The purpose of this letter is to provide supervisory guidance on creditworthiness and credit risk management for corporate credit unions following the issuance of NCUA Final Rule Alternatives to the Use of Credit Ratings published in the Federal Register on December 13, 2012.1 The rule implemented statutory requirements in Title IX of the Dodd-Frank Wall Street Reform and Consumer Protection Act, by removing references to credit ratings in the NCUA regulations and replacing them with other appropriate standards. The rule is effective June 11, 2013.
Minimal amount of credit risk means the amount of credit risk when the issuer of a security has a very strong capacity to meet all financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has a very strong capacity to meet all financial commitments if the risk of default by the obligor is very low, and the full and timely repayment of principal and interest on the security is expected. A corporate credit union may consider any or all of the following factors, to the extent appropriate, with respect to the credit risk of a security: Credit spreads; securities-related research; internal or external credit risk assessments; default statistics; inclusion on an index; priorities and enhancements; price, yield, and/or volume; asset class specific factors. This list of factors is not meant to be exhaustive or mutually exclusive.
Investment grade means the issuer of a security has an adequate capacity to meet the financial commitments under the security for the projected life of the asset or exposure, even under adverse economic conditions. An issuer has an adequate capacity to meet financial commitments if the risk of default by the obligor is low and the full and timely repayment of principal and interest on the security is expected.
- Credit spreads (i.e., whether it is possible to demonstrate that a security is subject to a particular amount of credit risk based on the spread between the security’s yield and the yield of Treasury or other securities);
- Securities-related research (i.e., whether providers of securities-related research believe the issuer of the security will be able to meet its financial commitments, generally or specifically, with respect to the securities held by the credit union);
- Internal or external credit risk assessments (i.e., whether credit assessments developed internally by the credit union or externally by a credit rating agency, irrespective of its status as an NRSRO, express a view as to a particular security’s credit risk);
- Default statistics (i.e., whether providers of credit information relating to securities express a view that specific securities have a probability of default consistent with other securities with a particular amount of credit risk);
- Inclusion on an index (i.e., whether a security, or issuer of the security, is included as a component of a recognized index of instruments that are subject to a specific amount of credit risk);
- Priorities and enhancements (i.e., the extent to which a security is covered by credit enhancements, such as overcollateralization and reserve accounts);
- Price, yield, and/or volume (i.e., whether the price and yield of a security are consistent with other securities that the credit union has determined are subject to a particular amount of credit risk and whether the price resulted from active trading); and
- Asset class-specific factors (e.g., in the case of structured finance products, the quality of the underlying assets).
- Class/tranche and position in the cash flow waterfall of a securitized structure;
- Loss allocation rules, definitions of default, impact on performance, and market value triggers;
- Support provided by credit enhancements and/or liquidity enhancements, such as excess spread, overcollateralization and reserve accounts;
- Risk concentrations in underlying collateral, such as local demographics and economics that may contribute to default or diminished repayment;
- Contributing factors in special servicing, legal and credit administration;
- Quality of underwriting of underlying collateral and consistency with historical performance;
- The impact of collateral deterioration on tranche performance, default rates and loss severities under adverse circumstances;
- Performance of individual commercial properties in the case of commercial mortgage related securities; and
- Present and future contribution of guarantees when issued by government agencies.
Scott A. Hunt
Office of National Examinations and Supervision
177 FR 74103 (Dec. 13, 2012).
2OCC Final Rule and Guidance 77 FR 35253, 25259 (June 13, 2012); FDIC Final Rule and Guidance 77 FR 43151, 43155 (July 24, 2012).
3Federal Reserve Board of Governors, SR 12-15, November 15, 2012.
4SEC Proposed Rule 76 FR 26550 (May 6, 2011).