FDIC Smooths Way for CMO and Preferred Stock Offerings

By Herr, Julie Kitzes; Stolzer, Daniel R. | American Banker, June 30, 1986 | Go to article overview

FDIC Smooths Way for CMO and Preferred Stock Offerings


Herr, Julie Kitzes, Stolzer, Daniel R., American Banker


FDIC Smooths Way for CMO and Preferred Stock Offerings

ON APRIL 7, 1986, THE Federal Deposit Insurance Corp. set forth for public comment a proposed statement of policy (51 F.R. 12560, April 11, 1986) that sets guidelines for the establishment by certain FDIC-insured financial institutions of special-purpose finance subsidiaries to issue debt or equity securities to outside investors.

Finance subsidiaries allow financial institutions to issue collateralized mortgage obligations, known as CMOs, or preferred stock at rates lower than what the institutions would otherwise have to pay if they issued the securities directly.

Thus, finance subsidiaries afford thrifts the opportunity to obtain less costly funds that, if properly reinvested, will enhance the institution's assets, thereby increasing its profits. The policy statement affects FDIC-insured state-chartered commercial banks that are not members of the Federal Reserve System and FDIC-insured savings banks, both federally and state chartered.

The policy statement was issued at the same time as a letter from FDIC general counsel John C. Murphy Jr., responding to an inquiry from counsel to Standard & Poor's Corp., in connection with Standard & Poor's rating of financings issued by such finance subsidiaries.

In the April 9, 1986, letter, Mr. Murphy expressed his views concerning the circumstances in which a court would respect the separate corporate status of a special-purpose finance subsidiary upon the insolvency of and appointment of a receiver for the parent insured institution. The opinion of the general counsel was that in the event of the parent institution's insolvency, a court would not uphold an attempt by the receiver of the insured institution to consolidate the assets of the subsidiary with the parent, provided certain criteria were complied with, and assuming the absence of other factors such as fraud.

In 1984, in a letter to Standard & Poor's counsel, the general counsel of the Federal Home Loan Bank Board stated a similar opinion upon the same issue with respect to finance subsidiaries of thrift institutions insured by the Federal Savings and Loan Insurance Corp.

That letter gave Standard & Poor's the assurances it needed to provide investment grade, triple-A ratings and thus paved the way for a wave of CMO and fixed- and adjustable-rate preferred stock financings, including controlled adjustable-rate preferred stock (Carps), money market preferred stock, Dutch auction rate transferable securities (Darts) preferred stock, and others.

In the arena of competition between banks and thrifts and, to a lesser extent, between federally and state-chartered thrifts, the joint issuance of the policy statement and the April 9 letter can be scored as a "net-plus' for state nonmember commercial banks and both federally and state-chartered FDIC-insured savings banks.

Those FDIC-insured institutions now may engage in collateralized borrowing transactions that are not substantially different from the structured financings currently employed by federally chartered and, where the authority exists, state-chartered thrifts insured by the FSLIC.

Basic Method of Structured Financing

In its simplest form, in a structured financing the parent institution transfer certain assets to a special-purpose subsidiary to collateralize or otherwise support the securities issued. In return for the assets, the subsidiary remits the net proceeds of the offering to the parent for use in operations.

Where debt is issued at the subsidiary level, the trustee for the CMOs perfects a security interest in the transferred colllateral. If preferred stock is issued, no security interest is perfected.

However, because the subsidiary is chartered for the limited purpose of issuing the securities and can neither incur debt nor engage in any other business, the preferred stock is in fact insulated from other encumbrances, and is, therefore, backed by the collateral in a manner approximating a security interest. …

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FDIC Smooths Way for CMO and Preferred Stock Offerings
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