National banks must be able to determine on their own that the risk of default is low and a full, timely repayment of principal and interest is expected on an underlying loan before issuing the “investment grade” security, according to a new rule proposed by the Office of the Comptroller of the Currency Tuesday. The rule, when finalized, would effectively eliminate references to credit ratings agencies in OCC regulations, as required under the Dodd-Frank Act. These firms came under fire after the financial collapse in 2008 for rating many securities, particularly those backed by faulty mortgages, as high as AAA. In the years since, the credit rating agencies have been downgrading billions of RMBS deals. The OCC put out an advance notice of the proposal in August, followed by a similar one from the Office of Thrift Supervision in October. Under directive from Dodd-Frank, the OCC absorbed the OTS earlier this year. According to the proposal released Tuesday, the issuer of a security — backed by mortgages, auto loans, student loans and others — must have an “adequate capacity to meet financial commitments under the security for the projected life of the asset or exposure.” In order to meet this requirement, a national bank can use sources of information provided by credit ratings agencies, but it must also conduct its own due diligence. Therefore, it is possible that a security rated in the top four categories by a rating agency may still not satisfy the “investment grade” standard, the OCC said. After the advance notice was put out earlier in the fall, community and regional bankers argued that because they would not be allowed to rely on credit rating agencies to evaluate investments, larger institutions with more advanced analytical capabilities would hold yet another advantage. Even larger banks complained that international financial firms would hold an edge because they could sill rely on credit rating agencies when American banks could not. The OCC allowed smaller federal savings associations to continue to follow Federal Deposit Insurance Corp. guidance for commercial paper until the FDIC puts out new rules in July 2012. But these smaller banks must still consider interest rate, credit liquidity, price and other risks for other securities when determining if it is “investment grade.” The OCC said a number of comments asked the regulator to interpret the Dodd-Frank Act in a way that would still allow banks to consider credit ratings as one of several factors when measuring credit risk under the new rules. But most of the comments complained of the proposal’s regulatory burden and its effect on competitiveness. Write to Jon Prior. Follow him on Twitter @JonAPrior.
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