USAA Federal Savings Bank Pillar 3 Regulatory Capital Disclosures For the quarterly period ended June 30, 2015
Table of Contents Introduction and Scope of Application...1 Risk Management... 2 Basel Capital Framework... 3 Capital Structure...4 Exhibit 1: Regulatory Capital Instruments... 4 Exhibit 2: USAA Federal Savings Bank Capital Ratios... 5 Exhibit 3: Components of Regulatory Capital... 6 Capital Adequacy... 7 Exhibit 4: Risk-Weighted Assets... 7 Exhibit 5: Capital Ratios for FSB and USB... 8 Capital Conservation Buffer...9 Exhibit 6: Capital Conservation Buffer... 9 Exhibit 7: Eligible Retained Income under Capital Conservation Buffer Framework... 9 Credit Risk: General Disclosures...10 Exhibit 8: Credit Exposures by Type, Industry/Counterparty, and Geographic Distribution... 11 Exhibit 9: Average Credit Exposures by Type... 11 Exhibit 10: Credit Exposures by Type and Remaining Contractual Maturity... 12 Exhibit 11: Impaired Loans by Type and Geographic Distribution... 12 Exhibit 12: Allowance for Loan and Lease Losses... 13 Exhibit 13: Gross Charge-offs... 13 Exhibit 14: Reconciliation of Changes in Allowance for Loan and Lease Losses... 13 i June 30, 2015 USAA Federal Savings Bank
Table of Contents continued Counterparty Credit Risk-Related Exposures: General Disclosures...14 Exhibit 15: Counterparty Exposures... 15 Credit Risk Mitigation...16 Securitization... 17 Exhibit 16: Securitization Exposures... 18 Exhibit 17: Securitization Exposures by Risk Weight Bands... 19 Exhibit 18: USAA FSB Assets Held in Traditional Securitizations... 20 Equities Not Subject to the Market Risk Rule...21 Exhibit 19: Equities Not Subject to the Market Risk Rule, Carrying and Fair Value...21 Exhibit 20: Equities Not Subject to the Market Risk Rule by Risk-Weight Bands...21 Interest Rate Risk for Non-Trading Activities...22 Exhibit 21: Interest Rate Risk Simulation of Net Interest Income...22 ii June 30, 2015 USAA Federal Savings Bank
Introduction and Scope of Application United Services Automobile Association (USAA) is a membership-based association which, together with its family of companies, serves current and former commissioned and noncommissioned United States (U.S.) military officers, enlisted, retired military personnel, and their families. USAA Federal Savings Bank (the Bank or USAA FSB) is a full-service retail bank that offers credit cards, consumer loans, home equity loans, residential mortgages, trust services, and a full range of deposit products. Headquartered in San Antonio, Texas, the Bank operates primarily by electronic commerce through www.usaa.com, mobile banking, call centers, and direct mail. The Bank is regulated by the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Consumer Financial Protection Bureau (CFPB). Following is a description of certain Bank affiliates: USAA Founded in 1922, USAA is a Texas-based reciprocal inter-insurance exchange that provides property and casualty insurance products. Through its various subsidiaries, USAA provides financial products and services including personal lines of insurance, retail banking and individual investment products. USAA Capital Corporation USAA Capital Corporation (CapCo) is a direct wholly-owned subsidiary of USAA organized as a Delaware corporation. In addition to its holding company operations, CapCo serves as USAA s general purpose finance subsidiary. The Bank is a direct, wholly-owned subsidiary of CapCo. USAA Savings Bank USAA Savings Bank (USB) is an FDIC-insured Nevada state non-member bank organized in 1996. The USB is a direct, wholly-owned subsidiary of the Bank. The USB is engaged in credit card lending and related activities and is a consolidated subsidiary of the Bank for accounting and regulatory capital purposes. USAA Relocation Services, Inc. USAA Relocation Services, Inc. (Relo) is a real estate broker that provides counseling services for customers contemplating moving, and the sale or purchase of a home, through a contractual agreement with a relocation services company. For accounting purposes, Relo is a consolidated subsidiary of the Bank. However, for regulatory capital purposes, Relo is a nonfinancial subsidiary that is required to be deducted from the Bank s regulatory capital. There are no insurance subsidiaries included in the Bank s consolidated group. There are no subsidiaries with total capital less than the minimum capital requirements. 1 June 30, 2015 USAA Federal Savings Bank
Restrictions on Capital and Transfer of Funds Restrictions on capital transfers are limited to applicable regulatory requirements. Prior to any transfer, the Bank engages the appropriate regulatory authorities to complete notification and other requirements. Risk Management The Bank has established a robust and rigorous governance structure to address the risks that arise from providing loan and deposit products to its members. This structure is designed to identify and mitigate these risks to ensure the ongoing safety and soundness of the Bank and is facilitated through management committees that report to the Bank s Board of Directors (Board). Board of Directors The Board establishes the Bank s risk tolerance by setting risk limits and is responsible for independently evaluating management s decisions in the context of these limits. Board s Risk Committee The Board s Risk Committee is responsible for ensuring effective risk management practices. Key activities of this committee include approving and monitoring risk limits, approving policies, and approving escalation thresholds. This committee reports its activities and decisions to the Board. Management Committees The Risk Committee of the Board has delegated daily management responsibilities to the following management committees: Asset Liability Committee (ALCO) Financial risks Senior Officer Credit Committee (SOCC) Credit risks Compliance and Operational Risk Committee (CORC) Compliance and operational risks These committees are responsible for escalating issues to the Board s Risk Committee as appropriate. Risk Appetite Risk Appetite defines the amount and type of risk the Bank is willing to take in order to achieve its mission and business objectives. The Bank s Risk Appetite is at the heart of the Bank s Enterprise Risk Management framework and ensures management makes informed choices as it pursues fulfillment of its mission. The risks taken by the Bank must be aligned with the Risk Appetite set by the management committees and approved annually by the Board s Risk Committee. The Bank s Senior Risk Officer independently monitors risks through a comprehensive system of appetites and triggers. Basel Capital Framework 2 June 30, 2015 USAA Federal Savings Bank
The Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation and the Board of Governors of the Federal Reserve System are collectively referred to as the Agencies. When the Dodd-Frank Wall Street Reform and Consumer Protection Act became effective, the Bank became subject to the regulatory authority of the Agencies given its federal savings and loan association charter. In 2013, the Agencies made changes to the way banks are required to compute and manage regulatory capital and added requirements to make certain financial disclosures. The effective date of these changes as they apply to the Bank was January 1, 2015, though certain requirements will be phased in over several years (referred to within as the Basel Standardized Transitional requirements ). These changes are in large part aligned with the Basel capital framework, which consists of the three pillars described below. Pillar 1: Minimum Capital Requirements This pillar provides a framework for calculating regulatory capital and is segmented by credit risk, operational risk, and market risk. Pillar 2: Supervisory Review This pillar describes how the Agencies should review a bank s operations to ensure that it will continue to be financially strong should adverse circumstances arise. Pillar 3: Risk Disclosure and Market Discipline This pillar requires a bank to make public disclosures that describe its capital structure and major risks. The Bank s Pillar 3 Regulatory Disclosures document satisfies the Agencies Risk Disclosure and Market Discipline requirements. 3 June 30, 2015 USAA Federal Savings Bank
Capital Structure Regulatory Capital Instruments The Bank s regulatory capital instruments consist of common stock and noncumulative perpetual preferred stock, which are solely owned by CapCo. The Bank s current regulatory capital instruments are provided below. Exhibit 1: Regulatory Capital Instruments Information as of June 30, 2015 Capital Instrument Callable Current Rate Dividend Rate Methodology Annually adjustable Yes (1) 0.15% 75% of the most recent per annum noncumulative average yield adjusted to a constant perpetual preferred maturity for one-year United States Series A stock, $100 Treasury securities during seven par value calendar days, ending on December 14 of each year; next reset date December 15, 2015 Adjustable noncumulative perpetual preferred Series B stock, $100 par value Adjustable noncumulative perpetual preferred Series D stock, $100 par value Yes (1) 2.62% 175 basis points plus the most recent per annum average yield adjusted to a constant maturity for five-year United States Treasury securities during seven calendar days, ending on December 14 and ending on the successive five-year anniversary of the December 14 next preceding the date of issue; next reset date December 15, 2016 Yes (1) 5.61% 403 basis points plus the applicable five-year swaps rate. The applicable five-year swaps rate is the rate during the seven calendar days ending on December 14 and ending on the successive five-year anniversary of the December 14 next preceding the date of issue; next reset date December 15, 2018 Shares authorized; issued and outstanding 500,000; 250,000 500,000; 500,000 20,000,000; 2,000,000 Common stock, $90 par value No N/A N/A 10,000,000; 200,000 (1) The Bank s noncumulative perpetual preferred Series A, Series B and Series D stock is callable after a five-year period following share issuance, at the Bank s option at par value plus accrued but unpaid dividends on December 15 of each year. The preferred stock has a liquidation value equal to its redemption value and has preference over the common stock with respect to dividends and liquidation rights. 4 June 30, 2015 USAA Federal Savings Bank
Regulatory Capital The Bank is subject to minimum regulatory capital requirements that are prescribed by the Agencies. These requirements include maintaining adequate capital levels across several regulatory capital categories, which include common equity Tier 1 (CET1), Tier 1, Total risk-based capital (Total RBC) and leverage. CET1, Tier 1 and Total RBC are evaluated in relation to risk-weighted assets (RWA), which are calculated using categories across the Bank s balance sheet and Agency prescribed risk-weighting percentages. Leverage is evaluated by comparing Tier 1 capital to average total assets. CET1 capital includes retained earnings, common stock, and paid-in capital. Tier 1 capital includes CET1 as well as preferred stock. Total RBC includes Tier 1 capital and the allowance for loan and lease losses up to 1.25 percent of total RWA. The regulatory capital ratios are computed as follows: CET1: CET1 capital divided by RWA Tier 1: Tier 1 capital divided by RWA Total RBC: RBC divided by RWA Leverage: Tier 1 capital divided by total average assets The Bank s capital adequacy management program ensures that appropriate capital levels are held in consideration of its overall size, complexity, and risk profile. The Bank is required to maintain regulatory prescribed minimum capital ratios, which are provided in the following exhibit along with a summary of the Bank s regulatory capital amounts, RWA, average total assets, and capital ratios. Exhibit 2: USAA Federal Savings Bank Capital Ratios Regulatory Capital Basel Standardized Transitional Common Equity Tier 1 Capital $ 5,835 Tier 1 Capital $ 6,110 Total Capital $ 6,691 Assets Risk-Weighted Assets $ 46,367 Average Adjusted Total Assets $ 67,822 Capital Ratios (Well-capitalized / Minimum capital levels) Common Equity Tier 1 (6.50% / 4.50%) Tier 1 (8.00% / 6.00%) Total Risk Based (10.00% / 8.00%) Leverage (5.00% / 4.00%) 12.58% 13.18% 14.43% 9.01% 5 June 30, 2015 USAA Federal Savings Bank
Components of Capital The exhibit below presents a reconciliation of the Bank s total equity to the components of regulatory capital. Exhibit 3: Components of Regulatory Capital Basel Standardized Transitional Common Stock and Related Surplus Preferred Stock Retained Earnings Accumulated Other Comprehensive Income $ 966 275 4,915 6 Total Equity $ 6,162 Adjustments for: Preferred Stock Intangible Assets Accumulated Other Comprehensive Income Subsidiaries required to be deducted 10% and 15% Common Equity Tier 1 Capital Threshold Deductions Other $ (275) (32) (6) (14) 0 0 Common Equity Tier 1 Capital $ 5,835 Preferred Stock $ 275 Other 0 Tier 1 Capital $ 6,110 Allowance for Loan Losses includable as Tier 2 Capital $ 581 Other 0 Total Capital $ 6,691 6 June 30, 2015 USAA Federal Savings Bank
Capital Adequacy The Bank is committed to maintaining strong capital levels and does so through its capital adequacy management program. The Bank s risk management practices that govern capital adequacy are carried out by the ALCO, which is overseen by the Board. The ALCO utilizes several tools to assess the Bank s capital adequacy, which include actively monitoring trends, reviewing scenario and stress test analytics, and benchmarking the metrics provided by this information in relation to internal and regulatory thresholds. These tools enable an effective monitoring program and provide important inputs to the Bank s planning efforts. The ALCO s monitoring activities include the ongoing review of regulatory capital ratios, described in the section titled Regulatory Capital. The results for the most recent quarter-end are provided in the following exhibits. Exhibit 4: Risk Weighted Assets Exposures to sovereign entities $ 0 Exposures to certain supranational entities 0 Exposures to depository institutions 687 Exposures to public sector entities 131 Corporate exposures 7 Residential mortgage exposures 6,461 Statutory multifamily mortgages and pre-sold constructions loans 0 High volatility commercial real estate loans 0 Past due loans 504 Cleared transactions 6 Default fund contributions 0 Unsettled transactions 0 Securitization exposures 411 Equity exposures 10 Other assets (a) 38,297 Total Risk Weighted Assets before deduction of excess allowance for loans and lease losses $ 46,515 Less: Excess allowance for loan and lease losses 148 Total Standardized Risk Weighted Assets $ 46,367 (a) Other assets is primarily comprised of consumer and credit card loans 7 June 30, 2015 USAA Federal Savings Bank
A summary of FSB and USB s regulatory capital ratios are provided in the following exhibit. Exhibit 5: Capital Ratios for FSB and USB Information as of June 30, 2015 Basel Standardized Transitional Capital Ratios Common Equity Tier 1 Tier 1 Total Risk Based Capital Leverage USAA Federal Savings Bank 12.58% 13.18% 14.43% 9.01% USAA Savings Bank 75.95% 75.95% 77.38% 10.50% 8 June 30, 2015 USAA Federal Savings Bank
Capital Conservation Buffer The Agencies require new capital considerations, identified as regulatory capital buffers, to be phased-in beginning January 1, 2016, and fully phased-in by January 1, 2019. These changes require the Bank to maintain a capital conservation buffer (CCB) equal to at least 2.5 percent of total RWA above the regulatory minimum for the most constraining capital ratio (i.e., CET1, Tier 1, or Total RBC). In addition, the Agencies require disclosures of eligible retained income under the CCB framework, which reflects the difference between net income for the trailing four quarters less dividends paid during the trailing four quarters. The Bank s pro forma CCB and eligible retained income are provided in the following exhibits. Exhibit 6: Capital Conservation Buffer Information as of June 30, 2015 Basel Standardized Transitional Total Risk Based Capital Ratio Less: Minimum Total Risk Based Capital Ratio Less: Required Capital Conservation Buffer (according to transitional arrangements) Capital Conservation Buffer 14.43% (8.00%) (0.00%) 6.43% Exhibit 7: Eligible Retained Income under Capital Conservation Buffer Framework Basel Standardized Transitional Net Income over 4 previous quarters Less: Dividends paid over four previous quarters $ 769 (242) Total Eligible Retained Income $ 527 The Bank is not subject to any limitations on distributions and discretionary bonus payments resulting from the capital conservation buffer framework. 9 June 30, 2015 USAA Federal Savings Bank
Credit Risk: General Disclosures The Bank provides credit card, auto, residential mortgage and other consumer loans to its members, which creates credit risk. Credit risk represents the potential for the Bank to incur a financial loss if some of its members become unable or unwilling to repay their loans. To effectively manage credit risk, the Board governs the Bank s lending programs through the lending policy and ongoing monitoring activities and has delegated oversight over credit risk management to the SOCC. The SOCC enables the Bank to comply with the lending policy by establishing and monitoring lending guidelines and actively monitoring credit risk exposures. Non-accrual and Charge-off Methodologies A loan is impaired when it becomes probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. When loans become 90 days past due they are placed in non-accrual status. The loan is returned to accrual status once the borrower has resumed paying the full amount of the scheduled contractual interest and principal payments to bring the loan fully current and after six months of consistent repayment performance. When a credit card, home equity or mortgage loan becomes 180 days past due, it is charged off. When a consumer loan becomes 120 days past due, it is charged off. Allowance Methodology The Allowance for Loan and Lease Losses (ALLL) is a financial reserve that the Bank maintains to protect its financial health from the unfavorable impact that may arise from credit risk. This reserve is governed by the SOCC and the Board and is informed by various monitoring tools, including historical trends, current delinquency levels and statistical models. Charge-offs reduce the reserve, recoveries on loans charged off in prior periods increase the reserve and, if necessary, the reserve balance is increased or reduced, which directly impacts the income statement. Credit Exposures by Type, Industry/Counterparty, and Geographic Distribution The Bank s membership is geographically dispersed throughout the U.S. and the Bank s underwriting and risk management practices are not differentiated by region. The Bank employs sound underwriting standards that meet or exceed all state and federal regulations. Other concentrations (e.g., subprime exposure, credit bands, product concentration risk, geographical economic health, membership eligibility exposure) are actively managed and monitored by management and the SOCC. 10 June 30, 2015 USAA Federal Savings Bank
The following exhibits provide the Bank s total loan exposures by regulatory reporting category, industry/counterparty and geographic distribution. Exhibit 8: Credit exposures by type, industry/counterparty, and geographic distribution United States Foreign Total Residential Real Estate $ 8,708 $ 4 $ 8,712 Commercial Real Estate 0 0 0 Consumer Exposures 36,256 31 36,287 Other Exposures 22 0 22 Total Loan Exposures - Industry: Retail Credit $ 44,986 $ 35 $ 45,021 Off-Balance Sheet Loan Commitments: Retail Credit (a) $ 51,376 $ 112 $ 51,489 Due from Depository Institutions - Industry: Financial 5,427 0 5,427 Debt Securities - Industry: Government, Auto, Utility, Other 15,586 0 15,586 OTC Derivatives - Industry: Financial 49 0 49 Total Credit Exposures $ 117,425 $ 148 $ 117,573 (a) Primarily comprised of unused commitments on retail credit card lines The following exhibit provides the Bank s credit exposures by regulatory reporting category on an average basis for the three months ended June 30, 2015. Exhibit 9: Average credit exposures by type All dollars in millions and information for the three months ended June 30, 2015 Total Residential Real Estate $ 8,455 Commercial Real Estate 0 Consumer Exposures 35,450 Other Exposures 24 Total Loan Exposures $ 43,929 Off-Balance Sheet Loan Commitments (a) $ 51,435 Due from Depository Institutions 7,002 Debt Securities 15,746 OTC Derivatives 54 Total Credit Exposures $ 118,166 (a) Primarily comprised of unused commitments on retail credit card lines 11 June 30, 2015 USAA Federal Savings Bank
The following exhibit provides the Bank s credit exposures by type with the associated remaining contractual maturity. Exhibit 10: Credit exposures by type and remaining contractual maturity (a) Up to 1 year 1 to 5 Years Exhibit 11: Impaired Loans by type and geographic distribution Over 5 Years Residential Real Estate $ 5,760 $ 280 $ 2,493 $ 8,533 Commercial Real Estate 0 0 0 0 Consumer Exposures 16,625 12,399 7,036 36,059 Other Exposures 21 0 0 21 Total Loan Exposures $ 22,406 $ 12,679 $ 9,529 $ 44,614 Off-Balance Sheet Loan Commitments (b) $ 51,489 $ 0 $ 0 $ 51,489 Due from Depository Institutions 5,427 0 0 5,427 Debt Securities 1,860 6,614 7,112 15,586 OTC Derivatives 49 0 0 49 Total Credit Exposures $ 81,232 $ 19,293 $ 16,641 $ 117,166 (a) Remaining maturity for installment loans and next repricing date for revolving lines of credit (b) Primarily comprised of unused commitments on retail credit card lines The following exhibit provides the Bank s impaired total loan exposures by regulatory reporting category and geographic distribution. United States Troubled Debt Restructuring (Performing) Past due 30 through 89 days and still accruing Nonaccrual Total Total (a) Residential Real Estate $ 100 $ 29 $ 180 $ 309 Commercial Real Estate 0 0 0 0 Consumer Exposures 125 181 228 534 Other Exposures 0 4 0 4 Total Impaired Loans $ 225 $ 214 $ 409 $ 848 (a) Table includes a total of $1 million of foreign impaired loans 12 June 30, 2015 USAA Federal Savings Bank
The following exhibit provides the Bank s ALLL by category. Exhibit 12: Allowance for Loan and Lease Losses (a) Individually Evaluated for Impairment and Determined to Be Impaired Exhibit 13: Gross Charge-offs Total ALLL Impairment Residential Real Estate $ 15 $ 112 $ 127 Commercial Real Estate 0 0 0 Consumer Exposures 25 545 570 Other Exposures 0 0 0 Total ALLL $ 41 $ 657 $ 697 (a) All impaired loans have a related ALLL under GAAP. It is not the Bank s practice to allocate ALLL by geographic region. The following exhibit provides the Bank s gross charge-offs by regulatory reporting category. All dollars in millions and information for the six months ended June 30, 2015 Residential Real Estate Commercial Real Estate Consumer Exposures Other Exposures $ 39 0 298 0 Total Gross Charge-offs $ 336 The following exhibit provides a reconciliation of the changes in the Bank s ALLL. Exhibit 14: Reconciliation of Changes in Allowance for Loan and Lease Losses All dollars in millions and information for the six months ended June 30, 2015 Balance at beginning of current period Recoveries Less: Charge-offs Less: Write-downs Provision for loan and lease losses Adjustments Collectively Evaluated for $ 693 78 (336) (0) 264 (2) Balance at end of current period $ 697 Uncollectible retail credit card fees and finance charges reversed against income $ 26 13 June 30, 2015 USAA Federal Savings Bank
Counterparty Credit Risk-Related Exposures: General Disclosures The Bank meets member home financing needs through its residential mortgage loan product suite. Currently, the Bank originates and services the majority of its newly originated residential mortgage loans. By retaining servicing rights on these loans, the Bank records and maintains a financial asset, the mortgage servicing rights asset (MSR). The MSR balance changes over time as members make payments and as market interest rates change. To manage the interest rate risk associated with selling mortgage loans to investors and retaining servicing rights, the Bank engages in hedging activities. These hedging activities utilize over-the-counter (OTC) and centrally cleared derivative contracts. The goal of these hedging activities is to mitigate the interest rate risk associated with providing these products and to protect the Bank s financial security. OTC derivative activities are described below, while centrally cleared activities are not described further as these activities generate exposure to the clearing house but do not create direct exposure to counterparties similar to OTC contracts. Over-the-Counter Derivative Contracts Collateral Arrangements A third party independently evaluates the Bank s credit risk exposure for each counterparty on a daily basis. If this evaluation results in the need for action to mitigate the exposure, funds are exchanged between the Bank and its counterparties, which are generally referred to as margin activities. Policy limits, established by the ALCO and approved by the Board, guide the need for margin activities. Primary Types of Collateral The Bank enters into contractual agreements with its counterparties and these agreements identify the types of collateral that are eligible to be utilized in maintaining collateral arrangements. Potential Collateral Requirements Daily changes in market interest rates determine the amount of collateral (referred to as variation margin) that needs to be exchanged between the Bank and its counterparties. In the quarter ended June 30, 2015, the Bank did not purchase or sell any credit derivatives, or engage in any margin lending or repo-style transactions. 14 June 30, 2015 USAA Federal Savings Bank
The following exhibit provides the information about the Bank s OTC derivative contracts as of June 30, 2015. Exhibit 15: Counterparty Exposures Over-the-Counter Derivative Contracts Notional amount of contracts $ 1,739 Gross positive fair value of contracts 12 Collateral (held)/posted (10) Net exposure to counterparties $ 2 15 June 30, 2015 USAA Federal Savings Bank
Credit Risk Mitigation The Bank engages in credit risk mitigation activities, which include accepting collateral on certain loans. Collateral types include automobiles, motorcycles, boats, recreational vehicles, leisure vehicles, certificates of deposit, non-commercial residential property, and land where the borrower s intent is to build a house that they intend to occupy as their primary residence. Credit Concentration The Bank routinely monitors segments across its loan portfolio in an effort to monitor concentrations by product, geographic location, credit quality, and borrower. The Bank frequently analyzes the loan portfolio in an effort to identify additional segments and adjust monitoring oversight appropriately. The results from these monitoring activities are provided to senior management and the SOCC for review and to inform the decision making process. Loan Workout Programs The Bank enters into loan modification agreements with certain members who are experiencing financial distress. The loan workout program attempts to reduce the potential financial loss the Bank might otherwise experience by restructuring the member s loan terms and/or conditions in a way that enables the member to repay the loan and prevent repossession or foreclosure. Members are approved for these programs after they meet specific underwriting criteria, which include their willingness and ability to repay the debt. Counterparties Policy limits constrain the credit risk exposure that arises from OTC transactions. The ALCO routinely monitors the results from operations and directs action to ensure compliance with policy as necessary. These monitoring activities include the ongoing evaluation of concentrations, credit ratings and the Bank s financial exposure to each counterparty (i.e., value at risk). 16 June 30, 2015 USAA Federal Savings Bank
Securitization A participant in the securitization market is typically an originator, servicer, investor, or sponsor. The Bank s primary securitization-related activities are buying securities as an investor and serving as an originator and servicer in securitizations. Bank as Investor in Securitizations Securitization exposures held by the Bank include traditional non-government or non-agency guaranteed Asset-Backed Securitizations (ABS). In the context of the Basel capital framework, securitization exposure is defined as a transaction in which: All or a portion of the credit risk of the underlying exposure is transferred to third parties, and can be separated into two or more tranches that reflect different levels of seniority; the performance of the securitization depends upon the performance of the underlying exposures or reference assets; and all, or substantially all, of the underlying exposures or reference assets are financial exposures. Securitization exposures include on- or off-balance sheet exposures (including credit enhancements) that arise from a securitization or re-securitization transaction; or an exposure that directly or indirectly references a securitization (e.g., credit derivative). A resecuritization is a securitization exposure in which one or more of the underlying exposures is itself a securitization exposure. On-balance sheet exposures include securities, loans, servicing advances, and derivatives for which securitization trusts are the counterparty. Off-balance sheet exposures include liquidity commitments, certain recourse obligations, tranched credit derivatives, and derivatives for which the reference obligation is a securitization. Securitization exposures are classified as either traditional or synthetic. In a traditional securitization, the originator establishes a special purpose entity (SPE) and sells assets (either originated or purchased) to the SPE, which issues securities to investors. In a synthetic securitization, credit risk is transferred to an investor through the use of credit derivatives or guarantees. Risk Management The risks related to investments in securitization positions are managed in accordance with the Bank s risk management policies. Due Diligence For each securitization position, the Bank performs due diligence on the credit worthiness of each position prior to entering into that position, and documents such due diligence within three business days as required by Basel III. The Bank s due diligence procedures are designed to provide it with a comprehensive understanding of the features that would materially affect the performance of the securitization. 17 June 30, 2015 USAA Federal Savings Bank
The Bank s due diligence procedures include analyzing and monitoring: the quality of the position, including information regarding the performance of the underlying credit exposures and relevant market data; the structural and other enhancement features that may affect the credit quality of a securitization; and the servicer. The level of detail included in the due diligence procedures is commensurate with the complexity of each securitization position held. In addition to pre-trade due diligence, the due diligence procedures are performed on a quarterly basis for each securitization. Securitization Risk Weighted Assets The Bank calculates the regulatory capital requirement for securitization exposures in accordance with the Standardized Approach. The Bank utilizes the Simplified Supervisory Formula Approach (SSFA) to determine RWA for its securitization exposures. The SSFA framework considers the Bank's seniority in the securitization structure and risk factors inherent in the underlying assets. As of June 30, 2015, no securitization exposures were deducted from the Bank s regulatory capital. Securitizations by exposure type and capital treatment are summarized below. (a) Exhibit 16: Securitization Exposures Asset-backed securities - Auto Asset-backed securities - Utility Asset-backed securities - Other Notional Amount $ 316 239 207 Simplified Supervisory Formula Approach Risk Weighted Assets $ 94 276 41 Total securitization exposures $ 763 $ 411 (a) Exhibit related to the Bank as an investor in the securitization. 18 June 30, 2015 USAA Federal Savings Bank
Securitizations by capital treatment and risk weight bands are summarized below. (a) Exhibit 17: Securitization Exposures by Risk Weight Bands Notional Amount Simplified Supervisory Formula Approach Risk Weighted Assets Capital Impact of Risk Weighted Assets (b) Securitizations 0-20% risk weighting $ 441 $ 88 $ 7 21-100% risk weighting 100 37 3 101-500% risk weighting 222 286 23 501-1,250% risk weighting 0 0 0 Total securitization exposure $ 763 $ 411 $ 33 (a) Exhibit related to the Bank as an investor in the securitization. (b) The capital impact of RWA is calculated by multiplying risk weighted assets by the minimum total risk-based capital ratio of 8 percent. Bank as Securities Issuer As part of its capital and liquidity management programs, the Bank enters into securitization transactions. In a securitization transaction, loans originated by the Bank are transferred to a SPE, which then issues to investors various forms of interest in those assets. In a securitization transaction, the Bank typically receives cash as proceeds for the assets transferred to the SPE. The Bank often retains the right to service the transferred receivables and to repurchase those receivables from the SPE if the outstanding balance of the receivables falls to a level where the cost exceeds the benefits of servicing. The Variable Interest Entities (VIEs) associated with the Bank s consumer loan securitizations are not consolidated because the Bank does not hold a significant financial interest in the VIEs. Although the Bank services the consumer loans in the various VIEs, USAA has the unilateral right to reassign the Bank s servicing rights to any other USAA subsidiary without cause. All securitizations conducted by the Bank and USAA are completed in accordance with applicable regulation and US GAAP (Generally Accepted Accounting Principles adopted by the U.S. Securities and Exchange Commission). A summary of the significant pronouncements is discussed below. Accounting Standards Codification (ASC) Topic 860: Transfers and Servicing, provides the US GAAP accounting and reporting guidance for transfers and servicing of financial assets and extinguishments of liabilities. ASC Topic 810: Consolidations, provides the US GAAP accounting and requirements regarding the consolidation of off-balance sheet entities. ASC 820: Fair Value Measurements and Disclosures (ASC 820) states that the fair value of an 19 June 30, 2015 USAA Federal Savings Bank
asset (or liability) is the amount for which it could be bought or sold in a current transaction between willing parties in other than a forced liquidation sale. Quoted market prices in active markets are the best evidence of fair value and, if available, shall be used as the basis for the pricing. As quoted market prices for most of the financial assets and liabilities that arise in a securitization transaction are unavailable, estimation is necessary. ASC 820 states that if quoted market prices are not available, the estimate of fair value shall be based on the best information available. Such information includes prices for similar assets and liabilities and the results of valuation techniques such as discounted cash flow modeling. The Bank has elected to utilize the present value of estimated expected future cash flows using an observable discount rate commensurate with the risks involved to estimate fair value of the gain on sale recognized. As of June 30, 2015, the Bank does not have or retain beneficial ownership interest in the securitization vehicles of loans it has previously securitized. The Bank only retains servicing rights but does not maintain any ownership interest. USAA has purchased the certificate in the securitizations at fair value simultaneous with the execution of the deals. As such, the credit risk of the underlying loans has been transferred away from the Bank to the investors in the notes and the certificate. As of June 30, 2015, the Bank does not have any synthetic securitization exposure and does not act as a sponsor of any third party securitizations. As of June 30, 2015, the Bank classified $503 million of auto loans as held for sale. The Bank has not securitized any loans in the three months ending June 30, 2015. Exhibit 18: USAA FSB Assets Held in Traditional Securitizations (a) Principal Amount Outstanding Assets impaired or past due (b) Consumer - Auto $ 258 $ 2 Consumer - Other 5 0 Total $ 262 $ 2 (a) Represents assets held in nonconsolidated securitization VIEs. (b) Represents assets 30 days or more past due or on nonaccrual status. 20 June 30, 2015 USAA Federal Savings Bank
Equities Not Subject to the Market Risk Rule The Bank s equity holdings are limited to assets held within money market mutual funds by its custodian that arise from facilitating investment portfolio activities. The following exhibit provides the book and fair values of these investments as well as their impact to risk-weighted assets for the current quarter. Exhibit 19: Equities Not Subject to the Market Risk Rule, Carrying and Fair Value Carrying Value Fair Value Non-publicly Traded $ 0 $ 0 Publicly Traded 51 51 Total $ 51 $ 51 Exhibit 20: Equities Not Subject to the Market Risk Rule by Risk Weight Bands Risk Weights Carrying Value Risk Weighted Asset Amount Capital Impact of RWA (a) 0-20% risk weighting $ 51 $ 10 $ 0.8 21-100% risk weighting 0 0 0.0 101-500% risk weighting 0 0 0.0 501-1,250% risk weighting 0 0 0.0 Total Exposures $ 51 $ 10 $ 0.8 (a) The capital impact of RWA is calculated by multiplying risk weighted assets by the minimum total risk-based capital ratio of 8 percent. For these equity investments, during the six months ended June 30, 2015, any realized or unrealized gains or losses were appropriately reflected in the Bank s financial statements. 21 June 30, 2015 USAA Federal Savings Bank
Interest Rate Risk for Non-Trading Activities The Bank is exposed to non-trading interest rate risk that arises from member decisions to use loan and deposit products, as well as the Bank s investment and capital management actions. For example, the interest rate the Bank charges for a three-year auto loan is fixed for the three-year period. However, the interest rate that the Bank pays its members for holding funds in their deposit accounts is influenced by market rates, which could change on a daily basis. The difference between the fixed interest rate for the auto loan and the variable interest rate for the deposit account is the primary reason that the Bank is exposed to non-trading interest rate risk. The potential financial impact from non-trading interest rate risk is measured and evaluated on a frequent basis. The Bank s current estimates for a 100 basis point and 200 basis point parallel upward shift in interest rates are provided in the following exhibit. Exhibit 21: Interest Rate Risk Simulation of Net Interest Income ( NII ) Information as of June 30, 2015 % change in Net Interest Income + 100 bps 1.56% + 200 bps 3.24% 221749-0815 22 June 30, 2015 USAA Federal Savings Bank