Final Rule for FDIC’s Temporary Liquidity Guarantee Program: Important Changes

By: KAREN L. GRANDSTRAND & KARLA L. REYERSON

November 26, 2008

On November 21, 2008, the Federal Deposit Insurance Corporation (FDIC) adopted a final rule (Final Rule) for implementing its Temporary Liquidity Guarantee Program (TLG Program), a measure designed to promote financial stability by preserving confidence in the U.S. banking system and encouraging liquidity in order to ease lending to creditworthy businesses and consumers.

The TLG Program consists of two components—the Debt Guarantee Program (Debt Program), which guarantees certain senior unsecured debt issued by participating banks, and the Transaction Account Guarantee Program (TAG Program), which fully insures all noninterest-bearing transaction accounts of participating depository institutions.

The FDIC’s Final Rule for the TLG Program contains several substantive changes to the interim rule (Interim Rule), which was published on October 29, 2008, and amended on November 7, 2008, to extend the deadlines for opting out of the program, among other changes. This article discusses the changes embodied in the Final Rule. For additional information regarding the TLG Program, see our article dated November 21, 2008 and the FDIC’s Temporary Liquidity Guarantee Program Frequently Asked Questions.

Changes to the Debt Program

Definition of Senior Unsecured Debt

The FDIC’s Final Rule includes a modified definition of what constitutes Senior Unsecured Debt that will be covered under the Debt Program. First, between October 14, 2008 and December 5, 2008 Senior Unsecured Debt is defined as an unsecured borrowing with the following characteristics:

1. Evidenced by a written agreement or trade confirmation;
2. Having a specified and fixed principal amount;
3. Noncontingent and containing no embedded options, forwards, swaps, or other derivatives; and
4. Not, by its terms, subordinated to any other liability.

The definition above is substantially similar to the definition provided in the Interim Rule. Beginning December 6, 2008, however, debt will only be eligible for coverage under the Debt Program if it meets the requirements enumerated above and has a stated maturity of more than 30 days (or more than “one month”). The FDIC indicated that it decided to exclude debt issuances of 30 days or less after December 5, 2008 because it recognized that the cost of guaranteeing such short-term borrowings under the Debt Program would be prohibitively expensive. It also determined that guaranteeing such products would not serve the purpose of improving liquidity in the inter-bank lending market.

Calculation of an Entity’s Debt Guarantee Limit

The Final Rule does not modify the calculation of a bank or bank holding company’s debt guarantee limit for those entities that had Senior Unsecured Debt outstanding on September 30, 2008. For such entities, the maximum amount of Senior Unsecured Debt that the FDIC will guarantee under the Debt Program continues to equal 125% of the par value of the participating entity’s Senior Unsecured Debt that was outstanding as of the close of business September 30, 2008 and that was scheduled to mature on or before June 30, 2009. Entities must include in their calculations otherwise qualifying debt with a stated maturity of 30 days or less that was outstanding on September 30, 2008, but they should not include overnight debt.

The Final Rule provides an alternate method for calculating the debt guarantee limit for banks that did not have any Senior Unsecured Debt or only had federal funds purchased outstanding as of September 30, 2008. For such an institution, the debt guarantee limit will be equal to 2% of the institution’s consolidated total liabilities as of September 30, 2008, according to the institution’s Call Report.

The Final Rule does not provide an alternate method for calculating the debt guarantee limit for bank holding companies that did not have any Senior Unsecured Debt outstanding as of September 30, 2008. If these entities would like to have some amount of debt covered under the Debt Program, they must make a request to the FDIC. The FDIC will decide such requests on a case-by-case basis and intends to consult with the federal banking agency for any bank holding company making such a request.

The FDIC may allow an entity to either exceed its debt guarantee limit or lower it, upon the entity’s written request. The FDIC will consult the entity’s federal banking agency when considering such requests.

The Final Rule also allows banks that are owned by a bank holding company to issue the guaranteed debt available to the bank holding company through the bank. Banks that are part of a multi-bank holding company structure may only issue guaranteed debt of the holding company to the extent that other banks in the structure have not already done so on behalf of the holding company. A bank desiring to issue guaranteed debt on behalf of its holding company must give prior written notice both to the holding company and to the FDIC. Holding companies are not allowed to issue guaranteed debt using their bank’s debt guarantee limit.

The Final Rule indicates that upon merger of two entities eligible for participation in the Debt Program, the debt guarantee limit of the surviving entity of a merger will be equal to the combined debt guarantee limits of both entities calculated on a pro forma basis as of the close of business September 30, 2008, unless the FDIC, after consultation with the surviving entity and its appropriate federal banking agency, determines otherwise. If the acquiring entity previously opted out of the Debt Program, it will have a one-time option to opt in by filing an application with the FDIC.

Trigger for FDIC Payment Obligations

One of the major changes to the Debt Program adopted in the Final Rule involves the triggering event that will cause the FDIC to make payments to a creditor pursuant to the guarantee. The Interim Rule provided that the FDIC would make payments under the guarantee if a bank participant failed or if a bank holding company participant filed for bankruptcy.

In order to ensure that FDIC-guaranteed debt instruments will be widely accepted within the investment community, the FDIC changed the Final Rule to provide that the FDIC’s obligation to pay holders of FDIC-guaranteed debt issued by a participating entity shall arise upon the uncured failure of such entity to make a timely payment of principal or interest as required under the debt instrument (Payment Default). Upon a Payment Default, the FDIC will continue to make scheduled interest and principal payments under the terms of the debt instrument through maturity. For instruments with a maturity after June 30, 2012, the FDIC may, after that date, decide to make a payment in full of all outstanding principal and interest under the debt issuance.

Participating entities will be required to execute and file a master agreement with the FDIC that, among other things, provides for the repayment of the debt the entity owes to the FDIC resulting from any payment the FDIC makes under the guarantee (the Master Agreement). The Master Agreement also prescribes terms that must be included in the governing documents between the entity and debtholder for any future issuances of guaranteed debt.

Fee Structure

The Final Rule also includes changes to the fee structure for the Debt Program. Several commenters had indicated that the fees for shorter term debt were too high. Consequently, under the Final Rule the annualized assessment rate for debt with a maturity of 180 days or less will be 50 basis points. Debt with a maturity between 181 and 364 days will be assessed 75 basis points, and debt with a maturity of 365 days or more will be assessed 100 basis points.

In addition, the Final Rule includes a slightly higher assessment rate for bank holding companies in which the combined assets of all insured depository institutions affiliated with such entity constituted less than 50% of consolidated holding company assets as of September 30, 2008. For these bank holding companies, the assessment rates above will be increased by 10 basis points.

The penalty amounts assessed to those entities that exceed their debt guarantee limit is still twice the amount that would otherwise be assessed. The Final Rule indicates that the FDIC may lower the penalty amount for good cause shown.

Notice Requirements

The Final Rule requires that the following disclosure be included in all written materials provided to lenders or creditors regarding any Senior Unsecured Debt issued by it on or after December 19, 2008 through June 30, 2009 that is guaranteed under the Debt Program:

This debt is guaranteed under the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program and is backed by the full faith and credit of the United States. The details of the FDIC guarantee are provided in the FDIC’s regulations, 12 CFR Part 370, and at the FDIC’s website, www.fdic.gov/tlgp. The expiration date of the FDIC’s guarantee is the earlier of the maturity date of the debt or June 30, 2012.

In addition, participating entities must provide the following disclosure in all written materials provided to lenders or creditors regarding any Senior Unsecured Debt issued by it on or after December 19, 2008 through June 30, 2009 that is not guaranteed under the Debt Program:

This debt is not guaranteed under the Federal Deposit Insurance Corporation’s Temporary Liquidity Guarantee Program.

Changes to the TAG Program

Definition of Noninterest-Bearing Transaction Account

Perhaps the most significant change to the TAG Program is the expansion of the types of accounts considered to be noninterest-bearing transaction accounts, which are fully guaranteed for those entities participating in the TAG Program. The basic definition of a noninterest-bearing transaction account remains the same. Such an account exhibits the following characteristics:

1. The account is maintained at an insured depository institution;
2. The account does not accrue or pay interest; and
3. The insured depository institution does not reserve the right to require advance notice of an intended withdrawal.

The Final Rule makes two notable exceptions to the above definition. First, Interest on Lawyers Trust Accounts (IOLTAs) are now covered under the TAG Program. In addition, negotiable order of withdrawal accounts (NOW Accounts) that have interest rates no higher than .50% are covered if the bank commits to maintain the interest rate at or below .50% through December 31, 2009. Any NOW Account that has a rate in excess of .50% may become eligible for coverage if, prior to January 1, 2009, the institution holding the account reduces the interest rate to .50% or lower and commits to maintain a rate no higher than .50% through December 31, 2009.

Notice Requirements

The FDIC provides safe harbor sample notices for participants in the TAG Program and for institutions that opt out of participation. Any institution that offers noninterest-bearing transaction accounts, including IOLTAs and NOW Accounts as defined under the Final Rule, must display a lobby notice by December 19, 2008 indicating whether it is participating in the TAG Program. In addition, if an institution offers Internet deposit services, it must post a notice on its website. The following is the safe harbor sample notice for institutions that participate in the TAG Program:

[Institution Name] is participating in the FDIC’s Transaction Account Guarantee Program. Under that program, through December 31, 2009, all noninterestbearing transaction accounts are fully guaranteed by the FDIC for the entire amount in the account. Coverage under the Transaction Account Guarantee Program is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules.

The following is the safe harbor sample notice for institutions that do not participate in the TAG Program:

[Institution Name] has chosen not to participate in the FDIC’s Transaction Account Guarantee Program. Customers of [Institution Name] with noninterestbearing transaction accounts will continue to be insured through December 31, 2009 for up to $250,000 under the FDIC’s general deposit insurance rules.

Institutions that wish to modify or supplement these notices are allowed to do so, provided that the notice used clearly indicates whether the institution is participating in the TAG Program and, if the institution is participating, states that funds held in noninterest-bearing transaction accounts at the entity are guaranteed in full by the FDIC. The Final Rule specifically indicates that institutions who do not participate in the TAG Program may add information explaining the reasons for their nonparticipation.

The Final Rule continues to require institutions to give notice to customers whose funds are swept into, transferred to, or reclassified as, an account that is not guaranteed under the TAG Program. The notice must advise affected customers that such actions will void the FDIC’s guarantee with respect to the swept, transferred, or reclassified funds. The FDIC declined to offer a safe harbor sample notice or any required language to be included in the notice because it determined that the complexity and diversity of these products make it preferable for institutions to fashion their own disclosures.

Similarly, participants are required to disclose to depositors special situations where coverage under the TAG Program may or may not be available. The FDIC gives as an example official checks drawn on another insured depository institution. The payees of such checks are covered under the TAG Program only if the other institution is a participant. As with all other disclosures required under the TLG Program, such disclosures must be accurate, clear, and in writing and must be provided beginning December 19, 2008.

Making the Election

Banks and bank holding companies have until December 5, 2008 to analyze the Final Rule and to file an election form via FDICconnect. Those entities not using the election form to opt out of one or both programs must use it to disclose the amount of qualifying debt the entity has as of close of business September 30, 2008 that is scheduled to mature on or before June 30, 2009. The FDIC expressed confidence that the modifications it adopted as part of the Final Rule for the TLG Program will result in significant participation in the TLG Program. In the end, however, each entity needs to review these changes in conjunction with the provisions of the TLG Program that have not changed to determine whether participation in these programs still, or now, makes sense.