We have previously posted on the possibility of bank holding companies using the TLGP Debt Guarantee to provide capital to subsidiary banks.  In that post, we commented on the odds of success and noted that the FDIC had not taken a formal position.  Today, the FDIC updated its TLGP FAQ and confirmed that the odds of success are in fact very low.

The FDIC’s revised answer states:

Can guaranteed debt issued by the parent company be put in a subsidiary bank as capital?

The FDIC envisions few if any circumstances under which it would approve holding company applications to establish a cap or to increase a cap where the proceeds from the resulting guaranteed debt issuance would be injected as capital into a subsidiary bank.  The Temporary Liquidity Guarantee Program was not intended to be a capital enhancement program.  The Treasury Department’s TARP program has been set up for that purpose.  The purpose of the Temporary Liquidity Guarantee Program is to restore liquidity to the intermediate term debt market.

As a reminder, the TLGP’s alternative guarantee cap of 2% of liabilities only applies to depository institutions.  Bank holding companies are not entitled to use the 2% of liabilities test and are only eligible to issue 125% of the amount of senior unsecured debt that was outstanding as of September 30, 2008.  As a result of the pre-insolvency advice, we believe most community bank holding companies will be required to seek FDIC approval to establish a cap or to increase a cap in order to issue FDIC guaranteed debt.  Based on the FDIC’s updated analysis, this approval seems highly unlikely.

The FDIC’s updated FAQ also addresses the use of guaranteed debt as a source of subsidiary capital generally, for those institutions that have the ability to issue guaranteed debt at the holding company level.

The proceeds of guaranteed debt issued by the holding company and sold to a third party could be injected into the subsidiary bank as capital.  However, given the relatively short duration of the debt guarantee program, the holding company’s ability to retire the debt at maturity should be carefully considered.  The FDIC’s Risk Management Manual of Examination Policies provides the following guidance to examiners in evaluating the quality of new capital injections from a parent holding company:

Management’s access to capital sources, including holding company support is a vital factor in analyzing capital.  Also, the strength of a holding company will factor into capital requirements.  If a holding company previously borrowed funds to purchase newly issued stock of a subsidiary bank (a process referred to as double leverage), the holding company may be less able to provide additional capital.  The examiner would need to extend beyond ratio analysis of the bank to assess management’s access to capital sources.

The FDIC’s original answer to the same question was simply “Yes, a bank holding company may use proceeds from a debt issuance to purchase additional bank stock.”  That answer is still technically correct, but the revised answer certainly changes the context for the original answer.