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FEDERAL RESERVE BANK OF NEW YORK tSfQ tff/rtZ & ftZ ) A p r il 2 1 , 1 9 8 2 RETAIL AND WHOLESALE REPURCHASE AGREEMENTS T o th e C h i e f E x e c u tiv e O f f ic e r o f E a c h S ta te M e m b e r B a n k in th e S e c o n d F e d e r a l R e s e r v e D i s tr ic t: The u sa g e by banking o r g a n iz a tio n s for funding p u rp oses o f rep u rch a se a g r e e m e n ts in v o lv in g U .S . g o v e r n m e n t or a g e n c y s e c u r it ie s has in c r e a se d d r a m a tic a lly o v e r th e p a st s e v e r a l m o n th s. a s s o c ia te d w ith A lth ou gh to d a te th e r e h a v e b een th is a c t iv it y , w e b e lie v e th a t it fe w p rob lem s is ap p ro p ria te to bring to your a tte n tio n so m e c o n sid e r a tio n s to r e in fo r c e your a w a r e n e ss o f th e n eed to p r o c e e d c a u tio u s ly in o ffe r in g th e s e in str u m e n ts. W ith r e s p e c t to r e ta il rep u rch a se a g r e e m e n ts (r e ta il rep os), bank m a n a g e m en t should b ear in m ind th a t in so m e c a s e s it is d e a lin g w ith c u sto m e r s who do n ot n o rm a lly e n g a g e in la r g e d e n o m in a tio n , m on ey m a rk et tr a n sa c tio n s. In a d d itio n , b e c a u s e o f th e c o m p le x n a tu re o f r e ta il repos and th e p o ssib ility th a t r e ta il rep os m ay b e c o n fu se d w ith insured d e p o sits by th e g e n e r a l p u b lic, all m a te r ia l f a c t s o f a r e ta il repo tr a n sa c tio n should be d isc lo se d to th e c u s to m e r . S e c u r itie s and E x ch a n g e C o m m issio n has ta k en A s you are p robably a w a r e , th e th e p o sitio n th a t th e a n tifra u d p ro v isio n s o f F e d e r a l s e c u r it ie s la w s apply to th e s a le o f r e ta il rep os, and th e s e in s tr u m e n ts m ay be fu rth er su b je c t to v a rio u s S ta te s e c u r it ie s la w s. Banking o r g a n iz a tio n s en g a g in g in or plan n in g to e n g a g e in th e s a le o f r e ta il rep os a re urged to c o n s u lt and o b ta in th e op in ion o f le g a l c o u n se l c o m p e te n t in th e fie ld o f s e c u r it ie s la w s to d e te r m in e w h at c o n s t it u t e s s u f f ic ie n t d isc lo su r e to c u s to m e r s a s w e ll as to e n su re c o m p lia n c e w ith th e a n tifr a u d and o th e r a p p lic a b le p ro v isio n s o f F e d e r a l and S ta te s e c u r it ie s la w s. - 2 - T he f a c e o f a ll r e ta il r ep u rch a se a g r e e m e n ts should s t a t e c o n sp ic u o u sly and in b o ld - fa c e ty p e th a t "the o b lig a tio n is n ot a d e p o sit and is n o t insured by th e F e d e r a l D e p o s it Insu ran ce C o rp o ra tio n ," and c a r e should b e ta k en to avoid th e p o te n tia l m is r e p r e s e n ta tio n th a t r e ta il rep os a re g u a r a n te ed by th e U .S . g o v e r n m e n t. In a d d itio n to en su rin g th a t r e ta il repos a re not m isc o n str u e d as insured d e p o s its , we b e lie v e t h a t, a t a m in im u m , th e fo llo w in g in fo r m a tio n c o n c e rn in g r e ta il rep os should b e c o m m u n ic a te d to c u sto m e r s: 1. T he n atu re and te r m s o f r e ta il rep o s, m a tu r itie s and any p r e p a y m en t f e e s . in clu d in g in te r e s t r a te s paid, 2. A d e sc r ip tio n o f and a p p r o x im a te m a rk et v a lu e o f th e u n d erlyin g s e c u r ity or fr a c tio n a l in te r e s t th e r e o f c o lla t e r a liz in g th e a g r e e m e n ts. 3. A s ta t e m e n t th a t th e in te r e s t paid on a r e ta il repo is n ot n e c e ss a r ily r e la te d to th e y ie ld on th e u n d erlyin g c o lla t e r a l. 4. A s ta t e m e n t th a t th e bank w ill pay a t m a tu r ity a fix e d a m o u n t, in clu d in g in te r e s t on th e p u rch a se p r ic e , r e g a r d le ss o f any flu c tu a tio n in th e m a rk et v a lu e o f th e u n d erlyin g c o lla t e r a l. 5. A s ta t e m e n t th a t g e n e r a l banking a s s e t s w ill m o st lik e ly be used to s a tis fy th e bank's o b lig a tio n ra th er than p r o c e e d s from th e s a le o f th e u n d erlyin g s e c u r ity . 6. A s ta t e m e n t th a t th e m a rk et v a lu e o f th e c o lla te r a l co u ld d e p r e c ia te b e fo r e th e m a tu r ity o f th e a g r e e m e n t, th u s m ak in g th e in v e sto r an u n secu red c r e d ito r o f th e bank for th e d iff e r e n c e b e tw e e n th e rep u rch a se p r ic e o f th e r e ta il repo and th e m a rk et v a lu e o f th e u n d erlyin g c o lla t e r a l. 7. In fo rm a tio n a d v isin g th e c u sto m e r w h eth e r he or sh e h as a p e r fe c t e d lien on th e u n d erlyin g c o lla t e r a l under s t a t e la w , and w h eth er it is b ein g held by an in d e p e n d e n t t r u s t e e or c u sto d ia n . If th e c u sto m e r d o e s n ot h a v e a p e r fe c t e d s e c u r ity in te r e s t, th e le g a l c o n s e q u e n c e s, in clu d in g th e p o s s ib ility o f b e c o m in g an u n secu red g e n e r a l c r e d ito r , should be d e sc r ib e d . 8. A p p ro p ria te in fo r m a tio n regard in g th e bank and its fin a n c ia l c o n d itio n . If th e r e ta il repo a g r e e m e n t i t s e l f d o es n ot in clu d e a ll m a te r ia l d isc lo su r e s, th e f a c e o f th e a g r e e m e n t should m a k e s p e c if ic r e fe r e n c e to o th e r d o c u m e n ts p rovid ed to th e c u s to m e r c o n ta in in g s u f f ic ie n t m a te r ia l d is c lo s u r e s. C a re should a lso b e ta k e n w ith r e s p e c t to th e a d v e r tisin g and m a rk etin g o f r e ta il r e p o s. A ll a d v e r tis e m e n t s , a n n o u n c e m e n ts, and s o lic it a t io n s for r e ta il rep os -3should s t a t e th a t th e y are n ot d e p o sits o f th e issu in g bank and are n ot insu red by th e F D IC . A d v e r tise m e n ts and o th e r d o c u m e n ts p rovid ed to th e c u s to m e r s th a t r e fe r to th e u n d erlyin g U .S . G o v ern m en t or a g e n c y o b lig a tio n s se cu rin g r e ta il rep os should d is c lo s e s u f fic ie n t in fo r m a tio n to avoid th e p o te n tia l m is r e p r e se n ta tio n th a t r e ta il rep os a re g u a ra n teed by th e U .S . g o v e r n m e n t. As a m a tte r o f prudent banking p r a c tic e and in order to p ro v id e a cu sh io n o f p r o te c tio n for in d ivid u als w ho p u rch ase r e ta il rep o s, th e m a rk et v a lu e o f th e u n d erly in g s e c u r ity should be eq u al to or e x c e e d th e p u rch a se p r ic e o f th e r e ta il rep o a t th e tim e o f issu a n c e . In a d d itio n , in order to avoid th e p o te n tia l for c o n f lic t s o f in te r e s t, a bank should n ot s e ll its r e ta il rep os to its ow n tru st d e p a r tm e n t or to tru st a g e n c y a c c o u n ts over w h ich it or any a f f i li a t e has in v e stm e n t d is c r e tio n . S in ce b oth r e ta il and la rg e d en o m in a tio n w h o le sa le r ep u rch a se a g r e e m e n ts are in m any r e s p e c ts e q u iv a le n t to s h o r t-te r m b orrow in gs a t m a rk et r a te s o f in t e r e s t , banks en g a g in g in rep u rch a se a g r e e m e n ts should c a r e fu lly e v a lu a te th e ir in te r e s t r a te risk e x p o su r e a t variou s m a tu r ity le v e ls , fo r m u la te p o lic y o b je c tiv e s in lig h t o f th e in s titu tio n 's e n tir e a s s e t and lia b ility m ix , and ad op t p ro c e d u r e s to c o n tr o l m is m a tc h e s b e tw e e n a s s e t s and lia b ilit ie s . The d e g r e e to w h ich a bank borrow s th rou gh rep u rch a se a g r e e m e n ts a lso should b e a n a ly z e d w ith r e s p e c t to its liq u id ity n e e d s, and c o n tin g e n c y p lans should p rovid e for a lte r n a te so u r c e s o f funds in th e e v e n t o f a r u n -o ff o f r ep u rch a se a g r e e m e n t lia b ilitie s . Bank m a n a g e m e n t a lso should be a w a re o f c e r ta in c o n s id e r a tio n s and p o te n tia l risks a s s o c ia te d w ith w h o le sa le rep u rch a se a g r e e m e n ts e n te r e d in to in la rg e v o lu m e w ith in s titu tio n a l in v e sto r s an d /or b ro k ers. If th e v a lu e o f th e u n d erlyin g s e c u r it ie s e x c e e d s th e p r ice a t w h ich th e rep u rch a se a g r e e m e n t w as so ld , th e bank co u ld b e e x p o se d to th e risk o f lo ss in th e e v e n t th a t th e bu yer is u n ab le to p erfo rm and retu rn th e s e c u r it ie s . The p o ssib ility o f th is o cc u r rin g w ou ld o b v io u sly in c r e a s e if th e s e c u r it ie s a re p h y sic a lly tr a n sfe r r e d to th e in stitu tio n or broker w ith w h ich th e bank has e n te r e d in to th e re p u r c h a se a g r e e m e n t. M o reover, if th e s e c u r it ie s are not r e tu r n e d , th e bank co u ld be e x p o se d to th e p o ssib ility o f a s ig n ific a n t w r it e - o f f to th e e x t e n t th a t th e book v a lu e o f th e s e c u r it ie s e x c e e d s th e p r ice a t w h ich th e s e c u r itie s w e r e o r ig in a lly sold under th e rep u rch a se a g r e e m e n t. For th is r e a so n , banks should o b ta in s u f f ic ie n t fin a n c ia l in fo r m a tio n on and a n a ly z e th e fin a n c ia l c o n d itio n o f th o se in s titu tio n s and b rok ers w ith w hom th e y e n g a g e in rep u rch a se tr a n sa c tio n s. F e d e r a l R e s e r v e e x a m in e r s w ill b e ask ed to r e v ie w e a c h bank's in tern a l p r o c e d u r e s and p r a c tic e s for c o n s is te n c y w ith th e c o n sid e r a tio n s d isc u sse d a b o v e . A nthony M. S olomon , P r e s id e n t.
@FedFRASER