Last week, the Federal Deposit Insurance Corporation (FDIC) issued a final rule under Section 939(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act prohibiting savings associations from acquiring or retaining any corporate debt security that does not satisfy certain creditworthiness standards (Rule). The Rule can be accessed at http://www.fdic.gov/regulations/laws/federal/2012/2012-07-24_final-rule.pdf.Under the Rule, an insured savings association must determine that the security’s issuer has adequate capacity to satisfy all financial commitments relating to the security for the projected life of the security prior to acquiring it and periodically thereafter. All savings associations must be in compliance with the new Rule by January 1, 2013.
The FDIC also issued final guidance on supervisory expectations for savings association due diligence to determine whether a corporate debt security is eligible for investment under the Rule, which can be accessed at http://www.fdic.gov/regulations/laws/federal/2012/2012-07-24_final-guidance.pdf. The savings association must engage in a due diligence analysis that may include consideration of internal analyses, third-party research, and analytics including internal risk ratings, the default statistics of external credit rating agencies, and other sources of appropriate information. The issuer meets the FDIC standard of creditworthiness if it presents a low risk of default and is likely to make full and timely repayment of principal and interest.
Although the new Rule appears to set more stringent investment standards, the FDIC does not expect it to change the scope of permissible corporate debt securities. For instance, if a corporate bond was previously rated in one of the four highest categories, and was thus a permissible investment, a bond with similar default probabilities will be a permissible investment under this Rule.
We have seen significant fall-out and numerous lawsuits in the past several years involving financial institution purchases of corporate debt instruments arising out of issuer defaults. The new Rule is calculated to help prevent the proliferation of such difficulties for financial institutions going forward, but as with any regulation, its impact will be determined by its future application.