Less than 2 weeks after the enactment of the Emergency Economic Stabilization Act of 2008 (EESA), the Department of the Treasury began implementing the Troubled Assets Relief Program (TARP), albeit not in the form initially presented to Congress. At first, TARP envisioned that the Treasury would purchase mortgage-backed securities and certain other “troubled” assets from eligible financial institutions in order to infuse capital into the U.S. financial system and spur lending by the banking sector. When the Treasury began implementing TARP, market participants found that the Treasury had decided instead to purchase direct equity stakes in a limited subset of financial institutions, namely banks, savings associations, bank holding companies, and savings and loan holding companies engaged in activities permissible for financial holding companies.1 The status of the remaining TARP funds remains unclear for a number of reasons: the Congressional Oversight Panel formed under EESA has found fault with Treasury’s approach; the House Financial Services Committee Chairman, Barney Frank, introduced a bill calling for more precise standards on the disposition of TARP funds; and the incoming administration is attempting to determine the role that the disposition of the remaining funds may have on its overall policy initiatives.
Insurance companies have generally been left out of the scuffle for access to the funding provided under TARP and other programs. In particular, it appears that the lack of clear and authoritative federal regulatory oversight of insurance companies has rendered Treasury, Congress and others reluctant to allow insurance companies to participate in a direct and meaningful way in the various forms of federal assistance. However, in order to gain access to the TARP funds and other funding options, many insurers have explored becoming savings and loan holding companies (SLHCs) or bank or financial holding companies (BHCs, or FHCs). Given the generally more demanding supervisory structure imposed on BHCs (and FHCs), the more precise holding-company level capital requirements, and the so-called “source of strength” doctrine that may render BHCs (and FHCs) responsible for the financial position of their subsidiary banks, it appears that the SLHC route has become the most popular for insurers looking for eligibility for some of the federal funding available through TARP and other programs.
The remainder of this alert addresses: (1) the manner in which an insurer may attempt to get access to TARP funds and other federal funding sources; (2) a brief description of the additional regulation that could be imposed as a result of becoming an SLHC (BHC or FHC); and (3) some considerations for insurance company complexes to consider with respect to the impact of becoming an SLHC (BHC or FHC) or accepting other federal assistance.
Gaining Access to TARP Funds and Fed Funding
In an effort to gain access to TARP funds and other federal financing, some financial services companies began purchasing, or at least considered purchasing, banks or thrifts. Such purchases would in turn permit the institutions to apply for the desirable holding company status that would permit tapping into TARP funds. At least four insurance company complexes — Hartford, Genworth, Lincoln National and Aegon — announced their intention to purchase thrifts and apply to the Office of Thrift Supervision (OTS) to become SLHCs.2 Other institutions, e.g., American Express, CIT Group, GMAC and, most notably, Goldman Sachs and Morgan Stanley, opted to quickly convert existing non-bank subsidiaries (e.g., industrial loan companies chartered under Utah law) into banks and thereby become BHCs (or FHCs).
Importantly, there are varied implications associated with becoming a BHC or an FHC (regulated by the Federal Reserve (Fed)) or an SLHC (regulated by OTS). An insurance company complex that becomes an SLHC may gain access to TARP, as well as to the FDIC Temporary Liquidity Guarantee Program available for some categories of newly issued debt obligations and the FDIC guarantee for non-interest bearing bank accounts. In addition, and perhaps more importantly, being an SLHC positions an insurance company complex in a way that makes it more likely to be able to tap any future assistance (or revamping of TARP, for example) as a result of being subject to a federal regulatory authority. Being an SLHC, however, does not provide direct access to funds from the Fed as easily as such funds are extended to member banks of the Federal Reserve System and their respective BHCs.3
During the financial crisis, the Fed has extended assistance to a variety of financial institutions under its statutory authority.4 However, the Fed’s authority to help non-member financial institutions is limited and typically requires either an approval by the Federal Reserve Board or the posting of collateral to secure loan advances made by the Fed.5 SLHCs will have to compete with all other financial institutions that are not member banks for funding and other assistance from the Fed. The subsidiary thrift of an SLHC, however, may have access to certain types of funding from its district Federal Home Loan Bank, if the thrift is a member of the Federal Home Loan Bank System, but such funding is more limited than the funding available to banks that are members of the Federal Reserve System.6
Access to the Fed does not come without costs. Member banks and all BHCs and FHCs7 are subject to the Fed’s oversight, which typically has been more invasive than OTS’ oversight of SLHCs.8 Under OTS supervision, SLHCs are permitted to engage in a variety of business and commercial activities, including insurance underwriting, securities brokerage, real estate development, financial services and limited non-financial activities.9 A BHC’s activities, on the other hand, are very limited in scope, i.e., they must be “closely related to banking.”10 FHCs are permitted to engage in a broader range of activities than BHCs are permitted, as long as the FHCs’ activities are financial in nature or complementary or incidental to a financial activity.11 Even with this broad authority, however, FHCs’ activities are not as broad as some of the activities in which certain SLHCs may engage, including limitations on commercial investments. Whether this regulatory arbitrage opportunity will exist in the future remains to be seen; the OTS has been the target of significant criticism in the wake of the financial markets crisis and could be impacted by any financial services regulatory reforms advanced by the new administration and the new Congress.
Additional Regulatory Considerations for Banks, Thrifts and their Holding Companies
By purchasing a depository institution or otherwise becoming an SLHC, a BHC or an FHC, insurance company complexes will be subject to additional regulatory requirements, including the following:
Ongoing Examinations by Regulators. Banks and thrifts and their holding companies are subject to examination by their primary federal regulator, and by state regulators if the institution holds a state charter. An examination of a BHC, an FHC or an SLHC includes a review of the financial condition and management of the holding company, as well as transactions between the holding company, its other subsidiaries and its subsidiary institutions. The examination is designed to assess the risk to the banking institution posed by the holding company and its other subsidiaries.
Capital Requirements. New banks and thrifts must have sufficient capital to pay all organizational costs and to adequately support planned operations. Pursuant to OTS regulations, the minimum initial capital needed to form a thrift is $2 million, although higher capital levels are often required. All banks and thrifts must meet ongoing capital adequacy standards. The regulators define capital and establish minimum capital requirements in relation to the institution’s assets and off-balance sheet exposure that are adjusted for credit risk. Assets and off-balance sheet items are assigned to broad risk categories, each with appropriate risk weights.
Safety and Soundness. Regulation of banks and thrifts is generally driven by the goal of ensuring the “safety and soundness” of the institution. To meet this goal, the banking laws generally impose ongoing capital and reserve requirements on the banking institution. In addition, both BHCs and FHCs are subject to capital requirements. While SLHCs are not subject to regulatory capital requirements, they are required by OTS to have sufficient capital to support their risk profile.
Limitations on Transactions With Affiliates. Banks and thrifts are subject to significant limitations on transactions with affiliates and on capital distributions to their shareholders that would affect the institution’s ability to fund other initiatives. Under applicable banking laws, transactions with affiliates, including loans, must be on terms and conditions that are substantially the same, or at least as favorable to the banking institution, as transactions with non-affiliated parties would be, and transactions are subject to qualitative and quantitative collateral requirements.
Enforcement Powers of the Banking Regulators. Federal regulators have broad enforcement powers over banking institutions, their holding companies and their management. These powers include cease and desist (injunctive) authority, powers of suspension and removal (of officers and directors), civil monetary penalties, and termination of deposit insurance (by the Federal Deposit Insurance Corporation).
Other Laws Applicable to Banks and Thrifts. Banks and thrifts are subject to extensive federal regulation including: the Federal Reserve Act; the Community Reinvestment Act (requiring depository institutions to reinvest in the communities from which they solicit deposits); the Equal Credit Opportunity Act (prohibits inappropriate discrimination in lending); the Real Estate Settlement Procedures Act and the Home Mortgage Disclosure Act (imposing stringent disclosure and other requirements on residential mortgage lending); the Truth in Lending Act (imposing disclosure and other requirements on consumer lending), and the Truth in Savings Act (imposing disclosure requirements on deposit solicitation activities).
Other Regulatory Implications to Consider
In addition to the added regulatory regime that an insurance company complex takes on as a result of acquiring a thrift or bank — and becoming a BHC, an FHC or an SLHC — there are a number of additional implications under their existing regulatory regimes (e.g., insurance, broker-dealer and investment adviser regulation) that could arise. For example, to the extent that an equity infusion is provided to an insurer or its affiliates, consideration would need to be given to whether change in control requirements must be addressed under state insurance laws, FINRA membership rules, and investment adviser regulation. In addition, consideration may need to be given as to whether any inter-company flow of funds desired under various federal funding programs would be permissible under (1) banking laws applicable to interested transactions, (2) insurance holding company statutes applicable to interested transactions, and (3) broker-dealer expense sharing requirements.