This is the first in a series of three alerts on investment securities and risk-based capital requirements under Dodd Frank.

On November 18, 2011, the Office of the Comptroller of the Currency (the "OCC") released a notice of proposed rulemaking1 on Alternatives to the Use of External Credit Ratings in the Regulations of the OCC (the "Credit Ratings Alternatives") along with proposed Guidance on Due Diligence Requirements in Determining Whether Investment Securities2 are Eligible for Investment (the "Due Diligence Requirements"). The proposed rulemaking3 would remove the reference to credit ratings4 from three5 of the OCC's regulations and would replace these references with a new creditworthiness standard.

Legal Requirements for Permissible Investment Securities

Part 1 sets forth the legal requirements for determining whether, and under what circumstances, and what limitations an OCC supervised entity6 may permissibly invest in certain investment securities.7 Part 1 is important not only to national banks, federal branches and federal agencies of international banks, but also to state banks and state branches and agencies of such international banks because Part 1 applies to them as well8 To be permissible, the investment must be investment grade.9 Under the proposed Credit Ratings Alternative, a security is considered to be investment grade if the issuer of the security has an adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure.

Legal Requirements of the Credit Ratings Alternatives; SNR Denton Recommendations

To meet the standard set forth in the Credit Ratings Alternatives, banks must determine that the risk of default by the obligor is low and the full and timely repayment of the principal and interest is expected.10 The OCC does not define what it means by "low risk of default" or "expected full and timely repayment". Indeed, neither the Due Diligence Requirements nor the proposed Credit Ratings Alternatives provide specific instructions to banks regarding the actions the banks must take to determine that the risk of default is low or that full and timely repayment is expected.

In the absence of specific guidance from the OCC, we recommend that banks consider developing a process that is substantially similar to their process for making loans, including the development of a policy manual for Credit Ratings Alternatives similar to a credit policy guide used for underwriting extensions of credit. This would mean that before a bank invests in investment securities it would conduct an internal review of the investment, risk grade the investment based upon either internal models or external models that show the likelihood of default and the expectation of repayment. We also recommend that banks consider adopting or amending investment policies and procedures that, among other things, identify the range of investment securities that they will consider (and under what circumstances or conditions) and what investment securities they will not consider, the risk characteristics11 of each of the investment securities that will be considered, the approved investment amounts, the range of expected cash flows, the pricing parameters, the collateral requirements, if any, the internal review and approval process, the documentation requirements, and the recordkeeping requirements. Likewise, we recommend that banks consider implementing investment risk management and compliance reviews, and annual audits of its investment portfolio. Equally importantly, we recommend that banks include investment securities in the scope of their required stress tests and show the impact of each regulatory agency mandated scenario on the capital, earnings and the interest rate profiles of the banks.

OCC commentary in the Due Diligence Requirements12 notes that generally securities with good to very strong credit quality will meet the Credit Ratings Alternatives. The commentary also points out that banks should continue to maintain appropriate ongoing reviews of their investment portfolios to verify that their portfolios continue to meet safety and soundness13 requirements that are appropriate for the bank's risk profile and for the size and complexity of their portfolios.14 The OCC does not specify what it expects in terms of the details of the ongoing reviews.

The Standards and Limitations under Part 1

Part 1 sets forth the standards and limitations under which national banks may purchase, sell, deal in, underwrite, and hold securities, in accordance with 12 U.S.C. 24 (Seventh) and safe and sound banking practices. A national bank may securitize and sell assets that it holds as a part of its banking business and there is no limit that is linked to a specified percentage of the bank's capital and surplus.15 There are limits on a national bank's investment in pooled investments,16 however. A national bank may purchase and sell for its own account investment company shares provided that the portfolio of the investment company consists exclusively of assets that the national bank may purchase and sell for its own account and the bank's holdings of investment company shares do not exceed the concentration limitations in 12 C.F.R. 1.4(e).17 Part I identifies five Types of permissible securities and leaves room for the OCC to permit investments in other securities consistent with 12 U.S.C. 24 (Seventh) and safe and sound banking practices.18

Five Types of Permissible Securities

The five Types of permissible securities range from US government securities which have no limitations on the amount of the investment to securities with limitations linked to a percentage of the amount of capital and surplus of a bank, and to securities that promote certain socially beneficial interests. To simplify the categories, the OCC labels the securities Type I, Type II, Type III, Type IV and Type V.

A. Type I Securities19 (Obligations of the US; Obligations issued, insured or guaranteed by a US department or agency, where the full faith and credit of the US is implicated; Obligations issued by a department or agency of the US, or an agency or political subdivision of a state, that represent an interest in a loan or a pool of loans made to third parties, where the full faith and credit of the US has been implicated; General obligations of the US or state and municipal bonds for well capitalized banks; 12 U.S.C. 24 (Seventh) permissible securities)

Pursuant to 12 C.F.R. 1.3(a), a national bank may deal in, underwrite, purchase, and sell Type I securities, such as US government securities, securities issued by the various states, and certain municipal bonds, for its own account and the amount of the investment is not limited to a specified percentage of the bank's capital and surplus.20 As one might expect, Type I securities are considered to have very limited credit risk because the issuer is considered to be extremely creditworthy. Some commentators have observed that this assumption about the creditworthiness of the issuer is debatable in light of the financial condition of many states of the US, and in light of the recent downgrade of the credit rating of the US. Nonetheless, the proposed Credit Ratings Alternative assumption underlying Type I securities21 is that the issuer of the security has an adequate capacity to meet its financial commitments under the security for the projected life of the asset or exposure, which means the risk of default by the obligor is low and the full and timely repayment of principal and interest is expected.22

B. Type II Securities23 (Obligations of a state or state agency for housing, university or dormitory purposes; Obligations of international and multilateral development banks; permissible 12 U.S.C. 24 (Seventh) securities with a 10% limitation)

Pursuant to 12 C.F.R. 1.3(b), a national bank may deal in, underwrite, purchase, and sell Type II securities for its own account, provided the aggregate par value of Type II securities issued by any one obligor held by the bank does not exceed 10% of the bank's capital and surplus.24 The percentage limitation linked to the bank's capital and surplus reflects the OCC's view that Type II securities, while certainly considered safe, are not as creditworthy as Type I securities. Examples of Type II securities may include an obligation issued for housing, university, or dormitory purposes.25

C. Type III Securities26 (trust preferred securities; auction rate preferred securities; student loan auction rate securities; money market preferred stock; and other similar investments)

Pursuant to 12 C.F.R. 1.3(c), a national bank may purchase and sell Type III securities for its own account, provided the aggregate par value of Type III securities issued by any one obligor held by the bank does not exceed 10% of the bank's capital and surplus.27 A broader range of securities are considered to be Type III securities because they are not restricted to a specific category of issuers or instruments. However, because Type III securities are also perceived to contain more credit risk than Type I securities, they come with a limitation linked to the capital and surplus of the bank. Trust preferred securities,28 auction rate preferred securities and student loan auction rate securities,29 money market preferred stock,30 municipal revenue bonds and mutual fund shares (purchased and held by a bank that is not well capitalized),31 municipal bond tender option certificates,32 bonds convertible into equity,33 each may be Type III securities.

D. Type IV Securities34 (small business related securities; commercial mortgage-related securities; residential mortgage-related securities)

Pursuant to 12 C.F.R. 1.3(e), a national bank may purchase and sell Type IV securities for its own account because these securities are considered safe, and because Congress clearly intended to facilitate the purchase and sale of these types of securities. The amount of the Type IV securities that a bank may purchase and sell is not limited to a specified percentage of the bank's capital and surplus.35 Examples of Type IV securities include small business related securities, commercial mortgage-related securities and residential mortgage-related securities. Type IV securities are treated as if they have a credit risk similar to Type I securities.

E. Type V Securities36 (investment grade mortgage securitizations of home equity lines of credit; other investment grade securitizations)

Pursuant to 12 C.F.R. 1.3(f), a national bank may purchase and sell Type V securities for its own account provided that the aggregate par value of Type V securities issued by any one issuer held by the bank does not exceed 25% of the bank's capital and surplus. This restriction is imposed because Type V securities are considered to contain more credit risk than Type IV securities. Examples of Type V securities include rated (or presumably under the Credit Ratings Alternatives, investment grade) mortgage securitizations of home equity lines of credit and other securitizations.37

The Short Term Impact of the Removal of Credit Ratings

While credit ratings may still be used by financial institutions and investors, the effect of Section 939A of Dodd Frank is that such ratings are no longer required or even encouraged. The impact on financial institutions and investors of removing credit ratings from Part 1 is likely to be mixed, in part, because Part 1 already had a built-in alternate standard (i.e., the credit equivalent of investment grade), and, in part, because credit ratings were a widely used proxy for determining credit risk. The impact is also softened because of the widespread public criticism and concern about the reliability of credit ratings. This is likely to mean that investors and financial institutions are not likely to insist upon requiring credit ratings in many cases where they would have done so.

SNR Denton Observations

First, credit ratings have long been a part of the fabric of many financial transactions and small and large investors alike have relied upon those ratings as a key part of their risk management. In many cases, however, policy makers believe that investors and financial institutions used the ratings as a substitute for effective credit underwriting and acted as if the existence of a high enough credit rating supplanted the need for due diligence. This is among the reasons the OCC issued the Due Diligence Requirements that reminds national banks that they must still comply with the interagency "Supervisory Policy Statement on Investment Securities and End-User Derivatives Activities,"38 the interagency "Risk Management and Lessons Learned,"39 the interagency "Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts,"40 and the Supplemental Guidance.

Second, as the result of the financial crisis, NRSROs and faulty credit ratings have come under the microscope and have been specifically blamed for exacerbating the global subprime mortgage crisis. This has set off a nearly global negative chain reaction that has embolden policymakers, investors, Federal agencies and financial institutions to question the credibility of not only credit ratings during the financial crisis, but also credit ratings that have been issued since the inception of the financial crisis, including current credit ratings. These reactions have likely caused the NRSROs, in some cases, to respond with tougher ratings, which further exacerbate the problem because lower ratings increase the costs of issuers and investors, induce more criticism of the NRSROs and cause policymakers and Federal agencies to further limit the reliance upon credit ratings.

Third, it is substantially likely that a credit rating alone can no longer be the dispositive basis for an investment decision. Indeed, in the Supplemental Guidance, the OCC suggests this very point when it emphasized that "External credit ratings often are lagging indicators of credit quality. If a bank relies exclusively upon a credit rating, and does no internal analysis, it may find it has not received sufficient yield to compensate for the additional risk recognized in the market but not yet reflected in credit ratings." The OCC also pointed out that default in an investment security "will generally result in an assessment that depreciation is 'other than temporary' and the bank will have to recognize the security's depreciation as a current period expense."

Fourth, credit ratings can and will continue to be an important part of any analysis in complex transactions such as securitizations. This may mean that NRSROs will be forced to provide and disclose more of their analysis and the processes used to arrive at their determinations. In turn, as a result, investors, financial institutions and Federal agencies will have more of a voice in assessing whether that analysis supporting a credit rating is sufficient in scope and quality to be helpful. In fact, NRSROs will be required to disclose substantially more information about their methodologies and assumptions utilized in producing a credit rating, under rules mandated by Section 932 of Dodd Frank, as proposed in SEC Release 34-64514. It is also possible that NRSROs using an investor-pay model, particularly ones with a robust monitoring capability, will be an important resource for banks in making the required determinations.

Fifth, it remains to be seen whether the pricing of a credit rating will increase. On the one hand, NRSROs will not have as much leverage as they have had in the past. This militates in favor of NRSROs reducing their pricing in order to attract more business. On the other hand, NRSROs will have to do more work, and they may, in some cases, have to change their methodologies, and, in other cases, create new methodologies to justify their ratings. This militates in favor of increasing their pricing in order to account for the additional administrative costs and the additional risks. The decreased need for credit ratings and a possible resulting decline in demand for such ratings could also lead to more price competition among the NRSROs. However, it also could lead to fewer NRSROs because with less work to go around some firms may decide, or the market may decide for them, that it is no longer sufficiently profitable or the risks are too high to provide credit ratings.

Sixth, one of the advantages of a credit rating is that unless a significant event occurs, the credit rating remains reliable and does not need to be updated. However, the Due Diligence Requirements point out that national banks should "continue to maintain appropriate ongoing reviews of their investment portfolios to verify that their portfolios meet safety and soundness requirements that are appropriate for the institution's risk profile and for the size and complexity of their portfolio." The italicized language may seem reasonable on its face, but there is ambiguity about what is meant by an ongoing review and whether that means credit ratings become stale after a certain period of time. Does this mean the ongoing reviews must be conducted monthly? Quarterly? Semi-annually? Annually? How should the ongoing reviews be documented? Must this review include a review of the credit rating, if a credit rating has been issued, even if the bank could show that the credit rating was one of a number of factors considered? Must the credit rating methodology be reviewed in the context of other analysis that formed the basis of the decision, including internal models? What standards must be used to determine whether the credit rating is still acceptable?

Seventh, it is uncertain how the Federal agencies will treat a credit rating requirement that is based upon an enforceable contract or based upon a state law requirement. The Federal agencies, and possibly the courts, eventually will have to decide whether Section 939A of Dodd Frank preempts state law or contractual provisions that require a credit rating (or a rating of a certain level) before a particular investment can be made. If, for instance, the contract or the state law requirement obligates the investment decision to be based upon a credit rating, will an examiner understand that the bank faces a dilemma that requires patience or will the examiner ignore the contract or state law requirement and force the bank to rely upon something other than the credit rating? If this occurs, then clearly the bank would be exposed to substantial litigation risk, at the very least until such time as all of the various Dodd Frank preemption issues are conclusively resolved.

Eighth, until the financial crisis, it was widely accepted and generally assumed that financial institutions, investors and Federal agencies understood credit ratings and could live with any disclaimers or shortcomings of NRSROs such as the lack of transparency, the imbedded conflicts of interests and market pressures. The simplicity of the gradations of the ratings seemed to be easy to understand and explain. There is at least a question about how and whether investors will accept and understand the proposed Credit Ratings Alternatives. It is very likely that investors will not have access to either the raw data or the full analysis of the due diligence produced, if it is documented. Similarly, while large financial institutions may have the infrastructure, the expertise and the financial ability to absorb the cost of "ongoing reviews," it is doubtful that small financial institutions or small investors will be able to do so.

Footnotes

1.The OCC released the Credit Ratings Alternatives and the Due Diligence Requirements pursuant to Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank"). In substance, Section 939A requires the OCC and the other Federal agencies to review their regulations, and where they find that their regulations require a credit rating, the OCC and the other Federal agencies must remove the credit rating requirement and substitute in its place a standard of creditworthiness. On March 1, 20011, the National Credit Union Administration (the "NCUA") released a proposal to implement Section 939A of Dodd Frank (76 FR 11164) (March 1, 2011). On March 9, 2011, the Securities and Exchange Commission (the "SEC") released a notice of proposed rulemaking to implement Section 939A of Dodd Frank (76 FR 12896) (March 9, 2011). On May 12, 2011, the Commodities Futures Trading Commission (the "CFTC") released a notice of proposed rulemaking to implement Section 939A of Dodd Frank (76 FR 27802) (May 12, 2011). On September 27, 2011, the US Department of the Treasury released a proposed rule that would implement Section 939A of Dodd Frank (76 FR 59592) (September 27, 2011). Section 939A of Dodd Frank reflects the belief of many policy makers that the credit ratings issued by the nationally recognized statistical rating organizations ("NRSROs") were not reliable during the financial crisis and that regulatory agencies, financial institutions, and investors relied much too heavily on these faulty credit ratings.

2.Under 12 C.F.R. 1.2(e), an "investment security" means a marketable debt obligation that is not predominantly speculative in nature. Under the current Part 1, a security is not predominantly speculative in nature if it is rated investment grade. Under current 12 C.F.R. 1.2(e), when a security is not rated, in order to qualify as an investment security, the security must be the credit equivalent of a security rated investment grade. Likewise, under the proposed Credit Ratings Alternative, 12 C.F.R. 1.2(f) is slightly modified to provide that marketable means that the security (A) is registered under the Securities Act of 1933, 15 U.S.C. 77a et seq. ; (B) is a municipal revenue bond exempt from registration under the Securities Act of 1933, 15 U.S.C. 77c(a)(2); (C) is offered and sold pursuant to SEC Rule 144A, 17 C.F.R. 230.144A ("Rule 144A"), and investment grade; or (D) can be sold with reasonable promptness at a price that corresponds reasonably to its fair value.

3.The proposed rulemaking will also amend 12 C.F.R. 5.39 regarding financial subsidiaries, but those amendments are pursuant to Section 939(d) of Dodd Frank.

4.For these purposes, credit ratings were credit ratings issued by an NRSRO such as A.M. Best Company, Inc., DBRS Ltd., Egan-Jones Rating Company, Fitch, Inc., Japan Credit Rating Agency, Ltd., Kroll Bond Rating Agency, Inc. (f/k/a LACE Financial Corp.), Moody's Investors Service, Inc., Rating and Investment Information, Inc., Realpoint LLC, and Standard & Poor's Ratings Services.

5.12 C.F.R. 1 (Investment Securities), commonly referred to as Part 1; 12 C.F.R. 16 (Securities Offering Disclosure Rules), commonly referred to as Part 16; and 12 C.F.R. 28 (International Banking Activities), commonly referred to as Part 28.

6.Dodd Frank transferred to the OCC the authority to regulate, supervise and examine certain Federal savings banks that were regulated, supervised and examined by the former Office of Thrift Supervision (the "OTS"). The OCC changed the OTS investment security regulation, which is now set forth at 12 C.F.R. 160 (referred to as Part 160). Part 160 now refers to 12 U.S.C. 1831e, which means that the investment securities restrictions and the new creditworthiness standard for OCC supervised Federal savings banks will be determined by the Federal Deposit Insurance Corporation (the "FDIC"). On December 7, 2011, the FDIC issued a notice of proposed rulemaking (12 C.F.R. 362) on Permissible Investments for Federal and State Savings Associations: Corporate Debt Securities. The notice of proposed rulemaking would be effective, if it becomes a final rule, as of July 21, 2012, two years after the date of enactment of Dodd Frank.

7.The powers granted to national banks under 12 C.F.R. 1 supplement the powers granted to the overseas branches of national banks under 12 C.F.R. 211.

8.Pursuant to 12 U.S.C. 335, state banks that are members of the Federal Reserve System are subject to the same limitations and conditions that apply to national banks in connection with purchasing, selling, dealing in, and underwriting securities and stock. In addition, pursuant to 12 U.S.C. 378(a)(1), it is unlawful for any person, firm, corporation, association, business trust, or other similar organization, engaged in the business of issuing, underwriting, selling, or distributing, at wholesale or retail, or through syndicate participation, stocks, bonds, debentures, notes, or other securities, to engage at the same time to any extent whatever in the business of receiving deposits subject to check or to repayment upon presentation of a passbook, certificate of deposit, or other evidence of debt, or upon request of the depositor (this provision does not prohibit national banks or state banks or trust companies or other financial institutions or private bankers from dealing in, underwriting, purchasing, and selling investment securities, or issuing securities, to the extent permitted to national banking associations by 12 U.S.C. 24). Likewise, an insured state nonmember bank is prohibited from becoming or remaining affiliated with any securities underwriting affiliate company that directly engages in the public sale, distribution or underwriting of stocks, bonds, debentures, notes, or other securities activity, of a type not permissible for a national bank directly, unless the company is controlled by an entity that is supervised by a federal banking agency or the state nonmember bank obtains approval from the FDIC or otherwise complies with the regulations of the FDIC. 12 C.F.R. 362.8(b).

9.The current version of 12 C.F.R. 1 defines "investment grade" as a security that is rated in one of the four highest rating categories by two or more NRSROs or one NRSRO if the security has been rated by only one NRSRO. 12 C.F.R. 1.2(d).

10.The OCC notes that in the case of a structured finance transaction, principal and interest repayment is not necessarily solely reliant upon the direct debt repaying capacity of the issuer or obligor. Rather the credit risk profile may be influenced more by the quality of the underlying collateral and the cash flow rules and the structure of the security itself than by the condition of the issuer.

11.The risk characteristics should include a range of risks, including , interest rate risk, credit risk, liquidity risk, price fluctuations risk, foreign exchange risk, market and transaction risk, compliance risk, strategic risk, and reputation risk.

12.As a part of its due diligence, the Supplemental Guidance provides that "national banks should demonstrate an understanding of the specific type of asset-backed security structures they plan to purchase. Investment policies should specifically permit the holdings and establish appropriate limits. National banks should conduct appropriate due diligence before purchasing complex asset-backed security structures and should consider the impact of such purchases on the bank's capital and earnings under a variety of possible scenarios."

13.Under 12 C.F.R. 1.5(a), a national bank must comply with safe and sound banking practices and the requirements of 12 C.F.R. 1.3. The bank shall consider, as appropriate, the interest rate, credit, liquidity, price, foreign exchange, transaction, compliance, strategic, and reputation risks presented by a proposed activity, and the particular activities undertaken by the bank must be appropriate for that bank.

14.In its Supplemental Guidance on Unsafe and Unsound Investment Portfolio Practices (OCC-2002-19) (May 22, 2002) (the "Supplemental Guidance"), the OCC noted that "some banks have seen such a large decline in their investment yields that, faced with the alternative of selling a large amount of funds at very low overnight rates, they are "chasing" investment yields. These banks have allowed the fear of rapidly declining asset yields to override prudent banking judgment and, in some cases, to assume unwarranted levels of risk. In many cases, banks have not taken steps to strengthen their risk management practices and policy controls consistent with the increase in their tolerance for risk." "Yield is an important consideration when a bank evaluates a security for purchase, and it is not inherently an unsafe and unsound practice to purchase high-yielding securities that are at the low end of the investment grade rating scale. However, when banks change their investing practices to take on more credit risk without appropriate credit due diligence, limits, and guidelines (including higher capital when needed), such practices become unsafe and unsound." "There is no "free lunch." To obtain higher yields, banks must take more credit risk, interest rate risk, liquidity risk, or combinations thereof."

15.12 C.F.R. 1.3 (g).

16.Under current Part 1, pooled investments must be (A) marketable and rated investment grade or the credit equivalent of a security rated investment grade, or (B) satisfy the requirements of 12 C.F.R. 1.3(i) and may not exceed 5% of the bank's capital and surplus.

17.Under 12 C.F.R. 1.4(e), a national bank shall use reasonable efforts to calculate and combine its pro rata share of a particular security in the portfolio of each investment company with the bank's direct holdings of that security. The bank's direct holdings of the particular security and the bank's pro rata interest in the same security in the investment company's portfolio may not, in the aggregate, exceed the investment limitation that would apply to the bank's direct holdings of that security. A national bank may elect not to combine its pro rata interest in a particular security in an investment company with the bank's direct holdings of that security if the investment company's holdings of the securities of any one issuer do not exceed 5% of its total portfolio and the bank's total holdings of the investment company's shares do not exceed the most stringent investment limitation that would apply to any of the securities in the company's portfolio if those securities were purchased directly by the bank.

18.The bank must determine that there is adequate evidence that an obligor possesses resources sufficient to provide for all required payments on its obligations, or, in the case of securities deemed to be investment securities on the basis of reliable estimates of an obligor's performance, that the bank reasonably believes that the obligor will be able to satisfy the obligation. 12 C.F.R. 1.5(b).

19.Under 12 C.F.R. 1.2(j), Type I securities include:

A. Obligations of the US;

B. Obligations issued, insured, or guaranteed by a department or an agency of the US Government, if the obligation, insurance, or guarantee commits the full faith and credit of the US for the repayment of the obligation;

C. Obligations issued by a department or agency of the US, or an agency or political subdivision of a state of the US, that represent an interest in a loan or a pool of loans made to third parties, if the full faith and credit of the US has been validly pledged for the full and timely payment of interest on, and principal of, the loans in the event of non-payment by the third party obligor(s);

D. General obligations of a state of the US or any political subdivision thereof; and municipal bonds if the bank is well capitalized;

E. Obligations authorized under 12 U.S.C. 24 (Seventh) as permissible for a national bank to deal in, underwrite, purchase, and sell for the bank's own account, including qualified Canadian government obligations; and

F. Other securities the OCC determines to be eligible as Type I securities under 12 U.S.C. 24 (Seventh).

20.12 C.F.R. 1.3(a).

21.Under 12 C.F.R. 1.120, an obligation qualifies as a Type I security if it is secured by an escrow fund consisting of obligations of the US or general obligations of a state or a political subdivision, and the escrowed obligations produce interest earnings sufficient for the full and timely payment of interest on, and principal of, the obligation.

22.12 C.F.R. 1.2(d).

23.Under 12 C.F.R. 1.2(k), Type II securities include:

A. Obligations issued by a state, or a political subdivision or agency of a state, for housing, university, or dormitory purposes that would not satisfy the definition of Type I securities;

B. Obligations of international and multilateral development banks and organizations listed in 12 U.S.C. 24 (Seventh);

C. Other obligations listed in 12 U.S.C. 24 (Seventh) as permissible for a bank to deal in, underwrite, purchase, and sell for the bank's own account, subject to a limitation per obligor of 10% of the bank's capital and surplus; and

D. Other securities the OCC determines to be eligible as Type II securities under 12 U.S.C. 24 (Seventh).

24.If the proceeds of each issue are to be used to acquire and lease real estate and related facilities to economically and legally separate industrial tenants, and if each issue is payable solely from and secured by a first lien on the revenues to be derived from rentals paid by the lessee under net noncancellable leases, the bank may apply the 10% investment limitation separately to each issue of a single obligor. 12 C.F.R. 1.3(d).

25.12 C.F.R. 1.130.

26.Under 12 C.F.R. 1.2(l), Type III securities include an investment security that does not qualify as a Type I, II, IV, or V security. Examples of Type III securities also include corporate bonds and municipal bonds that do not satisfy the definition of Type I securities.

27.If the proceeds of each issue are to be used to acquire and lease real estate and related facilities to economically and legally separate industrial tenants, and if each issue is payable solely from and secured by a first lien on the revenues to be derived from rentals paid by the lessee under net noncancellable leases, the bank may apply the 10% investment limitation separately to each issue of a single obligor. 12 C.F.R. 1.3(d).

28.OCC Interpretive Letter 777 (April 8, 1997).

29.OCC Interpretive Letter 1124 (November 3, 2009).

30.OCC Interpretive Letter 781 (April 9, 1997).

31.OCC Interpretive Letter 912 (July 3, 2001).

32.OCC Interpretive Letter 1070 (September 6, 2006).

33.OCC Interpretive Letter 930 (March 11, 2002).

34.Under the proposed Credit Ratings Alternative, 12 C.F.R. 1.2(m) would be slightly modified so that Type IV securities would include:

A. A small business-related security as defined in section 3(a)(53)(A) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(53)(A), that is fully secured by interests in a pool of loans to numerous obligors;

B. A commercial mortgage-related security that is offered or sold pursuant to section 4(5) of the Securities Act of 1933, 15 U.S.C. 77d(5), that is investment grade, or a commercial mortgage-related security as described in section 3(a)(41) of the Securities Exchange Act of 1934, 15 U.S.C. 78c(a)(41), that represents ownership of a promissory note or certificate of interest or participation that is directly secured by a first lien on one or more parcels of real estate upon which one or more commercial structures are located and that is fully secured by interests in a pool of loans to numerous obligors;

C. A residential mortgage-related security that is offered and sold pursuant to section 4(5) of the Securities Act of 1933, 15 U.S.C. 77d (5), that is investment grade, or a residential mortgage-related security as described in section 3(a) (41) of the Securities Exchange Act of 1934, 15 U.S.C. 78c (a) (41)), that does not otherwise qualify as a Type I security.

35.Under the current Part 1, a national bank may hold small business-related securities, as defined in section 3(a) (53) (A) of the Securities Exchange Act of 1934, 15 U.S.C. 78c (a) (53) (A), of any one issuer with an aggregate par value not exceeding 25% of the bank's capital and surplus if those securities are rated investment grade in the third or fourth highest investment grade rating categories. There is no limitation for the two highest investment grade rating categories.

36.Under the proposed Credit Ratings Alternative, 12 C.F.R. 1.2(n) would be slightly modified so that Type V securities would include investment grade, marketable, securities that are not Type IV securities that are fully secured by interests in a pool of loans to numerous obligors and in which a national bank could invest directly.

37.OCC Interpretive Letter 1035 (July 21, 2005). According to OCC Interpretive Letter 1035, in 1996, the OCC added Type V securities to address separately investment grade securities representing interests in assets a bank may invest in directly.

38.Supervisory Policy Statement on Investment Securities and End-User Derivatives Activities (April 23, 1998) issued by the OCC, the FDIC, the OTS, the Board of Governors of the Federal Reserve System (the "Federal Reserve") and the NCUA. (63 FR 78) (April 23, 1998).

39.Risk Management and Lessons Learned issued by the OCC, the FDIC and the Federal Reserve (OCC Bulletin 2009-15) (May 22, 2009).

40.Uniform Agreement on the Classification of Assets and Appraisal of Securities Held by Banks and Thrifts issued by the OCC, the FDIC, the OTS and the Federal Reserve (OCC Bulletin 2004-25) (June 15, 2004).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.