On July 24, 2012, the Federal Deposit Insurance Corporation (the “FDIC”) issued a final rule prohibiting any insured savings association from acquiring or retaining a corporate debt security unless it determines, prior to acquiring such security and periodically thereafter, that the issuer of that security has adequate capacity to meet all financial commitments under the security for the projected life of the security.2 The final rule, which amends 12 CFR § 362.11(b)(1), was promulgated under Section 939A of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“DFA”). The final rule replaces the investment grade standard that was removed from Section 28(d) of the Federal Deposit Insurance Act by DFA Section 939A with alternative standards of creditworthiness.3 The FDIC also published final guidance on due diligence requirements for savings associations in determining whether a corporate debt security is eligible for investment.4 Under the final guidance, a federal or state savings association would satisfy the requirements of 12 CFR Part 362.11(b)(1) if, based on its assessment, the issuer of the corporate debt security presents a “low risk of default” and is likely to make a “full and timely repayment” of principal and interest; these key concepts, however, are not further defined in the final guidance. The investment must also be consistent with safe and sound banking practices.
The final guidance includes examples of appropriate factors that a savings association should consider in its due diligence analysis, which include, but are not limited to, the following:
- Confirm spread to U.S. Treasuries is consistent with bonds of similar credit quality;
- Confirm risk of default is low and consistent with bonds of similar credit quality;
- Confirm capacity to pay through internal credit analysis that can be supplemented with other third-party analytics;
- Understand applicable market demographics/economics; and
- Understand current levels and trends in operating margins, operating efficiency, profitability, return on assets and return on equity.
The range and type of specific factors an institution should consider will vary depending on the particular type and nature of the security.
Although savings associations are permitted to consider an external credit rating for purposes of determining whether the investment in the corporate debt security is in compliance with the rule, they must supplement any external credit assessment with due diligence processes and analyses that are appropriate for the size and complexity of the security. A security with an investment grade rating is not automatically deemed to satisfy the rule’s creditworthiness standard. The FDIC specifically stated that the more complex a security’s structure, the greater the expectations, even when the credit quality is perceived to be very high. The FDIC also noted that savings associations should not purchase securities for which they do not understand the relevant risks.
The final rule is not expected to change the scope of permissible corporate debt securities investments. If a corporate bond was a permissible investment prior to the final rule due to its falling within one of the four highest credit rating categories, a bond with similar default probabilities should be permissible under the final rule.
Because savings associations purchase structured products issued by other issuers, they will have to consider the final rule and the final guidance prior to purchasing such securities. In particular, they will have to weigh the suggested diligence factors, and any other relevant factors, such as the complexity of the structured product, prior to their investment. It also will be important for the savings associations to document their diligence activities and conclusions, inasmuch as federal examiners will want to see concrete evidence of a savings association’s compliance with the new rule.
The final rule was effective on July 21, 2012. Savings associations must be in compliance with the final rule by January 1, 2013.