Can we go back to the topic of disclosures in relation to swept balances to paydown a line of credit? I have a few questions/clarifications:

1. True- these are covered sweeps and customers will need a disclosure?

Based on the ABA Telephone briefing (see slide #15), would a bank have to disclose to their sweep to LOC customer's that in the event of a bank failure:

"If the bank was acquired (purchased and assumed) the sweep product would normally be transferred to the acquiring institution. Any funds used to paydown the customer's loan would be available to be swept back to the customer's account, business as usual." or
"In a payoff the FDIC would recognize the customer's reduced loan balance and p-ay the balance in the deposit account (as reflected in the institution's end-of-the-day of failure according to the normal insurance procedures."

2. Do you agree we have to tell our sweep to LOC customer's this? If so, ouch, this is not going to be pretty.

Yes. You also need to understand operationally when your sweep occurs to determine whether you may be impacted by FDIC's Cutoff Point.

Thanks for the response Brenda. I'm not sure what you mean by FDIC's cutoff point?

From FDIC:

"The FDIC’s intention is to complete internal postings of transactions presented or authorized prior to the institution’s normal cutoff rules or the FDIC Cutoff Point, as applicable, according to the depository institution’s normal procedures—thus, as explained below, the nature of the liability may change after the FDIC Cutoff Point. Any transaction—including sweep arrangements—would be completed for that day according to normal procedures if it involves only the movement of funds between accounts within the confines of the depository institution.

Some sweep arrangements shift funds within the depository institution from a deposit account to ownership in a sweep investment vehicle. The value and nature of these claims will be determined as they rest on the books and records of the depository institution as reflected in its end-of-day ledger balances.

If the institution’s ordinary cutoff time for the day’s business on the day of failure for any particular kind of transaction precedes the FDIC Cutoff Point, the institution’s ordinary cutoff time will be used. Where the institution’s ordinary cutoff time for an individual kind of transaction is later than the FDIC Cutoff Point, the institution’s cutoff time will be replaced by the FDIC Cutoff Point. The ‘‘Applicable Cutoff Time’’ used for any kind of transaction, thus, will be the earlier of the institution’s ordinary cutoff time or the FDIC Cutoff Point. Different kinds of transactions may have different Applicable Cutoff Times. Transactions occurring after the Applicable Cutoff Time will be posted as a subsequent day’s business, if the operations of the failed institution are carried on by a successor institution or by the FDIC as receiver or insurer."

I want to make sure I understand this. If we have customers who set up a transfer to take money out of their checking and transfer it to savings or money market (which are internal account) then these type of transfer are not included in the final rule?

Not this rule.

A few operational issues you may need to be looking at to ensure you have properly executed repos:

1) is your bank's securities custodian holding the securities held as collateral for repos in a SEPARATE account;
2) are you providing some type of daily client list to the bank's custodian confirming entities holding securities and confirming sale to these clients;
3) does the agreement with the custodian reference ability of client to take control of securities in event the bank can't meet its obligations to repurchase;
4) are your repo confirmations in compliance with Reg H and Government Securities Act to fully disclose securities to customers and FDIC (NOT, NOT, may disclosure)
5) are you allocating securities based on market value and not par value

This is challenging to say the least.

Brenda thank you again for all your help on this issue. One last question. In your list of 6 items a bank may want to consider to be sure the repo is properly executed, take a look at #5. With your "Not, Not, may" reference, are you referring to the NDIP disclosure "Not FDIC insured, Not guaranteed by the bank, may lose value"? I assume so, but I want to be sure.

Yes, that needs to be on the confirmations provided to the customers for repos collateralized by securities and other non-FDIC insured investments.

Does anyone have an example of their disclosure for repo accounts that they would like to share?

I thought there were two seperate definitions for loan transfer/sweep activity. One qualifies as a sweep and one does not.

I thought the "definition of sweep" did not apply to - "Sweeps to pay down (amortize) loan accounts where there is no return sweep to the originating deposit account;"

If the definition does not apply, then that type of loan transaction is not a sweep account;

if it is not a sweep account, then the sweep disclosure requirement does not apply.

However, under internal sweeps - "Sweeps from a deposit account to pay an existing loan where the funds are swept back into the originating deposit account. Funds that have been swept out of the deposit account will be used to reduce the loan balance: funds remaining in the deposit account are insured deposits."

Sweep disclosures are required for this type as worded in the second sentence.

Does anyone else agree with me? If I am wrong I would appreciate your comments.

I agree with your statements. We don't really have many sweeps for loan payments that will amortize the loan, thus our disclosure work will primarily focus on the 20 or so customers that sweep to paydown their Line of Credit (LOC). But as I stated in an earlier post..... the disclosures are not going to be pretty, but we are going to soften the disclosure language that was included in the ABA resentation and we also plan to translate it to customer-English. At the beginning of each disclosure we may state something like "All banks are required to provide you these new disclosures , blah, blah". Plus we plan to call our existing sweep-LOC customers and explain the required disclosure before we send it.

Good luck.

We have been going over REPO Sweep account. Couple of questions:

1. Does anyone have a definition of "Substitution"? This is where we seem to be hung up.

2. If our contract names us as an agent for the customer, we are then permitted to make investment decisions for the customer. If the customer does not like that choice, they tell us and we no longer use that investment option. Does this scenario satisfy the reg when it talks about "who controls" the security?

Thanks

To prevent having to deal with the issue of substitution, we modified our agreements with client and custodian to provide for a "quiet period". After close of business each day until next business morning no securities held as collateral may be traded. That way we won't have to worry about substitution issues on overnight repos.

I don't think you have properly addressed the issue of control and in the scenario described, you don't seem to have a properly executed sweep. Consider this info from ABA guidance:

"Properly executed sweeps generally involve a third-party custodian for the assets who takes direction to effect the transfer of funds or securities only from the repo customer. By contrast, “improperly executed” sweeps typically involve repos for which the bank retains control over the security or a pool of securities and simultaneously serves as the repo buyer’s custodial agent. This type of repo is often called a hold-in-custody, or HIC repo. Even though the assets are segregated in accordance with the Treasury Department’s rules under the Government Securities Act and the assets may be held at a correspondent bank or other third party, FDIC’s position is that a HIC repo gives the bank too much control over the securities for the customer to have a perfected security interest."

Brenda,


That is also one of the issues we are struggling with. Do you have "Repo Sweeps" and if you do, how are you handling the third party control?

Are there companies out there that act as the "third-party custodian for the assets who takes direction to effect the transfer of funds or securities only from the repo customer"?

As noted above, we are amending our custodian agreement. I think the way most of our repos have been working have not been worded to comply with this provision. This just wasn't how the industry generally worked. The bank served as the client agent and nobody ever questioned that practice.

Based on the guidance; however, I believe we have until July 1 to get in compliance with this requirement or face having violations of Reg Q and Reg D as well as a large account base that will qualify for the special FDIC assessment.

When going over the ruling and our contracts, we came to conclusion too that we appear to have the HIC type agreement.

I can see how the "quiet period" could help with the substitution part, but how are you amending your contracts to help with the control issue?

Does anyone have a draft of a letter they would be willing to share?

It is currently in our master agreement that we reserve the right to substitute securities. We do not as a matter of practice substitute securities but it would be necessary if the security was called or matures.

Would this type of substitution be allowed and if so would it still be considered a "properly executed" repo?

Do we need language in our master agreement to accomodate this situation?

How is everyone dealing with deleting from their agreements the right to substitute securities? As market values go up and down securities would be removed from or assigned to the customer. Would that be considered substitution or just addition and deletion with a base group of securities remaining intact?
What fun!

SJB,

But the way I am understanding this, we can't even do that for them. The customer has to have the control and make the order.

Do manual sweeps count? We have some commercial customers who have authorized us to sweep funds above a certain balance from their deposit account to pay down their line balances but they are handled manually at the end of the day by a clerk - Do we need to disclose?

We have an Ag Line of Credit that is attached to a Checking Account. The customer writes checks and when those checks present to the bank, the LOC advances (in the exact amount of the checks presented) to cover the checks presented that day. All this happens in the nightly processing.

Some customers will deposit additional funds into the checking account. After the outstanding checks are paid with the advance from the LOC, any remaining funds in the checking account are swept back to the loan to pay down the balance.

This is not a zero balance account in the sense that the account owner can deposit funds even when the LOC is paid to zero.

I do not believe that this requires the disclosure. No funds leave the institution, the checking account is an insured account. No funds go to an investment account of any kind. The account is settled daily. The LOC is not amortized.

There is a "sweep" involved. The "sweep" occurs at the initiation of the customer (by depositing additional funds in the checking account, that initiates the sweep to the LOC, but only when the LOC has a balance due)

I would love to have a second opinion

As you have described the account, I would agree that this does not require the disclosure.

It appears many of us use the "HIC" repo to accomodate our clients, but now will require a major overhaul to comply with the new rule. I can understand the urgency, but if we are using the FHLB as custodian, how do we get to the point where the buyer has control? It does not seem feasible if a security matures or is called that, the bank or buyer would not want to have the security replaced or "substiuted" to replace the maturing security. I am told that the bank and not the buyer would have to instruct the FHLB to transfer the security to the buyer, thereby not meeting the "properly executed" agreement in the eyes of the FDIC's new rule. All very confusing as these repo's have been around for years. Wondering if the FDIC is caught up in litigation over these very issues hence the final rules?

Anyone with any suggestions or clarification. We have only a handful of such accounts and would hate to discontinue the service. In its current configuration, the final rule and costs to comply would not be economically feasible for such a small group of accounts. Any suggestions or alternative products come to mind.

Have you spoken with FHLB to determine whether they are making any changes in their agreement to accommodate FDIC "clarification" on how our repos should be working? If these are strictly overnight repos, you may be able to accommodate with an agreement that securities pledged are not subject to being traded overnight (could possibly specify times like 6pm to 8 am) AND updates to your client agreement regarding control of the pledged securities.