OCC Lending Limit Final Rule: OCC Issues Final Rule on Lending Limits and Makes Several Key Modifications

Sullivan & Cromwell LLP - June 27, 2013

On June 19, 2013, the Office of the Comptroller of the Currency (“OCC”) issued a final rule (the “Final Rule”) to implement Section 610 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Section 610 expanded the statutory definition of “loans and extensions of credit” in the lending limit provisions of the National Bank Act and Home Owners’ Loan Act to include the credit exposure arising from derivative transactions and securities financing transactions.

The Final Rule amends the OCC’s interim final rule issued on June 20, 2012 (the “Interim Final Rule”), which was discussed in our Memorandum to Clients dated June 27, 2012. Both the Final Rule and the Interim Final Rule set out the procedures and methodologies for calculating the credit exposure for derivative transactions and securities financing transactions and also establish a single set of lending limit rules applicable to both national banks and federally- and state-chartered savings associations (collectively, “banks”). Annex A to this Memorandum summarizes the methodologies, as amended by the Final Rule, that banks may use to calculate such credit exposures.

Key differences between the Final Rule and the Interim Final Rule include the following: 

  • The Final Rule further extends the compliance date for provisions implementing Section 610 from July 1, 2013 to October 1, 2013.
  • The Final Rule replaces the Remaining Maturity Method (“RMM”) — one of the two non-model methods included in the Interim Final Rule for measuring credit exposure arising from derivative transactions (other than credit derivative transactions) included in the Interim Final Rule — with the Current Exposure Method (“CEM”). 
  • In addition to the internal model method (renamed the “Model Method” in the Final Rule) and the non-model method (renamed the “Basic Method” in the Final Rule), the Final Rule permits banks to measure credit exposure arising from securities financing transactions by applying the standard supervisory haircuts for such transactions using the current risk-based capital rules of the appropriate federal banking agency’s capital rules or the proposed Basel III advanced approaches capital rules once finalized (collectively, the Basel Collateral Haircut Method (“BCHM”)) as an additional non-model method.
  • The Final Rule recognizes that there may be circumstances in which the use of only one calculation method for all derivative and all securities financing transactions may not be appropriate and clarifies that the appropriate federal banking agency may, in its discretion, permit a bank to use a specific method to calculate credit exposure, and that this method may apply to all or specific transactions if the appropriate federal banking agency finds that such method is consistent with the safety and soundness of the bank.
  • The Final Rule increases the threshold amount in the definition of effective margining arrangement from $1 million to $25 million and subjects the amount of the threshold to the lending limit. The Final Rule, like the Interim Final Rule, requires banks to enter into an effective margining arrangement in order to use an internal model approach to calculate counterparty exposure arising from a credit derivative.
  • Under the Final Rule, credit protection, such as credit default or total return swaps, can be used to reduce all types of credit exposures to a borrower, subject to certain requirements discussed below. In addition to those requirements, the total amount of such reduction may not exceed 10% of the bank’s capital and surplus.

The Final Rule does not address some of the other key concerns of commenters, such as excluding credit exposures to central counterparties or central counterparty guaranty funds, but, as noted in the preamble to the Final Rule, the OCC will continue to monitor the role of central counterparties and will revisit the Final Rule for exposures to such entities if necessary. The OCC also leaves open the treatment of credit exposures arising from sold tranched index credit derivatives, which the OCC intends to address through interpretations after further review. Furthermore, the OCC notes in the preamble to the Final Rule that it will consider whether further amendments to the Final Rule are necessary if an international agreement on large exposure limits currently contemplated by the Basel Committee on Banking Supervision is reached.

Finally, the Final Rule specifies certain criteria for the internal model approval process. The OCC states in the preamble to the Final Rule that national banks and federal savings associations that plan to seek approval for the use of a model pursuant to the Final Rule should contact their examiner-in-charge to begin the approval process.

The Final Rule also applies to state savings associations (for which the appropriate federal banking agency is the Federal Deposit Insurance Corporation (“FDIC”)) and to federally- and state-licensed branches of foreign banking organizations (for which the appropriate federal banking agency is, in the case of federally-licensed branches, the OCC and, in the case of state-licensed branches, the Board of Governors of the Federal Reserve System (“Federal Reserve”)). The preamble to the Final Rule states that the FDIC and the Federal Reserve will each have their own internal processes for approving the use of internal models. Thus, a state savings association should contact the FDIC and a state-licensed branch of a foreign banking organization should contact the Federal Reserve if it is planning to use a model approach to seek guidance as to the respective agency’s approval process.