The Federal Reserve, the FDIC and the OCC have published guidance for banks and thrifts that outlines principles related to the proper classification of securities without relying on ratings issued by nationally recognized statistical rating organizations (i.e., external credit ratings). The guidance issued on October 29, entitled the Uniform Agreement on the Classification and Appraisal of Securities Held by Depository Institutions, helps to implement Section 939A of the Dodd–Frank Act, which requires each federal agency to remove references to, and requirements of reliance on, external credit ratings in any regulation issued by the agency that requires the assessment of the creditworthiness of a security or money market instrument. The guidance revises the 2004 Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts by replacing references to credit ratings with alternative standards of creditworthiness consistent with the requirements of the Dodd–Frank Act. According to the guidance, the agencies’ current asset classification definitions are not changing. The guidance clarifies how the characteristics of investment securities should be interpreted within the existing classification categories. The agencies expect banks to perform an assessment of creditworthiness that is not solely reliant on external credit ratings, according to the guidance. An assessment may include internal risk analyses and a risk rating framework, third-party research and analytics (which could include external credit ratings), default statistics and other sources of data as appropriate for the particular security. According to the guidance, the depth of analysis should be a function of the security’s risk characteristics.
Nutter Notes: In accordance with the requirements of the Dodd–Frank Act, the OCC revised its investment security regulations (12 C.F.R. Part 1) in 2012 to remove reliance on external credit ratings. Investments in securities and stock by state member banks are required under the Federal Reserve Act and the Federal Reserve’s Regulation H to comply with the OCC’s investment security regulations. The Federal Deposit Insurance Act limits the investments that a state nonmember bank may make to those permissible for national banks, with certain exceptions approved by the FDIC under 12 C.F.R. Part 362. The FDIC in 2012 amended 12 C.F.R. Part 362 to harmonize the limitations on investments by state and federal savings associations in corporate debt securities with the OCC’s investment security regulations. The OCC’s investment security regulations require banks to monitor investment credit quality through an analytical review of the obligor rather than solely through external credit ratings. According to the new guidance, credit quality monitoring requires bank management to determine whether a security continues to be investment grade or if it has deteriorated and thus requires reclassification. The guidance clarifies the classification standards for securities held by a bank and provides examples that demonstrate when a security is investment grade and when it is not investment grade. Investment grade securities are no longer defined as 1 of the 4 highest credit ratings, but instead are those deemed by the purchasing bank’s credit analyses as having an adequate capacity to repay the obligation. Under the OCC’s investment security regulations, an issuer has adequate capacity to meet its financial commitments if the risk of default is low and the full and timely repayment of principal and interest is expected.