We are having discussions with clients regarding the possibility of issuing FDIC-guaranteed debt under the TLGP’s Debt Guarantee Program at the holding company level and using the proceeds of that debt to increase the capital of the bank subsidiary.  This is particularly attractive for banks that are eligible to report their risk-based capital positions on a bank-only basis.  (The Federal Reserve’s risk-based capital measures are generally applied on a bank-only basis for bank holding companies with consolidated assets of less than $500 million.)

Permissible Use for BHC FDIC-Guaranteed Debt

The FDIC’s Frequently Asked Questions (FAQ) explicitly permits a bank holding company to use the proceeds from a guaranteed debt issuance to purchase additional shares of bank stock.

Need to Apply to FDIC for Approval

In our experience, however, most bank holding companies for community banks had no, or very limited amounts of, senior unsecured debt outstanding as of September 30, 2008.  As a result, the bank holding company will have to file a letter application with the FDIC and, if different, the federal banking regulator for its largest subsidiary bank to establish an FDIC-guaranteed debt limit.  The letter application must describe the details of the request, provide a summary of the applicant’s strategic operating plan, and describe the proposed use of the debt proceeds.

In evaluating applications from bank holding companies to establish or increase their limit, the FDIC has stated that it will consider the extent of the financial activity of the entities within the holding company structure, the strength, from a ratings perspective, of the issuer of the obligations that will be guaranteed, and the size and extent of the activities of the organization.  In addition, the FDIC may consider any other relevant factors and/or impose any conditions it deems appropriate.

Odds of Success

The updated FAQ indicates that applications will be “closely” evaluated, and approvals will be granted “on a limited basis.”

The Temporary Liquidity Guarantee Program and the Debt Guarantee component were designed to promote financial stability in the system by “preserving confidence in the banking system and encouraging liquidity in order to ease lending to creditworthy businesses and consumers.”  The programs were not originally designed to serve as a source of capital, unlike the TARP Capital program.  However, these programs, and the advice from the banking regulators, are continually shifting to meet changing demands.

We understand that bank holding companies which have approached the FDIC have generally gotten positive preliminary feedback.  However, to date, we are not aware of any bank holding company that has received formal approval to issue FDIC-guaranteed debt for the purpose of increasing the capital of its subsidiary.

Another Potential Limitation

For de novo institutions, or institutions subject to formal agreements with their primary federal regulators, the issuance of debt at the bank holding company level is also likely to be subject to approval by the Federal Reserve.

Short Term Capital

Since the FDIC guarantee is set to expire on June 30, 2012, institutions relying on bank holding company-issued FDIC-guaranteed debt will need to replace the guaranteed debt with other capital within three years.  This strategy represents a bet that the market for bank stocks will recover within three years to permit the entity to replace the debt capital, or that the Bank’s earnings will be sufficient to redeem or refinance the debt capital.