QIS3: Quantitative Impact Study

Letters of Credits (LOCs)

Should Letters of Credits (LOCs) be included under the category of "Other Balance Sheet Items" or under "Corporate"? Does the classification depend on the nature of the counterparty (client classification)?

Answer: LOCs issued by the reporting institution should be classified as undrawn commitments based on the nature of the account party for whom the LOC was issued, typically a corporate customer. Spreadsheets for both the Standardized and IRB approaches record these commitments in "Section B" for the relevant portfolio (e.g., corporate). Customer obligations to the reporting bank that are, themselves, backed by LOCs issued by other banks should be reflected using the substitution approach as claims on other banks.

SWAPTIONS

Should "SWAPTIONS" be classified as Over The Counter Derivatives (OTCs)? These investment instruments are customized by an intermediary according to bank requirements?

Answer: Yes.

Sovereign Exposures

What exposure should be classified as a sovereign exposure under the Data Exposure Worksheet? Specifically, how to treat these:

Industrial development bonds backed by a local government agency. This type of bond is issued to finance local projects such as shopping centers, where the resulting commercial property serves as collateral. Investment participation is limited to investors residing in the home state.

Securities guaranteed by the Government National Mortgage Association (GINNIE MAE), the Federal National Mortgage Association (FANNIE MAE) or debt instruments issued by any other government-sponsored agency.

Municipal Bonds

Answer: First, do not conclude that all U.S. Gov, U.S. Gov agency, Municipals, Municipal Pensions, etc. belong to the PSE classification. Obligations that are supported by the full faith and credit of the U.S. government (e.g., Treasuries, FHLBanks, or Ginnie Mae) are certainly treated as sovereigns. However, claims on other PSEs, including state and municipal governments, should be treated as claims on either bank or corporate borrowers. For practical (and QIS) purposes, respondents should base such decisions on whether the obligor has taxation authority and whether the exposure is supported by the "full faith and credit" of the obligor. In such cases, record the exposure as a claim on a bank. Exposures to entities with more limited funding sources, such as those involving revenue bonds, should be recorded as claims on corporations. That would include exposures to Fannie Mae and Freddie Mac.

Commercial Entities

What is the definition of "commercial" entities regarding the spreadsheet "Investments in Related Entities"? Should we include all equity investments in non-financial and non-insurance entities?

Answer: No. This spreadsheet should include only "permanent" equity investments of the reporter that represent more than 25 percent of a company's voting shares. Consequently, do not report on this spreadsheet equity investments held pursuant to SBIC or similar legislative programs or under venture capital investment authority of financial holding companies or the "portfolio investment" authority of Regulation K. As a result, few, if any, U.S. institutions would be expected to report an amount on this line. Institutions that believe they have relevant investments to report should discuss the matter further with their QIS regulatory contact.

Default

What is the definition of default? Does it mean past due for more than 90 days, and is this definition applicable regardless of the portfolio type?

Answer: A default is considered to have occurred with regard to a particular obligor when either or both of the two following events has taken place:

The bank considers that the obligor is unlikely to pay its credit obligations to the banking group in full, without recourse by the bank to actions such as realizing security (if held). The elements to be interpreted as indicating the likelihood of repayment are detailed in paragraphs 400-401.
The obligor's payments are past due for a certain period of time on any material credit obligation to the banking group. For most portfolios, that period is set at more than 90 days. However, for retail credits, U.S. banks should measure default at >180 days for credit cards and exposures secured by real estate and at >120 days for other retail credits. Those criteria are consistent with current guidance issued by the FFIEC. Overdrafts are considered as being past due once the customer has breached an advised limit or has been advised of a limit smaller than current outstandings. Additional information on the treatment of overdrafts is detailed in paragraph 406.

Banks should have clearly articulated and documented policies in place for counting the number of days a credit is past due. These policies should include re-aging of the facilities, granting extensions, deferrals, renewals and rewrites to existing accounts. More specific requirements on re-aging are detailed in paragraph 405.

A bank should use the reference definition for recording actual defaults on IRB asset classes and for estimating PDs, and (where relevant) LGDs and EADS. In arriving at these estimations, the bank may use external data available to it that is not itself consistent with the definition, subject to the requirements set out in paragraph 409, which detail PD/LGD/EAD estimation of the using external data. Additional details on recording actual defaults are included in paragraph 403.

For retail exposures, banks may apply the definition of default at the level of a particular facility, rather than at the level of an obligor. Consequently, default by a borrower on one obligation does not require a bank to treat all of the borrower's other obligations to the banking organization as being in default.

Banking Book / Trading Book

Have the definitions of the Banking book and the Trading book changed for Basel-2 and QIS-3 purposes?

Answer: The Technical Guidance provides a slightly different and more restrictive definition of the Trading Book than is current applied by the 1996 Market Risk Amendment (see TG paragraphs 619-624). However, for QIS purposes U.S. banks may continue to view transactions currently booked in trading accounts as qualifying for trading account treatment.

Turnover

Under the PD/LGD Approach, Equity exposures require firm size information in terms of turnover (paragraph 12.24 of the Quantitative Impact Study 3 Instructions). Define turnover as it relates to firm size.

Answer: "Turnover" is defined as the firm's annual sales revenue.

Equity Investments

Should investments in money market and bond mutual funds that, themselves, contain only non-equity assets be treated as equity investments?

Answer: Equity investments should exclude investments in money market and bond mutual funds, which themselves contain only non-equity assets. Report such mutual funds on the basis of their underlying assets."

Bank Exposure

The QIS 3.0 Information Package does not provide a definition of bank exposure in the Portfolio Definitions section. Should we rely on the definition outlined in the Internal Ratings-Based Approach document provided in January 2001, which simply categorizes bank exposure as those exposures to banks and securities firms including certain Multilateral Development Banks (MDBs)? (IRB Approach, Chapter 4, Pg. 43).

Answer: Yes.

Public Sector Entities

According to Section 2.1.2, Pg. 7 of the QIS 3.0 Working Draft on Technical Guidance:

This excerpt leads one to believe that PSEs should be categorized either as sovereign or bank exposure depending on national discretion. However, the QIS 3.0 Information Package, Section B.1.1, Pg. 34 states that the definition for corporate exposure "would also include those public sector entities (PSEs) that do not meet the characteristics of a sovereign . . ." The two definitions seem contradictory.

The Fed has already delineated that PSEs will not be considered as sovereign exposure. Does the Fed then consider PSEs corporate or bank exposure?

Answer: In the above context, the reference to "claims on banks" in section 2.12 of the Working Draft is used only to show that similar options are available for PSEs as for claims on banks., i.e., Option 1 or Option 2. However, depending on the nature of business of the PSE in question (as with any other exposure classification) banks would classify the PSE either as a corporate or bank exposure. Thus, given that US national discretion has already ruled out treatment of PSEs as sovereign exposures, PSEs would fit in as corporate or bank based on the nature of the exposure. See paragraphs 31-32 (and related footnotes) of the Technical Guidance (905 KB PDF) paper.

The Information Package (Section 6.13) notes that the post-collateral exposures in the Current Accord worksheet reflect the risk weight of the collateral taken against an exposure. It appears as though this does not take into account the value of the collateral and therefore the total exposures recorded pre- and post-collateral remain unchanged. Is that a correct assumption? Is this also true for pre- and post- protection?

Answer: You are partially correct in that the "Pre collateral" total exposures will equal the "Post collateral" total exposures. However, the value of the collateral is taken into account as evident in the last two columns of the table "Pre CRM RWA" and "Post CRM RWA." Here you can see that the risk weight changes due to collateral do reduce the RWA.

In the "Standardized" worksheet and using the simple approach to CRM, do you treat the RWA post-collateral using the same tables as you would use to find the RWA of, for example, sovereigns? So, if a corporate loan to an unrated company (100% RWA) were secured with state or muni bonds (20% RWA), would it have a 20% RWA?

Answer: Yes, when adjusting (reallocating) exposures to reflect the effect of collateral, use the risk weight associated with the underlying collateral, in this case the entity that issued the debt instruments. Use the tables shown in paragraphs 27-51 of the Technical Guidance paper. In the example above, institutions would record a $100 loan to an unrated company using several spreadsheet entries: Enter $100 on the 100 percent line under the "All exposures" column and also under the column titled "Pre-collateral". Then "reallocate" the $100 to the 20 percent line under the column titled "Post-collateral."

Standardized Approach - Equity Section 9 - Risk weight choices are 100% and 150%, Tech Guide p. 12 paragraph 47 states supervisors may apply a risk weight of 150%. Can you provide clarity - when would we apply a risk weight of 150%?

Answer: The 150% risk weight would be applied to all equity investments as defined for the IRB approach in paragraphs 197 to 200 of the Technical Guidance. Therefore, all equity holdings in commercial entities, public or private.

We are using June 30, 2002 as our reporting date. However, we may not have available the external ratings for the Standardised Approach that were in effect as of June 30th. We would be forced to use external ratings as of September 30th or later, which may even be a more conservative approach considering the current environment. Is this a problem?

Answer: That approach is fine. Institutions should not, however, feel encouraged to take the "most conservative" approach in completing the QIS. At this point, regulators are evaluating alternative proposals, not imposing capital requirements.

Under the standardized approach for investments in securitizations, GNMA collateralized mortgage obligations default to a 20% risk-weight. Since these are government guaranteed, we recognize a credit risk mitigant (CRM) thereby reducing the exposure. Total Risk Weighted Assets for Securitized Investments is capturing the pre-CRM total, rather than the post. Is this correct?

Answer: Under the standardised approach, GNMA securities should be placed in the 0 percent risk weight category (similar to U.S. Treasury securities). They should not be incorporated in QIS-3 using the CRM rules.

Under the Advanced approach, why are the EAD rates fixed except in the case of commitments?

Answer: Please refer to paragraphs 11.2 and 11.3 in the QIS instructions and paragraphs 269-277 of the Technical Guidance. As per the rules, under the Advanced approach, the drawn amounts are fixed at 100%. Off-balance sheet items are entered after credit conversion. Banks are allowed to enter their EADs for commitments only as per the rules.

In the worksheet entitled "Current" should "All exposures" = sum of "unsecured exposures" + "pre-collateral exposures" +"pre-protection exposures"? (See, for example, section 4a, although it appears many places.)

Answer: Yes.

Our system considers guarantors as a factor in determining LGD, as opposed to the PD. While we will likely change this approach if new capital standards are adopted, we will not have the data organized differently in time to complete the survey. We will try to adjust for this, where possible, but may still overestimate the risk of the portfolio.

Perhaps more troublesome is the standardized approach and its requirement for external ratings. Since we do not intend to pursue that approach, we are not inclined to incur costs associated with gathering the necessary ratings. Should we still complete the standardized worksheet? If so, may we create a conversion table from our (more granular) risk rating scale and translate that to the AAA, AA, etc. grading scale, and base our RWA off of that conversion?

Answer: Yes, we strongly encourage all participants to provide their best information regarding all four alternative approaches — the current, standardized, and both IRB methods. That information will be very helpful in "calibrating" the various standards, ensuring that each standard is sound, and providing institutions an appropriate incentive to invest in strong risk measurement and management information systems and techniques. Where information is not readily available, institutions are encouraged to provide their best estimates using reasonable estimating techniques.

The Federal Reserve understands that banks may find much of the requested information challenging to provide and will certainly accept best estimates, such as that provided by a "conversion" table. Where different approaches are taken that may produce materially different results or significant uncertainty about their comparability, institutions are requested to describe the approach taken.

Remember, estimates are acceptable. In the case above, for example, if the institution could estimate the portion of borrowers that are unlikely to have external ratings, it could slot those exposures at 100 percent and not apply to them the imputed external ratings. In short, do your best. We do not expect institutions to incur unreasonable costs or undertake heroic efforts.

How does Basel II treat "other assets" that are weighted at 100 percent under current standards, but that are not specifically addressed in the Technical Guidance, e.g., under the Advanced IRB classifications? Are they to be ignored and not included in QIS?

Answer: The Accord proposals (particularly for IRB) are silent on the appropriate treatment for such "other assets". (For the Standardised Approach, a brief mention is made in paragraph 48 of the Technical Guidance.) For QIS 3 purposes, continue to risk weight at 100% those assets that are not addressed in the Technical Guidance and that receive a 100% RW under the Current Accord.

For the spreadsheets, list these items in Section A5 of the "Data" spreadsheet under the appropriate sub-categories of "Other Assets". Then, sum the assets, risk weight them at 100%, and enter that total in cell E129 of the "Capital" spreadsheet, which is used to record such "other assets" and also assets in operations for which "Basel-2" type information is unavailable. At present, we do not have a specific list of such residual items, so use your judgement to categorize them. In short, as is the case now, the default risk weight is 100 percent. For further guidance, see Section A, Question 4 at http://www.bis.org/bcbs/qis/qis3qa.htm.

Data Template – The provision information requested excludes general loan loss reserves, is that correct?

Answer: Yes. General loan loss reserves are to be included on the "Capital" sheet.

Under the line item for other assets, other types of reserves can be captured here (non-loan loss related)?

Answer: Yes.

Should valuation adjustments for derivatives (liquidity reserve, etc.) be included as a reserve for the Trading Book On Balance Sheet and OTC Derivative categories?

Answer: Yes. They should be included under the "Other Trading Book Assets" in the "Data" sheet if the values of derivatives are reported gross of these adjustments. If derivatives valuations are shown net of these adjustments the adjustments should not be included in "Other Trading Book Assets" since this would constitute a double counting. If these adjustments are included in "Other Trading Book Assets" please make an identifying footnote.

Should other reserves, possibly legal reserves, for which no corresponding asset exists, be included under the Banking Book Other Assets section?

Answer: Yes.

Are the exposures reported in the sections entitled "Assets not included in the QIS-3" meant to allow for portfolios that we could not capture in any of the approaches? Is this more of a plug to get to the proper total exposures? If not, how should this be used?

Answer: Yes, it is essentially a "plug" to allow national supervisors to evaluate the coverage the bank has achieved in QIS 3. It will also allow both banks and supervisors to reconcile, as far as possible, the total balance sheet assets submitted in the QIS with their most recent balance sheet figures, as provided in other regulatory or public financial statements.

Confirm where on the worksheets to record exposures related to non-securitization investment securities, fed funds sold, deposit placements, and Bank Owned Life Insurance (BOLI) exposures? Is it correct to classify them as Sovereign, Bank, or Corporate "Drawn and Off-Balance Sheet Exposures"?

Answer: Yes, that is the appropriate placement.

Paragraph 236 of the Technical Guidance states that the formula for the corporate exposure maturity adjustment is as such: (0.08451 - 0.05898* log(PD))^2. This would imply log with the base of 10. The Excel-based QIS workbook uses natural log in the formula. Confirm the formula should use the natural log.

Answer: All logarithms are natural logs, which use base e.

What is the relevant time horizon over which PD is intended to represent the likelihood of an asset entering default?

Answer: The PD is intended to be the estimate of the probability of default within the next twelve months.

Is it the Committee's intent to express PD as annual or lifetime losses? The Commercial IRB framework suggests that PD is the mean probability of an asset entering default within a single year. The Retail IRB framework makes reference to asset maturity being "subsumed in the correlation assumption," suggesting the risk weight functions have been calibrated for maturity. Further, if PD represents an annual default rate should it be sensitive to the immediately preceding 12 months or the average of an entire business cycle? Estimating PD based on the most recent 12 months raises the issue of procyclicality.

Answer: For retail as for corporate exposures, the PD is intended to be the estimate of the probability of default over the next twelve months. The correlation assumption for residential mortgage exposures in particular is intended to (partially) subsume the possibility of economic losses on the portfolio due to the longer average maturity of exposures without requiring an explicit maturity adjustment.

It is not appropriate to estimate PDs or ELs using only the most recent twelve months of data. Quantification of PDs or ELs for particular rating grades or exposure classes should use as long a time series as the bank believes is relevant and in no case less than five years (although three years of data is allowed during the first two years after Basel II goes live).

This leaves the important question of how exposures are intended to be slotted into ratings grades. For the corporate portfolio where this is based on individual credit assessments and judgments, more frequent re-ratings will no doubt produce more pro-cyclical outcomes. The Basel Committee encourages banks to move toward approaches where the rating is more "through-the-cycle" than "point-in-time", but does not feel that it is currently feasible to require a "through-the-cycle" approach for all banks. Even though much retail slotting is more mechanical in nature (i.e., FICO scores), similar considerations may apply.

A common method of deriving PD is to use monthly or quarterly data from a particular pricing segment within a portfolio. Another potential issue arises if the observations are drawn from a growing portfolio. The loss information will be biased to the early portion of the loss vintage curve, and the early portion of the loss vintage curve is not fully ramped. Therefore, losses will be lower and PD will be understated. Is this acceptable?

Answer: In general, the Committee wants to look to strong internal bank practices as a guidepost. Where a bank believes the issue identified here is material, presumably the bank is considering whether additional steps (i.e., segmentation by vintage) are necessary to achieve appropriate estimates of risk and economic capital. The Committee has stepped back from explicit mandatory segmentation requirements in areas such as this because of concerns with excessive burden and complexity, but with the understanding that banks will take the appropriate steps to deliver unbiased estimates of PD. Over time, of course, approaches that do not deliver unbiased estimates will be shown to be inadequate through the results that they produce.

Banks must also determine volatility around PD to establish the level of recognition for future margin income (FMI). Simple statistical analysis states that standard deviation increases as the square root of the number of periods, however, this may yield much tighter results than the more traditional cohort/vintage analysis. How does the Committee intend for banks to convert the standard deviation of their monthly or quarterly distributions to the prescribed annual measure used in the FMI test?

Answer: The Committee envisions that the monthly or quarterly loss observations should be annualized prior to the calculation of the standard deviation. This is equivalent to assuming that the volatility increases linearly with time as opposed to increasing with the square root of time. The latter assumption only holds if the monthly or quarterly observations are statistically independent. However, both common sense and empirical observation suggest that monthly or quarterly loss rates on these portfolios are likely to exhibit extremely high levels of serial correlation.

How to account for loans that the VA guarantees? When a loan defaults, the VA can either directly reimburse the bank or, if it determines the quality of loan servicing was not up to VA criteria, may refuse to pay, leaving the bank with the credit risk of the underlying counterparty. Although the VA has rarely, if ever, excercised its option not to pay, the risk is still present. Consequently, should the bank risk weight according to the VA (as guarantor) or on the basis of the underlying mortgagees.

Answer: Technically, the loans are only conditionally quaranteed by the VA and should be risk weighted according to the underlying mortgages.

How should an institution slot mortgages that it is warehousing and plans to sell within 45-60 days, since they are temporary holdings and not subject to institution's typical retail risk rating?

Answer: Treat them as retail.

How should residential mortgage loans be treated in cases where the loan-to-value ratio exceeds 100%?

Answer: To the extent that the unsecured balance can satisfy the required criteria for retail exposures, the preferential risk weight of 75% will be appropriate.

What are the criteria for slotting low-asset-correlation, income producing commercial real estate (IPRE) with corporate loans?

Answer: Background. Paragraphs 209-211 state that, with one area of exception, banks must provide their own estimates of PD, LGD, EAD, and maturity when using the advanced approach, but must apply supervisory assumptions for all parameters except PD when using the foundation approach. These requirements are basic to the draft proposal. The exception cited relates to specialty lending, which has been a particularly troublesome topic to address because of the unique risk characteristics often associated with this activity and the historically low amount of available data with which to estimate the risk underlying SL exposures. To that point, the Technical Guidance (paragraphs 212-213) states that banks unable to estimate adequately PDs associated with SL lending must "map their internal risk grades into five supervisory categories," pursuant to a version of the foundation approach termed the "supervisory slotting criteria approach" (see Annex 4). Institutions that can adequately estimate PDs and all other key parameters may treat SL exposures as corporate exposures using the advanced approach, unless the SL exposure involves HVCRE (paragraph 215). In the case of HVCRE, the "supervisory slotting" approach is always required. A question arises, therefore, regarding what operational standards must banks apply when estimating PDs and other parameters for purposes of QIS, particularly with respect to certain CRE.

Response: As mentioned in transmittal documents to the Technical Guidance, prior Q/As, and November's conference call, the draft criteria included in the TG are relaxed for purposes of QIS. While institutions should seek, as much as possible, to adhere to the "spirit" of these standards when completing the QIS, they are not in effect now and supervisors do not expect banks to meet them fully during this survey period. For now, use your judgment and apply reasonably consistent criteria in deciding such matters in all aspects of the QIS. Given the general scarcity of data available to measure risk in CRE, we would encourage most institutions to treat IPRE using the supervisory slotting approach, rather than as corporate credits. Nevertheless, the corporate option remains available to institutions comfortable taking that approach for both the foundation and advanced IRB measurement methods. Respondents should not, however, interpret this QIS guidance as suggesting future supervisory views. Those questions have yet to be fully addressed.

CRE note: Note that the supplemental information requested in Memo A and B at the bottom of the FIRB Specialized Lending spreadsheet is for information only. Entries into this portion of the spreadsheet have no effect on calculations.

Do the supervisory categories for specialised lending have external rating equivalents?

Answer: Yes, each supervisory category broadly corresponds to a range of external ratings as outlined below. Further, the Committee relied on the external rating equivalents in calibrating the associated risk weights.

Strong:	BBB– or better
Good:	BB+ or BB
Satisfactory:	BB– or B+
Weak:	B to C-

Specialised lending is an area where we are having extreme difficulty determining a way to extract the level of information required. We may not be able to break out this portfolio from the others based on our current systems and processes. Are other (U.S.) banks experiencing similar difficulties? Any suggestions? What are the Fed's expectations?

Answer: As far as the detailed aspects of the Specialized Lending sheet, we have recently sent further guidance to each of the banks which mainly includes a detailed list of definitions for CRE property types based on high volatility CRE and low volatility CRE. If possible, we would like banks to classify at least this part of their Specialized Lending portfolio in more detail based on these definitions. Of course, as with other parts of the QIS, our expectation is that banks will make a "best efforts" attempt, which includes estimation and sampling. We only ask that you include any relevant notes or information when estimating/sampling in the "Notes" sheet.

Would all types of commercial real estate-secured loans where the borrower occupies the property, as opposed to being an investor/developer in a property, be construed as corporate, rather than SL?

Answer: Yes, generally, loans secured by commercial real estate that is occupied by the borrower should be classified as collateralized corporate loans, because such loans rely "on the credit quality of the borrower rather than "primarily on the income generated by the asset(s)".

Should I assume that object finance loans are intended to cover LARGE aircraft or similar equipment that have an identifiable cash flow stream associated with them, as opposed to small equipment leases that are a minor part of a firm's operations?

Answer: The object finance treatment is meant for leases and loans to organizations of limited scope, such as SPVs, where their only source of repayment is the rental of the equipment to third parties. For example, a long-term aircraft lease to a major carrier would be classified as a corporate exposure since repayment of the lease is not singularly dependent on the aircraft's ability to generate income. Repayment of the lease is dependent on the profitability of the entire airline's activities. A 20-year lease to an SPV, whose sole asset is the subject aircraft and its intent is to sub-lease the aircraft to third parties on a short-term basis, would receive object finance treatment.

Structures fitting the object finance definition are not common in the U.S. banking system. As a result, most if not all leases and loans to finance aircraft, ships, railcars, etc. will be treated as "corporate" exposures under the IRB approach. However, there is one difference for lease transactions where the residual exposes the bank to price risk of the underlying equipment. In those cases the residual will be risk weighted at 100% and the discounted lease payment stream will receive a risk weight similar to all other corporate exposures (dependent on the lessee's PD and the transaction's LGD and tenor). The same treatment will apply to direct finance and leveraged leases. The Committee has not formulated a treatment for leases that are classified as operating leases on a bank's books. These are not thought to be material.

Loans and leases to finance business equipment for corporate entities should be classified as corporate or small business exposures. The residual treatment discussed in the preceding paragraph applies to all lease transactions.

Please describe the term "structured" in the context of commodity finance. We make short-term loans to farmers secured by their harvest that I would be inclined to treat as corporate, rather than SL. Same thing with loans to oil producers. Is that approach correct?

Answer: Loans to U.S. farmers should not be classified as commodity finance. They should be slotted as corporate or small business exposures. The commodity finance treatment is meant for loans to commodity brokers where the bank cannot judge the broker's credit worthiness or the broker's financial capacity does not justify extending credit, yet the transaction is structured in a manner that provides adequate protections to the bank. It is unlikely that U.S. banks will have exposures that will fall within this treatment.

Will asset-based lending will be considered SL?

Answer: Asset-based lending is not SL. ABL exposures will be treated as corporate or small business exposures with the exception of those that meet the qualification criteria for the "purchased receivables" treatment.

In general, the ABL activities below will be treated as the following types of exposures for IRB purposes:

Accounts receivable financing - corporate or small business
Inventory financing - corporate or small business
Factoring - purchased receivables
Structured financings of receivables that result in the true sale of the receivables from the originator to the bank - purchased receivables
Structured financings of receivables that result in a secured financing on the part of the originator - corporate

Point of Clarification on Leases

The Bank has a sizeable number of single-investor and leveraged leases, where we rely upon the residual value (i.e. the fair market value of an asset at the expiration of a lease) for full repayment with return.

The QIS 3.0 Information Package, Section B.5.1 (i), Pg. 37, states that an instrument is considered to be an equity exposure if it meets all of the following requirements:

Is irredeemable in the sense that the return of invested funds can be achieved only by the sale of the investment or the rights to the investment or by the liquidation of the issuer;
Does not embody an obligation on the part of the issuer; and
Conveys a residual claim on the assets or income of the issuer.

Based on the definition of equity exposure, would single-investor and leveraged leases be considered equity exposure or still, object finance exposure?

Answer: Single investor and leveraged leases should be considered object finance.

I understand that exposures considered HVCRE must meet the conditions for specialized lending set forth in paragraph 180 of the QIS-3 Technical Guidance (905 KB PDF) paper. In other words, a loan to the Marriott Corporation to fund the construction of a new hotel would not receive the HVCRE treatment if the bank had recourse to the larger corporation and the repayment of the loan did not depend on the success of the specific project. Is this interpretation is accurate?

Answer: Yes, that is correct.

In the QIS 3.0 Information Package, Section B.8.2 (1), Pg. 41, high volatility commercial real estate is said to include "[c]ommercial real estate exposures secured by properties of types that are categorized by the national supervisor as sharing higher volatilities in portfolio default rates." What are the real estate exposures that the Fed considers as high volatility?

Answer: High-volatility portfolios include several types of CRE loans:

those secured by office, hotel, or single-use properties;
CRE loans financing any of the land acquisition, development, or construction (ADC) phases of such properties; and
CRE loans financing ADC for any other property where the borrower does not have substantial equity at risk and the source of repayment for the exposure is either (a) the uncertain sale of the property in the future or (b) cash flows whose source is substantially uncertain (i.e., the property has not yet been pre-leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate).

The U.S. regulatory agencies have not yet determined what constitutes "substantial equity."

Conversely, low-volatility portfolios include CRE loans secured by multifamily, industrial, or retail properties, as well as those financing any of the land acquisition, development, or construction (ADC) phases for such properties where (1) the borrower has substantial equity at risk and/or (2) the source of repayment for the exposure is not uncertain. The question of "certainty" relates to whether the property has already been either sold or pre-leased to the occupancy rate prevailing in that geographic market for that type of commercial real estate.

An acceptable approach QIS purposes, would be to include in HVCRE exposures all loans secured by hotel, office, or single-use properties as well as CRE financing for land acquisition, development, or construction of such properties.

What treatment should be given to re-sales under the Data/Exposure worksheet? (Under what category in the Data/Exposure worksheet should it be placed)?

Answer: "Re-sales" as they are categorized under repo-style transactions should be entered under C1 (banking book) and C2 (trading book) of the Data sheet based on the nature of the counterparty, i.e., corporate, sovereign, retail, etc.

Are "fails" considered to be past due or "defaults" in the case of repo-type and securities lending transactions?

Answer: In many situations "fails" for these types of transactions result from temporary market conditions and do not reflect credit deterioration or default on the part of the bank's counterparty. In any event, the transaction continues to be secured and marked-to-market daily, although remargining stops. In the standardized approach, apply the haircut appropriate to daily MTM without remargining, which would result in a 20-day holding period. Otherwise, rely on your assessment of the likelihood that the counterparty will pay, rather than the "failure in transaction" definition.

Can we use our internal haircuts for the Foundation IRB Approach for Repos and Derivatives?

Answer: Yes, under the Comprehensive Approach, which is permissible under the Foundation IRB.

It seems as if repo transactions (where we receive cash) generate risk weighted assets under the proposed accord, which is different than the current accord. Is this understanding correct? If so, what is the rationale behind it?

Answer: Your understanding is correct. Under the proposal, there will be a capital charge for repo transactions. When the value of the security provided as collateral exceeds the cash received, the bank has a credit exposure to the counterparty for the difference. The bank must hold capital for that exposure. When calculating the exposure, the bank must take into account the potential increase in the value of the security and thus the potential increase of the exposure. The current accord does not require capital for that potential future exposure. The bank must apply a "haircut" to increase the value of the security posted as collateral unless the repo transaction meets the conditions in paragraph 133 of the Technical Guidance (905 KB PDF) paper.

Where are repos, reverse repos, securities lending and securities borrowing exposures to be placed in the QIS? Are they all to be placed in the same exposure box depending on counterparty risk weighting? Since repos and securities lent are liabilities and reverse repos and securities borrowed are assets, it doesn't seem intuitive to me to place them in the same exposure category.

Answer: The proposal focuses on exposures, not assets or liabilities. In all of the transaction types referenced in the question, the bank places its exposure to the counterparty from the transaction in the risk weighting bucket appropriate for the counterparty. The exposure is calculated by determining the difference between the current value of the exposure adjusted for potential increases in value and the current collateral value adjusted for potential decrease in value and any foreign exchange or maturity mismatches.

The QIS makes no mention of Fed Funds Sold. Are they included in repo-style transactions?

Answer: Fed Funds Sold are not a collateralized transaction. It is a short term unsecured loan and should be treated as an exposure to a bank counterparty. As a short term loan, Fed Funds Sold are exempt from the 1 year maturity floor in the advanced IRB approach described in paragraphs 281 and 282 of the Technical Guidance (905 KB PDF) paper.

In the Standardised Approach worksheet, the repo transaction sections contain a cell to identify the methodology for these transactions. Under the Standardised Approach, aren't the standard regulatory haircuts the only option? The other options, own estimate or VaR, apply to the IRB approaches, correct? Is this a mistake?

Answer: The CRM proposals (Simple and Comprehensive) apply wholly to the Standardised Approach so that one is not restricted only to the standard regulatory haircuts. The drop down box in the Standardised sheet provides the four different choices for recognition of collateral under either the 1) Simple (substitution based) 2) Comprehensive - Standard haircuts 3) Comprehensive - own estimate haircuts 4) Comprehensive - VaR based.

The National Discretion documents indicates that U.S. banks must use the market-based, rather than the PD/LGD approach for reporting equity investments. May U.S. banks use either the simple risk weight or the internal model method described under the market-based approach? Under the simple method, what is meant by the offsetting values?

Answer: Information on equity investments is requested only if the institution considers these investments to be "material", in which case the company most likely measures the investment risk using internal models. For QIS purposes, assume that the model meets necessary standards and provide the results in Panel 2b. If no model results are available, use only the simple risk weight approach. Under that approach, the term "offsetting values" refers to shorts or other positions that directly hedge an equity exposure.

What equity exposures are grandfathered for purposes of the QIS-3?

Answer: All equity exposures as of the date that the final revised Accord is published will be grandfathered. However, to effect this exclusion and assume that all current equity holdings receive only the standardized approach for QIS purposes would preclude the collection of information necessary to assess the impact of the proposed treatment on equity investments that would not be excluded in the future. Accordingly, the QIS should be prepared assuming no grandfathering of equity holdings. Appropriate adjustments and qualifications will be made when the QIS data is reviewed.

Are SBIC investments excluded from the IRB approach because they are part of "legislated programmes"? Should these investments, nevertheless, be included in the Standardised QIS-3 reporting?

Answer: All SBIC investments quality for such exclusions and are exempt from treatment they would otherwise receive in an IRB approach, but that does not mean they should be omitted or ignored. Rather, they should be reported in Panel 1 of the IRB equity worksheet (Instructions p. 23 sections 12.5 & 12.6 and Tech Guide section 314). For the Standardized Approach, report these investments at a 150 percent risk weight in Panel 9.

Paragraph 301 of the Technical Guidance states that supervisors will decide on the appropriate approach for equity exposures not held in the trading book. Please advise when it is appropriate to use the Market-Based Approach versus the PD/LGD Approach.

Answer: U.S. banks should use one of the two variants of the Market Based Approach: the simple risk weight method, or the internal models method. U.S. banks are not asked to use the PD/LGD approach.

Should Federal Reserve and Federal Home Loan Bank stock ownership positions be treated as Sovereign exposures and not as equity exposures? If they are to be treated as equity exposures, do they qualify for the exclusion as described in paragraph 313 of the Technical Guidance and given a zero risk weighting?

Answer: Federal Reserve stock is exempt from regulatory capital charges and should be risk-weighted at zero percent. However, investments in shares of Federal Home Loan Banks should be risk-weighted at 20 percent for amounts required by the FHLB System. Share holdings that exceed the required amounts should be risk-weighted at 100 percent. For QIS purposes, institutions may weight all such FHLB shares at 20 percent, for convenience.

Equity mutual fund assets are held on the balance sheet as hedges for deferred compensation liabilities. Would these assets be evaluated as equity exposures based on their nominal value or could they be offset by the corresponding liability?

Answer: For purposes of QIS-3, only the asset side of the balance sheet should be used. If the payments on the deferred compensation liabilities are directly tied to the returns on the equities, it might be useful to note that feature, so that the U.S. can account for this effect in the future. Therefore, the balance sheet carrying values of these equity mutual fund assets should be included as equity exposures.

A publicly traded equity holding is defined as any equity security traded on a recognized security exchange (paragraph 304 of the Technical Guidance). How are mutual funds that contain some or all publicly traded equity holdings to be classified, publicly traded or non-publicly traded?

Answer: Mutual funds with publicly available share prices should be treated as "publicly traded". If the mutual fund also contains debt instruments, then for QIS-3 purposes, the bank may (but does not have to) carve-out that portion of its investment that represents an indirect holding of debt instruments, which are treated as other loans and debt securities.

In the worksheet entitled "Current" what collateral types are acceptable? Is this simply the RWA as listed in the '88 Accord, so cash = 0%, residential mortgage = 50%, etc.? How do we record collateralized exposures?

Answer: The current accord recognizes only cash on deposit with the bank, securities issued or guaranteed by OECD central governments (including by U.S. government agencies or U.S. government-sponsored agencies), and securities issued by multilateral lending or regional development banks. Claims secured by such collateral are generally assigned to the 20 percent risk-weight category.

In completing the QIS spreadsheets for the Current approaches, institutions should first slot exposures according to the risk weight indicated for that asset category by the Current Accord and then record the existence of recognized collateral. Consequently, in the case of an $100 residential mortgage exposure (no guarantee), respondents should enter $100 on the 50 percent risk weight line under the heading "All exposures" and also under both the "pre-" and "post collateral" columns. The spreadsheets will then apply the risk weight to the nominal amount of exposure to produce $50 of risk-weighted assets. Had FNMA guaranteed the transaction, the reporter would have the same entry for "all exposures", then enter $100 on the 50 percent line under the "Pre-protection" heading and again on the 20 percent line under the "post protection" heading. Those entries would reflect the FNMA guarantee and produce risk-weighted assets of $20. For further examples, consult the Basel Committee's QIS web site at www.bis.org.

Is a "Leveraged Closed end Fixed income Fund" considered a core market participant?

Answer: The list of core market participants includes:

Sovereigns, central banks and PSEs
Banks and securities firms;
Other financial companies (including insurance companies) eligible for a 20% risk weight;
Regulated mutual funds that are subject to capital or leverage requirements;
Regulated pension funds; and
Recognised clearing organisations

Therefore, if the "Leveraged Closed End Fixed Income Fund" is regulated and subject to capital/leverage requirements, then it could be considered a core market participant.

Should the exposures by LGD category be captured by the after credit protection PD?

Answer: Yes, so exposures should remain in the same "After credit protection" PD bucket.

Are the exposure values reflective of the E* exposure after risk mitigation for all exposures, whether on or off balance sheet , or classified as repos and derivatives? by Maturity? (same two questions as above, by LGD) by EAD? (same two questions as above, by LGD)

Answer: Yes to all of the above.

Exposures by LGD category are reconciled to the same total exposure numbers. Wouldn't the haircuts applied in the E* calculation under the Standardized comprehensive and the Foundation and Advanced IRB approaches make this impossible?

Answer: No. To begin, for financial collateral, after calculating E*, the remaining amount E – E* is placed into the 0% "Financial Collateral" LGD bucket so that it adds up to the original amount, E* + (E – E*) = E. Similarly, for other types of collateral, the amount collateralized falls under the appropriate LGD bucket and the remaining portion falls under the 45% "Unsecured senior claims" LGD bucket. In this case, the two amounts also sum to the original exposure amount.

We noticed that the spreadsheets for both the Foundation and Advanced IRB Approach reconcile exposures before and after credit protection to the same total exposure numbers for all portfolios and exposures. Are we to conclude that the exposures after credit protection reflect the same exposure values as before protection (unchanged by collateral value and exposure haircuts), with only shifts in the PD of the exposures?

Answer: Yes. Please refer to the "Guarantees & Credit Derivatives" section (paragraph 3.14) in the QIS instructions.

Which portfolio should banks use when a retail exposure is partially guaranteed by a corporate?

Answer: Banks should report the guaranteed portion in the corporate portfolio and report the remaining unsecured portion in the retail portfolio. For the guaranteed portion recorded in the corporate portfolio, banks should first assign a risk weight according to the underlying obligor (i.e. retail) under the "pre-protection" column. Under the "post protection" column, banks should then assign the risk weight according to the guarantor (i.e. corporate). The same question could also arise regarding SMEs partially guaranteed by a corporate. Similarly, in such a case the unsecured portions should be left in the SME portfolio.

I have a question regarding the maturity adjustment being described in the QIS 3 - technical guidance document (p. 49)

Maturity adjustment (b) = (0.08451 - 0.05898 x log (PD))^2

Do you use the Base-10-log or the natural logarithm? As one could imagine, the difference between those two is quite significant.

Answer: The formula uses the natural logarithm. Since others may have the same question, I am forwarding this response for inclusion in the QIS FAQs.

How should "Purchased Receivables" be recorded in various sections of the Data worksheet?

Answer: Section 14, p. 28, QIS Instructions discusses how to treat "Purchased Receivables" in QIS 3. I have also discussed this issue with A. Piccinoni earlier in an earlier telephone conversation.

Please explain what is meant by the "bottom-up" or "top-down" approach for measuring risk in purchased receivables and also the criteria for determining which approach must be used.

Answer: The "top-down" and "bottom-up" approach refer to the level of aggregation used to measure the risk of the receivables in the pool. The top-down approach uses aggregate data that characterize the underlying pool as a whole, whereas the bottom-up approach measures the risk of the individual receivables comprising the pool.

In virtually all cases of purchased retail receivables, institutions should expect to apply the top down approach, reflecting the large volume of small exposures. However, review the criteria (paragraphs 319-320 of the Tech Guidance) and the relevant operational standards contained in paragraphs 439-447, recognizing that the operational standards are relaxed for purposes of QIS. These standards seek to maintain the integrity of risk parameters and speak to the legal certainty of the bank's ownership and control of the cash remittances from the receivables; the effectiveness of its monitoring and workout systems, and other factors.

However, when evaluating purchases corporate receivables, the assumed approach is bottom up. Institution may certainly use a top-down approach for corporate receivables, but in doing so they should adhere more closely to the eligibility and operational requirements described in paragraphs 204 and 439-447. The top-down approach was designed for programs such as factoring, where it is infeasible for a bank to compute IRB capital charges using the bottom-up approach. In addition, the top-down approach would be used in securitization transactions, such as asset-backed-commercial-paper programs, where an SPV purchases receivables from a company and securitizes them, and where an IRB bank provides credit enhancement for the transaction. Within the US, this latter application is likely to be the most prevalent. Also, the top-down approach was developed at the explicit request of ABCP issuers, who argued that without it they could not implement the IRB capital charges.

In the "Originators" worksheet, what amount should be reported in the item "Total nominal amounts of underlying facilities in pool"? Should it include the seller's interest? Similarly, should the capital requirement for the seller's interest be included in the item "What was the capital charge pre-securitisation (under the standardised approach)"?

Answer: The seller's interest in a revolving retail securitization is not subject to the securitization framework and should be recorded in the appropriate parts of the standardized and IRB retail spreadsheets. In other words, the inputs related to a particular securitization should reflect only the investor's interest. As a consequence, the line item "Investors portion of underlying pool" should be reported at 100 percent. Banks should, however, include the size of the seller's interest as an annotation.

What capital charge is applied to the risk weighted balances once the securitized assets are assumed to be brought back on balance sheet?

Answer: In the case of credit card receivables that are brought "on-balance sheet" because of an early amortization charge, use the Kirb that applies to the entire master trust, and which is also the basis for using the SFA. Apply that rate to the portion of the investors' interest that is converted to an on-balance sheet equivalent.

In the case of an asset pool, use the pool PD and LGD to derive a risk weight that is then multiplied against the notional amount of the exposure to produce risk-weighted assets. The amount of risk-weighted assets is then multiplied by 8 percent to calculate the internal ratings based capital charge (Kirb) and that is added to the other IRB capital requirements on other assets.

What category should be assigned to mortgage loans issued/repackage by a private bank, instead of a government sponsored agency? Should this type of instrument be classified as "Corporate "or "Securitized Assets"?

Answer: Institutions must consider the nature of the instrument representing the exposure, as well as relevant collateral and guarantees. For example, mortgage pass-throughs should be classified as residential mortgages, while securitizations would also entail the division into tranches of the risk embedded in the underlying assets.

For the purpose of calculating regulatory capital requirements, transactions that satisfy a) and b), or a) and c), as well as d) of the following conditions are considered to be securitisations under the New Accord:

Transactions involving one or more underlying credit exposures from which stratified positions or tranches are created that reflect different degrees of credit risk. Such positions may take the form of a security or of an unfunded credit derivative;
Transactions where payments to investors depend upon the performance of specified underlying credit exposure(s), as opposed to being derived from an obligation (e.g. debt) of the entity originating those exposures. Such underlying credit exposures may include loans, commitments and receivables;
Transactions that involve credit derivative(s) where the investors' potential risk is dependent upon the performance of the underlying pool of credit exposure(s); and
Transactions that do not satisfy the definition of specialised lending as specified in paragraphs 182 to 189.

For our retail securitizations, we currently calculate the before-tax and after-tax recourse amounts for the current low level recourse rules. For QIS-3 do we focus on the before-tax or the after-tax numbers to drive the capital calculation?

Answer: Residual interests (e.g. I/O strips) may be recorded net of any associated deferred tax liability associated with the residual interest in question.

May banks treat asset-backed securities purchased and recognized on the balance sheet as "other loan exposures" and assess a capital charge based on PD/LGD of the underlying exposures? Or, should the bank view them as invested securitized assets and apply the SFA or RBA approach under the securitization guidelines? Can the bank choose?

Answer: For any purchased asset-backed securities, where the security is rated, the ratings based approach should be applied. The bank should apply the securitization section of the rules. If an external rating is available, the bank should rely on that rating. If no rating is available, the bank should use the hierarchy described in the securitization rules.

Similarly for asset-backed commercial paper conduit programs, the subordinated credit enhancements provided is recognized on the balance sheet. Can the bank view these exposures as normal loan exposures and apply the PD/LGD approach? Or should the bank view them as subordinated, first-loss tranches under securitization guidelines? Can the bank choose?

Answer: For QIS-3, these tranches should be treated using the securitization section and should be slotted into the SFA framework (assuming they are not rated) based on their level of loss subordination. These exposures will generally NOT be in a first-loss position. Usually, first-loss protection is provided by the sellers into the counduit.

Liquidity facilities under asset-backed commercial paper conduit programs often (but not always) have maturities of 364 days or less. The underlying assets often have maturities that are longer than 1 year. In order to compute the Kirb of the assets for the securitization SFA approach, can the bank assume that the maturity of the underlying assets is equivalent to the maturity of the liquidity facility, since the bank's exposure is effectively limited by the expiration date(s) of the facilities?

Answer: No. Kirb should be calculated using the maturities of the underlying assets in the conduit. If the maturities of the underlying assets are not readily available, estimates should be used. Also, it should be noted that, under the SFA, there is no CCF reduction for the securitization exposures of under one year. However, for 'market disruption' eligible liquidity facitilities, an implicit CCF reduction is provided. Specifically, for such a facility, the IRB capital charge is computed as the product of (a) the capital charge implied by the SFA and (b) 20%.

It is quite burdensome to calculate the capital charge against each transaction subject to the securitization treatments, since the capital charge on each transaction must be calculated individually. For QIS purposes, is it permissible for a bank to carry out these computations for a representative sampling of securitization exposures, by type, and then extrapolate these results to the appropriate sub-portfolio as a whole?

Answer: Yes, but please inform your supervisor how you determined the sample and carried out the extrapolation. In addition, please note that since QIS-3 constitutes the first (and only) field-testing of the securitization proposals, the Basel Committee is relying heavily on bank responses to identify problems relating to the operational feasibility and reasonableness of the proposals. Thus, banks are encouraged to perform the necessary computations for as many transactions as possible. If sampling must be used, please include representative transactions for as many underlying asset types and structures (e.g., traditional securitization, synthetic securitization, ABCP, etc.) as is feasible.

Under "Securitizations (Originators)", information is requested for each "transaction". Credit card securitizers use a master trust structure - one large pool of loans that support many transactions. For example, one master trust could support 30, 40 or 50+ transactions. May I report at the master trust level and not address individual transactions? The individual transactions are supported by the same pool of loans and are structured consistently.

Answer: Yes, report at the master trust level.

How does the QIS Survey define Gross Income? Should this item be calculated excluding income from (a) Gain on Sale of Securities, (b) Trading Sales, (c) Derivatives Gains and, (d) Gains on Sales of Loans?

Answer: To make it easier for U.S. banks, the following items from your Call Report should be included in Gross Income; everything else should be excluded:

Net Interest Income:

3.	Net interest income [4074] (which is total interest income [4107] minus total interest expense [4073])

Net Non-Interest Income:

5.a.	Income from fiduciary activities [4070]
5.b.	Service charges on deposit accounts in domestic offices [4080]
5.d.	Investment banking, advisory, brokerage, and underwriting fees & commissions [B490]
5.e.	Venture capital revenue [B491]
5.f.	Net servicing fees [B492]
5.g.	Net securitization income [B493]
5.i.	Net gains (losses) on sales of loans and leases [5416]
5.j.	Net gains (losses) on sales of OREO [5415]
5.k.	Net gains (losses) on sales of other assets (excluding securities) [B496]
5.l.	Other non-interest income [B497]

Net Trading Income:

5.c.	Trading revenue [A220]

In what category should we include loans issued to subsidiaries to fund the operations of certain "business lines"? (Transfer Pricing)

Answer: All loans to subsidiaries consolidated in the respondent's consolidated financial statements should be eliminated during the financial consolidation process and, thereby, would not appear in the QIS. Exposures to any unconsolidated subsidiaries should be reported as exposures to unrelated parties. Such unconsolidated subsidiaries should be rare and immaterial to the consolidated parent institution. If that is not the case, please consult your QIS regulatory contact.