteristics that
increase or decrease the projected unexpected losses of a multifamily
mortgage exposure. Although the specified risk characteristics are not
exhaustive, they capture key commercial real estate loan performance
drivers, and are commonly used in commercial real estate loan
underwriting and rating.
The risk multipliers are substantially the same as those of the
2018 proposal, with some simplifications and refinements. In
particular, FHFA enhanced the risk multiplier for loan size to
simultaneously make it more granular and less prone to large jumps in
credit risk capital from moving from one bracket to the next. FHFA also
removed the risk multiplier for multifamily loans with a government
subsidy. The multifamily risk multipliers are presented below in Table
24.

[[Page 39325]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.024

BILLING CODE 8070-01-C
As with the single-family risk multipliers, each risk factor could
take multiple values, and each value or range of values would have a
risk multiplier associated with it. For any particular multifamily
mortgage exposure, each risk multiplier could take a value of 1.0,
above 1.0, or below 1.0. A risk multiplier of 1.0 would imply that the

[[Page 39326]]

risk factor value for a multifamily mortgage exposure is similar to, or
in a certain range of, the particular risk characteristic found in the
multifamily segment's synthetic loan. A risk multiplier value above 1.0
would be assigned to a risk factor value that represents a riskier
characteristic than the one found in the multifamily segment's
synthetic loan, while a risk multiplier value below 1.0 would be
assigned to a risk factor value that represents a less risky
characteristic than the one found in the multifamily segment's
synthetic loan. Finally, the risk multipliers would be multiplicative,
so each multifamily mortgage exposure in a multifamily segment would
receive a risk multiplier for every risk factor pertinent to that
multifamily segment, even if the risk multiplier is 1.0 (implying no
change to the base risk weight for that risk factor). The total
combined risk multiplier for a multifamily mortgage exposure would be,
in general, the product of all individual risk multipliers pertinent to
the multifamily segment in which the exposure is classified. The
proposed multifamily risk multipliers are:
Payment performance. The payment performance risk
multiplier would capture risks associated with historical payment
performance. Multifamily mortgage exposures would be assigned one of
four values: Performing, delinquent, re-performing (without
modification), and modified. A performing loan would be one that has
never been delinquent in its payments; a delinquent loan would be one
that is 60 days or more past due; a re-performing loan would be one
that is current in its payments, but has been delinquent in its
payments at least once since origination and has cured without
modification; and a modified loan would be one that is current in its
payments, but has been modified at least once since origination or has
gone through a workout plan. An Enterprise would be required to hold
more credit risk capital for multifamily mortgage exposures that have a
delinquency and/or modification history than for those that do not.
Specifically, performing multifamily mortgage exposures would receive a
risk multiplier of 1.0, while delinquent, re-performing, and modified
exposures would receive a risk multiplier greater than 1.0.
Interest-only. The interest-only risk multiplier would
capture risks associated with interest-only exposures during the
interest-only period. Interest-only loans are generally riskier than
non-interest-only loans, all else equal, and the proposed rule would
partially account for this increased amortization and leveraging risk
by requiring an Enterprise to use its fully amortized payments to
calculate DSCR. Using amortized payment would lower the DSCR, resulting
in a higher credit risk capital requirement all else equal. In
addition, the proposed rule would further account for interest-only
risk with a risk multiplier. Specifically, non-interest-only exposures
would receive a risk multiplier of 1.0, while interest-only exposures
would receive a risk multiplier of 1.1 during the interest-only period.
Loan term. The loan term risk multiplier would capture
risks associated with the remaining term of a multifamily mortgage
exposure. The majority of the Enterprises' multifamily mortgage
exposures have a loan term of five years or longer, and in general,
multifamily mortgage exposures with a shorter term are less risky than
those with a longer term. Multifamily mortgage exposures with shorter
loan terms carry relatively less uncertainty about eventual changes in
property performance and future refinancing opportunities, while
multifamily mortgage exposures with longer loan terms carry relatively
higher uncertainty about the borrower's ability to refinance in the
future. In the proposed rule, a 10-year loan term would be considered a
baseline risk, so exposures with a remaining loan term between 7 years
and 10 years would receive a risk multiplier of 1.0. The 7- to-10-year
range represents a conservative range FHFA believes is appropriate.
Multifamily mortgage exposures with remaining loan terms shorter than 7
years would receive risk multipliers less than 1.0, and multifamily
mortgage exposures with remaining loan terms longer than 10 years would
receive a risk multiplier greater than 1.0. At origination, the
remaining loan term would equal the original loan term.
Original amortization term. The amortization term risk
multiplier would capture risks associated with the amortization term of
a multifamily mortgage exposure. In general, a multifamily mortgage
exposure with a shorter repayment period faces less risk of a borrower
defaulting on its payments than does a multifamily mortgage exposure
with a longer repayment period. The most common amortization term for
multifamily mortgage exposures is 30 years, even though most have an
original loan term with a balloon payment due earlier, often in 10
years. While amortization terms can potentially take any value, FHFA
believes that given the high number of multifamily mortgage exposures
with an amortization term between 25 and 30 years, the values
represented in the risk multiplier table would sufficiently account for
the differences in risk associated with amortization term. In the
proposed rule, a 30-year amortization term would represent a baseline
level of risk, and a multifamily mortgage exposure with a 30-year
amortization term would receive a risk multiplier of 1.0. A multifamily
mortgage exposure with an amortization term less than 25 years would
receive a risk multiplier less than 1.0, while a multifamily mortgage
exposure with an amortization term greater than 30 years would receive
a risk multiplier of 1.1.
Original loan size. Multifamily mortgage exposures with
larger original loan balances are generally considered less risky than
those with smaller balances, because larger balances are commonly
associated with larger investors with more access to capital and
experience. In addition, the collateral securing a large loan is often
a larger, more established, and/or newer property. Alternatively,
multifamily mortgage exposures with smaller original balances are often
associated with investors with limited funding and smaller, less
competitive properties. An original loan size of $10 million would
represent a baseline level of risk, and multifamily mortgage exposures
meeting that criterion would receive a risk multiplier of 1.0. In a
change from the 2018 proposal, and in response to commenters that
recommended FHFA add granularity to the loan size risk multiplier in
part to avoid large jumps in the credit risk capital requirement when
moving from one risk multiplier bucket to the next, multifamily
mortgage exposures above or below $10 million would receive a loan size
risk multiplier that changes in $1 million increments between $3
million and $25 million. The loan size risk multipliers in the proposed
rule were calculated by extrapolating between the loan size risk
multiplier breakpoints in the 2018 proposal. Multifamily mortgage
exposures with an original loan balance greater than $10 million would
receive a risk multiplier less than 1.0, and multifamily mortgage
exposures with an original loan balance less than $10 million would
receive a risk multiplier greater than 1.0.
Special products. The multifamily special products that
would receive a multifamily risk multiplier were selected for their
importance based on FHFA staff analysis and expertise, pursuant to
discussions with the Enterprises and their collective multifamily
business experiences, and in recognition of commenter feedback on the
2018 proposal. The special

[[Page 39327]]

products, discussed individually below, are student housing and rehab/
value-add/lease-up loans.
Student housing loans provide financing for the operation of
apartment buildings for college students. The rental periods for units
in these properties often correspond to the institution's academic
calendar, so the properties have a high annual turnover of occupants.
Student renters, by and large, might not be as careful with the use and
maintenance of the rental units as more mature households. As a result,
apartment buildings focusing on student housing customarily have more
volatile occupancy and less predictable maintenance expenses. In the
proposed rule, this would imply higher risk, which leads to a risk
multiplier greater than 1.0 for student housing exposures.
The second type of special product includes loans issued to finance
rehab/value-add/lease-up projects. Rehab and value-add projects refer
to types of renovations, where a rehab project is a like-for-like
renovation and a value-add project is one that increases a property's
value by adding a new feature to an existing property or converts one
component of a property into a more marketable feature, such as
converting unused storage units into a fitness center. A lease-up
property is one that is recently constructed and still in the process
of securing tenants for occupancy. Recently built properties, and those
subject to improvements, typically require more intense marketing
efforts in the early stages of property operation. It often takes
longer for these properties to reach and stabilize at reasonable
occupancy levels. These factors elevate the property's risk, which in
the proposed rule would lead to a risk multiplier greater than 1.0 for
exposures backing these properties.
Although not requiring a risk multiplier, a special type of
multifamily mortgage exposure contemplated by the proposed rule is a
supplemental loan. Supplemental loans refer to multifamily loans issued
to a borrower for a property against which the borrower has previously
received a loan. There can be more than one supplemental loan for any
borrower/property combination. These loans, by definition, increase
loan balances, which lead to higher LTVs and could lead to lower DSCRs,
which could lead to higher risk. Therefore, the proposed rule would
require an Enterprise to account for this potentially higher risk by
recalculating DSCRs and LTVs for the original and supplemental loans
using combined loan balances and income/payment information. The
Enterprise would calculate risk weights for the original and
supplemental loans using the aggregate LTV and DSCR and the separate
loan characteristics of each loan, with the exception of the loan size
risk multiplier which would be determined using the aggregate UPB of
the original loan and all supplemental loans.
In a change from the 2018 proposal, the proposed rule would not
include a risk multiplier for multifamily mortgage exposures with a
government subsidy. FHFA sought feedback on the government subsidy risk
multiplier in the 2018 proposal, and commenters recommended FHFA
consider implementing the risk multiplier based on the level of
subsidy. FHFA analyzed the available performance data for government-
subsidized multifamily mortgage exposures, due to the relatively low
instances of loss across multifamily loan programs that include a
government subsidy, FHFA determined it was not feasible to accurately
calibrate thresholds at which the level of government subsidy impacted
the probability of loss occurring or the severity of that loss. As a
result of that analysis, FHFA has determined to take the approach of
eliminating the government subsidy risk multiplier from the proposed
rule to avoid instances where a loan with a limited subsidy would
qualify for the risk multiplier.
FHFA received several additional comments on the multifamily risk
multipliers in the 2018 proposal. Two commenters recommended FHFA add
granularity to the interest-only risk multiplier, with one commenter
suggesting gradations be added to the risk multiplier for the length of
the interest-only term, or at least a differentiation for a partial
interest-only versus a full interest-only. FHFA is proposing the
interest-only risk multiplier as in the 2018 proposal because FHFA
continues to believe in the validity of the analysis supporting the
interest-only risk multiplier. In that analysis, historical data with
which to calibrate an interest-only risk multiplier by interest-only
term length was limited, and feedback from the industry participants
with whom FHFA consulted disagreed as to the nature of a more granular
risk multiplier. Another commenter recommended FHFA add risk
multipliers for additional product types such as construction and mod-
rehab loans, for loan features such as cross-collateralization, and for
non-financial structural terms such as borrower covenants. While FHFA
acknowledges different product types and features may represent
differential levels of risk, the risk multipliers were selected in part
due to data availability, and in part because FHFA concluded that the
risk multipliers would represent a simple and transparent way to adjust
the base capital requirements for the most important multifamily risks
faced by an Enterprise in a regulatory capital framework.
Question 58. Are the risk multipliers for multifamily mortgage
exposures appropriately formulated and calibrated to require credit
risk capital sufficient to ensure each Enterprise operates in a safe
and sound manner and is positioned to fulfill its statutory mission
across the economic cycle?
Question 59. Are there any adjustments, simplifications, or other
refinements that FHFA should consider for the risk multipliers for
multifamily exposures?
Question 60. Should the combined risk multiplier for a multifamily
mortgage exposure be subject to a floor or a cap?
6. Minimum Adjusted Risk Weight
The 2018 proposal acknowledged that combinations of overlapping
characteristics could potentially result in unduly low credit risk
capital requirements for certain multifamily mortgage exposures. Under
the 2018 proposal, the Enterprises were required to impose a floor of
0.5 to any combined multifamily risk multiplier. FHFA has taken a
somewhat different approach in the proposed rule. As for single-family
mortgage exposures, the proposed rule would establish a floor on the
adjusted risk weight for a multifamily mortgage exposure equal to 15
percent.
First, as discussed in Section IV.B, a risk weight floor is
appropriate to mitigate certain risks and limitations associated with
the underlying historical data and models. These risks include the
potential that crisis-era losses were mitigated by the unprecedented
federal government support of the economy and the impact of lower
interest rates. In addition, they include potentially material risks
that are not assigned a risk-based requirement, for example those that
might arise from natural or other disasters.
Second, comparison to the U.S. banking framework's credit risk
capital requirements for similar exposures contributed to FHFA's view
that a risk weight floor is appropriate, while also raising important
questions as to the sizing of that risk weight floor. As of September
30, 2019, with the proposed 15 percent risk weight floor, the average
pre-CRT net credit risk capital requirement on the Enterprises'
multifamily mortgage exposures would have been 4.1 percent of unpaid

[[Page 39328]]

principal balance, implying an average risk weight of 51 percent. That
51 percent average risk weight is only modestly greater than the 50
percent average risk weight without the floor. The U.S. banking
framework generally assigns a 100 percent risk weight to multifamily
mortgage exposures to determine the credit risk capital requirement
(equivalent to an 8.0 percent adjusted total capital requirement),
although some multifamily mortgage exposures are eligible for a 50
percent risk weight. Before adjusting for the capital buffers under the
proposed rule and the U.S. banking framework, the Enterprises' credit
risk capital requirements for multifamily mortgage exposures would have
been roughly half that of the default risk weight under the U.S.
banking framework.
This comparison is complicated by the fact that the 51 percent
average risk weight reflects adjustments for MTMLTV. In particular,
some meaningful portion of the gap currently between the credit risk
capital requirements of the Enterprises and U.S. banking organizations
under the proposed rule is due to the proposed rule's use of MTMLTV
instead of OLTV, as under the U.S. banking framework, to assign credit
risk capital requirements for mortgage exposures. In a different
economic environment, perhaps after several years of declining
multifamily property prices, the mark-to-market framework could have
resulted in higher credit risk capital requirements than the U.S.
banking framework.\71\
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\71\ In consideration that the U.S. banking framework utilizes
OLTVs, a comparison of the credit risk capital requirements for
newly acquired multifamily mortgage exposures under the 2018
proposal and the proposed rule provides the most direct comparison
of credit risk capital requirements for new originations. Under the
proposed rule, gross credit risk capital (prior to adjustments for
CRT) on newly acquired multifamily mortgage exposures as of
September 30, 2019, with an average MTMLTV of approximately 67
percent, would have been approximately 5.3 percent of unpaid
principal balance, implying an average risk weight of 67 percent.
This compares to the 100 percent default risk weight generally
applicable under the U.S. banking framework. These risk weights
would then decline to the extent multifamily property prices
appreciate or increase to the extent multifamily property prices
depreciate.
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However, the current gap between the credit risk capital
requirements of U.S. banking organizations and the Enterprises under
the proposed rule is still informative to the calibration of an
appropriate risk weight floor. FHFA sized the 15 percent risk weight
floor to mirror the risk weight floor for single-family mortgage
exposures. FHFA is soliciting comment on that sizing, in particular
whether a multifamily-specific risk-weight floor might be more
appropriate.
Question 61. Is the minimum floor on the adjusted risk weight for a
multifamily mortgage exposure appropriately calibrated to mitigate
model and related risks associated with the calibration of the
underlying base risk weights and risk multipliers and to otherwise
ensure each Enterprise operates in a safe and sound manner and is
positioned to fulfill its statutory mission across the economic cycle?
Question 62. Should the minimum floor on the adjusted risk weight
for a multifamily mortgage exposure be decreased or increased, perhaps
to align the minimum floor with the more risk-sensitive standardized
risk weights assigned to similar exposures under the Basel or U.S.
banking framework?
Question 63. Should the risk weight floor for a multifamily
mortgage exposure be different from the risk weight floor for a single-
family mortgage exposure?
Question 64. Should the floor or other limit used to determine a
multifamily mortgage exposure's credit risk capital requirement be
assessed against the base risk weight, the risk weight adjusted for the
risk multipliers, or some other input used to determine that credit
risk capital requirement?

C. CRT and Other Securitization Exposures

1. Background
a. PLS and CMBS Investments
The Enterprises have exposure to PLS and commercial mortgage-backed
securities (CMBS) to the extent that they invest in PLS or CMBS or
guarantee PLS or CMBS that have been re-securitized by an Enterprise.
In the lead up to the 2008 financial crisis, each Enterprise
substantially increased its investments in PLS, and those PLS
investments were a source of a meaningful portion of each Enterprise's
initial crisis-era capital exhaustion. The Enterprises have not
acquired material amounts of PLS since 2008. However, the Enterprises
do retain some relatively small amount of legacy PLS, and each
Enterprise might acquire PLS in the future, subject to any regulations
that FHFA may prescribe. The proposed rule therefore contemplates
regulatory capital requirements for the credit, spread, and operational
risk posed by these PLS and CMBS exposures.
b. Single-Family CRT
CRT transactions provide credit protection beyond that provided by
loan-level credit enhancements. CRT can be viewed as an Enterprise
paying a portion of its guarantee fee as a cost of transferring credit
risk to private sector investors. To date, single-family CRT have
included transferring expected and unexpected losses. The Enterprises
have developed a variety of single-family CRT product types, including
structured debt issuances (known as Structured Agency Credit Risk
(STACR) for Freddie Mac and Connecticut Avenue Securities (CAS) for
Fannie Mae), insurance/reinsurance transactions (known as Agency Credit
Insurance Structure (ACIS) for Freddie Mac and Credit Insurance Risk
Transfer (CIRT) for Fannie Mae), and senior-subordinate securities.
The STACR and CAS securities account for the majority of single-
family CRT to date. These securities are issued as notes from a trust
and do not constitute the sale of mortgage loans or their cash flows.
Instead, STACR and CAS are considered to be synthetic notes because
their cash flows are determined by the credit risk performance of a
notional reference pool of mortgage loans. For the STACR and CAS
transactions, the Enterprises receive the proceeds of the note issuance
at the time of sale to investors. The Enterprises pay interest to
investors on a monthly basis and allocate principal to investors based
on the repayment and credit performance of the single-family mortgage
exposures in the underlying reference pool. Investors ultimately
receive a return of their principal, less any covered credit losses.
The transactions are fully collateralized since investors pay for the
notes in full. Thus, the Enterprises do not bear any counterparty
credit risk on debt transactions.
Pool-level reinsurance transactions such as CIRT and ACIS, which
generally cover hundreds or thousands of single-family mortgage loans,
are considered CRT. Pool insurance transactions are typically
structured with an aggregated loss amount. The Enterprises, as policy
holders, typically retain some portion (or all) of the first loss. The
cost of pool-level insurance is generally paid by the Enterprise, not
the lender or borrower. In general, an Enterprise may bear counterparty
credit risk because insurance transactions are not fully
collateralized. This counterparty credit risk may be somewhat
mitigated, however, by conducting transactions with diversified
reinsurers that have books of business that may be less correlated with
the Enterprises or with insurers in compliance with an Enterprise's
insurer eligibility standards.
In a senior-subordinate (senior-sub) securitization, the Enterprise
sells a

[[Page 39329]]

pool of single-family mortgage exposures to a trust that securitizes
cash flows from the pool into several tranches of bonds, similar to PLS
transactions. The subordinated bonds, also called mezzanine and first-
loss bonds, provide the credit protection for the senior bond. Unlike
STACR and CAS, the bonds created in a senior-sub transaction are MBS,
not synthetic securities. In addition, unlike typical MBS issued by the
Enterprises, generally only the senior tranche is guaranteed by the
Enterprise.
Historically the Enterprises have also engaged in front-end (or
upfront) lender risk sharing transactions similar to CRT, but the
single-family lender risk sharing programs will be discontinued by
year-end 2020.
c. Multifamily CRT
The Enterprises also reduce the credit risk on their multifamily
guarantee books of business by transferring and sharing risk through
multifamily CRT. As discussed in Section VIII.B.1, the Enterprises have
historically operated different multifamily business models, which has
led to the utilization of two broad types of multifamily CRT: Loss
sharing and securitizations. Within each type, individual CRT
transactions can have unique structures. The proposed rule's approach
would be general enough to accommodate the full range of multifamily
CRT currently utilized by the Enterprises.
The loss sharing CRT structure is a front-end risk transfer, which
is defined as a CRT an Enterprise enters into with a lender before the
lender delivers the loan to the Enterprise. The Enterprise and lender
share future losses according to a specified arrangement, commonly from
the first dollar of loss, and in exchange the lender is compensated for
taking on credit risk. Because these transactions are not always fully
collateralized, a loss sharing CRT generally exposes the Enterprise to
counterparty credit risk.
In the multiclass securitization CRT structure, an Enterprise sells
a pool of multifamily mortgage exposures to a trust that securitizes
cash flows from the pool into several tranches of bonds. The
subordinated bonds, also called mezzanine and first-loss bonds, are
sold to market participants. These subordinated bonds provide credit
protection for the senior bond, which is the only tranche that is
guaranteed by the Enterprise. These sales typically result in a
significant transfer of the credit risk on the underlying multifamily
mortgage exposures.
In addition to, and often on top of, loss sharing and
securitization CRT structures, the Enterprises also transfer
multifamily credit risk using reinsurance CRT transactions. In these
back-end transactions, such as Fannie Mae's CIRT program, an Enterprise
enters into agreements with third parties to cover losses on a pool of
multifamily mortgage exposures up to a certain percentage. The
Enterprise, as policy holder, typically retains some portion (or all)
of the first losses on the pool and compensates the third parties,
generally reinsurers, for bearing subsequent losses up to a detachment
point. To the extent that these deals are not fully collateralized, the
proposed rule would increase an Enterprise's post-deal exposure to
reflect counterparty risk.
2. PLS and Other Non-CRT Securitization Exposures
As contemplated by the 2018 proposal, an Enterprise would determine
its credit risk capital requirement for PLS and other securitization
exposures under a securitization framework that would be substantially
the same as that of the U.S. banking framework. As discussed in Section
VIII.C.3, an Enterprise may elect to determine its credit risk capital
requirement for a retained CRT exposure under a somewhat different
framework, even if that retained CRT exposure might be similar to an
exposure to a traditional or synthetic securitization under the
securitization framework.
The exposure amount of an Enterprise's on-balance sheet
securitization exposure generally would be the carrying value of the
exposure, while the exposure amount of an off-balance sheet
securitization exposure generally would be the notional amount of the
exposure.\72\
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\72\ For both on- and off-balance sheet securitization
exposures, there would be special rules for determining the exposure
amount and risk weights for repo-style transactions, eligible margin
loans, OTC derivative contracts, and derivatives that are cleared
transactions (other than credit derivatives).
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An Enterprise generally would assign a risk weight for a PLS or
other securitization exposure using the simplified supervisory formula
approach (SSFA). Pursuant to the SSFA, an Enterprise would determine
the risk weight for a securitization exposure using a formula that is
based, among other things, on the subordination level of the
securitization exposure and the adjusted aggregate credit risk capital
requirement of the underlying exposures. A 1,250 percent risk weight
would be assigned to any securitization exposure that absorbs losses up
to the adjusted aggregate credit risk capital requirement of the
underlying exposures. After that point, the risk weight for a
securitization exposure would be assigned pursuant to an exponential
decay function that decreases as the detachment point or attachment
point increases, subject to a minimum risk weight of 20 percent.
At the inception of a securitization, the SSFA's exponential decay
function for risk weights, together with the 20 percent risk weight
floor, would require more regulatory capital on a transaction-wide
basis than would be required if the underlying exposures had not been
securitized. That is, if the Enterprise held every tranche of a
securitization, its overall regulatory capital requirement would be
greater than if the Enterprise owned all of the underlying exposures.
Like the U.S. banking regulators, FHFA believes this outcome is
important to reduce regulatory capital arbitrage through
securitizations and to manage the structural and other risks that might
be posed by a securitization.\73\
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\73\ See Regulatory Capital Rules: Regulatory Capital,
Implementation of Basel III, Capital Adequacy, Transition
Provisions, Prompt Corrective Action, Standardized Approach for
Risk-weighted Assets, Market Discipline and Disclosure Requirements,
Advanced Approaches Risk-Based Capital Rule, and Market Risk Capital
Rule, 78 FR 62018, 62119 (Oct. 11, 2013) (hereinafter Joint Agency
Regulatory Capital Final Rule) (``At the inception of a
securitization, the SSFA requires more capital on a transaction-wide
basis than would be required if the underlying assets had not been
securitized. That is, if the banking organization held every tranche
of a securitization, its overall capital requirement would be
greater than if the banking organization held the underlying assets
in portfolio. The agencies believe this overall outcome is important
in reducing the likelihood of regulatory capital arbitrage through
securitizations.'').
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3. Retained CRT Exposures
a. Assessment Framework
As discussed in the 2018 proposal, FHFA has established certain
core principles to guide the developments of the Enterprises' CRT
programs. Each CRT must transfer a meaningful amount of credit risk to
private investors to reduce risk to the Enterprises, and the cost of
the CRT must be economically sensible. In addition, a CRT must not
interfere with the Enterprise's core business, including the ability of
borrowers to access credit. The CRT programs have been intended to
attract a broad investor base, be scalable, and incorporate a regular
program of issuances. In transactions where credit risk may not be
fully collateralized, the CRT counterparties must be financially
strong, post collateral for a portion of their exposure, and be
expected to fulfill

[[Page 39330]]

their commitments in adverse market conditions.
FHFA has continued to refine the assessment framework based on its
understanding of the safety and soundness risks and limits relating to
the effectiveness of CRT in transferring credit risk on the underlying
exposures. Commenters on the 2018 proposal argued that CRT has less
loss-absorbing capacity than an equivalent amount of equity financing.
FHFA agrees that CRT transfers credit risk only on a specified
reference pool, while equity financing is available to ``cross cover''
credit risk on other exposures of the Enterprise. FHFA also agrees that
CRT transfers only credit risk, while equity financing can absorb
losses arising from operational and market risks. Related to this, an
Enterprise generally may pause distributions on equity financing during
a financial stress but typically must continue debt service or other
payments on CRT instruments. Therefore, equity financing provides more
robust safety and soundness benefits across exposures and risks than a
similar amount of credit exposure transferred through CRT.
One of the lessons of the 2008 financial crisis is that
securitization structures, especially complex securitizations, might
not perform as expected during a financial stress, with some large
banking organizations even electing to reconsolidate some of their
securitizations.\74\ Similarly, there might be unique legal risks posed
by the contractual terms of CRT structures and by the practices
associated with contractual enforcement. While the 2018 proposal
already contemplated reductions to the capital relief provided by a CRT
based on the counterparty risk and maturity-related risk of CRT, FHFA
agrees that there are structural and other risks that were not
reflected in those adjustments that could further limit the
effectiveness of CRT in transferring credit risk. FHFA continues to
look to opportunities to enhance its framework for assessing the
Enterprises' CRT programs to mitigate these safety and soundness risks.
---------------------------------------------------------------------------

\74\ See Risk-Based Capital Guidelines; Capital Adequacy
Guidelines; Capital Maintenance: Regulatory Capital; Impact of
Modifications to Generally Accepted Accounting Principles;
Consolidation of Asset-Backed Commercial Paper Programs; and Other
Related Issues, 74 FR 47138, 47142 (Sept. 15, 2009) (``In the case
of some structures that banking organizations were not required to
consolidate prior to the 2009 GAAP modifications, the recent turmoil
in the financial markets has demonstrated the extent to which the
credit risk exposure of the sponsoring banking organization to such
structures (and their related assets) has in fact been greater than
the agencies estimated, and more associated with non-contractual
considerations than the agencies had expected. For example, recent
performance data on structures involving revolving assets show that
banking organizations have often provided non-contractual (implicit)
support to prevent senior securities of the structure from being
downgraded, thereby mitigating reputational risk and the associated
alienation of investors, and preserving access to cost-effective
funding.''); see also FCIC Report at 246, available at https://www.govinfo.gov/content/pkg/GPO-FCIC/pdf/GPO-FCIC.pdf (``When the
mortgage securities market dried up and money market mutual funds
became skittish about broad categories of ABCP, the banks would be
required under these liquidity puts to stand behind the paper and
bring the assets onto their balance sheets, transferring losses back
into the commercial banking system. In some cases, to protect
relationships with investors, banks would support programs they had
sponsored even when they had made no prior commitment to do so.'');
see also FCIC Report at 138-139 (``The events of 2007 would reveal
the fallacy of those assumptions and catapult the entire $25 billion
in commercial paper straight onto the bank's balance sheet,
requiring it to come up with $25 billion in cash as well as more
capital to satisfy bank regulators.'').
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Besides safety and soundness, FHFA's assessment framework also
considers the extent to which an Enterprise's CRT program could limit
the Enterprise's ability to fulfill its statutory mission to provide
stability and ongoing assistance to the secondary mortgage market
across the economic cycle. As discussed in the 2018 proposal, a
financial stress could reduce investor demand for, or increase the cost
of, new CRT issuances or undermine the financial strength of some
existing CRT counterparties. The pro-cyclicality of some CRT structures
could adversely impact an Enterprise's ability to support the secondary
mortgage market if an Enterprise were not to have sufficient equity
financing to support new acquisitions of mortgage exposures. To fulfill
its mission, an Enterprise should avoid overreliance on CRT and should
maintain at least enough equity capital to support new originations
during a period of financial stress, when new CRT issuances might not
be available. For these and other reasons, capital relief for CRT under
the 2018 proposal did not extend to the going- concern buffer, and the
proposed rule also would not provide CRT capital relief for the capital
conservation buffer.
FHFA's assessment framework also seeks to prevent each Enterprise's
CRT program from undermining the liquidity, efficiency,
competitiveness, or resiliency of the national housing finance markets.
Some CRT structures might tend to increase the leverage in the housing
finance system, especially to the extent some CRT investors themselves
rely on short-term debt funding. The disruption in the CRT markets
during the recent COVID-19-related financial stress might have been
driven in part by leveraged market participants that had invested in
CRT rapidly de-levering when confronted by margin calls on short-term
financing.
b. Enhancements to the 2018 Proposal
FHFA is proposing enhancements to the 2018 proposal's regulatory
capital treatment of CRT to refine its balancing of the safety and
soundness benefits of CRT against the potential safety and soundness,
mission, and housing market stability risks that might be posed by CRT.
Consistent with the U.S. banking framework, FHFA is proposing
operational criteria to mitigate the risk that the terms or structure
of the CRT would not be effective in transferring credit risk. FHFA's
proposed operational criteria would provide capital relief on a CRT
only if certain conditions are satisfied, including:
The CRT is of a category of CRT structures that has been
approved by FHFA as effective in transferring credit risk.
The terms and conditions in the CRT do not include
provisions that might undermine the effectiveness of the transfer of
the credit risk (e.g., by allowing for the termination of the CRT due
to deterioration in the credit quality of the underlying exposures).
Clean-up calls relating to the CRT are limited to
specified circumstances.
The Enterprise publicly discloses--
[cir] The material recourse or other risks that might reduce the
effectiveness of the CRT in transferring credit risk; and
[cir] Each operational criterion for a traditional securitization
or a synthetic securitization that is not satisfied by the CRT and the
reasons that each such condition is not satisfied.
These operational criteria for CRT are less restrictive than those
applicable to traditional or synthetic securitizations under the U.S.
banking framework. For example, a senior/subordinated structure need
not be off-balance sheet under GAAP, as required for traditional
securitizations under the U.S. banking framework, while a financial
guarantee need not be provided by a company that is not predominantly
engaged in the business of providing credit protection, as required for
an eligible guarantee under the U.S. banking framework. To partially
mitigate the safety and soundness risks posed by this less restrictive
approach, FHFA would require an Enterprise to publicly disclose
material risks to the effectiveness of the CRT so as to foster market
discipline and FHFA's supervision and regulation. FHFA is also seeking
comment on other operational criteria it might adopt for CRT.

[[Page 39331]]

FHFA is also proposing to prescribe the regulatory capital
consequences of an Enterprise providing support to a CRT in excess of
the Enterprise's pre-determined contractual obligations. As under the
U.S. banking framework, if an Enterprise provides implicit support for
a CRT, the Enterprise would be required to include in its risk-weighted
assets all of the underlying exposures associated with the CRT as if
the exposures were not covered by the CRT. The Enterprise also would be
required to disclose publicly (i) that it has provided implicit support
to the CRT and (ii) the risk-based capital impact to the Enterprise of
providing that implicit support. These requirements are intended to
discourage an Enterprise from providing implicit support during a
financial stress or otherwise, for example by providing financing to
CRT investors or by repurchasing CRT exposures during a financial
stress.
Generally consistent with the U.S. banking framework, FHFA also is
proposing a prudential floor of 10 percent on the risk weight assigned
to any retained CRT exposure. Under the 2018 proposal, a retained CRT
exposure with a detachment point less than the net credit risk capital
requirement of the underlying mortgage exposures would, in effect, have
had a risk weight of 1,250 percent, while a retained exposure with an
attachment point only marginally greater than that net credit risk
capital requirement would have had a risk weight of 0 percent. A
retained CRT exposure with an attachment point just beyond that cut-off
point likely still would pose some credit risk as a result of the model
risks associated with the calibration of the credit risk capital
requirement of the underlying exposures, and also the risk that a CRT
will not perform as expected in transferring credit risk to third
parties.\75\ The prudential floor for a retained CRT exposure avoids
treating that exposure as posing no credit risk.
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\75\ For these and other reasons, the Basel and U.S. banking
frameworks impose a prudential floor on the risk weight for any
securitization exposure. BCBS, Revisions to the Securitisation
Framework Consultative Document at 17 (Dec. 2013; final July 2016),
available at https://www.bis.org/publ/bcbs269.pdf. (``The objectives
of a risk-weight floor are: [m]itigate concerns related to incorrect
model specifications and error from banks' estimates of inputs to
capital formulas ([i.e.] model risk); and [r]educe the variation in
outcomes for similar risks.'').
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The 10 percent minimum risk weight is less than the 20 percent
minimum risk weight under the U.S. banking framework for securitization
exposures. FHFA's sizing of the minimum risk weight seeks to strike an
appropriate balance between permitting CRT while also mitigating the
safety and soundness, mission, and housing stability risk that might be
posed by some CRT. FHFA is soliciting comment on whether to align the
risk weight floor for retained CRT exposures with the various different
floors for securitizations exposures under the Basel and U.S. banking
frameworks.
Finally, FHFA is proposing refinements to the adjustments to the
regulatory capital treatment of CRT for the counterparty, loss-timing,
and other risks that a CRT might not be effective in transferring
credit risk to third parties. As discussed in Section VIII.C.3.c, FHFA
is proposing to refine the 2018 proposal's adjustments for counterparty
risk and loss-timing risk, and proposing to add a general adjustment
for the differences between CRT and regulatory capital. These CRT-
specific adjustments do introduce some complexity, and as discussed in
Section VIII.C.3.d, FHFA is also soliciting comment on an alternative
approach based on the U.S. banking framework's SSFA that is simpler but
also less tailored.
Under either FHFA's proposed or alternative approach, at the
inception of a CRT, FHFA generally would require more credit risk
capital on a transaction-wide basis than would be required if the
underlying mortgage exposures had not been made subject to a CRT. That
is, if an Enterprise held every tranche of a CRT, its credit risk
capital requirement on the retained CRT exposures generally would be
greater than the credit risk capital requirement of the underlying
mortgage exposures. As under the securitization framework, this
departure from strict capital neutrality is important to manage the
potential safety and soundness risks of CRT. This approach would help
mitigate the model risk associated with the calibration of the credit
risk capital requirements of the underlying exposures and also the
model risk posed by the calibration of the adjustments for loss-timing
and counterparty risks.\76\ Complex CRT also may pose structural risk
and other risks that merit a departure from capital neutrality.\77\
This departure from capital neutrality also is important to reducing
the likelihood of regulatory capital arbitrage through CRT.\78\
---------------------------------------------------------------------------

\76\ BCBS, Revisions to the Securitisation Framework
Consultative Document at 4 (Dec. 2013; final July 2016), available
at https://www.bis.org/publ/bcbs269.pdf. (``Capital requirements
should be calibrated to reasonably conservative standards. This
requires the framework to account for the model risk of determining
the risks of specific exposures. Models for securitisation tranche
performance depend in turn on models for underlying pools. In
addition, securitisations have a wide range of structural features
that do not exist for banks holding the underlying pool outright and
that are impossible to capture in models. This layering of models
and simplifying assumptions can exacerbate model risk, justifying a
rejection of a strict ``capital neutrality'' premise ([i.e.] the
total capital required after securitisation should not be identical
to the total capital before securitisation).'').
\77\ BCBS, Revisions to the Securitisation Framework at 6 (Dec.
2014; rev. July 2016), available at https://www.bis.org/bcbs/publ/d374.pdf (``All other things being equal, a securitisation with
lower structural risk needs a lower capital surcharge than a
securitisation with higher structural risk; and a securitisation
with less risky underlying assets requires a lower capital surcharge
than a securitisation with riskier underlying assets.'').
\78\ See Joint Agency Regulatory Capital Final Rule, 78 FR at
62119 (``At the inception of a securitization, the SSFA requires
more capital on a transaction-wide basis than would be required if
the underlying assets had not been securitized. That is, if the
banking organization held every tranche of a securitization, its
overall capital requirement would be greater than if the banking
organization held the underlying assets in portfolio. The agencies
believe this overall outcome is important in reducing the likelihood
of regulatory capital arbitrage through securitizations.'').
---------------------------------------------------------------------------

One implication of departing from capital neutrality is that an
Enterprise might have some existing CRT structures for which the
aggregate credit risk capital requirement of the retained CRT exposures
actually would be greater than the aggregate credit risk capital
requirement of the underlying exposures. This outcome might be more
likely, all else equal, where the underlying exposures have a lower
average risk weight, for example, a CRT with respect to seasoned
single-family mortgage exposures. As under the U.S. banking framework,
an Enterprise may elect to not recognize a CRT for purposes of the
credit risk capital requirements and instead hold risk-based capital
against the underlying exposures. FHFA has assumed for purposes of the
proposed rule that an Enterprise would make this election in those
cases where the aggregate credit risk capital requirement of the
underlying exposures is less than that of the retained CRT exposures.
Question 65. What changes, if any, should FHFA consider to the
operational criteria for CRT?
Question 66. What changes, if any, should FHFA consider to the
regulatory consequences of an Enterprise providing implicit support to
a CRT?
Question 67. Is the 10 percent prudential floor on the risk weight
for a retained CRT exposure appropriately calibrated?
Question 68. Should FHFA increase the prudential floor on the risk
weight for a retained CRT exposure, for example so that it aligns with
the 20

[[Page 39332]]

percent minimum risk weight under the U.S. banking framework?
Question 69. Should FHFA take a different approach to an
Enterprise's existing CRT?
c. Adjustments to CRT Capital Relief
The proposed rule would implement a framework through which an
Enterprise would determine its credit risk-weighted assets for any
retained CRT exposures and any other credit risk that might be retained
on its CRT. An Enterprise would calculate credit risk-weighted assets
for retained credit risk in a CRT using risk weights and exposure
amounts for each CRT tranche. The exposure amount of the retained CRT
exposures for each tranche would be increased by adjustments to reflect
counterparty credit risk and the length of CRT coverage (i.e.,
remaining time until maturity). The proposed rule would also set a
credit risk capital requirement floor for retained risk effectuated
through a tranche-level risk weight floor.
In addition, the approach would reduce the risk-weighted assets for
risk sold by 10 percent to account for the fact that CRT transactions
do not provide the same protection as regulatory capital. As discussed
by several commenters on the 2018 proposal, the credit protection from
a CRT is not fungible to cover losses on other exposures. Furthermore,
during a financial stress the Enterprises can stop equity dividend
payments whereas the cost of CRT credit protection, in many cases, is
an ongoing liability. Therefore, for each tranche, an Enterprise would
reduce the risk-weighted assets assigned to private investors or
covered by a loss sharing agreement by 10 percent and add the reduction
to the Enterprise's apportioned exposure amount in the tranche.
Overall, the proposed rule would require each Enterprise to hold
either: (i) Credit risk capital on any credit risk which it has
retained or to which it is otherwise exposed (including non-
transferable counterparty credit risk on the CRT's underlying mortgage
exposures); or (ii) the aggregate credit risk capital on the CRT's
underlying mortgage exposures. If the Enterprise chooses the former,
then in general, an Enterprise would be required to hold less
regulatory capital for CRT transactions that provide coverage (i) on a
higher percentage of unexpected losses, (ii) for a longer period, and
(iii) with lower levels of counterparty credit risk.
The following example provides an illustration of the proposed
rule's capital requirements if an Enterprise elects to hold capital
against the credit risk from its retained CRT exposures. Consider the
following inputs from an illustrative CRT (see Figure 3):
$1,000 million in unpaid principal balance of performing
30-year fixed rate single-family mortgage exposures with OLTVs greater
than 60 percent and less than or equal to 80 percent;
CRT coverage term of 10 years;
Three tranches--B, M1, and AH--where tranche B attaches at
0% and detaches at 0.5%, tranche M1 attaches at 0.5% and detaches at
4.5%, and tranche AH attaches at 4.5% and detaches at 100%;
Tranches B and AH are retained by the Enterprise, and
ownership of tranche M1 is split between capital markets (60 percent),
a reinsurer (35 percent), and the Enterprise (5.0 percent);
The aggregate credit risk-weighted assets on the single-
family mortgage exposures underlying the CRT are $343.8 million;
Aggregate expected losses on the single-family mortgage
exposures underlying the CRT of $2.5 million; and
The reinsurer posts $2.8 million in collateral, has a
counterparty financial strength rating of 3, and does not have a high
level of mortgage concentration risk.

[[Page 39333]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.025

The Enterprises would first calculate the risk weights for each
tranche assuming full effectiveness of the CRT in transferring credit
risk on the underlying mortgage exposures. In general, tranche risk
weights are the highest for the riskiest, most junior tranches (such as
tranche B), and lower for the more senior tranches (such as tranches M1
and AH). For the illustrative CRT, the overall risk weights for
tranches AH, M1, and B are 10%, 781%, and 1,250%, where 10% reflects
the minimum risk weight.
[GRAPHIC] [TIFF OMITTED] TP30JN20.026

where

[[Page 39334]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.027

Next, the Enterprise would calculate the adjusted exposure amount
of its retained CRT exposures to reflect the effectiveness of the CRT
in transferring credit risk on the underlying mortgage exposures. For
the illustrative CRT, tranches AH and B are retained by the Enterprise,
and do not need further adjustment. Risk associated with tranche M1 is
transferred through a capital markets transaction and a loss sharing
agreement. Risk transfer on this tranche is subject to the following
three effectiveness adjustments, which are reflected in the
Enterprise's adjusted exposure amount: Loss sharing effectiveness
adjustment (LSEA), loss timing effectiveness adjustment (LTEA), and
overall effectiveness adjustment (OEA).
To account for the effectiveness of loss sharing on tranche M1, the
proposed rule would adjust its exposure amount on tranche M1 to reflect
the retention of some of the counterparty credit risk that was
nominally transferred to the counterparty. The proposed rule adjusts
effectiveness for (i) uncollateralized unexpected loss (UnCollatUL) and
(ii) uncollateralized risk-in-force above stress loss (SRIF). For the
illustrative CRT, the counterparty haircut is 5.2% as per the proposed
single-family CP haircuts, from Table 21, UnCollatUL is 42.5%, and SRIF
is 37.5%. The proposed rule's LTEA on tranche M1 would be 96.4%.
[GRAPHIC] [TIFF OMITTED] TP30JN20.028

where
[GRAPHIC] [TIFF OMITTED] TP30JN20.029

To account for effectiveness from the timing of coverage, the
proposed rule would adjust the Enterprise's exposure amount for tranche
M1 to reflect the retention of some loss timing risk that was nominally
transferred. The loss timing factor addresses the mismatch between
lifetime losses on the 30-year fixed-rate single-family mortgage
exposures underlying the CRT and the CRT's coverage. The loss timing
factor for the illustrative CRT with 10 years of coverage and backed by
30-year fixed-rate single-family whole loans and guarantees with OLTVs
greater than 60 percent and less than or equal to 80 percent is 88
percent for both the capital markets transaction and loss sharing
agreement. For the illustrative CRT, tranche M1's LTEA is 85.6% and is
derived by scaling stress loss by the 88% loss timing factor.
[GRAPHIC] [TIFF OMITTED] TP30JN20.030

where

LTKA = max((2.75% + 0.25%) * 88%-0.25%, 0%) =
2.39%

For the last adjustment, the proposed rule would include a 10%
overall reduction in capital relief to reflect for the fact that CRT
transactions do not provide the same loss-absorbing capacity as
regulatory capital (OEA).

OEA = (1-10%) = 90%

The adjusted exposure amounts (AEAs) combine the effectiveness
adjustments, aggregate UPB, tranche thickness, and an adjustment for
expected losses (to tranche B in the example). For the illustrative
CRT, the proposed rule would calculate AEAs as follows:

[[Page 39335]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.031

where the Enterprise's adjusted exposures (EAEs) for tranches A and B
are 100% and

EAE,M1 = 100%-(60% * 85.6% * 90%)-(35% * 96.4% *
85.6% * 90%) = 27.8%.

Finally, to calculate risk weighted assets after CRT, the proposed
rule combines AEAs with the tranche-level risk weights. For the
illustrative CRT, the proposed rule would calculate risk weighted
assets (RWA) as follows:

RWA$,AH = AEA$,AH * RW,AH =
$955m * 10% = 95.5m
RWA$,M1 = AEA$,M1 * RWA,M1 =
11.1m * 781% = 86.7m
RWA$,B = AEA$,B * RW,B = 2.5m
* 1250% = $31.3m

with total RWAs on the retained CRT exposures at $213.5 million, a
decline of $130.3 million from the aggregate credit risk-weighted
assets on the underlying single-family mortgage exposures of $343.8
million.
Seasoned CRT
A seasoned CRT differs from when it was newly issued due to the
changing risk profile on the mortgage exposures underlying the CRT, and
changes to the CRT structure which may have developed since issuance.
Therefore, an Enterprise would be required to periodically re-calculate
capital adjustments on its seasoned CRT transactions.
For each seasoned CRT, the proposed rule would require the
Enterprise to update the data elements originally considered. In
particular, the proposed rule would require the Enterprise to update
credit risk capital and expected losses on the underlying whole loans
and guarantees, tranche structure, ownership, and counterparty credit
risk.
CRT Prepayments
The rate at which principal on a CRT's underlying exposures is paid
down (principal paydowns) affects the allocation of credit losses
between the Enterprises and investors/reinsurers. Principal paydowns
include regularly scheduled principal payments and unscheduled
principal prepayments. In general, a CRT's tranches are paid down in
the order of their seniority outlined in the CRT's transaction
documents. For tranches with shared ownership, principal paydowns are
allocated on a pro-rata basis. Under certain conditions unusually fast
prepayments can erode the credit protection provided by the CRT by
paying down the subordinate tranches and leave the Enterprises more
vulnerable to credit losses. In particular, unexpectedly high
prepayments can compromise the protection afforded by CRT and reduce
the CRT's benefit or capital relief.
FHFA reviewed the effect on capital relief of applying stressful
prepayment and loan delinquency projections to recent CRT. FHFA
concluded that deal features, specifically triggers, mitigate the
effects of fast prepayments by diverting unscheduled principal
prepayments to the Enterprise-held senior tranche. For example, a
minimum credit enhancement trigger redirects prepayments to the senior
tranche when the senior credit enhancement falls below a pre-specified
threshold. Similarly, a delinquency trigger diverts prepayments when
the average monthly delinquency balance (i.e., underlying single-family
mortgage exposures that are 90 days or more delinquent, in foreclosure,
bankruptcy, or REO) exceeds a pre-specified threshold.
FHFA considered whether it would be desirable to include language
in the proposed rule requiring specific triggers in CRT transactions.
However, FHFA decided against such language because variations across
transactions complicate the establishment of fixed triggers that could
be prudently applied uniformly across deals. Further, mandating a fixed
set of triggers could reduce innovation in managing principal paydowns.
For these reasons, FHFA believes that the proposed rule would
appropriately consider single-family CRT prepayments.
Multifamily Loss-Timing Factors
One notable enhancement in the proposed CRT capital framework for
multifamily mortgage exposures would be the application of multifamily
loss timing factors. The loss timing factor would address the mismatch
between lifetime multifamily losses on the whole loans and guarantees
underlying a CRT and the term of coverage on the CRT. In the 2018
proposal, FHFA sought comment on how to implement a multifamily loss
timing adjustment, but commenters did not suggest an approach. The
proposed rule would implement a simple adjustment based on the
contractual maturity of the CRT and the maturities of the underlying
multifamily mortgage exposures.
Multifamily Counterparty Risk
In multifamily CRT transactions involving loss sharing and/or
reinsurance agreements, an Enterprise is exposed to counterparty credit
risk. In such instances, the Enterprise would consider posted
collateral, concentration risk, and the financial strength of the
counterparty before applying the counterparty haircut. In multifamily
loss sharing agreements, the Enterprise would also consider at-risk
servicing rights before applying the haircut.
In the proposed CRT capital framework, an Enterprise would be
permitted to offset counterparty credit risk with collateral by
reducing the Enterprise's uncollateralized exposure subject to a
counterparty haircut. Fannie Mae has historically required DUS lenders
to post collateral subject to certain terms and conditions, referred to
as restricted liquidity, which Fannie Mae can access in the event of a
lender default. In the proposed rule, restricted liquidity would be
considered equivalent to other forms of collateral. In addition, as
part of its DUS loss sharing agreements, Fannie Mae generally retains a
contractual claim to the lenders' at-risk servicing rights that can be
exercised by Fannie Mae under different circumstances. The 2018
proposal included a provision for an Enterprise to decrease its
uncollateralized exposure by 50 percent if the Enterprise had any
contractual claim to at-risk servicing rights. In response to comments
that suggested FHFA should clarify the treatment of

[[Page 39336]]

servicing rights, the proposed rule would include an updated treatment
of servicing rights such that in the counterparty haircut calculation,
an Enterprise may reduce its uncollateralized exposure by 1 year of
estimated future servicing revenue if the Enterprise has a contractual
claim to the at-risk servicing rights. FHFA believes that this more
explicit accounting of the value of lender servicing rights would
reduce the possibility of manipulation without materially affecting the
magnitude of the adjustment to uncollateralized exposure in the CRT
capital calculation.
In response to comments on the 2018 proposal, FHFA considered
additional potential risk mitigants that may be present in loss-sharing
CRT transactions such as entity-based capital, lender CRT transactions,
and intrinsic risk-retention benefits, but opted not to include
counterparty credit risk offsets for these features in the proposed
rule. While these features may lead to benefits that decrease the
credit risk faced by an Enterprise, FHFA does not have sufficient
information to accurately quantify the magnitude of these potential
benefits. However, to the extent that features such as entity-based
capital and lender CRT transactions lead to stronger counterparty
financial strength ratings, these loss mitigating factors would be
reflected in an Enterprise's risk-based capital requirements in the
form of smaller counterparty haircuts.
To calculate the counterparty haircut in the proposed rule, an
Enterprise would use a modified version of the Basel IRB approach that
considers the creditworthiness of the counterparty. Similar to the
single-family discussion of how counterparty risk is amplified due to
the correlation between a counterparty's credit exposure and the
Enterprises' credit exposure (concentration risk), the proposed rule
would assign larger haircuts to multifamily counterparties with higher
levels of concentration risk relative to diversified counterparties. An
Enterprise would assess the level of multifamily mortgage risk
concentration for each individual counterparty to determine whether the
counterparty is well diversified or whether it has a high concentration
risk, and counterparties with a lower concentration risk would be
assigned a smaller counterparty haircut relative to counterparties with
higher concentration risk. This difference is captured through the
asset valuation correlation multiplier, AVCM. An Enterprise would
assign an AVCM of 1.75 to counterparties with high concentration risk
and an AVCM of 1.25 to more well-diversified counterparties.
The counterparty haircut would be calculated as the product of
stress loss given default (LGD), stress probability of default (PD),
and a maturity adjustment for the asset. Along with the AVCM, other
parameterization assumptions in the proposed rule include a stress LGD
of 45 percent, a maturity adjustment calibrated to five years, a
stringency level of 99.9 percent, and expected PDs calculated using an
historical one-year PD matrix for all financial institutions. For each
CRT that involves counterparty credit risk, an Enterprise would select
a counterparty haircut and apply it to the uncollateralized exposure in
the CRT. The proposed multifamily counterparty risk haircut multipliers
are presented below in Table 25.
[GRAPHIC] [TIFF OMITTED] TP30JN20.032

Question 70. Is the proposed approach to determining the credit
risk capital requirement for retained CRT exposures appropriately
formulated?
Question 71. Are the adjustments for counterparty risk
appropriately calibrated?
Question 72. Are the adjustments for loss-timing and other
maturity-related risk appropriately calibrated?
Question 73. Is the 10 percent adjustment for the general
effectiveness of CRT appropriately calibrated?
Question 74. Is the 10 percent adjustment for the general
effectiveness of CRT appropriate in light of the proposed rule's
prudential floor on the risk weight for retained CRT exposures?
Question 75. Should FHFA impose any restrictions on the collateral
eligible to secure CRT that pose counterparty risk?
d. Alternative Approach
The proposed approach to CRT described under VIII.C.3.c has
significant advantages over the approach to CRT taken by the Basel and
U.S. banking framework's SSFA to the extent that it provides a more
granular and mortgage risk-sensitive framework for determining the
capital relief from CRT. There is, however, a trade-off between a more
risk-sensitive approach

[[Page 39337]]

and the complexity and other operational burdens of that more granular
approach. FHFA is also soliciting comment on a simpler but less
tailored alternative approach under which the Enterprise would
determine the risk weight for a retained CRT exposure using the SSFA of
the securitization framework. A 1,250 percent risk weight would be
assigned to any retained CRT exposure that absorbs losses up to the
adjusted aggregate credit risk capital requirement of the underlying
exposures. After that point, the risk weight for the retained CRT
exposure would be assigned pursuant to an exponential decay function
that decreases as the detachment point or attachment point increases.
The key difference from the SSFA under the securitization framework
would be that the prudential floor for the risk weight for a retained
CRT exposure would be 10 percent instead of 20 percent.
Under this approach, there would be no specific, tailored
adjustment for counterparty risk or loss-timing risk or a general
adjustment for the differences between CRT and equity financing.
Instead, as under the Basel and U.S. banking framework's SSFA, FHFA
proposes to use a supervisory adjustment factor, the constant term p,
to determine the overall level of regulatory capital required for all
tranches of a CRT under the SSFA. A higher value of p would increase
the amount of regulatory capital required under the SSFA with
detachment points beyond the adjusted aggregate credit risk capital
requirement of the underlying exposures. As described by the BCBS,
``[t]he supervisory adjustment factor in the SSFA is intended to reduce
cliff effects and apply conservatism for tranches with detachment
points beyond [the adjusted aggregate credit risk capital requirement
of the underlying exposures]. In addition, the supervisory adjustment
factor can be seen to account for imprecision or uncertainty associated
with using standardized approach risk weights for underlying exposures.
. . .'' \79\
---------------------------------------------------------------------------

\79\ BCBS, Revisions to the Basel Securisation Framework
Consultative Document at 23 (Dec. 2012; final Dec. 2014) available
at https://www.bis.org/publ/bcbs236.pdf.
---------------------------------------------------------------------------

Question 76. Should FHFA require an Enterprise to determine the
credit risk capital requirement for retained CRT exposures using a
modified version of the SSFA?
Question 77. Is the SSFA properly formulated for retained CRT
exposures or should other risk drivers, such as maturity, be
incorporated?
Question 78. Is the SSFA (particularly the supervisory adjustment
factor, p) appropriately calibrated for retained CRT exposures?

D. Other Exposures

While substantially all of an Enterprise's credit risk is posed by
its single-family and multifamily mortgage exposures, each Enterprise
does have some amount of credit risk arising from a wide variety of
other exposures, including non-traditional mortgage exposures and non-
mortgage exposures. Some of these non-mortgage exposures--for example,
an Enterprise's OTC and cleared derivatives and repo-style
transactions--raise complex and technical issues to calibrating credit
risk capital requirements. FHFA believes it is important to assign a
credit risk capital requirement to all material exposures, even if
small in amount relative to an Enterprise's aggregate credit risk
exposure. As under the 2018 proposal, FHFA proposes to incorporate into
the proposed rule the extensive expertise of the U.S. and international
banking regulators in calibrating credit risk capital requirements for
these other exposures, with adjustments as appropriate for the
Enterprises. The Basel framework has evolved over almost four decades
of debate and collaboration among the world's experts in regulatory
capital. That framework also has been revamped to incorporate the
lessons of the 2008 financial crisis. Moreover, the complex and
technical issues posed by these other exposures risk distracting FHFA
from its core area of relative expertise--fashioning a mortgage risk-
sensitive framework for the Enterprises--were FHFA to endeavor to
develop its own framework for assigning credit risk capital
requirements for these other exposures.
As discussed in this Section VIII.D, an Enterprise generally would
assign risk weight for exposures other than mortgage exposures using
the same risk weights assigned under the U.S. banking framework's
standardized approach, in particular the Federal Reserve Board's
regulatory capital requirements at subpart D of 12 CFR part 217
(Regulation Q).\80\ Exposures that would be assigned risk weights under
the U.S. banking framework include corporate exposures, exposures to
sovereigns, OTC derivatives, cleared transactions, collateralized
transactions, and off-balance sheet exposures.
---------------------------------------------------------------------------

\80\ The proposed rule cross-references relevant sections of 12
CFR part 217 as in effect on April 23, 2020. For the final rule,
FHFA will assess whether the final rule will cross-reference
sections of 12 CFR part 217 as of that same date or as of a later
date, taking into account the materiality and nature of any
amendments to that part after April 23, 2020 and any restrictions
under applicable law.
---------------------------------------------------------------------------

Similarly, some exposures that were assigned credit risk capital
requirements under the 2018 proposal would instead have a risk weight
assigned under the U.S. banking framework. These would include some
DTAs, municipal debt, reverse mortgage loans, reverse MBS, and cash and
cash equivalents.
For any exposure that is not assigned a specific risk weight under
the proposed rule, the default risk weight would be 100 percent,
consistent with the U.S. banking framework.
1. Commitments and Other Off-Balance Sheet Exposures
As under the U.S. banking framework, the proposed rule would
require an Enterprise to calculate the exposure amount of an off-
balance sheet item by multiplying the off-balance sheet component,
which is usually the notional amount, by the applicable credit
conversion factor (CCF). Off-balance sheet items subject to this
approach would include guarantees, mortgage commitments, contingent
items, certain repo-style transactions, financial standby letters of
credit, and forward agreements.
An Enterprise would apply a zero percent CCF to the unused portion
of commitments that are unconditionally cancelable by the Enterprise. A
commitment would be any legally binding arrangement that obligates an
Enterprise to extend credit or to purchase assets.
The CCF would increase to 20 percent for a commitment with an
original maturity of one year or less that is not unconditionally
cancelable by the Enterprise. The CCF would increase to 50 percent for
a commitment with an original maturity of more than one year that is
not unconditionally cancelable by the Enterprise. An Enterprise would
apply a 100 percent CCF to off-balance sheet guarantees, repurchase
agreements, securities lending or borrowing transactions, financial
standby letters of credit, and forward agreements.
The off-balance sheet component of a repurchase agreement would
equal the sum of the current market values of all positions the
Enterprise has sold subject to repurchase. The off-balance sheet
component of a securities lending transaction would equal the sum of
the current fair values of all positions the Enterprise has lent under
the transaction. For securities borrowing transactions, the off-balance
sheet component would equal the sum of the current fair values of all
non-cash

[[Page 39338]]

positions the Enterprise has posted as collateral under the
transaction.
2. Exposures to Sovereigns
Consistent with the U.S. banking framework, exposures to the U.S.
government, its central bank, or a U.S. government agency and the
portion of an exposure that is directly and unconditionally guaranteed
by the U.S. government, its central bank, or a U.S. government agency
would receive a zero percent risk weight. The portion of a deposit
insured by the Federal Deposit Insurance Corporation (FDIC) or the
National Credit Union Administration (NCUA) also may be assigned a zero
percent risk weight. An exposure conditionally guaranteed by the U.S.
government, its central bank, or a U.S. government agency would receive
a 20 percent risk weight.
3. Crossholdings of Enterprise MBS
Under the 2018 proposal, an MBS guaranteed by an Enterprise would
have had a credit risk capital requirement of 0 percent. Consistent
with the U.S. banking framework, the proposed rule would assign a 20
percent risk weight to the exposures of an Enterprise to the other
Enterprise or another GSE (other than equity exposures and acquired CRT
exposures). The 20 percent risk weight would extend to an Enterprise's
exposures to MBS guaranteed by the other Enterprise.
The Enterprises currently are in conservatorship and benefit from
Treasury support under the PSPA. However, the Enterprises remain
privately-owned corporations, and their obligations do not have the
explicit guarantee of the full faith and credit of the United States.
The U.S. banking regulators ``have long held the view that obligations
of the GSEs should not be accorded the same treatment as obligations
that carry the explicit guarantee of the U.S. government.'' \81\ FHFA
agrees that the MBS and other obligations of an Enterprise should be
subject to a credit risk capital requirement that is greater than that
assigned to those obligations that have an explicit guarantee of the
full faith and credit of the United States.
---------------------------------------------------------------------------

\81\ 77 FR 52888, 52896 (Aug. 30, 2012).
---------------------------------------------------------------------------

Under the direction of FHFA, the Enterprises have implemented a
single security initiative that is intended to increase the liquidity
of the to-be-announced (TBA) market. Under the initiative, each
Enterprise has begun issuing a single MBS known as the Uniform
Mortgage-Backed Security (UMBS). On March 12, 2019, UMBS trading began
in the forward TBA market, marking the consolidation of the formerly
distinct markets for each Enterprise's MBS. In June 2019, settlement of
TBA trades for UMBS began.
FHFA believes that the new, consolidated UMBS market will lead to a
more efficient, resilient, and liquid secondary mortgage market and
further FHFA's statutory obligation and the Enterprises' charter
obligations to support the liquidity of U.S. housing finance markets.
For the UMBS market to continue to work, market participants must
continue to view UMBS as fungible with respect to the issuing
Enterprise. That is, investors must generally agree that a UMBS of a
certain coupon and maturity issued by one Enterprise is roughly
equivalent to the corresponding UMBS issued by the other.\82\
---------------------------------------------------------------------------

\82\ To support investor confidence in that fungibility, FHFA
promulgated a final rule governing Enterprise actions that affect
UMBS cash flows to investors, issues quarterly prepayment monitoring
reports, and has used its powers as the Enterprises' conservator to
limit certain pooling practices with respect to the creation of
UMBS. In November 2019, FHFA issued a request for input on
Enterprise UMBS pooling practices.
---------------------------------------------------------------------------

To foster that fungibility, each Enterprise may issue a ``Supers''
mortgage-related security, which is a re-securitization of UMBS and
certain other TBA-eligible securities, including other Supers. If an
Enterprise guarantees a security backed in whole or in part by
securities of the other Enterprise, the Enterprise is obligated under
its guarantee to fund any shortfall in the event that the other
Enterprise fails to make a payment due on its securities. The
Enterprises have entered into an indemnification agreement relating to
commingled securities issued by the Enterprises. The indemnification
agreement obligates each Enterprise to reimburse the other for any such
shortfall.
Question 79. Should FHFA adjust the regulatory capital treatment
for exposures to MBS guaranteed by the other Enterprise to mitigate any
risk of disruption to the UMBS?
Question 80. Should FHFA consider a different risk weight for
second-level re-securitizations backed by UMBS?
Question 81. What should be the regulatory capital treatment of any
credit risk mitigation effect of any indemnification or similar
arrangements between the Enterprises relating to UMBS re-
securitizations?
Question 82. Should FHFA adopt different risk weights for MBS
guaranteed by an Enterprise and the unsecured debt of an Enterprise?
4. Corporate Exposures
Consistent with the U.S. banking framework, credit exposures to
companies that are not depository institutions or securitization
vehicles generally would be assigned a 100 percent risk weight. A
corporate exposure is an exposure to a company that is not an exposure
to a sovereign, the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
the European Stability Mechanism, the European Financial Stability
Facility, a multi-lateral development bank (MDB), a depository
institution, a foreign bank, a credit union, or a public sector entity
(PSE), a GSE, a mortgage exposure, a cleared transaction, a default
fund contribution, a securitization exposure, an equity exposure, or an
unsettled transaction.
5. OTC Derivative Contracts
An Enterprise would determine its credit risk capital requirement
for the counterparty risk for OTC derivative contracts as if it were a
banking organization subject to the Federal Reserve Board's risk-based
capital requirements, in particular 12 CFR 217.34. An OTC derivative
contract generally would not include a derivative contract that is a
cleared transaction, which would be subject to a different approach as
discussed in Section VIII.D.6.
A derivative contract is a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity derivative
contracts, credit derivative contracts, and any other instrument that
poses similar counterparty credit risks. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or five business days.
To determine the risk-weighted assets for an OTC derivative
contract, an Enterprise would first determine its exposure amount for
the OTC derivative contract and then apply to that amount a risk weight
based on the counterparty, eligible guarantor, or recognized
collateral.
For a single OTC derivative contract that is not subject to a
qualifying master netting agreement, the exposure amount would be the
sum of (i) the current

[[Page 39339]]

credit exposure, which would be the greater of the mark-to-market value
or zero, and (ii) the potential future exposure (PFE), which would be
calculated by multiplying the notional principal amount of the OTC
derivative contract by a prescribed conversion factor.
For multiple OTC derivative contracts subject to a qualifying
master netting agreement, the exposure amount would be calculated by
adding the net current credit exposure and the adjusted sum of the PFE
amounts for all OTC derivative contracts subject to the qualifying
master netting agreement. The net current credit exposure would be the
greater of zero and the net sum of all positive and negative mark-to-
market values of the individual OTC derivative contracts subject to the
qualifying master netting agreement.
If an OTC derivative contract is collateralized by financial
collateral, an Enterprise may recognize the credit risk mitigation
benefits of the financial collateral pursuant to the rules governing
collateralized transactions, as discussed in Section VIII.D.7.
6. Cleared Transactions
An Enterprise would determine its credit risk capital requirement
for the counterparty risk for derivatives and repo-style transactions
cleared through a central counterparty as if it were a banking
organization subject to the Federal Reserve Board's risk-based capital
requirements, in particular 12 CFR 217.35. To determine the risk-
weighted assets for a cleared transaction, an Enterprise that is a
clearing member client or a clearing member would multiply the trade
exposure amount for the cleared transaction by the appropriate risk
weight. An Enterprise also would be subject to a credit risk capital
requirement for default fund contributions to CCPs.
7. Credit Risk Mitigation
An Enterprise may recognize the risk-mitigation effects of
guarantees, credit derivatives, and collateral for purposes of its
risk-based capital requirements in the same way a banking organization
may under the Federal Reserve Board's risk-based capital requirements,
in particular 12 CFR 217.36 and 217.37. Under that approach, an
Enterprise generally may use the substitution approach to recognize the
credit risk-mitigation effect of an eligible guarantee from an eligible
guarantor or eligible credit derivative and the simple approach to
recognize the effect of eligible collateral. Under the substitution
approach, if the protection amount of an eligible guarantee or eligible
credit derivative is greater than or equal to the exposure amount of
the hedged exposure, an Enterprise generally may substitute the risk
weight applicable to the guarantor or credit derivative protection
provider for the risk weight assigned to the hedged exposure. Under the
simple approach, the collateralized portion of the exposure generally
would receive the risk weight applicable to the eligible collateral
(with an exception for repo-style transactions, eligible margin loans,
collateralized derivative contracts, and single-product netting sets of
such transactions).

IX. Credit Risk Capital: Advanced Approach

The proposed rule would require an Enterprise to comply with the
risk-based capital requirements using the higher of its risk-weighted
assets calculated under the standardized approach and the advanced
approach, where risk-weighted assets include credit risk, operational
risk, and market risk components. The advanced approach requirements
would require each Enterprise to maintain its own processes for
identifying and assessing credit risk, market risk, and operational
risk. These requirements should ensure that each Enterprise continues
to enhance its risk management system and also that neither Enterprise
simply relies on the standardized approach's lookup grids and
multipliers to define credit risk tolerances, measure its credit risk,
or allocate economic capital. In the course of FHFA's supervision of
each Enterprise's internal models for credit risk, FHFA also could
identify opportunities to update or otherwise enhance the standardized
approach's lookup grids and multipliers through future rulemakings as
market conditions evolve.
Under the proposed rule's advanced approach requirements, an
Enterprise would be required to have a process for assessing its
overall capital adequacy in relation to its risk profile and maintain
infrastructure with risk measurement and management processes that are
appropriate given the Enterprise's size and complexity. An Enterprise's
senior management would be required to ensure that the Enterprise's
internal models, operational risk quantification systems, and related
advanced systems functions comply with the proposed rule's minimum
requirements. The Enterprise's board of directors (or a designated
committee of the board) would be required to at least annually review
the effectiveness of, and approve, the Enterprise's advanced systems.
An Enterprise's advanced systems would be required to include an
internal risk rating and segmentation system that differentiates among
degrees of credit risk for the Enterprise's mortgage and other
exposures. An Enterprise also would be required to have a process that
estimates risk parameters for the Enterprise's exposures. An
Enterprise's estimates of risk parameters must incorporate relevant and
available data, and an Enterprise generally must demonstrate, among
other things, that its estimates are representative of long run
experience and take into account any changes in underwriting or
recovery practices. Default, loss severity, and exposure amount data
generally must include periods of economic downturn conditions. An
Enterprise would be required to review--at least annually--its
reference data.
An Enterprise would be required to conduct an independent
validation, on an ongoing basis, of its advanced systems. The
validation must include an evaluation of the conceptual soundness of
the advanced systems, an ongoing monitoring process that includes
verification of processes and benchmarking, and an outcomes analysis
process that includes backtesting.
An Enterprise also would be required to periodically stress test
its advanced systems including a consideration of how economic cycles,
especially downturns, affect risk-based capital requirements.
An Enterprise would be required to meet these minimum requirements
on an ongoing basis. An Enterprise also would be required to notify
FHFA when the Enterprise makes any material change to its advanced
systems.
In addition to the proposed rule's requirements, an Enterprise's
advanced systems would be implemented under FHFA's supervisory review.
As part of that review process, FHFA issues advisory bulletins to
communicate its supervisory expectations to FHFA supervision staff and
to the Enterprises on specific supervisory matters and topics. Through
FHFA's supervision program, FHFA on-site examiners conduct supervisory
activities to ensure safe and sound operations of the Enterprises.
These supervisory activities may include the examination of the
Enterprises to determine whether they meet the expectations set in the
advisory bulletins. Examinations may also be conducted to determine
whether the Enterprises comply with their own policies and procedures,
regulatory and

[[Page 39340]]

statutory requirements, or FHFA directives.
FHFA's 2013-07 Advisory Bulletin reflects supervisory expectations
for an Enterprise's model risk management. The Advisory Bulletin sets
minimum thresholds for model risk management and differentiates between
large, complex entities and smaller, less complex entities. As the
Enterprises are large complex entities, the Advisory Bulletin subjects
them to heightened standards for internal audit, model risk management,
model control framework, and model lifecycle management.
The proposed rule would not provide a comprehensive set of
guardrails and prescriptions for an Enterprise's internal models
outside of the minimum requirements discussed above and FHFA's
supervision.
Question 83. Should FHFA require an Enterprise to separately
determine its credit risk-weighted assets using its own internal
models?
Question 84. Should there be a prudential floor on the credit risk
capital requirement for a mortgage exposure determined by an Enterprise
using its internal models?
Question 85. Should FHFA prescribe more specific requirements and
restrictions governing the internal models and other procedures used by
an Enterprise to determine its advanced credit risk-weighted assets?
Question 86. Should FHFA require an Enterprise to determine its
advanced credit risk-weighted assets under subpart E of the Federal
Reserve Board's Regulation Q? If so, what changes to that subpart E
would be appropriate?
Question 87. Alternatively, should compliance with subpart E of the
Federal Reserve Board's Regulation Q offer a safe harbor for compliance
with the proposed rule's advanced approaches requirements?
Question 88. Should FHFA preserve the U.S. banking framework's
scalar factor of 1.06 for determining advanced credit risk-weighted
assets calculated?
Question 89. What transition period, if any, is appropriate for an
Enterprise to comply with the proposed rule's requirements governing
the determination of the Enterprise's advanced credit risk-weighted
assets?
Question 90. What transition period would be appropriate if an
Enterprise were required to determine its advanced credit risk-weighted
assets under subpart E of the Federal Reserve Board's Regulation Q?
Question 91. Should there be an additional capital requirement to
mitigate any model risk associated with the internal models used by an
Enterprise to determine its advanced credit risk-weighted assets?

X. Market Risk Capital

The proposed rule would require an Enterprise to calculate its
market risk-weighted assets for mortgage exposures and other exposures
with spread risk. Single-family and multifamily loans and investments
in securities held in an Enterprise's portfolio have market risk from
changes in value due to movements in interest rates and credit spreads,
among other things. As the Enterprises currently hedge interest rate
risk at the portfolio level, and under the assumption that the
Enterprises' hedging effectively manages that risk, the market risk
capital requirements would be limited only to spread risk.\83\
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\83\ FHFA's supervision of each Enterprise includes examinations
of the effectiveness of the Enterprise's hedging of its interest
rate risk.
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This proposed approach is considerably different from that of the
U.S. banking framework. Under the U.S. banking framework, covered
banking organizations are required to measure and otherwise manage
market risk and hold a commensurate amount of capital. Generally, an
asset held by a covered banking organization for trading purposes is
not included in the calculation of credit risk-weighted assets.
Instead, the covered banking organization determines the market risk
capital requirement for its trading assets using prescribed
methodologies, multiplies that market risk capital requirement by 12.5
to determine the market risk-weighted assets for its covered positions,
and then adds the market risk-weighted assets to its credit risk-
weighted assets to determine its risk-based capital requirements. The
prescribed methodologies under the U.S. banking framework determine
market risk capital requirements for trading assets based on the
general and specific market risk of the assets. General risk is the
risk of loss in the market value of positions resulting from broad
market movements (e.g., changes in interest rates), while specific risk
is the risk of loss in the market value of positions due to factors
other than broad market movements, including event risk or default
risk. Notably, the U.S. banking framework's approach to market risk
capital is not limited only to spread risk, as is contemplated by the
proposed rule. FHFA is seeking comment on whether to adopt a different
approach, perhaps one more similar to that of the U.S. banking
framework.
Exposures subject to the market risk capital requirement would
include any tangible asset that has more than de minimis spread risk,
regardless of whether the position is marked-to-market for financial
statement reporting purposes and regardless of whether the position is
held by the Enterprise for the purpose of short-term resale or with the
intent of benefiting from actual or expected short-term price
movements, or to lock in arbitrage profits. Covered positions include:
Any NPL, re-performing loan (RPL), reverse mortgage loan,
or other mortgage exposure that, in any case, does not secure an MBS
guaranteed by the Enterprise;
Any MBS guaranteed by an Enterprise, MBS guaranteed by
Ginnie Mae, reverse mortgage security, PLS, CRT exposure, or other
securitization exposure; and
Any other trading asset or trading liability, whether on-
or off-balance sheet.

A. Standardized Approach

Under the standardized approach, an Enterprise would calculate
market risk-weighted assets using a prescribed single point approach, a
spread duration approach, or the Enterprise's internal models depending
on the risk characteristics of the covered position.
1. Single Point Approach
An Enterprise would utilize the single point approach for any RPL,
NPL, reverse mortgage loan, or reverse mortgage security. The primary
risk for these assets generally is credit risk. The underlying
borrowers may have limited refinancing opportunities due to recent or
current delinquencies, and these covered positions are often relatively
insensitive to prepayment risk. For these reasons, FHFA believes the
spread risk profile of these covered positions would be sufficiently
represented by a single point estimate.
An Enterprise would calculate the market risk-weighted assets for
these covered positions as the product of the market value of the
covered position, the applicable single point shock assumption for the
covered position, and 12.5. The applicable single point shock
assumptions would be:
0.0475 for an RPL or an NPL;
0.0160 for a reverse mortgage loan; and
0.0410 for a reverse mortgage security.
2. Spread Duration Approach
An Enterprise would utilize the spread duration approach for any
multifamily mortgage exposure, any PLS, or any MBS guaranteed by an
Enterprise or Ginnie Mae and secured

[[Page 39341]]

by multifamily mortgage exposures due to their increased complexity
relative to exposures in the single point approach category. Despite
their complexity, PLS represent only a small portion of the
Enterprises' portfolios, as the Enterprises' purchases of PLS have been
restricted during conservatorship. Under the spread duration approach,
an Enterprise would multiply the amount of the applicable spread shock
by the spread duration of the covered position. Spread shock is
typically based on historical spread shocks. Spread duration, or the
sensitivity of the market value of an asset to changes in the spread,
is often determined by using models that involve assumptions about
interest rate movements and prepayment sensitivity.
An Enterprise would calculate the market risk-weighted assets for
each of these covered positions as the product of the market value of
the covered position, the spread duration as estimated by the
Enterprise using its internal models, the applicable spread shock for
the covered position, and 12.5. The applicable spread shocks would be:
0.0015 for a multifamily mortgage exposure that does not
secure an MBS guaranteed by an Enterprise;
0.0265 for a PLS; and
0.0100 for an MBS guaranteed by an Enterprise or by Ginnie
Mae and secured by multifamily mortgage exposures (other than interest-
only (IO) securities guaranteed by an Enterprise or Ginnie Mae).
FHFA received a comment on the 2018 proposal suggesting the
multifamily mortgage exposure spread shock of 15 basis points was too
low relative to the 100 basis point spread shock prescribed for
Enterprise- and Ginnie Mae-guaranteed multifamily MBS, considering that
the Enterprises' MBS are pass-through securities and that historically,
multifamily mortgage exposures have been less liquid than multifamily
MBS. The commenter recommended that FHFA, at a minimum, equate the
spread shocks.
FHFA analyzed the impact of increasing the multifamily mortgage
exposure spread shock from 15 basis points to 100 basis points. In
addition to a market risk capital requirement, multifamily mortgage
exposures would also have a credit risk capital requirement, and in
practice, perceptions of credit risk might be a component of market
risk. In the proposed rule, Ginnie Mae-guaranteed MBS would not have a
credit risk capital requirement, while Enterprise-guaranteed MBS would
have a 20 percent risk weight for purposes of the credit risk capital
requirements. FHFA determined that if the market risk capital
requirement for multifamily mortgage exposures were increased through
the imposition of a 100 basis point spread shock, the total risk-based
capital requirement (credit risk capital plus market risk capital plus
operational risk capital) for multifamily mortgage exposures would
exceed, to an undesirable degree, the total risk-based capital
requirement for Enterprise- and Ginnie Mae-guaranteed multifamily MBS.
For this reason, FHFA is opting not to implement the commenter's
recommendation.
3. Internal Models Approach
An Enterprise would utilize the internal models approach for
covered positions with spread risk not covered under the single point
approach or the spread duration approach. This would include an
Enterprise's CMBS exposures, which in the 2018 proposal would have
received a combined single-point capital requirement for credit risk
and spread risk. In general, an Enterprise would use the internal
models approach for covered positions with relatively higher levels of
complexity or higher prepayment sensitivity.
Single-family exposures in this category would include performing
loans and Enterprise- and Ginnie Mae-guaranteed single-family MBS. The
spread risk profile on performing loans is relatively complex due to
high prepayment sensitivity. Prepayment risk on performing loans might
vary significantly across amortization terms, vintages, and mortgage
rates. The high prepayment sensitivity might suggest that more
simplified approaches, such as the single point approach, would not
capture key risk drivers. Also, spread shocks may vary across a variety
of single-family mortgage exposure characteristics. Thus, the spread
duration approach, which relies on a constant spread shock, might not
capture key single-family market movements. An internal models
approach, however, would allow the Enterprises to differentiate spread
risk across multiple risk characteristics such as amortization term,
vintage, and mortgage rates. Further, the Enterprises could account for
important market risk factors, such as updated spread shocks, to
reflect market changes.
Similarly, the spread risk profile on Enterprise- and Ginnie Mae-
guaranteed single-family MBS is relatively complex due to high
prepayment sensitivity of the underlying collateral. Further, CMOs can
often contain complex features and structures that alter prepayments
across different tranches based on the CMO's structure. As a result,
spread durations might vary significantly across mortgage products,
amortization terms, vintages and mortgage rates and tranches. The use
of an Enterprise's internal models to calculate market risk capital
requirements would allow the Enterprise to account for important market
risk factors that affect spreads and spread durations.
One commenter on the 2018 proposal recommended FHFA allow the
Enterprises to utilize internal models for complex multifamily MBS in
order to maintain flexibility in allowing the spread shocks to vary
according to each security's features and structure, as well as
underlying market conditions. FHFA determined that multifamily IO
securities represent, in general, the more complex of Enterprise-
guaranteed MBS. In consideration of the commenter's suggestion and in
alignment with the proposed market risk capital requirement for
Enterprise- and Ginnie Mae-guaranteed single-family IO securities, the
proposed rule would require an Enterprise to use its internal models to
calculate the market risk-weighted assets for Enterprise- and Ginnie
Mae-guaranteed multifamily IO securities.
Because an Enterprise would calculate the market risk-weighted
assets for these covered positions using its internal models, the
Enterprise would be subject to certain model risk management
requirements, as discussed in Section X.B. In addition, an Enterprise
utilizing its internal models would be subject to FHFA's general
regulatory oversight and supervisory review.
Question 92. Are the point and spread measures used to determine
spread risk capital requirements for certain covered positions
appropriately calibrated for that purpose?
Question 93. Should there be a minimum floor on the spread risk
capital requirement for any covered position subject to the internal
models approach?
Question 94. Should FHFA adopt an approach to market risk capital
that is more similar to the Basel framework, for example by limiting
the scope of the market risk capital requirements to a smaller set of
positions (e.g., those positions analogous to the trading book) or by
requiring market risk capital for market risks other than spread risk
(e.g., value-at-risk, stress value-at-risk, incremental risk, etc.)? If
so, what positions and activities of the Enterprises should be subject
to that approach?

[[Page 39342]]

Question 95. Should the spread risk and other market risks for
single-family and multifamily whole loans instead be set in an
Enterprise-specific manner through the supervisory process, taking into
account the market risk management strategies employed by the
Enterprise?
Question 96. Should FHFA assume interest rate risk is fully hedged
for purposes of determining market risk capital requirements?
Question 97. What requirements and restrictions should apply to the
internal models used to determine standardized market risk-weighted
assets?

B. Advanced Approach

An Enterprise also would calculate its advanced market risk-
weighted assets using its own internal models. An Enterprise would have
significant latitude in the scope and design of those internal models
for measuring spread risk on its covered positions. FHFA is soliciting
comment on whether to adopt a more prescriptive approach, perhaps
requiring an Enterprise to determine a measure of market risk that
includes a VaR-based capital requirement, a stressed VaR-based capital
requirement, specific risk add-ons, incremental risk capital
requirements, and comprehensive risk capital requirements, as under the
U.S. banking framework.
Given the central role of the Enterprises' internal models in
determining both standardized and advanced market risk capital
requirements, the proposed rule includes a number of requirements and
restrictions relating to the management of the related model risks. An
independent risk control unit would be required to approve any internal
model to calculate its risk-based capital requirement. An Enterprise
must notify FHFA when the Enterprise plans to extend the use of a model
to an additional business line or product type or the Enterprise makes
any material change to its internal models.
The Enterprise would be required to periodically review (and at
least annually) its internal models, and enhance those models as
appropriate. The Enterprise also must integrate the internal models
used for calculating its spread risk measure into its daily risk
management process.
More generally, the sophistication of an Enterprise's internal
models would have to be commensurate with the complexity and amount of
its covered positions. The Enterprise's internal models must properly
measure all the material risks. The Enterprise would be required to
have a process for updating its internal models to ensure continued
applicability and relevance.
The Enterprise also must have an independent risk control unit that
reports directly to senior management. The Enterprise must have an
independent validation process that includes an evaluation of the
conceptual soundness of the internal models, an ongoing monitoring
process that includes verification of processes and the comparison of
the Enterprise's model outputs with relevant internal and external data
sources or estimation techniques, and an outcomes analysis process that
includes backtesting.
Question 98. Are the requirements governing an Enterprise's
internal models for determining spread risk capital requirements
appropriately formulated?
Question 99. Should FHFA adopt a more prescriptive approach to the
determination of advanced market risk-weighted assets, perhaps
requiring an Enterprise to determine a measure of market risk that
includes a VaR-based capital requirement, a stressed VaR-based capital
requirement, specific risk add-ons, incremental risk capital
requirements, and comprehensive risk capital requirements, as under the
U.S. banking framework?

C. Market Risk Management

The reliability of the internal models used in determining an
Enterprise's standardized and advanced market risk-weighted assets will
depend in part on the Enterprise's market risk management practices
more generally. Consistent with the U.S. banking framework, the
proposed rule includes a number of requirements and restrictions
relating to the management of spread risk and also other market risks.
An Enterprise would be required to have a process for assessing its
overall capital adequacy in relation to its market risk. An Enterprise
also would be required to have policies and procedures for actively
managing all covered positions. At a minimum, these policies and
procedures must require, among other things, marking covered positions
to market or to model on a daily basis, daily assessment of the
Enterprise's ability to hedge position and portfolio risks, and
establishment and daily monitoring of limits on covered positions by an
independent risk control unit.
An Enterprise also would be required to have a process for
valuation of its covered positions that includes policies and
procedures on marking positions to market or to model, independent
price verification, and valuation adjustments or reserves.
An Enterprise would be required to periodically (and at least
quarterly) stress test the market risk of its covered positions. The
stress tests must take into account concentration risk, illiquidity
under stressed market conditions, and risks arising from the
Enterprise's trading activities that may not be adequately captured in
its internal models.
An Enterprise also must have an internal audit function that at
least annually assesses the effectiveness of the controls supporting
the Enterprise's market risk measurement systems and reports its
findings to the Enterprise's board of directors (or a committee
thereof).

XI. Operational Risk Capital

The proposed rule would establish an operational risk capital
requirement to be calculated using the advanced measurement approach of
the U.S. banking framework, but with a floor set at 15 basis points of
adjusted total assets. The operational risk capital requirement would
be included in an Enterprise's risk-weighted assets for the purposes of
calculating risk-based capital requirements. This approach has been
developed in response to comments on the 2018 proposal. Commenters on
the 2018 proposal suggested that the proposed Basel basic indicators
approach was insufficient because the Enterprises were too complex to
justify such a simple approach and also because FHFA's implementation
did not allow the requirement to vary appropriately under the basic
indicators approach.
Operational risk is the risk of loss resulting from inadequate or
failed internal processes, people, and systems or from external events
(including legal risk but excluding strategic and reputational risk).
Under the proposed rule, the Enterprise's risk-based capital
requirement for operational risk generally would be its operational
risk exposure minus any eligible operational risk offsets. That amount
would potentially be subject to adjustments if the Enterprise qualifies
to use operational risk mitigants. An Enterprise's operational risk
exposure would be the 99.9th percentile of the distribution of
potential aggregate operational losses, as generated by the
Enterprise's operational risk quantification system over a one-year
horizon (and not incorporating eligible operational risk offsets or
qualifying operational risk mitigants).
While the advanced measurement approach is risk-sensitive, the
proposed

[[Page 39343]]

operational risk capital requirement would be subject to a floor of 15
basis points of adjusted total assets. It is important that operational
risk capital does not fall below a meaningful, credible amount. Fifteen
(15) basis points of adjusted total assets would represent
approximately double what FHFA originally proposed in the 2018
proposal, and approximately double the amount of operational risk
capital estimated internally by the Enterprises using the Basel
standardized approach. FHFA believes doubling the internally estimated
figure is appropriate given the estimates were calculated using
historical results achieved exclusively while in conservatorship. FHFA
also calibrated this floor taking into account the operational risk
capital requirements of large U.S. banking organizations. Of the U.S.
bank holding companies with at least $500 billion in total assets at
the end of 2019, the smallest operational risk capital requirement was
0.69 percent of that U.S. banking organization's total leverage
exposure.
Question 100. Is the advanced measurement approach appropriately
formulated and calibrated as a measure of operational risk capital for
the Enterprises?
Question 101. Should FHFA consider other approaches to calculating
operational risk capital requirements (e.g., the Basel standardized
approach)?
Question 102. Is the minimum floor on an Enterprise's operational
risk capital appropriately calibrated?

XII. Impact of the Enterprise Capital Rule

A. Enterprise-Wide

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B. Single-Family Business

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D. Other Assets
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XIII. Comparisons to the U.S. Banking Framework

As discussed in Section V.B.2 and also in the 2018 proposal,
comparisons to the U.S. banking framework's capital requirements are
complicated by the different risk profiles of the Enterprises and large
banking organizations.\84\ The Enterprises, for example, transfer much
of the interest rate and funding risk on their mortgage exposures
through their sales of guaranteed MBS, while banking organizations
generally fund themselves through customer deposits and other sources.
On the other hand, the monoline nature of the Enterprises' mortgage-
focused businesses suggests that the concentration risk profile of an
Enterprise is generally greater than that of a diversified banking
organization

[[Page 39355]]

with a similar amount of mortgage credit risk.
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\84\ 83 FR at 33323.
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While the Enterprises and large banking organizations' risk
profiles are different with respect to some risks, those differences
should not preclude a comparison of the credit risk capital requirement
of a large U.S. banking organization for a specific mortgage exposure
to the credit risk capital requirement of an Enterprise for a similar
mortgage exposure. Under both frameworks, the credit risk capital
requirements for mortgage exposures are calibrated to absorb unexpected
losses. Comparisons of credit risk capital requirements of the large
U.S. banking organizations to credit risk capital requirements of the
Enterprises under the proposed rule are, however, still complicated by
the fact that the proposed rule's requirements could be very different
depending on the economic environment. In a favorable economic
environment, particularly after sustained periods of house price growth
and strong employment such as experienced in the U.S. prior to the
first quarter of 2020, the proposed rule's mortgage risk-sensitive
framework is likely to show lower credit risk capital requirements than
the U.S. banking framework. Conversely, in a period of financial
stress, the proposed rule's mortgage risk-sensitive framework could
show higher credit risk capital requirements than the U.S. banking
framework.
FHFA's mortgage risk-sensitive framework results in a more granular
calibration of credit risk capital requirements for mortgage exposures,
and some meaningful portion of the current gap between the credit risk
capital requirements of the Enterprises and large banking organizations
under the proposed rule is due to the proposed rule's use of MTMLTV
instead of OLTV, as under the U.S. banking framework, to assign credit
risk capital requirements. Adjusting for the appreciation in the value
of the underlying real property generally has led to lower actual
credit risk capital requirements at the Enterprises, and some of the
gap between the credit risk capital requirements of the Enterprises and
large U.S. banking organizations might be expected to narrow were real
property prices to move toward their long-term trend.
With that context, FHFA is seeking comment on the appropriateness
of key differences between the credit risk capital requirements for
mortgage exposures under the proposed rule and the U.S. banking
framework.
Risk-based credit risk capital requirements. As discussed
in Sections VIII.A.7 and VIII.B.6, as of September 30, 2019 and before
adjusting for CRT or the buffers under both frameworks, the average
credit risk capital requirements for the Enterprises' single-family and
multifamily mortgage exposures generally were roughly half those of
similar exposures under the U.S. banking framework. Those lower average
credit risk capital requirements are before any capital relief afforded
through CRT.
CRT capital treatment. As discussed in Sections VIII.C.3.c
and VIII.C.3.d, the proposed rule solicits comments on two different
approaches to determining the remaining credit risk on exposures of a
CRT that are retained by the Enterprise and any credit risk in effect
retained by the Enterprise as a result of the potential ineffectiveness
of CRT in transferring credit risk. Under both approaches, the minimum
risk weight assigned to retained CRT exposures would be 10 percent,
which is less than the 20 percent risk weight floor for securitization
exposures under the U.S. banking framework.
CRT eligibility. As discussed in Section VIII.C.3.b, the
proposed rule provides credit risk capital relief for a number of CRT
structures that would not be eligible for capital relief under the U.S.
banking framework. The proposed rule also generally subjects CRT
structures to less restrictive operational criteria.
Mortgage insurance. Similarly, as discussed in Section
VIII.A.6, the proposed rule generally provides more credit risk capital
relief for mortgage insurance and other loan-level credit enhancement,
and for a broader range of counterparties, than the U.S. banking
framework.
In addition to these different credit risk capital requirements for
mortgage exposures, FHFA is seeking comment on other aspects in which
the proposed rule and the U.S. banking framework differs. For example:
Leverage ratio requirements. Under the proposed rule's
leverage ratio requirement, an Enterprise would be required to maintain
tier 1 capital in excess of 2.5 percent of its adjusted total assets.
An Enterprise also would be required to maintain tier 1 capital in
excess of 4.0 percent of its adjusted total assets to avoid
restrictions on capital distributions and discretionary bonus payments.
A U.S. banking organization is required to maintain tier 1 capital
greater than 4.0 percent of its total assets. A large U.S. banking
organization also must maintain tier 1 capital in excess of 5.0 percent
of its total leverage exposure to avoid restrictions on capital
distributions and discretionary bonus payments.\85\
---------------------------------------------------------------------------

\85\ Insured depository institutions subsidiaries of certain
large U.S. bank holding companies must maintain tier 1 capital of
6.0 percent or greater of total assets to be ``well capitalized.''
See, e.g., 12 CFR 6.4(b)(1)(i)(D).
---------------------------------------------------------------------------

Market risk capital. The proposed rule and U.S. banking
framework take considerably different approaches to market risk capital
requirements. As discussed in Section X, the proposed rule generally
assigns market risk capital requirements to a broader set of exposures,
including ones already subject to credit risk capital requirements,
while the U.S. banking framework requires market risk capital not just
for spread risk but also a broader range of market risks.
Capital conservation buffer. As discussed in Section
VII.A, the proposed rule's PCCBA is assessed against adjusted total
assets, not risk-weighted assets. This risk-insensitive approach
reduces the impact that the PCCBA potentially could have on higher risk
exposures, avoids amplifying the secondary effects of any model or
similar risks inherent to the calibration of granular risk weights for
mortgage exposures, and further mitigates the pro-cyclicality in
aggregate risk-based capital requirements.
Stability capital buffer. The proposed rule's stability
capital buffer is tailored to the risk that an Enterprise's default or
other financial distress could have on the liquidity, efficiency,
competitiveness, and resiliency of national housing finance markets.
The U.S. banking framework's GSIB surcharge is tailored to equalize the
expected impact on the stability of the financial system of the failure
of a GSIB with the expected systemic impact of the failure of a large
bank holding company that is not a GSIB. Because the stability capital
buffer is a component of the capital conservation buffer, the stability
capital buffer is assessed against an Enterprise's adjusted total
assets, while the GSIB surcharge is more risk-sensitive in that it is
assessed against risk-weighted assets.
Internal-ratings approach. Like the U.S. banking
framework, each Enterprise would be required to determine its risk-
weighted assets under two approaches--a standardized approach and an
advanced approach--with the greater of the two risk-weighted assets
used to determine its risk-based capital requirements. Unlike the U.S.
banking framework, the proposed rule would be significantly less
prescriptive as to requirements and restrictions governing the internal
models used to

[[Page 39356]]

determine the advanced risk-weighted assets.
Question 103. Are the differences between the credit risk capital
requirements for mortgage exposures under the proposed rule and the
U.S. banking framework appropriate?
Question 104. Which, if any, aspects of the proposed rule should be
further aligned with the U.S. banking framework?

XIV. Compliance Period

This proposed rule would establish a post-conservatorship
regulatory capital framework that ensures that each Enterprise operates
in a safe and sound manner and is positioned to fulfill its statutory
mission to provide stability and ongoing assistance to the secondary
mortgage market across the economic cycle. Given the Enterprises'
current conservatorship status and capitalization, certain sections and
subparts of the proposed rule would be subject to delayed compliance
dates as set forth in Sec. 1240.4. The capital requirements and
buffers set out in subpart B of the proposed rule would have a delayed
compliance date, unless adjusted by FHFA as described below, of the
later of one year from publication of the final rule or the date of the
termination of conservatorship. FHFA recognizes that the path for
transition out of conservatorship and meeting the full capital
requirements and buffers is not settled at this time. Therefore, the
proposed rule would provide FHFA with the discretion, based on FHFA's
assessment of capital market conditions and the likely feasibility of
an Enterprise to achieve capital levels sufficient to comply with the
capital requirements proposed at Sec. 1240.10, to defer compliance
with the capital requirements and thereby not subject an Enterprise to
statutory prohibitions on capital distributions that would apply if
those requirements were not met. During that deferral period, the PCCBA
would be the CET1 capital that would otherwise be required under Sec.
1240.10 plus the PCCBA that would otherwise apply under normal
conditions under Sec. 1240.11(a)(5); and the PLBA would be 4.0 percent
of the adjusted total assets of the Enterprise. To benefit from the
deferral period, an Enterprise would be required to comply with any
corrective plan or agreement or order that sets out the actions by
which an Enterprise will achieve compliance with the capital
requirements by a specified date.
In addition, the proposed rule would delay compliance for reporting
under Sec. 1240.1(f) for one year from the date of publication of the
final rule.
Question 105. Are the delayed compliance dates tailored in a manner
to promote the ability of an Enterprise to achieve compliant regulatory
capital levels?

XV. Temporary Increases of Minimum Capital Requirements and Other
Conforming Amendments

To reinforce its reserved authorities under Sec. 1240.1(d), FHFA
is proposing to amend its existing rule, 12 CFR part 1225, ``Minimum
Capital--Temporary Increase,'' to clarify that the authority
implemented in that rule to temporarily increase a regulated entity's
required capital minimums applies to risk-based minimum capital levels
as well as to minimum leverage ratios. This amendment aligns the scope
of this regulation, adopted under 12 U.S.C. 4612(d), with the FHFA
Director's authority under 12 U.S.C. 4612(e) to establish additional
capital and reserve requirements for particular purposes, which
authorizes risk-based adjustments to capital requirements for
particular products and activities and is not limited to adjustments to
the leverage ratio. FHFA is also proposing to amend the definition of
``total exposure'' in Sec. 1206.2 to have the same meaning as
``adjusted total assets'' as defined in Sec. 1240.2. FHFA is also
proposing to remove 12 CFR part 1750.
Question 106. Should FHFA conform the definition of ``total
exposure'' in Sec. 1206.2 to have the same meaning as ``adjusted total
assets'' as defined in Sec. 1240.2?
Question 107. In addition to the questions asked above, FHFA
requests comments on any aspect of the proposed rule.

XVI. Paperwork Reduction Act

The Paperwork Reduction Act (PRA) (44 U.S.C. 3501 et seq.) requires
that regulations involving the collection of information receive
clearance from the Office of Management and Budget (OMB). The proposed
rule contains no such collection of information requiring OMB approval
under the PRA. Therefore, no information has been submitted to OMB for
review.

XVII. Regulatory Flexibility Act

The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) requires that
a regulation that has a significant economic impact on a substantial
number of small entities, small businesses, or small organizations must
include an initial regulatory flexibility analysis describing the
regulation's impact on small entities. FHFA need not undertake such an
analysis if the agency has certified that the regulation will not have
a significant economic impact on a substantial number of small
entities. 5 U.S.C. 605(b). FHFA has considered the impact of the
proposed rule under the Regulatory Flexibility Act. The General Counsel
of FHFA certifies that the proposed rule, if adopted as a final rule,
would not have a significant economic impact on a substantial number of
small entities because the proposed rule is applicable only to the
Enterprises, which are not small entities for purposes of the
Regulatory Flexibility Act.

List of Subjects

12 CFR Part 1206

Assessments, Federal home loan banks, Government-sponsored
enterprises, Reporting and recordkeeping requirements.

12 CFR Part 1225

Federal home loan banks, Federal National Mortgage Association,
Federal Home Loan Mortgage Corporation, Capital, Filings, Minimum
capital, Procedures, Standards.

12 CFR Part 1240

Capital, Credit, Enterprise, Investments, Reporting and
recordkeeping requirements.

12 CFR Part 1750

Banks, banking, Capital classification, Mortgages, Organization and
functions (Government agencies), Risk-based capital, Securities.

Authority and Issuance

For the reasons stated in the preamble, under the authority of 12
U.S.C. 4511, 4513, 4513b, 4514, 4515-17, 4526, 4611-4612, 4631-36, FHFA
proposes to amend chapters XII and XVII, of title 12 of the Code of
Federal Regulation as follows:

CHAPTER XII--FEDERAL HOUSING FINANCE AGENCY

SUBCHAPTER A--ORGANIZATION AND OPERATIONS

PART 1206--ASSESSMENTS

0
1. The authority citation for part 1206 continues to read as follows:

Authority: 12 U.S.C. 4516.

0
2. Amend 12 CFR 1206.2 by revising the definition of ``Total exposure''
to read as follows:

Sec. 1206.2 Definitions.

* * * * *
Total exposure has the same meaning given to adjusted total assets
in 12 CFR 1240.2.
* * * * *

[[Page 39357]]

SUBCHAPTER B--ENTITY REGULATIONS

PART 1225--MINIMUM CAPITAL--TEMPORARY INCREASE

0
3. The authority citation for part 1225 continues to read as follows:

Authority: 12 U.S.C. 4513, 4526 and 4612.

0
4. Amend 12 CFR 1225.2 by revising the definition of ``Minimum capital
level'' to read as follows:

Sec. 1225.2 Definitions.

* * * * *
Minimum capital level means the lowest amount of capital meeting
any regulation or orders issued pursuant to 12 U.S.C. 1426 and 12
U.S.C. 4612, or any similar requirement established by regulation,
order or other action.
* * * * *

SUBCHAPTER C--ENTERPRISES

0
5. Add part 1240 to subchapter C to read as follows:

PART 1240--CAPITAL ADEQUACY OF ENTERPRISES

Sec.
Subpart A--General Provisions
1240.1 Purpose, applicability, reservations of authority, and
reporting.
1240.2 Definitions.
1240.3 Operational requirements for counterparty credit risk.
1240.4 Compliance dates.
Subpart B--Capital Requirements and Buffers
1240.10 Capital requirements.
1240.11 Capital conservation buffer and leverage buffer.
Subpart C--Definition of Capital
1240.20 Capital components and eligibility criteria for regulatory
capital instruments.
1240.21 [Reserved]
1240.22 Regulatory capital adjustments and deductions.
Subpart D--Risk-Weighted Assets--Standardized Approach
1240.30 Applicability.

Risk-Weighted Assets for General Credit Risk

1240.31 Mechanics for calculating risk-weighted assets for general
credit risk.
1240.32 General risk weights.
1240.33 Single-family mortgage exposures.
1240.34 Multifamily mortgage exposures.
1240.35 Off-balance sheet exposures.
1240.36 Derivative contracts.
1240.37 Cleared transactions.
1240.38 Guarantees and credit derivatives: Substitution treatment.
1240.39 Collateralized transactions.

Risk-Weighted Assets for Unsettled Transactions

1240.40 Unsettled transactions.

Risk-Weighted Assets for CRT and Other Securitization Exposures

1240.41 Operational requirements for CRT and other securitization
exposures.
1240.42 Risk-weighted assets for CRT and other securitization
exposures.
1240.43 Simplified supervisory formula approach (SSFA).
1240.44 Credit risk transfer approach (CRTA).
1240.45 Securitization exposures to which the SSFA and the CRTA do
not apply.
1240.46 Recognition of credit risk mitigants for securitization
exposures.

Risk-Weighted Assets for Equity Exposures

1240.51 Exposure measurement.
Subpart E--Risk-Weighted Assets--Internal Ratings-Based and Advanced
Measurement Approaches
1240.100 Purpose, applicability, and principle of conservatism.
1240.101 Definitions.
1240.121 Minimum requirements.
1240.122 Ongoing qualification.
1240.123 Advanced approaches credit risk-weighted asset
calculations.
1240.161 Qualification requirements for incorporation of operational
risk mitigants.
1240.162 Mechanics of operational risk risk-weighted asset
calculation.
Subpart F--Risk-Weighted Assets--Market Risk
1240.201 Purpose, applicability, and reservation of authority.
1240.202 Definitions.
1240.203 Requirements for managing market risk.
1240.204 Measure for spread risk.
Subpart G--Stability Capital Buffer
1240.400 Stability capital buffer.

Authority: 12 U.S.C. 4511, 4513, 4513b, 4514, 4515, 4517, 4526,
4611-4612, 4631-36.

Subpart A--General Provisions

Sec. 1240.1 Purpose, applicability, reservations of authority, and
reporting.

(a) Purpose. This part establishes capital requirements and overall
capital adequacy standards for the Enterprises. This part includes
methodologies for calculating capital requirements.
(b) Authorities--(1) Limitations of authority. Nothing in this part
shall be read to limit the authority of FHFA to take action under other
provisions of law, including action to address unsafe or unsound
practices or conditions, deficient capital levels, or violations of law
or regulation under the Safety and Soundness Act, and including action
under sections 1313(a)(2), 1365-1367, 1371-1376 (12 U.S.C. 4513(a)(2),
4615-4617, and 4631-4636).
(2) Permissible activities. Nothing in this part may be construed
to authorize, permit, or require an Enterprise to engage in any
activity not authorized by its authorizing statute or that would
otherwise be inconsistent with its authorizing statute or the Safety
and Soundness Act.
(c) Applicability--(1) Covered regulated entities. This part
applies on a consolidated basis to each Enterprise.
(2) Capital requirements and overall capital adequacy standards.
Each Enterprise must calculate its capital requirements and meet the
overall capital adequacy standards in subpart B of this part.
(3) Regulatory capital. Each Enterprise must calculate its
regulatory capital in accordance with subpart C of this part.
(4) Risk-weighted assets. (i) Each Enterprise must use the
methodologies in subparts D and F of this part to calculate
standardized total risk-weighted assets.
(ii) Each Enterprise must use the methodologies in subpart E and
subpart F of this part to calculate advanced approaches total risk-
weighted assets.
(d) Reservation of authority regarding capital. Subject to
applicable provisions of the Safety and Soundness Act--
(1) Additional capital in the aggregate. FHFA may require an
Enterprise to hold an amount of regulatory capital greater than
otherwise required under this part if FHFA determines that the
Enterprise's capital requirements under this part are not commensurate
with the Enterprise's credit, market, operational, or other risks.
(2) Regulatory capital elements. (i) If FHFA determines that a
particular common equity tier 1 capital, additional tier 1 capital, or
tier 2 capital element has characteristics or terms that diminish its
ability to absorb losses, or otherwise present safety and soundness
concerns, FHFA may require the Enterprise to exclude all or a portion
of such element from common equity tier 1 capital, additional tier 1
capital, or tier 2 capital, as appropriate.
(ii) Notwithstanding the criteria for regulatory capital
instruments set forth in subpart C of this part, FHFA may find that a
capital element may be included in an Enterprise's common equity tier 1
capital, additional tier 1 capital, or tier 2 capital on a permanent or
temporary basis consistent with the loss absorption capacity of the
element and in accordance with Sec. 1240.20(e).
(3) Risk-weighted asset amounts. If FHFA determines that the risk-
weighted asset amount calculated under this part by the Enterprise for
one or more exposures is not commensurate with the risks associated
with those exposures, FHFA may require the Enterprise to assign a
different risk-weighted asset amount to the exposure(s) or to deduct

[[Page 39358]]

the amount of the exposure(s) from its regulatory capital.
(4) Total leverage. If FHFA determines that the adjusted total
asset amount calculated by an Enterprise under Sec. 1240.10 is
inappropriate for the exposure(s) or the circumstances of the
Enterprise, FHFA may require the Enterprise to adjust this exposure
amount in the numerator and the denominator for purposes of the
leverage ratio calculations.
(5) Consolidation of certain exposures. FHFA may determine that the
risk-based capital treatment for an exposure or the treatment provided
to an entity that is not consolidated on the Enterprise's balance sheet
is not commensurate with the risk of the exposure and the relationship
of the Enterprise to the entity. Upon making this determination, FHFA
may require the Enterprise to treat the exposure or entity as if it
were consolidated on the balance sheet of the Enterprise for purposes
of determining the Enterprise's risk-based capital requirements and
calculating the Enterprise's risk-based capital ratios accordingly.
FHFA will look to the substance of, and risk associated with, the
transaction, as well as other relevant factors FHFA deems appropriate
in determining whether to require such treatment.
(6) Other reservation of authority. With respect to any deduction
or limitation required under this part, FHFA may require a different
deduction or limitation, provided that such alternative deduction or
limitation is commensurate with the Enterprise's risk and consistent
with safety and soundness.
(e) Corrective action and enforcement. FHFA may enforce this part
pursuant to sections 1371, 1372, and 1376 of the Safety and Soundness
Act (12 U.S.C. 4631, 4632, 4636) and also may enforce the total capital
requirement established under Sec. 1240.10(a) and the core capital
requirement established under Sec. 1240.10(e) pursuant to section 1364
of the Safety and Soundness Act (12 U.S.C. 4614). This part is also a
prudential standard adopted under section 1313b of the Safety and
Soundness Act (12 U.S.C. 4513b), excluding Sec. 1240.11, which is a
prudential standard only for purposes of Sec. 1240.4(d). That section
authorizes the Director to require that an Enterprise submit a
corrective plan under 12 CFR 1236.4 specifying the actions the
Enterprise will take to correct the deficiency if the Director
determines that an Enterprise is not in compliance with this part.
(f) Reporting procedure and timing--(1) Capital Reports. Each
Enterprise shall file a capital report with FHFA every calendar quarter
providing the information and data required by FHFA. The specifics of
required information and data, and the report format, will be
separately provided to the Enterprise by FHFA. The report shall include
the ratio of capital requirement under Sec. 1240.10 to the adjusted
total assets of the Enterprise and the maximum payout ratio of the
Enterprise.
(2) Timing. The capital report shall be submitted not later than 60
days after calendar quarter end or at such other time as the Director
requires.
(3) Approval. The capital report must be approved by the Chief Risk
Officer and the Chief Financial Officer of an Enterprise prior to
submission to FHFA.
(4) Adjustment. In the event an Enterprise makes an adjustment to
its financial statements for a quarter or a date for which information
was provided pursuant to this paragraph (f), which would cause an
adjustment to a capital report, an Enterprise must file with the
Director an amended capital report not later than 15 days after the
date of such adjustment.

Sec. 1240.2 Definitions.

As used in this part:
12 CFR 217 means the regulation published at 12 CFR part 217 as of
April 23, 2020.
Acquired CRT exposure means, with respect to an Enterprise:
(1) Any exposure that arises from a credit risk transfer of the
Enterprise and has been acquired by the Enterprise since the issuance
or entry into the credit risk transfer by the Enterprise; or
(2) Any exposure that arises from a credit risk transfer of the
other Enterprise.
Additional tier 1 capital is defined in Sec. 1240.20(c).
Adjusted allowances for credit losses (AACL) means valuation
allowances that have been established through a charge against earnings
or retained earnings for expected credit losses on financial assets
measured at amortized cost and a lessor's net investment in leases that
have been established to reduce the amortized cost basis of the assets
to amounts expected to be collected as determined in accordance with
GAAP. For purposes of this part, adjusted allowances for credit losses
include allowances for expected credit losses on off-balance sheet
credit exposures not accounted for as insurance as determined in
accordance with GAAP. Adjusted allowances for credit losses allowances
created that reflect credit losses on purchased credit deteriorated
assets and available-for-sale debt securities.
Adjusted total assets means the sum of the items described in
paragraphs (1) though (9) of this definition, as adjusted pursuant to
paragraph (9) for a clearing member Enterprise:
(1) The balance sheet carrying value of all of the Enterprise's on-
balance sheet assets, plus the value of securities sold under a
repurchase transaction or a securities lending transaction that
qualifies for sales treatment under GAAP, less amounts deducted from
tier 1 capital under Sec. 1240.22(a), (c), and (d), and less the value
of securities received in security-for-security repo-style
transactions, where the Enterprise acts as a securities lender and
includes the securities received in its on-balance sheet assets but has
not sold or re-hypothecated the securities received, and less the fair
value of any derivative contracts;
(2) The potential future credit exposure (PFE) for each derivative
contract or each single-product netting set of derivative contracts
(including a cleared transaction except as provided in paragraph (9) of
this definition and, at the discretion of the Enterprise, excluding a
forward agreement treated as a derivative contract that is part of a
repurchase or reverse repurchase or a securities borrowing or lending
transaction that qualifies for sales treatment under GAAP), to which
the Enterprise is a counterparty as determined under 12 CFR 217.34, but
without regard to 12 CFR 217.34(b), provided that:
(i) An Enterprise may choose to exclude the PFE of all credit
derivatives or other similar instruments through which it provides
credit protection when calculating the PFE under 12 CFR 217.34, but
without regard to 12 CFR 217.34(b), provided that it does not adjust
the net-to-gross ratio (NGR); and
(ii) An Enterprise that chooses to exclude the PFE of credit
derivatives or other similar instruments through which it provides
credit protection pursuant to paragraph (2)(i) of this definition must
do so consistently over time for the calculation of the PFE for all
such instruments;
(3) The amount of cash collateral that is received from a
counterparty to a derivative contract and that has offset the mark-to-
fair value of the derivative asset, or cash collateral that is posted
to a counterparty to a derivative contract and that has reduced the
Enterprise's on-balance sheet assets, unless such cash collateral is
all or part of variation margin that satisfies the following
requirements:
(i) The variation margin is used to reduce the current credit
exposure of the derivative contract, calculated as

[[Page 39359]]

described in 12 CFR 217.34(b) and not the PFE; and
(ii) For derivative contracts that are not cleared through a QCCP,
the cash collateral received by the recipient counterparty is not
segregated (by law, regulation, or an agreement with the counterparty);
(iii) Variation margin is calculated and transferred on a daily
basis based on the mark-to-fair value of the derivative contract;
(iv) The variation margin transferred under the derivative contract
or the governing rules of the CCP or QCCP for a cleared transaction is
the full amount that is necessary to fully extinguish the net current
credit exposure to the counterparty of the derivative contracts,
subject to the threshold and minimum transfer amounts applicable to the
counterparty under the terms of the derivative contract or the
governing rules for a cleared transaction;
(v) The variation margin is in the form of cash in the same
currency as the currency of settlement set forth in the derivative
contract, provided that for the purposes of this paragraph, currency of
settlement means any currency for settlement specified in the governing
qualifying master netting agreement and the credit support annex to the
qualifying master netting agreement, or in the governing rules for a
cleared transaction; and
(vi) The derivative contract and the variation margin are governed
by a qualifying master netting agreement between the legal entities
that are the counterparties to the derivative contract or by the
governing rules for a cleared transaction, and the qualifying master
netting agreement or the governing rules for a cleared transaction must
explicitly stipulate that the counterparties agree to settle any
payment obligations on a net basis, taking into account any variation
margin received or provided under the contract if a credit event
involving either counterparty occurs;
(4) The effective notional principal amount (that is, the apparent
or stated notional principal amount multiplied by any multiplier in the
derivative contract) of a credit derivative, or other similar
instrument, through which the Enterprise provides credit protection,
provided that:
(i) The Enterprise may reduce the effective notional principal
amount of the credit derivative by the amount of any reduction in the
mark-to-fair value of the credit derivative if the reduction is
recognized in common equity tier 1 capital;
(ii) The Enterprise may reduce the effective notional principal
amount of the credit derivative by the effective notional principal
amount of a purchased credit derivative or other similar instrument,
provided that the remaining maturity of the purchased credit derivative
is equal to or greater than the remaining maturity of the credit
derivative through which the Enterprise provides credit protection and
that:
(A) With respect to a credit derivative that references a single
exposure, the reference exposure of the purchased credit derivative is
to the same legal entity and ranks pari passu with, or is junior to,
the reference exposure of the credit derivative through which the
Enterprise provides credit protection; or
(B) With respect to a credit derivative that references multiple
exposures, the reference exposures of the purchased credit derivative
are to the same legal entities and rank pari passu with the reference
exposures of the credit derivative through which the Enterprise
provides credit protection, and the level of seniority of the purchased
credit derivative ranks pari passu to the level of seniority of the
credit derivative through which the Enterprise provides credit
protection;
(C) Where an Enterprise has reduced the effective notional amount
of a credit derivative through which the Enterprise provides credit
protection in accordance with paragraph (4)(i) of this definition, the
Enterprise must also reduce the effective notional principal amount of
a purchased credit derivative used to offset the credit derivative
through which the Enterprise provides credit protection, by the amount
of any increase in the mark-to-fair value of the purchased credit
derivative that is recognized in common equity tier 1 capital; and
(D) Where the Enterprise purchases credit protection through a
total return swap and records the net payments received on a credit
derivative through which the Enterprise provides credit protection in
net income, but does not record offsetting deterioration in the mark-
to-fair value of the credit derivative through which the Enterprise
provides credit protection in net income (either through reductions in
fair value or by additions to reserves), the Enterprise may not use the
purchased credit protection to offset the effective notional principal
amount of the related credit derivative through which the Enterprise
provides credit protection;
(5) Where an Enterprise acting as a principal has more than one
repo-style transaction with the same counterparty and has offset the
gross value of receivables due from a counterparty under reverse
repurchase transactions by the gross value of payables under repurchase
transactions due to the same counterparty, the gross value of
receivables associated with the repo-style transactions less any on-
balance sheet receivables amount associated with these repo-style
transactions included under paragraph (1) of this definition, unless
the following criteria are met:
(i) The offsetting transactions have the same explicit final
settlement date under their governing agreements;
(ii) The right to offset the amount owed to the counterparty with
the amount owed by the counterparty is legally enforceable in the
normal course of business and in the event of receivership, insolvency,
liquidation, or similar proceeding; and
(iii) Under the governing agreements, the counterparties intend to
settle net, settle simultaneously, or settle according to a process
that is the functional equivalent of net settlement, (that is, the cash
flows of the transactions are equivalent, in effect, to a single net
amount on the settlement date), where both transactions are settled
through the same settlement system, the settlement arrangements are
supported by cash or intraday credit facilities intended to ensure that
settlement of both transactions will occur by the end of the business
day, and the settlement of the underlying securities does not interfere
with the net cash settlement;
(6) The counterparty credit risk of a repo-style transaction,
including where the Enterprise acts as an agent for a repo-style
transaction and indemnifies the customer with respect to the
performance of the customer's counterparty in an amount limited to the
difference between the fair value of the security or cash its customer
has lent and the fair value of the collateral the borrower has
provided, calculated as follows:
(i) If the transaction is not subject to a qualifying master
netting agreement, the counterparty credit risk (E*) for transactions
with a counterparty must be calculated on a transaction by transaction
basis, such that each transaction i is treated as its own netting set,
in accordance with the following formula, where Ei is the fair value of
the instruments, gold, or cash that the Enterprise has lent, sold
subject to repurchase, or provided as collateral to the counterparty,
and Ci is the fair value of the instruments, gold, or cash that the
Enterprise has borrowed, purchased subject to resale, or received as
collateral from the counterparty:

Ei* = max {0, [Ei-Ci]{time}

[[Page 39360]]

(ii) If the transaction is subject to a qualifying master netting
agreement, the counterparty credit risk (E*) must be calculated as the
greater of zero and the total fair value of the instruments, gold, or
cash that the Enterprise has lent, sold subject to repurchase or
provided as collateral to a counterparty for all transactions included
in the qualifying master netting agreement ([Sigma]Ei), less the total
fair value of the instruments, gold, or cash that the Enterprise
borrowed, purchased subject to resale or received as collateral from
the counterparty for those transactions ([Sigma]Ci), in accordance with
the following formula:

E* = max {0, [[Sigma]Ei-[Sigma]Ci]{time}

(7) If an Enterprise acting as an agent for a repo-style
transaction provides a guarantee to a customer of the security or cash
its customer has lent or borrowed with respect to the performance of
the customer's counterparty and the guarantee is not limited to the
difference between the fair value of the security or cash its customer
has lent and the fair value of the collateral the borrower has
provided, the amount of the guarantee that is greater than the
difference between the fair value of the security or cash its customer
has lent and the value of the collateral the borrower has provided;
(8) The credit equivalent amount of all off-balance sheet exposures
of the Enterprise, excluding repo-style transactions, repurchase or
reverse repurchase or securities borrowing or lending transactions that
qualify for sales treatment under GAAP, and derivative transactions,
determined using the applicable credit conversion factor under 12 CFR
217.33(b), provided, however, that the minimum credit conversion factor
that may be assigned to an off-balance sheet exposure under this
paragraph is 10 percent; and
(9) For an Enterprise that is a clearing member:
(i) A clearing member Enterprise that guarantees the performance of
a clearing member client with respect to a cleared transaction must
treat its exposure to the clearing member client as a derivative
contract for purposes of determining its adjusted total assets;
(ii) A clearing member Enterprise that guarantees the performance
of a CCP with respect to a transaction cleared on behalf of a clearing
member client must treat its exposure to the CCP as a derivative
contract for purposes of determining its adjusted total assets;
(iii) A clearing member Enterprise that does not guarantee the
performance of a CCP with respect to a transaction cleared on behalf of
a clearing member client may exclude its exposure to the CCP for
purposes of determining its adjusted total assets;
(iv) An Enterprise that is a clearing member may exclude from its
adjusted total assets the effective notional principal amount of credit
protection sold through a credit derivative contract, or other similar
instrument, that it clears on behalf of a clearing member client
through a CCP as calculated in accordance with paragraph (4) of this
definition; and
(v) Notwithstanding paragraphs (9)(i) through (iii) of this
definition, an Enterprise may exclude from its adjusted total assets a
clearing member's exposure to a clearing member client for a derivative
contract, if the clearing member client and the clearing member are
affiliates and consolidated for financial reporting purposes on the
Enterprise's balance sheet.
Adjusted total capital means the sum of tier 1 capital and tier 2
capital.
Advanced approaches total risk-weighted assets means:
(1) The sum of:
(i) Credit-risk-weighted assets for general credit risk (including
for mortgage exposures), cleared transactions, default fund
contributions, unsettled transactions, securitization exposures
(including retained CRT exposures), equity exposures, and the fair
value adjustment to reflect counterparty credit risk in valuation of
OTC derivative contracts, each as calculated under Sec. 1240.123.
(ii) Risk-weighted assets for operational risk, as calculated under
Sec. 1240.162(c); and
(iii) Advanced market risk-weighted assets; minus
(2) Excess eligible credit reserves not included in the
Enterprise's tier 2 capital.
Advanced market risk-weighted assets means the advanced measure for
spread risk calculated under Sec. 1240.204(a) multiplied by 12.5.
Affiliate has the meaning given in section 1303(1) of the Safety
and Soundness Act (12 U.S.C. 4502(1)).
Allowances for loan and lease losses (ALLL) means valuation
allowances that have been established through a charge against earnings
to cover estimated credit losses on loans, lease financing receivables
or other extensions of credit as determined in accordance with GAAP.
For purposes of this part, ALLL includes allowances that have been
established through a charge against earnings to cover estimated credit
losses associated with off-balance sheet credit exposures as determined
in accordance with GAAP.
Carrying value means, with respect to an asset, the value of the
asset on the balance sheet of an Enterprise as determined in accordance
with GAAP. For all assets other than available-for-sale debt securities
or purchased credit deteriorated assets, the carrying value is not
reduced by any associated credit loss allowance that is determined in
accordance with GAAP.
Central counterparty (CCP) means a counterparty (for example, a
clearing house) that facilitates trades between counterparties in one
or more financial markets by either guaranteeing trades or novating
contracts.
CFTC means the U.S. Commodity Futures Trading Commission.
Clean-up call means a contractual provision that permits an
originating Enterprise or servicer to call securitization exposures
before their stated maturity or call date.
Cleared transaction means an exposure associated with an
outstanding derivative contract or repo-style transaction that an
Enterprise or clearing member has entered into with a central
counterparty (that is, a transaction that a central counterparty has
accepted).
(1) The following transactions are cleared transactions:
(i) A transaction between a CCP and an Enterprise that is a
clearing member of the CCP where the Enterprise enters into the
transaction with the CCP for the Enterprise's own account;
(ii) A transaction between a CCP and an Enterprise that is a
clearing member of the CCP where the Enterprise is acting as a
financial intermediary on behalf of a clearing member client and the
transaction offsets another transaction that satisfies the requirements
set forth in Sec. 1240.3(a);
(iii) A transaction between a clearing member client Enterprise and
a clearing member where the clearing member acts as a financial
intermediary on behalf of the clearing member client and enters into an
offsetting transaction with a CCP, provided that the requirements set
forth in Sec. 1240.3(a) are met; or
(iv) A transaction between a clearing member client Enterprise and
a CCP where a clearing member guarantees the performance of the
clearing member client Enterprise to the CCP and the transaction meets
the requirements of Sec. 1240.3(a)(2) and (a)(3).
(2) The exposure of an Enterprise that is a clearing member to its
clearing member client is not a cleared transaction where the
Enterprise is either acting as a financial intermediary and enters into
an offsetting transaction with a CCP or where the Enterprise

[[Page 39361]]

provides a guarantee to the CCP on the performance of the client.
Clearing member means a member of, or direct participant in, a CCP
that is entitled to enter into transactions with the CCP.
Clearing member client means a party to a cleared transaction
associated with a CCP in which a clearing member acts either as a
financial intermediary with respect to the party or guarantees the
performance of the party to the CCP.
Client-facing derivative transaction means a derivative contract
that is not a cleared transaction where the Enterprise is either acting
as a financial intermediary and enters into an offsetting transaction
with a qualifying central counterparty (QCCP) or where the Enterprise
provides a guarantee on the performance of a client on a transaction
between the client and a QCCP.
Collateral agreement means a legal contract that specifies the time
when, and circumstances under which, a counterparty is required to
pledge collateral to an Enterprise for a single financial contract or
for all financial contracts in a netting set and confers upon the
Enterprise a perfected, first-priority security interest
(notwithstanding the prior security interest of any custodial agent),
or the legal equivalent thereof, in the collateral posted by the
counterparty under the agreement. This security interest must provide
the Enterprise with a right to close-out the financial positions and
liquidate the collateral upon an event of default of, or failure to
perform by, the counterparty under the collateral agreement. A contract
would not satisfy this requirement if the Enterprise's exercise of
rights under the agreement may be stayed or avoided:
(1) Under applicable law in the relevant jurisdictions, other than
(i) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar to the U.S. laws
referenced in this paragraph (1)(i) in order to facilitate the orderly
resolution of the defaulting counterparty;
(ii) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (1)(i) of this
definition; or
(2) Other than to the extent necessary for the counterparty to
comply with the requirements of subpart I of Federal Reserve Board's
Regulation YY (part 252 of this title), part 47 of this title, or part
382 of this title, as applicable.
Commitment means any legally binding arrangement that obligates an
Enterprise to extend credit or to purchase assets.
Common equity tier 1 capital is defined in Sec. 1240.20(b).
Company means a corporation, partnership, limited liability
company, depository institution, business trust, special purpose
entity, association, or similar organization.
Core capital has the meaning given at section 1303(7) of the Safety
and Soundness Act (12 U.S.C. 4502(7)).
Corporate exposure means an exposure to a company that is not:
(1) An exposure to a sovereign, the Bank for International
Settlements, the European Central Bank, the European Commission, the
International Monetary Fund, the European Stability Mechanism, the
European Financial Stability Facility, a multi-lateral development bank
(MDB), a depository institution, a foreign bank, a credit union, or a
public sector entity (PSE);
(2) An exposure to a GSE;
(3) A mortgage exposure;
(4) A cleared transaction;
(5) A default fund contribution;
(6) A securitization exposure; or
(7) An equity exposure.
Credit derivative means a financial contract executed under
standard industry credit derivative documentation that allows one party
(the protection purchaser) to transfer the credit risk of one or more
exposures (reference exposure(s)) to another party (the protection
provider) for a certain period of time.
Credit-enhancing interest-only strip (CEIO) means an on-balance
sheet asset that, in form or in substance:
(1) Represents a contractual right to receive some or all of the
interest and no more than a minimal amount of principal due on the
underlying exposures of a securitization; and
(2) Exposes the holder of the CEIO to credit risk directly or
indirectly associated with the underlying exposures that exceeds a pro
rata share of the holder's claim on the underlying exposures, whether
through subordination provisions or other credit-enhancement
techniques.
Credit risk mitigant means collateral, a credit derivative, or a
guarantee.
Credit union means an insured credit union as defined under the
Federal Credit Union Act (12 U.S.C. 1752 et seq.).
Credit risk transfer (CRT) means any traditional securitization,
synthetic securitization, senior/subordinated structure, credit
derivative, guarantee, or other structure or arrangement (other than
primary mortgage insurance, a traditional securitization that satisfies
the conditions under Sec. 1240.41(a), or a synthetic securitization
that satisfies the conditions under Sec. 1240.41(b)) that allows an
Enterprise to transfer the credit risk of one or more mortgage
exposures (reference exposure(s)) to another party (the protection
provider).
Current Expected Credit Losses (CECL) means the current expected
credit losses methodology under GAAP.
Default fund contribution means the funds contributed or
commitments made by a clearing member to a CCP's mutualized loss
sharing arrangement.
Depository institution means a depository institution as defined in
section 3 of the Federal Deposit Insurance Act.
Derivative contract means a financial contract whose value is
derived from the values of one or more underlying assets, reference
rates, or indices of asset values or reference rates. Derivative
contracts include interest rate derivative contracts, exchange rate
derivative contracts, equity derivative contracts, commodity derivative
contracts, credit derivative contracts, and any other instrument that
poses similar counterparty credit risks. Derivative contracts also
include unsettled securities, commodities, and foreign exchange
transactions with a contractual settlement or delivery lag that is
longer than the lesser of the market standard for the particular
instrument or five business days.
Discretionary bonus payment means a payment made to an executive
officer of an Enterprise, where:
(1) The Enterprise retains discretion as to whether to make, and
the amount of, the payment until the payment is awarded to the
executive officer;
(2) The amount paid is determined by the Enterprise without prior
promise to, or agreement with, the executive officer; and
(3) The executive officer has no contractual right, whether express
or implied, to the bonus payment.
Distribution means:
(1) A reduction of tier 1 capital through the repurchase of a tier
1 capital instrument or by other means, except when an Enterprise,
within the same quarter when the repurchase is announced, fully
replaces a tier 1 capital instrument it has repurchased by issuing
another capital instrument that meets the eligibility criteria for:
(i) A common equity tier 1 capital instrument if the instrument
being repurchased was part of the Enterprise's common equity tier 1
capital, or
(ii) A common equity tier 1 or additional tier 1 capital instrument
if

[[Page 39362]]

the instrument being repurchased was part of the Enterprise's tier 1
capital;
(2) A reduction of tier 2 capital through the repurchase, or
redemption prior to maturity, of a tier 2 capital instrument or by
other means, except when an Enterprise, within the same quarter when
the repurchase or redemption is announced, fully replaces a tier 2
capital instrument it has repurchased by issuing another capital
instrument that meets the eligibility criteria for a tier 1 or tier 2
capital instrument;
(3) A dividend declaration or payment on any tier 1 capital
instrument;
(4) A dividend declaration or interest payment on any tier 2
capital instrument if the Enterprise has full discretion to permanently
or temporarily suspend such payments without triggering an event of
default; or
(5) Any similar transaction that FHFA determines to be in substance
a distribution of capital.
Dodd-Frank Act means the Dodd-Frank Wall Street Reform and Consumer
Protection Act of 2010 (Pub. L. 111-203, 124 Stat. 1376).
Early amortization provision means a provision in the documentation
governing a securitization that, when triggered, causes investors in
the securitization exposures to be repaid before the original stated
maturity of the securitization exposures, unless the provision:
(1) Is triggered solely by events not directly related to the
performance of the underlying exposures or the originating Enterprise
(such as material changes in tax laws or regulations); or
(2) Leaves investors fully exposed to future draws by borrowers on
the underlying exposures even after the provision is triggered.
Effective notional amount means for an eligible guarantee or
eligible credit derivative, the lesser of the contractual notional
amount of the credit risk mitigant and the exposure amount of the
hedged exposure, multiplied by the percentage coverage of the credit
risk mitigant.
Eligible clean-up call means a clean-up call that:
(1) Is exercisable solely at the discretion of the originating
Enterprise or servicer;
(2) Is not structured to avoid allocating losses to securitization
exposures held by investors or otherwise structured to provide credit
enhancement to the securitization; and
(3)(i) For a traditional securitization, is only exercisable when
10 percent or less of the principal amount of the underlying exposures
or securitization exposures (determined as of the inception of the
securitization) is outstanding; or
(ii) For a synthetic securitization or credit risk transfer, is
only exercisable when 10 percent or less of the principal amount of the
reference portfolio of underlying exposures (determined as of the
inception of the securitization) is outstanding.
Eligible credit derivative means a credit derivative in the form of
a credit default swap, nth-to-default swap, total return swap, or any
other form of credit derivative approved by FHFA, provided that:
(1) The contract meets the requirements of an eligible guarantee
and has been confirmed by the protection purchaser and the protection
provider;
(2) Any assignment of the contract has been confirmed by all
relevant parties;
(3) If the credit derivative is a credit default swap or nth-to-
default swap, the contract includes the following credit events:
(i) Failure to pay any amount due under the terms of the reference
exposure, subject to any applicable minimal payment threshold that is
consistent with standard market practice and with a grace period that
is closely in line with the grace period of the reference exposure; and
(ii) Receivership, insolvency, liquidation, conservatorship or
inability of the reference exposure issuer to pay its debts, or its
failure or admission in writing of its inability generally to pay its
debts as they become due, and similar events;
(4) The terms and conditions dictating the manner in which the
contract is to be settled are incorporated into the contract;
(5) If the contract allows for cash settlement, the contract
incorporates a robust valuation process to estimate loss reliably and
specifies a reasonable period for obtaining post-credit event
valuations of the reference exposure;
(6) If the contract requires the protection purchaser to transfer
an exposure to the protection provider at settlement, the terms of at
least one of the exposures that is permitted to be transferred under
the contract provide that any required consent to transfer may not be
unreasonably withheld;
(7) If the credit derivative is a credit default swap or nth-to-
default swap, the contract clearly identifies the parties responsible
for determining whether a credit event has occurred, specifies that
this determination is not the sole responsibility of the protection
provider, and gives the protection purchaser the right to notify the
protection provider of the occurrence of a credit event; and
(8) If the credit derivative is a total return swap and the
Enterprise records net payments received on the swap as net income, the
Enterprise records offsetting deterioration in the value of the hedged
exposure (either through reductions in fair value or by an addition to
reserves).
Eligible credit reserves means all general allowances that have
been established through a charge against earnings or retained earnings
to cover expected credit losses associated with on- or off-balance
sheet wholesale and retail exposures, including AACL associated with
such exposures. Eligible credit reserves exclude allowances that
reflect credit losses on purchased credit deteriorated assets and
available-for-sale debt securities and other specific reserves created
against recognized losses.
Eligible CRT structure means any category of credit risk transfers
that has been approved by FHFA as effective in transferring the credit
risk of one or more mortgage exposures to another party, taking into
account any counterparty, recourse, or other risk to the Enterprise and
any capital, liquidity, or other requirements applicable to
counterparties (including any arrangement under which an entity that is
approved by an Enterprise to originate multifamily mortgage exposures
retains credit risk of one or more multifamily mortgage exposures pari
passu with the Enterprise on substantially the same terms and
conditions as in effect on [the date the proposed rule is published]
for Fannie Mae's credit risk transfers known as the ``Delegated
Underwriting and Servicing program'').
Eligible guarantee means a guarantee that:
(1) Is written;
(2) Is either:
(i) Unconditional, or
(ii) A contingent obligation of the U.S. government or its
agencies, the enforceability of which is dependent upon some
affirmative action on the part of the beneficiary of the guarantee or a
third party (for example, meeting servicing requirements);
(3) Covers all or a pro rata portion of all contractual payments of
the obligated party on the reference exposure;
(4) Gives the beneficiary a direct claim against the protection
provider;
(5) Is not unilaterally cancelable by the protection provider for
reasons other than the breach of the contract by the beneficiary;
(6) Except for a guarantee by a sovereign, is legally enforceable
against

[[Page 39363]]

the protection provider in a jurisdiction where the protection provider
has sufficient assets against which a judgment may be attached and
enforced;
(7) Requires the protection provider to make payment to the
beneficiary on the occurrence of a default (as defined in the
guarantee) of the obligated party on the reference exposure in a timely
manner without the beneficiary first having to take legal actions to
pursue the obligor for payment;
(8) Does not increase the beneficiary's cost of credit protection
on the guarantee in response to deterioration in the credit quality of
the reference exposure;
(9) Is not provided by an affiliate of the Enterprise; and
(10) Is provided by an eligible guarantor.
Eligible guarantor means:
(1) A sovereign, the Bank for International Settlements, the
International Monetary Fund, the European Central Bank, the European
Commission, a Federal Home Loan Bank, Federal Agricultural Mortgage
Corporation (Farmer Mac), the European Stability Mechanism, the
European Financial Stability Facility, a multilateral development bank
(MDB), a depository institution, a bank holding company as defined in
section 2 of the Bank Holding Company Act of 1956, as amended (12
U.S.C. 1841 et seq.), a savings and loan holding company, a credit
union, a foreign bank, or a qualifying central counterparty; or
(2) An entity (other than a special purpose entity):
(i) That at the time the guarantee is issued or anytime thereafter,
has issued and outstanding an unsecured debt security without credit
enhancement that is investment grade;
(ii) Whose creditworthiness is not positively correlated with the
credit risk of the exposures for which it has provided guarantees; and
(iii) That is not an insurance company engaged predominately in the
business of providing credit protection (such as a monoline bond
insurer or re-insurer).
Eligible margin loan means:
(1) An extension of credit where:
(i) The extension of credit is collateralized exclusively by liquid
and readily marketable debt or equity securities, or gold;
(ii) The collateral is marked-to-fair value daily, and the
transaction is subject to daily margin maintenance requirements; and
(iii) The extension of credit is conducted under an agreement that
provides the Enterprise the right to accelerate and terminate the
extension of credit and to liquidate or set-off collateral promptly
upon an event of default, including upon an event of receivership,
insolvency, liquidation, conservatorship, or similar proceeding, of the
counterparty, provided that, in any such case:
(A) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(1) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs,\1\ or laws of foreign
jurisdictions that are substantially similar to the U.S. laws
referenced in this paragraph (1)(iii)(A)(1) in order to facilitate the
orderly resolution of the defaulting counterparty; or
---------------------------------------------------------------------------

\1\ This requirement is met where all transactions under the
agreement are (i) executed under U.S. law and (ii) constitute
``securities contracts'' under section 555 of the Bankruptcy Code
(11 U.S.C. 555), qualified financial contracts under section
11(e)(8) of the Federal Deposit Insurance Act, or netting contracts
between or among financial institutions under sections 401-407 of
the Federal Deposit Insurance Corporation Improvement Act or the
Federal Reserve's Regulation EE (12 CFR part 231).
---------------------------------------------------------------------------

(2) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (1)(iii)(A)(1) of
this definition; and
(B) The agreement may limit the right to accelerate, terminate, and
close-out on a net basis all transactions under the agreement and to
liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Federal Reserve Board's
Regulation YY (part 252 of this title), part 47 of this title, or part
382 of this title, as applicable.
(2) In order to recognize an exposure as an eligible margin loan
for purposes of this subpart, an Enterprise must comply with the
requirements of Sec. 1240.3(b) with respect to that exposure.
Equity exposure means:
(1) A security or instrument (whether voting or non-voting) that
represents a direct or an indirect ownership interest in, and is a
residual claim on, the assets and income of a company, unless:
(i) The issuing company is consolidated with the Enterprise under
GAAP;
(ii) The Enterprise is required to deduct the ownership interest
from tier 1 or tier 2 capital under this part;
(iii) The ownership interest incorporates a payment or other
similar obligation on the part of the issuing company (such as an
obligation to make periodic payments); or
(iv) The ownership interest is a securitization exposure;
(2) A security or instrument that is mandatorily convertible into a
security or instrument described in paragraph (1) of this definition;
(3) An option or warrant that is exercisable for a security or
instrument described in paragraph (1) of this definition; or
(4) Any other security or instrument (other than a securitization
exposure) to the extent the return on the security or instrument is
based on the performance of a security or instrument described in
paragraph (1) of this definition.
ERISA means the Employee Retirement Income and Security Act of 1974
(29 U.S.C. 1001 et seq.).
Executive officer means a person who holds the title or, without
regard to title, salary, or compensation, performs the function of one
or more of the following positions: President, chief executive officer,
executive chairman, chief operating officer, chief financial officer,
chief investment officer, chief legal officer, chief lending officer,
chief risk officer, or head of a major business line, and other staff
that the board of directors of the Enterprise deems to have equivalent
responsibility.
Exposure amount means:
(1) For the on-balance sheet component of an exposure (including a
mortgage exposure); an OTC derivative contract; a repo-style
transaction or an eligible margin loan for which the Enterprise
determines the exposure amount under Sec. 1240.39; a cleared
transaction; a default fund contribution; or a securitization
exposure), the Enterprise's carrying value of the exposure.
(2) For the off-balance sheet component of an exposure (other than
an OTC derivative contract; a repo-style transaction or an eligible
margin loan for which the Enterprise calculates the exposure amount
under Sec. 1240.39; a cleared transaction; a default fund
contribution; or a securitization exposure), the notional amount of the
off-balance sheet component multiplied by the appropriate credit
conversion factor (CCF) in Sec. 1240.35.
(3) For an exposure that is an OTC derivative contract, the
exposure amount determined under Sec. 1240.36.
(4) For an exposure that is a cleared transaction, the exposure
amount determined under Sec. 1240.37.
(5) For an exposure that is an eligible margin loan or repo-style
transaction for which the Enterprise calculates the exposure amount as
provided in Sec. 1240.39, the exposure amount determined under Sec.
1240.39.

[[Page 39364]]

(6) For an exposure that is a securitization exposure, the exposure
amount determined under Sec. 1240.42.
Federal Deposit Insurance Act means the Federal Deposit Insurance
Act (12 U.S.C. 1813).
Federal Deposit Insurance Corporation Improvement Act means the
Federal Deposit Insurance Corporation Improvement Act (12 U.S.C. 4401).
Federal Reserve Board means the Board of Governors of the Federal
Reserve System.
Financial collateral means collateral:
(1) In the form of:
(i) Cash on deposit with the Enterprise (including cash held for
the Enterprise by a third-party custodian or trustee);
(ii) Gold bullion;
(iii) Long-term debt securities that are not resecuritization
exposures and that are investment grade;
(iv) Short-term debt instruments that are not resecuritization
exposures and that are investment grade;
(v) Equity securities that are publicly traded;
(vi) Convertible bonds that are publicly traded; or
(vii) Money market fund shares and other mutual fund shares if a
price for the shares is publicly quoted daily; and
(2) In which the Enterprise has a perfected, first-priority
security interest or, outside of the United States, the legal
equivalent thereof (with the exception of cash on deposit and
notwithstanding the prior security interest of any custodial agent).
Foreign bank means a foreign bank as defined in Sec. 211.2 of the
Federal Reserve Board's Regulation K (12 CFR 211.2) (other than a
depository institution).
Gain-on-sale means an increase in the equity capital of an
Enterprise resulting from a traditional securitization other than an
increase in equity capital resulting from:
(1) The Enterprise's receipt of cash in connection with the
securitization; or
(2) The reporting of a mortgage servicing asset.
General obligation means a bond or similar obligation that is
backed by the full faith and credit of a public sector entity (PSE).
Government-sponsored enterprise (GSE) means an entity established
or chartered by the U.S. government to serve public purposes specified
by the U.S. Congress but whose debt obligations are not explicitly
guaranteed by the full faith and credit of the U.S. government,
including an Enterprise.
Guarantee means a financial guarantee, letter of credit, insurance,
or other similar financial instrument (other than a credit derivative)
that allows one party (beneficiary) to transfer the credit risk of one
or more specific exposures (reference exposure) to another party
(protection provider).
Investment grade means that the entity to which the Enterprise is
exposed through a loan or security, or the reference entity with
respect to a credit derivative, has adequate capacity to meet financial
commitments for the projected life of the asset or exposure. Such an
entity or reference entity has adequate capacity to meet financial
commitments if the risk of its default is low and the full and timely
repayment of principal and interest is expected.
Mortgage-backed security (MBS) means a security collateralized by a
pool or pools of mortgage exposures, including any pass-through or
collateralized mortgage obligation.
Mortgage exposure means either a single-family mortgage exposure or
a multifamily mortgage exposure.
Multifamily mortgage exposure means an exposure that is secured by
a first or subsequent lien on a property with five or more residential
units.
Mortgage servicing assets (MSAs) means the contractual rights owned
by an Enterprise to service for a fee mortgage loans that are owned by
others.
Multilateral development bank (MDB) means the International Bank
for Reconstruction and Development, the Multilateral Investment
Guarantee Agency, the International Finance Corporation, the Inter-
American Development Bank, the Asian Development Bank, the African
Development Bank, the European Bank for Reconstruction and Development,
the European Investment Bank, the European Investment Fund, the Nordic
Investment Bank, the Caribbean Development Bank, the Islamic
Development Bank, the Council of Europe Development Bank, and any other
multilateral lending institution or regional development bank in which
the U.S. government is a shareholder or contributing member or which
FHFA determines poses comparable credit risk.
Netting set means a group of transactions with a single
counterparty that are subject to a qualifying master netting agreement
or a qualifying cross-product master netting agreement. For purposes of
calculating risk-based capital requirements using the internal models
methodology in subpart E of this part, this term does not cover a
transaction:
(1) That is not subject to such a master netting agreement; or
(2) Where the Enterprise has identified specific wrong-way risk.
Nth-to-default credit derivative means a credit derivative that
provides credit protection only for the nth-defaulting reference
exposure in a group of reference exposures.
Originating Enterprise, with respect to a securitization, means an
Enterprise that directly or indirectly originated or securitized the
underlying exposures included in the securitization.
Over-the-counter (OTC) derivative contract means a derivative
contract that is not a cleared transaction. An OTC derivative includes
a transaction:
(1) Between an Enterprise that is a clearing member and a
counterparty where the Enterprise is acting as a financial intermediary
and enters into a cleared transaction with a CCP that offsets the
transaction with the counterparty; or
(2) In which an Enterprise that is a clearing member provides a CCP
a guarantee on the performance of the counterparty to the transaction.
Protection amount (P) means, with respect to an exposure hedged by
an eligible guarantee or eligible credit derivative, the effective
notional amount of the guarantee or credit derivative, reduced to
reflect any currency mismatch, maturity mismatch, or lack of
restructuring coverage (as provided in Sec. 1240.38).
Publicly-traded means traded on:
(1) Any exchange registered with the SEC as a national securities
exchange under section 6 of the Securities Exchange Act; or
(2) Any non-U.S.-based securities exchange that:
(i) Is registered with, or approved by, a national securities
regulatory authority; and
(ii) Provides a liquid, two-way market for the instrument in
question.
Public sector entity (PSE) means a state, local authority, or other
governmental subdivision below the sovereign level.
Qualifying central counterparty (QCCP) means a central counterparty
that:
(1)(i) Is a designated financial market utility (FMU) under Title
VIII of the Dodd-Frank Act;
(ii) If not located in the United States, is regulated and
supervised in a manner equivalent to a designated FMU; or
(iii) Meets the following standards:
(A) The central counterparty requires all parties to contracts
cleared by the counterparty to be fully collateralized on a daily
basis;
(B) The Enterprise demonstrates to the satisfaction of FHFA that
the central counterparty:

[[Page 39365]]

(1) Is in sound financial condition;
(2) Is subject to supervision by the Federal Reserve Board, the
CFTC, or the Securities Exchange Commission (SEC), or, if the central
counterparty is not located in the United States, is subject to
effective oversight by a national supervisory authority in its home
country; and
(3) Meets or exceeds the risk-management standards for central
counterparties set forth in regulations established by the Federal
Reserve Board, the CFTC, or the SEC under Title VII or Title VIII of
the Dodd-Frank Act; or if the central counterparty is not located in
the United States, meets or exceeds similar risk-management standards
established under the law of its home country that are consistent with
international standards for central counterparty risk management as
established by the relevant standard setting body of the Bank of
International Settlements; and
(2)(i) Provides the Enterprise with the central counterparty's
hypothetical capital requirement or the information necessary to
calculate such hypothetical capital requirement, and other information
the Enterprise is required to obtain under 12 CFR 217.35(d)(3);
(ii) Makes available to FHFA and the CCP's regulator the
information described in paragraph (2)(i) of this definition; and
(iii) Has not otherwise been determined by FHFA to not be a QCCP
due to its financial condition, risk profile, failure to meet
supervisory risk management standards, or other weaknesses or
supervisory concerns that are inconsistent with the risk weight
assigned to qualifying central counterparties under Sec. 1240.37.
(3) A QCCP that fails to meet the requirements of a QCCP in the
future may still be treated as a QCCP under the conditions specified in
Sec. 1240.3(e).
Qualifying master netting agreement means a written, legally
enforceable agreement provided that:
(1) The agreement creates a single legal obligation for all
individual transactions covered by the agreement upon an event of
default following any stay permitted by paragraph (2) of this
definition, including upon an event of receivership, conservatorship,
insolvency, liquidation, or similar proceeding, of the counterparty;
(2) The agreement provides the Enterprise the right to accelerate,
terminate, and close-out on a net basis all transactions under the
agreement and to liquidate or set-off collateral promptly upon an event
of default, including upon an event of receivership, conservatorship,
insolvency, liquidation, or similar proceeding, of the counterparty,
provided that, in any such case:
(i) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(A) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar to the U.S. laws
referenced in this paragraph (2)(i)(A) in order to facilitate the
orderly resolution of the defaulting counterparty; or
(B) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (2)(i)(A) of this
definition; and
(ii) The agreement may limit the right to accelerate, terminate,
and close-out on a net basis all transactions under the agreement and
to liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Federal Reserve Board's
Regulation YY (part 252 of this title), part 47 of this title, or part
382 of this title, as applicable.
Repo-style transaction means a repurchase or reverse repurchase
transaction, or a securities borrowing or securities lending
transaction, including a transaction in which the Enterprise acts as
agent for a customer and indemnifies the customer against loss,
provided that:
(1) The transaction is based solely on liquid and readily
marketable securities, cash, or gold;
(2) The transaction is marked-to-fair value daily and subject to
daily margin maintenance requirements;
(3)(i) The transaction is a ``securities contract'' or ``repurchase
agreement'' under section 555 or 559, respectively, of the Bankruptcy
Code (11 U.S.C. 555 or 559), a qualified financial contract under
section 11(e)(8) of the Federal Deposit Insurance Act, or a netting
contract between or among financial institutions under sections 401-407
of the Federal Deposit Insurance Corporation Improvement Act or the
Federal Reserve Board's Regulation EE (12 CFR part 231); or
(ii) If the transaction does not meet the criteria set forth in
paragraph (3)(i) of this definition, then either:
(A) The transaction is executed under an agreement that provides
the Enterprise the right to accelerate, terminate, and close-out the
transaction on a net basis and to liquidate or set-off collateral
promptly upon an event of default, including upon an event of
receivership, insolvency, liquidation, or similar proceeding, of the
counterparty, provided that, in any such case:
(1) Any exercise of rights under the agreement will not be stayed
or avoided under applicable law in the relevant jurisdictions, other
than:
(i) In receivership, conservatorship, or resolution under the
Federal Deposit Insurance Act, Title II of the Dodd-Frank Act, or under
any similar insolvency law applicable to GSEs, or laws of foreign
jurisdictions that are substantially similar to the U.S. laws
referenced in this paragraph (3)(ii)(A)(1)(i) in order to facilitate
the orderly resolution of the defaulting counterparty;
(ii) Where the agreement is subject by its terms to, or
incorporates, any of the laws referenced in paragraph (3)(ii)(A)(1)(i)
of this definition; and
(2) The agreement may limit the right to accelerate, terminate, and
close-out on a net basis all transactions under the agreement and to
liquidate or set-off collateral promptly upon an event of default of
the counterparty to the extent necessary for the counterparty to comply
with the requirements of subpart I of the Federal Reserve Board's
Regulation YY (part 252 of this title), part 47 of this title, or part
382 of this title, as applicable; or
(B) The transaction is:
(1) Either overnight or unconditionally cancelable at any time by
the Enterprise; and
(2) Executed under an agreement that provides the Enterprise the
right to accelerate, terminate, and close-out the transaction on a net
basis and to liquidate or set-off collateral promptly upon an event of
counterparty default; and
(3) In order to recognize an exposure as a repo-style transaction
for purposes of this subpart, an Enterprise must comply with the
requirements of Sec. 1240.3(e) with respect to that exposure.
Resecuritization means a securitization which has more than one
underlying exposure and in which one or more of the underlying
exposures is a securitization exposure.
Resecuritization exposure means:
(1) An on- or off-balance sheet exposure to a resecuritization; or
(2) An exposure that directly or indirectly references a
resecuritization exposure.
Retained CRT exposure means, with respect to an Enterprise, any
exposure that arises from a credit risk transfer of the Enterprise and
has been retained by the Enterprise since the issuance or

[[Page 39366]]

entry into the credit risk transfer by the Enterprise.
Revenue obligation means a bond or similar obligation that is an
obligation of a PSE, but which the PSE is committed to repay with
revenues from the specific project financed rather than general tax
funds.
Securities and Exchange Commission (SEC) means the U.S. Securities
and Exchange Commission.
Securities Exchange Act means the Securities Exchange Act of 1934
(15 U.S.C. 78).
Securitization exposure means:
(1) An on-balance sheet or off-balance sheet credit exposure
(including credit-enhancing representations and warranties) that arises
from a traditional securitization or synthetic securitization
(including a resecuritization);
(2) An exposure that directly or indirectly references a
securitization exposure described in paragraph (1) of this definition;
(3) A retained CRT exposure; or
(4) An acquired CRT exposure.
Securitization special purpose entity (securitization SPE) means a
corporation, trust, or other entity organized for the specific purpose
of holding underlying exposures of a securitization, the activities of
which are limited to those appropriate to accomplish this purpose, and
the structure of which is intended to isolate the underlying exposures
held by the entity from the credit risk of the seller of the underlying
exposures to the entity.
Servicer cash advance facility means a facility under which the
servicer of the underlying exposures of a securitization may advance
cash to ensure an uninterrupted flow of payments to investors in the
securitization, including advances made to cover foreclosure costs or
other expenses to facilitate the timely collection of the underlying
exposures.
Single-family mortgage exposure means an exposure that is secured
by a first or subsequent lien on a property with one to four
residential units.
Sovereign means a central government (including the U.S.
government) or an agency, department, ministry, or central bank of a
central government.
Sovereign default means noncompliance by a sovereign with its
external debt service obligations or the inability or unwillingness of
a sovereign government to service an existing loan according to its
original terms, as evidenced by failure to pay principal and interest
timely and fully, arrearages, or restructuring.
Sovereign exposure means:
(1) A direct exposure to a sovereign; or
(2) An exposure directly and unconditionally backed by the full
faith and credit of a sovereign.
Standardized market risk-weighted assets means the standardized
measure for spread risk calculated under Sec. 1240.204(a) multiplied
by 12.5.
Standardized total risk-weighted assets means:
(1) The sum of:
(i) Total risk-weighted assets for general credit risk as
calculated under Sec. 1240.31;
(ii) Total risk-weighted assets for cleared transactions and
default fund contributions as calculated under Sec. 1240.37;
(iii) Total risk-weighted assets for unsettled transactions as
calculated under Sec. 1240.40;
(iv) Total risk-weighted assets for CRT and other securitization
exposures as calculated under Sec. 1240.42;
(v) Total risk-weighted assets for equity exposures as calculated
under Sec. 1240.51;
(vi) Risk-weighted assets for operational risk, as calculated under
Sec. 1240.162(c); and
(vii) Standardized market risk-weighted assets; minus
(2) Excess eligible credit reserves not included in the
Enterprise's tier 2 capital.
Subsidiary means, with respect to a company, a company controlled
by that company.
Synthetic securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is retained or transferred to one or more third parties
through the use of one or more credit derivatives or guarantees (other
than a guarantee that transfers only the credit risk of an individual
mortgage exposure or other retail exposure);
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures; and
(4) All or substantially all of the underlying exposures are
financial exposures (such as mortgage exposures, loans, commitments,
credit derivatives, guarantees, receivables, asset-backed securities,
mortgage-backed securities, other debt securities, or equity
securities).
Tier 1 capital means the sum of common equity tier 1 capital and
additional tier 1 capital.
Tier 2 capital is defined in Sec. 1240.20(d).
Total capital has the meaning given at section 1303(23) of the
Safety and Soundness Act (12 U.S.C. 4502(23)).
Traditional securitization means a transaction in which:
(1) All or a portion of the credit risk of one or more underlying
exposures is transferred to one or more third parties other than
through the use of credit derivatives or guarantees;
(2) The credit risk associated with the underlying exposures has
been separated into at least two tranches reflecting different levels
of seniority;
(3) Performance of the securitization exposures depends upon the
performance of the underlying exposures;
(4) All or substantially all of the underlying exposures are
financial exposures (such as mortgage exposures, loans, commitments,
credit derivatives, guarantees, receivables, asset-backed securities,
mortgage-backed securities, other debt securities, or equity
securities);
(5) The underlying exposures are not owned by an operating company;
(6) The underlying exposures are not owned by a small business
investment company defined in section 302 of the Small Business
Investment Act;
(7) The underlying exposures are not owned by a firm an investment
in which qualifies as a community development investment under section
24 (Eleventh) of the National Bank Act;
(8) FHFA may determine that a transaction in which the underlying
exposures are owned by an investment firm that exercises substantially
unfettered control over the size and composition of its assets,
liabilities, and off-balance sheet exposures is not a traditional
securitization based on the transaction's leverage, risk profile, or
economic substance;
(9) FHFA may deem a transaction that meets the definition of a
traditional securitization, notwithstanding paragraph (5), (6), or (7)
of this definition, to be a traditional securitization based on the
transaction's leverage, risk profile, or economic substance; and
(10) The transaction is not:
(i) An investment fund;
(ii) A collective investment fund (as defined in 12 CFR 208.34);
(iii) An employee benefit plan (as defined in 29 U.S.C. 1002(3)), a
governmental plan (as defined in 29 U.S.C. 1002(32)) that complies with
the tax deferral qualification requirements provided in the Internal
Revenue Code;
(iv) A synthetic exposure to the capital of a financial institution
to the

[[Page 39367]]

extent deducted from capital under Sec. 1240.22; or
(v) Registered with the SEC under the Investment Company Act of
1940 (15 U.S.C. 80a-1 et seq.) or foreign equivalents thereof.
Tranche means all securitization exposures associated with a
securitization that have the same seniority level.
Underlying exposures means one or more exposures that have been
securitized in a securitization transaction.
Wrong-way risk means the risk that arises when an exposure to a
particular counterparty is positively correlated with the probability
of default of such counterparty itself.

Sec. 1240.3 Operational requirements for counterparty credit risk.

For purposes of calculating risk-weighted assets under subpart D of
this part:
(a) Cleared transaction. In order to recognize certain exposures as
cleared transactions pursuant to paragraphs (1)(ii), (iii), or (iv) of
the definition of ``cleared transaction'' in Sec. 1240.2, the
exposures must meet the applicable requirements set forth in this
paragraph (a).
(1) The offsetting transaction must be identified by the CCP as a
transaction for the clearing member client.
(2) The collateral supporting the transaction must be held in a
manner that prevents the Enterprise from facing any loss due to an
event of default, including from a liquidation, receivership,
insolvency, or similar proceeding of either the clearing member or the
clearing member's other clients. Omnibus accounts established under 17
CFR parts 190 and 300 satisfy the requirements of this paragraph (a).
(3) The Enterprise must conduct sufficient legal review to conclude
with a well-founded basis (and maintain sufficient written
documentation of that legal review) that in the event of a legal
challenge (including one resulting from a default or receivership,
insolvency, liquidation, or similar proceeding) the relevant court and
administrative authorities would find the arrangements of paragraph
(a)(2) of this section to be legal, valid, binding and enforceable
under the law of the relevant jurisdictions.
(4) The offsetting transaction with a clearing member must be
transferable under the transaction documents and applicable laws in the
relevant jurisdiction(s) to another clearing member should the clearing
member default, become insolvent, or enter receivership, insolvency,
liquidation, or similar proceedings.
(b) Eligible margin loan. In order to recognize an exposure as an
eligible margin loan as defined in Sec. 1240.2, an Enterprise must
conduct sufficient legal review to conclude with a well-founded basis
(and maintain sufficient written documentation of that legal review)
that the agreement underlying the exposure:
(1) Meets the requirements of paragraph (1)(iii) of the definition
of eligible margin loan in Sec. 1240.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(c) Qualifying master netting agreement. In order to recognize an
agreement as a qualifying master netting agreement as defined in Sec.
1240.2, an Enterprise must:
(1) Conduct sufficient legal review to conclude with a well-founded
basis (and maintain sufficient written documentation of that legal
review) that:
(i) The agreement meets the requirements of paragraph (2) of the
definition of qualifying master netting agreement in Sec. 1240.2; and
(ii) In the event of a legal challenge (including one resulting
from default or from receivership, insolvency, liquidation, or similar
proceeding) the relevant court and administrative authorities would
find the agreement to be legal, valid, binding, and enforceable under
the law of the relevant jurisdictions; and
(2) Establish and maintain written procedures to monitor possible
changes in relevant law and to ensure that the agreement continues to
satisfy the requirements of the definition of qualifying master netting
agreement in Sec. 1240.2.
(d) Repo-style transaction. In order to recognize an exposure as a
repo-style transaction as defined in Sec. 1240.2, an Enterprise must
conduct sufficient legal review to conclude with a well-founded basis
(and maintain sufficient written documentation of that legal review)
that the agreement underlying the exposure:
(1) Meets the requirements of paragraph (3) of the definition of
``repo-style transaction'' in Sec. 1240.2, and
(2) Is legal, valid, binding, and enforceable under applicable law
in the relevant jurisdictions.
(e) Failure of a QCCP to satisfy the rule's requirements. If an
Enterprise determines that a CCP ceases to be a QCCP due to the failure
of the CCP to satisfy one or more of the requirements set forth in
paragraphs (2)(i) through (2)(iii) of the definition of a QCCP in Sec.
1240.2, the Enterprise may continue to treat the CCP as a QCCP for up
to three months following the determination. If the CCP fails to remedy
the relevant deficiency within three months after the initial
determination, or the CCP fails to satisfy the requirements set forth
in paragraphs (2)(i) through (2)(iii) of the definition of a ``QCCP''
continuously for a three-month period after remedying the relevant
deficiency, an Enterprise may not treat the CCP as a QCCP for the
purposes of this part until after the Enterprise has determined that
the CCP has satisfied the requirements in paragraphs (2)(i) through
(2)(iii) of the definition of a QCCP for three continuous months.

Sec. 1240.4 Compliance dates.

(a) Delayed compliance dates. Certain sections and subparts of this
part are subject to delayed compliance dates under this section.
(b) Reporting compliance. Section 1240.1(f) has a compliance date
of one year from [DATE OF PUBLICATION OF FINAL RULE].
(c) Capital requirements and buffers. Subject to paragraph (d) of
this section, subpart B of this part has a compliance date with respect
to an Enterprise of the later of:
(1) One year from [DATE OF PUBLICATION OF FINAL RULE]; and
(2) The date of the termination of the conservatorship of the
Enterprise.
(d) Capital restoration plan or other interim order. (1) The
Director may determine to direct a later compliance date for an
Enterprise to achieve compliance with Sec. 1240.10 based on his
assessment of capital market conditions and the likely feasibility of
the plan of the Enterprise to achieve capital levels sufficient to
comply with Sec. 1240.10 and avoid restrictions on capital
distributions and discretionary bonuses under Sec. 1240.11(b).
(2) If the Director makes a determination under paragraph (d)(1) of
this section:
(i) For the period between the compliance date for Sec. 1240.11
under paragraph (c) of this section and any later compliance date for
Sec. 1240.10 under this paragraph (d), the prescribed capital
conservation buffer amount of the Enterprise will be the amount equal
to:
(A) The CET1 capital that would otherwise be required under Sec.
1240.10(d); plus
(B) The prescribed capital conservation buffer amount that would
otherwise apply under Sec. 1240.11(a)(5);
(ii) For the period between the compliance date for Sec. 1240.11
under paragraph (c) of this section and the later compliance date for
Sec. 1240.10 under this paragraph (d), the prescribed leverage buffer
amount of the Enterprise

[[Page 39368]]

will be equal to 4.0 percent of the adjusted total assets of the
Enterprise; and
(iii) The compliance date for Sec. 1240.10 will be tolled if the
Enterprise is in compliance with:
(A) Any corrective plan pursuant to section 1313B of the Safety and
Soundness Act (12 U.S.C. 4513b(b)(1)) and 12 CFR 1236.4(c), approved by
FHFA, which may prescribe the feasible actions and milestones by which
the Enterprise will achieve compliance with Sec. 1240.10 by the date
directed by FHFA; and
(B) Any agreement or order pursuant to section 1371 of the Safety
and Soundness Act (12 U.S.C. 4631), including any requirement under any
plan required under that agreement or order to achieve compliance with
Sec. 1240.10.

Subpart B--Capital Requirements and Buffers

Sec. 1240.10 Capital requirements.

(a) Total capital. An Enterprise must maintain total capital not
less than the amount equal to 8.0 percent of the greater of:
(1) Standardized total risk-weighted assets; and
(2) Advanced approaches total risk-weighted assets.
(b) Adjusted total capital. An Enterprise must maintain adjusted
total capital not less than the amount equal to 8.0 percent of the
greater of:
(1) Standardized total risk-weighted assets; and
(2) Advanced approaches total risk-weighted assets.
(c) Tier 1 capital. An Enterprise must maintain tier 1 capital not
less than the amount equal to 6.0 percent of the greater of:
(1) Standardized total risk-weighted assets; and
(2) Advanced approaches total risk-weighted assets.
(d) Common equity tier 1 capital. An Enterprise must maintain
common equity tier 1 capital not less than the amount equal to 4.5
percent of the greater of:
(1) Standardized total risk-weighted assets; and
(2) Advanced approaches total risk-weighted assets.
(e) Core capital. An Enterprise must maintain core capital not less
than the amount equal to 2.5 percent of adjusted total assets.
(f) Leverage ratio. An Enterprise must maintain tier 1 capital not
less than the amount equal to 2.5 percent of adjusted total assets.
(g) Capital adequacy. (1) Notwithstanding the minimum requirements
in this part, an Enterprise must maintain capital commensurate with the
level and nature of all risks to which the Enterprise is exposed. The
supervisory evaluation of an Enterprise's capital adequacy is based on
an individual assessment of numerous factors, including the character
and condition of the Enterprise's assets and its existing and
prospective liabilities and other corporate responsibilities.
(2) An Enterprise must have a process for assessing its overall
capital adequacy in relation to its risk profile and a comprehensive
strategy for maintaining an appropriate level of capital.

Sec. 1240.11 Capital conservation buffer and leverage buffer.

(a) Definitions. For purposes of this section, the following
definitions apply:
(1) Capital conservation buffer. An Enterprise's capital
conservation buffer is the amount calculated under paragraph (c)(2) of
this section.
(2) Eligible retained income. The eligible retained income of an
Enterprise is the greater of:
(i) The Enterprise's net income, as defined under GAAP, for the
four calendar quarters preceding the current calendar quarter, net of
any distributions and associated tax effects not already reflected in
net income; and
(ii) The average of the Enterprise's net income for the four
calendar quarters preceding the current calendar quarter.
(3) Leverage buffer. An Enterprise's leverage buffer is the amount
calculated under paragraph (d)(2) of this section.
(4) Maximum payout ratio. The maximum payout ratio is the
percentage of eligible retained income that an Enterprise can pay out
in the form of distributions and discretionary bonus payments during
the current calendar quarter. The maximum payout ratio is determined
under paragraph (b)(2) of this section.
(5) Prescribed capital conservation buffer amount. An Enterprise's
prescribed capital conservation buffer amount is equal to its stress
capital buffer in accordance with paragraph (a)(7) of this section plus
its applicable countercyclical capital buffer amount in accordance with
paragraph (e) of this section plus its applicable stability capital
buffer in accordance with paragraph (f) of this section.
(6) Prescribed leverage buffer amount. An Enterprise's prescribed
leverage buffer amount is 1.5 percent of the Enterprise's adjusted
total assets, as of the last day of the previous calendar quarter.
(7) Stress capital buffer. An Enterprise's stress capital buffer is
0.75 percent of the Enterprise's adjusted total assets, as of the last
day of the previous calendar quarter.
(b) Maximum payout amount. (1) Limits on distributions and
discretionary bonus payments. An Enterprise shall not make
distributions or discretionary bonus payments or create an obligation
to make such distributions or payments during the current calendar
quarter that, in the aggregate, exceed the amount equal to the
Enterprise's eligible retained income for the calendar quarter,
multiplied by its maximum payout ratio.
(2) Maximum payout ratio. The maximum payout ratio of an Enterprise
is the lowest of the payout ratios determined by its capital
conservation buffer and its leverage buffer, as set forth on Table 1 to
paragraph (b)(5) of this section.
(3) No maximum payout amount limitation. An Enterprise is not
subject to a restriction under paragraph (b)(1) of this section if it
has:
(i) A capital conservation buffer that is greater than its
prescribed capital conservation buffer amount; and
(ii) A leverage buffer that is greater than its prescribed leverage
buffer amount.
(4) Negative eligible retained income. An Enterprise may not make
distributions or discretionary bonus payments during the current
calendar quarter if:
(i) The eligible retained income of the Enterprise is negative; and
(ii) Either:
(A) The capital conservation buffer of the Enterprise was less than
its stress capital buffer; or
(B) The leverage buffer of the Enterprise was less than its
prescribed leverage buffer amount.
(5) Prior approval. Notwithstanding the limitations in paragraphs
(b)(1) through (b)(3) of this section, FHFA may permit an Enterprise to
make a distribution or discretionary bonus payment upon a request of
the Enterprise, if FHFA determines that the distribution or
discretionary bonus payment would not be contrary to the purposes of
this section or to the safety and soundness of the Enterprise. In
making such a determination, FHFA will consider the nature and extent
of the request and the particular circumstances giving rise to the
request.

[[Page 39369]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.046

(c) Capital conservation buffer--(1) Composition of the capital
conservation buffer. The capital conservation buffer is composed solely
of common equity tier 1 capital.
---------------------------------------------------------------------------

\2\ An Enterprise's ``capital buffer'' means, as applicable, its
capital conservation buffer or its leverage buffer.
\3\ An Enterprise's ``prescribed buffer amount'' means, as
applicable, its prescribed capital conservation buffer amount or its
leverage prescribed buffer amount.
---------------------------------------------------------------------------

(2) Calculation of capital conservation buffer. (i) An Enterprise's
capital conservation buffer is equal to the lowest of the following,
calculated as of the last day of the previous calendar quarter:
(A) The Enterprise's adjusted total capital minus the minimum
amount of adjusted total capital under Sec. 1240.10(b);
(B) The Enterprise's tier 1 capital minus the minimum amount of
tier 1 capital under Sec. 1240.10(c); or
(C) The Enterprise's common equity tier 1 capital minus the minimum
amount of common equity tier 1 capital under Sec. 1240.10(d).
(ii) Notwithstanding paragraphs (c)(2)(i)(A) through (C) of this
section, if the Enterprise's adjusted total capital, tier 1 capital, or
common equity tier 1 capital is less than or equal to the Enterprise's
minimum adjusted total capital, tier 1 capital, or common equity tier 1
capital, respectively, the Enterprise's capital conservation buffer is
zero.
(d) Leverage buffer--(1) Composition of the leverage buffer. The
leverage buffer is composed solely of tier 1 capital.
(2) Calculation of the leverage buffer. (i) An Enterprise's
leverage buffer is equal to the Enterprise's tier 1 capital minus the
minimum amount of tier 1 capital under Sec. 1240.10(f), calculated as
of the last day of the previous calendar quarter.
(ii) Notwithstanding paragraph (d)(2)(i) of this section, if the
Enterprise's tier 1 capital is less than or equal to the minimum amount
of tier 1 capital under Sec. 1240.10(d), the Enterprise's leverage
buffer is zero.
(e) Countercyclical capital buffer amount--(1) Composition of the
countercyclical capital buffer amount. The countercyclical capital
buffer amount is composed solely of common equity tier 1 capital.
(2) Amount--(i) Initial countercyclical capital buffer. The initial
countercyclical capital buffer amount is zero.
(ii) Adjustment of the countercyclical capital buffer amount. FHFA
will adjust the countercyclical capital buffer amount in accordance
with applicable law.
(iii) Range of countercyclical capital buffer amount. FHFA will
adjust the countercyclical capital buffer amount between zero percent
and 0.75 percent of adjusted total assets.
(iv) Adjustment determination. FHFA will base its decision to
adjust the countercyclical capital buffer amount under this section on
a range of macroeconomic, financial, and supervisory information
indicating an increase in systemic risk, including the ratio of credit
to gross domestic product, a variety of asset prices, other factors
indicative of relative credit and liquidity expansion or contraction,
funding spreads, credit condition surveys, indices based on credit
default swap spreads, options implied volatility, and measures of
systemic risk.
(3) Effective date of adjusted countercyclical capital buffer
amount--
(i) Increase adjustment. A determination by FHFA under paragraph
(e)(2)(ii) of this section to increase the countercyclical capital
buffer amount will be effective 12 months from the date of
announcement, unless FHFA establishes an earlier effective date and
includes a statement articulating the reasons for the earlier effective
date.
(ii) Decrease adjustment. A determination by FHFA to decrease the
established countercyclical capital buffer amount under paragraph
(e)(2)(ii) of this section will be effective on the day following
announcement of the final determination or the earliest date
permissible under applicable law or regulation, whichever is later.
(iii) Twelve month sunset. The countercyclical capital buffer
amount will return to zero percent 12 months after the effective date
that the adjusted countercyclical capital buffer amount is announced,
unless FHFA announces a decision to maintain the adjusted
countercyclical capital buffer amount or adjust it again before the
expiration of the 12-month period.
(f) Stability capital buffer. An Enterprise must use its stability
capital buffer calculated in accordance with subpart G of this part for
purposes of determining its maximum payout ratio under Table 1 to
paragraph (b)(5) of this section.

Subpart C--Definition of Capital

Sec. 1240.20 Capital components and eligibility criteria for
regulatory capital instruments.

(a) Regulatory capital components. An Enterprise's regulatory
capital components are:
(1) Common equity tier 1 capital;
(2) Additional tier 1 capital;
(3) Tier 2 capital;
(4) Core capital; and
(5) Total capital.

[[Page 39370]]

(b) Common equity tier 1 capital. Common equity tier 1 capital is
the sum of the common equity tier 1 capital elements in this paragraph
(b), minus regulatory adjustments and deductions in Sec. 1240.22. The
common equity tier 1 capital elements are:
(1) Any common stock instruments (plus any related surplus) issued
by the Enterprise, net of treasury stock, that meet all the following
criteria:
(i) The instrument is paid-in, issued directly by the Enterprise,
and represents the most subordinated claim in a receivership,
insolvency, liquidation, or similar proceeding of the Enterprise;
(ii) The holder of the instrument is entitled to a claim on the
residual assets of the Enterprise that is proportional with the
holder's share of the Enterprise's issued capital after all senior
claims have been satisfied in a receivership, insolvency, liquidation,
or similar proceeding;
(iii) The instrument has no maturity date, can only be redeemed via
discretionary repurchases with the prior approval of FHFA to the extent
otherwise required by law or regulation, and does not contain any term
or feature that creates an incentive to redeem;
(iv) The Enterprise did not create at issuance of the instrument
through any action or communication an expectation that it will buy
back, cancel, or redeem the instrument, and the instrument does not
include any term or feature that might give rise to such an
expectation;
(v) Any cash dividend payments on the instrument are paid out of
the Enterprise's net income, retained earnings, or surplus related to
common stock, and are not subject to a limit imposed by the contractual
terms governing the instrument.
(vi) The Enterprise has full discretion at all times to refrain
from paying any dividends and making any other distributions on the
instrument without triggering an event of default, a requirement to
make a payment-in-kind, or an imposition of any other restrictions on
the Enterprise;
(vii) Dividend payments and any other distributions on the
instrument may be paid only after all legal and contractual obligations
of the Enterprise have been satisfied, including payments due on more
senior claims;
(viii) The holders of the instrument bear losses as they occur
equally, proportionately, and simultaneously with the holders of all
other common stock instruments before any losses are borne by holders
of claims on the Enterprise with greater priority in a receivership,
insolvency, liquidation, or similar proceeding;
(ix) The paid-in amount is classified as equity under GAAP;
(x) The Enterprise, or an entity that the Enterprise controls, did
not purchase or directly or indirectly fund the purchase of the
instrument;
(xi) The instrument is not secured, not covered by a guarantee of
the Enterprise or of an affiliate of the Enterprise, and is not subject
to any other arrangement that legally or economically enhances the
seniority of the instrument;
(xii) The instrument has been issued in accordance with applicable
laws and regulations; and
(xiii) The instrument is reported on the Enterprise's regulatory
financial statements separately from other capital instruments.
(2) Retained earnings.
(3) Accumulated other comprehensive income (AOCI) as reported under
GAAP.\4\
---------------------------------------------------------------------------

\4\ See Sec. 1240.22 for specific adjustments related to AOCI.
---------------------------------------------------------------------------

(4) Notwithstanding the criteria for common stock instruments
referenced above, an Enterprise's common stock issued and held in trust
for the benefit of its employees as part of an employee stock ownership
plan does not violate any of the criteria in paragraphs (b)(1)(iii),
(b)(1)(iv) or (b)(1)(xi) of this section, provided that any repurchase
of the stock is required solely by virtue of ERISA for an instrument of
an Enterprise that is not publicly-traded. In addition, an instrument
issued by an Enterprise to its employee stock ownership plan does not
violate the criterion in paragraph (b)(1)(x) of this section.
(c) Additional tier 1 capital. Additional tier 1 capital is the sum
of additional tier 1 capital elements and any related surplus, minus
the regulatory adjustments and deductions in Sec. 1240.22. Additional
tier 1 capital elements are:
(1) Subject to paragraph (e)(2) of this section, instruments (plus
any related surplus) that meet the following criteria:
(i) The instrument is issued and paid-in;
(ii) The instrument is subordinated to general creditors and
subordinated debt holders of the Enterprise in a receivership,
insolvency, liquidation, or similar proceeding;
(iii) The instrument is not secured, not covered by a guarantee of
the Enterprise or of an affiliate of the Enterprise, and not subject to
any other arrangement that legally or economically enhances the
seniority of the instrument;
(iv) The instrument has no maturity date and does not contain a
dividend step-up or any other term or feature that creates an incentive
to redeem; and
(v) If callable by its terms, the instrument may be called by the
Enterprise only after a minimum of five years following issuance,
except that the terms of the instrument may allow it to be called
earlier than five years upon the occurrence of a regulatory event that
precludes the instrument from being included in additional tier 1
capital, a tax event, or if the issuing entity is required to register
as an investment company pursuant to the Investment Company Act of 1940
(15 U.S.C. 80a-1 et seq.). In addition:
(A) The Enterprise must receive prior approval from FHFA to
exercise a call option on the instrument.
(B) The Enterprise does not create at issuance of the instrument,
through any action or communication, an expectation that the call
option will be exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the Enterprise must either: Replace the instrument to be called with an
equal amount of instruments that meet the criteria under paragraph (b)
of this section or this paragraph (c); \5\ or demonstrate to the
satisfaction of FHFA that following redemption, the Enterprise will
continue to hold capital commensurate with its risk.
---------------------------------------------------------------------------

\5\ Replacement can be concurrent with redemption of existing
additional tier 1 capital instruments.
---------------------------------------------------------------------------

(vi) Redemption or repurchase of the instrument requires prior
approval from FHFA.
(vii) The Enterprise has full discretion at all times to cancel
dividends or other distributions on the instrument without triggering
an event of default, a requirement to make a payment-in-kind, or an
imposition of other restrictions on the Enterprise except in relation
to any distributions to holders of common stock or instruments that are
pari passu with the instrument.
(viii) Any distributions on the instrument are paid out of the
Enterprise's net income, retained earnings, or surplus related to other
additional tier 1 capital instruments.
(ix) The instrument does not have a credit-sensitive feature, such
as a dividend rate that is reset periodically based in whole or in part
on the Enterprise's credit quality, but may have a dividend rate that
is adjusted periodically independent of the Enterprise's credit
quality, in relation to general market interest rates or similar
adjustments.
(x) The paid-in amount is classified as equity under GAAP.

[[Page 39371]]

(xi) The Enterprise, or an entity that the Enterprise controls, did
not purchase or directly or indirectly fund the purchase of the
instrument.
(xii) The instrument does not have any features that would limit or
discourage additional issuance of capital by the Enterprise, such as
provisions that require the Enterprise to compensate holders of the
instrument if a new instrument is issued at a lower price during a
specified time frame.
(xiii) If the instrument is not issued directly by the Enterprise
or by a subsidiary of the Enterprise that is an operating entity, the
only asset of the issuing entity is its investment in the capital of
the Enterprise, and proceeds must be immediately available without
limitation to the Enterprise or to the Enterprise's top-tier holding
company in a form which meets or exceeds all of the other criteria for
additional tier 1 capital instruments.\6\
---------------------------------------------------------------------------

\6\ De minimis assets related to the operation of the issuing
entity can be disregarded for purposes of this criterion.
---------------------------------------------------------------------------

(xiv) The governing agreement, offering circular, or prospectus of
an instrument issued after [the effective date of the final rule] must
disclose that the holders of the instrument may be fully subordinated
to interests held by the U.S. government in the event that the
Enterprise enters into a receivership, insolvency, liquidation, or
similar proceeding.
(2) Notwithstanding the criteria for additional tier 1 capital
instruments referenced above, an instrument issued by an Enterprise and
held in trust for the benefit of its employees as part of an employee
stock ownership plan does not violate any of the criteria in paragraph
(c)(1)(iii) of this section, provided that any repurchase is required
solely by virtue of ERISA for an instrument of an Enterprise that is
not publicly-traded. In addition, an instrument issued by an Enterprise
to its employee stock ownership plan does not violate the criteria in
paragraphs (c)(1)(v) or (c)(1)(xi) of this section.
(d) Tier 2 Capital. Tier 2 capital is the sum of tier 2 capital
elements and any related surplus, minus the regulatory adjustments and
deductions in Sec. 1240.22. Tier 2 capital elements are:
(1) Subject to paragraph (e)(2) of this section, instruments (plus
related surplus) that meet the following criteria:
(i) The instrument is issued and paid-in.
(ii) The instrument is subordinated to general creditors of the
Enterprise.
(iii) The instrument is not secured, not covered by a guarantee of
the Enterprise or of an affiliate of the Enterprise, and not subject to
any other arrangement that legally or economically enhances the
seniority of the instrument in relation to more senior claims.
(iv) The instrument has a minimum original maturity of at least
five years. At the beginning of each of the last five years of the life
of the instrument, the amount that is eligible to be included in tier 2
capital is reduced by 20 percent of the original amount of the
instrument (net of redemptions) and is excluded from regulatory capital
when the remaining maturity is less than one year. In addition, the
instrument must not have any terms or features that require, or create
significant incentives for, the Enterprise to redeem the instrument
prior to maturity.\7\
---------------------------------------------------------------------------

\7\ An instrument that by its terms automatically converts into
a tier 1 capital instrument prior to five years after issuance
complies with the five-year maturity requirement of this criterion.
---------------------------------------------------------------------------

(v) The instrument, by its terms, may be called by the Enterprise
only after a minimum of five years following issuance, except that the
terms of the instrument may allow it to be called sooner upon the
occurrence of an event that would preclude the instrument from being
included in tier 2 capital, a tax event. In addition:
(A) The Enterprise must receive the prior approval of FHFA to
exercise a call option on the instrument.
(B) The Enterprise does not create at issuance, through action or
communication, an expectation the call option will be exercised.
(C) Prior to exercising the call option, or immediately thereafter,
the Enterprise must either: Replace any amount called with an
equivalent amount of an instrument that meets the criteria for
regulatory capital under this section; \8\ or demonstrate to the
satisfaction of FHFA that following redemption, the Enterprise would
continue to hold an amount of capital that is commensurate with its
risk.
---------------------------------------------------------------------------

\8\ An Enterprise may replace tier 2 capital instruments
concurrent with the redemption of existing tier 2 capital
instruments.
---------------------------------------------------------------------------

(vi) The holder of the instrument must have no contractual right to
accelerate payment of principal or interest on the instrument, except
in the event of a receivership, insolvency, liquidation, or similar
proceeding of the Enterprise.
(vii) The instrument has no credit-sensitive feature, such as a
dividend or interest rate that is reset periodically based in whole or
in part on the Enterprise's credit standing, but may have a dividend
rate that is adjusted periodically independent of the Enterprise's
credit standing, in relation to general market interest rates or
similar adjustments.
(viii) The Enterprise, or an entity that the Enterprise controls,
has not purchased and has not directly or indirectly funded the
purchase of the instrument.
(ix) If the instrument is not issued directly by the Enterprise or
by a subsidiary of the Enterprise that is an operating entity, the only
asset of the issuing entity is its investment in the capital of the
Enterprise, and proceeds must be immediately available without
limitation to the Enterprise or the Enterprise's top-tier holding
company in a form that meets or exceeds all the other criteria for tier
2 capital instruments under this section.\9\
---------------------------------------------------------------------------

\9\ An Enterprise may disregard de minimis assets related to the
operation of the issuing entity for purposes of this criterion.
---------------------------------------------------------------------------

(x) Redemption of the instrument prior to maturity or repurchase
requires the prior approval of FHFA.
(xi) The governing agreement, offering circular, or prospectus of
an instrument issued after [the effective date of the final rule] must
disclose that the holders of the instrument may be fully subordinated
to interests held by the U.S. government in the event that the
Enterprise enters into a receivership, insolvency, liquidation, or
similar proceeding.
(2) Any eligible credit reserves that exceed expected credit losses
to the extent that the excess reserve amount does not exceed 0.6
percent of credit risk-weighted assets.
(e) FHFA approval of a capital element. (1) An Enterprise must
receive FHFA prior approval to include a capital element (as listed in
this section) in its common equity tier 1 capital, additional tier 1
capital, or tier 2 capital unless the element:
(i) Was included in an Enterprise's tier 1 capital or tier 2
capital prior to [the publication date of the proposed rule] and the
underlying instrument may continue to be included under the criteria
set forth in this section; or
(ii) Is equivalent, in terms of capital quality and ability to
absorb losses with respect to all material terms, to a regulatory
capital element FHFA determined may be included in regulatory capital
pursuant to paragraph (e)(3) of this section.
(2) An Enterprise may not include an instrument in its additional
tier 1 capital or a tier 2 capital unless FHFA has determined that the
Enterprise has made appropriate provision, including in any resolution
plan of the Enterprise, to ensure that the instrument would not pose a
material impediment to the

[[Page 39372]]

ability of an Enterprise to issue common stock instruments following
the appointment of FHFA as conservator or receiver under the Safety and
Soundness Act.
(3) After determining that a regulatory capital element may be
included in an Enterprise's common equity tier 1 capital, additional
tier 1 capital, or tier 2 capital, FHFA will make its decision publicly
available, including a brief description of the material terms of the
regulatory capital element and the rationale for the determination.
(f) FHFA prior approval. An Enterprise may not repurchase or redeem
any common equity tier 1 capital, additional tier 1, or tier 2 capital
instrument without the prior approval of FHFA to the extent such prior
approval is required by paragraphs (b), (c), or (d) of this section, as
applicable.

Sec. 1240.21 [Reserved]

Sec. 1240.22 Regulatory capital adjustments and deductions.

(a) Regulatory capital deductions from common equity tier 1
capital. An Enterprise must deduct from the sum of its common equity
tier 1 capital elements the items set forth in this paragraph (a):
(1) Goodwill, net of associated deferred tax liabilities (DTLs) in
accordance with paragraph (e) of this section, including goodwill that
is embedded in the valuation of a significant investment in the capital
of an unconsolidated financial institution in the form of common stock
(and that is reflected in the consolidated financial statements of the
Enterprise), in accordance with paragraph (d) of this section;
(2) Intangible assets, other than MSAs, net of associated DTLs in
accordance with paragraph (e) of this section;
(3) Deferred tax assets (DTAs) that arise from net operating loss
and tax credit carryforwards net of any related valuation allowances
and net of DTLs in accordance with paragraph (e) of this section;
(4) Any gain-on-sale in connection with a securitization exposure;
(5) Any defined benefit pension fund net asset, net of any
associated DTL in accordance with paragraph (e) of this section, held
by the Enterprise. With the prior approval of FHFA, this deduction is
not required for any defined benefit pension fund net asset to the
extent the Enterprise has unrestricted and unfettered access to the
assets in that fund. An Enterprise must risk weight any portion of the
defined benefit pension fund asset that is not deducted under this
paragraph (a) as if the Enterprise directly holds a proportional
ownership share of each exposure in the defined benefit pension fund.
(6) The amount of expected credit loss that exceeds its eligible
credit reserves.
(b) Regulatory adjustments to common equity tier 1 capital. (1) An
Enterprise must adjust the sum of common equity tier 1 capital elements
pursuant to the requirements set forth in this paragraph (b). Such
adjustments to common equity tier 1 capital must be made net of the
associated deferred tax effects.
(i) An Enterprise must deduct any accumulated net gains and add any
accumulated net losses on cash flow hedges included in AOCI that relate
to the hedging of items that are not recognized at fair value on the
balance sheet.
(ii) An Enterprise must deduct any net gain and add any net loss
related to changes in the fair value of liabilities that are due to
changes in the Enterprise's own credit risk. An Enterprise must deduct
the difference between its credit spread premium and the risk-free rate
for derivatives that are liabilities as part of this adjustment.
(c) Deductions from regulatory capital related to investments in
capital instruments.\10\ An Enterprise must deduct an investment in the
Enterprise's own capital instruments as follows:
---------------------------------------------------------------------------

\10\ The Enterprise must calculate amounts deducted under
paragraphs (c) through (f) of this section after it calculates the
amount of ALLL or AACL, as applicable, includable in tier 2 capital
under Sec. 1240.20(d).
---------------------------------------------------------------------------

(1) An Enterprise must deduct an investment in the Enterprise's own
common stock instruments from its common equity tier 1 capital elements
to the extent such instruments are not excluded from regulatory capital
under Sec. 1240.20(b)(1);
(2) An Enterprise must deduct an investment in the Enterprise's own
additional tier 1 capital instruments from its additional tier 1
capital elements; and
(3) An Enterprise must deduct an investment in the Enterprise's own
tier 2 capital instruments from its tier 2 capital elements.
(d) Items subject to the 10 and 15 percent common equity tier 1
capital deduction thresholds. (1) An Enterprise must deduct from common
equity tier 1 capital elements the amount of each of the items set
forth in this paragraph (d) that, individually, exceeds 10 percent of
the sum of the Enterprise's common equity tier 1 capital elements, less
adjustments to and deductions from common equity tier 1 capital
required under paragraphs (a) through (c) of this section (the 10
percent common equity tier 1 capital deduction threshold).
(i) DTAs arising from temporary differences that the Enterprise
could not realize through net operating loss carrybacks, net of any
related valuation allowances and net of DTLs, in accordance with
paragraph (e) of this section. An Enterprise is not required to deduct
from the sum of its common equity tier 1 capital elements DTAs (net of
any related valuation allowances and net of DTLs, in accordance with
paragraph (e) of this section) arising from timing differences that the
Enterprise could realize through net operating loss carrybacks. The
Enterprise must risk weight these assets at 100 percent.
(ii) MSAs net of associated DTLs, in accordance with paragraph (e)
of this section.
(2) An Enterprise must deduct from common equity tier 1 capital
elements the items listed in paragraph (d)(1) of this section that are
not deducted as a result of the application of the 10 percent common
equity tier 1 capital deduction threshold, and that, in aggregate,
exceed 17.65 percent of the sum of the Enterprise's common equity tier
1 capital elements, minus adjustments to and deductions from common
equity tier 1 capital required under paragraphs (a) through (c) of this
section, minus the items listed in paragraph (d)(1) of this section
(the 15 percent common equity tier 1 capital deduction threshold).\11\
---------------------------------------------------------------------------

\11\ The amount of the items in paragraph (d) of this section
that is not deducted from common equity tier 1 capital pursuant to
this section must be included in the risk-weighted assets of the
Enterprise and assigned a 250 percent risk weight.
---------------------------------------------------------------------------

(3) For purposes of calculating the amount of DTAs subject to the
10 and 15 percent common equity tier 1 capital deduction thresholds, an
Enterprise may exclude DTAs and DTLs relating to adjustments made to
common equity tier 1 capital under paragraph (b) of this section. An
Enterprise that elects to exclude DTAs relating to adjustments under
paragraph (b) of this section also must exclude DTLs and must do so
consistently in all future calculations. An Enterprise may change its
exclusion preference only after obtaining the prior approval of FHFA.
(e) Netting of DTLs against assets subject to deduction. (1) Except
as described in paragraph (e)(3) of this section, netting of DTLs
against assets that are subject to deduction under this section is
permitted, but not required, if the following conditions are met:
(i) The DTL is associated with the asset; and

[[Page 39373]]

(ii) The DTL would be extinguished if the associated asset becomes
impaired or is derecognized under GAAP.
(2) A DTL may only be netted against a single asset.
(3) For purposes of calculating the amount of DTAs subject to the
threshold deduction in paragraph (d) of this section, the amount of
DTAs that arise from net operating loss and tax credit carryforwards,
net of any related valuation allowances, and of DTAs arising from
temporary differences that the Enterprise could not realize through net
operating loss carrybacks, net of any related valuation allowances, may
be offset by DTLs (that have not been netted against assets subject to
deduction pursuant to paragraph (e)(1) of this section) subject to the
conditions set forth in this paragraph (e).
(i) Only the DTAs and DTLs that relate to taxes levied by the same
taxation authority and that are eligible for offsetting by that
authority may be offset for purposes of this deduction.
(ii) The amount of DTLs that the Enterprise nets against DTAs that
arise from net operating loss and tax credit carryforwards, net of any
related valuation allowances, and against DTAs arising from temporary
differences that the Enterprise could not realize through net operating
loss carrybacks, net of any related valuation allowances, must be
allocated in proportion to the amount of DTAs that arise from net
operating loss and tax credit carryforwards (net of any related
valuation allowances, but before any offsetting of DTLs) and of DTAs
arising from temporary differences that the Enterprise could not
realize through net operating loss carrybacks (net of any related
valuation allowances, but before any offsetting of DTLs), respectively.
(4) An Enterprise must net DTLs against assets subject to deduction
under this section in a consistent manner from reporting period to
reporting period. An Enterprise may change its preference regarding the
manner in which it nets DTLs against specific assets subject to
deduction under this section only after obtaining the prior approval of
FHFA.
(f) Insufficient amounts of a specific regulatory capital component
to effect deductions. Under the corresponding deduction approach, if an
Enterprise does not have a sufficient amount of a specific component of
capital to effect the required deduction after completing the
deductions required under paragraph (d) of this section, the Enterprise
must deduct the shortfall from the next higher (that is, more
subordinated) component of regulatory capital.
(g) Treatment of assets that are deducted. An Enterprise must
exclude from standardized total risk-weighted assets and advanced
approaches total risk-weighted assets any item deducted from regulatory
capital under paragraphs (a), (c), and (d) of this section.

Subpart D--Risk-Weighted Assets--Standardized Approach

Sec. 1240.30 Applicability.

(a) This subpart sets forth methodologies for determining risk-
weighted assets for purposes of the generally applicable risk-based
capital requirements for the Enterprises.
(b) This subpart is also applicable to covered positions, as
defined in subpart F of this part.

Risk-Weighted Assets For General Credit Risk

Sec. 1240.31 Mechanics for calculating risk-weighted assets for
general credit risk.

(a) General risk-weighting requirements. An Enterprise must apply
risk weights to its exposures as follows:
(1) An Enterprise must determine the exposure amount of each
mortgage exposure, each other on-balance sheet exposure, each OTC
derivative contract, and each off-balance sheet commitment, trade and
transaction-related contingency, guarantee, repo-style transaction,
forward agreement, or other similar transaction that is not:
(i) An unsettled transaction subject to Sec. 1240.40;
(ii) A cleared transaction subject to Sec. 1240.37;
(iii) A default fund contribution subject to Sec. 1240.37;
(iv) A retained CRT exposure, acquired CRT exposure, or other
securitization exposure subject to Sec. Sec. 1240.41 through 1240.46;
or
(v) An equity exposure (other than an equity OTC derivative
contract) subject to Sec. 1240.51.
(2) An Enterprise must multiply each exposure amount by the risk
weight appropriate to the exposure based on the exposure type or
counterparty, eligible guarantor, or financial collateral to determine
the risk-weighted asset amount for each exposure.
(b) Total risk-weighted assets for general credit risk. Total risk-
weighted assets for general credit risk equals the sum of the risk-
weighted asset amounts calculated under this section.

Sec. 1240.32 General risk weights.

(a) Exposures to the U.S. government. (1) Notwithstanding any other
requirement in this subpart, an Enterprise must assign a zero percent
risk weight to:
(i) An exposure to the U.S. government, its central bank, or a U.S.
government agency; and
(ii) The portion of an exposure that is directly and
unconditionally guaranteed by the U.S. government, its central bank, or
a U.S. government agency. This includes a deposit or other exposure, or
the portion of a deposit or other exposure, that is insured or
otherwise unconditionally guaranteed by the FDIC or NCUA.
(2) An Enterprise must assign a 20 percent risk weight to the
portion of an exposure that is conditionally guaranteed by the U.S.
government, its central bank, or a U.S. government agency. This
includes an exposure, or the portion of an exposure, that is
conditionally guaranteed by the FDIC or NCUA.
(b) Certain supranational entities and multilateral development
banks (MDBs). An Enterprise must assign a zero percent risk weight to
an exposure to the Bank for International Settlements, the European
Central Bank, the European Commission, the International Monetary Fund,
the European Stability Mechanism, the European Financial Stability
Facility, or an MDB.
(c) Exposures to GSEs. (1) An Enterprise must assign a zero percent
risk weight to any MBS guaranteed by the Enterprise (other than any
retained CRT exposure).
(2) An Enterprise must assign a 20 percent risk weight to an
exposure to another GSE, including an MBS guaranteed by the other
Enterprise, other than an equity exposure or preferred stock.
(d) Exposures to depository institutions and credit unions. (1) An
Enterprise must assign a 20 percent risk weight to an exposure to a
depository institution or credit union that is organized under the laws
of the United States or any state thereof, except as otherwise provided
under paragraph (d)(2) of this section.
(2) An Enterprise must assign a 100 percent risk weight to an
exposure to a financial institution if the exposure may be included in
that financial institution's capital unless the exposure is:
(i) An equity exposure; or
(ii) Deducted from regulatory capital under Sec. 1240.22.
(e) Exposures to U.S. public sector entities (PSEs). (1) An
Enterprise must assign a 20 percent risk weight to a general obligation
exposure to a PSE that is organized under the laws of the United States
or any state or political subdivision thereof.
(2) An Enterprise must assign a 50 percent risk weight to a revenue

[[Page 39374]]

obligation exposure to a PSE that is organized under the laws of the
United States or any state or political subdivision thereof.
(f) Corporate exposures. An Enterprise must assign a 100 percent
risk weight to all its corporate exposures.
(g) Residential mortgage exposures--(1) Single-family mortgage
exposures. An Enterprise must assign a risk weight to a single-family
mortgage exposure in accordance with Sec. 1240.33.
(2) Multifamily mortgage exposures. An Enterprise must assign a
risk weight to a multifamily mortgage exposure in accordance with Sec.
1240.34.
(h) Past due exposures. Except for an exposure to a sovereign
entity or a mortgage exposure, if an exposure is 90 days or more past
due or on nonaccrual:
(1) An Enterprise must assign a 150 percent risk weight to the
portion of the exposure that is not guaranteed or that is unsecured;
(2) An Enterprise may assign a risk weight to the guaranteed
portion of a past due exposure based on the risk weight that applies
under Sec. 1240.38 if the guarantee or credit derivative meets the
requirements of that section; and
(3) An Enterprise may assign a risk weight to the collateralized
portion of a past due exposure based on the risk weight that applies
under Sec. 1240.39 if the collateral meets the requirements of that
section.
(i) Other assets. (1) An Enterprise must assign a zero percent risk
weight to cash owned and held in the offices of an insured depository
institution or in transit.
(2) An Enterprise must assign a 20 percent risk weight to cash
items in the process of collection.
(3) An Enterprise must assign a 100 percent risk weight to DTAs
arising from temporary differences that the Enterprise could realize
through net operating loss carrybacks.
(4) An Enterprise must assign a 250 percent risk weight to the
portion of each of the following items to the extent it is not deducted
from common equity tier 1 capital pursuant to Sec. 1240.22(d):
(i) MSAs; and
(ii) DTAs arising from temporary differences that the Enterprise
could not realize through net operating loss carrybacks.
(5) An Enterprise must assign a 100 percent risk weight to all
assets not specifically assigned a different risk weight under this
subpart and that are not deducted from tier 1 or tier 2 capital
pursuant to Sec. 1240.22.
(j) Insurance assets. (1) An Enterprise must risk-weight the
individual assets held in a separate account that does not qualify as a
non-guaranteed separate account as if the individual assets were held
directly by the Enterprise.
(2) An Enterprise must assign a zero percent risk weight to an
asset that is held in a non-guaranteed separate account.

Sec. 1240.33 Single-family mortgage exposures.

(a) Definitions. Subject to any additional instructions set forth
on Table 1 to this paragraph (a), for purposes of this section:
Adjusted MTMLTV means, with respect to a single-family mortgage
exposure, the amount equal to:
(i) The MTMLTV of the single-family mortgage exposure (or, if the
loan age of the single-family mortgage exposure is less than 6, the
OLTV of the single-family mortgage exposure); divided by
(ii) The amount equal to 1 plus the single-family countercyclical
adjustment of the single-family mortgage exposure.
Approved insurer means an insurance company that is currently
approved by an Enterprise to guarantee or insure single-family mortgage
exposures acquired by the Enterprise.
Cancellable mortgage insurance means a mortgage insurance policy
that, pursuant to its terms, may or will be terminated before the
maturity date of the insured single-family mortgage exposure, including
as required or permitted by the Homeowners Protection Act of 1998 (12
U.S.C. 4901).
Charter-level coverage means mortgage insurance that satisfies the
minimum requirements of the authorizing statute of an Enterprise.
Cohort burnout means the number of refinance opportunities since
the loan age of the single-family mortgage exposure was 6, categorized
into ranges pursuant to the instructions set forth on Table 1 to this
paragraph (a).
Coverage percent means, with respect to mortgage insurance or a
recourse agreement, the percent of the sum of the unpaid principal
balance, any lost interest, and any foreclosure costs that is used to
determine the benefit or other coverage under a mortgage insurance
policy or recourse agreement.
Days past due means the number of days a single-family mortgage
exposure is past due.
Debt-to-income ratio (DTI) means the ratio of a borrower's total
monthly obligations (including housing expense) divided by the
borrower's monthly income, as calculated under the Guide of the
Enterprise.
Deflated single-family house price index (DeflatedSFHPI) means the
amount equal to:
(i) The most recently available FHFA quarterly, not-seasonally-
adjusted U.S. all transactions house price index; divided by
(ii) The average quarterly observation from the Consumer Price
Index for All Urban Consumers, All Items Less Shelter in U.S. City
Average, that corresponds to the same quarter.
Full recourse agreement means a recourse agreement that provides
for a coverage percent of 100 percent and has a term of the coverage
that is equal to the life of the single-family mortgage exposure.
Guide means, as applicable, the Fannie Mae Single Family Selling
Guide, the Fannie Mae Single Family Servicing Guide and the Freddie Mac
Single-family Seller/Servicers Guide.
Guide-level coverage means mortgage insurance that satisfies the
requirements of the Guide of the Enterprise with respect to mortgage
insurance that has a coverage percent that exceeds charter-level
coverage.
Interest-only (IO) means a single-family mortgage exposure that
requires only payment of interest without any principal amortization
during all or part of the loan term.
Loan age means the number of scheduled payment dates since the
origination of a single-family mortgage exposure.
Loan-level credit enhancement means:
(i) Mortgage insurance;
(ii) A recourse agreement; or
(iii) A participation agreement.
Loan documentation means the completeness of the documentation used
to underwrite a single-family mortgage exposure, as determined under
the Guide of the Enterprise.
Loan purpose means the purpose of a single-family mortgage exposure
at origination.
Long-run single-family house price index trend (LRSFHPITrend)
means,

LRSFHPITrend =
1.0873681e^{0.00294746 * (Number of Quarters)}

where equal to the number of quarters from 1975Q1 to the given
reporting quarter and where 1975Q1 is counted as one.
MI cancellation feature means an indicator for whether mortgage
insurance is cancellable mortgage insurance or non-cancellable mortgage
insurance, assigned pursuant to the instructions set forth on Table 1
to this paragraph (a).
Modification means:
(i) Any permanent amendment or other change to the interest rate,
maturity date, unpaid principal balance, or other contractual term of a
single-family mortgage exposure; or
(ii) Entry into any repayment plan with respect to any amounts that
are

[[Page 39375]]

past due under the terms of a single-family mortgage exposure.
Modified re-performing loan (modified RPL) means a single-family
mortgage exposure (other than an NPL) that has been subject to a
modification.
Months since last modification means the number of scheduled
payment dates since the effective date of the last modification of a
single-family mortgage exposure.
Mortgage concentration risk means the extent to which a mortgage
insurer or other counterparty is exposed to mortgage credit risk
relative to other risks.
MTMLTV means, with respect to a single-family mortgage exposure,
the amount equal to:
(i) The unpaid principal balance of the single-family mortgage
exposure; divided by
(ii) The amount equal to:
(A) The unpaid principal balance of the single-family mortgage
exposure at origination; divided by
(B) The OLTV of the single-family mortgage exposure; multiplied by
(C) The most recently available FHFA Purchase-only State-level
House Price Index of the State in which the property securing the
singe-family mortgage exposure is located; divided by
(D) The FHFA Purchase-only State-level House Price Index, as of
date of the origination of the single-family mortgage exposure, in
which the property securing the singe-family mortgage exposure is
located.
Non-cancellable mortgage insurance means a mortgage insurance
policy that, pursuant to its terms, may not be terminated before the
maturity date of the insured single-family mortgage exposure.
Non-modified re-performing loan (non-modified RPL) means a single-
family mortgage exposure (other than a modified RPL or an NPL) that was
previously an NPL at any time in the prior 48 calendar months.
Non-performing loan (NPL) means a single-family mortgage exposure
that is 60 days or more past due.
Occupancy type means the borrowers' intended use of the property
securing a single-family mortgage exposure.
Original credit score means the borrower's credit score as of the
origination date of a single-family mortgage exposure.
OLTV means, with respect to a single-family mortgage exposure, the
amount equal to:
(i) The unpaid principal balance of the single-family mortgage
exposure at origination; divided by
(ii) The lesser of:
(A) The appraised value of the property securing the single-family
mortgage exposure; and
(B) The sale price of the property securing the single-family
mortgage exposure.
Origination channel means the type of institution that originated a
single-family mortgage exposure, assigned pursuant to the instructions
set forth on Table 1 to this paragraph (a).
Partial recourse agreement means a recourse agreement that is not a
full recourse agreement.
Participation agreement means, with respect to a single-family
mortgage exposure, any agreement between an Enterprise and the seller
of the single-family mortgage exposure pursuant to which the seller
retains a participation of not less than 10 percent in the single-
family mortgage exposure.
Past due means, with respect to a single-family mortgage exposure,
that any amount required to be paid by the borrower under the terms of
the single-family mortgage exposure has not been paid.
Payment change from modification means the amount, expressed as a
percent, equal to:
(i) The amount equal to:
(A) The monthly payment of a single-family mortgage exposure after
a modification; divided by
(B) The monthly payment of the single-family mortgage exposure
before the modification; minus
(ii) 1.0.
Percentage difference between DeflatedSFHPI and LRSFHPITrend
(DiffLRSFHPITrend%) means
[GRAPHIC] [TIFF OMITTED] TP30JN20.047

Performing loan means any single-family mortgage exposure that is
not an NPL, a modified RPL, or a non-modified RPL.
Previous maximum days past due means the maximum number of days a
modified RPL or non-modified RPL was past due in the prior 36 calendar
months.
Product type means an indicator reflecting the contractual terms of
a single-family mortgage exposure as of the origination date, assigned
pursuant to the instructions set forth on Table 1 to this paragraph
(a).
Property type means the physical structure of the property securing
a single-family mortgage exposure.
Recourse agreement means, with respect to a single-family mortgage
exposure, any agreement (other than a participation agreement) between
an Enterprise and the seller of the single-family mortgage exposure
pursuant to which the seller agrees either to reimburse the Enterprise
for any loss arising out of the default of single-family mortgage
exposure or to repurchase or replace the single-family mortgage
exposure in the event of the default of the single-family mortgage
exposure.
Refinance opportunity means, with respect to a single-family
mortgage exposure, any calendar month in which the Primary Mortgage
Market Survey (PMMS) rate for the month and year of the origination of
the single-family mortgage exposure exceeds the PMMS rate for that
calendar month by more than 50 basis points.
Refreshed credit score means the borrower's most recently available
credit score.
Single-family countercyclical adjustment (SFCCyCAdj%) means

[[Page 39376]]

if DiffLRSFHPITrend% is greater than 5% then
[GRAPHIC] [TIFF OMITTED] TP30JN20.048

if DiffLRSFHPITrend% is less than -5% then
[GRAPHIC] [TIFF OMITTED] TP30JN20.049

Otherwise SFCCyCAdj% = 0%.

Streamlined refi means a single-family mortgage exposure that was
refinanced through a streamlined refinance program of an Enterprise,
including the Home Affordable Refinance Program, Relief Refi, and Refi-
Plus.
Subordination means, with respect to a single-family mortgage
exposure, the amount equal to the original unpaid principal balance of
any second lien single-family mortgage exposure divided by the lesser
of the appraised value or sale price of the property that secures the
single-family mortgage exposure.

Table 1 to Paragraph (a): Permissible Values and Additional Instructions
------------------------------------------------------------------------
Additional
Defined term Permissible values instructions
------------------------------------------------------------------------
Cohort burnout.............. ``No burnout,'' if High if unable to
the single-family determine.
mortgage exposure
has not had a
refinance
opportunity since
the loan age of the
single-family
mortgage exposure
was 6.
``Low,'' if the
single-family
mortgage exposure
has had 12 or fewer
refinance
opportunities since
the loan age of the
single-family
mortgage exposure
was 6.
``Medium,'' if the
single-family
mortgage exposure
has had between 13
and 24 refinance
opportunities since
the loan age of the
single-family
mortgage exposure
was 6.
``High,'' if the
single-family
mortgage exposure
has had more than
24 refinance
opportunities since
the loan age of the
single-family
mortgage exposure
was 6.
Coverage percent............ 0 percent <= 0 percent if outside
coverage percent <= of permissible
100 percent. range or unable to
determine.
Days past due............... Non-negative integer 210 if negative or
unable to
determine.
Debt-to-income (DTI) ratio.. 0 percent < DTI < 42 percent if
100 percent. outside of
permissible range
or unable to
determine.
Interest-only (IO).......... Yes, no............. Yes if unable to
determine.
Loan age.................... 0 <= loan age <= 500 500 if outside of
permissible range
or unable to
determine.
Loan documentation.......... None, low, full..... None if unable to
determine.
Loan purpose................ Purchase, cashout Cashout refinance if
refinance, rate/ unable to
term refinance. determine.
MTMLTV...................... 0 percent < MTMLTV If the property
<= 300 percent. securing the single-
family mortgage
exposure is located
in Puerto Rico or
the U.S. Virgin
Islands, use the
FHFA House Price
Index of the United
States.
If the property
securing the single-
family mortgage
exposure is located
in Hawaii, use the
FHFA Purchase-only
State-level House
Price Index of
Guam.
If the single-family
mortgage exposure
was originated
before 1991, use
the Enterprise's
proprietary housing
price index.
Use geometric
interpolation to
convert quarterly
housing price index
data to monthly
data.
300 percent if
outside of
permissible range
or unable to
determine.
Mortgage concentration risk. High, not high...... High if unable to
determine.
MI cancellation feature..... Cancellable mortgage Cancellable mortgage
insurance, non- insurance, if
cancellable unable to
mortgage insurance. determine.
Occupancy type.............. Investment, owner- Investment if unable
occupied, second to determine.
home.
OLTV........................ 0 percent < OLTV <= 300 percent if
300 percent. outside of
permissible range
or unable to
determine.

[[Page 39377]]

Original credit score....... 300 <= original If there are credit
credit score <= 850. scores from
multiple credit
repositories for a
borrower, use the
following logic to
determine a single
original credit
score:
If there
are credit
scores from two
repositories,
take the lower
credit score.
If there
are credit
scores from
three
repositories,
use the middle
credit score.
If there
are credit
scores from
three
repositories and
two of the
credit scores
are identical,
use the
identical credit
score.
If there are
multiple borrowers,
use the following
logic to determine
a single original
credit score:
Using
the logic above,
determine a
single credit
score for each
borrower.
Select
the lowest
single credit
score across all
borrowers.
600 if outside of
permissible range
or unable to
determine.
Origination channel......... Retail, third-party TPO includes broker
origination (TPO). and correspondent
channels.
TPO if unable to
determine.
Payment change from -80 percent < If the single-family
modification. payment change from mortgage exposure
modification < 50 initially had an
percent. adjustable or step-
rate feature, the
monthly payment
after a permanent
modification is
calculated using
the initial
modified rate.
0 percent if unable
to determine.
-79 percent if less
than or equal to -
80 percent.
49 percent if
greater than or
equal to 50
percent.
Previous maximum days past Non-negative integer 181 months if
due. negative or unable
to determine.
Product type................ ``FRM30'' means a Product types other
fixed-rate single- than FRM30, FRM20,
family mortgage FRM15 or ARM1/1
exposure with an should be assigned
original to FRM30.
amortization term Use the post-
greater than 309 modification
months and less product type for
than or equal to modified mortgage
429 months. exposures.
``FRM20'' means a ARM1/1 if unable to
fixed-rate single- determine.
family mortgage
exposure with an
original
amortization term
greater than 189
months and less
than or equal to
309 months.
``FRM15'' means a
fixed-rate single-
family mortgage
exposure with an
original
amortization term
less than or equal
to 189 months.
``ARM1/1'' is an
adjustable-rate
single-family
mortgage exposure
that has a mortgage
rate and required
payment that adjust
annually.
Property type............... 1-unit, 2-4 units, Use condominium for
condominium, cooperatives.
manufactured home. 2-4 units if unable
to determine.
Refreshed credit score...... 300 <= refreshed If there are credit
credit score <= 850. scores from
multiple credit
repositories for a
borrower, use the
following logic to
determine a single
refreshed credit
score:
If there
are credit
scores from two
repositories,
take the lower
credit score.
If there
are credit
scores from
three
repositories,
use the middle
credit score.
If there
are credit
scores from
three
repositories and
two of the
credit scores
are identical,
use the
identical credit
score.
If there are
multiple borrowers,
use the following
logic to determine
a single Original
Credit Score:
Using
the logic above,
determine a
single credit
score for each
borrower.
Select
the lowest
single credit
score across all
borrowers.
600 if outside of
permissible range
or unable to
determine.
Streamlined refi............ Yes, no............. No if unable to
determine.
Subordination............... 0 percent <= 80 percent if
Subordination <= 80 outside permissible
percent. range.
------------------------------------------------------------------------

(b) Risk weight--(1) In general. Subject to paragraph (b)(2) of
this section, an Enterprise must assign a risk weight to a single-
family mortgage exposure equal to:
(i) The base risk weight for the single-family mortgage exposure as
determined under paragraph (c) of this section; multiplied by
(ii) The combined risk multiplier for the single-family mortgage
exposure as

[[Page 39378]]

determined under paragraph (d) of this section; multiplied by
(iii) The adjusted credit enhancement multiplier for the single-
family mortgage exposure as determined under paragraph (e) of this
section.
(2) Minimum risk weight. Notwithstanding the risk weight determined
under paragraph (b)(1) of this section, the risk weight assigned to a
single-family mortgage exposure may not be less than 15 percent.
(c) Base risk weight--(1) Performing loan. The base risk weight for
a performing loan is set forth on Table 2 to this paragraph (c)(1). For
purposes of this paragraph (c)(1), credit score means, with respect to
a single-family mortgage exposure, (i) the original credit score of the
single-family mortgage exposure, if the loan age of the single-family
mortgage exposure is less than 6, or (ii) the refreshed credit score of
the single-family mortgage exposure.
[GRAPHIC] [TIFF OMITTED] TP30JN20.050

(2) Non-modified RPL. The base risk weight for a non-modified RPL
is set forth on Table 3 to this paragraph (c)(2). For purposes of this
paragraph (c)(2), re-performing duration means, with respect to a non-
modified RPL, the number of scheduled payment dates since the non-
modified RPL was last an NPL.
[GRAPHIC] [TIFF OMITTED] TP30JN20.051

(3) Modified RPL. The base risk weight for a modified RPL is set
forth on Table 4 to this paragraph (c)(3). For purposes of this
paragraph (c)(3), re-performing duration means, with respect to a
modified RPL, the lesser of: (i) The months since last modification of
the modified RPL; and (ii) the number of scheduled payment dates since
the modified RPL was last an NPL.

[[Page 39379]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.052

(4) NPL. The base risk weight for an NPL is set forth on Table 5 to
this paragraph (c)(4).
[GRAPHIC] [TIFF OMITTED] TP30JN20.053

(d) Combined risk multiplier. The combined risk multiplier for a
single-family mortgage exposure is equal to the product of each of the
applicable risk multipliers set forth under the applicable single-
family segment on Table 6 to this paragraph (d).

Table 6 to Paragraph (d): Risk Multipliers
----------------------------------------------------------------------------------------------------------------
Single-family segment
---------------------------------------------------------------
Risk factor Value or range Performing Non-modified
loan RPL Modified RPL NPL
----------------------------------------------------------------------------------------------------------------
Loan Purpose.................. Purchase........ 1.0 1.0 1.0
Cashout 1.4 1.4 1.4
refinance.
Rate/term 1.3 1.2 1.3
refinance.
----------------------------------------------------------------------------------------------------------------
Occupancy Type................ Owner-occupied 1.0 1.0 1.0 1.0
or second home.
Investment...... 1.2 1.5 1.3 1.2
----------------------------------------------------------------------------------------------------------------
Property Type................. 1-unit.......... 1.0 1.0 1.0 1.0
2-4 unit........ 1.4 1.4 1.3 1.1
Condominium..... 1.1 1.0 1.0 1.0
Manufactured 1.3 1.8 1.6 1.2
home.
----------------------------------------------------------------------------------------------------------------
Origination Channel........... Retail.......... 1.0 1.0 1.0 1.0
TPO............. 1.1 1.1 1.1 1.0
----------------------------------------------------------------------------------------------------------------
DTI........................... DTI <= 25%...... 0.8 0.9 0.9
25% < DTI <= 40% 1.0 1.0 1.0
DTI > 40%....... 1.2 1.2 1.1
----------------------------------------------------------------------------------------------------------------
Product Type.................. FRM30........... 1.0 1.0 1.0 1.0
ARM1/1.......... 1.7 1.1 1.0 1.1
FRM15........... 0.3 0.3 0.5 0.5
FRM20........... 0.6 0.6 0.5 0.8
----------------------------------------------------------------------------------------------------------------
Subordination................. No subordination 1.0 1.0 1.0
30% < OLTV <= 1.1 0.8 1.0
60% and.
0% <
subordination
<= 5%.
30% < OLTV <= 1.5 1.1 1.2
60% and
subordination >
5%.
OLTV > 60% and.. 1.1 1.2 1.1
0% <
subordination
<= 5%.

[[Page 39380]]

OLTV > 60% and.. 1.4 1.5 1.3
subordination >
5%.
----------------------------------------------------------------------------------------------------------------
Loan Age...................... Loan age <= 24 1.0
months.
24 months < loan 0.95
age <= 36
months.
36 months < loan 0.80
Age <= 60
months.
Loan age > 60 0.75
months.
----------------------------------------------------------------------------------------------------------------
Cohort Burnout................ No burnout...... 1.0
Low............. 1.2
Medium.......... 1.3
High............ 1.4
----------------------------------------------------------------------------------------------------------------
Interest-only................. No IO........... 1.0 1.0 1.0
Yes IO.......... 1.6 1.4 1.1
----------------------------------------------------------------------------------------------------------------
Loan Documentation............ Full............ 1.0 1.0 1.0
None or low..... 1.3 1.3 1.2
----------------------------------------------------------------------------------------------------------------
Streamlined Refi.............. No.............. 1.0 1.0 1.0
Yes............. 1.0 1.2 1.1
----------------------------------------------------------------------------------------------------------------
Refreshed Credit Score for Refreshed credit .............. 1.6 1.4
Modified RPLs and Non- score < 620.
modified RPLs.
620 <= refreshed .............. 1.3 1.2
credit score <
640.
640 <= refreshed .............. 1.2 1.1
credit score <
660.
660 <= refreshed .............. 1.0 1.0
credit score <
700.
700 <= refreshed .............. 0.7 0.8
credit score <
720.
720 <= refreshed .............. 0.6 0.7
credit score <
740.
740 <= refreshed .............. 0.5 0.6
credit score <
760.
760 <= refreshed .............. 0.4 0.5
credit score <
780.
Refreshed credit .............. 0.3 0.4
score >= 780.
----------------------------------------------------------------------------------------------------------------
Payment Change from Payment change .............. .............. 1.1
Modification. >= 0%.
-20% <= payment .............. .............. 1.0
change < 0%.
-30% <= payment .............. .............. 0.9
change < -20%.
Payment change < .............. .............. 0.8
-30%.
----------------------------------------------------------------------------------------------------------------
Previous Maximum Days Past Due 0-59 days....... .............. 1.0 1.0
60-90 days...... .............. 1.2 1.1
91-150 days..... .............. 1.3 1.1
151+ days....... .............. 1.5 1.1
----------------------------------------------------------------------------------------------------------------
Refreshed Credit Score for Refreshed credit .............. .............. .............. 1.2
NPLs. score < 580.
580 <= refreshed .............. .............. .............. 1.1
credit score <
640.
640 <= refreshed .............. .............. .............. 1.0
credit score <
700.
700 <= refreshed .............. .............. .............. 0.9
credit score <
720.
720 <= refreshed .............. .............. .............. 0.8
credit score <
760.
760 <= refreshed .............. .............. .............. 0.7
credit score <
780.
Refreshed credit .............. .............. .............. 0.5
score >= 780.
----------------------------------------------------------------------------------------------------------------

(e) Credit enhancement multiplier--(1) Amount--(i) In general. The
adjusted credit enhancement multiplier for a single-family mortgage
exposure that is subject to loan-level credit enhancement is equal to
1.0 minus the product of:
(A) 1.0 minus the credit enhancement multiplier for the single-
family mortgage exposure as determined under paragraph (e)(2) of this
section; multiplied by
(B) 1.0 minus the counterparty haircut for the loan-level credit
enhancement as determined under paragraph (e)(3) of this section.
(ii) No loan-level credit enhancement. The adjusted credit
enhancement multiplier for a single-family mortgage exposure that is
not subject to loan-level credit enhancement is equal to 1.0.
(2) Credit enhancement multiplier. (i) The credit enhancement
multiplier for a single-family mortgage exposure that is subject to a
participation agreement is 1.0.
(ii) The credit enhancement multiplier for a single-family mortgage
exposure that is subject to a full recourse agreement is 0.
(iii) The credit enhancement multiplier for a single-family
mortgage exposure that is subject to a partial recourse agreement is:
(A) 1.0; minus
(B) The amount equal to:
(1) The coverage percent of the partial recourse agreement;
multiplied by

[[Page 39381]]

(2) A loss timing adjustment determined under Sec. 1240.44(g) as
if the partial recourse agreement were a CRT.
(iv) Subject to paragraph (e)(2)(v) of this section, the credit
enhancement multiplier for--
(A) A performing loan, non-modified RPL, or modified RPL that is
subject to non-cancellable mortgage insurance is set forth on Table 7
to paragraph (e)(2)(v)(E) of this section;
(B) A performing loan or non-modified RPL that is subject to
cancellable mortgage insurance is set forth on Table 8 to paragraph
(e)(2)(v)(E) of this section;
(C) A modified RPL with a 30-year post-modification amortization
that is subject to cancellable mortgage insurance is set forth on Table
9 to paragraph (e)(2)(v)(E) of this section;
(D) A modified RPL with a 40-year post-modification amortization
that is subject to cancellable mortgage insurance is set forth on Table
10 to paragraph (e)(2)(v)(E) of this section; and
(E) NPL, whether subject to non-cancellable mortgage insurance or
cancellable mortgage insurance, is set forth on Table 11 to paragraph
(e)(2)(v)(E) of this section.
(v) Notwithstanding anything to the contrary in this paragraph (e),
for purposes of paragraph (e)(2)(iv) of this section:
(A) The OLTV of a single-family mortgage exposure will be deemed to
be 80 percent if the single-family mortgage exposure has an OLTV less
than or equal to 80 percent.
(B) If the single-family mortgage exposure has an interest-only
feature, any cancellable mortgage insurance will be deemed to be non-
cancellable mortgage insurance.
(C) If the coverage percent of the mortgage insurance is greater
than charter-level coverage and less than guide-level coverage, the
credit enhancement multiplier is the amount equal to a linear
interpolation between the credit enhancement multiplier of the single-
family mortgage exposure for charter-level coverage and the credit
enhancement multiplier of the single-family mortgage exposure for
guide-level coverage.
(D) If the coverage percent of the mortgage insurance is less than
charter-level coverage, the credit enhancement multiplier is the amount
equal to the midpoint of a linear interpolation between a credit
enhancement multiplier of 1.0 and the credit enhancement multiplier of
the single-family mortgage exposure for charter-level coverage.
(E) If the coverage percent of the mortgage insurance is greater
than guide-level coverage, the credit enhancement multiplier is
determined as if the coverage percent were guide-level coverage.
BILLING CODE 8070-01-P
[GRAPHIC] [TIFF OMITTED] TP30JN20.054

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[GRAPHIC] [TIFF OMITTED] TP30JN20.055

[GRAPHIC] [TIFF OMITTED] TP30JN20.056

[[Page 39383]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.057

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BILLING CODE 8070-01-C
(3) Credit enhancement counterparty haircut--(i) Definitions. For
purposes of this paragraph (e)(3), the counterparty rating for a
counterparty is:
(A) 1, if the Enterprise has determined that the counterparty is
expected to perform all of its contractual obligations under
foreseeable adverse events.
(B) 2, if the Enterprise has determined that there is negligible
risk the counterparty may not be able to perform all of its contractual
obligations under foreseeable adverse events.
(C) 3, if the Enterprise has determined that there is a slight risk
the counterparty might not be able to perform all of its contractual
obligations under foreseeable adverse events.
(D) 4, if the Enterprise has determined that foreseeable adverse
events will have a greater impact on ``4'' rated counterparties than
higher rated counterparties.
(E) 5, if the Enterprise has determined that the counterparty might
not perform all of its contractual obligations under foreseeable
adverse events.
(F) 6, if the Enterprise has determined that the counterparty is
not expected to meet its contractual obligations under foreseeable
adverse events.
(G) 7, if the Enterprise has determined that the counterparty's
ability to perform its contractual obligations is questionable.
(H) 8, if the Enterprise has determined that the counterparty is in
default on a material contractual obligation or is under a resolution
proceeding or similar regulatory proceeding.
(ii) Counterparty haircut. The counterparty haircut is set forth on
Table 12 to this paragraph (e)(3)(ii). For purposes of this paragraph
(e)(3)(ii), RPL means either a modified RPL or a non-modified RPL.

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Sec. 1240.34 Multifamily mortgage exposures.

(a) Definitions. Subject to any additional instructions set forth
on Table 1 to this paragraph (a), for purposes of this section:
Acquisition debt-service-coverage ratio (acquisition DSCR) means,
with respect to a multifamily mortgage exposure, the amount equal to:
(i) The net operating income (NOI) (or, if not available, the net
cash flow) of the multifamily property that secures the multifamily
mortgage exposure, at the time of the acquisition by the Enterprise
(or, if not available, at the time of the underwriting or origination)
of the multifamily mortgage exposure; divided by
(ii) The scheduled periodic payment on the multifamily mortgage
exposure (or, if interest-only, fully amortizing payment), at the time
of the acquisition by the Enterprise (or, if not available, at the time
of the origination) of the multifamily mortgage exposure.
Acquisition loan-to-value (acquisition LTV) means, with respect to
a multifamily mortgage exposure, the amount, determined as of the time
of the acquisition by the Enterprise (or, if not available, at the time
of the underwriting or origination) of the multifamily mortgage
exposure, equal to:
(i) The unpaid principal balance of the multifamily mortgage
exposure; divided by
(ii) The value of the multifamily property securing the multifamily
mortgage exposure.
Debt-service-coverage ratio (DSCR) means, with respect to a
multifamily mortgage exposure:
(i) The acquisition DSCR of the multifamily mortgage exposure if
the loan age of the multifamily mortgage exposure is less than 6; or
(ii) The MTMDSCR of the multifamily mortgage exposure.
Interest-only (IO) means a multifamily mortgage exposure that
requires only payment of interest without any principal amortization
during all or part of the loan term.
Loan age means the number of scheduled payment dates since the
origination of the multifamily mortgage exposure.
Loan term means the number of years until final loan payment (which
may be a balloon payment) under the terms of a multifamily mortgage
exposure.
LTV means, with respect to a multifamily mortgage exposure;
(i) The acquisition LTV of the multifamily mortgage exposure if the
loan age of the multifamily mortgage exposure is less than 6, or
(ii) The MTMLTV of the multifamily mortgage exposure.
Mark-to-market debt-service coverage ratio (MTMDSCR) means, with
respect to a multifamily mortgage exposure, the amount equal to--
(i) The net operating income (or, if not available, the net cash
flow) of the multifamily property that secures the multifamily mortgage
exposure, as reported on the most recently available property operating
statement; divided by
(ii) The scheduled periodic payment on the multifamily mortgage
exposure (or, for interest-only, fully amortizing payment), as reported
on the most recently available property operating statement.
Mark-to-market loan-to-value (MTMLTV) means, with respect to a
multifamily mortgage exposure, the amount calculated by adjusting the
acquisition LTV using a multifamily property value index or property
value estimated based on net operating income and capitalization rate
indices.
Multifamily adjustable-rate exposure means a multifamily mortgage
exposure that is not, at that time, a multifamily fixed-rate exposure.
Multifamily fixed-rate exposure means a multifamily mortgage
exposure that, at that time, has an interest rate that may not then
increase or decrease based on a change in a reference index or other
methodology, including:
(i) A multifamily mortgage exposure that has an interest rate that
is fixed over the life of the loan; and
(ii) A multifamily mortgage exposure that has an interest rate that
may increase or decrease in the future, but is fixed at that time.
Net cash flow means, with respect to a multifamily mortgage
exposure, the amount equal to:
(i) The net operating income of the multifamily mortgage exposure;
minus
(ii) Reserves for capital improvements; minus
(iii) Other expenses not included in net operating income required
for the proper operation of the multifamily

[[Page 39386]]

property securing the multifamily mortgage exposure, including any
commissions paid to leasing agents in securing renters and special
improvements to the property to accommodate the needs of certain
renters.
Net operating income means, with respect to a multifamily mortgage
exposure, the amount equal to:
(i) The rental income generated by the multifamily property
securing the multifamily mortgage exposure; minus
(ii) The vacancy and property operating expenses of the multifamily
property securing the multifamily mortgage exposure.
Original amortization term means the number of years, determined as
of the time of the origination of a multifamily mortgage exposure, that
it would take a borrower to pay a multifamily mortgage exposure
completely if the borrower only makes the scheduled payments, and
without making any balloon payment.
Original loan size means the dollar amount of the unpaid principal
balance of a multifamily mortgage exposure at origination.
Payment performance means the payment status of history of a
multifamily mortgage exposure, assigned pursuant to the instructions
set forth on Table 1 to this paragraph (a).
Supplemental mortgage exposure means any multifamily fixed-rate
exposure or multifamily adjustable-rate exposure that is originated
after the origination of a multifamily mortgage exposure that is
secured by all or part of the same multifamily property.
Unpaid principal balance (UPB) means the outstanding loan amount of
a multifamily mortgage exposure.

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(b) Risk weight--(1) In general. Subject to paragraphs (b)(2) and
(b)(3) of this section, an Enterprise must assign a risk weight to a
multifamily mortgage exposure equal to:
(i) The base risk weight for the multifamily mortgage exposure as
determined under paragraph (c) of this section; multiplied by
(ii) The combined risk multiplier for the multifamily mortgage
exposure as determined under paragraph (d) of this section.
(2) Minimum risk weight. Notwithstanding the risk weight determined
under paragraph (b)(1) of this section, the risk weight assigned to a
multifamily mortgage exposure may not be less than 15 percent.
(3) Loan groups. If a multifamily property that secures a
multifamily mortgage exposure also secures one or more supplemental
mortgage exposures:
(i) A multifamily mortgage exposure-specific base risk weight must
be determined under paragraph (c) of this section using for each of
these multifamily mortgage exposures a single DSCR and single LTV, both
calculated as if all of the multifamily mortgage exposures secured by
the multifamily

[[Page 39388]]

property were consolidated into a single multifamily mortgage exposure;
and
(ii) A multifamily mortgage exposure-specific combined risk
multiplier must be determined under paragraph (d) of this section based
on the risk characteristics of the multifamily mortgage exposure
(except with respect to the loan size multiplier, which would be
determined using the aggregate unpaid principal balance of these
multifamily mortgage exposures).
(c) Base risk weight--(1) Multifamily fixed-rate exposure. The base
risk weight for a multifamily fixed-rate exposure is set forth on Table
2 to this paragraph (c)(1).
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(2) Multifamily adjustable-rate exposure. The base risk weight for
a multifamily adjustable-rate exposure is set forth on Table 3 to this
paragraph (c)(2).
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(d) Combined risk multiplier. The combined risk multiplier for a
multifamily mortgage exposure is equal to the product of each of the
applicable risk multipliers set forth on Table 4 to this paragraph (d).

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BILLING CODE 8070-01-C

Sec. 1240.35 Off-balance sheet exposures.

(a) General. (1) An Enterprise must calculate the exposure amount
of an off-balance sheet exposure using the credit conversion factors
(CCFs) in paragraph (b) of this section.

[[Page 39390]]

(2) Where an Enterprise commits to provide a commitment, the
Enterprise may apply the lower of the two applicable CCFs.
(3) Where an Enterprise provides a commitment structured as a
syndication or participation, the Enterprise is only required to
calculate the exposure amount for its pro rata share of the commitment.
(4) Where an Enterprise provides a commitment or enters into a
repurchase agreement and such commitment or repurchase agreement, the
exposure amount shall be no greater than the maximum contractual amount
of the commitment, repurchase agreement, or credit-enhancing
representation and warranty, as applicable.
(b) Credit conversion factors--(1) Zero percent CCF. An Enterprise
must apply a zero percent CCF to the unused portion of a commitment
that is unconditionally cancelable by the Enterprise.
(2) 20 percent CCF. An Enterprise must apply a 20 percent CCF to
the amount of commitments with an original maturity of one year or less
that are not unconditionally cancelable by the Enterprise.
(3) 50 percent CCF. An Enterprise must apply a 50 percent CCF to
the amount of commitments with an original maturity of more than one
year that are not unconditionally cancelable by the Enterprise.
(4) 100 percent CCF. An Enterprise must apply a 100 percent CCF to
the amount of the following off-balance sheet items and other similar
transactions:
(i) Guarantees;
(ii) Repurchase agreements (the off-balance sheet component of
which equals the sum of the current fair values of all positions the
Enterprise has sold subject to repurchase);
(iii) Off-balance sheet securities lending transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all positions the Enterprise has lent under the transaction);
(iv) Off-balance sheet securities borrowing transactions (the off-
balance sheet component of which equals the sum of the current fair
values of all non-cash positions the Enterprise has posted as
collateral under the transaction); and
(v) Forward agreements.

Sec. 1240.36 Derivative contracts.

An Enterprise must determine its risk-weighted assets for OTC
derivative contracts as provided under 12 CFR 217.34, substituting
``Enterprise'' for ``Board-regulated institution''.

Sec. 1240.37 Cleared transactions.

An Enterprise must determine its risk-weighted assets for cleared
transactions as provided under 12 CFR 217.35, substituting
``Enterprise'' for ``Board-regulated institution.''

Sec. 1240.38 Guarantees and credit derivatives: Substitution
treatment.

An Enterprise may recognize the credit risk mitigation benefits of
an eligible guarantee or eligible credit derivative by substituting the
risk weight associated with the protection provider for the risk weight
assigned to an exposure, as provided under 12 CFR 217.36, substituting
``Enterprise'' for ``Board-regulated institution.''

Sec. 1240.39 Collateralized transactions.

An Enterprise may recognize the risk-mitigating effects of
financial collateral as provided under 12 CFR 217.37, substituting
``Enterprise'' for ``Board-regulated institution.''

Risk-Weighted Assets for Unsettled Transactions

Sec. 1240.40 Unsettled transactions.

An Enterprise must determine its risk-weighted assets for unsettled
transactions under 12 CFR 217.38, substituting ``Enterprise'' for
``Board-regulated institution.''

Risk-Weighted Assets for CRT and Other Securitization Exposures

Sec. 1240.41 Operational requirements for CRT and other
securitization exposures.

(a) Operational criteria for traditional securitizations. An
Enterprise that transfers exposures it has purchased or otherwise
acquired to a securitization SPE or other third party in connection
with a traditional securitization may exclude the exposures from the
calculation of its risk-weighted assets only if each condition in this
section is satisfied. An Enterprise that meets these conditions must
hold risk-based capital against any credit risk it retains in
connection with the securitization. An Enterprise that fails to meet
these conditions must hold risk-based capital against the transferred
exposures as if they had not been securitized and must deduct from
common equity tier 1 capital any after-tax gain-on-sale resulting from
the transaction. The conditions are:
(1) The exposures are not reported on the Enterprise's consolidated
balance sheet under GAAP;
(2) The Enterprise has transferred to one or more third parties
credit risk associated with the underlying exposures;
(3) Any clean-up calls relating to the securitization are eligible
clean-up calls; and
(4) The securitization does not:
(i) Include one or more underlying exposures in which the borrower
is permitted to vary the drawn amount within an agreed limit under a
line of credit; and
(ii) Contain an early amortization provision.
(b) Operational criteria for synthetic securitizations. For
synthetic securitizations, an Enterprise may recognize for risk-based
capital purposes the use of a credit risk mitigant to hedge underlying
exposures only if each condition in this paragraph (b) is satisfied. An
Enterprise that meets these conditions must hold risk-based capital
against any credit risk of the exposures it retains in connection with
the synthetic securitization. An Enterprise that fails to meet these
conditions or chooses not to recognize the credit risk mitigant for
purposes of this section must instead hold risk-based capital against
the underlying exposures as if they had not been synthetically
securitized. The conditions are:
(1) The credit risk mitigant is:
(i) Financial collateral;
(ii) A guarantee that meets all criteria as set forth in the
definition of ``eligible guarantee'' in Sec. 1240.2, except for the
criteria in paragraph (3) of that definition; or
(iii) A credit derivative that meets all criteria as set forth in
the definition of ``eligible credit derivative'' in Sec. 1240.2,
except for the criteria in paragraph (3) of the definition of
``eligible guarantee'' in Sec. 1240.2.
(2) The Enterprise transfers credit risk associated with the
underlying exposures to one or more third parties, and the terms and
conditions in the credit risk mitigants employed do not include
provisions that:
(i) Allow for the termination of the credit protection due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the Enterprise to alter or replace the underlying
exposures to improve the credit quality of the underlying exposures;
(iii) Increase the Enterprise's cost of credit protection in
response to deterioration in the credit quality of the underlying
exposures;
(iv) Increase the yield payable to parties other than the
Enterprise in response to a deterioration in the credit quality of the
underlying exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement

[[Page 39391]]

provided by the Enterprise after the inception of the securitization;
(3) The Enterprise obtains a well-reasoned opinion from legal
counsel that confirms the enforceability of the credit risk mitigant in
all relevant jurisdictions; and
(4) Any clean-up calls relating to the securitization are eligible
clean-up calls.
(c) Operational criteria for credit risk transfers. For credit risk
transfers, an Enterprise may recognize for risk-based capital purposes,
the use of a credit risk transfer only if each condition in this
paragraph (c) is satisfied. An Enterprise that meets these conditions
must hold risk-based capital against any credit risk of the exposures
it retains in connection with the credit risk transfer. An Enterprise
that fails to meet these conditions or chooses not to recognize the
credit risk transfer for purposes of this section must instead hold
risk-based capital against the underlying exposures as if they had not
been subject to the credit risk transfer. The conditions are:
(1) The credit risk transfer is an eligible CRT structure.
(2) The Enterprise transfers credit risk associated with the
underlying exposures to one or more third parties, and the terms and
conditions in the credit risk transfer employed do not include
provisions that:
(i) Allow for the termination of the credit risk transfer due to
deterioration in the credit quality of the underlying exposures;
(ii) Require the Enterprise to alter or replace the underlying
exposures to improve the credit quality of the underlying exposures;
(iii) Increase the Enterprise's cost of credit protection in
response to deterioration in the credit quality of the underlying
exposures;
(iv) Increase the yield payable to parties other than the
Enterprise in response to a deterioration in the credit quality of the
underlying exposures; or
(v) Provide for increases in a retained first loss position or
credit enhancement provided by the Enterprise after the inception of
the credit risk transfer;
(3) The Enterprise obtains a well-reasoned opinion from legal
counsel that confirms the enforceability of the credit risk transfer in
all relevant jurisdictions; and
(4) Any clean-up calls relating to the credit risk transfer are
eligible clean-up calls.
(5) The Enterprise includes in its periodic disclosures under the
Federal securities laws, or in other appropriate public disclosures, a
reasonably detailed description of--
(i) The material recourse or other risks that might reduce the
effectiveness of the credit risk transfer in transferring the credit
risk on the underlying exposures to third parties; and
(ii) Each condition under paragraph (a) of this section (governing
traditional securitizations) or paragraph (b) of this section
(governing synthetic securitizations) that is not satisfied by the
credit risk transfer and the reasons that each such condition is not
satisfied.
(d) Due diligence requirements for securitization exposures. (1)
Except for exposures that are deducted from common equity tier 1
capital and exposures subject to Sec. 1240.42(h), if an Enterprise is
unable to demonstrate to the satisfaction of FHFA a comprehensive
understanding of the features of a securitization exposure that would
materially affect the performance of the exposure, the Enterprise must
assign the securitization exposure a risk weight of 1,250 percent. The
Enterprise's analysis must be commensurate with the complexity of the
securitization exposure and the materiality of the exposure in relation
to its capital.
(2) An Enterprise must demonstrate its comprehensive understanding
of a securitization exposure under paragraph (c)(1) of this section,
for each securitization exposure by:
(i) Conducting an analysis of the risk characteristics of a
securitization exposure prior to acquiring the exposure, and
documenting such analysis within three business days after acquiring
the exposure, considering:
(A) Structural features of the securitization that would materially
impact the performance of the exposure, for example, the contractual
cash flow waterfall, waterfall-related triggers, credit enhancements,
liquidity enhancements, fair value triggers, the performance of
organizations that service the exposure, and deal-specific definitions
of default;
(B) Relevant information regarding the performance of the
underlying credit exposure(s), for example, the percentage of loans 30,
60, and 90 days past due; default rates; prepayment rates; loans in
foreclosure; property types; occupancy; average credit score or other
measures of creditworthiness; average LTV ratio; and industry and
geographic diversification data on the underlying exposure(s);
(C) Relevant market data of the securitization, for example, bid-
ask spread, most recent sales price and historic price volatility,
trading volume, implied market rating, and size, depth and
concentration level of the market for the securitization; and
(D) For resecuritization exposures, performance information on the
underlying securitization exposures, for example, the issuer name and
credit quality, and the characteristics and performance of the
exposures underlying the securitization exposures; and
(ii) On an on-going basis (no less frequently than quarterly),
evaluating, reviewing, and updating as appropriate the analysis
required under paragraph (c)(1) of this section for each securitization
exposure.

Sec. 1240.42 Risk-weighted assets for CRT and other securitization
exposures.

(a) Securitization risk weight approaches. Except as provided
elsewhere in this section or in Sec. 1240.41:
(1) An Enterprise must deduct from common equity tier 1 capital any
after-tax gain-on-sale resulting from a securitization and apply a
1,250 percent risk weight to the portion of a CEIO that does not
constitute after-tax gain-on-sale.
(2) If a securitization exposure does not require deduction under
paragraph (a)(1) of this section, an Enterprise may assign a risk
weight to the securitization exposure either using the simplified
supervisory formula approach (SSFA) in accordance with Sec. Sec.
1240.43(a) through 1240.43(d) for a securitization exposure that is not
a retained CRT exposure or an acquired CRT exposure or using the credit
risk transfer approach (CRTA) in accordance with Sec. 1240.44 for a
retained CRT exposure, and in either case, subject to the limitation
under paragraph (e) of this section.
(3) If a securitization exposure does not require deduction under
paragraph (a)(1) of this section and the Enterprise cannot, or chooses
not to apply the SSFA or the CRTA to the exposure, the Enterprise must
assign a risk weight to the exposure as described in Sec. 1240.45.
(4) If a securitization exposure is a derivative contract (other
than protection provided by an Enterprise in the form of a credit
derivative) that has a first priority claim on the cash flows from the
underlying exposures (notwithstanding amounts due under interest rate
or currency derivative contracts, fees due, or other similar payments),
an Enterprise may choose to set the risk-weighted asset amount of the
exposure equal to the amount of the exposure as determined in paragraph
(c) of this section.
(b) Total risk-weighted assets for securitization exposures. An
Enterprise's total risk-weighted assets for securitization exposures
equals the sum of the risk-weighted asset amount

[[Page 39392]]

for securitization exposures that the Enterprise risk weights under
Sec. Sec. 1240.41(d), 1240.42(a)(1), 1240.43, 1240.44, or 1240.45, and
paragraphs (e) through (h) of this section, as applicable.
(c) Exposure amount of a CRT or other securitization exposure--(1)
On-balance sheet securitization exposures. Except as provided for
retained CRT exposures in Sec. 1240.44(f), the exposure amount of an
on-balance sheet securitization exposure (excluding a repo-style
transaction, eligible margin loan, OTC derivative contract, or cleared
transaction) is equal to the carrying value of the exposure.
(2) Off-balance sheet securitization exposures. Except as provided
in paragraph (h) of this section or as provided for retained CRT
exposures in Sec. 1240.44(f), the exposure amount of an off-balance
sheet securitization exposure that is not a repo-style transaction,
eligible margin loan, cleared transaction (other than a credit
derivative), or an OTC derivative contract (other than a credit
derivative) is the notional amount of the exposure.
(3) Repo-style transactions, eligible margin loans, and derivative
contracts. The exposure amount of a securitization exposure that is a
repo-style transaction, eligible margin loan, or derivative contract
(other than a credit derivative) is the exposure amount of the
transaction as calculated under Sec. 1240.36 or Sec. 1240.39, as
applicable.
(d) Overlapping exposures. If an Enterprise has multiple
securitization exposures that provide duplicative coverage to the
underlying exposures of a securitization, the Enterprise is not
required to hold duplicative risk-based capital against the overlapping
position. Instead, the Enterprise may apply to the overlapping position
the applicable risk-based capital treatment that results in the highest
risk-based capital requirement.
(e) Implicit support. If an Enterprise provides support to a
securitization (including a CRT) in excess of the Enterprise's
contractual obligation to provide credit support to the securitization
(implicit support):
(1) The Enterprise must include in risk-weighted assets all of the
underlying exposures associated with the securitization as if the
exposures had not been securitized and must deduct from common equity
tier 1 capital any after-tax gain-on-sale resulting from the
securitization; and
(2) The Enterprise must disclose publicly:
(i) That it has provided implicit support to the securitization;
and
(ii) The risk-based capital impact to the Enterprise of providing
such implicit support.
(f) Interest-only mortgage-backed securities. Regardless of any
other provisions in this subpart, the risk weight for a non-credit-
enhancing interest-only mortgage-backed security may not be less than
100 percent.
(g) Nth-to-default credit derivatives--(1) Protection provider. An
Enterprise may assign a risk weight using the SSFA in Sec. 1240.43 to
an nth-to-default credit derivative in accordance with this paragraph
(g). An Enterprise must determine its exposure in the nth-to-default
credit derivative as the largest notional amount of all the underlying
exposures.
(2) Attachment and detachment points. For purposes of determining
the risk weight for an nth-to-default credit derivative using the SSFA,
the Enterprise must calculate the attachment point and detachment point
of its exposure as follows:
(i) The attachment point (parameter A) is the ratio of the sum of
the notional amounts of all underlying exposures that are subordinated
to the Enterprise's exposure to the total notional amount of all
underlying exposures. The ratio is expressed as a decimal value between
zero and one. In the case of a first-to-default credit derivative,
there are no underlying exposures that are subordinated to the
Enterprise's exposure. In the case of a second-or-subsequent-to-default
credit derivative, the smallest (n-1) notional amounts of the
underlying exposure(s) are subordinated to the Enterprise's exposure.
(ii) The detachment point (parameter D) equals the sum of parameter
A plus the ratio of the notional amount of the Enterprise's exposure in
the nth-to-default credit derivative to the total notional amount of
all underlying exposures. The ratio is expressed as a decimal value
between zero and one.
(3) Risk weights. An Enterprise that does not use the SSFA to
determine a risk weight for its nth-to-default credit derivative must
assign a risk weight of 1,250 percent to the exposure.
(4) Protection purchaser--(i) First-to-default credit derivatives.
An Enterprise that obtains credit protection on a group of underlying
exposures through a first-to-default credit derivative that meets the
rules of recognition of 12 CFR 217.36(b) must determine its risk-based
capital requirement for the underlying exposures as if the Enterprise
synthetically securitized the underlying exposure with the smallest
risk-weighted asset amount and had obtained no credit risk mitigant on
the other underlying exposures. An Enterprise must calculate a risk-
based capital requirement for counterparty credit risk according to 12
CFR 217.34 for a first-to-default credit derivative that does not meet
the rules of recognition of 12 CFR 217.36(b).
(ii) Second-or-subsequent-to-default credit derivatives. (A) An
Enterprise that obtains credit protection on a group of underlying
exposures through a nth-to-default credit derivative that meets the
rules of recognition of 12 CFR 217.36(b) (other than a first-to-default
credit derivative) may recognize the credit risk mitigation benefits of
the derivative only if:
(1) The Enterprise also has obtained credit protection on the same
underlying exposures in the form of first-through-(n-1)-to-default
credit derivatives; or
(2) If n-1 of the underlying exposures have already defaulted.
(B) If an Enterprise satisfies the requirements of paragraph
(i)(4)(ii)(A) of this section, the Enterprise must determine its risk-
based capital requirement for the underlying exposures as if the
Enterprise had only synthetically securitized the underlying exposure
with the nth smallest risk-weighted asset amount and had obtained no
credit risk mitigant on the other underlying exposures.
(C) An Enterprise must calculate a risk-based capital requirement
for counterparty credit risk according to 12 CFR 217.34 for a nth-to-
default credit derivative that does not meet the rules of recognition
of 12 CFR 217.36(b).
(h) Guarantees and credit derivatives other than nth-to-default
credit derivatives--(1) Protection provider. For a guarantee or credit
derivative (other than an nth-to-default credit derivative) provided by
an Enterprise that covers the full amount or a pro rata share of a
securitization exposure's principal and interest, the Enterprise must
risk weight the guarantee or credit derivative as if it holds the
portion of the reference exposure covered by the guarantee or credit
derivative.
(2) Protection purchaser. (i) An Enterprise that purchases a
guarantee or OTC credit derivative (other than an nth-to-default credit
derivative) that is recognized under Sec. 1240.46 as a credit risk
mitigant (including via collateral recognized under Sec. 1240.39) is
not required to compute a separate counterparty credit risk capital
requirement under Sec. 1240.31, in accordance with 12 CFR 217.34(c).
(ii) If an Enterprise cannot, or chooses not to, recognize a
purchased credit derivative as a credit risk mitigant under Sec.
1240.46, the Enterprise must

[[Page 39393]]

determine the exposure amount of the credit derivative under Sec.
1240.36.
(A) If the Enterprise purchases credit protection from a
counterparty that is not a securitization SPE, the Enterprise must
determine the risk weight for the exposure according to this subpart D.
(B) If the Enterprise purchases the credit protection from a
counterparty that is a securitization SPE, the Enterprise must
determine the risk weight for the exposure according to section Sec.
1240.42, including Sec. 1240.42(a)(4) for a credit derivative that has
a first priority claim on the cash flows from the underlying exposures
of the securitization SPE (notwithstanding amounts due under interest
rate or currency derivative contracts, fees due, or other similar
payments).

Sec. 1240.43 Simplified supervisory formula approach (SSFA).

(a) General requirements for the SSFA. To use the SSFA to determine
the risk weight for a securitization exposure, an Enterprise must have
data that enables it to assign accurately the parameters described in
paragraph (b) of this section. Data used to assign the parameters
described in paragraph (b) of this section must be the most currently
available data; if the contracts governing the underlying exposures of
the securitization require payments on a monthly or quarterly basis,
the data used to assign the parameters described in paragraph (b) of
this section must be no more than 91 calendar days old. An Enterprise
that does not have the appropriate data to assign the parameters
described in paragraph (b) of this section must assign a risk weight of
1,250 percent to the exposure.
(b) SSFA parameters. To calculate the risk weight for a
securitization exposure using the SSFA, an Enterprise must have
accurate information on the following five inputs to the SSFA
calculation:
(1) KG is the weighted-average (with unpaid principal
used as the weight for each exposure) adjusted total capital
requirement of the underlying exposures calculated using this subpart.
KG is expressed as a decimal value between zero and one
(that is, an average risk weight of 100 percent represents a value of
KG equal to 0.08).
(2) Parameter W is expressed as a decimal value between zero and
one. Parameter W is the ratio of the sum of the dollar amounts of any
underlying exposures of the securitization that meet any of the
criteria as set forth in paragraphs (b)(2)(i) through (vi) of this
section to the balance, measured in dollars, of underlying exposures:
(i) Ninety days or more past due;
(ii) Subject to a bankruptcy or insolvency proceeding;
(iii) In the process of foreclosure;
(iv) Held as real estate owned;
(v) Has contractually deferred payments for 90 days or more, other
than principal or interest payments deferred on:
(A) Federally-guaranteed student loans, in accordance with the
terms of those guarantee programs; or
(B) Consumer loans, including non-federally-guaranteed student
loans, provided that such payments are deferred pursuant to provisions
included in the contract at the time funds are disbursed that provide
for period(s) of deferral that are not initiated based on changes in
the creditworthiness of the borrower; or
(vi) Is in default.
(3) Parameter A is the attachment point for the exposure, which
represents the threshold at which credit losses will first be allocated
to the exposure. Except as provided in Sec. 1240.42(g) for nth-to-
default credit derivatives, parameter A equals the ratio of the current
dollar amount of underlying exposures that are subordinated to the
exposure of the Enterprise to the current dollar amount of underlying
exposures. Any reserve account funded by the accumulated cash flows
from the underlying exposures that is subordinated to the Enterprise's
securitization exposure may be included in the calculation of parameter
A to the extent that cash is present in the account. Parameter A is
expressed as a decimal value between zero and one.
(4) Parameter D is the detachment point for the exposure, which
represents the threshold at which credit losses of principal allocated
to the exposure would result in a total loss of principal. Except as
provided in Sec. 1240.42(g) for nth-to-default credit derivatives,
parameter D equals parameter A plus the ratio of the current dollar
amount of the securitization exposures that are pari passu with the
exposure (that is, have equal seniority with respect to credit risk) to
the current dollar amount of the underlying exposures. Parameter D is
expressed as a decimal value between zero and one.
(5) A supervisory calibration parameter, p, is equal to 0.5 for
securitization exposures that are not resecuritization exposures and
equal to 1.5 for resecuritization exposures (except p is equal to 0.5
for resecuritization exposures secured by MBS guaranteed by an
Enterprise).
(c) Mechanics of the SSFA. KG and W are used to
calculate KA, the augmented value of KG, which
reflects the observed credit quality of the underlying exposures.
KA is defined in paragraph (d) of this section. The values
of parameters A and D, relative to KA determine the risk
weight assigned to a securitization exposure as described in paragraph
(d) of this section. The risk weight assigned to a securitization
exposure, or portion of a securitization exposure, as appropriate, is
the larger of the risk weight determined in accordance with this
paragraph (c) or paragraph (d) of this section and a risk weight of 20
percent.
(1) When the detachment point, parameter D, for a securitization
exposure is less than or equal to KA, the exposure must be
assigned a risk weight of 1,250 percent.
(2) When the attachment point, parameter A, for a securitization
exposure is greater than or equal to KA, the
Enterprise must calculate the risk weight in accordance with paragraph
(d) of this section.
(3) When A is less than KA and D is greater than
KA, the risk weight is a weighted-average of 1,250 percent
and 1,250 percent times KSSFA calculated in accordance with
paragraph (d) of this section. For the purpose of this weighted-average
calculation:
(i) The weight assigned to 1,250 percent equals
[GRAPHIC] [TIFF OMITTED] TP30JN20.064

(ii) The weight assigned to 1,250 percent times KSSFA
equals
[GRAPHIC] [TIFF OMITTED] TP30JN20.065

(iii) The risk weight will be set equal to:
[GRAPHIC] [TIFF OMITTED] TP30JN20.066

(d) SFA equation. (1) The Enterprise must define the following
parameters:
[GRAPHIC] [TIFF OMITTED] TP30JN20.087

e = 2.71828, the base of the natural logarithms.

(2) Then the Enterprise must calculate according to the following
equation:
[GRAPHIC] [TIFF OMITTED] TP30JN20.067

[[Page 39394]]

(3) The risk weight for the exposure (expressed as a percent) is
equal to KSSFA * 1,250.
(e) Limitations. Notwithstanding any other provision of this
section, an Enterprise must assign a risk weight of not less than 20
percent to a securitization exposure.

Sec. 1240.44 Credit risk transfer approach (CRTA).

(a) General requirements for the CRTA. To use the CRTA to determine
the risk weighted assets for a retained CRT exposure, an Enterprise
must have data that enables it to assign accurately the parameters
described in paragraph (b) of this section. Data used to assign the
parameters described in paragraph (b) of this section must be the most
currently available data; if the contracts governing the underlying
exposures of the credit risk transfer require payments on a monthly or
quarterly basis, the data used to assign the parameters described in
paragraph (b) of this section must be no more than 91 calendar days
old. An Enterprise that does not have the appropriate data to assign
the parameters described in paragraph (b) of this section must assign a
risk weight of 1,250 percent to the retained CRT exposure.
(b) CRTA parameters. To calculate the risk weighted assets for a
retained CRT exposure, an Enterprise must have accurate information on
the following ten inputs to the CRTA calculation.
(1) Parameter A is the attachment point for the exposure, which
represents the threshold at which credit losses will first be allocated
to the exposure. Parameter A equals the ratio of the current dollar
amount of underlying exposures that are subordinated to the exposure of
the Enterprise to the current dollar amount of underlying exposures.
Any reserve account funded by the accumulated cash flows from the
underlying exposures that is subordinated to the Enterprise's exposure
may be included in the calculation of parameter A to the extent that
cash is present in the account. Parameter A is expressed as a value
between 0 and 100 percent.
(2) Parameter AggUPB$ is the aggregate unpaid principal balance of
the underlying mortgage exposures.
(3) Parameter CM% is the percentage of a tranche sold in the
capital markets. CM% is expressed as a value between 0 and 100 percent.
(4) Parameter Collat%RIF is the amount of financial collateral
posted by a counterparty under a loss sharing contract expressed as a
percentage of the risk in force. For multifamily lender loss sharing
transactions where an Enterprise has the contractual right to receive
future lender guarantee-fee revenue, the Enterprise may include up to
12 months of expected guarantee-fee revenue in collateral. Collat%RIF
is expressed as a value between 0 and 100 percent.
(5) Parameter D is the detachment point for the exposure, which
represents the threshold at which credit losses of principal allocated
to the exposure would result in a total loss of principal. Parameter D
equals parameter A plus the ratio of the current dollar amount of the
exposures that are pari passu with the exposure (that is, have equal
seniority with respect to credit risk) to the current dollar amount of
the underlying exposures. Parameter D is expressed as a value between 0
and 100 percent.
(6) Parameter EL$ is the remaining lifetime net expected credit
risk losses of the underlying mortgage exposures. EL$ must be
calculated internally by an Enterprise. If the contractual terms of the
CRT do not provide for the transfer of the counterparty credit risk
associated with any loan-level credit enhancement or other loss sharing
on the underlying mortgage exposures, then the Enterprise must
calculate EL$ assuming no counterparty haircuts. Parameter EL$ is
expressed in dollars.
(7) Parameter HC is the haircut for the counterparty in contractual
loss sharing transactions.
(i) For a CRT with respect to single-family mortgage exposures, the
counterparty haircut is set forth on Table 12 to paragraph (e)(3)(ii)
of Sec. 1240.33, determined as if the counterparty to the CRT were a
counterparty to loan-level credit enhancement (as defined in Sec.
1240.33(a)) and considering the counterparty rating and mortgage
concentration risk of the counterparty to the CRT and the single-family
segment and product of the underlying single-family mortgage exposures.
(ii) For a CRT with respect to multifamily mortgage exposures, the
counterparty haircut is set forth on Table 1 to this paragraph
(b)(7)(ii), with counterparty rating and mortgage concentration risk
having the meaning given in Sec. 1240.33(a).
[GRAPHIC] [TIFF OMITTED] TP30JN20.068

[[Page 39395]]

(8) Parameter LS is the percentage of a tranche that is
either insured, reinsured, or afforded coverage through lender
reimbursement of credit losses of principal. LS is expressed as
a value between 0 and 100 percent.
(9) Parameter LTF is the loss timing factor which accounts
for maturity differences between the CRT and the underlying mortgage
exposures. Maturity differences arise when the maturity date of the CRT
is before the maturity dates of the underlying mortgage exposures.
LTF is expressed as a value between 0 and 100 percent.
(i) An Enterprise must have the following information to calculate
LTF for a CRT with respect to multifamily mortgage exposures:
(A) The remaining months to the contractual maturity of the CRT
(CRTRMM).
(B) The remaining months to maturity of the underlying multifamily
mortgage exposures (MMERMM). If the underlying multifamily mortgage
exposures have different maturity dates, MMERMM should reflect the
multifamily mortgage exposure with the longest maturity.
(C) An Enterprise must use the following method to calculate
LTF for multifamily CRTs:
[GRAPHIC] [TIFF OMITTED] TP30JN20.069

(ii) An Enterprise must have the following information to calculate
LTF for a newly issued CRT with respect to single-family
mortgage exposures:
(A) The original closing date (or effective date) of the CRT and
the maturity date on the CRT.
(B) UPB share of single-family mortgage exposures that have
original amortization terms of less than or equal to 189 months
(CRTF15).
(C) UPB share of single-family mortgage exposures that have
original amortization terms greater than 189 months and OLTVs of less
than or equal to 80 percent (CRT80NotF15).
(D) The duration of seasoning.
(E) An Enterprise must use the following method to calculate
LTF for single-family CRTs: Calculate CRT months to maturity
(CRTMthstoMaturity) using one of the following methods:
(1) For single-family CRTs with reimbursement based upon occurrence
or resolution of delinquency, CRTMthstoMaturity is the difference
between the CRT's maturity date and original closing date, except for
the following:
(i) If the coverage based upon delinquency is between one and three
months, add 24 months to the difference between the CRT's maturity date
and original closing date; and
(ii) If the coverage based upon delinquency is between four and six
months, add 18 months to the difference between the CRT's maturity date
and original closing date.
(2) For all other single-family CRTs, CRTMthstoMaturity is the
difference between the CRT's maturity date and original closing date.
(i) If CRTMthstoMaturity is a multiple of 12, then an Enterprise
must use the first column of Table 2 to paragraph (b)(9)(ii)(E)(2)(iii)
of this section to identify the row matching CRTMthstoMaturity and take
a weighted average of the three loss timing factors in columns 2, 3,
and 4 as follows:

LTF% = (CRTLT15 * CRTF15) + (CRTLT80Not15 *
CRT80NotF15) + (CRTLTGT80Not15 * CRT80NotF15) +
(CRTLTGT80Not15 * (1-CRT80NotF15 -CRTF15))

(ii) If CRTMthstoMaturity is not a multiple of 12, an Enterprise
must use the first column of Table 2 to paragraph (b)(9)(ii)(E)(2)(iii)
of this section to identify the two rows that are closest to
CRTMthstoMaturity and take a weighted average between the two rows of
loss timing factors using linear interpolation, where the weights
reflect CRTMthstoMaturity.
(iii) For seasoned single-family CRTs, the LTF is
calculated:
[GRAPHIC] [TIFF OMITTED] TP30JN20.070

where
CRTLTM is the loss timing factor calculated under (ii) of
this subsection.
CRTLTS is the loss timing factor calculated under (ii) of
this subsection replacing
CRTMthstoMaturity with the duration of seasoning.

[[Page 39396]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.071

BILLING CODE 8070-01-P
(10) Parameter RWA$ is the aggregate credit risk-weighted assets
associated with the underlying mortgage exposures.
(11) Parameter CntptyRWA$ is the aggregate credit risk-weighted
assets due to counterparty haircuts from loan-level credit
enhancements. CntptyRWA$ is the difference between:
(i) Parameter RWA$; and
(ii) Aggregate credit risk-weighted assets associated with the
underlying mortgage exposures where the counterparty haircuts for loan-
level credit enhancements are set to zero.
(c) Mechanics of the CRTA. The risk weight assigned to a retained
CRT exposure, or portion of a retained CRT

[[Page 39397]]

exposure, as appropriate, is the larger of RW determined in
accordance with paragraph (d) of this section and a risk weight of 10
percent.
(1) When the detachment point, parameter D, for a retained CRT
exposure is less than or equal to the sum of KA and AggEL, the
exposure must be assigned a risk weight of 1,250 percent.
(2) When the attachment point, parameter A, for a retained CRT
exposure is greater than or equal to or equal to the sum of KA and
AggEL, determined in accordance with paragraph (d) of this
section, the exposure must be assigned a risk weight of 10 percent.
(3) When parameter A is less than or equal to the sum of KA and
AggEL, and parameter D is greater than the sum of KA and
AggEL, the Enterprise must calculate the risk weight as 1,250%
multiplied by the ratio of (i) the sum of KA and AggEL less
parameter A to (ii) the difference between parameter D and parameter A.
(d) CRTA equations.
[GRAPHIC] [TIFF OMITTED] TP30JN20.072

If the contractual terms of the CRT do not provide for the transfer
of the counterparty credit risk associated with any loan-level credit
enhancement or other loss sharing on the underlying mortgage exposures,
then the Enterprise shall calculate KA as follows:
[GRAPHIC] [TIFF OMITTED] TP30JN20.073

Otherwise the Enterprise shall calculate KA as follows:
[GRAPHIC] [TIFF OMITTED] TP30JN20.074

(e) Limitations. Notwithstanding any other provision of this
section, an Enterprise must assign an overall risk weight of not less
than 10 percent to a retained CRT exposure.
(f) Adjusted exposure amount (AEA)--(1) In general. The adjusted
exposure amount (AEA) of a retained CRT exposure is equal to:
[GRAPHIC] [TIFF OMITTED] TP30JN20.075

(2) Inputs--(i) Enterprise Adjusted Exposure. The adjusted exposure
(EAE) of an Enterprise with respect to a retained CRT exposure is as
follows:

EAE,Tranche = 100% - (CM,Tranche
* LTEA,Tranche,CM * OEA%) -
(LS,Tranche * LSEA,Tranche,LS *
LTEA,Tranche,LS * OEA%),

Where the loss timing effectiveness adjustments (LTEA) for a retained
CRT exposure are determined under paragraph (g) of this section, the
loss sharing effectiveness adjustment (LSEA) for a retained CRT
exposure is determine under paragraph (h) of this section, and the
overall effectiveness adjustment (OEA) is determined under paragraph
(i) of this section.
(ii) Expected Loss Share. The expected loss share is the share of a
tranche that is covered by expected loss (ELS):

[GRAPHIC] [TIFF OMITTED] TP30JN20.076

[[Page 39398]]

(iii) Risk weight. The risk weight of a retained CRT exposure is
determined under paragraph (d) of this section.
(g) Loss timing effectiveness adjustments. The loss timing
effectiveness adjustments (LTEA) for a retained CRT exposure is
calculated according to the following calculation:

if (SLS,Tranche - ELS,Tranche) >
0 then
[GRAPHIC] [TIFF OMITTED] TP30JN20.077

[GRAPHIC] [TIFF OMITTED] TP30JN20.078

Otherwise LTEA,Tranche,CM = 100% and
LTEA,Tranche,LS = 100% where KA adjusted
for loss timing (LTKA) is as follows:

LTKA,CM = max ((KA + AggEL) * LTF,CM
LTKA,LS = max ((KA + AggEL) * LTF,LS;
and
LTF,CM is LTF calculated for the capital
markets component of the tranche,
LTF,LS is LTF calculated for the loss
sharing component of the tranche, and the share of the tranche that is
covered by expected loss (ELS) and the share of the tranche that is
covered by stress loss (SLS) are
[GRAPHIC] [TIFF OMITTED] TP30JN20.079

(h) Loss sharing effectiveness adjustment. The loss sharing
effectiveness adjustment (LSEA) for a retained CRT exposure is
calculated according to the following calculation:

if (RW,Tranche - ELS,Tranche *
1250%) > 0 then
[GRAPHIC] [TIFF OMITTED] TP30JN20.080

Otherwise

LESA,Tranche = 100%

where

UnCollatUL,Tranche = max (0%,
SLS,Tranche - max (CollatRIF,Tranche,
ELS,Tranche))
SRIF,Tranche = 100% - max
(SLS,Tranche, CollatRIF,Tranche)

and the share of the tranche that is covered by expected loss (ELS) and
the share of the tranche that is covered by stress loss (SLS) are

[[Page 39399]]

[GRAPHIC] [TIFF OMITTED] TP30JN20.081

(i) Overall effectiveness adjustment. The overall effectiveness
adjustment (OEA) for a retained CRT exposure is calculated according to
the following calculation:

OEA = 90%

(j) RWA supplement for retained loan-level counterparty credit
risk. If the Enterprise elects to use the CRTA for a retained CRT
exposure and if the contractual terms of the CRT do not provide for the
transfer of the counterparty credit risk associated with any loan-level
credit enhancement or other loss sharing on the underlying mortgage
exposures, then the Enterprise must add the following risk-weighted
assets supplement (RWASup$) to risk weighted assets for the
retained CRT exposure.

RWASup$,Tranche = CntptyRWA$ * (D - A)

Otherwise the Enterprise shall add an RWASup$ of $0.

(k) Credit risk-weighted assets for the retained CRT exposure are
as follows:

RWA$,Tranche = AEA$,Tranche * RW,Tranche
+ RWASup$,Tranche

[Alternative: Modified SSFA]

(a) General requirements. To use the CRT approach to determine the
risk weight for a CRT exposure, an Enterprise must have data that
enables it to assign accurately the parameters described in paragraph
(b) of this section. Data used to assign the parameters described in
paragraph (b) of this section must be the most currently available
data; if the contracts governing the underlying exposures of the CRT
require payments on a monthly or quarterly basis, the data used to
assign the parameters described in paragraph (b) of this section must
be no more than 91 calendar days old. An Enterprise that does not have
the appropriate data to assign the parameters described in paragraph
(b) of this section must assign a risk weight of 1,250 percent to the
exposure.
(b) CRTA parameters. To calculate the risk weight for a CRT
exposure using the CRTA, an Enterprise must have accurate information
on the following five inputs to the CRTA calculation, each as defined
and calculated under Sec. 1240.43(b): KG; W; A; D; and p.
(c) Mechanics of the CRTA. The risk weight assigned to a CRT
exposure, or portion of a CRT exposure, as appropriate, is the larger
of the risk weight determined in accordance with this paragraph (c) or
paragraph (d) of Sec. 1240.43 and a risk weight of 10 percent.
(d) Limitations. Notwithstanding any other provision of this
section, an Enterprise must assign a risk weight of not less than 10
percent to a CRT exposure.
(e) Adjusted exposure amount. The exposure amount for a CRT
exposure is not subject to an adjustment under this section.
(f) RWA adjustment for retained loan-level counterparty credit
risk. If the Enterprise elects to use the CRTA for a retained CRT
exposure and if the contractual terms of the CRT do not provide for the
transfer of the counterparty credit risk associated with any loan-level
credit enhancement or other loss sharing on the underlying mortgage
exposures, then the Enterprise must increase the risk-weighted assets
of the retained CRT exposure by the amount equal to the portion of
aggregate RWAs on the underlying mortgage exposures associated with
counterparty credit risk.

Sec. 1240.45 Securitization exposures to which the SSFA and the CRTA
do not apply.

An Enterprise must assign a 1,250 percent risk weight to any
acquired CRT exposure and all securitization exposures to which the
Enterprise does not apply the SSFA under Sec. 1240.43 or the CRTA
under Sec. 1240.44.

Sec. 1240.46 Recognition of credit risk mitigants for securitization
exposures.

(a) General. (1) An originating Enterprise that has obtained a
credit risk mitigant to hedge its exposure to a synthetic or
traditional securitization that satisfies the operational criteria
provided in Sec. 1240.41 may recognize the credit risk mitigant under
Sec. Sec. 1240.38 or 1240.39, but only as provided in this section.
(2) An investing Enterprise that has obtained a credit risk
mitigant to hedge a securitization exposure may recognize the credit
risk mitigant under Sec. Sec. 1240.38 or 1240.39, but only as provided
in this section.
(b) Mismatches. An Enterprise must make any applicable adjustment
to the protection amount of an eligible guarantee or credit derivative
as required in 12 CFR 217.36(d) through (f) for any hedged
securitization exposure. In the context of a synthetic securitization,
when an eligible guarantee or eligible credit derivative covers
multiple hedged exposures that have different residual maturities, the
Enterprise must use the longest residual maturity of any of the hedged
exposures as the residual maturity of all hedged exposures.

Risk-Weighted Assets for Equity Exposures

Sec. 1240.51 Exposure measurement.

An Enterprise must calculate its risk-weighted assets for any
equity exposures that are permissible under the Enterprise's
authorizing statute under 12 CFR 217.51 through 217.53 of this title,
substituting ``Enterprise for ``Board-regulated institution.''

Subpart E--Risk-Weighted Assets--Internal Ratings-Based and
Advanced Measurement Approaches

Sec. 1240.100 Purpose, applicability, and principle of conservatism.

(a) Purpose. This subpart E establishes:
(1) Minimum requirements for using Enterprise-specific internal
risk measurement and management processes for calculating risk-based
capital requirements; and
(2) Methodologies for the Enterprises to calculate their advanced
approaches total risk-weighted assets.

[[Page 39400]]

(b) Applicability. (1) This subpart applies to each Enterprise.
(2) An Enterprise must also include in its calculation of advanced
credit risk-weighted assets under this subpart all covered positions,
as defined in subpart F of this part.
(c) Principle of conservatism. Notwithstanding the requirements of
this subpart, an Enterprise may choose not to apply a provision of this
subpart to one or more exposures provided that:
(1) The Enterprise can demonstrate on an ongoing basis to the
satisfaction of FHFA that not applying the provision would, in all
circumstances, unambiguously generate a risk-based capital requirement
for each such exposure greater than that which would otherwise be
required under this subpart;
(2) The Enterprise appropriately manages the risk of each such
exposure;
(3) The Enterprise notifies FHFA in writing prior to applying this
principle to each such exposure; and
(4) The exposures to which the Enterprise applies this principle
are not, in the aggregate, material to the Enterprise.

Sec. 1240.101 Definitions.

(a) Terms that are set forth in Sec. 1240.2 and used in this
subpart have the definitions assigned thereto in Sec. 1240.2.
(b) For the purposes of this subpart, the following terms are
defined as follows:
Advanced internal ratings-based (IRB) systems means an Enterprise's
internal risk rating and segmentation system; risk parameter
quantification system; data management and maintenance system; and
control, oversight, and validation system for credit risk of exposures.
Advanced systems means an Enterprise's advanced IRB systems,
operational risk management processes, operational risk data and
assessment systems, operational risk quantification systems, and, to
the extent used by the Enterprise, the internal models methodology,
advanced CVA approach, double default excessive correlation detection
process, and internal models approach (IMA) for equity exposures.
Backtesting means the comparison of an Enterprise's internal
estimates with actual outcomes during a sample period not used in model
development. In this context, backtesting is one form of out-of-sample
testing.
Benchmarking means the comparison of an Enterprise's internal
estimates with relevant internal and external data or with estimates
based on other estimation techniques.
Business environment and internal control factors means the
indicators of an Enterprise's operational risk profile that reflect a
current and forward-looking assessment of the Enterprise's underlying
business risk factors and internal control environment.
Dependence means a measure of the association among operational
losses across and within units of measure.
Economic downturn conditions means, with respect to an exposure
held by the Enterprise, those conditions in which the aggregate default
rates for that exposure's exposure subcategory (or subdivision of such
subcategory selected by the Enterprise) in the exposure's jurisdiction
(or subdivision of such jurisdiction selected by the Enterprise) are
significantly higher than average.
Eligible operational risk offsets means amounts, not to exceed
expected operational loss, that:
(i) Are generated by internal business practices to absorb highly
predictable and reasonably stable operational losses, including
reserves calculated consistent with GAAP; and
(ii) Are available to cover expected operational losses with a high
degree of certainty over a one-year horizon.
Expected operational loss (EOL) means the expected value of the
distribution of potential aggregate operational losses, as generated by
the Enterprise's operational risk quantification system using a one-
year horizon.
External operational loss event data means, with respect to an
Enterprise, gross operational loss amounts, dates, recoveries, and
relevant causal information for operational loss events occurring at
organizations other than the Enterprise.
Internal operational loss event data means, with respect to an
Enterprise, gross operational loss amounts, dates, recoveries, and
relevant causal information for operational loss events occurring at
the Enterprise.
Operational loss means a loss (excluding insurance or tax effects)
resulting from an operational loss event. Operational loss includes all
expenses associated with an operational loss event except for
opportunity costs, forgone revenue, and costs related to risk
management and control enhancements implemented to prevent future
operational losses.
Operational loss event means an event that results in loss and is
associated with any of the following seven operational loss event type
categories:
(i) Internal fraud, which means the operational loss event type
category that comprises operational losses resulting from an act
involving at least one internal party of a type intended to defraud,
misappropriate property, or circumvent regulations, the law, or company
policy excluding diversity- and discrimination-type events.
(ii) External fraud, which means the operational loss event type
category that comprises operational losses resulting from an act by a
third party of a type intended to defraud, misappropriate property, or
circumvent the law. All third-party-initiated credit losses are to be
treated as credit risk losses.
(iii) Employment practices and workplace safety, which means the
operational loss event type category that comprises operational losses
resulting from an act inconsistent with employment, health, or safety
laws or agreements, payment of personal injury claims, or payment
arising from diversity- and discrimination-type events.
(iv) Clients, products, and business practices, which means the
operational loss event type category that comprises operational losses
resulting from the nature or design of a product or from an
unintentional or negligent failure to meet a professional obligation to
specific clients (including fiduciary and suitability requirements).
(v) Damage to physical assets, which means the operational loss
event type category that comprises operational losses resulting from
the loss of or damage to physical assets from natural disaster or other
events.
(vi) Business disruption and system failures, which means the
operational loss event type category that comprises operational losses
resulting from disruption of business or system failures.
(vii) Execution, delivery, and process management, which means the
operational loss event type category that comprises operational losses
resulting from failed transaction processing or process management or
losses arising from relations with trade counterparties and vendors.
Operational risk means the risk of loss resulting from inadequate
or failed internal processes, people, and systems or from external
events (including legal risk but excluding strategic and reputational
risk).
Operational risk exposure means the 99.9th percentile of the
distribution of potential aggregate operational losses, as generated by
the Enterprise's operational risk quantification system over a one-year
horizon (and not incorporating eligible operational risk offsets or
qualifying operational risk mitigants).
Risk parameter means a variable used in determining risk-based
capital requirements for exposures, such as

[[Page 39401]]

probability of default, loss given default, exposure at default, or
effective maturity.
Scenario analysis means a systematic process of obtaining expert
opinions from business managers and risk management experts to derive
reasoned assessments of the likelihood and loss impact of plausible
high-severity operational losses. Scenario analysis may include the
well-reasoned evaluation and use of external operational loss event
data, adjusted as appropriate to ensure relevance to an Enterprise's
operational risk profile and control structure.
Unexpected operational loss (UOL) means the difference between the
Enterprise's operational risk exposure and the Enterprise's expected
operational loss.
Unit of measure means the level (for example, organizational unit
or operational loss event type) at which the Enterprise's operational
risk quantification system generates a separate distribution of
potential operational losses.

Sec. 1240.121 Minimum requirements.

(a) Process and systems requirements. (1) An Enterprise must have a
rigorous process for assessing its overall capital adequacy in relation
to its risk profile and a comprehensive strategy for maintaining an
appropriate level of capital.
(2) The systems and processes used by an Enterprise for risk-based
capital purposes under this subpart must be consistent with the
Enterprise's internal risk management processes and management
information reporting systems.
(3) Each Enterprise must have an appropriate infrastructure with
risk measurement and management processes that meet the requirements of
this section and are appropriate given the Enterprise's size and level
of complexity. The Enterprise must ensure that the risk parameters and
reference data used to determine its risk-based capital requirements
are representative of long run experience with respect to its credit
risk and operational risk exposures.
(b) Risk rating and segmentation systems for exposures. (1) An
Enterprise must have an internal risk rating and segmentation system
that accurately, reliably, and meaningfully differentiates among
degrees of credit risk for the Enterprise's exposures. When assigning
an internal risk rating, an Enterprise may consider a third-party
assessment of credit risk, provided that the Enterprise's internal risk
rating assignment does not rely solely on the external assessment.
(2) If an Enterprise uses multiple rating or segmentation systems,
the Enterprise's rationale for assigning an exposure to a particular
system must be documented and applied in a manner that best reflects
the obligor or exposure's level of risk. An Enterprise must not
inappropriately allocate exposures across systems to minimize
regulatory capital requirements.
(3) In assigning ratings to exposures, an Enterprise must use all
relevant and material information and ensure that the information is
current.
(c) Quantification of risk parameters for exposures. (1) The
Enterprise must have a comprehensive risk parameter quantification
process that produces accurate, timely, and reliable estimates of the
risk parameters on a consistent basis for the Enterprise's exposures.
(2) An Enterprise's estimates of risk parameters must incorporate
all relevant, material, and available data that is reflective of the
Enterprise's actual exposures and of sufficient quality to support the
determination of risk-based capital requirements for the exposures. In
particular, the population of exposures in the data used for estimation
purposes, the underwriting standards in use when the data were
generated, and other relevant characteristics, should closely match or
be comparable to the Enterprise's exposures and standards. In addition,
an Enterprise must:
(i) Demonstrate that its estimates are representative of long run
experience, including periods of economic downturn conditions, whether
internal or external data are used;
(ii) Take into account any changes in underwriting practice or the
process for pursuing recoveries over the observation period;
(iii) Promptly reflect technical advances, new data, and other
information as they become available;
(iv) Demonstrate that the data used to estimate risk parameters
support the accuracy and robustness of those estimates; and
(v) Demonstrate that its estimation technique performs well in out-
of-sample tests whenever possible.
(3) The Enterprise's risk parameter quantification process must
produce appropriately conservative risk parameter estimates where the
Enterprise has limited relevant data, and any adjustments that are part
of the quantification process must not result in a pattern of bias
toward lower risk parameter estimates.
(4) The Enterprise's risk parameter estimation process should not
rely on the possibility of U.S. government financial assistance.
(5) Default, loss severity, and exposure amount data must include
periods of economic downturn conditions, or the Enterprise must adjust
its estimates of risk parameters to compensate for the lack of data
from periods of economic downturn conditions.
(6) If an Enterprise uses internal data obtained prior to becoming
subject to this subpart E or external data to arrive at risk parameter
estimates, the Enterprise must demonstrate to FHFA that the Enterprise
has made appropriate adjustments if necessary to be consistent with the
Enterprise's definition of default. Internal data obtained after the
Enterprise becomes subject to this subpart E must be consistent with
the Enterprise's definition of default.
(7) The Enterprise must review and update (as appropriate) its risk
parameters and its risk parameter quantification process at least
annually.
(8) The Enterprise must, at least annually, conduct a comprehensive
review and analysis of reference data to determine relevance of the
reference data to the Enterprise's exposures, quality of reference data
to support risk parameter estimates, and consistency of reference data
to the Enterprise's definition of default.
(d) Operational risk--(1) Operational risk management processes. An
Enterprise must:
(i) Have an operational risk management function that:
(A) Is independent of business line management; and
(B) Is responsible for designing, implementing, and overseeing the
Enterprise's operational risk data and assessment systems, operational
risk quantification systems, and related processes;
(ii) Have and document a process (which must capture business
environment and internal control factors affecting the Enterprise's
operational risk profile) to identify, measure, monitor, and control
operational risk in the Enterprise's products, activities, processes,
and systems; and
(iii) Report operational risk exposures, operational loss events,
and other relevant operational risk information to business unit
management, senior management, and the board of directors (or a
designated committee of the board).
(2) Operational risk data and assessment systems. An Enterprise
must have operational risk data and assessment systems that capture
operational risks to which the

[[Page 39402]]

Enterprise is exposed. The Enterprise's operational risk data and
assessment systems must:
(i) Be structured in a manner consistent with the Enterprise's
current business activities, risk profile, technological processes, and
risk management processes; and
(ii) Include credible, transparent, systematic, and verifiable
processes that incorporate the following elements on an ongoing basis:
(A) Internal operational loss event data. The Enterprise must have
a systematic process for capturing and using internal operational loss
event data in its operational risk data and assessment systems.
(1) The Enterprise's operational risk data and assessment systems
must include a historical observation period of at least five years for
internal operational loss event data (or such shorter period approved
by FHFA to address transitional situations, such as integrating a new
business line).
(2) The Enterprise must be able to map its internal operational
loss event data into the seven operational loss event type categories.
(3) The Enterprise may refrain from collecting internal operational
loss event data for individual operational losses below established
dollar threshold amounts if the Enterprise can demonstrate to the
satisfaction of FHFA that the thresholds are reasonable, do not exclude
important internal operational loss event data, and permit the
Enterprise to capture substantially all the dollar value of the
Enterprise's operational losses.
(B) External operational loss event data. The Enterprise must have
a systematic process for determining its methodologies for
incorporating external operational loss event data into its operational
risk data and assessment systems.
(C) Scenario analysis. The Enterprise must have a systematic
process for determining its methodologies for incorporating scenario
analysis into its operational risk data and assessment systems.
(D) Business environment and internal control factors. The
Enterprise must incorporate business environment and internal control
factors into its operational risk data and assessment systems. The
Enterprise must also periodically compare the results of its prior
business environment and internal control factor assessments against
its actual operational losses incurred in the intervening period.
(3) Operational risk quantification systems. The Enterprise's
operational risk quantification systems:
(i) Must generate estimates of the Enterprise's operational risk
exposure using its operational risk data and assessment systems;
(ii) Must employ a unit of measure that is appropriate for the
Enterprise's range of business activities and the variety of
operational loss events to which it is exposed, and that does not
combine business activities or operational loss events with
demonstrably different risk profiles within the same loss distribution;
(iii) Must include a credible, transparent, systematic, and
verifiable approach for weighting each of the four elements, described
in paragraph (d)(2)(ii) of this section, that an Enterprise is required
to incorporate into its operational risk data and assessment systems;
(iv) May use internal estimates of dependence among operational
losses across and within units of measure if the Enterprise can
demonstrate to the satisfaction of FHFA that its process for estimating
dependence is sound, robust to a variety of scenarios, and implemented
with integrity, and allows for uncertainty surrounding the estimates.
If the Enterprise has not made such a demonstration, it must sum
operational risk exposure estimates across units of measure to
calculate its total operational risk exposure; and
(v) Must be reviewed and updated (as appropriate) whenever the
Enterprise becomes aware of information that may have a material effect
on the Enterprise's estimate of operational risk exposure, but the
review and update must occur no less frequently than annually.
(e) Data management and maintenance. (1) An Enterprise must have
data management and maintenance systems that adequately support all
aspects of its advanced systems and the timely and accurate reporting
of risk-based capital requirements.
(2) An Enterprise must retain data using an electronic format that
allows timely retrieval of data for analysis, validation, reporting,
and disclosure purposes.
(3) An Enterprise must retain sufficient data elements related to
key risk drivers to permit adequate monitoring, validation, and
refinement of its advanced systems.
(f) Control, oversight, and validation mechanisms. (1) The
Enterprise's senior management must ensure that all components of the
Enterprise's advanced systems function effectively and comply with the
minimum requirements in this section.
(2) The Enterprise's board of directors (or a designated committee
of the board) must at least annually review the effectiveness of, and
approve, the Enterprise's advanced systems.
(3) An Enterprise must have an effective system of controls and
oversight that:
(i) Ensures ongoing compliance with the minimum requirements in
this section;
(ii) Maintains the integrity, reliability, and accuracy of the
Enterprise's advanced systems; and
(iii) Includes adequate governance and project management
processes.
(4) The Enterprise must validate, on an ongoing basis, its advanced
systems. The Enterprise's validation process must be independent of the
advanced systems' development, implementation, and operation, or the
validation process must be subjected to an independent review of its
adequacy and effectiveness. Validation must include:
(i) An evaluation of the conceptual soundness of (including
developmental evidence supporting) the advanced systems;
(ii) An ongoing monitoring process that includes verification of
processes and benchmarking; and
(iii) An outcomes analysis process that includes backtesting.
(5) The Enterprise must have an internal audit function or
equivalent function that is independent of business-line management
that at least annually:
(i) Reviews the Enterprise's advanced systems and associated
operations, including the operations of its credit function and
estimations of risk parameters;
(ii) Assesses the effectiveness of the controls supporting the
Enterprise's advanced systems; and
(iii) Documents and reports its findings to the Enterprise's board
of directors (or a committee thereof).
(6) The Enterprise must periodically stress test its advanced
systems. The stress testing must include a consideration of how
economic cycles, especially downturns, affect risk-based capital
requirements (including migration across rating grades and segments and
the credit risk mitigation benefits of double default treatment).
(g) Documentation. The Enterprise must adequately document all
material aspects of its advanced systems.

Sec. 1240.122 Ongoing qualification.

(a) Changes to advanced systems. An Enterprise must meet all the
minimum requirements in Sec. 1240.121 on an ongoing basis. An
Enterprise must notify FHFA when the Enterprise makes any change to an
advanced system that would result in a material change in the
Enterprise's advanced approaches total

[[Page 39403]]

risk-weighted asset amount for an exposure type or when the Enterprise
makes any significant change to its modeling assumptions.
(b) Failure to comply with qualification requirements. (1) If FHFA
determines that an Enterprise fails to comply with the requirements in
Sec. 1240.121, FHFA will notify the Enterprise in writing of the
Enterprise's failure to comply.
(2) The Enterprise must establish and submit a plan satisfactory to
FHFA to return to compliance with the qualification requirements.
(3) In addition, if FHFA determines that the Enterprise's advanced
approaches total risk-weighted assets are not commensurate with the
Enterprise's credit, market, operational, or other risks, FHFA may
require such an Enterprise to calculate its advanced approaches total
risk-weighted assets with any modifications provided by FHFA.

Sec. 1240.123 Advanced approaches credit risk-weighted asset
calculations.

(a) An Enterprise must use its advanced systems to determine its
credit risk capital requirements for each of the following exposures:
(1) General credit risk (including for mortgage exposures);
(2) Cleared transactions;
(3) Default fund contributions;
(4) Unsettled transactions;
(5) Securitization exposures;
(6) Equity exposures; and
(7) The fair value adjustment to reflect counterparty credit risk
in valuation of OTC derivative contracts.
(b) The credit-risk-weighted assets calculated under this subpart E
equals the aggregate credit risk capital requirement under paragraph
(a) of this section multiplied by 12.5.

Sec. 1240.161 Qualification requirements for incorporation of
operational risk mitigants.

(a) Qualification to use operational risk mitigants. An Enterprise
may adjust its estimate of operational risk exposure to reflect
qualifying operational risk mitigants if:
(1) The Enterprise's operational risk quantification system is able
to generate an estimate of the Enterprise's operational risk exposure
(which does not incorporate qualifying operational risk mitigants) and
an estimate of the Enterprise's operational risk exposure adjusted to
incorporate qualifying operational risk mitigants; and
(2) The Enterprise's methodology for incorporating the effects of
insurance, if the Enterprise uses insurance as an operational risk
mitigant, captures through appropriate discounts to the amount of risk
mitigation:
(i) The residual term of the policy, where less than one year;
(ii) The cancellation terms of the policy, where less than one
year;
(iii) The policy's timeliness of payment;
(iv) The uncertainty of payment by the provider of the policy; and
(v) Mismatches in coverage between the policy and the hedged
operational loss event.
(b) Qualifying operational risk mitigants. Qualifying operational
risk mitigants are:
(1) Insurance that:
(i) Is provided by an unaffiliated company that the Enterprise
deems to have strong capacity to meet its claims payment obligations
and the Enterprise assigns the company a probability of default equal
to or less than 10 basis points;
(ii) Has an initial term of at least one year and a residual term
of more than 90 days;
(iii) Has a minimum notice period for cancellation by the provider
of 90 days;
(iv) Has no exclusions or limitations based upon regulatory action
or for the receiver or liquidator of a failed depository institution;
and
(v) Is explicitly mapped to a potential operational loss event;
(2) In evaluating an operational risk mitigant other than
insurance, FHFA will consider whether the operational risk mitigant
covers potential operational losses in a manner equivalent to holding
total capital.

Sec. 1240.162 Mechanics of operational risk risk-weighted asset
calculation.

(a) If an Enterprise does not qualify to use or does not have
qualifying operational risk mitigants, the Enterprise's dollar risk-
based capital requirement for operational risk is its operational risk
exposure minus eligible operational risk offsets (if any).
(b) If an Enterprise qualifies to use operational risk mitigants
and has qualifying operational risk mitigants, the Enterprise's dollar
risk-based capital requirement for operational risk is the greater of:
(1) The Enterprise's operational risk exposure adjusted for
qualifying operational risk mitigants minus eligible operational risk
offsets (if any); or
(2) 0.8 multiplied by the difference between:
(i) The Enterprise's operational risk exposure; and
(ii) Eligible operational risk offsets (if any).
(c) The Enterprise's risk-weighted asset amount for operational
risk equals the greater of:
(1) The Enterprise's dollar risk-based capital requirement for
operational risk determined under paragraphs (a) or (b) multiplied by
12.5; and
(2) The Enterprise's adjusted total assets multiplied by 0.0015
multiplied by 12.5.

Subpart F--Risk-Weighted Assets--Market Risk

Sec. 1240.201 Purpose, applicability, and reservation of authority.

(a) Purpose. This subpart F establishes risk-based capital
requirements for spread risk and provides methods for the Enterprises
to calculate their measure for spread risk.
(b) Applicability. This subpart applies to each Enterprise.
(c) Reservation of authority. Subject to applicable provisions of
the Safety and Soundness Act:
(1) FHFA may require an Enterprise to hold an amount of capital
greater than otherwise required under this subpart if FHFA determines
that the Enterprise's capital requirement for spread risk as calculated
under this subpart is not commensurate with the spread risk of the
Enterprise's covered positions.
(2) If FHFA determines that the risk-based capital requirement
calculated under this subpart by the Enterprise for one or more covered
positions or portfolios of covered positions is not commensurate with
the risks associated with those positions or portfolios, FHFA may
require the Enterprise to assign a different risk-based capital
requirement to the positions or portfolios that more accurately
reflects the risk of the positions or portfolios.
(3) In addition to calculating risk-based capital requirements for
specific positions or portfolios under this subpart, the Enterprise
must also calculate risk-based capital requirements for covered
positions under subpart D or subpart E of this part, as appropriate.
(4) Nothing in this subpart limits the authority of FHFA under any
other provision of law or regulation to take supervisory or enforcement
action, including action to address unsafe or unsound practices or
conditions, deficient capital levels, or violations of law.

Sec. 1240.202 Definitions.

(a) Terms set forth in Sec. 1240.2 and used in this subpart have
the definitions assigned in Sec. 1240.2.
(b) For the purposes of this subpart, the following terms are
defined as follows:
Backtesting means the comparison of an Enterprise's internal
estimates with actual outcomes during a sample period not used in model
development. For

[[Page 39404]]

purposes of this subpart, backtesting is one form of out-of-sample
testing.
Covered position means, any asset that has more than de minimis
spread risk (other than any intangible asset, such as any servicing
asset), including:
(i) Any NPL, RPL, reverse mortgage loan, or other mortgage exposure
that, in any case, does not secure an MBS guaranteed by the Enterprise;
(ii) Any MBS guaranteed by an Enterprise, MBS guaranteed by Ginnie
Mae, reverse mortgage security, PLS, commercial MBS, CRT exposure, or
other securitization exposure, regardless of whether the position is
held by the Enterprise for the purpose of short-term resale or with the
intent of benefiting from actual or expected short-term price
movements, or to lock in arbitrage profits; and
(iii) Any other trading asset or trading liability (whether on- or
off-balance sheet).\12\
---------------------------------------------------------------------------

\12\ Securities subject to repurchase and lending agreements are
included as if they are still owned by the Enterprise.
---------------------------------------------------------------------------

Market risk means the risk of loss on a position that could result
from movements in market prices, including spread risk.
Private label security (PLS) means any MBS that is collateralized
by a pool or pools of single-family mortgage exposures and that is not
guaranteed by an Enterprise or by Ginnie Mae.
Reverse mortgage means a mortgage loan secured by a residential
property in which a homeowner relinquishes equity in their home in
exchange for regular payments.
Reverse mortgage security means a security collateralized by
reverse mortgages.
Spread risk means the risk of loss on a position that could result
from a change in the bid or offer price of such position relative to a
risk free or funding benchmark, including when due to a change in
perceptions of performance or liquidity of the position.

Sec. 1240.203 Requirements for managing market risk.

(a) Management of covered positions--(1) Active management. An
Enterprise must have clearly defined policies and procedures for
actively managing all covered positions. At a minimum, these policies
and procedures must require:
(i) Marking covered positions to market or to model on a daily
basis;
(ii) Daily assessment of the Enterprise's ability to hedge position
and portfolio risks, and of the extent of market liquidity;
(iii) Establishment and daily monitoring of limits on covered
positions by a risk control unit independent of the business unit;
(iv) Routine monitoring by senior management of information
described in paragraphs (a)(1)(i) through (a)(1)(iii) of this section;
(v) At least annual reassessment of established limits on positions
by senior management; and
(vi) At least annual assessments by qualified personnel of the
quality of market inputs to the valuation process, the soundness of key
assumptions, the reliability of parameter estimation in pricing models,
and the stability and accuracy of model calibration under alternative
market scenarios.
(2) Valuation of covered positions. The Enterprise must have a
process for prudent valuation of its covered positions that includes
policies and procedures on the valuation of positions, marking
positions to market or to model, independent price verification, and
valuation adjustments or reserves. The valuation process must consider,
as appropriate, unearned credit spreads, close-out costs, early
termination costs, investing and funding costs, liquidity, and model
risk.
(b) Requirements for internal models. (1) A risk control unit
independent of the business unit must approve any internal model to
calculate its risk-based capital requirement under this subpart.
(2) An Enterprise must meet all of the requirements of this section
on an ongoing basis. The Enterprise must promptly notify FHFA when:
(i) The Enterprise plans to extend the use of a model to an
additional business line or product type;
(ii) The Enterprise makes any change to an internal model that
would result in a material change in the Enterprise's risk-weighted
asset amount for a portfolio of covered positions; or
(iii) The Enterprise makes any material change to its modeling
assumptions.
(3) FHFA may determine an appropriate capital requirement for the
covered positions to which a model would apply, if FHFA determines that
the model no longer complies with this subpart or fails to reflect
accurately the risks of the Enterprise's covered positions.
(4) The Enterprise must periodically, but no less frequently than
annually, review its internal models in light of developments in
financial markets and modeling technologies, and enhance those models
as appropriate to ensure that they continue to meet the Enterprise's
standards for model approval and employ risk measurement methodologies
that are most appropriate for the Enterprise's covered positions.
(5) The Enterprise must incorporate its internal models into its
risk management process and integrate the internal models used for
calculating its market risk measure into its daily risk management
process.
(6) The level of sophistication of an Enterprise's internal models
must be commensurate with the complexity and amount of its covered
positions. An Enterprise's internal models may use any of the generally
accepted approaches, including variance-covariance models, historical
simulations, or Monte Carlo simulations, to measure market risk.
(7) The Enterprise's internal models must properly measure all the
material risks in the covered positions to which they are applied.
(8) The Enterprise's internal models must conservatively assess the
risks arising from less liquid positions and positions with limited
price transparency under realistic market scenarios.
(9) The Enterprise must have a rigorous and well-defined process
for re-estimating, re-evaluating, and updating its internal models to
ensure continued applicability and relevance.
(c) Control, oversight, and validation mechanisms. (1) The
Enterprise must have a risk control unit that reports directly to
senior management and is independent from the business units.
(2) The Enterprise must validate its internal models initially and
on an ongoing basis. The Enterprise's validation process must be
independent of the internal models' development, implementation, and
operation, or the validation process must be subjected to an
independent review of its adequacy and effectiveness. Validation must
include:
(i) An evaluation of the conceptual soundness of (including
developmental evidence supporting) the internal models;
(ii) An ongoing monitoring process that includes verification of
processes and the comparison of the Enterprise's model outputs with
relevant internal and external data sources or estimation techniques;
and
(iii) An outcomes analysis process that includes backtesting.
(3) The Enterprise must stress test the market risk of its covered
positions at a frequency appropriate to each portfolio, and in no case
less frequently than quarterly. The stress tests must take into account
concentration risk (including concentrations in single issuers,
industries, sectors, or markets), illiquidity under stressed market
conditions, and risks arising from the Enterprise's trading activities
that may

[[Page 39405]]

not be adequately captured in its internal models.
(4) The Enterprise must have an internal audit function independent
of business-line management that at least annually assesses the
effectiveness of the controls supporting the Enterprise's market risk
measurement systems, including the activities of the business units and
independent risk control unit, compliance with policies and procedures,
and calculation of the Enterprise's measures for spread risk under this
subpart. At least annually, the internal audit function must report its
findings to the Enterprise's board of directors (or a committee
thereof).
(d) Internal assessment of capital adequacy. The Enterprise must
have a rigorous process for assessing its overall capital adequacy in
relation to its market risk.
(e) Documentation. The Enterprise must adequately document all
material aspects of its internal models, management and valuation of
covered positions, control, oversight, validation and review processes
and results, and internal assessment of capital adequacy.

Sec. 1240.204 Measure for spread risk.

(a) General requirement--(1) In general. An Enterprise must
calculate its standardized measure for spread risk by following the
steps described in paragraph (a)(2) of this section. An Enterprise also
must calculate an advanced measure for spread risk by following the
steps in paragraph (a)(2) of this section.
(2) Measure for spread risk. An Enterprise must calculate the
standardized measure for spread risk, which equals the sum of the
spread risk capital requirements of all covered positions using one or
more of its internal models except as contemplated by paragraphs (b) or
(c) of this section. An Enterprise also must calculate the advanced
measure for spread risk, which equals the sum of the spread risk
capital requirements of all covered positions calculated using one or
more of its internal models.
(b) Single point approach--(1) General. For purposes of the
standardized measure for spread risk, the spread risk capital
requirement for a covered position that is an RPL, an NPL, a reverse
mortgage loan, or a reverse mortgage security is the amount equal to:
(i) The market value of the covered position; multiplied by
(ii) The applicable single point shock assumption for the covered
position under paragraph (b)(2) of this section.
(2) Applicable single point shock assumption. The applicable single
point shock assumption is:
(i) 0.0475 for an RPL or an NPL;
(ii) 0.0160 for a reverse mortgage loan; and
(iii) 0.0410 for a reverse mortgage security.
(c) Spread duration approach--(1) General. For purposes of the
standardized measure for spread risk, the spread risk capital
requirement for a covered position that is a multifamily mortgage
exposure, a PLS, or an MBS guaranteed by an Enterprise or Ginnie Mae
and secured by multifamily mortgage exposures is the amount equal to:
(i) The market value of the covered position; multiplied by
(ii) The spread duration of the covered position determined by the
Enterprise using one or more of its internal models; multiplied by
(iii) The applicable spread shock assumption under paragraph (c)(2)
of this section.
(2) Applicable spread shock assumption. The applicable spread shock
is:
(i) 0.0015 for a multifamily mortgage exposure;
(ii) 0.0265 for a PLS; and
(iii) 0.0100 for an MBS guaranteed by an Enterprise or by Ginnie
Mae and secured by multifamily mortgage exposures (other than IO
securities guaranteed by an Enterprise or Ginnie Mae).

Subpart G--Stability Capital Buffer

Sec. 1240.400 Stability capital buffer.

(a) Definitions. For purposes of this subpart:
(1) Mortgage assets means, with respect to an Enterprise, the
dollar amount equal to the sum of:
(i) The unpaid principal balance of its single-family mortgage
exposures, including any single-family loans that secure MBS guaranteed
by the Enterprise;
(ii) The unpaid principal balance of its multifamily mortgage
exposures, including any multifamily mortgage exposures that secure MBS
guaranteed by the Enterprise;
(iii) The carrying value of its MBS guaranteed by an Enterprise or
Ginnie Mae, PLS, and other securitization exposures (other than its
retained CRT exposures); and
(iv) The exposure amount of any other mortgage assets.
(2) Residential mortgage debt outstanding means the dollar amount
of mortgage debt outstanding secured by one- to four-family residences
or multifamily residences that are located in the United States (and
excluding any mortgage debt outstanding secured by non-farm, non-
residential or farm properties).
(b) Amount. An Enterprise must calculate its stability capital
buffer under this section on an annual basis by December 31 of each
year. The stability capital buffer of an Enterprise is equal to:
(1) The ratio of:
(i) The mortgage assets of the Enterprise as of December 31 of the
previous calendar year; to
(ii) The residential mortgage debt outstanding as of December 31 of
the previous calendar year, as published by FHFA;
(2) Minus 0.05;
(3) Multiplied by 5;
(4) Divided by 100; and
(5) Multiplied by the adjusted total assets of the Enterprise.
(c) Effective date of an adjusted stability capital buffer--(1)
Increase in stability capital buffer. An increase in the stability
capital buffer of an Enterprise under this section will take effect
(i.e., be incorporated into the maximum payout ratio under Table 1 to
paragraph (b)(5) of Sec. 1240.11) on January 1 of the year that is one
full calendar year after the increased stability capital buffer was
calculated.
(2) Decrease in stability capital buffer. A decrease in the
stability capital buffer of an Enterprise will take effect (i.e., be
incorporated into the maximum payout ratio under Table 1 to paragraph
(b)(5) of Sec. 1240.11) on January 1 of the year immediately following
the calendar year in which the decreased stability capital buffer was
calculated.

[Alternative Approach]

Sec. 1240.400 Stability capital buffer.

(a) Amount. An Enterprise must calculate its stability capital
buffer under this section on an annual basis by December 31 of each
year. The stability capital buffer of an Enterprise is equal to:
(1) Subject to paragraph (b) of this section, the GSIB surcharge as
calculated under subpart H of 12 CFR 217 (expressed as a percent), as
if the Enterprise were a globally systemic important BHC under 12 CFR
217.402; multiplied by
(2) The weighted average of the risk weights of the mortgage
exposures of the Enterprise (weighted by exposure amount) as of the
effective date of the final rule; multiplied by
(3) The adjusted total assets of the Enterprise.
(b) Adjustment to systemic indicator score. In calculating the GSIB
surcharge

[[Page 39406]]

under paragraph (a)(1) of this section, the Enterprise must:
(1) Exclude from the sum of its systemic indicator scores the
systemic indicators for substitutability (payments activity, assets
under custody, and underwritten transactions in debt and equity
markets) and cross-jurisdictional activity (cross-jurisdictional claims
and cross-jurisdictional liabilities); and
(2) Divide the sum of its systemic indicator scores, as adjusted
under paragraph (b)(1) of this section, by the amount equal to 0.60.
(c) Effective date of an adjusted stability buffer--(1) Increase in
stability capital buffer. An increase in the stability buffer of an
Enterprise under this section will take effect (i.e., be incorporated
into the maximum payout ratio under Table 1 to paragraph (b)(5) of
Sec. 1240.11) on January 1 of the year that is one full calendar year
after the increased stability capital buffer was calculated.
(2) Decrease in stability capital buffer. A decrease in the
stability buffer of an Enterprise will take effect (i.e., be
incorporated into the maximum payout ratio under Table 1 to paragraph
(b)(5) of Sec. 1240.11) on January 1 of the year immediately following
the calendar year in which the decreased stability capital buffer was
calculated.

CHAPTER XII--FEDERAL HOUSING FINANCE AGENCY

SUBCHAPTER C--SAFETY AND SOUNDNESS

PART 1750--[REMOVED]

0
6. Remove part 1750.

Mark A. Calabria,
Director, Federal Housing Finance Agency.
[FR Doc. 2020-11279 Filed 6-29-20; 8:45 am]
BILLING CODE 8070-01-P

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