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New Broad Treasuries Repo Rate “Best Practice” Benchmark

On June 22, the Alternative Reference Rates Committee (the “ARRC”) identified a broad Treasuries repo financing rate (the “Broad Treasuries Financing Rate”) that, according to the ARRC, in its consensus view represents best practice for use in certain new U.S. dollar derivatives and other financial contracts.

The work of the ARRC grew out of the past instances of manipulation of the LIBOR market which caused a loss of confidence in LIBOR – particularly as it had previously been determined and reported – as a reliable interest rate benchmark.  That led the G20 to instruct the Financial Stability Board to review broadly-recognized interest rate benchmarks and devise a plan to ensure that the construction of these benchmarks are sound and used appropriately in the markets.  According to the Working Group on Alternative Interest Rates initiated by the Federal Reserve in furtherance of the plan, the goals were two-fold: (1) strengthen the integrity of existing benchmark rates, and (2) develop alternative reference rates that would be free of many of the risks (including manipulation) associated with existing benchmarks.  The Broad Treasuries Financing Rate would be one such alternative rate.

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Legal Lending Limits and Credit Exposure for Derivatives – Georgia

As we previously discussed, the Georgia Department of Banking and Finance has confirmed that Georgia charted banks will be able to use any of the methodologies permissible for national banks when determining credit exposure for derivatives, subject to review through the examination process as to their appropriate implementation. For those elements of the OCC methodology requiring the written approval of the OCC prior to implementation, the Department’s written approval would likewise be required prior to implementation by Georgia state-chartered banks.

Notwithstanding this broad permission, we think that most community banks will find the “Conversion Factor Matrix Method” to be less burdensome and easier to calculate. Under the Conversion Factor Matrix Method, credit exposure is calculated as follows:

Credit Exposure equals Current Credit Exposure plus Potential Future Exposure [12 CFR § 32.9(b)(1)(i)]

The exposure will remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction. The conversion matrix is set out in the legal lending limit rule adopted by the OCC and set out in the updated CFR.

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Swaps, Dodd-Frank and the Community Bank

Despite the breadth and complexity of Dodd-Frank regulation of derivatives, there are comparatively few key regulations that affect an interest rate swap offered by a typical community bank. This article provides an overview and a ray of hope that these regulations can be mastered by a community bank.

Less than 3% of banks under $1 billion in assets are engaging in interest rate swap transactions. Only 7% of all banks in the U.S. are doing so. Yet, virtually every community banker complains about losing good loans to larger banks offering long term fixed rate loans. Larger banks are only able to offer those fixed rate loans because they hedge the interest rate risk represented by a fixed rate loan with a corresponding interest rate swap. One would think that community banks would scramble to compete effectively by doing their own interest rate swaps.

A key reason for bankers’ hesitation is a misinformed concern about the regulatory and accounting burdens. Some bankers mistakenly believe that their regulators forbid them from engaging in any derivative transactions such as an interest rate swap. Let’s examine each of these common fears and compare to regulatory reality.

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Legal Lending Limits and Credit Exposure for Derivatives

On June 19, 2013, the OCC issued a final rule (the “Rule”) updating its existing regulations on legal lending limits in response to Section 610 of the Dodd Frank Act. Section 610 amended the federal lending limits statute, (12 USC § 84) to include credit exposures arising from derivative transactions and repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The Rule also takes into account differences that existed between national banks and saving associations and preserves some of the statutory exceptions that savings associations previously enjoyed. The Rule replaces, and modifies to some extent, the Interim Rule adopted on June 20, 2012. The Rule provides three different methods for calculating credit exposure, one of which will be applicable to larger banks and two that will be more attractive to regional and community banks.

The Rule is relevant to state chartered banks as well since Section 611 of Dodd Frank provides that state banks may only engage in derivative transactions if the law of the sate takes into account credit exposure to derivatives. Over the last two years state legislatures passed laws addressing this issue.  [See, e.g.: GA Code Ann § 7-1-285 amended to include credit exposure under a derivative when calculating a bank’s legal lending limit to any one borrower]. State banking departments have also promulgated rules advising state chartered banks on which model they should follow. [See, e.g., California:  “California state chartered banks shall use the Conversion Factor Matrix Method to determine the credit exposure of derivative transactions for purposes of complying with California’s lending limit;” Maryland: “For the purposes of calculating the Derivative-Securities Credit Exposure for compliance with the Maryland Limit, the Commissioner will require state-chartered banking institutions to measure the Derivative-Securities Credit Exposure in accordance with and subject to the limitations and exemptions under the OCC’s Interim Final Rule, as amended by the final rule upon issuance.”]

The Georgia  DBF has confirmed that Georgia charted banks will be able to use any of the methodologies permissible for national banks when determining credit exposure for derivatives, subject to review through the examination process as to their appropriate implementation. For those elements of the OCC methodology requiring the written approval of the OCC prior to implementation, the Department’s written approval would likewise be required prior to implementation by Georgia state-chartered banks. Notwithstanding this broad permission, we think that most community banks will find the “Conversion Factor Matrix Method” to be less burdensome and easier to calculate.

Under the Conversion Factor Matrix Method, credit exposure is calculated as follows:

Credit Exposure equals Current Credit Exposure plus Potential Future Exposure [12 CFR § 32.9(b)(1)(i)]

The exposure will remain fixed at the potential future credit exposure of the derivative transaction as determined at the execution of the transaction. The conversion matrix is set out in the legal lending limit rule adopted by the OCC and set out in the updated CFR.

The Rule lends itself very well to state regulatory application in that it is devised in a manner that will allow banks to adopt a compliance regimen that fits their size and risk management requirements, subject to an overall requirement that whichever method they choose is always subject to safety and soundness requirements.

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Legal Lending Limits and Credit Exposure for Derivatives

On June 20, 2012,  the OCC issued an interim final rule (the “Rule”) that amends its existing regulations on legal lending limit in response to Section 610 of the Dodd Frank Act. Section 610 amended the federal lending limits statute, (12 USC § 84) to include credit exposures arising from derivative transactions and repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions. The Rule also takes into account differences that existed between national banks and saving associations and preserves some of the statutory exceptions that savings associations previously enjoyed. The Rule provides three different methods for calculating credit exposure, one of which will be applicable to larger banks and two that will be more attractive to regional and community banks.

The Rule is relevant to state chartered banks as well since Section 611 of Dodd Frank provides that state banks may only engage in derivative transactions if the law of the sate takes into account credit exposure to derivatives. During the past legislative session many state legislatures passed laws addressing this issue.  For example, Georgia amended its legal lending limit statute, GA Code Ann § 7-1-285 to include credit exposure under a derivative when calculating its legal lending limit to any one borrower. The Georgia statute also allows a bank to determine the actual credit exposure pursuant to a methodology acceptable to the Department of Banking and Finance and the bank’s primary federal regulator. One would expect the various state regulators to look very carefully at the three options presented by the OCC when determining the method they will approve for their respective state. The Rule lends itself very well to state regulatory application in that it is devised in a manner that will allow banks to adopt a compliance regimen that fits their size and risk management requirements, subject to an overall requirement that whichever method they choose is always subject to safety and soundness requirements.

Specifically, the Rule provides that banks can choose to measure the credit exposure of derivatives (except credit derivatives) in one of three ways:

  1. through an OCC-approved internal model,
  2. by use of a look-up table that fixes the attributable exposure at the execution of the transaction, or
  3. by use of a look-up table that incorporates the current mark to market and a fixed add-on for each year of the transaction’s remaining life.

For credit derivatives (transactions in which banks buy or sell credit protection against loss on a third-party reference entity), the Rule provides a special process for calculating credit exposure, based on exposure to the counterparty and reference entity. With respect to securities financing transactions, institutions can choose to use either an OCC-approved internal model or fix the attributable exposure based on the type of transaction (repurchase agreement, reverse repurchase agreement, securities lending transaction, or securities borrowing transaction).

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Financial Services Update – July 22, 2011

Debt Limit Negotiations Continue

On Tuesday, the House passed its “Cut, Cap and Balance” legislation which would cut government spending now, cap it in the future and approve a constitutional amendment to balance the federal budget. On Friday, the Senate voted to table a motion to consider the measure. However, after another tense week of negotiations between the Senate Republicans, Senate Democrats, House Republicans, House Democrats, and the President Obama, the outline of a purported deal seemed to emerge late Thursday. Congressional Democrats reported that President Obama discussed with them a deal he had reached with Speaker John Boehner to raise the debt ceiling by $2.4 trillion, enough to get through the 2012 elections, with at least as much in immediate spending cuts and a promise of  “tax reform”  in 2012. On Friday, in response to the news of a “deal,” Speaker Boehner told the House Republican Conference there was “no deal,”  but that he will continue to negotiate with the White House over the weekend. The most important questions remaining are how many House Republicans will vote for a deal that does not include immediate tax increases but does include the promise of broader “tax reform” next year and how many House Democrats will vote for a deal with no tax increases.

Greece Gets Another Bailout

On Thursday, European finance ministers agreed to a new $157 billion financial aid package for Greece in exchange for forcing Greece’s bond holders to accept a bond exchange that gives them less than originally promised. The new plan for Greece will provide for the euro zone’s bailout fund and the International Monetary Fund to lend Greece $157 billion over the next three years at 3.5% interest. Private creditors who hold Greek debt that matures in the coming years will “voluntarily” turn in their bonds and accept new ones that mature far in the future.

The EU also agreed Thursday to an expansion of its bailout fund. That vehicle, once restricted to lending to countries near the brink of collapse, will now be able to buy euro-zone bonds on secondary markets to move prices and lend directly to countries even before they lose access to private funding and could even include lending to finance bank recapitalizations. The leaders also agreed to cut the once-lofty interest rates that the bailout fund charges and extend to as much as 30 years the maturities of the loans it provides. Ireland and Portugal, both currently receiving European aid, will get breaks on their interest rates to 3.5%. Ireland was paying around 6% on the EU portion of its euro 67.5 billion bailout.

Treasury Sells Off Remaining Stake of Chrysler

On Thursday, the Treasury Department sold its remaining stake in Chrysler losing a total of $1.3 billion. Italian automaker Fiat purchased the U.S. government’s remaining 6% stake in Chrysler for $560 million, formally concluding the $12.5-billion bailout.

Suit Against Goldman Dismissed

On Thursday, former Australian hedge fund Basis Yield Alpha’s legal challenge to Goldman Sachs’ infamous Timberwolf 2007-1 collateralized debt obligation was dismissed by Judge Barbara Jones of the U.S. District Court for the Southern District of New York. Jones cited a Supreme Court decision that held that U.S. securities-fraud laws apply only to domestic transactions.

Senate Banking Hearing on One Year Anniversary of Dodd-Frank

On Thursday, in a hearing before the Senate Banking Committee, federal banking regulators testified on the implementation of the Dodd-Frank Wall Street Reform Act. Regulators said they are moving fast enough to give markets certainty, but slow enough to get hundreds of new rules right. A handful of regulatory agencies are writing hundreds of new rules to police the swaps market, reduce risk at the biggest financial firms, and bring the so-called shadow banking system — which includes hedge funds and non-traditional lenders — into the traditional regulatory framework. The SEC and CFTC have struggled to keep pace with the swift rule-writing timeline laid out in Dodd-Frank, and are months behind schedule on many key rules. However, in a surprising move, Federal Reserve Chairman Ben Bernanke said federal bank regulators may rethink their crackdown on derivatives if a global agreement cannot be reached on margin requirements thereby acknowledging that U.S. banks would be at a significant competitive disadvantage if their foreign rivals do not have to demand margin, or collateral, for derivatives trades.

More Information:

If you have any questions regarding any of these issues, please contact:

Matt Jessee, Policy Advisor
matt.jessee@bryancave.com
1 314 259 2463

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Financial Services Update – April 29, 2011

Q1 GDP Slows to 1.8%

On Thursday, the Bureau of Economic Analysis announced that the U.S. GDP growth rate in the first quarter of 2011 slowed to an annual rate of 1.8 percent, compared to a rate of 3.1 percent in fourth quarter 2010 and 3.7 percent in first quarter 2010. The Bureau cited a combination of lower-than-expected economic data, global energy uncertainty, and concerns about the budget deficit as causes of the growth rate decelerating.

Bernanke Announces Rates to Stay at Near Zero, Ends Bond Buying Program

On Wednesday, Federal Reserve Chairman Ben Bernanke held his first quarterly press conference in which he said that the economy and job market are improving moderately, but the housing market and other factors such as gas prices continue to be a drag on growth. He announced that the Fed plans to end the $600 billion treasury bond-buying program in June and will leave interest rates at their current levels. The event followed a two-day meeting of the Fed’s policymaking committee at which the central bank indicated continuity in its strategy. The Fed’s bond buying program known as the second round of quantitative easing, or “QE2,” will expire as scheduled at the end of June. The Fed also maintained its near-zero target for short-term interest rates, where it has been since December 2008, and indicated that it expects to keep rates “exceptionally low” for “an extended period.”

Debt Ceiling Vote

The vote to increase the U.S. government’s borrowing ceiling beyond the current limit of $14 trillion has become the hot topic in Congress. While the Treasury Department’s original estimate was that the ceiling would need to be raised by mid-May, the Department is now saying it could hold out till July but would need to take extraordinary measures. While the measure is expected to easily pass the Senate, the question remains whether the House can pass such a bill. House Speaker John Boehner (R-OH) said this week that he will not guarantee a vote on bill to raise the debt limit, much less passage of such a bill, without cuts in discretionary spending and alterations of entitlements such as Medicare and Medicaid. Congress returns next week from its two week recess, and House Republicans plan to hold a series of meetings to gather feedback from their Members about the debt ceiling.

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Financial Services Update – April 22, 2011

Japan Announces Disaster Relief Fund

On Friday, Japanese Finance Minister Yoshihiko Noda announced a 4 trillion yen ($48.5 billion) emergency budget for disaster relief in the wake of the nuclear crisis triggered by the March tsunami. Noda said the government would not issue new bonds to pay for the fund, and the cabinet plans to submit the emergency budget to parliament on April 28. Given that the material damage alone from the disaster could top $300 billion, the government is expected to seek additional future disaster funding that will likely require tax increases and debt financing.

Justice Department Examines NYSE/Nasdaq/ICE Merger

On Wednesday, Nasdaq-OMX CEO Robert Greifeld and ICE CEO Jeffrey Sprecher disclosed in a letter to NYSE Euronext’s board that they are in discussions with the antitrust division of the Justice Department (DOJ) after buying NYSE Euronext stock which triggered the DOJ’s antitrust review. The letter also disclosed that Nasdaq-OMX and ICE are willing to pay NYSE Euronext $350 million if DOJ blocks their proposed takeover, an offer they say is now based on “fully committed financing” of $3.8 billion.

On April 10, NYSE Euronext ’s board rejected the Nasdaq/ICE unsolicited $11.3 billion proposal and affirmed its February agreement to merge with Deutsche Boerse AG for $9.5 billion in stock. The agreement with Deutsche Boerse includes a payout of 250 million euros ($358 million) should that deal fall apart.  NYSE Euronext acknowledged that it had received the Nasdaq/ICE reverse break up free proposal and that its board is reviewing the matter.

S&P Changes U.S. Long Term Rating from Stable to Negative

On Monday, Standard & Poor’s Ratings Services (S&P) changed its outlook on the U.S. long-term credit rating from stable to negative because ” the U.S. has relative to its ‘AAA’ peers very large budget deficits, rising government indebtedness, and the path to addressing these is not clear.”  While the S&P affirmed the U.S. ‘AAA’ long-term and ‘A-1+’ short-term sovereign credit ratings, it also predicted at least a one-in-three chance that it could lower its long-term rating on the U.S. within two years because of the increased risk that the political negotiations over when and how to address both the medium and long-term fiscal challenges will persist until at least after the elections in 2012.

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Financial Services Update – February 4, 2011

Warren Interviews AGs for Consumer Protection Agency

Reports this week indicate that Elizabeth Warren, who is interim head of the U.S. Consumer Financial Protection Bureau, has interviewed four Democratic state attorneys general to be her permanent successor. The four AGs reportedly in the running are Tom Miller of Iowa, Lisa Madigan of Illinois, Roy Cooper of North Carolina and Martha Coakley of Massachusetts. The bureau is scheduled to officially start work on July 21. Under the Dodd-Frank Wall Street Reform Act, which President Obama signed in July, the bureau must have a Senate-confirmed director to perform certain functions such as the supervision and regulation of non-bank financial firms.

House Republicans Release Top Line Budget Numbers

With President Obama set to release his FY 2012 budget on February 14, House Republican leaders on Thursday announced they would seek $32 billion in spending cuts from the resolution currently funding the government. Republicans framed their proposal as cutting $74 billion from President Obama’s 2011 budget request.  However, because Obama’s budget was never approved by the last Congress, the cuts would actually be made against a continuing resolution now funding the government. That resolution is to expire on March 4, and if lawmakers do not agree on another short-term measure or one funding the government for the rest of the year, they risk a government shutdown. The spending ceiling announced by House Budget Committee Chairman Paul Ryan (R-WI) represents a $58 billion cut in non-security discretionary funding. While details of the specific department cuts were not announced on Thursday, the House Appropriations Committee next week will release its bill detailing the specific department budgets based on the spending ceiling. Reports indicate that the Democratic majority in the Senate is opposed to the House Republican budget cuts.

TARP Program Breaks Even with Fifth Third Bank Repayment

On Thursday, the Treasury Department announced that Fifth Third Bank has now fully repaid its $3.4 billion in TARP loans and that total repayments and other income from programs within TARP (approximately $243 billion) have nearly surpassed total disbursements under those programs (approximately $245 billion). The Treasury Department also announced that current estimates indicate that bank programs within TARP will ultimately provide a profit of nearly $20 billion to taxpayers.

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Financial Services Update

Financial Services Update

October 2, 2010

Authored by: Matt Jessee

Kaufman To Replace Warren At TARP

On Thursday, Senator Harry Reid (D-NV) announced that Senator Ted Kaufman (D-DE) was appointed to replace Elizabeth Warren as chair of the Congressional Oversight Panel for the Troubled Assets Relief Program (TARP). Kaufman was appointed to fill then-Senator Joe Biden’s remaining two years of his Senate term after being elected Vice President. Kaufman will serve until a new Senator from Delaware is sworn in on November 15 

Dodd-Frank Implementation Delayed

On Wednesday, Congress passed a spending bill to fund government operations through early December and then recessed until after the November election. However, requested budget increases for financial regulators were not included in the spending bill, which will likely result in the delay in implementation of the Dodd-Frank Wall Street Reform Act until 2011. The funding shortage would be particularly impactful on the Commodity Futures Trading Commission and Securities and Exchange Commission, which will be responsible for oversight of the over-the-counter derivatives market. Republicans, who overwhelmingly voted against the Dodd-Frank law, are poised for significant gains in the elections. If Republicans win a majority in either chamber, they have promised to block the requested funding increases for the SEC and CFTC in order to hamper the law’s implementation. 

On Thursday, Federal Reserve Chairman Ben Bernanke, Deputy Treasury Secretary Neal Wolin, Securities and Exchange Commission Chairman Mary Shapiro, Commodity Futures Trading Commission Chairman Gary Gensler, and FDIC Chairman Sheila Behr indicated to the Senate Banking Committee that their agencies will work together to ensure the Dodd-Frank Wall Street Reform Act is implemented effectively. However, Republicans questioned whether the regulators had too much power to design and implement the new regulatory structure. Behr testified that the FDIC delayed a vote on its first major rulemaking for the law this week, and Gensler testified that a list of rules his agency must pass for derivatives markets will not be ready for statute-imposed deadlines. Overall, the bill requires the regulators to write more than 500 rules, conduct 81 studies, and submit 93 reports in coming years.

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