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S. HRG. 102-729
NOMINATION OF ALAN GREENSPAN
HEARING
BEFORE THE
COMMITTEE ON
BANKING, HOUSING, AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED SECOND CONGRESS
SECOND SESSION
ON
REAPPOINTMENT OF ALAN GREENSPAN, OF NEW YORK, TO BE CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE
SYSTEM FOR A TERM OF 4 YEARS
JANUARY 29, 1992
Printed for the use of the Committee on Banking, Housing, and Urban Affairs
U.S. GOVERNMENT PRINTING OFFICE
52-418 ±5
WASHINGTON : 1992
For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-039096-6
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
DONALD W. RIEGLE, JR., Michigan, Chairman
JAKE GARN, Utah
ALAN CRANSTON, California
ALFONSE M. D'AMATO, New York
PAUL S. SARBANES, Maryland
PHIL GRAMM, Texas
CHRISTOPHER J. DODD, Connecticut
CHRISTOPHER S. BOND, Missouri
ALAN J. DIXON, Illinois
CONNIE MACK, Florida
JIM SASSER, Tennessee
WILLIAM V. ROTH, JR., Delaware
TERRY SANFORD, North Carolina
PETE V. DOMENICI, New Mexico
RICHARD C. SHELBY, Alabama
NANCY LANDON KASSEBAUM, Kansas
BOB GRAHAM, Florida
ARLEN SPECTER, Pennsylvania
TIMOTHY E. WIRTH, Colorado
JOHN F. KERRY, Massachusetts
RICHARD H. BRYAN, Nevada
STEVEN B. HARRIS, Staff Director and Chief Counsel
LAMAR SMITH, Republican Staff Director and Economist
PATRICK J. LAWLER, Chief
Economist
RAYMOND NATTER, Republican General Counsel
EDWARD M . MALAN,
(II)
Editor
CONTENTS
WEDNESDAY, JANUARY 29, 1992
Page
Opening statement of Chairman Riegle
Opening statements of:
Senator Garn
Senator Dixon
Senator D'Amato
Prepared statement
Senator Wirth
Senator Bond
Senator Mack
Senator Sanford
Prepared statement
Senator Sasser
Prepared statement
Senator Kerry
Senator Graham
Senator Specter
Senator Sarbanes
Senator Shelby
Prepared statement
1
4
5
6
8
9
9
11
13
14
15
17
18
23
31
45
51
51
WITNESS
Alan Greenspan, Chairman, Board of Governors, Federal Reserve System,
Washington, DC
Prepared statement
Federal Reserve press release:
March 1, 1991; Supervisory steps designed to reduce impediments to
lending to credit worthy borrowers
March 25, 1991; Revisions to Regulation P
January 14, 1992; Proposal to lift the limit on the amount of noncumulative perpetual preferred stock
February 6, 1992; Vote to discontinue use of the supervisory definition of highly leveraged transactions
Office Correspondence, January 16, 1992; Regulatory Capital Treatment
of Identifiable Intangible Assets
Board of Governors of the Federal Reserve System correspondence to the
Officer in Charge of Supervision at each Federal Reserve Bank:
July 16, 1991, re: Examination guidelines on real estate loans
September 23, 1991, re: Classification guidelines for assets
October 2, 1991, re: Communications efforts regarding credit availability concerns
October 7, 1991, re: Meetings with senior bank executives on credit
availability issues
November 7, 1991, re: Interagency examination guidance on commercial real estate loans
November 8, 1991, re: Examination review procedures
December 5, 1991, re: National examiners' conference
December 12, 1991, re: Communication and examination procedures
concerning credit availability
December 13, 1991, re: Discussing and resolving differences between
bankers and examiners
Memorandum dated February 12, 1992; re: Analysis of Senator Specter's
proposal regarding penalty-free withdrawals from retirement accounts..
(hi)
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94
101
124
136
151
168
208
215
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221
251
271
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288
292
420
IV
Page
Alan Greenspan, Chairman, Board of Governors, Federal Reserve System,
Washington, DC—Continued
Magazine article, Florida Forecast 1992 CFB, January 13-19, 1992, entitled "Global Commerce Sails Ahead"
Response to written questions of:
Senator Riegle
Senator Sasser
Senator Sanford
Senator Graham
Senator Kerry
Senator D'Amato
Senator Kassebaum
426
298
373
392
394
401
412
419
THE REAPPOINTMENT OF ALAN GREENSPAN,
OF NEW YORK, TO BE CHAIRMAN OF THE
BOARD OF GOVERNORS OF THE FEDERAL
RESERVE SYSTEM FOR A TERM OF 4 YEARS
WEDNESDAY, JANUARY 29, 1992
U . S . SENATE,
COMMITTEE ON B A N K I N G , H O U S I N G , AND U R B A N AFFAIRS,
Washington, DC.
The committee met at 10:05 a.m., in room SD-538 of Dirksen
Senate Office Building, Senator Donald W. Riegle, Jr. (chairman of
the committee) presiding.
OPENING STATEMENT OF CHAIRMAN DONALD W. RIEGLE, JR.
The CHAIRMAN. The committee will come to order.
Let me welcome all those in attendance this morning. We have
two items to attend to this morning.
One is that I want to report out the nomination favorably of
Albert Casey to be Chief Executive Officer of the Resolution Trust
Corporation. We'll maintain a rolling quorum for that purpose and
I would ask that as members arrive, they record themselves on
that nomination.
I want to begin the period for voting now and will extend it until
the hearing concludes. If a quorum is established in that time, and
I expect it will be, we'll announce the final vote before we adjourn
and the nomination will be reported to the full Senate later today.
Second, I want to take the occasion to welcome a new member to
the committee. Senator Arlen Specter of the State of Pennsylvania
is joining us this morning and we're very pleased to have him as a
new member of the committee.
I think it's appropriate to say that he follows in the very distinguished path of his former colleague, and our dear friend, Senator
John Heinz, who we lost in that tragic air accident. We keep John
Heinz's picture up on the wall, Arlen, behind there, as I'm sure
you saw, as a continuing remembrance of him and tribute to the
outstanding job that he did on this committee.
Senator Chafee served in an intervening period in the seat that
you now hold and we're sorry to lose Senator Chafee, but we're
very pleased to have you and we welcome you as a member of this
committee.
Senator SPECTER. Well, thank you very much, Mr. Chairman, for
those very generous remarks.
(1)
2
I'm delighted to be on this very important committee and to
carry forward the work that our late departed colleague, Senator
Heinz, had been so active in.
This is a very important committee nationally, but especially important to the Commonwealth of Pennsylvania, dealing with the
problems of housing and mass transit, to say nothing of the banking and Federal Reserve and FDIC and issues of overwhelming importance as we try to move through a very complicated time in our
Nation's economy.
So I thank you for the introductory remarks and I look forward
to very active participation.
The CHAIRMAN. We welcome you and we look forward to your
contribution and active participation.
Senator Garn?
Senator G A R N . Mr. Chairman, if I could just add my welcome to
my distinguished colleague from Pennsylvania. I'm very pleased on
this side of the aisle that we have such an articulate and intelligent colleague to join this panel.
Senator D'AMATO. Don't get carried away.
[Laughter.]
Senator SPECTER. I thank you, Senator Garn. I also thank Senator D'Amato.
Senator GARN. Well, with his remarks, we may try and find a
replacement for him.
[Laughter.]
Senator D'AMATO. Believe me, there are a lot of people trying to
do that.
[Laughter.]
The CHAIRMAN. This morning, the committee wants to welcome
the Chairman of the Federal Reserve, Alan Greenspan, who is here
for the purpose of his confirmation hearing for a second 4-year
term as Chairman of the Federal Reserve Board, and his nomination to a new 14-year term as a member of that Board.
The job of Federal Reserve Chairman has often been called the
second most important position in our Government. And there's
good reason for that.
The Fed has responsibility for our Nation's monetary policy,
giving it a key role in influencing economic fluctuations, the money
supply, and the inflation rate.
It certainly has a great bearing on the degree to which we have
economic growth in the economy.
The Fed is also one of our principal banking regulators, with specific responsibility for supervising State-chartered Federal Reserve
member banks and all bank holding companies. And broader responsibility for ensuring orderly financial markets.
The Fed chairman also sits on the Oversight Board of the Resolution Trust Corporation, which supervises the disposition of failed
thrifts.
This is a most important nomination, I think the most important
nomination that comes before this committee, and very possibly
before the entire Senate.
Now looking over the record of the last AV2 years, there is much
to be concerned about, and we need to take a searching look at that
record today.
3
This morning's GNP data, which shows the economy about flat
in the last quarter of last year, are part of the continuing evidence
of our current serious economic problems. The President, of course,
focused much of his commentary last night on that same array of
problems.
But poor economic performance is not just a recent or temporary
development. Since Chairman Greenspan's initial appointment in
the summer of 1987, the economy's annual average growth rate has
been an anemic IV2 percent. But even that rate reflects only
growth in the labor force and increased rates of depreciation of
capital goods.
Per capita national income, which better measures economic
well-being, has shown no improvement at all during that time. And
as a recent report by the Fed documents, incomes have been increasingly skewed toward the very wealthy, leaving average Americans and those at low-income levels worse off.
Pointing these facts out does not say that the blame for them
and bad economic trends can be tracked to the Fed solely or without consideration of other major factors. But certainly it has a
bearing, and a significant bearing and that needs to be examined
today.
It is my own view that there still is clearly lacking an adequate
national economic strategy to provide the growth we need to improve the economic well-being of our citizens and to enable our
country to compete more effectively in the world economy.
Monetary policy is a vital element of economic strategy and must
be carefully examined. Since August 1987, the principal measure of
the money stock, M2, as it's called, has grown at only a 4 percent
annual rate, which is half the rate of the preceding 4 years and
less than the rate of price inflation.
M2 growth has been below the mid-point of the Fed's own target
ranges in each of the last 5 years. In the last 2 years it was at or
near the very bottom of its range, despite the recession. So something is clearly wrong here. When the Fed sets its own target
range and finds that you've got a chronic situation where the performance is at the low end of that range, something is not working
properly. I think we have to try to figure out what that is and respond to it. We need to discuss that and other suggestions about
how we get our economy moving in a much more vigorous fashion.
In other areas there are also concerns. In recent years, we have
witnessed a wave of bank and thrift failures unprecedented since
the Great Depression. Although banks under the Fed's direct control have fared better than others, large holding companies under
the Fed's regulatory supervision have become increasingly weak,
and the Fed's lending practices to failing banks appears to have
added to the ultimate cost of those banks that have failed.
Other important questions arise about the role of foreign ownership in our banking system. BCCI is one example. But the issue is
broader than that and we'll get into that.
Now, just one or two other things here.
Last night, the President, in his remarks, made the following
comment, and I'm quoting from page 4 of his speech. He is talking
here about the problem of a lack of credit within the banking
4
system. And the direct quote that I want to cite into the record
now is as follows. The President said:
The banking credit crunch must end. I won't neglect my responsibility for sound
regulations that serve the public good, but regulatory overkill must be stopped. And
I have instructed our Government regulators to stop it.
I think in the course of your remarks this morning, I would ask
you to tell us what that means. What specifically is being done?
Has the regulatory process been out of bounds, as he implies here
with respect to your part of the bank regulatory system, and what
are these instructions that have been given to stop the practices
that the President is objecting to? I'd like you to explain to us exactly how that's being carried out so that we have a clear understanding of it.
There are other items. I know my colleagues have opening comments that they want to make. Let me yield to Senator Garn.
OPENING STATEMENT OF SENATOR JAKE GARN
Senator GARN. Thank you, Mr. Chairman. First of all, let me say
on behalf of my colleagues on this side of the dias, that the President is coming up to meet with Republican Senators at 10:30. So if
you see all or most of them leave, it's nothing to do with you,
Chairman Greenspan. It's just that the most important person is
more important than the second most important person, I guess.
However, I will ignore the first most important person and stay
for the second most important person.
Chairman Greenspan, you have been waiting for this confirmation hearing since last July, when you were first nominated for a
second term as Chairman of the Board of Governors of the Federal
Reserve. I regret that the committee has made you wait so long for
this confirmation hearing.
Many of us believe that the Federal Reserve should have eased
monetary policy earlier last year. I believe the anemic economic
growth we have recently been experiencing is largely attributable
to inadequate growth in the monetary aggregates during 1991.
Recently, we have seen signs of a pick-up in monetary growth
and I certainly hope that that growth continues. But if it doesn't, I
hope that the Fed is ready to act quickly to inject additional monetary stimulus into the economy.
As a member of Congress, however, I must confess to some embarrassment at criticizing the Fed and/or the administration's economic policies of late, because Congress certainly shares at least as
much blame as either of you for this economic difficulty.
The committees of Congress responsible for the financial services
sector of our economy have a particularly poor record. I would
• modify ,that, however, to say that this committee acted on the
President's banking reform last year, by producing a broad comprehensive bill. This committee did recommend full funding for the
RTC. But Congress as a whole failed to enact either. I think that
that has added to the problem.
Last year, this committee rejected the renomination of an outstanding public servant, Comptroller of the Currency Bob Clark.
What I said at the time and I now repeat is the voting down of his
5
nomination was an unsuccessful attempt to make Bob Clark the
scapegoat for the problems in the commercial banking industry.
The result of that unfortunate political exercise has added, I believe, to bank examiners' fear for their careers and reputations if
they don't put the fear of God into the on-the-line commercial
bankers who dare to make new loans.
I would also comment about the President's State of the Union
delivered last night. The credit crunch has a lot to do with Congress because I can remember sitting here harassing every regulator that came before this committee for being too lax, and saying
that we simply weren't tight enough. Now after they've tightened
up, we are blasting them for being too tough.
Who can be surprised that our economy has been hobbled by inadequate credit? Congress deserves similar criticism for its failure
last year to respond to the administration's constructive legislative
package that would have strengthened the commercial banking industry. Again, I emphasize, this committee did not do that. We
passed out of committee a very broad comprehensive bill that the
House of Representatives was simply unwilling to deal with.
Last year, by imposing only new costs on banks to pay for the
Bank Insurance Fund recapitalization, without helping the banks
pay for those costs, Congress contributed to the further weakening
of our banking system.
The budget released by the administration today projects an even
more troubling consequence of the failure by Congress to act to
strengthen the banking system. Unless Congress will act soon on
the second half of the administration's proposal, the funding provided last year will not be enough.
And I would emphasize that in Mr. Casey's confirmation hearing
last week, he testified that because Congress's unwillingness to
enact the administration full amount requested, it cost the taxpayers $375 to $450 million since November 15.
Again, the Senate was willing to do that. The House was not.
The bottom line is this—if Congress continues to turn its back on
financial restructuring, Congress will be guaranteeing an eventual
need for a taxpayer bail-out of the Bank Insurance Fund, as well as
the savings and loan insurance fund.
I certainly think the cycle has come full circle and it's time that
Congress did something about the restructuring of our banking
system.
This morning, I hope we can talk constructively about financial
structure, as well as monetary policy. I hope my fellow Senators
will use this hearing to give Chairman Greenspan a chance to fully
explain all of his views, as I'm sure that we will.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Garn.
Senator Dixon?
OPENING STATEMENT OF SENATOR ALAN J. DIXON
Senator DIXON. Mr. Chairman, I'm pleased to be here this morn-
ing as the Senate Banking Committee considers the nomination of
Alan Greenspan to another term as Chairman of the Board of Governors of the Federal Reserve System.
6
As you've pointed out, Mr. Chairman, many people believe that
the chairmanship of the Fed is the second most powerful job in
Washington.
I don't know whether that's true or not, but I do know the Federal Reserve exercises enormous power and influence over our economy. And it's our economy that we need to be thinking about as we
consider Chairman Greenspan's renomination.
As my colleagues know very well, we are in a serious recession.
People are hurting and every institution in Government must act
to remedy that pain.
Monetary policy and the health of the banking system are two
key factors in generating economic growth. But the banking
system, while basically sound, is under serious stress and monetary
policy as exercised by the Fed has not been able to get the economy
moving again, at least not so far.
Chairman Greenspan told this committee when he was before us
earlier this month that most of the Fed's mail regarding the Fed's
efforts to bring down interest rates and expand the money supply
has been critical.
I understand the fear of those living on fixed incomes who are
seeing their interest income erode. But I also understand the fear
of families that have seen their incomes stagnate or erode over the
last several years and even longer. I understand that they are concerned about their future, about whether they can buy a home,
about whether they can afford to educate their children, about
whether they'll be bankrupted by an unexpected illness.
And I understand that many Americans look at how our economy has been working in recent years and fear that their children
will not have the opportunities they had and that their children
will not live as well as they have lived.
I hope, Mr. Chairman, that you also understand those fears.
When you're confirmed, and I'm sure you will be, I hope you'll be
working with Congress and the President to get the economy
moving again and to do everything you can at the Fed to help address the long-term problems we're facing. I look forward to voting
favorably on your confirmation. I thank the Chair.
The CHAIRMAN. Very good.
Senator D'Amato?
OPENING STATEMENT OF SENATOR ALFONSE M. D'AMATO
Senator D'AMATO. Thank you, Mr. Chairman.
Mr. Chairman, I find myself in an unusually difficult position because, personally, I have a great fondness and a good relationship
with Mr. Greenspan, our Chairman, before he became Chairman,
before I became a Senator, and all during that period of time.
I have to say, however, that the very thing I was concerned
about, going back more than a year ago, close to 18 months ago
was interest rates. I remember the hearing of January, when I
said, and I'm paraphrasing:
What world do you live in? You're worried about inflation. Businesses are closing.
We're in a recession. Cut the interest rates.
To simply say that we did too little too late is to underscore
something that many, many, people have come forward to state.
7
Had the Federal Reserve made the kinds of cuts to finally get
the discount rate down with greater dispatch, a great deal of the
pain that many individuals have endured could have been minimized.
I'm not suggesting that this would have solved all of the economy's problems. There are other problems that could be corrected
with better tax policy to stimulate spending and create investment
incentives—particularly in the real estate sector. We need to revitalize this sector of our economy that has been so devastated and
which accounts for such a significant portion of our gross national
product.
The CBO 1992 budget report points out, and I quote:
The gradual pace of monetary easing may have eroded its stimulative effect.
I get no comfort by saying, I told you so. Had we had these lower
rates 18 months ago, however, I think that it would have had a
more substantial stimulative impact. Let's give credit where credit
is due—there are some very beneficial things taking place.
The refinancing of home mortgages, for example, will reduce the
interest expenditures of American families by about $40 billion a
year. This is very positive.
I'm sorry the Fed had to wait so long to ease the discount rate. I
think that it is a reflection of the Fed's failure to grasp the significance of what was actually taking place in the economy, and the
depth of the recession.
I'm convinced that we now must look toward the future. I would
like to hear from the Chairman, because we have discussed this
issue both privately and at public forums, what Congress can do to
deal with the absolute economic crisis as it relates to the real
estate industry and the lack of credit for sound commercial
projects.
This is not just a phenomenon indigenous to the Northeast
region. Creditworthy applicants everywhere are suffering—people
with unfinished projects can't get construction loans or permanent
mortgages.
This restriction on credit is absolutely going to continue to exacerbate economic decline and the current recession. Banks will not
loan to people undertaking beneficial often essential projects. I am
not even talking about areas that have been overbuilt and that
have too much commercial space.
I am referring to sound projects that are fully rented where
people cannot get financing. This is the most frequent complaint I
hear from individuals and firms in the real estate industry. It isn't
just the rich guy who suffers in this situation, it's also the people
who work in the industry—the carpenter, the electrician.
Congress and the regulators must address the problem of credit
availability because even a discount rate of one percent will not
have an appreciable impact unless that credit is going to be made
available out there in the street.
While there has been some substantial improvements such as the
refinancing of homes, we have still failed to address the problem of
making credit available to see that good and creditworthy projects
have adequate financing rather than banks calling in this type of
loan.
8
Mr. Chairman, I ask that my prepared statement be included in
the record as if read in its entirety, and I would hope that the
Chairman would share with us later his thoughts on how we can
address this critical problem of credit availability.
The CHAIRMAN. Without objection, it is so ordered.
PREPARED STATEMENT OF SENATOR ALFONSE M. D'AMATO
Mr. Chairman, I welcome Alan Greenspan, who is no stranger to
this committee, for today's hearing on his reappointment.
The Fed has been promising us economic recovery for some time
now. Indeed, I have railed at Chairman Greenspan for over a year
to lower the discount rate of interest.
The Fed has taken Davey steps to cure the Goliath problems of
the economy. Unlike Davey, however, the Fed did not kill Goliath
even though the Fed had more than a slingshot at its disposal.
This is not just a case of bad aim. It is more of a case of no aim.
The Fed should have been more decisive in lowering interest rates.
As the CBO January 1992 Budget Report points out, "[t]he gradual
pace of monetary easing may have eroded its stimulative effect."
Today, the discount rate is at 3.5 percent—the lowest it has been
since November 1964, but banks are not making loans. Credit is finally cheap but it is unavailable even to creditworthy borrowers.
As a result, lower interest rates came too late to provide any new
credit to cure the economy's malaise.
You are probably expecting me to say that the Fed did "too little
too late." This may be accurate, but I am not going to say it.
The growth in M2 continues to decline, down from 3.3 percent in
1990 to 2.4 percent in 1991. Credit is scarce and consumer confidence is low, primarily because there is so much uncertainty about
the economy. Before a full economic recovery can happen, consumer confidence must be restored and credit must be made available.
The Fed, the OCC, the FDIC and the OTS issued a joint supervisory statement on November 7, 1991, in an attempt to ease the
credit crunch. These guidelines are a step toward making credit
more available in the area of commercial real estate loans.
I would be interested to hear from Chairman Greenspan whether
the bank regulatory agencies have contemplated anything similar
for other types of loans.
Finally, to give credit where credit is deserved (something banks
should start doing)—lower interest rates have caused applications
for refinancing to rise a dramatic 120 percent since October.
At a minimum, the refinancing surge has reduced the mortgage
interest expense in some households. It is estimated that mortgage
refinancing will save American families a total of $40 billion a
year.
The CBO 1992 Report on the Budget states that there may be
more room for the Fed to ease monetary policy further without any
great risk of inflation. I will be interested to hear Chairman Greenspan's opinion on this.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Wirth?
9
OPENING STATEMENT OF SENATOR TIMOTHY E. WIRTH
Senator W I R T H . Thank you, Mr. Chairman.
Chairman Greenspan, I want to start by thanking you for your
service and for your willingness to take this task on again. I know
it's a very tedious and sometimes frustrating operation, but we
really appreciate your help and your work.
Senator DOMENICI. Senator Wirth, would you yield for a request
to the Chairman?
Senator W I R T H . Absolutely.
Senator DOMENICI. Thank you very much.
Mr. Chairman, I know everyone has very difficult schedules. I
don't want to impose on you. But I very much want to inquire of
the Chairman regarding some real estate and other issues.
Is it possible that you might accommodate, even if I'm very late
coming back, to just leave it open for me to inquire?
The CHAIRMAN. Absolutely.
Senator DOMENICI. I appreciate that.
The CHAIRMAN. I'll protect the Senator's rights and we'll always
do that.
Senator DOMENICI. I thank you very much.
Senator W I R T H . Mr. Chairman, I was just about to say, I know
that some of our Republican colleagues have to go to meet with the
President, I just had a couple of comments to make, but I know
they have to leave. If you all want to jump right in at this
point
The CHAIRMAN. If we go in the order in which members have arrived.
Senator Bond, did you want to make a comment now?
OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND
Senator BOND. Thank you. I certainly appreciate the courtesy of
my friend from Colorado.
I do want to join in welcoming Chairman Greenspan before this
committee for the long awaited reconfirmation hearing. I think it's
very timely that we have his views on economic policy in the wake
of the State of the Union.
As our ranking member, Senator Garn, has pointed out, we have
too much of a good thing today and several of us will be forced to
be gone for a portion of this hearing.
Mr. Chairman, we would welcome your suggestions on how we
can separate the wheat from the chaff and all of the different economic remedies which have been proposed.
I think we seem to hear bipartisan agreement that tax changes
and policy changes are needed to spur long-term growth, investment, and international competitiveness, but we have a little problem that the labels seem to be applied to different remedies, depending upon the speaker.
For one example, we've heard much partisan rhetoric on the
impact of a differential for capital gains. We would welcome your
views in your high office as to what might be the basic economic
impact if we did restore a differential for long-term capital gains.
I do want to commend you and the Federal Reserve for bringing
interest rates down. I think all of us want to claim credit when in-
10
terest rates go down. None of us want to be around when interest
rates go up.
We know that the Federal Reserve has the direct responsibility,
but I think you would probably agree that Congress has a negative
responsibility if we bust the budget. If the deficit goes up further,
there's no way that the Federal Reserve working on short-term
rates can avoid long-term rates going up, which imposes an inflationary pressure.
One point I hope that you'll address, and I perhaps will have an
opportunity to discuss it when we come back, is the seeming slow
growth in the money supply.
A lot of concern has been expressed that the money supply has
grown at the very low end of the target range, or perhaps even
below. And there are some who think that this may have had a
further impact on the credit tightening.
In any event, Congress is in bad need of constructive advice on
how we can adopt fiscal policy that will complement the monetary
policy toward making credit available and assuring long-term
growth in the economy.
Mr. Chairman, I particularly appreciate your courtesy and that
of Senator Wirth.
The CHAIRMAN. Very good. Senator Mack?
Senator M A C K . I intend to stay, so if Senator Wirth wants to go
ahead
The CHAIRMAN. Very good.
Senator W I R T H . If I might, Mr. Chairman.
The CHAIRMAN. Senator Wirth?
Senator W I R T H . A very brief comment.
We're having a major national debate about health care. And
one of the pieces of that debate is how do we structure the system
so that we do more to keep people well, the preventive side, rather
than just focusing on helping people after they get sick. And I'm
not sure that isn't a useful metaphor as we look at the banking
system.
I think all indications are that we're going to continue to have
some problems in various segments of the country, various regional
areas such as we had some years ago in the Rocky Mountain region
and the Southwest.
I wanted, when we get into questions, Chairman Greenspan, to
have you focus a little bit on the preventive side. There are a
number of ideas and proposals out there, and I think this is now a
good time for us to sit back and look once again at what makes the
most sense. The administration has proposed major structural
changes, Glass-Steagal, providing new bank powers, as the best preventive medicine.
Others have suggested that the capital requirements that have
been laid on the financial institutions have caused the contraction
of credit and that maybe we should be looking at that. Some have
suggested that there be something like the RFC, where the Government might help with those capital requirements.
A third set of proposals that has been made is various tax credits
to banks related to the loans that they might make to job generating enterprises, small business in particular. Would that help
11
banks to meet their reserve requirements and encourage them to
make loans?
Obviously, as well, there's been reference to regulatory changes.
When we get to this point, I'd very much appreciate your
wisdom, what are the two or three or four things that you think
would be most important for us to be thinking about and doing in
this coming year if we are concerned about the preventive side of
medicine for banks, rather than just waiting, as we have tended to
do and I think that's the nature of the way the Government operates to react to the problem.
Reaction has cost us billions of dollars in the savings and loan
disaster and now we're seeing a great deal of money going into the
banks and the FDIC.
Maybe there are steps that we can take that would be more constructive and certainly save taxpayer dollars.
So that's what my primary interest is and I really greatly appreciate the benefit of your wisdom and experience on that.
Thank you very much, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Wirth.
I might note, just in terms of the hearing today, back when your
nomination was made, a little past mid-year of last year, for some
reason the nomination was kind of in the mill at the White House
for a while. It was finally made, and the papers came up here.
Senator Garn has pointed out a minute ago, as everyone in this
room who follows the issues knows, we were involved in a very intense effort to try to get the comprehensive banking reform bill
passed, which of course had in it some things that you felt very
strongly about which you had come to speak for.
So in that period of time as we were working on that, the administration gave you a recess appointment which you now serve
under, in which you are fully empowered to be able to operate in
your capacity at the Fed.
Then, as we were coming down the home stretch in the closing
days of the session of Congress, we scheduled this hearing. We had
a date set, and we were programmed to do it. Then the banking bill
unfortunately fell apart in the House of Representatives, and we
were required to shift our schedule around. We had to cancel that
hearing at the last minute, which I regretted, as I know you did as
well.
So this is our first opportunity since that time to be able to have
you here. We've looked forward to having you and are pleased
you're here today.
We've had two other Senators join us and I'm just going to ask
them for any opening comments that they may have
Senator MACK. Mr. Chairman?
The CHAIRMAN. I beg your pardon. Senator Mack, excuse me. We
recognize you next.
OPENING STATEMENT OF SENATOR CONNIE MACK
Senator MACK. Thank you, Chairman Riegle.
Welcome, Mr. Greenspan. My focus today is really just a continuation of an expression of a problem that's been developing in the
State of Florida for 2 years now. It was 2 years ago in which I re-
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member doing what all of us do when we go back home, listen to
our constituents. Two years ago, I heard very, very clearly all
around the State of Florida, but primarily as a result of examinations of the State's largest banks, that credit was not available,
that credit was being turned off.
That's been running 2 years, to the point that in my last visit
home, people were using words that I haven't heard in my 10 years
in the Congress and my 16 years in business prior to that. They
were talking about suicides.
Individuals who have worked their entire lives in developing
projects and being involved in real estate, all of a sudden are finding that there just isn't credit available.
I guess I speak with a little bit more conviction about this particular problem because that 16 years prior to being involved in
politics was in fact in the lending business. So I have some inclination, some idea of—I know some of these people. I know the
projects that they're talking about. I can tell who's giving me the
straight line and who's not.
And when I see in the State of Florida, certainly one of the fastest growing States in the Nation, and in particular areas which are
the fastest growing in our State, with people moving in at rather
rapid rates, with projects that in fact make sense, can't get credit, I
wonder if it's that bad in my part of the country, how bad it must
be in other parts of the country.
My concern in our discussions today, and I really just look forward to some dialog, is how do we address the question of providing
credit primarily to the real estate market.
But I don't want to imply that there has not been an impact
beyond that because there clearly has. Businesses of all types, lines
of credit that have been established and have been on the books for
15 years, companies in better economic condition, better financial
condition today than when they obtained the lines of credit originally, are now being told that those lines are no longer available.
And what concerns me is I see a downward spiral developing,
and almost every action that we're doing creates an even further
downward spiral. Things like the RTC dumping real estate onto the
market at the worst time.
We told the RTC back in 1989, we wanted you to get this real
estate and we wanted you to get rid of it. But that was 1989. This is
1992, and the markets are completely different. And to just dump
real estate on the market, it seems to me that it just further depresses the market and continues the downward spiral. It undermines the capital structure of the financial institution. And the
only way they know how to get their capital ratios back into place
in these conditions is in fact to call loans or not make loans.
I would suggest that the good loans are the ones that are being
called because they're the only ones that can pay them off.
And so my line of questioning will be really kind of like, what do
we do to stop this? What do we do to get this thing turned around
and going in the opposite direction?
So, again, I look forward to our discussions and I appreciate your
being here this morning, Mr. Greenspan.
The CHAIRMAN. Thank you, Senator Mack.
Senator Sanford?
13
Senator SANFORD. Thank you very much. I'll just put a prepared
statement in the record and just make one comment now.
The CHAIRMAN. We'll make it a part of the record.
OPENING STATEMENT OF SENATOR TERRY SANFORD
Senator SANFORD. The biggest mark of the Great Depression was
bank failures. That probably had a great deal to do with aggravating a slipping economy and possibly was the primary cause of the
Depression, though that is a matter that might be debated.
In any event, almost the first thing done to stabilize the economy
was to deal with the situation of bank failures. We did it in a way
that demonstrated that it could be done. And indeed, a rarity—it
could be done and make a profit for the Government in the process.
I'm very much concerned about what Senator Mack has just discussed. I've heard from literally hundreds of real estate people who
are simply distraught that they're in a collapsing situation and see
no way out and see very little that we are doing to help them.
I just talked to a furniture manufacturer who now is probably
going to have to go out of business because he can't get a line of
credit. He never had any problem with credit, never had any problem with not paying back, but he had that line of credit with the
Bank of New England, reinforcing my proposition from the very
beginning that that bank should never have been closed, but it
should have been recapitalized under the concept of the old Reconstruction Finance Corporation procedures.
In fact, I put a piece of legislation in last spring to create a
modern RFC that we called the Bank Emergency Investment
Trust.
I want to mention that because while it's not precisely in your
field, but it relates in another way to the banking regulation, I'm
afraid that what we've just done with the Federal Deposit Insurance Corporation, the so-called improvement act that we've passed,
that we probably have encouraged bank closings, the equivalent of
bank failures.
The ripple effect—in fact, I called it a ripple effect until I realized it was coming from Boston to High Point, North Carolina. It's
a wave effect of a bank failure.
I would hope that we could determine that the policy of this
country should be that a bank will not be allowed to fail if there's
any way to prevent that failure. And I think that in most cases, it
can be prevented, not just to keep open a bad operation, but the
very fact that we have that resource and potential gives us the tool
to insist on mergers or to insist on management changes or to
insist on anything we want to.
But so often, it's simply a bookkeeping matter of too little capital
because of the dwindling value of the assets.
So, in any event, I want to put that into the equation, that part
of our policy should be that the banks must not fail if there's any
other alternative.
14
PREPARED STATEMENT OF SENATOR TERRY SANFORD
Mr. Chairman, I would like to commend you for holding this
hearing this morning. I regard this nomination as one of the most
important ones this committee is responsible for reviewing. Economic recovery is atop everyone's agenda, however, all political
posturing aside, solutions to our economic woes must address basic
structural problems in our economy and result in long-term growth
and productivity.
The members of the Federal Reserve Board play a key role in
formulating economic policy by determining and implementing
monetary policy. In short, the Federal Reserve's influence over the
lending and investing activities of depository institutions and their
influence over the cost and availability of money and credit requires them to contribute substantially to the strength and vitality
of the United States' economy. It is imperative that the Chairman
of this independent body demonstrates a solid commitment to lasting economic recovery.
There is no doubt that current economic troubles result from the
build up of debt. However, as the Federal Reserve reported earlier
this week, savings due to lower interest rates for households is
going toward debt reduction, not consumer spending. For the first
time since the Depression, real spendable incomes have fallen in
the majority of households. The recent dramatic reduction in the
interest rate has not exactly brought about the expected results.
The burden of past debts overwhelms profits, causing purchasing
power to decline further.
I hope the Federal Reserve will listen to the recommendations of
the many economists who have testified on Capitol Hill over the
past month. I also urge the Federal Reserve to consider further
cuts in the discount rate if appropriate, particularly since the inflationary fears expressed by the Fed in its slower than necessary reduction of the discount rate did not materialize, any further reduction of rates should be sooner rather than later.
In addition to executing monetary policy, the Federal Reserve
Board functions as a regulator and ensures that commercial banks
are responsive to the Nation's financial needs and objectives. The
projections for bank failures in 1992 are grim to say the least. The
other regulators have been considering assistance programs to save
troubled institutions that are financially viable. I am concerned
that the recently passed Federal Deposit Insurance Corporation Improvement Act (FDICIA), will cause even more banks that are marginally capitalized, but financially viable to fail, thus costing the
taxpayers more money, not to mention the disastrous effects a
bank failure has on a community. An alternative to the costly
practice of closing these banks could prevent foreclosures on loans
made by such banks, the abrupt removal of the lines of credit to
community businesses, and job losses. I will be interested to hear
Mr. Greenspan's comments on such a proposal.
Finally, in its role as a policy maker for bank regulation, I urge
the Fed to look closely at the causes of the credit crunch. Complaints are rife of lenders refusing to renew good, well collateralized loans to creditworthy borrowers. This is one area where if the
Fed does too little, too late, as some have suggested its interest rate
15
reductions were, there will be no opportunity to catch up. Businesses and borrowers unnecessarily put out of business cannot be easily
revived. Economic value will decline and jobs will be lost, neither
to be recovered.
Again, I commend the Chairman for holding this hearing in such
a timely manner. I look forward to hearing Mr. Greenspan's assessment of the economy and prospects for recovery.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you very much.
The Chairman of the Budget Committee, Senator Sasser?
OPENING STATEMENT OF SENATOR JIM SASSER
Senator SASSER. Thank you, Mr. Chairman.
I want to welcome Dr. Greenspan before the committee this
morning and say that his reappointment comes at a very critical
time in the economic history of this country. Particularly if we
look at the economic history of the country in the latter part of the
20th century.
I want to say at the outset, and Dr. Greenspan knows this, I have
great respect for his professional expertise, particularly as an analyst of very complex economic data. I think perhaps he has no peer
in that regard.
And I certainly appreciate Dr. Greenspan's cooperation and the
assistance that he has provided not only this committee, Mr. Chairman, but the Budget Committee which I've chaired over the last 4
years. He's rightfully earned the respect of many members of both
committees.
Now, having said that, we've got to face the fact that this Nation
is in the grip of a very severe recession. It's the longest recession
that we've experienced since the 1930's.
I think there's something different about this recession than the
other recessions that we've experienced since World World II.
Perhaps we're now evidencing some basic structural changes in
this economy that we've not seen in previous recessions.
I was struck by a statement that Dr. Greenspan made before the
House Banking Committee, a few weeks ago. And to paraphrase
that statement, Dr. Greenspan said that he saw anxiety about the
economic future of the country such as he had not seen in his lifetime.
Please forgive me for taking a little license with your statement,
Mr. Chairman, but I'm speaking from memory and that is generally the thrust of your comments.
Perhaps that anxiety is based on substantial ground. Many
economists believe that the actual unemployment rate is really in
the double digits. And certainly the unemployment rate is in the
double digits if you take into consideration those who want to work
full-time but are obligated to work part-time because full-time jobs
are not available.
There are more Americans on food stamps than at any time in
our history, to my knowledge. I was astounded to learn that one in
every ten Americans today, as this committee meets, Mr. Chairman, are on food stamps. And we're seeing a new type of food
stamp recipient—middle-class, white-collar individuals. Those who
16
previously had middle management jobs are now reduced to trying
to get by until they can find other work making ends meet means
supplementing their diet with food stamps.
Retail sales continue to fall. And just today, the new GDP figures
came out. We see that the economy is still dead in the water, the
last quarter just at 3/ioths of 1 percent increase.
I say all that to get around to saying this. The Federal Reserve
and monetary policy have played a role in this recession. I'll say
that quite frankly to you, Dr. Greenspan.
Throughout 1988 and the first half of 1989, the Federal Reserve
focused, it appears to me, almost exclusively on inflation and
pushed the Federal funds rate up to 10 percent.
Now this translated into interest rates that were much higher
than many thought justified and certainly much higher than I
thought necessary.
It resulted in economic growth that was too slow. I think the
Federal Reserve has an obligation not only to worry about inflation, but it has an obligation to send a signal that the Fed believes
in a growing, dynamic economy to those who hew the wood and
draw the water in this Nation.
One way of doing that is to keep interest rates as low as the circumstances will permit.
Mr. Chairman, to the credit of Dr. Greenspan, I think since the
recession began, he's pursued the right direction on interest rates.
They've come down significantly. But I would say that they've
come down so gradually, that until just recently, with some very
significant easing, the economy has not noticed these very gradual
reductions in rates.
There was never any strong signal early on from the Fed that it
was going to do all it could to keep the economy out of recession. I
think the small, repeated easing measures may have created the
expectation in the economy that, there are going to be other easing
measures in the near future. And possibly some individuals and
businesses delayed spending in hope of getting lower interest rates.
These are not just my views. Dr. Paul Samuelson, a Nobel Prizewinning economist, who Dr. Greenspan knows well and has consulted with, has said before our committee that the Fed's response
to the recession has been, and I quote, "too slow, too little, too
late."
Mr. Chairman, I say all this because the reappointment of Dr.
Alan Greenspan that's pending before this committee ought to be
viewed in terms of the economic recovery that we want for this
Nation.
I think we need to know why monetary policy has not worked
thus far. I think we need to know if it ever will work, in Dr. Greenspan's judgment, to bring us out of this recession.
And I think we ought to try to send a very clear signal, those of
us who believe in this view, and I believe in it very strongly, that
the Chairman of the Federal Reserve Board and the Federal Reserve have an obligation at all times to send a strong signal to the
business community, to labor, and to others who work in this economy that the Fed is prepared to take the lead and do what's necessary to stimulate growth in the economy.
17
I thank you, Mr. Chairman, and again, I welcome Dr. Greenspan
before the committee.
PREPARED STATEMENT OF SENATOR JIM SASSER
Thank you Mr. Chairman for calling this hearing on Dr. Alan
Greenspan's nomination for a second term as chairman of the Federal Reserve Board. Dr. Greenspan's appointment is a critical one,
at a critical time.
I say at the outset that I have enormous respect for Dr. Greenspan's professional expertise and competence, particularly as an
analyst of complex economic data. I appreciate the cooperation and
assistance he has provided this committee, and the Budget Committee, over the past 4 years. He has earned our respect for guiding
the FED through an extremely difficult period.
However, the Nation is in the grip of a tremendous recession—
the longest since the 1930's. Many economists believe the actual
unemployment rate is in the double digits. An unprecedented
number of Americans—one in ten—are on food stamps and retail
sales are falling faster than a plummeting meteor.
And let's face the facts: The Federal Reserve, and Monetary
Policy, have played a role in this recession.
Throughout 1988, and the first half of 1989, the Federal Reserve
kept inflation on the front burner, and pushed the Federal funds
rate up to 10 percent. This translated into interest rates that were
higher than many thought justified. Resulting in economic growth
that was too slow.
To his credit, since the recession began, Dr. Greenspan has pursued the right direction on interest rates—they have been brought
down significantly. But the pace of the reductions have been very,
very gradual. Until just recently, the FED's easing has been so incremental—it's almost as if the economy hasn't noticed.
Mr. Chairman, there certainly was never any strong signal, early
on, from the Fed, that it was going to do all it could to keep the
economy out of recession.
Indeed, according to a recent report by the Congressional Budget
Office, "the gradual pace of monetary easing may have eroded its
stimulative effect. The small, repeated easing measures may have
created expectations of further moves, possibly causing some businesses and individuals to delay spending in hopes of getting lower
interest rates later on—it [The Fed's Policy] may have helped to
delay the recovery."
This criticism has been echoed by others, most notably Dr. Paul
Samuelson, who said the Fed, in responding to this recession, has
been "too slow, too little, and too late."
The speed, responsiveness, and effectiveness of monetary policy
has become a key issue. Many of us were concerned 2 year ago,
when we embarked on the 1990 budget agreement, that the Fed
might not be able to takeover and counteract a contraction in fiscal
policy.
But Dr. Greenspan told me in writing, at the time, that "Monetary Policy—can be—implemented in a very short span of time, if
need be—[and] has the ability to act quickly enough to support economic expansion."
18
Now, however, some 2 weeks ago—in Dr. Greenspan's own words:
"Trying to be as oblique as possible"—we learned that "we have
fairly extended lags of very indeterminant duration for monetary
policy."
Mr. Chairman, we are at a very vital juncture both in terms of
Dr. Greenspan's reappointment and in terms of economic recovery.
We need to know why monetary policy has not worked thus far,
and when if ever it will work, to bring us out of this morass.
Accordingly, I would hope that Dr. Greenspan is not oblique in
his presentation today. Thank you.
The CHAIRMAN. Thank you, Senator Sasser.
Senator Kerry?
OPENING STATEMENT OF SENATOR JOHN F. KERRY
Senator KERRY. Thank you, Mr. Chairman.
Mr. Chairman, welcome. I appreciate the time you took to visit
both yesterday and prior to that. Also, your courtesies in helping
me to try to understand some of the complexities that my colleagues have referred to. And I'm not going to take very long here.
I know that we want to get to the questioning.
But as I expressed to you yesterday, I have concerns about the
degree to which our Fed policy has in fact contributed to the current predicament that we're in. I was just actually looking back at
some earlier visits which you made to this committee 2 years ago
in which I asked some very, I thought, pointed questions about the
state of the New England economy and found that you did not
share the view at that time about some of the difficulties that we
were facing.
And particularly, perhaps felt trapped between the difficulties of
being Chairman of the Fed and the way in which the media respond to almost any pronouncement you make and the possibilities
of in fact making happen what you feared and therefore, not wanting to say some things publicly as a consequence so that they
wouldn't happen, but in fact they did.
So we're all troubled because many of us are concerned that it's
hard for us to separate between where you are trying to legitimately protect from bad consequences occurring as a result of what you
do perceive and say publicly, and then the steps you take as a
matter of policy to try to remedy them.
I think Senator Sasser has articulated for all of us the sense that
perhaps those steps to remedy never were taken, and that we're
feeling some of those consequences right now.
You and I discussed yesterday what's happening in New England. It is not a recession; it is a depression. And we are hurting
more deeply than perhaps any other region in the country.
What concerns me greatly is that everything that is happening
to us today was happening to us 2 years ago, was raised in this
committee 2 years ago, has been offered prior to this to Bill Seidman when he was serving, and now to Mr. Taylor, and to you and
to others, and you serve on the Board of the RTC and are probably
the single most influential member of the Open Market Committee
and you are certainly the foremost banker, if you will, in this country.
19
I have, like my colleagues, enormous respect for your abilities
and for your expertise. And none of us are capable of calling all of
these things correctly, and they are indeed extremely complex, and
I acknowledge that.
But some simple things seem to be overlooked at this point in
time, or somehow, the message is not reaching those that need to
be reached.
In New England, we have what I would call a collateral crunch,
not just a credit crunch. The principal problem that so many of our
businesses face is that the collateral that they offered has been
suddenly reduced in value.
And notwithstanding the reduction in value of that collateral,
which usually was real estate, the Fed kept monetary policy, credit
policy, that was more concerned, as Senator Sasser said, with inflation and therefore, kept deflating the value of that collateral.
As a consequence of the devaluation of the collateral, an instant
crisis was precipitated almost by the stroke of a pen, not by any
other events in the market place.
Companies that were able to meet their orders, to pay their payroll, to meet their interest payments, to continue to produce, were
suddenly put on the liquidation block, and are being today.
I can tell you, Mr. Chairman, and I told you this yesterday, but I
want it on the record here, I visited a couple of weeks ago with an
over 100-year-old department store chain based in Massachusetts.
Ten different outlets. Real estate assets valued in today's market at
$24 million.
They can't get a $750,000 line of credit.
I have received calls from companies in southeastern Massachusetts, one particularly, that has gone from 30 to 300 employees in
the last couple of years. It could put 50 more employees to work
tomorrow. It has half a million dollars of backlogged orders.
But instead of filling those orders and calling in those employees,
it may be liquidated within the next weeks because its collateral is
low and the banks are calling them in and suggesting that they've
got to pay up immediately because of the arbitrariness of the regulatory process.
Now the President last night in the State of the Union message,
said, that's got to stop.
Mr. Chairman, I heard that 2 years ago. I heard that in his last
State of the Union message. And I've heard it from Secretary
Brady. I've heard it from Mr. Taylor and from others.
So the question that many of us are just frustratingly left asking
is who's really going to make this happen? Is the country's most
influential banker and one of our single most important voices on
the economy going to weigh in on this and have the ability, though
I know you're not directly in charge of that, but clearly, you have
influence with respect to it and clearly, the tight credit. The cost of
money has a great deal to do with that deflation.
If the Fed had the interest rates lower, if the Fed has more
money that's available, then you can lend that money at less cost
and those companies are in less predicament. And perhaps the
bankers look at the balance sheet differently.
There is a clear link in terms of your policies to these things that
are happening to us.
20
This pain has been greatly augmented by bureaucracy and by
bad judgment. It is not just the market place that has created this.
It is Government that has significantly contributed to this downturn.
I think people are just increasingly frustrated with all of that.
So as we turn to you, our most important banker, in this reconfirmation process, and I am certainly disposed to reconfirm you, I
guess we just want to know, is it really going to happen? What's
going to happen? What role do you intend to play? And with what
kind of candor can you address these current predicaments and
help us to understand where we're going?
I might add, I saw a study recently that showed, that compared
Japanese car making with American car making. And the single
great cost differential that they pointed out that existed was the
cost of capital, and that what has really disadvantaged us to a
great degree has been this preoccupation with inflation at a time
when many of us perceive that it's deflation that is our concern,
not inflation, and we can in fact use a little bit of inflation, almost.
The Fed certainly could play a very significant role in restoring
some of the value to the real estate and to the market place of this
country.
So those are my concerns as we approach this. And I might add,
I don't know how to—I know people who were worth a lot of
money, as many of us do, just a year ago, 2 years ago. And they're
worth nothing today. They don't even live in the home they lived
in. You can't describe what is happening out there.
I sat with workers who have been looking for work for 2 years.
Their home is on the chopping block. They can't pay their medical
bills. They don't know where to turn. And they look to us, and
we're left saying that we really have been part of the problem.
Mr. Chairman, it's a daunting task and we all have confidence in
you, but we're looking for the real answers to this to understand
what the response is going to be.
Thank you, Mr. Chairman.
The C H A I R M A N . Thank you, Senator Kerry.
Chairman Greenspan, let me ask you to stand and raise your
right hand.
Do you swear that the testimony you're about to give is the
truth, the whole truth, and nothing but the truth, so help you God?
M r . GREENSPAN. I do.
The C H A I R M A N . DO you agree to appear and testify before any
duly constituted committee of the Senate?
M r . GREENSPAN. I do.
The C H A I R M A N . Very good. Thank you.
We're very pleased to have you now. All of us have known you
for a good number of years. In our own case, it probably goes back
about 2 decades. It's with great personal respect that the committee and I welcome you here. I'd like your opening comments and
then we'll go to the questions.
21
STATEMENT OF ALAN GREENSPAN, OF NEW YORK, TO BE CHAIRMAN OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM FOR A TERM OF 4 YEARS
Mr. GREENSPAN. Thank you very much, Mr. Chairman.
I wish to thank you, Mr. Chairman, Senator Garn, and members
of the committee, for scheduling this hearing to consider my nomination to a second term as Chairman of the Federal Reserve Board
and to a full 14-year term as a member of that Board. I am especially grateful to President Bush for the confidence he has in me to
make these nominations.
I have testified before you frequently on the state of the economy
and the conduct of monetary policy, including as recently as 2
weeks ago. I also have given you my views and those of the Federal
Reserve Board on a wide variety of specific regulatory and supervisory matters pertaining to banks over the last several years. I
would expect to be addressing your questions on these issues again
here today.
In my brief opening statement, however, on the occasion of these
hearings on my confirmation, I thought it might be appropriate to
step back a little from the application of policy in specific circumstances and discuss some general principles that I believe should
guide decisions on the monetary policy and banking structure of
this country.
I see the fundamental task of monetary policy as fostering the
financial conditions most conducive to the American economy performing at its fullest potential. As I have often noted, there is
every reason to believe that the main contribution the central
bank can make to the achievement of this national economic objective over long periods is to promote reasonable price stability. Removing uncertainty about future price levels and eliminating the
costs and distortions inevitably involved in coping with inflation
will encourage productive investment and saving to raise living
standards. Monetary policy is uniquely qualified to address this
issue: Inflation is ultimately determined by the provision of liquidity to the economy by the central bank; and except through its
effect on inflation, monetary policy has little long-term influence
on the growth of capital and the labor force or the increase in productivity, which together determine long-run economic growth.
But a central bank must also recognize that the "long run" is
made up of a series of "short runs." Our policies do affect output
and employment in the short- and intermediate-terms, and we
must be mindful of these effects. The monetary authority can, and
should, lean against prevailing trends not only when inflation
threatens, but also when the forces of disinflation seem to be gathering excessive momentum. That is, in fact, what has concerned us
in recent months, and we have been taking actions designed to
assist in returning the economy to a solid growth path.
However, the Federal Reserve, or any other central bank, must'
also be conscious of the limits of its capabilities. We can try to provide a backdrop for stable, sustainable growth, but we cannot iron
out every fluctuation, and attempts to do so could be counter-productive. What we have learned about monetary policy since the beginnings of the Federal Reserve System is that the longer-term
22
effect of a policy action may be quite different from its initial
impact; what we don't know with precision is the size and timing of
these effects, especially in the short-run. Uncertainty about the
near term twists and turns of the economy, along with the awareness of the potential differences between long- and short-term effects suggest both flexibility in the conduct of monetary policy and
close attention to the longer-term context in conducting day-to-day
operations.
Monetary policy actions are transmitted to the economy through
the financial system, and the influence of weakness in that system
on how the economy responds has been all too evident in recent
years. A structurally sound and vigorous financial system not only
facilitates monetary policy implementation, but is itself no less important to support an economy operating at its highest potential.
Such a system must effectively and efficiently gather savings and
distribute them to where they will be of most value to society in
promoting productive investment and supporting consumption.
Banks and other depositories have a key role to play in this
system. They are the channels through which payments pass, they
are the chief repositories of households' liquid assets, and they
extend credit to many who have limited, if any, access to alternate
sources of financing. Our Nation's banking system must be strong,
not only in the sense of safe and sound, but also in the sense of
being efficient and innovative in delivering vital services to the
economy. That strength undoubtedly has eroded in recent years, in
part through errors of judgment by depositories and their regulators, but also through the combined effects of a stiffer competitive
environment and continued legal restraints on the ability of depositories to respond and adapt.
Against that background, I, and the Board of Governors, have
brought three interrelated principles to bear on our approach to
banking structure and regulation. First is the importance of a
strong capital position. Capital brings market discipline to bear on
institutions that otherwise might be tempted to take excessive risk
by their access to the Federal safety net. And it insulates the taxpayers holding up that safety net from the losses associated with
unwise risk taking, should that occur nonetheless.
Second is the need for more certain and prompt supervisory actions when capital and other key indicators of the financial health
of an institution decline. This not only will protect the taxpayers,
but it also gives depositories planning their financial structures
more certainty about governmental reactions and induces them to
take early action to strengthen those structures.
Congress and the regulators have gone a long way in acting on
these first two principles. Unfortunately, progress on the third is
more limited. That principle embraces the necessity for greater
competitive scope for well capitalized banking organizations—
across boundaries of geography and product line. Both sets of
boundaries have been made increasingly arbitrary and artificial by
innovation and internationalization of financial services.
An ability to delivery desirable services to the public is a prerequisite for generating the profits necessary to build capital and for
keeping an innovative banking system capable of meeting the
23
changing needs for credit and deposit services of a dynamic economy.
The last 4 years have seen no paucity of challenges at the Federal Reserve. As much as we sometimes might wish otherwise, I suspect the years ahead will be no less challenging. While much remains to be done, important strides have been made—in private
markets and in Government policies to restore the normal vigor of
the American economy and our banking system. To that end, I believe the Banking Committees' oversight and our continuing consultations have been a most helpful and constructive factor. Should
the Senate choose to confirm me for a second term as Chairman of
the Federal Reserve Board, I would look forward to working with
this committee to assure the sound financial system and vital economy the American people rightfully expect.
Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Chairman Greenspan.
We've been joined by Senator Graham.
Senator Graham, did you have an opening comment that you
wanted to make before we go to the questions?
OPENING COMMENTS OF SENATOR BOB GRAHAM
Senator GRAHAM. Mr. Chairman, I do not, other than to express
my admiration for the Chairman for his contribution to correcting
monetary policy at a time when that has been the principal and
only rudder available for U.S. economic direction.
I have some questions which I would like to ask at the appropriate time.
The CHAIRMAN. Chairman Greenspan, there are a number of subjects to move through today. As you've heard earlier, the Republican members of the committee, those not present, are meeting with
President Bush, who has come up to the Capitol today.
We will accommodate them when they return. We'll take whatever time it needs. If at any time we're interrupted by a vote or
you need a break, you indicate. But we want to proceed on through
and attempt to finish today, even if we have to go past the lunch
hour.
Last February, the Fed's monetary policy report noted about the
FOMC, as it's called, and I'm going to quote:
Committee members stressed that M2 expansion, noticeably above the lower end
of the range, likely would be needed to foster a satisfactory performance of the economy in 1991.
And it looks as if they were right when one examines what has
happened. M2 growth stayed right at the bottom of the range,
while the economy went into a very severe recession.
I think the question that I have, and you've heard it repeated
here today by a number of members in different ways, why is it
that the Fed has seemed to be unable to get the M2 number up
higher, even higher within your own range? And why has it proven
to be impossible to get a faster money supply growth?
I'm convinced that's really hurt us. I don't say that that's been
the intention of policy, but that's the way policy has taken place
here. I think we need to understand what happened and what can
be done to fix it.
24
Mr. GREENSPAN. That's a major issue, Mr. Chairman.
First, let me say that M2, which we have focused on and still believe to be the crucial money supply aggregate, has behaved in
ways which really have confounded history.
If we were to look at the relationship, for example, between interest rates and money supply in the context of the way the system
functions, say, prior to the last year, year and a half, money supply
now would be running at the upper end, perhaps even touching the
outer edges of the ranges.
What has occurred is a very significant and major downward
shift in the relationships between interest rates and money supply
growth.
I might add, parenthetically, that Ml and the monetary base
have been growing very rapidly, but that has not spilled over into
M2.
In addition, we are not getting the relationship between the
economy and money supply that has historically been the case.
In fact, if you take a close look at the relationship between interest rates, on the one hand, and income velocity on the other, a relationship which has tended to be remarkably tight and reflecting a
much more sophisticated analytical relationship, what we have
found is that income velocity—that is, the ratio of gross domestic
product to M2—has been rising slightly over the last year when, by
all history, the sharp decline in interest rates that had occurred
would have implied a significant decline in velocity.
Or put in another context, we are getting far more in the way of
GNP or gross domestic product per dollar of M2 than history would
have suggested.
So we have got two major problems with respect to the M2 aggregate.
On the one hand, we're having difficulty keeping it up at levels
which we would like, although I must say in recent weeks it's
shown a good deal more buoyancy.
But it is certainly true over the last year, it has been running
much beneath where we would like and it kept falling relative to
our expectations based on past history throughout the year.
Fortunately, this did not bring with it the type of contraction in
economic activity which historically would have been suggested
merely looking at the levels of M2 which actually prevailed.
We have seen, for example, a significant contraction in the savings and loan industry as we've taken a big chunk of that industry
out and liquidated it, and a major part of the decline in M2 as a
measured variable reflects a very dramatic decline in small time
deposits, especially in the thrifts.
Fortunately, we have had a dramatic expansion of securitization
of home mortgages and as a consequence of that, the contraction of
the thrifts as an institution has not, so far as we can judge, materially affected permanent home mortgages.
The issue of construction loans is a different issue, which I presume I will address at a later time.
But what this is saying to us, in effect, is that we have had a
major structural change without affecting the levels of economic
activity, even though a big chunk of the M2 was in effect dissipated.
25
Similarly, we are also seeing evidence of a very large change in
recent months of individuals moving from M2-type deposits into
mutual funds, which are not included in the M2 aggregate, but do
provide the form and type of liquidity which M2 usually measures.
Having said all of that, I myself and my colleagues are still concerned that the money supply has been dragging and has been a
factor which has been suppressing the normal levels of nominal
GNP.
It turns out that the numbers are not very large, but any suppression, in our judgment, is unacceptable.
The major reasons why we moved interest rates lower at many
times when in fact the economy was rising through a goodly part of
the third and fourth quarters, is that money supply was behaving,
in our judgment, at too slow a pace. And we continue to hold that
view.
My impression is that the most recent data are suggestive of an
easing in that process and some expectation that the money supply
is moving back to more normal relationships. But it's much too
soon to know that.
And so, finally, Mr. Chairman, I would say to you that it is a
major issue with us. We are doing as much as we can to understand what the changes in the process are. And rather than abandon M2 and saying its behavior is irrelevant, on the contrary, we
say it's something that has to be explained and indeed, we have
other evidence which suggests to us that it does remain an important element in monetary policy guidance.
The CHAIRMAN. I'm going to try to stay within the time limits
today as best we can and still allow people to finish a point that
they're making. And I'm going to try to do that now with myself
and do it the same way with everybody else because I don't want to
lose the points that you've just made. The concern that I have is
this. You've acknowledged to us that your targeting on M2 has
fallen way short of what you would like to have seen.
Mr. GREENSPAN. That's correct.
The CHAIRMAN. And I take what you're saying is you think that
things are working in some new and unusual way, and in fact has
hurt the kind of recovery that we might have gotten.
Mr. GREENSPAN. In part.
The CHAIRMAN. Well, let's say it's in part. I know there are other
factors here as well.
Here's what I'm concerned about. It's so late in the game now,
with just the damage that's been done, the kind of downward spiral
problem that Senator Mack has referred to, we've got 16 million
people in the country right now that want to work and are not able
to find full-time work, and it's a very, very serious problem.
It seems to me that we have to be certain that we're getting M2
up to a level that really provides the money supply that the economy needs.
In other words, I don't think we can afford to continue to fall
short. I think we have to be certain that what you're doing is adequate to really lift that to a sufficient level.
And I want to know whether you can tell us today with confidence and with a very high degree of judgmental certainty on your
part that what we are now doing in terms of the new monetary
26
policy efforts that you're undertaking has solved this problem, and
that we are now going to see M2 growth sufficient to really lift this
economy and keep it moving up.
Mr. GREENSPAN. Let me just say, first, Mr. Chairman, remember
that M2 is really a proxy for something else. It's the proxy for adequate liquidity in the system.
There are occasions when M2 has failed to be an appropriate
proxy for the total of liquidity in the system which has been occurring. And rather than be directly concerned in all cases, irrespective of what happens, to focus on a specific level of M2—what we
ought to do is to focus on the requirements of adequate liquidity in
the system.
And to the extent that M2 is used to make certain we get the
position where it, in effect, is registering the correct
The CHAIRMAN. Well, that's the question. Are we getting it? Can
you tell us today as you sit here, after a series of policy steps that
really didn't get that job done, recognizing the proxy point you
make, are we getting it now?
Can we be confident that we've taken the policy steps, and
they're now in place, to give us the lift that we need in this area?
Mr. GREENSPAN. What we are seeing, Mr. Chairman, is that the
liquidity is beginning to build. We're seeing it in large part coming
from other than money supply areas.
For example, there has been, as you well know, record issuances
of both equity and debt in the financial markets which is improving and has been a major factor in liquifying the strained balance
sheets that I discussed before this committee a couple of weeks ago.
This is a very potent force and an important one.
There are also indications of a general stirring that is going on
in the markets which are suggestive that the balance sheets are
improving.
At this particular moment, my own impression is that M2 will
shortly begin to reflect those forces. If it does not, obviously, we
have to look very closely to make certain that what we are looking
at is a statistical aberration, a failure of a proxy to adequately
measure what it's really supposed to be measuring, or whether the
fundamental liquidity aspects of this economy are falling short.
The CHAIRMAN. Senator Garn?
Senator GARN. Thank you, Mr. Chairman.
Chairman Greenspan, I want to go back to what I along with
some other members talked about in opening statements, the socalled credit crunch.
As I'm sure you're aware, one of the aspects that I feel very
strongly about which is not discussed very often as a part of that
problem is lender liability. I feel very badly that in the comprehensive banking bill we passed last year, many parts were eliminated
in conference. Part of that was my section on lender liability.
I still feel that this is a very significant part of the credit crunch.
A lot of the evidence is anecdotal, but it comes from all over the
country. We've had many banks who issue small business loans testify before the committee saying that they simply were being very,
very cautious and not making a lot of the loans that they used to
because of the possibility of being held liable for pollution clean-up
that they had nothing to do with.
27
My bill went through several different modifications making it
very clear that if a financial institution RTC, FDIC, or Government
agencies held property, and they had anything to do with the management and in any way contributed to that pollution, they ought
to be held liable for the clean up.
Just because you simply held a mortgage on this particular business, building, whatever, you are not liable for the clean up. The
environmentalists have fought the bill as somehow anti-environment. It has nothing to do with pollution. Beyond a credit issue, it
is a matter of fairness that someone who had nothing to do with
causing pollution should not be required to pay for the clean-up.
Governor Kelly testified last fall that environmental liability is a
significant contributing factor to the present credit crunch. Bill
Seidman testified last fall that if there was one thing that we could
do before the end of the session that would be helpful to him at the
FDIC, it would be to pass lender liability.
So with all of that background, I simply would like your opinion
of the impact of this liability problem and pollution control on the
credit crunch. Also, do you feel it is important to clarify those
court decisions and pass legislation that would ensure that innocent lenders are not held liable? Finally, what impact would lender
liability have on the credit crunch if we were able to pass it?
Mr. GREENSPAN. Senator, in the surveys that we have taken
through our various Federal Reserve banks, we have clearly concluded that it is a problem and that it is a factor in the restraint of
credit.
To that extent, it is an element in the credit crunch and it is a
factor which is causing problems which are quite significant for a
number of lenders.
I would be hopeful that this issue can be resolved as expeditiously as one can do it through the legislative process.
Senator G A R N . Well, I appreciate that. I certainly intend to continue the push for it because all of the other solutions we have
talked about, there are other factors. I do think this is a more significant one than a lot of people think.
I think everybody believes that there has been an overreaction
on the part of the regulators and examiners. I can certainly understand why.
As I also mentioned, the regulators took a beating from Congress
a few years ago for being too lax. If I had been a regulator and constantly was berated at witness tables and other forums I would
tighten up as well.
I do think there has been overreaction, as the President mentioned last night. I would like your opinion, do you agree that there
has been an overreaction, and if so, what steps are you taking at
the Fed to try and alleviate that part of the problem?
Mr. GREENSPAN. Senator, there has been an overreaction. I think
it's important. If I may take a minute to go back and review a little
history to understand why that is, so that we'll have some basis of
preventing this type of what I would call a regulatory cycle reemerging in the future.
It's fairly clear, as I've indicated to this committee previously,
that with the enactment of some of the incentives for commercial
real estate in the 1981 Tax Act, we oversolved a problem which we
28
had earlier; that is, depreciation—the tax codes on depreciation
prior to that Act, especially for commercial construction, were
really much too restrictive and noneconomic.
But instead of changing it to economic, we overdid it and went
the other direction. We created incentives which, in conjunction
with a tight market, induced a veritable explosion in commercial
construction and, most specifically, commercial construction values.
Appraisals went up very sharply and what we were observing
was presumed collateral values which would support very substantial amounts of commercial mortgages through banks.
As it's turned out, that bubble broke. The valuations which
reached their peak in 1985 nationally, and at a later time in the
east, brought down collateral values very substantially, and created
a whole attitude toward real estate which we're living with today.
But in that process, as commercial bankers moved to create. A
major increase in the proportion of their assets which are commercial mortgages, and the values kept escalating, supervisors, and examiners, looking at these appraisals, certified actions as being appropriate, those actions.
That has turned around 180 degrees for just the reasons you
imply. I don't find it at all surprising that we've had a regulatory
reversal. Human nature, being what it is, any of us in that particular position would have done precisely what the examiners and supervisors have done.
What we have to implement, as policy, are means of supervision
which prevent that type of cyclical behavior from occurring.
We obviously cannot change human nature, but we certainly can
change the procedures that we are involved with.
So I would look at the particular period not as one that leads us
to forbearance for forbearance's sake—would be a terrible mistake.
We should look at the current period as a means by which we can
look at policy over a full cyclical horizon and be able to put in
place policies which would prevent this very unfortunate supervisory cycle which I believe we have gone through.
I must say to you, Senator, that my colleagues in this area don't
all agree with me on this question. This is a view that I have. Some
of them have different views. Some of them think I'm mistaken on
this.
But what we are all in agreement on is that we have to get a
long-term, rational policy of supervision which doesn't create ups
and downs solely as a result of supervisory reactions to volatile
changes in appraisals.
Senator GARN. My time is up. I agree with you because I sat
through the years when we were constantly hearing forbearance.
We certainly don't want to go back to that time because that was a
major cause of the S&L crisis. Everybody was pleading in those
hearings saving, "don't close my institution." "Let them grow out
of it." And Keep them open."
In return, now you get the overreaction of what is now too tight.
I think that overreaction exists and it must be modified. But you
used the key word. If we push from these political pulpits to go
back toward forbearance, we will buy another financial disaster.
We must try and smooth out those ups and downs. Congress
must encourage a much more balanced policy. Ease up. I'd like to
29
get the word forbearance out of our vocabularies because of the disastrous consequences of forbearance in the 1980's.
Thank you, Mr. Chairman.
The CHAIRMAN. Senator Wirth?
Senator WIRTH. Thank you, Mr. Chairman.
Mr. Greenspan, I'd like to go, if I might, to the question that I
suggested in my opening comments about the health care metaphor.
There has been a good deal of discussion over the last 3 years
about bank powers, as some have suggested, the solution to the
problems that our financial institutions have.
I think it has been demonstrated, one, that that issue is enormously difficult for us to resolve, no matter where you come down
on it, because of all of the veto power conflicting interests and
views that surround this issue. And second, some disagree pretty
strongly that new powers in fact would have a major impact, at
least in the immediate future.
The question then becomes, are there steps that we ought to be
considering relating to these very special institutions, our banks
and other financial institutions, are there steps that we might take
that will help in the short term.
I mentioned capital requirements earlier. Senator Mack built
upon that and knows much more about this than I do, the notion
that such tight capital requirements are putting pressures on
banks to call long-time performing loans.
Are there steps that we might take there? Are there steps that
we might take in the upcoming tax legislation?
Some have suggested the potential of tax credits to banks. If they
are making loans of a particular nature, tax credits could help support capital.
I would like to know what would you do? If you were sitting
where we are, looking at the economic recovery package that's
coming up, what would you suggest that we ought to be doing from
the perspective of the Banking Committee for both the short-term
and the long-term?
Mr. GREENSPAN. Well, with respect to the Banking Committee or
banks?
Senator WIRTH. Banks in general. What might we initiate, obviously? It would go to many committees of jurisdiction. But banks as
a general proposition.
Mr. GREENSPAN. Senator, looking at the major problems that we
have seen in banking over the years, as we've observed, their franchise began to erode for competitive reasons with respect to other
financial institutions. It's become increasingly clear that giving
them powers which enables them to compete, but also to increase
the average capital position, is a necessity and is clearly the longterm required solution to the difficulties which confront banks.
The Basle capital requirements were, as you may recall, the
result of conversations initiated 4 or 5 years ago, and were meant,
and continue to apply to longer term needs of the world banking
community, especially those in the United States.
I would be very chary about trying to change those mid-stream.
First of all, it would be almost impossible to get international
52-418 - 92 - 2
30
agreements. I do think that we can look at certain areas of the way
in which we control capital.
We have, for example, been looking at the so-called leverage
ratio, which is a secondary capital ratio imposed because the basic
agreement at this stage does not have interest rate risk embodied
in it.
There are discussions which have been proceeding in which we're
trying to examine whether we have the most sensible set of capital
standards.
I would be
Senator WIRTH. Excuse me. Those are discussions between you
and the Department of the Treasury or
Mr. GREENSPAN. Yes. These are amongst the various supervisory
and regulatory authorities.
I would be very careful about changing long-term capital requirements at this specific stage; that is, bringing them down for cyclical
reasons, because I'm not sure that we can effectively do that. And I
must say, Senator, I'm not convinced that the problems that we
have with respect to what we call the credit crunch lie to a very
large extent, or even a material extent, in those capital requirements.
I do think that the fear of losing capital is a very crucial aspect
of this whole phenomenon. But it is largely the consequence of
fears of bankers that their nonperforming loans will turn bad, be
written off, cut into their capital, and require that they squeeze
down the total institution.
So I would be far more inclined at this stage to look at alternate
means of resolving these issues, and I would be very hesitant at
this stage, unless it is effectively demonstrated, and I doubt that is
the case at this stage, that these are a major impediment to the
functioning of these particular institutions.
Senator WIRTH. What are the alternate means that you were just
referring to?
Mr. GREENSPAN. I would say at this particular point, what we are
finding is that, while the credit crunch has not eased, it hasn't
gotten worse. But we are now for the first time beginning to see
some evidence that nonperforming loans are beginning to flatten
and turn down.
This is a necessary condition for the ending of the credit crunch
because unless and until bankers feel comfortable that the quality
of their assets are such that expanding loans will not impair the
franchise value of their bank, until that occurs, we are going to
continue to get an extraordinarily distorted extension of credit that
we have called a credit crunch, but has broader implications with
respect to the way the financial system functions.
At this stage, we are getting increasing capital into these institutions. Rather than lower the requirement, it's far more important
that we just increase the amount of capital to assuage the concerns
that some banks obviously do have.
And we have seen a very dramatic increase in capital, and anything that this committee can do to enhance the capability of institutions to attract capital would be helpful.
As I and my colleagues have testified before this committee on
numer< s occasions, it is our belief that the best way of doing that
31
is to try to improve the powers of these institutions in a manner
which would enhance their attractiveness to the financial market,
and increase their earnings, and because earnings are increasing
and the outlook for earnings improves, that capital will automatically flow from the market place into these institutions in a
manner which would be more than adequate to finance them.
Senator WIRTH. Mr. Chairman, thank you very much.
The CHAIRMAN. Thank you.
Senator Specter?
OPENING STATEMENT OF SENATOR ARLEN SPECTER
Senator SPECTER. Thank you, Mr. Chairman.
Chairman Greenspan, you and I have discussed an issue which I
would like to pursue with you this morning, and that is an idea
which Senator Domenici and I proposed on stimulating consumer
purchasing power by use of IRA's and 401(k) programs, with an opportunity for people who have those interests to be able to withdraw a certain amount, which we established at $10,000 a year for
middle-income Americans, without any penalty and without tax in
the first year, with taxes to be paid in the 4 succeeding years.
President Bush, last night, in his State of the Union address,
picked up that idea. I would like to explore it with you today in
terms of your evaluation as to what that might add to consumer
purchasing power.
There is obviously a trade-off if we use savings. But savings are
really for a rainy day and we have in effect a cloudburst today
with the economic problems which we face.
We find ourselves in a straightjacket of a sort, with the budget
agreement because we cannot reduce taxes. We cannot increase
spending without finding some set-offs. But we have the available
funds, some $800 billion.
This idea which Senator Domenici and I have proposed is a takeoff on the Super IRA proposal which has 74 cosponsors, where the
idea has been advanced to use IRA's in the future and allow those
funds to be utilized for capital investments like college tuition or
medical expenses or first time homebuyers.
Our proposal would utilize the existing IRA's to try to stimulate
consumer purchasing power pretty much on a concept that we
need some revitalization of confidence.
Paraphrasing what Franklin Delano Roosevelt said, all we have
to fear is fear itself, if we can get the process going, people would
be inclined to spend some of their money if they thought that they
were not going to be alone.
And I know from your prior testimony, you have noted that the
statistics are not as bleak now as they have been at some times in
the past, in 1982, for example, except for the factor of confidence.
You and I had discussed this, as I noted, before, yesterday, in addition, when we had a brief conversation. I would be interested in
your assessment as to how much money might be spent and what
effect it might have on consumer purchasing power.
Mr. GREENSPAN. Senator, as we discussed yesterday, it's not an
easy calculation to make largely because what we are in effect
trying to make a judgment of is how many individuals would take
32
advantage of the tax changes that are implicit in that activity,
such that they would decide to forgo long-term or retirement savings to make purchases in the short-run. It is fairly clear that some
would. What we are not clear on, and hopefully, we can get a
better judgment of, is what type of impact that would have.
As I indicated to you yesterday, I suggested that since we are unclear as to how much of an effect that might have, it would be
really important, to avoid significant fiscal hemorrhage, that these
types of activities have upper limits on them so that they would be
contained both with respect to levels and time, so that they achieve
the type of specific purpose which I presume is the basis of your
particular recommendation.
Senator SPECTER. If I might just interrupt you there.
So you would think that, if it is to be done, there ought to be an
upper limit, say establish some dollar figure, and when that much
has been taken down by holders of IRA's or 401(k)'s, that that
would be the end of it, until we had a chance to re-evaluate the
economic impact and see if there was too much stimulus to consumer purchasing power.
Mr. GREENSPAN. As I indicated to this committee a couple of
weeks ago, Senator, I have not yet come to the point where significant fiscal initiatives for short-term means are desirable.
My main concern with respect to that issue is not so much that
moderate types of activities will create distortions in the system.
I'm worried about if they begin to mushroom and you begin to
overload the system.
So my concern really rests with the fact that whatever is done, if
it is done, be limited because if it turns out that, in an endeavor to
impact some short-term fiscal stimulus to the system, we do so, but
create some longer-term problems with respect to fiscal affairs, we
will be most concerned about the outcome.
So what I'm saying is I hope that, in evaluating this, that you
endeavor to keep it to the specific rifle focus, so to speak, that
you're endeavoring to engage in.
Senator SPECTER. When we talked yesterday, you said you would
give some thought, some idea as to what kind of consumer purchasing power might be generated, and perhaps also to what you would
establish at this point as an outer limit to see what the status of
the economy was after X-dollars had been spent.
I realize that these are very complex, judgmental calls and as I
said to you yesterday, we really need the help of the experts, realizing how difficult it is.
Could you give us some guidance along those lines?
Mr. GREENSPAN. Yes. We will look at it and try to give you our
best shot at what type of impact is likely to occur under various
assumptions relevant to what you are suggesting.
Senator SPECTER. Well, the red light has gone on in my first
round. I will not exceed my time, but just to focus the questions
which we'd like your written responses to, would be what impact
you think would be present on stimulating consumer purchasing
power and what upper limit ought to be restricted without unduly
fueling those fires.
Thank you very much, Mr. Chairman.
Thank you, Chairman Riegle.
33
[Chairman Greenspan subsequently submitted the following information for the record:]
Mr. GREENSPAN. Following our discussion, I directed the Board's
research staff to do an analysis of your proposal for allowing penalty-free withdrawals from IRA and 401(k) plans for certain purposes
and to estimate the effect of the proposal on consumer purchasing.
I am enclosing that analysis for your review.
It should be noted that because of the multiplicity of factors involved, the analysis is difficult, and it must be recognized that it is
not possible to reach a high degree of confidence with respect to
the conclusions.
This memorandum analyzes Senator Specter's proposal regarding penalty-free
withdrawals from retirement account, focusing especially on the issue of how great
an impact the action would have on household spending. Section I describes in
greater detail the provisions of the proposal; Section II discusses some analytical
considerations bearing on the spending issue; Section III presents some relevant estimates derived from the national Survey of Consumer Finance; Section IV offers
some conjectures on the likely spending effects.
I. The Proposal
The proposed legislation would allow certain taxpayers to make penalty-free withdrawals from retirement-type accounts, provided the withdrawals are applied
toward one or more qualified purchases. Specifically:
• The proposal would allow withdrawals from IRA's Keoghs, and 401(k)'s.
• Eligibility would be restricted to those earning less than $100,000 (if married
and filing jointly), $50,000 (if married and filing separately), or $75,000 (all
others).
• According to the legislation in its current form, qualified expenditures would
include the purchase or improvement of real property, and the purchase of durable goods. In his floor speech and in other communications, Senator Specter
has also mentioned medical expenses and college tuition.
• Each taxpayer would be allowed to withdraw no more than $10,000.
• Withdrawals would have to be made on or before December 31, 1992; associated expenditures would have to be made either (a) within 6 months of the withdrawal, or (b) by the time the taxpayer files his/her return for the relevant tax
year (in most cases, no later than April 15, 1993). The more restrictive of (a) or
(b) would be the binding rule.
• Regular tax liability on the withdrawn funds would still be owed; however,
the liability could be spread over a period of 4 years following the withdrawal.
• In his floor speech and written communications, Senator Specter also mentions the possibility of allowing those who take advantage of his proposal to replenish the funds in their IRA or 401(k) over the 5 years following the withdrawal. The existing legislation does not contain this provision.
II. Analytical Considerations
Several analytical points are worth making about the likely impact of the proposal on household spending:
• It is useful to think of qualifying households as falling in one of three categories: not liquidity-constrained, extremely liquidity-constrained, and somewhat liquidity-constrained.
• Households that are not liquidity-constrained will probably not be interested in tapping their retirement savings, because doing so would remove
those savings from their current tax-sheltered status.
• Households that are extremely pressed for the funds will be tapping their
funds in any event, and would choose to pay the 10 percent penalty in the
absence of Senator Specter's proposal. The extra spending generated by the
Senator's proposal via these households would be only $1,000—smaller by
an order of magnitude than the overall amount of $10,000.
• Therefore, the proposal likely would have its greatest impact on the
spending of the intermediate group: those households that are somewhat liquidity-constrained, but not too much so. These households will be induced
to make a withdrawal that they otherwise would not have made.
• About two-thirds of 401(k)'s have borrowing provisions. Therefore, owners of
these accounts have access to the wealth they hold in 401(k)'s even in the ab-
34
sence of Senator Specter's proposal. Evidence suggests that many households
take advantage of these loan provisions. For example, one recent survey found
that 9 percent of account-holders initiated a new loan during 1990, while 21 percent had a loan outstanding at the end of 1990.1 Roughly 90 percent of such
plans allow general-purpose loans (and therefore cover a wider range of expenditures than would Senator Specter's plan).
• The tax amortization feature probably will make relatively little difference to
the proposal's influence on spending: Standard theories of consumer behavior
predict that taxpayers who know that a liability is outstanding will be inclined
to set aside most, if not all, of the tax liability upon receipt of the withdrawal.
This prediction is supported by available evidence concerning the relationship
between ordinary income tax refunds and consumer spending.2 3
III. Empirical Evidence
The following estimates from the 1989 Survey of Consumer Finance shed further
light on the likely impact of the proposal on household spending:
• According to the SCF, qualified accounts (including IRA's, 401(k)'s, Keoghs,
thrift, and saving plans) amounted to $1,239 trillion in 1989.4
• Of this amount, $893 billion was held by families headed by someone aged
less than 59 years old. Older people already can withdraw funds from retirement accounts without penalty.
• Next, $736 billion was held by families meeting both the income constraints
specified under the Specter proposal and the above-mentioned age cutoff.
• Ownership of that $736 billion was highly concentrated, however. If we count
only the first $10,000 in retirement funds per family, then the qualified pool of
funds shrinks to only $136 billion
• Median liquid assets held by all families meeting the proposed age and
income criteria were $1,950.5 Among families reporting ownership of some retirement funds, median liquid asset holdings were $6,180. Among families holding at least $5,000 in retirement funds, median liquid asset holdings were
$6,180. Among families holding at least $5,000 in retirement funds, median
liquid asset holdings were $9,800. This result conforms with the common finding
that those who save via IRA's and Keoghs also tend to save by other means.
Families that are holding substantial amounts outside their retirement accounts will be less interested in tapping their retirement funds if given the opportunity to do so penalty-free.
• Transaction costs could be sufficiently great to persuade some families who
otherwise would take advantage of Senator Specter's proposal not to liquidate
their IRA's or 401(k)'s. These costs would include, for example, early withdrawal penalties on time deposits and broker commissions.
IV. Spending Effects
A fundamental fact should be kept in mind while assessing the likely influence of
the proposed program on household spending: The proposal would do nothing to
raise the wealth of households, other than of those who anticipated incurring a
withdrawal penalty. Therefore, the proposal would influence household spending
mainly by relaxing liquidity constraints currently binding on some households. The
above data from the SCF suggest that this impact probably would not be very great,
given that a considerable portion of the available retirement-related wealth is
owned by families holding substantial amounts of other liquid assets.
1
2
Hewitt Associates, Lincolnshire, IL, News and Information Release, January 23, 1992.
See "Income Tax Refunds and the Timing of Consumer Expenditure," David W. Wilcox,
mimeo, Federal Reserve Board.
3
Low-income taxpayers will experience some benefit from being allowed to smooth some of
the liability into lower tax brackets. However, evidence from the Survey of Consumer Finance
suggests that eligible families would have higher-than-normal incomes, and so would not benefit
from this aspect of the proposal to any great degree.
4
Respondents to the 1989 SCF reported total holdings in IRA's and Keoghs of $598 billion.
For comparison, the Employee Benefit Research Institute puts the total for IRA's and Keoghs in
1989 at $494 billion. SCF respondents reported an additional $295 billion in 401(k)'s, quite close
to the estimate for 1988 of $277 billion based on data from the Department of Labor's Form
5500. Finally, SCF respondents reported $346 billion in thrift or saving plans, or other definedcontribution plans with borrowing provisions.
5
Liquid assets were defined as the sum of checking accounts, money market accounts, CD's,
other bank accounts, mutual fund holdings, saving bonds, other Government and private bonds,
direct stock holdings, and accounts held at brokers.
35
Some withdrawals undoubtedly would occur if the proposal were to be adopted,
but the incremental effect of the proposal on expenditure will be less than the total
amount withdrawn for two reasons: First, some withdrawals would have been taken,
even in the absence of the program, ,by families extremely pressed for liquidity.
Second, some withdrawals from 401(k) s will represent, in effect, a substitution of
outright withdrawal for borrowing that would have taken place in the absence of
the program.
There is no way of predicting with any confidence the amount of additional expenditure that would be forthcoming in response to implementation of the proposal.
It seems reasonable to guess, on the basis of the evidence presented here, that the
increment to spending would amount to less than 1 percent of personal consumption
expenditure (or $40 billion)—and it quite possibly would be substantially less. If the
permissible penalty-free withdrawal were to be raised to $20,000, it would raise the
amount released on the estimates above from $136 billion to $206 billion. However,
while the spending effect probably would be greater, it would likely be only modestly so, because the additional balances affected would, on average, be held by individuals who are less liquidity-constrained.
The CHAIRMAN. Thank you.
Senator Sasser?
Senator SASSER. Thank you, Mr. Chairman.
Dr. Greenspan, I want to go back to a question that I really
didn't get to ask in its entirety the last time you were here. It's an
important question.
One of the implicit understandings underlying the 1990 budget
agreement was that the Congress, and the administration, to some
extent, would be transferring to the Fed the obligation of keeping
the economy rolling along and not going into recession.
Indeed, it was partly at the urging of the Fed that we arrived at
a budget agreement to reduce spending and raise revenues by
roughly $500 billion over 5 years.
And as an inducement to do that, there was an implicit understanding that we would see rates coming down, or at least that the
Fed would be mindful of the economy. In essence, the Congress and
the administration were getting in the backseat of the car and putting you and your colleagues at the steering wheel, to some extent,
Dr. Greenspan.
At the time I was concerned about the effect that a contraction
in fiscal policy would have on the economy to the extent that this
budget agreement was a significant $500 billion reduction.
I asked you in July of 1990, if monetary policy could act quickly
to counter the fiscal contraction that was coming.
I thought that the Fed ought to be easing in advance of the
budget agreement, due to what I perceived to be a lag effect in
monetary policy.
This economy is sort of like the Queen Elizabeth II. You turn the
wheel and the ship starts responding sometime later, very slowly.
You responded, at the time, that the Fed would wait until after
the budget agreement was finalized to ease rates and you did
assure me, and I quote, "that monetary policy changes can be suggested, debated, decided, and implemented in a very short span of
time."
And continuing from your letter, "If need be, monetary policy
has the ability to act quickly enough to support economic expansion."
Now, you did wait until after the budget agreement to ease. As a
matter of fact, the Fed did not seriously begin to reduce rates until
December of 1990, after the recession was already 6 months old.
36
The steps that were taken initially were very gradual, as I said
earlier, and very incremental.
Monetary policy was supposed to be our safety valve, but we fell
off into a recession, anyway. Thus far, monetary policy does not
seem to have worked and Congress sits here with its hands tied
with regard to fiscal stimulus by the 1990 budget agreement.
I want to ask you, Dr. Greenspan, why the Fed didn't act quickly
when we were on the cusp of the recession, to push rates down and
prevent a further economic downturn.
I want to go further and ask you, do you believe that monetary
policy is capable of pulling us out of the recession now? Should we
rely only on monetary policy? And if so, when is it going to get us
out of this economic quagmire? That's a three-pronged question.
Mr. GREENSPAN. Senator, first let me start by saying that we
started easing basically in the spring of 1989, as we began to see
the consequences of the balance sheet problems which were beginning to emerge and the weakness that was occurring in the underlying system.
We moved the Federal funds rate, as you in fact indicated another time, down from approximately 10 percent to under 8 percent
in the fall of 1990.
And in that sense, we had been basically trying to anticipate a
change in the levels of economic activity in advance.
It was not clear to what extent the recession would take hold
and whether or not the level of easing that had already taken
place was adequate or not adequate.
One of the basic problems that we had was a recognition of the
fact through all of this period and subsequently, that a crucial element in addressing what we variously called either the balance
sheet problem or a specific form of the balance sheet problem, the
credit crunch. What that particular process needed to address it
was lower long-term interest rates.
And our major concern was to be certain that as we moved shortterm rates lower, we could move, induce, drive, whatever the appropriate term is, long-term rates to move with the short-term
rates because, basically, the Federal Reserve cannot control directly long-term rates.
The evidence that we had coming out of the latter part of the
1980's was that the market's basic evaluation of inflation, rightly
or wrongly, was that it was going to remain at a fairly significant
level. And what that did was to keep long-term interest rates up
higher than would otherwise be the case by a significant amount.
Without going into the analytics of that at this time, what
became clear to us in our evaluation of the long-term market was
. that the decline that was occurring in long-term rates, modest as it
was, was wholly a reflection of the fact that the inflation expectations that were falling and reflecting the long-term rate were those
only of the next 3-to-5 years.
The market's implicit long-term inflation expectation 10, 15
years out remained stubbornly high. And our concern was that
unless we could break the back of that expectation, our ability to
bring long-term rates down enough to make a significant difference
would be limited.
37
And indeed, as I mentioned here a couple of weeks ago, it really
was not until the fall of 1991, that the first major signs were there
that the long-term inflation expectations embodied in the market
place were beginning to ease enough so that we could look to a
major decline in long-term rates if we eased.
That's the reason why we accelerated our monetary easing in
that period, because it became clear that we now had the capability
of really bringing long-term rates down.
And that has had the effect, as I'm sure you're aware, in fact, as
you have mentioned, of significantly increasing the refinancing of
mortgages and homes. It's created a record level of issuance of corporate debt for purposes of liquification of corporate balance
sheets, and has indirectly created a major increase in equity issuance as well.
So, in that sense, monetary policy is clearly working to try to
break the back of this credit crunch balance sheet constriction of
the economy.
Is it enough? I think so. Do I know that for sure? The answer is
no, I do not.
Senator SASSER. Can you assure us today that monetary policy
will bring us out of this recession?
Mr. GREENSPAN. My best judgment at this stage is that it will.
Senator SASSER. Well, when, Dr. Greenspan?
Mr. GREENSPAN. I would say that if it is not doing so within the
next several months, then the statement I'm making requires revision.
[Laughter.]
But let me be much more specific and tell you what we know
and what we don't know.
Senator this is a situation—that is, the balance sheet strain situation—is unique to the second part of the 20th century. We have
not seen anything like this before.
We have not seen real estate values fall precipitously. We have
not seen collateral values create the type of problem that has been
so much of a concern to us.
What we do see at this particular stage is a stirring in the markets. We are seeing, for example, some evidence that Homebuilding
is finally beginning to move, and that's a crucial aspect of the situation. We are beginning to see some very subtle signs that the erosion in the economy is beginning to stabilize.
If that process continues, then the economy will be picking up on
its own independently of whatever fiscal policy moves the Congress
chooses to make.
My only concern about fiscal policy moves is that it is very easy
to overdo them. And we have sufficient experience of overloading
the system, which suggests to me that we have to be quite careful.
My best judgment at this stage, fully recognizing that we are
dealing with a very shallow data base, and a very extraordinary set
of circumstances which we have not seen before, is that this economy can move out of this extraordinary lethargy with monetary
policy alone.
I say that knowing that I don't know that for certain, but it is
my best judgment at this stage.
38
And as I said to this committee when I was here the last time,
I'm not yet ready to argue in favor of a significant fiscal package.
That might occur. In other words, it is conceivable that there are
other forces here which we are not aware of at this point which
would suggest that we do that.
I have not seen them as yet.
Senator SASSER. Well, my time has expired. Thank you, Mr.
Chairman.
The CHAIRMAN. In yielding to Senator Mack I think some would
argue that the President in part last night did put forward a fiscal
package.
Mr. GREENSPAN. I would say that the President did, and I would
say that it is not a major one and, like many of the packages which
individual Members of the Congress and specifically this committee
have brought forward, they are not the types of packages which in
and of themselves would, in my judgment, create long-term problems.
My estimate is I don't think they are necessary at this point, but
I understand that it's very easy to have differences of opinion and
a desire to create an insurance which I have full sympathy with
knowing the state of our knowledge.
My concern is not any of the individual packages that I have
heard because none of them, or I should say none of which I am
aware, have the capacity to overload the system in the long run.
My major concern is that in the process of endeavoring to reach
an agreed package within the Congress that the type of negotiations that could occur could create a much larger and potentially
fiscally disruptive package of an order of magnitude that no individual member or sponsor would himself particularly wish as the
final conclusion.
The difference really is whether or not whatever is done is restrained to a short-term package without long-term implications, or
whether in the bargaining process that might emerge we create a
package which is far too large for the type of problem which it
needs to address.
The CHAIRMAN. Senator Mack.
Senator MACK. Thank you, Senator Riegle.
Mr. Chairman, I want to pursue the comments in my opening
statements having to do with real estate, and I'm drawing from the
things you said here this morning that you do believe that real
estate values or the decline in real estate values is a major factor
in this recessionary period that we're experiencing.
Mr. GREENSPAN. Most certainly. The decline in real estate values
has had a very extraordinary effect on commercial lenders, mainly
banks, but also insurance companies and others, and it has been
the major factor which has created the credit crunch.
Senator MACK. All right. Again, I just want to mention a couple
of figures for the record. We did talk about them yesterday, but
FDIC sources for Florida insured commercial banks. For example,
one of them that really stands out is the unused commitments on
commercial real estate and construction loans. Those total loans
declined from September 1990 of $4.4 billion to September 1991 to
$2.25 billion, about a 50 percent decline. Now to me that's an indicator of future activities. It might be short-term future activities,
39
but clearly future activities with respect to construction and development.
Mr. Chairman, you mentioned liquidity and increased capital
and with low-interest rates, but yet the banks are not lending.
They are not lending money in the real estate market, and it seems
to me that without some—if we cannot find some way to increase
lending in real estate, I don't know what can occur that can stop
the decline in values of real estate.
I guess what I'm saying to you is you have kind of implied that if
we would just hold tight that with the increased liquidity and increased capital in our lending institutions that they will eventually
lend again in real estate. I am not comfortable with that response
at all.
Mr. GREENSPAN. Let me suggest, Senator, that there has obviously got to be more to the response that I have just given you with
respect to that particular problem. What we are dealing with at
this particular point is a general attitude on the part of a number
of banks that they overlent in a lot of different areas, mainly real
estate, and are under extraordinary pressure at this stage with respect to the safety and soundness of their institution, or at least as
they perceive it, and are particularly concerned about getting nonperforming loans down and the safety of their capital position assured.
Fortunately, we seem to be getting, as I indicated earlier, some
indication that overall nonperforming loans are flattening out and
in many areas declining. It is not an overly impressive trend yet,
but it's really the very first sign that we've had that something of
this nature is occurring.
If we get increasing earnings in the banks, which is beginning to
occur, and that's the reason why the stock prices for bank holding
companies have done so well of late and why individual banks have
been able to sell new equity in the market with some degree of success in recent months.
Basically we are looking at a situation where appraisal values, at
least until recently for which we have data, are still falling. It is
unclear whether those appraisal values are truly reflecting the
actual values of properties in an open market sense or whether we
have been engaging in accounting procedures with respect to appraisals which focus on liquidating values of property for collateral.
Senator MACK. Let me just hope in here for a second. It seems to
me that what is happening in the area of appraisals is the reverse
of what occurred as you talked about it a little bit earlier in the
beginning of the cycle if you will, the 1981 through 1985 and
beyond period in which people were appraising on their expectations of a marketing continuing to increase, whereas today the appraisals are being made on the basis of a market that they see continuing to decline.
Again, just because the time is somewhat short, I understand
what you re saying, but I just say to you that the folks that I'm
talking to in Florida, we're going to see many good businesses go
under as a result of the failure to be able to obtain credit.
Mr. GREENSPAN. I agree with you, Senator, and that's what concerns us the most. What I'm trying to suggest is what we as regulators have got to do, and we have come part way, but not as far as I
40
would like to see us get, what is needed is to find a mechanism
which accelerates this process by which what we are getting is a
willingness to lend, because of a perception on the part of the bank
that their capital position is now secure and eventually a sense
that unless they start to lend, they will begin to lose their competitive position vis-a-vis other banks.
And I would say to you that we have been only partially successful to date, but it is an ongoing concern on the part of regulators,
and unless and until this issue can be put behind us, an intensive
effort has to be maintained to find solutions to what is the unique
event in the post-World War II period.
I have not run into anything close to this, and I'm sure you, Senator, as a banker have observed very much the same phenomenon.
This is a very different type of problem than we have seen in banking since the 1930's.
Senator MACK. Just a final comment. In my 2 6 years, 1 6 in business and 10 in the Congress now I have never seen anything like
this, and I do think that we need to come up with some creative
approach frankly to address the question. I don't see anything out
there that I have heard that indicates that something is going to
stop this continual decline in the value of real estate.
My concern is if we don't it could further undermine the value
or the capital structure of other financial institutions which brings
more real estate into the hands of the FDIC and the RTC who then
turns around and dumps it on the market and further drives down
the values of real estate.
So I look forward to working with you to see if we can come up
with some kind of approach. Again, I know projects, and I know
what the values are and I have seen recent appraisers. Bankers are
just saying if it has the term real estate in it, we're not lending.
We don't care if there is a cash flow and we don't care whether
there is a real estate collateral value to protect it, they are not
lending, and that's killing our economy.
Mr. GREENSPAN. Senator, that's precisely the problem. It's the
word "real estate" if we could change would be helpful. The reason
we moved as we did to change the HLT definitions where we could,
because it was an idea, a concept originated by the regulators, is
precisely for this reason.
The difficulty that we have got in dealing with real estate is it's
a generic concept and security analysts and analysts of all types
look at the issue of real estate as something which is negative, and
what we have got to do is to change the structure of the way this
issue is being approached.
I will say just at the end of this short conversation that fortunately there appears to be improvement in the banking system.
Earnings are improving, capital is improving, and while that is not
a sufficient condition to end this particular problem, it is clearly a
necessary condition. So it's not as though we are back to square
one. We are not. But we still have a good way to go as far as I'm
concerned.
Senator MACK. Thank you, Mr. Chairman.
The CHAIRMAN. We need to continue that. I appreciate that line
of questioning. I think it's very important.
Senator Graham.
41
Senator G R A H A M . Thank you, Mr. Chairman, and I would like to
continue that and return to the earlier discussion on capital standards.
One of the criticisms that has been made of the capital standards
is that they are not discrete in terms of types of real estate. For
instance, housing, residential housing is treated as it would be commercial, and that's particularly true as it relates to the construction finance.
What I'm hearing is that a major impediment to the residential
housing industry has been the inability of builders to get access to
construction finance, and that in part is because of the unfavorable
capital standard which is set for all construction finance whether
it's of a commercial property or of a housing property.
(A) Is that factually accurate as you understand the capital
standards and, (B) If it is accurate, do you believe that is a legitimate reason why banks have been reticent to make residential construction finance and; (C) What would you do about it?
Mr. GREENSPAN. Well, Senator, the standards stipulate that residential mortgages are weighted at half the commercial rate or the
construction loan rate on the grounds that
Senator G R A H A M . NO, I'm speaking about construction and not
the in-loan mortgage.
Mr. GREENSPAN. Yes, O K . Construction loans at this stage are
weighted the same as commercial mortgages, and the reason they
are is the fact that they are perceived to be a standard loan with
risk involved.
Senator GRAHAM. Are construction financed loans for residential
rated at the same level as construction finance for commercial?
Mr. GREENSPAN. Commercial. In other words, it is only the permanent mortgage that is weighted at a half.
Senator G R A H A M . IS the empirical data over time that construction financing for residential had the same degree of risk for the
lender as construction finance for commercial?
Mr. GREENSPAN. My recollection is that if you took a look at the
basic loss record, one to four family mortgages over a long period of
time, the loss rate is very low.
Senator G R A H A M . NOW, again, I'm focusing on the construction.
Mr. GREENSPAN. But the construction loans in the most recent
period have apparently created lots of problems for a lot of depository institutions.
Senator G R A H A M . And that's for residential as discrete from commercial construction?
Mr. GREENSPAN. That's correct. But as you may be aware, Senator, there has been discussion about segregating parts of residential
mortgages, or I should say there is a case which the builders have
been pushing and we have been looking at in which they argue
that if a particular project or a particular loan is basically pre-sold,
in other words, if a house is pre-sold and the long-term mortgage is
available, that the risk of take-out is really de minimis and that
therefore the construction loan on that particular type of project
should be counted at the 50 percent risk weighted basis like the
other loans.
That is an issue which we are examining at this stage, but in
answer to your general question, construction loans, whether for
42
residential or non-residential, are unweighted, meaning a hundred
percent of risk.
Senator GRAHAM. I would like to have some analytical work done
on that distinction between residential construction and other
forms of construction finance to see if there is a justification for
the similar treatment that is now being accorded.
Mr. GREENSPAN. When I used to look at these data, my recollection is that we do not request on our forms to separate residential
from non-residential construction loans so that the data are not directly available, but I suspect we ought to be able to get at least
some judgments in calling around and trying to get a sample which
might be useful for your purposes.
Senator GRAHAM. My anecdotal information and my own intuition would be that there would be a difference, and it would be a
difference in the direction that the residential construction has
been less of a vulnerable pattern.
Mr. GREENSPAN. I would suspect that you're correct on that, Senator, but let's see if we can find some direct evidence which demonstrates whether that is in fact the case.
[Chairman Greenspan subsequently submitted the following information for the record:]
Consistent with the Basle Accord, the standard risk weight for claims on private
sector obligors under the U.S. risk-based capital guidelines is 100 percent. The 100
percent risk category encompasses a broad spectrum of credit risk ranging from
AAA-rated corporate commercial paper to loans for speculative real estate development. Residential construction loans generally are considered to be less risky than
commercial real estate development loans. While there are no firm data, anecdotal
evidence from around the country provides support for that statement. At the same
time, residential construction loans are considerably more risky than many other
types of loans in the 100 percent category. I would note, for example, that speculative residential construction loans played an important contributing role in the failure of a number of savings and loan associations and banks in the southwest and
northeast.
The one exception in the Basle Accord to assigning a 100 percent risk weight to
claims on private sector borrowers is for permanent loans secured by mortgages on
residential property. These loans may be assigned a 50 percent risk weight. The
Basle Accord, however, specifically excludes assigning loans to companies engaged
in specifically excludes assigning loans to companies engaged in speculative real
estate development to the 50 percent risk category.
However, where a developer has obtained a construction loan to build a 1- to 4family residence that has been presold and that meets reasonable prudential criteria, we believe a case can be made that such loans are not speculative in nature and
can be treated the same as permanent loans on 1- to 4-family properties for capital
adequacy purposes. Reasonable prudential criteria would include, for example, a
substantial earnest money deposit from the buyer and a firm commitment for permanent mortgage financing. In such circumstances, the risk of the builder failing to
complete construction of the residence and, thus, failing to close on the sale and
repay the construction loan has been greatly reduced. Accordingly, Federal banking
regulators currently are considering extending the preferential 50 percent risk
weight to presold residential construction loans that meet prudential criteria of this
type.
Senator GRAHAM. Mr. Chairman, in the limited time that I have
I'm going to shift to an entirely different subject matter.
One of the provisions in the banking bill that passed last November had to do with the international banks and provided a greater
responsibility to the Federal Reserve System for the oversight of
those banks, banks of a foreign origin doing business in the United
States.
43
One of the peculiarities of my State which has caused concern is
that many of those foreign banks are from relatively small countries and therefore themselves are small financial institutions and
that they might be disadvantaged by a regulatory scheme that required excessive by their standards amounts of scale of operation
in order to do business in the United States.
The legislation which passed had some provisions that were intended to discourage that negative view of the smaller foreign
banks. I wonder if you have any comments as to where the Federal
Reserve Board is in terms of implementing those foreign banks
standards and specifically how they might affect smaller banks
from smaller countries?
Mr. G R E E N S P A N . Well, Senator, as you know, we did have conversations and correspondence on this question. So we're fully aware
of your interests and concerns.
I assume that the regulatory provisions to implement the legislation that has just been passed are in process at this stage, but I
don't know specifically how far along that is.
[Chairman Greenspan confers with his staff.]
General Counsel says it's probably going to be available in about
60 days.
Senator G R A H A M . Thank you, Mr. Chairman. I would like to continue to monitor that as it goes through the regulatory process.
Mr. G R E E N S P A N . We shall do so.
The C H A I R M A N . Senator Bond.
Senator B O N D . Thank you, Mr. Chairman.
Chairman Greenspan, to go back to the points I raised in my initial comments, it would be very helpful for you to give us some
guidance. All of us are facing a smorgasbord of remedies, and there
are some sound economic ideas, there are some different policy prescriptions, there are some mechanisms that would probably make
Rube Goldberg look unimaginative and there are perhaps a few
that are just plain wrong.
For guidance as we approach the economic stimulus package
would you set out the two or three worst ideas, the things that we
must not do first.
Mr. G R E E N S P A N . I appreciate the question, Senator.
We are in a very difficult period at this stage. It is true that our
economic statistics indicate that we're not declining, we're flat, but
it is a flatness which seems to have no bounce at this stage, and as
I've said here on previous occasions and at other committees, there
is a general view of the longer-term outlook in this country
amongst many segments of our population which is, in my judgment, very discouraging, and I am quite concerned that there is
this fear about the longer term which must be addressed.
Therefore, I'm very much concerned that if we engage in too
large a fiscal package, assuming a fiscal package comes down the
pike, we could actually undercut the longer term and create much
more difficult problems for the budget, and in fact create in many
respects the type of long-term economic climate that a lot of our
citizens are fearful of.
So I would say, first, it is terribly important that whatever is
done that we do not change the long-term, or do not increase the
44
long-term structural budget deficit. Actions to reduce it are crucial
if we are to increase savings in this society and investment.
I would list that as the critical criterion, because if you give a
number of different criteria, none of them will be adhered to. So I
would basically say it is very important that not only do we protect
the long-term budget deficit from increasing in rhetoric, but we do
so in a manner which is implementable and the markets can perceive it as implementable, because if they begin to fear that we are
going to create a major new inflationary surge over the very long
term, they may be wrong, but what they will succeed in doing is
moving long-term interest rates up and that will be clearly counterproductive to our short-term desire to get the economy moving.
Senator BOND. When you say a large fiscal package then, you are
clearly saying a large increase in the deficit. If there were a major
revisions within the tax structure, for example, that did not increase the deficit, would that alone be a problem? Would that
cause uncertainty, or is just the deficit?
Mr. GREENSPAN. NO, I would think that anything which was constructed in a manner which not only stipulated that the budget
agreement, so to speak, or the ranges of longer-term deficits were
kept in place, but that actions were taken to make sure that was in
fact to be done.
Senator BOND. One or two of our colleagues, and I don't see any
of them here to speak for themselves, so I would ask the question
maybe on their behalf. One or two of our colleagues have said that
maybe this is the time for us to consider moving toward a consumption tax to some degree as a means of improving our international competitiveness in exports, imports and also to lessen the
disincentive for saving and investment. Would such a proposal
have a positive or negative impact on long-term growth in job creation?
Mr. GREENSPAN. In strictly economic terms if one looks at a shift
from income taxes to consumption taxes, one must assume that the
savings rate for the Nation as a whole rises and that you create the
type of investment that one would presume occurs as a consequence of that.
The concern that a lot of people have, however, is that if you
move in this direction, you create the dynamics which could very
readily create much higher value added or business transfer taxes
and not really address the budget deficit.
In principle I like the idea of moving to consumption taxes, but
as a practical matter I'm not certain that there is any easy way to
do so in the particular context that now exists within this country
and the different interest groups that would be affected one way or
the other. So I'm not inclined to push in that direction because I
don't think it will get very far.
Senator BOND. Well, my next question obviously is now that
we've gotten rid of the less desirable options, from a fiscal policy
standpoint what economically would be the most sensible changes
we coufyi conceivably make to encourage savings and long-term investment for growth and job creation?
Mr. GREENSPAN. Senator, as I have said before this committee on
numerous occasions, the best way to get national savings increased
45
is to reduce the drain of budget deficits against gross private savings.
I have also indicated that while the evidence on IRA's, for example, is mixed with respect to whether they engender savings or not,
that the goal of increasing national savings is so important to this
country that one could almost argue that even if it's unclear, one
should take the risk that the IRA's will work because at worse they
can't do very much harm.
But when you get beyond that, it is very difficult to find a series
of tax proposals which will enhance private savings, especially in
the household sector, in any appreciable manner relative to the
effect that a significant reduction in the budget deficit would do.
Senator BOND. Capital gains?
Mr. G R E E N S P A N . I wouldn't look at capital gains as a savings
issue as much as I would as an investment incentives. So I would
not put that in as a particular tax which I would look to as a major
creator of savings directly.
Senator BOND. Mr. Chairman, I thank you and thank the members of the committee.
The C H A I R M A N . That's a pretty important answer.
Senator Sarbanes.
OPENING STATEMENT OF SENATOR PAUL S. SARBANES
Senator SARBANES. Thank you very much, Mr. Chairman, and,
Chairman Greenspan, welcome.
Senator SARBANES. I sat down to breakfast this morning and
promptly proceeded to get indigestion reading an article on the
front page of the Business Section of the Baltimore Sun, "Confidence Slips Another Notch," and I don't know whether you can see
this chart from there, but this is consumer confidence.
Mr. G R E E N S P A N . That's the Conference Board survey which was
released yesterday.
Senator SARBANES. That's the Conference Board survey and it
shows another further drop. I mean it has really dropped, precipitously over the last few months, and in fact the Conference Board
said that it was now down to its lowest level since the 1981-82 recession.
Mr. G R E E N S P A N . A S I recall it was since 1980.
Senator SARBANES. In October the index took an especially steep
dive falling to 60.1 from 72.9 the month before. It slid further to
52.7 in November before stabilizing in December, and now it has
gone down again to 50.4, and they do a survey of 5,000 households.
They found only 6.4 percent of all respondents in January consider
business conditions good, while 51 percent said they were bad. Both
figures show more pessimism than in the preceding month.
Moreover, the survey showed that an increasingly large number
of households are experiencing hardship. Close to one out of four
report that someone in the household was unemployed over the
past 12 months. Of those who are back on the job, nearly half are
making less money. So if they've been unemployed, even if they
managed to get back on the job, just under half are making less
money than they were making before.
46
Now in this article it said the report from the Conference Board
was considered especially significant by economists because it
showed that Americans aren't responding to some of the lowest
borrowing costs in nearly two decades. That means they aren't
taking out loans for new homes, cars and appliances in sufficient
numbers to stimulate the economy out of the recession.
On the contrary, economists said, the Conference Board survey
shows that many consumers are holding back saving their money
in case they need it for essentials.
I think individuals are focusing more on the further deterioration of the job
market and their own family's financial situation, said Gary Ciminero, Chief Economist at Fleet-Norstar Financial Group in Providence, the biggest bank in economically battered New England. Job prospects and job concerns continue to mount.
That's what driving things he said. It should be patently obvious that interest rate
cuts haven't worked.
The article then goes on and says Federal Reserve Board Chairman, Alan Greenspan, who orchestrated dramatic reductions in interest rates last year to encourage more borrowing, has said those
moves should be sufficient to get the economy growing again.
And let me just interject, I understand you're reasserting that
position this morning in response to the questioning that has been
put to you.
The article then goes on and says by some reckonings the economy is in the 18th month of recession, which would be the longest
slump since the Great Depression.
Then, quote, and I'm now quoting from the article, this is not my
statement, "For heavens sake, this report today should have told
Alan Greenspan you haven't done enough."
Let me repeat that. "For heavens sake, this report today should
have told Alan Greenspan you haven't done enough," said Morey
Harris, Chief Economist at Paine, Weber Group, a large Wall
Street brokerage.
What do you say to those comments?
Mr. GREENSPAN. First, let me say that the evidence of borrowing
is beginning to emerge in the important residential construction
area. We are beginning, as I'm sure you've seen, to get reports at
this moment, to a large extent anecdotal, but increasingly in a statistical sense that residential housing is beginning to come back
and that sales are beginning to pick up in the month of January.
I will go further with respect to the specific issue relevant to actions taken by the Federal Reserve to repeat what I said here 2
weeks ago. If the Federal Open Market Committee concludes that
more is required, we will be there.
Senator SARBANES. What is the down side of doing more? If we've
got this consumer confidence problem, we've got a sluggish economy and the employment rate last month was the highest it has
been during the recession of 7.1 and capacity utilization is down,
what is the down side of easing monetary policy further?
You've actually not eased it significantly. In fact, you're just
about paralleling now the easing that was done in previous recessions at a time when fiscal policy was also being used as a tool to
stimulate the economy rather than being, as it were, frozen as in
this instance, and when we didn't have the credit crunch problem
that a number of my colleagues have referred to in the course of
47
their questioning, both of which it would seem to me would add additional arguments for further easing of monetary policy.
Mr. G R E E N S P A N . I would agree that the evaluation of relative degrees of ease during recessions does require, as you point out,
taking into account the fact that fiscal policy has been unable to
implement its usual role, and that is an issue which we reflect
upon.
On the other side of it to be considered as well is that even
though confidence has eroded quite considerably and you don't
need these surveys to know that that is in fact the case—you just
speak to people—the economy is up from its lows and is more than
half way back from where it started down. So that in that sense it
is not the same type of environment. We are in fact, and have
been, easing in an economy which has come up off the floor, and in
that respect it is not that we are looking at a continuous erosion in
activity.
But to respond to your question, which is a very important one,
our major concern since we view this problem as a balance sheet
problem is to get long-term interest rates down. It will not serve
our purposes very much if we bring short-term rates down and
long-term rates don't move with it.
Senator SARBANES. Well now let me just ask you on that very
point. In this morning's budget the administration makes the assumption that the interest rate on 90-day Treasury bills will fall
from 5.4 percent in 1991 to 4.1 percent in 1992, and then raise to
just over 5 percent through 1997. For 10-year Treasury notes the
administration assumes the interest rate will fall from 7.9 percent
in 1991 to 7 percent in 1992, and then gradually decline to 6.6 percent by 1997.
I have three very quick questions to put to you.
First, did the administration consult with you before it developed
its interest rate assumptions?
Mr. G R E E N S P A N . They did not.
Senator SARBANES. Are these assumptions realistic?
Mr. G R E E N S P A N . I don't know. This is the first time I've heard
them, or I might say the first time I heard of some of the numbers
was this morning when I saw it on the tape.
Senator SARBANES. Therefore, I gather the answer to the last
question is also negative, and that is did the administration get a
commitment from you to conduct monetary policy to achieve these
interest rates?
M r . GREENSPAN. NO.
Senator SARBANES. SO
the administration has in effect developed
these interest rate assumptions sort of out of the air, or at least
they have not been developed with any consultation with the Federal Reserve which helps to make the interest rates; is that right?
Mr. G R E E N S P A N . That's conventional procedure. I don't think
that I recall an administration consulting with the Fed on these
budget forecast numbers. Implicit in their numbers, incidentally, is
a rise in the Treasury bill rate because it currently is at 3.8 percent.
Senator SARBANES. DO you think it's realistic that these rates are
going to come down the way they've projected them?
Mr. G R E E N S P A N . The long-term rates?
48
Senator SARBANES. Yes, and the short-term rates.
Mr. G R E E N S P A N . Well, the short-term rates are rising in their
forecast and not declining. I mean currently we're at 3.8 percent.
Did you say they are at 4.2 percent?
Senator SARBANES. This is for the year. This is not at a particular point in the year.
Mr. G R E E N S P A N . I can't comment on the specific forecast, but
there is an inflation premium which is still in long-term interest
rates which I think over the long run will gradually dissipate, and
I see no reason why long-term rates should not over the longer run
move lower if inflation expectations continue to be subdued as they
clearly are in the current period.
Senator SARBANES. Well, Mr. Chairman, my time is up.
The C H A I R M A N . Chairman, I want to just clarify one thing and
then I want to go to Senator Domenici, and that last night the
President in his remarks said the following. He said, "Finally
working with the Federal Reserve we will continue to support monetary policy that keeps both interest rates and inflation down."
Now, of course, working with the Federal Reserve can mean a lot
of different things, but I take it from your testimony just now that
that should not be read to mean a consultative relationship in
terms of really forecasting these interest rates and trying to arrive
at a monetary policy blend with non-monetary policy that would
produce the numbers in the budget. I take it should not be read to
mean working with the Federal Reserve would carry that message
with it; is that correct?
Mr. G R E E N S P A N . That is correct. We do obviously consult with
them and try to coordinate as best we can because this is one Government and these policies are of necessity interrelated with one
another. So we do exchange views on a fairly continuous basis and,
in my view, quite satisfactorily.
We do not engage, however, in creating common specific interest
rate goals to be implemented by some joint effort. That is not what
that means nor, in my judgment, should it mean. I don't think that
would be an appropriate role for the central bank.
The C H A I R M A N . Senator Domenici.
Senator DOMENICI. Thank you very much, Mr. Chairman.
Chairman Greenspan, let me clarify a statement you made in response to Senator Bond's inquiry regarding the capital gains, the
difference in the treatment of capital gains from ordinary income
treatment. You indicated that you would not put capital gains
under the heading or rubric of increasing savings. But might I ask
doesn't it quite appropriately fit in the category of stimulating investments?
Mr. G R E E N S P A N . In fact, I thought that's what I said. I said it creates incentives to invest and, as I've argued before this committee
on numerous occasions, it's an important element in any tax program, and I've even gone further in repeating a position I've held
for a number of years that I would much prefer to see the capital
gains tax at zero because it's not the type of revenue raiser which
is appropriate for an economy which needs growth.
Senator DOMENICI. Well, I would put it this way. There are a lot
of Senators and other people in the country talking about catching
up with Japan, and it appears to me that when we talk that way
49
we do not refer to catching up with Japan in terms of increasing
investments because as a matter of fact there is a lot of catching
up to do there in that they have a capital gains differential of significant proportions and other incentives to investment in savings.
Is that not correct?
Mr. G R E E N S P A N . I believe so, but I'm looking at it strictly in
terms of what our economy needs. I would not necessarily allude to
what others are doing because each economy in respect to incentives and its tax structure is quite different, and it's important to
look at our particular structure not necessarily in the context of
how it looks relative to other countries.
Senator DOMENICI. I understand that, and I agree wholeheartedly. However, I don't think it's just an accident that most of the
competing economies do treat capital investment significantly different than we do in terms of the gains upon disposition or sale
which, as I say, could be an accident, but it seems to me to be
rather significant in that it's everywhere.
Mr. G R E E N S P A N . That is correct.
Senator DOMENICI. Let me ask with reference to monetary policy
and reducing interest rates and the efforts you have made thus far.
I gather what you have said here today is if it appears that more is
necessary, obviously the Federal Reserve is concerned about the
lack of responsiveness in the American economy in terms of
growth; is that correct?
Mr. G R E E N S P A N . That is correct. Senator.
Senator DOMENICI. And that is the most significant negative
quality in the American economy today, and you're not concerned
about inflation and other things as much as you are with the failure of this economy to catch hold and grow; is that correct?
Mr. G R E E N S P A N . N O , I don't think it is correct. Unless we are
concerned about inflation, we are not concerned about long-term
growth, and I would argue, as I indeed indicated in my opening remarks, that if we wish to have a functioning economy which grows
at it's maximum long-term potential, one of the necessary conditions to achieve that is a non-inflationary economy. What inflationary economies basically do is create an inordinate amount of volatility in the system and over the long run it inhibits real growth.
So I would not separate the issue of inflation as a long-term concern and long-term growth.
Senator DOMENICI. Let me move to another point. The American
people seem to be saying in most of the major poles of late when
they are asked what they are most concerned about, they seem to
be saying that you're saying that the long-term growth of the
American economy is a very high concern, and they are suggesting
that one of the principal concerns that they have is the rather
large American deficit.
Now since the American people feel that way, and I believe they
are smarter than we give them credit for, are you also saying here
today that you do not favor significant new spending programs at
this point in time because they are probably going to affect the
long-term health of the American economy?
Mr. G R E E N S P A N . I would be cautious about spending programs
because it will make the reduction in the long-term structural deficit exceptionally difficult, and since I view that as a major issue to
50
create savings in this economy which leads to investment, I would
be very reserved about major new expenditure programs.
Senator DOMENICI. Well, I believe that most of the criticism
about the President's proposals has been summarized in a statement of no new ideas. It seems to me that most of those new ideas
are new spending programs of one sort of another which are absent
from the President's proposals with reference to the overall budget.
And because I believe that, I wanted to ask you, probably within
the next 48 hours somewhere in the House, probably in the Ways
and Means Committee, a chart will go up for all the world to see
and the major networks will be there, and it's going to be a measuring of the President's tax proposals according to the progressivity
formulas that have been invented over there in the House by this
professional staff.
Now that bothers me very much because obviously there is a difference between progressivity as they define it and a stimulus for
this economy which may come from the tax side. And might I ask,
could you suggest to us what kind of index we might generate and,
believe me, since they generate one, we ought to generate one here
in the next 48 hours. Don't you think we ought to invent one, or
could we invent one and put it to the test and call it job creating
index? Would the Federal Reserve have any opinion on the job creating qualities of the tax proposals that are before us and others
that the other side might have?
Mr. G R E E N S P A N . Well, I would certainly say that we couldn't do
anything in 48 hours because we have just seen these proposals in
the last 12 to 15 hours.
The crucial question here is not the immediate incidence of taxation, which is the procedure that is employed here, but some endeavor to try to find what is the change in after tax earnings of
various different groups within our society, and that to me is a
much better measure of the degree of progressivity. If in fact implicit in any particular program is an ability to enhance the level
of economic activity, it may well turn out that a program which in
the first iteration looks to be progressive may turn out to be the
reverse and vice versa.
Senator D O M E N I C I . I thank you for that answer, and I frankly believe you should not be so cautious about preparing an index because nobody other than five or six people can understand theirs,
and maybe we can use five or six that would understand ours and
it ought to therefore be just as good.
However, let me move on to real estate. The President has hit
the nail on the head. Hardly any other national perspective is
being given to the policies involved in real estate free fall in values
and what we ought to do to prop it up.
I urge that you and the Federal Reserve monitor carefully what
is happening to real estate values in the United States and that
you do everything within your regulatory power without additional
ones to see that the lending institutions are taking the right course
of action in their lending practices regarding such things as mark
to market and those concepts that are out there that make it more
difficult to justify either new loans or the continuation of old ones
in the commercial market.
51
I think it's devastating to find that there is no increase and in
fact a loss in the total lending for commercial purposes and on
commercial real estate by our major banks in the United States.
That has got to turn around, and if there are regulatory impediments you should try to cure them, and I urge where we need to
change things that you suggest to us what we change them, because most Americans don't understand that real estate is a huge
part of the American economy. From houses and homes all the way
to office buildings and everything in between is a very large part of
the transactional activities in this country, and we've got to stop
that fall some way.
I think the President's suggestions are good, and I don't have
time to ask you if you do, but I will submit a question to you on
that score in writing and ask for other suggestions along those
lines.
Thank you very much.
Mr. GREENSPAN. Let me just say very quickly, Senator, that we
spend an inordinate amount of time trying to understanding what
is going on in real estate values throughout the Nation. It's not an
easy job, but we've put a great deal of thought into that issue and
follow it very closely.
Senator DOMENICI. Thank you very much.
The CHAIRMAN. Senator Shelby.
OPENING REMARKS OF SENATOR RICHARD C. SHELBY
Senator SHELBY. Thank you, Mr. Chairman.
Mr. Chairman, I was not here for all of Chairman Greenspan's
testimony. I was in the Energy Committee, and I have a prepared
statement that I would like to be made part of the record first.
The CHAIRMAN. Without objection, it's so ordered.
PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
Mr. Chairman, I first want to commend you for scheduling this
morning's hearing. I believe that the state of the Nation's economy
demands a strong hand at the helm. The chairman of the Federal
Reserve should not be subject to the political vagaries of the confirmation process. I hope that after this hearing, we will then have a
swift markup and floor vote.
Chairman Greenspan, you steer the Nation's economic ship
through turbulent waters right now. The economy has floundered
in a recession for several quarters. Unemployment is up, bankruptcies are up, housing starts are down to the lowest level since World
War II.
Interest rates have plunged but there is still a credit crunch.
Lenders are hesitant to lend, even to the best borrowers. Consumers are not buying, out of fear of what tomorrow will bring. Businesses are laying off thousands of employees at a time, in a vicious
downward cycle, that seems to escalate.
We cannot lay the blame for this at your feet. We have asked
you from your first day to do the job with one hand tied behind
your back; the budget deficit leaves the Federal Reserve with less
room to maneuver. The commercial real estate market was overbuilt. Not surprisingly, asset values dropped. The decline in values
52
was precipitated by vast Government holdings of real estate acquired from failed savings and loans.
Worse than all of this bad news, is what you and I discussed a
couple of days ago: the long range expectations of this generation.
For the first time ever in our Nation's history, this generation is
fearful over what the future holds. Rather than hoping to surpass
their parent's standard of living, today's generation is hoping
merely to obtain it.
I believe that the present recession represents a fork in the road.
We can go for a short-term boost to the economy and hope to coast
out of this recession. Or we can put together a package of longterm growth incentives that will enhance this Nation's competitiveness and fuel the country's growth for years to come.
For the health of the country and for the future of today's generation, I believe that we must emphasize long range growth. I
hope that today in your testimony you will share with us your view
on the merits of some of the ideas out there, such as investment
tax credits, capital gains relief, and expanded IRA's.
Last night, in his State of the Union Address, the President
listed a number of items he would like to see passed by Congress by
March 20. Presumably, he is looking for a turn around in the economy by November. If we were to pass his initiatives, many of which
are already supported by many of us here on the hill, would the
economy respond that quickly? Or are we already working our way
out of the recession, without these incentives?
Are there any proposals out there, that if we passed them, we
would do more harm than good?
You have done a good job for this country so far and I trust that
you will continue to do so in the future. Thank you, Mr. Chairman.
Chairman Greenspan, I had a nice conversation with you a
couple of days ago about a lot of things that you've rehashed here
today, and I appreciate that.
I asked you then, and it has been alluded to today about monetary policy, the easing of interest rates. I commend the Fed for
what you've done there. I hope you will do more. I mentioned this
the other day and you did not rule that out. You indicated to me
and you indicated a few minutes ago that it will depend on what
happens in the economy, so to speak, and what the numbers show.
I don't believe you can just jump start the economy strictly by
monetary policy, but I believe that will be a significant factor.
What bothers me is that any stimulus could have counter results,
and as an economist and Chairman of the Federal Reserve you've
indicated that to me.
What I'm concerned with, and we had the President's State of
the Union last night and his opening proposals. They've been
hashed here today, and a lot of those I personally like. They will
overall do some good for the long run and hopefully not a lot of
damage to the deficit, but this could just be the opening bid in the
Congress. It's a political year and, as Senator Domenici had mentioned, we don't know what is going to come out of my side of the
aisle or the other side of the aisle or a combination of everything.
That has got to concern you as Chairman of the Federal Reserve
and your Board of Governors. Will it be some legislation that will
really do some damage to the economy as the economy begins to
53
pick up, as we hope it will. Is that a real concern of yours, Mr.
Chairman?
Mr. GREENSPAN. Yes. As I said earlier while you were in your
other committee, Senator, in looking across the spectrum at the
various individual short-term fiscal initiatives which members of
this committee, and others, those in the House and the administration, none of them that I'm aware of strike me as potentially creating major difficulties in the longer term.
In that respect the bond market's reaction to the President's program, which was quite positive in both Tokyo and London right
after he spoke, is an indication of that.
But the concern that I have is that in the process of trying to
implement any of these programs into a general agreement which
can pass both Houses and be accepted by the President, that instead of averaging programs, we add them up, and that would concern me because that would create a longer term problem for the
economy which would immediately be perceived in the markets
which would move long-term interest rates back up and create a
short-term problem for us that I doubt very much that we need.
Senator SHELBY. IS it basically a fundamental given among
economists that the worst and most dangerous thing for any economy is debt and deficit? High deficits will breed, among other
things, inflation, the psychology of inflation and retard long-term
growth?
Mr. GREENSPAN. Senator, there are differences. There are a
number of very reputable economists who think that the deficit
either does not matter or it hasn't the types of effects that the majority of economists believe that deficits do.
Senator SHELBY. What is your opinion?
Mr. GREENSPAN. My opinion is that they matter and they matter
a great deal, and my major concern is
Senator SHELBY. And why? Explain that.
Mr. GREENSPAN. Essentially it's largely that they subtract from
private savings and as a consequence delimit the amount of financing available for domestic private investment, and that in turn is a
crucial issue with respect to American standards of living, the
growth of the economy and the general lifestyles that we would
like to achieve.
Senator SHELBY. And the fear that the American people have as
I go around, and not just in my State of Alabama, but there is a
great fear among the American people, and a lot of economists say
this, that our children will not have the standard of living that we
have and will not have the opportunities that we have. You've
heard that and you've seen numbers on it.
Mr. G R E E N S P A N . Senator, that view, which I find very disturbing,
is one of the elements in the lack of confidence which Senator Sarbanes has so correctly identified.
Senator SHELBY. Chairman Greenspan, just briefly could you
compare the 1982 recession to where we are in 1992 as to the severity and the problem in structure and debt and everything that goes'
with it. Let's go back 10 years. In 1982 we were in a recession, and
we're in one in 1992.
Mr. GREENSPAN. The 1982 recession, if one believes the data are
accurately reflecting various changes in what is going on in the
54
economy, was much more severe than we have been going through
to date. The unemployment rate, the layoff rate and all of the various labor force indications, the levels of economic activity and operating rates all suggest that. That's the reason why I'm so concerned about the climate of confidence in this country.
If it were worse, one could say it was the result of the short-term
business cycle, that therefore when the economy came out of a recession, as it always does, that we would be restored to some sense
of normality. But rather than give one a sense of unconcern when
you look at some of these data and their relative degree of relationship to the 1982 or 1975 recessions, it actually creates more of a
concern on my part because it's telling me that something much
more profound is going on which we don't at this stage yet fully
understand.
Senator SHELBY. Briefly you've alluded to the fact here and
you've told me personally that there are some numbers, and of
course they are not crystallized maybe yet, indicating that the
economy is beginning to turn around. Do you look for a turn-up in
the economy in the second quarter, some signs of something positive and not just a little bubble?
Mr. GREENSPAN. Yes, I do. My best judgment as to the forces that
are now beginning to emerge suggest that. But I do wish to hasten
to add that we are in an environment which is quite different from
historical business cycles, at least of recent history. We have to be
cautious about coming to definitive conclusions without the firm
evidence emerging, and as far as I'm concerned, I would expect the
economy to quicken its pace, but I'm spending a great deal of time
watching rather than forecasting.
Senator SHELBY. There have been a lot of false signals in the
past.
Mr. GREENSPAN. Exactly.
Senator SHELBY. Mr. Chairman, my time is up.
The CHAIRMAN. Thank you.
Senator Kerry
Senator KERRY. Thank you, Mr. Chairman.
Chairman Greenspan, you talked about the problem of inflation
and your reaction to it, and a number of Senators have asked you
about that. Would you rather have inflation or deflation?
Mr. GREENSPAN. I would prefer neither. They are both destructive.
Senator KERRY. Well, isn't it true that historically in the United
States the greatest periods of real growth in America have always
come with 5 or 6 percent inflation and that every time we've had
zero inflation we've had periods of stagnation?
Mr. GREENSPAN. I'm not sure which is cause and which is effect
because of the difficulties that one has in evaluating this process.
It used to be that the conventional wisdom amongst macroeconomists was that the ideal state was a modest degree of inflation as
creating maximum economic growth. That view has been largely
discarded in the last decade or so pretty much around the world,
and what evidence we have is suggestive of the fact that the lower
the rate of inflation, or more exactly the lower the rate of expected
inflation, the lower is the risk premiums embodied in the cost of
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capital, and the crucial issue relevant to economic growth is low
capital costs.
What evidence that we have suggests that inflationary environments do not lead to cost of capital that is sustainable over the
long run, and often what you get is a combination of both expansion and inflation in which it's the expansion which is causing the
inflation, but it doesn't go on very long. It's a cycle, and unless and
until we can observe growth which is sustainable, it is very difficult to argue that inflation helps rather than hinders.
Senator K E R R Y . D O you agree that we have a collateral crunch
right now?
Mr. GREENSPAN. Oh, I do indeed, yes.
Senator KERRY. Let me before I ask you the open ended question,
let me share with you an article that I found particularly interesting. It's an October 15, 1991 article in the Wall Street Journal written by Mr. John Rutledge, who is Chairman of Rutledge and Company, a merchant bank in Claremont, California.
He said the following:
The Fed Reserve has been busy since December cranking the Federal funds down
a quarter point at a time searching for the level of interest rates that will breathe
life back into the dead economy. It might just as well save its breath. The issue for
policymakers is not how to make people willing to spend money. It is restoring their
confidence so they will stop trying to unload the stockpile of houses, cars and other
fixed assets that they already own. There is no level of interest rates that will make
the public content to hold the existing stock.
He then says:
It's the availability of money for business, not its cost, that is at issue. The United
States does not need lower interest rates. It needs Roto-Rooter for the banking
system. As long as bank regulators pay more attention to credit risk than interest
rate risk, however, bankers will keep socking their money away in Treasuries and
businesses will go hungry for working capital.
That is precisely what is happening in New England, and I think
that's exactly what the Senator from Florida referred to.
Now he states:
The Fed should work with the RTC to estimate the size of this aggregate supply
bulge from the resale markets and to target a money growth rate sufficient to sterilize the effects of the RTC sales on net worth.
In retrospect this is precisely what Paul Volker did with the Fed in 1983 when
growth in M2 jumped to 11.8 percent. It happened again in 1986 with a 9.5 percent
M2 growth under somewhat milder deflationary circumstances.
Mr. Rutledge ends his article by saying:
An explicit announcement by the Government that it will use monetary policy to
stabilize the price of real assets would restore the public's confidence in their homes
and in their futures and would provide a firm foundation for long-term growth.
Could you comment on that.
Mr. GREENSPAN. Well, that's a very long issue to comment on,
but let me make a few basic comments.
You have to distinguish between asset values and commodity
values. I have no doubt that were we to inflate the currency by a
massive program of expansion that we could turn all sorts of
values up. You could very easily inflate residential and commercial
real estate, but the question that is far more important is what
happens to the rest of the economy in the process.
And I would suggest to you that that would seem to work only
for a very short period of time and create a massive structural
56
problem in the financial system with values going all over the
place, mainly adversely.
Senator KERRY. May I interrupt you there politely and just ask
you to follow up on that—isn't that exactly what happened in 1986
with the change in passive loss and its sudden imposition so that
the collateral went down, and now you're seeing this massive uncomfortable adjustment in the marketplace as a result of that?
Mr. GREENSPAN. N O , but the declines in values that occurred at
that time were really very small relative to what we're seeing
today. First of all, residential property values did not go down.
They were still going up during that period.
The decline that occurred in the overall commercial real estate
value in that period was largely in the Southwest. Actual commercial real estate values were rising in the East and continued to rise
until 1988. So the situation was far different then from what we're
confronted with today. That's not to say that I don't think we
ought to be looking at this thing for further actions that can be
taken to resolve it.
In response to Senator Mack's question, I think that we're not
there. We've made some progress. We understand a lot of the processes that are going on, and frankly the banking system is improving and we're a lot closer to the resolution of this issue, but I don't
think we're there yet. We've got a way to go.
Senator KERRY. What steps would you now recommend?
Mr. GREENSPAN. I would not wish to recommend anything at this
stage unless and until the regulators, my colleagues in this particular area were all in agreement on a specific project, because I don't
think it's productive to raise issues until we have resolved them.
We are all aware of this particular issue, and we are quite concerned about the decline in real estate values. As far as I'm concerned unless and until we turn that around, we are going to have
very serious continuing problems. Even though improvements are
occurring in a number of financial institutions, I just don't see how
we can get commercial banks, insurance companies and the like
back to full viable operation assisting the economy until this real
estate issue is resolved.
If somebody could find a way to wave a wand which would resolve some particular problem in this economy without any other
adverse consequences, it's exactly that that I would choose. If we
could find a way to turn real estate values up without secondary
negative effects, that would be the most important thing that we
can do as a regulatory initiative.
Senator KERRY. I take it, and my light is on
The C H A I R M A N . GO ahead and finish.
Senator KERRY.
but I take it that the President's suggestion
of restoring passive loss is not meant to apply, and you would not
want it to apply to new construction
Mr. GREENSPAN. That is correct.
Senator KERRY.
but that would only go as to existing structures, and that would restore value.
Mr. GREENSPAN. Well, I haven't looked at the detail of the President's proposal.
Senator KERRY. There wasn't any that we saw.
57
Mr. GREENSPAN. I don't know whether or not it's for existing
structures only. Is it?
Senator KERRY. I don't know. That's what I'm asking, but it
seems absurd to me to return to where we were obviously creating
an economic benefit to put up something that nobody is going to
use.
Mr. GREENSPAN. The majority of the projects I would assume
under the President's proposal would be existing structures.
As I've said here, and 2 weeks ago, I discussed precisely this
question of passive losses and changing the tax law limiting, however, the capability of taking such losses to existing properties on
the ground that the last thing we need is more newly constructed
empty space.
Senator KERRY. And I cut you off before you were able to end the
Government making this announcement about monetary policy in
order to restore value.
Mr. GREENSPAN. I'm not disposed to make specific announcements about anything that would be contemplated unless and until
we get to a point where those types of things would be done.
I will say to you that I know John Rutledge quite well, and I
have great respect for his insights. I happen not to agree with his
particular proposals that he is suggesting there because he's leaving out a large number of secondary consequences which I don't
think would be tolerable.
Senator KERRY. Thank you, Mr. Chairman.
The CHAIRMAN. Chairman Greenspan, we're going to continue on
here. Would you want a brief break? We're going to stop at about
1:45.
Mr. GREENSPAN. NO, that's all right.
The CHAIRMAN. All right. Then we'll either come back this afternoon if there are questions left, or perhaps tomorrow. I would like
to do it today if that's workable for you.
I want to take you quickly through some things that we've
touched on today.
When you were here 2 weeks ago you indicated at that time that
the Fed had taken the policy actions in lowering rates that you
thought would get the job done, and that as you saw it at that
point, and you've confirmed today as I've heard you, you feel professionally that your policy for the moment at least is where you
want it to be and you think it will work.
You're not certain about that, but you think it will work. You're
seeing at least the beginnings of some positive signs, but importantly you said also 2 weeks ago that you have further room that you
can go if you decide later that you need to do that. Is that a fair
summary?
Mr. GREENSPAN. That is correct, Mr. Chairman.
The CHAIRMAN. OK. Now I've also heard you say today that
you're not convinced looking at the economy that we need a fiscal
stimulus package added to the mixture right now, that in effect
you think monetary policy easing that you've done is enough, in
your professional judgment, and will probably work, and you're not
prepared at this time to say that a fiscal package is needed from a
policy point of view.
58
You said the President, or whoever is putting one forward, could
do it as an insurance policy, but from your point of view, monetary
policy now, having been eased as much as it has, will be sufficient
without a fiscal stimulus package added on the margin. Is that correct?
Mr. G R E E N S P A N . It should be sufficient.
The C H A I R M A N . It should be. It's your professional judgment as
you sit here today that you think in fact it is and will be. You're
not recommending either further monetary policy easing now or a
fiscal stimulus package.
Mr. G R E E N S P A N . That is correct, Mr. Chairman.
The C H A I R M A N . All right.
Senator SARBANES. I S that no fiscal stimulus package or nothing
beyond the limited restrained package that you indicated you
thought would not create long-term problems?
Mr. G R E E N S P A N . It's a marginal call, Senator. My major concern
about a limited package is that it will not remain limited. If it
were limited, then I really have no strong objections to it.
The C H A I R M A N . But significantly what he has said here today,
and what the record will reflect, and he has just in a sense confirmed, is he thinks that the monetary policy actions already taken
in and of themselves, in his judgment, will be sufficient to bring
the economy out of this.
Senator SARBANES. A S I understand it, it's your view that nothing further should be done. I mean that's basically your view right
now?
Mr. G R E E N S P A N . Yes, that's correct, Senator. If I had my choice,
knowing all the uncertainties, of which there are innumerable
ones, but one has got to make a decision, the decision I would make
at this stage is for the moment to do nothing.
The C H A I R M A N . N O W having established that clearly, let me just
say to you with all due respect
Mr. G R E E N S P A N . May I just amend that slightly because this
issue came up 2 weeks ago.
T h e CHAIRMAN. Y e s .
Mr. G R E E N S P A N . I would
go, as I indicated back then, to the passive loss question and the capital gains question, which I did raise
2 weeks ago when this issue came up. I have not changed my view
in the last 2 weeks, let's put it that way.
The C H A I R M A N . Well, in that area it seemed to me that you were
making the point that you were talking in terms of general economic policy in theory. That was not in the context of what it
takes to pull the economy out of the recession and get back on a
growth track, which is really the thrust of my question to you now.
Mr. G R E E N S P A N . That's correct, yes.
The C H A I R M A N . All right. Now I must tell you for what it's
worth, and we have different vantage points here, we need something more than we've already done in the way of monetary policy,
and it can be a combination of further monetary policy help and
some fiscal activity on the margin.
I say that because when you were talking earlier, you were talking about the fact that a lot of this problem is a balance sheet problem and is about unwinding the excesses of the past and so forth. It
is very importantly a balance sheet problem, but it's also an
59
income statement problem, and that's what in my mind Senator
Mack was getting to in some of his comments, and I see it in other
ways in terms of the part of the country I come from.
The income statement side of the problem is that you've got businesses failing at a very rapid rate: they are just not making it because the economy right now is performing so poorly and so
weakly. It's hurting a vast number of individual citizens, workers
of all sorts.
You saw the scene I'm sure in Chicago the other day where in
sub-zero temperatures thousands of people lined up to compete for
a job in a hotel that was opening there.
We're seeing unemployment among people of all skill levels.
We're seeing permanent job reductions that are putting engineers
out of work, putting teachers out of work, putting skilled tradesmen and women out of work—all kinds of people with all kinds of
high level operational talents that can't find re-employment in the
economy today because there are just not enough jobs to go around.
Virtually every major company, as you know, is announcing not
just layoffs but permanent job reductions. You're seeing it in financial services in the areas that you regulate. United Technologies
last week announced that it was shedding some 14,000 jobs. Most of
those are professional jobs. You are as familiar as I am and others
here would be with the announcements that IBM has made, GM
has made and so forth.
We've got a rather urgent problem on our hands about making
sure that we really get some lift under this economy and get people
back to work. It's really serious when people are not able to find
work no matter how aggressively they search for it, and if they do
find something, it's at a lower skill level. In other words, you have
an engineer driving a taxi cab or you have a teacher working in a
hamburger place. That in the employment statistics would appear
as if somebody has found a job, but clearly we've notched down and
we're underperforming as a society.
I don't see much of a lift occurring right now. You've cited the
beginnings a little bit in housing. When you were here in July you
thought maybe we were coming out of the recession, and you testified that you saw some glimmers of hope on the horizon and you
cited those.
Well, those essentially evaporated and then we stayed down at a
very low level and, as you say now, we're sort of flat and you see
no bounce. That was your comment a few minutes ago, you don't
see any bounce yet.
Mr. GREENSPAN. That's correct.
The CHAIRMAN. I must tell you I am very concerned about waiting any longer to see some bounce. The inflation concern is a
proper concern on the margin, but the deflation concern and the
exhaustion of resources by individuals who are out there desperate
to find work to support their families and even to feed themselves
is of a scale right now that I have not seen before in the 25 years
that I've served in the Congress, and it's getting worse and not
better.
The fact that it's happening out there is not anecdotal because
the numbers show us that. The consumer confidence data cited by
Senator Sarbanes and which the University of Michigan surveys
60
show, are, in effect, the people of the country saying to all of us in
policy making positions—to you, to us, to the President—that they
don't feel good about the economic track we're on. They don't have
the confidence, because too many things are going wrong out where
they live.
It is the situation in Florida where Senator Mack comes from,
it's an industrial base problem in the region of the country that I
come from, and I suspect it's a multitude of layoffs that we see
here in the metropolitan Washington area and in the area that
Senator Sarbanes represents. It's a 50-State problem. It's in California. It's everywhere.
I'm concerned that there is some kind of a disconnection between
the gravity of the situation as it's actually happening in people's
lives, as they are struggling to articulate it through polls and
through every manner of way in which the public can try and find
its voice and say it, and the message here at the policy levels at the
top, which in effect is hang in there, we think we've got it right
this time and we think it's going to work; be patient.
I don't know how you say to somebody who is out there in quite
a desperate situation, whether it's a blue collar worker or a white
collar worker, somebody with a high professional training level or
someone with a lower level, single parent, man or woman who is
out there trying to make ends meet, that if they are just patient a
little longer the thing is going to work out. You said a while ago
that to get to a good long-run sustained balanced growth, it's a
series of short-run steps, and I agree with you exactly.
We're in the midst of some terrible, terrible short-run steps, and
I don't feel it's being reflected in what we are doing, in either the
sense of urgency that we have at the top policy levels or the steps
we are taking.
I think we have to now add some things on the margin to make
certain we start to pull the country out of this recession. We've got
to get some lift under our wings here. I don't see that lift today. So
I'm stating a view, and I'm going to ask you to respond to it. I
think more is needed. We can debate what part might come from
monetary policy and what part might come from fiscal policy, but
something more is needed.
To drive the inflation rate down another half a percentage point
or a quarter of a percentage point or keep it from going up a half a
point or a quarter of a point I think is to create a kind of damage
of a size and dimension that is really causing the country to lose
confidence in where we're going and who's in charge.
Mr. GREENSPAN. Senator, let me say you articulate your position
exceptionally well, and I have great sympathy for the issues you're
raising because it's a very difficult judgment.
Let me say this though, that we are not interested in whether
the inflation rate is up a half a point or down a half a point. That
is not what the issue is. The issue is whether or not long-term rates
continue to fall because, in my judgment, that is a necessary condition for the reliquification of the system.
What we wish to be sure of is when we move in the short end
that the long-term interest rates fall as well, because if that doesn't
happen, then we create more problems than we know. While I fully
understand and in fact am in substantial agreement with the posi-
61
tion you have just outlined, I want to be sure that whatever it is
we do in monetary or fiscal policy works, and it's that area which I
find myself most concerned upon. I don't think we can afford to do
things which don't work, and that's my major concern at this
stage.
The C H A I R M A N . Well, if I may say, we know we've got at least 1 6
million people unemployed out there right now, and Lord knows
how many businesses that are either going into Chapter 11 or are
one half step away from it, and they can't wait 6 weeks, 6 months
or another year.
In other words, there comes a point when the size of the problem
is so large and so acute for real people—for individuals and families and their children—that we've got to have a response that
starts to change their situation now.
It's not a future expectations issue. It's about being able to go
down to the grocery store this afternoon and buy bread and milk
and the basic things. We have millions of people right now who are
in a situation where they are not able to meet their basic circumstances. It's a miserable, cruel, genuine fact of life and everybody is
seeing it. That's why these polls that are coming in are so severe in
what they're saying.
You talk about seeing a condition that's outside the scope of
what you've seen professionally. That's what the public is telling us
through the polling data. They are giving polling results about the
Nation being on the wrong economic track that we've never seen
before, and at some point we all have to recognize that the people
are telling us something that is real and that they are feeling.
They are right on this and that we've got to do more to respond to
it.
Mr. G R E E N S P A N . I understand what you're saying, Mr. Chairman.
The C H A I R M A N . Well, we need a stronger answer. We've got to
come up with a strategy to respond to the country's economic situation. It has got to be bigger and stronger and it has got to kick in
now, and the people who can help make it happen are going to
have to sit down around a table together and come up with a plan
that is believable and starts to work.
We're out of time. I don't think we can continue to gamble that
what we've done may or may not work. We've got to be absolutely
certain that what we're doing will work.
Senator Mack, I appreciate your patience.
Senator M A C K . Thank you, Mr. Chairman.
I want to continue along the line of my focus here this morning
with respect to real estate and pick up on comments made with respect to confidence.
There has been, and I think John Rutledge has written about
this as well, there has been a decline in the value of real estate,
and let me now focus on single-family homes. For the first time
since World War II there has been a decline in the value of someone's equity, and a great amount of the equity that people hold in
this country is in their home. If they see that for the first time
since 1945 that there has been a decline in their only real savings
account, this is a real discouragement about any future purchases.
52-418 - 92 - 3
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I was wondering whether you share that feeling or do you concur
in that idea that real estate values in fact are undermining the
confidence of the average American?
Mr. G R E E N S P A N . Clearly on the business sector the commercial
real estate is unambiguously doing that. The data on residential
real estate and the observations we have is mixed. The actual
levels of values, if one can add them up from coast to coast, which I
have some doubts about, don't show very much change.
But what has happened is that the expectation of the continued
rise in home equity values has been altered in recent years, and
that has had the effect of removing a sense of security which a
number of householders have had looking at years of very significant rises in values of their properties.
So that what you're observing, and I think correctly, when you
sense that there is a loss of confidence, is that it's not that the
values are going down very much, but there is a definite removal
of a plus that has existed for a number of years and couldn't go on
indefinitely. I mean the values were rising beyond long-term possibilities.
Fortunately, there is not any really nationwide decline in residential values, although in a number of regions they are down, and
in some specific areas down quite appreciably.
Senator M A C K . SO this concern about real estate values affects
the level of confidence in the economy?
Mr. G R E E N S P A N . I think it does.
Senator M A C K . I want to ask a series of short questions now related to, and again it's pretty obvious my concern is what is happening to real estate. I just think it's the fundamental focal point
of what we are experiencing.
The proposals that the President has made range from allowing
IRA withdrawals for the purpose of purchasing a home, a tax
credit for the first-time homebuyer. In your opinion, will that stimulate additional activity with respect to home purchases and is
there any correlation between let's say an increase in new construction and housing purchasing and confidence?
Mr. G R E E N S P A N . Oh, yes. I have no doubt that if the President's
program on home purchase is implemented, that it will have a
positive effect on construction. It's likely that a goodly part of the
increase will be borrowing from the future, but I'm not sure that's
all bad.
Senator M A C K . With respect to the President's proposal to make
pension funds more available for real estate investment, should
that help the real estate market?
Mr. G R E E N S P A N . Senator, I'm not fully aware of what the exact
proposal is, but the principal is something that we should be looking at and something which could be helpful in supplying funds
outside the banking system to legitimate real estate projects. Without knowing the full details, it's something which certainly should
be looked at by the Congress.
Senator M A C K . SO again that's addressing this credit crunch that
we've been talking about that maybe this would be an additional
source of lending in the real estate market?
Mr. G R E E N S P A N . Yes, Senator.
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Senator MACK. I think you've already referred to it a couple of
times, but I just want to make sure I'm clear about it. I recall
asking you some time ago about capital gains, and you made basically the same comment this morning, that you would go further
than my proposal, which was a 15 percent rate, and you would
eliminate it. But it was asked in the context of both I believe you
and also at that time Bill Seidman as to whether lower taxes on
capital gains in essence is a stimulus for pushing up the value of
assets.
I guess my question is a fairly straightforward economic one. I
would assume that you would agree that lower tax rates mean
asset values increase?
Mr. GREENSPAN. Yes, Senator.
Senator MACK. SO by lowering the capital gains rate, that is another way to add value to the real estate market?
Mr. GREENSPAN. It should have that effect, yes.
Senator MACK. And my last question along this line has to do
with the passive loss, to which you've addressed some comments
this morning, and again I haven't had a chance to look at all the
details of the President's proposal either with respect to passive
loss, but I have a feeling it does not go back to pre-1986, that in
essence what it says is that those who are actively engaged in the
real estate business would receive these changes with respect to
passive loss.
Mr. GREENSPAN. They would have the capability of employing
passive losses to offset gains.
Senator MACK. And that should encourage more investment in
real estate and I would assume help values of real estate as well?
M r . GREENSPAN. Y e s .
Senator MACK. The
only other question that is on my mind
really kind of goes back to Senator Kerry. He raised on a couple of
occasions this morning the idea of deflation. Do you have a sense
that the economy is experiencing deflation?
Mr. GREENSPAN. Not at this stage. It's a severe case of disinflation. With the exception of certain regions and certain industries,
such as New England and real estate, I would not describe the
American economy as in a state of deflation.
Senator MACK. IS there a risk of that occurring?
Mr. GREENSPAN. Certainly.
Senator MACK. HOW high is that risk?
Mr. GREENSPAN. I have no idea, but it's other than zero.
Senator MACK. Pardon?
Mr. GREENSPAN. It's other than zero. We know that there are
those risks.
Senator MACK. And it's not quite a hundred I guess, is it?
Mr. GREENSPAN. NO, it is not, Senator. It is small, but not something to be dismissed out of hand.
Senator MACK. In conclusion, I gather from the response to the
various questions I raised with respect to IRA's and pension funds
that the suggestions that have been made by the President with respect to the economy should have a positive impact on real estate
and real estate values?
Mr. GREENSPAN. I would assume so.
Senator MACK. Thank you, Mr. Chairman.
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The CHAIRMAN. Thank you, Senator Mack.
Senator Sarbanes.
Senator SARBANES. Thank you very much, Mr. Chairman.
Chairman Greenspan, your bottom policy conclusion here this
morning is that nothing should be done in a sense that the actions
that the Fed has taken to reduce the interest rate will provide the
impetus to move the economy out of the recession.
Some articles on occasion have referred to the Chairman of the
Federal Reserve Board as the most powerful economic policymaker
in the world, and of course if your policy prescription now were followed, it would be in effect your policy, the Fed's policy on interest
rates that was being relied upon to get us out of the recession.
In a democratic society where does your legitimacy come from?
On what basis are you accountable and where does the legitimacy
come from that places such really awesome power in your hands
and that of your colleagues to make such basic decisions that will
affect the economic circumstance of every one of our citizens, and
indeed citizens all around the world?
Mr. GREENSPAN. First of all, let me emphasize what you just indicated. It's not the Chairman or even the Board of Governors that
has that authority. It's the Federal Open Market Committee which
comprises a much larger group, as you have addressed in some
detail.
The issue rests with a very difficult problem in a democratic society when you have a central bank, as indeed every industrialized,
civilized society must have.
The basic problem that you have when you're confronted with
the question of how does a central bank function and who does it is
very difficult for our type of society, because while I don't agree
with you that we have as much power as you're implying, there is
no question that a central bank does have significant impact on the
economy and of necessity on the citizens of our Nation.
This is an issue which, as you well know, has been a major
debate within our country since its founding, and indeed in the
early stages when we had the Bank of the United States and a variety of concerns about central banking, we did not have a central
bank from 1836 to 1913.
Senator SARBANES. Andrew Jackson put it out of business.
Mr. GREENSPAN. He put the concept out of business for precisely
that reason, that is, the issue of the question of what is the role of
a central bank in a democratic society.
Our legitimacy comes from the statutes, the Federal Reserve Act
of 1913 passed by the Congress in which certain very specific authorities are granted and the process that we're going through
today is part of that action.
Senator SARBANES. Exactly. Your accountability essentially derives from the judgments made by officials elected by the American
public, namely, the President has nominated you, and now you
must be confirmed by the Senate, and to that extent you become
publicly accountable. Now you get a long term and so forth, but
nevertheless.
That's also true of all of your colleagues on the Federal Reserve
Board; is that correct?
M r . GREENSPAN. Y e s .
65
Senator SARBANES. N O W I want to ask you about the members of
the Federal Open Market Committee which after all makes the
most fundamental decisions on monetary policy. The seven members of the Federal Reserve Board are on the Open Market Committee. They are all nominated by the President and confirmed by
the Senate, but the representatives or the presidents of the banks,
the Federal Reserve Banks, are simply private people picked in a
private way, and yet they exercise major public power.
Now we don't find that in other central banks. In fact, in
German where the central bank is reputed to have such independence, the 11 landbank presidents who participate in monetary
policy decisions are all appointed by the Upper House of the
German Parliament.
Senator Riegle and Senator Sasser and I have joined in introducing a bill that would in effect put the power of the Federal Open
Market Committee in the Federal Reserve Board, those that are
publicly accountable, and let these bank presidents serve as an advisory committee to you.
I don't see where their legitimacy comes from to be making these
major public decisions when they clearly represent a private interest.
Mr. G R E E N S P A N . Senator, I would not say that they represent a
private interest because these are full-time Government employees
with top secret clearances and all of the arrangements relevant to
Government employment conflicts of interest and all of the issues
which relate to the members of the Federal Reserve Board.
Senator SARBANES. They are picked by the board of directors of
the regional banks and those boards are dominated by the local
commercial banks, are they not?
Mr. G R E E N S P A N . Yes and no. I would say that the combination of
the Board of Governors and the individual banks choose the presidents. We at the Federal Reserve Board have the authority to
remove individuals, and indeed as a practical matter have a very
strong voice, if not the ultimate voice, as to who those individuals
are.
Now the issue that you raise is an issue, as you know, which has
essentially concerned all of us who were involved in this activity
since the beginning of the Federal Reserve System. My own view of
this is that while I recognize a number of the difficulties that you
have raised and for which I have some sympathy, as a practical
matter we would do considerable damage to the Federal Reserve
System as a functioning entity if we effectively removed the voting
power of the individual members, the presidents who serve in a rotating basis on the FOMC.
Senator SARBANES. Well, I am hard put to find any basis on
which they ought to be accorded voting authority. They are not accountable to the public. They go through no process that constitutes a public selection as do you and your other colleagues on the
Federal Reserve Board.
Now let me simply ask you. Just before Christmas Alan Murry
and David Wessal in the Wall Street Journal wrote a story that
starts off: It was a Christmas Eve conversion that rivaled that of
Ebenezer Scrooge. Abandoning his long cherished gradualism, Alan
Greenspan, Chairman of the Federal Reserve Board, Friday pre-
66
sented the Nation with a surprisingly large interest rate reduction.
Seventeen months after the beginning of the recession and less
than a year from the Presidential election the Fed cut the discount
rate, and it then goes on to discuss the amount by which you cut
the discount rate and so forth.
Now I'm confident that you've read this article I assume more
than once and are familiar with it, and it sort of details, you know,
having to fly to Chicago to get the Chicago Fed to make a request
for a full point cut and the previous articles that detailed the problems, internal problems within the making of policy in the Federal
Reserve System that were being posed by some of the bank presidents, reserve bank presidents.
First of all, let me ask you is this article essentially accurate in
its reporting of what took place? It's a very fascinating article.
Mr. G R E E N S P A N . I don't recall it in detail. It is partly correct and
partly incorrect as my recollection serves me on it.
Senator SARBANES. Well, I'm sure we're going to visit it once
again at some hearing, and before that occasion if you would familiarize yourself with the article. I won't press you on it now. I would
like to take out of it those elements that you think are incorrect,
because it certainly sounds very plausible to me, and I'm struck in
reading it by again this power that has been put in the hands of
private individuals. They have no accountability. At least you're
accountable.
The C H A I R M A N . That's why you're in here today.
Senator SARBANES. And your colleagues are accountable. In fact,
I at some point may suggest to the Chairman that not only the
Chairman but perhaps some of his colleagues should come with
him to some of these hearings because I have to say I perceive a
greater sensitivity on your part individually to some of the concerns that are being raised here by members of the committee than
I perceive on the part of some of your colleagues on the Board, let
alone these presidents of the Federal Reserve Banks across the
country.
I mean most of them are hard money people, as they used to say
when we debated monetary policy in those terms. There is just no
question about it, and given the sort of constituency from which
they come and which has placed them there, that's understandable.
The C H A I R M A N . And to which it's fair to say that they are beholden if they want to stay where they are.
Senator SARBANES. YOU know, Government policymakers may
split over what policy should be. I mean that's the purpose of
public debate. In fact, there is not necessarily agreement here, but
to have a small handful of individuals representing private interests who in effect in some instances within the Fed system, as I understand it, have impeded the efforts of those members of the Fed
system who are publicly accountable to conduct a monetary policy
in a certain direction which would be perceived to be in the best
interests of the country, I find no basis—they have no legitimacy.
Now let me ask one other line of questioning.
Paul Volker when he was Chairman supported the notion that
the Chairman's term should be a fixed 4-year period to begin,
Volker wanted a year after a Presidential election. I think there
was some discussion and no one wanted it to begin immediately,
67
even those who wanted a change in Congress, and so essentially
the discussion was should it come 6 months after or a year after.
That was the range of discussion. But he accepted the proposition
that the Chairman's term should be fixed so that even if you
change Chairmen during the 4-year period they wouldn't get a new
4-year lease. That's the current arrangement.
If you are confirmed as Chairman, your 4 years will begin to run
from the time of taking the oath of office, as I understand it. Now
that means under the current circumstance your Chairmanship
would extend through into the last year of whoever is elected
President.
Now obviously, again to go back to my public accountability
problem, if the President is going to nominate the person to be the
Chairman and he is to be confirmed, obviously there has been some
thought that the President ought to be able to make an indication
amongst the seven members who he thinks ought to be the Chairman. Otherwise if you didn't think that mattered, you would have
the Board itself pick its Chairman.
So the fact that you've brought the President into the process indicates that there is some sensitivity to the notion that the President ought to have at least that limited degree of influence to
name the Chairman of the Fed.
Now how do we address this problem? Now the November election may turn out so that the President for the subsequent 4 years
is the man who nominated you to be the Chairman, and if that's
the case then the practical issue I'm raising isn't presented.
But the election may also turn out that someone else becomes
the President, and that person, who may want a different Chairman of the Federal Reserve, in effect has been handed a Chairman
for virtually his entire first term in office.
Why wouldn't the notion of setting a fixed 4-year period, and I'm
prepared to have a period at the beginning, I mean I wouldn't have
it begin coincident with the beginning of the President's term, but
keep sort of a, whatever you want to call it, a cooling down period
or whatever you want, but I don't think that the possibility that a
newly elected President would have to serve virtually his entire
term of office with a Chairman of the Fed, given the great power
and influence of the Chairman, that was simply handed to him by
the previous President meets the test of accountability.
Mr. GREENSPAN. Senator, I have no strong objection to that. The
only concern that I have had and still have really rests on the
issue of a Federal Reserve Chairman resigning or leaving for whatever reason, say, 6 months or so or 9 months before the term ends
and creating essentially an interim Chairmanship. That is a very
inefficient means of handling the particular job that I have.
But the arguments that you raise are important arguments from
an accountability point of view, and I can't say to you honestly
that I have strong convictions on this issue one way or the other,
and if the issue of this potential short-term Chairman could be resolved in a satisfactory way, then I would have no difficulty whatever in supporting the point of view that you've just expressed.
The CHAIRMAN. Are you going to move off that subject?
Senator SARBANES. I was, yes.
The CHAIRMAN. Would you yield to me?
68
Senator SARBANES. Certainly.
The C H A I R M A N . I admire the fact that you are a very dedicated
public man. You've shown that through service going at least as
far back as the Ford administration and I suspect even before that.
Would it be appropriate for me to assume in line with the philosophy you've just outlined that if you found yourself in the kind of
situation, the hypothetical that he describes, that we got a new
President and some number of months passed and the new President indicated a desire to be able to appoint a Chairman of the Fed
more to that President's liking, would that be something you would
be prepared to respond to?
Mr. G R E E N S P A N . Frankly, Senator, I've never given it any
thought because I
The C H A I R M A N . I don't imagine you have. I hadn't either until
listening to the argument.
Mr. G R E E N S P A N . In fact until the Senator raised the issue I
hadn't thought about that issue in any great detail. So I would not
be prepared at this stage to give you an answer to that.
Senator SARBANES. Well, I do commend the issue to you for some
thought I guess I would say.
M r . GREENSPAN. O K .
Senator SARBANES. I'm
interested in the hiring activities at the
Federal Reserve in terms of trying to advance minorities in professional positions.
M r . G R E E N S P A N . SO a r e w e .
Senator SARBANES. What has
been done there, how successful
has it been and is there an action program underway to try to accomplish that?
Mr. G R E E N S P A N . There is, indeed, and we have worked quite diligently on that question, and I would say with modest success.
We have had difficulty holding qualified minority PhD's and
other high-qualified people I would suspect in large part because
we are delimited in what we can pay. We tracked I would say the
best people. They get stolen away on occasion, like the gentleman
who is sitting right directly behind you—but that's not occurring
very often. In the minority case it's tough, but we have a special
program and we've discussed this at the Board of Governors quite
often.
Senator SARBANES. DO you have a program to reach back earlier
in the development process to find really bright people say in college and find some way to try to put them on a track that will
bring them along so you're not then simply looking for the PhD's
who might otherwise have been produced, because that becomes
very difficult?
Mr. G R E E N S P A N . We do part of that, but let me just consult
quickly.
[Chairman Greenspan consults with his staff.]
Currently we have a minority dissertation fellowship program in
conjunction with the American Economics Association.
Senator SARBANES. I commend you for that, and I urge you on
with it.
Do you think any purpose would be served—you come here and
you hear from, well you hear from a lot of members here, in the
House, before this committee and before other committees, and you
69
have a personal exchange which gives you a flavor of the concerns
that motivate members, some of them to my judgment very reasonable and rational and others perhaps not so much so, but that's
what public debate is all about.
You then have to go back to these meetings and you become the
sole translator of this experience to your colleagues who are
ranked as equals in making the public policy decision. Now you're
the Chairman and presumably you have a greater degree of influence, but nevertheless they have a vote whether it's within the
Board itself or in the Open Market Committee when you get there.
Now maybe they read about these hearings if they get reported
or perhaps they might look at a transcript, but that still doesn't
accomplish the same interchange that takes place, and I'm frankly
coming more and more to the point of view that these other policymakers ought to come in and sit at that table on occasion.
I mean why should the whole burden fall on your shoulders to be
the translator or the interpreter of the concerns and the thinking
that is being reflected by the elected representatives of the people
to your colleagues? Why shouldn't they get it directly?
Mr. G R E E N S P A N . N O reason that I'm aware of.
Senator SARBANES. N O W one final question. When was the last
time you met with President Bush to discuss the economic situation and economic policy?
Mr. G R E E N S P A N . I would say a couple of weeks ago.
Senator SARBANES. DO you meet would you say on a periodic
basis, I mean not necessarily regularly, but frequent enough to constitute ongoing consultation?
Mr. G R E E N S P A N . I would think so. I'm not aware there is a deficiency particularly that is gross in that area, and I try to communicate as best I can with his colleagues and try to get some discussion
of the economic outlook. We, for example, meet once a month at
the Council of Economic Advisers and with the senior Treasury officials.
Senator SARBANES. That's on a regular basis?
Mr. G R E E N S P A N . A regular basis.
Senator SARBANES. Formalized regular meetings.
M r . GREENSPAN. Y e s .
Senator SARBANES. Thank you very much, Mr. Chairman.
The C H A I R M A N . Just one thing on that point, and then we'll
recess until about 3 o'clock. On an occasion several weeks ago, you
and I and FDIC Director Taylor met to talk about some of the problems in the banking system and some of the aspects of banking legislation that was then pending.
Out of that conversation relevant to what Senator Sarbanes has
just touched on I asked you to have a conversation with the President on the matters that we had been discussing. Did that conversation take place?
Mr. G R E E N S P A N . In part, yes.
The C H A I R M A N . Pardon?
Mr. G R E E N S P A N . Yes, in part. I mean I discussed some of the
issues that you and I discussed.
The C H A I R M A N . In part. Can you give me a percentage? Was it 10
percent, 50 percent, 70 percent?
70
Mr. G R E E N S P A N . The most important issues that we discussed
would say.
The C H A I R M A N . Have been conveyed directly to the President?
I
M r . GREENSPAN. Y e s .
The C H A I R M A N . The committee stands in recess until approximately 3 o'clock. Let me just inquire is that workable from your
point of view and your schedule?
Mr. G R E E N S P A N . Sure.
The C H A I R M A N . All right. Let me also announce that the committee has voted by a vote of 21 to 0 to report the nomination of Mr.
Casey favorably to the Senate.
Senator SARBANES. Mr. Chairman, on Mr. Casey it's my understanding that in response to the inquiries that we put to Mr. Casey
that they are making a real effort there to find a way to try to
meet what was contained in the law about enabling employees and
retirees from institutions they have taken over to keep their group
coverage with respect to their health insurance, which is a very important issue.
The C H A I R M A N . Well, let me report that that's correct, and I
assume we'll have an answer on that forthwith.
Mr. G R E E N S P A N . I was wondering can we possibly make it 3:15
p.m.?
T h e CHAIRMAN. Y e s .
The committee will stand in recess until 3:15 p.m.
[The committee recessed at 2:15 p.m., to reconvene at 3:15 p.m.]
AFTERNOON SESSION
[3:15 p.m.]
The C H A I R M A N . The committee will come to order.
Chairman Greenspan, this afternoon I want to move through a
series of questions that we were not able to get into earlier. I'm interested in your views on investments by foreign interests in U.S.
banks. This is occasioned not only by the BCCI case, but other
issues related to that.
What is your general view of foreign investments in American
banks and financial institutions.
Mr. G R E E N S P A N . I would say, so long as they adhere to the laws
of the United States and engage in practices which are legal in all
respects, that they clearly have made a contribution and should
continue to make a contribution to the financial system of this
country.
The C H A I R M A N . NOW, do you think it rises to a different level of
significance if the foreign investors actually control a U.S. bank?
Mr. G R E E N S P A N . They do that, in large respect, in most cases
where they have wholly owned subsidiaries, American chartered
banks, and with the egregious exception, which you raise with respect to BCCI, and a few others which have been creating great
concern for us, foreign owners have been largely, as best we can
judge, good corporate citizens, and have served the banking community and their customers in this country in an exemplary fashion.
The C H A I R M A N . What about applying the same issue to the question of the largest banks in the country? Does it make any differ-
71
ence if the foreign investment is concentrated in the biggest American banks, as opposed to medium-sized or small banks?
Mr. GREENSPAN. In principle, it shouldn't, but I certainly recognize that there are certain conditions in which interests can arise
which could induce the Congress, for public policy purposes, to
want to make changes.
I mean, for example, as we do with airlines or broadcast networks. If you're asking me, as an economist, or somebody interested strictly in this context, in the financial integrity of our system
and its functioning, I would see no need to make any difference.
The only need would have to occur for other reasons similar to
those of national security or with respect to related concerns.
The CHAIRMAN. NOW, as a matter of practice, if a bank holding
company under the supervision of the Fed was considering, or
being approached with respect to, significant foreign investment in
the bank holding company, would that be an issue that the bank
would normally come to the Fed and talk about, or come to you or
other Fed board members to talk about?
Mr. GREENSPAN. Yes. Obviously, any major change of ownership
or any significant investment would require our surveillance.
The CHAIRMAN. NOW, back in 1987, when Bank of America raised
capital, it sought hundreds of millions of dollars from foreign interests, as I'm sure you know.
Was the Fed aware of that at the time? Was the Fed alerted to
that before the fact?
Mr. GREENSPAN. I don't think I was around at that time, as I
recall. My colleagues are shaking their heads, no.
The CHAIRMAN. IS it, no, that they're not sure, or, no, that there
was no contact from Bank of America.
Is there someone there that can help?
[Discussion off the record.]
Mr. GREENSPAN. It's a little fuzzy. They did not have to come to
the Board for an application, which meant that the form of the potential borrowing was not of an ownership nature.
But if you would like, I could make certain that we clarify that
and answer that in writing officially.
The CHAIRMAN. I would like a clarification on that, and we
would like to see that answer, to see if it's complete enough in
terms of what we want to establish.
Now, Citicorp is another instance of a major bank holding company that's raised billions of dollars in capital from foreign interests, as you well know.
Did Citicorp come and discuss that with the Fed ahead of time?
M r . GREENSPAN. Y e s .
[Chairman Greenspan subsequently submitted the following information for the record:]
In October 1987, BankAmerica Corporation issued $425 million of capital securities to a large group of foreign, primarily Japanese, investors. The interest of Japanese investors in purchasing capital securities of BankAmerica was made known to
the Federal Reserve Bank of San Francisco as early as January 1987 in the context
of discussions with BankAmerica as to its capital position. No applications were required to be filed.
Twenty-six Japanese financial institutions purchased $250 million of subordinated
capital notes and warrants to purchase 6.25 million common shares. Twenty Japanese life insurance companies, 11 casualty insurance companies, and 2 securities
72
companies purchased $100 million of convertible preferred stock. Bank of America
International Limited in London underwrote another $75 million of notes and warrants which were presumably distributed to European and other Asian investors.
The $425 million of capital securities comprised approximately 5.3 percent of BankAmerica's resulting primary capital.
The
CHAIRMAN. Did they discuss that with you?
M r . GREENSPAN. Y e s .
The CHAIRMAN. Can you give us a sense as to
how that works?
What happens when they come in?
Mr. GREENSPAN. They came in and discussed it with us, unofficially, since they sold preferred stock, which does not require an
application. But when and if it converts to common, then it does
require an application. Even though the application wasn't required, that issue was discussed with us.
The CHAIRMAN. I would think, if a bank was going to sell a preferred issue that had a conversion aspect to it, that that ought to
trip the wire, and there ought to be a requirement that it meet
whatever the test is for an equity investment.
Would I be incorrect in assuming that that's how it works?
Mr. GREENSPAN. I would say, as a practical matter, that is how it
works.
The CHAIRMAN. B C C I was involved with several American banks,
as you know. The committee is interested in not only the banks
that were secretly owned by B C C I , like First American, but also
banks that had significant transactions with B C C I .
So far, the Federal Reserve has cooperated completely with us in
terms of our initial inquiries along those lines, and we thank you
for that cooperation. As we continue to look at that issue, and at
the BCCI relationship with other American banks, I assume that
we can count on your continued complete cooperation in providing
us with whatever information we need?
M r . GREENSPAN. Y e s .
The CHAIRMAN. Thank
you.
Now, according to published reports, which you've probably seen,
in national magazines like Time Magazine in October 1991. There's
an indication that Bank of America was performing correspondent
services in the amount of about a billion dollars a day for BCCI, as
late as 1988.
Do you have any awareness of that fact, or anything relating to
that?
Mr. GREENSPAN. NO, except that, as I recall, they were an original shareholder, and basically backed out at a point. The particular
transactions they were involved with is not something I would be
specifically familiar with. I was not aware of this particular phenomenon.
Is that in a published document?
T h e CHAIRMAN. Y e s .
Let me just inquire. Is that covered in this Time Magazine story?
[Discussion off the record.]
The CHAIRMAN. According to Time Magazine, the San Franciscobased bank, Bank of America, concedes that during the 1980's, it
handled some $1.3 billion a day of BCCI money. This is the source
of the information that's the basis for the question that I posed to
you.
73
Mr. G R E E N S P A N . We have no official knowledge of that, as far as
I know.
The C H A I R M A N . IS there anybody with you that has any knowledge of it?
Mr. G R E E N S P A N . There's an implication that they had deposits
with the Bank of America, but certainly a billion dollars sounds
like a very high number, and that's actually transactions, that's
not deposits.
The C H A I R M A N . Well, what we'll do in that area is submit any
further questions we have, and I'd then ask that—you've given us
the assurance that any information that we need along that line
you'll readily provide. I thank you for that.
Let me ask you about the degree to which the Federal Reserve
monitors, in an active way, the foreign activities of American
banks.
Is that something you keep close track of, as a matter of course?
Mr. G R E E N S P A N . Well, in examining a holding company, we are
obviously involved in the full operation, and inevitably, are looking
at all aspects of a particular institution, abroad as well as at home.
The C H A I R M A N . Would that involve sending regulators or examiners into operations, overseas operations of American banks?
Mr. G R E E N S P A N . We do that on occasion, yes.
The C H A I R M A N . IS that on a special situation basis, or is it done
as a matter of course?
Mr. G R E E N S P A N . It's a continuing examination process.
The C H A I R M A N . SO there's a formal, regular process by which
that's done, on-site exams in foreign countries?
Mr. G R E E N S P A N . Yes. It may not be scheduled in any systematic
manner, but it's done on a continuous basis.
The C H A I R M A N . NOW, with respect to American banks that have
agencies or subsidiaries, say, that would be active in Columbia, or
elsewhere in South America, does the Federal Reserve monitor
those operations, too, with on-site examinations?
Mr. G R E E N S P A N . They're in Columbia and they are subsidiaries'
agencies?
The C H A I R M A N . Pardon?
Mr. G R E E N S P A N . We do, yes. But let me check on that and add to
the record.
The C H A I R M A N . The reason that I ask, as you well know, we've
had lots of situations arise with respect to money laundering operations as it relates to drug traffic and a lot of the drug traffic that
comes up out of those areas of South and Central America. It's a
problem throughout the United States.
Certainly Florida's had to contend with the problem. We get it in
a certain form in the State of Michigan, and so forth.
But it would be your testimony, today, that with respect, say, to
a major banking operation by an American company in a place like
Columbia, where we know we have a serious drug problem, that
you do on-site examinations there of those American banking operations, and really track what they're doing, so you're confident
about what's going on in those banks?
Mr. G R E E N S P A N . Yes. I mean, it would be essentially the primary
regulator, though it may be either the Federal Reserve, working
through the holding company, or the OCC, generally.
74
The CHAIRMAN. I'm concerned a bit about whether you can have
a catch-22 situation. If the OCC is looking at the national bank,
and if the Fed is looking at the holding company that the bank is a
part of, does that gives you a nice, tight examination process?
In other words, it seems to me, you could run into a situation, at
least potentially, where you go and do your work, and they go and
do their work, and that may not be a sufficient combined effort.
Mr. GREENSPAN. But there is a general awareness of that particular problem amongst the agencies. And, as I understand it, we endeavor to coordinate in a manner so that we do get an integrated
appraisal without something falling through the cracks.
The CHAIRMAN. Well, let me ask you this question with respect
to bank holding companies that have large operations in countries
that are major drug centers. Is it fair for the committee to conclude
that the Fed, for its part of the oversight and regulatory process,
could state, with a very high degree of confidence, that they're
monitoring those kinds of situations with great care to make sure
that nothing improper is going on?
Mr. GREENSPAN. I should certainly hope so, because that's the
basic purpose of the activity.
The CHAIRMAN. I would hope so, too. But I guess what I'm asking
is for something more than that. I'm asking for professional certification that there is an extra effort applied in situations like that,
where it would seem the potential for a problem could be quite
large.
Mr. GREENSPAN. That is my understanding of the way we operate.
The C H A I R M A N . NOW, your staff is with you here. I just want to
be absolutely clear about this on the record, because you're relying
in part on their assertions, and if that's the case, fine. But I may
ask them to put that assertion on the record, too, so it isn't just
your reliance on somebody else.
Mr. GREENSPAN. I see no reason to qualify that statement. That's
our basic purpose, and so far as we know, it's being done well.
[Chairman Greenspan subsequently submitted the following information for the record:]
Regulation K, the Board's regulation governing international banking operations,
requires that U.S. banks operating foreign branches or subsidiaries maintain a
system of records and controls that would ensure the effective management of these
offices by the parent U.S. banking institution. The regulation requires that "Such
systems shall provide, in particular, information on risk assets, liquidity management, operations, internal controls, and adherence to management policies." Such
reports would include internal and external audits of the foreign operations.
The Regulation further requires that the management information described
above shall be made available to bank examiners. Using this information, examiners review the international operations of U.S. banks during the regular examination of the bank's overall operations. As with U.S. operations, such examinations
are conducted largely at the head office of the U.S. bank. Examiners seek to determine not only that the foreign operations are being operated in a safe and sound
manner, but also that the bank has sufficient assurances that these offices are conforming to all of the bank's policies and procedures.
The Federal Reserve supplements the annual examinations at the head office
with a program of conducting periodic onsite examination of significant foreign offices in those countries where local law and regulation permits examinations by foreign authorities. Generally, significant foreign branches of State member banks and
significant foreign subsidiaries of all Edge Corporations (including those owned by
national banks) are examined at least once every 3 years on site. The System conducts about 30-50 foreign examinations and visitations a year. In addition, the
75
Comptroller of the Currency and some State regulatory authorities also conduct
periodic overseas examinations.
Onsite examinations are designed largely to verify that the information on foreign
operations available at the U.S. head office accurately reflects the financial and operating conditions at the foreign branch or subsidiary. The examinations verify the
adequacy of internal and external audit procedures, and the ability of head office
management to assure adherence to all of the bank's policies and procedures by the
bank's foreign offices. In 1987 the Board specifically mandated that overseas examinations of foreign branches include procedures to determine how a bank is implementing safeguards against money laundering.
In general the Federal Reserve believes that this combination of head office examinations supplemented by periodic onsite examinations of significant offices provides reasonable assurances that overseas operations are adhering to bank policies,
including those policies designed to prevent involvement in money laundering operations. However, I should make it clear that not all foreign offices are examined. In
Colombia, for example, only 2 U.S. banks have subsidiaries which are allowed under
local law to accept deposits. Because the nature and scope of the subsidiaries' activities are small in relation to the total assets and capital of the banks, they have not
been examined onsite.
Some countries in which U.S. banks operate do not allow onsite examination of
branches or subsidiaries in their jurisdiction by U.S. or other foreign supervisory
authorities. In such cases the Board has determined that, in view of the other supervisory tools available, the benefits to U.S. banking and commerce from allowing
U.S. banks to operate in these jurisdictions outweigh the problems resulting from
the inability to conduct onsite examinations. However, the Board has urged and
continues to urge such countries to permit examinations by the Federal Reserve. In
addition to legal barriers, some foreign offices of U.S. banks have not been examined because it was determined that onsite examination of such offices may not be
cost effective in view of the small size of the offices.
The CHAIRMAN. All right.
I'm going to go to one other issue, now, and then I'm going to
yield to my colleagues, and we'll try to move along as quickly as we
can.
I want to refer, again, to something we touched on this morning,
but I want to nail it down a little more clearly than we were able
to then.
The President said, last night, and I quote here again:
The banking credit crunch must end. I won't neglect my responsibility for sound
regulations that serve the public good, but regulatory overkill must be stopped, and
I have instructed our Government regulators to stop it.
Specifically, in terms of the part of the banking system that the
Fed supervises, has there been a pattern of regulatory overkill in
your supervisory and regulatory activities?
Mr. GREENSPAN. It's difficult to say very specifically in individual
cases. We, of course, are the smallest part of this, so it's difficult to
judge.
The CHAIRMAN. I understand.
Mr. GREENSPAN. But it's my impression that there have been
fairly broad swings, from the status of regulation in the mid-sixties,
through where it is today. And I personally have been very specifically concerned about the issue of marking real estate to market
specifically, and issues of appraisals based on liquidating value of
properties, which I judge to be the key supervisory issue which is
creating what I consider to be difficulties in this particular area.
But I would say that while there are differences amongst us
about the degree of the swing in regulatory zeal, if you wish to put
it that way, we're all aware of the fact that there has been a significant switch, to a greater or lesser extent. And we don't think generally, if that is the case in a particular institution, that it is
76
proper, and that is why we, as a group, have engaged in a series of
actions and promulgations which we are hopeful will change this
situation and the culture of examination in a manner which makes
it more rational and stable, and not subject to volatility.
The C H A I R M A N . NOW, I want to narrow the question down. I hear
what you've said. I want to narrow it down now just to the banks
that are under Federal Reserve supervision. Leave out, for the
moment, those that the FDIC supervises or those that the OCC supervises.
When I look at a comparative listing of the losses by banks, according to who the primary regulator is, the Fed has a very tiny
percentage of the charges against the bank insurance fund from
banks under your direct supervision.
Mr. G R E E N S P A N . We're net plus in the fact that contributions are
greater than losses.
The C H A I R M A N . I would think that's right, that your contributions are actually greater than your losses. But taking it either
way, even if you just take the raw losses, they're a very tiny percentage.
Now, you might look at that, and you might say, that's because
you fellows run a tight ship and you've done a good job of regulating your part of the banking system, and they've done a good job of
disciplining themselves, so you haven't had very many losses.
Somebody else might look at that and say, there aren't many
losses because you've been so tight, so tough, some of this regulatory overkill. I don't make that presumption, but I can see how one
might put that construction on it.
I guess the question that I want to address to you, just as it relates to your bank supervisory activities and the people under your
jurisdiction, is it your judgment that the Fed has been involved, to
any significant degree worth talking about, in regulatory overkill?
Mr. G R E E N S P A N . It's clearly been less in the Fed to a substantial
extent than what I hear is going on in the community at large.
Why that is subject to a number of interpretations. My suspicion
is that we did not go to the other extreme as much in the 1980's as
the system as a whole.
The C H A I R M A N . YOU mean, from something like regulatory underkill to regulatory overkill?
Mr. G R E E N S P A N . Yes. Although I can hardly imagine that we
fully escaped that cycle. It just doesn't seem credible to me that we
would have been immune.
But it is the case, at least it has been told to me, that there's less
of a problem in the State member banks than in the other commercial banks.
The C H A I R M A N . Well, I have two other things related to this, and
then I'll yield to Senator Mack.
Am I to understand that the President has instructed you, as one
of the three regulators. His words are: I have instructed our Government regulators to stop it.
Do I assume that what you've been asked to stop doing, or the
practices that you've now been asked to adopt are ones that would
be fully within the bounds of Generally Accepted Accounting Practices?
Mr. G R E E N S P A N . Oh, indeed.
77
The C H A I R M A N . There is no suggestion of moving outside Generally Accepted Accounting Principles, to any contrived accounting
values, or anything of that kind?
Mr. G R E E N S P A N . NO. I, myself, have argued about certain accounting practices, but those are fully GAP-type accounting principles. It's a question of, which are the appropriate application of
specific evaluation processes to an examination process. But certainly, it's within professional
The C H A I R M A N . We're not going to regulatory accounting or anything of that sort?
Mr. G R E E N S P A N . Certainly not.
The C H A I R M A N . Or inventing values that would be outside the
normal scope of Generally Accepted Accounting Practice?
Mr. G R E E N S P A N . Most certainly not. Were we to do that, we
would be defeating the purpose of going to a stabilized examination
procedure.
The C H A I R M A N . All right. Now, the second and last question is
related to this.
What are the instructions, then, that you've been given by the
President?
Mr. G R E E N S P A N . There are no explicit instructions, other than
his request that we examine all of this, and work on it. And we've
been doing that, now, for several months, and originally at his
behest. So it's essentially his initiation which led to an Ad Hoc
Committee of regulators to sit down and approach this problem in
a manner which could resolve the issues about practices which we
consider to be inappropriate.
And in that sense, it is the President's initiative, but the specifics
of what went on, or what is being done, has been wholly in the
hands of the regulators. In other words, neither the President nor
any of his associates has endeavored to force any particular actions
which we, as a group, thought inappropriate.
The C H A I R M A N . It's sort of like, heal thyself. In other words, instruct thyself.
Mr. G R E E N S P A N . We agree with him on the concerns. If we
didn't, the issue would never have arisen.
The C H A I R M A N . The changes that are to be made, or the new
practices that have been put in place—can you enumerate those for
us, briefly and specifically?
Mr. G R E E N S P A N . We have, over the last several months, initiated
a series of specific actions, the latest of which is the HLT change,
the most important one originally referred to the issue of how the
appropriate procedures to evaluate real estate, as a detailed examination processes to coordinate means of doing that.
The C H A I R M A N . IS this all in writing?
Mr. G R E E N S P A N . Yes, it is, and I'd be most delighted, if you
would like, Mr. Chairman, to make it available to you for the
record.
The C H A I R M A N . I think we need it for the record, and we ought
to make it part of the record.
That listing, when we receive it, in writing, does that cover the
entire scope? Is that 100 percent of what has been done? Or is
there anything in addition to that that has not been put in writing
that that would constitute a change in practice?
78
Mr. GREENSPAN. There may be others. What we will do is try to
flag those and make you aware of it, and try to put them in writing
to the extent that we can.
There may be a number of things that are in the works which
have not been completed. We can make you aware of the fact that
we're thinking about them, but unless and until we come to a conclusion, we would not have a written document which we could
employ.
[Chairman Greenspan subsequently submitted the following information for the record:]
Examination Guidelines and Related Materials (Letters and Statements)
1. HLTs—Federal Reserve Press Release on the Discontinuance of the Supervisory
Definition of HLTs. (2/6/92)
2. Intangibles—Federal Reserve Proposal on Regulatory Capital Treatment of Identifiable Intangible Assets. (1/16/92)
3. Preferred Stock—Federal Reserve Press Release on the Treatment of Perpetual
Preferred Stock for Risk-Based Capital Purposes. (1/14/92)
4. AD-Letter 91-85—Letter Announcing the National Examiners' Conference. (12/
5/91)
5. S-Letter 2546—Federal Reserve's Policy on Resolving Examination Differences.
(12/13/91)
6. SR-Letter 91-29—Communication and Examination Procedures Concerning
Credit Availability—Including Procedures to Monitor Implementation of Initiatives.
(12/12/91)
7. SR-Letter 91-26—Examination Review Procedures—Program for Evaluating and
Reviewing Use of Appraisals. (11/8/91)
8. AD-Letter 91-78—Interagency Meeting of Federal Financial Regulatory Examination Staff. (Baltimore Conference, 11/8/91)
9. SR-Letter 91-25—Interagency Examination Guidance on Commercial Real Estate
Loans. (Press Release, 11/7/91)
10. SR-Letter 91-24—Interagency Examination Guidance on Commercial Real
Estate Loans. (Includes Interagency Statement, 11/7/91)
11. SR-Letter 91-19—Communication Efforts Regarding Credit Availability Concerns. ("Town Meeting," 10/2/91)
12. AD-Letter 91-72—Meetings with Senior Bank Executives on Credit Availability
Issues. (10/7/91)
13. SR-Letter 91-18—Classification Guidelines For An Asset When a Substantial
Portion Has Been Charged Off. (9/23/91)
14. SR-Letter 91-16—Supplementary Examination Guidelines on Real Estate Loans
and Certain Reporting Issues Pertaining to Nonaccrual Loans, Including Guidance
on Refinancing Mini-Perm Loans. (7/16/91)
15. March 1 Statement—Federal Reserve Press Release and Interagency Policy
Statement on Credit Availability. (3/1/91)
Other Initiatives Under Consideration Regarding Credit Availability
1. Insubstance Foreclosure—Concern has been expressed by bankers and accountants that some borrowers, who are willing to work out their debts, are being forced
into non-performing status prematurely, and in some cases, are being forced into
foreclosure due to an interpretation of an SEC financial reporting standard (FRR 28
Insubstance Foreclosure).
The bank and thrift regulatory agencies have met with the SEC to clarify this
rule and to issue specific examples of the rule which bankers and accountants can
use to interpret the rule. Specifically, the OCC has provided the SEC with examples
for their review.
2. Risk Weight for Presold Residential Construction Loans—It has been proposed
that presold residential construction loans be assigned a 50 percent risk weighting,
rather than 100 percent. This provision was included in the recent banking legisla-
79
tion (Federal Deposit Insurance Corporation Improvement Act, Section 474). The
proposal has been presented to the Federal Financial Institutions Examination
Council and amendments to the risk-based capital guidelines are being drafted to
implement this revision.
The CHAIRMAN. Senator Mack?
Senator MACK. Thank you, Senator Riegle.
Mr. Chairman, I want to try to get you to reconcile, for me, several different comments this morning.
One of the things that I believe that you indicated this morning
was that, you felt that monetary policy was going to be sufficient to
get the economy moving again, that there are indicators out there
now, right early stages, but you're hopeful that monetary policy
will in fact solve the problem that we're in now. And you gave the
impression that a fiscal package was not something that you would
encourage.
And then I asked you a series of questions with respect to the
President's initiative, having to do with capital gains, passive loss,
IRA's, tax credits, pension funds, and whether you thought that
those would be helpful in the real estate market.
It was fair that we concluded that what's happening in the real
estate market is clearly one of the major factors that's affecting
the economy.
So I'm a little
Mr. GREENSPAN. I understand what your problem is. It's a definitional issue, Senator. When I talk about a fiscal package, I'm talking about something which is macroeconomic, in other words, some
basic, overall tax policy or expenditure policy.
This is a specific set of proposals for a specific industry which
you could, I guess, call fiscal. I had not been thinking of it in those
terms. Because I would, in fact, be in favor, as I've indicated earlier, of doing those individual items, because they would be useful.
But I did not mean that to be included with or part of, or essentially a fiscal package, in the sense that I would consider these
other types of broad tax expenditure policy initiatives.
Senator MACK. SO those four or five items that I mentioned that
are part of the President's package you feel would be helpful to the
economy?
Mr. GREENSPAN. They would be helpful, even if we did not
have—leaving aside the residential purchase $5,000 credit. Talking
about commercial real estate, the pension fund issue, the issue of
passive losses, and any of the associated elements involved with
that, I suspect would be desirable with or without concerns about
the economy, because they are probably the correct thing to do for
the system as a whole, independently of the current period.
Senator MACK. SO you see those both being good for the economy
on both the short-term and long-term basis?
M r . GREENSPAN. Y e s .
Senator MACK. And anybody
who may have gone from here this
morning thinking that you'd really not encourage some fiscal package, if they concluded that meant that these items had been proposed by the President, you were not talking about them at all.
Mr. GREENSPAN. NO. In fact, I would say, most of the items that
I've heard on the issue of commercial real estate make sense to me,
both short-term and long-term. The only item being some general
80
passive loss change, which I don't think is required in this particular context, and wouldn't create something which we do not need,
mainly large, empty, newly constructed office buildings.
Senator M A C K . Right. But it's not your conclusion that the President's proposal is what you just referred to?
Mr. G R E E N S P A N . NO, I don't think it is.
Senator M A C K . I have a follow-on question to the series of questions that Chairman Riegle raised a minute ago.
And I was just kind of struck by your comment that you think
that the regulatory practices in the Fed have not been, let's say, as
zealous as some other regulatory organizations.
I'm curious. The banks that the Fed regulates, is there a substantial difference in the make-up of the assets of those banks, compared to the banks say that the OCC or the FDIC are regulating?
Mr. G R E E N S P A N . I would be doubtful of that. Remember, however, we have a much smaller sample than they, and there could be
differences, but I'm not aware really of any systematic type differences.
Senator M A C K . I'm not trying to be critical. I'm just saying if
there really is a substantial difference between the two, maybe
there's some things that we can identify, specific actions that we
can respond to, that
Mr. G R E E N S P A N . My recollection is, when I've seen the balance
sheets of the various groupings, I mean, they are not different in a
substantial manner.
Senator M A C K . DO the banks that the Fed regulates not invest
heavily in commercial real estate?
Mr. G R E E N S P A N . NO. They did and they've got problems.
Let me tell you what my evidence is, which is really less than
scientific. It's that I hear, certainly from all of the anecdotal evidence and the complaints that one gets, there's a disproportionately low number coming from State member banks. Now, I emphasize that that may be biased in one form or another, but when I
check with the people, they don't find that surprising.
But I do not wish to convey to you that we've engaged in some
scientific sample and have concluded that is in fact the case. That
has not been done.
Senator M A C K . Yes. I didn't get that impression, but I just was
struck by your comment.
Mr. G R E E N S P A N . My basic view is that I was sort of pleased by
the fact but I didn't pursue it too far.
Senator M A C K . I understand.
Thank you, Mr. Chairman.
The C H A I R M A N . Thank you, Senator Mack.
The C H A I R M A N . Senator Sarbanes.
Senator SARBANES. Thank you, Mr. Chairman.
Chairman Greenspan, at the pre-recession peak, the unemployment rate was down to 5.3 percent.
Mr. G R E E N S P A N . 5 . 2 percent, I believe.
Senator SARBANES. 5 . 2 percent. O K , I stand corrected. And the
economy was operating at about 84 percent of capacity.
Since then, over the intervening months, the unemployment has
risen to 7.1 percent and capacity utilization has fallen down into
the high seventies.
81
Now according to the Fed, capacity is growing at an annual rate
of 2.6 percent. I think you have just come out with a study that
shows capacity growing at 2.6 percent annually.
The President's budget projects that real GDP will grow only 3
percent per year from 1993 through 1997, even assuming all of his
policy recommendations are adopted.
Now at that rate, how many years will it take to restore the
economy to its level of performance prior to the start of the recession?
Mr. GREENSPAN. There is a statistical problem here which we
have not been able to resolve and it is the following: that the industrial production index—at least until recently, I haven't seen this
updated—but the industrial production index that we publish relative to the value in constant dollars of the industrial production
index that is in the gross national product, has been rising. Meaning that our index based on the physical volume indicators is rising
relative to the implicit part of the GNP which includes that.
It is several tenths of a percent, as I recall, so that the reconciliation would require making that adjustment, and without knowing
exactly what it would be it is hard to answer the question that you
suggest.
But I find it difficult, if the overall growth rate stays at 1.6 percent no matter what you do with the numbers, that you can bring
the operating rate up in any significant manner on our statistical
base.
I may be mistaken. It is conceivable. I don't expect the share of
manufacturing to increase significantly in the GNP.
Senator SARBANES. Well now, when you testified before this committee in 1989, you said, and I quote:
When the economy is operating below capacity, bringing demand in line with
supply can involve real GNP growth that is faster for a time than its long-run potential.
M r . GREENSPAN. Y e s .
Senator SARBANES. End
of quote.
I take it that one could conclude from that coming out of a recession, the economy should grow faster than its long-run potential. Is
that a fair conclusion?
Mr. GREENSPAN. Y e s .
Senator SARBANES. HOW much faster and
Mr. GREENSPAN. I would say it depends
for how long?
on how far beneath potential you are. I mean, it is clearly a function of assuming that
you get back to high operating levels.
If you start off in a deep recession, obviously you can go quite a
while at above normal growth.
Senator SARBANES. NOW do you see any prospect that coming out
of this recession, the economy is going to grow faster than its longrun potential?
Mr. GREENSPAN. It could for a short period, but it couldn't for
anything other than a short period.
Senator SARBANES. When do you expect that to happen? We
knew in the fourth quarter, well, basically GDP was unchanged,
virtually. A sensible point.
82
Mr. GREENSPAN. We have recovered a little over half of the decline in GDP, so that we have still got something under a percent
to go back to where we were when the recession began. And if you
assume at that point that we were already somewhat suppressed,
there is additional room on top of that, so that one can readily see
that we have an additional 1 to IV2 percent, perhaps maybe more,
which could move in excess of potential. And obviously if that is
concentrated in a couple of quarters, you can get a rather vigorous
number.
But that is not something which I am forecasting at this particular stage. I think that
Senator SARBANES. Well, where's this going to come from? Domestic demand was off 1.6 percent last quarter, the last quarter of
1991. Government purchases were down. Non-residential fixed investment was down.
Mr. GREENSPAN. YOU can get increases in capital investment.
You can get increases in exports. That, in turn, would engender an
increase in real incomes which would move consumption expenditures up some.
Obviously you could get for the short-term, inventory investment. And finally, residential building probably has got some
upside potential.
Senator SARBANES. HOW long do you think the unemployment
rate is going to stay above 6 percent? What do you expect the unemployment rate to be for 1992?
Mr. GREENSPAN. I would say certainly above 6 percent.
Senator SARBANES. Would it be at 7 percent?
Mr. GREENSPAN. I wouldn't try to guess at this stage. I would say
at the moment, unless this economy begins to pick up at a pace
faster than I suspect it is going to, we are not going to get very
much progress on the unemployment rate. We'll get some, but not
a lot.
The CHAIRMAN. Does that mean then it could stay above 7 percent for the year?
Mr. GREENSPAN. I would doubt that, and if it did then I would
say the recovery is non-existent. If it stays above 7 percent, especially if it hedges higher, that is suggestive of a very weak growth
rate, or in fact even a decline.
Senator SARBANES. HOW do you address this too late and too
little criticism which has been leveled at the Fed?
Let me put the question to you this way. When you testified here
in August of 1989, discussing the possibility of a recession and what
could cause a recession, you said amongst other things:
Moreover, I cannot rule out a policy mistake as the trigger for a downturn. We at
the Federal Reserve might fail to restrain a speculative surge in the economy, or
fail to recognize that we were holding reserves too tight for too long.
I guess I really want to put the question to you whether there
has been a policy mistake, and I want to be very careful to concede
up front that I am asking you to look back, so it's not sufficient to
answer the question to say: "Well, at the time we made the judgment, it looked reasonable. Reasonable people might have differed,
but this constituted a reasonable judgment on our part."
83
And I understand that and I respect that. But I want now the
benefit of hindsight, as you look back on how the economy has
moved and what has transpired, whether in fact there was a policy
mistake in that the Fed should have moved sooner and with a
greater degree of action in terms of addressing the economic situation.
Mr. Greenspan.
Mr. G R E E N S P A N . Let me answer that question in two ways.
Through the period, say 1989 through the spring of 1991, I would
argue that we could not have gotten long-term rates down materially more than occurred under those conditions. Indeed, in 1989, it
worked against us.
And if you conclude, as we did, that the crucial issue was to get
the balance sheet strain which had evolved during the 1980's to
unwind in a manner which would free the economy to function in
a more effective manner, then we are looking at a question of: is it
possible that if we had moved sooner, let's assume, that long-term
rates would have come down faster?
If I were to conclude that, I would say yes, there was a policy
mistake. But I honestly cannot say that. In retrospect as well as at
the time, I don't think we can say that we could have gotten longterm rates down appreciably more, enough, certainly, to have made
a difference.
Now it is the case that we very purposefully stopped easing as
the economy was coming back in the spring of 1991. We might
have eased during that period. I'm not sure whether or not we
would have had bad market reaction as a consequence.
But it is the case that we had not anticipated that the economy
would essentially fizzle out, as it did, toward the end of the third
quarter.
So it is a tricky question of whether, even were we to know what
was going to happen, it would have made a major difference.
I do know that looking back without the hindsight question, in
other words, even asking ourselves were we misled by certain figures, I cannot say that I can honestly agree to that. I don't recall
any such action.
We may have been wrong on the question of our judgments of
where the long market would go relative to the short market. I
know of no evidence to suggest that we were wrong, but I cannot
give you ironclad evidence that we weren't.
Senator SARBANES. Well, did the long market react positively
when you did the one-point cut in late December?
Mr. G R E E N S P A N . Yes. Very much so.
Senator SARBANES. Very much so.
Mr. G R E E N S P A N . Yes. Much better than I would have expected.
Senator SARBANES. NOW, why wasn't there reason to think that it
might have acted better if you had done that sooner?
Mr. G R E E N S P A N . Largely for the reason which I indicated here
earlier, and which I may have discussed a couple of weeks ago, that
it has only been in the recent period when the—let me retrace for
a minute. I hate to get too technical, but let me try to see if I can
simplify something to clarify exactly how we were functioning in
that period.
84
We endeavor to take the long-term U.S. Treasury bond, the 30year bond, and break it into parts so that we in effect have got the
equivalent of that, but essentially in pieces which reflect inflation
expectations, in part long-term, intermediate-term and short-term.
Technically, what we were doing was looking at one year maturities of Treasury issues 26 years in the future, 28 years in the
future, 30 years in the future, 10 years, 5 years.
Algebraically, you can define the 30-year bond as effectively the
sum, weighted sum, of those individual tranches of Treasury debt.
The reason why that is very useful to look at is it tells you why
long-term interest rates are falling. The decline in long-term interest rates that was occurring up until the fall of 1991 was predominantly, in fact completely, the result of declines in the short ends
of the markets.
In other words, to an extent that inflation expectations were relevant, it was caused by a decline in inflation expectations 2, 3, 4, 5
years out, but not 8, 10, 12, 15. Those inflation expectations, as we
would measure them, were flat, unresistant to the decline.
It is our judgment that were we to make a major move at that
point, say earlier on, we would not have gotten a significant response in the long end of the market, and conceivably could have
gotten an adverse response.
Senator SARBANES. IS the inflation target that your standard—
that you are bearing in mind as you go through this exercise in
terms of what is desirable, a zero inflation?
Mr. GREENSPAN. NO. There are two issues here. One is what we
think would be a desired inflation rate which, as I have put it
before at this committee, would be one in which individual businessmen would no longer be concerned about the rate of inflation
for business decision making. That's not what I am talking about
here.
Senator SARBANES. YOU went further than that in some of your
testimony. You said in October 1980:
I think that inflation could be brought down to levels which are closer to zero
without putting the economy into recession, though I do suspect there might be
some modest loss of economic growth relative to what would otherwise have been
the case.
If the Fed looks out as you are trying to shape this economic
landscape, I mean, is one of your goals a zero inflation rate?
Mr. GREENSPAN. NO. One of our goals is, as I said in my opening
remarks this morning, reasonably stable prices. Reasonably stable
prices being defined in a manner which contributes to long-term
economic growth potential.
But in any event, the issue I was raising here is not our judgments as to what inflation expectations are, but trying to make a
judgment of what the market's expectations are and therefore how
markets would respond, how long-term issues specifically would respond to monetary policy.
We're not making judgments as to whether that is desirable or
undesirable, but really as a forecasting tool.
Senator SARBANES. Well, those buzzers that are ringing is the
sign of a vote. Chairman Riegle is, as I understand it, planning to
return to continue the hearing, and since I have to leave to vote, I
will put the committee in a recess until then.
85
Thank you very much. The committee will stand in recess.
[Recess at 4:10 p.m.]
[The committee reconvened at 4:24 p.m.]
The C H A I R M A N . The committee will resume, and I hope we can
finish up here promptly. You have been very patient and it is all to
the good if we can finish in one day rather than have to go over to
a second day, so that is why we are proceeding with the afternoon
session.
With interest rates coming down as much as they have, and
people who have savings in banks, financial institutions, certificate
of deposit and other kinds of insured savings accounts are taking
their money out of the banks and they are either taking it to the
stock market or to a mutual fund or somewhere else. They are
searching for higher yields.
Can you tell us a little bit about the volume and the degree to
which the migration of that money, the disintermediation, is
having any appreciable effect on the deposits at institutions that
you are aware of?
Mr. G R E E N S P A N . Some, yes. The volume of mutual fund sales,
both bond and stock funds, are very large, and they have been so
for quite a while.
The anecdotal discussions relate to basically the process you are
concerned about, namely a very large part of that is coming out of
banks into the mutual funds strictly on the issue of yield.
The orders of magnitude are really quite large. For example, the
total of equity and bond funds was almost $12 billion in November,
$16 billion in October, $13 billion in September and my impression
of December was that it continued at a very high rate.
So there is no evidence of diminution and these are rather large
numbers relevant to the money supply.
The C H A I R M A N . Does that create any problems with respect to
moving money out of the banking system? Is that creating any
pinches within the banking system or for individual institutions?
Mr. G R E E N S P A N . I would doubt it, because at this particular stage
there is a very large liquid position in the banking system, essentially U.S. Treasuries that are being held. And I am not aware that
that is creating a lending problem or a supply of funds problem
from the banks to their customers.
The C H A I R M A N . N O W yesterday, as you know, the stock market
hit a new high. Price/earnings ratios for stocks have climbed over
20 recently, and it is approaching the peak that preceded the crash
of 1987.
That isn't to say that we will get a crash of 1992, but it is interesting that the price/earnings ratio is getting into the same range
we saw back then.
Now when you started your last term, you expressed your concern about excess in the stock market. You are on the record in
that regard. Your fears proved to be justified because the market
went through a very major crash and adjustment about 2 months
later. And I and others on this committee also were expressing concerns at that time.
I am wondering what observation or thought you have as we are
seeing this large movement of money out of savings accounts and
86
banks, with the banks quite liquid because they are not making a
lot of loans, and into mutual funds, stocks, and bonds.
Isn't that part of what is driving the market up?
Mr. G R E E N S P A N . The major thing that is driving the market is
the fall in inflation expectations. History tells us that when inflation expectations fall, price/earnings ratios rise and vice versa.
And so while it is true that the level of P/E ratios currently is
not significantly different from where it was back in 1987, a little
more sophisticated analysis—in other words, trying to get at the
real rates of return and evaluating that in the context of inflation
expectations, has the current levels still short of where they were
back then.
That says nothing about where, obviously, the market is going,
but using price/earnings ratios per se, that does not give you a full
picture of what the relative values are.
The C H A I R M A N . What do inflation expectations look like in Germany these days, West Germany?
Mr. G R E E N S P A N . They are rising.
The C H A I R M A N . United Germany. Pardon?
Mr. G R E E N S P A N . They are rising.
The C H A I R M A N . Are they more severe than ours?
Mr. G R E E N S P A N . I would certainly say that they are rising relative to ours. Remember, for a very long time, they were down quite
a good deal.
I can't differentiate except to say that whereas in the most
recent past their expectations, whatever they were, were rising,
ours were falling.
The C H A I R M A N . Well, they have been raising their interest rates,
have they not?
M r . GREENSPAN. Y e s .
The C H A I R M A N . I have a concern about that. Where would their
rates be now relative to ours?
Mr. G R E E N S P A N . Higher in both the long and the short end of the
market. Currently the German 3-month rates are at 9.40 percent
and ours, obviously, are
The C H A I R M A N . 9.40 percent? Three-month rate.
Mr. G R E E N S P A N . 9 . 4 0 percent. This is the interbank loan rate.
Ours are 4.10 percent.
The C H A I R M A N . SO ours are less than half.
M r . GREENSPAN. Y e s .
The C H A I R M A N . N O W , do they have an inflation expectation over
there that is twice ours?
Mr. G R E E N S P A N . NO. I would say their real rates are higher than
ours. So it's not wholly inflation expectation.
The C H A I R M A N . Yes, it's something else. I am not sure that one
could always make the relationship between the level of interest
rates and inflationary expectations. Isn't that just part of the mix?
Mr. G R E E N S P A N . It's only part of the mix. That's correct. You
can't do it for the short end of the market. It's a much more relevant evaluation issue when you are dealing in the long end.
For example—this is more relevant to this particular question—
for example, long-term government yields of 10-year maturities
show Germany at 7.9 percent. This is yesterday's data, and the
87
United States 7.2 percent. Now that's more of a reflection of what
the real differences are.
The C H A I R M A N . SO the longer-term inflation expectations would
seem to be roughly comparable, if you measure by the differences
in those rates.
Mr. G R E E N S P A N . The reason I hesitate to make a judgment is it
is very difficult to extract long-term inflation expectations out of
these markets. But roughly comparable, obviously cannot be all
that wrong with long-term rates sitting where they are.
The C H A I R M A N . With respect to the problems in the banking
system, which we have discussed before, is it fair to say that the
problems are still with us and, in fact, it may take 2, 3, 4, 5 years
to really move through the period of the accumulation of stress, financial stress, on a significant number of banks in the banking
system and certainly some key banks?
Mr. G R E E N S P A N . I would certainly say it is going to take a while
but we are moving in the right direction. I am quite pleased by the
extent to which new equity offerings amongst the bank holding
companies are being taken down rather well. That's adding to their
capital position and it is curing a lot of problems in a lot of areas.
But there is no question we still have got a way to go and I
would scarcely want to argue that we are going to be out of this
nonperforming loan difficulty, the credit crunch, the associated
issues, in a period that is a matter of a few months. I think it is
longer than that.
The C H A I R M A N . Yes, it's longer than that.
Mr. G R E E N S P A N . But it is improving. It is the only hopeful issue
with respect to this problem.
The C H A I R M A N . NOW, when you lowered the discount rate recently by a full percentage point, that had the effect, did it not, of helping the banks by lowering the cost of funds to the banks? Doesn't
that give the banks some oxygen?
Mr. G R E E N S P A N . Well, actually, in that particular case, maybe
not. Because you may recall that the prime rate moved down a full
percentage point at that point, but that CD rates and Fed funds
rates did not go down a full point. So it may at a particular time,
have squeezed them slightly, but that is from a level which had already opened up quite significantly.
The C H A I R M A N . Don't most of the banks today have a pretty good
spread between the cost of funds and what they are paying out on
deposits and such?
Mr. G R E E N S P A N . I'm sorry?
The C H A I R M A N . Aren't banks being helped by the fact that their
costs of funds are down and they are not paying as much?
M r . GREENSPAN. Y e s .
The C H A I R M A N . Hasn't the Fed, in fact, helped the banks in that
way?
Mr. G R E E N S P A N . I would say that is correct.
The C H A I R M A N . Would that have been part of the reason the Fed
made the moves it did?
Mr. G R E E N S P A N . I believe in public testimony before this committee at the time, I was suggesting as one of the reasons for the
moves was to approach the credit crunch in part by trying to open
up the profit margins of the lending operation. And that clearly
88
has occurred and it has been of assistance in preventing the crunch
from getting worse at a crucial point.
But those margins are still open, earnings are accordingly large,
and I would suspect that when the credit crunch begins to ease,
those margins are going to start to come down again.
The CHAIRMAN. I have heard you say that before. That will be
the time when there is really competition out there and the banks
are really going out and competing with one another for those good
loans.
All of my colleagues keep telling me they are waiting for that
day to arrive. None of them are seeing it anywhere around the
country, so
Mr. GREENSPAN. We are waiting, too, Mr. Chairman.
The CHAIRMAN. Earlier this month, there was an article in the
Federal Reserve Bulletin that I am sure you saw and were aware
of, that reported that while average family incomes rose modestly
during the 1980's, the gains were concentrated almost entirely
among the very wealthy, and that the median income hardly
moved at all during that decade.
Is there any explanation for why the concentration of gains are
found in the upper income groups, in terms of the work the Fed
has done on this?
Mr. GREENSPAN. I wouldn't necessarily say it is the Fed work,
but there is a significant amount of academic work in this area.
And what we know is that there has been a major opening up in
the spread of income relevant to education, so that college graduates versus high school graduates now earn more relative to what
they would have earned say 10 years ago.
My suspicion of the cause of this phenomenon is the tremendous
increase in technology and the major move toward conceptual
output, if I may put it that way. That is, a far greater degree of
technological products as the major elements in the value added of
our economy, has put a premium on education and that, in turn,
has reflected itself in the marketplace and opened up the wage patterns in the manner which those data seem to suggest.
The CHAIRMAN. Does tax policy seem to have any impact on it?
Mr. GREENSPAN. These are pre-tax data, and I doubt if the tax
policy indirectly would have impacted it, although obviously, if you
then reconverted those data on an after tax basis, you would find
that there was a somewhat wider gap.
The CHAIRMAN. Yes. I'm afraid so. Hopefully one of these days
we'll muster the votes to do something about that.
I want to get into one other area, and then we'll finish. This has
to do with foreign banking, again, in the United States.
A fellow by the name of Michael DeStefano, who is the Vice
President of Standard & Poor's Corporation, testified before this
committee in September 1990. And he told us at that time that foreign banks have had, and I quote him:
Tremendous penetration in the commercial and industrial areas of lending in this
country here in the United States.
Continuing, he said:
Something like 25 percent of commercial and industrial assets are held by foreign
banks, and they tend to be the better quality assets. Foreign banks are willing to
89
compete on price and go after good quality business, the result of which is that
many U.S. banks have had to seek earnings opportunities elsewhere, notably in
areas which, we all recognize as high-risk areas.
I then asked him if our domestic banks were losing out to foreign
banks for good quality industrial and business customers principally because of price competition. He replied, and I again quote him:
Pure and simple. Price competition.
I am wondering if you would agree with his observation that
price competition by foreign banks for the better quality loans has
forced our own U.S. banks to go after higher risk loans, whether in
commercial real estate or in other areas, which in turn may well
be the reason, or one of the reasons, why they have sustained a
higher pattern of losses, which has weakened their capital position,
and helped empty the deposit insurance fund.
Do you know whether we have any laws or regulations in effect
that permit foreign banks to raise funds more cheaply in this country than domestic banks and enable them to compete for better
customers solely on price?
Mr. GREENSPAN. I don't see how they can. I mean, there's an
open market for funds, and I can't see how they can basically
obtain a significantly lower cost of funds unless they are AAA-type
institutions, and they may get an edge our AAA institutions tend
to get, but I don't think it would reflect itself in enough of a price
advantage to really make a difference.
I think we can explain very readily why we've had the problems
that we've had.
The CHAIRMAN. Wouldn't one of the reasons be who pays for Federal deposit insurance and who doesn't?
Mr. GREENSPAN. Well, I would assume that the ones we are talking about are paying for Federal deposit insurance, if that's the
case.
If it is not, then there is another cost involved.
The CHAIRMAN. My understanding is that on wholesale deposits
they don't pay any deposit insurance premiums.
Mr. GREENSPAN. That's right. These are essentially the foreign
branches. Foreign subsidiaries do pay.
The CHAIRMAN. Yes. These are foreign operators that come in
and have a financial advantage in that respect, and can cherry-pick
the good customers, and go after them, and develop the primary—
the best, the premium banking relationships—and leave the rest of
the business to the American competitors, who then in turn have
to reach out, I think, for probably a higher-risk profile loan.
Mr. GREENSPAN. My impression is that the higher-risk profile
that has occurred is a result of many other factors, not the least of
which was the LDC loan issue, and the desire to pick up a significant amount of commercial mortgages, because they were very
profitable at the time they were accumulated. I must say I would
be doubtful that a considerable amount of the problem we confront
occurs as a consequence of this, although your figures are correct.
And it is, as I recall—I haven't checked these numbers, but 25
percent strikes me as about the right order of magnitude.
The CHAIRMAN. If that continues to grow, on the one hand, somebody might say, that's fine. If foreigners want to come in and set
90
up banking operations and offer credit opportunities to Americans
and so forth, so be it.
But if it has the effect of growing in such a way that it weakens
the indigenous American system in ways like I have spoken about,
they are also not under the burden of complying with CRA investment requirements, you can have a situation where eventually our
dependence on foreign credit is such that the provider of foreign
credit can accumulate a kind of economic power in our system to
decide who gets loans and who doesn't, and what they pay for them
and what they don't. I have to tell you, in watching how some
countries operate, I'm not comfortable with that.
I like the idea of keeping our banking system and the integrity of
it in terms of the availability of credit very much in the hands of
people in this country whose overriding interest would be the wellbeing of this country.
Mr. GREENSPAN. The risk-based capital guidelines are going to
adjust for that in part although it doesn't fully respond to your
concerns.
The interesting issue, however, is that one would have thought
that if that were a major problem, we would begin to see an extraordinarily large amount of foreign loans coming in here as a
consequence of our credit crunch, which we don't.
And one observes that the Japanese, who have been a very big
part of that, have actually not been expanding. They have been
caught, as you know, by their problems at home, and have pulled
back considerably in their lending practices abroad.
So to the extent that the problem exists, and I frankly am not
sufficiently aware of it to give you a firm judgment about its order
of magnitude, it does not appear to be increasing. But if you would
like, I will look into that and try to give you a much more informed response.
[Chairman Greenspan subsequently submitted the following information for the record:]
The Federal Reserve collects weekly data on U.S. commercial and industrial loans
in U.S. offices of large banks, including branches and agencies of foreign banks.
These data show that in 1991 such loans by U.S. branches and agencies of Japanese
banks actually declined by about 7 percent compared to a decline of about 3 percent
in all banks. Commercial and industrial loans booked in the U.S. offices of all foreign banks did increase substantially in 1991; however, most of the reported increase reflected a transfer of existing loans from off-shore branches of these banks
to their U.S. offices following the reduction of reserve requirements by the Board. If
this effect is factored out, it is estimated that branches and agencies of foreign
banks increased their U.S. commercial and industrial loans by about 7 percent in
1991.
The CHAIRMAN. I am going just to raise two other questions, and
then we will finish.
We had Alex Sheshunoff here, and of course you know he's a
noted banking analyst. He testified before the committee in October 1989. Now, this would be
years ago.
He told us then that we ought to balance our trade deficit with
Japan by selling them things, and I quote him:
Not assets, nor banks.
Then he went on to say:
91
Many major Japanese banks through strategic acquisitions have acquired the
marketing skills and physical presence that will enable them to provide low cost
loans to American businesses.
And furthermore:
Banks end up controlling who gets credit and who doesn't, and the idea that a
foreign-owned financial institution would then be determining which industries and
which customers grow in a particular part of the country is a risk that I do not
think we need to incur.
So here's a fellow looking at it from a different vantage point,
but expressing his concern about an accumulation of power in the
banking sector of our economy, where who gets credit and who
doesn't and what they pay for it is a terribly important issue.
I do have a concern about it, and it is multiplied by the fact that,
as you well know, we maintain a relatively open market here in
the United States for Japan and others, and we don't find the same
attitude and same circumstance abroad, particularly in Japan.
Although, as you say, Japan has its own current financial
market problems, about 15 percent of all the banking assets in
America today are under the control of Japanese banks. Does that
square with your numbers?
Mr. GREENSPAN. It sounds approximately right.
The CHAIRMAN. About 15 percent. A lot of people in America
would be surprised to know that. In California, I understand, it's
about 25 percent. Is that about right?
M r . GREENSPAN. Y e s .
The CHAIRMAN. DO you know what the percentage of American
banking assets are in Japan? It's less than 1 percent.
Mr. GREENSPAN. I can attest to the fact that it's quite small.
T h e CHAIRMAN. Y e s .
They have here in this country a very substantial share. There
we have virtually no share.
And that's not unique to the United States. The entire foreign
share of banking assets in Japan—the United States and the whole
rest of the world—is only about 3 percent.
We don't have a reciprocal, open, two-way relationship with
Japan in terms of financial services. Shouldn't we have?
Mr. GREENSPAN. Well, I think we should.
The CHAIRMAN. Shouldn't we insist on that?
Mr. GREENSPAN. I certainly would say that it would be beneficial
to Japan. It would be beneficial to the United States if that were to
happen.
The CHAIRMAN. It seems to me when the percentages become
that extreme—and you see it in a lot of other areas. It's also true
in manufactured, high value-added goods, whether it's cars, computer chips, or other kinds of things.
Japan maintains a closed market. We can't get in. They have
access to an open market here that provides opportunities for
them—profit opportunities, which they make full use of. We don't
have those same opportunities there.
Is it fair, then, to say that it would be your position and the position of the Fed that we ought to be asking for and expecting the
same market access in Japan for financial services that we provide
the Japanese here?
92
Mr. G R E E N S P A N . I can't speak for my colleagues, because we
haven't discussed this in particular.
All I would suggest to you is that it would be to everybody's advantage if there was more inter—I should say cross-border—financial institution location.
I would defer at the moment in trying to evaluate the means by
which that would best be accomplished, but—you asked me whether it would be desirable if it were to happen, and the answer is,
probably yes.
The C H A I R M A N . Japan's now at 15 percent of the market nationwide, and 25 percent of the market for banking in California. It's
tapered off for reasons that you and I both just discussed.
Suppose it were 50 percent? Would that bother you?
Mr. G R E E N S P A N . It bothers me when it's 2 5 percent. But that
bothers me for different reasons.
It's an issue of—I would like to see our assets owned by Americans, and in fact I would like to see the United States as a viable
operation.
But I'm also acutely aware of the fact that what is occurring,
and has been occurring, is an increasing flow of imports as shares
of GNP, and as a consequence, an ever increasing degree of cross
border flows and ownership.
And I recognize that there has to be, if the world continues to
integrate, as it does, an ever increasing amount of cross-border financial institution locations as well.
So, if you are saying to me should we have a public policy which
restricts that, I would be quite hesitant because I'm not sure it
serves American interests to do it.
I would like to see us on a competitive basis—if I may put it that
way—but I'm not sure I would like to change the goal posts enough
to make it easier for us to do that.
The C H A I R M A N . Well, you've just said a minute ago that you certainly think we ought to have access to the other fellow's market.
You don't have any problem with that.
M r . GREENSPAN. NO.
The C H A I R M A N . And we ought to have the same access there that
he has here.
This question is about strategic areas of the economy, I would
argue that banking is a strategic area of the economy. We are
seeing that right now. That's one of the reasons the economy is in
trouble.
Hypothetically, if I saw another country—it wouldn't matter
which country—reaching the point where they had 50 percent of
the banking assets in the United States, I would be troubled by
that, all the cross-border theory notwithstanding, because it's a key
industry.
We ought to keep essential control of that in our own country.
Suppose it got to 75 percent? We're not there yet, but we were at
one time at a very low level. We weren't up to 15 percent with respect to just one country, namely Japan.
Wouldn't it be troubling to you if we found a situation where,
say, more than half the control of the banking assets of this country were in the hands of foreign banks?
93
Mr. G R E E N S P A N . I'd be concerned about it, Mr. Chairman. I am
not sure that I would want to initiate legal action to change that.
But that is a national security question, and it is essentially a
public policy question, which goes beyond the issue of what is an
efficient banking system.
The C H A I R M A N . I agree with you. But that's why it brings it
right into this room, because you and I are public policymakers,
and it is a strategic issue, and this is the place where this kind of
thing ought to be thought about and talked about.
We ought to talk about it before the fact and not after the facts
where we wake up one day and find out that we're in a situation
we don't want to be in.
I would hope the Fed would take a look at it. And I would hope
the Fed would take a very aggressive position that if any nation
begins to move significantly into financial services in this country—banking services, part of your responsibility—that the Fed
would be very outspoken and aggressive in suggesting that we
ought to have equivalent opportunities in the home market of that
same country.
There really is no acceptable basis for arguing for a double
standard that says that our market is wide open, but we will tolerate a closed market condition in the other fellow's market.
I would hope that the Fed would find its voice on this issue because I think that this is a strategic industry.
Mr. G R E E N S P A N . I will communicate your views to my colleagues.
The C H A I R M A N . I know there are other members who could not
be here who have questions for you, and we would ask you to respond to those fully for the record. And I know you will.
We thank you for your testimony today. The committee stands in
recess.
[Whereupon, at 4:55 p.m., the hearing was adjourned.]
[Response to written questions and additional material supplied
for the record follow:]
52-418 - 92
94
For release on delivery
10 a.m., E,S.T.
January 29, 1992
Statement by
Alan Greenspan
Chairman
Board of Governors of the Federal Reserve System
before the
Committee on Banking, Housing, and Urban Affairs
of the
United States Senate
January 29, 1992
95
Mr. Chairman members of the committee, I want to
thank you for scheduling this hearing to consider my
nomination to a second term as Chairman of the Federal
Reserve Board and to a full 14-year term as a member of that
Board.
I am especially grateful to President Bush for the
confidence he had in me to make these nominations.
I have testified before you frequently on the state
of the economy and the conduct of monetary policy, including
as recently as two weeks ago.
I also have given you my
views and those of the Federal Reserve Board on a wide range
of specific regulatory and supervisory matters pertaining to
banks over the last several years.
I would expect to be
addressing your questions on these issues again here today.
In my brief opening statement, however, on the occasion of
these hearings on my confirmation, I thought it might be
appropriate to step back a little from the application of
policy in specific circumstances and discuss some general
principles that I believe should guide decisions on the
monetary policy and banking structure of this country.
I see the fundamental task of monetary policy as
fostering the financial conditions most conducive to the
American economy performing at its fullest potential.
As I
have often noted before, there is every reason to believe
that the main contribution the central bank can make to the
96
-2achievement of this national economic objective over long
periods is to promote reasonable price stability.
Removing
uncertainty about future price levels and eliminating the
costs and distortions inevitably involved in coping with
inflation will encourage productive investment and saving to
raise living standards.
Monetary policy is uniquely quali-
fied to address this issue:
Inflation is ultimately deter-
mined by the provision of liquidity to the economy by the
central bank; and, except through its effect on inflation,
monetary policy has little long-term influence on the growth
of capital and the labor force or the increase in productivity, which together determine long-run economic growth.
But a central bank must also recognize that the
"long run" is made up of a series of "short runs".
Our
policies do affect output and employment in the short- and
intermediate-terms, and we must be mindful of these effects.
The monetary authority can, and should, lean against prevailing trends not only when inflation threatens, but also
when the forces of disinflation seem to be gathering excessive momentum.
That is, in fact, what has concerned us in
recent months, and we have been taking actions designed to
assist in returning the economy to a solid growth path.
However, the Federal Reserve, or any other central
bank, must also be conscious of the limits of its capabili-
97
-2-
ties.
We cam try to provide a backdrop for stable, sus-
tainable growth, but we can not iron out every fluctuation,
and attempts to do so could be counterproductive.
What we
have learned about monetary policy since the beginnings of
the Federal Reserve System is that the longer-term effect of
a policy action may be quite different from its initial
impact; what we don't know with precision is the size and
timing of these effects, especially in the short run.
Un-
certainty about the near-term twists and turns of the economy. along with the awareness of the potential differences
between long- and short-term effects suggest both flexibility in the conduct of monetary policy and close attention
to the longer-term context in conducting day-to-day operations .
Monetary policy actions are transmitted to the
economy through the financial system, and the influence of
weakness in that system on how the economy responds has been
all too evident in recent years.
A structurally sound and
vigorous financial system not only facilitates monetary
policy implementation, but is itself no less important to
support an economy operating at its highest potential.
Such
a system must effectively and efficiently gather savings and
distribute them to where they will be of most value to
society in promoting productive investment and supporting
consumption.
Banks and other depositories have a key role
98
-2-
to play in this system.
They are the channels through which
payments pass, they are the chief repositories of households' liquid savings, and they extend credit to many who
have limited, if amy, access to alternative sources of
financing.
Our nation's banking system must be strong—not
only in the sense of safe and sound, but also in the sense
of being efficient and innovative in delivering vital
services to the economy.
That strength undoubtedly has
eroded in recent years, in part through errors of judgment
by depositories and their regulators, but also through the
combined effects of a stiffer competitive environment and
continued legal restraints on the ability of depositories to
respond and adapt.
Against that background I, and the Board of Governors, have brought three interrelated principles to bear on
our approach to banking structure and regulation.
the importance of a strong capital position.
First is
Capital brings
market discipline to bear on institutions that otherwise
might be tempted to take excessive risk by their access to
the federal safety net.
And, it insulates the taxpayers
holding up that safety net from the losses associated with
unwise risk taking, should that occur nonetheless.
Second
is the need for more certain and prompt supervisory actions
when capital and other key indicators of the financial
99
-2-
health of an institution decline.
This not only will pro-
tect the taxpayers, but it also gives depositories planning
their financial structures more certainty about governmental
reactions, and induces them to take early action to
strengthen those structures.
Congress and the regulators have gone a long way in
acting on these first two principles.
gress on the third is more limited.
Unfortunately, proThat principle embraces
the necessity for greater competitive scope for well-capitalized banking organizations—across boundaries of geography and product line.
Both sets of boundaries have been
made increasingly arbitrary and artificial by innovation and
internationalization of financial services.
An ability to
deliver desirable services to the public is a prerequisite
for generating the profits necessary to build capital and
for keeping an innovative banking system capable of meeting
the changing needs for credit and deposit services of a
dynamic economy.
The last four years have seen no paucity of challenges at the Federal Reserve.
As much as we sometimes
might wish otherwise, I suspect the years ahead will be no
less challenging.
While much remains to be done, important
strides have been m a d e — i n private markets and in government
policies to restore the normal vigor of the American economy
and our banking system.
To that end, I believe the Banking
100
- 6 -
Committees' oversight and our continuing consultations have
been a most helpful and constructive factor.
Should the
Senate choose to confirm me for a second term as Chairman of
the Federal Reserve Board, I would look forward to working
with this Committee to assure the sound financial system and
vital economy the American people rightfully expect.
101
FEDERAL RESERVE press release
For immediate release
March 1, 1991
A series of supervisory steps designed to reduce impediments to
lending by banks and thrifts to credit-worthy borrowers was announced today by
the Federal bank and thrift supervisors.
In announcing the changes, the agencies said the intent of this effort
is to contribute to a climate in which banks and thrifts will make loans to
credit-worthy borrowers and work constructively with borrowers experiencing
financial difficulties, consistent with safe and sound banking practices.
The agencies issuing a statement on the changes are the Office of the
Comptroller of the Currency, the Federal Deposit Insurance Corporation, the
Federal Reserve Board, and the Office of Thrift Supervision.
The joint policies clarify that the supervisory evaluation of real
estate loans is based on the ability of the collateral to generate cash flow
over time, not upon its immediate liquidation value;
encourage banks to
disclose additional information about nonaccrual loans;
sound loans to credit-worthy borrowers;
encourage banks to make
and facilitate the workout of problem
loans.
The agencies are also considering the merits of proposed guidelines
that address the accrual of income on certain loans that have been partially
charged off.
The agencies and the Securities and Exchange Commission will both
solicit public comment on the proposed guidelines.
Any formal guidance issued
will be based on the comments received from the public and on-going discussions
between the agencies and the SEC.
(OVER)
102
The supervisory statements and clarifications will be sent to field
examiners and supervisory personnel.
Copies of a general statement and the
joint policy guidelines are attached.
-0-
Attachments
103
joint
Federal Reserve Board
Comptroller of the Currency
Office of Thrift Supervision
Federal Deposit Insurance Corporation
News Release
GENERAL STATEMENT
Recent c r e d i t p r o b l e m s have u n d e r s c o r e d t h e importance
prudent lending p r a c t i c e s t o the o v e r a l l
the nation's
financial
system.
i n a number o f s e c t o r s
The e m e r g e n c e o f c r e d i t
t o review t h e i r lending p r a c t i c e s
w e l l a s t h e i r c a p a c i t y t o meet c r e d i t demands.
have w i s e l y t i g h t e n e d
Many
as
institutions
c r e d i t standards where such standards
had
Others have reduced t h e pace of l e n d i n g
r e s p o n s e t o t h e n e e d t o s h o r e up t h e i r c a p i t a l p o s i t i o n s
strengthen t h e i r balance
It is possible,
in
and
sheets.
however,
t h a t some d e p o s i t o r y
institutions
may h a v e b e c o m e o v e r l y c a u t i o u s i n t h e i r l e n d i n g p r a c t i c e s .
some i n s t a n c e s t h i s
In
c a u t i o n has been a t t r i b u t e d t o concerns
the part of l e n d e r s t h a t the regulators of
institutions
of
problems
o f t h e economy h a s p r o m p t e d many
depository i n s t i t u t i o n s
become t o o l o o s e .
of
s a f e t y and s o u n d n e s s
are applying excessively
on
depository
rigorous
examination
standards.
The F e d e r a l b a n k i n g a n d t h r i f t r e g u l a t o r s d o n o t w a n t
availability
of
credit.to
sound b o r r o w e r s t o be
a f f e c t e d by s u p e r v i s o r y p o l i c i e s o r d e p o s i t o r y
misunderstandings
about them.
are issuing a s e r i e s
As a r e s u l t ,
institutions'
the agencies
o f g u i d e l i n e s and s t a t e m e n t s t h a t
intended t o c l a r i f y regulatory p o l i c i e s
reduce concerns d e p o s i t o r y
today
are
i n a number o f a r e a s
i n s t i t u t i o n s may h a v e a b o u t
of c r e d i t t o sound b o r r o w e r s .
Specifically,
encourage enhanced d i s c l o s u r e
(1)
and
extensions
statements released
today:
the
adversely
the guidelines
and
to
104
2
the public,
(2)
facilitate
extensions
of
credit to
borrowers and t h e workout o f problem l o a n s ,
sound a s s e s s m e n t s
institutions
of
the value of
and F e d e r a l
Recent concerns
availability
willingness
The g u i d e l i n e s
nor are they expected,
problems.
requirements),
these
prudent c r e d i t
extensions
Enhanced d i s c l o s u r e
will
The new g u i d a n c e r e c e n t l y
Depository
it
shutting
credit
off
t h e economy t h a t
Consistent
institutions,
is
comptroller
o f more
detailed
financial
with varying degrees of
on
Highly
among
risk.
have t r a d i t i o n a l l y worked w i t h
important
t o sound borrowers,
In the current
for institutions
especially
are experiencing temporary
their
economic
to
avoid
in sectors
of
problems.
w i t h sound banking p r a c t i c e s ,
i n c l u d i n g t h o s e w i t h low c a p i t a l
and c o n s t r u c t i v e
is
portfolios.
s h o u l d h e l p by d i f f e r e n t i a t i n g
especially
work i n a n a p p r o p r i a t e
help
i s s u e d by t h e O f f i c e of t h e
institutions
have
changes
borrowers.
institutions'
b o r r o w e r s who a r e e x p e r i e n c i n g p r o b l e m s .
environment,
time,
help to ensure that the public
loans in public
to
credit
r a t e s and
and r e c e n t banking a g e n c y g u i d e l i n e s
assets
f o r some
should
t o sound
(OCC) o n s u g g e s t e d d i s c l o s u r e s
information about nonaccrual
broad g r o u p s o f
their
statements
t o "solve" a l l
initiatives
better informed about the nature of
Leveraged T r a n s a c t i o n s ,
have
and
When c o m b i n e d w i t h o t h e r s t e p s t h a t
in reserve
statements,
and
l o w e r money m a r k e t i n t e r e s t
facilitate
of the Currency
assure
t o e x t e n d new c r e d i t a n d
which have been under development
(such as
better
depository
a t t e n t i o n on r e g u l a t o r y p o l i c i e s
work w i t h t r o u b l e d b o r r o w e r s .
been taken
e s t a t e by
examiners.
e f f e c t s on i n s t i t u t i o n s '
are not intended,
sound
(3)
r e l a t e d to a t i g h t e n i n g of c r e d i t
focused the agencies'
released today,
real
and
depository
positions,
fashion with
should
borrowers
105
3
who may b e e x p e r i e n c i n g
include
S u c h e f f o r t s may
r e a s o n a b l e workout arrangements or prudent s t e p s
restructure
place
temporary d i f f i c u l t i e s .
extensions
effective
concentrations
of c r e d i t .
internal
Institutions
c o n t r o l s t o manage and r e d u c e
over a reasonable period
of t i m e ,
industry or geographic
in
excessive
need
not
a u t o m a t i c a l l y r e f u s e c r e d i t t o sound borrowers because
borrower's particular
to
t h a t have
of
the
location.
The documents r e l e a s e d t o d a y by t h e F e d e r a l bank and
regulatory
a g e n c i e s aim t o
l o a n s by a d d r e s s i n g t h e
restructured
generally
facilitate
the workout of
income a c c r u a l t r e a t m e n t o f
d e b t and a c q u i r e d n o n a c c r u a l
Further,
there
of the accounting treatment of m u l t i p l e
s i n g l e b o r r o w e r when s o m e ,
borrower are
formally
loans consistent
accepted accounting principles.
clarification
but not a l l ,
thrift
problem
with
is
a
loans to a
of t h e l o a n s t o
the
troubled.
T h e a g e n c i e s h a v e a l s o c l a r i f i e d when p a y m e n t s may b e
r e c o g n i z e d a s income on a c a s h b a s i s
f o r loans t h a t have
partially
the agencies
charged-off.
guidelines
In a d d i t i o n ,
t h a t a d d r e s s how i n s t i t u t i o n s
loans t h a t have been p a r t i a l l y
Finally,
the agencies
for real
estate
real
estate.
The p o l i c i e s
Disclosure
on l i q u i d a t i o n
market
on
values
analysis
values.
Public
of Nonaccrual
Loans
Nonaccrual
v a r y w i d e l y w i t h r e s p e c t t o t h e i r q u a l i t y and
generating capacity.
on
provide
loan l o s s reserves or net carrying
Enhanced D i s c l o s u r e t o t h e
A.
income
charged-off.
loans should r e f l e c t a r e a l i s t i c
and n o t b e b a s e d s o l e l y
1.
can accrue
been
developing
are a l s o c l a r i f y i n g t h e i r p o l i c i e s
t h e s u p e r v i s o r y v a l u a t i o n of
that the evaluation of
are
Consequently,
loans
cash
the simple total
of
such
106
l o a n s on an i n s t i t u t i o n ' s
of t h e
institution's
address t h i s
is
these assets.
b o o k s may n o t b e a g o o d
financial position.
indicator
One m e t h o d
to
t o p r o v i d e more i n f o r m a t i o n t o t h e p u b l i c
For e x a m p l e ,
useful
supplemental
might i n c l u d e
i n f o r m a t i o n on t h e amount o f c h a r g e - o f f s
on n o n a c c r u a l
loans,
these assets,
and t h e p o r t i o n o f t h e s e
substantial
cash
OCC r e c e n t l y
suggestions
t h e amount o f
loans that
i s s u e d a Banking B u l l e t i n t h a t
for the voluntary disclosure
fully
taken
c a s h payments r e c e i v e d
on
generate
flow.
i n f o r m a t i o n on n o n a c c r u a l
agencies
on
disclosures
loans.
of
contains
additional
The F e d e r a l
regulatory
support the voluntary d i s c l o s u r e s
s u g g e s t e d b y t h e OCC a n d d e s c r i b e d
in the
of the
type
attached
statement.
Bt Pisslpsmre <?f Highly Leverage Transactions fffLT?)
The F e d e r a l b a n k i n g a g e n c i e s h a v e p r e v i o u s l y d e v e l o p e d
u n i f o r m s u p e r v i s o r y d e f i n i t i o n f o r HLTs.
definition
is
a
The p u r p o s e o f
t o p r o v i d e a c o n s i s t e n t means t o m o n i t o r
t o HLT b o r r o w e r s .
The a g e n c i e s h a v e r e c e n t l y p r o v i d e d
the
attached additional
g u i d a n c e t o e x a m i n e r s and b a n k e r s on
application of
definition.
this
This guidance s t r e s s e s
t h e HLT d e s i g n a t i o n d o e s n o t i m p l y a s u p e r v i s o r y
of the
credit,
not f i t
criticism
certain
extensions
such as loans t o debtors-in-possession
the definition
reported.
The c r i t e r i a
(DIPs),
o f HLT l o a n s a n d s h o u l d n o t b e
f o r t h e removal
agencies will
other steps
continue
t o review these
are warranted in view of
a n d p e r f o r m a n c e o f HLT c r e d i t s ,
do
so
o f a l o a n f r o m HLT
s t a t u s have been expanded i n t h e a t t a c h e d document.
if
the
that
credit.
The g u i d a n c e a l s o makes c l e a r t h a t
of
the
loans
criteria
the
to
The
determine
characteristics
including the quality
and
107
5
reliability
2.
of
the borrower's
Other Lending
cash
flow.
Issues
T h e r e a p p e a r s t o b e some c o n c e r n t h a t a n y new
by i n s t i t u t i o n s
that
requirements w i l l
is
essential
necessarily
result
t o m e e t minimum
institutions
that
such i n s t i t u t i o n s
Institutions
are
Institutions
capital-to-assets
sheets
low-risk
deposits.
all
high-quality
objective
assets
Such a c t i o n s by t h e m s e l v e s ,
l e n d t o sound borrowers,
of
fail
their
balance
risk
exposure,
or of
core
under-capitalized
portfolios.
at depository
institutions.
agency r e q u i r e s such i n s t i t u t i o n s
to prepare a plan
the steps they will take to attain the
capital
levels.
of
capital
In general,
details
continuation
to
important
T h e a g e n c i e s , s h a r e common p r o c e d u r e s t o a d d r e s s
deficiencies
to
lending
or the r e f u s a l
to achieve the
improving the quality of
institutions'
steps
compliance
r a t i o s through shrinking t h e i r
of
it
meet
financial
t h a t s e e k t o improve
should avoid actions that raise t h e i r
such as the s a l e
to
not
should a t t a i n c a p i t a l
i n a p r u d e n t manner t h a t s t r e n g t h e n s t h e i r
conditions.
While
fail
s t a n d a r d s t a k e e f f e c t i v e and t i m e l y
deficiency,
required to cease prudent,
activities.
lending
capital
in supervisory c r i t i c i s m .
that depository
minimum c a p i t a l
address t h i s
fail
each
that
minimum
Approved p l a n s g e n e r a l l y do n o t p r e c l u d e
sound lending a c t i v i t i e s ,
including
s t e p s t o work w i t h b o r r o w e r s e n c o u n t e r i n g
financial
a
prudent
difficulties.
Similarly,
institutions
t h e r e a p p e a r s t o b e some c o n c e r n
with loan concentrations
t u r n i n g down g o o d l o a n s .
are
The b e n e f i t s o f
that
automatically
adequate
portfolio
108
6
diversification
institutions
are well
and t h e i r
r e c o g n i z e d by
regulators.
a g e n c i e s have not e s t a b l i s h e d r i g i d
concentrations,
depository
Although the
rules
on
they are in agreement t h a t ,
sound o p e r a t i n g p o l i c y ,
depository
regulatory
asset
as a matter
institutions
e s t a b l i s h and a d h e r e t o p o l i c i e s t h a t c o n t r o l
of
should
"concentration
risk."
Institutions
t h a t have i n p l a c e e f f e c t i v e
internal
c o n t r o l s t o manage and r e d u c e undue c o n c e n t r a t i o n s o v e r
reasonable period of
time,
c r e d i t t o sound borrowers.
policies
need n o t a u t o m a t i c a l l y
The p u r p o s e o f
s h o u l d be t o improve t h e o v e r a l l
portfolios.
institutions'
q u a l i t y of
The r e p l a c e m e n t o f u n s o u n d l o a n s w i t h
loans can enhance t h e q u a l i t y of a d e p o s i t o r y
portfolio,
3.
e v e n when c o n c e n t r a t i o n
levels
a
refuse
their
sound
institution's
are not
reduced.
Pecpgnitipn <?t incopg gn certain Nopp^rfgmipg Loan^
Q u e s t i o n s have been r a i s e d regarding t h e r e c o g n i t i o n
income on l o a n s t h a t have b e e n p a r t i a l l y
subject
is
regulatory
not e x p l i c i t l y
addressed
reporting requirements.
in the
without requiring
recovered,
fully
a s i n c o m e on a
f o r l o a n s t h a t have been p a r t i a l l y
of
This
agencies'
The a g e n c i e s w i s h
c l a r i f y t h a t payments can be r e c o g n i z e d
basis
charged-off.
to
cash
charged-off,
that the prior charge-off
first
be
s o l o n g a s t h e remaining book b a l a n c e i s
deemed
collectible.
The a g e n c i e s ,
Commission
(SEC),
along with the S e c u r i t i e s
each plan t o s o l i c i t
proposed g u i d e l i n e s which would a l l o w c e r t a i n
l o a n s t o b e p l a c e d b a c k on a c c r u a l
reduced t o
an a p p r o p r i a t e
level
and E x c h a n g e
p u b l i c comment o n
status
nonperforming
once the loans
through charge-offs.
Any
are
109
7
formal guidance
received
issued will
b e b a s e d on t h e
comments
f r o m t h e p u b l i c and o n - g o i n g d i s c u s s i o n s
the agencies
and t h e
between
SEC.
The a g e n c i e s h a v e r e l e a s e d t o d a y s u p e r v i s o r y
on a v a r i e t y
of
other issues
and f o r m a l l y r e s t r u c t u r e d
discussion
of
regulatory
income r e c o g n i t i o n ,
acquisition
4.
of
In recent
these
institutions'
appropriate,
part,
their
in c e r t a i n markets.
loan loss
estimates
reserves
of
commercial
real
reflect
and,
estate
estate.
It
is
The b a s i c
r e s e r v e s based on,
techniques
especially
important t h a t
valuation
n o t o n l y e x i s t i n g market c o n d i t i o n s ,
expectations
of the property's
The F e d e r a l r e g u l a t o r y
of loan l o s s
agencies
real
reserves.
thrust of t h i s guidance i s t o ensure
l o a n s not be a s s e s s e d s o l e l y
over time.
i n t o account the lack of
that
on t h e b a s i s
and c y c l i c a l
of
capacity
Supervisory evaluations
liquidity
but
performance
t h e i r p o l i c y on t h e a s s e s s m e n t o f
of t h e p r o p e r t i e s
it
in
values.
l i q u i d a t i o n v a l u e s b u t a l s o on t h e i n c o m e - p r o d u c i n g
take
to
of
where t h e y b e l i e v e d
estate,
e s t a t e v a l u e s and t h e e s t a b l i s h m e n t
income p r o p e r t y
the
declines
In response
h a v e f o c u s e d a t t e n t i o n on t h e
i n t h e market over time.
are r e i t e r a t i n g
real
the value of real
techniques
reasonable
and
examiners have reviewed t h e adequacy
These a c t i o n s
also
l o a n s t o one b o r r o w e r ,
a
basis
assets.
have required additional
used t o a s s e s s
to cash
t h e r e have been s i g n i f i c a n t
values
declines,
include
Estate Lpans
months,
estate
assets
These g u i d e l i n e s
requirements related
multiple
valuation pf
in real
debt.
nonaccrual
guidance
related to nonaccrual
should
nature
110
8
of
real
estate
m a r k e t s and t h e t e m p o r a r y
s u p p l y a n d demand f o r r e a l
5.
imbalances
e s t a t e t h a t may
in
the
that
any
occur.
pgyjew pf supervisory Finding?
T h e a g e n c i e s w a n t t o make c l e a r t h e i r p o l i c y
i n s t i t u t i o n may r e q u e s t a r e v i e w o f a n y m a j o r
reached as part of
the supervisory process,
decision
including
r e l a t e d t o a s s e t c l a s s i f i c a t i o n and r e q u i r e d r e s e r v e
those
levels.
Ill
DISCLOSURE OF NONACCRUAL ASSETS
The p u r p o s e o f
suggested
the
attached schedule
f o r m a t t o b a n k i n g and t h r i f t
i s to provide a
organizations
r e p o r t i n g more i n f o r m a t i o n i n p u b l i c d i s c l o s u r e s
assets,
including loans,
disclosures
However,
presented
financial
or r e l e v a n t ,
assets
of
whatever format
required.
are encouraged t o
on t h e i n s t i t u t i o n ' s
operations.
is
disclose
deemed
the
financial
Such d i s c l o s u r e s
c o n s i d e r e d a p p r o p r i a t e by
may
the
institution.
In recent months,
the
t h e i r analysts have placed
nonaccrual a s s e t s
to the total
institutions
about t h e s e
fully explain the
financial
condition
financial
institutions
of
organizations.
is
nonaccrual
assets
limited
income,
institutions.
assets
reports.
a format t h a t c o u l d be used
contribution
to net
income.
This
the prospects
for
o r d e r l y workout and u l t i m a t e
repayment o f
assets
in
Nonaccrual
placed
loans t o developing
to
of
in assessing
status.
and
some
additional
i n t h e i r annual
i n f o r m a t i o n on t h e c h a r a c t e r i s t i c s
and t h e i r
to
As a r e s u l t ,
i n f o r m a t i o n may p r o v e u s e f u l
nonaccrual
and
on t h e e a r n i n g s
h a v e s a i d t h e y w a n t t o make
an example of
nonaccrual a s s e t s
interest
of
Current
a s s e t s have g e n e r a l l y been
financial
about nonaccrual
Attached
and
S u c h i n f o r m a t i o n may n o t b e s u f f i c i e n t
impact of
provide additional
industry
e m p h a s i s o n t h e amount
amount o f n o n a c c r u a l a s s e t s ,
foregone.
disclosures
financial
increasing
a t b a n k i n g and t h r i f t
public disclosures
interest
additional
information or other information
c o n d i t i o n and r e s u l t s
financial
nonaccrual
The
i n o r d e r t o improve understanding of
impact of nonaccrual
utilize
and s e c u r i t i e s .
in t h i s guidance are not
institutions
publicly t h i s type of
useful
leases,
for
about
countries
the
are
112
- 2 -
not
intended
these
to
be
included
are g e n e r a l l y
The d e t a i l
appropriate
disclose
more s p e c i f i c
principal
values,
provided
or necessary
p a r t of t h e d a t a
in the
or other
to other real
properties,
i n t h e e x a m p l e may n o t b e
for all
categories
example.
significant
banks.
of
owned,
because
assets
O t h e r s may w i s h t o
facts.
associated
Financial
similar
including
of
considered
Some b a n k s may e l e c t
nonaccrual
assets,
appropriate
and a s e g r e g a t i o n
inflows.
Attachment
estate
example,
separately.
p a y m e n t s on n o n a c c r u a l
also consider providing
cash
in the attached
disclosed
disclose
institutions
inflows
with
to
only
collateral
disclosures
net cash
properties
or
may
related
from t h e
significant
net
SAflTLE DISCLOSURE
Generally, the accrual of income is discontinued when the full collection of principal or interest is in doubt, or when the
payment of principal or interest has become contractually 90 days past due unless the obligation is both well secured and In
the process of collection. Nonaccrual loans amounted to $
at December 31, 1990. This amount is net of aggregate
cliarge-of f s on t-hese loans of $
.
Further information regarding the balance of nonaccrual loans at December 31, 1990, and related interest payment
information, is as follows:
Book balance
at December
31, 1990
<si
Contractual
balance at
December 31,
1990
fash interest: pavmenta applied as (6)(7)
recovery of
interest
prior partial
reduction of
i neome
charge-oHa
principal—:
Contractually past due with:
o
o
o
substantial performance
(1)
limited performance
(2)
no performance
Contractually current, however,:
o
o
payment in full of principal
or Interest In doubt
(3)
other
(4)
Total
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
114
EXPLANATIONS REGARDING SAMPLE NONACCRUAL DISCLOSURE FORMAT
(1)
While
in t h i s
periodic
If
unable
category
to
payments
substantial
able to
contractual
to
the
is
disclosed,
of
performance which
is
not
the
should
The d e t e r m i n a t i o n
of
depending upon t h e
also
contractual
with
terms.
considered
something
less
management
should disclose
This
threshold
or
differ
be
loans,
considered.
payments and t h e n
However,
definition
a
interest
if
a
significant
then performance would
than substantial.
its
to
the
meaningful
a s p e c i f i e d time,
payment were missed,
due.
be
considers
For a m o r t i z i n g
interest-only
p e r f o r m a n c e o n l y m i g h t be c o n s i d e r e d .
principal
a
payments would l i k e l y
payment a t
should
it
performance w i l l
repayment
For l o a n s
payments
disclosed.
substantial
loan
and i n t e r e s t
principal
to provide
be
borrower
a s p e c i f i e d minimum,
information disclosed.
both p r i n c i p a l
single
periodic
management
a threshold
within
used
required
the
substantial
While t h e r e
should be s u f f i c i e n t
definition
making
relative
identify
distinction
delinquency,
performance
be s u b s t a n t i a l .
threshold
cure
would be c o n s i s t e n t l y
In any
of
likely
be
event,
"substantial"
performance.
(2)
Borrower
as defined,
(3)
While not
on n o n a c c r u a l
principal
applied
doubt
(4)
is
but
or
to
as
to
reported
contractually
status
due t o
interest.
full
is
or
as
less
than s u b s t a n t i a l
making some p e r i o d i c
past
to
no longer doubt as
nonaccrual.
However,
performance,
payment.
the
loan has been
to the
full
extent
necessary
o f ' t h e book
to
full
to
are
of
being
eliminate
balance.
collectibility
for other reasons,
For example,
placed
collection
p a y m e n t s on s u c h l o a n s
the
collectibility
interest.
due,
doubt as
Interest
reduce principal
There
principal
demonstrating
is
interest
the
income
is
of
loan
is
being
115
- 2 -
recorded
on a c a s h b a s i s ,
w h i l e the borrower d e m o n s t r a t e s
a
p e r i o d of performance or i n t e r e s t payments are r e c o r d e d a s
loss
(5)
N e t o f c h a r g e - o f f s t o - d a t e and i n t e r e s t p a y m e n t s a p p l i e d
principal.
The book b a l a n c e s h o u l d n o t i n c l u d e
f o r any a l l o c a t i o n s
of
if
are
such a l l o c a t i o n s
(6)
the allowance
any
on t h e l o a n s
in nonaccrual
from t h e time t h o s e
f o r l o a n and l e a s e
from any o f t h e s e
nonaccrual
It will
be l i k e l y
that
status.
the cash i n t e r e s t payments during
loans prior to t h e i r placement
some l o a n s w i l l
move b e t w e e n
In such c a s e s ,
Additionally,
balance i s
on
categories
year-to-date
m a n a g e m e n t may c o n s i d e r i t
cash
category
useful
interest
on
to
disclose
nonaccrual
A s i m p l e r a t e m i g h t be d i s c l o s e d o r d a t a p r o v i d e d
allow the reader t o determine the y i e l d ,
As t h e c a s h i n t e r e s t
year-end balances
only,
a t December 31,
1990,
as
data i n the t a b l e
f o r the period they were i n
The a v e r a g e
w o u l d b e p r o p e r l y w e i g h t e d when a g g r e g a t e d ,
relative
amount o f
relates
l o a n s on n o n a c c r u a l
s t a t u s during t h e year then ended.
time within the year t h a t
l o a n s were in nonaccrual
status.
to
follows:
the d i s c l o s u r e might provide
weighted average book balance of
The
the
reported.
t h e y i e l d p r o v i d e d from c a s h payments o f
(a)
during
1990,
payment d a t a would be r e c l a s s i f i e d t o t h e same
where t h e p e r i o d - e n d
loans.
payments
status.
between reporting dates.
interest
losses,
s t a t u s a t December 3 1 ,
l o a n s were p l a c e d on n o n a c c r u a l
amount s h o u l d n o t i n c l u d e
year
to
reductions
made.
Represents t h e a p p l i c a t i o n of cash i n t e r e s t
1990,
(7)
loan
recoveries.
to
a
status
nonaccrual
balances
to reflect
individual
the
116
-3(b)
I t nay p r o v e d i f f i c u l t t o m o n i t o r and r e p o r t
average balances
suggested
relate to period-end
might supplement
the entire reporting
Cash i n t e r e s t
balances.
Alternatively,
weighted
they
management
related t o nonaccrual
payments on a l l
nonaccrual
status
loans while
facilitate
of
the determination
all
nonaccrual
loans
The
for
of
be
directly
yields.
loans during
in
no
amount
should generally
from t h o s e w h i c h c o n t r i b u t e d
Average b a l a n c e
the
activity
(including
at period end).
applied to principal
distinguished
because
period:
longer in nonaccrual
period.
above,
s t a t u s during the period
of payments
income t o
(a),
the suggested tabular disclosure with
f o l l o w i n g two d i s c l o s u r e s
nonaccrual
in
the
to
117
SUPERVISORY GUIDANCE REGARDING THE
DEFINITION OF HIGHLY-LEVERAGED TRANSACTIONS
The g u i d e l i n e s
uniform i n t e r a g e n c y
procedures
below are i n t e n d e d
Overview.
this
credit
HLT s t a t u s .
the r e s t r u c t u r i n g
is
most
borrower a r e
is
outstanding
also
The r e g u l a t o r y
financing transaction.
factors
flow,
is
general
criticism
criticized,
ability
debt,
future prospects,
management,
of
means of
the
considered
inappropriate
transactions.
basis.
a n HLT,
same
such time as
the
reviews
and p r i n c i p a l
and t r e n d s ,
and c o n t i n u i t y
to
this
is
not
of the
any
of
cash
on
borrower's
borrower's
Participation
transactions
conducted
to support the r i s k s
range
include
the
position.
in h i g h l y - l e v e r a g e d
so long as i t
a whole
factors
i n c l u d i n g the maintenance of
reserves
is
B e f o r e a n y HLT o r
These
lender's collateral
organizations
and l o a n l o s s
as
the
The HLT d e s i g n a t i o n d o e s
of a c r e d i t .
conditions
quality
banking
and p r u d e n t m a n n e r ,
of
an
a g g r e g a t i n g and m o n i t o r i n g
t o pay i n t e r e s t
economic
and t h e
designated
until
an e x a m i n e r
on a c r e d i t - b y - c r e d i t
outstanding
is
of
business
determining
p u r p o s e o f t h e HLT d e f i n i t i o n
type of
credit
credit
a type
f r o m HLT s t a t u s .
a consistent
other
The p u r p o s e o f
i n HLT t o t a l s
provide
imply a s u p e r v i s o r y
is
an o n g o i n g
and f u t u r e o b l i g a t i o n s
included
removed
of
i m p o r t a n t when i n i t i a l l y
Once an i n d i v i d u a l
all -currently
borrower
definition.
financed primarily with debt.
individual
the
existing
A highly-leveraged transaction
financing which i n v o l v e s
concern
t o supplement
d e f i n i t i o n o f HLTs a n d t h e
for applying
(HLTs)
in a
adequate
is
not
sound
capital
associated with
these
118
2
Treatment
of
Debtor-in-possession
The a g e n c i e s h a v e f u r t h e r
(DIP1
considered the question
Financings.
of
whether
DIP l o a n s s h o u l d b e i n c l u d e d
i n t h e HLT p o r t f o l i o .
One
consideration
is
estate
considered
in t h i s
a legally
regard
separate
bankruptcy borrower.
that the bankruptcy
and d i s t i n c t
In a d d i t i o n ,
borrower
Further,
code i s d e s i g n e d t o promote
DIP l e n d i n g a n d ,
value
of
protection
to
the bankruptcy
the debtor.
Therefore,
trustee-in-possession)
the Chapter 11
DIP l e n d e r s
estate
proceedings
will
concern
generally
p r e - p e t i t i o n debt of
C h a p t e r 11 b a n k r u p t c y )
c o n t i n u e t o be i n c l u d e d
will
delisting
G u i d a n c e on D e l i s t i n g
added t o
the
specific
borrowers
eligible
for
delisting
buyout,
acquisition,
( a f t e r a company e m e r g e s
or
Credits
of
criteria
f r o m HLT s t a t u s
recapitalization
time,
the wording of
leverage t e s t
options.
The g e n e r a l
along with the
delisting
(a)
Options
that
when a l l
the
despite
is
operating with high
specific delisting
criteria
General
for
leverage.
criteria
of
the
75
b e i n g made c o n s i s t e n t w i t h t h e s e
delisting
make
direct
d e b t s a t i s f y i n g t h e HLT
are r e i t e r a t e d
f o u r s p e c i f i c ways t o become e l i g i b l e
f r o m HLT
new
below
for
status.
Criteria
—
removal
f r o m HLT s t a t u s ,
ability
to
from
i n HLT
f r o m HLT S t a t u s .
HLT d e l i s t i n g
p e r t a i n i n g t o e x p o s u r e s d e s i g n a t e d a s HLTs b e c a u s e
percent
exempt
h a s b e e n p a i d a n d when c o m p a n i e s p e r f o r m w e l l
an e x t e n d e d p e r i o d
Further,
in
be
occurs.
being
purpose t e s t
of
(or
a n HLT b o r r o w e r
debt
are
the
and t o p r o m o t e r e h a b i l i t a t i o n
and a n y p o s t - r e o r g a n i z a t i o n
exposure u n t i l
affords
in order t o preserve
financing for a business
All
pre-
bankruptcy
thereby,
court-approved debtor-in-possession
C h a p t e r 11 r e o r g a n i z a t i o n
f r o m HLT d e s i g n a t i o n .
is
from t h e
l o a n s t o DIPs g e n e r a l l y do not
m e e t t h e HLT p u r p o s e t e s t .
significant
some
important
operate
For c r e d i t s t o become e l i g i b l e
a company must d e m o n s t r a t e
successfully
as a
an
highly-leveraged
for
119
3
company o v e r
a period
of
time.
Under normal
two y e a r s s h o u l d be s u f f i c i e n t
for the credit
p e r f o r m a n c e and t o v a l i d a t e
projections.
the appropriateness
The b a n k i n g o r g a n i z a t i o n
thorough review of
circumstances,
to
show
of
should conduct
the obligor to include,
at
o v e r a l l management p e r f o r m a n c e a g a i n s t t h e b u s i n e s s
cash flow coverages,
sales,
if
operating margins,
applicable,
reduction
status
in leverage,
a
a minimum,
of
plan,
asset
and
industry
risk.
(b)
Specific Criteria
criteria,
at
least
—
In a d d i t i o n t o t h e s e
cne of
the
must be met t o become e l i g i b l e
(1)
For e x p o s u r e s
percent
leverage
delisting
that
test,
If
reliance
two y e a r s
is
full,
even
buyout,
or
t h e HLT p u r p o s e t e s t ,
if
The r e f i n a n c i n g
additional
then the
for delisting
ratio
of
from c a s h g e n e r a t e d
assets,
or a c a p i t a l
sales.
most
borrower's
is
debt
t h e repayment of
from o p e r a t i o n s ,
a
if
repaid
liabilities
continues to exceed 75
injection.
an
f r o m HLT s t a t u s
HLT p u r p o s e - r e l a t e d
Rather,
75
reduced
a company's
borrowings does not c o n s t i t u t e
o f HLT d e b t .
the
for
recapitalization
the borrower's total
leverage
of
satisfactorily
d e b t s a t i s f y i n g t h e HLT p u r p o s e t e s t
assets
because
on u n p l a n n e d a s s e t
have passed s i n c e
credits, are e l i g i b l e
all
included
exposures are e l i g i b l e
servicing debt
recent acquisition,
satisfying
were
criteria
delisting:
and t h e company h a s d e m o n s t r a t e d
to continue
w i t h o u t undue
(2)
for
general
specific
f r o m HLT s t a t u s w h e n l e v e r a g e
b e l o w 75 p e r c e n t ,
ability
following
to
in
total
percent.
through
repayment
d e b t must
occur
planned s a l e s
of
120
4
(3)
For e x p o s u r e s
percent
leverage
eligible
general
4
for
t h a t were
test,
included
a borrower's
delisting
when t h e
performance c r i t e r i a
(four)
consecutive
because
credits
borrower
since
for at
its
last
the
buyout,
or r e c a p i t a l i z a t i o n i n v o l v i n g f i n a n c i n g ;
company
a
has
positive
net
worth;
and
75
least
acquisition,
the
the
company's
l e v e r a g e r a t i o does not s i g n i f i c a n t l y exceed i t s
industry
norm.
leverage
Although
this
criteria
does not
t o be reduced t o l e s s than 75 p e r c e n t ,
demonstrate
an a b i l i t y
satisfactorily
asset
(4)
of
t h e borrower must
servicing
without undue r e l i a n c e
For
those
liabilities
exposures
on
debt
unplanned
delisting
criteria
ability
to
stated
the borrower's
ise t h e e x p o s u r e
that
in
is
acceptable
(a)
previous
financial
to
under t h e
guidance,
be r e v i e w e d
for
any
the
demonstrated
continue to
condition
"doubling
leverage
b a s e d upon
a b o v e and a
satisfactorily
in
arose
t o g r e a t e r t h a n 50 p e r c e n t "
general
As w a s
to continue
require
sales.
criteria,
the
satisfies
for delisting
years
of
are
service
the
significant
after delisting
relisting.
debt.
changes
should
121
SUPERVISORY GUIDANCE ON CERTAIN ISSUES
RELATING TO NONACCRUAL ASSETS
AND FORMALLY RESTRUCTURED DEBT
Cash b a s i s
income r e c o g n i t i o n .
Current
regulatory
r e p o r t i n g r e q u i r e m e n t s do n o t p r e c l u d e t h e c a s h
recognition
of
i n c o m e on n o n a c c r u a l
t h a t have been p a r t i a l l y
remaining
book
Recognition
of
be l i m i t e d
of
income on a c a s h b a s i s
of
recoveries
of
recovered.
prior
of
ability
placed
and
in
deemed
this
to
for
the
rate.
fully
collectible.
should
one
individual
performance.
interest
should
asset's
Thus,
status,
a
when
as
these charge-offs
borrower.
an a s s e t
nonaccrual
the
Any c a s h
l i m i t should be recorded
charge-offs until
loans
assessment
is
the contractual
been f u l l y
status
loan
loans
the
w h i c h would h a v e b e e n a c c r u e d on
at
in excess
nonaccrual
the
provided that
balance
to that
Multiple
charged o f f ) ,
basis
(including
interest
recorded balance
received
assets
As
a
general
be determined
collectibility
one
loan
depository
to
have
principle,
based
and
on
a borrower
institution
an
payment
does
is
not
automatically have t o place a l l other extensions of c r e d i t to
that
borrower i n nonaccrual
has
multiple
a
loans
single
status,
extensions
more
of
and
depository
of
these
When a d e p o s i t o r y i n s t i t u t i o n
or other extensions
borrower,
the
status.
credit
other
one
loan
of
credit outstanding
meets
institution
criteria
should
for
evaluate
to
nonaccrual
its
other
t o t h a t borrower t o determine whether one
assets
should
also
be
placed
in
or
nonaccrual
status.
Acquisition
(or the
receiver
securities
that
of
nonaccrual
of
a failed
the
assets.
A depository
institution)
institution
had
may s e l l
maintained
institution
loans
in
or
debt
nonaccrual
122
2
status.
S u c h l o a n s o r d e b t s e c u r i t i e s t h a t h a v e b e e n a c q u i r e d from
an u n a f f i l i a t e d t h i r d p a r t y b y a d e p o s i t o r y
institution
reported
with
by
B u l l e t i n No.
met,
the
purchaser
6.
in
accordance
When t h e c r i t e r i a s p e c i f i e d i n t h i s
t h e s e a s s e t s may b e p l a c e d
Treatment of f o r m a l l y r e s t r u c t u r e d debt.
and o f
performance
according
loap t o accrual
to
in accordance
a reasonable
sustained
historical
with
repayment
repayment
in a nonaccrual s t a t u s . 2
status,
are
A l o a n or other debt
15 s o a s t o b e r e a s o n a b l y a s s u r e d o f
need n o t be m a i n t a i n e d
Practice
Bulletin
status.1
in accrual
instrument t h a t has been f o r m a l l y r e s t r u c t u r e d
FASB S t a t e m e n t No.
s h o u l d be
AICPA
schedule
In returning
payment
the
performance
f o r a r e a s o n a b l e t i m e p r i o r t o t h e r e s t r u c t u r i n g may b e t a k e n
into
account.
A FASB 15 r e s t r u c t u r i n g
recorded investment
that
is
willing
equal
to
to
the
accept
for
loan or other debt
may r e s u l t
in the loan,
rate
that
i.e.,
in a market y i e l d
an e f f e c t i v e
the
depository
a new l o a n w i t h c o m p a r a b l e
instrument
that qualifies
on
interest
the
rate
institution
risk.
is
While a
a s a FASB S t a t e m e n t
N o . 15 r e s t r u c t u r i n g m u s t b e d i s c l o s e d a s s u c h i n t h e y e a r t h a t t h e
restructuring
rates
of
took
interest
place,
need
restructured
not
troubled debt restructurings
continue
to
assets
be
in subsequent
that
yield
reported
as
market
FASB
years.
P r a c t i c e B u l l e t i n No. 6 , A m o r t i z a t i o n o f D i s c o u n t s
C e r t a i n Acquired Loans.
American I n s t i t u t e of C e r t i f i e d
P u b l i c Accountants, August 1989.
on
2
S t a t e m e n t o f F i n a n c i a l A c c o u n t i n g S t a n d a r d s No. 1 5 ,
Accounting
bv
Debtors
and
Creditors
fpr
Trpublefl
R e s t r u c t u r i n g s . F i n a n c i a l Accounting Standards Board, June
1977.
15
123
14 Other i s s u e s .
and
Lease
credit
B e c a u s e an a n a l y s i s o f t h e A l l o w a n c e f o r Loan
Losses
risks
(ALLL)
in
the
requires
an
portfolio,
assessment
many
of
the
depository
relative
institutions
a t t r i b u t e f o r a n a l y t i c a l p u r p o s e s p o r t i o n s o f t h e ALLL t o l o a n s and
other
assets
supervisory
based
on
classified
agency.
past
unidentified
history
losses
category in the
Furthermore,
"substandard"
by
Management may do t h i s
or
other
associated
factors,
with
loans
management
because
that
it
or
a
believes,
there
classified
may
in
be
this
aggregate.
management may u s e t h i s
analytical
approach
in
e s t i m a t i n g t h e t o t a l amount n e c e s s a r y f o r t h e ALLL and i n c o m p a r i n g
t h e ALLL t o v a r i o u s
rule,
an
individual
categories
loan
of
loans over time.
classified
substandard
As a
may
general
remain
in
accrual s t a t u s as long as the regulatory reporting requirements for
a c c r u a l t r e a t m e n t a r e m e t , e v e n when an a t t r i b u t i o n o f t h e ALLL h a s
b e e n made.
124
FEDERAL RESERVE press release
For immediate release
March 25, 1991
The Federal Reserve Board today announced revisions to
Regulation P (Minimum Security Devices and Procedures for Federal
Reserve? Banks and State Member Banks).
The revisions become effective May 1, 1991.
The revisions update the current rules adopted in 1969,
simplify and clarify the rule's existing areas of flexibility,
eliminate many obsolete or technical requirements particularly
those in Appendix A, and delete references to required reports
following elimination of reporting requirements in this area by
the Financial Institution's Reform, Recovery and Enforcement Act
of 1989.
The revisions do not otherwise substantively change the
regulation, which is already relatively brief and flexible, and
add no new regulatory burden.
A copy of the Board's notice is attached.
- 0 -
Attachment
125
FEDERAL RESERVE SYSTEM
12 CFR P a r t 216
[ R e g u l a t i o n P; D o c k e t No.
R-0688]
S e c u r i t y D e v i c e s and P r o c e d u r e s
AGENCY:
Board o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e
ACTION:
Final
SUMMARY:
System.
rule.
The Board o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e
("Board"),
System
i n c o o r d i n a t i o n w i t h t h e o t h e r f e d e r a l bank
supervisory agencies,
has reviewed Regulation P —
D e v i c e s and P r o c e d u r e s — and d e t e r m i n e d t h a t i t
Security
is
appropriate
to r e v i s e the r e g u l a t i o n to r e f l e c t changes in the technology
security devices,
and t o implement c h a n g e s made by t h e
I n s t i t u t i o n s Reform, R e c o v e r y and E n f o r c e m e n t A c t o f
("FIRREA").
of
Financial
1989
The p r o p o s e d r e v i s i o n was p u b l i s h e d f o r comment by
t h e Board i n A p r i l 1 9 9 0 .
(55 F.R.
1 2 8 5 9 , A p r i l 6,
1990).
The
r e v i s i o n i n c o r p o r a t e s amendments made t o t h e Bank P r o t e c t i o n Act
o f 1968 by FIRREA and p r o v i d e s banks w i t h t h e f l e x i b i l i t y
avoid the t e c h n i c a l obsolescence t h a t occurred with the
to
existing
regulation.
DATE:
T h i s r e g u l a t i o n i s e f f e c t i v e May 1,
1991,
except
renewal
o f t h e r e c o r d k e e p i n g r e q u i r e m e n t FR 4 0 0 4 and d i s c o n t i n u a n c e
t h e FR 4003 and FR 4005 r e p o r t s ,
March 3 1 ,
w h i c h w i l l be e f f e c t i v e
1991.
FOR FURTHER INFORMATION CONTACT:
Attorney
of
(202/452-2418),
E l a i n e M. B o u t i l i e r ,
Legal D i v i s i o n ,
R e g u l a t o r y P l a n n i n g and R e v i e w D i r e c t o r
52-418 - 92 - 5
o r Thomas A.
(202/452-2326),
Senior
Durkin,
O f f i c e of
126
14 the Secretary,
Board o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e
W a s h i n g t o n , D. C. 2 0 5 5 1 .
For t h e h e a r i n g i m p a i r e d
T e l e c o m m u n i c a t i o n D e v i c e f o r t h e Deaf
System,
only.
("TDD"), D o r o t h e a Thompson
(202/452-3544).
SUPPLEMENTARY INFORMATION:
The Bank P r o t e c t i o n A c t o f
requires the federal f i n a n c i a l i n s t i t u t i o n supervisory
1968
agencies
t o e s t a b l i s h minimum s t a n d a r d s f o r bank s e c u r i t y d e v i c e s and
p r o c e d u r e s t o d i s c o u r a g e bank c r i m e and t o a s s i s t
in
i d e n t i f i c a t i o n o f p e r s o n s who commit s u c h c r i m e s .
§ 1882.
the
12 U . S . C .
To implement t h i s s t a t u t e a u n i f o r m r e g u l a t i o n was
a d o p t e d i n 1969 by e a c h o f t h e s u p e r v i s o r y a g e n c i e s
C o m p t r o l l e r of t h e C u r r e n c y ,
Corporation,
Federal Deposit
—
Insurance
F e d e r a l Home Loan Bank Board (now known a s
O f f i c e of T h r i f t S u p e r v i s i o n ) ,
and t h e Board.
With t h e
the
exception
o f minor c h a n g e s i n 1973 and 1 9 8 1 , t h i s r e g u l a t i o n h a s n o t b e e n
m o d i f i e d s i n c e i t was f i r s t a d o p t e d .
The Board,
other federal financial i n s t i t u t i o n supervisory
along with
the
agencies,
r e q u e s t e d comments on a p r o p o s e d r e v i s i o n o f t h i s r e g u l a t i o n
year.
(55 F . R .
1 2 8 5 0 , A p r i l 6,
last
1990).
The Board r e c e i v e d a t o t a l o f 43 comments on t h e
p r o p o s e d c h a n g e s t o R e g u l a t i o n P.
Twenty-nine of t h e s e
comments
were r e c e i v e d from b a n k s ; f i v e were r e c e i v e d from m a n u f a c t u r e r s
o f s e c u r i t y e q u i p m e n t ; s i x w e r e r e c e i v e d from a s s o c i a t i o n s
c o n n e c t e d w i t h banks ( e . g . ,
r e c e i v e d from R e s e r v e B a n k s .
was s u p p o r t i v e :
trade associations);
and t h r e e were
The o v e r a l l r e s p o n s e t o t h e
32 o f t h e comments e x p r e s s e d s u p p o r t f o r
changes
the
127
10
revisions,
w h i l e o n l y 11 comments were n o t s u p p o r t i v e .
t h e f i v e equipment manufacturers opposed t h e c h a n g e s ,
f i v e o f t h e t w e n t y - n i n e commenting b a n k s were
supportive.
Four o f
but
twenty-
generally
The p r i m a r y o b j e c t i o n o f t h o s e o p p o s i n g t h e
was t h a t t h e r e v i s e d s t a n d a r d s w e r e t o o v a g u e ; i n
changes
particular,
some commenters o p p o s e d d e l e t i o n o f Appendix A and A p p e n d i x B.
One o f t h e t r a d e a s s o c i a t i o n s
appendices because,
opposed t h e d e l e t i o n of
in i t s view,
o f f i c e r s t h a t depend on t h e s e a p p e n d i c e s f o r
because i t
security
guidance.
Appendix A s e t f o r t h s p e c i f i c a t i o n s f o r
d e v i c e s t o be u s e d i n b a n k s .
these
small i n s t i t u t i o n s have
security
The Board i s d e l e t i n g t h i s
i s t o o s p e c i f i c and h a s become o b s o l e t e .
The Board
b e l i e v e s t h a t any s t a n d a r d s t h a t c o n t i n u e t o r e f e r e n c e
s e c u r i t y d e v i c e s a r e a l s o l i k e l y t o become o b s o l e t e
appendix
specific
because
t e c h n o l o g y i s c o n t i n u i n g t o advance a t a r a p i d p a c e .
To a v o i d
the n e c e s s i t y of c o n s t a n t l y updating required s e c u r i t y
devices,
t h e r e v i s e d r e g u l a t i o n r e q u i r e s e a c h bank t o d e s i g n a t e a
security
o f f i c e r t o a d m i n i s t e r a w r i t t e n s e c u r i t y program, w h i c h would
require,
a t a minimum, t h a t f o u r s p e c i f i c s e c u r i t y d e v i c e s
installed,
but l e a v e s i t t o t h e d i s c r e t i o n of t h e
be
security
o f f i c e r t o determine which a d d i t i o n a l s e c u r i t y d e v i c e s w i l l
meet t h e n e e d s o f t h e program.
I n t h i s way t h e s e c u r i t y
c a n c h o o s e t h e most u p - t o - d a t e e q u i p m e n t t h a t m e e t s
r e q u i r e m e n t s o f h i s p a r t i c u l a r bank.
r e f e r r i n g t o Underwriters Laboratory
the
Some commenters recommended
("UL") a p p r o v a l o r ANSI
s p e c i f i c a t i o n s a s a s u b s t i t u t e f o r Appendix A.
best
officer
Because t h e
level
128
o f r i s k v a r i e s from i n s t i t u t i o n t o i n s t i t u t i o n ,
not b e l i e v e t h a t i t
t h e Board d o e s
i s appropriate to specify particular
of s e c u r i t y d e v i c e s a s mandatory.
Nevertheless,
features
security
o f f i c e r s would be e x p e c t e d t o i d e n t i f y t h e l e v e l o f r i s k t o
i n s t i t u t i o n and a d o p t an a p p r o p r i a t e s e c u r i t y program,
their
taking
i n t o c o n s i d e r a t i o n a p p l i c a b l e ANSI and UL s t a n d a r d s .
Appendix B c o n c e r n e d p r o p e r e m p l o y e e c o n d u c t a f t e r a
robbery.
Although t h i s appendix has been e l i m i n a t e d ,
t h e Board
b e l i e v e s t h a t t r a i n i n g o f e m p l o y e e s s h o u l d be i n c l u d e d i n a
b a n k ' s s e c u r i t y program and n o t e s t h a t s e v e r a l
organizations
o f f e r t r a i n i n g programs f o r bank e m p l o y e e s and s e c u r i t y
Some l e t t e r s t h a t w e r e g e n e r a l l y s u p p o r t i v e o f
officers.
the
r e v i s i o n commented t h a t t h e r e g u l a t i o n was t o o narrow and s h o u l d
c o v e r " w h i t e - c o l l a r crime" as w e l l .
Regulation P i s
i n r e s p o n s e t o t h e Bank P r o t e c t i o n A c t , w h i c h i s
intended t o "discourage robberies,
burglaries,
promulgated
specifically
and
larcenies."
W h i l e t h e Board a g r e e s t h a t w h i t e - c o l l a r c r i m e s s u c h a s f r a u d and
embezzlement are problems,
t h e s e c r i m e s a r e c o v e r e d by o t h e r
laws
o u t s i d e t h e s c o p e o f R e g u l a t i o n P.
The r e v i s e d r e g u l a t i o n e s t a b l i s h e s a minimum s t a n d a r d
by r e q u i r i n g f o u r s p e c i f i e d s e c u r i t y d e v i c e s :
a secure space
for
c a s h ; a l i g h t i n g s y s t e m f o r i l l u m i n a t i n g t h e v a u l t ; an a l a r m
s y s t e m ; and tamper r e s i s t e n t l o c k s on e x t e r i o r d o o r s and windows.
In a d d i t i o n ,
t h e proposed r e g u l a t i o n e s t a b l i s h e s t h e c o n t e n t s
a s e c u r i t y program, e . g . .
business,
p r o c e d u r e s f o r o p e n i n g and c l o s i n g
f o r s a f e k e e p i n g of v a l u a b l e s ,
and f o r
identifying
of
for
129
14 persons committing crimes.
T h e s e a r e t h e minimum p r o c e d u r e s
s h o u l d c o m p r i s e a b a n k ' s s e c u r i t y program.
To a s s i s t banks
e s t a b l i s h i n g t h e i r program, t h e r e g u l a t i o n s u g g e s t s
f a c t o r s t o b e c o n s i d e r e d when s e l e c t i n g a d d i t i o n a l
devices.
In making t h e s e s u g g e s t i o n s ,
that
in
certain
security
t h e Board n o t e s t h a t
t h e 22 y e a r s s i n c e p a s s a g e o f t h e Bank P r o t e c t i o n A c t ,
in
trade
a s s o c i a t i o n s and o t h e r v e n d o r s h a v e p r o d u c e d s e c u r i t y manuals and
i n f o r m a t i o n d e s i g n e d f o r banks o f v a r i o u s
sizes.
To e n s u r e t h a t a b a n k ' s s e c u r i t y program i s r e v i e w e d on
a regular basis for e f f e c t i v e n e s s ,
the regulation requires a
r e p o r t t o be made by t h e s e c u r i t y o f f i c e r t o t h e b a n k ' s board o f
directors at l e a s t annually.
requirement,
This changes the
previous
w h i c h was e l i m i n a t e d by FIRREA, t h a t r e p o r t s must be
f i l e d p e r i o d i c a l l y w i t h a bank's primary s u p e r v i s o r y
Nevertheless,
still
t h e a n n u a l r e p o r t s t o t h e board o f d i r e c t o r s
c o n t a i n i n f o r m a t i o n such as t h e s t a t u s of
training,
agency.
should
employee
t h e number o f o f f e n s e s a g a i n s t t h e bank, and t h e
s u c c e s s of p r o s e c u t i o n f o r such o f f e n s e s .
When r e q u e s t i n g comments on t h e p r o p o s e d amendments
R e g u l a t i o n P, t h e Board a l s o p r o p o s e d e l i m i n a t i o n o f
three
r e p o r t s r e l a t i n g t o r e c o r d k e e p i n g and r e p o r t i n g r e q u i r e m e n t s
the regulation:
FR 4003
(Statement Regarding S e c u r i t y
That Do Not Meet t h e Minimum R e q u i r e m e n t s o f R e g u l a t i o n
FR 4004
P),
and FR 4005 (Annual S t a t e m e n t o f
C o m p l i a n c e w i t h t h e Bank P r o t e c t i o n A c t o f 1 9 6 8 ) .
of
Devices
( W r i t t e n S e c u r i t y Program f o r S t a t e Member Banks a s
R e q u i r e d by R e g u l a t i o n P ) ,
to
Only two
14 -
130
comments w e r e r e c e i v e d o n t h i s
e l i m i n a t i o n of t h e r e p o r t s .
requires a written security
issue,
a n d FR 4 0 0 5 r e p o r t s
—
program,
program.
1
e f f e c t i v e o n March 3 1 ,
discontinuance
of
1980,
t h e Board
1991.
3507 of
§ 3507,
has
T h e FR 4 0 0 4
discontinued,
required to maintain a written
(44 U . S . C .
still
— t h e FR 4 0 0 3
has not been
In a c c o r d a n c e w i t h s e c t i o n
Reduction Act of
however,
these reports
a recordkeeping requirement,
b e c a u s e banks a r e s t i l l
the
Because t h e r e v i s e d r e g u l a t i o n
d e c i d e d t o d i s c o n t i n u e o n l y two of
report,
and b o t h s u p p o r t e d
the
security
Paperwork
a n d 5 CFR 1 3 2 0 . 1 3 ) ,
t h e FR 4 0 0 3 a n d FR 4 0 0 5 r e p o r t s h a s
the
been
r e v i e w e d and a p p r o v e d by t h e Board u n d e r O f f i c e o f Management
Budget d e l e g a t e d a u t h o r i t y a f t e r c o n s i d e r a t i o n of
r e c e i v e d d u r i n g t h e p u b l i c comment
Renewal of
delegated authority
1991,
which i s
FR 4 0 0 4
is
the
period.
approved by t h e Board
( 5 CFR 1 3 2 0 . 9 )
t o be e f f e c t i v e
l e s s t h a n 30 d a y s f r o m p u b l i c a t i o n o f
because the authority
for the
under
o n March
this
The Board f i n d s g o o d c a u s e f o r an e f f e c t i v e d a t e l e s s
d a y s from p u b l i c a t i o n
than
31,
ruling.
30
recordkeeping
1
For p u r p o s e s o f t h e Paperwork R e d u c t i o n A c t , t h e
recordkeeping requirement of t h i s r e g u l a t i o n f o r establishment
w r i t t e n s e c u r i t y programs i s d e s c r i b e d as f o l l o w s :
(1) R e p o r t t i t l e :
W r i t t e n S e c u r i t y Program
f o r S t a t e Member B a n k s ; ( 2 ) A g e n c y r e p o r t
number:
FR 4 0 0 4 ; ( 3 ) 0MB D o c k e t n u m b e r :
7 1 0 0 - 0 1 1 2 ; (4) Frequency:
recordkeeping;
(5) R e p o r t e r s :
S t a t e member b a n k s ;
(6) Annual r e p o r t i n g h o u r s :
513;
(7) E s t i m a t e d a v e r a g e h o u r s p e r r e s p o n s e :
0 . 5 p e r y e a r ; ( 8 ) Number o f r e s p o n d e n t s :
1025.
The i n f o r m a t i o n c o l l e c t i o n i s
mandatory (12 U . S . C . § 1 8 8 2 ( b ) ) .
and
comments
of
131
14 requirement
without
e x p i r e s o n March 3 1 ,
i t would be d i s r u p t i v e
maintain such records.
existing
less
1991 and a p e r i o d o f
to the
Furthermore,
recordkeeping requirement,
required
is a continuation
s o an e f f e c t i v e d a t e
t h a n 30 d a y s p r i o r n o t i c e h a s no h a r m f u l e f f e c t on
institutions
354,
605(b)
5 U.S.C.
of
Flexibility
S 601 e t
seg.),
not have a s i g n i f i c a n t
small
entities.
with the security
economic
Small e n t i t i e s
standards
revision provides
s e c u r i t y programs,
established
the
institutions.
Banks,
in
to
L. N o .
that
this
substantial
complying
in the prior
in
regulation,
devising
two of
which should ease
the
costs
three
the
institutions.
CFR P a r t
Banking,
final
impact on a
T h e amendment a l s o d e l e t e s
U
96-
already were
f o r more f l e x i b i l i t y
r e g u l a t o r y burden on s m a l l
gubjegts
(Pub.
which should h e l p minimize t h e e x i s t i n g
r e p o r t s r e q u i r e d by t h e government,
of
an
with
Pursuant
Act
t h e Board c e r t i f i e s
rule will
to the
Act A n a l y s i s .
the Regulatory F l e x i b i l i t y
number o f
and t h i s
to
of
involved.
Regulatory
section
Ust
institutions
this
time
216:
Federal Reserve System,
recordkeeping requirements,
Security measures,
Reporting
state
and
member
banks.
For t h e r e a s o n s s e t
216 o f t h e Code o f
as
follows:
out in t h e preamble,
Federal Regulations
Title
i s proposed t o be
12,
Part
amended
132
14 PART 216 - SECURITY PROCEDURES
Sec.
216.1
Authority,
216.2
Designation of s e c u r i t y
purpose,
and s c o p e .
216.3
Security
program.
216.4
Report.
216.5
F e d e r a l R e s e r v e Banks.
AUTHORITY:
Section 216.1
(a)
officer.
12 U . S . C .
Authority,
§§ 1 8 8 1 -
purpose,
1884
and s c o p e .
T h i s r e g u l a t i o n i s i s s u e d by t h e Board o f G o v e r n o r s o f
t h e Federal Reserve System
( t h e "Board") p u r s u a n t t o s e c t i o n 3 o f
t h e Bank P r o t e c t i o n A c t o f
1968
(12 U . S . C . § 1 8 8 2 ) .
It applies
F e d e r a l R e s e r v e Banks and s t a t e banks t h a t a r e members o f
Federal Reserve System.
I t r e q u i r e s e a c h bank t o
appropriate s e c u r i t y procedures t o discourage
burglaries,
and l a r c e n i e s ,
and t o a s s i s t
to
the
adopt
robberies,
in the
identification
and p r o s e c u t i o n o f p e r s o n s who commit s u c h a c t s .
(b)
I t i s t h e r e s p o n s i b i l i t y o f t h e member b a n k ' s board o f
d i r e c t o r s t o comply w i t h t h i s r e g u l a t i o n and e n s u r e t h a t a
w r i t t e n s e c u r i t y program f o r t h e b a n k ' s main o f f i c e and b r a n c h e s
i s d e v e l o p e d and
Section 216.2
implemented.
D e s i g n a t i o n of s e c u r i t y
officer.
Upon b e c o m i n g a member o f t h e F e d e r a l R e s e r v e S y s t e m ,
s t a t e b a n k ' s b o a r d o f d i r e c t o r s ".hall d e s i g n a t e a
o f f i c e r who s h a l l h a v e t h e a u t h o r i t y ,
a
security
s u b j e c t t o t h e approval
t h e board o f d i r e c t o r s t o d e v e l o p , w i t h i n a r e a s o n a b l e t i m e ,
of
but
133
14 no l a t e r t h a n 180 d a y s ,
and t o a d m i n i s t e r a w r i t t e n
security
program f o r e a c h b a n k i n g o f f i c e .
216.3
S e c u r i t y program.
(a)
C o n t e n t s o f s e c u r i t y program.
The s e c u r i t y
program
shall:
(1)
e s t a b l i s h p r o c e d u r e s f o r o p e n i n g and c l o s i n g
b u s i n e s s and f o r t h e s a f e k e e p i n g o f a l l
negotiable securities,
for
currency,
and s i m i l a r v a l u a b l e s a t
all
times;
(2)
e s t a b l i s h procedures that w i l l a s s i s t
in
i d e n t i f y i n g persons committing crimes a g a i n s t
the
i n s t i t u t i o n and t h a t w i l l p r e s e r v e e v i d e n c e t h a t may
a i d i n t h e i r i d e n t i f i c a t i o n and p r o s e c u t i o n .
p r o c e d u r e s may i n c l u d e ,
(i)
but are not l i m i t e d
in
office;
using i d e n t i f i c a t i o n devices,
prerecorded serial-numbered b i l l s ,
electronic devices;
(iii)
to:
m a i n t a i n i n g a camera t h a t r e c o r d s a c t i v i t y
t h e banking
(ii)
Such
such as
or chemical
and
and
r e t a i n i n g a r e c o r d o f any r o b b e r y ,
burglary,
o r l a r c e n y c o m m i t t e d a g a i n s t t h e bank;
(3)
p r o v i d e f o r i n i t i a l and p e r i o d i c t r a i n i n g
of
o f f i c e r s and e m p l o y e e s i n t h e i r r e s p o n s i b i l i t i e s
t h e s e c u r i t y program and i n p r o p e r e m p l o y e e
d u r i n g and a f t e r a b u r g l a r y ,
robbery,
under
conduct
or larceny;
and
134
14 (4)
provide for s e l e c t i n g ,
testing,
operating,
maintaining appropriate security devices,
i n p a r a g r a p h (b) o f t h i s
(b)
Security devices.
(2)
section,
such a s a v a u l t ,
safe,
liquid
or o t h e r s e c u r e
a l i g h t i n g system f o r i l l u m i n a t i n g ,
hours of darkness,
t h e a r e a around t h e v a u l t ,
tamper-resistent
space;
during
v a u l t i s v i s i b l e from o u t s i d e t h e b a n k i n g
(3)
at a
devices:
a means o f p r o t e c t i n g c a s h and o t h e r
assets,
specified
Each member bank s h a l l h a v e ,
minimum, t h e f o l l o w i n g s e c u r i t y
(1)
as
and
the
if
the
office;
l o c k s on e x t e r i o r d o o r s and
e x t e r i o r windows t h a t may b e o p e n e d ;
(4)
an alarm s y s t e m o r o t h e r a p p r o p r i a t e d e v i c e
promptly n o t i f y i n g t h e n e a r e s t r e s p o n s i b l e
e n f o r c e m e n t o f f i c e r s o f an a t t e m p t e d o r
robbery or b u r g l a r y ;
(5)
for
law
perpetrated
and
such o t h e r d e v i c e s a s t h e s e c u r i t y
d e t e r m i n e s t o be a p p r o p r i a t e ,
taking
officer
into
consideration:
(i)
t h e incidence of crimes a g a i n s t
institutions
(ii)
in the
t h e amount o f c u r r e n c y and o t h e r
exposed t o robbery,
(iii)
burglary,
and
valuables
larceny;
t h e d i s t a n c e o f t h e b a n k i n g o f f i c e from t h e
n e a r e s t r e s p o n s i b l e law enforcement
(iv)
financial
area;
t h e c o s t of t h e s e c u r i t y
officers;
devices;
135
(v)
other s e c u r i t y measures in e f f e c t a t
banking o f f i c e ;
(vi)
the
and
t h e p h y s i c a l c h a r a c t e r i s t i c s of
s t r u c t u r e o f t h e b a n k i n g o f f i c e and
the
its
surroundings.
Section 216.4
Report.
The s e c u r i t y o f f i c e r f o r e a c h member bank s h a l l r e p o r t
at
l e a s t a n n u a l l y t o t h e b a n k ' s board o f d i r e c t o r s on t h e
implementation,
administration,
and e f f e c t i v e n e s s o f t h e
security
program.
Section 216.5
F e d e r a l R e s e r v e Banks.
Each R e s e r v e Bank s h a l l d e v e l o p and m a i n t a i n a w r i t t e n
s e c u r i t y program f o r i t s main o f f i c e and b r a n c h e s s u b j e c t
r e v i e w and a p p r o v a l o f t h e
Board.
By o r d e r of t h e Board o f G o v e r n o r s o f t h e F e d e r a l
S y s t e m , March 2 2 ,
to
Reserve
1991.
(signed)
Jennifer J. Johnson
J e n n i f e r J . Johnson
A s s o c i a t e S e c r e t a r y o f t h e Board
136
FEDERAL RESERVE press release
For i m m e d i a t e r e l e a s e
H P
January 14,
1992
The F e d e r a l R e s e r v e B o a r d t o d a y a p p r o v e d a p r o p o s a l
lift
t h e l i m i t o n t h e amount o f n o n c u m u l a t i v e p e r p e t u a l
s t o c k t h a t bank h o l d i n g c o m p a n i e s may i n c l u d e
f o r purposes of c a l c u l a t i n g t h e i r
in Tier 1
to
preferred
capital
r i s k - b a s e d and l e v e r a g e
capital
ratios.
T h e r e c u r r e n t l y i s no l i m i t o n t h e amount o f
n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k t h a t s t a t e member b a n k s
may i n c l u d e i n T i e r 1 c a p i t a l .
Cumulative p e r p e t u a l p r e f e r r e d s t o c k w i l l c o n t i n u e
be i n c l u d e d i n T i e r
the current
l i m i t of
1 capital
f o r bank h o l d i n g c o m p a n i e s ,
25 p e r c e n t o f T i e r 1 c a p i t a l .
The B o a r d ' s o r d e r i s
attached.
-0-
Attachment
up
to
to
137
FEDERAL RESERVE SYSTEM
12 CFR P a r t s 208 and 225
[ R e g u l a t i o n H, R e g u l a t i o n Y; D o c k e t No. R - 0 7 4 0 ]
C a p i t a l ; C a p i t a l Adequacy G u i d e l i n e s
AGENCY:
Board o f G o v e r n o r s o f t h e F e d e r a l R e s e r v e S y s t e m .
ACTION:
R e v i s i o n s t o C a p i t a l Adequacy G u i d e l i n e s .
SUMMARY:
The Board i s amending i t s r i s k - b a s e d and l e v e r a g e
c a p i t a l g u i d e l i n e s t o remove t h e l i m i t on t h e amount o f
n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k bank h o l d i n g
companies
may i n c l u d e i n T i e r 1 c a p i t a l .
preferred
Cumulative p e r p e t u a l
s t o c k w i l l c o n t i n u e t o b e i n c l u d e d i n T i e r 1 c a p i t a l f o r bank
h o l d i n g c o m p a n i e s , up t o a l i m i t o f 25 p e r c e n t o f T i e r 1 c a p i t a l .
This change t o t h e g u i d e l i n e s w i l l a f f o r d banking
greater f l e x i b i l i t y in raising
EFFECTIVE DATE:
organizations
capital.
The amendments t o t h e c a p i t a l
adequacy
g u i d e l i n e s a r e e f f e c t i v e [upon p u b l i c a t i o n i n t h e
Federal
Register.]
FOR FURTHER INFORMATION CONTACT:
Director
(202/452-2618),
Roger T. C o l e ,
Rhoger H Pugh, Manager
Assistant
(202/728-5883),
138
14 Norah M. B a r g e r ,
Supervisory Financial Analyst
R o b e r t E. Motyka,
Senior Financial Analyst
(202/452-2402),
(202/452-3621),
D i v i s i o n o f B a n k i n g S u p e r v i s i o n and R e g u l a t i o n ;
O'Rourke,
Senior Attorney
(202/452-3288),
the hearing impaired only.
(TDD), D o r o t h e a Thompson
and M i c h a e l
Legal D i v i s i o n .
J.
For
Telecommunication Device f o r t h e
Deaf
(202/452-3544).
SUPPLEMENTARY INFORMATION:
I.
BACKGROUND
The i n t e r n a t i o n a l
bank c a p i t a l
standards
Accord)1 a l l o w banks t o i n c l u d e noncumulative
(Basle
perpetual
p r e f e r r e d s t o c k i n T i e r 1 c a p i t a l and p l a c e no f o r m a l l i m i t
on
t h e amount o f s u c h i n s t r u m e n t s t h a t may b e i n c l u d e d i n T i e r
l.2
The B a s l e f r a m e w o r k , w h i c h by i t s t e r m s a p p l i e s o n l y
to
i n t e r n a t i o n a l l y a c t i v e b a n k s , was a d o p t e d b y t h e F e d e r a l
f o r s t a t e member b a n k s .
risk-based capital
In a d d i t i o n ,
Reserve
t h e Board c h o s e t o a p p l y a
framework s i m i l a r t o t h e B a s l e A c c o r d t o
U.S.
1
The B a s l e A c c o r d i s a r i s k - b a s e d c a p i t a l f r a m e w o r k t h a t w a s
p r o p o s e d by t h e B a s l e Committee on Banking R e g u l a t i o n s
and
S u p e r v i s o r y P r a c t i c e s and e n d o r s e d by t h e c e n t r a l bank g o v e r n o r s o f
t h e Group o f Ten ( G - 1 0 ) c o u n t r i e s i n J u l y 1 9 8 8 .
The C o m m i t t e e i s
c o m p r i s e d o f r e p r e s e n t a t i v e s o f t h e c e n t r a l b a n k s and s u p e r v i s o r y
a u t h o r i t i e s f r o m t h e G - 1 0 c o u n t r i e s ( B e l g i u m , Canada,
France,
Germany, I t a l y , J a p a n , N e t h e r l a n d s , S w e d e n , S w i t z e r l a n d , t h e U n i t e d
Kingdom, and t h e U n i t e d S t a t e s ) and Luxembourg.
2
Noncumulative
perpetual
preferred
stock
is
perpetual
p r e f e r r e d s t o c k w h o s e d i v i d e n d s , i f m i s s e d , d o n o t a c c r u e and w i l l
n e v e r be p a i d .
Cumulative perpetual p r e f e r r e d s t o c k i s p r e f e r r e d
s t o c k whose d i v i d e n d s , i f m i s s e d b e c a u s e of i n s u f f i c i e n t e a r n i n g s
o r any o t h e r r e a s o n , accumulate u n t i l a l l a r r e a r a g e s a r e p a i d o u t .
Cumulative
preferred
dividends
have
preference
over
common
d i v i d e n d s , w h i c h c a n n o t b e p a i d o u t a s l o n g a s any c u m u l a t i v e
p r e f e r r e d d i v i d e n d s remain unpaid.
139
14 basis.3
bank h o l d i n g c o m p a n i e s g e n e r a l l y on a c o n s o l i d a t e d
Under t h e F e d e r a l R e s e r v e ' s bank h o l d i n g company c a p i t a l
guidelines,
h o l d i n g companies are allowed t o i n c l u d e both
n o n c u m u l a t i v e and c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k i n T i e r 1
capital,
but the t o t a l of a l l perpetual preferred
stock
i n c l u d a b l e i n T i e r 1 c a p i t a l i s l i m i t e d t o 25 p e r c e n t o f
1.*
Tier
Amounts o f s u c h s t o c k i n e x c e s s o f t h e l i m i t a t i o n may b e
included in Tier 2 c a p i t a l .
The l i m i t on p r e f e r r e d s t o c k
is
c o n s i s t e n t w i t h t h e B o a r d ' s l o n g - s t a n d i n g v i e w t h a t common e q u i t y
s h o u l d remain t h e dominant form o f a b a n k i n g
capital
organization's
structure.
A p r i n c i p a l reason for the Board's d e c i s i o n t o
limit
t h e amount o f p e r p e t u a l , p r e f e r r e d s t o c k i n bank h o l d i n g company
Tier 1 c a p i t a l i s the f a c t that cumulative preferred,
p e r p e t u a l p r e f e r r e d most p r e v a l e n t i n U . S .
financial
the type of
markets,
normally i n v o l v e s p r e s e t d i v i d e n d s t h a t can o n l y be d e f e r r e d ,
cancelled.
not
An i n s t i t u t i o n t h a t p a s s e s d i v i d e n d s on c u m u l a t i v e
p r e f e r r e d s t o c k must pay o f f any a c c u m u l a t e d a r r e a r a g e s b e f o r e
c a n resume payment o f i t s common s t o c k d i v i d e n d s .
Thus,
r e l i a n c e on c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k and t h e
it
undue
related
3
For bank h o l d i n g c o m p a n i e s w i t h c o n s o l i d a t e d a s s e t s o f l e s s
t h a n $150 m i l l i o n i n a s s e t s , t h e r i s k - b a s e d c a p i t a l g u i d e l i n e s
g e n e r a l l y a r e a p p l i e d on a b a n k - o n l y b a s i s .
4
Under t h e r i s k - b a s e d c a p i t a l g u i d e l i n e s , c e r t a i n t y p e s o f
p e r p e t u a l p r e f e r r e d s t o c k do n o t q u a l i f y f o r i n c l u s i o n i n T i e r 1
capital.
For e x a m p l e , p e r p e t u a l p r e f e r r e d s t o c k i n w h i c h t h e
d i v i d e n d i s r e s e t p e r i o d i c a l l y b a s e d , i n w h o l e o r i n p a r t , upon t h e
b a n k i n g o r g a n i z a t i o n ' s c r e d i t s t a n d i n g i s e x c l u d e d from T i e r 1
c a p i t a l , b u t may b e i n c l u d e d i n T i e r 2 c a p i t a l .
140
14 p o s s i b i l i t y o f l a r g e d i v i d e n d a r r e a r a g e s c o u l d c o m p l i c a t e an
o r g a n i z a t i o n ' s a b i l i t y t o r a i s e new common e q u i t y i n t i m e s o f
financial difficulty.
On t h e o t h e r hand, d i v i d e n d s on
noncumulative preferred,
cancelled.
l i k e d i v i d e n d s on common s t o c k , may b e
Thus, w i t h r e s p e c t t o d i v i d e n d s ,
noncumulative
preferred stock has c h a r a c t e r i s t i c s t h a t are c o n s i s t e n t
common s t o c k ,
with
t h e p r i n c i p a l component o f T i e r 1 c a p i t a l .
Conditions i n t h e banking i n d u s t r y underscore
d e s i r a b i l i t y of a f f o r d i n g banking o r g a n i z a t i o n s
f l e x i b i l i t y in raising capital.
the
greater
This can a s s i s t o r g a n i z a t i o n s
s t r e n g t h e n i n g t h e i r c a p i t a l p o s i t i o n s and e x p a n d i n g t h e i r
t o e x t e n d c r e d i t t o sound b o r r o w e r s .
considerations,
In view of
in
ability
these
on O c t o b e r 3 1 , 1 9 9 1 , t h e Board p r o p o s e d removing
t h e l i m i t on t h e amount o f n o n c u m u l a t i v e p r e f e r r e d s t o c k
bank h o l d i n g c o m p a n i e s may i n c l u d e i n T i e r 1 c a p i t a l .
that
T h i s was
c o n s i s t e n t w i t h o t h e r s t e p s i n i t i a t e d by t h e F e d e r a l bank
regulatory agencies,
i n c o n j u n c t i o n w i t h t h e T r e a s u r y Department,
t o address concerns r e l a t i n g t o the a v a i l a b i l i t y of c r e d i t
to
sound b o r r o w e r s .
By removing t h e l i m i t f o r n o n c u m u l a t i v e
perpetual
p r e f e r r e d s t o c k , t h e Board n o t e d , t h e p r o p o s a l would a c h i e v e
p a r i t y w i t h regard t o the treatment of noncumulative
p r e f e r r e d s t o c k between t h e U.S. r i s k - b a s e d c a p i t a l
perpetual
guidelines
f o r bank h o l d i n g c o m p a n i e s and t h e B a s l e framework f o r b a n k s .
Thus, t h e p r o p o s a l would p l a c e U . S . bank h o l d i n g c o m p a n i e s on a
more e q u a l f o o t i n g w i t h f o r e i g n banks s u b j e c t t o t h e B a s l e Accord
141
w i t h r e g a r d t o t h e i r a b i l i t y t o augment T i e r 1 c a p i t a l
through
t h e i s s u a n c e of noncumulative perpetual p r e f e r r e d s t o c k .
p r o p o s a l a l s o would conform t h e t r e a t m e n t o f
The
noncumulative
p r e f e r r e d f o r h o l d i n g companies t o t h e t r e a t m e n t f o r s t a t e member
b a n k s , w h i c h , c o n s i s t e n t w i t h t h e B a s l e A c c o r d , may i n c l u d e
n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k i n T i e r 1 w i t h o u t any
formal l i m i t .
The Board i n d i c a t e d t h a t t h e
additional
f l e x i b i l i t y p r o v i d e d by t h i s p r o p o s a l c o u l d a s s i s t bank h o l d i n g
c o m p a n i e s t o s t r e n g t h e n t h e i r c a p i t a l p o s i t i o n s and expand
lending
their
capacity.
The Board n o t e d t h a t ,
a l t h o u g h i t was p r o p o s i n g
to
remove t h e l i m i t on n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k ,
it
c o n t i n u e d t o b e l i e v e t h a t bank h o l d i n g c o m p a n i e s s h o u l d
avoid
o v e r r e l i a n c e on p r e f e r r e d s t o c k w i t h i n T i e r 1 c a p i t a l .
In
this
r e g a r d , t h e Board n o t e d t h a t t h e c a p i t a l s t r u c t u r e o f a bank
h o l d i n g company i s s u b j e c t t o q u a r t e r l y r e v i e w ( t h r o u g h t h e
a n a l y s i s of f i n a n c i a l reports f i l e d with t h e Federal
Reserve),
and t h e c o m p o s i t i o n o f an o r g a n i z a t i o n ' s c a p i t a l b a s e and
its
c a p i t a l p l a n s are s u b j e c t t o i n - d e p t h assessment during annual
i n s p e c t i o n s and a s p a r t o f t h e F e d e r a l R e s e r v e ' s c o n s i d e r a t i o n
applications.
The Board f u r t h e r s t a t e d t h a t t h e l a n g u a g e o f
F e d e r a l R e s e r v e ' s r i s k - b a s e d c a p i t a l g u i d e l i n e s makes c l e a r
Board's long-standing b e l i e f
t h a t banking o r g a n i z a t i o n s
a v o i d o v e r r e l i a n c e on n o n v o t i n g e q u i t y i n s t r u m e n t s ,
preferred stock,
in Tier 1 capi tal .
the
the
should
including
Capital structures that
i n c o n s i s t e n t w i t h t h i s p r i n c i p l e may r e s u l t i n s u p e r v i s o r y
of
or
are
142
14 enforcement a c t i o n s ,
including p o s s i b l e denial of
f i l e d with the Federal Reserve.
In a d d i t i o n ,
applications
rating
agencies
t a k e t h e amount o f common e q u i t y and p r e f e r r e d s t o c k an
organization has, as well as the o v e r a l l composition of
organization's core c a p i t a l ,
the
i n t o account in determining
organization's financial ratings.
the
Thus, t h e Board c o n c l u d e d
i t s p r o p o s a l t h a t t h e r e a r e a number o f mechanisms i n p l a c e
in
to
m o n i t o r b a n k i n g o r g a n i z a t i o n s ' u s e o f p r e f e r r e d s t o c k and t o
d i s c o u r a g e undue r e l i a n c e on s u c h
instruments.
The comment p e r i o d f o r t h i s p r o p o s a l ended on November
22,
1991.
The Board r e c e i v e d comments from t w e n t y - o n e
respondents.
public
None o f t h e commenters o p p o s e d t h e p r o p o s a l and
f o u r t e e n commenters, o r t w o - t h i r d s o f t h e t o t a l ,
supported
it.
Two o f t h e s e commenters, h o w e v e r , q u e s t i o n e d t h e l a n g u a g e i n t h e
B o a r d ' s p r o p o s a l t h a t o v e r r e l i a n c e by a b a n k i n g o r g a n i z a t i o n on
p r e f e r r e d s t o c k and o t h e r n o n v o t i n g e q u i t y e l e m e n t s w i t h i n T i e r 1
could r e s u l t in supervisory or enforcement a c t i o n s .
These
commenters a s k e d f o r s p e c i f i c g u i d a n c e on t h e p e r m i s s i b l e
l i m i t w i t h i n T i e r 1 f o r such nonvoting
upper
instruments.
S e v e n commenters n e i t h e r s u p p o r t e d n o r o p p o s e d t h e
p r o p o s a l b u t e x p r e s s e d t h e v i e w t h a t removal o f t h e l i m i t a t i o n on
noncumulative preferred stock includable in Tier 1 c a p i t a l
p r o v i d e l i t t l e o r no b e n e f i t t o bank h o l d i n g c o m p a n i e s '
would
ability
t o r a i s e c a p i t a l b e c a u s e t h e y v i e w t h e market f o r n o n c u m u l a t i v e
preferred as limited.
Three o f t h e commenters t h a t
explicitly
s u p p o r t e d t h e p r o p o s a l e x p r e s s e d s i m i l a r r e s e r v a t i o n s on t h e
143
14 b e n e f i t s p r o v i d e d by t h e p r o p o s a l .
F i v e o f t h e commenters t h a t
did not e x p l i c i t l y support the proposal put f o i t h
proposals to increase t h i s a b i l i t y .
alternative
One o f t h e s e s u g g e s t i o n s was
t h e removal o f t h e l i m i t on c u m u l a t i v e p e r p e t u a l p r e f e r r e d
bank h o l d i n g c o m p a n i e s may i n c l u d e i n T i e r 1 .
Another
was t o i n c l u d e i n c a p i t a l some amount o f i d e n t i f i a b l e
stock
suggestion
intangible
a s s e t s s u c h a s p u r c h a s e d c r e d i t c a r d i n t a n g i b l e s and c o r e
deposit
intangibles.5
Based on t h e comments r e c e i v e d ,
t h e Board i s now
i s s u i n g i n f i n a l form amendments t o i t s r i s k - b a s e d and c a p i t a l
l e v e r a g e g u i d e l i n e s t o remove t h e l i m i t a t i o n on t h e amount o f
n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k bank h o l d i n g c o m p a n i e s
may i n c l u d e i n T i e r 1 c a p i t a l .
Bank h o l d i n g c o m p a n i e s
c o n t i n u e t o be a b l e t o i n c l u d e cumulative p e r p e t u a l
stock in Tier 1 capital,
will
preferred
up t o a l i m i t o f 25 p e r c e n t o f T i e r
The Board b e l i e v e s t h a t a l i m i t a t i o n on c u m u l a t i v e
1.
perpetual
p r e f e r r e d s t o c k i s a p p r o p r i a t e b e c a u s e d i v i d e n d s on t h i s t y p e o f
instrument can o n l y be d e f e r r e d , not c a n c e l l e d .
Since
the
e x i s t e n c e o f l a r g e d i v i d e n d a r r e a r a g e s c o u l d c o m p l i c a t e an
o r g a n i z a t i o n ' s a b i l i t y t o r a i s e common e q u i t y i n t i m e s o f
financial difficulty,
t h e Board b e l i e v e s t h a t t h e amount o f
c u m u l a t i v e p r e f e r r e d s t o c k bank h o l d i n g c o m p a n i e s c a n i n c l u d e
as
T i e r 1 c a p i t a l s h o u l d c o n t i n u e t o be l i m i t e d t o 25 p e r c e n t .
5
The Board i s c u r r e n t l y r e v i e w i n g t h e c a p i t a l t r e a t m e n t o f
intangible a s s e t s together with the other federal
financial
i n s t i t u t i o n s r e g u l a t o r y a g e n c i e s and w i l l a d d r e s s t h i s m a t t e r
separately at a later date.
144
A l t h o u g h t h e Board i s r e m o v i n g t h e l i m i t
noncumulative preferred,
on
i t c o n t i n u e s t o b e l i e v e t h a t common
e q u i t y s h o u l d remain t h e dominant form o f a banking
organization's capital
structure.
Thus,
t h e Board w i l l
retain
the language in i t s risk-based c a p i t a l g u i d e l i n e s s t a t i n g
that
b a n k i n g o r g a n i z a t i o n s s h o u l d a v o i d o v e r r e l i a n c e on n o n v o t i n g
equity instruments,
Tier 1 capital.
number o f
including perpetual preferred stock,
the institution,
financial condition
the e x i s t e n c e of m u l t i p l e c l a s s e s of
the level
equity accounts of consolidated s u b s i d i a r i e s ,
among b a n k i n g o r g a n i z a t i o n s ,
t h e Board w i l l
Date
g u i d e l i n e s a r e e f f e c t i v e upon p u b l i c a t i o n .
553(d)
elements
basis.
The amendments t o t h e r i s k - b a s e d and l e v e r a g e
U.S.C.
and
greatly
c o n t i n u e t o make a
f i n a l d e t e r m i n a t i o n on o v e r r e l i a n c e on n o n v o t i n g e q u i t y
Effective
in
and t h e l e v e l
S i n c e t h e s e f a c t o r s can vary
on a c a s e - b y - c a s e
of
common
and q u a l i t y o f m i n o r i t y i n t e r e s t s
q u a l i t y of preferred stock.
II.
their
Any d e t e r m i n a t i o n o f o v e r r e l i a n c e d e p e n d s on a
factors including the overall
shareholders,
in
g e n e r a l l y p r e s c r i b i n g 30 d a y s '
The p r o v i s i o n s o f
5
prior n o t i c e of
the
e f f e c t i v e d a t e of a r u l e have not been f o l l o w e d i n
w i t h t h e a d o p t i o n o f t h i s amendment.
p r o v i d e s t h a t such p r i o r n o t i c e
capital
connection
S e c t i o n 553(d)
also
i s not n e c e s s a r y whenever a
rule
r e d u c e s r e g u l a t o r y burdens or t h e r e i s good c a u s e f o r
finding
t h a t such n o t i c e i s contrary t o the p u b l i c i n t e r e s t .
As n o t e d
145
14 above,
b y r e m o v i n g t h e l i m i t a t i o n on t h e amount o f
noncumulative
p e r p e t u a l p r e f e r r e d s t o c k bank h o l d i n g c o m p a n i e s may i n c l u d e
Tier 1 capital,
II.
t h i s r u l e does reduce such a r e g u l a t o r y
Regulatory F l e x i b i l i t y Act
Analysis
The F e d e r a l R e s e r v e Board d o e s n o t b e l i e v e
a d o p t i o n o f t h i s p r o p o s a l would have a s i g n i f i c a n t
i m p a c t on a s u b s t a n t i a l
that
economic
number o f s m a l l b u s i n e s s e n t i t i e s
a c c o r d w i t h t h e s p i r i t and p u r p o s e s o f t h e R e g u l a t o r y
Act
(5 U . S . C .
601 e t s e q . ) .
In t h a t regard,
the
In a d d i t i o n ,
proposed
b e c a u s e t h e r i s k - b a s e d and
c a p i t a l g u i d e l i n e s g e n e r a l l y do n o t a p p l y t o bank
L i s t of
not a f f e c t such
holding
leverage
holding
companies w i t h c o n s o l i d a t e d a s s e t s of l e s s t h a n $150
t h i s proposal w i l l
in
Flexibility
amendment w o u l d r e d u c e c e r t a i n r e g u l a t o r y b u r d e n s on bank
companies.
in
burden.
million,
companies.
Subjects
12 CFR P a r t
208
Accounting,
Appraisals,
Agricultural
Banks, banking,
Confidential business information,
Federal Reserve System,
of condition,
Securities,
Capital
Currency,
Flood insurance,
R e p o r t i n g and r e c o r d k e e p i n g
S t a t e member b a n k s .
loan l o s s e s ,
Branches,
Applications,
adequacy,
Dividend
payments,
P u b l i c a t i o n of
requirements,
reports
146
10
12 CFR P a r t
225
A d m i n i s t r a t i v e p r a c t i c e and p r o c e d u r e ,
Banks,
banking,
companies,
Capital adequacy,
Appraisals,
Federal Reserve System,
R e p o r t i n g and r e c o r d k e e p i n g r e q u i r e m e n t s ,
Holding
Securities,
S t a t e member b a n k s .
For t h e r e a s o n s s e t
forth in t h i s
t o t h e Board's a u t h o r i t y under s e c t i o n
Company A c t o f
International
1956
(12 U . S . C .
5(b)
1844(b)),
Lending S u p e r v i s i o n Act of
notice,
and
pursuant
o f t h e Bank H o l d i n g
and s e c t i o n 910 o f
1983
(12 U . S . C .
t h e B o a r d i s a m e n d i n g 12 CFR P a r t s 2 0 8 a n d 2 2 5 b y r e v i s i n g
t o read as
the
3909),
them
follows:
PART 2 0 8 - MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
1.
The a u t h o r i t y c i t a t i o n
f o r P a r t 208 c o n t i n u e s t o r e a d
as
follows:
AUTHORITY:
S e c t i o n s 9,
the Federal Reserve Act,
248(c),
13(j)
461,
481-486,
11(a),
11(c),
a s amended
601,
and 6 1 1 ,
19,
21,
1814 and 1 8 2 3 ( j ) ,
respectively);
Banking Act of
1978
and 2 5 ( a )
321-338,
respectively);
of the Federal Deposit Insurance Act,
International
25,
(12 U . S . C .
section
sections
a s amended
7(a)
(12 U . S . C .
of
of
248(a),
(12
4 and
U.S.C.
the
3105);
sections
907-
147
n
910 o f
the International
U.S.C.
3906-3909);
17,
78b,
17A,
a n d 23 o f
781(b),
36)
2,
12(b),
the Securities
781(g),
respectively);
Lending S u p e r v i s i o n Act of
sections
781(i),
section
1122 o f t h e F i n a n c i a l
Appendix A -
2.
1.
(5),
78q,
1983
Institutions
1989
(12 U . S . C .
Reform,
1934
(15
U.S.C.
and
78w,
(12
U.S.C.
and s e c t i o n s
Recovery
3310 and
(5),
78q-l,
5155 o f t h e R e v i s e d S t a t u t e s
1927;
(12
15B(c)
1101-
and
3331-3351).
[Amended]
The f o o t n o t e d e s i g n a t o r
footnote 6 is
PART 2 2 5 -
12(i),
Exchange Act of
78o-4(c)
a s a m e n d e d b y t h e McFadden A c t o f
Enforcement Act of
12(g),
removed and
in the text
is
removed
and
reserved.
BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
The a u t h o r i t y c i t a t i o n
f o r Part 225 c o n t i n u e s
t o read
follows:
AUTHORITY:
1844(b),
Appendix A 2.
12 U . S . C .
3106,
3108,
1817(j)
3907,
1818,
3310,
and
1831i,
1843(c)
(8),
3331-3351.
[Amended]
Appendix A i s
(13),
3909,
amended by r e v i s i n g p a r a g r a p h s
(ii)
and
as
148
14 (iii)
and a d d i n g p a r a g r a p h
(iv)
in II.A.1.,
by r e v i s i n g
l a s t t h r e e s e n t e n c e s o f t h e t h i r d p a r a g r a p h and t h e
fourth paragraph in I I . A . l . b . ,
by r e v i s i n g t h e t h i r d
entry
u n d e r t h e h e a d i n g a n d b y a d d i n g a new e n t r y d i r e c t l y
after
t h e newly r e v i s e d t h i r d entry i n Attachment I I ,
revising
II.
f o o t n o t e 1 i n Attachment VI,
follows:
***
1.
***
(i)
***
(ii)
Qualifying noncumulative perpetual
stock
(iii)
(including related
Qualifying cumulative perpetual preferred
limitations
(iv)
Minority
described
interest
consolidated
a.
b.
preferred
surplus).
(including related surplus),
subject to
below,
1 is
elements,
(that is,
of
subsidiaries,
***
*** However,
company's t i e r
stock
certain
in the equity accounts
t h e a g g r e g a t e amount o f
p e r p e t u a l p r e f e r r e d s t o c k t h a t may b e i n c l u d e d
capital
and by
t o read as
***
A.
stock
the
entire
cumulative
in a
holding
l i m i t e d t o o n e - t h i r d o f t h e sum o f
excluding the cumulative perpetual
items i ,
ii,
and i v a b o v e ) .
Stated
core
preferred
differently,
t h e a g g r e g a t e a m o u n t may n o t e x c e e d 25 p e r c e n t o f t h e sum o f
core capital
elements,
including cumulative perpetual
all
preferred
149
14 stock
(that
perpetual
be i n c l u d e d
tier
is,
items,
i,
ii,
iii,
and i v a b o v e ) .
preferred stock outstanding
in t i e r
(see discussion
Any
cumulative
in excess of t h i s
limit
2 c a p i t a l w i t h o u t any s u b l i m i t s w i t h i n
While t h e g u i d e l i n e s
allow for the inclusion
of
p r e f e r r e d s t o c k and l i m i t e d amounts
cumulative perpetual preferred stock in t i e r
1,
it
is
1 capital.
companies should avoid o v e r r e l i a n c e
Thus,
Qualifying
remain
holding
on p r e f e r r e d s t o c k
nonvoting equity elements within t i e r
perpetual
bank
of
desirable
f r o m a s u p e r v i s o r y s t a n d p o i n t t h a t v o t i n g common e q u i t y
t h e dominant form o f t i e r
Qualifying
that
below).
noncumulative perpetual
Attachment
or
l.*****
II.***
No
noncumulative
preferred
limit
stock
L i m i t e d t o 25% o f t h e
cumulative
perpetual preferred
o f common s t o c k ,
stock
and m i n o r i t y
sum
qualifying
perpetual preferred
stock,
interests
***
Attachment
1
VI.***
Cumulative perpetual preferred s t o c k
tier
is
limited
1 t o 25% o f t h e sum o f common s t o c k h o l d e r s '
qualifying perpetual
interests.
may
preferred stock,
and
within
equity,
minority
150
14 -
Appendix D -
3.
[Amended]
Appendix D i s
sentences
in
amended by r e v i s i n g
footnote
3 to
read as
the
first
two
follows:
XX. ***
3
At t h e end o f
companies
accounts
includes
of
consolidated
preferred
preferred
stock.
to
January
13,
1 capital
Tier
1
Governors of
preferred
in the
perpetual
stock
is
capital.)***
the
Federal
Reserve
(signed) William W. Wiles
W i l l i a m W. W i l e s
S e c r e t a r y of t h e Board
equity
noncumulative
cumulative
1992.
holding
interest
qualifying
and q u a l i f y i n g
(Cumulative perpetual
of
f o r bank
minority
subsidiaries,
stock,
25 p e r c e n t
Board o f
Tier
common e q u i t y ,
perpetual
limited
1992,
System,
151
FEDERAL RESERVE press release
For immediate release
February 6, 1992
The Federal Reserve Board has voted to discontinue use of the
supervisory definition of highly-leveraged transactions (HLTs) after June 30,
1992.
The Board will also discontinue the reporting of HLT exposure by banking
organizations it regulates after the June 30, 1992, reporting date.
In the interim, the Board has approved revisions to the supervisory
definition of HLTs to be used by banks and bank holding companies for reporting
their HLT exposure as of March 31, 1992, and June 30, 1992.
Although the Board will phase out the use of the formal supervisory
definition of HLTs, guidance previously issued by the Board for assessing
individual credits that finance corporate restructurings and for evaluating
internal processes for initiating and reviewing these credits will continue to
be used by examiners for this purpose.
Due to the complex nature and level of risk associated with such HLT
financings, boards of directors and management at banking organizations will be
expected to continue to monitor carefully their banking organization's risk
exposure to these credits.
Similar action to discontinue use of the HLT definition and reporting
has also been approved by the Comptroller of the Currency and the Federal
Deposit Insurance Corporation.
The Board's notice is attached.
-0Attachment
152
DEPARTMENT OF THE TREASURY
OFFICE OF THE COMPTROLLER OF THE CURRENCY
[DOCKET NO. 91-7]
FEDERAL DEPOSIT INSURANCE CORPORATION
[DOCKET NO. 050984]
FEDERAL RESERVE SYSTEM
[Docket No. R—0734]
The Supervisory Definition of
Highly-Leveraged Transactions
AGENCIES: Office of the Comptroller of the Currency, Treasury
(OCC); Federal Deposit Insurance Corporation (FDIC); and Board of
Governors of the Federal Reserve System (Board).
ACTION:
Notice.
SUMMARY: The Office of the Comptroller of the Currency, the
Federal Deposit Insurance Corporation and the Board of Governors
of the Federal Reserve System have approved: (1) the
discontinuance, after June 30, 1992, of the supervisory
definition of highly-leveraged transactions (HLT's); and (2) the
discontinuance of the reporting of HLT exposure by banking
organizations regulated by the agencies after the June 30, 1992
reporting date. In the interim, the agencies have approved
revisions to the supervisory definition of HLT's to be used by
banks and bank holding companies for reporting their HLT exposure
as of March 31, 1992 and June 30, 1992.
Although the agencies will phase out the use of the formal
supervisory definition, guidance previously issued by each agency
for assessing individual credits that finance corporate
restructurings and for evaluating internal processes for
initiating and reviewing these credits will continue to be used
by examiners for this purpose. Due to the complex nature and
level of risk associated with such financings, boards of
directors and management at banking organizations will be
expected to continue to monitor carefully their banking
organization's risk exposure to these credits.
DATES:
Effective Date.
12, 1992.
The notice is effective on February
Compliance Dates. The use of the supervisory
definition of highly-leveraged transactions by the agencies will
be discontinued effective after the June 30, 1992 financial
reporting date for banking organizations regulated by the
agencies. In the period preceding discontinuance of the
definition, revisions to the definition have been approved for
reporting HLT exposure as of March 31, 1992 and June 30, 1992.
153
- 2 FOR FURTHER INFORMATION COOT ACT:
OCC: John W. Turner, National Bank Examiner, (202/874-5170),
Chief*s National Bank Examiner's Office.
FDIC: Garfield Gimber, Examination Specialist, (202/898-6913),
Division of Supervision.
Board: Todd Glissman, Supervisory Financial Analyst (202/4523953), or William Spaniel, Senior Financial Analyst (202/4523469), Division of Banking Supervision and Regulation. For the
hearing impaired only. Telecommunications Device for the Deaf
("TDD"), Dorothea Thompson (202/452-3544).
SUPPLEMENTARY INFORMATION:
On July 10, 1991, the agencies
published for comment the supervisory definition of highlyleveraged transactions [56 FR 31464, July 10, 1991]. The
agencies sought comment on all aspects of the HLT definition and
criteria, as well as comments on specific issues raised by
questions which the agencies had received. The comment period
expired on September 26, 1991. The agencies received over 265
comments on the proposal.
After reviewing the status of the HLT definition,
considering comments received from the public, and evaluating
proposed revisions, the agencies have approved the phase out of
the supervisory definition of HLT's and the discontinuance of
reporting of HLT's after the June 30, 1992 financial reporting by
banking organizations. The agencies have also approved revisions
to the definition for use by banking organizations in reporting
their HLT exposure as of March 30, 1992 and June 30, 1992.
The agencies, in approving the phase out of the supervisory
definition of HLT's, have taken under consideration the public
comments received on the HLT definition, the current status of
HLT credits, the reduced level of merger and acquisition activity
in recent months, and the reluctance of lenders, in some cases,
to extend credit to sound borrowers. The agencies considered all
options for maintaining or phasing out supervisory oversight of
highly-leveraged transactions. These included phasing out the
definition, giving banks the flexibility to establish their own
individual definitions, and proposing revisions to the
supervisory definition.
While the agencies did not favor the immediate
discontinuance of the definition, the agencies believe that the
HLT definition has largely accomplished its purposes and have
approved the phase out of the definition. The definition
encouraged financial institutions to focus attention on the need
for internal controls and review mechanisms to monitor these
types of financing transactions. The definition also encouraged
financial institutions to structure highly leveraged credits in a
tanner consistent with the risks involved. The HLT definition
154
- 3 has played a role in helping the bank regulatory agencies
identify these credits and monitor the risks associated with HLT
portfolios over time. At the same time, the supervisory
definition of highly-leveraged transactions was not intended to
impart supervisory criticism.
With the phase out of the definition, the agencies'
examiners will continue to evaluate, on an annual basis, those
credits meeting the Shared National Credit Program criteria to
assess the risk posed to insured depository institutions and
holding companies by the individual credits, and such credits
will be subject to supervisory criticism when appropriate. All
other credits will be reviewed, as appropriate, through the
normal examination process. Examiners will continue to
thoroughly review each borrower's financial condition, income and
cash flow; the value of any collateral or guarantees; the quality
and continuity of the borrower's management; the borrower's
ability to service its debt obligations; and other credit quality
considerations. Consistent with sound banking practice, banking
organizations will continue to be expected to have systems in
place to monitor the risks associated with segments of their
lending portfolios, including highly leveraged credits.
The agencies have adopted revisions to the definition to
address concerns raised by the application and content of the
definition. These revisions in the definition are to be used by
banking organizations during the period preceding the
discontinuance of the definition to report the level of their HLT
exposure as of March 30, 1992 and June 30, 1992. These revisions
include: (1) allowing banking organizations to delist certain
companies from HLT status that adequately service debt and
clearly demonstrate superior cash flow, relative to their
respective industry or peer group; (2) reducing the timeframe in
which a company's performance is evaluated before being delisted
from HLT status; (3) delisting companies, previously designated
as HLT's, emerging from Chapter 11 bankruptcy that are no longer
highly leveraged; and (4) excluding certain loans from HLT
reporting when fully collateralized by cash or cash equivalent
securities.
Cash Flow Tests
A cash flow test was not included in the original
supervisory HLT definition or delisting criteria. Although
delisting criteria state that cash flow coverage is to be taken
into consideration when reviewing the overall performance of a
borrower for delisting, a specific measure was not defined. The
reason for not incorporating a specific cash flow test was
because (1) the definition was implemented to provide a
consistent means of aggregating and monitoring a type of
financing transaction, thus relying heavily on a purpose test and
an easily-calculated leverage test; (2) it was deemed problematic
155
- 4 to develop a universal cash flow measure that could be used for
all industries; and (3) there was a desire to avoid any
impression that the definition implied a supervisory criticism of
a credit, noting that cash flow is a primary factor in credit
quality reviews.
The agencies, in publishing the supervisory definition of
highly-leveraged transactions for comment, specifically sought
comment on the appropriateness of the inclusion of a cash flow
measure. A majority of comments from both companies and banks
strongly favored the use of a cash flow test in the HLT
definition, particularly for delisting purposes. Some favored a
standardized cash flow test; others favored an industry-specific
cash flow test; and some expressed a preference for both.
Several banks stated, however, that it would be difficult to
implement a cash flow measure for initially designating credits
as HLTs because the analysis would have to be based on cash flow
projections and not on historical performance.
In light of the comments received, the agencies reviewed
potential cash flow measures including a debt service coverage
ratio, an interest coverage ratio, and a ratio measuring the
magnitude of debt in relationship to operating cash flow. All
measures proved difficult to define adequately, particularly for
use in analyzing companies in different industries. Moreover, it
was found to be extremely difficult to establish a standardized
level of "acceptable" cash flow that could be applied to all
industries.
The agencies concluded that it was not appropriate to adopt
a standardized cash flow test; rather, the agencies believe that
banking organizations should analyze pertinent cash flow ratios
for individual HLT companies, then make a determination as to the
quality and strength of each company's cash flow performance,
subject to examiner review. Under the revision approved by the
agencies, the credits of a highly leveraged company could be
considered eligible for delisting by banking organizations on a
case-by-case basis, if the company demonstrates superior cash
flow coverage, relative to the company.'s industry or peer group,
and the company has adequately serviced debt for a reasonable
period of time since its last buyout, acquisition or leveraged
recapitalization.
Reduce Timeframes for Delisting:
Presently, a borrower designated as an HLT must show good
performance for a minimum of two years from the date of the
transaction before being eligible for delisting from HLT status.
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- 5 1
After two years, if leverage has been reduced below 75 percent,
a borrower becomes eligible for delisting. If a borrower remains
highly leveraged, however, the borrower must demonstrate
performance for a period of up to four years before being
eligible to be delisted from HLT status.
Upon considering the comments received, the agencies have
determined that the delisting criteria should be amended by:
(a)
Reducing the delisting timeframe from two years to one year
for companies that deleverage below 75 percent or were
designated as HLTs under the "doubling of liabilities to
greater than 50 percent" leverage test. Under this
standard, companies would have to continue to meet general
performance criteria to be delisted.
(b)
Reducing^ the delisting timeframe from four years to three
years for companies that remain highly leveraged.
A
company would have to demonstrate performance for three
consecutive years since its last highly-leveraged
transaction and have a positive net worth in order to be
eligible for delisting. The requirement that a company's
leverage ratio not significantly exceed its industry norm in
order to be delisted would be eliminated.
The agencies believe that allowing companies that deleverage
themselves to be delisted sooner from HLT status should encourage
companies to improve their capitalization and credit standing by
reducing leverage and issuing additional equity. These
substantive changes to HLT delisting criteria are expected to
allow a significant number of companies to be removed from HLT
status, given the number of companies recently issuing equity and
the number of HLTs that have now aged beyond three years.
Delist Certain Companies Emerging From Chapter XI Bankruptcy:
In previous guidance, post-reorganization debt (after a
company emerges from Chapter 11 bankruptcy) of a company that was
designated HLT prior to bankruptcy proceedings retained an HLT
designation until the company became eligible for delisting.
Although a company was often deleveraged as a result of the reorganization, the company could not be delisted for at least
two years from the date it was designated as an HLT.
Several comments stated that a company should not be
designated HLT upon emerging from Chapter 11 reorganization if
leverage is below 75 percent. It was indicated that continuing
*The leverage ratio is defined as total liabilities divided
by total assets as reflected on financial statements prepared in
accordance with generally accepted accounting principles (GAAP).
157
- 6 the HLT designation could interfere with these companies1 ability
to obtain post-reorganization financing. The agencies recognize
that the purpose of Chapter 11 of the bankruptcy code is to help
reorganize companies pursuant to a court-approved plan. Further,
many reorganized companies emerging from bankruptcy are no longer
highly leveraged and are, in essence, operating with a new
balance sheet.
Reflecting these views, the Congress in the recently passed
banking legislation "Federal Deposit Insurance Corporation
Improvement Act of 1991" (Section 474) amended the Federal
Deposit Insurance Act to prohibit a federal banking agency from
designating by regulation or otherwise a corporation as a highlyleveraged transaction (HLT) solely because such corporation is or
has been a debtor or bankrupt under Title 11, if after
confirmation of reorganization, such corporation would not
otherwise be highly leveraged. In implementing the Congressional
intent underlying this amendment, the agencies believe that this
should serve to emphasize the role played by the bankruptcy code
and remove any implied hindrance to this type of lending.
Exclude Certain Fully-collateralised Loans from HLT Statusi
Comments were received on the inclusion of certain loans
fully-collateralized by cash or cash equivalent securities in an
HLT company's aggregate HLT.exposure. It was indicated that the
purpose of these fully-collateralized loans is generally not to
take on additional debt for acquisition or restructuring
purposes. It was also noted that a company arranging such a loan
had sufficient liquid resources available on its balance sheet
and, therefore, would not have needed to borrow such funds.
Given these reasons, the agencies have found it appropriate to
exclude certain fully-collateralized loans from HLT reporting by
banking organizations.
Other Comments
Comment letters expressed support for several additional
revisions to the HLT definition that.the agencies have decided
not to adopt at this time. Potential revisions that were not
adopted include (1) exempting companies with investment-grade
senior debt from HLT designation and (2) excluding debt of
certain subsidiaries from a consolidated company's HLT
designation.
Under HLT guidelines, it is possible for a company with
investment-grade senior debt to be designated an HLT if the
company has been involved in significant merger and acquisition
activity and has very high leverage. Comment letters indicated,
however, that very few such companies exist.
52-418 - 92
158
- 7 To date, investment-grade companies have not been exempted
from the HLT definition because of a desire to (1) avoid
including credit quality criteria in the definition; (2) avoid
inequitable treatment for companies that may meet investment
grade criteria but are too small to be evaluated by the major
rating agencies; and (3) avoid dependence on outside credit
rating agencies, noting that credit quality of a company can
quickly deteriorate under the burden of heavy debt.
Based on comment letters received, the agencies have
determined that exempting companies with investment-grade senior
debt from HLT designation would appear to have little impact on
the number of companies designated as HLTs, but it would serve to
reinforce the perception that an HLT designation conveys credit
quality information or criticism. Some comments noted that
financial institutions could publicly disclose the level of
investment-grade companies in their HLT portfolios, thus
mitigating criticism by analysts of this portion of their
portfolios. Given that exempting investment-grade companies from
HLT designation could further reinforce negative perceptions
concerning the overall credit quality of HLT loan portfolios, the
agencies decided not to adopt such a change.
Comments were also received on the inclusion of the debt of
subsidiaries as part of the aggregate HLT exposure. According to
the HLT guidelines, if a company satisfies the HLT purpose and
leverage tests on a consolidated basis, then a loan to any part
of the organization is designated HLT. Also, if a subsidiary
satisfies the HLT criteria and its debt level is significant
enough to cause the consolidated organization to meet HLT
leverage criteria, then all debt of the entire organization is
designated HLT.
The review of financial statements and calculation of the
leverage ratio for HLT purposes is conducted using generally
accepted accounting principles (GAAP). Analyzing companies on a
consolidated basis when determining HLT status is considered
consistent with GAAP. Moreover, experience with consolidated
organizations has shown that when one aspect of a company's
operations becomes imperiled, the entire organization may be
negatively impacted.
Although a significant number of comments favored excluding
debt of certain subsidiaries from a parent company's HLT
designation if appropriate protective covenants are maintained
between the parent and subsidiary, the agencies found significant
problems related to the use and review of protective covenants.
Protective covenants cited as examples include restrictions on
the movement of assets between parent and subsidiary companies,
limitations on the payment of dividends to a parent company,
restrictions on inter-company debt, and so forth. Bach
protective covenant, however, is unique, thus requiring a very
159
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difficult and tine consuming review and evaluation process to
determine its strength. Also, protective covenants may not work
as specified when a company is in financial difficulty or enters
bankruptcy proceedings. Experience has shown that technical
separation of companies through the use of loan covenants has not
always been effective in protecting a company against liabilities
emanating from its parent, subsidiary, or affiliate, especially
in bankruptcy situations where the separation between parent and
subsidiary can and has been breached.
Given a desire to adhere closely to GAAP whenever possible,
the influence that parent companies can exert over so-called
"stand alone" subsidiaries when financial needs arise, and the
difficulties involved in evaluating and enforcing protective
covenants, the agencies have determined not to exclude certain
subsidiaries of HLT parent companies from the HLT designation.
Definition and Guidance Regarding
Highly-Leveraged Transactions (,,HLTsM), As Revised
ft^nrma-pr of Definition
A bank or bank holding company is considered to be involved
in a highly-leveraged transaction when credit is extended to or
investment is made in a business where the financing transaction
involves the buyout, acquisition, or recapitalization of an
existing business and one of the following criteria is met:
(a)
the transaction results in a liabilities-to-assets leverage
ratio higher than 75 percent; fi£
(b)
the transaction at least doubles the subject company's
liabilities and results in a liabilities-to-assets leverage
ratio higher than 50 percent;
(c)
the transaction is designated an HLT by a syndication agent
or a federal bank regulator.
Additional guidance on the Definition of HLTs
A highly-leveraged transaction is a type of financing which
involves the restructuring of an ongoing business concern
financed primarily with debt. The purpose of an individual
credit is most important when initially determining HLT status.
Once an individual credit is designated as an HLT, all currently
outstanding and future obligations of the same borrower are also
included in HLT totals. This includes working capital loans and
other ordinary credits, until such time as the borrower is
delisted.
160
- 9 The regulatory purpose of the HLT definition is to provide a
consistent means of aggregating and monitoring this type of
financing transaction. It must be pointed out that the HLT
designation does not imply a supervisory criticism of a credit.
Before any HLT or any other credit is criticized, an examiner
should review a whole range of factors on a credit-by-credit
basis. These factors include cash flow, general ability to pay
interest and principal on outstanding debt, economic conditions
and trends, the borrower's future prospects, the quality and
continuity of the borrower's management, and the lender's
collateral position. Participation of banking organizations in
highly-leveraged transactions is not considered inappropriate so
long as it is conducted in a sound and prudent manner, including
the maintenance of adequate capital and loan loss reserves to
support the risks associated with these transactions.
Borrowers having questions regarding the HLT definition
should first refer these questions to their bankers. Bankers
should then refer questions they cannot answer to the bank's
primary federal regulator.
Purpose Test
To become eligible for designation as an HLT, a financing
transaction must involve the buyout, acquisition, or
recapitalization of an existing business, domestic or foreign.
This definition encompasses traditional leveraged buyouts,
management buyouts, corporate mergers and acquisitions, and
significant stock buybacks. Leveraged Employee Stock Option
Plans (ESOPs) are also included when used to acquire or
recapitalize an existing business.
For purposes of satisfying the HLT purpose test, a leveraged
recapitalization involves a replacement of equity with debt on a
company's balance sheet by means of a stock repurchase or
dividend payout. Refinancing existing debt in a company is not
deemed to be a leveraged recapitalization.
Exclusions frpffi the HLT Definition; .
Single Asset or Leases This purpose test excludes the
acquisition or recapitalization of a single asset or lease (e.g.,
a large commercial building or an aircraft), or a shell company
formed to hold a single asset or lease, from the HLT definition.
Although such an acquisition may be highly leveraged, the asset
or lease, in and of itself, is not considered an ongoing business
concern and, therefore, is not intended to be included in the HLT
category. However, the acquisition or recapitalization of a
leasing corporation which invests in fleets of equipment for
leasing, or a building company which invests in real estate
projects would satisfy the HLT purpose test.
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10
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Threshold Tests Loans and exposures to any obligor in which the
total financing package, including all obligations held by all
participants, does not exceed S20 million, at the time of
origination, may be excluded from HLT designation. Nonetheless,
there may be some banking organizations that in the aggregate
have significant exposure to transactions below the threshold
level• It is expected that those organizations would continue to
monitor closely these transactions as part of their aggregate HLT
exposures.
Historioal Cutoff Dates An HLT transaction not included in the
Shared National Credit Program, that meets or exceeds the $20
million test, may be excluded from HLT designation if it
originated prior to January 1, 1987, the original terms and
conditions of the credit are materially unchanged, the credit has
not been criticized by examiners, and the financial condition of
the debtor has not deteriorated.
Debtor-in-Possession Financings s Court-approved debtor-inpossession (or trustee-in-possession) financing for a business
concern in Chapter 11 reorganization proceedings will generally
be exempt from HLT designation. All pre-petition debt of an HLT
borrower and any post-reorganization debt (after a company
emerges from Chapter 11 bankruptcy) will continue to be included
in HLT exposure until delisting occurs.
Loans Fully-Collateralised With Cash or Cash Equivalents: All
loans (credit facilities) that are fully-collateralized with cash
or cash equivalents are excluded from HLT reporting by banking
organizations. Cash collateral consists of a deposit in the
financial institution advancing the loan proceeds, segregated and
under the control of the financial institution, and unequivocally
pledged to secure the loan. Cash equivalents are deemed to
include U.S. Government and certain other readily-marketable
securities qualifying for a zero risk-weight under risk-based
capital standards. Cash equivalents must be held in custody by
and unequivocally pledged to the lending financial institution.
Leverage Tests
In addition to the purpose test, one of the following
criteria must be met for the transaction to be considered' an HLT:
1)
The transaction at least doubles the subject company1s
liabilities and results in a total liabilities to total
assets (leverage) ratio higher than 50 percent.
NOTE: The purpose of this leverage test is to capture
transactions in which a company must suddenly deal with a
substantially higher debt burden. The greatest risk in a
credit exposure is not necessarily the absolute level of
debt but may be the impact on a company of significant new
162
- n debt. A key HLT success factor is ability to handle a
sudden, large increase in debt.
The "doubling of liabilities1* is intended to capture those
transactions where new debt is used to facilitate the
buyout, acquisition, or recapitalization of a business. If
the sua of the acquiring and acquired companies' liabilities
would double as a result of the new debt taken on to effect
the combination of the companies, then the transaction is
considered an HLT, and all exposure to the company is
designated an HLT. It is not intended to cover a doubling
resulting from the simple addition of the existing
liabilities of the two companies.
Any refinanced portion of old debt in a transaction should
continue to be treated as old debt for purposes of applying
this leverage test. Further, if there was no debt in either
company prior to the transaction, then any new debt will
result in a "doubling of liabilities."
In an acquisition involving one or more operating divisions
of a company (as opposed to stand-alone subsidiaries),
existing liabilities of the seller associated with specific
operating assets being transferred in the transaction may be
allocated to the resulting company for purposes of applying
the "doubling of liabilities" test. The burden of proof is
on the resulting company and its financial institution(s) to
substantiate that the allocation of the seller's liabilities
to the resulting company is appropriate.
When calculating a company's leverage for the purpose of
this test, captive finance company subsidiaries and
subsidiary depository institutions should be excluded from
the consolidated organization.
The transaction results in a total liabilities to total
assets (leverage) ratio higher than 75 percent.
NOTE: When a company's leverage ratio exceeds 75 percent,
the determination of whether exposure to the company is
designated an HLT further depends on the composition of-the
company's total liabilities after the transaction. If a
significant portion of the liabilities (generally 25 percent
or more of total liabilities) derives from buyouts,
acquisitions, or recapitalizations, either past or present,
then all exposure to the company is designated an HLT. If,
after the transaction, debt related to buyouts,
acquisitions, or recapitalizations, either past or present,
represents less than 25 percent of total liabilities, then
the exposure to the company need not be designated an HLT.
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Again, when calculating a company's leverage for the purpose
of this test, captive finance company subsidiaries and
subsidiary depository institutions should be excluded from
the consolidated organization.
3)
The transaction is designated an HLT by a syndication agent*
In specific cases, the bank supervisory agencies may also
designate a transaction as an HLT even if it does not meet
the conditions outlined above. (It is anticipated that this
would be done infrequently and only in material cases.)
Definition
of
the
leverage
Ratio
The leverage ratio is total liabilities divided by total
assets as reflected in financial statements prepared in
accordance with generally accepted accounting principles (GAAP).
Total assets of the resulting enterprise include intangible
assets (such as goodwill). Total liabilities include all forms
of debt (including any new debt taken on to facilitate the
transaction) and claims, including all subordinated debt and nonperpetual preferred stock. Perpetual preferred stock is
generally considered equity for purposes of calculating HLT
leverage. However, exceptions could be made on a case-by-case
basis if the stock has characteristics more akin to debt than
equity.
Off-balance sheet exposure, including claims related to
foreign exchange contracts, interest rate swaps, and other risk
protection or cash management products may normally be excluded
from HLT exposure as long as their credit equivalent exposure is
small relative to other types of obligations. (It is expected,
however, that internal management information and control systems
be in place to capture these exposures.)
I f a parent company uses "double leverage" (that is, takes
on debt and downstreams it as equity to a subsidiary) to assist a
subsidiary in an HLT purpose-related transaction, then the debt
at the parent company will be considered HLT purpose-related debt
when c a l c u l a t i n g
leverage
for the
c o m p a n y on a
consolidated
basis.
In an acquisition involving a pure assumption of debt with
no new debt issued, the transaction is not designated an HLT
unless the resulting company's aggregate outstanding HLT purposerelated debt (from all previous transactions) is significant
(generally 25 percent or more of total liabilities) and the 75
percent leverage test is satisfied.
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Consolidation of HLT Exposure
All credit extended to, or investments made in an HLT should
be aggregated with any ordinary business loans to, or investments
in, the same obligor.
If a company satisfies the HLT purpose and leverage tests on
a c o n s o l i d a t e d b a s i s , then a loan to ang part of the organization
is deemed to be an HLT. On the other hand, if only a subsidiary
of a company satisfies the HLT tests, then the subsidiary could
"stand alone" as an HLT; however, if the subsidiary's debt level
is significant enough to cause the consolidated organization to
meet HLT leverage criteria, then all debt of the entire
organization is designated HLT.
guarantees of Payment
If a parent company supplies an irrevocable, unconditional
guarantee of payment on behalf of its subsidiary and the leverage
of the consolidated organization does not meet HLT leverage
criteria, then the subsidiary will generally not be designated an
HLT. On the other hand, if the subsidiary1s leverage is
significant enough to cause the consolidated organization to meet
HLT leverage criteria, then all debt of the entire organization
is accorded HLT status. (NOTE: Third-party guarantees and
guarantees by related subsidiaries of a company have no effect on
the HLT designation. While these types of guarantees offer credit
enhancement benefits which will be taken into consideration
during the review of individual credits by examiners, they
generally lack the stronger bonds of support inherent in the
relationship between a parent and its subsidiary.)
When a foreign parent company provides the equivalent of an
irrevocable and unconditional guarantee of payment on behalf of a
subsidiary,
the
subsidiary's
debt will
normally not be
designated
as HLT debt as long as the consolidated organization does not
meet HLT leverage criteria and the following two conditions are
met:
(1)
Written opinions from legal counsel in the country of origin
and the United States are provided which state that the
equivalent of a written guarantee of debt repayment exists
which is irrevocable and unconditional; and
(2)
The credit files in the U.S. banking organizations lending
to the subsidiary contain consolidated financial statements
for the foreign parent stated in U.S. dollars under U.S.
accounting rules.
165
- 14 Aaent: a n d Lead Bank
Responsibility
To ensure consistent application of the definition, the
agent or lead bank is responsible for determining whether or not
a transaction qualifies as an HLT. The agent or lead bank is
charged with the timely notification to participants regarding
the status of the transaction and of any change in that status,
i.e. designation as an HLT or delisting as an HLT.
The responsibility of the agent or lead bank to determine
HLT status does not preclude a participant bank from designating
a transactions as an HLT or relieve a participant from performing
its own credit analysis. Examiners will review transactions for
compliance with the HLT definition in the context of the Shared
National Credit Program and during regular on-site examinations.
Delisting Criteria
HLT exposure of a given borrower may be removed from HLT
status upon satisfying one of the following criteria:
(a)
Credits of a company emerging from protection under Chapter
11 of the U.S. Bankruptcy Code at the consummation of a
court-approved plan of reorganization will be immediately
delisted from HLT status, if the company's leverage ratio is
less than 75 percent at the time of reorganization.
(b)
A borrower's credits that were designated as HLTs under the
"doubling of liabilities to greater than 50 percent"
leverage test or that have reduced leverage to less than 75
percent will be considered eligible for delisting if the
company has performed well for one year (since its last
buyout, acquisition, or leveraged recapitalization involving
financing) and demonstrates an ability to continue
satisfactorily servicing debt. To verify adequate
performance and validate the appropriateness of financial
projections of a company, the lender should conduct a
thorough review of the obligor to include, at a minimum,
overall management performance against the business plan,
cash flow coverages, operating margins, industry risk, and
status of asset sales, if applicable.
(c)
Credits of a company whose leverage continues to exceed the
75 percent leverage test will be considered eligible for
delisting by banking organizations on a case-by-case basis,
if the company demonstrates superior cash flow coverage,
relative to the company's industry or peer group, and the
company has adequately serviced debt for a reasonable period
of time since its last buyout, acquisition, or leveraged
recapitalization involving financing. To verify strong
performance, the lender should conduct a thorough review of
the obligor to include, at a minimum, the quality and
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strength of cash flow coverages, operating margins,
reduction in leverage, appropriateness of the company's
financial projections, overall management performance
against the business plan, industry risk, and status of
asset sales, if applicable. Credits delisted in this manner
will subsequently be reviewed, and potentially subject to
relisting, by examiners during the normal course of an
examination.
(d)
Credits of a company whose leverage continues to exceed the
75 percent leverage test will be considered eligible for
delisting if the company has performed adequately for at
least three years since its last buyout, acquisition, or
leveraged recapitalization involving financing; and the
company has a positive net worth. To verify adequate
performance and validate the appropriateness of financial
projections of a company, the lender should conduct a
thorough review of the obligor to include, at a minimum,
overall management performance against the business plan,
cash flow coverages, operating margins, industry risk, and
status of asset sales, if applicable.
It is expected that banks will maintain records of delisted
exposures and reasons for delisting. After delisting, any
significant changes in the obligor's financial condition should
cause the exposure to be reviewed for relisting. Records
pertaining to delisting and relisting of HLTs will be reviewed by
examiners in the context of the Shared National Credit Program
and/or regular on-site examinations.
Date
Robert L. Clarke
Comptroller of the Currency
Date
Executive Secretary of the
Federal Deposit Insurance Corporation
2/6/92
Date
( s i g n e d ) W i l l i a m W. W i l e s
William W. Wiles
Secretary of the
Board of Governors of the Federal Reserve System
BILLING CODES:
OCC
FDIC
BOARD
4810—33—M
6714-01-M
6210-01-M
(1/3)
(1/3)
(1/3)
168
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
Office Correspondence
Date: January 16, 1993
To; B o a r d o f G o v e r n o r s
Seltfect: R e g u l a t o r y C a p i t a l
Treatment of
Fnw:
D i v i s i o n of Banking
S u p e r v i s i o n and R e g u l a t i o n *
ACTION REQUESTED:
Intangible
Identifiable
Assets
The B o a r d ' s a p p r o v a l t o r e q u e s t p u b l i c
f o r a 3 0 - d a y p e r i o d on a p r o p o s a l d e v e l o p e d on a
b a s i s b y t h e s t a f f s o f t h e OCC, FDIC, OTS, a n d t h e
Reserve t o achieve uniformity in the treatment of
assets
for regulatory capital
As d e s c r i b e d b e l o w ,
intangible
assets
includable
relationships
rights
("PCCRs"),
in capital
("FMSRs")
proposal
limits
on
for purposes
of
ratios.
Purchased
and p u r c h a s e d c r e d i t
s u b j e c t t o an o v e r a l l
50 p e r c e n t o f T i e r 1 c a p i t a l
intangible
the interagency s t a f f
r i s k - b a s e d and l e v e r a g e c a p i t a l
mortgage s e r v i c i n g
Federal
purposes.
would e s t a b l i s h t h e t y p e s o f and q u a n t i t a t i v e
calculating
and a s e p a r a t e s u b l i m i t o f
f o r PCCRs, w o u l d q u a l i f y f o r
in capital.
excludes a l l
("CDIs")
from c a p i t a l .
e x c l u d e d from c a p i t a l
In a d d i t i o n ,
core deposit
goodwill will
25
continue to
Staff
* Messrs.
Cole,
a n d Holm a n d M s . B a r g e r .
Pugh,
is
of
inclusion
c o n s i s t e n t w i t h l o n g s t a n d i n g p o l i c y and
framework.
limit
intangibles
risk-based capital
Struble,
card
aggregate
percent of Tier 1 capital
The p r o p o s a l
comment
coordinated
a l s o proposing that
be
the
the
169
14 suggested changes in the c a p i t a l treatment of
be incorporated i n t o the c a p i t a l
intangible
r a t i o s used for
e x a m i n a t i o n s and a p p l i c a t i o n s p u r p o s e s .
Board's e x i s t i n g c a p i t a l guidelines,
Consistent with
however,
ratios
(after deducting a l l
overall capital
adequacy,
the
t h e B o a r d may i n
c e r t a i n c a s e s c o n t i n u e t o e v a l u a t e an o r g a n i z a t i o n ' s
capital
assets
both
intangibles)
tangible
in assessing
i f warranted by t h e c o n d i t i o n of
its
the
organization.
The a t t a c h e d d r a f t F e d e r a l R e g i s t e r n o t i c e
p u b l i c comment s e t s
requesting
forth in detail the revisions to the
Board's
r i s k - b a s e d and l e v e r a g e c a p i t a l g u i d e l i n e s t h a t would b e
necessary i f ,
consideration,
staff
a f t e r r e v i e w i n g t h e comments and
further
t h e Board d e c i d e s t o implement t h e
interagency
proposal.1
SUMMARY:
With t h e B o a r d ' s a p p r o v a l ,
p u b l i c comment w i l l
s o u g h t on p r o p o s e d r e v i s i o n s t o t h e F e d e r a l R e s e r v e ' s
be
capital
adequacy g u i d e l i n e s t h a t would p r o v i d e e x p l i c i t g u i d a n c e t o
member b a n k s a n d b a n k h o l d i n g c o m p a n i e s o n t h e t r e a t m e n t
i d e n t i f i a b l e i n t a n g i b l e a s s e t s for purposes of c a l c u l a t i n g
r i s k - b a s e d and l e v e r a g e c a p i t a l
ratios.
The p r o p o s a l
state
of
their
was
d e v e l o p e d and i s b e i n g r e l e a s e d f o r p u b l i c comment o n a
^ r i o r t o publication of t h i s proposal in the Federal
R e g i s t e r . Board s t a f f w i l l c o n s u l t upon t h e f i n a l w o r d i n g o f t h e
p r o p o s a l w i t h t h e s t a f f s o f t h e FDIC, OCC, and OTS.
Accordingly,
s t a f f s e e k s a p p r o v a l t o make i n s i g n i f i c a n t c h a n g e s i n w o r d i n g , i f
and a s n e c e s s a r y , t o a c h i e v e f i n a l i n t e r a g e n c y a g r e e m e n t .
Any
s i g n i f i c a n t c h a n g e s would be r e f e r r e d t o t h e Board f o r d i s c u s s i o n
or notation vote as appropriate.
170
14 c o o r d i n a t e d b a s i s w i t h t h e FDIC, OCC, a n d OTS i n o r d e r t o
u n i f o r m i t y among t h e b a n k i n g a g e n c i e s
these assets
international
i n a manner t h a t
in the capital
i s consistent with
risk-based capital
achieve
treatment
standards.
The p r o p o s a l w o u l d p e r m i t b a n k i n g o r g a n i z a t i o n s
include
in capital
(that
is,
mortgage s e r v i c i n g r i g h t s
relationships
(NPCCRsN),
n o t d e d u c t from c a p i t a l )
("PMSRs")
in excess of these l i m i t s ,
as well
and a l l
intangible assets,
intangible
subject
as core deposit
intangibles
would be
deducted
for
a s s e t s that are being proposed
in Tier 1 capital,
i.e.,
PMSRs a n d PCCRs.
In
for
addition,
t h e market v a l u e s of t h e s e a s s e t s g e n e r a l l y are not a f f e c t e d
the financial
c o n d i t i o n o f t h e o r g a n i z a t i o n t h a t owns
In order t o
implement a p r o v i s i o n of t h e
Deposit Insurance Corporation
("FDIC")
do
PMSRs a n d PCCRs
A r e a s o n a b l y a c t i v e and l i q u i d market e x i s t s
the identifiable
inclusion
they
PCCRs w o u l d b e
25 p e r c e n t o f T i e r 1.
other identifiable
card
in the aggregate,
n o t e x c e e d 50 p e r c e n t o f T i e r 1 c a p i t a l .
from T i e r 1.
to
purchased
and p u r c h a s e d c r e d i t
provided that,
to a separate sublimit of
of
the
by
them.
Federal
Improvement Act o f
1991
a n d t o a c h i e v e c o n s i s t e n c y w i t h c u r r e n t FDIC a n d OTS r u l e s
regarding the valuation of
PMSRs, t h e p r o p o s a l
f a i r market v a l u e and book v a l u e o f
least
quarterly
statement purposes),
the
PMSRs m u s t b e d e t e r m i n e d
in accordance with certain c r i t e r i a
purposes of calculating
regulatory capital
and t h a t ,
(but not f o r
t h e a m o u n t o f PMSRs r e p o r t e d o n t h e
s h e e t would be reduced t o t h e l e s s e r o f :
states that
90 p e r c e n t o f
at
for
financial
balance
their
171
14 f a i r market v a l u e ,
90 p e r c e n t of t h e i r o r i g i n a l
purchase
price,
o r 100 p e r c e n t o f t h e i r r e m a i n i n g u n a m o r t i z e d book v a l u e .
proposal would a l s o r e q u i r e banking o r g a n i z a t i o n s t o
The
subject
t h e i r PCCRs t o t h e s a m e v a l u a t i o n a n d d i s c o u n t i n g a p p r o a c h e s
as
t h o s e p r o p o s e d f o r FMSRs.
BACKGROUND:
Currently,
the four federal banking a g e n c i e s
somewhat w i t h r e g a r d t o t h e t r e a t m e n t o f
assets
(that
is,
calculation of
deduct a l l
intangible
ratios.
intangible
assets
in
o t h e r t h a n PMSRs f r o m T i e r 1 c a p i t a l .
from T i e r 1 c a p i t a l ,
of t h e i r
inclusion
and q u a l i t y o f
the capital
identifiable
a d e q u a c y and o v e r a l l
but determines
the
i n an o r g a n i z a t i o n ' s
institutions.
In addition,
by banking o r g a n i z a t i o n s ,
organization's
capital
institution
in
banking
in reviewing expansionary
proposals
as well as i t s tangible
can document t h a t
i t s holdings of other
an
capital.
i n t a n g i b l e s o t h e r t h a n PMSRs u n l e s s
meet c e r t a i n c r i t e r i a ,
the
assessing
the Federal Reserve considers both
stated capital
T h e OTS d e d u c t s a l l
intangible assets
asset quality of
The
identifiable
p o s i t i o n on a c a s e - b y - c a s e b a s i s and h a s l o n g c o n s i d e r e d
level
the
T h e FDIC a n d OCC f u l l y
F e d e r a l R e s e r v e d o e s n o t a u t o m a t i c a l l y d e d u c t any
appropriateness
differ
intangible
a s s e t s other than goodwill)
regulatory capital
intangibles
identifiable
an
intangibles
i n w h i c h c a s e t h e y may b e i n c l u d e d
in
capital.
All the agencies specify limits
intangibles that
institutions
can i n c l u d e
f o r t h e amount
in capital.
of
T h e OCC
172
14 p e r m i t s FMSRs t o a c c o u n t f o r u p t o 2 5 p e r c e n t o f T i e r 1
capital,
w h i l e t h e FDIC p e r m i t s t h e m t o a c c o u n t f o r u p t o 5 0 p e r c e n t
Tier 1.
T h e OTS a l s o p e r m i t s PMSRs t o b e i n c l u d e d u p t o
percent of Tier 1 capital
(e.g.,
CDIs)
and l i m i t s o t h e r q u a l i f y i n g
t o 25 p e r c e n t o f T i e r 1 c a p i t a l .
current risk-based capital
intangible
assets
assets will
in excess of
particularly
close
guidelines
be monitored,
50
intangibles
Board's
indicate that while
identifiable
25 p e r c e n t o f T i e r 1 c a p i t a l
all
intangible
are subject
to
scrutiny.
T h e FDIC a n d OTS a l s o s u b j e c t
v a l u a t i o n and d i s c o u n t i n g r e q u i r e m e n t s .
institutions
The
of
PMSRs t o
certain
These a g e n c i e s
t o determine t h e f a i r market v a l u e of
require
PMSRs b y
a p p l y i n g an a p p r o p r i a t e market d i s c o u n t r a t e t o t h e n e t
servicing
cash flows,
in
original
taking
i n t o a c c o u n t any s i g n i f i c a n t c h a n g e s
v a l u a t i o n assumptions such a s prepayment e s t i m a t e s .
FDIC a n d OTS r u l e s a l s o r e q u i r e t h a t t h e b o o k v a l u e o f
reviewed quarterly.
be recognized
If
for inclusion
in regulatory capital,
it
must
treatment of
the banking a g e n c i e s have been
identifiable
intangible
review,
for capital
the staff
in
adequacy purposes.
i s proposing to
comment r e v i s i o n s t o t h e B o a r d ' s c a p i t a l
reviewing
assets with
a i m o f d e v e l o p i n g g r e a t e r u n i f o r m i t y among t h e a g e n c i e s
treatment of these a s s e t s
b a s i s of t h i s
carry
their
income.
For some t i m e ,
the capital
PMSRs b e
a n i n s t i t u t i o n w i s h e s t o a l l o w PMSRs t o
them a t a book v a l u e e q u a l t o t h e d i s c o u n t e d v a l u e o f
future net servicing
The
issue
for
the
the
On t h e
public
adequacy g u i d e l i n e s
to
173
14 provide e x p l i c i t
g u i d a n c e on t h e t y p e s o f
intangible assets
s t a t e member b a n k s a n d b a n k h o l d i n g c o m p a n i e s may i n c l u d e
capital
and s p e c i f i c a t i o n s on a p p r o p r i a t e l i m i t s w i t h i n
The p r o p o s a l ,
which i s
Register notice,
treatment of
i s b a s e d on a t e n t a t i v e a g r e e m e n t on
is
t h e FDIC,
in the capital
The p r o p o s a l
permitted to
states
capital
in the aggregate,
Amounts o f
as a l l
t h e amount o f t h e s e a s s e t s
proposal
provided
25 p e r c e n t o f
assets,
ratios.
As s e t
attached Federal Register notice,
r e f l e c t s the interagency
not
PCCRs
Tier
PMSRs a n d PCCRs i n e x c e s s o f t h e s e a m o u n t s ,
intangible
be
that,
included does
an o r g a n i z a t i o n ' s T i e r 1 c a p i t a l .
other identifiable
regulatory capital
intangible
banking
t h a t banking o r g a n i z a t i o n s would
would be d e d u c t e d from T i e r 1 f o r p u r p o s e s o f
1 capital
The
is
these
standards.
would be s u b j e c t t o a s e p a r a t e s u b l i m i t of
l.
the
The p r o p o s a l
treatment of these a s s e t s .
i n c l u d e PMSRs a n d PCCRs i n c a p i t a l ,
e x c e e d 50 p e r c e n t o f
well
the
i n o r d e r t o a c h i e v e u n i f o r m i t y among t h e
consistent with international
2
capital.
reached by t h e s t a f f s of
t h e OCC, a n d t h e OTS.
in
Federal
f o r p u b l i c comment o n a c o o r d i n a t e d b a s i s w i t h
other agencies
agencies
forth in the attached draft
intangible assets
Federal Reserve,
released
set
that
including
as
CDIs,
calculating
f o r t h i n more d e t a i l
in
the
t h e e x c l u s i o n o f CDIs f r o m T i e r
staff
consensus that
a s s e t s h a v e many o f t h e c h a r a c t e r i s t i c s
of
these
goodwill
2
F o r p u r p o s e s o f c a l c u l a t i n g t h e l i m i t a t i o n s o n PMSRs a n d
PCCRs i n c l u d a b l e i n c a p i t a l a s a p e r c e n t a g e o f T i e r 1 c a p i t a l ,
T i e r 1 i s d e f i n e d a s t h e sum o f c o r e c a p i t a l e l e m e n t s n e t o f
g o o d w i l l a n d i d e n t i f i a b l e i n t a n g i b l e a s s e t s o t h e r t h a n PMSRs a n d
PCCRs.
174
14 and t h a t t h e i r v a l u e t e n d s t o f a l l
s i g n i f i c a n t l y when a
depository
financial
institution
experiences
Staff b e l i e v e s that t h i s proposal
difficulty.
represents
r e a s o n a b l e c o m p r o m i s e among t h e b a n k i n g a g e n c i e s '
w i t h r e g a r d t o t h e t y p e s and amounts o f
may b e i n c l u d e d i n c a p i t a l .
approach o f f e r s a b a s i s
banking a g e n c i e s
current
intangible
In s t a f f ' s view,
the
a
treatment of
that
proposed
f o r a c h i e v i n g c o n s i s t e n c y among
in their capital
rules
assets
the
identifiable
intangible assets while preserving the integrity
of the
capital
definition.
The p r o p o s a l a l s o d e a l s w i t h t h e v a l u a t i o n o f
PMSRs
c o n s i s t e n t w i t h p r o v i s i o n s o f t h e FDIC I m p r o v e m e n t A c t o f
which was r e c e n t l y s i g n e d i n t o law.
requires that the value of
institution's
capital
S e c t i o n 475 o f t h e
Act
PMSRs i n c l u d e d i n c a l c u l a t i n g
n o t e x c e e d 90 p e r c e n t o f t h e i r
1991,
an
fair
market
v a l u e and t h a t s u c h v a l u e b e d e t e r m i n e d a t l e a s t q u a r t e r l y .
In
o r d e r t o implement t h e v a l u a t i o n p r o v i s i o n s o f s e c t i o n 475 and
the
interests
of
achieving consistency
in the treatment
i n t a n g i b l e a s s e t s among t h e b a n k i n g a g e n c i e s ,
that
of
the proposal
i n s t i t u t i o n s must d e t e r m i n e t h e f a i r market v a l u e and
b o o k v a l u e o f t h e i r PMSRs a t l e a s t q u a r t e r l y i n a c c o r d a n c e
the criteria
states
the
with
d i s c u s s e d a b o v e t h a t t h e FDIC a n d OCC c u r r e n t l y
e m p l o y i n t h e i r r u l e s r e g a r d i n g FMSRs.
The p r o p o s a l
also
i n d i c a t e s t h a t the discount rate used for the c a l c u l a t i o n of
v a l u e should not be l e s s than t h a t derived a t the time
acquisition,
in
book
of
b a s e d upon t h e e s t i m a t e d c a s h f l o w s and t h e
price
175
14 paid for the a s s e t a t the time of
purchase.
I n o r d e r t o i m p l e m e n t t h e d i s c o u n t o n PMSRs
under s e c t i o n 475,
calculating
purposes),
the proposal
regulatory capital
t h e amount o f
states that,
required
for purposes
(but not f o r f i n a n c i a l
statement
PMSRs r e p o r t e d o n t h e b a l a n c e
a s s e t would be reduced t o t h e l e s s e r
of
sheet
of:
(i)
9 0 p e r c e n t o f t h e f a i r m a r k e t v a l u e o f t h e PMSRs;
or
(ii)
90 p e r c e n t o f t h e o r i g i n a l p u r c h a s e p r i c e p a i d f o r
PMSRs; o r
the
(iii)
100 p e r c e n t o f t h e remaining u n a m o r t i z e d book v a l u e
t h e PMSRs.
of
T h i s d i s c o u n t i n g a p p r o a c h i s t h e same a s t h a t w h i c h
FDIC a n d OTS c u r r e n t l y
associations
r e q u i r e s t a t e nonmember b a n k s a n d
t o apply t o t h e i r holdings of
PMSRs.
Staff
is
p r o p o s i n g t h a t t h e B o a r d s e e k s p e c i f i c p u b l i c comment o n
the
approach d i s c u s s e d above t o t h e v a l u a t i o n and d i s c o u n t i n g
PMSRs i n c l u d a b l e
in
at least as subjective
as i t
is
f o r PMSRs, t h e
a l s o w o u l d r e q u i r e t h a t PCCRs b e s u b j e c t t o a d i s c o u n t .
to achieve consistency
intangible
assets
in the valuation of
included
in capital,
t h a t banking o r g a n i z a t i o n s w i l l
for
proposal
In
the proposal
indicates
a l s o be required t o determine
u s i n g t h e same c r i t e r i a
In t h i s connection,
the
the
least
as those proposed f o r
PMSRs,
a n d t o s u b j e c t t h e i r PCCRs t o t h e s a m e v a l u e a d j u s t m e n t a s
p r o p o s e d f o r PMSRs.
order
identifiable
f a i r m a r k e t v a l u e a n d b o o k v a l u e o f t h e i r PCCRs a t
quarterly,
for
capital.
S i n c e t h e c a l c u l a t i o n of t h e f a i r market v a l u e
PCCRs i s
the
savings
proposal
that
176
14 specifically
s e e k s p u b l i c comment o n t h i s a p p r o a c h t o
v a l u a t i o n and d i s c o u n t i n g
Staff
is
f o r PCCRS.
a l s o proposing that the suggested changes
the capital
treatment of
the capital
r a t i o s u s e d f o r b o t h e x a m i n a t i o n s and
purposes.
i n t a n g i b l e a s s e t s be incorporated
Consistent with the Board's e x i s t i n g
guidelines,
however,
ratios
deducting a l l
in assessing
overall
Attachment
into
capital
tangible capital
intangibles)
its
i f warranted by t h e c o n d i t i o n o f t h e
in
applications
t h e B o a r d may i n c e r t a i n c a s e s c o n t i n u e
e v a l u a t e an o r g a n i z a t i o n ' s
adequacy,
the
(after
capital
organization.
to
177
Attachment
FEDERAL RESERVE SYSTEM
12 CFR P a r t s 2 0 8 a n d 2 2 5
[ R e g u l a t i o n H, R e g u l a t i o n Y; D o c k e t N o .
Capital;
C a p i t a l Adequacy
]
Guidelines
AGENCY:
Board o f Governors o f t h e F e d e r a l R e s e r v e
ACTION:
Notice of
Proposed Revisions t o Capital
System.
Adequacy
Guidelines.
SUMMARY:
The Board i s
s e e k i n g comment o n a p r o p o s a l t o
the Federal Reserve's c a p i t a l
adequacy g u i d e l i n e s
for
h o l d i n g c o m p a n i e s a n d s t a t e member b a n k s t o p r o v i d e
g u i d a n c e on t h e t y p e s o f
(i.e.,
not deducted)
limits
in the Tier .1-capital
purposes.
in capital.
The p r o p o s a l ,
conjunction with the s t a f f s of the
included
calculation
The p r o p o s a l
for
also
and d i s c o u n t s t h a t would be a p p l i c a b l e t o s u c h
includable
is
explicit
i n t a n g i b l e a s s e t s t h a t may b e
b a s e d and l e v e r a g e c a p i t a l
revise
bank
risk-
includes
intangibles
which was d e v e l o p e d
four f e d e r a l banking
in
agencies,
a i m e d a t a c h i e v i n g g r e a t e r c o n s i s t e n c y among t h e a g e n c i e s
respect to the capital
being released
The p r o p o s a l
capital
i s consistent with
with
the
purchased mortgage s e r v i c i n g
and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
be includable
with
is
standards.
Under t h e p r o p o s a l ,
("PMSRs")
i n t a n g i b l e a s s e t s and
f o r p u b l i c comment o n a c o o r d i n a t e d b a s i s
these agencies.
international
treatment of
in the Tier 1 capital
("PCCRs")
rights
would
computation provided t h a t ,
in
178
n
the aggregate,
capital
t h e y do not exceed a l i m i t of
p e r c e n t of T i e r 1.
well
50 p e r c e n t o f T i e r
a n d p r o v i d e d t h a t PCCRs n o t e x c e e d a s u b l i m i t o f
PMSRs a n d PCCRs i n e x c e s s o f t h e s e l i m i t s ,
as core deposit
intangible assets,
capital
elements
intangibles
("CDIs")
and a l l
Deposit Insurance Corporation
n
( FDIC )
core
capital.
In order 'to implement a p r o v i s i o n of t h e
N
Federal
Improvement A c t o f
1991
a n d t o c o n f o r m t o t h e c u r r e n t r u l e s o f t h e FDIC a n d t h e O f f i c e
Thrift Supervision
institutions
1
COTS' ),
t h e Board a l s o
i s proposing
certain criteria.
In a d d i t i o n ,
regulatory capital
(but not f o r f i n a n c i a l
in accordance
for purposes of
statement
90 p e r c e n t o f t h e i r o r i g i n a l
o r 100 p e r c e n t or r e m a i n i n g unamortized book
The p r o p o s a l
with
purposes),
FMSRs
r e p o r t e d on t h 4 b a l a n c e s h e e t t o t h e l e s s e r o f 90 p e r c e n t
price,
of
purchase
value.
s t a t e s t h a t o r g a n i z a t i o n s must
also
d e t e r m i n e t h e f a i r m a r k e t v a l u e a n d b o o k v a l u e o f PCCRs a t
quarterly,
in accordance with certain c r i t e r i a ,
and
calculating
i n s t i t u t i o n s w o u l d b e r e q u i r e d t o r e d u c e t h e amount o f
f a i r market v a l u e ,
of
that
be r e q u i r e d t o determine t h e f a i r market v a l u e
b o o k v a l u e o f t h e i r PMSRs a t l e a s t q u a r t e r l y
their
as
other
w o u l d b e d e d u c t e d f r o m t h e sum o f t h e
in determining Tier 1
1
25
least
and s u b j e c t
PCCRs
t o t h e s a m e v a l u e a d j u s t m e n t a s t h a t p r o p o s e d f o r PMSRs.
The
Board i s
valuing
specifically
and d i s c o u n t i n g
s e e k i n g comment o n t h i s
The p r o p o s e d c h a n g e s i n t h e c a p i t a l
i n t a n g i b l e a s s e t s would be i n c o r p o r a t e d
approach t o
PMSRs a n d PCCRs.
treatment
into the capital
of
ratios
179
14 u s e d f o r b o t h e x a m i n a t i o n s and a p p l i c a t i o n s p u r p o s e s .
Consistent
with the Board's e x i s t i n g capital
the
guidelines,
however,
Board
may i n c e r t a i n c a s e s c o n t i n u e t o e v a l u a t e a n
organization's
tangible capital
intangibles)
assessing
its
overall
condition of the
DATE:
ratios
(after deducting a l l
capital
adequacy,
if
warranted by
in
the
organization.
Comments o n t h e p r o p o s e d r e v i s i o n s t o t h e F e d e r a l
Board's risk-based c a p i t a l
guidelines
guidelines
and l e v e r a g e
s h o u l d b e s u b m i t t e d on o r b e f o r e
Reserve
capital
[30 days
after
publication].
ADDRESS:
Comments,
w h i c h s h o u l d r e f e r t o d o c k e t No.
b e m a i l e d t o Mr. W i l l i a m .W. W i l e s ,
of t h e Federal Reserve System,
Avenues,
2223,
N.W.,
Washington,
Eccles Building,
Board o f
2 0 t h S t r e e t and
D.C.
Governors
Constitution
2 0 5 5 1 ; o r d e l i v e r e d t o Room B -
between 8
Comments may b e i n s p e c t e d
5:00 p.m. weekdays,
Secretary,
, may
a.m.
and 5 : 1 5 p.m.
weekdays.
i n Room B - 1 1 2 2 b e t w e e n 9 : 0 0 a . m .
except as provided in section 2612.8
Board's Rules Regarding A v a i l a b i l i t y
of
Information,
of
and
the
12 CFR
261.8.
FOR FURTHER INFORMATION CONTACT:
Rhoger H Pugh,
Manager
(202/728-5883),
N o r a h M. B a r g e r ,
Supervisory Financial
Analyst
(202/452-2402),
C h a r l e s H. Holm, S u p e r v i s o r y F i n a n c i a l
Analyst
(202/452-3502),
Division of
Banking S u p e r v i s i o n and
Regulation;
180
14 a n d S c o t t G. A l v a r e z ,
Legal D i v i s i o n .
A s s o c i a t e General Counsel
(202/452-3583),
For t h e h e a r i n g impaired o n l y .
D e v i c e f o r t h e Deaf
(TDD),
D o r o t h e a Thompson
Telecommunication
(202/452-3544).
SUPPLEMENTARY INFORMATION:
I.
Background
The Board i s p r o p o s i n g t o r e v i s e t h e F e d e r a l
capital
adequacy g u i d e l i n e s
member b a n k s t o p r o v i d e e x p l i c i t
g u i d a n c e on t h e t y p e s
i n t a n g i b l e a s s e t s t h a t may b e i n c l u d e d i n
from)
the Tier 1 capital
capital
calculation
(i^e.,
not
deducted
leverage
p u r p o s e s and t h e l i m i t s and d i s c o u n t s t h a t w o u l d
in capital.
be
The
i s b a s e d on a t e n t a t i v e ^agreement on t h e t r e a t m e n t
intangible
assets
r e a c h e d by t h e s t a f f s o f t h e F e d e r a l
t h e FDIC, t h e O f f i c e o f t h e C o m p t r o l l e r o f
a n d t h e OTS.
It
i s being released
coordinated basis with these other agencies
international
i n a manner t h a t
capital
the Currency
in order t o
in the capital
i s consistent with
standards
of
Reserve,
("OCC),
f o r p u b l i c comment o n a
u n i f o r m i t y among t h e b a n k i n g a g e n c i e s
these assets
state
of
f o r r i s k - b a s e d and
a p p l i c a b l e t o such i n t a n g i b l e s includable
proposal
Reserve's
f o r bank h o l d i n g c o m p a n i e s and
(Basle
Accord).
achieve
treatment
of
the
1
x
The B a s l e A c c o r d i s a r i s k - b a s e d c a p i t a l f r a m e w o r k t h a t w a s
p r o p o s e d by t h e
Basle
Committee on Banking R e g u l a t i o n s
and
S u p e r v i s o r y P r a c t i c e s and e n d o r s e d by t h e c e n t r a l bank g o v e r n o r s o f
t h e Group o f Ten (G-10) c o u n t r i e s i n J u l y 1 9 8 8 .
The Committee i s
c o m p r i s e d o f r e p r e s e n t a t i v e s o f t h e c e n t r a l b a n k s and s u p e r v i s o r y
authorities
from t h e G-10 c o u n t r i e s
(Belgium,
Canada,
France
Germany, I t a l y , J a p a n , N e t h e r l a n d s , Sweden, S w i t z e r l a n d , t h e U n i t e d
Kingdom, and t h e U n i t e d S t a t e s ) and Luxembourg.
181
14 The B a s l e A c c o r d r e q u i r e s t h a t b a n k s d e d u c t
from t h e i r c o r e c a p i t a l
for risk-based capital
by i t s
purposes.
2
adopted by t h e F e d e r a l R e s e r v e f o r a l l
s i m i l a r t o t h e B a s l e Accord t o U.S.
was
s t a t e member b a n k s .
In
bank h o l d i n g
Under t h i s
companies,
s t a n d a r d f o r s t a t e member b a n k s a n d b a n k h o l d i n g
ratio,
i s deducted f r t a f t h e core c a p i t a l
also
leverage
elements
standard.
The B a s l e A c c o r d d o e s n o t a d d r e s s t h e t r e a t m e n t
intangible
assets
intangible assets.
discretion
Tier
capital
companies.
s e r v e s a s t h e numerator of t h e
for purposes of the leverage
bank
from
t h e B o a r d hatf a d o p t e d a l e v e r a g e
Since Tier 1 capital
goodwill
framework
framework,
holding companies are a l s o required t o deduct goodwill
Furthermore,
which
a c t i v e banks,
t h e Board c h o s e t o a p p l y a r i s k - b a s e d c a p i t a l
g e n e r a l l y on a c o n s o l i d a t e d b a s i s . 3
1 capital.
capital
The B a s l e f r a m e w o r k ,
terms a p p l i e s only t o i n t e r n a t i o n a l l y
addition,
goodwill
elements in determining Tier 1
other than goodwill,
Consequently,
U.S.
that
is,
of
identifiable
bank r e g u l a t o r s
in s p e c i f y i n g the treatment of t h e s e other
have
intangible
^ h e risk-based c a p i t a l g u i d e l i n e s u t i l i z e the r a t i o of a
banking o r g a n i z a t i o n ' s T i e r 1 c a p i t a l , which i s composed o f c o r e
c a p i t a l e l e m e n t s s u c h a s common a n d p e r p e t u a l p r e f e r r e d s t o c k , a n d
T i e r 2 c a p i t a l , which i s composed o f supplementary c a p i t a l e l e m e n t s
s u c h a s t h e a l l o w a n c e f o r l o a n and l e a s e l o s s e s and s u b o r d i n a t e d
d e b t , t o t h e o r g a n i z a t i o n ' s t o t a l o n - b a l a n c e s h e e t a s s e t s and o f f balance c r e d i t arrangements, adjusted for t h e i r r e l a t i v e r i s k s .
a
For bank h o l d i n g companies w i t h c o n s o l i d a t e d a s s e t s o f l e s s
than $150 m i l l i o n i n a s s e t s , t h e r i s k - b a s e d c a p i t a l
guidelines
g e n e r a l l y a r e a p p l i e d on a b a n k - o n l y b a s i s .
*The l e v e r a g e c a p i t a l g u i d e l i n e s u t i l i z e a r a t i o o f t h e b a n k ' s
Tier 1 capital elements t o i t s t o t a l on-balance sheet a s s e t s .
182
15 *
assets,
spirit
provided t h a t such treatment
of t h e Basle Accord.
i s consistent with
F e d e r a l R e s e r v e and t h e o t h e r U . S .
determining the treatment of
banking agencies
identifiable
The r e l i a b i l i t y
and p r e d i c t a b i l i t y
assets
a s s o c i a t e d w i t h t h e a s s e t and t h e d e g r e e o f
2.
3.
life
and
certainty
determining
i.e,
an a c t i v e and l i q u i d m a r k e t ;
and
The s a l a b i l i t v
i.e.,
of the a s s e t ,
of
the f e a s i b i l i t y
of
organization
assets.
A l l t h e a g e n c i e s h a v e d e t e r m i n e d t h a t PMSRs
subject to certain
and a l l
limits.
allow such a s s e t s
generally
in Tier 1
capital,
The a g e n c i e s d i f f e r o n t h e e x t e n t
which o t h e r i n t a n g i b l e s meet t h e c r i t e r i a
d i f f e r e n t procedures regarding t h e i r
and f o l l o w
t h a n PMSRs f r o m T i e r 1 c a p i t a l .
somewhat
intangibles
other
The F e d e r a l R e s e r v e d o e s
a u t o m a t i c a l l y d e d u c t any i d e n t i f i a b l e
to
treatment.
T h e FDIC a n d OCC f u l l y d e d u c t a l l
1 capital,
the
the existence
s e l l i n g t h e a s s e t a p a r t from t h e banking
meet t h e s e c r i t e r i a
flows
value;
The m a r k e t a b i l i t y o f t h e a s s e t ,
o r from t h e bulkvctfi^its
has
criteria:
of any c a s h
t h a t can be a c h i e v e d i n p e r i o d i c a l l y
asset's useful
the
in
intangible
b e e n t o e v a l u a t e them on t h e b a s i s o f t h e f o l l o w i n g
1.
the
The b a s i c a p p r o a c h t a k e n b y
not
intangible asset
from T i e r
but determines the appropriateness of t h e i r
inclusion
i n t h e c a l c u l a t i o n o f an o r g a n i z a t i o n ' s
capital
case-by-case basis.
intangible assets
Because even those
meet t h e above c r i t e r i a
p o s i t i o n on a
generally contain a high degree of
that
risk,
183
15
*
t h e Board h a s l o n g c o n s i d e r e d t h e l e v e l
identifiable
and o v e r a l l
intangible assets
identifiable
at
least
i n some c a s e s ,
intangible assets
and,
therefore,
(e.g.,
certain
CDIs)
adequacy
T h e OTS h a s
other
may m e e t t h e
three
has not required the deduction of
of these other i d e n t i f i a b l e
capital
of
in assessing the capital
a s s e t q u a l i t y of banking i n s t i t u t i o n s .
concluded that,
criteria
and q u a l i t y
intangible assets
in
some
calculating
ratios.
All
intangibles
the agencies specify limits
that
institutions
f o r t h e amount
can include i n c a p i t a l .
of
T h e 0CC
p e r m i t s PMSRs t o a c c o u n t f o r u p t o 2 5 p e r c e n t o f T i e r 1
capital.
T h e OTS p e r m i t s PMSRs t o b e i n c l u d e d u p t o 5 0 p e r c e n t o f T i e r
capital,
and o t h e r q u a l i f y i n g i n t a n g i b l e s
l i m i t e d t o 25 p e r c e n t o f T i e r 1 c a p i t a l .
up t o 50 p e r c e n t o f T i e r 1 c a p i t a l ,
based c a p i t a l
assets will
excess of
guidelines
identifiable
T h e FDIC p e r m i t s
intangible
scrutiny,
o f PMSRs.
in
to
and
means.
valuation
f o r d e t e r m i n i n g t h e f a i r m a r k e t v a l u e and book
In addition,
purposes of c a l c u l a t i n g
statement purposes)
sheet will
assets
are subject
T h e FDIC a n d t h e OTS a l s o i m p o s e c e r t a i n
requirements
their capital
(but not f o r
t h e a m o u n t o f PMSRs r e p o r t e d o n t h e
be reduced t o the l e s s e r
rules state that
regulatory capital
of:
PMSRs
risk-
intangible
both through t h e i n s p e c t i o n
e x a m i n a t i o n p r o c e s s and by o t h e r a p p r o p r i a t e
1
are
The B o a r d ' s c u r r e n t
25 p e r c e n t o f T i e r 1 c a p i t a l
close
CDIs)
i n d i c a t e "^that w h i l e a l l
be monitored,
particularly
(e.g.,
value
for
financial
balance
184
14 (i)
9 0 p e r c e n t o f t h e f a i r m a r k e t v a l u e o f t h e PMSRs;
(ii)
90 p e r c e n t o f t h e o r i g i n a l
PMSRs;
(iii)
purchase price paid for
t h e banking a g e n c i e s have been
treatment of
identifiable
intangible
b a s i s of t h i s review,
for capital
provide e x p l i c i t
capital
the
for
to
intangible assets
and s p e c i f i c a t i o n s on
the
On t h e
adequacy g u i d e l i n e s
g u i d a n c e on t h e t y p e s o f
in capital
limits within capital.
in
adequacy purposes.
t h e B o a r d i s now p r o p o s i n g t o i s s u e
p u b l i c comment r e v i s i o n s t o i t s
may b e i n c l u d e d
reviewing
assets with
a i m o f d e v e l o p i n g g r e a t e r u n i f o r m i t y among t h e a g e n c i e s
treatment of these a s s e t s
that
appropriate
The p r o D o s e d r e v i s i o n s a r e b a s e d on a
a g r e e m e n t r e a c h e d by. t h e - s t a f f s o f t h e f o u r
federal
banking a g e n c i e s w i t h respect) 'to t h e r e g u l a t o r y c a p i t a l
intangible
of
PMSRs.
For some t i m e ,
the capital
of
the
or
100 p e r c e n t o f t h e r e m a i n i n g u n a m o r t i z e d book v a l u e
the
tentative
or
treatment
assets.
T h e F e d e r a l R e s e r v e i s a l s o p r o p o s i n g t h a t PMSRs b e
subject t o c e r t a i n valuation requirements that are
w i t h p r o v i s i o n s o f t h e FDIC I m p r o v e m e n t A c t o f
c u r r e n t FDIC a n d OTS r u l e s r e g a r d i n g PMSRs.
The A c t
t h a t t h e v a l u e o f r e a d i l y m a r k e t a b l e PMSRs i n c l u d e d
calculation
of
an i n s t i t u t i o n ' s
capital
consistent
1991 and w i t h
requires
in
the
n o t e x c e e d 90 p e r c e n t
their
f a i r m a r k e t v a l u e and t h a t s u c h v a l u e b e d e t e r m i n e d
least
quarterly.
s e t down c r i t e r i a
the
T h e c u r r e n t FDIC a n d OTS r u l e s r e g a r d i n g
of
at
PMSRs
f o r d e t e r m i n i n g both t h e f a i r market v a l u e
and
185
18
book v a l u e o f t h e s e a s s e t s .
Since the calculation of the
m a r k e t v a l u e f o r PCCRs i s a t l e a s t a s s u b j e c t i v e t h a n i t
fair
is
for
PMSRs, t h e F e d e r a l R e s e r v e i s a l s o p r o p o s i n g t h a t PCCRs b e
s u b j e c t t o t h e s a m e v a l u a t i o n r e q u i r e m e n t s a s PMSRs.
The p r o p o s e d c h a n g e s i n t h e c a p i t a l
treatment
of
i n t a n g i b l e a s s e t s would be incorporated i n t o t h e c a p i t a l
u s e d f o r b o t h e x a m i n a t i o n s and a p p l i c a t i o n s p u r p o s e s .
with the Board•s,existing capital guidelines,
ratios
Consistent
however,
the
Board
may i n c e r t a i n c a s e s c o n t i n u e t o e v a l u a t e a n
organization's
tangible capital
intangibles)
assessing
its
ratios
overall capital
condition of the
II.
(after deducting.all
adequacy,
i f ^ w a r r a n t e d by
in
the
organization.
Proposal
The Board i s p r o p p s i n g t h e f o l l o w i n g t r e a t m e n t
identifiable
intangioie assets
leverage capital
1.
PMSRs a n d PCCRs w o u l d b e c o n s i d e r e d
As s u c h ,
d e d u c t e d from c a p i t a l
qualifying
t h e y would not have t o
provided that,
in the
p r o v i d e d t h a t PCCRs d o n o t e x c e e d a s u b l i m i t o f
percent of Tier 1 c a p i t a l .
PMSRs a n d PCCRs i n
o f t h e s e l i m i t s would be d e d u c t e d from t h e c o r e
elements
in determining Tier 1
be
aggregate,
t h e y d o n o t e x c e e d 50 p e r c e n t o f T i e r 1 c a p i t a l
and
25
excess
capital
capital.
T h e l i m i t s o n PMSRs a n d PCCRs w o u l d b e b a s e d o n a
and
guidelines:
intangible assets.
2.
for
for purposes of the risk-based
186
18
percentage of Tier 1 capital
these a s s e t s are deducted,
before excess holdings
but a f t e r goodwill
other nonqualifying identifiable
(e.g.,
COIs)
are
intangible
and
deducted.
market v a l u e and t o r e v i e w t h e book v a l u e o f
PMSRs a n d PCCRs a t l e a s t q u a r t e r l y .
fair
their
Banking
organizations that wish t o include these a s s e t s
will
in
b e n o t b e a b l e t o c a r r y them a t a book
value that exceeds the discounted value of t h e i r
net
all
assets
I n s t i t u t i o n s would be required t o determine t h e
capital
of
future
income.
For p u r p o s e s o f c a l c u l a t i n g
for financial
regulatory capital
s t a t e m e n t purposes.) t h e amount o f
a n d PCCRs r e p o r t e d
price,
90 p e r c e n t of t h e i r o r i g i n a l
o r 100 p e r c e n t o f t h e i r r e m a i n i n g
book v a l u e .
The Board i s
not
PMSRs
t&hewbalance s h e e t a s s e t w o u l d
reduced t o t h e l e s s e r o f 90 p e r c e n t o f t h e i r
market v a l u e ,
(but
be
fair
purchase
unamortized
seeking s p e c i f i c
public
comment o n t h e p r o p o s e d a p p r o a c h t o d i s c o u n t i n g
PMSRs
a n d PCCRs, w h i c h i s c u r r e n t l y e m p l o y e d b y t h e FDIC a n d
t h e OTS f o r PMSRs.
CDIs and a l l
other identifiable
intangible assets
be d e d u c t e d from t h e c o r e c a p i t a l
o f c a l c u l a t i n g an i n s t i t u t i o n ' s
as,
elements
Tier 1 capital,
i n accordance with the Basle Accord,
deducted.
for
would
purposes
just
goodwill
is
187
18
I n c l u d i n g a n d L i m i t i n g PMSRs a n d PCCRs w i t h i n
Capital
T h e B o a r d b e l i e v e s t h a t PMSRs a n d PCCRs f o r t h e
part meet t h e t h r e e c r i t e r i a
outlined
that the agencies use to evaluate
Thus,
deduction of
such a s s e t s
in the previous
identifiable
intangible
r i s k - b a s e d and l e v e r a g e c a p i t a l
and s a l a b i l i t y
believes
f a i r l y a c t i v e and l i q u i d m a r k e t s e x i s t
intangible assets,
and t h u s i t
Since the r e l i a b i l i t y
the
Board
f o r PMSRs
i»\feasible to sell
a s s e t s a p a r t from t h e banking o r g a n i z a t i o n
assets.
the
be
limits.
that pertain to
marketability
card p o r t f o l i o s ,
of
the
r a t i o s g e n e r a l l y would n o t
With r e g a r d t o t h e two c r i t e r i a
and c r e d i t
assets.
for purposes of c a l c u l a t i n g
n e c e s s a r y p r o v i d e d t h e s e a s s e t s do n o t e x c e e d s p e c i f i e d
that
most
section
pr t h e b u l k o f
these
its
of cash f l o w s *nd market v a l u e
t h e s e a s s e t s can vary s i g n i f i c a n t l y ,
however,
t h e Board
of
is
p r o p o s i n g t o l i m i t t h e a m o u n t o f PMSRr a n d PCCRs i n c l u d a b l e
in
capital.
The u n c e r t a i n t y . a s s o c i a t e d w i t h t h e c a s h f l o w s
market v a l u e of
level
of
PMSRs s t e m s f r o m t h e f a c t t h a t c h a n g e s
interest
in
the
r a t e s c a n h a v e a s i g n i f i c a n t e f f e c t on m o r t g a g e
prepayment e x p e c t a t i o n s .
of
and
Furthermore,
t h e c a s h f l o w s and
value
PMSRs a r e a f f e c t e d b y c r e d i t q u a l i t y r i s k s a n d o p e r a t i n g
a s s o c i a t e d with mortgage s e r v i c i n g r i g h t s .
Because the
servicer
i s generally obligated t o provide a steady cash flow to the
o f t h e m o r t g a g e and u n d e r t a k e normal c o l l e c t i o n
foreclosure,
efforts
t h e s e r v i c e r can incur a s i g n i f i c a n t
c o l l e c t i o n and a d m i n i s t r a t i v e
owner
and
increase
c o s t s when a m o r t g a g e
risks
becomes
in
188
18
delinquent.
In a d d i t i o n ,
u n d e r some a r r a n g e m e n t s ,
"recourse" s e r v i c i n g arrangements,
t h e repayment of t h e l o a n s .
The a b i l i t y
t h e loans can have t h e g r e a t e s t
servicing
in such
known
the servicer also
as
guarantees
of borrowers t o
impact on t h e v a l u e o f
repay
the
arrangements.
T h e v a l u e a n d c a s h f l o w s a s s o c i a t e d w i t h PCCRs,
t h o s e a s s o c i a t e d w i t h PMSRs, a r e a f f e c t e d b y c h a n g e s i n
r a t e s and c r e d i t q u a l i t y
a f f e c t e d by t h e amount o f
lines
of credit?
factors.
They a l s o can be
like
interest
significantly
f u t u r e borrowings under t h e c r e d i t
the attrition
r a t e , t h e
rate at
c r e d i t c a r d h o l d e r s t e r m i n a t e theis£ r e l a t i o n s h i p s ,
which could
d u e t o t h e f a i l u r e o f t h e banfc t o o f f e r c o m p e t i t i v e t e r m s
features;
and o t h e r
card
which
be
and
factors.
G i v e n - t h e v o l a t i l i t y -of t h e c a s h f l o w s a n d m a r k e t
v a l u e s a s s o c i a t e d 'witfc PMSgs a n d PCCRs, t h e B o a r d i s
t h a t t h e a g g r e g a t e ilmednt o f
such a s s e t s
l i m i t e d t o 50 p e r c e n t o f T i e r 1 c a p i t a l .
value of
includable
in capital
Furthermore,
since
PCCRs i s d e p e n d e n t u p o n many a s s u m p t i o n s a n d t h e
f o r PCCRs i s
sublimit of
25 p e r c e n t o f T i e r 1 c a p i t a l .
which t h i s proposal
market
assets
identifiable
t h e Board
f o r a banking o r g a n i z a t i o n
intangible assets,
in
believes
to
i n an amount t h a t w o u l d c a u s e i t s
total
i n c l u d i n g PMSRs a n d
PCCRs, t o e x c e e d 2 5 p e r c e n t o f T i e r 1 c a p i t a l ,
separate
During t h e p e r i o d
i s o u t f o r p u b l i c comment,
i t would be i n a d v i s a b l e
acquire intangible
holdings of
be
the
l e s s m a t u r e a n d l i q u i d t h a n t h e m a r k e t f o r PMSRs,
t h e B o a r d i s p r o p o s i n g t h a t PCCRs b e s u b j e c t t o a
that
proposing
above which
limit
189
18
intangible
assets
are subject to particularly c l o s e
under t h e Board's current r i s k - b a s e d c a p i t a l
In order t o provide
these
limits,
f o r a s i m p l e method o f
that
is,
before excess holdings of
assets
are deducted,
t h e sum o f c o r e c a p i t a l
(e.g.,
common a n d p e r p e t u a l p r e f e r r e d e q u i t y )
other nonqualifying intangible assets.
calculation could result
in the inclusion
a n a m o u n t f a r g r e a t e r t h a n 25 p e r c e n t ,
df ^ i e r
PMSRs a n d PCCRs.
institution
PMSRs a n d PCCRs e x c e e d t h e sum o f
Accordingly,^the
language t o
its
holdings of
intangible
capital
and
adequacy g u i d e l i n e s
assets
for
regarding
included in capital,
of
deductible
an
its
elements.
cautionary
excessive
w h i c h may b e
practice.
S e c t i o n 4 7 5 o f t h e FOIC I m p r o v e m e n t A c t o f
an i n s t i t u t i o n ' s
capital
PMSRs i n c l u d e d
52-418 - 92 - 7
1991
in the calculation
n o t e x c e e d 90 p e r c e n t o f t h e i r
d e t e r m i n e d on a q u a r t e r l y b a s i s .
r u l e s r e g a r d i n g PMSRs a t p r e s e n t r e q u i r e
net
in
PMSPs a n d P Q c g s
r e q u i r e s t h a t t h e amount o f
market v a l u e ,
PMSRs a n d
even though
core capital
and
PCCRs
1 capital
Board i s p r o p o s i n g t o add
v i e w e d a s an u n s a f e and unsound
valuation 9t
its
capital
of
and o f
I t would be p o s s i b l e
to report positive T i ^ l
these
of
in capital
other nonqualifying intangible assets,
on
elements
l e s s goodwill
T h i s method
PCCRs i n a n a m o u n t f a r g r e a t e r t h a n 5 0 j » 6 4 c e n t ,
amounts o f
calculating
t h e Board i s p r o p o s i n g t h a t t h e l i m i t s b e b a s e d
a percentage of Tier 1 c a p i t a l
goodwill,
scrutiny
guidelines.
of
fair
T h e FDIC a n d OTS
institutions
to
190
18
d e t e r m i n e t h e f a i r market v a l u e o f t h e s e a s s e t s by a p p l y i n g an
a p p r o p r i a t e market d i s c o u n t r a t e t o t h e n e t s e r v i c i n g c a s h
t a k i n g i n t o a c c o u n t any s i g n i f i c a n t c h a n g e s i n o r i g i n a l
a s s u m p t i o n s s u c h a s prepayment e s t i m a t e s .
flows,
valuation
The FDIC and OTS r u l e s
a l s o contain c e r t a i n requirements with regard t o
the
d e t e r m i n a t i o n o f t h e book v a l u e o f PMSRs, w h i c h i s t o b e r e v i e w e d
quarterly.
Under t h e s e r u l e s ,
i f an i n s t i t u t i o n w i s h e s
i n c l u d e PMSRs a s s e t s i n r e g u l a t o r y c a p i t a l ,
t h e s e a s s e t s may n o t e x c e e d t h e d i s c o u n t e d amount o f
estimated future net servicing
to
t h e book v a l u e
of
their
income,.
I n o r d e r t o implement t h e v a r i a t i o n p r o v i s i o n s
of
S e c t i o n 475 and i n t h e i n t e r e s t s o f a c h ^ e ^ i n g c o n s i s t e n c y i n t h e
t r e a t m e n t o f i n t a n g i b l e a s s e t s among ^ h e b a n k i n g a g e n c i e s ,
the
Board i s p r o p o s i n g t o r e q u i r e itis-tei'tutions t o d e t e r m i n e t h e
market v a l u e and t h e book -v%2tie o f t h e i r PMSRs a t l e a s t
fair
quarterly
i n a c c o r d a n c e witlr* t l W c r i t e r i a e s t a b l i s h e d by t h e FDIC and t h e
OTS i n t h e i r r u l e s r e g a r d i n g PMSRs.
The d i s c o u n t r a t e u s e d
for
t h e c a l c u l a t i o n o f book v a l u e s h o u l d n o t b e l e s s t h a n t h a t
d e r i v e d a t t h e time of a c q u i s i t i o n ,
b a s e d upon t h e e s t i m a t e d
f l o w s and t h e p r i c e p a i d f o r t h e a s s e t a t t h e t i m e o f
cash
purchase.
I n o r d e r t o implement t h e d i s c o u n t on PMSRs r e q u i r e d
u n d e r S e c t i o n 4 7 5 , t h e Board i s a l s o p r o p o s i n g t o u s e t h e
d i s c o u n t i n g a p p r o a c h c u r r e n t l y employed by t h e FDIC and t h e OTS
f o r s t a t e nonmember banks and s a v i n g s a s s o c i a t i o n s .
approach,
Under t h i s
f o r purposes of c a l c u l a t i n g r e g u l a t o r y c a p i t a l
for f i n a n c i a l statement purposes),
(but not
i n s t i t u t i o n s would be r e q u i r e d
191
18
t o r e d u c e t h e amount o f PMSRs r e p o r t e d on t h e b a l a n c e s h e e t
to the lesser
(i)
of:
90 p e r c e n t o f t h e i r f a i r market v a l u e ;
(ii)
asset
or
90 p e r c e n t o f t h e o r i g i n a l p u r c h a s e p r i c e p a i d f o r t h e
assets;
(iii)
or
100 p e r c e n t o f t h e i r r e m a i n i n g u n a m o r t i z e d book v a l u e .
I f b o t h t h e a p p l i c a t i o n o f t h e l i m i t on PMSRs and t h e
adjustment
o f t h e b a l a n c e s h e e t a s s e t f o r PMSRs would r e s u l t i n an amount
b e i n g d e d u c t e d from c a p i t a l ,
t h e b a n k i n g o r g a n i z a t i o n would
d e d u c t o n l y t h e g r e a t e r o f t h e two amounts from t h e sum o f
its
core c a p i t a l elements in determining Tie* 1 c a p i t a l .
While t h e
Board i s s e e k i n g p u b l i c comment on a l l a s p e c t s o f i t s
proposal,
i t s e e k s s p e c i f i c comment on t h e a p p r o a c h d i s c u s s e d a b o v e t o
v a l u a t i o n and d i s c o u n t i n g o f PMSRs i n c l u d a b l e i n
As i n d i c a t e d e a r l i e r ,
capital.
the c a l c u l a t i o n of the
fair
market v a l u e f o r PCCRs i s c o n s i d e r e d t o b e a t l e a s t a s
a s t h e r e l a t e d c a l c i H a t i o n i s f o r PMSRs.
the
subjective
Consequently,
t h e Board
b e l i e v e s t h e v a l u a t i o n o f PCCRs s h o u l d b e s u b j e c t t o t h e same
r e q u i r e m e n t s a s t h o s e p r o p o s e d f o r PMSRs and t h a t t h e s e
s h o u l d a l s o be d i s c o u n t e d .
assets
In order t o maintain c o n s i s t e n c y
in
the v a l u a t i o n of i d e n t i f i a b l e i n t a n g i b l e s included in
capital,
t h e Board i s p r o p o s i n g t h a t o r g a n i z a t i o n s b e r e q u i r e d
to
d e t e r m i n e t h e f a i r market and book v a l u e o f t h e i r PCCRs a t
quarterly,
and t o s u b j e c t t h e s e a s s e t s t o a v a l u e a d j u s t m e n t i d e n t i c a l
least
u s i n g t h e same c r i t e r i a a s t h o s e p r o p o s e d f o r PMSRs,
to
192
18
t h a t p r o p o s e d f o r FMSRs.
The Board i s s e e k i n g s p e c i f i c
public
comment on t h i s approach t o v a l u a t i o n and d i s c o u n t i n g o f PCCRs.
Pedu<?tipn pf CDIs
The p r o p o s a l would r e q u i r e a f u l l d e d u c t i o n o f
identifiable intangible assets,
capital,
goodwill.
other
i n c l u d i n g CDIs, from T i e r 1
w h i c h i s t h e same t r e a t m e n t a s t h a t a c c o r d e d t o
This treatment r e f l e c t s the Board's general
t h a t CDIs h a v e many o f t h e same c h a r a c t e r i s t i c s a s
w h i c h t h e B a s l e Accord r e q u i r e s t o
A l t h o u g h CDIs h a v e v a l i i ^
f i n a n c i a l l y strong,
conclusion
goodwill,
d e d u c t e d from c a p i t a l .
an o r g a n i z a t i o n
is
t h e i r v a l u e t e n d s v t ^ f a l l s i g n i f i c a n t l y when
the organization experiences financial d i f f i c u l t y .
Depositors
who a r e c o n c e r n e d a b o u t t h e v i a b i l i t y o f a problem
institution
a r e more l i k e l y t o w i t h d r a w t h e i r f u n d s , t h u s d i m i n i s h i n g
d e p o s i t s and t h e v a l u e o f t h e r e l a t e d i n t a n g i b l e
core
asset.
M o r e o v e r , a t r o u b l e d * i n s t i t u t i o n may b e r e q u i r e d t o r a i s e
the
i n t e r e s t r a t e s on i t s c o r e d e p o s i t s a l o n g w i t h o t h e r s o u r c e s
funds in order t o r e t a i n d e p o s i t o r s ,
r e d u c e t h e v a l u e o f CDIs.
Thus, CDIs p r o v i d e l i t t l e
f o r an i n s t i t u t i o n i n t i m e s o f s t r e s s o r f o r t h e bank
fund i f t h e i n s t i t u t i o n f a i l s .
of
which i n turn can a l s o
protection
insurance
This lack of p r o t e c t i o n has been
e v i d e n t i n c l o s e d and a s s i s t e d t r a n s a c t i o n s h a n d l e d by t h e FDIC
and t h e R e s o l u t i o n T r u s t C o r p o r a t i o n
("RTC") where t h e amount o f
t h e premium r e c e i v e d on d e p o s i t t r a n s f e r t r a n s a c t i o n s
t y p i c a l l y very
low.
is
193
18
M o r e o v e r , CDIs a r e n o t p u r c h a s e d s e p a r a t e l y b u t a s p a r t
o f an a c q u i s i t i o n o f a d e p o s i t o r y i n s t i t u t i o n o r t h e p u r c h a s e o f
some o f i t s b r a n c h e s and t h e a s s u m p t i o n o f r e l a t e d
Accordingly,
deposits.
CDIs a r e n o t g e n e r a l l y s a l a b l e a p a r t from t h e
b r a n c h e s o f t h e d e p o s i t o r y i n s t i t u t i o n and, t h u s , p r o v i d e
liquidity to the institution.
Consequently,
CDIs do n o t
m e e t t h e s a l a b i l i t y c r i t e r i o n t h e Board u s e s t o
identifiable intangibles,
as described above.
little
fully
evaluate
Furthermore,
b e c a u s e CDIs a r e o f t e n a c q u i r e d i n a merger a l o n g w i t h
goodwill,
i n s t i t u t i o n s would h a v e an i n c e n t i v e tct arflsign h i g h e r amounts o f
t h e a c q u i s i t i o n c o s t t o CDIs r a t h e r t h a n t<^ g o o d w i l l i f CDIs were
t o be i n c l u d e d i n t h e c a p i t a l
computation.
A c t i v e and l i q u i d m a r k e t s d o i ) o t e x i s t f o r CDIs and,
t h u s t h e i r v a l u e - i s d e r i v e d b a s e d - o n many h i g h l y
assumptions,
subjective
w h i c h ^nay b e d i f f i c u l t f o r e x a m i n e r s t o
assess.
Such a s s u m p t i o n s inc^p^cr t h e l e n g t h o f t i m e a c q u i r e d d e p o s i t s may
remain w i t h t h e a c q u i r i n g o r g a n i z a t i o n ,
the expected
future
i n t e r e s t r a t e on f u n d s g e n e r a t e d by t h e d e p o s i t s o r on
a l t e r n a t i v e s o u r c e s o f f u n d s , and t h e e x p e c t e d f u t u r e
r a t e and s e r v i c i n g c o s t s on t h e c o r e
interest
deposits.
The Board h a s n o t y e t d e t e r m i n e d t h a t
other
i d e n t i f i a b l e i n t a n g i b l e s meet t h e t h r e e c r i t e r i a d i s c u s s e d
t h a t t h e Board u s e s t o e v a l u a t e i n t a n g i b l e a s s e t s .
t h e Board i s p r o p o s i n g t o d e d u c t a l l t h e s e o t h e r
above
Accordingly,
intangible
a s s e t s from T i e r 1 f o r p u r p o s e s o f c a l c u l a t i n g r i s k - b a s e d and
leverage capital
ratios.
194
18
III.
Regulatory F l e x i b i l i t y Act A n a l y s i s
The F e d e r a l R e s e r v e Board d o e s n o t b e l i e v e a d o p t i o n o f
t h i s p r o p o s a l would h a v e a s i g n i f i c a n t e c o n o m i c i m p a c t on a
s u b s t a n t i a l number o f s m a l l b u s i n e s s e n t i t i e s
small banking o r g a n i z a t i o n s ) ,
(in t h i s
i n a c c o r d w i t h t h e s p i r i t and
p u r p o s e s o f t h e R e g u l a t o r y F l e x i b i l i t y A c t (5 U . S . C .
seq.).
In t h i s regard, t h e v a s t majority of small
o r g a n i z a t i o n s h a v e v e r y l i m i t e d amounts o f
intangible assets,
case,
601 e t
banking
identifiable
which are t h e s u b j e c t of t h i s p r o p o s a l ,
component o f t h e i r c a p i t a l s t r u c t u r e s .
as a
In a d d i t i o n , because
the
r i s k - b a s e d and l e v e r a g e c a p i t a l g u i d e l i n e s g e n e r a l l y do n o t a p p l y
t o bank h o l d i n g c o m p a n i e s w i t h c o n s o l i d a t e d a s s e t s o f l e s s
$150 m i l l i o n ,
List of
than
t h i s proposal w i l l not a f f e c t such companies.
Subjects
12 CFR P a r t 208
Accounting, Agricultural loan l o s s e s ,
Appraisals,
Banks, b a n k i n g ,
Branches, Capital
Confidential business information,
Securities,
R e p o r t i n g and r e c o r d k e e p i n g
S t a t e member b a n k s .
adequacy,
Currency, Dividend payments,
Federal Reserve System, Flood insurance,
of c o n d i t i o n ,
Applications,
Publication of
requirements,
reports
195
18
12 CFR P a r t 225
A d m i n i s t r a t i v e p r a c t i c e and p r o c e d u r e ,
Banks, b a n k i n g ,
companies,
Appraisals,
C a p i t a l adequacy, Federal Reserve System,
R e p o r t i n g and r e c o r d k e e p i n g r e q u i r e m e n t s ,
Holding
Securities,
S t a t e member b a n k s .
For t h e r e a s o n s s e t f o r t h i n t h i s n o t i c e ,
and p u r s u a n t
t o t h e B o a r d ' s a u t h o r i t y u n d e r s e c t i o n 5 ( b ) o f t h e Bank H o l d i n g
Company A c t o f 1956 (12 U . S . C .
1 8 4 4 ( f c j ) , and s e c t i o n 910 o f
I n t e r n a t i o n a l L e n d i n g S u p e r v i s i o n A c t o f 1983 (12 U . S . C .
the
3909),
t h e Board i s amending 12 CFR P a r t s 208%aAd 225 t o r e a d a s
follows:
PART 208 - MEMBERSHIP OF STATE BANKING INSTITUTIONS IN THE
FEDERAL RESERVE SYSTEM
1.
The a u t h o r i t y c i t a t i o n f o r P a r t 208 c o n t i n u e s t o r e a d a s
follows:
AUTHORITY:
S e c t i o n s 9,
11(a),
11(c),
1 9 , 2 1 , 2 5 , and 2 5 ( a )
t h e F e d e r a l R e s e r v e A c t , a s amended (12 U . S . C . 3 2 1 - 3 3 8 ,
248(c),
13(j)
461, 481-486,
6 0 1 , and 6 1 1 , r e s p e c t i v e l y ) ;
of
248(a),
s e c t i o n s 4 and
o f t h e F e d e r a l D e p o s i t I n s u r a n c e A c t , a s amended (12 U . S . C .
1814 and 1 8 2 3 ( j ) ,
r e s p e c t i v e l y ) ; s e c t i o n 7(a) of
the
196
18
International
Banking Act of
910 o f t h e I n t e r n a t i o n a l
U.S.C.
17,
78b,
3906-3909);
17A,
(12 U . S . C .
sections
2,
12(b),
and 23 o f t h e S e c u r i t i e s
781(b),
781(g),
respectively);
36)
1978
781(i),
section
1122 o f t h e F i n a n c i a l
Appendix A -
2.
12(g),
sections
78o-4(c)
(5),
1983
12(i),
Exchange Act o f
78q,
78q-l,
(12 U . S . C .
U.S.C.
and 78w,
(12
Recovery
^310 and
(5),
(15
U.S.C.
1 9 2 7 ; and s e c t i o n s
I n s t i t u t i o n s Reform,
1989
907-
(12
15B(c)
1934
5155 o f t h e R e v i s e d S t a t u t e s
a s a m e n d e d b y t h e McFadden A c t o f
Enforcement Act of
3105);
Lending S u p e r v i s i o n Act of
1101-
and
3331-3351).
[Amended]
Appendix A i s
paragraphs of
paragraphs,
amended b y r e m o v i n g t h e
II.B.l.b.
t o read as
first
three
and r e p l a c i n g them w i t h f i v e
new
follows:
* * * * *
XX.
***
A.
***
B.
***
1.
a.***
b.
appropriateness
assets
assets,
of
Other i n t a n g i b l e
In determining
including p a r t i c u l a r types of
other than goodwill,
in a bank's capital
c o n s i d e r s a number o f
assets.
that
is,
identifiable
calculation,
factors,
intangible
intangible
the Federal
including—
Reserve
the
197
18
1.
the ability
t o e s t a b l i s h a market v a l u e
a n n u a l b a s i s t h r o u g h an i d e n t i f i a b l e
the r e l i a b i l i t y
and p r e d i c t a b i l i t y
for the asset
stream of cash
hold this
value notwithstanding the future prospects of the
the existence
3.
the f e a s i b i l i t y
flows,
of these cash flows,
the degree of certainty that the asset w i l l
2.
on an
and
market
bank;
o f an a c t i v e and l i q u i d m a r k e t f o r t h e
asset;
and
of
from t h e b u l k o f
s e l l i n g t h e a s s e t a p a r t from t h e bank
its
assets.
The F e d e r a l R e s e r v e h a s d e t e r m i n e d t h a t
marketable purchased mortgage s e r v i c i n g
c r e d i t card r e l a t i o n s h i p s
and,
thus,
may b e i n c l u d e d i n < t h a t
provided that,
of t h e s e a s s e t s
included in capital
1 capital.
readily
f i ^ f c t s and
purchased
g e n e r a l l y me$t t h e s e t h r e e
bank's c a p i t a l ,
tier
is,
criteria
n o t d e d u c t e d from)
in the aggregate the t o t a l
a
amount
d o e s n o t e x c e e d 50 p e r c e n t
Purchased c r e d i t card r e l a t i o n s h i p s
t o a separate sublimit of
25 p e r c e n t o f t i e r
are
1 capital.
in excess of these l i m i t a t i o n s ,
other identifiable
intangibles
intangible assets,
and f a v o r a b l e l e a s e h o l d s ,
bank's core capital
elements
as well
including core
as
Amounts
1
i s defined net of goodwill
intangible
and a l l
from a
capital.
For p u r p o s e s o f c a l c u l a t i n g t h e s e l i m i t a t i o n s ,
capital
card
all
deposit
are t o be deducted
in determining t i e r
of
subject
o f p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t
relationships
or
tier
1
identifiable
a s s e t s o t h e r than purchased mortgage s e r v i c i n g
rights
198
18
and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s .
T h i s method
calculation
in capital
could result
mortgage s e r v i c i n g
in the
inclusion
r i g h t s and p u r c h a s e d c r e d i t c a r d
i n an amount g r e a t e r t h a n 50 p e r c e n t ,
card r e l a t i o n s h i p s
amount o f t i e r
capital
purchased
relationships
and o f p u r c h a s e d
credit
i n a n a m o u n t g r e a t e r t h a n 25 p e r c e n t ,
1 capital
ratios.
of
of
used t o c a l c u l a t e
In such i n s t a n c e s ,
d e t e r m i n e t h a t a bank i s
operating
manner b e c a u s e o f o v e r r e l i a n c e
an
of
the
institution's
t h e F e d e r a l R e s e r v e may
i n ar* u n s a f e a n d u n s o u n d
on i n t a n g i b l e
assets
in t i e r
1
capital.
Banks s h o u l d d e t e r m i n e t h e f a i r A a r k e t v a l u e o f
p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t
relationships
the
at least
quarterly..
The q u a r t e r l y d e t e r m i n a t i o n
f a i r market v a l u e of t h e s e a s s e t s
f o r any s i g n i f i c a n t
including changes
changes
intangible
discount
shall
in original
assets,
of the current
include
valuation
i n prepayment e s t i m a t e s .
b e b a s e d on an a n a l y s i s
assumptions,
The v a l u a t i o n
relationships
at
least
values as necessary.
estimated useful
these assets
life,
shall
shall
f a i r market v a l u e of
the
market
flows.
Banks s h o u l d a l s o r e v i e w t h e book v a l u e o f
purchased mortgage s e r v i c i n g
of
adjustments
d e t e r m i n e d by a p p l y i n g an a p p r o p r i a t e
rate t o the net cash
their
card
their
r i g h t s and p u r c h a s e d c r e d i t
q u a r t e r l y a n d make a d j u s t m e n t s t o
These a s s e t s
card
these
should be amortized over
n o t t o e x c e e d 15 y e a r s .
their
The book v a l u e
n o t e x c e e d t h e d i s c o u n t e d amount o f
their
of
199
18
estimated
f u t u r e n e t income.
used for t h i s
At no t i m e s h o u l d t h e d i s c o u n t
c a l c u l a t i o n be l e s s
of a c q u i s i t i o n ,
than that derived at the
paid for the a s s e t at the time of purchase.
assets
included
in capital
c a r r y i n g amount.
If
intangible
s h o u l d b e made t o t h e e x t e n t t h a t
f u t u r e n e t income i s
An i n s t i t u t i o n t h a t
less
than the
includes purchased
may n o t c a r r y t h e s e a s s e t s a t a b o o k
that exceeds the discounted value'of their
toaet^er with
during the examination
For r e g u l a t o r y ^ ^ J i p i t a l
purposes
(but not
(b)
90 p e r c e n t o f t h e o r i g i n a l
assets;
(c)
If
f a i r market
for
financial
servicing
of:
value;
purchase price paid for
100 p e r c e n t o f t h e i r r e m a i n i n g u n a m o r t i z e d book
a d j u s t m e n t o f t h e b a l a n c e s h e e t amount f o r t h e s e
value.
mortgage
r i g h t s and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
the
or
b o t h t h e a p p l i c a t i o n o f t h e l i m i t s on p u r c h a s e d
servicing
market
r e p o r t e d on a
be reduced t o t h e l e s s e r
90 p e r c e n t o f t h e i r
its
supporting
r i g h t s and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
(a)
in
value
process.
s t a t e m e n t p u r p o s e s ^ t h e amount o f p u r c h a s e d m o r t g a g e
bank's balance sheet w i l l
mortgage
income.
r e v i e w b o t h t h e book v a l u e r and t h e f a i r
value assigned to these assets,
documentation,
future net
the
asset's
s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
regulatory capital
price
unanticipated
a writedown of t h e book v a l u e o f
d i s c o u n t e d amount o f
Examiners w i l l
time
b a s e d upon t h e e s t i m a t e d c a s h f l o w s and t h e
prepayments occur,
rate
and
intangibles
the
200
33
would r e s u l t
i n an amount b e i n g d e d u c t e d from c a p i t a l ,
the
would d e d u c t o n l y t h e g r e a t e r o f t h e two amounts from i t s
capital
elements
in determining t i e r
1
capital.
Whenever n e c e s s a r y — i n p a r t i c u l a r ,
when
assessing
a p p l i c a t i o n s t o expand or t o engage i n o t h e r a c t i v i t i e s
could e n t a i l unusual or higher-than-normal
on a c a s e - b y - c a s e b a s i s ,
individual
intangible assets),
ratios
t o g e t h e r w i t h t h a q u a l i t y and v a l u e o f
the
i n making an
overall
adequacy.*****
A p p e n d i x B i s emended by r e v i s i n g
revising the last
II.
an
[Amended]
t o read as
2
of
will,
all
assessment of c a p i t a l
2.
that
Board
(after deducting
b a n k ' s t a n g i b l e and i n t a n g i b l e a s s e t s '
Appendix B -
risks—the
continue to consider the level
bank's tangible capital
bank
core
f o o t n o t e 2 and
s e n t e n c e of the second paragraph in
II.,
follows:
***
At t h e end o f
1992,
i n c l u d e s common e q u i t y ,
of consolidated
Tier 1 capital
minority
subsidiaries,
f o r s t a t e member b a n k s
interests
in the equity
and q u a l i f y i n g
perpetual
preferred stock.
goodwill;
amounts of purchased mortgage s e r v i c i n g
purchased c r e d i t
In addition,
card r e l a t i o n s h i p s t h a t ,
accounts
noncumulative
Tier 1 capital
in the
rights
excludes
and
aggregate,
201
18
e x c e e d 50 p e r c e n t o f T i e r 1 c a p i t a l ;
card r e l a t i o n s h i p s
all
credit
t h a t e x c e e d 25 p e r c e n t o f T i e r 1 c a p i t a l ;
other intangible assets.
certain
amounts o f p u r c h a s e d
investments
The F e d e r a l R e s e r v e may
in subsidiaries
and
exclude
or a s s o c i a t e d companies
as
appropriate.
* * *
***Average t o t a l
consolidated a s s e t s are defined as the
average t o t a l
assets
lease
r e p o r t e d on t h e b a n k ' s R e p o r t s o f C o n d i t i o n
losses)
Income
("Call Report"),
mortgage s e r v i c i n g
that,
less goodwill;
ampunts o f
for loan
are in excess of
relationships
56 p e r c e n t of T i e r
amounts of purchased c r e d i t card r e l a t i o n s h i p s
25 p e r c e n t o f T i e r
any i n v e s t m e n t s
1 capital;
in subsidiaries
all
other intangible
in
1
excess
assets;
or a s s o c i a t e d companies t h a t
F e d e r a l R e s e r v e d e t e r m i n e s s h o u l d be d e d u c t e d from T i e r
capital.3
and
and
purchased
r i g h t s and p u r c h a s e d c r e d i t c a r d
in the aggregate,
capital;
of
(defined net of the allowance
quarterly
and
the
1
*****
PART 2 2 5 - BANK HOLDING COMPANIES AND CHANGE IN BANK CONTROL
1.
The a u t h o r i t y c i t a t i o n
f o r P a r t 225 c o n t i n u e s t o read
follows:
AUTHORITY:
1844(b),
12 U . S . C .
3106,
3108,
1817(j)
3907,
(13),
3909,
1818,
3310,
and
1831i,
1843(c)
3331-3351.
(8),
as
202
18
Appendix A -
2.
[Amended]
A p p e n d i x A i s amended b y r e m o v i n g t h e f i r s t
paragraphs of I I . B . l . b .
and r e p l a c i n g them,
three
t o read
as
follows:
II.
***
A.
***
B.
***
l.a.***
b.
appropriateness
of
O t h e r int?rKUfr*fe A s s e t s .
including particular types of
a s s e t s other than goodwill,
assets,
that
is,
identifiable
i n a bank h o l d i n g company's c a p i t a l
F e d e r a l R e s e r v e c o n s i d e r s a number o f
1.
In determining
t h e a b i l i t y t o e s t a b l i s h a market v a l u e
a n n u a l b a s i s t h r o u g h an i d e n t i f i a b l e
the r e l i a b i l i t y
and p r e d i c t a b i l i t y
intangible
intangible
calculation,
factors,
the
including—
for the asset
stream of cash
on an
flows,
of t h e s e cash flows,
the degree of certainty that the asset w i l l
the
hold t h i s
value notwithstanding the future prospects of the
and
market
banking
organization;
2.
t h e e x i s t e n c e o f an a c t i v e and l i q u i d market f o r t h e
asset;
and
3.
the f e a s i b i l i t y
from t h e b u l k of
of
s e l l i n g t h e a s s e t a p a r t from t h e bank
its
assets.
or
203
18
The F e d e r a l R e s e r v e h a s d e t e r m i n e d t h a t
readily
m a r k e t a b l e p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and
c r e d i t card r e l a t i o n s h i p s
and,
thus,
g e n e r a l l y meet t h e s e t h r e e
may b e i n c l u d e d i n
h o l d i n g company's c a p i t a l ,
total
50 p e r c e n t o f t i e r
tier
(that is,
Purchased c r e d i t
1 capital.
limitations,
as well
as a l l
in determining t i e r
1
For p u r p o s e s o f c a l c u l a t i n g
assets
these limitations,
and a l l
T h i s method
calculation could result
in capital
in the inclusion
m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t c a r d
i n an amount g r e a t e r t h a n 50 p e r c e n t ,
organization's
capital
ratios.
a
rights
of
purchased
relationships
and o f p u r c h a s e d
used t o c a l c u l a t e
1
of
i n an amount g r e a t e r t h a n 25 p e r c e n t ,
1 capital
credit
of
the
banking
In such i n s t a n c e s ,
R e s e r v e may d e t e r m i n e t h a t a b a n k i n g o r g a n i z a t i o n
tier
identifiable
other than purchased mortgage s e r v i c i n g
amount o f t i e r
are
capital
and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s .
card r e l a t i o n s h i p s
assets,
capital.
i s defined net of goodwill
intangible
rights
intangible
core
of
these
i n t a n g i b l e s and f a v o r a b l e l e a s e h o l d s ,
t o be d e d u c t e d from a banking o r g a n i z a t i o n s
capital
25 p e r c e n t
in excess of
other identifiable
the
exceed
card
Amounts o f p u r c h a s e d m o r t g a g e s e r v i c i n g
including core deposit
elements
does not
are subject to a separate sublimit of
and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
a bank
in the aggregate
included in capital
1 capital.
criteria
n o t d e d u c t e d from)
provided that,
amount o f t h e s e a s s e t s
relationships
purchased
the
Federal
i s operating
in
204
18
an u n s a f e and unsound manner b e c a u s e o f o v e r r e l i a n c e
intangible
assets
in t i e r
1
capital.
Banking o r g a n i z a t i o n s
should determine the f a i r
v a l u e of t h e i r purchased mortgage s e r v i c i n g
credit
card r e l a t i o n s h i p s
on
rights
at least quarterly.
and
The
quarterly
d e t e r m i n a t i o n o f t h e f a i r market v a l u e of t h e s e a s s e t s
include adjustments
f o r any s i g n i f i c a n t c h a n g e s i n
valuation assumptions,
The v a l u a t i o n
shall
market
purchased
shall
original
i n c l u d i n g changes in prepayment
estimates.
b e b a s e d on an a n a l y s i s o f t h e c u r r e n t
market v a l u e of t h e i n t a n g i b l e
a p p r o p r i a t e market d i s c o u n t
assets,
rate t o the net cash
Banking o r g a n i z a t i o n s
fair
d e t e r m i n e d by a p p l y i n g
an
flows.
s h o u l d a l s o r e v i e w t h e book
value
o f t h e i r p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d
credit
card r e l a t i o n s h i p s
to
a t l e a s t q u a r t e r l y a n d make a d j u s t m e n t s
these values as necessary.
their estimated useful
value of t h e s e a s s e t s
their estimated
discount
These a s s e t s
life,
shall
future net
should be amortized
n o t t o e x c e e d 15 y e a r s .
n o t e x c e e d t h e d i s c o u n t e d amount
income.
At no t i m e s h o u l d
acquisition,
b a s e d upon t h e e s t i m a t e d c a s h
derived
flows
and t h e p r i c e p a i d f o r t h e a s s e t a t t h e t i m e o f p u r c h a s e .
u n a n t i c i p a t e d prepayments occur,
intangible
assets
included in capital
c a r r y i n g amount.
If
a writedown of t h e book v a l u e
e x t e n t t h a t t h e d i s c o u n t e d amount o f
than the a s s e t ' s
of
the
r a t e used f o r t h i s c a l c u l a t i o n be l e s s than t h a t
at the time of
over
The book
s h o u l d b e made t o
future net
the
income i s
less
A banking o r g a n i z a t i o n
that
of
205
18
i n c l u d e s purchased mortgage s e r v i c i n g
card r e l a t i o n s h i p s
assets
in i t s
r i g h t s and p u r c h a s e d
regulatory capital
credit
may n o t c a r r y
these
a t a book v a l u e t h a t e x c e e d s t h e d i s c o u n t e d v a l u e of
future net
income.
Examiners w i l l
r e v i e w both t h e book v a l u e
t h e f a i r market v a l u e a s s i g n e d t o t h e s e a s s e t s ,
together
supporting documentation,
process.
during the
For r e g u l a t o r y c a p i t a l
statement purposes),
inspection
purposes
(but not f o r
banking o r g a n i z a t i o n ' s balance s h e e t w i l l
and
with
financial
t h e amount o f p u r c h a s e d m o r t g a g e
r i g h t s and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
lesser
their
servicing
r e p o r t e d on a
be reduced t o
the
of:
(a)
90 p e r c e n t of t h e i r
(b)
90 p e r c e n t o f t h e o r i g i n a l
assets;
(c)
f a i r market
value;
purchase price paid
value.
mortgage
r i g h t s and p u r c h a s e d c r e d i t c a r d r e l a t i o n s h i p s
a d j u s t m e n t o f t h e b a l a n c e s h e e t amount f o r t h e s e
would r e s u l t
the
or
100 p e r c e n t o f t h e i r remaining unamortized book
I f b o t h t h e a p p l i c a t i o n o f t h e l i m i t s on p u r c h a s e d
servicing
for
and
intangibles
i n an amount b e i n g d e d u c t e d from c a p i t a l ,
the
banking o r g a n i z a t i o n would deduct o n l y t h e g r e a t e r of t h e
amounts from i t s
core capital
elements
the
two
in determining t i e r
1
capital.
Whenever n e c e s s a r y — i n p a r t i c u l a r ,
when
assessing
applications
t o expand or t o engage i n o t h e r a c t i v i t i e s
could e n t a i l
unusual or higher-than-normal
risks—the
that
Board
will,
206
18
on a c a s e - b y - c a s e b a s i s ,
continue to consider the level
individual
bank's tangible capital
intangible
assets),
(after deducting
all
the
assessment of c a p i t a l
Appendix D -
2.
assets,
i n making an
overall
adequacy.*****
[Amended]
A p p e n d i x D i s amended b y r e v i s i n g t h e l a s t t w o
i n f o o t n o t e 3 and r e v i s i n g t h e l a t f t s e n t e n c e o f t h e
paragraph i n I I . ,
II.
3
an
t o g e t h e r w i t h t h e q u a l i t y and v a l u e o f
b a n k ' s t a n g i b l e and i n t a n g i b l e
ratios
of
sentences
second
t o read as f o l l o w s :
*****
***
***In a d d i t i o n ,
Tier 1 c a p i t a l excludes goodwill;
amounts
o f p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t
relationships
capital;
that,
i n t h e "aggregate,
assets.
e x c e e d 50 p e r c e n t o f T i e r
amounts of purchased c r e d i t card r e l a t i o n s h i p s
e x c e e d 25 p e r c e n t o f T i e r 1 c a p i t a l ;
and a l l
other
T h e F e d e r a l R e s e r v e may e x c l u d e c e r t a i n
subsidiaries
card
or a s s o c i a t e d companies as
1
that
intangible
investments
in
appropriate.
* * *
***Average t o t a l
consolidated a s s e t s are defined as the
average t o t a l
assets
lease
r e p o r t e d on t h e banking o r g a n i z a t i o n ' s
losses)
Financial
Statements
quarterly
(defined net of the allowance for loan
("FR Y-9C R e p o r t " ) ,
and
Consolidated
less goodwill;
amounts
207
18
o f p u r c h a s e d m o r t g a g e s e r v i c i n g r i g h t s and p u r c h a s e d c r e d i t
relationships
that,
of Tier 1 c a p i t a l ;
in excess of
assets;
in the aggregate,
are in excess of
amounts o f purchased c r e d i t card
25 p e r c e n t o f T i e r 1 c a p i t a l ;
and any i n v e s t m e n t s
all
in subsidiaries
or
other
50
intangible
associated
deducted
capital.
Board o f Governors o f t h e F e d e r a l R e s e r v e
January
percent
relationships
companies t h a t t h e Fedaral Reserve determines should be
from T i e r 1
,
1992.
W i l l i a m W. W i l e s
S e c r e t a r y o f t h e Board
card
System,
208
B O A R D OF G O V E R N O R S
or THE
FEDERAL R E S E R V E S Y S T E M
WASHINGTON, D. C. 2 Q S S 1
July 16, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANX
SUBJECT:
Supplementary E x a m i n a t i o n G u i d e l i n e s on R e a l E s t a t e
Loans and C e r t a i n R e p o r t i n g I s s u e s P e r t a i n i n g t o
Nonaccrual Loans
On March 1 , 1 9 9 1 , t h e F e d e r a l b a n k and t h r i f t
regulatory agencies j o i n t l y issued a statement clarifying certain
s u p e r v i s o r y and a c c o u n t i n g p o l i c i e s .
The s t a t e m e n t w a s i s s u e d i n
r e s p o n s e t o c o n c e r n s t h a t some s u p e r v i s o r y p o l i c i e s , o r
d e p o s i t o r y i n s t i t u t i o n s ' misunderstandings about t h e p o l i c i e s ,
were i n h i b i t i n g t h e e x t e n s i o n of loans t o sound, creditworthy
borrowers.
The g u i d e l i n e s a n d c l a r i f i c a t i o n s c o n t a i n e d i n t h e
March 1 s t s t a t e m e n t e s t a b l i s h a framework, c o n s i s t e n t w i t h s a f e
and sound banking p r a c t i c e s , w i t h i n which banking o r g a n i z a t i o n s
c a n make l o a n s t o c r e d i t w o r t h y b o r r o w e r s a n d w o r k i n a
c o n s t r u c t i v e and p r u d e n t f a s h i o n w i t h b o r r o w e r s e x p e r i e n c i n g
temporary f i n a n c i a l d i f f i c u l t i e s .
The s t a t e m e n t w a s b a s e d u p o n
t h e p r i n c i p l e t h a t p r u d e n t l e n d i n g p r a c t i c e s on t h e p a r t o f b a n k s
a n d t i m e l y and e f f e c t i v e s u p e r v i s o r y a c t i o n s o n t h e p a r t o f
r e g u l a t o r s s h o u l d n o t i n h i b i t banking o r g a n i z a t i o n s from p l a y i n g
an a c t i v e r o l e i n f i n a n c i n g t h e needs of c r e d i t w o r t h y borrowers.
T h i s l e t t e r s u p p l e m e n t s t h e c o n t e n t s o f t h e March 1 s t
s t a t e m e n t and p r o v i d e s g u i d a n c e t o s u p e r v i s o r y and e x a m i n a t i o n
personnel regarding c e r t a i n supervisory p o l i c i e s or practices
t h a t may h a v e an i m p a c t o n c r e d i t a v a i l a b i l i t y .
As w a s t r u e w i t h
t h e e a r l i e r interagency statement, the guidance contained in t h i s
l e t t e r i s c o n s i s t e n t w i t h s o u n d b a n k i n g p r a c t i c e s and g e n e r a l l y
accepted accounting principlesi
Supervisory asset
assessments
Concerns have been e x p r e s s e d t h a t problems broadly
a s s o c i a t e d w i t h some s e c t o r s o r s e g m e n t s o f a n i n d u s t r y , s u c h a s
c e r t a i n commercial r e a l e s t a t e markets, c o u l d l e a d t o o v e r l y
p e s s i m i s t i c a s s e s s m e n t s of p a r t i c u l a r c r e d i t s t h a t are not
a f f e c t e d by t h e p r o b l e m s o f t h e t r o u b l e d s e c t o r s .
The March 1 s t
s t a t e m e n t r e i t e r a t e s t h a t r e a l e s t a t e l o a n s s h o u l d n o t be
a s s e s s e d s o l e l y on t h e b a s i s o f t h e l i q u i d a t i o n v a l u e o f t h e
209
18
underlying c o l l a t e r a l ; rather, c o n s i d e r a t i o n should a l s o be given
to a property's s t a b i l i z e d capacity to generate cash flow to
s e r v i c e i t s debt.
C o n s i s t e n t w i t h t h i s p r i n c i p l e and
longstanding supervisory practice, loans or c r e d i t s that are
a d e q u a t e l y p r o t e c t e d by t h e c u r r e n t sound w o r t h and d e b t - s e r v i c e
c a p a c i t y of the borrower or t h e underlying c o l l a t e r a l g e n e r a l l y
s h o u l d not be s u b j e c t t o examiner c l a s s i f i c a t i o n .
These p r i n c i p l e s hold f o r i n d i v i d u a l c r e d i t s , even i f
p o r t i o n s or segments of t h e industry t o which t h e borrower
belongs are experiencing f i n a n c i a l d i f f i c u l t i e s .
The e v a l u a t i o n
o f e a c h c r e d i t s h o u l d b e b a s e d upon t h e f u n d a m e n t a l s o f t h e
p a r t i c u l a r credit, that i s , the borrower's (or the c o l l a t e r a l ' s )
c u r r e n t and s t a b i l i z e d c a s h f l o w , e a r n i n g and d e b t s e r v i c e
capacity, financial performance, net worth, guarantees, future
p r o s p e c t s , and o t h e r f a c t o r s r e l e v a n t t o t h e b o r r o w e r ' s a b i l i t y
t o s e r v i c e and r e t i r e i t s d e b t .
Real
estate
construction
and m i n i - p e r m
loans
T h e March 1 s t g u i d a n c e s t a t e s t h a t i n s t i t u t i o n s t h a t
h a v e i n p l a c e e f f e c t i v e c o n t r o l s t o manage and r e d u c e undue
c o n c e n t r a t i o n s over t i m e , need not r e f u s e c r e d i t t o sound
borrowers simply because of the borrower's industry or geographic
location.
I t i s important t o emphasize t h a t t h i s p r i n c i p l e
a p p l i e s t o p r u d e n t l o a n r e n e w a l s a n d r o l l o v e r s , a s w e l l a s t o new
e x t e n s i o n s o f c r e d i t t h a t a r e u n d e r w r i t t e n i n a sound manner.
Many b a n k s h a v e made c o n s t r u c t i o n l o a n s t h a t u p o n
completion of the c o n s t r u c t i o n phase of t h e p r o j e c t w i l l require
l o n g e r - t e r m or t a k e - o u t f i n a n c i n g .
In a d d i t i o n , during t h e 1980s
s o m e b a n k s made medium t e r m ( u p t o 7 y e a r s t o m a t u r i t y ) l o a n s t o
f i n a n c e commercial r e a l e s t a t e a f t e r c o m p l e t i o n of t h e
c o n s t r u c t i o n phase.
Many o f t h e s e c o n s t r u c t i o n a n d s o - c a l l e d
" m i n i - p e r m " l o a n s a r e now c o m i n g d u e o r w i l l b e c o m i n g d u e o v e r
t h e n e x t 12 t o 24 m o n t h s .
U n d e r c u r r e n t c o n d i t i o n s , o b l i g o r s o n t h e s e l o a n s may
continue to find i t d i f f i c u l t to obtain adequate sources of longterm c r e d i t .
I n s o m e c a s e s , b a n k s may d e t e r m i n e t h a t t h e m o s t
d e s i r a b l e and p r u d e n t c o u r s e i s t o r o l l o v e r o r renew l o a n s t o
t h o s e b o r r o w e r s who h a v e d e m o n s t r a t e d a n a b i l i t y t o p a y i n t e r e s t
o n t h e i r d e b t s , b u t who may n o t b e i n a p o s i t i o n , a t t h e p r e s e n t
time, to obtain long-term financing for the principal.
The a c t
of r e f i n a n c i n g or renewing l o a n s t o sound borrowers, i n c l u d i n g
c r e d i t w o r t h y commercial or r e s i d e n t i a l r e a l e s t a t e d e v e l o p e r s ,
g e n e r a l l y should not be s u b j e c t t o s u p e r v i s o r y c r i t i c i s m i n the
a b s e n c e of w e l l - d e f i n e d w e a k n e s s e s t h a t j e o p a r d i z e repayment of
the loans.
R e f i n a n c i n g s or renewals should be s t r u c t u r e d in a
manner t h a t i s c o n s i s t e n t w i t h s o u n d b a n k i n g , s u p e r v i s o r y , and
210
18
a c c o u n t i n g p r a c t i c e s , and t h a t p r o t e c t s t h e bank and i m p r o v e s
p r o s p e c t s f o r c o l l e c t i n g o r r e c o v e r i n g on t h e a s s e t .
Assessment
of
asset
its
concentrations
T h e March 1 s t s t a t e m e n t i n d i c a t e s t h a t w h i l e t h e
r e g u l a t o r y a g e n c i e s h a v e n o t e s t a b l i s h e d s p e c i f i c r u l e s on a s s e t
c o n c e n t r a t i o n s , d e p o s i t o r y i n s t i t u t i o n s s h o u l d e s t a b l i s h and
adhere t o p o l i c i e s t h a t control concentration r i s k .
One a s p e c t
of such a system of r i s k control i s the d e f i n i t i o n of a s s e t
concentrations.
Traditionally, loans t o related groups ot
b o r r o w e r s , l o a n s c o l l a t e r a l i z e d by a s i n g l e s e c u r i t y o r
s e c u r i t i e s w i t h common c h a r a c t e r i s t i c s , a n d l o a n s t o b o r r o w e r s
w i t h common c h a r a c t e r i s t i c s w i t h i n a n i n d u s t r y o f t e n h a v e b e e n
i n c l u d e d i n homogeneous r i s k g r o u p i n g s when a s s e s s i n g a s s e t
concentrations.
In i d e n t i f y i n g a s s e t c o n c e n t r a t i o n s , commercial r e a l
e s t a t e l o a n s and r e s i d e n t i a l r e a l e s t a t e l o a n s can be v i e w e d
s e p a r a t e l y when t h e i r p e r f o r m a n c e i s n o t s u b j e c t t o s i m i l a r
economic or f i n a n c i a l r i s k s .
I n t h e same v e i n , c o m m e r c i a l r e a l
e s t a t e development l o a n s need n o t n e c e s s a r i l y be grouped w i t h
r e s i d e n t i a l r e a l e s t a t e d e v e l o p m e n t l o a n s , e s p e c i a l l y when t h e
r e s i d e n t i a l developer has firm, r e l i a b l e purchase c o n t r a c t s f o r
t h e s a l e o f t h e homes upon c o m p l e t i o n .
Even w i t h i n t h e
c o m m e r c i a l d e v e l o p m e n t and c o n s t r u c t i o n s e c t o r , d i s t i n c t i o n s f o r
c o n c e n t r a t i o n p u r p o s e s may b e m a d e , w h e n a p p r o p r i a t e , b e t w e e n
t h o s e l o a n s t h a t h a v e f i r m t a k e o u t c o m m i t m e n t s a n d t h o s e t h a t do
not.
Groups o r c l a s s e s o f r e a l e s t a t e l o a n s s h o u l d , o f c o u r s e ,
b e c o m b i n e d a n d v i e w e d a s c o n c e n t r a t i o n s when t h e y d o s h a r e
s i g n i f i c a n t common c h a r a c t e r i s t i c s a n d a r e s i m i l a r l y a f f e c t e d b y
adverse economic, f i n a n c i a l , or b u s i n e s s developments.
I n s t i t u t i o n s with a s s e t concentrations are expected to
p u t i n p l a c e e f f e c t i v e i n t e r n a l p o l i c i e s , s y s t e m s , and c o n t r o l s
t o m o n i t o r and manage t h i s r i s k .
Concentrations that involve
e x c e s s i v e o r undue r i s k s r e q u i r e c l o s e s c r u t i n y by t h e bank and
should be reduced over a reasonable period of time.
Banking
o r g a n i z a t i o n s with a need t o reduce a s s e t c o n c e n t r a t i o n s are
normally expected t o develop a plan that i s r e a l i s t i c , prudent,
and a c h i e v a b l e i n v i e w o f t h e b a n k ' s p a r t i c u l a r c i r c u m s t a n c e s and
market c o n d i t i o n s .
In s i t u a t i o n s where c o n c e n t r a t i o n l e v e l s have
b e e n b u i l t u p o v e r a n e x t e n d e d p e r i o d , i t may t a k e t i m e , i n some
c a s e s s e v e r a l y e a r s , t o a c h i e v e a more b a l a n c e d a n d d i v e r s i f i e d
p o r t f o l i o mix.
What i s c r i t i c a l i s t h a t b a n k i n g o r g a n i z a t i o n s
have i n p l a c e a d e q u a t e s y s t e m s and c o n t r o l s f o r r e d u c i n g undue or
e x c e s s i v e c o n c e n t r a t i o n s in accordance w i t h a prudent plan,
s t r o n g c r e d i t p o l i c i e s and l o a n a d m i n i s t r a t i o n s t a n d a r d s t o
c o n t r o l t h e r i s k s a s s o c i a t e d w i t h new l o a n s , a n d a d e q u a t e c a p i t a l
to protect the institution while i t s portfolio is being
restructured.
211
18
Issues relating to restructured
and p a r t i a l l y c h a r a e d - o f f l o a n s
debt
Working in a prudent manner.-with borrowers e x p e r i e n c i n g
f i n a n c i a l d i f f i c u l t i e s may i n v o l v e f o r m a l l y r e s t r u c t u r i n g l o a n s
and t a k i n g o t h e r m e a s u r e s i n r e c o g n i t i o n of t h e b o r r o w e r s '
c o n d i t i o n and repayment p r o s p e c t s .
Such a c t i o n s , i f done i n a
way t h a t i s c o n s i s t e n t w i t h p r u d e n t l e n d i n g p r i n c i p l e s and
s u p e r v i s o r y p r a c t i c e s , can improve a b a n k ' s p r o s p e c t s f o r
collection.
G e n e r a l l y a c c e p t e d a c c o u n t i n g p r i n c i p l e s (GAAP) a n d
r e g u l a t o r y r e p o r t i n g r e q u i r e m e n t s , p r o v i d e a framework f o r
r e p o r t i n g t h a t , i n s o m e c a s e s , may a l l e v i a t e c e r t a i n c o n c e r n s
t h a t l e n d e r s may h a v e a b o u t w o r k i n g i n a c o n s t r u c t i v e f a s h i o n
with borrowers experiencing financial d i f f i c u l t i e s .
The March 1, 1991 i n t e r a g e n c y p o l i c y s t a t e m e n t
p r e s e n t e d a number o f c l a r i f i c a t i o n s o f s u p e r v i s o r y p o l i c i e s
r e g a r d i n g i s s u e s r e l a t i n g t o n o n a c c r u a l a s s e t s and r e s t r u c t u r e d
loans.
T h r e e o f t h e s e c l a r i f i c a t i o n s i n d i c a t e d t h a t when c e r t a i n
c r i t e r i a a r e m e t , ( i ) i n t e r e s t p a y m e n t s on n o n a c c r u a l a s s e t s c a n
be r e c o g n i z e d a s income on a c a s h b a s i s w i t h o u t f i r s t r e c o v e r i n g
any p r i o r p a r t i a l c h a r g e - o f f s , ( i i ) n o n a c c r u a l a s s e t s can b e
r e s t o r e d t o a c c r u a l s t a t u s when s u b j e c t t o f o r m a l r e s t r u c t u r i n g s
i n a c c o r d a n c e w i t h F i n a n c i a l A c c o u n t i n g S t a n d a r d s B o a r d (FASB)
S t a t e m e n t No. 1 5 , and ( i i i ) r e s t r u c t u r i n g s t h a t y i e l d a m a r k e t
r a t e of i n t e r e s t would not have t o be included in r e s t r u c t u r e d
loan amounts r e p o r t e d in t h e y e a r s subsequent t o t h e y e a r of the
restructuring.
These c l a r i f i c a t i o n s , which are c o n s i s t e n t with
GAAP, h a v e b e e n f u l l y i n c o r p o r a t e d i n t o t h e i n s t r u c t i o n s f o r t h e
R e p o r t s o f C o n d i t i o n and Income ( " C a l l Reports") f i l e d by b a n k s
a n d t h e "Y R e p o r t s " f i l e d b y b a n k h o l d i n g c o m p a n i e s , a s o f J u n e
30, 1991.
A d d i t i o n a l c l a r i f i c a t i o n s on i s s u e s r e l a t i n g t o t h e
r e s t o r a t i o n t o a c c r u a l s t a t u s o f r e s t r u c t u r e d d e b t and n o n a c c r u a l
a s s e t s with p a r t i a l c h a r g e - o f f s are s e t forth below.
N o n a c c r u a l a s s e t s s u b j e c t t o FASB S t a t e m e n t N o . 1 5
restructurings.
The March 1 s t p o l i c y s t a t e m e n t i n d i c a t e d t h a t a
loan or o t h e r d e b t instrument t h a t has been formally r e s t r u c t u r e d
s o a s t o b e r e a s o n a b l y a s s u r e d . o f r e p a y m e n t and p e r f o r m a n c e
a c c o r d i n g t o i t s m o d i f i e d terms need n o t be maintained i n
nonaccrual s t a t u s .
Furthermore, the interagency p o l i c y i n d i c a t e d
that in returning the asset to accrual status,
sustained
h i s t o r i c a l payment performance f o r a reasonable time p r i o r t o the
r e s t r u c t u r i n g may b e t a k e n i n t o a c c o u n t .
F o r e x a m p l e , a l o a n may h a v e b e e n r e s t r u c t u r e d ,
in
p a r t , t o r e d u c e t h e amount o f t h e b o r r o w e r ' s c o n t r a c t u a l
payments.
I n s o d o i n g , t h e b o r r o w e r ' s r e s t r u c t u r e d t e r m s may
r e q u i r e p a y m e n t s t h a t do n o t e x c e e d t h e amount and f r e q u e n c y t h a t
have been d e m o n s t r a t e d by t h e s u s t a i n e d h i s t o r i c a l payment
p e r f o r m a n c e o f t h e b o r r o w e r f o r a r e a s o n a b l e t i m e b e f o r e t h e loan
212
18
was r e s t r u c t u r e d .
In t h i s s i t u a t i o n , assuming t h a t the
r e s t r u c t u r e d l o a n i s r e a s o n a b l y a s s u r e d o f r e p a y m e n t and
mance a c c o r d i n g t o i t s m o d i f i e d t e r m s , t h e l o a n c a n b e
immediately restored to accrual status.
perfor-
Clearly, a period of sustained performance, whether
p r i o r t o or subsequent t o t h e date of the r e s t r u c t u r i n g , i s a
very important f a c t o r in determining whether there i s reasonable
a s s u r a n c e o f r e p a y m e n t and p e r f o r m a n c e a c c o r d i n g t o t h e l o a n ' s
m o d i f i e d t e r m s . I n c e r t a i n c i r c u m s t a n c e s , e v i d e n c e may e x i s t
r e g a r d i n g o t h e r c h a r a c t e r i s t i c s o f t h e b o r r o w e r t h a t may _be
s u f f i c i e n t t o d e m o n s t r a t e a r e l a t i v e improvement i n t h e
b o r r o w e r ' s c o n d i t i o n and d e b t s e r v i c e c a p a c i t y , t h e r e b y r e d u c i n g
t h e d e g r e e o f r e l i a n c e on t h e b o r r o w e r ' s p e r f o r m a n c e t o d a t e i n
a s s e s s i n g p r o s p e c t s f o r f u t u r e performance and c o l l e c t i b i l i t y
under t h e modified terms.
For example, s u b s t a n t i a l and r e l i a b l e
s a l e s , l e a s e or r e n t a l c o n t r a c t s obtained by t h e borrower or
other important developments t h a t are expected t o s i g n i f i c a n t l y
i n c r e a s e t h e b o r r o w e r ' s c a s h f l o w and d e b t s e r v i c e c a p a c i t y and
s t r e n g t h e n t h e b o r r o w e r ' s c o m m i t m e n t t o r e p a y may b e s u f f i c i e n t
to provide this assurance.
In c e r t a i n circumstances, a prepond e r a n c e o f s u c h e v i d e n c e , i n a n d o f i t s e l f , may b e s u f f i c i e n t t o t
warrant returning a r e s t r u c t u r e d loan t o accrual s t a t u s , provided
t h e loan under i t s r e s t r u c t u r e d terms i s reasonably assured of
p e r f o r m a n c e and f u l l c o l l e c t i b i l i t y .
I t i s imperative that the reasons for the restoration
of r e s t r u c t u r e d debt t o a c c r u a l s t a t u s be documented.
Such
a c t i o n s s h o u l d be s u p p o r t e d by a c u r r e n t , w e l l documented c r e d i t
e v a l u a t i o n o f t h e b o r r o w e r ' s f i n a n c i a l c o n d i t i o n and p r o s p e c t s
f o r repayment under t h e m o d i f i e d terms.
This documentation w i l l
be s u b j e c t t o r e v i e w by e x a m i n e r s .
The f o r m a l r e s t r u c t u r i n g o f a l o a n o r o t h e r d e b t
i n s t r u m e n t s h o u l d b e u n d e r t a k e n i n ways which improve t h e
l i k e l i h o o d t h a t t h e c r e d i t w i l l be repaid i n f u l l under the
m o d i f i e d terms i n accordance w i t h a r e a s o n a b l e repayment
schedule.1
When r e s t r u c t u r i n g l o a n s , r e g u l a t o r y r e p o r t i n g
r e q u i r e m e n t s a n d GAAP d o n o t r e q u i r e b a n k i n g o r g a n i z a t i o n s t o
grant excessive concessions, forgive principal, or take other
s t e p s n o t commensurate w i t h t h e b o r r o w e r ' s a b i l i t y t o repay, i n
o r d e r t o u s e t h e r e p o r t i n g t r e a t m e n t s p e c i f i e d i n FASB S t a t e m e n t
No. 1 5 .
F u r t h e r m o r e , r e g u l a t o r y r e p o r t i n g r e q u i r e m e n t s a n d GAAP
do n o t p r e c l u d e i n s t i t u t i o n s from i n c l u d i n g i n t h e r e s t r u c t u r e d
t e r m s p r u d e n t c o n t i n g e n t p a y m e n t p r o v i s i o n s t h a t p e r m i t an i n s t i t u t i o n t o obtain appropriate recovery of concessions involved in
1
When a r e s t r u c t u r e d l o a n i s n o t r e a s o n a b l y a s s u r e d o f
r e p a y m e n t and p e r f o r m a n c e u n d e r i t s m o d i f i e d t e r m s i n a c c o r d a n c e
w i t h a r e a s o n a b l e r e p a y m e n t s c h e d u l e , t h e l o a n may n o t b e
restored to accrual status.
213
18
the restructuring
improve.
should the borrower's
condition
substantially
Treatment o f N o n a c c r u a l Loans w i t h P a r t i a l C h a r g e - o f f s .
Questions have been r a i s e d regarding whether p a r t i a l c h a r g e - o f f s
a s s o c i a t e d with a nonaccrual loan (that has not been formally
r e s t r u c t u r e d ) must f i r s t be f u l l y r e c o v e r e d b e f o r e a loan can be
restored to accrual status.
GAAP a n d r e g u l a t o r y r e p o r t i n g
r e q u i r e m e n t s do n o t e x p l i c i t l y a d d r e s s t h i s i s s u e .
In accordance w i t h t h e Call Report instructions-,
r e s t o r a t i o n t o a c c r u a l s t a t u s i s p e r m i t t e d when ( a ) t h e l o a n h a s
b e e n b r o u g h t f u l l y c u r r e n t w i t h r e s p e c t t o p r i n c i p a l and i n t e r e s t
and (b) t h e bank e x p e c t s t h a t t h e f u l l c o n t r a c t u a l b a l a n c e o f t h e
l o a n ( i n c l u d i n g any amounts c h a r g e d - o f f ) p l u s i n t e r e s t w i l l be
f u l l y c o l l e c t i b l e under t h e terms of t h e l o a n . 2
Thus, i n
determining whether a p a r t i a l l y c h a r g e d - o f f l o a n t h a t has been
brought f u l l y c u r r e n t can be returned t o a c c r u a l s t a t u s , i t i s
i m p o r t a n t t o d e t e r m i n e w h e t h e r t h e bank e x p e c t s t o r e c e i v e t h e
f u l l amount o f p r i n c i p a l and i n t e r e s t c a l l e d f o r by t h e l o a n ' s
terms.
When a l o a n h a s b e e n b r o u g h t f u l l y c u r r e n t w i t h r e s p e c t
t o c o n t r a c t u a l p r i n c i p a l and i n t e r e s t , and t h e b o r r o w e r ' s f i n a n c i a l c o n d i t i o n and p r o s p e c t s f o r repayment h a v e improved s o t h a t
t h e f u l l amount o f c o n t r a c t u a l p r i n c i p a l ( i n c l u d i n g any amounts
c h a r g e d - o f f ) a n d i n t e r e s t i s e x p e c t e d t o b e r e p a i d , t h e l o a n may
be r e s t o r e d t o a c c r u a l s t a t u s w i t h o u t h a v i n g t o f i r s t r e c o v e r t h e
charge-off.
On t h e o t h e r h a n d , t h i s t r e a t m e n t w o u l d n o t b e
a p p r o p r i a t e when t h e c h a r g e - o f f i s i n d i c a t i v e o f c o n t i n u i n g d o u b t
regarding the c o l l e c t i b i l i t y of principal or i n t e r e s t .
Since the
c r i t e r i a for nonaccrual s t a t u s include the requirement that loans
o r o t h e r a s s e t s b e p l a c e d i n n o n a c c r u a l s t a t u s when repayment i n
f u l l of p r i n c i p a l or i n t e r e s t i s not expected, such nonaccrual
loans could not be r e s t o r e d t o accrual s t a t u s .
It i s imperative that the reasons for the restoration
of a p a r t i a l l y c h a r g e d - o f f loan t o accrual s t a t u s be documented.
Such a c t i o n s s h o u l d be s u p p o r t e d by a c u r r e n t , w e l l documented
c r e d i t e v a l u a t i o n o f t h e b o r r o w e r ' s f i n a n c i a l c o n d i t i o n and
p r o s p e c t s f o r f u l l repayment of c o n t r a c t u a l p r i n c i p a l
(including
2
The i n s t r u c t i o n s f o r t h e C a l l R e p o r t s a n d "Y R e p o r t s "
discuss the c r i t e r i a for restoration to accrual status in the
g l o s s a r y e n t r i e s f o r "nonaccrual s t a t u s . "
This guidance also
permits restoration to accrual status for nonaccrual a s s e t s that
a r e b o t h w e l l s e c u r e d and i n t h e p r o c e s s o f c o l l e c t i o n .
In
addition, t h i s guidance permits restoration to accrual status,
when c e r t a i n c r i t e r i a a r e m e t , f o r f o r m a l l y r e s t r u c t u r e d d e b t a n d
acquired nonaccrual a s s e t s .
214
18
any amounts c h a r g e d - o f f ) and i n t e r e s t .
be s u b j e c t t o r e v i e w by e x a m i n e r s .
This documentation
will
A n o n a c c r u a l l o a n o r d e b t I n s t r u m e n t may h a v e b e e n
f o r m a l l y r e s t r u c t u r e d i n a c c o r d a n c e w i t h FASB ' S t a t e m e n t N o . 15 s o
that i t meets the c r i t e r i a for restoration to accrual s t a t u s
presented in the previous section (that addresses restructured
loans).
U n d e r GAAP, when a c h a r g e - o f f w a s t a k e n p r i o r t o t h e
d a t e o f t h e r e s t r u c t u r i n g , t h e c h a r g e - o f f does not have t o be
r e c o v e r e d b e f o r e t h e r e s t r u c t u r e d l o a n can be r e s t o r e d t o a c c r u a l
status.
When a c h a r g e - o f f o c c u r s a f t e r t h e d a t e o f t h e
r e s t r u c t u r i n g , t h e c o n s i d e r a t i o n s and t r e a t m e n t s d i s c u s s e d i n t h e
previous paragraphs in t h i s s e c t i o n are applicable.
Richard Spillenkothen
Deputy A s s o c i a t e D i r e c t o r
215
BOARD OF GOVERNORS
arTHi
V^j^g^'..
•SlrSP^f^WM**
FEDERAL RESERVE SYSTEM
WASHINOTON, O. C. 20551
WMm;
SR 9 1 - 1 8
(FIS)
September 23, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECTS
C l a s s i f i c a t i o n G u i d e l i n e s F o r An A s s e t When A
S u b s t a n t i a l P o r t i o n Has Been Charged O f f
I n some c r i s e s , i n s t i t u t i o n s w i t h l o a n s t o f i n a n c i a l l y
troubled borrowers have charged o f f s u b s t a n t i a l p o r t i o n s of these
credits.
Questions have been raised regarding t h e appropriate
s u p e r v i s o r y treatment of t h e remaining recorded b a l a n c e of t h e s e
loans.
This examination guidance i s intended to c l a r i f y existing
supervisory practices regarding the c l a s s i f i c a t i o n of p a r t i a l l y
charged-off loans.
Consistent with long standing supervisory practice,
the
e v a l u a t i o n of e a c h e x t e n s i o n o f c r e d i t s h o u l d be b a s e d upon t h e
fundamentals of the p a r t i c u l a r credit.
That i s , t h e e v a l u a t i o n
o f e a c h c r e d i t s h o u l d b e b a s e d upon t h e b o r r o w e r ' s ( o r t h e
c o l l a t e r a l ' s ) c u r r e n t and s t a b i l i z e d c a s h f l o w , e a r n i n g and d e b t
s e r v i c e capacity, f i n a n c i a l performance, net worth, guarantees,
f u t u r e p r o s p e c t s , and o t h e r f a c t o r s r e l e v a n t t o t h e b o r r o w e r ' s
a b i l i t y t o s e r v i c e and r e t i r e i t s d e b t .
Based upon c o n s i d e r a t i o n o f a l l o f t h e a b o v e r e l e v a n t
f i n a n c i a l f a c t o r s , t h i s e v a l u a t i o n may i n d i c a t e t h a t a c r e d i t h a s
w e l l - d e f i n e d weaknesses which jeopardize repayment i n f u l l , but
t h a t a p o r t i o n o f t h e l o a n may b e r e a s o n a b l y a s s u r e d o f
repayment.
When a n i n s t i t u t i o n h a s t a k e n a c h a r g e - o f f i n a
s u f f i c i e n t amount s o t h a t t h e r e m a i n i n g r e c o r d e d b a l a n c e o f t h e
l o a n i s b e i n g s e r v i c e d ( b a s e d upon r e l i a b l e s o u r c e s o f c a s h f l o w )
and i s r e a s o n a b l y a s s u r e d o f r e p a y m e n t , t h i s r e m a i n i n g r e c o r d e d
b a l a n c e would g e n e r a l l y b e c l a s s i f i e d no more s e v e r e l y t h a n
substandard.1
Consistent with long standing c l a s s i f i c a t i o n
g u i d e l i n e s , a substandard c l a s s i f i c a t i o n of the remaining
r e c o r d e d b a l a n c e w o u l d o n l y b e a p p r o p r i a t e when w e l l - d e f i n e d
weaknesses c o n t i n u e t o be p r e s e n t in the c r e d i t .
For example,
1
The a c c r u a l / n o n a c c r u a l s t a t u s o f t h e l o a n must c o n t i n u e t o be
determined in accordance with the glossary to the current
Call
Report i n s t r u c t i o n s .
Thus, w h i l e t h e s e p a r t i a l l y c h a r g e d - o f f l o a n s
may q u a l i f y f o r n o n a c c r u a l t r e a t m e n t , c a s h b a s i s r e c o g n i t i o n o f
income w i l l be a p p r o p r i a t e when t h e c r i t e r i a s p e c i f i e d i n t h e C a l l
Report guidance are met.
216
2
when t h e r e m a i n i n g r e c o r d e d b a l a n c e o f an a s s e t i s
readily marketable c o l l a t e r a l , the portion that i s
t h i s c o l l a t e r a l would g e n e r a l l y not be c l a s s i f i e d .
secured
secured
by
by
T h i s a p p r o a c h w o u l d g e n e r a l l y be a p p r o p r i a t e when an
i n s t i t u t i o n maintains s u f f i c i e n t controls over i t s
lending
f u n c t i o n and m a i n t a i n s adequate c u r r e n t documentation t o support
the credit analysis of the loan.
This c l a s s i f i c a t i o n approach
could not be u t i l i z e d f o r loans f o r which the l o s s exposure
c a n n o t b e r e a s o n a b l y d e t e r m i n e d , e . g . , l o a n s c o l l a t e r a l i z e d by
properties subject to environmental hazards.
This approach would
a l s o n o t b e j u s t i f i e d when s o u r c e s o f r e p a y m e n t a r e c o n s i d e r e d
unreliable.
Extensions of c r e d i t that have not been s u b j e c t
p a r t i a l c h a r g e - o f f s should continue t o be c l a s s i f i e d in
accordance with e x i s t i n g supervisory guidelines.
Richard Spillenkothen
Deputy A s s o c i a t e D i r e c t o r
to
217
BOARD
OF G O V E R N O R S
OP THE
FEDERAL RESERVE SYSTEM
WASHINGTON, •. C. 20S5I
SR 91-19 (FIS)
October 2, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH.FEDERAL RESERVE BANK
SUBJECT:
Communications
Concerns
E f f o r t s Regarding
Credit
Availability
As d i s c u s s e d on s e v e r a l o c c a s i o n s w i t h R e s e r v e Banks,
t h e f e d e r a l b a n k i n g a g e n c i e s a r e p r o c e e d i n g on a number o f f r o n t s
t o strengthen communications with bankers regarding general
i s s u e s a f f e c t i n g c r e d i t a v a i l a b i l i t y and t h e March 1 s t
interagency policy statement.
S e n i o r R e s e r v e Bank o f f i c i a l s and
Board s t a f f h a v e p a r t i c i p a t e d i n numerous m e e t i n g s w i t h b a n k e r s ,
b u s i n e s s m e n and members o f C o n g r e s s t o d i s c u s s c r e d i t
a v a i l a b i l i t y c o n c e r n s , h e a r t h e v i e w s o f b a n k e r s and b o r r o w e r s ,
and e x p l a i n t h e r a t i o n a l e and c o n t e x t o f s u p e r v i s o r y p o l i c i e s .
T h i s l e t t e r d e s c r i b e s t h e s e o n g o i n g e f f o r t s , p r o v i d e s some
r e l a t e d b a c k g r o u n d i n f o r m a t i o n , and s e t s o u t some a d d i t i o n a l
s t e p s t o broaden communication w i t h bank management.
The a t t a c h e d l e t t e r from t h e S e c r e t a r y o f t h e T r e a s u r y
t o a member o f C o n g r e s s p r o v i d e s a d d i t i o n a l i n f o r m a t i o n on t h e
r e g i o n a l "town m e e t i n g s " i n w h i c h t h e S y s t e m h a s p a r t i c i p a t e d t o
discuss credit a v a i l a b i l i t y concerns.
We b e l i e v e t h e s e m e e t i n g s
h a v e p r o v e n u s e f u l s o f a r and i t i s i m p o r t a n t t h a t we c o n t i n u e
t h i s c o n s t r u c t i v e program w i t h t h e involvement of s e n i o r Federal
Reserve o f f i c i a l s .
I n o r d e r t o s t a y a p p r i s e d o f t h e s e d i s c u s s i o n s , we a s k
t h a t e a c h R e s e r v e Bank p r e p a r e a summary memorandum o f a n y o f
I t would be h e l p f u l i f the
these public meetings attended.
summary i n c l u d e d t h e f o l l o w i n g i n f o r m a t i o n :
o
a l i s t of the participants in the congressional
d e l e g a t i o n and from t h e r e g u l a t o r y a g e n c i e s , and a
of t h e i n d u s t r i e s r e p r e s e n t e d by any o t h e r
participants;
o
a summary o f
o
an o v e r v i e w
the
of
topics
the
discussed;
general
tenor
of
and
the
meeting.
T h e s e m e m o r a n d a may b e f o r w a r d e d t o o t h e r f e d e r a l a g e n c i e s a s
p a r t o f t h e e f f o r t t o m o n i t o r and s h a r e m e a n i n g f u l i n f o r m a t i o n
developments a f f e c t i n g c r e d i t a v a i l a b i l i t y .
list
on
218
-
2
-
Another ongoing o b j e c t i v e i s t o e n s u r e t h a t any
q u e s t i o n s b a n k e r s h a v e r e g a r d i n g t h e March 1 s t s t a t e m e n t a r e
answered i n a t i m e l y manner.
To a s s i s t i n t h e a c h i e v e m e n t o f
t h i s o b j e c t i v e , the f o l l o w i n g procedures should be implemented
immediately t o further strengthen our communication e f f o r t s .
1.
During each o n - s i t e bank e x a m i n a t i o n , t h e e x a m i n e r - i n c h a r g e o r a n o t h e r R e s e r v e Bank o f f i c i a l s h o u l d
d e t e r m i n e i f t h e b a n k ' s s e n i o r management h a s any
questions regarding the general content or s p e c i f i c
p r o v i s i o n s o f t h e March 1 i n t e r a g e n c y p o l i c y s t a t e m e n t
or related guidance.
2.
I f s o , t h e e x a m i n e r o r R e s e r v e Bank o f f i c i a l s h o u l d
d i s c u s s t h e March 1 s t a t e m e n t w i t h , and a n s w e r any
q u e s t i o n s posed by, t h e b a n k ' s s e n i o r management.
3.
These i s s u e s can be discussed during the examination or
a t t h e e x i t m e e t i n g w i t h s e n i o r management.
If
a p p r o p r i a t e , t h e s e m a t t e r s can a l s o be d i s c u s s e d a t any
meetings with the bank's directors or the board's
examination or audit committee.
4.
Board s t a f f s h o u l d be c o n s u l t e d i f R e s e r v e Banks have
a n y q u e s t i o n s r e g a r d i n g s p e c i f i c a s p e c t s o f t h e March
1st statement or related p o l i c i e s .
The summaries of t h e r e g i o n a l town m e e t i n g s s h o u l d be
forwarded t o B i l l S p a n i e l (mail s t o p 186) a t t h e Board.
Any
q u e s t i o n s r e g a r d i n g t h e March 1 s t p o l i c y s t a t e m e n t s h o u l d b e
r e f e r r e d t o Roger Cole
(202-452-2619).
Richard Spillenkothen
Deputy A s s o c i a t e D i r e c t o r
Attachment
Cross
Reference:
SR 9 1 - 1 6 , SR 9 1 - 1 8 , a n d M a r c h
Interagency Policy Statement
1,
1991
219
THE SECRETARY OF THE TREASURY
WASHINGTON
June
21,
1991
e H o n o r a b l e Nancy L. J o h n s o n
.S. House of R e p r e s e n t a t i v e s
Washington, D.C.
20515
D e a r Ms.
Johnson:
A s a f o l l o w - u p t o my l e t t e r d a t e d A p r i l 2 4 ,
1991,
Treasury o f f i c i a l s have discussed with the f i n a n c i a l
institution
regulators your concept of a n a t i o n a l seminar.
The p u r p o s e of
t h e s e s s i o n s would be t o enhance t h e n a t i o n a l e f f o r t t o
communicate t h e r e g u l a t o r s * g u i d e l i n e s r e l e a s e d on March 1,
1991.
The r e g u l a t o r s b e l i e v e t h a t t h i s e f f o r t w i l l f u r t h a r t h e i r
o b j e c t i v e t h a t c r e d i t a v a i l a b i l i t y f o r sound borrowers n o t be
a d v e r s e l y impacted by s u p e r v i s o r y p o l i c i e s or b a n k e r s '
miisunderstandings about them.
L o g i s t i c a l l y , the r e g u l a t o r s b e l i e v e i t would be best
i f the l o c a l Congressional d e l e g a t i o n were to s e r v e as h o s t in a
"town meeting" format, p e r h a p s , i n s e v e r a l r e g i o n a l
locations.
Participants could include local bankers, business people,
and
o f f i c i a l s from the r e g i o n a l o f f i c e of t h e Federal Reserve,
C o m p t r o l l e r o f t h e C u r r e n c y , FDIC, a n d t h e O f f i c e o f T h r i f t
Supervision.
Ground r u l e s w i l l b e e s t a b l i s h e d w h i c h p r e c l u d e
" - a s e s p e c i f i c " r e g u l a t o r y m a t t e r s from being d i s c u s s e d , but, of
irse, a d e t a i l e d general d i s c u s s i o n should take place.
A d d i t i o n a l l y , e a c h a g e n c y h a s p r o v i d e d me w i t h a n
a s s e s s m e n t o f i t s c o m m u n i c a t i o n s e f f o r t , and a r e p o r t o f how
e f f e c t i v e , i n i t s v i e w , t h e March l , 1991 g u i d e l i n e s have been.
While i t i s too early for the r e g u l a t o r s to provide concrete
r e s u l t s or c i t e empirical e v i d e n c e of a change i n t h e w i l l i n g n e s s
or a b i l i t y of banks t o i n c r e a s e t h e i r lending a c t i v i t i e s ,
the
r e g u l a t o r s c i t e d some p o s i t i v e i m p r e s s i o n s .
The O f f i c e o f T h r i f t
Supervision reported credit a v a i l a b i l i t y in the r e s i d e n t i a l
real
e s t a t e area has nor been impaired o v e r t h e l a s t s e v e r a l months as
t h r i f t s have increased t h e i r lending in r e s i d e n t i a l r e a l e s t a t e .
Moreover, through communicating and c l a r i f y i n g s u p e r v i s o r y p o l i c y
guidelines to each f i e l d examiner across the country,
the
a g e n c i e s b e l i e v e t h a t t h e r e i s more c o n s i s t e n c y among f i e l d
examiners' p r a c t i c e s l e a d i n g t o a more balanced approach t o
conducting on-site examinations.
W h i l e we s e e s i g n s t h a t t h e c r e d i t c r u n c h i s i m p r o v i n g ,
t h i s i s a c r i t i c a l t i m e , a t i m e when a c c e s s t o c r e d i t by sound
b o r r o w e r s t o f i n a n c e b u s i n e s s i n v e n t o r i e s and h o m e b u i l d i n g a s
demand i n c r e a s e s i s f u n d a m e n t a l t o a r e b o u n d i n e c o n o m i c g r o w t h .
220
- 2 -
The r e g u l a t o r y a g e n c i e s h a v e c o m m i t t e d t o r e v i e w o t h e r
s u g g e s t i o n s t h a t c o u l d f a c i l i t a t e c r e d i t t o sound borrowers
t o a s s i s t in maintaining a balanced regulatory environment.
and
Again, thank you f o r your c o n s t r u c t i v e s u g g e s t i o n .
The
r e g u l a t o r s l o o k f o r w a r d t o w o r k i n g w i t h Members a n d l o c a l
o f f i c i a l s t o f a c i l i t a t e a s e t of productive meetings.
Please
contact the congressional a f f a i r s o f f i c e s of the r e g u l a t o r s t o
continue preparations for the meetings.
Sincerely,
cc:
Messrs.
Clarke,
N i c h o l a s F. Brady
G r e e n s p a n , S e i d m a n , Ryan
221
BOARD OF
GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
W A S H I N G T O N , D. C .
AD 91-72
(FIS)
20S51
D I V I S I O N ar BANKING
S U P S H V I 9 I D N AND REGULATION
October 7, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Meetings with Senior
Availability
Issues
Bank E x e c u t i v e s
on
Credit
As p r e v i o u s l y d i s c u s s e d w i t h R e s e r v e Banks, t h e F e d e r a l
R e s e r v e , t h e O f f i c e of t h e C o m p t r o l l e r of t h e Currency and t h e
o t h e r f e d e r a l r e g u l a t o r s have had u n d e r c o n s i d e r a t i o n a program
of m e e t i n g s w i t h s e n i o r bank e x e c u t i v e s t o r e v i e w i s s u e s
a f f e c t i n g bank l o a n p o r t f o l i o s and c r e d i t a v a i l a b i l i t y .
Both the
OCC a n d t h e F e d e r a l R e s e r v e h a v e d e c i d e d t o p u r s u e t h i s p r o g r a m
f o r commercial banks under t h e i r r e s p e c t i v e j u r i s d i c t i o n s
that
have l a r g e commercial r e a l e s t a t e l o a n p o r t f o l i o s .
It i s our
desire to conduct these meetings over the next four weeks.
S t a f f w i l l b e c o n t a c t i n g e a c h R e s e r v e Bank r e g a r d i n g
the commercial banks t h a t i t i s contemplated at the p r e s e n t time
w i l l be involved in t h i s e f f o r t .
The s e l e c t i o n h a s been b a s e d
upon t h e s i z e o f t h e b a n k s ' r e a l e s t a t e l o a n p o r t f o l i o s w i t h some
refinements t o achieve a measure of geographic d i s t r i b u t i o n .
S e v e r a l R e s e r v e Banks c u r r e n t l y do n o t have banks i n c l u d e d i n
this effort.
For t h e s e Reserve Banks, t h e attachment i s b e i n g
provided f o r background information on the nature of t h e program.
I f t h e s c o p e o f t h i s program i s expanded, t h e r e i s a l s o t h e
p o s s i b i l i t y t h a t some b a n k s f r o m t h e s e o t h e r d i s t r i c t s may b e
involved.
The p u r p o s e o f t h e s e m e e t i n g s i s t o s t r e n g t h e n o u r
u n d e r s t a n d i n g o f i s s u e s a f f e c t i n g t h e a v a i l a b i l i t y o f c r e d i t and
t h e c o n d i t i o n s banks a r e f a c i n g , d e t e r m i n e any q u e s t i o n s bankers
have r e g a r d i n g our p o l i c i e s r e l a t e d t o t h e s e i s s u e s , and s o l i c i t
t h e banks^" v i e w s o n f u r t h e r s t e p s t h a t c o u l d b e t a k e n t o a d d r e s s
credit a v a i l a b i l i t y concerns.
The m e e t i n g s a r e n o t e x a m i n a t i o n s
and a r e n o t i n t e n d e d t o r e i t e r a t e s u p e r v i s o r y m a t t e r s a l r e a d y
b e i n g a d d r e s s e d i n t h e normal s u p e r v i s o r y p r o c e s s .
Attached i s a l e t t e r that you are asked t o send t o the
c h i e f e x e c u t i v e o f f i c e r o f t h e s p e c i f i e d s t a t e member b a n k ( s )
in
order t o implement t h i s i n i t i a t i v e .
The e n c l o s e d l e t t e r
d e s c r i b e s t h e p u r p o s e of t h e m e e t i n g s and c o n t a i n s a s an
a t t a c h m e n t an a g e n d a o u t l i n e and a r e q u e s t f o r i n f o r m a t i o n t h e
bank i s a s k e d t o p r o v i d e p r i o r t o t h e m e e t i n g t o s e r v e a s a
starting point for the discussion.
As n o t e d i n t h e l e t t e r t o t h e
s t a t e member b a n k , we a r e s e e k i n g t h e i n v o l v e m e n t o f t h e b a n k ' s
52-418 - 92 - 8
222
2
CEO o r o t h e r h i g h l e v e l e x e c u t i v e a n d i t s c h i e f l e n d i n g o f f i c e r .
A s e n i o r o f f i c i a l from t h e Board's D i v i s i o n of Banking
S u p e r v i s i o n and R e g u l a t i o n would a l s o a t t e n d , a l o n g w i t h t h e
R e s e r v s Bank's s e n i o r o f f i c e r i n c h a r g e of s u p e r v i s i o n , and a
senior examiner or examining o f f i c e r .
R e s e r v e Banks are asked t o send t h e l e t t e r a s soon a s
p o s s i b l e and t o c o o r d i n a t e s c h e d u l i n g t h r o u g h Roger C o l e ' s o f f i c e
a t t h e Board t o e n s u r e t h e a v a i l a b i l i t y of a s e n i o r o f f i c i a l from
t h e Board
staff.
A t t h i s t i m e , we a n t i c i p a t e t h a t F r e d S t r u b l e ,
Steve Schemering or Rich Spillenkothen w i l l p a r t i c i p a t e in these
m e e t i n g s from t h e B o a r d , w i t h p o s s i b l y o n e o t h e r member o f t h e
Board's s t a f f .
As n o t e d i n p r e v i o u s c o m m u n i c a t i o n s w i t h R e s e r v e Banks,
t h i s i n i t i a t i v e has evolved out of discussions the banking
a g e n c i e s have conducted in Washington concerning s u p e r v i s o r y
p o l i c i e s , bank l e n d i n g a c t i v i t i e s , and t h e a v a i l a b i l i t y of c r e d i t
t o sound borrowers.
While t h i s program r e p r e s e n t s a s i g n i f i c a n t
c o m m i t m e n t o f t i m e a n d r e s o u r c e s , we b e l i e v e t h a t i t w i l l b e
h e l p f u l in s t r e n g t h e n i n g our understanding of developments
a f f e c t i n g bank l o a n p o r t f o l i o s and c r e d i t
availability.
Moreover, i t i s c o n s i s t e n t w i t h our commitment t o t a k e
appropriate s t e p s t o improve communications with banking
o r g a n i z a t i o n s o n s u p e r v i s o r y p o l i c i e s t h a t p e r t a i n t o , o r may
a f f e c t , the a v a i l a b i l i t y of c r e d i t .
Q u e s t i o n s o n t h i s e f f o r t may
Richard Spillenkothen
Deputy A s s o c i a t e D i r e c t o r
223
TO THE CHIEF EXECUTIVE OFFICER (CEO)
OF THE STATE MEMBER BANK ADDRESSED
Dear
:
For w e l l over a y e a r , t h e Federal R e s e r v e has been
c o n c e r n e d a b o u t t h e a v a i l a b i l i t y o f c r e d i t t o s o u n d b o r r o w e r s and
the p o t e n t i a l impact of r e g u l a t o r y or supervisory p o l i c i e s in
t h i s important area.
I n M a r c h o f t h i s y e a r , a s y o u may b e a w a r e ,
the f e d e r a l banking a g e n c i e s adopted a s e t of s u p e r v i s o r y
g u i d e l i n e s designed to reduce impediments to l e n d i n g t o c r e d i t w o r t h y b o r r o w e r s and t o c l a r i f y r e g u l a t o r y p o l i c i e s t h a t c o u l d be
h a v i n g an a d v e r s e e f f e c t on banks' w i l l i n g n e s s t o e x t e n d c r e d i t .
The b a n k i n g a g e n c i e s s t a t e d t h a t t h e y d i d n o t w a n t t h e
a v a i l a b i l i t y of loans to credit-worthy borrowers t o be adversely
a f f e c t e d by s u p e r v i s o r y p o l i c i e s or d e p o s i t o r y
institutions'
misunderstandings about them.
In a d o p t i n g t h e March 1 s t p o l i c y s t a t e m e n t and
implementing r e l a t e d examination g u i d e l i n e s , the Federal Reserve
h a s a t t e m p t e d t o c o m m u n i c a t e t h e s e p o l i c i e s i n a n e f f e c t i v e and
c l e a r manner t o b o t h t h e b a n k i n g i n d u s t r y and i t s
district
s u p e r v i s o r y and e x a m i n a t i o n s t a f f s .
The F e d e r a l R e s e r v e ,
t o g e t h e r with the other banking agencies, has a l s o sought to
m o n i t o r t h e i m p a c t and e f f e c t of t h e s e s u p e r v i s o r y p o l i c i e s ,
as
w e l l a s o t h e r d e v e l o p m e n t s t h a t may b e h a v i n g a n i m p a c t o n b a n k
l o a n p o r t f o l i o s and c r e d i t
availability.
In connection with t h i s o v e r a l l e f f o r t , t h e Federal
Reserve would l i k e in t h e near future t o meet with s e n i o r
o f f i c i a l s of your bank.
T h e p u r p o s e o f t h i s m e e t i n g w o u l d b e to
d i s c u s s c r e d i t a v a i l a b i l i t y i s s u e s a n d s o l i c i t y o u r v i e w s o n the
c o n d i t i o n s o r c h a l l e n g e s y o u r b a n k c u r r e n t l y f a c e s a n d e x p e c t s to
encounter over the next year or so in carrying out i t s
lending
activities.
An o u t l i n e o f t h e t o p i c s w e w o u l d l i k e t o c o v e r i n
t h i s meeting i s s e t f o r t h i n the enclosed agenda.
A s r e f l e c t e d i n t h e a g e n d a , w e w o u l d l i k e t o f o c u s on
real e s t a t e loan portfolios.
In t h i s c o n n e c t i o n , we w o u l d ask
y o u r c o o p e r a t i o n i n p r o v i d i n g t o u s p r i o r fro t;he m e e t i n g t h e
information requested in the attachment to the agenda.
"This
i n f o r m a t i o n , o r , i f n o t a v a i l a b l e i n t h i s f o r m f r o m y o u r internal
r e p o r t i n g systems, comparable data or e s t i m a t e s along t h e s e
224
2
l i n e s , would be h e l p f u l in s e r v i n g as a s t a r t i n g p o i n t f o r our
discussions.
While t h e agenda emphasizes r e a l e s t a t e
lending
i s s u e s , we would a p p r e c i a t e h e a r i n g y o u r v i e w s and c o n c e r n s on
any o t h e r components of t h e l o a n p o r t f o l i o t h a t you b e l i e v e would
be r e l e v a n t .
I want t o s t r e s s t h a t t h i s m e e t i n g i s n o t an
e x a m i n a t i o n ; nor i s i t i n t e n d e d t o be used as a forum t o
r e i t e r a t e s u p e r v i s o r y comments or c o n c e r n s t h a t have a l r e a d y been
d i s c u s s e d i n - d e p t h i n t h e normal e x a m i n a t i o n and s u p e r v i s o r y
follow-up process.
Rather, the purpose of the meeting i s t o hear
y o u r v i e w s on, and t h u s e n h a n c e o u r u n d e r s t a n d i n g o f ,
developments that are a f f e c t i n g the a v a i l a b i l i t y of c r e d i t t o
bank c u s t o m e r s .
S u c h d e v e l o p m e n t s may i n c l u d e , f o r e x a m p l e ,
changes in lending standards over the l a s t year, challenges posed
by t h e need t o r o l l o v e r or r e s t r u c t u r e c r e d i t s i n t h e absence of
l o n g - t e r m t a k e - o u t f i n a n c i n g , c h a n g e s i n r e a l e s t a t e m a r k e t s and
t h e a s s u m p t i o n s g o i n g i n t o r e a l e s t a t e a p p r a i s a l s , and t h e
a p p l i c a t i o n and impact o f s u p e r v i s o r y p o l i c i e s and p r o c e d u r e s .
Your v i e w s on o t h e r p o s s i b l e s t e p s t o a d d r e s s c r e d i t
availability
concerns would a l s o be welcome.
P a r t i c i p a n t s i n t h i s m e e t i n g from t h e F e d e r a l R e s e r v e
w i l l i n c l u d e a s e n i o r o f f i c i a l from t h e Board o f G o v e r n o r s i n
Washington and a s e n i o r s u p e r v i s o r y o f f i c i a l and examiner from
t h e F e d e r a l R e s e r v e Bank o f
.
In order t o
m a x i m i z e t h e v a l u e o f t h i s s e s s i o n , we w o u l d a p p r e c i a t e y o u r
p a r t i c i p a t i o n , or a n o t h e r s e n i o r e x e c u t i v e of y o u r bank, and t h e
bank's chief lending o f f i c e r in the meeting.
We w o u l d l i k e t o
h o l d t h i s m e e t i n g i n t h e n e x t few w e e k s , and I w i l l b e c a l l i n g
your o f f i c e i n the next few days t o e s t a b l i s h a mutually
c o n v e n i e n t d a t e and t i m e .
I want t o thank you f o r your c o o p e r a t i o n i n t h i s
effort.
A s I h a v e i n d i c a t e d a b o v e , we b e l i e v e t h i s s e s s i o n c a n
enhance t h e F e d e r a l R e s e r v e ' s u n d e r s t a n d i n g o f t h e c h a l l e n g e s you
are f a c i n g , as w e l l as t h e p o t e n t i a l impact of the s u p e r v i s o r y
p r o c e s s on bank l e n d i n g a c t i v i t i e s and c r e d i t
availability.
Sincerely,
Federal
Senior Vice President
R e s e r v e Bank o f
225
Agenda for Discussion
at Meetings
on Credit Availability Issues
1.
Overview of commercial real estate loan portfolio
characteristics; composition, maturity structure, and
performance (See Attachment 1).
2.
Bank's views on the current status and outlook for
commercial and residential real estate sectors.
a.
3.
4.
Assessment of current and future demand for
commercial and residential real estate loans.
Policies for restructuring or rolling over existing
commercial real estate loans.
a.
Terms, conditions, and requirements for rolling
over and restructuring construction and land
development, mini-perm, and residential development loans.
b.
Changes in these policies, requirements and
practices within last two years and any future
anticipated changes.
c.
Prospects for permanent take-out financing within
next 12 months.
Underwriting standards for new real estate loans.
a.
Current posture toward extending new loans:
construction and land development; mini-perms;
other commercial real estate; loans to residential
developers; and residential mortgages.
b.
Underwriting standards (regarding requirements for
net worth, loan-to-value, pricing, maturity,
collateral, cash flow, guarantees, etc.) for new
loans of the types in 4.a. above.
c.
Changes in these standards within the last two
years and any future anticipated changes.
226
- 2 -
5.
Appraisal assumptions for commercial real estate loans.
a.
Changes in the last two years in appraisal assumptions regarding occupancy rates, lease-up periods,
rental fees, discount or cap rates. Address
assumptions used by external appraiser?, as well
as for in-bank evaluations.
6.
Credit availability concerns, lending standards, and
outlook for credit demand pertaining to other aspects
of the portfolio.
(e.g., commercial and industrial,
HLT, small business, etc.)
7.
Bank's views on the factors that may be contributing to
constraints on institution's lending activities.
a.
Additibnal steps that could be taken to address
credit availability concerns.
Attachment
227
ATTACHMENT 1
The information requested by this attachment is confidential
and is for use by the Federal supervisory agencies.
In
answering the following questions, please use reasonable
estimates when certain information requested is not readily
available from your information systems.
1.
Overview of commercial real estate loan portfolio
characteristics; composition, maturity structure, and
performance.
Please provide the following information on certain
characteristics of the commercial real estate portfolio
in domestic offices, as of June 30, 1991.
a.
How large is the commercial real estate portfolio?
b.
Of the total commercial real estate portfolio, how
much is made up of:
i)
commercial construction and land development
loans
ii)
mini-perms (loans secured by commercial real
estate that are intended to come due some
time after the completion of the project
being financed and that may have original
maturities of up to seven or eight years)
iii) residential development
loans
iv)
c.
other commercial
real estate loans
Provide a breakdown of remaining maturity for the
commercial real estate portfolio (indicated at
item l.a. above) along the following lines:
i)
under 1 year
ii)
1 - 3
years
iii) 3 - 5
years
iv)
over 5 years
228
- 2 -
d.
Of the total commercial real estate loan portfolio, what amounts are:
i)
performing -- servicing both interest and
amortize principal as agreed
ii)
past due and not in nonaccrual status
iii) in nonaccrual status
[Note: The amounts for items i) through iii)
should total the amount shown for item l.a. above]
e.
iv)
already restructured,. and able to service
both interest and amortize principal under
modified terms
v)
current (or can be serviced) as to interest,
but cannot amortize principal as agreed under
modified terms
vi)
in process of, or expected to result in,
foreclosure
What percentage of the commercial real estate
loans maturing within the next 12 months [item
l.c.i) above] are likely to be:
i)
rolled over at a market rate of interest
ii)
restructured or rolled over where a concession is granted
iii) foreclosed upon
f.
If the responses to questions I.e., l.d., or I.e.
for the individual components of the commercial
real estate portfolio set forth in l.b. above
would differ significantly from the portfolio as a
whole, please provide separate answers to questions I.e., l.d., and I.e. for those components of
the portfolio.
g.
What is the cash yield on that portion of the
commercial real estate portfolio that is in
nonaccrual status [item l.d.iii) above]?
Tor purposes of this question, a "concession" by the
lending institution includes (a) a reduction of principal,
(b) a reduction of the stated interest rate to a level below
market rates for loans of similar terms and risk, (c) a
combination of (a) and (b), etc.
229
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Federal Reserve Board
Office of Thrift Supervision
NEWS
RELEASE
EMBARGOED FOR RELEASE at 2 p.m. EST
Thursday, November 7, 1991
FINANCIAL REGULATORS ISSUE JOINT
SUPERVISORY POLICY STATEMENT
WASHINGTON, D.C., Nov. 7, 1991 —
The four federal regulators of
bank and thrift institutions issued a joint statement today on the
review and classification of commercial real estate loans.
Today's
action is another step by the agencies to ensure that
misunderstandings about supervisory policies do not impede the
availability of credit to sound borrowers.
Development of this
document was announced in the Administration's October 8th statement
on "Easing The Credit Crunch To Promote Economic Growth."
The p o l i c y
on t h e
statement
provides clear
r e v i e w and c l a s s i f i c a t i o n
The d e t a i l e d
guidelines,
institutions
and e x a m i n e r s ,
indicators
values,
of
and t h e
The f o u r
the O f f i c e of
Deposit
troubled
cover
be s e n t
Corporation
of
real
to a l l
loan p o r t f o l i o
of
institutions'
the Comptroller
and c o m p r e h e n s i v e
commercial
analysis
regulatory agencies
Insurance
which w i l l
loans,
review of
of
that
loss
issued
-more-
the
guidance
loans.
depository
review
l o a n s and
the Currency
(FDIC),
estate
procedures,
collateral
allowances.
today's
(OCC),
Federal
guidelines
the
Reserve
Federal
Board
are
230
Supervisory policy statement - 2
(FRB), and the Office of Thrift Supervision (OTS).
Together, the
four agencies supervise the activities of the nation's 12,000
commercial banks and 2,200 thrift institutions.
In addition to today's issuance, the regulatory agencies are
undertaking three other actions:
o
National Meeting of Examiners
The agencies will hold a national meeting of senior
examination personnel in Baltimore, Md., on December 16 and
17 to review the policy statement and other initiatives
related to credit availability,
o
Random Audit Program
To assess the quality of examiners' review of collateral
value, the regulatory agencies will implement a random audit
program to determine how examiners review and analyze the
assumptions contained in appraisals as part of their loan
review process,
o
Holding Company Preferred Stock
The Federal Reserve Board, in a move designed to grant bank
holding companies greater flexibility in raising capital,
has issued for public comment a proposal to lift the limit
on the amount of noncumulative preferred stock that bank
holding companies may include in Tier 1 capital.
This
proposal, if adopted, can assist organizations in
strengthening their capital positions and expanding their
ability to extend credit to sound borrowers.
All of these steps follow previous actions by the regulatory
agencies in March and July to address credit availability concerns.
«*#
231
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Federal Reserve Board
Office of Thrift Supervision
Interagency Policy Statement on the Review and
Classification of Commercial Real Estate Loans
November 7,1991
Therecentdecline in credit extended by depository institutions has been attributed to
many factors. These factors include the general slowdown in the economy, the
overbuilding of cpmmercialrealestate properties in some markets, the desire of some
household and business borrowers, as well as some depository institutions, to
strengthen their balance sheets, changes by lenders in underwriting standards, and
concerns about the potential impact of certain supervisory policies or actions. To
ensure thatregulatorypolicies and actions do not inadvertently curtail the availability
of credit to sound borrowers, the four Federalregulatorsof banks and thrifts have
taken a number of steps to clarify and communicate their policies. The attached policy
statement is a further step in this effort.
On March 1, 1991, the four agencies — the Office of the Comptroller of the Currency,
the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Office
of Thrift Supervision — issued general guidelines that addressed a wide range of
supervisory policies. Included in the March issuance were brief discussions of the
workout of problems loans, lending by undercapitalized institutions, and a general
statement on the valuation ofrealestate loans.
The attached policy statement expands upon the March 1 and subsequent guidance as
itrelatesto thereviewand classification of commercialrealestate loans.
The intent of the statement by the agencies is to provide clear and comprehensive
guidance to ensure that supervisory personnel arereviewingloans in a consistent,
prudent, and balanced fashion and to ensure that all interested parties are aware of the
guidance.
The policy statement emphasizes that the evaluation ofrealestate loans is not based
solely on the value of the collateral, but on a review of the borrower's willingness and
capacity torepayand on the income-producing capacity of the properties.
232
The policy statement also provides guidance on how supervisory personnel analyze the
value of collateral. In general, examiners consider the institution's appraisals of
collateral (or internal evaluations, when applicable) to determine value and they review
the major facts, assumptions and approaches used in determining the value of the
collateral. Examiners seek to avoid challenges to underlying assumptions that differ in
only a limited way from norms that would generally be associated with the property
under review. Nonetheless, when reviewing the value of the collateral and any related
management adjustments, examiners ascertain that the value is based on assumptions
that are both prudent and realistic, and not on overly optimistic or overly pessimistic
assumptions.
The policy statement covers a wide range of specific topics, including:
• the general principles that examiners follow in reviewing commercial real estate
loan portfolios;
• the indicators of troubled real estate markets, projects, and related indebtedness;
• the factors examiners consider in their review of individual loans, including the use
of appraisals and the determination of collateral value;
• a discussion of approaches to valuing real estate, especially in troubled markets;
• the classification guidelines followed by the agencies, including the treatment of
guarantees; and
• the factors considered in the evaluation of an institution's allowance for loan and
lease losses.
This statement is intended to ensure that all supervisory personnel, lending institutions
and other interested parties have a clear understanding of the agencies' policies.
233
Interagency Policy Statement on the Review and
Classification of Commercial Real Estate Loans1
Introduction
This policy statement addresses the review and classification of commercial real estate
loans by examiners of the federal bank and thrift regulatory agencies.2 Guidance is
also provided on the analysis of the value of the underlying collateral. In addition,
this policy statement summarizes principles for evaluating an institution's process for
determining the appropriate level for the allowance for loan and lease losses, including
amounts that have been based on an analysis of the commercial real estate loan
portfolio.3 These guidelines are intended to promote the prudent, balanced, and
consistent supervisory treatment of commercial real estate loans, including those to
borrowers experiencing financial difficulties.
The attachments to this policy statement address three topics related to the review of
commercial real estate loans by examiners. The topics include the treatment of
guarantees in the classification process (Attachment 1); background information on the
valuation of income-producing commercial real estate loans in the examination process
(Attachment 2); and definitions of classification terms used by the federal bank and
thrift regulatory agencies (Attachment 3).
Examiner Review of Commercial Real Estate Loans
Loan Policy and Administration Review. As part of the analysis of an institution's
commercial real estate loan portfolio, examiners review lending policies, loan
administration procedures, and creditriskcontrol procedures. The maintenance of
prudent written lending policies, effective internal systems and controls, and thorough
1
For purposes of this policy statement, "commercial real estate loans" refers to all loans secured by real estate, except
for loans secured by 1 — 4 family residential properties. This does not refer to loans where the underlying collateral has
been taken solely through an abundance of caution where the terms as a consequence have not been made more favorable
than they would have been in the absence of the lien.
1
The agencies issuing this policy statement are the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.
3
For analytical purposes, as pan of its overall estimate of the allowance for loan and lease losses (ALLL) management
may attribute a portion of the ALLL to the commercial real estate loan portfolio. However, this does not imply that any
pan of the ALLL is segregated for, or allocated to, any particular asset or group of assets. The ALLL is availahle to absorb
all credit losses originating from the loan and lease portfolio.
For savings institutions, the ALLL is referred to as the "general valuation allowance" for purposes of the Thrift
Financial Report.
1
234
loan documentation are essential to the institution's management of the lending
function.
The policies governing an institution's real estate lending activities must include
prudent underwriting standards that are periodically reviewed by the board of directors
and clearly communicated to the institution's management and lending staff. The
institution must also have credit risk control procedures that include, for example,
prudent internal limits on exposure, an effective creditreviewand classification
process, and a methodology for ensuring that the allowance for loan and lease losses is
maintained at an adequate level The complexity and scope of these policies and
procedures should be appropriate to the size of the institution and the nature of the
institution's activities, and should be consistent with prudent banking practices and
relevant regulatory requirements.
Indicators of Troubled Real Estate Markets and Projects, and Related
Indebtedness. In order to evaluate the collectibility of an institution's commercial real
estate portfolio, examiners should be alert for indicators of weakness in the real estate
markets served by the institution. They should also be alert for indicators of actual or
potential problems in the individual commercialrealestate projects or transactions
financed by the institution.
Available indicators, such as permits for — and the value of — new construction,
absorption rates, employment trends, and vacancy rates, are useful in evaluating the
condition of commercialrealestate markets. Weaknesses disclosed by these types of
statistics may indicate that arealestate market is experiencing difficulties that may
result in cash flow problems for individualrealestate projects, decliningrealestate
values, and ultimately, in troubled commercialrealestate loans.
Indicators of potential or actual difficulties in commercial real estate projects may
include:
• An excess of similar projects under construction.
• Construction delays or other unplanned adverse eventsresultingin cost overruns
that mayrequirerenegotiationof loan terms.
• Lack of a sound feasibility study or analysis that reflects current and reasonably
anticipated market conditions.
• Changes in concept or plan (for example, a condominium project converted to an
apartment project because of unfavorable market conditions).
• Rent concessions or sales discountsresultingin cash flow below the level projected
in the original feasibility study or appraisal.
• Concessions on finishing tenant space, moving expenses, and lease buyouts.
2
235
• Slow leasing or lack of sustained sales activity and increasing sales cancellations
that mayreducethe project's income potential, resulting in protracted repayment or
default on the loan.
• Delinquent lease payments from major tenants.
• Land values that assume future rezoning.
• Tax arrearages.
As the problems associated with a commercialrealestate project become more
pronounced, problems with therelatedindebtedness may also arise. Such problems
include diminished cash flow to service the debt and delinquent interest and principal
payments.
While some commercialrealestate loans become troubled because of a general
downturn in the market, others become troubled because they were originated on an
unsound or a liberal basis. Common examples of these types of problems include:
• Loans with no or minimal borrower equity.
• Loans on speculative undeveloped property where the borrowers' only source of
repayment is the sale of the property.
• Loans based on land values that have been driven up by rapid turnover of
ownership, but without any corresponding improvements to the property or supportable income projections to justify an increase in value.
• Additional advances to service an existing loan that lacks credible support for full
repayment fromreliablesources.
• Loans to borrowers with no development plans or noncurrent development plans.
• Renewals, extensions and refinancings that lack credible support for full repayment
fromreliablesources and that do not have areasonablerepaymentschedule.4
Examiner Review of Individual Loans, Including the Analysis of Collateral Value.
The focus of an examiner'sreviewof a commercialrealestate loan, including binding
commitments, is the ability of the loan to berepaid.The principal factors that bear on
this analysis are the income-producing potential of the underlying collateral and the
borrower's willingness and capacity torepayunder the existing loan terms from the
borrower's otherresourcesif necessary. In evaluating the overallriskassociated with
4
As discussed more fully in the section on classification guidelines, the refinancing or renewing of loans to sound
borrow en would not result in a supervisory classification or criticism unless well-defined weaknesses exist that jeopardize
repayment of the loans. Consistent with sound banking practices, institutions should work in an appropriate and
constructive manner with borrowers who may be experiencing temporary difficulties.
3
236
a commercial real estate loan, examiners consider a number of factors, including the
character, overall financial condition andresources,and paymentrecordof the
borrower, the prospects for support from any financially responsible guarantors; and
the nature and degree of protection provided by the cash flow and value of the
underlying collateral.5 However, as other sources of repayment for a troubled
commercial real estate loan become inadequate over time, the importance of the
collateral's value in the analysis of the loan necessarily increases.
The appraisal regulations of the federal bank and thriftregulatoryagencies require
institutions to obtain appraisals when certain criteria are met6 Management is
responsible forreviewingeach appraisal's assumptions and conclusions for reasonableness. Appraisal assumptions should not be based solely on current conditions that
ignore the stabilized income-producing capacity of the property.7 Management should
adjust any assumptions used by an appraiser in determining value that are oveiiy
optimistic or pessimistic.
An examiner analyzes the collateral's value as determined by the institution's most
recent appraisal (or internal evaluation, as applicable). An examinerreviewsthe major
facts, assumptions, and approaches used by the appraiser (including any comments
made by management on the valuerenderedby the appraiser). Under the
circumstances described below, the examiner may make adjustments to this assessment
of value. Thisreviewand anyresultingadjustments to value are solely for purposes
of an examiner's analysis and classification of a credit and do not involve actual
adjustments to an appraisal.
A discounted cash flow analysis is an appropriate method for estimating the value of
income-producing real estate collateral.® This approach is discussed in more detail in
Attachment 2. This analysis should not be based solely on the current performance of
the collateral or similar properties; rather, it should take into account, on a discounted
basis, the ability of therealestate to generate income over time based upon reasonable
and supportable assumptions.
1
The treatment of guarantees in the classification process is discussed in Attachment 1.
* Department of the Treasury, Office of the Comptroller of the Currency, 12 CFR Pan 34 (Docket No. 90-16); Board
of Governors of the Federal Reserve System, 12 CFR Pans 208 and 225 (Regulation H and Y; Docket No. R-0685);
Federal Deposit Insurance Corporation, 12 CFR 323 (RIN 3064-ABQ5); Department of the Treasury, Office of Thrift
Supervision, 12 CFR Pan 564 (Docket No. 90-1495).
7
Stabilized income generally is defined as the yearly net operating income produced by the property at normal
occupancy and rental rates; it may be adjusted upward or downward from today's actual market conditions.
* The real estate appraisal regulations of the federal bank and thriftregulatoryagencies include a requirement that an
appraisal (a) follow areasonablevaluation method thai addresses the direct sales comparison, income, and cost approaches
to market value; (b) reconcile these approaches; and (c) explain the elimination of each approach not used. A discounted
cash flow analysis is recognized as a valuation method for the income approach.
4
237
When reviewing the reasonableness of the facts and assumptions associated with the
value of the collateral, examiners may evaluate:
• Current and projected vacancy and absorption rates;
• Lease renewal trends and anticipated rents;
• Volume and trends in past due leases;
• Effective rental rates or sale prices (taking into account all concessions);
• Net operating income of the property as compared with budget projections; and
• Discount rates and direct capitalization ("cap") rates.'
The capacity of a property to generate cash flow to service a loan is evaluated based
uponrents(or sales), expenses, and rates of occupancy that arereasonablyestimated to
be achieved over time. The determination of the level of stabilized occupancy and
rental rates should be based upon an analysis of current andreasonablyexpected
market conditions, taking into consideration historical levels when appropriate. The
analysis of collateral values should not be based upon a simple projection of current
levels of net operating income if markets are depressed orreflectspeculative pressures
but can be expected over areasonableperiod of time toreturnto normal (stabilized)
conditions. Judgment is involved in determining the time that it will take for a
property to achieve stabilized occupancy andrentalrates.
Examiners do not make adjustments to appraisal assumptions for credit analysis
purposes based on worst case scenarios that are unlikely to occur. For example, an
examiner would not necessarily assume that a building will become vacant just
because an existing tenant who isrentingat a rate above today's market rate may
vacate the property when the current lease expires. On the other hand, an adjustment
to value may be appropriate for credit analysis purposes when the valuation assumes
renewal at the above-market rate, unless that rate is areasonableestimate of the
expected market rate at the time of renewal.
When estimating the value of income-producingrealestate, discount rates and "cap"
rates shouldreflectreasonableexpectations about the rate ofreturnthat investors
require under normal, orderly and sustainable market conditions. Exaggerated,
imprudent, or unsustainably high or low discount rates, "cap" rates, and income
projections should not be used. Direct capitalization of nonstabilized income flows
should also not be used.
Assumptions, whenrecentlymade by qualified appraisers (and, as appropriate, by
institution management) and when consistent with the discussion above, should be
' Attachment 2 includes a discussion of discount rates and direct capitalization noes.
5
238
given a reasonable amount of deference. Examiners should not challenge the
underlying assumptions, including discount rates and "cap" rates used in appraisals,
that differ only in a limited way from norms that would generally be associated with
the property under review. The estimated value of the underlying collateral may be
adjusted for credit analysis purposes when the examiner can establish that any underlying facts or assumptions are inappropriate and can support alternative assumptions.
Classification Guidelines
As with other types of loans, commercial real estate loans that are adequately protected
by the current sound worth and debt service capacity of the borrower, guarantor, or the
underlying collateral generally are not classified. Similarly, loans to sound borrowers
that are refinanced or renewed in accordance with prudent underwriting standards,
including loans to creditworthy commercial or residential real estate developers, should
not be classified or criticized unless well-defined weaknesses exist that jeopardize
repayment. An institution will not be criticized for continuing to carry loans having
weaknesses that result in classification or criticism as long as the institution has a wellconceived and effective workout plan for such borrowers, and effective internal
controls to manage the level of these loans.
In evaluating commercial real estate credits for possible classification, examiners apply
standard classification definitions (Attachment 3).10 In determining the appropriate
classification, consideration should be given to all important information on repayment
prospects, including information on the borrower's creditworthiness, the value of, and
cash flow provided by, all collateral supporting the loan, and any support provided by
financially responsible guarantors.
The loan's record of performance to date is important and must be taken into
consideration. As a general principle, a performing commercial real estate loan should
not automatically be classified or charged-off solely because the value of the
underlying collateral has declined to an amount that is less than the loan balance.
However, it would be appropriate to classify a performing loan when well-defined
weaknesses exist that jeopardize repayment, such as the lack of credible support for
full repayment from reliable sources.11
These principles hold for individual credits, even if portions or segments of the
industry to which the borrower belongs are experiencing financial difficulties. The
evaluation of each credit should be based upon the fundamental characteristics
* These definitions are presented in Attachment 3 and address assets classified "substandard," "doubtful," or "loss" for
supervisory purposes.
11
Another issue that arises in the review of a commercial real estate loan is the loan's treatment as an accruing asset
or as a nonaccnial asset for reporting purposes. The federal bank and thrift regulatory agencies have provided guidance
on nonaccnial status in the instructions for the Reports of Condition and Income (Call Reports) for banks, and in the
instruct!ans for the Thrift Financial Report for savings associations, and in related supervisory guidance of die agencies.
6
239
affecting the collectibility of the particular credit The problems broadly associated
with some sectors or segments of an industry, such as certain commercialrealestate
markets, should not lead to overly pessimistic assessments of particular credits that are
not affected by the problems of the troubled sectors.
Classification of troubled project-dependent commercial real estate loans.12 The
following guidelines for classifying a troubled commercialrealestate loan apply when
therepaymentof the debt will be provided solely by the underlying real estate
collateral, and there are no other available andreliablesources of repayment
As a general principle, for a troubled project-dependent commercialrealestate loan,
any portion of the loan balance that exceeds the amount that is adequately secured by
the value of the collateral, and that can clearly be identified as uncollectible, should be
classified "loss."13 The portion of the loan balance that is adequately secured by the
value of the collateral should generally be classified no worse than "substandard." The
amount of the loan balance in excess of the value of the collateral, or portions thereof,
should be classified "doubtful" when the potential for full loss may be mitigated by the
outcomes of certain pending events, or when loss is expected but the amount of the
loss cannot bereasonablydeteimined.
If warranted by the underlying circumstances, an examiner may use a "doubtful"
classification on the entire loan balance. However, this would occur infrequently.
Guidelines for classifying partially charged-off loans. Based upon consideration of
allrelevantfactors, an evaluation may indicate that a credit has well-defined
weaknesses that jeopardize collection in full, but that a portion of the loan may be
reasonably assured of collection. When an institution has taken a charge-off in an
amount sufficient that theremainingrecordedbalance of the loan (a) is being serviced
(based uponreliablesources) and (b) isreasonablyassured of collection, classification
of theremainingrecordedbalance may not be appropriate. Gassification would be
appropriate when well-defined weaknesses continue to be present in the remaining
recorded balance. In such cases, theremainingrecordedbalance would generally be
classified no more severely than "substandard."
A more severe classification than "substandard" for theremainingrecordedbalance
would be appropriate if the loss exposure cannot be reasonably determined, e.g., where
significantriskexposures are perceived, such as might be the case for bankruptcy
situations or for loans collateralized by properties subject to environmental hazards.
In addition, classification of theremainingrecordedbalance would be appropriate
when sources ofrepaymentare considered unreliable.
u
The discussion in this section is not intended to address loans that must be treated as "other real estate owned" for
bankregulatoryreportingpurposes or "real estate owned" for thriftregulatoryreportingpurposes. Guidance on these assets
is presented in supervisory and reporting guidance of the agencies.
u
For purposes of this discussion, the "value of the collateral" is the value used by the examiner for credit analysis
purposes, as discussed in a previous section of this policy statement
7
240
Guidelines for classifying formally restructured loans. The classification treatment
previously discussed for a partially charged off loan would also generally be
appropriate for a formallyrestructuredloan when partial charge-offs have been taken.
For a formallyrestructuredloan, the focus of the examiner's analysis is on the ability
of the borrower torepaythe loan in accordance with its modified terms. Gassification
of a formallyrestructuredloan would be appropriate, if, after therestructuring,welldefined weaknesses exist that jeopardize the orderlyrepaymentof the loan in
accordance with reasonable modified terms.1* Troubled commercialrealestate loans
whose terms have been restructured should be identified in the institution's internal
creditreviewsystem, and closely monitored by management
Review of the Allowance for Loan and Lease Losses (ALLL)15
The adequacy of a depository institution's ALLL, including amounts based on an
analysis of the commercial real estate portfolio, must be based on a careful, well
documented, and consistently applied analysis of the institution's loan and lease portfolio.16
The determination of the adequacy of the ALLL should be based upon management's
consideration of all current significant conditions that might affect the ability of
borrowers (or guarantors, if any) to fulfill their obligations to the institution. While
historical loss experience provides areasonablestarting point, historical losses or even
recent trends in losses are not sufficient without further analysis and cannot produce a
reliable estimate of anticipated loss.
In determining the adequacy of the ALLL, management should also consider other
factors, including changes in the nature and volume of the portfolio; the experience,
ability, and depth of lending management and staff; changes in credit standards; collection policies and historical collection experience; concentrations of creditrisk;trends in
the volume and severity of past due and classified loans; and trends in the volume of
nonaccrual loans, specific problem loans and commitments. In addition, this analysis
should consider the quality of the institution's systems and management in identifying,
monitoring, and addressing asset quality problems. Furthermore, management should
consider external factors such as local and national economic conditions and
u
An example of a restructured commercial real estate loan that does not havereasonablemodified terms would be a
"cash flow" mortgage whichrequiresinterest payments only when the underlying collateral generates cash flow but provides
no substantive benefits to the lending institution.
u
Each of the federal bank and thrift regulatory agencies have issued guidance on the allowance for loan and lease
loases. The following discussion summarizes general principles for assessing the adequacy of the allowance for loan and
lease losses.
" The estimation process described in this section permits for a more accurate estimate of anticipated losses than could
be achieved by assessing the loan portfolio solely on an aggregate basis. However, it is only an estimation process and
does not imply that any part of the ALLL is segregated for, or allocated to, any particular asset or group of assets. The
ALLL is available to absorb all credit losses originating from the loan and lease portfolio.
8
241
developments; competition; and legal and regulatory requirements; as well as
reasonably foreseeable events that are likely to affect the collectibility of the loan
portfolio.
Management should adequately document the factors that were considered, the
methodology and process that were used in determining the adequacy of the ALLL,
and the range of possible credit losses estimated by this process. The complexity and
scope of this analysis must be appropriate to the size and nature of the institution and
provide for sufficient flexibility to accommodate changing circumstances.
Examiners will evaluate the methodology and process that management has followed
in arriving at an overall estimate of the ALLL in order to assure that all of the relevant
factors affecting the collectibility of the portfolio have been appropriately considered.
In addition, the overall estimate of the ALLL and the range of possible credit losses
estimated by management will bereviewedforreasonablenessin view of these factors.
This examiner analysis will also consider the quality of the institution's systems and
management in identifying, monitoring, and addressing asset quality problems.
As discussed in the previous section on classification guidelines, the value of the
collateral is considered by examiners in reviewing and classifying a commercial real
estate loan. However, for a performing commercialrealestate loan, the supervisory
policies of the agencies do notrequireautomatic increases to the ALLL solely because
the value of the collateral has declined to an amount that is less than the loan balance.
In assessing the ALLL during examinations, it is important torecognizethat
management's process, methodology, and underlying assumptionsrequirea substantial
degree of judgment. Even when an institution maintains sound loan administration and
collection procedures and effective internal systems and controls, the estimation of
anticipated losses may not be precise due to the wide range of factors that must be
considered. Further, the ability to estimate anticipated loss on specific loans and
categories of loans improves over time as substantive information accumulates
regarding the factors affectingrepaymentprospects. When management has (a)
maintained effective systems and controls for identifying, monitoring and addressing
asset quality problems and (b) analyzed all significant factors affecting the
collectibility of the portfolio, considerable weight should be given to management's
estimates in assessing the adequacy of the ALLL.
9
242
Attachment 1
TREATMENT OF GUARANTEES
IN THE CLASSIFICATION PROCESS
Initially, the original source of repayment and the borrower's intent and ability to
fulfill the obligation without reliance on third party guarantors will be the primary
basis for the review and classification of assets.1 The federal bank and thrift
regulatory agencies will, however, consider the support provided by guarantees in the
determination of the appropriate classification treatment for troubled loans. The
presence of a guarantee from a "financially responsible guarantor," as described below,
may be sufficient to preclude classification or reduce the severity of classification.
For purposes of this discussion, a guarantee from a "financially responsible guarantor"
has the following attributes:
• The guarantor must have both the financial capacity and willingness to provide
support for the credit;
• The nature of the guarantee is such that it can provide support for repayment of the
indebtedness, in whole or in part, during the remaining loan term; and2
• The guarantee should be legally enforceable.
The above characteristics generally indicate that a guarantee may improve the
prospects for repayment of the debt obligation.
Considerations relating to a guarantor's financial capacity. The lending institution
must have sufficient information on the guarantor's financial condition, income,
liquidity, cash flow, contingent liabilities, and other relevant factors (including credit
ratings, when available) to demonstrate the guarantor's financial capacity to fulfill the
obligation. Also, it is important to consider the number and amount of guarantees
currently extended by a guarantor, in order to determine that the guarantor has the
financial capacity to fulfill the contingent claims that exist.
Considerations relating to a guarantor's willingness to repay. Examiners normally
rely on their analysis of the guarantor's financial strength and assume a willingness to
perform unless there is evidence to the contrary. This assumption may be modified
1
Some loans are originated based primarily upon the financial strength of the guarantor, who is, in substance, ths
primary source of repayment In such circumstances, examiners generally assess the coUeoibiliiy of the loan based upon
the guarantor's ability to repay the loan.
2
Same guarantees may only provide for support for certain phases of a real estate project. It would not be appropriate
to rely upon these guarantees to support a troubled loan after the completion of these phases.
10
243
based on the "track record" of the guarantor, including payments made to date on the
asset under review or other obligations.
Examiners give due consideration to those guarantors that have demonstrated their
ability and willingness to fulfill previous obligations in their evaluation of current
guarantees on similar assets. An important consideration will be whether previously
required performance under guarantees was voluntary or theresultof legal or other
actions by the lender to enforce the guarantee. However, examiners give limited
credence, if any, to guarantees from obligors who haverenegedon obligations in the
past, unless there is clear evidence that the guarantor has the ability and intent to
honor the specific guarantee obligation under review.
Examiners also consider the economic incentives for performance from guarantors:
• Who have already partially performed under the guarantee or who have other
significant investments in the project;
• Whose other sound projects are cross-collateralized or otherwise intertwined with
the credit; or
• Where the guarantees are collateralized byreadilymarketable assets that are under
the control of a third party.
Other considerations. In general, only guarantees that are legally enforceable will be
relied upon. However, all legally enforceable guarantees may not be acceptable. In
addition to the guarantor's financial capacity and willingness to perform, it is expected
that the guarantee will not be subject to significant delays in collection, or undue
complexities or uncertainties about the guarantee.
The nature of the guarantee is also considered by examiners. For example, some
guarantees forrealestate projects only pertain to the development and construction
phases of the project. As such, these limited guarantees would not be relied upon to
support a troubled loan after the completion of those phases.
Examiners also consider the institution's intent to enforce the guarantee and whether
there are valid reasons to preclude an institution from pursuing the guarantee. A
history of timely enforcement and successful collection of the full amount of
guarantees will be a positive consideration in the classification process.
11
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Attachment 2
THE VALUATION OF INCOME-PRODUCING REAL ESTATE
Approaches to the Valuation of Real Estate
Appraisals are professional judgments of the market value of real property. Three
basic valuation approaches are used by professional appraisers in estimating the market
value of real property - the cost approach, the market data or direct sales comparison
approach, and the income approach. The principles governing the three approaches are
widely known in the appraisal field and wererecentlyreferencedin parallel regulations
issued by each of the federal bank and thriftregulatoryagencies. When evaluating the
collateral for problem credits, the three valuation approaches are not equally
appropriate.
1. Cost Approach. In the cost approach, the appraiser estimates the reproduction
cost of the building and improvements, deducts estimated depreciation, and adds
the value of the land. The cost approach is particularly helpful when reviewing
draws on construction loans. However, as the property increases in age, both
reproduction cost and depreciation become more difficult to estimate. Except
for special purpose facilities, the cost approach is usually inappropriate in a
troubled real estate market because construction costs for a new facility normally
exceed the market value of existing comparable properties.
2. Market Data or Direct Sales Comparison Approach. This approach examines
the price of similar properties that have sold recently in the local market,
estimating the value of the subject property based on the comparable properties'
selling price. It is very important that the characteristics of the observed
transactions be similar in terms of market location, financing terms, property
condition and use, timing, and transaction costs. The market approach generally
is used in valuing owner-occupied residential property because comparable sales
data are typically available. When adequate sales data are available, an analyst
generally will give the most weight to this type of estimate. Often, however, the
available sales data for commercial properties are not sufficient to justify a
conclusion.
3. The Income Approach. The economic value of an income-producing property
is the discounted value of the future net operating income stream, including any
"reversion" value of property when sold. If competitive markets are working
perfectly, the observed sales price should be equal to this value. For unique
properties or in markets that are thin or subject to disorderly or unusual
conditions, market value based on a comparable sales approach may be either
unavailable or distorted. In such cases, the income approach is usually the
appropriate method for valuing the property.
12
245
The income approach converts all expected future net operating income into
present value terms. When market conditions are stable and no unusual patterns
of future rents and occupancy rates are expected, the direct capitalization method
is often used to estimate the present value of future income streams. For
troubled properties, however, examiners typically utilize the more explicit
discounted cash flow (net present value) method for analytical purposes. In that
method, a time frame for achieving a "stabilized", or normal, occupancy and
rent level is projected. Each year's net operating income during that period is
discounted to arrive at the present value of expected future cash flows. The
property's anticipated sales value at the end of the period until stabilization (its
terminal orreversionvalue) is then estimated. Thereversionvalue represents
the capitalization of all future income streams of the property after the projected
occupancy level is achieved. The terminal orreversionvalue is then discounted
to its present value and added to the discounted income stream to arrive at the
total present market value of the property.
Valuation of Troubled Income-Producing Properties
When an income property is experiencing financial difficulties due to. general market
conditions or due to its own characteristics, data on comparable property sales often
are difficult to obtain. Troubled properties may be hard to market, and normal
financing arrangements may not be available. Moreover, forced and liquidation sales
can dominate market activity. When the use of comparables is not feasible (which is
often the case for commercial properties), the net present value of the most reasonable
expectation of the property's income-producing capacity — not just in today's market
but over time — offers the most appropriate method of valuation in the supervisory
process.
Estimates of the property's value should be based uponreasonableand supportable
projections of the determinants of future net operating income: rents (or sales),
expenses and rates of occupancy. Judgment is involved in estimating all of these
factors. The primary considerations for these projections include historical levels and
trends, the current market performance achieved by the subject and similar properties,
and economically feasible and defensible projections of future demand and supply
conditions. To the extent that current market activity is dominated by a limited
number of transactions or liquidation sales, high "capitalization" and discount rates
implied by such transactions should not be used. Rather, analysts should use rates that
reflect market conditions that are neither highly speculative nor depressed for the type
of property being valued and that property's location.
13
246
Technical Notes
In the process of reviewing arealestate loan and in the use of the net present value
approach of collateral valuation, several conceptual issues often are raised. The
following discussion sets forth the meaning and use of those key concepts.
The Discount Rate. The discount rate used in the net present value approach to
convert future net cash flows of income-producingrealestate into present market value
terms is the rate ofreturnthat market participantsrequirefor this type ofrealestate
investment The discount rate will vary over time with changes in overall interest
rates and in theriskassociated with the physical and financial characteristics of the
property. Theriskinessof the property depends both on the type ofrealestate in
question and on local market conditions.1
The Direct Capitalization ("Cap" Rate) Technique. The use of "cap" rates, or direct
income capitalization, is a method used by many market participants and analysts to
relate the value of a property to the net operating income it generates. In many
applications, a "cap" rate is used as a short cut for computing the discounted value of a
property's income streams.
The direct income capitalization method calculates the value of a property by dividing
an estimate of its "stabilized" annual income by a factor called a "cap" rate. Stabilized
income generally is defined as the yearly net operating income produced by the
property at normal occupancy andrentalrates; it may be adjusted upward or
downward from today's actual market conditions.The "cap" rate — usually defined for
each property type in a market area — is viewed by some analysts as therequiredrate
ofreturnstated in terms of current income. That is to say, the "cap" rate can be
considered a direct observation of therequiredeamings-to-price ratio in current income
terms. The "cap" rate also can be viewed as the number of cents per dollar of today's
purchase price investors would require annually over the life of the property to achieve
theirrequiredrate of return.
The "cap" rate method is appropriate if the net operating income to which it is applied
isrepresentativeof all future income streams or if net operating income and the
property's selling price are expected to increase at a fixed rate. The use of this
technique assumes that either the stabilized income or the "cap" rate used accurately
captures all relevant characteristics of the propertyrelatingto itsriskand income
potential. If the sameriskfactors,requiredrate ofreturn,financing arrangements, and
income projections are used, explicit discounting and direct capitalization will yield the
same results.
1
Regulatory policy of the Office of Thrift Supervision specifies thai, for supervisory purposes, thrifts are to use discount
rates that are consistent with generally accepted accounting principles for thrifts (which allow the use of an average-cost-ofcapital-funds rate to calculate net realizable value) or discount rates that are consistent with the practices of the federal
banking agencies.
14
247
This method alone is not appropriate for troubled real estate since income generated by
the propeity is not at nonnal or stabilized levels. In evaluating troubled real estate,
ordinary discounting typically is used for the period before the project reaches its full
income potential. A "terminal" "cap" rate is then utilized to estimate the value of the
property (its reversion or sales price) at the end of that period.
Differences Between Discount and Cap Rates. When used for estimating real estate
market values, discount and "cap" rates should reflect the current market requirements
for rates of return on properties of a given type. The discount rate is the required rate
of return including the expected increases in future prices and is applied to income
streams reflecting inflation. In contrast, the "cap" rate is used in conjunction with a
stabilized net operating income figure. The fact that discount rates for real estate are
typically higher than "cap" rates reflects the principal difference in the treatment of
expected increases in net operating income and/or property values.
Other factors affecting the "cap" rate used (but not the discount rate) include the useful
life of the property and financing arrangements. The useful life of the property being
evaluated affects the magnitude of the "cap" rate because the income generated by a
property, in addition to providing the required return on investment, must be sufficient
to compensate the investor for the depreciation of the property over its useful life.
The longer the useful life, the smaller is the depreciation in any one year, hence, the
smaller is the annual income required by the investor, and the lower is the "cap" rate.
Differences in terms and the extent of debt financing and the related costs must also be
taken into account.
Selecting Discount and Cap Rates. The choice of the appropriate values for discount
and "cap" rates is a key aspect of income analysis. Both in markets marked by lack of
transactions and those characterized by highly speculative or unusually pessimistic
attitudes, analysts consider historical required returns on the type of property in
question. Where market information is available to determine current required yields,
analysts carefully analyze sales prices for differences in financing, special rental
arrangements, tenant improvements, property location, and building characteristics. In
most local markets, the estimates of discount and "cap" rates used in income analysis
should generally fall within a fairly narrow range for comparable properties.
Holding Period vs. Marketing Period. When the income approach is applied to
troubled properties, a time frame is chosen over which a property is expected to
achieve stabilized occupancy and rental rates (stabilized income). That time period is
sometimes referred to as the "holding period." The longer the period before
stabilization, the smaller will be the reversion value included in the total value
estimate.
The holding period should be distinguished from the concept of "marketing period" —
a term used in estimating the value of a property under the sales comparison approach
15
248
and in discussions of property value when real estate is being sold. The marketing
period is the length of time that may be required to sell the property in an open
market
16
249
Glossary
Appraisal. A written statement independently and impartially prepared by a qualified
appraiser setting forth an opinion as to the market value of an adequately described
property as of a specific date(s), supported by the presentation and analysis of relevant
market information.
Capitalization rate. A rate used to conven income into value. Specifically, it is the
ratio between a property's stabilized net operating income and the property's sales
price. Sometimesreferredto as an overall rate because it can be computed as a
weighted average of component investment claims on net operating income.
Discount rate. A rate ofreturnused to convert future payments orreceiptsinto their
present value.
Holding period. The time frame over which a property is expected to achieve
stabilized occupancy andrentalrates (stabilized income).
Market value. The most probable cash sale price which a property should bring in a
competitive and open market under all conditionsrequisiteto a fair sale, the buyer and
seller each acting prudently and knowledgeably, and assuming the price is not affected
by undue stimulus. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions whereby:
1. buyer and seller are typically motivated (i.e., motivated by self-interest);
2. both parties are well informed or well advised, and acting in what they consider
their own best interests;
3. areasonabletime is allowed for exposure in the open market;
4. payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto; and
5. the price represents the normal consideration for the property sold unaffected by
special or creative financing or sales concessions granted by anyone associated
with the sale.
Marketing period. The term in which an owner of a property is actively attempting to
sell that property in a competitive and open market.
Net operating income (NOI). Annual income after all expenses have been deducted,
except for depreciation and debt service.
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250
Attachment 3
Classification Definitions1
The federal bank and thriftregulatoryagencies currently utilize the following
definitions for assets classified "substandard," "doubtful," and "loss" for supervisory
purposes:
Substandard Assets. A substandard asset is inadequately protected by the current
sound worth and paying capacity of the obligor or of the collateral pledged, if any.
Assets so classified must have a well-defined weakness or weaknesses that jeopardize
the liquidation of the debt They are characterized by the distinct possibility that the
institution will sustain some loss if the deficiencies are not corrected.
Doubtful Assets. An asset classified doubtful has all the weaknesses inherent in one
classified substandard with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts, conditions, and
values, highly questionable and improbable.
Loss Assets. Assets classified loss are considered uncollectible and of such little value
that their continuance as bankable assets is not warranted. This classification does not
mean that the asset has absolutely no recovery or salvage value, but rather it is not
practical or desirable to defer writing off this basically worthless asset even though
partialrecoverymay be effected in the future.
1
Office of the Comptroller of the Currency, Comptroller's Handbook for National Bank Examiners, Section 215.1,
"Classification of Credits;" Board of Govemon of the Federal Reserve System, Commercial Bank Examination Manual.
Section 21S. 1, "Classification of Credits;" Office of Thrift Supervision, Thrift Activities Regulatory Handbook, Section 260,
"Classification of Assets;" Federal Deposit Insurance Corporation, Division of Supervision Manual of Examination Policies,
Section 3.1, "Loans."
18
251
BOARD
OF
GOVERNORS
• F THE
SR 91-24 (FIS)
FEDERAL
RESERVE
W A S H I N G T O N . D. C.
SYSTEM
2D551
November 7, 1991
TO THE O F F I C E R I N CHARGE OF S U P E R V I S I O N
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Interagency Examination
Estate
Loans
Guidance
on
Commercial
Real
The F e d e r a l R e s e r v e and t h e o t h e r f e d e r a l bank and
t h r i f t r e g u l a t o r y a g e n c i e s have i s s u e d t o d a y an
interagency
p o l i c y s t a t e m e n t on t h e r e v i e w and c l a s s i f i c a t i o n o f
commercial
real estate loans (enclosed).
T h i s p o l i c y s t a t e m e n t expands upon
g u i d a n c e p r e s e n t e d i n t h e March 1, 1 9 9 1 j o i n t p o l i c y s t a t e m e n t on
t h e s u p e r v i s o r y t r e a t m e n t of commercial r e a l e s t a t e l o a n s and
is
examination
consistent with the Federal Reserve's existing
p o l i c i e s and p r a c t i c e s .
The p o l i c y s t a t e m e n t a d d r e s s e s a w i d e r a n g e o f
topics
r e l a t i n g to the supervisory evaluation of commercial real
estate
loans.
These t o p i c s include:
the review of management's
p o l i c i e s pertaining to the commercial real e s t a t e loan
portfolio;
i n d i c a t o r s of t r o u b l e d r e a l e s t a t e m a r k e t s , p r o j e c t s , and r e l a t e d
indebtedness; the f a c t o r s examiners consider in t h e i r review of
i n d i v i d u a l l o a n s ; and t h e i r a s s e s s m e n t of t h e v a l u e of
the
collateral.
The p o l i c y s t a t e m e n t a l s o p r e s e n t s
classification
g u i d e l i n e s f o r t r o u b l e d commercial r e a l e s t a t e l o a n s and
addresses the treatment of guarantees.
Furthermore, the
policy
s t a t e m e n t d i s c u s s e s g e n e r a l p r i n c i p l e s f o r t h e e v a l u a t i o n by
examiners of t h e a l l o w a n c e f o r loan and l e a s e l o s s e s ,
including
p o r t i o n s b a s e d on an a n a l y s i s of t h e commercial r e a l e s t a t e
loan
portfolio.
252
-
2
-
A c o p y o f t h i s p o l i c y s t a t e m e n t s h o u l d b e g i v e n t o each
o f f i c e r , manager, examiner, and o t h e r p r o f e s s i o n a l i n v o l v e d in
t h e s u p e r v i s i o n o f s t a t e member b a n k s .
I n a d d i t i o n , a c o p y of
t h i s g u i d a n c e s h o u l d b e s e n t t o t h e c h i e f e x e c u t i v e o f f i c e r of
e a c h s t a t e member b a n k i n y o u r d i s t r i c t .
We w i l l a l s o b e
providing t o you s h o r t l y a copy of the j o i n t interagency p r e s s
r e l e a s e a n d j o i n t s t a f f memorandum i s s u e d i n c o n n e c t i o n w i t h the
guidelines.
Richard Spillenkothen
Director
Enclosure
253
Interagency Policy Statement on the Review and
Classification of Commercial Real Estate Loans1
Introduction
This policy statement addresses the review and classification of commercial real estate
loans by examiners of the federal bank and thrift regulatory agencies.2 Guidance is
also provided on the analysis of the value of the underlying collateral. In addition,
this policy statement summarizes principles for evaluating an institution's process for
determining the appropriate level for the allowance for loan and lease losses, including
amounts that have been based on an analysis of the commercial real estate loan
portfolio.3 These guidelines are intended to promote the prudent, balanced, and
consistent supervisory treatment of commercial real estate loans, including those to
borrowers experiencing financial difficulties.
The attachments to this policy statement address three topics related to thereviewof
commercial real estate loans by examiners. The topics include the treatment of
guarantees in the classification process (Attachment 1); background information on the
valuation of income-producing commercial real estate loans in the examination process
(Attachment 2); and definitions of classification terms used by the federal bank and
thriftregulatoryagencies (Attachment 3).
Examiner Review of Commercial Real Estate Loans
Loan Policy and Administration Review. As part of the analysis of an institution's
commercial real estate loan portfolio, examiners review lending policies, loan
administration procedures, and creditriskcontrol procedures. The maintenance of
prudent written lending policies, effective internal systems and controls, and thorough
1
For purposes of this policy statement, "commercial real estate loans" refers to all loans secured by real estate, except
for loans secured by 1 — 4 family residential properties. This does not refer to loans where the underlying collateral has
been taken solely through an abundance of caution where the terms as a consequence have not been made more favorable
than they would have been in the absence of the lien.
2
The agencies issuing this policy statement are the Board of Governors of the Federal Reserve System, the Federal
Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision.
3
For analytical purposes, as part of its overall estimate of the allowance for loan and lease losses (ALLL) management
may attribute a portion of the ALLL to the commercial real estate loan portfolio. However, this does not imply that any
part of the ALLL is segregated for, or allocated to, any particular asset or group of assets. The ALLL is available to absorb
all credit losses originating from the loan and lease portfolio.
For savings institutions, the ALLL is referred to as the "general valuation allowance" for purposes of the Thrift
Financial Report
1
52-418 - 92 - 9
254
loan documentation are essential to the institution's management of the lending
function.
The policies governing an institution's real estate lending activities must include
pmdent underwriting standards that are periodically reviewed by the board of directors
and clearly communicated to the institution's management and lending staff. The
institution must also have credit risk control procedures that include, for example,
prudent internal limits on exposure, an effective credit review and classification
process, and a methodology for ensuring that the allowance for loan and lease losses is
maintained at an adequate level. The complexity and scope of these policies and
procedures should be appropriate to the size of the institution and the nature of the
institution's activities, and should be consistent with prudent banking practices and
relevantregulatoryrequirements.
Indicators of Troubled Real Estate Markets and Projects, and Related
Indebtedness. In order to evaluate the collectibility of an institution's commercial real
estate portfolio, examiners should be alert for indicators of weakness in the real estate
markets served by the institution. They should also be alert for indicators of actual or
potential problems in the individual commercial real estate projects or transactions
financed by the institution.
Available indicators, such as permits for — and the value of — new construction,
absorption rates, employment trends, and vacancy rates, are useful in evaluating the
condition of commercial real estate markets. Weaknesses disclosed by these types of
statistics may indicate that arealestate market is experiencing difficulties that may
result in cash flow problems for individualrealestate projects, decliningrealestate
values, and ultimately, in troubled commercial real estate loans.
Indicators of potential or actual difficulties in commercial real estate projects may
include:
• An excess of similar projects under construction.
• Construction delays or other unplanned adverse events resulting in cost overruns
that may require renegotiation of loan terms.
• Lack of a sound feasibility study or analysis that reflects current and reasonably
anticipated market conditions.
• Changes in concept or plan (for example, a condominium project converted to an
apartment project because of unfavorable market conditions).
• Rent concessions or sales discounts resulting in cash flow below the level projected
in the original feasibility study or appraisal.
• Concessions on finishing tenant space, moving expenses, and lease buyouts.
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• Slow leasing or lack of sustained sales activity and increasing sales cancellations
that may reduce the project's income potential, resulting in protracted repayment or
default on the loan.
• Delinquent lease payments from major tenants.
• Land values that assume future rezoning.
• Tax arrearages.
As the problems associated with a commercial real estate project become more
pronounced, problems with the related indebtedness may also arise. Such problems
include diminished cash flow to service the debt and delinquent interest and principal
payments.
While some commercial real estate loans become troubled because of a general
downturn in the market, others become troubled because they were originated on an
unsound or a liberal basis. Common examples of these types of problems include:
• Loans with no or minimal borrower equity.
• Loans on speculative undeveloped property where the borrowers' only source of
repayment is the sale of the property.
• Loans based on land values that have been driven up by rapid turnover of
ownership, but without any corresponding improvements to the property or supportable income projections to justify an increase in value.
• Additional advances to service an existing loan that lacks credible support for full
repayment from reliable sources.
• Loans to borrowers with no development plans or noncument development plans.
• Renewals, extensions and refinancings that lack credible support for full repayment
fromreliablesources and that do not have a reasonable repayment schedule.4
Examiner Review of Individual Loans, Including the Analysis of Collateral Value.
The focus of an examiner's review of a commercial real estate loan, including binding
commitments, is the ability of the loan to be repaid. The principal factors that bear on
this analysis are the income-producing potential of the underlying collateral and the
borrower's willingness and capacity to repay under the existing loan terms from the
borrower's otherresourcesif necessary. In evaluating the overallriskassociated with
4
As discussed more fully in the section on classification guidelines, the refinancing or renewing of loans to sound
borrowers would not result in a supervisory classification or criticism unless well-defined weaknesses exist that jeopardize
repayment of the loans. Consistent with sound banking practices, institutions should work in an appropriate and
constructive manner with borrowers who may be experiencing temporary difficulties.
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a commercial real estate loan, examiners consider a number of factors, including the
character, overall financial condition and resources, and payment record of the
borrower, the prospects for support from any financially responsible guarantors; and
the nature and degree of protection provided by the cash flow and value of the
underlying collateral.5 However, as other sources of repayment for a troubled
commercial real estate loan become inadequate over time, the importance of the
collateral's value in the analysis of the loan necessarily increases.
The appraisal regulations of the federal bank and thrift regulatory agencies require
institutions to obtain appraisals when certain criteria are met.6 Management is
responsible for reviewing each appraisal's assumptions and conclusions for reasonableness. Appraisal assumptions should not be based solely on current conditions that
ignore the stabilized income-producing capacity of the property.7 Management should
adjust any assumptions used by an appraiser in determining value that are overly
optimistic or pessimistic.
An examiner analyzes the collateral's value as determined by the institution's most
recent appraisal (or internal evaluation, as applicable). An examiner reviews the major
facts, assumptions, and approaches used by the appraiser (including any comments
made by management on the value rendered by the appraiser). Under the
circumstances described below, the examiner may make adjustments to this assessment
of value. This review and any resulting adjustments to value are solely for purposes
of an examiner's analysis and classification of a credit and do not involve actual
adjustments to an appraisal.
A discounted cash flow analysis is an appropriate method for estimating the value of
income-producing real estate collateral.8 This approach is discussed in more detail in
Attachment 2. This analysis should not be based solely on the current performance of
the collateral or similar properties; rather, it should take into account, on a discounted
basis, the ability of the real estate to generate income over time based upon reasonable
and supportable assumptions.
5
The treatment of guarantees in the classification process is discussed in Attachment 1.
' Department of the Treasury, Office of the Comptroller of the Currency, 12 CFR Part 34 (Docket No. 90-16); Board
of Governors of the Federal Reserve System, 12 CFR Pans 208 and 22S (Regulation H and Y; Docket No. R-0685);
Federal Deposit Insurance Corporation, 12 CFR 323 (RIN 3064-ABQ5); Department of the Treasury, Office of Thrift
Supervision, 12 CFR Part 564 (Docket No. 90-1495).
7
Stabilized income generally is defined as the yearly net operating income produced by the property at normal
occupancy and rental rates; it may be adjusted upward or downward from today's actual market conditions.
* The real estate appraisal regulations of the federal bank and thrift regulatory agencies include a requirement that an
appraisal (a) follow a reasonable valuation method that addresses the direct sales comparison, income, and cost approaches
to market value; (b) reconcile these approaches; and (c) explain the elimination of each approach not used. A discounted
cash flow analysis is recognized as a valuation method for the income approach.
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Whenreviewingthereasonablenessof the facts and assumptions associated with the
value of the collateral, examiners may evaluate:
• Current and projected vacancy and absorption rates;
• Lease renewal trends and anticipated rents;
• Volume and trends in past due leases;
• Effective rental rates or sale prices (taking into account all concessions);
• Net operating income of the property as compared with budget projections; and
• Discount rates and direct capitalization ("cap") rates.9
The capacity of a property to generate cash flow to service a loan is evaluated based
uponrentsCor sales), expenses, and rates of occupancy that arereasonablyestimated to
be achieved over time. The determination of the level of stabilized occupancy and
rental rates should be based upon an analysis of current andreasonablyexpected
market conditions, taking into consideration historical levels when appropriate. The
analysis of collateral values should not be based upon a simple projection of current
levels of net operating income if markets are depressed orreflectspeculative pressures
but can be expected over areasonableperiod of time toreturnto normal (stabilized)
conditions. Judgment is involved in determining the time that it will take for a
property to achieve stabilized occupancy andrentalrates.
Examiners do not make adjustments to appraisal assumptions for credit analysis
purposes based on worst case scenarios that are unlikely to occur. For example, an
examiner would not necessarily assume that a building will become vacant just
because an existing tenant who isrentingat a rate above today's market rate may
vacate the property when the current lease expires. On the other hand, an adjustment
to value may be appropriate for credit analysis purposes when the valuation assumes
renewal at the above-market rate, unless that rate is areasonableestimate of the
expected market rate at the time of renewal.
When estimating the value of income-producing real estate, discount rates and "cap"
rates shouldreflectreasonableexpectations about the rate ofreturnthat investors
require under normal, orderly and sustainable market conditions. Exaggerated,
imprudent, or unsustainably high or low discount rates, "cap" rates, and income
projections should not be used. Direct capitalization of nonstabilized income flows
should also not be used.
Assumptions, whenrecentlymade by qualified appraisers (and, as appropriate, by
institution management) and when consistent with the discussion above, should be
9
Attachment 2 includes a discussion of discount rates and direct capitalization rates.
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given a reasonable amount of deference. Examiners should not challenge the
underlying assumptions, including discount rates and "cap" rates used in appraisals,
that differ only in a limited way from norms that would generally be associated with
the property under review. The estimated value of the underlying collateral may be
adjusted for credit analysis purposes when the examiner can establish that any underlying facts or assumptions are inappropriate and can support alternative assumptions.
Classification Guidelines
As with other types of loans, commercial real estate loans that are adequately protected
by the current sound worth and debt service capacity of the borrower, guarantor, or the
underlying collateral generally are not classified. Similarly, loans to sound borrowers
that are refinanced orrenewedin accordance with prudent underwriting standards,
including loans to creditworthy commercial orresidentialreal estate developers, should
not be classified or criticized unless well-defined weaknesses exist that jeopardize
repayment. An institution will not be criticized for continuing to carry loans having
weaknesses that result in classification or criticism as long as the institution has a wellconceived and effective workout plan for such borrowers, and effective internal
controls to manage the level of these loans.
In evaluating commercial real estate credits for possible classification, examiners apply
standard classification definitions (Attachment 3).10 In determining the appropriate
classification, consideration should be given to all important information on repayment
prospects, including information on the borrower's creditworthiness, the value of, and
cash flow provided by, all collateral supporting the loan, and any support provided by
financiallyresponsibleguarantors.
The loan'srecordof performance to date is important and must be taken into
consideration. As a general principle, a performing commercialrealestate loan should
not automatically be classified or charged-off solely because the value of the
underlying collateral has declined to an amount that is less than the loan balance.
However, it would be appropriate to classify a performing loan when well-defined
weaknesses exist that jeopardize repayment, such as the lack of credible support for
fullrepaymentfromreliablesources.11
These principles hold for individual credits, even if portions or segments of the
industry to which the borrower belongs are experiencingfinancialdifficulties. The
evaluation of each credit should be based upon the fundamental characteristics
10
These definitions are presented in Attachment 3 and address assets classified "substandard," "doubtful," or "loss" for
supervisory purposes.
" Another issue that arises in the review of a commercial real estate loan is the loan's treatment as an accruing asset
or as a nonaccrual asset for reporting purposes. The federal bank and thrift regulatory agencies have provided guidance
on nonaccrual status in the instructions for the Reports of Condition and Income (Call Reports) for banks, and in the
instructions for the Thrift Financial Report for savings associations, and in related supervisory guidance of the agencies.
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affecting the collectibility of the particular credit. The problems broadly associated
with some sectors or segments of an industry, such as certain commercial real estate
markets, should not lead to overly pessimistic assessments of particular credits that are
not affected by the problems of the troubled sectors.
Classification of troubled project-dependent commercial real estate loans.12 The
following guidelines for classifying a troubled commercial real estate loan apply when
the repayment of the debt will be provided solely by the underlying real estate
collateral, and there are no other available and reliable sources of repayment.
As a general principle, for a troubled project-dependent commercial real estate loan,
any portion of the loan balance that exceeds the amount that is adequately secured by
the value of the collateral, and that can clearly be identified as uncollectible, should be
classified "loss."13 The portion of the loan balance that is adequately secured by the
value of the collateral should generally be classified no worse than "substandard." The
amount of the loan balance in excess of the value of the collateral, or portions thereof,
should be classified "doubtful" when the potential for full loss may be mitigated by the
outcomes of certain pending events, or when loss is expected but the amount of the
loss cannot bereasonablydetermined.
If warranted by the underlying circumstances, an examiner may use a "doubtful"
classification on the entire loan balance. However, this would occur infrequently.
Guidelines for classifying partially charged-off loans. Based upon consideration of
all relevant factors, an evaluation may indicate that a credit has well-defined
weaknesses that jeopardize collection in full, but that a portion of the loan may be
reasonably assured of collection. When an institution has taken a charge-off in an
amount sufficient that the remaining recorded balance of the loan (a) is being serviced
(based uponreliablesources) and (b) is reasonably assured of collection, classification
of theremainingrecordedbalance may not be appropriate. Classification would be
appropriate when well-defined weaknesses continue to be present in the remaining
recorded balance. In such cases, the remainingrecordedbalance would generally be
classified no more severely than "substandard."
A more severe classification than "substandard" for the remaining recorded balance
would be appropriate if the loss exposure cannot be reasonably determined, e.g., where
significantriskexposures are perceived, such as might be the case for bankruptcy
situations or for loans collateralized by properties subject to environmental hazards.
In addition, classification of the remainingrecordedbalance would be appropriate
when sources ofrepaymentare considered unreliable.
12
The discussion in this section is not intended to address loans that must be treated as "other real estate owned" for
bank regulatory reporting purposes or "real estate owned" for thrift regulatory reporting purposes. Guidance on these assets
is presented in supervisory and reporting guidance of the agencies.
13
For purposes of this discussion, the "value of the collateral" is the value used by the examiner for credit analysis
purposes, as discussed in a previous section of this policy statement.
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Guidelines for classifying formally restructured loans. The classification treatment
previously discussed for a partially charged off loan would also generally be
appropriate for a formally restructured loan when partial charge-offs have been taken.
For a formallyrestructuredloan, the focus of the examiner's analysis is on the ability
of the borrower torepaythe loan in accordance with its modified terms. Classification
of a formally restructured loan would be appropriate, if, after therestructuring,well-defined weaknesses exist that jeopardize the orderlyrepaymentof the loan in
accordance with reasonable modified terms.1* Troubled commercial real estate loans
whose terms have beenrestructuredshould be identified in the institution's internal
credit review system, and closely monitored by management
Review of the Allowance for Loan and Lease Losses (ALLL)15
The adequacy of a depository institution's ALLL, including amounts based on an
analysis of the commercial real estate portfolio, must be based on a careful, well
documented, and consistently applied analysis of the institution's loan and lease portfolio.16
The determination of the adequacy of the ALLL should be based upon management's
consideration of all current significant conditions that might affect the ability of
borrowers (or guarantors, if any) to fulfill their obligations to the institution. While
historical loss experience provides areasonablestarting point, historical losses or even
recent trends in losses are not sufficient without further analysis and cannot produce a
reliable estimate of anticipated loss.
In determining the adequacy of the ALLL, management should also consider other
factors, including changes in the nature and volume of the portfolio; the experience,
ability, and depth of lending management and staff; changes in credit standards; collection policies and historical collection experience; concentrations of credit risk; trends in
the volume and severity of past due and classified loans; and trends in the volume of
nonaccrual loans, specific problem loans and commitments. In addition, this analysis
should consider the quality of the institution's systems and management in identifying,
monitoring, and addressing asset quality problems. Furthermore, management should
consider external factors such as local and national economic conditions and
14
An example of a restructured commercial real estate loan that does not have reasonable modified terms would be a
"cash flow" mortgage which requires interest payments only when the underlying collateral generates cash flow but provides
no substantive benefits to the lending institution.
15
Each of the federal bank and thrift regulatory agencies have issued guidance on the allowance for loan and lease
losses. Hie following discussion summarizes general principles for assessing the adequacy of the allowance for loan and
lease losses.
" The estimation process described in this section permits for a more accurate estimate of anticipated losses than could
be achieved by assessing the loan portfolio solely on an aggregate basis. However, it is only an estimation process and
does not imply that any part of the ALLL is segregated for, or allocated to, any particular asset or group of assets. The
ALLL is available to absorb all credit losses originating from the loan and lease portfolio.
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developments; competition; and legal and regulatoryrequirements;as well as
reasonably foreseeable events that are likely to affect the collectibility of the loan
portfolio.
Management should adequately document the factors that were considered, the
methodology and process that were used in determining the adequacy of the ALLL,
and the range of possible credit losses estimated by this process. The complexity and
scope of this analysis must be appropriate to the size and nature of the institution and
provide for sufficientflexibilityto accommodate changing circumstances.
Examiners will evaluate the methodology and process that management has followed
in arriving at an overall estimate of the ALLL in order to assure that all of the relevant
factors affecting the collectibility of the portfolio have been appropriately considered.
In addition, the overall estimate of the ALLL and the range of possible credit losses
estimated by management will bereviewedforreasonablenessin view of these factors.
This examiner analysis will also consider the quality of the institution's systems and
management in identifying, monitoring, and addressing asset quality problems.
As discussed in the previous section on classification guidelines, the value of the
collateral is considered by examiners in reviewing and classifying a commercial real
estate loan. However, for a performing commercial real estate loan, the supervisory
policies of the agencies do notrequireautomatic increases to the ALLL solely because
the value of the collateral has declined to an amount that is less than the loan balance.
In assessing the ALLL during examinations, it is important torecognizethat
management's process, methodology, and underlying assumptionsrequirea substantial
degree of judgment. Even when an institution maintains sound loan administration and
collection procedures and effective internal systems and controls, the estimation of
anticipated losses may not be precise due to the wide range of factors that must be
considered. Further, the ability to estimate anticipated loss on specific loans and
categories of loans improves over time as substantive information accumulates
regarding the factors affecting repayment prospects. When management has (a)
maintained effective systems and controls for identifying, monitoring and addressing
asset quality problems and (b) analyzed all significant factors affecting the
collectibility of the portfolio, considerable weight should be given to management's
estimates in assessing the adequacy of the ALLL.
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Attachment 1
TREATMENT OF GUARANTEES
IN THE CLASSIFICATION PROCESS
Initially, the original source of repayment and the borrower's intent and ability to
fulfill the obligation withoutrelianceon third party guarantors will be the primary
basis for the review and classification of assets.1 The federal bank and thrift
regulatory agencies will, however, consider the support provided by guarantees in the
determination of the appropriate classification treatment for troubled loans. The
presence of a guarantee from a "financially responsible guarantor," as described below,
may be sufficient to preclude classification or reduce the severity of classification.
For purposes of this discussion, a guarantee from a "financiallyresponsibleguarantor"
has the following attributes:
• The guarantor must have both the financial capacity and willingness to provide
support for the credit;
• The nature of the guarantee is such that it can provide support forrepaymentof the
indebtedness, in whole or in part, during the remaining loan teim; and2
• The guarantee should be legally enforceable.
The above characteristics generally indicate that a guarantee may improve the
prospects for repayment of the debt obligation.
Considerations relating to a guarantor's financial capacity. The lending institution
must have sufficient information on the guarantor's financial condition, income,
liquidity, cash flow, contingent liabilities, and otherrelevantfactors (including credit
ratings, when available) to demonstrate the guarantor's financial capacity to fulfill the
obligation. Also, it is important to consider the number and amount of guarantees
currently extended by a guarantor, in order to determine that the guarantor has the
financial capacity to fulfill the contingent claims that exist.
Considerations relating to a guarantor's willingness to repay. Examiners normally
rely on their analysis of the guarantor's financial strength and assume a willingness to
perform unless there is evidence to the contrary. This assumption may be modified
1
Some loans are originated based primarily upon the financial strength of the guarantor, who is, in substance, the
primary source of repayment In such circumstances, examiners generally assess the collectibility of the loan based upon
the guarantor's ability to repay the loan.
2
Some guarantees may only provide for support for certain phases of a real estate project. It would not be appropriate
to rely upon these guarantees to support a troubled loan after the completion of these phases.
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based on the "track record" of the guarantor, including payments made to date on the
asset underreviewor other obligations.
Examiners give due consideration to those guarantors that have demonstrated their
ability and willingness to fulfill previous obligations in their evaluation of current
guarantees on similar assets. An important consideration will be whether previously
required performance under guarantees was voluntary or the result of legal or other
actions by the lender to enforce the guarantee. However, examiners give limited
credence, if any, to guarantees from obligors who have reneged on obligations in the
past, unless there is clear evidence that the guarantor has the ability and intent to
honor the specific guarantee obligation under review.
Examiners also consider the economic incentives for performance from guarantors:
• Who have already partially performed under the guarantee or who have other
significant investments in the project;
• Whose other sound projects are cross-collateralized or otherwise intertwined with
the credit; or
• Where the guarantees are collateralized byreadilymarketable assets that are under
the control of a third party.
Other considerations. In general, only guarantees that are legally enforceable will be
relied upon. However, all legally enforceable guarantees may not be acceptable. In
addition to the guarantor's financial capacity and willingness to perform, it is expected
that the guarantee will not be subject to significant delays in collection, or undue
complexities or uncertainties about the guarantee.
The nature of the guarantee is also considered by examiners. For example, some
guarantees forrealestate projects only pertain to the development and construction
phases of the project. As such, these limited guarantees would not be relied upon to
support a troubled loan after the completion of those phases.
Examiners also consider the institution's intent to enforce the guarantee and whether
there are valid reasons to preclude an institution from pursuing the guarantee. A
history of timely enforcement and successful collection of the full amount of
guarantees will be a positive consideration in the classification process.
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Attachment 2
THE VALUATION OF INCOME-PRODUCING REAL ESTATE
Approaches to the Valuation of Real Estate
Appraisals are professional judgments of the market value ofrealproperty. Three
basic valuation approaches are used by professional appraisers in estimating the market
value ofrealproperty -- the cost approach, the market data or direct sales comparison
approach, and the income approach. The principles governing the three approaches are
widely known in the appraisal field and wererecentlyreferencedin parallel regulations
issued by each of the federal bank and thrift regulatory agencies. When evaluating the
collateral for problem credits, the three valuation approaches are not equally
appropriate.
1. Cost Approach. In the cost approach, the appraiser estimates the reproduction
cost of the building and improvements, deducts estimated depreciation, and adds
the value of the land. The cost approach is particularly helpful when reviewing
draws on construction loans. However, as the property increases in age, both
reproduction cost and depreciation become more difficult to estimate. Except
for special purpose facilities, the cost approach is usually inappropriate in a
troubled real estate market because construction costs for a new facility normally
exceed the market value of existing comparable properties.
2. Market Data or Direct Sales Comparison Approach. This approach examines
the price of similar properties that have sold recently in the local market,
estimating the value of the subject property based on the comparable properties'
selling price. It is very important that the characteristics of the observed
transactions be similar in terms of market location,financingterms, property
condition and use, timing, and transaction costs. The market approach generally
is used in valuing owner-occupiedresidentialproperty because comparable sales
data are typically available. When adequate sales data are available, an analyst
generally will give the most weight to this type of estimate. Often, however, the
available sales data for commercial properties are not sufficient to justify a
conclusion.
3. The Income Approach. The economic value of an income-producing property
is the discounted value of the future net operating income stream, including any
"reversion" value of property when sold. If competitive markets are working
perfectiy, the observed sales price should be equal to this value. For unique
properties or in markets that are thin or subject to disorderly or unusual
conditions, market value based on a comparable sales approach may be either
unavailable or distorted. In such cases, the income approach is usually the
appropriate method for valuing the property.
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The income approach converts all expected future net operating income into
present value terms. When market conditions are stable and no unusual patterns
of future rents and occupancy rates are expected, the direct capitalization method
is often used to estimate the present value of future income streams. For
troubled properties, however, examiners typically utilize the more explicit
discounted cash flow (net present value) method for analytical purposes. In that
method, a time frame for achieving a "stabilized", or normal, occupancy and
rent level is projected. Each year's net operating income during that period is
discounted to arrive at the present value of expected future cash flows. The
property's anticipated sales value at the end of the period until stabilization (its
terminal or reversion value) is then estimated. The reversion value represents
the capitalization of all future income streams of the property after the projected
occupancy level is achieved. The terminal or reversion value is then discounted
to its present value and added to the discounted income stream to arrive at the
total present market value of the property.
Valuation of Troubled Income-Producing Properties
When an income property is experiencing financial difficulties due to general market
conditions or due to its own characteristics, data on comparable property sales often
are difficult to obtain. Troubled properties may be hard to market, and normal
financing arrangements may not be available. Moreover, forced and liquidation sales
can dominate market activity. When the use of comparables is not feasible (which is
often the case for commercial properties), the net present value of the most reasonable
expectation of the property's income-producing capacity — not just in today's market
but over time — offers the most appropriate method of valuation in the supervisory
process.
Estimates of the property's value should be based upon reasonable and supportable
projections of the determinants of future net operating income: rents (or sales),
expenses and rates of occupancy. Judgment is involved in estimating all of these
factors. The primary considerations for these projections include historical levels and
trends, the current market performance achieved by the subject and similar properties,
and economically feasible and defensible projections of future demand and supply
conditions. To the extent that current market activity is dominated by a limited
number of transactions or liquidation sales, high "capitalization" and discount rates
implied by such transactions should not be used. Rather, analysts should use rates that
reflect market conditions that are neither highly speculative nor depressed for the type
of property being valued and that property's location.
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Technical Notes
In the process of reviewing a real estate loan and in the use of the net present value
approach of collateral valuation, several conceptual issues often are raised. The
following discussion sets forth the meaning and use of those key concepts.
The Discount Rate. The discount rate used in the net present value approach to
convert future net cash flows of income-producing real estate into present market value
terms is the rate of return that market participants require for this type of real estate
investment The discount rate will vary over time with changes in overall interest
rates and in the risk associated with the physical and financial characteristics of the
property. The riskiness of the property depends both on the type of real estate in
question and on local market conditions.1
The Direct Capitalization ("Cap" Rate) Technique. The use of "cap" rates, or direct
income capitalization, is a method used by many market participants and analysts to
relate the value of a property to the net operating income it generates. In many
applications, a "cap" rate is used as a short cut for computing the discounted value of a
property's income streams.
The direct income capitalization method calculates the value of a property by dividing
an estimate of its "stabilized" annual income by a factor called a "cap" rate. Stabilized
income generally is defined as the yearly net operating income produced by the
property at normal occupancy and rental rates; it may be adjusted upward or
downward from today's actual market conditions.The "cap" rate — usually defined for
each property type in a market area — is viewed by some analysts as the required rate
of return stated in terms of current income. That is to say, the "cap" rate can be
considered a direct observation of the required eamings-to-price ratio in current income
terms. The "cap" rate also can be viewed as the number of cents per dollar of today's
purchase price investors would require annually over the life of the property to achieve
theirrequiredrate of return.
The "cap" rate method is appropriate if the net operating income to which it is applied
isrepresentativeof all future income streams or if net operating income and the
property's selling price are expected to increase at a fixed rate. The use of this
technique assumes that either the stabilized income or the "cap" rate used accurately
captures all relevant characteristics of the property relating to itsriskand income
potential. If the sameriskfactors,requiredrate ofreturn,financingarrangements, and
income projections are used, explicit discounting and direct capitalization will yield the
same results.
1
Regulatory policy of the Office of Thrift Supervision specifies that, for supervisory purposes, thrifts are to use discount
rates that are consistent with generally accepted accounting principles for thrifts (which allow the use of an average-cost-ofcapital-funds rate to calculate net realizable value) or discount rates that are consistent with the practices of the federal
banking agencies.
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This method alone is not appropriate for troubledrealestate since income generated by
the property is not at normal or stabilized levels. In evaluating troubled real estate,
ordinary discounting typically is used for the period before the projectreachesits full
income potential. A "terminal" "cap" rate is then utilized to estimate the value of the
property (its reversion or sales price) at the end of that period.
differences Between Discount and Cap Rates. When used for estimating real estate
market values, discount and "cap" rates should reflect the current market requirements
for rates ofreturnon properties of a given type. The discount rate is the required rate
ofreturnincluding the expected increases in future prices and is applied to income
streamsreflectinginflation. In contrast, the "cap" rate is used in conjunction with a
stabilized net operating income figure. The fact that discount rates forrealestate are
typically higher than "cap" rates reflects the principal difference in the treatment of
expected increases in net operating income and/or property values.
Other factors affecting the "cap" rate used (but not the discount rate) include the useful
life of the property andfinancingarrangements. The useful life of the property being
evaluated affects the magnitude of the "cap" rate because the income generated by a
property, in addition to providing the required return on investment, must be sufficient
to compensate the investor for the depreciation of the property over its useful life.
The longer the useful life, the smaller is the depreciation in any one year, hence, the
smaller is the annual incomerequiredby the investor, and the lower is the "cap" rate.
Differences in terms and the extent of debtfinancingand therelatedcosts must also be
taken into account.
Selecting Discount and Cap Rates. The choice of the appropriate values for discount
and "cap" rates is a key aspect of income analysis. Both in markets marked by lack of
transactions and those characterized by highly speculative or unusually pessimistic
attitudes, analysts consider historicalrequiredreturnson the type of property in
question. Where market information is available to determine currentrequiredyields,
analysts carefully analyze sales prices for differences infinancing,special rental
arrangements, tenant improvements, property location, and building characteristics. In
most local markets, the estimates of discount and "cap" rates used in income analysis
should generally fall within a fairly narrow range for comparable properties.
Holding Period vs. Marketing Period. When the income approach is applied to
troubled properties, a time frame is chosen over which a property is expected to
achieve stabilized occupancy andrentalrates (stabilized income). That time period is
sometimesreferredto as the "holding period." The longer the period before
stabilization, the smaller will be thereversionvalue included in the total value
estimate.
The holding period should be distinguished from the concept of "marketing period" —
a term used in estimating the value of a property under the sales comparison approach
10
268
and in discussions of property value whenrealestate is being sold. The marketing
period is the length of time that may be required to sell the property in an open
market.
10
269
Glossary
Appraisal. A written statement independently and impartially prepared by a qualified
appraiser setting forth an opinion as to the market value of an adequately described
property as of a specific date(s), supported by the presentation and analysis of relevant
market information.
Capitalization rate. A rate used to convert income into value. Specifically, it is the
ratio between a property's stabilized net operating income and the property's sales
price. Sometimesreferredto as an overall rate because it can be computed as a
weighted average of component investment claims on net operating income.
Discount rate. A rate ofreturnused to convert future payments orreceiptsinto their
present value.
Holding period. The time frame over which a property is expected to achieve
stabilized occupancy andrentalrates (stabilized income).
Market value. The most probable cash sale price which a property should bring in a
competitive and open market under all conditionsrequisiteto a fair sale, the buyer and
seller each acting prudently and knowledgeably, and assuming the price is not affected
by undue stimulus. Implicit in this definition is the consummation of a sale as of a
specified date and the passing of title from seller to buyer under conditions whereby:
1. buyer and seller are typically motivated (i.e., motivated by self-interest);
2. both parties are well informed or well advised, and acting in what they consider
their own best interests;
3. areasonabletime is allowed for exposure in the open market;
4. payment is made in terms of cash in U.S. dollars or in terms of financial
arrangements comparable thereto; and
5. the price represents the normal consideration for the property sold unaffected by
special or creative financing or sales concessions granted by anyone associated
with the sale.
Marketing period. The term in which an owner of a property is actively attempting to
sell that property in a competitive and open market.
Net operating income (NOI). Annual income after all expenses have been deducted,
except for depreciation and debt service.
17
270
Attachment 3
Classification Definitions1
The federal bank and thriftregulatoryagencies currently utilize the following
definitions for assets classified "substandard," "doubtful," and "loss" for supervisory
purposes:
Substandard Assets. A substandard asset is inadequately protected by the current
sound worth and paying capacity of the obligor or of the collateral pledged, if any.
Assets so classified must have a well-defined weakness or weaknesses that jeopardize
the liquidation of the debt. They are characterized by the distinct possibility that the
institution will sustain some loss if the deficiencies are not corrected.
Doubtful Assets. An asset classified doubtful has all the weaknesses inherent in one
classified substandard with the added characteristic that the weaknesses make
collection or liquidation in full, on the basis of currently existing facts, conditions, and
values, highly questionable and improbable.
Loss Assets. Assets classified loss are considered uncollectible and of such little value
that their continuance as bankable assets is not warranted. This classification does not
mean that the asset has absolutely no recovery or salvage value, but rather it is not
practical or desirable to defer writing off this basically worthless asset even though
partialrecoverymay be effected in the future.
1
Office of the Comptroller of the Cunency, Comptroller's Handbook for National Bank Examiners, Section 215.1,
"Classification of Credits;" Board of Governors of the Federal Reserve System, Commercial Bank Examination Manual,
Section 215.1, "Classification of Credits;" Office of Thrift Supervision, Thrift Activities Regulatory Handbook, Section 260,
"Classification of Assets;" Federal Deposit Insurance Corporation, Division of Supervision Manual of Examination Policies,
Section 3.1, "Loans."
18
271
BOARD
OF
GOVERNORS
F E D E R A L R E S E R V E SYSTEM
WASHINGTON,
C. 2 0 5 5 1
SR
91-26
(FIS)
November 8, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Examination Review Procedures—Program
and R e v i e w i n g Use o f A p p r a i s a l s
for
Evaluating
As p a r t o f c o n t i n u i n g e f f o r t s t o a s s u r e b a l a n c e and
c o n s i s t e n c y , the f e d e r a l banking agencies are taking c e r t a i n
s t e p s t o r e v i e w and m o n i t o r t h e u s e o f a p p r a i s a l s i n t h e
examination process.
The p u r p o s e o f t h i s e f f o r t i s t o p r o m o t e
c o n s i s t e n c y w i t h i n t e r a g e n c y g u i d e l i n e s on t h e e v a l u a t i o n o f r e a l
e s t a t e l o a n s and w i t h r e l a t e d e x a m i n a t i o n p o l i c i e s and
p r o c e d u r e s , i n c l u d i n g t h e March 1 s t i n t e r a g e n c y p o l i c y s t a t e m e n t
on c r e d i t a v a i l a b i l i t y .
(The r e l e v a n t p o l i c i e s and g u i d e l i n e s
a r e s e t f o r t h i n t h e c r o s s r e f e r e n c e s e c t i o n a t t h e end o f t h i s
letter.)
Among t h e s t e p s t o b e t a k e n i s t h e e s t a b l i s h m e n t o f a
random r e v i e w o r a u d i t p r o g r a m b y e a c h R e s e r v e Bank t o e n c o u r a g e
appropriate use of appraisals in the loan evaluation process.
E a c h R e s e r v e Bank i s a s k e d t o i m p l e m e n t t h i s p r o g r a m i m m e d i a t e l y .
I t i s s u g g e s t e d t h a t t h e program be c o n d u c t e d on a
random b a s i s b y an e x a m i n a t i o n o f f i c e r , a r e v i e w e x a m i n e r o r an
e x a m i n e r d e s i g n a t e d b y t h e R e s e r v e Bank t o a d m i n i s t e r t h e
program.
The r e v i e w e r s h o u l d d e t e r m i n e t h a t e x a m i n a t i o n
g u i d e l i n e s and p o l i c i e s h a v e b e e n c o n s i s t e n t l y a p p l i e d t o r e a l
e s t a t e c r e d i t s and t o t h e a n a l y s i s o f a p p r a i s a l s and l o a n v a l u e s .
Under t h i s program, t h e r e v i e w e r s h o u l d s e l e c t a sample o f r e a l
e s t a t e c r e d i t s , r e v i e w t h e work p a p e r s and a s s e s s t h e u s e o f
appraisals in the loan c l a s s i f i c a t i o n process.
As p a r t o f t h i s e f f o r t , t h e r e v i e w e r s h o u l d c o n s i d e r
any a d j u s t m e n t s t o t h e v a l u e of t h e c o l l a t e r a l by examiners or
management i n a r r i v i n g a t c o l l a t e r a l v a l u e s f o r u s e i n l o a n
classifications.
I f a d j u s t m e n t s a r e deemed n e c e s s a r y f o r c r e d i t
a n a l y s i s purposes t o accurately a s s e s s the value of c o l l a t e r a l ,
t h e r e v i e w e r s h o u l d n o t e t h e j u s t i f i c a t i o n and f r e q u e n c y o f any
s u c h a d j u s t m e n t made b y t h e e x a m i n e r o r management and t h e
a s s u m p t i o n s u s e d i n making t h e a d j u s t m e n t s .
The r e v i e w e r s h o u l d
a s c e r t a i n t h a t t h e examiner has g i v e n c o n s i d e r a t i o n t o t h e income
p r o d u c i n g c a p a c i t y o f t h e p r o p e r t y when e v a l u a t i n g i n c o m e
p r o p e r t y l o a n s , and t h a t t h e u s e o f t h e v a l u e o f t h e c o l l a t e r a l
in the loan evaluation process is consistent with supervisory
p o l i c i e s regarding the review of real e s t a t e loans.
272
2
The o b j e c t i v e o f t h e program i s t o promote t h e u s e o f
consistent, reasonable assumptions in assessing the value of real
estate collateral.
Examination s t a f f should be advised of t h e
r e s u l t s o f t h e s e r e v i e w s and t h e n e e d f o r c a r e f u l d o c u m e n t a t i o n
in-the use of the value of c o l l a t e r a l as a b a s i s for loan
classifications.
E a c h R e s e r v e Bank s h o u l d m a i n t a i n d o c u m e n t a t i o n
on t h i s p r o g r a m and b e p r e p a r e d t o p r o v i d e summary d a t a f o r
review during the operations review or as otherwise required.
Q u e s t i o n s r e g a r d i n g t h i s SR l e t t e r c a n b e r e f e r r e d t o
Roger Cole ( 2 0 2 / 4 5 2 - 2 6 1 8 ) , Steve Lovette ( 2 0 2 / 4 5 2 - 3 6 2 2 ) ,
Bill
Spaniel (202/452-3469) or Jack Jennings
(202/452-3053).
Richard Spillenkothen
Director
Cross
Reference:
SR 9 1 - 1 6 , SR 9 1 - 1 8 , SR 9 1 - 1 9 , M a r c h 1 ,
1991
I n t e r a g e n c y P o l i c y S t a t e m e n t and November 7,
1991 I n t e r a g e n c y P o l i c y S t a t e m e n t on t h e
R e v i e w and C l a s s i f i c a t i o n o f Commercial R e a l
E s t a t e Loans.
273
BOARD
M
m-.
OF
GOVERNORS
FEDERAL R E S E R V E SYSTEM
W A S H I N G T O N , Q. C. 2 0 5 5 1
AD 91-78 (FIS)
••^ss^November 8, 1991
TO THE OFFICER I N CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Interagency
Examination
Meeting
of
Federal
S t a f f - December 16 -
Financial
17, 1991
Regulatory
An I n t e r a g e n c y E x a m i n e r s C o n f e r e n c e i s s c h e d u l e d t o b e h e l d
D e c e m b e r 1 6 - 1 7 , 1 9 9 1 , a t t h e Omni I n n e r H a r b o r H o t e l , 1 0 1 W e s t
F a y e t t e S t r e e t , B a l t i m o r e , MD ( 3 0 1 ) 7 5 2 - 1 1 0 0 .
The c o n f e r e n c e w i l l
b e g i n a t 1 : 0 0 p . m . on December 1 6 t h and w i l l b e f o l l o w e d by a
dinner that evening.
The c o n f e r e n c e w i l l r e s u m e o n D e c e m b e r 1 7 t h
w i t h a c o n t i n e n t a l b r e a k f a s t a t 7 : 4 5 a . m . and w i l l l a s t u n t i l 5 : 0 0
p.m.
The p u r p o s e o f t h e c o n f e r e n c e i s t o p r o v i d e a forum f o r
senior
examination
staff
to
discuss
regulatory
policies
and
p r o c e d u r e s and t h e i r e f f e c t s on t h e a v a i l a b i l i t y o f c r e d i t .
The
Federal Reserve w i l l hold a one-day meeting of senior o f f i c e r s in
c h a r g e o f s u p e r v i s i o n a t t h e B a l t i m o r e Branch o f t h e
Federal
R e s e r v e Bank o f Richmond on D e c e m b e r 1 8 , 1 9 9 1 , and w i l l a d j o u r n a t
4:00 p.m.
In addition t o the senior o f f i c e r in charge of
supervision,
e a c h R e s e r v e Bank i s a s k e d t o s e n d t o t h e i n t e r a g e n c y c o n f e r e n c e
three or four additional examination personnel.
The g r o u p s h o u l d
i n c l u d e r e v i e w a n d s e n i o r f i e l d e x a m i n e r s - - i n d i v i d u a l s who h a v e
r e s p o n s i b i l i t y f o r s u p e r v i s i n g and c o n d u c t i n g o n - s i t e e x a m i n a t i o n s .
An a g e n d a f o r t h e s e n i o r v i c e p r e s i d e n t s ' m e e t i n g t o b e
on December 1 8 t h w i l l be forwarded i n t h e n e a r f u t u r e .
A l i m i t e d number o f rooms h a v e b e e n r e s e r v e d
December 1 5 t h , p r i m a r i l y f o r s t a f f t r a v e l l i n g from t h e
R e s e r v a t i o n s h a v e b e e n made f o r a l l
attendees for
T u e s d a y n i g h t s a t t h e Omni.
Accommodations f o r s t a
a v a i l a b l e Wednesday n i g h t .
held
f o r Sunday,
West C o a s t .
Monday and
f f are also
274
2
EXease s e n d a l i s t o f a t t e n d e e s from y o u r R e s e r v e Bank by
November 1 5 , 1 9 9 1 , w i t h room r e s e r v a t i o n r e q u i r e m e n t s t o A l i s o n
W a l d r o n ( 2 0 2 ) 4 5 2 - 2 5 3 8 , o r Mark B e n t o n ( 2 0 2 ) 4 5 2 - 5 2 0 5 ,
FAX n u m b e r
(202) 4 5 2 - 2 7 7 0 .
Further information, including agenda items, w i l l
be p r o v i d e d t o R e s e r v e Banks.
Q u e s t i o n s may b e d i r e c t e d t o M s .
W a l d r o n , o r Mr. B e n t o n .
Richard Spillenkothen
Director
275
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM
WASHINGTON, 0. C. 20551
SR 9 L — 25 (FIS)
DIVISION OF BANKING
SUPERVISION ANO REGULATION
November 7, 1991
TO THE OFFICER I N CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Interagency Examination
E s t a t e Loans
Guidance
on Commercial
Real
Enclosed f o r your information i s a copy of the j o i n t
i n t e r a g e n c y p r e s s r e l e a s e and j o i n t s t a f f memorandum i s s u e d i n
connection with the guidelines.
Richard Spillenkothen
Director
Enclosure
276
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Federal Reserve Board
Office of Thrift Supervision
NEWS RELEASE
EMBARGOED FOR RELEASE a t 2 p . m .
T h u r s d a y , November 7 , 1991
EST
FINANCIAL REGULATORS ISSUE JOINT
SUPERVISORY POLICY STATEMENT
WASHINGTON,
bank a n d t h r i f t
D.C.,
Nov.
r e v i e w and c l a s s i f i c a t i o n
action
is
another
misunderstandings
availability
of
about
credit
on " E a s i n g The C r e d i t
The p o l i c y
of
officer
of
examiner,
troubled
agencies
supervisory
review of
the A d m i n i s t r a t i o n ' s
provides
which w i l l
loan p o r t f o l i o
analysis
of
regulatory
of
be s e n t
loss
the
statement
guidance
estate
chief
loans.
executive
thrift
indicators
values,
and
of
the
allowances.
agencies
that
the
Comptroller
of
Insurance
Corporation
(FDIC),
8th
a n d e a c h bank a n d
and c o l l a t e r a l
this
Growth."
real
review procedures,
loans
the
of
and c o m p r e h e n s i v e
to
of
the
Today's
impede
October
commercial
institution
on
loans.
Development
Economic
clear
of
regulators
today
that
do n o t
in
institutions'
The f o u r
the O f f i c e
estate
policies
C r u n c h To P r o m o t e
guidelines,
cover
real
to ensure
sound b o r r o w e r s .
statement
federal
statement
to
each depository
loans,
The f o u r
a joint
commercial
r e v i e w and c l a s s i f i c a t i o n
The d e t a i l e d
Deposit
1991 —
issued
s t e p by t h e
document was a n n o u n c e d
on t h e
7,
institutions
the
-more-
issued
Currency
the
today's
(0CC),
Federal
guidelines
the
Reserve
Federal
Board
are
277
S u p e r v i s o r y
(FRB),
p o l i c y
and t h e O f f i c e
four agencies
commercial
of
supervise
undertaking
to
three
other
National
17 t o
related
o
will
the
To a s s e s s
of
review
o
Holding
quality
Reserve
for
amount o f
ability
agencies
these
in Baltimore,
statement
of
agencies
Md.,
of
are
senior
on December
and o t h e r
examiners'
agencies
will
16
and
initiatives
review of
implement
collateral
a random
r e v i e w and a n a l y z e
in appraisals
as part
of
their
audit
the
loan
to
if
extend
steps
Stock
Board,
greater
i n a move d e s i g n e d
flexibility
in
comment a p r o p o s a l
noncumulative
perpetual
c o m p a n i e s may i n c l u d e
adopted,
their
credit
to
bank
raising
capital,
to
the
lift
preferred
in Tier
1
limit
stock
capital.
organizations
in
positions
and e x p a n d i n g
their
to
sound
previous
address
###
to grant
can a s s i s t
capital
follow
i n March a n d J u l y
meeting
how e x a m i n e r s
public
bank h o l d i n g
strengthening
of
regulatory
availability,
contained
This proposal,
All
the
a national
policy
regulatory
companies
issued
that
institutions.
Company P r e f e r r e d
holding
on t h e
the
12,000
process,
The F e d e r a l
has
Together,
nation's
Examiners
hold
program to d e t e r m i n e
assumptions
(OTS).
the
Program
the
the
of
issuance,
to c r e d i t
Random A u d i t
value,
thrift
personnel
review
Supervision
actions:
Meeting
examination
2
activities
today's
The a g e n c i e s
-
Thrift
the
b a n k s and 2 , 2 0 0
In a d d i t i o n
o
s t a t e m e n t
borrowers.
actions
credit
by t h e
regulatory
availability
concerns.
278
Office of the Comptroller of the Currency
Federal Deposit Insurance Corporation
Federal Reserve Board
Office of Thrift Supervision
Interagency Policy Statement on the Review and
Classification of Commercial Real Estate Loans
November 7, 1991
The recent decline in credit extended by depository institutions has been attributed to
many factors. These factors include the general slowdown in the economy, the
overbuilding of commercial real estate properties in some markets, the desire of some
household and business borrowers, as well as some depository institutions, to
strengthen their balance sheets, changes by lenders in underwriting standards, and
concerns about the potential impact of certain supervisory policies or actions. To
ensure that regulatory policies and actions do not inadvertently curtail the availability
of credit to sound borrowers, the four Federal regulators of banks and thrifts have
taken a number of steps to clarify and communicate their policies. The attached policy
statement is a further step in this effort.
On March 1, 1991, the four agencies — the Office of the Comptroller of the Currency,
the Federal Deposit Insurance Corporation, the Federal Reserve Board, and the Office
of Thrift Supervision — issued general guidelines that addressed a wide range of
supervisory policies. Included in the March issuance were brief discussions of the
workout of problems loans, lending by undercapitalized institutions, and a general
statement on the valuation of real estate loans.
The attached policy statement expands upon the March 1 and subsequent guidance as
itrelatesto thereviewand classification of commercial real estate loans.
The intent of the statement by the agencies is to provide clear and comprehensive
guidance to ensure that supervisory personnel arereviewingloans in a consistent,
prudent, and balanced fashion and to ensure that all interested parties are aware of the
guidance.
The policy statement emphasizes that the evaluation of real estate loans is not based
solely on the value of the collateral, but on a review of the borrower's willingness and
capacity torepayand on the income-producing capacity of toe properties.
279
The policy statement also provides guidance on how supervisory personnel analyze the
value of collateral. In general, examiners consider the institution's appraisals of
collateral (or internal evaluations, when applicable) to determine value and they review
the major facts, assumptions and approaches used in determining the value of the
collateral. Examiners seek to avoid challenges to underlying assumptions that differ in
.only a limited way from norms that would generally be associated with the property
under review. Nonetheless, whenreviewingthe value of the collateral and any related
management adjustments, examiners ascertain that the value is based on assumptions
that are both prudent andrealistic,and not on overly optimistic or overly pessimistic
assumptions.
The policy statement covers a wide range of specific topics, including:
• the general principles that examiners follow inreviewingcommercial real estate
loan portfolios;
• the indicators o* troubledrealestate markets, projects, andrelatedindebtedness;
• the factors examiners consider in theirreviewof individual loans, including the use
of appraisals and the determination of collateral value;
• a discussion of approaches to valuingrealestate, especially in troubled markets;
• the classification guidelines followed by the agencies, including the treatment of
guarantees; and
• the factors considered in the evaluation of an institution's allowance for loan and
lease losses.
This statement is intended to ensure that all supervisory personnel, lending institutions
and other interested parties have a clear understanding of the agencies' policies.
280
BOARD OF GOVERNORS
FEDERAL RESERVE SYSTEM
WASHINGTON,D.C. 2MM
AD
91-85
(FIS)
December 5, 1991
TO THE OFFICERS IN CHARGE OF SUPERVISION AT EACH
FEDERAL RESERVE BANK
SUBJECT:
National
Examiners'
Conference
Enclosed i s information regarding the National
E x a m i n e r s ' C o n f e r e n c e s p o n s o r e d by t h e O f f i c e o f T h r i f t
S u p e r v i s i o n t o b e h e l d a t t h e O m n i - I n n e r Harbor H o t e l i n
B a l t i m o r e , M a r y l a n d o n D e c e m b e r 16 - 1 7 , 1 9 9 1 , a n d t h e m e e t i n g o f
t h e F e d e r a l R e s e r v e S e n i o r O f f i c e r s i n Charge o f S u p e r v i s i o n t o
b e h e l d a t t h e B a l t i m o r e B r a n c h o f t h e F e d e r a l R e s e r v e Bank o f
Richmond on December 18, 1 9 9 1 .
R e g i s t r a t i o n f o r t h e N a t i o n a l Examiners' Conference f o r
s t a f f t r a v e l l i n g t o B a l t i m o r e on Sunday w i l l be h e l d i n t h e
P r o m e n a d e a r e a o f t h e Omni f r o m 3 : 0 0 p . m . t o 5 : 0 0 p . m .
I n d i v i d u a l s a r r i v i n g o n Monday s h o u l d r e g i s t e r b e t w e e n 8 : 0 0 a . m .
and 1 : 0 0 p.m. i n t h e Promenade a r e a .
The N a t i o n a l E x a m i n e r s ' C o n f e r e n c e w i l l b e g i n o n
Monday, D e c e m b e r 1 6 t h a t 1 : 0 0 p . m . w i t h a n a d d r e s s b y S e c r e t a r y
of t h e Treasury N i c h o l a s Brady.
A r e c e p t i o n and d i n n e r w i l l be
h e l d f o r c o n f e r e n c e a t t e n d e e s a t t h e Omni o n Monday e v e n i n g .
The
c o n f e r e n c e w i l l a d j o u r n a t 5 : 0 0 p.m. on Tuesday.
T h e OTS h a s a r r a n g e d f o r t r a n s p o r t a t i o n t o BWI A i r p o r t
f o r conference p a r t i c i p a n t s immediately f o l l o w i n g adjournment.
I n a d d i t i o n , t r a n s p o r t a t i o n i s a v a i l a b l e by s h u t t l e e x p r e s s v a n
( $ 6 . 5 0 p e r t r i p ) o r t a x i ($15 t o $17 p e r t r i p ) .
The F e d e r a l R e s e r v e w i l l h o l d a r e c e p t i o n and d i n n e r a t
t h e Omni o n T u e s d a y e v e n i n g f o r t h e F e d e r a l R e s e r v e S e n i o r
O f f i c e r s i n Charge o f S u p e r v i s i o n .
The F e d e r a l R e s e r v e m e e t i n g
w i l l b e g i n a t t h e B a l t i m o r e Branch on Wednesday a t 8 : 0 0 a.m. and
w i l l adjourn a t 4 : 0 0 p.m.
The B r a n c h c a f e t e r i a w i l l b e o p e n f o r
281
Page 2
b r e a k f a s t a t 7:00 a.m.
The B r a n c h w i l l p r o v i d e t r a n s p o r t a t i o n t o
BWI A i r p o r t f o l l o w i n g t h e W e d n e s d a y m e e t i n g .
Please complete the
a t t a c h e d d e p a r t u r e f o r m a n d f a x i t t o Mark B e n t o n a t 2 0 2 - 4 5 2 2770.
I f you have any q u e s t i o n s ,
202-452-2618.
please
Richard Spillenkothen
Director
Attachments
call
Roger Cole
at
282
Office of Thrift Supervision
Department of the Treasurv
17C0 G Street. N.W.. W.ishincton. l \ C
November
22,
1991
MEMORANDUM
TO:
National
Examiners'
FROM:
Jonathan
Fiechter
(^//foiL
DATE:
November
22,
V
SUBJECT:
Federal Financial I n s t i t u t i o n
Regulators'
Examination Staff Conference
1991
Conference
Participants
/[ei^S*"
The f o u r F e d e r a l r e g u l a t o r s b a n k s and t h r i f t s — t h e O f f i c e o f
t h e C o m p t r o l l e r o f t h e C u r r e n c y (OCC), t h e F e d e r a l D e p o s i t
I n s u r a n c e C o r p o r a t i o n (FDIC), t h e F e d e r a l R e s e r v e Board (FRB),
a n d t h e O f f i c e o f . T h r i f t S u p e r v i s i o n (OTS) — h a v e j o i n e d
t o g e t h e r t o s p o n s o r a N a t i o n a l E x a m i n e r s ' C o n f e r e n c e t o be
h e l d o n D e c e m b e r 16 a n d 1 7 i n B a l t i m o r e , M a r y l a n d .
The
p u r p o s e o f t h e m e e t i n g i s t o r e v i e w and d i s c u s s t h e r e c e n t l y
i s s u e d i n t e r a g e n c y p o l i c y s t a t e m e n t on t h e r e v i e w and
c l a s s i f i c a t i o n o f c o m m e r c i a l r e a l e s t a t e l o a n s and t o
c o m m u n i c a t e o t h e r i n i t i a t i v e s and p o l i c i e s r e l a t e d t o c r e d i t
a v a i l a b i l i t y w i t h s e n i o r e x a m i n e r s of the four r e g u l a t o r y
agencies.
T h i s m e e t i n g s h o u l d p r o v e t o be b o t h p r o d u c t i v e and
informative.
As t h e a g e n c y t h a t h a s b e e n d e s i g n a t e d t o c o o r d i n a t e t h e
c o n f e r e n c e , we a t OTS a r e p r o v i d i n g y o u w i t h t h e n e c e s s a r y
i n f o r m a t i o n f o r you t o f i n a l i z e your t r a v e l p l a n s .
The
c o n f e r e n c e w i l l b e h e l d a t t h e OMNI I n n e r - H a r b o r H o t e l , 1 0 1 W.
F a y e t t e S t r e e t , Baltimore, Maryland.
The g e n e r a l m e e t i n g w i l l
b e g i n a t 1 : 0 0 p . m . o n M o n d a y , D e c e m b e r 16 a n d a d j o u r n a t 5 : 0 0
p . m . on T u e s d a y , December 1 7 .
I n a d d i t i o n , t h e OTS, FDIC, a n d
a l i m i t e d n u m b e r o f FRB s t a f f w i l l h o s t s e p a r a t e a g e n c y
Your a g e n c y c o o r d i n a t o r
m e e t i n g s on Wednesday, December 1 8 .
w i l l p r o v i d e f u r t h e r d e t a i l s on t h e i n d i v i d u a l group m e e t i n g s .
Attached hereto is information concerning hotel
reservations
and c o n f e r e n c e r e g i s t r a t i o n .
H o t e l r o o m s a t t h e OMNI h a v e
been reserved for each p a r t i c i p a n t .
A b l o c k o f rooms h a s b e e n
r e s e r v e d b e g i n n i n g Sunday, December 15, f o r t h o s e t r a v e l e r s
who c a n n o t a r r i v e b y t h e 1 : 0 0 p . m . s t a r t o f t h e c o n f e r e n c e .
Enclosure
283
NATIONAL EXAMINERS'
General
M o n d a y , December
1: 00pm-6:00pm
7 : 30pm-9:30pm
Tuesday, December
8 : 30am-5:00pm
6 : 30pm-8:30pm
7 :00pm-9:00pm
*No d i n n e r
CONFERENCE
Information
16;
Interagency
Interagency
Conference
Dinner
17:
Interagency Conference
FRB i n d i v i d u a l d i n n e r m e e t i n g
OTS i n d i v i d u a l d i n n e r m e e t i n g
meetings
planned
b y OCC o r
FDIC
Wednesday/ December 1 8 :
8 : 30am-10:30am
FDIC i n d i v i d u a l m e e t i n g
8:30am- 1:00pm
OTS i n d i v i d u a l m e e t i n g
8:00am- 4:00pm
FRB i n d i v i d u a l m e e t i n g ( h e l d
Baltimore o f f i c e )
*No a g e n c y
meeting
planned
at
FRB
b y OCC
Place:
OMNI-Inner Harbor Hotel
1 0 1 W. Fayette Street
Baltimore, MD
21201
(301) 752-1100
RESERVATIONS HAVE BEEN VERIFIED BY BOARD STAFF
B l o c k s o f rooms h a v e b e e n r e s e r v e d b e g i n n i n g S u n d a y , December
15 f o r t r a v e l e r s w h o c a n n o t a r r i v e b y 1 : 0 0 p m o n D e c e m b e r 1 6 .
P l e a s e c a l l t h e OMNI H o t e l d i r e c t l y a t ( 3 0 1 - 7 5 2 - 1 1 0 0 ) i n o r d e r
to confirm or c a n c e l your r e s e r v a t i o n .
They w i l l r e q u i r e your
f u l l name, g r o u p a f f i l i a t i o n , a r r i v a l and d e p a r t u r e t i m e s ,
p r e f e r e n c e f o r smoking or n o n - s m o k i n g rooms, and w h e t h e r you
need to guarantee l a t e a r r i v a l ( a f t e r 6:00pm).
Transportation:
S h u t t l e s e r v i c e i s a v a i l a b l e f r o m BWI a i r p o r t t o t h e h o t e l f o r
$6.50.
T r a n s p o r t a t i o n w i l l b e p r o v i d e d t o t h e OTS o f f - s i t e
d i n n e r on December 1 7 .
Bus s e r v i c e w i l l be a v a i l a b l e f r o m t h e
OMNI t o t h e a i r p o r t o n D e c e m b e r 1 7 a n d 1 8 .
284
Billing:
A room r a t e o f $ 7 1 . 0 0 / p e r n i g h t f o r s i n g l e o c c u p a n c y h a s b e e n
n e g o t i a t e d w i t h t h e OMNI h o t e l a n d w i l l b e b i l l e d t o e a c h
guest.
P l e a s e n o t e t h a t t h e OMNI h o t e l h a s a g r e e d n o t t o
c h a r g e a n y a d d i t i o n a l t a x e s t o t h i s room r a t e .
A government
i s s u e d c r e d i t c a r d s h o u l d be u s e d f o r p a y m e n t .
In the e v e n t
t h a t you do n o t have s u c h c r e d i t c a r d , p r e s e n t your g o v e r n m e n t
i d e n t i f i c a t i o n when s e t t l i n g y o u r b i l l .
Parking;
V a l e t - and s e l f - p a r k i n g i s a v a i l a b l e a t t h e h o t e l a t t h e r a t e
of $ 9 . 0 0 per day.
V a l e t s e r v i c e i s recommended s i n c e i t
i n c l u d e s i n / o u t p r i v i l e g e s and may b e c h a r g e d t o y o u r h o t e l
b i l l , unlike self-parking service.
Registration/Information;
R e g i s t r a t i o n w i l l be h e l d i n t h e Promenade a r e a on S u n d a y ,
D e c e m b e r 15 ( 3 : 0 0 p m - 5 : 0 0 p m ) and on M o n d a y , D e c e m b e r 16
(8:00am-l:00pm).
Please check-in at the Registration area
p r i o r t o t h e s t a r t o f t h e c o n f e r e n c e t o p i c k up m a t e r i a l s a n d
for further information.
I n a d d i t i o n , a n o f f i c e w i l l be s t a f f e d d u r i n g t h e c o n f e r e n c e
t o t a k e t e l e p h o n e m e s s a g e s and s e n d / r e c e i v e f a x t r a n s m i s s i o n s .
Conference
Coordinators:
For a d d i t i o n a l
FDIC:
OTS:
FRB:
OCC:
information,
y o u may
contact:
Mike Hovan ( 2 0 2 - 8 9 8 - 6 8 5 1 )
Louise Bartok ( 2 0 2 - 9 0 6 - 6 2 8 0 )
Mark B e n t o n ( 2 0 2 - 4 5 2 - 5 2 0 5 )
Inga Swanner ( 2 0 2 - 8 7 4 - 5 3 5 2 )
285
National i m l a i r i conf arenoe
Oani zimar Harbor total, Baltiaore, Maryland
Deoeaber If - 17, 19*1
Deoeaber l « ,
lttl
aBWfiTi
suaxoir
(Intamatlonal Ballroom)
1:00pm
l:20pm
Opening Reaarks (Secretary Bn.dy)
Overview of u. 8. loonoay and Coaaereial Real latate
Markets
U.S. iconoay <N. Boakin, Chaiiaan of the council of
Boonoaio Mviiorfl)
condition of tha Coaaareial 1**1 latata Market (R.
Larson, President and Chief Mxaoutive Offloor, tha
Tanbaan coapany and Maaber, Resolution Trust
Corporation oversight Board)
2:45pm
Ovarriav of Boonoaio Factors and Financial Regulatory
Folieiee on tha Availability of Cradit (J. Robaon,
Deputy Secretary, Department of tha Traaaury)
3:00pm
Break (Promanada)
3:40pn
Raviav of Various stataaanta on Cradit Availability
(Chair: riaohtar; Tritta/Spi 11 enkothen/coon1 ay)
o
o
o
Concantration of cradit
Non-uaa of liquidation accounting
Recognition of incona for cartain non-performing
o
Other isauaa relating to non-accrual asaats &
formally restructured debts
Policy concerning refinancing of conmercial real
estate loans
Clarification on Highly Leveraged Transactions
(HLT) Policy
loans
o
o
52-418 - 92 - 10
286
Page 2
4:40pm
Mow Regulatory initiatives (Chairx achameringj Dovney,
•teinbriak, stone)
Enhanced smaaiamtion Appeals l^roottt
o
o
Description of aach agony's current regional
and/or district procedures for handling disputes
Review of each agency's nev appeals program
communication of Policies to Unsure that Bxamination
Findings are consistent with iteoent ouidanoe on credit
Availability
5:4 opm
Adjournment
6 : 3 opm
Reception
7:30pm
Dinner (Jamas C. Killer, III,, Chairman, citisens for a
Bound Bconomy) (international Ballroom)
(Promenade)
December 17r ittl
7:00am
continental BreaJcfaet (Liberty Ballroom)
8:30am
New Regulatory Initiatives (Chair: Krauser Cola,
Miailovieh, pishmmn) (International Ballroom)
o
Indicators of troubled real estate
Analysis of collateral value
Use of appraisals and random audits of
appraisals
o
Classification guidelinea
—
o
Treatment of guarantees
Project-dependent commercial real estate
Partially charged-off loans
Use of insubstance foreclosure
Examiner reviev of allowances for loan and leaee
losses (ALLL)
Draft:
December 2, 1991
287
P
a
g
* 3
9:30am
lotioaa
12:oopm
Break (Promenade)
Breakout Beeaioaa (4 oeaoosreiit Beeaioaa, all of vaieb
w
o
u
d
l have a ease e
t
u
d
y or exaaplee, with the a
m
o
e
p
t
i
o
a
of seaaioa #4)
seaaioa is
valuation of Troubled Baal Batata
(SO ainutee) (
I
D
X
C lead)
Seaaioa as
Jtocountiag for Voaaoorual Assets
(so aiautaa) (in lead)
Beaaioa 3 s
ciaaeifieatlea of Troubled Beal Batata
and Alowance Policy
(50 ainutea) O
( CC lead)
Beeeioa 4 s
outlook for Seal Batata
(50 ainutea) (C*B lead)
Lunoh (International Ballroom)
l:30pm
R
e
s
u
m
e Breakout seealoaa
3:20pm
Break (Promenade)
4:00pm
omDOL B
B
B
Z
O
B
(Zate
raatioaa
lB
B
al
room)
R
e
v
i
e
w of coafaraaoe Beaaioaa
Q
u
e
s
t
i
o
n aad A
n
s
w
e
r -o
p
e
a F
o
r
u
m
Panel Members:
FDIC
FRB
OCC
OTS
4:45pm
Taylor
Laware
Clarice
Ryan
Coafereaoe e
n
d
s
Draft:
December 2 ,
1991
288
B O A R D
OF
G O V E R N O R S
OF T H E
F E D E R A L R E S E R V E SYSTEM
W A S H I N G T O N , 0 . C. 2 0 5 5 1
SR 91-29 (FIS)
DIVISION OF BANKING
SUPERVISION AND REGULATION
December 12, 1991
TO THE OFFICER IN CHARGE OF SUPERVISION
AT EACH FEDERAL RESERVE BANK
SUBJECT:
Communication and E x a m i n a t i o n
Credit Availability
Procedures
Concerning
The F e d e r a l R e s e r v e h a s a l o n g s t a n d i n g p o l i c y o f
m a i n t a i n i n g a p p r o p r i a t e c o m m u n i c a t i o n s w i t h b a n k e r s and
addressing legitimate issues concerning the a v a i l a b i l i t y of
credit.
In t h i s regard, Federal Reserve o f f i c i a l s are
p a r t i c i p a t i n g i n a number o f r e g i o n a l "town m e e t i n g s " w i t h
b a n k e r s and b o r r o w e r s , m e e t i n g w i t h b a n k s and t h e i r s e n i o r
management, and s t r e s s i n g t h e i m p o r t a n c e of e f f e c t i v e and p r o p e r
communications during o n - s i t e examinations.
Obtaining Views
Availability
on t h e
Examination
Process
and
Credit
These e f f o r t s have been b e n e f i c i a l in understanding t h e
v i e w s o f b a n k e r s , b u s i n e s s m e n , and l o c a l community l e a d e r s
c o n c e r n i n g t h e a v a i l a b i l i t y o f c r e d i t and t h e p e r f o r m a n c e o f
e x a m i n e r s i n m a i n t a i n i n g a p r u d e n t , b a l a n c e d and c o n s i s t e n t
approach t o examinations.
In order t o f o s t e r t h e s e b e n e f i c i a l
exchanges of information, the Federal Reserve i s encouraging i t s
s t a f f t o continue t h e s e i n i t i a t i v e s as s e t forth below:
o
D u r i n g e x a m i n a t i o n s , R e s e r v e Bank o f f i c i a l s
and e x a m i n e r s s h o u l d s t a n d ready t o d i s c u s s
w i t h b a n k e r s any l e g i t i m a t e c o n c e r n s or
questions regarding on-site examinations.
Such d i s c u s s i o n s c o u l d be h e l d a t any t i m e
during the examination process.
Both
e x a m i n a t i o n p e r s o n n e l a n d s e n i o r R e s e r v e Bank
o f f i c i a l s responsible for the examination
p r o c e s s should be a v a i l a b l e t o d i s c u s s the
progress of the examination,
examiner
f i n d i n g s and any p o l i c i e s o r p r o c e d u r e s
relating to the examination.
o
R e s e r v e Banks s h o u l d c o n t i n u e t o meet w i t h
b a n k e r s and b o r r o w e r s i n t h e "town m e e t i n g "
f o r m a t d i s c u s s e d i n SR 9 1 - 1 9 .
These meetings
provide a useful opportunity to obtain the
289
2
v i e w s o f b o r r o w e r s and b a n k e r s .
Each R e s e r v e
Bank s h o u l d m a i n t a i n r e c o r d s o f t h e s e
m e e t i n g s i n c l u d i n g a summary o f e a c h m e e t i n g ,
a r e p r e s e n t a t i v e l i s t of a t t e n d e e s , and t h e
t i m e , d a t e and l o c a t i o n o f t h e m e e t i n g .
These summaries should be a v a i l a b l e
for
r e v i e w a s n e e d e d and a c o p y o f e a c h summary
should be s e n t t o t h e Board.
o
R e s e r v e Banks a r e p a r t i c i p a t i n g i n a s e r i e s
o f m e e t i n g s w i t h b a n k e r s a s d i s c u s s e d i n AD
91-72.
The p u r p o s e o f t h e s e m e e t i n g s i s t o
strengthen our understanding of the
issues
a f f e c t i n g t h e a v a i l a b i l i t y of c r e d i t and t h e
c o n d i t i o n s banks are f a c i n g , t o respond t o
any q u e s t i o n s bankers have r e g a r d i n g our
p o l i c i e s , and t o c o n s i d e r f u r t h e r a p p r o p r i a t e
s t e p s that could be taken t o address c r e d i t
availability
concerns.
o
R e s e r v e Bank o f f i c i a l s m e e t f r e q u e n t l y w i t h
b a n k e r s on a w i d e v a r i e t y o f s u b j e c t s .
If
a p p r o p r i a t e and c i r c u m s t a n c e s p e r m i t ,
Reserve
Banks s h o u l d t a k e t h e o c c a s i o n i n t h e s e
m e e t i n g s t o s o l i c i t t h e b a n k e r s ' v i e w s on t h e
p o s s i b l e impact of e x a m i n a t i o n p o l i c i e s on
credit
availability.
With r e s p e c t t o each of t h e above programs,
comments
and s u g g e s t i o n s made by b a n k e r s f o r i m p r o v i n g t h e e x a m i n a t i o n
p r o c e s s i n a manner t h a t i s c o n s i s t e n t w i t h s a f e and sound
p r a c t i c e s s h o u l d be forwarded t o Board s t a f f f o r c o n s i d e r a t i o n .
Communication
witfr
g^^iner?
Each R e s e r v e Bank i s r e s p o n s i b l e f o r a s s u r i n g t h a t t h e
March 1 s t i n t e r a g e n c y p o l i c y s t a t e m e n t and a l l s u b s e q u e n t r e l a t e d
g u i d a n c e have b e e n e f f e c t i v e l y communicated t o e a c h s a f e t y and
soundness examiner.
R e s e r v e Banks h a v e a l r e a d y h a d t h e March 1 s t
statement e x p l a i n e d t o each examiner by a s e n i o r o f f i c e r .
In
a d d i t i o n , R e s e r v e Banks s h o u l d e n s u r e t h a t s u b s e q u e n t and r e l a t e d
g u i d a n c e i s a d e q u a t e l y communicated t o e x a m i n e r s on an o n g o i n g
b a s i s , and t h a t a n y new e x a m i n e r s a r e f u l l y and a p p r o p r i a t e l y
informed of the contents of these p o l i c i e s .
On O c t o b e r 2 , 1 9 9 1 , R e s e r v e B a n k s w e r e a s k e d t o
implement a d d i t i o n a l procedures t o s t r e n g t h e n communication
e f f o r t s w i t h b a n k e r s r e g a r d i n g t h e March 1 s t s t a t e m e n t and
related credit availability policies.
T h i s l e t t e r expands upon
t h e i n s t r u c t i o n s c o n t a i n e d i n SR 9 1 - 1 9 i n t h e f o l l o w i n g r e s p e c t s :
290
3
o
During t h e next o n - s i t e examination of each
s t a t e member b a n k , t h e e x a m i n e r - i n - c h a r g e o r
a n o t h e r R e s e r v e Bank o f f i c i a l i s a s k e d t o
e x p l a i n o r d i s c u s s t h e c o n t e n t and p r o v i s i o n s
o f t h e March 1 s t i n t e r a g e n c y p o l i c y s t a t e m e n t
and r e l a t e d g u i d a n c e w i t h t h e b a n k ' s s e n i o r
management.
o
I f t h e b a n k ' s s e n i o r management has any
q u e s t i o n s o r comments r e g a r d i n g t h e g e n e r a l
c o n t e n t o r s p e c i f i c p r o v i s i o n s o f t h e March
1st interagency policy statement or related
guidance, t h e s e i s s u e s should be addressed
during the examination or at the e x i t meeting
w i t h s e n i o r management.
If
appropriate,
t h e s e matters can a l s o be discussed at
meetings with the bank's board of d i r e c t o r s
or the board's examination or audit
committee.
Managing ImplenigntaUpn Qt Examination Procedures
R e s e r v e Banks have l o n g had e f f e c t i v e p r o c e d u r e s and
p r a c t i c e s f o r r e v i e w i n g e x a m i n a t i o n r e p o r t s and f o r a s s u r i n g t h a t
t h e S y s t e m ' s e x a m i n a t i o n p o l i c i e s and g u i d e l i n e s a r e f o l l o w e d i n
t h e c o n d u c t o f t h e e x a m i n a t i o n and t h e p r e p a r a t i o n of t h e r e p o r t .
As p a r t o f t h e r e v i e w p r o c e s s , R e s e r v e Banks a r e a s k e d t o
e s t a b l i s h a s p e c i f i c p r o c e d u r e f o r e n s u r i n g t h a t t h e March 1 s t
and r e l a t e d p o l i c y g u i d a n c e ( s e t f o r t h i n t h e Cross R e f e r e n c e
s e c t i o n b e l o w ) i s f o l l o w e d i n e a c h s t a t e member b a n k e x a m i n a t i o n .
The p r o c e d u r e s h o u l d i n c l u d e t h e f o l l o w i n g :
o
At t h e c o n c l u s i o n of t h e next examination,
t h e e x a m i n e r - i n - c h a r g e s h o u l d prepare and
s i g n a memorandum t o t h e f i l e s s t a t i n g t h a t
t h e p o l i c i e s a r e r e f l e c t e d and i n c o r p o r a t e d
i n t h e r e p o r t c o n t e n t s and f i n d i n g s .
This
memorandum s h o u l d a l s o b e s i g n e d b y t h e
review examiner.
T h i s memorandum s h o u l d b e r e t a i n e d i n t h e e x a m i n a t i o n
f i l e a n d b e a v a i l a b l e t o p r o v i d e summary d a t a f o r r e v i e w d u r i n g
the operations review or as otherwise required.
In addition,
the
c o n f i d e n t i a l s e c t i o n of the examination report should a l s o note
t h a t t h e r e p o r t i n c o r p o r a t e s t h e c r e d i t a v a i l a b i l i t y p o l i c i e s and
p r o c e d u r e s and t h a t t h e r e v i e w p r o c e d u r e s o u t l i n e d above were
f o l l o w e d by t h e examiner and t h e r e v i e w examiner.
This should be
noted a s p a r t of t h e response t o q u e s t i o n 5 on page D of t h e
confidential section of the examination report.
291
4
Q u e s t i o n s r e g a r d i n g t h i s SR l e t t e r c a n b e r e f e r r e d t o
Roger Cole (202/452-2618), Steve Lovette (202/452-3622) or B i l l
Spaniel
(202/452-3469).
Richard Spillenkothen
Director
Cross
Reference:
SR 9 1 - 1 6 , SR 9 1 - 1 8 , SR 9 1 - 1 9 , SR 9 1 - 2 6 , M a r c h
1, 1991 I n t e r a g e n c y P o l i c y S t a t e m e n t and
November 7, 1991 I n t e r a g e n c y P o l i c y S t a t e m e n t
on t h e Review and C l a s s i f i c a t i o n o f
Commercial Real E s t a t e Loans.
292
BOARD OF GOVERNORS
or-mc
FEDERAL RESERVE SYSTEM
s-2 54 6
WAMKNOTON, 0. C. 20M1
TO THC BOAM)
December 13, 1991
In carrying out. its supervisory responsibilities over the
years, the federal Reserve System has developed effective
informal practices for discussing and resolving differences
between bankers and examiners that arise in the context of onsite safety and soundness examinations. The existing process
affords opportunities for oa
management and directors to
communicate the:.r ,riews and concerns to examiners and Reserve
Bank officials during the course of the examination and foiicv-up
process.
Tr.ese practices ire intended to ensure that examination
findings are based upon a balanced, fair and prudent
consideration of ail relevant information. The objective of the
process is zo produce an accurate and clear report of the band's
condition and operations.
C u r r e n t l y , a state member bank t h a t b e l i e v e s an e r r o r has
been made i n its examination may r e q u e s t t h a t t h e m a t t e r be
r e v i e w e d by s u p e r v i s o r y p e r s o n n e l .
I f i n t h e j u d g m e n t o f the
R e s e r v e Bank t h e m a t t e r h a s m e r i t , c o n s i d e r a t i o n i s g i v e n t o the
i s s u e and an a t t e m p t i s made t o r e s o l v e t h e q u e s t i o n i n a f a i r
and s a t i s f a c t o r y m a n n e r .
For e x a m p l e , bank management may
d i s c u s s e x a m i n a t i o n f i n d i n g s and l o a n c l a s s i f i c a t i o n s w i t h the
e x a m i n e r - i n - c h a r g e or o t h e r s u p e r v i s o r y o f f i c i a l s during the ons i t e examination.
At t h e c o m p l e t i o n o f an e x a m i n a t i o n , e x a m i n e r s
a n d / o r s u p e r v i s o r y o f f i c i a l s m e e t w i t h bank management a n d , a s
a p p r o p r i a t e , t h e board of d i r e c t o r s t o d i s c u s s t h e e x a m i n e r ' s
f i n d i n g s and c o n c l u s i o n s .
These p r a c t i c e s , taken t o g e t h e r , are
designed to address p o t e n t i a l d i f f e r e n c e s that a r i s e during the
e x a m i n a t i o n and h a v e p r o v e d e f f e c t i v e i n m a i n t a i n i n g a p p r o p r i a t e
l i n e s o f c o m m u n i c a t i o n b e t w e e n bank management and d i r e c t o r s ,
e x a m i n e r s and s u p e r v i s o r y p e r s o n n e l .
T h i s i n f o r m a l p r o c e s s h a s w o r k e d w e l l o v e r t h e y e a r s and h a s
p r o v i d e d a means f o r a s s u r i n g t h a t s i g n i f i c a n t c o n c e r n s o r
q u e s t i o n s bankers have regarding examination f i n d i n g s are g i v e n
293
-
2
-
r e a s o n a b l e c o n s i d e r a t i o n by t h e F e d e r a l R e s e r v e .
Recent
developments r e g a r d i n g t h e p o t e n t i a l impact of examination
p o l i c i e s and p r o c e d u r e s on c r e d i t a v a i l a b i l i t y u n d e r s c o r e t h e
ongoing importance of t h i s p r o c e s s .
C o n s e q u e n t l y , R e s e r v e Banks
a r e e n c o u r a g e d t o c o n t i n u e t o p r o v i d e bank management and
d i r e c t o r s w i t h s u i t a b l e o p p o r t u n i t i e s t o d i s c u s s and r e s o l v e
q u e s t i o n s or concerns r e l a t i n g to examination f i n d i n g s .
Consistent with longstanding p r a c t i c e , t h i s process should
r e m a i n a n i n f o r m a l o n e t h a t i s i n t e n d e d t o b r i n g l e g i t i m a t e bank
c o n c e r n s o r q u e s t i o n s a r i s i n g i n c o n n e c t i o n w i t h s a f e t y and
soundness examinations t o the a t t e n t i o n of s u p e r v i s o r y personnel
o r o t h e r R e s e r v e Bank o f f i c i a l s .
I n some c a s e s , q u e s t i o n s o r
c o n c e r n s may b e r e f e r r e d b y t h e bank d i r e c t l y t o s e n i o r R e s e r v e
Bank o f f i c i a l s o r , on o c c a s i o n , t o t h e R e s e r v e Bank p r e s i d e n t .
These o f f i c i a l s have t h e d i s c r e t i o n t o d e c i d e whether the
c i r c u m s t a n c e s o f t h e p a r t i c u l a r s i t u a t i o n , i n c l u d i n g t h e v i e w s o.:'
t h e b a n k i n v o l v e d , s u g g e s t t h a t t h e m a t t e r s h o u l d b e r e s o l v e d by
i n d i v i d u a l s who d i d n o t p a r t i c i p a t e d i r e c t l y i n t h e p a r t i c u l a r
d e c i s i o n or e x a m i n a t i o n f i n d i n g under r e v i e w .
T h i s roul-l i n c l u d e
t h e R e s e r v e Bank p r e s i d e n t o r a d e s i g n e e d i r e c t l y a c c o u n t a b l e
the president for t h i s purpose.
In t h e s e s i t u a t i o n s
vh _ e - r e
e x a m i n e r might be c o n s u l t e d , t h e examiner v o u i d - j e r e r ^ i 1 '
jm v o i v e d i n m a k i n g t h e f i n a l d e t e r m i n a t i o n r e g a r d ^ n a -.he
r e s o l u t i o n of t h e m a t t e r .
The R e s e r v e Bank p r e s i d e n t o r 1 e s : -:-•>a l s o h a s t h e d i s c r e t i o n t o d e c i d e w h e t h e r an e f f o r t = a c . i l u
made t o r e s o l v e t h e i s s u e i n a manner t h a t i s c o n f i d e n t i v..
t h e e x a m i n e r i n v o l v e d and how t h i s e f f o r t , i f a p p r o p r i a t e
sbo.
oe undertaken.
M a t t e r s o r q u e s t i o n s c o n s i d e r e d by t h e p r e s i d e n t g e n e r a . /
s h o u l d b e l i m i t e d t o t h o s e t h a t a r e s i g n i f i c a n t and " h a t . :
;
an e f f e c t on t h e s a f e t y and s o u n d n e s s o f t h e i n s t i t u t i o n
i
n a v e an i m p a c t o n t h e o p e r a t i o n , m a n a g e m e n t , o r f i n a n c i a l
s t a n d i n g o f t h e i n s t i t u t i o n ; o r i i i ) h.ave a m a t e r i a l i m p a c t on
the r e g u l a t o r ' s s u p e r v i s i o n of the i n s t i t u t i o n .
Requests for
r e v i e w by t h e R e s e r v e Bank p r e s i d e n t s h o u l d b e a u t h o r i z e d by t h e
s t a t e member b a n k ' s b o a r d o f d i r e c t o r s a n d s h o u l d b e made w i t a . r
a r e a s o n a b l e t i m e from t h e o c c u r r e n c e of t h e e v e n t or d e c i s i o n
triggering the request.
The a v a i l a b i l i t y o f t h e i n f o r m a l p r o c e s s d e s c r i b e d i n t h i s
l e t t e r and t h e manner i n w h i c h i t i s c a r r i e d o u t i s a t t h e s o l e
d i s c r e t i o n o f t h e R e s e r v e Bank.
The p r o c e s s c a n n o t b e u s e d t o
appeal o r impede any e n f o r c e m e n t a c t i o n s s i n c e s u c h a c t i o n s have
t n e i r own f o r m a l a p p e a l s p r o c e d u r e s .
In a d d i t i o n , n o t h i n g i n
t h i s p r o c e s s p r e v e n t s t h e R e s e r v e Bank f r o m t a k i n g a n y
.supervisory or enforcement a c t i o n — formal or informal — t h a t
t h e R e s e r v e Bank d e e m s a p p r o p r i a t e t o p r o p e r l y d i s c h a r g e i t s
supervisory or examination r e s p o n s i b i l i t i e s .
294
3
A t t a c h e d i s a l e t t e r o u t l i n i n g t h i s p r o c e s s t h a t s h o u l d be
f o r w a r d e d t o e a c h s t a t e member bank i n y o u r d i s t r i c t .
Questions
r e g a r d i n g t h i s p r o c e s s may b e d i r e c t e d t o S t e p h e n C. S c h e m e r i n g ,
D e p u t y D i r e c t o r , D i v i s i o n o f B a n k i n g S u p e r v i s i o n and R e g u l a t i o n
a t (202) 4 5 2 - 2 8 9 3 o r R o g e r T. C o l e , A s s i s t a n t D i r e c t o r , D i v i s i o n
o f B a n k i n g S u p e r v i s i o n and R e g u l a t i o n a t ( 2 0 2 ) 4 5 2 - 2 6 1 8
W i l l i a m W. W i l e s
Secretary
Attachment
TO THE PRESIDENTS OF ALL FEDERAL RESERVE BANKS AND
THE OFFICERS IN CHARGE OF BRANCHES
295
S-2546
Attachment
TO THE CHIEF EXECUTIVE OFFICER OF
ALL STATE MEMBER BANKS
In c a r r y i n g out i t s s u p e r v i s o r y r e s p o n s i b i l i t i e s over t h e
years, the Federal Reserve System has endeavored t o ensure t h a t
e x a m i n a t i o n f i n d i n g s a r e b a s e d upon a b a l a n c e d , f a i r and
appropriate c o n s i d e r a t i o n of a l l relevant information,
including
t h e v i e w s and p e r s p e c t i v e s of bank management.
The e x i s t i n g
p r o c e s s a f f o r d s o p p o r t u n i t i e s f o r bank management and d i r e c t o r s
t o communicate t h e i r v i e w s and c o n c e r n s t o e x a m i n e r s and R e s e r v e
Bank o f f i c i a l s d u r i n g t h e c o u r s e o f t h e e x a m i n a t i o n a n d f o l l o w - u p
process.
The o b j e c t i v e o f t h e p r o c e s s i s t o p r o d u c e an a c c u r a t e
and c l e a r r e p o r t o f t h e b a n k ' s c o n d i t i o n and o p e r a t i o n s .
C u r r e n t l y , a s t a t e member b a n k t h a t b e l i e v e s a n e r r o r h a s
b e e n m a d e i n i t s e x a m i n a t i o n may r e q u e s t t h a t t h e m a t t e r b e
r e v i e w e d by s u p e r v i s o r y p e r s o n n e l .
I f in the judgment of t h e
R e s e r v e Bank t h e m a t t e r h a s m e r i t , c o n s i d e r a t i o n i s g i v e n t o t h e
i s s u e a n d an a t t e m p t i s made t o r e s o l v e t h e q u e s t i o n i n a f a i r
and s a t i s f a c t o r y manner.
F o r e x a m p l e , b a n k m a n a g e m e n t may
d i s c u s s e x a m i n a t i o n f i n d i n g s and l o a n c l a s s i f i c a t i o n s w i t h t h e
examiner-in-charge or other supervisory o f f i c i a l s .
Upon
c o m p l e t i o n o f an e x a m i n a t i o n , e x a m i n e r s a n d / o r s u p e r v i s o r y
o f f i c i a l s meet w i t h bank management and, a s a p p r o p r i a t e ,
the
board o f d i r e c t o r s t o d i s c u s s t h e e x a m i n e r ' s f i n d i n g s and
conclusions.
T h e s e p r a c t i c e s , t a k e n t o g e t h e r , h a v e p r o v i d e d an
avenue f o r maintaining appropriate l i n e s of communication between
bank management and d i r e c t o r s , e x a m i n e r s and s u p e r v i s o r y
personnel.
We b e l i e v e t h i s p r o c e s s h a s p l a y e d a n i m p o r t a n t r o l e o v e r
the years in helping to assure that s i g n i f i c a n t concerns or
q u e s t i o n s bankers have regarding examination f i n d i n g s are given
r e a s o n a b l e c o n s i d e r a t i o n by t h e F e d e r a l R e s e r v e .
Recent
developments regarding the p o t e n t i a l impact of examination
p o l i c i e s and p r o c e d u r e s on c r e d i t a v a i l a b i l i t y u n d e r s c o r e t h e
ongoing importance of t h i s avenue of communication.
Consistent with longstanding practice, t h i s informal process
r e m a i n s a v a i l a b l e t o bank management f o r t h e p u r p o s e o f b r i n g i n g
l e g i t i m a t e bank c o n c e r n s o r q u e s t i o n s a r i s i n g i n c o n n e c t i o n w i t h
s a f e t y and s o u n d n e s s e x a m i n a t i o n s t o t h e a t t e n t i o n o f s u p e r v i s o r y
p e r s o n n e l o r o t h e r a p p r o p r i a t e R e s e r v e Bank o f f i c i a l s .
I n some
296
-
2 -
c a s e s , q u e s t i o n s o r c o n c e r n s may b e r e f e r r e d b y b a n k management
d i r e c t l y t o s e n i o r R e s e r v e Bank o f f i c i a l s o r , o n o c c a s i o n , t o t h e
R e s e r v e Bank p r e s i d e n t .
These o f f i c i a l s have t h e d i s c r e t i o n t o
d e c i d e whether the circumstances of the p a r t i c u l a r s i t u a t i o n ,
i n c l u d i n g t h e v i e w s o f t h e bank i n v o l v e d , s u g g e s t t h a t t h e m a t t e r
s h o u l d b e r e s o l v e d by i n d i v i d u a l s who d i d n o t p a r t i c i p a t e
d i r e c t l y in t h e p a r t i c u l a r d e c i s i o n or examination f i n d i n g under
review.
T h i s c o u l d i n c l u d e t h e R e s e r v e Bank p r e s i d e n t o r a
d e s i g n e e d i r e c t l y a c c o u n t a b l e to t h e p r e s i d e n t for t h i s purpose.
In t h e s e s i t u a t i o n s , w h i l e t h e e x a m i n e r might be c o n s u l t e d , the
e x a m i n e r w o u l d g e n e r a l l y not be i n v o l v e d in m a k i n g t h e f i n a l
d e t e r m i n a t i o n r e g a r d i n g the resolution of the- m a t t e r ,
The
R e s e r v e Bank p r e s i d e n t or designee also has the d i s c r e t i o n cc
d e c i d e w h e t h e r an effort should be made to resolve t h e issue _r i
manner that is kept confidential from the examiner(s) involved
and how t h i s effort, if appropriate, should be undertaken.
Matters or questions addressed to the pras:.dar- should 'ce
limited to those that are significant and that ix nave an effect
on the safety and soundness of the irst.ituticr>: ii; have an
impact on the operation, management, or financial ^tandirg :f -.he
institution; or iii) have a material impact
the regulator's
supervision of the institutionRequests for review by -.he
Reserve 3ank president should be authorized oy -he state member
bank's board of directors and be made within a reasonable time
from the occurrence of the event or decision triggering the
request.
The a v a i l a b i l i t y and i m p l e m e n t a t i o n o f t h i s i n f o r m a l process
is a t t h e d i s c r e t i o n o f t h e R e s e r v e Bank.
I t i s i n t e n d e d for
d i s c u s s i n g and r e s o l v i n g l e g i t i m a t e c o n c e r n s o r g o o d f a i t h
d i f f e r e n c e s pertaining to material examination findings.
I t is
n o t t o b e u s e d t o a p p e a l o r i m p e d e a n y f o r m a l supervisory or
enforcement a c t i o n s .
Moreover, t h e e x i s t e n c e of t h i s informal
a v e n u e f o r c o m m u n i c a t i o n and r e s o l u t i o n d o e s n o t p r e v e n t t h e
F e d e r a l R e s e r v e from t a k i n g any s u p e r v i s o r y o r e n f o r c e m e n t a c t i o n
— f o r m a l o r i n f o r m a l — i t deems a p p r o p r i a t e t o d i s c h a r g e t h e
S y s t e m ' s s u p e r v i s o r y and e x a m i n a t i o n r e s p o n s i b i l i t i e s .
Q u e s t i o n s r e g a r d i n g t h i s p r o c e s s may b e d i r e c t e d
to...
297
12/5/91
Examination Appeal Process
The four federal regulatory agencies have chosen to adopt a
supplementary process to address issues arising out of
examinations of financial institutions. Guidelines for this
process are set forth below.
1.
The appeal process is a program that supplements or expands
upon other established supervisory review practices or
processes that are available to the institution in the
normal course of business. The availability and manner in
which this process is carried out is left to the discretion
of the individual agencies.
2.
This process cannot be used :o appeal or impede any formal
or irformal supervisory or enforcement actions. In
addition, nothing in this process prevents an individual
agency from taking any supervisory or enforcement action
that the agency deems appropriate.
3.
The z.ppeal process is available to address significant
issues arising from an examination finding or supervisory
action.
4.
The use of this appeal process is to be authorized bj the
institution. This would normally involve the institution's
board or its designee with prior knowledge of the board.
5.
Matters addressed by the appeal process should be United to
significant issues that:
cire material to the safety and soundness of the
institution, or
have an significant impact on the operation or
rianagement of the institution, or
have a material impact ca the regulator's supervision of
the institution.
The nateriality of the matter being appealed remains within
the discretion of the senior regulator.
6.
Appeals are to be made within a reasonable period of time
siren the occurrence of an examination finding or
supervisory action which is the subject of the appea].
Initiating the appeal promptly will assist in timely
reso.'.ution.
7.
The senior regulator will make a good faith effort to
evaluate and resolve the iss.ue in a confidential manner. in
situations where the appeal cannot be resolved
confidentially, the examiner may need to be consulted.
Kovever, the examiner will riot make recommendations
regarding, or be involved in deliberations concerning, the
final determination or resolution of the matter under
a.ppeal.
8.
The .appeal process will be handled by a high level o:i agency
management.
298
R E S P O N S E T O W R I T T E N QUESTIONS OF S E N A T O R R I E G L E F R O M
ALAN GREENSPAN
BOARD
OF
GOVERNORS
OF THE
FEDERAL R E S E R V E SYSTEM
W A S H I N G T O N , D. C. S 0 5 5 I
ALAN
February
T h e H o n o r a b l e D o n a l d W. R i e g l e ,
Chairman
Committee on Banking, Housing
and Urban A f f a i r s
United States Senate
Washington, D.C.
20510
D e a r Mr.
6,
1992
GREENSPAN
CHAIRMAN
Jr.
Chairman:
I am p l e a s e d t o r e s p o n d t o y o u r l e t t e r o f J a n u a r y 3 1
a s k i n g a d d i t i o n a l q u e s t i o n s i n c o n n e c t i o n w i t h my r e n o m i n a t i o n
hearing.
My r e s p o n s e t o y o u r q u e s t i o n s a n d t h o s e s u b m i t t e d b y
o t h e r members o f t h e Banking Committee a r e p r o v i d e d i n t h e
enclosure.
P l e a s e l e t me k n o w i f I c a n b e o f f u r t h e r a s s i s t a n c e .
Enclosure
299
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.l.
You a r e a b u s y man, w i t h a l o t o f i m p o r t a n t r e s p o n s i bilities.
One o f y o u r t a s k s i s t o s e r v e o n t h e R T C ' s
O v e r s i g h t Board.
L a s t y e a r , when we r e s t r u c t u r e d t h e
m a n a g e m e n t o f t h e RTC, t h e A d m i n i s t r a t i o n i n s i s t e d o n t h e
F e d e r a l R e s e r v e Chairman r e m a i n i n g on t h a t b o a r d .
How
v a l u a b l e do you f e e l your c o n t r i b u t i o n s a r e a s an O v e r s i g h t
B o a r d Member?
Do t h e y j u s t i f y t h e t i m e t a k e n a w a y f r o m
your other r e s p o n s i b i l i t i e s ?
A.1.
T h e a c t i v i t i e s o f t h e RTC a n d t h e O v e r s i g h t B o a r d c a n h a v e
e f f e c t s on t h e c o n d i t i o n of f i n a n c i a l i n s t i t u t i o n s and on
r e a l e s t a t e - r e l a t e d m a r k e t s i n many r e g i o n s o f t h e c o u n t r y .
As Chairman of t h e F e d e r a l R e s e r v e , I have an o b v i o u s
i n t e r e s t i n t h e s e e f f e c t s and b e l i e v e I b r i n g i n s i g h t s t o
t h e O v e r s i g h t Board i n i t s d e l i b e r a t i o n s of i t s
operations.
T h u s , I b e l i e v e my c o n t i n u e d i n v o l v e m e n t a t t h e O v e r s i g h t
Board i s on b a l a n c e b e n e f i c i a l .
Q.2.
As an O v e r s i g h t Board member, y o u a p p r o v e d t h e RTC's
program t o s e c u r i t i z e a s s e t s .
As I u n d e r s t a n d i t ,
these
d e a l s a r e s t r u c t u r e d s o t h a t t h e RTC r e t a i n s n e a r l y a l l t h e
r i s k , while s e l l i n g s e c u r i t i e s at i n t e r e s t r a t e s above
Treasury r a t e s t o fund a part of these a s s e t s .
What i s t h e
advantage in doing that?
What d o e s i t a c c o m p l i s h ?
A.2.
T h e O v e r s i g h t B o a r d h a s e n c o u r a g e d t h e u s e b y t h e RTC o f
s e c u r i t i z a t i o n a s a means of d i s p o s i n g of f i n a n c i a l a s s e t s .
I n o f f e r i n g t h e RTC e n c o u r a g e m e n t , t h e O v e r s i g h t B o a r d
a s k e d t h e RTC t o m a k e s u r e t h a t i t h a d i n p l a c e a p o l i c y
t h a t r e q u i r e s a d e t e r m i n a t i o n , p r i o r t o t h e i s s u a n c e of any
m o r t g a g e - b a c k e d s e c u r i t i e s , t h a t t h e r e t u r n t o t h e RTC w i l l
be higher than i f the mortgages were disposed in another
way.
T h r o u g h D e c e m b e r 3 1 , t h e RTC h a d s o l d a p p r o x i m a t e l y
$ 1 0 . 2 b i l l i o n i n s e c u r i t i e s backed by p e r f o r m i n g s i n g l e
f a m i l y and m u l t i f a m i l y mortgage l o a n s .
In t h i s process,
t h e r a t i n g a g e n c i e s h a v e r e q u i r e d t h e RTC t o s e t a s i d e a s a
c r e d i t enhancement, a p p r o x i m a t e l y 20 p e r c e n t o f t h e
proceeds from t h e s a l e of t h e s e c u r i t i e s i n a r e s e r v e fund,
i n t h e e v e n t of p o s s i b l e d e f a u l t s on t h e u n d e r l y i n g
mortgages.
This i s t h e a b s o l u t e l i m i t of t h e "risk11 t h a t
t h e RTC i s t a k i n g .
The a c t u a l l o s s e s r e s u l t i n g from
m o r t g a g e d e f a u l t s , h o w e v e r , w i l l l i k e l y b e much l o w e r s o
300
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.2.
(cont)
that the great bulk of the funds placed in reserve
w i l l be recovered.
T h e RTC e s t i m a t e s t h a t e v e n a f t e r
a c c o u n t i n g f o r t h e l o s s e s l i k e l y t o occur on t h e
mortgages i t has s e c u r i t i z e d , over $600 m i l l i o n has
already been saved through these transactions.
T h e RTC
has determined that in general, asset
securitization
p r o v i d e s h i g h e r r e t u r n s t o t h e RTC, h a s a r e a d i l y a v a i l a b l e market, and i s a r e a s o n a b l y e f f i c i e n t method of
a s s e t d i s p o s i t i o n , r e l a t i v e t o other forms.
Q.3.
S e c r e t a r y Brady h a s i n d i c a t e d t h a t he i s c o n s i d e r i n g
r e d u c i n g t h e s i z e of 3 0 - y e a r Treasury bond a u c t i o n s .
T h a t l o o k s l i k e an e a s y way t o r e d u c e T r e a s u r y i n t e r e s t
c o s t s and lower l o n g - t e r m i n t e r e s t r a t e s c r i t i c a l
to
investment decisions.
The Fed c o u l d s u p p l e m e n t s u c h a
program by p u r c h a s i n g more l o n g - t e r m d e b t and l e s s s h o r t term debt.
I s t h e r e a n y r e a s o n why we s h o u l d n ' t d o i t ?
A.3.
Academic s t u d i e s on whether r e d u c i n g t h e s u p p l y of
Treasury debt would help lower long-term i n t e r e s t r a t e s
do not g i v e a c l e a r i n d i c a t i o n t h a t such a p o l i c y would
be s u c c e s s f u l .
This i s because expectations of future
s h o r t - t e r m r a t e s a r e by f a r t h e p r i n c i p a l d e t e r m i n a n t o f
long-term r a t e s , not r e l a t i v e supplies of
securities.
N e v e r t h e l e s s , some e m p i r i c a l e v i d e n c e s u p p o r t s t h e
p r o p o s i t i o n and, g i v e n t h e p o t e n t i a l b e n e f i t s of reduced
long-term i n t e r e s t rates, I concur with the recent
d e c i s i o n of t h e T r e a s u r y t o c u t back on bond and l o n g term note issuance.
However, t h e s c o p e f o r c u t t i n g back
in one maturity s e c t o r i s l i m i t e d .
Given t h e huge s i z e
of the d e f i c i t , considerable s a l e s w i l l l i k e l y be needed
i n a l l m a t u r i t i e s , and l a r g e s h i f t s toward t h e s h o r t end
could d i s t o r t y i e l d s , thereby d i s s i p a t i n g any advantage
to the Treasury.
A major shortening of Treasury debt
a l s o would a l t e r t h e l i q u i d i t y p r o f i l e of t h e economy,
with p o s s i b l e implications for the stance of monetary
policy.
301
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.3.
(cont)
With r e g a r d t o t h e p o s s i b l e p a r t i c i p a t i o n by t h e F e d e r a l
R e s e r v e i n s u c h a p r o g r a m , we a r e a c t i v e i n p u r c h a s e s i n
a l l segments of t h e market, i n c l u d i n g t h e l o n g e r end, and
I would expect t h a t t o continue.
Last year, the Federal
Reserve added $ 1 1 - 1 / 2 b i l l i o n of coupon i s s u e s t o i t s
portfolio.
However, t h e volume of our p u r c h a s e s of
longer-term securities necessarily i s limited.
The
Federal Reserve needs considerable l i q u i d i t y in i t s
p o r t f o l i o t o e n s u r e t h a t we w i l l b e a b l e t o m e e t o u r
r e s e r v e o b j e c t i v e s i n t h e l e a s t d i s r u p t i v e way p o s s i b l e i n
a v a r i e t y of circumstances.
Q.4.
Some h a v e a r g u e d t h a t i n c r e a s e d s p e n d i n g f o r p u b l i c
investments i s desirable even i f i t increases the d e f i c i t ,
o n t h e g r o u n d s t h a t t h e r e t u r n s t o t h o s e i n v e s t m e n t s may b e
s u b s t a n t i a l l y g r e a t e r t h a n t h e p r i v a t e i n v e s t m e n t t h e y may
displace.
Do y o u a g r e e ?
A.4.
I a g r e e t h a t s o m e p u b l i c i n v e s t m e n t s may o f f e r s u b s t a n t i a l
r a t e s of return.
However, g i v e n t h e low n a t i o n a l s a v i n g
r a t e , t h e m o s t a p p r o p r i a t e way t o f u n d t h e s e w o u l d b e by
finding outlay or tax o f f s e t s elsewhere in the budget.
In general, debt finance i s appropriate for most p r i v a t e
investment p r o j e c t s because they u s u a l l y w i l l be funded
o n l y i f t h e y can g e n e r a t e an e a r n i n g s s t r e a m t h a t
is
s u f f i c i e n t to service the loan.
The market t h e r e f o r e
e n s u r e s t h a t t h e debt w i l l be s e l f - l i q u i d a t i n g .
Most
p u b l i c i n v e s t m e n t s do n o t , however, g e n e r a t e an i d e n t i f i a b l e earnings stream that provides a check of the
p r o j e c t ' s v i a b i l i t y and can be a s s i g n e d t o s e r v i c e and pay
the debt.
I t i s t h e r e f o r e more p r u d e n t t o f u n d s u c h
p r o j e c t s up f r o n t by c u t t i n g u n p r o d u c t i v e s p e n d i n g o r
raising revenues.
302
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.5.
Have you had a c h a n c e t o r e v i e w t h e T r e a s u r y ' s p r o p o s a l s
f o r reforming t h e t a x a t i o n of corporate income?
How c o s t l y
would they be?
Who w o u l d b e n e f i t ?
Would t h e y c o n t r i b u t e
s i g n i f i c a n t l y t o capital formation?
A.5.
The d o u b l e t a x a t i o n o f t h e r e t u r n t o i n v e s t m e n t i n
c o r p o r a t e e q u i t y — b y t h e c o r p o r a t e income t a x when e a r n i n g s
a r e r e a l i z e d and a g a i n by t h e i n d i v i d u a l income t a x when
shareholders r e c e i v e dividends or r e a l i z e c a p i t a l g a i n s —
p e n a l i z e s t h e c o r p o r a t e form of b u s i n e s s o r g a n i z a t i o n ,
d i s t o r t s c o r p o r a t i o n s ' f i n a n c i a l s t r u c t u r e s by f a v o r i n g
d e b t f i n a n c e o v e r e q u i t y f i n a n c e , and c r e a t e s an i n c e n t i v e
f o r c o r p o r a t i o n s t o r e t a i n e a r n i n g s , e v e n i f more
p r o d u c t i v e o p p o r t u n i t i e s may e x i s t o u t s i d e t h e c o r p o r a t i o n .
These d i s t o r t i o n s tend t o r a i s e the c o s t of c a p i t a l f o r
c o r p o r a t i o n s , and t h e h i g h l e v e r a g e a s s o c i a t e d w i t h t h e
preference for debt increases the economy's v u l n e r a b i l i t y
to financial stress.
The T r e a s u r y s t u d y d i s c u s s e s s e v e r a l p r o t o t y p e p l a n s f o r
i n t e g r a t i n g c o r p o r a t e and i n d i v i d u a l income t a x e s t h a t
would ameliorate t h e s e d i s t o r t i o n s .
The T r e a s u r y r e p o r t s
revenue l o s s e s t i m a t e s f o r v a r i o u s p l a n s ranging from a
l o s s o f $37 b i l l i o n ( e v a l u a t e d a t 1991 l e v e l s o f income)
f o r a p r o t o t y p e t h a t a l l o c a t e s corporate income t o
s h a r e h o l d e r s t o a r e v e n u e g a i n of up t o $42 b i l l i o n f o r a
comprehensive b u s i n e s s income t a x p r o t o t y p e .
The s t u d y
n o t e s , however, t h a t revenue e f f e c t s can be o f f s e t by
changing t h e o v e r a l l l e v e l of c a p i t a l t a x a t i o n .
Indeed,
the e f f i c i e n c y gain calculations reported in the study
assume t h a t such revenue-maintaining t a x adjustments are
made.
If capital tax rates are adjusted to maintain
r e v e n u e n e u t r a l i t y , t h e e f f e c t s on t h e d i s t r i b u t i o n o f t a x
burdens would be small.
The T r e a s u r y e s t i m a t e s a
s i g n i f i c a n t impetus t o c a p i t a l formation.
I have n o t had an o p p o r t u n i t y t o study t h e d e t a i l s of t h e
Treasury's a n a l y s i s ; I have long f e l t , however, t h a t our
p r e s e n t c o r p o r a t e t a x s t r u c t u r e i s f l a w e d , and I would hope
t h a t t h e Congress would f i n d the occasion t o explore t h e s e
i s s u e s once again.
303
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.6.
Are t h e r e p o r t e d unemployment numbers t h e b e s t way t o
measure unused labor resources?
Do t h e y u n d e r s t a t e t h e
c o s t s of t h i s recession r e l a t i v e to previous recessions?
A.6.
In g e n e r a l , t h e unemployment r a t e p r o v i d e s a u s e f u l summary measure o f r e s o u r c e u t i l i z a t i o n i n t h e l a b o r m a r k e t .
H o w e v e r , l i k e a l l summary m e a s u r e s , i t s h o u l d n o t b e u s e d
in isolation.
We h a v e , f o r e x a m p l e , b e e n m i n d f u l o f t h e
p o s s i b l e " u n d e r e m p l o y m e n t " o f a g o o d many w o r k e r s , a s w e l l
as of the unusually sharp d e c l i n e in labor f o r c e p a r t i c i p a t i o n , w h i c h may r e f l e c t i n p a r t a f o r m o f d i s c o u r a g e m e n t .
In a s s e s s i n g labor market c o n d i t i o n s , t h e Federal Reserve
B o a r d a n d t h e F e d e r a l Open M a r k e t C o m m i t t e e l o o k a t a w i d e
v a r i e t y of i n d i c a t o r s from both government
statistical
a g e n c i e s and non-government s o u r c e s a s w e l l a s r e p o r t s on
local conditions gathered through the Federal Reserve
Banks.
Taken a s a whole, t h i s i n f o r m a t i o n g i v e s u s , I
b e l i e v e , a comprehensive picture of current economic
conditions.
Q.7.
E c o n o m i e s i n J a p a n , Germany, and t h e U n i t e d Kingdom a p p e a r
t o be h a v i n g p r o b l e m s , a s w e l l a s o u r own.
How w i d e s p r e a d
i s the economic weakness i n t e r n a t i o n a l l y ?
Is there a
danger of a broad i n t e r n a t i o n a l s t a g n a t i o n or r e c e s s i o n ?
A.7.
During t h e p a s t 2 y e a r s growth in t h e major f o r e i g n
i n d u s t r i a l c o u n t r i e s has slowed from q u i t e r a p i d r a t e s
recorded in the l a t e 1980s.
To some e x t e n t ,
deceleration
was a r e a c t i o n t o t i g h t e r p o l i c i e s d e s i g n e d t o c o u n t e r
i n f l a t i o n a r y p r e s s u r e and b r i n g e c o n o m i c a c t i v i t y t o a more
sustainable, non-inflationary pace.
Although i n f l a t i o n
g e n e r a l l y h a s b e e n r e d u c e d , o u t c o m e s on g r o w t h among t h e
major i n d u s t r i a l c o u n t r i e s have v a r i e d .
Canada and t h e
U n i t e d Kingdom h a v e had f a i r l y p r o n o u n c e d r e c e s s i o n s ,
while
g r o w t h i n Germany and J a p a n h a s r e m a i n e d c o m p a r a t i v e l y
s t r o n g ( a l t h o u g h growth has s l o w e d somewhat i n r e c e n t
quarters there too).
The f i n a n c e m i n i s t e r s and c e n t r a l bank g o v e r n o r s o f t h e
Group o f S e v e n (G-7) c o u n t r i e s h a v e a g r e e d t h a t t h e g e n e r a l
slowdown i n t h e major i n d u s t r i a l c o u n t r i e s has c o n t i n u e d
l o n g e r than had been expected e a r l i e r .
However, monetary
p o l i c y s t a n c e s were eased during the past year in s e v e r a l
c o u n t r i e s (Japan, t h e U n i t e d Kingdom, and Canada).
Japan
has r e c o g n i z e d t h e need t o be a l e r t t o a f u r t h e r slowdown
i n i t s d o m e s t i c demand, and a d d i t i o n a l demand g e n e r a t e d by
304
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.7.
(cont)
German u n i f i c a t i o n i s e x p e c t e d t o c o n t r i b u t e t o a p i c k - u p
i n g r o w t h t h i s y e a r i n Germany (and i t s m a i n E u r o p e a n
trading partners), d e s p i t e continuation of a f a i r l y
t i g h t German m o n e t a r y s t a n c e .
The e x p e c t e d r e c o v e r y o f
t h e U . S . economy a l s o s h o u l d c o n t r i b u t e t o g l o b a l
recovery.
Accordingly, although forecasting i s
p a r t i c u l a r l y d i f f i c u l t in the current environment,
there
does not appear t o be a s i g n i f i c a n t r i s k of prolonged
s t a g n a t i o n or general r e c e s s i o n in t h e major f o r e i g n
industrial
countries.
Q.8.
R e c e n t l y , Fred Bergsten t o l d us he t h i n k s i
important t o g e t an u n d e r s t a n d i n g w i t h t h e
r a i s e t h e value of the yen r e l a t i v e t o the
way t o h e l p s t i m u l a t e our economy.
Do y o u
A.8.
F o r e i g n demand h a s c o n t i n u e d t o make a s i g n i f i c a n t
p o s i t i v e c o n t r i b u t i o n t o U.S. growth over t h e p a s t s e v e r a l
years.
Exports have grown a t a f a i r l y r a p i d p a c e and our
t r a d e d e f i c i t , i n c l u d i n g our b i l a t e r a l d e f i c i t w i t h Japan,
has narrowed s i g n i f i c a n t l y .
While the d o l l a r has
d e p r e c i a t e d s u b s t a n t i a l l y in r e c e n t months, p a r t l y in
response t o the easing of U.S. monetary c o n d i t i o n s ,
a
p o l i c y t h a t seeks t o depreciate the d o l l a r against the yen
o r any o t h e r c u r r e n c y i s n o t an a p p r o p r i a t e way t o
s t i m u l a t e t h e U.S. economy.
I t may d i s t o r t t h e e f f e c t s o f
o t h e r p o l i c i e s a n d h a v e a d v e r s e e f f e c t s o n o u r own e c o n o m y
and c o u l d l e a d t o a c o u n t e r p r o d u c t i v e p a t t e r n of
competitive depreciation.
Macroeconomic growth o b j e c t i v e s
s h o u l d be a c h i e v e d by p u r s u i n g sound a n t i - i n f l a t i o n a r y
monetary and f i s c a l p o l i c i e s .
On t h e o t h e r h a n d , s u c h
economic and f i n a n c i a l v a r i a b l e s a s growth r a t e s ,
i n f l a t i o n r a t e s , i n t e r e s t r a t e s , and e x t e r n a l payments
p o s i t i o n s are b e s t l e f t t o determine the c o n f i g u r a t i o n of
exchange rates.
t
is
Japanese to
dollar, as a
agree?
305
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.9.
I s t h e $70 b i l l i o n j u s t p r o v i d e d
Fund g o i n g t o b e enough?
to
the
A.9.
Of t h e $ 7 0 b i l l i o n , $ 2 5 b i l l i o n w a s m a d e a v a i l a b l e t o
a b s o r b l o s s e s and $45 b i l l i o n f o r working c a p i t a l ,
with
t h e l a t t e r t o b e r e p a i d from s a l e by BIF o f a s s e t s
acquired from f a i l i n g banks.
The BIF i t s e l f h a s a c c e s s t o
b e t t e r i n f o r m a t i o n than t h e Federal Reserve on problem
banks and i n d i c a t e d l a s t f a l l t h a t $70 b i l l i o n — s o
a l l o c a t e d — s h o u l d be s u f f i c i e n t .
Our b e s t e s t i m a t e a t
t h a t t i m e was t h a t $70 b i l l i o n would be c l o s e , b u t t h e
outcome was h e a v i l y dependent on t h e pace of r e c o v e r y i n
real e s t a t e markets.
I note t h a t t h e A d m i n i s t r a t i o n ' s most
f a c t s u g g e s t t h a t i n f i s c a l y e a r 1994
b i l l i o n additional loss appropriation
t h e r e were no f u r t h e r banking reform.
on t h e b e n e f i t s of such c o n g r e s s i o n a l
shortfall is certainly possible.
Bank
Insurance
recent budget did in
more t h a n $25
might be needed i f
Without commenting
action,
this
Q.10.
As t h e economy c o n t i n u e s t o d e t e r i o r a t e , t h e e f f e c t on
r e a l e s t a t e p r i c e s can o n l y be downward.
Crumbling r e a l
e s t a t e v a l u e s h a v e s p r e a d f r o m T e x a s t o New E n g l a n d a n d o n
down t h e E a s t C o a s t .
How d o y o u a s s e s s t h e c u r r e n t
condition of r e a l e s t a t e markets in other areas, such as
C a l i f o r n i a , and what a r e t h e p r o s p e c t s f o r r e a l e s t a t e
generally?
A.10.
The c o m m e r c i a l r e a l e s t a t e market i n C a l i f o r n i a h a s
deteriorated recently, with extensive overbuilding in a
number o f l o c a l e s .
Vacancy r a t e s s t i l l i n d i c a t e a broad
supply-demand imbalance i n commercial markets and i n t h e
m u l t i - f a m i l y r e n t a l segment of the r e s i d e n t i a l market.
R e c e n t r e p o r t s do s u g g e s t , however, t h a t t h e s i n g l e f a m i l y
home m a r k e t i s f i r m i n g .
306
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.ll.
What v a r i a t i o n d o y o u p e r c e i v e e x i s t s i n t h e c u r r e n t
c o n d i t i o n and f u t u r e r e c o v e r y p r o s p e c t s o f t h e e c o n o m i e s
of the d i f f e r e n t regions of the country?
A.11.
I n e v i t a b l y , some i n d u s t r i e s and some r e g i o n s w i l l a t any
given time be growing f a s t e r than o t h e r s .
But, i n due
c o u r s e , g e o g r a p h i c m o b i l i t y and c h a n g e s i n r e l a t i v e p r i c e s
tend to cause these regional d i f f e r e n c e s to even out.
Looking forward, I would expect t h a t t h o s e p a r t s of t h e
c o u n t r y t h a t have been most h e a v i l y r e l i a n t on d e f e n s e
spending w i l l face a p a r t i c u l a r l y challenging period of
adjustment; one would hope t h a t , i n a g e n e r a l l y expanding
economy, however, t h e r e l a t i v e l y s k i l l e d workers i n t h i s
i n d u s t r y would be r e a d i l y absorbed in other a c t i v i t i e s .
Q.12.
Please submit for the record, appropriate m a t e r i a l s
d e s c r i b i n g a c t i o n s t a k e n by t h e Fed t o r e d u c e r e g u l a t o r y
b u r d e n i n t h e p a s t 12 m o n t h s .
What o t h e r a c t i o n s a r e y o u
contemplating?
A.12.
Over t h e p a s t 12 t o 18 m o n t h s , t h e F e d e r a l R e s e r v e h a s
t a k e n a number o f s t e p s w i t h i n i t s l e g a l a u t h o r i t y t o
reduce regulatory burden.
The a c t i o n w i t h t h e b r o a d e s t
impact was t h e B o a r d ' s December 1990 d e c i s i o n t o r e d u c e
from t h r e e t o z e r o p e r c e n t t h e r e s e r v e r e q u i r e m e n t s on
e u r o c u r r e n c y l i a b i l i t i e s and s h o r t - t e r m n o n p e r s o n a l t i m e
deposits.
The Board a l s o r e v i s e d i t s R e g u l a t i o n P w h i c h
s e t s minimum s t a n d a r d s f o r s e c u r i t y d e v i c e s a n d p r o c e d u r e s
for state-member banks.
Most r e c e n t l y , t h e t h r e e U . S .
banking agencies have agreed t o discontinue use of the
supervisory d e f i n i t i o n of highly leveraged t r a n s a c t i o n s
(HLTs) a f t e r J u n e 3 0 , 1 9 9 2 . A s o f J u n e 3 0 , 1 9 9 2 ,
state
m e m b e r b a n k s w i l l n o t b e r e q u i r e d t o r e p o r t HLT e x p o s u r e .
The F e d e r a l R e s e r v e h a s r e c e n t l y e a s e d r e s t r i c t i o n s on t h e
amount of n o n c u m u l a t i v e p e r p e t u a l p r e f e r r e d s t o c k bank
h o l d i n g c o m p a n i e s may i n c l u d e i n t h e i r T i e r 1 c a p i t a l .
The Board a l s o c o n t i n u e s t o s u p p o r t t h e r e p e a l o f t h e
G l a s s - S t e a g a l l and McFadden A c t s , a s w e l l a s l i m i t a t i o n s
on l e n d e r l i a b i l i t y f o r e n v i r o n m e n t a l problems.
307
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.12.
(cont)
Finally, the Federal Reserve, along with the other federal
a g e n c i e s t h a t s u p e r v i s e d e p o s i t o r y i n s t i t u t i o n s , w i l l be
reviewing a l l of i t s r e g u l a t i o n s as part of t h e e f f o r t s of
the Federal Financial I n s t i t u t i o n s Examination Council
(FFIEC) t o c a r r y o u t t h e p r o v i s i o n s o f S e c t i o n 2 2 1 o f t h e
Federal D e p o s i t Insurance Corporation Improvement Act of
1 9 9 1 . T h i s s e c t i o n d i r e c t s t h e FFIEC t o p e r f o r m a s t u d y o n
r e g u l a t o r y burden i n c o n s u l t a t i o n with.' consumer and
community g r o u p s and o t h e r i n t e r e s t e d p a r t i e s .
A report
t o C o n g r e s s i s d u e w i t h i n o n e y e a r o f e n a c t m e n t o f FDICIA.
T h i s r e p o r t may s u g g e s t a number o f a d d i t i o n a l
actions
t h a t could be taken t o reduce r e g u l a t o r y burden.
308
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.13.
Based on m a t e r i a l s p r e v i o u s l y s u p p l i e d by t h e F e d e r a l
Reserve t o t h e Committee, t h e Federal Reserve l e n t f o r
5 o r more c o n s e c u t i v e d a y s t o a p p r o x i m a t e l y 2 2 0 b a n k s
and t h r i f t s t h a t u l t i m a t e l y f a i l e d b e t w e e n t h e t i m e y o u
b e c a m e Chairman a n d May 10 o f l a s t y e a r .
The c o s t o f
t h a t l e n d i n g t o t h e FDIC b y some m e t h o d s o f c a l c u l a t i o n
w o u l d b e more t h a n $ 1 b i l i o n .
Has t h i s p r a c t i c e s t o p p e d ?
Can y o u s u p p l y F e d e r a l R e s e r v e l e n d i n g r e c o r d s f o r a n y
i n s t i t u t i o n s t h a t f a i l e d a f t e r May 1 0 , 1 9 9 1 , a n d h a d
b o r r o w e d f o r 5 o r more c o n s e c u t i v e d a y s w i t h i n t h e
p r e c e d i n g 12 m o n t h s ?
A.13.
I n t h e p e r i o d f r o m A u g u s t 1 1 , 1 9 8 7 t h r o u g h May 1 0 , 1 9 9 1 ,
252 f e d e r a l l y i n s u r e d d e p o s i t o r y i n s t i t u t i o n s f a i l e d t h a t
h a d b o r r o w e d f o r a t l e a s t f i v e c o n s e c u t i v e d a y s a t some
p o i n t i n t h e 2 years p r i o r t o t h e i r f a i l u r e ; of t h e s e ,
172 w e r e .borrowing a t t i m e o f f a i l u r e .
Subsequently,
f r o m May 10 o f l a s t y e a r t h r o u g h J a n u a r y 3 1 o f t h i s y e a r ,
17 more i n s t i t u t i o n s h a v e f a i l e d t h a t h a d b o r r o w e d f o r
5 o r more c o n s e c u t i v e d a y s i n t h e 12 m o n t h s p r e c e d i n g
t h e i r f a i l u r e (lending records f o r each are e n c l o s e d ) ;
11 o f them were borrowing a t t h e t i m e o f f a i l u r e .
Throughout t h i s e n t i r e p e r i o d , p r o v i s i o n s of l i q u i d i t y
t o f i n a n c i a l l y troubled i n s t i t u t i o n s have taken p l a c e
i n c l o s e c o o p e r a t i o n and c o n s u l t a t i o n w i t h t h e r e l e v a n t
p r i m a r y r e g u l a t o r s and i n s u r a n c e a u t h o r i t i e s .
Federal
R e s e r v e c r e d i t h a s p r o v i d e d t r o u b l e d i n s t i t u t i o n s w i t h an
o p p o r t u n i t y t o r e s t o r e t h e m s e l v e s t o f i n a n c i a l h e a l t h and
t o a v o i d becoming a d r a i n on t h e i n s u r a n c e f u n d s ; i n t h e
many c a s e s w h e r e t h e s e e f f o r t s h a v e b e e n u n s u c c e s s f u l ,
d i s c o u n t window l e n d i n g h a s h e l p e d t o f a c i l i t a t e o r d e r l y
r e s o l u t i o n s and t o r e d u c e t h e c o s t s t o t h e i n s u r a n c e
funds.
In keeping with the i n t e n t of the r e c e n t l y passed
l e g i s l a t i o n , the Federal Reserve i s s t r i v i n g t o control
e v e n more c l o s e l y t h e p r o v i s i o n o f c r e d i t t o f i n a n c i a l l y
t r o u b l e d d e p o s i t o r i e s , and j u d g m e n t s a b o u t v i a b i l i t y p l a y
a p a r t i c u l a r l y prominent r o l e .
Where t h e F e d e r a l R e s e r v e ,
a f t e r c o n s u l t i n g w i t h t h e p r i m a r y r e g u l a t o r a n d t h e FDIC,
c o n c l u d e s t h a t an i n s t i t u t i o n i s n o t v i a b l e , a s s u r a n c e s
a r e s o u g h t f r o m t h e FDIC t h a t a n y e x t e n s i o n s o f c r e d i t
w o u l d f a c i l i t a t e p r o m p t and o r d e r l y r e s o l u t i o n s t h a t w o u l d
reduce c o s t s t o the insurance fund.
A n o t a b l e example i n
t h i s r e g a r d i s S o u t h e a s t Bank, N . A . , o f M i a m i , F l o r i d a .
A f t e r i t b e c a m e a p p a r e n t t h a t t h e bank w a s n o l o n g e r
v i a b l e , p r o v i s i o n s of Federal Reserve c r e d i t were a t t h e
FDIC1s r e q u e s t .
As t h e a t t a c h e d c o r r e s p o n d e n c e i n d i c a t e s ,
t h e FDIC b e l i e v e d t h a t s u c h c r e d i t e x t e n s i o n s w o u l d
s u p p o r t a n o r d e r l y r e s o l u t i o n o f t h e bank and r e d u c e t h e
c o s t t o t h e Bank I n s u r a n c e Fund.
309
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name:
Location:
A t l a n t i c Trust Company
Newsington, New Hampshire
Date o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
D i s c o u n t Window Loans
or 1 3 ( c )
Date
assistance:1/30/92
Loan Type
Ampuyit
At t i m e o f f a i l u r e :
1/30/92
Extended
$575,000
Peak borrowing:
1/30/92
Extended
$575,000
C o l l a t e r a l s e c u r i n g l o a n a t t i m e of
Book v a l u e :
$ 3,216,921.50
Lendable v a l u e :
$ 2,070,713.30
C o n s e c u t i v e d a v s o f borrowing:
failure
5
6-15
Number o f o c c u r r e n c e s i n t h e
0
12-month p e r i o d b e f o r e f a i l u r e :
1
16-30
0
M
Composite CAMEL r a t i n g s :
Rating
As-of" Date
f o r Rating
31-60
0
0
Date R e c e i v e d
from R e g u l a t o r
At t i m e o f f a i l u r e :
5
7/29/91
N/A
Previous r a t i n g s ,
5
4
2/12/91
5/7/90
N/A
N/A
i f any:
o v e r 60
Summary h i s t o r y o f c o l l a t e r a l p l e d g e d :
On October 7 , 1991, A t l a n t i c T r u s t Company ( A t l a n t i c ) p l e d g e d $ 1 . 1 MM i n
commercial and r e s i d e n t i a l mortgages a s c o l l a t e r a l . These l o a n s were h e l d i n
our v a u l t and g i v e n a c o l l a t e r a l v a l u e of $584 M. On October 9 , 1 9 9 1 , we
r e c e i v e d a l e t t e r from t h e FDIC r e q u e s t i n g our accommodation o f any borrowing
r e q u e s t s from A t l a n t i c e x p l a i n i n g t h a t an o r d e r l y r e s o l u t i o n p r o c e s s was
underway.
By y e a r - e n d , we had taken p o s s e s s i o n o f a d d i t i o n a l commercial and
r e s i d e n t i a l m o r t g a g e s , and A t l a n t i c ' s c o l l a t e r a l p o s i t i o n i n c r e a s e d t o a
p r i n c i p a l v a l u e o f $ 2 . 0 MM and a c o l l a t e r a l v a l u e o f $ 1 . 3 MM.
310
Atlantic Trust Company
Page Two
On January 8 , 1992, we r e c e i v e d an a d d i t i o n a l l e t t e r from t h e FDIC
e x p l a i n i n g t h a t our l e n d i n g i n r e s p o n s e t o a r e q u e s t from A t l a n t i c would
a s s i s t i n a r r a n g i n g "an o r d e r l y and l e s s c o s t l y s o l u t i o n t o t h e imminent
f a i l u r e " of A t l a n t i c .
I n e a r l y January,
1992, A t l a n t i c ' s
l i q u i d i t y p o s i t i o n began
to
d e t e r i o r a t e and v e t o o k p o s s e s s i o n o f a d d i t i o n a l r e s i d e n t i a l and commercial
m o r t g a g e s . On January 16, 1992, A t l a n t i c had c o l l a t e r a l i n our c u s t o d y w i t h
a p r i n c i p a l v a l u e o f $ 3 . 2 MM and a c o l l a t e r a l v a l u e o f $ 2 . 1 MM. Borrowing
began one week l a t e r , on January 23, 1992 and ended on t h e d a t e o f
r e s o l u t i o n , January 3 0 , 1992.
From January 1 6 , 1992 through t h e r e s o l u t i o n
d a t e , A t l a n t i c ' s c o l l a t e r a l p o s i t i o n remained t h e same.
Throughout t h e
borrowing d u r a t i o n , A t l a n t i c ' s l e v e l of u n i n s u r e d d e p o s i t s remained l e v e l a t
$2,000.
The d i s c o u n t window l o a n was p a i d by t h e FDIC on February 4 ,
1992.
311
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF FAILED INSTITUTION:
ATLANTIC TRUST COMPANY
LOCATION (CITY AND STATE): NEWINGTON, MA
Loan D a t e
01/23/92
01/24/92
01/25/92
01/26/92
01/27/92
01/28/92
01/29/92
01/30/92
01/31/92*
02/01/92*
02/02/92*
02/03/92*
C r e d i t Type
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
L o a n Amount
200,000
125,000
425,000
425,000
425,000
425,000
425,000
575,000
575,000
575,000
575,000
575,000
* M i s c o m m u n i c a t i o n a t t h e FDIC p r e v e n t e d p r o m p t p a y m e n t o f l o a n
01/31/92.
On 0 2 / 0 3 / 9 2 l o a n w a s r e p a i d b y FDIC a s R e c e i v e r .
on
312
FDIC
Federal Deposit Insurance Corporation
160 6ou1d Street. Weedharo. Massachusetts
02194
Boston Regional Office
(617) 449-908Q
October 9, 1991
PY FAX AND BY MAIL
Mr. Curtis L. Turner
Vice President
Federal Reserve Bank of Boston
600 Atlantic Avenue
Boston, Massachusetts 02106
SUBJECT: Atlantic Trust Company
Nevington, New Hampshire
Dear Mr. Turner:
As per our telephone conversation on October 4, 1991 t h i s o f f i c e requests that
the Reserve Bank accommodate the overnight borrowings of the subject bank.
While the bank i s in danger of f a i l i n g please be advised that an orderly
resolution process i s underway. Please direct any questions you may have to
Assistant Regional Director Carl W. Schnapp at 617-449-9080.
Lncerely,
H VC—
Paul H. Wiechman
Regional Director
313
01/0«/82
13:07
FDIC HUSTON RE(i.
I^J0U2/0U2
FDIC
Federal Oeposit Insurance Corporation
160 Could Street. Kecdha*. Massachusetts QMS*
(6171 4*3-3080
Boston Regional Office
January 8 , 1992
(via telecopier)
Mr. C u r t i s Turner
V i c e P r e s i d e n t , Loan and Credit
F e d e r a l Reserve Bank o f Boston
600 A t l a n t i c Avenue
B o s t o n , Massachusetts 02106
Re:
A t l a n t i c Trust Company
Durham Nev Hamsphlre
Dear Mr. Turner:
As d i s c u s s e d w i t h P e t e r Genpvich o f your o f f i c e v i t h Deputy R e g i o n a l D i r e c t o r
Jane* V. KcFarland o f my o f f i c e , t h i s i s t o c o n f i r m t h a t i t would a s s i s t t h e
Corporation i n arranging a n o r d e r l y end l e s s c o s t l y s o l u t i o n t o t h e Imminent
f a i l u r e o f t h e s u b j e c t bank i f t h e d i s c o u n t window o f t h e F e d e r a l R e s e r v e Bank
o f Boston were t o p r o v i d e £tmds f o r L i q u i d i t y purposes t o A t l a n t i c Trust
Company, should t h e bank make such a r e q u e s t . As y o u a r e aware, t h e bank I s
e x p e c t e d t o b e c l o s e d by t h e Nev Hampshire Commissioner o f Banks and t h e FDIC
named r e c e i v e r on F r i d a y , January 2 4 , 1992. The bank's l i q u i d i t y p o s i t i o n i s
approaching t h e c r i t i c a l s t a g e and w h i l e v e e x p e c t t o have an o r d e r l y
r e s o l u t i o n l i n e d up by January 24, 1992, any t r a n s a c t i o n w i l l be f a c i l i t a t e d by
che bank having backup l i q u i d i t y a v a i l a b l e .
Should y o u have any q u e s t i o n s , p l e a s e do n o t h e s i t a t e t o c o n t a c t me o r Deputy
R e g i o n a l D i r e c t o r KcFarland a t <617) 449-9080.
Sincerely,
Paul H. Vlechman
Regional Director
314
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name: BankEast
L o c a t i o n : M a n c h e s t e r , NH
Date of c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
D i s c o u n t Window Loans
Date
At time of f a i l u r e :
N/A
Peak borrowing:
11/01/90
C o l l a t e r a l securing loan at time of
Book v a l u e :
N/A
Lendable v a l u e :
N/A
or 1 3 ( c ) a s s i s t a n c e :
Loan Type
Amount
Adjustment
$21,600,000
failure
C o n s e c u t i v e days o f borrowing:
5
6-15
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
1
2
Composite CAMEL r a t i n g s
10/10/91
Rating
16-30
"As-of" Date
for Rating
31-60
Over 60
Date Received
from R e g u l a t o r
At t i m e of f a i l u r e :
5
3/31/91
N/A
Previous r a t i n g s ,
4
3
3
11/12/90
7/21/89
1/08/88
N/A
N/A
N/A
i f any:
Summary h i s t o r y o f c o l l a t e r a l
pledged:
A l l borrowings were s e c u r e d by s t a t e and m u n i c i p a l bonds a s w e l l a s
commercial l o a n s and commercial m o r t g a g e s .
When BankEast s t a r t e d borrowing
i n October, 1990, t h e t o t a l f a c e v a l u e of c o l l a t e r a l p l e d g e d t o t h i s Reserve
Bank was $ 4 8 . 3 m i l l i o n . The breakdown was a s f o l l o w s , w i t h l e n d a b l e v a l u e i n
parentheses:
s t a t e and m u n i c i p a l s e c u r i t i e s of $550 t h o u s a n d
($495
t h o u s a n d ) ; commercial mortgages of $ 2 3 . 9 m i l l i o n ( $ 1 1 . 9 m i l l i o n ) ; and
commercial l o a n s o f
$23.9 m i l l i o n
($11.9 m i l l i o n ) .
From t h e time
i n t e r m i t t e n t borrowing began on 1 0 / 2 6 / 9 0 and ended on 9 / 1 0 / 9 1 , c o l l a t e r a l
v a l u e s ranged a s h i g h a s $ 6 4 . 5 m i l l i o n ( $ 3 2 . 2 m i l l i o n ) by m i d - J a n u a r y , 1991
and f e l l as low a s $ 3 4 . 1 m i l l i o n ( $ 1 7 . 1 m i l l i o n ) by mid-September, 1991.
At t h e t i m e o f f a i l u r e , t h i s
commercial l o a n s , commercial
e q u i t y l o a n s , w i t h a combined
f o r p o t e n t i a l b o r r o w i n g s and
R e s e r v e Bank h e l d a t o t a l of $ 1 3 2 . 8 m i l l i o n of
m o r t g a g e s , c r e d i t card r e c e i v a b l e s , and home
l e n d a b l e v a l u e of $ 6 6 . 4 m i l l i o n , a s c o l l a t e r a l
FRB a c c o u n t o v e r d r a f t s .
315
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
N A M E OF FAILED INSTITUTIONS
LOCATION (CITY A N D STATE):
BANKEAST
MANCHESTER, NEW HAMPSHIRE
LOAN
DATE
CREDIT
TYPE
LOAN
AMOUNT
10/26/90
10/27/90
10/28/90
10/29/90
10/30/90
10/31/90
11/01/90
11/02/90
11/03/90
11/04/90
11/05/90
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
6,200,000
6,200,000
6,200,000
8,600,000
14,000,000
14,400,000
21,600,000
18,800,000
18,800,000
18,800,000
6,000,000
11/08/90
ADJ
16,700,000
11/13/90
11/14/90
11/15/90
ADJ
ADJ
ADJ
5,000,000
5,000,000
5,000,000
12/31/90
01/01/91
01/02/91
01/03/91
01/04/91
01/05/91
01/06/91
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
6,600,000
6,600,000
5,200,000
11,400,000
3,400,000
3,400,000
3,400,000
01/08/91
01/09/91
01/10/91
ADJ
ADJ
ADJ
2,400,000
2,150,000
5,700,000
01/15/91
ADJ
4,400,000
01/17/91
01/18/91
01/19/91
01/20/91
01/21/91
ADJ
ADJ
ADJ
ADJ
ADJ
13,800,000
6,900,000
6,900,000
6,900,000
6,900,000
01/24/91
EXT
10,000,000
316
01/28/91
01/29/91
01/30/91
01/31/91
EXT
EXT
EXT
EXT
1,000,000
3,200,000
2,900,000
12,400,000
09/03/91
09/04/91
EXT
EXT
13,000,000
5,500,000
09/10/91
EXT
9,000,000
317
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name: Beacon C o o p e r a t i v e Bank
L o c a t i o n : B r i g h t o n , MA
Date of c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
Discount Window Loans
At time o f f a i l u r e :
Peak borrowing:
or 1 3 ( c ) a s s i s t a n c e :
Loan Type
Extended
Date
6/21/91
6/18/91 -
6/21/91
C o l l a t e r a l s e c u r i n g l o a n a t t i m e of
Book v a l u e :
$12,940,117
Lendable v a l u e :
$ 4,941,551
C o n s e c u t i v e d a v s o f borrowing:
Extended
6/21/91
Amount
$1,033,000
$1,033,000
failure
5
6-15
16-30
31-60
Over 60
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
Composite CAMEL r a t i n g s
At t i m e o f
failure:
Previous r a t i n g s ,
if
any:
Summary h i s t o r y o f c o l l a t e r a l
Rating
"As-of" Date
for Rating
Date R e c e i v e d
from R e g u l a t o r
5
5/09/91
N/A
5
5
2
3/25/91
11/28/89
2/26/88
N/A
N/A
N/A
pledged:
Beacon borrowed f o r 46 c o n s e c u t i v e days l e a d i n g t o i t s f a i l u r e on 6 / 2 1 / 9 1 .
Borrowings f o r t h e f i r s t f o u r days were c o l l a t e r a l i z e d by $ 4 . 0 m i l l i o n of 1 - 4
f a m i l y r e s i d e n t i a l m o r t g a g e s w i t h a 50% l e n d a b l e v a l u e o f $ 2 . 0 m i l l i o n .
The
l a r g e r t h a n u s u a l h a i r c u t f o r t h i s a s s e t t y p e was t h e r e s u l t of q u e s t i o n a b l e
l e n d i n g p r a c t i c e s a t t h e bank.
Additional c o l l a t e r a l , with a $9.0 million
book v a l u e and a $ 3 . 0 m i l l i o n l e n d a b l e v a l u e , was t a k e n on a p r e c a u t i o n a r y
basis.
The a d d i t i o n a l c o l l a t e r a l c o n s i s t e d p r i m a r i l y o f c o n v e n t i o n a l 1 - 4
f a m i l y and n o n c o n v e n t i o n a l condominium and m u l t i f a m i l y m o r t g a g e s . The b a n k ' s
d e p o s i t b a s e remained r e l a t i v e l y s t a b l e and t h e l e v e l of borrowing d i d n o t
significantly escalate.
52-418 - 92 - 11
318
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
N A M E OF FAILED INSTITUTION: Beacon Co-operative Bank
LOCATION (CITY AND STATE): Brighton, M A
Loan Date
05/09/91
05/10/91
05/11/91
05/12/91
05/13/91
05/14/91
05/15/91
05/16/91
05/17/91
05/18/91
05/19/91
05/20/91
05/21/91
05/22/91
05/23/91
05/24/91
05/25/91
05/26/91
05/27/91
05/28/91
05/29/91
05/30/91
05/31/91
06/01/91
06/02/91
06/03/91
06/04/91
06/05/91
06/06/91
06/07/91
06/08/91
06/09/91
06/10/91
06/11/91
06/12/91
06/13/91
06/14/91
06/15/91
06/16/91
06/17/91
06/18/91
06/19/91
06/20/91
06/21/91
06/22/91
06/23/91
Credit Tvce
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
Loan Amount
700,000
701,000
701,000
701,000
701,000
701,000
801,000
802,000
803,000
803,000
803,000
803,000
803,000
803,000
803,000
804,000
804,000
804,000
804,000
804,000
929,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,030,000
1,031,000
1,031,000
1,031,000
1,032,000
1,032,000
1,032,000
1,032,000
1,033,000
1,033,000
1,033,000
1,033,000
1,033,000
1,033,000
319
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure of Depository Institution
(Detailed Record Attached)
Name:
Location:
CAPITAL BANK
DALLAS, TX
Date of conservatorship, receivership, or 13(c) assistance:
Discount window loans
Date
At time of failure
Peak borrowing:
1991-05-16
1991-05-16
1991-05-16
Loan Type
Amount
Extended
Extended
4,000,000.00
4,000,000.00
Collateral securing loan at time of failure
Book value
Lendable value
18,492,313.41
14,088,893.87
Consecutive days of borrowing:
5
Number of occurrences in the
36-month period before failure:
Composite CAMEL ratinqs
16-30
"As-of date"
for rating
5
4
5
4
3
3
1990-03-30
1989-11-30
1988-12-31
1988-02-26
1986-12-31
1986-04-16
Summary history of collateral pledged:
U.S Treasury securities
Customers notes
One-to-four family mortgages
31-60
Over 60
1
Rating
At time of failure:
Previous ratings, if any:
6-15
Date received
from regulator
1990-07-27
1990-05-30
1989-04-07
1988-05-18
1987-03-13
1986-08-11
320
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name of Failed Institution: CAPITAL BANK
Location (City and State): DALLAS, TX
Date
Loan
Type
Amount of
Loan Outstanding
91-03-06
91-03-07
91-03-08
91-03-09
91-03-10
91-03-11
91-03-12
91-03-13
91-03-14
E
E
E
E
E
E
E
E
E
1,215,000.00
1,960,000.00
2,240,000.00
2,240,000.00
2,240,000.00
2,240,000.00
1,625,000.00
1,415,000.00
275,000.00
91-03-19
E
150,000.00
91-03-21
91-03-22
91-03-23
91-03-24
E
E
E
E
75,000.00
450,000.00
450,000.00
450,0Q0.00
91-03-26
E
275,000.00
91-04-29
91-04-30
E
E
350,000.00
150,000.00
91-05-15
91-05-16
E
E
3,750,000.00
4,000,000.00
321
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name: C e n t r a l Bank
L o c a t i o n : Meriden, CT
Date o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
pjspQiwt Window LQ3PE
Pftte
At t i m e o f f a i l u r e :
Peak borrowing:
10/18/91
Loan Type
AffiPWlt
NOT APPLICABLE
2/19/91
ADJUSTMENT
C o l l a t e r a l s e c u r i n g loan a t time o f
Book v a l u e :
or 13(c) a s s i s t a n c e :
$11,500,000
failure
NOT APPLICABLE
Lendable v a l u e :
NOT APPLICABLE
Cpnsecv^tj,ve d^ys o f borrowing:
5
Number of o c c u r r e n c e s i n t h e
0
12-month p e r i o d b e f o r e f a i l u r e :
Composite CftfTO r a t i n g s :
Rating
6-15
16-30
0
0
"As-of" Date
f o r Rating
QVQV $Q
1
0
Date Received
from R e g u l a t o r
At t i m e of f a i l u r e :
4
3
5 / 1 1 / 9 0 (FDIC)
5/11/90 (State)
NOT AVAILABLE
NOT AVAILABLE
Previous r a t i n g s ,
2
2/10/89
NOT AVAILABLE
Summary
frjgtpry
i f any:
of c o l l a t e r a l
pledged:
A l l b o r r o w i n g s were s e c u r e d by commercial l o a n s t o t a l i n g $ 6 4 . 4 m i l l i o n , w i t h a
lendable value of $32.2 m i l l i o n .
At t h e t i m e o f f a i l u r e , $90 m i l l i o n o f commercial l o a n s and commercial mortgages
was h e l d i n t h i s R e s e r v e Bank's v a u l t p r o v i d i n g a l e n d a b l e v a l u e o f $39 m i l l i o n .
An a d d i t i o n a l p l e d g e o f commercial l o a n s , w i t h a $ 1 4 9 . 2 m i l l i o n book v a l u e and
a $ 7 4 . 6 m i l l i o n l e n d a b l e v a l u e , was t a k e n on a p r e c a u t i o n a r y b a s i s . These n o t e s
were n o t t a k e n i n t o t h i s R e s e r v e B a n k ' s p o s s e s s i o n .
EL0392
mil
322
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF F A I L E D I N S T I T U T I O N :
L O C A T I O N ( C I T Y AND S T A T E ) :
Loan Date
01/23/91
01/24/91
01/25/91
01/26/91
01/27/91
01/28/91
01/29/91
01/30/91
01/31/91
02/01/91
02/02/91
02/03/91
02/04/91
02/05/91
02/06/91
02/07/91
02/08/91
02/09/91
02/10/91
02/11/91
02/12/91
02/13/91
02/14/91
02/15/91
02/16/91
02/17/91
02/18/91
02/19/91
02/20/91
02/21/91
02/22/91
02/23/91
02/24/91
02/25/91
02/26/91
02/27/91
02/28/91
03/01/91
03/02/91
03/03/91
03/04/91
03/05/91
03/06/91
03/08/91
63/09/91
03/10/91
03/11/91
CENTRAL BANK
MERIDEN, CT
Credit Type
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
J^oan Amount
9,600,000
4,800,000
2,200,000
2,200,000
2,200,000
9,200,000
8,800,000
11,000,000
11,400,000
9,800,000
9,800,000
9,800,000
10,400,000
9,400,000
5,300,000
6,400,000
7,300,000
7,300,000
7,300,000
8,400,000
8,400,000
10,200,000
10,200,000
11,000,000
11,000,000
11,000,000
11,000,000
11,500,000
9,900,000
9,400,000
9,700,000
9,700,000
9,700,000
11,000,000
11,100,000
10,000,000
8,900,000
4,400,000
4,400,000
4,400,000
4,700,000
1,700,000
1,600,000
1,250,000
1,250,000
1,250,000
1,200,000
323
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name:
C o o l i d g e Bank and Trust Company
Location: Boston, Massachusetts
Date o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p , o r 1 3 ( c ) a s s i s t a n c e :
p j g c p u n t Window Loans
10/25/91
Date
Loan Type
Amount
At t i m e o f f a i l u r e :
10/25/91
Extended
$10,000,000
Peak borrowing:
10/25/91
Extended
$10,000,000
C o l l a t e r a l securing loan a t time of
Book v a l u e :
$23,776,977.91
Lendable v a l u e :
$19,021,582.33
CQnsecvitive day? o f borrowing:
§
Number o f o c c u r r e n c e s i n t h e
12-month p e r i o d b e f o r e f a i l u r e :
COffiPPSlte CAMEfr
At t i m e o f
ratings:
failure
6-i$
0
Rating
failure:
Previous r a t i n g s ,
if
16-30
1
0
" A s - o f " Date
f o r Rating
4/22/91
any:
31-60—over
0
69
0
Date R e c e i v e d
from R e g u l a t o r
N/A
3/19/91
4/6/90
7/22/88
fimmmary history of collateral pledged;
C o o l i d g e Bank and T r u s t Company, ( C o o l i d g e ) , d e l i v e r e d $ 1 2 . 5 MM i n
o n e - t o - f o u r f a m i l y r e s i d e n t i a l mortgage n o t e s t o t h e Reserve Bank on A p r i l
20, 1990.
T h e s e l o a n s were h e l d i n our v a u l t a s c o l l a t e r a l f o r p o t e n t i a l
D i s c o u n t Window borrowing and were g i v e n a c o l l a t e r a l v a l u e o f $ 1 1 . 2 MM.
I n l a t e August 1991, C o o l i d g e i n c r e a s e d i t s c o l l a t e r a l p l e d g e t o $ 2 5 . 8 MM i n
o n e - t o - f o u r f a m i l y r e s i d e n t i a l m o r t g a g e s . T h i s was g i v e n a c o l l a t e r a l v a l u e
o f $ 2 1 . 7 MM.
By l a t e October 1 9 9 1 , t h e p r i n c i p a l v a l u e o f t h e c o l l a t e r a l had
d e c r e a s e d t o $ 2 3 . 8 MM, w i t h a c o l l a t e r a l v a l u e o f $ 1 9 . 0 MM.
Negative
p u b l i c i t y l e d t o d e p o s i t o u t f l o w s a t t h e i n s t i t u t i o n and C o o l i d g e was f o r c e d
324
Coolidge Bank and Trust Co.
Page Two
t o borrow from t h e D i s c o u n t Window f o r n i n e c o n s e c u t i v e d a y s p r i o r t o i t s
c l o s i n g . The FDIC i n d i c a t e d t o t h e R e s e r v e Bank b o t h o r a l l y and i n w r i t i n g ,
t h a t i t s l e n d i n g f o r l i q u i d i t y p u r p o s e s would f a c i l i t a t e an o r d e r l y
r e s o l u t i o n of Coolidge.
C o o l i d g e was c l o s e d on F r i d a y , October 2 5 , 1 9 9 1 .
The D i s c o u n t Window l o a n was p a i d by t h e a c q u i r i n g i n s t i t u t i o n on Monday,
October 2 8 , 1991.
325
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF F A I L E D I N S T I T U T I O N :
L O C A T I O N ( C I T Y AND S T A T E ) :
Loan Date
12/04/90
12/05/90
10/17/91
10/18/91
10/19/91
10/20/91
10/21/91
10/22/91
10/23/91
10/24/91
10/25/91
COOLIDGE BANK AND T R U S T
B O S T O N , MA
Credit Typfe
ADJ
ADJ
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
Loan Amount
4,000,000
5,000,000
3,000,000
4,000,000
4,000,000
4,000,000
7,000,000
7,000,000
7,000,000
8,500,000
10,000,000
COMPANY
326
FDIC
Federal Deposit Insurance Corporation
160 Gould Street. Needham. Massachusetts
02194
(617) 449-9080
Boston Regional Office
October 17, 1991
Mr, Curtis Turner
Vice President
Loan and Credit
Federal Reserve Bank o f Boston
600 A t l a n t i c Avenue
Boston, Massachusetts 02106
RE:
Coolidge Bank and Trust Company
Boston. Massachusetts
Dear Mr. Turner:
As discussed w i t h Reviev Examiner James A. Bazydlo, t h i s i s t o confirm t h a t the
orderly r e s o l u t i o n of the subject bank v i l l be f a c i l i t a t e d by the discount
window of the Federal Reserve Bank of Boston providing funds t o Coolidge Bank
and Trust Company f o r l i q u i d i t y purposes should the bank make a request. As
you are aware the bank i s expected t o be closed and the FDIC named r e c e i v e r on
Friday, October 25, 1991.
Very truly yours
T w l H . Viechman
Regional Director
327
Summary Record of Discount Window Lending
Over 36-Month Period Prior to Failure of Depository Institution
(Detailed Record Attached)
Name o f
failed
Location
(city
institution:
Cosmopolitan National
and s t a t e ) :
Chicago.
Date of c o n s e r v a t o r s h i p ,
Discount
At time
Window L o a n s :
of
failure:
receivership,
securing
loan
N/A
Lendable Value:
N/A
Consecutive
of
Date:
Days
at time
Borrowing:
CAMEL R a t i n g s :
Rating
time of
Previous
assistance:5/17/91
Loan Type:
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
At
or 13(c)
06/01/90-06/03/90
Book V a l u e :
Composite
Illinois
Amount:
None
Peak borrowing:
Collateral
Bank
of
A
3 .225.000
failure
5
6-15
16-30
1
0
0
"As-of" Date
For R a t i n g
31-60
over
0
60
0
Date Received
From R e g u l a t o r
failure:
5
3
Ratings:
Summary H i s t o r y
of
Collateral
05/31/90
09/30/89
*
*
Pledged:
C o l l a t e r a l p l e d g e d c o n s i s t e d of Treasury N o t e s and U.S.
Agency
Securities.
On 1 / 3 0 / 9 1 , t h e p a r a m o u n t o f t h i s c o l l a t e r a l
was
$6,760,000 and, a f t e r applicable h a i r c u t s ,
had a l o a n v a l u e
of
$6,394,00.
While under extended c r e d i t ,
t h e p a r amount o f
the
collateral
on
3/4/91
was
$4,600,000,
with
a market
value
of
$4,046,000;
the
par
amount
of
the
collateral
on
3/5/91
was
$2,100,000, w i t h a market value of
$1,878,384.
* Upon c o m p l e t i o n
of
the
exam.
328
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name o f
Failed
Location
(city
DATE
Institution:
Cosmopolitan
and s t a t e ) :
Chicago.
LOAN
TYPE
National
Bank
Illinois
AMOUNT OF
LOAN OUTSTANDING
01/31/89
02/01/89
02/02/89
A
A
A
2,500,000
2,500,000
2,500,000
05/14/90
A
2,000,000
05/17/90
05/18/90
05/19/90
05/20/90
A
A
A
A
2,000,000
2,200,000
2,200,000
2,200,000
05/30/90
05/31/90
06/01/90
06/02/90
06/03/90
A
A
A
A
A
2,625,000
3,000,000
3,225,000
3,225,000
3,225,000
01/30/91
A
650,000
03/04/91
03/05/91
E
E
1,200,000
800,000
329
Sumnary Record of Disoount Window Lending
Over 12-Month Period Prior to Failure of Depository Institution
(Detailed Report Attached)
Name:
First Hanover Bank
Location:
Wilmington, North Carolina
Date of conservatorship, receivership, or 13(c) assistance: 10/25/91
piscount Window loans
At time of Failure:
Peak borrowing:
Date
loan Type
10/25/91
10/23/91
Extended
Extended
Amount
$10,000,000
$10,400,000
Collateral securing loan at time of failure:
Bock value:
Lendable value:
$41,415,474.00
$12,993,688.00
Consecutive davs of borrowing:
5
6=15
Number of occurrences in the
12—month period before failure:
0
1
Composite CAMEL ratings
At time of failure:
Previous ratings, if any:
Rating
5
4
3
2
2
16-30
0
"As of" date
for rating
07/08/91
04/12/91
09/10/90
01/02/90
07/31/88
21=60
over 60
1
0
Date received
ffron regulator
N/A
N/A
N/A
N/A
N/A
Summary history of collateral pledged:
August 21, 1991, First Hanover Bank, Wilmington, North Carolina pledged
Treasury and Agency securities totaling $2.9 million, with a collateral value
of $2.76 million.
On August 22, First Hanover began pledging residential mortgages and
oononercial loans. The first batch totaled $600 thousand and by month end
mortgages totaled $7.6 million with a collateral value of $1.1 million. Seme
of the files were in the process of being reviewed and others lacked
documentation.
Through the month of September First Hanover continued to pledge various
notes and provided missing documentation for notes held. As of October 3, the
total amount of collateral pledged (notes and securities) was $10.7 million
with a value of $4.0 million.
On October 4, a field warehouse was put into place. The loan portfolio
amounted to $40.7 million with a collateral value of $12.8 million. The
initial valuation for loan portfolio collateral is calculated as a percentage
of the total controlled after backing out past dues, nonaccruals, classified,
and various categories of loans not considered acceptable.
On October 25, the total collateral pledged was $41.4 million with a
value of $13.0. Qistonpr notes amounted to $39.6 million with a value of $11.3
million and securities amounted to $1.8 million with a value of $1.7 million.
330
Detailed Record of Discount Window Lending
Over 12-Month Period Prior to Failure
Name of failed institution:
Location:
08/23/91
08/24/91
08/25/91
08/26/91
08/27/91
08/28/91
08/29/91
Loan
Type
A
A
A
E
E
E
E
09/03/91
09/04/91
E
E
Pate
10/06/91
10/07/91
10/08/91
10/09/91
10/10/91
10/11/91
10/12/91
10/13/91
10/14/91
10/15/91
10/16/91
10/17/91
10/18/91
10/19/91
10/20/91
10/21/91
10/22/91
10/23/91
10/24/91
10/25/91
10/26/91
10/27/91
Amount of
Toan aitf^niinq
400,000.00
400,000.00
400,000.00
750,000.00
950,000.00
900,000.00
950,000.00
200,000.00
750,000.00
200,000.00
09/23/91
09/25/91
09/26/91
09/27/91
09/28/91
09/29/91
09/30/91
10/01/91
10/02/91
10/03/91
10/04/91
10/05/91
First Hanover Bank
Wilmington, North Carolina
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
400,000.00
200,000.00
400,000.00
400,000.00
400,000.00
400,000.00
2,300,000.00
2,300,000.00
2,700,000.00
4,300,000.00
4,300,000.00
4,300,000.00
6,000,000.00
7,200,000.00
7,800,000.00
7,800,000.00
7,950,000.00
7,950,000.00
7,950,000.00
7,950,000.00
7 500,000.00
8,500,000.00
8,400,000.00
9,400,000.00
9,400,000.00
9,400,000.00
10,150,000.00
10,050,000.00
10,400,000.00
10,200,000.00
10,000,000.00
10,000,000.00
10,000,000.00
331
SUMMARY RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE OF DEPOSITORY INSTITUTIONS
(Detailed Record Attached)
Name o f
Failed
Location
(city
Institution:
First
National
and s t a t e ) :
Toms R i v e r ,
Bank o f
Toms
NJ
D a t e o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p , o r 13 ( c ) a s s i s t a n c e : M a y
D i s c o u n t Window Loans
At t i m e
Peak
of
failure:
Borrowing:
Collateral
securing
Book v a l u e :
Lendable value:
$
$
Date
Loan Type
Amount
1991
Extended
$ 8 0 , 3 0 0 , 0 0 0 . .00
May 2 1 ,
1991
Extended
$ 8 6 , 5 0 0 , 0 0 0 . .00
loan
at
of failure
time
272,777,055.52
160,456,122.34
C o m p o s i t e CAMEL r a t i n g s
At t i m e o f
failure:
Previous ratings, i f
of
22,1991
May 2 2 ,
Consecutive days of borrowing
Number o f o c c u r r e n c e s i n t h e
36 mo. p e r i o d b e f o r e f a i l u r e :
Summary h i s t o r y
River
5
6-15
16-30
31-60
2
5
none
none
Ratings
"As o f " d a t e
for rating
5
4
2
2
2
2
01/31/91
06/30/90
06/30/89
06/30/88
12/31/87
12/31/86
any:
collateral
o v e r 60
none
Date r e c e i v e d
from r e g u l a t o r
Not
Not
Not
Not
Not
Not
available
available
available
available
available
available
pledged:
U.S.
Government
agency
securities
were
used
to
secure
all
borrowings
until
June
of
1990.
Institution
then
pledged
residential mortgages t o t a l l i n g $91.5 million.
B o r r o w i n g s f o r May,
1991 were s e c u r e d w i t h $272 m i l l i o n of commercial and r e s i d e n t i a l
m o r t g a g e s d e p o s i t e d w i t h t h e F e d e r a l R e s e r v e Bank o f P h i l a d e l p h i a .
332
Detailed Record of Discount Window Lending
Over 3 6 Month Period Prior to Failure
Name o f
Location
Failed
(city
Institution:
First
National
and s t a t e ) :
Toms R i v e r ,
Bank o f
NJ
Date
Loan
Type
1988
1/1
1/2
1/3
1/4
1/5
1/6
adjustment
adjustment
adjustment
adjustment
adjustment
adjustment
38.0
38.0
38.0
50.0
40.0
5.0
million
million
million
million
million
million
3/31
4/1
4/2
4/3
4/4
adjustment
adjustment
adjustment
adjustment
adjustment
50.0
50.0
50.0
50.0
11.0
million
million
million
million
million
6/30
7/1
7/2
7/3
7/4
7/5
adj ustment
adjustment
adjustment
adjustment
adjustment
adjustment
60.0
39.0
39.0
39.0
39.0
14.5
million
million
million
million
million
million
7/14
adjustment
3.0
million
9/21
9/2 2
adjustment
adjustment
10.0
6.0
million
million
9/30
10/1
10/2
adjustment
adj ustment
adjustment
17.0
17.0
17.0
million
million
million
12/29
12/30
12/31
adj ustment
adjustment
adjustment
47.0
62.0
62.0
million
million
million
1989
1/1
1/2
1/3
adjustment
adj ustment
adj ustment
62.0
62.0
61.0
million
million
million
2/8
adj ustment
1.0
million
adj ustment
26.0
million
2/15
Amount o f
Loan
Toms
River
333
3/7
adjustment
4.0
million
6/30
7/1
7/2
7/3
7/4
adjustment
adjustment
adjustment
adjustment
adjustment
29.0
29.0
29.0
3.7
3.7
million
million
million
million
million
7/10
adj ustment
.2'
million
7/12
adjustment
13.4
million
8/24
adjustment
3.4
million
9/5
adjustment
1.5
million
1990
1/2
adjustment
3.0
million
2/13
adj ustment
.5
million
4/10
adjustment
1.0
million
4/19
4/20
4/21
4/22
adjustment
adjustment
adjustment
adj ustment
5.0
11.0
11.0
11.0
million
million
million
million
4/24
adjustment
2.0
million
4/26
4/27
4/28
4/29
4/30
5/1
adjustment
adjustment
adj ustment
adj ustment
adj ustment
adj ustment
12.1
10.1
10.1
10.1
6.0
8.4
million
million
million
million
million
million
6/26
6/27
adj ustment
adjustment
3.0
4.0
million
million
7/16
adjustment
2.0
million
7/30
adjustment
1.0
million
8/13
adjustment
2.0
million
10/11
adj ustment
1.25
million
11/21
11/22
adjustment
adj ustment
.3
.3
million
million
12/5
adj ustment
5.0
million
334
1991
1/2
adjustment
1/15
adjustment
2/11
adjustment
5 .4 million
2/15
2/16
2/17
2/18
adjustment
adjustment
adjustment
adjustment
1 .4
1 .4
1 .4
1 .4
3/21
adjustment
1. 0 million
3/25
adjustment
.2 m i l l i o n
4/11
adjustment
1. . 0 m i l l i o n
5/9
5/10
5/11
5/12
5/13
5/14
5/15
5/16
5/17
5/18
5/19
5/20
5/21
5/22
extended
extended
extended
extended
extended
extended
extended
extended
extended
extended
extended
extended
extended
extended
2 .5 m i l l i o n
.5
33,. 0
26,. 5
26,. 5
26,. 5
28,. 5
37.. 5
32.. 5
47., 5
70.,5
70..5
70.,5
84. 0
86. 5
80. 3
million
million
million
million
million
million
million
million
million
million
million
million
million
million
million
million
million
million
million
335
Summary Record o f D i s c o u n t Window Lending
Over 36-Month P e r i o d P r i o r t o F a i l u r e o f D e p o s i t o r y I n s t i t u t i o n
( D e t a i l e d Report A t t a c h e d )
Name:
H i l t o n Head Bank & Trust Company, N.A.
Location:
H i l t o n Head I s l a n d , South C a r o l i n a
Date o f C o n s e r v a t o r s h i p , r e c e i v e r s h i p , or 1 3 ( c ) a s s i s t a n c e :
D i s c o u n t Window l o a n s
At t i m e o f F a i l u r e :
Peak b o r r o w i n g :
Date
Loan Type
08/30/91
08/13/91
Extended
Extended
C o l l a t e r a l s e c u r i n g loan a t time of
Book v a l u e :
Lendable v a l u e :
Amount
$ 900,000
$1,250,000
failure:
$6,533,657.96
$2,624,014.97
C o n s e c u t i v e days o f b o r r o w i n g :
5
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
1
Composite CAMEL r a t i n g s
At t i m e o f f a i l u r e :
Previous r a t i n g s , i f
08/30/91
any:
Summary h i s t o r y o f c o l l a t e r a l
Rating
5
4
4
4
3
3
2
2
6-15
16-30
31-60
o v e r 60
2
"As o f " d a t e
for rating
08/02/91
06/10/91
01/07/91
12/31/90
01/30/90
11/27/89
05/17/89
12/28/88
Date r e c e i v e d
from r e g u l a t o r
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
pledged:
A p r i l 2 5 , 1 9 9 1 , H i l t o n Head B&T Co. (HHB) p l e d g e d 6 commercial l o a n s w i t h
a c o l l a t e r a l v a l u e o f $ 9 0 0 t h o u s a n d . On t h e 2 9 t h , 6 r e s i d e n t i a l m o r t g a g e s
were p l e d g e d b r i n g i n g t h e t o t a l c o l l a t e r a l v a l u e t o $ 1 . 7 m i l l i o n .
On May 6 , 3 c o m m e r c i a l l o a n s w i t h d o c u m e n t a t i o n d e f i c i e n c i e s were
r e c e i v e d , i n c r e a s i n g t h e p a r amount t o $ 2 . 7 m i l l i o n w i t h no change t o t h e
c o l l a t e r a l value of $1.7 million.
On June 2 6 , 14 a d d i t i o n a l commercial l o a n s w e r e r e c e i v e d f o r r e v i e w .
A d d i t i o n a l d o c u m e n t a t i o n was r e q u i r e d f o r a m a j o r i t y of t h e 14 l o a n f i l e s
received.
From A p r i l 25 t o August 4 , t h e c o l l a t e r a l v a l u e s f l u c t u a t e d b e t w e e n
$.9 t o $1.7 m i l l i o n .
On August 1 , HHB p l e d g e d 13 more commercial l o a n s .
The new l o a n s ,
r e c e i v e d a l o n g w i t h t h e a d d i t i o n a l d o c u m e n t a t i o n f o r p r i o r l o a n s , were
r e v i e w e d and by A u g u s t 9 , t h e p a r amount had i n c r e a s e d t o $ 6 . 9 m i l l i o n w i t h a
c o l l a t e r a l value of $2.1 m i l l i o n .
By August 2 8 , c o l l a t e r a l amounted t o $ 6 . 5 m i l l i o n p a r amount w i t h a
c o l l a t e r a l value of $ 2 . 6 m i l l i o n .
336
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name o f f a i l e d i n s t i t u t i o n :
Location:
Date
Loan
Type
H i l t o n Head Bank & T r u s t Company, N.A.
H i l t o n Head I s l a n d , S o u t h C a r o l i n a
Amount o f
Loan O u t s t a n d .
$
750,000.00
750,000.00
750,000.00
750,000.00
750,000.00
04/25/91
04/26/91
04/27/91
04/28/91
04/29/91
A
A
A
A
A
08/01/91
A
200,000.00
08/05/91
08/06/91
08/07/91
08/08/91
08/09/91
08/10/91
08/11/91
08/12/91
08/13/91
08/14/91
A
A
A
A
E
E
E
E
E
E
750,000.00
750,000.00
750,000.00
750,000.00
750,000.00
750,000.00
750,000.00
550,000.00
1,250,000.00
550,000.00
08/16/91
08/17/91
08/18/91
E
E
E
200,000.00
200,000.00
200,000.00
08/22/91
08/23/91
08/24/91
08/25/91
08/26/91
08/27/91
08/28/91
08/29/91
08/30/91
08/31/91
09/01/91
09/02/91
E
E
E
E
E
E
E
E
E
E
E
E
900,000.00
900,000.00
900,000.00
900,000.00
1,150,000.00
750,000.00
500,000.00
750,000.00
900,000.00
900,000.00
900,000.00
900,000.00
337
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name: Iona S a v i n g s Bank
L o c a t i o n : T i l t o n , NH
Date o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
D i s c o u n t Window Loans
or 1 3 ( c ) a s s i s t a n c e :
Pate
At t i m e o f f a i l u r e :
10/11/91
Loan Type
Amount
Extended
$2,400,000
N/A
Peak borrowing:
7/29/91
C o l l a t e r a l securing loan at time of
Book v a l u e :
N/A
Lendable v a l u e :
N/A
C o n s e c u t i v e days of borrowing:
failure
5
6-15
16-30
31-60
Over 60
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
Composite CAMEL r a t i n g s
At t i m e o f
failure:
Previous r a t i n g s ,
if
any:
gyromgry h i s t o r y pf c o l l a t e r a l
1
Rating
"As-of" Date
f o r Rating
Date R e c e i v e d
from R e g u l a t o r
5
7/30/91
N/A
5
4
3
2
5/20/91
4/06/90
5/26/89
2/19/88
N/A
N/A
N/A
N/A
pledged;
Borrowings from 6 / 1 1 / 9 1 through 6 / 2 6 / 9 1 were s e c u r e d by 1 - 4
family
r e s i d e n t i a l mortgages t o t a l i n g $ 1 , 5 9 9 , 4 7 7 ,
w i t h a l e n d a b l e v a l u e of
$ 1 , 2 7 9 , 5 8 2 . Amounts borrowed from 6 / 2 7 / 9 1 t h r o u g h 8 / 1 5 / 9 1 were s e c u r e d by 1 4 family mortgages t o t a l i n g $ 3 , 6 2 0 , 4 5 8 , w i t h a lendable value of $ 2 , 8 9 6 , 3 6 6 .
At t h e t i m e o f f a i l u r e , 1 - 4 f a m i l y r e s i d e n t i a l mortgages t o t a l i n g
were h e l d p r o v i d i n g a l e n d a b l e v a l u e o f $ 2 , 8 8 3 , 9 7 2 .
$3,604,965
338
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF F A I L E D I N S T I T U T I O N :
LOCATION ( C I T Y AND S T A T E ) :
LOAN
DATE
06/11/91
06/12/91
06/13/91
06/14/91
06/15/91
06/16/91
06/17/91
06/18/91
06/19/91
06/20/91
06/21/91
06/22/91
06/23/91
06/24/91
06/25/91
06/26/91
06/27/91
06/28/91
06/29/91
06/30/91
07/01/91
07/02/91
07/03/91
07/04/91
07/05/91
07/06/91
07/07/91
07/08/91
07/09/91
07/10/91
07/11/91
07/12/91
07/13/91
07/14/91
07/15/91
07/16/91
07/17/91
07/18/91
07/19/91
07/20/91
07/21/91
IONA S A V I N G S BANK
T I L T O N , NEW HAMPSHIRE
CREDIT
TYPE
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
LOAN
AMOUNT
50,000
150,000
200,000
275,000
275,000
275,000
575,000
675,000
675,000
625,000
555,000
555,000
555,000
600,000
525,000
525,000
425,000
345,000
345,000
345,000
420,000
400,000
400,000
400,000
270,000
270,000
270,000
1,460,000
1,640,000
1,140,000
1,460,000
1,730,000
1,730,000
1,730,000
1,650,000
1,575,000
1,545,000
2,235,000
2,265,000
2,265,000
2,265,000
339
07/22/91
07/23/91
07/24/91
07/25/91
07/26/91
07/27/91
07/28/91
07/29/91
07/30/91
07/31/91
08/01/91
08/02/91
08/03/91
08/04/91
08/05/91
08/06/91
08/07/91
08/08/91
08/09/91
08/10/91
08/11/91
08/12/91
08/13/91
08/14/91
08/15/91
08/16/91
08/17/91
08/18/91
08/19/91
08/20/91
08/21/91
08/22/91
08/23/91
08/24/91
08/25/91
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
1,765,000
1,715,000
1,730,000
1,700,000
1,750,000
1,750,000
1,750,000
2,400,000
1,925,000
1,835,000
1,735,000
1,800,000
1,800,000
1,800,000
1,825,000
2,125,000
1,575,000
1,525,000
1,525,000
1,525,000
1,525,000
2,225,000
1,625,000
1,825,000
1,750,000
1,750,000
1,750,000
1,750,000
1,565,000
1,420,000
1,470,000
1,470,000
480,000
480,000
480,000
340
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name:
Merchants N a t i o n a l Bank
Location: Leominster, Massachusetts
Date of c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
pjgcount Wjnflow Loans
or 13(c) a s s i s t a n c e :
December 1 3 ,
Loan Typ.e
Amount
Date
At t i m e o f f a i l u r e :
not
Peak borrowing:
1/18/91
not applicable
Lendable v a l u e :
not a p p l i c a b l e
C o n s e c u t i v e d a y s o f bpyrowing:
§
6-15
0
0
At t i m e o f
Rating
failure:
Previous ratings, i f
any:
Summary H i s t o r y o f C Q i l ^ t e r ^ i
$ 6 . 3 MM
failure
Number o f o c c u r r e n c e s i n t h e
12-month p e r i o d b e f o r e f a i l u r e :
Composite CAMEL r a t i n g s :
applicable
Adjustment
CoUfrtereg securing loan a t time of
Book v a l u e :
1991
l,6-?0
1
" A s - o f " Date
f o r Rating
31-6Q
0
o y e r 6p
0
Date R e c e i v e d
from R e g u l a t o r
2/4/91
not available
10/12/90
2/28/90
5/15/89
not available
not available
not available
pigged
Merchants N a t i o n a l Bank (MNB) f i r s t borrowed on 1 2 / 2 6 and 1 2 / 2 7 / 9 0
c o l l a t e r a l i z e d by a $1MM T r e a s u r y n o t e .
The i n s t i t u t i o n n e x t borrowed on
1 2 / 3 1 / 9 0 c o l l a t e r a l i z e d by $2MM i n T r e a s u r y n o t e s .
341
MNB secured l o a n advances through t h e f i r s t 22 days of January w i t h
v a r i o u s Treasury and Agency s e c u r i t i e s h e l d f o r investment i n t h e i r Federal
Reserve Bank s a f e k e e p i n g account. On January 23, 1991, MNB d e l i v e r e d $6.5MM
of 1 - 4 f a m i l y r e s i d e n t i a l mortgage loans e s t a b l i s h i n g a permanently p l e d g e d
c o l l a t e r a l pool v a l u e d a t $4.8MM.
The d e l i v e r y of t h e r e s i d e n t i a l n o t e s
f r e e d up MNB's more l i g u i d a s s e t s f o r use i n o b t a i n i n g p r i v a t e s e c t o r
funding.
Loans extended a t an amount i n e x c e s s of t h e 1 - 4 family p l e d g e d
p o r t f o l i o were secured by Treasury and Agency s e c u r i t i e s .
On January 31,
1991, MNB had c o l l a t e r a l pledged t o t h e Reserve Bank w i t h a t o t a l p r i n c i p a l
of $10.6MM, c o n s i s t i n g of $6.6MM i n 1 - 4 f a m i l y mortgages and a $4MM Treasury
n o t e . The pledged pool was valued f o r c o l l a t e r a l purposes a t $8.2MM.
On February 5, 1991, MNB added $3.8MM of 1-4 f a m i l y mortgage l o a n s
b r i n g i n g t h e t o t a l p r i n c i p a l v a l u e pledged t o $14.6MM. This a f f o r d e d MNB a
c o l l a t e r a l c a p a c i t y of $11MM.
On February 21, 1991, t h e Reserve Bank r e l e a s e d t h e $4MM Treasury n o t e
f o r MNB t o use i n s e c u r i n g p r i v a t e s e c t o r repo funds. On February 2 7 , 1991,
t h e Reserve Bank a c c e p t e d $15.6MM i n commercial loans a t a 50% d i s c o u n t f o r
c o l l a t e r a l p u r p o s e s . This brought MNB's p r i n c i p a l value o f pledged a s s e t s t o
$26.2MM and o f f e r e d a c o l l a t e r a l c a p a c i t y of $ 14.6MM.
Subsequently, c o l l a t e r a l pledged by MNB t o the Reserve Bank remained
unchanged w i t h t h e e x c e p t i o n of normal p r i n c i p a l paydowns.
On March 31,
1991, MNB was p l e d g i n g $26.1MM i n commercial r e a l - e s t a t e and 1-4 f a m i l y
r e s i d e n t i a l l o a n s . This a f f o r d e d MNB a c o l l a t e r a l c a p a c i t y of $14.1MM. At
June 30, 1991, p r i n c i p a l updates had changed t h e v a l u e of t h e c o l l a t e r a l p o o l
t o $25.7MM i n p r i n c i p a l . This was valued a t $14.7MM f o r c o l l a t e r a l purposes
by t h e Reserve Bank.
On September 30, 1991, MNB's c o l l a t e r a l p l e d g e d
t o t a l l e d $24.5MM w i t h a c o l l a t e r a l value of $14MM.
On December 13, 1991, MNB's c l o s i n g d a t e , t h e Reserve Bank held i n i t s
v a u l t $9.4MM i n 1 - 4 f a m i l y mortgage l o a n s and $ 14.2MM i n commercial r e a l
estate.
The t o t a l p r i n c i p a l v a l u e of c o l l a t e r a l h e l d was $23.6MM with a
c o l l a t e r a l v a l u e of $14MM.
The FDIC i n d i c a t e d t o t h e Reserve Bank, both
o r a l l y and i n w r i t i n g , t h a t i t s l e n d i n g f o r l i q u i d i t y purposes would
f a c i l i t a t e an o r d e r l y r e s o l u t i o n o f MNB.
EL0392
mil
342
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF F A I L E D I N S T I T U T I O N :
L O C A T I O N ( C I T Y AND S T A T E ) :
froan Pate
12/26/90
12/27/90
MERCHANTS N A T I O N A L BANK
L E O M I N S T E R , MA
Credit Type
ADJ
ADJ
Loan Amount
975/000
450,000
12/31/90
01/01/91
ADJ
ADJ
1,125,000
1,125,000
01/03/91
01/04/91
01/05/91
01/06/91
01/07/91
01/08/91
01/09/91
01/10/91
01/11/91
01/12/91
01/13/91
01/14/91
01/15/91
01/16/91
01/17/91
01/18/91
01/19/91
01/20/91
01/21/91
01/22/91
01/23/91
01/24/91
01/25/91
01/26/91
01/27/91
01/28/91
01/29/91
01/30/91
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
3,200,000
2,450,000
2,450,000
2,450,000
1,050,000
1,950,000
1,400,000
3,500,000
5,080,000
5,080,000
5,080,000
1,400,000
3,000,000
4,500,000
5,450,000
6,275,000
6,275,000
6,275,000
6,275,000
5,125,000
4,000,000
5,250,000
5,225,000
5,225,000
5,225,000
1,400,000
1,775,000
750,000
06/20/91
ADJ
400,000
10/23/91
EXT
200,000
343
FDIC
Federal Deposit Insurance Corporation
160 Gould Street. Needham. Massachusetts
02194
(617) 449-9080
Boston Regional Office
October 21, 1991
Mr. Curtis Turner
Vice President
Loan and Credit
Federal Reserve Bank of Boston
600 Atlantic Avenue
Boston, Massachusetts 02106
RE: Merchants National Bank
Leominster. Massachusetts
Dear Mr. Turner:
As discussed v i t h Revlev Examiner James A. Bazydlo, this i s to confirm that the
orderly resolution of the subject bank w i l l be f a c i l i t a t e d by the discount
windov of the Federal Reserve Bank of Boston providing funds to Merchants
National Bank for liquidity purposes should the bank make a request. As you
are aware the bank i s tentatively expected to be closed and the FDIC named
receiver on Friday, December 13, 1991.
Very truly yours
Regional Director
344
SUMMARY RECORD OF DISCOUNT WINDOW LENDING
(Over 36-Month Period Prior to Failure)
NORTHWEST NATIONAL BANK
FAYETTEVILLE, AR
Date of Conservatorship,
Receivership or 13(c) Assistance:
D i s c o u n t Window L o a n s
At t i m e o f
Date
failure:
Peak Borrowing:
C o l l a t e r a l S e c u r i n g Loan a t Time o f
Par Value
8/16/91
Amount
8/16/91
E
$2,800,000
8/12/91
E
$3,475,000
Failure:
$4,662,303
Lendable Value
C o n s e c u t i v e Days o f
$3,602,112
Borrowing
5
6-15
Number o f o c c u r r e n c e s
i n t h e 36-month p e r i o d
prior to failure:
C o m p o s i t e CAMEL R a t i n g s
At t i m e o f
Loan Type
if
Rating
any:
Summary H i s t o r y o f C o l l a t e r a l
31-60
l
failure:
Previous ratings,
16-30
Over 6 0
2
"As-of" Date
for Rating
5
5/31/91
4
4
4
4
3
9/10/90
12/31/89
4/30/89
3/31/87
2/28/86
Date Received
from Regulator
Pledged
Date
8/16/89
Pledged/
Released
Pledged
Description
US Gvt & Agy
Par
Value
$2,150,000
Lendable
Value
$2,150,000
8/23/89
Released
US Agy
$1,150,000
$1,150,000
9/13/89
Released
US Gvt
$250,000
$250,000
9/21/89
Released
US Gvt
$750,000
$750,000
5/7/90
Pledged
US Gvt & Agy
$675,000
$675,000
5/21/90
Released
US Gvt & Agy
$675,000
$675,000
345
NORTHWEST NATIONAL BANK (contd)
FAYETTEVILLE, AR
Summary H i s t o r y o f C o l l a t e r a l P l e d g e d
Date
Pledged/
Released
Description
7/5/91
Pledged
US Gvt
(contd)
Lendable
Value
$900,000
$900,000
$602,294
$301,147*
$1,475,000
$1,475,000
1 - 4 Mortgage N o t e s
Car Loans
CD S e c u r e d Loans
$509,610
$114,307
$210,011
$254,805*
$45,723*
$105,005*
US Gvt
$300,000
$300,000
7/22/91
Pledged
1 - 4 Mortgage N o t e s
7/25/91
Pledged
US Gvt & Agy
7/29/91
Pledged
8/1/91
Pledged
8/5/91
Pledged
Car Loans
8/20/91
Released
US Gvt & Agy
1 - 4 Mortgage N o t e s
Car Loans
CD S e c u r e d Loans
*
Par
V*lue
$551,081
$220,432*
$2,675,000
$1,111,904
$665,388
$210,011
$2,675,000
$555,952*
$266,155*
$105,005*
L e n d a b l e v a l u e b a s e d o n p r e s e n c e o f p a s t d u e and n o n a c c u r a l n o t e s
o v e r a l l w e a k e n e d c o n d i t i o n o f bank a s s e t s .
and
346
NORTHWEST NATIONAL BANK (contd)
FAYETTEVILLE, AR
Detailed
Record
of
Discount
Window
Lending
(Over 36-Month Period Prior to Failure)
Date
8/16/89
8/17/89
8/18/89
8/19/89
8/20/89
8/21/89
8/22/89
8/23/89
8/24/89
8/25/89
8/26/89
8/27/89
8/28/89
8/29/89
8/30/89
8/31/89
9/1/89
9/2/89
9/3/89
9/4/89
9/5/89
9/6/89
9/7/89
9/8/89
9/9/89
9/10/89
9/11/89
9/12/89
9/13/89
9/14/89
9/15/89
9/16/89
9/17/89
9/18/89
9/19/89
Loan
Type
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
A
Amount of
Loan Outstandincr
$2,150,000
$2,150,000
$2,150,000
$2,150,000
$2,150,000
$2,150,000
$2,150,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$1,000,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
$700,000
347
NORTHWEST NATIONAL BANK (contd)
FAYETTEVILLE, AR
Detailed
Record
of
Discount
Window
Lending
(Over 36-Month Period Prior to Failure)
Date
5/7/90
5/8/90
5/9/90
5/10/90
5/11/90
5/12/90
5/13/90
5/14/90
5/15/90
5/16/90
5/17/90
5/18/90
5/19/90
5/20/90
Loan
Type
Amount of
Loan Outstanding
A
A
A
A
A
A
A
A
A
A
A
A
A
A
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
$650,000
348
NORTHWEST NATIONAL BANK (contd)
FAYETTEVILLE, AR
Detailed
Record
of
D i s c o u n t Window
Lending
(Over 36-Month Period Prior to Failure)
Loan
Type
Amount of
Loan Outstanding
7/8/91
7/9/91
A
A
$700,000
$700,000
7/11/91
7/12/91
7/13/91
7/14/91
7/15/91
7/16/91
7/17/91
7/18/91
7/19/91
7/20/91
7/21/91
7/22/91
7/23/91
7/24/91
7/25/91
7/26/91
7/27/91
7/28/91
7/29/91
7/30/91
7/31/91
8/1/91
8/2/91
8/3/91
8/4/91
8/5/91
8/6/91
8/7/91
8/8/91
8/9/91
8/10/91
8/11/91
8/12/91
8/13/91
8/14/91
8/15/91
8/16/91
8/17/91
8/18/91
A
A
A
A
A
A
A
A
A
A
A
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
$300,000
$300,000
$300,000
$800,000
$800,000
$800,000
$800,000
$800,000
$600,000
$600,000
$600,000
$900,000
$300,000
$400,000
$2,135,000
$2,135,000
$2,135,000
$2,135,000
$1,825,000
$1,300,000
$1,800,000
$2,260,000
$2,140,000
$2,140,000
$2,140,000
$2,790,000
$1,975,000
$2,400,000
$2,650,000
$2,500,000
$2,500,000
$2,500,000
$3,475,000
$2,575,000
$2,940,000
$2,665,000
$2,800,000
$2,800,000
$2,800,000
Date
349
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure of Depository Institution
(Detailed Record Attached)
Name:
Location:
PEOPLES BANK
HEWITT, TX
Date of conservatorship, receivership, or 13(c) assistance::
Discount window loans
Date
At time of failure
Peak borrowing:
1991-06-13
1991-04-24
1991-06-13
Loan Type
Amount
Extended
Extended
1,075,000.00
1,350,000.00
Collateral securing loan at time of failure
Book value
Lendable value
3,707,647.80
1,893,614.11
Consecutive days of borrowing:
5
6-15
16-30
Number of occurrences in the
36-month period before failure:
Composite CAMEL ratings
At time of failure:
Previous ratings, if any:
Rating
5
5
5
4
4
4
3
"As-of date"
for rating
1991-02-21
1990-06-04
1990-02-16
1989-08-30
1988-10-07
1987-10-22
1986-08-01
Book-entry U.S. government agency securities
Customers notes
Over 60
1
Summary history of collateral pledged:
52-418 - 92 - 12
31-60
Date received
from regulator
1991-04-17
1990-07-10
1990-07-06
1989-11-01
1989-01-06
1988-03-21
1986-11-21
350
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name of Failed Institution: PEOPLES BANK
ion (City and State):
HEWITT, TX
Date
Loan
Type
Amount of
Loan Outstanding
91-03-07
E
100,000.00
91-03-11
91-03-12
91-03-13
91-03-14
91-03-15
91-03-16
91-03-17
91-03-18
91-03-19
91-03-20
91-03-21
91-03-22
91-03-23
91-03-24
91-03-25
91-03-26
91-03-27
91-03-28
91-03-29
91-03-30
91-03-31
91-04-01
91-04-02
91-04-03
91-04-04
91-04-05
91-04-06
91-04-07
91-04-08
91-04-09
91-04-10
91-04-11
91-04-12
91-04-13
91-04-14
91-04-15
91-04-16
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
200,000.00
100,000.00
200,000.00
400,000.00
400,000.00
400,000.00
400,000.00
350,000.00
250,000.00
375,000.00
375,000.00
375,000.00
375,000.00
375,000.00
375,000.00
450,000.00
450,000.00
650,000.00
650,000.00
650,000.00
650,000.00
450,000.00
150,000.00
300,000.00
575,000.00
675,000.00
675,000.00
675,000.00
650,000.00
600,000.00
800,000.00
625,000.00
600,000.00
600,000.00
600,000.00
825,000.00
625,000.00
1
351
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name of Failed Institution: PEOPLES BANK
Location (City and State): HEWITT, TX
Date
91-04-17
91-04-18
91-04-19
91-04-20
91-04-21
91-04-22
91-04-23
91-04-24
91-04-25
91-04-26
91-04-27
91-04-28
91-04-29
91-04-30
91-05-01
91-05-02
91-05-03
91-05-04
91-05-05
91-05-06
91-05-07
91-05-08
91-05-09
91-05-10
91-05-11
91-05-12
91-05-13
91-05-14
91-05-15
91-05-16
91-05-17
91-05-18
91-05-19
91-05-20
91-05-21
91-05-22
91-05-23
91-05-24
91-05-25
91-05-26
Loan
Type
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
2
Amount of
Loan Outstanding
625,000.00
875,000.00
900,000.00
900,000.00
900,000.00
975,000.00
1,025,000.00
1,350,000.00
1,125,000.00
1,175,000.00
1,175,000.00
1,175,000.00
1,325,000.00
1,250,000.00
1,050,000.00
850,000.00
1,025,000.00
1,025,000.00
1,025,000.00
1,025,000.00
1,025,000.00
1,025,000.00
1,150,000.00
1,200,000.00
1,200,000.00
1,200,000.00
1,325,000.00
1,125,000.00
1,175,000.00
1,175,000.00
1,175,000.00
1,175,000.00
1,175,000.00
1,075,000.00
875,000.00
1,075,000.00
1,150,000.00
1,200,000.00
1,200,000.00
1,200,000.00
352
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name of Failed Institution:
Location (City and State):
PEOPLES BANK
HEWITT, TX
Loan
Date
91-05-27
91-05-28
91-05-29
91-05-30
91-05-31
91-06-01
91-06-02
91-06-03
91-06-04
91-06-05
91-06-06
91-06-07
91-06-08
91-06-09
91-06-10
91-06-11
91-06-12
91-06-13
Type
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
3
Amount of
Loan Outstanding
1,200,000.00
1,200,000.00
1,200,000.00
1,200,000.00
1,100,000.00
1,100,000.00
1,100,000.00
950,000.00
850,000.00
1,050,000.00
925,000.00
800,000.00
800,000.00
800,000.00
900,000.00
900,000.00
950,000.00
1,075,000.00
353
Summary Record of D i s c o u n t Window Lending
Over 36-Month P e r i o d P r i o r t o F a i l u r e of D e p o s i t o r y I n s t i t u t i o n
( D e t a i l e d Record A t t a c h e d )
Name of F a i l e d I n s t i t u t i o n S o u t h e a s t Bank. N.A.
Miami. F l o r i d a
Location
D a t e of C o n s e r v a t o r s h i p ,
Receivership, or 13(c) Assistance
9/19/91
Date
Loan_Type
Amount
At Time of F a i l u r e
9/19/91
EXT
$ 568.000.000
Peak Borrowing
9/19/91
EXT.
$ 568.000.000
C o l l a t e r a l S e c u r i n g Loan a t Time of
Book Value
Lendable Value
Failure:
$1.332.789.000
Consecutive D
Number o f O c c u r r e n c e s
i n t h e 36-Month
P e r i o d Before
Failure:
"As-Of" Date
for..Rating
At Time of F a i l u r e
IN_PROCESS
Previous Ratings,
i f Any
04/10/90...
01/26/90 .
.06/30/89.
01/31/89
Summary H i s t o r y o f C o l l a t e r a l
Date R e c e i v e d
from R e g u l a t o r
12^24/9004/19/90
03/21/90
12/15/89
04/06/89
Pledged:
I n e a r l y A p r i l o f 1 9 9 1 , S o u t h e a s t Bank p l e d g e d t o the d i s c o u n t window
commercial n o t e s h a v i n g a f a c e v a l u e o f $295 m i l l i o n and a l e n d a b l e v a l u e o f
$254- m i l l i o n .
At t h e same t i m e , t h e bank a l s o i d e n t i f i e d a s u b s t a n t i a l
volume o f o t h e r t y p e s o f l o a n s t h a t c o u l d be p l e d g e d q u i c k l y i n t h e e v e n t o f
a sudden and u n e x p e c t e d l y l a r g e need f o r F e d e r a l Reserve c r e d i t .
This
c o n s i s t e d o f $ 1 . 1 b i l l i o n o f consumer i n s t a l l m e n t l o a n s , $ 1 . 5 b i l l i o n o f
r e s i d e n t i a l and commercial r e a l e s t a t e m o r t g a g e s , and $286 m i l l i o n o f c r e d i t -
354
card r e c e i v a b l e s . On June 27, the f i r s t day o f discount-window borrowing b y
S o u t h e a s t , consumer i n s t a l l m e n t loans w i t h a l e n d a b l e value of $362 m i l l i o n
were pledged as a d d i t i o n a l c o l l a t e r a l .
On August 19, the remainder o f $ 1 . 1
b i l l i o n consumer i n s t a l l m e n t loans were pledged; the t o t a l consumer l o a n s had
a l e n d a b l e value of $977 m i l l i o n .
F i n a l l y , on August 27 commercial n o t e s
w i t h a f a c e value of $163 m i l l i o n and a l e n d a b l e v a l u e of $131 m i l l i o n were
p l e d g e d t o the d i s c o u n t window.
355
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
SOUTHEAST BANK NA
MIAMI , FL
CLOSED DATE: 0 9 / 1 9 / 9 1
LOAN
TYPE
OUTSTANDING
BALANCE
06/27/91
A
200,000,000
07/09/91
A
48,000,000
07/12/91
07/13/91
07/14/91
07/15/91
07/16/91
A
A
A
A
A
60,000,000
60,000,000
60,000,000
125,000,000
40,000,000
07/18/91
07/19/91
07/20/91
07/21/91
07/22/91
07/23/91
07/24/91
07/25/91
07/26/91
07/27/91
07/28/91
07/29/91
07/30/91
07/31/91
08/01/91
08/02/91
08/03/91
08/04/91
08/05/91
08/06/91
08/07/91
08/08/91
08/09/91
08/10/91
08/11/91
08/12/91
08/13/91
A
A
A
A
A
A
A
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
80,000,000
100,000,000
100,000,000
100,000,000
180,000,000
215,000,000
35,000,000
225,000,000
165,000,000
165,000,000
165,000,000
150,000,000
275,000,000
125,000,000
220,000,000
175,000,000
175,000,000
175,000,000
225,000,000
210,000,000
120,000,000
260,000,000
245,000,000
245,000,000
245,000,000
285,000,000
315,000,000
DATE
NOTE: D a i l y o u t s t a n d i n g l o a n b a l a n c e s i n c l u d e w e e k e n d d a y s .
blank l i n e indicates break in borrowing sequence.
Also,
356
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
SOUTHEAST BANK NA
MIAMI , F L
CLOSED DATE: 0 9 / 1 9 / 9 1
DATE
08/14/91
08/15/91
08/16/91
08/17/91
08/18/91
08/19/91
08/20/91
08/21/91
08/22/91
08/23/91
08/24/91
08/25/91
08/26/91
08/27/91
08/28/91
08/29/91
08/30/91
08/31/91
09/01/91
09/02/91
09/03/91
09/04/91
09/05/91
09/06/91
09/07/91
09/08/91
09/09/91
09/10/91
09/11/91
09/12/91
09/13/91
09/14/91
09/15/91
09/16/91
09/17/91
09/18/91
09/19/91
LOAN
TYPE
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
E
OUTSTANDING
BALANCE
230,000,000
300,000,000
295,000,000
295,000,000
295,000,000
290,000,000
320,000,000
225,000,000
350,000,000
415,000,000
415,000,000
415,000,000
325,000,000
325,000,000
327,000,000
460,000,000
442,000,000
442,000,000
442,000,000
442,000,000
500,000,000
343,000,000
420,000,000
435,000,000
435,000,000
435,000,000
485,000,000
460,000,000
405,000,000
535,000,000
565,000,000
565,000,000
565,000,000
535,000,000
540,000,000
548,000,000
568,000,000
NOTE: D a i l y o u t s t a n d i n g l o a n b a l a n c e s i n c l u d e
blank l i n e i n d i c a t e s break in borrowing
weekend days.
sequence.
Also,
357
BOARD
•
OF
GOVERNOR5
OF T H E
FEDERAL RESERVE
SYSTEM
W A S H I N G T O N , 0 . C. 2 0 5 5 1
August
19,
1991
Mr. L. W i l l i a m S e i d m a n
Chairman
Federal Deposit Insurance Corporation
5 5 0 S e v e n t e e n t h S t r e e t , N.W.
Washington, D.C.
20429
D e a r Mr.
Chairman:
As you a r e aware, S o u t h e a s t Bank, N.A. h a s b e e n
b o r r o w i n g f r o m t h e d i s c o u n t window o f t h e F e d e r a l R e s e r v e Bank o f
A t l a n t a r e g u l a r l y s i n c e mid J u l y o f t h i s y e a r .
In connection
w i t h t h e s e b o r r o w i n g s , t h e F e d e r a l R e s e r v e Bank of A t l a n t a h a s
r e c e n t l y conducted an examination of Southeast t o determine
whether S o u t h e a s t c o u l d be e x p e c t e d t o r e s t o r e normal a c c e s s t o
l i q u i d i t y i n t h e m a r k e t and t h e r e f o r e , b e a b l e t o r e p a y t h e
Federal Reserve loan.
Although the report of the examination i s s t i l l
being
f i n a l i z e d , b a s e d on p r e l i m i n a r y f i n d i n g s , we a r e c o n c e r n e d t h a t
S o u t h e a s t may n o t b e a b l e t o r e s t o r e n o r m a l a c c e s s t o l i q u i d i t y
without federal assistance.
Southeast currently has a Tier 1
leverage r a t i o of 2.3 percent.
Poor a s s e t q u a l i t y and c o n t i n u i n g
operating losses are expected to eliminate t h i s capital in the
foreseeable future.
Under t h e s e c i r c u m s t a n c e s , t h e F e d e r a l Reserve d o e s n o t
c o n s i d e r i t t o be appropriate f o r t h e Federal Reserve t o continue
t o extend credit t o Southeast unless such continued extensions of
credit w i l l enable the Federal Deposit Insurance Corporation t o
r e s o l v e S o u t h e a s t i n an o r d e r l y manner and m i n i m i z e t h e c o s t t o
t h e FDIC.
A c c o r d i n g l y , t h e Board i s r e q u e s t i n g t h e v i e w s of t h e
FDIC a s t o w h e t h e r c o n t i n u e d e x t e n s i o n o f F e d e r a l R e s e r v e c r e d i t
w o u l d b e c o n s i s t e n t w i t h t h e s e c r i t e r i a and t h e d u r a t i o n t h a t
such c r e d i t might be required.
Very t r u l y
yours,
W i l l i a m W. W i l e s
S e c r e t a r y o f t h e Board
358
FEDERAL DEPOSIT INSURANCE CORPORATION,
Washington,
dc 20429
OFFICE OF THE CHAIRMAN
August 22,
1991
Gentlemen:
You h a v e r e q u e s t e d t h e v i e w s o f t h e FDIC r e g a r d i n g t h e
r e s o l u t i o n o f S o u t h e a s t Bank, N.A.
Staff i s in discussion with a
number o f p r o s p e c t i v e a c q u i r o r s , a s w e l l a s S o u t h e a s t B a n k i n g
Corporation, regarding p o s s i b l e assistance.
Our o b j e c t i v e i s t o
consummate such a t r a n s a c t i o n w i t h i n a p p r o x i m a t e l y e i g h t weeks —
or i f open a s s i s t a n c e p r o v e s c o s t e f f e c t i v e t o e x e c u t e an
agreement, s u b j e c t t o any n e c e s s a r y s t o c k h o l d e r or bondholder
c o n s e n t s , w i t h i n t h e same t i m e - f r a m e .
We b e l i e v e t h a t , w h a t e v e r
t h e f o r m o f t h e t r a n s a c t i o n , i t w i l l r e d u c e t h e c o s t s t o t h e Bank
I n s u r a n c e Fund t o a v o i d h a v i n g t o b r i d g e t h e b a n k .
Accordingly,
we r e q u e s t t h a t t h e F e d e r a l R e s e r v e Bank o f A t l a n t a c o n t i n u e
l e n d i n g t o S o u t h e a s t Bank, N.A. u n t i l t h e 1 8 t h o f O c t o b e r .
Sincerely,
tC^cJ
L. W i l l i a m
Chairman
Board of Governors of t h e
Federal Reserve System
W a s h i n g t o n , D.C.
20551
Seidman
359
fgp
FEDERAL DEPOSIT INSURANCE CORPORATION,
Washington,
dc 20429
OFFICE OF THE CHAIRMAN
September 10,
1991
Gentlemen:
Y o u h a v e a g a i n r e q u e s t e d t h e v i e w s o f t h e FDIC
r e g a r d i n g t h e r e s o l u t i o n of S o u t h e a s t Bank, N.A.
Staff is in
d i s c u s s i o n w i t h a number o f p r o s p e c t i v e a c q u i r o r s , a s w e l l a s
Southeast Banking Corporation, regarding p o s s i b l e a s s i s t a n c e .
Based on a r e v i s e d s c h e d u l e , our o b j e c t i v e i s t o consummate a
c o s t e f f e c t i v e t r a n s a c t i o n w i t h r e s p e c t t o t h e bank w i t h i n t h e
Whatever t h e form of t h e t r a n s a c t i o n
t h i r d quarter of 1991.
u l t i m a t e l y consummated, we b e l i e v e t h a t p r o v i d i n g t h e a s s i s t a n c e
t o e f f e c t such a t r a n s a c t i o n would n o t e x c e e d t h e c o s t o f
l i q u i d a t i n g t h e bank a t t h i s time.
A c c o r d i n g l y , we r e q u e s t t h a t
t h e F e d e r a l R e s e r v e Bank o f A t l a n t a c o n t i n u e l e n d i n g t o S o u t h e a s t
Bank, N.A.
Sincerely,
L. W i l l i a m
Chairman
Board of Governors
Federal Reserve System
Washington, D.C.
20551
Seidman
360
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure of Depository Institution
(Detailed Record Attached)
Name:
Location:
TASCOSA NATIONAL BANK
AMARILL0, TX
Date of conservatorship, receivership, or 13(c) assistance:
Discount window loans
Date
At time of failure
Peak borrowing:
1991-06-13
1991-02-27
1991-06-13
Loan Type
Amount
Extended
0.00
1,000,000.00
Collateral securing loan at time of failure
Book value
Lendable value
6,861,557.21
5,214,783.48
Consecutive days of borrowing:
5
Number of occurrences in the
36-month period before failure:
Composite CAMEL ratings
At time of failure:
Previous ratings, if any:
16-30
31-60
Over 60
1
Rating
"As-of date"
for rating
5
5
5
4
4
4
4
1989-12-31
1989-06-30
1988-05-31
1987-06-30
1986-06-30
1985-05-31
1984-07-31
Summary history of collateral pledged:
Customers notes
6-15
Date received
from regulator
1990-06-11
1989-11-03
1988-09-20
1987-10-14
1986-10-24
1985-09-23
1985-01-17
361
Detailed Record of Discount Window Lending
Over 36-Month Period Prior to Failure
Name of Failed Institution:
Location (City and State):
TASCOSA NATIONAL BANK
AMARILLO, TX
Loan
Date
Type
91-02-26
91-02-27
91-02-28
91-03-01
91-03-02
91-03-03
E
E
E
E
E
E
1
Amount of
Loan Outstanding
500,000.00
1,000,000.00
1,000,000.00
600,000.00
600,000.00
600,000.00
362
Summary Record of Discount: Window
Lending Over 12-Month Period Prior to
Failure of Depository Institution
Name: U n i v e r s i t y Bank, N. A.
L o c a t i o n : Newton, MA
Date of c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
or 1 3 ( c ) a s s i s t a n c e :
5/31/91
D i s c o u n t Window Loans
Date
Loan Type
Amount
At t i m e of
5/31/91
Extended
$20,300,000
4/30/91
Extended
$28,900,000
failure:
Peak borrowing:
C o l l a t e r a l securing loan a t time of
Book v a l u e :
$59,324,700
Lendable v a l u e :
$39,863,882
failure
C o n s e c u t i v e days o f t>orroyj.nq:
6-15
16-30
31-60
Over 60
Number o f o c c u r r e n c e s i n t h e
36-month p e r i o d b e f o r e f a i l u r e :
Composite CAMEL r a t i n g s
At t i m e o f
Rating
failure:
Previous ratings,
if
any:
Summary h i s t o r y o f c o l l a t e r a l
"As-of" Date
f o r Rating
Date R e c e i v e d
from R e g u l a t o r
1/31/91
N/A
3/06/90
3/12/90
5/02/89
9/29/88
N/A
N/A
N/A
N/A
Pledged:
The t h r e e l o a n s p r i o r t o 4 / 2 5 / 9 0 were c o l l a t e r a l i z e d w i t h government
s e c u r i t i e s w i t h p r i n c i p a l v a l u e s t h a t ranged i n t o t a l from $600 t h o u s a n d t o
$2.5 m i l l i o n .
S u b s e q u e n t l y , U n i v e r s i t y Bank, N. A. ( U n i v e r s i t y ) began
p l e d g i n g 1 - 4 f a m i l y r e s i d e n t i a l m o r t g a g e s i n l i e u of s e c u r i t i e s .
By
1 2 / 3 1 / 9 0 , U n i v e r s i t y had p l e d g e d $ 2 7 . 9 m i l l i o n i n 1 - 4 f a m i l y r e s i d e n t i a l
mortgage l o a n s w i t h a l e n d a b l e v a l u e o f $ 2 2 . 3 m i l l i o n .
By J a n u a r y ' s c l o s e ,
U n i v e r s i t y ' s c o l l a t e r a l p o s i t i o n d e c r e a s e d s l i g h t l y due t o normal customer
b a l a n c e paydowns. On February 8 , 1 9 9 1 , U n i v e r s i t y i n c r e a s e d t h e l e v e l of 1 - 4
f a m i l y m o r t g a g e s t o $ 3 2 . 6 m i l l i o n , w i t h a l e n d a b l e v a l u e of $ 2 6 . 1 m i l l i o n .
On February 1 4 , 1991, U n i v e r s i t y s u b s t a n t i a l l y i n c r e a s e d i t s c o l l a t e r a l ,
d e l i v e r i n g $25 m i l l i o n of commercial r e a l e s t a t e l o a n s and i n c r e a s i n g t h e
l e v e l of 1-4 f a m i l y mortgages t o $34.8 m i l l i o n .
The t o t a l v a l u e of
c o l l a t e r a l p l e d g e d e q u a l l e d $ 5 9 . 8 m i l l i o n , p r o v i d i n g $39 m i l l i o n i n l e n d a b l e
value.
C o l l a t e r a l was m a i n t a i n e d a t t h i s l e v e l , w i t h s m a l l f l u c t u a t i o n s ,
363
Page 2 of 2
Name: U n i v e r s i t y Bank, N. A.
Location:
Newton, MA
Date o f c o n s e r v a t o r s h i p , r e c e i v e r s h i p ,
or 1 3 ( c ) a s s i s t a n c e :
5/31/91
u n t i l A p r i l 5, 1991.
On t h a t d a t e , U n i v e r s i t y . p l e d g e d an a d d i t i o n a l $64
m i l l i o n o f commercial and r e t a i l l o a n s . No c o l l a t e r a l v a l u e was a s s i g n e d t o
t h i s p l e d g e b e c a u s e t h e n o t e s were n o t i n t h i s R e s e r v e Bank's p o s s e s s i o n .
T h i s p o s i t i o n was m a i n t a i n e d u n t i l c l o s u r e . On A p r i l 30, 1991, t h i s R e s e r v e
Bank h e l d $ 2 2 . 3 m i l l i o n o f commercial l o a n s and $ 3 1 . 4 m i l l i o n o f 1 - 4 f a m i l y
r e s i d e n t i a l mortgages i n i t s v a u l t , w i t h a l e n d a b l e v a l u e o f $ 3 6 . 3 m i l l i o n .
These f i g u r e s i n c r e a s e d somewhat by t h e end o f May c l o s u r e d a t e t o $ 2 5 . 3
m i l l i o n , $34 m i l l i o n , and $ 3 9 . 8 m i l l i o n , r e s p e c t i v e l y .
364
DETAILED RECORD OF DISCOUNT WINDOW LENDING
OVER 3 6 MONTH PERIOD PRIOR TO FAILURE
NAME OF FAILED I N S T I T U T I O N :
LOCATION (CITY AND S T A T E ) :
l«oan p a t e
09/28/89
Credit
ADJ
U n i v e r s i t y Bank,
C a m b r i d g e , MA
Type
National
Loan Amount
600,000
12/27/89
ADJ
1,700,000
01/17/90
ADJ
100,000
04/25/90
ADJ
1,700,000
05/29/90
ADJ
1,500,000
11/19/90
ADJ
200,000
01/03/91
01/04/91
01/05/91
01/06/91
01/07/91
01/08/91
01/09/91
01/10/91
01/11/91
01/12/91
01/13/91
01/14/91
01/15/91
01/16/91
01/17/91
01/18/91
01/19/91
01/20/91
01/21/91
01/22/91
01/23/91
01/24/91
01/25/91
01/26/91
01/27/91
01/28/91
01/29/91
01/30/91
01/31/91
02/01/91
02/02/91
02/03/91
02/04/91
02/05/91
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
ADJ
EXT
EXT
2,000,000
2,800,000
2,800,000
2,800,000
3,200,000
4,650,000
2,950,000
3,500,000
5,150,000
5,150,000
5,150,000
6,000,000
2,800,000
1,450,000
1,500,000
4,150,000
4,150,000
4,150,000
4,150,000
6,300,000
200,000
6,400,000
7,100,000
7,100,000
7,100,000
8,800,000
9,000,000
4,900,000
10,700,000
13,300,000
13,300,000
13,300,000
15,500,000
14,500,000
Association
365
02/06/91
02/07/91
02/08/91
02/09/91
02/10/91
02/11/91
02/12/91
02/13/91
02/14/91
02/15/91
02/16/91
02/17/91
02/18/91
02/19/91
02/20/91
02/21/91
02/22/91
02/23/91
02/24/91
02/25/91
02/26/91
02/27/91
02/28/91
03/01/91
03/02/91
03/03/91
03/04/91
03/05/91
03/06/91
03/07/91
03/08/91
03/09/91
03/10/91
03/11/91
03/12/91
03/13/91
03/14/91
03/15/91
03/16/91
03/17/91
03/18/91
03/19/91
03/20/91
03/21/91
03/22/91
03/23/91
03/24/91
03/25/91
03/26/91
03/27/91
03/28/91
03/29/91
03/30/91
03/31/91
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
2,700,000
12,900,000
13,500,000
13,500,000
13,500,000
14,200,000
13,900,000
12,400,000
13,150,000
13,250,000
13,250,000
13,250,000
13,250,000
14,500,000
12,600,000
12,600,000
13,000,000
13,000,000
13,000,000
14,000,000
13,600,000
20,400,000
20,600,000
18,200,000
18,200,000
18,200,000
19,700,000
20,200,000
12,900,000
12,600,000
12,400,000
12,400,000
12,400,000
11,800,000
11,300,000
8,700,000
8,900,000
9,000,000
9,000,000
9,000,000
11,800,000
11,000,000
16,700,000
16,400,000
16,500,000
16,500,000
16,500,000
16,900,000
16,600,000
13,600,000
17,300,000
16,500,000
16,500,000
16,500,000
366
04/01/91
04/02/91
04/03/91
04/04/91
04/05/91
04/06/91
04/07/91
04/08/91
04/09/91
04/10/91
04/11/91
04/12/91
04/13/91
04/14/91
04/15/91
04/16/91
04/17/91
04/18/91
04/19/91
04/20/91
04/21/91
04/22/91
04/23/91
04/24/91
04/25/91
04/26/91
04/27/91
04/28/91
04/29/91
04/30/91
05/01/91
05/02/91
05/03/91
05/04/91
05/05/91
05/06/91
05/07/91
05/08/91
05/09/91
05/10/91
05/11/91
05/12/91
05/13/91
05/14/91
05/15/91
05/16/91
05/17/91
05/18/91
05/19/91
05/20/91
05/21/91
05/22/91
05/23/91
05/24/91
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
18,300,000
21,300,000
20,700/000
19,900,000
19,600,000
19,600,000
19,600,000
20,100,000
20,000,000
15,600,000
14,900,000
14,900,000
14,900,000
14,900,000
14,800,000
15,000,000
6,400,000
8,400,000
9,900,000
9,900,000
9,900,000
11,700,000
17,600,000
18,000,000
18,900,000
19,600,000
19,600,000
19,600,000
22,500,000
28,900,000
24,000,000
23,800,000
24,500,000
24,500,000
24,500,000
23,100,000
23,100,000
21,000,000
20,400,000
20,700,000
20,700,000
20,700,000
25,500,000
20,800,000
20,000,000
18,800,000
20,500,000
20,500,000
20,500,000
20,400,000
18,400,000
19,100,000
19,000,000
18,900,000
367
-05/25/91
05/26/91
05/27/91
05/28/91
05/29/91
05/30/91
05/31/91
06/01/91
06/02/91
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
EXT
18,900,000
18,900,000
18,900,000
19,200,000
20,800,000
21,600,000
20,300,000
20,300,000
20,300,000
368
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.14.
D u r i n g y o u r J a n u a r y 2 9 , 1992
appearance b e f o r e t h e Banking
Committee i n c o n n e c t i o n w i t h your r e n o m i n a t i o n a s Chairman
of the Federal Reserve System I asked you whether i t would
c o n c e r n y o u i f f o r e i g n e r s owned t h e l a r g e s t American
banks.
You i n d i c a t e d t h a t s p e a k i n g s t r i c t l y a s a n
economist i t would not although i t might r a i s e other
i s s u e s such as those of "national security" or r e l a t e d
concerns.
C a n y o u t e l l me w h a t t y p e o f n a t i o n a l s e c u r i t y
might be r a i s e d i f t h e l a r g e s t U.S. banks were
by f o r e i g n i n t e r e s t s ?
A.14.
concerns
controlled
I am n o t a n e x p e r t i n t h e " n a t i o n a l s e c u r i t y " c o n cerns of the United States.
T h i s i s t h e r e a s o n why I
r e s p o n d e d t o q u e s t i o n s on t h i s s u b j e c t i n t h e way I d i d
a t t h e J a n u a r y 29 h e a r i n g .
The i s s u e i s a t what p o i n t
i s the s t r i c t l y economic i n t e r e s t s t h a t the United S t a t e s
has in
t e r m s of t h e e f f i c i e n t f u n c t i o n i n g of t h e U . S . and
i n t e r n a t i o n a l f i n a n c i a l s y s t e m s outweighed by non-economic
concerns of a national s e c u r i t y or broader p u b l i c - p o l i c y
nature.
Speaking a s a c i t i z e n a s w e l l a s an e c o n o m i s t , I would be
inclined t o think of national s e c u r i t y concerns in terms
of c a s e s where c o n t r o l of t h e l a r g e s t U.S. banks might be
e x e r c i s e d by c i t i z e n s of a country or t h e government of a
c o u n t r y w i t h whom t h e U n i t e d S t a t e s i s a t w a r , w i t h whom
the United S t a t e s does not otherwise have diplomatic or
economic r e l a t i o n s , or whose p o l i t i c a l system i s i n d i r e c t
c o n f l i c t with ours.
As y o u know, I b e l i e v e t h e U n i t e d
S t a t e s w i l l be stronger economically i f i t has open
markets and p r o v i d e s o p p o r t u n i t i e s f o r i n v e s t m e n t i n t h i s
country t o a l l p o t e n t i a l i n v e s t o r s as long a s t h e y do not
c o n t e m p l a t e and do n o t have a h i s t o r y of i l l e g a l ,
unsafe
o r unsound p r a c t i c e s or a c t i v i t i e s t h a t c o u l d damage our
institutions.
The b a n k i n g i n d u s t r y i s r e l a t i v e l y h i g h l y r e g u l a t e d and
supervised.
As s u c h , i t would be d i f f i c u l t f o r t h e owners
o f a b a n k i n g i n s t i t u t i o n t o damage e i t h e r t h a t
institution
or the f i n a n c i a l i n t e r e s t s of the United States in a
m a t e r i a l way w i t h o u t d e t e c t i o n u n l e s s t h e o w n e r s f o l l o w e d
a d e l i b e r a t e p o l i c y of fraud, f o r example, or other types
of i n s t i t u t i o n a l m i s c o n d u c t , and such b e h a v i o r i s u n l i k e l y
t o go u n d e t e c t e d f o r an e x t e n d e d p e r i o d .
Moreover,
as
l o n g a s we h a v e an o p e n and c o m p e t i t i v e f i n a n c i a l s y s t e m ,
I am n o t p a r t i c u l a r l y c o n c e r n e d a b o u t t h e p o t e n t i a l
m i s a l l o c a t i o n o f bank l e n d i n g by f o r e i g n banks b e c a u s e
i n s t i t u t i o n s t h a t make n o n - e c o n o m i c l o a n s w i l l n o t s u r v i v e
for long.
369
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.15.
In a f o l l o w up t o t h e above q u e s t i o n I a s k e d you w h e t h e r
y o u w o u l d b e c o n c e r n e d i f we f o u n d o u r s e l v e s i n a
s i t u a t i o n where more t h a n h a l f t h e c o n t r o l o f t h e b a n k i n g
a s s e t s of t h i s country were in the hands of f o r e i g n banks.
You i n d i c a t e d t h a t w a s a " n a t i o n a l s e c u r i t y q u e s t i o n N t h a t
g o e s beyond t h e i s s u e of what i s an e f f i c i e n t
i n t e r n a t i o n a l banking system.
Can y o u e l a b o r a t e w h a t i s t h e n a t u r e o f t h e n a t i o n a l
s e c u r i t y i s s u e t h a t would be r a i s e d by h a v i n g f o r e i g n
banks c o n t r o l more t h a n h a l f t h e banking a s s e t s o f t h i s
country?
A.15.
The i s s u e w i t h r e s p e c t t o t h e s h a r e o f U . S . b a n k i n g a s s e t s
c o n t r o l l e d by f o r e i g n banks i s , a g a i n , a t what p o i n t t h e
s t r i c t l y economic i n t e r e s t s the United S t a t e s has in terms
of t h e e f f i c i e n t f u n c t i o n i n g of t h e U.S. and i n t e r n a t i o n a l
f i n a n c i a l s y s t e m s i s o u t w e i g h e d by n o n - e c o n o m i c c o n c e r n s
of a n a t i o n a l s e c u r i t y or broader p u b l i c - p o l i c y nature.
I would d i f f e r e n t i a t e two c a s e s .
The f i r s t c a s e i s where
c o n t r o l o v e r more t h a n h a l f o f t h e b a n k i n g a s s e t s o f t h i s
c o u n t r y might b e e x e r c i s e d by c i t i z e n s of a c o u n t r y o r t h e
g o v e r n m e n t o f a c o u n t r y w i t h whom t h e U n i t e d S t a t e s i s a t
w a r , w i t h whom t h e U n i t e d S t a t e s d o e s n o t o t h e r w i s e h a v e
d i p l o m a t i c or economic r e l a t i o n s , or whose p o l i t i c a l
system i s in direct c o n f l i c t with ours.
In t h i s case,
I
would h a v e t h e same c o n c e r n s a s I c i t e d i n a n s w e r i n g t h e
p r e v i o u s q u e s t i o n : e f f o r t s t o d e f r a u d U.S. c i t i z e n s and
d i r e c t l y or i n d i r e c t l y t o defraud the U.S. government.
In a second c a s e , where t h e ownership of U.S. banking
a s s e t s i s s p r e a d among a l a r g e number o f b a n k i n g
i n s t i t u t i o n s f r o m a l a r g e number o f d i f f e r e n t c o u n t r i e s ,
s u c h a s t o d a y when we h a v e a p p r o x i m a t e l y 3 0 0 f o r e i g n
banking i n s t i t u t i o n s from a b o u t 60 c o u n t r i e s o p e r a t i n g i n
t h e U n i t e d S t a t e s , I would be hard p r e s s e d t o come up w i t h
t h e "national s e c u r i t y " concern t h a t might be involved
a s i d e from t h o s e a s s o c i a t e d w i t h p a r t i c u l a r ownership
interests.
Moreover, I would note t h a t U.S. p o l i c y over
t h e y e a r s has been one of arguing a g a i n s t such "national
s e c u r i t y " j u s t i f i c a t i o n s when t h e y h a v e b e e n a d v a n c e d by
other countries in financial or other areas.
370
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
Q.16.
In terms of national security concerns over foreign
c o n t r o l of U.S. banking a s s e t s would any such c o n c e r n s ,
in
your view, be heightened i f t h e banks e x e r c i s i n g c o n t r o l
came from a c o u n t r y where our f i n a n c i a l i n s t i t u t i o n s had
l i t t l e i f any p r e s e n c e ?
Would an asymmetry i n m a r k e t
p r e s e n c e be p a r t of any n a t i o n a l s e c u r i t y c o n c e r n s o v e r
such matters?
A.16.
W i t h t h e q u a l i f i c a t i o n , a g a i n , t h a t I am n o t c h a r g e d w i t h
b r o a d n a t i o n a l s e c u r i t y r e s p o n s i b i l i t i e s , my v i e w a s a n
e c o n o m i s t i s t h a t we s h o u l d n o t b e c o n c e r n e d on n a t i o n a l
s e c u r i t y or economic grounds i f banks operating i n t h i s
c o u n t r y come from c o u n t r i e s i n w h i c h our f i n a n c i a l
i n s t i t u t i o n s have l i t t l e i f any p r e s e n c e .
T h e r e may b e
many s o u n d e c o n o m i c r e a s o n s why f i n a n c i a l i n s t i t u t i o n s may
o p e r a t e i n t h e U n i t e d S t a t e s t o our economic and f i n a n c i a l
advantage w h i l e our f i n a n c i a l i n s t i t u t i o n s choose t o have
l i t t l e i f any p r e s e n c e i n t h e c o u n t r i e s i n which t h o s e
foreign i n s t i t u t i o n s are chartered.
Moreover, I do not
t h i n k t h a t an asymmetry i n market p r e s e n c e would by i t s e l f
raise national security concerns.
Q.17.
During your t e s t i m o n y on January 29, 1992 I n o t e d t h a t
J a p a n c o n t r o l l e d a b o u t 15 p e r c e n t o f b a n k i n g a s s e t s i n
t h i s c o u n t r y a s a w h o l e and up t o 25 p e r c e n t i n m a r k e t s
such as California.
I f u r t h e r noted t h a t U.S. banks have
a b o u t one p e r c e n t and i n f a c t a l l f o r e i g n banks h a v e l e s s
t h a n t h r e e p e r c e n t of banking a s s e t s i n Japan and asked
y o u i f we s h o u l d n o t h a v e a r e c i p r o c a l , o p e n , t w o way
r e l a t i o n s h i p w i t h Japan i n terms of f i n a n c i a l
services.
Y o u s t a t e d t h a t M we s h o u l d " a n d I a g r e e .
Do y o u t h i n k t h a t i n o r d e r t o i n c r e a s e o u r n e g o t i a t i n g
leverage with the Japanese t o obtain such a r e l a t i o n s h i p
we s h o u l d g i v e o u r n e g o t i a t o r s i n t h e T r e a s u r y t h e
discretionary authority, in consultation with the banking
r e g u l a t o r s , t o deny Japanese f i n a n c i a l i n s t i t u t i o n s i n our
market n a t i o n a l treatment i f t h e i r government c o n t i n u e s t o
deny such treatment t o our i n s t i t u t i o n s i n t h e Japanese
market?
A.17.
When I a g r e e d w i t h y o u t h a t w e s h o u l d h a v e a r e c i p r o c a l ,
open, two-way r e l a t i o n s h i p w i t h Japan i n terms of
f i n a n c i a l s e r v i c e s , I did not intend t o argue t h a t one
does not e x i s t today.
On t h e w h o l e , w h i l e t h e r e a r e s o m e
problems with national treatment in the Japanese f i n a n c i a l
m a r k e t s a s t h e r e a r e i n o u r m a r k e t , my s e n s e i s t h a t t h e y
are r e l a t i v e l y minor.
371
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.17.
(cont)
Regardless of o n e ' s view of whether there i s n a t i o n a l
treatment of f o r e i g n f i n a n c i a l i n s t i t u t i o n s in Japan,
I would be h e s i t a n t , on t h a t b a s i s , t o f a v o r a p u b l i c
p o l i c y t h a t r e s t r i c t s a c c e s s t o our f i n a n c i a l markets.
I a l s o would be h e s i t a n t t o favor a p o l i c y of r e c i p r o c a l
n a t i o n a l treatment t h a t would g i v e our n e g o t i a t o r s t h e
d i s c r e t i o n a r y a u t h o r i t y t o deny Japanese f i n a n c i a l
instit u t i o n s n a t i o n a l treatment i n our market i f t h e Japanese
government were found t o deny such treatment t o our
i n s t i t u t i o n s in the Japanese market.
While I support encouraging other c o u n t r i e s t o
liberalize
a c c e s s t o t h e i r f i n a n c i a l markets because i t would be in
t h e i r i n t e r e s t s as well as the i n t e r e s t s of U.S.
financial
i n s t i t u t i o n s , I t h i n k i t would be a mistake t o abandon our
p o l i c y o f n a t i o n a l t r e a t m e n t i n an a t t e m p t t o a c h i e v e t h a t
end.
We e s s e n t i a l l y w o u l d b e s a y i n g t h a t w e a r e p r e p a r e d
t o f o r e g o t h e b e n e f i t s ( f o r example, l o w e r c o s t s and more
varied s e r v i c e s ) t o consumers of banking s e r v i c e s i n t h i s
country of having the p a r t i c i p a t i o n of f o r e i g n banks in
our market.
I do not t h i n k t h a t t h i s would be good p u b l i c
policy.
Moreover, I b e l i e v e t h a t t h e r e are b e t t e r ways t o
encourage other c o u n t r i e s t o open t h e i r markets such as
r e l i a n c e on market f o r c e s f a v o r i n g l i b e r a l i z a t i o n and on
p a t i e n t b i l a t e r a l and m u l t i l a t e r a l
negotiations.
Q.18.
T h e P r e s i d e n t o f t h e F e d e r a l R e s e r v e B a n k o f New Y o r k ,
E. G e r a l d C o r r i g a n , h a s f r e q u e n t l y t a k e n a p r o m i n e n t
l e a d e r s h i p r o l e i n q u e s t i o n s o f bank s u p e r v i s i o n and
p a r t i c u l a r l y i n t e r n a t i o n a l bank s u p e r v i s i o n .
In t h e s e
a c t i v i t i e s , d o e s Mr. C o r r i g a n r e p r e s e n t t h e F e d e r a l
R e s e r v e S y s t e m o r s o l e l y t h e F e d e r a l R e s e r v e Bank o f
New Y o r k ?
If the System, i s t h a t r e p r e s e n t a t i o n based
on any f o r m a l or i n f o r m a l d e l e g a t i o n o f
responsibility
from t h e Board of Governors?
A.18.
Mr. C o r r i g a n i s t h e P r e s i d e n t o f t h e F e d e r a l R e s e r v e B a n k
o f New Y o r k w h i c h , u n d e r d e l e g a t e d a u t h o r i t y f r o m t h e
Board, has s u b s t a n t i a l r e s p o n s i b i l i t i e s w i t h r e s p e c t t o
s u p e r v i s i o n both of domestic i n s t i t u t i o n s operating here
and abroad and o f f o r e i g n banks o p e r a t i n g i n t h e U . S .
In
view of those r e s p o n s i b i l i t i e s President Corrigan has a
g r e a t d e a l o f e x p e r t i s e and e x p e r i e n c e i n t h e bank
s u p e r v i s i o n a r e a and he h a s on o c c a s i o n been r e q u e s t e d t o
s h a r e t h a t knowledge and e x p e r i e n c e i n t e s t i m o n y b e f o r e
Congressional Committees.
In presenting such testimony
372
QUESTIONS FROM CHAIRMAN DONALD W. RIEGLE, JR.
A.18. and in giving speeches on bank supervision issues
(cont) President Corrigan has expressed his own views which are
not necessarily identical on every issue with those of the
Board of Governors but which in the great majority of
cases are not dissimilar to the views of the members of
the Board. In instances where President Corrigan 1 s views
differed from the position espoused by the Board of
Governors, it was my judgment that it would be useful for
the Congress to be exposed to an alternate view on issues
where reasonable and experienced analysts could differ.
President Corrigan as a matter of routine always provides
draft copies of his testimony and prepared speeches to the
senior staff of the Board of Governors and where
appropriate to the Chairman.
Because of his expertise in international supervisory
matters, President Corrigan was asked to serve as
Chairman of the Basle Committee on Banking Supervision.
President Corrigan consulted with me before accepting
that position, and I urged him to accept it. Before
Mr. Corrigan 1 s chairmanship and during it, positions
adopted by the Basle Committee, such as the 1988 capital
accord, must be independently reviewed and approved by
the Board of Governors.
373
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SASSER FROM
ALAN GREENSPAN
Q.l.
I am deeply concerned about an economic factor which often
eludes statistical analysis—consumer confidence.
Not too long ago the New York Times ran an article
entitled, "Need is seen for the Fed to consider
consumers." No matter what statistics reveal, people all
over the country feel uneasy about our ability to stage a
recovery at any time soon. Many people in my State of
Tennessee have lost a sense of job security. In fact,
fear of unemployment tops the list of Americans' worries.
Such deep public concern certainly affects consumer
demand.
At this time, 16 million Americans are unemployed or are
working part time because they are unable to locate fulltime work. The Bureau of Labor Statistics reports that
one in every ten families has someone unemployed and one
in every ten individuals is in need of food stamps.
As you are well aware, consumers as a group, represent two
thirds of all economic activity. But the public appears
more depressed about future economic prospects than at any
other time in the past few decades. Dr. Greenspan, you
stated last month, "There is a deep-seated concern out
there which I have not seen in my lifetime." Certainly,
we must address consumer fears and get the public on board
if we are to have a successful recovery.
Q.l.a
I am interested in how semi-intangible factors like public
confidence are measured at the Federal Reserve?
A.l.a
Confidence is evaluated in both formal and informal ways.
Like others, we look carefully at survey based measures of
confidence produced by such groups as the University of
Michigan's Survey Research Center, the Conference Board,
and Dun and Bradstreet. We also look at the results of
surveys conducted by a number of private polling organizations. Finally, we receive anecdotal information on
confidence and economic conditions throughout the country
in the reports we receive from the boards of directors of
the Federal Reserve Banks and branches and in the other
contacts the Reserve Banks have with their communities.
374
QUESTIONS FROM SENATOR JIM SASSER
Q.l.b
Is consumer confidence considered equally as important
as other economic factors?
A.l.b
It is very difficult to define how "important" any
particular variable is, but it is fair to say that
confidence receives close attention in our analysis.
Q.l.c
What can we do to stimulate or at least revive the
consumer sector?
A.l.c
The recent reductions in interest rates should provide
stimulus to the consumer sector over the coming months.
Perhaps a more important factor for reviving consumer
confidence is for economic policy to be clearly addressing
the concerns of Americans about longer-run trends in
living standards by ensuring that we have an environment
conducive to saving and productivity-increasing capital
formation.
Q.2.
Last fall the Federal Deposit Insurance Corporation
released estimates on its financial viability. The report
shows that, under a pessimistic scenario, the $70 billion
line of credit that the Bush Administration asked Congress
to make available, could be inadequate. The projections
show the FDIC running out of money by 1994 under this
scenario.
Everyone is wondering—when is this going to stop? You
assured us in 1989 that the savings and loan debacle was
a $40 billion dollar problem. Instead, we have already
spent $80 and another $80 is on the way for S&L's. From
past experience, it seems like the pessimistic scenario is
the least that will happen.
Of course, we know that the cost of the bank and savings
and loan problem is tied to the real estate market. If
prices in real estate keep deflating, more loans are going
to go belly up, more banks will be in trouble. There*s no
question—the taxpayers will have to carry this burden.
What you do on interest rates and as the nation's leading bank regulator matters a great deal. Real estate is
extraordinarily sensitive. When people ask why we have
these great problems in real estate, and in the banking
sector, I think it's fair that they examine the policies
of the Federal Reserve.
375
QUESTIONS FROM SENATOR JIM SASSER
Q.2.a
In your opinion, what is the adequacy of the $70 billion
line of credit?
A.2.a
Of the $70 billion, $25 billion was made available to
absorb losses and $45 billion for working capital,
with the latter to be repaid from sale by BIF of assets
acquired from failing banks. The BIF itself has access
to better information than the Federal Reserve on problem banks and indicated last fall that $70 billion—so
allocated—should be sufficient. Our best estimate at
that time was that $70 billion would be close, but the
outcome was heavily dependent, as you note in your question, on the pace of recovery in real estate markets.
I note that the Administration's most recent budget
did in fact suggest that in fiscal year 1994 more than
$25 billion additional loss appropriation might be needed
if there were no further banking reforms. Without commenting on the benefits of such congressional action, this
shortfall is certainly possible.
Q.2.b
Will direct taxpayer funding be required for the banks, as
well as the savings and loans?
A.2.b
The current $70 billion of BIF funding can, I think, be
repaid by the sale by BIF of failed bank assets plus the
higher deposit insurance premium. If BIF losses exceed
the $25 billion of loss funds now authorized, the
alternative to taxpayer funding would be still higher
premiums on the surviving banks. I am concerned that
long-term continuation of the 30 basis point premium
contemplated to begin in mid-1993 could be detrimental to
the long-run health of U.S. banks; a further increase in
premiums would almost certainly be counter-productive.
Thus, additional congressional appropriations to cover the
costs of the deposit insurance guarantee may be required.
Q. 2.c
Is the extraordinary real estate hangover of the banks
factored into interest rate decisions?
A.2.c
The weakness in the real estate sector and its effects on
banks have been important considerations in the Federal
Reserve's conduct of monetary policy in recent years. As
you note, the overbuilding of commercial real estate has
contributed substantially to asset quality problems at
financial intermediaries, which in turn has been a crucial
376
QUESTIONS FROM SENATOR JIM SASSER
A.2.c element behind their heightened reluctance to lend. The
(cont) "credit crunch" has interfered with normal credit flows,
especially to borrowers lacking access to open markets,
and without question has retarded spending and production.
In addition, high vacancy rates for commercial real estate
have represented the primary cause of the contraction in
expenditures on nonresidential construction. Countering
the restraining effects of the credit crunch and the
plunge in commercial construction on overall economic
performance has been one vital motivation behind Federal
Reserve policy easing. In the process of providing
economic stimulus, these policy easings have acted to
cushion the weakness in commercial real estate as well as
encourage an upturn in residential construction. The
easings also have served to improve the access of banks
to capital markets, thereby strengthening their balance
sheets and ability to extend credit.
377
QUESTIONS FROM SENATOR JIM SASSER
Q.3.
D r . G r e e n s p a n , l o o k i n g t o s e e w h a t may h a v e c a u s e d t h i s
r e c e s s i o n , I am s t r u c k b y t h e t i g h t e n i n g o f i n t e r e s t r a t e s
t h a t occurred b e g i n n i n g i n t h e s p r i n g of 1988 and
e x t e n d i n g i n t o t h e summer o f 1 9 8 9 .
We h a v e t a l k e d i n t h e
past about t h i s .
I stated, at the time, that given the
f r a g i l i t y i n t h e economy w i t h h i g h l y l e v e r a g e d
c o r p o r a t i o n s , problems i n banking and t h e huge f e d e r a l
b u d g e t d e f i c i t , t h a t t h e Fed s h o u l d be c a r e f u l n o t t o
overreact to inflation.
I t i s always e a s i e r t o look back than t o look forward, but
l o o k i n g a t core i n f l a t i o n , or i n p a r t i c u l a r c o r e consumer
p r i c e s , over t h i s c r i t i c a l 15-month p e r i o d ,
inflation
appears remarkably s t a b l e .
At t h e same t i m e , however, t h e Fed i n c r e a s e d i n t e r e s t
r a t e s by a l m o s t h a l f — 3 - 1 / 2 p e r c e n t a g e p o i n t s .
The
f e d e r a l f u n d s r a t e w e n t from 6 . 5 p e r c e n t t o n e a r l y 10
percent.
There was some e a s i n g i n 1989.
But t h e d e c l i n e i n r a t e s
i n 1989 was o n l y 1 - 1 / 2 p e r c e n t .
Less than half of the
i n c r e a s e i n 1988 and 89.
Rates were then s t a t i c f o r most
a l l of 1990—until well a f t e r the r e c e s s i o n began.
In J u l y of 1989, a t t h e end of t h i s p e r i o d of t i g h t e n i n g
r a t e s , you t e s t i f i e d t h a t you saw no i n d i c a t i o n t h a t a
r e c e s s i o n was imminent.
However, you s t a t e d t h a t a shock
t o t h e economy or a " p o l i c y mistake" by t h e Fed might
t r i g g e r a downturn.
You s a i d "Our j o b i s t o k e e p s u c h
e r r o r s t o an a b s o l u t e minimum."
Q.3.a
Approximately one year l a t e r , t h i s r e c e s s i o n o f f i c i a l l y
began.
Do y o u b l a m e t h e r e c e s s i o n o n t h e G u l f War a n d t h e
temporary r i s e i n o i l p r i c e s t h a t r e s u l t e d from t h a t
event?
A.3.a
D i s a g g r e g a t i n g any s e t of complex f o r c e s which t r i g g e r
r e c e s s i o n s i s d i f f i c u l t but i t i s clear that the sharp
c o n t r a c t i o n in output t h a t began in t h e l a t t e r part of
1990 and l a s t e d u n t i l t h e s p r i n g of 1991 was r e l a t e d t o
t h e I r a q i i n v a s i o n of Kuwait and t h e s u b s e q u e n t e f f e c t s on
o i l p r i c e s a s w e l l a s consumer and b u s i n e s s c o n f i d e n c e .
378
QUESTIONS FROM SENATOR JIM SASSER
Q.3.
b-e
Or was there, in your estimation, a "policy mistake" by
the Fed? Here interest rates just too high in the 19881989 period? Given the underlying problems in the
economy—and we knew they existed—does tight money look
to you now like it was the right policy choice in the late
1980s? Why did the Fed increase interest rates so steadily
over the period? Did the Fed think that 4 percent
inflation was too high and decided to risk recession to
bring it down?
A.3.
b-e
In early 1988, in the wake of the stock market crash of
October 1987, the Federal Reserve initially extended the
monetary easing that it had put in place late in 1987.
But as it became clear that the economy still was strong
and that the potential for inflation to rise beyond its
underlying rate of 4 percent or so was increasing, the
Federal Reserve began to tighten reserve conditions.
Before the tightening began, the monetary aggregates had
been running close to the top of their 1988 growth ranges.
Bond yields increased during the early part of the year,
as indications of economic strength raised concerns about
an uptrend of inflation. With strong growth of employment, the unemployment rate had dropped to 5-1/2 percent,
and labor costs accelerated during the year. For example,
the employment cost index rose at a 4.8 percent rate during 1988, a considerable advance over the 3-1/4 percent
rates of 1986 and 1987. By the end of 1988, the federal
funds rate had risen about 2 percentage points. Despite
this tightening, M2 and M3 were estimated to have increased 5-1/4 and 6-1/4 percent, respectively, near the
middle of their annual ranges, and debt growth, at 8.7
percent, was quite rapid. Consumer prices increased 4-1/4
percent, and real gross domestic product rose 3.3 p e r c e n t .
During 1989, the risks of an acceleration of inflation
appeared to decline somewhat as pressures on industrial
capacity diminished, commodity prices softened, and the
exchange value of the dollar rose. By midyear, the odds
seemed to favor some progress against inflation while
economic growth continued at a moderate rate. Consequently, the Federal Reserve began a gradual easing of
policy, taking steps that reduced the federal funds rate
more than a percentage point by year-end. M2 was estimated to have expanded at a 4.6 percent rate, ending
the year near the middle of its range. M3 growth, at
3.3 percent was near the lower end of its range. The slow
growth of M3, however, was judged to reflect primarily the
shrinkage of the thrift industry and a related rechanneling of funds in mortgage markets that appeared to have
little effect on overall credit availability. Indeed,
379
QUESTIONS FROM SENATOR JIM SASSER
A.3.
b-e
(cont)
o v e r a l l d e b t c o n t i n u e d t o expand r a p i d l y , a t an 8 p e r c e n t
r a t e during 1989.
The economy a l s o c o n t i n u e d t o grow, b u t
at a slower pace than in the preceding years.
N e v e r t h e l e s s , employment c o n t i n u e d t o expand a t a
s a t i s f a c t o r y p a c e and t h e a v e r a g e unemployment r a t e f o r
t h e y e a r e d g e d down t o 5 - 1 / 4 p e r c e n t , t h e l o w e s t l e v e l
since the early 1970s.
Despite earlier signs that sugg e s t e d some d e c e l e r a t i o n , consumer p r i c e s r o s e a b o u t
4-1/2 percent over the year.
The economy c o n t i n u e d t o expand d u r i n g t h e f i r s t h a l f o f
1990.
O v e r t h e f i r s t t w o q u a r t e r s o f 1 9 9 0 , GDP g r o w t h
a v e r a g e d s l i g h t l y more t h a n 1 - 1 / 2 p e r c e n t a t an annual
rate.
D u r i n g t h i s p e r i o d , t h e CPI e x c l u d i n g f o o d a n d
energy p r i c e s rose about 5-1/2 percent.
M2 e x p a n d e d a t a
f i v e percent rate during t h i s interval.
Over t h i s same
p e r i o d of time, evidence began t o accumulate t h a t c r e d i t
a v a i l a b i l i t y was c o n s t r a i n i n g a g g r e g a t e demand, and i n
r e s p o n s e t h e F e d e r a l R e s e r v e e a s e d p o l i c y around mid y e a r .
On t h e w h o l e , t h o u g h , t h e F e d e r a l R e s e r v e j u d g e d t h a t t h e
economy would c o n t i n u e t o expand a t a moderate p a c e ,
c o n s i s t e n t w i t h c o n t i n u e d growth of employment w h i l e
p u t t i n g downward p r e s s u r e on i n f l a t i o n .
However, a s
d i s c u s s e d i n t h e r e s p o n s e t o p a r t a) o f t h i s q u e s t i o n ,
the
sharp run-up in o i l p r i c e s t h a t accompanied t h e i n v a s i o n
o f Kuwait t o o k a t o l l on consumer and b u s i n e s s c o n f i d e n c e
and pushed t h e economy i n t o r e c e s s i o n .
In r e t r o s p e c t , i t appears that p o l i c y adjustments during
the 1988-89 period were appropriate.
There was a d i s t i n c t
p o t e n t i a l f o r a c c e l e r a t i n g i n f l a t i o n i n 1988 and 1989,
which t h e F e d e r a l R e s e r v e was t r y i n g t o c o u n t e r .
In f a c t ,
d e s p i t e o u r e f f o r t s , t h e CPI e x c l u d i n g f o o d a n d e n e r g y
r o s e from around 4 p e r c e n t over t h e 1985-87 p e r i o d t o over
5 percent in 1990.
N o n e t h e l e s s , when t h e F e d e r a l R e s e r v e ,
l o o k i n g f o r w a r d , saw t h a t i n f l a t i o n p r e s s u r e s were l i k e l y
t o a b a t e , we b e g a n t o e a s e p o l i c y i n 1 9 8 9 .
Until the oil
shock, i t appeared that the nation might have avoided
another round of a c c e l e r a t i n g i n f l a t i o n , w i t h o u t going
i n t o a r e c e s s i o n , though of n e c e s s i t y growth had slowed
a s e c o n o m i c o u t p u t moved i n t o l i n e w i t h i t s p o t e n t i a l .
380
QUESTIONS FROM SENATOR JIM SASSER
Q.4.
The New York Times recently carried an interesting article
concerning the statistics that the government uses to
measure the condition of the economy. According to the
Times. many economists are now saying that the official
6.8 percent U.S. unemployment rate considerably
understates the actual level of unemployment. According
to these analysts, official statistics provide a false
sense of the economy's strength and its potential for
rebounding. They believe that the real jobless rate is
well into double digits.
Indeed, when you consider the number of workers forced
to work part time—6.3 million—and those workers that are
so discouraged that they have given u p — 1 . 1 million—the
broader number of unemployed/underemployed came in at
16.3 million, or 13 percent of the workforce. One out of
every six unemployed persons has now been out of work for
more than 6 months.
Dr. Greenspan, you are known as the great decipherer of
economic data. I believe you learned of the Gulf War by
observing a jump in oil prices while at your computer.
Q.4.a
Do you think that unemployment is worse than the official
rate indicates?
A.4.a
One of the economic puzzles of the past two years has been
the sharp increase in the number of people who report that
they are not looking for work because they are in school,
ill, or have home responsibilities. To the extent that
some of these individuals are, in fact, out of the labor
force because of a perceived lack of job opportunities,
the amount of slack in the labor market is greater than
official statistics would indicate.
Q.4.b
Is the Fed relying on an inaccurate measure of economic
performance in making decisions?
A.4.b
As I indicated in my written response to a similar
question from Chairman Riegle, in general the unemployment
rate provides a useful summary measure of resource
utilization in the labor market. However, like all
summary measures it should not be used in isolation. In
assessing economic performance, the Federal Reserve Board
381
QUESTIONS FROM SENATOR JIM SASSER
A.4.b and the Federal Open Market Committee look at a wide
(cont) variety of indicators from both government statistical
agencies and non-government sources as well as reports on
local conditions gathered through the Federal Reserve
Banks. Taken as a whole, this information gives us, I
believe, a comprehensive picture of current economic
conditions.
Q.5.
I have long been a proponent of lower interest rates in
order to spur economic growth. Therefore, I am pleased
with the rate reductions that the Fed has engineered thus
far in this recession but I wish that the Fed had acted
more quickly and decisively earlier. Indeed, I think the
Federal Reserve has room to do more.
In this atmosphere of falling rates, I am struck by the
fact that rates on savings instruments are falling
faster than those on loans. In other words, the way
that the Fed's interest rate policy has filtered
through banks, it appears to be more of a detriment to
savers than it is a positive for borrowers.
The New York Times recently reported that "a year ago, the
average 6-month bank certificate of deposit was paying
7.14 percent, now it is 4.46 percent, a decline of 2.68
percentage points. But the rate for a 30 year fixed-rate
mortgage has fallen only 1.10 percentage points, to 8.38
percent."
Q.5.a
What is the reason for this?
A.5.a
The relative variation you cite for rates on retail CDs
versus those of 30-year fixed rate mortgages very closely
corresponds to the relative movements of the short- versus
long-ends of the Treasury and private yield curves over
this period. Investors in and issuers of many short- and
long-term instruments enjoy a wide variety of options,
making such financial markets quite competitive. The two
instruments you mention are good examples. Yields on
retail CDs tend to move fairly closely with rates on
Treasury bills of comparable maturities. Similarly, rates
on long-term mortgages with fixed interest rates have a
tendency to follow longer-term bond rates. This tendency
has been strengthened by the maturation of markets for
mortgage-backed securities, which facilitate investor
arbitrage across markets for longer-term instruments.
382
QUESTIONS FROM SENATOR JIM SASSER
A.5.a
(cont)
Short-term rates generally exhibit wider swings than longterm r a t e s across the i n t e r e s t r a t e c y c l e .
When s h o r t term r a t e s d e c l i n e during r e c e s s i o n s , the y i e l d curve
t y p i c a l l y s t e e p e n s , a s l o n g e r - t e r m r a t e s f a l l by l e s s ,
in
part because investors believe short-term rates
likely
w i l l r i s e a g a i n i n t h e f u t u r e a s t h e economy r e c o v e r s .
The c u r r e n t e p i s o d e h a s f o l l o w e d t h i s g e n e r a l p a t t e r n .
Q.5.b
Could t h e banks be u s i n g t h e o p p o r t u n i t y
rates to increase t h e i r spreads in order
on bank l o a n s ?
A.5.b
The s h a r p d e c l i n e i n d e p o s i t r a t e s r e f l e c t s t h e s h a r p
d e c l i n e i n s h o r t - t e r m market r a t e s , l e d by t h e f a l l i n t h e
f e d e r a l f u n d s r a t e s induced by monetary p o l i c y .
R a t e s on
bank l o a n s , w h i c h g e n e r a l l y t e n d t o f l u c t u a t e l e s s o v e r
t h e c y c l e than do v e r y s h o r t - t e r m market y i e l d s ,
have
lagged the drop in the f e d e r a l funds r a t e .
The w i d e n i n g
i n s p r e a d s between r a t e s l i k e t h e "prime" o r consumer l o a n
r a t e s and bank f u n d i n g c o s t s a l s o r e f l e c t s a r e c o g n i t i o n
o f t h e r i s k s o f l o s s o n new l o a n s i n an u n c e r t a i n e c o n o m i c
environment; such a widening i s t y p i c a l of periods of
e c o n o m i c w e a k n e s s , b u t t h e c h a n g e t h i s t i m e may h a v e b e e n
g r e a t e r b e c a u s e l e n d i n g p r a c t i c e s h a d i n many i n s t a n c e s
been unduly aggressive in e a r l i e r y e a r s — t h u s producing
t h e loan l o s s e s t o which you r e f e r .
Competitive pressures
work a g a i n s t t h e k i n d o f d i r e c t r e c o v e r y o f p a s t l o s s e s t o
which you r e f e r .
of
to
t h e drop in
cover losses
383
QUESTIONS FROM SENATOR JIM SASSER
Q.6.
Many o f t h o s e w h o a r g u e a g a i n s t f i s c a l s t i m u l u s , o r e v e n
monetary s t i m u l u s , contend t h a t such a c t i o n would do more
harm t h a n g o o d .
These i n d i v i d u a l s contend t h a t long-term
i n t e r e s t r a t e s would r i s e and choke o f f a c t i v i t y i n k e y
sectors, such as housing.
During t h i s r e c e s s i o n ,
longterm i n t e r e s t r a t e s have f a l l e n s l u g g i s h l y in response t o
Fed c u t s i n s h o r t r a t e s .
Mindful of t h i s ,
Senator
Sarbanes and I have urged t h e Treasury t o s h i f t
its
borrowing towards t h e s h o r t end of t h e y i e l d curve.
This
w o u l d make l o n g b o n d s somewhat more s c a r c e and d r i v e down
long-term interest rates.
Indeed you t o l d Senator
S a r b a n e s t h a t t h e T r e a s u r y and t h e Fed were s t u d y i n g s u c h
a move.
You s e e m e d t o i n d i c a t e t h a t i t w a s a g o o d i d e a .
What i s t h e t i m e - f r a m e f o r s h i f t i n g t o s h o r t e r t e r m
securities?
A.6.
Academic s t u d i e s on whether r e d u c i n g t h e s u p p l y o f
Treasury debt would h e l p lower long-term i n t e r e s t r a t e s
do not g i v e a c l e a r i n d i c a t i o n t h a t such a p o l i c y would
be s u c c e s s f u l .
This i s because expectations of future
s h o r t - t e r m r a t e s a r e by f a r t h e p r i n c i p a l d e t e r m i n a n t
of long-term r a t e s , not r e l a t i v e s u p p l i e s of
securities.
N e v e r t h e l e s s , some e m p i r i c a l e v i d e n c e s u p p o r t s t h e p r o p o s i t i o n and, g i v e n t h e p o t e n t i a l b e n e f i t s of reduced l o n g term i n t e r e s t r a t e s , I concur with the r e c e n t d e c i s i o n
o f t h e T r e a s u r y t o c u t back on bond and l o n g - t e r m n o t e
issuance.
However, t h e scope f o r c u t t i n g back i n one
maturity sector i s limited.
Given t h e huge s i z e of t h e
d e f i c i t , considerable s a l e s w i l l l i k e l y be needed in a l l
m a t u r i t i e s , and l a r g e s h i f t s toward t h e s h o r t end c o u l d
d i s t o r t y i e l d s , t h e r e b y d i s s i p a t i n g any a d v a n t a g e t o t h e
Treasury.
A major shortening of Treasury debt a l s o would
a l t e r t h e l i q u i d i t y p r o f i l e of t h e economy, w i t h p o s s i b l e
i m p l i c a t i o n s f o r the stance of monetary p o l i c y .
With r e g a r d t o t h e p o s s i b l e p a r t i c i p a t i o n by t h e F e d e r a l
R e s e r v e i n s u c h a p r o g r a m , we a r e a c t i v e i n p u r c h a s e s i n
a l l s e g m e n t s o f t h e m a r k e t , i n c l u d i n g t h e l o n g e r end, and
I would expect t h a t t o continue.
For example, i n 1991 t h e
Federal Reserve purchased roughly $11-1/2 b i l l i o n of U.S.
T r e a s u r y coupon s e c u r i t i e s from f o r e i g n c e n t r a l banks and
t h e market i n t h e normal c o u r s e of open market o p e r a t i o n s .
384
QUESTIONS FROM SENATOR JIM SASSER
A.6
However, the volume of our purchases of longer-term
(cont) securities necessarily is limited. The Federal Reserve
needs considerable liquidity in its portfolio to ensure
that we will be able to meet our reserve objectives in the
least disruptive way possible in all circumstances.
As to the time frame for a shortening of maturities of
securities in the hands of the public, as noted, the
Treasury just announced some shift toward shorter
maturities for the series of auctions to be held next week
and a continuation of such a tilt in its future offerings.
As the Federal Reserve periodically makes additions to its
permanent securities portfolio, we will be looking at the
possibility of purchasing additional coupon securities,
consistent with our liquidity needs.
Q.7.
Dr. Greenspan, in November 1990 you wrote a letter to
Securities and Exchange Commission Chairman Richard
Breeden expressing your strong concern about the
imposition of market value accounting on financial
institutions. You raised both economic and technical
concerns in arguing against market value accounting. I
share those concerns. Moreover, I am particularly
concerned, in light of the credit crunch and the
recession.
Q.7.a
In this difficult time shouldn't we be even more cautious
about abruptly revising the accounting model for the
nation's financial institutions?
A.7.a
Yes. At any time, a change to market value accounting
could have a major impact on the investing and lending
activities of banking organizations. The disruptive
effects, however, would tend to be greater during times of
economic stress, because it is just at such times that the
market values of assets, particularly certain categories
of loans, are subject to sharp and temporary fluctuation.
Currently, assets held for short-term trading purposes are
reported at market value, and assets held for sale are
reported at the lower of cost or market value. But these
assets generally comprise only a small portion of a
banking organization's total assets, which primarily
consist of investment securities and loans held for longterm portfolio purposes and so are carried at historical
cost.
385
QUESTIONS FROM SENATOR JIM SASSER
A.7.a There is a move to extend market value accounting to
(cont) long-term holdings of investment securities (but not to
loans). Such a change would likely reduce the amount of
securities banking organizations are willing to hold and
thus adversely affect bank liquidity. An approach similar
to market value accounting for securities'was in effect
prior to 1938, and serious concerns on the part of the
U.S. Treasury and the bank regulators over how this
regulatory policy was affecting the financial performance
of banks and influencing their investment decisions led to
the abandonment of that accounting concept in that year.
A shift to market value accounting for loans would have an
even more dramatic effect. There are not active, liquid
markets for most types of loans, and thus there is no
readily available information on their market values.
Estimates of value, therefore, are subject to a wide range
of uncertainty. Nor are there established standards for
estimating the market values of these assets. Thus,
developing estimates of values for loans would impose
heavy costs on banks and on regulators alike and would in
all likelihood not produce consistent or reliable results.
Moreover, there are many uncertainties involved with the
estimation of the market value of loans. Consequently,
the market value of loans tends to be volatile and this
volatility may be intensified in times of economic change.
Thus, banking organizations would likely steer away from
certain lending activities, particularly during
recessionary conditions. Such actions could hinder credit
availability and intensify weaknesses in the economy.
Lastly, the "piecemeal" application of market value
accounting to a large segment of a banking organization's
assets, as some accountants have advocated, without
applying market value accounting to the entire balance
sheet would produce a distorted picture of the
institution's earnings and capital.
In my view, these issues need to be fully explored and
resolved before dramatic moves to work on market
accounting for banking organizations are made.
386
QUESTIONS FROM SENATOR JIM SASSER
Q.7.b
What effect do you think that market value accounting will
have on the customers of financial institutions?
A.7.b
The answer to this question depends in part upon which
assets banks might be required to mark to market value.
As mentioned in A.7.a, if only investment securities were
reported at market value, banks would likely reduce their
holdings of these assets. This could adversely affect a
bank's liquidity position.
If all loans were required to be reported at market value,
banks would likely reduce certain lending activities.
Loans to small business firms, farmers, and other
borrowers that are particularly subject to cyclical
economic conditions are the types of credits that banks
might prove less willing to make.
Q.7.c
For instance, is a bank going to be more or less likely to
buy into a municipal bond offering of a small city or town
if it has to mark those bonds to market?
A.7.c
A requirement to mark municipal bonds to market would
likely make municipal bond offerings by small cities or
towns less attractive for banks. Securities issued by
small municipalities are more difficult to value since
active markets for these assets typically do not exist.
As in the case of loans, the absence of a liquid market
usually increases price volatility and would require that
complex and subjective estimates of market values be used
which impose a greater regulatory burden and higher costs.
Q.7.d
If a bank is less likely to buy those bonds, what will
happen to the locality's ability to finance itself?
A.7.d
Banking organizations generally purchase large portions of
bonds issued by small municipalities. Thus, if banks are
less likely to buy bonds issued by smaller cities and
towns, these municipalities would find it more difficult
to finance their activities. As a consequence, their
financing costs would increase.
387
QUESTIONS FROM SENATOR JIM SASSER
Q.8.
A s I t r a v e l i n my h o m e S t a t e o f T e n n e s s e e , I r e p e a t e d l y
hear about the s o - c a l l e d c r e d i t crunch.
Small
b u s i n e s s m e n , i n p a r t i c u l a r , a r e f i n d i n g i t much m o r e
d i f f i c u l t to obtain credit.
These are reputable
businessmen with s o l i d c r e d i t h i s t o r i e s , but they cannot
g e t a l o a n from a bank i n t h e r e g u l a r c o u r s e o f t h e i r
business.
A t t h e v e r y l e a s t , i t h a s become much more
d i f f i c u l t for these small businessmen to obtain financing.
P a p e r w o r k r e q u i r e m e n t s h a v e b e c o m e much g r e a t e r a n d t h e
p r o c e s s t a k e s much l o n g e r .
Q.8.a
In the estimation of the
t h i s problem and what i s
A.8.a
The g e n e r a l t i g h t e n i n g o f bank c r e d i t s t a n d a r d s (and t h e
emergence and p e r s i s t e n c e of t h e " c r e d i t crunch") i s a
s e r i o u s c o n c e r n o f t h e F e d e r a l R e s e r v e and h a s p r o l o n g e d
r e c e s s i o n a r y c o n d i t i o n s i n t h e economy.
Accordingly,
t h r o u g h i t s monetary p o l i c y e f f o r t s and i n i t s
supervision
o f b a n k h o l d i n g c o m p a n i e s a n d s t a t e member b a n k s , t h e
Federal Reserve has taken steps t o encourage further
l e n d i n g t o sound borrowers.
Regarding monetary p o l i c y ,
i n t e r e s t r a t e s , a s y o u know, h a v e d e c l i n e d s h a r p l y d u r i n g
the past year or so.
Regarding supervision, t h e banking
and t h r i f t r e g u l a t o r y a g e n c i e s have j o i n t l y i s s u e d
s t a t e m e n t s and t a k e n o t h e r a c t i o n s d e s i g n e d t o c l a r i f y and
communicate t h e i r p o l i c i e s t o both bankers and examiners
i n an a t t e m p t t o r e a c h a b e t t e r b a l a n c e i n t h e e v a l u a t i o n
and e x t e n s i o n of l o a n s .
These e f f o r t s have s t r e s s e d t h e
i m p o r t a n c e o f l e n d e r s c o n t i n u i n g t o work w i t h t r o u b l e d
c u s t o m e r s and t o make s o u n d l o a n s .
F e d e r a l R e s e r v e how p e r v a s i v e
being done about i t ?
is
Much o f t h e i n c r e a s e d p a p e r w o r k t h a t many b o r r o w e r s h a v e
s e e n r e s u l t s from t h e h e i g h t e n e d concerns of l e n d e r s
a b o u t r i s k s o f new l e n d i n g i n a p e r i o d o f s l o w e c o n o m i c
conditions.
I n some c a s e s , i t a l s o s t e m s from t h e n e e d
t o improve documentation t h a t i s n e c e s s a r y f o r t h e a p p l i c a t i o n and enforcement: of a sound c r e d i t e v a l u a t i o n p r o cess.
I n p a s t y e a r s , some i n s t i t u t i o n s had p e r m i t t e d
t h e i r c r e d i t s t a n d a r d s and l e n d i n g p r o c e d u r e s t o d e c l i n e , and needed t o i n c r e a s e t h e i n f o r m a t i o n a v a i l a b l e
t o them about t h e s t r e n g t h and n a t u r e of t h e i r b o r r o w e r s .
Although t h e concerns you r a i s e a f f e c t customers of a l l
388
QUESTIONS FROM SENATOR JIM SASSER
A.8.a size, small businesses generally have less resources to
(cont) meet the informational and collateral demands of their
lenders and are likely to feel the effect of such changes
most dramatically.
The regulatory H call reports," which provide substantial
financial information on the condition of depository
institutions, do not specifically identify the volume or
characteristics of loans to small businesses. Accordingly, one cannot address the full effect of recent
conditions on the availability of credit to this particular group of businesses. That situation will soon
change. Sections 122 and 477 of the recently enacted
Federal Deposit Insurance Corporation Improvement Act
of 1991 require bank and thrift regulatory agencies to
collect information, such as the number, volume, and
losses on loans to small businesses and small farms.
Although this legislation may impose still further
informational requirements on banks and their customers,
it will enable us to track the future volume and pattern
of small business loans.
Ultimately, the availability of credit in a particular
region or throughout the country rests heavily on the
presence of a strong and competitive banking system. In
its administration of the Bank Holding Company Act and in
meeting its general supervisory responsibilities, the
Federal Reserve will continue to take steps that promote
the strengthening of the nation's financial sector and
that encourage the extension of sound credit.
Q.8.b
Does the Fed think that the slowing down of the lending
process may be slowing the economy as well?
A.8.b
Yes, and we have been working assiduously to make sure
that our regulatory and supervisory activities are not
unduly inhibiting the flow of credit to creditworthy
borrowers. As well, our monetary policy actions have been
aimed in part at diminishing these problems and at
compensating for their negative effects on economic
activity.
389
QUESTIONS FROM SENATOR JIM SASSER
Q.8.c
Another concern of mine is that banks appear to have the
funds to lend but are more inclined to invest the funds in
securities. Is there anything to this observation? I
think it is absolutely vital for banks to be lending if
the economy is to grow.
Q.8.d
Has there been a discernable increase in bank investment
in securities and a decrease in bank lending?
A.8.
c-d
It is correct that expansion of bank balance sheets last
year was concentrated in their securities portfolio.
Total securities held by commercial banks expanded
16-1/2 percent last year, entirely reflecting a
23-1/4 percent rise in holdings of U.S. government
securities. Bank loans over the same period contracted by
just under 1 percent.
(A substantial proportion of banks1
acquisitions of U.S. government securities last year was
accounted for by mortgage-backed securities. Thus, these
acquisitions have represented credit extended indirectly
to the residential mortgage market.) A pattern of slower
loan growth and more rapid securities acquisitions is
typical during periods of economic weakness, as loan
demand falls off relative to banks' sources of funds and
banks lend more cautiously in view of the increased
prospect that borrowers will experience financial
difficulties and will be unable to service the loan. This
pattern has been exacerbated by the current pressures on
banking institutions, which have made them unusually
reluctant to lend. However, survey evidence indicates
that the tightening of loan terms and conditions has
stopped. Moreover, wider lending margins seem to be
bolstering bank profitability, and banks' capital
positions are improving as a result of these better
earnings as well as issuance of a substantial volume of
securities in the markets. Consequently, banks' ability
to lend is improving and they should be better positioned
to lend any needed support to a resumed expansion of the
economy.
390
QUESTIONS FROM SENATOR JIM SASSER
Q.9.
The President has indicated that he will push once
again for comprehensive reform to the nation's banking laws. Most of the more sweeping changes to the
laws governing the financial services industry did
not pass the Congress last year. It is likely that
banking reform proposals including additional securities powers for banks will continue to be deliberated upon slowly by the Congress.
Q.9.a
Will the Federal Reserve be taking any action to
increase the "gross revenue limitation" for bank
ineligible activities of a Section 20 affiliate?
A.9.a
The Board has not received any formal request to
revise upwards the Board's percentage limitation on
the securities underwriting activities of section 20
affiliates, and the Board has not initiated any action
to revise this limitation. A proposal to increase
the revenue limit raises a number of legal and policy
issues, including questions of interpretation of the
terms of the Glass-Steagall Act. Without the benefit
of analysis of these issues and of the Board's consideration and deliberation, I am unable to say at this
time what course of action the Board would take in
reviewing a proposal to raise the revenue limit applicable to section 20 affiliates.
Q.9.b
The Federal Reserve has proposed several modifications
to its firewall restrictions for section 20 affiliates.
Will the Board take action regarding these modifications?
A.9.b
The Board has proposed three modifications to the
firewall restrictions established in the Board's section
20 orders. The Board has sought public comment on
whether it should permit certain director interlocks
between banks and section 20 affiliates, modify the
cross-marketing restrictions imposed on section 20
affiliates, and permit banks to purchase U.S. government
agency securities and U.S. government-sponsored agency
securities from a section 20 affiliate. In each of
these three areas, the modifications that have been
proposed are limited and consistent with the legislation
considered by both the Senate and the House. The
proposals to permit limited director interlocks and to
391
QUESTIONS FROM SENATOR JIM SASSER
A.9.b
(cont)
permit the purchase of certain government agency
securities are similar to exceptions included in
S. 543 as reported by the Senate Banking Committee
and adopted by the full Senate. Similar exceptions
were also included in the legislation reported by the
House Banking Committee and the House Energy and
Commerce Committee. The legislation considered by
Congress did not contain a restriction on crossmarketing activities similar to the provision in the
Board's section 20 order that is under review by the
Board.
These proposals have been pending for approximately
18 months, and I would anticipate that the Board would
take action on them within the next several months.
392
RESPONSE TO WRITTEN QUESTIONS OF SENATOR SANFORD FROM
ALAN GREENSPAN
Q.l.
I applaud t h e s t e p s you have t a k e n t o reduce i n t e r e s t
rates.
U n f o r t u n a t e l y , a consequence o f l o v e r i n t e r e s t
r a t e s i s t h e s i g n i f i c a n t d e c l i n e i n i n t e r e s t income upon
w h i c h many p e o p l e d e p e n d .
In e a r l i e r responses you have
e x p r e s s e d hope t h a t t h e p u r c h a s i n g power of i n t e r e s t
income w i l l be s u s t a i n e d .
I s i t t r u e t h a t i f i n t e r e s t r a t e s and t h e r a t e o f
i n f l a t i o n remain about t h e same, i n t e r e s t r e c e i v e d
o f f s e t s i n f l a t i o n and p r e s e r v e s t h e p u r c h a s i n g power
only of the invested principal?
Many p e o p l e d e p e n d o n
i n t e r e s t income.
As s h o r t - t e r m r a t e s h a v e b e e n
approximately halved, so too has p a r a l l e l
interest
income.
The U . S . would h a v e t o e x p e r i e n c e a d e f l a t i o n
r a t e o f 50 p e r c e n t f o r i n t e r e s t income t o m a i n t a i n i t s
purchasing power.
I s t h i s an a c c u r a t e a s s e s s m e n t ?
Is
t h e r e such a p o i n t t h a t t h e b e n e f i t s d e r i v e d from lower
i n t e r e s t r a t e s no l o n g e r o u t w e i g h t h e burden t a k e n on by
p e o p l e l i v i n g on i n t e r e s t , m a i n l y r e t i r e e s ?
A.1.
On t h e n a r r o w q u a n t i t a t i v e q u e s t i o n y o u r a i s e ,
consider
a o n e - y e a r CD, f o r e x a m p l e , w i t h a p r i n c i p a l v a l u e o f
$100.
A s s u m e t h a t w i t h 5 p e r c e n t i n f l a t i o n t h e CD
c a r r i e d a r a t e o f 10 p e r c e n t b u t t h a t w i t h z e r o
inflation i t yielded 5 percent.
At t h e end of a y e a r ,
i n t h e f i r s t c a s e t h e i n v e s t o r would h a v e $ 1 1 0 , w i t h an
i n f l a t i o n - a d j u s t e d "real" v a l u e of about $105 ( i n terms
of p r i c e s p r e v a i l i n g a t the beginning of t h e p e r i o d ) .
In t h e second, n o - i n f l a t i o n c a s e , t h e i n v e s t o r would g e t
$105, but t h a t would have l o s t none of i t s purchasing
power.
S o i t t o o k much l e s s t h a n a " 5 0 p e r c e n t
d e f l a t i o n " t o k e e p t h e i n v e s t o r i n t h e same w e a l t h
p o s i t i o n — w h a t was " l o s t " i n lower r e a l i n t e r e s t income
w a s made up i n f u l l y m a i n t a i n e d r e a l p r i n c i p a l .
As a
m o r e g e n e r a l m a t t e r , t h e f a c t i s t h a t many h o u s e h o l d s
t h a t have been "net creditors" have enjoyed h i s t o r i c a l l y
h i g h r e a l r e t u r n s on f i x e d - i n c o m e i n v e s t m e n t s i n r e c e n t
years.
As t h e economy h a s s o f t e n e d and m o n e t a r y p o l i c y
h a s s o u g h t t o b u t t r e s s demand, r e a l i n t e r e s t r a t e s h a v e
declined—especially real short-term rates.
This i s the
phenomenon your q u e s t i o n a d d r e s s e s .
393
QUESTION FROM SENATOR TERRY SANFORD
A.l.
(cont)
Clearly, a good many households have been negatively
affected by this rate movement. But, in the current
circumstances, the alternative of pursuing a tight
monetary policy in order to push real rates higher would
be a prescription for economic contraction that would be
seriously detrimental to the majority of Americans.
Moreover, the lower inflation does benefit a great many
retirees who are living on fixed pensions or longer-term
fixed-income investments (such as bonds or annuities);
in addition, lower real interest rates boost stock
price-earnings ratios, so many retirees who own shares
also have benefitted.
Ultimately, low inflation will enhance the efficiency of
our economy and provide broad benefits to our populace.
394
RESPONSE TO WRITTEN QUESTIONS OF SENATOR GRAHAM FROM
ALAN GREENSPAN
INTERNATIONAL T I T L E TO S . 5 4 3 ,
Q.l.
F D I C IMPROVEMENT ACT
Mr. C h a i r m a n , I w o u l d l i k e t o c i t e s e v e r a l s e c t i o n s o f
a n a r t i c l e f r o m F l o r i d a F o r e c a s t . " G l o b a l Commerce
S a i l s Ahead".
"For t h e f i r s t t i m e F l o r i d a
i n t e r n a t i o n a l t r a d e topped $30 b i l l i o n :
Exports
t o t a l e d $15.5 b i l l i o n in 1990, surpassing 1989s record
$14.4 b i l l i o n . "
"Because of F l o r i d a ' s budget woes, t h e
Commerce D e p a r t m e n t ' s I n t e r n a t i o n a l T r a d e D i v i s i o n i s
l o o k i n g f o r ways t o s t r e t c h l i m i t e d d o l l a r s t o h e l p
e n t i c e f o r e i g n i n v e s t m e n t and t r a d e . "
"Latin American
countries, because of t h e i r c l o s e proximity t o Florida
and i t s n i n e t r a d e p o r t s , a r e c o n s i d e r e d v i t a l t o t h e
state's efforts.
The l e a d i n g r e c i p i e n t s o f F l o r i d a
e x p o r t s i n 1 9 9 0 — w e r e V e n e z u e l a a t $ 1 . 5 B" a n d i t g o e s
on.
"Foreign-owned companies employ about 186,500 or
4.1% o f t h e work f o r c e i n F l o r i d a " .
Much o f t h a t a r e
f o r e i g n bank e m p l o y e r s .
During 1990, L a t i n America and
Caribbean banks provided over $2.4 b i l l i o n i n t r a d e
financing through their Florida agencies.
I am c o n c e r n e d t h a t d u e t o t h e r e l a t i v e l y s m a l l s i z e
t h e s e b a n k s , t h e y may n o t f a r e w e l l i n t h e F e d e r a l
R e s e r v e ' s a p p r o v a l and t e r m i n a t i o n p r o c e s s e s .
of
*How w i l l t h e F e d e n s u r e t h a t f o r e i g n b a n k s f r o m
s m a l l e r c o u n t r i e s and d e v e l o p i n g r e g i o n s o f t h e w o r l d
s u c h a s L a t i n America and t h e Caribbean B a s i n a r e n o t
at a disadvantage in the Federal Reserve's application
a p p r o v a l p r o c e s s and t e r m i n a t i o n p r o c e s s ?
A.1.
I can a s s u r e you t h a t t h e Board w i l l apply a l l
standards relevant to i t s decisions pursuant t o the
F o r e i g n Bank S u p e r v i s i o n Enhancement A c t o f 1 9 9 1 ( t h e
Enhancement A c t ) , e n a c t e d by t h e Congress l a t e
last
y e a r , e v e n - h a n d e d l y and w i t h o u t d i s c r i m i n a t i n g a g a i n s t
banking i n s t i t u t i o n s on t h e b a s i s of t h e i r s i z e .
The
Enhancement Act p r o v i d e s e x p l i c i t l y t h a t t h e Board i s
n o t p e r m i t t e d t o make t h e s i z e o f a f o r e i g n bank " t h e
s o l e d e t e r m i n a n t f a c t o r " i n a c t i n g on a f o r e i g n b a n k ' s
a p p l i c a t i o n t o e s t a b l i s h an o f f i c e i n t h e U n i t e d S t a t e s
— whether t h e o f f i c e i s a branch, an agency, or a
commercial l e n d i n g company.
A similar restriction that
s i z e cannot be "the s o l e determinant f a c t o r " a p p l i e s t o
395
QUESTIONS FROM SENATOR BOB GRAHAM
A.1.
(cont)
findings by the Board with respect to a decision to
terminate a foreign bank's office in the United States.
In addition, both provisions permit the Board in making
its judgments under the Enhancement Act to take into
account the needs of the community the foreign bank
proposes to serve, or has served, as well as M the
length of operation" of the foreign bank and its
relative size in its home country.
Q.2.
Again, one of the continuing concerns revolves around
the definition of "comprehensive supervision on a
consolidated basis." While I understand this may be an
important factor in approval and termination decisions,
it is equally important that there be a reasonable
process for imposing this new requirement. Foreign
banks must be given notice as to the meaning of this
terminology and must be given a fair opportunity to
comply. My concerns are primarily with foreign banks
or agencies from Latin American and the CBI region.
Few of these developing countries have a comprehensive
bank regulatory scheme as far as I know.
*Do you know how many Caribbean Basin and Latin
American countries currently comply with this
requirement?
•How will the Fed treat these countries not now in
compliance?
•How will the Fed work with those countries that want
- to reform their regulatory scheme to provide them with
guidance and with an opportunity to make such changes?
A.2.
Many countries, including some of those in the
Caribbean Basin and Latin America, practice some degree
of supervision on a consolidated basis. Practices,
however, vary among countries. In this regard, it will
be necessary under the Foreign Bank Supervision
Enhancement Act of 1991 to conduct an individual
assessment of bank supervisory practices in individual
countries to determine whether the existing framework
ensures comprehensive supervision on a consolidated
396
QUESTIONS FROM SENATOR BOB GRAHAM
A.2.
(cont)
basis. Without the benefit of a current, thorough
analysis of supervisory practices in relevant countries
it is difficult to enumerate countries that may have
problems in this respect. The Board intends to work
closely with those supervisors that may wish to
strengthen existing supervisory practices. Efforts are
already under way to meet with interested authorities.
A conference with a number of supervisors from Latin
America has been arranged in Florida in early March to
discuss our views on consolidated supervision and to
respond to any concerns raised by the participants. In
addition, we intend to discuss this issue fully with
the Caribbean supervisors at their annual meeting in
Trinidad in May. We will also meet with individual
supervisors on an individual basis to discuss these
issues as opportunities arise or as they request
specific meetings.
52-418 - 92 - 13
397
QUESTIONS FROM SENATOR BOB GRAHAM
Q.3.
I understand that there are approximately 30 pending
foreign bank applications, for new branches or
agencies, which have been delayed in the Fed's
administrative process. This delay is having a
seriously adverse economic impact.
•What is the current policy and procedure for
approving foreign bank applications?
•What is the current time frame for the approval
process?
*How do you propose to correct this problem of
administrative delays?
A.3.
The Federal Reserve has been made aware of about 35
applications by foreign banks to establish branches or
agencies. Upon enactment of the Foreign Bank
Supervision Enhancement Act, the Federal Reserve
contacted state and federal authorities to determine
how many applications were pending at those agencies
that now require Board approval under the new
legislation. We communicated to the licensing
authorities, as well as to those foreign banks that
contacted us, that the Federal Reserve would begin to
process applications immediately and would not delay
processing until implementing regulations are adopted.
Foreign banks were advised to submit to the Federal
Reserve a copy of the information required by the state
or federal licensing authority, and that additional
information relating to the new statutory factors could
be provided in letter form.
At this time, not all of these banks have submitted
their applications. With respect to the applications
that have been received, we are in the process of
conducting background and name checks and gathering
other information on the statutory factors that must be
considered, including information on home country
supervision. Any delays that have been encountered are
the result of the necessity of ensuring that the
standards and criteria that the legislation establishes
are met. The Federal Reserve shall, however, move as
expeditiously as possible to review all applications in
a timely manner.
52-418 - 92 - 14
398
QUESTIONS FROM SENATOR BOB GRAHAM
Q.4.
I further understand that there are currently several
prior pending applications on which the Fed has been
consulting with the states.
•Will these applicants have to start the approval
process with the Fed all over again?
A.4.
No, the Federal Reserve will use as much of the information provided by the foreign banks to the state
licensing authorities as is possible and will process
applications from these banks on the basis of applications already submitted to the state authorities. To
the extent an application contains all information
necessary to make a determination under the Foreign
Bank Supervision Enhancement Act, the applicant would
not need to provide additional information. Similarly,
to the extent the state has previously conducted
background checks on the foreign bank and related
persons, the Federal Reserve will use this information
in order to expedite processing. There will be
instances, however, in which additional information
must be requested from the applicant foreign bank.
This type of information could include for example,
commitments to provide information to the Federal
Reserve that is necessary to enable a determination to
be made that the foreign bank is in compliance with
U.S. law, a standard under the Foreign Bank Supervision
Enhancement Act.
399
QUESTIONS FROM SENATOR BOB GRAHAM
Q.5.
M r . G r e e n s p a n , i s t h e B a s l e C o m m i t t e e a n d t h e OECD
( O r g a n i z a t i o n f o r Economic Cooperation and Development)
w o r k i n g on s t a n d a r d s f o r home c o u n t r y s u p e r v i s i o n ?
*What d o y o u t h i n k
they will
be?
*Will the Senate b i l l put the U.S.
t h e e f f o r t s of t h e B a s l e Committee
A.5.
in conflict with
a n d t h e OECD?
The B a s l e Committee on Banking S u p e r v i s i o n h a s s i n c e
i t s f o r m a t i o n i n 1974 p r o v i d e d a r e g u l a r forum f o r
c o o p e r a t i o n b e t w e e n member i n s t i t u t i o n s o n s u p e r v i s o r y
c o n c e r n s i n i n t e r n a t i o n a l b a n k i n g , i n c l u d i n g home
country supervision.
The p r i n c i p l e o f
consolidated
s u p e r v i s i o n by home c o u n t r y a u t h o r i t i e s w a s e n d o r s e d by
Committee members i n t h e R e v i s e d B a s l e C o n c o r d a t o f
1983.
In 1990 t h e Committee approved a Supplement t o
the Concordat, which addressed, i n t e r a l i a ,
the
authorization of foreign o f f i c e s , the information needs
o f p a r e n t a u t h o r i t i e s , and t h e exchange o f
information
between supervisory a u t h o r i t i e s .
T h e B a s l e C o m m i t t e e , i n l i g h t o f t h e BCCI e x p e r i e n c e ,
i s currently conducting a further review of these
i s s u e s t o determine what a d d i t i o n a l s t e p s might be
taken t o improve s u p e r v i s i o n of banks t h a t o p e r a t e
internationally.
Groups o f bank s u p e r v i s o r s from o t h e r
c o u n t r i e s are a l s o d i s c u s s i n g t h e improvement of t h e i r
bank s u p e r v i s o r y p r o c e s s e s , e s p e c i a l l y w i t h r e s p e c t t o
t h e i r banks t h a t operate i n t e r n a t i o n a l l y .
While these
d i s c u s s i o n s a r e o n - g o i n g , t h e c o n s e n s u s among c o u n t r i e s
seems t o be in favor of i n c r e a s i n g t h e comprehensiven e s s o f bank s u p e r v i s i o n b y home c o u n t r y a u t h o r i t i e s .
The F o r e i g n Bank S u p e r v i s i o n Enhancement A c t o f 1 9 9 1
a l s o addresses these areas of concern.
FBSEA r e q u i r e s
or
t h a t f o r e i g n banks e s t a b l i s h i n g branches, a g e n c i e s ,
s u b s i d i a r y banks i n t h e United S t a t e s be s u b j e c t t o
"comprehensive s u p e r v i s i o n on a c o n s o l i d a t e d b a s i s . "
This law should not cause c o n f l i c t w i t h c o u n t r i e s t h a t
have a d o p t e d and a r e implementing t h e s u p e r v i s o r y
approach recommended by t h e B a s l e Committee.
400
QUESTIONS FROM SENATOR BOB GRAHAM
LATIN AMERICAN DEBT:
Q.6.
How do you think the Brady Initiative is working on
bringing investors back into Latin America?
A.6.
A number of Latin American countries have regained
access to world capital markets in varying degrees in
the last couple of years. Mexico and Venezuela, two
countries that have made use of debt reduction schemes
for bank debt under the Brady Initiative, have been
quite successful in attracting capital flows mostly
from non-bank investors through the issuance of bonds
and through the sale of state-owned enterprises.
Chile, a country that had substantially reduced its
debt prior to the Brady Initiative, has perhaps come
the furthest toward voluntary access to world capital
markets. These three countries have implemented
extensive economic adjustment programs for sustained
periods of time. A credible shift toward sound
economic policies appears to be necessary to attract
investments from foreign investors, to mobilize
domestic savings for investment, and to induce the
repatriation of capital that had been sent abroad
during periods of economic uncertainty.
Q.7.
How do you think the countries are responding to this
program?
A.7.
A number of countries have responded to the Brady
Initiative, with varying success, including Costa Rica,
Uruguay, and the Philippines, as well as the countries
mentioned in the answer to Question 6. The key to
success over the longer term is the sustained implementation of appropriate economic policies. Argentina
and Brazil, two countries with substantial debt to
banks, including interest arrears, are currently
negotiating with banks to implement a Brady-style debt
reduction package. Argentina has been implementing
important economic adjustments for a substantial period
of time, while the IMF has more recently approved an
IMF stand-by program for Brazil. If debt reduction
packages with banks are negotiated, and Argentina and
Brazil implement economic policies consistent with
their IMF-supported adjustment programs while continuing to open their economies to international
investors, I would expect that they too would benefit
from greater access to world capital markets.
401
RESPONSE TO WRITTEN QUESTIONS OF SENATOR KERRY FROM
ALAN GREENSPAN
CREDIT CRUNCH AND COLLATERAL CRUNCH
Q.l.
In Massachusetts over the past two years, joblessness has
been exacerbated through the problem of small businesses
being denied credit as a result of shortfalls in their
collateral due to the collapse of real estate.
What steps would you undertake if you are reconfirmed to
respond to the collateral crunch which continues to dry up
credit in New England?
A.1.
Problems caused by the tightening in the availability of
bank credit have been a serious concern to the Federal
Reserve for some time. To some extent, such tightening was
needed to correct the deterioration in credit standards
over the 1980s that produced costly failures and caused
serious asset quality problems at many banks. It is clear,
however, that in all too many cases, such corrections have
gone too far and have prevented creditworthy borrowers from
obtaining the financing they need, with obvious and adverse
effects.
These developments have contributed to the Federal
Reserve's decision to take steps designed to reduce
interest rates and stimulate economic activity. We
continue to monitor the situation carefully, and stand
ready to take other actions necessary to foster sustainable
economic growth.
In the area of bank supervision, the Federal Reserve and
the other federal bank and thrift regulatory agencies have
during the past year actively and frequently communicated
their supervisory policies to bankers and to examiners,
alike. These statements were intended to increase the
availability of credit to sound borrowers and to encourage
banks to work with their financially troubled customers.
They also stressed that banks with real estate concentrations and those seeking to improve their capital ratios
should not automatically refuse new credit to sound
borrowers. We have also taken specific actions to ensure
that our supervisory process reflects a balanced review of
asset quality and that it does not contribute inappropriately to slow or negative loan growth. In this
connection, we have—among other actions—stressed that the
402
QUESTIONS FROM SENATORJIMSASSER
A.1.
the evaluation of real estate loans should not be based
(cont) solely on the value of collateral, but also on a review of
the borrower^ willingness and ability to repay and on the
income-producing capacity of the properties.
The past few years have clearly been stressful ones to
borrowers throughout the country and to much of the U.S.
banking system. However, progress has been made in
addressing the problems that declining real estate markets
and other economic weaknesses have caused. Many banks,
for example, have reduced or eliminated dividends and
raised significant amounts of new subordinated debt and
equity to bolster their capital positions, restructured
their activities to improve efficiency, and developed
plans to resolve problem credits. The improving condition
of many banks provides evidence that the combination of
these and other efforts is having positive effects. This
improvement, in turn, together with the supervisory
initiative described above, should have important positive
effects on the availability of credit. The Federal
Reserve, however, will continue to closely monitor
developments and take additional steps if that appears
necessary.
BIF RECAPITALIZATION
Q.2.
Last year, you testified that the $70 billion in borrowing
from the taxpayer could eventually be repaid by the banks,
and that no taxpayer bailout would be necessary.
Are you still confident that there will be no taxpayer
bailout of the U.S. bank insurance fund?
A.2.
Of the $70 billion, $25 billion was made available to
absorb losses and $45 billion for working capital, with
the latter to be repaid from sale by BIF of assets
acquired from failing banks. The BIF itself has access
403
QUESTIONS FROM SENATORJIMSASSER
A.2.
(cont)
to better information than the Federal Reserve on
problem banks and indicated last fall that $70 billion—
so allocated—should be sufficient. Our best estimate
at that time was that $70 billion would be close, but
the outcome was heavily dependent on the pace of recovery
in real estate markets.
I note that the Administration's most recent budget
did in fact suggest that in fiscal year 1994 more
than $25 billion additional loss appropriation might
be needed if there were no further banking reform.
Without commenting on the benefits of such congressional
action, this shortfall is certainly possible.
The current $70 billion of BIF funding can, I think,
be repaid by the sale by BIF of failed bank assets
plus the higher deposit insurance premium. If BIF
losses exceed the $25 billion of loss funds now
authorized, the alternative to taxpayer funding would
be still higher premiums on the surviving banks. I am
concerned that long-term continuation of the 30 basis
point premium contemplated to begin in mid-1993 could
be detrimental to the long-run health of U.S. banks; a
further increase in premiums would almost certainly be
counter-productive. Thus, additional congressional
appropriations to cover the costs of the deposit
insurance guarantee may be required.
DEFICITS AND HOW TO PAY FOR THEM
Q.3.
What has been the impact of federal borrowing to pay
for the S&L bailouts to date on the federal budget and
overall domestic economy? What impact do you expect this
borrowing to have on the budget and economy this year and
next year?
A.3.
The budget impact of federal borrowing for the saving and
loan bailout is summarized in lines 1 and 2 of the table
below. The impact on the budget, other than to increase
the unified deficit by around $50 billion per year, has
been' minimal because the Budget Enforcement Act of 1990,
as you know, explicitly excludes outlays to meet deposit
insurance liabilities from the deficit and spending
constraints of that Act.
404
QUESTIONS FROM SENATORJIMSASSER
A.3.
(cont)
The effects on the economy of borrowing to meet these
deposit insurance liabilities are probably quite small.
The outlays are for losses that have, for the most
part, accumulated in past years and become liabilities
of the government's deposit insurance institutions. The
deposit insurance outlays being recorded in the budget
represent the transfer of federal liabilities from the
books of the deposit institution to the Treasury's public
debt accounts.
However, significant economic effects may have occurred
as these losses were being incurred. The existence of
deposit insurance allowed some insolvent thrift institutions to make imprudent loans, loans whose price to the
borrower did not reflect the risk borne by federal
deposit insurance. This probably contributed to the
excessive and wasteful construction of commercial buildings and other risky projects during the 1980s. It thus
appears likely that the deposit insurance crisis has
affected the economy by stimulating investment during
this period, but some of this investment was been
diverted into unproductive uses because loan rates did
not fully reflect the risks borne by the government.
Q.4.
What impact do you believe the $70 billion borrowed for
the BIF recapitalization will have on our federal budget
and domestic economy?
A.4.
The budget impact of the bank resolution activities that
will be financed by the $70 billion of borrowing that has
recently been authorized for the Bank Insurance Fund is
summarized in lines 3 and 4 of the table. Differences in
estimates between OMB and CBO appear to reflect different
estimates of the pace at which resolution activity will
proceed, rather than different estimates of the size of
accumulated losses.
405
QUESTIONS FROM SENATORJIMSASSER
A.4.
(cont)
The a n a l y s i s of economic e f f e c t s i s t h e same a s f o r t h e
s a v i n g s and l o a n b a i l o u t d i s c u s s e d a b o v e .
The o u t l a y
f i g u r e s r e f l e c t t h e r e c o r d i n g on T r e a s u r y books o f
l i a b i l i t i e s t h a t were incurred in e a r l i e r y e a r s .
ESTIMATES 07 DEPOSIT INSURANCE OUTLAYS
(Fiscal
years,
billions
Actual
Saving
1)
2)
and
loans
OMB
CBO
of
dollars)
Projected
1992
1993
1990
1991
52
52
60
60
47
53
39
52
1
Banks2
3)
4)
OMB
CBO
6
6
7
7
33
15
38
17
Total
5)
6)
OMB
CBO
58
58
67
67
80
68
77
69
OMB a n d CBO a r e t h e i r J a n u a r y 1 9 9 2 b u d g e t e s t i m a t e s .
R e s o l u t i o n T r u s t C o r p o r a t i o n a n d t h e FSLIC R e s o l u t i o n
FDIC.
2
. Bank I n s u r a n c e Fund o f t h e F e d e r a l D e p o s i t I n s u r a n c e
Corporation.
Fund
of
Q.5.
What w o u l d h a v e b e e n t h e e f f e c t s o n t h e e c o n o m y i f t h e
C o n g r e s s h a d p l a c e d t h e S&L b a i l o u t a n d t h e B I F
r e c a p i t a l i z a t i o n on some form o f " p a y - a s - y o u - g o " p l a n
requiring o f f s e t t i n g budget cuts or revenues over a
three-year period for these expenditures, as with every
o t h e r program i n government?
A.5.
Subjecting deposit insurance outlays to pay-as-you-go
c o n s t r a i n t s would have s u b j e c t e d t h e budget and t h e
economy t o some l a r g e and unwarranted s h o c k s .
Large
swings i n t a x e s or spending programs would be required
because the outlay requirements for deposit insurance
406
QUESTIONS FROM SENATORJIMSASSER
A.5.
(cont)
programs are l i k e l y t o be q u i t e v o l a t i l e over t h e n e x t
several years.
M o r e i m p o r t a n t , a s I n o t e d i n my a n s w e r
t o your previous questions, u n l i k e most o u t l a y s in the
b u d g e t , t h e o u t l a y s now b e i n g i n c u r r e d f o r d e p o s i t
insurance are largely financial transactions.
No r e a l
economic a c t i v i t y i s occurring as these t r a n s a c t i o n s are
b e i n g r e c o r d e d on t h e b u d g e t .
The o f f s e t t i n g s p e n d i n g
c u t s or t a x i n c r e a s e s r e q u i r e d by a p a y - a s - y o u - g o
c o n s t r a i n t would, however, have e f f e c t s on r e a l
activity.
Q.6.
Would y o u s u p p o r t p l a c i n g f u t u r e f e d e r a l p a y m e n t s f o r t h e
S&Ls a n d b a n k s , i f a n y , o n a p a y - a s - y o u - g o b a s i s r a t h e r
than through borrowing from t h e Treasury?
A.6.
No,
for
the
reasons
stated
i n my p r e v i o u s
response.
SECURITIZATION OF PERFORMING COMMERCIAL LENDING
Q.7.
You h a v e w r i t t e n t h a t o n e o f t h e p r o b l e m s b a n k s h a v e i s
t h a t t h e y a r e l o n g - t e r m l e n d e r s who c a n b e b a d l y h u r t b y
s h o r t - t e r m f l u c t u a t i o n s i n i n t e r e s t r a t e s and c h a n g e s i n
the rate of i n f l a t i o n .
Mortgage lending by banks has
changed g r e a t l y as the r e s u l t of the s e c u r i t i z a t i o n of
such loans.
Should s e c u r i t i z a t i o n be more w i d e l y a p p l i e d t o
commercial lending as a t o o l in a s s i s t i n g banks t o
o v e r c o m e t h e i r c u r r e n t p r o b l e m s and f a c i l i t a t e new
lending?
I f s o , what s t e p s might t h e f e d e r a l government
take to f a c i l i t a t e
securitization?
A.7.
V a r i o u s a t t e m p t s h a v e b e e n made by b a n k i n g o r g a n i z a t i o n s
and i n v e s t m e n t banking f i r m s t o package and s e l l h i g h
q u a l i t y c o r p o r a t e debt, debt from c o r p o r a t e r e s t r u c t u r i n g s , and commercial r e a l e s t a t e c r e d i t s .
But,
s i g n i f i c a n t o b s t a c l e s have been encountered in t h e s e
efforts.
U n l i k e r e s i d e n t i a l mortgages and consumer
debt, t h e terms of commercial loans vary widely,
includi n g d i f f e r i n g a m o r t i z a t i o n s c h e d u l e s b a s e d on a s s e t
d i s p o s i t i o n , varying c o l l a t e r a l or covenant p r o t e c t i o n ,
and m u l t i p l e i n t e r e s t r a t e o p t i o n s .
Such l o a n s do n o t
lend themselves to standardized credit evaluation
407
QUESTIONS FROM SENATORJIMSASSER
A.7.
(cont)
techniques nor t o being packaged i n t o p o o l s of loans t h a t
can serve as c o l l a t e r a l for s e c u r i t i e s .
This lack of
s t a n d a r d i z a t i o n h a s made i t v e r y d i f f i c u l t t o s e c u r i t i z e
these loans.
Nevertheless, efforts to develop a basis for securitizing
commercial loans are continuing.
I t should be noted that
government played a major r o l e i n f o s t e r i n g t h e s e c u r i t i zation of r e s i d e n t i a l mortgages.
However, once t h e p a t t e r n was s e t , t h e s e c u r i t i z a t i o n of o t h e r t y p e s of loans
was p r i m a r i l y i n i t i a t e d and d e v e l o p e d by t h e p r i v a t e
s e c t o r without d i r e c t government a s s i s t a n c e
(although
c o n s u l t a t i o n was c a r r i e d out w i t h t h e r e g u l a t o r y a g e n c i e s
i n o r d e r t o make c e r t a i n t h a t s e c u r i t i z e d p r o d u c t s w e r e
c o n s i s t e n t w i t h s a f e and sound b a n k i n g p r a c t i c e s ) .
It
would seem t h a t t h i s l a t t e r approach, where t h e p r i v a t e
sector takes the i n i t i a t i v e , but regulatory a u t h o r i t i e s
a r e c o n s u l t e d on s a f e t y and s o u n d n e s s i s s u e s , i s t h e b e s t
means a t t h i s t i m e , of f u r t h e r i n g e f f o r t s t o s u c c e s s f u l l y
s e c u r i t i z e commercial loans.
BCCI AND F I R S T AMERICAN
Q.8.
Mr. C h a i r m a n , o n J a n u a r y 3 0 ,
v o t e d t o i s s u e c e a s e and d e s
Bank a n d t o BCCI.
According
a b s t a i n e d from t h i s a c t i o n .
abstention?
A.8.
On J a n u a r y 3 0 , 1 9 9 1 , I a b s t a i n e d f r o m a v o t e c o n c e r n i n g
i s s u a n c e o f a c e a s e a n d d e s i s t o r d e r a g a i n s t BCCI a n d
CCAH, t h e p a r e n t h o l d i n g c o m p a n y o f F i r s t A m e r i c a n
Bankshares.
I w a s a c q u a i n t e d w i t h Mr. R o b e r t A l t m a n ,
p r e s i d e n t o f F i r s t A m e r i c a n , a n d w a s u n s u r e i n my o w n
m i n d w h e t h e r t h i s f a c t s h o u l d p r e c l u d e me f r o m v o t i n g o n
t h e o r d e r s a g a i n s t BCCI a n d CCAH.
Therefore, I decided
to abstain until I could resolve the matter.
Four o t h e r
m e m b e r s o f t h e B o a r d w e r e p r e s e n t a n d my v o t e w a s n o t
necessary for the action.
Subsequently, I concluded that
my l i m i t e d a c q u a i n t a n c e w i t h M r . A l t m a n d i d n o t p o s e a
c o n f l i c t of i n t e r e s t t h a t would require a b s t e n t i o n .
I
have t h e r e f o r e p a r t i c i p a t e d i n a l l subsequent Board
d e l i b e r a t i o n s a n d d e c i s i o n s r e g a r d i n g BCCI a n d CCAH.
1991 t h e Federal Reserve
i s t orders t o F i r s t American
to public accounts,
you
What w a s t h e r e a s o n f o r y o u r
408
QUESTIONS FROM SENATORJIMSASSER
Q.9.
Last spring the Office of the Comptroller of the Currency
announced, in essence, that First American was not financially healthy. The OCC gave First American a rating of
4 out of a possible 5, indicating that it was bordering
on insolvency. While additional funds were provided the
institution last spring by the Sheikh of Abu Dhabi, it is
obvious that First American continues to remain under
financial pressures as a result of its relationship with
BCCI.
Q.9.a
What steps has the Federal Reserve taken to reduce the
possibility of First American failing?
A.9.a
The Federal Reserve has taken a number of steps to
stabilize the condition of the First American banking
organization. These include the issuance, on March 4,
1 9 9 1 , of a Cease and Desist Order against BCCI severing
all ownership relationships between BCCI and the First
American banking organization, and requiring divestiture
of BCCI 1 s shares of First American. BCCI had proposed to
effect the divestiture through a trust arrangement. On
July 5 , 1 9 9 1 , BCCI was closed and placed in the hands of
court appointed liquidators. Since that time, the Board
has continued to press the trust arrangement proposed in
the divestiture plan.
A second action taken by the Federal Reserve involved the
execution of a Written Agreement with the parent company
of the First American organization on September 1 0 , 1 9 9 1 .
This Agreement, which was executed to complement
enforcement actions taken by the primary federal and
state regulators of each of the First American subsidiary
banks, includes requirements that restrict additional
indebtedness and significant cash transactions, and
requires the development and implementation of a plan to
restore and maintain adequate capital at the holding
company and each of its subsidiary banks.
Through this and other actions, additional capital in
excess of $140 million was injected into the subsidiary
banks by First American in 1 9 9 1 .
In addition to funds
from the principal shareholders, this capital included
proceeds from the sale of certain assets, including the
409
QUESTIONS FROM SENATORJIMSASSER
A.9.a
(cont)
sale of First American's bank in Tennessee. In addition,
approximately $150 million of debt owed by the First
American parent companies to various note and debentureholders has been restructured. This restructuring alleviated financial pressures at the parent companies and
allowed them to better serve as a source of financial
strength to the subsidiary banks. In fact, no monies
have been received by CCAH ownership interests, either in
the form of debt payments, dividends, or other considerations.
Over the past year, Federal Reserve staff undertook
efforts to address management deficiencies at the senior
levels of the First American banking organization. In
August, Messrs. Clifford and Altman resigned their
positions at First American, and an experienced senior
banker has been retained as CEO.
Last, the Federal Reserve staff has been working with
the Department of Justice and the District Attorney of
New York County on the BCCI Plea Agreement, which was
accepted by the U.S. District Court for the District of
Columbia on January 24, 1992. Under this agreement, it
is anticipated that funds from BCCI will be available
within the next several months to support the First
American banks, if necessary.
Q.9.b
Is First American likely to require assistance from the
Federal Reserve?
A.9.b
As stated above, we expect that under the terms of the
Plea Agreement additional funds would be available to
support the First American banks within the next several
months if required. At present, we do not foresee any
need for immediate Federal Reserve assistance.
Q.9.c
What kinds of assistance might the Fed provide?
A.9.c
Where necessary, in the Federal Reserve's capacity as the
lender of last resort, we are able to provide extended
discount window credit to troubled depository institutions that are encountering liquidity pressures and are
unable to access alternative sources of funds on
410
QUESTIONS FROM SENATORJIMSASSER
A.9.c
(cont)
reasonable terms and conditions. In such situations, the
Federal Reserve works in close cooperation with the
primary regulator, either federal or state. The Federal
Reserve is particularly sensitive to the responsibilities
of the FDIC as insurer and receiver of failed depository
institutions in these situations. Therefore, we keep the
FDIC fully informed of the status of discount window
borrowings and consult closely with that agency in making
our decision whether to extend credit.
Q.9.d
How substantial is the risk that First American might
fail, despite the Fed's efforts?
A.9.d
First American, like some other banking organizations on
the East Coast, as well as other companies with high real
estate exposure, has experienced asset quality problems
and losses stemming from its exposure to commercial real
estate markets. Future developments in real estate
markets and the general strength of the local and
regional economy will, to a large extent, determine the
degree to which the capital and earnings of First
American will remain under pressure. One positive
development is the expected availability of funds within
the next several months as a result of the settlement
with BCCI's representatives to enhance the capital of
First American if required.
Q.10.
Some former Federal Reserve attorneys, after leaving
government, provided services to BCCI, to First American,
and to their shareholders.
Have you reviewed the role of former Federal Reserve
employees in connection with the BCCI affair?
Does the Federal Reserve need to consider additional
anti-revolving door provisions in light of its experience
in the BCCI affair.
A.10.
Former Board employees and officials are subject to the
full range of statutory post-employment restrictions
applicable to all government employees. Specifically,
former Board employees are subject to a lifetime ban on
411
QUESTIONS FROM SENATORJIMSASSER
A.10
(cont)
representing anyone before the government with regard to
a particular matter in which the employee participated
personally and substantially while at the Board. Former
Board employees are also prohibited for two years from
representing anyone before the government with regard to
a particular matter that was pending under the employee's
responsibility during his or her last year of Board service. Finally, senior Board personnel may not communicate with or appear before any officer or employee of the
Board for one year after separation.
The Board's inquiry into the BCCI matter is broad-based
and continuing. From what we have learned to date in our
investigation, current statutory protections appear to be
adequate, and I do not see the need for additional postemployment restrictions for Board employees.
412
RESPONSE TO WRITTEN QUESTIONS OF SENATOR D'AMATO FROM
ALAN GREENSPAN
Credit c<*rfl gap
Q.l.
On November 13, 1991, I introduced an amendment to the
banking bill to put a floating ceiling on the rate credit
card issuers could charge on their customer's balances.
I have a letter, dated November 15, 1991, from yourself
to Chalmers Wylie, the Ranking Minority Member of the
House Banking Committee. This letter, which I would like
included in the record, responds to Mr. Wylie's request
for the Fed's view on credit card interest rate caps.
In that letter, the Fed states that the cap would cause
lenders to cut back on the availability of credit cards,
"especially to borrowers who are more likely to encounter
problems meeting credit obligations" and that this could
adversely affect consumer spending.
Why should individuals who are good credit risks
subsidize those individuals who have a higher chance of
not paying off their credit card debt? Why would denying
credit to individuals who are poor credit risks have an
adverse effect on consumer spending? Should we give
these people credit cards just to spur consumer activity?
A.l.
Obviously good credit risks should not subsidize poorer
risks. But credit card issuers do not knowingly extend
credit to individuals who have a high probability of
failing to repay their debts. In fact, the vast majority
of card holders typically repay their debts as scheduled.
However, card issuers realize that a small percentage of
unknown borrowers likely will default, and they take this
into account when pricing card programs. At the same
time, there are special card programs designed for
customers who are viewed as good credit risks; these
programs offer lower rates and are accessible to
consumers who qualify. Such customers, therefore, need
not smbsidize poorer credit risks.
413
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
A.l.
(cont)
Credit card i s s u e r s do not provide cards t o consumers t o
spur economic a c t i v i t y .
Rather they are seeking t o earn
t h e h i g h e s t p o s s i b l e y i e l d on t h e i r l o a n a b l e f u n d s .
If
some c a r d i s s u e r s e r r and make c r e d i t a v a i l a b l e t o t o o
many p o o r c r e d i t r i s k s , t h e i r r e t u r n s w i l l r e f l e c t t h e s e
choices.
A broad-brush attempt t o screen out a l l
"high
r i s k " c u s t o m e r s l i k e l y would c a p t u r e a l a r g e number o f
h o u s e h o l d s who r e p a y d e b t s o n t i m e and d o n o t d e f a u l t .
In
t h i s r e g a r d , we b e l i e v e t h e a l l o c a t i o n o f c r e d i t i s b e s t
a c c o m p l i s h e d by a f r e e c o m p e t i t i v e market.
Q.2.
I n t h e November 15 l e t t e r , t h e Fed s t a t e s t h a t
information about c r e d i t card r a t e s i s a v a i l a b l e t o
consumers.
The volume o f r e s p o n s e from c r e d i t c a r d
consumers s u g g e s t s t h a t t h i s i s j u s t not so.
What c a n
t h e Fed d o t o make c r e d i t c a r d r a t e i n f o r m a t i o n more
available?
A.2.
Twice a year t h e Federal Reserve System prepares f o r t h e
p u b l i c a comprehensive l i s t of t h e terms a v a i l a b l e on
c r e d i t c a r d s p l a n s f o r about 160 l a r g e c r e d i t card
issuers.
The r e p o r t i s d e s i g n a t e d t h e E . 5 .
Statistical
R e l e a s e and i s e n t i t l e d t h e "Terms o f C r e d i t Card P l a n s . "
Many o f t h e c a r d i s s u e r s i n c l u d e d i n t h e r e p o r t o f f e r
r e l a t i v e l y low i n t e r e s t r a t e s a n d / o r no annual f e e s .
The
F e d e r a l R e s e r v e d i s t r i b u t e s t h e s e r e p o r t s t o members o f
t h e p u b l i c upon r e q u e s t f o r a nominal f e e .
Because of
our concern t h a t t h i s information has not been as r e a d i l y
a v a i l a b l e a s i t m i g h t b e , we w i l l s e e k t o e n h a n c e p u b l i c
awareness and a c c e s s t o t h i s i n f o r m a t i o n .
The F e d e r a l
R e s e r v e w i l l , b e g i n n i n g w i t h t h e March 1992 r e p o r t ,
r o u t i n e l y send c o p i e s t o t h e 1300 l i b r a r i e s t h a t compose
t h e Government D e p o s i t o r y Library System.
A l s o , we p l a n
t o d i s t r i b u t e a press r e l e a s e announcing the a v a i l a b i l i t y
of the l i s t , concurrent with the d i s t r i b u t i o n of the
March r e p o r t .
414
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
A.2.
(cont)
As we have noted on several occasions, a number of
private sector firms make credit card shoppers' guides
available to the public. Bank Card Holders of America,
for one, regularly advertises the availability of its
list of low rate cards on television and magazines with
national distribution. The availability of these low
rate lists, together with solicitations by new card
issuers or those issuers trying to increase market share,
provides considerable opportunity for qualified consumers
to select a lower rate issuer if they feel it is in their
best interest.
Credit Crunch Initiatives
Q.3.
Since March 1991, the regulators have been working on a
number of initiatives to help ease the credit crunch. On
November 7, the Fed, the OCC, the OTS and the FDIC
announced a joint statement to specifically address
commercial real-estate loans.
How do you think this policy statement will impact on
financial institutions treatment of commercial realestate loans?
A.3.
The policy statement should encourage financial
institutions to lend to credit-worthy borrowers and to
work constructively with borrowers experiencing financial
difficulties, consistent with safe and sound banking
practices. The statement made it clear that prudent
lending practices on the part of banks, and timely and
effective supervisory actions on the part of regulators,
should not inhibit banking organizations from playing an
active role in financing the needs of credit-worthy
borrowers.
The statement also addresses concerns about further
lending by institutions failing to meet minimum capital
requirements. While it remains essential that undercapitalized institutions take effective and timely steps
to address this deficiency, such institutions are not
required to cease prudent, low-risk lending activities or
preclude prudent steps to work with troubled borrowers.
415
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
A.3.
(cont)
Similarly, institutions with loan concentrations should
not automatically turn down good loans. Institutions
that have in place effective internal controls to manage
and reduce undue concentrations over a reasonable period
of time, need not automatically refuse credit to sound
borrowers.
Q.4.
Do you anticipate that this policy statement will
convince banks they will not be penalized by the
regulators for making commercial real-estate loans?
A.4.
The statement emphasized that loans would not be criticized simply because they are secured by commercial
real estate. Further, the policy statement indicated
that the evaluation of real estate loans by examiners
will not be based solely on the value of the collateral,
but on a review of the borrower's willingness and capacity to repay and on the income-producing capacity of the
underlying property. The statement further noted that
the agencies would take various steps to make sure that
examiners clearly understood and are prepared to follow
this guidance. We hope and expect that bankers will be
more willing to extend loans to credit-worthy borrowers.
Q.5.
What, if any, impact will this policy statement have on
the earnings statements of banks?
A.5.
The policy statement, to the extent that it encourages
the extension of safe and sound loans to credit-worthy
borrowers, should enhance the earnings of financial
institutions.
Q.6.
Do the regulators plan to initiate any similar policy
statements for other types of loans?
A.6.
At this time there are no initiatives underway to address
other specific loan categories. However, the underlying
lending principles outlined in the November 7 policy
statement are certainly relevant to other types of
commercial lending. The Federal Reserve, together with
the OCC and the FDIC, plan to discontinue use of the
416
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
A.6.
(cont)
supervisory d e f i n i t i o n of highly-leveraged transactions
(HLTs) a f t e r J u n e 3 0 , 1 9 9 2 .
In approving the phase out
o f t h e HLT d e f i n i t i o n , t h e a g e n c i e s r e c o g n i z e d t h a t t h e
d e f i n i t i o n has largely accomplished i t s purposes,
that
c i r c u m s t a n c e s have changed s i n c e t h e d e f i n i t i o n was
i m p l e m e n t e d , a n d t h a t t h e d e f i n i t i o n may b e h a v i n g a n
undue e f f e c t on p r i c i n g and a v a i l a b i l i t y o f c r e d i t t o
certain highly-leveraged borrowers.
Q.7.
Do t h e r e g u l a t o r s p l a n t o i m p l e m e n t a n y o t h e r m e a s u r e s
t h a t w i l l make l e n d i n g more p r o f i t a b l e t o b a n k s ?
A.7.
At t h i s t i m e , t h e Federal Reserve i s c l o s e l y m o n i t o r i n g
d e v e l o p m e n t s i n t h e economy and f i n a n c i a l m a r k e t s t o s e e
how i t s r e c e n t m o n e t a r y p o l i c y a c t i o n s a n d o t h e r s u p e r v i s o r y i n i t i a t i v e s t a k e n by t h e F e d e r a l R e s e r v e and
the other supervisory agencies are a f f e c t i n g economic
a c t i v i t y and t h e a v a i l a b i l i t y of c r e d i t .
Should further
a c t i o n s appear n e c e s s a r y , t h e Board i s prepared t o t a k e
them.
Q.8.
What d o y o u t h i n k s h o u l d b e d o n e t o f u r t h e r e a s e t h e
shortage of a v a i l a b l e c r e d i t t o credit-worthy borrowers?
A.8.
The Board w i l l c o n t i n u e t o e v a l u a t e t h e e f f e c t i v e n e s s
i t s r e c e n t p o l i c y a c t i o n s and of t h e p o l i c y s t a t e m e n t
r e l a t e d i n i t i a t i v e s and t a k e f u r t h e r s t e p s i f n e e d e d .
Interest
of
and
Rates
Q.9.
The d i s c o u n t r a t e i s a t 3.5%, t h e l o w e s t i t h a s b e e n
s i n c e 1 9 6 4 , y e t t h e CBO 1 9 9 2 R e p o r t o n t h e B u d g e t
s u g g e s t s t h a t t h e Fed h a s room t o f u r t h e r e a s e m o n e t a r y
p o l i c y without a great r i s k of i n f l a t i o n .
Do y o u a g r e e
t h a t t h e Fed c o u l d lower i n t e r e s t r a t e s f u r t h e r ?
Why o r
why n o t ?
A.9.
At t h e moment, i t a p p e a r s t h a t t h e s u b s t a n t i a l e a s i n g o f
monetary p o l i c y over r e c e n t months w i l l be s u f f i c i e n t t o
s u p p o r t a s a t i s f a c t o r y r e c o v e r y i n economic a c t i v i t y and
employment i n 1992.
But a s s e s s i n g t h e economic o u t l o o k
at the present time i s extraordinarily d i f f i c u l t .
We
a r e , o f c o u r s e , c o n t i n u i n g t o e v a l u a t e w h e t h e r some
a d d i t i o n a l i n s u r a n c e i n t h e way o f f u r t h e r m o n e t a r y e a s e
would be appropriate.
417
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
Section
20
Changes
Q.10.
The P r e s i d e n t h a s i n d i c a t e d t h a t h e w i l l p u s h a g a i n f o r
comprehensive changes t o the n a t i o n ' s banking lavs,
p a r t i c u l a r l y broader s e c u r i t i e s powers.
Sweeping changes
t o the laws governing the f i n a n c i a l s e r v i c e s
industry
failed to pass last year.
If reform measures languish in
Congress w i l l t h e Federal Reserve Board t a k e any a c t i o n
t o i n c r e a s e t h e " g r o s s r e v e n u e l i m i t a t i o n " f o r bank
i n e l i g i b l e a c t i v i t i e s of a S e c t i o n 20 a f f i l i a t e ?
A.10.
The Board h a s n o t r e c e i v e d any f o r m a l r e q u e s t t o r e v i s e
upwards t h e Board's p e r c e n t a g e l i m i t a t i o n on t h e s e c u r i t i e s u n d e r w r i t i n g a c t i v i t i e s of s e c t i o n 20 a f f i l i a t e s ,
and t h e Board h a s n o t i n i t i a t e d any a c t i o n t o r e v i s e t h i s
limitation.
A proposal to increase the revenue limit
r a i s e s a number o f l e g a l and p o l i c y i s s u e s ,
including
questions of interpretation of the terms of the GlassSteagall Act.
Without the b e n e f i t of a n a l y s i s of t h e s e
i s s u e s and o f t h e B o a r d ' s c o n s i d e r a t i o n and d e l i b e r a t i o n ,
I am u n a b l e t o s a y a t t h i s t i m e w h a t c o u r s e o f a c t i o n t h e
Board would t a k e i n r e v i e w i n g a p r o p o s a l t o r a i s e t h e
r e v e n u e l i m i t a p p l i c a b l e t o s e c t i o n 20 a f f i l i a t e s .
Q.ll.
The F e d e r a l R e s e r v e h a s p r o p o s e d s e v e r a l m o d i f i c a t i o n s t o
i t s f i r e w a l l r e s t r i c t i o n s f o r s e c t i o n 20 a f f i l i a t e s .
W i l l t h e Board t a k e a c t i o n r e g a r d i n g t h e s e m o d i f i c a t i o n s ?
A.11.
The Board h a s p r o p o s e d t h r e e m o d i f i c a t i o n s t o t h e
firewall restrictions established in the Board's section
20 o r d e r s .
The Board h a s s o u g h t p u b l i c comment on
whether i t s should permit c e r t a i n d i r e c t o r
interlocks
between banks and s e c t i o n 20 a f f i l i a t e s , m o d i f y t h e
c r o s s - m a r k e t i n g r e s t r i c t i o n s imposed on s e c t i o n 20
a f f i l i a t e s , and p e r m i t banks t o p u r c h a s e U . S . government
a g e n c y s e c u r i t i e s and U . S . g o v e r n m e n t - s p o n s o r e d a g e n c y
s e c u r i t i e s from a s e c t i o n 20 a f f i l i a t e .
In each of these
three area?, the modifications that have been proposed
418
QUESTIONS FROM SENATOR ALFONSE M. D'AMATO
A.11.
(cont)
are limited and consistent with the legislation
considered by both the Senate and the House. The
proposals to permit limited director interlocks and to
permit the purchase of certain government agency
securities are similar to exceptions included in S. 543
as reported by the Senate Banking Committee and adopted
by the full Senate. Similar exceptions were also
included in the legislation reported by the House Banking
Committee and the House Energy and Commerce Committee.
The legislation considered by Congress did not contain a
restriction on cross-marketing activities similar to the
provision in the Board's section 20 order that is under
review by the Board.
These proposals have been pending for approximately 18
months, and I would anticipate that the Board would take
action on them within the next several months.
419
RESPONSE TO WRITTEN QUESTIONS OF SENATOR KASSEBAUM FROM
ALAN GREENSPAN
Q.l.
C h a i r m a n G r e e n s p a n , B u s i n e s s Week r e c e n t l y r a n a n a r t i c l e
s t a t i n g the importance of eliminating the tax code's
preference for corporate debt over corporate'equity.
As
you know, t h e i n t e r e s t p a i d on c o r p o r a t e d e b t i s
d e d u c t i b l e w h i l e t h e d i v i d e n d s p a i d on c o r p o r a t e e q u i t y
are not.
The e f f e c t i s t h a t d i v i d e n d s a r e t a x e d t w i c e —
once a t t h e c o r p o r a t e l e v e l and once a t t h e i n d i v i d u a l
level.
Everyone a g r e e s t h a t i f c o s t was n o t a f a c t o r ,
corporate dividends should not be taxed twice.
Unfortunately, t h e revenue l o s s i s a major problem.
Would t h e r e b e any m e r i t i n making 50 p e r c e n t o f t h e
d i v i d e n d s on new e q u i t y i s s u e d , s a y , a f t e r December 3 1 ,
1992, d e d u c t i b l e and o f f s e t t h e r e v e n u e l o s s by
r e s t r i c t i n g t o 50 p e r c e n t t h e d e d u c t i o n f o r i n t e r e s t p a i d
on new d e b t i s s u e d a f t e r t h a t d a t e ?
What w o u l d b e t h e
drawbacks and b e n e f i t s of such a n e u t r a l i z i n g p r o p o s a l ?
If you were d r a f t i n g l e g i s l a t i o n t o e l i m i n a t e t h e t a x
code's preference for debt over equity—in a responsible
manner--how would you o f f s e t t h e revenue l o s s ?
Many h a v e s a i d t h a t t h e d o u b l e t a x a t i o n o f d i v i d e n d s i s a
major o b s t a c l e t o our long-term growth, something t h a t
Congress and t h e a d m i n i s t r a t i o n do n o t have t h e p o l i t i c a l
willpower to address.
Do y o u b e l i e v e t h i s i s s o m e t h i n g
t h a t should be addressed or simply ignored?
A.1.
The d o u b l e t a x a t i o n o f d i v i d e n d s and t h e f a v o r a b l e
tax treatment of debt are undesirable f e a t u r e s of our t a x
c o d e f o r t h e r e a s o n s you and o t h e r s h a v e c i t e d and c l e a r l y
should not be ignored.
I would be c a u t i o u s ,
however,
about piecemeal approaches t o dealing with t h e s e problems
t h a t m i g h t c r e a t e more d i s t o r t i o n s t h a n t h e y c o r r e c t .
I
t h i n k i t p r e f e r a b l e t o f o c u s a t t e n t i o n on a more comprehensive review of the corporate tax system,
including^
p r o p o s a l s t h a t would f u l l y i n t e g r a t e t h e c o r p o r a t e and
p e r s o n a l income t a x e s and t h a t would e a s e t h e o f t e n
c o n f i s c a t o r y tax r a t e s applied t o purely nominal c a p i t a l
gains.
In t h i s regard, t h e r e c e n t p l a n s put f o r t h by t h e
T r e a s u r y f o r i n t e g r a t i n g c o r p o r a t e and i n d i v i d u a l income
taxes deserve careful evaluation.
I recognize, of course,
t h a t d e s i g n i n g and implementing fundamental r e f o r m s i n
t h i s area w i l l be extremely d i f f i c u l t and, I e x p e c t ,
not
quickly completed.
On t h e i s s u e o f t h e r e v e n u e l o s s , m a n y o p t i o n s a r e
available.
Congress, of course, must u l t i m a t e l y d e c i d e
who i s t o b e a r t h e t a x b u r d e n o r w h i c h e x p e n d i t u r e s a r e
be c u t .
to
420
BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM
DIVISION OF RESEARCH AND STATISTICS
Date:
February 12,
1992
Subject:
A n a l y s i s of Senator S p e c t e r ' s Proposal Regarding
P e n a l t y - F r e e Withdrawals from Retirement: Accounts
T h i s memorandum a n a l y z e s
Senator S p e c t e r ' s
regarding p e n a l t y - f r e e withdrawals
focusing especially
a c t i o n would have
greater detail
discusses
issue;
conjectures
The
the provisions
Section III
o f how g r e a t
on h o u s e h o l d s p e n d i n g .
some a n a l y t i c a l
the national
It
on t h e i s s u e
some r e l e v a n t
Consumer F i n a n c e ;
on t h e l i k e l y
spending
accounts,
an i m p a c t
Section
of t h e proposal;
considerations
presents
Survey of
proposal
from retirement:
the
I describes
Section
b e a r i n g on t h e
estimates
in
II
spending
derived
S e c t i o n IV o f f e r s
from
some
effects.
Proposal
The p r o p o s e d l e g i s l a t i o n w o u l d a l l o w c e r t a i n t a x p a y e r s
make p e n a l t y - f r e e w i t h d r a w a l s
provided the withdrawals
purchases.
from r e t i r e m e n t - t y p e
to
accounts,
a r e a p p l i e d t o w a r d o n e or more
qualified
Specifically:
• The p r o p o s a l w o u l d a l l o w w i t h d r a w a l s f r o m I R A s ,
K e o g h s , and 4 0 1 ( k ) s .
• E l i g i b i l i t y would be r e s t r i c t e d t o t h o s e e a r n i n g
t h a n $ 1 0 0 , 0 0 0 ( i f m a r r i e d and f i l i n g j o i n t l y ) ,
$ 5 0 , 0 0 0 ( i f m a r r i e d and f i l i n g s e p a r a t e l y ) , o r
$75,000 ( a l l others).
less
• According t o t h e l e g i s l a t i o n i n i t s current form,
q u a l i f i e d e x p e n d i t u r e s would i n c l u d e t h e purchase or
improvement o f r e a l p r o p e r t y , and t h e p u r c h a s e o f
durable goods.
I n h i s f l o o r s p e e c h and i n o t h e r
communications. Senator Specter has a l s o mentioned
m e d i c a l e x p e n s e s and c o l l e g e t u i t i o n .
421
2
• Each t a x p a y e r would be a l l o w e d
than $10,000.
t o w i t h d r a w n o more
• W i t h d r a w a l s w o u l d h a v e t o b e made o n o r b e f o r e
December 3 1 , 1992; a s s o c i a t e d e x p e n d i t u r e s would h a v e
t o b e made e i t h e r ( a ) w i t h i n s i x m o n t h s o f t h e
w i t h d r a w a l , o r (b) by t h e t i m e t h e t a x p a y e r f i l e s
h i s / h e r r e t u r n f o r t h e relevant: t a x y e a r ( i n most
c a s e s , no l a t e r t h a n A p r i l 15, 1 9 9 3 ) .
The more
r e s t r i c t i v e o f ( a ) o r (b) w o u l d b e t h e b i n d i n g r u l e .
• R e g u l a r t a x l i a b i l i t y on t h e w i t h d r a w n f u n d s would
s t i l l be owed; h o w e v e r , t h e l i a b i l i t y c o u l d be s p r e a d
over a period of four years f o l l o w i n g the withdrawal.
• I n h i s f l o o r s p e e c h and w r i t t e n c o m m u n i c a t i o n s ,
Senator Specter a l s o mentions t h e p o s s i b i l i t y of
a l l o w i n g t h o s e who t a k e a d v a n t a g e o f h i s p r o p o s a l t o
r e p l e n i s h t h e f u n d s i n t h e i r IRA or 4 0 1 ( k ) o v e r t h e
f i v e years following the withdrawal.
The e x i s t i n g
l e g i s l a t i o n does not contain t h i s provision.
II. Analytical Considerations
Several analytical
likely
p o i n t s are worth making about
impact of t h e p r o p o s a l on household
the
spending:
• I t i s u s e f u l t o think of q u a l i f y i n g households as
f a l l i n g i n one of thre.e c a t e g o r i e s : n o t l i q u i d i t y c o n s t r a i n e d , e x t r e m e l y l i q u i d i t y - c o n s t r a i n e d , and
somewhat l i q u i d i t y - c o n s t r a i n e d .
• Households t h a t are not l i q u i d i t y - c o n s t r a i n e d w i l l
p r o b a b l y n o t be i n t e r e s t e d i n t a p p i n g t h e i r
r e t i r e m e n t s a v i n g s , b e c a u s e d o i n g s o would remove
t h o s e s a v i n g s from t h e i r current t a x - s h e l t e r e d
status.
• Households that are
pressed for the
f u n d s w i l l b e t a p p i n g t h e i r f u n d s i n any e v e n t ,
and w o u l d c h o o s e t o p a y t h e 1 0 p e r c e n t p e n a l t y i n
t h e absence of Senator S p e c t e r ' s p r o p o s a l .
The
422
-3-
extra
spending g e n e r a t e d by t h e S e n a t o r ' s p r o p o s a l
v i a t h e s e h o u s e h o l d s would be o n l y $ 1 , 0 0 0 - - s m a l l e r
by a n o r d e r o f m a g n i t u d e t h a n t h e o v e r a l l amount
of $10,000.
• T h e r e f o r e , t h e p r o p o s a l l i k e l y would have i t s
g r e a t e s t i m p a c t on t h e s p e n d i n g o f t h e
i n t e r m e d i a t e group: t h o s e households t h a t a r e
somewhat l i q u i d i t y - c o n s t r a i n e d , b u t n o t t o o much
so.
T h e s e h o u s e h o l d s w i l l b e i n d u c e d t o make a
w i t h d r a w a l t h a t t h e y o t h e r w i s e would not have
made.
• About t w o - t h i r d s o f 4 0 1 ( k ) s h a v e b o r r o w i n g
provisions.
T h e r e f o r e , owners of t h e s e a c c o u n t s have
a c c e s s to the wealth they hold in 401(k)s even in the
absence of Senator Specter's proposal.
Evidence
s u g g e s t s t h a t many h o u s e h o l d s t a k e a d v a n t a g e o f t h e s e
loan provisions.
For e x a m p l e , o n e r e c e n t s u r v e y
found t h a t 9 percent of account-holders i n i t i a t e d a
new l o a n d u r i n g 1 9 9 0 , w h i l e 21 p e r c e n t had a l o a n
o u t s t a n d i n g a t t h e end o f 1 9 9 0 .
Roughly
90 p e r c e n t o f s u c h p l a n s a l l o w g e n e r a l - p u r p o s e l o a n s
(and t h e r e f o r e c o v e r a w i d e r range o f e x p e n d i t u r e s
t h a n would Senator S p e c t e r ' s p l a n ) .
• The t a x a m o r t i z a t i o n f e a t u r e p r o b a b l y w i l l make
r e l a t i v e l y l i t t l e difference to the proposal's
i n f l u e n c e on s p e n d i n g :
Standard t h e o r i e s o f consumer
b e h a v i o r p r e d i c t t h a t t a x p a y e r s who know t h a t a
l i a b i l i t y i s outstanding w i l l be i n c l i n e d t o s e t
a s i d e most* i f n o t a l l , of t h e t a x l i a b i l i t y upon
r e c e i p t of the withdrawal.
This prediction i s
s u p p o r t e d by a v a i l a b l e e v i d e n c e c o n c e r n i n g t h e
r e l a t i o n s h i p b e t w e e n o r d i n a r y i n c o m e t a x r e f u n d s and
..
2,3
consumer s p e n d i n g .
1.
Hewitt A s s o c i a t e s ,
January 2 3 , 1 9 9 2 .
Lincolnshire.
IL, Hews and I n f o r m a t i o n R e l e a s e .
2.
See "Income Tax Refunds and t h e Timing o f Consumer E x p e n d i t u r e . " David
W. W i l c o x , mimee. F e d e r a l Reserve Board.
( F o o t n o t e c o n t i n u e s on n e x t page)
423
-4-
III.
Empirical
Evidence
The f o l l o w i n g e s t i m a t e s f r o m t h e 1 9 8 9 S u r v e y o f
Consumer
F i n a n c e s h e d f u r t h e r l i g h t on t h e l i k e l y i m p a c t o f t h e
on h o u s e h o l d
proposal
spending:
• A c c o r d i n g t o t h e SCF, q u a l i f i e d a c c o u n t s ( i n c l u d i n g
IRAs, 4 0 1 ( k ) s , K e o g h s . t h r i f t , and s a v i n g p l a n s )
amounted t o $ 1 , 2 3 9 t r i l l i o n i n 1989.
• Of t h i s a m o u n t , $ 8 9 3 b i l l i o n w a s h e l d b y f a m i l i e s
h e a d e d by someone a g e d l e s s t h a n 5 9 y e a r s o l d .
Older
p e o p l e a l r e a d y can withdraw f u n d s from r e t i r e m e n t
accounts without penalty.
• N e x t . $ 7 3 6 b i l l i o n was h e l d by f a m i l i e s m e e t i n g b o t h
t h e income c o n s t r a i n t s s p e c i f i e d under t h e S p e c t e r
p r o p o s a l and t h e a b o v e - m e n t i o n e d a g e c u t o f f .
• O w n e r s h i p o f t h a t $736 b i l l i o n was h i g h l y
c o n c e n t r a t e d , however.
I f we c o u n t o n l y t h e
$10,000 i n retirement funds per f a m i l y , then
q u a l i f i e d p o o l of funds s h r i n k s t o o n l y $136
first
the
billion.
( F o o t n o t e c o n t i n u e d from p r e v i o u s page)
3.
Low-income t a x p a y e r s w i l l e x p e r i e n c e some b e n e f i t from b e i n g a l l o w e d t o
smooth some of t h e l i a b i l i t y i n t o l o v e r t a x b r a c k e t s . However, e v i d e n c e from
t h e Survey of Consumer Finance s u g g e s t s t h a t e l i g i b l e f a m i l i e s would have
h i g h e r - t h a n - n o r m a l i n c o m e s , and s o would n o t b e n e f i t from t h i s a s p e c t of t h e
p r o p o s a l t o any g r e a t d e g r e e .
4.
Respondents t o t h e 1989 SCF reported t o t a l h o l d i n g s i n IRAs and Keoghs
o f $598 b i l l i o n .
For comparison, t h e Employee B e n e f i t Research I n s t i t u t e p u t s
t h e t o t a l f o r IRAs and Keoghs i n 1989 a t $494 b i l l i o n .
SCF r e s p o n d e n t s
r e p o r t e d an a d d i t i o n a l $295 b i l l i o n i n 4 0 1 ( k ) s , q u i t e c l o s e t o t h e e s t i m a t e
f o r 1988 o f $277 b i l l i o n based on data from t h e Department of Labor's
Form 5 5 0 0 . F i n a l l y . SCF r e s p o n d e n t s r e p o r t e d $346 b i l l i o n i n t h r i f t or s a v i n g
p l a n s , or o t h e r d e f i n e d - c o n t r i b u t i o n p l a n s w i t h borrowing p r o v i s i o n s .
424
-5-
Median l i q u i d a s s e t s h e l d by a l l f a m i l i e s m e e t i n g t h e
p r o p o s e d a g e and i n c o m e c r i t e r i a w e r e $ 1 , 9 5 0 .
Among f a m i l i e s r e p o r t i n g o w n e r s h i p o f some r e t i r e m e n t
f u n d s , median l i q u i d a s s e t h o l d i n g s were $ 6 , 1 8 0 .
Among f a m i l i e s h o l d i n g a t l e a s t $ 5 , 0 0 0 i n r e t i r e m e n t
f u n d s , median l i q u i d a s s e t h o l d i n g s were $ 9 , 8 0 0 .
T h i s r e s u l t c o n f o r m s w i t h t h e common f i n d i n g t h a t
t h o s e who s a v e v i a IRAs and K e o g h s a l s o t e n d t o s a v e
by o t h e r means.
Families that are holding
s u b s t a n t i a l amounts o u t s i d e t h e i r r e t i r e m e n t a c c o u n t s
w i l l be l e s s i n t e r e s t e d i n t a p p i n g t h e i r r e t i r e m e n t
f u n d s i f g i v e n t h e o p p o r t u n i t y t o do s o p e n a l t y - f r e e .
T r a n s a c t i o n c o s t s c o u l d be s u f f i c i e n t l y g r e a t t o
p e r s u a d e some f a m i l i e s who o t h e r w i s e w o u l d t a k e
advantage of Senator S p e c t e r ' s proposal not t o
l i q u i d a t e t h e i r IRAs o r 4 0 1 ( k ) s .
These c o s t s would
i n c l u d e , f o r e x a m p l e , e a r l y w i t h d r a w a l p e n a l t i e s on
t i m e d e p o s i t s and b r o k e r c o m m i s s i o n s .
IV, Spending Effects
A f u n d a m e n t a l f a c t s h o u l d b e k e p t i n mind w h i l e
assessing
the likely
i n f l u e n c e o f t h e p r o p o s e d p r o g r a m on h o u s e h o l d
spending:
The p r o p o s a l w o u l d do n o t h i n g t o r a i s e t h e w e a l t h
households,
o t h e r t h a n o f t h o s e who a n t i c i p a t e d
withdrawal penalty.
Therefore,
t h e p r o p o s a l would
h o u s e h o l d s p e n d i n g m a i n l y by r e l a x i n g l i q u i d i t y
c u r r e n t l y b i n d i n g o n some h o u s e h o l d s .
SCF s u g g e s t t h a t t h i s
incurring
related wealth i s
influence
constraints
The a b o v e d a t a f r o m t h e
i m p a c t p r o b a b l y would n o t be v e r y
given that a considerable portion of the a v a i l a b l e
of other l i q u i d
of
a
great,
retirement-
owned b y f a m i l i e s h o l d i n g s u b s t a n t i a l
amounts
assets.
5.
L i q u i d a s s e t s were d e f i n e d a s t h e sum of c h e c k i n g a c c o u n t s , money market
a c c o u n t s , CDs, o t h e r bank a c c o u n t s , mutual fund h o l d i n g s , s a v i n g bonds, o t h e r
government and p r i v a t e bonds, d i r e c t s t o c k h o l d i n g s , and a c c o u n t s h e l d at
brokers.
425
- 6 -
Some w i t h d r a w a l s u n d o u b t e d l y w o u l d o c c u r i f
were t o be adopted,
b u t t h e incremental
the
proposal
e f f e c t of t h e p r o p o s a l
expenditure w i l l
be l e s s than t h e t o t a l
reasons:
some w i t h d r a w a l s w o u l d h a v e b e e n t a k e n ,
First,
t h e a b s e n c e o f t h e p r o g r a m , by f a m i l i e s
liquidity.
in effect,
Second,
amount w i t h d r a w n f o r
some w i t h d r a w a l s f r o m 4 0 1 ( k ) s w i l l
a substitution
even
extremely pressed
of o u t r i g h t w i t h d r a w a l f o r
t h a t would have t a k e n p l a c e i n t h e a b s e n c e of t h e
represent,
program.
the
e x p e n d i t u r e t h a t would be f o r t h c o m i n g
r e s p o n s e t o i m p l e m e n t a t i o n of t h e p r o p o s a l .
to guess,
on t h e b a s i s
It
seems
in
reasonable
of t h e e v i d e n c e p r e s e n t e d h e r e ,
that
i n c r e m e n t t o s p e n d i n g w o u l d amount t o l e s s t h a n o n e p e r c e n t
personal
consumption expenditure
p o s s i b l y would be s u b s t a n t i a l l y
( o r $40 b i l l i o n ) - - a n d
less.
If the
it
it
would
r a i s e t h e amount r e l e a s e d
on t h e e s t i m a t e s a b o v e f r o m $ 1 3 6
However, w h i l e t h e s p e n d i n g
h e l d b y i n d i v i d u a l s who a r e l e s s
effect
i t w o u l d l i k e l y be o n l y m o d e s t l y
balances a f f e c t e d would,
of
quite
b i l l i o n t o $206 b i l l i o n .
p r o b a b l y would be g r e a t e r ,
the
permissible
p e n a l t y - f r e e withdrawal were t o be r a i s e d t o $ 2 0 , 0 0 0 ,
because the additional
in
for
borrowing
T h e r e i s n o way o f p r e d i c t i n g w i t h any c o n f i d e n c e
amount o f a d d i t i o n a l
on
two
on a v e r a g e ,
liquidity-constrained.
so,
be
426
Florida Forecast gz.'CPB
January 13-19 199?
INTERNATIONAL TRADE
GLOBAL COMMERCE SAILS AHEAD
Increase in foreign trade
helps state economy
achieve diversification
By Jerry Jackson
OF THE SENTINEL STAFF
F
lorida exports and imports snapped
records in 1990 and were on another fast track in 1991.
/""For the first time. Florida international
(trade topped $30 billion: Exports totaled
j$15.5 billion in 1990. surpassing 1989's
[record $14.4 billion, while imports inc a s e d to $15 billion, beating 1988 s record of $14 billion. Imports in 1989 were
down slightly to $13.9 billion.
Based on activity in the first half of
1991, the state Department of Commerce
projected that trade for the year could
top $32 billion.
Improvements in the economies of
Latin America and the Caribbean, the
main trading regions for Florida, are
partly responsible for the upsurge in foreign trade. Gov. Lawton Chiles said. And
prospects for more gains are bright.
"We're just scratch,
. ing the s u r f a c e , "
If
„ | Chiles said. "Interna-
Isr
state s economy.
In November. Chiles
selected Diego Asencio. former U.5. ambassador to Colombia
. . and
to Brazil, to be executive director of a new
state commission assigned to coordinate international affairs.
The Florida International Affairs Coma 26-member board comprising government
The panel
focus the :
nating trade
tries and by
ment of state grant money.
I
The commission will share office space
Tallahassee and Coral Cables with the
Department and in West
p ^ B ^ t i with the Business Development Board of Palm Beach Count}*.
jn
Comlnerce
Chiles and Fanner said Florida will
have to work hard to compete with other
Southern states, such as Georgia, which
has lured more Japanese investment
than Florida in recent years.
budget woes.
Commerce DepartTrade Division is
stretch limited dol-
lars to help entice foreign investment
. .
- examand. trade.
For
pie. the agency is experimenting with a
plan to exchange free
office space with the
government in Taiwan,
If the experiment sueceeds. similar arrangeI ^ J S S L V o ?
tral and South Amer-
Trade e
t out that Florida
imports, such as the shiploads of J a p *
nese automobiles landing at the port of
Jacksonville, are transferred across tfie
country by truck,
Likewise, much of the stale's exports
originate outside the stale and are counted only because they depart through one
0 f Florida's ports.
There » no data on Ftoricto-produced
goods that are exported, nor i , there pre« ^ infonnMion on ^ m u c h of ^ im.
ports remain in the state.
Based on growth rates during the past
five years, the Commerce Department
projects that exports and imports should
top $39 billion by 1995.
The leading recipients pf Florida ex*.or«gn
1 ports in 1990 - the most .ecenl year for
which data is avaiiaoie
available —
- were Venezuvenezu- ^ T J f T f T l l l L ^ " ' ^ 5™!?;.!?
E x p o r t s in 1990*
I t e l a at $1.5 billion; Brazil. $1.3 billion; Cotommerce "
. _ _ $1 billion; the Dominicani Repub- J®
^
$ 1 5 billion | lombia.
Venezuela
lie, $700 million; and Costa Rica and the j Foreign-owned companies employ
Brazil
$ 1 3 billion j United Kingdom. $500 million each.
- I «bout
c 186,500 workers, or 4.1 percent of
The countries with the most ship- \ the work force, in Florida,
$1.0 billion |
Colombia
Foreign, non-bank employers are 52 9
I Dominican Republic
$0.7 bilion | menu to Florida were Japan. S3 2 billion;
Brazil. $13 billion; Germany. $900 mil- petcent European. 22.8 percent Canadi$0.5 biMon
Costa Rica
a n ; Venezuela and Colombia. $700 mil- •».
percent LaUn American. 9.2 perlion
apiece:
and
the
Dominican
Repubcent
Asian. M percent Middle Eastern
$ 0 5 billion
| United Kingdom
lie. $600 million.
0.7 percent African.
Asencio. of Palm Beach County, said
I
m
p
o
r
t
s
in
1990*
the commission will provide "a force . . .
Leading the list of products exported ^ Rorida opened Aree
S3JbWion
to make sure everybody is marching in I Japan
through U.S. Customs districts in Florida fices in 1991 - in Seoul. S w t h taw. m
the same direction."
$1.3 bilion
in 1990 were fertilizer at $1.6 billion; air- February; Toronto in March; and r r a r u t
I Brazil
craft
parts. $500 million; office and data- furl, Germany, in July,
. Chiles said that another of Asencio's I West Germany
SO.Bbrfcon
processing machine parts. $400 million;
The State also opened tourism office*
challenges will be to ensure that the
- $0.7 bilion
automobiles, $400 million; and aerospace in Sao Paulo, Brazil, in May and in Tocommission "is not run like a bureaucra- I Venezuela
equipment,
$300 million.
kyo in August.
cy."
I Colombia
$0.7 bilion
The leading imports were trucks and
Florida has had a trade o r c e in Bn»$0.6 bilion
Dominican Republic
To help keep the operation decentralcars at $3.3 billion; military equipment sets, Belgium, and a corntoMtwn w e
ized, Chiles said. Asencio will divide his
•MM now* wartoraMd>i«Mai»a«i»6H
and repair parts, $700 million; orange and tourism office in Uwd»n- mosi w
time among three offices.
SouroK U.S. Otpaffiwrt 0
juice. $400 million; aircraft, 300 million; the newer offices serve
tfouwe
«
"We want troops out in the field,"
and kerosene. $300 million.
both tourism and trade- __ . .
Chiles said.
One of the commission's first mqor
tasks, now under way. is
strategic plan for the state.
"Coordination is FlAC's primary mission." said Commerce Secretary Greg
Farmer, one of the panel's members.
Competition among cities and ports has
been partially blamed for hampering
state efforts to attract more foreign trade
and investment
52-418 (432)
1 Florida's top m a r k e t s
;; h
@FedFRASER