FDIC to Reassure S&P on Funding Units; Letter Will Address Independence of Finance Subsidiaries When Parent Banks Fail

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FDIC to Reassure S&P on Funding Units

WASHINGTON -- The Federal Deposit Insurance Corp., in a move that is expected to expand the use of funding subsidiaries by banks, will issue assurances about the independence of such units when the parent bank fails.

The FDIC is writing a letter to Standard & Poor's Corp. that will address the issue of whether the agency may "pierce the corporate veil of the finance subsidiary" after a bank fails, said Stephen G. Pfeifer, an examination specialist for the FDIC.

While one state-chartered banks are already permitted to raise funds by issuing securities throuhg finance subsidiaries, Standard & Poor's in the past has regused to rate these securities because of the uncertainty of the subsidiary's independence from the parent bank. As a result, banks have avoided these transaction.

The FDIC letter is expected to give S&P the assurances it needs to issue ratings on these securities.

"There was never any comfort up to this point that the FDIC would not view those assets as part of the estate in the event of liquidation," Gilbert T. Schwartz, a banking attorney with Skadden, Arps, Slate, Meagher & Flom said.

The FDIC move is expected to enable banks to issue S&P-rated collecteralized mortgage obligations and auction-rate preferred stock through specialized finance subsidiaries. By filling a finance subsidiary with assets exceeding the value of the securities issuances, companies can obtain a higher securities rating -- thereby lowering their financing costs -- than they could if they issued the securities directly.

In a related development, the agency on Monday proposed a set of soundness and safety guidelines that FDIC-regulated banks establishing finance subsidiaries would be asked to meet.

The proposal, issued during an open meeting, states that:

* Finance subsidiaries should be wholly owned by the parent bank.

* Banks should not place more than 10% of their assets in a finance subsidiary.

* Proceeds from the subsidiary's issuance of securities should be immediately transferred to the parent bank.

* Value of collateral used to back the subsidiary's securities should not exceed 200% of the amount issued.

These guidelines apply only to FDIC regulated banks. …