OCC comes out with rules on legal lending limits; includes repo, sec lending and derivatives

Dodd-Frank Section 610 amends section 5200 of the Revised Statutes 12 U.S.C. 84 to include derivatives, sec lending, and repo in the legal lending limitsThe news services have picked up the OCC announcement of an “interim final rule” which governs how derivatives, securities lending, and repo fit into the bank legal lending limit calculations. There are a couple things in there that caught our eye…

From the OCC release….

Section 610 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010) (Dodd-Frank Act), amends section 5200 of the Revised Statutes 12 U.S.C. 84 to provide that the definition of “loans and extensions of credit” includes any credit exposure to a person arising from a derivative transaction, repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction between a national bank and that person. This amendment is effective July 21, 2012.

The limit for secured exposures is 25% of Tier 1 and Tier 2 capital. Incorporating exposure from repo, sec lending, and derivatives and monitoring them across a large national bank will be a technology challenge, but D-F told everyone it was coming.  Actually staying within the limit — probably not such a big deal with perhaps a few exceptions.

Some securities are not included — called Type 1 securities. These are defined in 12 CFR 1.2(j) primarily as UST and other US Gov’t “full faith and credit” instruments, Municipal General Obligations, and a catch-all “other securities the OCC determines to be eligible…”. Canadian governments are included in there as well.

From the OCC release…

A securities financing transaction is defined as a repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction. The interim final rule also removes current § 32.2(k)(1)(iii), which excludes repurchase agreements for Type I securities from the definition of loan or extension of credit.  Instead, it adds a provision, set forth at § 32.3(c)(11) and explained below, that exempts credit exposure arising from securities financing transactions involving Type I securities for all securities financing transactions.

Exposure is determined (for those using internal risk models) as unsecured exposure plus a PFE. For repo, sec lending and derivatives, the unsecured exposure starts out at zero and, as long as variation margin is collected, stays that way. For non-model users (basically smaller financials), there are fixed formulas.

What really caught our attention was this paragraph:

The interim final rule adds a new paragraph (a)(3) to § 32.6 to provide that a credit exposure arising from a derivative transaction or securities financing transaction and determined by the Internal Model Method specified in § 32.9(b)(1)(i) or § 32.9 (d)(3), respectively, will not be deemed a violation of the lending limits statute or regulation and will be treated as nonconforming if the extension of credit was within the national bank’s or savings association’s legal lending limit at execution and is no longer in conformity because the exposure has increased since execution.   

It sounds like once an exposure number is established, should it increase — say due to increased PFE caused by higher market volatility — that the increase in exposure can’t push the exposure over the limit. Maybe the increased exposure pushes utilization up, giving less available limit (should there be any), but it cannot trip the limit because of greater risk. We understand how hard it is the manage dynamic exposures, but this seems like it is really weakening the provision and a bit ironic.

A link to the story in Bloomberg story is here.

A link to the OCC Press Release is here.

A link to the OCC rule is here.

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