On June 19, 2013, the OCC issued a final rule (the “Rule”) updating its existing regulations on legal lending limits in response to Section 610 of the Dodd Frank Act. Section 610 amended the federal lending limits statute, (12 USC § 84) to include credit exposures arising from derivative transactions and repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The Rule also takes into account differences that existed between national banks and saving associations and preserves some of the statutory exceptions that savings associations previously enjoyed. The Rule replaces, and modifies to some extent, the Interim Rule adopted on June 20, 2012. The Rule provides three different methods for calculating credit exposure, one of which will be applicable to larger banks and two that will be more attractive to regional and community banks.
The Rule is relevant to state chartered banks as well since Section 611 of Dodd Frank provides that state banks may only engage in derivative transactions if the law of the sate takes into account credit exposure to derivatives. Over the last two years state legislatures passed laws addressing this issue. [See, e.g.: GA Code Ann § 7-1-285 amended to include credit exposure under a derivative when calculating a bank’s legal lending limit to any one borrower]. State banking departments have also promulgated rules advising state chartered banks on which model they should follow. [See, e.g., California: “California state chartered banks shall use the Conversion Factor Matrix Method to determine the credit exposure of derivative transactions for purposes of complying with California’s lending limit;” Maryland: “For the purposes of calculating the Derivative-Securities Credit Exposure for compliance with the Maryland Limit, the Commissioner will require state-chartered banking institutions to measure the Derivative-Securities Credit Exposure in accordance with and subject to the limitations and exemptions under the OCC’s Interim Final Rule, as amended by the final rule upon issuance.”]
The Georgia DBF has confirmed that Georgia charted banks will be able to use any of the methodologies permissible for national banks when determining credit exposure for derivatives, subject to review through the examination process as to their appropriate implementation. For those elements of the OCC methodology requiring the written approval of the OCC prior to implementation, the Department’s written approval would likewise be required prior to implementation by Georgia state-chartered banks. Notwithstanding this broad permission, we think that most community banks will find the “Conversion Factor Matrix Method” to be less burdensome and easier to calculate.
Under the Conversion Factor Matrix Method, credit exposure is calculated as follows:
Credit Exposure equals Current Credit Exposure plus Potential Future Exposure [12 CFR § 32.9(b)(1)(i)]
The exposure will remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction. The conversion matrix is set out in the legal lending limit rule adopted by the OCC and set out in the updated CFR.
The Rule lends itself very well to state regulatory application in that it is devised in a manner that will allow banks to adopt a compliance regimen that fits their size and risk management requirements, subject to an overall requirement that whichever method they choose is always subject to safety and soundness requirements.