[author: Keith R. Fisher]

The Office of the Comptroller of the Currency has issued an interim final rule on lending limits that applies not only to national banks but to thrift institutions as well.

Section 610 of the Dodd-Frank Wall Street Reform and Consumer Protection Act amended the statutory definition of “loans and extensions of credit” for lending limit purposes in both the National Bank Act and the Home Owners Loan Act (HOLA) to encompass credit exposures on derivative transactions, securities borrowing and lending transactions (SBLTs), repurchase agreements (repos), and reverse repos.

In addition to addressing these credit exposures, the interim final rule and request for comments issued on June 20, 2012, eliminates a separate lending limit regulation for thrifts and both consolidates them with and conforms them to OCC’s Part 32 regulations implementing national bank lending limits.

The general approach of the national bank lending limit, 12 U.S.C. Section 84, is to cap total “loans and extensions of credit” to any person to 15 percent of unimpaired capital and surplus, with the possibility of an additional 10 percent if the excess is fully secured by readily marketable collateral. In amending Section 84, Congress left it to OCC to delineate the contours of what constitutes “credit exposure” and the means by which such exposures will be calculated.

The rule accords covered institutions some flexibility in that regard. They may choose from among three different methodologies for calculating credit exposures arising out of derivatives transactions (other than credit derivatives, which are subject to special rules) and two alternatives for calculating credit exposures relating to SBLTs. Once chosen, the methodology must be used for all credit exposures in that category. The OCC release treats certain repos and reverse repos as economically indistinguishable from SBLTs and subjects them to the same regulatory treatment.

One option under the rule for both derivatives transactions and SBLTs is for an institution to use an internal model previously developed to comply with the advanced approaches developed in the banking agencies’ capital regulations under Basel II, so long as the model has been approved by the bank’s primary federal regulator. OCC notes, however, that it (or the FDIC) may require a bank to use a specific method if “necessary to promote the safety and soundness of the bank.”

The rule requires each covered institution to recalculate its lending limit on a quarterly basis or as of the date on which there is a change in the institution’s capital category (or more frequently if OCC so requires).

Exempt from SBLT lending limits are certain categories of investment securities that are not considered risky. These include, for national banks, Type 1 securities under Part 1 of OCC’s regulations, and for thrifts, securities listed in HOLA Sections 5(c)(1)(C)-(F), (H).

Another traditional feature of lending limit regulation is that a loan that complied when it was made does not become a violation of law if, with the passage of time, it ceases to comply as a result of various factors (decline of the bank’s unimpaired capital and surplus, devaluation of readily marketable collateral, etc.).

Relatedly, the rule provides that a credit exposure arising from a derivatives transaction or SLBTs measured using internal models will not be deemed a violation of either the lending limit statute or regulations and will instead be treated as nonconforming so long as “the extension of credit was within the institution’s legal lending limit at execution and is no longer in conformity because the exposure has increased since execution.”

The institution will be expected, however, to “use reasonable efforts” to bring such a loan or extension of credit that is nonconforming—because of a decline in capital or increase in credit exposure (but not decline in collateral value)—into conformity with the institution’s lending limit “unless to do so would be inconsistent with safe and sound banking practices.”

From the specificity of this forbearance provision, one infers that a derivative or SBLT credit exposure measured by one of the alternate methods that is within the lending limit when the transaction is executed but subsequently exceeds the lending limit because the exposure has increased would be a violation of the lending limit. It is possible that such a result is inadvertent and might be fixed after OCC has considered the comments filed.

This is the second rulemaking to focus on credit exposures from derivative transactions and SBLTs; the Federal Reserve Board has already initiated rulemaking to implement the single-counterparty credit limit (SCCL) mandated by Section 165(e) of Dodd-Frank. The latter covers only bank holding companies with $50 billion or more in consolidated assets and non-bank financial companies designated by the Financial Stability Oversight Council as systemically significant. The rule applies, in contrast, to all national banks and thrifts, regardless of size.

Other noteworthy aspects of the OCC release include the following:

• Intraday exposures from derivatives or SBLTs are not subject to the lending limits.
• Throughout the release, OCC requests comments on specific questions relating to the various methodologies and their efficacy.
• OCC specifically requests comment on whether a covered institution’s contingent obligation under derivative clearinghouse rules to advance funds to a guaranty fund should be subject to lending limits and, if so, what metric should be used. (Such exposures would be covered under the Fed's proposed SCCL Rules).

Comments are due by August 6, 2012. The effective date for the interim final rule is July 21, 2012 (which is the also the effective date for Dodd-Frank Section 610), except for the portion dealing with credit exposures arising from derivatives and SBLTs, which will become effective on January 1, 2013.

The attorneys in Ballard Spahr’s Consumer Financial Services Group and Bank Regulation and Supervision Group are experienced in assisting clients in understanding and implementing new regulatory requirements and in the preparation and filing of comments in agency rulemaking proceedings. For more information, please contact CFS Group Practice Leader Alan S. Kaplinsky at 215.864.8544 or kaplinsky@ballardspahr.com, CFS Group Practice Leader Jeremy T. Rosenblum at 215.864.8505 or rosenblum@ballardspahr.com, or, in the Bank Regulation and Supervision Group, Keith R. Fisher at 202.661.2284 or fisherk@ballardspahr.com.