Adopted Amendments of 7 TAC §§12.2, 12.3, 12.10 and 12.12

Title 7. Banking and Securities
Part 2. Texas Department of Banking
Chapter 12. Loans and Investments
Subchapter A. Lending Limits
7 TAC §§12.2, 12.3, 12.10 and 12.12

NOTE: This document was submitted to the Texas Register on the date indicated below. This is not the actual publication; the editorial staff of the Texas Register sometimes edits the submission. The Texas Department of Banking therefore does not guarantee the exact accuracy of this document.

Date: October 18, 2013

The Finance Commission of Texas (the commission), on behalf of the Texas Department of Banking (the department), adopts amendments to §§12.2, 12.3, 12.10, and 12.12, concerning the application of lending limits to credit exposure under derivative transactions and securities financing transactions, without changes to the proposed text as published in the August 30, 2013, issue of the Texas Register (38 TexReg 5616). The text will not be republished.

Last year, the commission adopted several new and amended sections in Chapter 12, Subchapter A, to comply with new federal law regarding application of the lending limit of Finance Code, §34.201, to such credit exposures, as published in the December 28, 2012, issue of the Texas Register (37 TexReg 10195) (the original adoption). The adopted provisions were modeled on the interim final rule of the Office of the Comptroller of the Currency (OCC) on the same subject, published in the June 21, 2012, edition of the Federal Register (77 Fed. Reg. 37265), for the reasons stated in the original adoption.

In general, a model based on the OCC approach takes advantage of the deeper capital markets expertise of the OCC. Further, state requirements similar to those imposed by the OCC on national banks tend to minimize the potential for regulatory arbitrage (converting from national bank to state bank) based on a perception of weaker state regulation. In anticipation that the OCC would ultimately revise its interim final rule, the commission indicated in its original adoption that further amendments would likely be proposed once the final disposition of the OCC rulemaking was known.

On June 19, 2013, the OCC released its final rule regarding procedures and methodologies for calculating the credit exposure under a derivative transaction or a securities financing transaction. Published in the June 25, 2013, edition of the Federal Register (78 Fed. Reg. 37930), the final rule had a number of changes made in response to comments. The amendments adopted today make similar changes. The explanations below are based in part on the OCC analysis and discussion at 78 Fed. Reg. 37930-37946 (June 25, 2013).

DISCUSSION OF ADOPTION

Amendments to §12.2

Amended §12.2(6) defines an "effective margining arrangement" as a master legal agreement governing derivative transactions between a bank and a counterparty that requires the counterparty to post, on a daily basis, variation margin to fully collateralize that amount of the bank's net credit exposure to the counterparty that exceeds $25 million created by the derivative transactions covered by the agreement. This threshold amount was formerly set at $1 million, which failed to address existing agreements with collateralization thresholds above the $1 million level. To help ensure that this increase in threshold amount does not raise new safety and soundness concerns, amended §12.12(b)(2)(A) requires the amount of the threshold under an effective margining arrangement to be added to the amount of counterparty exposure calculated under the model method, thereby subjecting the amount of the threshold to the legal lending limit.

The amended definition of "eligible credit derivative," at §12.2(7)(C)(ii), specifically includes a restructuring for obligors not subject to bankruptcy or insolvency as a credit event for a credit default swap. The prior definition inadvertently excluded such restructurings by referring only to bankruptcy or insolvency as a credit event for a credit default swap. Bankruptcy and insolvency regimes generally do not exist for sovereign or municipality reference obligors, and standard credit default swap contracts on sovereign and municipal reference exposures cover the buyer of protection for restructurings that, while not conducted by a bankruptcy court or receiver, nonetheless bind the holders of the sovereign or municipal debt to changes in principal, interest, or similar economic terms of the debt.

Amended §12.2(9) corrects an erroneous cross-reference.

Amendment to §12.3

Because the purchase of credit protection is a well-accepted risk management technique for managing credit concentration risk, amended §12.3(b) includes a new paragraph (8) to exclude from the application of the lending limits that part of a loan or extension of credit for which a bank has purchased protection if that protection is by way of a single-name credit derivative that meets the requirements for an eligible credit derivative contained in §12.2(7), but only if the reference obligor is the same legal entity as the borrower in the loan or extension of credit and the maturity of the protection purchased equals or exceeds the maturity of the loan or extension of credit. However, the total amount of such exclusion may not exceed 15% of the bank's Tier 1 capital.

Amendment to §12.10

Amended §12.10(b)(5) clarifies that banks choosing a non-model method for measuring credit exposure under derivatives transactions will be cited for nonconformance with respect to credit exposure under existing transactions that were within the lending limits when originated but later exceed the limit solely due to subsequent increases in credit exposure, and will have the opportunity to correct the nonconformance before it is deemed a violation. This amendment corrects an unintended result under the rule as originally adopted.

Amendments to §12.12

As amended, §12.12(b)(1)(A) and (c)(1)(A) are captioned as the "model method" to address possible confusion with the "Internal Models Approach" included in the federal capital adequacy guidelines for calculating the risk-weighted asset amount for equity exposures.

Amended §12.12(b)(1)(A)(iii) corrects an erroneous cross-reference to the federal capital adequacy guidelines, as does amended §12.12(c)(1)(A) to §32(d) of the federal capital adequacy guidelines.

Amended §12.12(b)(1)(A)(iii) and (c)(1)(A) now provide additional guidance regarding approval of alternate models or modifications to a previously approved model. Because the department does not possess adequate expertise to evaluate the adequacy of computer simulations that comprise a model, the views of the bank's primary federal banking regulatory agency will be a key element in any request for approval of an internal model.

Under the conversion factor matrix method set forth in §12.12(b)(1)(B), the credit exposure is equal to the potential future exposure as determined at execution of the transaction by reference to a simple look-up table (Table 1). Amendments to §12.12(b)(1)(B) are technical in nature and clarify this unchanged calculation.

Amendments to §12.12(b)(1)(C) substitute the "current exposure method," calculated in the manner provided by §32(c)(5), (6) and (7) of the federal capital adequacy guidelines, in lieu of the remaining maturity method as an option for measuring credit exposure of derivative transactions. The current exposure method is used under the federal banking agencies' current regulatory capital rules, both Basel I and II capital regimes, and would be retained under the Basel III-related proposals released by the OCC and the other federal banking agencies. Under the current exposure method, a bank calculates the credit exposure for derivative transactions by adding the current exposure (the greater of zero or the mark-to-market value) and the potential future exposure (calculated by multiplying the notional amount by a specified conversion factor which varies based on the type and remaining maturity of the contract) of the derivative transactions. The current exposure method incorporates additional calculations for netting arrangements and collateral and uses multipliers that are more tailored to computing the potential future exposure of derivative transactions. Because this provides a more refined analysis of credit exposure than the remaining maturity method, the remaining maturity method will no longer be available for use in connection with calculation of lending limits.

As described in connection with amended §12.2(6), amended §12.12(b)(2)(A) requires the amount of the threshold under an effective margining arrangement to be added to the amount of counterparty exposure calculated under the model method, in order to subject the amount of the threshold to the legal lending limit.

As amended, §12.12(b)(3) clarifies that calculated measure of exposure to a central counterparty must include an additional amount comprised of the initial margin posted plus any contributions to a guaranty fund at the time such contribution is made, if not already reflected in the calculation.

Amended §12.12(c)(1)(C) permits the credit exposure under securities financing transactions to be calculated by applying the standard supervisory haircuts for such transactions using the current federal risk-based capital standards or the proposed Basel III capital adequacy guidelines, once finalized (collectively, the Basel collateral haircut method), as an additional non-model approach. The caption of §12.12(c)(1)(B) was amended to make a conforming change.

Amended §12.12(b)(4) and §12.12(c)(2) provide that the commissioner in the exercise of discretion may permit a state bank to use a specific method to calculate credit exposure, and that this method may apply to all or specific transactions if the commissioner finds that such method is consistent with the safety and soundness of the bank. A state bank should not be able to exercise unlimited discretion to pick and choose among the calculation methods for different derivative or securities financing transactions, but there may be circumstances in which the use of only one calculation method for all transactions may present safety and soundness concerns or may not be practically feasible.

Explanatory Table

The OCC provided an explanatory table to aid in understanding its final rule, published with the final rule in the June 25, 2013, edition of the Federal Register (78 Fed. Reg. 37930, at 37939-37942). The department has prepared a similar explanatory table that lists each transaction subject to §12.12. The explanatory table is intended to aid in understanding the effect of the rule and can be viewed at www.dob.texas.gov/legal/1212_table.pdf. Upon request, a copy of the table can be obtained by email, fax or U.S. mail. The table is not a substitute for reviewing the rule directly.

The Department received no comments regarding the proposed amendments.

The amendments are adopted pursuant to Finance Code, §34.201(b), which authorizes the commission to adopt rules to administer the lending limit, including rules to: (1) define or further define terms used by §34.201, and (2) establish limits, requirements, or exemptions other than those specified by §34.201 for particular classes or categories of loans or extensions of credit. In addition, Finance Code, §31.003, authorizes the commission to adopt rules to accomplish the purpose of Subtitle A, relating to state banks. As required by Finance Code, §31.003(b), the commission considered the need to promote a stable banking environment, provide the public with convenient, safe, and competitive banking services, preserve and promote the competitive position of state banks with regard to national banks and other depository institutions in this state consistent with the safety and soundness of state banks and the state bank system, and allow for economic development in this state.

§12.2. Definitions.

Definitions in the Finance Code, Title 3, Subtitles A and G, are incorporated herein by reference. As used in this subchapter and in Finance Code, Chapter 34, concerning investments and loans, the following words and terms shall have the following meanings, unless the context clearly indicates otherwise.

(1) Borrower--A person who is named as a borrower, obligor, or debtor in a loan or extension of credit; a person to whom a state bank has credit exposure arising from a derivative transaction or a securities financing transaction, entered by the bank; or any other person, including but not limited to a drawer, endorser, or guarantor who is considered to be a borrower under the direct benefit, source of repayment, or common enterprise tests set forth in §12.9 of this title (relating to Aggregation and Attribution).

(2) Call report--The federal Consolidated Report of Condition and Income required by and filed under 12 U.S.C. §1817 (or under 12 U.S.C. §324 in the case of a bank that is a member of the Federal Reserve System), or a report of financial condition and results of operations of a state bank required by the banking commissioner under Finance Code, §31.108.

(3) Control--Control is presumed to exist when a person directly or indirectly, or acting through or together with one or more persons:

(A) owns, controls, or has the power to vote 25 percent or more of any class of voting securities of another person;

(B) controls, in any manner, the election of a majority of the directors, trustees, or other persons exercising similar functions of another person; or

(C) has the power to exercise a controlling influence over the management or policies of another person.

(4) Credit derivative--As defined in §2 of the federal capital adequacy guidelines.

(5) Derivative transaction--Includes any transaction that is a contract, agreement, swap, warrant, note, or option that is based, in whole or in part, on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities, securities, currencies, interest or other rates, indices, or other assets.

(6) Effective margining arrangement--A master legal agreement governing derivative transactions between a bank and a counterparty that requires the counterparty to post, on a daily basis, variation margin to fully collateralize that amount of the bank's net credit exposure to the counterparty that exceeds $25 million created by the derivative transactions covered by the agreement.

(7) Eligible credit derivative--A single-name credit derivative or a standard, non-tranched index credit derivative provided that:

(A) the derivative contract meets the requirements of an eligible guarantee, as defined in §2 of the federal capital adequacy guidelines, and has been confirmed by the protection purchaser and the protection provider;

(B) any assignment of the derivative contract has been confirmed by all relevant parties;

(C) if the credit derivative is a credit default swap, the derivative contract includes the following credit events:

(i) failure to pay any amount due under the terms of the reference exposure, subject to any applicable minimal payment threshold that is consistent with standard market practice and with a grace period that is closely in line with the grace period of the reference exposure; and

(ii) bankruptcy, insolvency, restructuring (for obligors not subject to bankruptcy or insolvency), or inability of the obligor on the reference exposure to pay its debts, or its failure or admission in writing of its inability generally to pay its debts as they become due, and similar events;

(D) the terms and conditions dictating the manner in which the derivative contract is to be settled are incorporated into the contract;

(E) if the derivative contract allows for cash settlement, the contract incorporates a robust valuation process to estimate loss with respect to the derivative reliably and specifies a reasonable period for obtaining post-credit event valuations of the reference exposure;

(F) if the derivative contract requires the protection purchaser to transfer an exposure to the protection provider at settlement, the terms of at least one of the exposures that is permitted to be transferred under the contract provides that any required consent to transfer may not be unreasonably withheld; and

(G) if the credit derivative is a credit default swap, the derivative contract clearly identifies the parties responsible for determining whether a credit event has occurred, specifies that this determination is not the sole responsibility of the protection provider, and gives the protection purchaser the right to notify the protection provider of the occurrence of a credit event.

(8) Eligible protection provider--An entity that is:

(A) a sovereign entity (a central government, including the U.S. government; an agency; department; ministry; or central bank);

(B) the Bank for International Settlements, the International Monetary Fund, the European Central Bank, the European Commission, or a multilateral development bank;

(C) a Federal Home Loan Bank;

(D) the Federal Agricultural Mortgage Corporation;

(E) a depository institution, as defined in section 3 of the Federal Deposit Insurance Act, 12 U.S.C. §1813(c);

(F) a bank holding company, as defined in section 2 of the Bank Holding Company Act, as amended, 12 U.S.C. §1841;

(G) a savings and loan holding company, as defined in section 10 of the Home Owners’ Loan Act, 12 U.S.C. §1467a;

(H) a securities broker or dealer registered with the SEC under the Securities Exchange Act of 1934, 15 U.S.C. §§78o et seq.;

(I) an insurance company that is subject to the supervision of a State insurance regulator;

(J) a foreign banking organization;

(K) a non-U.S.-based securities firm or a non-U.S.-based insurance company that is subject to consolidated supervision and regulation comparable to that imposed on U.S. depository institutions, securities broker-dealers, or insurance companies; or

(L) a qualifying central counterparty.

(9) Federal capital adequacy guidelines--The federal reference entitled "Capital Adequacy Guidelines for Banks: Internal-Ratings-Based and Advanced Measurement Approaches," codified as Appendix D to 12 C.F.R. part 325 (or Appendix F to 12 C.F.R. part 208 in the case of a bank that is a member of the Federal Reserve System).

(10) Federal risk-based capital standards--The federal system for calculating a bank's equity capital and its specified components, set forth in Appendix A to 12 C.F.R. part 325 (or Appendix A to 12 C.F.R. part 208 in the case of a bank that is a member of the Federal Reserve System).

(11) Qualifying central counterparty--As defined in §2 of the federal capital adequacy guidelines.

(12) Qualifying master netting agreement--As defined in §2 of the federal capital adequacy guidelines.

(13) Sale of federal funds--A transaction between depository institutions involving the transfer of immediately available funds resulting from credits to deposit balances at Federal Reserve Banks, or from credits to new or existing deposit balances due from a correspondent depository institution.

(14) Securities financing transaction--A repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction.

(15) Tier 1 capital--A state bank's unimpaired capital and surplus. A state bank's Tier 1 capital is calculated under the federal risk-based capital standards, is reported in the bank's most recent call report, and is periodically re-calculated as provided by §12.11 of this title (relating to Calculation of Lending Limit).

(16) Unimpaired capital and surplus--A state bank's core capital, equal to its Tier 1 capital calculated under the federal risk-based capital standards, and referred to as Tier 1 capital in this chapter.

§12.3. Loans and Extensions of Credit.

(a) Loans or extensions of credit for purposes of the Finance Code, §34.201, and this subchapter include:

(1) an overdraft, regardless of whether such overdraft was pre-arranged, other than an intra-day overdraft for which payment or deposit is received by the bank before the time at which the bank closes its accounting records for the business day on which the funds were advanced;

(2) a contractual obligation to advance funds to or on behalf of a person, including a bank's obligation to:

(A) make payment, directly or indirectly, to a third party contingent upon default by a customer of the bank in performing an obligation owed to the third party or upon another stated condition;

(B) guarantee or act as surety for the benefit of a person;

(C) advance funds under a legally binding commitment to lend; or

(D) advance funds under a standby letter of credit, a put, or other similar arrangement, however named or described, that represents an obligation to the beneficiary on the part of the issuing bank to repay money borrowed by or advanced to or for the account of the account party (the customer or applicant in a letter of credit transaction), make payment on account of any indebtedness undertaken by the account party, or make payment on account of a default by the account party in the performance of an obligation, but not including a bank's obligation under a commercial letter of credit or similar instrument if the issuing bank reasonably expects the beneficiary to draw on the issuer and the instrument neither guarantees payment nor provides for payment in the event of a default by a third party;

(3) a maker or endorser's obligation arising from the discount of commercial paper;

(4) third-party paper purchased to the extent it is subject to an agreement that the seller will repurchase the paper, including an obligation to repurchase the paper upon default or at the end of a stated period, less any applicable dealer reserves held by the bank as collateral security, unless such transaction is exempt under other provisions of the Finance Code or this subchapter;

(5) the sale of Federal funds with a maturity of more than one business day, but not Federal funds sold with a maturity of one day or less or Federal funds sold under a continuing contract, including contracts that provide for weekly settlement if the parties have the contractual right to obtain their funds at maturity of each transaction;

(6) loans or extensions of credit that have been charged off on the books of the bank, in whole or part, unless the loan or extension of credit is no longer legally enforceable by reason of:

(A) discharge in bankruptcy;

(B) expiration of the statute of limitations or judicial decision; or

(C) another reason, provided the bank maintains sufficient records to demonstrate that the loan is unenforceable;

(7) lease financing transactions made pursuant to the Finance Code, §34.204, unless otherwise exempt under §12.7 of this title (relating to Lease Financing);

(8) nonrecourse or limited recourse loans or extensions of credit;

(9) aggregate cash surrender value of life insurance policies from any one insurance company;

(10) any credit exposure to a person arising from a derivative transaction or a securities financing transaction between a state bank and the person, as determined pursuant to §12.12 of this title (relating to Credit Exposure Arising from Derivative and Securities Financing Transactions); and

(11) another category of transactions that is the equivalent of a loan or extension of credit as determined by the banking commissioner in the exercise of discretion.

(b) Loans or extensions of credit for purposes of the Finance Code, §34.201, and this subchapter do not include:

(1) funds advanced to or for the benefit of a borrower by a bank for taxes or insurance associated with collateral security for a loan or extension of credit, as well as funds advanced for utilities, security, and maintenance expenses associated with real property securing a loan or extension of credit, but only if necessary to preserve the value of the real property or other collateral security and consistent with safe and sound banking practices, provided the bank maintains sufficient records to demonstrate the necessity of the advance, and such advances are included in loans and extensions of credit thereafter until repaid for the purpose of determining whether additional loans or extensions of credit to the same borrower may be made within applicable lending limits;

(2) accrued and discounted interest on an existing loan or extension of credit, including interest that has been capitalized from prior notes and interest that has been advanced under terms and conditions of a loan agreement;

(3) that portion of a loan or extension of credit sold as a participation by a bank on a nonrecourse basis, provided the participation results in a pro rata sharing of credit risk proportionate to respective interests of the originating and participating lenders, except that:

(A) notwithstanding any requirement of Statement of Financial Accounting Standards No. 166 (Financial Accounting Standards Bd. 2009), for lending limit purposes, if the participation agreement provides that repayment must be applied first to the portions sold, a pro rata sharing will be considered to exist only if, in the event of default or comparable event provided in the agreement, the participants share in all subsequent repayments and collections in proportion to their actual percentage participation at the time of the occurrence of the event;

(B) if the originating bank funds the entire loan, the participants must be contractually obligated to remit their portion to the bank before the close of business (the time at which the bank closes its accounting records for the business day) on the next business day of the originating bank or its portion funded by the originating bank will be considered a loan by the originating bank to the borrower;

(C) in the case of a participation sold in an existing loan, the amount of the participation may not be subtracted from the outstanding loans and extensions of credit of the originating bank until the proceeds of sale are in the possession of the originating bank; and

(D) a loan participation agreement that provides for weekly settlement of amounts due to and from the participants meets the requirements of this paragraph if the outstanding balance to the borrower from the originating bank does not at any time exceed the bank's legal lending limit;

(4) an advance against uncollected funds in the normal course of collection pursuant to the bank's availability schedule issued in compliance with Regulation CC (12 C.F.R. §229.1 et seq.), including the amount of an item that must be credited to the customer under the bank's availability schedule but remains uncollected and unreturned because of a delay or defect in the collection system;

(5) the sale of Federal funds with a maturity of one day or less, or Federal funds sold under a continuing contract, including contracts that provide for weekly settlement if the parties have the contractual right to obtain their funds at maturity of each transaction;

(6) intra-day credit exposures arising from a derivative transaction or a securities financing transaction;

(7) a renewal or restructuring of a nonconforming loan as a new loan or extension of credit, subject to compliance with §12.10(b) of this title (relating to Nonconforming Loans); and

(8) that portion of one or more loans or extensions of credit, not to exceed 15% of the bank's Tier 1 capital, with respect to which the bank has purchased protection in the form of a single-name credit derivative that meets the requirements of §12.2(a)(7) of this title (relating to Definitions) from an eligible protection provider if the reference obligor is the same legal entity as the borrower in the loan or extension of credit and the maturity of the protection purchased equals or exceeds the maturity of the loan or extension of credit.

§12.10. Nonconforming Loans.

(a) A loan or extension of credit, within a bank's legal lending limit when made, will not be considered a violation of the applicable lending limit but will be cited as nonconforming if the loan no longer complies with the bank's legal lending limit because:

(1) the bank's Tier 1 capital has declined;

(2) borrowers have merged or otherwise become affiliated in such a way as to invoke aggregation under §12.9 of this title (relating to Aggregation and Attribution);

(3) the bank has merged with another depository institution or the bank has purchased all or substantially all of the assets of a failed depository institution from the Federal Deposit Insurance Corporation as receiver of such institution on or shortly after the date of its closing;

(4) the lending limit or capital definitions or standards have changed after the date the loan or extension of credit was originated;

(5) in the case of a credit exposure arising from a transaction identified in §12.12(a) of this title (relating to Credit Exposure Arising from Derivative and Securities Financing Transactions) and measured by the model method specified in §12.12(b)(1)(A) or (c)(1)(A), the current exposure method specified in §12.12(b)(1)(C), or the Basel collateral haircut method specified in §12.12(c)(1)(C), an increase in the credit exposure subject to the lending limits of Finance Code, §34.201, or this subchapter after execution of the transaction; or

(6) collateral securing the loan or extension of credit to satisfy the requirements of a special lending limit or lending limit exception has declined in value.

(b) A bank must exercise reasonable efforts to bring a loan or extension of credit that is nonconforming as a result of circumstances described in subsection (a)(1)-(5) of this section into conformity with the legal lending limit, consistent with safe and sound banking practices. As a last resort, a bank may renew or restructure an existing, nonconforming loan or extension of credit as a new, nonconforming loan or extension of credit without violating the Finance Code or this subchapter, unless:

(1) additional funds are advanced by the bank to the borrower, except as permitted by §12.4(b) of this title (relating to Loan Commitments);

(2) the original borrower is replaced by a new borrower; or

(3) the banking commissioner determines that the renewal or restructuring of the loan or extension of credit is designed to evade the bank’s lending limit.

(c) A bank must bring a loan or extension of credit that is nonconforming as a result of the circumstance described in subsection (a)(5) of this section into conformity with the legal lending limit on or before the 31st day after the nonconformity is discovered unless judicial proceedings, regulatory action, or other extraordinary circumstances beyond the bank’s control prevent the bank from taking action.

§12.12. Credit Exposure Arising from Derivative and Securities Financing Transactions.

(a) Scope. This section sets forth the rules for calculating the credit exposure arising from a derivative transaction or a securities financing transaction entered into by a state bank for purposes of determining the bank's lending limit pursuant to Finance Code, §34.201, and this subchapter.

(b) Derivative transactions.

(1) Non-credit derivatives. Subject to paragraphs (2)-(4) of this subsection, a state bank shall calculate the credit exposure to a counterparty arising from a derivative transaction by one of the following methods. Subject to paragraphs (3) and (4) of this subsection, a bank shall use the same method for calculating counterparty credit exposure arising from all of its derivative transactions.

(A) Model method.

(i) Credit exposure. The credit exposure of a derivative transaction under the model method is equal to the sum of the current credit exposure of the derivative transaction and the potential future credit exposure of the derivative transaction.

(ii) Calculation of current credit exposure. A bank shall determine its current credit exposure by the mark-to-market value of the derivative contract. If the mark-to-market value is positive, then the current credit exposure equals that mark-to-market value. If the mark-to-market value is zero or negative, then the current credit exposure is zero.

(iii) Calculation of potential future credit exposure. A bank shall calculate its potential future credit exposure by using an internal model that has been approved in writing for purposes of §32(d) of the federal capital adequacy guidelines, provided that the bank notifies the commissioner prior to its use for purposes of this section, or another model approved by the department based on the views of the bank's primary federal banking regulatory agency and any third party testing and evaluation reports submitted to the commissioner. Any substantive revisions to an internal model made after the bank has provided notice of its use, or after the commissioner has approved the use of an alternate model, must be approved by the commissioner before a bank may use the revised model for purposes of this section.

(iv) Net credit exposure. A bank that calculates its credit exposure by using the model method pursuant to this subparagraph may net credit exposures of derivative transactions arising under the same qualifying master netting agreement.

(B) Conversion factor matrix method. The credit exposure arising from a derivative transaction under the conversion factor matrix method is equal to and will remain fixed at the potential future credit exposure of the derivative transaction, which equals the product of the notional amount of the derivative transaction and a fixed multiplicative factor determined by reference to Table 1 of this section.

Figure: 7 TAC §12.12(b)(1)(B) (No change.)

(C) Current exposure method. The credit exposure arising from a derivative transaction (other than a credit derivative transaction) under the current exposure method is calculated in the manner provided by §32(c)(5), (6) and (7) of the federal capital adequacy guidelines.

(2) Credit derivatives.

(A) Counterparty exposure.

(i) General rule. Notwithstanding paragraph (1) of this subsection and subject to clause (ii) of this subparagraph, a state bank that uses the conversion factor matrix method or the current exposure method, or that uses the model method without entering an effective margining arrangement as defined in §12.2 of this title (relating to Definitions), shall calculate the counterparty credit exposure arising from credit derivatives entered by the bank by adding the net notional value of all protection purchased from the counterparty on each reference entity.

(ii) Special rule for certain effective margining arrangements. A bank must add the effective margining arrangement threshold amount to the counterparty credit exposure arising from credit derivatives calculated under the model method. The effective margining arrangement threshold is the amount under an effective margining arrangement with respect to which the counterparty is not required to post variation margin to fully collateralize the amount of the bank's net credit exposure to the counterparty.

(B) Reference entity exposure. A state bank shall calculate the credit exposure to a reference entity arising from credit derivatives entered into by the bank by adding the net notional value of all protection sold on the reference entity. A bank may reduce its exposure to a reference entity by the amount of any eligible credit derivative purchased on that reference entity from an eligible protection provider.

(3) Special rule for central counterparties. In addition to amounts calculated under paragraphs (1) and (2) of this subsection, the measure of counterparty exposure to a central counterparty must also include the sum of the initial margin posted by the bank plus any contributions made by it to a guaranty fund at the time such contribution is made. However, this requirement does not apply to a bank that uses an internal model pursuant to paragraph (1)(A) of this subsection if such model reflects the initial margin and any contributions to a guaranty fund.

(4) Mandatory or alternative use of method. The commissioner may in the exercise of discretion require or permit a state bank to use a specific method or methods set forth in this subsection to calculate the credit exposure arising from all derivative transactions, from any category of derivative transactions, or from a specific derivatives transaction if the commissioner in the exercise of discretion finds that such method is consistent with the safety and soundness of the bank.

(c) Securities financing transactions.

(1) In general. Except as provided by paragraph (2) of this subsection, a state bank shall calculate the credit exposure arising from a securities financing transaction by one of the following methods. A state bank shall use the same method for calculating credit exposure arising from all of its securities financing transactions.

(A) Model method. A state bank may calculate the credit exposure of a securities financing transaction by using an internal model that has been approved in writing for purposes of §32(b) of the federal capital adequacy guidelines, provided that the bank notifies the commissioner prior to its use for purposes of this section, or another model approved by the department based on the views of the bank's primary federal banking regulatory agency and any third party testing and evaluation reports submitted to the commissioner. Any substantive revisions to an internal model made after the bank has provided notice of its use, or after the commissioner has approved the use of an alternate model, must be approved by the commissioner before a bank may use the revised model for purposes of this section.

(B) Basic method. A state bank may calculate the credit exposure of a securities financing transaction as follows:

(i) Repurchase agreement. The credit exposure arising from a repurchase agreement shall equal and remain fixed at the market value at execution of the transaction of the securities transferred to the other party less cash received.

(ii) Securities lending.

(I) Cash collateral transactions. The credit exposure arising from a securities lending transaction where the collateral is cash shall equal and remain fixed at the market value at execution of the transaction of securities transferred less cash received.

(II) Non-cash collateral transactions. The credit exposure arising from a securities lending transaction where the collateral is other securities shall equal and remain fixed as the product of the higher of the two haircuts associated with the two securities, as determined by reference to Table 2 of this section, and the higher of the two par values of the securities. Where more than one security is provided as collateral, the applicable haircut is the higher of the haircut associated with the security lent and the notional-weighted average of the haircuts associated with the securities provided as collateral.

(iii) Reverse repurchase agreements. The credit exposure arising from a reverse repurchase agreement shall equal and remain fixed as the product of the haircut associated with the collateral received, as determined by reference to Table 2 of this section, and the amount of cash transferred.

(iv) Securities borrowing.

(I) Cash collateral transactions. The credit exposure arising from a securities borrowed transaction where the collateral is cash shall equal and remain fixed as the product of the haircut on the collateral received, as determined by reference to Table 2 of this section, and the amount of cash transferred to the other party.

(II) Non-cash collateral transactions. The credit exposure arising from a securities borrowed transaction where the collateral is other securities shall equal and remain fixed as the product of the higher of the two haircuts associated with the two securities, as determined by reference to Table 2 of this section, and the higher of the two par values of the securities. Where more than one security is provided as collateral, the applicable haircut is the higher of the haircut associated with the security borrowed and the notional-weighted average of the haircuts associated with the securities provided as collateral.

Figure: 7 TAC §12.12(c)(1)(B)(iv)(II)

TABLE 2—COLLATERAL HAIRCUTS

SOVEREIGN ENTITIES

Sovereign Entities

 

Residual maturity

Haircut without currency mismatch1

OECD Country Risk

Classification2 0-1………….

<= 1 year……………………….

>1 year, <= 5 years…………..

>5 years………………………..

………………………………..0.005

………………………………….0.02

………………………………….0.04

OECD Country Risk

Classification 2-3……………

<= 1 year……………………….

>1 year, <= 5 years…………..

>5 years………………………..

………………………………….0.01

………………………………….0.03

………………………………….0.06

CORPORATE AND MUNICIPAL BONDS THAT ARE BANK-ELIGIBLE INVESTMENTS

Corporate and Municipal Bonds that are Bank-eligible Investment

 

Residual maturity for debt securities

Haircut without currency mismatch

All…………………………

All…………………………

All…………………………

<= 1 year…………………………...

>1 year, <= 5 years……………....

>5 years…………………………….

………………………………….0.02

………………………………….0.06

………………………………….0.12

OTHER ELIGIBLE COLLATERAL

Main index3 equities (including convertible bonds)…………….

Other publicly traded equities (including convertible bonds)…..

Mutual funds………………………………………………………….

 

Cash collateral held…………………………………………………

0.15

0.25

Highest haircut applicable to any security in which the fund can invest

0

1 In cases where the currency denomination of the collateral differs from the currency denomination of the credit transaction, an additional 8.0% haircut will apply.

2 OECD Country Risk Classification means the country risk classification as defined in Article 25 of the OECD’s February 2011 Arrangement on Officially Supported Export Credits Arrangement.

3 Main index means the Standard & Poor’s 500 Index, the FTSE All-World Index, and any other index for which the covered company can demonstrate to the satisfaction of the Federal Reserve that the equities represented in the index have comparable liquidity, depth of market, and size of bid-ask spreads as equities in the Standard & Poor’s 500 Index and FTSE All-World Index.

 

(C) Basel collateral haircut method. A state bank may calculate the credit exposure of a securities financing transaction in the manner provided by §32(b)(2)(i) and (ii) of the federal capital adequacy guidelines.

(2) Mandatory or alternative use of method. The commissioner may in the exercise of discretion require or permit a state bank to use a specific method or methods set forth in this subsection to calculate the credit exposure arising from all securities financing transactions, from any category of securities financing transactions, or from a specific derivatives transaction if the commissioner finds in the exercise of discretion that such method is consistent with the safety and soundness of the bank.

 

Effective date: November 7, 2013, 38 TexReg 7685.