Transactions With Affiliates; Reverse Repurchase Agreements

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 563

[No. 98-76]

RIN 1550-AB16

Transactions With Affiliates; Reverse Repurchase Agreements

AGENCY: Office of Thrift Supervision, Treasury.

ACTION: Final rule.

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SUMMARY: The Office of Thrift Supervision (OTS) is issuing a final rule

to revise its regulations on transactions with affiliates. The final

rule clarifies that OTS will treat reverse repurchase agreements, with

one limited exception, as loans or other extensions of credit for the

purposes of section 11(a)(1)(A) of the Home Owners' Loan Act (HOLA).

Therefore, a savings association generally may not enter into a reverse

repurchase agreement with an affiliate that is engaged in non-bank-

holding company activities.

EFFECTIVE DATE: October 1, 1998.

FOR FURTHER INFORMATION CONTACT: Valerie J. Lithotomos, Counsel

(Banking and Finance), (202) 906-6439; Karen A. Osterloh, Assistant

Chief Counsel, (202) 906-6639, Regulations and Legislation Division,

Chief Counsel's Office; or Donna Deale, Manager, (202) 906-7488,

Supervision Policy, Office of Thrift Supervision, 1700 G Street, NW.,

Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

I. Background

Section 11(a)(1) of the Home Owners' Loan Act (HOLA) applies the

provisions of sections 23A and 23B of the Federal Reserve Act (FRA) to

every savings association to the same extent as if the thrift were a

member bank of the Federal Reserve System. Section 11(a)(1) also

imposes several additional restrictions on a savings association's

transactions with affiliates beyond those found in sections 23A and 23B

of the FRA. Specifically, section 11(a)(1)(A) states that ``no loan or

other extension of credit may be made to any affiliate unless that

affiliate is engaged only in activities described in section

10(c)(2)(F)(i) of the HOLA.'' These activities include activities

approved for bank holding companies by regulation, 12 CFR 225.28, or by

case-by-case order of the Federal Reserve Board, 12 CFR 225.23. Thus,

under section 11(a)(1)(A), a thrift may not make a loan or other

extension of credit to an affiliate engaged in non-bank holding company

activities (non-banking affiliate).

OTS is aware that there may be situations where savings

associations may wish to enter into reverse repurchase agreements with

their non-banking affiliates.1 These arrangements raise the

question whether a reverse repurchase agreement is a loan or other

extension of credit for the purposes of the prohibition in section

11(a)(1)(A) of the HOLA.

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\1\ A sale of assets subject to an agreement to repurchase is

known as a ``reverse repurchase agreement'' when a bank or thrift is

the purchaser of the assets. See M. Stigum, The Repo and Reverse

Markets 4 (1989).

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On April 13, 1998, OTS published a notice of proposed rulemaking

that would treat most reverse repurchase agreements as loans or other

extensions of credit.2 OTS noted that section 11(a)(1)(A)

does not define ``loan or other extension of credit,'' and does not

compel a legal conclusion that reverse repurchase agreements are, or

are not, prohibited by statute.3 Section 11, however,

focuses on prohibiting transactions with non-banking affiliates that

transfer credit and other risks to the thrift. As a general matter, a

reverse repurchase agreement with a non-banking affiliate bears many of

the economic characteristics of a loan or extension of credit to such

an affiliate.4 On this basis, OTS concluded that it was

appropriate to treat these transactions as loans or extensions of

credit under section 11(a)(1)(4).

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\2\ 63 FR 17966 (April 13, 1998).

\3\ In making this determination, OTS recognized that the

definition of ``covered transaction'' under section 23A(b)(7) of the

FRA lists ``a purchase of assets, including assets subject to an

agreement to repurchase'' separately from ``a loan or extension of

credit.'' See 12 U.S.C. 371c(b)(7)(A), (C). The fact that a reverse

repurchase is considered to be an asset purchase, rather than an

extension of credit under section 23A of the FRA, however, does not

control the interpretation of section 11 of the HOLA.

Although section 23A and section 11(a)(1)(A) are both designed

to prevent abuses by affiliates, the two statutes pursue this goal

differently. Section 23A identifies a class of covered transactions

that threaten prudent business relationships and places various

restrictions on the transactions. Some restrictions apply to all

transactions. Others apply only to certain types of covered

transactions. (E.g., loans and extensions of credit are subject to

specific collateralization requirements. Purchases, including

purchases that are subject to a repurchase agreement, are subject to

a prohibition on the purchase of low quality assets.) Thus, to

impose the appropriate restrictions, section 23A must distinguish

between covered transactions that are reverse repurchase agreements

and loans and covered transactions that are other extensions of

credit.

Moreover, we note that section 11(a)(1)(A) of the HOLA does not

specifically incorporate the definition of covered transaction under

section 23A. In light of the numerous other cross-references to

section 23A of the FRA that are contained in section 11 of the HOLA,

it is reasonable to conclude that if Congress had intended to

restrict ``loans or other extensions of credit'' only to those

transactions that are loans and extensions of credit for the

purposes of section 23A, it would have included a specific cross-

reference to that statute.

\4\ The savings association transfers funds to the affiliate,

expecting to be repaid when the company repurchases the assets. The

purchased assets essentially amount to collateral, since the savings

association is required to return the assets at the time of

repurchase. The savings association earns a pre-determined amount

under the agreement. The principal risk to the savings association,

its depositors and the deposit insurance fund is credit risk--the

possibility that the affiliate will default on its obligation to

make the repurchase. These types of agreements are generally

considered the functional equivalent of a loan or extension of

credit. See amendments to Federal Financial Institutions Examination

Council Policy Statement on Repurchase Agreements of Depository

Institutions with Securities Dealers and Others (``FFIEC Policy

Statement''), 63 FR 6935 (February 11, 1998).

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Credit and other risks may be ameliorated significantly under

certain circumstances. For example, in one arrangement recently

reviewed by OTS, a thrift planned to sell United States Treasury

securities to its holding company, subject to the thrift's agreement to

repurchase the securities after a pre-determined period, several years

later. Using reverse repurchase agreements, the savings association

would also purchase United States Treasury securities from the holding

company, subject to the holding company's agreement to repurchase on an

overnight (or next-business-day) basis. The holding company, in effect,

would use the overnight purchases to manage its available cash. At all

times,

[[Page 43293]]

the savings association's obligation to repurchase securities under its

agreement would exceed the holding company's obligation to repurchase

securities under its agreement. In this example, risk is mitigated

because the thrift is able to dispose of United States Treasury

securities, a highly liquid, federally guaranteed form of collateral.

The risk is further ameliorated by the offsetting repurchase agreements

between the thrift and the affiliate under which the thrift is, at all

times a net debtor to the affiliate. Accordingly, OTS proposed to

exclude such a connected set of transactions from the regulatory

prohibition.

II. Summary of Comment and Description of the Final Rule

The public comment period on the proposed rule closed on June 12,

1998. OTS received one comment from a law firm, on behalf of a client.

The commenter argued that section 11(a)(1)(A) of the HOLA does not

provide OTS with legal authority to prohibit reverse repurchase

agreements. As noted above, the preamble to the proposed rule

recognized that section 11(a)(1)(A) of the HOLA, on its face, did not

compel a legal conclusion that reverse repurchase agreements are, or

are not, prohibited as loans or extensions of credit. It is, however,

within OTS' purview to interpret and clarify the meaning of ``loan or

other extension of credit'' in section 11 by regulation. Section

3(b)(2) of the HOLA authorizes the Director to ``prescribe such

regulations . . . as the Director may determine to be necessary for

carrying out [the HOLA] and all other laws within the Director's

jurisdiction.5 Thus, OTS has sufficient legal authority to

issue this final rule interpreting the HOLA.

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\5\ 12 U.S.C. 1462a. See also 12 U.S.C. 1463(a) and 1464.

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The commenter also responded to a question posed in the preamble to

the proposed rule. The proposed regulation outlined the circumstances

under which OTS would not treat a reverse repurchase agreement as a

loan or other extension of credit under section 11(a)(1)(A) of the

HOLA. Specifically, the reverse repurchase agreement must be part of a

transaction or series of transactions meeting the following

requirements: (1) There must be offsetting repurchase agreements

between the thrift and the affiliate under which the thrift sells

assets subject to an agreement to repurchase. At all times, when the

agreements are netted, the thrift must be a net debtor to the

affiliate; and (2) The assets purchased under the agreements must be

United States Treasury securities, and the remaining term of securities

purchased by the savings association must exceed the term of the

reverse repurchase agreement. OTS specifically asked whether a cap

should be placed on the length of time by which the remaining term of

the securities may exceed the term of the reverse repurchase agreement.

The commenter opposed the imposition of any cap.

OTS agrees with the commenter that a cap is unnecessary in light of

the proposed requirement that the aggregate amount of the thrift's

outstanding obligation to repurchase securities from the affiliate must

at all times exceed the aggregate amount of the affiliate's outstanding

obligation to repurchase securities from the thrift. See proposed

Sec. 563.41(a)(3)(iii). Given this requirement, the savings association

will always be able to set off all of its repurchase obligations to the

affiliate, if the affiliate is unable to repurchase securities from the

thrift under the agreement. Thus, the savings association will not have

any net credit exposure to its affiliate. The proposal has not been

revised to include a cap.6

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\6\ The commenter opposed any additional restrictions. However,

if additional restrictions are to be imposed, the commenter

suggested that OTS require that the aggregate market value of the

securities purchased by the savings association under the reverse

repurchase agreement must exceed, by a specified margin (e.g., 102

percent), the amount of the affiliate's repurchase obligation under

the reverse repurchase agreement. OTS agrees that further regulatory

restrictions are unnecessary to mitigate the risks associated with

reverse repurchase agreements. Moreover, under the FFIEC Policy

Statement, cited above, we note that savings associations should

comply with specific margin guidelines for such repurchase

agreements.

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Today's final rule contains a technical clarification. Proposed

Sec. 563.41(a)(3)(i) stated that the savings association (or its

subsidiary) must ensure ``its right to dispose of the securities at any

time during the term of the agreement and upon default.'' OTS has

revised the final rule to clarify that the savings association (or its

subsidiary) must obtain possession or control of the underlying

securities to ensure that it has the right to dispose of the

securities. Other than this clarifying change, today's final rule is

substantially identical to the April proposal.

III. Executive Order 12866

The Director of OTS has determined that this final rule does not

constitute a ``significant regulatory action'' for the purposes of

Executive Order 12866.

IV. Regulatory Flexibility Act Analysis

Pursuant to section 605(b) of the Regulatory Flexibility Act, OTS

certifies that the final rule does not have a significant impact on a

substantial number of small entities. The final rule prohibits all

savings associations from entering into reverse repurchase agreements

with non-banking affiliates, except under very limited circumstances.

Thrifts currently engage in few reverse repurchase agreements with

affiliates. OTS is not aware of any small savings association that is

currently engaging in transactions that would be prohibited by this

rule. Accordingly, a regulatory flexibility analysis is not required.

V. Unfunded Mandates Act of 1995

Section 202 of the Unfunded Mandates Reform Act of 1995, Pub. L.

104-4 (Unfunded Mandates Act), requires that an agency prepare a

budgetary impact statement before promulgating a rule that includes a

federal mandate that may result in expenditure by state, local, and

tribal governments, in the aggregate, or by the private sector, of $100

million or more in any one year. If a budgetary impact statement is

required, section 205 of the Unfunded Mandates Act also requires an

agency to identify and consider a reasonable number of regulatory

alternatives before promulgating a rule. OTS has determined that the

final rule will not result in expenditures by state, local, or tribal

governments or by the private sector of $100 million or more.

Accordingly, this rulemaking is not subject to section 202 of the

Unfunded Mandates Act.

List of Subjects in 12 CFR Part 563

Accounting, Advertising, Crime, Currency, Investments, Reporting

and recordkeeping requirements, Savings associations, Securities,

Surety bonds.

Accordingly, the Office of Thrift Supervision hereby amends part

563, chapter V, title 12, Code of Federal Regulations as set forth

below:

PART 563--OPERATIONS

1. The authority citation for part 563 continues to read as

follows:

Authority: 12 U.S.C. 375b, 1462, 1462a, 1463, 1464, 1467a, 1468,

1817, 1820, 1828, 3806; 42 U.S.C. 4106.

2. Section 563.41 is amended by revising paragraph (a)(3) to read

as follows:

Sec. 563.41 Loans and other transactions with affiliates and

subsidiaries.

(a) * * *

(3) A savings association (or its subsidiary) may not make a loan

or other extension of credit to an affiliate, unless the affiliate is

engaged solely in

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activities described in 12 U.S.C. 1467a(c)(2)(F)(i), as defined in

Sec. 584.2-2 of this chapter. For the purposes of this paragraph

(a)(3), a loan or other extension of credit includes a purchase of

assets from an affiliate that is subject to the affiliate's agreement

to repurchase the assets. Such a purchase of assets, however, will not

be considered a loan or other extension of credit if the savings

association (or its subsidiary) has entered into a transaction or

series of transactions that meets all of the following requirements:

(i) The savings association (or its subsidiary) purchases United

States Treasury securities from the affiliate, the affiliate agrees to

repurchase the securities at the end of a stated term, the remaining

term of the securities purchased by the savings association (or its

subsidiary) exceeds the term of the affiliate's repurchase agreement,

and the savings association (or its subsidiary) has possession or

control of the securities and the right to dispose of the securities at

any time during the term of the agreement and upon default.

(ii) The affiliate purchases United States Treasury securities from

the savings association (or its subsidiary) and the savings association

(or its subsidiary) agrees to repurchase the securities at the end of a

stated term.

(iii) The aggregate amount of the affiliate's outstanding

obligations to repurchase securities from the savings association (or

its subsidiary) under the repurchase obligation described at paragraph

(a)(3)(i) of this section, at all times, is less than the aggregate

amount of the savings association's (or its subsidiary's) outstanding

obligations to repurchase securities from the affiliate under paragraph

(a)(3)(ii) of this section;

* * * * *

Dated: August 7, 1998.

By the Office of Thrift Supervision.

Ellen Seidman,

Director.

[FR Doc. 98-21756 Filed 8-12-98; 8:45 am]

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