Transactions with Affiliates; Reverse Repurchase Agreements

DEPARTMENT OF THE TREASURY

Office of Thrift Supervision

12 CFR Part 563

[No. 98-35]

RIN 1550-AB16

Transactions with Affiliates; Reverse Repurchase Agreements

AGENCY: Office of Thrift Supervision, Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Office of Thrift Supervision (OTS) is proposing to revise

its regulations on transactions with affiliates. Specifically, the OTS

proposes to clarify that it 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.

DATES: Comments must be received on or before June 12, 1998.

ADDRESSES: Send comments to Manager, Dissemination Branch, Records

Management and Information Policy, Office of Thrift Supervision, 1700 G

Street, NW., Washington, DC 20552, Attention Docket No. 98-35. These

submissions may be hand-delivered to 1700 G Street, NW., from 9:00 a.m.

to 5:00 p.m. on business days; they may be sent by facsimile

transmission to FAX Number (202) 906-7755 or by e-mail

[email protected]. Those commenting by e-mail should include

their name and telephone number. Comments will be available for

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inspection at 1700 G Street, NW., from 9:00 a.m. until 4:00 p.m. on

business days.

FOR FURTHER INFORMATION CONTACT: Valerie J. Lithotomos, Counsel

(Banking and Finance), (202) 906-6439; or 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.'' As defined by 12 CFR 584.2-2, these

activities include activities approved for bank holding companies by

regulation, 12 CFR 225.25, 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).

Congress enacted this prohibition to ``reflect . . . the fact that

affiliates of savings associations can engage in a far greater range of

activities than affiliates of banks, and can thus expose the savings

association to greater risks.'' The OTS believes this statement

incorporates three distinct but overlapping policies.

The purpose of the prohibition in section (a)(1)(A),

together with other specific restrictions in section 11(a), is to

protect the thrift from all forms of risk, including credit risk,

presented by non-banking affiliates. These risks are not fully

addressed by sections 23A and 23B of the FRA.

Because the creditors that are ultimately exposed to the

greater risks in these transactions are the depositors and the deposit

insurance fund, section 11(a)(1)(A) operates to ensure that thrift

deposits do not serve, via an extension of credit, as a source of funds

for the activities of a non-banking affiliate.

As a corollary of the second policy, the deposit insurance

fund should not support the risks of default by a non-banking

affiliate.

The OTS is aware that there may be situations where savings

associations have entered into repurchase and reverse repurchase

agreements with their non-banking affiliates. For example, in one

instance, 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,1 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, the savings association's obligation to

repurchase securities under its agreement would exceed the holding

company's obligation to repurchase securities under its agreement.

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\1\ A sale of securities subject to an agreement to repurchase

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

is the purchaser of the securities. See M. Stigum, The Repo and

Reverse Markets 4 (1989).

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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. Section 11(a)(1)(A)

does not define ``loan or other extension of credit.'' Thus, the face

of the statute does not compel a legal conclusion that reverse

repurchase agreements are, or are not, prohibited.2

Accordingly, the OTS has decided to resolve this issue through today's

rulemaking. While the agency does not believe that such agreements are

common, it believes that setting clear regulatory standards will help

to avoid future uncertainty.

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\2\ We recognize 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, is not controlling here.

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.

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The OTS is proposing to treat most reverse repurchase agreements as

loans or other extensions of credit. Section 11(a)(1)(A) of the HOLA

provision focuses on prohibiting transactions with non-banking

affiliates that would 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. 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 rate of interest 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.

Of course, in the example cited above, the risk is ameliorated

significantly 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 holding company under

which the thrift is, at all times a net debtor to the holding company.

Accordingly, as discussed more fully below, the OTS is proposing to

exclude such a connected set of transactions from the regulatory

prohibitions.

II. General Description of Proposed Rule

To address this and similar arrangements, the OTS is proposing to

revise 12 CFR 563.41(a)(3) to clarify that it will generally treat

reverse repurchase agreements as loans or other extensions of credit

for the purposes of section 11(a)(1)(A) of the HOLA. Such agreements

between a thrift and a non-

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banking affiliate would, therefore, be prohibited.

The proposed regulation also would outline circumstances in which

the OTS would not treat reverse repurchase agreements as loans or other

extensions of credit under section 11(a)(1)(A) of the HOLA. These

circumstances would be ones in which the agreements are consistent with

the policies underlying section 11(a)(1)(A) of HOLA and section 563.41

of the OTS regulations--avoidance of the use of insured deposits as a

source of funds for a non-banking affiliate, substantial elimination of

credit risk posed by the non-banking affiliate, and protection of the

insurance fund. Specifically, the proposed rule would not treat a

reverse repurchase agreement as a loan or other extension of credit if

the agreement is part of a set of transactions that meet the following

requirements:

In order that the agreements not channel insured deposits

to the non-banking affiliate, 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.

To make credit risk de minimis, and to avoid a risk to the

insurance fund, 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. The OTS specifically solicits comment on

whether, to reduce interest rate risk further, 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.

There may be other common types of reverse repurchase transactions

that avoid the use of insured deposits as a source of funds for an

affiliate, substantially eliminate credit risk, and protect the

insurance fund from risk of loss. Accordingly, the OTS specifically

requests comments on such other agreements. Commenters addressing this

issue should describe the nature of the agreements, and should explain

how the agreements are consistent with the purposes of section

11(a)(1)(A).

III. Executive Order 12866

The Director of the OTS has determined that this proposed 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, the

OTS certifies that this proposed rule will not have a significant

impact on a substantial number of small entities. The proposed rule

would prohibit 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. The 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. The OTS has determined that

the proposed 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 proposes to amend

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 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 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 subsidiary) has ensured its 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 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 subsidiary's) outstanding

obligations to repurchase securities from the affiliate under paragraph

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

* * * * *

Dated: April 2, 1998.

By the Office of Thrift Supervision.

Ellen Seidman,

Director.

[FR Doc. 98-9616 Filed 4-10-98; 8:45 am]

BILLING CODE 9720-01-P