Thrift Subsidiary Can Be Source of Cheap Capital
Luse, Eric, Fields, Henry M., American Banker
Savings institutions are invariably seeking new ways to attract low-cost funds and increase their capital, particularly during periods of escalating interest rates. In recent years, conversions of savings institutions from the mutual to stock form of organization have provided many of the stronger savings institutions with substantial new capital through the issuance of stock to the public.
In a rising interest-rate market, however, any rate-senstive stock (such as that of a commercial bank or savings institution) may not be readily marketable even at relatively low values. Similarly, in such a market, borrowing costs associated with a savings institution's direct issuance of subordinated debt or mortgage-backed securities may be prohibitive.
In response to this situation, a number of savings institutions have sought to raise funds through service corporation finance subsidiaries. These subsidiaries may issue preferred stock, collateralized mortgage obligations, mortgage-backed bonds, or other mortgage-related securities. Financing Structure
An association that seeks to raise funds through a service corporation subsidiary (the "finance subsidiary") would first transfer mortgage-backed or other low-risk securities to the finance subsidiary. The finance subsidiary would then issue preferred stock or mortgage-related securities with a market value less than that of the portfolio of low-risk securities transferred to it.
In connection with the issuance of the preferred stock or mortgage-related securities, the finance subsidiary would restrict its activities through its charter or otherwise and, in particular, would agree not to pledge or transfer the portfolio with which it was capitalized and not to incur any indebtedness or issue any other securities.
Further, the yield on the portfolio held by the finance subsidiary would be sufficient to fund the payment of dividends or interest on the new securities to be issued. As a result, the newly issued securities would essentially be "collateralized" by the subsidiary's portfolio of low-risk securities. Substantially all the proceeds of the securities offered by the finance subsidiary would be remitted to the parent savings institution.
The new securities issued by the finance subsidiary would, in principle, benefit from a strong rating by reason of the "collateralization" feature, which would insulate the newly issued securities from the financial condition and results of operations of the parent association.
In this connection, the general counsel of Federal Home Loan Bank Board has provided assurance that the Federal Savings and Loan Insurance Corp. could not gain access to the assest of the finance subsidiary in the event of a failure of the parent. The strong rating would result in favorable financing costs for the finance subsidiary and, upon remittance of proceeds to the parent, in lower overal borrowing costs for the association.
It should be pointed out that finance subsidiaries present special opportunities for mutual associations, which, by definition, are not authorized to issue stock. Through such entities, mutuals can issue preferred stock indirectly and thereby avail themselves of the rate advantages resulting from the dividends-received deductions available for corporate purchasers of preferred stock, as discussed below.
A finance subsidiary could also be used to issue debt abroad. Such a subsidiary could be organized in an offshore jurisdiction whose treaty with the United States permits the avoidance of backup withholding, thereby enhancing the attractiveness of securities issued by such a subsidiary to foreign investors. New Bank Board Regulations
A major obstacle to the use of finance subsidiaries to date has been a Bank Board regulation that prohibits federal associations from investing more than 2% of their assets in one or more service corporations for other than community development purposes. …