The following policy statement
concerning retail and wholesale repurchase agreements addresses certain
disclosure and safety-and-soundness considerations stemming from reliance,
for funding purposes, on the issuance of these instruments.
With regard to retail repos (repurchase agreements
in denominations under $100,000 and less than 90 days to maturity),
banks are cautioned to (1) consult legal counsel on what constitutes
adequate disclosure to customers under applicable state and federal
securities laws, (2) take steps to avoid potential misrepresentation
of retail repos as insured deposits or obligations guaranteed by the
U.S. government, and (3) make certain other minimum disclosure concerning
the nature and principal characteristics of retail repos. The policy
also outlines certain prudential steps banks should take in the issuance
of large-denomination wholesale repurchase agreements.
With respect to asset-liability
management and funding, the policy addresses the safety-and-soundness
considerations stemming from reliance on what are essentially short-term,
potentially volatile market-rate liabilities.
The usage by banking organizations, for funding
purposes, of repurchase agreements involving U.S. government or agency
securities has increased dramatically over the past several months.
Although to date there have been few problems associated with this
activity, we believe that it is appropriate to bring to your attention
some considerations to reinforce your awareness of the need to proceed
cautiously in offering these instruments.
With respect to retail repurchase agreements (retail repos),
bank management should bear in mind that in some cases it is dealing
with customers who do not normally engage in large-denomination, money
market transactions. In addition, because of the complex nature of
retail repos and the possibility that retail repos may be confused
with insured deposits by the general public, all material facts of
a retail repo transaction should be disclosed to the customer. As
you are probably aware, the Securities and Exchange Commission has
taken the position that the antifraud provisions of federal securities
laws apply to the sale of retail repos and these instruments may be
further subject to various state securities laws. Banking organizations
engaging in or planning to engage in the sale of retail repos are
urged to consult and obtain the opinion of legal counsel competent
in the field of securities laws to determine what constitutes sufficient
disclosure to customers as well as to ensure compliance with the antifraud
and other applicable provisions of federal and state securities laws.
The face of all retail repurchase agreements should state
conspicuously and in boldface type that “the obligation is not a deposit
and is not insured by the Federal Deposit Insurance Corporation,”
and care should be taken to avoid the potential misrepresentation
that retail repos are guaranteed by the U.S. government. In addition
to ensuring that retail repos are not misconstrued as insured deposits,
we believe that, at a minimum, the following information concerning
retail repos should be communicated to customers:
- the nature and terms of retail repos, including interest
rates paid, maturities, and any prepayment fees
- a description of and approximate market value of
the underlying security or fractional interest thereof collateralizing
the agreements
- a statement that the interest paid on a retail repo
is not necessarily related to the yield on the underlying collateral
- a statement that the bank will pay at maturity a fixed
amount, including interest on the purchase price, regardless of any
fluctuation in the market value of the underlying collateral
- a statement that general banking assets will most
likely be used to satisfy the bank’s obligation rather than proceeds
from the sale of the underlying security
- a statement that the market value of the collateral
could depreciate before the maturity of the agreement, thus making
the investor an unsecured creditor of the bank for the difference
between the repurchase price of the retail repo and the market value
of the underlying collateral
- information advising the customer whether he or she
has a perfected lien on the underlying collateral under state law,
and whether it is being held by an independent trustee or custodian
(If the customer does not have a perfected security interest, the
legal consequences, including the possibility of becoming an unsecured
general creditor, should be described.)
- appropriate information regarding the bank and its
financial condition
If the retail repo agreement itself does not
include all material disclosures, the face of the agreement should
make specific reference to other documents provided to the customer
containing sufficient material disclosures.
Care should also be taken with respect to the advertising
and marketing of retail repos. All advertisements, announcements,
and solicitations for retail repos should state that they are not
deposits of the issuing bank and are not insured by the FDIC. Advertisements
and other documents provided to the customers that refer to the underlying
U.S. government or agency obligations securing retail repos should
disclose sufficient information to avoid the potential misrepresentation
that retail repos are guaranteed by the U.S. government.
As a matter of prudent banking practice
and in order to provide a cushion of protection for individuals who
purchase retail repos, the market value of the underlying security
should be equal to or exceed the purchase price of the retail repo
at the time of issuance. In addition, in order to avoid the potential
for conflicts of interest, a bank should not sell its retail repos
to its own trust department or to trust agency accounts over which
it or any affiliate has investment discretion.
Since both retail and large-denomination wholesale
repurchase agreements are in many respects equivalent to short-term
borrowings at market rates of interest, banks engaging in repurchase
agreements should carefully evaluate their interest-rate risk exposure
at various maturity levels, formulate policy objectives in light of
the institution’s entire asset and liability mix, and adopt procedures
to control mismatches between assets and liabilities. The degree to
which a bank borrows through repurchase agreements also should be
analyzed with respect to its liquidity needs, and contingency plans
should provide for alternate sources of funds in the event of a run-off
of repurchase agreement liabilities.
Bank management also should be aware of certain considerations
and potential risks associated with wholesale repurchase agreements
entered into in large volume with institutional investors and/or brokers.
If the value of the underlying securities exceeds the price at which
the repurchase agreement was sold, the bank could be exposed to the
risk of loss in the event that the buyer is unable to perform and
return the securities. The possibility of this occurring would obviously
increase if the securities are physically transferred to the institution
or broker with which the bank has entered into the repurchase agreement.
Moreover, if the securities are not returned, the bank could be exposed
to the possibility of a significant write-off to the extent that the
book value of the securities exceeds the price at which the securities
were originally sold under the repurchase agreement. For this reason,
banks should obtain sufficient financial information on and analyze
the financial condition of those institutions and brokers with whom
they engage in repurchase transactions.
Federal Reserve examiners will be asked to review each
bank’s internal procedures and practices for consistency with the
considerations discussed above. S-2457; April 13, 1982.
