Bank Board's Rule on Thrift Finance Units Raise New Issues
Pozen, Robert C., Rudolph, Wendy S., American Banker
THE FEDERAL HOME LOAN Bank Baord recently adopted long-awaited revisions to its regulations governing finance subsidiaries of savings and loan associations. An association that complies with these regulations may raise funds by selling securities through a finance subsidiary while excluding the liabilities of the subsidiary in calculating the association's net worth requirement.
As explained below, the revised regulations ease some of the previous restrictions -- such as permitting as association to provide a broader guarantee of the obligations of its subsidiary -- and clarify a number of legal issues. But the regulations also raise new issues and impose a significant new requirement: duration matching. In brief, duration matching requires that the interest and principal payments on securities issued by a finance subsidiary coincide closely with the cash flow from the assets collateralizing these securities.
A finance subsidiary is a limited-purpose subsidiary that is permitted to issue any securities that its parent association may issue directly. An association may transfer to its finance subsidiary assets with an aggregate current book value of up to 30% of the current book value of the association's total assets. The proceeds of the subsidiary's sale of securities, net of reasonable costs, must be remitted to the parent association.
There are several advantages to issuing securities through a finance subsidiary. Most importantly, if the association complies with the regulations, then the obligations created by the issuance of securites will not be included in the parent association's total liabilities for purposes of calculating its net-worth requirements.
This enables an association of obtain cash without worrying about compliance with the growth limitations. The cash may then be used, for example, to fund existing loan commitments or to allow high interest deposits to run off. Alternatively, the proceeds from a subsidiary's securities offering may be used to increase the percentage of the association's qualified assets for tax purposes.
The issuance of securities through a finance subsidiary also enables an association to lower its cost of funds, because of the ability to obtain a high rating for the subsidiary's securities from a nationally recognized rating agency.
It certain procedures are followed in establishing and operating a finance subsidiary, the subsidiary will generally be considered a separate entity from its parent association. The insolvency of the association will not affect the obligations of the subsidiary. This means that a rating agency -- such as Standard & Poor's -- will focus on the assets collateralizing the subsidiary's securities rather than on the financial condition of the association in providing its rating of the securities.
Duration Matching Requirement
The most significant aspect of the revised regulations -- and the issue that prompted the greatest number of comments on the roposed regulations -- is duration that the securities issued by the subsidiary be collateralized by assets that have substantially the same duration as the securities issued and that this duration matching be maintained throughout the life of the securities without "active management" by the association or the finance subsidiary.
Prior to establishing a finance subsidiary, the directors of an association must authorize the creation of the subsidiary in furtherance of a written business plan to reduce interest-rate risk and control credit risk. In proposing the duration matching requirement, the Federal Home Loan Bank Board made clear that this was its way of insuring that the activities of the subsidiary did not increase the association's interest-rate risk.
But in adopting the revised regulations, the Bank Board went much further: The release accompanying the revisions emphasizes that the board only intended to provide the favorable networth treatment if the transaction is effectively a sale of the collateralizing assets. …