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The new RC-R preparation process has been the most significant change to Call Report submissions in 2015. During our reviews of clients’ Call Reports, we have noted some uncertainty regarding the new risk weighting requirements for certain investment securities. The recent changes have impacted the ways that corporate notes and bonds, including bank holding company issues, are to be risk weighted for capital adequacy purposes. In general, the change requires that banks look more deeply into each fixed income investment to determine which risk weighting to apply.

The Dodd-Frank law requires bank regulators to review their regulations, determine which were based on bond rating agency ratings, and modify regulations to eliminate reliance on ratings. This included the old “rating based” approach to risk weights of fixed income securities for capital adequacy and reporting on Schedule RC-R. The old “rating based” approach is now eliminated. Instead, banks must now consider the nature of the security and perform additional analysis to justify its risk weighting of securities, including all corporate debt issues. As with all aspects of capital adequacy and Call Report preparation, the risk weighting process for corporate bonds and notes should be thoroughly documented in case of potential review by regulators.

As a general rule, all corporate bonds or notes should go into the 100% category, unless there is a specific reason to justify a different “bucket”.  Based on information we have received from the FDIC, this includes bonds and notes issued by Bank Holding Companies (“BHC”). Acceptable reasons for a lower risk weight category are:

1. The issuer is specifically given a lower risk weight (e.g., issued by the U. S. Treasury, an Agency, a GCS, or a U. S. Bank)
2. The security’s collateral qualifies it for a lower weight (such as home mortgage pools)
3. The security has a guarantee which reduces the risk and qualifies the security for a lower weight (e.g., a governmental guarantee). Absent such collateral or guarantee considerations, all corporate debt securities should go into the 100% risk “bucket”, if they are performing (non performing bonds would go into the 150% bucket, and/or be candidates for OTTI). 

Banks should also be aware that securities of complex organizations may carry different weights.  A large bank holding company with a bank subsidiary could issue securities with different weights, depending on which entity is the issuer. For example, a BHC would have a 100% weight, but its bank subsidiary might carry a 20% weight.

Finally, the nature of the bond and its payments preference might be a factor. Some corporate issues might fit the definition of a “securitization” which could have much different weights. If a security is a securitization, specific Call Report instructions must be applied to determine the risk weight. Complex structuring of securities or payment preferences require additional analysis and could carry higher risk weights if they meet the definition of a securitization.

We suggest that all banks establish a process to thoroughly document and retain information they rely on to substantiate the risk weight used for each security in its portfolio, including (1) the issuer, (2) the collateral, (3) the existence of any guarantees (and risk weighting of the guarantor), and the structure or nature of payments and payment preferences for principal and interest related to security (to establish whether or not the security is a securitization). The same process should be followed for foreign corporate bonds, except the OECD rating and past default status of the issuer’s country must also be taken into consideration.

 

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