Basel
ii in the United States of America
From the
Basel ii
Compliance Professionals Association (BCPA),
the largest association of Basel ii Professionals in the
world
Final Rule, USA: Risk-Based Capital Standards:
Advanced Capital Adequacy Framework — Basel II
Early Amortization
Provisions
Background
Many securitizations of revolving credit
facilities (for example, credit card receivables)
contain provisions that
require the securitization to be wound down and investors to be repaid if the excess
spread falls below a certain threshold.
This
decrease in excess spread may, in some cases, be caused
by deterioration in the credit quality of the underlying
exposures.
An early
amortization event can increase a bank’s capital needs
if new draws on the revolving credit facilities need to
be financed by the bank using on-balance sheet sources
of funding.
The payment allocations used to distribute principal and finance charge
collections during the amortization phase of these transactions also can expose a bank to
greater risk of loss than in other securitization transactions.
The final rule, consistent
with the proposed rule, assesses a risk-based capital requirement that, in general, is
linked to the likelihood of an early amortization event to address the risks that early
amortization of a securitization poses to originating banks.
Consistent with the proposed rule, the
final rule defines an early amortization provision as a provision in a
securitization’s governing documentation that, when triggered,
causes investors in the
securitization exposures to be repaid before the original stated maturity of the securitization
exposure, unless the provision is solely triggered by events not related to the performance of
the underlying exposures or the originating bank (such as material changes in tax laws or
regulations).
Under the proposed rule, a bank would not
be required to hold regulatory capital against the investors’ interest if early
amortization is solely triggered by events not related to the performance of the
underlying exposures or the originating bank, such as
material changes in tax laws or regulation.
Under
the New Accord, a bank is also not required to hold regulatory capital
against the investors’ interest if
(i) the securitization has a replenishment structure in which the
individual underlying exposures do not
revolve and the early amortization ends
the ability of the originating bank to add new underlying
exposures to the securitization;
(ii) the
securitization involves revolving assets and contains
early amortization features that mimic term structures; or
(iii)
investors inthe securitization remain fully exposed to
future draws by borrowers on the underlying
exposures even after the occurrence of early amortization.
The
agencies sought comment on the appropriateness of these additional
exemptions in the U.S. markets for revolving securitizations.
Most commenters asserted
that the exemptions provided in the New Accord are prudent and should be adopted
by the agencies in order to avoid placing U.S.banking
organizations at a competitive disadvantage relative to
foreign competitors.
The
agencies generally agree with this view of exemption
(iii), above, and the definition of early amortization
provision in the final rule incorporates this exemption.
The
agencies have not included exemption (i) or (ii).
The
agencies do not believe that the exemption for non-revolving exposures is meaningful
because the early amortization provisions apply only to
securitizations with revolving underlying exposures.
The
agencies also do not believe that the exemption for early
amortization features that mimic term structures
is meaningful in the U.S. market.
Under the final rule, as under the
proposed rule, an originating bank must generally hold risk-based capital against
the sum of the originating bank’s interest and the investors’ interest arising from a
securitization that contains an early amortization
provision.
An
originating bank must compute its capital requirement for
its interest using the hierarchy of approaches for
securitization exposures as described above.
The originating bank’s risk-weighted asset
amount for the investors’ interest in the securitization is equal to the product of
the following five quantities:
(i) the EAD associated with the investors’ interest;
(ii) the appropriate CF as determined below;
(iii) KIRB;
(iv) 12.5; and (v) the proportion of the underlying
exposures in which the borrower is permitted to vary the drawn
amount within an agreed limit under a line of credit.
The agencies added (v) to the
final rule because, for securitizations containing both revolving and non-revolving
underlying exposures, only the revolving underlying exposures give rise to the risk of early
amortization.
Under the final rule, consistent with the
proposal, the investors’ interest with respect to a revolving securitization
captures both the drawn balances and undrawn lines of the
underlying exposures that are allocated to the investors
in the securitization.
The EAD associated with the investors’
interest is equal to the EAD of the underlying
exposures multiplied
by the ratio of:
(i) the total amount of securitization
exposures issued by the securitization SPE to investors; divided by
(ii) the outstanding principal amount of
underlying exposures.
In general, the applicable CF depends on
whether the early amortization provision repays investors through a controlled or
non-controlled mechanism and whether the underlying exposures are revolving retail
credit facilities that are uncommitted (unconditionally cancelable by the bank to
the fullest extent of Federal law, such as credit card receivables) or are other revolving
credit facilities (for example, revolving corporate
credit
facilities).
Consistent with the New Accord, under the proposed rule a
controlled early amortization provision would meet
each of the following conditions:
(i) The originating bank has appropriate
policies and procedures to ensure that it has sufficient capital and liquidity
available in the event of an early amortization;
(ii) Throughout the duration of the
securitization (including the early amortization period) there is the same pro rata sharing
of interest, principal, expenses, losses, fees, recoveries, and other cash flows from the
underlying exposures, based on the originating bank’s and the investors’ relative shares
of the underlying exposures outstanding measured on a consistent monthly basis;
(iii) The amortization period is
sufficient for at least 90 percent of the total underlying exposures outstanding at the
beginning of the early amortization period to have been repaid or recognized as in
default; and
(iv) The schedule for repayment of
investor principal is not more rapid than would be allowed by straight-line
amortization over an 18-month period.
An early amortization provision that does
not meet any of the above criteria is a non-controlled early amortization
provision.
The agencies solicited comment on the
distinction between controlled and non controlled early amortization provisions and on the
extent to which banks use controlled early amortization
provisions.
The
agencies also invited comment on the proposed definition of a controlled early
amortization provision, including in particular the 18- month period set forth above.
Commenters
generally believed that very few, if any, revolving securitizations would meet the
criteria needed to qualify for treatment as a controlled
early amortization structure.
One
commenter maintained that a fixed 18- month straight-line amortization period
was too long for certain exposures, such as prime credit cards.
The final rule is unchanged from the
proposal with respect to controlled and non controlled
early amortization provisions.
The
agencies believe that the proposed eligibility criteria for a controlled
early amortization are important indicators of the risks to which an originating bank would be
exposed in the event of any early amortization.
While a fixed 18-month straight-line
amortization period is unlikely to be the most appropriate period in all cases, it is a
reasonable period for the vast majority of cases.
The lower operational burden of using a
single, fixed amortization period warrants the potential diminution in risk-sensitivity.
Controlled early amortization
Under the proposed rule, to calculate the
appropriate CF for a securitization of uncommitted revolving retail exposures
that contains a controlled early amortization provision, a bank would compare the
three-month average annualized excess spread for the securitization to the point at which
the bank is required to trap excess spread under the
securitization transaction.
In
securitizations that do not require excess spread to be trapped, or that specify a trapping point
based primarily on performance measures other than the three-month average annualized
excess spread, the excess spread trapping point was
4.5
percent.
The bank
would divide the three-month average annualized excess spread level by the excess spread trapping
point and apply the appropriate CF from Table H.
A bank would apply a 90 percent CF for all
other revolving underlying exposures (committed exposures and nonretail
exposures) in securitizations containing a controlled early amortization provision.
The proposed CFs for uncommitted revolving retail credit lines were much lower than for committed
retail credit lines or for non-retail credit lines because of the demonstrated ability of
banks to monitor and, when appropriate, to curtail promptly uncommitted retail credit lines
for customers of deteriorating credit quality.
Such account management tools are
unavailable for committed lines, and banks may be less proactive about using such tools in
the case of uncommitted non-retail credit lines owing to lender liability concerns and the
prominence of broad-based, longer-term customer relationships.
Non-controlled early amortization
Under the proposed rule, to calculate the
appropriate CF for securitizations of uncommitted revolving retail exposures
that contain a non-controlled early amortization provision, a bank would perform the excess
spread calculations described in the controlled early amortization section above and then
apply the CFs in Table I.
 
A bank would use a 100 percent CF for all
other revolving underlying exposures (committed exposures and nonretail
exposures) in securitizations containing a non controlled early amortization provision.
In other
words, no risk transference would be recognized for these transactions; an
originating bank’s IRB capital requirement would be the same as if the underlying exposures
had not been securitized.
A few commenters asserted that the
proposed CFs were too high.
The
agencies believe, however, that the proposed CFs
appropriately capture the risk to the bank of a
potential early amortization event.
The
agencies also believe that the proposed CFs, which are consistent with the New Accord,
foster consistency across national jurisdictions.
Therefore, the agencies are
maintaining the proposed CFs in the final rule with one exception, discussed below.
In circumstances where a securitization
contains a mix of retail and non retail exposures or a mix of committed and
uncommitted exposures, a bank may take a pro rata approach
to determining the CF for the securitization’s early
amortization provision.
If a pro rata approach is not feasible, a bank
must treat the securitization as a securitization of
non retail exposures if a single underlying
exposure is a non retail exposure and must treat
the securitization as a securitization of
committed exposures if a single underlying exposure is a committed exposure.
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