FED and FDIC
Federal Reserve and FDIC Requirements on Non-Performing Assets
Risk Based Capital Ratios
Supervisory risk-based capital ratios that related capital to weighted-risk assets for state member banks are described in 12 C.F.R. Appendix A to Part 208
Based upon this regulation banks need to have a minimum of 7.25 percent for qualifying total capital to weighted risk assets of 7.25 percent. Performing residential first liens have 50% risk weight in contrast to 100% for loans over 90 days delinquent.
“Residential property loans that do not meet all the specified criteria – including less than 90 days past due - or that are made for the purpose of speculative property development are placed in the 100 percent risk category.”
In other words when the loan becomes non-performing the financial entity needs to put half of the unpaid balance value to capital reserve.
Ability to borrow and lend – Asset Based Commercial Paper (ABCP) Liquidity eligibility.
12 C.F.R. Appendix A to Part 208 also states:
“Eligible ABCP liquidity facility means a liquidity facility supporting ABCP, in form or in substance, that is subject to an asset quality test at the time of draw that precludes funding against assets that are 90 days or more past due or in default.”
Typically, commercial paper is an unsecured, short-term promissory note issued in bearer form by a financial or nonfinancial company to satisfy its funding needs. Its popularity as a funding mechanism stems from its availability as an alternative to short-term bank loans and (2) its lower relative costs when compared with bank loans or debt issuance. ABCP is an essential source of liquidity for a financial entity. When an asset becomes non-performing it cuts out this crucial funding source.
Time to liquidate non-performing assets.
The time when a non-performing loan need to be charged off can vary depending who is insuring the deposits of the lending instructions. FDIC regulations states URL
“One- to four-family residential real estate loans and home-equity loans that are past due 90 days or more with loan-to-value ratios greater than 60 percent should be classified Substandard. Properly secured residential real estate loans with loan-to-value ratios equal to or less than 60 percent are generally not classified based solely on delinquency status. Home-equity loans to the same borrower at the same institution
as the senior mortgage loan with a combined loan-to-value ratio equal to or less than 60 percent need not be classified. However, home equity loans where the institution does not hold the senior mortgage, that are past due 90 days or more should be classified Substandard, even if the loan-to-value ratio is equal to, or less than, 60 percent.
For open- and closed-end loans secured by residential real estate, a current assessment of value should be made no later than 180 days past due. Any outstanding loan balance in excess of the value of the property, less cost to sell, should be classified Loss and charged off.”
Not all lending institutions are insured and regulated by FDIC. For example Credit Unions are controlled by NACU.
It is important to note that loans sold on the secondary market may not be regulated in terms of asset liquidation which has relevant implication on the probability on issuing deficiency judgments.
As described above non-performing assets are severally degrading the performance of a federally regulated financial entity. As a rule of thumb non-performing asset ratios over 10% are at the rim of a feasible operation. With the word of William K. Black, former lawyer at the Federal Home Loan Bank of San Francisco and the OTS and currently an associate professor of economics and law at the University of Missouri-Kansas City:
“At the 5 percent range, you’re probably hurting, once it gets around 10 percent, you’re likely toast.”
